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. Business Overview Lifeway was founded in 1986 by Michael Smolyansky a refugee from the former USSR who emigrated from Eastern Europe to the United States in 1976 with his wife and young daughter. 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 a probiotic beverage that is tart and tangy, high in protein, calcium and vitamin D. 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. 18 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 a portion of 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. Results of Operations Three Months Ended September 30, 2023 Compared to Three Months Ended September 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 September 30, 2023 2022 $ % $ % Net sales 40,896 100.0% 38,140 100.0% Cost of goods sold 29,099 71.2% 29,962 78.6% Depreciation expense 654 1.6% 590 1.5% Total cost of goods sold 29,753 72.8% 30,552 80.1% Gross profit 11,143 27.2% 7,588 19.9% Selling expenses 2,884 7.1% 2,843 7.4% General & administrative expense 3,085 7.5% 3,415 9.0% Amortization expense 135 0.3% 135 0.4% Total operating expenses 6,104 14.9% 6,393 16.8% Income from operations 5,039 12.3% 1,195 3.1% Other (expense) income: Interest expense (109 ) (0.3% ) (77 ) (0.2% ) Gain on sales of property and equipment – 0.0% – 0.0% Other (expense) income, net (1 ) 0.0% (5 ) 0.0% Total other (expense) income (110 ) (0.3% ) (82 ) (0.2% ) Income before provision for income taxes 4,929 12.0% 1,113 2.9% Provision for income taxes 1,517 3.7% 130 0.3% Net income 3,412 8.3% 983 2.6% 19 Net Sales Net sales finished at $40,896 for the three-month period ended September 30, 2023, an increase of $2,756 or 7.2% 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 September 30: 2023 2022 $ % $ % Drinkable Kefir excluding ProBugs $ 33,035 81% $ 30,297 79% Cheese 3,353 8% 3,211 9% Cream and other 1,811 4% 1,874 4% Drinkable yogurt 1,485 4% 1,482 5% ProBugs Kefir 820 2% 882 2% Other dairy 392 1% 394 1% Net Sales $ 40,896 100% $ 38,140 100% Gross Profit Gross profit as a percentage of net sales was 27.2% during the three-month period ended September 30, 2023. Gross profit percentage was 19.9% 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 $41 to $2,884 during the three-month period ended September 30, 2023 from $2,843 during the same period in 2022. General and Administrative Expenses General and administrative expenses decreased $330 to $3,085 during the three-month period ended September 30, 2023 from $3,415 during the same period in 2022. The decrease is primarily driven by the termination of the endorsement agreement in September 2022. Provision for Income Taxes The provision for income taxes was $1,517 and $130 during the three months ended September 30, 2023 and 2022, respectively. The effective income tax rate for the three months ended September 30, 2023 was 30.8% compared to 11.7% 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. 20 Nine months Ended September 30, 2023 Compared to Nine months Ended September 30, 2022 The following table presents certain information concerning our financial results, including information presented as a percentage of consolidated net sales: Nine months Ended September 30, 2023 2022 $ % $ % Net sales 118,030 100.0% 105,730 100.0% Cost of goods sold 85,428 72.4% 85,032 80.4% Depreciation expense 1,953 1.7% 1,833 1.7% Total cost of goods sold 87,381 74.1% 86,865 82.2% Gross profit 30,649 25.9% 18,865 17.8% Selling expenses 8,974 7.6% 8,527 8.1% General & administrative expense 10,028 8.5% 9,546 9.0% Amortization expense 405 0.3% 405 0.4% Total operating expenses 19,407 16.4% 18,478 17.5% Income from operations 11,242 9.5% 387 0.4% Other (expense) income: Interest expense (322 ) (0.3% ) (171 ) (0.2% ) Gain on sales of property and equipment 33 0.0% – 0.0% Other (expense) income, net (1 ) 0.0% (10 ) 0.0% Total other (expense) income (290 ) (0.3% ) (181 ) (0.2% ) Income before provision for income taxes 10,952 9.2% 206 0.2% Provision (benefit) for income taxes 3,554 3.0% (2 ) 0.0% Net income 7,398 6.2% 208 0.2% Net Sales Net sales finished at $118,030 for the nine-month period ended September 30, 2023, an increase of $12,300 or 11.6% 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 nine months ended September 30: 2023 2022 $ % $ % Drinkable Kefir excluding ProBugs $ 94,174 80% $ 82,779 78% Cheese 10,074 9% 9,233 9% Cream and other 5,362 4% 5,438 5% Drinkable yogurt 4,760 4% 4,559 5% ProBugs Kefir 2,490 2% 2,481 2% Other dairy 1,170 1% 1,240 1% Net Sales $ 118,030 100% $ 105,730 100% Gross Profit Gross profit as a percentage of net sales was 25.9% during the nine-month period ended September 30, 2023. Gross profit percentage was 17.8% 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. 21 Selling Expenses Selling expenses increased by $447 to $8,974 during the nine-month period ended September 30, 2023 from $8,527 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 $482 to $10,028 during the nine-month period ended September 30, 2023 from $9,546 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, partially offset by the termination of the endorsement agreement in September 2022. Provision (Benefit) for Income Taxes The provision (benefit) for income taxes was $3,554 and $(2) during the nine months ended September 30, 2023 and 2022, respectively. The effective income tax rate for the nine months ended September 30, 2023 was 32.5% compared to (0.8)% 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. 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 September 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, if a serious economic or credit market crisis ensues, it could have a negative effect on our liquidity, results of operations and financial condition. As discussed in Note 14, Subsequent Events, the Company paid the outstanding line of credit balance of $2,777 in full on October 6, 2023. 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). 22 Cash Flow The following table is derived from our Consolidated Statement of Cash Flows: Nine months Ended September 30, Net Cash Flows Provided By (Used In): 2023 2022 Operating activities $ 12,144 $ 3,639 Investing activities $ (3,206 ) $ (3,189 ) Financing activities $ (750 ) $ (750 ) Operating Activities Net cash provided by operating activities was $12,144 during the nine-month period ended September 30, 2023 compared to $3,639 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 $3,206 during the nine-month period ended September 30, 2023 compared to $3,189 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 $750 during the nine-month period ended September 30, 2023 and 2022, respectively. The cash used represents the quarterly principal payments under the term loan. Debt Obligations As of September 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 September 30, 2023. The Company had $2,981 outstanding under the note payable, net of $19 of unamortized deferred financing fees, as of September 30, 2023. The Company’s interest rate on debt outstanding under the revolving line of credit and note payable as of September 30, 2023 was 7.34% and 7.40%, respectively. The Company is in compliance with all applicable financial debt covenants as of September 30, 2023. See Note 7 to our Consolidated Financial Statements for additional information regarding our indebtedness and related agreements. As discussed in Note 14, Subsequent Events, the Company paid the outstanding line of credit balance of $2,777 in full on October 6, 2023. 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 nine months ended September 30, 2023. 23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable.