Lifeway Foods Inc (LWAY) 2016 Q3 法說會逐字稿

Greetings, and welcome to the Lifeway Foods' Third Quarter 2016 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to Hunter Wells of ICR. Thank you, Ms. Wells, you may now begin.

Good morning, and welcome to Lifeway Foods earnings conference call to discuss the company's results for the third quarter 2016. On the call with me, today are Julie Smolyansky, President and Chief Executive Officer; Ed Smolyansky, Chief Operating Officer; and John Waldron, Chief Financial Officer. By now, everyone should have had access to the release, which went out this yesterday afternoon at approximately 4:05 p.m. Eastern Time. If you had not received the release, it is available on the Investor Relations portion of Lifeway's website at www.lifewaykefir.com. 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 calls posted on our website. And with that, I would like to turn the call over to Lifeway's CEO, Julie Smolyansky.

Thanks, Hunter, and thank you to everyone, who's joined us on today's conference call. I will begin by providing an overview of key business highlights for the third quarter of 2016, and then I will review our strategic initiatives. Next, John will discuss the quarterly and year-to-date financial results in more detail. Finally, Ed and I will be available to take your questions. Third quarter net sales increased to $30 million from $29.6 million in the prior year. Our improved top line reflects steady progress that we've made to expand our distribution and propel increased velocity of our kefir product. I'm pleased with our solid performance, however, before I dive into the details, I would like to take a few minutes for those who may be new on the call to provide a little bit more color about who we are and why we are strongly positioned for future success. It's an exciting time to be meeting in the U.S. the leading U.S. kefir producer and marketer of kefir. Alive and active

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exciting time be the U.S. producer and marketer kefir alive and active cultured dairy products, packed with protein, calcium and probiotics. For 30 years, Lifeway has dominated the category owning over 90% of total kefir sales in the U.S.

Our mission is to provide the best probiotic and nutritious food resonate strongly with consumers who are increasingly concerned with eating healthy. 43% of consumers today buy yogurt and kefir for benefits associated with digestive health. Additionally, a study by Mintel recently stated that the yogurt and yogurt drink category is expected to grow over $11 billion by 2021. These trends coupled with our less than 5% penetration of the total U.S. household provides tremendous opportunity for us to take our business to the next level of growth.

So how will we get there? Number 1, increasing Lifeway's brand awareness. Over the past year, we've made key investments in our marketing strategies in order to further grow our consumer awareness of Lifeway. Just this past year, we have invested in the production of nationally launched commercial collaboration with designers such as Cynthia Rowley and partnerships with athletes and health advocates like U.S. Olympian, Carli Lloyd, to help drive awareness in -- of Lifeway.

Looking ahead, this is an area we'll continue to focus on in efforts to further increase our household penetration.

Moving on to our next strategy. Number 2, developing innovative product. Lifeway began with a single product, a 32-ounce bottle of plain drinkable kefir. Today, we have hundreds of different varieties flavors and sizes of kefir to suit the many tastes and preferences of our consumers. We are proud of our ability to innovate and this continues to be an important focus of area that we maintain our position as the leading name on kefir. In fact, we are pushing into new categories and offering choices to consumers with the launch of supplement kefir cups and cups farmer cheese.

And finally, number 3, expanding distribution across sales channels and geographies. Once sold exclusively in niche and specialty health food stores, kefir has gone mainstream. Today, Lifeway products can be purchased at major retailers all across America, and there's still wide space remaining for us to sell. Jennifer Reilly, our new Senior Executive Vice President of Sales and her team continues to make solid progress in expanding our footprint in both new and existing retailers. We also recently added new talent for sales team that will be fully dedicated to unlocking food service in small-format opportunities. Also under Jennifer's leadership, we intend to step up our focus of Lifeway's top customers in 2017.

We have clearly articulated growth strategy, a committed team of employees, a phenomenal product and a proven track record of success. Our marketing and sales initiatives are working. Lifeway's total house -- U.S. household penetration was up 28% over the last year. Still, we know, there is much work to be done and we could not be more excited for the future opportunities that lay ahead of us and at our ability to achieve increased growth and expand profitability across our businesses as we execute on those strategic initiatives.

I would now like to turn over our review to our recent results. We are pleased to continue -- we are pleased with the continued progress we made to grow our top line and expanded distribution of Lifeway's products to new and existing retailers. Some of our Q3 wins include, 1,200 stores added at Food Lion, primarily in the Southeast region of the U.S. This is a significant milestone for us as Food Lion is a new customer with substantial white space opportunity for future expansion. We've expanded throughout -- additional expansion across multi-outlet retail channels all across the South. The use of our Protein Kefir, Whole Milk Kefir and ProBugs added across traditional and natural banners.

