Lifeway Foods, Inc. — Q3 2011 Form 10-Q
Business and period: Lifeway produces kefir and other dairy products, including farmer’s cheese, children’s products, frozen kefir and vegetable-based seasoning. This unaudited report covers the quarter and nine months ended September 30, 2011; comparisons are with the same 2010 periods unless noted.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Gross sales | $19.42M | $15.91M | $58.38M | $47.42M |
| Net sales | $17.70M | $14.59M | $53.20M | $43.77M |
| Gross profit | $6.24M | $5.26M | $18.79M | $17.22M |
| Operating income | $1.57M | $1.91M | $5.53M | $6.81M |
| Net income | $1.03M | $0.90M | $3.22M | $3.86M |
| Diluted/basic EPS | $0.06 | $0.05 | $0.20 | $0.23 |
- Q3 net sales increased 21%; gross margin was approximately 35.2% versus 36.1%, operating margin 8.9% versus 13.1%, and net margin 5.8% versus 6.2%.
- Nine-month net sales increased 22%; gross margin was approximately 35.3% versus 39.3%, operating margin 10.4% versus 15.6%, and net margin 6.1% versus 8.8%.
- Operating cash flow for the first nine months was $2.59M, down from $3.97M. Investing used $2.11M and financing used $2.85M. Cash fell $2.37M from year-end 2010 to $0.86M.
- At September 30, current assets were $18.68M and current liabilities $8.53M. The company also held $1.81M in investments and $0.30M in certificates of deposit.
- Total notes payable were $7.81M, including $1.92M current and $5.88M long-term. The company reported compliance with its bank covenants. Total equity was $35.81M.
Changes, outlook and notable items
- Management attributed sales growth to stronger demand and awareness for Kefir, ProBugs Organic Kefir for kids and BioKefir. Frozen Kefir, launched in April 2011, contributed approximately $0.30M in Q3 and $0.55M for the nine-month period.
- Higher milk, transportation and petroleum-based supply costs pressured margins. Conventional milk was 35%–45% more expensive year over year in Q3 and 20%–25% more expensive for the nine-month period.
- Selling expenses rose 49% in Q3 and 39% year to date, reflecting increased marketing and advertising. Year-to-date selling expense included approximately $0.70M for a 25th-anniversary cross-country tour, which management characterized as non-recurring.
- Despite lower operating income, Q3 net income increased as the effective tax rate fell to 30% from 53%; management attributed the rate change primarily to revised estimates. Nine-month net income declined despite a lower effective tax rate of 40% versus 43%.
- Management said it expected to fund foreseeable liquidity needs internally and continued to explore acquisitions. No numerical earnings or revenue guidance was provided.
- Disclosure controls were deemed ineffective at the reasonable-assurance level because of previously identified material weaknesses. Remediation included accounting software and additional controls; management performed additional post-closing procedures and said the financial statements fairly present the periods shown.
- The filing reported no legal proceedings and no applicable risk-factor update. Available-for-sale investments had $148,517 of unrealized losses at quarter-end; management did not consider material investments other-than-temporarily impaired. A $2.8M Morgan Stanley credit line was due on demand and secured by investments and cash/CDs.
Investor verification points
- Whether sales growth can continue and new products, including Frozen Kefir, can scale profitably.
- How milk and other input-cost inflation, pricing, and promotional spending affect gross and operating margins.
- Whether the company generates sufficient operating cash as receivables and inventory grow; verify the timing and availability of liquid investments and deposits.
- Debt repayment and refinancing needs, particularly the demand credit line and the $5.07M balloon payment due in February 2014.
- Progress in remediating the disclosed material weaknesses and whether disclosure controls become effective.
- The reported non-recurring anniversary-tour expense and the sustainability of the lower tax rate reflected in Q3 earnings.