10-Q 1 a2019093010-q.htm 10-Q 09-30-2019 Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to ______________
 
Commission File Number 0-26542
CRAFT BREW ALLIANCE, INC.
(Exact name of registrant as specified in its charter) 
Washington
 
91-1141254
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
929 North Russell Street
 
 
Portland, Oregon
 
97227-1733
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:  (503) 331-7270
Securities Registered pursuant to Section 12(b) of the Act:
 
 
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, $0.005 par value
BREW
The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐ 
Smaller reporting company ☐
Emerging growth company ☐

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

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

The number of shares of the registrant’s common stock outstanding as of November 7, 2019 was 19,466,244.
 



CRAFT BREW ALLIANCE, INC.
INDEX TO FORM 10-Q
 
PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II ‑ OTHER INFORMATION
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
Item 6.
 
 
 

1


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements
 
CRAFT BREW ALLIANCE, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except par value)
 
 
September 30,
2019
 
December 31,
2018
Assets
 
 
 
Current assets:
 
 
 
Cash, cash equivalents and restricted cash
$
11,782

 
$
1,200

Accounts receivable, net
18,357

 
29,998

Inventory, net
21,500

 
17,216

Other current assets
4,025

 
3,121

Total current assets
55,664

 
51,535

Property, equipment and leasehold improvements, net
110,924

 
113,189

Operating lease right-of-use assets
23,841

 

Goodwill
21,935

 
21,986

Trademarks
44,211

 
44,289

Intangible and other assets, net
5,473

 
5,048

Total assets
$
262,048

 
$
236,047

Liabilities and Shareholders' Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
19,475

 
$
17,552

Accrued salaries, wages and payroll taxes
5,881

 
5,635

Refundable deposits
3,467

 
4,123

Deferred revenue
3,251

 
6,015

Other accrued expenses
8,142

 
3,618

Current portion of long-term debt and finance lease obligations
1,498

 
919

Total current liabilities
41,714

 
37,862

Deferred revenue, non-current
20,300

 

Long-term debt and finance lease obligations, net of current portion
33,124

 
46,573

Fair value of derivative financial instruments
332

 
116

Deferred income tax liability, net
9,562

 
12,381

Long-term operating lease liabilities
24,269

 

Other liabilities
1,188

 
2,680

Total liabilities
130,489

 
99,612

Commitments and contingencies (Note 15)


 


Common shareholders' equity:
 

 
 

Common stock, $0.005 par value. Authorized 50,000,000 shares; issued and outstanding 19,466,244 and 19,382,641
97

 
97

Additional paid-in capital
145,276

 
144,013

Accumulated other comprehensive loss
(247
)
 
(86
)
Accumulated deficit
(13,567
)
 
(7,589
)
Total common shareholders' equity
131,559

 
136,435

Total liabilities and common shareholders' equity
$
262,048

 
$
236,047

 The accompanying notes are an integral part of these financial statements.

2


CRAFT BREW ALLIANCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Sales
$
50,349

 
$
55,639

 
$
163,932

 
$
170,977

Less excise taxes
3,188

 
2,750

 
9,220

 
8,778

Net sales
47,161

 
52,889

 
154,712

 
162,199

Cost of sales
33,857

 
36,190

 
101,938

 
108,302

Gross profit
13,304

 
16,699

 
52,774

 
53,897

Selling, general and administrative expenses
16,465

 
16,712

 
61,411

 
47,317

Operating income (loss)
(3,161
)
 
(13
)
 
(8,637
)
 
6,580

Interest expense
(616
)
 
(107
)
 
(1,428
)
 
(348
)
Other income (expense), net
24

 
(13
)
 
57

 
42

Income (loss) before income taxes
(3,753
)
 
(133
)
 
(10,008
)
 
6,274

Income tax provision (benefit)
(2,529
)
 
(194
)
 
(4,030
)
 
1,600

Net income (loss)
$
(1,224
)
 
$
61

 
$
(5,978
)
 
$
4,674

Basic and diluted net income (loss) per share
$
(0.06
)
 
$

 
$
(0.31
)
 
$
0.24

Shares used in basic per share calculations
19,466

 
19,370

 
19,435

 
19,338

Shares used in diluted per share calculations
19,466

 
19,545

 
19,435

 
19,525

 
The accompanying notes are an integral part of these financial statements.


3


CRAFT BREW ALLIANCE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Net income (loss)
$
(1,224
)
 
$
61

 
$
(5,978
)
 
$
4,674

Unrealized gain (loss) on derivative hedge transactions, net of tax
(25
)
 
38

 
(161
)
 
167

Comprehensive income (loss)
$
(1,249
)
 
$
99

 
$
(6,139
)
 
$
4,841

 
The accompanying notes are an integral part of these financial statements.


4


CRAFT BREW ALLIANCE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands)
 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated
Other Comprehensive Loss
 
 
 
Total
Common Shareholders' Equity
 
 
Shares
 
Par Value
 
 
 
Accumulated Deficit
 
Balance at December 31, 2017
 
19,310

 
$
96

 
$
142,196

 
$
(164
)
 
$
(11,337
)
 
$
130,791

Adoption of accounting standard ASC 606
 

 

 

 

 
(394
)
 
(394
)
Stock-based compensation
 

 

 
485

 

 

 
485

Unrealized gain on derivative financial instruments, net of tax of $29
 

 

 

 
83

 

 
83

Net income
 

 

 

 

 
161

 
161

Balance at March 31, 2018
 
19,310

 
96

 
142,681

 
(81
)
 
(11,570
)
 
131,126

Issuance of shares under stock plans, net of shares withheld for tax payments
 
23

 

 
206

 

 

 
206

Stock-based compensation
 
29

 
1

 
201

 
 
 
 
 
202

Unrealized gain on derivative financial instruments, net of tax of $15
 

 

 

 
46

 

 
46

Tax payments related to stock-based awards
 

 

 
(84
)
 

 

 
(84
)
Net income
 

 

 

 

 
4,452

 
4,452

Balance at June 30, 2018
 
19,362

 
97

 
143,004

 
(35
)
 
(7,118
)
 
135,948

Issuance of shares under stock plans, net of shares withheld for tax payments
 
20

 

 
221

 

 

 
221

Stock-based compensation
 

 

 
372

 

 

 
372

Unrealized gain on derivative financial instruments, net of tax of $13
 

 

 

 
38

 

 
38

Tax payments related to stock-based awards
 

 

 
(8
)
 

 

 
(8
)
Net income
 

 

 

 

 
61

 
61

Balance at September 30, 2018
 
19,382

 
$
97

 
$
143,589

 
$
3

 
$
(7,057
)
 
$
136,632



5


 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated
Other Comprehensive Loss
 
 
 
Total
Common Shareholders' Equity
 
 
Shares
 
Par Value
 
 
 
Accumulated Deficit
 
Balance at December 31, 2018
 
19,383

 
$
97

 
$
144,013

 
$
(86
)
 
$
(7,589
)
 
$
136,435

Stock-based compensation, net of shares withheld for tax payments
 
29

 

 
418

 

 

 
418

Unrealized loss on derivative financial instruments, net of tax of $16
 

 

 

 
(47
)
 

 
(47
)
Tax payments related to stock-based awards
 

 

 
(157
)
 

 

 
(157
)
Net loss
 

 

 

 

 
(7,364
)
 
(7,364
)
Balance at March 31, 2019
 
19,412

 
97

 
144,274

 
(133
)
 
(14,953
)
 
129,285

Stock-based compensation, net of shares withheld for tax payments
 
53

 

 
835

 

 

 
835

Unrealized loss on derivative financial instruments, net of tax of $31
 

 

 

 
(89
)
 

 
(89
)
Tax payments related to stock-based awards
 

 

 
(168
)
 

 

 
(168
)
Net income
 

 

 

 

 
2,610

 
2,610

Balance at June 30, 2019
 
19,465

 
97

 
144,941

 
(222
)
 
(12,343
)
 
132,473

Stock-based compensation, net of shares withheld for tax payments
 
1

 

 
335

 

 

 
336

Unrealized loss on derivative financial instruments, net of tax of $9
 

 

 

 
(25
)
 

 
(25
)
Net loss
 

 

 

 

 
(1,224
)
 
(1,224
)
Balance at September 30, 2019
 
19,466

 
$
97

 
$
145,276

 
$
(247
)
 
$
(13,567
)
 
$
131,559


The accompanying notes are an integral part of these financial statements.


