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U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-KSB/A
AMENDMENT NO. 1
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2003
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from: ___________ to ___________
Commission file number: 0-17363
LIFEWAY FOODS, INC.
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(Name of small business issuer in its charter)
Illinois 36-3442829
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
6431 West Oakton, Morton Grove, Illinois 60053
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (847) 967-1010
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, No Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in this Amendment No. 1 to
Annual Report on Form 10-KSB/A. [ ]
The issuer's revenues for its most recent fiscal year were: $14,877,788
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (approximately 2,202,136 shares) computed by reference to the
price at which the stock was sold as of March 12, 2004 ($17.60 per share as
quoted on the National Market System of the Nasdaq Stock Market) was:
$38,757,593.60
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
The number of shares outstanding of each of the issuer's classes of common
equity, as of March 12, 2004 were: 8,436,888 shares of Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Notice of Annual Meeting and Proxy Statement, to be filed no
later than April 29, 2004, for the Registrant's 2004 Annual Meeting of
Shareholders, scheduled to be held June 12, 2004, are incorporated by reference
in Part III.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
2
PART I
CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS TO
DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this document and any document
incorporated by reference herein, are advised that this document and documents
incorporated by reference into this document contain both statements of
historical facts and forward looking statements. Forward looking statements are
subject to certain risks and uncertainties, which could cause actual results to
differ materially from those indicated by the forward looking statements.
Examples of forward looking statements include, but are not limited to (i)
projections of revenues, income or loss, earnings or losses per share, capital
expenditures, dividends, capital structure and other financial items, (ii)
statements of Lifeway plans and objectives, including the introduction of new
products, or estimates or predictions of actions by customers, suppliers,
competitors or regulatory authorities, (iii) statements of future economic
performance, and (iv) statements of assumptions underlying other statements and
statements about Lifeway or its business.
This document and any documents incorporated by reference herein also
identify important factors which could cause actual results to differ materially
from those indicated by forward looking statements. These risks and
uncertainties include price competition, the decisions of customers or
consumers, the actions of competitors, changes in the pricing of commodities,
the effects of government regulation, possible delays in the introduction of new
products, customer acceptance of products and services, and other factors which
are described herein and/or in documents incorporated by reference herein.
The cautionary statements made pursuant to the Private Litigation
Securities Reform Act of 1995 above and elsewhere by Lifeway Foods, Inc.
("Lifeway" or the "Company") should not be construed as exhaustive or as any
admission regarding the adequacy of disclosures made by Lifeway prior to the
effective date of such Act. Forward looking statements are beyond the ability of
Lifeway to control and in many cases we cannot predict what factors would cause
results to differ materially from those indicated by the forward looking
statements.
ITEM 1. DESCRIPTION OF BUSINESS.
EXPLANATORY NOTE REGARDING AMENDMENT
The subsection of this Item regarding transactions between Lifeway and
Groupe Danone SA is being amended hereby to clarify certain details of the
transactions and explain the potential impact to shareholders of the expiration
on September 30, 2004 of certain agreements between Lifeway and Danone.
Additionally, certain information regarding purchases of Lifeway shares by
Danone from non-affiliate individuals was removed from this Item as it is not
relevant and previously was disclosed in Schedule 13D and Schedule 13D/A filings
made by Danone in 1999. Finally, minor revisions were made to the text.
BUSINESS DEVELOPMENT
Lifeway Foods, Inc. commenced operations in February 1986, and was
incorporated under the laws of the State of Illinois on May 19, 1986. The
Company's principal business activity is the manufacturing of probiotic,
cultured, functional dairy and non-dairy health food products. Lifeway's primary
products are kefir, a drinkable dairy beverage similar to but distinct from
yogurt, in several flavors sold under the name "Lifeway Kefir"; a line of
various drinkable yogurts sold under the "La Fruta" and "Tuscan" brands; and
"BasicsPlus," a dairy based immune-supporting dietary supplement beverage. The
Company also produces several soy-based kefir beverages under the "SoyTreat"
trademark. In addition to the drinkable products, Lifeway manufactures "Lifeway
Farmer Cheese," a line of various farmer cheeses; and "Sweet Kiss," a fruit
sugar-flavored spreadable cheese similar in consistency to cream cheese. The
Company also manufactures and markets a vegetable-based seasoning under the
"Golden Zesta" brand. In the Chicago metropolitan area, Lifeway distributes its
products on its own trucks and via one distributor. Lifeway distributes its
products primarily throughout the United States and to a limited but growing
extent in Eastern Canada. All of Lifeway's products are manufactured at
Company-owned facilities.
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SUBSIDIARY CORPORATION
On September 30, 1992, Lifeway formed a wholly-owned subsidiary, LFI
Enterprises, Inc. ("LFIE"), incorporated in the State of Illinois. Until August
1, 2001, LFIE operated a "Russian" theme restaurant and supper club facility. On
August 1, 2001, Lifeway ceased operations at the facility after condemnation
proceedings were initiated by the Village of Niles, Illinois, which sought to
control the property for municipal purposes. This property was sold in January
2003 for a capital gain of $1.2 million.
On March 19, 2004, LFIE formed Lifeway Foods Canada, LLC, an Illinois
limited liability company ("LFC"), to serve as a holding company for prospective
operations within Canada. LFIE is the manager and sole member of LFC.
