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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from: ______________ to ______________
Commission file number: 0-17363
LIFEWAY FOODS, INC.
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(Name of small business issuer in its charter)
Illinois 36-3442829
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
6431 West Oakton, Morton Grove, Illinois 60053
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (847) 967-1010
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Common Stock,
No Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 [X] No [_]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year were: $16,319,210
The aggregate market value of the voting and non-voting common equity held by
non-affiliates (approximately 2,194,181 shares) computed by reference to the
price at which the stock was sold as of December 31, 2004 ($9.14 per share as
quoted on the National Market System of the Nasdaq Stock Market) was:
$20,054,817
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
The number of shares outstanding of each of the issuer's classes of common
equity, as of February 28, 2005 were: 8,419,938 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Notice of Annual Meeting and Proxy Statement, to be filed no
later than April 30, 2005, for the Registrant's 2005 Annual Meeting of
Shareholders, scheduled to be held June 11, 2005, are incorporated by reference
in Part III.
Transitional Small Business Disclosure Format (check one): Yes [_] No [X]
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LIFEWAY FOODS, INC.
TABLE OF CONTENTS
PART I....................................................................... 3
Item 1. Description of Business............................................. 3
Item 2. Description of Property............................................. 9
Item 3. Legal Proceedings................................................... 10
Item 4. Submission of Matters to a Vote of Stockholders..................... 10
PART II...................................................................... 11
Item 5. Market for Common Equity and Related Stockholder Matters............ 11
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 12
Item 7. Financial Statements................................................ 14
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................ 26
Item 8a. Controls and Procedures............................................. 26
Item 8b. Other information................................................... 26
PART III..................................................................... 27
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section (16a) of the Exchange Act and Code
of Ethics........................................................... 27
Item 10. Executive Compensation.............................................. 27
Item 11. Security Ownership of Certain Beneficial Owners and Management...... 27
Item 12. Certain Relationships and Related Transactions...................... 27
Item 13. Exhibits and Reports on Form 8-K.................................... 27
Item 14. Principal Accountant Fees and Services.............................. 29
Signatures................................................................... 30
2
PART I
CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS TO
DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, readers of this document and any
document incorporated by reference herein, are advised that this document and
documents incorporated by reference into this document contain both statements
of historical facts and forward looking statements. Forward looking statements
are subject to certain risks and uncertainties, which could cause actual results
to differ materially from those indicated by the forward looking statements.
Examples of forward looking statements include, but are not limited to (i)
projections of revenues, income or loss, earnings or losses per share, capital
expenditures, dividends, capital structure and other financial items, (ii)
statements of Lifeway Foods, Inc.'s plans and objectives, including the
introduction of new products, or estimates or predictions of actions by
customers, suppliers, competitors or regulatory authorities, (iii) statements of
future economic performance, and (iv) statements of assumptions underlying other
statements and statements about Lifeway Foods, Inc. or its business.
This document and any documents incorporated by reference herein also
identify important factors which could cause actual results to differ materially
from those indicated by forward looking statements. These risks and
uncertainties include price competition, the decisions of customers or
consumers, the actions of competitors, changes in the pricing of commodities,
the effects of government regulation, possible delays in the introduction of new
products, customer acceptance of products and services, and other factors which
are described herein and/or in documents incorporated by reference herein.
The cautionary statements made pursuant to the Private Litigation
Securities Reform Act of 1995 above and elsewhere by Lifeway Foods, Inc.
("Lifeway" or the "Company") should not be construed as exhaustive or as any
admission regarding the adequacy of disclosures made by Lifeway prior to the
effective date of such act. Forward looking statements are beyond the ability of
Lifeway to control and in many cases we cannot predict what factors would cause
results to differ materially from those indicated by the forward looking
statements.
ITEM 1. DESCRIPTION OF BUSINESS.
BUSINESS DEVELOPMENT
Lifeway Foods, Inc. commenced operations in February 1986, and was
incorporated under the laws of the State of Illinois on May 19, 1986. The
Company's principal business activity is the manufacturing of probiotic,
cultured, functional dairy and non-dairy health food products. Lifeway's primary
products are kefir, a drinkable dairy beverage similar to but distinct from
yogurt, in several flavors sold under the name "Lifeway Kefir"; a line of
various drinkable yogurts sold under the "La Fruta" and "Tuscan" brands; and
"BasicsPlus," a dairy based immune-supporting dietary supplement beverage. The
Company also produces several soy-based kefir beverages under the "SoyTreat"
trademark. In addition to the drinkable products, Lifeway manufactures "Lifeway
Farmer Cheese," a line of various farmer cheeses; "Sweet Kiss," a fruit
sugar-flavored spreadable cheese similar in consistency to cream cheese; and a
line of assorted fruit and vegetable flavored cream cheese under the brand
"Cream Cheese Gourmet." The Company also manufactures and markets a
vegetable-based seasoning under the "Golden Zesta" brand. In the Chicago
metropolitan area, Lifeway distributes its products on its own trucks and via
one distributor. The Company distributes "Cream Cheese Gourmet" branded cream
cheese products in the Philadelphia metropolitan area using its own trucks.
Lifeway manufactures all of its products at Company-owned facilities and
distributes its products primarily throughout the United States.
SUBSIDIARY ENTITIES
On September 30, 1992, Lifeway formed a wholly-owned subsidiary, LFI
Enterprises, Inc. ("LFIE"), incorporated in the State of Illinois. Until August
1, 2001, LFIE operated a "Russian" theme restaurant and supper club facility. On
August 1, 2001, Lifeway ceased operations at the facility after condemnation
proceedings were initiated by the Village of Niles, Illinois, which sought to
control the property for municipal purposes. This property was sold in January
2003 for a capital gain of approximately $1.2 million.
On March 19, 2004, LFIE formed Lifeway Foods Canada, LLC, an Illinois
limited liability company ("LFC"), to serve as a holding company for prospective
operations within Canada. LFIE is the manager and sole member of LFC.
On July 26, 2004, Lifeway, by its subsidiary, LFIE, acquired certain
assets and inventory of Ilya's Farms, Inc., a twelve year old, privately-held
gourmet cream cheese producer based in the Philadelphia metropolitan area. No
prior relationship existed between Ilya's Farms, Inc. or its principal, Michael
Kofman, and either the Company or LFIE.
3
The total cash purchase consideration of $575,600 for the assets and
inventory of Ilya's Farms, Inc. was paid by LFIE in cash from Company funds
without financing. Additionally, there are certain royalty payments to be made
in connection therewith. The Company provided a guaranty of payment for the
transaction. The acquisition included approximately $64,000 of tangible assets
(including certain manufacturing equipment and a delivery truck) and inventory
as well as the brand name "Ilya's Farms" and other trademarks and the recipes
and manufacturing processes previously used by Ilya's Farms, Inc. The equipment
acquired by LFIE from Ilya's Farms, Inc. was previously used to manufacture
cream cheese products. The inventory which was purchased by LFIE consisted
entirely of different varieties of cream cheese. The founder of Ilya's Farms,
Inc., Michael Kofman, assisted LFIE over a one-month transition period and is
available, if needed, on a consulting basis going forward. Additionally, LFIE
has hired the 10 employees formerly employed by Ilya's Farms, Inc.
BUSINESS OF ISSUER
PRODUCTS
Lifeway's primary product is kefir, which, like the better-known
product of yogurt, is a fermented dairy product. Kefir has a slightly
effervescent quality, with a taste similar to yogurt and a consistency similar
to buttermilk. It is a product distinct from yogurt because it incorporates the
unique microorganisms of kefir as the cultures to ferment the milk. Lifeway's
Kefir is a drinkable product intended for use as a breakfast meal or a snack, or
as a base for lower-calorie dressings, dips, soups or sauces. Kefir is also used
as the base of Lifeway's plain farmer's cheese, a cheese made without salt,
sugar or animal rennet. In addition, kefir is the primary ingredient of
Lifeway's "Sweet Kiss" product, a fruit sugar-flavored, cream cheese-like spread
which is intended to be used as a dessert spread or frosting.
Kefir contains a unique mixture of several live microorganisms and
nutrients such as proteins, minerals and vitamins. Kefir is highly digestible
and, due to its acidity and enzymes, stimulates digestion of other foods. Kefir
is considered to be the most favorable milk product for people suffering from
genetically-based lactose intolerance. A study published in the May 2003 issue
of the Journal of the American Dietetic Association suggests that kefir improves
lactose digestion and tolerance in adults with lactose maldigestion. Studies
also indicate that kefir may stimulate protein digestion and appetite, decrease
the cholesterol content in blood, improve salivation and excretion of stomach
and pancreatic enzymes and peristalsis. As compared to yogurt, many naturopathic
practitioners consider kefir to be the best remedy for digestive troubles
because it has a very low curd tension (the curd breaks up very easily into
small particles). The curd of yogurt, on the other hand, holds together or
breaks into lumps. The small size of the kefir curd facilitates digestion by
presenting a large surface area on which digestive agents may work.
Kefir is a good source of calcium, protein, and Vitamin B-complex. In
addition, because the fermentation process produces a less sour tasting product
than yogurt, less sugar is required to make a desirable product, and the end
product contains fewer calories than regular yogurt.
Lifeway currently sells some or all of the products listed below,
except as specifically noted, to various retail establishments including
supermarkets, grocery stores, gourmet shops, delicatessens and convenience
stores.
LIFEWAY'S KEFIR. "Lifeway's Kefir" is a drinkable kefir product
manufactured in ten regular and low-fat varieties, including plain, raspberry,
blueberry, strawberry, cherry, peach, banana-strawberry, cappuccino, chocolate
and vanilla, and sold in 32 ounce containers featuring color-coded caps and
labels describing nutritional information. In March 1996, Lifeway began
marketing its non-fat, low cholesterol kefir in six flavors--plain, raspberry,
strawberry, strawberry-banana, peach and blueberry. The kefir product is
currently marketed under the name "Lifeway's Kefir," and is typically sold by
retailers from their dairy sections.
