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EX-31.1 - 302 CERTIFICATION OF THE C.E.O. - Lifeway Foods, Inc.exh31-1_17723.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 

 
(Mark One)  
   
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:  September 30, 2014
 
o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
Commission File Number: 000-17363
 

 
LIFEWAY FOODS, INC.
(Exact Name of Registrant as Specified in its Charter)
 

 
Illinois
36-3442829
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 6431 West Oakton, Morton Grove, IL 60053
(Address of Principal Executive Offices, Zip Code)
 
(847) 967-1010
(Registrant’s Telephone Number, Including Area Code) 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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  x   No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  x   No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer  o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o   No  x
 
As of November 10, 2014, 16,346,017 shares of the registrant’s common stock, no par value, were outstanding.
 


 
 
 
 
LIFEWAY FOODS, INC.
 
Table of Contents
 
 
PART I – FINANCIAL INFORMATION
 
Item 1.
Financial Statements.
 3
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
18
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
22
Item 4.
Controls and Procedures.
22
 
 
PART II – OTHER INFORMATION
 
Item 1.
Legal Proceedings.
24
Item 1 A.
Risk Factors.
24
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
24
Item 3.
Defaults Upon Senior Securities.
24
Item 4.
Mine Safety Disclosure.
24
Item 5.
Other Information.
24
Item 6.
Exhibits.
24
 
Signatures.
25
 
Index of Exhibits.
26
 
 
 
 
 
 
 
- 2 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, 2014 and 2013 (Unaudited) and December 31, 2013


   
September 30,
   
December 31,
 
   
2014
   
2013
   
2013
 
ASSETS
                 
                   
Current assets
                 
Cash and cash equivalents
  $ 2,795,429     $ 1,240,730     $ 3,306,608  
Investments
    3,057,214       2,506,463       2,516,380  
Certificates of deposits in financial institutions
          115,373       15,373  
Inventories
    7,134,857       8,382,287       6,899,008  
Accounts receivable, net of allowance for doubtful accounts and discounts ($1,300,000 and $1,350,000 and $1,050,000)
    11,803,145       11,313,652       10,444,839  
Prepaid expenses and other current assets
    54,944       88,629       128,323  
Other receivables
    26,720       89,100       103,272  
Deferred income taxes
    360,765       394,277       322,071  
Refundable income taxes
    842,425       423,242       1,014,947  
Total current assets
    26,075,499       24,553,753       24,750,821  
                         
Property and equipment, net
    21,874,520       21,637,492       20,824,448  
                         
Intangible assets
                       
Goodwill
    14,068,091       14,068,091       14,068,091  
Other intangible assets, net of accumulated amortization of $5,005,117, $4,376,640 and $4,468,359 at September 30, 2014 and 2013 and at December 31, 2013, respectively
    3,238,683       3,929,360       3,750,441  
Total intangible assets
    17,306,774       17,997,451       17,818,532  
                         
Other Assets
                       
Long-term accounts receivable, net of current portion
    270,599       280,000       280,000  
Total assets
  $ 65,527,392     $ 64,468,696     $ 63,673,801  
                         
                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                       
                         
Current liabilities
                       
Current maturities of notes payable
  $ 877,038     $ 878,088     $ 875,002  
Accounts payable
    7,318,512       5,429,988       6,723,179  
Accrued expenses
    1,243,876       1,323,213       1,284,060  
Accrued income taxes
          1,292,762        
Total current liabilities
    9,439,426       8,924,051       8,882,241  
                         
Notes payable
    8,339,282       9,214,853       8,999,012  
                         
Deferred income taxes
    2,065,221       2,917,213       2,843,426  
Total liabilities
    19,843,929       21,056,117       20,724,679  
                         
Stockholders' equity
                       
Common stock, no par value; 40,000,000 shares authorized; 17,273,776 shares issued; 16,346,017 shares outstanding at September 30, 2014, September 30, 2013 and December 31, 2013
    6,509,267       6,509,267       6,509,267  
Paid-in-capital
    2,032,516       2,032,516       2,032,516  
Treasury stock, at cost
    ( 8,187,682 )     ( 8,187,682 )     ( 8,187,682 )
Retained earnings
    45,367,487       43,056,422       42,587,214  
Accumulated other comprehensive income (loss), net of taxes
    ( 38,125 )     2,056       7,807  
Total stockholders' equity
    45,683,463       43,412,579       42,949,122  
                         
Total liabilities and stockholders' equity
  $ 65,527,392     $ 64,468,696     $ 63,673,801  


See accompanying notes to financial statements.