BUSINESS OF ISSUER
PRODUCTS
Lifeway's primary product is kefir, which, like the better-known
product of yogurt, is a fermented dairy product. Kefir has a slightly
effervescent quality, with a taste similar to yogurt and a consistency similar
to buttermilk. It is a product distinct from yogurt because it incorporates the
unique microorganisms of kefir as the cultures to ferment the milk. Lifeway's
Kefir is a drinkable product intended for use as a breakfast meal or a snack, or
as a base for lower-calorie dressings, dips, soups or sauces. Kefir is also used
as the base of Lifeway's plain farmer's cheese, a cheese made without salt,
sugar or animal rennet. In addition, kefir is the primary ingredient of
Lifeway's "Sweet Kiss" product, a fruit sugar-flavored, cream cheese-like spread
which is intended to be used as a dessert spread or frosting.
Kefir contains a unique mixture of several live microorganisms and
nutrients such as proteins, minerals and vitamins. Kefir is highly digestible
and, due to its acidity and enzymes, stimulates digestion of other foods. Kefir
is considered to be the most favorable milk product for people suffering from
genetically-based lactose intolerance. A study published in the May 2003 issue
of the Journal of the American Dietetic Association, suggests that kefir
improves lactose digestion and tolerance in adults with lactose maldigestion.
Studies also indicate that kefir may stimulate protein digestion and appetite,
decrease the cholesterol content in blood, improve salivation and excretion of
stomach and pancreatic enzymes and peristalsis. As compared to yogurt, many
Naturopathic practitioners consider kefir to be the best remedy for digestive
troubles because it has a very low curd tension (the curd breaks up very easily
into small particles). The curd of yogurt, on the other hand, holds together or
breaks into lumps. The small size of the kefir curd facilitates digestion by
presenting a large surface area for the digestive agents to work on.
Kefir is a good source of calcium, protein and Vitamin B-complex. In
addition, because the fermentation process produces a less sour tasting product
than yogurt, less sugar is required to make a desirable product, and the end
product contains fewer calories than regular yogurt.
Lifeway currently sells some or all of the products listed below, except as
specifically noted, to various retail establishments including supermarkets,
grocery stores, gourmet shops, delicatessens and convenience stores.
LIFEWAY'S KEFIR. "Lifeway's Kefir" is a drinkable kefir product
manufactured in eleven varieties--plain (regular and low-fat), raspberry,
blueberry, strawberry, cherry, peach, banana-strawberry, cappuccino, chocolate
and vanilla -- and sold in 32 ounce containers featuring color-coded caps and
labels describing nutritional information. In March 1996, Lifeway began
marketing its fat-free, low cholesterol kefir in six flavors--plain, raspberry,
strawberry, strawberry-banana, peach and blueberry. The kefir product is
currently marketed under the name "Lifeway's Kefir," and is typically sold by
retailers from their dairy sections.
LIFEWAY'S ORGANIC SOYTREAT. "SoyTreat" is a soy alternative to dairy kefir
and is made from organic soy milk, which is derived from non-genetically
modified soybeans. SoyTreat can be consumed by those who desire the benefits of
kefir, but are lactose intolerant or interested in a soy-based alternative to
milk. SoyTreat also provides 6.25g of soy protein per serving, and features the
United States Food and Drug Administration-approved health
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claim, "25g of soy protein a day as part of a diet low in saturated fat can help
lower cholesterol and reduce the risk of heart disease." At present SoyTreat is
manufactured in seven flavors: Strawberry, Apple, Peach, Coconut, Coffee Latte,
English Toffee and Dulce de Leche.
LIFEWAY'S ORGANIC KEFIR. "Lifeway's Organic Kefir" meets the organic
standards and specifications of the United States Department of Agriculture for
organic products and is manufactured in four flavors: Plain, Raspberry,
Strawberry and Peach. Lifeway Organic Kefir is sweetened with organic cane
juice.
LA FRUTA DRINKABLE YOGURT. "La Fruta" is a yogurt like drink similar to a
milkshake or smoothie that is specifically formulated to accommodate the
Hispanic market, the fastest growing demographic in the U.S. La Fruta is
manufactured in six flavors: strawberry, mango, pina colada, banana-strawberry,
horchata and tres leches.
LA FRUTA CHEESE. "La Fruta Cheese" is a cheese product similar to cream
cheese that is specifically formulated to accommodate the Hispanic market, the
fastest growing demographic in the U.S. La Fruta Cheese is manufactured in a
tres leche flavor.
TUSCAN BRAND DRINKABLE YOGURT. "Tuscan Brand Drinkable Yogurt" is a
cultured dairy beverage mainly marketed on the East Coast and manufactured in a
variety of flavors which vary depending upon distributor demand.
FARMER CHEESE. "Farmer Cheese" is based on a cultured soft cheese and is
intended to be used in a variety of recipes as a low fat, low-cholesterol,
low-calorie substitute for cream cheese or ricotta, and is available in various
styles.
ELITA; BAMBINO. "Elita" and "Bambino" cheeses are low-fat, low-cholesterol
kefir based cheese spreads which are marketed as an alternative to cream cheese.
