Lifeway Foods, Inc. — Q1 2014 Form 10-Q
Business context and period. This unaudited filing covers the three months ended March 31, 2014, compared with Q1 2013. Lifeway produces and distributes dairy products, principally kefir, as well as other food products. Its sales are primarily to U.S. retail food customers.
Financial performance and position
- Sales: Gross sales were $32.06 million, up 16% from $27.59 million. Net sales were $29.13 million, up approximately 19% from $24.39 million. Discounts and allowances fell to 9% of gross sales from 12%.
- Profit and margins: Gross profit was $7.07 million, down 18% from $8.59 million; gross margin was approximately 24.3%, versus 35.2%. Operating income declined to $1.03 million from $3.73 million; operating margin was approximately 3.5%, versus 15.3%. Net income was $660,178, or $0.04 per diluted share, compared with $2.37 million, or $0.14 per share.
- Cash flow: Operating cash flow was $440,262, down from $814,759. Investing activities used $1.05 million, primarily reflecting $807,894 of property and equipment purchases. Financing activities used $219,073 for debt repayments. Cash and equivalents declined by $831,900 during the quarter to $2.47 million.
- Liquidity: Current assets were $26.49 million and current liabilities were $10.57 million, for working capital of approximately $15.92 million and a current ratio of about 2.5. Cash plus investments totaled approximately $5.27 million. Refundable income taxes were $2.58 million, a substantial current asset.
- Debt and equity: Notes payable totaled $9.65 million, including $879,354 current maturities; long-term notes were $8.78 million. Stockholders’ equity was $43.61 million. The company had no line-of-credit borrowings and disclosed up to $5 million of availability.
Changes versus Q1 2013
- Management attributed sales growth primarily to increased sales and awareness of Lifeway’s kefir products, including ProBugs Organic Kefir for kids and BioKefir.
- Milk costs, the company’s largest raw-material cost, were approximately 35% higher year over year. Cost of goods sold, excluding depreciation, rose to about 74% of net sales from 63%.
- Selling expense rose approximately 24% to $3.48 million; total operating expenses increased to $6.04 million from $4.86 million.
- The company incurred approximately $450,000 in combined cost of goods sold and general and administrative expenses related to starting up the Lifeway Wisconsin facility. It acquired Golden Guernsey assets for approximately $7.4 million in July 2013; the filing says those assets had not yet been placed in service.
- Total assets increased to $65.65 million from $58.09 million, including higher property and equipment and refundable income taxes. Notes payable increased from $5.36 million at March 31, 2013 to $9.65 million.
Outlook, risks and other notable items
- Management said it expected to fund foreseeable liquidity requirements internally and continued to explore potential acquisitions. No quantified earnings or revenue guidance was provided.
- The Private Bank loans carry variable rates and are secured by substantially all company assets. They require minimum fixed-charge-ratio and tangible-net-worth thresholds. The $5 million line of credit was scheduled to mature May 31, 2014. A 1 percentage-point increase in interest rates was estimated to add approximately $99,000 in annual interest expense.
- Key disclosed risks include higher and volatile milk costs, competition and pricing pressure, reliance on two major customers, production and distribution capacity constraints, product safety and regulatory exposure, debt and covenant requirements, and the possibility of labor unionization at the Wisconsin facility. Two customers represented approximately 30% of gross sales and 34% of accounts receivable in Q1 2014.
- Management concluded that disclosure controls and internal control over financial reporting were not effective as of March 31, 2014, citing material weaknesses involving segregation of duties, financial statement preparation, period-end systems and calculations (including inventory), and entity-level controls. The company was beginning to identify an outside consultant to help develop remediation plans; management reported performing additional post-closing procedures.
- Management said ordinary-course litigation was not expected to have a material adverse effect. The filing reports no material pending legal proceedings.
Important facts for investors to verify
- Track milk-cost trends, pricing and promotional allowances, and whether sales growth translates into restored gross and operating margins.
- Verify the Wisconsin facility’s operating status, the timing and costs of placing Golden Guernsey assets in service, and the facility’s effect on production capacity and cash needs.
- Review the May 31, 2014 line-of-credit maturity and subsequent refinancing or extension, loan covenant compliance, and debt repayment requirements.
- Assess the collectability and timing of the $2.58 million refundable income-tax asset, and monitor the concentration of sales and receivables in two customers.
- Follow remediation of the disclosed material weaknesses and any subsequent changes in control effectiveness.
- Reconcile filing inconsistencies: the cash-flow statement shows a Q1 2014 cash decrease of $831,900, while MD&A also describes a $265,249 decrease in a comparison that is unclear; the MD&A cites Q1 2013 tax expense of $1,422,192, while the financial statements report $1,411,192.