ITEM 1A. RISK FACTORS
In evaluating and understanding us and our business,
you should carefully consider the risks described below, in conjunction with all of the other information included in this Annual Report
on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained
in Part II, Item 7 and “Quantitative and Qualitative Disclosures About Market Risk” contained in Part II, Item 7A. The risks
and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we
currently believe are not material, may become important factors that adversely affect our business. If any of the events or circumstances
described in the following risk factors actually occurs, our business, financial condition, results of operations, and future prospects
could be materially and adversely affected.
RISKS RELATED TO OUR BUSINESS
Our product categories face a high level of
competition, which could negatively impact our sales and results of operations.
We compete with a limited number of other domestic
kefir producers and consequently face a small amount of direct competition for kefir products. However, our kefir-based products compete
with other dairy products, notably spoonable and drinkable yogurt, and, increasingly, with non-dairy probiotic products that incorporate
kefir cultures but are not kefir. We face significant competition for limited retailer shelf space in each of our product categories.
Competition in our product categories is based on product innovation, product quality, price, brand recognition and loyalty, effectiveness
of marketing, promotional activity, and our ability to identify and satisfy consumer tastes and preferences. We believe that our brands
have benefited in many cases from being the first to introduce products in their categories, and their success has attracted competition
from other food and beverage companies that produce branded products, as well as from private label competitors. Some of our competitors,
such as Danone, General Mills, Chobani, Hain Celestial Group, and Nestle, have substantial financial and marketing resources. These competitors
and others may be able to introduce innovative products more quickly or market their products more successfully than we can, which could
cause our growth rate to be slower than we anticipate and could cause sales to decline.
We also compete with producers of non-dairy products,
such as Millennium Products and PepsiCo, that have lower ingredient and production-related costs. As a result, these competing producers
may be able to offer their products to customers at a lower price point. This could cause us to lower our prices, resulting in lower profitability
or, in the alternative, cause us to lose market share if we fail to lower prices. Furthermore, private label competitors are generally
able to sell their products at lower prices because private label products typically have lower marketing costs than their branded counterparts.
If our products fail to compete successfully with other branded or private label offerings, demand for our products and our sales volumes
could be negatively impacted.
Additionally, due to high levels of competition, certain
of our key retailers may demand price concessions on our products or may become more resistant to price increases for our products. Increased
price competition and resistance to price increases have had, and may continue to have, a negative effect on our results of operations.
We may not be able to successfully implement our business strategy
for our brands on a timely basis or at all.
We believe that our future success depends, in part,
on our ability to implement our strategy of leveraging our existing brands with our new products to maintain our market position in our
product categories; drive increased sales; acquire or establish new brands; and create strategic alliances including potential joint ventures.
Our ability to implement this strategy depends, among other things, on our ability to:
· compete successfully in the product categories in which we choose to operate;
· increase our brand recognition and loyalty;
· negotiate acquisitions and joint ventures on terms acceptable to us; and
If we fail to execute these and other important elements
of our business strategy, our business and results of operations could be adversely affected.
One key element of our business strategy is to introduce
timely, new, cost-effective, and appealing products and to innovate successfully within our existing product categories. However, consumer
tastes and preferences change rapidly, and evolve over time. Factors that may affect consumer tastes and preferences include:
Our future investments may not produce the results
we expect when we expect them for a variety of reasons including those described herein. Our future product development and innovation
will be reliant on our ability to identify and develop potential new growth opportunities. This process is inherently risky and will result
in investments of substantial time and resources for which we may not achieve any return or value. Successful product development and
innovation is also affected by our ability to launch new or improved products successfully and on a timely and cost-effective basis.
We may have to pay cash, incur debt, or issue equity,
equity-linked, or debt securities to fund our business strategy, or may be unable to fund that strategy. Any of these events could adversely
affect our financial results and our business. We could experience similar effects if we invest resources in a strategy that ultimately
proves unsuccessful. If, due to a failure of our strategy or any other reason, consumer demand for our products declines, our sales volumes,
results of operations, and our business could be negatively affected, and we may not be able to create or sustain growth or successfully
implement our business strategy.
Interruption of our supply chain could affect
our ability to manufacture or distribute products, could adversely affect our business and sales, and/or could increase our operating
costs and capital expenditures.
We have several supply agreements with suppliers and
co-packers that require them to provide us with specific finished goods, including packaging and kefir. For some of these products, we
essentially rely on a single supplier or co-packer as our sole source for the item. The failure for any reason of any such sole source
or other co-packer to fulfill its obligations under the applicable agreements with us or the termination or renegotiation of any such
sourcing agreement could result in disruptions to our supply of finished goods and have an adverse effect on our results of operations.
Additionally, our suppliers and co-packers are subject to risk, including labor disputes, union organizing activities, financial liquidity,
inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability
to timely provide us with acceptable products, which could disrupt our supply of finished goods, or require that we incur additional expense
by providing financial accommodations to the supplier or co-packer or taking other steps to seek to minimize or avoid supply disruption,
such as establishing new arrangements with other providers. A new arrangement may not be available on terms as favorable to us as our
existing arrangements, if at all.
Our inability to maintain sufficient internal capacity
or establish satisfactory co-packing, warehousing and distribution arrangements could limit our ability to operate our business or implement
our strategic plan and could negatively affect our sales volumes and results of operations.
Disruption of our manufacturing or distribution
chains or information technology systems, including disruption due to cybersecurity threats, could adversely affect our business.
The success of our business depends, in part, on maintaining
a strong production platform and we rely primarily on internal production resources to fulfill our manufacturing needs. Our ongoing initiatives
to expand our production platform and our productive capacity could fail to achieve such objectives and, in any case, could increase our
operating costs beyond our expectations and could require significant additional capital expenditures. If we cannot maintain sufficient
production, warehousing, and distribution capacity, either internally or through third party agreements, we may be unable to meet customer
demand and/or our manufacturing, distribution, and warehousing costs may increase, which could negatively affect our business.
Furthermore, damage or disruption to our manufacturing
or distribution capabilities due to weather, natural disaster, fire, environmental incident, terrorism, cybersecurity threats and other
security breaches, pandemic, strikes, the financial or operational instability of key distributors, warehousing, and transportation providers,
or other reasons could impair our ability to manufacture or distribute our products.
We rely on a limited number of production and distribution
facilities. A disruption in operations at any of these facilities or any other disruption in our supply chain relating to common carriers,
supply of raw materials and finished goods, or otherwise, whether as a result of casualty, natural disaster, power loss, telecommunications
failure, cybersecurity threat, terrorism, labor shortages, contractual disputes or other causes, could significantly impair our ability
to operate our business and adversely affect our relationship with our customers. Furthermore, our insurance coverage may not be adequate
to cover all related costs.
Our information technology systems are also critical
to the operation of our business and essential to our ability to successfully perform day-to-day operations. These systems include, without
limitation, networks, applications, and outsourced services in connection with the operation of our business. A failure of our information
technology systems to perform as we anticipate could disrupt our business and result in transaction errors, processing inefficiencies,
and sales losses, causing our business to suffer. In addition, our information technology systems may be vulnerable to damage or interruption
from circumstances beyond our control, including fire, natural disasters, systems failures, and cybersecurity threats. Cybersecurity threats
in particular are persistent, evolve quickly and include, without limitation, computer viruses, unauthorized attempts to access information,
denial of service attacks, and other electronic security breaches. Like our customers, suppliers, subcontractors and other third parties
with whom we do business generally, we expect that we will continue to be the subject of cybersecurity threats. In some cases, we must
rely on the safeguards put in place by the third parties with whom we do business to protect against security threats. We believe we have
implemented appropriate measures and controls and have invested in sufficient resources to appropriately identify and monitor these threats
and mitigate potential risks, including risks involving our customers and suppliers. However, there can be no assurance that any such
actions will be sufficient to prevent cybersecurity breaches, disruptions to mission critical systems, the unauthorized release of sensitive
information or corruption of data, or harm to facilities or personnel.
These threats and other events could disrupt our operations,
or the operations of our customers, suppliers, subcontractors and other third parties; could require significant management attention
and resources; could result in the loss of business, regulatory actions and potential liability; and could negatively impact our reputation
among our customers and the public. Any of these outcomes could have a negative impact on our financial condition, results of operations,
or liquidity.
Our debt and financial obligations could adversely
affect our financial condition, our ability to obtain future financing, and our ability to operate our business.
