form10q_17110.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:  March 31, 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) 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  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  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 March 31, 2011, the issuer had 16,443,809 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.
  20
       
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.
  24
       
       
SIGNATURES
    25
       
EXHIBIT INDEX
    26
 
 
 
2

 
PART I – FINANCIAL INFORMATION
 
ITEM 1.    FINANCIAL STATEMENTS.
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
March 31, 2011 and 2010 (Unaudited) and December 31, 2010
 
   
(Unaudited)
       
   
March 31,
   
December 31,
 
   
2011
   
2010
   
2010
 
ASSETS
                 
                   
Current assets
                 
Cash and cash equivalents
  $ 2,075,791     $ 652,177     $ 3,229,939  
Investments
    1,314,382       4,397,781       1,079,232  
Certificates of deposits in financial institutions
    250,000       550,000       250,000  
Inventories
    4,752,054       3,869,825       3,985,374  
Accounts receivable, net of allowance for doubtful accounts and discounts
    8,346,560       7,726,348       6,793,276  
Prepaid expenses and other current assets
    126,919       38,447       158,315  
Other receivables
    74,879       49,081       104,680  
Deferred income taxes
    368,176       303,431       328,470  
Refundable income taxes
    ---       476,915       906,748  
Total current assets
    17,308,761       18,064,005       16,836,034  
                         
Property and equipment, net
    15,129,655       14,481,822       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 $2,500,066 and $1,773,968 at March 31, 2011 and 2010 and $2,304,107 at December 31, 2010, respectively
    5,805,934       6,083,670       6,001,893  
Total intangible assets
    19,874,025       19,889,761       20,069,984  
                         
Other assets
    ---       500,000       ---  
                         
Total assets
  $ 52,312,441     $ 52,935,588     $ 52,058,731  
                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                       
                         
Current liabilities
                       
Checks written in excess of bank balances
  $ 1,067,073     $ 533,458     $ 1,341,210  
Current maturities of notes payable
    2,364,774       4,733,354       2,851,610  
Accounts payable
    3,781,059       3,116,627       4,183,481  
Accrued expenses
    595,841       637,263       509,459  
Accrued income taxes
    430,246       ---       ---  
Total current liabilities
    8,238,993       9,020,702       8,885,760  
                         
Notes payable
    5,995,558       6,502,222       6,122,225  
                         
Deferred income taxes
    3,332,473       3,318,273       3,401,728  
Total liabilities
    17,567,024       18,841,197       18,409,713  
                         
Stockholders' equity
                       
Common stock, no par value; 20,000,000 shares authorized; 17,273,776 shares issued; 16,443,809 shares outstanding at March 31, 2011; 17,273,776 shares issued; 16,754,572 shares outstanding at March 31, 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       1,992,257       2,032,516  
Treasury stock, at cost
    ( 7,271,836 )     ( 4,182,190 )     ( 6,425,546 )
Retained earnings
    33,501,646       29,722,098       31,575,875  
Accumulated other comprehensive income (loss), net of taxes
    ( 26,176 )     52,959       ( 43,094 )
Total stockholders' equity
    34,745,417       34,094,391       33,649,018  
                         
Total liabilities and stockholders' equity
  $ 52,312,441     $ 52,935,588     $ 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 Months Ended March 31, 2011 and 2010 (Unaudited)
and for the Year Ended December 31, 2010
 
   
(Unaudited)
             
   
March 31
   
December 31,
 
   
2011
   
2010
   
2010
 
                                     
Sales
  $ 19,047,266           $ 15,964,159           $ 63,543,445        
Less: discounts and allowances
    ( 1,743,363 )           ( 1,075,013 )           ( 5,043,552 )      
Net Sales
    17,303,903       17,303,903       14,889,146       14,889,146       58,499,893       58,499,893  
                                                 
Cost of goods sold
            9,651,272               8,076,612               36,926,973  
Depreciation expense
            376,513               403,375               1,393,745  
                                                 
Total cost of goods sold
            10,027,785               8,479,987               38,320,718  
                                                 
