LWAY · Read the filing

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, 2024 and 2023 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

Unsolicited Proposal

On November 5, 2024, we announced that our board

of directors (our “Board”) determined, after careful and thorough consideration in consultation with the Company’s independent

financial and legal advisors, that the unsolicited proposal made on September 23, 2024 by Danone North America PBC (“Danone”)

to acquire all of the shares of the Company that it did not already own for $25.00 per share, substantially undervalued the Company and

was not in the best interests of the Company or its stockholders or other stakeholders. In connection with that determination, we entered

into a Shareholder Rights Agreement with Computershare Trust Company, N.A., as rights agent (the “Rights Agreement”). Pursuant

to the Rights Agreement, our Board declared a dividend of one preferred share purchase right (each a “Right”) for each outstanding

share of Company common stock to stockholders of record as of the close of business on November 18, 2024. Each Right entitles its holder,

subject to the terms of the Rights Agreement, to purchase from the Company one one-thousandth of one share of Series A Junior Participating

Preferred Stock, no par value, of the Company at an exercise price of $130.00 per Right, subject to adjustment. Rights also attach to

any shares of Company common stock that become outstanding after November 18, 2024 and prior to the earlier of the Distribution Time (as

defined in the Rights Agreement) and the redemption or expiration of the Rights, and in certain other circumstances described in the Rights

Agreement.

On November 15, 2024, Danone revised its offer

to acquire all of the shares of the Company that it did not already own from $25.00 per share to $27.00 per share. On November 20, 2024,

we announced our Board’s determination that, after careful and thorough consideration in consultation with the Company’s independent

financial and legal advisors, the revised unsolicited proposal substantially undervalued the Company and was not in the best interests

of the Company or its stockholders or other stakeholders. On November 26, we announced additional information regarding the information

the Board used to come to this determination.

Debt Refinancing

On February 5, 2025,

the Company entered into the Fifth Modification to the Amended and Restated Loan and Security Agreement (the “Fifth Modification”)

with its current lender. The Fifth Modification, among other things, (i) increased the commitment for revolving loans under the Credit

Agreement from $5,000 to $25,000, with interest payable at either the lender Base Rate (the Prime Rate minus 1.00%) or the SOFR plus 1.75%,

(ii) extended the termination date of the Credit Agreement to February 5, 2028 and (iii) replaced the quarterly minimum working capital

financial covenant with a financial covenant to maintain a maximum cash flow leverage ratio of no greater than 2.00 to 1.00 for each fiscal

quarter commencing with the fiscal quarter ending March 31, 2025. The remaining material terms and conditions of the Credit Agreement

remain substantially unchanged. The Company had no outstanding borrowings at the time of entry into the Fifth Modification.

Products

In October 2024, we began to roll out our first

products with 100% lactose free labeling. Our products were already up to 99% lactose free, so we are pleased to further attract consumers

with our new Organic Whole Milk Flavor Fusion items that have this added benefit, along with decreased sugar content. In demand flavors

including Hot Honey, Matcha Latte, and Passionfruit Lychee are new additions to our portfolio. The entire lineup is loaded with high-quality

bioavailable nutrients, and plays to our strengths, as our organic products have been incredibly successful to date.

We expect health and wellness trends to continue to

be a tailwind for our entire premium product portfolio. We plan to continue to invest behind our key products to capture more and more

of this growing market,

Distribution Strategy

In September 2024, we announced our first expansion

of Kefir distribution in the South African market. In November 2024, we announced our expansion within Dubai and the UAE. The offering

of 32oz Lifeway Kefir, 8oz Lactose-Free Lifeway Kefir, ProBugs and farmer cheese, exported from the United States, is expected to begin

shipping in the first quarter of 2025 and will become available in supermarkets and hypermarkets in Dubai and across the Emirates. We

are taking a measured, and thoughtful approach to global expansion, as we seek markets that are primed for success and can be accessed

without a major initial investment.

Trends and Uncertainties

Current Macroeconomic Environment

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 produce and package our products, staffing, and transportation of our products

to customers. This proactive planning has allowed the Company to meet increased demand.

