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Lifeway Foods 10-K 2009
WWW.EXFILE.COM, INC. -- 888-775-4789 -- LIFEWAY FOODS, INC. -- FORM 10-K


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

R
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the fiscal year ended December 31, 2008
   
£
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from: __________ to __________ 
Commission file number: 0-17363
 
LIFEWAY FOODS, INC.
(Name of  registrant as specified in its charter)

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

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

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

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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  ¨
Accelerated filer  ¨
Non-accelerated filer o
Smaller reporting company þ 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o   No R

The issuer’s revenues for its most recent fiscal year were: $44,461,455.

The aggregate market value of the voting and non-voting common equity held by non-affiliates (approximately 4,822,576 shares) computed by reference to the price at which the stock was sold as of March 2, 2009 ($7.65 per share as quoted on the National Market System of the Nasdaq Stock Market) was: $36,892,706.
 

The number of shares outstanding of each of the issuer’s classes of common equity, as of March 2, 2009 is 16,722,592 shares of Common Stock.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
No portions of the Notice of Annual Meeting and Proxy Statement, to be filed no later than April 30, 2009, for the Registrant’s 2009 Annual Meeting of Shareholders, scheduled to be held June 19, 2009, are incorporated by reference in Part III.



LIFEWAY FOODS, INC.

Table of Contents

PART I
 
Item 1.
Business
4
     
Item 1A.
Risk Factors
13
     
Item 1B. Unresovled Staff Comments 
13
     
Item 2.
Properties
13
     
Item 3.
Legal Proceedings
14
     
Item 4.
Submission of Matters to a Vote of Security Holders
14
   
 
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of  Equity Securities
14
     
Item 6.
Selected Financial Data
16
     
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
     
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
18
     
Item 8.
Financial Statements and Supplementary Data
18
     
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 37
     
Item 9A.
Controls and Procedures
 37
     
Item 9B.
Other Information
37
     
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
 38
     
Item 11.
Executive Compensation
 41
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 43
     
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 44
     
Item 14.
Principal Accountant Fees and Services
 44
     
PART IV
   
Item 15.
Exhibits, Financial Statement Schedules
 46
     
 
Signatures
48
     
 
Index of Exhibits
49
     
 
List of Subsidiaries
 
     
  Consent of Independent Registered Public Accounting Firm   
     
 
Rule 13a-14(a)/15d-14(a) Certifications
 
     
 
    Section 1350 Certifications
 
     
  Press Release   
2

PART I
 
CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
THAT COULD CAUSE THE COMPANY’S ACTUAL RESULTS TO
DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS
 
In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, readers of this document and any document incorporated by reference herein, are advised that this document and documents incorporated by reference into this document contain both statements of historical facts and forward looking statements. Forward looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward looking statements. Examples of forward looking statements include, but are not limited to (i) projections of revenues, income or loss, earnings or losses per share, capital expenditures, dividends, capital structure and other financial items, (ii) statements of Lifeway Foods, Inc.’s plans and objectives, including the introduction of new products, or estimates or predictions of actions by customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, and (iv) statements of assumptions underlying other statements and statements about Lifeway Foods, Inc. or its business.
 
This document and any documents incorporated by reference herein also identify important factors which could cause actual results to differ materially from those indicated by forward looking statements. These risks and uncertainties include price competition, the decisions of customers or consumers, the actions of competitors, changes in the pricing of commodities, the effects of government regulation, possible delays in the introduction of new products, customer acceptance of products and services, and other factors which are described herein and/or in documents incorporated by reference herein.
 
The cautionary statements made pursuant to the Private Litigation Securities Reform Act of 1995 above and elsewhere by Lifeway Foods, Inc. (“Lifeway” or the “Company”) should not be construed as exhaustive or as any admission regarding the adequacy of disclosures made by Lifeway prior to the effective date of such act. Forward looking statements are beyond the ability of Lifeway to control and in many cases we cannot predict what factors would cause results to differ materially from those indicated by the forward looking statements.
 
 
 
 
 
 
 
3

ITEM 1.   BUSINESS.
 
BUSINESS DEVELOPMENT

Lifeway Foods, Inc., an Illinois corporation, commenced operations in February 1986, and was incorporated under the laws of the State of Illinois on May 19, 1986. The Company’s principal business activity is the manufacturing of probiotic, cultured, functional dairy and non-dairy health food products. Lifeway’s primary products are kefir, a drinkable dairy beverage similar to but distinct from yogurt, in several flavors sold under the name “Lifeway Kefir” and “Helios Nutrition Organic Kefir”; a line of various drinkable yogurts sold under the “La Fruta”, “Tuscan” and “Lassi” brands; and “BasicsPlus,” a dairy based immune-supporting dietary supplement beverage. The Company also produces several soy-based kefir beverages under the “SoyTreat” trademark. In addition to the drinkable products, Lifeway manufactures “Lifeway Farmer Cheese,” a line of various farmer cheeses, a line of gourmet cream cheeses, and “Sweet Kiss,” a fruit sugar-flavored spreadable cheese similar in consistency to cream cheese. The Company also manufactures and markets a vegetable-based seasoning under the “Golden Zesta” brand. In the Chicago metropolitan area, Lifeway distributes its products on its own trucks and via one distributor. The Company directly distributes its products in the Philadelphia metropolitan area using its own truck. Lifeway manufactures all of its products at Company-owned facilities and distributes its products primarily throughout the United States.
 
SUBSIDIARY ENTITIES
 
On September 30, 1992, Lifeway formed a wholly-owned subsidiary, LFI Enterprises, Inc. (“LFIE”), incorporated in the State of Illinois. Until August 1, 2001, LFIE operated a “Russian” theme restaurant and supper club facility. On August 1, 2001, Lifeway ceased operations at the facility after condemnation proceedings were initiated by the Village of Niles, Illinois, which sought to control the property for municipal purposes. This property was sold in January 2003 for a capital gain of approximately $1.2 million.

On March 19, 2004, LFIE formed Lifeway Foods Canada, LLC, an Illinois limited liability company (“LFC”), to serve as a holding company for prospective operations within Canada. LFIE is the manager and sole member of LFC.

On July 26, 2004, Lifeway, by its subsidiary, LFIE, acquired certain assets and inventory of Ilya’s Farms, Inc., a twelve year old, privately-held gourmet cream cheese producer based in the Philadelphia metropolitan area. No prior relationship existed between Ilya’s Farms, Inc. or its principal, Michael Kofman, and either the Company or LFIE.
 
The total cash purchase consideration of $575,600 for the assets and inventory of Ilya’s Farms, Inc. was paid by LFIE in cash from Company funds without financing. Additionally, there are certain royalty payments to be made in connection therewith. The Company provided a guaranty of payment for the transaction. The acquisition included approximately $64,000 of tangible assets (including certain manufacturing equipment and a delivery truck) and inventory as well as the brand name “Ilya’s Farms” and other trademarks and the recipes and manufacturing processes previously used by Ilya’s Farms, Inc. The equipment acquired by LFIE from Ilya’s Farms, Inc. was previously used to manufacture cream cheese products. The inventory which was purchased by LFIE consisted entirely of different varieties of cream cheese. The founder of Ilya’s Farms, Inc., Michael Kofman, assisted LFIE over a one-month transition period and is available, if needed, on a consulting basis going forward. Additionally, LFIE has hired the 10 employees formerly employed by Ilya’s Farms, Inc.

On August 3, 2006, the Company acquired all of the issued and outstanding stock of Helios Nutrition, Ltd. (“Helios”) from the stockholders of Helios for a combination of 202,650 shares of the Company’s common stock, $2,500,000 in cash, and a promissory note issued by the Company in favor of Amani Holdings, LLC in the principal amount of $4,200,000.
 
