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<SEC-DOCUMENT>0001072613-02-000513.txt : 20020415
<SEC-HEADER>0001072613-02-000513.hdr.sgml : 20020415
ACCESSION NUMBER:		0001072613-02-000513
CONFORMED SUBMISSION TYPE:	10KSB
PUBLIC DOCUMENT COUNT:		1
CONFORMED PERIOD OF REPORT:	20011231
FILED AS OF DATE:		20020328

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:		1934 Act
		SEC FILE NUMBER:	000-17363
		FILM NUMBER:		02591941

	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>form10-k_11143.txt
<DESCRIPTION>LIFEWAY FOODS, INC. FORM 10-K DATED 12/31/2001
<TEXT>
================================================================================

                                  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, 2001

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

           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. $10,683,983
                                                                    -----------

           State the aggregate market value of the common stock held by
non-affiliates, approximately 1,198,816 shares, computed by reference to the
price at which the stock was sold as of a specified date within the past 60
days. $8,691,416 as of March 22, 2002, based on the closing price of $7.25 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: 4,268,844 shares of
Common Stock as of March 22, 2002.

                      DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Notice of Annual Meeting and Proxy Statement for the
Registrant's 2002 Annual Meeting of Shareholders, scheduled to be held June 1,
2002, are incorporated by reference in Part III.

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

                                     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.

           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 principal business activity is the manufacturing of
probiotic, cultured functional dairy and non-dairy health food products. The
Company's primary products are kefir, a drinkable dairy beverage similar to but
distinct from yogurt, in several flavors sold under the name "Lifeway Kefir"; a
line of various drinkable yogurts sold under the name "La Fruta," and "Tuscan";
a dairy based immune-supporting dietary supplement beverage called Basics Plus.
The Company also produces several soy-based kefir beverages under the name "Soy
Treat." In addition to the drinkable products, the Company manufactures a line
of various farmer cheeses sold under the name "Lifeway Farmer Cheese"; and a
fruit sugar-flavored spreadable cheese similar in consistency to cream cheese
sold under the name of "Sweet Kiss." The Company also markets 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.

           PRODUCTS

           The Company's primary product is kefir, which, like the better-known
product of yogurt, is a cultured dairy beverage. 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. 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 farmer 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.

                                        1
<PAGE>

           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, and 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. All of the Company's products are certified
Kosher.

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

           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.

           TUSCAN BRAND DRINKABLE YOGURT. "Tuscan Brand Drinkable Yogurt" is a
cultured dairy beverage mainly marketed on the East Coast and manufactured in
five flavors.

           LA FRUTA DRINKABLE YOGURT. "La Fruta" is a yogurt like drink similar
to a milkshake or smoothie that is specifically formulated to accommodate the
Hispanic market, the fastest growing demographic in the U.S. La Fruta is
manufactured in four flavors: strawberry, mango, pina colada, and
banana-strawberry.

           LIFEWAY ORGANIC KEFIR. "Certified-Organic Kefir" meets all the
organic standards and  specifications  and is manufactured in four flavors.
Organic kefir is sweetened with organic cane juice.

           LIFEWAY ORGANIC SOYTREAT. "SoyTreat" is a soy alternative to dairy
kefir and 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."

           FARMER CHEESE. "Farmer Cheese" is based on a cultured soft cheese and
is intended to be used in a variety of recipes as a low fat, low-cholesterol,
low-calorie substitute for cream cheese or ricotta, and is available in various
styles.

           ELITA; BAMBINO. "Elita" and "Bambino cheese are low-fat,
low-cholesterol kefir based cheese spreads which are marketed as an alternative
to cream cheese.

           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 Lifeway is developing sales of the product
internationally and via the internet.

                                        2

<PAGE>

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

           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 ten 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 other independent stores.

           In addition to the State of Illinois, the Company's products are
distributed to over 10,000 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 a line 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 and Russia.

           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.

