ITEM 1A
RISK FACTORS
In evaluating and understanding us and
our business, you should carefully consider the risks described below, in conjunction with all of the other information included
in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results
of Operations” contained in Part II, Item 7 and “Quantitative and Qualitative Disclosures About Market Risk”
contained in Part II, Item 7A. The risks and uncertainties described below are not the only ones we face. Additional risks and
uncertainties that we are unaware of, or that we currently believe are not material, may become important factors that adversely
affect our business. If any of the events or circumstances described in the following risk factors actually occurs, our business,
financial condition, results of operations, and future prospects could be materially and adversely affected.
RISKS RELATED TO OUR BUSINESS
Our product categories face a high
level of competition, which could negatively impact our sales and results of operations.
We compete with a limited number of other
domestic kefir producers and consequently faces a small amount of direct competition for kefir products. However, our kefir-based
products compete with other dairy products, notably spoonable and drinkable yogurt, and, increasingly, with non-dairy probiotic
products that incorporate kefir cultures but are not kefir. We face significant competition for limited retailer shelf space in
each of our product categories. Competition in our product categories is based on product innovation, product quality, price, brand
recognition and loyalty, effectiveness of marketing, promotional activity, and our ability to identify and satisfy consumer tastes
and preferences. We believe that our brands have benefited in many cases from being the first to introduce products in their categories,
and their success has attracted competition from other food and beverage companies that produce branded products, as well as from
private label competitors. Some of our competitors, such as Danone, General Mills, Chobani, Hain Celestial Group, and Nestle, have
substantial financial and marketing resources. These competitors and others may be able to introduce innovative products more quickly
or market their products more successfully than we can, which could cause our growth rate to be slower than we anticipate and could
cause sales to decline.
We also compete with producers of non-dairy
products, such as Millennium Products and PepsiCo, that have lower ingredient and production-related costs. As a result, these
competing producers may be able to offer their products to customers at a lower price point. This could cause us to lower our prices,
resulting in lower profitability or, in the alternative, cause us to lose market share if we fail to lower prices. Furthermore,
private label competitors are generally able to sell their products at lower prices because private label products typically have
lower marketing costs than their branded counterparts. If our products fail to compete successfully with other branded or private
label offerings, demand for our products and our sales volumes could be negatively impacted.
Additionally, due to high levels of competition,
certain of our key retailers may demand price concessions on our products or may become more resistant to price increases for our
products. Increased price competition and resistance to price increases have had, and may continue to have, a negative effect on
our results of operations.
We may not be able to successfully implement our business
strategy for our brands on a timely basis or at all.
We believe that our future success depends,
in part, on our ability to implement our strategy of leveraging our existing brands with our current and new products to maintain
our market position in our product categories; drive increased sales; acquire or establish new brands; and create strategic alliances
including potential joint ventures. Our ability to implement this strategy depends, among other things, on our ability to:
· compete successfully in the product categories in which we choose to operate;
· increase our brand recognition and loyalty;
· negotiate acquisitions and joint ventures on terms acceptable to us; and
If we fail to execute these and other important
elements of our business strategy, our business and results of operations could be adversely affected.
One key element of our business strategy
is to introduce timely, new, cost-effective, and appealing products and to innovate successfully within our existing product categories.
However, consumer tastes and preferences change rapidly, and evolve over time. Factors that may affect consumer tastes and preferences
include:
Our future investments may not produce
the results we expect when we expect them for a variety of reasons including those described herein. Our future product development
and innovation will be reliant on our ability to identify and develop potential new growth opportunities. This process is inherently
risky and will result in investments of substantial time and resources for which we may not achieve any return or value. Successful
product development and innovation is also affected by our ability to launch new or improved products successfully and on a timely
and cost-effective basis.
We may have to pay cash, incur debt, or
issue equity, equity-linked, or debt securities to fund our business strategy, or may be unable to fund that strategy. Any of these
events could adversely affect our financial results and our business. We could experience similar effects if we invest resources
in a strategy that ultimately proves unsuccessful. If, due to a failure of our strategy or any other reason, consumer demand
for our products declines, our sales volumes, results of operations, and our business could be negatively affected, and we may
not be able to create or sustain growth or successfully implement our business strategy.
Interruption of our supply chain could affect our
ability to manufacture or distribute products, could adversely affect our business and sales, and/or could increase our operating
costs and capital expenditures.
We have several supply agreements with
suppliers and co-packers that require them to provide us with specific finished goods, including packaging and kefir. For some
of these products, we essentially rely on a single supplier or co-packer as our sole source for the item. The failure for any reason
of any such sole source or other co-packer to fulfill its obligations under the applicable agreements with us or the termination
or renegotiation of any such sourcing agreement could result in disruptions to our supply of finished goods and have an adverse
effect on our results of operations. Additionally, our suppliers and co-packers are subject to risk, including labor disputes,
union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic
and political conditions that could limit their ability to timely provide us with acceptable products, which could disrupt our
supply of finished goods, or require that we incur additional expense by providing financial accommodations to the supplier or
co-packer or taking other steps to seek to minimize or avoid supply disruption, such as establishing new arrangements with other
providers. A new arrangement may not be available on terms as favorable to us as our existing arrangements, if at all.
