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<SEC-DOCUMENT>0001035704-01-000287.txt : 20010402
<SEC-HEADER>0001035704-01-000287.hdr.sgml : 20010402
ACCESSION NUMBER:		0001035704-01-000287
CONFORMED SUBMISSION TYPE:	10KSB
PUBLIC DOCUMENT COUNT:		1
CONFORMED PERIOD OF REPORT:	20001231
FILED AS OF DATE:		20010330

FILER:

	COMPANY DATA:	
		COMPANY CONFORMED NAME:			LIFEWAY FOODS INC
		CENTRAL INDEX KEY:			0000814586
		STANDARD INDUSTRIAL CLASSIFICATION:	DAIRY PRODUCTS [2020]
		IRS NUMBER:				363442829
		STATE OF INCORPORATION:			IL
		FISCAL YEAR END:			1231

	FILING VALUES:
		FORM TYPE:		10KSB
		SEC ACT:		
		SEC FILE NUMBER:	000-17363
		FILM NUMBER:		1586116

	BUSINESS ADDRESS:	
		STREET 1:		6431 W OAKTON
		CITY:			MORTON GROVE
		STATE:			IL
		ZIP:			60053
		BUSINESS PHONE:		7089671010

	MAIL ADDRESS:	
		STREET 1:		6431 W OAKTON
		CITY:			MORTON GROVE
		STATE:			IL
		ZIP:			60053
</SEC-HEADER>
<DOCUMENT>
<TYPE>10KSB
<SEQUENCE>1
<FILENAME>d85557e10ksb.txt
<DESCRIPTION>FORM 10KSB FOR FISCAL YEAR END DECEMBER 31, 2000
<TEXT>

<PAGE>   1

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

                                   FORM 10-KSB

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

               For the fiscal year ended December 31, 2000

[ ]      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.
- --------------------------------------------------------------------------------
           (Name of small business issuer as specified in its charter)

<TABLE>
<S>                                                                                            <C>
                         ILLINOIS                                                                         36-3442829
- --------------------------------------------------------------                                 ---------------------------------
(State or other jurisdiction of incorporation or organization)                                 (IRS Employer Identification No.)

6431 WEST OAKTON, MORTON GROVE, ILLINOIS                                                                    60053
- ----------------------------------------                                                                  ----------
(Address of principal executive offices)                                                                  (Zip Code)

Issuer's telephone number: (847) 967-1010
                           --------------

Securities registered under Section 12(b) of the Exchange Act: None
                                                               ----

Securities registered under Section 12(g) of the Exchange Act: Common Stock, No Par Value
                                                               --------------------------
</TABLE>

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

         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.  [ ]

         State issuer's revenues for its most recent fiscal year. $9,176,739
                                                                  ----------

         State the aggregate market value of the common stock held by
non-affiliates, approximately 1,247,216 shares, computed by reference to the
price at which the stock was sold as of a specified date within the past 60
days. $8,730,512 as of March 23, 2001, based on the closing price of $7.00 per
share as quoted on NASDAQ.

         State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 4,318,444 shares of Common
Stock as of March 23, 2001.

                      DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Notice of Annual Meeting and Proxy Statement for the
Registrant's 2001 Annual Meeting of Shareholders, scheduled to be held June 16,
2001, are incorporated by reference in Part III.

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


<PAGE>   2

                                     PART I

               CAUTIONARY STATEMENT IDENTIFYING IMPORTANT FACTORS
                THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS TO
            DIFFER FROM THOSE PROJECTED IN FORWARD LOOKING STATEMENTS

         In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, readers of this document and any
document incorporated by reference herein, are advised that this document and
documents incorporated by reference into this document contain both statements
of historical facts and forward looking statements. Forward looking statements
are subject to certain risks and uncertainties, which could cause actual results
to differ materially for those indicated by the forward looking statements.
Examples of forward looking statements include, but are not limited to (i)
projections of revenues, income or loss, earning or loss per share, capital
expenditures, dividends, capital structure and other financial items, (ii)
statements of the plans and objectives of the Company or its management of Board
of Directors, including the introduction of new products, or estimates or
predictions of actions by customers, suppliers, competitors or regulatory
authorities, (iii) statements of future economic performance, and (iv)
statements of assumptions underlying other statements and statements about the
Company or its business.

         This document and any documents incorporated by reference herein also
identify important factors which could cause actual results to differ materially
from those indicated by forward looking statements. These risks and
uncertainties include price competition, the decisions of customers, the actions
of competitors, the effects of government regulation, possible delays in the
introduction of new products, customer acceptance of products and services, and
other factors which are described herein and/or in documents incorporated by
reference herein.

         The cautionary statements made pursuant to the Private Litigation
Securities Reform Act of 1995 above and elsewhere by the Company should not be
construed as exhaustive or as any admission regarding the adequacy of
disclosures made by the Company prior to the effective date of such Act. Forward
looking statements are beyond the ability of the Company to control and in many
cases the Company cannot predict what factors would cause results to differ
materially from those indicated by the forward looking statements.

ITEM 1.    DESCRIPTION OF BUSINESS.

Business Development

         Lifeway Foods, Inc. (the "Company") commenced operations in February,
1986, and was incorporated under the laws of the State of Illinois on May 19,
1986. The Company's primary product is kefir, a drinkable product similar to but
distinct from yogurt, in several flavors sold under the name "Lifeway Kefir"; a
plain farmer's cheese sold under the name "Lifeway Farmer's Cheese"; fruit
sugar-flavored product similar in consistency to cream cheese sold under the
name of "Sweet Kiss;" a dairy based immune-supporting dietary supplement
beverage called Basics Plus and other kefir-based products. 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 distributes
its products primarily throughout the United States. The Company also
distributes some of its products internationally by exporting to Eastern Europe
and Canada.

Subsidiary Corporation

         LFI Enterprises, Inc.

         On September 30, 1992, the Company formed a wholly-owned subsidiary
corporation, LFI Enterprises, Inc. ("LFIE"), incorporated in the State of
Illinois. LFIE operates a "Russian" theme restaurant and supper club facility,
known as "Moscow Nites," catering to the Chicago area's East European ethnic
communities.



                                       1
<PAGE>   3

Business of Issuer

         Products

         The Company's primary product is kefir which, like the better-known
product of yogurt, is a fermented dairy product. Kefir has a slightly
effervescent quality, with a taste similar to yogurt and a consistency similar
to buttermilk. It is a distinct product from yogurt because it uses the unique
microorganisms of kefir as the culture to ferment the milk. The Company's basic
kefir is a drinkable product intended for use as a breakfast meal or a snack, or
as a base for lower-calorie dressings, dips, soups or sauces. The kefir is also
used as the base of the Company's plain farmer's cheese, a cheese without salt,
sugar or animal rennet. In addition, kefir is the primary ingredient of the
Company's "Sweet Kiss" product, a fruit sugar-flavored, cream cheese-like spread
which is intended to be used as a dessert spread or frosting.

