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EXCEL - IDEA: XBRL DOCUMENT - Lifeway Foods, Inc.Financial_Report.xls
EX-21 - SUBSIDIARIES OF LIFEWAY FOODS, INC. - Lifeway Foods, Inc.exh21_17243.htm
EX-31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF JULIE SMOLYANSKY - Lifeway Foods, Inc.exh31-1_17243.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF JULIE SMOLYANSKY - Lifeway Foods, Inc.exh32-1_17243.htm
EX-32.2 - SECTION 1350 CERTIFICATION OF EDWARD P. SMOLYANSKY - Lifeway Foods, Inc.exh32-2_17243.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - Lifeway Foods, Inc.exh23-1_17243.htm
EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF EDWARD P. SMOLYANSKY - Lifeway Foods, Inc.exh31-2_17243.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, 2011
   
£
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from: __________ to __________ 
 
Commission file number: 000-17363
 
 
LIFEWAY FOODS, INC.
(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 St., Morton Grove, Illinois 60053
(Address of principal executive offices) (Zip Code)
 
(847) 967-1010
(Registrant’s telephone number, including area code)
 
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 þ     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.  ¨

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 computed by reference to the price at which the stock was last sold as of June 30, 2011 ($11.18 per share as quoted on the National Market System of The Nasdaq Global Market) was $51,982,114.
 
The number of shares outstanding of each of the issuer’s classes of common equity, as of March 9, 2012 is 16,391,909 shares of Common Stock.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
None.
 


 
 
 
LIFEWAY FOODS, INC.

Table of Contents
 
PART I
   
       
Item 1.
Business
  2
       
Item 2.
Properties
  9
       
Item 3.
Legal Proceedings
  9
       
     
PART II
   
       
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  10
       
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  11
       
Item 8.
Financial Statements and Supplementary Data
  12
       
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
  31
       
Item 9A.
Controls and Procedures
  31
       
Item 9B.
Other Information
  31
       
     
PART III
   
       
Item 10.
Directors, Executive Officers and Corporate Governance
  32
       
Item 11.
Executive Compensation
  33
       
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  35
       
Item 13.
Certain Relationships and Related Transactions  and Director Independence
  36
       
Item 14.
Principal Accountant Fees and Services
  37
       
       
PART IV
     
       
Item 15.
Exhibits, Financial Statement Schedules
  38
       
 
Signatures
  40
       
 
Index of Exhibits
  41
 
 
- 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 (“Lifeway” or the “Company”) 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 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 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.
  
 
 
 
- 1 -

 
PART I

ITEM 1.   BUSINESS.
 
BUSINESS DEVELOPMENT

Lifeway Foods, Inc. (the “Company” or “Lifeway”), 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. Lifeway manufactures all of its products at Company-owned facilities and distributes its products primarily throughout the United States.  In the Chicago metropolitan area, Lifeway distributes its products on its own trucks and via one distributor. The Company directly distributes its products in the Philadelphia and Tri State metropolitan areas 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.
 
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 ten 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 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 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.
 
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. The Company expects customers, either distributors who go into third party retail stores to sell the product they have purchased from us, or the direct retail customer that may service their own stores, as general good business practice to rotate the perishable products, make or obtain frequent delivery of products, replacement of damaged, old or substandard packages and deliver or have deliveries made directly to the refrigerated case.  It is to the benefit of the distributor or retailer, as well as the Company, not to have spoiled, out dated, or substandard product on the shelf.  However, due to the perishable nature of the product, the Company’s distributors and retailers have no right to return any product to the Company.
 
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. 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.
 
- 3 -

 
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.
 
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 and United Natural Foods. In 2011, two customers represented approximately 31% 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, 2011 was approximately 21.1% 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.
 
- 4 -

 
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. 
 
Mark/Reg. No.
Goods/Services
Date of Registration
Expiration of
Registration
Comments
ProBug Design 1,
Reg. No. 3266378
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
ProBug Design 2,
Reg. No. 3263130
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
Penelope ProBug Design,
Reg. No. 3408792
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
BA3APHBIII (a Stylized presentation of “bazarny” in Cyrillic characters),
Reg. No. 3590660
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
BAMBINO,
Reg. No. 2770522
cheeses, cottage cheeses and other dairy products, excluding ice cream, ice milk, and frozen yogurt
October 7, 2003
October 7, 2013
An Affidavit of Continued Use was timely filed between the fifth and sixth anniversaries of the registration date.  Registration is renewable between the ninth and tenth anniversaries of the registration date or the six-month grace period following the registration expiration date.
BAZARNY,
Reg. No. 3597883
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
BIO KEFIR,
Reg. No. 3886709
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
CHANGING THE WORLD, ONE MOUTHFUL AT A TIME. (Stylized) ,
Reg. No. 3541999
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
- 5 -

