<PAGE>   1
                         REVIEW AND DISCUSSION DRAFT #2
                                 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 June 30, 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                     (IRS Employer
    incorporation 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 AUGUST 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
         June 30, 1997 and 1996

                  Consolidated Balance Sheets
                  December 31, 1996 and
                  June 30, 1997 and 1996 (unaudited)                                           F-1 - F-2

                  Consolidated Statements of Income
                  for the year ended December 31, 1996 and
                  for the three and  six months ended June 30, 1997 and 1996 (unaudited)          F-3

                  Consolidated Statements of Changes in Stockholders' Equity
                  for the year ended December 31, 1996 and
                  for the six months ended June 30, 1997 (unaudited)                              F-4

                  Consolidated Statements of Cash Flows
                  for the year ended December 31, 1996 and
                  for the six months ended June 30, 1997 and 1996 (unaudited)                  F-5 - F-6

                  Notes to Consolidated Financial Statements (unaudited)                       F-7 - F-14

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


PART II - OTHER INFORMATION                                                                        5


SIGNATURES                                                                                         6
</TABLE>



                                       2
<PAGE>   3
                         PART I - FINANCIAL INFORMATION
















                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                              FINANCIAL STATEMENTS
                             JUNE 30, 1997 AND 1996


























                                       3

<PAGE>   4


                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET



<TABLE>
<CAPTION>

                                                         (UNAUDITED)
                                                           JUNE 30,        
                                                  -------------------------    DECEMBER 31,
ASSETS                                               1997           1996           1996
                                                  ----------     ----------    ------------

<S>                                               <C>            <C>            <C>       
CURRENT ASSETS
      Cash and cash equivalent                    $  774,667     $  542,661     $  996,101
      Investments                                    220,009        342,000        213,671
      Accounts receivable, net of allowance
         for doubtful accounts of  $48,000 at
         June 30, 1997 and 1996 and
         December 31, 1996                           772,327        628,380        620,408
      Other receivables                               15,200         25,000         23,600
      Inventories                                    581,431        365,429        413,324
      Prepaid expenses and other assets                7,714        407,929          7,714
      Deferred income taxes                           41,418         34,480         41,418
                                                  ----------     ----------     ----------

      TOTAL CURRENT ASSET                          2,412,766      2,345,879      2,316,236

PROPERTY AND EQUIPMENT
      Land                                           658,400        369,500        658,400
      Buildings, machinery and equipment           3,793,191      2,191,697      3,288,231
                                                  ----------     ----------     ----------
      Total property and equipment                 4,451,591      2,561,197      3,946,631
      Less:  accumulated depreciation              1,158,372        963,231      1,069,536
                                                  ----------     ----------     ----------
      PROPERTY AND EQUIPMENT, NET                  3,292,819      1,597,966      2,877,095

OTHER ASSETS
      Intangible assets                              330,343        330,343        330,343
      Less;  accumulated amortization                285,257        238,381        264,036
                                                  ----------     ----------     ----------
      TOTAL OTHER ASSETS                              45,086         91,962         66,307
                                                  ----------     ----------     ----------

TOTAL ASSETS                                      $5,751,071     $4,035,807     $5,259,638
                                                  ==========     ==========     ==========

</TABLE>









                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-1


<PAGE>   5

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET



LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                       (UNAUDITED)
                                                         JUNE 30,               
                                               ---------------------------     DECEMBER 31, 
                                                  1997             1996           1996
                                               ----------       ----------     ------------

<S>                                            <C>              <C>            <C>        
CURRENT LIABILITIES
      Current maturities of notes payable      $   111,170      $   43,588     $   105,928
      Accounts Payable                             337,188         214,979         242,079
      Accrued expenses                             243,755         217,251         272,054
                                               -----------      ----------     -----------
      TOTAL CURRENT LIABILITIES                    692,113         475,818         620,061


LONG-TERM LIABILITIES
      Notes payable                              1,415,985         639,209       1,468,904