           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. The Company also sponsors several
different sporting events as an additional marketing tool.

           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.

                                        3
<PAGE>

           COMPETITION

           Although the Company faces a small amount of 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 2001, no customer comprised over 10 % of sales.

           PATENTS, TRADEMARKS, LICENSES, ROYALTY AGREEMENTS

           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.

           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

                                        4
<PAGE>

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.

           On March 20, 2001, the Company received trademark approval from the
U.S. Patent and Trademark office for the trademark "Garden Harmony", for its
unripened cheese spreads.

           On November 6, 2001, the Company received trademark approval from the
U.S. Patent and Trademark office for the trademark "Korovka", for its dairy
based spreads.

           In addition, the Company maintains various state licenses and permits
required to operate its businesses.

           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, probiotic 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 2001, the
amount the Company expended for research and new product development was not
material to the financial position of the Company.

           EMPLOYEES

           The Company currently employs approximately 50 employees. All of
those employees are engaged in the manufacturing process of the Company's kefir
and kefir-based products. None of the Company's employees are covered by
collective bargaining agreements.

                                        5
<PAGE>

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 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,
2001, the loan had a balance of $155,506.

           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,
2001, the loan had a balance of $366,253.

           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
loan to the Company from American National Bank and Trust Company of Chicago,
collateralized by the real estate, was refinanced in November 2001 and has a
balloon payment of $412,142 due in November 2006. The mortgage note is payable
in monthly installments of principal of $3,435 plus interest at 6.51%. At
December 31, 2001, the loan had a balance of $614,779.

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

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


ITEM 3. LEGAL PROCEEDINGS.

           A. 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 N. Caldwell Avenue, Niles, Illinois, where the Company
operated the Moscow Nights Restaurant until August 2001. The Company is
vigorously defending the lawsuit.

           B. On August 21, 2001, Fresh Made, Inc. filed a lawsuit against the
Company in the United States District Court for the Eastern District of
Pennsylvania. The lawsuit also named Michael Smolyansky and Danone Foods, Inc.
as defendants. The lawsuit primarily alleges claims of abuse of process,
restraint of trade, unfair competition, interference with business
relationships, and antitrust claims, and requests an injunction against the
defendants and unspecified monetary damages alleged to be in excess of one
million dollars. Danone Foods, Inc. was subsequently dismissed as a defendant.

           The Company believes that the lawsuit was filed in retaliation of the
Company's attempts to force Fresh Made, Inc. to comply with a settlement
agreement the parties had executed in connection with a prior trademark
infringement lawsuit filed by the Company against Fresh Made in Illinois. The
Company believes that the Pennsylvania lawsuit is frivolous and without merit,
and will vigorously defend the lawsuit and pursue counterclaims against Fresh
Made. The Company has filed a Motion to Dismiss the Complaint, which is pending.


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, 2001, to a vote of security holders through the solicitation
of proxies or otherwise.

                                        6
<PAGE>

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:

                                            Low Bid     High Bid
                                            -------     --------

                     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

                     1st Qtr.   2001         $4.50       $7.00
                     2nd Qtr.   2001         $4.75       $7.75
                     3rd Qtr.   2001         $6.25       $8.00
                     4th Qtr.   2001         $5.55       $7.95

HOLDERS

           As of March 22, 2002, there were approximately 109 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 2001.

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

RESULTS OF OPERATIONS

           The year ended December 31, 2001 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, 2001, Sales were $10,683,983, which
is a $1,507,244 (or 16%) increase from $9,176,739 in 2000. This increase is
attributable to increased sales of existing products, as well as the
introduction of several new products during the year.

           Cost of Goods Sold as a percentage of Sales was 60% in 2001, compared
to 58% in 2000.

           Operating Expenses for 2001 were $2,797,747, which is only a $90,792
(or 3%) increase from $2,706,955 in 2000. Despite the increased operations in
2001, the Company was able to stabilize overall operating expenses

                                        7
<PAGE>

during the year. In addition, depreciation expenses (a non-cash expense)
incurred during 2001 were approximately $173,000 more than in 2000.

