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Operator
Greetings and welcome to the Lifeway Foods first quarter 2011 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. It is now my pleasure to introduce your host, Ms. Katie Turner of ICR. Thank you Ms.Turner, you may begin.
- ICR
Thanks. Good afternoon, and welcome to Lifeway Foods first quarter 2011 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, 2011, which went out this afternoon at approximately 4.05 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 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 posted on their website. With that, I'd like to turn the call over to Lifeway's CEO, Julie Smolyansky.
- CEO
Thank you for joining us today. We're extremely pleased with our overall performance in the first quarter of 2011. It was our best quarter ever, from the top to the bottom lines. We continue to expand our product offerings, retail shelf space, and increase the number of retail partners. We continue to see Lifeway Kefir products gaining strong consumer awareness as our increased marketing initiatives enable us to report accelerated sales growth of 25% to $20 million after adjusting for the one less Friday in the first quarter of 2011.
Today, the Kefir industry represents about $150 million in annual sales, and we believe the industry is growing in excess of 20% as new people every day are learning for the first time about Kefir and its many benefits. In addition, the drinkable yogurt category is roughly $300 million, based on IRI data. As we celebrate our 25th anniversary, we believe Lifeway is extremely well positioned to see tremendous future growth opportunities.
As part of our focus on increasing awareness and long-term growth of our company, on May 16 we will be finishing an 11-week, coast-to-coast 25th anniversary Kefir marketing tour in New York that will provide feature sampling of multiple Kefir beverage flavors, human-powered blender bikes, making Lifeway Kefir smoothies, games, prizes, and a retro-theme hearkening back to the company's roots in the 1980s. The tour raised $25,000 for Healthy Kids Challenge, a nonprofit organization that promotes healthy eating and physical activity for children. Lifeway pledged to donate a dollar for every minute pedaled on the blender bike by tour guests. We chose Healthy Kids Challenge as a charity because the organization shares Lifeway's commitment to good nutrition and a healthy lifestyle, as reflected in the low-fat, low-calorie, probiotic properties of Lifeway Kefir.
Lifeway has also marked its 25 years of active culture with a limited edition Lifeway birthday cake flavor that has been so popular that it will remain in our Kefir lineup indefinitely. Another great example of the growth we have had is the introduction of Lifeway's new Good for You frozen yogurt alternative, which is the latest edition to an extensive line of Kefir dairy beverages and associated probiotic foods. Our frozen products began shipping to our distribution network in mid-April, and it's the first Kefir to be sold in the grocery aisle, providing an extra healthy snack dessert replacement for ice cream or frozen yogurt. At the same time, our new frozen products will be incremental source of revenue, as this is the first time Lifeway will be in the freezers grocer section.
Like Lifeway's well-known Kefir beverages and Starfruit Frozen Kefir, Lifeway Frozen Kefir contains 10 live probiotic cultures, which is up to three times more than yogurt with roughly half the calories. This helps stimulate digestion and support the immune system. The new pint-sized containers of Lifeway Frozen Kefir are available in strawberry, pomegranate, mango, and original flavor. The original flavor is also sold in a 3.6 ounce single serve size package with a spoon. The first stores to carry the product range from New York's Food Emporium, Gristedes and Key Foods, to Fresh Market, Price Chopper, Wegman's, Kroger, Ralph's and Jewel food stores in Chicago. Already, over 3,000 retailers are stocking Lifeway Frozen Kefir and every day new retail partners are signing up to bring these in.
As a reminder, in the latter half of 2010, we increased our marketing and advertising investment in order to benefit the increased national attention in Kefir and educate the consumer on our many years of innovation and great tastes. We have dramatically increased customer awareness of Kefir and great examples of this is our large following on Facebook, as well as increasing our website traffic by over 70% compared to the first quarter of 2010. In addition, we're very excited about the opportunity for consumers to follow Lifeway on Twitter. We will post new locations on Lifeway's Facebook page and Twitter account as Lifeway's Frozen Kefir reaches their doors.
Frozen yogurt continues to be a strong growth segment and our Starfruit Cafe business is riding the same wave. We continue to see demand in expanding an afternoon dessert to both breakfast and lunch meal replacements. As we previously mentioned, we're also expanding our Starfruit Cafe this spring with the location within the Chicago Cubs ballpark, Wrigley Field. We believe this will be a tremendous marketing and sales opportunity for our frozen products and symbolizes the growth and crossover of Kefir into mainstream.
