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
Modified Revolving Credit Facility remains substantively unchanged and in full force and effect, including customary representations,
warranties, and covenants on the part of Lifeway, including financial covenants requiring us to maintain a fixed charge coverage
ratio of no less than 1.25 to 1.00 each of the fiscal quarters ending through the expiration date. The Modified Revolving Credit
Facility continues to provide for events of default, including failure to repay principal and interest when due and failure to
perform or violation of the provisions or covenants of the agreement, as a result of which amounts due under the Modified Revolving
Credit Facility may be accelerated.
As of December 31, 2020, we had $2,768
net of $9 of unamortized deferred financing costs, outstanding under the Revolving Credit Facility. We had $2,223 available for
future borrowings as of December 31, 2020.
As amended, all outstanding amounts under
the Loans bear interest, at Lifeway’s election, at either the lender Base Rate (the Prime Rate minus 1.00%) or the LIBOR
plus 1.95%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee of 0.20% and, in conjunction
with the issuance of any letters of credit, a letter of credit fee of 0.20%. Lifeway’s interest rate on debt outstanding
under our Revolving Credit Facility as of December 31, 2020 was 2.10%.
We are in compliance with all applicable
financial debt covenants as of December 31, 2020. See Note 7 to our Consolidated Financial Statements for additional information
regarding our indebtedness and related agreements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financing
arrangements as defined in Item 303(a)(4) of Regulation S-K.
Contractual Obligations
Not applicable.
Critical Accounting Policies and
Use of Estimates
Critical accounting policies are defined
as those most important to the portrayal of a company’s financial condition and results, and require the most difficult,
subjective, or complex judgments. In many cases, the accounting treatment of a particular transaction is specifically dictated
by US GAAP with no need for the application of our judgement. In certain circumstances, the preparation of our Consolidated Financial
Statements in conformity with US GAAP requires us to use our judgment to make certain estimates and assumptions. These estimates
affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the Consolidated
Financial Statements and the reported amounts of net sales and expenses during the reporting period. We believe in the quality
and reasonableness of our critical accounting estimates; however, materially different amounts might be reported under different
conditions or using assumptions, estimates or making judgments different from those that we have applied. Management has discussed
the development and selection of these critical accounting policies, as well as our significant accounting policies (see Note 2
to the Consolidated Financial Statements), with the Audit Committee of our Board of Directors. We have identified the policies
described below as our critical accounting policies.
Goodwill and intangible asset valuation
Goodwill totaled $9,124 as of December
31, 2020. The Company completed its annual goodwill impairment analysis as of December 31, 2020. Our assessment did not result
in an impairment. Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable
intangible assets acquired. We estimate the fair value of our one reporting unit annually (as of December 31), or more frequently
if certain conditions exist, using a combination of the fair values derived from both the income approach and the market approach.
Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash
flows. Cash flow projections are based on our estimates of revenue growth rates and operating margins, taking into consideration
industry and market conditions. The discount rate used to determine the present value of future cash flows is based on the weighted-average
cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to
the business's ability to execute on the projected cash flows. The market approach estimates fair value based on market multiples
of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics.
The resulting fair value, based on the income and market approaches, is then compared to the carrying value to determine if impairment
is necessary.
We reviewed our indefinite lived intangible
assets, which consist of brand names totaling $3,700 as of December 31, 2020, using the relief from royalty method. Significant
assumptions include the royalty rate, revenue growth rates, and discount rates. Our assumptions were based on historical performance
and management estimates of future performance. Our assessment did not result in an impairment in 2020.
Sales discounts & allowance.
We offer various trade promotions and sales
incentive programs to customers and consumers. From time to time, we grant certain sales discounts to customers which are classified
as a reduction in sales. The measurement and recognition of discounts and allowances involve the use of judgment and our estimates
are made based on historical experience and specific customer program accruals. Differences between estimated and actual discount
and allowance costs are normally not material and are recognized in earnings in the period such differences are determined. The
process for analyzing trade promotion programs could impact our results of operations and trade spending accruals depending on
how actual results of the programs compare to original estimates. As of December 31, 2020, we had $1 million of accrued discounts
and allowances.
Share-based compensation.
