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

The following analysis should be read in conjunction with the unaudited financial statements of the Company and related notes included elsewhere in this quarterly report and the audited financial statements and Management's Discussion and Analysis contained in our Form 10-K, for the fiscal year ended December 31, 2011.

Comparison of Quarter Ended June 30, 2012 to Quarter Ended June 30, 2011

Results of Operations

Total consolidated Gross sales increased by $2,800,955 (approximately 14%) to $22,713,958 during the three-month period ended June 30, 2012 from $19,913,003 during the same three-month period in 2011. This increase is primarily attributable to increased sales and awareness of the Company's flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™. In addition, Lifeway's Frozen Kefir line, which was launched in April 2011, contributed approximately $800,000 to sales during the second quarter of 2012.

Total consolidated Net sales increased by $2,355,462 (approximately 13%) to $20,553,380 during the three-month period ended June 30, 2012 from $18,197,918 during the same three-month period in 2011. Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.

Total cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 59% during the second quarter of 2012, compared to approximately 68% during the same period in 2011. The decrease was primarily attributable to a 20% decrease in the cost of conventional milk, the Company's largest raw material, partially offset by a 5% increase in the cost of organic milk as compared to the same period last year.

Total operating expenses increased $110,433 (approximately 2.3%) to $4,910,679 during the second quarter of 2012, from $4,800,246 during the same period in 2011. This increase was primarily attributable to increased general and administrative expenses, partially offset by a decrease in selling and amortization expenses.

Income from operations increased by $2,426,538 (approximately 34%) to $3,126,752 during the second quarter of 2012, from $700,214 during the same period in 2011.

Provision for income taxes was $1,065,607, or a 34% effective tax rate for the second quarter of 2012 compared to an income tax expense of $380,659, or a 59% effective tax rate during the same period in 2011. Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.

Net income was $2,049,128, or $0.13 per diluted share for the three-month period ended June 30, 2012 compared to $265,542, or $0.02 per share in the same period in 2011.

Comparison of Six-Month Period Ended June 30, 2012 to Quarter Ended June 30, 2011

Total consolidated Gross sales increased by $5,299,590 (approximately 14%) to $44,259,859 during the six-month period ended June 30, 2012 from $38,960,269 during the same six-month period in 2011. This increase is primarily attributable to increased sales and awareness of the Company's flagship line, Kefir, as well as ProBugs® Organic Kefir for kids and BioKefir™. In addition, Lifeway Frozen Kefir line, which was launched in April 2011, contributed to approximately $1.5 million to sales during the six-month period ended June 30, 2012.

Total consolidated Net sales increased by $4,448,757 (approximately 13%) to $39,950,578 during the six-month period ended June 30, 2012 from $35,501,821 during the same six-month period in 2011. Net sales are recorded as gross sales less promotional activities such as slotting fees paid, couponing, spoilage and promotional allowances as well as early payment terms given to customers.

Total cost of goods sold as a percentage of net sales, excluding depreciation expense, were approximately 61% during the six-month period ended June 30, 2012 compared to 61% during the six-month period ended June 30, 2011. The cost of milk, the Company's largest raw material, was similar during the six-month period ended June 30, 2012 when compared to the same period in 2011.

Total operating expenses as a percentage of net sales were approximately 25% during the six-month period ended June 30, 2012 compared to approximately 26% during the same period in 2011. Selling related expenses increased by $78,358 (approximately 2%) to $5,326,515 during the six-month period ended June 30, 2012, from $5,248,157 during the same period in 2011.

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Income from operations increased by $1,033,447 (approximately 26%) to $4,999,283 during the six-month period ended June 30, 2012, from $3,965,836 during the same period in 2011.

Provision for income taxes was $1,825,520, or a 37% effective tax rate, for the six-month period ended June 30, 2012 compared with $1,673,376, or, a 43% tax rate, during the same period in 2011. Income taxes are discussed in Note 10 of the Notes to Consolidated Financial Statements.

Net income was $3,144,116, or $0.19 per share, for the six-month period ended June 30, 2012 compared to $2,191,313 or $0.13 per share in the same period in 2011.

Liquidity and Capital Resources

Sources and Uses of Cash

Net cash provided by operating activities was $4,127,928 during the six-months ended June 30, 2012 compared to $848,370 during the same period in 2011. This increase is primarily attributable to the increase in net income of $952,803.

Net cash used in investing activities was $563,870 during the six-months ended June 30, 2012 compared to $847,307 during the same period in 2011. This decrease is primarily attributable to the decrease in purchases of property and equipment of $268,822.

Net cash from financing activities used was $2,678,883 during the six-months ended June 30, 2011. The decrease resulted primarily from the repurchase of treasury stock, repayment of notes payable and a dividend of $0.07 per share paid in the second quarter of 2012.

The Company had a net increase in cash and cash equivalents of $885,175 during the six-month period ended June 30, 2012 compared to a net loss of $1,831,416 during the same period in 2011. The Company had cash and cash equivalents of $2,000,325 as of June 30, 2012 compared to $1,398,523 as of June 30, 2011.

Assets and Liabilities

Total assets were $53,759,666 as of June 30, 2012, which is an increase of $870,317 when compared to June 30, 2011. This is primarily due to an increase in cash and cash equivalents of $601,802 of June 30, 2012 when compared to June 30, 2011.

Total current liabilities were $8,254,853 as of June 30, 2012, which is a decrease of $451,614 when compared to June 30, 2011. This is primarily due to a $1,351,564 decrease in current maturities of notes payable.

Notes payable decreased by $729,400 as of June 30, 2012 when compared to June 30, 2011. The balance of the notes payable as of June 30, 2012 was $5,228,395.

Total stockholder's equity was $37,035,592 as of June 30, 2012, which is an increase of $2,140,042 when compared to June 30, 2011. This is primarily due to an increase in retained earnings of $2,661,907 when compared to June 30, 2011.

All of our marketable securities are classified as available-for-sale on our balance sheet. All of these securities are stated thereon at market value as of the end of the applicable period. Gains and losses on the portfolio are determined by the specific identification method.

We anticipate being able to fund the Company's foreseeable liquidity requirements internally.

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