Lifeway Foods, Inc. (LWAY) Q2 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the Lifeway Foods Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Hunter Wells of ICR. Thank you. Please go ahead.

Good afternoon and welcome to Lifeway Foods earnings conference call to discuss the Company's results for the second quarter of 2016. On the call with me today are Julie Smolyansky, President and Chief Executive Officer; Ed Smolyansky, Chief Operating Officer; and John Waldron, Chief Financial Officer. By now, everyone should have had access to the release which went out this morning at approximately 8:00 AM Eastern Time. If you have not received the release, it is available on the Investor Relations portion of Lifeway's Web site at www.lifewaykefir.com. This call is being webcast and a replay will be available on the Company's Web site. Before we begin, we would like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed on them. Similarly, descriptions of Lifeway's objectives, strategies, plans, goals or targets contained herein are also considered forward-looking statements. Actual results could differ materially from those projected in any forward-looking statements. Lifeway assumes no obligation to update any forward-looking projections that may be made in today's release or a call posted on the Web site. And with that, I would like to turn the call over to Lifeway's CEO, Julie Smolyansky.

Thanks Hunter. Good morning to everyone who’s joined us on today’s call. I’ll begin with an overview of our business in the second quarter of 2016, and then provide an update on our strategic initiatives. Next, John, will discuss our quarterly and year-to-date financial results in more detail. Finally, Ed, John and I, will be available to take questions. Our strong start to the year continued into the second quarter. Net sales increased over 4% to approximately $31 million, reflecting continued demand for Lifeway’s household probiotic and kefir dairy products. In addition to top line growth, we continue to benefit from lower milk cost, which is coupled with improved manufacturing efficiencies, fueled one of our most profitable success second quarters in our Company’s history. We’re pleased with our momentum for the first six months of 2016, and believe we’re strongly positioned to achieve continued growth. Before I discuss our near and long-term opportunities, I first like to review some highlights that contributed to our growth and success in the second quarter. Our recent results were primarily driven by increased distribution across new and existing retailers. Some of our Q2 wins include; new shipments of our Organic Whole Milk Kefir to [MarketAxess], Harris Teeter, Wegmans, and Big Y stores. Whole milk dairy products continue to be a growing trend within the natural foods category as reported by DairyFoods.com earlier this year. More and more we are seeing consumers embrace healthful fat products as they are perceived as a more wholesome option than low fat alternatives. On February -- our February collaboration with designer Cynthia Rowley in which we launched a limited edition Hibiscus Rhubarb Pie flavor performed well, continuing to our top line growth and help drive strong PR for the Lifeway brand. Positive class of this innovative new product and designer collaboration included [pit] in the Chicago Tribune and the company, and also created excitement for the subsequent launch of our seasonal Watermelon Kefir flavor. Last quarter, we announced our strategic plan to expand our advertising and marketing initiatives around Probugs to help support continued growth. In Q2, we premiered our second national television commercial, the start aired nationally in June and July, and was targeted to viewers with children’s with Porbugs distribution areas. Additionally, it now has over 600,000 views on the Lifeway YouTube channel. We believe this commercial helps contribute to the increased sales of Probugs products and successfully added distribution at buyers and publics. In addition, Porbugs Bites are easy to eat freeze-dried melts for babies and toddlers shipped to major Lifeway customers, including Giant Carlisle, Stop and Shop, Price Chopper and Wegmans. These innovative new bites are non-refrigerated and can be found in the baby aisles grocery store. We are very excited for additional distribution of Probugs Bites to our customers as it allows to occupy space outside of the refrigerated dairy aisle and serve a younger demographic of children. In effort to drive heightened awareness of our Probugs Bites, we invested in increased promotional activity, which was further supported by our recent Porbugs commercial. Finally, turning to international opportunities, we recently began shipping our second wave of products to Mexico. This extended line up included added distribution of Lifeway Kefir with Oats and Perfect 12 stevia sweetened kefir. To support additional distribution in Mexico, I participated in a well received media to our culminating with an appearance on a major Mexican radio station. As the largest producer and marketer of kefir in the United States, we are continued to be committed to expanding distribution of Lifeway products to new and existing retailers. Since 2010, the overall kefir category has grown from 59 million to over 120 million, and since 2002, from 12 million to 120 million, with Lifeway owning over 90% of total kefir sales. We believe our growth will continue to be supported by increased awareness and overall benefits of healthy diet and benefits of probiotics on the digestive health. And we’re focused on a number of relative initiatives to do so. Last quarter, we announced since the appointment of two time Olympic gold medallist and FIFA World Cup Champion Carli Lloyd as our new brand ambassadors. She’s continued to share her experiences with Lifeway to her many followers, which include over 600,000 people across social media platforms such as Facebook, Twitter and Instagram. Additionally, our previously announced commercial, featuring Carli, is scheduled to debut later this month. Additionally, in August, Lifeway served as a vendor and sponsor at the music festival Lollapalooza in Chicago. At our Lifeway Kefir shop, we provided a line up of refreshing smoothies and frozen treats to over 300,000 attendees. This was just one of many events Lifeway has participated in this year, including the Pitchfork Music Fest, Wanderlust Yoga Festival, the Taste of Chicago, and more. We believe these demos and specials are essential for our fast growing brand awareness and ability to successfully grow distribution. We are very pleased with our improved business results and our strong start to fiscal ’16. More than ever, we remain confident in our long-term growth opportunities as we continue to execute on our strategic initiatives. We believe we’re well positioned to achieve continued growth by; number one, increasing Lifeway’s brand awareness; number two, developing new innovative products; and finally, number three, expanding distribution across sales channels and geographies. We’ll continue to execute against this plan as we grow our business and return value to our shareholders. With that, I would like to turn the call over to John to discuss our financial results in more detail. John?

