##### 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 September 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.)
 6431 WEST OAKTON, MORTON GROVE, ILLINOIS 60053
 (Issuers telephone number)
 (Former name, former address and former fiscal year, if changed since last report)
 Yes þ
No o
 o o
 APPLICABLE ONLY TO CORPORATE ISSUERS
  o þ




---



##### 



INDEX
 PART I  FINANCIAL INFORMATION
    
    
    3ITEM 1. FINANCIAL STATEMENTS
    
    
    3ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    
    20ITEM 3. CONTROLS AND PROCEDURES
    
    
    23PART II  OTHER INFORMATION
    
    
    23ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
    
    
    23SIGNATURE
    
    
    24Section 302 CertificationSection 302 CertificationSection 1350 CertificationSection 1350 Certification
  302 Certifications  Section 1350 Certifications
 2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 LIFEWAY
FOODS, INC. AND SUBSIDIARY
 CONSOLIDATED FINANCIAL STATEMENTS
 September 30, 2006 and 2005
 AND DECEMBER 31, 2005
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, 2006 and 2005 (Unaudited) and December 31, 2005
 (Unaudited)September 30,
    
    
    December, 312006
    
    
    2005
    
    
    2005ASSETSCurrent assetsCash and cash equivalents
    
    $
    1,242,306
    
    
    $
    4,191,755
    
    
    $
    4,354,081Marketable securities
    
    
    8,042,189
    
    
    
    7,580,531
    
    
    
    7,478,697Inventories
    
    
    2,628,508
    
    
    
    1,301,066
    
    
    
    1,716,999Accounts receivable, net of allowance for doubtful accounts
of $45,000 and $15,000 at September 30, 2006 and 2005
and $35,000 at December 31, 2005
    
    
    3,984,991
    
    
    
    2,637,528
    
    
    
    2,517,615Prepaid expenses and other current assets
    
    
    46,547
    
    
    
    82,293
    
    
    
    9,144Other receivables
    
    
    59,810
    
    
    
    109,093
    
    
    
    56,435Deferred income taxes
    
    
    108,154
    
    
    
    46,881
    
    
    
    142,772Refundable income taxes
    
    
    68,346
    
    
    
    58,037
    
    
    
    11,562Total current assets
    
    
    16,180,851
    
    
    
    16,007,184
    
    
    
    16,287,305Property and equipment, net
    
    
    8,574,181
    
    
    
    7,755,352
    
    
    
    7,751,446Intangible assetsGoodwill
    
    
    7,321,114
    
    
    
    75,800
    
    
    
    75,800Other intangible assets, net of accumulated amortization
of $142,010 and $59,379 at September 30, 2006 and 2005
and $92,432 at December 31, 2005
    
    
    300,628
    
    
    
    366,567
    
    
    
    350,206Total intangible assets
    
    
    7,621,742
    
    
    
    442,367
    
    
    
    426,006Total assets
    
    $
    32,376,774
    
    
    $
    24,204,903
    
    
    $
    24,464,757LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent maturities of notes payable
    
    $
    1,124,284
    
    
    $
    534,938
    
    
    $
    532,454Accounts payable
    
    
    1,251,720
    
    
    
    648,881
    
    
    
    426,253Accrued expenses
    
    
    270,990
    
    
    
    453,895
    
    
    
    355,011Total current liabilities
    
    
    2,646,994
    
    
    
    1,637,714
    
    
    
    1,313,718Notes payable
    
    
    6,191,521
    
    
    
    2,919,656
    
    
    
    2,903,349Deferred income taxes
    
    
    346,217
    
    
    
    362,314
    
    
    
    348,923Stockholders equityCommon stock
    
    
    6,509,267
    
    
    
    6,509,267
    
    
    
    6,509,267Paid-in-capital
    
    
    1,080,911
    
    
    
    82,738
    
    
    
    90,725Treasury stock, at cost
    
    
    (1,235,542
    )
    
    
    (1,034,172
    )
    
    
    (1,024,659
    )Retained earnings
    
    
    16,807,609
    
    
    
    13,715,660
    
    
    
    14,422,948Accumulated other comprehensive income (loss), net of taxes
    
    
    29,797
    
    
    