6


CRAFT BREW ALLIANCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(5,978
)
 
$
4,674

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Depreciation and amortization
7,993

 
7,985

Gain on sale or disposal of Property, equipment and leasehold improvements
(8
)
 
(549
)
Deferred income taxes
(2,764
)
 
(673
)
Stock-based compensation
1,589

 
1,058

Lease expense
171

 

Other
(189
)
 
206

Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
11,975

 
(676
)
Inventories
(3,851
)
 
(2,905
)
Other current assets
(1,120
)
 
2,360

Accounts payable and other accrued expenses
8,986

 
4,922

Deferred revenue
17,537

 
1,950

Accrued salaries, wages and payroll taxes
247

 
(1,128
)
Refundable deposits
(114
)
 
(560
)
Net cash provided by operating activities
34,474

 
16,664

 
 
 
 
Cash flows from investing activities:
 

 
 

Expenditures for Property, equipment and leasehold improvements
(10,478
)
 
(6,216
)
Proceeds from sale of Property, equipment and leasehold improvements
55

 
22,998

Restricted cash from sale of Property, equipment and leasehold improvements

 
515

Business combinations and asset acquisitions
(274
)
 

Net cash provided by (used in) investing activities
(10,697
)
 
17,297

 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of long-term debt
5,192

 

Principal payments on debt and finance lease obligations
(798
)
 
(520
)
Net repayments under revolving line of credit
(17,264
)
 
(22,199
)
Proceeds from issuances of common stock

 
427

Tax payments related to stock-based awards
(325
)
 
(92
)
Net cash used in financing activities
(13,195
)
 
(22,384
)
Increase in Cash, cash equivalents and restricted cash
10,582

 
11,577

 
 
 
 
Cash, cash equivalents and restricted cash:
 

 
 

Beginning of period
1,200

 
579

End of period
$
11,782

 
$
12,156

Supplemental disclosure of cash flow information:
 

 
 

Cash paid for interest
$
1,414

 
$
396

Cash paid for income taxes, net
559

 
450

Cash paid for amounts included in measurement of lease liabilities
2,369

 

Supplemental disclosure of non-cash information:
 

 
 

Right-of-use assets obtained in exchange for operating lease obligations
$
24,898

 
$

Right-of-use assets obtained in exchange for finance lease obligations
2,538

 

Purchases of Property, equipment and leasehold improvements included in Accounts payable at end of period
937

 
205

The accompanying notes are an integral part of these financial statements.

7


CRAFT BREW ALLIANCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation

The accompanying consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Annual Report”). These consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements are unaudited but, in the opinion of management, reflect all material adjustments necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods presented. All such adjustments were of a normal, recurring nature. The results of operations for such interim periods are not necessarily indicative of the results of operations for the full year.

Reclassifications
Certain reclassifications have been made to the prior year's data to conform to the current year's presentation. None of the changes affect our previously reported consolidated Net sales, Gross profit, Operating income (loss), Net income (loss) or Basic and diluted net income (loss) per share.

Note 2. Recent Accounting Pronouncements

ASU 2018-15
In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-15, "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract." ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. We are still evaluating the effect of the adoption of ASU 2018-15.

ASU 2018-13
In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement." ASU 2018-13 removes, modifies and adds certain disclosure requirements on fair value measurements. ASU 2018-13 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. We are still evaluating the effect of the adoption of ASU 2018-13.
 
ASU 2017-12
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 refines and expands hedge accounting for both financial and commodity risks. Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. It also makes certain targeted improvements to simplify the application of hedge accounting guidance. ASU 2017-12 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018, on a prospective basis. We did not adopt ASU 2017-12 as it was not applicable to our financial position, results of operations or cash flows.

ASU 2017-04
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment." ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. An entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative 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. ASU 2017-04 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our financial position, results of operations or cash flows.


8


ASU 2016-13
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)." ASU 2016-13 addresses accounting for credit losses for assets that are not measured at fair value through net income on a recurring basis. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods, with early adoption permitted for fiscal years beginning after December 15, 2018. We do not expect the adoption of ASU 2016-13 to have a material effect on our financial position, results of operations or cash flows.

ASU 2016-02, ASU 2018-10 and ASU 2018-11
In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods.

In July 2018, the FASB issued ASU 2018-10, "Codification Improvements to Topic 842, Leases." ASU 2018-10 provides narrow amendments that clarify how to apply certain aspects of the guidance in ASU 2016-02. ASU 2018-10 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods.

In July 2018, the FASB issued ASU 2018-11, "Leases (Topic 842): Targeted Improvements." ASU 2018-11 provides an optional transition method, that allows entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2018-11 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods.

The new leases guidance affects all companies and organizations that lease assets, and requires them to record on their balance sheet right-of-use ("ROU") assets and lease liabilities for the rights and obligations created by those leases. Under ASC 842, a lease is an arrangement that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The new guidance retains a distinction between finance leases and operating leases, while requiring companies to recognize both types of leases on their balance sheet. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the criteria for distinguishing between capital leases and operating leases in legacy U.S. GAAP - ASC 840. Lessor accounting remains substantially the same as ASC 840, but with some targeted improvements to align lessor accounting with the lessee accounting model and with the revised revenue recognition guidance under ASC 606. The new standard and amendments require new qualitative and quantitative disclosures for both lessees and lessors.
 
On January 1, 2019, we adopted ASC 842 and elected the optional transition method under which we initially applied the standard on that date without adjusting amounts for prior periods, which we continue to present in accordance with ASC 840, including related disclosures. We evaluated the potential cumulative effect of applying the new leases guidance and determined that such an adjustment would be immaterial. In connection with our adoption, we:

elected the package of three practical expedients available under the transition provisions which allowed us to: (i) not reassess whether expired or existing contracts were or contained leases, (ii) not reassess the lease classification for expired or existing leases, and (iii) not reassess initial direct costs for existing leases.
determined the land easement practical expedient was not applicable.
as applicable, used hindsight for specified determinations and assessments in applying the new leases guidance.
did not separate lease and associated non-lease components for transitioned leases, but instead are accounting for them together as a single lease component.
elected to utilize the recognition exemption for short-term leases of one year or less at inception

Our adoption did not change the classification of lease-related expenses in the Consolidated Statements of Operations, and we do not expect significant changes to our pattern of expense recognition. As a result, we expect our adoption will not materially affect our cash flows.