We have outstanding debt obligations that could adversely
affect our financial condition and limit our ability to successfully implement our business strategy. Furthermore, from time to time,
we may need additional financing to support our business and pursue our business strategy, including strategic acquisitions. Our ability
to obtain additional financing, if and when required, will depend on investor demand, our operating performance, the condition of the
capital markets, and other factors. We cannot assure that additional financing will be available to us on favorable terms when required,
or at all. If we raise additional funds through the issuance of equity, equity-linked, or debt securities, those securities may have rights,
preferences, or privileges senior to those of our common stock, and, in the case of equity and equity-linked securities, our existing
stockholders may experience dilution.
As of December 31, 2022, we had $2.77 million outstanding
under the Revolving Credit Facility and $3,72 million outstanding under the note payable, net of $25 thousand of unamortized deferred
financing. Our loan agreements contain certain restrictions and requirements that among other things:
· impose on us financial and operational restrictions.
Our ability to meet our debt service obligations will
depend on our future performance, which will be affected by the other risk factors described in this Annual Report on Form 10-K. If we
do not generate enough cash flow to pay our debt service obligations, we may be required to refinance all or part of our existing debt,
sell our assets, borrow more money or raise equity. There is no guarantee that we will be able to take any of these actions on a timely
basis, on terms satisfactory to us, or at all.
Our Revolving Credit Facility and term loan bear interest
at variable rates. If market interest rates increase, it will increase our debt service requirements, which could adversely affect our
cash flow.
Our loan agreements also contain provisions that restrict our ability to:
· borrow money or guarantee debt;
· create liens;
· make specified types of investments and acquisitions;
· pay dividends on or redeem or repurchase stock;
· enter into new lines of business;
· enter into transactions with affiliates; and
· sell assets or merge with other companies.
These restrictions on the operation of our business
could harm our ability to execute on our business strategy by, among other things, limiting our ability to take advantage of financing,
merger and acquisition opportunities, and other corporate opportunities. Various risks, uncertainties, and events beyond our control could
affect our ability to comply with these covenants. Unless cured or waived, a default would permit lenders to accelerate the maturity of
the debt under the credit agreement and to foreclose upon the collateral securing the debt.
Loss of our key management or other personnel,
or an inability to attract such management and other personnel, could negatively impact our business.
We depend on the skills, working relationships, and
continued services of key personnel, including our experienced senior management team. We also depend on our ability to attract and retain
qualified personnel to operate and expand our business. If we lose one or more members of our senior management team whose responsibilities
cannot otherwise be distributed among our other officers, or if we fail to attract talented new employees, our business and results of
operations could be negatively affected.
Employee strikes and other labor-related disruptions
may adversely affect our operations.
We have a union contract governing the terms and conditions
of employment for a significant portion of our workforce. Although we believe union relations since the union’s certification as
the exclusive bargaining representative of this portion of our workforce have been amicable, there is no assurance that this will continue
in the future or that we will not be subject to future union organizing activity. There are potential adverse effects of labor disputes
with our own employees or by others who provide warehousing, transportation, and distribution, both domestic and foreign, of our raw materials
or other products. Strikes or work stoppages or other business interruptions could occur if we are unable to renew collective bargaining
agreements on satisfactory terms or enter into new agreements on satisfactory terms, which could impair manufacturing and distribution
of our products or result in a loss of sales, which could adversely impact our business, financial condition, or results of operations.
The terms and conditions of existing, renegotiated, or new collective bargaining agreements could also increase our costs or otherwise
affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy.
Our intellectual property rights are valuable, and any inability
to protect them could reduce the value of our products and brands.
We consider our intellectual property rights, particularly
our trademarks, but also our copyrights, registered domain names, and proprietary trade secrets, technology, know-how, processes and other
proprietary rights to be a significant and valuable aspect of our business. We attempt to protect our intellectual property rights by
relying on a combination of trademark, copyright, trade dress, trade secret, and other intellectual property laws, and domain name dispute
resolution systems; as well as licensing agreements, third-party confidentiality, nondisclosure, and assignment agreements; and by policing
third-party misuses of our intellectual property. Our failure to obtain or maintain adequate protection of our intellectual property rights,
or any change in law or other changes that serve to lessen or remove the current legal protections of our intellectual property, may diminish
our competitiveness and could materially harm our business.