    11,726
    
    
    
    (99,514
    )Total stockholders equity
    
    
    23,192,042
    
    
    
    19,285,219
    
    
    
    19,898,767Total liabilities and stockholders equity
    
    $
    32,376,774
    
    
    $
    24,204,903
    
    
    $
    24,464,757
  3




---



##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
For the Three and Nine Months Ended September 30, 2006 and 2005 (Unaudited)
and The Year Ended December 31, 2005
 (Unaudited)
    
    
    (Unaudited)Three Months Ended
    
    
    Nine Months Ended
    
    
    Year EndedSeptember 30
    
    
    September 30
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2005Sales
    
    $
    7,456,649
    
    
    $
    5,194,648
    
    
    $
    19,827,069
    
    
    $
    14,924,076
    
    
    $
    20,131,654Cost of goods sold
    
    
    4,599,428
    
    
    
    3,073,314
    
    
    
    11,550,612
    
    
    $
    8,607,538
    
    
    
    11,664,065Gross profit
    
    
    2,857,221
    
    
    
    2,121,334
    
    
    
    8,276,457
    
    
    
    6,316,538
    
    
    
    8,467,589Operating expenses
    
    
    1,737,901
    
    
    
    1,359,171
    
    
    
    4,820,613
    
    
    $
    3,793,394
    
    
    
    5,066,227Income from operations
    
    
    1,119,320
    
    
    
    762,163
    
    
    
    3,455,844
    
    
    
    2,523,144
    
    
    
    3,401,362Other income (expense):Interest and dividend income
    
    
    86,318
    
    
    
    72,363
    
    
    
    294,583
    
    
    
    212,927
    
    
    
    323,365Interest expense
    
    
    (96,557
    )
    
    
    (36,877
    )
    
    
    (209,983
    )
    
    
    (51,195
    )
    
    
    (100,762
    )Gain (loss) on sale of marketable
securities, net
    
    
    89,260
    
    
    
    162,446
    
    
    
    277,674
    
    
    
    324,433
    
    
    
    445,327Gain on marketable securities
classified as trading
    
    
    (2,370
    )
    
    
    (681
    )
    
    
    691
    
    
    
    14,355
    
    
    
    13,773Total other income
    
    
    76,651
    
    
    
    197,251
    
    
    
    362,965
    
    
    
    500,520
    
    
    
    681,703Income before provision for
income taxes
    
    
    1,195,971
    
    
    
    959,414
    
    
    
    3,818,809
    
    
    
    3,023,664
    
    
    
    4,083,065Provision for income taxes
    
    
    456,012
    
    
    
    400,464
    
    
    
    1,434,148
    
    
    
    1,182,479
    
    
    
    1,534,592Net income
    
    $
    739,959
    
    
    $
    558,950
    
    
    $
    2,384,661
    
    
    $
    1,841,185
    
    
    $
    2,548,473Basic and diluted earnings per
common share
    
    
    0.04
    
    
    
    0.03
    
    
    
    0.14
    
    
    
    0.11
    
    
    
    0.15Weighted average number of shares
outstanding
    
    
    16,860,139
    
    
    
    16,786,768
    
    
    
    16,855,889
    
    
    
    16,815,536
    
    
    
    16,808,992COMPREHENSIVE INCOMENet income
    
    $
    739,959
    
    
    $
    558,950
    
    
    $
    2,384,661
    
    
    $
    1,841,185
    
    
    $
    2,548,473Other comprehensive income (loss),
net of tax:Unrealized gains (losses) on
marketable securities
(net of tax benefits)
    
    
    102,436
    
    
    
    103,458
    
    
    
    312,717
    
    
    
    82,988
    
    
    
    42,708Less reclassification adjustment
for gains (losses)
included in net income (net of taxes)
    
    
    (73,184
    )
    
    
    (96,369
    )
    
    
    (183,406
    )
    
    
    (190,442
    )
    
