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: September 30, 2017March 31, 2021

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)

_____________________

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:

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. Yesx Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted 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 Noo

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)

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

AsNumber of November 3, 2017, 16,024,264 shares of the registrant’s common stock,Common Stock, no par value, were outstanding.outstanding as of May 3, 2021: 15,631,314  

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

September 30, 2017March 31, 2021 and December 31, 20162020

(In thousands)

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Loss) and Comprehensive Income (Loss)Operations

For the three months ended March 31, 2021 and nine months ended September 30, 2017 and 20162020

(Unaudited)

(In thousands, except per share data)

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

For the Nine Months Ended September 30, 2017 and 2016

(Unaudited)

(In thousands)

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2017 and 2016

(Unaudited)

(In thousands)

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2017 and December 31, 2016

(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 consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. For further information, refer toof 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 disclosuresrelated notes included in Company’sour Annual Report on Form 10-K as of and for the fiscal year ended December 31, 2016. Certain amounts in prior-year financial statements were reclassified to conform to the current-year presentation. The results2020. Results of operations for the periodinterim 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.

Revenue Recognitionrecognition

The Company records sales whenWe sell food and beverage products across select product categories to customers predominantly within the following four criteria have been met: (i) The product has been shippedUnited States (see Note 12, Segments, Products and the Company has no significant remaining obligations; (ii) Persuasive evidenceCustomers). We also sell bulk cream, a byproduct of an agreement exists; (iii) The price to the buyer is fixed or determinable; and (iv) Collection is probable. In addition, shipping costs invoiced to the customers are included in net sales and the related costs are included in cost of sales.

The Company routinely offers sales allowances and discounts to our customers and consumers. These programs include rebates, in-store display and demo allowances, allowances for non-salable product, coupons and other trade promotional activities. These allowances are considered reductions in the price of our products and thus are recorded as reductions to gross sales. Some of these incentives are recorded by estimating incentive costs based on our historical experience and expected levels of performance of the trade promotion. We maintain a reserve for the estimated allowances incurred but unpaid. Differences between estimated and actual allowances are normally insignificant and are recognized in income in the period such differences are determined. Product returns have historically not been material.

Bulk cream is a by-product of the Company’s 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 does not use its by-product bulk creamexpects to be entitled to receive in any of its end products, but rather disposes of it through sales to other companies. Bulk cream by-product sales are included in net sales.exchange for these goods or services, using the five-step method required by ASC 606.

AdvertisingFor the Company, the contract is the approved sales order, which may also be supplemented by other agreements that formalize various terms and promotional costsconditions 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.

The Company expenses advertising costs as incurred. ForPerformance obligations promised in a contract are identified based on the nine months ended September 30, 2017 and 2016 total advertising expenses were $4,703 and $5,418 respectively. Forgoods or services that will be transferred to the three months ended September 30, 2017 and 2016 total advertising expenses were $1,892 and $2,665 respectively.

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.

Recently Adopted Accounting PronouncementsAdvertising and promotional costs

InLifeway expenses advertising costs as incurred. For the three months ended March 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-09, Compensation-Stock Compensation – Improvements to Employee Share-Based Payment Accounting. The new guidance simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities,31, 2021 and classification in the statement of cash flows. Under this ASU, excess tax benefits2020 total advertising expenses were $1,393 and deficiencies are no longer recognized as additional paid-in capital in the consolidated balance sheets. This guidance was effective on January 1, 2017. The adoption of this amendment had no impact on the consolidated financial statements.$536 respectively.

Recent accounting pronouncements

Adopted

In November 2015,December 2019, the FASB issued ASU 2015-17,Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes – Balance Sheet Classification of Deferred Taxes. This new guidance simplifies the presentation of deferred income taxes and requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. Previous guidance required deferred tax assets and liabilities to be separated into current and noncurrent amounts on the balance sheet. This guidance was effective on January 1, 2017. The Company elected to adopt this guidance as of the first fiscal quarter in 2017 and has applied the update on a retrospective basis. The Company changed its accounting principle to reduce the cost and complexity inherent in recording deferred taxes as current and noncurrent on the consolidated balance sheets. As a result, the Company has reclassified $662 of current deferred tax asset to noncurrent deferred tax liability in the consolidated balance sheet as of December 31, 2016.

