Lifeway Foods Inc (LWAY) 2011 Q2 法說會逐字稿

Greetings and welcome to Lifeway Foods, Inc.'s second-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, [Katie Turner] of ICR. Thank you, Ms. Turner. You may begin.

Thank you. Good morning and welcome to Lifeway Foods' second-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 second-quarter earnings release for the period ending June 30, 2011. 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'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 and 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 statement. Lifeway [stands] no obligation to update any forward-looking projections that may be made on today's release or on the call posted on their website.

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

Hello, everyone. Thanks for joining us today. We are pleased to report that we generated record sales in the second quarter of 2011. Our record sales numbers were met with higher costs and greater expenses specifically attributed to a rise in -- the record rise in the price of milk, our largest raw material, and a one-time non-reoccurring marketing expense associated with our 25th anniversary national marketing campaign.

But despite these costs, we are still very pleased with our ability to grow and our top line and future increase of our cash flow generation. We continue to expand our product offering, retail shelf space, and increase our number of retail partners in the second quarter. We are extremely pleased with the launch of Lifeway Frozen Kefir.

Our frozen product began shipping to our distribution network in mid-April and it's the first kefir product to be so in the grocery freezer aisle, providing an extra healthy snack and dessert replacement for ice cream or frozen younger.

Lifeway's well-known kefir beverages and Starfruit frozen kefir -- Lifeway's Frozen Kefir contains 10 probiotics cultures, up to three times more than yogurt with only about half the calories, which helps stimulate digestion and support the immune system.

At the same time, our new frozen product will be an incremental source of revenue since this is the first time that Lifeway will be in the grocer's freezer section. Frozen Kefir is now available in approximately 2,000 to 3,000 retail locations by the end of second quarter and we believe that we can continue to grow distribution in the US significantly.

In the second quarter, as we mentioned on last quarter's call, Lifeway celebrated its 25th year anniversary with an 11-week coast-to-coast marketing tour that provided feature sampling of multiple kefir beverages, flavors, games, prizes, and a retro theme hearkening back to the Company's roots in the 1980s. We also marked our 25th year of -- 25 years of active culture with a limited edition of Lifeway birthday cake flavored kefir that has been so popular that it will remain on our kefir lineup indefinitely.

We also handed out 30,000 samples of our Frozen Kefir over the course of 60 days. We were overwhelmed with the positive consumer feedback and responsiveness to our marketing campaign. This is visible by the tremendous interest in the product via Twitter, Facebook, blogs, traditional media, and it's already translating into sales and more retailers.

We continue to explore new and innovative ways to reach our consumers specifically at events like Taste of Chicago and Lollapalooza where we sold more than 20,000 units of Frozen Kefir at Taste of Chicago and over 25,000 units of frozen kefir at Lollapalooza. These two events provided us with the unique opportunity to showcase our frozen product to a variety of different consumers who we might not otherwise reach specifically here in Chicago, but considering both of these events are even international events, this will help our reach outside of Chicago.

In addition, we have the opportunity to expand our international kefir distribution with the launch of Frozen Kefir in the UK in the near short-term future. We are very excited about this launch and believe that it will lead to further retail distribution in the UK and Europe. Lifeway continues to be better positioned than ever to capitalize on the future growth opportunities in the US and internationally.

A great example of this is the shipment of kefir to Costco Japan. Our product will begin shipping this month and while we do not expect the sales to be generated from Costco Japan to have a big meaningful impact, we do believe that long term we can continue to increase sales with further expansion into Costco in other countries.

Frozen Kefir -- frozen yogurt continues to be a strong growth segment and our Starfruit Cafe business is riding the same wave. We continue to see demand expanding from our afternoon desert to both a breakfast and lunch meal replacement. Starfruit Cafe comparable store sales were up 10% as compared to the same quarter last year.

Today, the kefir industry represents approximately $150 million in annual retail sales and we believe the industry is growing in excess of 20% as new people every day are learning about kefir and its many benefits. In addition, the drinkable yogurt category is roughly a 300 million based on -- category based on IRI data. Lifeway has only begun to realize our marketing -- market-leading industry position. Over the last 25 years we have built a huge base of kefir customers and that continues to expand as more people look for a natural, healthy, convenient food option that also tastes great.

That is something to celebrate, both for us and for our consumers.

Going forward, we continue to expect 2011 to be a year of record sales and profitability. And now, I'd like to turn over the call to Ed to review our second-quarter 2011 results in more detail.

