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Executives

Hunter Wells - IR, ICR

Julie Smolyansky - CEO

Edward Smolyansky - CFO

Analysts

Mitchell Pinheiro - Imperial Capital

Howard Halpern - Taglich Brothers

James Fronda - Sidoti

Ivan Zwick - Raymond James

Lifeway Foods, Inc. (LWAY) Q4 2013 Earnings Conference Call March 31, 2014 4:30 PM ET

Operator

Greetings, and welcome to the Lifeway Foods, Inc. Fourth Quarter and Full Year 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Hunter Wells. Thank you. Please begin.

Hunter Wells

Good afternoon, and welcome to Lifeway Foods fourth quarter and full year 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 fourth quarter and full year earnings release for the period ending December 31, 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 begin with an overview of our growth and success in 2013, including a brief discussion of our fourth quarter and full year 2013 financial results in more detail. Then, I will open up the call and take your question.

We are extremely pleased with our performance in 2013. This year, we generated record sales, the highest in our company's history, and we are confident that our strong growth will continue into 2014.

I am very impressed with our team's ability to closely manage the controllable aspects of our business in the face of higher milk prices, our largest raw material.

In 2013, we continue to be focused on expanding our product line and increasing distribution. This past October, we were extremely honored to once again be named by Forbes Magazine as one of the Best Small Companies in America. We were ranked 48 out of 100, and I believe that this prestigious recognition speaks to the hard work and dedication of our entire team.

One of the most exciting highlights this past year was the purchase of the Golden Guernsey dairy plant in Wisconsin, which will provide us with an additional manufacturing capacity for our growing business.

We added the 170,000 square foot plant to our existing 50,000 square foot facility in Morton Grove, Illinois, which allows us to more than quadruple our production capacity, and provide much needed expansion abilities.

Additionally, we are very pleased to be able to re-hire a portion of the workforce that lost their jobs after the plant was closed down this past January in a bankruptcy filing.

We expect this facility to be fully running by the third quarter of 2014, and believe its purchase is fundamental to support our growing business long-term. We continue to make strides in increasing distribution of our product. Long gone are the days of Kefir being a specialty niche health food product. Instead, mainstream customers are embracing Lifeway Kefir and its nutritious benefit. This past year, we continue to increase distribution in large retailers, including Kroger, Walmart, Target, Costco and many more.

Across the pound in Europe, we continue to demonstrate strong sales at Harvey Nichols and whole foods locations in London. Additionally, we have just rolled out our Frozen Kefir product to about 339 Holland & Barrett retail location throughout the U.K.

We remain dedicated to focusing our time and resources to increasing distribution of our product and remain optimistic about our opportunities in 2014. Lifeway continues to be better positioned than ever to capitalize on the future growth opportunities in the U.S. and internationally.

In 2013, we also continue to focus on grassroots marketing and advertising in order to cultivate further awareness of our Kefir product. We participated in many high profile events, including attending the presidential inauguration in January, where we served our delicious Kefir to audience members of three events attended by the President.

Personally, I am extremely honored to participate in these inaugural events as I am an avid supporter of the First Lady's Let's Move initiative, which encourage healthy food choices and exercise for young people.

Some other notable events include participation in the Sundance Film Festival, the South Beach Food & Wine Festival, and our very first -- as our second South by Southwest event, which is an interactive film and music conference in Austin, Texas. We love engaging with our fans and meeting new and long-time customers of our products. In offering delicious samples at these high profile events, we continue to drive growth and increase exposure to our product.

In addition to promoting our product at popular music and food festivals, we continue to utilize social media to connect with new and existing customers and offering our product. Currently, our Facebook page is liked by over 300,000 fans and over 100,000 people follow our Twitter page.

Each quarter a number of our fans and followers increased exponentially, and we pride ourselves in the ability to use innovative marketing techniques to promote the Lifeway brand and believe our success in the social media universe is essential to our continued growth.

Frozen yogurt continues to be a strong growth segment. Despite this year being one of the coldest winters on record, sales continued to increase. One Starfruit café location was closed permanently due to the closure of a neighborhood hospital, which dramatically reduced the market. We view this as a non-reoccurring event, and other locations continue to exceed our performance expectation.

