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, ~~2018~~2019

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

For the transition period from __________ to __________

Commission File Number: 000-17363

LIFEWAY FOODS, INC.

(Exact Name of Registrant as Specified in its Charter)

Illinois

36-3442829

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

6431 West Oakton, Morton Grove, IL 60053

(Address of Principal Executive Offices, Zip Code)

(847) 967-1010

(Registrant’s Telephone Number, Including Area Code)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ xNo ☐o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ xNo ☐o

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ oNo ☒x

AsNumber of shares of Common Stock, no par value, outstanding as of November 5, ~~2018, 15,837,695 shares of the registrant’s common stock, no par value, were outstanding.~~

2019: 15,709,939

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.	1720
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	2226
Item 4.	Controls and Procedures.	2226

PART II – OTHER INFORMATION
Item 1.	Legal Proceedings.	2327
Item ~~1 A.~~1A.	Risk Factors.	2327
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	2327
Item 3.	Defaults Upon Senior Securities.	2327
Item 4.	Mine Safety Disclosure.	2327
Item 5.	Other Information.	2327
Item 6.	Exhibits.	2328
	Signatures.	2429

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

~~September 30, 2018 and December 31, 2017~~

(In thousands)

	September 30, 2018 (Unaudited)			December 31, 2017			September 30, 2019 (Unaudited)			December 31, 2018
Current assets
Cash and cash equivalents	$	2,726		$	4,978		$	5,512		$	2,998
Investments, at fair value		500			–
Accounts receivable, net of allowance for doubtful accounts and discounts & allowances of $1,550 and $2,010 at September 30, 2018 and December 31, 2017 respectively		8,073			8,676
Accounts receivable, net of allowance for doubtful accounts and discounts & allowances of $1,240 and $1,220 at September 30, 2019 and December 31, 2018 respectively								6,572			6,276
Inventories, net		6,837			7,697			6,758			5,817
Prepaid expenses and other current assets		1,298			983			1,477			1,077
Refundable income taxes		2,959			2,347			827			2,748
Total current assets		22,393			24,681			21,146			18,916

Property, plant and equipment, net		25,035			24,645			22,620			24,573
Operating lease right-of-use asset								839			–

Intangible assets
Goodwill & indefinite-lived intangibles		14,068			14,068			12,824			12,824
Other intangible assets, net		485			975			192			344
Total intangible assets		14,553			15,043			13,016			13,168

Other assets		150			150			165			150
Total assets	$	62,131		$	64,519		$	57,786		$	56,807

Current liabilities
Current maturities of notes payable	$	–		$	3,166
Accounts payable		6,263			6,848		$	6,968		$	4,570
Accrued expenses		3,118			2,984			3,402			2,777
Accrued income taxes		82			203			63			106
Total current liabilities		9,463			13,201			10,433			7,453

Line of credit		5,990			–			4,224			5,995
Notes payable		–			3,113
Operating lease liabilities								527			–
Deferred income taxes, net		840			840			390			390
Other long-term liabilities		661			775			76			564
Total liabilities		16,954			17,929			15,650			14,402

Stockholders' equity
Preferred stock, no par value; 2,500 shares authorized; no shares issued or outstanding at September 30, 2018 and December 31, 2017, respectively		–			–
Common stock, no par value; 40,000 shares authorized; 17,274 shares issued; 15,838 and 16,008 outstanding at September 30, 2018 and December 31, 2017, respectively		6,509			6,509
Preferred stock, no par value; 2,500 shares authorized; no shares issued or outstanding at September 30, 2019 and December 31, 2018, respectively								–			–
Common stock, no par value; 40,000 shares authorized; 17,274 shares issued; 15,706 and 15,814 outstanding at September 30, 2019 and December 31, 2018, respectively								6,509			6,509
Paid-in capital		2,211			2,244			2,348			2,303
Treasury stock, at cost		(12,918	)		(11,812	)		(12,630	)		(12,970	)
Retained earnings		49,375			49,649			45,909			46,563
Total stockholders' equity		45,177			46,590			42,136			42,405

Total liabilities and stockholders' equity	$	62,131		$	64,519		$	57,786		$	56,807

See accompanying notes to consolidated financial statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

~~For the three months and nine months ended September 30, 2018 and 2017~~

(Unaudited)

(In thousands, except per share data)

	Three Months Ended September 30,						Nine months Ended September 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017			2019			2018			2019			2018

Net sales	$	24,480		$	28,786		$	80,318		$	92,636		$	22,729		$	24,480		$	70,497		$	80,318

Cost of goods sold		17,892			20,331			57,412			65,262			16,813			17,892			51,223			57,412
Depreciation expense		738			618			2,143			1,801			743			738			2,235			2,143
Total cost of goods sold		18,630			20,949			59,555			67,063			17,556			18,630			53,458			59,555

Gross profit		5,850			7,837			20,763			25,573			5,173			5,850			17,039			20,763

Selling expenses		3,136			4,010			10,537			11,648			2,679			3,136			8,509			10,537
General and administrative		3,150			3,145			9,851			10,743			2,710			3,150			9,100			9,851
Amortization expense		163			168			490			504			39			163			152			490
Total operating expenses		6,449			7,323			20,878			22,895			5,428			6,449			17,761			20,878

(Loss) income from operations		(599	)		514			(115	)		2,678
Loss from operations														(255	)		(599	)		(722	)		(115	)

Other income (expense):
Interest expense		(82	)		(62	)		(220	)		(180	)		(65	)		(82	)		(202	)		(220	)
Gain (loss) on sale of property and equipment		28			(34	)		42			(39	)
Gain on sale of property and equipment														154			28			183			42
Other income, net		3			–			11			–			77			3			82			11
Total other income (expense)		(51	)		(96	)		(167	)		(219	)		166			(51	)		63			(167	)

(Loss) income before provision for income taxes		(650	)		418			(282	)		2,459
Loss before provision for income taxes														(89	)		(650	)		(659	)		(282	)

(Benefit) provision for income taxes		(136	)		175			(8	)		1,056
Benefit for income taxes														(17	)		(136	)		(58	)		(8	)

Net (loss) income	$	(514	)	$	243		$	(274	)	$	1,403
Net loss													$	(72	)	$	(514	)	$	(601	)	$	(274	)

(Loss) earnings per common share:
Loss per common share:
Basic	$	(0.03	)	$	0.02		$	(0.02	)	$	0.09		$	(0.00	)	$	(0.03	)	$	(0.04	)	$	(0.02	)
Diluted	$	(0.03	)	$	0.02		$	(0.02	)	$	0.09		$	(0.00	)	$	(0.03	)	$	(0.04	)	$	(0.02	)

Weighted average common shares:
Basic		15,872			16,093			15,886			16,123			15,740			15,872			15,761			15,886
Diluted		16,256			16,168			16,354			16,218			15,740			16,256			15,761			16,354

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, 2018 17,274 $ 6,509 (1,266 ) $ (11,812 ) $ 2,244 $ 49,649 $ 46,590

Issuance of common stock in connection with stock-based compensation – – 16 151 (54 ) – 97

Treasury stock purchased – – (131 ) (1,052 ) – – (1,052 )

Stock-based compensation – – – – 5 – 5

Net loss – – – – – 70 70

Balance, March 31, 2018 17,274 $ 6,509 (1,381 ) $ (12,713 ) $ 2,195 $ 49,719 $ 45,710

Issuance of common stock in connection with stock-based compensation – – 6 52 (17 ) – 35

Treasury stock purchased – – (20 ) (116 ) – – (116 )

Stock-based compensation – – – – 6 – 6

Net loss – – – – – 170 170

Balance June 30, 2018 17,274 $ 6,509 (1,395 ) $ (12,777 ) $ 2,184 $ 49,889 $ 45,805

Treasury stock purchased – – (41 ) (141 ) – – (141 )

Stock-based compensation – – – – 27 – 27

Net loss – – – – – (514 ) (514 )

Balance, September 30, 2018 17,274 $ 6,509 (1,436 ) $ (12,918 ) $ 2,211 $ 49,375 $ 45,177
5
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, 2019 17,274 $ 6,509 (1,460 ) $ (12,970 ) $ 2,303 $ 46,563 $ 42,405

Cumulative impact of change in accounting principles, net of tax – – – – – (53 ) (53 )

Issuance of common stock in connection with stock-based compensation – – 41 351 142 – 493

Treasury stock purchased – – (82 ) (205 ) – – (205 )

Stock-based compensation – – – – 218 – 218

Net loss – – – – – (388 ) (388 )

Balance, March 31, 2019 17,274 $ 6,509 (1,501 ) $ (12,824 ) $ 2,663 $ 46,122 $ 42,470

Issuance of common stock in connection with stock-based compensation – – 62 527 (548 ) – (21 )

Treasury stock purchased – – (74 ) (180 ) – – (180 )

Stock-based compensation – – – – 115 – 115

Net loss – – – – – (141 ) (141 )

Balance June 30, 2019 17,274 $ 6,509 (1,513 ) $ (12,477 ) $ 2,230 $ 45,981 $ 42,243

Treasury stock purchased – – (54 ) (153 ) – – (153 )

Stock-based compensation – – – – 118 – 118

Net loss – – – – – (72 ) (72 )

Balance, September 30, 2019 17,274 $ 6,509 (1,567 ) $ (12,630 ) $ 2,348 $ 45,909 $ 42,136
See accompanying notes to consolidated financial statements
6
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Nine Months Ended September 30,
2019 2018
Cash flows from operating activities:
Net loss $ (601 ) $ (274 )
Adjustments to reconcile net loss to operating cash flow:
Depreciation and amortization 2,387 2,633
Bad debt expense 20 50
Reserve for inventory obsolescence 177 580
Stock-based compensation 714 827
Non-cash interest expense 17 9
Deferred revenue (73 ) (72 )
(Gain) on sale of property and equipment (183 ) (42 )
(Increase) decrease in operating assets:
Accounts receivable (316 ) 553
Inventories (1,118 ) 280
Refundable income taxes 1,921 (612 )
Prepaid expenses and other current assets (399 ) (291 )
Increase (decrease) in operating liabilities:
Accounts payable 2,397 (586 )
Accrued expenses 53 (588 )
Accrued income taxes (43 ) (121 )
Net cash provided by operating activities 4,953 2,346

Cash flows from investing activities:
Purchases of property and equipment (610 ) (2,581 )
Proceeds from sale of property and equipment 513 90
Purchase of investments (15 ) (500 )
Net cash used in investing activities (112 ) (2,991 )

Cash flows from financing activities:
Purchase of treasury stock (538 ) (1,309 )
Borrowings under revolving credit facility – 6,050
Repayment of line of credit (1,789 ) –
Payment of deferred financing costs – (69 )
Repayment of notes payable – (6,279 )
Net cash used in financing activities (2,327 ) (1,607 )

Net increase (decrease) in cash and cash equivalents 2,514 (2,252 )

