Galaxy Nutritional Foods (GXY) 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

__________________________________________________________________

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from_______ to ______

Commission File Number 1-15345

GALAXY NUTRITIONAL FOODS, INC.

(Exact name of registrant as specified in its charter)

Delaware	25-1391475
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

5955 T. G. Lee Blvd., Suite 201
Orlando, Florida	32822
(Address of principal executive offices)	(Zip Code)

(407) 855-5500

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þNO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):       

Large accelerated filer  o Accelerated filer  o Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).       YES  o NO þ

On February 8, 2008, there were 17,110,016 shares of common stock, $.01 par value per share, outstanding.

1

GALAXY NUTRITIONAL FOODS, INC.

Index to Form 10-Q

For the Quarter Ended December 31, 2007

		PAGE NO.
PART I.                FINANCIAL INFORMATION
Item 1.	Financial Statements
Balance Sheets		3
Statements of Operations		4
Statement of Stockholders’ Deficit		5
Statements of Cash Flows		6
Notes to Financial Statements		7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
PART II.               OTHER INFORMATION
Item 1A.	Risk Factors	27
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits	31
SIGNATURES		35

2

PART I. FINANCIAL INFORMATION

GALAXY NUTRITIONAL FOODS, INC.

Balance Sheets

			DECEMBER 31,			MARCH 31,
	Notes		2007			2007
			(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash			$	1,442,261		$	879,487
Trade receivables, net				2,581,702			2,652,845
Inventories, net				100,558			377,432
Prepaid expenses and other				264,700			261,693
Total current assets				4,389,221			4,171,457
PROPERTY AND EQUIPMENT, NET				70,706			90,181
OTHER ASSETS				74,823			102,980
TOTAL			$	4,534,750		$	4,364,618
LIABILITIES AND STOCKHOLDERS’ DEFICIT
CURRENT LIABILITIES:
Secured borrowings		2	$	--		$	556,886
Accounts payable				1,409,884			1,718,088
Accrued and other current liabilities				878,888			823,258
Current portion of accrued employment contracts		3		423,569			366,305
Related party note payable		3		2,685,104			--
Total current liabilities				5,397,445			3,464,537
ACCRUED EMPLOYMENT CONTRACTS, less current portion		3		2,154			194,491
RELATED PARTY NOTE PAYABLE		2		--			2,677,144
Total liabilities				5,399,599			6,336,172
COMMITMENTS AND CONTINGENCIES		4		--			--
STOCKHOLDERS’ DEFICIT:
Common stock				171,100			171,100
Additional paid-in capital				70,167,149			70,167,149
Accumulated deficit				(71,203,098	)		(72,309,803	)
Total stockholders’ deficit				(864,849	)		(1,971,554	)
TOTAL			$	4,534,750		$	4,364,618

See accompanying notes to financial statements

3

GALAXY NUTRITIONAL FOODS, INC.

Statements of Operations

(UNAUDITED)

			THREE MONTHS ENDED						NINE MONTHS ENDED
			DECEMBER 31,						DECEMBER 31,
	Notes		2007			2006			2007			2006
Net Sales			$	6,446,099		$	6,110,619		$	18,763,360		$	20,670,958
Cost of Goods Sold				4,145,200			3,417,232			11,346,406			12,450,194
GROSS MARGIN				2,300,899			2,693,387			7,416,954			8,220,764
OPERATING EXPENSES:
Selling				871,797			775,043			2,702,038			2,621,845
Delivery				263,923			217,431			772,786			643,714
General and administrative, including $0, $10,000, $0 and $108,160 non-cash compensation related to stock based transactions		5		672,530			639,030			1,883,647			2,496,658
Employment contract expense-general and administrative		3		--			--			346,447			--
Research and development				86,511			47,345			249,506			134,128
Reserve on stockholder note receivable				--			--			--			1,428,000
Cost of disposal activities		1		--			134,744			--			283,547
Loss on disposal of assets				512			19,775			512			44,280
Total operating expenses				1,895,273			1,833,368			5,954,936			7,652,172
INCOME FROM OPERATIONS				405,626			860,019			1,462,018			568,592
INTEREST EXPENSE				(110,261	)		(133,835	)		(343,313	)		(623,273	)
INCOME (LOSS) BEFORE TAXES				295,365			726,184			1,118,705			(54,681	)
FEDERAL INCOME TAX EXPENSE				--			--			(12,000	)		--
NET INCOME (LOSS)			$	295,365		$	726,184		$	1,106,705		$	(54,681	)
BASIC NET INCOME (LOSS) PER COMMON SHARE		6	$	0.02		$	0.04		$	0.06		$	0.00
DILUTED NET INCOME (LOSS) PER COMMON SHARE		6	$	0.01		$	0.03		$	0.05		$	0.00

See accompanying notes to financial statements.

4

GALAXY NUTRITIONAL FOODS, INC.

Statement of Stockholders’ Deficit

Nine Months Ended December 31, 2007

(UNAUDITED)

	Common Stock
	Shares		Par Value		Additional Paid-In Capital		Accumulated Deficit			Total
Balance at March 31, 2007		17,110,016	$	171,100	$	70,167,149	$	(72,309,803	)	$	(1,971,554	)
Net income		--		--		--		1,106,705			1,106,705
Balance at December 31, 2007		17,110,016	$	171,100	$	70,167,149	$	(71,203,098	)	$	(864,849	)

See accompanying notes to financial statements.

5

GALAXY NUTRITIONAL FOODS, INC.

Statements of Cash Flows

(UNAUDITED)

Nine Months Ended December 31,	Notes		2007			2006
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net Income (Loss)			$	1,106,705		$	(54,681	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation and amortization				33,308			130,102
Amortization of debt discount and financing costs				36,117			256,546
Provision for future credits and doubtful accounts on trade receivables				(632,500	)		(253,150	)
Inventory reserve Provision for loss on stockholder note receivable				5,615 --			-- 1,428,000
Loss on disposal of assets				512			44,280
Non-cash compensation related to stock-based transactions				--			108,160
(Increase) decrease in:
Trade receivables				703,643			1,356,545
Inventories, net				271,259			(66,946	)
Prepaid expenses and other				(3,007	)		(176,477	)
Increase (decrease) in:
Accounts payable				(308,204	)		(1,317,088	)
Accrued and other liabilities				(79,443	)		(675,201	)
NET CASH FROM OPERATING ACTIVITIES				1,134,005			780,090
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchase of property and equipment				(14,345	)		(22,854	)
Proceeds from sale of equipment				--			45,455
Decrease in other assets				--			34,923
NET CASH FROM (USED IN) INVESTING ACTIVITIES				(14,345	)		57,524
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net payments on secured borrowings				(556,886	)		(745,225	)
Borrowings on term notes payable				--			1,200,000
Repayments on term notes payable				--			(1,200,000	)
Principal payments on capital lease obligations				--			(62,826	)
Financing costs for long term debt				--			(144,011	)
NET CASH USED IN FINANCING ACTIVITIES				(556,886	)		(952,062	)
NET INCREASE (DECREASE) IN CASH		7		562,774			(114,448	)
CASH, BEGINNING OF PERIOD				879,487			435,880
CASH, END OF PERIOD			$	1,442,261		$	321,432

See accompanying notes to financial statements.

6

GALAXY NUTRITIONAL FOODS, INC.

Notes to Financial Statements

(UNAUDITED)

(1) Summary of Significant Accounting Policies

The unaudited financial statements have been prepared by Galaxy Nutritional Foods, Inc. (the “Company”), in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and applicable rules and regulations of the Securities and Exchange Commission. The accompanying financial statements contain all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of such financial statements. Certain information and disclosures normally included in the financial statements prepared in accordance with GAAP have been omitted under such rules and regulations although the Company believes that the disclosures are adequate to make the information presented not misleading. The March 31, 2007 balance sheet data was derived from the audited financial statements, but does not include all disclosures required by GAAP. These unaudited financial statements should be read in conjunction with the financial statements and notes included on Form 10-K for the fiscal year ended March 31, 2007. Interim results of operations for the nine-month period ended December 31, 2007 may not necessarily be indicative of the results to be expected for the full year.

Revenue Recognition

Sales are recognized upon shipment of products to customers. The Company offers a right of return policy on certain products sold to certain retail customers in the conventional grocery stores and mass merchandising industry. If the product is not sold during its shelf life, the Company will allow a credit for the unsold merchandise. Since the shelf life of the Company’s products ranges from 4 months to one year, the Company historically averages less than 2% of gross sales in credits for unsold product. The Company’s reserve on accounts receivable takes these potential future credits into consideration. Certain expenses such as returns, slotting fees, rebates, coupons and other discounts are accounted for as a reduction to Revenues.

Disposal Costs

On December 8, 2005, the Company completed the sale of substantially all of its manufacturing and production equipment to Schreiber Foods, Inc., a Wisconsin corporation (“Schreiber”) for $8,700,000 in cash pursuant to an Asset Purchase Agreement dated June 30, 2005. In connection with the Asset Purchase Agreement, the Company also entered into a Supply Agreement with Schreiber (the “Supply Agreement”) on June 30, 2005 pursuant to which, Schreiber became the Company’s sole source of supply and distribution for substantially all of its products in November 2005.

The Company accounted for the costs associated with these transactions in accordance with SFAS No. 146, “Accounting for Costs Associated with an Exit or Disposal Activity,” (“SFAS 146”) because the above arrangements were planned and controlled by management and materially changed the manner in which the Company’s business was conducted. In accordance with SFAS 146, costs associated with disposal activities were reported as a reduction of income from operations.