           Net Income for 2001 was $1,220,927, which is a $293,827 increase (or
32%) from $927,100 in 2000.

           Earnings per share in 2001 was $.28, which is a $.07 per share (or
33%) increase from 2000.

           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.

LIQUIDITY AND CAPITAL RESOURCES

           As of December 31, 2001, the Company had working capital in the
amount of $8,082,089, cash and cash equivalents in the amount of $936,949, and
marketable securities of $5,754,986. The Company expects all cash requirements
can be met internally for the next 12-month period.

           Net cash provided by operating activities increased by $282,684 (or
19%), to $1,796,724 in 2001, from $1,514,040 in 2000.

           Net cash used in investing activities decreased by $2,711,731 (or
59%), to $1,915,523 in 2001, from $4,627,254 in 2000. This substantial decrease
is primarily due to an overall decrease in the net difference between purchases
and sales of marketable securities in 2001, as compared to 2000. In 2000, the
Company had substantial purchases (net of sales) of marketable securities to
invest almost $5 million the Company received in late 1999 as an equity
investment from Groupe Danone.

           Net cash used in financing activities was $381,353 in 2002, compared
to $90,608 in 2000. This difference was due to the purchase of 45,000 shares of
the company's common stock in market transactions in December 2001, which shares
now constitute treasury stock, at a cost of $287,033. In the fourth quarter of
2001, based upon its belief that the Company's common stock was undervalued, the
Company's board of directors authorized a repurchase program of up to 50,000
shares of the Company's common stock within a one year period from the date of
the first purchase under the program.

           The Company held marketable securities with a fair market value of
$5,754,986 as of December 31 ,2001. These marketable securities have a cost
basis of $6,994,354, which represents $1,239,368 in unrealized losses (net of
unrealized gains) as of December 31, 2001.

OTHER DEVELOPMENTS

           As a result of a pending lawsuit filed by the Niles Park District of
Illinois in its attempt to acquire and take possession of the real estate owned
by the Company's subsidiary, LFI Enterprises, Inc., the Company closed the
"Moscow Nites" restaurant and supper club facility effective August 1, 2001.
Management believes that the decision to close the restaurant will allow the
Company to focus on its core business of manufacturing probiotic, cultured,
functional dairy and non-dairy health food products. The Company is continuing
to vigorously defend the lawsuit.

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 ACCOUNTING AND
        FINANCIAL DISCLOSURE.

             None.

                                        8
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                                  ANNUAL REPORT
                           DECEMBER 31, 2001 AND 2000


                                Table of Contents

                                                                            Page
                                                                             No.

Independent Auditors' Report.............................................    F2

Consolidated Statement of Financial Condition............................    F3

Consolidated Statements of Income and Comprehensive Income...............    F4

Consolidated Statements of Changes in Stockholders' Equity...............    F5

Consolidated Statements of Cash Flows....................................    F6

Notes to Consolidated Financial Statements............................... F7-F12


                                       F-1
<PAGE>

                          INDEPENDENT AUDITORS' REPORT


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


We have audited the accompanying consolidated statement of financial condition
of LIFEWAY FOODS, INC. AND SUBSIDIARY as of December 31, 2001, and the related
consolidated statements of income and comprehensive income, changes in
stockholders' equity, and cash flows for the years ended December 31, 2001 and
2000. 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, 2001, and the results of its operations and its
cash flows for the years ended December 31, 2001 and 2000, in conformity with
accounting principles generally accepted in the United States of America.


