Lifeway Foods, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing; results below compare full-year 2018 with full-year 2017. Financial amounts are in millions of dollars unless otherwise noted.
Business context
Lifeway is a U.S. producer and marketer of kefir and other cultured dairy and probiotic products. Drinkable kefir accounted for 76% of 2018 net sales. The company reports one operating segment and manufactures approximately 98% of revenue at its own facilities.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $103.350 | $118.893 |
| Gross profit / gross margin | $25.858 / 25.0% | $30.696 / 25.8% |
| Operating loss | $(3.110) / (3.0%) of sales | $(0.526) / (0.4%) of sales |
| Net loss | $(3.086); $(0.19) per diluted share | $(0.346); $(0.02) per diluted share |
| Cash provided by operations | $2.417 | $3.808 |
| Capital expenditures | $2.824 | $5.341 |
| Cash and cash equivalents at year-end | $2.998 | $4.978 |
At year-end, total current assets were $18.916 million and current liabilities were $7.453 million. Total assets were $56.807 million, total liabilities $14.402 million, and stockholders’ equity $42.405 million. Revolver borrowings were $5.995 million, net of deferred financing costs, with approximately $3.950 million available under the borrowing base. The facility had a $10 million revolving limit, an incremental facility of up to $5 million, and a May 2021 maturity. Its interest rate was variable; the weighted-average rate at year-end was 4.98%.
Material changes and notable items
- Sales declined 13.1%, primarily from a 16.6% unfavorable volume/mix impact, reflecting softer branded drinkable and ProBugs kefir volumes. Pricing contributed 1.8% and lower trade promotion spending 1.7% in offsets.
- Gross margin fell 0.8 percentage points. Management cited lower sales and fixed-cost absorption, increased trade promotion investment, and higher freight and fixed costs; pricing and lower variable costs partly offset these pressures.
- Operating expenses declined to $28.968 million from $31.222 million, but the company recorded a $1.244 million non-cash goodwill impairment in the fourth quarter. It also incurred $0.845 million of severance expense during 2018.
- Selling expense declined 18.8%, in part because of reduced television advertising and other marketing spend. Advertising expense was $4.518 million versus $7.402 million in 2017.
- Operating cash flow decreased to $2.417 million. Investing cash use was $2.720 million, while financing cash use was $1.677 million. Cash declined by $1.980 million during the year.
- The company refinanced prior term loans with a revolving credit facility in May 2018. At December 31, it was not in compliance with minimum EBITDA and fixed-charge-coverage covenants, but obtained a waiver. An April 2019 amendment, effective March 31, reduced the revolving limit to $9 million, retained an incremental facility of up to $5 million, and disclosed $4.720 million of borrowings at the time of modification.
Outlook, risks, and contingencies
Management said it expected innovation efforts to continue diversifying revenue sources in 2019; no quantified revenue, earnings, or cash-flow guidance was provided. New product introductions partly offset weaker core kefir volumes in 2018. Management expected liquidity needs to be met through operating cash flows, the revolving facility, and cash resources.
Key disclosed risks include continued volume and category softness, intense competition and retailer pricing pressure, customer concentration, raw milk and other input-cost volatility, dependence on suppliers and distribution channels, food-safety and product-liability exposure, and manufacturing or cybersecurity disruptions. Two customers represented approximately 21% of 2018 sales; UNFI accounted for about 12% and another customer about 9%. The Smolyansky family controlled approximately 50.4% of common stock, and Danone beneficially owned approximately 22%.
The company reported a material weakness in controls over management’s review of a third-party specialist’s goodwill impairment analysis; management concluded disclosure controls and internal control over financial reporting were ineffective at year-end. The auditor issued an adverse opinion on internal control, while issuing an unqualified opinion on the financial statements. Management said it was evaluating and planning remediation. Lifeway reported ordinary-course legal matters, with no material adverse effect considered likely, but stated that outcomes and potential losses could not be predicted with reasonable certainty. Adoption of the lease standard in 2019 was expected to increase assets by approximately $0.745 million and liabilities by approximately $0.772 million.
Most important facts for investors to verify
- Whether sales volumes stabilize and product innovation can offset weakness in core drinkable kefir.
- Progress on remediating the goodwill-review control weakness and whether subsequent filings report effective controls.
- Compliance with the amended credit-facility covenants, available borrowing capacity, and the effect of variable interest rates.
- Whether gross margin and operating cash generation recover amid promotion, freight, fixed-cost, and input-cost pressures.
- Customer concentration, especially the exposure represented by the two largest customers, and any changes in their purchasing levels.
- The assumptions supporting goodwill valuation and the potential for further impairment if operating performance or forecasts weaken.