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

                                  Form 10-QSB

(Mark One)

    [X]  QUARTERLY REPORT UNDER SECTION 13 OR 5(d) OF THE SECURITIES EXCHANGE
         ACT OF 1934  

                   For the quarterly period ended September 30, 1998

    [ ]  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              (IRS Employer Identification No.) 
incorporation or organization)

               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 November 4, 1998, the issuer
had 3,785,677 shares of common stock, no par value, outstanding.

Transitional Small Business Disclosure Format (Check one):    Yes [ ]   No [X]


<PAGE>


                                   INDEX


PART I - FINANCIAL INFORMATION                                      Page
                                                                    ----

Item 1.  Financial Statements.                                      F-1

         Lifeway Foods, Inc. and Subsidiaries
         September 30, 1998 and 1997

            Consolidated Balance Sheets
            December 31, 1997 and
            September 30, 1998 and 1997                          F-2 - F-3

            Consolidated Statements of Income
            for the year ended December 31, 1997 and
            for the three months ended September 30, 
            1998 and 1997 (unaudited) for the nine 
            months ended September 30, 1998 and
            1997 (unaudited)                                        F-4

            Consolidated Statements of Changes in 
            Stockholders' Equity for the year ended 
            December 31, 1997 and for the nine months 
            ended September 30, 1998 and 1997 (unaudited)           F-5

            Consolidated Statements of Cash Flows
            for the year ended December 31, 1997 and
            for the nine months ended September 30, 1998 
            and 1997 (unaudited)                                 F-6 - F-7

            Notes to Consolidated Financial Statements
            (unaudited)                                          F-8 - F-15

Item 2.  Management's Discussion and Analysis of Financial
         Conditions and Results of Operations                        3

PART II - OTHER INFORMATION                                          4

SIGNATURES                                                           5



<PAGE>



                      PART I - FINANCIAL INFORMATION


Item 1.  Financial Statements.






                   LIFEWAY FOODS, INC. AND SUBSIDIARIES
                            FINANCIAL STATEMENTS
                        SEPTEMBER 30, 1998 AND 1997



























                                     F-1


<PAGE>


                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET


<TABLE>
<CAPTION>
                                                             (Unaudited)
                                                             September 30,               December 31,
ASSETS                                                   1998             1997               1997
                                                   ---------------   ---------------   ----------------
<S>                                                <C>               <C>               <C>

Current Assets
     Cash and cash equivalent                      $       695,799   $       503,366   $        550,670
     Investments                                           236,686           224,224            227,622
     Accounts receivable, net of allowance
         for doubtful accounts of  $48,000 at
         September 30, 1998 and 1997 and
         December 31, 1997                                 868,145           768,996            818,245
     Other receivables                                      16,200            15,200             15,200
     Inventories                                           721,000           671,999            614,022
     Prepaid expenses and other assets                      44,229             7,714              7,714
     Deferred income taxes                                  17,936            41,418             59,354
                                                   ---------------   ---------------   ----------------

     Total current asset                                 2,599,995         2,232,917          2,292,827

Property and Equipment
     Land                                                  658,400           658,400            658,400
     Buildings, machinery and equipment                  4,873,748         4,320,082          4,540,891
                                                   ---------------   ---------------   ----------------
     Total property and equipment                        5,532,148         4,978,482          5,199,291
     Less:  accumulated depreciation                     1,547,093         1,202,790          1,283,486
                                                   ---------------   ---------------   ----------------
     Property and equipment, net                         3,985,055         3,775,693          3,915,805

Other Assets
     Intangible assets                                     330,343           330,343            330,343
     Less:  accumulated amortization                       316,881           295,868            306,477
                                                   ---------------   ---------------   ----------------
     Total other assets                                     13,462            34,475             23,866
                                                   ---------------   ---------------   ----------------

Total Assets                                       $     6,598,512   $     6,043,084   $      6,232,498
                                                   ===============   ===============   ================
</TABLE>




                  SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                     F-2


<PAGE>



                       LIFEWAY FOODS, INC. AND SUBSIDIARIES
                            CONSOLIDATED BALANCE SHEET


<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                            (Unaudited)
                                                           September 30,            December 31,
                                                      1998               1997           1997
                                                  ------------      ------------   --------------
<S>                                               <C>               <C>            <C>  

