Lifeway Foods, Inc. (LWAY) FY 2022 MD&A

ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition
and results of operations as of and for the years ended December 31, 2022 and 2021 should be read in conjunction with the audited consolidated
financial statements and the notes to those statements that are included elsewhere in this Annual Report on Form 10-K. In addition to
historical information, the following discussion contains certain forward-looking statements within the “safe harbor” provisions
of the Private Securities Litigation Reform Act of 1995. These statements relate to our future plans, objectives, expectations and intentions.
These statements may be identified by the use of words such as "may," "could," "believe," "future,"
"depend," "expect," "will," "result," "can," "remain," "assurance,"
"subject to," "require," "limit," "impose," "guarantee," "restrict," "continue,"
"become," "predict," "likely," "opportunities," "effect," "change," "future,"
"predict," and "estimate," and similar terms or terminology, or the negative of such terms or other comparable terminology.
Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bounds
of our knowledge of our business, our actual results could differ materially from those discussed in these statements. Factors that could
contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section in Part I, Item
1A. We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available
or other events occur in the future.

Recent Developments

COVID-19 Pandemic Impact

We have seen increased customer and consumer demand
for our products during the pandemic as consumers increased their food purchases for in-home consumption. We have not experienced significant
supply chain disruptions or labor supply shortages and have continued to satisfy customer and consumer demand for our products. Management
continues to proactively manage the supply and transportation of materials used to make and package our products, staffing, and transportation
of our products to customers. This proactive planning has allowed the Company to avoid disruption to its manufacturing facilities and
production, transportation, and sales and to meet the increased demand. The Company has maintained full production capacity available
at all locations and does not anticipate manufacturing or staffing disruptions in the near term.

However, the COVID-19
pandemic, or any future pandemic, may limit the availability of, or increase the cost of, employees, ingredients, packaging and other
inputs necessary to produce our products, and our operations may be negatively impacted. In 2022, our costs increased primarily due to
inflationary price increases of milk, other ingredients, packaging materials, and transportation to our customers. However, because of
market conditions or for competitive reasons, our pricing actions may sometimes lag input cost changes, or we may not be able to pass
along the full effect of increases in raw materials and other input costs as we incur them.

During 2022, social distancing, shelter-in-place
and work-from-home mandates and recommendations have continued to be reduced or eliminated. The increased customer demand for our products
as consumers increased their at-home consumption and e-commerce purchasing during the COVID-19 pandemic may change or decrease due to
the decrease in social distancing and stay-at-home and work-from-home mandates and recommendations. We are unable to predict the nature
and timing of when such change may occur, if at all.

Results of Operations

Comparison of Year Ended December 31, 2022 to Year
Ended December 31, 2021 (in 000’s)

Net Sales

Net sales were $141,568 for the year ended December
31, 2022, an increase of $22,503 or 18.9% versus prior year. The net sales increase was primarily driven by higher volumes of our branded
drinkable kefir and the impact of price increases implemented during the year, and to a lesser extent, the favorable impact of our acquisition
of Glen Oaks Farms during the third quarter of 2021. Approximately 18% of the net sales increase results from the full year 2022 impact
of our acquisition of Glen Oaks Farms during the third quarter of 2021.

Gross Profit

Gross profit as a percentage of net sales decreased
to 18.9% during the year ended December 31, 2022 from 24.1% during the same period in 2021. The decrease versus the prior year was primarily
due to the unfavorable impact of milk pricing, and the inflationary price increases of other ingredients, packaging materials, and freight,
partially offset by the decrease in depreciation expense and favorable labor efficiency due to increased volumes. We took favorable pricing
actions during 2022 to recover a portion of the input and freight cost inflation. However, for market conditions or competitive reasons,
our pricing actions may also lag input cost changes, or we may not be able to pass along the full effect of increases in raw materials
and other input costs as we incur them.