On February 6, 2009, the Company acquired all of the issued and outstanding stock (the “Shares”) of Fresh Made, Inc., a Pennsylvania corporation (“Fresh”) for a combination of $8,050,000 (less certain offsets) in cash, and a promissory note in the principal amount of $2,735,000.00, due on February 6, 2011, 128,948 shares of common stock of Lifeway valued at a total of $980,000.00, and cancellation of a $265,000.00 loan.  In connection with such acquisition, Lifeway also acquired 1.1355 acres of land in Philadelphia, PA (the “Property”).  The consideration for the Property was $2,000,000.00.
 
BUSINESS OF ISSUER
 
PRODUCTS
 
Lifeway’s primary product is kefir, which, like the better-known product of yogurt, is a fermented dairy product. Kefir has a slightly effervescent quality, with a taste similar to yogurt and a consistency similar to buttermilk. It is a product distinct from yogurt because it incorporates the unique microorganisms of kefir as the cultures to ferment the milk. Lifeway’s Kefir is a drinkable product intended for use as a breakfast meal or a snack, or as a base for lower-calorie dressings, dips, soups or sauces. Kefir is also used as the base of Lifeway’s plain farmer’s cheese, a cheese made without salt, sugar or animal rennet. In addition, kefir is the primary ingredient of Lifeway’s “Sweet Kiss” product, a fruit sugar-flavored, cream cheese-like spread which is intended to be used as a dessert spread or frosting.
 
4

Kefir contains a unique mixture of several live microorganisms and nutrients such as proteins, minerals and vitamins. Kefir is highly digestible and, due to its acidity and enzymes, stimulates digestion of other foods. Kefir is considered to be the most favorable milk product for people suffering from genetically-based lactose intolerance. A study published in the May 2003 issue of the Journal of the American Dietetic Association suggests that kefir improves lactose digestion and tolerance in adults with lactose maldigestion. Studies also indicate that kefir may stimulate protein digestion and appetite, decrease the cholesterol content in blood, improve salivation and excretion of stomach and pancreatic enzymes and peristalsis. As compared to yogurt, many naturopathic practitioners consider kefir to be the best remedy for digestive troubles because it has a very low curd tension (the curd breaks up very easily into small particles). The curd of yogurt, on the other hand, holds together or breaks into lumps. The small size of the kefir curd facilitates digestion by presenting a large surface area on which digestive agents may work.
 
Kefir is a good source of calcium, protein, and Vitamin B-complex. In addition, because the fermentation process produces a less sour tasting product than yogurt, less sugar is required to make a desirable product, and the end product contains fewer calories than regular yogurt.
 
Lifeway currently sells some or all of the products listed below, except as specifically noted, to various retail establishments including supermarkets, grocery stores, gourmet shops, delicatessens and convenience stores.
 
LIFEWAY’S KEFIR.  “Lifeway’s Kefir” is a drinkable kefir product manufactured in ten regular and low-fat varieties, including plain, pomegranate, raspberry, blueberry, strawberry, cherry, peach, banana-strawberry, cappuccino and vanilla, and sold in 32 ounce containers and 8 ounce single serving containers featuring color-coded caps and labels describing nutritional information. In March 1996, Lifeway began marketing its non-fat, low cholesterol kefir in six flavors — plain, raspberry, strawberry, strawberry-banana, peach and blueberry. The kefir product is currently marketed under the name “Lifeway’s Kefir,” and is typically sold by retailers from their dairy sections.
 
LIFEWAY’S ORGANIC SOYTREAT.  “SoyTreat” is a soy alternative to dairy kefir and is made from organic soy milk, which is derived from non-genetically modified soybeans. SoyTreat can be consumed by those who desire the benefits of kefir, but are lactose intolerant or interested in a soy-based alternative to milk. SoyTreat also provides 7.0g of soy protein per serving, and features the United States Food and Drug Administration-approved health claim, “25g of soy protein a day as part of a diet low in saturated fat can help lower cholesterol and reduce the risk of heart disease.” At present SoyTreat is manufactured in two flavors: strawberry and peach.
 
LIFEWAY’S ORGANIC KEFIR.  “Lifeway’s Organic Kefir” meets the organic standards and specifications of the United States Department of Agriculture for organic products and is manufactured in five flavors: plain, wildberry, raspberry, strawberry and peach. Lifeway’s Organic Kefir is sweetened with organic cane juice.
 
LIFEWAY’S SLIM6.  “Lifeway’s Slim6” is a line of low-fat kefir beverages with no added sugar designed for consumers who follow low-carbohydrate diets. Lifeway’s Slim6 has only 8 grams of carbohydrates and 2.5 grams of fat per 8-ounce serving and is available in five flavors: strawberries n’ cream, mixed berry, tropical fruit, strawberry-banana and an original, unsweetened version.
 
LA FRUTA DRINKABLE YOGURT.  “La Fruta” is a yogurt like drink similar to a milkshake or smoothie that is specifically formulated to accommodate the Hispanic market, the fastest growing demographic in the United States. La Fruta is manufactured in six flavors: strawberry, mango, pina colada, banana-strawberry, horchata and tres leches.
 
LA FRUTA CHEESE.  “La Fruta Cheese” is a cheese product similar to cream cheese that is specifically formulated to accommodate the Hispanic market, the fastest growing demographic in the United States. La Fruta Cheese is manufactured in a tres leches flavor.
 
TUSCAN BRAND DRINKABLE YOGURT.  “Tuscan Brand Drinkable Yogurt” is a cultured dairy beverage mainly marketed on the East Coast and manufactured in a variety of flavors which vary depending upon distributor demand.
 
5

FARMER CHEESE.  “Farmer Cheese” is based on a cultured soft cheese and is intended to be used in a variety of recipes as a low fat, low-cholesterol, low-calorie substitute for cream cheese or ricotta, and is available in various styles.
 
SWEET KISS.  “Sweet Kiss” is a sweet cheese probiotic spread available in five flavors: plain, plain with raisins, apple, peach and chocolate.
 
ELITA; BAMBINO.  “Elita” and “Bambino” cheeses are low-fat, low-cholesterol kefir based cheese spreads which are marketed as an alternative to cream cheese.
 
KRESTYANSKI TWOROG.  “Krestyanski Tworog” is a European-style kefir-based soft style cheese which can also be used in a variety of recipes, eaten with a spoon, used as a cheese spread, or substituted in recipes for cream cheese, ricotta cheese or cottage cheese and is marketed to consumers of various Eastern European ethnicities.
  
BASICS PLUS.  “Basics Plus” is a patented kefir-based beverage product designed to improve gastrointestinal functions, enhancing the immune system. This product contains certain “passive immunity products” purchased from GalaGen, Inc. prior to its 2002 bankruptcy as described elsewhere in this report. Lifeway is currently engaged in discussion with several potential new suppliers of passive immunity products and is not currently manufacturing this beverage.
 
KEFIR STARTER.  “Kefir Starter” is a powdered form of kefir that is sold in envelope packets and allows a consumer to make his or her own drinkable kefir at home by adding milk. Lifeway continues to develop sales of the product internationally and via the internet.
 
LASSI.  “Lassi” is a cultured drink inspired by the traditions of India. Sold in 8 ounce containers in two flavors, strawberry and mango.
 
GOLDEN ZESTA.  “Golden Zesta” is a vegetable-based seasoning, which, because of its low sodium content, may also be used as a salt substitute and is marketed to delicatessens, gourmet shops and ethnic grocers.
 
IT’S PUDDING.  “It’s Pudding!” is the only organic pudding produced in the following flavors: rice, chocolate, vanilla, banana and tapioca.
 
PROBUGS.  “ProBugs” is a kefir product that contains 10 live and active kefir cultures. Aimed at children ages 2-9, ProBugs comes in three flavors, “Sublime Slime Limetm,” “Orange Creamy Crawlertm” and “Goo-Berry Pietm” and is packaged in patented no spill spout pouches designed as cartoon bug characters Peter, Polly and Penelope ProBugtm.
 
HELIOS NUTRITION ORGANIC KEFIR.  “Helios Nutrition Organic Kefir” is a kefir product made from organic milk and manufactured with a unique blend of active cultures. It is sold in 8 and 32 ounce bottles and made in five flavors: peach, plain, strawberry, vanilla and raspberry.
 
