UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC 20549




FORM
10-Q


______________________________________




(Mark
      One)





x
            QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the quarterly period ended:  September 30, 2009




o
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the transition period from __________ to __________






Commission
File Number: 000-17363




______________________________________




LIFEWAY
FOODS, INC.


(Exact
Name of Registrant as Specified in its Charter)




______________________________________






Illinois
            36-3442829(State
      or Other Jurisdiction of Incorporation or Organization)
            (I.R.S.
      Employer Identification No.)






6431 West Oakton, Morton Grove, IL
60053


(Address
of Principal Executive Offices, Zip Code)




(847-967-1010)


(Registrant’s
Telephone Number, Including Area Code)






Indicate
      by check mark whether the registrant (1) filed all reports required to be
      filed by Section 13 or 15(d) of  the Securities Exchange
      Act of 1934 during the past 12 months (or for such shorter period that the
      registrant  was required to file such reports), and
      (2) has been subject to such filing requirements for the past
      90 days.   Yes  o  
      No  xIndicate
      by check mark whether the registrant has submitted electronically and
      posted on its corporate Web site, if any, every Interactive Data file
      required to be submitted and posted pursuant to Rule 405 of Regulation S-T
      (§232.405 of this chapter) during the preceding 12 months (or for such
      shorter period that the registrant was required
              to
      submit and post such files).   Yes  o  
      No  oIndicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer or a smaller reporting
      company. See definition of “large accelerated filer,” “accelerated filer”
      and “smaller reporting company” in Rule 12b-2 of the Exchange
      Act.Large
      accelerated filer o
            Accelerated
      filer o
            Non-accelerated
      filer  o
            Smaller
      reporting company x




Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).   Yes  o  
      No  xAs
      of September 30, 2009, the issuer had 16,775,930 shares of
      common stock, no par value,
outstanding.







LIFEWAY
FOODS, INC.


CONTENTS
TO FORM 10-Q








PART
      I —
                          FINANCIAL
      INFORMATION
                          Page(s)ITEM
      1.
                          FINANCIAL
      STATEMENTS.
                          4NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
                          8ITEM
      2.
                          MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.
                          24ITEM
      3.
                          QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
                          25ITEM 4T.
                          CONTROLS
      AND PROCEDURES.
                          25PART
      II —
                          OTHER
      INFORMATION
                          26ITEM
      1.
                          LEGAL
      PROCEEDINGS.
                          26ITEM 1A.
                          RISK
      FACTORS.
                          26ITEM
      2.
                          UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
                          26ITEM
      3.
                          DEFAULTS
      UPON SENIOR SECURITIES.
                          26ITEM
      4.
                          SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS.
                          26ITEM
      5.
                          OTHER
      INFORMATION.
                          26ITEM
      6.
                          EXHIBITS.
                          27SIGNATURES
                          
                          28EXHIBIT
      INDEX
                          
                          29














– 2
–










LIFEWAY
FOODS, INC. AND SUBSIDIARIES




CONSOLIDATED
FINANCIAL STATEMENTS




SEPTEMBER
30, 2009 and 2008




AND
DECEMBER 31, 2008





























































– 3
–


PART
I — FINANCIAL INFORMATION




ITEM
1. FINANCIAL STATEMENTS.




LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Consolidated
Statements of Financial Condition
 September
30, 2009 and 2008 (Unaudited) and December 31, 2008




(Unaudited)September
      30
                                            
                                            
                                            December
      31,2009
                                            
                                            
                                            2008
                                            
                                            
                                            2008ASSETSCurrent
      assetsCash
      and cash equivalents
                                            
                                            $
                                            804,387
                                            
                                            
                                            $
                                            530,866
                                            
                                            
                                            $
                                            277,248Marketable
      securities
                                            
                                            
                                            4,950,457
                                            
                                            
                                            
                                            5,668,940
                                            
                                            
                                            
                                            5,262,168Inventories
                                            
                                            
                                            4,106,631
                                            
                                            
                                            
                                            4,207,094
                                            
                                            
                                            
                                            3,097,542Accounts
      receivable, net of allowance for doubtful accountsof $35,011 at
      September 30, 2009 and 2008 and$110,011 at December
      31, 2008
                                            
                                            
                                            7,311,856
                                            
                                            
                                            
                                            5,161,414
                                            
                                            
                                            
                                            4,765,865Prepaid
      expenses and other current assets
                                            
                                            
                                            45,565
                                            
                                            
                                            
                                            20,864
                                            
                                            
                                            
                                            23,226Other
      receivables
                                            
                                            
                                            37,715
                                            
                                            
                                            
                                            28,918
                                            
                                            
                                            
                                            40,314Deferred
      income taxes
                                            
                                            
                                            338,070
                                            
                                            
                                            
                                            909,479
                                            
                                            
                                            
                                            919,649Refundable
      income taxes
                                            
                                            
                                            26,276
                                            
                                            
                                            
                                            ---
                                            
                                            
                                            
                                            356,416Total
      current assets
                                            
                                            
                                            17,620,957
                                            
                                            
                                            
                                            16,527,575
                                            
                                            
                                            
                                            14,742,428Property
      and equipment, net
                                            
                                            
                                            13,812,039
                                            
                                            
                                            
                                            10,989,500
                                            
                                            
                                            
                                            11,062,714Intangible
      assetsGoodwill
      and other non amortizable brand asset
                                            
                                            
                                            12,154,091
                                            
                                            
                                            
                                            5,414,858
                                            
                                            
                                            
                                            5,414,858Other
      intangible assets, net of accumulated amortization of$1,429,509
      and $841,561 at September 30, 2009 and 2008 and$921,422 at December
      31, 2008
                                            
                                            
                                            6,428,129
                                            
                                            
                                            
                                            3,016,077
                                            
                                            
                                            
                                            2,936,216Total
      intangible assets
                                            
                                            
                                            18,582,220
                                            
                                            
                                            
                                            8,430,935
                                            
                                            
                                            
                                            8,351,074Other
      assets
                                            
                                            
                                            500,000
                                            
                                            
                                            
                                            500,000
                                            
                                            
                                            
                                            500,000Total
      assets
                                            
                                            $
                                            50,515,216
                                            
                                            
                                            $
                                            36,448,010
                                            
                                            
                                            $
                                            34,656,216LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      liabilitiesCurrent
      maturities of notes payable
                                            
                                            $
                                            6,231,204
                                            
                                            
                                            $
                                            1,125,608
                                            
                                            
                                            $
                                            928,444Accounts
      payable
                                            
                                            
                                            2,180,297
                                            
                                            
                                            
                                            2,361,318
                                            
                                            
                                            
                                            2,260,272Accrued
      expenses
                                            
                                            
                                            683,685
                                            
                                            
                                            
                                            532,662
                                            
                                            
                                            
                                            458,282Margin
      payable
                                            
                                            
                                            —
                                            
                                            
                                            
                                            428,951
                                            
                                            
                                            
                                            —Accrued
      income taxes
                                            
                                            
                                            —
                                            
                                            
                                            
                                            308,260
                                            
                                            
                                            
                                            —Total
      current liabilities
                                            
                                            
                                            9,095,186
                                            
                                            
                                            
                                            4,756,799
                                            
                                            
                                            
                                            3,646,998Notes
      payable
                                            
                                            
                                            7,400,573
                                            
                                            
                                            
                                            3,219,338
                                            
                                            
                                            
                                            3,108,014Deferred
      income taxes
                                            
                                            
                                            2,010,273
                                            
                                            
                                            
                                            1,615,421
                                            
                                            
                                            
                                            1,607,155Stockholders'
      equityCommon
      stock, no par value; 20,000,000 shares authorized; 17,273,776 shares
      issued; 16,775,930 shares outstanding at September 30, 2009; 17,273,776
      shares issued; 16,730,226 shares outstanding at September 30, 2008; and
      17,273,776 shares issues; 16,724,467 shares outstanding at December 31,
      2008
                                            
                                            
                                            6,509,267
                                            
                                            
                                            
                                            6,509,267
                                            
                                            
                                            
                                            6,509,267Paid-in-capital
                                            
                                            
                                            1,939,316
                                            
                                            
                                            
                                            1,175,539
                                            
                                            
                                            
                                            1,202,009Treasury
      stock, at cost
                                            
                                            
                                            ( 3,851,462
                                            )
                                            
                                            
                                            ( 3,207,213
                                            )
                                            
                                            
                                            ( 3,302,025
                                            )Retained
      earnings
                                            
                                            
                                            27,833,816
                                            
                                            
                                            
                                            23,126,672
                                            
                                            
                                            
                                            22,383,707Accumulated
      other comprehensive loss, net of taxes
                                            
                                            
                                            ( 421,753
                                            )
                                            
                                            
                                            ( 747,813
                                            )
                                            
                                            
                                            ( 498,909
                                            )Total
      stockholders' equity
                                            
                                            
                                            32,009,184
                                            
                                            
                                            
                                            26,856,452
                                            
                                            
                                            
                                            26,294,049Total
      liabilities and stockholders' equity
                                            
                                            $
                                            50,515,216
                                            
                                            
                                            $
                                            36,448,010
                                            
                                            
                                            $
                                            34,656,216






See accompanying notes to financial
statements




– 4
–
 LIFEWAY FOODS, INC. AND SUBSIDIARIESConsolidated
Statements of Income and Comprehensive IncomeFor the Three and Nine Months
Ended September 30, 2009 and 2008 (Unaudited)and the Year Ended December 31,
2008