KRESTYANSKI TWOROG. "Krestyanski Tworog" is a European-style kefir-based
soft style cheese which can also be used in a variety of recipes, eaten with a
spoon, used as a cheese spread, or substituted in recipes for cream cheese,
ricotta cheese or cottage cheese and is marketed to consumers of various Eastern
European ethnicities.
BASICS PLUS. "Basics Plus" is a patented kefir-based beverage product
designed to improve gastrointestinal functions and thus enhances the immune
system. This product contains certain "passive immunity products" purchased from
GalaGen, Inc. prior to its 2002 bankruptcy as described elsewhere in this
report. Lifeway is currently engaged in discussion with several potential new
suppliers of passive immunity products and is not currently manufacturing this
beverage.
KEFIR STARTER. "Kefir Starter" is a powdered form of kefir that is sold in
envelope packets and allows a consumer to make his or her own drinkable kefir at
home by adding milk. Lifeway continues to develop sales of the product
internationally and via the internet.
GOLDEN ZESTA. "Golden Zesta" is a vegetable-based seasoning, which, because
of its low sodium content, may also be used as a salt substitute and is marketed
to delicatessens, gourmet shops and ethnic grocers.
Lifeway intends to continue to develop new products, such as salad dressing
and a frozen dessert product based on kefir and Farmer's Cheese. There is no
assurance that such products or any other new products can be developed
successfully or marketed profitably.
DISTRIBUTION
With its ten company-owned trucks, Lifeway distributes its products
directly and extensively in the State of Illinois, primarily in the Chicago
metropolitan area, including major retail chains such as Jewel Food Stores,
Dominick's Finer Foods, Treasure Island Food Marts, Whole Foods and independent
retailers.
In addition to the State of Illinois, Lifeway's products are distributed to
stores throughout the United States. Lifeway has verbal distribution
arrangements with various distributors throughout the United States. These
verbal
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distribution arrangements, in the opinion of Lifeway, allow management the
necessary latitude to expand into new areas and markets and establish new
relationships with distributors on an ongoing basis. Lifeway has not offered any
exclusive territories to any distributors.
Distributors are provided Lifeway products at wholesale prices for
distribution to their retail accounts. Lifeway believes that the price at which
its products are sold to its distributors is competitive with the prices
generally paid by distributors for similar products in the markets served. In
all areas served, distributors currently deliver the products directly to the
refrigerated cases of dairy sections of their retail customers. Each distributor
carries a line of Lifeway's products on its trucks, and checks the retail stores
for space allocated to Lifeway's products, determines inventory requirements and
places Lifeway products directly into the retailers' dairy cases. Lifeway
believes this method of distribution best serves the needs of each retail store,
and is the best available means to ensure consistency and quality of product
handling, quality control, flavor selection and favorable retail display. Under
the distribution arrangements, each distributor must meet certain prescribed
product handling, service and administrative requirements including, among
others, frequency of delivery, replacement of damaged, old or substandard
packages, and delivery of products directly to the refrigerated case.
Additionally, Lifeway distributes its products internationally by exporting
to distributors operating in the Canadian provinces of Ontario and Quebec.
Lifeway's products are subject to strict import quotas imposed by the Trade
Control Policy Division of the Department of Foreign Affairs and International
Trade of Canada. In an attempt to address this situation, management is
exploring various alternatives to permit expansion of Lifeway's product line in
Canada. Lifeway believes that it currently is in compliance with all applicable
Canadian regulations.
MARKETING
Lifeway continues to promote the verifiable nutritional characteristics,
purity of product and good taste of its kefir and kefir-based products. Lifeway
primarily advertises its products through local radio stations, which
advertisements are directed to both users and non-users of cultured milk
products of all kinds. In addition, through newspaper and magazine advertising,
Lifeway provides educational information on its products and appeals to the
common perception that the products may be of particular benefit for a wide
range of ills, including intestinal disorders, and continues to educate the
public on the possible health benefits which could be derived from the use of
kefir and kefir-based products. Lifeway believes that the potential for
healthful benefits as suggested by the educational information it has obtained
properly serves as the basis for an advertising strategy.
In addition to local radio stations, newspapers and magazines, Lifeway
promotes further exposure of its products through the internet, catalog
advertising and promotion, store demonstrations throughout the U.S, and
participation in various trade shows. Lifeway also sponsors several different
sporting events in the Chicago, Illinois metropolitan area as an additional
marketing tool.
Lifeway does not promote products manufactured under the LaFruta and Tuscan
brand names with any marketing or advertising.
COMPETITION
Although Lifeway faces a small amount of direct competition in the United
States and Canadian markets for kefir products, Lifeway's kefir-based products
compete with all other yogurt and other dairy products. Many producers of yogurt
and other dairy products are well-established and have significantly greater
financial resources than Lifeway to promote their products.
In connection with the certain Support Agreement between Lifeway and Danone
Foods, Inc., as well as certain other transactions between the two companies
described elsewhere in this report, the parties agreed that they would not
compete with each other during the term of the Support Agreement and for three
years after termination of the agreement with respect to certain yogurt, cheese
and kefir products. Specifically, Lifeway agreed not to produce or sell in the
United States or Western Europe any type of yogurt, fromage frais, Italian style
cheese, chilled desserts or any soy-based products, other than those that are
kefir-based or those that were already being produced and sold
6
by Lifeway as of December 24, 1999; and Danone agreed not to produce or sell any
type of kefir-based products in the United States.
