Lifeway Foods(LWAY) - 2022 Q3 - Quarterly Report

PART I – FINANCIAL INFORMATION Item 1. Financial Statements. This section presents Lifeway Foods' unaudited consolidated financial statements and notes covering accounting policies, assets, liabilities, and related party transactions Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Note 1 – Basis of Presentation This note details the basis of financial statement presentation, including restatements for prior period errors and reclassifications - The Company restated its historical consolidated financial statements for the three and nine months ended September 30, 2021, to correct errors in accounting for deferred income tax liabilities and goodwill from a 2009 acquisition[23] - Certain amounts were reclassified from investing to operating cash flows for the nine months ended September 31, 2021, with no impact on other consolidated statements[24] Note 2 – Summary of Significant Accounting Policies This note outlines the company's significant accounting policies, including its single reportable segment and evaluation of new accounting guidance - The Company is managed as a single reportable segment, with substantially all revenues from cultured dairy products sold in the United States[29] - Management is evaluating new accounting guidance (ASU 2021-08, ASU 2020-04, ASU 2016-13) but does not currently expect a material impact on its consolidated financial statements[30][31][32] Note 3 – Inventories, net This note provides a detailed breakdown of the company's inventory composition, including ingredients, packaging, and finished goods Inventory Composition (in thousands): | Category | Sep 30, 2022 (in thousands) | Dec 31, 2021 (in thousands) | Change ($ in thousands) | Change (%) | | :------------ | :----------- | :----------- | :--------- | :--------- | | Ingredients | $2,536 | $2,279 | +$257 | +11.3% | | Packaging | $3,254 | $2,723 | +$531 | +19.5% | | Finished goods | $3,402 | $3,283 | +$119 | +3.6% | | Total | $9,192 | $8,285 | +$907 | +10.9% | Note 4 – Property, Plant and Equipment, net This note details the composition of property, plant, and equipment, highlighting changes in construction in process and total net assets Property, Plant and Equipment, net (in thousands): | Category | Sep 30, 2022 (in thousands) | Dec 31, 2021 (in thousands) | Change ($ in thousands) | Change (%) | | :---------------------- | :----------- | :----------- | :--------- | :--------- | | Construction in process | $1,894 | $417 | +$1,477 | +354.2% | | Total, net | $20,905 | $20,130 | +$775 | +3.8% | Note 5 – Goodwill and Intangible Assets This note discusses the company's goodwill and intangible assets, including the reclassification of a brand name asset and changes in total finite-lived assets - Goodwill balance remained unchanged at $11,704 thousand as of September 30, 2022[36] - An indefinite-lived brand name intangible asset with a net book value of $3,700 thousand was reclassified to a finite-lived asset (15 years useful life) effective January 1, 2022[37] - Total finite-lived intangible assets increased from $4,278 thousand (Dec 31, 2021) to $7,573 thousand (Sep 30, 2022), primarily due to the reclassification and an increase in brand names[37] Note 6 – Accrued Expenses This note provides a breakdown of accrued expenses, including payroll, incentive compensation, and total accrued liabilities Accrued Expenses (in thousands): | Category | Sep 30, 2022 (in thousands) | Dec 31, 2021 (in thousands) | Change ($ in thousands) | Change (%) | | :---------------------------- | :----------- | :----------- | :--------- | :--------- | | Payroll and incentive compensation | $3,438 | $2,951 | +$487 | +16.5% | | Total accrued expenses | $4,378 | $3,724 | +$654 | +17.6% | Note 7 – Debt This note details the company's debt obligations, including term loans and revolving credit facilities, and confirms compliance with financial covenants - Term loan balance decreased to $3,750 thousand (gross) as of September 30, 2022, from $4,500 thousand at December 31, 2021[40] - The Revolving Credit Facility had $2,777 thousand outstanding and $2,223 thousand available for future borrowings as of September 30, 2022[45] - The Company was in compliance with all financial covenants (fixed charge coverage ratio and minimum working capital) at September 30, 2022[44][127] Note 8 – Leases This note provides information on the company's lease expenses, weighted-average remaining lease term, and discount rate for operating leases - Total lease expense (including short-term leases) for the nine months ended September 30, 2022, was $191 thousand, a decrease from $245 thousand in 2021[48] - The weighted-average remaining lease term for operating leases was 2.51 years, with a weighted average discount rate of 14.20% as of September 30, 2022[50] Note 9 – Commitments and Contingencies This note outlines the company's policies for