Gross profit
            7,276,118               6,409,159               20,179,175  
                                                 
Selling expenses
            2,221,808               1,994,847               7,603,098  
General and administrative
            1,592,729               1,490,157               5,576,908  
Amortization expense
            195,959               175,760               724,537  
                                                 
Total Operating Expenses
            4,010,496               3,660,764               13,904,543  
                                                 
Income from operations
            3,265,622               2,748,395               6,274,632  
                                                 
Other income (expense):
                                               
Interest and dividend income
            17,593               54,508               260,552  
Rental income
            ---               1,235               11,785  
Interest expense
            ( 62,130 )             ( 95,942 )             ( 350,997 )
Gain (loss) on sale of investments, net
            ( 2,597 )             ( 29,259 )             250,480  
Total other income (expense)
            ( 47,134 )             ( 69,458 )             171,820  
                                                 
Income before provision for
                                               
   income taxes
            3,218,488               2,678,937               6,446,452  
                                                 
Provision for income taxes
            1,292,717               910,248               2,823,986  
                                                 
Net income
          $ 1,925,771             $ 1,768,689             $ 3,622,466  
                                                 
Basic and diluted earnings
                                               
per common share
            0.12               0.11               0.22  
                                                 
Weighted average number of
                                               
  shares outstanding
            16,489,954               16,761,774               16,663,557  
                                                 
COMPREHENSIVE INCOME
                                               
                                                 
Net income
          $ 1,925,771             $ 1,768,689             $ 3,622,466  
                                                 
Other comprehensive income
                                               
(loss), net of tax:
                                               
Unrealized gains on
                                               
investments (net of tax)
            15,451               46,143               114,297  
Less reclassification adjustment
                                               
for (gains) losses included in
                                               
net income (net of taxes)
            1,467               17,175               (147,032 )
                                                 
Comprehensive income
          $ 1,942,689             $ 1,832,007             $ 3,589,731  
 
See accompanying notes to financial statements
 
4

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Three Months Ended March 31, 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
    ---       (28,365 )     28,365       ---       ---       (340,105 )     ---       ---       (340,105 )
                                                                         
Issuance of treasury stock for compensation
    ---       4,382       (4,382 )     ---       26,471       4,688       ---       ---       31,159  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of
taxes and reclassification adjustment
    ---       ---       ---       ---       ---       ---       ---       63,318       63,318  
                                                                         
Net income for the three months ended March 31, 2010
    ---       ---       ---       ---       ---       ---       1,768,689       ---       1,768,689  
                                                                         
Balances at March 31, 2010
    17,273,776       16,754,572       519,204     $ 6,509,267     $ 1,992,257     $ (4,182,190 )   $ 29,722,098     $ 52,959     $ 34,094,391  
                                                                         
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
    ---       (92,848 )     92,848       ---       ---       (846,290 )     ---       ---       (846,290 )
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
    ---       ---       ---       ---       ---       ---       ---       16,918       16,918  
                                                                         
Net income for the three months ended March 31, 2011
    ---       ---       ---       ---       ---       ---       1,925,771       ---       1,925,771  
                                                                         
Balances at March 31, 2011
    17,273,776       16,443,809       829,967     $ 6,509,267     $ 2,032,516     $ (7,271,836 )   $ 33,501,646     $ (26,176 )   $ 34,745,417  

See accompanying notes to financial statements
 
 
5

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2011 and 2010 (Unaudited)
and for the Year Ended December 31, 2010
 
   
(Unaudited)
       
   
March 31,
   
December
 
   
2011
   
2010
   
2010
 
                   
Cash flows from operating activities:
                 
Net income
  $ 1,925,771     $ 1,768,689     $ 3,622,466  
Adjustments to reconcile net income to net
                       
cash flows from operating activities, net of acquisition:
                       