Turning to private label, we are posting strong shipments on our private label products with select retailers. And distribution gains were not limited to the U.S. Just a few weeks ago, we made the exciting announcement that Lifeway will launch 4 of our most popular flavors of drinkable kefir in Ireland. Starting in November Lifeway will be available in over 140 stores across 2 major retailers in Ireland. As many of you are already aware, this will not be our first foray into international markets. In recent years, we have expanded our reach into Canada, Latin America and the United Kingdom. We're very encouraged with our recent performance in Canada. Third quarter sales were up a 157% compared to the prior quarter and we've also added distribution of our products at select Whole Foods in Canada. While our international footprint is small, it continues to grow and we look forward evaluating additional opportunities for international expansion as global finance for probiotic products continue to rise.

Earlier this year, we announced our plan to expand our advertising and marketing initiatives to help drive increased brand awareness of Lifeway. This has continued to be an important area of focus for us. In our third quarter, we debuted a campaign featuring our brand ambassador 2-time Olympic gold medalist and FIFA World Cup champion, Carli Lloyd. The campaign resulted in millions of impressions across digital media and websites, such as espn.com. Additionally, we aired the commercial during the premiere episode of Harry Connick Jr's new talk show, which was ranked the best national talk debut in past 3 years. We continue to be pleased with the results of our strategic partnership with Carli and I look forward to sharing future updates on our marketing initiatives on upcoming calls.

In summer, we are very pleased with our -- in summary, we are very pleased with our improved business results and remain confident in our long-term growth opportunities as we continue to execute on our strategic initiatives. We've made essential investments in marketing and in marketing -- in manufacturing facilities to help support our long-term growth. I'm impressed with our recent progress and confident that our ability to execute on our strategic initiatives in order to drive long-term growth and increase value for our shareholders. With that, I'd like to turn the call over to John to discuss our financial results in more detail. John?

Thank you, Julie, and good morning to those who have joined us on the call. Today, I will review our third quarter and year-to-date results for the period ended September 30, 2016. And I will turn the call back over to Julie for her closing remarks. Before I comment on our third quarter, I want to take your attention that in connection with our third quarter Form 10-Q that we filed yesterday. We have revised our proprietary financial statement to properly select the classifications on certain overhead costs and cost of goods sold. These costs had previously been incorrectly included in general and administrative expenses. Additional discussion regarding this revision is included in first footnote of our financial statement.

Turning to the quarter. Third quarter net sales increased 1.3% to $30 million from $29.6 million in the same period last year, reflecting volume gains in organic and private label products and the introduction of new items, partially offset by increased investment in trade program. Gross margin decreased 22.6% from 30.2% in the same period 1 year ago, primarily due to increased trade promotion and unfavorable mix. Selling expenses increased approximately $1.6 million to $4.3 million in the third quarter of 2016, from $2.7 million in the year-ago period. The increase in selling expenses reflects the step up in advertising investments that Julie mentioned in her remarks. General and administrative expenses decreased by $0.7 million or 17.3% to $3.3 million reflecting lower professional fees, partially offset by higher compensation levels.

The effective tax rate for the third quarter of 2016 exceeded 100% compared to 50.9% in the third quarter of 2015. The higher tax rate in the third quarter of 2016 is primarily due to relatively low level of profits we reported in the third quarter of 2016. Additional information regarding our tax rate has been included in the third quarter Form 10-Q. Net loss was approximately $64,000 or $0.00 per diluted share in the third quarter of 2016, compared to net income of $893,000 or $0.05 per diluted share in the third quarter of 2015.

Turning now to our year-to-date results. Net sales increased by $4.6 million or approximately 5.2% to $93.7 million during the 9-month period in September 30, 2016, from $89 million during the same period a year ago, driven by volume gains within our private label and organic products, the introduction of new items and lower trade promotion. Gross margin increased to 28.2% from 26.2% last year, reflecting lower input costs, primarily milk and lower trade promotion, partially offset by unfavorable mix. Selling expenses increased approximately 24.4% to $10.7 million from $8.6 million in the first 9 months of 2015, reflecting our investments in advertising. While general and administrative expenses decreased approximately 3.2% to $10.3 million. Our effective tax rate for the first 9 months of 2016 was 33% compared to 50.8% last year, primarily reflecting the implementation of tax planning strategy in 2016.

Net income was approximately $3 million or $0.19 per diluted share compared to net income of $1.6 million or $0.10 per diluted share for the 9-month period ended September 30, 2015. We did not repurchase any shares of common stock during the third quarter. Approximately 1.2 million shares are available to repurchase under our authorized program as of September 30, 2016. The stock repurchase program has no expiration date and may be suspended or discontinued at any time. That concludes my standard remarks. Now I will turn the call back over to Julie.