We also face the risk of claims that we have infringed
third parties’ intellectual property rights. Any claims of intellectual property infringement, even those without merit, could be
expensive and time consuming to defend, cause us to cease making, licensing, or using products that incorporate the challenged intellectual
property, require us to redesign or rebrand our products or packaging, divert management’s attention and resources, or require us
to enter into royalty or licensing agreements to obtain the right to use a third party’s intellectual property. Any royalty or licensing
agreements, if required, may not be available to us on acceptable terms or at all. Additionally, a successful claim of infringement against
us could result in our being required to pay significant damages, enter into costly license or royalty agreements, or stop the sale of
certain products, any of which could have a negative effect on our results of operations.
The Smolyansky family controls a substantial portion of our common
stock and has the ability to control the outcome of matters submitted for stockholder approval.
Although the members of the Smolyansky family
together control less than 50% of our common stock collectively, they could significantly influence any matter requiring approval by our
stockholders, including the election of all of our directors and the approval or rejection of any merger, change of control, or other
significant corporate transaction. It is unlikely that any person interested in acquiring Lifeway will be able to do so without obtaining
the consent of some members of the Smolyansky family. The Smolyansky family’s interests may not always be aligned with other stockholders’
interests. By exercising their influence, members of the Smolyansky family could cause Lifeway to take actions that are at odds with the
investment goals of institutional, short-term, non-voting, or other non-controlling investors, or that have a negative effect on our stock
price.
Our business could be negatively affected as a result of the
actions of stockholders.
Our business could be negatively affected as
a result of stockholder actions, which could cause us to incur significant expense, hinder execution of our business strategy, and impact
the trading value of our securities. Stockholder actions, including potential proxy contests, requires significant time and attention
by management and our Board, potentially interfering with our ability to execute our strategic plan. We may be required to incur significant
legal fees and other expenses related to stockholder actions, and the attention of our management may be diverted by such actions. While
we welcome our stockholders’ constructive input, there can be no assurance that stockholder actions would not result in negative
impacts to the Company. Any of these impacts could materially and adversely affect our business and operating results, and the market
price of our Common Stock could be subject to significant fluctuation or otherwise be adversely affected by stockholder actions.
RISKS RELATED TO OUR INDUSTRY
The consolidation of our customers or the loss
of any of our largest customers could negatively impact our sales and results of operations.
Customers, such as supermarkets and food distributors,
continue to consolidate. This consolidation has produced larger, more sophisticated organizations with increased negotiating and buying
power that are able to resist price increases or demand increased promotional programs, as well as operate with lower inventories, decrease
the number of brands that they carry and increase their emphasis on private label products, all of which could negatively impact our business.
The consolidation of retail customers also increases the risk that a significant adverse impact on their business could have a corresponding
material adverse impact on our business.
Two of our customers together accounted for 22% of
our net sales in the fiscal year ended December 31, 2022. Where we enter into written agreements with our customers, they are generally
terminable after short notice periods by the customer. In addition, our customers sometimes award contracts based on competitive bidding,
which could result in lower profits for contracts we win and the loss of business for contracts we lose. The loss of any large customer,
the reduction of purchasing levels, or the cancellation of any business from a large customer for an extended period of time could negatively
affect our sales and results of operations.
We rely on sales made by or through our independent
distributors to customers. Distributors purchase directly for their own account for resale. The loss of, or business disruption at, one
or more of these distributors may harm our business. If we are required to obtain additional or alternative distribution agreements or
arrangements in the future, we cannot be certain that we will be able to do so on satisfactory terms or in a timely manner. Our inability
to enter into satisfactory distribution agreements may inhibit our ability to implement our business plan or to establish markets necessary
to expand the distribution of our products successfully.
We are subject to the risk of product contamination
and product liability claims, which could harm our reputation, force us to recall products and incur substantial costs.
The sale of food products for human consumption involves
the risk of injury to consumers. Such injuries may result from tampering by unauthorized third parties, inadvertent mislabeling, product
contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during
the storage, processing, handling or transportation phases. We also may be subject to liability if our products or production processes
violate applicable laws or regulations, including environmental, health, and safety requirements, or in the event our products cause injury,
illness, or death.
