Attached files

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EX-21 - SUBSIDIARIES OF LIFEWAY FOODS, INC. - LIFEWAY FOODS INCexh21_17053.htm
EX-31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF JULIE SMOLYANSKY - LIFEWAY FOODS INCexh31-1_17053.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF JULIE SMOLYANSKY - LIFEWAY FOODS INCexh32-1_17053.htm
EX-99.1 - PRESS RELEASE - LIFEWAY FOODS INCexh99-1_17053.htm
EX-10.10 - FOURTH MODIFICATION TO LOAN AND SECURITY AGREEMENT - LIFEWAY FOODS INCexh10-1_17053.htm
EX-32.2 - SECTION 1350 CERTIFICATION OF EDWARD P. SMOLYANSKY - LIFEWAY FOODS INCexh32-2_17053.htm
EX-23.1 - ACCOUNTANT'S CONSENT - LIFEWAY FOODS INCexh23-1_17053.htm
EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF EDWARD P. SMOLYANSKY - LIFEWAY FOODS INCexh31-2_17053.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K

R
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the fiscal year ended December 31, 2010
   
£
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from: __________ to __________ 
Commission file number: 0-17363
 
 
LIFEWAY FOODS, INC.
(Name of  registrant as specified in its charter)

Illinois
36-3442829
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
 
6431 West Oakton, Morton Grove, Illinois 60053
(Address of principal executive offices) (Zip Code)
 
Registrant’s telephone number:
(847) 967-1010
 
Securities registered under Section 12(b) of the Exchange Act:
 
Title of Each Class
Name of each exchange on which registered
Common Stock, No Par Value
Nasdaq Global Market
 
Securities registered under Section 12(g) of the Exchange Act:
None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o   No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o   No  þ

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

 
 

 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 £     No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

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  ¨
Accelerated filer  ¨
Non-accelerated filer o
Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No R

The aggregate market value of the voting and non-voting common equity held by non-affiliates (approximately 4,648,000 shares) computed by reference to the price at which the stock was last sold as of June 30, 2010 ($9.74 per share as quoted on the National Market System of The Nasdaq Global Market) was: $45,271,520.
 
The number of shares outstanding of each of the issuer’s classes of common equity, as of March 1, 2011 is 16,502,566 shares of Common Stock.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
None.
 


 
 
 
LIFEWAY FOODS, INC.

Table of Contents
 
PART I
   
Item 1.
Business
  1
       
Item 2.
Properties
  14
       
Item 3.
Legal Proceedings
  15
       
PART II
   
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  15
       
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  17
       
Item 8.
Financial Statements and Supplementary Data
  20
       
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
  41
       
Item 9A.
Controls and Procedures
  41
       
Item 9B.
Other Information
  42
       
PART III
   
Item 10.
Directors, Executive Officers and Corporate Governance
  42
       
Item 11.
Executive Compensation
  44
       
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  46
       
Item 13.
Certain Relationships and Related Transactions  and Director Independence
  47
       
Item 14.
Principal Accountant Fees and Services
  48
       
PART IV
     
Item 15.
Exhibits, Financial Statement Schedules
  49
       
  Signatures   51
       
 
Index of Exhibits
  52
 
 
 
- i -

 
CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
THAT COULD CAUSE THE COMPANY’S ACTUAL RESULTS TO
DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS
 
In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, readers of this document and any document incorporated by reference herein, are advised that this document and documents incorporated by reference into this document contain both statements of historical facts and forward looking statements. Forward looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward looking statements. Examples of forward looking statements include, but are not limited to, (i) projections of revenues, income or loss, earnings or losses per share, capital expenditures, dividends, capital structure and other financial items, (ii) statements of Lifeway Foods, Inc.’s plans and objectives, including the introduction of new products, or estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, and (iv) statements of assumptions underlying other statements and statements about Lifeway Foods, Inc. or its business.
 
This document and any documents incorporated by reference herein also identify important factors which could cause actual results to differ materially from those indicated by forward looking statements. These risks and uncertainties include price competition, the decisions of customers or consumers, the actions of competitors, changes in the pricing of commodities, the effects of government regulation, possible delays in the introduction of new products, customer acceptance of products and services, and other factors which are described herein and/or in documents incorporated by reference herein.
 
The cautionary statements made pursuant to the Private Litigation Securities Reform Act of 1995 above and elsewhere by Lifeway Foods, Inc. (“Lifeway” or the “Company”) should not be construed as exhaustive or as any admission regarding the adequacy of disclosures made by Lifeway prior to the effective date of such act. Forward looking statements are beyond the ability of Lifeway to control and in many cases we cannot predict what factors would cause results to differ materially from those indicated by the forward looking statements.
  
PART I

ITEM 1.   BUSINESS.
 
BUSINESS DEVELOPMENT

Lifeway Foods, Inc., an Illinois corporation, commenced operations in February 1986, and was incorporated under the laws of the State of Illinois on May 19, 1986. The Company’s principal business activity is the manufacturing of probiotic, cultured, functional dairy and non-dairy health food products. Lifeway’s primary products are kefir, a drinkable dairy beverage similar to but distinct from yogurt, in several flavors sold under the name “Lifeway Kefir” and “Helios Nutrition Organic Kefir”; a line of various drinkable yogurts sold under the “Tuscan” and “Lassi” brands; and “BasicsPlus,” a dairy based immune-supporting dietary supplement beverage. In addition to the drinkable products, Lifeway manufactures “Lifeway Farmer Cheese,” a line of various farmer cheeses, a line of gourmet cream cheeses, and “Sweet Kiss,” a fruit sugar-flavored spreadable cheese similar in consistency to cream cheese. The Company also manufactures and markets a vegetable-based seasoning under the “Golden Zesta” brand. In the Chicago metropolitan area, Lifeway distributes its products on its own trucks and via one distributor. Lifeway manufactures all of its products at Company-owned facilities and distributes its products primarily throughout the United States.  The Company directly distributes its products in the Philadelphia metropolitan area using its own trucks.

SUBSIDIARY ENTITIES
 
On August 3, 2006, the Company acquired all of the issued and outstanding stock of Helios Nutrition, Ltd. (“Helios”).  Pride of Main Street Dairy, L.L.C., a Minnesota limited liability company, is 100% owned by Helios.
 
- 1 -

 
Starfruit, L.L.C. and Starfruit Franchisor, L.L.C. are both wholly-owned subsidiaries formed on March 26, 2007 and July 15, 2008, respectively, in connection with the Company’s Starfruit cafe activities.

On February 6, 2009, the Company acquired all of the issued and outstanding stock of Fresh Made, Inc., a Pennsylvania corporation (“Fresh Made”).   
 
On October 14, 2010, Lifeway First Juice, Inc., an Illinois corporation and a wholly-owned subsidiary of the Company (“Lifeway First Juice”) acquired substantially all of the assets of First Juice, Inc., a Delaware corporation (“First Juice”).
 