9


The adjustments to our Consolidated Balance Sheets upon adoption of ASC 842, effective January 1, 2019 were as follows (in thousands):
 
 
Balance at
December 31, 2018
 
Adjustments due to
ASC 842
 
Balance at
January 1, 2019
Assets
 
 
 
 
 
 
Accounts receivable
 
$
29,998

 
$
300

 
$
30,298

Other current assets
 
3,121

 
(216
)
 
2,905

Property, equipment and leasehold improvements, net
 
113,189

 
(2,538
)
 
110,651

Operating lease right-of-use assets
 

 
19,726

 
19,726

Intangible and other assets, net
 
5,048

 
1,140

 
6,188

 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Other accrued expenses
 
3,618

 
269

 
3,887

Long-term lease liabilities
 

 
18,143

 
18,143


Note 3. Cash, Cash Equivalents and Restricted Cash

We maintain cash balances with financial institutions that may exceed federally insured limits. We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. As of September 30, 2019 and December 31, 2018, we did not have any cash equivalents.

As part of our cash management system, we use a controlled disbursement account to fund cash distribution checks presented for payment by the holder. Checks issued but not yet presented to banks may result in overdraft balances for accounting purposes. As of September 30, 2019 there were no bank overdrafts. As of December 31, 2018 there were $0.6 million of bank overdrafts included in Accounts payable on our Consolidated Balance Sheet. Changes in bank overdrafts from period to period are reported in the Consolidated Statements of Cash Flows as a component of operating activities within Accounts payable and Other accrued expenses.

Cash and cash equivalents that are restricted as to withdrawal or use under terms of certain contractual agreements are recorded in Cash, cash equivalents and restricted cash on our Consolidated Balance Sheets. As of September 30, 2019 we no longer had any restricted cash. Restricted cash of $0.5 million at December 31, 2018 represents funds held in an escrow account from the sale of our Woodinville brewery related to a lien; the lien was resolved in our favor and the restriction was removed in the third quarter of 2019.

Note 4. Inventories

Inventories are stated at the lower of standard cost or net realizable value.

We regularly review our inventories for the presence of obsolete product attributed to age, seasonality and quality. If our review indicates a reduction in utility below the product’s carrying value, we reduce the product to a new cost basis. We record the cost of inventory for which we estimate we have more than a twelve-month supply as a component of Intangible and other assets, net on our Consolidated Balance Sheets.

Inventories consisted of the following (in thousands):
 
September 30,
2019
 
December 31,
2018
Raw materials
$
8,741

 
$
7,146

Work in process
3,370

 
3,219

Finished goods
5,740

 
4,319

Packaging materials
2,486

 
891

Promotional merchandise
600

 
1,139

Brewpub food, beverages and supplies
563

 
502

 
$
21,500

 
$
17,216

Work in process is beer held in fermentation tanks prior to the filtration and packaging process.

10


Note 5. Leases

We lease office space, restaurant and production facilities, warehouse and storage space, land and equipment under operating leases that expire at various dates through the year ending December 31, 2064. Certain leases contain renewal options for varying periods and escalation clauses for adjusting rent to reflect changes in price indices or scheduled adjustments. We exercise judgment in determining the reasonably certain lease term based on the provisions of the underlying agreement, the economic value of leasehold improvements and other relevant factors. Certain leases require us to pay for insurance, taxes and maintenance applicable to the leased property. Under the terms of the land lease for our New Hampshire Brewery, we hold a first right of refusal to purchase the property should the lessor decide to sell the property.

We lease equipment under finance leases that expire at various dates through the year ending December 31, 2024. Ownership of the leased equipment transfers to us at the end of each lease term.

Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

If our leases do not provide an implicit rate, we develop an estimated incremental borrowing rate at the commencement date based on the estimated rate at which we would borrow, in the current economic environment, an amount equal to the lease payments over a similar term on a collateralized basis which is used to in determine the present value of lease payments. There were no new operating lease obligations recognized at adoption in comparison to our operating lease obligations disclosed as of December 31, 2018. Our accounting for finance (formerly capital) leases is substantially unchanged.

As described further in Note 2, we adopted ASC 842 as of January 1, 2019. Prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting under ASC 840.

Lease-related liabilities consisted of the following (in thousands):
 
September 30,
2019
 
December 31,
2018
Operating lease liabilities:
 
 
 
Current lease liabilities included in Other accrued expenses
$
863

 
$

Long-term lease liabilities
24,269

 

Total operating lease liabilities
25,132

 

Financing lease liabilities:
 
 
 
Current portion included in Current portion of long-term debt and finance lease obligations
391

 
477

Long-term portion of lease liabilities included in Long-term debt and finance lease obligations, net of current portion
879

 
1,101

Total financing lease liabilities
1,270

 
1,578

Total lease liabilities
$
26,402

 
$
1,578

Weighted-average remaining lease term:
 
 
 
Operating leases
25 years

 

Finance leases
4 years

 

Weighted-average discount rate:

 

Operating leases
4.72
%
 

Finance leases
3.56
%
 



11


As of September 30, 2019, the maturities of our operating lease liabilities were as follows (in thousands):
 
Operating Leases
Remainder of 2019
$
518

2020
2,002

2021
2,028

2022
2,091

2023
1,958

Thereafter
34,234

Total minimum lease payments
42,831

Less: present value adjustment
(17,699
)
Operating lease liabilities
$
25,132


As of September 30, 2019, the maturities of our finance lease liabilities were as follows (in thousands):
 
Finance Leases
Remainder of 2019
$
180

2020
333

2021
266

2022
199

2023
199

Thereafter
199

Total minimum lease payments
1,376

Less: present value adjustment
(106
)
Finance lease liabilities
$
1,270


Components of lease cost were as follows (in thousands):


Three Months Ended
September 30, 2019
 
Nine Months Ended
September 30, 2019
Operating lease cost(1)
$
904

 
$
2,642

Finance lease cost:
 
 
 
Amortization of right-of-use asset
42

 
127

Interest on lease liabilities
15

 
37

Sublease income
(69
)
 
(138
)
Total lease cost
$
892

 
$
2,668


(1) Includes short-term, month-to-month lease and variable lease costs, which were immaterial.


12


Total future minimum lease payments as of December 31, 2018 consisted of (in thousands):
 
Operating Lease Obligations
 
Capital Lease Obligations
2019
$
11,208

 
$
529

2020
1,937

 
333

2021
1,863

 
266

2022
1,793

 
199

2023
1,465

 
199

Thereafter
25,446

 
199

 
$
43,712

 
1,725

Amount representing interest
 
 
(148
)
 
 
 
$
1,577


Note 6. Acquisitions

On October 10, 2018, we purchased the intellectual property assets of Cisco Brewers ("Cisco") and we increased our ownership interest in Wynwood Brewing Co. ("Wynwood") from 24.5% to 100%. The purchase transaction of Cisco was accounted for as an asset acquisition. The increase in our ownership interest in Wynwood was accounted for under the acquisition method of accounting as a step acquisition. As required by this method, we remeasured our preexisting 24.5% equity interest to its acquisition-date fair value.

On November 29, 2018, we acquired substantially all the assets of Appalachian Mountain Brewery ("AMB"). The acquisition of AMB was accounted for under the acquisition method of accounting and all assets acquired and liabilities assumed were recorded at their respective acquisition-date fair values.

Given the close proximity of the closing dates of the acquisitions to the end of our fiscal year and the potential for working capital adjustments that may impact recognized amounts, the allocation of the purchase price to the underlying net assets was preliminary as of December 31, 2018. During 2019, we recorded immaterial adjustments to the allocation of the purchase price for the Cisco asset purchase and the AMB and Wynwood acquisitions.