Thanks, John. We have made solid progress in 2016, to strengthen our business. We are beginning to see the positive results of our strategic marketing investments and our confidence and our ability to accelerate and expand distribution of our unique and healthy product portfolio. Our team remains focused on execution of our strategic initiative, which we believe are building blocks to strengthen our business and enable us to unlock additional value for our shareholders.

Looking ahead, we are confident in our ability to increase consumer awareness of Lifeway and achieve improved business performance. Thank you for joining us on the call today and for your interest in Lifeway. This concludes our overview for the third quarter of 2016. Ed, John and I would now like to open the call up for your questions. Operator?

(Operator Instructions) Our first question is from the line of Eric Gottlieb with D.A. Davidson.

I just got 1, I will ask you again? Can we get more details as to discounting and gross sales at least commentary about them versus last quarter or last year?

Sure. I think I could take that from a volume and mix perspective for a stand-alone quarter we had kind of a low single-digit uptick in the volumes that affected the velocity of sales for the quarter. And offsetting that was the elevated level of trade promotions that I referenced, which attracted another kind of a low single-digit from the overall velocity for the quarter year-over-year.

Got it. Okay. And then your commentary in your release doesn't really match the numbers that I am seeing. Household penetration is up 28%, but sales are only up 1.3%. Can you explain the disconnect there?

I can try to take that and I'll let Julie or Ed comment but, so our household penetration, and I think this was in Julie's remarks is roughly a 5% household penetration. And so it was previously closer to a 4% and we do that straight math on the penetration rate. It moves it from a small single-digit to a slightly larger small single-digit kind of household penetration. And so the disconnect between that lift and the sales lift is largely consequential of what we think is the implication that we're getting into more households, we're in more homes, we're in more pantries, we're in more refrigerators, I should say. And that I think we have consumers that are in and out of the product.

But I think the positive story here is that we're reaching more consumers. That may not stick, they may not stay with us, they may try it and think about it, pause and then come back to the product, but we look to that metric is like an obvious indicator of upside and we're encouraged I think with that increase, it's the suggestion that the advertising and marketing campaigns are working and we want to keep feeling that in getting the consumer to stick to our product.

Okay. Fair enough. You also cited an unfavorable mix, what was the details on that? What products increased versus last year and now what products decreased that led to that mix?

Yes. So I think there's a little bit of product mix and maybe a little bit of customer mix that's working in the negative direction. So -- and you appreciate that our portfolio of products is not all the same, a 32-ounce plain bottle of kefir has a different margin profile than the 8-ounce bottle of kefir and our organic product compared to our conventional product has a different margin profile. Organics, in particular, has a relatively lower margin profile. 8-ounce product generally has a lower margin profile. So the implication I think is that those -- kind of those lower margin profile products are increasing in terms of the total mix and the organic products, in particular, is one that has increased year-over-year that we introduced the whole milk organic products at Expo West last year. We gained distribution and it's starting to now be a part of the mix and has an unfavorable impact.

From the customer perspective, we have a range of customers. We sell direct to retailers obviously, but we also sell indirect through distributors and we have customers that pick up the product, we have customers that deliver the product. So across all of those variable you get different margin rates down to the customer and some of that is moving in a direction that's having modest adverse effect on the gross profit rate.

And now looking at the kefir sales, results have been in a decline -- sequential decline for 3 quarters now, despite for all those marketing efforts and new business ones. Again, gross margin -- gross sales breakout would help here, but I'm wondering why sales have been weak? Have you lost any business? You talk about win, but have you talked -- have you lost any?

Yes. No. So we're not losing any accounts, I mean there is nothing moving in a negative direction from the number of accounts that we're selling into. For a 9-month period year-over-year we have volume gains that are in the kind of middle to high single-digit kind of a category. So we're not losing customers, we're gaining volumes, the trade promotions on a year-to-date basis. It's actually marginally favorable year-over-year for 9 months, but we're not losing customers and I guess, that's -- those are my comments.

And then marketing expenses, what kind of levels should we go in for -- like the Carli Lloyd, is that, that's done and paid for?

There is going to be a little trickle into the fourth quarter because the campaign spread over quarter end. So I think there is 2 weeks of advertising that's running in the fourth quarter and by and large, the dollars are behind us at the end of the third quarter.

And then the tax rate going forward, I know why it jumps around a lot, but in the past, you've said that the 50% rate is kind of gone and we should be in the high 30s, despite what happened this quarter. Is that still the case?

Yes. So my expectation is consistent with what I think we talked about in the prior quarter, which is absence of discrete items that affect the rate. We expect to be in the high 30s, as you mentioned. In 2016, we had a favorable resolution of a matter regarding an audit process with the IRS and so when we finish the year we'll be below that 37% to 39% kind of a rate giving effect to that favorable outcome, which probably takes the rate down several hundred basis points, but it's unique to that event.