LIFEWAY'S ORGANIC SOYTREAT. "SoyTreat" is a soy alternative to dairy
kefir and is made from organic soy milk, which is derived from non-genetically
modified soybeans. SoyTreat can be consumed by those who desire the benefits of
kefir, but are lactose intolerant or interested in a soy-based alternative to
milk. SoyTreat also provides 6.25g of soy protein per serving, and features the
United States Food and Drug Administration-approved health claim, "25g of soy
protein a day as part of a diet low in saturated fat can help lower cholesterol
and reduce the risk of heart disease." At present SoyTreat is manufactured in
five flavors: strawberry, apple, peach, coconut and coffee latte.
LIFEWAY'S ORGANIC KEFIR. "Lifeway's Organic Kefir" meets the organic
standards and specifications of the United States Department of Agriculture for
organic products and is manufactured in four flavors: plain, raspberry,
strawberry and peach. Lifeway's Organic Kefir is sweetened with organic cane
juice.
LIFEWAY'S SLIM6. "Lifeway's Slim6" is a line of low-fat kefir beverages
with no added sugar designed for consumers who follow low-carbohydrate diets.
Lifeway's Slim6 has only 8 grams of carbohydrates and 2.5 grams of fat per
8-ounce serving and is available in five flavors: strawberries n' cream, mixed
berry, tropical fruit, strawberry-banana and an original, unsweetened version.
4
LA FRUTA DRINKABLE YOGURT. "La Fruta" is a yogurt like drink similar to
a milkshake or smoothie that is specifically formulated to accommodate the
Hispanic market, the fastest growing demographic in the U.S. La Fruta is
manufactured in six flavors: strawberry, mango, pina colada, banana-strawberry,
horchata and tres leches.
LA FRUTA CHEESE. "La Fruta Cheese" is a cheese product similar to cream
cheese that is specifically formulated to accommodate the Hispanic market, the
fastest growing demographic in the United States. La Fruta Cheese is
manufactured in a tres leches flavor.
TUSCAN BRAND DRINKABLE YOGURT. "Tuscan Brand Drinkable Yogurt" is a
cultured dairy beverage mainly marketed on the East Coast and manufactured in a
variety of flavors which vary depending upon distributor demand.
FARMER CHEESE. "Farmer Cheese" is based on a cultured soft cheese and
is intended to be used in a variety of recipes as a low fat, low-cholesterol,
low-calorie substitute for cream cheese or ricotta, and is available in various
styles.
SWEET KISS. "Sweet Kiss" is a sweet cheese probiotic spread available
in five flavors: plain, plain with raisins, apple, peach and chocolate.
ELITA; BAMBINO. "Elita" and "Bambino" cheeses are low-fat,
low-cholesterol kefir based cheese spreads which are marketed as an alternative
to cream cheese.
KRESTYANSKI TWOROG. "Krestyanski Tworog" is a European-style
kefir-based soft style cheese which can also be used in a variety of recipes,
eaten with a spoon, used as a cheese spread, or substituted in recipes for cream
cheese, ricotta cheese or cottage cheese and is marketed to consumers of various
Eastern European ethnicities.
CREAM CHEESE GOURMET. Lifeway produces a line of over 40 flavors of
cream cheeses under the "Cream Cheese Gourmet" brand name. The different flavors
are manufactured in original and low-fat varieties and include such flavors as
plain, strawberry, horseradish, lox & onion, bleu cheese, pesto, cinnamon &
raisin, and vegetable. The Cream Cheese Gourmet line of cream cheeses was
acquired by Lifeway in the acquisition of substantially all of the assets of
Ilya's Farms, Inc. described elsewhere in this report and is marketed primarily
to smaller and ethnic grocers, delicatessens and coffee shops.
BASICS PLUS. "Basics Plus" is a patented kefir-based beverage product
designed to improve gastrointestinal functions,enhancing the immune system. This
product contains certain "passive immunity products" purchased from GalaGen,
Inc. prior to its 2002 bankruptcy as described elsewhere in this report. Lifeway
is currently engaged in discussion with several potential new suppliers of
passive immunity products and is not currently manufacturing this beverage.
KEFIR STARTER. "Kefir Starter" is a powdered form of kefir that is sold
in envelope packets and allows a consumer to make his or her own drinkable kefir
at home by adding milk. Lifeway continues to develop sales of the product
internationally and via the internet.
GOLDEN ZESTA. "Golden Zesta" is a vegetable-based seasoning, which,
because of its low sodium content, may also be used as a salt substitute and is
marketed to delicatessens, gourmet shops and ethnic grocers.
Lifeway intends to continue to develop new products based on kefir and
Farmer Cheese. There is no assurance that such products or any other new
products can be developed successfully or marketed profitably.
DISTRIBUTION
With its twelve company-owned trucks, Lifeway distributes its products
directly and extensively in the State of Illinois, primarily in the Chicago
metropolitan area, including major retail chains such as Jewel Food Stores,
Dominick's Finer Foods, Treasure Island Food Marts, Whole Foods and independent
retailers. Lifeway also distributes over 40 different assorted cream cheese
products under the Cream Cheese Gourmet brand name in the Philadelphia
metropolitan area.
In addition to the Chicago and Philadelphia metropolitan areas,
Lifeway's products are distributed to stores throughout the United States.
Lifeway has verbal distribution arrangements with various distributors
throughout the United States. These verbal distribution arrangements, in the
opinion of Lifeway, allow management the necessary latitude to expand into new
areas and markets and establish new relationships with distributors on an
ongoing basis. Lifeway has not offered any exclusive territories to any
distributors.
Distributors are provided Lifeway products at wholesale prices for
distribution to their retail accounts. Lifeway believes that the price at which
its products are sold to its distributors is competitive with the prices
generally paid by distributors for similar
5
products in the markets served. In all areas served, distributors currently
deliver the products directly to the refrigerated cases of dairy sections of
their retail customers. Each distributor carries a line of Lifeway's products on
its trucks, checks the retail stores for space allocated to Lifeway's products,
determines inventory requirements of the store and places Lifeway products
directly into the retailers' dairy cases. Lifeway believes this method of
distribution best serves the needs of each retail store, and is the best
available means to ensure consistency and quality of product handling, quality
control, flavor selection and favorable retail display. Under the distribution
arrangements, each distributor must meet certain prescribed product handling,
service and administrative requirements including, among others, frequency of
delivery, replacement of damaged, old or substandard packages, and delivery of
products directly to the refrigerated case.
Additionally, Lifeway has attempted international distribution of
certain of its products by attempting to export to distributors operating in the
Canadian provinces of Ontario and Quebec. Lifeway's products are subject to
strict import quotas imposed by the Trade Control Policy Division of the
Department of Foreign Affairs and International Trade of Canada. In an attempt
to address this situation, management is exploring various alternatives to
permit expansion of Lifeway's product line in Canada. Lifeway believes that it
currently is in compliance with all applicable Canadian regulations.
MARKETING
Lifeway continues to promote the verifiable nutritional
characteristics, purity and good taste of its kefir and kefir-based products.
Lifeway primarily advertises its products through local radio stations, which
advertisements are directed to both users and non-users of cultured milk
products of all kinds. In addition, through newspaper and magazine advertising,
Lifeway provides educational information on its products and appeals to the
common perception that the products may be of particular benefit for a wide
range of ills, including intestinal disorders, and continues to educate the
public on the possible health benefits which could be derived from the use of
kefir and kefir-based products. Lifeway believes that the potential for
healthful benefits as suggested by the educational information it has obtained
properly serves as the basis for such an advertising strategy.
In addition to local radio stations, newspapers and magazines, Lifeway
promotes further exposure of its products through the internet, catalog
advertising and promotion, store demonstrations throughout the United States,
and participation in various trade shows. Lifeway also sponsors several
different sporting events in the Chicago metropolitan area as an additional
marketing tool.
Lifeway does not promote products manufactured under the LaFruta and
Tuscan brand names with any marketing or advertising.
COMPETITION
Although Lifeway faces a small amount of direct competition in the
United States and Canadian markets for kefir products, Lifeway's kefir-based
products compete with all other yogurt and other dairy products. Many producers
of yogurt and other dairy products are well-established and have significantly
greater financial resources than Lifeway to promote their products.
In connection with the certain Stockholders' Agreement, as amended,
between Lifeway, Danone Foods, Inc. and other parties, as well as certain other
transactions between these two foregoing companies described elsewhere in this
report, the parties agreed that they would not compete with each other during
the term of the Stockholders' Agreement and for three years after termination of
the agreement with respect to certain yogurt, cheese and kefir products.
Specifically, Lifeway agreed not to produce or sell in the United States or
Western Europe any type of yogurt, fromage frais, Italian style cheese, chilled
desserts or any soy-based products, other than those that are kefir-based or
those that were already being produced and sold by Lifeway as of December 24,
1999; and Danone agreed not to produce or sell any type of kefir-based products
in the United States. The term of the current non-competition covenant between
Lifeway and Danone expires on December 30, 2005.
SUPPLIERS
Lifeway purchases its raw materials, such as milk, sugar and fruit from
unaffiliated suppliers, and is not limited or contractually bound to any
supplier. Lifeway has ready access to multiple suppliers for all of its raw
materials and packaging requirements. Prior to making any purchase, Lifeway
determines which supplier can offer the lowest price for the highest quality of
product. The raw and packaging materials purchased by Lifeway are considered
commodity items and are widely available on the open market with the exception
of the licensed ingredient in BasicsPlus. Lifeway owns and operates the means of
production of all of its products.