The Company recorded accruals in connection with the asset sale and outsourcing of its manufacturing operations in fiscal 2006. The initial accruals included estimates pertaining to employee termination costs and abandonment of excess equipment and facilities and other potential costs. Given the significance and complexity of these activities, and the timing of the execution of such activities, the accrual process involved periodic reassessments of estimates made at the time the original decisions were made, including evaluating estimated employment terms, contract cancellation charges and real estate market conditions for sub-lease rents. Currently, there are no further costs that require estimates and any future disposal costs will be recorded as incurred in accordance with SFAS 146.

Non-Cash Compensation Related to Stock-Based Transactions

Effective April 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”). SFAS 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.

7

SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after the effective date, as well as to the unvested portion of awards outstanding as of the effective date. The Company uses the Black-Scholes option-pricing model to value its new stock option grants under SFAS 123R, applying the “modified prospective method” for existing grants which requires the Company to value stock options prior to its adoption of SFAS 123R under the fair value method and expense the value over the requisite service period. SFAS 123R also requires the Company to estimate forfeitures in calculating the expense related to stock-based compensation. In addition, SFAS 123R requires the Company to reflect cash flows resulting from excess tax benefits related to those options as a cash inflow from financing activities rather than as a reduction of taxes paid.

The Black-Scholes option-pricing model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The risk-free rate is based on the U.S. Treasury zero-coupon rates with a remaining term equal to the expected term of the option. Expected volatilities are based on the historical volatility of the Company’s stock. Prior to April 1, 2006, the Company input the expected term of options granted based on the contractual life of the options granted. Upon adoption of SFAS 123R, the Company inputs the expected term of options granted based on information derived from historical data on employee exercises and post-vesting employment termination behavior. There is no expected dividend yield.  These factors could change in the future, which may affect the stock-based compensation expense in future periods. SFAS 123R also requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. There were no issuances of stock awards during the three and nine months ended December 31, 2007. Therefore, the Company did not make any assumptions under the Black-Scholes option-pricingmodel during these periods.

The Company estimated the fair value of each stock-based award during the three and nine month periods ended December 31, 3006 using the Black-Scholes pricing model with the following assumptions:

	Three Months Ended			Nine Months Ended
	December 31, 2006			December 31, 2006
Risk-free interest rate		4.52	%		4.07-4.94	%
Volatility		48.7	%		50.3-51.9	%
Expected life (months)		120			36-120
Dividends		None			None

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period, which approximates the requisite service period. Stock-based compensation expense recognized in the Company's Statements of Operations for the periods presented includes compensation expense for share-based payment awards granted prior to, but not yet vested as of March 31, 2006 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to March 31, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. As stock-based compensation expense recognized in the Statement of Operations is based on awards ultimately expected to vest and to be exercised, it will be reduced for estimated forfeitures. There was no forfeiture rate applied to the stock-based compensation expense for the three and nine months ended December 31, 2006 as all options were fully vested and were able to be exercised.

Net Income (Loss) per Common Share

Net income (loss) per common share is computed by dividing net income or loss by the weighted average shares outstanding.  Diluted net income (loss) per common share is computed on the basis of weighted average shares outstanding plus potential common shares which would arise from the exercise of stock options and warrants and conversion of convertible debt.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expense during the reporting period. The Company’s significant estimates include the allowance for trade receivables, inventory reserves, valuation of deferred taxes and valuation of non-cash compensation related to stock-based transactions. Actual results could differ from these estimates.

8

Segment Information

The Company does not identify separate operating segments for management reporting purposes. The results of operations are the basis on which management evaluates operations and makes business decisions. The Company sells to customers throughout the United States and 12 other countries.

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised),“Business Combinations,” (“SFAS 141(R)”). SFAS 141(R) changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company is currently evaluating the impact of the pending adoption of SFAS 141(R) on its results of operations and financial condition.

In June 2007, the FASB ratified EITF Issue No. 07-03, "Accounting for Nonrefundable Advance Payments for Goods and Services Received for Use in Future Research and Development Activities." EITF 07-03 requires companies to defer nonrefundable advance payments for goods and services and to expense that advance payment as the goods are delivered or services are rendered. If the company does not expect to have the goods delivered or services performed, the advance should be expensed. EITF 07-03 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact of adopting EITF 07-03 on its financial statements.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. The Company is currently evaluating the effect, if any, the adoption of SFAS 159 will have on its financial statements, results of operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 simplifies and codifies guidance on fair value measurements under generally accepted accounting principles. This standard defines fair value, establishes a framework for measuring fair value and prescribes expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the effect, if any, the adoption of SFAS 157 will have on its financial statements, results of operations and cash flows.

Income Taxes and Recently Adopted Accounting Pronouncement

The Company adopted the provisions of FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109,” (“FIN 48”), on April 1, 2007. FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company has not recognized a liability as a result of the implementation of FIN 48. A reconciliation of the beginning and ending amount of unrecognized tax benefits has not been provided since there is no unrecognized benefit as of the date of adoption. The Company has not recognized interest expense or penalties as a result of the implementation of FIN 48. If there were an unrecognized tax benefit, the Company would recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. The Company files income tax returns in the U.S. federal jurisdiction and in various states.

Deferred income taxes are recognized for the tax consequences of temporary differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities in accordance with SFAS No. 109, “Accounting for Income Taxes.” Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

Financial Instruments

SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of fair value information about financial instruments. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2007.

9

The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values. These financial instruments include cash, trade receivables, accounts payable and accrued liabilities. Fair values were assumed to approximate carrying values for these financial instruments since they are short term in nature and their carrying amounts approximate fair values or they are receivable or payable on demand. The fair value of the Company’s secured borrowings and related party note payable is estimated based upon the quoted market prices for the same or similar instruments or on the current rates offered to the Company for debt with the same remaining maturities.

(2)   Secured Borrowings and Related Party Note Payable

Secured Borrowings

On June 23, 2006, the Company entered into a Receivables Purchase Agreement with Commercial Finance Division, formerly known as Systran Financial Services Corporation, a subsidiary of Textron Financial Corporation (“Commercial Finance”), whereby Commercial Finance provides financing to the Company through advances against certain trade receivable invoices due to the Company (the “Commercial Finance Agreement”). The Commercial Finance Agreement is secured by the Company’s accounts receivable and all other assets. Generally, subject to a maximum principal amount of $3,500,000 which can be borrowed under the Commercial Finance Agreement, the amount available for borrowing is equal to 85% of the Company’s eligible accounts receivable invoices less a dilution reserve and any required fixed dollar reserves. The dilution and fixed dollar reserves are currently set at 7% and $100,000, respectively. Advances under the Commercial Finance Agreement bear interest at a variable rate equal to the prime rate plus 1.5% per annum (8.75% on December 31, 2007). However, the Commercial Finance Agreement requires a $4,500 minimum monthly interest charge to be assessed. The Company is also obligated to pay a $1,500 monthly service fee.

The initial term of the Commercial Finance Agreement ends on June 23, 2009 and may renew automatically for consecutive twelve-month terms unless terminated sooner. The Commercial Finance Agreement may be accelerated in the event of certain defaults by the Company including among other things, a default in the Company’s payment and/or performance of any obligation to Commercial Finance or any other financial institution, creditor, or bank; and any change in the conditions, financial or otherwise, of the Company which reasonably causes Commercial Finance to deem itself insecure. In such an event, interest on the Company’s borrowings would accrue at the greater of twelve percent per annum or the variable rate of prime plus 1.5% and the Company would be liable for an early termination premium ranging from 1% to 3%, depending upon the timing of such termination, of the maximum principal amount available under the Commercial Finance Agreement. As of December 31, 2007, there were no amounts advanced under the Commercial Finance Agreement.

In accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Debt,” the Company accounts for the Commercial Finance Agreement as a liability since it is a full-recourse agreement and the Company maintains effective control over the accounts receivable.

Related Party Note Payable

Pursuant to a Note Purchase Agreement dated July 19, 2006, the Company issued a new unsecured convertible note for $2,685,104 (the “Convertible Note”) to Mr. Frederick A. DeLuca. The proceeds from the Convertible Note were used to repay or refinance several notes totaling $2.4 million that matured on June 15, 2006 and a $285,104 registration rights penalty owed to Mr. DeLuca. The Convertible Note accrues interest at 12.5% per annum. No interest or principal payments are required under the Convertible Note until its maturity. Principal, together with any accrued and unpaid interest, on the Convertible Note is convertible at any time prior to payment into shares of the Company’s common stock at a conversion price of $0.35 per share. The closing market price of the Company’s common stock as quoted on the OTC Bulletin Board on July 19, 2006 was $0.28. As additional consideration for making the loan, the Company issued Mr. DeLuca a warrant (the “Warrant”) to purchase up to 200,000 shares of the Company’s common stock at an exercise price equal to $0.35 per share. The Warrant is fully vested and can be exercised on or before the expiration date of July 19, 2009. In July 2006, the Company recorded the $18,000 fair value of the Warrant as a discount to debt that was amortized from July 2006 through October 2007.

Pursuant to a Note Modification Agreement dated March 14, 2007, the Company and Mr. DeLuca agreed to extend the maturity date of the Convertible Note from October 19, 2007 to October 19, 2008. All other terms of the Convertible Note remain the same.

10

Pursuant to the Note Purchase Agreement dated July 19, 2006 and the Note Modification Agreement dated March 14, 2007, the Company’s Convertible Note together with any accrued and unpaid interest thereon, is convertible at any time prior to payment into shares of the Company’s common stock at a conversion price of $0.35 per share. As a result of the convertible features of the Convertible Note, Mr. DeLuca’s ownership in the Company may increase from approximately 23% to nearly 52% by October 2008. The calculation of ownership assumes, among other things, that Mr. DeLuca converts the entire amount of principal and all accrued interest on the Convertible Note through October 19, 2008 into an aggregate of 9,861,364 shares and exercises of all of his currently outstanding warrants into 500,000 shares of the Company’s common stock.

