<PAGE>   1



                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-QSB

(Mark One)

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

                            For the quarterly period ended March 31, 1997

       [ ]  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

                            For the transition period from _______ to _______ 

                            Commission file number: 0-17363

                             LIFEWAY FOODS, INC.
--------------------------------------------------------------------------------
       (Exact name of small business issuer as specified in it charter)

        Illinois                                                 36-3442829   
--------------------------------------------------------------------------------
(State or other jurisdiction of incorporation                  (IRS Employer
or organization)                                             Identification No.)


               7625 North Austin Avenue, Skokie, Illinois 60077
--------------------------------------------------------------------------------
                   (Address of principal executive offices)

                               (847) 967-1010
                         ---------------------------
                         (issuer's telephone number)

--------------------------------------------------------------------------------
       (Former name, former address and former fiscal year, if changed
                             since last report)

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 such shorter
period that the issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.  Yes [X]    No [  ]

              APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
                 PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the issuer filed all documents and reports required to be filed
by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court.     Yes [  ]     No [  ]

                    APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:  As of May 1, 1997, the
issuer had 3,774,977 shares of common stock, no par value, outstanding.

Transitional Small Business Disclosure Format (Check one):  Yes [ ]  No [X]
<PAGE>   2
                                     INDEX



PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
                                                                                              Page
                                                                                              ----
<S>                                                                                        <C>
         Lifeway Foods, Inc. and Subsidiaries
                                             
         March 31, 1997 and 1996
                                

                 Certified Public Accountants Report on
                 Unaudited Financial Statements                                               F-2

                 Consolidated Balance Sheets
                 March 31, 1997 and 1996                                                   F-3 - F-4

                 Consolidated Statements of Income
                 for the three months ended March 31, 1997 and 1996                           F-5

                 Consolidated Statements of Changes in Stockholders' Equity
                 for the three months ended March 31, 1997 and 1996                           F-6

                 Consolidated Statements of Cash Flows
                 for the three months ended March 31, 1997 and 1996                        F-7 - F-8

                 Notes to Consolidated Financial Statements
                 March 31, 1997 and 1996                                                   F-9 - F-16

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITIONS AND RESULTS OF OPERATIONS                                                  4


PART II - OTHER INFORMATION                                                                    5


SIGNATURES                                                                                     7
</TABLE>


                                      2

<PAGE>   3
                         PART I - FINANCIAL INFORMATION





                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                             FINANCIAL STATEMENTS
                           MARCH 31, 1997 AND 1996


                           [Following page is F-1]





                                      3
<PAGE>   4
                    LIFEWAY FOODS, INC. AND SUBSIDIARIES

                            FINANCIAL STATEMENTS

                           MARCH 31, 1997 AND 1996





                              TABLE OF CONTENTS





Certified Public Accountants Report on Financial Statements            F-2

Consolidated Balance Sheets -
March 31, 1997 and 1996                                             F-3 - F-4

Consolidated Statements of Income -
for the three months ended March 31, 1997 and 1996                     F-5

Consolidated Statements of Changes in Stockholders' Equity -
for the three months ended March 31, 1997 and 1996                     F-6

Consolidated Statement of Cash Flows -
for the three months ended March 31, 1997 and 1996                  F-7 - F-8

Notes to Consolidated Financial Statements -
March 31, 1997 and 1996                                             F-9 - F16











                                      F-1




<PAGE>   5



                               ROBERT L. DELORME
                          CERTIFIED PUBLIC ACCOUNTANT
                         1010 JORIE BOULEVARD/SUITE 300
                           OAK BROOK, ILLINOIS 60521

                                 (630) 571-1800






                      CERTIFIED PUBLIC ACCOUNTANTS REPORT
                            ON FINANCIAL STATEMENTS



To the Shareholders and Directors
Lifeway Foods, Inc.
Skokie, Illinois



The accompanying balance sheets of Lifeway Foods, Inc. and Subsidiaries as of
March 31, 1997 and 1996 and the related statements of income, changes in
stockholders' equity and cash flows for the three months then ended were not
audited by me and, accordingly, I do not express an opinion or any other form
of assurance on them.

The accompanying financial statement of Lifeway Foods, Inc. and subsidiaries as
of December 31, 1996 and for the year then ended were audited by other
auditors. They expressed an unqualified opinion on them in their report dated
February 14, 1997. They have not performed any audit procedures since that
date.