Lifeway intends to continue to develop new products based on kefir and Farmer Cheese. There is no assurance that such products or any other new products can be developed successfully or marketed profitably.

DISTRIBUTION
 
With its twelve company-owned trucks, Lifeway distributes its products directly and extensively in the State of Illinois, primarily in the Chicago metropolitan area. Lifeway also directly distributes its products in the Philadelphia and Tri State metropolitan area.
 
In addition to the Chicago and Philadelphia and Tri State metropolitan areas, Lifeway’s products are distributed to stores throughout the United States. Lifeway has verbal distribution arrangements with various distributors throughout the United States. These verbal distribution arrangements, in the opinion of Lifeway, allow management the necessary latitude to expand into new areas and markets and establish new relationships with distributors on an ongoing basis. Lifeway has not offered any exclusive territories to any distributors.
 
6

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

Although Lifeway faces a small amount of direct competition in the United States and Canadian markets for kefir products, Lifeway’s kefir-based products compete with all other yogurt and other dairy products. Many producers of yogurt and other dairy products are well-established and have significantly greater financial resources than Lifeway to promote their products.
 
In connection with the certain Stockholders’ Agreement, as amended, between Lifeway, Danone Foods, Inc. and other parties, as well as certain other transactions between these two foregoing companies described elsewhere in this report, the parties agreed that they would not compete with each other during the term of the Stockholders’ Agreement, as extended, with respect to certain yogurt, cheese and kefir products. Specifically, Lifeway agreed not to produce or sell in the United States or Western Europe any type of yogurt, fromage frais, Italian style cheese, chilled desserts or any soy-based products, other than those that are kefir-based or those that were already being produced and sold by Lifeway as of December 24, 1999, and Danone agreed not to produce or sell any type of kefir-based products in the United States. On January 15, 2009, the term of the Stockholders’ Agreement was extended to December 31, 2009.
 
SUPPLIERS

Lifeway purchases its raw materials, such as milk, sugar and fruit from unaffiliated suppliers, and is not limited or contractually bound to any supplier. Lifeway has ready access to multiple suppliers for all of its raw materials and packaging requirements. Prior to making any purchase, Lifeway determines which supplier can offer the lowest price for the highest quality of product. The raw and packaging materials purchased by Lifeway are considered commodity items and are widely available on the open market with the exception of the licensed ingredient in BasicsPlus. Lifeway owns and operates the means of production of all of its products.
  
7

MAJOR CUSTOMERS
 
Lifeway distributes its products to numerous accounts throughout the United States. Concentrations of credit with regard to trade accounts receivable and sales are limited due to the fact that Lifeway’s customers are spread across different geographic areas. The customers are concentrated in the retail food industry, for example, Trader’s Joe’s. In 2008, Lifeway’s largest customer represented approximately 9% of sales and reflected sales in various regions of the United States outside the Chicago, Illinois metropolitan area.
 
TRANSACTIONS WITH GROUPE DANONE SA
 
All share amounts and prices in this subsection are historical and have not been adjusted for the stock split which occurred in the first quarter of 2004 or in the second quarter of 2006. On October 1, 1999, Lifeway and certain members of the Smolyansky family sold shares of restricted common stock to Danone at $10.00 per share. Later in 1999, Danone purchased additional shares of common stock from certain individuals, including shares purchased in transactions with certain Company affiliates, including Lifeway’s founder Michael Smolyansky, Val Nikolenko, Vice President of Production and Pol Sikar, a director, and his affiliates. As a result of these transactions, Danone became the beneficial owner of 20% of the outstanding common stock of Lifeway. Pursuant to the terms and conditions of the transaction, Lifeway granted certain limited rights to Danone, which include a right to nominate one director, anti-dilutive rights relating to future offerings and limited registration rights. In addition, as described above, Lifeway and Danone are parties to a Stockholders’ Agreement dated October 1, 1999, pursuant to which the parties agreed that they would not compete with each other through December 31, 2009 with respect to certain yogurt, cheese and kefir products. The Stockholders’ Agreement also provides that Danone may not own more than 20% of the outstanding common stock of Lifeway as a result of direct or indirect acquisition of shares. Danone’s interest as of December 31, 2008 was approximately 20.7% due to reductions in Lifeway’s shares outstanding, primarily due to share repurchases by Lifeway. On January 15, 2009, the term of the Stockholders’ Agreement was extended to December 31, 2009. The ability of Danone to sell such a large stake in Lifeway could have a negative effect on the Company’s stock price.

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

Mark
Use
Date of Registration
Expiration of
Registration
Comments
Lifeway
Cheese and kefir
December 12, 1989
December 12, 2009
Registration was timely renewed on December 12, 1999. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
Sweet Kiss
Cheese, cottage cheese
and other milk
products, excluding
ice cream, ice milk
and frozen yogurt
February 10, 1998
February 10, 2018
Registration was timely renewed on May 23, 2008.  Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
Kwashenka
Kefir, yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
February 10, 1998
February 10, 2018
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
Bambino
Cheeses, cottage cheeses and other milk products
October 7, 2003
October 7, 2013
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
 
8


Mark
Use
Date of
Registration
Expiration of
Registration
Comments
KPECTBRHCKNN (A stylized presentation of “Krestyanskiy” in Cyrillic characters-means “Peasant”)
Cheeses, cottage cheeses and other milk products excluding ice cream, ice milk and frozen yogurt
September 8, 1998
September 8, 2018
Registration was timely renewed on August 23, 2008. Registration is renewable for ten year periods or during the six-month grace period following the registration expiration date.
BA3APHBIII (A stylized presentation of “Bazarny” in Cyrillic characters)
Pressed unripened cheese
July 25, 2000
July 25, 2010
An Affidavit of Continued Use was timely filed between the 5th and 6th anniversaries of the registration date.  Registration is renewable between the 9th and 10th anniversaries of the registration date or the six-month grace period following the registration expiration date.
BA3APHBIII (A stylized presentation of “Bazarny” in Cyrillic characters)
Cultured milk products, excluding ice cream, ice milk and frozen yogurt; cheeses and cottage cheese.
   
Application filed on July 31, 2008, based on actual use.
BAZARNY
Cultured milk products, excluding ice cream, ice milk and frozen yogurt; cheeses and cottage cheese.
   
Application filed on July 31, 2008, based on actual use.
SoyTreat
Soy-based food beverage intended for use as cultured milk substitute
November 11, 2008
November 11, 2014
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
Korovka
Dairy-based spread
November 6, 2001
November 6, 2011
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
La Fruta
Cultured milk products, excluding ice cream, ice milk and frozen yogurt
March 29, 2005
March 29, 2015
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
 
9


Mark
Use
Date of Registration
Expiration of
Registration
Comments
PTICHYE MOLOKO (a stylized presentation of “Ptichye Moloko” in Cyrillic characters)
Kefir, yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
October 18, 2005
October 18, 2015
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
BIOKEFIR
yogurt, cheeses, cottage cheeses and other milk products, excluding ice cream, ice milk and frozen yogurt
   
Application filed April 8, 2008, on an intent-to-use basis.  A Notice of Allowance was issued on November 18, 2008. A Statement of Use is due on May 18, 2009, or within the 3 year extension period following the Notice of Allowance date. After acceptance of the Statement of Use, registration will precede in due course.
SUBLIME SLIME LIME
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2013
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PROBUGS
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2013
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
ORANGE CREAMY CRAWLER
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2013
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
(DESIGN)
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 17, 2007
July 17, 2013
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
(DESIGN)
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
July 10, 2007
July 10, 2013
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
 
10

Mark
Use
Date of Registration
Expiration of
Registration
Comments
(DESIGN)
Penelope
Dairy-based beverages; dairy-based food beverages; kefir; soy- based food beverage used as milk substitute
April 8, 2008
April 8, 2014
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
PRIDE OF MAIN STREET
Dairy Product
November 9, 1987
November 9, 2007
Only for the State of MN, not in US
HELIOS NUTRITION
Dairy products and functional foods
October 5, 1999
October 5, 2009
 Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT
Franchise services, namely, offering technical and business management assistance in the establishment and operation of restaurants
October 7, 2008
October 7, 2014
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
STARFRUIT
Restaurant services
June 24, 2008
June 24, 2014
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date.
GOO-BERRY PIE
Dairy-based beverages; dairy-based food beverages; kefir; soy-based food beverage used as a milk substitute
April 1, 2008
April 1, 2014
Registration is renewable at the time of expiration provided mandatory documents are filed with the USPTO between the 5th and 6th anniversaries of the registration date or the six-month grace period following the sixth anniversary date. 


11

PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS
 
Lifeway also uses the following unregistered trademarks, and claims common law rights to: “Elita,” “Healthy Foods Today for a Better Life Tomorrow,” “Milkshake Smoothie,” “Toplenka,” “White Cheese,” “Drink It to Be Beautiful Inside and Out,”  “Golden Zesta” and “Pride of Main Street.”
 
On December 27, 1990, Lifeway purchased the Tuscan brand-name liquid drinkable yogurt customer list along with a limited license of the trademark and use of the Tuscan liquid yogurt U.P.C. codes from a third party.
 
In October 1998, Lifeway entered into a sublicense agreement with GalaGen, Inc. and Metagenics, Inc. with an effective date of May 1, 1998 (“Lifeway sublicense”), wherein GalaGen sublicensed patent rights of Metagenics for kefir-based products containing natural immune components exclusively to Lifeway. Under the rights granted to it by the Lifeway sublicense, Lifeway manufactures and sells products using the Basics Plus trademark. GalaGen had acquired the primary license for such patent rights in an agreement executed with Metagenics in April 1998. The terms of the Lifeway sublicense provide that Metagenics will permit Lifeway to continue to have the exclusive patent rights to produce or sell kefir-based products containing natural immune components in the event the original license between GalaGen and Metagenics is terminated, and such termination was not caused by Lifeway. On February 25, 2002, GalaGen filed a petition for bankruptcy in the Unites States Bankruptcy Court, District of Minnesota, which terminated both its primary license with Metagenics and its participation in the Lifeway sublicense. The license and sublicense were excluded from the sale of assets of GalaGen pursuant to an order of the Bankruptcy Court. Lifeway has not received any indication that Metagenics will not permit Lifeway to continue to have the exclusive patent rights to produce or sell kefir-based products containing natural immune components. Thus, Lifeway believes that it continues to have the exclusive patent rights licensed directly from Metagenics. Either party may terminate the license agreement for cause. The term of the license agreement expires when the last valid claim of the patent rights expires, which currently is July 2, 2013, however, this term can be extended in accordance with the terms of the license agreement.
 
In connection with the purchase of Ilya’s Farm, Inc., the Company has undertaken a royalty obligation of 5% of all sales of Ilya’s Farm, Inc.’s products, which is paid quarterly, in arrears.
 
REGULATION

Lifeway is subject to regulation by federal, state and local governmental authorities regarding the distribution and sale of food products. Although Lifeway believes that it currently has all material government permits, licenses, qualifications and approvals for its operations, there can be no assurance that Lifeway will be able to maintain its existing licenses and permits or to obtain any future licenses, permits, qualifications or approvals which may be required for the operation of Lifeway’s business.
 
Lifeway believes that it is currently in compliance with all applicable environmental laws and that the cost of such compliance was not material to the financial position of Lifeway.
 
In addition, any Lifeway products exported to Canada would be subject to strict quotas imposed by the Trade Control Policy Division of the Department of Foreign Affairs and International Trade of Canada. Lifeway believes that it currently is in compliance with all applicable Canadian regulations. The Company exported no products to Canada in 2008.
 
RESEARCH AND DEVELOPMENT
 
Lifeway continues its program of new product development, centered around the nutritional and “low calorie” features of its proprietary kefir formulas.
 
Lifeway conducts primarily all of its research internally, but at times will employ the services of an outside testing facility. During 2007 and 2008, the amount Lifeway expended for research and new product development was not material to the financial position of Lifeway and no amount was customer supported.
 
12

EMPLOYEES
 
Lifeway currently employs approximately 200 employees, all of whom are full-time employees. Substantially all of these employees are engaged in the manufacturing of the Company’s products. None of Lifeway’s employees are covered by collective bargaining agreements.
 
ITEM 1A. RISK FACTORS.

Not applicable to smaller reporting company.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS.
 
Not applicable.

ITEM 2.  PROPERTIES.
 
On May 16, 1988, Lifeway purchased an approximately 26,000 square foot parcel of real property, including an approximately 8,500 square foot one-story brick building in good condition, located at 7625 N. Austin Avenue, Skokie, Illinois. Lifeway uses this facility for manufacturing and storage and has no plans to improve or renovate this property. The acquisition loan to Lifeway from 1st National Bank of Morton Grove, collateralized by the real estate, was refinanced in 1998 by Lifeway and paid off in full on February 21, 2002. Lifeway is the only occupant of this property and presently holds fee simple title free and clear of all encumbrances thereto. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
On October 16, 1996, Lifeway purchased a 110,000 square foot commercially-zoned parcel of real property, including a 46,000 square foot one-story brick building in good condition, located at 6431 Oakton Avenue, Morton Grove, Illinois. This property is used as Lifeway’s corporate headquarters and main manufacturing facility. This property has been improved every year since the time of purchase by the addition of custom-built refrigerated storage space and the addition of various machinery and equipment used to manufacture, package and store Lifeway’s products. Lifeway is the only occupant of this property and presently holds fee simple title subject to a mortgage which secures the property as collateral for the acquisition loan to Lifeway from MB Financial Bank of Morton Grove. The acquisition loan was refinanced in September 2006 at a rate of 7% and is payable in monthly principal and interest installments of $3,273, with a balloon payment of $416,825 due in September 2011. At December 31, 2008, the loan had a balance of $438,926. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
In June 2005, the Company purchased a 100,000-square-foot distribution and warehousing facility that is equipped with 40,000 square feet of refrigeration. The facility, located at 6101 Gross Point Road in Niles, Illinois, will be used to store raw materials and finished goods in order to relieve space pressures at the Company’s existing 50,000-square foot building, less than a mile away. The additional space at the Company’s main plant will be used to expand production capacity for the Company’s kefir and other probiotic products. Lifeway is the only occupant of this property and presently holds fee simple title subject to a mortgage which secures the property as collateral for the acquisition loan to Lifeway from Harris Bank at a rate of 5.6% and is payable in monthly principal and interest installments of $19,513 with a balloon payment of $2,652,142.70 due July 14, 2010. At December 31, 2008, the loan had a balance of $2,760,288. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
Included in the purchase of Pride of Main Street Dairy on August 3, 2006, Lifeway acquired an approximately 35,000 square foot commercially zoned parcel of real estate located at 214 Main Street S. Sauk Centre, MN, including a 16,000 square foot two-story brick building used for production, and a 5,600 square foot storage facility. This property is used as the main headquarters and main production facility for Pride of Main Street Dairy. The building was built in the 1920’s with an addition in 1990. The facility is being used to produce all of the Pride of Main Street Dairy products, and approximately 70% of the Helios Nutrition Organic Kefir, with the remaining 30% being produced in Lifeway’s main production facility in Morton Grove, Illinois. Pride of Main Street is the only occupier of this property and presently holds fee simple title free and clear of all encumbrances thereto. The value of this property may be subject to real estate market forces that typically affect industrial real estate in the area immediately surrounding the property.
 
13

On February 6, 2009, in connection with the Company’s acquistion of Fresh Made, Inc., a Pennsylvania corporation, Lifeway also acquired 1.1355 acres of land in Philadelphia, PA (the “Property”).  The consideration for the Property was $2,000,000.00. Fresh Made is the only occupier of this property. The Company holds fee simple title free and clear of all encumbrances other than that certain mortgage securing indebtedness due to the sellers and incurred in connection with its acquisition.

