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
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 grant fair value of Restricted Stock Units (“RSUs”) and Performance Share Unit (“PSUs”) awards is equal to
the Company’s closing stock price on the grant date. The Company granted RSU and PSU awards during 2022 to employees under the 2022
long-term incentive-based plan, and RSU awards to non-employee Directors under the 2022 Non-Employee Director Equity and Deferred Compensation
Plan. We do not estimate forfeitures in measuring the grant date fair value, but rather account for forfeitures as they occur. See Note
11 to our consolidated financial statements for further detail.
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. The assumptions about future taxable income require the use of significant judgment and are consistent with the
plans and estimates we are using to manage our underlying businesses.
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
Report of Independent Registered Accounting Firm (PCAOB ID 248) F-2
Consolidated Balance Sheets as of December 31, 2022 and 2021 F-3
Notes to Consolidated Financial Statements F-7
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 sheet of Lifeway Foods, Inc. and Subsidiaries (the “Company”) as of December 31, 2021, the related consolidated statement
of operations, stockholders’ equity, and cash flows for the year 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 the results of its operations and its cash flows for the year ended December
31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our
audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB")
and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the
standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. As part of our audit 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 audit 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 audit provide a reasonable basis for our opinion.
/s/ Mayer Hoffman McCann P.C.
We have served as the Company's auditor since 2015, which ended in 2022
Chicago, Illinois
July 21, 2022
Report of Independent Registered Public Accounting
Firm
Board of Directors and Stockholders
Lifeway Foods, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheet of Lifeway
Foods, Inc. and subsidiaries (the “Company”) as of December 31, 2022, the related consolidated statements of operations, stockholders’
equity, and cash flows for the year ended December 31, 2022, 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, 2022, and the results of its operations and its cash flows for the year ended December 31, 2022, in conformity with accounting principles
generally accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. 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 audit 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 audit 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 audit 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 audit 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 audit provides 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/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2022.
Chicago, Illinois
March 27, 2023
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2022 and 2021
(In thousands)
December 31,
Current assets
Cash and cash equivalents $ 4,444 $ 9,233
Prepaid expenses and other current assets 1,445 1,254
Refundable income taxes 44 344
Operating lease right-of use asset 174 216
Current liabilities
Current portion of note payable $ 1,250 $ 1,000
Accrued income taxes – 725
Operating lease liabilities 104 85
Other long-term liabilities – 147
Commitments and contingencies (Note 9) – –
Stockholders’ equity
Preferred stock, no par value; 2,500 shares authorized; none issued – –
Total liabilities and stockholders’ equity $ 68,999 $ 70,874
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 2022 and 2021
(In thousands, except per share data)
Other income (expense):
Realized gain on investments, net – 2
Loss on sale of property and equipment (241 ) (88 )
Other (expense) income – (62 )
Total other income (expense) (508 ) (264 )
Income before provision for income taxes 1,841 5,616
Provision for income taxes 917 2,305
Basic earnings per common share $ 0.06 $ 0.21
Diluted earnings per common share $ 0.06 $ 0.21
Weighted average number of shares outstanding - Basic 15,396 15,537
Weighted average number of shares outstanding - Diluted 15,718 15,773
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
For the Years Ended December 31, 2022 and 2021
(In thousands)
Common Stock
Issued In treasury Paid-In Retained Total
Shares $ Shares $ Capital Earnings Equity
Treasury stock purchased – – (250 ) (1,583 ) – – (1,583 )
Stock-based compensation – – – – 673 – 673
Treasury stock purchased – – (850 ) (3,997 ) – – (3,997 )
Stock-based compensation – – – – 1,630 – 1,630
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2022 and 2021
(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization 2,972 2,873
Non-cash interest expense 6 11
Non-cash rent expense – 1
Bad debt expense – 2
Deferred revenue (28 ) (30 )
Deferred income taxes (172 ) 257
Loss on sale of property and equipment 241 88
(Increase) decrease in operating assets:
Refundable income taxes 300 (313 )