recording provisions for legal matters and assesses the materiality of current accruals - The Company records provisions for legal matters when a loss is probable and estimable[52] - Current accruals for outstanding legal matters are not material individually or in aggregate, and management believes ultimate resolution will not have a material adverse effect[52] Note 10 – Income taxes This note details the company's effective income tax rates, explains changes, and reports on unrecognized tax benefits Effective Income Tax Rates: | Period | Sep 30, 2022 | Sep 30, 2021 | | :----- | :----------- | :----------- | | 3 Months | 11.7% | 52.3% | | 9 Months | (0.8)% | 35.2% | - The change in effective tax rate is attributed to the difference in pre-tax (loss) income in 2022 compared to 2021, and recurring/non-recurring factors[55] - Unrecognized tax benefits decreased from $98 thousand at September 30, 2021, to $0 at September 30, 2022, following a settlement in Q1 2022[56] Note 11 – Stock-based and Other Compensation This note describes the company's stock-based compensation plans, including authorized shares, compensation expense, and future recognition - The 2022 Omnibus Incentive Plan was approved, authorizing 3.25 million shares for various awards, with 3.00 million shares remaining available as of September 30, 2022[59][60] - Total pre-tax stock-based compensation expense for the nine months ended September 30, 2022, was $175 thousand, up from $106 thousand in 2021[63] - Future compensation expense related to restricted stock awards was $624 thousand as of September 30, 2022, to be recognized on a weighted average basis over the next 1.57 years[63] Note 12 – Products and Customers This note details Lifeway's primary products, net sales by category, and identifies major customer concentrations - Lifeway's primary product is drinkable kefir, and it manufactures and markets products under various brand names[72] Net Sales by Product Category (Nine Months Ended September 30): | Product Category | 2022 ($ in thousands) | 2022 (%) | 2021 ($ in thousands) | 2021 (%) | | :--------------------------- | :-------------------- | :------- | :-------------------- | :------- | | Drinkable Kefir other than ProBugs | $82,779 | 78% | $72,204 | 82% | | Cheese | $9,233 | 9% | $9,158 | 11% | | Cream and other | $5,438 | 5% | $2,568 | 3% | | Drinkable yogurt | $4,559 | 5% | $739 | 1% | | ProBugs Kefir | $2,481 | 2% | $2,197 | 2% | | Other dairy | $1,240 | 1% | $1,225 | 1% | | Total Net Sales | $105,730 | 100% | $88,091 | 100% | - Two major customers accounted for approximately 22% of net sales for the nine months ended September 30, 2022[75] Note 13 – Related Party Transactions This note describes transactions with related parties, including consulting and endorsement agreements with a Board member - A consulting agreement with Ludmila Smolyansky, a Board member, was terminated effective January 17, 2022, significantly reducing service fees from $375 thousand in 2021 to $22 thousand in 2022 (nine months)[77] - An endorsement agreement with Ms. Smolyansky was terminated on September 6, 2022, with a $400 thousand lump sum payment[80][81] - Royalties paid under the endorsement agreement were $400 thousand for the nine months ended September 30, 2022, down from $450 thousand in 2021[82] Note 14 – Subsequent Events This note discloses significant events occurring after the reporting period, including a share repurchase and an amendment to a settlement agreement - On November 7, 2022, the Company agreed to purchase 850,340 shares of common stock from Ludmila Smolyansky at $4.70 per share, representing a 20% discount to the average closing price[83][84] - The purchased shares will be held in treasury[84] - An amendment to a prior Settlement Agreement grants the Company a right of first refusal on shares (subject to Danone's right) and extends a standstill agreement for Ms. Smolyansky and Mr. Smolyansky through the 2024 annual meeting[85] Consolidated Balance Sheet Highlights (September 30, 2022 vs. December 31, 2021): | Metric | Sep 30, 2022 (in thousands) | Dec 31, 2021 (in thousands) | Change (in thousands) | | :----------------------------- | :-------------------------- | :-------------------------- | :----- | | Total Assets | $73,771 | $70,874 | +$2,897 | | Total Liabilities | $23,274 | $21,743 | +$1,531 | | Total Stockholders' Equity | $50,497 | $49,131 | +$1,366 | Consolidated Statements of Operations Highlights (Three Months Ended September 30): | Metric | 2022 (in thousands) | 2021 (in thousands) | Change ($ in thousands) | Change (%) | | :----------------------------- | :------------------ | :------------------ | :--------- | :--------- | | Net Sales | $38,140 | $29,553 | +$8,587 | +29.1% | | Gross Profit | $7,588 | $6,993 | +$595 | +8.5% | | Income from Operations | $1,195 | $1,044 | +$151 | +14.5% | | Net Income | $983 | $480 | +$503 | +104.8% | | Basic