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Lifeway Foods Inc.(LWAY - Snapshot Report) posted earnings of 7 cents per share in the first quarter of 2012, edging out the Zacks Consensus Estimate by a penny, but lagging the year-ago quarter earnings of 12 cents per share. The better-than-expected results were attributable to double-digit top-line growth.

Lifeway Foods primarily engages in manufacturing dairy and non-dairy health food products. The company reported gross sales of $21.6 million in the quarter, up 13.0% year over year. The upside in revenue was attributable to higher sales and increased customer acceptance for its flagship product Kefir as well as other product lines including Bio Kefir and ProBugs organic Kefir for kids.

During the quarter, gross profit slipped 11% year over year to $6.8 million and gross margin contracted 800 basis points (bps) to 35%, attributed to a 30% surge in transportation cost arising from higher fuel prices and freight expense and a 20% hike in the cost of milk, the most crucial ingredient for the company.

Operating expense jumped 13% year over year to $4.9 million during the quarter, due to higher selling, general and administrative expenses particularly related to increased investment in marketing and advertising for brand awareness. The upside was partially offset by dip in amortization expense.

Operating income of the company fell 43% to $1.9 million due to an upside in operating expenses and drop in gross margin.

The company recently inked a deal with Target to triple the distribution of its kefir line in Target stores as well as add new Lifeway products to Target's dairy cases.

Financial Position

As of March 31, 2012, Lifeway Foods had cash and cash equivalents of $0.8 million versus $1.1 million at December 31, 2012. During the quarter, net cash provided by operating activities was up $0.4 million to $1.5 million and shareholders’ equity increased $1.6 million to $36.3 million. 

The Morton Grove, Illinois-based company also remains focused on boosting shareholder value. Lifeway has initiated an annual cash dividend of 7 cents per share, payable on June 29, 2012 to shareholders of record as of May 30, 2012.

Our Take

Morton Grove, Illinois-based Lifeway reported better-than-expected results and continues to focus on distribution of its Kefir line, which is Lifeway's flagship product in both domestic and international markets. The recent agreement with Target is encouraging as the deal will bolster sales at the retail chain as well as increase awareness with Target customers. Management remains optimistic for 2012 and committed to expanding its business and enhancing shareholder value. The price of milk is also easing out, but higher freight and fuel costs will continue to be headwind in 2012. Hence, we expect estimates to go up in the coming days. The Zacks Consensus Estimates for 2012 and 2013 are pegged at 26 cents and 30 cents a share, respectively.

Lifeway, which competes with Dean Foods Co. (DF - Analyst Report), currently retains a Zacks #5 Rank, which translates into a short-term Strong Sell rating. We are also maintaining our long-term Underperform recommendation on the stock.

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