Lifeway Foods, Inc. (LWAY) Business

ITEM 1.      BUSINESS

OVERVIEW

Lifeway was founded in 1986 by Michael Smolyansky,
ten years after he and his family emigrated from Eastern Europe to the United States. Lifeway was the first to successfully introduce
kefir to the U.S. consumer on a commercial scale, initially catering to ethnic consumers in the Chicago, Illinois metropolitan area. Lifeway
has grown to become the largest producer and marketer of kefir in the U.S. and an important player in the broader market spaces of probiotic-based
products and natural, “better for you” foods.

Unless otherwise noted herein, all amounts in
this Form 10-K are in thousands, except per share numbers.

PRODUCTS

Our primary product is drinkable kefir, a cultured
dairy product. Lifeway kefir is tart and tangy, high in protein, calcium and vitamin D.

We manufacture (directly or through co-packers)
and market products under the Lifeway, Fresh Made and GlenOaks Farms brand names, as well as under private labels on behalf of certain
customers.

Our product categories are:

Net sales of products by category were as follows
for the years ended December 31:

Product innovation and new product development

Lifeway is committed to maintaining its position
as the leading producer of kefir and a recognized leader in the market for probiotic products. We routinely evaluate opportunities for
new product development, flavors and formulations, improved package design, new product configurations and other innovation avenues. Beyond
our core drinkable kefir products, we have an ongoing effort to extend the strength of the Lifeway brand and leverage the capabilities
of the Lifeway organization into fresh categories and into additional channels of trade, such as Convenience; Foodservice; Club; and Drug.

Lifeway considers research and development of
new products to be a significant part of our overall business philosophy. Where possible, we leverage our existing staff and facilities
to conduct our innovation, research, and development efforts, rather than maintaining a dedicated research and development staff and facilities
or relying solely on third parties.

PRODUCTION

Manufacturing

During 2025 and 2024, approximately 95% and
94% of our revenue, respectively, was derived from products manufactured at our own facilities. We currently operate the following
manufacturing and distribution facilities:

All our fixed assets associated with manufacturing,
storage, and distribution of our products are in the United States.

Co-Packers

In addition to the products manufactured in our
own facilities, independent manufacturers (“co-packers”) manufacture some of our products. We have a co-packer agreement to
manufacture drinkable yogurt and a small percentage of our Lifeway kefir product in California. We have a co-packer agreement to manufacture
drinkable kefir in Ireland, to serve our European markets. During 2025 and 2024, approximately 5% and 6% of our revenue, respectively,
was derived from products manufactured by co-packers. Our domestic co-packer is Safe Quality Food (“SQF”) certified and follows
Good Manufacturing Practices (“GMPs”). Additionally, the co-packers are required to ensure our products are manufactured in
accordance with our quality specifications and that they are compliant with all applicable laws and regulations.

SALES AND DISTRIBUTION

Sales Organization

We sell our products primarily through our direct
sales force, brokers, and distributors. Our sales organization strives to cultivate strong, collaborative relationships with our customers
that facilitate favorable shelf placement for our products, which we believe drives sales volumes when combined with our marketing efforts
and our brand strength. Our relationships with food brokers provide additional customer coverage as a supplement to our direct sales force.

Distribution inside the United States

Lifeway’s products reach the consumer through
three primary “route-to-market” pathways:

Under the retail-direct channel, we sell our products
to retailers and deliver products through either the retailers’ carriers or third-party carriers that deliver to such retailers’
distribution centers. In turn, our retailers then deliver the products to their respective stores. Under the retail direct-model, optimal
product merchandising, assortment and product presentation are attended to by the retailer. Sales to our retail-direct customers represent
approximately 51% of our total net sales for the year ended 2025.

Under the distributor channel, we sell our products
to distributors and deliver products through either the distributors’ carriers or third-party carriers that deliver to such distributors’
designated warehouses. In turn, our distributors then sell and ship our products to their retail customers. Our distributors often use
a DSD model of their own to make deliveries directly to individual stores, but they also make deliveries to retailers’ distribution
centers. The distributor attends to optimal product merchandising, assortment, and product presentations at the retail end of the channel,
with support from Lifeway’s direct sales force and broker network. Sales to our distributor customers represent approximately 47%
of our total net sales for year ended 2025.

Under the direct store delivery (“DSD”)
route to market, we sell our products to retailers and deliver it directly to the store using Company-owned vehicles and a team of Lifeway
merchandisers who engage face-to-face with store management to ensure optimal product assortments and presentations. We operate our DSD
model in the Chicago, Illinois metropolitan area only. Sales to our DSD customers represent approximately 2% of our total net sales for
the year ended 2025.

Distribution outside of the U.S.

