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Lifeway Foods (NASDAQ:LWAY)

Q2 2013 Earnings Call

August 14, 2013 4:30 pm ET

Executives

Hunter Wells

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

Operator

Greetings, and welcome to the Lifeway Foods, Inc. Second Quarter 2013 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Hunter Wells of ICR. Thank you. Ms. Wells, you may now begin.

Hunter Wells

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

By now, everyone should have access to the second quarter earnings release for the period ending June 30, 2013, which went out this afternoon at approximately 4:05 p.m. Eastern Time. If you have not received the release, it is 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 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 call posted on their website.

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

Julie Smolyansky

Thank you for joining us today. I will provide you with a brief overview of our growth and success in the second quarter. And then, at the conclusion of my remarks, both Ed and I will be available to take your questions.

We are pleased with our second quarter results, as the amazing health benefits of probiotics increasingly resonate with today's consumer. This has enabled us to further increase distribution with new and existing retail partners and drive a 12% net sales increase to $23.1 million in the second quarter.

In the quarter, we experienced a 20% increase in the cost of milk, reducing our consolidated gross margin to 33% versus 37% in the second quarter last year. We also incurred approximately $300,000 in professional fees related to the acquisition of the Golden Guernsey dairy plant, our new manufacturing facility.

Despite these headwinds, we generated a net income of $1.4 million or $0.09 per diluted share. And more importantly, we ended the quarter with $4.9 million in cash and cash equivalents, an increase of $2.3 million or 116%. We believe that with this cash generation and improved balance sheet, that Lifeway is better positioned than ever before to capitalize on our tremendous growth opportunities.

While we are well aware of the health benefits of Lifeway Foods and our kefir products, there are still many people who have not tried our products. This is why we consistently invest in our marketing and advertising efforts to increase consumer awareness. These investments are paying off.

Lifeway commands a dominant market share in kefir, encompassing at least 95% of the market in the United States. While we are the dominant brand in kefir, we have much opportunity for overall growth in the yogurt category. Only 17% of the U.S. population has indicated that they have ever used a probiotic-enriched food in the past 30 days. As more people learn about the health benefits of our products, our sales and product distribution will increase.

Focusing on distribution, we continue to execute on our plans to increase distribution in new and existing retailers. We are now available in Wal-Mart nationwide. ProBugs are one of the top-selling brands at Whole Foods in the category, and we plan to continue to introduce new products to increase our shelf space at these major retailers.

Looking ahead, we plan to expand our distribution in other big-box retailers nationwide and also plan to increase our presence internationally. Lucky for us, healthy living trends have gone mainstream, and American and international consumers are demanding healthful and nutritious products, such as Lifeway Kefir, to be available at their local grocery stores.

Last quarter, we announced the launch of Lifeway Frozen Kefir products at Harvey Nichols in London. Today, I'm pleased to announce that Lifeway Frozen Kefir is also available for purchase at all Whole Foods locations throughout the U.K. The Brits love their frozen yogurt, and our product has been a tremendous success. We believe that the expansion into the U.K. has strongly positioned us to pursue additional distribution opportunities throughout the European Union, as the global wallet share for natural food continues to climb.

The market for organic foods and beverages in Europe is the largest worldwide, accounting for almost half of all global sales of organically grown products, with a projected compound annual growth of 7.5% from 2012 to 2016.

Domestically, Frozen Kefir continues to be a hit and has enjoyed double-digit annual sales growth. Lifeway Frozen Kefir is now carried in more than 1,000 U.S. stores, including Kroger, Wegmans and Whole Foods.

As many of you are aware, we acquired the Golden Guernsey dairy plant in Wisconsin. We continue to believe that this acquisition sets us up for well increased sales growth in 2014, as it will provide us with additional manufacturing capacity for our growing kefir-based business.

The plant will add another 170,000 square feet to our existing 50,000 square foot facility in Morton Grove and will more than quadruple our production capacity and expansion abilities. We estimate that this plant will be fully functional by year end.

Our growth as a company is fueled in part by the growing natural food movement, as well as the mounting awareness of health benefits of probiotic products like kefir. Probiotics are good bacteria that keep the system healthy and balanced. In less than 2 months, the Affordable Care Act will require every state to have web-based exchange, where people can comparison-shop for a healthy -- health policy. We believe that preventative care and nutritional counseling will likely be major components of this plan. As Americans increasingly shift their focus to small healthful changes they can make to their lives to save big on health care cost, we at Lifeway believe there's no better way to do this than our recommendation for daily consumption of probiotics and cultured foods like kefir.

We are very excited about what lies ahead, and we remain focused on the successful growth of our brand, attracting new customers and growing our sales to increase value for our shareholders. We believe that 2013 will be a year of record growth for Lifeway Foods.

