form10q_17208.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:  September 30, 2011
 
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) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceeding12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x   No  o
 
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  x   No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions 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 November 1, 2011, the issuer had 16,425,809 shares of common stock, no par value, outstanding.
 


 
 
 
 
LIFEWAY FOODS, INC.
CONTENTS TO FORM 10-Q
 
 
     
Page(s)
PART I —
FINANCIAL INFORMATION
 
 
       
ITEM 1.
FINANCIAL STATEMENTS.
  3
       
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
  19
       
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
  22
       
ITEM 4.
CONTROLS AND PROCEDURES.
  22
       
       
PART II —
OTHER INFORMATION
   
       
ITEM 1.
LEGAL PROCEEDINGS.
   22
       
   ITEM 1A.
RISK FACTORS.
  22
       
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
   23
       
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.
  23
       
ITEM 4.
REMOVED AND RESERVED.
  23
       
ITEM 5.
OTHER INFORMATION.
  23
       
ITEM 6.
EXHIBITS.
  23
       
       
SIGNATURES
    24
       
EXHIBIT INDEX
    25
 
 
 
2

 
PART I – FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS.
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, 2011 and 2010 (unaudited) and December 31, 2010
 
   
(Unaudited)
September 30,
   
December 31,
 
   
2011
   
2010
   
2010
 
ASSETS
                 
                   
Current assets
                 
Cash and cash equivalents
  $ 860,683     $ 849,657     $ 3,229,939  
Investments
    1,814,344       3,488,502       1,079,232  
Certificates of deposits in financial institutions
    300,000       450,000       250,000  
Inventories
    5,779,926       4,509,153       3,985,374  
Accounts receivable, net of allowance for doubtful accounts and discounts
    9,362,672       7,795,659       6,793,276  
Prepaid expenses and other current assets
    86,402       37,120       158,315  
Other receivables
    14,833       62,290       104,680  
Deferred income taxes
    458,001       277,393       328,470  
Refundable income taxes
                906,748  
Total current assets
    18,676,861       17,469,774       16,836,034  
                         
Property and equipment, net
    15,380,717       14,930,309       15,152,713  
                         
Intangible assets
                       
Goodwill and other non amortizable brand assets
    14,068,091       13,806,091       14,068,091  
Other intangible assets, net of accumulated amortization of $2,891,981 and $2,106,851 at September 30, 2011 and 2010 and $2,304,107 at December 31, 2010, respectively
    5,414,019       5,732,149       6,001,893  
Total intangible assets
    19,482,110       19,538,240       20,069,984  
                         
Other assets
          500,000        
                         
Total assets
  $ 53,539,688     $ 52,438,323     $ 52,058,731  
                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                       
                         
Current liabilities
                       
Checks written in excess of bank balances
  $ 870,987     $ 1,002,101     $ 1,341,210  
Current maturities of notes payable
    1,923,436       3,608,978       2,851,610  
Accounts payable
    4,529,757       2,708,534       4,183,481  
Accrued expenses
    857,862       739,982       509,459  
Accrued income taxes
    351,107       567,926        
Total current liabilities
    8,533,149       8,627,521       8,885,760  
                         
Notes payable
    5,882,691       6,197,778       6,122,225  
                         
Deferred income taxes
    3,313,092       3,120,432       3,401,728  
Total liabilities
    17,728,932       17,945,731       18,409,713  
                         
Stockholders' equity
                       
Common stock, no par value; 20,000,000 shares authorized; 17,273,776 shares issued; 16,425,809 shares outstanding at September 30, 2011; 17,273,776 shares issued; 16,597,749 shares outstanding at September 30, 2010; 17,273,776 shares issued; 16,536,657 shares outstanding at December 31, 2010
    6,509,267       6,509,267       6,509,267  
Paid-in-capital
    2,032,516       2,018,727       2,032,516  
Treasury stock, at cost
    ( 7,447,975 )     ( 5,897,308 )     ( 6,425,546 )
Retained earnings
    34,797,229       31,811,438       31,575,875  
Accumulated other comprehensive income (loss), net of taxes
    ( 80,281 )     50,468       ( 43,094 )
Total stockholders' equity
    35,810,756       34,492,592       33,649,018  
                         
Total liabilities and stockholders' equity
  $ 53,539,688     $ 52,438,323     $ 52,058,731  
 
 
See accompanying notes to financial statements
 
3

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Three and Nine Months Ended September 30, 2011 and 2010 (Unaudited)
and for the Year Ended December 31, 2010
 
 
   
(Unaudited)
Three Months Ended
   
(Unaudited)
Nine Months Ended
   
Year Ended
 
   
September, 30
   
September, 30
   
December 31,
 
   
2011
   
2010
   
2011
   
2010
   
2010
 
                                                             
Sales
  $ 19,423,533             15,908,784             58,383,802           $ 47,419,499           $ 63,543,445        
Less: discounts and allowances
    ( 1,721,929 )           ( 1,315,767 )           ( 5,180,377 )           ( 3,651,976 )           ( 5,043,552 )      
Net Sales
    17,701,604       17,701,604       14,593,017       14,593,017       53,203,425       53,203,425       43,767,523       43,767,523       58,499,893       58,499,893  
                                                                                 
