10-Q 1 form10q_16885.htm FORM 10-Q form10q_16885.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:  June 30, 2010
 
o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
Commission File Number: 000-17363
 
 
LIFEWAY FOODS, INC.
(Exact Name of Registrant as Specified in its Charter)
 
 
Illinois
36-3442829
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
 
 6431 West Oakton, Morton Grove, IL 60053
(Address of Principal Executive Offices, Zip Code)
 
(847-967-1010)
(Registrant’s Telephone Number, Including Area Code) 
 
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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  o   No  x
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  o   No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer  o
Smaller reporting company x
 
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o   No  x
 
As of June 30, 2010, the issuer had 16,657,478 shares of common stock, no par value, outstanding.
 
 
 
 
 
LIFEWAY FOODS, INC.
CONTENTS TO FORM 10-Q
 
 
PART I —
FINANCIAL INFORMATION
  
Page(s)
       
ITEM 1.
FINANCIAL STATEMENTS.
   3
       
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
   8
       
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
   21
       
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
   24
       
   ITEM 4T.
CONTROLS AND PROCEDURES.
   24
       
       
       
PART II —
OTHER INFORMATION
   24
       
ITEM 1.
LEGAL PROCEEDINGS.
   24
       
    ITEM 1A.
RISK FACTORS.
   24
       
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
   24
       
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.
   25
       
ITEM 4.
REMOVED AND RESERVED.
   25
       
ITEM 5.
OTHER INFORMATION.
   25
       
ITEM 6.
EXHIBITS.
   26
       
       
       
SIGNATURES
     27
       
EXHIBIT INDEX
     28
 

 
- 2 -
 
 



 


 
LIFEWAY FOODS, INC. AND SUBSIDIARIES

 CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010 AND 2009
AND DECEMBER 31, 2009












 
- 3 -
 
PART I — FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS.
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, 2010 and 2009 (Unaudited) and December 31, 2009
 
   
(Unaudited)
        
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
ASSETS
                  
                   
Current assets
                  
Cash and cash equivalents
   $ 858,490     $ 582,766     $ 630,407  
Investments
     3,411,804       4,659,161       4,392,125  
Certificates of deposits in financial institutions
     550,000       —       652,005  
Inventories
     4,154,719       3,817,195       3,296,976  
Accounts receivable, net of allowance for doubtful accounts and discounts
     7,780,512       6,064,801       5,999,738  
Prepaid expenses and other current assets
     70,130       55,669       40,697  
Other receivables
     142,389       65,730       49,758  
Deferred income taxes
     389,249       638,372       251,456  
Refundable income taxes
     —       778,125       1,308,978  
Total current assets
     17,357,293       16,661,819       16,622,140  
                         
Property and equipment, net
     14,890,327       13,793,929       14,282,182  
                         
Intangible assets
                        
Goodwill and other non amortizable brand asset
     13,806,091       13,806,091       13,806,091  
Other intangible assets, net of accumulated amortization of $1,949,729 and $1,260,809 at June 30, 2010 and 2009 and $1,598,208 at December 31, 2009
     5,907,909       6,596,829       6,259,430  
Total intangible assets
     19,714,000       20,402,920       20,065,521  
                         
Other assets
     500,000       500,000       500,000  
                         
Total assets
   $ 52,461,620     $ 51,358,668     $ 51,469,843  
                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                        
                         
Current liabilities
                        
Checks written in excess of bank balances
   $ 847,374     $ —     $ 342,976  
Current maturities of notes payable
     4,431,873       6,219,788       4,842,315  
Accounts payable
     2,259,236       2,024,313       2,764,000  
Accrued expenses
     531,553       617,662       614,344  
Accrued income tax
     604,323       —       —  
Total current liabilities
     8,674,359       8,861,763       8,563,635  
                         
Notes payable
     6,397,780       7,907,847       6,890,214  
                         
Deferred income taxes
     3,262,795       3,593,740       3,444,664  
Total liabilities
     18,334,934       20,363,350       18,898,513  
                         
Stockholders' equity
                        
Common stock, no par value; 20,000,000 shares authorized; 17,273,776 shares issued;16,657,478 shares outstanding at June 30, 2010; 17,273,776 shares issued: 16,812,955 shares outstanding at June 30, 2009; 17,273,776 shares issued; 16,778,555 shares outstanding at December 31, 2009
     6,509,267       6,509,267       6,509,267  
Paid-in-capital
     2,018,727       1,912,845       1,965,786  
Treasury stock, at cost
     ( 5,256,054 )     ( 3,353,490 )     ( 3,846,773 )
Retained earnings
     30,906,602       26,463,077       27,953,409  
Accumulated other comprehensive loss, net of taxes
     ( 51,856 )     ( 536,381 )     ( 10,359 )
Total stockholders' equity
     34,126,686       30,995,318       32,571,330  
                         
Total liabilities and stockholders' equity
   $ 52,461,620     $ 51,358,668     $ 51,469,843  

 
- 4 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Three and Six Months Ended June 30, 2010 and 2009 (Unaudited)
and for the Year Ended December 31, 2009
 
   
(Unaudited)
    
(Unaudited)
        
   
Three Months Ended
    
Six Months Ended
    
Year Ended
  
   
June 30,
    
June 30,
    
December 31,
  
   
2010
    
2009
    
2010
    
2009
    
2009
  
                               
Sales
     15,546,556       14,479,429       31,510,715       28,215,509       58,115,878  
                                         
Cost of goods sold
     9,273,872       7,978,110       17,892,871       16,102,691       36,083,553  
Depreciation expense
     281,220       353,654       684,595       570,428       1,134,404  
                                         
Total cost of goods sold
     9,555,092       8,331,764       18,577,466       16,673,119       37,217,957  
                                         
Gross profit
     5,991,464       6,147,665       12,933,249       11,542,390       20,897,921  
                                         
Selling expenses
     2,183,304       1,386,815       4,710,777       2,694,740       5,987,917  
General and administrative
     1,478,062       1,437,505       2,968,219       2,810,103       5,294,550  
Amortization expense
     175,761       168,698       351,521       339,388       676,786  
                                         
Total Operating Expenses
     3,837,127       2,993,018       8,030,517       5,844,231       11,959,253  
                                         
Income from operations
     2,154,337       3,154,647       4,902,732       5,698,159       8,938,668  
                                         
Other income (expense):
                                        
Interest and dividend income
     53,176       48,506       107,684       110,717       199,047  
Rental Income
     2,800       11,947       4,035       21,294       35,240  
Interest expense
     ( 80,164 )     ( 110,090 )     ( 176,106 )     ( 264,473 )     ( 442,703 )
Loss on Disposition of Equipment
     —       ( 2,825 )     —       ( 2,825 )     ( 2,826 )
Gain (loss) on sale of marketable securities, net
     84,043       53,638       54,784       ( 96,152 )     ( 278,474 )
Total other income (expense)
     59,855       1,176       ( 9,603 )     ( 231,439 )     ( 489,716 )
                                         