Current Liabilities
     Current maturities of notes payable          $    266,964      $    106,903   $      681,561
     Accounts Payable                                  356,183           358,186          394,390
     Accrued expenses                                  293,896           367,190          429,197
                                                  ------------      ------------   --------------
     Total current liabilities                         917,043           832,279        1,505,148


Long-Term Liabilities
     Notes payable                                   1,128,087         1,399,520          791,920

Deferred Income Taxes                                   37,822            36,362           79,240


Stockholders' Equity
     Common Stock                                    1,426,916         1,387,354        1,396,316
     Retained Earnings                               3,107,462         2,406,387        2,478,692
     Treasury Stock                                   (18,818)          (18,818)         (18,818)
                                                 ------------      -------------   --------------
     Total stockholders' equity                      4,515,560         3,774,923        3,856,190
                                                  ------------      ------------    -------------

Total Liabilities and Stockholders' Equity        $  6,598,512      $  6,043,084    $   6,232,498
                                                  ============      ============    =============
</TABLE>








                   SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                       F-3


<PAGE>


                         LIFEWAY FOODS, INC. AND SUBSIDIARIES
                          CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                           (Unaudited)                   (Unaudited)              For the
                                   For the three  months ended   For  the  nine  months ended    year ended
                                         September 30,                  September 30,           December 31,
                                   ---------------------------   ----------------------------   ------------
                                      1998            1997           1998            1997           1997
                                   ------------   ------------   ------------    ------------   ------------
<S>                                <C>            <C>            <C>             <C>            <C>  

Sales                              $  1,747,870   $  1,504,353   $  5,072,862    $  4,392,201   $  5,960,878

Cost of goods sold                      914,117        834,422      2,313,480       2,406,970      3,434,605
                                   ------------   ------------   ------------    ------------   ------------

Gross Profit                            833,753        669,931      2,759,382       1,985,231      2,526,273

Operating Expenses                      510,435        418,809      1,679,994       1,121,072      1,486,338
                                   ------------   ------------   ------------    ------------  -------------

Income from operations                  323,318        251,122      1,079,388         864,159      1,039,935

Other income (expense)
     Interest income                      8,904         11,526         28,412          37,395         47,344
     Interest expense                (  32,842)     (  24,221)      ( 81,502)        (90,550)      (124,218)
     Other Income                             0         15,750              0         214,058        214,058
                                   ------------   ------------   ------------    ------------  -------------
     Total other income
     (expense)                         (23,938)          3,055      ( 53,090)         160,903        137,184
                                   ------------   ------------   ------------    ------------  -------------

Income before income taxes              299,380        254,177      1,026,298       1,025,062      1,177,119

Provision for income taxes              115,976         98,465        397,528         397,050        476,802
                                   ------------   ------------   ------------    ------------  -------------

Net Income                         $    183,404   $    155,712   $    628,770    $    628,012  $     700,317
                                   ============   ============   ============    ============  =============

Earnings per share                 $        .05   $        .04   $        .17    $        .17  $         .19
                                   ============   ============   ============    ============  =============

Weighted average shares
outstanding                           3,790,274      3,789,277      3,790,274       3,789,277      3,776,102
                                   ============   ============   ============    ============  =============



               SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                  F-4


<PAGE>


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



</TABLE>
<TABLE>
<CAPTION>
                                      Common Stock, No par Value
                                      10,000,000 Shares Authorized
                                      ----------------------------

                                                       # of
                                                     Shares of
                                      # of Shares    Treasury        Common      Treasury          Retained
                                           Issued      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       18,818                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       18,818        1,778,375

Shares exchanged in
     non-cash transaction                   3,900             0         21,562            0                0

Net income for the year
     ended December 31, 1997                    0             0              0            0          700,317
                                      -----------   -----------    -----------  -----------      -----------

Balances at
     December 31, 1997                  3,789,277        10,400      1,396,316       18,818        2,478,692

Shares exchanged in
     non-cash transaction                   6,800             0         30,600            0                0

Net income for the nine months
     ended September 30, 1998                   0             0              0            0          628,770
                                      -----------   -----------    -----------  -----------      -----------