 
- 3 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Three and Nine Months Ended September 30, 2014 and 2013 (Unaudited)
 
 
   
(Unaudited)
   
(Unaudited)
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Sales
  $ 32,704,435           $ 26,601,341           $ 97,359,630           $ 80,030,021        
Less: discounts and allowances
    ( 2,594,213 )           ( 2,808,811 )           ( 8,552,286 )           ( 8,772,576 )      
Net sales
    30,110,222       30,110,222       23,792,530       23,792,530       88,807,344       88,807,344       71,257,445       71,257,445  
                                                                 
Cost of goods sold
            21,697,954               16,513,357               64,812,489               47,217,179  
Depreciation expense
            1,010,966               410,797               2,022,204               1,226,629  
                                                                 
Total cost of goods sold
            22,708,920               16,924,154               66,834,693               48,443,808  
                                                                 
Gross profit
            7,401,302               6,868,376               21,972,651               22,813,637  
                                                                 
Selling expenses
            2,804,127               2,815,126               9,977,636               8,291,960  
General and administrative
            2,627,566               1,671,080               7,115,393               5,567,649  
Amortization expense
            178,919               178,201               536,758               533,884  
                                                                 
Total operating expenses
            5,610,612               4,664,407               17,629,787               14,393,493  
                                                                 
Income from operations
            1,790,690               2,203,969               4,342,864               8,420,144  
                                                                 
Other income (expense):
                                                               
Interest and dividend income
            22,739               36,535               86,664               82,166  
Rental income
            1,201               2,231               2,900               8,889  
Interest expense
            ( 62,084 )             ( 59,887 )             ( 194,377 )             ( 133,610 )
Gain on sale of investments, net reclassified from OCI
            ( 22,940 )             161               39,190               121,441  
Gain on sale of equipment
            85,077                             8,592                
Other Income
                          209,175               1,674               219,404  
Total other income (expense)
            23,993               188,215               (55,357 )             298,290  
                                                                 
Income before provision for income taxes
            1,814,683               2,392,184               4,287,507               8,718,434  
                                                                 
Provision for income taxes
            789,005               702,257               1,507,234               3,258,928  
                                                                 
Net income
          $ 1,025,678             $ 1,689,927             $ 2,780,273             $ 5,459,506  
                                                                 
Basic and diluted earnings per common share
            0.06               0.10               0.17               0.33  
                                                                 
Weighted average number of shares outstanding
            16,346,017               16,346,017               16,346,017               16,346,017  
                                                                 
COMPREHENSIVE INCOME
                                                               
                                                                 
Net income
          $ 1,025,678             $ 1,689,927             $ 2,780,273             $ 5,459,506  
                                                                 
Other comprehensive income
                                                               
    (loss), net of tax:
                                                               
    Unrealized gains (losses) on
                                                               
      investments (net of tax)
            ( 93,679 )             29,356               ( 22,524 )             17,079  
    Less reclassification adjustment
                                                               
      for (gains) losses included in
                                                               
      net income (net of taxes)
            13,702               ( 91 )             (23,408 )             ( 68,614 )
                                                                 
Comprehensive income
          $ 945,701             $ 1,719,192             $ 2,734,341             $ 5,407,971  

See accompanying notes to financial statements.