DEFERRED INCOME TAXES                               36,362          45,395          36,362


STOCKHOLDERS' EQUITY
      Common Stock                               1,374,754       1,355,935       1,374,754
      Retained Earnings                          2,250,675       1,519,450       1,778,375
      Treasury Stock                               (18,818)              0         (18,818)
                                               -----------      ----------     -----------
      TOTAL STOCKHOLDERS' EQUITY                 3,606,611       2,875,385       3,134,311
                                               -----------      ----------     -----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY     $ 5,751,071      $4,035,807     $ 5,259,638
                                               ===========      ==========     ===========

</TABLE>






















                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-2


<PAGE>   6

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                       CONSOLIDATED STATEMENTS OF INCOME






<TABLE>
<CAPTION>
                                        (UNAUDITED)                      (UNAUDITED)
                                FOR THE THREE MONTHS ENDED         FOR THE SIX MONTHS ENDED          FOR THE
                                          JUNE 30,                         JUNE 30,                YEAR ENDED
                               ----------------------------      ----------------------------      DECEMBER 31,
                                   1997            1996             1997             1996             1996 
                               -----------      -----------      -----------      -----------      ----------- 

<S>                            <C>              <C>              <C>              <C>              <C>        
SALES                          $ 1,473,984      $ 1,352,889      $ 2,887,848      $ 2,611,528      $ 5,295,405

COST OF GOODS SOLD                 662,052          642,487        1,322,933        1,154,720        2,976,307
                               -----------      -----------      -----------      -----------      -----------

GROSS PROFIT                       811,932          710,402        1,564,915        1,456,808        2,319,098

OPERATING EXPENSES                 488,173          414,444          951,878          873,381        1,383,049
                               -----------      -----------      -----------      -----------      -----------


INCOME FROM OPERATIONS             323,759          295,958          613,037          583,427          936,049

OTHER INCOME (EXPENSE)
      Interest income               13,456           13,371           25,869           23,245           52,140
      Interest expense             (29,635)          (9,078)         (66,329)         (21,680)         (62,168)
      Other Income                 123,965                0          198,308              689           59,087
                               -----------      -----------      -----------      -----------      -----------

      TOTAL OTHER INCOME
      (EXPENSE)                    107,786            4,293          157,848            2,254           49,059
                               -----------      -----------      -----------      -----------      -----------

INCOME BEFORE INCOME TAXES         431,545          300,251          770,885          585,681          985,108

PROVISION FOR INCOME TAXES         168,175          119,812          298,585          226,838          367,340
                               -----------      -----------      -----------      -----------      -----------

NET INCOME                     $   263,370      $   180,439      $   472,300      $   358,843      $   617,768
                               ===========      ===========      ===========      ===========      ===========

EARNINGS PER SHARE$            $       .07      $       .05      $       .13      $       .10      $       .16
                               ===========      ===========      ===========      ===========      ===========

WEIGHTED AVERAGE SHARES
OUTSTANDING                      3,777,385        3,774,977        3,777,385        3,774,977        3,777,385
                               ===========      ===========      ===========      ===========      ===========


</TABLE>














                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-3


<PAGE>   7

                      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         18,818                 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


Net income for the six months
     ended June 30, 1997                     0             0                 0              0           472,300
                                     ---------        ------        ----------        -------        ----------

BALANCES AT
  JUNE 30, 1997                      3,785,377        10,400         1,374,754        $18,818        $2,250,675
                                     =========        ======        ==========        =======        ==========

</TABLE>



















                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-4


<PAGE>   8

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


<TABLE>
<CAPTION>
                                                                         (UNAUDITED)
                                                                 FOR THE SIX MONTHS ENDED
                                                                           JUNE 30,          FOR THE YEAR ENDED
                                                                 ------------------------       DECEMBER 31
                                                                    1997           1996            1996  
                                                                 ---------      ---------    ------------------

<S>                                                              <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net income                                                 $ 472,300      $ 358,843      $   617,768
      Adjustments to reconcile net income to net
         cash flows from operating activities:
              Depreciation and amortization                        110,057        111,248          243,208
              Deferred income taxes                                      0              0          (15,971)
              Gain on sale of asset                                      0           (689)               0
              (Increase) decrease in operating assets:
                    Accounts receivable                           (151,919)       (23,759)         (15,787)
                    Other receivable                                 8,400          1,200            2,600
                    Inventories                                   (168,107)       (77,329)        (125,224)
                    Prepaid expenses and other assets                    0       (386,723)          13,492
               Increase (decrease) in operating liabilities:
                    Accounts payable                                95,109        (30,245)          (3,145)
                    Accrued expenses                               (28,299)       (46,352)           8,451
                                                                 ---------      ---------      -----------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES                   337,541        (93,806)         725,392