The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values recorded as of December 31, 2018. We expect to finalize these amounts during the fourth quarter of 2019.


13


Note 7. Related Party Transactions

As of September 30, 2019 and December 31, 2018, Anheuser-Busch, LLC ("A-B") owned approximately 31.2% and 31.3%, respectively, of our outstanding common stock.

Transactions with A-B, Ambev and Anheuser-Busch Worldwide Investments, LLC (“ABWI”)
In December 2015, we partnered with Ambev, the Brazilian subsidiary of Anheuser-Busch InBev SA, to distribute Kona beers into Brazil. In August 2016, we also entered into an International Distribution Agreement with ABWI, an affiliate of A-B, pursuant to which ABWI distributes our malt beverage products in jurisdictions outside the United States, subject to the terms and conditions of our prior agreement with our other international distributor, CraftCan Travel LLC, and certain other limitations.

Contract Brewing Arrangement with Anheuser-Busch Companies, LLC ("ABC")
On January 30, 2018, we entered into a Contract Brewing Agreement (the “Brewing Agreement”) with ABC, an affiliate of A-B, pursuant to which we brew, package, and palletize certain malt beverage products of A-B's craft breweries at our Portland, Oregon, and Portsmouth, New Hampshire, breweries as selected by ABC. Under the terms of the Brewing Agreement, ABC pays us a per barrel fee that varies based on the annual volume of the specified product brewed by us, plus (a) our actual incremental costs of brewing the product and (b) certain capital costs and costs of graphics and labeling that we incur in connection with the brewed products.

The Brewing Agreement, as extended, will expire on December 31, 2019, unless the arrangement is extended at the mutual agreement of the parties. The Brewing Agreement contains specified termination rights, including, among other things, the right of either party to terminate the Brewing Agreement if (i) the other party fails to perform any material obligation under the Brewing Agreement or any other agreement between the parties, subject to certain cure rights, or (ii) the Master Distributor Agreement is terminated.

Transactions with A-B, Ambev, ABWI and ABC consisted of the following (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Gross sales to A-B and Ambev
$
38,740

 
$
41,737

 
$
129,779

 
$
129,588

International distribution fee earned from ABWI
812

 
850

 
2,436

 
2,550

International distribution fee from ABWI, recorded in Deferred revenue, net
19,188

 
650

 
17,564

 
1,950

Contract brewing fee earned from ABC
139

 
821

 
781

 
1,679

Margin fee paid to A-B, classified as a reduction of Sales
574

 
601

 
1,839

 
1,806

Inventory management and other fees paid to A-B, classified in Cost of sales
98

 
97

 
295

 
287

Media and other reimbursement from A-B, classified as a reduction of Selling, general and administrative expenses

 
192

 

 
192


Amounts due to or from A-B and ABWI were as follows (in thousands):
 
September 30,
2019
 
December 31,
2018
Amounts due from A-B related to beer sales pursuant to the A-B distributor agreement
$
12,631

 
$
17,946

Amounts due from ABWI and A-B related to international distribution fee and media reimbursement

 
6,000

Refundable deposits due to A-B
(3,712
)
 
(2,840
)
Amounts due to A-B for services rendered
(6,725
)
 
(5,140
)
Net amount due from A-B and ABWI
$
2,194

 
$
15,966



14


Transactions with Wynwood Brewing Co. ("Wynwood")
As of September 30, 2019 and December 31, 2018, Wynwood was a wholly owned subsidiary. During the nine-month period ended September 30, 2018, we owned a 24.5% interest in Wynwood. The carrying value of our investment was $2.0 million as of September 30, 2018.

Transactions with Wynwood prior to its becoming a wholly owned subsidiary consisted of the following (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Master distributor fee earned
$

 
$
3

 
$

 
$
22

Share of loss, classified as a component of Other income (expense), net

 
22

 

 
44

Refund of investment, classified as a reduction in the carrying value of the equity method investment

 

 

 
23


Related Party Operating Leases
We lease our headquarters office space, banquet space and storage facilities located in Portland, land and certain equipment from two limited liability companies, both of whose members include our former Board Chair, who is also a significant shareholder, and his brother, who continues to be employed by us. This lease is included in the ROU asset and lease liabilities recorded on our Consolidated Balance Sheets. Lease payments to these lessors were as follows (in thousands):
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
2019
 
2018
 
2019
 
2018
$
41

 
$
41

 
$
123

 
$
123


We hold lease and sublease obligations for certain office space and the land underlying the brewery and pub location in Kona, Hawaii, with a company whose owners have a charitable foundation that owns more than 5% of our common stock. The sublease contracts expire on various dates through 2020, with an extension at our option for two five-year periods. We exercised our option to extend these leases commencing in September 2020. These leases are included in the ROU asset and lease liabilities recorded on our Consolidated Balance Sheets. Lease payments to this lessor were as follows (in thousands):
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
2019
 
2018
 
2019
 
2018
$
172

 
$
145

 
$
511

 
$
435



15


Note 8. Debt

Long-term debt consisted of the following (in thousands):
 
September 30, 2019
 
December 31, 2018
Term loan, due September 30, 2023
$
8,494

 
$
8,823

Line of credit, due September 30, 2023
19,828

 
37,092

Secured borrowing, due June 21, 2026
5,030

 

 
33,352

 
45,915

Less current portion, term loan and secured borrowing
(1,107
)
 
(442
)
 
$
32,245

 
$
45,473


Credit Agreement
On October 10, 2018, we executed a First Amendment (the " First Amendment") to our Amended and Restated Credit Agreement with Bank of America, N.A. ("BofA") dated November 30, 2015 (the "Credit Agreement"). The Credit Agreement as amended by the First Amendment provides for a revolving line of credit (“Line of Credit”), including provisions for cash borrowings and up to $2.5 million notional amount of letters of credit, and a $10.8 million term loan (“Term Loan”). The primary changes effected by the First Amendment were to increase the maximum amount available under the Line of Credit from $40.0 million to $45.0 million and to extend the maturity date of the Line of Credit from November 30, 2020 to September 30, 2023, which is also the maturity date of the Term Loan. The maximum amount of the Line of Credit is subject to loan commitment reductions in the amount of $750,000 each quarter beginning March 31, 2020. The First Amendment also increased the limit on the total amount of investments that we may make in other craft brewers, other than the acquisition of all or substantially all of the assets or controlling ownership interests, from $5.0 million to $10.0 million. We may draw upon the Line of Credit for working capital and general corporate purposes.

As of September 30, 2019, we had $25.2 million in funds available to be drawn upon from our Line of Credit and $19.8 million of borrowings outstanding. At September 30, 2019, $8.5 million was outstanding under the Term Loan.

Under the Credit Agreement as in effect at September 30, 2019, interest accrues at an annual rate based on the London Inter-Bank Offered Rate (“LIBOR”) Daily Floating Rate plus a marginal rate. The marginal rate varies from 0.75% to 2.00% for the Line of Credit and Term Loan based on our funded debt ratio. At September 30, 2019, our marginal rate was 2.00%, resulting in an annual interest rate of 4.09%.

Accrued interest for the Term Loan is due and payable monthly. Principal payments on the Term Loan are due monthly in accordance with an agreed-upon schedule set forth in the Credit Agreement, with any unpaid principal balance and unpaid accrued interest due and payable on September 30, 2023.

The Credit Agreement authorizes acquisitions within the same line of business as long as we remain in compliance with the financial covenants of the Credit Agreement and there is at least $5.0 million of availability remaining on the Line of Credit following the acquisition.