Prepaid expenses and other current assets (191 ) (91 )
Increase (decrease) in operating liabilities:
Accrued income taxes (725 ) 72
Net cash provided by operating activities 3,987 5,564
Cash flows from investing activities:
Purchases of property and equipment (3,449 ) (1,922 )
Acquisition, net of cash acquired (580 ) (5,220 )
Net cash used in investing activities (4,029 ) (7,142 )
Cash flows from financing activities:
Purchase of treasury stock (3,997 ) (1,583 )
Payment of deferred financing cost – (32 )
Proceeds from note payable – 5,000
Repayment of note payable (750 ) (500 )
Net cash (used in) provided by financing activities (4,747 ) 2,885
Net (decrease) increase in cash and cash equivalents (4,789 ) 1,307
Cash and cash equivalents at the beginning of the period 9,233 7,926
Cash and cash equivalents at the end of the period $ 4,444 $ 9,233
Supplemental cash flow information:
Cash paid for income taxes, net of (refunds) $ 1,121 $ 2,288
Cash paid for interest $ 247 $ 102
Non-cash investing activities
Increase in right-of-use assets and operating lease obligations $ 83 $ 45
Business acquisition escrow payable $ – $ 580
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2022 and 2021
(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 Foods, Inc. and its
wholly owned subsidiaries (collectively “Lifeway” or the “Company”). All inter-company balances and transactions
have been eliminated in the consolidated financial statements.
Note 2 – Summary of significant accounting
policies
Use of estimates
The preparation of consolidated financial statements
in conformity with U.S. GAAP requires management to 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 $3,700 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 was effective January 1, 2022, at which time the Company began 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 no restricted cash as of December
31, 2022. The Restricted cash escrow funds of $580 were 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 escrow funds were remitted to the sellers in August 2022.
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 and beverage 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 includes 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. 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
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.
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 estimated 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,
2022, and 2021, 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 2022
or 2021.
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
Share-based compensation expense is recognized for
equity awards over the vesting period based on their grant date fair value. The fair value of restricted stock awards is equal to the
closing price of Lifeway’s stock on the date of grant. The Company does not estimate forfeitures in measuring the grant date fair
value, but rather account for forfeitures as they occur. The Company issues share based equity awards from treasury shares.
Treasury stock
Treasury stock is recorded using the cost method.
Advertising costs
Advertising costs are expensed as incurred and
reported in Selling expense in the Company’s consolidated statements of operations. Expenditures totaled $3,353
and $3,267
for the years ended December 31, 2022 and 2021, respectively.
Earnings (loss) per common share
Basic earnings (loss) per common share is computed
by dividing net income (loss) available to common stockholders by the weighted average number of common shares issued and outstanding
during the reporting period. Diluted earnings (loss) per common share is computed by dividing net income (loss) available to common stockholders
by the weighted average number of common shares issued and outstanding and the effect of all dilutive common stock equivalents related
to the Company’s outstanding stock-based compensation awards outstanding during the reporting period. For the years ended December
31, 2022 and 2021, there were 322 and 236 common stock equivalents outstanding, respectively.
Segments
The Company is managed as a single reportable segment.
The Chief Executive Officer, who is the Company’s Chief Operating Decision Maker (“CODM”), reviews financial information
on an aggregate basis for purposes of allocating resources and assessing financial performance, as well as for making strategic operational
decisions and managing the organization. Substantially all of Lifeway’s consolidated revenues relate to the sale of cultured dairy
products that it produces using the same processes and materials and are sold to consumers through a common network of distributors and
retailers in the United States.
Recent accounting pronouncements
Issued but not yet effective
In October 2021, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2021-08, Business Combinations (Topic 805):
Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The new guidance provides a single comprehensive
accounting model on revenue recognition for contracts with customers and requires that the acquirer in a business combination recognize
and measure contract assets and liabilities acquired in a business combination in accordance with Topic 606 (Revenue from Contracts with