##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2006
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 For
the transition period from  to
  LIFEWAY
FOODS, INC.
  Illinois
    
    36-3442829(State or other jurisdiction of incorporation or organization)
    
    (IRS Employer Identification No.)
  
   
  
  þ o
 o o
 APPLICABLE ONLY TO CORPORATE ISSUERS
  o þ




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##### 



INDEX
 PART I  FINANCIAL INFORMATION
    
    
    3ITEM 1. FINANCIAL STATEMENTS
    
    
    3ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    
    18ITEM 3. CONTROLS AND PROCEDURES
    
    
    20PART II  OTHER INFORMATION
    
    
    20ITEM 5. OTHER INFORMATION
    
    
    20ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
    
    
    20SIGNATURE
    
    
    21302 Certification302 CertificationSection 1350 CertificationSection 1350 CertificationPress Release
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS.
 LIFEWAY FOODS, INC. AND SUBSIDIARY
 CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 2006 and 2005
 AND DECEMBER 31, 2005
 LIFEWAY
FOODS, INC. AND SUBSIDIARY
Consolidated Statements of Financial Condition
March 31, 2006 and 2005 and December 31, 2005
 March 31,
    
    
    December, 312006
    
    
    2005
    
    
    2005ASSETSCurrent assetsCash and cash equivalents
    
    $
    3,817,745
    
    
    $
    5,434,032
    
    
    $
    4,354,081Marketable securities
    
    
    8,337,907
    
    
    
    6,895,472
    
    
    
    7,478,697Inventories
    
    
    2,024,330
    
    
    
    996,245
    
    
    
    1,716,999Accounts receivable, net of allowance for
doubtful accounts
of $45,000 and $15,000 at March 31, 2006 and 2005
and $35,000 at December 31, 2005
    
    
    3,054,017
    
    
    
    2,522,971
    
    
    
    2,517,615Prepaid expenses and other current assets
    
    
    15,247
    
    
    
    
    
    
    
    9,144Other receivables
    
    
    55,404
    
    
    
    105,759
    
    
    
    56,435Deferred income taxes
    
    
    
    
    
    
    89,535
    
    
    
    142,772Refundable income taxes
    
    
    40,388
    
    
    
    103,451
    
    
    
    11,562Total current assets
    
    
    17,345,038
    
    
    
    16,147,465
    
    
    
    16,287,305Property and equipment, net
    
    
    7,774,651
    
    
    
    3,432,149
    
    
    
    7,751,446Intangible assetsGoodwill
    
    
    75,800
    
    
    
    75,800
    
    
    
    75,800Other intangible assets, net of accumulated
amortization
of $108,958 and $26,990 at March 31, 2006 and
2005
and $92,432 at December 31, 2005
    
    
    333,680
    
    
    
    392,815
    
    
    
    350,206Total intangible assets
    
    
    409,480
    
    
    
    468,615
    
    
    
    426,006Total assets
    
    $
    25,529,169
    
    
    $
    20,048,229
    
    
    $
    24,464,757LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent maturities of notes payable
    
    $
    528,415
    
    
    $
    8,934
    
    
    $
    532,454Accounts payable
    
    
    453,022
    
    
    
    789,247
    
    
    
    426,253Accrued expenses
    
    
    245,168
    
    
    
    125,017
    
    
    
    355,011Deferred income taxes
    
    
    4,251
    
    
    
    
    
    
    
    Total current liabilities
    
    
    1,230,856
    
    
    
    923,198
    
    
    
    1,313,718Notes payable
    
    
    2,887,785
    
    
    
    460,940
    
    
    
    2,903,349Deferred income taxes
    
    
    345,709
    
    
    
    406,468
    
    
    
    348,923Stockholders equityCommon stock
    
    
    6,509,267
    
    
    
    6,509,267
    
    
    
    6,509,267Paid-in-capital
    
    
    98,712
    
    
    
    72,089
    
    
    
    90,725Treasury stock, at cost
    
    
    (1,015,146
    )
    
    
    (870,831
    )
    
    
    (1,024,659
    )Retained earnings
    
    
    15,317,611
    
    
    
    12,599,866
    
    
    
    14,422,948Accumulated other comprehensive income (loss),
net of taxes
    
    
    154,375
    
    
    
    (52,768
    )
    
    
    (99,514
    )Total stockholders equity
    
    
    21,064,819
    
    
    
    18,257,623
    
    
    