The Company amortized $1,289 and $7,960 of debt discount to interest expense in the three and nine months ended December 31, 2007, respectively. The Company amortized $3,600 and $133,419 related to debt discounts in the three and nine months ended December 31, 2006, respectively. Additionally, the Company recorded interest expense related to the related party note of $85,774 and $256,390 in the three and nine months ended December 31, 2007, respectively. The Company recorded interest expense related to related party notes of $85,774 and $237,335 in the three and nine months ended December 31, 2006. As of December 31, 2007, the outstanding principal balance on the Convertible Note is $2,685,104.

(3)   Related Party Transactions

Angelo S. Morini

In a Second Amended and Restated Employment Agreement effective October 13, 2003, Angelo S. Morini, the Company’s Founder, resigned from his positions with the Company as Vice Chairman and President and he is no longer involved in the daily operations of the Company. Mr. Morini remained a director of the Company until his resignation on March 8, 2007. Mr. Morini continues to be a stockholder in the Company. Additionally, he may carry out special assignments designated to him by the Chairman of the Board. The agreement is for a five-year period beginning October 13, 2003 and provides for an annual base salary of $300,000, plus standard health insurance benefits, club dues and an auto allowance.

Because Mr. Morini is no longer performing ongoing services for the Company, the Company accrued and expensed the five-year cost of this agreement in October 2003. The total estimated costs expensed under this agreement were $1,830,329 of which $289,111 remained unpaid but accrued as a current liability as of December 31, 2007. The obligation is being paid out in nearly equal monthly installments ending in October 2008.

Christopher Morini

On June 1, 2007, Christopher Morini resigned from his position as Vice President of New Business Development in order to pursue other opportunities. In accordance with the Separation and General Release Agreement which became effective on June 9, 2007, between the Company and Mr. C. Morini, the Company accrued $346,447 for wages and payroll taxes and expensed them under Employment Contract Expense-General and Administrative in the Statement of Operations in June 2007. After an initial lump sum payment of approximately $100,087, the remaining obligation is being paid out in nearly equal bi-weekly installments through February 2009. As of December 31, 2007, $136,612 remained unpaid but accrued ($134,458 as current liabilities and $2,154 as long-term liabilities).

(4)  Commitments and Contingencies

Supply Agreement

In November 2005, Schreiber began manufacturing and distributing substantially all of the Company’s products in accordance with a Supply Agreement that was signed on June 30, 2005. Schreiber uses the Company’s formulas and processes to manufacture products for the Company’s customers. The prices for such products are based on cost plus a processing fee as determined by the parties from time to time. Other material terms of the Supply Agreement are as follows:

·The initial term of the Supply Agreement is for a period of five years from the effective date of September 1, 2005 and is renewable at the Company’s option for up to two additional five-year periods (for a total term up to fifteen years). If the Company does not exercise its first option to extend the term, then the Company will be obligated to pay Schreiber $1,500,000. If the Company exercises its first option to extend the term, but does not exercise its second option to extend the term, then the Company will be obligated to pay Schreiber $750,000.

·The Supply Agreement originally provided for a contingent short-fall payment obligation up to $8,700,000 by the Company if a specified production level was not met during the one-year period from September 1, 2006 to August 31, 2007. If a contingent short-fall payment was accrued after such one-year period, it could be reduced by the amount by which production levels in the one-year period from September 1, 2007 to August 31, 2008 exceeded the specified target level of production, if any. The short-fall payment is based on a formula that calculates the payment as follows: ((required pounds shipped - actual pounds shipped) / required pounds shipped) * $8,700,000. In November 2006, the Supply Agreement was amended so that the short-fall payment obligation would not be measured until the one-year period from September 1, 2009 to August 31, 2010, and the target level of production was reduced by approximately 22%.

11

Stay, Severance, Sales Bonus Plan

On December 10, 2007, the Company adopted a Stay Bonus, Severance Bonus and Sales Bonus Plan (the “Plan”) to provide incentives and protections to certain key executives and directors in connection with a possible sale of the Company. The Plan provides for a stay bonus pool up to $475,000 to be paid following the Company’s receipt of a definitive purchase offer (as defined in the Plan) upon the earlier of the consummation of a sale of the Company pursuant to such purchase offer or the termination of the purchase offer (other than as a result of a breach by the Company). The stay bonus pool is to be paid $125,000 to David H. Lipka, the Company’s Chairman, and $100,000 to Michael E. Broll, the Company’s Chief Executive Officer. The remaining $250,000 of the stay bonus pool is currently unallocated and may be granted to other key executives at the discretion of Messrs Lipka and Broll. The Plan also provides for a severance bonus of $125,000 to be paid to David H. Lipka and $100,000 to be paid to Michael E. Broll in the event their positions are terminated other than for Cause (as defined in the Plan) or they resign within one year after the consummation of a sale of the Company. Finally, the Plan provides for a sales bonus pool to be determined based on a range of selling prices. The sales bonus pool will range from a minimum of $250,000 if the sale is in excess of a specified minimum sales target and will increase up to a maximum of 1.8% of the total sales price. The sales bonus pool will be allocated 55.5% to David H. Lipka and 44.5% to Michael E. Broll upon the consummation of a sale of the Company. The Plan was approved unanimously by the Board of Directors and separately by the two independent members of the Board.

Litigation

The Company is currently a party to certain legal proceedings, claims, disputes and litigation arising in the ordinary course of business. The Company currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse affect on the Company's financial position, results of operations or cash flows. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, the Company's business, financial condition, results of operations and cash flows could be materially and adversely affected.

(5)   Non-Cash Compensation Related to Stock-Based Transactions

Effective April 1, 2006, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after the effective date, as well as to the unvested portion of awards outstanding as of the effective date. The Company uses the Black-Scholes option-pricing model to value its new stock option grants under SFAS 123R, applying the “modified prospective method” for existing grants which requires the Company to value stock options prior to its adoption of SFAS 123R under the fair value method and expense the value over the requisite service period.

Compensation cost arising from nonvested stock granted to employees and from non-employee stock awards is recognized as expense using the graded vesting attribution method over the vesting period. As of March 31, 2007, there was no remaining unrecognized compensation cost related to nonvested stock. Additionally, there were no stock-based transactions during the three and nine months ended December 31, 2007. Therefore, there was no stock-based compensation expense nor any unrecognized compensation cost related to nonvested stock for the three and nine months ended December 31, 2007. For the three and nine months ended December 31, 2006, the Company’s stock-based compensation expense related to nonvested stock was $10,000 and $108,160.

12

The following table summarizes the Company’s plan and non-plan stock options outstanding as of December 31, 2007, as well asactivity during the nine months then ended:

	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term in Years		Aggregate Intrinsic Value
Outstanding at March 31, 2007		5,290,750			2.86
Granted		—			—
Exercised		—			—
Forfeited or expired		(1,644,501	)		3.18
Outstanding at December 31, 2007		3,646,249			2.72		2.7		-0-
Exercisable at December 31, 2007		3,646,249			2.72		2.7		-0-

There were no options granted and thus no weighted-average fair value computed on options during the three and nine months ended December 31, 2007. At December 31, 2007, the aggregate intrinsic value of options outstanding and options exercisable was zero, because the market value of the underlying stock was below the average exercise price of all options. The closing price of the Company’s common stock on December 31, 2007 as quoted on the OTC Bulletin Board was $0.26 per share. There were no options exercised during the three and nine months ended December 31, 2007 and 2006; and therefore, no intrinsic value or cash received from option exercises. During the three months ended December 31, 2006, there were 40,000 options granted at a weighted-average exercise price of $0.38 per share with a weighted-average fair value of $0.25 per share. During the nine months ended December 31, 2006, there were 540,000 options granted at a weighted-average exercise price of $0.44 per share with a weighted-average fair value of $0.19 per share.

(6)   Earnings Per Share

The following is a reconciliation of basic net income (loss) per share to diluted net income (loss) per share:

	THREE MONTHS ENDED					NINE MONTHS ENDED
	DECEMBER 31,					DECEMBER 31,
	2007		2006			2007			2006
Net income (loss) - basic	$	295,365	$	726,184		$	1,106,705		$	(54,681	)
Plus interest on convertible related party note payable		85,774		85,774			256,390			152,902
Net income (loss) - diluted	$	381,139	$	811,958		$	1,363,095		$	98,221
Weighted average shares outstanding - basic		17,110,016		17,109,910			17,110,016			17,926,015
Potential shares issued upon conversion of related party note payable		8,835,803		7,863,519			8,348,329			7,671,726
Potential shares “in-the-money” under stock option and warrant agreements		--		723,043			740,000			277,891
Less: Shares assumed repurchased under the treasury stock method		--		(652,400	)		(662,069	)		(251,005	)
Weighted average shares outstanding -diluted	$	25,945,819	$	25,044,072		$	25,536,276		$	25,624,627
Basic net income (loss) per common share	$	0.02	$	0.04		$	0.06		$	0.00
Diluted net income (loss) per common share	$	0.01	$	0.03		$	0.05		$	0.00

Options for 4,352,124 and 4,150,420 shares and warrants for 1,158,001 and 997,662 shares have not been included in the computation of diluted net income per common share for three and nine months ended December 31, 2007, respectively, as their effects were antidilutive.

13

Options for 4,797,975 and 4,920,837 shares and warrants for 1,123,142 and 1,127,469 shares have not been included in the computation of diluted net income (loss) per common share for the three and nine months ended December 31, 2006, respectively, as their effect would be antidilutive.

(7)   Supplemental Cash Flow Information

For purposes of the statement of cash flows, all highly liquid investments with a maturity date of three months or less are considered to be cash equivalents.