 
Mark/Reg. No.
Goods/Services
Date of Registration
Expiration of
Registration
Comments
FRUIT JUICE (Stylized),
Reg. No. 3413276
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
Fruit Juice Logo,
Reg. No. 3432421
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
GOO-BERRY PIE,
Reg. No. 3405134
dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverages 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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date. 
HELIOS NUTRITION,
Reg. No. 2283716
health foods, functional foods and medical foods, namely, dairy products excluding ice cream, ice milk and frozen yogurt
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.
KOROVKA,
Reg. No. 2504027
dairy-based spread
November 6, 2001
November 6, 2021
Registration was timely renewed on November 6, 2011. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
KPECTBRHCKNN (a Stylized presentation of “krestyanskiy” in Cyrillic characters-means “peasant”) ,
Reg. No. 2187363
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.
KWASHENKA,
Reg. No. 2135974
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.
LA FRUTA,
Reg. No. 2937061
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 fifth and sixth anniversaries of the registration date.  Registration is renewable between the ninth and tenth anniversaries of the registration date or the six-month grace period following the registration expiration date.
LIFEWAY,
Reg. No. 1571136
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.
ORANGE CREAMY CRAWLER,
Reg. No. 3263128
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
- 6 -

 
Mark/Reg. No.
Goods/Services
Date of Registration
 
Expiration of
Registration
Comments
PHYTOBOOST,
Reg. No. 3982487
dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverage used as a milk substitute
June 21, 2011
June 21, 2021
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date. 
PLAYGROUP PACK,
Reg. No. 3634999
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PRIDE OF MAIN STREET,
MN Reg. No. 12947
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.
PROBUGS,
Reg. No. 3263129
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
SOYTREAT,
Reg. No. 3530754
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT,
Reg. No. 3513252
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT,
Reg. No. 3454746
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT (Stylized),
Reg. No. 3879939
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
SUBLIME SLIME LIME,
Reg. No. 3263134
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
SWEET KISS,
Reg. No. 2135975
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.
TODDLER TASTEBUD TRAINING (Stylized),
Reg. No. 3542008
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
TRAINING WHEELS FOR HEALTHY EATING (Stylized),
Reg. No. 3412314
 
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 fifth and sixth anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
- 7 -

 
 
Mark/Ser. No.
Goods
Status & Filing Date
Comments
FIRST POP,
Ser. No. 77473329
frozen confections
Pending – Application filed May 13, 2008
Notice of Allowance (NOA) issued June 22, 2010. A Third  Extension of Time was granted December 7, 2011.  Applicant must file a Statement of Use or fourth Extension Request by June 22, 2012.
FIRST SMOOTHIE,
Ser. No. 85111072
fruit beverages, namely, smoothies
Pending – Application filed August 19, 2010
Notice of Allowance (NOA) issued September 20, 2011. Applicant must file a Statement of Use or first Extension Request by March 20, 2012.
FIRST WATER,
Ser. No. 77531563
drinking water
Pending – Application filed July 25, 2008
Notice of Allowance (NOA) issued January 12, 2010. The fourth Extension of Time was granted January 9, 2012. Applicant must file a Statement of Use or fifth Extension Request by July 12, 2012.
PRO2O,
Ser. No. 85362958
dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverage used as a milk substitute
 
beverages, namely, water and fruit and vegetable juices and fruit juices flavored with tea
Pending – Application filed July 5, 2011
Notice of Allowance (NOA) not yet issued.
PROLICIOUS,
Ser. No. 85362942
dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverage used as a milk substitute
 
beverages, namely, water and fruit and vegetable juices and fruit juices flavored with tea
Pending – Application filed July 5, 2011
Notice of Allowance (NOA) not yet issued.

Lifeway also uses, and claims common law rights to, the following unregistered trademarks: “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.
 
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.
 
- 8 -

 
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 2010 and 2011, 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 330 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. The Company only has distributor relationships with third party distributors.  No distributors are considered to be employees.  Company-owned vehicles are used by Company employees for local same day deliveries only and revenue is recognized on the date of delivery to the end retail customers.  Drivers of those vehicles are employees of the Company and all payroll, withholdings, and income taxes are accounted for in the same manner.
 
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.
  
On October 16, 1996, Lifeway purchased a 110,000 square foot commercially-zoned parcel of real property, including an approximately 50,000 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 approximately 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.
 
- 9 -

 
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
MARKET INFORMATION
 
 
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. 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
First Qtr. 2011
$  8.42  
$10.48
Second Qtr. 2011
$  9.03  
$11.24
Third Qtr. 2011
$  9.45  
$11.90
Fourth Qtr. 2011
$  8.80  
$11.20
       

As of March 9, 2012, there were approximately 90 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, 2011
 
0
 
0
 
0
 
186,754
November 1 to November 30, 2011
 
12,500
 
9.48
 
12,500
 
174,254
December 1 to December 31, 2011
 
4,000
 
9.78
 
4,000
 
170,254
Total
 
16,500
 
9.63
 
16,500
 
170,254

*On May 7, 2010, the Company established a share repurchase program for up to 200,000 shares with a plan expiration date of one year from the date of the first purchase.  On January 20, 2011, the Company approved a share repurchase program for up to 250,000 shares with a plan expiration date of one year from the date of the first purchase. Lifeway repurchased 127,348 shares of the Company’s securities in 2011 pursuant to these programs at a total cost of $1,181,428.  As of the date of this filing these plans were both expired.  On February 6, 2012, the Company approved a new share repurchase program for up to 200,000 shares with a plan expiration date of one year from the date of the first purchase.