Robert L. DeLorme, C.P.A.
Oak Brook, Illinois

April 30, 1997



                                      F-2
<PAGE>   6



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET





<TABLE>
<CAPTION>

                                                     (UNAUDITED)
                                                        MARCH 31,         
                                                -----------------------   DECEMBER 31,
ASSETS                                             1997         1996         1996  
                                                ----------   ----------   ----------
<S>                                             <C>          <C>          <C>       
CURRENT ASSETS
      Cash and cash equivalent                  $1,006,636   $  828,217   $  996,101
      Investments                                  216,865      330,000      213,671
      Accounts receivable, net of allowance
         for doubtful accounts of  $48,000 at
         March 31, 1997 and 1996 and
         December 31, 1996                         787,719      598,780      620,408
      Other receivables                             16,000       26,200       23,600
      Inventories                                  423,280      268,100      413,324
      Prepaid expenses and other assets             61,570       62,107        7,714
      Deferred income taxes                         41,418       34,480       41,418
                                                ----------   ----------   ----------
      Total current asset                        2,553,488    2,147,884    2,316,236

Property and Equipment
      Land                                         658,400      369,500      658,400
      Buildings, machinery and equipment         3,289,302    2,192,433    3,288,231
                                                ----------   ----------   ----------
      Total property and equipment               3,947,702    2,561,933    3,946,631
      Less:  accumulated depreciation            1,113,954      916,000    1,069,536
                                                ----------   ----------   ----------
      Property and equipment, net                2,833,748    1,645,933    2,877,095

Other Assets
      Intangible assets                            330,343      330,343      330,343
      Less;  accumulated amortization              274,647      229,988      264,036
                                                ----------   ----------   ----------
      Total other assets                            55,696      100,355       66,307
                                                ----------   ----------   ----------
Total Assets                                    $5,442,932   $3,894,172   $5,259,638
                                                ==========   ==========   ==========

</TABLE>
















                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-3




<PAGE>   7



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET







LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                  (UNAUDITED)
                                                     MARCH 31,            
                                             --------------------------   DECEMBER 31,
                                                1997           1996           1996 
                                             -----------    -----------   -----------
<S>                                          <C>            <C>           <C>        
CURRENT LIABILITIES
      Current maturities of notes payable    $   106,869    $    43,115   $   105,928
      Accounts Payable                           237,522        279,168       242,079
      Accrued expenses                           272,237        175,919       272,054
                                             -----------    -----------   -----------
      TOTAL CURRENT LIABILITIES                  616,628        498,202       620,061


LONG-TERM LIABILITIES
      Notes payable                            1,446,701        648,626     1,468,904

DEFERRED INCOME TAXES                             36,362         45.395        36,362


STOCKHOLDERS' EQUITY
      Common Stock                             1,374,754      1,362,938     1,374,754
      Retained Earnings                        1,987,305      1,339,011     1,778,375
      Treasury Stock                             (18,818)             0       (18,818)
                                             -----------    -----------   -----------
      TOTAL STOCKHOLDERS' EQUITY               3,343,241      2,701,949     3,134,311
                                             -----------    -----------   -----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY   $ 5,442,932    $ 3,894,172   $ 5,259,638
                                             ===========    ===========   ===========
</TABLE>








                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-4




<PAGE>   8



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                       CONSOLIDATED STATEMENTS OF INCOME






<TABLE>
<CAPTION>
                                            (UNAUDITED)
                                      FOR THE THREE MONTHS ENDED  
                                              MARCH 31,           FOR THE YEAR ENDED
                                      --------------------------    DECEMBER 31,    
                                         1997           1996            1996    
                                      -----------    -----------    -----------  
<S>                                   <C>            <C>            <C>        
SALES                                 $ 1,413,864    $ 1,258,639    $ 5,295,405

COST OF GOODS SOLD                        660,881        512,233      2,976,307
                                      -----------    -----------    -----------

GROSS PROFIT                              752,983        746,406      2,319,098

OPERATING EXPENSES                        463,705        458,937      1,383,049
                                      -----------    -----------    -----------


INCOME FROM OPERATIONS                    289,278        287,469        936,049

OTHER INCOME (EXPENSE)
      Interest income                      12,413          9,874         52,140
      Interest expense                    (36,694)       (12,602)       (62,168)
      Other Income                         74,343            689         59,087
                                      -----------    -----------    -----------
      TOTAL OTHER INCOME (EXPENSE)         50,062         (2,039)        49,059
                                      -----------    -----------    -----------

INCOME BEFORE INCOME TAXES                339,340        285,430        985,108

PROVISION FOR INCOME TAXES                130,410        107,026        367,340
                                      -----------    -----------    -----------

NET INCOME                            $   208,930    $   178,404    $   617,768
                                      ===========    ===========    ===========

EARNINGS PER SHARE                    $       .06    $       .05    $       .16
                                      ===========    ===========    ===========

WEIGHTED AVERAGE SHARES OUTSTANDING     3,777,385      3,778,977      3,777,385
                                      ===========    ===========    ===========
</TABLE>






                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-5




<PAGE>   9



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY








<TABLE>
<CAPTION>
                               COMMON STOCK, NO PAR VALUE
                               10,000,000 SHARES AUTHORIZED
                               ----------------------------
                                                    # OF
                                                  SHARES OF
                              # OF SHARES ISSUED  TREASURY    COMMON       TREASURY     RETAINED
                               AND OUTSTANDING     STOCK       STOCK        STOCK       EARNINGS 
                              ----------------  ----------   ----------   ----------   ----------
<S>                                <C>           <C>        <C>          <C>          <C>
BALANCES AT
  DECEMBER 31, 1995                3,785,377            0   $1,374,754   $        0   $1,160,607