Effective May 7, 2019, we executed a Second Amendment to the Credit Agreement with BofA (the “Second Amendment”). EBITDA, as defined in the Second Amendment, includes certain adjustments specified in the Second Amendment. Per the Second Amendment, beginning July 1, 2019, and in each fiscal quarter thereafter, the maximum Consolidated Leverage Ratio is 3.50 to 1.00, as A-B did not make a Qualifying Offer as defined in the International Distribution Agreement. Effective September 25, 2019, we executed a Third Amendment to the Credit Agreement with BofA that allows us to net Consolidated Funded Indebtedness with Qualified Cash and Cash Equivalents on hand in an amount not to exceed $10 million, to arrive at Consolidated Net Funded Indebtedness.

The Credit Agreement as in effect at September 30, 2019 required us to satisfy the following financial covenants: (i) a Consolidated Leverage Ratio (defined as Consolidated Net Funded Indebtedness to Consolidated EBITDA) of up to 3.50 to 1.00 and (ii) a Fixed Charge Coverage Ratio of at least 1.20 to 1.00. Failure to maintain compliance with these covenants is an event of default and would give BofA the right to declare the entire outstanding loan balance immediately due and payable. At September 30, 2019, we were in compliance with all applicable contractual financial covenants of the Credit Agreement.


16


Secured Borrowing
On June 20, 2019, we executed an agreement with BofA, pursuant to our Master Lease Agreement, for $5.2 million in cash in exchange for a secured interest in our previously installed can line at our Portland brewing facility. The maturity date of the secured borrowing is June 21, 2026. We used the funds to pay down our Line of Credit.

Note 9. Derivative Financial Instruments

Interest Rate Swap Contracts
Our risk management objectives are to ensure that business and financial exposures to risk that have been identified and measured are minimized using the most effective and efficient methods to reduce, transfer and, when possible, eliminate such exposures. Operating decisions contemplate associated risks and management strives to structure proposed transactions to avoid or reduce risk whenever possible.

We have assessed our vulnerability to certain business and financial risks, including interest rate risk associated with our variable-rate long-term debt. To mitigate this risk, effective January 23, 2014, we entered into an interest rate swap contract with BofA for 75% of the term loan ("Term Loan") balance, to hedge the variability of interest payments associated with our variable-rate borrowings under our Term Loan with BofA. The Term Loan contract and the interest rate swap terminate on September 30, 2023. The Term Loan contract had a total notional value of $6.4 million as of September 30, 2019. Through this swap agreement, we pay interest at a fixed rate of 2.86% and receive interest at a floating-rate of the one-month LIBOR, which was 2.04% at September 30, 2019.

Since the interest rate swap hedges the variability of interest payments on variable rate debt with similar terms, it qualifies for cash flow hedge accounting treatment.

As of September 30, 2019, an unrealized net loss of $0.3 million was recorded in Accumulated other comprehensive income (loss) as a result of these hedges. The effective portion of the gain or loss on the derivatives is reclassified into Interest expense in the same period during which we record Interest expense associated with the related debt. There was no hedge ineffectiveness during the first nine months of 2019 or 2018.

The fair value of our derivative instruments recorded as a component of Other liabilities on our Consolidated Balance Sheets was as follows (in thousands):
 
September 30,
2019
 
December 31,
2018
Fair value of interest rate swap liability
$
(332
)
 
$
(116
)
 
The effect of our interest rate swap contracts that were accounted for as a derivative instrument on our Consolidated Statements of Operations was as follows (in thousands):
Derivatives in Cash Flow Hedging Relationships
 
Amount of Gain (Loss)
Recognized in Accumulated OCI (Effective Portion)
 
Location of Loss Reclassified
from Accumulated OCI into
Income (Effective Portion)
 
Amount of Loss Reclassified from Accumulated OCI into
Income (Effective Portion)
Three Months Ended
September 30,
 
 
 
 
 
 
2019
 
$
(34
)
 
Interest expense
 
$
10

2018
 
$
52

 
Interest expense
 
$
13

 
 
 
 
 
 
 
Nine Months Ended
September 30,
 
 
 
 
 
 
2019
 
$
(216
)
 
Interest expense
 
$
22

2018
 
$
225

 
Interest expense
 
$
52

See also Note 10.


17


Note 10. Fair Value Measurements

Factors used in determining the fair value of our financial assets and liabilities are summarized into three broad categories:

Level 1 – quoted prices in active markets for identical securities as of the reporting date;
Level 2 – other significant directly or indirectly observable inputs, including quoted prices for similar securities, interest rates, prepayment speeds and credit risk; and
Level 3 – significant inputs that are generally less observable than objective sources, including our own assumptions in determining fair value.

The factors or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.

The following table summarizes liabilities measured at fair value on a recurring basis (in thousands):
Fair Value at September 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Interest rate swap
 
$

 
$
(332
)
 
$

 
$
(332
)
 
 
 
 
 
 
 
 
 
Fair Value at December 31, 2018
 
 

 
 

 
 

 
 

Interest rate swaps
 
$

 
$
(116
)
 
$

 
$
(116
)

We did not have any assets measured at fair value on a recurring basis at September 30, 2019 or December 31, 2018.

The fair value of our interest rate swaps was based on quarterly statements from the issuing bank. There were no changes to our valuation techniques during the nine months ended September 30, 2019.

We believe the carrying amounts of Cash, cash equivalents and restricted cash, Accounts receivable, Other current assets, Accounts payable, Accrued salaries, wages and payroll taxes, and Other accrued expenses are a reasonable approximation of the fair value of those financial instruments because of the nature of the underlying transactions and the short-term maturities involved.

We had fixed-rate debt outstanding as follows (in thousands):
 
September 30,
2019
 
December 31,
2018
Fixed-rate debt on Consolidated Balance Sheets
$
6,300

 
$
1,577

Estimated fair value of fixed-rate debt
6,576

 
1,591


We calculate the estimated fair value of our fixed-rate debt using a discounted cash flow methodology. Using estimated current interest rates based on a similar risk profile and duration (Level 2), the fixed cash flows are discounted and summed to compute the fair value of the debt.


18


Note 11. Revenue Recognition

The following table disaggregates our Sales by major source (in thousands):
 
 
Three Months Ended September 30, 2019
 
Nine Months Ended September 30, 2019
 
 
Beer Related(1)
 
Brewpubs
 
Total
 
Beer Related(1)
 
Brewpubs
 
Total
Product sold through distributor agreements(2)
 
$
42,667

 
$

 
$
42,667

 
$
139,700

 
$

 
$
139,700

Alternating proprietorship and contract brewing fees(3)
 
381

 

 
381

 
1,581

 

 
1,581

International distribution fees
 
812

 

 
812

 
2,436

 

 
2,436

Brewpubs(4)
 

 
5,991

 
5,991

 

 
18,260

 
18,260

Other(5)
 
498

 

 
498

 
1,955

 

 
1,955

 
 
$
44,358

 
$
5,991

 
$
50,349

 
$
145,672

 
$
18,260

 
$
163,932


 
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
 
Beer Related(1)
 
Brewpubs
 
Total
 
Beer Related(1)
 
Brewpubs
 
Total
Product sold through distributor agreements(2)
 
$
45,326

 
$

 
$
45,326

 
$
139,141

 
$

 
$
139,141

Alternating proprietorship and contract brewing fees(3)
 
2,863

 

 
2,863

 
8,748

 

 
8,748

International distribution fees
 
850

 

