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

                                  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 September 30, 2005


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

          For the transition period from __________ to __________

                         Commission file number: 0-17363



                               LIFEWAY FOODS, INC.
--------------------------------------------------------------------------------
        (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)

                 6431 WEST OAKTON, MORTON GROVE, ILLINOIS 60053
--------------------------------------------------------------------------------
                    (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 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 September 30, 2005, the issuer
had 8,393,855 shares of common stock, no par value, outstanding.

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

                                      INDEX


PART I - FINANCIAL INFORMATION................................................3

   ITEM 1.  FINANCIAL STATEMENTS..............................................3
   ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION........19
   ITEM 3.  CONTROLS AND PROCEDURES..........................................21

PART II - OTHER INFORMATION..................................................21

   ITEM 2. LEGAL PROCEEDINGS.................................................21
   ITEM 5. OTHER INFORMATION.................................................21
   ITEM 6. EXHIBITS..........................................................22

SIGNATURE....................................................................23





















                                        2
<PAGE>

                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                 Consolidated Statements of Financial Condition
                           September 30, 2005 and 2004
                              and December 31, 2004

<TABLE><CAPTION>
                                                                         SEPTEMBER 30,           DECEMBER 31,
                                                                 ----------------------------    ------------
                                                                     2005            2004            2004
                                                                 ------------    ------------    ------------
<S>                                                              <C>             <C>             <C>
ASSETS
------

CURRENT ASSETS
   Cash and cash equivalents                                     $  4,191,755    $  5,348,135    $  5,773,285
   Marketable securities                                            7,580,531       6,727,867       6,741,987
   Accounts receivable, net of allowance for doubtful
      accounts of $15,000 at September 30, 2005 and 2004
      and December 31, 2004                                         2,637,528       1,943,032       2,024,036
   Other receivables                                                  109,093          80,582          72,137
   Inventories                                                      1,301,066         915,951         905,697
   Prepaid expenses and other current assets                           82,293           8,344           7,260
   Deferred income taxes                                               46,881          90,937              --
   Refundable income taxes                                             58,037          68,042         258,617
                                                                 ------------    ------------    ------------
   TOTAL CURRENT ASSETS                                            16,007,184      15,182,890      15,783,019

PROPERTY AND EQUIPMENT, NET                                         7,755,352       3,482,524       3,420,138

INTANGIBLE ASSETS
   Goodwill                                                            75,800         511,800          75,800
   Other intangible assets, net of amortization of $59,379
      and $26,990 at September 30, 2005 and December 31, 2004         366,567              --         409,010
                                                                 ------------    ------------    ------------
TOTAL INTANGIBLE ASSETS                                               442,367         511,800         484,810

TOTAL ASSETS                                                     $ 24,204,903    $ 19,177,214    $ 19,687,967
                                                                 ============    ============    ============


LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------

CURRENT LIABILITIES
   Current maturities of notes payable                           $    534,938    $     11,716    $      8,784
   Accounts payable                                                   648,881         701,145         641,651
   Accrued expenses                                                   453,895         186,591         195,541
   Deferred income taxes                                                                   --          36,214
                                                                 ------------    ------------    ------------
   TOTAL CURRENT LIABILITIES                                        1,637,714         899,452         882,190

NOTES PAYABLE                                                       2,919,656         465,796         463,541

DEFERRED INCOME TAXES                                                 362,314         426,895         424,039

STOCKHOLDERS' EQUITY
   Common stock                                                     6,509,267       6,509,267       6,509,267
   Paid-in-capital                                                     82,738          56,540          64,314
   Stock subscription receivable                                                       (5,000)             --
   Treasury stock, at cost                                         (1,034,172)       (652,776)       (649,039)
   Retained earnings                                               13,715,660      11,534,832      11,874,475
   Accumulated other comprehensive income (loss), net of taxes         11,726         (57,792)        119,180
                                                                 ------------    ------------    ------------
   TOTAL STOCKHOLDERS' EQUITY                                      19,285,219      17,385,071      17,918,197
                                                                 ------------    ------------    ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                       $ 24,204,903    $ 19,177,214    $ 19,687,967
                                                                 ============    ============    ============
</TABLE>

                 See accompanying notes to financial statements

                                       3
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           Consolidated Statements of Income and Comprehensive Income
        For the Three and Nine Months Ended September 30, 2005 and 2004
                      and The Year Ended December 31, 2004


<TABLE><CAPTION>
                                                THREE MONTHS ENDED              NINE MONTHS ENDED
                                                   SEPTEMBER 30,                   SEPTEMBER 30,           DECEMBER 31,
                                           ----------------------------    ----------------------------    ------------
                                               2005            2004            2005            2004            2004
                                           ------------    ------------    ------------    ------------    ------------
<S>                                        <C>             <C>             <C>             <C>             <C>
SALES                                      $  5,194,648    $  4,138,606    $ 14,924,076    $ 12,075,778    $ 16,319,210

Cost of goods sold                            3,073,314       2,239,553    $  8,607,538    $  6,604,554       9,034,971
                                           ------------    ------------    ------------    ------------    ------------

GROSS PROFIT                                  2,121,334       1,899,053       6,316,538       5,471,224       7,284,239

Operating expenses                            1,359,171       1,157,906    $  3,793,394    $  3,089,336       4,333,788
                                           ------------    ------------    ------------    ------------    ------------

INCOME FROM OPERATIONS                          762,163         741,147       2,523,144       2,381,888       2,950,451

Other income (expense):
   Interest and dividend income                  72,363          49,689         212,927         124,897         185,575
   Interest expense                             (36,877)         (7,584)        (51,195)        (23,103)        (31,441)
   Gain (loss) on sale of marketable
      securities, net                           162,446          12,386         324,433         321,716         354,128
   Gain (loss) on marketable securities
      classified as trading                        (681)         15,681          14,355         (12,077)        (16,487)
                                           ------------    ------------    ------------    ------------    ------------
Total other income                              197,251          70,172         500,520         411,433         491,775
                                           ------------    ------------    ------------    ------------    ------------

INCOME BEFORE PROVISION FOR INCOME TAXES        959,414         811,319       3,023,664       2,793,321       3,442,226

Provision for income taxes                      400,464         296,210       1,182,479       1,080,905       1,390,167
                                           ------------    ------------    ------------    ------------    ------------
NET INCOME                                 $    558,950    $    515,109    $  1,841,185    $  1,712,416    $  2,052,059
                                           ============    ============    ============    ============    ============
BASIC AND DILUTED EARNINGS PER COMMON
SHARE                                              0.07            0.06            0.22            0.20            0.24
                                           ============    ============    ============    ============    ============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING                                   8,400,700       8,440,888       8,400,750       8,440,888       8,439,159
                                           ============    ============    ============    ============    ============
COMPREHENSIVE INCOME
--------------------

