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Lifeway Foods, Inc. - Quarter Report: 2019 March (Form 10-Q)

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

x       QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: March 31, 2019

 

o       TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission File Number: 000-17363

 

LIFEWAY FOODS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Illinois 36-3442829

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

6431 West Oakton, Morton Grove, IL 60053

(Address of Principal Executive Offices, Zip Code)

 

(847) 967-1010

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol(s) Name of each exchange on which
registered
 Common Stock, no par value  LWAY Nasdaq Global Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

 

  Large accelerated filer  o Accelerated filer  o
  Non-accelerated filer  o Smaller reporting company  x
  Emerging growth company  o  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No x

 

Number of shares of Common Stock, no par value, outstanding as of May 3, 2019: 15,795,034

 

 

 

 

   

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION  
Item 1. Financial Statements. 3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 20
Item 4. Controls and Procedures. 20
   
PART II – OTHER INFORMATION  
Item 1. Legal Proceedings. 22
Item 1 A. Risk Factors. 22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 22
Item 3. Defaults Upon Senior Securities. 22
Item 4. Mine Safety Disclosure. 22
Item 5. Other Information. 22
Item 6. Exhibits. 22
  Signatures. 23

 

 

 

 

 

 

 

 2 

 

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

March 31, 2019 and December 31, 2018

(In thousands)

 

  

March 31,

2019

(Unaudited)

  

December 31,

2018

 
Current assets          
Cash and cash equivalents  $2,524   $2,998 
Accounts receivable, net of allowance for doubtful accounts and discounts & allowances of $1,220 at March 31, 2019 and December 31, 2018 respectively   7,374    6,276 
Inventories, net   6,514    5,817 
Prepaid expenses and other current assets   1,123    1,077 
Refundable income taxes   1,258    2,748 
Total current assets   18,793    18,916 
           
Property, plant and equipment, net   23,959    24,573 
Operating lease right-of-use asset   1,056     
           
Intangible assets          
Goodwill & indefinite-lived intangibles   12,824    12,824 
Other intangible assets, net   271    344 
Total intangible assets   13,095    13,168 
           
Other assets   165    150 
Total assets  $57,068   $56,807 
           
Current liabilities          
Accounts payable  $5,601   $4,570 
Accrued expenses   3,114    2,777 
Accrued income taxes   87    106 
Total current liabilities   8,802    7,453 
Line of credit   4,671    5,995 
Operating lease liabilities   611     
Deferred income taxes, net   390    390 
Other long-term liabilities   124    564 
Total liabilities   14,598    14,402 
           
Stockholders' equity          
Preferred stock, no par value; 2,500 shares authorized; no shares issued or outstanding at March 31, 2019 and December 31, 2018, respectively        
Common stock, no par value; 40,000 shares authorized; 17,274 shares issued; 15,773 and 15,814 outstanding at March 31, 2019 and December 31, 2018, respectively   6,509    6,509 
Paid-in capital   2,663    2,303 
Treasury stock, at cost   (12,824)   (12,970)
Retained earnings   46,122    46,563 
Total stockholders' equity   42,470    42,405 
           
Total liabilities and stockholders' equity  $57,068   $56,807 

 

 

See accompanying notes to consolidated financial statements 

 

 3 

 

 

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

For the three months ended March 31, 2019 and 2018

(Unaudited)

(In thousands, except per share data)

 

   2019   2018 
         
Net Sales  $24,615   $28,742 
           
Cost of goods sold   17,567    20,025 
Depreciation expense   745    680 
Total cost of goods sold   18,312    20,705 
           
Gross profit   6,303    8,037 
           
Selling expense   3,139    4,018 
General and administrative expense   3,492    3,705 
Amortization expense   73    163 
Total operating expenses   6,704    7,886 
           
(Loss) income from operations   (401)   151 
           
Other income (expense):          
Interest expense   (69)   (63)
Gain on sale of property equipment   25    15 
Other income, net   3    5 
Total other income (expense)   (41)   (43)
           
(Loss) income before provision for income taxes   (442)   108 
           
(Benefit) provision for income taxes   (54)   38 
           
Net (loss) income  $(388)  $70 
           
(Loss) earnings per common share:          
Basic  $(0.02)  $0.00 
Diluted  $(0.02)  $0.00 
           
Weighted average common shares:          
Basic   15,767    15,908 
Diluted   15,767    16,019 

 

See accompanying notes to consolidated financial statements

 

 4 

 

 

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity 

For the Three Months Ended March 31, 2019 and 2018

(Unaudited)

(In thousands)

 

    Common Stock                    
    Issued     In treasury     Paid-In     Retained     Total  
    Shares     $     Shares     $     Capital     Earnings     Equity  
                                           
Balance, January 1, 2018     17,274     $ 6,509       (1,266 )   $ (11,812 )   $ 2,244     $ 49,649     $ 46,590  
                                                         
Issuance of common stock in connection with stock-based compensation                 16       151       (54 )           97  
                                                         
Treasury stock purchased                 (131 )     (1,052 )                 (1,052 )
                                                         
Stock-based compensation                             5             5  
                                                         
Net income                                   70       70  
                                                         
Balance, March 31, 2018     17,274     $ 6,509       (1,381 )   $ (12,713 )   $ 2,195     $ 49,719     $ 45,710  
                                                         
Balance, January 1, 2019     17,274     $ 6,509       (1,460 )   $ (12,970 )   $ 2,303     $ 46,563     $ 42,405  
                                                         