 
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.
 
 
- 10 -

 
ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Comparison of Quarter Ended December 31, 2011 to Quarter Ended December 31, 2010

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 audited financial statements and Management’s Discussion and Analysis contained in our quarterly reports on Form 10-Q, for the fiscal quarters ended March 31, 2011, June 30, 2011, and September 30, 2011.

Results of Operations

Total consolidated gross sales increased by $2,615,251 (approximately 16%) to $18,739,197 during the three-month period ended December 31, 2011 from $16,123,946 during the same three-month period in 2010.  This increase is primarily attributable to increased sales and awareness of the Company’s flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™.  In addition, Lifeway’s Frozen Kefir line, which was launched in April 2011, contributed approximately $350,000 to sales during the fourth quarter of 2011.

Total consolidated net sales increased by $2,034,614 (approximately 14%) to $16,766,984 during the three-month period ended December 31, 2011 from $14,732,370 during the same three-month period in 2010.  Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers. The total allowance for promotions and discounts during the three-month period ended December 31, 2011 was $1,972,213, or 10.5% of gross sales, compared to the total allowance for promotions and discounts during the three-month period ended December 31, 2010 of $1,391,576, or 8.6% of gross sales.  This increase is a result of an adjustment made during the three-month period ended December 31, 2011 the Company recorded an increase in allowances for promotions and discounts of $0.5 million associated with write-offs of accounts receivable balances outstanding as of December 31, 2011 for known discounts.  These discounts have previously been accounted for through a reserve applied against accounts receivable.

Cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 74% during the fourth quarter of 2011, compared to approximately 77% during the same period in 2010. The decrease was primarily attributable to lower costs of transportation and other petroleum-based production supplies, partially offset by the increased cost of conventional and organic milk, the Company’s largest raw material.  The total cost of milk was approximately 20% higher during the fourth quarter 2011 when compared to the same period in 2010.

Operating expenses as a percentage of net sales were approximately 25% during the fourth quarter of 2011, compared to approximately 24% during the same period in 2010.   This increase was primarily attributable to increased selling expenses as compared to the same period in 2010.  Selling related expenses increased by $426,593 (approximately 21%) to $2,444,737 during the fourth quarter of 2011, from $2,018,144 during the same period in 2010.  This increase is directly attributable to increases in marketing and advertising of the Company’s flagship line, Kefir, as well as ProBugs Organic Kefir for kids, BioKefir and Lifeway’s Frozen Kefir.

The Company reported a loss in operations of $457,050 during the fourth quarter of 2011, an improvement of $79,343 from $536,393 during the same period in 2010.

Income tax benefit was $137,528 for the fourth quarter of 2011 compared to $133,299 during the same period in 2010.

Total net loss was $365,933 or a loss of $0.02 per diluted share for the three-month period ended December 31, 2011 compared to a net loss of $235,563 or a loss of $0.01 per diluted share in the same period in 2010.

Comparison of Year Ended December 31, 2011 to Year Ended December 31, 2010

Total consolidated gross sales increased by $13,579,554 (approximately 21%) to $77,122,999 during the twelve-month period ended December 31, 2011 from $63,543,445 during the same twelve-month period in 2010.  This increase is primarily attributable to increased sales and awareness of the Company’s flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™.  In addition, Lifeway’s Frozen Kefir line, which was launched in April 2011, contributed approximately $700,000 to sales during the twelve-month period ended December 31, 2011.

Total consolidated net sales increased by $11,470,516 (approximately 20%) to $69,970,409 during the twelve-month period ended December 31, 2011 from $58,499,893 during the same twelve-month period in 2010.  Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.  The total allowance for promotions and discounts during 2011 was $7,152,590, or 9.2% of gross sales, compared to the total allowance for promotions and discounts during 2010 of $5,043,552, or 7.9% of gross sales.  This increase is a result of during the three-month period ended December 31, 2011 the Company recorded an increase in allowances for promotions and discounts of $0.5 million associated with write-offs of accounts receivable balances outstanding as of December 31, 2011 for known discounts.  These discounts have previously been accounted for through a reserve applied against accounts receivable.

Cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 66% during the twelve-month period ended December 31, 2011, compared to approximately 63% during the same period in 2010. The increase was primarily attributable to the cost of conventional and organic milk, the Company’s largest raw material.  The total cost of milk was approximately 20 to 25% higher during the twelve-month period ended December 31, 2011 when compared to the same period in 2010.

