ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the
financial condition and results of operations as of and for the years ended December 31, 2023 and 2022 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,” 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
Current Macroeconomic Environment and Inflation Impact
During 2022, we experienced inflationary and cost
pressures due to volatility and disruption in the global economy which have increased our production and distribution costs. During 2023,
we experienced some moderation of inflationary pressures and have experienced pricing declines in certain of our input costs, such as
conventional milk. In response to these persistent inflationary and cost pressures, we instituted price increases in 2022 on many of our
products. These inflation-justified price increases mitigated a portion of our increased costs.
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 chain of materials used to produce and transport our products to customers. This proactive planning has
allowed the Company to avoid disruption to its manufacturing facilities, transportation, and sales, and to meet the increased demand.
The Company has maintained production at all locations and does not anticipate manufacturing or staffing disruptions in the near term.
Results of Operations
Comparison of Year Ended December 31, 2023
to Year Ended December 31, 2022 (in 000’s)
The following table presents certain information
concerning our financial results, including information presented as a percentage of consolidated net sales:
Year Ended December 31,
$ % $ %
Other income (expense):
Gain (loss) on sale of property and equipment 34 0.0% (241 ) (0.2% )
Other income (expense) 4 0.0% – 0.0%
Total other income (expense) (346 ) (0.2% ) (508 ) (0.4% )
Net Sales
Net sales were $160,123 for the year ended December
31, 2023, an increase of $18,555 or 13.1% versus prior year. The net sales increase was primarily driven by higher volumes of our branded
drinkable kefir, and to a lesser extent the impact of price increases implemented during the fourth quarter of 2022.
Gross Profit
Gross profit as a percentage of net sales increased
to 26.5% during the year ended December 31, 2023 from 18.9% during the same period in 2022. The increase versus the prior year was primarily
due to the higher volumes of our branded products and the favorable impact of milk pricing, and to a lesser extent the price increases
implemented during the fourth quarter of 2022 and decreased transportation costs.
Selling Expenses
Selling expenses increased by $472 to $11,776
during the year ended December 31, 2023 from $11,304 during the same period in 2022. The increase is primarily due to increased compensation
expense, partially offset by the reduction in royalty expense resulting from the termination of the endorsement agreement in September
2022.
General and Administrative Expenses
General and administrative expenses increased
$537 to $13,130 during the year ended December 31, 2023 from $12,593 during the same period in 2022. The increase is primarily a result
of increased incentive compensation expense, partially offset by the termination of the endorsement agreement in September 2022 and reduced
professional fees.
Provision for Income Taxes
The provision for income taxes includes federal,
state and local income taxes. The provision for income taxes was $5,282 and $917 during the year ended December 31, 2023 and 2022, respectively.
The effective income tax rate was 31.7% in 2023
compared to 49.1% in 2022. The statutory Federal and state tax rates remained consistent from 2022 to 2023. The Company consistently reflects
non-deductible items such as 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 2023, the percentage effect is different
due to the difference in pre-tax income in 2023 compared to 2022.
The Company’s 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, settlement of tax audits, and the expiration of the statute of limitations in relation to unrecognized
tax benefits. The Company records 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.
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, $5,000 was available under the Revolving Credit Facility as of December 31, 2023 (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’s 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).
Cash Flow
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 $ (4,410 ) $ (4,029 )
Financing activities $ (3,777 ) $ (4,747 )
Operating Activities
Net cash provided by operating activities was
$16,941 in 2023 compared to $3,987 in 2022. The increase was primarily due to higher cash earnings driven by increased product volumes
and declines in certain input costs, and the change in working capital.
Investing Activities
Net cash used in investing activities was $4,410
in 2023 compared to $4,029 in 2022. The increase in cash used reflects our planned capital spending increase during 2023 compared to 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 $3,777 in 2023 compared to $4,747 in 2022. The Company paid the outstanding line of credit balance of $2,777 in full on October 6,
2023. There were no amounts outstanding under the line of credit after October 6, 2023, through December 31, 2023.
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, (i)
Ms. Smolyansky sold 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 used 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 are held
in treasury by the Company.