Depreciation and amortization
    572,472       579,135       2,118,282  
Loss (Gain) on sale of investments, net
    2,597       29,259       ( 250,480 )
Deferred income taxes
    ( 119,129 )     ( 222,915 )     ( 96,918 )
Treasury stock issued for compensation
    ---       31,159       154,245  
Increase in allowance for doubtful accounts
    20,000       ---       17,754  
(Increase) decrease in operating assets:
                       
Accounts receivable
    ( 1,573,284 )     ( 1,726,610 )     ( 811,292 )
Other receivables
    29,801       677       ( 54,922 )
Inventories
    ( 766,680 )     ( 572,849 )     ( 682,398 )
Refundable income taxes
    906,748       832,063       402,230  
Prepaid expenses and other current assets
    31,396       2,250       ( 117,618 )
Increase (decrease) in operating liabilities:
                       
Accounts payable
    ( 402,422 )     352,627       1,419,479  
Accrued expenses
    86,382       22,919       ( 104,885 )
Income taxes payable
    430,246       ---       ---  
Net cash provided by operating activities
    1,143,898       1,096,404       5,615,943  
                         
Cash flows from investing activities:
                       
Purchases of investments
    ( 445,049 )     ( 356,498 )     ( 2,161,552 )
Proceeds from sale of investments
    234,388       531,455       5,669,158  
Proceeds from redemption of certificates of deposit
    ---               402,005  
Purchases of property and equipment
    ( 353,455 )     ( 603,015 )     ( 2,229,274 )
Acquisition of the assets of First Juice
    ---       ---       ( 270,000 )
Net cash provided by (used in) investing activities
    ( 564,116 )     ( 428,058 )     1,410,337  
                         
Cash flows from financing activities:
                       
Proceeds of note payable
    ---       ---       250,000  
Checks written in excess of bank balances
    ( 274,137 )     190,482       998,234  
Purchases of treasury stock
    ( 846,290 )     ( 340,105 )     ( 2,666,288 )
Repayment of notes payable
    ( 613,503 )     ( 496,953 )     ( 3,008,694 )
Net cash used in financing activities
    ( 1,733,930 )     ( 646,576 )     ( 4,426,748 )
                         
Net (decrease) increase in cash and cash equivalents
    ( 1,154,148 )     21,770       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
  $ 2,075,791     $ 652,177     $ 3,229,939  

See accompanying notes to financial statements
 
 
6

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 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 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
March 31, 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
March 31, 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
March 31, 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 three months ended March 31, 2011 and 2010 total advertising costs and promotional discounts and allowances were $4,545,043, $1,445,997 and $1,361,694, respectively.  For the year ended 2010 and for the three months ended March 31, 2011 and 2010, $2,390,002, $829,345, and $829,068 were classified as advertising expense, respectively, and $2,155,041, $616,652, and $532,626 were considered to be promotional discounts and allowances and were classified as reductions of sales, 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 three months ended March 31, 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.



 
 
10

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

Note 3 – ACQUISITIONS

On October 20, 2010, Lifeway purchased certain assets of First Juice, Inc., a producer of organic fruit and vegetable juice beverages designed for children (“First”).  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.

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-compete agreement
   
-0-
 
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:

   
March 31, 2011
   
March 31, 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 customer related intangibles
    4,504,200       1,166,160       4,305,200       695,568       4,504,200       1,039,323  
Lease acquisition
    87,200       81,750       87,200       70,590       87,200       79,941  
Customer relationship
    985,000       383,056       985,000       300,972       985,000       362,526  
Trade names
    2,248,000       621,100       1,980,000       484,000       2,248,000       585,267  
Formula
    438,000       204,400       438,000       160,600       438,000       193,450  
    $ 8,306,000     $ 2,500,066     $ 7,857,638     $ 1,773,968     $ 8,306,000     $ 2,304,107  

 
 
11

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

Note 4 – INTANGIBLE ASSETS - Continued

Amortization expense is expected to be as follows for the 12 months ending March 31:

2012
 
$
780,200
 
2013
   
760,317
 
2014
   
714,192
 
                         2015
   
711,367
 
2016
   
711,367
 
Thereafter
   
2,128,491
 
   
$
5,805,934
 

Amortization expense during the three months ended March 31, 2011 and 2010 and the year ended December 31, 2010 was $195,959, $175,760 and $724,537, respectively.