Under certain circumstances, we may be required to
recall or withdraw products, suspend production of our products, or cease operations, which may lead to a material adverse effect on our
business. In addition, customers may cancel orders for such products as a result of such events. Even if a situation does not necessitate
a recall or market withdrawal, and even if we and each of our co-packers and suppliers comply in all material respects with all applicable
laws and regulations, we may become subject to claims or lawsuits relating to such matters. Even if a product liability claim is unsuccessful
or is not fully pursued, the negative publicity surrounding any assertion that our products caused illness or physical harm, including
the risk of reputational harm being magnified and/or distorted through the rapid dissemination of information over the Internet, including
through news articles, blogs, chat rooms, and social media, could adversely affect our reputation with existing and potential customers
and consumers and our corporate and brand image. Moreover, claims or liabilities of this type might not be covered by our insurance or
by any rights of indemnity or contribution that we may have against others. We maintain product liability and product recall insurance
in amounts that we believe to be adequate. However, we cannot be sure that we will not incur claims or liabilities for which we are not
insured or that exceed the amount of our insurance coverage. A product liability judgment against us or a product recall could have a
material adverse effect on our business, consolidated financial condition, results of operations or liquidity.
We rely on independent certification for several of our products
and facilities.
We rely on independent certification, such as certifications
of our products as “organic,” or “gluten-free,” to differentiate our products from others. The loss of any independent
certifications could adversely affect our market position as a probiotic-based product and natural, “better for you” foods
company, which could harm our business. We rely on independent SQF certification at some of our facilities, a certification that some
of our customers require us to maintain.
We must comply with the requirements of independent
organizations or certification authorities in order to label our products as certified. For example, we can lose our “organic”
certification if a manufacturing plant becomes contaminated with non-organic materials, or if it is not properly cleaned after a production
run. In addition, all organic raw materials must be certified organic or organic compliant. Our products could lose their organic certifications
if our raw material suppliers lose their organic certifications. Similarly, we could lose our SQF certification if we do not meet the
requirements of the SQF Code. The loss of these certifications could cause us to lose customers that require Lifeway products and/or facilities
to carry some or all of them, which could negatively affect our sales and results of operations.
Increases in the cost of raw milk could reduce
our gross margin and profit.
Conventional and organic raw milk, our primary raw
material, is an agricultural commodity that is subject to price fluctuations. Both conventional and organic milk prices in fiscal 2022
were higher than the prior year, and there can be no assurance that such prices will remain at these levels in the future. The supply
and price of raw milk may be impacted by, among other things, weather, natural disasters, real or perceived supply shortages, lower dairy
and crop yields, general increases in farm inputs and costs of production, political and economic conditions, labor actions, government
actions, and trade barriers. Increases in the market price for raw milk or over-order premiums charged by producers may also impact our
ability to enter into purchase commitments at a fixed price. There can be no assurance that our purchasing practices will mitigate future
price risk. As a result, increases in the cost of raw milk could have an adverse impact on our profitability.
In addition, the dairy industry continues to experience
periodic imbalances between supply and demand for organic raw milk. Industry regulation and the costs of organic farming compared to costs
of conventional farming can impact the supply of organic raw milk in the market. Oversupply levels of organic raw milk can increase competitive
pressure on our products and pricing, while supply shortages can cause higher input costs and reduce our ability to deliver product to
our customers. Cost increases in raw materials and other inputs could cause our profits to decrease significantly compared to prior periods,
as we may be unable to increase our prices to offset the increased cost of these raw materials and other inputs. If we are unable to obtain
raw materials and other inputs for our products or offset any increased costs for such raw materials and inputs, our business could be
negatively affected.
Reduced availability of raw materials and other
inputs, as well as increased costs for them, could adversely affect us.
Our business depends heavily on raw materials and
other inputs in addition to conventional and organic raw milk, such as sweeteners, diesel fuel, packaging material, resin, and other commodities.
Our raw materials are generally sourced from third-party suppliers, and we are not assured of continued supply, pricing, or exclusive
access to raw materials from any of these suppliers. In 2022, costs to us increased primarily due to inflationary price increases of other
ingredients, packaging materials, and freight. 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.
The organic ingredients we use in some of our products
are less plentiful and available from a fewer number of suppliers than their conventional counterparts. Competition with other manufacturers
in the procurement of organic product ingredients may increase in the future if consumer demand for organic products increases.
Our business is subject to various food, environmental,
and health and safety laws and regulations, which may increase our compliance costs, subject us to liabilities, or otherwise adversely
affect our business.
