Lifeway Foods, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with the three months ended March 31, 2018. Balance-sheet comparisons are with December 31, 2018. Unless otherwise noted, amounts are in USD thousands.
Business context
Lifeway manufactures and sells cultured dairy products, principally drinkable kefir, primarily in the United States. It reports one operating segment. Drinkable kefir other than ProBugs generated $18.9 million, or 77%, of Q1 sales.
Financial performance and liquidity
- Revenue: Net sales were $24.615 million, down $4.127 million (14.4%).
- Profitability: Gross profit was $6.303 million, down 21.6%; gross margin was 25.6% versus 28.0%. Operating loss was $401,000 versus operating income of $151,000. Net loss was $388,000, or $0.02 per share, versus net income of $70,000, or $0.00 per share.
- Expenses: Selling expense fell 21.9% to $3.139 million; G&A was approximately $3.49 million. The MD&A reports $3.491 million, while the income statement reports $3.492 million. Advertising expense was $1.088 million versus $1.389 million.
- Cash flow: Operating cash flow was $1.182 million, compared with $853,000. Investing used $121,000, including $137,000 of capital spending. Financing used $1.535 million, including $1.330 million of line-of-credit repayments and $205,000 of treasury-stock purchases. Cash declined $474,000 to $2.524 million. Operating cash flow benefited from $1.545 million of income-tax refunds, partly offset by working-capital changes.
- Liquidity and debt: Current assets were $18.793 million and current liabilities $8.802 million. The revolving facility had $4.671 million outstanding, net of deferred financing costs, and approximately $4.280 million available under the borrowing base. The facility is secured by substantially all company assets; average Q1 debt interest rate was 4.98%.
- Other balance-sheet items: Total assets were $57.068 million; stockholders’ equity was $42.470 million. Adoption of lease accounting added a $1.056 million right-of-use asset and $1.106 million of lease liabilities at March 31.
Changes versus prior period
- Management attributed lower sales to continued softness in dairy and cultured-dairy consumption, lower volumes of branded drinkable kefir and cupped kefir/Skyr, and increased trade promotions and allowances. Pricing gains introduced in Q2 2018 partly offset the decline.
- Lower sales, fixed-cost operating leverage, increased trade promotion investment, and higher freight costs contributed to lower gross margin; reduced variable costs and pricing partly offset these pressures.
- Selling costs fell mainly from reduced, less-efficient advertising and marketing, along with organizational savings and lower broker commissions. G&A also declined, mainly due to lower compensation and incentive compensation.
- Capital spending was $137,000 versus $879,000 in Q1 2018. The company repurchased approximately 82,000 shares for $205,000, compared with $1.052 million of repurchases in the prior-year quarter.
Outlook, risks, contingencies, and notable items
- Outlook: The filing provides no specific revenue or earnings guidance. Management expects foreseeable liquidity needs to be met through operating cash flows, cash, and revolving-credit availability, while noting that these expectations depend on business and financing performance.
- Credit amendment: An April 10, 2019 amendment, effective March 31, reduced the revolving-line maximum from $10 million to $9 million, with a possible incremental facility of up to $5 million. It revised interest-rate terms and financial covenants, including a minimum fixed-charge coverage ratio of 1.25 to 1.0. The company reported compliance with applicable covenants at March 31.
- Controls: 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 had begun but was not complete; management stated that additional procedures supported the fair presentation of the reported financial statements.
- Risks and contingencies: Management cited exposure to legal proceedings, food and dairy regulation, economic and interest-rate conditions, milk and other input costs, supply-chain disruptions, new-product execution, liquidity, and credit-agreement compliance. It said legal matters were not expected to have a material adverse effect, but could not predict outcomes or estimate possible losses for contingencies.
- Related parties: The board chairperson received $250,000 in consulting fees and $150,000 in product royalties during Q1, each amount unchanged from Q1 2018.
- Tax: The company recorded a $54,000 income-tax benefit; its estimated effective tax rate was 12.2%, versus 35.1% in the prior-year quarter. Management cited state tax effects, valuation allowances, and nondeductible compensation.
Key facts for investors to verify
- Whether sales-volume weakness and trade-promotion spending persist, and whether pricing and cost actions can restore gross margin.
- Borrowing-base availability and covenant headroom under the amended credit facility, particularly if operating performance remains weak.
- Progress and effectiveness of remediation for the goodwill-impairment review material weakness.
- The timing and cash-flow impact of tax refunds, working-capital movements, and planned capital spending.
- Customer concentration: the filing says two major customers accounted for approximately 22% of sales, and investors may wish to confirm the concentration detail.
- The filing’s G&A amount differs slightly between the income statement ($3.492 million) and MD&A ($3.491 million).