Cash and cash equivalents at the beginning of the period 2,998 4,978

Cash and cash equivalents at the end of the period $ 5,512 $ 2,726

Supplemental cash flow information:
Cash paid for income taxes, net of (refunds) $ (1,937 ) $ 724
Cash paid for interest $ 214 $ 189

Non-cash investing activities
Right-of-use assets recognized at ASU 2016-02 transition $ 944 $ –
Operating lease liability recognized at ASU 2016-02 transition $ 997 $ –
Right-of-use assets and operating lease liabilities recognized after ASU 2016-02 transition $ 280 $ –

See accompanying notes to consolidated financial statements

4
~~LIFEWAY FOODS, INC. AND SUBSIDIARIES~~
~~Consolidated Statements of Stockholders’ Equity~~
~~For the Nine months Ended September 30, 2018 and 2017~~
~~(Unaudited)~~
~~(In thousands)~~
Common Stock
Issued In treasury Paid-In Retained Total
Shares $ Shares $ Capital Earnings Equity

Balance, January 1, 2017 17,274 $ 6,509 (1,120 ) $ (10,340 ) $ 2,198 $ 49,995 $ 48,362

Treasury stock purchased – – (117 ) (1,187 ) – – (1,187 )

Stock-based compensation – – – – 49 – 49

Net income – – – – – 1,403 1,403

Balance, September 30, 2017 17,274 $ 6,509 (1,237 ) $ (11,527 ) $ 2,247 $ 51,398 $ 48,627

Balance, January 1, 2018 17,274 $ 6,509 (1,266 ) $ (11,812 ) $ 2,244 $ 49,649 $ 46,590

Issuance of common stock in connection with stock-based compensation – – 22 203 (71 ) – 132

Treasury stock purchased – – (192 ) (1,309 ) – – (1,309 )

Stock-based compensation – – – – 38 – 38

Net loss – – – – – (274 ) (274 )

Balance, September 30, 2018 17,274 $ 6,509 (1,436 ) $ (12,918 ) $ 2,211 $ 49,375 $ 45,177
~~See accompanying notes to consolidated financial statements~~
5
~~LIFEWAY FOODS, INC. AND SUBSIDIARIES~~
~~Consolidated Statements of Cash Flows~~
~~For the Nine months Ended September 30, 2018 and 2017~~
~~(Unaudited)~~
~~(In thousands)~~
2018 2017
Cash flows from operating activities:
Net (loss) income $ (274 ) $ 1,403
Adjustments to reconcile net income to operating cash flow:
Depreciation and amortization 2,633 2,305
Non-cash interest expense 9 –
Bad debt expense 50 –
Reserve for inventory obsolescence 580 320
Stock-based compensation 827 901
Deferred revenue (72 ) –
(Gain) loss on sale of property and equipment (42 ) 39
(Increase) decrease in operating assets:
Accounts receivable 553 (814 )
Inventories 280 (328 )
Refundable income taxes (612 ) (462 )
Prepaid expenses and other current assets (291 ) (231 )
Increase (decrease) in operating liabilities:
Accounts payable (586 ) 1,384
Accrued expenses (588 ) 252
Accrued income taxes (121 ) (580 )
Net cash provided by operating activities 2,346 4,189

Cash flows from investing activities:
Purchases of investments (500 ) (25 )
Purchases of property and equipment (2,581 ) (3,932 )
Proceeds from sale of property and equipment 90 37
Net cash used in investing activities (2,991 ) (3,920 )

Cash flows from financing activities:
Borrowings under revolving credit facility 6,050 –
Payment of deferred financing costs (69 ) –
Purchase of treasury stock (1,309 ) (1,187 )
Repayment of notes payable (6,279 ) (630 )
Net cash used in financing activities (1,607 ) (1,817 )

Net decrease in cash and cash equivalents (2,252 ) (1,548 )

Cash and cash equivalents at the beginning of the period 4,978 8,812

Cash and cash equivalents at the end of the period $ 2,726 $ 7,264

Supplemental cash flow information:
Cash paid for income taxes, net of refunds $ 724 $ 2,098
Cash paid for interest $ 189 $ 180
~~See accompanying notes to consolidated financial statements~~
67

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, ~~2018~~2019 and December 31, ~~2017~~2018
(Unaudited)
(In thousands, except per share data)

Note 1 – Basis of Presentation

Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) for interim financial information, and do not include all of the information and disclosures required for complete, audited financial statements. In the opinion of management, these statements include all adjustments ~~consisting only of normal recurring adjustments, considered~~ necessary for a fair presentation ~~have been included. For further information, refer to~~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 ~~disclosures~~related notes included in our Annual Report on Form 10-K as of and for the year ended December 31, ~~2017. Certain amounts in prior-year financial statements were reclassified to conform to the current-year presentation. The results~~2018. Results of operations for ~~the period~~interim periods are not necessarily indicative of the results to be expected for other interim periods or the full year.
A detailed description of our significant accounting policies can be found in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Principles of consolidation

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

Note 2 – Significant Accounting Policies

Use of estimates

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

Revenue Recognition

We sell food and beverage products across select product categories to customers predominantly within the United States (see Note ~~11,~~12, Segments, Products and Customers). We also sell bulk cream, a byproduct of our fluid milk manufacturing process. WeIn accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, we recognize revenue when control over the products transfers to our customers, which generally occurs upon delivery to our customers or their common carriers. We adopted this standard at the beginning of fiscal year 2018, with no significant impact to our financial position or results of operations, using the modified retrospective method. The amount of revenue recognized reflects the consideration to which we expect to be entitled to receive in exchange for these goods or services, using the five-step method required by ASC 606.
8
For the Company, the contract is the approved sales order, which may also be supplemented by other agreements that formalize various terms and conditions with customers. We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.
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.

~~Revenues are recorded net of discounts and allowances to our customers and consumers. Known~~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, ~~and coupon redemption, are estimated at the time of sale. We base these estimates of expected amounts principally on historical utilization and redemption rates. Estimates that affect revenue, such as~~ trade incentives and coupon ~~redemptions, are monitored and adjusted each period until~~redemption, is estimated utilizing the ~~incentives realized or the coupons expire.~~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.~~costs. 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.

7
~~Deferred Financing Costs~~
We record deferred financing costs incurred in conjunction with its debt obligations. These costs are capitalized and amortized over the lives of the associated debt to interest expense using the effective interest method. Debt issuance costs associated with term debt and lines of credit are recorded as a direct deduction from the face amount of the debt. Total deferred financing costs, net of $9 and $0 of accumulated amortization, at September 30, 2018 and December 31, 2017 were $60 and $0, respectively.
~~Investments~~
~~All investment securities are classified as available-for-sale and are carried at fair value. The Company holds a Level 1 fair value investment in a short-term fixed income fund at September 30, 2018.~~
Advertising and promotional costs

Lifeway expenses advertising costs as incurred. For the nine months ended September 30, ~~2018~~2019 and ~~2017~~2018 total advertising expenses were ~~$3,557~~$2,650 and ~~$4,703~~$3,557 respectively. For the three months ended September 30, ~~2018~~2019 and ~~2017~~2018 total advertising expenses were ~~$972~~$786 and ~~$1,892~~$972 respectively.

Recently Adopted Accounting Pronouncements

In ~~June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting~~. The new guidance is intended to simplify aspects of accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. The new guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted, but no earlier than an entity’s adoptions of Topic 606. We adopted this new standard in June 2018. The adoption of this amendment had no impact on the consolidated financial statements.
In May 2017, the Financial Accounting Standards Board ("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. This guidance was effective January 1, 2018. The adoption of this amendment had no 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. The new guidance is intended to address the diversity in practice in how certain cash receipts and cash payments are presented 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, and other topics. This guidance was effective January 1, 2018. The adoption of this amendment had no impact 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. This guidance was effective January 1, 2018. The adoption of this amendment had no impact on the consolidated financial statements.
8
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 an entity 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, this guidance was effective January 1, 2018. We adopted the new standard on January 1, 2018 on a modified retrospective basis. The adoption of this amendment had no impact on the consolidated financial statements. Refer to the Revenue Recognition section above and Note 11, Segment, Products, and Customers for additional information.
~~Recently Issued Accounting Pronouncements~~
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 February 2016, the FASB issued ASU No. 2016-02, ~~Leases.~~Leases (Topic 842), which affects any entity that enters into a lease (as that term is defined in ASU 2016-02), with some specified scope exceptions. Under ASU 2016-02, companies can adopt the amended guidance using a modified retrospective transition approach, using an application date of either the beginning of the earliest comparative period presented or the beginning of the reporting period in which the companies first apply the new standard. We adopted this standard on January 1, 2019 using the application date of January 1, 2019, and elected certain practical expedients allowed under the standard. In July 2018, the FASB issued ASU No. 2018-11, Leases (842), Targeted Improvements, which provides an additional transition election to not restate comparative periods for the effects of applying the new standard. The guidance requires lessees to recognize ~~lease~~right-of-use assets and lease liabilities in the balance sheet and disclose key information about leasing arrangements, such as information about variable lease payments and options to renew and terminate leases. The amended guidance will require both operating and finance leases to be recognized in the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The new guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted. The amendments in this ASU should be adopted using a modified retrospective transition approach, which requires application
Lifeway elected certain of the practical expedients that are permitted under the transition guidance within ASU 2016-02 and related standards. Among other things, this practical expedient allowed us to carryforward the historical lease classification, and not reassess initial direct costs for any existing leases as of January 1, 2019 or reassess whether any expired or existing contracts are or contain leases. In addition, we elected to adopt the hindsight practical expedient to determine the reasonably certain lease term for existing leases. We made an accounting policy election to continue recording leases with an initial term of 12 months or less consistent with our prior financial reporting and elect the practical expedient to combine lease and non-lease components. We have revised our relevant policies and procedures, as applicable, to meet the new accounting, reporting and disclosure requirements of Topic 842 and have updated internal controls accordingly.
9
The main difference between the guidance atin ASU 2016-02 and prior GAAP is the ~~beginning~~recognition of right-of-use assets and lease liabilities by lessees for those leases classified as operating leases under current GAAP. Recognition of the ~~earliest comparative period presented in~~right-of-use assets and liabilities had a material impact to our consolidated balance sheets upon adoption. However, since all our leases are operating leases under ASC 840 and we will carryforward the ~~year of adoption. Management is currently evaluating the impact that~~historical lease classification, the new ~~guidance will~~standard did not have a material impact on our Consolidated Statements of Operations, Consolidated Statements of Stockholders’ Equity, or Consolidated Statements of Cash Flows. The adoption resulted in an increase of the ~~consolidated financial statements.~~right-of-use assets of approximately $944 and lease liabilities of $997, and an adjustment to beginning retained earnings of $53 as of January 1, 2019.
Recently Issued Accounting Pronouncements
We do not anticipate a material impact upon adoption from any accounting standards issued but not yet adopted.

