##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 For the transition period from  to
 Commission file number: 0-17363
 LIFEWAY FOODS, INC.
  Illinois
    
    36-3442829(State or other jurisdiction of incorporation or organization)
    
    (IRS Employer Identification No.)
  
   
  
  þ o
 o þ
 APPLICABLE ONLY TO CORPORATE ISSUERS
 State the number of shares outstanding of each of the issuers classes of common equity, as of the
latest practicable date: As of August 8, 2006, the issuer had 8,396,536 shares of common stock, no par
value, outstanding.
 o þ




---



##### 



INDEX
 PART I  FINANCIAL INFORMATION
    
    
    3ITEM 1. FINANCIAL STATEMENTS
    
    
    3ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    
    16ITEM 3. CONTROLS AND PROCEDURES
    
    
    19PART II  OTHER INFORMATION
    
    
    19ITEM 5. OTHER INFORMATION
    
    
    19ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
    
    
    19SIGNATURE
    
    
    20CertificationCertificationSection 1350 CertificationSection 1350 CertificationPRESS RELEASE




---



##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 LIFEWAY FOODS, INC. AND SUBSIDIARY
 CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2006 and 2005
 AND DECEMBER 31, 2005
 (Unaudited)June 30,
    
    
    December, 312006
    
    
    2005
    
    
    2005ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,621,803
    
    
    $
    2,024,384
    
    
    $
    4,354,081Marketable securities
    
    
    8,581,674
    
    
    
    6,301,790
    
    
    
    7,478,697Inventories
    
    
    2,320,818
    
    
    
    1,106,211
    
    
    
    1,716,999Accounts receivable, net of allowance for doubtful
accounts
of $45,000 and $15,000 at June 30, 2006 and 2005
and $35,000 at December 31, 2005
    
    
    3,561,038
    
    
    
    2,556,808
    
    
    
    2,517,615Prepaid expenses and other current assets
    
    
    51,823
    
    
    
    102,448
    
    
    
    9,144Other receivables
    
    
    67,332
    
    
    
    106,896
    
    
    
    56,435Deferred income taxes
    
    
    116,544
    
    
    
    55,352
    
    
    
    142,772Refundable income taxes
    
    
    
    
    
    
    172,635
    
    
    
    11,562Total current assets
    
    
    18,321,032
    
    
    
    12,426,524
    
    
    
    16,287,305Property and equipment, net
    
    
    7,762,286
    
    
    
    7,757,150
    
    
    
    7,751,446Intangible assetsGoodwill
    
    
    75,800
    
    
    
    75,800
    
    
    
    75,800Other intangible assets, net of accumulated amortization
of $125,488 and $59,379 at June 30, 2006 and 2005
and $92,432 at December 31, 2005
    
    
    317,154
    
    
    
    376,621
    
    
    
    350,206Total intangible assets
    
    
    392,954
    
    
    
    452,421
    
    
    
    426,006Total assets
    
    $
    26,476,272
    
    
    $
    20,636,095
    
    
    $
    24,464,757LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent maturities of notes payable
    
    $
    542,089
    
    
    $
    12,662
    
    
    $
    532,454Accounts payable
    
    
    704,061
    
    
    
    659,351
    
    
    
    426,253Accrued expenses
    
    
    382,543
    
    
    
    427,307
    
    
    
    355,011Accrued income tax
    
    
    441,049
    
    
    
    
    
    
    
    Total current liabilities
    
    
    2,069,742
    
    
    
    1,099,320
    
    
    
    1,313,718Notes payable
    
    
    2,849,504
    
    
    
    454,046
    
    
    
    2,903,349Deferred income taxes
    
    
    343,619
    
    
    
    381,049
    
    
    
    348,923Stockholders equityCommon stock
    
    
    6,509,267
    
    
    
    6,509,267
    
    
    
    6,509,267Paid-in-capital
    
    
    104,036
    
    
    
    74,751
    
    
    
    90,725Treasury stock, at cost
    
    
    (         1,468,091
    )
    
    
    (         1,043,685
    )
    