Income before provision for income taxes
     2,214,192       3,155,823       4,893,129       5,466,720       8,448,952  
                                         
Provision for income taxes
     1,029,688       623,918       1,939,936       1,387,350       2,879,250  
                                         
Net income
   $ 1,184,504     $ 2,531,905     $ 2,953,193     $ 4,079,370     $ 5,569,702  
                                         
Basic and diluted earnings per common share
     0.07       0.15       0.18       0.24       0.33  
                                         
Weighted average number of shares outstanding
     16,701,539       16,823,691       16,731,549       16,823,691       16,798,164  
                                         
COMPREHENSIVE INCOME
                                        
                                         
Net income
   $ 1,184,504     $ 2,531,905     $ 2,953,193     $ 4,079,370     $ 5,569,702  
                                         
Other comprehensive income (loss), net of tax:
                                        
Unrealized gains (losses) on investments (net of tax)
     ( 55,842 )     338,409       ( 9,339 )     ( 93,913 )     325,086  
Less reclassification adjustment for (gains) losses included in net income (net of taxes)
     (49,333 )     (31,486 )     (32,158 )     56,441       163,464  
                                         
Comprehensive income
   $ 1,079,329     $ 2,838,828     $ 2,911,696     $ 4,041,898     $ 6,058,252  
 
 
- 5 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Six Months Ended June 30, 2010 and 2009 (Unaudited)
and for the Year Ended December 31, 2009
 
   
Common Stock, No Par Value
20,000,000 Shares		    
# of Shares
                            
Accumulated
Other
        
      Authorized    
of
                            
Comprehensive
  
 
  
   
# of Shares
    
# of Shares
    
Treasury
    
Common
    
Paid In
    
Treasury
    
Retained
    
Income (Loss),
      
   
Issued
    
Outstanding
    
Stock
    
Stock
    
Capital
    
Stock
    
Earnings
    
Net of Tax
    
Total
  
                                                       
Balances at December 31, 2008
     17,273,776       16,724,467       549,309     $ 6,509,267     $ 1,202,009     $ (3,302,025 )   $ 22,383,707     $ (498,909 )   $ 26,294,049  
                                                                         
Redemption of stock
     —       ( 87,991 )     87,991       —       —       ( 905,607 )     —       —       ( 905,607 )
                                                                         
Issuance of treasury stock for compensation
     —       13,132       ( 13,132 )     —       119,039       25,597       —       —       144,636  
                                                                         
Issuance of treasury stock for Fresh Made acquisition
     —       128,947       ( 128,947 )     —       644,738       335,262       —       —       980,000  
                                                                         
Other comprehensive income (loss):
                                                                        
Unrealized gains on securities, net of taxes and reclassification adjustment
     —       —       —       —       —       —       —       488,550       488,550  
                                                                         
Net income for the year ended
December 31, 2009
     —       —       —       —       —       —       5,569,702       —       5,569,702  
                                                                         
Balances at December 31, 2009
     17,273,776       16,778,555       495,221     $ 6,509,267     $ 1,965,786     $ (3,846,773 )   $ 27,953,409     $ (10,359 )   $ 32,571,330  
                                                                         
                                                                         
Balances at January 1, 2009
     17,273,776       16,724,467       549,309     $ 6,509,267     $ 1,202,009     $ (3,302,025 )   $ 22,383,707     $ (498,909 )   $ 26,294,049  
                                                                         
Redemption of stock
     —       ( 48,341 )     48,341       —       —       ( 402,947 )     —       —       ( 402,947 )
                                                                         
Issuance of treasury stock for compensation
     —       7,882       ( 7,882 )     —       66,098       16,220       —       —       82,318  
                                                                         
Issuance of treasury stock for Fresh Made acquisition
     —       128,947       ( 128,947 )     —       644,738       335,262       —       —       980,000  
                                                                         
Other comprehensive income (loss):
                                                                        
Unrealized gains on securities, net of taxes and reclassification adjustment
     —       —       —       —       —       —       —       ( 37,472 )     (37,472 )
                                                                         
Net income for the six months ended June 30, 2009
     —       —       —       —       —       —       4,079,370       —       4,079,370  
                                                                         
Balances at June 30, 2009
     17,273,776       16,812,955       460,821     $ 6,509,267     $ 1,912,845     $ (3,353,490 )   $ 26,463,077     $ (536,381 )   $ 30,995,318  
                                                                         
                                                                         
Balances at January 1, 2010
     17,273,776       16,778,555       495,221     $ 6,509,267     $ 1,965,786     $ (3,846,773 )   $ 27,953,409     $ (10,359 )   $ 32,571,330  
                                                                         
Redemption of stock
     —       ( 129,841 )     129,841       —       —       ( 1,418,657 )     —       —       ( 1,418,657 )
                                                                         
Issuance of treasury stock for compensation
     —       8,764       ( 8,764 )     —       52,941       9,376       —       —       62,317  
                                                                         
Other comprehensive income (loss):
                                                                        
Unrealized gains on securities, net of taxes and reclassification adjustment
     —       —       —       —       —       —       —       ( 41,497 )     ( 41,497 )
                                                                         
                                                                   
Net income for the six months ended June 30, 2010
     —       —       —       —       —       —       2,953,193       —       2,953,193  
                                                                         
Balances at June 30, 2010
     17,273,776       16,657,478       616,298     $ 6,509,267     $ 2,018,727     $ (5,256,054 )   $ 30,906,602     $ (51,856 )   $ 34,126,686  

 
- 6 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2010 and 2009 (Unaudited)
and for the Year Ended December 31, 2009
 
   
(Unaudited)
        
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
                   
Cash flows from operating activities:
                  
Net income
   $ 2,953,193     $ 4,079,370     $ 5,569,702  
Adjustments to reconcile net income to net cash flows from operating activities, net of acquisition:
                        
Depreciation and amortization
     1,036,116       909,816       1,811,190  
(Gain) Loss on sale of investments, net
     ( 54,784 )     96,152       278,474  
Loss on disposition of assets
     —       2,825       2,826  
Deferred income taxes
     ( 290,465 )     179,796       389,754  
Treasury stock issued for compensation
     62,317       82,318       144,636  
Decrease in allowance for doubtful accounts
     —       —       ( 75,000 )
(Increase) decrease in operating assets:
                        
Accounts receivable
     ( 1,780,774 )     ( 752,978 )     ( 612,915 )
Other receivables
     ( 92,631 )     ( 25,416 )     ( 7,758 )
Inventories
     ( 857,743 )     ( 346,800 )     173,419  
Refundable income taxes
     1,308,978       ( 435,205 )     ( 475,635 )
Prepaid expenses and other current assets
     ( 29,433 )     5,029       9,506  
Increase (decrease) in operating liabilities:
                        