BUSINESS OF ISSUER
 
PRODUCTS
 
Lifeway’s primary product is kefir, which, like the better-known product of yogurt, is a fermented dairy product. Kefir has a slightly effervescent quality, with a taste similar to yogurt and a consistency similar to buttermilk. It is a product distinct from yogurt because it incorporates the unique microorganisms of kefir as the cultures to ferment the milk. Lifeway’s Kefir is a drinkable product intended for use as a breakfast meal or a snack, or as a base for lower-calorie dressings, dips, soups or sauces. Kefir is also used as the base of Lifeway’s plain farmer’s cheese, a cheese made without salt, sugar or animal rennet. In addition, kefir is the primary ingredient of Lifeway’s “Sweet Kiss” product, a fruit sugar-flavored, cream cheese-like spread which is intended to be used as a dessert spread or frosting. 

Kefir contains a unique mixture of several live microorganisms and nutrients such as proteins, minerals and vitamins.   Kefir is a good source of calcium, protein and B Vitamins. In addition, because the fermentation process does not produce a highly sour-tasting product, the end product has fewer calories than some similar products in the dairy category.
 
Lifeway currently sells some or all of the products listed below, except as specifically noted, to various retail establishments including supermarkets, grocery stores, gourmet shops, delicatessens and convenience stores.
 
LIFEWAY’S KEFIR.  “Lifeway’s Kefir” is a drinkable kefir product manufactured in ten regular and low-fat varieties, including plain, pomegranate, raspberry, blueberry, strawberry, cherry, peach, banana-strawberry, cappuccino and vanilla, and sold in 32-ounce containers and 8-ounce single serving containers featuring color-coded caps and labels describing nutritional information. In March 1996, Lifeway began marketing its non-fat, low-cholesterol kefir in six flavors — plain, raspberry, strawberry, strawberry-banana, peach and blueberry. The kefir product is currently marketed under the name “Lifeway’s Kefir,” and is typically sold by retailers from their dairy sections.
 
LIFEWAY’S ORGANIC KEFIR.  “Lifeway’s Organic Kefir” meets the organic standards and specifications of the United States Department of Agriculture for organic products and is manufactured in five flavors: plain, wildberry, raspberry, strawberry and peach. Lifeway’s Organic Kefir is sweetened with organic cane juice.
 
LIFEWAY’S SLIM6.  “Lifeway’s Slim6” is a line of low-fat kefir beverages with no added sugar designed for consumers who follow low-carbohydrate diets. Lifeway’s Slim6 has only 8 grams of carbohydrates and 2.5 grams of fat per 8-ounce serving and is available in five flavors: strawberries n’ cream, mixed berry, tropical fruit, strawberry-banana and an original, unsweetened version.
 
PROBUGS.  “ProBugs” is a kefir product that contains 10 live and active kefir cultures. Aimed at children ages 2-9, ProBugs comes in three flavors, “Sublime Slime Lime®,” “Orange Creamy Crawler” and “Goo-Berry Pie®” and is packaged in patented no spill spout pouches designed as cartoon bug characters Peter, Polly and Penelope ProBug®.
 
- 2 -

 
TUSCAN BRAND DRINKABLE YOGURT.  “Tuscan Brand Drinkable Yogurt” is a cultured dairy beverage mainly marketed on the East Coast and manufactured in a variety of flavors which vary depending upon distributor demand.
 
FARMER CHEESE.  “Farmer Cheese” is based on a cultured soft cheese and is intended to be used in a variety of recipes as a low fat, low-cholesterol, low-calorie substitute for cream cheese or ricotta, and is available in various styles.
 
SWEET KISS.  “Sweet Kiss” is a sweet cheese probiotic spread available in five flavors: plain, plain with raisins, apple, peach and chocolate.
 
ELITA; BAMBINO.  “Elita” and “Bambino” cheeses are low-fat, low-cholesterol kefir based cheese spreads which are marketed as an alternative to cream cheese.
 
KRESTYANSKI TWOROG.  “Krestyanski Tworog” is a European-style kefir-based soft style cheese which can also be used in a variety of recipes, eaten with a spoon, used as a cheese spread, or substituted in recipes for cream cheese, ricotta cheese or cottage cheese and is marketed to consumers of various Eastern European ethnicities.
  
BASICS PLUS.  “Basics Plus” is a patented kefir-based beverage product designed to support gastrointestinal functions and the immune system.  This product contains certain “passive immunity products” purchased from GalaGen, Inc. prior to its 2002 bankruptcy.  Lifeway is currently engaged in discussion with several potential new suppliers of passive immunity products and is not currently manufacturing this beverage.
 
KEFIR STARTER.  “Kefir Starter” is a powdered form of kefir that is sold in envelope packets and allows a consumer to make his or her own drinkable kefir at home by adding milk. Lifeway continues to develop sales of this product internationally and via the internet.
 
LASSI.  “Lassi” is a cultured drink inspired by the traditions of India. Sold in 8-ounce containers in two flavors, strawberry and mango.
 
GOLDEN ZESTA.  “Golden Zesta” is a vegetable-based seasoning, which, because of its low sodium content, may also be used as a salt substitute and is marketed to delicatessens, gourmet shops and ethnic grocers.
 
HELIOS NUTRITION ORGANIC KEFIR.  “Helios Nutrition Organic Kefir” is a kefir product made from organic milk and manufactured with a unique blend of active cultures. It is sold in 8 and 32 ounce bottles and made in five flavors: peach, plain, strawberry, vanilla and raspberry.
 
- 3 -

 
Lifeway intends to continue to develop new products based on kefir and Farmer Cheese. There is no assurance that such products or any other new products can be developed successfully or marketed profitably.

DISTRIBUTION
 
With its fifteen company-owned trucks, Lifeway distributes its products directly and extensively in the State of Illinois, primarily in the Chicago metropolitan area. Lifeway also directly distributes its products in the Philadelphia and Tri State metropolitan area.
 
In addition to the Chicago, Philadelphia and Tri State metropolitan areas, Lifeway’s products are distributed to stores throughout the United States. Lifeway has verbal distribution arrangements with various distributors throughout the United States. Lifeway believes these verbal distribution arrangements allow management the necessary latitude to expand into new areas and markets and establish new relationships with distributors on an ongoing basis. Lifeway has not offered any exclusive territories to any distributors.
 
Distributors are provided Lifeway products at wholesale prices for distribution to their retail accounts. Lifeway believes that the price at which its products are sold to its distributors is competitive with the prices generally paid by distributors for similar products in the markets served. In all areas served, distributors currently deliver the products directly to the refrigerated cases of dairy sections of their retail customers. Each distributor carries a line of Lifeway’s products on its trucks, checks the retail stores for space allocated to Lifeway’s products, determines inventory requirements of the store and places Lifeway products directly into the retailers’ dairy cases. Lifeway believes this method of distribution best serves the needs of each retail store, and is the best available means to ensure consistency and quality of product handling, quality control, flavor selection and favorable retail display. Under the distribution arrangements, each distributor must meet certain prescribed product handling, service and administrative requirements including, among others, frequency of delivery, replacement of damaged, old or substandard packages, and delivery of products directly to the refrigerated case.
 
Additionally, Lifeway has attempted international distribution of certain of its products by attempting to export to distributors operating in the Canadian provinces of Ontario and Quebec. Lifeway’s products are subject to strict import quotas imposed by the Trade Control Policy Division of the Department of Foreign Affairs and International Trade of Canada. In an attempt to address this situation, management is exploring various alternatives to permit expansion of Lifeway’s product line in Canada. Lifeway believes that it currently is in compliance with all applicable Canadian regulations.
  