         Kefir contains a unique mixture of several live microorganisms and body
nutrients such as proteins, minerals and vitamins. Kefir is highly digestible
and, due to its acidity and enzymes, stimulates digestion of other foods. Kefir
is considered to be the most favorable milk product for people suffering from
genetically stipulated lactose intolerance. Studies indicate that kefir seems to
stimulate protein digestion and appetite, decrease the cholesterol content in
blood, improve salivation and excretion of stomach and pancreatic enzymes and
peristalsis. As compared to yogurt, many Naturopathic doctors consider kefir to
be the best remedy for digestive troubles because it has a very low curd tension
(the curd breaks up very easily into small particles). The curd of yogurt, on
the other hand, holds together or breaks into lumps. The small size of the kefir
curd facilitates digestion by presenting a large surface for the digestive
agents to work on.

         Kefir is a good source of calcium, protein, and Vitamin B-complex. In
addition, because the fermentation process produces a less sour tasting product
than yogurt, less sugar is required to make a desirable product, and the end
product contains fewer calories.

         The Company's currently sells the products listed below to various
retail establishments including supermarkets, grocery stores, gourmet shops,
delicatessens and convenience stores.

         LIFEWAY KEFIR. "Lifeway Kefir" is a drinkable kefir product
manufactured in eleven flavors -- plain (regular and low-fat), raspberry,
blueberry, strawberry, cherry, peach, banana-strawberry, cappuccino, chocolate
and vanilla -- in 32 ounce containers featuring color-coded caps and labels
describing nutritional information. In March 1996, the Company began marketing
its fat-free, low cholesterol kefir in six flavors. The kefir product is
currently marketed under the name "Lifeway's Kefir," and is sold from the dairy
section. Lifeway Kefir has a shelf life of approximately 60 days. All flavors
contain fructose, fruit juice, kefir culture, and pasteurized, low-fat milk and
natural flavorings.

         GOLDEN ZESTA. "Golden Zesta" is a vegetable-based seasoning which,
because of its low sodium content, may also be used as a salt substitute.

         FARMER'S CHEESE. "Farmer's Cheese" is based on a cultured soft cheese
and is intended to be used in a variety of recipes as a lowfat, low-cholesterol,
low-calorie substitute for cream cheese or ricotta, and is available in regular
and Swiss style.

         ELITA. "Elita" is a low-fat, low-cholesterol spreadable kefir product
which is marketed as an alternative to cream cheese.

         KWASHENKA. "Kwashenka" is a kefir product that is designed to be eaten
with a spoon, like most yogurt products.

         BASICS PLUS. "Basics Plus" is a patented kefir-based beverage product
designed to improve gastrointestinal functions and, thus, enhance the immune
system. This product contains certain "passive immunity products" produced by
GalaGen, Inc.



                                       2
<PAGE>   4

         SOYTREAT. SoyTreat is a non-dairy alternative to kefir made from
organic soy milk, which is derived from non-genetically modified soybeans.
SoyTreat can be consumed by those who desire the benefits of kefir, but are
either lactose intolerant or vegan. SoyTreat also provides 6.25g of soy protein
per serving, and features the FDA health claim, "25g of soy protein a day as
part of a diet low in saturated fat can help lower cholesterol and reduce the
risk of heart disease."

         KRESTYANSKI TWOROG. Krestyanski Tworog is a European kefir-based soft
style cheese which can also be used in a variety of recipes, eaten with a spoon,
used as a cheese spread, or substituted in recipes for cream cheese, ricotta
cheese, or cottage cheese.

         KEFIR STARTER. "Kefir Starter" is a powder form of kefir that is sold
in envelope packets and allows a consumer to make their own drinkable kefir at
home by adding milk, and is developing sales of the product internationally and
via the internet.

         The Company intends to continue to develop new products, such as salad
dressing and a frozen dessert product based on kefir and Farmer's Cheese,
although there is no assurance that such products can be developed successfully
or marketed profitably.

         Distribution

         With its nine Company-owned trucks, the Company distributes its
products directly to over 1,200 stores in the State of Illinois, including major
retail chains such as Jewel Food Stores, Dominick's Finer Foods, Treasure Island
Food Marts, Whole Foods and Butera Food Stores.

         In addition to the State of Illinois, the Company's products are
distributed to over 8,000 stores throughout the United States. The Company has
verbal distribution arrangements with various distributors throughout the United
States. These verbal distribution arrangements, in the opinion of the Company,
allow management the necessary latitude to expand into new areas and markets and
establish new relationships with distributors on an ongoing basis. The Company
has not offered any exclusive territories to any distributors.

         These distributors are provided Lifeway products at wholesale prices
for distribution to their retail accounts. The Company believes that the price
at which its products are sold to its distributors is competitive with the
prices generally paid by distributors for similar products in the markets
served. In all areas served, distributors currently deliver the products
directly to the refrigerated cases of dairy sections of the retail stores. Each
distributor carries the full complement of Lifeway's products on its trucks, and
checks the retail stores for space allocated to Lifeway's products, determines
inventory requirements, and places Lifeway products directly into the case. The
Company prefers such method of distribution in order to serve the needs of each
retail store, and to ensure consistency and quality of product handling, quality
control, flavor selection and retail display. Under the distribution
arrangements, each distributor must meet certain prescribed product handling,
service and administrative requirements including, among others, frequency of
delivery, replacement of damaged, old or substandard packages, and delivery of
products directly to the refrigerated case.

         Additionally, the Company distributes its products internationally by
exporting to Canada, Russia and the Ukraine.

         Marketing

         The Company continues to promote the verifiable nutritional
characteristics, purity of product, and good taste of its kefir and kefir-based
products. The Company primarily advertises its products through local radio
stations, which are directed to both users and non-users of cultured milk
products of all kinds. In addition, through newspapers and magazines, the
Company provides educational information on its products and appeals to the
common perception that the products may be of particular benefit for a wide
range of ills, including intestinal disorders, and continues to educate the
public on the possible health benefits which could be derived from the use of
kefir and kefir-based products. Although no scientific studies have proven the
certainty of such unverifiable health claims, the Company believes that the
potential for healthful benefits as suggested by such studies can serve as the
basis for an advertising strategy.



                                       3
<PAGE>   5


         In addition to local radio stations, newspapers and magazines, the
Company receives further exposure of its products through the internet, catalog
advertising and promotion, inside store demonstrations throughout the U.S., and
participation in various trade shows.

         On December 24, 1999, the Company entered into a Support Agreement with
a subsidiary of Group Danone. The primary purpose of the Support Agreement,
which provides for an initial term of three years and is renewable annually
thereafter, is to allow the Company access to Danone's brokers and distributors
in the United States.

         Competition

         Although the Company faces very little direct competition in the United
States for the kefir market, the Company's kefir-based products are subject to
competition from other yogurt and other dairy products. Many producers of yogurt
and other dairy products are well-established and have significantly greater
financial resources than the Company.