Cumulative impact of change in accounting principles, net of tax                                   (53     (53)  
                                                         
Issuance of common stock in connection with stock-based compensation                 41       351       142             493  
                                                         
Treasury stock purchased                 (82 )     (205 )                 (205 )
                                                         
Stock-based compensation                             218             218  
                                                         
Net loss                                   (388     (388
                                                         
Balance, March 31, 2019     17,274     $ 6,509       (1,501 )   $ (12,824 )   $ 2,663     $ 46,122     $ 42,470  

 

 

See accompanying notes to consolidated financial statements

 

 5 

 

 

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Three Months Ended March 31, 2019 and 2018

(Unaudited)

(In thousands)

 

   2019   2018 
Cash flows from operating activities:          
Net (loss) income  $(388)  $70 
Adjustments to reconcile net (loss) income to operating cash flow:          
Depreciation and amortization   818    843 
Bad debt expense       20 
Reserve for inventory obsolescence   30    130 
Stock-based compensation   353    386 
Non-cash interest expense   6     
Deferred revenue   (24)   (24)
(Gain) on sale of property and equipment   (25)   (15)
(Increase) decrease in operating assets:          
Accounts receivable   (1,099)   467 
Inventories   (727)   52 
Refundable income taxes   1,490    (448)
Prepaid expenses and other current assets   (57)   (185)
Increase (decrease) in operating liabilities:          
Accounts payable   1,031    288 
Accrued expenses   (207)   (629)
Accrued income taxes   (19)   (102)
Net cash provided by operating activities   1,182    853 
           
Cash flows from investing activities:          
Purchases of property and equipment   (137)   (879)
Proceeds from sale of property and equipment   31    32 
Purchase of investments   (15)    
Net cash used in investing activities   (121)   (847)
           
Cash flows from financing activities:          
Purchase of treasury stock   (205)   (1,052)
Repayment of line of credit   (1,330)    
Repayment of notes payable       (210)
Net cash used in financing activities   (1,535)   (1,262)
           
Net decrease in cash and cash equivalents   (474)   (1,256)
           
Cash and cash equivalents at the beginning of the period   2,998    4,978 
           
Cash and cash equivalents at the end of the period  $2,524   $3,722 
           
Supplemental cash flow information:          
Cash paid for income taxes, net of (refunds)  $(1,525)  $587 
Cash paid for interest  $84   $63 
           
Non-cash investing activities          
Right-of-use assets recognized at ASU 2016-02 transition  $944   $ 
Operating lease liability recognized at ASU 2016-02 transition  $997   $ 
Right-of-use assets and operating lease liabilities recognized after ASU 2016-02 transition  $242   $ 

 

See accompanying notes to consolidated financial statements

 

 

 6 

 

 

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

March 31, 2019 and December 31, 2018

(Unaudited)

(In thousands, except per share data)

 

Note 1 – Basis of Presentation

 

Basis of presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) for interim financial information, and do not include all of the information and disclosures required for complete, audited financial statements. In the opinion of management, these statements include all adjustments necessary for a fair presentation of the results of all interim periods reported herein. The consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K as of and for the year ended December 31, 2018. Results of operations for interim periods are not necessarily indicative of the results to be expected for other interim periods or the full year.

 

A detailed description of our significant accounting policies can be found in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

 

Principles of consolidation

 

Our consolidated financial statements include the accounts of Lifeway Foods, Inc. and all its wholly owned subsidiaries (collectively “Lifeway” or the “Company”). All significant intercompany accounts and transactions have been eliminated.

 

Note 2 – Significant Accounting Policies

 

Use of estimates

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made in preparing the consolidated financial statements include the reserve for promotional allowances, the valuation of goodwill and intangible assets, stock-based and incentive compensation, and deferred income taxes.

 

Revenue Recognition

 

We sell food and beverage products across select product categories to customers predominantly within the United States (see Note 11, Segments, Products and Customers). We also sell bulk cream, a byproduct of our fluid milk manufacturing process. In accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, we recognize revenue when control over the products transfers to our customers, which generally occurs upon delivery to our customers or their common carriers. We adopted this standard at the beginning of fiscal year 2018, with no significant impact to its financial position or results of operations, using the modified retrospective method. The amount of revenue recognized reflects the consideration to which we expect to be entitled to receive in exchange for these goods or services, using the five-step method required by ASC 606.

 

For the Company, the contract is the approved sales order, which may also be supplemented by other agreements that formalize various terms and conditions with customers. We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.

 

 

 

 7 

 

 

Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer, which is the delivery of food products which provide immediate benefit to the customer.

 

We account for product shipping and handling as fulfillment activities with revenues for these activities recorded within net revenue and costs recorded within cost of goods sold. Any taxes collected on behalf of government authorities are excluded from net revenues.

 

Variable consideration, which typically includes volume-based rebates, known or expected pricing or revenue adjustments, such as trade discounts, allowances for non-saleable products, product returns, trade incentives and coupon redemption, is estimated utilizing the most likely amount method.

 

Key sales terms, such as pricing and quantities ordered, are established on a frequent basis such that most customer arrangements and related incentives have a one year or shorter duration. As such, we do not capitalize contract inception costs and we capitalize product fulfillment costs in accordance with U.S. GAAP and our inventory policies. We do not have any significant deferred revenue or unbilled receivables at the end of a period. We generally do not receive noncash consideration for the sale of goods, nor do we grant payment financing terms greater than one year.