In July 2015, the FASB issued ASU 2015-11, Inventory –(Topic 740): Simplifying the Measurement of Inventory. The core principal of the guidance is that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance was effective on January 1, 2017. The adoption of this amendment had no impact on the consolidated financial statements.

Recently Issued Accounting Pronouncements

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. The new guidance provides clarity and reduces both diversity in practice and cost of complexity when accounting for a change to the terms of or conditions of a share-based payment award. The amendments in this Update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The new guidance will be effective for fiscal years beginning on or after December 15, 2017 and interim periods within those years. Early adoption of the guidance is permitted. The adoption of this amendment is not expected to have a material impact on the consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. The new guidance simplifies the subsequent measurement of goodwill by removing the second step of the two-step impairment test. The amendment requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The new guidance will be effective for annual periods or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The amendment should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this amendment is not expected to have a material impact on the consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments.Income Taxes. The new guidance is intended to addressenhance and simplify various aspects of the diversityaccounting 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 practice in how certain cash receiptsaccounting 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 cash payments are presenteddisclosures.

Issued but not yet effective

In March 2020, the FASB issued Accounting Standards Update (“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 classified in the statement of cash flows, such as debt prepayment or debt extinguishment costs, contingent consideration payments made after an acquisition, proceeds from the settlement of insurance claims,exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other topics.transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The new guidance will be effective for fiscal years beginning on or afterprospectively as of March 12, 2020 through December 15, 201731, 2022 and interim periods within those fiscal years. Early adoption of the guidance is permitted. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.

In FebruaryJune 2016, the FASB issued ASU No. 2016-02, Leases.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 requires lessees to recognize lease assets and lease liabilities inshould be applied on either a prospective transition or modified-retrospective approach depending on the balance sheet and disclose key information about leasing arrangements, such as information about variable lease payments and options to renew and terminate leases.subtopic. 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. The new guidance is effective for financial statements issued for fiscal yearsannual periods beginning after December 15, 2018, and2022, including interim periods within those years. Earlyfiscal years, with early adoption is permitted. The amendments in this ASU should be adopted using a modified retrospective transition approach, which requires application of the new guidance at the beginning of the earliest comparative period presented in the year of adoption. We do not intend to early adopt the standard. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance modifies how entities measure equity investments and present changes in the fair value of financial liabilities. Under the new guidance, entities will have to measure equity investments that do not result in consolidation and are not accounted under the equity method at fair value and recognize any changes in fair value in net income unless certain conditions exist. The new guidance will be effective for fiscal years beginning on or after December 15, 2017 and interim periods within those years. Early adoption of the guidance is not permitted. The adoption of this amendment is not expected to have an impact on the consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific requirements. ASU 2014-09 establishes a five-step revenue recognition process in which an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented, or “modified retrospective” adoption, meaning the standard is applied only to the most current period presented in the financial statements. ASU 2014-09 also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. On August 12, 2015, the FASB approved a one year delay of the effective date to reporting periods beginning after December 15, 2017, while permitting companies to voluntarily adopt the new standard as of the original effective date. In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, which clarifies narrow aspects of ASC 606 or corrects unintended application of the guidance. The effective date and transition requirements for ASU 2016-20 are the same as the effective date and transition requirements for ASU 2014-09. Under the delayed effective date, the Company is required to adopt the new standard not later than January 1, 2018.

Management is currently evaluating the impact the adoption of this amendment will have on the Company's consolidated financial position, results of operations or cash flows and the method of retrospective application, either full or modified. Our completed evaluation will include the impact of the new standard on certain common practices currently employed by us, such as rebates, in-store display and demo allowances, allowances for non-saleable product, and coupons. We currently expect to utilize the modified retrospective transition method and to adopt the ASU on January 1, 2018. Based on our findings to date, we do not expect the standard to have a material impact on our results of operations or financial position; however, our assessment is not yet complete. During 2017, we plan to finalize our review and method of adoption.