         In connection with the Support Agreement between the Company and
Danone, the parties agreed that they would not compete with each other during
the term of the Support Agreement and for three years after termination of the
agreement with respect to certain yogurt, cheese and kefir products.
Specifically, the Company agreed not to produce or sell any type of yogurt,
fromage frais, Italian style cheese, chilled desserts or any soy-based products,
other than those that are kefir based or are already being produced and sold by
the Company, in the U.S. and Western Europe; and Danone agreed not to produce or
sell any type of kefir-based products in the U.S.

         Suppliers

         The Company purchases its raw materials, such as milk, sugar and fruit,
from unaffiliated suppliers, and is not limited or contractually bound to any
one. Prior to making any purchase, the Company determines which supplier can
offer the lowest price for the highest quality of product. The raw and packaging
materials purchased by the Company are considered commodity items and are widely
available on the open market. The Company owns and operates the means of
production of all of its products.

         Major Customers

         The Company distributes its products to more than 400 accounts
throughout the U.S. Concentrations of credit with regard to trade accounts
receivable and sales are limited due to the fact that the Company's customers
are spread across different geographic areas. The customers are concentrated in
the retail food industry. In 2000, no customer comprised over 10% of sales.

         Patents, Trademarks, Licenses, Franchises, Concessions, Royalty
Agreements, Labor Contracts

         On December 12, 1989, and June 12, 1990, the U.S. Patent and Trademark
Office granted the Company exclusive trademarks for the names "Lifeway's" and
"Healthy Eating," respectively. In addition, on January 10, 1992, the Company
was granted a trademark for the name "Lifeway's" for its use in Canada since
September 9, 1988. On December 12, 1999, the U.S. Patent and Trademark Office
granted the Company a ten year renewal of the "Lifeway's" trademark.

         On December 27, 1990, the Company purchased the Tuscan brand-name
liquid yogurt customer list along with a limited license of the trademark and
use of the Tuscan liquid yogurt U.P.C. codes from a third party.

         On June 30, 1992, the Company was granted trademarks for grain based,
non-alcoholic beverages, although it has no claim to the exclusive right to use
the names "KVAS," "KBAC" or "KWASS," apart from the mark as shown on the
Principal Register. Although the Company has developed the product under this
trademark, it is not currently marketing it.



                                       4
<PAGE>   6

         On August 19, 1997, the Company received trademark approval from the
U.S. Patent and Trademark Office for the stylized drawing trademark for Golden
Zesta.

         On February 10, 1998, the Company received trademark approval from the
U.S. Patent and Trademark Office for the trademark "Sweet Kiss," for its fruit
sugar-flavored product similar in consistency to cream cheese.

         On February 10, 1998, the Company received trademark approval from the
U.S. Patent and Trademark Office for the trademark "Kwashenka," for its
spoonable kefir.

         On October 17, 1997, GalaGen, Inc., made application to the U.S. Patent
and Trademark Office for the trademark "Basics Plus" for kefir-based products.
In July 1998, GalaGen, Inc., assigned the entire interest, including goodwill,
of the product to the Company. On September 7, 1999, the U.S. Patent and
Trademark Office granted the Company registration for the trademark "Basics
Plus." The Company has a nonexclusive license from GalaGen, Inc., to use the
trademark "Proventra" in connection with the Company's sales and marketing of
"Basics Plus."

         On September 8, 1998, the Company received trademark approval from the
U.S. Patent and Trademark Office for the trademark "Krestyanski" under which the
Company sells a line of products in the United States.

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

         On June 25, 2000, the Company received trademark approval from the U.S.
Patent and Trademark office for the trademark "Bazarniy", for cheese products.

         On December 12, 2000, the Company received trademark approval from the
U.S. Patent and Trademark office for the trademark "SoyTreat", for its soy-based
kefir.

         In addition, the Company maintains various state licenses and permits
required to operate its businesses, including a restaurant and liquor license,
renewed annually, held by the Company's wholly-owned subsidiary, LFI
Enterprises, Inc., for the operation of its "Russian" theme restaurant and
supper club.

         Regulation

         The Company is subject to regulation by federal, state and local
governmental authorities regarding the distribution and sale of food products.
Although the Company believes that it currently has all material government
permits, licenses, qualifications and approvals for its operations, there can be
no assurance that the Company will be able to maintain its existing licenses and
permits or to obtain any future licenses, permits, qualifications or approvals
which may be required for the operation of the Company's business. The Company
believes that it is currently in compliance with all applicable environmental
laws.

         Research and Development

         The Company continues its program of new product development, centered
around the nutritional and "low calorie" features of its proprietary kefir
formulas.

         The Company conducts primarily all of its research internally, but at
times will employ the services of an outside testing facility. During 2000, the
amount the Company expended for research and new product development was not
material to the financial position of the Company.



                                       5
<PAGE>   7

         Employees

         The Company and its subsidiary, LFI Enterprises, Inc., currently employ
approximately 60 employees, 5 of whom are part-time employees. Approximately 55
of those employees are engaged in the manufacturing process of the Company's
kefir and kefir-based products and 5 are employed in the restaurant operation.
None of the Company's employees are covered by collective bargaining agreements.

ITEM 2.    DESCRIPTION OF PROPERTY.

         On May 16, 1988, the Company purchased a 26,000 square foot parcel of
real property, including an 8,500 square foot one-story building, located at
7625 N. Austin Avenue, Skokie, Illinois. The purpose of the purchase was to
enable the Company to expand its production facilities and capacity pursuant to
its business plan and growing demand for its product. The Company brought the
facility to full capacity and completed its remodeling in 1994. In addition to
the increase in capacity, because of improved storage facilities, the Company
has been able to incur savings in the purchase of milk and other raw materials,
by virtue of its increased capacity to store bulk purchases. The loan to the
Company from 1st National Bank of Morton Grove, collateralized by the real
estate, was refinanced in 1998 and is payable in monthly installments of $1,767,
including interest at 7.25%, with a balloon payment of $139,838 due November,
2003. At December 31, 2000, the loan had a balance of $165,830.

         On October 9, 1992, the Company purchased certain real estate located
at 7800 N. Caldwell, Niles, Illinois. This property consists of approximately
75,000 square feet of commercially zoned property, and a 7,750 square foot
building. The loan to the Company from American National Bank and Trust Company
of Chicago, collateralized by the real estate, was refinanced in 1998 and has a
balloon payment of $343,151 due in August 2003 and carries an interest rate of
7.25% per annum. The Company's monthly payments are $3,161. At December 31,
2000, the loan had a balance of $377,713. The Company refurbished the property
in late 1992 and put it into productive use as a supper club facility, known as
"Moscow Nites," catering to the Chicago area's East European ethnic communities.
The premises are operated by the Company's wholly-owned subsidiary, LFI
Enterprises, Inc., an Illinois corporation.

