Lifeway Foods, Inc. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; includes fourth-quarter results. The company manufactures and distributes probiotic cultured dairy and related products, principally kefir. The financial statements were audited, with an unqualified opinion; the auditor was not engaged to audit internal control over financial reporting.
Financial performance
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Gross sales | $77.1 million | $63.5 million |
| Net sales | $70.0 million | $58.5 million |
| Gross profit | $22.6 million | $20.2 million |
| Operating income | $5.1 million | $6.3 million |
| Net income | $2.9 million | $3.6 million |
| Diluted EPS | $0.17 | $0.22 |
| Cash from operations | $4.0 million | $5.6 million |
- FY net sales rose approximately 20%, while operating income fell approximately 19% and net income fell approximately 21%. Management attributed sales growth mainly to Lifeway Kefir, ProBugs Organic Kefir and BioKefir; Frozen Kefir, launched in April 2011, contributed about $0.7 million in the year.
- Cost of goods sold excluding depreciation was approximately 66% of net sales, versus 63% in 2010; management cited conventional and organic milk costs approximately 20–25% higher. Operating expenses were about 25% of net sales versus 24%.
- Promotional discounts and allowances increased to $7.15 million, or 9.2% of gross sales, from $5.04 million, or 7.9%. The 2011 amount included a $0.5 million fourth-quarter adjustment for known customer discounts.
- Advertising expense was $3.16 million versus $2.39 million. Selling expenses included approximately $0.7 million for a 25th-anniversary tour, described by management as non-recurring.
Fourth quarter
- Gross sales increased approximately 16% to $18.74 million; net sales increased approximately 14% to $16.77 million.
- Operating loss improved to $457,050 from $536,393. Net loss was $365,933, or $0.02 per diluted share, compared with a $235,563 loss, or $0.01 per share, in Q4 2010.
- Cost of goods sold excluding depreciation declined to approximately 74% of net sales from 77%, partly due to lower transportation and petroleum-based supply costs; milk costs were approximately 20% higher year over year. Operating expenses rose to approximately 25% of net sales from 24%.
Cash, liquidity and debt
- Cash and cash equivalents were $1.12 million at year-end, down from $3.23 million. Operating cash flow was $4.04 million; investing activities used $2.11 million and financing activities used $4.04 million. The decline in operating cash flow was attributed mainly to a $1.49 million increase in accounts receivable.
- Current assets were $16.70 million and current liabilities $7.07 million at year-end. Total assets were $51.47 million; stockholders’ equity was $35.36 million.
- Total notes payable were $7.08 million, including $1.54 million current maturities; the long-term portion was $5.54 million. The principal bank term note bears variable interest, then 2.7963%, and has a $5.07 million balloon payment due February 2014. A $1.0 million bank line of credit bore variable interest, then 3.25%, and matured May 31, 2012. The company reported compliance with its debt covenants at December 31, 2011.
- Management expected foreseeable liquidity needs to be funded internally and said it continued to explore acquisition opportunities. No quantified earnings or revenue guidance was provided.
Risks, contingencies and notable disclosures
- Two customers represented approximately 31% of FY 2011 gross sales and 27% of year-end accounts receivable, creating customer concentration exposure.
- Milk is the company’s largest raw material; commodity price changes, competition, customer demand, regulation, product acceptance and new-product execution were identified as risks.
- Management concluded disclosure controls and internal controls over financial reporting were not effective at year-end, citing a material weakness in recording accruals for customer promotional discounts. The company reported remediation steps, including additional review and hiring a controller in March 2012; effectiveness of remediation was not yet established in the filing.
- No material pending legal proceedings were reported. The company had lease commitments for Starfruit stores; future minimum base rent totaled $635,865.
- Danone held approximately 21.1% of the company’s shares. The parties were discussing possible extensions to certain stockholder-agreement provisions; no further extensions had been agreed at the filing date.
- The company repurchased 127,348 shares in 2011 for approximately $1.18 million. It reported approval of a new program for up to 200,000 shares in February 2012. No cash dividends were anticipated in the foreseeable future.
Most important facts for investors to verify
- Whether promotional allowance accruals and related internal-control weaknesses were fully remediated after the year-end material weakness.
- Customer-level sales and receivables exposure, and whether the two major customers’ concentration has changed.
- Cash conversion and working-capital trends, particularly accounts receivable and inventory growth.
- Milk-cost trends, promotional spending, and whether sales growth can translate into restored operating margins.
- Repayment or refinancing plans for the 2014 balloon payment and the status of the bank line of credit after its stated May 2012 maturity.
- The status of Danone agreement provisions and the company’s plans for acquisitions, new products and capital allocation.