Thanks, Julie. I will now review our financial results for the second-quarter 2011 in a little more detail.

Second-quarter 2011 gross sales increased 28% to just under $20 million, $19.915 million to be exact, from $15.5 million for the same quarter in 2010. This increase is primarily attributable to obviously the increased distribution and sales of our flagship line of kefir as well as the ProBugs Organic Kefir for kids and, of course, the additional successful introduction of new product lines such as BioKefir and the Frozen Kefir, which was launched in April 2011, in that the Frozen Kefir line in just a few weeks has already contributed to $0.25 million in revenue for the second quarter.

Gross profit for the second quarter of 2011 decreased 3% to $7.3 million compared to $6.4 million in the same period a year ago. Our gross profit margin decreased to 29% in the second quarter versus 39% in the same period last year.

The majority of the gross profit was -- majority was negatively impacted by the obviously increased pricing of milk, transportation, and the other petroleum-based production supplies. The cost of milk was approximately 35% to 45% higher in the second quarter of 2011 when compared to the same quarter in 2010. This increase was partially offset by the USDA reclassification of our kefir drinks to a Class II product, but still it was still even then about 45% to 55% higher.

The cost to purchase that Class II milk is approximately 10% lower than compared to the existing Class I fluid milk price. So even though we did have some benefits, the whole complex of milk rose almost 50%.

The change of from Class I to Class II which started in January of this year should have a positive impact going forward on what we pay for our key ingredient, which is milk, and that is about 80% of our products cost of goods sold. In addition to having a positive effect on gross margins, the improved input cost will also allow our high-value probiotic kefir-based products to be more competitive with other non-Class I milk products such as yogurt and drinkable yogurts in the marketplace. And this expected increase in cash flow will provide us greater financial flexibility and enable us to have the opportunity to invest marketing efforts and retain cash for future initiatives.

In addition, please keep in mind during the second quarter of 2011 we purchased 30% more milk obviously of our revenues and the shipments were up 30%, we purchased 30% more milk. And to try to partially offset the increases in raw materials, we have implemented a 5% price increase which started July 1 of 2011.

Operating expenses as a percentage of net sales were approximately 25% during the second quarter when compared to the same quarter -- I'm sorry, when compared to 24% during the same quarter in 2011. So basically the -- we are seeing a lot of leverage from the operating expense side and especially from the general -- or general and administration side.

The increase of that 1% was primarily due to a $1 million increase in selling expense to $2.8 million of which -- which is important to note $700,000 of that $1 million increase in selling and advertising expense, $700,000 was directly attributable to our cross-country mobile tour. We view this $700,000 expense which was recorded during the second quarter as a nonrecurring advertising expense.

After all you only turn 25 once.

Operating income decreased to just above $700,000 during the second quarter of 2011 compared to $2.2 million during the same period last year. Decrease is obviously due to the increase in advertising expense as well as raw materials as we've discussed before.

And the provision for income taxes was about $380,000 or a 60% effective tax rate for the second quarter compared to $1 million or a 40% -- excuse me 47% tax rate during the same period last year. In addition to the higher effective rate, our tax expense was higher due to a Minnesota State Department of Revenue audit from 2006 to 2009, which resulted in approximately $89,000 in additional taxes being paid which were all recorded during that second quarter of 2011 and, again, something that we view as a nonrecurring tax expense.

We reported net income of $265,000 or $0.02 per diluted share when compared to $1.2 million of earnings or about $0.07 per diluted share during the same period last year.

I am not going to go too much into the six months' review because it's basically the same type of the story, but for cash flow, net cash provided by operating activities was about $850,000 during the three months ended June 30, 2011, to the decrease of $1.4 million when compared to the same period last year.

We had a net increase in cash and cash equivalents during the second quarter. Cash and cash equivalents for the six-month period were $1.4 million compared to cash and cash equivalents on hand of $860,000 during the same period ended June 30 of last year.

In conclusion, as Julie mentioned, we believe we are better positioned than ever before to realize future growth in the US and abroad with our kefir line. That being said, we believe raw material headwinds we experienced in the quarter are behind us and we expect to see an improvement in gross margins going forward. We also anticipate a tax rate when all the four quarters get blended to come down to our traditional 36% to 40%.

Keep in mind, Illinois also raised its income tax on corporations this year by 2%. That will -- obviously will also factor into a slightly higher tax rate, but that should all blend down to around like I said 38% for the year.