         On October 16, 1996, the Company purchased a 110,000 square foot parcel
of real property, zoned commercial, including a 46,000 square foot one-story
building, located at 6431 Oakton Avenue, Morton Grove, Illinois. The purchase
enabled the Company to further expand its production facilities and capacity.
The loan to the Company from American National Bank and Trust Company of
Chicago, collateralized by the real estate, has a balloon payment of $618,214
due in November 2001. The mortgage note is payable in monthly installments of
principal of $5,109 plus interest at 8.05%. At December 31, 2000, the loan had a
balance of $674,413.

         For financial statement and tax purposes, the Company depreciates its
real property buildings on a straight line basis over 31 to 39 years.

         The Company believes it has adequate insurance coverage for all its
properties.

ITEM 3.    LEGAL PROCEEDINGS.

         On June 22, 2000, the Niles Park District of Illinois filed a lawsuit
in the Circuit Court of Cook County, Illinois, naming the Company as a
defendant. The Park District, through the lawsuit, is attempting to exercise its
rights of eminent domain to acquire and take possession of the Company's
property situated at 7800 Caldwell Avenue, Niles, Illinois, where the Moscow
Nights Restaurant currently operates. The Company is vigorously defending the
lawsuit.


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

         No matter was submitted during the fourth quarter of the fiscal year
ended December 31, 2000, to a vote of security holders through the solicitation
of proxies or otherwise.




                                       6
<PAGE>   8

PART II

ITEM 5.    MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Market Information

         The Company's Common Stock, no par value, the only class of common
equity of the Company, is traded on the NASDAQ National Market under the symbol
"LWAY." Trading commenced on March 29, 1988.

         The range of high and low bid quotations for the Company's Common Stock
for the quarterly periods within the two most recent fiscal years, as reported
by NASDAQ, is set forth in the following table:

<TABLE>
<CAPTION>
                                          Low Bid      High Bid
                                          --------     --------

<S>                                      <C>          <C>
                  1st Qtr 1999            $   3.50     $   5.00
                  2nd Qtr 1999            $   3.56     $  7.875
                  3rd Qtr 1999            $   6.00     $   9.50
                  4th Qtr 1999            $ 6.0625     $  8.625

                  1st Qtr 2000            $   5.00     $   7.75
                  2nd Qtr 2000            $   5.00     $   8.00
                  3rd Qtr 2000            $   4.25     $ 6.5625
                  4th Qtr 2000            $   4.25     $   6.25
</TABLE>

Holders

         As of March 23, 2001, there were approximately 116 holders of record of
the Company's Common Stock (not including beneficial owners holding in
"street-name").

Dividends

         The Company has paid no cash dividends on its Common Stock and
management does not anticipate that such dividends will be paid in the
foreseeable future.

Sales of Unregistered Securities

         There were no sales of unregistered securities in 2000.

ITEM 6.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

Results of Operations

         The year ended December 31, 2000 was another record year for the
Company, with all-time highs for Sales, Net Income, and Earnings Per Share. The
relevant details of the Company's Results of Operations are as follows:

         For the year ended December 31, 2000, Sales were $9,176,739, which is a
$1,269,168 (or 16%) increase from $7,907,571 in 1999. This increase is primarily
attributable to increased sales of existing products.

         Cost of Goods Sold as a percentage of Sales was 58% in 2000, compared
to 59% in 1999.

         Operating Expenses for 2000 were $2,706,955, which is a $529,318 (or
24%) increase from $2,177,637 in 1999. This increase is due in part to increased
operations in the current year. Additionally, during 2000, the Company paid
non-recurring expenses in excess of $300,000 for: 1) initial filing fees and
legal fees in connection



                                       7
<PAGE>   9

with the listing of the Company's common stock on the NASDAQ National Market
System (NMS) stock exchange, and 2) legal fees and costs in connection with the
Company's successful efforts to protect one of its trademarks and the defense of
a pending lawsuit relating to its restaurant property. Also, depreciation
expenses (a non-cash expense) incurred during 2000 were approximately $168,000
more than in 1999.

         Net Income for 2000 was $927,100, which is a $244,642 increase (or 36%)
from $682,458 in 1999. This increase is attributable to a $258,629 increase in
interest and dividend income in 2000 compared to 1999.

         Earnings per share in 2000 was $.21, which is a $.04 per share (or 24%)
increase from 1999.

Liquidity and Capital Resources

         As of December 31, 2000, the Company had working capital in the amount
of $7,025,285, cash and cash equivalents in the amount of $1,437,101, and
marketable securities of $4,850,357. The Company expects all cash requirements
can be met internally for the next 12-month period.

         Net cash provided by operating activities increased by $572,145 (or
56%), to $1,588,690 in 2000, from $1,016,545 in 1999. This substantial increase
is primarily due to increased sales.

         Net cash used in investing activities increased by $2,707,916 (or
136%), to $4,701,904 in 2000, from $1,993,988 in 1999. This substantial increase
is primarily due to increased purchases (net of sales) of marketable securities
in 2000 to invest almost $5 million received in late 1999 as an equity
investment from Groupe Danone (described below).

         Net cash used in financing activities was $90,608 in 2000, compared to
net cash provided by investing activities of $4,989,951 in 1999. This
substantial difference was the result of the proceeds from the issuance of
common stock upon exercise of stock options and an investment of almost $5
million from Groupe Danone (described below) in 1999.

         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.

Transactions with Groupe Danone

         On October 1, 1999, the Company issued and sold 497,767 shares of
restricted common stock to Danone Foods, Inc. ("Danone"), a subsidiary of Groupe
Danone based in Paris, France. The purchase price paid to the Company was $10.00
per share, for gross proceeds of $4,977,670.

         Pursuant to the terms and conditions of a Stock Purchase Agreement and
a Stockholders' Agreement, the Company granted certain limited rights to Danone,
which include a right to nominate one director, anti-dilutive rights relating to
future offerings, and limited registration rights.

         The Company and Danone also agreed that they would not compete with
each other for a period of five years with respect to certain yogurt, cheese and
kefir products.

         In connection with the transaction, Danone also purchased 150,000
outstanding shares of common stock from certain shareholders, including the
Company's controlling shareholder, on similar terms. As a result of these
purchases, Danone became the beneficial owner of 15% of the outstanding common
stock of the Company.

         Subsequent to the initial transactions described above, Danone
purchased an additional 215,922 shares of common stock in private transactions
with certain shareholders, including the Company's controlling shareholder and
two other affiliates. As a result of these additional purchases, Danone is
presently the beneficial owner of 20% of the outstanding common stock of the
Company. The parties have agreed that, subject to limited exceptions, for a
period of five years, Danone may not own more than 20% of the outstanding common
stock of the Company.



                                       8
<PAGE>   10

         On November 15, 1999, Mr. Thomas Kunz, as the nominee of Danone, joined
the Board of Directors. Mr. Kunz is President, CEO and a director of both Danone
and its subsidiary, The Dannon Company, Inc. In these positions, Mr. Kunz has
strategic and direct responsibilities for Groupe Danone's dairy products in the
U.S. and Canada as well as worldwide category responsibility for dairy desserts.