Nine Months Ended December 31,	2007		2006
Non-cash financing and investing activities:
Purchase of equipment through a capital lease	$	--	$	5,088
Payment of note payable through issuance of revised note payable		--		1,200,000
Payment of accrued liability through issuance of note payable		--		285,104
Cancellation of treasury shares		--		1,344,461
Cash paid for:
Interest		50,805		225,091

(8)   Economic Dependence and Segment Information

The Company has one operating segment and sells to customers throughout the United States, Puerto Rico, and the U.S. controlled Virgin Islands (together considered the United States) and 12 foreign countries. For the three months ended December 31, 2007 and 2006, the Company’s gross sales were $6,888,900 and $6,647,852, respectively. For the nine months ended December 31, 2007 and 2006, the Company’s gross sales were $20,317,013 and $22,726,357, respectively. Gross sales derived from foreign countries were approximately $999,000 and $785,000*, representing 15% and 12% of gross sales for the three months ended December 31, 2007 and 2006, respectively. Gross sales derived from foreign countries were approximately $2,759,000 and $2,633,000*, representing 14% and 12% of gross sales for the nine months ended December 31, 2007 and 2006, respectively. Gross sales are attributed to individual countries based on the customer’s shipping address. The Company has no long-term assets located outside of the United States.

The following table sets forth the percentage of gross sales to each foreign country, which accounted for 10% or more of the Company’s foreign gross sales for the three and nine months ended December 31, 2007 and 2006:

	THREE MONTHS ENDED						NINE MONTHS ENDED
	DECEMBER 31,						DECEMBER 31,
	2007			2006*			2007			2006*
Canada		85	%		85	%		87	%		81	%
Other		15	%		15	%		13	%		19	%

* The sales to foreign countries for the three and nine months ended December 31, 2006, have been restated to remove sales to Puerto Rico and the US controlled Virgin Islands. Sales to Puerto Rico and the US controlled Virgin Islands are now included in domestic sales.

The Company had one customer that accounted for approximately 16% of gross sales for the three and nine months ended December 31, 2007. The Company had one customer that accounted for approximately 15% and 13% of gross sales for the three and nine months December 31, 2006, respectively. There were no customers whose balance outstanding was greater than 10% of accounts receivable as of December 31, 2007 or 2006.

Pursuant to the Supply Agreement with Schreiber, the Company purchased approximately 100% and 99% of its total raw material purchases from Schreiber for the three and nine months, respectively, ended December 31, 2007 and 2006.

14

GALAXY NUTRITIONAL FOODS, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to enhance a reader’s understanding of the financial condition, changes in financial condition and results of operations of our company. This MD&A is a supplement to and should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report. This Form 10-Q & MD&A contain forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by our company. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “project,” “estimate,” “may,” “will,” “could,” “should,” “potential,” or “continue” or the negative or variations of these words or similar expressions are intended to identify forward-looking statements. Additionally, these forward-looking statements include, but are not limited to statements regarding:

· Improving cash flows from operations;

· Marketing our existing products and those under development;

· Our estimates of future revenue and profitability;

· Our expectations regarding future expenses, including cost of goods sold and the raw material cost of casein, in particular, delivery, selling, general and administrative, research and development expenses, and disposal costs;

· Our estimates regarding capital requirements and need for additional financing; and

· Competition in our market.

Although we believe that these forward-looking statements are reasonable at the time they are made, these statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from our historical results and those expressed or forecasted in any forward-looking statements as a result of a variety of factors, including those set forth under “Risk Factors” and elsewhere in, or incorporated by reference into, this Form 10-Q and our Form 10-K for the fiscal year ended March 31, 2007. We are not required and undertake no obligation to publicly update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Terms such as “fiscal 2008”, “fiscal 2007” or “fiscal 2006” refer to our fiscal years ending March 31, 2008, 2007 and 2006, respectively. Terms such as “first quarter,” “second quarter,” “third quarter,” or “fourth quarter” refer to the fiscal quarters ending June 30, September 30, December 31, or March 31, respectively.

This MD&A contains the following sections:

· Business Environment

· Critical Accounting Policies

· Results of Operations

· Liquidity and Capital Resources

· Recent Accounting Pronouncements

Business Environment

General

Galaxy Nutritional Foods, Inc. (our “Company”) develops and globally markets plant based cheese alternatives, organic dairy and other organic and natural food products to grocery and natural foods retailers, mass merchandisers and foodservice accounts. Galaxy Nutritional Foods Veggie(R), the leading brand in the grocery cheese alternative category and our Company’s top selling product group, is primarily merchandised in the produce section and provides calcium and protein without cholesterol, saturated fat or trans-fat. Other popular brands include: Galaxy Nutritional Foods Rice(R), Veggy(R), Vegan(R), Rice Vegan(R), and Wholesome Valley Organic(R). Galaxy Nutritional Foods, Inc. is dedicated to developing nutritious and delicious food products made with high quality natural ingredients that exceed the expectations of today’s health conscious consumers. We are also committed to reducing its environmental impact as part of an Eat Green for Body & Earth(TM) program that offsets carbon emissions associated with product shipping and emphasizes the use of organic ingredients. Our Company headquarters are located in Orlando, Florida, and our common stock is quoted on the OTC Bulletin Board under the symbol “GXYF.”

15

In fiscal 2006, we determined that our manufacturing capacity was significantly in excess of our requirements and that it would be advantageous to outsource our manufacturing and distribution operations. On June 30, 2005, we entered into a Supply Agreement with Schreiber Foods, Inc., a Wisconsin corporation (“Schreiber”), whereby we agreed that Schreiber would become our sole source of supply for substantially all of our products. The initial term of the Supply Agreement is for a period of fifteen years from June 30, 2005 to June 30, 2020. Schreiber uses our formulas and processes to manufacture our products for our customers. In November 2005, Schreiber began to deliver such products directly to our customers.

On December 8, 2005, we completed the sale of substantially all of our manufacturing and production equipment to Schreiber for $8,700,000 in cash pursuant to an Asset Purchase Agreement dated June 30, 2005. Our Company has now converted from a manufacturing company into a branded marketing company that will continue to develop, market and sell our products.

Cheese Alternative Category

We are the market leader within our cheese alternative category niche, but in being so, the category increases or decreases partly as a result of our marketing and pricing efforts. We believe that the greatest source of future growth in the cheese alternative category will come through consumers shifting to cheese alternatives from natural cheese. Our products typically sell at a premium over the price of natural cheese. Our strategy is to broaden the consumer base to include younger, less price sensitive consumers seeking products with overall health and nutrition attributes. Historically, our products and marketing efforts appealed to older consumers purchasing cheese alternatives for specific dietary concerns.

Marketing

We use several internal and external reports to monitor sales and profitability by product, brand, segment, form and channel of sale to determine the outside factors affecting the sales levels. These reports provide management information on which product, brand, segments, forms and/or channel sales are increasing or decreasing both in units sold and price per unit. By reviewing these reports along with industry data from publications, syndicated retail consumption reports, and conversations with major retailers, other manufacturers in the food and beverage industry, and ingredient and service suppliers, we make decisions on which brands to promote and analyze trends in the consumer marketplace.

In our fiscal 2007 marketing campaign, we began an ongoing consumer print advertising campaign in national health and fitness publications including Weight Watchers and Shape. Product attributes and information on where to find our products were incorporated into a unified marketing message in our efforts to increase consumer education and awareness of cheese alternatives. In fiscal 2008, we are continuing our Veggie print advertising campaign to include Veggie brand advertisements in Shape, Women’s Health and Parenting. We also expanded print advertising to include specialty publications, including Vegetarian Times and VegNews to seek new consumers for our Rice, Veggy and Rice Vegan brands. Additionally, we implemented less frequent promotions but with deeper discounts to the consumers.

As we grow our marketing initiatives, valuable insights on campaign efficacy are gained and used to fine-tune our efforts. Such information is then used to increase our return on marketing expenditures by focusing on those efforts that increase brand and product awareness, increase consumer education and ultimately broaden the consumer base within the cheese alternative category.

Measurements of Financial Performance

On a monthly basis, we compare the statements of operations, balance sheets and statements of cash flows to budgeted expectations to identify variances and opportunities for cost savings. In addition, we analyze sales and profitability relative to budgeted amounts for individual products, brand groups, channels of distribution and individual customers. These reports are also tailored to provide us with information on promotional costs by product and customers. Areas that are performing below expectations are reviewed to determine actions that we can take to improve performance. Additionally, marketing uses this information to tailor our promotions to make them more effective and profitable.

We focus on several items in order to measure our performance. We are working towards obtaining and maintaining positive trends in the following areas:

· Operating cash flow

· Gross margin in dollars and % of gross sales

· Operating income excluding non-cash compensation related to stock-based transactions and disposal costs

16

· EBITDA excluding non-cash compensation related to stock-based transactions and disposal costs

· Volume and margin analysis by individual inventory items

· Key financial ratios (such as accounts receivable and accounts payable turnover ratios)

Debt Maturity Issues

Pursuant to a Note Purchase Agreement dated July 19, 2006 as modified on March 14, 2007, we issued a new unsecured convertible note for $2,685,104 (the “Convertible Note”) to Mr. Frederick A. DeLuca. The Convertible Note together with any accrued and unpaid interest thereon, is convertible at the election of Mr. DeLuca, at any time on or prior to October 19, 2008 into shares of our common stock at a conversion price of $0.35 per share. If Mr. DeLuca does not choose to convert this Convertible Note into stock and does not extend the maturity date of the Convertible Note, then we will be required to pay principal plus accrued interest thereon in the amount of $3,451,478 on October 19, 2008. With our current cash balances and the ability to borrow additional funds on our Commercial Finance Agreement, we have the ability to repay a substantial portion of this obligation, but it will not be enough to repay the entire amount owed. If Mr. DeLuca does not convert some or all of the Convertible Note or we do not repay, refinance or amend the existing Convertible Note, then our inability to pay would trigger a default. In addition to Mr. DeLuca pursuing remedies for collection of such indebtedness, interest would begin accruing at the rate of 17.5%. Additionally, a default on the Convertible Note would trigger a cross default in our Commercial Finance Agreement which can then be terminated by Commercial Finance. Any outstanding balance owed under the Commercial Finance Agreement could become immediately due and payable and bear interest at 12% in addition to other fees and penalties. Therefore, a default on the Convertible Note would have a material adverse affect on the liquidity and financial condition of our Company and we may not be able to continue as a going concern. Management will be initiating discussions with Mr. DeLuca regarding extending the maturity, refinancing and/or converting all or a portion of the Convertible Note into equity on or before its maturity in October 2008, but there can be no assurances that we will be successful in our negotiations.

