Lifeway Foods, Inc. 10-K

ITEM 5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is listed on the Nasdaq Global Market under the symbol “LWAY.” Trading commenced on March 29, 1988. As of March 8, 2021, there were approximately 59 holders of record of Lifeway’s Common Stock, one of which was Cede & Co., a nominee for Depository Trust Company, or DTC, and 75 financial institutions as nominees for beneficial owners or in “street name” the shares of which were deposited into participant accounts at DTC and are considered to be held of record by Cede & Co. as one stockholder. Common stock price The following table shows the high and low sale prices per share of our common stock as reported on the Nasdaq Global Market for each quarter during the two most recent fiscal years: Common Stock Price Range 2019 Low High First Quarter $ 1.98 $ 2.75 Second Quarter $ 1.94 $ 4.00 Third Quarter $ 2.19 $ 3.59 Fourth Quarter $ 1.87 $ 2.44 2020 Low High First Quarter $ 1.50 $ 2.65 Second Quarter $ 1.71 $ 2.99 Third Quarter $ 2.30 $ 7.45 Fourth Quarter $ 4.61 $ 7.81 Dividend Policy Lifeway does not routinely declare and pay dividends. From time to time however our Board of Directors may declare and pay dividends depending on our operating cash flow, financial condition, capital requirements and such other factors as the Board of Directors may deem relevant. There were no dividends declared or paid in fiscal 2020 or 2019. 18 Issuer Purchases of Equity Securities Period Total number of shares purchased Average price paid per share Total number of shares purchased as part of a publicly announced program (a) Approximate Dollar Value of Shares that may yet be Purchased Under the Plans or Programs ($ in thousands) 1/1/2019 to 1/31/2019 46,743 $ 2.54 46,743 $ 4,384 2/1/2019 to 2/28/2019 9,100 $ 2.75 9,100 $ 4,358 3/1/2019 to 3/31/2019 26,932 $ 2.24 26,932 $ 4,298 4/1/2019 to 4/30/2019 4,300 $ 2.24 4,300 $ 4,288 5/1/2019 to 5/31/2019 57,817 $ 2.49 57,817 $ 4,145 6/1/2019 to 6/30/19 11,146 $ 2.32 11,146 $ 4,119 8/1/2019 to 8/31/19 37,567 $ 2.69 37,567 $ 4,018 9/1/2019 to 9/30/19 17,531 $ 2.98 17,531 $ 3,965 Fiscal Year 2019 211,136 $ 2.55 211,136 $ 3,965 1/1/2020 to 1/31/2020 97,739 $ 2.33 97,739 $ 3,738 2/1/2020 to 2/28/2020 35,198 $ 2.49 35,198 $ 3,650 3/1/2020 to 3/31/2020 45,469 $ 1.98 45,469 $ 3,560 4/1/2020 to 4/30/2020 11 $ 2.01 11 $ 3,560 Fiscal Year 2020 178,417 $ 2.27 178,417 $ 3,560 (a) During the fourth quarter of 2015, Lifeway publicly announced a share repurchase program. On November 1, 2017, the our Board of Directors amended the 2015 stock repurchase program (the “2017 amendment”), by adding to (i.e., exclusive of the shares previously authorized under the 2015 stock program repurchase) the authorization the lesser of $5,185 or 625 shares. The program has no expiration date. As of April 2020, the Company had reached the amended threshold of 625 shares and therefore no shares of common stock remain available to be purchased under the 2017 Repurchase Plan Amendment. ITEM 6 SELECTED FINANCIAL DATA Not applicable 19 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 for the years ended December 31, 2020 and December 31, 2019 should be read in conjunction with the audited consolidated financial statements and the notes to those statements that are included elsewhere in this 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. Results of Operations Comparison of Year Ended December 31, 2020 to Year Ended December 31, 2019 (in 000’s) December 31, Change 2020 2019 $ % Net sales $ 102,026 $ 93,662 $ 8,364 8.9% Cost of goods sold $ 72,006 $ 68,367 $ (3,639 ) – Depreciation expense 3,087 3,146 59 – Total cost of goods sold 75,093 71,513 (3,580 ) (5.0% ) Gross profit $ 26,933 $ 22,149 $ 4,784 21.6% Gross Profit % to net sales 26.4% 23.6% Selling expenses $ 10,197 $ 11,062 $ 865 7.8% Selling expenses % to net sales 10.0% 11.8% General & administrative expenses 11,661 12,828 1,167 9.1% General & administrative % to net sales 11.4% 13.7% Amortization expense 152 192 40 20.8% Total operating expenses $ 22,010 $ 24,082 $ 2,072 8.6% Total operating expense % to net sales 21.6% 25.7% Income (loss) from operations $ 4,923 $ (1,933 ) $ 6,856 354.7% Income (loss) from operations % to net sales 4.8% (2.1% ) 20 Net Sales Net sales were $102,026 for the year ended December 31, 2020, an increase of $8,364 or 8.9% versus prior year. The net sales increase was primarily driven by higher volumes of our branded drinkable kefir, partially offset by lower cream revenues associated with a decline in the market price of butter fat. Gross Profit Gross profit as a percentage of net sales increased to 26.4% during the year ended December 31, 2020 from 23.6% during the same period in 2019. The increase versus the prior year was primarily due to the impact of favorable milk pricing, and to a lesser extent favorable freight costs. Selling Expenses Selling expenses decreased by $865 or 7.8% to $10,197 during the year ended December 31, 2020 from $11,062 during the same period in 2019. The decrease versus prior year primarily reflects a reduction in advertising and marketing expense, such as trade shows and other marketing events which were postponed due to COVID-19 and the lower planned spending on in-store demonstrations in 2020 compared to 2019. Selling expenses as a percentage of net sales were 10.0% during the year ended December 31, 2020 compared to 11.8% for the same period in 2019. General and Administrative