Operating expenses as a percentage of net sales were approximately 25% during the twelve-month period ended December 31, 2011 compared to approximately 24% during the same period in 2010.  Selling related expenses increased by $2,602,343 (approximately 34%) to $10,205,441 during the twelve-month period ended December 31, 2011, from $7,603,098 during the same period in 2010. This increase is attributable to the Company recording an approximate $700,000 expense related its 25th Anniversary Cross Country Mobile tour, which occurred in the second quarter and was expensed during the second quarter of 2011.  The Company views this as a non-recurring advertising expense.
 
- 11 -

 
Total operating income decreased by $1,198,141 (approximately 19%) to $5,076,491 during the twelve-month period ended December 31, 2011, from $6,274,632 during the same period in 2010.

Provision for income taxes was $1,977,837 or a 41% effective tax rate, for the twelve-month period ended December 31, 2011 compared with $2,823,986, or a 44% effective tax rate, during the same period in 2010.  The decline in the effective tax rate is primarily the result of changes in estimates reflected in the current period.  Additionally, during the year ended December 31, 2010, a liability of approximately $220,000 was recognized resulting from the completion of an IRS review of the Company’s 2007 and 2008 federal tax return filings.  Income taxes are discussed in Note 11 of the Notes to Consolidated Financial Statements.

Total net income was $2,855,421 or $0.17 per share for the twelve-month period ended December 31, 2011 compared to $3,622,466 or $0.22 per share in the same period in 2010.

Liquidity and Capital Resources

Sources and Uses of Cash

Net cash provided by operating activities was $4,042,021 during the twelve-months ended December 31, 2011 compared to net cash provided by operating activities of $5,615,943 the same period in 2010.  This decrease is primarily attributable to the increase in accounts receivable of $1,494,790.

Net cash used in investing activities was $2,112,657 during the twelve-months ended December 31, 2011 compared to net cash provided by investing activities of $1,410,377 in the same period in 2010. This decrease is primarily due to a decrease in proceeds from sale of investments of $3,858,342 compared to 2010.

The Company had a net decrease in cash and cash equivalents of $2,114,789 during the twelve-month period ended December 31, 2011 compared to a net increase in cash and cash equivalents of $2,599,532 during the same period in 2010.  The Company had cash and cash equivalents of $1,115,150 as of December 31, 2011 compared to cash and cash equivalents of $3,229,939 as of December 31, 2010.

Assets and Liabilities

Total assets were $51,473,308 as of December 31, 2011, which is a decrease of $585,423 when compared to December 31, 2010.  This is primarily due to amortization of intangible assets of $783,833 as of December 31, 2011, when compared to December 31, 2010.

Total current liabilities were $7,072,720 as of December 31, 2011, which is a decrease of $1,813,040 when compared to December 31, 2010. This is primarily due to a $1,310,894 decrease in current maturities of notes payable.

Notes payable decreased by $582,389 as of December 31, 2011, when compared to December 31, 2010.  The balance of the notes payable as of December 31, 2011 was $5,539,836.

Total stockholder’s equity was $35,357,157 as of December 31, 2011, which is an increase of $1,708,139 when compared to December 31, 2010.  This is primarily due the increase in retained earnings of $2,855,421 when compared to December 31, 2010.

We previously held significant portions of our assets in investment securities. During the fourth quarter of 2010, we converted certain securities to cash and cash equivalents in order to ensure we had easy access to capital to capitalize on the opportunities we see ahead for our business.  All of our marketable securities are classified as available-for-sale on our balance sheet.  All of these securities are stated thereon at market value as of the end of the applicable period. Gains and losses on the portfolio are determined by the specific identification method.

We anticipate being able to fund the Company’s foreseeable liquidity requirements internally. We continue to explore potential acquisition opportunities in our industry in order to boost sales while leveraging our distribution system to consolidate and lower costs.
 
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.
 
 
- 12 -

 
 
 
 
 
 
 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED FINANCIAL STATEMENTS
 
DECEMBER 31, 2011 and 2010
 
 
 
 
 
 
 
 
 
 

 
 
- 13 -

 
 
 
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, 2011 and 2010, 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, 2011. 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 audits 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, 2011 and 2010, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

/s/ Plante & Moran, PLLC 
Chicago, IL
March 30, 2012
 
 
 
 
 
- 14 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
December 31, 2011 and 2010
 
   
December 31,
 
   
2011
   
2010
 
ASSETS
           
             
Current assets
           
Cash and cash equivalents
  $ 1,115,150     $ 3,229,939  
Investments
    1,695,044       1,079,232  
Certificates of deposits in financial institutions
    300,000       250,000  
Inventories
    4,954,475       3,985,374  
Accounts receivable, net of allowance for doubtful accounts and discounts
    7,950,276       6,793,276  
Prepaid expenses and other current assets
    79,630       158,315  
Other receivables
    224,204       104,680  
Deferred income taxes
    338,690       328,470  
Refundable income taxes
   