 
Note 5 – INVESTMENTS

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

March 31, 2011
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
  $ 261,472     $ 6,227     $ ( 37,440 )   $ 230,259  
Mutual Funds
    103,346       1,902       ( 798 )     104,450  
Preferred Securities
    203,514       ---       ( 12,984 )     190,530  
Corporate Bonds
    792,379       3,941       ( 7,177 )     789,143  
Total
  $ 1,360,711     $ 12,070     $ ( 58,399 )   $ 1,314,382  

March 31, 2010
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
  $ 1,278,619     $ 190,688     $ ( 120,631 )   $ 1,348,676  
Mutual Funds
    228,746       6,781       ( 4,326 )     231,201  
Preferred Securities
    388,705       7,450       ( 63,703 )     332,452  
Corporate Bonds
    1,595,713       84,119       ( 6,877 )     1,672,955  
Government Agency Obligations
    815,778       3,433       ( 6,714 )     812,497  
Total
  $ 4,307,561     $ 292,471     $ ( 202,251 )   $ 4,397,781  

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
 

 
 
12

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

Note 5 – INVESTMENTS - Continued

Proceeds from the sale of investments were $5,669,158, $234,388 and $531,455 during the year ended December 31, 2010 and for the three months ended March 31, 2011 and 2010, respectively.

Gross gains of $451,420, $15,652 and $23,737 and gross losses of $200,940, $18,249 and $52,996 were realized on these sales during the year ended December 31, 2010 and for the three months ended March 31, 2011 and 2010, 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 March 31, 2011 and 2010 and at December 31, 2010:

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
March 31, 2011
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
  $ 163,063     $ ( 7,801 )   $ 25,270     $ ( 29,639 )   $ 188,333     $ ( 37,440 )
Mutual Funds
    20,124       ( 680 )     5,824       ( 118 )     25,948       ( 798 )
Preferred Securities
    ---       ---       190,530       ( 12,984 )     190,530       ( 12,984 )
Corporate Bonds
    409,750       ( 7,177 )     ---       ---       409,750       ( 7,177 )
    $ 592,937     $ ( 15,658 )   $ 221,624     $ ( 42,741 )   $ 814,561     $ ( 58,399 )

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
March 31, 2010
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
  $ 79,393     $ ( 29,937 )   $ 205,060     $ ( 90,694 )   $ 284,453     $ ( 120,631 )
Mutual Funds
    414       ( 4 )     26,034       ( 4,322 )     26,448       ( 4,326 )
Preferred Securities
    ---       ---       310,252       ( 63,703 )     310,252       ( 63,703 )
Corporate Bonds
    164,144       ( 5,510 )     103,645       ( 1,367 )     267,789       ( 6,877 )
Government Agency Obligations
    479,469       ( 5,563 )     85,376       ( 1,151 )     564,845       ( 6,714 )
    $ 723,420     $ ( 41,014 )   $ 730,367     $ ( 161,237 )   $ 1,453,787     $ (202,251 )

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 2010
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
 
$
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)
)

 
 
13

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


Note 5 – INVESTMENTS - Continued

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 March 31, 2011, there were nine equity securities, fourteen mutual fund securities, two preferred securities, and five corporate bond securities 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 March 31, 2011.
 
