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EX-31.1 - 302 CERTIFICATION OF THE C.E.O. - Lifeway Foods, Inc.exh31-1_17854.htm
EX-31.2 - 302 CERTIFICATION OF THE C.F.O. - Lifeway Foods, Inc.exh31-2_17854.htm
EX-32.1 - 906 CERTIFICATION OF THE C.E.O. - Lifeway Foods, Inc.exh32-1_17854.htm
EX-32.2 - 906 CERTIFICATION OF THE C.F.O. - Lifeway Foods, Inc.exh32-2_17854.htm


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

 
(Mark One)  
   
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:  March 31, 2015
 
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  o   No  x
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes o    No  x
 
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 September 24, 2015, 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.
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
22
Item 4.
Controls and Procedures.
22
 
 
PART II – OTHER INFORMATION
 
Item 1.
Legal Proceedings.
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 -

 
ITEM 1.  FINANCIAL STATEMENTS.

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
March 31, 2015 and December 31, 2014

   
March 31,
   
December 31,
 
   
2015
   
2014
 
ASSETS
 
(Unaudited)
       
             
Current assets
           
Cash and cash equivalents
 
$
3,824,923
   
$
3,260,244
 
Investments, at fair value
   
3,038,503
     
2,779,140
 
Certificates of deposits in financial institutions
   
134,981
     
149,965
 
Inventories
   
6,327,345
     
5,814,219
 
Accounts receivable, net of allowance for doubtful accounts and discounts of $1,100,000 and $1,050,000 at March 31, 2015 and  December 31, 2014, respectively
   
10,218,003
     
10,213,541
 
Prepaid expenses and other current assets
   
87,009
     
251,922
 
Other receivables
   
118,425
     
134,338
 
Deferred income taxes
   
439,596
     
408,340
 
Refundable income taxes
   
90,764
     
1,140,796
 
Total current assets
   
24,279,549
     
24,152,505
 
                 
Property and equipment, net
   
22,341,373
     
21,892,395
 
                 
Intangible assets
               
Goodwill
   
14,068,091
     
14,068,091
 
Other intangible assets, net
   
2,880,845
     
3,059,764
 
Total intangible assets
   
16,948,936
     
17,127,855
 
                 
Other Assets
               
Long-term accounts receivable, net of current portion
   
265,152
     
251,683
 
Total assets
 
$
63,835,010
   
$
63,424,438
 
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities
               
Current maturities of notes payable
 
$
840,000
   
$
872,285
 
Accounts payable
   
4,123,138
     
5,586,755
 
Accrued expenses
   
3,460,774
     
2,066,076
 
Accrued income taxes
   
144,585
     
 
Total current liabilities
   
8,568,497
     
8,525,116
 
                 
Notes payable
   
7,885,555
     
8,124,515
 
                 
Deferred income taxes
   
1,961,408
     
2,075,095
 
Total liabilities
   
18,415,460
     
18,724,726
 
                 
Stockholders’ equity
               
Common stock, no par value; 40,000,000 shares authorized;
               
17,273,776 shares issued; 16,346,017 shares outstanding
               
at March 31, 2015 and December 31, 2014
   
6,509,267
     
6,509,267
 
Paid-in-capital
   
2,032,516
     
2,032,516
 
Treasury stock, at cost
   
 (8,187,682
)
   
(8,187,682
)
Retained earnings
   
45,197,336
     
44,543,618
 
Accumulated other comprehensive loss, net of taxes
   
(131,887
)
   
(198,007
)
Total stockholders’ equity
   
45,419,550
     
44,699,712
 
                 
Total liabilities and stockholders’ equity
 
$
63,835,010
   
$
63,424,438
 
 

 
See accompanying notes to consolidated financial statements

 
- 3 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Three Months Ended March 31, 2015 and 2014
(Unaudited)
   
Three Months Ended March 31,
 
   
2015
   
2014
 
Gross sales
  $ 33,103,084     $ 32,061,147  
Less: discounts and promotional allowances
    (3,480,960 )     (2,929,436 )
Net sales
    29,622,124       29,131,711  
                 
Cost of goods sold
    20,647,967       21,681,910  
Depreciation expense
    590,627       783,361  
                 
Total cost of goods sold
    21,238,594       22,465,271  
                 
Gross profit
    8,383,530       6,666,440  
                 
Selling expenses
    4,162,403       3,479,688  
General and administrative
    2,631,896       2,380,631  
Amortization expense
    178,919       178,919  
                 
Total operating expenses
    6,973,218       6,039,238  
                 
Income from operations
    1,410,312       627,202  
                 
Other income (expense):
               
Interest and dividend income
    25,479       28,698  
Rental income
    1,800       500  
Interest expense
    (65,341 )     (65,569 )
(Loss)/Gain on sale of investments, net
               
reclassified from OCI
    (5,093 )     4,808  
Gain on sale of equipment
    36,000        
Other income (expense), net
    (98,932 )      
Total other income (expense)
    (106,087 )     (31,563 )
                 
Income before provision for
               
   income taxes
    1,304,225       595,639  
                 
Provision for income taxes
    650,507       298,461  
                 
Net income
  $ 653,718     $ 297,178  
                 
Basic and diluted earnings
               
   per common share
    0.04       0.02  
                 
Weighted average number of
               
   common shares outstanding
    16,346,017       16,346,017  
                 
COMPREHENSIVE INCOME
               
                 
Net income
  $ 653,718     $ 297,178  
                 
Other comprehensive income
               
(loss), net of tax:
               
Unrealized gains (losses) on
               
  investments (net of tax)
    (46,260 )     8,044  
Less reclassification adjustment
               
  for (gains) losses and other than
               
      temporary impairments included in
               
  net income (net of taxes)
    112,380       (2,717 )
                 
Comprehensive income
  $ 719,838     $ 302,505  
 
 
See accompanying notes to consolidated financial statements

 
- 4 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
For the Three Months Ended March 31, 2015 and 2014
(Unaudited)
 
 
 
                                 
Accumulated
       
                                 
Other
       
   
Common Stock
               
Comprehensive
       
   
Issued
   
In treasury
   
Paid In
   
Retained
   
Income (Loss),
       
   
Shares
   
$
   
Shares
   
$
   
Capital
   
Earnings
   
Net of Tax
   
Total Equity
 
                                                             
     
 
Balances at December 31, 2013
   
17,273,776
   
$
6,509,627
     
(927,759
)
 
$
(8,187,682
)
 
$
2,032,516
   
$
42,587,214
   
$
7,807
   
$
42,949,122
 
                                             
 
 
Other comprehensive income
   
     
     
     
     
     
     
5,327
     
5,327
 
                                                             
     
 
Net income for the three months ended March 31, 2014
   
     
     
     
     
     
297,178
     
     
297,178
 
                                                             
     
 
Balances at March 31, 2014
   
17,273,776
   
$
6,509,627
     
(927,759
)
 
$
(8,187,682
)
 
$
2,032,516
   
$
42,884,392
   
$
13,134
   
$
43,251,627
 
                                                             
     
 
Balances at December 31, 2014
   
17,273,776
   
$
6,509,627
     
(927,759
)
 
$
(8,187,682
)
 
$
2,032,516
   
$
44,543,618
   
$
(198,007
)
 
$
44,699,712
 
                                                             
     
 
Other comprehensive income
   
     
     
     
     
     
     
66,120
 
   
66,120
 
 
                                                           
     
 
Net income for the three months ended March 31, 2015
   
     
     
     
     
     
653,718
     
     
653,718
 
                                                             
     
 
Balances at March 31, 2015
   
17,273,776
   
$
6,509,627
     
(927,759
)
 
$
(8,187,682
)
 
$
2,032,516
   
$
45,197,336
   
$
(131,887
)
 
$
45,419,550
 
 
 
 
 
 
 
 
 
 
 
 
 

 
See accompanying notes to consolidated financial statements
 
 
- 5 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2015 and 2014
(Unaudited)


   
March 31,
 
   
2015
   
2014
 
             
Cash flows from operating activities:
           
Net income
 
$
653,718
   
$
297,178
 
Adjustments to reconcile net income to net
               
cash flows from operating activities:
               
Depreciation and amortization
   
769,546
     
962,280
 
Loss (gain) on sale of investments, net
   
5,093
     
(4,808
)
Impairment of investments     179,500      
 
Deferred income taxes
   
(196,103
)
   
(196,401
)
Bad debt expense
   
250
     
126,049
 
Gain on sale of equipment
   
(36,000
)
   
 
(Increase) decrease in operating assets:
               
Accounts receivable
   
(32,942
)
   
(468,826
)
Other receivables
   
15,913
     
11,644
 
Inventories
   
(513,126
)
   
(456,876
)
Refundable income taxes
   
1,050,032
     
(1,602,376
)
Prepaid expenses and other current assets
   
164,913
     
88,468
 
Increase (decrease) in operating liabilities:
               
Accounts payable
   
(1,463,617
)
   
235,820
 
Accrued expenses
   
1,394,698
     
1,448,110
 
Accrued income taxes
   
144,585
     
 
Net cash provided by operating activities
   
2,136,460
     
440,262
 
                 
Cash flows from investing activities:
               
Purchases of investments
   
(1,005,138
)
   
(814,804
)
Proceeds from sale of investments
   
693,223
     
554,609
 
Redemption of certificates of deposits
   
99,965
     
15,000
 
Investments in certificates of deposits
   
(84,981
)
   
 
Purchases of property and equipment
   
(1,039,605
)
   
(807,894
)
Proceeds from sale of equipment
   
36,000
     
 
Net cash used in investing activities
   
(1,300,536
)
   
(1,053,089
)
                 
Cash flows from financing activities:
               
Repayment of notes payable
   
(271,245
)
   
(219,073
)
Net cash used in financing activities
   
(271,245
)
   
(219,073
)
                 
Net (decrease) increase in cash and cash equivalents
   
564,679
     
(831,900
)
                 
Cash and cash equivalents at the beginning of the period
   
3,260,244
     
3,306,608
 
                 
Cash and cash equivalents at the end of the period
 
$
3,824,923
   
$
2,474,708
 
                 
                 
Supplemental cash flow information                
Cash paid for income taxes   $ 40,000     $ 2,109,500  
Cash paid for interest   $ 65,110     $ 66,210  


See accompanying notes to consolidated financial statements

 
- 6 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 1 – NATURE OF BUSINESS

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 health food products. Lifeway’s primary product is kefir, a dairy beverage similar to but distinct from yogurt, in several flavors and in several packages. In addition to kefir, Lifeway manufactures “Lifeway Farmer Cheese,” a line of various farmer cheeses. Lifeway distributes its products throughout the United States and in London, England. The Company manufactures all of its products distributed in the United States at Company-owned facilities. In the Chicago metropolitan area, Lifeway distributes its products on its own trucks and via distributors. The Company directly distributes its products in the Philadelphia and Tri State metropolitan areas using its own trucks. The Company distributes its products throughout the remainder of the United States via distributors. The Company’s products distributed in London are manufactured and shipped to stores by a third party co-packer. Products sold by the Company to distributors in the United States may be resold by such distributors within or outside of the United States, including in Mexico, Costa Rica and the Caribbean. The Company’s products are also manufactured and distributed in Canada by a third party co-packer.

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Corrections of prior period financial statements
As reported in the Company’s fiscal 2014 annual report on Form 10-K, the Company recorded out-of-period adjustments during fiscal 2014 to correct the accounting for certain errors related primarily to the provision for income taxes and an understatement of depreciation expense arising from assigning incorrect useful lives.  The Company has revised its previously issued interim consolidated financial statements to correct for these matters. The adjustments decreased previously reported first quarter income before provision for income taxes by approximately $400,000 and net income by approximately $363,000.  

There was no impact to quarterly cash flows in 2014 as the increase in net income was offset by the decrease in the non-cash reconciling items for depreciation expense and refundable income taxes. The Company does not believe that these adjustments are material to the results of operations, financial position or cash flows for any of its previously reported interim consolidated financial statements.  Accordingly, the March 31, 2014 interim consolidated financial statements included herein have been revised to reflect the adjustments discussed above. The Company will also revise its 2014 second and third quarter interim consolidated financial statements prospectively within its 2015 second and third quarter Quarterly Reports on Form 10-Q.

The net-of-tax effect of these adjustments decreases the Company’s previously reported 2014 earnings per common and diluted share by $0.02 and $0.03 for the quarters ended March 31 and June 30, respectively and increases the Company’s earnings per common and diluted share by $0.05 for the quarter ended December 31, 2014.
  
Basis of presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information, and do not include all of the information and disclosures required for complete, audited financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation, have been included. For further information, refer to the consolidated financial statements and disclosures included in the consolidated financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2014.

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,
 
 
- 7 -

 
 LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
L.L.C. 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 consolidated financial statements in conformity with U.S. GAAP 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 reserve for promotional allowances, the fair value of investment securities, the valuation of goodwill and 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. The Company routinely offers sales allowances and discounts to our customers and consumers. These programs include rebates, in-store display and demo allowances, allowances for non-salable product, coupons and other trade promotional activities. These allowances are considered reductions in the price of our products and thus are recorded as reductions to gross sales. Some of these incentives are recorded by estimating incentive costs based on our historical experience and expected levels of performance of the trade promotion. We maintain a reserve at the end of each period for the estimated allowances incurred but unpaid.  Differences between estimated and actual allowances are normally insignificant and are recognized in earnings in the period such differences are determined. Product returns have historically not been material.
 
Bulk cream is a by-product of the Company’s fluid milk manufacturing process. The company does not use bulk cream in any of its end products, but rather disposes of it through sales to other companies. Bulk cream by-product sales are included in gross sales.

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 26% and 30% of gross sales for the three months ended March 31, 2015 and 2014, respectively.
   
Cash and cash equivalents
All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
 
 
 
 
 
 
- 8 -

 
 LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

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 to the extent they are considered temporary in nature. Amortization, accretion, interest and dividends, realized gains and losses, and declines in fair value judged to be other-than-temporary on available-for-sale securities are recorded as a component of 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 fair value has occurred include: the fair value of the security in relation to its carrying amount; 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 fair 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 collected 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 allowance 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

 
Intangible assets acquired in business combinations
Intangible assets acquired in a business combination are recorded 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.  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.

 
- 9 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 

Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Intangible assets are being amortized over the following useful lives:

Category
 
Years
Recipes
 
4
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. Periods subject to examination for the Company’s federal returns are the 2012, 2013 and 2014 tax years. The amount of unrecognized tax benefits that, if recognized, would impact the annual effective tax rate was not significant as of March 31, 2015 and December 31, 2014. The total amount of unrecognized tax benefits can change due to audit settlements, tax examination activities, statute expirations and the recognition and measurement criteria under accounting for uncertainty in income taxes.
 
Treasury stock
Treasury stock is recorded using the cost method.

Advertising and promotional costs
The Company expenses advertising costs as incurred. For the three months ended March 31, 2015 and 2014 total advertising expenses were $1,874,538 and $819,016, respectively.

Earnings per common share
Earnings per common share were computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. For the three months ended March 31, 2015 and 2014 the weighted average number of shares outstanding used in the calculation of diluted and basic earnings per share were the same.
 
Segments
The Company has two separate operating segments, the sale of fermented dairy products and three retail locations in Illinois that sell the Company’s fermented dairy products. The Company has determined reportable segments 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.  Substantially all of the consolidated revenues of the Company relate to the sale of fermented dairy products which are produced using the same processes and materials and are sold to consumer retail food sellers through direct delivery and distributors in the United States.

 
- 10 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued

Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific requirements. ASU 2014-09 establishes a five-step revenue recognition process in which an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. In August 2015 the FASB delayed the effective date for implementation of ASU 2014-09. Under the delayed effective date, the Company is required to adopt the new standard not later than January 1, 2018. Management is currently evaluating the impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial position, results of operations or cash flows and the method of retrospective application, either full or modified.

In July 2015, the FASB issued new accounting guidance for measuring inventory.  The core principal of the guidance is that an entity should measure inventory at the lower of cost and net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.  This guidance does not apply to inventory that is being measured using the Last-In, First-Out (LIFO) or the retail inventory method.  The guidance is effective for financial statements issued for annual and interim periods beginning after December 15, 2016 on a prospective basis.  Early adoption is permitted.  Management is currently evaluating the impact this will have on the consolidated financial statements.

 
Note 3 – INTANGIBLE ASSETS

Intangible assets, net consists of the following:

   
As of
 
   
March 31, 2015
   
December 31, 2014
 
Recipes
 
$
43,600
   
$
43,600
 
Customer lists and other customer related intangibles
   
4,529,200
     
4,529,200
 
Customer relationship
   
985,000
     
985,000
 
Trade names
   
2,248,000
     
2,248,000
 
Formula     438,000       438,000  
    Subtotal     8,243,800       8,243,800  
Accumulated amortization
   
(5,362,955
)
   
(5,184,036
)
Intangible assets, net
 
$
2,880,845
   
$
3,059,764
 
 
 
Note 4 – INVESTMENTS

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

March 31, 2015
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
Common Stocks & ETFs
 
$
1,044,604
   
$
20,042
   
$
(86,266
)
 
$
978,380
 
Mutual Funds
   
58,330
     
     
(3,667
)
   
54,663
 
Preferred Securities
   
97,405
     
3,315
     
     
100,720
 
Corporate Bonds
   
2,046,093
     
6,726
     
(148,079
)
   
1,904,740
 
Total
 
$
3,246,432
   
$
30,083
   
$
(238,012
)  
$
3,038,503
 
 
 
 
 
- 11 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)

 
Note 4 – INVESTMENTS – Continued
 
December 31, 2014
 
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
Common Stocks & ETFs
 
$
530,328
   
$
19,608
   
$
(64,046
)
 
$
485,890
 
Mutual Funds
   
445,337
     
0
     
(10,624
)
   
434,713
 
Preferred Securities
   
180,120
     
195
     
(2,075
)
   
178,240
 
Corporate Bonds
   
1,948,596
     
1,880
     
(270,179
)
   
1,680,297
 
Total
 
$
3,104,381
   
$
21,683
   
$
(346,924
)
 
$
2,779,140
 

 
Proceeds from the sale of investments were $693,223 and $554,609 for the three months ended March 31, 2015 and 2014, respectively.
 
Gross gains of $5,502 and $19,651 and gross losses of $10,595 and $14,843 were realized on these sales during the three months ended March 31, 2015 and 2014, respectively.
 
The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2015 and December 31, 2014:
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
March 31, 2015
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Common Stocks & ETFs
 
$
458,306
   
$
(43,834
)
 
$
159,492
   
$
(42,432
)
 
$
617,798
   
$
(86,265
)
Mutual Funds
   
54,663
     
(3,667
)
   
0
     
0
     
54,663
     
(3,667
)
Preferred Securities
   
0
     
0
     
0
     
0
     
0
     
0
 
Corporate Bonds
   
1,922,104
     
(60,687
)
   
489,394
     
(87,392
)
   
2,411,498
     
(148,079
)
   
$
2,435,073
   
$
(108,188
)
 
$
648,886
   
$
(129,824
)
 
$
3,083,960
   
$
(238,012
)
 
 
 
   
Less Than 12 Months
   
12 Months or Greater
   
Total
 
December 31, 2014
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Common Stocks & ETFs
 
$
162,268
   
$
(49,053
)
 
$
141,417
   
$
(14,993
)
 
$
303,685
   
$
(64,046
)
Mutual Funds
   
434,713
     
(10,624
)
   
0
     
0
     
434,713
     
(10,624
)
Preferred Securities
   
80,640
     
(2,075
)
   
0
     
0
     
80,640
     
(2,075
)
Corporate Bonds
   
1,056,140
     
(194,641
)
   
497,277
     
(75,538
)
   
1,553,417
     
(270,179
)
   
$
1,733,761
   
$
(256,393
)
 
$
638,694
   
$
(90,531
)
 
$
2,372,455
   
$
(346,924
)

 
The Company’s investments in equity securities, mutual funds, preferred securities, and corporate bonds consist of investments in common stock, preferred stock, structured notes and other debt securities of companies in various industries. During the first quarter of 2015, the Company recorded other-than-temporary impairment losses of approximately $180,000 with respect to three structured notes.  The impairment loss is included in “other income (expense), net” in the accompanying consolidated statements of income and comprehensive income. The structured notes allow the issuer to settle at less than par in certain circumstances. In reaching a conclusion to record these other-than-temporary impairment losses, the Company evaluated the near-term prospects of the issuers and determined it was probable the issuers would have the ability to settle the bonds for an amount less than par value at maturity. With respect to one other corporate bond with 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
 
 
 
- 12 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)

 
Note 4 – INVESTMENTS – Continued
 
hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company did not consider the investment to be other-than-temporarily impaired at March 31, 2015.
 
 
Note 5 – INVENTORIES

Inventories consist of the following:
 
   
March 31,
2015
   
December 31,
2014
 
Finished goods
  $ 1,808,030     $ 2,373,476  
Production supplies
    2,891,156       2,069,742  
Raw materials
    1,628,159       1,371,001  
Total inventories
  $ 6,327,345     $ 5,814,219  

 
Note 6 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

   
March 31,
2015
   
December 31,
2014
 
Land
 
$
1,856,370
   
$
1,856,370
 
Buildings and improvements
   
16,315,094
     
15,125,803
 
Machinery and equipment
   
22,505,404
     
20,434,910
 
Vehicles
   
1,310,527
     
1,244,560
 
Office equipment
   
564,908
     
465,801
 
Construction in process
   
23,500
     
2,408,754
 
     
42,575,803
     
41,536,198
 
Less accumulated depreciation
   
20,234,430
     
19,643,803
 
Total property and equipment
 
$
22,341,373
   
$
21,892,395
 

 
Note 7 – ACCRUED EXPENSES

Accrued expenses consist of the following:

   
March 31,
2015
   
December 31,
2014
 
Accrued payroll and payroll taxes
 
$
848,176
   
$
891,763
 
Accrued property tax
   
280,669
     
331,278
 
Other
   
2,331,929
     
843,035
 
   
$
3,460,774
   
$
2,066,076
 

 
 