EPS | $0.06 | $0.03 | +$0.03 | +100.0% | Consolidated Statements of Operations Highlights (Nine Months Ended September 30): | Metric | 2022 (in thousands) | 2021 (in thousands) | Change ($ in thousands) | Change (%) | | :----------------------------- | :------------------ | :------------------ | :--------- | :--------- | | Net Sales | $105,730 | $88,091 | +$17,639 | +20.0% | | Gross Profit | $18,865 | $22,719 | -$3,854 | -17.0% | | Income from Operations | $387 | $5,474 | -$5,087 | -92.9% | | Net Income | $208 | $3,404 | -$3,196 | -93.9% | | Basic EPS | $0.01 | $0.22 | -$0.21 | -95.5% | Consolidated Statements of Cash Flows Highlights (Nine Months Ended September 30): | Metric | 2022 (in thousands) | 2021 (in thousands) | Change ($ in thousands) | | :-------------------------------- | :------------------ | :------------------ | :--------- | | Net cash provided by operating activities | $3,639 | $5,855 | -$2,216 | | Net cash used in investing activities | $(3,189) | $(6,905) | +$3,716 | | Net cash (used in) provided by financing activities | $(750) | $3,142 | -$3,892 | | Net (decrease) increase in cash and cash equivalents | $(300) | $2,092 | -$2,392 | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. This section analyzes Lifeway's financial condition and operational results, including forward-looking statements, recent developments, performance, liquidity, and critical accounting policies - The Company has seen increased demand for products during the pandemic and has managed supply chain and labor effectively, but anticipates continued pressure from milk pricing and other input costs[91][92][97][108] - Management believes current liquidity (cash flow from operations, revolving credit and term loan facility, and cash) is sufficient for working capital, capital requirements, and growth initiatives[115] - No material changes to critical accounting policies and estimates, except for the change in useful life of one brand name intangible asset, as detailed in Note 5[129] Cautionary Statement Regarding Forward-Looking Statements This statement advises that the report contains forward-looking information based on management's beliefs, subject to material differences due to various risks - The report contains forward-looking statements identified by words such as 'anticipate,' 'intend,' 'plan,' and 'expect,' which are based on management's beliefs and assumptions[88] - Actual outcomes and results may differ materially due to various risks, including actions of competitors and customers, changes in commodity pricing, government regulation, and supply chain disruptions[89] Recent Developments This section discusses the impact of the COVID-19 pandemic on demand and the challenges of rising input costs, particularly milk and transportation - The COVID-19 pandemic led to increased customer and consumer demand for products for in-home consumption, which the Company met without significant supply chain or labor disruptions[91] - In 2022, costs increased primarily due to inflationary price increases of milk, other ingredients, packaging materials, and transportation[92] - The Company's pricing actions may sometimes lag input cost changes or may not be able to pass along the full effect of increases due to market conditions or competitive reasons[92] Results of Operations - Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021 This section compares the company's operational performance for the three months ended September 30, highlighting changes in net sales, gross profit, expenses, and income taxes - Net sales increased by $8,587 thousand (29.1%) to $38,140 thousand, primarily driven by higher volumes of branded drinkable kefir and price increases[95] - Gross profit as a percentage of net sales decreased to 19.9% from 23.7% in the prior year, mainly due to unfavorable milk pricing and increased freight and other input costs[97] - General and administrative expenses increased by $221 thousand to $3,415 thousand, primarily due to increased legal and professional fees and incentive compensation, partially offset by lower consulting expense[99] - The provision for income taxes decreased to $130 thousand (11.7% effective rate) from $527 thousand (52.3% effective rate), influenced by the difference in pre-tax income[100][101] Results of Operations - Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021 This section compares the company's operational performance for the nine months ended September 30, detailing changes in net sales, gross profit, expenses, and income taxes - Net sales increased by $17,639 thousand (20.0%) to $105,730 thousand, primarily driven by higher volumes of branded drinkable kefir and price increases[106] - Gross profit as a percentage of net sales decreased to 17.8% from 25.8% in the prior year, mainly due to unfavorable milk pricing and increased freight and other input costs[108] - General and administrative