Rising Cost of Goods

Casein is a dried skim milk protein that is the principal raw ingredient used in most of our products. In the third quarter of fiscal 2008, the average price of casein increased more than 50% compared to the average price in the first half of fiscal 2008. We anticipate that the average price of casein will increase another 33% or more in the fourth quarter of fiscal 2008. Although we recently implemented several strategic plans of action in an effort to at least partially minimize the negative effect of these anticipated casein price increases, we anticipate that for the remainder of fiscal 2008, gross margins on a majority of our products will continue to decline.  We further anticipate that gross margins as a percentage of net sales for fiscal 2008 will be approximately four to eight percentage points lower than our fiscal 2007 annual average. Additionally, we anticipate that our income from operations will continue to be materially and adversely affected by the decline in gross margins.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of income and expense during the reporting periods presented. Our significant estimates include the allowance for trade receivables which is made up of reserves for promotions, discounts and bad debts, inventory reserves, valuation of deferred taxes and valuation of compensation expense on stock-based awards. Although we believe that these estimates are reasonable, actual results could differ from those estimates given a change in conditions or assumptions that have been consistently applied.

Management has discussed the selection of critical accounting policies and estimates with our Board of Directors, and the Board of Directors has reviewed our disclosure relating to critical accounting policies and estimates in this quarterly report on Form 10-Q. Our critical and significant accounting policies are described in Note 1 of our financial statements. The critical accounting policies used by management and the methodology for its estimates and assumptions are as follows:

Valuation of Accounts Receivable and Chargebacks

We record revenue upon shipment of products to our customers and upon reasonable assurance of collection on the sale. We generally provide credit terms to customers based on net 30-day terms. We perform ongoing credit evaluations of our accounts receivable balances. Based on historical experience, we make reserves for anticipated future customer credits for rebates, sales promotions, coupons, spoils and other reasons that relate to current period sales. In addition, we evaluate the accounts for potential uncollectible amounts based on a specific identification methodology and record a general reserve for all remaining balances.

17

Based on the age of the receivable, cash collection history and past dilution in the receivables, we make an estimate of our anticipated bad debt, anticipated future authorized deductions due to current period activity and anticipated collections on non-authorized amounts that customers have currently deducted on past invoices. Based on this analysis, we reserved $862,000 and $1,518,000 for known and anticipated future credits and doubtful accounts at December 31, 2007 and 2006, respectively. We believe that this estimate is reasonable, but there can be no assurance that our estimate will not change given a change in economic conditions or business conditions within the food industry, our individual customer base or our Company.

Inventory

Inventories are valued at the lower of cost or market. Cost is determined using a weighted average, first-in, first out method. We review our inventory valuation each month and write off or reserve for inventory related to obsolete, discontinued and damaged goods. In addition, we reduce the value of any finished good item to market value when that value is believed to be less than the cost of the item.

Deferred Taxes

Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We have reserved our net deferred tax assets in full since we have not established a history of taxable income.

Valuation of Non-Cash Stock-Based Compensation

Effective April 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”). SFAS 123R requires companies to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.

SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after the effective date, as well as to the unvested portion of awards outstanding as of the effective date. We use the Black-Scholes option-pricing model to value our new stock option grants under SFAS 123R, applying the “modified prospective method” for existing grants which requires us to value stock options prior to our adoption of SFAS 123R under the fair value method and expense the value over the requisite service period. SFAS 123R also requires us to estimate forfeitures in calculating the expense related to stock-based compensation. In addition, SFAS 123R requires us to reflect cash flows resulting from excess tax benefits related to those options as a cash inflow from financing activities rather than as a reduction of taxes paid.

From April 1, 2003 through March 31, 2006, we accounted for stock awards granted to employees and directors under the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and applied SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” (“SFAS 148), prospectively to all employee and director awards granted on or after April 1, 2003. Prior to April 1, 2003, we accounted for stock awards granted to employees and directors under the recognition and measurement principles of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees, and related Interpretations,” (“APB 25”) as interpreted by Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”).

The Black-Scholes option-pricing model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The risk-free rate is based on the U.S. Treasury zero-coupon rates with a remaining term equal to the expected term of the option. Expected volatilities are based on the historical volatility of our stock. Prior to April 1, 2006, we input the expected term of options granted based on the contractual life of the options granted. For any new awards, we input the expected term of options granted based on information derived from historical data on employee exercises and post-vesting employment termination behavior. There is no expected dividend yield.  These factors could change in the future, which may affect the stock-based compensation expense in future periods. SFAS 123R also requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.There were no issuances of stock awards during the three and nine months ended December 31, 2007. Therefore, we did not make any assumptions under the Black-Scholes option-pricingmodel during these periods.

18

The Company estimated the fair value of each stock-based award during the three and nine month periods ended December 31, 3006 using the Black-Scholes pricing model with the following assumptions:

	Three Months Ended			Nine Months Ended
	December 31, 2006			December 31, 2006
Risk-free interest rate		4.52	%		4.07-4.94	%
Volatility		48.7	%		50.3-51.9	%
Expected life (months)		120			36-120
Dividends		None			None

On an option with a risk-free interest rate of 5%, volatility of 45% and a term of 60 months, we would experience a $.01 change in the fair value if we were to change our estimate of the interest rate by two percentage points, the volatility percentage by five percentage points, or the expected term by five months.

Results of Operations

	3-Months Ended December 31,												9-Months Ended December 31,
	2007			2006			$ Change			% Change			2007			2006			$ Change			% Change
Net Sales		6,446,099			6,110,619			335,480			5.5	%		18,763,360			20,670,958			(1,907,598	)		-9.2	%
Cost of Goods Sold		4,145,200			3,417,232			727,968			21.3	%		11,346,406			12,450,194			(1,103,788	)		-8.9	%
Gross Margin		2,300,899			2,693,387			(392,488	)		-14.6	%		7,416,954			8,220,764			(803,810	)		-9.8	%
Gross Profit %		35.7	%		44.1	%								39.5	%		39.8	%

Sales

For the three months ended December 31, 2007 and 2006, the Company’s gross sales before discounts, returns and allowance were $6,888,900 and $6,647,852, respectively. For the nine months ended December 31, 2007 and 2006, the Company’s gross sales before discounts, returns and allowances were $20,317,013 and $22,726,357, respectively. The following chart sets forth the percentage of gross sales derived from our product brands during the three and nine months ended December 31, 2007 and 2006:

	THREE MONTHS ENDED						NINE MONTHS ENDED
	DECEMBER 31,						DECEMBER 31,
Brand	2007			2006			2007			2006
Veggie		65.2	%		66.7	%		66.7	%		59.7	%
Private Label, Imitation and Other		10.3	%		11.5	%		10.4	%		19.2	%
Rice		12.9	%		11.0	%		12.1	%		10.5	%
Veggy		4.2	%		4.0	%		4.3	%		4.2	%
Wholesome Valley Organic		3.4	%		3.2	%		2.8	%		3.2	%
Vegan		4.0	%		3.6	%		3.7	%		3.2	%

Net sales, after discounts, returns and allowances, in the three months ended December 31, 2007 increased 5% compared to net sales in the three months ended December 31, 2006. In terms of gross sales dollars, sales of private label and imitation products were down approximately 7% from the three month period ended December 31, 2006 to the three month period ended December 31, 2007. Sales of branded products were up approximately 5% over the same period. The three months ended December 31, 2007 continued the stabilization and increase in sales of our branded products as a result of our three step strategy to 1) implement consistent and more effective marketing efforts; 2) increase distribution and velocity per store; and 3) improve products with higher quality ingredients and new packaging.

Net sales, after discounts, returns and allowances, in the nine months ended December 31, 2007 decreased 9% from net sales in the nine months ended December 31, 2006, primarily due to the strategic elimination of marginally profitable and unprofitable private label and imitation products in the first half of fiscal 2007. In terms of gross sales dollars, sales of private label and imitation products were down approximately 52% from the nine month period ended December 31, 2006 to the nine month period ended December 31, 2007. Sales of branded products were down less than 1% over the same period.

19

We anticipate that our annual sales in fiscal 2008 will be lower than annual sales reported in fiscal 2007 reflecting the lower baseline sales projected after the elimination of the majority of the private label and imitation business.

Cost of Goods Sold

Cost of goods sold was approximately 64% and 56% of net sales in the three months ended December 31, 2007 and 2006, and 61% and 60% of net sales in the nine months ended December 31, 2007 and 2006, respectively. This increase in cost of goods sold as a percentage of net sales is primarily due to increased prices in casein. Casein is a dried skim milk protein that is the principal raw ingredient used in most of our products. In the third quarter of fiscal 2008, the average price of casein increased more than 50% compared to the average price in the first half of fiscal 2008. We anticipate that the average price of casein will increase another 33% or more in the fourth quarter of fiscal 2008.

Due to a current worldwide shortage and a weaker US Dollar in relation to the Euro, forecasts from our suppliers indicate these historically high casein prices will remain at least through the end of fiscal 2008 and the beginning of fiscal 2009. This dramatic increase in supply costs is expected to substantially increase our cost of goods sold and correspondingly substantially reduce our gross margins through the remainder of fiscal 2008.