CASH FLOWS FROM INVESTING ACTIVITIES:
      Purchase of investments                                       (6,338)      (112,000)         (13,671)
      Sale of investments                                                0        100,100          129,411
      Purchase of property and equipment                          (504,960)       (16,060)      (1,401,494)
      Proceeds from sales of assets                                      0              0                0
                                                                 ---------      ---------      -----------
NET CASH PROVIDED BY (USED) IN
     INVESTING ACTIVITIES                                         (511,298)       (27,960)      (1,285,754)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from notes payable                                        0              0          919,645
      Repayments of notes payable                                  (47,677)       (18,917)         (46,471)
      Purchase of Treasury Stock                                         0        (18,819)         (18,818)
                                                                 ---------      ---------      -----------
NET CASH USED IN FINANCING ACTIVITIES                              (47,677)       (37,680)         854,356
                                                                 ---------      ---------      -----------

NET INCREASE (DECREASE) IN CASH AND
     CASH EQUIVALENTS                                             (221,434)      (159,446)         293,994

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


CASH AND CASH EQUIVALENTS AT END OF PERIOD                       $ 774,677      $ 542,661      $   996,101
                                                                 =========      =========      ===========

</TABLE>




                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-5


<PAGE>   9

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



<TABLE>
<CAPTION>
                                                            (UNAUDITED)
                                                     FOR THE SIX MONTHS ENDED   
                                                             JUNE 30,             FOR THE YEAR ENDED
                                                     ------------------------         DECEMBER 31
                                                       1997            1996              1996
                                                     --------        --------     ------------------

<S>                                                  <C>             <C>              <C>     
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Cash paid for interest                               $ 66,329        $ 21,680         $ 62,168
                                                     ========        ========         ========

Cash paid for income taxes                           $286,560        $164,900         $486,900
                                                     ========        ========         ========

</TABLE>








































                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-6


<PAGE>   10

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 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-7


<PAGE>   11

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 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>
           <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-8
<PAGE>   12

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 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 SIX MONTHS ENDED
                                              JUNE 30,           FOR THE YEAR ENDED
                                     ------------------------         DECEMBER 31
                                       1997            1996              1996 
                                     --------        --------    ------------------

          <S>                        <C>             <C>             <C> 
          Finished goods             $410,478        $226,229        $300,287
          Production supplies          84,088          69,000          33,957
          Raw materials                86,865          70,200          79,080
                                     --------        --------        --------
                                     $581,431        $365,429        $413,324
                                     ========        ========        ========
        </TABLE>





                                      F-9
<PAGE>   13

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 4 - PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
                                             (UNAUDITED)
                                     FOR THE SIX MONTHS ENDED
                                              JUNE 30,           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       1,663,437     1,233,899         1,448,752
        Vehicles                        109,877       109,877           109,877
        Leasehold improvements          370,507        51,169            80,232
                                     ----------    ----------        ----------
                                     $4,451,590    $2,561,197        $3,946,631
                                     ==========    ==========        ==========
</TABLE>

      Depreciation charged to income for the three and six months ended June
      30, 1997 and 1996 was $ 44,417 , $47,231 , $88,835 and $94,462
      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 SIX MONTHS ENDED
                                                                                      JUNE 30,           FOR THE YEAR ENDED
                                                                             ------------------------         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                                   $  206,071     $221,324        $  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.  Collateralized by real estate                                      427,620      452,345           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.                            888,991            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                                                                  4,473        9,128             7,045
                                                                             ----------     --------         ---------

          Total                                                               1,527,155      682,787         1,574,832

</TABLE>



                                      F-10


<PAGE>   14

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 5 - NOTES PAYABLE - CONTINUED      

<TABLE>
<CAPTION>
                                             (UNAUDITED)
                                     FOR THE SIX MONTHS ENDED
                                              JUNE 30,           FOR THE YEAR ENDED
                                     ------------------------         DECEMBER 31
                                       1997            1996              1996 
                                     --------        --------    ------------------