NET INCOME                                 $    558,950    $    515,109    $  1,841,185    $  1,712,416    $  2,052,059

Other comprehensive income (loss), net
of tax:
   Unrealized gains (losses) on
      marketable securities
      (net of tax benefits)                     103,458         (11,245)       (282,988)        (25,827)        170,107
Less reclassification adjustment for
   gains (losses)
included in net income (net of taxes)           (96,369)         (5,140)       (190,442)       (188,202)       (207,164)
                                           ------------    ------------    ------------    ------------    ------------
Comprehensive income                       $    566,039    $    498,724    $  1,733,731    $  1,498,387    $  2,015,002
                                           ============    ============    ============    ============    ============
</TABLE>

                 See accompanying notes to financial statements

                                        4
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           Consolidated Statements of Changes in Stockholders' Equity
                  For the Nine Months Ended September 30, 2005
                      and the Year Ended December 31, 2004


<TABLE><CAPTION>
                      COMMON STOCK, NO PAR VALUE
                     10,000,000 SHARES AUTHORIZED  # OF SHARES
                     ---------------------------        OF
                      # OF SHARES    # OF SHARES     TREASURY        COMMON         PAID IN
                        ISSUED       OUTSTANDING       STOCK          STOCK         CAPITAL
                     ------------   ------------   ------------   ------------   ------------
<S>                  <C>            <C>            <C>            <C>            <C>
BALANCES AT
DECEMBER 31, 2003       8,636,888      8,436,888        200,000   $  6,509,267   $         --

Issuance of
treasury stock                 --          4,550         (4,550)            --         64,314

Other comprehensive
income (loss):
  Unrealized losses
  on securities,
  net of taxes and
  reclassification
  adjustment                   --             --             --             --             --

Payment on
subscription
receivable                     --             --             --             --             --

Net income for the
year ended December
31, 2004                       --             --             --             --             --
                     ------------   ------------   ------------   ------------   ------------
BALANCES AT
DECEMBER 31, 2004       8,636,888      8,441,438        195,450   $  6,509,267   $     64,314


Issuance of
treasury stock                 --          2,417         (2,417)            --         18,424

Redemption of
treasury stock                 --        (50,000)        50,000             --             --

Other comprehensive
income (loss):
  Unrealized losses
  on securities,
  net of taxes and
  reclassification
  adjustment                   --             --             --             --             --

Net income for the
nine months ended
September 30, 2005             --             --             --             --             --
                     ------------   ------------   ------------   ------------   ------------
BALANCES AT
SEPTEMBER 30, 2005      8,636,888      8,393,855        243,033   $  6,509,267   $     82,738
                     ============   ============   ============   ============   ============





                                                                  ACCUMULATED
                                                                     OTHER
                        STOCK                                    COMPREHENSIVE
                     SUBSCRIPTION     TREASURY       RETAINED    INCOME (LOSS),
                      RECEIVABLE        STOCK        EARNINGS      NET OF TAX        TOTAL
                     ------------   ------------   ------------   ------------   ------------
BALANCES AT
DECEMBER 31, 2003    $    (15,000)  $   (679,956)  $  9,822,416   $    156,237   $ 15,792,964

Issuance of
treasury stock                 --         30,917             --             --         95,231

Other comprehensive
income (loss):
  Unrealized losses
  on securities,
  net of taxes and
  reclassification
  adjustment                   --             --             --        (37,057)       (37,057)

Payment on
subscription
receivable                 15,000             --             --             --         15,000

Net income for the
year ended December
31, 2004                       --             --      2,052,059             --      2,052,059
                     ------------   ------------   ------------   ------------   ------------
BALANCES AT
DECEMBER 31, 2004    $         --   $   (649,039)  $ 11,874,475   $    119,180   $ 17,918,197


Issuance of
treasury stock                 --         16,421             --             --         34,845

Redemption of
treasury stock                 --       (401,554)            --             --       (401,554)

Other comprehensive
income (loss):
  Unrealized losses
  on securities,
  net of taxes and
  reclassification
  adjustment                   --             --             --       (107,454)      (107,454)

Net income for the
nine months ended
September 30, 2005             --             --      1,841,185             --      1,841,185
                     ------------   ------------   ------------   ------------   ------------
BALANCES AT
SEPTEMBER 30, 2005   $         --   $ (1,034,172)  $ 13,715,660   $     11,726   $ 19,285,219
                     ============   ============   ============   ============   ============
</TABLE>



                 See accompanying notes to financial statements

                                        5
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                      Consolidated Statements of Cash Flows
              For the Nine Months Ended September 30, 2005 and 2004
                      and the Year Ended December 31, 2004


<TABLE><CAPTION>
                                                                        NINE MONTHS ENDED          YEAR ENDED
                                                                           SEPTEMBER 30,           DECEMBER 31,
                                                                   ----------------------------    ------------
                                                                       2005            2004            2004
                                                                   ------------    ------------    ------------
<S>                                                                <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
-------------------------------------
  NET INCOME                                                       $  1,841,185    $  1,712,416    $  2,052,059
  Adjustments to reconcile net income to net cash flows from
  operating activities:
      Depreciation and amortization                                     486,050         474,876         669,994
      Gain on sale of marketable securities, net                       (324,433)       (321,716)       (354,128)
      (Gain)/Loss on marketable securities classified as trading        (14,355)         12,077          16,487
      Deferred income taxes                                             (69,220)         45,776          45,560
      Treasury stock issued for services                                 34,845              --          95,231
      (Increase) decrease in operating assets:
          Accounts receivable                                          (613,492)       (142,891)       (223,895)
          Other receivables                                             (36,956)         85,185          93,630
          Inventories                                                  (395,369)       (104,379)        (94,125)
          Refundable income taxes                                       200,580         238,129          47,554
          Prepaid expenses and other current assets                     (75,033)         (7,551)         (6,469)
      Increase (decrease) in operating liabilities:
          Accounts payable                                                7,230         (94,176)       (153,670)
          Accrued expenses                                              258,354           2,991          11,941
                                                                   ------------    ------------    ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES                             1,299,386       1,900,737       2,200,169