We recently implemented several strategic plans of action in an effort to at least partially minimize the negative effect of these anticipated casein price increases. These strategies include reducing promotional spending and consumer advertising and increasing customer pricing on certain affected product lines, as well as, reformulating existing products to reduce the amount of required casein and expanding and accelerating the roll-out of new products which do not require casein.

Gross Margin

Gross margins declined 15% and 10% in the three and nine months ended December 31, 2007 compared to the three and nine months ended December 31, 2006, respectively. In the three months ended December 31, 2007, gross profit declined 8 percentage points from 44% to 36%. This decrease in gross margins and profits is primarily due to the rapid increase in the cost of goods sold as stated above, and to a smaller extent additional inventory write-offs for some out of date and obsolete inventory. We do not believe that we are able to pass this entire cost increase on to our consumers through immediate price increases without causing substantial reductions in our sales volumes.

We anticipate that for the remainder of fiscal 2008, gross margins on a majority of our products will continue to decline. We further anticipate that gross margins as a percentage of net sales for fiscal 2008 will be approximately four to eight percentage points lower than our fiscal 2007 annual average. Additionally, we anticipate that our income from operations will continue to be materially and adversely affected by the decline in gross margins.

EBITDA

We utilize certain GAAP measures such as Operating Income and Net Income and certain non-GAAP measures, in order to compute key financial measures that are reviewed by management, lenders and investors in order to effectively review our current on-going operations and analyze trends related to our financial condition and results of operations. The non-GAAP measures are key factors upon which we prepare and review our budgets and forecasts. In our calculation of key financial non-GAAP measures for adjusted Operating Income, adjusted Net Income and adjusted EBITDA, we exclude items such as non-cash compensation and reserves related to stock-based transactions, disposal costs and loss on disposal of assets. These adjusted measures are not in accordance with, or an alternative for, generally accepted accounting principles and may be different from non-GAAP measures reported by other companies.

EBITDA (a non-GAAP measure):
	3-Months Ended December 31,										9-Months Ended December 31,
	2007		2006		$ Change			% Change			2007		2006		$ Change			% Change
Net Sales		6,446,099		6,110,619		335,480			5.5	%		18,763,360		20,670,958		(1,907,598	)		-9.2	%
Cost of Goods Sold		4,145,200		3,417,232		727,968			21.3	%		11,346,406		12,450,194		(1,103,788	)		-8.9	%
Gross Margin		2,300,899		2,693,387		(392,488	)		-14.6	%		7,416,954		8,220,764		(803,810	)		-9.8	%

20

EBITDA (a non-GAAP measure):
	3-Months Ended December 31,												9-Months Ended December 31,
	2007			2006			$ Change			% Change			2007			2006			$ Change			% Change
Operating Expenses:
Selling		871,797			775,043			96,754			12.5	%		2,702,038			2,621,845			80,193			3.1	%
Delivery		263,923			217,431			46,492			21.4	%		772,786			643,714			129,072			20.1	%
General and administrative, including $0, $10,000, $0 and $108,160 non-cash stock compensation(1)		672,530			639,030			33,500			5.2	%		1,883,647			2,496,658			(613,011	)		-24.6	%
Employment contract expense(2)		-			-			-			0.0	%		346,447			-			346,447			100.0	%
Research and development		86,511			47,345			39,166			82.7	%		249,506			134,128			115,378			86.0	%
Reserve on stockholder note receivable(2)		-			-			-			0.0	%		-			1,428,000			(1,428,000	)		-100.0	%
Cost of disposal activities(2)		-			134,744			(134,744	)		-100.0	%		-			283,547			(283,547	)		-100.0	%
Loss on disposal of assets(2)		512			19,775			(19,263	)		-97.4	%		512			44,280			(43,768	)		-98.8	%
Total operating expenses		1,895,273			1,833,368			61,905			3.4	%		5,954,936			7,652,172			(1,697,236	)		-22.2	%
Income from Operations(3)		405,626			860,019			(454,393	)		-52.8	%		1,462,018			568,592			893,426			157.1	%
Interest expense, net		(110,261	)		(133,835	)		23,574			-17.6	%		(343,313	)		(623,273	)		279,960			-44.9	%
Income (Loss) before Taxes		295,365			726,184			(430,819	)		-59.3	%		1,118,705			(54,681	)		1,173,386			-2145.9	%
Federal Income Tax Expense		-			-			-			0.0	%		(12,000	)		-			(12,000	)		100.0	%
NET INCOME (LOSS)		295,365			726,184			(430,819	)		-59.3	%		1,106,705			(54,681	)		1,161,386			-2123.9	%
Interest expense, net		110,261			133,835			(23,574	)		-17.6	%		343,313			623,273			(279,960	)		-44.9	%
Taxes		-			-			-			0.0	%		12,000			-			12,000			100.0	%
Depreciation and amortization		11,246			24,005			(12,759	)		-53.2	%		33,308			130,102			(96,794	)		-74.4	%
EBITDA (a non-GAAP measure)		416,872			884,024			(467,152	)		-52.8	%		1,495,326			698,694			796,632			114.0	%
EBITDA, as a % of Net Sales		6.5	%		14.5	%								8.0	%		3.4	%

(1) In our calculation of key financial measures, we exclude the non-cash compensation related to stock-based transactions because we believe that this item does not accurately reflect our current on-going operations. Many times non-cash compensation is calculated based on fluctuations in our stock price, which can skew the financial results dramatically up and down. The market price of our common shares is outside our control and typically does not reflect our current operations.

(2) In our calculation of key financial measures, we exclude the employment contract expenses related to Christopher Morini, the reserve on stockholder note receivable, disposal costs and loss on disposal of assets because we believe that these items do not reflect expenses related to our current on-going operations. See below for a detailed description of these items.

(3) Operating Income has increased due to the non-recurrence of certain non-standard expenses such as the reserve on stockholder note receivable and disposal costs.

Selling

Selling expense is partly a function of sales through variable costs such as brokerage commissions and promotional costs and partly fixed with certain fixed costs for marketing campaigns and employee salaries and benefits. The 12% increase in selling expenses for the three months ended December 31, 2007 compared to the three months ended December 31, 2006 is primarily attributable to increased consumer advertising; specifically magazine advertising in healthy-women publications such as Shape, Women’s Health and Parenting and increased brokerage costs as a result of higher sales in the three months ended December 31, 2007. Selling expenses only increased 3% during the nine months ended December 31, 2007 compared to the nine months ended December 31, 2006 due to the increased consumer advertising.

21

Selling expenses increased from 13% of net sales during the three and nine months ended December 31, 2006 to 14% of net sales for the three and nine months ended December 31, 2007. This change is attributable to the shift in sales mix toward branded products and away from imitation and private label products. Historically, very little advertising and promotion costs were associated with the imitation and private label products. Nearly all of our promotional spending is directed toward our branded products and is therefore tied more to our branded sales levels rather than overall sales. As we have eliminated low margin private label and imitations sales, our selling expenses as a percentage of overall sales has increased.

We expect that fixed selling expense amounts for advertising and market research in fiscal 2008 will be consistent with fiscal 2007, but fiscal 2008 selling expenses will increase as a percentage of sales compared to fiscal 2007 due to the lower sales volumes.

Delivery

Delivery expense is primarily a function of sales as our primary supplier drop-ships products to our customers and charges a fixed, per-pound contractual delivery fee that is subject to adjustment from time to time. Delivery costs increased from 3% of net sales for the nine month period ended December 31, 2006 compared to 4% of net sales for the nine month period ended December 31, 2007. In September 2006, the per pound delivery rate charged by our primary supplier was adjusted upward to reflect current market conditions. Additionally, in order to improve customer service and reduce order lead times, we began storing and distributing inventory out of two additional distribution centers. As a result, our delivery costs increased 1% beginning in the third quarter of fiscal 2007. Delivery costs for the three months ended December 31, 2007 and 2006 reflect the current average of 4% of net sales. We anticipate delivery expense for fiscal 2008 will remain at approximately 4% of net sales.

General and Administrative

During the three months ended December 31, 2007, general and administrative expenses increased approximately $34,000 compared to the three months ended December 31, 2006. This increase was due to salary increases that became effective during this fiscal year and bonus accruals during the three months ended December 31, 2007. During the nine months ended December 31, 2007, general and administrative expenses decreased approximately $613,000 compared to the nine months ended December 31, 2006. The main contributors to this decrease were lower legal costs, lower audit and accounting costs, reduced depreciation and occupancy costs and no non-cash stock compensation primarily in the first half of fiscal 2008. Legal costs were higher in the prior year periods primarily as a result of continued legal fees related to our exploration of strategic alternatives (including the potential sale of our Company that was abandoned in April 2006). As a result of the outsourcing of our manufacturing process, as well as the restructuring of our outstanding debt in June 2006, many of the time-consuming and complex accounting issues related to our operations were eliminated. This has resulted in a reduction of our audit and other accounting-related fees. Occupancy costs, including insurance, maintenance and utilities have decreased from the prior year periods as a result of the move of our corporate headquarters to a smaller facility in October 2006. Depreciation expense is lower due to less leasehold improvements and equipment in the smaller facility. Additionally, bad debt expense declined over $75,000 due to improved collection efforts. We did not issue any stock awards in the three and nine months ended December 31, 2007 and therefore, did not incur any non-cash compensation expense related to stock-based transactions compared to $10,000 and $108,160 in the three and nine months ended December 31, 2006.

Excluding the effects of non-cash compensation related to stock-based transactions, which cannot be predicted, we anticipate that in fiscal 2008 general and administrative expenses will continue to be lower than total expense in fiscal 2007. However, we anticipate that we will begin incurring additional costs related to the implementation of the requirements of Section 404 of The Sarbanes Oxley Act throughout the remainder of fiscal 2008 and into fiscal 2009.