Our inability to maintain sufficient internal
capacity or establish satisfactory co-packing, warehousing and distribution arrangements could limit our ability to operate our
business or implement our strategic plan and could negatively affect our sales volumes and results of operations.
Disruption of our manufacturing or
distribution chains or information technology systems, including disruption due to cybersecurity threats, could adversely affect
our business.
The success of our business depends, in
part, on maintaining a strong production platform and we rely primarily on internal production resources to fulfill our manufacturing
needs. Our ongoing initiatives to expand our production platform and our productive capacity could fail to achieve such objectives
and, in any case, could increase our operating costs beyond our expectations and could require significant additional capital expenditures.
If we cannot maintain sufficient production, warehousing, and distribution capacity, either internally or through third party agreements,
we may be unable to meet customer demand and/or our manufacturing, distribution, and warehousing costs may increase, which could
negatively affect our business.
Furthermore, damage or disruption to our
manufacturing or distribution capabilities due to weather, natural disaster, fire, environmental incident, terrorism, cybersecurity
threats and other security breaches, pandemic, strikes, the financial or operational instability of key distributors, warehousing,
and transportation providers, or other reasons could impair our ability to manufacture or distribute our products.
We rely on a limited number of production
and distribution facilities. A disruption in operations at any of these facilities or any other disruption in our supply chain
relating to common carriers, supply of raw materials and finished goods, or otherwise, whether as a result of casualty, natural
disaster, power loss, telecommunications failure, cybersecurity threat, terrorism, labor shortages, contractual disputes or other
causes, could significantly impair our ability to operate our business and adversely affect our relationship with our customers.
Furthermore, our insurance coverage may not be adequate to cover all related costs.
Our information technology systems are
also critical to the operation of our business and essential to our ability to successfully perform day-to-day operations. These
systems include, without limitation, networks, applications, and outsourced services in connection with the operation of our business.
A failure of our information technology systems to perform as we anticipate could disrupt our business and result in transaction
errors, processing inefficiencies, and sales losses, causing our business to suffer. In addition, our information technology systems
may be vulnerable to damage or interruption from circumstances beyond our control, including fire, natural disasters, systems failures,
and cybersecurity threats. Cybersecurity threats in particular are persistent, evolve quickly and include, without limitation,
computer viruses, unauthorized attempts to access information, denial of service attacks, and other electronic security breaches.
Like our customers, suppliers, subcontractors and other third parties with whom we do business generally, we expect that we will
continue to be the subject of cybersecurity threats. In some cases we must rely on the safeguards put in place by the third parties
with whom we do business to protect against security threats. We believe we have implemented appropriate measures and controls
and have invested in sufficient resources to appropriately identify and monitor these threats and mitigate potential risks, including
risks involving our customers and suppliers. However, there can be no assurance that any such actions will be sufficient to prevent
cybersecurity breaches, disruptions to mission critical systems, the unauthorized release of sensitive information or corruption
of data, or harm to facilities or personnel.
These threats and other events could disrupt
our operations, or the operations of our customers, suppliers, subcontractors and other third parties; could require significant
management attention and resources; could result in the loss of business, regulatory actions and potential liability; and could
negatively impact our reputation among our customers and the public. Any of these outcomes could have a negative impact on our
financial condition, results of operations, or liquidity.
Our debt and financial obligations
could adversely affect our financial condition, our ability to obtain future financing, and our ability to operate our business.
We have outstanding debt obligations that
could adversely affect our financial condition and limit our ability to successfully implement our business strategy. Furthermore,
from time to time, we may need additional financing to support our business and pursue our business strategy, including strategic
acquisitions. Our ability to obtain additional financing, if and when required, will depend on investor demand, our operating performance,
the condition of the capital markets, and other factors. We cannot assure that additional financing will be available to us on
favorable terms when required, or at all. If we raise additional funds through the issuance of equity, equity-linked, or debt securities,
those securities may have rights, preferences, or privileges senior to those of our common stock, and, in the case of equity and
equity-linked securities, our existing stockholders may experience dilution.
As of December 31, 2020, we had outstanding
borrowings of $2,768, net of $9 of unamortized deferred financing costs, which consisted of a revolving line of credit. Our loan
agreements contain certain restrictions and requirements that among other things:
· impose on us financial and operational restrictions.
Our ability to meet our debt service
obligations will depend on our future performance, which will be affected by the other risk factors described in this Annual Report
on Form 10-K. If we do not generate enough cash flow to pay our debt service obligations, we may be required to refinance all
or part of our existing debt, sell our assets, borrow more money or raise equity. There is no guarantee that we will be able to
take any of these actions on a timely basis, on terms satisfactory to us, or at all.
Our notes bear interest at variable rates.
If market interest rates increase, it will increase our debt service requirements, which could adversely affect our cash flow.
Our loan agreements also contain provisions that restrict our
ability to:
· borrow money or guarantee debt;
· create liens;
· make specified types of investments and acquisitions;
· pay dividends on or redeem or repurchase stock;
· enter into new lines of business;
· enter into transactions with affiliates; and
· sell assets or merge with other companies.
