Lifeway Foods, Inc. (LWAY) FY 2023 MD&A

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

The following discussion and analysis of the
financial condition and results of operations as of and for the years ended December 31, 2023 and 2022 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,” 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

Current Macroeconomic Environment and Inflation Impact

During 2022, we experienced inflationary and cost
pressures due to volatility and disruption in the global economy which have increased our production and distribution costs. During 2023,
we experienced some moderation of inflationary pressures and have experienced pricing declines in certain of our input costs, such as
conventional milk. In response to these persistent inflationary and cost pressures, we instituted price increases in 2022 on many of our
products. These inflation-justified price increases mitigated a portion of our increased costs.

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 chain of materials used to produce and transport our products to customers. This proactive planning has
allowed the Company to avoid disruption to its manufacturing facilities, transportation, and sales, and to meet the increased demand.
The Company has maintained production at all locations and does not anticipate manufacturing or staffing disruptions in the near term.

Results of Operations

Comparison of Year Ended December 31, 2023
to Year Ended December 31, 2022 (in 000’s)

The following table presents certain information
concerning our financial results, including information presented as a percentage of consolidated net sales:

Net Sales

Net sales were $160,123 for the year ended December
31, 2023, an increase of $18,555 or 13.1% versus prior year. The net sales increase was primarily driven by higher volumes of our branded
drinkable kefir, and to a lesser extent the impact of price increases implemented during the fourth quarter of 2022.

Gross Profit

Gross profit as a percentage of net sales increased
to 26.5% during the year ended December 31, 2023 from 18.9% during the same period in 2022. The increase versus the prior year was primarily
due to the higher volumes of our branded products and the favorable impact of milk pricing, and to a lesser extent the price increases
implemented during the fourth quarter of 2022 and decreased transportation costs.

Selling Expenses

Selling expenses increased by $472 to $11,776
during the year ended December 31, 2023 from $11,304 during the same period in 2022. The increase is primarily due to increased compensation
expense, partially offset by the reduction in royalty expense resulting from the termination of the endorsement agreement in September
2022.

General and Administrative Expenses

General and administrative expenses increased
$537 to $13,130 during the year ended December 31, 2023 from $12,593 during the same period in 2022. The increase is primarily a result
of increased incentive compensation expense, partially offset by the termination of the endorsement agreement in September 2022 and reduced
professional fees.

Provision for Income Taxes

The provision for income taxes includes federal,
state and local income taxes. The provision for income taxes was $5,282 and $917 during the year ended December 31, 2023 and 2022, respectively.

The effective income tax rate was 31.7% in 2023
compared to 49.1% in 2022. The statutory Federal and state tax rates remained consistent from 2022 to 2023. The Company consistently reflects
non-deductible items such as 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 2023, the percentage effect is different
due to the difference in pre-tax income in 2023 compared to 2022.

The Company’s 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, settlement of tax audits, and the expiration of the statute of limitations in relation to unrecognized
tax benefits. The Company records 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.

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, $5,000 was available under the Revolving Credit Facility as of December 31, 2023 (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’s 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).

Cash Flow

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

Operating Activities

Net cash provided by operating activities was
$16,941 in 2023 compared to $3,987 in 2022. The increase was primarily due to higher cash earnings driven by increased product volumes
and declines in certain input costs, and the change in working capital.

Investing Activities

Net cash used in investing activities was $4,410
in 2023 compared to $4,029 in 2022. The increase in cash used reflects our planned capital spending increase during 2023 compared to 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 $3,777 in 2023 compared to $4,747 in 2022. The Company paid the outstanding line of credit balance of $2,777 in full on October 6,
2023. There were no amounts outstanding under the line of credit after October 6, 2023, through December 31, 2023.

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, (i)
Ms. Smolyansky sold 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 used 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 are held
in treasury by the Company.

Debt Obligations

The Company is party to an 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 Credit Agreement provides for, among other things, a $5 million term loan to be repaid in quarterly installments
of principal and interest over a term of five years, a revolving line of credit up to a maximum of $5 million (the “Revolving Credit
Facility”) and an incremental facility not to exceed $5 million. The termination date of the term loan is August 18, 2026, unless
earlier terminated. The termination date of the revolving credit facility is June 30, 2025, unless earlier terminated.

As of December 31, 2023, the Company had $0 outstanding
under the Revolving Credit Facility and $2,733 outstanding under the note payable, net of $17 of unamortized deferred financing fees.
The Company had $5,000 available for future borrowings under the Revolving Credit Facility as of December 31, 2023.

All outstanding amounts under the loans bear interest
at the Secured Overnight Financing Rate (“SOFR”), plus 2.07%. The Company’s interest rate on debt outstanding under
the note payable as of December 31, 2023 was 6.29%. Interest is 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 is in compliance with all applicable
financial debt covenants as of December 31, 2023. 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.

Critical Accounting Estimates

Critical accounting estimates are defined as those
most important to the portrayal of a company’s financial condition and results, and require the most difficult, subjective, or complex
judgments. 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 and Corporate
Governance Committee of our Board of Directors. We have identified the policies described below as our critical accounting policies that
require us to make subjective or complex judgments.

Goodwill impairment

Goodwill totaled $11,704 as of December 31, 2023.
Goodwill represents the excess purchase price over the fair value of the net tangible and other identifiable intangible assets acquired.
Goodwill is not amortized.

The Company has one reporting unit within its
single reportable segment. We review and evaluate our goodwill for potential impairment at a minimum annually, as of December 31, or more
frequently if circumstances indicate that impairment is possible. We completed our annual goodwill impairment analysis as of December
31, 2023. Our assessment did not result in an impairment.

In testing goodwill for impairment, the Company
has the option to perform a qualitative test (also known as “Step 0”) or a quantitative test (“Step 1”). Under
the Step 0 test, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of
the reporting unit is less than its carrying value. Qualitative factors may include, but are not limited to, economic conditions, industry
and market considerations, cost factors, overall financial performance of the reporting unit and other entity and reporting unit specific
events. If after assessing these qualitative factors, the Company determines it is “more-likely-than-not” that the fair value
of the reporting unit is less than the carrying value, then performing the Step 1 quantitative test is necessary.

Step 1 of the quantitative test requires comparison
of the fair value of the Company’s one reporting unit to the carrying value. If the carrying value of the reporting unit is less
than the fair value, no impairment exists. Otherwise, the Company would recognize an impairment charge for the amount by which the carrying
amount of the reporting unit exceeds its fair value up to the amount of goodwill allocated to the reporting unit.

Under a Step 1 quantitative test, we estimate
the fair value of our one reporting unit using a combination of the fair values derived from both the income approach and the market approach.
Under the income approach, the Company uses a discounted cash flow methodology which requires management to make significant estimates
and assumptions related to forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth
rates, and long-term discount rates, among others. 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. For the market approach, the Company uses the guideline public
company method. 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 Company also reconciles the fair value of its reporting unit
to its current market capitalization, allowing for a reasonable control premium.

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, 2023, we had $1,270 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 date 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 2023 to employees. The PSU
awards are contingent upon the achievement of strategic milestones during a three-year measurement period. The expense recognition of
PSU awards therefore requires management to make judgements and estimates at the end of each reporting period as to the cumulative three-year
milestone achievements. Changes in managements estimate of the three-year cumulative milestone achievements are recognized as change in
management estimate in a subsequent period. We do not estimate forfeitures in measuring the grant date fair value of RSUs and PSUs, but
rather account for forfeitures as they occur. Forfeitures have historically been immaterial. 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.