Over the last 25 years, we've built a huge base of Kefir customers that continues to expand as more people look for healthy, natural, convenient food options that also taste good. This is something to celebrate, both for us and for our customers. Going forward, we continue to expect 2011 to be a year of record sales and profitability. Now, I'd lake to turn the call over to Ed for his review of our first quarter 2011 results in more detail.
- CFO
Thanks, Julie. Now, I will review our financial results for the first quarter of 2011 in a little bit more detail. First quarter sales rose 19% to just over $19 million, compared to $16 million for the same period in 2010. This increase again is primarily attributable to increased sales and growing awareness of Kefir, and well as our ProBugs organic Kefir kids' line, and the successful introduction of BioKefir, which was launched in late fall of last year. During the first quarter of 2011, we had one less Friday based on the Thursday calendar and date of March 31, and it is significant because we ship 60%-70% of our weekly shipments on Fridays. That's how we record our revenue. So, in the first quarter, we only had 12 full ship weeks versus a full 13 quarter ship weeks in 2010. Going forward, the second quarter and the third quarter will each have a full 13 ship weeks, as will the fourth quarter.
Gross profit for the first quarter of 2011 increased 14% to $17.3 million compared to $6.4 million in the same period a year ago. Our gross profit margin decreased by 1% to 42%, versus 43% in the same period of 2010. Gross profit was impacted by increased prices of transportation and other petroleum-based production supplies like plastics, labels, and corrugated boxes. These were partially offset by the decreased price in conventional milk, which is our largest raw material. The cost of milk was about 5% lower during the first quarter of 2011 compared with the same period a year ago.
Beginning January 1 of this year, the USDA reclassified Kefir drinks as a class two product, and therefore the milk used to produce Kefir carries historically about a 10% lower price per pound compared to the existing class one fluid milk level. As a reminder, January 1, 2011, the USDA did reclassify Kefir drinks into this yogurt category because they do not directly compete with class one fluid milk products, and therefore the milk used to produce Kefir should not be priced at that same class one fluid milk level. Kefir is often consumed as a healthy snack or a meal replacement, similar to that of yogurt, and therefore should be priced at the class two level, which again, has historically been the way yogurt has been priced. So, this change from class one to class two, which took into effect for the first time in the first quarter, should have a positive impact on what Lifeway pays for its key ingredient, which is about 75% to 80% of the product's cost of goods sold.
In addition to having a positive effect on gross margins, the improved input costs will also allow all of our high-value probiotic Kefir-based products to be more competitive with other products of similar nature, such as yogurts, that are in the marketplace. This expected increase in cash flow will provide greater financial flexibility and enable us to continue to invest in our marketing efforts and, of course, retain cash for future initiatives.
Operating expenses as a percentage of sales were approximately 23.2% during the first quarter of 2011. That's compared to about 24.5% during the same period a year ago. So, in that portion, total advertising costs were about $4 million when compared to $3.1 million for the same period last year. Operating income did increase about 20% to $3.3 million during the first quarter, compared to operating income of $2.7 million in the same period last year. As a percentage of sales, net sales, our operating income increased 40 basis points to about 19%, compared to about 18.5% same period a year ago. Total income before taxes increased by approximately $540,000 or 20% to $3.2 million from $2.7 million the same period a year ago.
For taxes, for the provision for income taxes for this period was $1.3 million or a 40% effective rate during the first quarter, when compared to $900,000 or a 34% effective tax rate during 2010, so our effective tax rate had increased about 6% from the same period a year ago. We are pleased to announce that we reported net income of $1.9 million or $0.12 per diluted share compared to net income of $1.8 million or $0.11 per diluted share in the same period a year ago. Net cash provided by operating activities was $1.2 million during the three months ended March 31, 2011, which is an increase of about $55,000 when compared to the same period last year. We had a net increase in cash and cash equivalents of $1.4 million during the first quarter, compared to the same period last year. We ended the quarter with cash and cash equivalents of $2.1 million, compared with cash of about $700,000 at the same time last year for March 31.
With that, that concludes our financial overview. We'd like to now open the call to your questions.
Operator
Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. (Operator Instructions) Our first question is from the line of James Franda with Sidoti & Company. Please go ahead.
- Analyst
You said you guys had rolled out the new product, the frozen product, into 3,000 retail locations. Can you give me an idea of what's that going to grow to going forward? Is it going to double? Can you give me an idea of more color on that?