Note 3 – Inventories, net

Inventories consisted of the following:

September 30,
2018 December 31,
2017
Ingredients $ 1,970 $ 1,717
Packaging 2,064 2,453
Finished goods 2,803 3,527
Total inventories $ 6,837 $ 7,697
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September 30,
2019 December 31,
2018
Ingredients $ 2,293 $ 1,580
Packaging 2,124 2,072
Finished goods 2,341 2,165
Total inventories $ 6,758 $ 5,817

Note 4 – Property, Plant and Equipment, net

Property, plant and equipment consisted of the following:

September 30,
2018 December 31,
2017 September 30,
2019 December 31,
2018
Land $ 1,747 $ 1,747 $ 1,565 $ 1,747
Buildings and improvements 17,446 17,260 17,119 17,520
Machinery and equipment 30,598 27,539 29,891 29,692
Vehicles 901 901 778 937
Office equipment 879 734 851 838
Construction in process 693 1,683 806 546
52,264 49,864 51,010 51,280
Less accumulated depreciation (27,229 ) (25,219 ) (28,390 ) (26,707 )
Total property, plant and equipment, net $ 25,035 $ 24,645 $ 22,620 $ 24,573

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Note 5 – Goodwill and Intangible Assets

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

September 30,
2018 December 31,
2017 September 30,
2019 December 31,
2018
Gross goodwill $ 10,368 $ 10,368
Accumulated impairment losses (1,244 ) (1,244 )
Goodwill $ 10,368 $ 10,368 9,124 9,124
Brand names 3,700 3,700 3,700 3,700
Goodwill and indefinite-lived intangible assets $ 14,068 $ 14,068 $ 12,824 $ 12,824
Finite-lived Intangible Assets

Other intangible assets, net consisted of the following:

September 30,
2018 December 31,
2017 September 30,
2019 December 31,
2018
Recipes $ 44 $ 44 $ 44 $ 44
Customer lists and other customer related intangibles 4,529 4,529 4,529 4,529
Customer relationship 985 985 985 985
Trade names 2,248 2,248 2,248 2,248
Formula 438 438 438 438
8,244 8,244 8,244 8,244
Accumulated amortization (7,759 ) (7,269 ) (8,052 ) (7,900 )
Other intangible assets, net $ 485 $ 975 $ 192 $ 344

Note 6 – Accrued Expenses

Accrued expenses consisted of the following:

September 30,
2018
December 31,
2017
September 30,
2019
December 31,
2018

Payroll and incentive compensation $ 2,271 $ 2,208 $ 2,285 $ 1,937
Current portion of operating lease liabilities 354 –
Real estate taxes 401 371 296 398
Other 446 405 467 442
$ 3,118 $ 2,984
Total accrued expenses $ 3,402 $ 2,777

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Note 7 – Debt

Notes Payable

September 30,
2018

December 31,
2017

Variable rate term loan due May 31, 2018. Principal and interest payable monthly with a balloon payment due at maturity. Paid in full. $ – $ 2,832
Variable rate term loan due May 31, 2019. Principal and interest payable monthly with a balloon payment due at maturity. Paid in full. – 3,447
Total term loans – 6,279
Less current portion – (3,166 )
Total long-term portion $ – $ 3,113
The ~~variable rate~~two term loans were refinanced and paid in full on May 7, 2018. The term loans were subject to interest at the prime rate or at the LIBOR plus 2.5% and were collateralized by substantially all of Lifeway’s assets. ~~The two term loans were refinanced and paid in full on May 7, 2018.~~ See Line of Credit below.

Line of Credit

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

As of September 30, ~~2018,~~2019, we ~~have $5,990,~~had $4,224 net of ~~$60~~$37 of unamortized deferred financing costs, outstanding under the ~~New~~ Revolving Credit Facility. We ~~have~~had approximately ~~$3,950~~$4,739 available under the Borrowing Base for future borrowings as of September 30, ~~2018.~~2019.

All outstanding amounts under the Loans bear interest, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.5%, or the Prime Rate) or the LIBOR plus 2.50%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee. Lifeway’s average interest rate on debt outstanding under our Revolving Credit ~~Agreement~~Facility for the ~~period May 7, 2018 through~~quarter ended September 30, ~~2018 ranged from 4.52% -~~2019 was 4.86%.

The commitment under the Revolving Credit Facility matures May 7, 2021. The ~~new revolving line of credit~~Revolving Credit Facility is presented as a long-term debt obligation as of September 30, ~~2018.~~2019. The Loans and all other amounts due and owed under the Revolving Credit Facility and related documents are secured by substantially all of our assets.

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

The Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters through December 31, 2018; maintain (a) a fixed charge coverage ratio of no less than 1.25 to 1.0, and (b) a Senior Debt to EBITDA ratio of not more than 3.00 to 1.0 at December 31, 2018 and for each of the succeeding fiscal quarters ending through the expiration date. The Revolving Credit Facility also provides for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement, as a result of which amounts due under the Revolving Credit Facility may be accelerated.

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”).

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All outstanding amounts under the Loans bear interest, based on a level of the Senior Debt to EBITDA ratio, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.0% to 0.5%, or the Prime Rate) or the LIBOR plus 2.25% to 3.00%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee.
As amended, the Modified Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters through December 31, 2019, and maintain a fixed charge coverage ratio of no less than 1.25 to 1.00 for each of the fiscal quarters ending through the expiration date. The Modified Revolving Credit Facility also provides for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement, as a result of which amounts due under the Modified Revolving Credit Facility may be accelerated.
We were in compliance with the minimum EBITDA and fixed charge coverage ratio covenants at September 30, 2019.
Note 8 – Leases
Lifeway has operating leases for three retail stores for its Lifeway Kefir Shop subsidiary, certain machinery and equipment, and office space. All lease payments are fixed, not variable. Remaining lease terms for these leases range from less than 1 year to 5 years. Some of our leases include options to extend the leases for up to 5 years and have been included in our calculation of the right-of-use asset and lease liabilities. There are no residual value guarantees. We do not currently have leases which meet the finance lease classification as defined under ASC 842.
We do not record leases with an initial term of 12 months or less on the balance sheet. Expense for these short-term leases is recorded on a straight-line basis over the lease term. Total lease expense was $552 and $555 (including short term leases) for the nine months ended September 30, 2019 and 2018, respectively. Total lease expense was $187 and $180 (including short term leases) for the three months ended September 30, 2019 and 2018, respectively.
Lifeway treats contracts as a lease when the contract conveys the right to use a physically distinct asset for a period of time in exchange for consideration, we direct the use of the asset and 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
Year Operating Leases
Three months ended December 31, 2019 $ 144
2020 303
2021 227
2022 190
2023 71
Thereafter 7
Total lease payments 942
Less: Interest (61 )
Present value of lease liabilities $ 881
13
The weighted-average remaining lease term for our operating leases was 2.8 years as of September 30, 2019. The weighted average discount rate of our operating leases was 5.38% as of September 30, 2019. Cash paid for amounts included in the measurement of lease liabilities was $437 for the nine months ended September 30, 2019. Cash paid for amounts included in the measurement of lease liabilities was $145 for the three months ended September 30, 2019.

Note 89 – Commitments and contingencies
~~Lease obligations~~
We lease corporate office space, three retail stores for our Lifeway Kefir Shop subsidiary, and certain machinery and equipment, under operating leases. Total lease expense was $555 and $497 for the nine months ended September 30, 2018 and 2017, respectively. Total lease expense was $180 and $175 for the three months ended September 30, 2018 and 2017, respectively.

Litigation

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

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

Lifeway’s contingencies are subject to substantial uncertainties, including for each such contingency the following, among other factors: (i) the procedural status of the case; (ii) whether the case has or may be certified as a class action suit; (iii) the outcome of preliminary motions; (iv) the impact of discovery; (v) whether there are significant factual issues to be determined or resolved; (vi) whether the proceedings involve a large number of parties and/or parties and claims in multiple jurisdictions or jurisdictions in which the relevant laws are complex or unclear; (vii) the extent of potential damages, which are often unspecified or indeterminate; and (viii) the status of settlement discussions, if any, and the settlement posture of the parties. Consequently, Lifeway cannot predict with any reasonable certainty the timing or outcome of such contingencies, and we are unable to estimate a possible loss or range of loss.
In a letter dated May 19, 2016, Lifeway received a request to voluntarily produce documents in connection with a confidential, informal inquiry by the Division of Enforcement of the SEC concerning Lifeway’s internal controls, disclosure controls procedures, and internal control over financial reporting for fiscal years 2013 through the date of the letter. Following the SEC’s issuance of a Wells Notice and discussions with the SEC staff about the SEC’s alleged claims, we reached an agreement in principle to resolve the inquiry on November 9, 2018. Under the terms of the proposed settlement, Lifeway would pay one hundred thousand dollars in a civil penalty and agree to cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 13a-1, 13a-13, and 13a-15, thereunder. Lifeway will enter into the offer of settlement without admitting or denying the allegations therein and the settlement will resolve all allegations by the SEC against us. In accordance with U.S. GAAP, we made a corresponding accrual in our financial statements. The settlement remains subject to final approval by the SEC.

Note 910 – Income taxes

For each interim period, Lifeway estimates the effective tax rate (“ETR”) expected to be applicable for the full year and applies that rate to income before provision for income taxes for the period. ~~Additionally, we~~The effective tax rate for the nine months ended September 30, 2019 was 8.8% compared to 3.0% for the nine months ended September 30, 2018. The effective tax rate for the three months ended September 30, 2019 was 19.3% compared to 20.9% for the three months ended September 30, 2018. Our effective tax rate may change from period to period based on recurring and non-recurring factors including the relative mix of pre-tax earnings (or losses), the underlying income tax rates applicable to various state and local taxing jurisdictions, settlement of tax audits, the impact of non-deductible items, changes in valuation allowances, and the expiration of the statute of limitations in relation to unrecognized tax benefits. We record discrete income tax items such as enacted tax rate changes and completed tax audits in the period in which they occur.

The effective tax rate for the three months ended September 30, 2018 was 20.9% compared to 41.9% for the three months ended September 30, 2017. The effective tax rate for the nine months ended September 30, 2018 was 3.0% compared to 42.9% for the nine months ended September 30, 2017. On December 22, 2017, Congress enacted the Tax Cuts and Jobs Act of 2017. The Act contains several key tax provisions that affected us, including without limitation a reduction of the federal corporate income tax rate to 21% effective January 1, 2018, and the repeal of the domestic manufacturing deduction for 2018. In 2018, our effective income tax rate reflects the current federal statutory rate of 21%, while the rate for 2017 reflects the then-current federal statutory rate of 35%. The relative mix of pre-tax earnings (or losses), the underlying income tax rates applicable to various state and local taxing jurisdictions, and the impact of non-deductible items can also affect our periodic effective income tax rate.