    19,898,767Total liabilities and stockholders equity
    
    $
    25,529,169
    
    
    $
    20,048,229
    
    
    $
    24,464,757
  3




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##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARY
Consolidated Statements of Income and Comprehensive Income
For the Three Months Ended March 31, 2006 and 2005
and The Year Ended December 31, 2005
 Three Months Ended
    
    
    Year EndedMarch 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Sales
    
    $
    6,003,023
    
    
    $
    4,656,860
    
    
    $
    20,131,654Cost of goods sold
    
    
    3,212,566
    
    
    
    2,577,956
    
    
    
    11,664,065Gross profit
    
    
    2,790,457
    
    
    
    2,078,904
    
    
    
    8,467,589Operating expenses
    
    
    1,384,085
    
    
    
    1,155,180
    
    
    
    5,066,227Income from operations
    
    
    1,406,372
    
    
    
    923,724
    
    
    
    3,401,362Other income (expense):Interest and dividend income
    
    
    86,235
    
    
    
    65,276
    
    
    
    323,365Interest expense
    
    
    (50,226
    )
    
    
    (7,442
    )
    
    
    (100,762
    )Gain (loss) on sale of
marketable
securities, net
    
    
    (36,878
    )
    
    
    198,140
    
    
    
    445,327Gain on marketable securities
classified as trading
    
    
    512
    
    
    
    3,516
    
    
    
    13,773Total other income
    
    
    (357
    )
    
    
    259,490
    
    
    
    681,703Income before provision for
income taxes
    
    
    1,406,015
    
    
    
    1,183,214
    
    
    
    4,083,065Provision for income taxes
    
    
    511,352
    
    
    
    457,823
    
    
    
    1,534,592Net income
    
    $
    894,663
    
    
    $
    725,391
    
    
    $
    2,548,473Basic and diluted earnings per
common share
    
    
    0.11
    
    
    
    0.09
    
    
    
    0.30Weighted average number of
shares
outstanding
    
    
    8,396,189
    
    
    
    8,432,653
    
    
    
    8,404,496COMPREHENSIVE INCOMENet income
    
    $
    894,663
    
    
    $
    725,391
    
    
    $
    2,548,473Other comprehensive income
(loss),
net of tax:Unrealized gains (losses) on
marketable securities
(net of tax benefits)
    
    
    275,537
    
    
    
    (56,722
    )
    
    
    42,708Less reclassification adjustment
for gains (losses)
included in net income (net of
taxes)
    
    
    (21,648
    )
    
    
    (115,226
    )
    
    
    (261,402
    )Comprehensive income
    
    $
    1,148,552
    
    
    $
    553,443
    
    
    $
    2,329,779
  4




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##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders Equity
For the Three Months Ended March 31, 2006
and the Year Ended December 31, 2005
 Common Stock, No Par Value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accumulated10,000,000 Shares
    
    
    # of Shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    OtherAuthorized
    
    
    of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive# of Shares
    
    
    # of Shares
    
    
    Treasury
    
    
    Common
    
    
    Paid In
    
    
    Treasury
    
    
    Retained
    
    
    Income (Loss),Issued
    
    
    Outstanding
    
    
    Stock
    
    
    Stock
    
    
    Capital
    
    
    Stock
    
    
    Earnings
    
    
    Net of Tax
    
    
    TotalBalances at December 31, 2004
    
    
    8,636,888
    
    
    
    8,441,438
    
    
    
    195,450
    
    
    $
    6,509,267
    
    
    $
    64,314
    
    
    $
    (649,039
    )
    
    $
    11,874,475
    
    
    $
    119,180
    
    
    $
    17,918,197Issuance of treasury stock
    
    
    
    
    
    
    3,817
    
    
    
    (3,817
    )
    
    
    
    
    
    
    26,411
    
    
    
    25,934
    
    
    
    
    
    
    
    
    
    
    
    52,345Redemption of stock
    
    
    
    
    
    
    (50,000
    )
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    (401,554
    )
    
    
    
    
    
    
    
    
    
    
    (401,554
    )Other comprehensive income (loss):Unrealized losses on securities, net of
taxes and reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (218,694
    )
    
    
    (218,694
    )Net income for the year
ended December 31, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,548,473
    
    
    
    
    
    
    
    2,548,473Balances at December 31, 2005
    
    
    8,636,888
    
    
    