Note 6 – INVENTORIES

Inventories consist of the following:

   
March 31,
  December 31,
   
2011
   
2010
   
2010
Finished goods
 
$
1,959,323
   
$
1,287,500
 
$
      1,636,988
Production supplies
   
1,637,602
     
1,571,096
   
 1,527,064 
Raw materials
   
1,155,129
     
1,011,229
   
 821,322 
Total inventories
 
$
4,752,054
   
$
3,869,825
 
$
     3,985,374

Note 7 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
         
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Land
 
$
1,178,160
   
$
1,178,160
 
$       1,178,160
Buildings and improvements
   
11,367,274
     
10,684,220
 
11,328,860
Machinery and equipment
   
14,006,251
     
12,677,396
 
13,713,649
Vehicles
   
1,073,745
     
961,245
 
976,745
Office equipment
   
374,564
     
276,427
 
352,135
Construction in process
   
---
     
207,830
 
96,990
     
27,999,994
     
25,985,278
 
27,646,539
Less accumulated depreciation
   
12,870,339
     
11,503,456
 
12,493,826
Total property and equipment
 
$
15,129,655
   
$
14,481,822
 
$     15,152,713

Depreciation expense during the three months ended March 31, 2011 and 2010 and for the year ended December 31, 2010 was $376,513, $403,375 and $1,393,745, respectively.
 
 
14

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


Note 8 ACCRUED EXPENSES

Accrued expenses consist of the following:
         
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Accrued payroll and payroll taxes
 
$
320,531
   
$
298,246
 
181,274
Accrued property tax
   
203,933
     
222,537
 
273,876
Other
   
71,377
     
116,480
 
54,309
   
$
595,841
   
$
637,263
 
509,459
 
Note 9 – NOTES PAYABLE

Notes payable consist of the following:

   
March 31,
 
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.
 
$
6,502,222
   
$
7,008,889
 
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, 2011.  The Company is in the process of negotiating a renewal of this facility at maturity.  Collateralized by substantially all assets of the Company.
   
---
     
500,000
 
                   
Line of credit with Morgan Stanley for borrowings up to $2.8 million at variable interest rate, currently at 3.01% due on demand.  Collateralized by investments with a fair value of $1,077,323, cash and CD’s totaling $1,711,934 at March 31, 2011.
   
1,858,110
     
2,484,522
 
2,344,946
                   
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 March 31, 2010).  This balance was paid in full during August, 2010.
   
---
     
1,242,165
 
Total notes payable
   
8,360,332
     
11,235,576
 
8,973,835
Less current maturities
   
2,364,774
     
4,733,354
 
2,851,610
Total long-term portion
 
$
5,995,558
   
$
6,502,222
 
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 March 31, 2011, the Company was in compliance with these covenants.
 
15

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

Note 9 – NOTES PAYABLE - Continued

Maturities of notes payables are as follows:

For the Period Ended March 31,
   
       
2012
 
$
2,364,774
 
2013
   
506,664
 
2014
   
5,488,894
 
Total
 
$
8,360,332
 

 
Note 10 – PROVISION FOR INCOME TAXES

The provision for income taxes consists of the following:

   
For the Three Months Ended
 
For the Year Ended
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Current:
             
Federal
 
$
1,005,605
   
$
916,582
 
2,269,819
State and local
   
406,241
     
216,581
 
651,085
Total current
   
1,411,846
     
1,133,163
 
2,920,904
Deferred
   
(    119,129)
     
(    222,915)
 
(        96,918)
Provision for income taxes
 
$
1,292,717
   
$
910,248
 
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 Three Months Ended
 
Ended
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Federal income tax expense computed at the statutory rate
 
$
1,094,286
   
$
910,838
 
 $     2,180,228
State and local tax expense, net
   
305,756
     
128,589
 
651,085
Permanent differences
   
(    58,415)
     
(    129,179)
 
(     117,247)
Tax credits and other
   
(48,910)
     
---
 
109,920
Provision for income taxes
 
$
1,292,717
   
$
910,248
 
$     2,823,986




 

 
 
16

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

Note 10 – PROVISION FOR INCOME TAXES - Continued

Amounts for deferred tax assets and liabilities are as follows:
         
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Non-current deferred tax assets (liabilities) arising from:
Temporary differences -
             
Accumulated depreciation and amortization from purchase accounting adjustments
 
$
(3,604,041)
   
$
(3,655,289)
 
$   (3,673,296)
Capital loss carry-forwards
   
271,568
     
337,016
 
271,568
Total non-current net deferred tax liabilities
   
(3,332,473)
     