In the coming year, we have plans to open several self-served frozen soft-serve kefir kiosk at several prime grocery store locations, and believe that due to the successful sales of our Frozen Kefir, they will also receive positive responses from our customers.

Focusing our results in more detail for the fourth quarter of 2013, gross sales increased 26% to 28.9 million, compared to 22.9 million for the fourth quarter of 2012. This increase is primarily attributable to increased sales and awareness of the company's flagship line, Kefir, as well as ProBugs Organic Kefir for kids and BioKefir.

Fourth quarter total consolidated net sales increased approximately 26% to 26.3 million from 20.8 million in the fourth quarter of 2012. Net sales are recorded as gross sales less promotional activities, such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.

Gross profit for the fourth quarter of 2013 decreased 30% to 4.8 million compared to 6 million in the fourth quarter of this prior year. The gross profit margin was 18% in the fourth quarter 2013 compared to 29% in the fourth quarter of 2012. This decrease was primarily attributable to the increased cost of conventional milk, the company's largest raw material. The total cost of milk was approximately 30% higher during the fourth quarter of 2013 when compared to the same period in 2012.

Our net loss is $0.03 per diluted share compared to earnings per diluted share of $0.07 in the fourth quarter of 2012.

Now, I will review a few financial highlights for the full year of 2013. 2013 total consolidated gross sales increased approximately 21% or 19.2 million to 109 million from 90 million in 2012. This increase is primarily attributable to the increased sales and awareness of Company's flagship line Kefir as well as ProBugs Organic Kefir for Kids and BioKefir.

Total consolidated net sales increased 20% to 16.2 million –- or 16.2 million to 97.5 million during the 12 month period ended December 31, 2013, from 81.4 million during the same 12-month period in 2012.

2013 net income was 5 million or $0.30 compared to 5.6 million or $0.34 per share in 2012. To wrap up the financial overview, tomorrow we plan to file our full 2013 financial results on Form 10-K with the SEC for your reference.

I would now like to share with you a glimpse of what we have in store for 2014. I met with some of you earlier this month at Natural Products Expo West, one of the largest natural, organic and healthy product food shows. Each year at this event, we showcase our newest and best products. This year was no exception. Some of our newest creations include Lifeway Kefir with Oats. This new product is very high in fiber feature with 1.5 grams of soluble oat powder that packs the nutritional punch of oat meal.

It has the smooth texture and a hint of oat flavor plus 11 grams of complete protein. This oat kefir offers a choice of breakfast-friendly Blueberry Maple, Apple Cinnamon or Vanilla Plum flavors for a complete on-the-go breakfast or a great midday pick-me-up.

Another great product is the sweet alternative through our traditional product line. Lifeway Perfect 12 Kefir is our first product to be sweetened with stevia, a perfect choice for diabetics or those slashing their sugar intake. With 12 probiotic cultures and 12 grams of carbs, this line features the all natural sweetening with no calorie stevia leaf extract and no added sugar. At 110 calories, it's good enough to eat for dessert. Flavors include Orange Cream, Apple Pear Cobbler, Triple Berry Tart and Key Lime Pie.

Last, but not least is what I think is our most innovative new product, Lifeway Veggie Kefir. This is a savory alternative to fruit flavor kefirs that lets you drink your probiotics and your veggies at the same time. This new product let vegetable juices in Kefir to deliver one full serving of vegetables as well as the full nutritional kick of kefir in every eight ounce glass. This new savory flavors include tomato, cucumber and beet, each offered without any added sugar or salt. There is nothing like this product currently on the market, and I believe it will be our next big hit.

In conclusion, we are extremely pleased with our growth and success over the past year. Our base kefir business continues to perform extremely well, and we are enjoying increasing in sales, which we believe is attributable to our increased consumer awareness around the benefits of kefir products. We stand by our belief that eating healthy is not a fad but the future of how we eat in America.

Healthy eating and good for you food products are in an industry that is poised to grow 226 billion by 2018 with an annual growth rate of 8.6%. Dairy products, and in particular, yoghurts and kefir style products are known to be high in protein and full of healthy good for you gut bacteria that helps your body fight disease, depression and obesity.

We are proud to serve a product that contributes to the healthy lives of our customers and their families. As we see it, Lifeway has only begun to realize our market leading industry position, and we expect another record year of growth in 2014. We are already off to a strong start, and expect 24% increase in net sales for the first quarter of 2014 compared to the same period last year.