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

ITEM 3.  LEGAL PROCEEDINGS.>
 
Lifeway is 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 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
No matter was submitted during the fourth quarter of the fiscal year ended December 31, 2008, to a vote of security holders through the solicitation of proxies or otherwise.
  
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
MARKET INFORMATION
 
Lifeway’s Common Stock, no par value, the only class of common equity of Lifeway, is traded on The Nasdaq Stock Market National Market System under the symbol “LWAY.” Trading commenced on March 29, 1988.
 
The range of high and low bid quotations for Lifeway’s Common Stock for the quarterly periods within the two most recent fiscal years, as reported by The Nasdaq Stock Market National Market System, is set forth in the following table:

 
Low Bid
 
High Bid
First Qtr. 2007
  8.51
 
10.24
Second Qtr. 2007
  8.55
 
11.59
Third Qtr. 2007
11.09
 
17.75
Fourth Qtr. 2007
  9.62
 
20.75
First Qtr. 2008
9.25
 
11.75
Second Qtr. 2008
10.40
 
14.05
Third Qtr. 2008
9.02
 
15.48
Fourth Qtr. 2008
5.43
 
11.89

Note: The foregoing quotations have been adjusted for the August 14, 2006 two-for-one company stock split.
 
As of March 2, 2009, there were approximately 88 holders of record of Lifeway’s Common Stock. The Company has no information regarding beneficial owners whose shares are held in street name.
 
DIVIDENDS

Lifeway has paid no cash dividends on its Common Stock since inception and management does not anticipate that such dividends will be paid in the foreseeable future.
 
14

SALES OF UNREGISTERED SECURITIES

There were no sales of unregistered securities in 2008.
 
PURCHASES OF THE COMPANY’S SECURITIES

Period
 
(a) Total
Numbers of
Shares (or Units)
Purchased
 
(b) Average Price Paid per Share (or Unit)
 
(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
 
(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
January 1, 2008 to January 31, 2008*
 
3,000
 
$ 
9.53
 
3,000
 
97,000
February 1, 2008 to February 28, 2008 *
 
15,800
   
10.12
 
15,800
 
81,200
March 1, 2008 to March 31, 2008*
 
18,200
   
9.59
 
18,200
 
63,000
April 1, 2008 to April 31, 2008*
 
21,745
   
12.80
 
21,745
 
41,255
May 1, 2008 to May 31, 2008*
 
24,418
   
12.47
 
24,418
 
16,837
June 1, 2008 to June 30, 2008*
 
7,656
   
12.12
 
7,656
 
9,181
July 1, 2008 to July 30, 2008*
 
9,181
   
11.03
 
9,181
 
0
*Total
 
100,000
 
$
11.09
 
100,000
 
0
                   
December 1, 2008 to December 31, 2008** 
 
12,009
 
$ 
8.22
 
12,009
 
87,991
**Total 
 
12,009
 
8.22
 
12,009
 
87,991
 
* Pursuant to the share repurchase program approved on December 17, 2007 for 100,000 split adjusted shares with a plan expiration date of one year.
** Pursuant to the share repurchase program approved November 20, 2008 for 100,000 split adjusted shares with a plan expiration date of one year.  As of the date of this filing, Lifeway has repurchased an additional 15,195 shares of the Company’s securities in 2009 pursuant to this program at a total cost of $101,628.31.

EQUITY COMPENSATION PLAN INFORMATION
 
See Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, of this Annual Report on Form 10-K for information regarding securities authorized for issuance under our equity compensation plans.
15

ITEM 6.  SELECTED FINANCIAL DATA.

Not applicable to smaller reporting company.

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

RESULTS OF OPERATIONS
 
The following analysis should be read in conjunction with the audited financial statements of the Company and related notes included elsewhere in this annual report and the unaudited financial statements and Management’s Discussion and Analysis contained in our Form 10-QSB, for the fiscal quarters ended March 31, 2008, June 30, 2008, and September 30, 2008.
 
Comparison of Quarter Ended December 31, 2008 to Quarter Ended December 31, 2007
 
Sales increased by $401,371, (approximately 4%) to $10,575,543 during the three month period ended December 31, 2008 from $10,174,172 during the same three month period in 2007. This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship product, Kefir and Probugs, Lifeway’s organic kids oriented Kefir.  The company’s flagship brand Lifeway, grew 8% in the fourth quarter 2008 when compared to the same quarter in 2007.  The company’s Helios Organic Kefir brand, which was acquired in August 2006, saw a decline in sales of $153,000 from $1,043,000 in the fourth quarter 2007 to $890,000 in the same period in 2008 or a decrease of 14.6%.  The decrease is primarily attributable to the decline in demand of higher cost, premium organic products as well as an overall slowdown in demand associated with retailers who primarily sell these products.  We believe that this slowdown in this premium priced food segment is temporary as macro economic conditions improve.
 
Cost of goods sold as a percentage of sales was approximately 82% during the fourth quarter 2008, compared to about 77% during the same period in 2007. This increase is primarily attributable to the increase in labor costs as well as the costs of packaging supplies and transportation expenses.  During the fourth quarter 2008, oil related production supplies and fuel surcharges on product deliveries remained at higher levels when compared to the same period 2007, but have subsequently begun to decrease as the price of oil has decreased since the record highs experienced in August and September 2008.  Historically, there is a several month lag when material suppliers institute price decreases based on the declining costs of the underlying materials.  Additionally, as part of Lifeway’s growth strategy, the company increased its product sampling and demonstration activities, couponing, and other promotional initiatives in the fourth quarter 2008, when compared to the same period in 2007, which has an impact on cost of goods sold.  During the fourth quarter 2008, the company also created a reserve account for these types of promotional expenses off invoice in the amount $75,000 that did not exist in the fourth quarter 2007.
 
Even though the cost of conventional milk was lower in the fourth quarter 2008 compared to the same period a year ago, the cost of organic milk and other organic raw material ingredients increased approximately 10% during this same period.  In the fourth quarter 2008, amount of organic products sold comprised approximately 30% of Lifeway’s total sales.  These products include Lifeway’s Organic Kefir, Lifeway’s Organic ProBugs kids Kefir, and Lifeway’s Helios Organic Kefir lines.
 
Operating expenses as a percentage of sales was approximately 19% during the fourth quarter, 2008, compared to about 20% during the same period in 2007.  This decrease is primarily attributable to a decrease in selling related expenses and operating synergies gained by the consolidation of the 2006 Helios Nutrition acquisition into our overall operations, as well as our continuing efforts to maximize efficiency through capital investments.  Even though there were substantial professional fees and expenses paid in the fourth quarter, 2008 related to the February 6, 2009 acquisition of Fresh Made, Inc., we were able to lower the overall operating expenses as a percentage of sales during the fourth quarter, 2008, when compared to the same period a year ago.
 
 Total other expenses for the fourth quarter 2008 were $1,252,744, compared with total other expenses of $91,373 during the same period in 2007.  This increase is primarily attributable to a higher realized loss on the sale of marketable securities in 2008, when compared to the same period in 2007.  During the fourth quarter 2008, the company realized losses in the amount of $587,243 and recognized an impairment to marketable securities in the amount of $687,971.  During the fourth quarter 2007, the company realized losses in the amount of $123,799.  Marketable securities are discussed in Note 4 of the Notes to Consolidated Financial Statements.

Total net loss for the group was $742,965, or $.04 per split adjusted share for the fourth quarter, 2008, compared with $153,109, or $.01 per split adjusted share in the same period in 2007.

Comparison of Year Ended December 31, 2008 to Year Ended December 31, 2007

Sales increased by $5,732,299 (approximately 15%) to $44,461,455 during the twelve month period ended December 31, 2008 from $38,729,156 during the same twelve month period in 2007.  This increase is primarily attributable to increased sales and awareness of Lifeway’s flagship product, Kefir and Probugs, Lifeway’s organic kids oriented Kefir.  The company’s flagship brand, Lifeway Kefir grew approximately 17% in 2008 when compared to 2007.  Included in that figure is Lifeway Probugs Organic Kefir, which increased sales 124% to $1,760,254 in 2008 compared to sales of $786,326 in 2007.  In 2008, the Helios Kefir brand generated revenues of $4,482,848, compared to 2007 revenues of $4,563,026.

