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 as of and for the years ended December 31, 2021 and 2020 should be read in conjunction with the audited consolidated
financial statements and the notes to those statements that are included elsewhere in this Annual 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.
Restatement of Previously Issued Consolidated
Financial Statements
During the preparation of our fiscal 2021 consolidated
financial statements, we identified a material error in the accounting for our deferred income tax liabilities and goodwill. Specifically,
in connection with our 2009 acquisition of Fresh Made, Inc., we did not record a deferred income tax liability and corresponding increase
to goodwill related to the difference in the book and income tax bases for the $3.7 million Fresh Made indefinite-lived brand name intangible
asset acquired. The error resulted in a $1.18 million understatement of both deferred income tax liabilities and goodwill of as of January
1, 2020. The Restatement had no impact on our Consolidated Statements of Operations, Consolidated Statements of Cash Flows, or Consolidated
Statements of Stockholders’ Equity during 2021 and 2020. The impact of the Restatement on periods prior to 2020 had no effect on
opening retained earnings as of January 1, 2020.
The accounting adjustments required to correct
the error in the consolidated financial statements for the year ended December 31, 2020 as a result of completing the restatement
process are described in Note 1 – Basis of presentation - Restatement of Previously Issued Consolidated Financial Statements included
in “Part II – Item 8 – Financial Statements and Supplementary Data.” Note 17 – Restatement of previously
issued unaudited consolidated financial statements presents the accounting adjustments to correct the error in the quarterly consolidated
financial statements for the fiscal quarters in 2020 and 2021.
The accompanying Management’s Discussion
and Analysis of Financial Condition and Results for Operation gives effect to the Restatement adjustments made to the previously reported
Consolidated Financial Statements for the year ended December 31, 2020.
Recent Developments
COVID-19 Pandemic Impact
In December 2019, COVID-19 was first reported
and subsequently characterized by the World Health Organization ("WHO") as a pandemic in March 2020. In an effort to reduce
the global transmission of COVID-19, various policies and initiatives have been implemented by governments around the world, including
orders to close businesses not deemed "essential", shelter-in-place orders enacted by state and local governments, and the practice
of social distancing measures when engaging in essential activities.
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. Management’s proactive
planning allowed the Company to avoid disruption to its manufacturing facilities and production, transportation, and sales and to meet
the increased demand without delay. The Company has maintained full production capacity available at all locations and does not anticipate
manufacturing or staffing disruptions in the near term.
To date, we
have seen increased customer and consumer demand for our products. We have not experienced significant supply chain disruptions or labor
supply shortages and we have continued to be able to satisfy customer and consumer demand for our products. However, the COVID-19 pandemic,
or any future pandemic, may limit the availability of, or increase the cost of, employees, ingredients, packaging and other inputs necessary
to produce our products, and our operations may be negatively impacted. In 2021, our costs increased primarily due to inflationary price
increases of milk, other ingredients, packaging materials, and freight. However, because of market conditions or for competitive reasons,
our pricing actions may sometimes lag input cost changes, or we may not be able to pass along the full effect of increases in raw materials
and other input costs as we incur them.
Recently, in 2022, social distancing,
shelter-in-place and work-from-home mandates and recommendations have begun to be reduced or eliminated. The increased customer demand
for our products as consumers increased their at-home consumption and e-commerce purchasing during the COVID-19 pandemic may change or
decrease due to the decrease in social distancing and stay-at-home and work-from-home mandates and recommendations. We are unable to predict
the nature and timing of when such change may occur, if at all.
Results of Operations
Comparison of Year Ended December 31, 2021
to Year Ended December 31, 2020 (in 000’s)
December 31,
$ % $ %
Other income (expense):
Gain on investments 2 0.0 % 4 0.0 %
Loss on sales or property and equipment (88 ) (0.1 %) (28 ) (0.0 %)
Total other income (expense) (264 ) (0.2 %) (95 ) (0.1 %)
Income before provision for income taxes 5,616 4.7 % 4,828 4.7 %
Net Sales
Net sales were $119,065 for the year ended December
31, 2021, an increase of $17,039 or 16.7% versus prior year. The net sales increase was primarily driven by higher volumes of our branded
drinkable kefir and, to a lesser extent, the favorable impact of our acquisition of Glen Oaks Farms during the third quarter of 2021.