Gleeson, Sklar, Sawyers & Cumpata LLP
Elgin, Illinois
February 18, 2002


                                       F-2
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                  CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
                                DECEMBER 31, 2001



ASSETS
- ------
Current assets
Cash and cash equivalents                                          $    936,949
Marketable securities                                                 5,754,986
Accounts receivable, net of allowance for doubtful
accounts of $15,000                                                   1,316,626
Other receivables                                                        52,602
Inventories                                                             800,773
Prepaid expenses and other current assets                                33,686
Deferred income taxes                                                   560,543
                                                                   ------------
TOTAL CURRENT ASSETS                                                  9,456,165

PROPERTY, PLANT, AND EQUIPMENT, NET                                   5,020,865
                                                                   ------------
TOTAL ASSETS                                                       $ 14,477,030
                                                                   ============



LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES
Current maturities of notes payable                                $     90,249
Margin account                                                          431,795
Accounts payable                                                        543,401
Accrued expenses                                                        163,715
Income taxes payable                                                    144,916
                                                                   ------------
TOTAL CURRENT LIABILITIES                                             1,374,076

NOTES PAYABLE                                                         1,116,410

DEFERRED INCOME TAXES                                                   436,265

STOCKHOLDERS' EQUITY
Common stock                                                          6,509,267
Stock subscription receivable                                           (15,000)
Treasury stock, at cost                                                (287,033)
Retained earnings                                                     6,071,793
Accumulated other comprehensive income, net of tax                     (728,748)
                                                                   ------------
TOTAL STOCKHOLDERS' EQUITY                                           11,550,279
                                                                   ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                         $ 14,477,030
                                                                   ============



                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-3
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

<TABLE><CAPTION>
                                                                    2001                   2000
                                                                ------------           ------------
<S>                                                             <C>                    <C>
SALES                                                           $ 10,683,983           $  9,176,739

Cost of goods sold                                                 6,448,992              5,307,681
                                                                ------------           ------------

GROSS PROFIT                                                       4,234,991              3,869,058

Operating expenses                                                 2,797,747              2,706,955
                                                                ------------           ------------

INCOME FROM OPERATIONS                                             1,437,244              1,162,103

Other income (expense):
Interest and dividend income                                         232,173                368,987
Interest expense                                                    (107,425)               (92,500)
Gain on sale of marketable securities, net                           249,522                 14,800
                                                                ------------           ------------
Total other income                                                   374,270                291,287
                                                                ------------           ------------

INCOME BEFORE PROVISION FOR INCOME TAXES                           1,811,514              1,453,390

Provision for income taxes                                           590,587                526,290
                                                                ------------           ------------

NET INCOME                                                      $  1,220,927           $    927,100
                                                                ============           ============

EARNINGS PER SHARE COMMON SHARE                                 $       0.28           $       0.21
                                                                ============           ============

WEIGHTED AVERAGE SHARES OUTSTANDING                                4,318,158              4,318,444
                                                                ============           ============
COMPREHENSIVE INCOME

NET INCOME                                                      $  1,220,927           $    927,100

Other comprehensive income, net of tax:
Unrealized losses on marketable securities (net of tax
benefits of $381,128 and $129,492)                                  (537,505)              (205,113)
Less reclassification adjustment for losses
included in net income                                                13,870                  6,791
                                                                ------------           ------------

COMPREHENSIVE INCOME                                            $    697,292           $    728,778
                                                                ============           ============
</TABLE>

                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-4
<PAGE>

                       LIFEWAY FOODS, INC. AND SUBSIDIARY
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

<TABLE><CAPTION>
                                  COMMON STOCK, NO PAR VALUE
                                      10,000,000 SHARES                                                                 ACCUMULATED
                                          AUTHORIZED        # OF SHARES                                                    OTHER
                                   ------------------------     OF                   STOCK                             COMPREHENSIVE
                                   # OF SHARES  # OF SHARES  TREASURY   COMMON    SUBSCRIPTION   TREASURY     RETAINED     INCOME,
                                     ISSUED     OUTSTANDING   STOCK      STOCK     RECEIVABLE     STOCK       EARNINGS   NET OF TAX
                                    ---------   ----------    ------   ----------   --------    ---------    ----------  ---------
<S>                                 <C>          <C>          <C>      <C>          <C>         <C>          <C>         <C>
BALANCES AT DECEMBER 31, 1999       4,318,444    4,318,444      --     $6,509,267   $(15,000)   $    --      $3,923,766  $  (6,791)