Lifeway’s primary market is the United States;
however, certain distributors based in the United States sell our products to retailers in Mexico, portions of Central and South America,
and the Caribbean. Additionally, Lifeway products reach consumers in France, Ireland, and the Middle East under third party co-manufacturing
agreements and in-country broker and distributor arrangements. Sales distributed outside the United States represented 7% of net sales
for the year ended 2025.

Channel- and Market-Specific Distribution and Broker Representation
Arrangements

Lifeway’s generally standardized agreements
with independent distributors and food brokers allow us the latitude to establish new relationships as opportunities and needs arise.
Where appropriate given the relationship, market, and business opportunity, we offer exclusive channels, markets, and/or territories to
our distributors and brokers.

We provide our independent distributors with products
at wholesale prices for distribution to their retail accounts. Lifeway believes that the prices at which we sell our products to distributors
are competitive compared with the prices generally paid by distributors for similar products in the markets served. Due to the perishable
nature of our products and the costs to return, we do not offer return privileges to any of our distributors or channel customers; however,
from time to time we do provide our customers with allowances for non-saleable product.

Lifeway engages independent food brokers generally
on a commission basis, subject in some cases to a minimum commission guarantee. The commissions vary based on the scope of services provided
and customers served. Our brokers represent our products to a variety of prospective buyers. These buyers could be specialty stores, retail
grocery chains, wholesalers, foodservice operators and distributors, drug chains, convenience stores, club stores, mass merchandisers,
industrial users, schools and universities, or military installations. With support from our direct sales force, brokers may provide other
value-added services. These may include scheduling and coordinating promotions, merchandising, centralized ordering, and data collection
services.

MARKETING

We use a combination of sales incentives, trade
promotions, and consumer promotions to market our products.

Sales Incentives and Trade Promotion
Allowances

Lifeway offers various sales incentives and trade
promotional programs to its retailer and distributor customers from time to time in the normal course of business. These sales incentives
and trade promotion programs include rebates, in-store display and demo allowances, allowances for non-saleable product, every day low
price (“EDLP”) coupons, and other trade promotional activities. Trade promotions support price features, displays, and other
merchandising of our products by our retail and distributor customers. We record these arrangements as a reduction to net sales in our
consolidated statements of operations.

Consumer Promotions and Marketing Campaigns

We engage in an ongoing and wide variety of marketing
and media campaigns – primarily digital and social media, print advertising, television advertising, and event marketing. We complement
these marketing and media efforts with industry-related trade shows and in-store promotional events. Our consumer marketing efforts also
include cooperative advertising programs with our retail customers and various couponing campaigns, online consumer relationship programs,
and other similar forms of promotions.

Our marketing efforts are aimed at stimulating
demand with new and existing consumers by elevating awareness and consumption of kefir and probiotics, as well as enhancing our brand
equity. Our awareness marketing seeks to promote the positive nutritional attributes and flavor of our products.

COMPETITION

Lifeway competes with a limited number of other
domestic kefir producers and consequently faces a small amount of direct competition for kefir products. However, Lifeway’s kefir-based
products compete with other dairy products, such as spoonable and drinkable yogurt, and, increasingly, with non-dairy probiotic products.
Many of our competitors are well-established and have significantly greater financial resources than Lifeway to promote their products.

SUPPLIERS

We purchase our ingredients such as milk, cultures,
and other ingredients from unaffiliated suppliers. In addition, we purchase significant quantities of ingredients and product packaging
materials and utilities, such as natural gas and electricity to operate our facilities. Purchases are made through purchase orders or
contracts, and price, delivery terms, and product specifications vary. The prices for our principal inputs can fluctuate based on economic,
weather, and other conditions. Lifeway believes it has access to alternative suppliers for critical ingredients, packaging, and other
input requirements.

MAJOR CUSTOMERS

During the year ended December 31, 2025, two customers
accounted for a total of 24% of our total net sales. Two customers accounted for a total of 24% of net accounts receivable as of December
31, 2025.

SEGMENTS

Lifeway has determined that it has one reportable
segment based on how our chief operating decision maker manages the business and in a manner consistent with the internal reporting provided
to the chief operating decision maker. The chief operating decision maker, who is responsible for allocating resources and assessing Company
performance, has been identified as the Chief Executive Officer. Substantially all our consolidated revenues relate to the sale of cultured
dairy products that we produce using the same processes and materials and are sold to consumers through a common network of distributors
and retailers in the United States.