That concludes our second quarter overview. Ed and I would now like to open the call up for your question. Operator?

Question-and-Answer Session

Operator

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

Howard Halpern - Taglich Brothers, Inc., Research Division

I do have one question, and this is more based on the historical trends that have occurred. Typically, gross and net sales play off the first quarter and tend to either stay steady or rise into the fourth quarter. Is there anything that occurred that may have caused it to slip a little bit, revenue from one quarter to the next?

Julie Smolyansky

Well, in the first quarter, we stocked up Wal-Mart nationwide, so that's why the first quarter looked a little bit off-kilter, like in -- stronger. And so when you compare it, that had a big part of it. But I do think it'll even out since we've had so many great new product introductions in the last year, and those are all being set right now into major retailers. And ProBugs, we've been focusing on heavily and have had a lot of great placement. It's really exciting since ProBugs was launch basically at the time that the recession started, and it is the most expensive dairy product on the shelf space. And it has done so well in certain markets, like Whole Foods, where the shopper really wasn't as impacted as it was for kind of other markets within the United States. And now that we're coming out, we can tell that we're even coming out because so many mass retailers are really looking at the success that ProBugs has had in some of the more upscale markets and are now placing them on their store shelves. So it's really exciting to see.

Howard Halpern - Taglich Brothers, Inc., Research Division

And how is that, the ProBugs, translating into -- if I recall, you have your frozen yogurt, but don't you have a product that sort of matches that in the frozen area?

Julie Smolyansky

Yes, we have the frozen push-ups -- Frozen ProBugs push-ups. So due to the success of ProBugs as a strong brand, we have done a series of line extensions, including ProBugs Blast, which is now going into significant retailers, the Blast and then the dehydrated Bites, which will be coming into distribution points soon.

Howard Halpern - Taglich Brothers, Inc., Research Division

And how -- I don't know whether you've targeted this area, but with the healthy trend in schools, has that been a target area for you guys to focus on?

Julie Smolyansky

Yes. Yes. As a matter of fact, the guidelines just came out today for what the healthy snack recommendations will be kind of going forward in the school system, and we are definitely working with the USDA and school systems to look for opportunities to include our products because our products do meet their healthy snack guideline.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And off of Q2 results and as you get the new dairy up and running, do you have some estimate of how expenses might increase or capital expenses that are necessary to get that up and running by the end of the year?

Julie Smolyansky

I'll let Eddie comment on that. But I will say that there is a significant amount of assets that we won't be using that we can liquidate, which would probably offset some of our expenditures. But I'll let Ed go into detail on that.

Edward P. Smolyansky

Yes. So a lot of the expenses, non-capital expenses, have already been baked in because all of those are basically production -- I'm sorry, professional fees. A lot of the -- so those are already included in the first 6 months of the year. In terms of what we'll be able to see or realize going forward are going to be savings because we'll be able to produce our own materials, our own bottles. And we'll also be able to utilize all those assets to our advantage, for instance, to process milk and things like that, that we were doing before at the same facility. I think we touch based on this in the last conference call very slightly. Of course, there will be some slight ramp-up expenditures. But all the equipment is already in place. And in fact, we're going to take about 10% of the cost assets or cost of the assets that were purchased that had equipment in there, and we'll be able to sell that because it's just not useful for us. So we'll actually be able to use a lot of that stuff and then get money back from it.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. So I'll see that sort of as a net-net offset in the cash flow statement. If you require some expenses, you can now have that asset sales basically in -- it will sort of net itself out that way?

Edward P. Smolyansky

Yes, we don't see us like spending a lot more on capital expenditures in the next 6 to 12 months. It will actually probably be a net benefit.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. It would just be the employees, then, and as many as you hire, then that factors into the whole setup up there?

Edward P. Smolyansky

Of course.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And one final one. I know Julie said milk costs rose in this quarter. Can you give some perspective on what you or what the markets actually see for milk in the next quarter or 2?

Edward P. Smolyansky

Yes, we never really know where milk is going to go. Of course, we can always look to trends and things like that. I think there were some numbers that came out today and said that corn and different livestock futures were at 52-week lows. So hopefully, that will only -- yes, only push our inputs lower. But we, yes, we don't guide on the milk costs on that.

Julie Smolyansky

Okay. Well, thank you for your participation today. We appreciate the hard work and dedication of our employees, the support of our loyal customers and shareholders, and we look forward to sharing our third quarter 2013 results with you in the coming months. And I hope everyone enjoys the rest of the summer. Thank you.

Edward P. Smolyansky

Thank you.

Operator

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

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