41,316
      906,748  
Total current assets
    16,698,785       16,836,034  
                 
Property and equipment, net
    15,198,822       15,152,713  
                 
Intangible assets
               
Goodwill and other non amortizable brand assets
    14,068,091       14,068,091  
Other intangible assets, net of accumulated amortization of $3,087,940 and $2,304,107 at December 31, 2011 and 2010, respectively
    5,218,060       6,001,893  
Total intangible assets
    19,286,151       20,069,984  
                 
Other Assets                
Long-term accounts receivable net of current portion     289,550       0  
                 
Total assets
  $ 51,473,308     $ 52,058,731  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities
               
Checks written in excess of bank balances
  $ 592,040     $ 1,341,210  
Current maturities of notes payable
    1,540,716       2,851,610  
Accounts payable
    4,386,239       4,183,481  
Accrued expenses
    553,725       509,459  
Total current liabilities
    7,072,720       8,885,760  
                 
Notes payable
    5,539,836       6,122,225  
                 
Deferred income taxes
    3,503,595       3,401,728  
Total liabilities
    16,116,151       18,409,713  
                 
Stockholders' equity
               
Common stock, no par value; 20,000,000 shares authorized; 17,273,776 shares issued; 16,409,317 shares outstanding at December 31, 2011; 17,273,776 shares issued; 16,536,657 shares outstanding at December 31, 2010
    6,509,267       6,509,267  
Paid-in-capital
    2,032,516       2,032,516  
Treasury stock, at cost
    ( 7,606,974 )     ( 6,425,546 )
Retained earnings
    34,431,296       31,575,875  
Accumulated other comprehensive loss, net of taxes
    ( 8,948 )     ( 43,094 )
Total stockholders' equity
    35,357,157       33,649,018  
                 
Total liabilities and stockholders' equity
  $ 51,473,308     $ 52,058,731  
 
See accompanying notes to financial statements
 
 
- 15 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Years Ended December 31, 2011 and 2010
 
   
Years Ended
 
   
December 31,
 
   
2011
   
2010
 
                         
Gross sales
  $ 77,122,999           $ 63,543,445        
Less: discounts and allowances
    ( 7,152,590 )           ( 5,043,552 )      
Net sales
    69,970,409       69,970,409       58,499,893       58,499,893  
                                 
Cost of goods sold
            45,866,632               36,926,973  
Depreciation expense
            1,552,961               1,393,745  
                                 
Total cost of goods sold
            47,419,593               38,320,718  
                                 
Gross profit
            22,550,816               20,179,175  
                                 
Selling expenses
            10,205,441               7,603,098  
General and administrative
            6,485,051               5,576,908  
Amortization expense
            783,833               724,537  
                                 
Total operating expenses
            17,474,325               13,904,543  
                                 
Income from operations
            5,076,491               6,274,632  
                                 
Other income (expense):
                               
Interest and dividend income
            70,611               260,552  
Rental income
            7,150               11,785  
Interest expense
            ( 247,342 )             (350,997 )
Impairment of investments             ( 36,032 )            
 
Gain (loss) on sale of investments, net
            ( 29,256 )             250,480  
Other expense
            ( 8,364 )            
 
Total other income (expense)
            ( 243,233 )             171,820  
                                 
Income before provision for
                               
   income taxes
            4,833,258               6,446,452  
                                 
Provision for income taxes
            1,977,837               2,823,986  
                                 
Net income
          $ 2,855,421             $ 3,622,466  
                                 
Basic and diluted earnings
                               
per common share
            0.17               0.22  
                                 
Weighted average number of
                               
  shares outstanding
            16,442,948               16,663,557  
                                 
COMPREHENSIVE INCOME
                               
                                 
Net income
          $ 2,855,421             $ 3,622,466  
                                 
Other comprehensive income
                               
    (loss), net of tax:
                               
    Unrealized gains (losses) on
                               
      investments (net of tax)
            17,616               114,297  
    Less reclassification adjustment
                               
      for (gains) losses included in
                               
      net income (net of taxes)
           
16,530
              ( 147,032 )
                                 
Comprehensive income
          $ 2,889,567             $ 3,589,731  
 
See accompanying notes to financial statements
 
 
- 16 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2011 and 2010
 
 
   
Common Stock, No Par Value
                                 
Accumulated
       
    20,000,000 Shares    
# of Shares
                           
Other
       
    Authorized    
of
                           
Comprehensive
       
   
# of Shares
   
# of Shares
   
Treasury
   
Common
   
Paid In
   
Treasury
   
Retained
   
Income (Loss),
       
   
Issued
   
Outstanding
   
Stock
   
Stock
   
Capital
   
Stock
   
Earnings
   
Net of Tax
   
Total
 
                                                       
Balances at December 31, 2009
    17,273,776       16,778,555       495,221     $ 6,509,267     $ 1,965,786     $ (3,846,773 )   $ 27,953,409     $ (10,359 )     32,571,330  
                                                                         