    8,395,255
    
    
    
    241,633
    
    
    $
    6,509,267
    
    
    $
    90,725
    
    
    $
    (1,024,659
    )
    
    $
    14,422,948
    
    
    $
    (99,514
    )
    
    $
    19,898,767Issuance of treasury stock
    
    
    
    
    
    
    1,400
    
    
    
    (1,400
    )
    
    
    
    
    
    
    7,987
    
    
    
    9,513
    
    
    
    
    
    
    
    
    
    
    
    17,500Redemption of stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other comprehensive income (loss):Unrealized gains on securities, net of
taxes and reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    253,889
    
    
    
    253,889Net income for the three months
ended March 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    894,663
    
    
    
    
    
    
    
    894,663Balances at March 31, 2006
    
    
    8,636,888
    
    
    
    8,396,655
    
    
    
    240,233
    
    
    $
    6,509,267
    
    
    $
    98,712
    
    
    $
    (1,015,146
    )
    
    $
    15,317,611
    
    
    $
    154,375
    
    
    $
    21,064,819
  5




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##### Table of Contents



LIFEWAY
FOODS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2006 and 2005
and the Year Ended December 31, 2005
 Three Months Ended
    
    
    Years EndedMarch 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Cash flows from operating activities:Net income
    
    $
    894,663
    
    
    $
    725,391
    
    
    $
    2,548,473Adjustments to reconcile net income to net
cash flows from operating activities:Depreciation and amortization
    
    
    143,437
    
    
    
    140,742
    
    
    
    650,945(Gain)Loss on sale of marketable securities, net
    
    
    36,878
    
    
    
    (198,140
    )
    
    
    (445,327
    )Gain on marketable securities
classified as trading
    
    
    (512
    )
    
    
    (3,516
    )
    
    
    (13,773
    )Deferred income taxes
    
    
    (34,822
    )
    
    
    (22,343
    )
    
    
    (100,236
    )Treasury stock issued for services
    
    
    17,500
    
    
    
    11,512
    
    
    
    52,345Increase in allowance for doubtful accounts
    
    
    10,000
    
    
    
    
    
    
    
    (Increase) decrease in operating assets:Accounts receivable
    
    
    (546,402
    )
    
    
    (498,935
    )
    
    
    (493,579
    )Other receivables
    
    
    1,031
    
    
    
    (33,622
    )
    
    
    15,702Inventories
    
    
    (307,331
    )
    
    
    (90,548
    )
    
    
    (811,302
    )Refundable income taxes
    
    
    (28,826
    )
    
    
    155,166
    
    
    
    247,055Prepaid expenses and other current assets
    
    
    (6,103
    )
    
    
    7,260
    
    
    
    (1,884
    )Increase (decrease) in operating liabilities:Accounts payable
    
    
    26,769
    
    
    
    147,596
    
    
    
    (215,398
    )Accrued expenses
    
    
    (109,843
    )
    
    
    (70,524
    )
    
    
    159,470Net cash provided by operating activities
    
    
    96,439
    
    
    
    270,039
    
    
    
    1,592,491Cash flows from investing activities:Purchases of marketable securities
    
    
    (1,423,859
    )
    
    
    (1,910,623
    )
    
    
    (6,460,561
    )Sale of marketable securities
    
    
    960,801
    
    
    
    1,665,869
    
    
    
    5,810,391Purchases of property and equipment
    
    
    (150,114
    )
    
    
    (136,558
    )
    
    
    (4,916,811
    )Net cash used in investing activities
    
    
    (613,172
    )
    
    
    (381,312
    )
    
    
    (5,566,981
    )Cash flows from financing activities:Proceeds from note payable
    
    
    
    
    
    
    
    
    
    
    3,000,000Purchases of treasury stock
    
    
    
    
    
    
    (225,529
    )
    
    
    (401,554
    )Repayment of notes payable
    
    
    (19,603
    )
    
    
    (2,451
    )
    
    
    (36,522
    )Loan costs
    
    
    
    
    
    
    
    
    
    
    (6,638
    )Net cash provided by (used in) financing activities
    
    
    (19,603
    )
    
    
    (227,980
    )
    
    
    2,555,286Net decrease in cash and cash equivalents
    
    
    (536,336
    )
    
    
    (339,253
    )
    
    
    (1,419,204
    )Cash and cash equivalents at the beginning of the period
    
    
    4,354,081
    
    
    