(3,318,273)
 
(3,401,728)
 
Current deferred tax assets arising from:
                 
Unrealized losses on investments
   
24,384
     
(37,261)
 
30,320
Impairment of investments
   
---
     
59,003
 
4,232
Inventory
   
212,089
     
163,979
 
168,875
Allowance for doubtful accounts and discounts
   
131,703
     
117,710
 
125,043
Total current deferred tax assets
   
368,176
     
303,431
 
328,470
 
Net deferred tax liability
 
$
(2,964,297)
   
$
(3,014,842)
 
$   (3,073,258)


Note 11 – SUPPLEMENTAL CASH FLOW INFORMATION

The Company applied a previous investment in First Juice of $500,000 toward the acquisition.  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 Three Months Ended
 
Ended
   
March 31,
 
December 31,
   
2011
   
2010
 
2010
Interest
 
$
58,624
   
$
106,643
 
$         375,347
Income taxes
 
$
200,000
   
$
301,100
 
$      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 March 31, 2011 and 2010, there were no stock options outstanding or exercisable.  There were approximately 940,000 shares available for issuance under the Plan at March 31, 2011.
 
17

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

Note 12 – STOCK AWARD AND STOCK OPTION PLANS
 
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.

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 March 31, 2011, March 31, 2010 or December 31, 2010.



 
18

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

 




 








 


 
 
19

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

Comparison of Quarter Ended March 31, 2011 to Quarter Ended March 31, 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 $3,083,107 (approximately 19%) to $19,047,266 during the three month period ended March 31, 2011 from $15,964,159 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.

Cost of goods sold as a percentage of net sales, excluding depreciation expense, was approximately 55.8% during the first quarter of 2011, compared to approximately 54.2% during the same period in 2010. The slight increase was primarily attributable to the cost of transportation and other petroleum based production supplies partially offset by the decreased cost of conventional milk, our largest raw material.  The cost of milk was approximately 10% lower during the first quarter 2011 when compared to the same period in 2010.  Gross profit increased approximately 14% during the first quarter of 2011 compared with the same period in 2010.
 
Operating expenses as a percentage of net sales were approximately 23.2% during the first quarter of 2011 compared to approximately 24.6% during the same period in 2010.   This decrease was primarily attributable to decreased promotional allowances as compared to the same period in 2010.

Total operating income increased by $517,227 (approximately 19%) to $3,265,622 during the first quarter of 2011, from $2,748,395 during the same period in 2010.

Total other expenses for the first quarter of 2011 were $47,134 compared with total expenses of $69,458 during the same period in 2010.  This decrease in total other expenses is primarily attributable to a higher realized loss on the sale of investments during the first quarter 2010 compared to the same period in 2011.  Additionally, interest expense decreased by $33,812 to $62,130 during the first quarter of 2011 from $95,942 during the same period in 2010.  Investments are discussed in Note 5 of the Notes to Consolidated Financial Statements.
 
Total net income was $1,925,771 or $0.12 per share for the three month period ended March 31, 2011 compared to $1,768,689 or $0.11 per share in the same period in 2010.  This represents a 9% increase in net income for the first quarter of 2011 compared to the same period in 2010.

Liquidity and Capital Resources

Sources and Uses of Cash

Net cash provided by operating activities was $1,143,898 during the three months ended March 31, 2011 which is an increase of $47,494 when compared to the same period in 2010.  This increase is primarily attributable to a decrease in deferred income taxes and accounts receivable.

Net cash used in investing activities was $564,116 during the three months ended March 31, 2011 which is an increase of $136,058 compared to the same period in 2010.  This increase is primarily due to an increase in purchases of investments.

 
20

 
The Company had a net increase in cash and cash equivalents of $1,423,614 during the first quarter of 2011 compared to the same period in 2010.  The Company had cash and cash equivalents of $2,075,791 as of March 31, 2011 compared with cash and cash equivalents of $652,177 as of March 31, 2010.
 