 
- 4 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Nine Months Ended September 30, 2014 and 2013 (Unaudited) and For the Year Ended December 31, 2013


   
Common Stock, No Par Value
                                 
Accumulated
       
    40,000,000 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 January 1, 2013
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 38,904,777     $ 53,591     $ 39,312,469  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes
                                              ( 45,784 )     (45,784 )
                                                                         
Net income for the year ended December 31, 2013
                                        4,990,298             4,990,298  
                                                                         
Dividends ($.08) per share
                                        (1,307,861 )           (1,307,861 )
                                                                         
Balances at December 31, 2013
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 42,587,214     $ 7,807     $ 42,949,122  
                                                                         
Balances at January 1, 2013
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 38,904,777     $ 53,591     $ 39,312,469  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes
                                              (51,535 )     (51,535 )
                                                                         
Net income for the nine months ended September 30, 2013
                                        5,459,506             5,459,506  
                                                                         
Dividends ($.08) per share
                                        (1,307,861 )           (1,307,861 )
                                                                         
Balances at September 30, 2013
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 43,056,422     $ 2,056     $ 43,412,579  
                                                                         
Balances at January 1, 2014
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 42,587,214     $ 7,807     $ 42,949,122  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes
                                              (45,932 )     (45,932 )
                                                                         
                                                                         
Net income for the nine months ended September 30, 2014
                                        2,780,273             2,780,273  
                                                                         
Balances at September 30, 2014
    17,273,776       16,346,017       927,759     $ 6,509,267     $ 2,032,516     $ (8,187,682 )   $ 45,367,487     $ (38,125 )   $ 45,683,463  

See accompanying notes to financial statements.

 
- 5 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)


   
(Unaudited)
 
   
September 30,
 
   
2014
   
2013
 
             
Cash flows from operating activities:
           
Net income
  $ 2,780,273     $ 5,459,506  
Adjustments to reconcile net income to net
               
cash flows from operating activities:
               
Depreciation and amortization
    2,558,962       1,760,513  
Gain on sale of investments, net
    ( 39,190 )     ( 121,441 )
Deferred income taxes
    ( 783,607 )     ( 231,218 )
Bad debt expense
    76,049       26,819  
Gain on sale of equipment
    (8,592 )     (209,175 )
(Increase) decrease in operating assets:
               
Accounts receivable
    ( 1,548,110 )     ( 2,612,905 )
Other receivables
    76,552       ( 80,275 )
Inventories
    ( 235,849 )     ( 2,443,101 )
Refundable income taxes
    172,522       (338,414 )
Prepaid expenses and other current assets
    73,379       33,509  
Increase (decrease) in operating liabilities:
               
Accounts payable
    595,333       1,173,263  
Accrued expenses
    ( 40,184 )     167,536  
Income taxes payable
          1,038,451  
Net cash provided by operating activities
    3,677,538       3,623,068  
                 
Cash flows from investing activities:
               
Purchases of investments
    ( 2,319,742 )     ( 2,877,968 )
Proceeds from sale of investments
    1,736,946       2,281,792  
Redemption of certificates of deposits
    15,000       334,627  
Purchases of property and equipment
    ( 3,052,303 )     ( 8,205,669 )
Proceeds from sale of equipment
    89,076       537,500  
Net cash used in investing activities
    (3,531,023 )     (7,929,718 )
                 
Cash flows from financing activities:
               
Dividends paid
          (1,307,861 )
Net proceeds from debt issuance
          4,975,000  
Repayment of notes payable
    ( 657,694 )     ( 405,985 )
Net cash used in financing activities
    ( 657,694 )     3,261,154  
                 
Net decrease in cash and cash equivalents
    (511,179 )     (1,045,496 )
                 
Cash and cash equivalents at the beginning of the period
    3,306,608       2,286,226  
                 
Cash and cash equivalents at the end of the period
  $ 2,795,429     $ 1,240,730  

See accompanying notes to financial statements.

 
- 6 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013

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. In addition, products are sold throughout the United States by distributors. The Company also distributes some of its products in London.

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Basis of presentation
The accompanying unaudited financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of Management, necessary for fair presentation of results for the interim periods.  The unaudited consolidated financial statements contained in this Quarterly Report should be read in conjunction with the consolidated financial statements contained in our 2013 Annual Report on Form 10-K.