MARKETING
 
Lifeway continues to promote the verifiable nutritional characteristics, purity and good taste of its kefir and kefir-based products. Lifeway primarily advertises its products through local radio stations, which advertisements are directed to both users and non-users of cultured milk products of all kinds. In addition, through newspaper and magazine advertising, Lifeway provides educational information on its products and appeals to the common perception that the products may be of particular health benefit, including promoting digestion, and continues to educate the public on the possible health benefits which could be derived from the use of kefir and kefir-based products.
 
In addition to local radio stations, newspapers and magazines, Lifeway promotes further exposure of its products through the internet, catalog advertising and promotion, store demonstrations throughout the United States, and participation in various trade shows. Lifeway also sponsors several different sporting events in the Chicago metropolitan area as an additional marketing tool.
 
Lifeway does not promote products manufactured under the Tuscan brand name with any marketing or advertising.
 
 
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COMPETITION

Although Lifeway faces a small amount of direct competition in the United States and Canadian markets for kefir products, Lifeway’s kefir-based products compete with all other yogurt and other dairy products. Many producers of yogurt and other dairy products are well-established and have significantly greater financial resources than Lifeway to promote their products.
 
In connection with the certain Stockholders’ Agreement, as amended, between Lifeway, Danone Foods, Inc. and other parties, as well as certain other transactions between the two foregoing companies described elsewhere in this report, the parties agreed that they would not compete with each other during the term of the Stockholders’ Agreement with respect to certain yogurt, cheese and kefir products. On December 31, 2009, the term of the non-compete obligation was extended to December 31, 2010 and the non-compete obligation was limited solely to kefir products. No further extensions to the term of the non-compete obligation have been agreed upon by Danone and Lifeway at this time, however, Lifeway is discussing further extensions with Danone. The remaining provisions of the Stockholders Agreement are in full force and effect.
 
SUPPLIERS

Lifeway purchases its raw materials, such as milk, sugar and fruit from unaffiliated suppliers, and is not limited or contractually bound to any supplier. Lifeway has ready access to multiple suppliers for all of its raw materials and packaging requirements. Prior to making any purchase, Lifeway determines which supplier can offer the lowest price for the highest quality of product. The raw and packaging materials purchased by Lifeway are considered commodity items and are widely available on the open market with the exception of the licensed ingredient in BasicsPlus. Lifeway owns and operates the means of production of all of its products.
  
MAJOR CUSTOMERS
 
Lifeway distributes its products to numerous accounts throughout the United States. Concentrations of credit with regard to trade accounts receivable and sales are limited due to the fact that Lifeway’s customers are spread across different geographic areas.  However, customers are concentrated in the retail food industry, for example, Trader’s Joe’s. In 2010, Lifeway’s largest customer represented approximately 9% of sales and reflected sales in various regions of the United States outside the Chicago metropolitan area.
 
TRANSACTIONS WITH GROUPE DANONE SA
 
All share amounts and prices in this subsection are historical and have not been adjusted for the stock splits which occurred in the first quarter of 2004 and the second quarter of 2006. On October 1, 1999, Lifeway and certain members of the Smolyansky family sold shares of restricted common stock to Danone at $10.00 per share. Later in 1999, Danone purchased additional shares of common stock from certain individuals, including shares purchased in transactions with certain Company affiliates, including Lifeway’s founder Michael Smolyansky, Val Nikolenko, Vice President of Production and Pol Sikar, a director, and his affiliates. As a result of these transactions, Danone became the beneficial owner of approximately 20% of the outstanding common stock of Lifeway. Pursuant to the terms and conditions of the transaction, Lifeway granted certain limited rights to Danone, which include a right to nominate one director, anti-dilutive rights relating to future offerings and limited registration rights. In addition, as described above, Lifeway and Danone are parties to a Stockholders’ Agreement dated October 1, 1999, as amended through extensions of certain provisions pursuant to which the parties agreed, among other things, that they would not compete with each other through December 31, 2010 with respect to certain kefir products. The Stockholders’ Agreement also provides that Danone may not own more than 20% of the outstanding common stock of Lifeway as a result of direct or indirect acquisition of shares during the standstill period, which was extended to December 31, 2010. Danone’s interest as of December 31, 2010 was approximately 20.9% due to reductions in Lifeway’s shares outstanding, primarily due to share repurchases by Lifeway. No further extensions of certain provisions to the Stockholders Agreement have been agreed upon by Danone and Lifeway at this time, however, Lifeway is discussing further extensions with Danone. The remaining provisions of the Stockholders Agreement are in full force and effect.

PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS
 
All trademark registrations have been granted by the United States Patent and Trademark Office (“USPTO”), unless otherwise noted below. Each trademark registration may be renewed upon expiration. Lifeway intends to make all timely filings as required for all trademarks listed.
 
- 5 -

 
Mark
Use
Date of Registration
Expiration of
Registration
Comments
Lifeway
Cheese and kefir
December 12, 1989
December 12, 2019
Registration was timely renewed on December 12, 2009. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
Sweet Kiss
Cheese, cottage cheese
and other milk
products, excluding
ice cream, ice milk
and frozen yogurt
February 10, 1998
February 10, 2018
Registration was timely renewed on May 23, 2008.  Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
Kwashenka
Kefir, yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
February 10, 1998
February 10, 2018
Registration was timely renewed on May 23, 2008. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
Bambino
Cheeses, cottage cheeses and other milk products
October 7, 2003
October 7, 2013
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
         
 
 
Mark
Use
Date of
Registration
Expiration of
Registration
Comments
KPECTBRHCKNN (A stylized presentation of “Krestyanskiy” in Cyrillic characters-means “Peasant”)
Cheeses, cottage cheeses and other milk products excluding ice cream, ice milk and frozen yogurt
September 8, 1998
September 8, 2018
Registration was timely renewed on August 23, 2008. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
BA3APHBIII (A stylized presentation of “Bazarny” in Cyrillic characters)
Cultured milk products, excluding ice cream, ice milk and frozen yogurt; cheeses and cottage cheese.
March 17, 2009
March 17, 2019
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
- 6 -

 
BAZARNY
Cultured milk products, excluding ice cream, ice milk and frozen yogurt; cheeses and cottage cheese.
March 31, 2009
March 31, 2019
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
SoyTreat
Soy-based food beverage intended for use as cultured milk substitute
November 11, 2008
November 11, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
Korovka
Dairy-based spread
November 6, 2001
November 6, 2011
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
La Fruta
Cultured milk products, excluding ice cream, ice milk and frozen yogurt
March 29, 2005
March 29, 2015
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
 
 
- 7 -

 
Mark
Use
Date of Registration
Expiration of
Registration
Comments
PTICHYE MOLOKO (a stylized presentation of “Ptichye Moloko” in Cyrillic characters)
Kefir, yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
October 18, 2005
October 18, 2015
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
BIO KEFIR
Yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
December 7, 2010
December 7, 2020
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
SUBLIME SLIME LIME
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2017
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PROBUGS
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2017
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
ORANGE CREAMY CRAWLER
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2017
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
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(DESIGN)
 
 
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 17, 2007
July 17, 2017
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
(DESIGN)
 
 
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2017
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.


