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Lifeway Foods (NASDAQ:LWAY)

Q1 2013 Earnings Call

May 15, 2013 4:30 pm ET

Executives

Katie M. Turner - Managing Director of Healthy Living

Julie Smolyansky - Chief Executive Officer, President and Director

Edward P. Smolyansky - Chief Financial Officer, Chief Operating Officer, Chief Accounting Officer, Treasurer and Secretary

Analysts

Howard Halpern - Taglich Brothers, Inc., Research Division

James Fronda - Sidoti & Company, LLC

Peter Castellanos

Ivan Zwick

Operator

Greetings, and welcome to Lifeway Foods, Inc. First Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Katie Turner of ICR. Thank you. Ms. Turner, you may begin.

Katie M. Turner

Thanks. Good afternoon, and welcome to Lifeway Foods First Quarter 2013 Earnings Conference Call. On the call with me today are Julie Smolyansky, Chief Executive Officer; and Ed Smolyansky, Chief Financial Officer.

By now everyone should have access to the first quarter earnings release for the period ending March 31, 2013, which went out this afternoon at approximately 4:05 p.m. Eastern Time. If you've not received the release, it's available on the Investor Relations portion of Lifeway's website at www.lifeway.net. This call is being webcast, and a replay will be available on the company's website.

Before we begin, we'd 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 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 press release or on the call that we're hosting today.

And with that, I'd like to turn the call over to Lifeway CEO, Julie Smolyansky.

Julie Smolyansky

Thank you, Katie, and good afternoon, everybody. Today, I would like to begin with a brief overview of our exciting first quarter results and an update on our business. We are extremely pleased with our first quarter 2013 results and have started the year off with record results. Sales remained strong and combined with the lower cost of milk and careful management of our expenses, we had a 26% increase in net sales to over $24 million and saw a 100% increase in earnings to $0.14 for the first quarter of 2013.

Class 2 milk prices have remained relatively flat into the second quarter, and we believe this will continue to drive improvements in gross profit. As we continue to grow, we are focused on improving our balance sheet and cash flow long term. In the first quarter, we had a net increase in cash and cash equivalents of $1.6 million during the 3-month period ended March 31, 2013. The company had cash and cash equivalents of $2.7 million compared to the cash and cash equivalents of $1.6 million -- $1.2 million in the same period last year.

We remain focused on efficiencies to help us deliver solid bottom line results. The Lifeway brand continues to grow within the expanding health and wellness product category. With strong sales momentum and a strong balance sheet, we will continue to expand our company and deliver record sales and record earnings growth.

As we work to carefully manage out internal costs, we continue to see increased consumer demand for Lifeway Kefir. We believe that there is a massive opportunity to expand sales and distribution with our product within the natural and organic industry.

In the first quarter, we continued to increase distribution with new and existing retailers. Just last week, we made the exciting announcement that Lifeway has expanded into the U.K. with new distribution agreements at Harvey Nichols, a leading retailer in London to some of the most exclusive brands. Four flavors of Lifeway Frozen Kefir were debuted in 500 milliliter packaging, including vanilla, raspberry, strawberry and mango.

The guilt-free indulgence will enable diet and health-conscious U.K. consumers to enjoy frozen treats that's low calorie, low fat, gluten-free, lactose-free and packed with 3x live probiotic cultures of yogurt. We know this is an exciting opportunity for Lifeway as we expand our brand internationally.

Overseas expansion takes advantage of strong growth in the U.K. frozen yogurt market, in which sales in the U.K. have increased 50% with the wave of new fro-yo shops across the region. Most importantly, Lifeway's expansion into the U.K. also positions the company to pursue additional distribution opportunities throughout Europe and as the global wallet share for natural foods continues to climb.

The market for organic food and beverages in Europe is the largest worldwide, accounting for almost half of all global sales of organically grown products, with the projected compound annual growth rate of 7.5% from 2012 to 2016. We believe Harvey Nichols is an ideal launching pad in the U.K. and a solid first step in a broader initiative to bring kefir and our related products to interested consumers anywhere in the world.