Accounts payable
     ( 504,764 )     ( 440,911 )     298,800  
Accrued expenses
     ( 82,791 )     36,719       96,062  
Accrued income taxes
     604,323       —       —  
Net cash provided by operating activities
     2,271,542       3,390,715       7,603,061  
                         
Cash flows from investing activities:
                        
Purchases of investments
     ( 538,852 )     ( 3,342,662 )     ( 6,156,682 )
Proceeds from sale of investments
     1,502,724       4,127,666       6,928,321  
Proceeds from redemption of certificates of deposit
     102,545       —       —  
Purchases of property and equipment
     ( 1,292,741 )     ( 714,052 )     ( 1,766,280 )
Acquisition of Fresh Made, net of cash acquired
     —       ( 10,498,224 )     ( 11,042,546 )
Net cash used in investing activities
     ( 226,324 )     ( 10,427,272 )     ( 12,037,187 )
                         
Cash flows from financing activities:
                        
Proceeds of note payable
     250,000       9,342,085       9,353,504  
Checks written in excess of bank balances
     504,398       —       342,976  
Purchases of treasury stock
     ( 1,418,657 )     ( 402,947 )     ( 905,607 )
Repayment of notes payable
     ( 1,152,876 )     ( 1,597,063 )     ( 4,003,588 )
Net cash (used in) provided by in financing activities
     ( 1,817,135 )     7,342,075       4,787,285  
                         
Net increase in cash and cash equivalents
     228,083       305,518       353,159  
                         
Cash and cash equivalents at the beginning of the period
     630,407       277,248       277,248  
                         
Cash and cash equivalents at the end of the period
   $ 858,490     $ 582,766     $ 630,407  

 
- 7 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009


Note 1 – NATURE OF BUSINESS
 
Lifeway Foods, Inc. (The “Company”) commenced operations in February 1986 and incorporated under the laws of the state of Illinois on May 19, 1986. The Company’s principal business activity is the production of dairy products. Specifically, the Company produces Kefir, a drinkable product which is similar to but distinct from yogurt, in several flavors sold under the name “Lifeway’s Kefir;” a plain farmer’s cheese sold under the name “Lifeway’s Farmer’s Cheese;” a fruit sugar-flavored product similar in consistency to cream cheese sold under the name of “Sweet Kiss;” and a dairy beverage, similar to Kefir, with increased protein and calcium, sold under the name “Basics Plus.”  The Company also produces several soy-based products under the name “Soy Treat” and a vegetable-based seasoning under the name “Golden Zesta.” The Company currently distributes its products throughout the Chicago Metropolitan area and various cities in the East Coast through local food stores.  In addition, the products are sold throughout the United States and Ontario, Canada by distributors. The Company also distributes some of its products to Eastern Europe.


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting policies applied in the preparation of the accompanying financial statements follows:

Basis of presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  However, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of Management, necessary for fair statement of results for the interim periods.

Principles of consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, LFI Enterprises, Inc., Helios Nutrition, Ltd., Pride of Main Street, L.L.C., Starfruit, L.L.C., Fresh Made, Inc and Starfruit Franchisor, L.L.C.  All significant intercompany accounts and transactions have been eliminated.  The financial statements include the results of operations from Fresh Made, Inc from February 6, 2009 through the end of the period (see Note 3).

Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Significant estimates made in preparing the consolidated financial statements include the allowance for doubtful accounts and discounts, the valuation of investment securities, the valuation of goodwill, intangible assets, and deferred taxes.

Revenue Recognition
Sales of Company produced dairy products are recorded at the time of shipment and the following four criteria have been met: (i)  The product has been shipped and the Company has no significant remaining obligations; (ii)  Persuasive evidence of an agreement exists; (iii)  The price to the buyer is fixed or determinable and (iv)  Collection is probable.  In addition, shipping costs invoiced to the customers are included in net sales and the related cost in cost of sales.
 
- 8 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
Cash and cash equivalents
All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.

The Company maintains cash deposits at several institutions located in the greater Chicago, Illinois and Philadelphia, Pennsylvania metropolitan areas.

Investments
All investment securities are classified as available-for-sale and are carried at fair value. Unrealized gains and losses on available-for-sale securities are reported as a separate component of stockholders’ equity. Amortization, accretion, interest and dividends, realized gains and losses, and declines in value judged to be other-than-temporary on available-for-sale securities are recorded in other income. All of the Company's securities are subject to a periodic impairment evaluation. This evaluation depends on the specific facts and circumstances. Factors that we consider in determining whether an other-than-temporary decline in value has occurred include: the market value of the security in relation to its cost basis; the financial condition of the investee; and the intent and ability to retain the investment for a sufficient period of time to allow for possible recovery in the market value of the investment.
 
Accounts receivable
Credit terms are extended to customers in the normal course of business.  The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral.

Accounts receivable are recorded at invoice amounts, and reduced to their estimated net realizable value by recognition of an allowance for doubtful accounts and net of anticipated discounts.  The Company’s estimate of the allowance for doubtful accounts is based upon historical experience, its evaluation of the current status of specific receivables, and unusual circumstances, if any.  Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms.  Accounts considered uncollectible are charged against the allowance.

Inventories
Inventories are stated at the lower of cost or market, cost being determined by the first-in, first-out method.
 
Property and equipment
Property and equipment is stated at depreciated cost or fair value where depreciated cost is not recoverable.  Depreciation is computed using the straight-line method.  When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period.  The cost of maintenance and repairs is charged to income as incurred; significant renewals and betterments are capitalized.

Property and equipment is being depreciated over the following useful lives:

Category
  
Years
Buildings and improvements
  
31 and 39
Machinery and equipment
  
5 – 12
Office equipment
  
5 – 7
Vehicles
  
5
 
 
- 9 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
Intangible assets
The Company accounts for intangible assets at historical cost.  Intangible assets acquired in a business combination are recorded under the purchase method of accounting at their estimated fair values at the date of acquisition.  Goodwill represents the excess purchase price over the fair value of the net tangible and other intangible assets acquired.  Goodwill is not amortized, but is reviewed for impairment at least annually.  Brand assets represent the fair value of brands acquired.  Brand assets have an indefinite life and therefore are not amortized, rather are reviewed periodically for impairment.  The Company amortizes other intangible assets over their estimated useful lives, as disclosed in the table below.

The Company reviews intangible assets and their related useful lives at least once a year to determine if any adverse conditions exist that would indicate the carrying value of these assets may not be recoverable.   The Company conducts more frequent impairment assessments if certain conditions exist, including:  a change in the competitive landscape, any internal decisions to pursue new or different strategies, a loss of a significant customer, or a significant change in the market place including changes in the prices paid for the Company’s products or changes in the size of the market for the Company’s products.