That concludes our financial overview and we would now like to open the call to the questions.

(Operator Instructions). Howard Halpern with Taglich Brothers.

Congratulations on your 25th anniversary. First question and I did some back of the envelope calculations for this quarter. Would you -- would it be fair to say that approximately $2 million of the cost of goods sold increase from the first quarter of this year was due to purchasing more milk and the price rise in milk with the remaining -- the petroleum cost?

Yes. Obviously from if we look at the quarter in the sequential model, so if we're comparing the second quarter to the first quarter, sales rose from $19 million to $20 million, which is about 10% there. So the purchasing of the milk obviously has gone up as well and the purchase cost of the milk has also gone up. So the higher price of the milk is actually greater exacerbated because we are purchasing more and more as the quarters go.

And have you done any kind of -- not so much for the milk because I know that is a variable that is uncontrollable, but for the petroleum costs, have you taken a look at -- I mean, maybe different types of innovative packaging and how to transport to, differently maybe, to mitigate increase some efficiencies if the price of oil were to go up again or continue at these high levels?

Well, we are starting to see it come down and so the trucking companies are lowering their fuel surcharges, but they are not going to be going down to levels that they were at two or three years ago obviously, but they are coming down. And yes, as far as changing our packaging we always are looking for better suppliers and we found suppliers from other countries, other continents that are lower in price.

But really at this point we can't change -- we cannot change our packaging too much because that is what our branding is. You know. we can't jeopardize future growth of our revenues and our brand by trying to save a couple of cents on packaging here and there.

Okay. And with the -- when you move internationally maybe this question is more directed to the UK because Japan costs obviously don't do Costco, but to get to the UK and to distribute there, how are you going to go about doing that? Through a licensing agreement, through -- what are the logistics of it?

Well, we are using, it's not exactly a licensing agreement. It's our brand, the Lifeway brand and I don't want to go into too much detail just yet, but just to say that there's a strong possibility that we will effectively be able to launch our brand there by summertime (multiple speakers).

So we are working on that strategy or getting the pieces together to implement the strategy that we set course throughout the year.

Yes, we don't necessarily envision us investing in building our own facilities.

Right. No (multiple speakers).

So it would probably (multiple speakers) co packing development agreement with an existing manufacturer of these products.

So that would then mitigate some of the shipping cost so it would be a prop -- it wouldn't only be a sales venture, it would be a profitable venture too?

Well, yes. Correct. We hope so.

(multiple speakers).

Okay, you know, the logistics costs of transporting overseas --.

No, no we won't be exporting out -- those costs are just not possible.

That's what I wanted to make sure. Of the tour, the $700,000 increase is and I know that's one time for the celebration, but is any of that going to remain to some degree as you keep on with the different types of promotions you have at [that point]? Or can we assume that sales costs are going to go back down to the $2 million to $2.3 million range in the future?

Yes. I think it is safe to say that we, obviously, we will be as our [end] business increases, our advertising budget will obviously increase with it. But it will go up as much as sales go up or less. We budget for it.

And the tour is simply something that is not going to occur in future quarters. So you are going to see that selling expense come down probably by $700,000 or maybe $650,000 or something like that. Obviously we are going to -- we continue to do advertising and promotions, but we don't have shipping and place that is so capital-intensive like that tour coming up in the future.

And so expansive. I mean that was sort of a way to get through coast to coast in some of the top markets in the United States and you really can't do that without sort of an organized effort or --. But we still do obviously grass roots and sampling and when we launch a new product, we have to -- there are -- components of that is sampling. So NPR and all of that. So it will just -- there's always a different story to tell and the tour is a way by which to garner a more [pricing] sampling and all the other things.

And of the 2,000 to 3,000 retail locations you are in with the new Frozen Kefir, how many distribution points are you at and then how many more distribution points to get into greater number of retail locations do you envision by at the start of the fourth quarter?

Well, when you say distribution points do you mean each facing on each store?

No, I mean how many, I guess, distribution hubs so if you are in Kroger, how many distribution places are you -- all right, you know warehouses are you in and then how are you going to migrate those warehouses?

I don't know how many exact warehouses we are in, but just based on -- like I had mentioned a little bit earlier, we are in 2,000 to 3,000 retailers with Frozen today. So in terms of exact -- you know we are in most of the Whole Foods. We are in Wegman's, we are in [Dominic's], we are in Whole Foods, we are in [Select Jewels], we are in Ralph. I mean, the list goes on and on, but exactly how many of those stores it's hard to tell. They don't always tell us, the distributor picks it up and not every retailer checks in that they've purchased that.