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Note 1011 – Stock-based and Other Compensation

~~Stock Options~~
In December 2015, Lifeway ~~shareholders~~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.~~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, ~~2018, 3.469~~2019, 3.381 million shares remain available under the Omnibus Incentive Plan. ~~We have not established a pace for~~While we plan to continue to issue awards pursuant to the ~~frequency of awards under the Omnibus Incentive~~ Plan ~~and~~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, ~~2018:~~2019:

Options Weighted
average
exercise price Weighted
average
remaining contractual life Aggregate
intrinsic value Options Weighted
average
exercise price Weighted
average
remaining contractual life Aggregate
intrinsic value

Outstanding at December 31, 2017 45 $ 10.45
Outstanding at December 31, 2018 41 $ 10.42 7.22 –
Granted – $ – – $ –
Exercised – $ – – $ –
Forfeited (3) $ 11.10 – $ –
Outstanding at September 30, 2018 42 $ 10.40 7.50 $ –
Exercisable at September 30, 2018 36 $ 10.42 7.50 $ –
Outstanding at September 30, 2019 41 $ 10.42 6.47 $ –
Exercisable at September 30, 2019 41 $ 10.42 6.47 $ –

For the nine months ended September 30, ~~2018~~2019 and ~~2017~~2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $9$1 and ~~$35,~~$9, respectively. For the nine months ended September 30, ~~2018~~2019 and ~~2017~~2018 tax-related benefits of $2$0 and ~~$14~~$2 were also recognized. For the three months ended September 30, ~~2018~~2019 and ~~2017~~2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $2$0 and ~~$6,~~$2, respectively. For the three months ended September 30, ~~2018~~2019 and ~~2017~~2018 tax-related benefits of $0 ~~and $3~~ were also recognized. As of September 30, 2019, there is no remaining unearned compensation expense related to non-vested stock options.
15
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 nine months ended September 30, 2019.
RSA’s

Outstanding at December 31, 2018 25
Granted 39
Shares issued upon vesting (12 )
Forfeited –
Outstanding at September 30, 2019 52
Weighted average grant date fair value per share outstanding $ 3.90
We expense RSA’s over the service period. For the nine months ended September 30, 2019 and 2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $82 and $29, respectively. For the nine months ended September 30, 2019 and 2018 tax-related benefits of $22 and $8, respectively, were also recognized. For the three months ended September 30, 2019 and 2018 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $30 and $25, respectively. For the three months ended September 30, 2019 and 2018 tax-related benefits of $8 and $7, respectively, were also recognized. As of September 30, 2019, the total remaining unearned compensation related to non-vested ~~stock options~~RSA’s was ~~$4,~~$134, which is expected to be amortized over the weighted-average remaining service period of ~~0.73~~1.35 years.

~~Restricted Stock Units~~
Lifeway granted 20 Restricted Stock Units (“RSUs”) to certain independent directors in June 2018 and 6 RSU’s to employees during the quarter ended September 30, 2018. 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, 2018:~~
RSU’s

Outstanding at December 31, 2017 –
Granted 26
Shares issued upon vesting –
Forfeited –
Outstanding at September 30, 2018 26
Weighted average grant date fair value per share outstanding $ 5.63
13
We expense RSU’s over the service period. For the nine months ended September 30, 2018 and 2017 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $29 and $14, respectively. For the nine months ended September 30, 2018 and 2017 tax-related benefits of $8 and $6 were also recognized. For the three months ended September 30, 2018 and 2017 total pre-tax stock-based compensation expense recognized in the consolidated statements of operations was $25 and $5, respectively. For the three months ended September 30, 2018 and 2017 tax-related benefits of $7 and $2 were also recognized. As of September 30, 2018, the total remaining unearned compensation related to non-vested RSU’s was $116, which is expected to be amortized over the weighted-average remaining service period of 1.30 years.
Long-Term Incentive Plan Compensation

~~In January 2017,~~ Lifeway established anlong-term incentive-based compensation ~~program~~programs for fiscal year 2017 (the “2017 Plan”), fiscal year 2018 (the “2018 Plan”), and for fiscal year 2019 (the “2019 Plan”) for certain senior executives and key employees (the “participants”). ~~We established a similar plan for participants for fiscal year 2018 (the “2018” Plan).~~ Under both the 2017 Plan and the 2018 Plan, long-term incentive compensation is based on ~~(a)~~ Lifeway’s achievement of certain sales and adjusted EBITDA performance levels versus respective targets established by the Board for each fiscal ~~year, and (b) for certain senior executives other than our CEO and COO,~~year. Under the 2019 Plan, long-term equity incentive compensation is based on Lifeway’s achievement of ~~individual performance objectives.~~four strategic milestones over a three-year period from Fiscal 2019 through Fiscal 2021.
2017 Plan

Under the 2017 Plan, collectively the participants had the opportunity to earn cash and equity-based incentive compensation in amounts ranging from $0 to $11,025 depending on Lifeway’s performance levels compared to the respective targets and the ~~senior executive’s~~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, 2019 and 2018, $234 and $551 was expensed under the 2017 Plan as stock-based compensation expense in the consolidated statements of operations. For the nine months ended September 30, 2017, $2,106 was expensed under the 2017 Plan, of which $1,254 was recorded as cash bonus expense and $852 was recorded as stock-based compensation expense in the consolidated statements of operations.operations, respectively. For the three months ended September 30, 2019 and 2018, $54 and $139 was expensed under the 2017 Plan as stock-based compensation expense in the consolidated statements of operations. For the three months ended September 30, 2017, $121 was expensed under the 2017 Plan, of which $6 was recorded as cash bonus expense and $115 was recorded as stock-based compensation expense in the consolidated statements of operations.operations, respectively. As of September 30, ~~2018,~~2019, the total remaining unearned compensation related to the 2017 Plan was ~~$494,~~$103, of which ~~$139 is expected to be recognized through the balance of fiscal year 2018 subject to vesting;~~$54 and ~~$303 and $52~~$49 is expected to be recognized in 2019 and 2020, respectively, subject to vesting.

16
2018 Plan
Under the 2018 Plan, collectively the participants ~~have~~had the opportunity to earn cash and equity-based incentive compensation in amounts ranging from $0 to $11,200 depending on Lifeway’s performance levels compared to the respective targets and the ~~senior executive’s~~participants performance compared to their individual objectives. The equity portion of the incentive compensation iswas payable in restricted stock that vests one-third in each of the three years from the 2018 grant dates. For the nine months ended September 30, 2018, $303 was expensed under the 2018 Plan, of which $76 was recorded as cash bonus expense and $227 was recorded as stock-based compensation expense in the consolidated statements of operations. For the three months ended September 30, 2018, $157 was expensed under the 2018 Plan as stock-based compensation expense in the consolidated statements of operations. Due to the final fiscal 2018 financial results, there were no equity-based incentives awarded under the 2018 Plan.
2019 Plan
Under the 2019 Plan, collectively the participants have the opportunity to earn equity-based incentive compensation in amounts ranging from $0 to $1,776 depending on Lifeway’s performance levels compared to the respective targets. The equity-based incentive compensation is payable in restricted stock that vests 50% of unvested shares in year one, 50% of unvested shares in year two, and 100% of remaining unvested shares in year three from the 2019 grant date. For the nine months ended September 30, 2019, $103 was expensed under the 2019 Plan as stock-based compensation expense in the consolidated statements of operations. For the three months ended September 30, 2019, $35 was expensed under the 2019 Plan as stock-based compensation expense in the consolidated statements of operations.
2019 Retention Award
During Q1 2019, we awarded a special retention grant (the “2019 Retention Award”) of restricted stock to senior executives and key employees (the “participants”). The equity-based incentive compensation is payable in restricted stock that vests one-third in March 2019, one-third in March 2020 and one-third in March 2021. For the nine months ended September 30, 2019, $265 was expensed under the 2019 Retention Award as stock-based compensation expense in the consolidated statements of operations. For the three months ended September 30, 2019, $54 was expensed under the 2019 Retention Award as stock-based compensation expense in the consolidated statements of operations.

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, ~~2018~~2019 and ~~2017~~2018 total contribution expense recognized in the consolidated statements of operations was ~~$319~~$269 and ~~$296,~~$319, respectively. For the three months ended September 30, ~~2018~~2019 and ~~2017~~2018 total contribution expense recognized in the consolidated statements of operations was $88 and $90, ~~and $59,~~ respectively.

Note 1112 – Segments, Products and Customers

Lifeway’s primary product is drinkable kefir, a cultured dairy product. Lifeway Kefir is a tart and tangy, ~~cultured milk smoothie that is~~ high in protein, calcium and vitamin D. Thanks to our exclusive blend of kefir cultures, each cup of kefir contains 12 live and active cultures and 15 to 20 billion beneficial CFU (Colony Forming Units) at the time of manufacture.

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We manufacture (directly or through co-packers) our products under our own brand, as well as under private labels on behalf of certain customers. Lifeway offers ~~over 50~~approximately 20 varieties of our kefir products including more than 2060 flavors. In addition to our core drinkable kefir products, we offer several lines of products developed through our innovation and development efforts. These include Kefir Cups, a strained, cupped version of our kefir; and Organic Farmer Cheese Cups, a cupped version of our soft cheeses, both served in resealable 5 oz. ~~containers with mini-spoons.~~containers. We also offer ~~Lifeway Elixir, a line of non-dairy, sparkling organic probiotic beverages, as well as probiotic supplements for adults and children. In late 2017, we also announced that we would begin offering~~ Skyr, a strained cupped Icelandic ~~yogurt, and~~yogurt; Plantiful, a plant-based probiotic beverage made from organic and non-GMO pea protein with 10 vegan kefir ~~cultures.~~cultures; a line of probiotic supplements for adults and children; and a soft serve kefir mix.

Our product categories are:

•· Drinkable Kefir, sold in a variety of organic and non-organic sizes, flavors, and types, including low fat, non-fat, whole milk, protein, BioKefir (a 3.5 oz. kefir with additional probiotic cultures), and Kefir with Oats.

•· ~~Cheese, which includes~~ European-style soft cheeses, ~~and~~including farmer cheese in resealable cups.

•· Cream and other, which consists primarily of cream, a byproduct of making our ~~fluid milk manufacturing process, and non-dairy products.~~kefir.

•· ProBugs, a line of kefir products in drinkable ~~frozen,~~ and ~~freeze dried~~frozen formats, designed for children.

•· ~~Cupped Kefir and Skyr,~~Other Dairy, which ~~include~~includes Cupped Kefir and Icelandic Skyr, a line of strained kefir and yogurt products in resealable cups.

•· Frozen Kefir, available in both bars and pint-size containers.