If the estimate of an intangible asset’s remaining useful life is changed, the remaining carrying amount of the intangible asset is amortized prospectively over the revised remaining useful life.

Intangible assets are being amortized over the following useful lives:

Category
  
Years
Recipes
  
4
Customer lists and other customer related intangibles
  
7-10
Lease agreement
  
7
Trade names
  
15
Formula
  
10
Customer relationships
  
12

Income taxes
Deferred income taxes arise from temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of the assets and liabilities to which they relate.  Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.
 
The principal sources of temporary differences are different depreciation and amortization methods for financial statement and tax purposes, unrealized gains or losses related to investments, capitalization of indirect costs for tax purposes, purchase price adjustments, and the recognition of an allowance for doubtful accounts for financial statement purposes.
 
- 10 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The only periods subject to examination for the Company’s federal return are the 2006 through 2009 tax years. The Company believes that its income tax filing positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded.
 
Subsequent to June 30, 2010, the IRS completed a review of the Company’s 2007 and 2008 federal tax return filings, resulting in a liability of approximately $220,000 being recognized as of June 30, 2010.  The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before taxes. There were no such items during the periods covered in this report.

Treasury stock
Treasury stock is recorded using the cost method.

Advertising costs
The Company expenses advertising costs as incurred.  During the year ended December 31, 2009 and for the six months ended June 30, 2010 and 2009, approximately $1,689,540, $2,272,520 and $780,116 of such costs respectively, were expensed.

Earnings per common share
Earnings per common share were computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.  For the six months ended June 30, 2010 and 2009 and for the year ended December 31, 2009, diluted and basic earnings per share were the same, as the effect of dilutive securities options outstanding was not significant.

Reclassification
Certain 2009 balance sheet amounts have been reclassified to conform to the 2010 presentation.

Note 3 – ACQUISITION

On February 6, 2009, we completed a Stock Purchase Agreement (the “Stock Agreement”) under which Lifeway purchased all of the issued and outstanding stock (the “Shares”) of Fresh Made, Inc., a Pennsylvania corporation (“Fresh”).  The consideration for the Shares was an aggregate of $8,048,000 in cash, a note in the principal amount of $2,735,000, due on August 1, 2010 as amended and restated, 128,948 shares of common stock of Lifeway valued at a total of $980,000 (“Lifeway’s Common Stock”), the cancellation of a loan in the principal amount of $265,000.  The issuance of Lifeway’s Common Stock was exempted from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

Also on February 6, 2009, we entered into and consummated a Real Property Purchase Agreement (the “Real Property Agreement”) under which we acquired 1.1355 acres of land in Philadelphia, PA (the “Property”).  The consideration for the Property was approximately $2,000,000.

The acquisition was consummated to expand the geographic footprint of Lifeway as well as grow market share.  The acquisition was accounted for using the purchase accounting method of accounting, and accordingly, the purchase price was allocated to assets acquired and the liabilities assumed based on the
 
- 11 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 3 – ACQUISITION - Continued

fair value as of the merger date.  Acquisition costs for legal and professional fees have been included in General and Administrative costs.  None of the goodwill resulting from the acquisition is tax deductible.

The estimated fair value of assets acquired, including the real property, and liabilities assumed consisted of the following:

Cash and cash equivalents
   $ 226,000  
Accounts receivable (contractual amounts totaling $545,958)
     546,000  
Other current assets
     361,000  
Building and other fixed assets
     2,617,000  
Customer list
     4,000,000  
Non amortizable goodwill and brand asset
     8,391,000  
Current liabilities
     ( 461,000 )
Deferred tax liability associated with purchase adjustments
     ( 1,652,000 )
       Total fair value of assets acquired and liabilities assumed
   $ 14,028,000  


The following pro forma disclosures, including the effect of purchase accounting adjustments, depict the results of operations for the six months ended June 30, 2009 and the year ended December 31, 2009 as though the merger with Fresh had taken place as of January 1, 2009:
 
   
For the Six Months Ended
June 30, 2009
    
For the Year Ended
December 31, 2009
  
Gross revenue
   $ 29,331,092     $ 59,231,461  
                 
Net income
   $ 4,128,139     $ 5,618,471  
                 
Earnings per share
   $ 0.25     $ 0.33  

Note 4 – INTANGIBLE ASSETS
 
Intangible assets, and the related accumulated amortization, consist of the following:

   
June 30, 2010
    
June 30, 2009
    
December 31, 2009
  
   
Cost
    
Accumulated Amortization
    
Cost
    
Accumulated Amortization
    
Cost
    
Accumulated Amortization
  
Recipes
   $ 43,600     $ 43,600     $ 43,600     $ 43,600     $ 43,600     $ 43,600  
Customer lists and other customer related intangibles
     4,305,200       803,744       4,305,200       385,166       4,305,200       587,393  
Lease acquisition
     87,200       73,707       87,200       61,245       87,200       67,473  
Other
     6,638       6,638       6,638       6,638       6,638       6,638  
Customer relationship
     985,000       321,490       985,000       239,410       985,000       280,454  
Contractual backlog
     12,000       12,000       12,000       12,000       12,000       12,000  
Trade names
     1,980,000       517,000       1,980,000       385,000       1,980,000       451,000  
Formula
     438,000       171,550       438,000       127,750       438,000       149,650  
    $ 7,857,638     $ 1,949,729     $ 7,857,638     $ 1,260,809     $ 7,857,638     $ 1,598,208  
 
 
- 12 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009
 
 
Note 4 – INTANGIBLE ASSETS - Continued

Amortization expense is expected to be as follows for the 12 months ending June 30:

2011
   $
703,040
  
2012
    
690,583
  
2013
    
690,583
  
                         2014
    
676,958
  
2015
    
657,883
  
Thereafter
    
2,488,862
  
    $
5,907,909
  

Amortization expense during the six months ended June 30, 2010 and 2009 and for the year ended December 31, 2009 was $351,521, $339,388 and $676,786, respectively.
 