These restrictions on the operation of
our business could harm our ability to execute on our business strategy by, among other things, limiting our ability to take advantage
of financing, merger and acquisition opportunities, and other corporate opportunities. Various risks, uncertainties, and events
beyond our control could affect our ability to comply with these covenants. Unless cured or waived, a default would permit lenders
to accelerate the maturity of the debt under the credit agreement and to foreclose upon the collateral securing the debt.
Loss of our key management or other
personnel, or an inability to attract such management and other personnel, could negatively impact our business.
We depend on the skills, working relationships,
and continued services of key personnel, including our experienced senior management team. We also depend on our ability to attract
and retain qualified personnel to operate and expand our business. If we lose one or more members of our senior management team,
or if we fail to attract talented new employees, our business and results of operations could be negatively affected.
Employee strikes and other labor-related
disruptions may adversely affect our operations.
We have a union contract governing the
terms and conditions of employment for a significant portion of our workforce. Although we believe union relations since the union’s
certification as the exclusive bargaining representative of this portion of our workforce have been amicable, there is no assurance
that this will continue in the future or that we will not be subject to future union organizing activity. There are potential adverse
effects of labor disputes with our own employees or by others who provide warehousing, transportation, and distribution, both domestic
and foreign, of our raw materials or other products. Strikes or work stoppages or other business interruptions could occur if we
are unable to renew collective bargaining agreements on satisfactory terms or enter into new agreements on satisfactory terms,
which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our
business, financial condition, or results of operations. The terms and conditions of existing, renegotiated, or new collective
bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes
to enhance our efficiency or to adapt to changing business needs or strategy.
Our intellectual property rights are valuable, and any
inability to protect them could reduce the value of our products and brands.
We consider our intellectual property rights,
particularly our trademarks, but also our copyrights, registered domain names, and proprietary trade secrets, technology, know-how,
processes and other proprietary rights to be a significant and valuable aspect of our business. We attempt to protect our intellectual
property rights by relying on a combination of trademark, copyright, trade dress, trade secret, and other intellectual property
laws, and domain name dispute resolution systems; as well as licensing agreements, third-party confidentiality, nondisclosure,
and assignment agreements; and by policing third-party misuses of our intellectual property. Our failure to obtain or maintain
adequate protection of our intellectual property rights, or any change in law or other changes that serve to lessen or remove the
current legal protections of our intellectual property, may diminish our competitiveness and could materially harm our business.
We also face the risk of claims that we
have infringed third parties’ intellectual property rights. Any claims of intellectual property infringement, even those
without merit, could be expensive and time consuming to defend, cause us to cease making, licensing, or using products that incorporate
the challenged intellectual property, require us to redesign or rebrand our products or packaging, divert management’s attention
and resources, or require us to enter into royalty or licensing agreements to obtain the right to use a third party’s intellectual
property. Any royalty or licensing agreements, if required, may not be available to us on acceptable terms or at all. Additionally,
a successful claim of infringement against us could result in our being required to pay significant damages, enter into costly
license or royalty agreements, or stop the sale of certain products, any of which could have a negative effect on our results of
operations.
The Smolyansky family controls a majority of our common
stock and has the ability to control the outcome of matters submitted for stockholder approval.
A majority of our common stock is controlled
by members of the Smolyansky family, and collectively, they have the ability to control the outcome of stockholder votes, including
the election of all of our directors and the approval or rejection of any merger, change of control, or other significant corporate
transaction. No person interested in acquiring Lifeway will be able to do so without obtaining the consent of the Smolyansky family.
We believe that having the Smolyansky family as a significant part of a long-term-focused, committed, and engaged stockholder base
provides us with an important strategic advantage, particularly in a business with a mature, well-recognized brand. This advantage
could be eroded or lost, however, should Smolyansky family members cease, collectively, to be controlling stockholders of Lifeway.
We desire to remain independent and family-owned, and we believe the Smolyansky family shares these interests. However, the Smolyansky
family’s interests may not always be aligned with other stockholders’ interests. By exercising their control, the Smolyansky
family could cause Lifeway to take actions that are at odds with the investment goals of institutional, short-term, non-voting,
or other non-controlling investors, or that have a negative effect on our stock price.
Because the Smolyansky family, collectively,
controls a majority of our common stock (approximately 50.1%), we are considered a “controlled company” under Nasdaq
Listing Rules. Controlled companies are exempt from Nasdaq listing standards that require a board composed of a majority of independent
directors, a fully independent nominating/corporate governance committee, and a fully independent compensation committee. Our
Board of Directors has determined that Lifeway will avail itself of these exemptions, though we currently maintain a Board composed
of a majority of independent directors. As a result of the controlled company exemption, our corporate governance practices differ
from those of non-controlled companies, which are subject to all of the Nasdaq corporate governance requirements. Specifically,
while we continue to maintain a majority of independent directors on the Board and to ensure that a committee of those independent
directors select director nominees and determine the compensation of our officers, we have not, in the past, maintained separate
compensation or nominating committees. In May, 2020, the Board of Directors formed a separate Compensation Committee and adopted
a Compensation Committee Charter. In the event we cease to be a controlled company, we will be required to comply with all of
the corporate governance standards under Nasdaq’s rules, subject to applicable transition periods.