Expenses General and administrative expenses decreased $1,167 or 9.1% to $11,661 during the year ended December 31, 2020 from $12,828 during the same period in 2019. The decrease is primarily a result of lower compensation expense due to organizational changes made in 2019 and lower incentive compensation, partially offset by increased professional fee expense. Provision for Income Taxes The provision for income taxes includes federal, state and local income taxes. Income tax expense was $1,596 and $782 during the year ended December 31, 2020 and 2019, respectively. Our effective income tax rate (ETR) for the year ended December 31, 2020 was 33.1% compared to an ETR of 63.3% in the same period last year. The decrease in effective tax rate is primarily the result of separate state tax rates, non-deductible compensation expense related to equity incentive awards, the provision for unrecognized tax benefits and a benefit recognized in 2020 due to the enactment of the “Coronavirus Aid, Relief, and Economic Security Act” (the CARES Act). 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 2019, the percentage effect is substantially different due to the difference in pre-tax income in 2020 compared to 2019. Our effective tax rate may change from period to period based on recurring and non-recurring factors including the relative mix of pre-tax earnings (or losses), the underlying income tax rates applicable to various state and local taxing jurisdictions, enacted tax legislation, the impact of non-deductible items, changes in valuation allowances, and the expiration of the statute of limitations in relation to unrecognized tax benefits. We record discrete income tax items such as enacted tax rate changes in the period in which they occur. Section 162(m) of the Internal Revenue Code (the “Code”) limits the deductibility of compensation paid to certain of our executives. Under the Tax Cuts and Jobs Act (the “Act”) amendments to Section 162(m), no tax deduction in taxable years beginning after December 31, 2017 is allowed for compensation paid to any covered employee to the extent that the total compensation for that covered employee exceeds $1,000,000 in any taxable year. Although the Act eliminated the prior tax deduction under Section 162(m) for performance-based executive compensation, it included a transition rule under which the changes to Section 162(m) will not apply to awards made to our covered employees who had the right to participate in our 2015 Omnibus Incentive Plan pursuant to written binding contracts in effect as of November 2, 2017, as long as those contracts have not subsequently been modified in any material respect. Accordingly, subject to further guidance from the Treasury Department and the Internal Revenue Service (“IRS”), the performance-based compensation paid to our executives under our Omnibus Plan remained eligible for the Section 162(m) exemption in 2019. Beginning in 2020, compensation exceeding the threshold for covered employees is non-deductible for income tax purposes. Income taxes are discussed in Note 10 in the Notes to the Consolidated Financial Statements. 21 Net Income (Loss) We reported net income of $3,232 or $0.21 per basic and diluted common share for the year ended December 31, 2020 compared to net income of $453 or $0.03 per basic and diluted common share in the same period in 2019. Liquidity and Capital Resources The ultimate impact that the COVID-19 pandemic or any future pandemic or disease outbreak will have on our business and our consolidated results of operations is uncertain. To date we have seen increased customer and consumer demand for our products as consumers initially began pantry loading and have increased their at-home consumption as a result of social distancing and stay-at-home and work-from-home mandates and recommendations. However, this increased customer and consumer demand may decrease in the coming months if and when the need for social distancing and stay-at-home and work-from-home mandates and recommendations decrease, and we are unable to predict the nature and timing of when that impact may occur, if at all. . Although to date we have not experienced supply chain constraints, and we have continued to be able to fully satisfy customer and consumer demand for our products, the continued unprecedented demand for food and other consumer packaged goods products as a result of the COVID-19 pandemic or any future pandemic may limit the availability of, or increase the cost of, ingredients, packaging and other raw materials necessary to produce our products, and our operations may be negatively impacted. Additionally, pandemics or disease outbreaks could result in a widespread health crisis that could adversely affect economies and financial markets, consumer spending and confidence levels resulting in an economic downturn that could affect customer and consumer demand for our products. Our efforts to manage and mitigate these factors may be unsuccessful, and the effectiveness of these efforts depends on factors beyond our control, including the duration and severity of any pandemic or disease outbreak, as well as third party actions taken to contain its spread and mitigate public health effects. The ultimate impact of the COVID-19 pandemic on our business will depend on many factors, including, among others, the duration of social distancing and stay-at-home and work-from-home mandates and recommendations and