Lifeway Foods, Inc. — Q1 2015 Form 10-Q
Business and period: The company manufactures and sells probiotic cultured dairy products, principally kefir, along with farmer cheese. This unaudited report covers the three months ended March 31, 2015, with comparison to Q1 2014. The 2014 interim financial statements were revised for prior-period errors.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $29.62 million | $29.13 million | +1.7% |
| Gross profit / margin | $8.38 million / 28.3% | $6.67 million / 22.9% | Margin +5.4 percentage points |
| Operating income / margin | $1.41 million / 4.8% | $0.63 million / 2.2% | Income more than doubled |
| Net income / margin | $653,718 / 2.2% | $297,178 / 1.0% | +120% |
| Basic and diluted EPS | $0.04 | $0.02 | +$0.02 |
| Operating cash flow | $2.14 million | $440,262 | +$1.70 million |
| Capital expenditures | $1.04 million | $807,894 | +$231,711 |
Net sales growth reflected cream sales, which began in April 2014, partly offset by lower drinkable kefir volumes. Gross sales rose 3.2%, but discounts and promotional allowances increased 18.8% to $3.48 million, reaching 10.5% of gross sales versus 9.1%. Lower raw-material costs, primarily milk, improved cost of goods sold as a share of sales to 71.7% from 77.1%. Selling costs rose 19.6%, mainly because advertising more than doubled; the company ran its first national television commercial. General and administrative expense rose 10.6%, including higher facilities costs at the Wisconsin site and professional fees.
Financial position and liquidity
- At March 31, 2015, cash and cash equivalents were $3.82 million; current assets were $24.28 million and current liabilities $8.57 million, for working capital of approximately $15.71 million.
- Total assets were $63.84 million and stockholders’ equity $45.42 million. Notes payable totaled $8.73 million, including $840,000 current maturities, down from $9.00 million at year-end 2014. The company reported covenant compliance.
- A $5 million revolving credit facility was undrawn at quarter-end. It was later extended to July 31, 2016. Term loans have variable interest rates; management estimated a 1 percentage-point rate increase would add about $90,000 to annual interest expense.
- Operating cash flow benefited from lower income-tax payments and working-capital movements. Investing cash use was $1.30 million, principally reflecting Wisconsin-facility capital spending; financing cash use was $271,245 in note repayments. Cash increased $564,679 during the quarter.
Material changes, outlook, and risks
- Management said it expected to fund foreseeable liquidity needs internally and continued to explore acquisition opportunities. The filing provides no quantified revenue or earnings guidance.
- The company recorded approximately $180,000 of other-than-temporary impairment losses on three structured-note investments. Investment fair value was $3.04 million at quarter-end.
- Two customers represented approximately 26% of gross sales, versus 30% in Q1 2014. This remains a customer-concentration exposure.
- The company disclosed prior-period accounting errors, primarily involving income taxes and depreciation. It revised Q1 2014 pretax income downward by approximately $400,000 and net income by approximately $363,000; it said there was no effect on 2014 quarterly cash flows and did not consider the adjustments material to the previously reported interim periods.
- The report was filed late. Nasdaq had notified the company of noncompliance with periodic filing requirements because the 2014 Form 10-K and Q1 and Q2 2015 Forms 10-Q were overdue. The company said it was working to regain compliance; the bank had granted filing-delivery waivers. The filing states disclosure controls and procedures were ineffective as of quarter-end due to previously identified material weaknesses, with remediation underway.
- Management said ordinary-course litigation was not expected to have a material adverse effect, and reported no material changes to the risk factors in the 2014 Form 10-K. Subsequent to quarter-end, the board authorized a stock repurchase program of up to $3.5 million and 250,000 shares; execution and timing were discretionary.
Important facts for investors to verify
- Whether the company filed subsequent overdue reports and regained Nasdaq listing compliance, and the status of the disclosed control weaknesses.
- Whether sales growth and improved gross margin persisted, particularly given lower kefir volumes, higher promotional allowances, and the dependence on lower milk costs.
- Whether the Wisconsin facility’s operating costs and capital spending delivered expected benefits, and whether customer concentration changed.
- Subsequent performance and valuation of the investment portfolio, including the impaired structured notes, and the effect of variable interest rates on debt service.
- Whether the authorized repurchase was implemented and its effect on liquidity and share count.