MAJOR CUSTOMERS
Lifeway distributes its products to numerous accounts throughout the
United States. Concentrations of credit with regard to trade accounts receivable
and sales are limited due to the fact that Lifeway's customers are spread across
different geographic areas. The
6
customers are concentrated in the retail food industry. In 2004, Lifeway's
largest customer represented approximately 9% of sales and reflected sales in
various regions of the United States outside the Chicago, Illinois metropolitan
area.
TRANSACTIONS WITH GROUPE DANONE SA
All share amounts and prices in this subsection are historical and have
not been adjusted for the stock split which occurred in the first quarter of
2004. On October 1, 1999, Lifeway sold 497,767 shares of restricted common stock
to Danone at $10.00 per share. Danone also concurrently purchased 150,000
outstanding shares of common stock from Lifeway's founder, and then controlling
shareholder, President and CEO, Michael Smolyansky; his wife and current
Chairperson of the Board, Ludmila Smolyansky; his daughter and the current
President and CEO, Julie Smolyansky; his son and current Chief Financial &
Accounting Officer and Treasurer, Edward Smolyansky, on similar terms. Later in
1999, Danone purchased an additional 215,922 shares of common stock from certain
individuals, including 52,262 shares purchased in transactions with certain
Company affiliates, including Michael Smolyansky (38,362 shares), Val Nikolenko,
Vice President of Production (3,900 shares) and Pol Sikar, a director, and his
affiliates (10,000 shares).
As a result of these transactions, Danone became the beneficial owner
of 20% of the outstanding common stock of Lifeway. Pursuant to the terms and
conditions of the transaction, Lifeway granted certain limited rights to Danone,
which include a right to nominate one director, anti-dilutive rights relating to
future offerings and limited registration rights. From November 1999 through
August 2004, Thomas Kunz served on Lifeway's Board of Directors as Danone's
nominee. In August 2004, Mr. Kunz was replaced as Danone's nominee by Juan
Carlos, the current President and CEO of Danone. In addition, as described
above, Lifeway and Danone are parties to a Stockholders' Agreement dated October
1, 1999, pursuant to which the parties agreed that they would not compete with
each other through December 30, 2005 with respect to certain yogurt, cheese and
kefir products. The Stockholders' Agreement also provides that Danone may not
own more than 20% of the outstanding common stock of Lifeway as a result of
direct or indirect acquisition of shares. Danone's interest as of December 31,
2004 was approximately 20.4% due to reductions in Lifeway's shares outstanding,
primarily due to share repurchases by Lifeway. The term of the Stockholders'
Agreement has been extended through December 30, 2005. The ability of Danone to
sell, or the prospect of Danone being able to sell should such restrictions
lapse, such a large stake in Lifeway could have a negative effect on the
Company's stock price.
PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS
All trademark registrations have been granted by the United States
Patent and Trademark Office ("USPTO"), unless otherwise noted below. Each
trademark registration may be renewed upon expiration. Lifeway intends to make
all timely filings as required for all trademarks listed.
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DATE OF EXPIRATION OF
MARK USE REGISTRATION REGISTRATION COMMENTS
=================================================================================================================================
Lifeway's Cheese and kefir December 12, 1989 December 12, 2009 Registration is renewable at the time
of expiration.
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Lifeway's Cheese and kefir January 10, 1992 January 10, 2007 This registration was granted by the
(Canada) Canadian Intellectual Property Office
based upon the use of the mark in
Canada since September 9, 1988.
================ ================================== ================= ================= =====================================
Golden Zesta Dehydrated vegetable soup mix; and August 19, 1997 August 19, 2007 Registration is renewable at the time
spices, seasonings, food for non- of expiration.
nutritional purposes for use as a
flavoring
================ ================================== ================= ================= =====================================
Sweet Kiss Cheese, cottage cheese and other February 10, 1998 February 10, 2008 Registration is renewable at the time
milk products, excluding ice of expiration.
cream, ice milk and frozen yogurt
================ ================================== ================= ================= =====================================
Kwashenka Kefir, yogurt, cheeses, cottage February 10, 1998 February 10, 2008 Registration is renewable at the time
cheeses and other milk products, of expiration.
excluding ice cream, ice milk and
frozen yogurt
================ ================================== ================= ================= =====================================
Bambino Cheeses, cottage cheeses and other October 7, 2003 October 7, 2013 Registration is renewable at the time
milk products of expiration provided mandatory
documents are filed before the USPTO
by October 7, 2009.
================ ================================== ================= ================= =====================================
KPECTBRHCKNN Cheeses, cottage cheeses and September 8, 1998 September 8, 2008 Registration is renewable at the time
(A stylized other milk products excluding of expiration.
presentation of ice cream, ice milk and frozen
"Krestyanskiy" yogurt
in Cyrillic
characters)
================ ================================== ================= ================= =====================================
BasicsPlus Dairy-based food beverages for September 7, 1999 September 7, 2009 In May 1998, GalaGen, Inc., assigned
use as a dietary supplement the entire interest, including the
goodwill, of this mark to Lifeway.
Registration is renewable at the time
of expiration provided mandatory
documents are filed with the USPTO by
September 7, 2005.
================ ================================== ================= ================= =====================================
BA3APHBIII Pressed unripened cheese July 25, 2000 July 25, 2010 Registration is renewable at the time
(A stylized of expiration provided presentation
presentation of of mandatory documents are filed
"Bazarniy" in with the USPTO by July 25, 2006.
Cyrillic
characters)
================ ================================== ================= ================= =====================================
SoyTreat Soy-based food beverage intended December 12, 2000 December 12, 2010 Registration is renewable at the time
for use as cultured milk of expiration provided mandatory
substitute documents are filed with the USPTO by
December 12, 2006.
================ ================================== ================= ================= =====================================
Garden Harmony Unripened cheese-based March 20, 2001 March 20, 2011 Registration is renewable at the time
spread of expiration provided mandatory
documents are filed with the USPTO by
March 20, 2007.
================ ================================== ================= ================= =====================================
Korovka Dairy-based spread November 6, 2001 November 6, 2011 Registration is renewable at the time
of expiration provided mandatory
documents are filed with the USPTO by
November 6, 2007.
================ ================================== ================= ================= =====================================
La Fruta Cultured milk products, excluding Not applicable Not applicable This application was filed on January
ice cream, ice milk and frozen 17, 2003 and is still pending before
yogurt the USPTO. Final review prior to
publication has been completed;
application will be published for
opposition.
================ ================================== ================= ================= =====================================
Cream Cheese Kefir, yogurt, cheeses, cream This application has not been filed
Gourmet cheeses and other milk products, with United States Patent and
excluding ice cream, ice milk and Trademark office.
frozen yogurt
================ ================================== ================= ================= =====================================
PTICHYE MOLOKO Kefir, yogurt, cheeses, cottage This application has been approved
(A stylized cheeses and other milk products, for publication.
presentation of excluding ice cream, ice milk and
"Ptichye Moloko" frozen yogurt
in Cyrillic
characters)
================ ================================== ================= ================= =====================================
BIOKEFIR Yogurt, cheeses, cottage cheeses Filed on an Intent-to-Use basis. The
and other milk products, excluding Company received the filing receipt
ice cream, ice milk and frozen in November.
yogurt
================ ================================== ================= ================= =====================================
SLIM 6 Cultured milk products, excluding Newly filed application; not yet
ice cream, ice milk and frozen assigned examining attorney.
yogurt
================ ================================== ================= ================= =====================================
CMOPOIHHKA Kefir, yogurt, cheeses, cream Newly filed application; not yet
(A stylized cheeses and other milk products, assigned examining attorney.
presentation of excluding ice cream, ice milk and
"Smorodinka" in frozen yogurt
Cyrillic
characters)
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8
PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS (CONTINUED)
Lifeway also uses the following unregistered trademarks, and claims
common law rights to: "Elita," "Healthy Foods Today for a Better Life Tomorrow,"
"Milkshake Smoothie," "Toplenka," "White Cheese," "Drink It to Be Beautiful
Inside and Out," and "Cream Cheese Gourmet."
On December 27, 1990, Lifeway purchased the Tuscan brand-name liquid
drinkable yogurt customer list along with a limited license of the trademark and
use of the Tuscan liquid yogurt U.P.C. codes from a third party.
In October 1998 Lifeway entered into a sublicense agreement with
GalaGen, Inc. and Metagenics, Inc. with an effective date of May 1, 1998
("Lifeway sublicense"), wherein GalaGen sublicensed patent rights of Metagenics
for kefir-based products containing natural immune components exclusively to
Lifeway. Under the rights granted to it by the Lifeway sublicense, Lifeway
manufactures and sells products using the Basics Plus trademark. GalaGen had
acquired the primary license for such patent rights in an agreement executed
with Metagenics in April 1998. The terms of the Lifeway sublicense provide that
Metagenics will permit Lifeway to continue to have the exclusive patent rights
to produce or sell kefir-based products containing natural immune components in
the event the original license between GalaGen and Metagenics is terminated, and
such termination was not caused by Lifeway. On February 25, 2002, GalaGen filed
a petition for bankruptcy in the Unites States Bankruptcy Court, District of
Minnesota, which terminated both its primary license with Metagenics and its
participation in the Lifeway sublicense. The license and sublicense were
excluded from the sale of assets of GalaGen pursuant to an order of the
Bankruptcy Court. Lifeway has not received any indication that Metagenics will
not permit Lifeway to continue to have the exclusive patent rights to produce or
sell kefir-based products containing natural immune components. Thus, Lifeway
believes that it continues to have the exclusive patent rights licensed directly
from Metagenics. Either party may terminate the license agreement for cause. The
term of the license agreement expires when the last valid claim of the patent
rights expires, which currently is July 2, 2013, however, this term can be
extended in accordance with the terms of the license agreement.