Approximately 11% of the net sales increase results from our acquisition of Glen Oaks Farms during the third quarter of 2021. Approximately
20% of the net sales increase results from the Farmers to Families Food Box program with the USDA, which began during the middle of the
first quarter of 2021 and ended during May 2021.
Gross Profit
Gross profit as a percentage of net sales decreased
to 24.1% during the year ended December 31, 2021 from 26.4% during the same period in 2020. The decrease versus the prior year was primarily
due to the unfavorable impact of milk pricing, and the inflationary price increases of other ingredients, packaging materials, and freight,
partially offset by the decrease in depreciation expense and favorable labor efficiency due to increased volumes. We took favorable pricing
actions beginning in December 2021 to recover input and freight cost inflation. However, for market conditions or competitive reasons,
our pricing actions may also lag input cost changes, or we may not be able to pass along the full effect of increases in raw materials
and other input costs as we incur them.
Selling Expenses
Selling expenses increased by $900 to $11,097
during the year ended December 31, 2021 from $10,197 during the same period in 2020. The increase versus prior year is primarily due to
increased investment in advertising and marketing programs, partially offset by lower compensation and broker expense.
General and Administrative Expenses
General and administrative expenses decreased
$50 to $11,611 during the year ended December 31, 2021 from $11,661 during the same period in 2020. The decrease is primarily a result
of lower compensation, related party consulting, and office rent expense, partially offset by higher employee incentive compensation expense.
Provision for Income Taxes
The provision for income taxes includes federal,
state and local income taxes. The provision for income taxes was $2,305 and $1,596 during the year ended December 31, 2021 and 2020, respectively.
Our effective income tax rate was 41.0% in 2021
compared to 33.1% in 2020. The statutory Federal and state tax rates remained consistent from 2020 to 2021. The Company has a number of
items that are nondeductible or are discrete adjustments to tax expense. 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 2021, the percentage effect is different due to the difference in pre-tax income in 2021 compared to 2020.
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 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.
Income taxes are discussed
in Note 10 in the Notes to the Consolidated Financial Statements.
Net Income (Loss)
We reported net income of $3,311 or $0.21 per
basic and diluted common share for the year ended December 31, 2021 compared to net income of $3,232 or $0.21 per basic and diluted common
share in the same period in 2020.
Liquidity and Capital Resources
Cash Flow
At this time, the COVID-19 pandemic has not materially
impacted our operations. We expect to meet our foreseeable liquidity and capital resource requirements, and to ensure the continuation
of the Company as a going concern, through anticipated cash flows from operations, our revolving credit facility and cash and cash equivalents.
If additional borrowings are needed, approximately $2,223 was available under the Revolving Credit Facility as of December 31, 2021. See
Note 7 to our Consolidated Financial Statements for additional information regarding our Revolving Credit Facility. We are in compliance
with the terms of the Credit Agreement and expect to meet foreseeable financial requirements. 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.
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.
Sources and Uses of Cash
Lifeway had a net increase in cash and cash equivalents
of $1,307 and $4,090 during the years ended December 31, 2021 and 2020, respectively. The drivers of the year over year change are as
follows:
Net cash provided by operating activities was
$6,144 in 2021 compared to $6,385 in 2020, a decrease in cash provided of $241. The decrease is primarily due to the change in working
capital.
Net cash used in investing activities was $7,722
in 2021 compared to $1,890 in 2020, an increase in cash used of $5,832. The increase reflects the August 2021 acquisition of Glen Oak
Farms, Inc. The $5,800 acquisition purchase price was funded through proceeds from our new $5,000 term loan and existing cash. Capital
spending was $1,922 in 2021 compared to $1,895 in 2020. 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 provided by financing activities was
$2,885 during the year ended December 31, 2021 compared to net cash used in financing activities of $405 in the same period in 2020.