Note 3 – Inventories, net

Inventories consisted of the following:

Note 4 – Property, Plant and Equipment, net

Property, plant and equipment consisted of the following:

Note 5 – Goodwill and Intangible Assets

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

Finite-lived Intangible Assets

Other intangible assets, net consisted of the following:

Note 6 – Accrued Expenses

Accrued expenses consisted of the following:

Note 7 – Notes PayableDebt

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. 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”).

On December 10, 2019, Lifeway entered into the Second Modification to the Amended and Restated Loan and Security Agreement, as amended, (the “Second Modification”) with its existing lender. The variable rate termSecond Modification amends the Amended and Restated Loan and Security Agreement, as amended, by redefining the “Borrowing Base” and further clarifying the definitions of “Eligible Accounts” and “Eligible Inventory.” The “Borrowing Base” under this amendment means, generally, an amount equal to the sum of (a) 85% of the unpaid amount of all eligible accounts receivable, plus (b) 50% of the value of all eligible inventory. The Second Modification also addresses the calculation of interest after the potential discontinuance of LIBOR and its replacement with a replacement benchmark interest rate.

On September 30, 2020, Lifeway entered into the Third Modification to the Amended and Restated Loan and Security Agreement, as amended, (the “Third Modification”) with its existing lender. The Third Modification amends the Amended and Restated Loan and Security Agreement, as amended, by removing the monthly borrowing base reporting requirement effective September 30, 2020, including a covenant to maintain a quarterly minimum working capital financial covenant, as defined, of no less than $11.25 million each of the fiscal quarters commencing the fiscal quarter ending December 31, 2020 through the expiration date, and eliminating the tier interest pricing structure. The Amended and Restated Loan and Security Agreement continues to provide Lifeway with a revolving line of credit up to a maximum of $5 million (the “Revolving Loan”) and provides the Borrowers with an incremental facility not to exceed $5 million (the “Incremental Facility” and together with the Revolving Loan, the “Loans”). The Termination Date of the Revolving Loan was extended to June 30, 2025, unless earlier terminated.

Except as described above, as amended, the Modified Revolving Credit Facility 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 Revolving Credit Facility 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 Revolving Credit Facility may be accelerated. The loans and all other amounts due and owed under the Revolving Credit Facility and related documents are subject to interest at the prime rate or at the LIBOR rate plus 2.5% and are collateralizedsecured by substantially all of the assetsour assets.

As of the Company. In addition,March 31, 2021, we had $2,774 net of $3 of unamortized deferred financing costs, outstanding under the termsRevolving Credit Facility. We had $2,223 available for future borrowings as of the related agreements, the Company is subject to minimum fixed charged ratio and tangible net worth thresholds, which among other things may limit the Company's ability to pay dividends or repurchase shares of its common stock. Further, under the agreements the Company is required to deliver its annual and quarterly financial statements and related SEC filings within specified timeframes. The Company was in compliance with these financial covenants at September 30, 2017.

In addition, the Company has a $5 million revolving credit facility. Borrowings under the facility are subject to interest at the prime rate or LIBOR plus 2.5%. As of September 30, 2017 there were no borrowings under the facility. The facility expires in July 2018.March 31, 2021.

As amended, all outstanding amounts under the Loans 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 line fee of 0.20% and, in conjunction with the issuance of any letters of credit, a letter of credit fee of 0.20%. Lifeway’s interest rate on debt outstanding under our Revolving Credit Facility as of March 31, 2021 was 2.15%.

We were in compliance with the fixed charge coverage ratio and minimum working capital covenants at March 31, 2021.

Note 8 – Leases

Lifeway has 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 its office space leases in June 2020. The Company also lease 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 4 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 $78 and $179 (including short term leases) for the three months ended March 31, 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

The weighted-average remaining lease term for our operating leases was 2.05 years as of March 31, 2021. The weighted average discount rate of our operating leases was 7.85% as of March 31, 2021. Cash paid for amounts included in the measurement of lease liabilities was $55 and $142 for the three months ended March 31, 2021 and 2020, respectively.