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

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

BALANCES AT DECEMBER 31, 2000       4,318,444    4,318,444      --      6,509,267    (15,000)        --       4,850,866   (205,113)

Purchase of treasury stock               --        (45,000)   45,000         --         --       (287,033)         --         --

Other comprehensive income:
Unrealized losses on securities,
net of taxes and reclassification
adjustment                               --           --        --           --         --           --            --     (523,635)

Net income for the year
ended December 31, 2001                  --           --        --           --         --           --       1,220,927       --
                                    ---------   ----------    ------   ----------   --------    ---------    ----------  ---------

BALANCES AT DECEMBER 31, 2001       4,318,444    4,273,444    45,000   $6,509,267   $(15,000)   $(287,033)   $6,071,793  $(728,748)
                                    =========   ==========    ======   ==========   ========    =========    ==========  =========
</TABLE>

                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-5
<PAGE>
                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

<TABLE><CAPTION>
                                                                   2001                  2000
                                                                -----------           -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
- -------------------------------------
<S>                                                             <C>                   <C>
NET INCOME                                                      $ 1,220,927           $   927,100
Adjustments to reconcile net income to net
  cash flows from operating activities:
    Depreciation and amortization                                   777,350               609,520
    Gain on sale of marketable securities, net                     (249,522)              (14,800)
    Deferred income taxes                                            47,952               149,870
    Provision for doubtful accounts                                  15,000                  --
    (Increase) decrease in operating assets:
      Accounts receivable                                          (149,966)             (215,935)
      Other receivables                                             (52,602)               57,193
      Inventories                                                   119,238               (76,052)
      Prepaid expenses and other current assets                     (33,686)                 --
    Increase (decrease) in operating liabilities:
      Accounts payable                                               25,776               (37,068)
      Accrued expenses                                               (4,105)               49,658
      Income taxes payable                                           80,362                64,554
                                                                -----------           -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES                         1,796,724             1,514,040

CASH FLOWS FROM INVESTING ACTIVITIES:
- -------------------------------------
  Purchase of marketable securities                              (9,246,972)           (8,807,854)
  Sales of marketable securities                                  7,687,102             5,201,892
  Purchases of property, plant and equipment                       (712,798)           (1,095,942)
  Change in margin account                                          357,145                74,650
                                                                -----------           -----------
NET CASH USED IN INVESTING ACTIVITIES                            (1,915,523)           (4,627,254)

CASH FLOWS FROM FINANCING ACTIVITIES:
- -------------------------------------
  Repayment of notes payable                                        (94,320)              (90,608)
  Purchase of treasury stock                                       (287,033)                 --
                                                                -----------           -----------
NET CASH USED IN FINANCING ACTIVITIES                              (381,353)              (90,608)
                                                                -----------           -----------

NET DECREASE IN CASH AND CASH EQUIVALENTS                          (500,152)           (3,203,822)

Cash and cash equivalents at the beginning of the year            1,437,101             4,640,923
                                                                -----------           -----------

CASH AND CASH EQUIVALENTS AT END OF YEAR                        $   936,949           $ 1,437,101
                                                                ===========           ===========
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

                                      F-6
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

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. The Company also distributes some of its products internationally
     by exporting to Eastern Europe. For the years ended December 31, 2001 and
     2000, export sales of the Company were approximately $19,000 and $154,000,
     respectively.

     On September 30, 1992, the Company formed a wholly owned subsidiary
     corporation, LFI Enterprises, Inc., (LFIE) incorporated in the state of
     Illinois. LFIE was formed for the purpose of operating a "Russian" theme
     restaurant and supper club on property acquired by the Company on October
     9, 1992. The restaurant/supper club commenced operations in late November
     1992. As of July 2001, the restaurant/supper club terminated all
     operations.