         On December 24, 1999, the Company entered into a Support Agreement with
The Dannon Company, Inc. (a subsidiary of Danone). The primary purpose of the
Support Agreement, which provides for an initial term of three years and is
renewable annually thereafter, is to allow the Company access to Danone's
brokers and distributors in the United States. The parties agreed that they
would not compete with each other during the term of the Support Agreement and
for three years after termination of the agreement with respect to certain
yogurt, cheese and kefir products.


ITEM 7.    FINANCIAL STATEMENTS.

         The consolidated financial statements that constitute Item 7 of this
report and a table of contents thereto commence on page F-1 through F-17, which
pages follow this page.


ITEM 8.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTANT AND
           FINANCIAL DISCLOSURE.

           None.



                                       9
<PAGE>   11

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                                  ANNUAL REPORT
                           DECEMBER 31, 2000 AND 1999



                                TABLE OF CONTENTS


<TABLE>
<S>                                                                                                         <C>
Independent Auditors' Report..............................................................................      F-2

Consolidated Balance Sheet................................................................................  F-3-F-4

Consolidated Statements of Income and Comprehensive Income................................................      F-5

Consolidated Statements of Changes in Stockholders' Equity................................................      F-6

Consolidated Statements of Cash Flows.....................................................................  F-7-F-8

Notes to Consolidated Financial Statements................................................................ F-9-F-17
</TABLE>



                                      F-1
<PAGE>   12

                          INDEPENDENT AUDITORS' REPORT



To the Board of Directors and Stockholders
LIFEWAY FOODS, INC. AND SUBSIDIARY
Skokie, Illinois


We have audited the accompanying consolidated balance sheet of LIFEWAY FOODS,
INC. AND SUBSIDIARY as of December 31, 2000, and the related consolidated
statements of income and comprehensive income, changes in stockholders' equity,
and cash flows for the years ended December 31, 2000 and 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of LIFEWAY FOODS, INC. AND
SUBSIDIARY as of December 31, 2000, and the results of their operations and
their cash flows for the years ended December 31, 2000 and 1999 in conformity
with accounting principles generally accepted in the United States of America.



Gleeson, Sklar, Sawyers & Cumpata LLP
Elgin, Illinois
February 14, 2001




                                      F-2
<PAGE>   13

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2000


<TABLE>
<S>                                                              <C>
ASSETS

CURRENT ASSETS
     Cash and cash equivalents                                   $  1,437,101
     Marketable securities                                          4,850,357
     Accounts receivable                                            1,181,660
     Inventories                                                      920,011
     Deferred income taxes                                            166,660
                                                                 ------------
     TOTAL CURRENT ASSETS                                           8,555,789

PROPERTY, PLANT, AND EQUIPMENT
     Land                                                             658,400
     Buildings, machinery, and equipment                            7,062,577
                                                                 ------------
     Total                                                          7,720,977
     Less accumulated depreciation                                  2,701,362
                                                                 ------------
     PROPERTY, PLANT, AND EQUIPMENT, NET                            5,019,615

OTHER ASSETS
     Intangible asset, net
                                                                           --
                                                                 ------------

TOTAL ASSETS                                                     $ 13,575,404
                                                                 ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-3
<PAGE>   14

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                     CONSOLIDATED BALANCE SHEET - CONTINUED
                                DECEMBER 31, 2000


<TABLE>
<S>                                                              <C>
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
     Current maturities of notes payable                         $    705,855
     Accounts payable                                                 517,625
     Accrued expenses                                                 242,470
     Taxes payable                                                     64,554
                                                                 ------------
     TOTAL CURRENT LIABILITIES                                      1,530,504

LONG-TERM LIABILITIES                                                 529,322

DEFERRED INCOME TAXES                                                 375,558

STOCKHOLDERS' EQUITY
     Common stock                                                   6,509,267
     Stock subscription receivable                                    (15,000)
     Retained earnings                                              4,850,866
     Accumulated other comprehensive income, net of tax              (205,113)
                                                                 ------------
     TOTAL STOCKHOLDERS' EQUITY                                    11,140,020
                                                                 ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                       $ 13,575,404
                                                                 ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-4
<PAGE>   15

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
                 FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999


<TABLE>
<CAPTION>
                                                                     2000              1999
                                                                 ------------      ------------

<S>                                                              <C>               <C>
SALES                                                            $  9,176,739      $  7,907,571

Cost of goods sold                                                  5,307,681         4,664,987
                                                                 ------------      ------------

GROSS PROFIT                                                        3,869,058         3,242,584

Operating expenses                                                  2,706,955         2,177,637
                                                                 ------------      ------------

INCOME FROM OPERATIONS                                              1,162,103         1,064,947

Other income (expense):
     Interest and dividend income                                     368,987           110,358
     Interest expense                                                 (92,500)         (112,144)
     Gain on sale of marketable securities, net                        14,800             6,621
                                                                 ------------      ------------
     Total other income                                               291,287             4,835
                                                                 ------------      ------------

INCOME BEFORE PROVISION FOR INCOME TAXES                            1,453,390         1,069,782

Provision for income taxes                                            526,290           387,324
                                                                 ------------      ------------

NET INCOME                                                       $    927,100      $    682,458
                                                                 ============      ============

EARNINGS PER SHARE COMMON SHARE                                  $       0.21      $       0.17
                                                                 ============      ============

WEIGHTED AVERAGE SHARES OUTSTANDING                                 4,318,444         3,933,005
                                                                 ============      ============


COMPREHENSIVE INCOME:

NET INCOME                                                       $    927,100      $    682,458

Other comprehensive income, net of tax:
     Unrealized losses on securities (net of tax
         benefits of $129,492 and $3,931)                            (205,113)           (6,791)
     Less reclassification adjustment for losses
         included in net income                                         6,791            11,637
                                                                 ------------      ------------

COMPREHENSIVE INCOME                                             $    728,778      $    687,304
                                                                 ============      ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-5
<PAGE>   16

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999


<TABLE>
<CAPTION>
                                                   COMMON STOCK, NO PAR VALUE
                                                        10,000,000 SHARES
                                                           AUTHORIZED
                                                 ------------------------------      # OF SHARES
                                                 # OF SHARES       # OF SHARES         TREASURY          COMMON
                                                    ISSUED         OUTSTANDING          STOCK             STOCK
                                                 ------------      ------------      ------------      ------------
<S>                                             <C>               <C>                <C>              <C>

BALANCES AT DECEMBER 31, 1998                       3,796,077         3,796,077            10,400      $  1,426,916

Issuance of common stock                              497,767           497,767                --         4,977,670


Cost of issuance of new stock                              --                --                --           (51,501)

Stock options exercised                                35,000            35,000                --           175,000

Retirement of treasury stock                          (10,400)          (10,400)          (10,400)          (18,818)

Other Comprehensive income:
   Unrealized losses on securities, net
   of reclassification adjustment                          --                --                --                --

Net income for the year
   ended December 31, 1999                                 --                --                --                --
                                                 ------------      ------------      ------------      ------------