Repurchase of
   treasury stock                          0       10,400            0       18,819            0

Net income for the year
    ended December 31, 1996                0            0            0            0      617,768
                                  ----------   ----------   ----------   ----------   ----------

BALANCES AT
   DECEMBER 31, 1996               3,785,377       10,400    1,374,754       18,819    1,778,375

Net income for the three months
     ended March 31, 1997                  0            0            0            0      208,930
                                  ----------   ----------   ----------   ----------   ----------

BALANCES AT
  MARCH 31, 1997                   3,785,377       10,400    1,374,754   $   18,819   $1,987,305
                                  ==========   ==========   ==========   ==========   ==========
</TABLE>






                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-6




<PAGE>   10



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS



<TABLE>
<CAPTION>
                                                                     (UNAUDITED)
                                                               FOR THE THREE MONTHS ENDED  
                                                                       MARCH 31,           FOR THE YEAR ENDED  
                                                               --------------------------    DECEMBER 31       
                                                                  1997           1996            1996       
                                                               -----------    -----------    -----------
<S>                                                            <C>            <C>            <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net income                                               $   208,930    $   178,404    $   617,768
      Adjustments to reconcile net income to net
         cash flows from operating activities:
              Depreciation and amortization                         55,029         55,624        243,208
              Deferred income taxes                                      0              0        (15,971)
              Gain on sale of asset                                      0           (689)             0
              (Increase) decrease in operating assets:
                    Accounts receivable                           (167,311)         5,841        (15,787)
                    Other receivable                                 7,600              0          2,600
                    Inventories                                     (9,956)        20,000       (125,224)
                    Prepaid expenses and other assets              (53,856)       (40,901)        13,492
               Increase (decrease) in operating liabilities:
                    Accounts payable                                (4,557)        33,944         (3,145)
                    Accrued expenses                                   183        (87,684)         8,451
                                                               -----------    -----------    -----------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES                    36,062        346,645        725,392

CASH FLOWS FROM INVESTING ACTIVITIES:
      Purchase of investments                                       (3,194)      (100,000)       (13,671)
      Sale of investments                                                0        100,100        129,411
      Purchase of property and equipment                            (1,071)       (16,796)    (1,401,494)
      Proceeds from sales of assets                                      0              0              0
                                                               -----------    -----------    -----------
NET CASH PROVIDED BY (USED) IN
     INVESTING ACTIVITIES                                           (4,265)       (16,696)    (1,285,754)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from notes payable                                        0        919,645
      Repayments of notes payable                                  (21,262)        (9,917)       (46,471)
      Purchase of Treasury Stock                                         0        (11,816)       (18,818)
                                                               -----------    -----------    -----------
NET CASH USED IN FINANCING ACTIVITIES                              (21,262)       (21,733)       854,356
                                                               -----------    -----------    -----------

NET INCREASE (DECREASE) IN CASH AND
     CASH EQUIVALENTS                                               10,535        126,110        293,994

CASH AND CASH EQUIVALENTS AT
     BEGINNING OF PERIOD                                           996,101        702,107        702,107
                                                               -----------    -----------    -----------

CASH AND CASH EQUIVALENTS AT END OF PERIOD                     $ 1,006,636    $   828,217    $   996,101
                                                               ===========    ===========    ===========
</TABLE>








                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-7




<PAGE>   11



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>

                                                           (UNAUDITED)
                                                    FOR THE THREE MONTHS ENDED   FOR THE YEAR ENDED
                                                              MARCH 31,             DECEMBER 31
                                                     --------------------------
                                                         1997           1996           1996
                                                     ------------   ------------   ------------
<S>                                                  <C>            <C>            <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash paid for interest                               $     36,694   $     12,602   $     62,168
                                                     ============   ============   ============

Cash paid for income taxes                           $     90,000   $     90,900   $    486,900
                                                     ============   ============   ============
</TABLE>











                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-8




<PAGE>   12



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


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 produces Kefir, a drinkable product which is similar to
      but distinct from yogurt in several flavors sold under the name
      "Lifeway's Kefir"; a line of drinkable yogurt; a plain farmer's cheese
      sold under the name "Lifeway's Farmer's Cheese"; and a fruit
      sugar-flavored product similar in consistency to cream cheese sold under
      the name of "Sweet Kiss." 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. The Company has also expanded the distribution of some of its
      products internationally by exporting to Eastern Europe through its
      wholly-owned subsidiary Lifeway International, Inc. For the years ended
      December 31, 1996 and 1995 export sales of the Company were approximately
      $414,000 and $215,000, respectively.