 

Advertising and promotional costs

 

Lifeway expenses advertising costs as incurred. For the three months ended March 31, 2019 and 2018 total advertising expenses were $1,088 and $1,389 respectively.

 

Recently Adopted Accounting Pronouncements

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which affects any entity that enters into a lease (as that term is defined in ASU 2016-02), with some specified scope exceptions. Under ASU 2016-02, companies can adopt the amended guidance using a modified retrospective transition approach, using an application date of either the beginning of the earliest comparative period presented or the beginning of the reporting period in which the companies first apply the new standard. We adopted this standard on January 1, 2019 using the application date of January 1, 2019, and elected certain practical expedients allowed under the standard. In July 2018, the FASB issued ASU No. 2018-11, Leases (842), Targeted Improvements, which provides an additional transition election to not restate comparative periods for the effects of applying the new standard. The guidance requires lessees to recognize right-of-use assets and lease liabilities in the balance sheet and disclose key information about leasing arrangements, such as information about variable lease payments and options to renew and terminate leases. The amended guidance will require both operating and finance leases to be recognized in the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.

 

Lifeway elected certain of the practical expedients that are permitted under the transition guidance within ASU 2016-02 and related standards. Among other things, this practical expedient allowed us to carryforward the historical lease classification, and not reassess initial direct costs for any existing leases as of January 1, 2019 or reassess whether any expired or existing contracts are or contain leases. In addition, we elected to adopt the hindsight practical expedient to determine the reasonably certain lease term for existing leases. We made an accounting policy election to continue recording leases with an initial term of 12 months or less consistent with our prior financial reporting and elect the practical expedient to combine lease and non-lease components. We have revised its relevant policies and procedures, as applicable, to meet the new accounting, reporting and disclosure requirements of Topic 842 and has updated internal controls accordingly.

 

The main difference between the guidance in ASU 2016-02 and prior GAAP is the recognition of right-of-use assets and lease liabilities by lessees for those leases classified as operating leases under current GAAP. Recognition of the right-of-use assets and liabilities had a material impact to our consolidated balance sheets upon adoption. However, since all our leases are operating leases under ASC 840 and we will carryforward the historical lease classification, the new standard did not have a material impact on our Consolidated Statements of Operations, Consolidated Statements of Stockholders’ Equity, or Consolidated Statements of Cash Flows. The adoption resulted in an increase of the right-of-use assets of approximately $944 and lease liabilities of $997, and an adjustment to beginning retained earnings of $53 as of January 1, 2019.

 

 

 

 8 

 

 

Recently Issued Accounting Pronouncements

 

We do not anticipate a material impact upon adoption from any accounting standards issued but not yet adopted.

 

Note 3 – Inventories, net

 

Inventories consisted of the following:

 

   March 31,
2019
   December 31,
2018
 
Ingredients  $1,742   $1,580 
Packaging   2,188    2,072 
Finished goods   2,584    2,165 
Total inventories  $6,514   $5,817 

 

Note 4 – Property, Plant and Equipment, net

 

Property, plant and equipment consisted of the following:

 

   March 31,
2019
   December 31,
2018
 
Land  $1,747   $1,747 
Buildings and improvements   17,566    17,520 
Machinery and equipment   29,744    29,692 
Vehicles   828    937 
Office equipment   838    838 
Construction in process   527    546 
    51,250    51,280 
Less accumulated depreciation   (27,291)   (26,707)
Total property, plant and equipment, net  $23,959   $24,573 

 

 

Note 5 – Goodwill and Intangible Assets

 

Goodwill & indefinite-lived intangible assets consisted of the following:

 

   March 31,
2019
   December 31,
2018
 
Gross goodwill  $10,368   $10,368 
Accumulated impairment losses   (1,244)   (1,244)
Goodwill   9,124    9,124 
Brand names   3,700    3,700 
Goodwill and indefinite-lived intangible assets  $12,824   $12,824 

 

 

 

 9 

 

 

Finite-lived Intangible Assets

 

Other intangible assets, net consisted of the following:

 

   March 31,
2019
   December 31,
2018
 
Recipes  $44   $44 
Customer lists and other customer related intangibles   4,529    4,529 
Customer relationship   985    985 
Trade names   2,248    2,248 
Formula   438    438 
    8,244    8,244 
Accumulated amortization   (7,973)   (7,900)
Other intangible assets, net  $271   $344 

 

Note 6 – Accrued Expenses

 

Accrued expenses consisted of the following:

 

   March 31,
2019
  

December 31,

2018

 
Payroll and incentive compensation  $1,881   $1,937 
Operating leases   495     
Real estate taxes   297    398 
Other   441    442 
   $3,114   $2,777 

 

Note 7 – Debt

 

Notes Payable

 

We had two variable rate term loans with an aggregate outstanding balance of $6,069 as of March 31, 2018. The term loans were subject to interest at the prime rate or at the LIBOR plus 2.5% and were collateralized by substantially all of Lifeway’s assets. The two term loans were refinanced and paid in full on May 7, 2018. See Line of Credit below.

 

Line of Credit

 

On May 7, 2018, Lifeway entered into an Amended and Restated Loan and Security Agreement (the “Revolving Credit Facility”) with its existing lender. The Revolving Credit Facility provides for a revolving line of credit up to a maximum of $10 million (the “Revolving Loan”) with an incremental facility not to exceed $5 million (the “Incremental Facility” and together with the Revolving Loan, the “Loans”). The proceeds of the Loans were used to pay off Lifeway’s existing debt with the lender under the Loan and Security Agreement, Revolving Note, and Term Note entered into on February 6, 2009, and for general working capital purposes. Upon closing, we retired all the then-outstanding term loans described above.