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., Lifeway First Juice, Inc. (IL), First Juice, Inc. (DE) and Lifeway Wisconsin, Inc. Lifeway Wisconsin, Inc. was created to facilitate the operation of a production facility in Wisconsin. All significant intercompany accounts and transactions have been eliminated.

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, the valuation of investment securities, 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 within the United States of America. Two major customers accounted for approximately __ percent and 35 percent of gross sales for the nine months ended September 30, 2014 and 2013, respectively. These customers accounted for approximately __ percent, 30 percent and 22 percent of accounts receivable as of September 30, 2014, September 30, 2013 and December 31, 2013, respectively.
 
 
- 7 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013


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 anticipated discounts. The Company’s estimate of the allowances for doubtful accounts and anticipated discounts are based upon historical experience, its evaluation of the current status and contract terms of specific receivables, and unusual circumstances, if any. Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms. Accounts considered uncollectible are charged against the allowance.

Inventories
Inventories are stated at the lower of cost or market.  Our products are valued using the first in, first out method.  The costs of inventories include raw materials, direct labor and indirect production and overhead costs.

Property and equipment
Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets. 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 expense 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
Leasehold improvements
 
Shorter of expected useful life or lease term


 
 
- 8 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013


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. 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
Lease agreement
 
7
Trade names
 
8-15
Formula
 
10
Customer relationships
 
8-12

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

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

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 returns are the 2011, 2012 and 2013 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.



 
- 9 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013
 

Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Treasury stock
Treasury stock is recorded using the cost method.

Advertising and promotional costs
The Company expenses advertising costs as incurred. For the three and nine months ended September 30, 2014 and 2013 total advertising expenses were $643,127 and $2,462,313, $551,492 and $1,859,798, respectively.

Earnings per common share
Earnings per common share were computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. For the three and nine months ended September 30, 2014 and 2013, the weighted average number of shares outstanding used in the calculation of diluted and basic earnings per share were the same.

Segments
Currently, the Company has one segment with multiple dairy products. All such dairy products are produced using the same process and materials, sold to consumers retail food sellers through direct delivery and distributors in the United States of America.  The reportable segment has been determined based on how the Company’s chief operating decision maker manages the business and in a manner consistent with the internal reporting provided to the chief operating decision maker. The chief operating decision-maker, who is responsible for allocating resources and assessing performance of the operating segments, has been identified as the Chief Financial Officer and the board of directors that makes strategic decisions. The Company’s sales in foreign markets are considered not to be material and accordingly the Company has not presented financial information by geography.
 

Note 3 – INTANGIBLE ASSETS

Intangible assets, and the related accumulated amortization, consist of the following:

   
September 30, 2014
   
September 30, 2013
   
December 31, 2013
 
   
Cost
   
Accumulated Amortization
   
Cost
   
Accumulated Amortization
   
Cost
   
Accumulated Amortization
 
Recipes
 
$
43,600
   
$
43,600
   
$
43,600
   
$
43,600
   
$
43,600
   
$
43,600
 
Customer lists and other customer related intangibles
   
4,504,200
     
2,813,737
     
4,504,200
     
2,361,808
     
4,504,200
     
2,474,790
 
Customer relationship
   
985,000
     
649,348
     
985,000
     
579,264
     
985,000
     
596,785
 
Trade names
   
2,248,000
     
1,140,732
     
2,248,000
     
990,868
     
2,248,000
     
1,028,334
 
Formula
   
438,000
     
357,700
     
438,000
     
313,900
     
438,000
     
324,850
 
   
$
8,218,800
   
$
5,005,117
   
$
8,218,800
   
$
4,289,440
   
$
8,218,800
   
$
4,468,359
 

 
Amortization expense is expected to be approximately the following for the 12 months ending September 30:

2015
 
$
715,677
 
2016
   
708,377
 
2017
   
671,877
 
2018
   
658,197
 
2019
   
293,156
 
Thereafter
   
166,399
 
   
$
3,213,683
 

Amortization expense during the three and nine months ended September 30, 2014 and 2013 was $178,919 and $536,758, $178,201 and $533,884, respectively.


