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Executives

Hunter Wells

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

Analysts

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

Howard Halpern - Taglich Brothers, Inc., Research Division

James Fronda - Sidoti & Company, LLC

Anne E. Morrissy - Gamco Mathers Fund

Ivan Zwick

Lifeway Foods (LWAY) Q3 2013 Earnings Call November 14, 2013 4:30 PM ET

Operator

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

Hunter Wells

Good afternoon, and welcome to Lifeway Foods third quarter and 2013 earnings conference call. On the call with me today is Ed Smolyansky, Chief Financial Officer.

By now, everyone should have access to the third quarter earnings release for the period ending September 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 material 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 CFO, Ed Smolyansky.

Edward P. Smolyansky

Thank you. Good afternoon, and thank you for joining us. President and CEO of Lifeway, Julie Smolyansky, is traveling abroad in pursuit of global expansion and is unable to join today's call.

I would like to begin with the brief comment on our record growth and success for the third quarter. Then I will review our third quarter 2013 financial results in more detail. And finally, I will open up the call to take your questions.

Overall, we are very pleased with the progress we have made thus far in fiscal year 2013. We're thrilled to report another quarter of record results, which demonstrates our steady progress in growing Lifeway into a leading health food brand. We believe these strong quarterly results will help generate record results for the full year.

Every day, doctors and health scientists publish new reports on the benefits of probiotics. The probiotics industry is growing and by 20 -- I'm sorry, 2018 is expected to have to be a $45 billion category around the world. Lifeway is expertly positioned to receive the benefits of this growth, as over 60% of probiotics are dairy based.

As always, we plan to launch new products for our customers and we'll continue to make investments in our business that help create strong momentum for sales growth and increase our distribution.

In the past couple of weeks, we started to ramp-up the use of our Golden Guernsey dairy plant facility which we purchased back in July 2013. This facility is a strategic, long-term investment for Lifeway. When the facility is in full use, it will allow us to triple our current capacity and greatly increase the scale in which we manufacture Lifeway products. We will experience lower costs when we become our own supplier of milk in bottles. This would be very beneficial to our margins as the expense purchased this process milk and bottles from outside vendors are some of our top costs. We look forward to benefits -- of utilizing this facility in the future.

Additionally, we have remained committed to returning capital to our shareholders. This year, we paid our second annual dividend, and increased it $0.08 -- to $0.08 from $0.07. We were able to increase the dividend because of our strong cash flows, which still allowed us to increase spending in our marketing and advertising budgets.

Looking ahead, we continue to reward our shareholders with their support of Lifeway Foods.

I'll now review our financial results for the third quarter 2013. For the third quarter, gross sales increased 18% to $26.6 million compared to $22.6 million same time last year. This increase is primarily attributable to the increased sales of our flagship line kefir and ProBugs Organic Kefir for Kids.

Third quarter total consolidated net sales increased approximately 15% to $23.8 million from $20.6 million in the third quarter of 2012.

Net sales -- excuse me, gross profit for the third quarter of 2013 was $6.9 million, which was approximately the same in the third quarter of the prior year -- previous year.

Gross profit margin was 29% in the third quarter of 2013 compared to 34% in the third quarter of 2012. Of course, this was primarily attributable to a 35% increase in the cost of milk, our largest raw material.

Operating expenses decreased 3% to $4.7 million from $4.8 million during the same period last year. This decrease is primarily attributable to a decrease in selling-related expenses.

The third quarter 2013 effective tax rate was 29% compared to 32% in the period of same last year.

Our total net income was $1.7 million or $0.10 per diluted share compared to $1.4 million or $0.09 per diluted share the same period last year.

Next I'll review a few balance sheet and cash flow highlights. The company had $1.2 million in cash and cash equivalents as of September 30, 2013. Total stockholder equity was $43.4 million, which is an increase of $5 million when compared to the September 30, 2012. Net cash provided by operating activities decreased 2.5% to $3.6 million for the third quarter of 2013.

Net cash used in investing activities was $7.9 million compared to $1.2 million in the same period last year. Also, please note, cash flow from investing activities includes approximately $540,000 from proceeds related to the sale of equipment and other fixed assets as well -- I'm sorry and -- as well as other income of approximately $209,000 on our income statements. These items are due to sales of assets acquired in the Wisconsin facility and subsequent income was made as a result of the transaction.

Going forward, we believe Lifeway is well-positioned for future growth with the right people, products and of course, capacity in place to support consumer demand for many years to come.

That concludes our financial overview. We'd now like to open it up the call to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Mitch Pinheiro with Imperial Capital.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

A couple of questions. One, so I imagine milk costs will stay relatively high here in the fourth quarter. Are you going to adjust pricing at all? Any plans to adjust pricing, I should ask?

Edward P. Smolyansky

No, we don't. We don't really constantly increase or decrease our pricing relative to where milk costs go. It takes about 6 months to implement a price anyways. However, we do feel that since we are bringing in our own milk processing into the Golden Guernsey dairy facility in a couple of weeks or may be next month, hopefully, we'll be able to increase or decrease the cost associated with how we're getting it now. So it all depends when we start doing that.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

So, right -- as of now, it's not Golden Guernsey is not being -- is not processing milk for you?

Edward P. Smolyansky

Correct.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

Okay. And it'll start in a month or so, is what you're saying?

Edward P. Smolyansky

Yes, it could be in a couple of weeks or a month.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

Okay. How about on the frozen side, how did the frozen -- the new frozen products perform?

Edward P. Smolyansky

I mean, they continue to perform great, double-digit growth. We don't breakout sales by product line. So -- but they're always growing 15% to 20%.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

And is that...