    
    (         1,024,659
    )Retained earnings
    
    
    16,067,650
    
    
    
    13,156,711
    
    
    
    14,422,948Accumulated other comprehensive income (loss), net of
taxes
    
    
    545
    
    
    
    4,636
    
    
    
    (99,514
    )Total stockholders equity
    
    
    21,213,407
    
    
    
    18,701,680
    
    
    
    19,898,767Total liabilities and stockholders equity
    
    $
    26,476,272
    
    
    $
    20,636,095
    
    
    $
    24,464,757
 3




---



##### Table of Contents



(Unaudited)
    
    
    (Unaudited)Three Months Ended
    
    
    Six Months Ended
    
    
    Year EndedJune 30
    
    
    June 30
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2005Sales
    
    $
    6,367,397
    
    
    $
    5,072,567
    
    
    $
    12,370,420
    
    
    $
    9,729,427
    
    
    $
    20,131,654Cost of goods sold
    
    
    3,738,617
    
    
    
    2,956,267
    
    
    
    6,951,184
    
    
    
    5,534,223
    
    
    
    11,664,065Gross profit
    
    
    2,628,780
    
    
    
    2,116,300
    
    
    
    5,419,236
    
    
    
    4,195,204
    
    
    
    8,467,589Operating expenses
    
    
    1,698,626
    
    
    
    1,279,043
    
    
    
    3,082,711
    
    
    
    2,434,223
    
    
    
    5,066,227Income from operations
    
    
    930,154
    
    
    
    837,257
    
    
    
    2,336,525
    
    
    
    1,760,981
    
    
    
    3,401,362Other income (expense):Interest and dividend income
    
    
    122,033
    
    
    
    75,289
    
    
    
    208,264
    
    
    
    140,565
    
    
    
    323,365Interest expense
    
    
    (         63,200
    )
    
    
    (           6,876
    )
    
    
    (      113,426
    )
    
    
    (        14,318
    )
    
    
    (           100,762
    )Gain (loss) on sale of marketable
securities, net
    
    
    225,292
    
    
    
    (         36,153
    )
    
    
    188,414
    
    
    
    161,987
    
    
    
    445,327Gain on marketable securities
classified as trading
    
    
    2,549
    
    
    
    11,520
    
    
    
    3,061
    
    
    
    15,036
    
    
    
    13,773Total other income
    
    
    286,674
    
    
    
    43,780
    
    
    
    286,313
    
    
    
    303,270
    
    
    
    681,703Income before provision for
income taxes
    
    
    1,216,828
    
    
    
    881,037
    
    
    
    2,622,838
    
    
    
    2,064,251
    
    
    
    4,083,065Provision for income taxes
    
    
    466,784
    
    
    
    324,192
    
    
    
    978,136
    
    
    
    782,015
    
    
    
    1,534,592Net income
    
    $
    750,044
    
    
    $
    556,845
    
    
    $
    1,644,702
    
    
    $
    1,282,236
    
    
    $
    2,548,473Basic and diluted earnings per
common share
    
    
    0.04
    
    
    
    0.03
    
    
    
    0.10
    
    
    
    0.08
    
    
    
    0.15Weighted average number of shares
outstanding
    
    
    16,799,536
    
    
    
    16,795,398
    
    
    
    16,795,473
    
    
    
    16,830,160
    
    
    
    16,808,992COMPREHENSIVE INCOMENet income
    
    $
    750,044
    
    
    $
    556,845
    
    
    $
    1,644,702
    
    
    $
    1,282,236
    
    
    $
    2,548,473Other comprehensive income (loss),
net of tax:Unrealized gains (losses) on
marketable securities
(net of tax benefits)
    
    
    (         65,256
    )
    
    
    36,251
    
    
    
    210,281
    
    
    
    (        20,471
    )
    
    
    42,708Less reclassification adjustment
for gains (losses)
included in net income (net of taxes)
    
    
    (88,574
    )
    
    
    21,153
    
    
    
    (110,222
    )
    
    
    (        94,073
    )
    