Balances at
     September 30, 1998                 3,796,077        10,400    $ 1,426,916  $    18,818      $ 3,107,462
                                      ===========    ==========    ===========  ===========      ===========
</TABLE>


                SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                     F-5

<PAGE>

                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                    (Unaudited)
                                                             For the nine months ended         For the year ended
                                                                  September 30,                    December 31
                                                           -----------------------------
                                                               1998             1997                  1997
                                                           ------------     ------------       ------------------
<S>                                                        <C>              <C>                <C>   
Cash flows from operating activities:
     Net income                                            $    628,770     $    628,012        $    700,317
     Adjustments to reconcile net income to net
         cash flows from operating activities:
              Depreciation and amortization                     274,011          165,086             276,491
              Issuance of common stock in exchange
                  for services                                        0                0              21,562
         Deferred income taxes                                        0                0              24,942
         (Increase) decrease in operating assets:
              Accounts receivable                              (49,900)        (148,588)           (197,837)
              Other receivable                                  (1,000)            8,400               8,400
              Inventories                                     (106,978)        (258,675)           (200,698)
              Prepaid expenses and other assets                (36,515)                0                   0
         Increase (decrease) in operating liabilities:
              Accounts payable                                 (38,207)          116,107             152,311
              Accrued expenses                                (135,301)           95,136             157,143
                                                           ------------     ------------       -------------
Net cash provided (used) by operating activities                534,880          605,478             942,631

Cash flows from investing activities:
     Purchase of investments                                    (9,064)         (10,553)            (13,951)
     Purchase of property and equipment                       (332,857)      (1,031,851)         (1,272,760)
                                                           ------------     ------------       -------------
Net cash provided by (used in)
     investing activities                                     (341,921)      (1,042,404)         (1,286,711)

Cash flows from financing activities:
     Proceeds from issuance of common stock                      30,600           12,600                   0
     Repayments of notes payable                               (78,430)         (68,409)           (101,351)
                                                          -------------     ------------       -------------
Net cash used in financing activities                          (47,830)         (55,809)           (101,351)
                                                          -------------     ------------       -------------

Net increase (decrease) in cash and
     cash equivalents                                           145,129        (492,735)           (445,431)

Cash and cash equivalents at
     beginning of period                                        550,670          996,101             996,101
                                                          -------------     ------------       -------------

Cash and cash equivalents at end of period                $     695,799     $   503,3667       $     550,670
                                                          =============     ============       =============
</TABLE>

                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                    F-6

<PAGE>



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

<TABLE>
<CAPTION>
                                                                   (Unaudited)
                                                             For the nine months ended
                                                           -----------------------------    
                                                                  September 30,              For the year ended
                                                           -----------------------------         December 31
                                                               1998              1997                1997
                                                           ------------     ------------     ------------------
<S>                                                        <C>              <C>                 <C> 

Supplemental disclosures of cash flow information:

     Cash paid for interest                                $     81,502     $     90,550        $    124,218
                                                           ============     ============        ============

     Cash paid for income taxes                            $    502,000     $    286,560        $    267,996
                                                           ============     ============        ============


Supplemental schedule of non-cash financial activities:

     Issuance of common stock in exchange
         for consulting fees                              $      30,600     $     12,600        $     21,562
                                                          =============    =============       =============
</TABLE>





















               SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                  F-7


<PAGE>

                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997


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 also
     distributes  some of its products  internationally  by exporting to Eastern
     Europe.  For the years ended December 31, 1997 and 1996 export sales of the
     Company were approximately $381,000 and $414,000, respectively.

     In 1992,  the  Company  formed  Lifeway  International,  Inc.  ("LII") as a
     majority-owned subsidiary to facilitate the distribution of its products to
     Eastern  Europe.  The Company is considering  merging the operations of LII
     into the operations of the Company in 1998 to simplify the exporting of its
     products.

     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 the  property  acquired  by the  Company on
     October 9, 1992.  The  restaurant/supper club  commenced 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.

     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.


<PAGE>


     Cash Equivalents
     ----------------

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

     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.