Note 89 – Commitments and contingencies

Lease obligationsLitigation

The Company leases three retail stores for its Lifeway Kefir Shop subsidiary, certain machinery and equipment, and office space under operating leases. Total lease expense was $497 and $331 for the nine months ended September 30, 2017 and 2016, respectively. Total lease expense was $175 and $171 for the three months ended September 30, 2017 and 2016, respectively.

Litigation

The Company 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 the Company’sour business activities.

The Company recordsWe record accruals for outstanding legal matters when it believeswe believe it is probable that a loss will be incurred and the amount of such loss can be reasonably estimated. The Company evaluates,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, the Company doeswe do not establish an accrued liability. Currently, none of the Company’sour accruals for outstanding legal matters are material individually or in the aggregate to the Company’sour 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 the Companywe ultimately isare required to make payments in connection with an adverse outcome, it is possible that it could have a material adverse effect on the Company’sour business, financial condition, results of operations or cash flows.

The Company’sLifeway’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, the CompanyLifeway cannot predict with any reasonable certainty the timing or outcome of such contingencies, and the Company iswe are unable to estimate a possible loss or range of loss.

In a letter dated May 19, 2016, the Company received a request to voluntarily produce documents in connection with a confidential, informal inquiry by the Division of Enforcement of the SEC concerning the Company’s internal controls, disclosure controls procedures, and internal control over financial reporting for fiscal years 2013 through the date of the letter. The SEC has informed the Company that the inquiry should not be construed as an indication that any violation of any federal securities law has occurred or as a reflection upon the merits of any person, company, or securities involved. Since receiving the letter, the Company has been cooperating with the SEC and will continue to do so.

Note 910 – Income taxes

For each interim period, the CompanyLifeway 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. Additionally,The effective tax rate for the Company recordsthree months ended March 31, 2021 was 31.2% compared to 27.5% for the three months ended March 31, 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 effectiveCARES act features several tax rateprovisions 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 three months ended September 30, 2017 was 41.9% compared to over 100.0% for the three months ended September 30, 2016. The effective tax rate for the nine months ended September 30, 2017 was 42.9% compared to 33.0% for the nine months ended September 30, 2016.March 31, 2020.

Note 10 – Fair Value Measurements

Unrecognized tax benefits were $96 and $90 at March 31, 2021 and 2020, respectively. We do not expect material changes to our unrecognized tax benefits during the next twelve months. The Company’s financial assets and liabilities include cash and cash equivalents, accounts receivable, accounts payable and notes payable, and are reported at carrying value which approximates fair value.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

Stock Options

In December 2015, Lifeway shareholdersstockholders 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.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, 2017, 3.448March 31, 2021, 3.317 million shares remain available under the Omnibus Incentive Plan. The Company has not established a pace forWhile we plan to continue to issue awards pursuant to the frequency of awards under the Omnibus Incentive Plan andat 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 ninethree months ended September 30, 2017:March 31, 2021:

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 March 31, 2021.

We expense RSA’s over the service period. For the ninethree months ended September 30, 2017March 31, 2021 and 20162020 total pre-tax stock-based compensation expense recognized in the consolidated statements of incomeoperations was $36 and comprehensive income was $35 and $100, respectively. For the nine months ended September 30, 2017 and 2016 tax-related benefits of $14 and $37 were also recognized. For the three months ended September 30, 2017 and 2016 total pre-tax stock-based compensation expense recognized in the consolidated statements of income and comprehensive income was $6 and $58,$5, respectively. For the three months ended September 30, 2017March 31, 2021 and 20162020 tax-related benefits of $3$11 and $22$1, respectively, were also recognized. As of September 30, 2017,March 31, 2021, the total remaining unearned compensation related to non-vested stock optionsRSA’s was $25,$108, which is expected to be amortized over the weighted-average remaining service period of 1.22 years.

We measure the fair value of stock options using the Black-Scholes option pricing model. The expected term of options granted was based on the weighted average time of vesting and the end of the contractual term. We utilized this simplified method as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.

