Lifeway Foods, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in this Form 10-Q is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements, the accompanying notes, and the MD&A included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 (the “Form 10-K”). Unless otherwise specified, any description of “our”, “we”, and “us” in this MD&A refer to Lifeway Foods, Inc. and our subsidiaries. Cautionary Statement Regarding Forward-Looking Statements In addition to historical information, this quarterly report contains “forward-looking” statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of words such as “anticipate,” “from time to time,” “intend,” “plan,” “ongoing,” “realize,” “should,” “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," "predict," and "estimate,” and similar terms or terminology, or the negative of such terms or other comparable terminology. Examples of forward-looking statements include, among others, statements we make regarding: · Expectations of the effect on our financial condition of claims, litigation, environmental costs, contingent liabilities and governmental and regulatory investigations and proceedings; · Strategy for acquisitions, customer retention, growth, product development, market position, financial results and reserves; Estimates of the amounts of sales allowances and discounts to our customers and consumers; · Our belief that we will maintain compliance with our loan agreements and have sufficient liquidity to fund our business operations. Forward looking statements are based on management’s beliefs, assumptions, estimates and observations of future events based on information available to our management at the time the statements are made and include any statements that do not relate to any historical or current fact. These statements are not guarantees of future performance and they involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from what is expressed, implied or forecast by our forward-looking statements due in part to the risks, uncertainties, and assumptions that include: · The actions of our competitors and customers, including those related to price competition; · The decisions of customers or consumers; · Our ability to successfully implement our business strategy; · Changes in the pricing of commodities · The effects of government regulation; · The impact of the COVID-19 outbreak on our business, suppliers, consumers, customers, and employees; · Disruptions to our supply chain, or our manufacturing and distribution capabilities, including those due to cybersecurity threats and the COVD-19 outbreak; and · Such other factors as discussed throughout Part I, Item 1 “Business”; Part I, Item 1A “Risk Factors”; and Part II, Item 7 “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021 and that are described from time to time in our filings with the SEC. 19 These factors are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors could also have material adverse effects on future results. The Company intends these forward-looking statements to speak only at the date made. Except as otherwise required to be disclosed in periodic reports required to be filed by public companies with the SEC pursuant to the SEC's rules, Lifeway has no duty to update these statements, and it undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Recent Developments COVID-19 Pandemic Impact We have seen increased customer and consumer demand for our products during the pandemic as consumers increased their food purchases for in-home consumption. We have not experienced significant supply chain disruptions or labor supply shortages and have continued to satisfy customer and consumer demand for our products. Management continues to proactively manage the supply and transportation of materials used to make and package our products, staffing, and transportation of our products to customers. This proactive planning has allowed the Company to avoid disruption to its manufacturing facilities and production, transportation, and sales and to meet the increased demand. The Company has maintained full production capacity available at all locations and does not anticipate manufacturing or staffing disruptions in the near term. However, the COVID-19 pandemic, or any future pandemic, may limit the availability of, or increase the cost of, employees, ingredients, packaging and other inputs necessary to produce our products, and our operations may be negatively impacted. In 2022, our costs increased primarily due to inflationary price increases of milk, other ingredients, packaging materials, and transportation to our customers. However, because of market conditions or for competitive reasons, our pricing actions may sometimes lag input cost changes, or we may not be able to pass along the full effect of increases in raw materials and other input costs as we incur them. During 2022, social distancing, shelter-in-place and work-from-home mandates and recommendations have continued to be reduced or eliminated. The increased customer demand for our products as consumers increased their at-home consumption and e-commerce purchasing during the COVID-19 pandemic may change or decrease due to the decrease in social distancing and stay-at-home and work-from-home mandates and recommendations. We are unable to predict the nature and timing of when such change may occur, if at all. 20 Results of Operations Three Months Ended March 31, 2022 Compared to Three Months Ended March 31, 2021 The following table presents certain information concerning our financial results, including information presented as a percentage of consolidated net sales: Three Months Ended March 31, 2022 2021 $ % $ % Net sales 34,099 100.0% 29,376 100.0% Cost of goods sold 27,863 81.7% 20,512 69.8% Depreciation expense 656 1.9% 815 2.8% Total cost of goods sold 28,519 83.6% 21,327 72.6% Gross profit 5,580 16.4% 8,049 27.4% Selling expenses 3,202 9.4% 3,222 11.0% General & administrative expenses 3,292 9.7% 2,891 9.8% Amortization expense 135 0.4% – 0.0% Total operating expenses 6,629 19.5% 6,113 20.8% (Loss) income from operations (1,049 ) (3.1% ) 1,936 6.6% Other (expense) income: Interest expense (42 ) (0.1% ) (22 ) (0.1% ) Loss on sales or property and equipment – 0.0% (7 ) 0.0% Other (expense) income, net (1 ) 0.0% (8 ) 0.0% Total other (expense) income (43 ) (0.1% ) (37 ) (0.1% ) (Loss) income before provision for income taxes (1,092 ) (3.2% ) 1,899 6.5% (Benefit) provision for income taxes (197 ) (0.6% ) 593 2.0% Net (loss) income (895 ) (2.6% ) 1,306 4.5% 21 Net Sales Net sales finished at $34,099 for the three-month period ended March 31, 2022, an increase of $4,723 or 16.1% versus prior year. The net sales increase was primarily driven by higher volumes of our branded drinkable kefir and the impact of price increases implemented during the quarter, and to a lesser extent the favorable impact of our acquisition of GlenOaks Farms during the third quarter of 