 

As of March 31, 2019, we had $4,671, net of $49 of unamortized deferred financing costs, outstanding under the Revolving Credit Facility. We had approximately $4,280 available under the Borrowing Base for future borrowings as of March 31, 2019.

 

 

 

 10 

 

 

All outstanding amounts under the Loans bear interest, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.5%, or the Prime Rate) or the LIBOR plus 2.50%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee. Lifeway’s average interest rate on debt outstanding under our Revolving Credit Facility for the quarter ended March 31, 2019 was 4.98%.

 

The commitment under the Revolving Credit Facility matures May 7, 2021. The Revolving Credit Facility is presented as a long-term debt obligation as of March 31, 2019. The Loans and all other amounts due and owed under the Revolving Credit Facility and related documents are secured by substantially all of our assets.

 

Amounts available for borrowing under the Revolving Credit Facility equal the lesser of (i) the Borrowing Base (as defined below), or (ii) $10 million (plus the amount of any Incremental Facility requested by Lifeway and approved by lender), in each case, as the same is reduced by the aggregate principal amount outstanding under the Loans. “Borrowing Base” under the Revolving Credit Facility means, generally, an amount equal to our cash and cash equivalents plus our eligible accounts receivable and eligible inventory, less certain reserves, divided by 1.5.

 

The Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters through December 31, 2018; maintain (a) a fixed charge coverage ratio of no less than 1.25 to 1.0, and (b) a Senior Debt to EBITDA ratio of not more than 3.00 to 1.0 at December 31, 2018 and for each of the succeeding fiscal quarters ending through the expiration date. The Revolving Credit Facility also provides 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 Revolving Credit Facility may be accelerated.

 

The revolving credit facility was amended on April 10, 2019, effective March 31, 2019. See Note 14 for discussion of this subsequent event. We were in compliance with the minimum EBITDA and fixed charge coverage ratio covenants at March 31, 2019 as defined in Note 14. 

 

Note 8 – Leases

 

Lifeway has operating leases for three retail stores for its Lifeway Kefir Shop subsidiary, certain machinery and equipment, and office space. All lease payments are fixed, not variable. Remaining lease terms for these leases range from less than 1 year to 5 years. Some of our leases include options to extend the leases for up to 5 years and have been included in our calculation of the right-of-use asset and lease liabilities. There are no residual value guarantees. We do not currently have leases which meet the finance lease classification as defined under ASC 842.

 

We do not record leases with an initial term of 12 months or less on the balance sheet. Expense for these short-term leases is recorded on a straight-line basis over the lease term. Total lease expense was $175 and $180 (including short term leases) for the three months ended March 31, 2019 and 2018, respectively.

 

Lifeway treats contracts as a lease when the contract conveys the right to use a physically distinct asset for a period of time in exchange for consideration, we direct the use of the asset and obtains substantially all the economic benefits of the asset.

 

Right-of-use assets and lease liabilities are measured and recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. We have elected the practical expedient to combine lease and non-lease components into a single component for all of its leases. For many of our leases such as real estate leases, we are unable to determine an implicit rate; therefore, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments for those leases. We include options to extend or terminate the lease in the measurement of the right-of-use asset and lease liability when it is reasonably certain that it will exercise such options. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

 

 

 11 

 

 

Future maturities of lease liabilities were as follows

 

Year  Operating Leases 
Nine months ended December 31, 2019  $428 
2020   294 
2021   219 
2022   181 
2023   63 
Thereafter   4 
Total lease payments   1,189 
Less: Interest   (83)
Present value of lease liabilities  $1,106 

 

The weighted-average remaining lease term for our operating leases was 2.9 years as of March 31, 2019. The weighted average discount rate of our operating leases was 5.27% as of March 31, 2019. Cash paid for amounts included in the measurement of lease liabilities was $147 for the three-month period ended March 31, 2019.

 

Note 9 – Commitments and contingencies

 

Litigation

 

Lifeway is engaged in various legal actions, claims, and proceedings arising in the normal course of business, including commercial disputes, product liabilities, intellectual property matters and employment-related matters resulting from our business activities.

 

We record accruals for outstanding legal matters when we believe it is probable that a loss will be incurred and the amount of such loss can be reasonably estimated. We evaluate, on a periodic basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, we do not establish an accrued liability. Currently, none of our accruals for outstanding legal matters are material individually or in the aggregate to our financial position and it is management’s opinion that the ultimate resolution of these outstanding legal matters will not have a material adverse effect on our business, financial condition, results of operations, or cash flows. However, if we ultimately are required to make payments in connection with an adverse outcome, it is possible that it could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Lifeway’s contingencies are subject to substantial uncertainties, including for each such contingency the following, among other factors: (i) the procedural status of the case; (ii) whether the case has or may be certified as a class action suit; (iii) the outcome of preliminary motions; (iv) the impact of discovery; (v) whether there are significant factual issues to be determined or resolved; (vi) whether the proceedings involve a large number of parties and/or parties and claims in multiple jurisdictions or jurisdictions in which the relevant laws are complex or unclear; (vii) the extent of potential damages, which are often unspecified or indeterminate; and (viii) the status of settlement discussions, if any, and the settlement posture of the parties. Consequently, Lifeway cannot predict with any reasonable certainty the timing or outcome of such contingencies, and we are unable to estimate a possible loss or range of loss.