 
850

 
2,550

 

 
2,550

Brewpubs(4)
 

 
6,166

 
6,166

 

 
18,278

 
18,278

Other(5)
 
434

 

 
434

 
2,260

 

 
2,260

 
 
$
49,473

 
$
6,166

 
$
55,639

 
$
152,699

 
$
18,278

 
$
170,977


(1)
Beer Related sales include sales to A-B subsidiaries including Ambev, ABWI and ABC. Sales to wholesalers through the A-B distributor agreement in the three-month period ended September 30, 2019 and 2018 represented 77.7% and 76.9% of our Sales, respectively. Sales to wholesalers through the A-B distributor agreement in the nine-month period ended September 30, 2019 and 2018 represented 80.0% and 77.2% of our Sales, respectively.
(2)
Product sold through distributor agreements included domestic and international sales of owned and non-owned brands pursuant to terms in our distributor agreements.
(3)
Alternating proprietorship fees ceased in the fourth quarter of 2018.
(4)
Brewpub sales include sales of promotional merchandise and sales of beer directly to customers.
(5)
Other sales include sales of beer related merchandise, hops and spent grain.
 
Revenue is recognized when obligations under the terms of a contract with our customers are satisfied; generally this occurs when the product arrives at distribution centers or when the wholesaler takes possession. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods. We consider customer purchase orders, which in some cases are governed by a master agreement, to be the contracts with a customer. For each contract related to the production of beer, we consider the promise to transfer products, each of which is distinct, to be the identified performance obligation. The transaction price for each performance obligation is specifically identified within the contract with our customer and represents the fair standalone selling price. Discounts are recognized as a reduction to Sales at the time we recognize the revenue. We generally do not grant return privileges, except in limited and specific circumstances.

As of September 30, 2019, we had receivables related to contracts with customers of $18.4 million, net of the allowance for doubtful accounts of $25,000. As of December 31, 2018, we had receivables related to contracts with customers of $30.0 million, net of the allowance for doubtful accounts of $25,000.


19


As of September 30, 2019 and December 31, 2018, contract liabilities, which consisted of obligations associated with our gift card programs, were $0.2 million and $0.4 million, respectively, and were included in Other accrued expenses on the Consolidated Balance Sheets.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of accounting pursuant to ASC 606. In contracts with multiple performance obligations, we identify each performance obligation and evaluate whether the performance obligation is distinct within the context of the contract at contract inception. Performance obligations that are not distinct at contract inception are combined.
 
We entered into an International Distribution Agreement ("IDA") with A-B for the rights to serve as our exclusive distributor in international territories defined by the IDA for a 10-year period. The IDA represents a single international license to all territories defined in the IDA. Revenue is recognized on a straight-line basis over the 10-year term of the agreement. In accordance with ASC 606, we evaluate the factors used in our estimates of variable consideration to be received under contracts on a quarterly basis. We estimate variable consideration as the most likely amount to which we expect to be entitled. During the third quarter of 2019, we received the final payment under the IDA which resulted in total consideration received of $34.0 million. We consider the 10-year contractual term of the IDA as the most likely term of the agreement and will recognize the revenue from these payments over that period. We believe that the possibility of a significant reversal of cumulative revenue recognized from this agreement under this conclusion is remote. Under the IDA, A-B has the right to issue purchase orders to distribute product in international territories defined by the IDA. Each purchase order placed under the IDA is a distinct performance obligation. The transaction price for each performance obligation is a sales-based royalty, which is recognized as revenue in accordance with the sales-based royalty exception. Accordingly, royalty revenue is recognized as the variability associated with the royalty is resolved, which is upon A-B's subsequent sale of our product.

In cases where all conditions to a sale are not met at the time of sale, revenue recognition is deferred until all conditions are met. As of December 31, 2018, Deferred revenue on our Consolidated Balance Sheets included $6.0 million related to the IDA. On August 23, 2019, ABC announced it would not make a Qualifying Offer and we received a one-time incentive payment in the amount of $20.0 million on that date as required by the terms of the IDA. For the nine months ended September 30, 2019, we recognized $2.4 million as Sales, resulting in Deferred revenue of $23.6 million at September 30, 2019. We expect to recognize an additional $0.8 million of Deferred revenue as Sales in the remainder of 2019, $3.2 million in 2020, and $19.5 million thereafter.


20


Note 12. Segment Results and Concentrations

Our chief operating decision maker monitors Net sales and gross margins of our Beer Related operations and our Brewpubs operations. Beer Related operations include the brewing operations and related domestic and international beer and cider sales of our Kona, Widmer Brothers, Redhook, Omission, AMB, Cisco, and Wynwood beer brands and Square Mile cider brand. Brewpubs operations primarily include our brewpubs, some of which are located adjacent to our Beer Related operations. We do not track operating results beyond the gross margin level or our assets on a segment level.

Net sales, Gross profit and gross margin information by segment was as follows (dollars in thousands):
 
 
Three Months Ended September 30,
2019
 
Beer
Related
 
Brewpubs
 
Total
Net sales
 
$
41,170

 
$
5,991

 
$
47,161

Gross profit
 
$
12,692

 
$
612

 
$
13,304

Gross margin
 
30.8
%
 
10.2
%
 
28.2
%
 
 
 
 
 
 
 
2018
 
 

 
 

 
 

Net sales
 
$
46,723

 
$
6,166

 
$
52,889

Gross profit
 
$
16,261

 
$
438

 
$
16,699

Gross margin
 
34.8
%
 
7.1
%
 
31.6
%
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
2019
 
Beer
Related
 
Brewpubs
 
Total
Net sales
 
$
136,452

 
$
18,260

 
$
154,712

Gross profit
 
$
50,876

 
$
1,898

 
$
52,774

Gross margin
 
37.3
%
 
10.4
%
 
34.1
%
 
 
 
 
 
 
 
2018
 
 

 
 

 
 

Net sales
 
$
143,921

 
$
18,278

 
$
162,199

Gross profit
 
$
52,913

 
$
984

 
$
53,897

Gross margin
 
36.8
%
 
5.4
%
 
33.2
%
 
The segments use many of the same assets. For internal reporting purposes, we do not allocate assets by segment and, therefore, no asset by segment information is provided to our chief operating decision maker.

In preparing this financial information, certain expenses were allocated between the segments based on management estimates, while others were based on specific factors such as headcount. These factors can have a significant impact on the amount of Gross profit for each segment. While we believe we have applied a reasonable methodology, assignment of other reasonable cost allocations to each segment could result in materially different segment Gross profit.

Sales to wholesalers through the A-B distributor agreement represented the following percentage of our Sales:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
2019
 
2018
 
2019
 
2018
77.7
%
 
76.9
%
 
80.0
%
 
77.2
%
 
Receivables from A-B and ABWI represented the following percentage of our Accounts receivable balance:
 
September 30,
2019
 
December 31,
2018
68.8
%
 
79.8
%


21


Note 13. Significant Stock-Based Plan Activity and Stock-Based Compensation

Stock-Based Compensation
Stock-based compensation expense was recognized in our Consolidated Statements of Operations as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Cost of sales
$
(3
)
 
$
42

 
$
79

 
$
108

Selling, general and administrative expense
339

 
329

 
1,510

 
950

Total stock-based compensation expense
$
336

 
$
371

 
$
1,589

 
$
1,058


At September 30, 2019, we had total unrecognized stock-based compensation expense of $1.8 million, which will be recognized over the weighted average remaining vesting period of 2.0 years.
 