    
    (261,402
    )Comprehensive income
    
    $
    769,211
    
    
    $
    566,039
    
    
    $
    2,513,972
    
    
    $
    1,733,731
    
    
    $
    2,329,779
  4




---



##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders Equity
For the Nine Months Ended September 30, 2006 (Unaudited)
and the Year Ended December 31, 2005
 Common Stock,No Par Value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
       Accumulated20,000,000 Shares
    
    
    # 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 for compensation
    
    
    
    
    
    
    4,666
    
    
    
    (4,666
    )
    
    
    
    
    
    
    13,311
    
    
    
    15,855
    
    
    
    
    
    
    
    
    
    
    
    29,166Issuance of treasury stock for acquisition of Helios
    
    
    
    
    
    
    202,650
    
    
    
    
    
    
    
    
    
    
    
    976,875
    
    
    
    323,125
    
    
    
    
    
    
    
    
    
    
    
    1,300,000Redemption of stock
    
    
    
    
    
    
    (89,682
    )
    
    
    89,682
    
    
    
    
    
    
    
    
    
    
    
    (549,863
    )
    
    
    
    
    
    
    
    
    
    
    (549,863
    )Other comprehensive income (loss):Unrealized gains on securities, net of
taxes and reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129,311
    
    
    
    129,311Net income for the nine months
ended September 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,384,661
    
    
    
    
    
    
    
    2,384,661Balances at September 30, 2006
    
    
    17,273,776
    
    
    
    16,908,144
    
    
    
    568,282
    
    
    $
    6,509,267
    
    
    $
    1,080,911
    
    
    $
    (1,235,542
    )
    
    $
    16,807,609
    
    
    $
    29,797
    
    
    $
    23,192,042
  5




---



##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2006 and 2005 (Unaudited)  and the Year Ended December 31, 2005
 Nine Months Ended
    
    
    Year EndedSeptember 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Cash flows from operating activities:Net income
    
    $
    2,384,661
    
    
    $
    1,841,185
    
    
    $
    2,548,473Adjustments to reconcile net income to net
cash flows from operating activities, net of acquisition:Depreciation and amortization
    
    
    457,844
    
    
    
    486,050
    
    
    
    650,945(Gain)Loss on sale of marketable securities, net
    
    
    (277,674
    )
    
    
    (324,433
    )
    
    
    (445,327
    )Gain on marketable securities
classified as trading
    
    
    (691
    )
    
    
    (14,355
    )
    
    
    (13,773
    )Deferred income taxes
    
    
    (58,932
    )
    
    
    (69,220
    )
    
    
    (100,236
    )Treasury stock issued for services
    
    
    29,166
    
    
    
    34,845
    
    
    
    52,345Increase in allowance for doubtful accounts
    
    
    10,000
    
    
    
    
    
    
    
    (Increase) decrease in operating assets:Accounts receivable
    
    
    (1,197,722
    )
    
    
    (613,492
    )
    
    
    (493,579
    )Other receivables
    
    
    (3,375
    )
    
    
    (36,956
    )
    
    
    15,702Inventories
    
    
    (691,875
    )
    
    
    (395,369
    )
    
    
    (811,302
    )Refundable income taxes
    
    
    (56,784
    )
    
    
    200,580
    
    
    
    247,055Prepaid expenses and other current assets
    
    
    468
    
    
    
    (75,033
    )
    
    
    (1,884
    )Increase (decrease) in operating liabilities:Accounts payable
    
    
    427,705
    
    
    
    7,230
    
    
    
    (215,398
    )Accrued expenses
    
    
    (84,021
    )
    
    
    258,354
    
    
    
    159,470Net cash provided by operating activities
    
    
    938,770
    
    
    
    1,299,386
    
    
    
    1,592,491Cash flows from investing activities:Purchases of marketable securities
    
    
    (5,258,207
    )
    
    
    (5,149,008
    )
    
    
    (6,460,561
    )Sale of marketable securities
    
    
    5,193,235
    
    
    
    4,466,196
    
    
    
    5,810,391Purchases of property and equipment
    
    
    (500,118
    )
    
    
    (4,772,181
    )
    
    
    (4,916,811
    )Acquisition of Helios, net of cash acquired
    
    
    (2,514,679
    )Net cash used in investing activities
    
    
    (3,079,769
    )
    
    
    (5,454,993
    )
    