(Unaudited)
                                                    
                                                    
                                                    (Unaudited)Three
      Months Ended
                                                    
                                                    
                                                    Nine
      Months Ended
                                                    
                                                    
                                                    Year
      EndedSeptember
      30,
                                                    
                                                    
                                                    September
      30,
                                                    
                                                    
                                                    December
      31,2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2008
                                                    
                                                    
                                                    2008Sales
                                                    
                                                    
                                                    15,433,876
                                                    
                                                    
                                                    $
                                                    11,240,282
                                                    
                                                    
                                                    $
                                                    43,649,383
                                                    
                                                    
                                                    $
                                                    33,885,912
                                                    
                                                    
                                                    
                                                    44,461,455Cost
      of goods sold
                                                    
                                                    
                                                    8,892,088
                                                    
                                                    
                                                    
                                                    7,505,794
                                                    
                                                    
                                                    
                                                    24,994,778
                                                    
                                                    
                                                    
                                                    22,403,574
                                                    
                                                    
                                                    
                                                    30,926,114Depreciation
      expense
                                                    
                                                    
                                                    288,613
                                                    
                                                    
                                                    
                                                    197,366
                                                    
                                                    
                                                    
                                                    859,044
                                                    
                                                    
                                                    
                                                    581,920
                                                    
                                                    
                                                    
                                                    777,715Total
      cost of goods sold
                                                    
                                                    
                                                    9,180,701
                                                    
                                                    
                                                    
                                                    7,703,160
                                                    
                                                    
                                                    
                                                    25,853,822
                                                    
                                                    
                                                    
                                                    22,985,494
                                                    
                                                    
                                                    
                                                    31,703,829Gross
      profit
                                                    
                                                    
                                                    6,253,175
                                                    
                                                    
                                                    
                                                    3,537,122
                                                    
                                                    
                                                    
                                                    17,795,561
                                                    
                                                    
                                                    
                                                    10,900,418
                                                    
                                                    
                                                    
                                                    12,757,626Selling
      Expenses
                                                    
                                                    
                                                    1,231,216
                                                    
                                                    
                                                    
                                                    957,978
                                                    
                                                    
                                                    
                                                    3,176,162
                                                    
                                                    
                                                    
                                                    3,171,269
                                                    
                                                    
                                                    
                                                    4,098,176General
      and Administrative
                                                    
                                                    
                                                    1,613,828
                                                    
                                                    
                                                    
                                                    1,032,043
                                                    
                                                    
                                                    
                                                    5,173,724
                                                    
                                                    
                                                    
                                                    3,109,506
                                                    
                                                    
                                                    
                                                    4,149,010Amortization
      expense
                                                    
                                                    
                                                    168,699
                                                    
                                                    
                                                    
                                                    79,862
                                                    
                                                    
                                                    
                                                    508,086
                                                    
                                                    
                                                    
                                                    239,585
                                                    
                                                    
                                                    
                                                    319,446Total
      Operating Expenses
                                                    
                                                    
                                                    3,013,743
                                                    
                                                    
                                                    
                                                    2,069,883
                                                    
                                                    
                                                    
                                                    8,857,972
                                                    
                                                    
                                                    
                                                    6,520,360
                                                    
                                                    
                                                    
                                                    8,566,632Income
      from operations
                                                    
                                                    
                                                    3,239,432
                                                    
                                                    
                                                    
                                                    1,467,239
                                                    
                                                    
                                                    
                                                    8,937,589
                                                    
                                                    
                                                    
                                                    4,380,058
                                                    
                                                    
                                                    
                                                    4,190,994Other
      income (expense):Interest
      and dividend income
                                                    
                                                    
                                                    34,180
                                                    
                                                    
                                                    
                                                    95,042
                                                    
                                                    
                                                    
                                                    144,899
                                                    
                                                    
                                                    
                                                    261,037
                                                    
                                                    
                                                    
                                                    343,329Rental
      Income
                                                    
                                                    
                                                    12,047
                                                    
                                                    
                                                    
                                                    13,647
                                                    
                                                    
                                                    
                                                    33,340
                                                    
                                                    
                                                    
                                                    36,940
                                                    
                                                    
                                                    
                                                    48,886Interest
      expense
                                                    
                                                    
                                                    ( 99,864
                                                    )
                                                    
                                                    
                                                    ( 71,928
                                                    )
                                                    
                                                    
                                                    ( 364,337
                                                    )
                                                    
                                                    
                                                    ( 226,851
                                                    )
                                                    
                                                    
                                                    ( 298,619
                                                    )Impairment
      of marketable securities
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 270,908
                                                    )
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 270,908
                                                    )
                                                    
                                                    
                                                    ( 958,879
                                                    )Loss
      on Disposition of Equipment
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 2,825
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    —Gain
      (loss) on sale of marketablesecurities,
      net
                                                    
                                                    
                                                    ( 178,143
                                                    )
                                                    
                                                    
                                                    ( 110,259
                                                    )
                                                    
                                                    
                                                    ( 274,296
                                                    )
                                                    
                                                    
                                                    ( 146,404
                                                    )
                                                    
                                                    
                                                    ( 733,647
                                                    )Total
      other income (Expense)
                                                    
                                                    
                                                    ( 231,780
                                                    )
                                                    
                                                    
                                                    ( 344,406
                                                    )
                                                    
                                                    
                                                    ( 463,219
                                                    )
                                                    
                                                    
                                                    ( 346,186
                                                    )
                                                    
                                                    
                                                    ( 1,598,930
                                                    )Income
      before provision forincome
      taxes
                                                    
                                                    
                                                    3,007,652
                                                    
                                                    
                                                    
                                                    1,122,833
                                                    
                                                    
                                                    
                                                    8,474,370
                                                    
                                                    
                                                    
                                                    4,033,872
                                                    
                                                    
                                                    
                                                    2,592,064Provision
      for income taxes
                                                    
                                                    
                                                    1,636,911
                                                    
                                                    
                                                    
                                                    267,917
                                                    
                                                    
                                                    
                                                    3,024,261
                                                    
                                                    
                                                    
                                                    1,378,632
                                                    
                                                    
                                                    
                                                    679,789Net
      income
                                                    
                                                    $
                                                    1,370,741
                                                    
                                                    
                                                    $
                                                    854,916
                                                    
                                                    
                                                    $
                                                    5,450,109
                                                    
                                                    
                                                    $
                                                    2,655,240
                                                    
                                                    
                                                    $
                                                    1,912,275Basic
      and diluted earnings percommon
      share
                                                    
                                                    
                                                    0.08
                                                    
                                                    
                                                    
                                                    0.05
                                                    
                                                    
                                                    
                                                    0.32
                                                    
                                                    
                                                    
                                                    0.16
                                                    
                                                    
                                                    
                                                    0.11Weighted
      average number ofshares
      outstanding
                                                    
                                                    
                                                    16,798,623
                                                    
                                                    
                                                    
                                                    16,730,650
                                                    
                                                    
                                                    
                                                    16,799,134
                                                    
                                                    
                                                    
                                                    16,867,890
                                                    
                                                    
                                                    
                                                    16,765,080COMPREHENSIVE INCOMENet
      income
                                                    
                                                    $
                                                    1,370,741
                                                    
                                                    
                                                    $
                                                    854,916
                                                    
                                                    
                                                    $
                                                    5,450,109
                                                    
                                                    
                                                    $
                                                    2,655,240
                                                    
                                                    
                                                    $
                                                    1,912,275Other
      comprehensive income (loss),net
      of tax:Unrealized
      gains (losses) onmarketable
      securities(net
      of tax benefits)
                                                    
                                                    
                                                    114,628
                                                    
                                                    
                                                    
                                                    ( 480,045
                                                    )
                                                    
                                                    
                                                    326,060
                                                    
                                                    
                                                    
                                                    ( 895,641
                                                    )
                                                    
                                                    
                                                    ( 720,517
                                                    )Less
      reclassification adjustmentfor
      (gains) lossesincluded
      in net income (net of taxes)
                                                    
                                                    
                                                    104,609
                                                    
                                                    
                                                    
                                                    64,746
                                                    
                                                    
                                                    
                                                    161,071
                                                    
                                                    
                                                    
                                                    85,963
                                                    
                                                    
                                                    
                                                    430,651Comprehensive
      income
                                                    
                                                    $
                                                    1,589,978
                                                    
                                                    
                                                    $
                                                    439,617
                                                    
                                                    
                                                    $
                                                    5,937,240
                                                    
                                                    
                                                    $
                                                    1,845,562
                                                    
                                                    
                                                    $
                                                    1,622,409




See accompanying notes to financial
statements




– 5
–
 
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Consolidated
Statements of Changes in Stockholders' Equity
 For
the Nine Months Ended September 30, 2009 (Unaudited)
 and
the Year Ended December 31, 2008








Common
      Stock,
                                                      No
      Par Value
                                                    
                                                    
                                                    #
      of
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Accumulated20,000,000
      Shares
                                                    
                                                    
                                                    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, 2007
                                                    
                                                    
                                                    17,273,776
                                                    
                                                    
                                                    