whether additional waves of COVID-19 or different variants of COVID-19 will affect the United States and other markets, our ability and the ability of our suppliers to continue to operate our and their manufacturing facilities and maintain the supply chain without material disruption and procure ingredients, packaging and other raw materials when needed despite unprecedented demand in the food industry, and the extent to which macroeconomic conditions resulting from the pandemic and the pace of the subsequent recovery may impact consumer eating and shopping habits. We cannot predict the duration or scope of the disruption. Therefore, the financial impact cannot be reasonably estimated at this time. To date, our manufacturing facilities have not been significantly impacted. We have full production capacity available at all locations at this time. On March 16, 2020, the food industry, including grocery stores and their suppliers, and transportation were classified by the U.S. federal government as critical infrastructure industry. As a result, our employees and facilities, as well as the retailers and distributors that sell our products, will be able to remain in operation. During the first quarter of 2020, Management, anticipating the spread of Covid-19 and its effects, implemented a plan to mitigate effects of Covid-19 on supply and transportation of materials used to make and package our products, staffing, and transportation of our products to customers. While the situation is fluid, we have evaluated all manufacturing locations and do not anticipate any staffing shortages or interruption of our production, transportation and sale of products in the near term. Cash Flow At this time, the COVID-19 pandemic has not materially impacted on our operations. We expect to meet our foreseeable liquidity and capital resource requirements through anticipated cash flows from operations; our revolving credit facility; and cash and cash equivalents to ensure the continuation of the Company as a going concern. The success of our business and financing strategies will continue to provide us with the financial flexibility to take advantage of various opportunities as they arise. Given the dynamic nature of COVID-19, we will continue to assess our liquidity needs while continuing to manage our discretionary spending and investment strategies. 22 Sources and Uses of Cash Lifeway had a net increase in cash and cash equivalents of $4,090 during the year ended December 31, 2020 and a net increase in cash and cash equivalents of $838 in the same period in 2019. The drivers of the year over year change are as follows: Net cash provided by operating activities was $6,385 and $3,811 during the year ended December 31, 2020 and 2019, respectively. The increase in cash provided by operating activities is primarily due to the increase in cash generated through higher revenues and reduced expenses in 2020, offset by the change in working capital. Net cash used in investing activities was $1,890 during the year ended December 31, 2020 compared to net cash provided by investing activities of $838 in the same period in 2019. The increase of net cash used in investing activities in 2020 reflects higher capital spending. In addition, during 2019, the Company tendered approximately 45.6% of one of its investments recorded under the cost method on the consolidated balance sheets for cash proceeds of $1,509. See financing section below for use of those proceeds. We received net proceeds of $474 related to the sale of our Skokie, IL facility during 2019. Capital spending was $1,895 during the year ended December 2020 compared to $1,178 in 2019. Our capital spending is focused in three core areas: growth, cost reduction, and facility improvements. Growth capital spending supports new product innovation and enhancements. Cost reduction and facility improvements support manufacturing efficiency, safety and productivity. Net cash used in financing activities was $405 and $3,811 during the years ended December 31, 2020 and 2019, respectively. Under the terms of our line of credit agreement (see Note 7), we utilized proceeds from our federal and state income tax refunds to repay $1,330 on our revolving line of credit during 2019. We utilized the proceeds from the sale of our Skokie, IL facility to repay $459 on our revolving line of credit during 2019. We utilized proceeds from the sale of our investment described in the investing section above to make a mandatory prepayment of $1,484 on our revolving line of credit during 2019. On November 1, 2017, Lifeway’s Board approved an increase in the aggregate amount under our previously announced 2015 stock repurchase program (the “2017 Repurchase Plan Amendment”), by adding to (i.e., exclusive of the shares previously authorized under the 2015 stock repurchase program) the authorization the lesser of $5,185 or 625 shares. We repurchased approximately 179 shares of common stock at a cost of $405 during the year ended December 31, 2020 under the 2017 Repurchase Plan Amendment. We repurchased approximately 211 shares of common stock at a cost of $538 during the year ended December 31, 2019 under the 2017 Repurchase Plan Amendment. We may execute transactions from time to time in the open market or by private negotiation, in accordance with all applicable securities laws and regulations. We intend to hold repurchased shares in treasury for general corporate purposes, including