The increase in net cash provided by financing activities relates to the term loan entered into during August 2021 in connection with
the acquisition of Glen Oaks Farms, Inc. See the Debt Obligations section below for further detail.
On June 24, 2021, Lifeway’s Board authorized
a plan to repurchase up to 250 shares of Common Stock in the open market within 24 months at no more than $10 per share. We repurchased
all 250 shares of common stock at a cost of $1,583 during the three-month period ended September 30, 2021. We intend to hold repurchased
shares in treasury for general corporate purposes, including issuances under our 2015 Omnibus Incentive Plan. Treasury shares are accounted
for using the cost method.
Debt Obligations
On August 18, 2021, Lifeway entered into the
Fourth Modification (the “Fourth Modification”) to the Amended and Restated Loan and Security Agreement (as amended and modified
from time to time, the “Credit Agreement”) with its existing lender and certain of its subsidiaries. The Fourth Modification
amends the Credit Agreement to provide for, among other things, a $5 million term loan by the existing lender to the borrowers to be
repaid in quarterly installments of principal and interest over a term of five years (the “Term Loan”). The termination
date of the Term Loan is August 18, 2026, unless earlier terminated. Except for the addition of the Term Loan, the Credit Agreement remains
substantively unchanged and in full force and effect.
As of December 31, 2021, we had $2,777 outstanding
under the Revolving Credit Facility and $4,470 outstanding under the note payable, net of $30 of unamortized deferred financing fees.
We had $2,223 available for future borrowings under the Revolving Credit Facility as of December 31, 2021. 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% on the Revolving Credit
Facility and, in conjunction with the issuance of any letters of credit, a letter of credit fee of 0.20%. The interest rate on debt outstanding
under the Loans as of December 31, 2021 was 2.15%.
We are in compliance with all applicable financial
debt covenants as of December 31, 2021. 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 Estimates
Critical accounting estimates are those estimates
made in accordance with U.S. GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to
have a material impact on the financial condition or results of operations of the registrant. In many cases, the accounting treatment
of a particular transaction is specifically dictated by U.S. GAAP with no need for the application of our judgement. In certain circumstances,
the preparation of our Consolidated Financial Statements in conformity with U.S. 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 $11,704 as of December 31, 2021.
The Company completed its annual goodwill impairment analysis as of December 31, 2021. 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, 2021, 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 2021.
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, 2021, we had $1,170 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.
No stock options were issued during 2021 or 2020.
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 Annual Report on 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 (PCAOB ID 199) F-1
Consolidated Balance Sheets as of December 31, 2021 and 2020 F-2
Notes to Consolidated Financial Statements (as restated) 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, 2021 and 2020, the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2021,
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, 2021 and 2020, and the results of its operations
and its cash flows for each of the years in the two-year period ended December 31, 2021, in conformity with accounting principles generally
accepted in the United States of America.
Restatement of the 2020 Financial Statements
As discussed in Note 1, the 2020 financial statements
have been restated to correct a misstatement.