Going forward, we remain intently focused on creating new and innovative products and expanding distribution to drive sales and further enhance shareholder value. We appreciate your interest in Lifeway Foods and we would now like to open the call up to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question comes from the line of Mitch Pinheiro with Imperial Capital. Please proceed with your question.

Mitchell Pinheiro - Imperial Capital

Hi, good afternoon. My first question, just on milk costs, as you look at the first quarter, it looks like milk costs are upwards sequentially from the fourth. So, we are going to see sort of a similar margin compression or do we – should we read this differently?

Edward Smolyansky

Hi, this is Ed. So, with regard to milk, we are looking at what we were seeing in the first quarter. It's basically either a little bit up, a couple of percentage points up from fourth quarter or flat. Keep in mind also that we have started to process our own milk in the new dairy facility in Wisconsin in about mid February.

So, that's actually going to probably give us about 5% decrease in processing cost that we were paying in the fourth quarter of 2013 and previously obviously. So, we think that any increases are going to be absorbed and mitigated against by processing our own milk in that new facility. But again, that only started about mid February.

Mitchell Pinheiro - Imperial Capital

Okay, that's helpful. Is that -- what percentage of your total milk costs will you be able to self-process when the plants are fully running at 100%?

Edward Smolyansky

Yeah. We will be able to process all of the milk that we need to (indiscernible) process it now ourselves versus paying someone to process it before.

Mitchell Pinheiro - Imperial Capital

Okay. And so, that helps by maybe 5% in this quarter, which is only maybe getting half of the benefit. We might see that benefit increase in the out quarters this year?

Edward Smolyansky

Exactly. Yeah.

Mitchell Pinheiro - Imperial Capital

Okay. And then, are you going to do anything different from selling expense, advertising and marketing in 2014 to support the launch of these new products?

Julie Smolyansky

Yeah. Well, I think we are [continuously] [ph] doing advertising and marketing, and of course continue to scale that as the expense - our sales continue to rise and the new products are on board. And so, we continue to look for great opportunities to promote our lines to influencers and create that market.

Mitchell Pinheiro - Imperial Capital

Will it be anything incremental, anything different doing more in-store sampling or anything going on other than typical strategy?

Julie Smolyansky

Well, we haven't started our Super Bowl ad yet. So, no. I think everything else is within the normal line of business, and advertising and kind of day-to-day advertising and marketing for a product like ours. But it's in proportion to our sales.

Mitchell Pinheiro - Imperial Capital

Okay. And then, with all these new products and I did taste them with you at the Natural Food Show. They are terrific new products. My question is where is the shelf space, where is the new shelf space going to come from? Is it -- will you have to prune some of your space? Are you taking it from somewhere? Are there resellers adding?

Julie Smolyansky

Yeah, we’d be taking it from something else. We’d be taking it from some other place, not ours. We wouldn't be replacing our existing products unless there was a SKU here or there that didn't sell but pretty much everything that's on the shelf right now are the best sellers. So, we will be getting new space.

Mitchell Pinheiro - Imperial Capital

Okay. And then just like a short final question related to that. Do you see more kefir products hitting the shelves, different brands, obviously it's a very strong category?

Julie Smolyansky

We still have 97% of the space. We control 97% of the market share, and I actually see that the kefir is, if you had the insight, the data insight that I have gotten, they are actually being discontinued in many cases. And I believe that in the next two to three years, you will see a lot of discontinuation from a lot of the other brand because the sales are not there to support them actually.

Mitchell Pinheiro - Imperial Capital

Okay.

Julie Smolyansky

Kind of like whoever is there right now is paying to stay there, but that's not sustainable.

Mitchell Pinheiro - Imperial Capital

Okay, terrific. Thank you very much.

Julie Smolyansky

No problem.

Operator

Thank you. Our next question comes from the line of Howard Halpern with Taglich Brothers. Please proceed with your question.

Howard Halpern - Taglich Brothers

Congratulations, great year, guys.

Edward Smolyansky

Thank you.

Julie Smolyansky

Thank you.

Howard Halpern - Taglich Brothers

I guess, almost to your last point and the new products that are coming online are you going to be able to maybe mitigate some of the higher milk prices with your own price increase down the road in 2014?

