LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2016 and December 31, 2015
(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 U.S. generally accepted accounting principles ("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, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation, have been included. For further information, refer to the consolidated financial statements and disclosures included in the consolidated financial statements included in the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2015.
Certain amounts in prior-year financial statements were reclassified to conform to the current-year presentation. The results for the period are not necessarily indicative of the results to be expected for other interim periods or the full year.
New presentation format.
In prior periods, the Company presented gross sales, discounts and promotional allowances and net sales as distinct financial statement captions in our statements of income (loss) and comprehensive income (loss). During the second quarter of 2016, the Company concluded that it was appropriate to simply present net sales. All prior periods have been conformed to the new presentation.
Corrections of errors and revisions of prior period financial statements
During the third quarter of fiscal 2016, the Company recorded adjustments to properly classify indirect manufacturing overhead costs related to certain production facilities within our manufacturing platform as an element of Cost of Goods Sold in our Statements of Income (Loss) and Comprehensive Income (Loss). In prior periods these costs were incorrectly classified in General and Administrative expenses.
Additionally, in the first and second quarter of 2015, certain executive compensation was classified in Selling expenses that more appropriately should be classified as General and Administrative expenses. We previously corrected these classification errors in our first and second quarter 2016 filings on Form 10-Q with the SEC.
Collectively,
these adjustments had the following impact on our Consolidated Statements of Income (Loss) and Comprehensive Income (Loss):
|
|
(Unaudited)
Three Months Ended
March 31, 2016
|
|
|
(Unaudited)
Six Months Ended
June 30, 2016
|
|
|
|
As Previously Reported
|
|
|
Adjustment
|
|
|
As Revised
|
|
|
As Previously Reported
|
|
|
Adjustment
|
|
|
As Revised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
32,570
|
|
|
$
|
—
|
|
|
$
|
32,570
|
|
|
$
|
63,701
|
|
|
$
|
—
|
|
|
$
|
63,701
|
|
Cost of Goods Sold
|
|
|
23,351
|
|
|
|
519
|
|
|
|
23,870
|
|
|
|
44,290
|
|
|
|
976
|
|
|
|
45,266
|
|
Gross Profit
|
|
|
9,219
|
|
|
|
(519
|
)
|
|
|
8,700
|
|
|
|
19,411
|
|
|
|
(976
|
)
|
|
|
18,435
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
|
2,964
|
|
|
|
—
|
|
|
|
2,964
|
|
|
|
6,427
|
|
|
|
—
|
|
|
|
6,427
|
|
General & administrative
|
|
|
4,465
|
|
|
|
(519
|
)
|
|
|
3,946
|
|
|
|
7,968
|
|
|
|
(976
|
)
|
|
|
6,992
|
|
Amortization
|
|
|
176
|
|
|
|
—
|
|
|
|
176
|
|
|
|
353
|
|
|
|
—
|
|
|
|
353
|
|
Operating expenses
|
|
|
7,605
|
|
|
|
(519
|
)
|
|
|
7,086
|
|
|
|
14,748
|
|
|
|
(976
|
)
|
|
|
13,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Operations
|
|
$
|
1,614
|
|
|
$
|
—
|
|
|
$
|
1,614
|
|
|
$
|
4,663
|
|
|
$
|
—
|
|
|
$
|
4,663
|
|
|
|
(Unaudited)
Three Months Ended
March 31, 2015
|
|
|
(Unaudited)
Six Months Ended
June 30, 2015
|
|
|
|
As Previously Reported
(a)
|
|
|
Adjustment
|
|
|
As Revised
|
|
|
As Previously Reported
(a)
|
|
|
Adjustment
|
|
|
As Revised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
29,622
|
|
|
$
|
—
|
|
|
$
|
29,622
|
|
|
$
|
59,443
|
|
|
$
|
—
|
|
|
$
|
59,443
|
|
Cost of Goods Sold
|
|
|
21,239
|
|
|
|
458
|
|
|
|
21,697
|
|
|
|
44,044
|
|
|
|
1,017
|
|
|
|
45,061
|
|
Gross Profit
|
|
|
8,383
|
|
|
|
(458
|
)
|
|
|
7,925
|
|
|
|
15,399
|
|
|
|
(1,017
|
)
|
|
|
14,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
|
3,302
|
|
|
|
—
|
|
|
|
3,302
|
|
|
|
5,920
|
|
|
|
—
|
|
|
|
5,920
|
|
General & administrative
|
|
|
3,492
|
|
|
|
(458
|
)
|
|
|
3,034
|
|
|
|
7,662
|
|
|
|
(1,017
|
)
|
|
|
6,645
|
|
Amortization
|
|
|
179
|
|
|
|
—
|
|
|
|
179
|
|
|
|
358
|
|
|
|
—
|
|
|
|
358
|
|
Operating expenses
|
|
|
6,973
|
|
|
|
(458
|
)
|
|
|
6,515
|
|
|
|
13,940
|
|
|
|
(1,017
|
)
|
|
|
12,923
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Operations
|
|
$
|
1,410
|
|
|
$
|
—
|
|
|
$
|
1,410
|
|
|
$
|
1,459
|
|
|
$
|
—
|
|
|
$
|
1,459
|
|
(a)
|
As previously reported in our first and second quarter 2016 Form 10Q filings.