CASH FLOWS FROM INVESTING ACTIVITIES:
-------------------------------------
  Purchases of marketable securities                                 (5,149,008)     (5,790,781)     (6,265,671)
  Sale of marketable securities                                       4,466,196       5,306,395       6,096,652
  Purchases of property and equipment                                (4,772,181)       (224,669)       (330,411)
  Acquisition of Ilya's Farms, Inc. net of assets acquired                   --        (511,800)       (511,800)
  Loan acquisition costs                                                 (6,638)             --              --
                                                                   ------------    ------------    ------------
NET CASH USED IN INVESTING ACTIVITIES                                (5,461,631)     (1,220,855)     (1,011,230)

CASH FLOWS FROM FINANCING ACTIVITIES:
-------------------------------------
  Proceeds from stock subscription receivable                                --          83,720          15,000
  Proceeds from note payable                                          3,000,000              --              --
  Purchases of treasury stock                                          (401,554)         10,000              --
  Repayment of notes payable                                            (17,731)        (23,286)        (28,473)
                                                                   ------------    ------------    ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                   2,580,715          70,434         (13,473)
                                                                   ------------    ------------    ------------

Net increase/(decrease) in cash and cash equivalents                 (1,581,530)        750,316       1,175,466

Cash and cash equivalents at the beginning of the period              5,773,285       4,597,819       4,597,819
                                                                   ------------    ------------    ------------

CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD                 $  4,191,755    $  5,348,135    $  5,773,285
                                                                   ============    ============    ============
</TABLE>
                                        6
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 1 - NATURE OF BUSINESS

Lifeway Foods, Inc. (The "Company") commenced operations in February 1986 and
incorporated under the laws of the state of Illinois on May 19, 1986. The
Company's principal business activity is the production of dairy products.
Specifically, the Company produces Kefir, a drinkable product which is similar
to but distinct from yogurt, in several flavors sold under the name "Lifeway's
Kefir;" a plain farmer's cheese sold under the name "Lifeway's Farmer's Cheese;"
a fruit sugar-flavored product similar in consistency to cream cheese sold under
the name of "Sweet Kiss;" and a dairy beverage, similar to Kefir, with increased
protein and calcium, sold under the name "Basics Plus." The Company also
produces several soy-based products under the name "Soy Treat" and a
vegetable-based seasoning under the name "Golden Zesta." The Company currently
distributes its products throughout the Chicago Metropolitan area through local
food stores. In addition, the products are sold throughout the United States and
Ontario, Canada by distributors. The Company also distributes some of its
products to Eastern Europe.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     A summary of the significant accounting policies applied in the preparation
of the accompanying financial statements follows:

         Principles of consolidation
         ---------------------------
         The consolidated financial statements include the accounts of the
         Company and its wholly-owned subsidiary, LFI Enterprises, Inc. All
         significant intercompany accounts and transactions have been
         eliminated.

         Use of estimates
         ----------------
         The preparation of financial statements in conformity with the Public
         Company Accounting Oversight Board (PCAOB) requires management to make
         estimates and assumptions that affect the reported amounts of assets
         and liabilities and disclosure of contingent assets and liabilities at
         the date of the financial statements and reported amounts of revenues
         and expenses during the reporting period. Actual results could differ
         from those estimates.

         Revenue Recognition
         -------------------
         Sales represent sales of Company produced dairy products that are
         recorded at the time of shipment. In addition, shipping costs invoiced
         to the customers are included in net sales and the related cost in cost
         of sales.

                                        7
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

         Cash and cash equivalents
         -------------------------
         All highly liquid investments purchased with an original maturity of
         three months or less are considered to be cash equivalents.

         The Company maintains cash deposits at several institutions located in
         the greater Chicago, Illinois and Philadelphia, Pennsylvania
         metropolitan areas. Deposits at each institution are insured up to
         $100,000 by the Federal Deposit Insurance Corporation or the Securities
         Investor Protector Corporation.

         Bank balances of amounts reported by financial institutions are
         categorized as follows:

                                                September 30,       December 31,
                                           -----------------------  ------------
                                              2005         2004         2004
                                           ----------  -----------  ------------
         Amounts insured                   $  500,000   $ 500,000    $  472,341
         Uninsured and uncollateralized
           amounts                          3,959,945   5,041,913     5,456,188
                                           ----------  -----------  ------------
         Total bank balances               $4,459,945  $5,541,913    $5,928,529
                                           ==========  ===========  ============

         Marketable securities
         ---------------------
         Marketable securities are classified as available-for-sale or trading
         and are stated at fair value or quoted prices. Gains and losses related
         to marketable securities sold are determined by the specific
         identification method.

         Accounts receivable
         -------------------
         Credit terms are extended to customers in the normal course of
         business. The Company performs ongoing credit evaluations of its
         customers' financial condition and generally requires no collateral.

         Accounts receivable are recorded at invoice amounts, and reduced to
         their estimated net realizable value by recognition of an allowance for
         doubtful accounts. The Company's estimate of the allowance for doubtful
         accounts is based upon historical experience, its evaluation of the
         current status of specific receivables, and unusual circumstances, if
         any. Accounts are considered past due if payment is not made on a
         timely basis in accordance with the Company's credit terms. Accounts
         considered uncollectible are charged against the allowance.

         Inventories
         -----------
         Inventories are stated at lower of cost or market, cost being
         determined by the first-in, first-out method.

                                        8
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

         Property and equipment
         ----------------------
         Property and equipment are stated at depreciated cost or fair value
         where depreciated cost is not recoverable. Depreciation is computed
         using the straight-line method. When assets are retired or otherwise
         disposed of, the cost and related accumulated depreciation are removed
         from the accounts, and any resulting gain or loss is recognized in
         income for the period. The cost of maintenance and repairs is charged
         to income as incurred; significant renewals and betterments are
         capitalized.

         Property and equipment are being depreciated over the following useful
         lives:

                       Category                               Years
               --------------------------                   ---------
               Buildings and improvements                   31 and 39
               Machinery and equipment                        5 - 12
               Office equipment                               5 - 7
               Vehicles                                         5


         Intangible assets
         -----------------
         The Company accounts for intangible assets at historical cost.
         Intangible assets acquired in a business combination are recorded under
         the purchase method of accounting at their estimated fair values at the
         date of acquisition. Goodwill represents the excess purchase price over
         the fair value of the net tangible and other intangible assets
         acquired. Goodwill is not amortized. The Company amortizes other
         intangible assets over their estimated useful lives, as disclosed in
         the table below.

