Lifeway Has a Pulse

Now, that's what I call "service."

Three months ago, in reviewing the first-quarter earnings report for healthy dairy queen Lifeway Foods (NASDAQ:LWAY), I observed that Lifeway had succeeded in growing its Q1 sales by an even healthier 18% over Q1 2004. I proceeded to muse aloud about how nice it would be "if only [Lifeway's] free cash flow and profits growth could again match that performance." Well, check that box off your stock investing wish list, Fools, because Lifeway's profits growth is back.

(As for the free cash flow, we'll get to that in a sec.)

In Q2 2005, Lifeway continued to grow its revenues strongly, outdoing even its Q1 performance by posting 27% year-over-year sales growth. Combined, these first two quarters of fiscal 2005 have outperformed the year-ago period by 23%, sales-wise. Likewise on the profits front, where Lifeway grew its bottom line faster than it did its sales, posting $0.07 per diluted share for the quarter, and $0.15 year to date. That makes for year-on-year growth rates of, respectively, 29% and 7% for the Q1 and H1 comparisons.

In response, as of this writing, Mr. Market has skimmed 9% off of Lifeway's market cap. Say it with me now, all together: "Huh?!"

That's a fair question, if a bit vague. But I think I know what you're asking, so here's the answer:

Lifeway had a number of "bad" numbers in this quarter's report, which kept investors from embracing its earnings news wholeheartedly. First and foremost, the company laid out a lot of cash to purchase a new warehouse facility large enough to house its rapidly growing dairy empire. That helped to sap away $3.5 million of the company's cash and equivalents. It also hurt Lifeway's free cash flow, which swung from positive $860,000 in H1 2004, to nearly $3.8 million in negative FCF for Q2 2005. In fact, cash from operations declined, even before subtracting out the capital expenditures on Lifeway's new digs, totaling $970,000 in H1 last year, but just $860,000 so far this year.

While I'm just speculating, it could be that Lifeway's sales growth is actually contributing to its free cash flow decline -- because of where the growth is coming from. In recent months, Lifeway has signed big customersTarget (NYSE:TGT) and Cosi (NASDAQ:COSI) to retail its product. Now we see sales rising rapidly again, but accounts receivable rising even faster (33% year over year). If Lifeway's new customers are taking advantage of their size to stretch the definition of "please pay promptly," that could explain why free cash flow isn't expanding as rapidly as Lifeway investors would like to see.

For further Foolish news and views on Lifeway, read:

• Lifeway Finds Its Target
• Lifeway on Ice
• Vitamin D Is for Deficit
• Can Lifeway Survive a Disaster?

Fool contributor Rich Smith does not own shares of Target, Cosi, or Lifeway. Truth be told, he would love to own shares of Lifeway Foods again, but not at this price.