Restricted Stock Units

Pursuant to the 2015 Omnibus Incentive Plan, Lifeway granted 2 Restricted Stock Units (“RSUs”) to certain key employees in December 2016. An RSU represents the right to receive one share of common stock in the future. RSUs have no exercise price.

The following table summarizes RSU activity during the nine months ended September 30, 2017:

We expense RSU’s over the service period. For the nine months ended September 30, 2017 and 2016 total pre-tax stock-based compensation expense recognized in the consolidated statements of income and comprehensive income was $14 and $0, respectively. For the nine months ended September 30, 2017 and 2016 tax-related benefits of $6 and $0 were also recognized. For the three months ended September 30, 2017 and 2016 total pre-tax stock-based compensation expense recognized in the consolidated statements of income and comprehensive income was $5 and $0, respectively. For the three months ended September 30, 2017 and 2016 tax-related benefits of $2 and $0 were also recognized. As of September 30, 2017, the total remaining unearned compensation related to non-vested RSU’s was $6, which is expected to be amortized over the weighted-average remaining service period of 0.71 years.Long-Term Incentive Plan Compensation

Incentive Compensation

In March 2016 Lifeway established anlong-term incentive-based compensation programprograms for fiscal year 2017 (the “2016“2017 Plan”) and for fiscal year 2019 (the “2019 Plan”) for certain senior executives and key employees (the “participants”). TheUnder both the 2017 Plan, long-term incentive compensation wasis based on theLifeway’s achievement of certain sales and adjusted EBITDA performance levels versus respective targets in 2016.established by the Board for each fiscal year. Under the 20162019 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 senior executives2017 Plan, collectively the participants had the opportunity to earn cash and equity-based incentive compensation in amounts ranging from $0 to $4,000 for fiscal 2016 depending on the performance levels compared to the respective targets. For the nine months and three months ended September 30, 2016, bonuses of $1,280 and $240 were expensed under the 2016 Plan, respectively.

In January 2017, Lifeway established an incentive-based compensation program (the “2017 Plan”) for certain senior executives and key employees (the “participants”). The number of participants under the 2017 Plan was expanded from the 2016 Plan. Under the 2017 Plan, incentive compensation is based on (a) the achievement of certain sales and EBITDA performance levels versus respective targets in 2017, and (b) for certain senior executives, the achievement of individual performance objectives. Under the 2017 Plan, collectively the participants may earn cash and equity based incentive compensation in amounts ranging from $0 to $11,025 depending on the Company’sLifeway’s performance levels compared to the respective targets and the senior executive’sparticipants 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 ninethree months ended September 30, 2017, $2,106March 31, 2021 and 2020, $0 and $49 was accrued under the 2017 Plan, of which $1,254 was recorded as cash bonus expense and $852 was recordedexpensed as stock-based compensation expense in the consolidated statements of incomeoperations, respectively. As of March 31, 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 comprehensive income.100% of remaining unvested shares in year three from the 2019 grant date. For the three months ended September 30, 2017, $121March 31, 2021 and 2020, $19 and $13 was accrued under the 2017 Plan, of which $6 was recorded as cash bonus expense and $115 was recordedexpensed as stock-based compensation expense in the consolidated statements of incomeoperations, 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 comprehensive income.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 three months ended March 31, 2021 and 2020, $8 and $43 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of March 31, 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 three months ended March 31, 2021 and 2020, $90 and $0 was expensed as stock-based compensation expense in the consolidated statements of operations, respectively. As of March 31, 2021, the total remaining unearned compensation was $610, of which $274 will be recognized in 2021, $221 in 2022, $98 in 2023, and $17 in 2024, respectively, subject to vesting.

Retirement Benefits

The CompanyLifeway has a defined contribution plan which is available to substantially all full-time employees. Under the terms of the plan, the Company matcheswe match employee contributions under a prescribed formula. For the ninethree months ended September 30, 2017March 31, 2021 and 20162020 total contribution expense recognized in the consolidated statements of incomeoperations was $113 and comprehensive income was $296 and $255,$118, respectively. For the three months ended September 30, 2017 and 2016 total contribution expense recognized in the consolidated statements of income and comprehensive income was $59 and $82, respectively.