|
|
|
(Unaudited)
Nine Months Ended
September 30, 2015
|
|
|
Twelve Months Ended
December 31, 2015
|
|
|
|
As Previously Reported
|
|
|
Adjustment
(b)
|
|
|
As Revised
|
|
|
As Previously Reported
|
|
|
Adjustment
(b)
|
|
|
As Revised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
89,042
|
|
|
$
|
—
|
|
|
$
|
89,042
|
|
|
$
|
118,587
|
|
|
$
|
—
|
|
|
$
|
118,587
|
|
Cost of Goods Sold
|
|
|
64,588
|
|
|
|
1,137
|
|
|
|
65,725
|
|
|
|
86,986
|
|
|
|
1,556
|
|
|
|
88,542
|
|
Gross Profit
|
|
|
24,454
|
|
|
|
(1,137
|
)
|
|
|
23,317
|
|
|
|
31,601
|
|
|
|
(1,556
|
)
|
|
|
30,045
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
|
9,486
|
|
|
|
(860
|
)
|
|
|
8,626
|
|
|
|
12,752
|
|
|
|
(860
|
)
|
|
|
11,892
|
|
General & administrative
|
|
|
10,920
|
|
|
|
(277
|
)
|
|
|
10,643
|
|
|
|
13,730
|
|
|
|
(696
|
)
|
|
|
13,034
|
|
Amortization
|
|
|
537
|
|
|
|
—
|
|
|
|
537
|
|
|
|
716
|
|
|
|
—
|
|
|
|
716
|
|
Operating expenses
|
|
|
20,943
|
|
|
|
(1,137
|
)
|
|
|
19,806
|
|
|
|
27,198
|
|
|
|
(1,556
|
)
|
|
|
25,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from Operations
|
|
$
|
3,511
|
|
|
$
|
—
|
|
|
$
|
3,511
|
|
|
$
|
4,403
|
|
|
$
|
—
|
|
|
$
|
4,403
|
|
(b)
|
Includes the reclassification of certain executive compensation from Selling to General and administrative expenses.
|
Further, these adjustments had no impact on the measurement of Income before provision for incomes taxes, Net income (loss), Basic and diluted earnings (loss) per common share or any element of the Consolidated Balance Sheets or Statements of Cash Flows for any of the respective periods. The Company determined these adjustments to be immaterial, individually and in the aggregate, to our previously filed consolidated financial statements.
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 fair value of investment securities, the valuation of goodwill and intangible assets, and deferred income taxes.
Revenue Recognition
The Company records sales when the following four criteria have been met: (i) The product has been shipped and the Company has no significant remaining obligations; (ii) Persuasive evidence of an agreement exists; (iii) The price to the buyer is fixed or determinable; and (iv) Collection is probable. In addition, shipping costs invoiced to the customers are included in net sales and the related costs are included in cost of sales.
The Company routinely offers sales allowances and discounts to our customers and consumers. These programs include rebates, in-store display and demo allowances, allowances for non-salable product, coupons and other trade promotional activities. These allowances are considered reductions in the price of our products and thus are recorded as reductions to gross sales. Some of these incentives are recorded by estimating incentive costs based on our historical experience and expected levels of performance of the trade promotion. We maintain a reserve for the estimated allowances incurred but unpaid. Differences between estimated and actual allowances are normally insignificant and are recognized in income in the period such differences are determined. Product returns have historically not been material.