    5,773,285
    
    
    
    5,773,285Cash and cash equivalents at the end of the period
    
    
    3,817,745
    
    
    $
    5,434,032
    
    
    $
    4,354,081
  6




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 1  NATURE OF BUSINESS
  Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  Principles of consolidation
  Use of estimates
  Revenue Recognition
  Cash and cash equivalents
   7




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
  March 31,
    
    
    December 312006
    
    
    2005
    
    
    2005Amounts insured
    
    $
    478,025
    
    
    $
    500,000
    
    
    $
    462,571Uninsured and uncollateralized amounts
    
    
    3,823,916
    
    
    
    5,303,533
    
    
    
    4,331,179Total bank balances
    
    $
    4,301,941
    
    
    $
    5,803,533
    
    
    $
    4,793,750
 Marketable securities
 Accounting for Certain Investments in Debt and Equity
Securities Accounting for Noncurrent Marketable Equity Securities
 Accounts receivable
   Inventories
  Property and equipment
   Category
    
    YearsBuildings and improvements
    
    31 and 39Machinery and equipment
    
    5  12Office equipment
    
    5  7Vehicles
    
    5
 8




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
 Intangible assets
      Category
    
    YearsRecipes
    
    
    4Customer lists and other
customer related intangibles
    
    
    8Lease agreement
    
    
    7
 Income taxes
   9




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  Continued
 Treasury stock
  Advertising costs
  Earning per common share
  Note 3  INTANGIBLE ASSETS
  March 31, 2006
    
    
    March 31, 2005
    
    
    December 31, 2005Accumulated
    
    
    
    
    
    
    Accumulated
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Cost
    
    
    Amortization
    
    
    Cost
    
    
    AmortizationRecipes
    
    $
    43,600
    
    
    $
    18,167
    
    
    $
    43,600
    
    
    $
    7,267
    
    
    $
    43,600
    
    
    $
    15,442Customer lists and
other customer
related intangibles
    
    
    305,200
    
    
    
    69,033
    
    
    
    305,200
    
    
    
    27,613
    
    
    
    305,200
    
    
    
    58,678Lease acquisition
    
    
    87,200
    
    
    
    20,762
    
    
    
    87,200
    
    
    
    8,305
    
    
    
    87,200
    
    
    
    17,648Goodwill
    
    
    75,800
    
    
    
    
    
    
    
    75,800
    
    
    
    
    
    
    
    75,800
    
    
    
    Loan acquisition costs
    
    
    6,638
    
    
    
    996
    
    
    
    
    
    
    
    
    
    
    
    6,638
    
    
    
    664$
    518,438
    
    
    $
    108,958
    
    
    $
    511,800
    
    
    $
    43,185
    
    
    $
    518,438
    
    
    $
    92,432
  2007
    
    
    66,2222008
    
    
    66,2222009
    
    
    51,5722010
    
    
    45,819Thereafter
    
    
    103,845$
    333,680
  10




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 4  MARKETABLE SECURITIES
  Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairMarch 31, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities
    
    $
    2,565,132
    
    
    $
    470,019
    
    
    $
    (102,220
    )
    
    $
    
    
    
    $
    2,932,931Mutual Funds
    
    
    584,921
    
    
    
    3,269
    
    
    
    (38,806
    )
    
    
    
    
    
    
    549,384Preferred Securities
    
    
    1,119,577
    
    
    
    993
    
    
    
    (30,128
    )
    
    
    
    
    
    
    1,090,442Private Investment
LP
    
    
    600,000
    
    
    
    35,864
    
    
    
    
    
    
    
    
    
    
    
    635,864Certificates of
Deposit
    
    
    150,000
    
    
    
    
    
    
    
    (1,410
    )
    
    
    
    
    
    
    148,590Corporate Bonds
    
    
    2,508,126
    
    
    
    10,040
    
    
    
    (84,182
    )
    
    
    
    
    
    
    2,433,984Municipal Bonds,
maturing within
five years
    
    
    61,275
    
    
    
    839
    
    
    
    (1,289
    )
    
    
    
    
    
    
    60,825Government agency
obligations,
maturing after five
years
    
    
    488,088
    
    
    
    
    
    
    
    
    
    
    
    (2,201
    )
    
    
    485,887Total
    
    $
    8,077,119
    
    
    $
    521,024
    
    
    $
    (258,035
    )
    
    $
    (2,201
    )
    