Note 14. Earnings Per Share

The reconciliation between the number of shares used for the basic and diluted per share calculations, as well as other related information, is as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Weighted average common shares used for basic EPS
19,466

 
19,370

 
19,435

 
19,338

Dilutive effect of stock-based awards

 
175

 

 
187

Shares used for diluted EPS
19,466

 
19,545

 
19,435

 
19,525

 
 
 
 
 


 


Stock-based awards not included in diluted per share calculations as they would be antidilutive
71

 

 
65

 


Note 15. Commitments and Contingencies

The disclosure of purchase commitments in these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2018. The disclosures below relate to legal commitments with significant events occurring during the nine months ended September 30, 2019.

General
We are subject to various claims and pending or threatened lawsuits in the normal course of business. Although we do not anticipate that the resolution of legal proceedings arising in the normal course of business or the proceeding described below will have a material adverse effect on our financial position, results of operations or cash flows, we cannot predict this with certainty.

Legal
On February 28, 2017 and March 6, 2017, respectively, two lawsuits, Sara Cilloni and Simone Zimmer v. Craft Brew Alliance, Inc., and Theodore Broomfield v. Kona Brewing Co. LLC, Kona Brew Enterprises, LLP, Kona Brewery LLC, and Craft Brew Alliance, Inc., were filed in the United States District Court for the Northern Division of California. On April 7, 2017, the two lawsuits were consolidated into a single complaint under the Broomfield case. The lawsuit alleges that the defendants misled customers regarding the state in which Kona Brewing Company beers are manufactured. On April 28, 2017, we filed a motion to dismiss the complaint, which was granted in part and denied in part on September 1, 2017. On September 26, 2018, the Court granted Plaintiffs’ motion for class certification, forming a class of persons within the state of California who purchased certain Kona Brewing Company products within the relevant statute of limitations period. Our motion for reconsideration was denied on October 16, 2018. On May 30, 2019, we announced our entry into a definitive settlement agreement, which received preliminary approval from the Court on June 14, 2019. We recorded a charge of $4.7 million on a pre-tax basis in the quarter ended March 31, 2019, based on our estimate of the probable costs of settling the litigation. The settlement claims period ended October 7, 2019. The total cost of settling the litigation is not expected to be materially in excess of $4.7 million.


22


Note 16. Subsequent Events

On November 11, 2019, Craft Brew Alliance, Inc., a Washington corporation (the “Company”), Anheuser-Busch Companies, LLC, a Delaware limited liability company (“A-B”), and Barrel Subsidiary, Inc., a Washington corporation and wholly owned subsidiary of A-B (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Agreement”), pursuant to which Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing as the surviving entity in the Merger as a direct subsidiary of A-B. A-B, which currently owns 31.2% of the outstanding shares of the Company’s common stock, has agreed to acquire the remaining outstanding shares for $16.50 per share in cash (the “Merger Consideration”). The Agreement provides that, at the Effective Time, each then outstanding option to purchase Shares (a “Company Option”), whether vested or unvested, shall, automatically and without any action on the part of the holder thereof, fully vest (to the extent unvested) and shall be cancelled and converted into the right to receive (without interest) an amount in cash equal to the product of (i) the number of Shares subject to the Company Option immediately prior to the Effective Time multiplied by (ii) the excess, if any, of (A) the Merger Consideration over (B) the exercise price per Share of such Company Option. In addition, each then outstanding restricted stock unit award corresponding to Shares (a “Company RSU Award”) shall, automatically and without any required action on the part of the holder thereof, be cancelled and converted into the right to receive (without interest) an amount in cash equal to the product of (i) the number of Shares subject to such Company RSU Award (which number, for any performance-based Company RSU Awards, shall equal (x) for Company RSU Awards for the 2017-2019 performance cycle, thirty-three percent of the number of Shares that would be earned based on target performance and (y) for Company RSU Awards for the 2018-2020 and 2019-2021 performance cycles, one hundred percent of the number of Shares that would be earned on target performance), multiplied by (ii) the Merger Consideration. Completion of the transaction is contingent on the satisfaction of customary closing conditions, including approval by a majority of the outstanding shares held by shareholders not affiliated with A-B and certain regulatory approvals. The transaction is expected to close in 2020.


23


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q includes forward-looking statements. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will,” “may,” “plan” and similar expressions or their negatives identify forward-looking statements, which generally are not historical in nature. These statements are based upon assumptions and projections that we believe are reasonable, but are by their nature inherently uncertain. Many possible events or factors could affect our future financial results and performance, and could cause actual results or performance to differ materially from those expressed, including those risks and uncertainties described in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Annual Report”), and those described from time to time in our future reports filed with the Securities and Exchange Commission (the “SEC”). Certain forward-looking statements are subject to the anticipated occurrence and timing of the closing of the merger transaction pursuant to which Anheuser-Busch Companies, LLC, is expected to acquire Craft Brew Alliance, Inc. Caution should be taken not to place undue reliance on these forward-looking statements, which speak only as of the date of this quarterly report.

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto included herein, as well as the audited Consolidated Financial Statements and Notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2018 Annual Report. The discussion and analysis includes period-to-period comparisons of our financial results. Although period-to-period comparisons may be helpful in understanding our financial results, we believe that they should not be relied upon as an accurate indicator of future performance.

24


Overview

Craft Brew Alliance, Inc. ("CBA") is the seventh largest craft brewing company in the U.S. and a leader in brewing, branding, and bringing to market world-class American craft beers. Publicly traded on NASDAQ under the ticker symbol BREW, CBA is headquartered in Portland, Oregon and operates breweries and brewpubs across the U.S.

Our distinctive portfolio combines the power of Kona Brewing Co., one of the top craft beer brands in the world, with strong regional breweries and innovative lifestyle brands, including Appalachian Mountain Brewery, Cisco Brewers, Omission Brewing Co., Redhook Brewery, Square Mile Cider Co., Widmer Brothers Brewing, and Wynwood Brewing Co. We nurture the growth and development of our brands in today’s increasingly competitive beer market through our state-of-the-art brewing and distribution capability, integrated sales and marketing infrastructure, and strong focus on innovation, local community and sustainability.

CBA was formed in 2008 through the merger of Redhook Brewery and Widmer Brothers Brewing, the two largest craft brewing pioneers in the Northwest at the time. Following a successful strategic brewing and distribution partnership, Kona Brewing Co. joined CBA in 2010. As part of CBA, Kona has expanded its reach across all 50 U.S. states and approximately 30 countries, while remaining deeply rooted in its home of Hawaii.

As consumers increasingly seek more variety and more local offerings, Craft Brew Alliance has expanded its portfolio and home markets with strong regional craft beer brands in targeted markets. In 2015 and 2016, we formed strategic partnerships with Appalachian Mountain Brewery, based in Boone, North Carolina; Cisco Brewers, based in Nantucket, Massachusetts; and Wynwood Brewing Co., based in the heart of Miami’s vibrant multicultural arts district. Building on the success of these partnerships, we acquired all three brands in the fourth quarter of 2018, fundamentally transforming our footprint and paving the way to increase our investments in their growth and drive shareholder value. In 2019, CBA launched The pH Experiment as a separate business unit focused on anticipating drinkers’ needs and quickly rolling out new offerings to quench their thirst.