 
 

 
- 13 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)

 
Note 8 – NOTES PAYABLE

Notes payable consist of the following:

   
March 31,
2015
   
December 31,
2014
 
             
Note payable to Private Bank in monthly installments of $42,222, plus variable interest rate (currently 2.67%) with a balloon payment for the remaining balance. Collateralized by substantially all assets of the Company. Maturity date - May 31, 2018.
  $ 4,225,555     $ 4,352,222  
                 
Note payable to Private Bank in monthly installments of $27,778, plus variable interest rate (currently 2.67%) with a balloon payment for the remaining balance, maturing on May 31, 2019, collateralized by substantially all assets of the Company.
    4,500,000       4,583,333  
                 
Notes payable to Ford Credit Corp. payable in monthly installments of $1,778 at 5.99%, paid March 2015.
          12,198  
                 
Note payable to Fletcher Jones of Chicago, Ltd LLC in monthly installments of $1,769 at 6.653%, paid in March 2015.
          49,047  
Total notes payable
    8,725,555       8,996,800  
Less current maturities
    840,000       872,285  
Total long-term portion
  $ 7,885,555     $ 8,124,515  

 
In accordance with the Private Bank agreements referenced above, the Company is subject to minimum fixed charged ratio and tangible net worth thresholds. The Company was in compliance with these financial covenants at March 31, 2015.  Further, the Company is required to deliver its annual and quarterly consolidated financial statements and related SEC filings within specified timeframes. Due to the Company’s delay in completing such filings the Company obtained waivers as further discussed in Note 14.

In addition, as of March 31, 2015 the Company had a $5 million revolving credit facility with The Private Bank. Borrowings under the facility were subject to interest at the prime rate or LIBOR plus 2.5%. At March 31, 2015 there were no borrowings under the facility. The facility expires on July 31, 2016.

Maturities of notes payables are as follows:

For the 12 Months Ended March 31,
   
2016
 
$
840,000
 
2017
   
840,000
 
2018
   
840,000
 
2019
   
3,038,899
 
2020     3,166,656  
Total
 
$
8,725,555
 
 
 


 
- 14 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)

 
Note 9 – COMMITMENTS AND CONTINGENCIES

The Company leases three stores for its Starfruit subsidiary. Total expense for these leases was $64,981 and $71,921 for the three months ended March 31, 2015 and 2014, respectively. The Company is also responsible for additional rent equal to real estate taxes and other operating expenses. Future annual minimum base rental payments for the leases as of March 31, 2015 are approximately as follows:

       
For the 12 months ending March 31,
       
2016
 
$
73,000
 
2017
   
75,000
 
2018
   
70,000
 
2019
   
37,000
 
Total
 
$
255,000
 
 
 
Note 10 – PROVISION FOR INCOME TAXES

The effective tax rate for the three months ended March 31, 2015 was 49.9% compared to 50.1% for the three months ended March 31, 2014.   The difference between the statutory and effective tax rate reflects certain operating expenses that are not fully deductible for federal income tax purposes.

 
Note 11 – FAIR VALUE MEASUREMENTS

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, provides the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described as follows:

Level 1. Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.

Level 2. Inputs to the valuation methodology include the following:

 
Quoted prices for similar assets or liabilities in active markets;
 
Quoted prices for identical or similar assets or liabilities in inactive markets;
 
Inputs other than quoted prices that are observable for the asset or liability;
 
Inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
 
If the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability.

Level 3. Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

Following is a description of the valuation methodologies used for assets measured at fair value on a recurring basis. There have been no changes in the methodologies used as of March 31, 2015 and December 31, 2014.
 
 

 
- 15 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 11 – FAIR VALUE MEASUREMENTS – Continued

The majority of the Company’s fair value measurements for investments are classified within Level 1 or Level 2 of the fair value hierarchy. The Company’s Level 1 fair value measurements, which include mutual funds and common stocks, is based on quoted market prices in active markets for identical securities. The Company’s Level 2 fair value measurements, which include corporate bonds, is based on other observable inputs, specifically a valuation model which utilized vendor pricing for similar securities.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

The following table sets forth by level, within the fair value hierarchy, the Company’s financial assets measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:


   
Assets and Liabilities at Fair Value as of March 31, 2015
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Mutual Funds
  $
54,663
    $
    $
    $
54,663
 
Stocks
   
978,380
     
     
     
978,380
 
Preferred Securities
   
     
100,720
     
     
100,720
 
Corporate Bonds
   
     
1,795,740
     
145,000
     
1,904,740
 


   
Assets and Liabilities at Fair Value as of December 31, 2014
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Mutual Funds
  $
434,713
    $
    $
    $
434,713
 
Stocks
   
485,890
     
     
     
485,890
 
Preferred Securities
   
     
178,240
     
     
178,240
 
Corporate Bonds
   
     
1,680,297
     
     
1,680,297
 

The Company’s financial assets and liabilities which are not recorded at fair value on a recurring basis include cash and cash equivalents, certificate of deposit, accounts receivable, other receivables, accounts payable and notes payable for which carrying value approximates fair value.

 
Note 12 – LITIGATION

The Company is named a party to lawsuits in the normal course of business. In the opinion of management, the resolution of these lawsuits will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

 
- 16 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 13 – SEGMENTS AND PRODUCTS

The Company manufactures probiotic, cultured, functional dairy health food products. The Company’s primary product is kefir, a dairy beverage similar to but distinct from yogurt, in several flavors and in several packages. In addition to the drinkable products, Lifeway manufactures “Lifeway Farmer Cheese,” a line of various farmer cheeses.