                                F-8


<PAGE>

                 LIFEWAY FOODS, INC. AND SUBSIDIARIES
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
           SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997


Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

     Bank balances of amounts reported by financial institutions are categorized
     as follows at December 31, 1997:

     Amounts insured by FDIC                                 $    227,910
     Uninsured and uncollateralized amounts                       507,524
                                                             ------------
     Total bank balances                                     $    735,434
                                                             ============

     Investments
     -----------

     The Company's  investments  include  certificates  of deposit with maturity
     dates   greater   than  three   months,   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, 1997,  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 lower of cost or  realized  value.
     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


<PAGE>



     Intangible Assets
     -----------------

     Intangible  Assets  are  stated  at cost  and  are amortized over estimated
     useful lives of the assets using the straight-line method as follows:

         Covenant not to compete                           10 years
         U.P.C. Codes                                       7 years
         Organization costs                                 5 years




                                   F-9



<PAGE>

                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997


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.

     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 the year ended December 31, 1997 and 1996,
     diluted  and basic  earnings  per share  were the  same,  as the  effect of
     dilutive securities options outstanding was not significant.

     Change in Accounting Principle
     ------------------------------

     In June 1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
     Statements  of  Financial   Accounting   Standards   No.  130,   "Reporting
     Comprehensive  Income" (SFAS 130) and No. 131,  "Disclosures about Segments
     of an Enterprise and Related  Information".  The Company required  adoption
     date is January 1, 1998. SFAS 130  establishes  standards for the reporting
     and  display  of  comprehensive   income.  SFAS  131establishes   reporting
     requirements  for  information  about  operating   segments.   The  Company
     anticipates  adoption  of SFAS 130 and  SFAS  131 will not have a  material
     impact on its financial statements.



<PAGE>



Note 3 - INVENTORIES

     Inventories consisted of the following:
                                          (Unaudited)
                                  For the nine months ended   For the year ended
                                         September 30,           December 31
                                      1998           1997            1997
                                  -----------    -----------  ------------------

         Finished goods           $   330,000    $   415,542     $    314,993
         Production supplies          206,000        147,045          138,527
         Raw materials                185,000        113,865          160,502
                                  -----------    -----------     ------------
                                  $   721,000    $   671,999     $    614,022
                                  ===========    ===========     ============












                                   F-10



<PAGE>

                    LIFEWAY FOODS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997

Note 4 - PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
Property and equipment consisted of the following:         (Unaudited)
                                                    For the nine months ended
                                                        September 30,               For the year ended
                                                 -------------------------------         December 31
                                                      1998               1997               1997
                                                 -------------    --------------    ------------------
<S>                                              <C>               <C>                <C>

                  Land                           $     658,400     $     658,400      $     658,400
                  Buildings and improvement          1,649,370         1,649,370          1,567,574
                  Machinery and equipment            3,022,256         2,503,863          2,779,201
                  Vehicles                             119,770           109,877            113,885
                  Office equipment                      82,352            56,972             80,231
                                                 -------------     -------------      -------------
                                                 $   5,532,148     $  4,978,482       $   5,199,291
                                                 =============     =============      =============
</TABLE>

     Depreciation  charged  to  income  for the  three  and  nine  months  ended
     September 30, 1998  and 1997 was $ 87,869,  $44,417 , $263,607 and $133,253
     respectively, and $234,050 for the year ended December 31, 1997.

     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  $214,058 and
     $59,000  of rent  during  1997 and 1996,  respectively,  included  in other
     income.

Note 5 - NOTES PAYABLE

<TABLE>
<CAPTION>
                                                                      (Unaudited)
                                                               For the nine months ended 
                                                                     September 30,           For the year ended
                                                              ----------------------------      December 31
                                                                  1998             1997             1997
                                                              -------------   ------------   ------------------
<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.                    $    184,932    $    200,983      $  197,106


<PAGE>


     Mortgage note payable, American National Bank 
     and Trust Company of Chicago, payable in monthly 
     installments of $3,161 including interest at 7.25%, 
     with a balloon payment of $343,154 due August
     2003.  Collaterlized by real estate.                          397,763         423,511         416,220

     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.                812,356         878,773         858,339

     Note payable, Glenview State Bank, payable in 
     monthly installments of $460, including interest 
     at 6.25%, due March, 1998.  Collateralized by
     automobile.                                                         0           3,156           1,816
                                                               -----------    ------------     -----------