Certain employees and non-employee directors
receive various forms of share-based payment awards and we recognize compensation expense for these awards based on their grant
date fair values. The fair values of stock option awards are estimated on the grant date using the Black-Scholes option pricing
model, which incorporates certain assumptions regarding the expected term of an award and expected stock price volatility. The
expected term is determined under the simplified method, using an average of the contractual term and vesting period of the stock
options. The expected volatility is based on the historic volatility of our common stock. We do not estimate forfeitures in measuring
the grant date fair value, but rather account for forfeitures as they occur. Key assumptions are described in further detail in
Note 11 to our consolidated financial statements.
Income taxes.
We pay income taxes based on tax statutes,
regulations, and case law of the various jurisdictions in which we operate. At any given time, multiple tax years are subject to
audit by the various taxing authorities. Income taxes are accounted for under the asset and liability method. Deferred income tax
assets and liabilities are recognized for the future tax effects of temporary differences between financial and income tax reporting
using tax rates in effect for the years in which the differences are expected to reverse.
We recognize an income tax benefit from
an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing
authorities based on the technical merits of the position. The income tax benefit recognized in our financial statements from such
a position is measured based on the largest estimated benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement. These judgments and estimates made at a point in time may change based on the outcome of tax audits and changes to,
or further interpretations of, regulations. If such changes take place, there is a risk that our tax rate may increase or decrease
in any period, which would impact our earnings. Future business results may affect deferred tax liabilities or the valuation of
deferred tax assets over time.
Recent Accounting Pronouncements.
See Note 2, Summary of Significant Accounting Policies, in
the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K for information regarding recent accounting
pronouncements.
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2020 and 2019 F-2
Notes to Consolidated Financial Statements F-6
Report of Independent Registered Public
Accounting Firm
To the Board of Directors and
Stockholders of Lifeway Foods, Inc. and
Subsidiaries:
Opinion on the Financial Statements
We have audited the accompanying consolidated
balance sheets of Lifeway Foods, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related
consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period
ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion,
the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020
and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020,
in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based
on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB")
and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with
the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have,
nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required
to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the
effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures
to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures
that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures
in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made
by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a
reasonable basis for our opinion.
Critical Audit Matters
Critical audit matters are matters arising
from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee
and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging,
subjective, or complex judgments. We determined that there are no critical audit matters.
/s/ Mayer Hoffman McCann P.C.
We have served as the Company's auditor
since 2015
Chicago, Illinois
March 25 2021
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2020 and 2019
(In thousands)
December 31,
Current assets
Cash and cash equivalents $ 7,926 $ 3,836
Prepaid expenses and other current assets 1,163 1,598
Refundable income taxes 31 681
Operating lease right-of use asset 345 738
Intangible assets
Goodwill and indefinite-lived intangibles 12,824 12,824
Other intangible assets, net – 152
Current liabilities
Operating lease liabilities 165 488
Deferred income taxes, net 1,764 922
Other long-term liabilities 77 58
Commitments and contingencies
Stockholders’ equity
Total liabilities and stockholders’ equity $ 60,069 $ 56,987
See accompanying notes to consolidated
financial statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 2020
and 2019
(In thousands, except per share data)
Income (loss) from operations 4,923 (1,933 )
Other income (expense):
Fair value gain on investments – 1,731
Realized gain on investments, net 4 1,413
(Loss) gain on sale of property and equipment (28 ) 189
Total other (expense) income (95 ) 3,168
Income before provision for income taxes 4,828 1,235
Provision for income taxes 1,596 782
Basic earnings per common share $ 0.21 $ 0.03
Diluted earnings per common share $ 0.21 $ 0.03
Weighted average number of shares outstanding - Basic 15,597 15,748
Weighted average number of shares outstanding - Diluted 15,766 15,804