    
    (           261,402
    )Comprehensive income
    
    $
    596,214
    
    
    $
    614,249
    
    
    $
    1,744,761
    
    
    $
    1,167,692
    
    
    $
    2,329,779
 4




---



##### Table of Contents



Common Stock,No Par Value20,000,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedShares
    
    
    # of Shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    OtherAuthorized
    
    
    of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive# of Shares
    
    
    # of Shares
    
    
    Treasury
    
    
    Common
    
    
    Paid In
    
    
    Treasury
    
    
    Retained
    
    
    Income (Loss),Issued
    
    
    Outstanding
    
    
    Stock
    
    
    Stock
    
    
    Capital
    
    
    Stock
    
    
    Earnings
    
    
    Net of Tax
    
    
    TotalBalances at December 31, 2004
    
    
    17,273,776
    
    
    
    16,882,876
    
    
    
    390,900
    
    
    $
    6,509,267
    
    
    $
    64,314
    
    
    $
    (649,039
    )
    
    $
    11,874,475
    
    
    $
    119,180
    
    
    $
    17,918,197Issuance of treasury stock
    
    
    
    
    
    
    7,634
    
    
    
    (7,634
    )
    
    
    
    
    
    
    26,411
    
    
    
    25,934
    
    
    
    
    
    
    
    
    
    
    
    52,345Redemption of stock
    
    
    
    
    
    
    (100,000
    )
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    (401,554
    )
    
    
    
    
    
    
    
    
    
    
    (401,554
    )Other comprehensive income (loss):Unrealized losses on securities, net of
taxes and reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (218,694
    )
    
    
    (218,694
    )Net income for the year
ended December 31, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,548,473
    
    
    
    
    
    
    
    2,548,473Balances at December 31, 2005
    
    
    17,273,776
    
    
    
    16,790,510
    
    
    
    483,266
    
    
    $
    6,509,267
    
    
    $
    90,725
    
    
    $
    (1,024,659
    )
    
    $
    14,422,948
    
    
    $
    (99,514
    )
    
    $
    19,898,767Issuance of treasury stock
    
    
    
    
    
    
    4,666
    
    
    
    (4,666
    )
    
    
    
    
    
    
    13,311
    
    
    
    15,855
    
    
    
    
    
    
    
    
    
    
    
    29,166Redemption of stock
    
    
    
    
    
    
    (74,988
    )
    
    
    74,988
    
    
    
    
    
    
    
    
    
    
    
    (459,287
    )
    
    
    
    
    
    
    
    
    
    
    (459,287
    )Other comprehensive income (loss):Unrealized gains on securities, net of
taxes and reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100,059
    
    
    
    100,059Net income for the six months
ended June 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,644,702
    
    
    
    
    
    
    
    1,644,702Balances at June 30, 2006
    
    
    17,273,776
    
    
    
    16,720,188
    
    
    
    553,588
    
    
    $
    6,509,267
    
    
    $
    104,036
    
    
    $
    (1,468,091
    )
    
    $
    16,067,650
    
    
    $
    545
    
    
    $
    21,213,407
 5




---



##### Table of Contents



Six Months Ended
    
    
    Year EndedJune 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Cash flows from operating activities:Net income
    
    $
    1,644,702
    
    
    $
    1,282,236
    
    
    $
    2,548,473Adjustments to reconcile net income to net
cash flows from operating activities:Depreciation and amortization
    
    
    291,678
    
    
    
    318,346
    
    
    
    650,945(Gain)Loss on sale of marketable securities, net
    
    
    (188,414
    )
    
    
    (161,987
    )
    
    
    (445,327
    )Gain on marketable securities
classified as trading
    
    
    (3,061
    )
    
    
    (15,036
    )
    
    
    (13,773
    )Deferred income taxes
    
    
    (52,541
    )
    
    
    (53,968
    )
    
    
    (100,236
    )Treasury stock issued for services
    
    
    29,166
    
    
    
    17,345
    
    
    
    52,345Increase in allowance for doubtful accounts
    
    
    10,000
    
    
    
    
    
    
    
    (Increase) decrease in operating assets:Accounts receivable
    
    
    (1,053,423
    )
    