         Total                                                 $ 1,395,051    $  1,506,423     $ 1,473,481
</TABLE>





                                  F-11


<PAGE>

                    LIFEWAY FOODS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997

Note 5 - NOTES PAYABLE - Continued

<TABLE>
<CAPTION>
                                                                (Unaudited)
                                                        For the nine months ended        For the year ended
                                                               September 30,             For the year ended
                                                       -------------------------------       December 31
                                                           1998               1997               1997
                                                       -----------        ------------   ------------------
<S>                                                    <C>                <C>                 <C>

Less current maturities                                    266,964             106,903             681,561
                                                       -----------        ------------        ------------

         Total                                         $ 1,128,087        $  1,399,520        $    791,920
                                                       ===========        ============        ============

     Maturities of notes payable are as follows:

         Year Ending December 31,
                           1998                                                               $    681,561
                           1999                                                                     61,308
                           2000                                                                     61,308
                           2001                                                                    669,304
                                                                                              ------------

                           Total                                                              $  1,473,481
</TABLE>

Note 6 - PROVISION FOR INCOME TAXES

     The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
                                                                   (Unaudited)
                                                            For the nine months ended 
                                                                  September 30,           For the year ended
                                                          ------------------------------     December 31
                                                               1998              1997            1997
                                                          -------------    -------------  ------------------
<S>                                                       <C>              <C>               <C>

     Current
         Federal                                          $     323,912    $     323,522     $     369,507
         State                                                   73,616           73,528            82,353
                                                          -------------    -------------     -------------
     Total current                                              397,528          397,050           451,860
     Deferred                                                         0                0            24,942
                                                          -------------    -------------     -------------

     Provision for income taxes                           $     397,528    $     397,050     $     476,802
                                                          =============    =============     =============

<PAGE>


     A  reconciliation  of the  provision  for  income  taxes and the income tax
     computed at the statutory rate is as follows:
                                                                  (Unaudited)
                                                            For the nine months ended
                                                                 September 30,            For the year ended
                                                          ------------------------------       December 31
                                                              1998              1997               1997
                                                          -------------    -------------  ------------------

         Federal income tax expense
            computed at the statutory rate                $     323,912    $     323,522       $   399,596
         State taxes, expense                                    73,616           73,528            58,764
         Permanent book/tax difference                                0                0            18,442
                                                          -------------    -------------       -----------
 
         Provision for income taxes                       $     397,528    $     397,050       $   476,802
                                                          =============    =============       ===========
</TABLE>


                                    F-12


<PAGE>


                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997


Note 6 - PROVISION FOR INCOME TAXES - Continued

Amounts for deferred tax assets and  liabilities  as of December 31, 1997 are as
follows:

         Non-current deferred tax liabilities arising from:
              Temporary differences - principally
                  Book/tax, accumulated depreciation                $     82,012
                  Book/tax, accumulated amortization                    ( 2,772)
                                                                    ------------
              Total deferred tax liabilities                              79,240

         Current deferred tax assets arising from:
              Book/tax, allowance for doubtful accounts             $     22,176
               Book/tax, inventory                                        37,178
                                                                    ------------
         Total deferred tax assets                                        59,354

         Net deferred tax liability                                 $     19,886
                                                                    ============


Note 7 - 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 9.8%
     and 9.6% of 1997 sales and 12.7% and 22.2% of trade accounts  receivable as
     of December 31, 1997, respectively.

Note 9 -  INTANGIBLE ASSETS

     Intangible assets consisted of the following at December 31, 1997:

         Covenant Not to Compete                                       $  50,000
         UPC Codes                                                       200,000
         Organization Costs                                               44,343
                                                                       ---------
                                                                         294,343
         Accumulated amortization                                        270,477
                                                                       ---------
                                                                       $  23,866
                                                                       =========
     Total  amortization  charged  against  income for the three and nine months
     ended September 30, 1998 and 1997 was $3,469, $10,611,  $10,404 and $31,832
     respectively, and $42,441 for the year ended December 31, 1997.