See accompanying notes to consolidated
financial statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’
Equity
For the Years Ended December 31, 2020
and 2019
(In thousands)
Common Stock
Issued In treasury Paid-In Retained Total
Shares $ Shares $ Capital Earnings Equity
Treasury stock purchased – – (211 ) (538 ) – – (538 )
Stock-based compensation – – – – 515 – 515
Treasury stock purchased – – (179 ) (405 ) – – (405 )
Stock-based compensation – – – – 282 – 282
See accompanying notes to consolidated
financial statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2020
and 2019
(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization 3,239 3,338
Non-cash interest expense 23 23
Non-cash rent expense (37 ) (17 )
Bad debt expense (6 ) 7
Deferred Revenue (91 ) (97 )
Reserve for inventory obsolescence – (52 )
Stock-based compensation 393 838
Fair value gain on investment – (1,731 )
Net gain on sale of investment – (1,413 )
(Loss) gain on sale of property and equipment 28 (189 )
(Increase) decrease in operating assets:
Prepaid expenses and other current assets 423 (526 )
Increase (decrease) in operating liabilities:
Operating lease asset amortization/liability – (17 )
Accrued income taxes 500 47
Net cash provided by operating activities 6,385 3,811
Cash flows from investing activities:
Purchases of investments – (15 )
Proceeds from sale of investments – 1,509
Purchases of property and equipment (1,895 ) (1,178 )
Proceeds from sale of property and equipment 5 522
Net cash (used in) provided by investing activities (1,890 ) 838
Cash flows from financing activities:
Purchase of treasury stock (405 ) (538 )
Repayment of line of credit – (3,273 )
Net cash used in financing activities (405 ) (3,811 )
Net increase in cash and cash equivalents 4,090 838
Cash and cash equivalents at the beginning of the period 3,836 2,998
Cash and cash equivalents at the end of the period $ 7,926 $ 3,836
Supplemental cash flow information:
Cash paid for income taxes, net of (refunds) $ (426 ) $ (1,865 )
Cash paid for interest 99 259
Non-cash investing activities
Right-of-use assets recognized at ASU 2016-02 transition – 944
Operating lease liability recognized at ASU 2016-02 transition – 997
Non-cash financing activities
Issuance of common stock under equity incentive plans 522 –
See accompanying notes to consolidated
financial statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
(In thousands)
Note 1 – Basis of presentation
The accompanying consolidated financial
statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United
States of America (“U.S. GAAP”). Our consolidated financial statements include all of the assets, liabilities and results
of operations of Lifeway’s wholly owned subsidiaries (collectively “Lifeway” or the “Company”). All
inter-company balances and transactions have been eliminated in the consolidated financial statements.
Note 2 – Summary of significant
accounting policies
Use of estimates
The preparation of consolidated financial
statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements
and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant
estimates made in preparing the consolidated financial statements include the reserve for promotional allowances, the valuation
of goodwill and intangible assets, stock-based and incentive compensation, and deferred income taxes.
Going Concern
The Company follows the guidance in Accounting
Standards Codification (“ASC”) 205-40, Presentation of Financial Statements - Going Concern which requires management
to assess an entity’s ability to continue as a going concern and to provide related disclosure in certain circumstances.
There were no conditions or events, when considered in the aggregate, that raise substantial doubt about the Company’s ability
to continue as a going concern within one year after the date the financial statements are issued.
Revenue Recognition
We sell food and beverage products across
select product categories to customers predominantly within the United States (see Note 12, Segments, Products and Customers).
We also sell bulk cream, a byproduct of our fluid milk manufacturing process. In accordance with ASC 606, Revenue from Contracts
with Customers, we recognize revenue when control over the products transfers to our customers, which generally occurs upon delivery
to our customers or their common carriers. The amount of revenue recognized reflects the consideration to which the Company expects
to be entitled to receive in exchange for these goods or services, using the five-step method required by ASC 606.
For the Company, the contract is the approved
sales order, which may also be supplemented by other agreements that formalize various terms and conditions with customers. The
Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors
including the customer’s historical payment experience or, in the case of a new customer, published credit and financial
information pertaining to the customer.
Performance obligations promised in a contract
are identified based on the goods or services that will be transferred to the customer, which is the delivery of food products
which provide immediate benefit to the customer.
We account for product shipping and handling
as fulfillment activities with revenues for these activities recorded within net revenue and costs recorded within cost of goods
sold. Any taxes collected on behalf of government authorities are excluded from net revenues.