- CFO
Currently, what we hope to achieve with the frozen product is to achieve what we've done with our regular Kefir line. So, our regular Kefir line is in about 10,000 retail stores, maybe 11,000 depending on who's reporting, and currently the frozen has been launched in about 3,000. If we can replicate that number, that's kind of our goal, is to be in all of those same stores.
- Analyst
Great. Going forward, do you think the selling expenses are going to come down a bit in the back half of the year because of less marketing going on and advertising?
- CEO
Well, I don't think that there's going to be less marketing or advertising, because we continue to grow, so we need to continue to support that business and growing the business. So, we're not in a completely saturated market. There's still lots of opportunities and to capture that. Now we have very strong momentum. We are (inaudible) it will continue to be consistent.
- CFO
Yes, we want to make sure that we don't lose the momentum that we've gained in the last 2 quarters.
- Analyst
Right, makes sense.
- CFO
Like I said, the first quarter was actually one of our largest growth quarters that we've seen in a handful of years. I think if I look back, if my memory serves me correct, I don't think we've achieved 20% revenue growth for 3 or 4 years. We want to make sure we're capturing this momentum and we're engaging with our customers and all that.
- Analyst
Right, and in terms of the tax rate, it was a little higher than I had forecast. Going forward, is it going to be around this 40% range, or a little lower, maybe 34%?
- CFO
When it starts to get blended, I think it might come down a couple of points as it blends throughout the rest of the year, but keep in mind, Illinois raised its income tax rate starting in January 2011 by 2 percentage points. So, that's kind of where I think a little bit of that increase is.
- Analyst
All right. Great job, guys. Thanks for your help.
Operator
(Operator Instructions) And our next question is from the line of Howard Halpern with Taglich Brothers. Please go ahead.
- Analyst
Congratulations, guys. Great quarter.
- CEO
Thanks.
- Analyst
In the press release, you talk about the advertising expense to approximate 9% to 10% of sales. I'm assuming that's gross sales. Am I correct?
- CFO
Yes, that's on the gross sales side. And that takes into account 2 portions. If you look at our income statement, you will see basically a new line item, which is our promotional off-gross sales activity, and then our actual hard advertising costs. Combined, we can consider that, let's say, a marketing bucket.
- Analyst
Okay. And do you have any general guidance maybe on the percentage breakdown that we'll see? Is it going to be a 50/50 split between promotional discounts and allowances, and then dropping into the sales line?
- CFO
That's hard for us to say right now because we have all these new products coming out, and they do require to partner with the retailers for slotting and for promotions and things like that. We try to target that promotional kind of discount level at about 7%, and if sales are growing at 20% to 25%, it's safe to say that will probably grow at 10%. We always try to capture and try to be around 7% for that number.
- Analyst
Now, is slotting fees and gaining the shelf space for the frozen product different than the traditional dairy shelf?
- CEO
No, it's about the same.
- Analyst
About the same. Okay.
- CEO
But we generally haven't -- we don't generally pay a lot of slotting dollars. We kind of weigh out the costs of the slotting versus maybe taking a little bit of extra time to get it on the shelf. But with this product, because it's going to be more seasonal, we want to make sure that we hit this summer so that next summer we can have a really good story to tell. That's why we might be pushing a little harder.
- Analyst
What kind of activities are you going to -- are you going to have a lot of in-store promotions for the frozen product?
- CEO
Demos -- not as much promotions as much as demos, because the product is such a superior quality and taste. From our small market research, everyone has said that this thing is just really delicious and that the key to it is just getting it in the hands of people to try.
- Analyst
So it's one taste for the customer and the kids in the store and -- .
- CEO
And you have a lifetime consumer, hopefully.
- Analyst
And where within the frozen section will it be placed? With all of the other frozen yogurts?
- CEO
Yes, with the different frozen yogurts and gelatos and specialty premium products.
- Analyst
Whole Foods has not yet picked up -- ?
- CEO
Yes, they have as well. Different regions. They are rolling it out in different regions.
- Analyst
Okay.
- CEO
Eventually -- .
- CFO
By next spring, it'll be in all -- it should be in all those Whole Foods stores. Some of them are on different schedules and take different times to bring in different items like a frozen or a perishable product.