Employment Contract Expense

On June 1, 2007, Christopher Morini resigned from his position as Vice President of New Business Development in order to pursue other opportunities. In accordance with the Separation and General Release Agreement which became effective on June 9, 2007, between our Company and Mr. C. Morini, we accrued $346,447 for wages and payroll taxes and expensed them under Employment Contract Expense-General and Administrative in the Statement of Operations in June 2007. After an initial lump sum payment of approximately $100,087, the remaining obligation is being paid out in nearly equal bi-weekly installments through February 2009.

Research and Development

Research and development expenses increased by approximately $39,000 or 83% for the three months ended December 31, 2007 and by approximately $115,000 or 86% for the nine months ended December 31, 2007 when compared to the same periods of the prior year. This increase is primarily a result of costs associated with the reformulation of our Rice Shred products. We reformulated these products to make them more appealing to natural foods consumers. Additionally, we developed a new product line for our Wholesome Valley Organic brand during the current fiscal year. In the prior year, nearly all new product development projects, including reformulations to existing products, were postponed until our outsourcing partners understood our existing products. We anticipate that research and development costs will continue to be higher in fiscal 2008, based on current plans for new product development and existing product reformulations to improve taste and quality and to possibly reduce casein content.

22

Reserve on Stockholder Note Receivable

In June 1999, in connection with an amended and restated employment agreement for Angelo S. Morini, our founder and original Chief Executive Officer, we consolidated two full-recourse notes receivable ($1,200,000 from November 1994 and $11,572,200 from October 1995) related to his purchase of 2,914,286 shares of our common stock into a single stockholder note receivable in the amount of $12,772,200 that was due on June 15, 2006. This stockholder note receivable was non-interest bearing and non-recourse and was secured by the 2,914,286 shares of our common stock (the “Shares”).

For the fiscal year ended March 31, 2006, we reserved $10,120,200 against this stockholder note receivable under the assumption that we would not be able to collect proceeds in excess of the $2,652,000 value of the Shares as of such date. The value of the Shares was computed using the closing price of our common stock on March 31, 2006 of $0.91 multiplied by the 2,914,286 shares.

On June 16, 2006, Mr. Morini failed to repay the non-recourse note obligation to our Company. On June 20, 2006, we delivered notice to Mr. Morini that we intended to exercise our rights to the Shares and retain all the Shares in full satisfaction of his obligations under the stockholder note receivable. On July 6, 2006, Mr. Morini consented to our acceptance of the Shares in full satisfaction of his obligations under the stockholder note receivable. Based upon the $0.42 closing price of our common stock as quoted on the OTC Bulletin Board on June 16, 2006, the Shares had an approximate value of $1,224,000 on such date. Accordingly, we recorded an additional expense of $1,428,000 in June 2006 in order to record the additional decline in the value of the Shares from its $2,652,000 value as of March 31, 2006. In July 2006, we cancelled the Shares along with 30,443 other treasury shares.

Although this expense resulted in a material loss to our operations, it did not have any affect on the balance sheet since the stockholder note receivable was already shown as a reduction to Stockholders’ Deficit.

Cost of Disposal Activities

We accounted for the costs associated with the disposal of our manufacturing operations in accordance with SFAS No. 146, “Accounting for Costs Associated with an Exit or Disposal Activity,” because the arrangements were planned and controlled by management and materially changed the manner in which our business was conducted. We report our disposal costs for the period as Costs of Disposal Activities in the Statement of Operations. There were no further disposal costs in the three and nine months ended December 31, 2007. Disposal costs during the three and nine months ended December 31, 2006 were $134,744 and $283,547, respectively. Currently, we do not anticipate any additional disposal costs, but if they do occur, we intend to expense them as incurred.

Interest Expense

Interest expense decreased by approximately $24,000 or 18% and $280,000 or 45% in the three and nine months ended December 31, 2007 compared to the three and nine months ended December 31, 2006, respectively. The decrease in interest expense for the three months ended December 31, 2007 is a result of lower overall borrowing levels in the current period compared to the prior period. The decrease in interest expense for the nine months ended December 31, 2007 is a result of lower interest rates (including the effects of discount amortization) after refinancing all of our outstanding debt in June 2006, as well as lower overall borrowing levels in the current nine month period. In the nine months ended December 31, 2007, we experienced a decrease in interest expense related to our debt facilities of approximately $59,000 due to lower average outstanding principal balances. Amortization of loan costs decreased by approximately $95,000 due to lower loan fees charged by our new lenders. Additionally, pursuant to several Note and Warrant Purchase Agreements entered into in fiscal 2006 and fiscal 2007, we issued warrants to purchase up to 800,000 shares of our common stock. We recorded the initial fair value of the warrants of $18,000 and $444,731 in fiscal 2007 and fiscal 2006, respectively, as a discount to debt. Amortization of this non-cash debt discount decreased by approximately $126,000 in the nine months ended December 31, 2007 compared to the nine months ended December 31, 2006.

We anticipate that our interest expense will decrease an average of approximately 40% in fiscal 2008, due to lower interest rates, lower debt balances, lower loan fees and lower non-cash debt discount amortization. Our current loan facility with Commercial Finance Division accrues interest based on a variable prime plus rate. Prime rate is currently at 6.0% and it is uncertain if this will change during the remainder of fiscal 2008. Any changes in the prime rate would further affect our interest expense in fiscal 2008.

23

Liquidity and Capital Resources

9-Months Ended December 31,	2007			2006			$ Change			% Change
Cash from (used in) operating activities		1,134,005			780,090			353,915			45.4	%
Cash from (used in) investing activities		(14,345	)		57,524			(71,869	)		-124.9	%
Cash used in financing activities		(556,886	)		(952,062	)		395,176			-41.5	%
Net increase (decrease) in cash		562,774			(114,448	)		677,222			-591.7	%

Future Capital Needs

With the reduction in overall debt and lender fees, we expect to see annual interest savings of approximately $300,000 in fiscal 2008. As discussed under Cost of Goods Sold, we are anticipating a substantial increase in our product costs that we will not be able to pass on to the consumers immediately. Therefore, we will be using more cash to support operations, but still anticipate that we will provide positive operating cash flow for fiscal 2008.

Pursuant to a Note Purchase Agreement dated July 19, 2006 as modified on March 14, 2007, we issued a new unsecured convertible note for $2,685,104 (the “Convertible Note”) to Mr. Frederick A. DeLuca. The Convertible Note together with any accrued and unpaid interest thereon, is convertible at the election of Mr. DeLuca, at any time on or prior to October 19, 2008 into shares of our common stock at a conversion price of $0.35 per share. If Mr. DeLuca does not choose to convert this Convertible Note into stock and does not extend the maturity date of the Convertible Note, then we will be required to pay principal plus accrued interest thereon in the amount of $3,451,478 on October 19, 2008. With our current cash balances and the ability to borrow additional funds on our Commercial Finance Agreement, we have the ability to repay a substantial portion of this obligation, but it will not be enough to repay the entire amount owed. If Mr. DeLuca does not convert some or all of the Convertible Note or we do not repay, refinance or amend the existing Convertible Note, then our inability to pay would trigger a default. In addition to Mr. DeLuca pursuing remedies for collection of such indebtedness, interest would begin accruing at the rate of 17.5%. Additionally, a default on the Convertible Note would trigger a cross default in our Commercial Finance Agreement which can then be terminated by Commercial Finance. Any outstanding balance owed under the Commercial Finance Agreement could become immediately due and payable and bear interest at 12% in addition to other fees and penalties. Therefore, a default on the Convertible Note would have a material adverse affect on the liquidity and financial condition of our Company and we may not be able to continue as a going concern. Management will be initiating discussions with Mr. DeLuca regarding extending the maturity, refinancing and/or converting all or a portion of the Convertible Note into equity on or before its maturity in October 2008, but there can be no assurances that we will be successful in our negotiations.

Operating and Investing Activities

Cash from operating activities in the nine months ended December 31, 2007 primarily came from operating profits from the sale of our products.

In the first nine months of fiscal 2008, cash used in investing activities related to our purchase of office equipment. Cash provided from investing activities in the first nine months of fiscal 2007 came primarily from the sales of fixed assets and the refund of various security deposits related to the termination of our lease at our prior operating facility in November 2006. We do not anticipate any large capital expenditures or deposits during fiscal 2008.

Financing Activities

9-Months Ended December 31,	2007			2006
Net borrowings (payments) on line of credit and bank overdrafts		(556,886	)		(745,225	)
Issuances of debt		-			1,200,000
Payments of debt and capital leases		-			(1,406,837	)
Issuances of stock & associated costs		-			-
Cash used in financing activities		(556,886	)		(952,062	)

24

Debt Financing

On June 23, 2006, we entered into a Receivables Purchase Agreement with Commercial Finance Division, formerly known as Systran Financial Services Corporation, a subsidiary of Textron Financial Corporation (“Commercial Finance”), whereby Commercial Finance provides financing to our Company through advances against certain trade receivable invoices due to our Company (the “Commercial Finance Agreement”). The Commercial Finance Agreement is secured by our accounts receivable and all other assets. Generally, subject to a maximum principal amount of $3,500,000 which can be borrowed under the Commercial Finance Agreement, the amount available for borrowing is equal to 85% of our eligible accounts receivable invoices less a dilution reserve and any required fixed dollar reserves. The dilution and fixed dollar reserves are currently set at 7% and $100,000, respectively. Advances under the Commercial Finance Agreement bear interest at a variable rate equal to the prime rate plus 1.5% per annum (8.75% on December 31, 2007). However, the Commercial Finance Agreement requires a $4,500 minimum monthly interest charge to be assessed. We are also obligated to pay a $1,500 monthly service fee.