We first launched Lifeway Frozen Kefir in -- at U.S. in -- at Fashion Week in New York 2 years ago. It has exceeded our expectations, and it's one of the most successful product launches since the company was founded in 1986. Spring and summer weather will soon bring higher temperatures across the country, and we believe the demand for Frozen Kefir will increase as consumers look for delicious and healthy treats to keep them cool in the upcoming warmer months.

Today, we are also excited to announce the acquisition of Golden Guernsey dairy plant in Waukesha, Wisconsin. We believe this new capacity comes at a perfect time to help support our current demand and future growth opportunities long term. This acquisition will enable us to quadruple our manufacturing capacity, adding 170,000 square feet to our existing 50,000-square-foot facility.

The Golden Guernsey plant was shuttered this past January following a bankruptcy filing, and we look forward to getting more than 100 employees back to work in Wisconsin. We will also use renewable energy in our operations as we continue to provide the highest quality products to our consumers as we remain increasingly focused on sustainable business practices. We expect this transaction to close on June 10.

Eating healthy is not a trend. It is a new lifestyle choice that consumers are making. There will continue to be major growth within the natural food industry as more and more consumers demand healthy foods for themselves and their families. At Lifeway, we are proud to create a product that supports the lifestyle of health-conscious consumers. The benefits of probiotics continue to make news headlines as medical and food researchers learn about these amazing health benefits. Our strategy is to remain true to our values of providing nutritious and convenient kefir products as we grow and expand our company and deliver record sales and earnings growth.

That concludes our first quarter business overview. Ed and I are now available for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Howard Halpern with Taglich Brothers.

Howard Halpern - Taglich Brothers, Inc., Research Division

In terms of modeling going forward in the second half of the year from the acquisition, is that going to be financed again through another note -- promissory note?

Edward P. Smolyansky

Yes. So how people should view the acquisition, we did not acquire the business or the company per se. We acquired the assets, so the property, plant and manufacturing of the assets. As you know, the business had been shut down for almost 5 months since January 5. So it'd be about 5 months, almost. And the products that, that business is selling, we don't know right now in what flux or capacity those brands are still at. Some -- obviously, they went to milk and all the other products. Someone else's are probably starting to take over that business. But what we purchased was property, plant and equipment and the hard assets. And so it's not an acquisition of an ongoing concern technically right now.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And then...

Edward P. Smolyansky

So -- sorry, just let me finish -- yes, I'm sorry. Let me just finish that thought. So we do plan on obtaining our traditional mortgage of that property at some point.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And then in terms of it's been shuttered, so you're going to have to do some maybe design and some improvements to it and some capital equipment spending. What would you say -- I know it might ramp in the third quarter and then maybe a little more in the fourth quarter. Do you have a general idea how much that might -- you might be spending on bringing it up to your standards?

Edward P. Smolyansky

Well, right now we don't know because we still have to evaluate what products and what we're going to be doing inside of that property, plant and equipment asset that we purchased. Are we going to continue all the same -- or try to continue all the same products that were being produced? Maybe, maybe not. Don't forget that, that facility was supplying us the milk that we have been using or had been buying from that facility and from that company. So we can now at least turn the machines on and go back to taking that milk and processing it for the needs of our Illinois facility. So that's obviously something that could be done in the very near term. And then of course, we will have to use the facility at some point to probably produce kefir, as the capacity for kefir in our main -- Morton Grove, Illinois facility is already coming close to its end. So yes, so it's very difficult to tell in terms of going forward how much CapEx we're going to be adding per year, but it -- yes.

Howard Halpern - Taglich Brothers, Inc., Research Division

But more likely than not, since you're now going to be running it, whatever cost that you put into it, you're going to gain in productivity over time?

Edward P. Smolyansky

Yes, absolutely. Yes. And so of course, the -- how should I put it, the margins that were being passed through by that company to sell us or get us the milk that we need will now not be obviously passed through later.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And in terms of -- I know the promotions and discounts went up just a little bit as a percentage of sales. Is this a good number now to use going forward, this 12% -- 10% to 12% or so?

Edward P. Smolyansky

It's -- yes, 10% to 12% has always been historic for us. Some quarters, it's 11%; some quarters, it could be 12% or 10.5%, but within that range is always historic. We generally -- I don't think we've ever gone higher than 13% in the quarter.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And lastly, in terms of you’re now pushing to the U.K. and hopefully into the rest of Europe, do you anticipate or is your plan to see it mirror really the 2 years growth that you had from 0 to now in the U.S.?