Results of Operations

Comparison of Year Ended December 31, 2024 to Year

Ended December 31, 2023 (in thousands)

The following table presents certain information concerning

our financial results, including information presented as a percentage of consolidated net sales:

Year Ended December 31,

$ % $ %

Other income (expense):

Gain (loss) on sale of property and equipment (8 ) 0.0% 34 0.0%

Total other income (expense) 117 0.0% (346 ) (0.2% )

Net Sales

Net sales were $186,820 for the year ended December

31, 2024, an increase of $26,697 or 16.7% versus prior year. The net sales increase was primarily driven by higher volumes of our branded

drinkable kefir.

Gross Profit

Gross profit as a percentage of net sales decreased

to 26.0% during the year ended December 31, 2024 from 26.5% during the same period in 2023. The decrease versus the prior year was driven

by the unfavorable impact of milk pricing, and to a lesser extent the increase in other input costs, partially offset by favorable transportation

costs.

Selling Expenses

Selling expenses increased by $2,967 to $14,743

during the year ended December 31, 2024 from $11,776 during the same period in 2023. Selling expenses as a percentage of net sales increased

to 7.9% during the year ended December 31, 2024 from 7.4% during the same period in 2023. The increase is primarily a result of our continued

investments in marketing activities to drive brand awareness and sales volumes.

General and Administrative Expenses

General and administrative expenses increased

$6,309 to $19,439 during the year ended December 31, 2024 from $13,130 during the same period in 2023. Legal and professional fees associated

with non-routine stockholder action and the Danone unsolicited purchase proposal, and the CEO retention bonus awarded in the fourth quarter

of 2024, account for approximately 75% of the increase. General and administrative stock-based compensation expense increased $784 compared

to the same period in 2023.

Provision for Income Taxes

The provision for income taxes includes federal,

state and local income taxes. The provision for income taxes was $4,944 and $5,282 during the year ended December 31, 2024 and 2023, respectively.

The effective income tax rate was 35.4% in 2024

compared to 31.7% in 2023. The statutory Federal and state tax rates remained consistent from 2023 to 2024. 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 2024, the percentage effect is different

primarily due to the increase in certain non-deductible compensation in 2024 compared to 2023. The increase is partially offset by the

difference in pre-tax income in 2024 compared to 2023.

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 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, 2024 (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:

Year Ended December 31,

Net Cash Flows Provided By (Used In):

Investing activities $ (6,682 ) $ (4,410 )

Financing activities $ (2,750 ) $ (3,777 )

Operating Activities

Net cash provided by operating activities was $12,962

in 2024 compared to $16,941 in 2023. The decrease was primarily due to lower cash earnings driven by non-routine stockholder action, and

the change in working capital.

Investing Activities

Net cash used in investing activities was $6,682 in

2024 compared to $4,410 in 2023. The increase in cash used reflects our planned capital spending increase during 2024 compared to 2023.

Our capital spending is focused in three core areas: growth, cost reduction, and facility improvements. Growth capital spending supports

increased production capacity, new product innovation and enhancements. Cost reduction and facility improvements support manufacturing

efficiency, safety, and productivity. We continue to make capital expenditures primarily to modernize manufacturing facilities and support

productivity initiatives.

Financing Activities

Net cash used in financing activities was

$2,750 in 2024 compared to $3,777 in 2023. The cash used represents the quarterly principal payments under the term loan. The Company

paid the outstanding term loan balance of $2,250 in full during the second quarter of 2024.

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 $5,000 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 $5,000 (the “Revolving Credit

Facility”) and an incremental facility not to exceed $5,000. The termination date of the term loan is August 18, 2026, unless earlier

terminated. The term loan was terminated during the second quarter of 2024 upon payment of the outstanding loan balance in full. The termination

date of the revolving credit facility is June 30, 2025, unless earlier terminated.

As of December 31, 2024, the Company had $0 outstanding

under the Revolving Credit Facility and note payable. The Company had $5,000 available for future borrowings under the Revolving Credit

Facility as of December 31, 2024.

All outstanding amounts under the loans bear interest

at the Secured Overnight Financing Rate (“SOFR”), plus 2.07%. 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, 2024. 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, 2024.

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, 2024. 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, 2024, we had $1,590 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 2024 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND

SUPPLEMENTARY DATA

Report of Independent Registered Accounting Firm (PCAOB ID 248) F-1

Consolidated Balance Sheets as of December 31, 2024 and 2023 F-2

Notes to Consolidated Financial Statements F-6

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM

Board of Directors and Stockholders

Lifeway Foods, Inc.

