Lifeway Foods, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2018. Financial amounts are in thousands of dollars, except per-share data. Lifeway sells cultured dairy products, primarily in the United States; drinkable kefir is its largest product category.
Financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $27,096 | $31,733 | $55,838 | $63,850 |
| Gross profit | $6,876 | $9,279 | $14,913 | $17,736 |
| Gross margin | 25.4% | 29.2% | 26.7% | 27.8% |
| Operating income | $333 | $1,898 | $484 | $2,164 |
| Net income | $170 | $1,036 | $240 | $1,160 |
| Diluted EPS | $0.01 | $0.06 | $0.02 | $0.07 |
- Revenue and profitability: Sales fell 14.6% in Q2 and 12.5% in the first half. First-half operating margin was 0.9%, versus 3.4% a year earlier. Operating expenses declined, but not enough to offset lower gross profit.
- Cash flow: First-half operating cash flow was $2,109, compared with $3,323 in 2017. Investing used $1,989, including $2,024 of capital expenditures. Financing used $1,466; cash decreased by $1,346 to $3,632.
- Liquidity and debt: At June 30, cash was $3,632, current assets $23,815 and current liabilities $10,741. The May refinancing replaced term loans with a revolving facility. The balance was $5,984 net of deferred financing costs, with approximately $3,950 available under the borrowing base. The facility matures May 7, 2021; no term loans remained outstanding.
- Other balance-sheet items: Total assets were $63,924 and stockholders’ equity $45,805. The company repurchased approximately 150,000 shares for $1,168 in the first half.
Changes versus the prior comparable period
- Management attributed lower sales principally to volume and product mix: down 16.1% in Q2 and 14.8% for the first half. Branded and ProBugs drinkable kefir were soft; new-item introductions partially offset declines. Management said the weakness was consistent with broader dairy and cultured-dairy category declines.
- Q2 pricing contributed 2.2% and first-half pricing 0.6%, including a Q2 2018 price increase intended to recover higher input costs. First-half lower trade spending partly offset increased coupon redemptions.
- Gross margin declined, reflecting coupon activity, softer category sales and mix, and lower volume against fixed costs. Lower trade and freight expenses provided partial offsets.
- Lower incentive compensation reduced general and administrative expense by 21.4% in Q2 and 11.8% for the first half. First-half selling expense fell 3.1%, while selling expense as a share of sales rose to 13.3% from 12.0%.
- Two customers accounted for approximately 22% of first-half sales and 23% of Q2 sales in 2018, indicating customer concentration.
Outlook, risks and notable matters
- The filing provides no specific sales or earnings guidance. Management expects to meet foreseeable liquidity needs through operating cash flow, cash and the revolving facility, and said the 2018 tax-law changes are expected to benefit future earnings, EPS and cash flow. The estimated combined statutory federal, state, local and foreign rate was reduced from approximately 39.5% to 27.7%; actual interim effective tax rates were 34.8% for the first half and 34.6% for Q2.
- The credit agreement includes minimum EBITDA requirements during 2018, a fixed-charge coverage ratio of at least 1.25:1, and a senior-debt-to-EBITDA ceiling of 3.00:1 beginning December 31, 2018 and thereafter. The company reported compliance with applicable covenants at June 30, 2018.
- Risks cited include lower product demand, milk and other input-cost changes, supply disruptions, new-product execution, competition, regulatory changes, liquidity and covenant compliance, and legal or investigative proceedings.
- Lifeway reported an ongoing confidential, informal SEC Division of Enforcement inquiry, begun in 2016, concerning internal controls and disclosure controls for fiscal 2013 through the inquiry date. The company said it was cooperating; the SEC had stated the inquiry was not an indication that a violation occurred. Management concluded disclosure controls were effective as of June 30, 2018 and reported no material second-quarter changes to internal control over financial reporting.
- The company reported ordinary-course litigation and said current legal accruals were not material; it could not estimate a possible loss or range for contingencies. The Chairperson received $500 in consulting fees and $300 in product royalties in the first half, amounts unchanged from 2017.
Key facts for investors to verify
- Whether the sales and volume declines continued, and whether the price increase and new products offset demand softness and promotional costs.
- Gross-margin trends, including the effects of coupons, product mix, fixed costs and milk or other input prices.
- Operating cash generation, capital spending, borrowing-base availability and continued compliance with the facility’s financial covenants.
- Developments in the SEC inquiry and litigation, and any implications for controls, disclosures or financial exposure.
- Customer concentration and related-party consulting and royalty arrangements.