Julie Smolyansky

I mean, we routinely go through price increases as every other company does, because there is general inflation. So, yes, so this continues to be price elasticity, and we have the ability to incorporate those increases into our business. We are a brand. It's not a commodity. So, it's -- you pay for your brand.

Howard Halpern - Taglich Brothers

Okay. And organic milk prices, are they rising in tandem with conventional milk prices?

Julie Smolyansky

Well, I think there is a shortage of organic milk right now in general across the country. And that's something that we continue to be challenged with, but wrap our brains around how to mitigate those shortages and work on our contracts and relationships with organic farmers. But yeah, I mean, unfortunately or fortunately, the need for organic continues to grow so high in our country and around the world that we really need to [farm] [ph] organic much quicker and that is a long lead time for a farm to be certified organic. So, we are really just encouraging as many farmers to take those steps, to supply and create more supply because the demand is so strong right now.

Howard Halpern - Taglich Brothers

Okay. And you talked about Europe a little bit and your recent I guess win the U.K., do you expect by the end of this year to be beyond U.K. and into other European countries?

Julie Smolyansky

I don't know if it will happen specifically in 2014, but our intention is to eventually launch our drinkable line, and we are kind of -- I don't want to say, practicing with our frozen line. But we feel like there is a learning curve and opportunity to create the system that we need to have and then really launch with our drinkable line eventually.

I believe that Lifeway has the opportunity to become a global brand. I think if you think about Hershey's Chocolate, Tropicana Orange Juice, these are brands when you dominate the market and then have a market share like we do and at the level that we have that Lifeway is synonymous with Kefir and that is a global story. So, long-term, I think that we should be everywhere just like Hershey's Chocolate is or Tropicana.

Howard Halpern - Taglich Brothers

Keep up the great work, guys.

Julie Smolyansky

Thank you.

Edward Smolyansky

Thank you.

Operator

Thank you. Our next question comes from the line of James Fronda with Sidoti & Company. Please proceed with your question.

James Fronda - Sidoti

Hi guys. Just in terms of the milk prices, there is no I guess futures market out there, if you guys have -- try to offset any of this?

Edward Smolyansky

Yeah. We get this question once every three months, but yeah, there is a futures market, it only trades, it's very limited. And we've gabbled in trying to hedge before, and then it really for our product when you are actually taking delivery of milk. If you are going to lose some of it and then you are going to gain some of that, at the end of the year you are going to end up, just doing a lot of trades and not making and not actually hedging. So, we found that it's not fruitful for us to engage in that type of business.

James Fronda - Sidoti

Okay.

Edward Smolyansky

Yeah. So, for us hedging is or offsetting cost of rising milk prices is in the form of the price increase which still we said -- we do periodically do. Anymore, anyway still and this year we do have one set in the next couple of months.

James Fronda - Sidoti

Right, okay. And you said the first quarter revenue growth was in line with this quarter in terms of -- around that 20% range?

Edward Smolyansky

The first quarter revenues, which -- first quarter ended today, we are going to be somewhere, and the net sales are going to be somewhere in the range of 30 million. And I believe that's about a 26% increase, 25-26% from last year's first quarter.

James Fronda - Sidoti

Okay, sounds good. All right, thanks.

Edward Smolyansky

Okay, thanks.

Operator

Thank you. Our next question comes from the line of Ivan Zwick with Raymond James. Please proceed with your question.

Ivan Zwick - Raymond James

Well, most of my questions have been answered, but what's your plan for Canada, what's happening there?

Julie Smolyansky

Ed, you want to talk on that?

Edward Smolyansky

Yeah. So, we are launching product, the product is being co-packed in Canada, at very large Canadian and actually North American dairy company. And the product will probably be in the stores second quarter. So, they have already produced product, they are out there selling it, samples are there, and we already have listings in several large retailers. And we'll just continue on. So, I think second quarter it will be in the stores …

Ivan Zwick - Raymond James

Okay, well, thank you. Keep up with the good work.

Julie Smolyansky

Thank you.

Operator

We have no further questions at this time. I'll like to turn the floor back over to Julie Smolyansky for closing.

Julie Smolyansky

Yes. Well, thank you for your participation today. And we look forward to sharing our first quarter 2014 results with you in the coming months. Have a good evening.

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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