Selling Expenses

Selling expenses increased by $207 to $11,304
during the year ended December 31, 2022 from $11,097 during the same period in 2021. The increase versus prior year is primarily due to
increased investment in advertising and marketing programs, increased broker expense, partially offset by lower compensation expense.

General and Administrative Expenses

General and administrative expenses
increased $982 to $12,593 during the year ended December 31, 2022 from $11,611 during the same period in 2021. The increase is
primarily a result of increased legal and professional fees, which include expense related to non-routine stockholder action, the
fiscal year 2020 Form 10-K restatement, and incentive compensation, partially offset by lower consulting expense to our former
Chairperson of the Board of Directors.

Provision for Income Taxes

The provision for income taxes includes federal,
state and local income taxes. The provision for income taxes was $917 and $2,305 during the year ended December 31, 2022 and 2021, respectively.

Our effective income tax rate was 49.1% in 2022
compared to 41.0% in 2021. The statutory Federal and state tax rates remained consistent from 2021 to 2022. The Company has a number of
items that are nondeductible or are discrete adjustments to tax expense. The Company consistently reflects non-deductible officer compensation
expense, non-deductible compensation expense related to equity incentive awards and separate state tax rates from year to year. Although
similar items were reflected in 2022, the percentage effect is different due to the difference in pre-tax income in 2022 compared to 2021.

Our effective tax rate may change from period
to period based on recurring and non-recurring factors including the relative mix of pre-tax earnings (or losses), the underlying income
tax rates applicable to various state and local taxing jurisdictions, enacted tax legislation, the impact of non-deductible items, changes
in valuation allowances, and the expiration of the statute of limitations in relation to unrecognized tax benefits. We record discrete
income tax items such as enacted tax rate changes in the period in which they occur.

Section 162(m) of the Internal Revenue Code (the
“Code”) limits the deductibility of compensation paid to certain of our executives to the extent their total compensation
exceeds $1 million in any taxable year.

Income taxes are discussed
in Note 10 in the Notes to the Consolidated Financial Statements.

Net Income (Loss)

We reported net income of $924 or $0.06 per basic
and diluted common share for the year ended December 31, 2022 compared to net income of $3,311 or $0.21 per basic and diluted common share
in the same period in 2021.

Liquidity and Capital Resources

Management
assesses the Company's liquidity in terms of its ability to generate cash to fund its operating, investing, and financing activities.
The Company remains in a strong financial position, and while it has been impacted by the macroeconomic challenges with commodity inflation
and other input cost increases, the Company believes that its cash flow from operations, revolving credit and term loan facility, and
cash and cash equivalents will continue to provide sufficient liquidity for its working capital needs, capital resource requirements,
and growth initiatives and to ensure the continuation of the Company as a going concern.

If additional
borrowings are needed, $2,223 was available under the Revolving Credit Facility as of December 31, 2022 (see Note 7, Debt). We are in
compliance with the terms of the Credit Agreement and expect to meet foreseeable financial requirements. The success of our business and
financing strategies will continue to provide us with the financial flexibility to take advantage of various opportunities as they arise.
To date, we have been successful in generating cash and obtaining financing as needed. However, if a serious economic or credit market
crisis ensues, it could have a negative effect on our liquidity, results of operations and financial condition.

The Company’
most significant ongoing short-term cash requirements relate primarily to funding operations (including expenditures for raw materials,
labor, manufacturing and distribution, trade and promotions, advertising and marketing, and income tax liabilities) as well as expenditures
for property, plant, and equipment.

Long-term cash
requirements primarily relate to funding long-term debt repayments (see Note 7, Debt) and deferred income taxes (see Note 10, Income Taxes).

The following table is derived from our Consolidated
Statement of Cash Flows:

Operating Activities

Net cash provided by operating activities was
$3,987 in 2022 compared to $5,564 in 2021. The decrease was primarily due to lower cash earnings, which reflect the impact of input and
freight cost inflation in 2022, and the change in working capital.