    
    (532,772
    )
    
    
    (493,579
    )Other receivables
    
    
    (10,897
    )
    
    
    (34,759
    )
    
    
    15,702Inventories
    
    
    (603,819
    )
    
    
    (200,514
    )
    
    
    (811,302
    )Refundable income taxes
    
    
    11,562
    
    
    
    85,982
    
    
    
    247,055Prepaid expenses and other current assets
    
    
    (42,679
    )
    
    
    (95,188
    )
    
    
    (1,884
    )Increase (decrease) in operating liabilities:Accounts payable
    
    
    277,808
    
    
    
    17,700
    
    
    
    (215,398
    )Accrued expenses
    
    
    27,532
    
    
    
    231,766
    
    
    
    159,470Accrued income taxes
    
    
    441,049
    
    
    
    
    
    
    
    Net cash provided by operating activities
    
    
    778,663
    
    
    
    859,151
    
    
    
    1,592,491Cash flows from investing activities:Purchases of marketable securities
    
    
    (3,968,844
    )
    
    
    (2,454,680
    )
    
    
    (6,460,561
    )Sale of marketable securities
    
    
    3,230,866
    
    
    
    2,876,669
    
    
    
    5,810,391Purchases of property and equipment
    
    
    (269,466
    )
    
    
    (4,622,870
    )
    
    
    (4,916,811
    )Net cash used in investing activities
    
    
    (1,007,444
    )
    
    
    (4,200,881
    )
    
    
    (5,566,981
    )Cash flows from financing activities:Proceeds from note payable
    
    
    
    
    
    
    
    
    
    
    3,000,000Purchases of treasury stock
    
    
    (459,287
    )
    
    
    (401,554
    )
    
    
    (401,554
    )Repayment of notes payable
    
    
    (44,210
    )

    
    
    
    
    
    
    (36,522
    )Loan costs
    
    
    
    
    
    
    (5,617
    )
    
    
    (6,638
    )Net cash provided by (used in) financing activities
    
    
    (503,497
    )
    
    
    (407,171
    )
    
    
    2,555,286Net decrease in cash and cash equivalents
    
    
    (732,278
    )
    
    
    (3,748,901
    )
    
    
    (1,419,204
    )Cash and cash equivalents at the beginning of the period
    
    
    4,354,081
    
    
    
    5,773,285
    
    
    
    5,773,285Cash and cash equivalents at the end of the period
    
    $
    3,621,803
    
    
    $
    2,024,384
    
    
    $
    4,354,081
 6




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
June 30, 2006 and 2005
and December 31, 2005
 Note 1  NATURE OF BUSINESS
  Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  Principles of consolidationThe consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiary, LFI Enterprises, Inc. All significant intercompany accounts and
transactions have been eliminated.Use of estimatesThe 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.Revenue RecognitionSales represent sales of Company produced dairy products that are recorded at the time of
shipment. In addition, shipping costs invoiced to the customers are included in net sales
and the related cost in cost of sales.Cash and cash equivalentsAll 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. Deposits at each institution are
insured up to $100,000 by the Federal Deposit Insurance Corporation or the Securities
Investor Protector Corporation.
 Bank balances of amounts reported by financial institutions are categorized as follows:
 June 30,
    
    
    December 312006
    
    
    2005
    
    
    2005Amounts insured
    
    $
    340,460
    
    
    $
    403,372
    
    
    $
    462,571Uninsured and uncollateralized amounts
    
    
    3,792,076
    
    
    
    1,916,182
    
    
    
    4,331,179Total bank balances
    
    $
    4,132,536
    
    
    $
    2,319,554
    
    
    $
    4,793,750
 Marketable securities
 Accounting for Certain Investments in Debt and Equity Securities Accounting for
Noncurrent Marketable Equity Securities
 7




---



##### Table of Contents



Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
  Accounts receivable
   Inventories
  Property and equipment
   Category
    