SUPPLIERS
Lifeway purchases its raw materials, such as milk, sugar and fruit from
unaffiliated suppliers, and is not limited or contractually bound to any one.
Lifeway has ready access to multiple suppliers for all of its raw materials and
packaging requirements. Prior to making any purchase, Lifeway determines which
supplier can offer the lowest price for the highest quality of product. The raw
and packaging materials purchased by Lifeway are considered commodity items and
are widely available on the open market with the exception of the licensed
ingredient in BasicsPlus. Lifeway owns and operates the means of production of
all of its products.
MAJOR CUSTOMERS
Lifeway distributes its products to numerous accounts throughout the U.S.
Concentrations of credit with regard to trade accounts receivable and sales are
limited due to the fact that Lifeway's customers are spread across different
geographic areas. The customers are concentrated in the retail food industry. In
2003, Lifeway's largest customer represented approximately 9% of sales and
reflects sales in various regions of the United States outside the Chicago,
Illinois metropolitan area.
TRANSACTIONS WITH GROUPE DANONE SA
All share amounts and prices in this subsection are historical and have not
been adjusted for the stock split which occurred in the first quarter of 2004.
On October 1, 1999, Lifeway sold 497,767 shares of restricted common stock to
Danone at $10.00 per share. Danone also concurrently purchased 150,000
outstanding shares of common stock from Lifeway's founder, and then controlling
shareholder, President and CEO, Michael Smolyansky; his wife and current
Chairperson of the Board, Ludmila Smolyansky; his daughter and current President
and CEO, Julie Smolyansky; his son and current Controller, Edward Smolyansky on
similar terms. Later in 1999, Danone purchased an additional 215,922 shares of
common stock from certain individuals, including 52,262 shares purchased in
transactions with certain Company affiliates, including Michael Smolyansky
(38,362 shares), Val Nikolenko, Vice President of Production (3,900 shares) and
Pol Sikar, a director, and his affiliates (10,000 shares).
As a result of these transactions, Danone became the beneficial owner of
20% of the outstanding common stock of Lifeway. Pursuant to the terms and
conditions of the transaction, Lifeway granted certain limited rights to Danone,
which include a right to nominate one director, anti-dilutive rights relating to
future offerings and limited registration rights. Since November 1999, Thomas
Kunz, president and CEO of Danone, has served on Lifeway's Board of Directors as
Danone's nominee. In addition, as described above, Lifeway and Danone are
parties to a Stockholders' Agreement dated October 1, 1999, pursuant to which
the parties agreed that they would not compete with each other through September
30, 2004 with respect to certain yogurt, cheese and kefir products. The
Stockholders' Agreement also provides that Danone may not own more than 20% of
the outstanding common stock of Lifeway as a result of direct or indirect
acquisition of shares. Danone's interest as of the date hereof is approximately
20.4% due to reductions in Lifeway's shares outstanding, primarily due to share
repurchases. If the Stockholders' Agreement is not renewed on or before
September 30, 2004, Danone would be able to sell its shares of Lifeway common.
The ability of Danone to sell, or the prospect of Danone being able to sell
should such restrictions lapse, such a large stake in Lifeway could have a
negative effect on the Company's stock price.
Additionally, on December 24, 1999, Lifeway entered into a Support
Agreement with Danone, the primary purpose of which was to allow Lifeway access
to Danone's brokers and distributors in the United States. The Support Agreement
provided for an initial term of three years and was renewable annually
thereafter. On February 11, 2003, the term of the Support Agreement was extended
through December 31, 2003. Lifeway and Danone did not renew the term of the
Support Agreement after December 31, 2003 due to the expectation of the parties
that this and other agreements between them would be discussed and possibly
renegotiated pending their expiration on September 30, 2004.
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PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS
All trademark registrations have been granted by the United States Patent and
Trademark Office ("USPTO"), unless otherwise noted below. Each trademark
registration may be renewed upon expiration. Lifeway intends to make all timely
filings as required for all trademarks listed.
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Date of Expiration of
Mark Use Registration Registration Comments
==================== =================================== ================= ================= ===============================
Lifeway's Cheese and kefir December 12, 1989 December 12, 2009 Registration is renewable at
the time of expiration.
Lifeway's Cheese and kefir January 10, 1992 January 10, 2007 This registration was granted
(Canada) by the Canadian Intellectual
Property Office based upon the
use of the mark in Canada since
September 9,1988.
Golden Zesta Dehydrated vegetable soup August 19, 1997 August 19, 2007 Registration is renewable at
mix; and spices, seasonings, the time of expiration.
food additives for non-nutritional
purposes for use as a flavoring
Sweet Kiss Cheese, cottage cheese and other February 10, 1998 February 10, 2008 Registration is renewable at
milk products, excluding ice the time of expiration.
cream, ice milk and frozen yogurt
Kwashenka Kefir, yogurt, cheeses, cottage February 10, 1998 February 10, 2008 Registration is renewable at
cheeses and other milk products, the time of expiration provided
excluding ice cream, ice milk and mandatory documents are filed
frozen yogurt with the USPTO by February 10,
2004. Lifeway filed the
mandatory documents prior to
their due date, and acceptance
of such mandatory documents is
pending before the USPTO.