Our business operations are subject to numerous requirements
in the United States relating to food safety, production, and marketing, as well as the protection of the environment, and health and
safety matters. The food production and marketing industry is subject to a variety of federal, state, local, and foreign laws and regulations,
including food safety requirements related to the ingredients, manufacture, processing, storage, marketing, advertising, labeling, and
distribution of our products, as well as those related to worker health and workplace safety. Our activities, both in and outside of the
United States, are subject to extensive regulation. We are regulated by, among other federal and state authorities, the FDA, USDA, the
U.S. Federal Trade Commission (“FTC”), and the U.S. Departments of Commerce, and Labor, as well as by similar authorities
in the foreign countries in which we do business. Environmental laws including the Clean Air Act, the Clean Water Act, the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, as amended, and the National Organic Standards of the U.S. Department
of Agriculture, as well as similar state and local statutes and regulations in the United States and in each of the foreign countries
in which we do business apply to our business operations as well. These laws and regulations govern, among other things, air emissions
and the discharge of wastewater and other pollutants, the use of refrigerants, the handling and disposal of hazardous materials, and the
cleanup of contamination in the environment.
In addition, the marketing and advertising of our
products could make us the target of claims relating to alleged false or deceptive advertising under federal, state, and foreign laws
and regulations, and we may be subject to initiatives that limit or prohibit the marketing and advertising of our products to children.
We are also subject to federal laws and regulations
relating to our organic products and production. For example, as required by the National Organic Program (“NOP”), we rely
on third parties to certify certain of our products and production locations as organic. Regulations and formal and informal positions
taken by the NOP pursuant to the Organic Foods Production Act of 1990, which created the NOP, are subject to continued review and scrutiny.
Changes in these laws or regulations or the introduction
of new laws or regulations could increase our compliance costs, increase other costs of doing business for us, our customers, or our suppliers,
or restrict our actions, which could adversely affect our results of operations. In some cases, new laws and regulations or other federal
and state regulatory initiatives could interrupt distribution of our products or force changes in our production processes and our products.
Governmental regulations also affect taxes and levies, healthcare costs, energy usage, immigration, and other labor issues, all of which
may have a direct or indirect effect on our business or those of our customers or suppliers. These costs could negatively affect our results
of operations and financial condition. Further, if we are found to be in violation of applicable laws and regulations in these areas,
we could be subject to civil remedies, including third-party claims for property damage or personal injury, fines, injunctions, recalls,
cleanup costs, and other civil sanctions, as well as potential criminal sanctions, any of which could have a material adverse effect on
our business.
RISKS RELATED TO COVID-19 AND OTHER
PANDEMIC OR DISEASE OUTBREAKS
Pandemics or disease outbreaks, such
as the COVID-19 pandemic, may disrupt consumption and trade patterns, supply chains, available labor supply, and production processes,
which could materially affect our operations and results of operations.
The ultimate impact that the COVID-19 pandemic
or any future pandemic or disease outbreak will have on our business and our consolidated results of operations is uncertain.
To date we have seen increased customer
and consumer demand for our products. 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 2022, 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.
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 we have realized
over the past two years 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.
The ultimate impact
of the COVID-19 pandemic on our business will depend on many factors, including, among others, whether additional waves of COVID-19 or
different variants of COVID-19 will affect the United States and other markets and the duration of any social distancing and stay home
and work from home mandates or recommendations that may occur as a result of such COVID-19 wave or variant; our ability and the ability
of our suppliers to continue to maintain production despite unprecedented demand in the food industry, supply chain disruptions, tight
labor markets and increased raw materials and packaging costs; and the extent to which macroeconomic conditions resulting from the pandemic
and the pace of the subsequent recovery impact consumer eating and shopping habits. We cannot predict the duration or scope of the disruption
or the impact of any recovery from the impacts of COVID-19. Therefore, the financial impact cannot be reasonably estimated at this time.
Future pandemics
or disease outbreaks could similarly adversely affect economies and financial markets, consumer spending and confidence levels and result
in an economic downturn that affects customer demand for our products. Our efforts to manage and mitigate these risks 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We operate the following facilities:
Location Owned / Leased Principal Use
Waukesha, Wisconsin Owned Production of kefir, administrative offices
Niles, Illinois Owned Distribution center, administrative offices
Lifeway believes that its facilities are adequate
for its current needs and that suitable additional space will be available on commercially acceptable terms as required. We believe that
we have adequate insurance coverage for all our properties.