Note 5 – INVESTMENTS

The cost and fair value of investments classified as available for sale are as follows:

June 30, 2010
  
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
                         
Equities
   $ 653,068     $ 26,400     $ ( 117,892 )   $ 561,576  
Mutual Funds
     206,961       3,056       ( 7,853 )     202,164  
Preferred Securities
     272,629       6,650       ( 64,789 )     214,490  
Corporate Bonds
     1,751,719       89,355       ( 30,140 )     1,810,934  
Government Agency Obligations
     615,767       8,625       ( 1,752 )     622,640  
Total
   $ 3,500,144     $ 134,086     $ ( 222,426 )   $ 3,411,804  


June 30, 2009
  
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
                         
Equities
   $ 1,536,976     $ 57,665     $ ( 178,926 )   $ 1,415,715  
Mutual Funds
     617,082       842       ( 267,818 )     350,106  
Preferred Securities
     680,527       14,361       ( 207,218 )     487,670  
Corporate Bonds
     506,165       5,836       ( 7,781 )     504,220  
Government Agency Obligations
     1,889,963       15,201       ( 3,714 )     1,901,450  
Total
   $ 5,230,713     $ 93,905     $ ( 665,457 )   $ 4,659,161  
 
 
- 13 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 5 – INVESTMENTS - Continued
 
December 31, 2009
  
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
                         
Equities
   $ 1,385,524     $ 177,024     $ (128,547 )   $ 1,434,001  
Mutual Funds
     172,543       7,453       ( 22,833 )     157,163  
Preferred Securities
     388,705       6,700       ( 95,753 )     299,652  
Corporate Bonds
     1,569,245       65,226       ( 6,772 )     1,627,699  
Government Agency Obligations
     893,755       2,989       ( 23,134 )     873,610  
Total
   $ 4,409,772     $ 259,392     $ (277,039 )   $ 4,392,125  

Proceeds from the sale of investments were $6,928,321, $1,605,269 and $4,127,666 during the year ended December 31, 2009 and for the six months ended June 30, 2010 and 2009, respectively.

Gross gains of $351,419, $120,850 and $235,408 and gross losses of $629,893, $66,066 and $331,562 were realized on these sales during the year ended December 31, 2009 and for the six months ended June 30, 2010 and 2009, respectively.

The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2010 and 2009 and at December 31, 2009:

   
Less Than 12 Months
    
12 Months or Greater
    
Total
  
June 30, 2010
  
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
  
                                     
Equities
   $ 58,222     $ ( 10,953 )   $ 154,154     $ (106,939 )   $ 212,376     $ ( 117,892 )
Mutual Funds
     278       ( 4 )     99,486       ( 7,849 )     99,764       ( 7,853 )
Preferred Securities
     —       —       193,090       ( 64,789 )     193,090       ( 64,789 )
Corporate Bonds
     499,285       ( 26,989 )     181,076       ( 3,151 )     680,361       ( 30,140 )
Government Agency Obligations
     —       —       84,775       ( 1,752 )     84,775       ( 1,752 )
    $ 557,785     $ ( 37,946 )   $ 712,581     $ (184,480 )   $ 1,270,366     $ (222,426 )
 
 
- 14 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 5 – INVESTMENTS - Continued
 
   
Less Than 12 Months
    
12 Months or Greater
    
Total
  
June 30, 2009
  
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
  
                                     
Equities
   $ 537,047     $ ( 113,772 )   $ 270,700     $ ( 65,154 )   $ 807,747     $ ( 178,926 )
Mutual Funds
     95,391       ( 33,238 )     248,327       (234,580 )     343,718       ( 267,818 )
Preferred Securities
     21,527       ( 3,368 )     365,740       (203,850 )     387,267       ( 207,218 )
Corporate Bonds
     —       —       212,531       ( 7,781 )     212,531       ( 7,781 )
Government Agency Obligations
     —       —       202,046       ( 3,714 )     202,046       ( 3,714 )
    $ 653,965     $ ( 150,378 )   $ 1,299,344     $ (515,079 )   $ 1,953,309     $ ( 665,457 )
 

 
   
Less Than 12 Months
    
12 Months or Greater
    
Total
  
December 31, 2009
  
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
    
Fair Value
    
Unrealized Losses
  
                                     
Equities
   $ 128,959     $ ( 27,142 )   $ 230,502     $ ( 101,405 )   $ 359,461     $ ( 128,547 )
Mutual Funds
     1,694       ( 321 )     131,870       ( 22,512 )     133,564       ( 22,833 )
Preferred Securities
     —       —       278,202       ( 95,753 )     278,202       ( 95,753 )
Corporate Bonds
     178,874       ( 3,176 )     124,395       ( 3,596 )     303,269       ( 6,772 )
Government Agency Obligations
     564,941       ( 20,096 )     161,466       ( 3,038 )     726,407       ( 23,134 )
    $ 874,468     $ ( 50,735 )   $ 926,435     $ ( 226,304 )   $ 1,800,903     $ ( 277,039 )


Equities, Mutual Funds, Corporate Bonds and Government Agency Obligations - The Company's investments in equity securities, mutual funds, corporate bonds and government agency obligations consist of investments in common stock, preferred stock and debt securities of companies in various industries.  The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the impairment. Based on that evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider any material investments to be other-than-temporarily impaired at June 30, 2010.

Preferred Securities - The Company's investments in preferred securities consist of investments in preferred stock of companies in various industries.  The Company evaluated the continuing performance of the securities, the credit worthiness of the issuers as well as the near-term prospects of the security in relation to the severity and duration of the impairment. Based on that evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider any material investments to be other-than-temporarily impaired at June 30, 2010.
 
- 15 -
 
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 6 – INVENTORIES

Inventories consist of the following:

   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Finished goods
   $ 1,405,538     $ 1,500,090     $ 1,101,885  
Production supplies
     1,657,546       1,704,240       1,367,457  
Raw materials
     1,091,635       612,865       827,634  
Total inventories
   $ 4,154,719     $ 3,817,195     $ 3,296,976  


Note 7 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
 
   
June 30,
    
December 31
  
   
2010
    
2009
    
2009
  
Land
   $ 1,178,160     $ 1,178,160     $ 1,178,160  
Buildings and improvements
     11,051,821       9,769,348       10,380,393  
Machinery and equipment
     13,182,669       12,213,069       12,525,241  
Vehicles
     963,245       961,245       961,245  
Office equipment
     299,110       208,213       255,616  
Construction in process
     —       —       81,608  
      26,675,005       24,330,035       25,382,263  
Less accumulated depreciation
     11,784,676       10,536,106       11,100,081  
Total property and equipment
   $ 14,890,327     $ 13,793,929     $ 14,282,182  

Depreciation expense during the six months ended June 30, 2010 and 2009 and for the year ended December 31, 2009 was $684,595, $570,428, and $1,134,404 respectively.