BALANCES AT DECEMBER 31, 1999                       4,318,444         4,318,444                --      $  6,509,267

Other comprehensive income:
   Unrealized losses on securities, net
   of reclassification adjustment                          --                --                --                --

Net income for the year
   ended December 31, 2000                                 --                --                --                --

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

BALANCES AT DECEMBER 31, 2000                       4,318,444         4,318,444                --      $  6,509,267
                                                 ============      ============      ============      ============

<CAPTION>

                                                                                                        ACCUMULATED
                                                                                                           OTHER
                                                     STOCK                                             COMPREHENSIVE
                                                  SUBSCRIPTION       TREASURY           RETAINED           INCOME,
                                                   RECEIVABLE          STOCK            EARNINGS         NET OF TAX
                                                  ------------      ------------      ------------     -------------
<S>                                              <C>               <C>               <C>              <C>

BALANCES AT DECEMBER 31, 1998                     $         --      $    (18,818)     $  3,241,308     $    (11,637)

Issuance of common stock                                    --                --                --               --

Cost of issuance of new stock                               --                --                --               --

Stock options exercised                                (15,000)               --                --               --

Retirement of treasury stock                                --            18,818                --                --


Other comprehensive income:
   Unrealized losses on securities, net
   of reclassification adjustment                           --                --                --            4,846

Net income for the year
   ended December 31, 1999                                  --                --           682,458               --
                                                  ------------      ------------      ------------     ------------

BALANCES AT DECEMBER 31, 1999                     $    (15,000)     $         --      $  3,923,766     $     (6,791)

Other comprehensive income:
   Unrealized losses on securities, net
   of reclassification adjustment                           --                --                --         (198,322)

Net income for the year
   ended December 31, 2000                                  --                --           927,100              --

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

BALANCES AT DECEMBER 31, 2000                     $    (15,000)     $         --      $  4,850,866     $   (205,113)
                                                  ============      ============      ============     ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-6
<PAGE>   17

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999


<TABLE>
<CAPTION>
                                                                     2000              1999
                                                                 ------------      ------------
<S>                                                              <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   NET INCOME                                                    $    927,100      $    682,458
   Adjustments to reconcile net income to net
     cash flows from operating activities:
       Depreciation and amortization                                  609,520           441,214
       Amortization of discounts on securities                             --            (6,643)
       Gain on sale of marketable securities, net                     (14,800)           (6,621)
       Deferred income taxes                                          149,870            54,147
       (Increase) decrease in operating assets:
         Accounts receivable                                         (215,935)         (118,456)
         Other receivables                                             57,193           (40,993)
         Inventories                                                  (76,052)            7,558
         Prepaid expenses and other assets                                 --            11,772
       Increase (decrease) in operating liabilities:
         Accounts payable                                              37,582           (33,628)
         Accrued expenses                                              49,658            25,737
         Taxes payable                                                 64,554                --
                                                                 ------------      ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES                           1,588,690         1,016,545

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of marketable securities                               (8,807,854)       (1,845,570)
   Sales of marketable securities                                   5,201,892           645,968
   Purchase of property, plant and equipment                       (1,095,942)         (794,386)
                                                                 ------------      ------------
NET CASH USED IN INVESTING ACTIVITIES                              (4,701,904)       (1,993,988)

CASH FLOWS FROM FINANCING ACTIVITIES:
   Repayment of notes payable                                         (90,608)          (96,218)
   Proceeds from issuance of common stock                                  --         5,137,670
   Stock issuance costs                                                    --           (51,501)
                                                                 ------------      ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                   (90,608)        4,989,951
                                                                 ------------      ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS               (3,203,822)        4,012,508

Cash and cash equivalents at the beginning of the year              4,640,923           628,415
                                                                 ------------      ------------

CASH AND CASH EQUIVALENTS AT END OF YEAR                         $  1,437,101      $  4,640,923
                                                                 ============      ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-7
<PAGE>   18

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
                 FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999


<TABLE>
<CAPTION>
                                                                          2000             1999
                                                                      ------------     ------------
<S>                                                                   <C>              <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
   Cash paid for interest                                             $     92,500     $    112,144
                                                                      ============     ============
   Cash paid for income taxes                                         $    319,000     $    376,250
                                                                      ============     ============

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
   AND FINANCING ACTIVITIES:
     Purchase of automobile by issuing a note payable                 $         --     $     22,000
                                                                      ============     ============
     Issuance of common stock in exchange for note receivable
                                                                      $         --     $     15,000
                                                                      ============     ============
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS



                                      F-8
<PAGE>   19

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2000 AND 1999


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 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. The Company also
     distributes some of its products internationally by exporting to Eastern
     Europe. For the years ended December 31, 2000 and 1999, export sales of the
     Company were approximately $154,000 and $162,000, respectively.

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

     The majority of the Company's revenues are derived from the sale of the
     Company's principal products.


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. All significant intercompany
         accounts and transactions have been eliminated.

         Use of estimates

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and reported amounts of revenues and
         expenses during the reporting period. Actual results could differ from
         those estimates.



                                      F-9
<PAGE>   20

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


         Cash and cash equivalents

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




                                      F-10
<PAGE>   21

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

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

          Balances of amounts reported by financial institutions are categorized
          as follows at December 31, 2000:

<TABLE>
<S>                                                             <C>
               Amounts insured                                  $    403,780
               Uninsured and uncollateralized amounts              1,037,102
                                                                ------------
               Total bank balances                              $  1,440,882
                                                                ============
</TABLE>

          Marketable securities

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

          Accounts receivable

          The allowance for doubtful accounts is based on management's
          evaluation of outstanding accounts receivable at the end of the year.
          At December 31, 2000, no allowance for doubtful accounts has been made
          since all receivables were considered collectible.

          Inventories

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

          Property, plant, and equipment

          Property, plant, and equipment are stated at the lower of cost or net
          realizable value. Depreciation is computed using the straight-line
          method. When assets are retired or otherwise disposed of, the cost and
          related accumulated depreciation are removed from the accounts, and
          any resulting gain or loss is recognized in income for the period. The
          cost of maintenance and repairs is charged to income as incurred;
          significant renewals and betterments are capitalized.

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

<TABLE>
<CAPTION>
                    Category                                  Years
                    --------                                 -------
<S>                                                          <C>
                    Buildings and improvements               19 - 31
                    Machinery and equipment                   5 - 12
                    Office equipment                           5 - 7
                    Vehicles                                       5
</TABLE>



                                      F-11
<PAGE>   22

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


          Intangible asset

               Lifeway Foods had a covenant not to compete, which was fully
          amortized as of December 31, 2000. This intangible asset was stated at
          cost and was amortized over ten years using the straight-line method.




                                      F-12
<PAGE>   23

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


          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,
          unrealized gains or losses related to marketable securities and
          capitalization of indirect costs for tax purposes.

          Revenue recognition

          Revenue from the sale of products is generally recognized at time of
          shipment to the customer.

          Advertising costs

          The Company expenses advertising costs as incurred. During 2000 and
          1999, $538,472 and $491,751, respectively, were expensed.