                                                    16,827,726
                                                    
                                                    
                                                    
                                                    446,050
                                                    
                                                    
                                                    
                                                    6,509,267
                                                    
                                                    
                                                    
                                                    1,120,669
                                                    
                                                    
                                                    
                                                    (2,078,165
                                                    )
                                                    
                                                    
                                                    20,471,432
                                                    
                                                    
                                                    
                                                    ( 209,043
                                                    )
                                                    
                                                    
                                                    25,814,160Redemption
      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
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    96,968Other
      comprehensive income (loss):Unrealized
      losses on securities, net oftaxes and reclassification
      adjustment
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 289,866
                                                    )
                                                    
                                                    
                                                    ( 289,866
                                                    )Net
      income for the yearended December 31,
      2008
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    1,912,275
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    1,912,275Balances
      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
                                                    )
                                                    
                                                    
                                                    26,294,049Redemption
      of stock
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 87,991
                                                    )
                                                    
                                                    
                                                    87,991
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 905,607
                                                    )
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    ( 905,607
                                                    )Issuance
      of treasury stock for compensation
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    10,507
                                                    
                                                    
                                                    
                                                    ( 10,507
                                                    )
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    92,569
                                                    
                                                    
                                                    
                                                    20,908
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    113,477Issuance
      of treasury stock for Fresh Madeacquisition
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    128,947
                                                    
                                                    
                                                    
                                                    ( 128,947
                                                    )
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    644,738
                                                    
                                                    
                                                    
                                                    335,262
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    980,000Other
      comprehensive income (loss):Unrealized
      gains on securities, net oftaxes and reclassification
      adjustment
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    77,156
                                                    
                                                    
                                                    
                                                    77,156Net
      income for the nine months endedSeptember 30,
      2009
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    5,450,109
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    5,450,109Balances
      at September 30, 2009
                                                    
                                                    
                                                    17,273,776
                                                    
                                                    
                                                    
                                                    16,775,930
                                                    
                                                    
                                                    
                                                    497,846
                                                    
                                                    
                                                    $
                                                    6,509,267
                                                    
                                                    
                                                    $
                                                    1,939,316
                                                    
                                                    
                                                    $
                                                    (3,851,462
                                                    )
                                                    
                                                    $
                                                    27,833,816
                                                    
                                                    
                                                    $
                                                    (421,753
                                                    )
                                                    
                                                    $
                                                    32,009,184






See accompanying notes to financial
statements


– 6
–
 
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Consolidated
Statements of Cash Flows
 For
the Nine Months Ended September 30, 2009 and 2008 (Unaudited)
 and
the Year Ended December 31, 2008
 (Unaudited)Nine
      Months EndedSeptember
      30,
                                      
                                      
                                      September
      30,
                                      
                                      
                                      December
      31,2009
                                      
                                      
                                      2008
                                      
                                      
                                      2008Cash flows from operating
      activities:Net
      income
                                      
                                      $
                                      5,450,109
                                      
                                      
                                      $
                                      2,655,240
                                      
                                      
                                      $
                                      1,912,275Adjustments
      to reconcile net income to netcash
      flows from operating activities, net of acquisition:Depreciation
      and amortization
                                      
                                      
                                      1,367,130
                                      
                                      
                                      
                                      821,505
                                      
                                      
                                      
                                      1,092,995(Gain)Loss
      on sale of marketable securities, net
                                      
                                      
                                      274,296
                                      
                                      
                                      
                                      146,404
                                      
                                      
                                      
                                      733,647Loss
      on disposition of assets
                                      
                                      
                                      2,825
                                      
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Impairment
      of marketable securities
                                      
                                      
                                      —
                                      
                                      
                                      
                                      270,908
                                      
                                      
                                      
                                      958,879Deferred
      income taxes
                                      
                                      
                                      236,063
                                      
                                      
                                      
                                      ( 125,221
                                      )
                                      
                                      
                                      ( 509,386
                                      )Treasury
      stock issued for compensation
                                      
                                      
                                      113,476
                                      
                                      
                                      
                                      65,809
                                      
                                      
                                      
                                      96,968Increase
      (decrease) in allowance for doubtful accounts
                                      
                                      
                                      —
                                      
                                      
                                      
                                      ( 4,449
                                      )
                                      
                                      
                                      70,551(Increase)
      decrease in operating assets:Accounts
      receivable
                                      
                                      
                                      ( 2,000,033
                                      )
                                      
                                      
                                      ( 947,303
                                      )
                                      
                                      
                                      ( 626,754
                                      )Other
      receivables
                                      
                                      
                                      2,599
                                      
                                      
                                      
                                      14,193
                                      
                                      
                                      
                                      2,797Inventories
                                      
                                      
                                      ( 636,236
                                      )
                                      
                                      
                                      ( 700,540
                                      )
                                      
                                      
                                      409,012Refundable
      income taxes
                                      
                                      
                                      807,067
                                      
                                      
                                      
                                      240,880
                                      
                                      
                                      
                                      ( 115,536
                                      )Prepaid
      expenses and other current assets
                                      
                                      
                                      4,661
                                      
                                      
                                      
                                      665
                                      
                                      
                                      
                                      ( 1,973
                                      )Increase
      (decrease) in operating liabilities:Accounts
      payable
                                      
                                      
                                      ( 284,927
                                      )
                                      
                                      
                                      766,988
                                      
                                      
                                      
                                      665,942Accrued
      expenses
                                      
                                      
                                      167,114
                                      
                                      
                                      
                                      118,650
                                      
                                      
                                      
                                      44,243Accrued
      income taxes
                                      
                                      
                                      —
                                      
                                      
                                      
                                      308,260
                                      
                                      
                                      
                                      —Net
      cash provided by operating activities
                                      
                                      
                                      5,504,144
                                      
                                      
                                      
                                      3,631,989
                                      
                                      
                                      
                                      4,733,660Cash flows from investing
      activities:Purchases
      of marketable securities
                                      
                                      
                                      ( 6,050,202
                                      )
                                      
                                      
                                      ( 4,864,873
                                      )
                                      
                                      
                                      ( 5,782,452
                                      )Sale
      of marketable securities
                                      
                                      
                                      6,792,962
                                      
                                      
                                      
                                      4,659,350
                                      
                                      
                                      
                                      5,323,423Increase
      in margin
                                      
                                      
                                      —
                                      
                                      
                                      
                                      428,951
                                      
                                      
                                      
                                      —Purchases
      of property and equipment
                                      
                                      
                                      ( 1,020,776
                                      )
                                      
                                      
                                      ( 1,892,472
                                      )
                                      
                                      
                                      ( 2,157,315
                                      )Acquisition
      of Fresh Made, net of cash acquired
                                      
                                      
                                      ( 3,442,546
                                      )
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Net
      cash used in investing activities
                                      
                                      
                                      ( 3,720,562
                                      )
                                      
                                      
                                      ( 1,669,044
                                      )
                                      
                                      
                                      ( 2,616,344
                                      )Cash flows from financing
      activities:Proceeds
      of note payable
                                      
                                      
                                      1,753,504
                                      
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —Purchases
      of treasury stock, net
                                      
                                      
                                      ( 905,607
                                      )
                                      
                                      
                                      ( 1,139,987
                                      )
                                      
                                      
                                      ( 1,239,488
                                      )Repayment
      of notes payable
                                      
                                      
                                      ( 2,104,340
                                      )
                                      
                                      
                                      ( 887,977
                                      )
                                      
                                      
                                      ( 1,196,465
                                      )Net
      cash provided (used) in financing activities
                                      
                                      
                                      ( 1,256,443
                                      )
                                      
                                      
                                      ( 2,027,964
                                      )
                                      
                                      
                                      ( 2,435,953
                                      )Net
      increase (decrease) in cash and cash equivalents
                                      
                                      
                                      527,139
                                      
                                      
                                      
                                      ( 65,019
                                      )
                                      
                                      
                                      ( 318,637
                                      )Cash
      and cash equivalents at the beginning of the period
                                      
                                      
                                      277,248
                                      
                                      
                                      
                                      595,885
                                      
                                      
                                      
                                      595,885Cash
      and cash equivalents at the end of the period
                                      
                                      $
                                      804,387
                                      
                                      
                                      $
                                      530,866
                                      
                                      
                                      $
                                      277,248
   See accompanying notes to financial
statements




– 7
–


LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 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., Starfruit, L.L.C., Fresh Made, Inc and Starfruit
Franchise, 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 investment securities, 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.
 