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
July 21, 2022
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2021 and 2020
(In thousands)
December 31,
Current assets
Cash and cash equivalents $ 9,233 $ 7,926
Prepaid expenses and other current assets 1,254 1,163
Refundable income taxes 344 31
Operating lease right-of use asset 216 345
Intangible assets
Goodwill and indefinite-lived intangibles 15,404 14,004
Other intangible assets, net 4,278 –
Current liabilities
Current portion of note payable $ 1,000 $ –
Operating lease liabilities 85 165
Other long-term liabilities 147 77
Commitments and contingencies – –
Stockholders’ equity
Preferred stock, no par value; 2,500 shares authorized; none issued – –
Total liabilities and stockholders’ equity $ 70,874 $ 61,249
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 2021 and 2020
(In thousands, except per share data)
Other income (expense):
Realized gain on investments, net 2 4
Loss on sale of property and equipment (88 ) (28 )
Other (expense) income (62 ) 47
Total other income (expense) (264 ) (95 )
Income before provision for income taxes 5,616 4,828
Basic earnings per common share $ 0.21 $ 0.21
Diluted earnings per common share $ 0.21 $ 0.21
Weighted average number of shares outstanding - Basic 15,537 15,597
Weighted average number of shares outstanding - Diluted 15,773 15,766
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’
Equity
For the Years Ended December 31, 2021 and 2020
(In thousands)
Common Stock
Issued In treasury Paid-In Retained Total
Shares $ Shares $ Capital Earnings Equity
Cumulative impact of change in accounting principles, net of tax – – – – – – –
Treasury stock purchased – – (179 ) (405 ) – – (405 )
Stock-based compensation – – – – 282 – 282
Treasury stock purchased – – (250 ) (1,583 ) – – (1,583 )
Stock-based compensation – – – – 673 – 673
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2021 and 2020
(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization 2,873 3,239
Non-cash interest expense 11 23
Non-cash rent expense 1 (37 )
Bad debt expense 2 (6 )
Deferred Revenue (30 ) (91 )
Loss on sale of property and equipment 88 28
(Increase) decrease in operating assets:
Refundable income taxes (313 ) 649
Prepaid expenses and other current assets (91 ) 423
Increase (decrease) in operating liabilities:
Operating lease asset amortization/liability – –
Accrued income taxes 72 500
Net cash provided by operating activities 5,564 6,385
Cash flows from investing activities:
Purchases of property and equipment (1,922 ) (1,895 )
Proceeds from sale of property and equipment – 5
Acquisition, net of cash acquired (5,220 ) –
Net cash used in investing activities (7,142 ) (1,890 )
Cash flows from financing activities:
Purchase of treasury stock (1,583 ) (405 )
Payment of deferred financing cost (32 ) –
Proceeds from note payable 5,000 –
Repayment of note payable (500 ) –
Net cash provided by (used in) financing activities 2,885 (405 )
Net increase in cash and cash equivalents 1,307 4,090
Cash and cash equivalents at the beginning of the period 7,926 3,836
Cash and cash equivalents at the end of the period $ 9,233 $ 7,926
Supplemental cash flow information:
Cash paid for income taxes, net of (refunds) $ 2,288 $ (426 )
Cash paid for interest $ 102 $ 99
Non-cash investing activities
Business acquisition escrow payable $ 580 $ –
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, 2021 and 2020
(In thousands)
Note 1 – Basis of presentation
The 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”).
The 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.
Restatement of Previously Issued Consolidated
Financial Statements
Lifeway has restated herein its consolidated financial
statements as of and for the year ended December 31, 2020. In addition, the Company has restated its unaudited quarterly consolidated
financial statements for the first three quarters of the years ended December 31, 2020 and 2021, as presented in Note 17 – Correction
of previously issued unaudited consolidated financial statements. Lifeway has also restated impacted amounts within the notes to the consolidated
financial statements, as applicable.
Restatement Background
During the preparation of the fiscal 2021 consolidated
financial statements, the Company identified an error in the accounting for its deferred income tax liabilities and goodwill. Specifically,
in connection with its 2009 acquisition of Fresh Made, Inc., the Company did not record a deferred income tax liability and corresponding
increase to goodwill related to the difference in the book and income tax bases for the $3,700 Fresh Made indefinite-lived brand name
intangible asset acquired. The error resulted in a $1,180 understatement- of both deferred income tax liabilities and goodwill of as of
January 1, 2020. The Restatement had no impact on the Company’s Consolidated Statements of Operations, Consolidated Statements of
Cash Flows, or Consolidated Statements of Stockholders’ Equity during 2021 and 2020. The impact of the Restatement on periods prior
to 2020 had no effect on opening retained earnings as of January 1, 2020.