 
- 10 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013
 

Note 4 – INVESTMENTS

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

September 30, 2014
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
Equities
 
$
1,023,998
   
$
82,968
   
$
(53,441
)
 
$
1,053,525
 
Mutual Funds
   
7,040
     
0
     
(633
)
   
6,407
 
Preferred Securities
   
416,415
     
24,959
     
(4,330
)
   
437,044
 
Corporate Bonds
   
1,673,591
     
2,397
     
(115,750
)
   
1,560,238
 
Total
 
$
3,121,044
   
$
110,324
   
$
(174,154
)
 
$
3,057,214
 
 
 
September 30, 2013
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
Equities
 
$
887,418
   
$
115,298
   
$
(29,256
)
 
$
973,460
 
Mutual Funds
   
69,849
     
0
     
(1,965
)
   
67,884
 
Preferred Securities
   
528,306
     
3,684
     
(26,363
)
   
505,627
 
Corporate Bonds
   
1,017,252
     
1
     
(57,761
)
   
959,492
 
Total
 
$
2,502,825
   
$
118,983
   
$
(115,345
)
 
$
2,506,463
 
 
 
December 31, 2013
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
Equities
 
$
1,006,169
   
$
98,213
   
$
(32,181
)  
$
1,072,201
 
Mutual Funds
   
54,847
     
1,994
     
0
     
56,841
 
Preferred Securities
   
464,585
     
12,960
     
(15,449
)    
462,096
 
Corporate Bonds
   
973,333
     
1,329
     
(49,420
)    
925,242
 
Total
 
$
2,498,934
   
$
114,496
   
$
(97,050
)  
$
2,516,380
 

 
Proceeds from the sale of investments were $317,584, $1,736,946 and $332,953, $2,281,792 for the three and nine months ended September 30, 2014 and 2013, respectively.

Gross gains of $2,988, $83,810 and $161,421 and gross losses of $25,928, $44,620 and $39,980 were realized on these sales during the three months ended September 30, 2014, nine months ended September 30, 2014 and 2013, 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 September 30, 2014 and 2013 and at December 31, 2013:

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
September 30, 2014
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Equities
 
$
326,673
   
$
(40,115
)
 
$
83,996
   
$
(13,326
)
 
$
410,669
   
$
(53,441
)
Mutual Funds
   
6,407
     
(633
)
   
0
     
0
     
6,407
     
(633
)
Preferred Securities
   
175,790
     
(4,330
)
   
0
     
0
     
175,790
     
(4,330
)
Corporate Bonds
   
910,520
     
(65,250
)
   
522,316
     
(50,500
)
   
1,432,836
     
(115,750
)
   
$
1,419,390
   
$
(110,328
)
 
$
606,312
   
$
(63,826
)
 
$
2,025,702
   
$
(174,154
)
 
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
September 30, 2013
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Equities
 
$
292,456
   
$
(28,897
)
 
$
21,409
   
$
(359
)
 
$
313,865
   
$
(29,256
)
Mutual Funds
   
50,080
     
(1,965
)
   
0
     
0
     
50,080
     
(1,965
)
Preferred Securities
   
276,933
     
(26,363
)
   
0
     
0
     
276,933
     
(26,363
)
Corporate Bonds
   
868,294
     
(54,667
)
   
80,994
     
(3,094
)
   
949,288
     
(57,761
)
   
$
1,487,763
   
$
(111,892
)
 
$
102,403
   
$
(3,453
)
 
$
1,590,166
   
$
(115,345
)
 

 
- 11 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013
 

Note 4 – INVESTMENTS - Continued

   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 2013
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Equities
 
$
213,222
   
$
(32,181
)
 
$
0
   
$
0
   
$
213,222
   
$
(32,181
)
Mutual Funds
   
0
     
0
     
0
     
0
     
0
     
0
 
Preferred Securities
   
224,125
     
(15,449
)
   
0
     
0
     
224,125
     
(15,449
)
Corporate Bonds
   
615,986
     
(42,827
)
   
96,726
     
(6,593
)
   
712,712
     
(49,420
)
   
$
1,053,333
   
$
(90,457
)
 
$
96,726
   
$
(6,593
)
 
$
1,150,059
   
$
(97,050
)

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 September 30, 2014, there were three corporate bond securities that had unrealized losses greater than twelve months. 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 September 30, 2014.