We proudly brew and package our craft beers in three company-owned production breweries located in Portland, Oregon; Portsmouth, New Hampshire; and Kailua-Kona, Hawaii. In 2018, we continued to leverage our contract brewing agreement with A-B Commercial Strategies, LLC (“ABCS”), an affiliate of Anheuser-Busch, LLC (“A-B”), through which we brew select CBA brands in A-B’s Fort Collins, Colorado brewery. Additionally, we own and operate five innovation breweries in Portland, Oregon; Seattle, Washington; Portsmouth, New Hampshire; Boone, North Carolina; and Miami, Florida; they are primarily used for small-batch production and limited-release beers offered primarily in our brewpubs and brands’ home markets.

We distribute our beers to retailers through wholesalers that are aligned with the A-B network. These sales are made pursuant to a Master Distributor Agreement (the “A-B Distributor Agreement”) with A-B, which extends through 2028. As a result of this distribution arrangement, we believe that, under alcohol beverage laws in a majority of states, these wholesalers would own the exclusive right to distribute our beers in their respective markets if the A-B Distributor Agreement expires or is terminated. As competition puts increasing pressure on craft brands outside of their home markets, we are continuing our efforts to stabilize and strengthen Widmer Brothers and Redhook in the Pacific Northwest, while expanding distribution of Appalachian Mountain Brewery, Cisco Brewers, and Wynwood Brewing Co. across their respective home markets of North Carolina, New England, and South Miami.

Separate from our A-B wholesalers, we maintain an internal independent sales and marketing organization with resources across the key functions of brand management, field marketing, field sales, and national retail sales.

We operate in two segments: Beer Related operations and Brewpubs operations. Beer Related operations include the brewing, and domestic and international sales, of craft beers and ciders from our breweries. Brewpubs operations primarily include our five brewpubs, four of which are located adjacent to our Beer Related operations, as well as other merchandise sales, and sales of our beers directly to customers.




25


Following is a summary of our financial results:
Nine Months Ended September 30,
 
Net sales
 
Net income (loss)
 
Number of
barrels sold
2019
 
$154.7 million
 
$(6.0) million
 
585,400
2018
 
$162.2 million
 
$4.7 million
 
587,400

Results of Operations

The following table sets forth, for the periods indicated, certain information from our Consolidated Statements of Operations expressed as a percentage of Net sales(1):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Sales
106.8
 %
 
105.2
 %
 
106.0
 %
 
105.4
 %
Less excise taxes
(6.8
)
 
(5.2
)
 
(6.0
)
 
(5.4
)
Net sales
100.0

 
100.0

 
100.0

 
100.0

Cost of sales
71.8

 
68.4

 
65.9

 
66.8

Gross profit
28.2

 
31.6

 
34.1

 
33.2

Selling, general and administrative expenses
34.9

 
31.6

 
39.7

 
29.2

Operating income (loss)
(6.7
)
 

 
(5.6
)
 
4.1

Interest expense
(1.3
)
 
(0.2
)
 
(0.9
)
 
(0.2
)
Other income (expense), net
0.1

 

 

 

Income (loss) before income taxes
(8.0
)
 
(0.3
)
 
(6.5
)
 
3.9

Income tax provision (benefit)
(5.4
)
 
(0.4
)
 
(2.6
)
 
1.0

Net income (loss)
(2.6
)%
 
0.1
 %
 
(3.9
)%
 
2.9
 %

(1)
Percentages may not add due to rounding.

26



Segment Information
Net sales, Gross profit and Gross margin information by segment was as follows (dollars in thousands):
 
 
Three Months Ended September 30,
2019
 
Beer
Related
 
Brewpubs
 
Total
Net sales
 
$
41,170

 
$
5,991

 
$
47,161

Gross profit
 
$
12,692

 
$
612

 
$
13,304

Gross margin
 
30.8
%
 
10.2
%
 
28.2
%
 
 
 
 
 
 
 
2018
 
 

 
 

 
 

Net sales
 
$
46,723

 
$
6,166

 
$
52,889

Gross profit
 
$
16,261

 
$
438

 
$
16,699

Gross margin
 
34.8
%
 
7.1
%
 
31.6
%
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
2019
 
Beer
Related
 
Brewpubs
 
Total
Net sales
 
$
136,452

 
$
18,260

 
$
154,712

Gross profit
 
$
50,876

 
$
1,898

 
$
52,774

Gross margin
 
37.3
%
 
10.4
%
 
34.1
%
 
 
 
 
 
 
 
2018
 
 

 
 

 
 

Net sales
 
$
143,921

 
$
18,278

 
$
162,199

Gross profit
 
$
52,913

 
$
984

 
$
53,897

Gross margin
 
36.8
%
 
5.4
%
 
33.2
%
 

27


Sales by Category
Sales by category were as follows (dollars in thousands):
 
 
Three Months Ended September 30,
 
Dollar
 
 
Sales by Category
 
2019
 
2018
 
Change
 
% Change
A-B and A-B related(1)
 
$
39,117

 
$
42,807

 
$
(3,690
)
 
(8.6
)%
Contract brewing and beer related(2)
 
5,241

 
6,666

 
(1,425
)
 
(21.4
)%
Excise taxes
 
(3,188
)
 
(2,750
)
 
(438
)
 
15.9
 %
Net beer related sales
 
41,170

 
46,723

 
(5,553
)
 
(11.9
)%
Brewpubs(3)
 
5,991

 
6,166

 
(175
)
 
(2.8
)%
Net sales
 
$
47,161

 
$
52,889

 
$
(5,728
)
 
(10.8
)%
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
Dollar
 
 
Sales by Category
 
2019
 
2018
 
Change
 
% Change
A-B and A-B related(1)
 
$
131,157

 
$
132,011

 
$
(854
)
 
(0.6
)%
Contract brewing and beer related(2)
 
14,515

 
20,688

 
(6,173
)
 
(29.8
)%
Excise taxes
 
(9,220
)
 
(8,778
)
 
(442
)
 
5.0
 %
Net beer related sales
 
136,452

 
143,921

 
(7,469
)
 
(5.2
)%
Brewpubs(3)
 
18,260

 
18,278

 
(18
)
 
(0.1
)%
Net sales
 
$
154,712

 
$
162,199

 
$
(7,487
)
 
(4.6
)%

(1)
A-B and A-B related includes domestic and international sales of our owned brands sold through A-B and Ambev, as well as non-owned brands sold pursuant to master distribution agreements in 2018, fees earned pursuant to the Brewing Agreement with Anheuser-Busch Companies, LLC ("ABC"), and the international distribution fees earned from ABWI.
(2)
Beer related includes international sales of our beers, and brands, not sold through A-B or Ambev, as well as fees earned through alternating proprietorship agreements during 2018.
(3)
Brewpubs sales include sales of promotional merchandise and sales of beer directly to customers.

Shipments by Category
Shipments by category were as follows (in barrels):
Three Months Ended September 30,
 
2019 Shipments
 
2018 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions
(1)
A-B and A-B related(2)
 
159,200

 
170,000

 
(10,800
)
 
(6.4
)%
 
2
%
Contract brewing and beer related(3)
 
24,100

 
24,000

 
100

 
0.4
 %
 
 

Brewpubs
 
2,100

 
1,800

 
300

 
16.7
 %
 
 

Total
 
185,400

 
195,800

 
(10,400
)
 
(5.3
)%
 
 

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
2019 Shipments
 
2018 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions
(1)
A-B and A-B related(2)
 
515,300

 
514,800

 
500

 
0.1
 %
 
0
%
Contract brewing and beer related(3)
 
64,200

 
67,000

 
(2,800
)
 
(4.2
)%
 
 

Brewpubs
 
5,900

 
5,600

 
300