In connection with the purchase of Ilya's Farm, Inc., the Company has
undertaken a royalty obligation.
REGULATION
Lifeway is subject to regulation by federal, state and local
governmental authorities regarding the distribution and sale of food products.
Although Lifeway believes that it currently has all material government permits,
licenses, qualifications and approvals for its operations, there can be no
assurance that Lifeway will be able to maintain its existing licenses and
permits or to obtain any future licenses, permits, qualifications or approvals
which may be required for the operation of Lifeway's business.
Lifeway believes that it is currently in compliance with all applicable
environmental laws and that the cost of such compliance was not material to the
financial position of Lifeway.
In addition, any Lifeway products exported to Canada would be subject
to strict quotas imposed by the Trade Control Policy Division of the Department
of Foreign Affairs and International Trade of Canada. Lifeway believes that it
currently is in compliance with all applicable Canadian regulations. The Company
did not export any products to Canada in 2004.
RESEARCH AND DEVELOPMENT
Lifeway continues its program of new product development, centered
around the nutritional and "low calorie" features of its proprietary kefir
formulas.
Lifeway conducts primarily all of its research internally, but at times
will employ the services of an outside testing facility. During 2004, the amount
Lifeway expended for research and new product development was not material to
the financial position of Lifeway.
EMPLOYEES
Lifeway currently employs approximately 75 employees, all of whom are
full-time employees. Substantially all of these employees are engaged in the
manufacturing of the Company's products. None of Lifeway's employees are covered
by collective bargaining agreements.
ITEM 2. DESCRIPTION OF PROPERTY.
On May 16, 1988, Lifeway purchased an approximately 26,000 square foot
parcel of real property, including an approximately 8,500 square foot one-story
brick building in good condition, located at 7625 N. Austin Avenue, Skokie,
Illinois. Lifeway uses this facility for manufacturing and storage and has no
plans to improve or renovate this property. The acquisition loan to
9
Lifeway from 1st National Bank of Morton Grove, collateralized by the real
estate, was refinanced in 1998 by Lifeway and paid off in full on February 21,
2002. Lifeway is the only occupant of this property and presently holds fee
simple title free and clear of all encumbrances thereto. The value of this
property may be subject to real estate market forces that typically affect
industrial real estate in the area immediately surrounding the property. The
Company's book value for this property is approximately $529,172.
On October 9, 1992, Lifeway purchased an approximately 75,000 square
foot commercially zoned parcel of real property, including an approximately
7,750 square foot one-story building, located at 7800 N. Caldwell, Niles,
Illinois. Until its closing on August 1, 2001, this property was the site of the
"Moscow Nights" facility operated by LFIE. The acquisition loan to Lifeway from
American National Bank and Trust Company of Chicago, collateralized by the real
estate, was refinanced by Lifeway in 1998 and paid off in full on September 30,
2002. Lifeway held fee simple title to this property free and clear of all
encumbrances until this property was transferred to the Niles Park District in
January 2003 in exchange for approximately $1.8 million paid in settlement of a
condemnation lawsuit previously reported.
On October 16, 1996, Lifeway purchased a 110,000 square foot
commercially-zoned parcel of real property, including a 46,000 square foot
one-story brick building in good condition, located at 6431 Oakton Avenue,
Morton Grove, Illinois. This property is used as Lifeway's corporate
headquarters and main manufacturing facility. This property has been improved
every year since the time of purchase by the addition of custom-built
refrigerated storage space and the addition of various machinery and equipment
used to manufacture, package and store Lifeway's products. Lifeway is the only
occupant of this property and presently holds fee simple title subject to a
mortgage which secures the property as collateral for the acquisition loan to
Lifeway from MB Financial Bank of Morton Grove. The acquisition loan was
refinanced in September 2002 at a rate of 6.25% and is payable in monthly
principal and interest installments of $3,273, with a balloon payment of
$454,275 due in September 2006. At December 31, 2004, the loan had a balance of
$472,325. The value of this property may be subject to real estate market forces
that typically affect industrial real estate in the area immediately surrounding
the property. The Company's book value for this property is approximately
$1,229,054.
For financial statement and tax purposes, Lifeway depreciates its
buildings and improvements on a straight line basis over 31 and 39 years.
Management believes that Lifeway has adequate insurance coverage for
all its properties.
ITEM 3. LEGAL PROCEEDINGS.
On April 14, 2003, Vera Smolyansky filed a complaint seeking
unspecified damages in the Circuit Court of Cook County, Illinois naming Lifeway
as a defendant. The complaint alleges breaches of the Uniform Commercial Code,
the Magnunson-Moss Warranty Act and the Illinois Consumer Fraud Act with respect
to the labeling of certain Lifeway products. Vera Smolyansky is the wife of Yuri
Smolyansky, who is the brother of the late Michael Smolyansky (the founder of
Lifeway), the uncle of Julie Smolyansky (the Company's Chief Executive Officer),
the uncle of Edward Smolyansky (the Company's Chief Financial & Accounting
Officer and Treasurer) and the brother-in-law of Ludmila Smolyansky (Lifeway's
Chairperson of the Board). The Company believes that the lawsuit is without
merit and is vigorously defending against these claims.
On December 4, 2004 a former employee requested a Motion for Summary
Judgment on the issue of liability in a lawsuit filed against the Company by the
former employee. The motion was granted on February 10, 2005 and on February 18,
2005 the case was referred to a Magistrate Judge for a settlement conference.
The lawsuit alleges non payment of overtime wages in violation of
federal employment laws, with an estimated amount between $7,500 and $15,000.
The suit was filed in the United States District Court for the Northern District
of Illinois on behalf of all employees who were classified as non-exempt during
2001 through 2003. Outside counsel for the company has advised that at this
stage in the proceedings he cannot offer an opinion as to the probable outcome.
In addition to the foregoing, Lifeway is from time to time engaged in
other litigation matters arising in the ordinary course of business none of
which presently is expected to have a material adverse effect on its business
results or operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the fourth quarter of the fiscal year
ended December 31, 2004, to a vote of security holders through the solicitation
of proxies or otherwise.
10
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
Lifeway's Common Stock, no par value, the only class of common equity
of Lifeway, is traded on The Nasdaq Stock Market National Market System under
the symbol "LWAY." Trading commenced on March 29, 1988.
The range of high and low bid quotations for Lifeway's Common Stock for
the quarterly periods within the two most recent fiscal years, as reported by
The Nasdaq Stock Market National Market System, is set forth in the following
table:
Low Bid High Bid
----------- -----------
1st Qtr. 2003 $ 12.24 $ 15.00
2nd Qtr. 2003 $ 13.40 $ 17.00
3rd Qtr. 2003 $ 15.50 $ 30.50
4th Qtr. 2003 $ 25.12 $ 37.00
1st Qtr. 2004 $ 12.99 $ 46.98
2nd Qtr. 2004 $ 9.86 $ 28.24
3rd Qtr. 2004 $ 8.66 $ 20.31
4th Qtr. 2004 $ 8.80 $ 11.19
Note: The foregoing quotations have been adjusted for the March 8, 2004
two-for-one Company stock split.
As of March 16, 2005, there were approximately 77 holders of record of
Lifeway's Common Stock. The Company has no information regarding beneficial
owners whose shares are held in street name.
DIVIDENDS
Lifeway has paid no cash dividends on its Common Stock and management
does not anticipate that such dividends will be paid in the foreseeable future.
SALES OF UNREGISTERED SECURITIES
There were no sales of unregistered securities in 2004, 2003 or 2002.
PURCHASES OF THE COMPANY'S SECURITIES
Neither Lifeway nor any of its affiliates purchased any of the
Company's securities in 2004.
EQUITY COMPENSATION PLAN INFORMATION
-------------------- ----------------------- ------------------------- -------------------------------
PLAN CATEGORY NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES REMAINING
BE ISSUED UPON EXERCISE PRICE OF OUTSTANDING AVAILABLE FOR FUTURE ISSUANCE
OF OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND UNDER EQUITY COMPENSATION PLANS
WARRANTS AND RIGHTS RIGHTS (EXCLUDING SECURITIES WARRANTS
AND RIGHTS REFLECTED IN COLUMN
(a))
-------------------- ----------------------- ------------------------- -------------------------------
Equity compensation $0.00 468,000
plans approved 0
by security holders
-------------------- ----------------------- ------------------------- -------------------------------
Equity compensation 0 $0.00 0.00
plans not approved
by security holders*
-------------------- ----------------------- ------------------------- -------------------------------
Total 0 0 468,000
-------------------- ----------------------- ------------------------- -------------------------------
* All of Lifeway's equity compensation plans have been approved by shareholders.
11
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION.
RESULTS OF OPERATIONS
For the year ended December 31, 2004, sales were $16,319,210, which is
a $1,441,422 (approximately 10%) increase from $14,877,788 in 2003. We believe
that approximately $600,000 of the 2004 increase in sales was attributable to a
new customer as of June 2003, Sav-A-Lot, Ltd., the 13th largest grocery chain in
the United States, operating more than 1000 Sav-A-Lot and Supervalu food stores
nationwide, which represented sales of a significant amount of 8 oz. bottles of
Lifeway's LaFruta line. Sav-A-Lot, ceased ordering Lifeway products in May 2004,
and, during this first 5 months of 2004, Sav-A-Lot accounted for approximately
$600,000 in sales. In June 2004, Lifeway also instituted a price increase of
approximately 10-15% on all products.
LFIE accounted for $421,726 of total sales revenues during the period
from August 1, 2004 to December 31, 2004. Of the total $421,726 revenues from
LFIE, $155,446 was earned due to sales of Lifeway's Kefir and Farmer Cheese
products sent from our Morton Grove, Illinois facility to Philadelphia,
Pennsylvania for distribution in the tri-state area of Pennsylvania, New Jersey
and New York. The remaining $266,280 of LFIE revenues for the period from August
1, 2004 through December 31, 2004 was earned from sales of the Cream Cheese
Gourmet line of products acquired from Ilya's Farms, Inc. in the third quarter
of 2004. Ilya's Farms had approximately $525,000 in sales from its cream cheese
line in 2003.