Bulk cream is a by-product of the Company's fluid milk manufacturing process. The Company does not use bulk cream in any of its end products, but rather disposes of it through sales to other companies. Bulk cream by-product sales are included in net sales.
Advertising and promotional costs
The Company expenses advertising costs as incurred. For the nine months ended September 30, 2016 and 2015 total advertising expenses were $5,418 and $4,145 respectively. For the three months ended September 30, 2016 and 2015 total advertising expenses were $2,665 and $1,324 respectively.
Recent Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board ("FASB") issued new guidance 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. The new guidance will be effective for fiscal years beginning on or after December 15, 2017 and interim periods within those years. Early adoption of the guidance is permitted. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.
In March 2016, the FASB issued new guidance regarding certain aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new guidance will be effective for fiscal years beginning on or after December 15, 2016 and interim periods within those years. Early adoption of the guidance is permitted. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.
In February 2016, the FASB issued new guidance regarding leases. The guidance requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize on the balance sheet 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. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.
In January, 2016, the FASB issued new guidance regarding the recognition and measurement of financial assets and liabilities. The new guidance modifies how entities measure equity investments and present changes in the fair value of certain financial liabilities. Under the new guidance, entities will have to measure equity investments that do not result in consolidation and are not accounted under the equity method at fair value and recognize any changes in fair value in net income unless certain conditions exist. The new guidance will be effective for fiscal years beginning on or after December 15, 2017 and interim periods within those years. Other than for recognition and measurement, early adoption of the guidance is permitted. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.
In November 2015, the FASB issued new guidance regarding the balance sheet classification of deferred income taxes. This new guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. Previous guidance required deferred tax assets and liabilities to be separated into current and noncurrent amounts on the balance sheet. The guidance is effective for fiscal years beginning on or after December 15, 2016, and interim periods within those years. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements.
In July 2015, the FASB issued new accounting guidance for measuring inventory. The core principal of the guidance is that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance does not apply to inventory that is being measured using the Last-In, First-Out (LIFO) or the retail inventory method. The guidance is effective for financial statements issued for annual and interim periods beginning after December 15, 2016 on a prospective basis. Early adoption is permitted. Management is currently evaluating the impact this will have on the consolidated financial statements.
In May 2014, the FASB issued new guidance regarding revenue recognition. Additional revenue recognition guidance clarifications have been issued subsequent to May 2014. Collectively the new revenue recognition guidance supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific requirements. The new guidance establishes a five-step revenue recognition process in which an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. The Company is required to adopt the new guidance not later than January 1, 2018. Management is currently evaluating the impact that the new guidance will have on the consolidated financial statements and the method of retrospective application, either full or modified.
Note 3 – Intangible Assets
Goodwill & indefinite-lived intangible assets consists of the following:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Goodwill
|
|
$
|
10,368
|
|
|
$
|
10,368
|
|
Brand names
|
|
|
3,700
|
|
|
|
3,700
|
|
Goodwill & indefinite lived intangible assets
|
|
$
|
14,068
|
|
|
$
|
14,068
|
|
Other intangible assets, net consists of the following:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Recipes
|
|
$
|
44
|
|
|
$
|
44
|
|
Customer lists and other customer related intangibles
|
|
|
4,529
|
|
|
|
4,529
|
|
Customer relationship
|
|
|
985
|
|
|
|
985
|
|
Trade names
|
|
|
2,248
|
|
|
|
2,248
|
|
Formula
|
|
|
438
|
|
|
|
438
|
|
|
|
|
8,244
|
|
|
|
8,244
|
|
Accumulated amortization
|
|
|
(6,429
|
)
|
|
|
(5,900
|
)
|
Intangible assets, net
|
|
$
|
1,815
|
|
|
$
|
2,344
|
|
Note 4 – Investments
The cost and fair value of investments classified as available for sale are as follows:
September 30, 2016
|
|
Cost
|
|
|
Unrealized
Gains
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks & ETF's
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Mutual Funds
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Preferred Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Corporate Bonds
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
December 31, 2015
|
|
Cost
|
|
|
Unrealized
Gains
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks & ETF's
|
|
$
|
690
|
|
|
$
|
17
|
|
|
$
|
(94
|
)
|
|
$
|
613
|
|
Mutual Funds
|
|
|
27
|
|
|
|
—
|
|
|
|
(1
|
)
|
|
|
26
|
|
Preferred Securities
|
|
|
98
|
|
|
|
6
|
|
|
|
—
|
|
|
|
104
|
|
Corporate Bonds
|
|
|
1,518
|
|
|
|
43
|
|
|
|
(88
|
)
|
|
|
1,473
|
|
Total
|
|
$
|
2,333
|
|
|
$
|
66
|
|
|
$
|
(183
|
)
|
|
$
|
2,216
|
|
Gross gains of $185 and $14 and gross losses of $200 and $35 were realized on these sales during the nine months ended September 30, 2016 and 2015, respectively. Gross gains of $120 and $1 and gross losses of $108 and $0 were realized on these sales during the three months ended September 30, 2016 and 2015 respectively.