Debt Obligations
The Company is party to an 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 Credit Agreement provides for, among other things, a $5 million term loan to be repaid in quarterly installments
of principal and interest over a term of five years, a revolving line of credit up to a maximum of $5 million (the “Revolving Credit
Facility”) and an incremental facility not to exceed $5 million. The termination date of the term loan is August 18, 2026, unless
earlier terminated. The termination date of the revolving credit facility is June 30, 2025, unless earlier terminated.
As of December 31, 2023, the Company had $0 outstanding
under the Revolving Credit Facility and $2,733 outstanding under the note payable, net of $17 of unamortized deferred financing fees.
The Company had $5,000 available for future borrowings under the Revolving Credit Facility as of December 31, 2023.
All outstanding amounts under the loans bear interest
at the Secured Overnight Financing Rate (“SOFR”), plus 2.07%. The Company’s interest rate on debt outstanding under
the note payable as of December 31, 2023 was 6.29%. Interest is 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 is in compliance with all applicable
financial debt covenants as of December 31, 2023. 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.
Critical Accounting Estimates
Critical accounting estimates are defined as those
most important to the portrayal of a company’s financial condition and results, and require the most difficult, subjective, or complex
judgments. In many cases, the accounting treatment of a particular transaction is specifically dictated by 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 and Corporate
Governance Committee of our Board of Directors. We have identified the policies described below as our critical accounting policies that
require us to make subjective or complex judgments.
Goodwill impairment
Goodwill totaled $11,704 as of December 31, 2023.
Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable intangible assets acquired.
Goodwill is not amortized.
The Company has one reporting unit within its
single reportable segment. We review and evaluate our goodwill for potential impairment at a minimum annually, as of December 31, or more
frequently if circumstances indicate that impairment is possible. We completed our annual goodwill impairment analysis as of December
31, 2023. Our assessment did not result in an impairment.
In testing goodwill for impairment, the Company
has the option to perform a qualitative test (also known as “Step 0”) or a quantitative test (“Step 1”). Under
the Step 0 test, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of
the reporting unit is less than its carrying value. Qualitative factors may include, but are not limited to, economic conditions, industry
and market considerations, cost factors, overall financial performance of the reporting unit and other entity and reporting unit specific
events. If after assessing these qualitative factors, the Company determines it is “more-likely-than-not” that the fair value
of the reporting unit is less than the carrying value, then performing the Step 1 quantitative test is necessary.
Step 1 of the quantitative test requires comparison
of the fair value of the Company’s one reporting unit to the carrying value. If the carrying value of the reporting unit is less
than the fair value, no impairment exists. Otherwise, the Company would recognize an impairment charge for the amount by which the carrying
amount of the reporting unit exceeds its fair value up to the amount of goodwill allocated to the reporting unit.
Under a Step 1 quantitative test, we estimate
the fair value of our one reporting unit using a combination of the fair values derived from both the income approach and the market approach.
Under the income approach, the Company uses a discounted cash flow methodology which requires management to make significant estimates
and assumptions related to forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth
rates, and long-term discount rates, among others. 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. For the market approach, the Company uses the guideline public
company method. 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 Company also reconciles the fair value of its reporting unit
to its current market capitalization, allowing for a reasonable control premium.
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, 2023, we had $1,270 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 date 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 2023 to employees. The PSU
awards are contingent upon the achievement of strategic milestones during a three-year measurement period. The expense recognition of
PSU awards therefore requires management to make judgements and estimates at the end of each reporting period as to the cumulative three-year
milestone achievements. Changes in managements estimate of the three-year cumulative milestone achievements are recognized as change in
management estimate in a subsequent period. We do not estimate forfeitures in measuring the grant date fair value of RSUs and PSUs, but
rather account for forfeitures as they occur. Forfeitures have historically been immaterial. 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 248) F-1
Consolidated Balance Sheets as of December 31, 2023 and 2022 F-2
Notes to Consolidated Financial Statements F-6
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Lifeway Foods, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Lifeway
Foods, Inc. (an Illinois corporation) and subsidiaries (the “Company”) as of December 31, 2023 and 2022, the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2023,
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, 2023 and 2022, and the results of its operations
and its cash flows for each of the two years in the period ended December 31, 2023, in conformity with accounting principles generally
accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public
accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to
be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations
of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit
of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control
over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material
misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation
of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matters
The 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.
GRANT THORNTON LLP
We have served as the Company’s auditor since 2022.