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

Net sales of products by category were as follows for the nine months ended September 30:

Nine months ended September 30, 2019 2018
2018 % 2017 % $ % $ %
Drinkable Kefir other than ProBugs $ 61,255 76% $ 71,559 77% $ 54,126 77% $ 61,255 76%
Cheese 8,443 11% 8,527 9% 8,348 12% 8,443 11%
Cream and other 4,104 5% 5,053 5% 3,359 5% 4,104 5%
Cupped Kefir and Skyr 3,154 4% 2,379 3%
ProBugs Kefir 2,166 3% 3,700 4% 2,050 3% 2,166 3%
Other dairy 1,334 2% 3,154 4%
Frozen Kefir (a) 1,196 1% 1,418 2% 1,280 1% 1,196 1%
Net Sales $ 80,318 100% $ 92,636 100% $ 70,497 100% $ 80,318 100%

(a) Includes Lifeway Kefir Shop sales
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Net sales of products by category were as follows for the three months ended September 30:

Three months ended September 30, 2019 2018
2018 % 2017 % $ % $ %
Drinkable Kefir other than ProBugs $ 18,877 77% $ 22,154 77% $ 17,513 77% $ 18,877 77%
Cheese 2,656 11% 2,829 10% 2,791 12% 2,656 11%
Cream and other 1,406 6% 1,615 6% 913 4% 1,406 6%
Cupped Kefir and Skyr 699 3% 889 3%
ProBugs Kefir 471 2% 843 3% 590 3% 471 2%
Other dairy 432 2% 699 3%
Frozen Kefir (a) 371 1% 456 1% 490 2% 371 1%
Net Sales $ 24,480 100% $ 28,786 100% $ 22,729 100% $ 24,480 100%

(a) Includes Lifeway Kefir Shop sales
15

Significant Customers – Sales are predominately to companies in the retail food industry located within the United States. Two major customers accounted for approximately 22% of net sales for the nine months ended September 30, 2019 and 2018, ~~and 2017,~~respectively. Two major customers accounted for approximately 21% and 20% ~~and 21%~~ of net sales for the three months ended September 30, 2019 and 2018, ~~and 2017,~~ respectively.

Note 1213 – Related ~~party transactions~~Party Transactions

Lifeway obtains consulting services from the Chairperson of its board of directors. Fees earned ~~by the Chairperson~~ are included in general and administrative expenses in the accompanying consolidated statements of operations and were $750 during each of the nine months ended September 30, ~~2018~~2019 and ~~2017.~~2018. Fees earned ~~by the Chairperson~~ are included in general and administrative expenses in the accompanying consolidated statements of operations and were $250 during each of the three months ended September 30, ~~2018~~2019 and ~~2017.~~2018.

Lifeway is also a party to a royalty agreement with the Chairperson of its board of directors under which we pay the Chairperson a royalty based on the sale of certain Lifeway products, not to exceed $50 in any fiscal month. Royalties earned ~~by the Chairperson~~ are included in selling expenses in the accompanying consolidated statements of operations and were ~~$445~~$441 and ~~$450~~$445 during the nine months ended September 30, 2019 and 2018, respectively. Royalties earned are included in selling expenses in the accompanying consolidated statements of operations and ~~2017, respectively,~~were $143 and $145 ~~and $150~~ during the three months ended September 30, 2019 and 2018, ~~and 2017, respectively~~respectively.
Note 14 – Subsequent Events
On October 22, 2019, the Company sold approximately 45.6% of one of its investments recorded under the cost method on the consolidated balance sheets. The Company recognized a $1,413 gain on sale of the investment, which will be recorded in other income (expense) on the consolidated statements of operations during the fourth quarter of 2019. Under the terms of its line of credit agreement (see Note 7), the Company made a mandatory prepayment of $1,484, equal to the net proceeds of the sale of the investment, to the line of credit during the fourth quarter.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in this Form 10-Q is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements, the accompanying notes, and the MD&A included in our Annual Report on Form 10-K for the fiscal year ended December 31, ~~2017~~2018 (the “Form 10-K”). Unless otherwise specified, any description of “our”, “we”, and “us” in this MD&A refer to Lifeway Foods, Inc. and our subsidiaries.

Cautionary Statement Regarding Forward-Looking Statements

In addition to historical information, this quarterly report contains “forward-looking” statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of words such as "anticipate," "believe," "could," "estimate," "expect," "from time to time," "future," "intend," "plan," "likely," "may," "ongoing," "realize," "should," "will," and similar terms or terminology, or the negative of such terms or other comparable terminology. Examples of forward-looking statements include, among others, statements we make regarding:

•· Expectations of the effect on our financial condition of claims, litigation, environmental costs, contingent liabilities and governmental and regulatory investigations and proceedings;
•· Strategy for acquisitions, customer retention, growth, product development, market position, financial results and reserves; Estimates of the amounts of sales allowances and discounts to our customers and consumers;
•· Our belief that we will maintain compliance with our loan agreements and have sufficient liquidity to fund our business ~~operations;~~operations.

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

•· The impact of investigative and legal proceedings;
•· Developments and changes in laws and regulations, including regulation of the dairy or food industries through legislative action and revised rules and standards applied by the Food & Drug Administration (FDA);
•· Economic and financial conditions, including volatility in interest and exchange rates, commodity and equity prices, and the value of our assets;
•· Changes in the price of milk and other key materials and disruptions in supply chains for these materials;
•· Strategic actions, including acquisitions and dispositions and our success in launching new products;
•· The impact on our competitive position if we do not maintain compliance with our loan agreements and/or sufficient liquidity to fund our business operations;
•· Such other factors as discussed throughout Part I, Item 1 “Business”; Part I, Item 1A “Risk Factors”; and Part II, Item 7 “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018 and that are described from time to time in our filings with the SEC.
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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.

Results of Operations

17
Three Months Ended September 30, ~~2018~~2019 Compared to Three Months Ended September 30, ~~2017~~
~~Results of Operations~~
~~(In thousands)~~2018

September 30, Favorable / (Unfavorable) September 30, Change
2018 2017 $ % 2019 2018 $ %
Net sales $ 24,480 $ 28,786 $ (4,306 ) (15.0% ) $ 22,729 $ 24,480 $ (1,751 ) (7.2% )

Cost of goods sold $ 17,892 $ 20,331 $ 2,439 $ 16,813 $ 17,892 $ 1,079
Depreciation expense 738 618 (120 ) 743 738 (5 )
Total cost of goods sold $ 18,630 $ 20,949 $ 2,319 11.1% $ 17,556 $ 18,630 $ 1,074 5.8%

Gross profit $ 5,850 $ 7,837 $ (1,987 ) (25.4% ) $ 5,173 $ 5,850 $ (677 ) (11.6% )
Gross Profit % to net sales 23.9% 27.2% 22.8% 23.9%

Selling expenses $ 3,136 $ 4,010 $ 874 21.8% $ 2,679 $ 3,136 $ 457 14.6%
Selling expenses % to net sales 12.8% 13.9% 11.8% 12.8%

General & administrative expenses $ 3,150 $ 3,145 $ (5 ) (0.2% ) $ 2,710 $ 3,150 $ 440 14.0%
General & administrative % to net sales 12.9% 10.9% 11.9% 12.9%

Amortization expense $ 163 $ 168 $ 5 3.0% $ 39 $ 163 $ 124 76.1%

Total operating expenses $ 6,449 $ 7,323 $ 874 11.9% $ 5,428 $ 6,449 $ 1,021 15.8%
Total operating expense % to net sales 26.3% 25.4% 23.9% 26.3%
(Loss) income from operations $ (599 ) $ 514 $ (1,113 ) (216.5% )
(Loss) income from operations % to net sales (2.4% ) 1.8%
Loss from operations $ (255 ) $ (599 ) $ 344 (57.4% )
Loss from operations % to net sales (1.1% ) (2.4% )

Net Sales

Net sales finished at ~~$24,480~~$22,729 for the three-month period ended September 30, ~~2018,~~2019, a decrease of ~~$4,306~~$1,751 or ~~15.0%~~7.2% versus prior year. The net sales softness continued to reflect the overall lower consumption in the dairy and cultured dairy product categories. Versus prior year, ~~volume declines~~the decline was primarily ~~resulted from volume / mix~~driven by lower volumes of ~~17.6% due to lower~~our branded ~~and ProBugs~~ drinkable kefir and cupped kefir and Skyr sales, partially offset by the incremental volume of new products. In addition, an increase in trade promotion and allowances of 0.6% resulted as targeted programming and product activity was executed. This was partially offset by pricing gains of 3.2% which commenced during second quarter 2018.item introductions.
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Gross Profit

Gross profit as a percentage of net sales was ~~23.9%~~22.8% during the three-month period ended September 30, ~~2018.~~2019. Gross profit percentage was ~~27.2%~~23.9% in the prior year. The decline versus the prior year was primarily due to the unfavorable impact of operating leverage that arises from lower net sales ~~higher freight and~~relative to fixed costs, partially offset by a reduction in variable costs. Additionally, depreciation expense increased reflecting the continued investment in manufacturing improvements.

Selling Expenses

Selling expenses decreased by ~~$874~~$457 or ~~21.8%~~14.6% to ~~$3,136~~$2,679 during the three-month period ended September 30, 2019 from $3,136 during the same period in 2018. The decrease versus prior year, primarily reflects a ~~change~~reduction in ~~media spending to reduce~~advertising and marketing programs with lower ~~efficiency. The primary driver was~~efficiency, and compensation savings from organizational changes made in 2018. Selling expenses as a percentage of net sales were 11.8% during the ~~lapping of television media eliminated from third quarter 2018 that occurred~~three-month period ended September 30, 2019 compared to 12.8% for the same period in ~~the previous year, and to a lesser extent lower broker commissions and marketing spending.~~2018.
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General and ~~administrative expenses~~Administrative Expenses

General and administrative expenses ~~were slightly higher for~~decreased $440 or 14.0% to $2,710 during the three-month period ~~ending~~ended September 30, 2019 from $3,150 during the same period in 2018. The decrease is primarily a result of lower compensation expense due to organizational changes made in 2018, ~~finishing at $3,150, 0.2% above prior year. This reflects increased~~lower incentive compensation, and lower professional fees, partially offset by ~~lower~~increased legal expenses.

Provision for Income Taxes

The provision for income taxes includes federal, state and local income taxes. Benefit for income taxes was ~~$136~~$17 during the three months ended September 30, ~~2018,~~2019, compared to a ~~provision~~benefit for income taxes of ~~$175~~$136 during the same period in ~~2017.~~ 2018.
Our effective income tax rate (ETR) for the three months ended September 30, ~~2018~~2019 was ~~20.9%~~19.3% compared to an ETR of ~~41.9%~~20.9% in the same period last year. The ~~lower~~decrease in the effective tax rate ~~reflects~~was primarily due to the non-deductible expense amounts being a ~~high~~higher percentage of pre-tax income, non-deductible compensation expense related to equity incentive awards, and adjustments to state income tax ~~expense against relatively low pre-tax book income/(loss).~~receivable. The decrease in the effective tax rate was partially offset due to separate state tax rates and a change in valuation allowance.

