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, 2022 (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: · Changes in the pricing of commodities; · The actions and decisions of our competitors and customers, including those related to price competition; · Our ability to successfully implement our business strategy; · 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 · 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, 2022 and that are described from time to time in our filings with the SEC. 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. 19 Business Overview Lifeway was founded in 1986 by Michael Smolyansky shortly after he and his wife, Ludmila Smolyansky, emigrated from Eastern Europe to the United States. Lifeway was the first to successfully introduce kefir to the U.S. consumer on a commercial scale, initially catering to ethnic consumers in the Chicago, Illinois metropolitan area. In the years that have followed, Lifeway has grown to become the largest producer and marketer of kefir in the U.S. and an important player in the broader market spaces of probiotic-based products and natural, “better for you” foods. The Company’s primary product is drinkable kefir, a cultured dairy product. Lifeway Kefir is tart and tangy, high in protein, calcium and vitamin D. Thanks to our exclusive blend of kefir cultures, each cup of kefir contains 12 live and active cultures and 25 to 30 billion beneficial CFU (Colony Forming Units) at the time of manufacture. The Company manufactures (directly or through a co-manufacturer) and markets products under the Lifeway, Fresh Made, and GlenOaks Farms brand names, as well as under private labels on behalf of certain customers. The Company’s product categories are: · Drinkable Kefir, a cultured dairy product sold in a variety of organic and non-organic sizes, flavors, and types. · European-style soft cheeses, including farmer cheese, white cheese, and Sweet Kiss. · Cream and other, which primarily consists of cream, a byproduct of raw milk processing. · Drinkable Yogurt, sold in a variety of sizes and flavors. · ProBugs, a line of kefir products designed for children. · Other Dairy, which primarily consists of Fresh Made butter and sour cream. Recent Developments Current Macroeconomic Environment and Inflation Impact Since 2022, we have been experiencing inflationary and cost pressures due to volatility and disruption in the global economy which have increased our production and distribution costs. Specifically, the cost of milk, other ingredients, packaging materials, and transportation to our customers has increased, and continue to unfavorably affect our profitability and operating cash flows. We expect inflationary pressures to persist throughout 2023, although at lower levels than experienced in 2022. In response to these persistent inflationary and cost pressures, we instituted price increases in 2022 on many of our products. We expect that these inflation-justified price increases will continue to help mitigate 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 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 at all locations and does not anticipate manufacturing or staffing disruptions in the near term. 20 Results of Operations Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022 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, 2023 2022 $ % $ % Net sales 37,904 100.0% 34,099 100.0% Cost of goods sold 29,030 76.6% 27,863 81.7% Depreciation expense 648 1.7% 656 1.9% Total cost of goods sold 29,678 78.3% 28,519 83.6% Gross profit 8,226 21.7% 5,580 16.4% Selling expenses 3,519 9.3% 3,202 9.4% General & administrative expense 3,135 8.2% 3,292 9.7% Amortization expense 135 0.4% 135 0.4% Total operating expenses 6,789 17.9% 6,629 19.5% Income (loss) from operations 1,437 3.8% (1,049 ) (3.1% ) Other (expense) income: Interest expense (104 ) (0.3% ) (42 ) (0.1% ) Other (expense) income, net 5 0.0% (1 ) 0.0% Total other (expense) income (99 ) (0.3% ) (43 ) (0.1% ) Income (loss) before provision for income taxes 1,338 3.5% (1,092 ) (3.2% ) Provision (benefit) for income taxes 508 1.3% (197 ) (0.6% ) Net income (loss) 830 2.2% (895 ) (2.6% ) Net Sales Net sales finished at $37,904 for the three-month period ended March 31, 2023, an increase of $3,805 or 11.2% 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 fourth quarter of 2022. Net sales by product category were as follows for the three months ended March 31: 2023 2022 $ % $ % Drinkable Kefir excluding ProBugs $ 29,800 79% $ 26,362 77% Cheese 3,345 9% 3,024 9% Cream and other 1,920 5% 1,968 6% Drinkable yogurt 1,616 4% 1,551 5% ProBugs Kefir 808 2% 782 2% Other dairy 415 1% 412 1% Net Sales $ 37,904 100% $ 34,099 100% 21 Gross Profit Gross profit as a percentage of net sales was 21.7% during the three-month period ended March 31, 2023. Gross profit percentage was 16.4% in the prior year. The increase versus the prior year was primarily due to the impact of price increases implemented during the fourth quarter of 2022 and higher volumes of our branded products, and to a lesser extent the favorable impact of milk pricing and favorable transportation costs. Selling Expenses Selling expenses increased by $317 to $3,519 during the three-month period ended March 31, 2023 from $3,202 during the same period in 2022. The increase is primarily due to increased investment in advertising and marketing programs, and 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 decreased $157 to $3,135 during the three-month period ended March 31, 2023 from $3,292 during the same period in 2022. Provision (Benefit) for Income Taxes The provision (benefit) for income taxes was $508 and $(197) during the three months ended March 31, 2023 and 2022, respectively. The effective income tax rate for the three months ended March 31, 2023 was 37.9% compared to 18.1% in the same period last year. The statutory Federal and state tax rates remained consistent from 2022 to 2023. 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 2023, the percentage effect is different due to the difference in pre-tax (loss) 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 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. 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, 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, 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. 22 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, in our Annual Report on Form 10-K). Cash Flow The following table is derived from our Consolidated Statement of Cash Flows: Three months Ended March 31, Net Cash Flows Provided By (Used In): 2023 2022 Operating activities $ 3,027 $ (648 ) Investing activities $ (1,762 ) $ (348 ) Financing activities $ (500 ) $ (250 ) Operating Activities Net cash provided by operating activities was $3,027 during the three-month period ended March 31, 2023 compared to net cashed used of $648 in the same period in 2022. The increase was primarily due to higher cash earnings which reflect the impact of price increases implemented during the fourth quarter of 2022 and the change in working capital. Investing Activities Net cash used in investing activities was $1,762 during the three-month period ended March 31, 2023 compared to $348 in the same period 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 $500 during the three-month period ended March 31, 2023 compared to net cash used in financing activities of $250 in the same period in 2022. The increase in cash used is due to the timing of the fourth quarter 2022 quarterly principal payment under the term loan. Debt Obligations As of March 31, 2023, 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, 2023. The Company had $3,228 outstanding under the note payable, net of $22 of unamortized deferred financing fees, as of March 31, 2023. The Company’s interest rate on debt outstanding under the revolving line of credit and note payable as of March 31, 2023 was 6.66% and 4.94%, respectively. The Company is in compliance with all applicable financial debt covenants as of March 31, 2023. See Note 7 to our Consolidated Financial Statements for additional information regarding our indebtedness and related agreements. 23 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, 2022. There were no material changes to the Company’s critical accounting policies and estimates in the three months ended March 31, 2023. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.