Chicago, Illinois
March 20, 2024
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2023 and 2022
(In thousands)
December 31,
Current assets
Prepaid expenses and other current assets 2,019 1,445
Refundable income taxes – 44
Operating lease right-of use asset 192 174
Current liabilities
Current portion of note payable $ 1,250 $ 1,250
Accrued income taxes 474 –
Line of credit – 2,777
Operating lease liabilities 118 104
Commitments and contingencies (Note 9) – –
Stockholders’ equity
Preferred stock, no par value; 2,500 shares authorized; none issued – –
Total liabilities and stockholders’ equity $ 81,654 $ 68,999
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 2023 and 2022
(In thousands, except per share data)
Other income (expense):
Gain (loss) on sale of property and equipment 34 (241 )
Other income (expense) 4 –
Total other income (expense) (346 ) (508 )
Income before provision for income taxes 16,649 1,841
Provision for income taxes 5,282 917
Net earnings per common share:
Weighted average common shares outstanding:
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’
Equity
For the Years Ended December 31, 2023 and 2022
(In thousands)
Common Stock
Issued In treasury Paid-In Retained Total
Shares $ Shares $ Capital Earnings Equity
Treasury stock purchased – – (850 ) (3,997 ) – – (3,997 )
Stock-based compensation – – – – 1,630 – 1,630
Stock-based compensation – – – – 1,565 – 1,565
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2023 and 2022
(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization 3,162 2,972
Non-cash interest expense 6 6
Bad debt expense 2 –
Deferred revenue – (28 )
Deferred income taxes (28 ) (172 )
(Gain) loss on sale of property and equipment (34 ) 241
(Increase) decrease in operating assets:
Prepaid expenses and other current assets (574 ) (191 )
Refundable income taxes 44 300
Increase (decrease) in operating liabilities:
Accrued income taxes 474 (725 )
Net cash provided by operating activities 16,941 3,987
Cash flows from investing activities:
Purchases of property and equipment (4,351 ) (3,449 )
Proceeds from sale of equipment 41 –
Acquisition, net of cash acquired – (580 )
Purchase of investments (100 ) –
Net cash used in investing activities (4,410 ) (4,029 )
Cash flows from financing activities:
Repayment of line of credit (2,777 ) –
Repayment of note payable (1,000 ) (750 )
Purchase of treasury stock – (3,997 )
Net cash used in financing activities (3,777 ) (4,747 )
Net increase (decrease) in cash and cash equivalents 8,754 (4,789 )
Cash and cash equivalents at the beginning of the period 4,444 9,233
Cash and cash equivalents at the end of the period $ 13,198 $ 4,444
Supplemental cash flow information:
Cash paid for income taxes, net of (refunds) $ 4,792 $ 1,121
Cash paid for interest $ 415 $ 247
Non-cash investing activities
Accrued purchase of property and equipment $ 137 $ 424
Right-of-use assets obtained in exchange for lease obligations $ 94 $ 83
See accompanying notes to consolidated financial
statements
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2023 and 2022
(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.
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.
Revenue Recognition
Lifeway sells food and beverage products across
select product categories to customers predominantly within the United States (see Note 13 – Disaggregation of Revenue, Significant
Customers, and Geographic Information). 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 maintains allowances for potential credit losses based on historical collection experiences and the current
economic condition of specific customers. All account receivables have an original term of less than one year. 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.
Goodwill
Goodwill represents the excess purchase price
over the fair value of the net tangible and other identifiable intangible assets acquired. Goodwill is not amortized, but it is subject
to an annual assessment for impairment, which the Company performs on its one reporting unit during the fourth quarter (as of December
31), or more frequently if events occur or circumstances change such that it is more likely than not that an impairment may exist.
In testing goodwill for impairment, the Company
has the option to perform a qualitative test (also known as “Step 0”) or a quantitative test (“Step 1”). Under
the Step 0 test, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of
the reporting unit is less than its carrying value. Qualitative factors may include, but are not limited to, economic conditions, industry
and market considerations, cost factors, overall financial performance of the reporting unit and other entity and reporting unit specific
events. If after assessing these qualitative factors, the Company determines it is “more-likely-than-not” that the fair value
of the reporting unit is less than the carrying value, then performing the Step 1 quantitative test is necessary.