Mark
Use
Date of Registration
Expiration of
Registration
Comments
(DESIGN)
Penelope
       
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
April 8, 2008
April 8, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PRIDE OF MAIN STREET
Dairy Product
November 9, 1987
November 9, 2017
Only for the State of Minnesota, not in US – Registration was renewed in 2007.  Registration is renewable for ten  years.
HELIOS NUTRITION
Dairy products and functional foods
October 5, 1999
October 5, 2019
Registration was timely renewed on April 2, 2010. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date or the six-month grace period following the sixth anniversary date..
 
 
- 9 -

 
STARFRUIT
Franchise services, namely, offering technical and business management assistance in the establishment and operation of restaurants
October 7, 2008
October 7, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT
Restaurant services
June 24, 2008
June 24, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
GOO-BERRY PIE
Dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverage used as a milk substitute
April 1, 2008
April 1, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date. 

Mark
Use
Registration Date
Expiration of Registration
Comments
PHYTOBOOST
Dairy-based beverages; dairy-based food beverages; Kefir; soy-based food beverage used as a milk substitute
Pending – Application was filed April 6, 2010
N/A
Notice of Allowance (NOA) issued November 2, 2010. Applicant must file a Statement of Use or Extension Request within six months of the NOA issuance date.
TRAINING WHEELS FOR HEALTHY EATING (Stylized)
 
Fruit Juices
April 15, 2008
 
 
 
 
April 15, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
- 10 -

 
FRUIT JUICE LOGO
logo
Fruit Juices
May 20, 2008
 
May 20, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PLAYGROUP PACK
Fruit Juices
June 9, 2009
June 9, 2019
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
FRUIT JUICE (Stylized)
Fruit Juices
April 15, 2008
April 15, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
- 11 -

 
CHANGING THE WORLD, ONE MOUTHFUL AT A TIME. (Stylized)
Fruit Juices
December 2, 2008
December 2, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
TODDLER TASTEBUD TRAINING (Stylized)
Fruit Juices
December 2, 2008
December 2, 2018
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
FIRST POP
Frozen Confections
Pending – Application filed July 25, 2008
N/A
Notice of Allowance (NOA) issued June 22, 2010. A First Extension of Time was granted December 6, 2010.  Applicant must file a Statement of Use or 2nd Extension Request by June 22, 2011.
FIRST WATER
Drinking Water
Pending – Application filed July 25, 2008
N/A
Notice of Allowance (NOA) issued January 12, 2010. First and Second Extensions of Time were granted. Applicant must file a Statement of Use or 3rd  Extension Request by July 12, 2011.
 
 
- 12 -

 
FIRST SMOOTHIE
Smoothies
Pending – Application filed August 19, 2010
N/A
A non-final Office action issued December 6, 2010. This is a letter from the examining attorney requiring additional information and/or making an initial refusal. The applicant must respond to this Office action by June 6, 2011.
STARFRUIT (Stylized)
KEFIR
November 23, 2010
November 23, 2020
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PROBOOST
Dairy-based beverages containing probiotic cultures; kefir
Pending – Application filed May 4, 2010
N/A
Final Office action issued February 23, 2011. Applicant has until August 23, 2011 to respond.


Lifeway also uses, and claims common law rights, the following unregistered trademarks to: “Elita,” “Healthy Foods Today for a Better Life Tomorrow,” “Milkshake Smoothie,” “Toplenka,” “White Cheese,” “Drink It to Be Beautiful Inside and Out,”  “Golden Zesta” and “Pride of Main Street.”
 
On December 27, 1990, Lifeway purchased the Tuscan brand-name liquid drinkable yogurt customer list along with a limited license of the trademark and use of the Tuscan liquid yogurt U.P.C. codes from a third party.
 
In October 1998, Lifeway entered into a sublicense agreement with GalaGen, Inc. and Metagenics, Inc. with an effective date of May 1, 1998 (“Lifeway sublicense”), wherein GalaGen sublicensed patent rights of Metagenics for kefir-based products containing natural immune components exclusively to Lifeway. Under the rights granted to it by the Lifeway sublicense, Lifeway manufactures and sells products using the Basics Plus trademark. GalaGen had acquired the primary license for such patent rights in an agreement executed with Metagenics in April 1998.
 
 
- 13 -

 
The terms of the Lifeway sublicense provide that Metagenics will permit Lifeway to continue to have the exclusive patent rights to produce or sell kefir-based products containing natural immune components in the event the original license between GalaGen and Metagenics is terminated, and such termination was not caused by Lifeway. On February 25, 2002, GalaGen filed a petition for bankruptcy in the United States Bankruptcy Court, District of Minnesota, which terminated both its primary license with Metagenics and its participation in the Lifeway sublicense. The license and sublicense were excluded from the sale of assets of GalaGen pursuant to an order of the Bankruptcy Court. Lifeway has not received any indication that Metagenics will not permit Lifeway to continue to have the exclusive patent rights to produce or sell kefir-based products containing natural immune components. Thus, Lifeway believes that it continues to have the exclusive patent rights licensed directly from Metagenics. Either party may terminate the license agreement for cause. The term of the license agreement expires when the last valid claim of the patent rights expires, which currently is July 2, 2013, however, this term can be extended in accordance with the terms of the license agreement.
 
In connection with its purchase of Ilya’s Farm, Inc., the Company has undertaken a royalty obligation of 5% of all sales of Ilya’s Farm, Inc.’s products paid quarterly, in arrears.
 
REGULATION

Lifeway is subject to regulation by federal, state and local governmental authorities regarding the distribution and sale of food products. Although Lifeway believes that it currently has all material government permits, licenses, qualifications and approvals for its operations, there can be no assurance that Lifeway will be able to maintain its existing licenses and permits or to obtain any future licenses, permits, qualifications or approvals which may be required for the operation of Lifeway’s business.
 
Lifeway believes that it is currently in compliance with all applicable environmental laws and that the cost of such compliance was not material to the financial position of Lifeway.
 
In addition, any Lifeway products exported to Canada would be subject to strict quotas imposed by the Trade Control Policy Division of the Department of Foreign Affairs and International Trade of Canada. Lifeway believes that it currently is in compliance with all applicable Canadian regulations. The Company exported no products to Canada in 2010.
 
RESEARCH AND DEVELOPMENT
 
Lifeway continues its program of new product development, centered around the nutritional and “low calorie” features of its proprietary kefir formulas.
 
Lifeway conducts primarily all of its research internally, but at times will employ the services of an outside testing facility. During 2009 and 2010, the amount Lifeway expended for research and new product development was not material to the financial position of Lifeway and no amount was customer supported.
 
EMPLOYEES
 
Lifeway currently employs approximately 315 employees, all of whom are full-time employees. Substantially all of these employees are engaged in the manufacturing of the Company’s products. None of Lifeway’s employees are covered by collective bargaining agreements.
 
ITEM 2.  PROPERTIES.
 