~~On December 22, 2017,~~Section 162(m) of the Internal Revenue Code (the “Code”) limits the deductibility of compensation paid to certain of our executives. Under the Tax Cuts and Jobs Act (the “Act”) ~~was signed into law. The Act significantly changed U.S. income~~amendments to Section 162(m), no tax law by, among other things, reducing the U.S. federal income tax rate from 35% to 21%, transitioning from a global tax system to a modified territorial tax system, eliminating the domestic manufacturing deduction ~~reducing the dividend received deduction, and limiting the tax deductions for interest expense and executive compensation.~~
~~An estimated provisional impact of the remeasurement of deferred income taxes was recorded~~ in ~~the provision (benefit) for income taxes for the year ended~~taxable years beginning after December 31, ~~2017. However, our review of~~2017 is allowed for compensation paid to any covered employee to the ~~implications of~~extent that the total compensation for that covered employee exceeds $1,000,000 in any taxable year. Although the Act eliminated the prior tax deduction under Section 162(m) for performance-based executive compensation, it included a transition rule under which the changes to Section 162(m) will ~~be ongoing throughout 2018~~not apply to awards made to our covered employees who had the right to participate in our 2015 Omnibus Incentive Plan pursuant to written binding contracts in effect as ~~additional clarification and guidance are provided on how the IRS and state authorities will implement tax reform. We will also watch for additional~~of November 2, 2017, as long as those contracts have not subsequently been modified in any material respect. Accordingly, subject to further guidance from the ~~SEC or~~Treasury Department and the FASB related to tax reform. Effective January 1, 2018, we currently estimate that the impact of the Act will lower our combined statutory federal income tax rate plus an estimate for state, local and foreign income taxes from approximately 39.5% to 27.7%. Among other effects, the Act’s lower federal statutory rate is partially offset by the adverse impact of the Act’s elimination of the domestic manufacturing deduction. In future periods,Internal Revenue Service (“IRS”), we expect that performance-based compensation paid to our executives under our Omnibus Plan will remain eligible for the ~~Act to favorably impact net earnings, diluted earnings per share, and cash flows, primarily due to the Act’s reduction of the federal corporate tax rate.~~Section 162(m) exemption in 2019.

Income taxes are discussed in Note ~~9 in the Notes to the Consolidated Financial Statements.~~
~~Net income (loss)~~
We reported a net loss of $(514) or $(0.03) per basic and diluted common share for the three-month period ended September 30, 2018 compared to net income of $243 or $0.02 per basic and diluted common share in the same period in 2017.
~~Comparison of the nine-month period ended September 30, 2018 compared to the nine-month period ended September 30, 2017~~
~~Results of Operations~~
~~(In thousands)~~
September 30, Favorable / (Unfavorable)
2018 2017 $ %
Net sales $ 80,318 $ 92,636 $ (12,318 ) (13.3% )

Cost of goods sold $ 57,412 $ 65,262 $ 7,850
Depreciation expense 2,143 1,801 (342 )
Total cost of goods sold $ 59,555 $ 67,063 $ 7,508 11.2%

Gross profit $ 20,763 $ 25,573 $ (4,810 ) (18.8% )
Gross Profit % to net sales 25.9% 27.6%

Selling expenses $ 10,537 $ 11,648 $ 1,111 9.5%
Selling expenses % to net sales 13.1% 12.6%

General & administrative expenses $ 9,851 $ 10,743 $ 892 8.3%
General & administrative % to net sales 12.3% 11.6%

Amortization expense $ 490 $ 504 $ 14 2.8%

Total operating expenses $ 20,878 $ 22,895 $ 2,017 8.8%
Total operating expense % to net sales 26.0% 24.7%
(Loss) income from operations $ (115 ) $ 2,678 $ (2,793 ) (104.3% )
(Loss) income from operations % to net sales (0.1% ) 2.9%
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~~Net Sales~~
Net sales were $80,318 for the nine-month period ended September 30, 2018, a decrease of $12,318 or 13.3%. The decline was primarily due to volume / mix of 15.7%, partially offset by lower spend in trade promotion and allowances of 1.0%, partially offset by pricing gains of 1.4%. The decline in volume / mix was primarily driven by volume softness in our branded and ProBugs drinkable kefir, partially offset by the incremental volume of new item introductions. The volume decline reflects lower consumption of our products that is consistent with the overall volume decline in dairy and cultured dairy product categories.
Pricing primarily includes the favorable impact of a second quarter 2018 price increase to recover higher input costs. This increase was partially offset by the lapping of a price reduction driven by the shift in delivery method for select customers in the first quarter 2017. The favorable promotional activity reflects lower trade spending, partially offset by the increased redemptions on our 2018 coupon program.
~~Gross Profit~~
Gross profit as a percentage of net sales decreased to 25.9% during the nine-month period ended September 30, 2018 from 27.6% during the same period in 2017. The lower gross profit percentage primarily reflects category sales softness, product mix, fixed costs and incremental coupon activity. This was partially offset by an increase in pricing and lower trade spending.
~~Selling Expenses~~
Selling expenses decreased by $1,111 or 9.5% to $10,537 during the nine-month period ended September 30, 2018 from $11,648 during the same period in 2017. The decreased selling expenses primarily reflect the reduction in lower efficiency media spending and lower broker commissions and other marketing spending.
~~General and administrative expenses~~
General and administrative expenses decreased $892 or 8.3% to $9,851 during the nine-month period ended September 30, 2018 from $10,743 during the same period in 2017. The decrease is primarily a result of lower incentive compensation.
~~Provision for Income Tax~~
Benefit for income taxes was $8 during the nine-months ended September 30, 2018, compared to a provision for income taxes of $1,056 during the same period in 2017. Our effective tax rate (ETR) for the nine-months ended September 30, 2018 was 3.0% compared to an ETR of 42.9% in the same period last year. The low effective tax rate reflects a high percentage of non-deductible tax expense against low pre-tax book income results.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Act significantly changed U.S. income tax law by, among other things, reducing the U.S. federal income tax rate from 35% to 21%, transitioning from a global tax system to a modified territorial tax system, eliminating the domestic manufacturing deduction, reducing the dividend received deduction, and limiting the tax deductions for interest expense and executive compensation.
An estimated provisional impact of the remeasurement of deferred income taxes was recorded in the provision (benefit) for income taxes for the year ended December 31, 2017. However, our review of the implications of the Act will be ongoing throughout 2018 as additional clarification and guidance are provided on how the IRS and state authorities will implement tax reform. We will also watch for additional guidance from the SEC or the FASB related to tax reform. Effective January 1, 2018, we currently estimate that the impact of the Act will lower our combined statutory federal income tax rate plus an estimate for state, local and foreign income taxes from approximately 39.5% to 27.7%. Among other effects, the Act’s lower federal statutory rate is partially offset by the adverse impact of the Act’s elimination of the domestic manufacturing deduction. In future periods, we expect the Act to favorably impact net earnings, diluted earnings per share, and cash flows, primarily due to the Act’s reduction of the federal corporate tax rate.
~~Income taxes are discussed in Note 9~~10 in the Notes to the Consolidated Financial Statements.

2022

Net ~~income (loss)~~(Loss) Income

We reported a net loss of ~~$(274)~~$(72) or ~~$(0.02)~~$(0.00) per basic and diluted common share for the three-month period ended September 30, 2019 compared to a net loss of $(514) or $(0.03) per basic and diluted common share in the same period in 2018.
Nine months Ended September 30, 2019 Compared to Nine months Ended September 30, 2018
September 30, Change
2019 2018 $ %
Net sales $ 70,497 $ 80,318 $ (9,821 ) (12.2% )

Cost of goods sold $ 51,223 $ 57,412 $ 6,189
Depreciation expense 2,235 2,143 (92 )
Total cost of goods sold $ 53,458 $ 59,555 $ 6,097 10.2%

Gross profit $ 17,039 $ 20,763 $ (3,724 ) (17.9% )
Gross Profit % to net sales 24.2% 25.9%

Selling expenses $ 8,509 $ 10,537 $ 2,028 19.2%
Selling expenses % to net sales 12.1% 13.1%

General & administrative expenses $ 9,100 $ 9,851 $ 751 7.6%
General & administrative % to net sales 12.9% 12.3%

Amortization expense $ 152 $ 490 $ 338 69.0%

Total operating expenses $ 17,761 $ 20,878 $ 3,117 14.9%
Total operating expense % to net sales 25.2% 26.0%
Loss from operations $ (722 ) $ (115 ) $ (607 ) 527.8%
Loss from operations % to net sales (1.0% ) (0.1% )
Net Sales
Net sales were $70,497 for the nine-month period ended September 30, 2019, a decrease of $9,821 or 12.2% versus prior year. The net sales softness continued to reflect the overall lower consumption in the dairy and cultured dairy product categories. Versus prior year, the decline was primarily driven by lower volumes of our branded drinkable kefir and cupped kefir and Skyr sales, partially offset by the incremental volume of new item introductions.
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Gross Profit
Gross profit as a percentage of net sales decreased to 24.2% during the nine-month period ended September 30, 2019 from 25.9% during the same period in 2018. The lower gross profit percentage primarily reflects category sales softness, the unfavorable impact of operating leverage that arises from lower net sales relative to fixed costs, and increased freight costs, partially offset by a reduction in variable costs.
Selling Expenses
Selling expenses decreased by $2,028 or 19.2% to $8,509 during the nine-month period ended September 30, 2019 from $10,537 during the same period in 2018. The decreased selling expenses primarily reflect the reduction in advertising and marketing programs with lower efficiency and compensation savings from organizational changes made in 2018. Selling expenses as a percentage of net sales were 12.1% during the nine-month period ended September 30, 2019 compared to 13.1% for the same period in 2018.
General and Administrative Expenses
General and administrative expenses decreased $751 or 7.6% to $9,100 during the nine-month period ended September 30, 2019 from $9,851 during the same period in 2018. The decrease is primarily a result of lower compensation expense due to organizational changes made in 2018, lower incentive compensation, and lower professional fees, partially offset by increased legal expenses.
Provision for Income Taxes
The provision for income taxes includes federal, state and local income taxes. Benefit for income taxes was $58 during the nine months ended September 30, 2019, compared to a benefit for income taxes of $8 during the same period in 2018.
Our effective income tax rate (ETR) for the nine months ended September 30, 2019 was 8.8% compared to an ETR of 3.0% in the same period last year. The increase in the effective tax rate was primarily due to the separate state tax rates and non-deductible expense amounts being a lower percentage of pre-tax income, offset by a decrease in the rate attributable to non-deductible compensation expense related to equity incentive awards.
Section 162(m) of the Code limits the deductibility of compensation paid to certain of our executives. Under the Act’s amendments to Section 162(m), no tax deduction in taxable years beginning after December 31, 2017 is allowed for compensation paid to any covered employee to the extent that the total compensation for that covered employee exceeds $1,000,000 in any taxable year. Although the Act eliminated the prior tax deduction under Section 162(m) for performance-based executive compensation, it included a transition rule under which the changes to Section 162(m) will not apply to awards made to our covered employees who had the right to participate in our 2015 Omnibus Incentive Plan pursuant to written binding contracts in effect as of November 2, 2017, as long as those contracts have not subsequently been modified in any material respect. Accordingly, subject to further guidance from the Treasury Department and the Internal Revenue Service (“IRS”), we expect that performance-based compensation paid to our executives under our Omnibus Plan will remain eligible for the Section 162(m) exemption in 2019.
Income taxes are discussed in Note 10 in the Notes to the Consolidated Financial Statements.
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Net (Loss) Income
We reported a net loss of $(601) or $(0.04) per basic and diluted common share for the nine-month period ended September 30, ~~2018~~2019 compared to net income of ~~$1,403~~$(274) or ~~$0.09~~$(0.02) per basic and diluted common share in the same period in ~~2017.~~2018.