But we can tell that it's getting to be somewhat significant and there's a story now to tell. And I think for next -- for the summer season next year I think we'll have a really good story to tell from this past history, just this last year --.

And where is the biggest region that you want to go to next? Is it like the Southeast or the Florida region or California?

I mean, we are national. We don't, we're not (multiple speakers).

I mean, where do you want to push though for the next big you know because I know you are going to be national, but you have to start in a different location so if you were to go to Publix or Ralph's, or you know is there one area where you want to -- I know the Northeast is a bear to get into because they're messed up in there -- how they distribute, but is there one area that you really are pushing toward next?

No, not really any particular one area. See, the other thing is every retailer is buying on their own calendar. So somebody is looking at frozen in April. Somebody is looking at frozen in October. We are selling it based on the appointments that we can get as to when the category reviews are at each of the retailers. So it's based on their calendar, not ours.

Okay.

And of course the South, of course, the South and the Southeast are better places for this type of a product because it is more -- it's warm there, more --

Throughout the year.

Throughout the year versus --

The California is kind of a great market for us with Ralph's and all the Whole Foods originating there and -- or the bulk of them originating there. So the South is always great year-round and as we cool up in the north part of the country, we will be kind of a little bit more focused on the South, but again, we are really focused on the calendar of the retailer, not any particular region. We will take whichever appointments we will get.

One final one which is -- well, let me go back in the queue and congratulations and hopefully we will celebrate another 25th year in another 25 years.

Thank you.

Thanks. Something else that I wanted to mention, Howard, I don't know if it's -- we also have been -- it is in our press release, I believe, but we have also been accruing for fourth-quarter bonuses as we stated. So in the first six months, we accrued $100,000 in expense that is traditionally paid out in the fourth quarter. But this time, this year, like we said in the fourth-quarter call, we are trying to spread it out over four quarters evenly, so it cannot take a $300,000 experience all for Christmas bonuses or holiday bonuses, whatever.

So that is also included in there and that's $100,000 expense for the first six months.

Sounds great and congratulations on 25.

Thank you.

James Fronda with Sidoti & Company.

The other analyst actually asked a lot of my questions, but I guess could you guys talk about -- are there any new products that you guys thought about going forward for 2012, I guess?

Well, we're -- we have several products in the pipeline and we explore that we always internally explore when the best time to launch is, given the success of some of the products that we launched in 2011 already, as well as the last quarter. And I will say BioKefir was launched in the last two months of 2010 and Frozen launched this year.

So we consider these guys kind of a lot of priorities that we are focusing on them to give them a successful launch and not spread too thin. But also at the same time, like I said, there are several new products in the pipeline that we are anticipating on launching within the next 12 months, let's say.

Okay. And in terms of the Starfruit Cafe business, I mean have you thought about expanding that in terms of a franchise or any moves on that?

Well, we have thought about expanding into franchises and we've gone through the licensing procedure and all of the regulations to start to sell those, so we are looking at how we could explore that franchising opportunity. And if you know of anybody feel free to give us a call and let us know.

But we also have this new food truck, that's our fruit food truck which is -- that's wildly popular. So that's another opportunity that the truck itself can be expanded upon, not just the stores. But we view the stores more as for us a marketing platform for kefir in general, at least here in Chicago. And we would love to see it expand if an entrepreneur would be interested in partnering with us in other markets.

Thanks.

Yes, it's a great platform for us to test new products potentially as well as the Frozen -- Lifeway Frozen Kefir really was born out of the Starfruit concept and without the Starfruit stores being around we probably would never have launched a time for frozen products for retail.

All right. Thanks, guys.

(Operator Instructions). Ivan Zwick with Raymond James.

A lot of my questions have been answered, but I do have a few things I want you to maybe expound on a little. On this tour that you did that you spent $700,000, we are six weeks into the new quarter. Can you tell if it's had a pretty major effect just on your sales in areas where you went and that sort of thing?

Our sales are up already almost 30% roughly. So I think that's a positive factor. We can also see, like I said, it's a tremendous pop in followers on Twitter and Facebook and a definite increase in the blogging and mention. So I think that that's -- it's really hard to say it specifically because of the tour, but anything that increases that buzz and sales and all of that is, I think, is going in the right direction.