On May 16, 1988, Lifeway purchased an approximately 26,000 square foot parcel of real property, including an approximately 8,500 square foot one-story brick building in good condition, located at 7625 N. Austin Avenue, Skokie, Illinois. Lifeway uses this facility for manufacturing and storage and has no plans to improve or renovate this property.  Lifeway is the only occupant of this property and presently holds fee simple title subject to a mortgage which secures the property as collateral for certain loans to Lifeway from The Private Bank & Trust as discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation (the “Loans”).  The Loans are secured by all of the assets of Lifeway, including a first mortgage on Lifeway’s real property located in Skokie, Illinois, Niles, Illinois and Morton Grove, Illinois.  A portion of the proceeds of the Loans was used to pay off previously existing mortgage loans.   The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
 
- 14 -

 
On October 16, 1996, Lifeway purchased a 110,000 square foot commercially-zoned parcel of real property, including a 46,000 square foot one-story brick building in good condition, located at 6431 Oakton Avenue, Morton Grove, Illinois. This property is used as Lifeway’s corporate headquarters and main manufacturing facility. This property has been improved every year since the time of purchase by the addition of custom-built refrigerated storage space and the addition of various machinery and equipment used to manufacture, package and store Lifeway’s products. Lifeway is the only occupant of this property and presently holds fee simple title subject to a mortgage which secures the property as collateral for the Loans discussed above.   The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
In June 2005, the Company purchased a 100,000-square-foot distribution and warehousing facility that is equipped with 40,000 square feet of refrigeration. The facility, located at 6101 Gross Point Road in Niles, Illinois, will be used to store raw materials and finished goods in order to relieve space pressures at the Company’s existing 50,000-square foot building, less than a mile away. The additional space at the Company’s main plant will be used to expand production capacity for the Company’s kefir and other probiotic products. Lifeway is the only occupant of this property and presently holds fee simple title subject to a mortgage which secures the property as collateral for the Loans discussed above.  The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
Included in the purchase of Pride of Main Street Dairy on August 3, 2006, Lifeway acquired an approximately 35,000 square foot commercially-zoned parcel of real estate located at 214 Main Street S. Sauk Centre, Minnesota, including a 16,000 square foot two-story brick building used for production, and a 5,600 square foot storage facility. This property is used as the main headquarters and main production facility for Pride of Main Street Dairy. The building was built in the 1920’s with an addition in 1990. The facility is being used to produce all of the Pride of Main Street Dairy products, and approximately 70% of the Helios Nutrition Organic Kefir, with the remaining 30% being produced in Lifeway’s main production facility in Morton Grove, Illinois. Lifeway is the only occupant of this property and presently holds fee simple title subject to negative mortgage pledge as part of the collateral package for the Loans discussed above. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
On February 6, 2009, in connection with the Company’s acquisition of Fresh Made, Inc., Lifeway also acquired 1.135 acres of land in Philadelphia.  Lifeway is the only occupant of this property and presently holds fee simple title subject to a negative mortgage pledge as part of the collateral package for the Loans discussed above. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.

For financial statement and tax purposes, Lifeway depreciates its buildings and improvements on a straight line basis over 31 and 39 years.
 
Management believes that Lifeway has adequate insurance coverage for all its properties.

ITEM 3.  LEGAL PROCEEDINGS.
 
Lifeway is not party to any material pending legal proceedings.  Lifeway is from time to time engaged in litigation matters arising in the ordinary course of business none of which presently is expected to have a material adverse effect on its business results or operations.
    
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
MARKET INFORMATION
 
 
- 15 -

 
Lifeway’s Common Stock, no par value, the only class of common equity of Lifeway, is traded on The Nasdaq Global Market under the symbol “LWAY.” Trading commenced on March 29, 1988.
 
The high and low sales prices for Lifeway’s Common Stock for the quarterly periods within the two most recent fiscal years, as reported by The Nasdaq Global Market, is set forth in the following table:

 
Low Bid
 
High Bid
First Qtr. 2009
6.07
 
9.72
Second Qtr. 2009
6.57
 
13.50
Third Qtr. 2009
10.67
 
14.94
Fourth Qtr. 2009
9.87
 
12.50
First Qtr. 2010
11.34
 
12.70
Second Qtr. 2010
8.07
 
12.07
Third Qtr. 2010
9.60
 
11.27
Fourth Qtr. 2010
9.31
 
10.60

As of March 15, 2011, there were approximately 82 holders of record of Lifeway’s Common Stock. The Company has no information regarding beneficial owners whose shares are held in street name.
 
DIVIDENDS

Lifeway has paid no cash dividends on its Common Stock since inception and management does not anticipate that such dividends will be paid in the foreseeable future.
 
SALES OF UNREGISTERED SECURITIES

None.

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

October 1 to October 31, 2010
 
10,886
  11.65   10,886   97,808
November 1 to November 30, 2010
 
35,071
    9.83   35,071   62,737
December 1 to December 31, 2010
 
15,135
    9.63   15,135   47,602
Total
 
61,092
  10.10   61,092   47,602

The Company established a share repurchase program approved December 17, 2009 (for 100,000 shares with a plan expiration date of one year) and on May 7, 2010, the Company approved a new share repurchase program of up to 200,000 shares with a plan expiration date of one year from the date of the first purchase.  As of the date of this filing, Lifeway has repurchased 252,398 shares of the Company’s securities in 2010 pursuant to these programs at a total cost of $2,666,288.

 
- 16 -

 
EQUITY COMPENSATION PLAN INFORMATION
 
See Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, of this Annual Report on Form 10-K for information regarding securities authorized for issuance under our equity compensation plans.
 

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
Comparison of Quarter Ended December 31, 2010 to Quarter Ended December 31, 2009
 
 
The following analysis should be read in conjunction with the audited financial statements of the Company and related notes included elsewhere in this annual report and the unaudited financial statements and Management’s Discussion and Analysis contained in our Form 10-Q, for the fiscal quarters ended March 31, 2010, June 30, 2010, and September 30, 2010.
 
Results of Operations
 
Total gross consolidated group sales increased by $1,657,451 (approximately 11%) to $16,123,946 during the three month period ended December 31, 2010, from $14,466,495 during the three month period ended December 31, 2009. This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship line, Kefir, as well as ProBugs® Organic Kefir for kids.
 
Cost of goods sold as a percentage of gross sales, excluding depreciation, were approximately 71% during the fourth quarter 2010, compared to about 66% during the same period in 2009.  This increase is a result of higher prices of conventional milk, our largest raw material, and higher costs of other raw materials, such as cost of transportation and other petroleum based production supplies, which were partially offset through higher sales volume as well as an increase in production efficiencies.  The cost of milk was approximately 30% higher during the fourth quarter 2010 when compared to the same period in 2009.  Gross profit decreased approximately 5% during the fourth quarter of 2010, when compared with the same period in 2009.
 
Operating expenses as a percentage of sales were approximately 22% during the fourth quarter of 2010 compared to approximately 21% during the same period in 2009. This increase is primarily attributable to a planned increase in selling expenses due to increased advertising spend in order to drive awareness of our expanding product offerings. Advertising costs were $1,008,849 compared to $160,000 for the same period in 2009.  We expect advertising expense to be approximately 10% of sales in coming quarters.
 
Interest expense during the fourth quarter 2010 increased to $88,723 compared to interest expense of $78,366 during the same period a year ago. Notes payable are discussed in Note 9 of the Notes to Consolidated Financial Statements.
 
Total loss before taxes increased by $343,444 to a loss of $368,862 during the fourth quarter 2010, from a loss of $25,418 during the same period in 2009.
 
- 17 -

 
Income tax benefit was $133,299 for the 2010 fourth quarter compared with an income tax benefit of $145,011 during the same period in 2009.
 