RISKS RELATED TO OUR INDUSTRY
The consolidation of our customers
or the loss of any of our largest customers could negatively impact our sales and results of operations.
Customers, such as supermarkets and food
distributors, continue to consolidate. This consolidation has produced larger, more sophisticated organizations with increased
negotiating and buying power that are able to resist price increases or demand increased promotional programs, as well as operate
with lower inventories, decrease the number of brands that they carry and increase their emphasis on private label products, all
of which could negatively impact our business. The consolidation of retail customers also increases the risk that a significant
adverse impact on their business could have a corresponding material adverse impact on our business.
Two of our customers together accounted
for 21% of our net sales in the fiscal year ended December 31, 2020. Where we enter into written agreements with our customers,
they are generally terminable after short notice periods by the customer. In addition, our customers sometimes award contracts
based on competitive bidding, which could result in lower profits for contracts we win and the loss of business for contracts we
lose. The loss of any large customer, the reduction of purchasing levels, or the cancellation of any business from a large customer
for an extended period of time could negatively affect our sales and results of operations.
We rely on sales made by or through our
independent distributors to customers. Distributors purchase directly for their own account for resale. The loss of, or business
disruption at, one or more of these distributors may harm our business. If we are required to obtain additional or alternative
distribution agreements or arrangements in the future, we cannot be certain that we will be able to do so on satisfactory terms
or in a timely manner. Our inability to enter into satisfactory distribution agreements may inhibit our ability to implement our
business plan or to establish markets necessary to expand the distribution of our products successfully.
We are subject to the risk of product
contamination and product liability claims, which could harm our reputation, force us to recall products and incur substantial
costs.
The sale of food products for human consumption
involves the risk of injury to consumers. Such injuries may result from tampering by unauthorized third parties, inadvertent mislabeling,
product contamination or spoilage including the presence of foreign objects, substances, chemicals, other agents, or residues introduced
during the storage, processing, handling or transportation phases. We also may be subject to liability if our products or production
processes violate applicable laws or regulations, including environmental, health, and safety requirements, or in the event our
products cause injury, illness, or death.
Under certain circumstances, we may be
required to recall or withdraw products, suspend production of our products, or cease operations, which may lead to a material
adverse effect on our business. In addition, customers may cancel orders for such products as a result of such events. Even if
a situation does not necessitate a recall or market withdrawal, and even if we and each of our co-packers and suppliers comply
in all material respects with all applicable laws and regulations, we may become subject to claims or lawsuits relating to such
matters. Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion
that our products caused illness or physical harm, including the risk of reputational harm being magnified and/or distorted through
the rapid dissemination of information over the Internet, including through news articles, blogs, chat rooms, and social media,
could adversely affect our reputation with existing and potential customers and consumers and our corporate and brand image. Moreover,
claims or liabilities of this type might not be covered by our insurance or by any rights of indemnity or contribution that we
may have against others. We maintain product liability and product recall insurance in amounts that we believe to be adequate.
However, we cannot be sure that we will not incur claims or liabilities for which we are not insured or that exceed the amount
of our insurance coverage. A product liability judgment against us or a product recall could have a material adverse effect on
our business, consolidated financial condition, results of operations or liquidity.
We rely on independent certification for several of our
products and facilities.
We rely on independent certification, such
as certifications of our products as “organic”, or “gluten-free,” to differentiate our products from others.
The loss of any independent certifications could adversely affect our market position as a probiotic-based products and natural,
“better for you” foods company, which could harm our business. We rely on independent SQF certification at some of
our facilities, a certification that some of our customers require us to maintain.
We must comply with the requirements of
independent organizations or certification authorities in order to label our products as certified. For example, we can lose our
“organic” certification if a manufacturing plant becomes contaminated with non-organic materials, or if it is not properly
cleaned after a production run. In addition, all organic raw materials must be certified organic or organic compliant. Our products
could lose their organic certifications if our raw material suppliers lose their organic certifications. Similarly, we could lose
our SQF certification if we do not meet the requirements of the SQF Code. The loss of these certifications could cause us to lose
customers that require Lifeway products and/or facilities to carry some or all of them, which could negatively affect our sales
and results of operations.
Increases in the cost of raw milk
could reduce our gross margin and profit.
Conventional and organic raw milk, our
primary raw material, is an agricultural commodity that is subject to price fluctuations. Although both conventional and organic
milk prices in fiscal 2020 were lower than the prior year, there can be no assurance that such prices will remain at these levels
in the future. The supply and price of raw milk may be impacted by, among other things, weather, natural disasters, real or perceived
supply shortages, lower dairy and crop yields, general increases in farm inputs and costs of production, political and economic
conditions, labor actions, government actions, and trade barriers. Increases in the market price for raw milk or over-order premiums
charged by producers may also impact our ability to enter into purchase commitments at a fixed price. There can be no assurance
that our purchasing practices will mitigate future price risk. As a result, increases in the cost of raw milk could have an adverse
impact on our profitability.