- CEO
Pretty much going forward, if you want to know -- I really urge everyone to get on Twitter and to follow Lifeway, because we are basically going to not use press releases to announce new stores. We feel there's a -- it's costly to put out a release, and Twitter is an economical way to notify people of store-by-store launch. So, if you want to know where it's going, I suggest that you follow the feed.
- Analyst
Okay. So it's going to be social media-driven by where it is and the reaction of people -- .
- CEO
That's part of the strategy on launching it, is to create a social media component of a desire and need to follow the Twitter feed. And specifically, under the hash tag, frozenkefir.
- Analyst
And in terms of capacity, do you have enough capacity if you were to reach that 10,000 retail store level within the next 6 to 8 months?
- CEO
Yes.
- Analyst
Okay. And then, should we look at that 5% as really the baseline in decline in the milk price from -- I guess driven mostly from the reclassification? Is that -- ?
- CFO
Yes. It's hard to say going forward because the prices are forecasted to be up a little bit for the average and duration of the year. So we'll see some benefit, but it might not translate directly into 10% because -- I've stated this on the call before. If for the rest of the year milk prices are up 10%, but we see a 10% savings, we're just where we were last year.
- Analyst
Okay. For modeling purposes, that 5% decline to flattish is a fair estimation to gauge at this point?
- CFO
I think so.
- Analyst
Okay, guys. Well, keep up the great work.
- CEO
Thanks.
Operator
(Operator Instructions) Our next question is from Ivan Zwick with Raymond James. Please go ahead.
- Analyst
Hello, Julie and Edward, we're back to the old days. This is a great quarter. I just have a few questions to ask you. Is there any update on anything new happening with your food service area of the business or the Starfruits franchises?
- CEO
Like 7-Eleven, you mean, for example? Or -- ?
- Analyst
No, I just -- well, I knew you were in 7-Eleven. I think now they've been rolled out to the company-owned 7-Eleven stores in other parts of the country after the Chicago test. But I was just wondering if anything new on the franchising of the Starfruits or anything else in food service, in that part of the business?
- CEO
Well, like I said, we have Wrigley Field, Starfruit's in Wrigley Field. There's also a couple of other locations that Starfruit is going to be going into this summer through Levy restaurant group, but we haven't announced that yet. There is an announcement in the future in the next couple of weeks. That's through Levy. And we are in talks with a number of franchisee potential people who are interested. But nothing has been close to even -- there's nothing signed, let's say. So, it's just in talks.
And in terms of the other food service opportunities, so the Kefir's in 7-Eleven and a handful of other convenience store locations, but it is an ongoing process. There is an airline that is interested in the product with the little shots. Those new little 3 ounce shots are kind of what the airline industry is looking for, so that's another big opportunity coming down the pipeline.
- Analyst
And what about Wal-Mart? Can you give us an update on if they're expanding? I know they're doing real well in the store in my town.
- CEO
Yes, they are expanding. We just doubled our shelf space through Wal-Mart. So, that's doubled the store distribution, I would say.
- Analyst
Okay. And I think you mentioned Kroger. They've already accepted the frozen product?
- CEO
Yes.
- Analyst
Okay, because it's not here. I'll try to get it in the store.
- CEO
It just takes time to get that network going, to get it working through the pipeline from the purchase order to the shipping, to getting it on the trucks, to getting it into their warehouse. For them to start to distribute, it's a couple of weeks, but it's coming. If you maybe nudged your store manager, that would be appreciated.
- Analyst
I know the last gentleman asked if you had the capacity to handle the 10,000 or 12,000 locations on the frozen, if you got it in the next 6 months, and you said you did. I tasted that product over a year ago when you first came out with it, and I think you'll be there. That span of time is far superior to everything that it competes with.
- CEO
Absolutely. I agree with you.
- Analyst
Keep up the good work. Quarters like the good old days like you just came through with.
- CEO
Thanks. I think they've always been good quarters.
- Analyst
Well, but this was outstanding.
- CEO
Thanks, Ivan. As they say, it's a marathon, not a 5K.
Operator
We have no further questions in the queue at this time.
- CEO
Okay. Again, we are ringing the closing bell on May 16 in Times Square. We invite anybody who'd like to be there to celebrate with us. The 16th is actually the date of incorporation 25 years ago, and we've come a long way, and it's been absolutely our pleasure and joy to watch this and have a hand at creating something that is so special. We thank you for all of your support and investment, obviously. Together, it's a wonderful story. So, we'll see you on the 16th.
Operator
Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.