Net sales of products by category for the three months ended March 31 were as follows:

   
2015
   
2014
 
Drinkable Kefir other than ProBugs
  $
25,587,341
    $
25,087,811
 
ProBugs
   
2,006,071
     
1,863,897
 
Lifeway Farmer Cheese
 
 
1,722,392
   
 
1,686,188
 
Frozen Kefir
   
306,320
     
493,815
 
Net Sales
 
$
29,622,124
   
$
29,131,711
 


The Company has two operating segments, the sale of fermented dairy products and three retail locations in Illinois that sell the Company’s fermented dairy products. The Company has determined its reportable segments 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. Substantially all of the consolidated revenues of the Company relate to the sale of fermented dairy products which are produced using the same processes and materials and are sold to consumer retail food sellers through direct delivery and distributors in the United States.

The Company has less than $1 million in revenues attributable to its retail locations during the three months ended March 31, 2015 and 2014. The annual revenues attributable to the three retail locations are not material and accordingly the Company has not presented financial information separately for this segment. Substantially all of the consolidated revenues and assets of the Company are within the United States.
 
 
Note 14 - SUBSEQUENT EVENTS

On April 6, 2015, May 14, 2015 and August 25, 2015 the Company received letters (the “Nasdaq Notices”) from The NASDAQ Stock Market LLC (“Nasdaq”) notifying the Company that because it had not yet filed with the SEC its Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (the “Form 10-K”) and its Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2015 (the “First Quarter Form 10-Q”) and June 30, 2015 (the “Second Quarter Form 10-Q”), the Company is not in compliance with the periodic filing requirements for continued listing set forth in Nasdaq Listing Rule 5250(c)(1).  The Company filed the Form 10-K on August 14, 2015 and by filing this report, has filed the First Quarter Form 10-Q. The Company is diligently working to file the Second Quarter Form 10-Q and to regain compliance with Nasdaq Rule 5250(c)(1).

On August 11, 2015, The Private Bank agreed to extend the due date for the Company to deliver its Annual Report on Form 10-K for the fiscal year ended December 31, 2014 until August 14, 2015 as well as the due date for the Company to deliver its First Quarter Form 10-Q to September 30, 2015 and its Second Quarter Form 10-Q to October 15, 2015.  On August 11, 2015, The Private Bank also extended the maturity date for the revolving credit facility to July 31, 2016.

 
- 17 -

 
LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2015 and December 31, 2014
(Unaudited)
 
 
Note 14 - SUBSEQUENT EVENTS – Continued

On September 24, 2015, the Company’s Board of Directors authorized a stock repurchase program under which the Company may repurchase up to $3,500,000 of the Company’s common stock not to exceed an aggregate of 250,000 shares, in the open market or in privately negotiated transactions, in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Securities Exchange Act of 1934, as amended. The extent to which the Company repurchases its shares and the timing of such repurchases, will depend upon a variety of factors, including market conditions, regulatory requirements and other corporate considerations, as determined by management. The repurchase program may be suspended or discontinued at any time.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
- 18 -

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

The following discussion of the financial condition and results of operations of Lifeway Foods, Inc. as of and for the three months ended March 31, 2015 should be read in conjunction with the unaudited consolidated financial statements and the notes to those statements that are included elsewhere in this report on Form 10-Q and the audited financial statements and Management’s Discussion and Analysis contained in our Form 10-K for the fiscal year ended December 31, 2014 (the “Form 10-K”). In addition to historical information, the following discussion contains certain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as “may”, “will”, “could”, “expect”, “anticipate”, “intend”, “believe”, “estimate”, “plan”, “predict”, and similar terms or terminology, or the negative of such terms or other comparable terminology. Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section of the Form 10-K. We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future.

Comparison of Quarter Ended March 31, 2015 to Quarter Ended March 31, 2014

Results of Operations

Net sales

The following table summarizes our net sales:

   
Three months ended
March 31,
   
Change
 
   
2015
   
2014
   
$
     
%
 
Gross Sales
  $
33,103,084
    $
32,061,147
    $
1,041,937
     
3.2%
 
Less: Discounts & promotional allowances
   
(3,480,960
)
   
(2,929,436
)
   
(551,524
)
   
18.8%
 
Net Sales
  $
29,622,124
    $
29,131,711
    $
490,413
     
1.7%
 
Discounts & promotional allowances % to gross sales
   
10.5%
     
9.1%
                 

 
Net sales increased by $490,413 or 1.7% to $29,622,124 during the three-month period ended March 31, 2015 from $29,131,711 during the same three-month period in 2014. The 1.7% increase is due to cream sales in 2015 partially offset by lower volumes of drinkable Kefir.  The Company began selling cream, a by-product of the Company’s manufacturing process, in April 2014.  The increase in net sales reflects a $1,041,937 or 3.2% increase in gross sales offset somewhat by higher discounts and promotional allowances as the Company increased its promotional activity in the first quarter of 2015 compared to the same period in 2014.  
 