Note 8 – ACCRUED EXPENSES

Accrued expenses consist of the following:
 
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Accrued payroll and payroll taxes
   $ 161,175     $ 219,842     $ 191,744  
Accrued property tax
     299,254       300,446       306,707  
Other
     71,124       97,374       115,893  
    $ 531,553     $ 617,662     $ 614,344  

 
- 16 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 9 – NOTES PAYABLE

Notes payable consist of the following:

   
June 30,
    
December 31
  
   
2010
    
2009
    
2009
  
                   
Note payable to Private Bank in monthly installments of $42,222, plus variable interest rate, currently at 2.756%, with a balloon payment of $5,066,667 due February 6, 2014.  Collateralized by substantially all assets of the Company.
   $ 6,904,444     $ 7,388,889     $ 7,135,556  
                         
Line of credit with Private Bank at variable interest rate, currently at 2.781%, due on February 6, 2011.  Collateralized by substantially all assets of the Company.
     750,000       2,400,000       500,000  
                         
Line of credit with Morgan Stanley at variable interest rate, currently at 2.23% due on demand.  Collateralized by investments.
     2,303,090       1,945,621       2,468,151  
                         
Notes payable to Ilya Mandel & Michael Edelson, subordinated to Private Bank, payable in quarterly installments of $341,875, plus interest at the floating rate per annum (3.25% at June 30, 2010) due August 1, 2010, as amended and restated.  Collateralized by a mortgage on specific real estate and shares of the Company’s common stock.
     872,119       2,393,125       1,628,822  
Total notes payable
     10,829,653       14,127,635       11,732,529  
Less current maturities
     4,431,873       6,219,788       4,842,315  
Total long-term portion
   $ 6,397,780     $ 7,907,847     $ 6,890,214  


Maturities of notes payables are as follows:

For the Period Ended June 30,
    
       
2011
   $ 4,431,873  
2012
     506,664  
2013
     506,664  
2014
     5,384,452  
Total
   $ 10,829,653  
 
 
- 17 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009


Note 10 – PROVISION FOR INCOME TAXES

The provision for income taxes consists of the following:

         
For the
  
   
For the Six Months Ended
    
Year Ended
  
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Current:
                  
Federal
   $ 1,759,484     $ 974,423     $ 2,045,904  
State and local
     470,917       233,131       443,592  
Total current
     2,230,401       1,207,555       2,489,496  
Deferred
     ( 290,465 )     179,796       389,754  
Provision for income taxes
   $ 1,939,936     $ 1,387,350     $ 2,879,250  

A reconciliation of the provision for income taxes and the income tax computed at the statutory rate is as follows:

         
For the
  
   
For the Six Months Ended
    
Year Ended
  
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Federal income tax expense computed at the statutory rate
   $ 1,663,664     $ 1,858,685     $ 2,872,644  
State and local tax expense, net
     234,870       262,403       405,550  
Permanent differences
     ( 92,868 )     ( 733,738 )     ( 178,160 )
Tax credits and other
     134,270       —       ( 220,784 )
Provision for income taxes
   $ 1,939,936     $ 1,387,350     $ 2,879,250  


Amounts for deferred tax assets and liabilities are as follows:
 
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Non-current deferred tax assets (liabilities) arising from:
Temporary differences -
                  
Accumulated depreciation
   $ ( 2,014,477 )   $ ( 1,941,740 )   $ ( 2,129,680 )
Purchase accounting adjustments
     ( 1,585,334 )     (1,652,000 )      ( 1,652,000 )
Capital loss carry-forwards
     337,016       —       337,016  
Total non-current net deferred tax liabilities
     ( 3,262,795 )     ( 3,593,740 )     ( 3,444,664 )
Current deferred tax assets arising from:
                        
Unrealized (gains) losses on investments
     95,488       431,188       7,288  
Impairment of investments
     —       —       59,003  
Inventory
     176,051       161,749       139,730  
Allowance for doubtful accounts and discounts
     117,710       45,435       45,435  
Total current deferred tax assets
     389,249       638,372       251,456  
Net deferred tax liability
   $ ( 2,873,546 )   $ ( 2,955,368 )   $ ( 3,193,208 )
 
 
- 18 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 11 – SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest and income taxes are as follows:
 
         
For the
  
   
For the Six Months Ended
    
Year Ended
  
   
June 30,
    
December 31,
  
   
2010
    
2009
    
2009
  
Interest
   $ 211,836     $ 250,553     $ 419,186  
Income taxes
   $ 317,346     $ 1,563,750     $ 3,432,228  

Note 12 – STOCK AWARD AND STOCK OPTION PLANS

The Company has a registration statement filed with the Securities and Exchange Commission in connection with a Consulting Service Compensation Plan covering up to 1,200,000 of the Company’s common stock shares. Pursuant to such Plan, the Company may issue common stock or options to purchase common stock to certain consultants, service providers, and employees of the Company.  The option price, number of shares, grant date, and vesting terms are determined at the discretion of the Company’s Board of Directors.

As of December 31, 2009 and at June 30, 2010 and 2009, there were no stock options outstanding or exercisable.  There were approximately 940,000 shares available for issuance under the Plan at June 30, 2010.

On May 28, 2009, Lifeway's Board of Directors approved awards of an aggregate amount of 18,000 shares to be awarded under its Employee and Consulting Services and Compensation Plan to certain key employees and consultants for services rendered to the Company.  The stock awards were made on May 28, 2009 and have vesting periods of one year. The expense for the awards is measured as of July 14, 2009 at $14.69 per share for 18,000 shares, or a total stock award expense of $264,420. This expense was recognized as the stock awards vested in 12 equal portions of $22,035, or 1,500 shares per month for one year.

On June 13, 2008, Lifeway's Board of Directors approved awards of an aggregate amount of 10,500 shares to be awarded under its Employee and Consulting Services and Compensation Plan to certain key employees and consultants for services rendered to the Company.  The stock awards were made on June 13, 2008 and had vesting periods of one year. The expense for the awards was measured as of July 1, 2008 at $11.87 per share for 10,500 shares, or a total stock award expense of $124,635. This expense was recognized as the stock awards vested in 12 equal portions of $10,386, or 875 shares per month for one year.

Note 13 – FAIR VALUE MEASUREMENTS

Generally accepted accounting principles define fair value as the exchange price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date.  The standards emphasize that fair value is a market-based measurement, not an entity-specific measurement and establish the following fair value hierarchy used in fair value measurements:

Level 1 – Inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2 – Inputs use other inputs that are observable, either directly or indirectly.  These inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
 
 
- 19 -
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2010 and 2009
and December 31, 2009

 
Note 13 – FAIR VALUE MEASUREMENTS - Continued

Level 3 – Inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation.  The Company’s assessment of the significance of particular inputs to these fair measurements requires judgment and considers factors specific to each asset or liability.

Disclosures concerning assets and liabilities measured at fair value are as follows:

   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
    
Significant Other Observable Inputs
(Level 2)
    
Significant Unobservable
Inputs
(Level 3)
    
Balance
  
Assets
                        
Investment securities- available - for – sale June 30, 2010
   $ 3,411,804       —       —     $ 3,411,804  
December 31, 2009
   $ 4,392,125       —       —     $ 4,392,125  
June 30, 2009
   $ 4,659,161       —       —     $ 4,659,161  


Note 14 – RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, FASB issued FASB ASC 810, Consolidation. The objective of FASB ASC 810 is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. FASB ASC 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The adoption of this standard did not have an impact on the Company’s financial position or results of operation.
 
 
- 20 -
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Comparison of Quarter Ended June 30, 2010 to Quarter Ended June 30, 2009.