    
    (5,566,981
    )Cash flows from financing activities:Proceeds from note payable
    
    
    
    
    
    
    3,000,000
    
    
    
    3,000,000Purchases of treasury stock
    
    
    (549,863
    )
    
    
    (401,554
    )
    
    
    (401,554
    )Repayment of notes payable
    
    
    (420,913
    )
    
    
    (17,731
    )
    
    
    (36,522
    )Loan costs
    
    
    
    
    
    
    (6,638
    )
    
    
    (6,638
    )Net cash provided by (used in) financing activities
    
    
    (970,776
    )
    
    
    2,574,077
    
    
    
    2,555,286Net decrease in cash and cash equivalents
    
    
    (3,111,775
    )
    
    
    (1,581,530
    )
    
    
    (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
    
    $
    1,242,306
    
    
    $
    4,191,755
    
    
    $
    4,354,081
  6




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 1  NATURE OF BUSINESS
    Cash
    
    $
    11,321Accounts Receivable Assumed
    
    
    279,654Inventories
    
    
    219,634Equipment, Building and Land
    
    
    730,883Prepaid Items
    
    
    37,871Goodwill and Amortizable Intangibles
    
    
    7,245,314Total Assets Acquired
    
    
    8,524,677Note Payable and Accounts Payable Assumed
    
    
    (498,677
    )Net Assets Acquired
    
    $
    8,026,000
  7




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  Principles of consolidation
  Use of estimates
  Revenue Recognition
  Cash and cash equivalents
    September 30,
    
    
    December 312006
    
    
    2005
    
    
    2005Amounts insured
    
    $
    392,445
    
    
    $
    500,000
    
    
    $
    462,571Uninsured and uncollateralized amounts
    
    
    1,101,926
    
    
    
    3,959,945
    
    
    
    4,331,179Total bank balances
    
    $
    1,494,371
    
    
    $
    4,459,945
    
    
    $
    4,793,750
 8




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 2
 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
 Marketable securities
 Accounting for Certain Investments in Debt and Equity
Securities Accounting for Noncurrent Marketable Equity Securities
 Accounts receivable
   Inventories
  Property and equipment
   Category
    
    YearsBuildings and improvements
    
    31 and 39Machinery and equipment
    
    5  12Office equipment
    
    5  7Vehicles
    
    
    5
 9




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
 Intangible assets
     Category
    
    YearsRecipes
    
    4Customer lists and other customer related intangibles
    
    8Lease agreement
    
    7
 Income taxes
   10




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
 Treasury stock
  Advertising costs
  Earning per common share
  Note 3  INTANGIBLE ASSETS
  September 30, 2006
    
    
    September 30, 2005
    
    
    December 31, 2005Accumulated
    
    
    
    
    
    
    Accumulated
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Cost
    
    
    Amortization
    
    
    Cost
    
    
    AmortizationRecipes
    
    $
    43,600
    
    
    $
    23,617
    
    
    $
    43,600
    
    
    $
    12,717
    
    
    $
    43,600
    
    
    $
    15,442Customer lists and
other customer
related intangibles
    
    
    305,200
    
    
    
    89,743
    
    
    
    305,200
    
    
    
    48,323
    
    
    
    305,200
    
    
    
    58,678Lease acquisition
    
    
    87,200
    
    
    
    26,990
    
    
    
    87,200
    
    
    
    14,533
    
    
    
    87,200
    
    
    
    17,648Goodwill
    
    
    7,321,114
    
    
    
    
    
    
    
    75,800
    
    
    
    
    
    
    
    75,800
    
    
    
    Loan acquisition costs
    
    
    6,638
    
    
    
    1,660
    
    
    
    6,638
    
    
    
    498
    
    
    
    6,638
    
    
    
    664$
    7,763,752
    
    
    $
    142,010
    
    
    $
    518,438
    
    
    $
    76,071
    
    
    $
    518,438
    
    
    $
    92,432
  2007
    
    $
    66,1052008
    
    
    66,1052009
    
    
    56,1132010
    
    
    47,2112011
    
    
    45,157Thereafter
    
    
    19,937$
    300,628
  11




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
And December 31, 2005
 Note 4  MARKETABLE SECURITIES
  Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairSeptember 30, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities
    