    $
    8,337,907
 Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairMarch 31, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities and Mutual
Funds
    
    $
    3,824,477
    
    
    $
    152,989
    
    
    $
    (184,109
    )
    
    
    
    
    
    $
    3,793,357Preferred Securities
    
    
    65,000
    
    
    
    200
    
    
    
    (2,262
    )
    
    
    
    
    
    
    62,938Certificates of
Deposit
    
    
    150,000
    
    
    
    
    
    
    
    (7,530
    )
    
    
    
    
    
    
    142,470Corporate Bonds
    
    
    2,333,986
    
    
    
    50
    
    
    
    (49,948
    )
    
    
    
    
    
    
    2,284,088Municipal bonds,
maturing within
five years
    
    
    24,875
    
    
    
    715
    
    
    
    
    
    
    
    
    
    
    
    25,590Government agency
obligations,
maturing after five
years
    
    
    600,000
    
    
    
    
    
    
    
    
    
    
    
    (12,971
    )
    
    
    587,029Total
    
    $
    6,998,338
    
    
    $
    153,954
    
    
    $
    243,849
    
    
    
    (12,971
    )
    
    $
    6,895,472
 11




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
And December 31, 2005
 Note 4  MARKETABLE SECURITIES  Continued
 Loss onMarketableSecuritiesUnrealized
    
    
    Unrealized
    
    
    Classified as
    
    
    FairDecember 31, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Trading
    
    
    ValueEquities
    
    $
    2,432,964
    
    
    $
    212,336
    
    
    
    (198,478
    )
    
    
    
    
    
    $
    2,446,822Mutual Funds
    
    
    699,921
    
    
    
    3,770
    
    
    
    (74,148
    )
    
    
    
    
    
    
    629,543Preferred Securities
    
    
    1,002,738
    
    
    
    1,468
    
    
    
    (30,892
    )
    
    
    
    
    
    
    973,314Private Investment
LP
    
    
    600,000
    
    
    
    
    
    
    
    (5,146
    )
    
    
    
    
    
    
    594,854Certificates of
Deposit
    
    
    240,000
    
    
    
    
    
    
    
    (1,125
    )
    
    
    
    
    
    
    238,875Corporate Bonds
    
    
    2,514,044
    
    
    
    809
    
    
    
    (77,888
    )
    
    
    
    
    
    
    2,436,965Municipal Bonds,
maturing within
five years
    
    
    61,275
    
    
    
    957
    
    
    
    (1,195
    )
    
    
    
    
    
    
    61,037Government agency
obligations,
maturing after five
years
    
    
    100,000
    
    
    
    
    
    
    
    
    
    
    
    (2,713
    )
    
    
    97,287Total
    
    $
    7,650,942
    
    
    $
    219,340
    
    
    $
    (388,872
    )
    
    $
    (2,713
    )
    
    $
    7,478,697
    Less Than 12 Months
    
    
    12 Months or Greater
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    UnrealizedDescription of Securites
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    LossesEquities
    
    $
    477,869
    
    
    $
    (46,355
    )
    
    $
    157,038
    
    
    $
    (55,865
    )
    
    $
    634,907
    
    
    $
    ( 102,220
    )Mutual Funds
    
    
    230,250
    
    
    
    (19,750
    )
    
    
    249,489
    
    
    
    (19,056
    )
    
    
    479,739
    
    
    
    (38,806
    )Preferred Securities
    
    
    887,440
    
    
    
    (29,598
    )
    
    
    24,470
    
    
    
    (530
    )
    
    
    911,910
    
    
    
    (30,128
    )Certificates of Deposit
    
    
    
    
    
    
    
    
    
    
    148,637
    
    
    
    (1,410
    )
    
    
    148,637
    
    
    
    (1,410
    )Corporate Bonds
    
    
    330,699
    
    
    
    (13,684
    )
    
    
    1,634,162
    
    
    
    (70,498
    )
    
    
    1,964,861
    
    
    
    (84,182
    )Municipal Bonds
    
    
    35,111
    
    
    
    (1,289
    )
    
    
    
    
    
    
    
    
    
    
    35,111
    
    
    
    (1,289
    )$
    1,961,369
    
    
    $
    ( 110,676
    )
    
    $
    2,213,796
    
    
    $
    ( 147,359
    )
    