So the first part of the quarter you are up about 30%. So I'm sure that has had an effect on it.

Yes, well, I mean we were up 30% before the tour and we are up 30 -- you know this year is going to be that 25 call it percent growth, but the tour is something that --. It's very difficult to pinpoint and measure, but it's something that has long-term effect. It's something --.

And we don't note that if we hadn't done the tour would we be up 30% or would we be flat. Let's not forget that there is still somewhat of a turmoil within the economy and there is still a recession. So the fact that we are up 30%, I think so far we are doing the right thing to keep going even if that cost is a little bit more to push the brand, push the product, and what not.

But we did not retreat, let's say, through this. And so I think that that's showing a positive impact and a worthwhile investment.

Okay. And I assume this quarter we are going to be getting down close to normal tax rate, Edward, from what you said going forward. On the frozen yogurt, can you tell from the --.

It's kefir, Ivan.

Pardon?

Frozen kefir.

I'm sorry, frozen kefir. My mistake. That is a big mistake. Anyway, on the frozen kefir, the only monitor I've got we finally get on our [Kroger] store in two flavors, plain and strawberry, but they are just blowing it out of there. But can you tell from the stores you've already got it in earlier because they've only had it here like a couple of weeks, are you getting substantial reorders? Can you tell from that if it's really having a big impact?

Yes. I think it's one of the best launches that we have ever done.

Okay and do you have a ballpark figure when you get this out to the places you want that you know you are getting to distribute to, what it could mean for on an annual basis in sales?

That is so hard to tell right now. I think it could potentially -- I'm not going to draw numbers, but I think is one of the best launches we've had. I think it is one of the most unique and innovative products. We are first to market with this tart and tangy healthy dessert alternative. I think it's a natural winner.

This one, it's a home run and I think it's got global potential. I think it is the product that potentially can be a platform to grow on globally.

And while we are talking about the global thing that you just mentioned before talking, where like by the end of next year with your license or [call] or however you would do it, where do you envision yourself outside of the country besides the UK?

We have our sights set on Europe, but the UK and the let's say Russian, Eastern Europe. We have our sights on a few other countries, but we are going to test with those two countries.

Okay. Also and Edward mentioned about these, some of the expenses mitigating in this quarter, I guess you are referring to the milk and to the oil-based thing. Is it going to be fairly substantial do you feel in this quarter from what you are seeing for the prices you are starting to pay?

Yes. They are heading in the right direction for us. How substantial will it end up becoming, I don't know. The price is really, I don't even know what September's prices are yet. So they just don't come out that far in advance. The market is looking like it is coming down for everything, but is it going to come down that 30%? Who knows? (multiple speakers).

But I think as stated in a press release and in our discussion analysis that our largest cost of goods sold, which is milk, has hit I think its record high for a couple of months in June, June and July, and looks like at this point it's -- it peaked and now is going to go through its traditional three- to four-year cycle. Which, three- to four-year cycle for this commodity from peak to valley back to peak. We saw record high milk prices about 3.5 to four years ago and about a year and a half they were record low. So as anything with supply and demand goes, looks like we are heading back into the other direction which is good for us.

And I just also wanted to touch one little thing. As we were sitting on his call and I was thinking about the recession and sales and growth and whatnot, I would like to remind everyone that I think was, I don't know the exact date when they declared the recession, but in 2008 our sales were roughly about $40 million. And today we are going on trending on like $80 million by 2011. So in three years we have doubled our business in a recession.

That's pretty outstanding in my opinion and I don't know how many other companies are doubling their business in three years in a recession. So I just want everyone to know that that's a pretty good factor for this Company.

And I've just got one final question. Can you -- on the Wal-Mart distribution, can you tell me what's happened with it? Is it picking up and I haven't seen the frozen kefir.

The frozen has not -- is not going into Wal-Mart yet. But we have doubled the Wal-Mart business this year.

Okay.

We doubled the amount of stores.

Right, but are you going into some more of their distribution centers?

Right. Exactly. Into more distribution centers.

Yes, we are also looking at other of their chain stores so like Sam's Clubs and things like that and BJ's and all the other clubs, club outlets. It's not just Wal-Mart.

All right. Thanks a lot. Business is good and let's have another good year.

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

Thank you for joining us on the call and we look forward to another outstanding 25 years, another two great quarters to wrap up the year and hope everyone has an enjoyable end of summer and we will see you here in about three months or so.

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

Thank you.