Note 12 – Segments, Products and Customers

The Company manufactures probiotic, cultured, functional dairy health food products. The Company'sLifeway’s primary product is drinkable kefir, a cultured dairy beverage similarproduct. Lifeway Kefir is tart and tangy, high in protein, calcium and vitamin D. Thanks to but distinct from yogurt, in several flavorsour exclusive blend of kefir cultures, each cup of kefir contains 12 live and in several package configurations. In additionactive cultures and 25 to 30 billion beneficial CFU (Colony Forming Units) at the drinkable products, Lifeway manufactures "Lifeway Farmer Cheese," a linetime of various farmer cheeses.manufacture.

The CompanyWe manufacture (directly or through co-packers) and market products under the Lifeway and Fresh Made brand names, as well as under private labels on behalf of certain customers.

Our product categories are:

Lifeway has determined that it has one reportable segment based on how the Company'sour 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 Companyour 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 theour consolidated revenues of the Company relate to the sale of fermentedcultured dairy products which are producedthat 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:follows for the three months ended March 31:

Significant Customers – Sales are predominately to companies in the retail food industry located within the United States. Two major customers accounted for approximately 22% and 23% of net sales for the nine months ended September 30, 2017 and 2016, respectively, and 21% and 22% of net sales for the three months ended September 30, 2017March 31, 2021 and 2016,2020, respectively.

Note 13 – Related party transactionsParty Transactions

The CompanyLifeway obtains consulting services from the Chairperson of its board of directors. Fees earnedOn December 28, 2020, Lifeway entered into an amended and restated consulting agreement (the “Agreement”), effective as of December 31, 2020, with the Chairperson. Under the terms and conditions of the Agreement, the Chairperson will continue to provide consulting services with respect to, among other things, our business strategy, international expansion and product management and expansion. For the services, the Company will pay an annual service fee of $500. The Chairperson will also be eligible for an annual performance fee target of $500 based on the achievement of specified performance criteria. The Chairpersons annual service fee and target bonus amounts are subject to periodic change by the ChairpersonCompensation Committee of the Company’s Board of Directors on 30 days’ prior written notice to the Chairperson. The Agreement shall continue until either party provides at least a 10-day written notice of termination.

Service fees earned are included in general and administrative expenses in the accompanying consolidated statements of income and comprehensive incomeoperations and were $750 and $787 during the nine months ended September 30, 2017 and 2016, respectively,$125 and $250 and $248 during each of the three months ended September 30, 2017March 31, 2021 and 2016,2020, respectively. During the three months ended March 31, 2021, the Company recorded $94 related to estimated earnings under the fiscal year 2021 annual performance fee target. This amount is included in general and administrative expenses in the accompanying consolidated statements of operations.

The CompanyLifeway is also a party to a royalty agreement with the Chairperson of its board of directors under which the Company payswe pay the Chairperson a royalty based on the sale of certain Lifeway product,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 income and comprehensive incomeoperations and were $450$150 during the nine months ended September 30, 2017 and 2016, and $150 duringeach of the three months ended September 30, 2017March 31, 2021 and 2016.2020.

Note 14 – Subsequent EventCOVID-19

On September 24, 2015,The ultimate impact that the Company's BoardCOVID-19 pandemic or any future pandemic or disease outbreak will have on our business and our consolidated results of Directors authorizedoperations is uncertain.

To date we have seen increased customer and consumer demand for our products as consumers initially began pantry loading and have increased their at-home consumption as a stock repurchase program (the “2015 stock repurchase program”) under whichresult of social distancing and stay-at-home and work-from-home mandates and recommendations. However, this increased customer and consumer demand may decrease in the Companycoming months if and when the need for social distancing and stay-at-home and work-from-home mandates and recommendations decrease, and we are unable to predict the nature and timing of when that impact may from timeoccur, if at all.

