Lifeway Foods, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Financial statement amounts are in thousands of dollars unless otherwise noted. Lifeway sells cultured dairy products, primarily drinkable kefir, largely to U.S. customers.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $22.729 million | $24.480 million | $70.497 million | $80.318 million |
| Gross profit | $5.173 million | $5.850 million | $17.039 million | $20.763 million |
| Gross margin | 22.8% | 23.9% | 24.2% | 25.9% |
| Operating loss | $(0.255) million | $(0.599) million | $(0.722) million | $(0.115) million |
| Net loss | $(0.072) million | $(0.514) million | $(0.601) million | $(0.274) million |
| Basic and diluted loss per share | $(0.00) | $(0.03) | $(0.04) | $(0.02) |
Q3 sales declined 7.2% year over year; nine-month sales declined 12.2%. Management attributed the weakness to lower consumption in dairy and cultured dairy categories, particularly reduced volumes of branded drinkable kefir, cupped kefir and Skyr. New product introductions partly offset the declines. Drinkable kefir other than ProBugs generated 77% of nine-month sales.
Q3 gross margin fell 1.1 percentage points, mainly from weaker sales and fixed-cost operating leverage, partly offset by lower variable costs. Nine-month margin fell 1.7 points, also reflecting higher freight costs. Selling and administrative expense reductions helped narrow the Q3 operating loss, but nine-month operating loss widened as lower gross profit outweighed expense savings. Selling expense fell 19.2% and G&A fell 7.6% for the nine months, with savings from reduced advertising, organizational changes and lower incentive compensation; increased legal expense partly offset G&A savings.
Cash flow, liquidity and debt
- Operating cash flow: $4.953 million for the first nine months, compared with $2.346 million in 2018. Management attributed the increase primarily to working-capital changes, including higher accounts payable and refunds of income taxes.
- Investing cash flow: Used $0.112 million, versus $2.991 million used in 2018. Capital spending was $0.610 million, down from $2.581 million; the company also received $0.513 million from property and equipment sales, including net proceeds of $0.474 million from the Q3 Skokie facility sale.
- Financing cash flow: Used $2.327 million, including $1.789 million of line-of-credit repayments and $0.538 million for treasury stock purchases.
- Cash: Increased $2.514 million from year-end 2018 to $5.512 million at September 30, 2019. Current assets were $21.146 million and current liabilities were $10.433 million.
- Debt and availability: The revolving credit facility balance was $4.224 million, net of unamortized financing costs, with approximately $4.739 million available under the borrowing base. The facility matures May 7, 2021; the quarterly average interest rate was 4.86%. The company reported covenant compliance at September 30, 2019.
Outlook, risks and notable items
- No specific earnings or revenue guidance was provided. Management expects to fund foreseeable needs with operating cash flows, the revolving facility and cash on hand, while noting liquidity depends on business and financing performance.
- Key risks identified include dairy and food-industry regulation, milk and other input-price or supply disruptions, competition and product-launch execution, legal proceedings, and maintaining liquidity and loan-covenant compliance.
- Disclosure controls and procedures were deemed ineffective at quarter-end because of a previously reported material weakness in management’s review of a third-party goodwill impairment analysis. Remediation was underway; management stated additional procedures were performed to support the financial statements.
- The company reported ordinary-course litigation, with no material accruals and no expected material adverse effect according to management, but said it could not estimate a possible loss or range for contingencies.
- Two major customers accounted for approximately 22% of nine-month sales. Related-party payments to the board chair included $0.750 million for consulting and $0.441 million in royalties for the nine months.
- On October 22, 2019, Lifeway sold approximately 45.6% of a cost-method investment, recognizing a $1.413 million gain to be recorded in Q4. It made a mandatory $1.484 million line-of-credit prepayment from the sale proceeds.
- Adoption of lease accounting on January 1, 2019 added approximately $0.944 million of right-of-use assets and $0.997 million of lease liabilities, and reduced opening retained earnings by $0.053 million; management said the adoption did not materially affect operating results or cash flows.
Important facts to verify
- The MD&A describes nine-month 2018 results as “net income of $(274),” but the statements report a net loss of $(274) thousand. Verify the intended wording; the 2019 nine-month loss was $(601) thousand.
- Track whether sales-volume weakness and lower gross margins persist, and whether expense reductions can offset the effect on operating results.
- Monitor operating cash flow quality, given the role of working-capital movements and tax refunds, as well as borrowing-base availability and covenant compliance.
- Follow remediation of the goodwill impairment review control weakness and any developments in legal contingencies or customer concentration.
- Confirm the Q4 accounting for the investment sale gain and the related mandatory debt prepayment.