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

         Cash 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 metropolitan area. Deposits at each
         institution are insured up to $100,000 by the Federal Deposit Insurance
         Corporation or the Securities Investor Protector Corporation.

                                       F-7
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

         Bank balances of amounts reported by financial institutions are
         categorized as follows at December 31, 2001.

                Amounts insured                                 $  404,031
                Uninsured and uncollateralized amounts             490,713
                                                                ----------
                Total bank balances                             $  894,744
                                                                ==========

         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.

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

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

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

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

         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 methods for financial statement and tax purposes,
         unrealized gains or losses related to marketable securities,
         capitalization of indirect costs for tax purposes, and the use of an
         allowance for doubtful accounts for financial statement purposes.

                                      F-8
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

         Advertising costs
         -----------------
         The Company expenses advertising costs as incurred. During 2001 and
         2000, approximately $473,800 and $538,500, 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 year. For 2001 and 2000, diluted
         and basic earnings per share were the same, as the effect of dilutive
         securities options outstanding was not significant.


Note 3 - MARKETABLE SECURITIES

     The cost and fair value of marketable securities available for sale at
December 31, 2001 are as follows:

<TABLE><CAPTION>
                                                         Unrealized       Unrealized         Fair
                                            Cost            Gains           Losses           Value
                                        -----------      -----------     -----------      -----------
<S>                                     <C>              <C>             <C>              <C>
          December 31, 2001
          -----------------
          Equities                      $ 3,447,853      $    46,888     $(1,238,666)     $ 2,256,075
          Preferred securities              777,723            6,827          (6,240)         778,310
          Municipal bonds, maturing
            within five years             2,554,622             --           (63,184)       2,491,438
          Government agency
            obligations, maturing
            after five years                248,755             --            (7,392)         241,363
          Options, maturing within
            one year                        (34,600)          22,400            --            (12,200)
                                        -----------      -----------     -----------      -----------
          Total                         $ 6,994,354      $    76,115     $(1,315,483)     $ 5,754,986
                                        ===========      ===========     ===========      ===========
</TABLE>

     Proceeds from the sale of marketable securities were $7,687,102 and
     $5,201,892, in 2001 and 2000, respectively.

     Gross gains of $249,522 and $14,800, were realized on these sales for 2001
     and 2000, respectively.


Note 4 - INVENTORIES

     Inventories consist of the following at December 31, 2001:

                 Finished goods                       $   273,932
                 Production supplies                      280,897
                 Raw materials                            245,944
                                                      -----------
                                                      $   800,773
                                                      ===========


                                      F-9
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

Note 5 - PROPERTY, PLANT, AND EQUIPMENT

     Property, plant, and equipment consist of the following at December 31,
     2001:

                 Land                                      $    658,400
                 Building and improvements                    2,727,986
                 Machinery and equipment                      4,668,863
                 Vehicles                                       359,383
                 Office equipment                                84,945
                                                           ------------
                                                              8,499,577
                 Less accumulated depreciation                3,478,712
                                                           ------------
                 Total                                     $  5,020,865
                                                           ============

     Depreciation charged to income for the years ended December 31, 2001 and
     2000 was $777,350 and $604,520, respectively .


Note 6 - NOTES PAYABLE

     Notes payable consist of the following at December 31, 2001:

          Mortgage note payable to a bank, 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.                                              $   155,506

          Mortgage note payable to a bank, 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.
                                                                        366,253
          Note payable to a bank, payable in monthly
          installments of $532, including interest at 7.5%,
          due December 2002. Collateralized by a vehicle.                 6,169

          Mortgage note payable to a bank, payable in
          monthly installments of principal of $3,435 plus
          interest at 6.51%, with a balloon payment of
          $412,142 due November 2006. Collateralized by
          real estate.                                                  614,779