Bambino Cheeses, cottage cheeses and October 7, 2003 October 7, 2013 Registration is renewable at
other milk products the time of expiration provided
mandatory documents are filed
with the USPTO by October 7,
2009.
KPECTBRHCKNN Cheeses, cottage cheeses and September 8, 1998 September 8, 2008 Registration is renewable at
(A stylized other milk products, excluding ice the time of expiration
presentation of cream, ice milk and frozen yogurt provided mandatory documents
"Krestyanskiy" in are filed with the USPTO by
Cyrillic characters) September 8, 2004.
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PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS (CONTINUED)
Date of Expiration of
Mark Use Registration Registration Comments (if any)
==================== =================================== ================= ================= ===============================
BasicsPlus Dairy-based food beverages for use September 7, 1999 September 7, 2009 In May 1998, GalaGen, Inc.,
a dietary supplement assigned the entire interest,
including the goodwill, of
this mark to Lifeway.
Registration is renewable at
the time of expiration provided
mandatory documents are filed
with the USPTO by September 7,
2005.
BA3APHBIII Pressed unripened cheese July 25, 2000 June 25, 2010 Registration is renewable at
(A stylized the time of expiration provided
presentation of mandatory documents are filed
"Bazarniy" in with the USPTO by July 25,
Cyrillic characters) 2006.
SoyTreat Soy-based food beverage intended December 12, 2000 December 12, 2010 Registration is renewable at
for use as a cultured milk the time of expiration provided
substitute mandatory documents are filed
with the USPTO by December 12,
2006.
Garden Harmony Unripened cheese-based spreads March 20, 2001 March 20, 2011 Registration is renewable at
the time of expiration provided
mandatory documents are filed
with the USPTO by March 20,
2007.
Korovka Dairy-based spread November 6, 2001 November 6, 2011 Registration is renewable at
the time of expiration provided
mandatory documents are filed
with the USPTO by November 6,
2007.
La Fruta Cultured milk products, excluding Not applicable Not applicable This application was filed on
ice cream, ice milk and frozen January 17, 2003 and is still
yogurt pending before the USPTO.
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PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS (CONTINUED)
Lifeway also uses the following unregistered trademarks, and claims common
law rights to: "Elita," "Healthy Foods Today for a Better Life Tomorrow,"
"Milkshake Smoothie," "Toplenka," "White Cheese," and "Drink It to Be Beautiful
Inside and Out."
On December 27, 1990, Lifeway purchased the Tuscan brand-name liquid yogurt
customer list along with a limited license of the trademark and use of the
Tuscan liquid yogurt U.P.C. codes from a third party.
In October 1998 Lifeway entered into a sublicense agreement with GalaGen,
Inc. and Metagenics, Inc. with an effective date of May 1, 1998 ("Lifeway
sublicense"), wherein GalaGen sublicensed patent rights of Metagenics for
kefir-based products containing natural immune components exclusively to
Lifeway. Under the rights granted to it by the Lifeway sublicense, Lifeway
manufactures and sells products using the Basics Plus trademark. GalaGen had
acquired the primary license for such patent rights in an agreement executed
with Metagenics in April 1998. The terms of the Lifeway sublicense provide that
Metagenics will permit Lifeway to continue to have the exclusive patent rights
to produce or sell kefir-based products containing natural immune components in
the event the original license between GalaGen and Metagenics is terminated, and
such termination was not caused by Lifeway. On February 25, 2002, GalaGen filed
a petition for bankruptcy in the Unites States Bankruptcy Court, District of
Minnesota, which terminated both its primary license with Metagenics and its
participation in the Lifeway sublicense. The license and sublicense were
excluded from the sale of assets of GalaGen pursuant to an order of the
Bankruptcy Court. Lifeway has not received any indication that Metagenics will
not permit Lifeway to continue to have the exclusive patent rights to produce or
sell kefir-based products containing natural immune components. Thus, Lifeway
believes that it continues to have the exclusive patent rights licensed directly
from Metagenics. Either party may terminate the license agreement for cause. The
term of the license agreement expires when the last valid claim of the patent
rights expires, which currently is July 2, 2013, however, this term can be
extended in accordance with the terms of the license agreement.
REGULATION
Lifeway is subject to regulation by federal, state and local governmental
authorities regarding the distribution and sale of food products. Although
Lifeway believes that it currently has all material government permits,
licenses, qualifications and approvals for its operations, there can be no
assurance that Lifeway will be able to maintain its existing licenses and
permits or to obtain any future licenses, permits, qualifications or approvals
which may be required for the operation of Lifeway's business. Lifeway believes
that it is currently in compliance with all applicable environmental laws.
In addition, Lifeway product that are exported to Canada are subject to
strict quotas imposed by the Trade Control Policy Division of the Department of
Foreign Affairs and International Trade of Canada. Lifeway believes that it
currently is in compliance with all applicable Canadian regulations.
RESEARCH AND DEVELOPMENT
Lifeway continues its program of new product development, centered
around the nutritional and "low calorie" features of its proprietary kefir
formulas.