16


Cost of goods sold as a percentage of sales excluding depreciation expense was approximately 70% in 2008, compared to about 66% in 2007.  This increase is primarily attributable to the increase in labor costs as well as the costs of packaging supplies and transportation expenses.  During the 2008, oil related production supplies and fuel surcharges on product deliveries remained at higher levels when compared to 2007, but have subsequently begun to decrease as the price of oil has decreased since the record highs experienced in August and September 2008.  Historically, there is a several month lag when material suppliers institute price decreases based on the declining costs of the underlying materials.  Additionally, as part of Lifeway’s growth strategy, the company increased its product sampling and demonstration activities, couponing, and other promotional initiatives in the fourth quarter 2008, when compared to the same period in 2007, which has an impact on cost of goods sold.  During the fourth quarter 2008, the company also created a reserve account for these types of promotional expenses off invoice in the amount $75,000 that did not exist in the fourth quarter 2007.  Milk prices on average were similar as a whole in 2008 when compared to 2007.
 
Operating expenses as a percentage of sales was approximately 19% in 2008, compared to about 20% in 2007.  This decrease is primarily attributable to an increase in sales, a decrease in selling related expenses and operating synergies gained by the consolidation of the 2006 Helios Nutrition acquisition into our overall operations, as well as our continuing efforts to maximize efficiency through capital investments.  Even though there were substantial professional fees and expenses related to the February 6, 2009 acquisition of Fresh Made, Inc. paid in the fourth quarter 2008, we were able to lower the overall operating expenses as a percentage of sales during the fourth quarter 2008, when compared to the same period a year ago.

Total other expenses for 2008 were $1,598,930, compared with total other income of $528,150 during the same period in 2007.  This increase in expenses is primarily attributable to a higher realized loss on the sale of marketable securities in 2008, when compared to the same period in 2007.  During 2008, the company realized losses in the amount of $733,647 and recognized an impairment to marketable securities in the amount of $958,879.  During 2007, the company realized gains in the amount of $539,739.  Marketable securities are discussed in Note 4 of the notes to the financial statements.

Provision for income taxes was $679,789, or a 26% tax rate in 2008 compared with $1,812,539 or a 37% tax rate in 2007. Income taxes are discussed in Note 9 of the Notes to Consolidated Financial Statements.

Total net income for the group was $1,912,275, or $.11 per split adjusted share for the twelve months ended December 31, 2008, compared with $3,152,660, or $.19 per split adjusted share in the same period in 2007.  

SOURCES AND USES OF CASH IN 2008

Net cash provided by operating activities was $4,733,660 during the twelve months ended December 31, 2008, which is an increase of $2,386,523 compared to $2,347,137 of net cash provided by operating activities the same period in 2007.  This increase in cash provided by operating activities is primarily due to a $1,393,370 swing in the impact inventories had on cash flows as of December 31, 2008, from the same period in 2007.

Net cash used in investing activities was $2,616,344 during the twelve months ended December 31, 2008, which is an increase of $1,715,014 compared to the same period in 2007.  This increase is primarily due to the Company’s sale of $7,168,246 of marketable securities during 2007 compared to selling $5,323,423 of marketable securities during 2008, therefore generating more cash by selling investments in 2007.  The company also used $2,157,315 to purchase machinery and equipment in 2008 compared with using $1,824,879 to purchase machinery and equipment in 2007. The Company has no additional capital expenditures outside the ordinary course of business.

Net cash used in financing activities was $2,435,953 during the twelve months ended December 31, 2008, which is an increase of $38,219 compared to $2,397,734 of net cash used in financing activities during the same period in 2007.  This increase is primarily attributable to the Company’s repurchase of $1,239,488 of treasury shares during 2007, compared with the Company’s repurchase of $752,603 of treasury shares during 2007.

A significant portion of our assets are held in marketable securities. All of our marketable securities are classified as available-for-sale on our balance sheet, while the mortgage-backed securities are classified as trading. All of these securities are stated thereon at market value as of the end of the applicable period. Gains and losses on the portfolio are determined by the specific identification method.

We anticipate being able to fund the Company’s foreseeable liquidity requirements internally. Other than the February 6, 2009 acquisition of Fresh Made, Inc., we know of no trend, demand or event which would negatively affect liquidity in 2009. We continue to explore potential acquisition opportunities in our industry in order to boost sales while leveraging our distribution system to consolidate and lower costs.

Other Developments

On June 13, 2008, Lifeway’s Board of Directors approved awards of an aggregate amount of 10,500 shares to be awarded under its Employee and Consulting Services and Compensation Plan to certain key employees and consultants for services rendered to the Company.  The stock awards were made on June 13, 2008 and have vesting periods of one year. The expense for the awards is measured as of July 1, 2007 at $11.87 per share for 10,500 shares, or a total stock award expense of $124,635. This expense will be recognized as the stock awards vest in 12 equal portions of $10,386, or 875 shares per month for one year.

On May 18, 2007, Lifeway’s Board of Directors approved awards of an aggregate amount of 8,400 shares to be awarded under its Employee and Consulting Services and Compensation Plan to certain employees and consultants for services rendered to the Company. The stock awards were made on June 1, 2007 and have vesting periods of one year. The expense for the awards is measured as of June 1, 2007 at $9.90 per share for 8,400 shares, or a total stock award expense of $83,160. This expense will be recognized as the stock awards vest in 12 equal portions of $6,930, or 700 shares per month for one year.
 
As stated, the Company acquired Fresh Made, Inc. on February 6, 2009. This acquisition will affect the Company’s sales and operating income as the Fresh Made operations are fully assimilated into the Companys operations.

17

Off-Balance Sheet Arrangements

We have never entered into any off-balance sheet financing arrangements and have never established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

Critical Accounting Policies

Lifeway’s analysis and discussion of its financial condition and results of operations are based upon its consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. US GAAP provides the framework from which to make these estimates, assumptions and disclosures. Lifeway chooses accounting policies within US GAAP that management believes are appropriate to accurately and fairly report Lifeway’s operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions and has discussed the development and selection of critical accounting policies with its audit committee of the Board of Directors. For further information concerning accounting policies, refer to Note 2 — Nature of Business and Significant Accounting Policies in the notes to the consolidated financial statements.
 
Subsequent Events
 
On February 6, 2009, Lifeway Foods, Inc., a Illinois corporation (“Lifeway”) entered into and consummated a Stock Purchase Agreement (the “Stock Agreement”) by and among Lifeway, Ilya Mandel, an individual and Michael Edelson, an individual (each a “Seller” and collectively “Sellers”).

Upon the terms and subject to the conditions set forth in the Stock Agreement, Lifeway purchased from Sellers all of the issued and outstanding stock (the “Shares”) of Fresh Made, Inc., a Pennsylvania corporation (“Fresh”).  The consideration for the Shares was an aggregate of $8,050,000, less certain offsets for any selling expenses in excess of certain limits set forth in the Stock Agreement and other payments and funded debt all as set forth in the Stock Agreement, a note in the principal amount of $2,735,000, due on February 6, 2011, 128,948 shares of common stock of Lifeway valued at a total of $980,000 (“Lifeway’s Common Stock”), the cancellation of a loan in the principal amount of $265,000 and not more than $98,000 in funds held in Fresh’s two accounts with Vist Financial Corp.  The issuance of Lifeway’s Common Stock was exempted from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

Also on February 6, 2009, Lifeway entered into and consummated a Real Property Purchase Agreement (the “Real Property Agreement”) by and among Sellers and Lifeway.  Pursuant to the Real Property Agreement, Lifeway acquired 1.1355 acres of land in Philadelphia, PA (the “Property”) from Sellers.  The consideration for the Property was $2,000,000.
 
Recent Accounting Pronouncements
 
In December 2007, the FASB issued SFAS No. 141(R) “Business Combinations.”  SFAS No. 141(R) states that all business combinations (whether full, partial or step acquisitions) will result in all assets and liabilities of an acquired business being recorded at their acquisition date fair values.  Earn-outs and other forms of contingent consideration and certain acquired contingencies will also be recorded at fair value at the acquisition date.  SFAS No. 141(R) also states acquisition costs will generally be expensed as incurred; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense; and restructuring costs will be expensed in periods after the acquisition date.  This statement is effective for financial statements issued for fiscal years beginning after December 15, 2008.  The Company will apply the provisions of this standard to any acquisitions that it completes on or after December 15, 2008.
 
18

Forward Looking Statements

In this report, in reports subsequently filed by Lifeway with the SEC on Form 10-QSB and filed or furnished on Form 8-K, and in related comments by management, our use of the words “believe,” “expect,” “anticipate,” “estimate,” “forecast,” “objective,” “plan,” “goal,” “project,” “explore,” “priorities/targets,” and similar expressions is intended to identify forward-looking statements. While these statements represent our current judgment on what the future may hold, and we believe these judgments are reasonable, actual results may differ materially due to numerous important factors that are described in this report and other factors that may be described in subsequent reports which Lifeway may file with the SEC on Form 10-QSB and filed or furnished on Form 8-K, including but not limited to:

 
Changes in economic conditions, commodity prices;

 
Shortages of and price increase for fuel, labor strikes or work stoppages, market acceptance of the Company’s new products;

 
Significant changes in the competitive environment;

 
Changes in laws, regulations, and tax rates; and

 
Management’s ability to achieve reductions in cost and employment levels, to realize production efficiencies and to implement capital expenditures, all at of the levels and times planned by management.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable to smaller reporting company.
 
 
The annotated consolidated financial statements of the Company that constitute Item 8 of this report commence on the pages that follow this page.
 

19

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 

 
To the Shareholders of
LIFEWAY FOODS, INC. AND SUBSIDIARIES

We have audited the accompanying consolidated balance sheets of LIFEWAY FOODS, INC. AND SUBSIDIARIES (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2008.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LIFEWAY FOODS, INC. AND SUBSIDIARIES as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.
 
Plante & Moran, PLLC
Grand Rapids, MI
March 31, 2009
 
 
 
 
 
 
 
20

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
December 31, 2008 and 2007
 
   
December 31,
   
December 31,
 
   
2008
   
2007
 
ASSETS
           
             
Current assets
           
Cash and cash equivalents
  $ 277,248     $ 595,885  
Marketable securities
    5,262,168       6,989,474  
Inventories
    3,097,542       3,506,554  
Accounts receivable, net of allowance for doubtful accounts of $110,011 and $39,460 at December 31, 2008 and 2007
    4,765,865       4,209,662  
Prepaid expenses and other current assets
    23,226       21,253  
Other receivables
    40,314       43,111  
Deferred income taxes
    919,649       311,960  
Refundable income taxes
    356,416       240,880  
Total current assets
    14,742,428       15,918,779  
                 
Property and equipment, net
    11,062,714       9,678,948  
                 
Intangible assets
               
Goodwill
    5,414,858       5,414,858  
Other intangible assets, net of accumulated amortization of $921,422 and $601,976 at December 31, 2008 and 2007
    2,936,216       3,255,662  
Total intangible assets
    8,351,074       8,670,520  
                 
Other assets
    500,000       500,000  
                 
Total assets
  $ 34,656,216     $ 34,768,247  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities
               
Current maturities of notes payable
  $ 928,444     $ 1,136,126  
Accounts payable
    2,260,272       1,594,330  
Accrued expenses
    458,282       414,039  
Total current liabilities
    3,646,998       3,144,495  
                 
Notes payable
    3,108,014       4,096,797  
                 
Deferred income taxes
    1,607,155       1,712,795  
                 
Stockholders’ equity
               
Common stock, no par value;  20,000,000 shares authorized; 17,273,776 shares issued; 16,724,467 shares outstanding at December 31, 2008; 17,273,776 shares issued; 16,827,726 shares outstanding at December 31, 2007
    6,509,267       6,509,267  
Paid-in-capital
    1,202,009       1,120,669  
Treasury stock, at cost
    ( 3,302,025 )     ( 2,078,165 )
Retained earnings
    22,383,707       20,471,432  
Accumulated other comprehensive loss, net of taxes
    ( 498,909 )     ( 209,043 )
Total stockholders’ equity
    26,294,049       25,814,160  
                 
Total liabilities and stockholders’ equity
  $ 34,656,216     $ 34,768,247  
 
See accompanying notes to financial statements

21

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Years Ended December 31, 2008 and 2007
 
 
   
Year Ended
   
Year Ended
 
   
December 31,
   
December 31,
 
   
2008
   
2007
 
             
Sales
    44,461,455     $ 38,729,156  
                 
Cost of goods sold
    30,926,114       25,582,981  
Depreciation expense
    777,715       726,647  
                 
Total cost of goods sold
    31,703,829       26,309,628  
                 
Gross profit
    12,757,626       12,419,528  
                 
Selling Expenses
    4,098,176       3,744,388  
General and Administrative
    4,149,010       3,914,825  
Amortization expense
    319,446       323,266  
                 
Total Operating Expenses
    8,566,632       7,982,479  
                 
Income from operations
    4,190,994       4,437,049  
                 
Other income (expense):
               
Interest and dividend income
    343,329       350,286  
Rental Income
    48,886       48,305  
Interest expense
    ( 298,619 )     ( 410,180 )
Impairment of marketable securities
    ( 958,879 )      
Gain (loss) on sale of marketable securities, net
    ( 733,647 )     539,739  
Total other income (Expense)
    ( 1,598,930 )     528,150  
                 
Income before provision for income taxes
    2,592,064       4,965,199  
                 
Provision for income taxes
    679,789       1,812,539  
                 
Net income
  $ 1,912,275     $ 3,152,660  
                 
Basic and diluted earnings per common share
    0.11       0.19  
                 
Weighted average number of shares outstanding
    16,765,080       16,855,611  
                 
COMPREHENSIVE INCOME
               
                 
Net income
  $ 1,912,275     $ 3,152,660  
                 
Other comprehensive income (loss), net of tax:
               
Unrealized gains (losses) on marketable securities (net of tax benefits)
    ( 720,517 )     ( 47,091 )
Less reclassification adjustment for (gains) losses included in net income (net of taxes)
    430,651       ( 315,721 )
                 
Comprehensive income
  $ 1,622,409     $ 2,789,848  

 
See accompanying notes to financial statements

22

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2008 and 2007
 
 
 
   
Common Stock, No Par Value
                                 
Accumulated
       
   
20,000,000 Shares
   
# of Shares
                           
Other
       
   
Authorized
   
of
                           
Comprehensive
       
   
# of Shares
   
# of Shares
   
Treasury
   
Common
   
Paid In
   
Treasury
   
Retained
   
Income (Loss),
       
   
Issued
   
Outstanding
   
Stock
   
Stock
   
Capital
   
Stock
   
Earnings
   
Net of Tax
   
Total
 
                                                       
Balances at December 31, 2006
    17,273,776       16,897,826       375,950       6,509,267       1,080,911       (1,334,313 )     17,318,772       153,770       23,728,407  
                                                                         
Redemption of stock
          ( 75,000 )     75,000                   ( 752,603 )                 ( 752,603 )
                                                                         
Issuance of treasury stock for compensation
          4,900       ( 4,900 )           39,758       8,751                   48,509  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized losses on securities, net of taxes and reclassification adjustment
                                              ( 362,813 )     ( 362,813 )
                                                                         
Net income for the year ended December 31, 2007
                                        3,152,660             3,152,660  
                                                                         
                                                                         
Balances at December 31, 2007
    17,273,776       16,827,726       446,050       6,509,267       1,120,669       (2,078,165 )     20,471,432       ( 209,043 )     25,814,160  
                                                                         