Variable consideration, which typically
includes volume-based rebates, known or expected pricing or revenue adjustments, such as trade discounts, allowances for non-saleable
products, product returns, trade incentives and coupon redemption, is estimated utilizing the most likely amount method.
Key sales terms, such as pricing and quantities
ordered, are established on a frequent basis such that most customer arrangements and related incentives have a one year or shorter
duration. As such, we do not capitalize contract inception costs and we capitalize product fulfillment costs in accordance with
U.S. GAAP and our inventory policies. We do not have any significant deferred revenue or unbilled receivables at the end of a period.
We generally do not receive noncash consideration for the sale of goods, nor do we grant payment financing terms greater than one
year.
Accounts Receivable
We provide credit terms to customers in-line
with industry standards and maintain allowances for potential credit losses based on historical experience. Customer balances are
written off after all collection efforts are exhausted. Estimated product returns, which have not been material, are deducted from
sales at the time of revenue recognition. The Company does not charge interest on past due accounts receivable.
Cash and cash equivalents
Lifeway considers cash and all highly liquid
investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated
at cost, which approximates or equals fair value due to their short-term nature.
Lifeway from time to time may have bank
deposits in excess of insurance limits of the Federal Deposit Insurance Corporation. Lifeway has not experienced any losses in
such accounts and believes it is not exposed to any significant credit risk related to its cash and cash equivalents.
Inventories
Inventories are stated at the lower of
cost or net realizable value, valued on a first in, first out basis (“FIFO”). The costs of finished goods inventories
include raw materials, direct labor, and overhead costs. Inventories are stated net of reserves for excess or obsolete inventory.
Property, plant and equipment
Property, plant and equipment are recorded
at cost. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets
as follows:
Asset Useful Life
Buildings and improvements 31 and 39 years
Machinery and equipment 5 – 12 years
Office equipment 3 – 7 years
Vehicles 5 years
Leasehold improvements Shorter of expected useful life or lease term
We perform impairment tests when circumstances
indicate that the carrying value of an asset may not be recoverable. Expenditures for repairs and maintenance, which do not improve
or extend the life of the assets, are expensed as incurred.
Intangible Assets
Goodwill and indefinite-lived intangible
assets
Goodwill represents the excess purchase
price over the fair value of the net tangible and other identifiable intangible assets acquired. We estimate the fair value of
our one reporting unit annually (as of December 31), or more frequently if certain conditions exist, using a combination of the
fair values derived from both the income approach and the market approach. Under the income approach, we calculate the fair value
of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on our estimates
of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used
to determine the present value of future cash flows is based on the weighted-average cost of capital adjusted for the relevant
risk associated with business-specific characteristics and the uncertainty related to the business's ability to execute on the
projected cash flows. The market approach estimates fair value based on market multiples of revenue and earnings derived from comparable
publicly traded companies with similar operating and investment characteristics. The resulting fair value, based on the income
and market approaches, is then compared to the carrying value to determine if impairment is necessary.
We assess whether indefinite-lived intangible
asset impairment exists using both qualitative and quantitative assessments annually in the fourth quarter or more frequently,
if certain conditions exist. The qualitative assessment involves determining whether events or circumstances exist that indicate
it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If, based
on this qualitative assessment, we determine it is more likely than not that the fair value of an indefinite-lived intangible asset
is less than its carrying amount or if we elect not to perform a qualitative assessment, a quantitative assessment is performed
to determine whether an indefinite-lived intangible asset impairment exists. We test the indefinite-lived intangible assets for
impairment by comparing the carrying value to the fair value based on current revenue projections of the related operations, under
the relief from royalty method. Any excess of the carrying value over the amount of fair value is recognized as an impairment.
Any such impairment would be recognized in full in the reporting period in which it has been identified.
Definite lived intangible assets
Intangible assets acquired in a business
combination are recorded at their estimated fair values at the date of acquisition. Identifiable intangible assets with finite
lives are amortized over their estimate useful lives as follows:
Asset Useful Life
Recipes 4 years
Trade names 8-15 years
Formula 10 years
Customer lists 5-10 years
Customer relationships 12 years
All amortization expense related to intangible assets is recorded
in Amortization expense in the consolidated statements of operations.