    YearsBuildings and improvements
    
    31 and 39Machinery and equipment
    
    
    5  12Office equipment
    
    
    5  7Vehicles
    
    
    5
 Intangible assets
     8




---



##### Table of Contents



Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
  Category
    
    YearsRecipes
    
    
    4Customer lists and other
customer related intangibles
    
    
    8Lease agreement
    
    
    7
 Income taxes
  Treasury stock
  Advertising costs
  Earning per common share
  Note 3  INTANGIBLE ASSETS
  June 30, 2006
    
    
    June 30, 2005
    
    
    December 31, 2005Accumulated
    
    
    
    
    
    
    Accumulated
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Cost
    
    
    Amortization
    
    
    Cost
    
    
    AmortizationRecipes
    
    $
    43,600
    
    
    $
    20,892
    
    
    $
    43,600
    
    
    $
    9,992
    
    
    $
    43,600
    
    
    $
    15,442Customer lists and
other customer
related intangibles
    
    
    305,200
    
    
    
    79,388
    
    
    
    305,200
    
    
    
    37,968
    
    
    
    305,200
    
    
    
    58,678Lease acquisition
    
    
    87,200
    
    
    
    23,876
    
    
    
    87,200
    
    
    
    11,419
    
    
    
    87,200
    
    
    
    17,648Goodwill
    
    
    75,800
    
    
    
    
    
    
    
    75,800
    
    
    
    
    
    
    
    75,800
    
    
    
    Loan acquisition costs
    
    
    6,638
    
    
    
    1,328
    
    
    
    
    
    
    
    
    
    
    
    6,638
    
    
    
    664$
    518,438
    
    
    $
    125,484
    
    
    $
    511,800
    
    
    $
    59,379
    
    
    $
    518,438
    
    
    $
    92,432
 9




---



##### Table of Contents



Note 3  INTANGIBLE ASSETS  Continued
  2007
    
    $
    66,1052008
    
    
    66,1052009
    
    
    56,1132010
    
    
    47,2112011
    
    
    45,157Thereafter
    
    
    36,463$
    317,154
  Note 4  MARKETABLE SECURITIES
  Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairJune 30, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities
    
    $
    2,846,117
    
    
    $
    312,995
    
    
    $
    (154,061
    )
    
    
    
    
    
    $
    3,005,051Mutual Funds
    
    
    663,029
    
    
    
    2,583
    
    
    
    (   50,827
    )
    
    
    
    
    
    
    614,785Preferred Securities
    
    
    1,629,157
    
    
    
    1,081
    
    
    
    (   56,874
    )
    
    
    
    
    
    
    1,573,364Private Investment LP
    
    
    600,000
    
    
    
    38,480
    
    
    
    
    
    
    
    
    
    
    
    638,480Certificates of Deposit
    
    
    225,000
    
    
    
    
    
    
    
    (     6,278
    )
    
    
    
    
    
    
    218,722Corporate Bonds
    
    
    2,008,255
    
    
    
    746
    
    
    
    (   85,388
    )
    
    
    
    
    
    
    1,923,613Municipal Bonds
    
    
    61,275
    
    
    
    403
    
    
    
    (     1,929
    )
    
    
    
    
    
    
    59,749Government
Agency
    
    
    547,562
    
    
    
    
    
    
    
    
    
    
    
    348
    
    
    
    547,910Total
    
    $
    8,580,395
    
    
    $
    356,288
    
    
    $
    (355,357
    )
    
    $
    348
    
    
    $
    8,581,674
 Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairJune 30, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities and Mutual
Funds
    
    $
    3,693,256
    
    
    $
    200,374
    
    
    $
    (142,171
    )
    
    
    
    
    
    $
    3,751,459Preferred Securities
    
    
    40,000
    
    
    
    
    
    
    
    (    2,600
    )
    
    
    
    
    
    
    37,400Certificates of Deposit
    
    
    150,000
    
    
    
    
    
    
    
    (    6,270
    )
    
    
    
    
    
    
    143,730Corporate Bonds
    
    
    2,287,211
    
    
    
    
    
    
    
    (  42,900
    )
    
    
    
    
    
    
    2,244,311Municipal
Bonds
    
    
    24,875
    
    
    
    1,466
    
    
    