          Notes payable to finance companies, payable in
          monthly installments of $1,851, including
          interest at 0%, due November 2004. Collateralized
          by vehicles.                                                   63,952
                                                                    -----------
                                                                      1,206,659
          Less current maturities                                        90,249
                                                                    -----------
          Total                                                     $ 1,116,410
                                                                    ===========

                                      F-10
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

Note 6 - NOTES PAYABLE - Continued

     Maturities of notes payables are as follows:

         Year ending December 31,
                 2002                               $    90,249
                 2003                                   564,541
                 2004                                    60,731
                 2005                                    41,214
                 2006                                   449,924
                                                    ------------
                 Total                              $ 1,206,659
                                                    ============


Note 7 - PROVISION FOR INCOME TAXES

     The provision for income taxes consists of the following:

                                                2001              2000
                                              --------          --------
          Current:
             Federal                          $435,620          $297,416
             State                             107,015            79,004
                                              --------          --------
          Total current                        542,635           376,420
          Deferred                              47,952           149,870
                                              --------          --------
          Provision for income taxes          $590,587          $526,290
                                              ========          ========

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

                                                       2001             2000
                                                    ---------        ---------
          Federal income tax expense
            Computed at the statutory rate          $ 570,953        $ 494,153
          State taxes, expense                        132,240          104,354
          Temporary book/tax differences
            Depreciation                              (38,950)        (135,485)
            Other                                     (18,071)          81,581
          Permanent book/tax differences              (55,585)         (18,313)
                                                    ---------        ---------
          Provision for income taxes                $ 590,587        $ 526,290
                                                    =========        =========

     Amounts for deferred tax assets and liabilities are as follows at December
     31, 2001:

          Non-current deferred tax liabilities arising from:
             Temporary differences - principally
               Book/tax, accumulated depreciation                    $(436,265)
          Current deferred tax assets arising from:
             Book/tax, unrealized losses on marketable securities      510,620
             Book/tax, other                                            49,923
                                                                     ---------
             Total deferred tax assets                                 560,543
                                                                     ---------
          Net deferred tax asset                                     $ 124,278
                                                                     =========

                                      F-11
<PAGE>


                       LIFEWAY FOODS, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

Note 8 - SUPPLEMENTAL CASH FLOW INFORMATION

     Cash paid for interest and income taxes are as follows:

                                  2001              2000
                                --------          --------
          Interest              $107,425          $ 92,500
          Income taxes          $505,500          $319,000

     Non-cash investing and financing transactions during 2001 include the
     purchase of vehicles via note payables for $65,802 and the refinancing of
     debt for $618,214.

Note 9 - 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, 2001 and 2000.

     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, 2001 and 2000, there were no stock options outstanding
     or exercisable.


Note 10 - FAIR VALUE OF FINANCIAL INSTRUMENTS

     The estimated fair value of the Company's financial instruments, none of
     which are held for trading purposes, are as follows at December 31, 2001:

                                              Carrying              Fair
                                               Amount               Value
                                             ----------          ----------
          Cash and cash equivalents          $  936,949          $  936,949
          Marketable securities              $5,754,986          $5,754,986
          Notes payable                      $1,206,659          $1,106,310

     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.


                                      F-12
<PAGE>
                                    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:

Name                 Age  Position                                Officer Since
- ------------------- ----- --------------------------------------- -------------

Michael Smolyansky   54   CEO, CFO, President and Treasurer            1986
Valeriy Nikolenko    56   Vice President-Production and Secretary      1993

           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.

                                        9

<PAGE>

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    Description
Number

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, 2001.

                                       10
<PAGE>

                                   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, 2002

           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, 2002


                              By  /S/ POL SIKAR
                                -----------------------------------------------
                                  Pol Sikar, Director

                              Date: March 28, 2002


                              By  /S/ RICK D. SALM
                                -----------------------------------------------
                                  Rick D. Salm, Director

                              Date: March 28, 2002


                                       11


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