Thanks Julie, and good morning to all of you who’ve joined the call. I’d like to begin today by reviewing the restatement of our financial results for the first quarter of 2016. Then, I’ll move on to discuss our second quarter and year-to-date financial results for the period ended June 30, 2016. On August 15th, we filed a restatement of our financial results for the full year period ended March 31, 2016. As more fully described in the Form 10-Q-A as we filed on Monday, the first quarter results different from the originally reported results as follows. On a restated basis, gross profit was higher than previously recorded at $0.6 million to $9.2 million. On a restated basis, net income was higher by $0.3 million to $0.95 million. With regards to earnings per share, on a restated basis, Lifeway’s basic and diluted earnings per common share increased by $0.02 to $0.06 per share. As more fully described in the 10-Q-A, these restatements arose from errors and manual calculation of the Company’s priced out physical inventory at March 31, 2016 and in the accurate accounts payable cut-out procedures that resulted in material errors in the previously issued financial statements. Additional informations relating to the restatement in our internal control and refinancing reporting is included in the Form 10-Q-A and the related Form 8-K which as I mentioned we’ll file with the Securities and Exchange Commission on August 15th. Lifeway remains committed to providing common, accurate and transparent financial reporting. I’ll now discuss our second quarter and year-to-date financial results for the period ended June 30, 2016. Second quarter net sales increased 4.4% to $31.1 million from $29.8 million in the same period last year, primarily driven by higher sales of the Company’s probiotic dairy and kefir products and fewer discounts given to customers. Gross margin increased to 32.7% from 23.5% in the same period one year ago, primarily due to lower milk prices, a fewer discounts given to customers, lower packaging costs, improved labor productivity and improved leverage of our manufacturing costs related to increased reduction in our Waukesha facility, partially offset by an increase in certain ingredient costs. Selling expenses increased approximately $5.8 million to $3.5 million in the second quarter of 2016 from $2.6 million in the year ago period. This increase reflects higher advertising costs associated with an eight-week advertising campaign centered out on Probugs product line and higher royalty expense. General and administrative expenses decreased $0.7 million to $3.5 million from $4.2 million compared to the same period last year. The decline in our G&A costs was driven by lower professional fees. The effective tax rate was 27.2% in the second quarter of 2016 compared to 54.7% in the second quarter of 2015. The relatively low rate in second quarter of 2016 reflects the favorable resolution of certain tax matters and the relatively higher tax rate in the second quarter of 2015 was driven by certain operating expenses that were not fully deductible for income tax purposes in 2015. Net income was approximately $2.1 million and earnings per diluted share was $0.13 in the second quarter of 2016 compared to net income of $0.1 million and earnings per diluted share of $0.01 in second quarter of 2015. Turning now to our year-to-date results, net sales increased by $4.3 million or approximately 7.2% to $63.7 million during the six months period ended June 30, 2016 from $59.4 million during the same six month period in 2015, driven by higher private label sales and fewer discounts given to customers. Gross margin increased to 30.5% from 25.9% last year, reflecting lower milk prices, fewer discounts given to customers and improved leverage of manufacturing costs related to the increased reduction at our Waukesha facility. Selling expenses increased approximately 8.6% to $6.4 million from $5.9 million in the first six months of 2015, driven by higher salaries and royalty expense. General and administrative expenses increased approximately 4% to $8 million, reflecting higher salaries, partially offset by lower professional fees. Our effective tax rate for the first six months of 2016 was 31.3% compared to 50.6% last year. The drivers of the difference in our effective tax rate for the year-to-date are consistent with those I mentioned regarding the standalone second quarter. On a year-to-date basis, net income was approximately $3.1 million, more than 300% increase from the $0.8 million we reported last year. Earnings per diluted share was $0.19 compared to $0.05 for the six months period ended June 30, 2015. Lastly, under our share repurchase program, we bought back approximately 69,000 shares of common stock at an aggregate cost of $738,000 during the six months ended June 30, 2016. Approximately 1.2 million shares remain available to repurchase under our authorized program as of June 30, 2016. The stock repurchase program has no expiration date and maybe suspended or discontinued at any time. That concludes my final remarks on the financials. Now, I’d like to turn the call back over to Julie for her closing remarks.