Lifeway conducts primarily all of its research internally, but at times
will employ the services of an outside testing facility. During 2003, the amount
Lifeway expended for research and new product development was not material to
the financial position of Lifeway.
EMPLOYEES
Lifeway currently employs approximately 55 employees, all of whom are
full-time employees. Substantially all of those employees are engaged in the
manufacturing process of Lifeway's kefir and kefir-based products. None of
Lifeway's employees are covered by collective bargaining agreements.
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PART II
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION.
EXPLANATORY NOTE REGARDING AMENDMENT
This Item is being amended and restated in its entirety to correct and
clarify certain statements.
RESULTS OF OPERATIONS
The year ended December 31, 2003 was the second consecutive year of new
highs for sales, net income and earnings per share. For the year ended December
31, 2003, sales were $14,877,788, which is a $2,665,552 (approximately 22%)
increase from $12,212,236 in 2002. We believe that approximately half of the
2003 increase in sales was attributable to a new customer as of June 2003,
Sav-A-Lot, Ltd., which represented sales of a significant amount of 8 oz.
bottles of Lifeway's LaFruta line. Save-A-Lot, the 13th largest grocery chain in
the United States, operates more than 1000 Sav-A-Lot and Supervalu food stores
nationwide. The portion of the increase in sales not attributable to the new
relationship with Sav-A-Lot is primarily attributable to a nationwide increase
in the sales of existing products which we believe occurred because of continued
steady sales growth in the ethnic and natural foods markets. We also believe
that Lifeway's sales growth potentially is indirectly related to growth
experienced by its distributors. For example, United Natural Foods, Inc.
("United"), Lifeway's main distributor to natural and health food retailers
experienced a $200 million revenue increase in 2003, acquired two smaller
distributors and expanded its customer list to include over 14,000 retailers
across the United States. Distribution of Lifeway's products by United to its
new as well as existing customers is believed to account for some of the
increase in Lifeway's 2003 sales.
We believe, based on first quarter 2004 results as of March 22, 2004, that
Lifeway is on target for approximately 15% sales growth for the first half of
2004 compared to the first six months of 2003. At present, we also are in the
last stages of implementing our new shrink-sleeve packaging for our SoyTreat and
Lifeway's Kefir product lines. Our transition to updated packaging should be
completed during the third quarter of 2004, which we anticipate will contribute
to increased sales through the end of the second half of 2004. At industry trade
shows, we have observed significant interest and a positive reaction to our new
shrink-sleeve packaging. Several newly labeled flavors of our SoyTreat product
can already be seen on the store shelves in several regions, and several more
flavors of our flagship product, kefir, are in the final stages of this
packaging change.
Cost of goods sold as a percentage of sales was approximately 53% in 2003,
compared to about 55% in 2002. Even though the price of milk, the largest
component of our cost of goods sold, increased slightly during 2003 as compared
to 2002, Lifeway was able to decrease its cost of goods sold as a percentage of
sales through negotiated contracts with vendors and the purchase of other raw
materials in bulk, thus reducing per item cost. We anticipate that we will be
able to maintain our gross margins in 2004 even though the United States
Department of Agriculture has reported that it expects the average price of milk
to increase by 10-15% nationally in 2004. We anticipate being able to offset any
milk price increase in 2004 as well as increased costs for the new packaging
described above by selective increases in the prices of our products. While we
have not previously increased our prices in response to an increased cost of
milk, we do not expect that increased prices will have a negative impact on our
sales or revenues. Nonetheless, the anticipated increase in milk prices and
increased packaging costs present the largest risk to our gross margin in 2004.
Even though sales increased by approximately 22% in 2003, Lifeway's 2003
operating expenses as a percentage of sales ratio was similar to 2002. Our
operating expenses increased during 2003 due to our investment in the design and
implementation of our new shrink-sleeve packaging and due to the increased
professional services costs resulting from the Sarbanes-Oxley Act of 2001,and
the regulations promulgated pursuant thereto by the Securities and Exchange
Commission and the Nasdaq Stock Market. Additionally, Lifeway's annual aggregate
fuel costs, whether incurred directly or passed through to the Company by
distributors and delivery providers, increased in 2003.
Inflation has not had any measurable impact on the Company's results of
operations.
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DISPOSITION OF REAL PROPERTY
In the first quarter of 2003, we finalized the disposition of one property,
which resulted in a capital gain of approximately $1.2 million. We took the
opportunity presented by this disposition to sell certain impaired securities,
recognize the losses at a time when the losses could be matched for federal tax
purposes with all of the gain from the real estate disposition and furthering
our ongoing program of transitioning our liquid securities into higher grade
investments and thereby strengthening our balance sheet.
MARKETABLE SECURITIES
A significant portion of our assets are held in marketable securities. The
marketable securities are classified as available-for-sale on our balance sheet
and thus are stated thereon at market value as of the end of the applicable
period. Gains and losses on the portfolio are determined by the specific
identification method.
During the course of 2003, and now in 2004, we have been and will continue
to move away from higher-risk securities towards large cap value, higher
dividend yielding and tax-advantaged equities. At the end of 2003, our
investment portfolio was comprised of about 60% fixed income securities and
around 40% equity investments. However, our investment portfolio presently
consists of approximately 80% fixed income securities, and about 20% equity
investments. Of the equity portion, 85% is invested in large cap value stocks,
10% in small cap growth stocks, and 5% in large cap growth stocks. We believe,
given the current market conditions, this asset allocation strategy offers a
positive risk-reward ratio for our Company.