 

Note 10 – Income taxes

 

For each interim period, Lifeway estimates the effective tax rate (“ETR”) expected to be applicable for the full year and applies that rate to income before provision for income taxes for the period. The effective tax rate for the three months ended March 31, 2019 was 12.2% compared to 35.1% for the three months ended March 31, 2018. 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, settlement of tax audits, 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 and completed tax audits in the period in which they occur.

 

 

 

 

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Note 11 – Stock-based and Other Compensation

 

In December 2015, Lifeway stockholders approved the 2015 Omnibus Incentive Plan, which authorized the issuance of an aggregate of 3.5 million shares to satisfy awards of stock options, stock appreciation rights, unrestricted stock, restricted stock, restricted stock units, performance shares and performance units to qualifying employees. Under the Plan, the Board or its Audit and Corporate Governance Committee approves stock awards to executive officers and certain senior executives, generally in the form of restricted stock or performance shares. The number of performance shares that participants may earn depends on the extent to which the corresponding performance goals have been achieved. Stock awards generally vest over a three-year performance or service period. At March 31, 2019, 3.426 million shares remain available under the Omnibus Incentive Plan. While we plan to continue to issue awards pursuant to the Plan at least annually, we may choose to suspend the issuance of new awards in the future and may grant additional awards at any time including issuing special grants of restricted stock, restricted stock units, and stock options to attract and retain new and existing executives.

 

Stock Options

 

The following table summarizes stock option activity during the three months ended March 31, 2019:

 

    Options     Weighted
average
exercise price
    Weighted
average
remaining contractual life
    Aggregate
intrinsic value
 
                         
Outstanding at December 31, 2018     41     $ 10.42       7.22        –   
Granted         $                  
Exercised         $                  
Forfeited         $                  
Outstanding at March 31, 2019     41     $ 10.42       6.97     $  
Exercisable at March 31, 2019     39     $ 10.46       6.96     $  

  

For the three months ended March 31, 2019 and 2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $1 and $4, respectively. For the three months ended March 31, 2019 and 2018 tax-related benefits of $0 and $2 were also recognized. As of March 31, 2019, the total remaining unearned compensation related to non-vested stock options was $1, which is expected to be amortized over the weighted-average remaining service period of 0.25 years.

 

Restricted Stock Awards

 

A Restricted Stock Award (“RSA”) represents the right to receive one share of common stock in the future. RSAs have no exercise price. The grant date fair value of the awards is equal to our closing stock price on the grant date. The following table summarizes RSA activity during the three months ended March 31, 2019.

 

   RSA’s 
     
Outstanding at December 31, 2018   25 
Granted   7 
Shares issued upon vesting    
Forfeited    
Outstanding at March 31, 2019   32 
Weighted average grant date fair value per share outstanding  $4.19 

 

 

 

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We expense RSA’s over the service period. For the three months ended March 31, 2019 and 2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $25 and $1, respectively. For the three months ended March 31, 2019 and 2018 tax-related benefits of $7 and $0, respectively, were also recognized. As of March 31, 2019, the total remaining unearned compensation related to non-vested RSA’s was $71, which is expected to be amortized over the weighted-average remaining service period of 1.26 years.

 

Long-Term Incentive Plan Compensation

 

Lifeway established long-term incentive-based compensation programs for fiscal year 2017 (the “2017 Plan”), fiscal year 2018 (the “2018 Plan”), and for fiscal year 2019 (the “2019 Plan”) for certain senior executives and key employees (the “participants”). Under both the 2017 Plan and the 2018 Plan, long-term incentive compensation is based on Lifeway’s achievement of certain sales and adjusted EBITDA performance levels versus respective targets established by the Board for each fiscal year. Under the 2019 Plan, long-term equity incentive compensation is based on Lifeway’s achievement of four strategic milestones over a three-year period from Fiscal 2019 through Fiscal 2021.

 

2017 Plan

 

Under the 2017 Plan, collectively the participants had the opportunity to earn cash and equity-based incentive compensation in amounts ranging from $0 to $11,025 depending on Lifeway’s performance levels compared to the respective targets and the participants performance compared to their individual objectives. The equity portion of the incentive compensation is payable in restricted stock that vests one-third in each of the three years from the 2017 grant dates. For the three months ended March 31, 2019 and 2018, $127 and $286 was expensed under the 2017 Plan as stock-based compensation expense in the consolidated statements of operations, respectively. As of March 31, 2019, the total remaining unearned compensation related to the 2017 Plan was $210, of which $161 and $49 is expected to be recognized in 2019 and 2020, respectively, subject to vesting.

 

2018 Plan

 

Under the 2018 Plan, collectively the participants had the opportunity to earn cash and equity-based incentive compensation in amounts ranging from $0 to $11,200 depending on Lifeway’s performance levels compared to the respective targets and the participants performance compared to their individual objectives. The equity portion of the incentive compensation was payable in restricted stock that vests one-third in each of the three years from the 2018 grant dates. For the three months ended March 31, 2018, $171 was expensed under the 2018 Plan, of which $76 was recorded as cash bonus expense and $95 was recorded as stock-based compensation expense in the consolidated statements of operations. Due to the final fiscal 2018 financial results, there were no equity-based incentives awarded under the 2018 Plan.

 

2019 Plan

 

Under the 2019 Plan, collectively the participants have the opportunity to earn equity-based incentive compensation in amounts ranging from $0 to $1,776 depending on Lifeway’s performance levels compared to the respective targets. The equity-based incentive compensation is payable in restricted stock that vests 50% of unvested shares in year one, 50% of unvested shares in year two, and 100% of remaining unvested shares in year three from the 2019 grant date. For the three months ended March 31, 2019, $35 was expensed under the 2019 Plan as stock-based compensation expense in the consolidated statements of operations.

