Lifeway Foods, Inc. — Q2 2016 Form 10-Q
Business context and reporting period
Unaudited consolidated results for the quarter and six months ended June 30, 2016, compared with the same 2015 periods. Lifeway manufactures probiotic cultured dairy products, primarily drinkable kefir, and reports one operating segment. Amounts below are in millions of dollars unless noted.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $31.131 | $29.821 | $63.701 | $59.443 |
| Gross profit | $10.192 | $7.016 | $19.411 | $15.399 |
| Gross margin | 32.7% | 23.5% | 30.5% | 25.9% |
| Operating income | $3.049 | $0.049 | $4.663 | $1.459 |
| Net income | $2.107 | $0.098 | $3.062 | $0.753 |
| Diluted EPS | $0.13 | $0.01 | $0.19 | $0.05 |
- Six-month operating cash flow was $1.861 million, down from $4.703 million. Investing activities used $0.285 million and financing activities used $1.158 million; cash increased $0.418 million to $6.064 million.
- At June 30, cash was $6.064 million, investments were $1.763 million, and current assets and liabilities were $28.953 million and $10.451 million, respectively. Inventory was $9.312 million, up from $7.664 million at year-end.
- Notes payable totaled $7.539 million, including $0.840 million current maturities. Debt is variable-rate, secured by substantially all company assets; Lifeway said it was in compliance with its financial covenants.
- Capital spending was $1.382 million for the six months. The company repurchased 69,000 shares for $0.738 million; approximately $1.214 million remained authorized under its repurchase program at June 30.
Changes and management commentary
- Sales increased 4.4% in Q2 and 7.2% year to date. Management attributed growth to private-label sales, new items, fewer customer discounts, and, year to date, higher sales of the flagship 32-ounce product. ProBugs sales declined year to date.
- Gross margin improved substantially. Management cited lower milk and packaging costs, improved labor productivity, higher production volumes and manufacturing-cost leverage, partly offset by higher ingredient costs.
- Q2 selling costs rose 32.3%, reflecting an eight-week ProBugs advertising campaign and higher royalties. Six-month selling costs rose 8.6%, including higher salaries and royalties. Q2 G&A declined 16.0% as prior-year legal and professional fees subsided; six-month G&A rose 4.0%, mainly from salaries and incentive compensation.
- Operating cash flow declined as inventory increased with Waukesha production expansion, receivables rose with sales, and payment timing to suppliers and service providers was less favorable.
Outlook, risks and unusual items
- The filing provides no numerical revenue or earnings guidance. Management said expected liquidity needs would be met through operating cash flow, borrowings, and cash; it continued to explore potential acquisitions and anticipated ongoing productive-equipment and maintenance investment.
- The company’s $5 million revolving credit facility expired in July 2016. The filing does not describe replacement terms or availability after expiration.
- Disclosure controls and procedures remained ineffective at June 30 because of previously identified material weaknesses in internal control over financial reporting. Remediation was ongoing; management reported additional control measures and finance staffing changes.
- A favorable settlement of uncertain tax positions produced a $0.273 million tax benefit in the first half and reduced the effective tax rate. Six-month effective tax rates were 31.3% in 2016 and 50.6% in 2015.
- Related-party payments included $0.539 million in consulting fees to the board chairman for the first half and $0.300 million in royalties under a 2016 agreement. The royalty agreement caps payments at $50,000 per fiscal month.
- Two customers accounted for approximately 27% of first-half net sales. Management said ordinary-course litigation was not expected to have a material adverse effect; no material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- Whether internal-control material weaknesses have been remediated and disclosure controls become effective.
- Credit availability and terms following expiration of the revolving facility, and compliance with variable-rate debt covenants.
- Whether inventory growth and lower operating cash flow reverse as expanded production and sales develop.
- The sustainability of margin gains given input-cost changes, promotional activity, advertising, and customer concentration.
- The terms, governance, and financial effects of chairman consulting and royalty arrangements, as well as executive incentive awards.