Opinion on the financial statements

We have audited the accompanying consolidated

balance sheets of Lifeway Foods, Inc. (an Illinois corporation) and subsidiaries (the “Company”) as of December 31, 2024

and 2023, the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in

the period ended December 31, 2024, and the related notes (collectively referred to as the “financial statements”). In

our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company

as of December 31, 2024 and 2023, and the results of its operations and its cash flows for each of the two years in the period ended

December 31, 2024, in conformity with accounting principles generally accepted in the United States of America.

Basis for opinion

These consolidated financial statements are the

responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated

financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight

Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the

U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards

of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements

are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform,

an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal

control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal

control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess

the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond

to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating

the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical audit matters

The critical audit matters are matters arising from

the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and

that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging,

subjective, or complex judgments. We determined that there are no critical audit matters.

/s/ GRANT

THORNTON LLP

We have served as the Company’s auditor since 2022.

Chicago, Illinois

March 14, 2025

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2024 and 2023

(In thousands)

December 31,

Current assets

Prepaid expenses and other current assets 2,144 2,019

Refundable income taxes 631 –

Operating lease right-of use asset 118 192

Current liabilities

Current portion of note payable $ – $ 1,250

Accrued income taxes – 474

Operating lease liabilities 70 118

Commitments and contingencies (Note 9) – –

Stockholders’ equity

Preferred stock, no par value; 2,500 shares authorized; none issued – –

Total liabilities and stockholders’ equity $ 90,547 $ 81,654

See accompanying notes to consolidated financial

statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

For the Years Ended December 31, 2024 and 2023

(In thousands, except per share data)

Other income (expense):

Gain (loss) on sale of property and equipment (8 ) 34

Total other income (expense) 117 (346 )

Income before provision for income taxes 13,969 16,649

Net earnings per common share:

Weighted average common shares outstanding:

See accompanying notes to consolidated financial

statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

For the Years Ended December 31, 2024 and 2023

(In thousands)

Common Stock

Issued In treasury Paid-In Retained Total

Shares $ Shares $ Capital Earnings Equity

Stock-based compensation – – – – 1,565 – 1,565

Issuance of common stock on exercise of stock options – – 11 70 36 – 106

Stock-based compensation – – – – 2,561 – 2,561

See accompanying notes to consolidated financial

statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2024 and 2023

(In thousands)

Cash flows from operating activities:

Adjustments to reconcile net income to operating cash flow:

Depreciation and amortization 3,386 3,162

Non-cash interest expense 17 6

Bad debt expense – 2

Deferred income taxes 61 (28 )

Loss (gain) on sale of property and equipment 8 (34 )

(Increase) decrease in operating assets:

Prepaid expenses and other current assets (125 ) (574 )

Refundable income taxes (631 ) 44

Increase (decrease) in operating liabilities:

Accrued income taxes (474 ) 474

Net cash provided by operating activities 12,962 16,941

Cash flows from investing activities:

Purchases of property and equipment (6,697 ) (4,351 )

Proceeds from sale of equipment 15 41

Purchase of investments – (100 )

Net cash used in investing activities (6,682 ) (4,410 )

Cash flows from financing activities:

Repayment of line of credit – (2,777 )

Repayment of note payable (2,750 ) (1,000 )

Net cash used in financing activities (2,750 ) (3,777 )

Net increase in cash and cash equivalents 3,530 8,754

Cash and cash equivalents at the beginning of the period 13,198 4,444

Cash and cash equivalents at the end of the period $ 16,728 $ 13,198

Supplemental cash flow information:

Cash paid for income taxes, net of (refunds) $ 5,987 $ 4,792

Cash paid for interest $ 98 $ 415

Non-cash investing activities

Accrued purchase of property and equipment $ 407 $ 137

Right-of-use assets obtained in exchange for lease obligations $ – $ 94

See accompanying notes to consolidated financial

statements

LIFEWAY FOODS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2024 and 2023

(In thousands)

Note 1 – Basis of presentation

The consolidated financial statements and accompanying

notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

The consolidated financial statements include all of the assets, liabilities and results of operations of Lifeway Foods, Inc. and its

wholly owned subsidiaries (collectively “Lifeway” or the “Company”). All inter-company balances and transactions

have been eliminated in the consolidated financial statements.