  – 8
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
 
 
 Bank
balances of amounts reported by financial institutions are categorized as
follows:
 
 September
      30,
                  
                  
                  December
      31,2009
                  
                  
                  2008
                  
                  
                  2008Amounts
      insured
                  
                  $
                  1,787,108
                  
                  
                  $
                  138,913
                  
                  
                  $
                  847,711Uninsured
      and uncollateralized amounts
                  
                  
                  —
                  
                  
                  
                  846,239
                  
                  
                  
                  —Total
      bank balances
                  
                  $
                  1,787,108
                  
                  
                  $
                  985,152
                  
                  
                  $
                  847,711
 
 
 Marketable
securities
  All
investment securities are classified as available-for-sale, 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.
Amortization, accretion, interest and dividends, realized gains and losses, and
declines in value judged to be other-than-temporary on available-for-sale
securities are recorded in other income. All of the Company's securities are
subject to a periodic impairment evaluation. This evaluation depends on the
specific facts and circumstances. Factors that we consider in determining
whether an other-than-temporary decline in value has occurred include: the
market value of the security in relation to its cost basis; the financial
condition of the investee; and the intent and ability to retain the investment
for a sufficient period of time to allow for possible recovery in the market
value of the investment.
  Accounts
receivable
  Credit
terms are extended to customers in the normal course of business.  The
Company performs ongoing credit evaluations of its customers’ financial
condition and generally requires no collateral.
 
 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.
 
 
  – 9
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
 
 
 Property
and equipment are being depreciated over the following useful
lives:
 
 Category
                
                YearsBuildings
      and improvements
                
                31
      and 39Machinery
      and equipment
                
                5 –
      12Office
      equipment
                
                5 –
      7Vehicles
                
                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.  Brand assets represent the fair value of brands
acquired.  Brand assets have an indefinite life, therefore are not
amortized, rather are reviewed periodically for impairment.  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
                
                YearsRecipes
                
                4Customer
      lists and othercustomer
      related intangibles
                
                7-10Lease
      agreement
                
                7Trade
      names
                
                15Formula
                
                10Customer
      relationships
                
                12
 
 
 – 10
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 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 “Accounting for Uncertainty in Income
Taxes — an interpretation of FASB Statement No. 109,” which clarifies the
accounting and disclosure for uncertainty in tax positions, as defined. Pursuant
to the adoption 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 the adoption.
In addition, the Company did not record a cumulative effect adjustment related
to the adoption of the standard.
 
 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 for the nine months ended September 30, 2009 and 2008,
approximately $1,530,207, $1,288,844 and $1,241,442 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 nine months ended September 30, 2009 and 2008
and the year ended December 31, 2008, diluted and basic earnings per share
were the same, as the effect of dilutive securities options outstanding was not
significant.
 
 
 – 11
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
3 – ACQUISITION
  
 On
February 6, 2009, Lifeway Foods, Inc., a Illinois corporation (“Lifeway”)
completed 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”).
 
 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 $8,048,000, 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 approximately
$2,089,000.
 
 The
acquisition was accounted for using the purchase accounting method of
accounting, and accordingly, the purchase price was allocated to assets acquired
and the liabilities assumed based on the fair value as of the merger
date.  Acquisition costs for legal and professional fees have been
included in General and Administrative costs.
 
 The
estimated fair value of assets acquired, including the real property, and
liabilities assumed consisted of the following:
 
 Cash
      and cash equivalents
                  
                  $
                  226,000Accounts
      receivable (contractual amounts totaling $545,958)
                  
                  
                  546,000Other
      current assets
                  
                  
                  361,000Building
      and other fixed assets
                  
                  
                  2,617,000Customer
      list
                  
                  
                  4,000,000Non
      amortizable goodwill and brand asset
                  
                  
                  6,739,000Current
      liabilities
                  
                  
                  ( 461,000
                  )Total
      fair value of assets acquired and liabilities assumed
                  
                  $
                  14,028,000
 
 
 
 
 – 12
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 Note
4 – INTANGIBLE ASSETS
 
 
 Intangible
assets, and the related accumulated amortization, consist of the
following:
 
 September
      30, 2009
                      
                      
                      September
      30, 2008
                      
                      
                      December
      31, 2008Cost
                      
                      
                      Accumulated
      Amortization
                      
                      
                      Cost
                      
                      
                      Accumulated
      Amortization
                      
                      
                      Cost
                      
                      
                      Accumulated
      AmortizationRecipes
                      
                      $
                      43,600
                      
                      
                      $
                      43,600
                      
                      
                      $
                      43,600
                      
                      
                      $
                      42,009
                      
                      
                      $
                      43,600
                      
                      
                      $
                      43,600Customer
      lists and other customer related intangibles
                      
                      
                      4,305,200
                      
                      
                      
                      486,280
                      
                      
                      
                      305,200
                      
                      
                      
                      172,583
                      
                      
                      
                      305,200
                      
                      
                      
                      182,938Lease
      acquisition
                      
                      
                      87,200
                      
                      
                      
                      64,359
                      
                      
                      
                      87,200
                      
                      
                      
                      51,904
                      
                      
                      
                      87,200
                      
                      
                      
                      55,019Other
                      
                      
                      6,638
                      
                      
                      
                      6,638
                      
                      
                      
                      6,638
                      
                      
                      
                      4,317
                      
                      
                      
                      6,638
                      
                      
                      
                      4,647Customer
      relationship
                      
                      
                      985,000
                      
                      
                      
                      259,932
                      
                      
                      
                      985,000
                      
                      
                      
                      177,848
                      
                      
                      
                      985,000
                      
                      
                      
                      198,368Contractual
      backlog
                      
                      
                      12,000
                      
                      
                      
                      12,000
                      
                      
                      
                      12,000
                      
                      
                      
                      12,000
                      
                      
                      
                      12,000
                      
                      
                      
                      12,000Trade
      names
                      
                      
                      1,980,000
                      
                      
                      
                      418,000
                      
                      
                      
                      1,980,000
                      
                      
                      
                      286,000
                      
                      
                      
                      1,980,000
                      
                      
                      
                      319,000Formula
                      
                      
                      438,000
                      
                      
                      
                      138,700
                      
                      
                      
                      438,000
                      
                      
                      
                      94,900
                      
                      
                      
                      438,000
                      
                      
                      
                      105,850$
                      7,857,638
                      
                      
                      $
                      1,429,509
                      
                      
                      $
                      3,857,638
                      
                      
                      $
                      841,561
                      
                      
                      $
                      3,857,638
                      
                      
                      $
                      921,422
 
 Amortization
expense is expected to be as follows for the 12 months ending September
30:
 
 2010
                      
                      $
                      667,7162011
                      
                      
                      667,6312012
                      
                      
                      651,8002013
                      
                      
                      624,5502014
                      
                      
                      624,550Thereafter
                      
                      
                      3,191,882$
                      6,428,129
 
 Amortization
expense during the nine months ended September 30, 2009 and 2008 and for the
year ended December 31, 2008 was $508,086, $239,585 and $319,446,
respectively.
 
 Goodwill
and brand assets increased during the period ending September 30, 2009 due to
the acquisition of Fresh Made (See Note 3).
  
 Note
5 – MARKETABLE SECURITIES
 
 The cost
and fair value of marketable securities classified as available for sale are as
follows:
 
 September 30, 2009
                              
                              Cost
                              
                              
                              Unrealized
                                Gains
                              
                              
                              Unrealized
                                Losses
                              
                              
                              Fair
                                ValueEquities
                              
                              $
                              1,383,083
                              
                              
                              $
                              127,024
                              
                              
                              
                              ( 137,790
                              )
                              
                              $
                              1,372,317Mutual
      Funds
                              
                              
                              178,166
                              
                              
                              
                              2,018
                              
                              
                              
                              ( 25,885
                              )
                              
                              
                              154,299Preferred
      Securities
                              
                              
                              388,705
                              
                              
                              
                              7,080
                              
                              
                              
                              ( 135,301
                              )
                              
                              
                              260,484Corporate
      Bonds
                              
                              
                              1,559,094
                              
                              
                              
                              48,181
                              
                              
                              
                              ( 9,246
                              )
                              
                              
                              1,598,029Government
      Agency Obligations
                              
                              
                              933,760
                              
                              
                              
                              9,212
                              
                              
                              
                              ( 6,764
                              )
                              
                              
                              936,208Certificate
      of Deposits
                              
                              
                              652,005
                              
                              
                              
                              —
                              
                              
                              
                              ( 22,885
                              )
                              
                              
                              629,120Total
                              
                              $
                              5,094,813
                              
                              
                              $
                              193,515
                              
                              
                              $
                              ( 337,871
                              )
                              
                              $
                              4,950,457
 
  – 13
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
5 – MARKETABLE SECURITIES - Continued
 
 
 September 30, 2008
                    
                    Cost
                    
                    
                    Unrealized
                      Gains
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      ValueEquities
                    
                    $
                    3,077,340
                    
                    
                    $
                    55,002
                    
                    
                    $
                    ( 639,374
                    )
                    
                    $
                    2,492,968Mutual
      Funds
                    
                    
                    940,322
                    
                    
                    
                    —
                    
                    
                    
                    ( 287,919
                    )
                    
                    
                    652,403Preferred
      Securities
                    
                    
                    1,714,758
                    
                    
                    
                    —
                    
                    
                    
                    ( 509,150
                    )
                    
                    
                    1,205,608Corporate
      Bonds
                    
                    
                    917,990
                    
                    
                    
                    —
                    
                    
                    
                    ( 75,144
                    )
                    
                    
                    842,846Municipal
      Bonds
                    
                    
                    4,586
                    
                    
                    
                    374
                    
                    
                    
                    —
                    
                    
                    
                    4,960Government
      agencyObligations
                    
                    
                    478,507
                    
                    
                    
                    —
                    
                    
                    
                    ( 8,352
                    )
                    