      On September 30, 1992, the Company formed a wholly-owned subsidiary
      corporation, LFI Enterprises, Inc., (LFIE) incorporated in the state of
      Illinois. LFI Enterprises, Inc. was formed for the purpose of operating a
      "Russian" theme restaurant and supper club on the property acquired by
      the Company on October 9, 1992.
      The restaurant/supper club commenced its operations in late November
      1992.


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 and majority owned subsidiaries. All significant
      intercompany accounts and transactions have been eliminated, including
      $120,000 of rent paid by LFIE to the Company in 1996 and 1995 for use of
      the restaurant which is owned by the Company.

      Use of Estimates

      The preparation of financial statements in conformity with generally
      accepted accounting principles 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.

      Cash Equivalents

      All highly liquid investments purchased with a maturity of three months
      or less are considered to be cash equivalents.











                                      F-9




<PAGE>   13



                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

      Investments

      Effective December 31, 1994, the Company adopted the provisions of
      Statement of Financial Accounting Standards No 115 " Accounting for
      certain Debt and Equity Securities" (SFAS 115). In accordance with this
      Statement, securities are classified as held-to-maturity,
      available-for-sale or trading.

      The Company's investments include certificates of deposit with maturity
      dates greater than three months and US Treasury Bonds which are all short
      term and held-to-maturity. Securities classified as held-to-maturity are
      stated at cost adjusted for amortization of premiums and accretion of
      discounts. At December 31, 1995, cost approximated market value. The
      Company does not currently have any trading or available-for-sale
      securities.

      Inventory

      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 cost. 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:


<TABLE>
<CAPTION>
                   Category                                      Years
                   --------                                      -----
<S>                                                              <C>
                   Buildings and improvements                      31
                   Machinery and equipment                       5-12
                   Office equipment                               5-7

</TABLE>

Intangible Assets

      Intangible Assets are stated at cost. Organization costs are amortized
      over five years using the straight-line method. Other intangible assets
      are amortized over the estimated useful lives of the assets using the
      straight-line method as follows:


<TABLE>
<CAPTION>
<S>                                                           <C>
                   Covenant not to compete                     10 years
                   Trademark license                          2.5 years
                   U.P.C. Codes                                 7 years
                   Customer lists                               5 years

</TABLE>










                                     F-10




<PAGE>   14



                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

      Income Taxes

      Deferred income taxes arise from temporary differences resulting from
      income and expense items reported for financial accounting and tax
      purposes in different periods. Deferred taxes are classified as current
      or noncurrent, 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 noncurrent depending on the periods in which the temporary
      differences are expected to reverse.

      The principal sources of temporary differences are different depreciation
      methods for financial statement and tax purposes, capitalization of
      indirect costs for tax purposes, use of allowance method for book
      purposes verses the direct method for tax purposes as to bad debts and
      amortization of customer list.

      Earning Per Common Share

      Earnings per common share were computed by dividing net income by
      weighted average number of shares of common stock outstanding during the
      year. For the year ended December 31, 1995, fully diluted and primary
      earnings per share were the same as there were no potentially dilutive
      common stock equivalents outstanding. See Note 11 for fully diluted
      earnings per share for the year ended December 31, 1994.

      Change in Accounting Principle

      In February 1997, the Financial Accounting Standards Board (FASB) issued
      Statements of Financial Accounting Standards No. 128, "Earnings Per
      Share" (SFAS 128) and No. 129, "Disclosure of Information About Capital
      Structure" (SFAS 129). The Company's required adoption date is January 1,
      1997. SFAS 128 changes the calculation for earnings per share. SFAS 129
      restates existing disclosures related to the Company's capital structure.
      The Company anticipates the adoption of SFAS 128 and SFAS 129 will not
      have a material impact on its financial statements.

      Reclassification of Financial Statement Presentation

      Certain reclassifications have been made to the 1995 financial statements
      to confirm with the 1996 financial statement presentation. Such
      reclassifications had no effect on net income as previously reported.


NOTE 3 - INVENTORIES

      Inventories consisted of the following:

<TABLE>
<CAPTION>
                              (UNAUDITED)
                       FOR THE THREE MONTHS ENDED  FOR THE YEAR ENDED
                                MARCH 31,            DECEMBER 31
                      --------------------------
                          1997           1996           1996 
                      ------------   ------------   ------------
<S>                   <C>            <C>            <C>         
Finished goods        $    285,291   $    174,600   $    300,287
Production supplies         84,088         47,500         33,957
Raw materials               53,901         46,000         79,080
                      ------------   ------------   ------------
                      $    423,280   $    268,100   $    413,324
                      ============   ============   ============
</TABLE>





                                      F-11




<PAGE>   15



                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 4 - PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:     

<TABLE>
<CAPTION>
                                   (UNAUDITED)
                            FOR THE THREE MONTHS ENDED                     
                                     MARCH 31,           FOR THE YEAR ENDED
                            ---------------------------      DECEMBER 31   
                                 1997           1996           1996 
                            ------------   ------------   ------------
<S>                         <C>            <C>            <C>         
Land                        $    658,400   $    369,500   $    658,752
Buildings and improvement      1,649,370        796,752      1,649,370
Machinery and equipment        1,448,274      1,234,635      1,448,752
Vehicles                         109,877        109,877        109,877
Leasehold improvements            81,781         51,169         80,232
                            ------------   ------------   ------------
                            $  3,947,702   $  2,561,933   $  3,946,631
                            ============   ============   ============
</TABLE>

      Depreciation charged to income for the three months ended March 31, 1997
      and 1996 was $44,418 and $47,231 respectively, and $200,767 for the year
      ended December 31, 1996.