In addition, the dairy industry continues
to experience periodic imbalances between supply and demand for organic raw milk. Industry regulation and the costs of organic
farming compared to costs of conventional farming can impact the supply of organic raw milk in the market. Oversupply levels of
organic raw milk can increase competitive pressure on our products and pricing, while supply shortages can cause higher input costs
and reduce our ability to deliver product to our customers. Cost increases in raw materials and other inputs could cause our profits
to decrease significantly compared to prior periods, as we may be unable to increase our prices to offset the increased cost of
these raw materials and other inputs. If we are unable to obtain raw materials and other inputs for our products or offset any
increased costs for such raw materials and inputs, our business could be negatively affected.
Reduced availability of raw materials
and other inputs, as well as increased costs for them, could adversely affect us.
Our business depends heavily on raw materials
and other inputs in addition to conventional and organic raw milk, such as sweeteners, diesel fuel, packaging material, resin,
and other commodities. Our raw materials are generally sourced from third-party suppliers, and we are not assured of continued
supply, pricing, or exclusive access to raw materials from any of these suppliers. In addition, some of our raw materials are also
agricultural products, and therefore subject to the same vulnerabilities described above for raw milk. Other events that adversely
affect our third-party suppliers and that are out of our control could also impair our ability to obtain the raw materials and
other inputs that we need in the quantities and at the prices that we desire. Such events include problems with our suppliers’
businesses, finances, labor relations, costs, production, insurance, and reputation.
The organic ingredients we use in some
of our products are less plentiful and available from a fewer number of suppliers than their conventional counterparts. Competition
with other manufacturers in the procurement of organic product ingredients may increase in the future if consumer demand for organic
products increases.
Our business is subject to various
food, environmental, and health and safety laws and regulations, which may increase our compliance costs, subject us to liabilities,
or otherwise adversely affect our business.
Our business operations are subject to
numerous requirements in the United States relating to food safety, production, and marketing, as well as the protection of the
environment, and health and safety matters. The food production and marketing industry is subject to a variety of federal, state,
local, and foreign laws and regulations, including food safety requirements related to the ingredients, manufacture, processing,
storage, marketing, advertising, labeling, and distribution of our products, as well as those related to worker health and workplace
safety. Our activities, both in and outside of the United States, are subject to extensive regulation. We are regulated by, among
other federal and state authorities, the FDA, USDA, the U.S. Federal Trade Commission (“FTC”), and the U.S. Departments
of Commerce, and Labor, as well as by similar authorities in the foreign countries in which we do business. Environmental laws
including the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act of 1980,
as amended, and the National Organic Standards of the U.S. Department of Agriculture, as well as similar state and local statutes
and regulations in the United States and in each of the foreign countries in which we do business apply to our business operations
as well. These laws and regulations govern, among other things, air emissions and the discharge of wastewater and other pollutants,
the use of refrigerants, the handling and disposal of hazardous materials, and the cleanup of contamination in the environment.
In addition, the marketing and advertising
of our products could make us the target of claims relating to alleged false or deceptive advertising under federal, state, and
foreign laws and regulations, and we may be subject to initiatives that limit or prohibit the marketing and advertising of our
products to children.
We are also subject to federal laws and
regulations relating to our organic products and production. For example, as required by the National Organic Program (“NOP”),
we rely on third parties to certify certain of our products and production locations as organic. Regulations and formal and informal
positions taken by the NOP pursuant to the Organic Foods Production Act of 1990, which created the NOP, are subject to continued
review and scrutiny.
Changes in these laws or regulations or
the introduction of new laws or regulations could increase our compliance costs, increase other costs of doing business for us,
our customers, or our suppliers, or restrict our actions, which could adversely affect our results of operations. In some cases,
new laws and regulations or other federal and state regulatory initiatives could interrupt distribution of our products or force
changes in our production processes and our products. Governmental regulations also affect taxes and levies, healthcare costs,
energy usage, immigration, and other labor issues, all of which may have a direct or indirect effect on our business or those of
our customers or suppliers. These costs could negatively affect our results of operations and financial condition. Further, if
we are found to be in violation of applicable laws and regulations in these areas, we could be subject to civil remedies, including
third-party claims for property damage or personal injury, fines, injunctions, recalls, clean up costs, and other civil sanctions,
as well as potential criminal sanctions, any of which could have a material adverse effect on our business.
RISKS
RELATED TO COVID-19 AND OTHER PANDEMIC OR DISEASE OUTBREAKS
Pandemics
or disease outbreaks, such as the novel coronavirus (COVID-19 virus), may disrupt consumption and trade patterns, supply chains,
and production processes, which could materially affect our operations and results of operations.
The
ultimate impact that the COVID-19 pandemic or any future pandemic or disease outbreak will have on our business and our consolidated
results of operations is uncertain.
To date
we have seen increased customer and consumer demand for our products as consumers initially began pantry loading and have increased
their at-home consumption as a result of social distancing and stay-at-home and work-from-home mandates and recommendations. However,
this increased customer and consumer demand may decrease in the coming months if and when the need for social distancing and stay-at-home
and work-from-home mandates and recommendations decrease, and we are unable to predict the nature and timing of when that impact
may occur, if at all. .
Although
to date we have not experienced supply chain constraints, and we have continued to be able to fully satisfy customer and
consumer demand for our products, the continued unprecedented demand for food and other consumer packaged goods products as a
result of the COVID-19 pandemic or any future pandemic may limit the availability of, or increase the cost of, ingredients,
packaging and other raw materials necessary to produce our products, and our operations may be negatively impacted.