    
    
    
    
    
    
    
    
    26,341Government
Agency
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    (      1,451
    )
    
    
    98,549Total
    
    $
    6,295,342
    
    
    $
    201,840
    
    
    $
    (193,941
    )
    
    $
    (      1,451
    )
    
    $
    6,301,790
 10




---



##### Table of Contents



Note 4  MARKETABLE SECURITIES  Continued
 Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairDecember 31, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities
    
    $
    2,432,964
    
    
    $
    212,336
    
    
    $
    ( 198,478
    )
    
    
    
    
    
    $
    2,446,822Mutual Funds
    
    
    699,921
    
    
    
    3,770
    
    
    
    (   74,148
    )
    
    
    
    
    
    
    629,543Preferred Securities
    
    
    1,002,738
    
    
    
    1,468
    
    
    
    (   30,892
    )
    
    
    
    
    
    
    973,314Private Investment LP
    
    
    600,000
    
    
    
    
    
    
    
    (     5,146
    )
    
    
    
    
    
    
    594,854Certificates of Deposit
    
    
    240,000
    
    
    
    
    
    
    
    (     1,125
    )
    
    
    
    
    
    
    238,875Corporate Bonds
    
    
    2,514,044
    
    
    
    809
    
    
    
    (   77,888
    )
    
    
    
    
    
    
    2,436,965Municipal Bonds,
maturing within five
years
    
    
    61,275
    
    
    
    957
    
    
    
    (     1,195
    )
    
    
    
    
    
    
    61,037Government agency
obligations, maturing
after five years
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    (   2,713
    )
    
    
    97,287Total
    
    $
    7,650,942
    
    
    $
    219,340
    
    
    $
    (388,872
    )
    
    $
    (2,713
    )
    
    $
    7,478,697
    Less Than 12 Months
    
    
    12 Months or Greater
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedDescription of Securities
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Value
    
    
    LossesEquities
    
    $
    1,204,022
    
    
    $
    (121,308
    )
    
    $
    150,607
    
    
    $
    (32,754
    )
    
    $
    1,354,629
    
    
    $
    (154,062
    )Mutual Funds
    
    
    145,882
    
    
    
    (   12,644
    )
    
    
    384,230
    
    
    
    (   38,182
    )
    
    
    530,112
    
    
    
    (  50,826
    )Preferred Securities
    
    
    1,427,028
    
    
    
    (   52,014
    )
    
    
    46,870
    
    
    
    (     4,860
    )
    
    
    1,473,898
    
    
    
    (  56,874
    )Certificates of Deposit
    
    
    72,607
    
    
    
    (     2,393
    )
    
    
    146,115
    
    
    
    (     3,885
    )
    
    
    218,722
    
    
    
    (    6,278
    )Corporate Bonds
    
    
    25,496
    
    
    
    (     2,370
    )
    
    
    1,622,197
    
    
    
    (   83,018
    )
    
    
    1,647,693
    
    
    
    (  85,388
    )Municipal Bonds
    
    
    34,471
    
    
    
    (     1,929
    )
    
    
    
    
    
    
    
    
    
    
    34,471
    
    
    
    (    1,929
    )$
    2,909,506
    
    
    $
    (192,658
    )
    
    $
    2,350,019
    
    
    $
    (162,699
    )
    
    $
    5,259,525
    
    
    $
    (  355,357
    )
 11




---



##### Table of Contents



Note 4  MARKETABLE SECURITIES  Continued
     Note 5  INVENTORIES
  June 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Finished goods
    
    $
    876,618
    
    
    $
    489,160
    
    
    $
    658,522Production supplies
    
    
    853,074
    
    
    
    359,625
    
    
    
    662,310Raw materials
    
    
    591,126
    
    
    
    257,426
    
    
    
    396,167Total inventories
    
    $
    2,320,818
    
    
    $
    1,106,211
    
    
    $
    1,716,999
 Note 6  PROPERTY AND EQUIPMENT
  June 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Land
    
    $
    909,232
    
    
    $
    909,232
    
    
    $
    909,232Buildings and improvements
    
    
    6,516,018
    
    
    