Cost of goods sold
            11,066,579               8,981,922               33,253,219               25,512,628               36,926,973  
Depreciation expense
            396,732               349,017               1,163,939               1,033,612               1,393,745  
                                                                                 
Total cost of goods sold
            11,463,311               9,330,939               34,417,158               26,546,240               38,320,718  
                                                                                 
Gross profit
            6,238,293               5,262,078               18,786,267               17,221,283               20,179,175  
                                                                                 
Selling expenses
            2,748,389               1,848,222               7,760,704               5,584,954               7,603,098  
General and administrative
            1,726,241               1,329,803               4,904,148               4,298,024               5,576,908  
Amortization expense
            195,958               175,760               587,874               527,280               724,537  
                                                                                 
Total Operating Expenses
            4,670,588               3,353,785               13,252,726               10,410,258               13,904,543  
                                                                                 
Income from operations
            1,567,705               1,908,293               5,533,541               6,811,025               6,274,632  
                                                                                 
Other income (expense):
                                                                               
Interest and dividend income
            14,465               97,697               49,152               205,381               260,552  
Rental income
            4,546               4,050               5,196               8,085               11,785  
Interest expense
            ( 61,074 )             ( 86,167 )             ( 195,502 )             ( 262,274 )             ( 350,997 )
Gain (loss) on sale of investments, net
      ( 33,477 )             ( 1,687 )             ( 35,533 )             53,097               250,480  
Loss on Disposition of Assets
            ( 20,135 )             ---               ( 20,135 )             ---               ---  
Total other income (expense)
            ( 95,675 )             13,893               ( 196,822 )             4,289               171,820  
                                                                                 
Income before provision for
                                                                               
   income taxes
            1,472,030               1,922,186               5,336,719               6,815,314               6,446,452  
                                                                                 
Provision for income taxes
            441,989               1,017,349               2,115,365               2,957,285               2,823,986  
                                                                                 
Net income
          $ 1,030,041             $ 904,837             $ 3,221,354             $ 3,858,029             $ 3,622,466  
                                                                                 
Basic and diluted earnings
                                                                               
per common share
            0.06               0.05               0.20               0.23               0.22  
                                                                                 
Weighted average number of
                                                                               
  shares outstanding
            16,428,005               16,625,414               16,450,973               16,695,782               16,663,557  
                                                                                 
COMPREHENSIVE INCOME
                                                                               
                                                                                 
Net income
          $ 1,030,041             $ 904,837             $ 3,221,354             $ 3,858,029             $ 3,622,466  
                                                                                 
Other comprehensive income
                                                                               
(loss), net of tax:
                                                                               
Unrealized gains on
                                                                               
investments (net of tax)
            ( 83,118 )             101,334               ( 57,263 )             91,995               114,297  
Less reclassification adjustment
                                                                               
for (gains) losses included in
                                                                               
net income (net of taxes)
            18,914               990               20,076               ( 31,168 )             ( 147,032 )
                                                                                 
Comprehensive income
          $ 965,837             $ 1,007,161             $ 3,184,167             $ 3,918,856             $ 3,589,731  
 
See accompanying notes to financial statements
 
4

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Nine Months Ended September 30, 2011 and 2010 (Unaudited)
and for the Year Ended December 31, 2010
 
 
         
Common Stock, No Par Value
                           
Accumulated
       
         
20,000,000 Shares
   
# of Shares
                           
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, 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  
                                                                         
Redemption of stock
    ---       ( 252,398 )     252,398       ---       ---       ( 2,666,288 )     ---       ---       ( 2,666,288 )
                                                                         
Issuance of treasury stock for compensation
    ---       10,500       ( 10,500 )     ---       66,730       87,515       ---       ---       154,245  
                                                                         
Issuance of treasury stock for Fresh Made acquisition
    ---                       ---                       ---       ---       ---  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
    ---       ---       ---       ---       ---       ---       ---       ( 32,735 )     (32,735 )
                                                                         
Net income for the year ended December 31, 2010
    ---       ---       ---       ---       ---       ---       3,622,466       ---       3,622,466  
                                                                         
Balances at December 31, 2010
    17,273,776       16,536,657       737,119     $ 6,509,267     $ 2,032,516     $ (6,425,546 )   $ 31,575,875     $ (43,094 )   $ 33,649,018  
                                                                         
                                                                         
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
    ---       (191,306 )     191,306       ---       ---       (2,059,911 )     ---       ---       (2,059,911 )
                                                                         
Issuance of treasury stock for compensation
    ---       10,500       (10,500 )     ---       52,941       9,376       ---       ---       62,317  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
    ---       ---       ---       ---       ---       ---       ---       60,827       60,827  
                                                                         
Net income for the nine months ended September 30, 2010
    ---       ---       ---       ---       ---       ---       3,858,029       ---       3,858,029  
                                                                         
Balances at September 30, 2010
    17,273,776       16,597,749       676,027     $ 6,509,267     $ 2,018,727     $ (5,897,308 )   $ 31,811,438     $ 50,468     $ 34,492,592  
                                                                         