Total loss was $235,563, or $0.01 per share, for the fourth quarter ended December 31, 2010, compared to net income of $119,593, or $0.01 per share, for the same period in 2009. 
 
Comparison of Year Ended December 31, 2010 to Year Ended December 31, 2009
 
Results of Operations
 
Sales increased by $5,427,576 (approximately 9%) to $63,543,445 during the twelve month period ended December 31, 2010, from $58,115,878 during the same twelve month period in 2009.  This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship line, Kefir, as well as Lifeway’s kids Kefir drink, ProBugs®.
 
Cost of goods sold as a percentage of gross sales, excluding depreciation expense, was approximately 58% in 2010, which compares to about 55% for the same period in 2009. Cost of goods sold were impacted by the higher cost of conventional milk, our largest raw material, which was approximately 30% higher in full year 2010 when compared to full year 2009.  We were able to offset the majority of the impact of increases in milk prices through other operational efficiencies.
 
Operating expenses as a percentage of sales were approximately 22% in 2010, compared to 21% in 2009. This increase is primarily attributable to a $1.6 million, or 60%,  planned increase in selling expenses due to an increased advertising spend in order to drive awareness of our expanding product offerings.  Total advertising costs increased by $2.7 million in 2010 when compared to 2009.  We expect advertising expense to be approximately 10% of sales in fiscal 2011.
 
Total other income in 2010 was $171,820 compared with total other expenses of $489,716 in 2009.  This increase is attributable to our gains on the sale of marketing securities of $250,480 in 2010, compared to a loss on the sale of marketable securities of $278,474 in 2009. Marketable securities are discussed in Note 5 of the Notes to Consolidated Financial Statements. We also benefitted from higher interest dividend income in 2010 as compared to 2009 and lower interest expenses.  
 
Total income before taxes decreased by $1,947,236 (approximately 22%) to $6,446,452 in 2010, from $8,448,952 in 2009.
 
Provision for income taxes was $2,823,986, or a 44% tax rate, in 2010 compared to $2,879,250, or a 34% tax rate, in 2009.  Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.
 
- 18 -

 
Total net income was $3,622,466, or $0.22 per share, in 2010 compared to $5,569,702, or $0.33 per share, in 2009. 
 
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
 
On February 6, 2009, Lifeway entered into a Loan and Security Agreement with The Private Bank & Trust (the “Loan Agreement”) which provided for (i) a term loan to Lifeway in the principal amount of $7,600,000, due on February 6, 2014 (the “Term Loan”) with annual interest rate equal to either the London Inter-Bank Offer Rate (“LIBOR”), plus 2.5% or the prime lending rate, and (ii) a revolving line of credit in the principal amount of $5,000,000 (the “Line of Credit,” together with the Term Loan, the “Loans”), which originally matured February 6, 2010.  The original maturity date was extended to May 31, 2011 on March 31, 2011.  The Line of Credit has an annual interest rate equal to either LIBOR, plus 2.5% or the prime lending rate.  The Loans are secured by all of the assets of Lifeway, including a first mortgage on Lifeway’s real property located in Skokie, Illinois, Niles, Illinois and Morton Grove, Illinois.  A portion of the proceeds of the Loans was used to pay off previously existing mortgage loans.  At December 31, 2010, the Loans had a balance of $6,628,889, and $0, respectively.  The Company entered into to a First Modification Agreement to Loan and Security Agreement dated as of August 13, 2009, a Second Modification Agreement dated November 12, 2009, a Third Modification Agreement dated February 6, 2010 and the Fourth Modification Agreement dated March 31, 2011 pursuant to which the allowed borrowing limits under the Line of Credit was reduced from $5,000,000 to $2,000,000 and certain covenants related to allowable capital expense limits and tangible net worth covenants were immaterially relaxed.  The Fourth Modification Agreement is filed herewith as Exhibit 10.10.
 
Net cash provided by operating activities was $5,615,943 in 2010, which is a decrease of $1,987,118 when compared to 2009. This decrease is primarily attributable to the decrease in net income of $1,947,236.
 
Net cash provided by investing activities was $1,410,337 in 2010, compared to net cash used in investing activities of $12,037,187 in 2009. This improvement is primarily due to the acquisition of Fresh Made Dairy, net of cash acquired in 2009.  The Company purchased $2,229,274 of property, plant and equipment in 2010 compared to the purchases of $1,766,280 in 2009.  This represents an increase of $462,994 in 2010 when compared to 2009.
 
Lifeway had a net increase in cash and cash equivalents of $2,599,532 during the twelve months ended December 31, 2010, compared to a net increase in cash and cash equivalents of $353,159 during the same period in 2009.  Lifeway had cash and cash equivalents at December 31, 2010, of $3,229,939, compared to cash and cash equivalents at the end of 2009 of $630,407.
 
Assets and Liabilities
 
Total assets were $52,058,731 as of December 31, 2010, which is a decrease of $588,888 when compared to total assets of the end of 2009.  Additionally, the value of the Company’s property, plant and equipment was $15,152,713 as of December 31, 2010, compared to $16,622,140 at the end of 2009.
 
Total current liabilities were $8,885,760 at the end of 2010, which is an increase of $322,125 when compared to the end of 2009.  This is primarily due to an increase in accounts payable. 
 
 
- 19 -

 
We previously had held significant portions of our assets in marketable securities. During the fourth quarter, 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 percent yogurt (by weight) as well as products intended to be meal replacements. The final rule will take effect January 01, 2011.
 
This change from Class 1 to Class 2 costing should have a positive impact on what Lifeway pays for its key milk ingredient, which is about 80 percent of the products' cost of goods sold.
 
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 in the 2011 first quarter.
 
The company reported that in September 2010, it purchased approximately 4.3 million pounds of Class 1 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 2 milk is typically 10-to-15 percent lower than the price of Class 1 milk.
 
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
The annotated consolidated financial statements of the Company that constitute Item 8 of this report commence on the pages that follow this page.
 
 
 
 
 
 
 
 

 
 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of
LIFEWAY FOODS, INC. AND SUBSIDIARIES

We have audited the accompanying consolidated balance sheets of LIFEWAY FOODS, INC. AND SUBSIDIARIES (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LIFEWAY FOODS, INC. AND SUBSIDIARIES as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.