Redemption of stock
          ( 112,009 )     112,009                   ( 1,239,488 )                 ( 1,239,488 )
                                                                         
Issuance of treasury stock for compensation
          8,750       ( 8,750 )           81,340       15,628                   96,968  
                                                                         
Other comprehensive income (loss):
                                                                       
Unrealized gains on securities, net of taxes and reclassification adjustment
                                              ( 289,866 )     ( 289,866 )
                                                                         
Net income for the year ended December 31, 2008
                                        1,912,275             1,912,275  
                                                                         
                                                                         
Balances at December 31, 2008
    17,273,776       16,724,467       549,309     $ 6,509,267     $ 1,202,009     $ (3,302,025 )   $ 22,383,707     $ (498,909 )   $ 26,294,049  
 
 
See accompanying notes to financial statements

23

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2008 and 2007
 
 
   
Years Ended
 
   
December 31,
 
   
2008
   
2007
 
             
Cash flows from operating activities:
           
Net income
  $ 1,912,275     $ 3,152,660  
Adjustments to reconcile net income to net
               
cash flows from operating activities, net of acquisition:
               
Depreciation and amortization
    1,092,995       1,049,913  
(Gain)Loss on sale of marketable securities, net
    733,647       ( 539,739 )
Impairment of marketable securities
    958,879        
Deferred income taxes
    ( 509,386 )     ( 223,717 )
Treasury stock issued for compensation
    96,968       48,509  
Increase (decrease) in allowance for doubtful accounts
    70,551       ( 40,540 )
(Increase) decrease in operating assets:
               
Accounts receivable
    ( 626,754 )     ( 226,405 )
Other receivables
    2,797       27,939  
Inventories
    409,012       ( 984,358 )
Refundable income taxes
    ( 115,536 )     26,891  
Prepaid expenses and other current assets
    ( 1,973 )     ( 9,270 )
Increase (decrease) in operating liabilities:
               
Accounts payable
    665,942       131,316  
Accrued expenses
    44,243       ( 66,062 )
Net cash provided by operating activities
    4,733,660       2,347,137  
                 
Cash flows from investing activities:
               
Investment in cost method securities
          ( 500,000 )
Purchases of marketable securities
    ( 5,782,452 )     ( 5,744,697 )
Sale of marketable securities
    5,323,423       7,168,246  
Purchases of property and equipment
    ( 2,157,315 )     (1,824,879 )
Net cash used in investing activities
    ( 2,616,344 )     ( 901,330 )
                 
Cash flows from financing activities:
               
Proceeds of note payable
          300,000  
Purchases of treasury stock, net
    ( 1,239,488 )     ( 752,603 )
Repayment of notes payable
    ( 1,196,465 )     ( 1,945,131 )
Net cash used in financing activities
    ( 2,435,953 )     ( 2,397,734 )
                 
Net decrease in cash and cash equivalents
    ( 318,637 )     ( 951,927 )
                 
Cash and cash equivalents at the beginning of the period
    595,885       1,547,812  
                 
Cash and cash equivalents at the end of the period
  $ 277,248     $ 595,885  


See accompanying notes to financial statements

24

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2008 and 2007


Note 1 – NATURE OF BUSINESS
 
Lifeway Foods, Inc. (The “Company”) commenced operations in February 1986 and incorporated under the laws of the state of Illinois on May 19, 1986. The Company’s principal business activity is the production of dairy products. Specifically, the Company produces Kefir, a drinkable product which is similar to but distinct from yogurt, in several flavors sold under the name “Lifeway’s Kefir;” a plain farmer’s cheese sold under the name “Lifeway’s Farmer’s Cheese;” a fruit sugar-flavored product similar in consistency to cream cheese sold under the name of “Sweet Kiss;” and a dairy beverage, similar to Kefir, with increased protein and calcium, sold under the name “Basics Plus.”  The Company also produces several soy-based products under the name “Soy Treat” and a vegetable-based seasoning under the name “Golden Zesta.” The Company currently distributes its products throughout the Chicago Metropolitan area and various cities in the East Coast through local food stores.  In addition, the products are sold throughout the United States and Ontario, Canada by distributors. The Company also distributes some of its products to Eastern Europe.


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Principles of consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, LFI Enterprises, Inc., Helios Nutrition, Ltd., Pride of Main Street, L.L.C. and Starfruit, L.L.C.  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 goodwill, intangible assets and deferred taxes.

Revenue Recognition
Sales represent sales of Company produced dairy products that 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.

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.

 
25

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2008 and 2007

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
Gross bank balances, not including outstanding checks, of amounts reported by financial institutions are categorized as follows:

   
December 31,
 
   
2008
   
2007
 
Amounts insured
  $ 847,711     $ 576,563  
Uninsured and uncollateralized amounts
          523,295  
Total bank balances
  $ 847,711     $ 1,099,858  

 
Marketable securities
 
All investment securities are classified as available-for-sale, and are carried at fair value or quoted market prices. Unrealized gains and losses on available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax. 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 size and duration of the decline; the financial condition of the investee; and the intent and ability to retain the investment for a sufficient period of time to allow for possible recovery in the market value of the investment.
 
Accounts receivable
 
Credit terms are extended to customers in the normal course of business.  The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral.

Accounts receivable are recorded at invoice amounts, and reduced to their estimated net realizable value by recognition of an allowance for doubtful accounts.  The Company’s estimate of the allowance for doubtful accounts is based upon historical experience, its evaluation of the current status of specific receivables, and unusual circumstances, if any.  Accounts are considered past due if payment is not made on a timely basis in accordance with the Company’s credit terms.  Accounts considered uncollectible are charged against the allowance.

Inventories
Inventories are stated at the lower of cost or market, cost being determined by the first-in, first-out method.
 
Property and equipment
Property and equipment are stated at depreciated cost or fair value where depreciated cost is not recoverable.  Depreciation is computed using the straight-line method.  When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period.  The cost of maintenance and repairs is charged to income as incurred; significant renewals and betterments are capitalized.

 
26

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2008 and 2007

 
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
Property and equipment are 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

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

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

Intangible assets are being amortized over the following useful lives:

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






27

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2008 and 2007


Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
Income taxes
Deferred income taxes arise from temporary differences resulting 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 marketable securities, capitalization of indirect costs for tax purposes, and the recognition of an allowance for doubtful accounts for financial statement purposes.

As of January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined. Pursuant to FIN 48, the Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The only periods subject to examination for the Company’s federal return are the 2004 through 2007 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 pursuant to FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before taxes. There were no such items during the periods covered in this report.

Treasury stock
Treasury stock is recorded using the cost method.

Advertising costs
The Company expenses advertising costs as incurred.  During the year ended December 31, 2008 and 2007, approximately $1,530,207 and $1,642,114 of such costs respectively, were expensed.

Earning 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 year ended December 31, 2008 and 2007, diluted and basic earnings per share were the same, as the effect of dilutive securities options outstanding was not significant.




 
28

LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2008 and 2007


Note 3 – INTANGIBLE ASSETS

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

   
December 31, 2008
   
December 31, 2007
 
   
Cost
   
Accumulated Amortization
   
Cost
   
Accumulated Amortization
 
Recipes
  $ 43,600     $ 43,600     $ 43,600     $ 37,242  
Customer lists and other customer related intangibles
    305,200       182,938       305,200       141,518  
Lease acquisition
    87,200       55,019       87,200       42,562  
Other
    6,638       4,647       6,638       3,319  
Customer relationship
    985,000       198,368       985,000       116,285  
Contractual backlog
    12,000       12,000       12,000       12,000  
Trade names
    1,980,000       319,000       1,980,000       187,000  
Formula
    438,000       105,850       438,000       62,050  
    $ 3,857,638     $ 921,422     $ 3,857,638     $ 601,976  

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

2009
  $
313,225
 
2010
   
312,756
 
2011
   
300,964
 
2012
   
257,883
 
                         2013
   
257,883
 
Thereafter