Edward P. Smolyansky

Are you talking specifically about the frozen product line?

Howard Halpern - Taglich Brothers, Inc., Research Division

Yes, the Frozen Kefir, yes. Do you anticipate -- and maybe not the dollar amount, but the ramp to be about what we saw in the U.S.?

Edward P. Smolyansky

Are you asking, I think, the revenue side, right?

Howard Halpern - Taglich Brothers, Inc., Research Division

Well, both -- well, either the revenue side or the cases shipped, how do you anticipate or what do you anticipate the U.K. ramp to look like? Similar to the U.S. ramp when you started out?

Edward P. Smolyansky

Julie would be...

Julie Smolyansky

Well, that would be -- I don't think that we have any expectations or -- it's a new area for us. We're really building a foundation. Lifeway is not known in Europe, and kefir is not known in the U.K. per se, though it is known in Europe and probiotics are highly consumed in Europe and they're growing at a 7% rate. And we expect that the probiotics market is to reach a $45 billion around the world globally with Europe and Asia making up for a majority of that. 70% of that growth is coming out of probiotics dairy products. So there's a tremendous opportunity. But again, Lifeway is not known in U.K. or London. So we are really testing this out there's a couple of different models that we can look at, and we're exploring all options. But we're going to kind of go conservatively and see what happens and test the waters and make tweaks as we go. But it's the beginning hopefully of other things to come down the line. But I don't have major expectations and won't even begin to try to plan or project 2 years down the line.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And for marketing purposes, are you going to start out with like a social media in the U.K. to get sort of grassroots word-of-mouth out?

Julie Smolyansky

Yes, demos, social media, which is very cost effective, using influence or marketing, things like that, word-of-mouth, kind of building a strong base of early adopters and kind of cutting-edge individuals who will embrace our product and brand, and then kind of grow from there and try to grow throughout Europe.

Operator

[Operator Instructions] Our next question comes from the line of James Fronda with Sidoti & Company.

James Fronda - Sidoti & Company, LLC

I guess if milk prices start to rise again, do you think you'll be able to offset those price increases? I guess, will the acquisition that you just made help to offset those costs as well?

Edward P. Smolyansky

Yes, theoretically, of course, yes, that's -- because now we will have a dairy processing or a milk processing facility. Traditionally, or historically speaking, those facilities process milk for us, and then they have their own upcharge and their own profit margins that they have to pass through. Those will go away. Of course, there's going to obviously be variable expenses in order to do that, but that essentially becomes now our business. So there's definitely 5% to 10% cushion for us if milk prices go up, let's say that much.

Operator

Your next question comes from the line of Peter Castellanos with Glacier Partners.

Peter Castellanos

Just a couple of questions on that acquisition again. The driver for that, was that more to kind of get some advantage in your margins? Or is it really more for just to get a secure source of milk?

Julie Smolyansky

It's a combination. We are at capacity in Morton Grove, so we are really bumping up against capacity restraints. And so we were either going to have to break ground really, really soon and start ramping up construction ASAP, or we could have -- we found this opportunity. And I'll let Ed continue to expand on what I've just said. I know he wants to say something.

Edward P. Smolyansky

Yes, no, you finish your question or...

Peter Castellanos

Excuse me, I'm sorry. Just to understand that business, will you be 100% of their business at this -- or how much of the business will you be doing just directly with Lifeway on the dairy?

Edward P. Smolyansky

I think you're thinking about it in a different way. We don't have the problem finding a source of milk. The Midwest has abundant supplies of milk. And so what happens are all of these farms that are in the Midwest, whether it be in Illinois, Wisconsin or Iowa or wherever, they take -- the cows go and they take -- they get milked, right, and all this milk has to go somewhere. What we do with our kefir is we need it processed in a certain way for our own use in Illinois to make kefir. And so we'll have that opportunity back, but that was not necessarily a driving factor. It was more, as Julie said, to be able to secure our future in the next several years, knowing that our capacity in Morton Grove, existing capacity, is already starting to...