ITEM 3. LEGAL
PROCEEDINGS
From time to time, we are engaged in litigation matters
arising in the ordinary course of business. While the results of litigation and claims cannot be predicted with certainty, Lifeway believes
that no such matter is reasonably likely to have a material adverse effect on our financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the Nasdaq Global Market
under the symbol “LWAY.” Trading commenced on March 29, 1988. As of March 14, 2023, there were approximately 49 holders of
record of Lifeway’s Common Stock, one of which was Cede & Co., a nominee for Depository Trust Company, or DTC, and 73 financial
institutions as nominees for beneficial owners or in “street name” the shares of which were deposited into participant accounts
at DTC and are considered to be held of record by Cede & Co. as one stockholder.
Common stock price
The following table shows the high and low sale prices
per share of our common stock as reported on the Nasdaq Global Market for each quarter during the two most recent fiscal years:
Common Stock Price Range
Low High
Low High
Dividend Policy
Lifeway does not routinely declare and pay dividends.
From time to time however our Board of Directors may declare and pay dividends depending on our operating cash flow, financial condition,
capital requirements and such other factors as the Board of Directors may deem relevant.
There were no dividends declared or paid in fiscal
2022 or 2021.
Issuer Purchases of Equity Securities
ITEM 6. [RESERVED]
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, 2022 and 2021 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.
Recent Developments
COVID-19 Pandemic Impact
We have seen increased customer and consumer demand
for our products during the pandemic as consumers increased their food purchases for in-home consumption. We have not experienced significant
supply chain disruptions or labor supply shortages and have continued to satisfy customer and consumer demand for our products. Management
continues to proactively manage the supply and transportation of materials used to make and package our products, staffing, and transportation
of our products to customers. This proactive planning has allowed the Company to avoid disruption to its manufacturing facilities and
production, transportation, and sales and to meet the increased demand. The Company has maintained full production capacity available
at all locations and does not anticipate manufacturing or staffing disruptions in the near term.
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 2022, our costs increased primarily due to
inflationary price increases of milk, other ingredients, packaging materials, and transportation to our customers. 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.
During 2022, social distancing, shelter-in-place
and work-from-home mandates and recommendations have continued 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, 2022 to Year
Ended December 31, 2021 (in 000’s)
December 31,
$ % $ %
Other income (expense):
Gain on investments – 0.0% 2 0.0%
Loss on sale of property and equipment (241 ) (0.2% ) (88 ) (0.1% )
Other Income, net – 0.0% (62 ) 0.0%
Total other income (expense) (508 ) (0.4% ) (264 ) (0.2% )
Income before provision for income taxes 1,841 1.3% 5,616 4.7%
Net Sales
Net sales were $141,568 for the year ended December
31, 2022, an increase of $22,503 or 18.9% versus prior year. The net sales increase was primarily driven by higher volumes of our branded
drinkable kefir and the impact of price increases implemented during the year, and to a lesser extent, the favorable impact of our acquisition
of Glen Oaks Farms during the third quarter of 2021. Approximately 18% of the net sales increase results from the full year 2022 impact
of our acquisition of Glen Oaks Farms during the third quarter of 2021.
Gross Profit
Gross profit as a percentage of net sales decreased
to 18.9% during the year ended December 31, 2022 from 24.1% during the same period in 2021. 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 during 2022 to recover a portion of the 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 $207 to $11,304
during the year ended December 31, 2022 from $11,097 during the same period in 2021. The increase versus prior year is primarily due to
increased investment in advertising and marketing programs, increased broker expense, partially offset by lower compensation expense.
General and Administrative Expenses
General and administrative expenses
increased $982 to $12,593 during the year ended December 31, 2022 from $11,611 during the same period in 2021. The increase is
primarily a result of increased legal and professional fees, which include expense related to non-routine stockholder action, the
fiscal year 2020 Form 10-K restatement, and incentive compensation, partially offset by lower consulting expense to our former
Chairperson of the Board of Directors.
Provision for Income Taxes
The provision for income taxes includes federal,
state and local income taxes. The provision for income taxes was $917 and $2,305 during the year ended December 31, 2022 and 2021, respectively.