The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2016 and December 31, 2015:
|
|
Less Than 12 Months
|
|
|
12 Months or Greater
|
|
|
Total
|
|
September 30, 2016
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks & ETF's
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Mutual Funds
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Preferred Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Corporate Bonds
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or Greater
|
|
|
Total
|
|
December 31, 2015
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
Fair Value
|
|
|
Unrealized Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks & ETF's
|
|
$
|
225
|
|
|
$
|
(72
|
)
|
|
$
|
152
|
|
|
$
|
(22
|
)
|
|
$
|
377
|
|
|
$
|
(94
|
)
|
Mutual Funds
|
|
|
26
|
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
26
|
|
|
|
(1
|
)
|
Preferred Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Corporate Bonds
|
|
|
370
|
|
|
|
(32
|
)
|
|
|
479
|
|
|
|
(56
|
)
|
|
|
849
|
|
|
|
(88
|
)
|
|
|
$
|
621
|
|
|
$
|
(105
|
)
|
|
$
|
631
|
|
|
$
|
(78
|
)
|
|
$
|
1,252
|
|
|
$
|
(183
|
)
|
The Company's investments in equity securities, mutual funds, preferred securities, and corporate bonds consisted of investments in common stock, preferred stock, structured notes and other debt securities of companies in various industries. The Company recorded other-than-temporary impairment losses related to certain structured notes of $0 and $385 during the nine months ended September 30, 2016 and 2015 respectively. The structured notes allow the issuer to settle at an amount less than par in certain circumstances. In reaching a conclusion to record these other-than-temporary impairment losses, the Company evaluated the near-term prospects of the issuers and determined it was probable the issuers would have the ability to settle the bonds for an amount less than par value at maturity.
Note 5 – Inventories
Inventories consist of the following:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Finished goods
|
|
$
|
3,357
|
|
|
$
|
2,946
|
|
Production supplies
|
|
|
3,168
|
|
|
|
2,636
|
|
Raw materials
|
|
|
2,661
|
|
|
|
2,082
|
|
Total inventories
|
|
$
|
9,186
|
|
|
$
|
7,664
|
|
Note 6 – Property and Equipment
Property and equipment consist of the following:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Land
|
|
$
|
1,747
|
|
|
$
|
1,807
|
|
Buildings and improvements
|
|
|
16,387
|
|
|
|
16,387
|
|
Machinery and equipment
|
|
|
22,533
|
|
|
|
22,907
|
|
Vehicles
|
|
|
848
|
|
|
|
1,298
|
|
Office equipment
|
|
|
709
|
|
|
|
709
|
|
Construction in process
|
|
|
1,765
|
|
|
|
311
|
|
|
|
|
43,989
|
|
|
|
43,419
|
|
Accumulated depreciation
|
|
|
(22,386
|
)
|
|
|
(22,044
|
)
|
Total property and equipment
|
|
$
|
21,603
|
|
|
$
|
21,375
|
|
Note 7 – Accrued Expenses
Accrued expenses consist of the following:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Accrued payroll and payroll taxes
|
|
$
|
1,462
|
|
|
$
|
859
|
|
Accrued property tax
|
|
|
297
|
|
|
|
377
|
|
Other
|
|
|
243
|
|
|
|
302
|
|
Total accrued expenses
|
|
$
|
2,002
|
|
|
$
|
1,538
|
|
Note 8 – Notes Payable
|
|
September 30,
2016
|
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
Variable rate bank notes due May 31, 2018. Principal and interest payable monthly with a balloon payment due at maturity.