Peter Castellanos

So we shouldn't expect you to be doing business with other people and it will be strictly Lifeway operation?

Edward P. Smolyansky

Correct.

Julie Smolyansky

No. Well, it's not -- I mean, we'll -- if there's folks that still want dairy, they want milk coming out of there, sure, we would definitely take a look at the existing contracts and use whatever operations and existing business that we have and try to roll it in. That's not necessarily the goal. But the goal is to grow the Lifeway brand in cultured dairy products and -- but like I said, in the meantime as we do that, while we kind of ramp that up in scale, we can definitely try to fulfill existing contracts or needs that they have using whatever the former business model was.

Julie Smolyansky

Product, not business model. We would have our own business model.

Peter Castellanos

A couple question just on the U.S. The Costco expansion in the New England and Wal-Mart, can you comment at all about some of the big-box retailers and how that might be going? Is there anything you can comment on about how that's going?

Julie Smolyansky

I mean, we continue to grow our business in all of our retailers, everyone from Wal-Mart to Costco to Target. We've expanded our sets at Target. We're pretty much expanding everywhere across the country with new and existing products. So it's a really exciting time. We recently launched about 7 new items just 1.5 months ago at Expo West, so we're getting listings for those items. So it's a great time for Lifeway.

Peter Castellanos

And so Costco right now is still just in New England, though. Is that correct?

Julie Smolyansky

No, no. We also sell in the Midwest and in the West Coast.

Edward P. Smolyansky

And the Southeast as well with Florida.

Peter Castellanos

Okay. Right. And then just my last question, somewhere in your filings on -- I saw that there's -- you mentioned the expansion in terms of the number of doors you're in, and the number went from 400 to 4,000 in about 2 years. Is that number correct? And is that a number that you're familiar with?

Julie Smolyansky

Yes, I mean, we think it's a guesstimation, but we don't know for sure. We look at IRI and spend reports, and that's kind of a guesstimation based on the existing numbers and data that we get.

Peter Castellanos

Because what doesn't -- what's kind of confusing about that, if it went from 400 to 4,000 in that 2-year period that you have thought the revenues would go much faster now, and maybe I just don't understand how the placement of the -- how the SKU...

Edward P. Smolyansky

I think that, that portion was just referring to the frozen line.

Peter Castellanos

I see. Yes.

Julie Smolyansky

Right. Correct.

Edward P. Smolyansky

For sure. 10 years ago, we were in 10,000 stores for kefir, but not for frozen obviously. So that -- I think that number is referring to the frozen segment, not our full business.

Operator

Our next question comes from line of Ivan Zwick with Raymond James.

Ivan Zwick

The other question I want to ask you, though, is so I'm getting the handle on this plant that you're acquiring. You were just getting processed milk in there. You weren't making any of your products in there?

Julie Smolyansky

No, just getting milk from them, tankers of milk.

Ivan Zwick

Okay. So -- and from what you described, you're running into hitting capacity in Morton Grove, and you're going to have like around 100 employees. That -- I'm trying to sort of put a handle on what you're going to do in the way of new products or additional products that you're going to make in that plant, as well as doing the processing of the milk. Can you sort of give me an idea what your plans are?

Edward P. Smolyansky

Well, the processing -- yes. Well, the processing of the milk is already existing in that -- that ability for that place is -- that has -- they have that capability already, so nothing new needs to be done. So it's just about turning on the light switch and getting that process going once again. In terms of what products we are going to make, actually, branded products, we don't exactly know yet. There's opportunities for a variety of fluid beverages, whether it's milk, whether it's juices or anything that's fluid could be processed through there. There's fillers and all the infrastructure. Of course, again, the main idea is that when kefir will continue to grow, as we believe it will, we need to have to make sure that we can produce that product. That is our company, that is our core business and that remains our concentration for what that new facility will wind up doing.

Ivan Zwick

Okay. Well, let me sort of ask the question this way to maybe get a handle of what I'm looking for. This new facility is a certain size and a certain amount was being used for processing milk, okay. When you eliminate the processing of the milk, how much more capacity for new products could you possibly have in addition to your existing plant in Morton Grove?

