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Lifeway Foods, Inc. (NASDAQ:LWAY)

Q2 2014 Earnings Conference Call

August 11, 2014 16:30 ET

Executives

Hunter Wells - Investor Relations, ICR

Julie Smolyansky - President and Chief Executive Officer

Ed Smolyansky - Chief Financial Officer

Analysts

Mitch Pinheiro - Imperial Capital

Howard Halpern - Taglich Brothers

Operator

Greetings, and welcome to the Lifeway Foods Incorporated Second Quarter 2014 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 your host, Hunter Wells. Thank you, Ms. Wells. You may begin.

Hunter Wells - Investor Relations, ICR

Good afternoon, and welcome to Lifeway Foods second quarter 2014 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, 2014, which went out this afternoon at approximately 4:05 PM Eastern Time. If you have not received a 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 upon 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 maybe 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 - President and Chief Executive Officer

Thank you, Hunter, and good afternoon everybody. I would like to now provide you all with an overview of our results in the second quarter. Additionally, I will give an update on our growth and outlook for fiscal 2014. At the conclusion of my remarks, both Ed and I will be available to take your questions.

We are very pleased with our solid results in the second quarter, which were driven by increased distribution with new and existing retail partners as popularity of our nutritious kefir products continues to grow. Second quarter net sales increased 28% to $29.6 million. In this quarter, we experienced a 30% increase in the cost of milk compared to the same period last year. Despite these increased milk prices, we generated net income of $1.1 million or $0.07 per diluted share. Milk prices, which peaked in the second quarter of this year, continued to slightly trend downward.

Overall, I am impressed with our second quarter performance. I believe we are better positioned than ever before to capitalize on our tremendous growth opportunities. The probiotic market has been experiencing steady global growth with the largest increase coming from the probiotic food and beverage segment. As the U.S. category leader in the kefir space with over 92% market share, we have benefited from that growth and are now in a position to build our presence in the global marketplace.

I would now like to discuss our second quarter operational highlights. We continue to make progress in growing their distribution with new and existing retailers in the second quarter. In the United States, we added new distribution in WinCo, a West Coast grocery chain of about 100 stores and increased our SKU distribution in existing customers such as Albertsons, Intermountain West, Associated Foods, Lowe’s, Farm Fresh, Giant and Ingles.

Most recently, we announced the expansion of our flagship probiotic kefir into Canada, where we launched in more than 1,000 stores around the country. Our entry into the Canadian market marked our second international expansion in the 14 months following the 2013 introduction of our kefir products in UK. In Canada, our Lifeway Kefir will be carried in mass-market chain drugstores and health food stores. In addition to Canada, we have continued our successful expansion into the UK. I believe that entering the UK and now Canada markets are the first steps to our plan to duplicate our success in the U.S. and in other markets around the world. We continue to believe that we have a lot of runway to grow distribution deeper in existing customers and gain incremental shelf space in new customers.

In April, we launched our largest ever print advertising campaign, which included (indiscernible) focused on the theme of MotherCulture. The ad campaign was placed in national distributed top tier print publications such as People, American Baby, Health, InStyle and Shape magazine. Our team was extremely pleased with the success of this campaign with over 30 million impression generated. This print campaign coincided with the social network initiative in which customer share their own ideas surrounding motherhood by using the hashtag #MotherCulture. We were extremely pleased with the buzz generated by this campaign and I believe that was significant in growing our brand recognition in this past quarter.

In addition to the mother culture print campaign, this past June, we announced the Commitment to Action with the Clinton Global Initiative America CGI, America meeting in Denver, Colorado hosted by the former Secretary Hillary Clinton. In effort to address the opportunity gap for 16 to 24-year-old, we launched an internship program to help underserved youth build valuable job skills in entry level positions while earning full-time wages. We are planning to work with Chicago area non-profits to identify young people to participate in the internship and full-time positions at Lifeway’s senior leadership offices. In order to create economic opportunities for youth while gaining valuable new perspectives.

The recession has technically been over for more than four years, almost 6 million young Americans are still out of work. At Lifeway, we are proud to make a commitment to action for the Clinton Global Initiative to address this urgent issue. Our internship and job program gives participants a chance to receive experience in mentoring they need to build future opportunities. I am excited to meet our future interns and employees and look forward to their contributions to Lifeway over the coming months.