 

2019 Retention Award

 

During Q1 2019, we awarded a special retention grant (the “2019 Retention Award”) of restricted stock to senior executives and key employees (the “participants”). The equity-based incentive compensation is payable in restricted stock that vests one-third in March 2019, and one-third in March 2020 and 2021, respectively. For the three months ended March 31, 2019, $157 was expensed under the 2019 Retention Award as stock-based compensation expense in the consolidated statements of operations.

 

 

 

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Retirement Benefits

 

Lifeway has a defined contribution plan which is available to substantially all full-time employees. Under the terms of the plan, we match employee contributions under a prescribed formula. For the three months ended March 31, 2019 and 2018 total contribution expense recognized in the consolidated statements of operations was $96 and $132, respectively.

 

Note 12 – Segments, Products and Customers

 

Lifeway’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 15 to 20 billion beneficial CFU (Colony Forming Units) at the time of manufacture.

 

We manufacture (directly or through co-packers) our products under our own brand, as well as under private labels on behalf of certain customers. Lifeway offers approximately 20 varieties of our kefir products including more than 60 flavors. In addition to our core drinkable kefir products, we offer several lines of products developed through our innovation and development efforts. These include Kefir Cups, a strained, cupped version of our kefir; and Organic Farmer Cheese Cups, a cupped version of our soft cheeses, both served in resealable 5 oz. containers. We also offer Skyr, a strained cupped Icelandic yogurt; Plantiful, a plant-based probiotic beverage made from organic and non-GMO pea protein with 10 vegan kefir cultures; a line of probiotic supplements for adults and children; and a soft serve kefir mix.

 

Our product categories are:

 

  Drinkable Kefir, sold in a variety of organic and non-organic sizes, flavors, and types, including low fat, non-fat, whole milk, protein, BioKefir (a 3.5 oz. kefir with additional probiotic cultures), and Kefir with Oats.
     
  European-style soft cheeses, including farmer cheese in resealable cups.
     
  Cream and other, which consists primarily of cream, a byproduct of making our kefir.
     
  ProBugs, a line of kefir products in drinkable and frozen formats, designed for children.
     
  Other Dairy, which includes Cupped Kefir and Icelandic Skyr, a line of strained kefir and yogurt products in resealable cups.
     
  Frozen Kefir, available in both bars and pint-size containers.

 

Lifeway has determined that it has one reportable segment based on how our chief operating decision maker manages the business and in a manner consistent with the internal reporting provided to the chief operating decision maker. The chief operating decision maker, who is responsible for allocating resources and assessing our performance, has been identified collectively as the Chief Financial Officer, the Chief Operating Officer, the Chief Executive Officer, and Chairperson of the board of directors. Substantially all of our consolidated revenues relate to the sale of cultured dairy products that we produce using the same processes and materials and are sold to consumers through a common network of distributors and retailers in the United States.

 

Net sales of products by category were as follows for the three months ended March 31:

 

    2019     2018  
    $     %     $     %  
Drinkable Kefir other than ProBugs   $ 18,886       77%     $ 21,663       76%  
Cheese     2,851       12%       2,934       10%  
Cream and other     1,301       5%       1,492       5%  
ProBugs Kefir     763       3%       952       3%  
Other dairy     479       2%       1,337       5%  
Frozen Kefir (a)     335       1%       364       1%  
Net Sales   $ 24,615       100%     $ 28,742       100%  

 

(a) Includes Lifeway Kefir Shop sales

 

 

 

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Significant Customers – Sales are predominately to companies in the retail food industry located within the United States. Two major customers accounted for approximately 22% of net sales for the three months ended March 31, 2019 and 2018, respectively.

 

Note 13 – Related party transactions

 

Lifeway obtains consulting services from the Chairperson of its board of directors. Fees earned by the Chairperson are included in general and administrative expenses in the accompanying consolidated statements of operations and were $250 during each of the three months ended March 31, 2019 and 2018.

 

Lifeway is also a party to a royalty agreement with the Chairperson of its board of directors under which we pay the Chairperson a royalty based on the sale of certain Lifeway products, not to exceed $50 in any fiscal month. Royalties earned by the Chairperson are included in selling expenses in the accompanying consolidated statements of operations and were $150 during each of the three months ended March 31, 2019 and 2018, respectively.

 

Note 14 – Subsequent Events

 

On April 10, 2019, effective March 31, 2019, Lifeway entered into the First Modification to the Amended and Restated Loan and Security Agreement (the “Modified Revolving Credit Facility”) with its existing lender. Under the amendment, the Modified Revolving Credit Facility provides for a revolving line of credit up to a maximum of $9 million (the “Revolving Loan”) with an incremental facility not to exceed $5 million (the “Incremental Facility” and together with the Revolving Loan, the “Loans”).

 

All outstanding amounts under the Loans bear interest, based on a level of the Senior Debt to EBITDA ratio, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.0% to 0.5%, or the Prime Rate) or the LIBOR plus 2.25% to 3.00%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee.

 

As amended, the Modified Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters through December 31, 2019, and maintain a fixed charge coverage ratio of no less than 1.25 to 1.0 each of the fiscal quarters ending through the expiration date. The Modified Revolving Credit Facility also provides 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.