                    
                    470,155Total
                    
                    $
                    7,133,503
                    
                    
                    $
                    55,376
                    
                    
                    $
                    ( 1,519,939
                    )
                    
                    $
                    5,668,940
 
 December 31, 2008
                    
                    Cost
                    
                    
                    Unrealized
                      Gains
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      ValueEquities
                    
                    $
                    2,116,004
                    
                    
                    $
                    75,333
                    
                    
                    $
                    ( 279,487
                    )
                    
                    $
                    1,911,850Mutual
      Funds
                    
                    
                    888,182
                    
                    
                    
                    202
                    
                    
                    
                    ( 339,970
                    )
                    
                    
                    548,414Preferred
      Securities
                    
                    
                    1,541,423
                    
                    
                    
                    13,075
                    
                    
                    
                    ( 308,963
                    )
                    
                    
                    1,245,535Corporate
      Bonds
                    
                    
                    783,761
                    
                    
                    
                    1,559
                    
                    
                    
                    ( 19,289
                    )
                    
                    
                    766,031Municipal
      Bonds
                    
                    
                    4,586
                    
                    
                    
                    414
                    
                    
                    
                    —
                    
                    
                    
                    5,000Government
      agencyObligations
                    
                    
                    778,140
                    
                    
                    
                    8,668
                    
                    
                    
                    ( 1,470
                    )
                    
                    
                    785,338Total
                    
                    $
                    6,112,096
                    
                    
                    $
                    99,251
                    
                    
                    $
                    ( 949,179
                    )
                    
                    $
                    5,262,168
  
 Proceeds
from the sale of marketable securities were $5,323,423, $6,792,962 and
$4,659,350 during the year ended December 31, 2008 and for the nine months ended
September 30, 2009 and 2008 respectively.
 
 Gross
gains of $384,574, $346,407 and $376,751 and gross losses of $1,118,221,
$620,702 and $523,155 were realized on these sales during the year ended
December 31, 2008 and for the nine months ended September 30, 2009 and 2008,
respectively.
 
 The
following table shows the gross unrealized losses and fair value of Company's
investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at September 30, 2009:
 
 
 
 
 – 14
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
5 – MARKETABLE SECURITIES - Continued
 
 Less
      Than 12 Months
                    
                    
                    12
      Months or Greater
                    
                    
                    TotalDescription
      of Securities
                    
                    Fair
      Value
                    
                    
                    Unrealized
      Losses
                    
                    
                    Fair
      Value
                    
                    
                    Unrealized
      Losses
                    
                    
                    Fair
      Value
                    
                    
                    Unrealized
      LossesEquities
                    
                    $
                    304,784
                    
                    
                    $
                    ( 82,750
                    )
                    
                    $
                    87,596
                    
                    
                    $
                    ( 55,040
                    )
                    
                    $
                    392,380
                    
                    
                    $
                    ( 137,790
                    )Mutual
      Funds
                    
                    
                    86,194
                    
                    
                    
                    ( 17,854
                    )
                    
                    
                    39,061
                    
                    
                    
                    ( 8,031
                    )
                    
                    
                    125,255
                    
                    
                    
                    ( 25,885
                    )Preferred
      Securities
                    
                    
                    3,264
                    
                    
                    
                    ( 1,101
                    )
                    
                    
                    235,390
                    
                    
                    
                    ( 134,200
                    )
                    
                    
                    238,654
                    
                    
                    
                    ( 135,301
                    )Corporate
      Bonds
                    
                    
                    409,307
                    
                    
                    
                    ( 6,405
                    )
                    
                    
                    101,403
                    
                    
                    
                    ( 2,841
                    )
                    
                    
                    510,710
                    
                    
                    
                    ( 9,246
                    )Government
      AgencyObligations
                    
                    
                    259,936
                    
                    
                    
                    ( 5,085
                    )
                    
                    
                    76,297
                    
                    
                    
                    ( 1,679
                    )
                    
                    
                    336,233
                    
                    
                    
                    ( 6,764
                    )Certificates
      ofDeposit
                    
                    
                    379,120
                    
                    
                    
                    ( 22,885
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    379,120
                    
                    
                    
                    ( 22,885
                    )$
                    1,442,605
                    
                    
                    $
                    ( 136,080
                    )
                    
                    $
                    539,747
                    
                    
                    $
                    ( 201,791
                    )
                    
                    $
                    1,982,352
                    
                    
                    $
                    ( 337,871
                    )
 
 
 For the
year ended December 31, 2008, we recorded other than temporary impairments
related to investments in marketable securities in certain investments of
$958,879.  The impairments recognized relate to securities that were
in an unrealized loss position at December 31, 2008 that were subsequently sold
and equity holdings that we consider other than temporarily impaired due to the
recent performance of the issuers of those securities.
 
 Equities,
Mutual Funds, Corporate Bonds and Government Agency Obligations -The Company's
investments in equity securities, mutual funds, corporate bonds and government
agency obligations consist of investments in common stock, preferred stock and
debt securities of companies in various industries.  The Company
evaluated the near-term prospects of the issuer in relation to the severity and
duration of the impairment. Based on that evaluation and the Company's ability
and intent to hold these investments for a reasonable period of time sufficient
for a forecasted recovery of fair value, the Company does not consider any
material investments to be other-than-temporarily impaired at September 30,
2009.
 
 Preferred
Securities - The Company's investments in preferred securities consist of
investments in preferred stock of companies in various
industries.  The Company evaluated the continuing performance of the
securities, the credit worthiness of the issuers as well as the near-term
prospects of the security in relation to the severity and duration of the
impairment. Based on that evaluation and the Company's ability and intent to
hold these investments for a reasonable period of time sufficient for a
forecasted recovery of fair value, the Company does not consider any material
investments to be other-than-temporarily impaired at September 30,
2009.
 
 
 
 – 15
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
6 – INVENTORIES
 
 Inventories
consist of the following:
 September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Finished
      goods
                    
                    $
                    1,626,092
                    
                    
                    $
                    1,375,304
                    
                    
                    $
                    1,343,811Production
      supplies
                    
                    
                    1,718,779
                    
                    
                    
                    1,604,106
                    
                    
                    
                    1,291,484Raw
      materials
                    
                    
                    761,760
                    
                    
                    
                    1,227,684
                    
                    
                    
                    462,247Total
      inventories
                    
                    $
                    4,106,631
                    
                    
                    $
                    4,207,094
                    
                    
                    $
                    3,097,542
 
  Note
7 – PROPERTY AND EQUIPMENT
 
 Property
and equipment consist of the following:
 September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Land
                    
                    $
                    1,178,160
                    
                    
                    $
                    969,232
                    
                    
                    $
                    969,232Buildings
      and improvements
                    
                    
                    9,967,295
                    
                    
                    
                    7,102,608
                    
                    
                    
                    7,138,042Machinery
      and equipment
                    
                    
                    12,292,030
                    
                    
                    
                    8,227,558
                    
                    
                    
                    8,229,202Vehicles
                    
                    
                    961,245
                    
                    
                    
                    610,558
                    
                    
                    
                    610,558Office
      equipment
                    
                    
                    238,029
                    
                    
                    
                    137,120
                    
                    
                    
                    180,351Construction
      in process
                    
                    
                    —
                    
                    
                    
                    2,120,346
                    
                    
                    
                    2,309,04524,636,759
                    
                    
                    
                    19,167,422
                    
                    
                    
                    19,436,430Less
      accumulated depreciation
                    
                    
                    10,824,720
                    
                    
                    
                    8,177,922
                    
                    
                    
                    8,373,716Total
      property and equipment
                    
                    $
                    13,812,039
                    
                    
                    $
                    10,989,500
                    
                    
                    $
                    11,062,714
 
 Depreciation
expense during the year ended December 31, 2008 and for the nine months ended
September 30, 2009 and 2008 was $777,715, $859,044 and $581,920,
respectively.
 
 
 Note8–ACCRUED EXPENSES
 
 Accrued
expenses consist of the following:
 
 September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Accrued
      payroll and payroll taxes
                    
                    $
                    234,269
                    
                    
                    $
                    111,631
                    
                    
                    $
                    98,089Accrued
      property tax
                    
                    
                    376,840
                    
                    
                    
                    363,672
                    
                    
                    
                    291,819Other
                    
                    
                    72,576
                    
                    
                    
                    57,359
                    
                    
                    
                    68,374$
                    683,685
                    
                    
                    $
                    532,662
                    
                    
                    $
                    458,282
 
 
 
 – 16
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
9 – NOTES PAYABLE
 
 Notes
payable consist of the following:
 September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Mortgage
      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.
                    
                    
                    —
                    
                    
                    $
                    440,874
                    
                    
                    $
                    438,926Mortgage
      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.
                    
                    
                    —
                    
                    
                    
                    2,779,572
                    
                    
                    
                    2,760,288Note
      payable to Amani Holding LLC, payable in quarterly installments of
      $262,500 plus interest at the floating prime rate per annum (7.25% at
      December 31, 2007) due September 1, 2010 secured by letter of
      credit.
                    
                    
                    —
                    
                    
                    
                    1,124,500
                    
                    
                    
                    837,244Note
      payable to Private Bank in monthly installments of $42,222, plus variable
      interest rate, currently at 2.945%, with a balloon payment of $5,066,667
      due February 6, 2014.  Collateralized by substantially all
      assets of the Company.
                    