Investing Activities

Net cash used in investing activities was $4,029 in
2022 compared to $7,142 in 2021. The decrease in cash used reflects the August 2021 acquisition of GlenOaks Farms, Inc., partially offset
by increased capital spending in 2022. Our capital spending is focused in three core areas: growth, cost reduction, and facility improvements.
Growth capital spending supports new product innovation and enhancements. Cost reduction and facility improvements support manufacturing
efficiency, safety, and productivity.

Financing Activities

Net cash used in financing activities was $4,747
during 2022 compared to net cash provided by financing activities of $2,885 in 2021. The decrease in cash used relates to the term loan
entered into during August 2021 in connection with the acquisition of GlenOaks Farms, Inc., partially offset by the quarterly principal
payments under the term loan.

On June 24, 2021, Lifeway’s Board authorized
a plan to repurchase up to 250 shares of Common Stock in the open market within 24 months at no more than $10 per share. We repurchased
all 250 shares of common stock at a cost of $1,583 during the three-month period ended September 30, 2021. We intend to hold repurchased
shares in treasury for general corporate purposes, including issuances under our 2015 Omnibus Incentive Plan. Treasury shares are accounted
for using the cost method.

On November 7, 2022, the Company entered into
a Stock Purchase Agreement with Ludmila Smolyansky (“Ms. Smolyansky”), to purchase 850,340 shares of Lifeway common stock
from Ms. Smolyansky, Board of Director member. The shares were repurchased during the fourth quarter of 2022.

Pursuant to the Stock Purchase Agreement, the
Company and Ms. Smolyansky have agreed, among other things, that (i) Ms. Smolyansky will sell the shares at a purchase price of $4.70
per share, which represents a twenty percent (20.0%) discount to the average closing price of the common stock on Nasdaq over the five
(5) trading day period ended on the trading day immediately preceding the date of the Stock Purchase Agreement and (ii) Ms. Smolyansky
will use a portion of the proceeds to satisfy in full certain obligations of Ms. Smolyansky, which are secured by previously disclosed
pledges of common stock, causing all such pledges to be released. The purchased shares will be held in treasury by the Company.

Debt Obligations

On August 18, 2021, Lifeway entered into the Fourth
Modification (the “Fourth Modification”) to the Amended and Restated Loan and Security Agreement (as amended and modified
from time to time, the “Credit Agreement”) with its existing lender and certain of its subsidiaries. The Fourth Modification
amends the Credit Agreement to provide for, among other things, a $5 million term loan by the existing lender to the borrowers to be repaid
in quarterly installments of principal and interest over a term of five years (the “Term Loan”).  The termination date
of the Term Loan is August 18, 2026, unless earlier terminated. Except for the addition of the Term Loan, the Credit Agreement remains
substantively unchanged and in full force and effect.

As of December 31, 2022, we had $2,777 outstanding
under the Revolving Credit Facility and $3,727 outstanding under the note payable, net of $23 of unamortized deferred financing fees.
We had $2,223 available for future borrowings under the Revolving Credit Facility as of December 31, 2022. As amended, all outstanding
amounts under the Loans bear interest, at Lifeway’s election, at either the lender Base Rate (the Prime Rate minus 1.00%) or the
LIBOR plus 1.95%, payable monthly in arrears. Lifeway is also required to pay a quarterly unused line fee of 0.20% on the Revolving Credit
Facility and, in conjunction with the issuance of any letters of credit, a letter of credit fee of 0.20%.

The Company’s interest rate on debt outstanding
under the revolving line of credit and note payable as of December 31, 2022 was 6.17% and 6.29%, respectively.

We are in compliance with all applicable financial
debt covenants as of December 31, 2022. See Note 7 to our Consolidated Financial Statements for additional information regarding our indebtedness
and related agreements.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements
as defined in Item 303(a)(4) of Regulation S-K.

Contractual Obligations

Not applicable.