|
|
$
|
3,465
|
|
|
$
|
3,846
|
|
|
|
|
|
|
|
|
|
|
Variable rate bank notes due May 31, 2019. Principal and interest payable monthly with a balloon payment due at maturity.
|
|
|
3,864
|
|
|
|
4,113
|
|
|
|
|
|
|
|
|
|
|
Total notes payable
|
|
|
7,329
|
|
|
|
7,959
|
|
Less current maturities
|
|
|
840
|
|
|
|
840
|
|
Total long-term portion
|
|
$
|
6,489
|
|
|
$
|
7,119
|
|
The variable rate bank notes are subject to interest at the prime rate or at the LIBOR rate plus 2.5% and are collateralized by substantially all of the assets of the Company. In addition, under the terms of the related agreements, the Company is subject to minimum fixed charged ratio and tangible net worth thresholds, which among other things may limit the Company's ability to pay dividends or repurchase shares of its common stock. The Company was in compliance with these financial covenants at September 30, 2016. Further, under the agreements the Company is required to deliver its annual and quarterly financial statements and related SEC filings within specified timeframes. At the time of filing this Form 10-Q the Company was in compliance with these requirements.
In addition, the Company has a $5 million revolving credit facility. Borrowings under the facility are subject to interest at the prime rate or LIBOR plus 2.5%. As of September 30, 2016 and December 31, 2015 there were no borrowings under the facility. The facility expires in July 2017.
Note 9 – Commitments and contingencies
Lease obligations
-The Company leases corporate office space and three stores for its Lifeway Kefir Shop subsidiary. Total rent expense for these leases was $171 and $93 for the nine months ended September 30, 2016 and 2015, respectively. The Company is also responsible for additional rent equal to real estate taxes and other operating expenses.
Litigation
-The Company 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 the Company's business activities.
The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred and the amount of such loss can be reasonably estimated. The Company evaluates, on a periodic basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. Currently, none of the Company's accruals for outstanding legal matters are material individually or in the aggregate to the Company's 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 operation, or cash flows. However, if the Company ultimately is required to make payments in connection with an adverse outcome, it is possible that it could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows.
The Company's contingencies are subject to substantial uncertainties, including for each such contingency the following, among other factors: (i) the procedural status of the case; (ii) whether the case has or may be certified as a class action suit; (iii) the outcome of preliminary motions; (iv) the impact of discovery; (v) whether there are significant factual issues to be determined or resolved; (vi) whether the proceedings involve a large number of parties and/or parties and claims in multiple jurisdictions or jurisdictions in which the relevant laws are complex or unclear; (vii) the extent of potential damages, which are often unspecified or indeterminate; and (viii) the status of settlement discussions, if any, and the settlement posture of the parties. Consequently, the Company cannot predict with any reasonable certainty the timing or outcome of such contingencies, and the Company is unable to estimate a possible loss or range of loss.
Note 10 – Income taxes
For each interim period, the Company estimates the effective tax rate (ETR) expected to be applicable for the full year and applies that rate to income before provision for income taxes for the period. Additionally, the Company records 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, 2016 exceeded 100% compared to an ETR of 50.9% for the three months ended September 30, 2015. The ETR for the three-month period ended September 30, 2016 reflects a change in the estimated U.S. manufacturing deduction and the relatively small amount of income before provision for income taxes. The ETR for the three-month period ended September 30, 2015 reflects certain operating expenses that were not fully deductible for federal income tax purposes.
The effective tax rate for the nine months ended September 30, 2016 was 33.0% compared to an ETR of 50.8% for the nine months ended September 30, 2015. During the nine months ended September 30, 2016 we recorded an income tax benefit of $265 as a result of the favorable settlement of uncertain tax positions, which reduced the ETR by 5.9%. During the nine months ended September 30, 2015 we incurred certain operating expenses that were not fully deductible for federal income tax purposes, which increased the ETR by 8.1%.