Redemption of stock
          ( 252,398 )     252,398                   ( 2,666,288 )                 ( 2,666,288 )
                                                                         
Issuance of treasury stock for compensation
          10,500       ( 10,500 )           66,730       87,515                   154,245  
                                                                         
Unrealized gains on securities, net of taxes
                                              ( 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  
                                                                         
Redemption of stock
          (127,340 )     127,340                   (1,181,428 )                 (1,181,428 )
                                                                         
Unrealized losses on securities, net of taxes
                                              34,146       34,146  
                                                                         
Net income for the year ended December 31, 2011
                                        2,855,421             2,855,421  
                                                                         
Balances at December 31, 2011
    17,273,776       16,409,317       864,459       6,509,267       2,032,516       (7,606,974 )     34,431,296       (8,948 )     35,357,157  
 
See accompanying notes to financial statements
 
 
- 17 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2011 and 2010
 
   
December 31,
 
   
2011
   
2010
 
             
Cash flows from operating activities:
           
Net income
  $ 2,855,421     $ 3,622,466  
Adjustments to reconcile net income to net
               
cash flows from operating activities, net of acquisition:
               
Depreciation and amortization
    2,336,794       2,118,282  
Loss (gain) on sale of investments, net
    29,256       ( 250,480 )
Loss on disposition of equipment
    20,135        
Impairment of investments
    36,032        
Deferred income taxes
     68,217       ( 96,918 )
Treasury stock issued for compensation
          154,245  
Bad debt expense
    48,240       17,754  
(Increase) decrease in operating assets:
               
Accounts receivable
    ( 1,494,790 )     ( 811,292 )
Other receivables
    ( 119,524     ( 54,922 )
Inventories
    ( 969,101 )     ( 682,398 )
Refundable income taxes
    865,432       402,230  
Prepaid expenses and other current assets
    78,685       ( 117,618 )
Increase (decrease) in operating liabilities:
               
Accounts payable
    202,758       1,419,479  
Accrued expenses
    84,466       ( 104,885 )
Net cash provided by operating activities
    4,042,021       5,615,943  
                 
Cash flows from investing activities:
               
Purchases of investments
    ( 2,434,340 )     ( 2,161,552 )
Proceeds from sale of investments
    1,810,816       5,669,158  
Investments in certificates of deposits
    ( 50,000 )      
Proceeds from redemption of certificates of deposit
          402,005  
Purchases of property and equipment
    ( 1,439,133 )     ( 2,229,274 )
Acquisition of the assets of First Juice
          ( 270,000 )
Net cash (used in) provided by investing activities
    ( 2,112,657 )     1,410,337  
                 
Cash flows from financing activities:
               
Proceeds from note payable
    2,000,000       250,000  
Checks written in excess of bank balances
    ( 749,170 )     998,234  
Purchases of treasury stock
    ( 1,181,428 )     ( 2,666,288 )
Repayment of notes payable
    ( 4,113,555 )     ( 3,008,694 )
Net cash used in financing activities
    ( 4,044,153 )     ( 4,426,748 )
                 
Net (decrease) increase in cash and cash equivalents
    ( 2,114,789 )     2,599,532  
                 
Cash and cash equivalents at the beginning of the period
    3,229,939       630,407  
                 
Cash and cash equivalents at the end of the period
  $ 1,115,150     $ 3,229,939  
 
See accompanying notes to financial statements
 
 
- 18 -

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


Note 1 – NATURE OF BUSINESS

Lifeway Foods, Inc. (the “Company” or “Lifeway”) 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 on the East Coast through local food stores.
 

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, Helios Nutrition, Ltd., Pride of Main Street, L.L.C., Starfruit, L.L.C., Fresh Made, Inc. and Starfruit Franchisor, L.L.C. In 2010, the Company acquired the assets of First Juice, Inc. (“First Juice”) and consolidated the operations into the operations of the Company. All significant intercompany accounts and transactions have been eliminated. The financial statements include the results of operations from the acquisition of the assets of First Juice from October 14, 2010 through the end of the period (see Note 3).

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

Revenue Recognition
Sales of Company produced dairy products are recorded at the time of shipment and the following four criteria have been met: (i) The product has been shipped and the Company has no significant remaining obligations; (ii) Persuasive evidence of an agreement exists; (iii) The price to the buyer is fixed or determinable and (iv) Collection is probable. In addition, shipping costs invoiced to the customers are included in net sales and the related cost in cost of sales. Discounts and allowances are reported as a reduction of gross sales unless the allowance is attributable to an identifiable benefit separable from the purchase of the product, the value of which can be reasonably estimated, which would be charged to the appropriate expense account.
 