                    
                    7,262,222
                    
                    
                    
                    —
                    
                    
                    
                    —Line
      of credit with Private Bank at variable interest rate, currently at
      2.945%, due on February 6, 2010.  Collateralized by real
      estate.
                    
                    
                    2,400,000
                    
                    
                    
                    —
                    
                    
                    
                    —Line
      of credit with Morgan Stanley at variable interest rate, currently at
      2.40%.  Secured by marketable securities.
                    
                    
                    1,957,040
                    
                    
                    
                    —
                    
                    
                    
                    —Subordinated
      notes payable to Ilya Mandel & Michael Edelson, payable in quarterly
      installments of $341,875, plus interest at the floating rate per annum
      (3.3% at September 30, 2009) due February 6, 2011.
                    
                    
                    2,012,515
                    
                    
                    
                    —
                    
                    
                    
                    —Total
      notes payable
                    
                    
                    13,631,777
                    
                    
                    
                    4,344,946
                    
                    
                    
                    4,036,458Less
      current maturities
                    
                    
                    6,231,204
                    
                    
                    
                    1,125,608
                    
                    
                    
                    928,444Total
      long-term portion
                    
                    $
                    7,400,573
                    
                    
                    $
                    3,219,338
                    
                    
                    $
                    3,108,014
 
 
 
 – 17
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
9 – NOTES PAYABLE - Continued
 
 Maturities
of notes payables are as follows:
 
 For
      the Period Ended September 30,2010
                      
                      $
                      6,231,2042011
                      
                      
                      1,151,6822012
                      
                      
                      506,6672013
                      
                      
                      506,6672014
                      
                      
                      5,235,557Total
                      
                      $
                      13,631,777
 
 
  Note
10 – PROVISION FOR INCOME TAXES
 
 The
provision for income taxes consists of the following:
 
 For
      theFor
      the Nine Months Ended
                    
                    
                    Year
      EndedSeptember
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Current:Federal
                    
                    $
                    2,293,323
                    
                    
                    $
                    1,267,998
                    
                    
                    $
                    1,005,159State
      and local
                    
                    
                    494,875
                    
                    
                    
                    235,855
                    
                    
                    
                    184,016Total
      current
                    
                    
                    2,788,198
                    
                    
                    
                    1,503,853
                    
                    
                    
                    1,189,175Deferred
                    
                    
                    236,063
                    
                    
                    
                    ( 125,221
                    )
                    
                    
                    ( 509,386
                    )Provision
      for income taxes
                    
                    $
                    3,024,261
                    
                    
                    $
                    1,378,632
                    
                    
                    $
                    679,789
 
 A
reconciliation of the provision for income taxes and the income tax computed at
the statutory rate is as follows:
 
 For
      theFor
      the Nine Months Ended
                    
                    
                    Year
      EndedSeptember
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Federal
      income tax expensecomputed
      at the statutory rate
                    
                    $
                    2,881,286
                    
                    
                    $
                    1,463,625
                    
                    
                    $
                    881,302State
      and local tax expense, net
                    
                    
                    406,770
                    
                    
                    
                    206,629
                    
                    
                    
                    124,419Permanent
      differences
                    
                    
                    ( 263,795
                    )
                    
                    
                    ( 291,622
                    )
                    
                    
                    ( 150,772
                    )Other
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    ( 175,160
                    )Provision
      for income taxes
                    
                    $
                    3,024,261
                    
                    
                    $
                    1,378,632
                    
                    
                    $
                    679,789
 
 
 
 
 – 18
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
10 – PROVISION FOR INCOME TAXES - Continued
 
 
 Amounts
for deferred tax assets and liabilities are as follows:
 September
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Non-current
      deferred tax liabilitiesarising
      from:
                      Temporary
      differences -accumulated
      depreciation and amortization
                    
                    $
                    (2,010,273
                    )
                    
                    $
                    (1,615,421
                    )
                    
                    $
                    (1,607,155
                    )Current
      deferred tax assets arising from:Unrealized
      losses on marketable securities
                    
                    
                    59,619
                    
                    
                    
                    716,749
                    
                    
                    
                    351,020Impairment
      of marketable securities
                    
                    
                    59,003
                    
                    
                    
                    —
                    
                    
                    
                    396,017Inventory
                    
                    
                    174,013
                    
                    
                    
                    178,271
                    
                    
                    
                    127,177Allowance
      for doubtful accounts
                    
                    
                    14,460
                    
                    
                    
                    14,459
                    
                    
                    
                    14,460Allowance
      for promotions
                    
                    
                    30,975
                    
                    
                    
                    —
                    
                    
                    
                    30,975Total
      current deferred tax assets(liabilities)
                    
                    
                    338,070
                    
                    
                    
                    909,479
                    
                    
                    
                    919,649Net
      deferred tax liability
                    
                    $
                    (1,672,203
                    )
                    
                    $
                    (705,942
                    )
                    
                    $
                    (687,506
                    )
 
 
 Note
11 – SUPPLEMENTAL CASH FLOW INFORMATION
 
 Cash paid
for interest and income taxes are as follows:
 For
      theFor
      the Nine Months Ended
                    
                    
                    Year
      EndedSeptember
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008
                    
                    
                    2008Interest
                    
                    $
                    330,095
                    
                    
                    $
                    222,166
                    
                    
                    $
                    307,620Income
      taxes
                    
                    $
                    2,458,149
                    
                    
                    $
                    937,967
                    
                    
                    $
                    1,288,428
 
 
 Note
12 – STOCK AWARD AND STOCK OPTION PLANS
  
 The
Company has a registration statement filed with the Securities and Exchange
Commission in connection with a Consulting Service Compensation Plan covering up
to 1,200,000 of the Company’s common stock shares. Pursuant to such Plan, the
Company may issue common stock or options to purchase common stock to certain
consultants, service providers, and employees of the Company.  The
option price, number of shares, grant date, and vesting terms are determined at
the discretion of the Company’s Board of Directors.
 
 As of
December 31, 2008 and at September 30, 2009 and 2008, there were no stock
options outstanding or exercisable. There were approximately 940,000 shares
available for issuance under the Plan at September 30, 2009.
 
 – 19
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
12 – STOCK AWARD AND STOCK OPTION PLANS - Continued
 
 
 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, 2008 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 key 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.
 
 
 Note
13 – FAIR VALUE MEASUREMENTS
 
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.”  SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in accordance with U.S. GAAP, and expands
disclosures about fair value measurements.  The statement clarifies
that the exchange price is the price in an orderly transaction between market
participants to sell an asset or transfer a liability at the measurement
date.  The statement emphasizes that fair value is a market-based
measurement and not an entity-specific measurement.  The statement
establishes a fair value hierarchy used in fair value measurements and expands
the required disclosures of assets and liabilities measured at fair
value.
 
 Level 1 –
Inputs use quoted prices in active markets for identical assets or liabilities
that the Company has the ability to access.
 
 Level 2 –
Inputs use other inputs that are observable, either directly or
indirectly.  These inputs include quoted prices for similar assets and
liabilities in active markets, and other inputs such as interest rates and yield
curves that are observable at commonly quoted intervals.
 
 Level 3 –
Inputs are unobservable inputs, including inputs that are available in
situations where there is little, if any, market activity for the related asset
or liability.
 
 In
instances where inputs used to measure fair value fall into different levels in
the above fair value hierarchy, fair value measurements in their entirety are
categorized based on the lowest level input that is significant to the
valuation.  The Company’s assessment of the significance of particular
inputs to these fair measurements requires judgment and considers factors
specific to each asset or liability.
 
  – 20
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
13 – FAIR VALUE MEASUREMENTS - Continued
 
 
 Disclosures
concerning assets and liabilities measured at fair value are as
follows:
 
 Quoted
      Prices in
                  Active
      Markets
                  for
      Identical
                  Assets
      (Level 1)
                
                
                Significant
      Other
                  Observable
                  Inputs
      (Level 2)
                
                
                Significant
                  Unobservable
                  Inputs
      (Level 3)
                
                
                Balance
      at
                  September
                  30,
      2009AssetsInvestment
      securities- available - for - sale
                
                $
                4,950,457
                
                
                
                —
                
                
                
                —
                
                
                $
                4,950,457
 
  
 Note
14 – 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.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51.”  This
statement amends ARB No. 51 to establish accounting and reporting
standards for the noncontrolling interest (minority interest) in a subsidiary
and for the deconsolidation of a subsidiary. Upon its adoption, noncontrolling
interests will be classified as equity in the consolidated balance
sheets.  This statement also provides guidance on a subsidiary
deconsolidation as well as stating that entities need to provide sufficient
disclosures that clearly identify and distinguish between the interests of the
parent and the interests of the noncontrolling owners. This statement is
effective for financial statements issued for fiscal years beginning after
December 15, 2008.  The adoption of this standard did not have a
material impact on the Company’s financial condition, results of operations or
liquidity.
 