Additionally, pandemics or disease outbreaks could result in a widespread health crisis that could adversely affect economies
and financial markets, consumer spending and confidence levels resulting in an economic downturn that could affect customer
and consumer demand for our products.
Our
efforts to manage and mitigate these factors may be unsuccessful, and the effectiveness of these efforts depends on factors beyond
our control, including the duration and severity of any pandemic or disease outbreak, as well as third party actions taken to contain
its spread and mitigate public health effects.
The
ultimate impact of the COVID-19 pandemic on our business will depend on many factors, including, among others, the duration of
social distancing and stay-at-home and work-from-home mandates and recommendations and whether additional waves of COVID-19 or
different variants of COVID-19 will affect the United States and other markets, our ability and the ability of our suppliers to
continue to operate our and their manufacturing facilities and maintain the supply chain without material disruption and procure
ingredients, packaging and other raw materials when needed despite unprecedented demand in the food industry, and the extent to
which macroeconomic conditions resulting from the pandemic and the pace of the subsequent recovery may impact consumer eating and
shopping habits. We cannot predict the duration or scope of the disruption. Therefore, the financial impact cannot be reasonably
estimated at this time.
ITEM 1B
UNRESOLVED STAFF COMMENTS
None.
ITEM 2
PROPERTIES
We operate the following facilities:
Location Owned / Leased Principal Use
Waukesha, Wisconsin Owned Production of kefir, administrative offices
Niles, Illinois Owned Distribution center, administrative offices
Chicago, Illinois Leased 2 Retail stores
Lifeway believes that its facilities are
adequate for its current needs and that suitable additional space will be available on commercially acceptable terms as required.
We believe that we have adequate insurance coverage for all our properties.
ITEM 3
LEGAL PROCEEDINGS
From time to time we are engaged in litigation
matters arising in the ordinary course of business. While the results of litigation and claims cannot be predicted with certainty,
Lifeway believes that no such matter is reasonably likely to have a material adverse effect on our financial position or results
of operations.
ITEM 4
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the
Nasdaq Global Market under the symbol “LWAY.” Trading commenced on March 29, 1988. As of March 8, 2021, there
were approximately 59 holders of record of Lifeway’s Common Stock, one of which was Cede & Co., a nominee for
Depository Trust Company, or DTC, and 75 financial institutions as nominees for beneficial owners or in “street
name” the shares of which were deposited into participant accounts at DTC and are considered to be held of record
by Cede & Co. as one stockholder.
Common stock price
The following table shows the high and
low sale prices per share of our common stock as reported on the Nasdaq Global Market for each quarter during the two most recent
fiscal years:
Common Stock Price Range
Low High
Low High
Dividend Policy
Lifeway does not routinely declare and
pay dividends. From time to time however our Board of Directors may declare and pay dividends depending on our operating cash flow,
financial condition, capital requirements and such other factors as the Board of Directors may deem relevant.
There were no dividends declared or paid
in fiscal 2020 or 2019.
Issuer Purchases of Equity Securities
ITEM 6
SELECTED FINANCIAL DATA
Not applicable
ITEM 7
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial
condition and results of operations for the years ended December 31, 2020 and December 31, 2019 should be read in conjunction with
the audited consolidated financial statements and the notes to those statements that are included elsewhere in this report on Form
10-K. In addition to historical information, the following discussion contains certain forward-looking statements within the “safe
harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to our future plans,
objectives, expectations and intentions. These statements may be identified by the use of words such as "may," "could,"
"believe," "future," "depend," "expect," "will," "result," "can,"
"remain," "assurance," "subject to," "require," "limit," "impose,"
"guarantee," "restrict," "continue," "become," "predict," "likely,"
"opportunities," "effect," "change," "future," "predict," and "estimate,"
and similar terms or terminology, or the negative of such terms or other comparable terminology. Although we believe the expectations
expressed in these forward-looking statements are based on reasonable assumptions within the bounds of our knowledge of our business,
our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences
include, but are not limited to, those discussed in the “Risk Factors” section in Part I, Item 1A. We undertake no
obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other
events occur in the future.
Results of Operations
Comparison of Year Ended December 31,
2020 to Year Ended December 31, 2019 (in 000’s)
December 31, Change
Gross Profit % to net sales 26.4% 23.6%
Selling expenses % to net sales 10.0% 11.8%
General & administrative % to net sales 11.4% 13.7%
Total operating expense % to net sales 21.6% 25.7%
Income (loss) from operations % to net sales 4.8% (2.1% )
Net Sales
Net sales were $102,026 for the year ended
December 31, 2020, an increase of $8,364 or 8.9% versus prior year. The net sales increase was primarily driven by higher volumes
of our branded drinkable kefir, partially offset by lower cream revenues associated with a decline in the market price of butter
fat.
Gross Profit
Gross profit as a percentage of net sales
increased to 26.4% during the year ended December 31, 2020 from 23.6% during the same period in 2019. The increase versus the prior
year was primarily due to the impact of favorable milk pricing, and to a lesser extent favorable freight costs.