         Goodwill is reviewed for impairment at least annually. Since the
         Company only has one reporting unit, the test is based on a fair value
         approach applied for the entire company.

         The Company will review intangible assets and their related useful
         lives at least once a year to determine if any adverse conditions exist
         that would indicate the carrying value of these assets may not be
         recoverable. This review is called an impairment assessment. The
         Company will conduct more frequent impairment assessments if certain
         conditions exist, including: a change in the competitive landscape, any
         internal decisions to pursue new or different strategies, a loss of a
         significant customer, or a significant change in the market place
         including changes in the prices paid for the Company's products or
         changes in the size of the market for the Company's products.

         If the estimate of an intangible asset's remaining useful life is
         changed, the remaining carrying amount of the intangible asset is
         amortized prospectively over the revised remaining useful life.

         Intangible assets are being amortized over the following useful lives:

                       Category                               Years
               --------------------------                   ---------
               Recipes                                          4
               Customer lists and other
                 customer related intangibles                   8
               Lease agreement                                  7

                                        9
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


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 non-current, depending on the classification of the assets and
         liabilities to which they relate. Deferred taxes arising from temporary
         differences that are not related to an asset or liability are
         classified as current or non-current depending on the periods in which
         the temporary differences are expected to reverse.

         The principal sources of temporary differences are different
         depreciation and amortization methods for financial statement and tax
         purposes, unrealized gains or losses related to marketable securities,
         capitalization of indirect costs for tax purposes, and the recognition
         of an allowance for doubtful accounts for financial statement purposes.

         Treasury stock
         --------------
         Treasury stock is recorded using the cost method.

         Advertising costs
         -----------------
         The Company expenses advertising costs as incurred. During the years
         ended December 31, 2004 and for the nine months ended September 30,
         2005 and 2004, approximately $909,179, $914,598 and $619,852, of such
         costs respectively, were expensed.

         Earning per common share
         ------------------------
         Earnings per common share were computed by dividing net income
         available to common stockholders by the weighted average number of
         common shares outstanding during the period. For all periods presented,
         diluted and basic earnings per share were the same, as the effect of
         dilutive securities options outstanding was not significant.

NOTE 3 - ACQUISITION OF ILYA'S FARMS, INC.

On July 23, 2004, LFI Enterprises, Inc., an Illinois corporation and wholly
owned subsidiary of Lifeway ("LFIE"), acquired certain assets of Ilya's Farms,
Inc., a Pennsylvania corporation. The aggregate purchase price was $575,600,
paid by LFIE in cash from its current assets.

As a result of the acquisition LFIE now manufactures and distributes certain
cream cheese products under the brand name "Ilya's Farms" in the Philadelphia,
Pennsylvania metropolitan area. The results of operations of the acquired
business have been included in the consolidated financial statements since the
acquisition date.

The following table summarizes the values of the assets and inventory acquired
at the date of acquisition, July 23, 2004.

               Assets and Inventory Acquired           Value
          ----------------------------------------   --------
          Machinery and equipment                    $ 38,200
          Inventory                                    25,600
          Intangible assets                           511,800
                                                     --------
          Total aggregate purchase price             $575,600
                                                     ========
                                       10
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 4 - INTANGIBLE ASSETS

Intangible assets, and the related accumulated amortization, consist of the
following as of September 30, 2005:

                                                       Accumulated
                                           Cost        Amortization
                                          ---------    ------------

Recipes                                      43,600         12,717
Customer lists and other customer
  related intangibles                       305,200         48,323
Lease acquisition                            87,200         14,533
Goodwill                                     75,800            --
Loan acquisition costs                    $   6,638      $     498
                                          ---------      ---------
                                          $ 518,438      $  76,071
                                          =========      =========

Amortization expense is expected to be as follows for the 12 months ending
September 30:

                      2006                       $  66,105
                      2007                          66,105
                      2008                          66,105
                      2009                          56,113
                      2010                          54,873
                    Thereafter                      57,266
                                                 ----------
                                                 $ 366,567
                                                 ==========

Amortization expense during the nine months ended September 30, 2005 and year
ended December 31, 2004 was $49,081 and $26,990.

                                       11
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 5 - MARKETABLE SECURITIES


     The cost and fair value of marketable securities classified as available
for sale and trading are as follows:
<TABLE><CAPTION>
                                                                     Loss on
                                                                    Marketable
                                                                    Securities
                                           Unrealized  Unrealized  Classified as    Fair
     September 30, 2005            Cost      Gains       Losses       Trading       Value
     ------------------         ---------  ----------  ----------  -------------  ---------
<S>                             <C>        <C>         <C>         <C>            <C>
     Equities and Mutual
       Funds                    4,136,818     221,349    (121,835)                4,236,332
     Preferred Securities         955,233                 (19,849)                  935,384
     Certificates of Deposit      150,000                  (3,630)                  146,370
     Corporate Bonds            2,159,363                 (55,732)                2,103,631
     Municipal Bonds               61,275       1,012      (1,341)                   60,946

     Government agency
       obligations                100,000                                (2,132)     97,868
                                ---------  ----------  ----------  ------------   ---------
     Total                      7,562,689     222,361    (202,387)       (2,132)  7,580,531
                                =========  ==========  ==========  ============   =========


                                                                     Loss on
                                                                    Marketable
                                                                    Securities
                                           Unrealized  Unrealized  Classified as    Fair
     September 30, 2004            Cost      Gains       Losses       Trading       Value
     ------------------         ---------  ----------  ----------  -------------  ----------

     Equities/Mutual Funds     $3,713,163  $  101,144  $ (188,299) $         --   $3,626,008
     Preferred Securities          75,505       1,825         --             --       77,330

     Certificates of Deposit      150,000         --       (7,440)           --      142,560

     Corporate Bonds            1,614,275         --       (8,177)           --    1,606,098
     Municipal bonds,
      maturing within five
      years                       132,224       2,490         --             --      134,714
     Government agency
      Obligations,
      maturing
      After five years          1,153,234         --          --         (12,077)  1,141,157
                               ----------  ----------  ----------  -------------  ----------
     Total                     $6,838,401  $  105,459  $ (203,916) $     (12,077) $6,727,867
                               ==========  ==========  ==========  =============  ==========
</TABLE>
                                       12
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004

NOTE 5 - MARKETABLE SECURITIES - CONTINUED
<TABLE><CAPTION>
                                                                     Loss on
                                                                    Marketable
                                                                    Securities
                                           Unrealized  Unrealized  Classified as    Fair
     December 31, 2004            Cost      Gains       Losses       Trading       Value
     -----------------          ---------  ----------  ----------  -------------  ----------
<S>                             <C>        <C>         <C>         <C>            <C>
     Equities and Mutual
       Funds                   $3,414,459  $  341,230  $ (120,991) $         --   $3,634,698
     Preferred Securities          65,000         596         --             --       65,596
     Certificates of Deposit      150,000         --       (4,935)           --      145,065
     Corporate Bonds            1,639,275         --      (14,862)           --    1,624,413
     Municipal bonds,
      maturing within five
      years                       132,226       1,992         --             --      134,218
     Government agency
      obligations, maturing
      after five years          1,154,484         --          --         (16,487)  1,137,997
                               ----------  ----------  ----------  -------------  ----------
     Total                     $6,555,444  $  343,818  $ (140,788) $     (16,487) $6,741,987
                               ==========  ==========  ==========  =============  ==========
</TABLE>

Proceeds from the sale of marketable securities were $6,096,652, $4,466,196 and
$5,306,395 during the year ended December 31, 2004 and for the nine months ended
September 30, 2005 and 2004, respectively.

Gross gains of $354,128, $324,433 and $321,716 were realized on these sales
during the year ended December 31, 2004 and for the nine months ended September
30, 2005 and 2004, respectively.

NOTE 6 - INVENTORIES

Inventories consist of the following:

                                      September 30,        December 31,
                                -----------------------    ------------
                                    2005         2004          2004
                                -----------   ---------    ------------
Finished goods                  $  537,514    $ 386,700    $    404,206
Production supplies                460,664      308,766         297,791
Raw materials                      302,888      220,485         203,700
                                ----------    ---------    ------------
Total inventories               $1,301,066    $ 915,951    $    905,697
                                ==========    =========    ============

                                       13
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004

NOTE 7 - PROPERTY AND EQUIPMENT

     Property and equipment consist of the following:

                                              September 30,         December 31,
                                       -------------------------    -----------
                                           2005          2004           2004
                                       -----------   -----------    -----------
       Land                            $   909,232   $   470,900    $   470,900
       Buildings and improvements        6,441,412     2,453,681      2,481,257
       Machinery and equipment           5,667,016     5,316,766      5,394,932
       Vehicles                            510,510       408,898        408,898
       Office equipment                     78,763        78,763         78,763
                                       -----------   -----------    -----------
                                        13,606,938     8,729,008      8,834,750
       Less accumulated depreciation     5,851,581     5,246,484      5,414,612
                                       -----------   -----------    -----------
       Total property and equipment    $ 7,755,352    $3,482,524    $ 3,420,138
                                       ===========   ===========    ===========

     Depreciation expense during the year ended December 31, 2004 and for the
     nine months ended September 30, 2005 and 2004 was $643,004, $436,969 and
     $474,876, respectively.


NOTE 8 - NOTES PAYABLE

     Notes payable consist of the following:
<TABLE><CAPTION>
                                                                      September 30,      December 31,
                                                                 ----------------------  -----------
                                                                    2005        2004         2004
                                                                 ----------  ----------  -----------
<S>                                                              <C>         <C>         <C>
         Mortgage note payable to a bank, payable in monthly     $  465,179  $  474,659  $  472,325
         installments of $3,273 including interest at 6.25%,
         with a balloon payment of $454,275 due September 25,
         2006. Collateralized by real estate. Mortgage note
         payable to a bank, payable in monthly installments
         of $19,513 including interest at 5.6%, with a
         balloon payment of $2,652,143 due July 14, 2010.
         Collateralized by real estate.                           2,989,415
                                                                 ----------  ----------  -----------
         Notes payable to finance companies; paid in full
         November 2004.                                                 --        2,853          --
                                                                 ----------  ----------  -----------
         Total notes payable                                      3,454,596     477,512      472,325
         Less current maturities                                    534,938      11,716        8,784
                                                                 ----------  ----------  -----------
         Total long-term portion                                 $2,919,656  $  465,796  $   463,541
                                                                 ==========  ==========  ===========
</TABLE>

     Maturities of notes payables are as follows:

         As of September 30,
                 2006                            $  534,938
                 2007                                73,767
                 2008                                78,005
                 2009                                82,488
                 2010                             2,685,396
                                                 ----------
                 Total                           $3,454,594
                                                 ==========
                                       14
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004


NOTE 9 - PROVISION FOR INCOME TAXES

     The provision for income taxes consists of the following:

                                                                 For the
                                  For the Nine Months Ended     Year Ended
                                        September 30,          December 31,
                                   -----------------------     -----------
                                      2005         2004            2004
                                   ----------  -----------     -----------
Current:
   Federal                         $1,050,319   $  841,895     $ 1,084,557
   State and local                    201,380      193,231         260,050
                                   ----------  -----------     -----------
Total current                       1,251,699    1,035,126       1,334,607
Deferred                              (69,220)      45,779          45,560
                                   ----------  -----------     -----------
Provision for income taxes         $1,182,479  $ 1,080,905     $ 1,390,167
                                   ==========  ===========     ===========

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

                                                                 For the
                                  For the Nine Months Ended     Year Ended
                                         September 30,         December 31,
                                   ------------------------    -----------
                                      2005          2004           2004
                                   ----------    ----------    -----------
Federal income tax expense         $1,028,045     $ 880,399    $ 1,084,921
  computed at the statutory rate
State and local tax expense           145,136       203,912        251,283
Permanent book/tax differences          9,298        (3,406)        53,963
                                   ----------    ----------    -----------
Provision for income taxes         $1,182,479    $1,080,905    $ 1,390,167
                                   ==========    ==========    ===========

                                       15
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004

NOTE 9 - PROVISION FOR INCOME TAXES - CONTINUED


     Amounts for deferred tax assets and liabilities are as follows:
<TABLE><CAPTION>
                                                                         For the
                                         For the Nine Months Ended      Year Ended
                                                September 30,          December 31,
                                         --------------------------    -----------
                                             2005           2004           2004
                                         -----------    -----------    -----------
<S>                                      <C>            <C>            <C>
Non-current deferred tax liabilities
  a rising from:
 Temporary differences - principally
 Book/tax, accumulated depreciation      $  (362,314)   $  (426,895)   $  (424,039)
Current deferred tax liability arising
 from:
  Book/tax, unrealized losses (gains)
on marketable securities                      (8,250)        40,663        (83,850)
Current deferred tax assets arising
 from:
  Book/tax, inventory                         55,131         50,273         47,636
                                         -----------    -----------    -----------
Total current deferred tax assets             46,881         90,936        (36,214)
 (liabilities)
                                         -----------    -----------    -----------
Net deferred tax liability               $  (315,433)   $  (335,958)   $  (460,253)
                                         ===========    ===========    ===========
</TABLE>