Note 11 – Fair Value Measurements
FASB Accounting Standards Codification ("ASC") 820, Fair Value Measurements and Disclosures, provides the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described as follows:
Level 1.
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.
Level 2.
Inputs to the valuation methodology include the following:
|
●
|
Quoted prices for similar assets or liabilities in active markets;
|
|
●
|
Quoted prices for identical or similar assets or liabilities in inactive markets;
|
|
●
|
Inputs other than quoted prices that are observable for the asset or liability;
|
|
●
|
Inputs that are derived principally from or corroborated by observable market data by correlation or other means.
|
If the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability.
Level 3.
Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The asset or liability's fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.
The following is a description of the valuation methodologies used for assets measured at fair value on a recurring basis. There have been no changes in the methodologies used as of September 30, 2016 and December 31, 2015.
The majority of the Company's fair value measurements for investments are classified within Level 1 or Level 2 of the fair value hierarchy. The Company's Level 1 fair value measurements, which include mutual funds and common stock, is based on quoted market prices in active markets for identical securities. The Company's Level 2 fair value measurements, which include corporate bonds and preferred securities, is based on quoted prices in inactive markets for identical or similar assets. The company's level 3 fair value measurements which include other than temporarily impaired bonds are based on the present value of the estimated proceeds expected to be received at maturity of the bond. Those bonds were reclassified to level 3 from level 2 during 2015.
The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
The following table sets forth by level, within the fair value hierarchy, the Company's financial assets measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:
|
|
Assets at Fair Value as of September 30, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual Funds
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Common Stocks & ETF's
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Preferred Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Corporate Bonds
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
Assets at Fair Value as of December 31, 2015
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual Funds
|
|
$
|
26
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
26
|
|
Common Stocks & ETF's
|
|
|
613
|
|
|
|
—
|
|
|
|
—
|
|
|
|
613
|
|
Preferred Securities
|
|
|
—
|
|
|
|
104
|
|
|
|
—
|
|
|
|
104
|
|
Corporate Bonds
|
|
|
—
|
|
|
|
1,149
|
|
|
|
324
|
|
|
|
1,473
|
|
The Company's financial assets and liabilities which are not carried at fair value on a recurring basis include cash and cash equivalents, certificates of deposit, accounts receivable, other receivables, accounts payable, accrued expenses and notes payable for which carrying value approximates fair value.
Note 12 – Stock-based and Other Compensation
In December 2015, Lifeway shareholders 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. The Company has not established a pace for the frequency of awards under the Omnibus Incentive Plan, and 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.
Pursuant to the Omnibus Incentive Plan, Lifeway granted 26 stock options to certain key employees of the company effective January 1, 2016 and 24 stock options on July 1, 2016 (the "2016 options"). The 2016 options generally vest over a three-year period, on a relatively accelerated basis. The accelerated vesting reflects the landmark nature of the awards and the relative tenure of individual participants.
For the three and nine months ended September 30, 2016 total pre-tax stock-based compensation expense recognized in the consolidated statements of income (loss) and comprehensive income (loss) was $58 and $100, respectively. For the three and nine months ended September 30, 2016 tax-related benefits of $22 and $37 were also recognized.
The following table summarizes stock option activity during the nine months ended September 30, 2016:
|
|
Options
|
|
|
Weighted
average
exercise price
|
|
|
Weighted
average
remaining
contractual life
|
|
|
Aggregate
intrinsic value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31,2015
|
|
|
—
|
|
|
|
|
|
|
|
|
$
|
|
|
Granted
|
|
|
50
|
|
|
$
|
10.37
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
Terminated
|
|
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2016
|
|
|
50
|
|
|
$
|
10.37
|
|
|
|
9.50
|
|
|
$
|
329
|
|
Exercisable at September 30, 2016
|
|
|
7
|
|
|
$
|
9.57
|
|
|
|
9.75
|
|
|
$
|
50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We measure the fair value of stock options using the Black-Scholes option pricing model. The expected term of options granted was based on the weighted average time of vesting and the end of the contractual term. We utilized this simplified method as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.