Our effective income tax rate was 49.1% in 2022
compared to 41.0% in 2021. The statutory Federal and state tax rates remained consistent from 2021 to 2022. 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 2022, the percentage effect is different due to the difference in pre-tax income in 2022 compared to 2021.
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 to the extent their total compensation
exceeds $1 million 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 $924 or $0.06 per basic
and diluted common share for the year ended December 31, 2022 compared to net income of $3,311 or $0.21 per basic and diluted common share
in the same period in 2021.
Liquidity and Capital Resources
Management
assesses the Company's liquidity in terms of its ability to generate cash to fund its operating, investing, and financing activities.
The Company remains in a strong financial position, and while it has been impacted by the macroeconomic challenges with commodity inflation
and other input cost increases, the Company believes that its cash flow from operations, revolving credit and term loan facility, and
cash and cash equivalents will continue to provide sufficient liquidity for its working capital needs, capital resource requirements,
and growth initiatives and to ensure the continuation of the Company as a going concern.
If additional
borrowings are needed, $2,223 was available under the Revolving Credit Facility as of December 31, 2022 (see Note 7, Debt). 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.
To date, we have been successful in generating cash and obtaining financing as needed. However, if a serious economic or credit market
crisis ensues, it could have a negative effect on our liquidity, results of operations and financial condition.
The Company’
most significant ongoing short-term cash requirements relate primarily to funding operations (including expenditures for raw materials,
labor, manufacturing and distribution, trade and promotions, advertising and marketing, and income tax liabilities) as well as expenditures
for property, plant, and equipment.
Long-term cash
requirements primarily relate to funding long-term debt repayments (see Note 7, Debt) and deferred income taxes (see Note 10, Income Taxes).
The following table is derived from our Consolidated
Statement of Cash Flows:
Year Ended December 31,
Net Cash Flows Provided By (Used In):
Investing activities $ (4,029 ) $ (7,142 )
Operating Activities
Net cash provided by operating activities was
$3,987 in 2022 compared to $5,564 in 2021. The decrease was primarily due to lower cash earnings, which reflect the impact of input and
freight cost inflation in 2022, and the change in working capital.
Investing Activities
Net cash used in investing activities was $4,029 in
2022 compared to $7,142 in 2021. The decrease in cash used reflects the August 2021 acquisition of GlenOaks Farms, Inc., partially offset
by increased capital spending in 2022. 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.
Financing Activities
Net cash used in financing activities was $4,747
during 2022 compared to net cash provided by financing activities of $2,885 in 2021. The decrease in cash used relates to the term loan
entered into during August 2021 in connection with the acquisition of GlenOaks Farms, Inc., partially offset by the quarterly principal
payments under the term loan.
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.
On November 7, 2022, the Company entered into
a Stock Purchase Agreement with Ludmila Smolyansky (“Ms. Smolyansky”), to purchase 850,340 shares of Lifeway common stock
from Ms. Smolyansky, Board of Director member. The shares were repurchased during the fourth quarter of 2022.
Pursuant to the Stock Purchase Agreement, the
Company and Ms. Smolyansky have agreed, among other things, that (i) Ms. Smolyansky will sell the shares at a purchase price of $4.70
per share, which represents a twenty percent (20.0%) discount to the average closing price of the common stock on Nasdaq over the five
(5) trading day period ended on the trading day immediately preceding the date of the Stock Purchase Agreement and (ii) Ms. Smolyansky
will use a portion of the proceeds to satisfy in full certain obligations of Ms. Smolyansky, which are secured by previously disclosed
pledges of common stock, causing all such pledges to be released. The purchased shares will be held in treasury by the Company.
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, 2022, we had $2,777 outstanding
under the Revolving Credit Facility and $3,727 outstanding under the note payable, net of $23 of unamortized deferred financing fees.
We had $2,223 available for future borrowings under the Revolving Credit Facility as of December 31, 2022. 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 Company’s interest rate on debt outstanding
under the revolving line of credit and note payable as of December 31, 2022 was 6.17% and 6.29%, respectively.
We are in compliance with all applicable financial
debt covenants as of December 31, 2022. 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 impairment
Goodwill totaled $11,704 as of December 31, 2022.
The Company completed its annual goodwill impairment analysis as of December 31, 2022. 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.
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, 2022, we had $1,800 of accrued discounts and allowances.
Share-based compensation