INTELLECTUAL PROPERTY

We believe that our rights in our trademarks and
service marks are important to our marketing efforts to develop brand recognition and differentiate our brand from our competitors and
are a valuable part of our business. We own many domestic and international trademarks and service marks. In addition, we own numerous
registered and unregistered copyrights, registered domain names, and proprietary trade secrets, trade dress, technology, know-how, processes,
and other proprietary rights that are not registered. Depending on the jurisdiction, trademarks are generally valid as long as they are
in use and/or their registrations are properly maintained, and they have not been found to have become generic. Registrations of trademarks
can also generally be renewed indefinitely as long as the trademarks are in use. We also have licenses to use certain trademarks inside
and outside of the United States and to certain product formulas, all subject to the terms of the agreements under which such licenses
are granted. Lifeway’s policy is to pursue registration of intellectual property whenever appropriate. We protect our intellectual
property rights by relying on a combination of trademark, copyright, trade dress, trade secret and other intellectual property laws, and
domain name dispute resolution systems; as well as licensing agreements, third-party confidentiality, nondisclosure, and assignment agreements;
and by policing third-party misuses of our intellectual property. We regard the Lifeway family of trademarks and other intellectual property
as having substantial value and as being an important factor in the marketing of our products. The loss of such protection would have
a material adverse impact on our operations and share price.

REGULATION

Lifeway is subject to extensive regulation by
federal, state, and local governmental authorities. In the United States, agencies governing the manufacture, marketing, and distribution
of our products include, among others, the Federal Trade Commission (“FTC”), the United States Food & Drug Administration
(“FDA”), the United States Department of Agriculture (“USDA”), the United States Environmental Protection Agency
(“EPA”), the Occupational Safety and Health Administration (“OSHA”), and their state and local equivalents. Under
various statutes, these agencies prescribe, among other things, the requirements and standards for quality, safety, and representation
of our products to consumers. We are also subject to federal laws and regulations relating to our products and production. For example,
as required by the National Organic Program (“NOP”), we rely on third parties to certify certain of our products and production
locations as organic. Additionally, our facilities are subject to various laws and regulations regarding the release of material into
the environment and the protection of the environment in other ways.

Internationally, we are subject to the laws and
regulatory authorities of the foreign jurisdictions in which we manufacture and sell our products, including the Food Standards Agency
in the United Kingdom; the National Service of Health, Food Safety and Agro-Food Quality (known by its Spanish-language acronym “SENASICA”)
and the Federal Commission for the Protection from Sanitary Risks (“COFEPRIS”) in Mexico; the Food Safety Authority in Ireland;
and the European Food Safety Authority, which supports the European Commission, as well as individual country, province, state, and local
regulations.

Changes in these laws or regulations, or the introduction
of new laws or regulations, could increase the costs of doing business for the Company, our customers, or suppliers, or restrict our actions,
causing our results of operations to be adversely affected.

MILK INDUSTRY REGULATION

Our primary raw material is milk. The federal
government establishes minimum prices for raw milk purchased in federally regulated areas. Some states have established their own rules
for determining minimum prices. The federal government announces prices for raw milk each month. We are subject to federal government
regulations that establish minimum prices for milk, and we also pay producer (“over-order”) premiums, federal order administration
costs, and other related charges that vary by milk product, location, and supplier.

FOOD SAFETY

Lifeway takes appropriate precautions to ensure
the safety of our products. In addition to routine inspections by state and federal regulatory agencies, including the USDA and FDA, we
have instituted Company-wide systems that address topics such as supplier control; ingredient, packaging, and product specifications;
preventive maintenance; pest control; and sanitation. Each of our facilities also has in place a hazard analysis critical control points
(“HACCP”) plan that identifies critical pathways for contaminants and mandates control measures that must be used to prevent,
eliminate or reduce relevant food-borne hazards. To the extent that the federal Food Safety Modernization Act applies to Lifeway’s
business, we develop food safety plans and implement preventive measures to protect against food contamination. We also maintain a product
recall plan, including lot identifiability and traceability measures that allow us to act quickly to reduce the risk of consumption of
any product that we suspect may pose a health issue.

We maintain various types of insurance, including
product liability and product recall coverages, which we believe to be sufficient to cover potential product liabilities.

We have also implemented the SQF program at our
Illinois and Wisconsin facilities. SQF is a fully integrated food safety and quality management protocol designed specifically for the
food sector. The SQF Code, based on universally accepted CODEX Alimentarius, HACCP guidelines and the Global Food Safety Initiative (“GFSI”)
standards, offers a comprehensive methodology to manage food safety and quality simultaneously. SQF certification provides an independent
and external validation that a product, process or service complies with international, regulatory and other specified standards.

SEASONALITY

Lifeway’s business is not seasonal.

EMPLOYEES

As of December 31, 2025, we employed 293 full-time
and two part-time employees, of which 97 were members of a union bargaining unit in Illinois.

AVAILABLE INFORMATION

Lifeway maintains a corporate website at www.lifewayfoods.com
and makes available, free of charge, through this website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and amendments to those reports that we file with or furnish to the SEC as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the SEC. The information contained on our website is not part of this Report.