 
 
 

 
 
- 19 -

 
Cost of goods sold

The following table summarizes our cost of goods sold:

   
Three months ended
March 31,
   
Change
 
   
2015
   
2014
   
$
     
%
 
Purchases
  $
11,881,073
    $
15,474,120
    $
(3,593,047
)
   
-23.2%
 
Testing
   
13,974
     
8,313
     
5,661
     
68.1%
 
Supplies
   
683,663
     
288,208
     
395,455
     
137.2%
 
Salaries production
   
2,738,772
     
2,146,958
     
591,814
     
27.6%
 
Contract work
   
34,021
     
24,116
     
9,905
     
41.1%
 
Freight
   
3,208,756
     
2,826,332
     
382,424
     
13.5%
 
Delivery expense
   
107,234
     
83,223
     
24,011
     
28.9%
 
Outside services
   
     
1,581
     
(1,581
)
   
-100.0%
 
Labor and overhead
   
1,980,474
     
829,059
     
1,151,415
     
138.9%
 
Cost of Goods Sold, excluding depreciation
   
20,647,967
     
21,681,910
     
(1,033,943
)
   
-4.8%
 
Depreciation expense
   
590,627
     
783,361
     
(192,734
)    
24.6%
 
Cost of Goods Sold
  $
21,238,594
    $
22,465,271
    $
(1,226,677
)
   
-5.4%
 
Cost of Goods sold % to net sales
   
71.7%
     
77.1%
                 

Cost of goods sold, excluding depreciation expense, declined by $1,033,943 or 4.8% to $20,647,967 during the three-month period ended March 31, 2015 from $21,681,910 during the same three-month period in 2014.  Cost of goods sold, excluding depreciation expense as a percent of sales was 71.7% during the three-month period ended March 31, 2015 compared to 77.1% during the same three-month period in 2014.  The overall improvement in the cost of goods sold percent to sales reflects lower costs of purchases of raw materials, primarily lower milk prices, offset somewhat by increased labor and overhead, production salaries and supplies. In April, 2014 the Company began processing raw milk and producing Kefir related packaging in its Waukesha, Wisconsin facility, contributing to increased labor and overhead, production salaries and supplies in the first quarter of 2015 compared to the first quarter of 2014.

Depreciation expense decreased by $192,734 or about 24.6% to $590,627 during the three-month period ended March 31, 2015 from $783,361 during the same three-month period in 2014. The decrease reflects a $400,000 correction of depreciation expense related to periods prior to 2014 recognized in the first quarter of 2014 partially offset by increased depreciation expense associated with assets placed in service at the Lifeway Wisconsin location in 2015.

Selling Expenses

The following table summarizes our selling expenses:

   
Three months ended
March 31,
   
Change
 
   
2015
   
2014
   
$
     
%
 
Salesperson commissions
  $
564,466
    $
534,691
    $
29,775
     
5.6%
 
Advertising
   
1,874,538
     
819,016
     
1,055,522
     
129.0%
 
Salaries
   
1,466,630
     
1,604,153
     
(137,523
)
   
-8.6%
 
Promotions payable
   
47,879
     
72,882
     
(25,003
)
   
-34.3%
 
Travel
   
208,890
     
448,946
     
(240,056
)
   
-53.5%
 
Selling expense
  $
4,162,403
    $
3,479,688
    $
682,715
     
19.6%
 
% to net sales
   
14.1%
     
11.9%
                 

Selling expenses increased by $682,715 or 19.6% to $4,162,403 during the three-month period ended March 31, 2015 from $3,479,688 during the same period in 2014.  Selling expenses as a percentage of sales were 14.1% for the three-month period ended March 31, 2015 compared to 11.9% for the same period in 2014.  The increase resulted primarily from increases in advertising expenses offset partially by lower travel due to timing.  During the first quarter of 2015 the company ran its first national TV commercial contributing to the increased advertising expense.

 
- 20 -

 
General and administrative expenses

The following table summarizes our general and administrative expenses:

   
Three months ended
March 31,
   
Change
 
   
2015
   
2014
   
$
     
%
 
Salaries
  $
972,609
    $
935,132
    $
37,477
 
   
-2.7%
 
Rent
   
64,981
     
71,922
     
(6,941
)
   
-9.7%
 
Equipment lease
   
1,901
     
1,168
     
733
     
62.7%
 
Auto expense
   
21,201
     
15,425
     
5,776
     
37.4%
 
Office supplies
   
26,587
     
25,187
     
1,400
     
5.6%
 
Professional fees
   
877,958
     
743,868
     
134,090
     
18.0%
 
Permits and licenses
   
     
84,157
     
(84,157
)
   
-100.0%
 
Telephone expense
   
38,270
     
27,524
     
10,746
     
39.0%
 
Facilities
   
480,538
     
194,375
     
286,163
     
147.2%
 
Tax
   
76,038
     
32,344
     
43,694
     
135.1%
 
Miscellaneous
   
71,813
     
249,529
     
(177,716
)
   
-71.2%
 
General & administrative expense
  $
2,631,896
    $
2,380,631
    $
251,265
     
10.6%
 
% to net sales
   
8.9%
     
8.2%
                 

General and administrative expenses increased $251,265 or 10.6% to $2,631,896 during the three-month period ended March 31, 2015 from $2,380,631 during the same period in 2014.  The increase is primarily a result of increases in facilities expense and professional fees.  Professional fees, which consists primarily of legal and accounting fees increased by $134,090 or 18.0% to $877,958 in the three-month period ended March 31, 2015 from $743,868 during the same period in 2014.  Expenses related to our facilities, increased by $286,163 or 147.2% to $480,538 in the three-month period ended March 31, 2015 from $194,375 during the same period in 2014. The increase is primarily due to higher utility costs associated with the Wisconsin facility.

Income from operations and net income

The company reported income from operations of $1,410,312 during the first quarter of 2015, compared to $627,202 during the same period in 2014.  Provision for income taxes was $650,507, or a 49.9% effective rate for the first quarter of 2015 compared to a provision for income tax of $298,461, or a 50.1% effective tax rate, during the same period in 2014. Income taxes are discussed in Note 10 to the Notes to the Consolidated Financial Statements.