 
 
 
 – 21
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
14 – RECENT ACCOUNTING PRONOUNCEMENTS - Continued
 
 
 In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS No.
161”).  This statement requires enhanced disclosures about (a) how and
why an entity uses derivative instruments, (b) how derivative instruments and
related hedged items are accounted for under SFAS No. 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows.  SFAS No. 161 also requires that objectives for using
derivative instruments be disclosed in terms of underlying risk and accounting
designation and requires cross-referencing within the footnotes.  This
statement also suggests disclosing the fair values of derivative instruments and
their gains and losses in a tabular format.  This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008.  The adoption of this standard did
not have a material impact on the Company’s financial condition, results of
operations or liquidity.
 
 On
April 9, 2009, the FASB finalized three FASB Staff Positions (“FSPs”)
regarding the accounting treatment for investments including mortgage-backed
securities. These FSPs changed the method for determining if an
other-than-temporary impairment (“OTTI”) exists and the amount of OTTI to be
recorded through an entity’s income statement. The changes brought about by the
FSPs provide greater clarity and reflect a more accurate representation of the
credit and noncredit components of an OTTI event. The three FSPs are as
follows:
  ●
              
              FASB
      ASC 820-10-65-4, Fair Value Measurements and Disclosures provides
      guidelines for making fair value measurements that determine fair value
      when the volume and level of activity for assets or liabilities have
      significantly decreased and identify transactions that are not
      orderly.●
              
              FASB
      ASC 320-10-65, Investments — Debt and Equity Securities provides
      additional guidance designed to create greater clarity and consistency in
      accounting for and presenting impairment losses on
    securities.●
              
              FASB
      ASC 825-10-65, Financial Instruments enhances consistency in financial
      reporting by increasing the frequency of fair value
      disclosures.
 
 The
adoption of these did not have a material effect on the Company’s results of
operations or financial position.
 
 In
May 2009, FASB issued FASB ASC 855, Subsequent Events with the objective to
establish general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. FASB ASC 855 sets forth: (i) the period after
the balance sheet date during which management of a reporting entity should
evaluate events or transactions that may occur for potential recognition or
disclosure in the financial statements; (ii) the circumstances under which
an entity should recognize events or transactions occurring after the balance
sheet date in its financial statements; and (iii) the disclosures that an
entity should make about events or transactions that occurred after the balance
sheet date. FASB ASC 855 is effective for interim and annual financial periods
ending after June 15, 2009. The adoption of FASB ASC 855 on June 30, 2009,
did not have an impact on the Company’s consolidated financial
statements.
 
  – 22
–
 LIFEWAY
FOODS, INC. AND SUBSIDIARIES
 Notes
to Consolidated Financial Statements
 September
30, 2009 and 2008
 and
December 31, 2008
 
 
 Note
14 – RECENT ACCOUNTING PRONOUNCEMENTS - Continued
 
 
 In
June 2009, FASB issued FASB ASC 810, Consolidation. The objective of FASB
ASC 810 is to improve financial reporting by enterprises involved with variable
interest entities and to provide more relevant and reliable information to users
of financial statements. FASB ASC 810 shall be effective as of the beginning of
each reporting entity’s first annual reporting period that begins after
November 15, 2009, for interim periods within that first annual reporting
period, and for interim and annual reporting periods thereafter. Earlier
application is prohibited. The Company is currently evaluating the impact of the
adoption of this standard, but does not expect it have a material effect on the
Company’s financial position or results of operation.
  In
June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No.
168, “The FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles.” SFAS No. 168 approved the FASB Accounting
Standards Codification (the Codification) as the single source of authoritative
nongovernmental GAAP. All existing accounting standard documents, such as FASB,
American Institute of Certified Public Accountants, Emerging Issues Task Force
and other related literature, excluding guidance from the Securities and
Exchange Commission, have been superseded by the Codification. All other
non-grandfathered, non-SEC accounting literature not included in the
Codification has become nonauthoritative. The Codification is effective for
interim or annual periods ending after September 15, 2009. There have been
no changes to the content of our financial statements or disclosures as a result
of implementing the Codification during the quarter ended September 30, 2009.
However, as a result of implementation of the Codification, previous references
to new accounting standards and literature are no longer applicable.  All
future references to authoritative accounting literature in our consolidated
financial statements will be referenced in accordance with the
Codification.
 
 
 
 Note
15 – SUBSEQUENT EVENTS
  None.





– 23
–


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




Comparison
of Quarter Ended September 30, 2009 to Quarter Ended September 30,
2008
 
 The
following analysis should be read in conjunction with the unaudited financial
statements of the Company and related notes included elsewhere in this quarterly
report and the audited financial statements and Management’s Discussion and
Analysis contained in our Form 10-K, for the fiscal year ended December 31,
2008, and in the Management’s Discussion and Analysis contained in our Form
10-Q, for the fiscal quarters ended March 31, 2009 and June 30,
2009.
 
 Results
of Operations
 
 Total
consolidated group sales increased by $4,193,594, (approximately 37%) to
$15,433,876 during the three-month period ended September 30, 2009 from
$11,240,282 during the same three-month period in 2008. This increase is
primarily attributable to increased sales and awareness of Lifeway’s flagship
line, Kefir, as well as ProBugs® Organic Kefir for
kids.  Additionally, Lifeway recorded revenues from its February 6,
2009 acquisition of Fresh Made Dairy.  Included in the total group
sales was approximately $2,190,000 of revenue related to this acquisition and
recorded during the third quarter of 2009.
 
 Cost of
goods sold as a percentage of sales, excluding depreciation was approximately
58% during the third quarter 2009, compared to about 67% during the same period
in 2008. The decrease was primarily attributable to the decreased cost of
conventional milk, our largest raw material, and the cost of transportation and
other petroleum based production supplies.  The cost
of conventional milk was approximately 30% less during the 3rd quarter
2009, when compared to the same period in 2008. Gross
profit increased approximately 77% during the third quarter of 2009, when
compared with the same period in 2008.
 
 Operating
expenses as a percentage of sales were approximately 20% during the third
quarter 2009, compared to about 18% during the same period in
2008.   This increase is primarily attributable to a 111%
increase in amortization expense, a non cash expense, related to the February 6,
2009 acquisition of Fresh Made Dairy.
 
 Total
operating income increased by $1,772,193, (approximately 121%) to
$3,239,432during
the third quarter 2009, from $1,467,239 during the same period in
2008.
 
 Interest
expense during the third quarter 2009 was $99,864 compared with interest expense
of $71,928 during the same period a year ago.  This higher interest
expense is primarily attributable to the issuance of the note payable related to
the February 6, 2009 Fresh Made Dairy acquisition.  Notes payable are
discussed in Note 9 of the Notes to Consolidated Financial
Statements.
 
 Total
income before taxes increased by $1,884,819 (approximately 168%) to
$3,007,652during
the third quarter 2009, from $1,122,833 during the same period in
2008.
 
 Provision
for income taxes was $1,636,911, or a 54% tax rate, for the third quarter ended
September 30, 2009, compared with a provision for income taxes of $267,917, or a
24% tax rate, for the same period in 2008.  This increase was due to
an under estimate of income tax liability in the third quarter 2008, which
resulted in an increased adjustment to the provision for income taxes during the
third quarter 2009.
 Total net
income was $1,370,741or $.08 per share for
the third quarter ended September 30, 2009, compared with $854,916or $.05 per share in the
same period in 2008.  This represents a 60% increase in net income
from the third quarter 2009 when compared to the same period in
2008.
 
 Comparison of Nine-Month
Period Ended September 30, 2009 to Nine-Month Period Ended September 30,
2008
 
 Results
of Operations
 
 Sales
increased by $9,763,471, (approximately 29%) to $43,649,383 during the
nine-month period ended September 30, 2009 from $33,885,912 during the same
nine-month period in 2008. This increase is primarily attributable to increased
sales and awareness of Lifeway’s flagship line, Kefir, as well as Lifeway’s kids
Kefir drink, ProBugs®.  Additionally, Lifeway recorded revenues from
its February 6, 2009 acquisition of Fresh Made Dairy.  Included in the
total group sales was approximately $5,733,600 of revenue related to this
acquisition and recorded during the nine-month period ended September 30,
2009.
 
 Cost of
goods sold as a percentage of sales, excluding depreciation expense, was
approximately 57% during the nine-month period ended September 30, 2009,
compared to about 66% during the same period in 2008.  The decrease
was primarily attributable to the decreased cost of conventional milk, our
largest raw material, and the cost of transportation and other petroleum based
production supplies.
 
 Operating
expenses as a percentage of sales for Lifeway Foods were approximately 20%
during the nine-month period ended September 30, 2009, compared to about 19%
during the same period in 2008.  This increase is primarily
attributable to the increase in professional fees related to the February 6,
2009 acquisition of Fresh Made Dairy and a 112% increased amortization expense,
a non cash expense, also related to the Fresh Made Dairy acquisition. 
Professional
fees related to the acquisition were approximately $260,000.Many
of the acquisition related professional fees are non recurring
expenses.
 
 Total
operating income increased by $4,557,531, (approximately 104%) to
$8,937,589during
the nine-month period ending September 30, 2009, from $4,380,058 during the same
period in 2008.
 