/s/ Plante & Moran, PLLC
 
Grand Rapids, MI
March 31, 2011
 
 
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LIFEWAY FOODS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED FINANCIAL STATEMENTS
 
DECEMBER 31, 2010 and 2009
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
- 22 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
December 31, 2010 and 2009
 
   
December 31,
 
   
2010
   
2009
 
ASSETS
           
             
Current assets
           
Cash and cash equivalents
  $ 3,229,939     $ 630,407  
Investments
    1,079,232       4,392,125  
Certificates of deposits in financial institutions
    250,000       652,005  
Inventories
    3,985,374       3,296,976  
Accounts receivable, net of allowance for doubtful accounts and discounts
    6,793,276       5,999,738  
Prepaid expenses and other current assets
    158,315       40,697  
Other receivables
    104,680       49,758  
Deferred income taxes
    328,470       251,456  
Refundable income taxes
    906,748       1,308,978  
Total current assets
    16,836,034       16,622,140  
                 
Property and equipment, net
    15,152,713       14,282,182  
                 
Intangible assets
               
Goodwill and other non amortizable brand assets
    14,068,091       13,806,091  
Other intangible assets, net of accumulated amortization of $2,322,745 and $1,598,208 at December 31, 2010 and 2009, respectively
    6,001,893       6,259,430  
Total intangible assets
    20,069,984       20,065,521  
                 
Other assets
          500,000  
                 
Total assets
  $ 52,058,731     $ 51,469,843  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities
               
Checks written in excess of bank balances
  $ 1,341,210     $ 342,976  
Current maturities of notes payable
    2,851,610       4,842,315  
Accounts payable
    4,183,481       2,764,000  
Accrued expenses
    509,459       614,344  
Total current liabilities
    8,885,760       8,563,635  
                 
Notes payable
    6,122,225       6,890,214  
                 
Deferred income taxes
    3,401,728       3,444,664  
Total liabilities
    18,409,713       18,898,513  
                 
Stockholders' equity
               
Common stock, no par value; 20,000,000 shares authorized; 17,273,776 shares issued; 16,536,657 shares outstanding at December 31, 2010; 17,273,776 shares issued; 16,778,555 shares outstanding at December 31, 2009
    6,509,267       6,509,267  
Paid-in-capital
    2,032,516       1,965,786  
Treasury stock, at cost
    (6,425,546 )     (3,846,773 )
Retained earnings
    31,575,875       27,953,409  
Accumulated other comprehensive income (loss), net of taxes
    (43,094 )     (10,359 )
Total stockholders' equity
    33,649,018       32,571,330  
                 
Total liabilities and stockholders' equity
  $ 52,058,731     $ 51,469,843  

See accompanying notes to financial statements
 
- 23 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Years Ended December 31, 2010 and 2009
 
 
  Year Ended   Year Ended  
  December 31,   December 31,  
  2010   2009  
                     
Gross Sales
$ 63,543,445         $ 58,115,878        
Less: Promotional allowances
  (5,043,552 )         (4,198,235 )      
Net Sales
  58,499,893     58,499,893     53,917,643     53,917,643  
                         
Cost of goods sold
        36,926,973           31,885,318  
Depreciation expense
        1,393,745           1,134,404  
                         
Total cost of goods sold
        38,320,718           33,019,722  
                         
Gross profit
        20,179,175           20,897,921  
                         
Selling expenses
        7,603,098           5,987,917  
General and administrative
        5,576,908           5,294,550  
Amortization expense
        724,537           676,786  
                         
Total Operating Expenses
        13,904,543           11,959,253  
                         
Income from operations
        6,274,632           8,938,668  
                         
Other income (expense):
                       
Interest and dividend income
        260,552           199,047  
Rental income
        11,785           35,240  
Interest expense
        (350,997 )         (442,703 )
Loss on disposition of equipment
                  (2,826 )
Gain (loss) on sale of investments, net
        250,480           (278,474 )
Total other income (expense)
        171,820           (489,716 )
                         
Income before provision for
                       
   income taxes
        6,446,452           8,448,952  
                         
Provision for income taxes
        2,823,986           2,879,250  
                         
Net income
      $ 3,622,466         $ 5,569,702  
                         
Basic and diluted earnings
                       
per common share
        0.22           0.33  
                         
Weighted average number of
                       
  shares outstanding
        16,663,557           16,798,164  
                         
COMPREHENSIVE INCOME
                       
                         
Net income
      $ 3,622,466         $ 5,569,702  
                         
Other comprehensive income
                       
(loss), net of tax:
                       
Unrealized gains (losses) on
                       
investments (net of tax)
        114,297           325,086  
Less reclassification adjustment
                       
for (gains) losses included in
                       
net income (net of taxes)
        (147,032 )         163,464  
                         
Comprehensive income
      $ 3,589,731         $ 6,058,252  
 
See accompanying notes to financial statements
 
- 24 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2010 and 2009
 
   
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, 2008
    17,273,776       16,724,467       549,309     $ 6,509,267     $ 1,202,009     $ (3,302,025 )   $ 22,383,707     $ (498,909 )   $ 26,294,049  
                                                                         
Redemption of stock
          (87,991 )     87,991                   (905,607 )                 (905,607 )
                                                                         
Issuance of treasury stock for compensation
          13,132       (13,132 )           119,039       25,597                   144,636  
                                                                         
Issuance of treasury stock for Fresh Made acquisition
          128,947       (128,947 )           644,738       335,262                   980,000  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
                                              488,550       488,550  
                                                                         
Net income for the year ended December 31, 2009
                                        5,569,702             5,569,702  
                                                                         
Balances at December 31, 2009
    17,273,776       16,778,555       495,221     $ 6,509,267     $ 1,965,786     $ (3,846,773 )   $ 27,953,409     $ (10,359 )   $ 32,571,330  
                                                                         
                                                                         
                                                                         
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  
 
See accompanying notes to financial statements
 
- 25 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2010 and 2009
 
   
December 31,
 
   
2010
   
2009
 
             
Cash flows from operating activities:
           
Net income
  $ 3,622,466     $ 5,569,702  
Adjustments to reconcile net income to net
               
cash flows from operating activities, net of acquisition:
               
Depreciation and amortization
    2,118,282       1,811,190  
(Gain) Loss on sale of investments, net
    (250,480 )     278,474  
Loss on disposition of assets
          2,826  
Deferred income taxes
    (96,918 )     389,754  
Treasury stock issued for compensation
    154,245       144,636  
Increase (Decrease) in allowance for doubtful accounts
    17,754       (75,000 )
(Increase) Decrease in operating assets:
               
Accounts receivable
    (811,292 )     (612,915 )
Other receivables
    (54,922 )     (7,758 )
Inventories
    (682,398 )     173,419  
Refundable income taxes
    402,230       (475,635 )
Prepaid expenses and other current assets
    (117,618 )     9,506  
Increase (decrease) in operating liabilities:
               
Accounts payable
    1,419,479       298,800  
Accrued expenses
    (104,885 )     96,062  
Net cash provided by operating activities
    5,615,943       7,603,061  
                 
Cash flows from investing activities:
               
Purchases of investments
    (2,161,552 )     (6,156,682 )
Proceeds from sale of investments
    5,669,158       6,928,321  
Proceeds from redemption of certificates of deposit
    402,005        
Purchases of property and equipment
    (2,229,274 )     (1,766,280 )
Acquisition of the assets of First Juice
    (270,000 )      
Acquisition of Fresh Made, net of cash acquired
          (11,042,546 )
Net cash provided (used) in investing activities
    1,410,337       (12,037,187 )
                 
Cash flows from financing activities:
               
Proceeds of note payable
    250,000       9,353,504  
Checks written in excess of bank balances
    998,234       342,976  
Purchases of treasury stock
    (2,666,288 )     (905,607 )
Repayment of notes payable
    (3,008,694 )     (4,003,588 )
Net cash (used in) provided by in financing activities
    (4,426,748 )     4,787,285  
                 
Net increase in cash and cash equivalents
    2,599,532       353,159  
                 
Cash and cash equivalents at the beginning of the period
    630,407       277,248  
                 
Cash and cash equivalents at the end of the period
  $ 3,229,939     $ 630,407  
 
See accompanying notes to financial statements
 
- 26 -

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


Note 1 – NATURE OF BUSINESS

Lifeway Foods, Inc. (The “Company”) commenced operations in February 1986 and incorporated under the laws of the state of Illinois on May 19, 1986. The Company’s principal business activity is the production of dairy products. Specifically, the Company produces Kefir, a drinkable product which is similar to but distinct from yogurt, in several flavors sold under the name “Lifeway’s Kefir;” a plain farmer’s cheese sold under the name “Lifeway’s Farmer’s Cheese;” a fruit sugar-flavored product similar in consistency to cream cheese sold under the name of “Sweet Kiss;” and a dairy beverage, similar to Kefir, with increased protein and calcium, sold under the name “Basics Plus.”  The Company also produces 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:
 
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 Lifeway.  All significant intercompany accounts and transactions have been eliminated.  The financial statements include the results of operations from the acquisition of Fresh Made, Inc. from February 6, 2009 through the end of the period and the operations from the acquisition of the assets of First Juice from October 14, 2010 through the end of the year (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.