Edward P. Smolyansky

It's really good -- I mean, it's very early to try to analyze that right now. So that opportunity definitely exists. So -- but we don't know that right now, we just made the transaction yesterday.

Ivan Zwick

But by doing what you're doing, you obviously feel that you got a considerable amount of more capacity over what you got in Morton Grove for product or you wouldn't -- I don't think you would have bought it just for the milk processing. Is that right?

Julie Smolyansky

Right. We bought Lifeway processing. I think that commodity milk manufacturing is sort of an old game. There's not that much money to be made there. People are looking to switch out to value-added products like organic, GMO-free, grass-free range, grass-fed. Those are the things that we would potentially look at and consider. That's where I believe and where many people believe sort of the trend on eating is going, the trend on dairy is going. So that would be something that we would consider. But -- and the Lifeway manufacturing plant here in Morton Grove is about 50,000 square feet, and we're able to get about 70 million, 80 million out of this plant. So we think we can probably triple, quadruple our production abilities there over the next few years.

Ivan Zwick

Okay. That's what I was looking for, Julie. And one other question, too. You got plenty on your plate right now, but do you have any new products you're planning on introducing...

Julie Smolyansky

Well, we just launched 7 items, so we don't -- I mean, we have things in the pipeline that we are looking at for 2014. But we're really looking to push the products that we've just launched. That takes a little bit of marketing arm and dollars behind that and effort. So we're really focused on the things that we've just launched in this year. We are thinking about the things for 2014. You have to be -- we have to be cutting-edge with our developments and as we look at trends and things like that. So that is kind of in the horizon but nothing of -- nothing to note in the short term. Focused on our frozen, focused on growing our pints, focused on pushing out our bars, having a real strong spring and summer season and early fall season, pushing out our probiotic drinkable kefir product. So there's a lot of great work to do, and it's a wonderful time and yes, we do have a lot on our plate, but it's a wonderful thing to be doing and that it's a great time to be doing it.

Ivan Zwick

Well, great quarter, and I wish you all continued success. And what you mentioned about the amount of yogurt and that sort of thing in Europe, I just recently came back from there and competing, and I was in the Czech Republic. And it's very true what you're saying, there's so much of that product. It's just unbelievable. So I think...

Julie Smolyansky

Yes, and it's growing. I think we -- what we have is something new to bring to the table. No one has that tart and -- tart-tangy frozen product. They have a lot of fresh dairy yogurts, drinkable yogurt, things like that. But their ice cream sets tend to still be high-fat ice cream, high-caloric ice cream, gelato, things like that. But there's definitely a need and a new market opportunity globally for a fro-yo product, Pinkberry and these fro-yo shops are popping up everywhere. If you go to Harrods and go to their -- the top floor of Harrods, which is their kind of trendsetting, young, hip area, they have a fro-yo shop set up there. And it goes for $10 a serving. And it's -- on every corner in London, there is a fro-yo shop. But there's nothing in the grocery store for take-home, quick consumption, convenient consumption. And so this is one opportunity we see and a place that we can kind of break out. And then potentially bring, as we grow the Lifeway brand, if we can do it, bring our drinkable products to market there as well once we have established Lifeway as a brand there. And the boundaries have changed, social media and Internet and the ease at which we communicate with each other is -- has taken the walls and barriers away from this. And you can do it very conveniently, cost-effective and feeling like you're there. So the -- Britain is a good friend of America and agreements are very complementary, I think.

Ivan Zwick

Well, I was in 2 grocery stores in Prague, and I saw no frozen kefir or yogurt products. So I think you're totally right.

Julie Smolyansky

Yes. Well, hopefully, we'll see. Well, we're testing it at the very least. We're going to see what works. We'll tweak it if we have to and pivot. And in the meantime, we didn't make any major capital investments. We are contract manufacturing there. So it's not a big cost to try to take an opportunity if we see it and grab it and bring shareholder value to back home here.

Operator

[Operator Instructions] And since there are no further questions at this time, I'd like to turn the floor back over for any closing comments.

Julie Smolyansky

Well, thanks for your participation today. We look forward to sharing our second quarter of 2013 results with you in the next coming months, and have a good enjoyable spring and good health, everybody.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

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