 

 

 

 

 

 

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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, 2018 (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," "believe," "could," "estimate," "expect," "from time to time," "future," "intend," "plan," "likely," "may," "ongoing," "realize," "should," "will," 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 neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

 

  The impact of investigative and legal proceedings;
  Developments and changes in laws and regulations, including regulation of the dairy or food industries through legislative action and revised rules and standards applied by the Food & Drug Administration (FDA);
  Economic and financial conditions, including volatility in interest and exchange rates, commodity and equity prices, and the value of our assets;
  Changes in the price of milk and other key materials and disruptions in supply chains for these materials;
  Strategic actions, including acquisitions and dispositions and our success in launching new products;
  The impact on our competitive position if we do not maintain compliance with our loan agreements and/or sufficient liquidity to fund our business operations;
  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, 2018 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. We intend 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, we have no duty to update these statements, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

 

 

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Results of Operations

 

Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

 

   March 31,   Change 
   2019   2018   $   % 
Net sales  $24,615   $28,742   $(4,127)   (14.4%)
                     
Cost of goods sold  $17,567   $20,025   $2,458      
Depreciation expense   745    680    (65)     
Total cost of goods sold  $18,312   $20,705   $2,393    11.6% 
                     
Gross profit  $6,303   $8,037   $(1,734)   (21.6%)
Gross Profit % to net sales   25.6%    28.0%           
                     
Selling expenses  $3,139   $4,018   $879    21.9% 
Selling expenses % to net sales   12.8%    14.0%           
                     
General & administrative expenses  $3,492   $3,705   $213    5.7% 
General & administrative % to net sales   14.2%    12.9%           
                     
Amortization expense  $73   $163   $90    55.2% 
                     
Total operating expenses  $6,704   $7,886   $1,182    15.0% 
Total operating expense % to net sales   27.2%    27.4%           
(Loss) income from operations  $(401)  $151   $(552)   (365.6%)
Income from operations % to net sales   (1.6%)   0.5%           

 

Net Sales

 

Net sales finished at $24,615 for the three-month period ended March 31, 2019, a decrease of $4,127 or 14.4% versus prior year. The net sales softness continued to reflect the overall lower consumption in the dairy and cultured dairy product categories. Versus prior year, the decline was driven by lower volumes of our branded drinkable kefir and cupped kefir and Skyr sales, and an increase in trade promotion and allowances. This was partially offset by pricing gains which commenced during second quarter 2018.

 

Gross Profit

 

Gross profit as a percentage of net sales was 25.6% during the three-month period ended March 31, 2019. Gross profit percentage was 28.0% in the prior year. The decline versus the prior year was primarily due to the unfavorable impact of operating leverage that arises from lower net sales relative to fixed costs, increased trade promotion investment, and higher freight costs, partially offset by an increase in pricing which commenced during second quarter 2018, and a reduction in variable costs. Additionally, depreciation expense increased reflecting the continued investment in manufacturing improvements.

 

Selling Expenses

 

Selling expenses decreased by $879 or 21.9% to $3,139 during the three-month period ended March 31, 2019 from $4,018 during the same period in 2018. The decrease versus prior year, primarily reflects a reduction in advertising and marketing programs with lower efficiency, and to a lesser extent compensation savings from organizational changes made in 2018, and broker commissions. Selling expenses as a percentage of net sales were 12.8% during the three-month period ended March 31, 2019 compared to 14.0% for the same period in 2018.

 

 

 

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General and administrative expenses

 

General and administrative expenses decreased $214 or 5.8% to $3,491 during the three-month period ended March 31, 2019 from $3,705 during the same period in 2018. The decrease is primarily a result of lower compensation expense due to organizational changes made in 2018, and decreased incentive compensation.

 

Provision for Income Taxes

 

The provision for income tax includes federal, state and local income taxes. Benefit for income taxes was $54 during the three months ended March 31, 2019, compared to a provision for income taxes of $38 during the same period in 2018.

 

Our effective income tax rate (ETR) for the three months ended March 31, 2019 was 12.2% compared to an ETR of 35.1% in the same period last year. The lower effective tax rate was primarily due to the separate state tax rates, change in valuation allowance and non-deductible expense amounts being a higher percentage of pre-tax income. During the three-month period ended March 31, 2019, we recognized non-deductible compensation expense related to the 2017 LTIP awards. This resulted in a permanent rate effect and was considered in the estimated full year tax rate.

 

Section 162(m) of the Code limits the deductibility of compensation paid to certain of our executives. Under the Act’s 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”), we expect that performance-based compensation paid to our executives under our Omnibus Plan will remain eligible for the Section 162(m) exemption in 2019.

 

Income taxes are discussed in Note 10 in the Notes to the Consolidated Financial Statements.

 

Net (Loss) Income

 

We reported a net loss of $(388) or $(0.02) per basic and diluted common share for the three-month period ended March 31, 2019 compared to net income of $70 or $0.00 per basic and diluted common share in the same period in 2018.

 

Liquidity and Capital Resources

 

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. 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.

 

Sources and Uses of Cash

 

Lifeway had a net decrease in cash and cash equivalents of $474 during the three-month period ended March 31, 2019 compared to a net decrease in cash and cash equivalents of $1,256 in the same period in 2018. The drivers of the year over year change are as follows:

  

Net cash provided by operating activities was $1,182 during the three-month period ended March 31, 2019 compared to net cash provided by operating activities of $853 in the same period in 2018. The increase in cash provided by operating activities primarily results from $1,545 of federal and state income tax refunds received in Q1 2019, offset by the change in working capital.