NOTE 10 - SUPPLEMENTAL CASH FLOW INFORMATION

     Cash paid for interest and income taxes are as follows:

                                         (Unaudited)           For the Year
                                     For the Nine Months          Ended
                                      Ended September 30,      December 31,
                                   -----------------------     -----------
                                      2005         2004            2004
                                   ----------  -----------     -----------
Interest                           $   51,195  $    23,103     $    31,441
Income taxes                       $1,053,064  $   798,147     $ 1,298,348

NOTE 11 - STOCK OPTION PLANS

     The Company has a registration statement filed with the Securities and
     Exchange Commission in connection with a Consulting Service Compensation
     Plan covering up to 600,000 of the Company's common stock shares. Pursuant
     to such Plan, the Company may issue common stock or options to purchase
     common stock to certain consultants, service providers, and employees of
     the Company. There were 468,000 shares available for issuance under the
     Plan at December 31, 2004 and at September 30, 2005 and 2004. The option
     price, number of shares, grant date, and vesting terms are determined at
     the discretion of the Company's Board of Directors.

     As of December 31, 2004 and at September 30, 2005 and 2004, there were no
     stock options outstanding or exercisable.

                                       16
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004

NOTE 11 - STOCK OPTION PLANS - CONTINUED

     On February 12, 2004, Lifeway's Board of Directors approved awards of an
     aggregate amount of 5,100 shares to be awarded under its Employee and
     Consulting Services and Compensation Plan to certain employees and
     consultants for services rendered to the Company. The stock awards were
     made on April 1, 2004 and have vesting periods that vary from six months to
     one year, depending upon the individual grantee. The expense for the awards
     is measured as of April 1, 2004 at $20.93 per share for 5,100 shares, or a
     total stock award expense of $106,743. This expense is being recognized as
     the stock awards vest beginning with the recognition of $41,860 for 2,000
     shares vested on April 1, 2004. There were a total of 4,550 vested shares
     resulting in a stock award expense of $95,231 for the year ended December
     31, 2004, and an additional 1,400 shares vested during the quarter ended
     March 31, 2005 for an additional expense of $11,512.

     On May 23, 2005, Lifeway's Board of Directors approved awards of an
     aggregate amount of 5,600 shares to be awarded under its Employee and
     Consulting Services and Compensation Plan to certain employees and
     consultants for services rendered to the Company. The stock awards were
     made on June 1, 2005 and have vesting periods of one year. The expense for
     the awards is measured as of June 1, 2005 at $12.50 per share for 5,600
     shares, or a total stock award expense of $70,000. This expense will be
     recognized as the stock awards vest in 12 equal portions of $5,833, or 466
     shares per month for one year. During the quarter ended September 30, 2005,
     1,400 shares vested and the Company recognized a related expense of
     $17,500.

NOTE 12 - STOCK SPLIT

     On February 12, 2004, the Board of Directors of the Company declared a
     two-for-one stock split of the common stock of the Company payable on March
     8, 2004 to all of the Company's shareholders of record as of February 27,
     2004.

     As a result of the stock split, shareholders received two shares of common
     stock for every one share held on the record date. Upon completion of the
     split, the total number of shares of common stock outstanding increased
     from 4,218,444 to 8,436,888.

     The earnings per share calculations as presented on the consolidated
     statements of income and comprehensive income and the number of shares
     issued and outstanding per statement of changes in stockholders' equity
     have been adjusted to reflect split adjusted share amounts.

NOTE 13 - FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated fair value of the Company's financial instruments is as
     follows at:
<TABLE><CAPTION>
                       -----------------------   -----------------------   -----------------------
                             September 30,             September 30,              December 31,
                                 2005                      2004                      2005
                       -----------------------   -----------------------   -----------------------
                        Carrying       Fair       Carrying      Fair        Carrying      Fair
                         Amount        Value       Amount       Value        Amount       Value
                       ----------   ----------   ----------   ----------   ----------   ----------
<S>                    <C>          <C>          <C>          <C>          <C>          <C>
     Cash and cash     $4,191,755   $4,191,755   $5,348,135   $5,348,135   $5,773,285   $5,773,285
     equivalents
     Marketable
     securities        $7,580,531   $7,580,531   $6,727,867   $6,727,867   $6,741,987   $6,741,987
     Notes payable     $3,454,594   $3,437,469    $ 477,512   $  454,773    $ 472,325   $  469,696
</TABLE>

     The carrying values of cash and cash equivalents, and marketable securities
     approximate fair values. The fair value of the notes payable is based on
     the discounted value of contractual cash flows. The discount rate is
     estimated using rates currently offered for debt with similar maturities.

                                       17
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           SEPTEMBER 30, 2005 AND 2004
                              AND DECEMBER 31, 2004



NOTE 14 - PENDING LITIGATION

     On December 4, 2004 a former employee requested a Motion for Summary
     Judgment on the issue of Liability in a lawsuit filed against the Company
     by the former employee. The motion was granted on February 10, 2005 and on
     February 18, 2005 the case was referred to a Magistrate Judge for a
     settlement conference.

     The lawsuit alleges non payment of overtime wages in violation of federal
     employment laws, with an estimated amount between $90,000 and $100,000. The
     suit was filed in the United States District Court for the Northern
     District of Illinois on behalf of all employees who were classified as
     non-exempt during 2001 through 2003. The Company has accrued a $95,000
     liability in anticipation of a settlement.






















                                       18
<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

COMPARISON OF QUARTER ENDED SEPTEMBER 30, 2005 TO QUARTER ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------
2004
----

The following analysis should be read in conjunction with the unaudited
financial statements of the Company and related notes included elsewhere in this
quarterly report and the audited financial statements and Management's
Discussion and Analysis contained in our Form 10-KSB, for the fiscal year ended
December 31, 2004, and in the Management's Discussion and Analysis contained in
our Form 10-QSB, for the fiscal quarters ended March 31, 2005, and June 30,
2005.

RESULTS OF OPERATIONS

Sales increased by $1,056,042 (approximately 26%) to $5,194,648 during the three
month period ended September 30, 2005 from $4,138,606 during the same three
month period in 2004. This increase is primarily attributable to increased sales
and awareness of Lifeway's existing drinkable dairy products including La Fruta,
and its flagship line, Kefir.

Lifeway's wholly-owned subsidiary, LFI Enterprises, Inc. ("LFIE") accounted for
$247,416 of total sales revenues during the third quarter of 2005. Of the total
$264,807 revenues from LFIE, $112,671 was earned due to sales of Lifeway's Kefir
and Farmer Cheese products sent from our Morton Grove, Illinois facility to
Philadelphia, Pennsylvania for distribution in the tri-state area of
Pennsylvania, New Jersey and New York. The remaining $134,745 of LFIE revenues
for the third quarter of 2005 was earned from sales of the Cream Cheese Gourmet
line of products acquired from Ilya's Farms, Inc. in the third quarter of 2004.
Sales from the acquired Ilya's Farms cream cheese line in the third quarter 2004
were $103,635. This represents a 30% increase in sales for the cream cheese line
in the third quarter 2005 when compared to the same period year ago.

Cost of goods sold as a percentage of sales was approximately 59% during the
third quarter 2005, compared to about 54% during the same period in 2004. The
average cost of milk, Lifeway's largest cost of goods sold component, was
similar in the third quarter 2005 compared to the same period in 2004. Beginning
January 1, 2005, the minimum wage payable to Company's employees in Illinois
increased 18%. This higher wage increase (and indirect pressure for additional
increases) has had a negative impact on our gross margins in 2005, when compared
to 2004. We intend to primarily offset these wage increases by continuing to
invest in the automation of our production processes.

As we increased our shipments, the rise in fuel and transportation costs in the
third quarter, when compared to the same period a year ago, had a negative
impact on our gross margins. We were able to partially off-set this increase in
fuel costs by making prudent investments in the energy markets, as is evident in
our gains from the sale of marketable securities.

Operating expenses as a percentage of sales was approximately 26% during the
third quarter 2005, compared to about 28% during the same period in 2004. This
decrease is primarily attributable to our continuing efforts to improve our
production automation, through capital investments, thereby improving our
overall operating income. Lifeway also recognized an expense related to an
increase in a reserve established with respect to a lawsuit brought be a
previous employee, as discuss in Part II, Item 2 of this report.

Provision for income taxes was $400,464, or a 42% tax rate during the third
quarter 2005 compared with $296,210, or a 36% tax rate during the same period in
2004. Income taxes are discussed in Note 9 of the Notes to Consolidated
Financial Statements.

COMPARISON OF NINE MONTH PERIOD ENDED SEPTEMBER 30, 2005 TO NINE MONTH PERIOD
-----------------------------------------------------------------------------
ENDED SEPTEMBER 30, 2004
------------------------

RESULTS OF OPERATIONS

Sales increased by $2,848,298 (approximately 24%) to $14,924,076 during the nine
month period ended September 30, 2005 from $12,075,778 during the same nine
month period in 2004. This increase is primarily attributable to increased sales
and awareness of Lifeway's existing drinkable dairy products including La Fruta,
and its flagship line, Kefir.

                                       19
<PAGE>

Cost of goods sold as a percentage of sales was approximately 58% during the
nine month period ended September 30, 2005, compared to about 55% during the
same period in 2004. The average cost of milk, Lifeway's largest cost of goods
sold component, approximately 20% higher in the first quarter 2005, compared to
the same period in 2004, but was similar in the second and third quarters 2005
compared to the same periods in 2004. Beginning January 1, 2005, the minimum
wage payable to Company's employees in Illinois increased 18%. This higher wage
increase (and indirect pressure for additional increases) has had a negative
impact on our gross margins in 2005, when compared to 2004. We intend to
primarily offset these wage increases by continuing to invest in the automation
of our production processes.

Total other income for the six months ended September 30, 2005 was $500,520,
compared with $411,433 during the same period in 2004. This increase is
primarily attributable to the company earning more interest and dividends in
2005, when compared to the same period in 2004.

SOURCES AND USES OF CASH

Net cash used in investing activities was $5,461,631 during the nine months
ended September 30,2005, which is an increase of $4,240,776 compared to the same
period in 2004. This increase is primarily due to the Company's purchase of a
storage and distribution facility.

Net cash provided by financing activities was $2,580,715 during the nine months
ended September 30, 2005, which is an increase of $2,510,281 compared to the
same period in 2004. This increase is primarily attributable to the Company
financing the purchase of the above- mentioned facility. The Company entered
into a $3 million note that has a maturity of 5 years, at an interest rate of
5.6%. The Company also purchased 50,000 shares of its treasury stock at a cost
of $401,554 in the first nine months of 2005.

A significant portion of our assets are held in marketable securities. The
majority of our marketable securities are classified as available-for-sale on
our balance sheet, while the mortgage-backed securities are classified as
trading. All of these securities are stated thereon at market value as of the
end of the applicable period. Gains and losses on the portfolio are determined
by the specific identification method.

We anticipate being able to fund the Company's foreseeable liquidity
requirements internally. We continue to explore potential acquisition
opportunities in our industry in order to boost sales while leveraging our
distribution system to consolidate and lower costs.

OTHER DEVELOPMENTS

On May 23, 2005, Lifeway's Board of Directors approved awards of an aggregate
amount of 5,600 shares to be awarded under its Employee and Consulting Services
and Compensation Plan to certain employees and consultants for services rendered
to the Company. The stock awards were made on June 1, 2005 and have vesting
periods of one year. The expense for the awards is measured as of June 1, 2005
at $12.50 per share for 5,600 shares, or a total stock award expense of $70,000.
This expense will be recognized as the stock awards vest in 12 equal portions of
$5,833, or 466 shares per month for one year.

CRITICAL ACCOUNTING POLICIES

Lifeway's analysis and discussion of its financial condition and results of
operations are based upon its consolidated financial statements that have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("US GAAP"). The preparation of financial statements in
accordance with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses.
US GAAP provides the framework from which to make these estimates, assumptions
and disclosures. Lifeway chooses accounting policies within US GAAP that
management believes are appropriate to accurately and fairly report Lifeway's
operating results and financial position in a consistent manner. Management
regularly assesses these policies in light of current and forecasted economic
conditions and has discussed the development and selection of critical
accounting policies with its audit committee of the Board of Directors. For
further information concerning accounting policies, refer to Note 2 -- Nature of
Business and Significant Accounting Policies in the notes to the consolidated
financial statements.