     <S>                           <C>               <C>              <C> 

     Less current maturities           11,170          43,588            105,928
                                   ----------        --------         ----------


                Total              $1,415,985        $639,209         $1,468,904
                                   ==========        ========         ==========

</TABLE>


      Maturities of notes payable are as follows:

<TABLE>
            <S>                 <C>                                       <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 SIX MONTHS ENDED
                                                JUNE 30,           FOR THE YEAR ENDED
                                       ------------------------         DECEMBER 31
                                        1997            1996              1996 
                                       --------        --------    ------------------

     <S>                               <C>             <C>             <C> 
     Current
           Federal                     $243,308        $184,858        $ 312,270
           State                         55,277          41,980           71,041
                                       --------        --------        ---------
     Total current                      298,585         226,838          383,311
     Deferred                                 0               0          (15,971)
                                       --------        --------        ---------

     Provision for income taxes        $298,585        $226,838        $ 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 SIX MONTHS ENDED
                                                                JUNE 30,           FOR THE YEAR ENDED
                                                        ------------------------         DECEMBER 31
                                                          1997            1996              1996 
                                                        --------        --------    ------------------

     <S>                                                <C>             <C>             <C> 

     Federal income tax expense
       computed at the statutory rate                   $243,308        $184,858        $ 334,937
     State taxes, expense                                 55,277          41,980           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                         $298,585        $226,838        $ 367,340
                                                        ========        ========        =========
</TABLE>

                                      F-11


<PAGE>   15

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 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-12
<PAGE>   16

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 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-13
<PAGE>   17

                      LIFEWAY FOODS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  JUNE 30, 1997 AND 1996 AND DECEMBER 31, 1996


NOTE 12 - STOCK OPTION PLANS

      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 the plan. 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-14


<PAGE>   18


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 $113,457, up to $472,300 for the six month
period ending June 30, 1997, from $358,843 during the same six month period in
1996. The material components of this increase are detailed as follows:

         Sales and cost of goods sold increased by $276,320 and $168,213,
respectively, up to $2,887,848 and $1,322,933, respectively, during the six
month period ending June 30, 1997, from $2,611,528 and $1,154,720,
respectively, during the same six 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 $44,649, up to $66,329 during the six
month period ending June 30, 1997, from $21,680 during the same six 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 $197,619, up to $198,308 during the six
month period ending June 30, 1997, from $689 during the same six month period
in 1996. The increase 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 tenant vacate the property during the second quarter of 1997 so no future
rent revenues will be received, and the Company is now occupying the property
for its own use.

         Provision for income taxes increased by $71,747, up to $298,585 during
the six month period ending June 30, 1997, from $226,838 during the same six
month period in 1996. The increase is proportionate to the net income increase.

(2)      Material Changes in Financial Condition

         As of the six month period ending June 30, 1997, as compared to the
six month period ending June 30, 1996, the Company had working capital in the
amount of $1,720,653 as compared to $1,870,061, respectively, a decrease of
$149,408; and cash on hand in the amounts of $774,667 as compared to $542,661,
respectively, an increase of $232,006. The decrease in working capital is
primarily due to a large decrease in "prepaid expenses and other assets" for
the current year because this account had included in the prior period large
security deposits on property and equipment that have since been purchased.
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 $216,002, up to
$581,431 as of June 30, 1997, as compared to $365,429 as of June 30, 1996. The
increase is primarily due to an increase in production and sales.

         Net cash provided (used) by operating activities increased by
$431,347, up to $337,541 as of June 30, 1997, as compared to $(93,806) as of
June 30, 1996. The increase is primarily due to 1) a significant increase in
accounts payable due primarily to increased sales; and 2) a significant
decrease in prepaid expenses and other assets due primarily to the Company's
purchaser of property and equipment that had been under deposit in the prior
period.

         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.



                                       4
<PAGE>   19

                          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)

         10.9     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)

         =======================================

         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.


                                       5
<PAGE>   20



                                   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:   August 6, 1997



                                       6
<PAGE>   21

                                 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)

10.9     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.