Critical Accounting Estimates

Critical accounting estimates are those estimates
made in accordance with U.S. GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to
have a material impact on the financial condition or results of operations of the registrant. In many cases, the accounting treatment
of a particular transaction is specifically dictated by U.S. GAAP with no need for the application of our judgement. In certain circumstances,
the preparation of our Consolidated Financial Statements in conformity with U.S. GAAP requires us to use our judgment to make certain
estimates and assumptions. These estimates affect the reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the Consolidated Financial Statements and the reported amounts of net sales and expenses during the reporting
period. We believe in the quality and reasonableness of our critical accounting estimates; however, materially different amounts might
be reported under different conditions or using assumptions, estimates or making judgments different from those that we have applied.
Management has discussed the development and selection of these critical accounting policies, as well as our significant accounting policies
(see Note 2 to the Consolidated Financial Statements), with the Audit Committee of our Board of Directors. We have identified the policies
described below as our critical accounting policies.

Goodwill impairment

Goodwill totaled $11,704 as of December 31, 2022.
The Company completed its annual goodwill impairment analysis as of December 31, 2022. Our assessment did not result in an impairment.
Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable intangible assets acquired.
We estimate the fair value of our one reporting unit annually (as of December 31), or more frequently if certain conditions exist, using
a combination of the fair values derived from both the income approach and the market approach. Under the income approach, we calculate
the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on our estimates
of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used to determine
the present value of future cash flows is based on the weighted-average cost of capital adjusted for the relevant risk associated with
business-specific characteristics and the uncertainty related to the business's ability to execute on the projected cash flows. The market
approach estimates fair value based on market multiples of revenue and earnings derived from comparable publicly-traded companies with
similar operating and investment characteristics. The resulting fair value, based on the income and market approaches, is then compared
to the carrying value to determine if impairment is necessary.

Sales discounts & allowance

We offer various trade promotions and sales incentive
programs to customers and consumers. From time to time, we grant certain sales discounts to customers which are classified as a reduction
in sales. The measurement and recognition of discounts and allowances involve the use of judgment and our estimates are made based on
historical experience and specific customer program accruals. Differences between estimated and actual discount and allowance costs are
normally not material and are recognized in earnings in the period such differences are determined. The process for analyzing trade promotion
programs could impact our results of operations and trade spending accruals depending on how actual results of the programs compare to
original estimates. As of December 31, 2022, we had $1,800 of accrued discounts and allowances.

Share-based compensation

Certain employees and non-employee directors receive
various forms of share-based payment awards, and we recognize compensation expense for these awards based on their grant date fair values.
The grant fair value of Restricted Stock Units (“RSUs”) and Performance Share Unit (“PSUs”) awards is equal to
the Company’s closing stock price on the grant date. The Company granted RSU and PSU awards during 2022 to employees under the 2022
long-term incentive-based plan, and RSU awards to non-employee Directors under the 2022 Non-Employee Director Equity and Deferred Compensation
Plan. We do not estimate forfeitures in measuring the grant date fair value, but rather account for forfeitures as they occur. See Note
11 to our consolidated financial statements for further detail.

Income taxes

We pay income taxes based on tax statutes, regulations,
and case law of the various jurisdictions in which we operate. At any given time, multiple tax years are subject to audit by the various
taxing authorities. Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are
recognized for the future tax effects of temporary differences between financial and income tax reporting using tax rates in effect for
the years in which the differences are expected to reverse. The assumptions about future taxable income require the use of significant judgment and are consistent with the
plans and estimates we are using to manage our underlying businesses.

We recognize an income tax benefit from an uncertain
tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based
on the technical merits of the position. The income tax benefit recognized in our financial statements from such a position is measured
based on the largest estimated benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. These judgments
and estimates made at a point in time may change based on the outcome of tax audits and changes to, or further interpretations of, regulations.
If such changes take place, there is a risk that our tax rate may increase or decrease in any period, which would impact our earnings.
Future business results may affect deferred tax liabilities or the valuation of deferred tax assets over time.

Recent Accounting Pronouncements.

See Note 2, Summary of Significant Accounting Policies,
in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for information regarding
recent accounting pronouncements.