Balances at January 1, 2011
    17,273,776       16,536,657       737,119     $ 6,509,267     $ 2,032,516     $ (6,425,546 )   $ 31,575,875     $ (43,094 )   $ 33,649,018  
                                                                         
Redemption of stock
    ---       (110,848 )     110,848       ---       ---       (1,022,429 )     ---       ---       (1,022,429 )
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
    ---       ---       ---       ---       ---       ---       ---       ( 37,187 )     (37,187 )
                                                                         
Net income for the nine months ended September 30, 2011
    ---       ---       ---       ---       ---       ---       3,221,354       ---       3,221,354  
                                                                         
Balances at September 30, 2011
    17,273,776       16,425,809       847,967     $ 6,509,267     $ 2,032,516     $ (7,447,975 )   $ 34,797,229     $ (80,281 )   $ 35,810,756  
 
 
See accompanying notes to financial statements
 
5

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2011 and 2010 (Unaudited)
and for the Year Ended December 31, 2010
 
 
   
(Unaudited)
September 30,
   
December 31,
 
   
2011
   
2010
   
2010
 
                   
Cash flows from operating activities:
                 
Net income
  $ 3,221,354     $ 3,858,029     $ 3,622,466  
Adjustments to reconcile net income to net
                       
cash flows from operating activities, net of acquisition:
                       
Depreciation and amortization
    1,751,813       1,560,893       2,118,282  
Loss (Gain) on sale of investments, net
    35,533       ( 53,097 )     ( 250,480 )
Loss on sale of equipment
    20,135                  
Deferred income taxes
    ( 186,677 )     ( 392,966 )     ( 96,918 )
Treasury stock issued for compensation
    ---       62,317       154,245  
Increase in allowance for doubtful accounts
    80,000       ---       17,754  
(Increase) decrease in operating assets:
                       
Accounts receivable
    ( 2,649,396 )     ( 1,795,921 )     ( 811,292 )
Other receivables
    89,847       ( 12,532 )     ( 54,922 )
Inventories
    ( 1,794,552 )     ( 1,212,177 )     ( 682,398 )
Refundable income taxes
    906,748       1,308,978       402,230  
Prepaid expenses and other current assets
    71,913       3,577       ( 117,618 )
Increase (decrease) in operating liabilities:
                       
Accounts payable
    346,276       ( 55,466 )     1,419,479  
Accrued expenses
    348,403       125,638       ( 104,885 )
Income taxes payable
    351,107       567,926       ---  
Net cash provided by operating activities
    2,592,504       3,965,199       5,615,943  
                         
Cash flows from investing activities:
                       
Purchases of investments
    ( 1,806,564 )     ( 1,809,170 )     ( 2,161,552 )
Proceeds from sale of investments
    990,397       2,868,975       5,669,158  
Investments in certificates of deposits
    ( 50,000 )     ---       ---  
Proceeds from redemption of certificates of deposit
    ---       202,545       402,005  
Purchases of property and equipment
    ( 1,241,388 )     ( 1,681,740 )     ( 2,229,274 )
Acquisition of the assets of First Juice
    ---       ---       ( 270,000 )
Net cash provided by (used in) investing activities
    ( 2,107,555 )     ( 419,390 )     1,410,337  
                         
Cash flows from financing activities:
                       
Proceeds of note payable
    1,000,000       250,000       250,000  
Checks written in excess of bank balances
    ( 470,223 )     659,125       998,234  
Purchases of treasury stock
    ( 1,022,429 )     ( 2,059,911 )     ( 2,666,288 )
Repayment of notes payable
    ( 2,361,553 )     ( 2,175,773 )     ( 3,008,694 )
Net cash used in financing activities
    ( 2,854,205 )     ( 3,326,559 )     ( 4,426,748 )
                         
Net (decrease) increase in cash and cash equivalents
    ( 2,369,256 )     219,250       2,599,532  
                         
Cash and cash equivalents at the beginning of the period
    3,229,939       630,407       630,407  
                         
Cash and cash equivalents at the end of the period
  $ 860,683     $ 849,657     $ 3,229,939  
 
 
See accompanying notes to financial statements
 
6

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


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 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.  In 2010, the Company acquired the assets of First Juice, Inc. (“First Juice”) and consolidated the operations into the operations of the Company.  All significant intercompany accounts and transactions have been eliminated.  The financial statements include the results of operations from the acquisition of the assets of First Juice from October 14, 2010 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.  Discounts and allowances are reported as a reduction of gross sales unless the allowance is attributable to an identifiable benefit separable from the purchase of the product, the value of which can be reasonably estimated, which would be charged to the appropriate expense account.
 
 
 
7

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


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 anticipated discounts.  The Company’s estimate of the allowances for doubtful accounts and anticipated discounts are based upon historical experience, its evaluation of the current status and contract terms 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

 
 
 
8

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
Intangible assets acquired in business combinations
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 identifiable 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 per 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 are the result of temporary differences that arise 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.

 
9

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010

 
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 2009 and 2010 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.
 
During the year ended December 31, 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 and paid during 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 and promotional costs
The Company expenses advertising costs as incurred.  For the year ended December 31, 2010 and for the nine months ended September 30, 2011 and 2010 total advertising expenses were $2,390,002, $2,702,782 and $3,377,757, respectively. 
 