    6,427,993
    
    
    
    6,443,043Machinery and equipment
    
    
    5,982,646
    
    
    
    5,578,369
    
    
    
    5,806,853Vehicles
    
    
    534,365
    
    
    
    459,815
    
    
    
    513,670Office equipment
    
    
    78,763
    
    
    
    82,211
    
    
    
    78,76314,021,024
    
    
    
    13,457,620
    
    
    
    13,751,561Less accumulated depreciation
    
    
    6,258,738
    
    
    
    5,700,470
    
    
    
    6,000,115Total property and equipment
    
    $
    7,762,286
    
    
    $
    7,757,150
    
    
    $
    7,751,446
  12




---



##### Table of Contents



Note 7 ACCRUED EXPENSES
  June 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Accrued payroll and payroll taxes
    
    $
    105,898
    
    
    $
    123,237
    
    
    $
    104,873Accrued property tax
    
    
    271,155
    
    
    
    299,270
    
    
    
    244,916Other
    
    
    5,490
    
    
    
    4,800
    
    
    
    5,222$
    382,543
    
    
    $
    427,307
    
    
    $
    355,011
 Note 8  NOTES PAYABLE
 Notes payable consist of the following:
 June 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Mortgage note payable to a
bank, payable in monthly
installments of $3,273
including interest at 6.25%,
with a balloon payment of
$454,275 due September 25,
2006. Collateralized by real
estate.
    
    $
    457,605
    
    
    $
    466,708
    
    
    $
    462,695Mortgage note payable to a
bank, payable in monthly
installments of $19,513
including interest at 5.6%,
with a balloon payment of
$2,652,143 due July 14, 2010.
Collateralized by real estate.
    
    
    2,933,988
    
    
    
    
    
    
    
    2,973,108Total notes payable
    
    
    3,391,593
    
    
    
    466,708
    
    
    
    3,435,803Less current maturities
    
    
    542,089
    
    
    
    12,662
    
    
    
    532,454Total long-term portion
    
    $
    2,849,504
    
    
    $
    454,046
    
    
    $
    2,903,349
  For the year ended June 30,2007
    
    $
    542,0892008
    
    
    73,7672009
    
    
    78,0052010
    
    
    82,4882011
    
    
    2,615,244Total
    
    $
    3,391,593
 13




---



##### Table of Contents



Note 9  PROVISION FOR INCOME TAXES
  For theFor the Six Months Ended
    
    
    Year EndedJune 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Current:Federal
    
    $
    833,877
    
    
    $
    681,731
    
    
    $
    1,364,033State and local
    
    
    193,734
    
    
    
    154,252
    
    
    
    270,795Total current
    
    
    1,027,611
    
    
    
    835,983
    
    
    
    1,634,828Deferred
    
    
    (   49,475
    )
    
    
    (  53,968
    )
    
    
    ( 100,236
    )Provision for income taxes
    
    $
    978,136
    
    
    $
    782,015
    
    
    $
    1,534,592
  For TheFor The Six Months Ended
    
    
    Year EndedJune 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Federal income tax expense
computed at the statutory rate
    
    $
    891,480
    
    
    $
    701,846
    
    
    $
    1,388,242State and local tax expense, net
    
    
    125,850
    
    
    
    99,455
    
    
    
    195,987Permanent differences
    
    
    (  39,194
    )
    
    
    (    19,286
    )
    
    
    (   49,637
    )Provision for income taxes
    
    $
    978,136
    
    
    $
    782,015
    
    
    $
    1,534,592
  June 30,
    
    
    December 312006
    
    
    2005
    
    
    2005Non-current deferred tax liabilities
arising from:Temporary differences 
accumulated depreciation
    
    $
    (343,619
    )
    
    $
    (381,049
    )
    
    $
    (348,923
    )Current deferred tax assets
(liabilities) arising from:Unrealized losses (gains) on
marketable securities
    
    
    (        383
    )
    
    
    (     3,262
    )
    
    
    70,016Inventory
    
    
    98,342
    
    
    
    
    
    
    