    $
    4,175,165
    
    
    $
    (  258,035
    )
 12




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 4  MARKETABLE SECURITIES  Continued
      Note 5  INVENTORIES
  March 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Finished goods
    
    $
    753,631
    
    
    $
    444,519
    
    
    $
    658,522Production supplies
    
    
    772,311
    
    
    
    326,986
    
    
    
    662,310Raw materials
    
    
    498,388
    
    
    
    224,740
    
    
    
    396,167Total inventories
    
    $
    2,024,330
    
    
    $
    996,245
    
    
    $
    1,716,999
 13




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 6  PROPERTY AND EQUIPMENT
  March 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Land
    
    $
    909,232
    
    
    $
    470,900
    
    
    $
    909,232Buildings and improvements
    
    
    6,488,166
    
    
    
    2,483,007
    
    
    
    6,443,043Machinery and equipment
    
    
    5,911,844
    
    
    
    5,476,656
    
    
    
    5,806,853Vehicles
    
    
    513,670
    
    
    
    459,815
    
    
    
    513,670Office equipment
    
    
    78,763
    
    
    
    80,930
    
    
    
    78,76313,901,675
    
    
    
    8,971,308
    
    
    
    13,751,561Less accumulated depreciation
    
    
    6,127,024
    
    
    
    5,539,159
    
    
    
    6,000,115Total property and equipment
    
    $
    7,774,651
    
    
    
    3,432,149
    
    
    $
    7,751,446
  Note 7 ACCRUED EXPENSES
  March 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Accrued payroll and payroll taxes
    
    $
    57,326
    
    
    $
    33,154
    
    
    $
    104,873Accrued property tax
    
    
    182,341
    
    
    
    91,227
    
    
    
    244,916Other
    
    
    5,501
    
    
    
    636
    
    
    
    5,222$
    245,168
    
    
    $
    125,017
    
    
    $
    355,011
 Note 8  NOTES PAYABLE
  March 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Mortgage note payable to a
bank, payable in monthly
installments of $3,273
including interest at 6.25%,
with a balloon payment of
$454,275 due September 25,
2006. Collateralized by real
estate.
    
    $
    460,092
    
    
    $
    469,874
    
    
    $
    462,695Mortgage note payable to a
bank, payable in monthly
installments of $19,513
including interest at 5.6%,
with a balloon payment of
$2,652,143 due July 14, 2010.
Collateralized by real estate.
    
    
    2,956,108
    
    
    
    
    
    
    
    2,973,108Total notes payable
    
    
    3,416,200
    
    
    
    469,874
    
    
    
    3,435,803Less current maturities
    
    
    528,415
    
    
    
    8,934
    
    
    
    532,454Total long-term portion
    
    $
    2,887,785
    
    
    $
    460,940
    
    
    $
    2,903,349
 14




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 8  NOTES PAYABLE  Continued
  As of March 31,
2007
    
    $
    528,4152008
    
    
    73,7672009
    
    
    78,0052010
    
    
    82,4882011
    
    
    2,653,525Total
    
    $
    3,416,200
 Note 9  PROVISION FOR INCOME TAXES
  For theFor the Three Months Ended
    
    
    Year EndedMarch 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Current:Federal
    
    $
    443,238
    
    
    $
    384,812
    
    
    $
    1,364,033State and local
    
    
    102,936
    
    
    
    95,354
    
    
    
    270,795Total current
    
    
    546,174
    
    
    
    480,166
    
    
    
    1,634,828Deferred
    
    
    (34,822
    )
    
    
    (22,343
    )
    
    
    (100,236
    )Provision for income taxes
    
    $
    511,352
    
    
    $
    457,823
    
    
    $
    1,534,592
  For TheFor The Three Months Ended
    
    
    Year EndedMarch 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Federal income tax expense
computed at the statutory rate
    
    $
    478,045
    
    
    $
    372,925
    
    
    $
    1,388,242State and local tax expense, net
    
    
    67,742
    
    
    
    86,375
    
    
    
    195,987Permanent differences
    
    
    (34,435
    )
    
    
    (1,477
    )
    
    
    (49,637
    )Provision for income taxes
    
    $
    511,352
    
    
    $
    457,823
    
    
    $
    1,534,592
 15




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 9  PROVISION FOR INCOME TAXES  Continued
  March 31,
    
    
    December 312006
    
    
    2005
    
    
    2005Non-current deferred tax liabilities
arising from:Temporary
differences 
accumulated depreciation
    