Liquidity and Capital Resources

We expect to meet our foreseeable liquidity and capital resource requirements through anticipated cash flows from operations; our revolving credit facility; and cash and cash equivalents. The success of our business and financing strategies will continue to provide us with the financial flexibility to take advantage of various opportunities as they arise.

Sources and Uses of Cash

Lifeway had a net ~~decrease~~increase in cash and cash equivalents of ~~$1,752~~$2,514 during the nine-month period ended September 30, ~~2018~~2019 compared to a net decrease in cash and cash equivalents of ~~$1,548~~$2,252 in the same period in ~~2017.~~2018. The drivers of the year over year change are as follows:

Net cash provided by operating activities was ~~$2,346~~$4,953 during the nine-month period ended September 30, ~~2018~~2019 compared to net cash provided by operating activities of ~~$4,189~~$2,346 in the same period in ~~2017.~~2018. The ~~decline~~increase in cash provided by operating activities ~~reflects lower net income and timing of accrued expenses.~~is primarily due to the change in working capital.

Net cash used in investing activities was ~~$2,991~~$112 during the nine-month period ended September 30, ~~2018~~2019 compared to net cash used in investing activities of ~~$3,920~~$2,991 in the same period in ~~2017.~~2018. The lower level of net cash used in investing activities in ~~the 2018 period~~2019 reflects lower capital spending. Capital spending was ~~$2,581~~$610 during the nine-month period ended September 30, ~~2018~~2019 compared to ~~$3,932~~$2,581 in ~~2017.~~2018. Our capital spending is focused in three core ~~areas,~~areas: growth, cost reduction, and facility improvements. Growth capital spending supports new product innovation and enhancements. Cost reduction spending supports manufacturing efficiency, safety and productivity. We received net proceeds of $474 related to the sale of our Skokie, IL facility during Q3 2019.

Net cash used in financing activities was ~~$1,607~~$2,327 during the ~~nine months~~nine-month period ended September 30, ~~2018~~2019 compared to net cash used in financing activities of ~~$1,817~~$1,607 in the same period in ~~2017.~~2018. We utilized proceeds from our federal and state income tax refunds to repay $1,330 on our revolving line of credit during the first quarter of 2019. We utilized the proceeds from the sale of our Skokie, IL facility to repay $459 on our revolving line of credit during the third quarter of 2019. On November 1, 2017, Lifeway’s Board approved an increase in the aggregate amount under our previously announced 2015 stock repurchase program (the “2017 Repurchase Plan Amendment”), by adding to (i.e., exclusive of the shares previously authorized under the 2015 stock repurchase program) the authorization the lesser of $5,185 or 625 shares. We repurchased approximately 210 shares of common stock at a cost of $538 during the nine-month period ended September 30, 2019 under the 2017 Repurchase Plan Amendment. We repurchased approximately 192 shares of common stock at a cost of $1,309 during the nine-month period ended September 30, 2018 under the 2017 Repurchase Plan Amendment. We may execute transactions from time to time in the open market or by private negotiation, in accordance with all applicable securities laws and regulations. We intend to hold repurchased shares in treasury for general corporate purposes, including issuances under our 2015 Omnibus Incentive Plan. Treasury shares are accounted for using the cost method.

Revolving credit facility.
On ~~May 7, 2018~~April 10, 2019, effective March 31, 2019, Lifeway entered into anthe First Modification to the Amended and Restated Loan and Security Agreement (the ~~“Revolving~~“Modified Revolving Credit Facility”) with its existing lender. ~~The~~Under the amendment, the Modified Revolving Credit Facility provides for a revolving line of credit up to a maximum of ~~$10~~$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”).

~~The~~
25
All outstanding amounts under the Loans bear interest, based on a level of the Senior Debt to EBITDA ratio, at Lifeway’s election, at either the lender Base Rate (the greater of either the Federal Funds Rate plus 0.0% to 0.5%, or the Prime Rate) or the LIBOR plus 2.25% to 3.00%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee and, in conjunction with the issuance of any letters of credit, a letter of credit fee.
As amended, the Modified Revolving Credit Facility contains customary representations, warranties, and covenants on the part of Lifeway, including financial covenants requiring us to achieve a minimum EBITDA threshold for each of the fiscal quarters ~~during the year ended~~through December 31, ~~2018~~2019, and maintain ~~(a)~~ a fixed charge coverage ratio of no less than 1.25 to 1.0 ~~and (b) a senior debt to EBTIDA ratio of not more than 3.0 to 1.0 at December 31, 2018 and for~~ each of the ~~succeeding~~ fiscal quarters ending through the expiration date. The Modified Revolving Credit Facility also provides for events of default, including failure to repay principal and interest when due and failure to perform or violation of the provisions or covenants of the agreement, as a result of which amounts due under the Modified Revolving Credit Facility may be accelerated. We were in compliance with the applicable covenants as of September 30, ~~2018.~~2019
We used the revolving credit facility to retire all the then-outstanding term loans described in Note 7 to the consolidated financial statements. The revolving credit facility provides us advantages over our prior debt facilities, including that it does not require scheduled principal payments, gives us access to unused credit capacity, and does not require costly annual amendments or extensions. Additionally, we have no debt maturities until May 2021.
21
We have been able to deploy capital resources to take advantage of targeted growth opportunities, including the development of our cupped kefir and cheese products, and to improve our manufacturing platform’s capacity and capabilities. We believe we have ample access to additional capital, as evidenced by our revolving credit facility transaction in May 2018, and we may issue debt or equity securities from time to time when we determine that market conditions and the opportunity to utilize the proceeds from the issuance of such securities are favorable. Such opportunities could include refinancing existing indebtedness, funding capital expenditures, extending our debt maturities in a favorable interest rate environment, or taking advantage of acquisition opportunities that generate favorable returns.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes to our market risk during the third quarter of ~~2018.~~2019. For information regarding our exposure to certain market risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”, in the ~~2017~~2018 Form 10-K.

ITEM 4. CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures

Our evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act was performed under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer. The purpose of disclosure controls and procedures is to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
As previously disclosed under “Item 9A—Controls and Procedures” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, we concluded that our internal control over financial reporting was not effective based on the material weakness in our controls over the review of the result of the annual step one goodwill impairment evaluation performed by the third party valuation expert that we engaged. Based ~~upon~~on the material weakness, which we view as an integral part of our ~~most recent~~disclosure controls ~~evaluation,~~and procedures, our ~~CEO~~Chief Executive Officer and ~~CFO~~Chief Financial Officer have concluded that, ~~our Disclosure Controls were effective~~ as of the quarter ended September 30, ~~2018.~~2019, our disclosure controls and procedures were not effective. Nevertheless, based on a number of factors, including the performance of additional procedures by management designed to ensure the reliability of our financial reporting, we believe that the consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

(b) Changes in Internal Control over Financial Reporting

Our remediation efforts began during the nine months ended September 30, 2019. Remediation generally requires making changes to how controls are designed and implemented and then adhering to those changes for a sufficient period of time such that the effectiveness of those changes is demonstrated with an appropriate amount of consistency. We have begun to take certain remediation steps to address the material weakness referenced above and to improve our control over financial reporting. If not remediated these deficiencies could result in material misstatements to our consolidated financial statements.
In response to the material weakness described above, management is currently evaluating our policies and procedures related to the review of the analysis in goodwill impairment reports prepared by third-party valuation experts and plans to design and implement adequate internal controls and procedures to ensure that (i) goodwill impairment is properly reviewed, accounted for and disclosed, and (ii) management can more effectively evaluate analysis conducted by third-party valuation service providers that perform the step one goodwill impairment analysis. Management has adopted revised procedures related to the identification and selection of third-party valuation experts and is using that process to select a new third-party valuation expert to perform the annual goodwill impairment analysis.
There were no other changes in our internal control over financial reporting during the third quarter of ~~2018~~2019 that were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

2226

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

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

ITEM 1A. RISK FACTORS.

There have been no material changes to the Risk Factors disclosed in Part I, Item 1A of the ~~2017~~2018 Form 10-K.

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

Issuer Purchases of Equity Securities

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURE.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.
27

ITEM 6. EXHIBITS.

No. Description Form Period Ending Exhibit Filing Date

10.1 Employment Agreement dated July 20, 2018 with Neha J. Clark. 8-K 10.1 8/3/18

31.1 Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky Filed Herewith

31.2 Rule 13a-14(a)/15d-14(a) Certification of Neha Clark Filed Herewith

32.1 Section 1350 Certification of Julie Smolyansky Filed Herewith

32.2 Section 1350 Certification of Neha Clark Filed Herewith

99.1 Press release dated November 14, 2018 reporting Lifeway’s financial results for the nine months ended September 30, 2018. Furnished Herewith

101 Interactive Data Files Filed Herewith
No. Description Form Period Ending Exhibit Filing Date
31.1 Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky Filed Herewith
31.2 Rule 13a-14(a)/15d-14(a) Certification of Eric Hanson Filed Herewith
32.1 Section 1350 Certification of Julie Smolyansky Filed Herewith
32.2 Section 1350 Certification of Eric Hanson Filed Herewith
99.1 Press release dated November 14, 2019 reporting Lifeway’s financial results for the nine months ended September 30, 2019. Furnished Herewith
101 Interactive Data Files Filed Herewith

2328

SIGNATURES

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

LIFEWAY FOODS, INC.