SOURCES AND USES OF CASH IN 2003 AND 2004
Net cash used in financing activities was $30,707 in 2003, compared to
$1,068,077 in 2002. In 2003, the Company's use of cash in financing activities
was limited to periodic payments of principal and interest made on the mortgage
loan for Lifeway's headquarters and on the loans used to acquire some of its
delivery trucks. In 2002, however, in addition to making the same mortgage and
auto loan payments made in 2003, Lifeway also acquired 55,000 shares (110,000
shares when adjusted for the two-for-one stock split paid on March 8, 2004) of
its common stock under a repurchase program and fully paid off two mortgage
loans in advance of maturity.
We anticipate being able to fund the Company's forseeable liquidity
requirements internally. We continue to explore potential acquisition
opportunities in our industry in order to boost sales while leveraging our
distribution system to consolidate and lower costs. We anticipate closing an
acquisition in 2004 or early 2005. We expect that we will be able to use our
available cash and cash equivalents as funding for an acquisition of this size.
We are also exploring opportunities in Eastern Canada that will meet our desire
to expand sales in that region.
OTHER DEVELOPMENTS
As of March 22, 2004 we have realized approximately $350,000 in capital
gains resulting from the continuing rebalancing of the equity portion of our
portfolio toward more lower-risk investments. The capital gains tax liability
created by this realization will be offset by the capital loss carry forward as
of December 31, 2003.
At present, management strongly believes that foreseeable increases in
advertising and marketing costs, and professional services fees and potential
personnel recruitment, hiring and employment expenses incurred as a result of
compliance with the Sarbanes-Oxley Act and related SEC and Nasdaq regulations
will continue to increase and may result in a negative impact to earnings
sometime in the future. In addition, management is exploring options for
additional production and storage space in light of increased sales of and
demand for its products and the fact that its existing facilities are
approaching the limits of their capacity.
If the aggregate market value of Lifeway's outstanding common stock (also
known as the "public float") exceeds $25 million in the final 60 days of 2004,
Lifeway shall no longer file periodic reports under the SEC's regulations for
"Small Business Issuers" and shall become subject to further SEC filing
requirements. Additionally, if Lifeway's public float ever exceeds $75 million,
Lifeway would become subject to the SEC's "accelerated filer" requirements.
Management anticipates either or both of these events would further increase the
Company's professional service costs.
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Aside from the foregoing, management is not aware of any circumstances or
trends, which would have a negative impact upon future sales or earnings. There
have been no material fluctuations in the standard seasonal variations of
Lifeway's business in 2003. The accompanying financial statements include all
adjustments, which in the opinion of management are necessary in order to make
the financial statements not misleading.
CRITICAL ACCOUNTING POLICIES
Lifeway's analysis and discussion of its financial condition and results of
operations are based upon its consolidated financial statements that have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("US GAAP"). The preparation of financial statements in
accordance with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses.
US GAAP provides the framework from which to make these estimates, assumptions
and disclosures. Lifeway chooses accounting policies within US GAAP that
management believes are appropriate to accurately and fairly report Lifeway's
operating results and financial position in a consistent manner. Management
regularly assesses these policies in light of current and forecasted economic
conditions and has discussed the development and selection of critical
accounting policies with its audit committee of the Board of Directors. For
further information concerning accounting policies, refer to Note 2 -- Nature of
Business and Significant Accounting Policies in the notes to the consolidated
financial statements.
FORWARD-LOOKING STATEMENTS
In this report, in reports subsequently filed by Lifeway with the SEC on
Form 10-QSB and filed or furnished on Form 8-K, and in related comments by
management, our use of the words "believe," "expect," "anticipate," "estimate,"
"forecast," "objective," "plan," "goal," "project," "explore,"
"priorities/targets," and similar expressions is intended to identify
forward-looking statements. While these statements represent our current
judgment on what the future may hold, and we believe these judgments are
reasonable, actual results may differ materially due to numerous important
factors that are described in this report and other factors that may be
described in subsequent reports which Lifeway may file with the SEC on Form
10-QSB and filed or furnished on Form 8-K, including but not limited to:
- Changes in economic conditions, commodity prices;
- Shortages of and price increase for fuel, labor strikes or work
stoppages, market acceptance of the Company's new products;
- Significant changes in the competitive environment;
- Changes in laws, regulations, and tax rates; and
- Management's ability to achieve reductions in cost and employment
levels, to realize production efficiencies and to implement capital
expenditures, all at of the levels and times planned by management.
ITEM 8A. CONTROLS AND PROCEDURES
EXPLANATORY NOTE REGARDING AMENDMENT
This Item is being amended and restated in its entirety hereby to clarify
the Chief Executive Officer's position as to internal control matters and to
address the Company's intentions in this area for 2004.