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 nine months ended September 30, 2011 and 2010 and for the year ended December 31, 2010, diluted and basic earnings per share were the same, as the effect of dilutive securities options outstanding was not significant.

Reclassification
Certain 2010 balance sheet amounts have been reclassified to conform to the 2011 presentation.
 

 Note 3 – ACQUISITIONS

On October 14, 2010, Lifeway purchased certain assets of First Juice, Inc., a producer of organic fruit and vegetable juice beverages designed for children.  The consideration for substantially all of the assets was an aggregate of $770,000, consisting of a $500,000 previous investment in preferred stock and an additional $270,000 cash paid in 2010.  Production was moved to Lifeway facilities upon closing of the acquisition.  The acquisition was consummated to expand the Company’s presence in the children’s market, increase distribution channels for existing Lifeway products, and increase diversification of the Company’s products.   There were no significant liabilities assumed.  Acquisition costs for legal and professional fees have been included in General and Administrative costs and were not significant.  The entire amount of goodwill resulting from the acquisition is tax deductible.
 
 
10

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


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

Trade names
 
$
268,000
 
Other current assets
   
6,000
 
Customer lists
   
199,000
 
Fixed assets
   
35,000
 
Non amortizable goodwill and brand asset
   
262,000
 
       Total fair value of assets acquired and liabilities assumed
 
$
770,000
 

Had the acquisition occurred on January 1, 2010, the impact on the gross revenue and net income of the Company would not have been significant and would have had no impact on earnings per share for the full year ended December 31, 2010.

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

   
September 30, 2011
   
September 30, 2010
   
December 31, 2010
 
   
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 related intangibles
                                               
customer related intangibles
    4,504,200       1,419,834       4,305,200       911,919       4,504,200       1,039,323  
Lease acquisition
    87,200       85,368       87,200       76,824       87,200       79,941  
Customer relationship
    985,000       424,116       985,000       342,008       985,000       362,526  
Trade names
    2,248,000       692,763       1,980,000       550,000       2,248,000       585,267  
Formula
    438,000       226,300       438,000       182,500       438,000       193,450  
    $ 8,306,000     $ 2,891,981     $ 7,839,000     $ 2,106,851     $ 8,306,000     $ 2,304,107  

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

2012
 
$
756,634
 
2013
   
711,366
 
2014
   
711,366
 
                         2015
   
711,366
 
2016
   
704,066
 
Thereafter
   
1,819,221
 
   
$
5,414,091
 

Amortization expense during the nine months ended September 30, 2011 and 2010 and the year ended December 31, 2010 was $587,874, $527,281 and $724,537, respectively.

 
11

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


Note 5 – INVESTMENTS

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

September 30, 2011
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
  $ 681,162     $ 6,386     $ ( 88,910 )   $ 598,638  
Mutual Funds
    3,588       40       ( 794 )     2,834  
Preferred Securities
    114,452       ---       ( 18,154 )     96,298  
Corporate Bonds
    556,141       ---       ( 40,011 )     516,130  
Government Agency Obligations
    601,092       ---       ( 648 )     600,444  
                                 
Total
  $ 1,956,435     $ 6,426     $ ( 148,517 )   $ 1,814,344  

September 30, 2010
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
  $ 689,639     $ 27,867     $ ( 55,041 )   $ 662,465  
Mutual Funds
    96,537       6,323       ( 1,014 )     101,846  
Preferred Securities
    243,264       10,020       ( 11,764 )     241,520  
Corporate Bonds
    2,313,081       127,867       ( 19,777 )     2,421,171  
Government Agency Obligations
    60,005       1,495       ---       61,500  
                                 
Total
  $ 3,402,526     $ 173,572     $ ( 87,596 )   $ 3,488,502  

December 31, 2010
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
 
$
225,573
   
$
16,173
   
$
( 68,974
)
 
$
172,772
 
Mutual Funds
   
202,108
     
4,661
     
( 2,017
)
   
204,752
 
Preferred Securities
   
228,514
     
     
( 18,329
)
   
210,185
 
Corporate Bonds
   
496,451
     
843
     
( 5,771
)
   
491,523
 
                                 
Total
 
$
1,152,646
   
$
21,677
   
$
( 95,091
)
 
$
1,079,232
 


Proceeds from the sale of investments were $5,669,158, $990,397 and $2,868,975 during the year ended December 31, 2010 and for the nine months ended September 30, 2011 and 2010, respectively.

Gross gains of $451,420, $27,291 and $245,890 and gross losses of $200,940, $62,824 and $192,793 were realized on these sales during the year ended December 31, 2010 and for the nine months ended September 30, 2011 and 2010, respectively.