Thanks John. We are pleased with our solid progress that we’ve made thus far in 2016 and believe that we are well positioned to achieve a year of improved business performance. And looking ahead, we remain focused on our long-term strategies and are confident in our ability to deliver increased value for shareholders. That concludes our overview for the second quarter of 2016. Ed, John and I, would now like to open the call for your questions. Operator?

Thank you [Operator Instructions]. Our first question comes from the line of Eric Gottlieb with DA Davidson. Please go ahead with your question.

Good morning everyone. Congratulations on the great quarter. I am going to start with just a formal request. The amount of detail on the Q was a little bit less this quarter than what I am traditionally used to. So, formal request to get the normal informations back in. But because of that my line of questioning might be a little bit more detailed. First of all, how much was gross sales and how much was the level of discounting in the quarter?

John here let me try to expand to that. Firstly and sort of point out for the other listeners on the call in connection with the second quarter, the Company has revised this presentation and the financial statements and the MD&A to present net sales. And so the question about discounting, discount rate through first half of the year was in the low teens, just above single digit rate. In the year ago period, we’re moving towards middle teens for the same period. And so our rate of discount has gone down. Volumes on the gross sales side, which is not a part of the disclosure routine, were approximately 4.6% increase quarter-over-quarter for the second quarter.

And then I was wondering, how much of the positive results were due to [technical difficulty]? Yes, there was a noise there. Did you hear me?

Yes, we heard. I think I heard. So, I think the question here is how much of the margin expansion in the second quarter is attributable to milk pricing. And so, from a no pricing perspective, you may know that we source know from a couple of different suppliers we procure organic milk and we procure conventional milk. We buy raw milk and convert it ourselves for some of our products. And so there is varying sources there. In terms of the pricing, that’s probably a high single digit to low double digit price favourability for us year-over-year with more of that in second quarter than in the first quarter. In terms of quantification of how much of the favourability of margin rates, the broader context I think is there in the disclosure, which is that there is multiple things that are firing at the same time and are favor in addition to the milk pricing. And I can’t emphasize enough that we continue to expand what we’re doing in Waukesha. Our production throughputs in Waukesha more than doubled in the second quarter compared to the first quarter. So we’re seeing considerable favorable impact from manufacturing efficiencies. And I tried to order the presentation to show more impactful items, but milk pricing is towards the top of quantity what it was contributed. And I can’t carve out the exact percentage for you.

Well, given that obviously milk pricing is on the rise, I assume you are as well. Do you have any plans to mitigate that, maybe a price increase or cutting discounting even further? Or how you plan on combating that?

Yes, maybe I could turn it...

Well, first, can I just jump in? We have for 30 years been navigating price fluctuations with raw materials. So it's not something new for us. We’ve always had a pretty good amount of price elasticity in our product. And we continue to innovate products that are really in high demand that are unique that also offer a sense of premium that we’re not just to come out at even, there is not just a gallon of milk. The Kefir is a very technical life product that is expected to double in sales over the next five years in the probiotic category. We are also doing interesting things like launching probiotic pills, which also have a tremendous amount of elasticity to counter any fluctuations that we’re going to see in raw materials. But for 30 years, we’ve seen milk prices go up and milk prices go down, and the market just kind of moved with it. We haven’t really had to -- it hasn’t really hurt us in any way. And there are places where products can go up in price that we can raise prices and then there are some places where we would not want to raise prices due to competitive reasons, or other reasons. But we -- that’s something that we are worried about.

Okay. No, I wasn’t worried either I was just trying to get a sense of where you’re coming from.

Sure. It’s not something that’s new and it's something that we always have to deal with. And we’ll continue to. And like I said, like launching premium products, there is products with really interesting ingredients that offer a value for our customers is another area or way that we can counter the reason for price increase or look for other efficiencies, like expanding our production, increasing our production in Wisconsin. Those kinds of things allow us to bring prices down in other areas. So it's always something that we’re looking also.