issuances under our 2015 Omnibus Incentive Plan. Debt Obligations On September 30, 2020, Lifeway entered into the Third Modification to the Amended and Restated Loan and Security Agreement, as amended, (the “Third Modification”) with its existing lender. The Third Modification amends the Amended and Restated Loan and Security Agreement, as amended, by removing the monthly borrowing base reporting requirement effective September 30, 2020, including a covenant to maintain a quarterly minimum working capital financial covenant, as defined, of no less than $11.25 million each of the fiscal quarters commencing the fiscal quarter ended December 31, 2020 through the expiration date, and eliminating the tier interest pricing structure. The Amended and Restated Loan and Security Agreement continues to provide Lifeway with a revolving line of credit up to a maximum of $5 million (the “Revolving Loan”) and provides the Borrowers with an incremental facility not to exceed $5 million (the “Incremental Facility” and together with the Revolving Loan, the “Loans”). The Termination Date of the Revolving Loan was extended to June 30, 2025, unless earlier terminated. 23 Except as described above, amended, the Modified Revolving Credit Facility remains substantively unchanged and in full force and effect, including customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to maintain a fixed charge coverage ratio of no less than 1.25 to 1.00 each of the fiscal quarters ending through the expiration date. The Modified Revolving Credit Facility continues to provide for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement, as a result of which amounts due under the Modified Revolving Credit Facility may be accelerated. As of December 31, 2020, we had $2,768 net of $9 of unamortized deferred financing costs, outstanding under the Revolving Credit Facility. We had $2,223 available for future borrowings as of December 31, 2020. 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% and, in conjunction with the issuance of any letters of credit, a letter of credit fee of 0.20%. Lifeway’s interest rate on debt outstanding under our Revolving Credit Facility as of December 31, 2020 was 2.10%. We are in compliance with all applicable financial debt covenants as of December 31, 2020. 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 Policies and Use of Estimates Critical accounting policies 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 US GAAP with no need for the application of our judgement. In certain circumstances, the preparation of our Consolidated Financial Statements in conformity with US 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. 24 Goodwill and intangible asset valuation Goodwill totaled $9,124 as of December 31, 2020. The Company completed its annual goodwill impairment analysis as of December 31, 2020. Our assessment did not result in an impairment. Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable intangible assets acquired. We estimate the fair value of our one reporting unit annually (as of December 31), or more frequently if certain conditions exist, using a combination of the fair values derived from both the income approach and the market approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on our estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used to determine the present value of future cash flows is based on the weighted-average cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the business's ability to execute on the projected cash flows. The market approach estimates fair value based on market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics. The resulting fair value, based on the income and market approaches, is then compared to the carrying value to determine if impairment is necessary. We reviewed our indefinite lived intangible assets, which consist of brand names totaling $3,700 as of December 31, 2020, using the relief from royalty method. Significant assumptions include the royalty rate, revenue growth rates, and discount rates. Our assumptions were based on historical performance and management estimates of future performance. Our assessment did not result in an impairment in 2020. 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, 2020, we had $1 million of accrued discounts and allowances. Share-based compensation . Certain employees and non-employee directors receive various forms of share-based payment awards and we recognize compensation expense for these awards based on their grant date fair values. The fair values of stock option awards are estimated on the grant date using the Black-Scholes option pricing model, which incorporates certain assumptions regarding the expected term of an award and expected stock price volatility. The expected term is determined under the simplified method, using an average of the contractual term and vesting period of the stock options. The expected volatility is based on the historic volatility of our common stock. We do not estimate forfeitures in measuring the grant date fair value, but rather account for forfeitures as they occur. Key assumptions are described in further detail in Note 11 to our consolidated financial statements. 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. 25 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 Form 10-K for information regarding recent accounting pronouncements. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable