UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended: September 30, 2021

☐ 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 ☒ No ☐

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 ☒ No ☐

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 ☐	Accelerated Filer ☐
	Non-accelerated Filer ☒	Smaller reporting company☒
	Emerging growth company ☐

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. ☐

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

Number of shares of Common Stock, no par value, outstanding as of November 10, 2021: 15,434,936.

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.	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	30
Item 4.	Controls and Procedures.	30

PART II – OTHER INFORMATION
Item 1.	Legal Proceedings.	31
Item 1A.	Risk Factors.	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	31
Item 3.	Defaults Upon Senior Securities.	31
Item 4.	Mine Safety Disclosure.	31
Item 5.	Other Information.	31
Item 6.	Exhibits.	32
	Signatures.	33

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

September 30, 2021 and December 31, 2020

(In thousands)


	September 30,
	2021			December 31,
	Unaudited			2020
Current assets
Cash and cash equivalents	$	10,018		$	7,926
Accounts receivable, net of allowance for doubtful accounts and discounts & allowances of $1,290 and $1,350 at September 30, 2021 and December 31, 2020 respectively		9,828			8,002
Inventories, net		7,572			6,930
Prepaid expenses and other current assets		1,315			1,163
Refundable income taxes		415			31
Total current assets		29,148			24,052

Property, plant and equipment, net		20,546			21,048
Operating lease right-of-use asset		255			345

Intangible assets
Goodwill and indefinite-lived intangibles		14,224			12,824
Other intangible assets, net		4,367			–
Total intangible assets		18,591			12,824

Other assets		1,800			1,800
Total assets	$	70,340		$	60,069

Current liabilities
Current portion of note payable	$	1,000		$	–
Accounts payable		7,867			5,592
Accrued expenses		3,872			2,196
Accrued income taxes		100			653
Total current liabilities		12,839			8,441
Line of credit		2,777			2,768
Note payable		3,726			–
Operating lease liabilities		113			165
Deferred income taxes, net		1,764			1,764
Other long-term liabilities		62			77
Total liabilities		21,281			13,215

Commitments and contingencies		–			–

Stockholders' equity
Preferred stock, no par value; 2,500 shares authorized; no shares issued or outstanding at September 30, 2021 and December 31, 2020		–			–
Common stock, no par value; 40,000 shares authorized; 17,274 shares issued; 15,435 and 15,604 outstanding at September 30, 2021 and December 31, 2020, respectively		6,509			6,509
Paid-in capital		2,387			2,600
Treasury stock, at cost		(13,436	)		(12,450	)
Retained earnings		53,599			50,195
Total stockholders' equity		49,059			46,854

Total liabilities and stockholders' equity	$	70,340		$	60,069

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

For the three and nine months ended September 30, 2021 and 2020

(Unaudited)

(In thousands, except per share data)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2021			2020			2021			2020

Net sales	$	29,553		$	26,039		$	88,091		$	76,441

Cost of goods sold		21,915			17,710			63,273			53,613
Depreciation expense		645			752			2,099			2,326
Total cost of goods sold		22,560			18,462			65,372			55,939

Gross profit		6,993			7,577			22,719			20,502

Selling expenses		2,722			2,116			8,510			7,411
General and administrative		3,194			2,805			8,702			8,681
Amortization expense		33			39			33			117
Total operating expenses		5,949			4,960			17,245			16,209

Income from operations		1,044			2,617			5,474			4,293

Other income (expense):
Interest expense		(30	)		(27	)		(72	)		(96	)
Gain on investments		–			–			2			4
Loss on sale of property and equipment		(5	)		–			(88	)		(28	)
Other (expense) income, net		(2	)		–			(61	)		2
Total other income (expense)		(37	)		(27	)		(219	)		(118	)

Income before provision for income taxes		1,007			2,590			5,255			4,175

Provision for income taxes		527			764			1,851			1,223

Net income	$	480		$	1,826		$	3,404		$	2,952

Earnings (loss) per common share:
Basic	$	0.03		$	0.12		$	0.22		$	0.19
Diluted	$	0.03		$	0.12		$	0.22		$	0.19

Weighted average common shares:
Basic		15,473			15,602			15,572			15,595
Diluted		15,651			15,642			15,712			15,621

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Unaudited)

(In thousands)


	Common Stock
	Issued				In treasury						Paid-In			Retained		Total
	Shares		$		Shares			$			Capital			Earnings		Equity
Balance, January 1, 2020		17,274	$	6,509		(1,564	)	$	(12,601	)	$	2,380		$	46,963	$	43,251

Issuance of common stock in connection with stock-based compensation		–		–		27			210			306			–		516

Treasury stock purchased		–		–		(179	)		(405	)		–			–		(405	)

Stock-based compensation		–		–		–			–			62			–		62

Net income		–		–		–			–			–			146		146

Balance, March 31, 2020		17,274	$	6,509		(1,716	)	$	(12,796	)	$	2,748		$	47,109	$	43,570

Issuance of common stock in connection with stock-based compensation		–		–		34			248			(270	)		–		(22	)

Stock-based compensation		–		–		–			–			109			–		109

Net income		–		–		–			–			–			980		980

Balance, June 30, 2020		17,274	$	6,509		(1,682	)	$	(12,548	)	$	2,587		$	48,089	$	44,637

Issuance of common stock in connection with stock-based compensation		–		–		13			98			(98	)		–		–

Stock-based compensation		–		–		–			–			43			–		43

Net income		–		–		–			–			–			1,826		1,826

Balance, September 30, 2020		17,274	$	6,509		(1,669	)	$	(12,450	)	$	2,532		$	49,915	$	46,506

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity (continued)

(Unaudited)

(In thousands)

	Common Stock
	Issued				In treasury						Paid-In			Retained		Total
	Shares		$		Shares			$			Capital			Earnings		Equity

Balance, January 1, 2021		17,274	$	6,509		(1,669	)	$	(12,450	)	$	2,600		$	50,195	$	46,854

Stock-based compensation		–		–		–			–			64			–		64

Net income		–		–		–			–			–			1,306		1,306

Balance, March 31, 2021		17,274	$	6,509		(1,669	)	$	(12,450	)	$	2,664		$	51,501	$	48,224

Issuance of common stock in connection with stock-based compensation		–		–		45			339			(463	)		–		(124	)

Stock-based compensation		–		–		–			–			287			–		287

Net income		–		–		–			–			–			1,618		1,618

Balance, June 30, 2021		17,274	$	6,509		(1,624	)	$	(12,111	)	$	2,488		$	53,119	$	50,005

Issuance of common stock in connection with stock-based compensation		–		–		35			258			(258	)		–		–

Treasury stock purchased		–		–		(250	)		(1,583	)		–			–		(1,583	)

Stock-based compensation		–		–		–			–			157			–		157

Net income		–		–		–			–			–			480		480

Balance, September 30, 2021		17,274	$	6,509		(1,839	)	$	(13,436	)	$	2,387		$	53,599	$	49,059

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)


	Nine Months Ended September 30,
		2021			2020
Cash flows from operating activities:
Net income	$	3,404		$	2,952
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization		2,132			2,443
Non-cash interest expense		9			17
Non-cash rent expense		1			(38	)
Bad debt expense		6			(3	)
Deferred revenue		(23	)		(73	)
Stock-based compensation		608			274
Deferred income taxes		–			369
Loss (gain) on sale of property and equipment		88			28
(Increase) decrease in operating assets:
Accounts receivable		(1,832	)		(1,464	)
Inventories		(642	)		(80	)
Refundable income taxes		(384	)		492
Prepaid expenses and other current assets		(152	)		248
Increase (decrease) in operating liabilities:
Accounts payable		2,275			756
Accrued expenses		1,498			(595	)
Accrued income taxes		(553	)		22
Net cash provided by operating activities		6,435			5,348

Cash flows from investing activities:
Purchases of property and equipment		(1,685	)		(1,168	)
Proceeds from sale of property and equipment		–			5
Acquisition, net of cash acquired		(5,800	)		–
Net cash used in investing activities		(7,485	)		(1,163	)

Cash flows from financing activities:
Purchase of treasury stock		(1,583	)		(405	)
Payment of deferred financing cost		(25	)		–
Proceeds from note payable		5,000			–
Repayment of note payable		(250	)		–
Net cash provided by (used in) financing activities		3,142			(405	)

Net increase in cash and cash equivalents		2,092			3,780

Cash and cash equivalents at the beginning of the period		7,926			3,836

Cash and cash equivalents at the end of the period	$	10,018		$	7,616

Supplemental cash flow information:
Cash paid for income taxes, net of (refunds)	$	2,788		$	335
Cash paid for interest	$	60		$	82

Non-cash investing activities
Increase (decrease) in right-of-use assets and operating lease obligations	$	45		$	(58	)

Non-cash financing activities
Issuance of common stock under equity incentive plans	$	–		$	522

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(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 for the fiscal year ended December 31, 2020. 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, 2020.

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.

Cash and cash equivalents

Lifeway considers cash and all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates or equals fair value due to their short-term nature.

Lifeway from time to time may have bank deposits in excess of insurance limits of the Federal Deposit Insurance Corporation. Lifeway has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk related to its cash and cash equivalents.

The Company has $580 of restricted cash which is included in cash and cash equivalents as of September 30, 2021. The restricted cash balance represents escrow funds deposited by Lifeway in connection with the September 18, 2021 acquisition of certain assets of Glen Oaks Farms, Inc. The funds are security for the liability and indemnity obligations of seller as defined under the asset purchase agreement. The funds will remain in escrow for twelve months from the acquisition closing date, at which time the funds, less any amounts for outstanding seller obligations, will be remitted to the sellers.

Revenue recognition

We sell food and beverage products across select product categories to customers predominantly within the United States (see Note 12, Segments, Products and Customers). We also sell bulk cream, a byproduct of our fluid milk manufacturing process. In accordance with 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. The amount of revenue recognized reflects the consideration to which the Company expects 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. The Company applies 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.

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 nine months ended September 30, 2021 and 2020 total advertising expenses were $2,892 and $1,700 respectively. For the three months ended September 30, 2021 and 2020 total advertising expenses were $726 and $380, respectively.

Recent accounting pronouncements

Adopted

In December 2019, the FASB issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The new guidance is intended to enhance and simplify various aspects of the accounting for income taxes. The new guidance eliminates certain exceptions to the general approach to the income tax accounting model and adds new guidance to reduce the complexity in accounting for income taxes. The Company adopted this guidance on January 1, 2021. The adoption of this standard did not have a material impact on our consolidated financial statements and disclosures.

Issued but not yet effective

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The new guidance provides a single comprehensive accounting model on revenue recognition for contracts with customers and requires that the acquirer in a business combination recognize and measure contract assets and liabilities acquired in a business combination in accordance with Topic 606 (Revenue from Contracts with Customers). The amendments in this ASU are effective for fiscal years beginning after December 15, 2022. Early adoption is permitted, including adoption in an interim period. With early adoption, the amendments are applied retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of adoption and prospectively to all business combinations that occur on or after the date of initial application. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The new guidance provides optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The guidance will be effective prospectively as of March 12, 2020 through December 31, 2022 and interim periods within those fiscal years. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, in November 2018 issued an amendment, ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, and in November 2019 issued two amendments, ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates, and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments—Credit Losses. The series of new guidance amends the impairment model by requiring entities to use a forward-looking approach based on expected losses rather than incurred losses to estimate credit losses on certain types of financial instruments, including trade receivables. This may result in the earlier recognition of allowances for losses. The guidance should be applied on either a prospective transition or modified-retrospective approach depending on the subtopic. The guidance is effective for annual periods beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.

Note 3 – Inventories, net

Inventories consisted of the following:

Schedule Of Inventories
	September 30, 2021		December 31, 2020
Ingredients	$	2,120	$	1,725
Packaging		2,632		2,234
Finished goods		2,820		2,971
Total inventories	$	7,572	$	6,930

Note 4 – Property, Plant and Equipment, net

Property, plant and equipment consisted of the following:


	September 30, 2021			December 31, 2020
Land	$	1,565		$	1,565
Buildings and improvements		18,082			17,834
Machinery and equipment		31,959			31,707
Vehicles		778			778
Office equipment		895			857
Construction in process		399			228
		53,678			52,969
Less accumulated depreciation		(33,132	)		(31,921	)
Total property, plant and equipment, net	$	20,546		$	21,048

Note 5 – Goodwill and Intangible Assets

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


	Goodwill			Brand Names		Total

Balance at December 31, 2020, before accumulated impairment loses	$	10,368		$	3,700	$	14,068
Accumulated impairment loses		(1,244	)		–		(1,244	)
Balance at December 31, 2020		9,124			3,700		12,824
Acquisition (1)		1,400			–		1,400
Balance at September 30, 2021	$	10,524		$	3,700	$	14,224

(1)

Refer to Note 15 for additional information regarding acquisition-related adjustments to goodwill

Finite-lived Intangible Assets

Other intangible assets, net consisted of the following:

Schedule of other intangible assets
	September 30, 2021							December 31, 2020
	Gross					Net		Gross					Net
	Carrying		Accumulated			Carrying		Carrying		Accumulated			Carrying
	Amount		Amortization			Amount		Amount		Amortization			Amount
Recipes	$	44	$	(44	)	$	–	$	44	$	(44	)	$	–
Customer lists and other customer related intangibles		4,529		(4,529	)		–		4,529		(4,529	)		–
Customer relationship		3,385		(1,003	)		2,382		985		(985	)		–
Brand names		4,248		(2,263	)		1,985		2,248		(2,248	)		–
Formula		438		(438	)		–		438		(438	)		–
Total finite lived intangible assets	$	12,644	$	(8,277	)	$	4,367	$	8,244	$	(8,244	)	$	–

Note 6 – Accrued Expenses

Accrued expenses consisted of the following:

Schedule Of Accrued Expenses
	September 30, 2021		December 31, 2020
Payroll and incentive compensation	$	3,095	$	1,366
Real estate taxes		334		341
Current portion of operating lease liabilities		142		179
Other		301		310
Total accrued expenses	$	3,872	$	2,196

Note 7 – Debt

Note payable consisted of the following:

Schedule of note payable
	September 30, 2021			December 31, 2020

Variable rate term loan due August 18, 2026. Principal and interest (2.15% at September 30, 2021) payable monthly.	$	4,750		$	–
Unamortized deferred financing costs		(24	)		–
Total note payable		4,726			–
Less current portion		(1,000	)		–
Total long-term portion	$	3,726		$	–

Credit Agreement

On August 18, 2021, Lifeway entered into the Fourth Modification (the “Fourth Modification”) to the Amended and Restated Loan and Security Agreement (as amended and modified from time to time, the “Credit Agreement” and, as amended and modified by the Fourth Modification, the “Modified Credit Agreement”) with its existing lender and certain of its subsidiaries. The Fourth Modification amends the Credit Agreement to provide for, among other things, a $5 million term loan by the existing lender to the borrowers to be repaid in quarterly installments of principal and interest over a term of five years (the “Term Loan”). The termination date of the Term Loan is August 18, 2026, unless earlier terminated. Except for the addition of the Term Loan, the Credit Agreement remains substantively unchanged and in full force and effect.

As amended, all outstanding amounts under the revolving line of credit and term loan bear interest, at Lifeway’s election, at either the lender Base Rate (the Prime Rate minus 1.00%) or the LIBOR plus 1.95%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused revolving line of credit fee of 0.20% and, in conjunction with the issuance of any letters of credit, a letter of credit fee of 0.20%.

Revolving Credit Facility

As of September 30, 2021, we had $2,777 outstanding under the Revolving Credit Facility. We had $2,223 available for future borrowings under the Revolving Credit Facility as of September 30, 2021. Lifeway’s interest rate on debt outstanding under the Revolving Credit Facility as of September 30, 2021 was 2.15%.

Deferred Financing Costs

As of September 30, 2021, net unamortized deferred financing costs of $24 related to the term loan were included as a direct deduction from outstanding long-term debt.

Except as described above, as amended, the Modified Credit Agreement remains substantively unchanged and in full force and effect, including customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to maintain a fixed charge coverage ratio of no less than 1.25 to 1.00 each of the fiscal quarters ending through the expiration date. The Modified Credit Agreement continues to provide 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 Credit Agreement may be accelerated. The loans and all other amounts due and owed under the Credit Agreement and related documents are secured by substantially all of our assets.