                                    F-13


<PAGE>


                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997


Note 9 - 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 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                             Dairy                           Corporate
        1997                                Products        Restaurant        & Other         Consolidated
     ---------                           ------------      ------------     ------------      ------------
<S>                                      <C>               <C>              <C>               <C> 

     Sales                               $  5,612,930      $    347,948     $          0      $  5,960,878
     Net Income                          $    750,564      $   (38,400)     $   (11,847)      $    700,317
     Identifiable Assets                 $  6,056,942      $    119,261     $     56,295      $  6,232,498
     Depreciation and
         Amortization                    $    257,073      $     10,548     $      8,870      $    276,491
     Capital Additions                   $  1,272,760      $          0     $          0      $  1,272,760

        1996
     ---------
     Sale                                $  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      $          0     $          0      $  1,401,494
</TABLE>

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 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.

     The option  price,  number of shares and grant date are  determined  at the
     discretion of the  Company's  Board of Directors  and are  considered  100%
     vested at the grant  date.  Options  issued  under the plan expire June 30,
     2000.

     The fair value of each option grant is estimated on the date of grant using
     the Black-Scholes  option-pricing  model with the following  weight-average
     assumptions used for grants:  dividend yield of 0%, expected  volatility of



<PAGE>



     54%, risk free interest rate of 6.2% and expected lives of three years. The
     weighted-average  fair value of options  granted  during 1997 was $1.48 per
     share.

     The  Company  has  chosen  to  account  for  stock-based   compensation  in
     accordance  with APB  Opinion  25. If  compensation  cost  would  have been
     recognized in accordance with Statement of Financial  Accounting  Standards
     No. 123, "Accounting for Stock-Based Compensation," compensation cost would
     have increased by approximately $81,000, net income would have been reduced
     by  approximately  $48,000 in 1997,  and earnings per share would have been
     reduced by $0.01.







                                  F-14


<PAGE>

                     LIFEWAY FOODS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1997

Note 10 - STOCK OPTION PLANS - Continued

     A summary of option transactions during the year ended December 31, 1997 is
     shown below:

<TABLE>
<CAPTION>
                                                                Number          Weighted-Average
                                                                  of                Exercise
                                                                Shares                Price
                                                               --------         ----------------
<S>                                                            <C>              <C>
     Outstanding and exercisable at January 1, 1997                 ---                   N/A
     Granted                                                     55,000                 $5.00
     Exercised                                                      ---                 $5.00
     Forfeited                                                      ---                   ---
     Expired                                                        ---                   ---
                                                               --------
     Outstanding and exercisable at December 31, 1997            55,000                 $5.00
                                                               ========

     Available for issuance at December 31, 1997                245,000
                                                               ========

     Additionally,  during 1997, the Company issued 3,900 shares of common stock
     in exchange for services valued at $21,562.

Note 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated fair value of the Company's  financial  instruments,  none of
     which are held for trading purposes, are as follows at December 31, 1997:

                                                              Carrying                   Fair
                                                               Amount                    Value
                                                            -----------              ------------
         Cash and cash equivalents                          $   550,670              $    550,670
         Certificates of Deposit                                227,622                   227,622
         Note payable to bank                                     1,816                     1,816
         Mortgages payable                                    1,471,665                 1,446,985
                                                            -----------               -----------

         Total                                              $ 2,251,773               $ 2,227,093
                                                            ===========               ===========

     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-15


<PAGE>


Item 2.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

(1)      Material Changes in Results of Operations

         Net income for the nine month  period  ending  September  30,  1998 was
$628,770 an increase of $758 over the same nine month  period in 1997.  Although
sales increased for the current period,  they were offset by increased operating
expenses and a decrease in other income. The material  components of the charges
in net income are detailed as follows:

         Sales  increased by $680,661,  up to  $5,072,862  during the nine month
period ending  September 30, 1998,  from  $4,392,201  during the same nine month
period in 1997.  The  increase in Sales can be  attributed  to  increased  sales
volume as well as product  price  increases  implemented  during the most recent
quarter.  Cost of goods sold were $1,399,363 during the nine month period ending
September 30, 1998, a decrease of $93,490 from  $1,322,933  during the same nine
month  period in 1997.  This  decrease  in cost of goods sold can be  attributed
primarily to a change in product mix: the Company's new production  facility has
allowed the Company to produce and sell more  products  having a greater  profit
margin than in the past.