Cost of goods sold as a percentage of sales was approximately 55% in
2004, compared to about 53% in 2003. This increase is directly related to the
increased cost of milk during 2004. The average cost of milk, Lifeway's largest
cost of goods sold component increased approximately 35-40% in 2004 compared to
2003. Even though the price of milk experienced such a dramatic increase,
Lifeway was able to maintain strong relative gross margins by more efficiently
using our other material components.
Operating expenses as a percentage of sales in was approximately 26% in
2004, compared to about 24% in 2003. This increase is primarily attributable to
two expenses: (1) a $41,860 expense recognized in connection with the vesting in
the third quarter 2004 of 2,000 shares (valued at $20.93 per share at the time
of grant) of a total of 5,100 shares of Company stock granted to Lifeway
employees on February 12, 2004 and (2) an overall increase in utility expenses
and rising insurance and professional fees associated with the Sarbanes-Oxley
Act of 2002 and other regulatory compliance requirements. Lifeway also
experienced increased professional expenses in connection with the acquisition
by LFI Enterprises, Inc. of substantially all of the assets of Ilya's Farms,
Inc. on July 23, 2004. Also, the Company's advertising cost increased to
$909,179 in 2004 as compared to $629,500 in 2003.
Provision for income taxes was $1,390,167 in 2004 compared with
$1,354,548 in 2003. Income taxes are discussed in Note 8 of the Notes to
Consolidated Financial Statements.
SOURCES AND USES OF CASH IN 2004
Net cash used in investing activities was $1,011,230 for 2004 as
compared to net cash provided of $39,349 during 2003. The decrease in the net
investing activity cash flow during the year ended December 31, 2004 relative to
the same period in 2003 was attributable to the sale of property for $1,712,660
during 2003 and due to the purchase by LFI Enterprises, Inc. of substantially
all of the assets of Ilya's Farms, Inc. in exchange for $575,600 paid in cash
during 2004. Of the total cash amount of $575,600 used by LFI Enterprises, Inc.
in connection with the Ilya's Farms, Inc. asset acquisition, $511,800 was
recognized by Lifeway as intangible assets and goodwill, while $63,800 is
accounted for as part of the "Purchases of Property and Equipment" line item on
the Consolidated Statement of Cash Flows for 2004. In the opinion of Lifeway's
management, the acquisition by LFI Enterprises, Inc. of substantially all of the
assets of Ilya's Farms, Inc. is a positive step to broaden Lifeway's presence in
the market for manufactured dairy products.
During the year ended December 31, 2004, Lifeway also experienced net
negative investing cash flows in the amount of $169,019 ($6,265,671 used for
purchases less $6,096,652 used for sales) used for the purchase and sale of
marketable securities due to our continued efforts to move away from higher-risk
securities towards large cap value, higher dividend yielding and tax-advantaged
equities. Our efforts in this regard during 2004 also are reflected in a gain of
$354,128 on the sale of marketable securities. We believe, given the current
market conditions, this asset allocation strategy offers a positive risk-reward
ratio for our Company.
12
OTHER DEVELOPMENTS
On February 12, 2004, Lifeway's Board of Directors approved awards of
an aggregate amount of 5,100 shares to be awarded under its Employee and
Consulting Services and Compensation Plan to certain employees and consultants
for services rendered to the Company. The stock awards were made on April 1,
2004 and have vesting periods that vary from six months to one year, depending
upon the individual grantee. The expense for the awards is measured as of April
1, 2004 at $20.93 per share for 5,100 shares, or a total stock award expense of
$106,743. This expense will be recognized as the stock awards vest beginning
with the recognition of $41,860 for 2,000 shares vested on April 1, 2004. An
additional 2,000 shares of the total 5,100 vested in the third quarter of 2004.
The share numbers and per share expense have been adjusted to reflect the stock
split as of March 8, 2004. The vesting of certain of the restricted stock awards
had the effect of positively impacting financing activities because the shares
were awarded out of treasury shares. The stock award was recognized as a $41,860
expense ($20.93 per share, reflecting fair market value on the date of grant).
MARKETABLE SECURITIES
During the course of 2004, and now in 2005, we have been and will
continue to move away from higher-risk securities towards large cap value,
higher dividend yielding and tax-advantaged equities. Our investment portfolio
presently consists of approximately 45% fixed income securities, and about 55%
equity investments. Of the equity portion, approximately 85% is invested in
large cap value stocks, 10% in small cap growth stocks, and 5% in large cap
growth stocks. We believe, given the current market conditions, this asset
allocation strategy offers a positive risk-reward ratio for our Company.
A significant portion 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.
CRITICAL ACCOUNTING POLICIES
Lifeway's analysis and discussion of its financial condition and
results of operations are based upon its consolidated financial statements that
have been prepared in accordance with accounting principles generally accepted
in the United States ("US GAAP") consistently applied. The preparation of
financial statements in accordance with US GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. US GAAP provides the framework from which to
make these estimates, assumptions and disclosures. Lifeway chooses accounting
policies within US GAAP that management believes are appropriate to accurately
and fairly report Lifeway's operating results and financial position in a
consistent manner. Management regularly assesses these policies in light of
current and forecasted economic conditions and has discussed the development and
selection of critical accounting policies with its audit committee of the Board
of Directors. For further information concerning accounting policies, refer to
Note 2 -- Summary of Significant Accounting Policies in the notes to the
consolidated financial statements.
FORWARD-LOOKING STATEMENTS
In this report, in reports subsequently filed by Lifeway with the SEC
on Form 10-QSB and filed or furnished on Form 8-K, and in related comments by
management, our use of the words "expect," "anticipate," "estimate," "forecast,"
"objective," "plan," "goal," "project," "priorities/targets," the phrases "we
believe," "in the opinion of Lifeway's management" and similar expressions is
intended to identify forward-looking statements. While these statements
represent our current judgment on what the future may hold, and we believe these
judgments are reasonable, actual results may differ materially due to numerous
important factors that are described in this report and other factors that may
be described in subsequent reports which Lifeway may file with the SEC on Form
10-QSB and filed or furnished on Form 8-K, including but not limited to:
- Changes in economic conditions, commodity prices;
- Shortages of and price increase for fuel, labor strikes or work
stoppages, market acceptance of the Company's new products;
- Significant changes in the competitive environment;
- Changes in laws, regulations, and tax rates; and
- The ability of the Company 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.
13
ITEM 7. FINANCIAL STATEMENTS.
The annotated consolidated financial statements of the Company that
constitute Item 7 of this report commence on the pages that follow this page.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
LIFEWAY FOODS, INC. AND SUBSIDIARY
Morton Grove, Illinois
We have audited the accompanying consolidated statements of financial condition
of LIFEWAY FOODS, INC. AND SUBSIDIARY (the "Company") as of December 31, 2003
and the related consolidated statements of income and comprehensive income,
changes in stockholders' equity and cash flows for the year ended December 31,
2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of LIFEWAY FOODS, INC. AND
SUBSIDIARY as of December 31, 2003 and the results of its operations and its
cash flows for the year then ended in conformity with U.S. generally accepted
accounting principles.
Gleeson, Sklar, Sawyers & Cumpata LLP
Elgin, Illinois
February 19, 2004
14
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
LIFEWAY FOODS, INC. AND SUBSIDIARY
We have audited the accompanying consolidated statements of financial condition
of LIFEWAY FOODS, INC. AND SUBSIDIARY (the "Company") as of December 31, 2004
and the related consolidated statements of income and comprehensive income,
changes in stockholders' equity and cash flows for the year ended December 31,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of LIFEWAY FOODS, INC. AND
SUBSIDIARY as of December 31, 2004 and the results of its operations and its
cash flows for the year then ended in conformity with U.S. generally accepted
accounting principles.