    $
    2,918,943
    
    
    $
    249,781
    
    
    $
    (150,197
    )
    
    
    
    
    
    $
    3,018,527Mutual Funds
    
    
    288,630
    
    
    
    2,447
    
    
    
    (3,666
    )
    
    
    
    
    
    
    287,411Preferred Securities
    
    
    1,491,741
    
    
    
    5,214
    
    
    
    (28,560
    )
    
    
    
    
    
    
    1,468,395Private Investment LP
    
    
    600,000
    
    
    
    42,660
    
    
    
    
    
    
    
    
    
    
    
    642,660Certificates of Deposit
    
    
    225,000
    
    
    
    1,305
    
    
    
    (2,393
    )
    
    
    
    
    
    
    223,912Corporate Bonds
    
    
    2,153,896
    
    
    
    3,238
    
    
    
    (70,694
    )
    
    
    
    
    
    
    2,086,440Municipal Bonds
    
    
    160,757
    
    
    
    1,828
    
    
    
    (203
    )
    
    
    
    
    
    
    162,382Government agency
    
    
    154,483
    
    
    
    
    
    
    
    
    
    
    
    (2,021
    )
    
    
    152,462Total
    
    $
    7,993,450
    
    
    $
    306,473
    
    
    $
    (255,713
    )
    
    
    (2,021
    )
    
    $
    8,042,189
 Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairSeptember 30, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities and Mutual
Funds
    
    $
    4,136,818
    
    
    $
    221,349
    
    
    $
    (121,835
    )
    
    
    
    
    
    $
    4,236,332Preferred Securities
    
    
    955,233
    
    
    
    
    
    
    
    (19,849
    )
    
    
    
    
    
    
    935,384Certificates of Deposit
    
    
    150,000
    
    
    
    
    
    
    
    (3,630
    )
    
    
    
    
    
    
    146,370Corporate Bonds
    
    
    2,159,363
    
    
    
    
    
    
    
    (55,732
    )
    
    
    
    
    
    
    2,103,631Municipal bonds
    
    
    61,275
    
    
    
    1,012
    
    
    
    (1,341
    )
    
    
    
    
    
    
    60,946Government agency
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    (2,132
    )
    
    
    97,868Total
    
    $
    7,562,689
    
    
    $
    222,361
    
    
    $
    (202,387
    )
    
    $
    (2,132
    )
    
    $
    7,580,531
 12




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 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
    
    
    TotalDescription of
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    UnrealizedSecurities
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    LossesEquities
    
    $
    903,773
    
    
    $
    (107,132
    )
    
    $
    205,404
    
    
    $
    (43,065
    )
    
    $
    1,109,177
    
    
    $
    (150,197
    )Mutual Funds
    
    
    10,710
    
    
    
    (566
    )
    
    
    96,900
    
    
    
    (3,100
    )
    
    
    107,610
    
    
    
    (3,666
    )Preferred Securities
    
    
    330,360
    
    
    
    (3,115
    )
    
    
    682,405
    
    
    
    (25,445
    )
    
    
    1,012,765
    
    
    
    (28,560
    )Certificates of Deposit
    
    
    72,607
    
    
    
    (2,393
    )
    
    
    
    
    
    
    
    
    
    
    72,607
    
    
    
    (2,393
    )Corporate Bonds
    
    
    711,128
    
    
    
    (24,186
    )
    
    
    861,227
    
    
    
    (46,508
    )
    
    
    1,572,355
    
    
    
    (70,694
    )Municipal Bonds
    
    
    
    
    
    
    
    
    
    
    19,802
    
    
    
    (203
    )
    
    
    19,802
    
    
    
    (203
    )$
    2,028,578
    
    
    $
    (137,392
    )
    
    $
    1,865,738
    
    
    $
    (118,321
    )
    
    $
    3,894,316
    
    
    
    (255,713
    )
 13




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 4
 MARKETABLE SECURITIES  Continued
      Note 5  INVENTORIES
  September 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Finished goods
    
    $
    988,212
    
    
    $
    537,514
    
    
    $
    658,522Production supplies
    
    
    905,615
    
    
    