Selling Expenses
Selling expenses decreased by $865 or 7.8%
to $10,197 during the year ended December 31, 2020 from $11,062 during the same period in 2019. The decrease versus prior year
primarily reflects a reduction in advertising and marketing expense, such as trade shows and other marketing events which were
postponed due to COVID-19 and the lower planned spending on in-store demonstrations in 2020 compared to 2019. Selling expenses
as a percentage of net sales were 10.0% during the year ended December 31, 2020 compared to 11.8% for the same period in 2019.
General and Administrative Expenses
General and administrative expenses decreased
$1,167 or 9.1% to $11,661 during the year ended December 31, 2020 from $12,828 during the same period in 2019. The decrease is
primarily a result of lower compensation expense due to organizational changes made in 2019 and lower incentive compensation, partially
offset by increased professional fee expense.
Provision for Income Taxes
The provision for income taxes includes
federal, state and local income taxes. Income tax expense was $1,596 and $782 during the year ended December 31, 2020 and 2019,
respectively.
Our effective income tax rate (ETR) for
the year ended December 31, 2020 was 33.1% compared to an ETR of 63.3% in the same period last year. The decrease in effective
tax rate is primarily the result of separate state tax rates, non-deductible compensation expense related to equity incentive awards,
the provision for unrecognized tax benefits and a benefit recognized in 2020 due to the enactment of the “Coronavirus Aid,
Relief, and Economic Security Act” (the CARES Act). The Company consistently reflects non-deductible officer compensation
expense, non-deductible compensation expense related to equity incentive awards and separate state tax rates from year to year.
Although similar items were reflected in 2019, the percentage effect is substantially different due to the difference in pre-tax
income in 2020 compared to 2019.
Our effective tax rate may change from
period to period based on recurring and non-recurring factors including the relative mix of pre-tax earnings (or losses), the underlying
income tax rates applicable to various state and local taxing jurisdictions, enacted tax legislation, the impact of non-deductible
items, changes in valuation allowances, and the expiration of the statute of limitations in relation to unrecognized tax benefits.
We record discrete income tax items such as enacted tax rate changes in the period in which they occur.
Section 162(m) of the Internal Revenue
Code (the “Code”) limits the deductibility of compensation paid to certain of our executives. Under the Tax Cuts and
Jobs Act (the “Act”) amendments to Section 162(m), no tax deduction in taxable years beginning after December 31, 2017
is allowed for compensation paid to any covered employee to the extent that the total compensation for that covered employee exceeds
$1,000,000 in any taxable year. Although the Act eliminated the prior tax deduction under Section 162(m) for performance-based
executive compensation, it included a transition rule under which the changes to Section 162(m) will not apply to awards made to
our covered employees who had the right to participate in our 2015 Omnibus Incentive Plan pursuant to written binding contracts
in effect as of November 2, 2017, as long as those contracts have not subsequently been modified in any material respect. Accordingly,
subject to further guidance from the Treasury Department and the Internal Revenue Service (“IRS”), the performance-based
compensation paid to our executives under our Omnibus Plan remained eligible for the Section 162(m) exemption in 2019. Beginning
in 2020, compensation exceeding the threshold for covered employees is non-deductible for income tax purposes.
Income taxes are
discussed in Note 10 in the Notes to the Consolidated Financial Statements.
Net Income (Loss)
We reported net income of $3,232 or $0.21
per basic and diluted common share for the year ended December 31, 2020 compared to net income of $453 or $0.03 per basic and diluted
common share in the same period in 2019.
Liquidity and Capital Resources
The
ultimate impact that the COVID-19 pandemic or any future pandemic or disease outbreak will have on our business and our consolidated
results of operations is uncertain.
To date
we have seen increased customer and consumer demand for our products as consumers initially began pantry loading and have increased
their at-home consumption as a result of social distancing and stay-at-home and work-from-home mandates and recommendations. However,
this increased customer and consumer demand may decrease in the coming months if and when the need for social distancing and stay-at-home
and work-from-home mandates and recommendations decrease, and we are unable to predict the nature and timing of when that impact
may occur, if at all. .
Although
to date we have not experienced supply chain constraints, and we have continued to be able to fully satisfy customer and
consumer demand for our products, the continued unprecedented demand for food and other consumer packaged goods products as a
result of the COVID-19 pandemic or any future pandemic may limit the availability of, or increase the cost of, ingredients,
packaging and other raw materials necessary to produce our products, and our operations may be negatively impacted.
Additionally, pandemics or disease outbreaks could result in a widespread health crisis that could adversely affect economies
and financial markets, consumer spending and confidence levels resulting in an economic downturn that could affect customer
and consumer demand for our products.
Our
efforts to manage and mitigate these factors may be unsuccessful, and the effectiveness of these efforts depends on factors beyond
our control, including the duration and severity of any pandemic or disease outbreak, as well as third party actions taken to contain
its spread and mitigate public health effects.
The
ultimate impact of the COVID-19 pandemic on our business will depend on many factors, including, among others, the duration of
social distancing and stay-at-home and work-from-home mandates and recommendations and whether additional waves of COVID-19 or
different variants of COVID-19 will affect the United States and other markets, our ability and the ability of our suppliers to
continue to operate our and their manufacturing facilities and maintain the supply chain without material disruption and procure
ingredients, packaging and other raw materials when needed despite unprecedented demand in the food industry, and the extent to
which macroeconomic conditions resulting from the pandemic and the pace of the subsequent recovery may impact consumer eating and
shopping habits. We cannot predict the duration or scope of the disruption. Therefore, the financial impact cannot be reasonably
estimated at this time.