 
 
12

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


Note 5 – INVESTMENTS - Continued
 
The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011 and 2010 and at December 31, 2010:
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
September 30, 2011
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
  $ 386,005     $ ( 52,770 )   $ 33,294     $ ( 36,140 )   $ 419,299     $ ( 88,910 )
Mutual Funds
    238       ( 41 )     2,432       ( 753 )     2,670       ( 794 )
Preferred Securities
    ---       ---       96,298       ( 18,154 )     96,298       ( 18,154 )
Corporate Bonds
    380,326       ( 26,810 )     135,805       ( 13,201 )     516,131       ( 40,011 )
Government Agency obligations
    600,444       ( 648 )     ---       ---       600,444       ( 648 )
    $ 1,367,013     $ ( 80,269 )   $ 267,829     $ ( 68,248 )   $ 1,634,842     $ ( 148,517 )

 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
September 30, 2010
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
  $ 59,879     $ ( 5,726 )   $ 79,962     $ ( 49,315 )   $ 139,841     $ ( 55,041 )
Mutual Funds
    ---       ---       17,970       ( 1,014 )     17,970       ( 1,014 )
Preferred Securities
    ---       ---       216,750       ( 11,764 )     216,750       ( 11,764 )
Corporate Bonds
    625,104       ( 17,357 )     176,352       ( 2,420 )     801,456       ( 19,777 )
    $ 684,983     $ ( 23,083 )   $ 491,034     $ ( 64,513 )   $ 1,176,017     $ ( 87,596 )
 
 
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 2010
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
EquitiesEee EquitiEquities
 
$
48,202
   
$
(11,675
)
 
$
101,467
   
$
(57,299
)
 
$
149,669
   
$
(68,974
)
Mutual Funds
   
     
     
85,061
     
(2,017
)
   
85,061
     
(2,017
)
Preferred Securities
   
     
     
210,185
     
(18,329
)
   
210,185
     
(18,329
)
Corporate Bonds
   
146,710
     
(2,296
)
   
122,532
     
(3,475
)
   
269,242
     
(5,771
)
   
$
194,912
   
$
(13,971
)
 
$
519,245
   
$
(81,120
)
 
$
714,157
   
$
(95,091
)

Equities, Mutual Funds, Preferred Securities, 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.  As of September 30, 2011, there were thirty-six equity securities, one mutual fund security, two preferred securities, eight corporate bond securities and one government agency obligation security that had unrealized losses. 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 September 30, 2011.
 
 
13

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010
 
Note 6 – INVENTORIES

Inventories consist of the following:

   
September 30,
   
December 31,
 
   
2011
   
2010
   
2010
 
Finished goods
  $ 1,325,523     $ 1,523,234     $ 1,636,988  
Production supplies
    2,163,203       1,745,308       1,527,064  
Raw materials
    2,291,200       1,240,611       821,322  
Total inventories
  $ 5,779,926     $ 4,509,153     $ 3,985,374  

 
Note 7 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
 
           
   
September 30,
 
December 31,
 
   
2011
   
2010
 
2010
 
Land
 
$
1,178,160
   
$
1,178,160
 
$             1,178,160
 
Buildings and improvements
   
11,555,313
     
11,219,047
 
11,328,860
 
Machinery and equipment
   
14,374,318
     
13,256,649
 
13,713,649
 
Vehicles
   
1,289,307
     
976,745
 
976,745
 
Office equipment
   
377,309
     
299,823
 
352,135
 
Construction in process
   
261,865
     
133,579
 
96,990
 
     
29,036,272
     
27,064,003
 
27,646,539
 
Less accumulated depreciation
   
13,655,555
     
12,133,694
 
12,493,826
 
Total property and equipment
 
$
15,380,717
   
$
14,930,309
 
$           15,152,713
 

Depreciation expense during the nine months ended September 30, 2011 and 2010 and for the year ended December 31, 2010 was $1,163,939, $1,033,611 and $1,393,745, respectively.


Note 8 ACCRUED EXPENSES

Accrued expenses consist of the following:
 
           
   
September 30,
 
December 31,
 
   
2011
   
2010
 
2010
 
Accrued payroll and payroll taxes
 
$
460,676
   
$
303,436
 
$                  181,274
 
Accrued property tax
   
374,903
     
375,972
 
273,876
 
Other
   
22,283
     
60,574
 
54,309
 
   
$
857,862
   
$
739,982
 
$                  509,459
 
 

 
14

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010

Note 9 – NOTES PAYABLE

Notes payable consist of the following:
 
   
September 30,
 
December 31,
 
   
2011
   
2010
 
2010
 
                 
Note payable to Private Bank in monthly installments of $42,222, plus variable interest rate, currently at 2.761%, with a balloon payment of $5,066,667 due February 6, 2014.  Collateralized by substantially all assets of the Company.
 
$
6,248,889
   
$
6,735,556
 
$               6,628,889
 
                     
Line of credit with Private Bank at variable interest rate, currently at 2.761%.  The agreement has been extended with terms allowing borrowings up to $2.0 million, maturing on May 31, 2012.  Collateralized by substantially all assets of the Company.
   
---
     
750,000
 
 
                     
Line of credit with Morgan Stanley for borrowings up to $2.8 million at variable interest rate, currently at 2.94% due on demand.  Collateralized by investments with a fair value of $1,212,873, and cash and CD’s totaling $449,967 at September 30, 2011.
   