      During 1996, the Company acquired land, building and machinery for
      $1,350,000. A mortgage note payable was signed for approximately
      $920,000, related to this acquisition (see Note 5). The Company continued
      to rent the building to the former tenant and recognized approximately
      $59,000 of rent during 1996, included in other income.

NOTE 5 - NOTES PAYABLE   
<TABLE>
<CAPTION>
                                                                                       (UNAUDITED)
                                                                                FOR THE THREE MONTHS ENDED                        
                                                                                           MARCH 31,             FOR THE YEARNDED 
                                                                                -----------------------------      DECEMBER 31    
                                                                                    1997              1996             1996    
                                                                                -----------       -----------       -----------
<S>                                                                             <C>               <C>               <C>        
Mortgage note payable, 1st National Bank of Morton Grove, payable in
 monthly installments of $2,548, including interest at 7.5%, with a
 balloon payment of $184,900 due November
 1998.  Collateralized by real estate                                           $   209,820       $   224,368       $   213,490

Mortgage note payable, American National Bank and Trust Company of
 Chicago, payable in monthly installments of $4,498 including interest at
 6.75%, with a balloon payment of $394,000 due August
 1998.  Collaterlized by real estate                                                433,663           457,021           439,761

Mortgage note payable, American National Bank and Trust Company of
  Chicago, payable in monthly installments of principal of $5,109 plus
  interest at 8.05%, with a balloon payment of $618, 214 due
  November 2001.  Collateralized by real estate                                     904,318                 0           914,536

Note payable, Glenview State Bank, payable in monthly installments of
 $460, including interest at 6.25%,
 due March, 1998.  Collateralized by automobile                                       5,769            10,352             7,045
                                                                                -----------       -----------       -----------

     Total                                                                        1,553,570           691,741         1,574,832
</TABLE>



                                      F-12

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES



<PAGE>   16

                                      
                                      
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 5 - NOTES PAYABLE - CONTINUED         

<TABLE>
<CAPTION>
                                 (UNAUDITED)
                           FOR THE THREE MONTHS ENDED                      
                                   MARCH 31,           FOR THE YEAR ENDED  
                          ---------------------------    DECEMBER 31       
                              1997           1996           1996 
                          ------------   ------------   ------------

<S>                            <C>             <C>           <C>    
Less current maturities        106,869         43,115        105,928
                          ------------   ------------   ------------

           Total          $  1,446,701   $    648,626   $  1,468,904
                          ============   ============   ============
</TABLE>


      Maturities of notes payable are as follows:

<TABLE>

   <S>                         <C>       
   Year Ending December 31,
                1997           $  105,928
                1998              676,984
                1999               61,308
                2000               61,308
                2001              669,304
                               ----------

Total                          $1,574,832
                               =-========
</TABLE>


NOTE 6 - PROVISION FOR INCOME TAXES

      The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
                                    (UNAUDITED)
                             FOR THE THREE MONTHS ENDED                     
                                       MARCH 31,          FOR THE YEAR ENDED
                             ---------------------------     DECEMBER 31    
                                 1997           1996            1996   
                             ------------   ------------   -------------                     
<S>                          <C>            <C>            <C>         

Current
      Federal                $    106,118   $     86,603   $    312,270
      State                        24,292         20,423         71,041
                             ------------   ------------   ------------
Total current                     130,410        107,026        383,311
Deferred                                0              0        (15,971)
                             ------------   ------------   ------------

Provision for income taxes   $    130,410   $    107,026   $    367,340
                             ============   ============   ============
</TABLE>

      A reconciliation of the provision for income taxes and the income tax
      computed at the statutory rate is as follows:

<TABLE>
<CAPTION>
                                                     (UNAUDITED)
                                               FOR THE THREE MONTHS ENDED  
                                                      MARCH 31,            FOR THE YEAR ENDED  
                                              ---------------------------     DECEMBER 31      
                                                 1997            1996            1996   
                                              ------------   ------------   -------------                   
<S>                                           <C>            <C>            <C>         

Federal income tax expense
  computed at the statutory rate              $    106,118   $     86,603   $    334,937
State taxes, expense                                24,292         20,423         49,255
Book/tax, accumulated depreciation adjusted              0              0         (8,221)
Book/tax, inventory adjustment                           0              0         (5,857)
Permanent book/tax difference                            0              0         (2,774)
                                              ------------   ------------   ------------

