Lifeway Foods, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated results; monetary amounts below are in millions unless noted. Lifeway makes cultured dairy products, with drinkable kefir as its primary product.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $24.480 | $28.786 | $80.318 | $92.636 |
| Gross profit | $5.850 | $7.837 | $20.763 | $25.573 |
| Gross margin | 23.9% | 27.2% | 25.9% | 27.6% |
| Operating income (loss) | $(0.599) | $0.514 | $(0.115) | $2.678 |
| Net income (loss) | $(0.514) | $0.243 | $(0.274) | $1.403 |
| Diluted earnings (loss) per share | $(0.03) | $0.02 | $(0.02) | $0.09 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $2.346 | $4.189 |
Sales fell 15.0% in Q3 and 13.3% for the first nine months. Management attributed the decline mainly to weaker volume and mix, especially branded and ProBugs drinkable kefir, amid softer dairy and cultured-dairy consumption. Pricing gains and new product introductions partly offset declines. Nine-month drinkable kefir sales excluding ProBugs were $61.255 million, down from $71.559 million.
Gross margin declined as lower sales, product mix, higher freight and fixed costs, and coupon activity weighed on results; pricing and lower trade spending partly offset these effects. Selling expenses declined, reflecting reduced lower-efficiency media and marketing spending. Nine-month G&A expense also declined, primarily due to lower incentive compensation.
Cash, liquidity and debt
- At September 30, cash and cash equivalents were $2.726 million, current assets $22.393 million, and current liabilities $9.463 million.
- Operating cash flow was $2.346 million; capital spending was $2.581 million. Investing cash outflow was $2.991 million and financing cash outflow was $1.607 million for the nine months.
- The company refinanced its term loans in May 2018 with a revolving facility of up to $10 million, plus an incremental facility of up to $5 million subject to lender approval. At quarter-end, $5.990 million was outstanding, net of deferred financing costs, with approximately $3.950 million available under the borrowing base. The facility is secured by substantially all company assets and matures May 2021.
- Term loans were paid off; the company reported no term-loan balance at September 30. Revolver interest ranged from 4.52% to 4.86% during the period. The company reported compliance with applicable facility covenants at quarter-end.
- The company repurchased approximately 192,000 shares for $1.309 million during the nine months.
Outlook, risks and notable items
- No specific sales, earnings, or margin guidance is provided. Management expected to fund foreseeable needs through operating cash flows, the revolving facility, and cash on hand, and cited product development and manufacturing improvements as areas for investment.
- Management identified risks including continued dairy-category weakness, milk and other input-cost changes, supply disruptions, regulatory changes, litigation and investigations, and maintaining liquidity and loan covenant compliance.
- The company reached an agreement in principle with SEC staff on November 9, 2018, after an inquiry into controls and reporting for fiscal 2013 onward. The proposed settlement includes a $100,000 civil penalty and cease-and-desist provisions, without admission or denial; it remained subject to SEC approval. The company recorded an accrual.
- Two customers represented approximately 22% of nine-month sales. Related-party payments to the board chair included $750,000 for consulting and $445,000 in royalties during the nine months.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. Management estimated a reduction in its combined statutory rate to approximately 27.7% and expected the law to benefit future earnings and cash flows, while noting the elimination of the domestic manufacturing deduction partly offsets the benefit.
Key facts for investors to verify
- Reconcile the cash-flow narrative: MD&A states a nine-month cash decrease of $1.752 million, while the cash-flow statement reports $2.252 million and the reported beginning and ending cash balances also imply a $2.252 million decrease.
- Track sales volume, especially core drinkable kefir and ProBugs, and whether pricing and new products can offset category weakness.
- Monitor margins, operating results, cash generation, and use of the borrowing-base capacity.
- Review covenant performance, interest costs, and any final SEC settlement terms and approval.
- Consider the material customer concentration and the disclosed related-party consulting and royalty arrangements.