 

 

 

 

 

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Net cash used in investing activities was $121 during the three-month period ended March 31, 2019 compared to net cash used in investing activities of $847 in the same period in 2018. The lower level of net cash used in investing activities in 2019 reflects lower capital spending. Capital spending was $137 during the three-month period ended March 31, 2019 compared to $879 in 2018. 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 spending supports manufacturing efficiency, safety and productivity.

 

Net cash used in financing activities was $1,535 during the three-month period ended March 31, 2019 compared to net cash used in financing activities of $1,262 in the same period in 2018. We utilized proceeds from our federal and state income tax refunds to repay $1,330 on our revolving line of credit during the three-months ended March 31, 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 82 shares of common stock at a cost of $205 during the three-month period ended March 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. Treasury shares are accounted for using the cost method.

 

Revolving credit facility

 

On April 10, 2019, effective March 31, 2019, Lifeway entered into the First Modification to the Amended and Restated Loan and Security Agreement (the “Modified Revolving Credit Facility”) with its existing lender. Under the amendment, the Modified Revolving Credit Facility provides for a revolving line of credit up to a maximum of $9 million (the “Revolving Loan”) with an incremental facility not to exceed $5 million (the “Incremental Facility” and together with the Revolving Loan, the “Loans”).

 

All outstanding amounts under the Loans bear interest, based on a level of the Senior Debt to EBITDA ratio, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.0% to 0.5%, or the Prime Rate) or the LIBOR plus 2.25% to 3.00%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee.

 

As amended, the Modified Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters through December 31, 2019, and maintain a fixed charge coverage ratio of no less than 1.25 to 1.0 each of the fiscal quarters ending through the expiration date. The Modified Revolving Credit Facility also provides 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. We were in compliance with the applicable covenants as of March 31, 2019

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

There have been no material changes to our market risk during the first quarter of 2019. For information regarding our exposure to certain market risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”, in the 2018 Form 10-K.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

(a) Evaluation of Disclosure Controls and Procedures

 

Our evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act was performed under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer. The purpose of disclosure controls and procedures is to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

 

 

 

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As previously disclosed under “Item 9A—Controls and Procedures” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, we concluded that our internal control over financial reporting was not effective based on the material weakness in our controls over the review of the result of the annual step one goodwill impairment evaluation performed by the third party valuation expert that we engaged. Based on the material weakness, which we view as an integral part of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the quarter ended March 31, 2019, our disclosure controls and procedures were not effective. Nevertheless, based on a number of factors, including the performance of additional procedures by management designed to ensure the reliability of our financial reporting, we believe that the consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

 

(b) Changes in Internal Control over Financial Reporting

 

Our remediation efforts began during the three months ended March 31, 2019. Remediation generally requires making changes to how controls are designed and implemented and then adhering to those changes for a sufficient period of time such that the effectiveness of those changes is demonstrated with an appropriate amount of consistency. We have begun to take certain remediation steps to address the material weakness referenced above and to improve our control over financial reporting. If not remediated these deficiencies could result in material misstatements to our consolidated financial statements.

 

In response to the material weakness described above, management is currently evaluating our policies and procedures related to the review of the analysis in goodwill impairment reports prepared by third-party valuation experts and plans to design and implement adequate internal controls and procedures to ensure that (i) goodwill impairment is properly reviewed, accounted for and disclosed, and (ii) management can more effectively evaluate analysis conducted by third-party valuation service providers that perform the step one goodwill impairment analysis.

 

There were no other changes in our internal control over financial reporting during the first quarter of 2019 that were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

 

 

 

 

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

From time to time we are engaged in litigation matters arising in the ordinary course of business. While the results of litigation and claims cannot be predicted with certainty, Lifeway believes that no such matter is reasonably likely to have a material adverse effect on our financial position or results of operations.

 

ITEM 1A. RISK FACTORS.

 

There have been no material changes to the Risk Factors disclosed in Part I, Item 1A of the 2018 Form 10-K.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

Issuer Purchases of Equity Securities

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURE.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

ITEM 6. EXHIBITS.

 

No. Description   Form   Period Ending   Exhibit   Filing Date
                   
10.1 First Modification to Amended and Restated Loan and Security Agreement dated as of April 10, 2019 among Lifeway Foods, Inc., Fresh Made, Inc., The Lifeway Kefir Shop, LLC, Lifeway Wisconsin, Inc., and CIBC Bank USA, as Lender.   10-K   12/31/18   10.10   4/15/19
                   
31.1 Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky   Filed Herewith
               
31.2 Rule 13a-14(a)/15d-14(a) Certification of Eric Hanson   Filed Herewith
               
32.1 Section 1350 Certification of Julie Smolyansky   Filed Herewith
               
32.2 Section 1350 Certification of Eric Hanson   Filed Herewith
               
99.1 Press release dated May 20, 2019 reporting Lifeway’s financial results for the three months ended March 31, 2019.   Furnished Herewith
               
101 Interactive Data Files   Filed Herewith
                   

 

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  LIFEWAY FOODS, INC.  
     
     
       
Date: May 20, 2019 By:   /s/ Julie Smolyansky  
    Julie Smolyansky  
    Chief Executive Officer, President, and Director  
    (Principal Executive Officer)  
       
       
       
Date: May 20, 2019 By:   /s/ Eric Hanson  
    Eric Hanson  
    Chief Financial & Accounting Officer  
    (Principal Financial and Accounting Officer)  

 

 

 

 

 

 

 

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