Provision for income taxes                    $    130,410   $    107,026   $    367,340
                                              ============   ============   ============
</TABLE>

                                      F-13

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES



<PAGE>   17



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 6 - PROVISION FOR INCOME TAXES - CONTINUED

Amounts for deferred tax assets and liabilities as of December 31, 1996 are as
follows:

<TABLE>
<S>                                                         <C>       

Long-term deferred tax liabilities arising from:
      Temporary differences - principally
             Book/tax, accumulated depreciation             $   39,134
             Book/tax, accumulated amortization                 (2,772)
                                                            ----------
      Total deferred tax liabilities                            36,362

 Short-term deferred tax assets arising from:
             Book/tax, allowance for doubtful accounts      $   22,176
             Book/tax, inventory                                19,242
                                                            ----------
 Total deferred tax assets                                      41,418
                                                            ----------
 Net deferred tax asset                                     $    5,056
                                                            ==========
</TABLE>


NOTE 7 -  STOCKHOLDERS' EQUITY

      During 1996, the Company repurchased 10,400 shares of common stock at a
      cost of $18,818.


NOTE 8 - CUSTOMER AND CREDIT CONCENTRATIONS

      Concentrations of credit with regard to trade accounts receivable, which
      are uncollateralized, and sales are limited due to the fact the Company's
      customers are spread across different geographic areas. The customers are
      concentrated in the retail food industry. Two customers accounted for
      11.7% and 10.6% of 1996 sales and 16.4% and 19.9% of trade accounts
      receivable as of December 31, 1996, respectively.

NOTE 9 -  INTANGIBLE ASSETS

      Intangible assets consisted of the following at December 31, 1996:

<TABLE>
<S>                        <C>     
Covenant Not to Compete    $ 50,000
Customer List                 6,000
Trademark                    30,000
UPC Codes                   200,000
Organization Costs           44,343
                           --------
                            330,343
Accumulated amortization    274,647
                           --------
                           $ 55,696
                           ========
</TABLE>

      Total amortization charged against income for the years ended December
      31, 1996 and 1995 was $33,572 and $43,640, respectively.

NOTE 10 - FORMATION OF SUBSIDIARIES

      In 1992, the Company formed Lifeway International, Inc.("LLI") as a
      majority-owned subsidiary. In exchange for 98% of the issued and
      outstanding common stock, 2,320,000 shares, the Company transferred
      $108,000 in cash. The remaining 2% of the issued and outstanding common
      stock, 46,000 shares, was transferred to other shareholders ("Minority
      Shareholders") under a qualifying Rule 144 restricted stock issue in
      exchange for $145,000 in cash.

                                      F-14

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES



<PAGE>   18



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 10 - FORMATION OF SUBSIDIARIES - CONTINUED

      During 1994, the Company determined that it would not be able to
      implement its original business plan for LII. As a result, the Company
      conducted an exchange offer to the Minority Shareholders of LII, whereby
      each Minority Shareholder could alternatively exchange their shares for:

      1)  restricted common shares in the Company (including shares for 
          interest on their investment), or

      2)  receive a return of their original investment in cash plus interest 
          on their investment paid in restricted common shares in the Company.

      During 1994, Minority Shareholders owning 8,000 shares of LII elected to
      cash out and were paid $25,000. During 1995, Minority Shareholders owning
      28,800 shares in LII elected to cash out and were paid $90,000. In
      addition, these Minority Shareholders were entitled to 9,200 restricted
      common shares in the Company as payment of interest on their investment
      in LII. During 1995, Minority Shareholders owing 9,600 shares in LII
      elected to exchange their shares and were issued 26,400 restricted common
      shares of the Company, including 2,400 shares as payment of interest on
      their investment in LII. The total issue of 35,600 restricted common
      shares in the Company resulted in a .9% dilution of the current Company
      shareholder's interest. As of December 31, 1996, all minority interests
      in LII have been exchanged or cashed out under the terms of the exchange
      offer.

      On September 30, 1992, the Company formed LFI Enterprises, Inc. ("LFEI")
      as a wholly owned subsidiary. In exchange for all of the issued and
      outstanding common stock of LFEI, the Company transferred to LFEI $1,000
      in cash.