 Total
other expenses during the nine-month period ending September 30, 2009 were
$463,219, compared with total other expenses of $346,186 during the same period
in 2008.  This increase is primarily attributable to a higher interest
expense related to the February 6, 2009 Fresh Made Dairy
acquisition.  Interest expenses during the nine-month period ending
September 30, 2009 were $364,337, which includes approximately a $55,000 pre
-payment penalty on one of Lifeway’s real estate mortgages related to the
financing of the acquisition.  This pre-payment expense is a non
recurring expense.
 
 Total
income before taxes increased by $4,440,498, (approximately 110%) to
$8,474,370during
the nine-month period ended September 30, 2009, from $4,033,872 during the same
period in 2008.
 
 Provision
for income taxes was $3,024,261, or a 36% tax rate, for the nine-month period
ended September 30, 2009, compared with a provision for income taxes of
$1,378,632, or a 34% tax rate, for the same period in 2008.
 
 Total net
income was $5,450,109, or $.32 per share for the nine-month period ended
September 30, 2009, compared with $2,655,240, or $.16 per share in the same
period in 2008.  This represents a 105% increase in net income from
the nine-month period ended September 30, 2009 when compared to the same period
in 2008.
 
 –
24 –
 Sources
and Uses of Cash
 
 Net cash
provided by operating activities was $5,504,144during the nine-months
ended September 30, 2009, which is an increase of $1,872,155 when compared to
the same period in 2008.  This increase is primarily attributable to
the increase in net income of $2,794,869.
 
 Net cash used in investing activities was $3,720,562 during the
nine-months ended September 30, 2009, which is an increase of $2,051,518 when
compared to the same period in 2008.  This increase is primarily due
to the Company’s acquisition of Fresh Made Dairy, net of cash
acquired.  The Company purchased $1,020,776 worth of property, plant
and equipment during the first nine-months of 2009 when compared to the purchase
of $1,892,472 worth of property, plant in equipment during the same period in
2008.  This represents a decrease of $871,696 in the purchase of
equipment during the nine-months ended September 30, 2009, when compared to the
same period in 2008.  The Company also repaid certain of its short
term liabilities in the form of a margin loan in the amount of $407,479 during
its second quarter of 2009.
 
 Lifeway
had a net increase in cash and cash equivalents of $527,139during the nine-months
ended September 30, 2009, compared to a net decrease in cash and cash
equivalents of $65,019during the same period
in 2008.
 
 Assets
and Liabilities
 
 Total
assetswere
$50,515,216during
the nine-months ended September 30, 2009, which is an increase of $14,067,206
when compared to the same period in 2008.  This is primarily due the
Company’s acquisition of Fresh Made Dairy, which increased intangible assets by
$10,151,285 as of September 30, 2009 when compared to September 30,
2008.  Additionally, the value of the Company’s property, plant and
equipment was$13,812,039as of September 30,
2009, which is an increase of $2,822,539 from September 30, 2008.
 
 Total
current liabilitieswere $9,095,186during the nine-months
ended September 30, 2009, which is an increase of $4,338,387 when compared to
the same period in 2008.  This is primarily due the Company’s
acquisition of Fresh Made, which increased current maturities of notes payable
by $5,105,596 as of September 30, 2009 when compared to September 30,
2008.
 
 Significant
portions of our assets are held in marketable securities. The majority 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. 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 May
28, 2009, Lifeway's Board of Directors approved awards of an aggregate amount of
18,000 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 May 28, 2009 and have
vesting periods of one year. The expense for the awards is measured as of July
14, 2009 at $14.69 per share for 18,000 shares, or a total stock award expense
of $264,420. This expense will be recognized as the stock awards vest in 12
equal portions of $22,035, or 1500 shares per month for one year.


ITEM
3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
applicable.





ITEM
4T.    CONTROLS AND PROCEDURES.




Evaluation
of Disclosure Controls and Procedures




As of
September 30, 2009, we carried out an evaluation under the supervision and with
the participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were not effective at the reasonable assurance level as
of September 30, 2009 in ensuring that information required to be disclosed by
us under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified under the Exchange Act rules and forms due to the
material weaknesses as disclosed in our Form 10-K filed on March 31, 2009
which we cannot yet determine have been remedied by implementation of the
NAV software as described below. As a result, we performed additional analysis
and other post-closing procedures to ensure our consolidated financial
statements were prepared in accordance with generally accepted accounting
principles.





Accordingly,
management believes the consolidated financial statements included in this Form
10-Q fairly present, in all material respects, our financial condition, results
of operations and cash flows for the periods presented.




There was
no change in our internal control over financial reporting during our most
recently completed fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting,
other than the following.  As of June 1, 2009, the Company implemented
the software program Microsoft Business Solutions-Navision (“NAV”). The Company
intends for the NAV software to increase the financial reporting ability of the
Company over the Company’s previous accounting software, to implement
additional controls and strengthen the existing controls over the financial
reporting process, and to allow for additional documentation of the financial
reporting process.


–
25–
 
 PART
II — OTHER INFORMATION





ITEM 1.    LEGAL PROCEEDINGS.





None.





ITEM
1A.    RISK FACTORS.





Not
applicable.




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




(a)
            Not
      applicable.


(b)
            Not
      applicable.


(c)
            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 ProgramsJuly
      1, 2009 to July 31, 2009
                                                                
                                                                29,652
                                                                
                                                                
                                                                12.47
                                                                
                                                                29,652
                                                                
                                                                9,998Aug.
      1, 2009 to Aug. 31, 2009
                                                                
                                                                9,998
                                                                
                                                                
                                                                12.97
                                                                
                                                                9,998
                                                                
                                                                0*Total
                                                                
                                                                39,650
                                                                
                                                                $
                                                                12.72
                                                                
                                                                39,650
                                                                
                                                                0




*
Pursuant to the share repurchase program approved November 20, 2008
for 100,000 split adjusted shares with a plan expiration date of one
year.




ITEM 3.    DEFAULTS
UPON SENIOR SECURITIES.





None.




ITEM
4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.





None.





ITEM 5.    OTHER
INFORMATION.




On
November 16, 2009, the Company announced its financial results for the fiscal
quarter ended September 30, 2009 and certain other information. A copy of the
Company’s press release announcing these financial results and certain other
information is attached as Exhibit 99.1 hereto. The information contained in
Exhibit 99.1 hereto is being furnished, and should not be deemed “filed” for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or
otherwise subject to the liabilities imposed by that Section. The information
contained in Exhibit 99.1 shall not be incorporated by reference into any
registration statement or other document or filing under the Securities Act of
1933, as amended, except as may be expressly set forth in a specific filing. The
press release filed as an exhibit to this report includes “safe harbor” language
pursuant to the Private Securities Litigation Reform Act of 1995, as amended,
indicating that certain statements about the Company’s business and other
matters contained in the press release are “forward-looking.” The press release
also cautions investors that “forward-looking” statements may be different from
actual operating results. Finally, the press release states that a more thorough
discussion of risks and uncertainties which may affect the Company’s operating
results is included in the Company’s reports on file with the Securities and
Exchange Commission.




– 26
–


ITEM
6.    EXHIBITS.





Exhibit
                  Number
                
                Description
      of Document3.4
                
                Amended
      and Restated By-laws (incorporated by reference to
      Exhibit No. 3.5 of Lifeway’sCurrent 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 Exhibit3.5 of
      Lifeway’s Quarterly Report on Form 10-QSB for the quarter ended
      June 30, 2000 and filedon
      August 8, 2000). (File No. 000-17363)31.1
                
                Officer’s
      Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302
      of theSarbanes-Oxley
      Act of 2002.31.2
                
                Officer’s
      Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302
      of theSarbanes- Oxley
      Act of 2002.32.1
                
                Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuantto Section
      906 of the Sarbanes-Oxley Act of 2002.32.2
                
                Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuantto Section
      906 of the Sarbanes-Oxley Act of 2002.99.1
                
                Press
      Release dated November 16, 2009.














































































– 27
–


SIGNATURES




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












LIFEWAY
      FOODS, INC.(Registrant)Date:
                                November
      16, 2009
                                
                                By:
                                /s/
      Julie SmolyanskyJulie
      Smolyansky
                                  Chief
      Executive Officer,
                                  President
      and Director
   Date:
                November
      16, 2009
                
                By:
                /s/
      Edward P. SmolyanskyEdward
      P. Smolyansky
                  Chief
      Financial and Accounting
                  Officer and
      Treasurer















































– 28
–


EXHIBIT
INDEX







Exhibit
                  Number
                
                Description
      of Document3.4
                
                Amended
      and Restated By-laws (incorporated by reference to
      Exhibit No. 3.5 of Lifeway’sCurrent 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 Exhibit3.5 of
      Lifeway’s Quarterly Report on Form 10-QSB for the quarter ended
      June 30, 2000 and filedon
      August 8, 2000). (File No. 000-17363)31.1
                
                Officer’s
      Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302
      of theSarbanes- Oxley
      Act of 2002.31.2
                
                Officer’s
      Certificate Pursuant to 15 U.S.C. 7241, as Adopted Pursuant to Section 302
      of theSarbanes- Oxley
      Act of 2002.32.1
                
                Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuantto Section
      906 of the Sarbanes-Oxley Act of 2002.32.2
                
                Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
      Pursuantto Section
      906 of the Sarbanes-Oxley Act of 2002.99.1
                
                Press
      Release dated November 16,
2009.






















– 29
–