Our next question is from the line of Howard Halpern with Taglich Brothers.

Talked about, I guess, some customer wins in the quarter. Did you actually ship in this third quarter or is that going to favorably impact the fourth quarter, such as Food Lion?

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Yes, I think most of the third quarter gains are in front of us in terms of the distribution gains. The addition of Food Lion, I think we started actually shipping inside of the third quarter, but it wasn't for the total quarter. So you'll see more of that incrementality in the fourth quarter. And then, the other item that Julie mentioned in her remarks are not net new retailers and just more distribution within those -- within the existing retail customers that we had and that's -- I couldn't comment on the exact timing and pacing of that but I think, you'll see more of that in the fourth quarter than we saw in the third.

Okay. In terms of the gross margin and the mix, you see that unfavorability continuing or you have a way that you're going to start to mitigate that when we want to really see that too much going forward?

Yes. So like Julie commented about the things that are coming out of our innovation funnel for 2017. The Cups product -- the Cups Kefir and the Cup Cheese as well as our supplements, and the margin profile on those items are relatively higher than the historical margin rates, so depending on kind of the volumes that we are able to achieve in 2017 that bodes well for margin rate expansion.

In terms of the unfavorable mix with respect to the organics, I think time will tell, but's that's a hot item with consumers, so I would expect that's going to continue to grow. We're being thoughtful about the actions we're taking to protect the margin and do the right thing for the retailer and the consumer. So perhaps that may -- unfavorable mix may change in a bit of favorable way, but that's kind of out in front of us still.

And then in terms of growth strategies, Julie also mentioned, the fact that we've added dedicated resources to our sales organization with a focus on new channels and that is strategically underway. Our initiatives to expand into food services in small store formats as the prospect of what we think is important volume for us, it will put us in C-stores and food service establishments that won't at its own necessarily drive volume and profitability on its own as much as it will drive trial with the broader consumer base that will then feedback into the traditional format, right. So we get to C-stores, consumer tries, likes it and then starts buying the 32 oz. product in our traditional groceries. So that strategic initiative has -- is going to have some consequence on profit margins -- gross profit margins. It will add incremental gross profit dollars, but I think, it will have some prospects in pushing the rate lower.

So just in your general view out there with the marketing that's going on, what is going to occur hopefully early in 2017. You're fairly confident that at a minimum, you should be able to grow it in the mid-single digits?

Yes. We don't like to give guidance. We like to think of ourselves as a growth company and low single-digits to me, doesn't translate enough to a growth company. So I -- we've got a new leadership in our sales function. I think they're having very important impacts here in the third and fourth quarters. This is a great brand and it's a great product and we get that household penetration up and have the right kind of marketing that it bodes well for something higher than a low single-digit type of a growth rate.

I guess, 1 last one. Do you have, because you talked about household penetration and how it might go up then fall back and then go up again, do you have a program out there to attempt to find those customers who are trying it and a way to get them back into the stores to buy it.

Yes, I don't have a -- I don't know if Julie has a thought for you on that point or Ed, but...

Yes, I mean, that is what we do every single day at Lifeway, that's basically what we do every day for 30 years.

Our next question is from the line -- a follow-up from the line of Eric Gottlieb with a D.A. Davidson.

Just 1 last thing on milk pricing. I've noticed that we've had a trickle-up in recent months and we're expected to probably stay here maybe if you go slightly higher as we move through the year and next year. I'm wondering how that affects your business, how that trickles for?

Well, our product has a lot of price elasticity, still and with, again something that we've always had to navigate and plan around for 30 years, milk is our biggest raw material's cost. If the prices go up, then we adjust -- potentially raise the product prices on our products. When milk goes up, there is other things that potentially go down, so it's not just black and white, there is a whole range of other variables that go into the pricing and profit on our business, but we are confident that we can successfully move forward even if milk prices go up and they have been historically low for quite some time.

So there's that thing. And then the other piece of this is, we are also launching additional products that don't have any milk components in it like supplements and pills where there is a very strong margin associated with it, and while we don't have nearly the volume that we do in our kefir product on these new items. It's still something that we can build and grow and nurture as we go forward. So I don't feel concerned about milk prices today. And I haven't, yes, and I haven't -- I have not been concerned for 30 years, the entire time of Lifeway, they go up, they go down, people react, but the business continues to be strong and we adjust how we do things based on those prices.

Thank you. As there are no additional questions at this time, I will turn the floor back to Julie Smolyansky for closing remarks.

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 2016 fourth quarter and year-to-date results with you in the coming months. Have a good day.

Thank you. This concludes today's Lifeway Foods conference. Thank you for your participation. You may now disconnect your lines at this time.