And then on the mix of products, so you said that you had flat results from your flagship product. Farmer Cheese was up, Probugs was down. They kind of cancel each other out. And then you sited that private label was up and then new items were also up. Can you break that out? Like, how much incremental sales did you get from private label. And where was that private label? Like, what source or what channels, new customers or additional customers, or existing customers, that sort of thing. Just shed a little light there.

Sure. So, we started doing some private label for Kroger and for Wegmans. So those are new private labels, so existing long time, very loyal the same customers. Although, private label is not something I personally am excited to do, because I always want to, from the Lifeway brand. I also understand that that is where the direction that many retailers are going. So, if they’re going to do this anyway, Lifeway would rather be the one that is doing it and then that strengthens our relationship with the retailer. We have become more closely aligned in our values and our mission, and it certainly makes it a much easier to launch new products when you have such a loyal partner. So, we started working with some of our closest largest customers to do this private label. And that of course helps fund some of the initiatives and marketing and advertising for the rest of the business. And so, then in terms of other initiatives and what not, we don’t really -- we don’t break it down by which product is, for competitive reasons.

The cost for the Carli Lloyd campaign, has that been paid for, or is that upcoming?

That has mostly been paid for. And the actual commercial production and her fees has been paid for. We will be rolling out national TV commercials in -- just shortly after the Olympics. We’re in the blackout period right now. Once they start over then the commercials will start rolling out for the fall and help us with the real strong finish in 2016.

Got you...

We’re already seeing a great impact from retailers who are bringing in extra products to support the extra commercials and offering and caps and the lot of great distribution as a result of the commercial that they know is going to start shooting and creating more demand for products.

Great and [multiple speakers] Yes, John...

Just going to add that, yes, so the commercial been paid for but the advertising expense will be recognized in the third quarter.

Okay, and these got the other advertising rolling off for the ad that came up this quarter, that’s out, that’s done, right?

Correct, yes. So, I don’t think we’re going to see much of an uptick in that line item.

And then just one housekeeping on tax rate. Any expectations, going forward, I know, in terms of NOI?

Yes, I can speak to that. So, I think last quarter we talked about where we thought the effective tax rate will be for the Company on a full year basis for 2016. And I believe we called out something on the order of 38% to 39%. And in that in last quarter’s call, there was a clarification that I made that that could change if there was a tax rate change by the taxing authorities or through a set of resolution of tax matters that we have. And so, as I mentioned with my script, we did in fact had a little bit of that favorability in the quarter because of the resolution of the tax matter. On a prospective basis, normalized for the exclusion and the resolution of the tax matters, we’re seeing rate in the 37%-38% type of range based on the informations we have today. So, that’s our expectation.

Our next question comes from the line of Howard Halpern with Taglich Brothers. Please go ahead.

First question is regarding I guess with the capacity on Waukesha. You talked about how it increased with the expectation I guess during the second half. Is that capacity going to continue to increase? And what is the overall capacity for that facility?

I could take that. This is Ed. So, right now, we’re running about 150 million in gross shipments per year. And so we can, with Waukesha, we can ramp it up to, I think at this point, close to $500 million and that’s really our target goal and that’s where we see ourselves in the next few years. And so there is a lot of room for expansion in Wisconsin and that’s what we’re targeting.

And based on, I know you don’t necessarily like to offer guidance. But based on the advertising programs, I mean, what Julie had said out, the customers and your anticipation for the second half. You would anticipate second half revenues to net sales exceeding what you did in the first half?

We don’t offer guidance. But I mean we’re definitely positive on the direction of where we’re going and with new accounts and all the positive effects that are going to come from all the advertising that we’re doing, especially the halo effect from Olympic advertising. So, we’re definitely positive that the second half of the year is going to be better or as good if not better than the first-half.

And even if I know that milk is the number one input. But even with no prices, do you think you’re going to be able to hold that 30% gross margin in the second half?

I mean, milk prices are going to tick up a little bit, but we’re always getting other benefits from other ingredients and we’ll purchase in more of other commodities and things like that. So, I mean I think it's safe to say that the second quarter is really indicative of where we see our margins for the rest of the year.

And in that, with the gross margin, you talked about packaging. Now, you’ve been able, I guess, lower our packaging costs or in a way impact to get that gross margin improvement?

Well, we can’t go into too much detail. Putting Waukesha online has really given us the opportunity with space and a footprint to invest in more machinery and equipments to allow us to actually purchase different types of packaging options and lowering the cost of that as well.

Thank you. This concludes our question-and-answer session. I would like to turn the floor back over to management for closing remarks.

Thanks for your participation today. We really appreciate the hard work and dedication of all of our employees and the support of all of our loyal customers and shareholders. We look forward to sharing our 2016 third quarter results with you in the next coming months. And that would be the conclusion of our call, and I just want to wish everyone a happy end of summer. Thank you.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.