Edward P. Smolyansky

Yes, it's new consumers, it's new stores. And of course, we've launched a bunch of new frozen products this year. We've launched the other Frozen ProBugs push-ups in 3 flavors. We've launched, debt [ph] to leverage and create ProBugs brand and then we've also launched, I believe, 3 flavors of the frozen bars, looks like a stick. So yes, those were the launches this year and even the conventional, our original 4 pints that we launched a couple of years ago, are also doing great.

Mitchell B. Pinheiro - Imperial Capital, LLC, Research Division

Okay. And then just one other question, it's a balance sheet question. What was increase -- there was an increase in inventory, is that related to higher milk costs or is there anything else into that?

Edward P. Smolyansky

It's a combination of higher milk costs and timing. The quarter ended on a Monday, which means we had a full load of product in our facility versus, I believe, last quarter, it was -- a quarter ended on a Saturday or Sunday. So there's a timing issue, of course, and then, obviously, the product costs associated with the price of milk increases.

Operator

And our next question comes from Howard Halpern of Taglich Brothers.

Howard Halpern - Taglich Brothers, Inc., Research Division

First question, with regard to international sales, how has that progressed? And with Julie over there, how do you view that -- how should we look at that type of ramp into next year?

Edward P. Smolyansky

Well, right now, international is a -- it's rounding error in terms of volume or revenue right now. But we are increasing all of our presence in stores. So right now, we're in, I believe, 5 Whole Foods, we've got in placement into Harvey Nichols and brokers are really just starting to and salespeople are starting to pursue product. Of course you have to start somewhere in the United States. So the fact that the product is having a very good rapport and introduction into the stores and has very good -- is being received very well. We're confident we could increase to all of the stores in London -- or I'm sorry, in the U.K. That'll hopefully help us to move over to Europe for that frozen line as well.

Howard Halpern - Taglich Brothers, Inc., Research Division

Okay. And looking at, and this is really for the fourth quarter. I know the tax rate in the third quarter was 29%, the 9 months is 37%. Would you guesstimate that would be closer to the 37% than the 29% in the fourth quarter? Or is it too hard to...

Edward P. Smolyansky

It's probably -- it's a little too hard. I'm not a tax specialist. I'm not an accountant. But I would say it's probably going to be somewhere in between or closer 35%, 37%, that's our historic number. But we have -- there's a lot of things associated with the purchase of the facility for tax depreciation, things like that, so all that kind of comes into play.

Operator

Our next question comes from James Fronda, Sidoti & Company.

James Fronda - Sidoti & Company, LLC

Ed, just on the SG&A line, why was it so much lower from a year ago? And is that a good run rate to use going forward?

Edward P. Smolyansky

For the SG&A?

James Fronda - Sidoti & Company, LLC

Yes.

Edward P. Smolyansky

Yes, we are always -- our G&A is always -- we're always very efficient with it. Same thing with our selling. So as a percentage of sales, I think it’s similar to what it's been kind of historically. But like I said, we gained leverage from our G&A and management, and things like that.

James Fronda - Sidoti & Company, LLC

Okay. Is that a good run rate to use going forward?

Edward P. Smolyansky

Sure.

Operator

Our next question comes from Anne Morrissy of Gamco Investors.

Anne E. Morrissy - Gamco Mathers Fund

Ed, first, that Dominick's is leaving the Chicago area. Do you anticipate that that's going to have much of an impact on your revenues going forward?

Edward P. Smolyansky

Actually, I didn't hear Dominick's was leaving. But usually, when a chain of 100 or 120 stores leaves, some -- either another chain comes in or a Jewel, or someone else will pick up the slack. The people aren't leaving, the consumers aren't leaving. It's just that the stores might be. So no, I don't anticipate. We've had things -- we've had times where places and stores went bankrupt, things like that. And someone else just comes in and picks up the slack or those consumers just go across the street to somewhere else and buy the same product.

Operator

Our next question comes from Ivan Zwick of Raymond James & Co.

Ivan Zwick

A question on the Starfruit that you talked about quite a while ago, that you were going to do some individual small chains and all, that hasn't materialized. Where are we at with expanding that part of the company?

Edward P. Smolyansky

Yes, I mean, it's again, it's a rounding error. It's a number. It's not anything significant in our full-scale business. But it's something that we're experimenting with. We're not devoting all of our energy per se to that. But if opportunity pops up, I will look at it, and things like that. But there's nothing majorly new on that front.

Ivan Zwick

And also, on the new plant that you purchased that you said within a couple of weeks or month, some of the milk I guess will be going through there and that will cut some of the costs down, the milk expense. Can you give me an idea of what kind of magnitude of cut that might mean?

Edward P. Smolyansky

Well, I can't give you a detailed number. What I can tell us is historically, when a facility takes in raw milk and processes it for an end-user such as ourselves, they have a -- they build in their own margins and utilities. It's not a super high-margin product or because it's a commodity and basically, they're just skimming it and separating it, homogenizing, whatever the end-customer needs. So I would say historically, a company that's doing this, a dairy that's doing is for an end-user like us it could be somewhere around 5%. I don't know what their numbers are. But it's somewhere I think between 5% and 10%.

Ivan Zwick

On the amount of milk you use, that would be further [indiscernible].

Edward P. Smolyansky

Yes, of course, we have our own expenses, don't forget. But their profit margin is what their profit margin was. But I don't know if what theirs is was, or what a similar dairy company would be.

Operator

[Operator Instructions] At this time, I'd like to turn the conference back to Edward Smolyansky for closing comments.

Edward P. Smolyansky

Well, I think that that's it. Thank you for joining us and hopefully, Julie and I both will be on the next call, I'm sure we will. And have a good day, and holidays as well. Thank you

Operator

Thank you, ladies and gentlemen. This concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.

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