Assets and Liabilities
 
Total assets were $52,312,441 as of March 31, 2011, which is an increase of $253,710 when compared to December 31, 2010, and a decrease of $623,147 when compared to March 31, 2010.  This is primarily due to the other assets balance of $500,000 related to the Company’s previous investment in preferred stock of First Juice, Inc. as of March 31, 2010.
 
Total current liabilities were $8,238,993 as of March 31, 2011, which is a decrease of $646,767 when compared to December 31, 2010. Total current liabilities decreased by $781,709 when compared to March 31, 2010.  This is primarily due to the Company’s repayment of notes payable during 2010.  
 
Long term notes payables decreased by $126,667 as of March 31, 2011, when compared to December 31, 2010 and decreased by $506,664 when compared to March 31, 2010.  The balance of the long term notes payable as of March 31, 2011 was $5,995,558.
 
Total stockholder’s equity was $34,745,417 as of March 31, 2011, which is an increase of $1,096,399 when compared to December 31, 2010.  This is primarily due to the increase in retained earnings of $1,925,771 when compared to December 31, 2010 resulting from net income for the three month period ended March 31, 2011.  Total stockholder’s equity increased by $651,026 when compared to March 31, 2010.  This is primarily due to the increase in retained earnings of $3,779,548, which was offset by an increase in treasury stock of $3,089,646 as of March 31, 2011, when compared to March 31, 2010.

We previously held significant portions of our assets in investments. 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.

Other Developments
 
On August 24, 2010 the USDA ruled to exempt Kefir beverages from the Class I milk classification, which provides exemptions from the Class I definition for Kefir and other drinkable yogurt products containing at least 20% yogurt (by weight) as well as products intended to be meal replacements. The final rule went into effect January 1, 2011.
 
This change from Class I to Class II costing should have a positive impact on what Lifeway pays for its key milk ingredient, which is about 80% of the products' cost of goods sold.  The Company reported that in September 2010, it purchased approximately 4.3 million pounds of Class I conventional milk at an average price of $0.18 per pound. Under the new pricing structure, the Company would have paid about $0.16 per pound and saved approximately $85,000.  Historically, the price of Class II milk is typically 10 to 20% lower than the price of Class I milk.
 
In addition to having a positive effect on gross margins, the improved input costs will allow all of Lifeway’s Kefir-based products to be more competitive with other non-Class I milk products, such as yogurts in the marketplace. This expected increase in cash flow will provide greater financial flexibility, enabling the Company to expand marketing efforts or retain cash for future initiatives. Lifeway expects to see this improvement throughout 2011.
 
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 March 31, 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 March 31, 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 filed on March 31, 2011.   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

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 control over financial reporting.  

  
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*
Jan. 1, 2011 to Jan. 31, 2011 
 
32,007
 
9.19
 
32,007
 
265,595
Feb. 1, 2011 to Feb. 28, 2011 
 
23,341
 
9.21
 
23,341
 
242,254
March 1, 2011 to March 31, 2011
 
37,500
 
8.79
 
37,500
 
204,754
Total 
 
92,848
 
9.06
 
92,848
 
204,754
 
*The Company established a share repurchase program approved May 7, 2010 for up to 200,000 shares with a plan expiration date of one year from the date of the first purchase, and 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.
 
On May 12, 2011, the Company announced its financial results for the fiscal quarter ended March 31, 2011 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.

 
23

 
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.
     
99.1
 
 Press Release dated May 12, 2011.
 
 
 
 
 
 
24

 
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:  May 16,  2011
By:
 /s/ Julie Smolyansky
 
   
 Julie Smolyansky
 
   
 Chief Executive Officer, President
 and Director
 
       
       
       
       
       
       
Date: May 16, 2011
By:
 /s/ Edward P. Smolyansky
 
   
 Edward P. Smolyansky
 
   
 Chief Financial and Accounting
 Officer and Treasurer
 
       
       
       
       
 

 

 
 
 
25

 
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.
     
99.1
 
 Press Release dated May 12, 2011. 
 
 
 
 
 
 
 
26