Net income was $653,718 or $0.04 per basic and diluted common share for the three-month period ended March 31, 2015 compared to $297,178 or $0.02 per basic and diluted common share in the same period in 2014.
 

 
 
- 21 -

 
Liquidity and Capital Resources

Sources and Uses of Cash

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.

Net cash provided by operating activities was $2,136,460 during the three-months ended March 31, 2015 compared to net cash provided by operating activities of $440,262 in the same period in 2014. The increase is primarily attributable to lower income tax payments during the first quarter of 2015 and the relatively higher level of accounts receivable in the first quarter of 2014 associated with the increase in net sales in the first quarter of last year.

Net cash used in investing activities was $1,300,536 during the three-months ended March 31, 2015 compared to net cash used in investing activities of $1,053,089 in the same period in 2014. The increase in net cash used in investing activities is primarily due to purchases of property and equipment related to the Wisconsin facility.

The Company had a net increase in cash and cash equivalents of $564,679 during the three month period ended March 31, 2015 compared a net decrease in cash and cash equivalents of $831,900 in the same period in 2014.

At March 31, 2015, the Company had $840,000 of current maturities of notes payable.  The Company also has a $5 million revolving credit facility with The Private Bank. This facility remained unused at March 31, 2015 and is available for other general corporate purposes.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We do not undertake any specific actions to diminish our exposure to interest rate risk and we are not a party to any interest rate risk management transactions.  We do not purchase or hold any derivative financial instruments.  Our foreign sales are not material.  Accordingly, our currency rate risk is not currently material.

As of March 31, 2015, we had an outstanding balance under our bank term loans of approximately $8.726 million, and we have the option to borrow an additional $5 million from our line of credit.  The term loans bear interest at variable rates.  Based on the outstanding amount under such loans at March 31, 2015 of approximately $8.726 million (which remains outstanding as of the time of this filing) a 1.0 percent increase in interest rates would result in additional annualized interest expense of approximately $90,000.  For a detailed discussion of our notes payable, including a discussion of the applicable interest rate, please refer to Note 8, Notes Payable under Part I, Item 1 in this Quarterly Report on Form 10-Q.

 
ITEM 4.  CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Our evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act was performed under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer. The purpose of disclosure controls and procedures is to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

 
- 22 -

 
As previously disclosed under “Item 9A—Controls and Procedures” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, we concluded that our internal control over financial reporting was not effective based on the material weaknesses identified. Based on those material weaknesses, which we view as an integral part of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the quarter ended March 31, 2015, our disclosure controls and procedures were not effective. Nevertheless, based on a number of factors, including the performance of additional procedures by management designed to ensure the reliability of our financial reporting, we believe that the consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.
 
Management’s Remediation Initiatives

We continue to make progress toward achieving the effectiveness of our disclosure controls and procedures. Remediation generally requires making changes to how controls are designed and implemented and then adhering to those changes for a sufficient period of time such that the effectiveness of those changes is demonstrated with an appropriate amount of consistency. We believe that we have made significant improvements in our internal control over financial reporting and are committed to remediating our material weaknesses. Our Sarbanes Oxley compliance function is responsible for helping develop and monitor our short-term and long-term remediation plans. In addition, we have assigned owners to each material weakness to oversee the necessary remedial changes to the overall design of our internal control environment and to address the root causes of our material weaknesses.
 
In addition to the actions previously disclosed under “Item 9A—Controls and Procedures” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 our remediation initiatives summarized below, are intended to further address our specific material weaknesses and to continue to enhance our internal control over financial reporting.
 
 
•           Our leadership team remains committed to achieving and maintaining a strong control environment, high ethical standards and financial reporting integrity. This commitment will continue to be communicated to and reinforced with our employees.

•           We continue to foster awareness and understanding of standards and principles for accounting and financial reporting. This includes the implementation and clarification of specific accounting policies and procedures.

•           We continue to enhance the development, communication, and monitoring of processes and controls to ensure that appropriate account reconciliations and journal entry controls are performed, documented, and reviewed as part of our standardized procedures.

•           We continue to redesign our period-end closing and financial statement preparation process in order to improve both its effectiveness and efficiency.

Collectively, these and other actions are improving the foundation of our internal control over financial reporting.

Changes in Internal Control over Financial Reporting

Except as discussed above there were no changes in our internal control over financial reporting that occurred during the first quarter of 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


 
 
 

 
 
- 23 -

 
PART II – OTHER INFORMATION

 
ITEM 1.  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.

 
ITEM 1A.  RISK FACTORS.

There have been no material changes to the Risk Factors disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

 
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

 
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None.

 
ITEM 4.  MINE SAFETY DISCLOSURE.

Not applicable.

 
ITEM 5.  OTHER INFORMATION.

None.

 
ITEM 6.  EXHIBITS.
 
31.1
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
31.2
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101
Interactive Data Files.


 
 
 
- 24 -

 
SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



 
LIFEWAY FOODS, INC.
 
 
 
 
 
 
 
 
 
 
 
Date: September 29, 2015
By:
/s/ Julie Smolyansky
 
 
 
Julie Smolyansky
 
 
 
Chief Executive Officer, President, and Director
 
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
 
 
 
 
 
 
Date: September 29, 2015
By:
/s/ Edward P. Smolyansky
 
 
 
Edward P. Smolyansky
 
 
 
Chief Financial and Accounting Officer,
Treasurer, Chief Operating Officer and Secretary
(Principal Financial and Accounting Officer)
 





 
 
 
 
 
 
 
 
 
 

 



 
- 25 -

 
 
 
INDEX OF EXHIBITS


 
 

 
31.1
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2
Officer’s Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101
Interactive Data Files.