Date: November 14, 2019 By:   /s/ Julie Smolyansky
Julie Smolyansky
Chief Executive Officer, President, and Director
(Principal Executive Officer)

Date: November 14, ~~2018~~2019 By:   /s/ ~~Julie Smolyansky~~ Eric Hanson
~~Julie Smolyansky~~
~~Chief Executive Officer, President, and Director~~
~~(Principal Executive Officer)~~
~~Date: November 14, 2018~~ ~~By:~~   ~~/s/ Neha Clark~~
~~Neha Clark~~ Eric Hanson
Chief Financial & Accounting Officer
(Principal Financial and Accounting Officer)

2429

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

Balance, January 1, 2018		17,274	$	6,509		(1,266	)	$	(11,812	)	$	2,244		$	49,649		$	46,590

Issuance of common stock in connection with stock-based compensation		–		–		16			151			(54	)		–			97

Treasury stock purchased		–		–		(131	)		(1,052	)		–			–			(1,052	)

Stock-based compensation		–		–		–			–			5			–			5

Net loss		–		–		–			–			–			70			70

Balance, March 31, 2018		17,274	$	6,509		(1,381	)	$	(12,713	)	$	2,195		$	49,719		$	45,710

Issuance of common stock in connection with stock-based compensation		–		–		6			52			(17	)		–			35

Treasury stock purchased		–		–		(20	)		(116	)		–			–			(116	)

Stock-based compensation		–		–		–			–			6			–			6

Net loss		–		–		–			–			–			170			170

Balance June 30, 2018		17,274	$	6,509		(1,395	)	$	(12,777	)	$	2,184		$	49,889		$	45,805

Treasury stock purchased		–		–		(41	)		(141	)		–			–			(141	)

Stock-based compensation		–		–		–			–			27			–			27

Net loss		–		–		–			–			–			(514	)		(514	)

Balance, September 30, 2018		17,274	$	6,509		(1,436	)	$	(12,918	)	$	2,211		$	49,375		$	45,177

	Nine Months Ended September 30,
	2019			2018
Cash flows from operating activities:
Net loss	$	(601	)	$	(274	)
Adjustments to reconcile net loss to operating cash flow:
Depreciation and amortization		2,387			2,633
Bad debt expense		20			50
Reserve for inventory obsolescence		177			580
Stock-based compensation		714			827
Non-cash interest expense		17			9
Deferred revenue		(73	)		(72	)
(Gain) on sale of property and equipment		(183	)		(42	)
(Increase) decrease in operating assets:
Accounts receivable		(316	)		553
Inventories		(1,118	)		280
Refundable income taxes		1,921			(612	)
Prepaid expenses and other current assets		(399	)		(291	)
Increase (decrease) in operating liabilities:
Accounts payable		2,397			(586	)
Accrued expenses		53			(588	)
Accrued income taxes		(43	)		(121	)
Net cash provided by operating activities		4,953			2,346

Cash flows from investing activities:
Purchases of property and equipment		(610	)		(2,581	)
Proceeds from sale of property and equipment		513			90
Purchase of investments		(15	)		(500	)
Net cash used in investing activities		(112	)		(2,991	)

Cash flows from financing activities:
Purchase of treasury stock		(538	)		(1,309	)
Borrowings under revolving credit facility		–			6,050
Repayment of line of credit		(1,789	)		–
Payment of deferred financing costs		–			(69	)
Repayment of notes payable		–			(6,279	)
Net cash used in financing activities		(2,327	)		(1,607	)

Net increase (decrease) in cash and cash equivalents		2,514			(2,252	)

Cash and cash equivalents at the beginning of the period		2,998			4,978

Cash and cash equivalents at the end of the period	$	5,512		$	2,726

Supplemental cash flow information:
Cash paid for income taxes, net of (refunds)	$	(1,937	)	$	724
Cash paid for interest	$	214		$	189

Non-cash investing activities
Right-of-use assets recognized at ASU 2016-02 transition	$	944		$	–
Operating lease liability recognized at ASU 2016-02 transition	$	997		$	–
Right-of-use assets and operating lease liabilities recognized after ASU 2016-02 transition	$	280		$	–

	September 30, 2018		December 31, 2017
Ingredients	$	1,970	$	1,717
Packaging		2,064		2,453
Finished goods		2,803		3,527
Total inventories	$	6,837	$	7,697

	September 30, 2019		December 31, 2018
Ingredients	$	2,293	$	1,580
Packaging		2,124		2,072
Finished goods		2,341		2,165
Total inventories	$	6,758	$	5,817

	September 30, 2018		December 31, 2017

Variable rate term loan due May 31, 2018. Principal and interest payable monthly with a balloon payment due at maturity. Paid in full.	$	–	$	2,832
Variable rate term loan due May 31, 2019. Principal and interest payable monthly with a balloon payment due at maturity. Paid in full.		–		3,447
Total term loans		–		6,279
Less current portion		–		(3,166	)
Total long-term portion	$	–	$	3,113

Year	Operating Leases
Three months ended December 31, 2019	$	144
2020		303
2021		227
2022		190
2023		71
Thereafter		7
Total lease payments		942
Less: Interest		(61	)
Present value of lease liabilities	$	881

	Options		Weighted average exercise price		Weighted average remaining contractual life		Aggregate intrinsic value		Options		Weighted average exercise price		Weighted average remaining contractual life		Aggregate intrinsic value

Outstanding at December 31, 2017		45	$	10.45
Outstanding at December 31, 2018										41	$	10.42		7.22		–
Granted		–	$	–						–	$	–
Exercised		–	$	–						–	$	–
Forfeited		(3)	$	11.10						–	$	–
Outstanding at September 30, 2018		42	$	10.40		7.50	$	–
Exercisable at September 30, 2018		36	$	10.42		7.50	$	–
Outstanding at September 30, 2019										41	$	10.42		6.47	$	–
Exercisable at September 30, 2019										41	$	10.42		6.47	$	–

	RSA’s

Outstanding at December 31, 2018		25
Granted		39
Shares issued upon vesting		(12	)
Forfeited		–
Outstanding at September 30, 2019		52
Weighted average grant date fair value per share outstanding	$	3.90

	RSU’s

Outstanding at December 31, 2017		–
Granted		26
Shares issued upon vesting		–
Forfeited		–
Outstanding at September 30, 2018		26
Weighted average grant date fair value per share outstanding	$	5.63

	•·	Drinkable Kefir, sold in a variety of organic and non-organic sizes, flavors, and types, including low fat, non-fat, whole milk, protein, BioKefir (a 3.5 oz. kefir with additional probiotic cultures), and Kefir with Oats.

	•·	~~Cheese, which includes~~ European-style soft cheeses, ~~and~~including farmer cheese in resealable cups.

	•·	Cream and other, which consists primarily of cream, a byproduct of making our ~~fluid milk manufacturing process, and non-dairy products.~~kefir.

	•·	ProBugs, a line of kefir products in drinkable ~~frozen,~~ and ~~freeze dried~~frozen formats, designed for children.

	•·	~~Cupped Kefir and Skyr,~~Other Dairy, which ~~include~~includes Cupped Kefir and Icelandic Skyr, a line of strained kefir and yogurt products in resealable cups.

	•·	Frozen Kefir, available in both bars and pint-size containers.

	Three months ended September 30,								2019				2018
	2018		%		2017		%		$		%		$		%
Drinkable Kefir other than ProBugs	$	18,877		77%	$	22,154		77%	$	17,513		77%	$	18,877		77%
Cheese		2,656		11%		2,829		10%		2,791		12%		2,656		11%
Cream and other		1,406		6%		1,615		6%		913		4%		1,406		6%
Cupped Kefir and Skyr		699		3%		889		3%
ProBugs Kefir		471		2%		843		3%		590		3%		471		2%
Other dairy										432		2%		699		3%
Frozen Kefir (a)		371		1%		456		1%		490		2%		371		1%
Net Sales	$	24,480		100%	$	28,786		100%	$	22,729		100%	$	24,480		100%

	•·	Expectations of the effect on our financial condition of claims, litigation, environmental costs, contingent liabilities and governmental and regulatory investigations and proceedings;
	•·	Strategy for acquisitions, customer retention, growth, product development, market position, financial results and reserves; Estimates of the amounts of sales allowances and discounts to our customers and consumers;
	•·	Our belief that we will maintain compliance with our loan agreements and have sufficient liquidity to fund our business ~~operations;~~operations.

	•·	The impact of investigative and legal proceedings;
	•·	Developments and changes in laws and regulations, including regulation of the dairy or food industries through legislative action and revised rules and standards applied by the Food & Drug Administration (FDA);
	•·	Economic and financial conditions, including volatility in interest and exchange rates, commodity and equity prices, and the value of our assets;
	•·	Changes in the price of milk and other key materials and disruptions in supply chains for these materials;
	•·	Strategic actions, including acquisitions and dispositions and our success in launching new products;
	•·	The impact on our competitive position if we do not maintain compliance with our loan agreements and/or sufficient liquidity to fund our business operations;
	•·	Such other factors as discussed throughout Part I, Item 1 “Business”; Part I, Item 1A “Risk Factors”; and Part II, Item 7 “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018 and that are described from time to time in our filings with the SEC.

	September 30,					Favorable / (Unfavorable)						September 30,						Change
	2018			2017		$			%			2019			2018			$			%
Net sales	$	24,480		$	28,786	$	(4,306	)		(15.0%	)	$	22,729		$	24,480		$	(1,751	)		(7.2%	)

Cost of goods sold	$	17,892		$	20,331	$	2,439					$	16,813		$	17,892		$	1,079
Depreciation expense		738			618		(120	)					743			738			(5	)
Total cost of goods sold	$	18,630		$	20,949	$	2,319			11.1%		$	17,556		$	18,630		$	1,074			5.8%

Gross profit	$	5,850		$	7,837	$	(1,987	)		(25.4%	)	$	5,173		$	5,850		$	(677	)		(11.6%	)
Gross Profit % to net sales		23.9%			27.2%								22.8%			23.9%

Selling expenses	$	3,136		$	4,010	$	874			21.8%		$	2,679		$	3,136		$	457			14.6%
Selling expenses % to net sales		12.8%			13.9%								11.8%			12.8%

General & administrative expenses	$	3,150		$	3,145	$	(5	)		(0.2%	)	$	2,710		$	3,150		$	440			14.0%
General & administrative % to net sales		12.9%			10.9%								11.9%			12.9%

Amortization expense	$	163		$	168	$	5			3.0%		$	39		$	163		$	124			76.1%

Total operating expenses	$	6,449		$	7,323	$	874			11.9%		$	5,428		$	6,449		$	1,021			15.8%
Total operating expense % to net sales		26.3%			25.4%								23.9%			26.3%
(Loss) income from operations	$	(599	)	$	514	$	(1,113	)		(216.5%	)
(Loss) income from operations % to net sales		(2.4%	)		1.8%
Loss from operations												$	(255	)	$	(599	)	$	344			(57.4%	)
Loss from operations % to net sales													(1.1%	)		(2.4%	)

No.	Description	Form	Period Ending	Exhibit	Filing Date

10.1	Employment Agreement dated July 20, 2018 with Neha J. Clark.	8-K		10.1	8/3/18

31.1	Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky	Filed Herewith

31.2	Rule 13a-14(a)/15d-14(a) Certification of Neha Clark	Filed Herewith

32.1	Section 1350 Certification of Julie Smolyansky	Filed Herewith

32.2	Section 1350 Certification of Neha Clark	Filed Herewith

99.1	Press release dated November 14, 2018 reporting Lifeway’s financial results for the nine months ended September 30, 2018.	Furnished Herewith

101	Interactive Data Files	Filed Herewith

	LIFEWAY FOODS, INC.



Date: November 14, 2019	By:	/s/ Julie Smolyansky
		Julie Smolyansky
		Chief Executive Officer, President, and Director
		(Principal Executive Officer)



Date: November 14, ~~2018~~2019	By:	/s/ ~~Julie Smolyansky~~	Eric Hanson
		~~Julie Smolyansky~~
		~~Chief Executive Officer, President, and Director~~
		~~(Principal Executive Officer)~~



~~Date: November 14, 2018~~	~~By:~~	~~/s/ Neha Clark~~
		~~Neha Clark~~	Eric Hanson
		Chief Financial & Accounting Officer
		(Principal Financial and Accounting Officer)