Amortizable intangible assets are evaluated
for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Lifeway conducts
more frequent impairment assessments if certain conditions exist, such as a change in the competitive landscape, any internal decisions
to pursue new or different strategies, a loss of a significant customer, or a significant change in the market place including
changes in the prices paid for our products or changes in the size of the market for our products. If an evaluation of the undiscounted
cash flows indicates impairment, the asset is written down to its estimated fair value, which is generally based on discounted
future cash flows. If the estimated remaining useful life of an intangible asset is changed, the remaining carrying amount of the
intangible asset is amortized prospectively over the revised remaining useful life.
Fair value measurements
Fair value is estimated by applying the
following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within
the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 – Quoted prices
in active markets for identical assets or liabilities.
Level 2 – Observable
inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar
assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data
for substantially the full term of the assets or liabilities.
Level 3. Inputs that are
generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing
the asset or liability.
Lifeway’s financial assets and liabilities
that are not carried at fair value on a recurring basis include cash and cash equivalents, accounts receivable, other receivables,
accounts payable, accrued expenses and revolving line of credit for which carrying value approximates fair value.
The Company records its investments in
equity securities without a readily determinable fair value at cost minus impairment, if any, plus or minus changes resulting from
observable price changes in orderly transactions for the identical or a similar investment of the same issuer. During October 2019,
the Company sold approximately 45.6% of one of its investments recorded under the cost method and recognized a $1,438 gain on sale
of investment, which is recorded in other income (expense) on the consolidated statements of operations. The Company also recorded
an unrealized gain of $1,731 resulting from the observable price change of this transaction, which is recorded in other income
(expense) on the consolidated statements of operations. As of December 31, 2020, and 2019, the Company has one investment without
a readily determinable fair value which is recorded at $1,800 in other assets on the consolidated balance sheet.
Income taxes
The Provision for income taxes includes
federal, state, local and foreign income taxes currently payable, and those deferred because of temporary differences between the
financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference
between the financial statement and income tax bases of assets and liabilities using enacted tax rates expected to apply to taxable
income in the year in which the deferred tax assets or liabilities are expected to be realized or settled. The principal sources
of temporary differences are different depreciation and amortization methods for financial statement and tax purposes, incentive
compensation, unrealized gain, capitalization of indirect inventory costs for tax purposes, reserves for excess and obsolete inventory
and the allowance for doubtful accounts.
Valuation allowances are recorded to reduce
deferred tax assets when it is more likely not that a tax benefit will not be realized. Deferred income tax expense or benefit
is based on the changes in the asset or liability from period to period.
Lifeway has analyzed filing positions
in all the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these
jurisdictions. We recognize the income tax benefit from an uncertain tax position when it is more likely than not that, based
on technical merits, the position will be sustained upon examination, including resolutions of any related appeals or litigation
processes. We apply a more likely than not threshold to the recognition and derecognition of uncertain tax positions. Accordingly,
we recognize the amount of tax benefit that has a greater than 50% likelihood of being ultimately realized upon settlement. Future
changes in judgment related to the expected ultimate resolution of uncertain tax positions will affect earnings in the period
of such change. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax
benefit has been recognized in the financial statements. The total amount of unrecognized tax benefits can change due to audit
settlements, tax examination activities, statute expirations and the recognition and measurement criteria under accounting for
uncertainty in income taxes. Lifeway recognizes penalties and interest related to unrecognized tax benefits in the provision (benefit)
for income taxes in the consolidated statements of operations.
Share-based compensation
Share-based compensation expense is recognized
for equity awards over the vesting period based on their grant date fair value. The fair value of restricted stock awards is equal
to the closing price of our stock on the date of grant. We do not estimate forfeitures in measuring the grant date fair value,
but rather account for forfeitures as they occur. The Company issues share based equity awards from treasury shares.
Treasury stock
Treasury stock is recorded using the cost
method.
Advertising costs
Lifeway expenses advertising costs as incurred
and reported in Selling expense in our consolidated statements of operations. For the years ended December 31, 2020 and 2019 total
advertising expenses were $2,407 and $3,394, respectively.
Earnings (loss) per common share
Basic earnings (loss) per common share