1,384,468
     
2,321,200
 
2,344,946
 
                     
Notes payable to Ford Credit Corp. payable in monthly installments of $1,778.23 at 6.116%, secured by transportation equipment
   
72,753
     
---
 
---
 
                     
Note payable to Fletcher Jones of Chicago, Ltd LLC in monthly installments of $1,768.57 at 6.653%, due May 24, 2017, secured by transportation equipment
   
100,017
     
---
 
 
Total notes payable
   
7,806,127
     
9,806,756
 
8,973,835
 
Less current maturities
   
1,923,436
     
3,608,978
 
2,851,610
 
Total long-term portion
 
$
5,882,691
   
$
6,197,778
 
$              6,122,225
 

In accordance with the Private Bank agreements referenced above, the Company is subject to minimum fixed charged ratio and tangible net worth thresholds.  At September 30, 2011, the Company was in compliance with these covenants.
 
 
Maturities of notes payables are as follows:

For the Period Ended September 30,
   
       
2012
 
$
1,923,436
 
2013
   
541,115
 
2014
   
5,272,275
 
2015
   
35,575
 
2016
   
19,546
 
Thereafter
   
14,180
 
Total
 
$
7,806,127
 
 
 
 
 
 
15

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010

 
Note 10 – PROVISION FOR INCOME TAXES

The provision for income taxes consists of the following:
 
   
For the Nine Months Ended
 
For the Year Ended
   
September 30,
 
December 31,
   
2011
   
2010
 
2010
Current:
             
Federal
 
$
1,422,579
   
$
2,489,227
 
$         2,269,819
State and local
   
879,463
     
861,024
 
651,085
Total current
   
2,302,042
     
3,350,251
 
2,920,904
Deferred
   
(186,677)
     
(392,966)
 
(96,918)
Provision for income taxes
 
$
2,115,365
   
$
2,957,285
 
$        2,823,986

A reconciliation of the provision for income taxes and the income tax computed at the statutory rate is as follows:
 
       
For the Year
   
For the Nine Months Ended
 
Ended
   
September 30,
 
December 31,
   
2011
   
2010
 
2010
Federal income tax expense computed at the statutory rate
 
$
1,814,484
   
$
2,317,207
 
 $        2,180,228
State and local tax expense, net
   
506,988
     
497,918
 
651,085
Permanent differences
   
(146,938)
     
(167,615)
 
(117,247)
Tax credits and other
   
(59,169)
     
309,775
 
109,920
Provision for income taxes
 
$
2,115,365
   
$
2,957,285
 
$        2,823,986

Amounts for deferred tax assets and liabilities are as follows:
 
         
   
September 30,
 
December 31,
   
2011
   
2010
 
2010
Non-current deferred tax assets (liabilities) arising from:
 Temporary differences -
             
 Accumulated depreciation and amortization from purchase accounting adjustments
 
$
(3,584,660)
   
$
(3,457,448)
 
$   (3,673,296)
    Capital loss carry-forwards
   
271,568
     
337,016
 
271,568
Total non-current net deferred tax liabilities
   
(3,313,092)
     
(3,120,432)
 
(3,401,728)
 
Current deferred tax assets arising from:
                 
 Unrealized (gains) losses on investments
   
61,810
     
(35,509)
 
30,320
 Impairment of investments
   
---
     
4,234
 
4,232
 Inventory
   
257,963
     
190,958
 
168,875
   Allowance for doubtful accounts and discounts
   
138,228
     
117,710
 
125,043
Total current deferred tax assets
   
458,001
     
277,393
 
328,470
 
Net deferred tax liability
 
$
(2,855,091)
   
$
(2,843,039)
 
$   (3,073,258)

 
 
16

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


Note 11 – SUPPLEMENTAL CASH FLOW INFORMATION

The Company applied a previous investment in First Juice, Inc. of $500,000 toward the acquisition during 2010.  The impact on the acquisition and intangible assets has been omitted from the investing section of the cash flow statement.

Cash paid for interest and income taxes are as follows:
 
        For the Year
   
For the Nine Months Ended
  Ended
   
September 30,
  December 31,
   
2011
   
2010
  2010
Interest
 
$
195,448
   
$
314,578
  $
375,347
Income taxes
 
$
1,169,334
   
$
1,479,092
  $
2,824,824
 
 
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, 2010 and at September 30, 2011 and 2010, there were no stock options outstanding or exercisable.  There were approximately 940,000 shares available for issuance under the Plan at September 30, 2011.

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.

 
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.

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.



 
 
17

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2011 and 2010
and December 31, 2010


Note 13 – FAIR VALUE MEASUREMENTS - Continued

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.

The Company has available for sale investment securities measured at fair value on a recurring basis.  All categories of investment securities noted in Note 5 were valued using Level 1 inputs as described above, in 2011 and 2010.  There were no other assets or liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2011, September 30, 2010 or December 31, 2010.


Note 14 – RECENT ACCOUNTING PRONOUNCEMENTS

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures.   FASB ASU 2010-06 amends the fair value disclosure guidance to include new disclosures and changes to clarify existing disclosure requirements.  ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The impact of ASU 2010-06 on the Company’s disclosures was not significant to the consolidated financial statements.

 
 






 





 
18

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

Comparison of Quarter Ended September 30, 2011 to Quarter Ended September 30, 2010

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, 2010.