The following analysis should be read in conjunction with the unaudited financial statements of the Company and related notes included elsewhere in this quarterly report and the audited financial statements and Management’s Discussion and Analysis contained in our Form 10-K, for the fiscal year ended December 31, 2009, and in the Management’s Discussion and Analysis contained in our Form 10-Q, for the fiscal quarter ended March 31, 2010.

Results of Operations

Total consolidated group sales increased by $1,067,127 (approximately 7%) to $15,546,556 during the three month period ended June 30, 2010 from $14,479,429 during the three month period ended June 30, 2009.  This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship line, Kefir, as well as ProBugs™ Organic Kefir for kids.

Cost of goods sold as a percentage of sales was approximately 61% during the second quarter 2010, compared to about 58% during the same period in 2009.  The increase was primarily attributable to the higher cost of conventional milk, our largest raw material, to more normalized levels.  The 2009 second quarter experienced some of the lowest prices for milk on record.  The cost of conventional milk was approximately 45% higher during the second quarter 2010 when compared to the second quarter 2009.  Gross profit decreased approximately 2% during the second quarter of 2010, when compared with the same period in 2009.
 
Operating expenses as a percentage of sales were approximately 25% during the second quarter of 2010 compared to approximately 21% during the same period in 2009.  This increase was primarily attributable to a $796,489 increase of selling and marketing related expenses resulting from the Company’s advertising and marketing promotions.  General and administrative expenses remained flat.

Total operating income decreased by $1,000,310 (approximately 32%) to $2,154,337 during the second quarter 2010, from $3,154,647 during the same period in 2009.

Interest expense during the second quarter 2010 decreased to $80,164 compared to interest expense of $110,090 during the same period a year ago.  This lower interest expense is primarily attributable to a reduction of principal in the note payable related to the February 6, 2009 Fresh Made acquisition.  Notes payable are discussed in Note 9 of the Notes to Consolidated Financial Statements.

Provision for income taxes was $1,029,688, or a 47% effective tax rate, for the 2010 second quarter compared with $623,918, or a 20% effective tax rate, during the same period in 2009.  In addition to the higher rate, the Company’s tax expense was higher due to disallowed research and development credits from 2007 and 2008 that resulted in $220,000 in additional taxes being accrued for during the 2010 second quarter.  Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.  The difference in rates was due to a lower level of permanent tax differences in relation to pre-tax net income.
 
Total net income was $1,184,504, or $0.07 per share, for the second quarter ended June 30, 2010 compared to $2,531,905, or $0.15 per share, for the same period in 2009. This represents a 53% decrease in net income from the second quarter 2010 when compared to the same period in 2009.
 
- 21 -
 
Results of Operations

Sales increased by $3,295,206, (approximately 12%) to $31,510,715 during the six month period ended June 30, 2010 from $28,215,509 during the same six-month period in 2009.  This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship line, Kefir, as well as Lifeway’s kids Kefir drink, ProBugs®.
 
Cost of goods sold as a percentage of sales, excluding depreciation expense, was approximately 57% during the six month period ended June 30, 2010, as well as for the same period in 2009.  

Operating expenses as a percentage of sales for Lifeway Foods were approximately 25% during the six-month period ended June 30, 2010, compared to 21% during the same period in 2009.  This increase was primarily attributable to the increase of selling and marketing related expenses resulting from the Company’s advertising and marketing promotions.

Total other expenses during the six-month period ending June 30, 2010 were $9,603, compared with total other expenses of $231,439 during the same period in 2009.  This decrease is primarily attributable to a higher interest expense in the year ago period related to the February 6, 2009 Fresh Made acquisition.  Interest expenses during the six-month period ending June 30, 2009 were $264,473, which includes approximately a $55,000 pre -payment penalty on one of Lifeway’s real estate mortgages related to the financing of the acquisition.  This pre-payment expense was a non recurring expense.

Provision for income taxes was $1,939,936, or a 40% effective tax rate, for the six months ended June 30, 2010 compared to $1,387,350, or a 25% effective tax rate, during the same period in 2009.  In addition to the higher rate, the Company’s tax expense was higher due to disallowed research and development credits from 2007 and 2008 that resulted in $220,000 in additional taxes being accrued for during the 2010 second quarter.  Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.  The difference in rates was due to a lower level of permanent tax differences in relation to pre-tax net income.

Total net income was $2,953,193, or $0.18 per share for the six-month period ended June 30, 2010 compared to $4,079,370, or $0.24 per share, for the same period in 2009.

Sources and Uses of Cash

On February 6, 2009, Lifeway entered into a Loan and Security Agreement with The Private Bank & Trust (the “Loan Agreement”) which provided for (i) a term loan to Lifeway in the principal amount of $7,600,000, due on February 6, 2014 (the Term Loan”) with annual interest rate equal to either the London Inter-Bank Offer Rate (“LIBOR”), plus 2.5% or the prime lending rate, and (ii) a revolving line of credit in the principal amount of $5,000,000 (the “Line of Credit,” together with the Term Loan, the “Loans”), which originally matured February 6, 2010.  The original maturity date was extended to February 6, 2011 on February 6, 2010 pursuant to a Third Modification Agreement as previously disclosed.  The Line of Credit has an annual interest rate equal to either LIBOR, plus 2.5% or the prime lending rate.  The Loans are secured by all of the assets of Lifeway, including a first mortgage on Lifeway’s real property located in Skokie, Illinois, Niles, Illinois and Morton Grove, Illinois.  A portion of the proceeds of the Loans was used to pay off previously existing mortgage loans.  At December 31, 2009, the Loans had a balance of $7,135,556, and $500,000, respectively.  
 
Net cash provided by operating activities was $2,271,542 during the six months ended June 30, 2010, which is a decrease of $1,119,173 when compared to the same period in 2009.  This decrease is primarily attributable to the decrease in net income of $1,126,177.

Net cash used in investing activities was $226,324 during the six months ended June 30, 2010, which is a decrease of $10,200,948 when compared to the same period in 2009.  This decrease is primarily due to the Company’s 2009 acquisition of Fresh Made, net of cash acquired.  The Company purchased $1,292,741 worth of property, plant and
 
- 22 -
 
equipment during the first six months of 2010 when compared to the purchase of $714,052 worth of property, plant in equipment during the same period in 2009.  This represents an increase of $578,689 in the purchase of equipment during the six months ended June 30, 2010, when compared to the same period in 2009.   The Company also repurchased 129,841 of its common stock at a cost of $1,418,657 during the six month period ending June 30, 2010.

Lifeway had a net increase in cash and cash equivalents of $228,083 during the six months ended June 30, 2010, compared to a net increase in cash and cash equivalents of $305,518 during the same period in 2009.  Lifeway had cash and cash equivalents at the end June 30, 2010 of $858,490, compared to cash and cash equivalents at the end June 30, 2009 of $582,766.

Significant portions of our assets are held in marketable securities. The majority of our marketable securities are classified as available-for-sale on our balance sheet, while the mortgage-backed securities are classified as trading.  All of these securities 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.