    $
    (345,709
    )
    
    $
    (406,468
    )
    
    $
    (348,923
    )Current deferred tax assets
(liabilities) arising from:Unrealized losses (gains) on
marketable securities
    
    
    (108,615
    )
    
    
    37,127
    
    
    
    70,016Inventory
    
    
    85,779
    
    
    
    52,408
    
    
    
    72,756Allowance for doubtful accounts
    
    
    18,585
    
    
    
    
    
    
    
    Total current deferred tax assets
(liabilities)
    
    
    (4,251
    )
    
    
    89,535
    
    
    
    142,772Net deferred tax liability
    
    $
    (349,960
    )
    
    $
    (316,933
    )
    
    $
    (206,151
    )
 Note 10  SUPPLEMENTAL CASH FLOW INFORMATION
  For YearFor the Three Months Ended
    
    
    EndedMarch 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Interest
    
    $
    50,226
    
    
    $
    7,442
    
    
    $
    100,762Income taxes
    
    $
    575,000
    
    
    $
    325,372
    
    
    $
    1,425,600
 Note 11  STOCK OPTION PLANS
   16




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##### Table of Contents



LIFEWAY FOODS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
March 31, 2006 and 2005
and December 31, 2005
 Note 11  STOCK OPTION PLANS  Continued
   Note 12  FAIR VALUE OF FINANCIAL INSTRUMENTS
  March 31,
    
    
    March 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2005Carrying
    
    
    Fair
    
    
    Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    Value
    
    
    Amount
    
    
    ValueCash and cash
equivalents
    
    $
    3,817,745
    
    
    $
    3,817,745
    
    
    $
    5,434,032
    
    
    $
    5,434,032
    
    
    $
    4,354,081
    
    
    $
    4,354,081Marketable securities
    
    $
    8,337,907
    
    
    $
    8,337,907
    
    
    $
    6,895,472
    
    
    $
    6,895,472
    
    
    $
    7,478,697
    
    
    $
    7,478,697Notes payable
    
    $
    3,416,200
    
    
    $
    3,397,690
    
    
    $
    469,874
    
    
    $
    466,069
    
    
    $
    3,435,803
    
    
    $
    3,416,969
 Note 13  LITIGATION SETTLEMENT
  Note 14  RECENT ACCOUNTING PRONOUNCEMENTS
  17




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 Comparison of Quarter Ended March 31, 2006 to Quarter Ended March 31, 2005
  Results of Operations
      Sources and Uses of Cash
    18




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##### Table of Contents



Other Developments
  Critical Accounting Policies
  Forward Looking Statements
  
    
    Changes in economic conditions, commodity prices;
    
    Shortages of and price increase for fuel, labor strikes or work stoppages, market acceptance of the Companys new products;
    
    Significant changes in the competitive environment;
    
    Changes in laws, regulations, and tax rates; and
    
    Managements ability to achieve reductions in cost and employment levels, to realize production efficiencies and to
implement capital expenditures, all at of the levels and times planned by management.
 19




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##### Table of Contents



ITEM 3. CONTROLS AND PROCEDURES
   
 PART II  OTHER INFORMATION
 
 ITEM 5. OTHER INFORMATION
 .
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
  ExhibitNumber
    
    Description3.4
    
    Amended and Restated By-laws (incorporated by reference to Exhibit No. 3.5 of Lifeways
Current Report on Form 8-dated and filed on December 10, 2002). (File No. 000-17363)3.5
    
    Articles of Incorporation, as amended and currently in effect (incorporated by reference to
Exhibit 3.5 of Lifeways Quarterly Report on Form 10-QSB for the quarter ended June 30, 2000
and filed on August 8, 2000). (File No. 000-17363)11
    
    Statement re: Computation of per share earnings (incorporated by reference to Note 2 of the
Consolidated Financial Statements).31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Edward P. Smolyansky.32.1
    
    Section 1350 Certification of Julie Smolyansky.32.2
    
    Section 1350 Certification of Edward P. Smolyansky.99.1
    
    Press Release dated May 15, 2006- Lifeway Foods Reports 1st Quarter 2006 Results.
   20




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##### Table of Contents



SIGNATURE
   LIFEWAY FOODS, INC.By: /s/ Julie SmolyanskyJulie SmolyanskyChief Executive Officer, President, and Director/s/ Edward P. SmolyanskyChief Financial and Accounting Officerand Treasurer
 21