NOTE 11 - BUSINESS SEGMENT INFORMATION

      The Company's significant business segments include the sale of dairy
      products and the operations of a restaurant. "Corporate and other"
      includes revenues and expenses of the company's export subsidiary,
      general corporate expenses, interest expense, and interest income. The
      Company's operations, by business segment for 1996 and 1995 are as
      follows:

<TABLE>
<CAPTION>
                        Dairy                      Corporate
 1996                  Products      Restaurant     & Other      Consolidated
-------               -----------   -----------   ------------   ------------

<S>                   <C>           <C>           <C>            <C>        
Sales                 $ 4,863,339   $   432,066   $         0    $ 5,295,405
Net Income            $   558,134   $    65,080   $    (5,446)   $   617,768
Identifiable Assets   $ 5,054,029   $   114,878   $    90,731    $ 5,259,638
Depreciation and
    Amortization      $   223,210   $    11,129   $     8,869    $   243,208
Capital Additions     $ 1,401,494   $     2,700   $         0    $ 1,401,494

 1995  
-------
Sales                 $ 3,965,707   $   390,145   $   141,708    $ 4,497,560
Net Income            $   691,055   $    18,729   $  (269,059)   $   440,725
Identifiable Assets   $ 3,033,742   $   654,413   $   103,086    $ 3,791,241
Depreciation and
    Amortization      $   209,567   $    12,129   $     8,869    $   230,565
Capital Additions     $    45,494   $     2,700   $         0    $    48,194
</TABLE>





                                      F-15

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES



<PAGE>   19


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                 MARCH 31, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 12 - STOCK OPTION PLANS

      The Company previously adopted a Restricted Stock Plan which provides for
      the granting of stock options to Company employees. The maximum number of
      Company Stock shares that may be subject to the Restrictive Stock Option
      Plan is 300,000.

      On June 9, 1995, the Company filed a registration statement with the
      Securities and Exchange Commission in connection with a Consulting
      Service Compensation Plan covering up to 300,000 of the Company's Common
      Stock shares. Pursuant to the Plan, the Company may issue Common Stock or
      option to purchase Common Stock to certain consultants, service providers
      and employees of the Company.

      As of December 31, 1996, no options have been issued under either of the
      two plans. The Company did issue 20,000 shares of Common Stock in 1995
      for consulting services valued at $27,500. This issue resulted in a .5%
      dilution of the current Company shareholder's interests.


NOTE 13 - CONCENTRATION OF RISK

      The Company maintains cash deposits at several banks located in the
      greater Chicago, Illinois metropolitan area. Deposits at each bank are
      insured by the Federal Deposit Insurance Corporation up to $100,000.

      Bank balances of amounts reported by financial institutions which are
      categorized as follows at December 31, 1996:

<TABLE>
<S>                                                 <C>     
           Amounts insured by FDIC                  $147,374 
           Uninsured and uncollateralized amounts    732,472 
                                                    -------- 
           Total bank balance                       $879,846 
                                                    ======== 
</TABLE>


NOTE 14 - INVESTMENTS

      The amortized cost and fair value of investments at December 31, 1996
were:

<TABLE>
<CAPTION>
                                         Carrying        Fair        
                                          Amount         Value       
                                       ------------   ------------   
<S>                                    <C>            <C>            
           Cash and cash equivalents   $    996,101   $    996,101   
           Certificates of Deposit          213,671        213,671   
           Note payable to bank               7,045          7,045   
           Mortgages payable              1,567,787      1,548,436   
                                       ------------   ------------   
                                                                     
           Total Investment            $  2,784,604   $  2,765,253   
                                       ============   ============   
</TABLE>

      The carrying values of cash and cash equivalents, certificates of deposit
      and the note payable to bank approximate fair values. The fair value of
      the mortgage 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.





                                      F-16



<PAGE>   20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

(1)      Material Changes in Results of Operations

         Net income increased by $30,526, up to $208,930 for the three month
period ending March 31, 1997, from $178,404 during the same three month period
in 1996.  The material components of this increase are detailed as follows:

         Sales and cost of goods sold increased by $155,225 and $148,648,
respectively, up to $1,413,864 and $660,881, respectively, during the three
month period ending March 31, 1997, from $1,258,639 and $512,233, respectively,
during the same three month period in 1996.  The increase is primarily
attributable to increased sales of Kefir, Farmer's Cheese and Golden Zesta.  As
first disclosed in the Company's annual report of Form 10-KSB for the year
ended December 31, 1996, the financial statements reflect a change in
accounting for certain expenses, whereby certain expenses that have previously
been classified as operating expenses are now classified under cost of goods
sold.

         Interest expense increased by $24,092, up to $36,694 during the three
month period ending March 31, 1997, from $12,602 during the same three month
period in 1996.  The increase is primarily attributable to interest paid on a
mortgage note payable on real property that was purchased in 1996.

         Other income increased by $73,654, up to $74,343 during the three
month period ending March 31, 1997, from $689 during the same three month
period in 1996.  The increase is attributable to the receipt of rent revenues
from the current tenant occupying the real property that was acquired by the
Company in 1996.  The Company anticipates that the current tenant will vacate
the property during the second quarter of 1997, after which time no future rent
revenues are expected to be received and the Company anticipates occupying the
property for its own use.

         Provision for income taxes increased by $23,384, up to $130,410 during
the three month period ending March 31, 1997, from $107,026 during the same
three month period in 1996.  The increase is proportionate to the net income
increase.