The following assumptions were used for the grants in 2016:
|
|
Three Months Ended
September 30, 2016
|
|
|
|
Risk free interest rate
|
|
|
1.00 - 1.11%
|
|
|
|
Expected dividend yield
|
|
|
0.27%
|
|
|
|
Expected volatility
|
|
|
38.96 - 39.94%
|
|
|
|
Expected term
|
|
|
5.03 - 5.88
|
|
|
|
We expense stock options on a straight-line basis over the service period. As of September 30, 2016, the total remaining unearned compensation related to non-vested stock options was $94, which will be amortized over the weighted-average remaining service period of 1.15 years.
In March 2016 Lifeway established an incentive-based compensation program for certain senior executives (the "participants"). The incentive compensation is based on the achievement of certain sales and EBITDA performance levels versus respective targets
in 2016. Under the program, collectively the participants may earn cash and equity-based incentive compensation in amounts ranging from $0 to $4,000 during 2016 depending on the performance levels compared to the respective targets. The participants' achievement of equity-based compensation during the balance of 2016 is not considered to be probable. At September 30, 2016 bonuses of $1,280 had been earned under the program, including $200 of equity-based awards.
The company has a defined contribution plan which is available to substantially all full-time employees. Under the terms of the plan the company matches employee contributions under a prescribed formula. For the nine months ended September 30, 2016 and 2015 total contribution expense recognized in the consolidated statements of income (loss) and comprehensive income (loss) was $255 and $200 respectively. For the three months ended September 30, 2016 and 2015 total contribution expense recognized in the consolidated statements of income (loss) and comprehensive income (loss) was $82 and $53 respectively.
Note 13 – Segments, Products and Customers
The Company manufactures probiotic, cultured, functional dairy health food products. The Company's primary product is kefir, a dairy beverage similar to but distinct from yogurt, in several flavors and in several package configurations. In addition to the drinkable products, Lifeway manufactures "Lifeway Farmer Cheese," a line of various farmer cheeses.
The Company has determined that it has one reportable segment based on how the Company's 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 company performance, has been identified collectively as the Chief Financial Officer, the Chief Operating Officer, the Chief Executive Officer and Chairman of the board of directors. Substantially all of the consolidated revenues of the Company relate to the sale of fermented dairy products which are produced using the same processes and materials and are sold to consumers through a network of distributors and retailers in the United States.
Net sales of products by category were as follows:
|
|
Nine months ended
September 30,
|
|
|
Three months ended
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Cream and Drinkable Kefir other than ProBugs
|
|
$
|
80,135
|
|
|
$
|
76,723
|
|
|
$
|
25,533
|
|
|
$
|
25,902
|
|
Pro Bugs
|
|
|
4,962
|
|
|
|
5,999
|
|
|
|
1,606
|
|
|
|
1,702
|
|
Lifeway Farmer Cheese
|
|
|
7,579
|
|
|
|
5,125
|
|
|
|
2,479
|
|
|
|
1,661
|
|
Frozen Kefir
|
|
|
1,015
|
|
|
|
1,195
|
|
|
|
372
|
|
|
|
334
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
93,691
|
|
|
$
|
89,042
|
|
|
$
|
29,990
|
|
|
$
|
29,599
|
|
Significant Customers
-- Sales are predominately to companies in the retail food industry, located within the United States.
Two major customers accounted for approximately 23% and 22% of net sales for the nine months ended September 30, 2016 and 2015, respectively and 22% and 20% of net sales for the three months ended September 30, 2016 and 2015 respectively.
Note 14 – Related party transactions
The Company obtains consulting services from the Chairman of its board of directors. Fees earned by the Chairman are included in general and administrative expense in the accompanying consolidated statements of income (loss) and comprehensive income (loss) and were $787 and $727 during the nine months ended September 30, 2016 and 2015 respectively, and $248 and $340 during the three months ended September 30, 2016 and 2015 respectively.
Beginning in 2016 the Company is also a party to a royalty agreement with the Chairman of its board of directors under which the Company pays the Chairman a royalty based on the sale of certain Lifeway product, not to exceed $50 in any fiscal month. Royalties of $450 and $150 were earned by the Chairman during the nine months and three months ended September 30, 2016 respectively and were included in selling expenses in the accompanying consolidated statements of income (loss) and comprehensive income (loss).