Brand recognition and awareness of the health benefits of our probiotics keeps our products very essential to our long-term growth opportunities. According to the latest analysis, global sales of probiotic products has jumped from $30 billion to-date to over $45 billion in 2019 advising health consciousness, increased interest in functional food and ageing population and new probiotic products introduction in all categories continued to alter eating habits. Probiotic dairy products accounted for almost 80% of all probiotic foodstuffs in 2011 and are expected to continue to command the highest market share creating substantial growth potential for Lifeway Kefir products.

Our growth as a company is fueled in part by the growing natural food movement as well as mounting awareness of the health benefits of probiotic kefir – products like kefir. We outlay, so I believe there is no better way to do this than our recommendations for daily consumption of probiotic and cultured foods like Kefir.

I am very pleased with our results for the first half of fiscal 2014, we are 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 2014 will be a year of record gross to Lifeway Foods.

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

Question-and-Answer Session

Operator

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

Mitch Pinheiro - Imperial Capital

Yes. Hi, good afternoon.

Julie Smolyansky

Hi.

Mitch Pinheiro - Imperial Capital

I just wanted to drill down a little bit on the revenue growth if I could, within the revenue, very strong 28% growth, how did maybe it differ by channel sales into the natural channel versus sales in the mainstream?

Julie Smolyansky

Ed, go ahead.

Ed Smolyansky

Yes. I think it’s always usually a combination of both really and also new customers as well. If you see, I think its Julie talked about possibly some of the new customers that we have added. So, if it’s 30% growth, it’s usually split 10% amongst existing customers and with the existing customers it’s split halfway – some halfway between the natural channel as well as the mainstream – kind of mainstream Kroger’s and Safeway’s and what not. And let’s not forget the retail segment is a little bit different than it was say five years ago. And now the natural channel is becoming the mainstream channel as well. So, your whole food and sprouts and fresh markets, years ago, I think you could have considered them more of a niche or independent really more than niche or kind of a natural grocery store. And I think nowadays that line is getting melted into kind of mass. And then the mass retailers are also very strongly increasing their store within store concepts of having natural – more natural and organic offerings in their stores as well. So, everything is kind of moving together into the middle.

Mitch Pinheiro - Imperial Capital

You had an interesting new lineup of kefir up in – at the National Food Show featuring some savory flavor and I am yet to see them. Are they getting distribution yet and if so where can we find that?

Julie Smolyansky

Yes. There is – they are already on shelf in a handful of locations. You can check our Facebook and see exactly when new stores either start to stock them or even you could send a quick tweet over to our Twitter feed and you will be able to find them throughout the country, but there is a sort of starting to gain distribution.

Mitch Pinheiro - Imperial Capital

Okay. And then was there any – did you take any price increases in the quarter?

Ed Smolyansky

Yes. We took a 5% price increase, which started around May-June. That wasn’t a full cost before the price increase. So, we did not increase our organic offerings. We did not increase like probiotics, for instance. So, any of the organic milk-based products we did not increase and we also did not – we did not do a full 5% to all of our customers or most of them did, but some still that kind of niche markets. So, I would say it was probably you could take everything as a whole as probably in average of about 3% to 4% increase, if you just take them out in this side.

Mitch Pinheiro - Imperial Capital

And less than half that as an impact in the quarter?

Ed Smolyansky

I would say so.

Mitch Pinheiro - Imperial Capital

Run rate.

Ed Smolyansky

Yes, maybe two-thirds if it started in May, then it will probably be in May and June.

Mitch Pinheiro - Imperial Capital

Okay. And then just one last question, so what’s your – what’s the near-term outlook for milk cost?

Ed Smolyansky

So, they peaked basically in May and June and then we have started to see them slowly, little bit declined and they have kind of leveled off. And I think they are probably just going to probably stay somewhat leveled for the rest of the year, but they are about 5% to 10% down from the record highs in May-June or I am sorry April and May, still a little bit in June as well.

Mitch Pinheiro - Imperial Capital

Okay. Alright, thank you very much. I appreciate your time.

Julie Smolyansky

No problem.

Ed Smolyansky

Thank you.

Operator

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

Howard Halpern - Taglich Brothers

Congratulations. Great quarter guys.

Julie Smolyansky

Thank you.

Howard Halpern - Taglich Brothers

Have you started to see any economies of scale going on with the acquisition of Golden?

Ed Smolyansky

Yes, absolutely. I mean, you could see it in our numbers in fact compared to let’s say the first quarter, where Golden Guernsey was really not up and running yet. So, we have had a full one quarter, where we have been producing about 30% to 40% of our bottles. We have been processing about 70%, 80% of our milk. So, you have seen those margins increase from the first quarter of 2014 on basically the same set of sales or revenue numbers. So, the margins did expand and I think that, that is a very total sign and especially since milk almost was identical since in the first quarter. So, a lot of just raw material really did not move down that much or that significantly to have that impact of margins in the – margin improvement in the second quarter of 2014.