Note 2 – Summary of significant accounting

policies

Use of estimates

The preparation of consolidated financial statements

in conformity with U.S. GAAP requires management to use judgement 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 consolidated financial statements, and the

reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates. Significant

estimates made in preparing the consolidated financial statements include the reserve for promotional allowances, the valuation of goodwill

and intangible assets, stock-based and incentive compensation, and deferred income taxes.

Cash and cash equivalents

Lifeway considers cash and all highly liquid investments

purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which

approximates or equals fair value due to their short-term nature.

Lifeway from time to time may have bank deposits in

excess of insurance limits of the Federal Deposit Insurance Corporation. The Company places its cash and cash equivalents with high credit

quality financial institutions. Lifeway has not experienced any losses in such accounts and believes the financial risks associated with

these financial instruments are minimal.

Revenue Recognition

Lifeway sells food and beverage products across select

product categories to customers predominantly within the United States (see Note 13 – Disaggregation of Revenue, Significant Customers,

and Geographic Information). The Company also sells bulk cream, a byproduct of its fluid milk manufacturing process. In accordance with

ASC 606, Revenue from Contracts with Customers, Lifeway recognizes revenue when control over the products transfers to its customers,

which generally occurs upon delivery to its customers or their common carriers. The amount of revenue recognized reflects the consideration

to which the Company expects to be entitled to receive in exchange for these goods or services, using the five-step method required by

ASC 606.

For the Company, the contract is the approved sales

order, which may also be supplemented by other agreements that formalize various terms and conditions with customers. The Company applies

judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s

historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.

Performance obligations promised in a contract are

identified based on the goods or services that will be transferred to the customer, which is the delivery of food and beverage products

which provide immediate benefit to the customer.

Lifeway accounts for product shipping and handling

as fulfillment activities with revenues for these activities recorded within net revenue and costs recorded within cost of goods sold.

Any taxes collected on behalf of government authorities are excluded from net revenues.

Variable consideration, which includes known or expected

pricing or revenue adjustments, such as trade discounts, allowances for non-saleable products, product returns, trade incentives and coupon

redemption, is estimated utilizing the most likely amount method.

Key sales terms, such as pricing and quantities ordered,

are established on a frequent basis such that most customer arrangements and related incentives have a one year or shorter duration. As

such, the Company does not capitalize contract inception costs and it capitalizes product fulfillment costs in accordance with U.S. GAAP

and its inventory policies. It generally does not receive noncash consideration for the sale of goods, nor does it grant payment financing

terms greater than one year.

Accounts Receivable

Lifeway provides credit terms to customers in-line

with industry standards and maintains allowances for potential credit losses based on historical collection experiences and the current

economic condition of specific customers. All accounts receivables have an original term of less than one year. Customer balances are

written off after all collection efforts are exhausted. Estimated product returns, which have not been material, are deducted from sales

at the time of revenue recognition. The Company does not charge interest on past due accounts receivable. Accounts receivable, less allowances was $15,424, $13,875 and $11,414,

as of December 31, 2024, 2023, and 2022 respectively.

Inventories

Inventories are stated at the lower of cost or net

realizable value, valued on a first in, first out basis (“FIFO”). The costs of finished goods inventories include raw materials,

direct labor, and overhead costs. Inventories are stated net of reserves for excess or obsolete inventory.

Property, plant and equipment

Property, plant and equipment are recorded at cost.

Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets as follows:

Schedule of property and equipment, estimated useful lives

Asset Useful Life

Buildings and improvements 10 – 39 years

Machinery and equipment 5 – 12 years

Office equipment 3 – 7 years

Vehicles 5 years

Leasehold improvements Shorter of expected useful life or lease term

The Company performs impairment tests when circumstances

indicate that the carrying value of an asset may not be recoverable. Expenditures for repairs and maintenance, which do not improve or

extend the life of the assets, are expensed as incurred.

Goodwill

Goodwill represents the excess purchase price over

the fair value of the net tangible and other identifiable intangible assets acquired. Goodwill is not amortized, but it is subject to

an annual assessment for impairment, which the Company performs on its one reporting unit during the fourth quarter (as of December 31),

or more frequently if events occur or circumstances change such that it is more likely than not that an impairment may exist.