The Chief Executive Officer (who serves as the principal executive and
financial officer) conducted an evaluation of the effectiveness of the Company's
disclosure controls and procedures pursuant to Rule 13a-14 under the Securities
Exchange Act of 1934 as of December 31, 2003. The Company has historically
operated on strictly monitored cost constraints; with that perspective, the
Chief Executive Officer concluded that the disclosure controls and procedures
are effective in ensuring that all material information required to be filed in
this annual report has been made known to her. However, based upon the Company's
recent growth and improved cash position, as well as consultation with its
auditors, management intends to implement additional procedures to improve
internal controls
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in 2004. Specifically, an enhanced accounting software package has been
identified which will permit enhanced data recording and internal reporting,
additional on-site accounting staff and some changes to internal control
procedures.
As of the date of this annual report, there have been no known significant
changes in internal controls or in other factors that could significantly affect
these controls subject to the date of such evaluation.
PART III
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
EXPLANATORY NOTE REGARDING AMENDMENT
This Item is being amended and restated in its entirety to further clarify
the information regarding fees paid to the Company's principal accountant and to
set forth in detail information regarding the accountant pre-approval process of
the Company's audit committee.
Gleeson, Sklar, Sawyers and Cumpata, LLP ("Gleeson") was Lifeway's
principal accountant from January 1, 2003 through December 31, 2003.
AUDIT FEES
In 2002, Gleeson billed Lifeway approximately $32,500 for professional
services rendered for the audit of Lifeway's annual financial statements and
review of financial statements included in Lifeway's Form 10-QSB for services
that are normally provided in connection with statutory and regulatory filings
or engagements in 2002.
In 2003, Gleeson billed Lifeway approximately $41,500 for professional
services rendered for the audit of Lifeway's annual financial statements and
review of financial statements included in Lifeway's Form 10-QSB or services
that are normally provided in connection with statutory and regulatory filings
or engagements in 2003.
AUDIT-RELATED FEES
In 2002, Gleeson billed Lifeway approximately $6,185 for assurance and
related services that are reasonably related to the performance of the audit or
review of Lifeway's financial statements.
In 2003, Gleeson billed Lifeway approximately $4,701 for assurance and
related services that are reasonably related to the performance of the audit or
review of Lifeway's financial statements.
TAX FEES
No professional services were rendered by Gleeson to Lifeway regarding tax
advice, tax compliance and tax planning.
ALL OTHER FEES
No other fees were billed to Lifeway by Gleeson other than those described
in this report.
No hours expended by Gleeson in its engagement to audit Lifeway's financial
statements for the most recent fiscal year were attributable to work performed
by persons other than Gleeson's full-time permanent employees.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES ADOPTED PURSUANT TO
REGULATION S-X
The Lifeway Audit Committee (the "Committee"), comprised of Messrs. Rick D.
Salm and Pol Sikar, pre-approved Gleeson as the Company's independent auditor
for the year-ended December 31, 2004 and has adopted the following guidelines
regarding the engagement of the Company's independent auditor to perform
services for the Company:
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For audit services (including statutory audit engagements as required under
local country laws), the independent auditor will provide the Committee with an
engagement letter during the January-March quarter of each year outlining the
scope of the audit services proposed to be performed during the fiscal year. If
agreed to by the Committee, this engagement letter will be formally accepted by
the Committee at its first or second quarter meeting.
The independent auditor will submit to the Committee for approval an audit
services fee proposal after acceptance of the engagement letter.
For non-audit services, company management will submit to the Committee for
approval (during the second or third quarter of each fiscal year) the list of
non-audit services that it recommends the Committee engage the independent
auditor to provide for the fiscal year. Company management and the independent
auditor will each confirm to the Committee that each non-audit service on the
list is permissible under all applicable legal requirements. In addition to the
list of planned non-audit services, a budget estimating non-audit service
spending for the fiscal year will be provided. The Committee will approve both
the list of permissible non-audit services and the budget for such services. The
Committee will be informed routinely as to the non-audit services actually
provided by the independent auditor pursuant to this pre-approval process.
To ensure prompt handling of unexpected matters, the Committee delegates to
the Controller, Chief Financial Officer or Chief Executive Officer the authority
to amend or modify the list of approved permissible non-audit services and fees.
The Controller, Chief Financial Officer or Chief Executive Officer will report
action taken to the Committee at the next Committee meeting.
The independent auditor must ensure that all audit and non-audit services
provided to the Company have been approved by the Committee. The Controller or
Chief Financial Officer will be responsible for tracking all independent auditor
fees against the budget for such services and report at least annually to the
Committee.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunder duly authorized.
LIFEWAY FOODS, INC.
By: /s/ Julie Smolyansky
Date: April 20, 2004 -------------------------------------------
Julie Smolyansky, Chief Executive Officer,
Chief Financial and Accounting Officer,
President, Treasurer and Director
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
/s/ Julie Smolyansky
Date: April 20, 2004 -------------------------------------------
Julie Smolyansky, Chief Executive Officer,
Chief Financial and Accounting Officer,
President, Treasurer and Director
/s/ Ludmila Smolyansky
Date: April 20, 2004 -------------------------------------------
Ludmila Smolyansky
Chairperson of the Board of Directors
/s/ Pol Sikar
Date: April 26, 2004 -------------------------------------------
Pol Sikar, Director
/s/ Rick D. Salm
Date: April 20, 2004 -------------------------------------------
Rick D. Salm, Director
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