Plante & Moran, PLLC
March 24, 2005
15
LIFEWAY FOODS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2004 AND 2003
DECEMBER 31,
----------------------------
2004 2003
------------ ------------
ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 5,773,285 $ 4,597,819
Marketable securities 6,741,987 6,302,606
Accounts receivable, net of allowance for doubtful
accounts of $15,000 at Dec. 31, 2004 and 2003 2,024,036 1,800,141
Other receivables 72,137 165,767
Inventories 905,697 811,572
Prepaid expenses and other current assets 7,260 791
Deferred income taxes -- 27,038
Refundable income taxes 258,617 306,171
------------ ------------
TOTAL CURRENT ASSETS 15,783,019 14,011,905
PROPERTY AND EQUIPMENT, NET 3,420,138 3,732,731
Intangible assets
Goodwill 75,800 --
Other intangible assets, net of amortization
of $26,990 409,010 --
------------ ------------
TOTAL INTANGIBLE ASSETS 484,810 --
TOTAL ASSETS $ 19,687,967 $ 17,744,636
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Current maturities of notes payable $ 8,784 $ 28,289
Accounts payable 641,651 795,321
Accrued expenses 195,541 183,600
Deferred income taxes - current portion 36,214 --
------------ ------------
TOTAL CURRENT LIABILITIES 882,190 1,007,210
NOTES PAYABLE 463,541 472,509
DEFERRED INCOME TAXES 424,039 471,953
STOCKHOLDERS' EQUITY
Common stock 6,509,267 6,509,267
Paid-in-capital 64,314 --
Stock subscription receivable -- (15,000)
Treasury stock, at cost (649,039) (679,956)
Retained earnings 11,874,475 9,822,416
Accumulated other comprehensive income, net of taxes 119,180 156,237
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 17,918,197 15,792,964
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 19,687,967 $ 17,744,636
============ ============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
16
LIFEWAY FOODS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
YEARS ENDED DECEMBER 31,
----------------------------
2004 2003
------------ ------------
Sales $ 16,319,210 $ 14,877,788
Cost of goods sold 9,034,971 7,840,782
------------ ------------
GROSS PROFIT 7,284,239 7,037,006
Operating expenses 4,333,788 3,558,362
------------ ------------
INCOME FROM OPERATIONS 2,950,451 3,478,644
Other income (expense):
Interest and dividend income 185,575 96,850
Interest expense (31,441) (41,205)
Gain (loss) on sale of marketable securities, net 354,128 (1,293,579)
Gain on sale of property and equipment -- 1,246,287
Loss on marketable securities classified as trading (16,487) --
Other income -- 89,490
------------ ------------
Total other income (expense) 491,775 97,843
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 3,442,226 3,576,487
Provision for income taxes 1,390,167 1,354,548
------------ ------------
NET INCOME $ 2,052,059 $ 2,221,939
============ ============
BASIC AND DILUTED EARNINGS PER COMMON SHARE 0.24 0.26
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 8,439,159 8,436,888
============ ============
COMPREHENSIVE INCOME
NET INCOME $ 2,052,059 $ 2,221,939
Other comprehensive income (loss), net of tax:
Unrealized gains on marketable securities
(net of taxes) 170,107 212,634
Less reclassification adjustment for (gains) losses
included in net income (net of taxes) (207,164) 1,278,473
------------ ------------
COMPREHENSIVE INCOME $ 2,015,002 $ 3,713,046
============ ============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
17
LIFEWAY FOODS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
COMMON STOCK, NO
PAR VALUE 10,000,000
SHARES AUTHORIZED # OF SHARES
------------------------- OF STOCK
# OF SHARES # OF SHARES TREASURY COMMON PAID IN SUBSCRIPTION TREASURY
ISSUED OUTSTANDING STOCK STOCK CAPITAL RECEIVABLE STOCK
----------- ----------- ----------- ---------- -------- ------------ ---------
BALANCES AT
DECEMBER 31, 2002 8,636,888 8,436,888 200,000 $6,509,267 $ -- $ (15,000) $(679,956)
Other comprehensive
income:
Unrealized gains
on securities,
net of taxes and
reclassification
adjustment -- -- -- -- -- -- --
Net income for the
year ended December
31, 2003 -- -- -- -- -- -- --
----------- ----------- ----------- ---------- -------- ------------ ---------
BALANCES AT
DECEMBER 31, 2003 8,636,888 8,436,888 200,000 $6,509,267 -- $ (15,000) $(679,956)
Issuance of
treasury stock -- 4,550 (4,550) -- 64,314 -- 30,917
Other comprehensive
income:
Unrealized losses
on securities,
net of taxes and
reclassification
adjustment -- -- -- -- -- -- --
Payment on
subscription
receivable -- -- -- -- -- 15,000 --
Net income for the
year ended December
31, 2004 -- -- -- -- -- -- --
----------- ----------- ----------- ---------- -------- ------------ ---------
BALANCES AT
DECEMBER 31, 2004 8,636,888 8,441,438 195,450 $6,509,267 $ 64,314 $ -- $(649,039)
=========== =========== =========== ========== ======== ============ =========
ACCUMULATED
OTHER
COMPREHENSIVE
RETAINED INCOME (LOSS),
EARNINGS NET OF TAX TOTAL
----------- ------------ -----------
BALANCES AT
DECEMBER 31, 2002 $ 7,600,477 $ (1,334,870) $12,079,918
Other comprehensive
income:
Unrealized gains
on securities,
net of taxes and
reclassification
adjustment -- 1,491,107 1,491,107
Net income for the
year ended December
31, 2003 2,221,939 -- 2,221,939
----------- ------------ -----------
BALANCES AT
DECEMBER 31, 2003 $ 9,822,416 $ 156,237 $15,792,964
Issuance of
Treasury stock -- -- 95,231
Other comprehensive
income:
Unrealized losses
on securities,
net of taxes and
reclassification
adjustment -- (37,057) (37,057)
Payment on
Subscription
Receivable -- -- 15,000
Net income for the
year ended December
31, 2004 2,052,059 -- 2,052,059
----------- ------------ -----------
BALANCES AT
DECEMBER 31, 2004 $11,874,475 $ 119,180 $17,918,197
=========== ============ ===========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
18
LIFEWAY FOODS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
YEARS ENDED DECEMBER 31,
----------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
-------------------------------------
NET INCOME $ 2,052,059 $ 2,221,939
Adjustments to reconcile net income to net
cash flows from operating activities:
Depreciation and amortization 669,994 688,309
(Gain)/Loss on sale of marketable securities, net (354,128) 1,293,579
Loss on marketable securities classified as trading 16,487 --
Gain on sale of property and equipment -- (1,246,287)
Deferred income taxes 45,560 9,084
Treasury stock issued for services 95,231 --
(Increase) decrease in operating assets:
Accounts receivable (223,895) (364,920)
Other receivables 93,630 (105,516)
Inventories (94,125) (91,069)
Refundable income taxes 47,554 (306,171)
Prepaid expenses and other current assets (6,469) 485
Increase (decrease) in operating liabilities:
Accounts payable (153,670) 155,923
Accrued expenses 11,941 72
Income taxes payable -- (397,907)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,200,169 1,857,521
CASH FLOWS FROM INVESTING ACTIVITIES:
-------------------------------------
Purchase of marketable securities (6,265,671) (4,283,532)
Sales of marketable securities 6,096,652 3,025,285
Sale of assets -- 1,712,660
Purchases of property and equipment (330,411) (415,064)
Acquisition of Ilya's Farms, Inc.
net of assets acquired (511,800) --
------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,011,230) 39,349
CASH FLOWS FROM FINANCING ACTIVITIES:
-------------------------------------
Proceeds from stock subscription receivable 15,000 --
Repayment of notes payable (28,473) (30,707)
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (13,473) (30,707)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,175,466 1,866,163
Cash and cash equivalents at the beginning of the year 4,597,819 2,731,656
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 5,773,285 $ 4,597,819
============ ============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
19
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 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. During the year ended December 31, 2004 and 2003,
export sales of the Company were approximately $37,050 and $221,000,
respectively.
On September 30, 1992, the Company formed a wholly owned subsidiary corporation,
LFI Enterprises, Inc., (LFIE) incorporated in the state of Illinois. LFIE was
formed for the purpose of operating a "Russian" theme restaurant and supper club
on property acquired by the Company on October 9, 1992. The restaurant/supper
club commenced operations in late November 1992. As of July 2001, the
restaurant/supper club terminated all operations. In January 2003, the Company
sold the building and the land that housed LFIE for $1,712,660 and recognized a
gain of $1,246,287 on this transaction.
On July 23, 2004, LFIE acquired certain assets and inventory of Ilya's Farms,
Inc., a Pennsylvania corporation, for a total purchase price of $575,600. The
asset acquisition included approximately $63,800 of tangible assets (including
certain manufacturing equipment, a delivery truck and inventory) as well as
intangible assets such as the brand name "Ilya's Farms" and the recipes and
manufacturing processes previously used by Ilya's Farms, Inc. At present, LFIE
manufactures and distributes certain cream cheese products under the brand names
"Ilya's Farms" and under Lifeway Foods in the Philadelphia, Pennsylvania
metropolitan area.
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 subsidiary, LFI Enterprises, Inc. 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.
Revenue Recognition
-------------------
Sales represent sales of Company produced dairy products that are recorded at
the time of shipment. In addition, shipping costs invoiced to the customers are
included in net sales and the related cost in cost of sales.
Cash and cash 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
metropolitan area. Deposits at each institution are insured up to $100,000 by
the Federal Deposit Insurance Corporation or the Securities Investor Protector
Corporation.
Bank balances of amounts reported by financial institutions are categorized as
follows:
DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Amounts insured $ 472,341 $ 400,000
Uninsured and uncollateralized amounts 5,456,188 4,212,259
------------ ------------
Total bank balances $ 5,928,529 $ 4,612,259
============ ============
20
Marketable securities
---------------------
Marketable securities are classified as available-for-sale or trading and are
stated at fair market value basis or quoted prices. Gains and losses related to
marketable securities sold are determined by the specific identification method.
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 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 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.
Property and equipment are being depreciated over the following useful lives:
Category Years
-------------------------- ---------
Buildings and improvements 31 and 39
Machinery and equipment 5 - 12
Office equipment 5 - 7
Vehicles 5
Intangible assets
-----------------
The Company accounts for intangible assets at historical cost. Intangible assets
acquired in a business combination are recorded under the purchase method of
accounting at their estimated fair values at the date of acquisition. Goodwill
represents the excess purchase price over the fair value of the net tangible and
other intangible assets acquired. Goodwill is not amortized. The Company
amortizes other intangible assets over their estimated useful lives, as
disclosed in the table below.
Goodwill is reviewed for impairment at least annually. The Company will perform
its annual impairment test on July 23 (or the first business day immediately
following that date). Since the Company only has one reporting unit, the test is
based on a fair value approach applied for the entire company.
The Company will review 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. This review
is called an impairment assessment. The Company will conduct more frequent
impairment assessments if certain conditions exist, including: a change in the
competitive landscape, any internal decisions to pursue new or different
strategies, a loss of a significant customer, or a significant change in the
market place including changes in the prices paid for the Company's products or
changes in the size of the market for the Company's products.
If the estimate of an intangible asset's remaining useful life is changed, the
remaining carrying amount of the intangible asset is amortized prospectively
over the revised remaining useful life.