    72,756Allowance for doubtful accounts
    
    
    18,585
    
    
    
    58,614
    
    
    
    Total current deferred tax assets
(liabilities)
    
    
    116,544
    
    
    
    55,352
    
    
    
    142,772Net deferred tax liability
    
    $
    (227,075
    )
    
    $
    (325,697
    )
    
    $
    (206,151
    )
 Note 10  SUPPLEMENTAL CASH FLOW INFORMATION
  For YearFor the Six Months Ended
    
    
    EndedJune 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Interest
    
    $
    113,426
    
    
    $
    14,318
    
    
    $
    100,762Income taxes
    
    $
    578,467
    
    
    $
    751,757
    
    
    $
    1,425,600
 14




---



##### Table of Contents



Note 11  STOCK OPTION PLANS
     Note 12  FAIR VALUE OF FINANCIAL INSTRUMENTS
  June 30,
    
    
    June 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    Value
    
    
    Amount
    
    
    ValueCash and cash
equivalents
    
    $
    3,621,803
    
    
    $
    3,621,803
    
    
    $
    2,024,384
    
    
    $
    2,024,384
    
    
    $
    4,354,081
    
    
    $
    4,354,081Marketable securities
    
    $
    8,581,674
    
    
    $
    8,581,674
    
    
    $
    6,301,790
    
    
    $
    6,301,790
    
    
    $
    7,478,697
    
    
    $
    7,478,697Notes payable
    
    $
    3,391,593
    
    
    $
    3,385,569
    
    
    $
    466,708
    
    
    $
    464,169
    
    
    $
    3,435,803
    
    
    $
    3,416,969
 Note 13  RECENT ACCOUNTING PRONOUNCEMENTS
  15




---



##### Table of Contents



Note 14  SUBSEQUENT EVENTS
    
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 Comparison of Quarter Ended June 30, 2006 to Quarter Ended June 30, 2005
  Results of Operations
    16




---



##### Table of Contents



Comparison of Six-Month Period Ended June 30, 2006 to Six Month Period Ended June 30, 2005
 Results of Operations
      Sources and Uses of Cash
   17




---



##### Table of Contents



Liquidity
   Other Developments
  Critical Accounting Policies
  Forward Looking Statements
  
    
    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.
 18




---



##### Table of Contents



ITEM 3. CONTROLS AND PROCEDURES
   
 PART II  OTHER INFORMATION
 
 ITEM 5. OTHER INFORMATION
  .
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 ExhibitNumber
    
    Description3.4
    
    Amended and Restated By-laws (incorporated by reference to Exhibit No. 3.5 of Lifeways
Current Report on Form 8-K dated and filed on December 10, 2002). (File No. 000-17363)3.5
    
    Articles of Incorporation, as amended and currently in effect (incorporated by reference to
Exhibit 3.5 of Lifeways Quarterly Report on Form 10-QSB for the quarter ended June 30, 2000
and filed on August 8, 2000). (File No. 000-17363)11
    
    Statement re: Computation of per share earnings (incorporated by reference to Note 2 of the
Consolidated Financial Statements)31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Edward P. Smolyansky.32.1
    
    Section 1350 Certification of Julie Smolyansky.32.2
    
    Section 1350 Certification of Edward P. Smolyansky.99.1
    
    Press Release dated August 14,
2006  Lifeway Foods Inc. Reports Second Quarter and Six
Month Results.
  
 19




---



##### Table of Contents



SIGNATURE
   LIFEWAY FOODS, INC.By: /s/ Julie SmolyanskyJulie SmolyanskyChief Executive Officer, President, and Director/s/ Edward P. SmolyanskyChief Financial and Accounting Officer
And Treasurer
 20




---



##### Table of Contents



ExhibitNumber
    
    Description31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Edward P. Smolyansky.32.1
    
    Section 1350 Certification of Julie Smolyansky.32.2
    
    Section 1350 Certification of Edward P. Smolyansky.99.1
    
    Press Release dated August 14,
2006  Lifeway Foods Inc. Reports Second Quarter and Six Month
Results.
  
 21