Although to time, repurchase shares of its common stockdate we have not experienced supply chain constraints, and we have continued to be able to fully satisfy customer and consumer demand for an aggregate purchase price not to exceedour products, the lesser of $3,500 or 250 shares. On November 1, 2017, the Company’s Board of Directors amended the Company’s 2015 stock repurchase program (the “2017 amendment”), by increasing the authorization to the lesser of $5,185 or 625 shares, exclusivecontinued unprecedented demand for food and other consumer packaged goods products as a result of the shares previously authorized underCOVID-19 pandemic or any future pandemic may limit the 2015 stock repurchase program. Underavailability of, or increase the amended authorization, share repurchasescost of, ingredients, packaging and other raw materials necessary to produce our products, and our operations may be executed through various means,negatively impacted. Additionally, pandemics or disease outbreaks could result in a widespread health crisis that could adversely affect economies and financial markets, consumer spending and confidence levels resulting in an economic downturn that could affect customer and consumer demand for our products.

Our efforts to manage and mitigate these factors may be unsuccessful, and the effectiveness of these efforts depends on factors beyond our control, including the duration and severity of any pandemic or disease outbreak, as well as third party actions taken to contain its spread and mitigate public health effects.

The ultimate impact of the COVID-19 pandemic on our business will depend on many factors, including, among others, the duration of social distancing and stay-at-home and work-from-home mandates and recommendations and whether additional waves of COVID-19 or different variants of COVID-19 will affect the United States and other markets, our ability and the ability of our suppliers to continue to operate our and their manufacturing facilities and maintain the supply chain without limitationmaterial disruption and procure ingredients, packaging and other raw materials when needed despite unprecedented demand in the open market or in privately negotiated transactions, in accordance with all applicable securities lawsfood industry, and regulations, including without limitation Rule 10b-18 of the Securities Exchange Act of 1934, as amended. The extent to which macroeconomic conditions resulting from the Company repurchases its sharespandemic and the timingpace of such repurchases will depend upon a varietythe subsequent recovery may impact consumer eating and shopping habits. We cannot predict the duration or scope of factors, including market conditions, regulatory requirements and other corporate considerations. The repurchase program does not obligate the Company to purchase any shares, anddisruption. Therefore, the program mayfinancial impact cannot be terminated, suspended, increased, or decreased by the Company’s Board of Directors in its discretionreasonably estimated at anythis time.

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, 20162019 (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," "intend," "plan,“anticipate,” “from time to time,” “intend,” “plan,” “ongoing,” “realize,” “should,” “may,” “could," "believe," "estimate,"future," "depend," "expect," "future,"will," "result," "can," "remain," "assurance," "subject to," "require," "limit," "impose," "guarantee," "restrict," "continue," "become," "predict," "likely," "may,"opportunities," "should,"effect," "will""change," "predict," and "estimate,” and similar terms or terminology, or the negative of such terms or other comparable terminology. Examples of forward-looking statements include, among others, statements we make regardingregarding:

Forward-lookingForward looking statements are neither historical facts nor assurancesbased on management’s beliefs, assumptions, estimates and observations of future performance. Instead, theyevents based on information available to our management at the time the statements are based only on our current beliefs, expectationsmade 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-lookinginclude any statements that do not relate to theany historical or current fact. These statements are not guarantees of future performance and they are subject to inherentinvolve certain risks, uncertainties risks and changes in circumstancesassumptions that are difficult to predictpredict. Actual outcomes 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 causewhat is expressed, implied or forecast by our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others,due in part to the following:risks, uncertainties, and assumptions that include:

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.

Recent Developments

COVID-19 Pandemic Impact

In December 2019, a novel coronavirus disease ("COVID-19") was first reported and subsequently characterized by the World Health Organization ("WHO") as a pandemic in March 2020. In an effort to reduce the global transmission of COVID-19, various policies and initiatives have been implemented by governments around the world, including orders to close businesses not deemed "essential", shelter-in-place orders enacted by state and local governments, and the practice of social distancing measures when engaging in essential activities. Lifeway has seen increased orders from retail customers in response to increased consumer demand for food at home in response to government mandated social distancing and shelter in place orders in the United States and the immune boosting quality of our products.

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

Results of Operations