The following table summarizes the impact of the
restatement adjustments on the Consolidated Balance Sheet for the year ended December 31, 2020.
Schedule of restatement adjustments
As Previously Reported Restatement Adjustment As Restated
Current assets
Cash and cash equivalents $ 7,926 $ – $ 7,926
Prepaid expenses and other current assets 1,163 – 1,163
Refundable income taxes 31 – 31
Operating lease right-of use asset 345 – 345
Intangible assets
Other intangible assets, net – – –
Current liabilities
Operating lease liabilities 165 – 165
Other long-term liabilities 77 – 77
Commitments and contingencies – – –
Stockholders’ equity
Preferred stock, no par value; 2,500 shares authorized; none issued – – –
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 use judgement 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 the
reported amounts of net sales 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.
During the fourth quarter of 2021, the Company
completed an assessment of the useful life of its indefinite-lived brand name intangible asset and determined that it should adjust the
estimated useful life from an indefinite length to 15 years. The change in accounting estimate will be effective January 1, 2022, at which
time the Company will begin amortizing the asset over 15 years. The future amortization expense is included in the five-year intangible
asset amortization table in Note 5 – Goodwill and Intangible Assets.
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.
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. The Company places its cash and cash equivalents with high
credit quality financial institutions. Lifeway has not experienced any losses in such accounts and believes the financial risks associated
with these financial instruments are minimal.
The Company has $580 of restricted cash which
is included in cash and cash equivalents as of December 31, 2021. The restricted cash balance represents escrow funds deposited by Lifeway
in connection with the September 18, 2021 acquisition of certain assets of Glen Oaks Farms, Inc. The funds are security for the liability
and indemnity obligations of seller as defined under the asset purchase agreement. The funds will remain in escrow for twelve months from
the acquisition closing date, at which time the funds, less any amounts for outstanding seller obligations, will be remitted to the sellers.
Revenue Recognition
Lifeway sells food and beverage products across
select product categories to customers predominantly within the United States (see Note 12 - Segments, Products and Customers). The Company
also sells bulk cream, a byproduct of its fluid milk manufacturing process. In accordance with ASC 606, Revenue from Contracts with Customers,
Lifeway recognizes revenue when control over the products transfers to its customers, which generally occurs upon delivery to its 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.
Lifeway accounts 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, the Company does not capitalize contract inception costs and it capitalizes product fulfillment costs in accordance with U.S.
GAAP and its inventory policies. Lifeway does not have any significant deferred revenue or unbilled receivables at the end of a period.
It generally does not receive noncash consideration for the sale of goods, nor does it grant payment financing terms greater than one
year.
Accounts Receivable
Lifeway provides 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.
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:
Schedule Of Property And Equipment, Estimated Useful Lives
Asset Useful Life
Buildings and improvements 10 – 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
The Company performs 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. Lifeway estimates the fair value of its 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, it calculates the fair value of a reporting unit based
on the present value of estimated future cash flows. Cash flow projections are based on the Company’s 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.
Lifeway assesses 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,
the Company determines it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying
amount or if it elects not to perform a qualitative assessment, a quantitative assessment is performed to determine whether an indefinite-lived
intangible asset impairment exists. Lifeway tests 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:
Schedule Of Intangible Assets Useful Lives
Asset Useful Life
Recipes 4 years
Brand names 8-15 years
Formula 10 years
Customer lists 5-10 years
Customer relationships 15 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 its products or changes in the size of the market for its 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. As of December 31, 2021, and 2020,
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. The investment cost of $1,800 includes a cumulative unrealized gain of $1,731 resulting from an observable price
change in 2019. There were no upward or downward adjustments to the investment cost during 2021 or 2020.
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 analyzes 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. The Company
recognizes 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. It applies a more likely
than not threshold to the recognition and derecognition of uncertain tax positions. Accordingly, Lifeway recognizes 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