    460,664
    
    
    
    662,310Raw materials
    
    
    734,681
    
    
    
    302,888
    
    
    
    396,167Total inventories
    
    $
    2,628,508
    
    
    $
    1,301,066
    
    
    $
    1,716,999
 14




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 6  PROPERTY AND EQUIPMENT
  September 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Land
    
    $
    969,232
    
    
    $
    909,232
    
    
    $
    909,232Buildings and improvements
    
    
    6,715,371
    
    
    
    6,441,412
    
    
    
    6,443,043Machinery and equipment
    
    
    6,961,853
    
    
    
    5,667,016
    
    
    
    5,806,853Vehicles
    
    
    534,365
    
    
    
    510,510
    
    
    
    513,670Office equipment
    
    
    89,192
    
    
    
    78,763
    
    
    
    78,76315,270,013
    
    
    
    13,606,938
    
    
    
    13,751,561Less accumulated depreciation
    
    
    6,695,832
    
    
    
    5,851,581
    
    
    
    6,000,115Total property and equipment
    
    $
    8,574,181
    
    
    $
    7,755,352
    
    
    $
    7,751,446
  Note 7 ACCRUED EXPENSES
  September 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Accrued payroll and payroll taxes
    
    $
    34,979
    
    
    $
    135,090
    
    
    $
    104,873Accrued property tax
    
    
    202,080
    
    
    
    312,112
    
    
    
    244,916Other
    
    
    33,931
    
    
    
    6,693
    
    
    
    5,222$
    270,990
    
    
    $
    453,895
    
    
    $
    355,011
 Note 8  NOTES PAYABLE
  September 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Mortgage note payable to
a bank, payable in
monthly installments of
$3,273 including
interest at 7%, with a
balloon payment of
$416,825 due September
25, 2011.
Collateralized by real
estate.
    
    $
    455,079
    
    
    $
    465,179
    
    
    $
    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.
    
    
    2,923,226
    
    
    
    2,989,415
    
    
    
    2,973,108Note payable to Amani
Holding LLC, payable in
quarterly installments
of $262,500 plus
interest at the floating
prime rate per annum due
September 1, 2010
secured by letter of
credit
    
    
    3,937,500
    
    
    
    
    
    
    
    Total notes payable
    
    
    7,315,805
    
    
    
    3,454,594
    
    
    
    3,435,803Less current maturities
    
    
    1,124,284
    
    
    
    534,938
    
    
    
    532,454Total long-term portion
    
    $
    6,191,521
    
    
    $
    2,919,656
    
    
    $
    2,903,349
 15




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 8
 NOTES PAYABLE  Continued
  For the year ended September 30,2007
    
    $
    1,124,2842008
    
    
    1,125,2262009
    
    
    1,126,5972010
    
    
    3,522,8732011
    
    
    416,825Total
    
    $
    7,315,805
 Note 9  PROVISION FOR INCOME TAXES
  For theFor the Nine Months Ended
    
    
    Year EndedSeptember 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Current:Federal
    
    $
    1,203,942
    
    
    $
    1,050,319
    
    
    $
    1,364,033State and local
    
    
    289,274
    
    
    
    201,380
    
    
    
    270,795Total current
    
    
    1,493,216
    
    
    
    1,251,699
    
    
    
    1,634,828Deferred
    
    
    (59,068
    )
    
    
    (69,220
    )
    
    
    (100,236
    )Provision for income taxes
    
    $
    1,434,148
    
    
    $
    1,182,479
    
    
    $
    1,534,592
  For TheFor The Nine Months Ended
    
    
    Year EndedSeptember 30,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Federal income tax expense
computed at the statutory rate
    
    $
    1,298,395
    
    
    $
    1,028,045
    
    
    $
    1,388,242State and local tax expense, net
    
    
    183,268
    
    
    
    145,136
    
    
    
    195,987Permanent differences
    
    
    (47,515
    )
    
    
    9,298
    
    
    
    (49,637
    )Provision for income taxes
    
    $
    1,434,148
    
    
    $
    1,182,479
    
    
    $
    1,534,592
 16




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 9
 PROVISION FOR INCOME TAXES  Continued
  September 30,
    