Customer Concentration
Sales are predominately to companies in the retail food industry, located primarily within the United States of America.  Two major customers accounted for approximately 31 percent and 29 percent of gross sales for the years ending December 31, 2011 and 2010, respectively.  These customers accounted for approximately 27 percent and 20 percent of accounts receivable as of December 31, 2011 and 2010, respectively.
 
 
- 19 -

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


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Cash and cash equivalents
All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.

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

Investments
All investment securities are classified as available-for-sale and are carried at fair value. Unrealized gains and losses on available-for-sale securities are reported as a separate component of stockholders’ equity. Amortization, accretion, interest and dividends, realized gains and losses, and declines in value judged to be other-than-temporary on available-for-sale securities are recorded in other income. All of the Company's securities are subject to a periodic impairment evaluation. This evaluation depends on the specific facts and circumstances. Factors that we consider in determining whether an other-than-temporary decline in value has occurred include: the market value of the security in relation to its cost basis; the financial condition of the investee; and the intent and ability to retain the investment for a sufficient period of time to allow for possible recovery in the market value of the investment.

Accounts receivable
Credit terms are extended to customers in the normal course of business. The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral.   Balances expected to be paid beyond one year are classified as long-term.

Accounts receivable are recorded at invoice amounts, and reduced to their estimated net realizable value by recognition of an allowance for doubtful accounts and discounts. The Company’s estimate of the allowances for doubtful accounts and 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

 
 
- 20 -

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

Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

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

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

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

Intangible assets are being amortized over the following useful lives:
 
Category
 
Years
Recipes
 
4
Customer lists and other customer related intangibles
 
7-10
Lease agreement
 
7
Trade names
 
15
Formula
 
10
Customer relationships
 
12
     

Income taxes
Deferred income taxes are the result of temporary differences that arise from income and expense items reported for financial accounting and tax purposes in different periods. Deferred taxes are classified as current or non-current, depending on the classification of the assets and liabilities to which they relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.

The principal sources of temporary differences are different depreciation and amortization methods for financial statement and tax purposes, unrealized gains or losses related to investments, capitalization of indirect costs for tax purposes, purchase price adjustments, and the recognition of an allowance for doubtful accounts and discounts for financial statement purposes.

 
- 21 -

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

Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The only periods subject to examination for the Company’s federal return are the 2009 and 2010 tax years. The Company believes that its income tax filing positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded.

During the year ended December 31, 2010, the IRS completed a review of the Company’s 2007 and 2008 federal tax return filings, resulting in a liability of approximately $220,000 being recognized and paid during 2010. The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before taxes. There were no such items during the periods covered in this report.

Treasury stock
Treasury stock is recorded using the cost method.

Advertising and promotional costs
The Company expenses advertising costs as incurred. For the year ended December 31, 2011 and 2010 total advertising expenses were $3,156,096 and $2,390,002, respectively.

Earnings per common share
Earnings per common share were computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. For the years ended December 31, 2011 and 2010, diluted and basic earnings per share were the same, as the effect of dilutive securities options outstanding was not significant.

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

Note 3 – ACQUISITIONS

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

The estimated fair value of assets acquired, including the real property, and liabilities assumed consisted of the following:
 
Trade names
 
$
268,000
 
Other current assets
   
6,000
 
Customer lists
   
199,000
 
Fixed assets
   
35,000
 
Non amortizable goodwill and brand asset
   
262,000
 
Total fair value of assets acquired and liabilities assumed
 
$
770,000
 
 
 
- 22 -

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


Note 3 – ACQUISITIONS - Continued

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

Note 4 – INTANGIBLE ASSETS

Intangible assets, and the related accumulated amortization, consist of the following:
 
   
December 31, 2011
   
December 31, 2010
 
   
Cost
   
Accumulated
Amortization
   
Cost
   
Accumulated Amortization
 
Recipes
 
$
43,600
   
$
43,600
   
$
43,600
   
$
43,600
 
Customer lists and other  related intangibles
   
4,504,200
     
1,546,671
     
4,504,200
     
1,039,323
 
Lease acquisition
   
87,200
     
87,200
     
87,200
     
79,941
 
Customer relationship
   
985,000
     
444,618
     
985,000
     
362,526
 
Trade names
   
2,248,000
     
728,601
     
2,248,000
     
585,267
 
Formula
   
438,000
     
237,250
     
438,000
     
193,450
 
   
$
8,306,000
   
$
3,087,940
   
$
8,306,000
   
$
2,304,107
 

Amortization expense is expected to be as follows for the years ending December 31:

 
2012
 
$
754,817
 
2013
   
671,254
 
2014
   
657,883
 
2015
   
657,883
 
2016
   
657,883
 
Thereafter
   
1,818,340
 
   
$
5,218,060
 

Amortization expense during the years ended December 31, 2011 and 2010 was $783,833 and $724,537, respectively.
 

