Lifeway Foods, Inc. — Q2 2011 Form 10-Q
Business and period: The company produces and distributes dairy products, principally kefir, along with other food and beverage products. This unaudited filing covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Gross sales | $19.91 million | $15.55 million | $38.96 million | $31.51 million |
| Net sales | $18.20 million | $14.29 million | $35.50 million | $29.17 million |
| Gross profit | $5.27 million | $5.55 million | $12.55 million | $11.96 million |
| Operating income | $0.70 million | $2.15 million | $3.97 million | $4.90 million |
| Net income | $0.27 million | $1.18 million | $2.19 million | $2.95 million |
| Diluted and basic EPS | $0.02 | $0.07 | $0.13 | $0.18 |
- Margins: Q2 gross margin fell to about 29% from 39%, and operating margin to about 3.8% from 15.1%. First-half gross margin was about 35% versus 41%; operating margin was about 11.2% versus 16.8%.
- Cash flow: First-half operating cash flow was $0.85 million, down from $2.27 million. Investing used $0.85 million and financing used $1.83 million. Cash and equivalents declined $1.83 million from year-end to $1.40 million at June 30.
- Liquidity: Current assets were $17.97 million and current liabilities $8.71 million, implying working capital of approximately $9.27 million. Investments were $1.17 million and certificates of deposit $0.30 million.
- Debt: Notes payable totaled $7.85 million, including $1.89 million current maturities and $5.96 million long-term. The principal Private Bank note carries a variable rate, then 2.761%, and has a $5.07 million balloon payment due February 2014. The Morgan Stanley line, with $1.37 million outstanding, is due on demand and secured by investments, cash, and CDs. The company reported compliance with its bank covenants at quarter-end.
- Total assets were $52.89 million and stockholders’ equity was $34.90 million at June 30, 2011.
Changes and management commentary
- Q2 net sales rose 27% year over year; first-half net sales rose 22%. Management attributed growth mainly to Lifeway Kefir, ProBugs Organic Kefir for kids, and BioKefir. Frozen Kefir, launched in April, contributed approximately $250,000 in Q2 revenue.
- Despite sales growth, Q2 operating income fell about 67% and net income about 78%. Management cited higher conventional milk costs—about 35%–45% above Q2 2010—and higher transportation and petroleum-based production-supply costs. First-half milk costs were about 20%–25% higher year over year.
- Q2 selling expense increased approximately $1.05 million, including about $700,000 for a 25th-anniversary cross-country mobile tour, which management characterized as non-recurring. The company also repurchased 105,848 shares for $971,798 during the first half.
- The effective income tax rate was 59% in Q2 and 43% for the first half, versus 47% and 40%, respectively, in 2010. A Minnesota tax audit covering 2006–2009 resulted in approximately $89,000 of additional taxes in 2011.
- Management said it expects to fund foreseeable liquidity needs internally and continues to explore acquisitions. No quantified earnings or revenue guidance was provided.
Risks, contingencies, and other notable disclosures
- Management concluded disclosure controls and procedures were not effective at the reasonable-assurance level as of June 30, due to material weaknesses previously described in the 2010 Form 10-K. Additional analysis and post-closing procedures were performed; the filing reports no material change in internal control during the quarter.
- Unrealized investment losses totaled $45,762 at June 30. Management did not consider any material investments other-than-temporarily impaired.
- The filing reports no legal proceedings, no defaults on senior securities, and “Not applicable” for risk factors and market-risk disclosures.
- The 2010 First Juice asset acquisition expanded the company’s children’s product offering; it was not a current-quarter acquisition.
Investor verification points
- Verify whether cost inflation, particularly milk and transportation, continues to pressure gross margin and whether pricing or other actions offset it.
- Assess the sustainability of sales growth, including promotional discounts and allowances, and the contribution and economics of Frozen Kefir and other newer products.
- Review the status and remediation of the disclosed material weaknesses in disclosure controls and procedures.
- Confirm liquidity and debt-service capacity, including the demand feature on the Morgan Stanley line, covenant compliance, and the 2014 balloon maturity.
- Check subsequent tax developments related to the Minnesota audit and whether the one-time anniversary-tour expense is fully non-recurring.