 
Note 5 – INVENTORIES

Inventories consist of the following:

   
September 30,
   
December 31,
 
   
2014
   
2013
   
2013
 
Finished goods
 
$
3,177,603
   
$
3,106,557
   
$
3,027,900
 
Production supplies
   
1,669,984
     
3,469,239
     
2,690,097
 
Raw materials
   
2,287,270
     
1,806,491
     
1,181,011
 
Total inventories
 
$
7,134,857
   
$
8,382,287
   
$
6,899,008
 

 
Note 6 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

   
September 30,
   
December 31,
 
   
2014
   
2013
   
2013
 
Land
 
$
1,856,370
   
$
1,856,370
   
$
1,856,370
 
Buildings and improvements
   
15,496,906
     
14,921,016
     
14,587,022
 
Machinery and equipment
   
20,999,223
     
19,921,064
     
19,633,164
 
Vehicles
   
1,244,560
     
1,350,608
     
1,244,560
 
Office equipment
   
433,679
     
433,346
     
433,679
 
Construction in process
   
973,852
     
33,542
     
177,519
 
     
41,004,590
     
38,515,946
     
37,932,314
 
Less accumulated depreciation
   
19,130,070
     
16,878,454
     
17,107,866
 
Total property and equipment
 
$
21,874,520
   
$
21,637,492
   
$
20,824,448
 

Lifeway completed the purchase of Golden Guernsey’s assets on July 2, 2013. The cost was approximately $7.4 million.

Depreciation expense during the three and nine months ended September 30, 2014 and 2013 was $1,010,966 and $2,022,204, $410,797 and $1,226,629 respectively.  Included in the depreciation expense for the three months ended September 30, 2014 is an adjustment of approximately $470,000 related to the useful life of the Company’s Starfruit leasehold improvements.

 
- 12 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2014 and 2013 (Unaudited) and December 31, 2013
 

Note 7 ACCRUED EXPENSES

Accrued expenses consist of the following:

   
September 30,
   
December 31,
 
   
2014
   
2013
   
2013
 
Accrued payroll and payroll taxes
 
$
231,612
   
$
562,491
   
$
477,312
 
Accrued property tax
   
251,228
     
244,028
     
306,608
 
Other
   
761,036
     
516,694
     
500,140
 
   
$
1,243,876
   
$
1,323,213
   
$
1,284,060
 

Note 8 – NOTES PAYABLE

Notes payable consist of the following:

   
September 30,
   
December 31,
 
   
2014
   
2013
   
2013
 
Note payable to Private Bank in monthly installments of $42,222, plus variable interest rate, currently at 2.6677%, with a balloon payment for the remaining balance. Collateralized by substantially all assets of the Company. In May 2013, the Company refinanced this note under similar terms which extended the maturity date to May 31, 2018.
  $ 4,478,889     $ 4,985,556     $ 4,858,889  
                         
Note payable to Private Bank in monthly installments of $27,778, plus variable interest rate, currently at 2.6677% with a balloon payment for the remaining balance, maturing on May 31, 2019, collateralized by substantially all assets of the Company.
    4,666,667       5,000,000       4,916,667  
                         
Notes payable to Ford Credit Corp. payable in monthly installments of $1,778 at 5.99%, due July 2015, secured by transportation equipment.
    17,294       36,919       32,124  
                         
Note payable to Fletcher Jones of Chicago, Ltd LLC in monthly installments of $1,769 at 6.653%, due May 24, 2017, secured by transportation equipment.
    53,470       70,466       66,334  
Total notes payable
    9,216,320       10,092,941