So, I think really the big driving factor was the online – becoming online of Wisconsin facility. And again, it’s still – we are still ramping up or still increasing production capacity. So, for instance in June, we received our organic certificate in Wisconsin and now we will be able to actually process the organic milk. So, probably in the third quarter, we will be processing 95% of all of our milk needs with organic coming on as well. And we will get our second bottle blow-molder up and running and so 30% to 40% blowing our own bottles, which again is the highest actual material cost of our product. We will be – we will double that capacity to about 75% to 80% of all of our bottle needs. So, yes, we are going to see more significant savings even in the third and fourth quarter.

Howard Halpern - Taglich Brothers

Okay. With a little bit of a drift in the milk prices down, how should we help margins going forward then?

Ed Smolyansky

Sure, absolutely.

Howard Halpern - Taglich Brothers

In terms of the Canadian launch, I know it’s pretty early, but how are you seeing that and what is – what would you like to see in the next year or two in Canada in terms of the number of stores?

Julie Smolyansky

It has only one week.

Howard Halpern - Taglich Brothers

Right, especially couple of weeks.

Julie Smolyansky

Yes, so the product does hit the shelf, yes.

Ed Smolyansky

Yes, right now, we are in all of the Safeways and most of the Safeways which is one of the kind of mass market retailers across the country. And then I think by this time next year, we should have 50% to 60%, maybe 70% of penetration very quickly because we know that the product has already sold well. In Canada, we were not able to sell. I believe starting in 2002, 2003 with the in core restrictions. But prior to that, we do know that we sold approximately $5 million worth of products on a very – with really only one very small distributor. We have a lot – our distributor now is very large. They cover the whole country, all the stores. So, we are very excited with that opportunity. And I think we will get very large or full penetration across the country and retailers by this time next year.

Julie Smolyansky

It’s a small market, I mean it’s a necessary market, but it’s no where near the size of the market in U.S. It only has a population of 30 million people. So, it’s necessary we should be there. It’s a market that is very European (indiscernible) have this high expectation on high quality food. So, and we have lots of customers who – for many years continued to remain loyal to Lifeway and continue to ask for Lifeway. So, our expectation is that we will hit $10 million in revenue with Canada in a very short while and our sales $10 million of sales and it’s a license agreement. So, in terms of our – really we have too much.

Howard Halpern - Taglich Brothers

Cash flow coming in…?

Julie Smolyansky

Yes. So, a lot easier for us and no operational demand on for resources just help with the know-how, help with marketing, PR, promoting the products and kind of creating the brand, but very limited operational resources on our app. So, it’s just a perfect opportunity, they are kind of getting that market, penetrate and let them do the distribution and that’s the trend.

Howard Halpern - Taglich Brothers

Is that also going to be a market where you think you will be able to slide into the frozen kefir as time goes on?

Julie Smolyansky

Yes, I think that we can – we can stale all of our successful product launches that we have had over the last few years everything from probiotic to frozen everywhere. It’s just a matter of getting the customers, getting the operations, getting the recipe down, working with the team that’s on the ground, but yes all of our successful products we would like to scale everywhere around the world, but that makes sense.

Howard Halpern - Taglich Brothers

Okay. And do you think you would be comfortable in saying that operating expenses should be in the range of may be 18% to 22% of gross sales going forward, do you think that’s a reasonable expectation?

Ed Smolyansky

Yes, I mean, our operating expenses are always fairly stable. It’s not going down as a percentage of sales. They are growing up a little bit – maybe a little bit more historically speaking because of the – getting online in Canada – not Canada but Wisconsin. So, yes, there is a lot of extra kind of ramp-up expenditures there and they are operating of course the labor pool is a little bit different than it is in Chicago. So, things like that will have an effect, but once that is complete in 2014 and 2015, this should be always historically I think operating income – I am sorry expenses should always be kind of in that 19% to 21% range.

Howard Halpern - Taglich Brothers

Okay. Well, thanks and keep up the great work guys.

Ed Smolyansky

Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Julie Smolyansky - President and Chief Executive Officer

Thank you for your participation today. We appreciate the hard work and dedication of our employees and the support of our loyal customers and shareholders. We look forward to sharing our third quarter of 2014 results with you in the next coming months. Thank you.

Operator

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

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Source: Lifeway Foods' (LWAY) CEO Julie Smolyansky on Q2 2014 Results - Earnings Call Transcript

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