          Earnings per common share

          Earnings per common share were computed by dividing net income
          available to common stockholders by the weighted average number of
          common shares outstanding during the year. For the years ended
          December 31, 2000 and 1999, diluted and basic earnings per share were
          the same.

          Newly issued accounting standards

          In June 1998, the Financial Accounting Standards Board issued
          Statement of Financial Accounting Standards No. 133, "Accounting for
          Derivative Instruments and Hedging Activities." This statement
          requires the recognition of the fair value of derivatives as either
          assets or liabilities. The statement is effective for fiscal years
          beginning after June 15, 2000. It is anticipated that the adoption of
          the provisions of this statement will not have a material effect on
          the financial statements of the Company.

Note 3 - MARKETABLE SECURITIES

          The cost and fair value of marketable securities available for sale at
          December 31, 2000 follow:

<TABLE>
<CAPTION>
                                                                 Unrealized        Unrealized          Fair
                                                   Cost             Gains            Losses            Value
                                                ------------     ------------     ------------      ------------
<S>                                             <C>              <C>              <C>               <C>
          Equities                              $  2,685,816     $     43,503     $   (406,417)     $  2,322,902
          Government agency
            obligations, maturing
            within one year                        2,499,146           37,049           (8,740)        2,527,455
                                                ------------     ------------     ------------      ------------
          Total                                 $  5,184,962     $     80,552     $   (415,157)     $  4,850,357
                                                ============     ============     ============      ============
</TABLE>



                                      F-13
<PAGE>   24

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


Note 3 - MARKETABLE SECURITIES - Continued

     Proceeds from the sale of marketable securities were $5,201,892 and
     $645,968 in 2000 and 1999, respectively. Net gains of $14,800 and $6,621
     were realized on those sales.

Note 4 - INVENTORIES

     Inventories consisted of the following at December 31, 2000:

<TABLE>
<S>                                             <C>
          Raw materials                         $  175,247
          Production supplies                      253,066
          Finished goods                           491,698
                                                ----------
          Total                                 $  920,011
                                                ==========
</TABLE>

Note 5 - PROPERTY, PLANT, AND EQUIPMENT

     Property, plant, and equipment consisted of the following at December 31,
     2000:

<TABLE>
<S>                                             <C>
          Land                                  $  658,400
          Buildings and improvements             2,637,044
          Machinery and equipment                4,080,381
          Vehicles                                 273,580
          Office equipment                          71,572
                                                ----------
          Total                                 $7,720,977
                                                ==========
</TABLE>

          Depreciation charged to income was $604,520 and $436,214 in 2000 and
          1999, respectively.

Note 6 - NOTES PAYABLE

<TABLE>
<S>                                                                                  <C>
          Mortgage note payable, First National Bank of Morton Grove, payable in
          monthly installments of $1,767, including interest at 7.25%, with a
          balloon payment of $139,838 due November 2003. Collateralized by real
          estate.                                                                    $    165,830

          Mortgage note payable, American National Bank and Trust Company of
          Chicago, payable in monthly installments of $3,161 including interest
          at 7.25%, with a balloon payment of $343,151 due August 2003.
          Collateralized by real estate.                                                  377,713

          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.                                            674,413

          Note payable, Ford Motor Credit, payable in monthly installments of
          $540, including interest at 1.9%, due October 2001. Collateralized by
          a vehicle.                                                                        5,350

          Note payable, First National Bank of Morton Grove, payable in monthly
          installments of $532, including interest at 7.5%, due December 2002.
          Collateralized by a vehicle.                                                     11,871
                                                                                     ------------

          Subtotal                                                                      1,235,177
          Less current maturities                                                         705,855
                                                                                     ------------
          Total                                                                      $    529,322
                                                                                     ============
</TABLE>



                                      F-14


<PAGE>   25

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


Note 6 - NOTES PAYABLE - Continued

     Maturities of notes payable are as follows:

<TABLE>
<S>                                           <C>
          Year ending December 31,
                          2001                  $    705,855
                          2002                        28,121
                          2003                       501,201
                                                ------------
                          Total                 $  1,235,177
                                                ============
</TABLE>

Note 7 - PROVISION FOR INCOME TAXES

     The provision for income taxes consisted of:

<TABLE>
<CAPTION>
                                                    2000             1999
                                                ------------     ------------
<S>                                             <C>              <C>
          Current:
             Federal                            $    297,416     $    274,263
             State                                    79,004           58,914
                                                ------------     ------------
          Total current                              376,420          333,177

          Deferred:
             Federal                                 121,987           39,691
             State                                    27,883           14,456
                                                ------------     ------------
          Provision for income taxes            $    526,290     $    387,324
                                                ============     ============
</TABLE>

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

<TABLE>
<CAPTION>
                                                      2000              1999
                                                  ------------      ------------
<S>                                               <C>               <C>
          Federal income tax expense computed
             at the statutory rate                $    494,153      $    337,635
          State taxes, expense                         104,354            76,739
          Permanent book/tax differences               (72,217)          (27,050)
                                                  ------------      ------------
           Provision for income taxes             $    526,290      $    387,324
                                                  ============      ============
</TABLE>

     Amounts for deferred tax assets and liabilities as of December 31, 2000
     were are as follows:

<TABLE>
<S>                                                                   <C>
          Non-current deferred tax liabilities arising from:
             Temporary differences - principally
                 Book/tax, accumulated depreciation                   $    375,558

          Current deferred tax assets arising from:
                 Book/tax, allowance for unrealized losses                 111,550
                 Book/tax, inventories                                      55,110
                                                                      ------------
          Total deferred tax assets                                        166,660
                                                                      ------------
          Net deferred tax liability                                  $    208,898
                                                                      ============
</TABLE>


                                      F-15
<PAGE>   26

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


Note 8 - CUSTOMERS AND CREDIT CONCENTRATIONS

     Concentrations of credit with regard to trade accounts receivable, which
     are uncollateralized, and sales are limited due to the fact that the
     Company's customers are spread across different geographic areas. The
     customers are concentrated in the retail food industry. In 2000 and 1999,
     no customers comprised over 10% of sales.

Note 9 - INTANGIBLE ASSET

     As of December 31, 2000, the Company had the following intangible asset:

<TABLE>
<S>                                             <C>
          Covenant not to compete               $     50,000
          Less accumulated amortization               50,000
                                                ------------
          Intangible asset, net                 $         --
                                                ============
</TABLE>

     Total amortization charged against income for both of the years ended
     December 31, 2000 and 1999 was $5,000.

Note 10 - STOCK OPTION PLANS

     The Company has a registration statement filed with the Securities and
     Exchange Commission in connection with a Consulting Service Compensation
     Plan covering up to 300,000 of the Company's common stock shares. Pursuant
     to the Plan, the Company may issue common stock or options to purchase
     common stock to certain consultants, service providers, and employees of
     the Company. There were 234,300 shares available for issuance under the
     Plan at December 31, 2000 and 1999.

