Lifeway Foods, Inc. — Q1 2012 Form 10-Q
Business and period: The company produces and distributes dairy products, led by Lifeway Kefir, and related food products. This unaudited report covers the three months ended March 31, 2012, compared with the same period in 2011; balance-sheet figures are as of March 31, 2012 unless noted.
Financial results
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Gross sales | $21.55 million | $19.05 million |
| Net sales | $19.40 million | $17.30 million |
| Gross profit / margin | $6.76 million / 34.9% | $7.58 million / 43.8% |
| Operating income / margin | $1.87 million / 9.7% | $3.27 million / 18.9% |
| Net income | $1.09 million | $1.93 million |
| Diluted EPS | $0.07 | $0.12 |
| Operating cash flow | $1.55 million | $1.14 million |
- Sales growth was offset by sharply higher production and selling costs. Cost of goods sold, excluding depreciation, rose to approximately 63% of net sales from 54%.
- Cash and cash equivalents were $1.16 million, versus $2.08 million a year earlier. Current assets were $17.42 million and current liabilities $6.76 million, implying working capital of about $10.67 million.
- Notes payable totaled $6.15 million, including $790,000 current and $5.36 million long-term. The company also reported $333,000 in checks written in excess of bank balances. It held $1.72 million in investments and $300,000 in certificates of deposit.
- Q1 investing cash outflow was $145,000 and financing cash outflow was $1.36 million; cash increased by $41,000 during the quarter.
Material changes and management commentary
- Net sales increased 12% year over year. Management attributed growth primarily to Kefir, ProBugs Organic Kefir for kids and BioKefir; Frozen Kefir, launched in April 2011, contributed approximately $700,000 in Q1 2012 sales.
- Gross profit fell about 11% despite higher sales. Management cited a 30% increase in freight expense, higher fuel costs and milk costs approximately 20% above the prior-year quarter.
- Operating expenses rose 13%, primarily from increased selling and marketing spending for the company’s product lines. Advertising expense was $756,000, down from $829,000.
- Management said it expected to fund foreseeable liquidity requirements internally and continued to explore potential acquisitions. No specific earnings or revenue guidance was provided.
Risks, contingencies and unusual matters
- Customer concentration: Two major customers accounted for approximately 31% of gross sales in Q1 2012 and 30% of accounts receivable at March 31, 2012.
- Debt and liquidity: The principal bank note includes a $5.07 million balloon payment due February 2014. A $250,000 bank line of credit was scheduled to mature May 31, 2012. The company reported compliance with its bank covenants at quarter-end.
- Internal controls: Management concluded disclosure controls were not effective at the reasonable-assurance level because of a previously identified material weakness in tracking advertising programs and sales-promotion discounts. A controller was hired in March 2012, and management described new ledger and reconciliation procedures as remediation; effectiveness had not yet been established.
- The company reported no material pending legal proceedings and said ordinary-course litigation was not expected to have a material adverse effect. Management did not consider any investment materially other-than-temporarily impaired.
Important facts for investors to verify
- Whether higher freight, fuel and milk costs persist and whether sales growth can restore gross margins.
- The status and terms of the $250,000 credit line after its stated May 31, 2012 maturity, and the company’s plan for the February 2014 balloon payment.
- Whether the control remediation resolves the material weakness and improves the accuracy of promotional allowances and related reporting.
- Customer concentration and the collectability of receivables from the two major customers.
- Confirm share-count and balance-sheet details: the filing reports 16,390,417 shares outstanding at March 31, but 16,379,417 as of May 8; the MD&A also contains apparent date/amount inconsistencies in its liability and debt discussion.