 
- 27 -

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


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

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

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

Accounts receivable are recorded at invoice amounts, and reduced to their estimated net realizable value by recognition of an allowances 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

 
- 28 -

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

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

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

Intangible assets are being amortized over the following useful lives:

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

Income taxes
Deferred income taxes 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.
 
- 29 -

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

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The only periods subject to examination for the Company’s federal return are the 2006 through 2009 tax years. The Company believes that its income tax filing positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded.
 
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 the year.  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 years ended December 31, 2010 and 2009 total advertising and promotion costs were $4,386,606 and $1,689,540, respectively.  In 2010 and 2009 $2,390,003 and $1,689,540, respectively, were classified as advertising expense and $1,996,603 and $0, respectively, were classified as reductions of sales.
 
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 years ended December 31, 2010 and 2009, diluted and basic earnings per share were the same, as the effect of dilutive securities options outstanding was not significant.

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

Beginning in 2010 the company concluded to separately report discounts and allowances on the face of the income statement.  The Company’s agreements with its distributors and retail customers have continued evolve.  The Company determined that it was more appropriate to report the allowances and costs under those programs in this manner.  The 2009 income statement has been restated to reflect that change.  The discounts and allowances had been previously allocated between cost of sales and advertising.  The change had no effect on previously reported gross profit or net income.
 
 
 
- 30 -

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

Note 3 – ACQUISITIONS

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

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

The acquisition was consummated to expand the geographic footprint of Lifeway as well as grow market share.  The acquisition was accounted for using the purchase accounting method of accounting, and accordingly, the purchase price was allocated to assets acquired and the liabilities assumed based on the fair value as of the merger date.  Acquisition costs for legal and professional fees have been included in General and Administrative costs.  None of the goodwill resulting from the acquisition is tax deductible.

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

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


The following pro forma disclosures, including the effect of purchase accounting adjustments, depict the results of operations for the year ended December 31, 2009 as though the merger with Fresh had taken place as of January 1, 2009:
 
   
For the Year Ended December 31, 2009
 
Gross revenue
  $ 59,231,461  
         
Net income
  $ 5,618,471  
         
Earnings per share
  $ 0.33  

 
- 31 -

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

Note 3 – ACQUISITIONS - Continued

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.

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

   
December 31, 2010
   
December 31, 2009
 
   
Cost
   
Accumulated Amortization
   
Cost
   
Accumulated Amortization
 
Recipes
  $ 43,600     $ 43,600     $ 43,600     $ 43,600  
Customer lists and other customer related intangibles
    4,504,200       1,039,323       4,305,200       587,393  
Lease acquisition
    87,200       79,941       87,200       67,473  
Customer relationship
    985,000       362,526       985,000       280,454  
Trade names
    2,248,000       585,267       1,980,000       451,000  
Formula
    438,000       193,450       438,000       149,650  
    $ 8,306,000     $ 2,304,107     $ 7,839,000     $ 1,579,570  


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


Note 4 – INTANGIBLE ASSETS - Continued

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

2011
  $
737,320
 
2012
   
716,428
 
2013
   
697,353
 
                         2014
   
697,353
 
2015
   
697,353
 
Thereafter
   
2,456,086
 
    $
6,001,893
 

Amortization expense during the years ended December 31, 2010 and 2009 was $724,537 and $676,786, respectively.


Note 5 – INVESTMENTS

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

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  


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

Proceeds from the sale of investments were $5,669,158 and $6,928,321 during the years ended December 31, 2010 and 2009, respectively.

Gross gains of $451,420 and $351,419 and gross losses of $200,940 and $629,893 were realized on these sales during the years ended December 31, 2010 and 2009, respectively.

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

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  December 31, 2010 and 2009:

   
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 )

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

Equities, Mutual Funds, Corporate Bonds and Government Agency Obligations - The Company's investments in equity securities, mutual funds, corporate bonds and government agency obligations consist of investments in common stock, preferred stock and debt securities of companies in various industries.  The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the impairment. Based on that evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider any material investments to be other-than-temporarily impaired at December 31, 2010.

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

Note 6 – INVENTORIES

Inventories consist of the following:

   
December 31,
 
   
2010
   
2009
 
Finished goods
  $ 1,636,988     $ 1,101,885  
Production supplies
    1,527,064       1,367,457  
Raw materials
    821,322       827,634  
Total inventories
  $ 3,985,374     $ 3,296,976  


Note 7 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
       
   
December 31,
 
   
2010
   
2009
 
Land
  $ 1,178,160     $ 1,178,160  
Buildings and improvements
    11,328,860       10,380,393  
Machinery and equipment
    13,713,649       12,525,241  
Vehicles
    976,745       961,245  
Office equipment
    352,135       255,616  
Construction in process
    96,990       81,608  
      27,646,539       25,382,263  
Less accumulated depreciation
    12,493,826       11,100,081  
Total property and equipment
  $ 15,152,713     $ 14,282,182  

Depreciation expense during the years ended December 31, 2010 and 2009 was $1,393,745 and $1,134,404, respectively.



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


Note 8 ACCRUED EXPENSES

Accrued expenses consist of the following:
       
   
December 31,
 
   
2010
   
2009
 
Accrued payroll and payroll taxes
  $ 181,274     $ 191,744  
Accrued property tax
    273,876       306,707  
Other
    54,309       115,893  
    $ 509,459     $ 614,344  

 
Note 9 – NOTES PAYABLE

Notes payable consist of the following:

   
December 31,
 
   
2010
   
2009
 
             
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.
  $ 6,628,889     $ 7,135,556  
                 
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 in May 2011.  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  $679,508, cash and cd’s totaling $2,578,373  at December 31, 2010.
    2,344,946       2,468,151  
                 
Notes payable to Ilya Mandel & Michael Edelson, subordinated to Private Bank, payable in quarterly installments of $341,875, plus interest at the floating rate per annum (3.25% at December 31, 2010).  This balance was paid in full during August, 2010.
          1,628,822  
Total notes payable
    8,973,835       11,732,529  
Less current maturities
    2,851,610       4,842,315  
Total long-term portion
  $ 6,122,225     $ 6,890,214  

At December 31, 2010, the Company was not in compliance with the fixed charge ratio and capital expenditure covenants with Private Bank at December 31, 2010.  A debt covenant waiver was obtained subsequent to year end.

 
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