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; · 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. 20 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. 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. We have begun to see some moderation of inflationary pressures and have experienced pricing declines in certain of our input costs, such as milk. 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. 21 Results of Operations Three Months Ended June 30, 2023 Compared to Three Months Ended June 30, 2022 The following table presents certain information concerning our financial results, including information presented as a percentage of consolidated net sales: Three Months Ended June 30, 2023 2022 $ % $ % Net sales 39,230 100.0% 33,491 100.0% Cost of goods sold 27,299 69.6% 27,207 81.2% Depreciation expense 651 1.7% 587 1.8% Total cost of goods sold 27,950 71.3% 27,794 83.0% Gross profit 11,280 28.7% 5,697 17.0% Selling expenses 2,571 6.6% 2,482 7.4% General & administrative expense 3,808 9.7% 2,839 8.5% Amortization expense 135 0.3% 135 0.4% Total operating expenses 6,514 16.6% 5,456 16.3% Income from operations 4,766 12.1% 241 0.7% Other (expense) income: Interest expense (109 ) (0.3% ) (52 ) (0.2% ) Gain on sales of property and equipment 33 0.1% – 0.0% Other (expense) income, net (5 ) 0.0% (4 ) 0.0% Total other (expense) income (81 ) (0.2% ) (56 ) (0.2% ) Income before provision for income taxes 4,685 11.9% 185 0.5% Provision for income taxes 1,529 3.9% 65 0.2% Net income 3,156 8.0% 120 0.3% Net Sales Net sales finished at $39,230 for the three-month period ended June 30, 2023, an increase of $5,739 or 17.1% 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. Net sales by product category were as follows for the three months ended June 30: 2023 2022 $ % $ % Drinkable Kefir excluding ProBugs $ 31,339 80% $ 26,120 78% Cheese 3,376 9% 2,998 9% Drinkable yogurt 1,659 4% 1,526 5% Cream and other 1,631 4% 1,596 5% ProBugs Kefir 862 2% 817 2% Other dairy 363 1% 434 1% Net Sales $ 39,230 100% $ 33,491 100% 22 Gross Profit Gross profit as a percentage of net sales was 28.7% during the three-month period ended June 30, 2023. Gross profit percentage was 17.0% in the prior year. 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 $89 to $2,571 during the three-month period ended June 30, 2023 from $2,482 during the same period in 2022. General and Administrative Expenses General and administrative expenses increased $969 to $3,808 during the three-month period ended June 30, 2023 from $2,839 during the same period in 2022. The increase is primarily driven by incentive compensation and to a lesser extent expenses related to non-routine stockholder action. Provision for Income Taxes The provision for income taxes was $1,529 and $65 during the three months ended June 30, 2023 and 2022, respectively. The effective income tax rate for the three months ended June 30, 2023 was 32.6% compared to 35.3% 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 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. 23 Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022 The following table presents certain information concerning our financial results, including information presented as a percentage of consolidated net sales: Six Months Ended June 30, 2023 2022 $ % $ % Net sales 77,134 100.0% 67,590 100.0% Cost of goods sold 56,329 73.0% 55,070 81.5% Depreciation expense 1,299 1.7% 1,243 1.8% Total cost of goods sold 57,628 74.7% 56,313 83.3% Gross profit 19,506 25.3% 11,277 16.7% Selling expenses 6,090 7.9% 5,684 8.4% General & administrative expense 6,943 9.0% 6,131 9.1% Amortization expense 270 0.4% 270 0.4% Total operating expenses 13,303 17.3% 12,085 17.9% Income (loss) from operations 6,203 8.0% (808 ) (1.2% ) Other (expense) income: Interest expense (213 ) (0.3% ) (94 ) (0.1% ) Gain on sales of property and equipment 33 0.0% – 0.0% Other (expense) income, net – 0.0% (5 ) 0.0% Total other (expense) income (180 ) (0.3% ) (99 ) (0.1% ) Income (loss) before provision for income taxes 6,023 7.7% (907 ) (1.3% ) Provision (benefit) for income taxes 2,037 2.6% (132 ) (0.2% ) Net income (loss) 3,986 5.1% (775 ) (1.1% ) Net Sales Net sales finished at $77,134 for the six-month period ended June 30, 2023, an increase of $9,544 or 14.1% 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. Net sales by product category were as follows for the six months ended June 30: 2023 2022 $ % $ % Drinkable Kefir excluding ProBugs $ 61,139 79% $ 52,482 78% Cheese 6,721 9% 6,022 9% Cream and other 3,551 5% 3,564 5% Drinkable yogurt 3,275 4% 3,077 5% ProBugs Kefir 1,670 2% 1,599 2% Other dairy 778 1% 846 1% Net Sales $ 77,134 100% $ 67,590 100% 24 Gross Profit Gross profit as a percentage of net sales was 25.3% during the six-month period ended June 30, 2023. Gross profit percentage was 16.7% in the prior year. 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 $406 to $6,090 during the six-month period ended June 30, 2023 from $5,684 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 $812 to $6,943 during the six-month period ended June 30, 2023 from $6,131 during the same period in 2022. The increase is primarily driven by incentive compensation and to a lesser extent expenses related to non-routine stockholder action. Provision (Benefit) for Income Taxes The provision (benefit) for income taxes was $2,037 and $(132) during the six months ended June 30, 2023 and 2022, respectively. The effective income tax rate for the six months ended June 30, 2023 was 33.8% compared to 14.5% 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. 25 If additional borrowings are needed, $2,223 was available under the Revolving Credit Facility as of June 30, 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. 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: Six months Ended June 30, Net Cash Flows Provided By (Used In): 2023 2022 Operating activities $ 5,455 $ (529 ) Investing activities $ (1,950 ) $ (1,710 ) Financing activities $ (500 ) $ (500 ) Operating Activities Net cash provided by operating activities was $5,455 during the six-month period ended June 30, 2023 compared to net cashed used of $529 in the same period 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 $1,950 during the six-month period ended June 30, 2023 compared to $1,710 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 six-month period ended June 30, 2023 and 2022. The cash used represents the quarterly principal payments under the term loan. 26 Debt Obligations As of June 30, 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 June 30, 2023. The Company had $3,230 outstanding under the note payable, net of $20 of unamortized deferred financing fees, as of June 30, 2023. The Company’s interest rate on debt outstanding under the revolving line of credit and note payable as of June 30, 2023 was 7.14% and 7.10%, respectively. The Company is in compliance with all applicable financial debt covenants as of June 30, 2023. 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, 2022. There were no material changes to the Company’s critical accounting policies and estimates in the six months ended June 30, 2023. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.