Assets and Liabilities
 
Total assets were $52,461,620 as of June 30, 2010, which is an increase of $991,777 when compared to December 31, 2009, and an increase of $1,102,952 when compared to June 30, 2009.  This is primarily due to the increase in the value of the Company’s property, plant and equipment was $14,890,327 as of June 30, 2010, which is an increase of $1,096,398 from June 30, 2009.

Total current liabilities were $8,674,359 as of June 30, 2010, which is an increase of $110,724 when compared to December 31, 2009.  This is primarily due a $604,323 increase in accrued income taxes during the first half of 2010.  Total current liabilities were $8,674,359 as of June 30, 2010, which is a decrease of $187,404 when compared to June 30, 2009.  This is primarily due the Company’s repayment of current notes payables of $1,787,915.

Long term notes payables decreased by $492,434 as of June 30, 2010, when compared to December 31, 2009.  Long term notes payables decreased by $1,510,067 as of June 30, 2010, when compared to June 30, 2009.  The balance of the long term notes payable as of June 30, 2010 was $6,397,780.
 
Total stockholder’s equity was $34,126,686 as of June 30, 2010, which is an increase of $1,555,356 when compared to December 31, 2009.  This is primarily due the increase in retained earnings of $2,953,193 as of June 30, 2010, when compared to December 31, 2009.  Total stockholder’s equity was $34,126,686 as of June 30, 2010, which is an increase of $3,131,368 when compared to June 30, 2009.  This is primarily due the increase in retained earnings by $4,443,525 as of June 30, 2010, when compared to June 30, 2009.
 
Other Developments

On May 28, 2009, Lifeway's Board of Directors approved awards of an aggregate amount of 18,000 shares to be awarded under its Employee and Consulting Services and Compensation Plan to certain key employees and consultants for services rendered to the Company.  The stock awards were made on May 28, 2009 and have vesting periods of one year. The expense for the awards is measured as of July 14, 2009 at $14.69 per share for 18,000 shares, or a total stock award expense of $264,420. This expense will be recognized as the stock awards vest in 12 equal portions of $22,035, or 1,500 shares per month for one year.
 
- 23 -
 
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 4T.    CONTROLS AND PROCEDURES.
 
Evaluation of Disclosure Controls and Procedures

As of June 30, 2010, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial and Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial and Accounting Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of June 30, 2010 in ensuring that information required to be disclosed by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified under the Exchange Act rules and forms due to the material weaknesses described in our Form 10-K filed on March 31, 2010.   As a result, we performed additional analysis and other post-closing procedures to ensure our consolidated financial statements were prepared in accordance with generally accepted accounting principles. Accordingly, management believes the consolidated financial statements included in this Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.

There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
 
 
PART II — OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS.

None.

ITEM 1A.    RISK FACTORS.

Not applicable.
 
ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
(c)           PURCHASES OF THE COMPANY’S SECURITIES

Period
  
(a) Total
Numbers of
Shares (or Units)
Purchased
  
(b) Average Price Paid per Share (or Unit)
  
(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
  
(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
April 1, 2010 to April 30, 2010 
  
  38,388
    
11.25
  
  38,388
  
  33,247
May  1, 2010 to May 31, 2010 
  
  33,380
    
10.41
  
  33,380
  
199,867
June 1, 2010 to June 30, 2010*
  
  29,708
    
  9.98
  
  29,708
  
170,159
*Total 
  
101,476
  
$ 
10.60
  
101,476
  
170,159
 
The Company established a share repurchase program approved December 17, 2009 (for 100,000 shares with a plan expiration date of one year) and on May 7, 2010, the Company approved a new share repurchase program of up to 200,000 shares with a plan expiration date of one year from the date of the first purchase.  
 
 
- 24 -
 
ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.

None.
 
ITEM 4.    REMOVED AND RESERVED.
 
ITEM 5.    OTHER INFORMATION.
 
On August 16, 2010, the Company announced its financial results for the fiscal quarter ended June 30, 2010 and certain other information. A copy of the Company’s press release announcing these financial results and certain other information is attached as Exhibit 99.1 hereto. The information contained in Exhibit 99.1 hereto is being furnished, and should not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities imposed by that Section. The information contained in Exhibit 99.1 shall not be incorporated by reference into any registration statement or other document or filing under the Securities Act of 1933, as amended, except as may be expressly set forth in a specific filing. The press release filed as an exhibit to this report includes “safe harbor” language pursuant to the Private Securities Litigation Reform Act of 1995, as amended, indicating that certain statements about the Company’s business and other matters contained in the press release are “forward-looking.” The press release also cautions investors that “forward-looking” statements may be different from actual operating results. Finally, the press release states that a more thorough discussion of risks and uncertainties which may affect the Company’s operating results is included in the Company’s reports on file with the Securities and Exchange Commission.
 
- 25 -
 
ITEM 6.    EXHIBITS.

Exhibit
Number
  
Description of Document
     
3.4
  
Amended and Restated By-laws (incorporated by reference to Exhibit No. 3.5 of Lifeway’s Current Report on Form 8-K dated and filed on December 10, 2002). (File No. 000-17363)
     
3.5
  
Articles of Incorporation, as amended and currently in effect (incorporated by reference to Exhibit 3.5 of Lifeway’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2000 and filed on August 8, 2000). (File No. 000-17363)
     
4.1
   Amended and Restated Non-Negotiable Promissory Note.
     
31.1
  
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
  
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
    
32.1
  
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
  
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
99.1
  
Press Release dated  August 16, 2010. 
 
 

 
 
 

 
- 26 -
 
SIGNATURES
 
In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
  LIFEWAY FOODS, INC.  
 
(Registrant)
  
     
       
Date:       August 16,  2010
By:
/s/ Julie Smolyansky  
    Julie Smolyansky  
    Chief Executive Officer, President and Director  
       
       
       
       
       
       
Date:       August 16,  2010
By:
/s/ Edward P. Smolyansky  
    Edward P. Smolyansky  
   
Chief Financial and Accounting Officer and Treasurer
  
       
       
       
       
 
 
 
 

 


 
- 27 -
 
EXHIBIT INDEX

Exhibit
Number
  
Description of Document
     
3.4
  
Amended and Restated By-laws (incorporated by reference to Exhibit No. 3.5  of Lifeway’s Current Report on Form 8-K dated and filed on December 10, 2002). (File No. 000-17363)
     
3.5
  
Articles of Incorporation, as amended and currently in effect (incorporated by reference to Exhibit 3.5 of Lifeway’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2000 and filed on August 8, 2000). (File No. 000-17363)
     
4.1   Amended and Restated Non-Negotiable Promissory Note.
     
31.1
  
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
  
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1
  
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
  
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
99.1
  
Press Release dated August 16, 2010. 
 
 

 

 
 
 
 
- 28 -