To date, our manufacturing facilities
have not been significantly impacted. We have full production capacity available at all locations at this time. On March 16, 2020,
the food industry, including grocery stores and their suppliers, and transportation were classified by the U.S. federal government
as critical infrastructure industry. As a result, our employees and facilities, as well as the retailers and distributors that
sell our products, will be able to remain in operation. During the first quarter of 2020, Management, anticipating the spread of
Covid-19 and its effects, implemented a plan to mitigate effects of Covid-19 on supply and transportation of materials used to
make and package our products, staffing, and transportation of our products to customers. While the situation is fluid, we have
evaluated all manufacturing locations and do not anticipate any staffing shortages or interruption of our production, transportation
and sale of products in the near term.
Cash Flow
At this time, the COVID-19 pandemic has
not materially impacted on our operations. We expect to meet our foreseeable liquidity and capital resource requirements through
anticipated cash flows from operations; our revolving credit facility; and cash and cash equivalents to ensure the continuation
of the Company as a going concern. The success of our business and financing strategies will continue to provide us with the financial
flexibility to take advantage of various opportunities as they arise. Given the dynamic nature of COVID-19, we will continue to
assess our liquidity needs while continuing to manage our discretionary spending and investment strategies.
Sources and Uses of Cash
Lifeway had a net increase in cash and
cash equivalents of $4,090 during the year ended December 31, 2020 and a net increase in cash and cash equivalents of $838 in the
same period in 2019. The drivers of the year over year change are as follows:
Net cash provided by operating activities
was $6,385 and $3,811 during the year ended December 31, 2020 and 2019, respectively. The increase in cash provided by operating
activities is primarily due to the increase in cash generated through higher revenues and reduced expenses in 2020, offset by the
change in working capital.
Net cash used in investing activities was
$1,890 during the year ended December 31, 2020 compared to net cash provided by investing activities of $838 in the same period
in 2019. The increase of net cash used in investing activities in 2020 reflects higher capital spending. In addition, during 2019,
the Company tendered approximately 45.6% of one of its investments recorded under the cost method on the consolidated balance sheets
for cash proceeds of $1,509. See financing section below for use of those proceeds. We received net proceeds of $474 related to
the sale of our Skokie, IL facility during 2019. Capital spending was $1,895 during the year ended December 2020 compared to $1,178
in 2019. Our capital spending is focused in three core areas: growth, cost reduction, and facility improvements. Growth capital
spending supports new product innovation and enhancements. Cost reduction and facility improvements support manufacturing efficiency,
safety and productivity.
Net cash used in financing activities was
$405 and $3,811 during the years ended December 31, 2020 and 2019, respectively. Under the terms of our line of credit agreement
(see Note 7), we utilized proceeds from our federal and state income tax refunds to repay $1,330 on our revolving line of credit
during 2019. We utilized the proceeds from the sale of our Skokie, IL facility to repay $459 on our revolving line of credit during
2019. We utilized proceeds from the sale of our investment described in the investing section above to make a mandatory prepayment
of $1,484 on our revolving line of credit during 2019.
On November 1, 2017, Lifeway’s Board
approved an increase in the aggregate amount under our previously announced 2015 stock repurchase program (the “2017 Repurchase
Plan Amendment”), by adding to (i.e., exclusive of the shares previously authorized under the 2015 stock repurchase program)
the authorization the lesser of $5,185 or 625 shares. We repurchased approximately 179 shares of common stock at a cost of $405
during the year ended December 31, 2020 under the 2017 Repurchase Plan Amendment. We repurchased approximately 211 shares of common
stock at a cost of $538 during the year ended December 31, 2019 under the 2017 Repurchase Plan Amendment. We may execute transactions
from time to time in the open market or by private negotiation, in accordance with all applicable securities laws and regulations.
We intend to hold repurchased shares in treasury for general corporate purposes, including issuances under our 2015 Omnibus Incentive
Plan.
Debt Obligations
On September 30, 2020, Lifeway entered
into the Third Modification to the Amended and Restated Loan and Security Agreement, as amended, (the “Third Modification”)
with its existing lender. The Third Modification amends the Amended and Restated Loan and Security Agreement, as amended, by removing
the monthly borrowing base reporting requirement effective September 30, 2020, including a covenant to maintain a quarterly minimum
working capital financial covenant, as defined, of no less than $11.25 million each of the fiscal quarters commencing the fiscal
quarter ended December 31, 2020 through the expiration date, and eliminating the tier interest pricing structure. The Amended and
Restated Loan and Security Agreement continues to provide Lifeway with a revolving line of credit up to a maximum of $5 million
(the “Revolving Loan”) and provides the Borrowers with an incremental facility not to exceed $5 million (the “Incremental
Facility” and together with the Revolving Loan, the “Loans”). The Termination Date of the Revolving Loan was
extended to June 30, 2025, unless earlier terminated.
Except as described above, amended, the