Intangible assets are being amortized over the following useful lives:
Category Years
-------------------------- ---------
Recipes 4
Customer lists and
other customer
related intangibles 8
Lease agreement 7
21
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.
Treasury stock
--------------
Treasury stock is recorded using the cost method.
Advertising costs
-----------------
The Company expenses advertising costs as incurred. During the years ended
December 31, 2004 and 2003, approximately $909,179 and $629,500, 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 year. For 2004 and 2003, diluted and basic earnings per share were
the same, as the effect of dilutive securities options outstanding was not
significant.
NOTE 3 - ACQUISITION OF ILYA'S FARMS, INC.
On July 23, 2004, LFI Enterprises, Inc., an Illinois corporation and wholly
owned subsidiary of Lifeway ("LFIE"), acquired certain assets of Ilya's Farms,
Inc., a Pennsylvania corporation. The aggregate purchase price was $575,600,
paid by LFIE in cash from its current assets.
As a result of the acquisition LFIE now manufactures and distributes certain
cream cheese products under the brand name "Ilya's Farms" in the Philadelphia,
Pennsylvania metropolitan area. The results of operations of the acquired
business have been included in the consolidated financial statements since the
acquisition date.
The following table summarizes the values of the assets and inventory acquired
at the date of acquisition, July 23, 2004.
Assets and Inventory Acquired Value
----------------------------------- --------
Machinery and equipment $ 38,200
Inventory 25,600
Intangible assets 511,800
--------
Total aggregate purchase price $575,600
========
Intangible assets, and the related accumulated amortization, consist of the
following as of December 31, 2004:
Accumulated
Cost Amortization
--------- ------------
Recipes $ 43,600 $ 4,542
Customer lists and other customer
related intangibles 305,200 17,258
Lease acquisition 87,200 5,190
Goodwill 75,800 --
--------- --------
$ 511,800 $ 26,990
========= ========
Amortization expense is expected to be as follows for the years ending December
31:
2005 $ 64,777
2006 64,777
2007 64,777
2008 60,235
2009 50,244
Thereafter 104,200
---------
$ 409,010
Amortization expense during the year ended December 31, 2004 was $26,990.
Goodwill amortization for tax purposes totaled $2,527 for the year ended
December 31, 2004.
NOTE 4 - MARKETABLE SECURITIES
The cost and fair value of marketable securities classified as available for
sale and trading are as follows:
22
LOSS ON
MARKETABLE
SECURITIES
UNREALIZED UNREALIZED CLASSIFIED FAIR
DECEMBER 31, 2004 COST GAINS LOSSES AS TRADING VALUE
----------------------- ------------ ------------ ------------ ------------ ------------
Equities and Mutual
Funds $ 3,414,459 $ 341,230 $ (120,991) $ -- $ 3,634,698
Preferred Securities 65,000 596 -- -- 65,596
Certificates of Deposit 150,000 -- (4,935) -- 145,065
Corporate Bonds 1,639,275 -- (14,862) -- 1,624,413
Municipal bonds,
maturing within five
years 132,226 1,992 -- -- 134,218
Government agency
obligations, maturing
after five years 1,154,484 -- -- (16,487) 1,137,997
------------ ------------ ------------ ------------ ------------
Total $ 6,555,444 $ 343,818 $ (140,788) $ (16,487) $ 6,741,987
============ ============ ============ ============ ============
LOSS ON
MARKETABLE
SECURITIES
UNREALIZED UNREALIZED CLASSIFIED FAIR
DECEMBER 31, 2003 COST GAINS LOSSES AS TRADING VALUE
----------------------- ------------ ------------ ------------ ------------ ------------
Equities $ 2,326,722 $ 315,348 $ (48,837) $ -- $ 2,593,233
Preferred securities 200,505 2,985 (80) -- 203,410
Certificates of deposit 150,000 -- 150,000
Corporate Bonds 500,005 -- (1,333) -- 498,672
Municipal bonds,
maturing within five
years 2,405,067 1,545 (10) -- 2,406,602
Government agency
obligation 450,000 689 -- 450,689
------------ ------------ ------------ ------------ ------------
Total $ 6,032,299 $ 320,567 $ (50,260) $ -- $ 6,302,606
============ ============ ============ ============ ============
Proceeds from the sale of marketable securities were $6,096,652 and $3,025,285
during the years ended December 31, 2004 and 2003, respectively. Gross gains
(losses) of $354,128 and $(1,293,579), were realized on these sales during the
years ended December 31, 2004 and 2003, respectively.
NOTE 5 - INVENTORIES
Inventories consist of the following:
DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Finished goods $ 404,206 $ 436,291
Production supplies 297,791 231,376
Raw materials 203,700 143,905
------------ ------------
Total inventories $ 905,697 $ 811,572
============ ============
23
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Land $ 470,900 $ 470,900
Buildings and improvements 2,481,257 2,435,111
Machinery and equipment 5,394,932 5,138,822
Vehicles 408,898 380,743
Office equipment 78,763 78,763
------------ ------------
8,834,750 8,504,339
Less accumulated depreciation 5,414,612 4,771,608
------------ ------------
Total property and equipment $ 3,420,138 $ 3,732,731
============ ============
Depreciation expense during the years ended December 31, 2004 and 2003 was
$643,004 and $688,309, respectively.
NOTE 7 - NOTES PAYABLE
Notes payable consist of the following:
DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Mortgage 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. $ 472,325 $ 481,281
Notes payable to finance companies;
paid in full November 2004. -- 19,517
------------ ------------
Total notes payable 472,325 500,978
Less current maturities 8,784 28,289
------------ ------------
Total long-term portion $ 463,541 $ 472,509
============ ============
Maturities of notes payables are as follows:
As of December 31,
2005 $ 8,784
2006 463,541
------------
Total $ 472,325
============
NOTE 8 - PROVISION FOR INCOME TAXES
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Current:
Federal $ 1,084,557 $ 1,075,623
State 260,050 269,841
------------ ------------
Total current 1,334,607 1,345,464
Deferred 45,560 9,084
------------ ------------
Provision for income taxes $ 1,390,167 $ 1,354,548
============ ============
24
A reconciliation of the provision for income taxes and the income tax computed
at the statutory rate are as follows:
YEAR ENDED DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Federal income tax expense $ 1,084,921 $ 1,127,237
computed at the statutory rate
State taxes, expense 251,283 261,084
Permanent book/tax differences 53,963 (33,773)
------------ ------------
Provision for income taxes $ 1,390,167 $ 1,354,548
============ ============
Amounts for deferred tax assets and liabilities are as follows:
DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Non-current deferred tax liabilities $ (424,039) $ (471,953)
arising from:
Temporary differences - principally
Book/tax, accumulated depreciation
Current deferred tax liability arising
from:
Book/tax, unrealized gains on
marketable securities (83,850) (114,070)
Current deferred tax assets arising from:
Book/tax, capital loss carryforward -- 104,683
Book/tax, inventory 47,636 36,425
------------ ------------
Total current deferred tax assets
(liability) (36,214) 27,038
------------ ------------
Net deferred tax liability $ (460,253) $ (444,915)
============ ============
NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes are as follows:
YEARS ENDED DECEMBER 31,
---------------------------
2004 2003
------------ ------------
Interest $ 31,441 $ 41,205
Income taxes $ 1,298,348 $ 2,055,000
NOTE 10 - 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 600,000, as adjusted, 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. There were
468,000 shares available for issuance under the Plan at December 31, 2004 and
2003. 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, 2004 and 2003, there were no stock options outstanding or
exercisable.
25
On February 12, 2004, Lifeway's Board of Directors approved awards of an
aggregate amount of 5,100 shares to be awarded under its Employee and Consulting
Services and Compensation Plan to certain employees and consultants for services
rendered to the Company. The stock awards were made on April 1, 2004 and have
vesting periods that vary from six months to one year, depending upon the
individual grantee. The expense for the awards is measured as of April 1, 2004
at $20.93 per share for 5,100 shares, or a total stock award expense of
$106,743. This expense is being recognized as the stock awards vest beginning
with the recognition of $41,860 for 2,000 shares vested on April 1, 2004. There
were a total of 4,550 vested shares resulting in a stock award expense of
$95,231 for the year ended December 31, 2004.
NOTE 11 - STOCK SPLIT
On February 12, 2004, the Board of Directors of the Company declared a
two-for-one stock split of the common stock of the Company payable on March 8,
2004 to all of the Company's shareholders of record as of February 27, 2004.
As a result of the stock split, shareholders received two shares of common stock
for every one share held on the record date. Upon completion of the split, the
total number of shares of common stock outstanding increased from 4,218,444 to
8,436,888.
The earnings per share calculations as presented on the consolidated statements
of income and comprehensive income and the number of shares issued and
outstanding per statement of changes in stockholders' equity have been adjusted
to reflect split adjusted share amounts.
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the Company's financial instruments are as follows
at December 31,:
2004 2003
--------------------------- ---------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ------------ ------------ ------------
Cash and cash equivalents $ 5,773,285 $ 5,773,285 $ 4,597,819 $ 4,597,819
Marketable securities $ 6,741,987 $ 6,741,987 $ 6,302,606 $ 6,302,606
Notes payable $ 472,325 $ 469,696 $ 500,798 $ 483,469
The carrying values of cash and cash equivalents, and marketable securities
approximate fair values. The fair value of the notes payable is based on the
discounted value of contractual cash flows. The discount rate is estimated using
rates currently offered for debt with similar maturities.
NOTE 13 - PENDING LITIGATION
On December 4, 2004 a former employee requested a Motion for Summary Judgment on
the issue of Liability in a lawsuit filed against the Company by the former
employee. The motion was granted on February 10, 2005 and on February 18, 2005
the case was referred to a Magistrate Judge for a settlement conference.