         Operating expenses increased by $558,922, up to $1,679,994 for the nine
month period ending  September 30, 1998,  from  $1,121,072  during the same nine
month  period in 1997.  This  increase is  primarily  attributable  to increased
expenses  incurred  in  connection  with  the  operation  of the new  production
facility.

         Other income was $-0- for the nine month period  ending  September  30,
1998,  compared to $214,058  for the same nine month  period in 1997.  The other
income in 1997 is attributable to the receipt of rent revenues from a tenant who
occupied the real property that was acquired by the Company in 1996. The Company
is now occupying the property for its own use.

(2)      Liquidity and Capital Resources

         As of the nine month period  ending  September 30, 1998, as compared to
the nine month period ending September 30, 1997, the Company had working capital
in the amount of $1,682,952 as compared to $1,400,638, respectively, an increase
of  $282,314;  and  cash on hand in the  amounts  of  $695,799  as  compared  to
$503,366,  respectively,  an increase of $192,433. These increases are primarily
attributable  to  decreased  use of cash in the current year for the purchase of
additional  equipment  and a  build-up  of  inventories  for the new  production
facility, as compared to the prior year.  Additionally,  there was a decrease in
long-term liabilities and a corresponding increase in current liabilities due to
the upcoming maturities of several mortgage notes payable,  which will be due in
1998. The Company intends to refinance all of these mortgages during 1998.

         The Company's balance in inventory increased by $62,600, up to $721,000
as of September 30, 1998, as compared to $658,400 as of September 30, 1997.  The
increase is primarily due to an increase in production and sales.


<PAGE>


         Net  cash  used in  investing  activities  for the  nine  months  ended
September 30, 1998 was $341,921,  as compared to $1,042,404  for the same period
in 1997,  a decrease of  $700,483.  The use of cash in both periods is primarily
due to the  purchase of property  and  equipment  for use in the new  production
facility.

         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. The accompanying financial statements include all adjustments which in
the  opinion  of  management  are  necessary  in  order  to make  the  financial
statements not misleading.



<PAGE>


                         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 -

         In  October  1998  the  Company  finalized a sublicense  agreement with
GalaGen, Inc., with an effective date of May 1, 1998. Pursuant to the agreement,
the  Company  obtained  the  exclusive  worldwide rights to two patents, for the
duration of the patents, to produce and sell kefir-culture  based products which
contain  immunoglobulins,  such  as  the  Company's new functional food product,
Basic  Plus (TM).  GalaGen is the Company's supplier of the Proventra (TM) brand
natural  immune  components  used  in  Basic  Plus.  The owner of the patents is
Metagenics,  Incorporated.  In  exchange  for such rights, the Company agreed to
pay  $10,000  to GalaGen and a royalty to Metagenics  of one  percent of the net
sales  price of any  kefir-culture based products which contain immunoglobulins.

Item 6.  Exhibits and Reports on Form 8-K

(a)      Exhibits:  Exhibit Number and Brief Description

    3.1  Articles of Incorporation, with Certificate, and Amendments. (1)
    3.2  Bylaws of issuer. (1)
    3.3  Corrected Amendment to the Bylaws. (1)
    10.1 Lifeway Foods, Inc. Consulting and Services Compensation Plan, dated
         June 5, 1995. (2)
    27   Financial Data Schedule. (3)

    ----------------------------
    footnotes:

    (1)  Incorporated  by  reference  to the Company's registration statement on
         Form S-18 (File No. 33-14329-C), and Post-Effective Amendments thereto.
    (2)  Incorporated  by  reference  to the Company's registration statement on
         Form S-8 (File No. 33-93306).
    (3)  Filed herewith.

(b)      Reports on Form 8-K - None.


<PAGE>



                                  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:   November 5, 1998


<PAGE>



                               EXHIBIT INDEX

NUMBER            BRIEF DESCRIPTION

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

3.2           Bylaws of issuer. (1)

3.3           Corrected Amendment to the Bylaws. (1)

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

27            Financial Data Schedule. (3)

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

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

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

    (3) Filed herewith.


</TABLE>