(2)      Material Changes in Financial Condition

         As of the three month period ending March 31, 1997, as compared to the
three month period ending March 31, 1996, the Company had working capital in
the amount of $1,936,860 as compared to $1,649,682, respectively, an increase
of $287,178; and cash on hand in the amounts of $1,006,636 as compared to
$828,217, respectively, an increase of $178,419.  Cash flow from operations was
generated by the primary business activity of the Company.  During the
remainder of 1997, the Company anticipates purchasing additional equipment for
its proposed new production facility, and to gradually employ additional
persons on an as-needed basis for its operation.

         The Company's balance in inventory increased by $155,180, up to
$423,280 as of March 31, 1997, as compared to $268,100 as of March 31, 1996.
The increase is primarily due to an increase in production and sales.

         Net cash provided by operating activities decreased by $310,583, down
to $36,062 as of March 31, 1997, as compared to $346,645 as of March 31, 1996.
The decrease is primarily due to 1) a significant increase in accounts
receivable due primarily to increased sales; and 2) a significant decrease in
accrued expenses due primarily to the Company's payments of taxes that had
previously been accrued.

         The Company is not aware of any circumstances or trends which would
have a negative impact upon future sales or earnings.  There have been no
material fluctuations in the standard seasonal variations of the Company's
business.





                                      4
<PAGE>   21
                          PART II - OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

         None.

ITEM 2.  CHANGES IN SECURITIES

         None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

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

         None.

ITEM 5.  OTHER INFORMATION

         None.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)     Exhibits

Exhibit Number and Brief Description

         3.1     Articles of Incorporation of issuer, with Certificate, and
                 Amendments. (1)

         3.2     Bylaws of issuer. (1)

         3.3     Corrected Amendment to the Bylaws of issuer. (1)

         10.1    Lifeway Foods, Inc. Consulting and Services Compensation Plan,
                 dated June 5, 1995. (2)

         10.2    Employment Agreement between issuer and Michael Smolyansky.
                 (3)

         10.4    Industrial Building Lease between Lifeway Foods, Inc.  and
                 Michael Smolyansky, and Addendum to Building Lease. (3)

         10.5    Stock Option Agreements. (3)

         10.7    Restricted Stock Plan. (3)

         10.9    Real Estate Sales Contract, dated April 24, 1996, to purchase
                 a 110,000 square foot parcel of real property, zoned
                 industrial, in Morton Grove, Illinois. (4)

         27      Financial Data Schedule. (5)
                                                                                
--------------------




                                      5
<PAGE>   22

         footnotes:

         (1)     Incorporated by reference to the issuer's registration
                 statement on Form S-18 (File No. 33-14329-C), and
                 Post-Effective Amendments thereto.

         (2)     Incorporated by reference to the issuer's registration
                 statement on Form S-8 (File No. 33-93306).

         (3)     Incorporated by reference to the issuer's Current Reports
                 filed under cover of Form 8-K and amendments thereto.

         (4)     Incorporated by reference to the issuer's Quarterly Report on
                 Form 10-QSB for the period ended March 31, 1996.

         (5)     Filed herewith.


(b)      Reports on Form 8-K

         None.





                                      6
<PAGE>   23

                                  SIGNATURES

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


                                 LIFEWAY FOODS, INC.
                                                    


                                 By:  /s/ MICHAEL SMOLYANSKY                  
                                    -------------------------------------------
                                       Michael Smolyansky, Chief Executive 
                                       Officer, Chief Financial and Accounting 
                                       Officer, President, Treasurer and 
                                       Director


Date:   May 8, 1997





                                      7
<PAGE>   24
                                 EXHIBIT INDEX



3.1      Articles of Incorporation of issuer, with Certificate, and Amendments.
         (1)

3.2      Bylaws of issuer. (1)

3.3      Corrected Amendment to the Bylaws of issuer. (1)

10.1     Lifeway Foods, Inc. Consulting and Services Compensation Plan, dated
         June 5, 1995. (2)

10.2     Employment Agreement between issuer and Michael Smolyansky. (3)

10.4     Industrial Building Lease between Lifeway Foods, Inc. and Michael
         Smolyansky, and Addendum to Building Lease. (3)

10.5     Stock Option Agreements. (3)

10.7     Restricted Stock Plan. (3)

10.9     Real Estate Sales Contract, dated April 24, 1996, to purchase a
         110,000 square foot parcel of real property, zoned industrial, in
         Morton Grove, Illinois. (4)

27       Financial Data Schedule. (5)

         -------------------

(1)      Incorporated by reference to the issuer's registration statement on
         Form S-18 (File No. 33-14329-C), and Post- Effective Amendments
         thereto.

(2)      Incorporated by reference to the issuer's registration statement on
         Form S-8 (File No. 33-93306).

(3)      Incorporated by reference to the issuer's Current Reports filed under
         cover of Form 8-K and amendments thereto.

(4)      Incorporated by reference to the issuer's Quarterly Report on Form
         10-QSB for the period ended March 31, 1996.

(5)      Filed herewith.