Step 1 of the quantitative test requires comparison
of the fair value of the Company’s one reporting unit to the carrying value. If the carrying value of the reporting unit is less
than the fair value, no impairment exists. Otherwise, the Company would recognize an impairment charge for the amount by which the carrying
amount of the reporting unit exceeds its fair value up to the amount of goodwill allocated to the reporting unit.
Under a Step 1 quantitative test, we estimate
the fair value of our one reporting unit using a combination of the fair values derived from both the income approach and the market approach.
Under the income approach, the Company uses a discounted cash flow methodology which requires management to make significant estimates
and assumptions related to forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth
rates, and long-term discount rates, among others. 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. For the market approach, the Company uses the guideline public
company method. 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 Company also reconciles the fair value of its reporting unit
to its current market capitalization, allowing for a reasonable control premium.
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 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 marketplace 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, 2023, and 2022,
the Company has one equity 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 for this equity investment includes a cumulative unrealized gain of $1,731 resulting from
an observable price change in 2019. There were no upward or downward observable price change adjustments to the equity investment cost
during 2023 or 2022.
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 and performance share
awards are 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 fair value of stock options are measured using
the Black-Scholes option pricing model. The expected term of options granted was based on the weighted average time of vesting and the
end of the contractual term. The Company utilized this simplified method as it did not have sufficient historical exercise data to provide
a reasonable basis upon which to estimate the expected term.
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. Total advertising expense was $3,733 and $3,353
for the years ended December 31, 2023 and 2022, respectively.
Earnings per common share
Basic earnings per common share is computed
by dividing net income available to common stockholders by the weighted average number of common shares issued and outstanding
during the reporting period. Diluted earnings per common share is computed by dividing net income 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.
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 November 2023, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2023-07: Segment Reporting (Topic 280): Improvements
to Reportable Segment Disclosures. The new guidance requires entities to report incremental information about significant segment expenses
included in a segment’s profit or loss measure as well as the name and title of the chief operating decision maker. The guidance
also requires interim disclosures related to reportable segment profit or loss and assets that had previously only been disclosed annually.
The new standard is effective for our annual period ending December 31, 2024 and our interim periods during the fiscal year ending December
31, 2025. The guidance does not affect recognition or measurement in the Company’s consolidated financial statements.
In December 2023, the FASB issued ASU No.
2023-09: Income Taxes (Topic 740): Improvements to Income Tax Disclosures that requires entities to disclose additional information
about federal, state, and foreign income taxes primarily related to the income tax rate reconciliation and income taxes paid. The new
standard also eliminates certain existing disclosure requirements related to uncertain tax positions and unrecognized deferred tax liabilities.
The guidance is effective for our fiscal year ending December 31, 2024. The guidance does not affect recognition or measurement in the
Company’s consolidated financial statements.
Adopted
In October 2021, the FASB issued 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 Customers). The amendments in this ASU are effective for fiscal years beginning after December 15, 2022.
The Company adopted this standard during the first quarter of 2023. The adoption did not have a material impact on the Company’s
financial statements.
In March 2020, the FASB issued ASU No. 2020-04,
Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The new guidance provides
optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions that reference LIBOR
or another reference rate expected to be discontinued because of reference rate reform. The guidance will be effective prospectively as
of March 12, 2020 through December 31, 2022 and interim periods within those fiscal years. The ASU was effective upon issuance and allowed
companies to adopt the amendments on a prospective basis through December 31, 2024. The Company adopted this standard during the first
quarter of 2023. The adoption did not have a material impact on the Company’s financial statements.
In June 2016, the FASB issued ASU No. 2016-13,
Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, in November 2018 issued
an amendment, ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, and in November 2019 issued
two amendments, ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases
(Topic 842): Effective Dates, and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses. The
series of new guidance amends the impairment model by requiring entities to use a forward-looking approach based on expected losses rather
than incurred losses to estimate credit losses on certain types of financial instruments, including trade receivables. This may result
in the earlier recognition of allowances for losses. The guidance should be applied on either a prospective transition or modified-retrospective
approach depending on the subtopic. The guidance is effective for annual periods beginning after December 15, 2022, including interim
periods within those fiscal years, with early adoption permitted. The Company adopted this standard during the first quarter of 2023.
The adoption did not have a material impact on the Company’s financial statements.
Note 3 – Inventories, net
Schedule of inventories