Results of Operations

Total consolidated gross sales increased by $3,514,749 (approximately 22%) to $19,423,533 during the three-month period ended September 30, 2011 from $15,908,784 during the same three-month period in 2010.  This increase is primarily attributable to increased sales and awareness of flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™.  In addition, Lifeway Frozen Kefir line, which was launched in April 2011 or the second quarter of 2011, contributed approximately $300,000 to revenue during the third quarter 2011.

Total consolidated net sales increased by $3,108,587 (approximately 21%) to $17,701,604 during the three-month period ended September 30, 2011 from $14,593,017 during the same three-month period in 2010.  Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.

Cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 63% during the third quarter of 2011, compared to approximately 62% during the same period in 2010. The increase was primarily attributable to the cost of transportation and other petroleum based production supplies, as well as the increased cost of conventional milk, our largest raw material.  The cost of milk was approximately 35% to 45% higher during the third quarter 2011 when compared to the same period in 2010.
 
Operating expenses as a percentage of net sales were approximately 26% during the third quarter of 2011 compared to approximately 23% during the same period in 2010.   This increase was primarily attributable to increased selling expenses as compared to the same period in 2010.  Selling related expenses increased by $900,167 (approximately 49%) to $2,748,389 during the third quarter of 2011, from $1,848,222 during the same period in 2010.  This increase is directly attributable to increases in marketing and advertising of the Company’s flagship line, Kefir, as well as ProBugs® Organic Kefir for kids, BioKefir,™  and Lifeway’s Frozen Kefir.

Total operating income decreased by $340,588 (approximately 18%) to $1,567,705 during the third quarter of 2011, from $1,908,293 during the same period in 2010.

Provision for income taxes was $441,989, or a 30% effective tax rate, for the 2011 third quarter compared with $1,017,349, or a 53% tax rate, during the same period in 2010. The decline in the effective rate is primarily the result of changes in estimates reflected in the current period.  Additionally, during the year ended December 31, 2010, a liability of approximately $220,000 was recognized resulting from the completion of an IRS review of the Company's 2007 and 2008 federal tax return filings.  Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.

Total net income was $1,030,041 or $0.06 per share for the three-month period ended September 30, 2011 compared to $904,837 or $0.05 per share in the same period in 2010.

 
19

 
Comparison of Nine-Month Period Ended September 30, 2011 to Nine-Month Period Ended September 30, 2010

Total consolidated gross sales increased by $10,964,303, (approximately 23%) to $58,383,802 during the nine- month period ended September 30, 2011 from $47,419,499 during the same nine-month period in 2010.  This increase is primarily attributable to increased sales and awareness of flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™.  In addition, Lifeway Frozen Kefir line, which was launched in April 2011 or the second quarter of 2011, contributed approximately $550,000 to revenue during the first nine months of 2011.

Total consolidated net sales increased by $9,435,902 (approximately 22%) to $53,203,425 during the nine-month period ended September 30, 2011 from $43,767,523 during the same nine-month period in 2010.  Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.

Cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 63% during the nine-month period ended September 30, 2011, compared to approximately 58% during the same period in 2010. The increase was primarily attributable to the cost of transportation and other petroleum based production supplies, as well as the increased cost of conventional milk, our largest raw material.  The cost of milk was approximately 20 to 25% higher during the nine month period ended September 30, 2011 when compared to the same period in 2010.
 
Operating expenses as a percentage of net sales were approximately 25% during the nine-month period ended September 30, 2011 compared to approximately 24% during the same period in 2010.  Selling related expenses increased by $2,175,750 (approximately 39%) to $7,760,704 during the nine-month period ended September 30, 2011, from $5,584,954 during the same period in 2010. This increase is directly attributable to the Company recording an approximate $700,000 expense related its 25th Anniversary Cross Country Mobile tour, which occurred in the second quarter and was expensed during the second quarter of 2011, and other increases in marketing and advertising of the Company’s flagship line Kefir, as well as ProBugs® Organic Kefir for kids, BioKefir™, and Lifeway’s Frozen Kefir. The Company views this as a non-recurring advertising expense.

Total operating income decreased by $1,277,484 (approximately 19%) to $5,533,541 during the nine-month period ended September 30, 2011, from $6,811,025 during the same period in 2010.

Provision for income taxes was $2,115,365 or a 40% effective tax rate, for the nine-month period ended September 30, 2011 compared with $2,957,285, or a 43% tax rate, during the same period in 2010.  The decline in the effective rate is primarily the result of changes in estimates reflected in the current period.  Additionally, during the year ended December 31, 2010, a liability of approximately $220,000 was recognized resulting from the completion of an IRS review of the Company's 2007 and 2008 federal tax return filings.  Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.

Total net income was $3,221,354 or $0.20 per share for the nine-month period ended September 30, 2011 compared to $3,858,029 or $0.23 per share in the same period in 2010.

Liquidity and Capital Resources

Sources and Uses of Cash

Net cash provided by operating activities was $2,592,504 during the nine-months ended September 30, 2011 which is a decrease of $1,372,695 when compared to the same period in 2010.  This decrease is primarily attributable to the decrease in net income of $636,675.