                                       20
<PAGE>

FORWARD LOOKING STATEMENTS

In this report, in reports subsequently filed by Lifeway with the SEC on Form
10-QSB and filed or furnished on Form 8-K, and in related comments by
management, our use of the words "believe," "expect," "anticipate," "estimate,"
"forecast," "objective," "plan," "goal," "project," "explore,"
"priorities/targets," and similar expressions is intended to identify
forward-looking statements. While these statements represent our current
judgment on what the future may hold, and we believe these judgments are
reasonable, actual results may differ materially due to numerous important
factors that are described in this report and other factors that may be
described in subsequent reports which Lifeway may file with the SEC on Form
10-QSB and filed or furnished on Form 8-K, including but not limited to:

o    Changes in economic conditions, commodity prices;

o    Shortages of and price increase for fuel, labor strikes or work stoppages,
     market acceptance of the Company's new products;

o    Significant changes in the competitive environment;

o    Changes in laws, regulations, and tax rates; and

o    Management's ability to achieve reductions in cost and employment levels,
     to realize production efficiencies and to implement capital expenditures,
     all at of the levels and times planned by management.

ITEM 3. CONTROLS AND PROCEDURES

     The Chief Executive Officer and the Chief Accounting Officer conducted an
evaluation of the effectiveness of the Company's disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934 as
of September 30, 2005. The Company has historically operated on strictly
monitored cost constraints. With that perspective, the Chief Executive Officer
and the Chief Accounting Officer concluded that the disclosure controls and
procedures are effective in ensuring that all material information required to
be filed in this quarterly report has been made known to them. However, based
upon the Company's recent growth and improved cash position, as well as
consultation with its auditors, management intends to implement additional
procedures to improve internal controls over financial reporting in 2005.
Specifically, an enhanced accounting software package has been identified and
continues to be evaluated which will permit enhanced data recording and internal
reporting as well as additional on-site accounting staff and some changes to the
Company's internal control procedures over financial reporting.

     As of the date of this quarterly report, there have been no known
significant changes in internal controls or in other factors that could
significantly affect these controls subject to the date of such evaluation.

                           PART II - OTHER INFORMATION

ITEM 2. LEGAL PROCEEDINGS

     On December 4, 2004, a former employee requested a Motion for Summary
Judgment on the issue of liability in a lawsuit filed against the Company by the
former employee. The motion was granted on February 10, 2005 and on February 18,
2005 the case was referred to a Magistrate Judge for a settlement conference.
The lawsuit alleges non payment of overtime wages in violation of federal
employment laws, with an estimated amount between $90,000 and $100,000. The suit
was filed in the United States District Court for the Northern District of
Illinois on behalf of all employees who were classified as non-exempt during
2001 through 2003. Outside counsel for the Company has advised that at this
stage in the proceedings it cannot offer an opinion as to the probable outcome.
The Company continues to vigorously defend this matter. The Company has accrued
a $95,000 liability in anticipation of a settlement.

     On April 14, 2003, Vera Smolyansky filed a complaint seeking unspecified
damages in the Circuit Court of Cook County, Illinois naming Lifeway as a
defendant. This case was dismissed, with prejudice on June 30, 2005.

ITEM 5. OTHER INFORMATION

On October 3, 2005, the Company announced its financial results for the fiscal
quarter and six months ended September, 30, 2005 and certain other information.
A copy of the Company's press release announcing these financial results and
certain other information is attached as Exhibit 99.1 hereto. The information
contained in Exhibit 99.1 hereto is being furnished, and should not be deemed
"filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liabilities imposed by that Section. The
information contained in Exhibit 99.1 shall not be incorporated by reference
into any registration statement or other document or filing under the Securities
Act of 1933, as amended, except as may be expressly set forth in a specific
filing. The press

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<PAGE>

release filed as an exhibit to this report includes "safe harbor" language
pursuant to the Private Securities Litigation Reform Act of 1995, as amended,
indicating that certain statements about the Company's business and other
matters contained in the press release are "forward-looking." The press release
also cautions investors that "forward-looking" statements may be different from
actual operating results. Finally, the press release states that a more thorough
discussion of risks and uncertainties which may affect the Company's operating
results is included in the Company's reports on file with the Securities and
Exchange Commission.

ITEM 6. EXHIBITS

Exhibit
Number        Description
-------       -----------

  3.4        Amended and Restated By-laws (incorporated by reference to Exhibit
             No. 3.5 of Lifeway's Current Report on Form 8-dated and filed on
             December 10, 2002). (File No. 000-17363)

  3.5        Articles of Incorporation, as amended and currently in effect
             (incorporated by reference to Exhibit 3.5 of Lifeway's Quarterly
             Report on Form 10-QSB for the quarter ended June 30, 2000 and filed
             on August 8, 2000). (File No. 000-17363)

  11         Statement re: Computation of per share earnings (incorporated by
             reference to Note 2 of the Consolidated Financial Statements)

  31.1       Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky.

  31.2       Rule 13a-14(a)/15d-14(a) Certification of Edward P. Smolyansky.

  32.1       Section 1350 Certification of Julie Smolyansky.

  32.2       Section 1350 Certification of Edward P. Smolyansky.

  99.1       Press Release dated October 3, 2005- "Lifeway Foods Reports Record
             Third Quarter and Nine Months Sales Results."











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<PAGE>

                                    SIGNATURE


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.

Date: November 15, 2005

                                       LIFEWAY FOODS, INC.

                                       By: /s/ Julie Smolyansky
                                       ----------------------------------
                                       Julie Smolyansky
                                       Chief Executive Officer, President,
                                       and Director


                                       /s/ Edward P. Smolyansky
                                       ----------------------------------
                                       Chief Financial and Accounting Officer
                                       and Treasurer






















                                       23
<PAGE>

                                  EXHIBIT INDEX

Exhibit
Number       Description
------       -----------

 31.1        Rule 13a-14(a)/15d-14(a) Certification of Julie Smolyansky.

 31.2        Rule 13a-14(a)/15d-14(a) Certification of Edward P. Smolyansky.

 32.1        Section 1350 Certification of Julie Smolyansky.

 32.2        Section 1350 Certification of Edward P. Smolyansky.

 99.1        Press Release dated October 3, 2005- "Lifeway Foods Reports Record
             Third Quarter and Nine Months Sales Results."



























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