We were in compliance with the fixed charge coverage ratio and minimum working capital covenants at September 30, 2021.

Note 8 – Leases

Lifeway had operating leases for two retail stores for its Lifeway Kefir Shop subsidiary which includes fixed base rent payments as well as variable rent payments to reimburse the landlord for operating expenses and taxes. The Company terminated the operating lease of one of the Lifeway Kefir Shop retail stores during July 2021. The Company terminated its office space leases in September 2020. The Company also leases certain machinery and equipment with fixed base rent payments and variable costs based on usage. 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. Lifeway includes only fixed payments for lease components in the measurement of the right-of-use asset and lease liability. Variable lease payments are those that vary because of changes in facts or circumstances occurring after the commencement date, other than the passage of time. 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 $245 and $392 (including short term leases) for the nine months ended September 30, 2021 and 2020, respectively. Total lease expense was $76 and $81 (including short term leases) for the three months ended September 30, 2021 and 2020, 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 obtain 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 we will exercise such options. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

Future maturities of lease liabilities were as follows:

Future maturities of lease liabilities
Year	Operating Leases
Three months ended December 31, 2021	$	45
2022		149
2023		47
2024		30
2025		18
Thereafter		6
Total lease payments		295
Less: Interest		(40	)
Present value of lease liabilities	$	255

The weighted-average remaining lease term for our operating leases was 2.5 years as of September 30, 2021. The weighted average discount rate of our operating leases was 12.10% as of September 30, 2021. Cash paid for amounts included in the measurement of lease liabilities was $153 and $328 the nine months ended September 30, 2021 and 2020, respectively. Cash paid for amounts included in the measurement of lease liabilities was $46 and $56 for the three months ended September 30, 2021 and 2020, respectively.

Note 9 – Commitments and contingencies

Litigation

Lifeway is engaged in various legal actions, claims, audits, 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 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 nine months ended September 30, 2021 was 35.2% compared to 29.3% for the nine months ended September 30, 2020. The effective tax rate for the three months ended September 30, 2021 was 52.3% compared to 29.5% for the three months ended September 30, 2020. 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, enacted tax legislation, 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.

On March 27, 2020, the “Coronavirus Aid, Relief, and Economic Security Act” (the CARES Act) was enacted. The CARES act features several tax provisions and other measures that assist businesses impacted by the economic effects of the COVID-19 pandemic. The significant tax provisions include an increase in the limitation of the tax deduction for interest expense from 30% to 50% of adjusted earnings in 2019 and 2020, a five-year carryback allowance for net operating losses generated in tax years 2018-2020, increased charitable contribution limitations to 25% of taxable income in 2020, and a retroactive technical correction to the 2017 Tax Cuts and Jobs Act that makes qualified improvement property placed in service after December 31, 2017 eligible for bonus depreciation. The Company has recorded a $245 income tax benefit related to the net operating loss carryback provisions of the CARES Act for the nine months ended September 30, 2020.

Unrecognized tax benefits were $98 and $93 at September 30, 2021 and 2020, respectively. We do not expect material changes to our unrecognized tax benefits during the next twelve months. The Company believes that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If a tax audit is resolved in a manner inconsistent with its expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. We do not expect material changes to our unrecognized tax benefits during the next twelve months.

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 September 30, 2021, 3.281 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 nine months ended September 30, 2021:

Options

Weighted
average
exercise price

Weighted
average
remaining contractual life

Aggregate
intrinsic value

Outstanding at December 31, 2020

10.42

5.22

–

Granted

–

Exercised

–

Forfeited

–

Outstanding at September 30, 2021

10.42

4.47

–

Exercisable at September 30, 2021

10.42

4.47

–

As of December 31, 2019, all outstanding options were vested and there was no remaining unearned compensation expense.

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 September 30, 2021.