expenses increased by $844 thousand to $9,546 thousand, primarily due to increased legal and professional fees and incentive compensation, partially offset by lower consulting expense[110] - The provision for income taxes decreased to $(2) thousand ((0.8)% effective rate) from $1,851 thousand (35.2% effective rate), influenced by the difference in pre-tax (loss) income[111][112] Liquidity and Capital Resources This section analyzes the company's cash flow activities, changes in investing and financing, and its compliance with debt covenants - Net cash provided by operating activities decreased to $3,639 thousand for the nine months ended September 30, 2022, from $5,855 thousand in 2021, due to lower cash earnings and changes in working capital[122] - Net cash used in investing activities decreased to $3,189 thousand from $6,905 thousand, reflecting the prior year's GlenOaks Farms acquisition, partially offset by increased capital spending[123] - Net cash used in financing activities was $750 thousand in 2022, compared to net cash provided of $3,142 thousand in 2021, primarily due to term loan repayments versus proceeds from a term loan in the prior year[125] - The Company had $2,223 thousand available for future borrowings under the Revolving Credit Facility as of September 30, 2022, and was in compliance with all applicable financial debt covenants[117][126][127] Recent Accounting Pronouncements This section refers to Note 2 for details on recent accounting pronouncements and their expected impact on financial statements - Information regarding recent accounting pronouncements is provided in Note 2 – Summary of Significant Accounting Policies[128] Critical Accounting Policies and Estimates This section confirms no material changes to critical accounting policies, except for a change in the useful life of one brand name intangible asset - There were no material changes to the Company's critical accounting policies and estimates in the nine months ended September 30, 2022, except for the change in the estimated useful life of one brand name intangible asset, as disclosed in Note 5[129] Item 3. Quantitative and Qualitative Disclosures About Market Risk. This item states that there are no quantitative and qualitative disclosures about market risk applicable for this filing - Not applicable[130] Item 4. Controls and Procedures. This section details the evaluation of the Company's disclosure controls and procedures, deemed effective, and ongoing remediation for a material weakness in income tax accounting - The CEO and CFO concluded that the Company's disclosure controls and procedures were effective as of September 30, 2022[131] - Remediation efforts for a previously disclosed material weakness in internal control over financial reporting, specifically concerning income tax accounting and reporting, were ongoing during the three months ended September 30, 2022[132][133] Evaluation of Disclosure Controls and Procedures This section confirms the effectiveness of the company's disclosure controls and procedures as evaluated by management Changes in Internal Control over Financial Reporting This section addresses ongoing remediation efforts for a previously identified material weakness in internal control over financial reporting related to income tax accounting PART II – OTHER INFORMATION Item 1. Legal Proceedings. This item refers to Note 9, Commitments and Contingencies, for information regarding legal proceedings - Information on legal proceedings is available in Note 9, Commitment and Contingencies[137] Item 1A. Risk Factors. This item states that there have been no material changes from the risk factors previously disclosed in the Company's Annual Report on Form 10-K - No material changes from the risk factors disclosed in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2021[138] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. This item indicates that there were no unregistered sales of equity securities or use of proceeds to report during the period - None[139] Item 3. Defaults Upon Senior Securities. This item states that there were no defaults upon senior securities to report during the period - None[140] Item 5. Other Information. This item indicates that there is no other information to report - None[141] Item 6. Exhibits. This section lists all exhibits filed with the Form 10-Q, including various agreements, incentive plans, and certifications - Exhibits include Settlement Agreements, the 2022 Omnibus Incentive Plan, the 2022 Non-Employee Director Equity and Deferred Compensation Plan, and certifications[143] Signatures. Signatures The report was duly signed on November 14, 2022, by Julie Smolyansky, CEO, President, and Director, and Eric Hanson, CFO & Accounting Officer - The report was signed by Julie Smolyansky (CEO, President, and Director) and Eric Hanson (CFO & Accounting Officer) on November 14, 2022[147]