Net cash used in investing activities was $2,107,555 during the nine-months ended September 30, 2011 which is an increase of $1,688,165 compared to the same period in 2010.  This increase is primarily due to a decrease in proceeds from sale of investments of $1,878,578 compared to 2010.

The Company had a net increase in cash and cash equivalents of $11,026 during the third quarter of 2011 compared to the same period in 2010.  The Company had cash and cash equivalents of $860,683 as of September 30, 2011 compared with cash and cash equivalents of $849,657 as of September 30, 2010.
 
 
20

 
Assets and Liabilities
 
Total assets were $53,539,688 as of September 30, 2011, which is an increase of $1,480,957 when compared to December 31, 2010, and an increase of $1,101,365 when compared to September 30, 2010.  This is primarily due to an increase in accounts receivable of $1,567,013 as of September 30, 2011, when compared with September 30, 2010.
 
Total current liabilities were $8,533,149 as of September 30, 2011, which is a decrease of $352,611 when compared to December 31, 2010. Total current liabilities decreased by $94,372 when compared to September 30, 2010.  This is primarily due a $1,685,542 decrease in current maturities of notes payable partially offset by a $1,821,223 increase in accounts payable as of September 30, 2011, when compared to September 30, 2010.

Long term notes payable decreased by $239,534 as of September 30, 2011, when compared to December 31, 2010 and decreased by $315,087 when compared to September 30, 2010.  The balance of the long term notes payable as of September 30, 2011 was $5,882,691.
 
Total stockholder’s equity was $35,810,756 as of September 30, 2011, which is an increase of $2,161,738 when compared to December 31, 2010.  This is primarily due the increase in retained earnings of $3,221,354 when compared to December 31, 2010.  Total stockholder’s equity increased by $1,318,164 when compared to September 30, 2010.  This is primarily due the increase in retained earnings by $2,985,791 as of September 30, 2011, when compared to September 30, 2010.
 
We previously held significant portions of our assets in marketable securities. During the fourth quarter of 2010, we converted certain securities to cash and cash equivalents in order to ensure we had easy access to capital to capitalize on the opportunities we see ahead for our business.  All of our marketable securities are classified as available-for-sale on our balance sheet.  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.
 
We anticipate being able to fund the Company’s foreseeable liquidity requirements internally. We continue to explore potential acquisition opportunities in our industry in order to boost sales while leveraging our distribution system to consolidate and lower costs.
 
 
 
21

 
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.
 
 
 
ITEM 4.    CONTROLS AND PROCEDURES.
 
Evaluation of Disclosure Controls and Procedures

As of September 30, 2011, 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 September 30, 2011 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 for the year ended December 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.
 
 
Changes in Internal Control Over Financial Reporting

During 2011, the Company’s management continued to implement remediation activities to improve the quality of its internal control over financial reporting.  The Company implemented new policies and procedures in order to reduce or eliminate deficiencies. The most significant component of the changes in the internal control over financial reporting is the implementation of accounting software to provide additional entity level controls over advertising and sales promotional discounts with customers, controls over the identification, recording and review of period end activity for accounts receivable, accounts payable, fixed assets, inventory, and deferred taxes.  The Company, together with a professional services firm, will continue to test the Company’s internal control over financial reporting.  The changes in our internal control have not materially affected, and are not reasonably likely to materially affect, our internal control over financial reporting for the period ended September 30, 2011. The foregoing notwithstanding, we continue to evaluate the appropriate remediation measures required in order to address the previously identified material weaknesses.  Progress relative to our remediation measures will be disclosed in our subsequent Exchange Act reports.  We are committed to making continued improvements to address the previously identified material weaknesses.
 
 
 
PART II — OTHER INFORMATION
 

ITEM 1.    LEGAL PROCEEDINGS.

None.
 
 
ITEM 1A.    RISK FACTORS.

Not applicable.
 
 
 
22

 
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*
July 1, 2011 to July 31, 2011 
  0     0   191,754
August 1, 2011 to August 31, 2011 
  3,000   10.01   3,000   188,754
September 1, 2011 to September 30, 2011
  2,000   10.12   2,000   186,754
Total 
  5,000   10.07   5,000   186,754
 
*On January 1, 2011, the Company approved a new share repurchase program for up to 250,000 shares with a plan expiration date of one year from the date of the first purchase. 
 
 
ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.

None.
 
 
ITEM 4.    REMOVED AND RESERVED.
 
 
 
ITEM 5.    OTHER INFORMATION.
 
None.   
 
 
ITEM 6.    EXHIBITS.

Exhibit
Number
 
Description of Document
     
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.
     
101
 
Interactive Data Files.
     
 
 
23

 
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:  November 14,  2011
By:
 /s/ Julie Smolyansky
 
   
 Julie Smolyansky
 
   
 Chief Executive Officer, President
 and Director
 
       
       
       
       
       
       
Date: November 14, 2011
By:
 /s/ Edward P. Smolyansky
 
   
 Edward P. Smolyansky
 
   
 Chief Financial and Accounting
 Officer and Treasurer
 
       
       
       
       
 

 
 
 
 
 
24

 
EXHIBIT INDEX
 
 

Exhibit
Number
 
Description of Document
     
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.
     
101
 
Interactive Data Files.
     
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
25