     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, 2000 and 1999, there were no stock options outstanding
     or exercisable.

Note 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated fair values of the Company's financial instruments, none of
     which are held for trading purposes, are as follows at December 31, 2000:

<TABLE>
<CAPTION>
                                                  Carrying          Fair
                                                   Amount           Value
                                                ------------     ------------
<S>                                             <C>              <C>
          Cash and cash equivalents             $  1,437,101     $  1,437,101
                                                ============     ============
          Marketable securities                 $  4,850,357     $  4,850,357
                                                ============     ============
          Notes payable                         $  1,235,177     $  1,194,754
                                                ============     ============
</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 the rates currently offered for debt with similar
     maturities.



                                      F-16
<PAGE>   27

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                           DECEMBER 31, 2000 AND 1999


Note 12 - COMMON STOCK TRANSACTION

     On October 1, 1999, the Company entered into a stock purchase agreement and
     stockholders' agreement with Danone Foods, Inc. ("Danone"). As part of
     these agreements, the Company issued and sold 497,767 unregistered shares
     of restricted common stock to Danone, at a purchase price of $10.00 per
     share. Net of stock issuance costs of $51,501, this transaction resulted in
     an aggregate equity investment of $4,926,169.

     On December 24, 1999, the Company and Danone entered into a support
     agreement, which allowed the Company access to Danone's brokers and
     distributors in the United States and created a non-compete agreement
     between the Company and Danone for a period of three years from the
     termination of this support agreement. In addition, the parties have
     entered into reciprocal stock rights of first refusal and Danone has been
     granted anti-dilutive rights relating to future offerings and limited
     registration rights.



                                      F-17
<PAGE>   28

                                    PART III

         Certain information required by Part III is omitted from this report in
that the Company will file a definitive proxy statement pursuant to Regulation
14A (the "Proxy Statement") not later than 120 days after the end of the fiscal
year covered by this Report, and certain information included therein is
incorporated herein by reference. Only those sections of the Proxy Statement
which specifically address the items set forth herein are incorporated by
reference.

ITEM 9.    DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
           COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

Directors. The information regarding the Company's directors and certain other
information required by this Item is incorporated by reference to the Company's
Proxy Statement.

Executive Officers. The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
Name                                  Age        Position                                             Officer Since
- ----                                  ---        --------                                             -------------
<S>                                   <C>        <C>                                                  <C>

Michael Smolyansky                    53         CEO, CFO, President and Treasurer                        1986
Valeriy Nikolenko                     55         Vice President-Production and Secretary                  1993
</TABLE>

         MICHAEL SMOLYANSKY has been Chief Executive Officer, Chief Financial
Officer, President and Treasurer of the Company since its inception in February
1986. From 1976 to 1985, he was Project Engineer and Department Manager of E.J.
Littell Machine Co., of Chicago, Illinois, where he had primary responsibility
for design of material handling equipment. Mr. Smolyansky is a graduate of the
Kiev Institute of Technology (M.S., Mechanical Engineering, 1971). Mr.
Smolyansky devotes full time to the business of the Company and is also a
director of the Company. Mr. Smolyansky holds no other directorships in any
other reporting company.

         VALERIY NIKOLENKO has been Secretary of the Company since 1993 and Vice
President-Production since January 1996. From 1992 to 1993, he was employed as
an electronic technician in the United States. From 1982 to 1992, Mr. Nikolenko
was a Department Manager for a government controlled design bureau in Kiev. He
is a graduate of the Kiev Institute of Civil Aviation (M.S., Electronic
Engineering, 1969). Mr. Nikolenko devotes full time to the business of the
Company.

Compliance With Section 16(a) of the Securities Exchange Act of 1934

         The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the
Registrant's Proxy Statement.

ITEM 10.   EXECUTIVE COMPENSATION.

         The information required by this Item is incorporated by reference to
the Registrant's Proxy Statement.

ITEM 11.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required by this Item is incorporated by reference to
the Registrant's Proxy Statement.



                                       10
<PAGE>   29

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information required by this Item is incorporated by reference to
the Registrant's Proxy Statement.

ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K.

Financial Statements and Schedules

         A list of the Financial Statements and Financial Statement Schedules
filed as part of this Report is set forth in Item 7, and appears at page F-1 of
this Report, which list is incorporated herein by reference.

Exhibits

Exhibit
Number            Description

3.4               Bylaws, as amended. (Incorporated by reference to Exhibit No.
                  3.4 of the Company's Annual Report on Form 10-KSB for the year
                  ended December 31, 1999, and filed on March 29, 2000.)

3.5               Articles of Incorporation, as amended and currently in effect.
                  (Incorporated by reference to Exhibit 3.5 of the Company's
                  Quarterly Report on Form 10-QSB for the quarter ended June 30,
                  2000 and filed on August 8, 2000.)

10.1              Lifeway Foods, Inc. Consulting and Services Compensation Plan,
                  dated June 5, 1995. (Incorporated by reference to the
                  Company's Registration Statement on Form S-8, File No.
                  33-93306.)

10.10             Stock Purchase Agreement with Danone Foods, Inc., dated
                  October 1, 1999. (Incorporated by reference to Exhibit 10.10
                  of the Registrant's Current Report on Form 8-K dated October
                  1, 1999, and filed October 12, 1999.)

10.11             Stockholders' Agreement with Danone Foods, Inc. dated October
                  1, 1999. (Incorporated by reference to Exhibit 10.11 of the
                  Registrant's Current Report on Form 8-K dated October 1, 1999,
                  and filed October 12, 1999.)

10.12             Letter Agreement dated December 24, 1999 amending the
                  Stockholders' Agreement with Danone Foods, Inc. dated October
                  1, 1999. (Incorporated by reference to Exhibit 10.12 of the
                  Registrant's Current Report on Form 8-K dated December 24,
                  1999 and filed January 11, 2000.)

10.13             Support Agreement with The Dannon Company, Inc. dated December
                  24, 1999. (Incorporated by reference to Exhibit 10.13 of the
                  Registrant's Current Report on Form 8-K dated December 24,
                  1999 and filed January 11, 2000.)

21.2              List of Subsidiaries of the Registrant. (Incorporated by
                  reference to Exhibit 21.2 of the Company's Annual Report on
                  Form 10-KSB for the year ended December 31, 1998 and filed on
                  March 31, 1999.)

Reports on Form 8-K

         The Company did not file any Current Reports on Form 8-K during the
quarter ended December 31, 2000.



                                       11
<PAGE>   30

                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunder duly authorized.

                                LIFEWAY FOODS, INC.



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

                                Date: March 28, 2001

         In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.



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

                                Date: March 28, 2001



                                By   /s/ Pol Sikar
                                  ---------------------------------------------
                                   Pol Sikar, Director

                                Date: March 28, 2001



                                By   /s/ Rick D. Salm
                                  ---------------------------------------------
                                   Rick D. Salm, Director

                                Date: March 28, 2001





                                       12

</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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