2021. Gross Profit Gross profit as a percentage of net sales was 16.4% during the three-month period ended March 31, 2022. Gross profit percentage was 27.4% in the prior year. The decrease versus the prior year was primarily due to the unfavorable impact of milk pricing, and to a lesser extent the increased pricing of freight and other inputs, partially offset by the decrease in depreciation expense. We expect to see continued pressure in milk pricing and other input costs during the fiscal year 2022. Selling Expenses Selling expenses decreased by $20 to $3,202 during the three-month period ended March 31, 2022 from $3,222 during the same period in 2021. General and Administrative Expenses General and administrative expenses increased $401 to $3,292 during the three-month period ended March 31, 2022 from $2,891 during the same period in 2021. The increase is primarily a result of increased legal and professional fees, which includes expense related to the fiscal year 2020 Form 10-K restatement. Provision for Income Taxes The provision for income taxes was $197 and $593 during the three months ended March 31, 2022 and 2021, respectively. The effective income tax rate for the three months ended March 31, 2022 was 18.1% compared to 31.2% in the same period last year. The statutory Federal and state tax rates remained consistent from 2021 to 2022. The Company has items that are nondeductible or are discrete adjustments to tax expense. The company consistently reflects non-deductible officer compensation expense, non-deductible compensation expense related to equity incentive awards and separate state tax rates from period to period. Although similar items were reflected in 2022, the percentage effect is different due to the difference in pre-tax (loss) income in 2022 compared to 2021. 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 jurisdictional mix of earnings, enacted tax legislation, state income taxes, 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 and completed tax audits in the period in which they occur. Income taxes are discussed in Note 10 in the Notes to the Consolidated Financial Statements. 22 Liquidity and Capital Resources Management assesses the Company's liquidity in terms of its ability to generate cash to fund its operating, investing, and financing activities. The Company remains in a strong financial position, and while it has been impacted by the macroeconomic challenges with commodity inflation and other input cost increases, the Company believes that its cash flow from operations, revolving credit and term loan facility, and cash and cash equivalents will continue to provide sufficient liquidity for its working capital needs, capital resource requirements, and growth initiatives and to ensure the continuation of the Company as a going concern. If additional borrowings are needed, $2,223 was available under the Revolving Credit Facility as of March 31, 2022 (see Note 7, Debt). We are in compliance with the terms of the Credit Agreement and expect to meet foreseeable financial requirements. The success of our business and financing strategies will continue to provide us with the financial flexibility to take advantage of various opportunities as they arise. To date, we have been successful in generating cash and obtaining financing as needed. However, in connection with the COVID-19 pandemic or other circumstances, if a serious economic or credit market crisis ensues, it could have a negative effect on our liquidity, results of operations and financial condition. The Company’ most significant ongoing short-term cash requirements relate primarily to funding operations (including expenditures for raw materials, labor, manufacturing and distribution, trade and promotions, advertising and marketing, and income tax liabilities) as well as expenditures for property, plant and equipment. Long-term cash requirements primarily relate to funding long-term debt repayments (see Note 7, Debt) and deferred income taxes (see Note 10, Income Taxes, in our Annual Report on Form 10-K). 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. 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. Cash Flow The following table is derived from our Consolidated Statement of Cash Flows: Three Months Ended March 31, 2022 2021 Net cash (used in) provided by operating activities $ (648 ) $ 1,210 Net cash (used in) provided by investing activities (348 ) (518 ) Net cash (used in) provided by financing activities (250 ) – Operating Activities Net cash used in operating activities was $648 during the three-month period ended March 31, 2022 compared to net cash provided by operating activities of $1,210 in the same period in 2021. The decrease was primarily due to lower cash earnings, which reflect the impact of input and freight cost inflation in 2022, partially offset by the change in working capital. 23 Investing Activities Net cash used in investing activities was $348 during the three-month period ended March 31, 2022 compared to $518 in the same period in 2021. The decrease in cash used reflects lower capital spending. 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 $250 during the three-month period ended March 31, 2022 compared to net cash provided by financing activities of $0 in the same period in 2021. The increase in cash used relates to quarterly principal payments under the term loan entered into during August 2021 in connection with the acquisition of GlenOaks Farms, Inc. Debt Obligations As of March 31, 2022, the Company had $2,777 outstanding and $2,223 available for future borrowings under the revolving line of credit. Under the credit agreement, the Revolving Credit facility matures on June 30, 2025. The were no letters of credit issued or outstanding as of March 31, 2022. The Company had $4,222 outstanding under the note payable, net of $28 of unamortized deferred financing fees, as of March 31, 2022, The Company’s interest rate on debt outstanding under the revolving line of credit and note payable as of March 31, 2022 was 2.15%. The Company is in compliance with all applicable financial debt covenants as of March 31, 2022. See Note 7 to our Consolidated Financial Statements for additional information regarding our indebtedness and related agreements. Recent Accounting Pronouncements Information regarding recent accounting pronouncements is provided in Note 2 – Summary of Significant Accounting Policies. Critical Accounting Policies and Estimates A description of the Company's critical accounting policies and estimates is contained in its Annual Report on Form 10-K for the year ended December 31, 2021. There were no material changes to the Company’s critical accounting policies and estimates in the three months ended March 31, 2022, except for the change in estimated useful life of one brand name intangible asset which is disclosed in Note 5 – Goodwill and Intangible assets. 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.