The lawsuit alleges non payment of overtime wages in violation of federal
employment laws, with an estimated amount between $7,500 and $15,000. The suit
was filed in the United States District Court for the Northern District of
Illinois on behalf of all employees who were classified as non-exempt during
2001 through 2003. Outside counsel for the Company has advised that at this
stage in the proceedings he cannot offer an opinion as to the probable outcome.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. DISCLOSURE CONTROLS AND PROCEDURES
The Chief Executive Officer and the Chief Financial and Accounting
Officer conducted an evaluation of the effectiveness of the Company's disclosure
controls and procedures pursuant to Rule 13a-14 under the Securities Exchange
Act of 1934 as of December 31, 2004. While the Company operates on strictly
monitored cost constraints, based on that evaluation, the Chief Executive
Officer and the Chief Financial and Accounting Officer concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be filed in this annual report has been made known to
her. As of the date of this annual report, there have been no known significant
changes in internal controls or in other factors that could significantly affect
these controls subject to the date of such evaluation.
ITEM 8B. OTHER INFORMATION
None.
26
PART III
Certain information required by Part III is omitted from this report in
that Lifeway intends to file a definitive proxy statement pursuant to Regulation
14A (the "Proxy Statement") not later than 120 days after the end of the fiscal
year covered by this report, and certain information included therein is
incorporated herein by reference. Only those sections of the Proxy Statement
which specifically address the items set forth herein are incorporated by
reference.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
DIRECTORS. The information regarding Lifeway's directors and certain
other information required by this Item is incorporated by reference to the
Proxy Statement.
EXECUTIVE OFFICERS. The information regarding Lifeway's executive
officers and certain other information required by this Item is incorporated by
reference to the Proxy Statement.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the
Proxy Statement.
FAMILY RELATIONSHIPS
Julie Smolyansky, the President, CEO and director of Lifeway is the
daughter of Ludmila Smolyansky, Chairperson of the Board of Directors of Lifeway
and the sister of Edward P. Smolyansky. Edward P. Smolyansky, the Chief
Financial and Accounting Officer and Treasurer of Lifeway is the son of Ludmila
Smolyansky and the brother of Julie Smolyansky.
CODE OF ETHICS
The Company has adopted a Code of Ethics which is incorporated in this
report by reference to this report as an exhibit hereto.
ITEM 10. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to
the Proxy Statement filed by Lifeway on April 29, 2004.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to
the Proxy Statement.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
FINANCIAL STATEMENTS AND SCHEDULES
A list of the Financial Statements and Financial Statement Schedules
filed as part of this Report is set forth in Item 7, which list is incorporated
herein by reference.
27
(a) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- ---------------
3.4 Amended and Restated By-laws (incorporated by reference to Exhibit No.
3.5 of Lifeway's Current Report on Form 8-K dated and filed on December
10, 2002). (File No. 000-17363)
3.5 Articles of Incorporation, as amended and currently in effect
(incorporated by reference to Exhibit 3.5 of Lifeway's Quarterly Report
on Form 10-QSB for the quarter ended June 30, 2000 and filed on August
8, 2000). (File No. 000-17363)
10.1 Lifeway Foods, Inc. Consulting and Services Compensation Plan, dated
June 5, 1995 (incorporated by reference to Lifeway's Registration
Statement on Form S-8, File No. 33-93306). (File No. 000-17363)
10.10 Stock Purchase Agreement with Danone Foods, Inc., dated October 1, 1999
(incorporated by reference to Exhibit 10.10 of Lifeway's Current Report
on Form 8-K dated October 1, 1999, and filed October 12, 1999). (File
No. 000-17363)
10.11 Stockholders' Agreement with Danone Foods, Inc. dated October 1, 1999
(incorporated by reference to Exhibit 10.11 of Lifeway's Current Report
on Form 8-K dated October 1, 1999, and filed October 12, 1999). (File
No. 000-17363)
10.12 Extension to Stockholders' Agreement with Danone Foods, Inc. dated
September 28, 2004 (incorporated by reference to Exhibit 10.1 of
Lifeway's Current Report on Form 8-K dated October 1, 2004 and filed
October 18, 2004). (File No. 000-17363)
10.13 Second Extension to Stockholders' Agreement with Danone Foods, Inc.
dated October 29, 2004 (incorporated by reference to Exhibit 10.1 of
Lifeway's Current Report on Form 8-K dated October 29, 2004 and filed
November 4, 2004). (File No. 000-17363)
10.14 Third Extension of Stockholders' Agreement dated as of December 30,
2004 between Lifeway Foods, Inc. and Danone Foods, Inc. (Incorporated
by reference to Exhibit 10.1 of the Registrant's Current Report on Form
8-K dated December 24, 2004 and filed December 27, 2004). (File No.
000-17363)
10.15 Letter Agreement dated December 24, 1999 amending the Stockholders'
Agreement with Danone Foods, Inc. dated October 1, 1999 (incorporated
by reference to Exhibit 10.12 of Lifeway's Current Report on Form 8-K
dated December 24, 1999 and filed January 11, 2000). (File No.
000-17363)
10.16 Employment Agreement, dated September 12, 2002, between Lifeway Foods,
Inc. and Julie Smolyansky (incorporated by reference to Exhibit 10.14
of Amendment No. 2 filed April 30, 2003 to Lifeway's Quarterly Report
on Form 10-QSB/A for the quarter ended September 30, 2002). (File No.
000-17363)
11 Statement re: computation of per share earnings. (Incorporated by
reference to Note 2 of the Consolidated Financial Statements).
14 Code of Ethics (Incorporated by reference to Lifeway's Proxy Statement
on Schedule 14A filed on April 29, 2004). (File No. 000-17363)
21 List of Subsidiaries of the Registrant
28
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.
(b) Reports on Form 8-K
Current Report on Form 8-K dated December 24, 2004 and filed
December 27, 2004.
Current Report on Form 8-K dated November 15, 2004 and filed
November 19, 2004.
Current Report on Form 8-K dated October 29, 2004 and filed
November 4, 2004.
Current Report on Form 8-K dated October 1, 2004 and filed October
18, 2004.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
In 2003, Gleeson Sklar, Sawyers and Cumpata, Lifeway's principal
accountant, billed approximately $41,500 for professional services rendered for
the audit of Lifeway's annual financial statements and review of financial
statements included in the registrant's Form 10-Q (17 CFR 249.308a) or 10-QSB
(17 CFR 249.308b) or services that are normally provided in connection with
statutory and regulatory filings or engagements in 2003.
On May 13, 2004, the accounting firm of Gleeson Sklar, Sawyers and
Cumpata, merged with and into Plante & Moran, PLLC.
In 2004, Plante & Moran, PLLC, Lifeway's principal accountant, billed
approximately $70,000 for professional services rendered for the audit of
Lifeway's annual financial statements and review of financial statements
included in the registrant's Form 10-QSB (17 CFR 249.308b) or services that are
normally provided in connection with statutory and regulatory filings or
engagements in 2004.
AUDIT-RELATED FEES
In 2003, Lifeway's principal accountant billed approximately $4,701 for
assurance and related services that are reasonably related to the performance of
the audit or review of the registrant's financial statements.
In 2004, Lifeway's principal accountant billed approximately $8,900 for
assurance and related services that are reasonably related to the performance of
the audit or review of the registrant's financial statements.
TAX FEES
No professional services were rendered by the principal accountant for
tax advice, tax compliance and tax planning.
ALL OTHER FEES
No other fees were billed by the principal accountant other than those
described in this report.
No hours expended on Lifeway's principal accountant's engagement to
audit Lifeway's financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal accountant's
full-time permanent employees.
29
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunder duly authorized.
Date: March 31, 2005 LIFEWAY FOODS, INC.
By: /s/ Julie Smolyansky
------------------------------------------
Julie Smolyansky, Chief Executive Officer,
President, and Director
By: /s/ Edward P. Smolyansky
------------------------------------------
Chief Financial and Accounting Officer
and Treasurer
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below hereby constitutes and appoints Julie Smolyansky and Edward P.
Smolyansky, and each of them individually, his or her true and lawful agent,
proxy and attorney-in-fact, with full power of substitution and resubstitution,
for him or her and in his or her name, place and stead, in any and all
capacities, to (i) act on, sign and file with the Securities and Exchange
Commission any and all amendments to this Report together with all schedules and
exhibits thereto, (ii) act on, sign and file with the Securities and Exchange
Commission any and all exhibits to this Report and any and all exhibits and
schedules thereto, (iii) act on, sign and file any and all such certificates,
notices, communications, reports, instruments, agreements and other documents as
may be necessary or appropriate in connection therewith and (iv) take any and
all such actions which may be necessary or appropriate in connection therewith,
granting unto such agents, proxies and attorneys-in-fact, and each of them
individually, full power and authority to do and perform each and every act and
thing necessary or appropriate to be done, as fully for all intents and purposes
as he or she might or could do in person, and hereby approving, ratifying and
confirming all that such agents, proxies and attorneys-in-fact, any of them or
any of his, her or their substitute or substitutes, may lawfully do or cause to
be done by virtue hereof.
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Date: March 31, 2005 /s/ Julie Smolyansky
-----------------------------------------
Julie Smolyansky, Chief Executive Officer,
President, and Director
Date: March 31, 2005 /s/ Ludmila Smolyansky
-----------------------------------------
Ludmila Smolyansky
Chairperson of the Board of Directors
Date: March 31, 2005 /s/ Pol Sikar
-----------------------------------------
Pol Sikar, Director
Date: March 31, 2005 /s/ Rick D. Salm
-----------------------------------------
Rick D. Salm, Director
Date: March 31, 2005
-----------------------------------------
Juan Carlos, Director
Date: March 31, 2005
-----------------------------------------
Renzo Bernardi, Director
30
INDEX OF EXHIBITS
-----------------
21 List of Subsidiaries
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.
31