Note 5 – INVESTMENTS

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

December 31, 2011
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                         
Equities
 
$
682,569
   
$
55,244
   
$
(23,211
)  
$
714,602
 
Mutual Funds
   
64,563
     
3,275
     
(713
)    
67,125
 
Preferred Securities
   
64,452
     
     
(17,702
)    
46,750
 
Corporate Bonds
   
899,298
     
1,019
     
(33,750
)    
866,567
 
                                 
Total
 
$
1,710,882
   
$
59,538
   
$
(75,376
)  
$
1,695,044
 
 
 
- 23 -

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

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

Proceeds from the sale of investments were $1,810,816 and $5,669,158, during the years ended December 31, 2011 and 2010, respectively.

Gross gains of $33,278 and $451,420 and gross losses of $62,534 and $200,940 were realized on these sales during the years ended December 31, 2011 and 2010, respectively.

The following table shows the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010:
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 2011
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
                                     
Equities
 
$
176,966
   
$
(23,211)
   
 
   
 
   
$
176,966
   
$
(23,211)
 
Mutual Funds
   
     
     
10,585
     
(713)
     
10,585
     
(713)
 
Preferred Securities
   
     
     
46,750
     
(17,702)
     
46,750
     
(17,702)
 
Corporate Bonds
   
626,292
     
(24,000)
     
90,250
     
(9,750)
     
716,542
     
(33,750)
 
   
$
803,258
   
$
(47,211)
   
$
147,585
   
$
(28,165)
   
$
950,843
   
$
(75,376)
 

 
   
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
)

Equities, Mutual Funds, Preferred Securities, and Corporate Bonds - The Company's investments in equity securities, mutual funds, preferred securities, and corporate bonds consist of investments in common stock, preferred stock and debt securities of companies in various industries. As of December 31, 2011, there were seventeen equity securities, three mutual fund securities, one preferred security, and nine corporate bond securities that had unrealized losses. The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the impairment. Based on that evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company did not consider any material investments to be other-than-temporarily impaired at December 31, 2010.
 
We recorded other than temporary impairments related to investments in certain equities of $36,032 related to securities with a cost basis of $51,095 and a fair value of $15,063.  The impairments recognized relate to securities that were in an unrealized loss position at December 31, 2011 that we consider other than temporarily impaired due to the recent performance of the issuers of those securities.
 
 
- 24 -

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

Note 6 – INVENTORIES

Inventories consist of the following:
 
   
December 31,
       
   
2011
 
2010
       
Finished goods
 
$
1,976,050
   
$
1,636,988
         
Production supplies
   
2,042,611
     
1,527,064
         
Raw materials
   
935,814
     
821,322
         
Total inventories
 
$
4,954,475
   
$
3,985,374
         

 
Note 7 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:
 
             
   
December 31,
       
   
2011
   
2010
       
Land
  $ 1,178,160     $ 1,178,160          
Buildings and improvements
    11,633,077       11,328,860          
Machinery and equipment
    14,697,024       13,713,649          
Vehicles
    1,334,628       976,745          
Office equipment
    383,099       352,135          
Construction in process
    17,410       96,990          
      29,243,398       27,646,539          
Less accumulated depreciation
    14,044,576       12,493,826          
Total property and equipment
  $ 15,198,822     $ 15,152,713          

Depreciation expense during the years ended December 31, 2011 and 2010 was $1,552,961 and $1,393,745, respectively.


Note 8 ACCRUED EXPENSES

Accrued expenses consist of the following:
 
   
December 31,
         
   
2011
   
2010
         
Accrued payroll and payroll taxes
  $ 209,395     $ 181,274          
Accrued property tax
    323,885       273,876          
Other
    20,445       54,309          
    $ 553,725     $ 509,459          

 
 
- 25 -

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

Note 9 – NOTES PAYABLE

Notes payable consist of the following:
 
   
December 31,
       
   
2011
   
2010
       
                   
Note payable to Private Bank in monthly installments of $42,222, plus variable interest rate, currently at 2.7963%, with a balloon payment of $5,066,667 due February 6, 2014. Collateralized by substantially all assets of the Company.
  $ 5,914,445     $ 6,628,889          
                         
                         
Line of credit with Private Bank at variable interest rate, currently at 3.25%. The agreement has been extended with terms allowing borrowings up to $2.0 million, maturing on May 31, 2012. Collateralized by substantially all assets of the Company.
    1,000,000                
                         
                         
Line of credit with Morgan Stanley for borrowings up to $2.8 million at variable interest rate, currently at 3.00% due on demand. Collateralized by investments with a fair value of $1,212,873, and cash and CD’s totaling $449,967 at December 31, 2011.
          2,344,946          
                         
                         
Notes payable to Ford Credit Corp. payable in monthly installments of $1,778.23 at 5.99%, due July 2015, secured by transportation equipment.
    68,509                
                         
                         
Note payable to Fletcher Jones of Chicago, Ltd LLC in monthly installments of $1,768.57 at 6.653%, due May 24, 2017, secured by transportation equipment.
    97,598                
                         
Total notes payable
    7,080,552       8,973,835