RSA activity table
	RSA’s

Outstanding at December 31, 2020		78
Granted		25
Shares issued upon vesting		(43	)
Forfeited		–
Outstanding at September 30, 2021		60
Weighted average grant date fair value per share outstanding	$	3.80

We expense RSA’s over the service period. For the nine months ended September 30, 2021 and 2020 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $106 and $51, respectively. For the nine months ended September 30, 2021 and 2020 tax-related benefits of $31 and $14, respectively, were also recognized. For the three months ended September 30, 2021 and 2020 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $37 and $28, respectively. For the three months ended September 30, 2021 and 2020 tax-related benefits of $11 and $8, respectively, were also recognized. As of September 30, 2021, the total remaining unearned compensation related to non-vested RSA’s was $159, which is expected to be amortized over the weighted-average remaining service period of 1.38 years.

Long-Term Incentive Plan Compensation

Lifeway established long-term incentive-based compensation programs for fiscal year 2017 (the “2017 Plan”), fiscal year 2019 (the “2019 Plan”), and for fiscal year 2021 (the “2021 Plan”) for certain senior executives and key employees (the “participants”). Under the 2017 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. Under the 2021 Plan, long-term incentive compensation is based on Lifeway’s achievement of adjusted EBITDA performance versus the respective target established by the Board for 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 nine months ended September 30, 2021 and 2020, $0 and $49 was expensed under the 2017 Plan as stock-based compensation expense in the consolidated statements of operations, respectively. For the three months ended September 30, 2021 and 2020, $0 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of September 30, 2021, there was no remaining expense.

2019 Plan

Under the 2019 Plan, collectively the participants can 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 nine months ended September 30, 2021 and 2020, $89 and $90 was expensed under the 2019 Plan as stock-based compensation expense in the consolidated statements of operations, respectively. For the three months ended September 30, 2021 and 2020, $35 and $1 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively.

2019 Retention Award

During Q1 2019, we awarded a special retention grant (the “2019 Retention Award”) of restricted stock to certain senior executives and key employees (the “participants”). The equity-based incentive compensation is payable in restricted stock that vests one-third in March 2019, one-third in March 2020 and one-third in March 2021. For the nine months ended September 30, 2021 and 2020, $0 and $73 was expensed under the 2020 Retention Award as stock-based compensation expense in the consolidated statements of operations, respectively. For the three months ended September 30, 2021 and 2020, $0 and $15 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of September 30, 2021, there was no remaining expense.

2020 CEO Incentive Award

During the fourth quarter 2020, we awarded a long-term equity-based incentive of $750 to our Chief Executive Officer (the “2020 CEO Award”) depending on Lifeways 2020 performance levels compared to the respective targets. The equity-based incentive compensation is payable in restricted stock that vests one-third in April 2022, one-third in April 2023, and one-third in April 2024. The issuance of vested equity awards is subject to approval under the Stock Purchase Agreement dated October 1, 1999. For the nine months ended September 30, 2021 and 2020, $255 and $0 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. For the three months ended September 30, 2021 and 2020, $85 and $0 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of September 30, 2021, the total remaining unearned compensation was $445, of which $87 will be recognized in 2021, $229 in 2022, $105 in 2023, and $24 in 2024, respectively, subject to vesting. During Q2 2021, the number of shares awarded became fixed and determinable. Therefore, the award liability was reclassified from long-term liabilities to paid in capital.

2021 Equity Award

Under the 2021 Plan, collectively the participants can earn equity-based incentive compensation in amounts ranging from $0 to $1,069 depending on Lifeway’s achievement of the respective financial target. The equity-based incentive compensation is payable in restricted stock that is expected to vest one-third in March 2022, one-third in March 2023, and one-third in March 2024. For the nine months ended September 30, 2021, $150 was expensed under the 2021 Plan as stock-based compensation expense in the consolidated statements of operations, respectively. For the three months ended September 30, 2021, $150 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of September 30, 2021, the total remaining unearned compensation was $919, of which $236 will be recognized in 2021, $474 in 2022, $181 in 2023, and $28 in 2024, respectively, subject to vesting. As of September 30, 2021, the number of shares to be awarded is not fixed and determinable. Therefore, the liability is classified in accrued expenses and other long-term liabilities as of September 30, 2021. When the number of shares awarded becomes fixed and determinable, the award liability will be reclassified from liabilities to paid in capital.

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 nine months ended September 30, 2021 and 2020 total contribution expense recognized in the consolidated statements of operations was $315 and $

SEC Form 10-Q filed by Lifeway Foods, Inc.