    
    December 312006
    
    
    2005
    
    
    2005Non-current deferred tax liabilities
arising from:Temporary
differences 
accumulated depreciation
    
    $
    (346,217
    )
    
    $
    (362,314
    )
    
    $
    (348,923
    )Current deferred tax assets (liabilities) arising from:Unrealized losses (gains) on marketable securities
    
    
    (20,965
    )
    
    
    (8,250
    )
    
    
    70,016Inventory
    
    
    110,533
    
    
    
    55,131
    
    
    
    72,756Allowance for doubtful accounts
    
    
    18,585
    
    
    
    
    
    
    
    Total current deferred tax assets
(liabilities)
    
    
    108,153
    
    
    
    46,881
    
    
    
    142,772Net deferred tax liability
    
    $
    (238,064
    )
    
    $
    (315,433
    )
    
    $
    (206,151
    )
 Note 10  SUPPLEMENTAL CASH FLOW INFORMATION
  For YearFor the Nine Months Ended
    
    EndedSeptember 30,
    
    December 31,2006
    
    2005
    
    2005Interest
    
    $
    209,983
    
    
    $
    51,195
    
    
    $
    100,762Income taxes
    
    $
    1,555,444
    
    
    $
    1,053,064
    
    
    $
    1,425,600
  Note 11  STOCK OPTION PLANS
   17




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note
11  STOCK OPTION PLANS  Continued
   Note 12  FAIR VALUE OF FINANCIAL INSTRUMENTS
  September 30,
    
    September 30,
    
    December 31,2006
    
    2005
    
    2005Carrying
    
    Fair
    
    Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    Value
    
    Amount
    
    ValueCash and cash equivalents
    
    $
    1,242,306
    
    
    $
    1,242,306
    
    
    $
    4,191,755
    
    
    $
    4,191,755
    
    
    $
    4,354,081
    
    
    $
    4,354,081Marketable securities
    
    $
    8,042,189
    
    
    $
    8,042,189
    
    
    $
    7,580,531
    
    
    $
    7,580,531
    
    
    $
    7,478,697
    
    
    $
    7,478,697Notes payable
    
    $
    7,315,805
    
    
    $
    7,275,702
    
    
    $
    3,454,594
    
    
    $
    3,437,469
    
    
    $
    3,435,803
    
    
    $
    3,416,969
 Note 13  LITIGATION SETTLEMENT
  Note 14  RECENT ACCOUNTING PRONOUNCEMENTS
  18




---



##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
and December 31, 2005
 Note 15  STOCK SPLIT
   19




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 Comparison of Quarter Ended September 30, 2006 to Quarter Ended September 30, 2005
  Results of Operations
  ä
     
 Comparison of Nine Month Period Ended September 30, 2006 to Nine Month Period Ended September 30, 2005
 Results of Operations
  20




---



##### Table of Contents



ä
    Sources and Uses of Cash
     Other Developments
  21




---



##### Table of Contents



Critical Accounting Policies
  Forward Looking Statements
  
    
    Changes in economic conditions, commodity prices;
    
    Shortages of and price increases 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.
 22




---



##### Table of Contents



ITEM 3. CONTROLS AND PROCEDURES
   
 PART II  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-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)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.
  1.
    
    Incorporated herein by reference to the Form 8-K filed with the Commission on July 10,
2006 (File No. 000-17363).2.
    
    Incorporated herein by reference to the Form 8-K filed with the Commission on August 9,
2006 (File No. 000-17363).
 23




---



##### Table of Contents



SIGNATURE
   LIFEWAY FOODS, INC.By: /s/ Julie SmolyanskyJulie SmolyanskyChief Executive Officer, President, and Director/s/ Edward P. SmolyanskyChief Financial and Accounting OfficerAnd Treasurer 24




---



##### 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.
  1.
    
    Incorporated herein by reference to the Form 8-K filed with the Commission on
July 10, 2006 (File No. 000-17363).2.
    
    Incorporated herein by reference to the Form 8-K filed with the Commission on
August 9, 2006 (File No. 000-17363).
 25