The initial term of the Commercial Finance Agreement ends on June 23, 2009 and may renew automatically for consecutive twelve-month terms unless terminated sooner. The Commercial Finance Agreement may be accelerated in the event of certain defaults by our Company including among other things, a default in our payment and/or performance of any obligation to Commercial Finance or any other financial institution, creditor, or bank; and any change in the conditions, financial or otherwise, of our Company which reasonably causes Commercial Finance to deem itself insecure. In such an event, interest on our borrowings would accrue at the greater of twelve percent per annum or the variable rate of prime plus 1.5% and we would be liable for an early termination premium ranging from 1% to 3%, depending upon the timing of such termination, of the maximum principal amount available under the Commercial Finance Agreement. Although we had approximately $1.6 million available to draw pursuant to this Commercial Finance Agreement as of December 31, 2007, there were no amounts advanced, because we did not need additional cash on such date. The net amount of cash used to reduce the Commercial Finance Agreement for the nine months ended December 31, 2007 and 2006 was $556,886 and $745,225, respectively.

Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised),“Business Combinations,” (“SFAS 141(R)”). SFAS 141(R) changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company is currently evaluating the impact of the pending adoption of SFAS 141(R) on its results of operations and financial condition.

In June 2007, the FASB ratified EITF Issue No. 07-03, "Accounting for Nonrefundable Advance Payments for Goods and Services Received for Use in Future Research and Development Activities." EITF 07-03 requires companies to defer nonrefundable advance payments for goods and services and to expense that advance payment as the goods are delivered or services are rendered. If the company does not expect to have the goods delivered or services performed, the advance should be expensed. EITF 07-03 is effective for fiscal years beginning after December 15, 2007. We are currently evaluating the impact of adopting EITF 07-03 on our financial statements.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. We are currently evaluating the effect, if any, the adoption of SFAS 159 will have on our financial statements, results of operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 simplifies and codifies guidance on fair value measurements under generally accepted accounting principles. This standard defines fair value, establishes a framework for measuring fair value and prescribes expanded disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the effect, if any, the adoption of SFAS 157 will have on our financial statements, results of operations and cash flows.

25

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk results primarily from fluctuations in interest rates. The interest rate on our outstanding debt to Commercial Finance as of December 31, 2007 is floating and based on the prevailing market interest rate. For market-based debt, interest rate changes generally do not affect the market value of the debt but do impact future interest expense and hence earnings and cash flows, assuming other factors remain unchanged. A theoretical 1% increase or decrease in market rates in effect on December 31, 2007 with respect to our debt balances as of such date would increase or decrease interest expense and hence reduce or increase the net income of our Company depending on the outstanding balance of our secured borrowings.

Our sales during the nine months ended December 31, 2007 and 2006, which were denominated in a currency other than U.S. Dollars, were less than 10% of gross sales and no net assets were maintained in a functional currency other than U. S. Dollars during such periods. While we believe that the effects of changes in foreign currency exchange rates have not historically been significant to our operations or net assets, we are unable to forecast the effects that foreign currency exchange rates may have on our future operations.

We are exposed to price risk related to forecasted purchases of certain commodities, such as casein, that we primarily use in our products. Accordingly, we try to enter into purchase contracts to “lock-in” prices on these commodities. These contracts generally qualify for the normal purchase exception under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and are, therefore, not subject to its provisions. We do not utilize any commodity futures or options to hedge the price of commodities. Therefore, we are exposed to the volatility of our raw materials since our Supply Agreement with Schreiber is based on cost plus a processing fee. Based on current production levels, every $.10 increase in casein prices results in an annual increase of over $400,000 in costs of goods sold.

Item 4. Controls and Procedures

As of December 31, 2007, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”), and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures to insure that we record, process, summarize and report in a timely and effective manner the information required to be disclosed in reports filed with or submitted to the Securities and Exchange Commission. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective in timely bringing to their attention material information related to our Company required to be included in our periodic Securities and Exchange Commission filings. During the quarter ended December 31, 2007, there were no changes in our internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect those controls.

26

PART II. OTHER INFORMATION

Item 1A.Risk Factors

Statements other than historical information contained in this Form 10-Q are considered “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by our Company. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “project,” “estimate,” “may,” “will,” “could,” “should,” “potential,” or “continue” or the negative or variations of these words or similar expressions are intended to identify forward-looking statements. Although we believe that these forward-looking statements are reasonable at the time they are made, these statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from our historical results and those expressed or forecasted in any forward-looking statement as a result of a variety of factors as set forth below. We are not required and undertake no obligation to publicly update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

In addition to the other information in this Form 10-Q and risk factors previously disclosed in our Annual Report on Form 10-K for the year ended March 31, 2007, the following are some of the factors as of February 8, 2008, that could cause our Company’s actual results to differ materially from the expected results described in or underlying our Company’s forward-looking statements. These factors should be considered carefully while evaluating our business and prospects. If any of the following risks actually occur, they could seriously harm our business, financial condition, results of operations or cash flows.

If we terminate our Supply Agreement, we may be required to pay substantial penalties.

The initial term of the Supply Agreement with Schreiber is for a period of five years from the effective date of September 1, 2005 and is renewable at our option for up to two additional five-year periods (for a total term up to fifteen years). If we do not exercise our first option to extend the term, then we will be obligated to pay Schreiber $1,500,000. If we exercise our first option to extend the term, but do not exercise our second option to extend the term, then we will be obligated to pay Schreiber $750,000. Either penalty would have a material adverse affect on the liquidity and financial condition of our Company. We are in negotiations with Schreiber regarding an amendment to the existing Supply Agreement that would change, among other things, the initial term and the related penalties thereon.

We may be required to pay substantial short-fall penalties under our Supply Agreement.

The Supply Agreement with Schreiber originally provided for a contingent short-fall payment obligation up to $8,700,000 by our Company if a specified production level was not met during the one-year period from September 1, 2006 to August 31, 2007. If a contingent short-fall payment was accrued after such one-year period, it could be reduced by the amount by which production levels in the one-year period from September 1, 2007 to August 31, 2008 exceeded the specified target level of production, if any. The short-fall payment is based on a formula that calculates the payment as follows: ((required pounds shipped - actual pounds shipped) / required pounds shipped) * $8,700,000. In November 2006, the Supply Agreement was amended so that the short-fall payment obligation would not be measured until the one-year period from September 1, 2009 to August 31, 2010, and the target level of production was reduced by approximately 22%.

Although we have significantly improved our gross margins by discontinuing production of low margin products, our total sales (and the corresponding volume of our products being produced) have been substantially reduced.  We would need to greatly increase our present production volume before the measuring period from September 1, 2009 to August 31, 2010 in order to avoid a substantial shortfall payment.  Based on our present production volume, the estimated short-fall payment could exceed $6,400,000.

We may not have the ability to pay the required short-fall payment and Schreiber may use its contractual rights in order to collect and may cease production and shipment of our products. Such an action would have a material adverse affect on the liquidity and financial condition of our Company and it is unlikely that we would be able to continue as a going concern.

We are in negotiations with Schreiber regarding an amendment to the existing Supply Agreement that would change, among other things, the production requirement and related short-fall penalty.

27

The main ingredient in many of our products is subject to volatility and limited availability. Price increases for this commodity adversely affect our business.

Our Supply Agreement with Schreiber is based on cost plus a processing fee. Currently, the major cost ingredient in our products is casein, a dried skim milk protein that is purchased from foreign suppliers. Because we purchase casein from foreign suppliers, its availability is subject to a variety of factors, including but not limited to, trade regulations, foreign supply and exchange rate fluctuations. These factors could have an adverse effect on our business and our ability to compete with competitors that do not rely on foreign suppliers. We cannot assure you that we could obtain casein from U.S. sources if the foreign supply of casein were reduced or terminated. Even if we could obtain casein from U.S. sources, the prices for the casein would likely be significantly higher than we have paid historically. Any of these events would negatively affect our business, results of operations and cash flows.

Additionally, due to a current worldwide shortage and a weaker US Dollar in relation to the Euro, the average price of casein increased more than 50% in our third quarter of fiscal 2008 compared to the average price in the first half of fiscal 2008. We anticipate that the average price of casein will increase another 33% or more in the fourth quarter of fiscal 2008.  We recently implemented several strategic plans of action in an effort to at least partially minimize the negative effect of these anticipated casein price increases. These strategies include reducing promotional spending and consumer advertising and increasing customer pricing on certain affected product lines, as well as, reformulating existing products to reduce the amount of required casein and expanding and accelerating the roll-out of new products which do not require casein. Although we implemented these strategic plans of action, we anticipate that gross margins on a majority of our products will continue to decline for the remainder of fiscal 2008.  We further anticipate that gross margins as a percentage of net sales for fiscal 2008 will be approximately four to eight percentage points lower than our fiscal 2007 annual average. Additionally, we anticipate that our income from operations will continue to be materially and adversely affected by the decline in gross margins.

A private investor owns a large percentage of the outstanding shares, which could materially limit the ownership rights of investors.

As of February 8, 2008, Frederick DeLuca, a private investor, owned approximately 23% of our outstanding common stock and held warrants and a convertible note which, if exercised with accrued and unpaid interest on the convertible note as of such date and assuming the exercise of no other outstanding options or warrants, would give him ownership of approximately 51% of our outstanding common stock. Investors who purchase common stock in our Company may be unable to elect any specific members of the board of directors or exercise significant control over us or our business as a result of Mr. Deluca’s ownership. Additionally, Mr. DeLuca may be able to exercise significant influence over our policies and Board composition.

Stockholders may experience further dilution.

We have a substantial number of outstanding options and warrants and a convertible note to acquire shares of common stock. As of February 8, 2008, we have a total of 14,949,010 shares reserved for future issuance upon exercise of options or warrants and conversion of the convertible note. None of these securities are “in the money,” as of such date. “In the money” generally means that the current market price of the common stock is above the exercise price of the shares subject to the option, warrant or note conversion. The issuance of common stock upon the exercise of these options and warrants or note conversion could adversely affect the market price of the common stock or result in substantial dilution to our existing stockholders. In addition, any future securities issuances by our Company could result in the issuance, or potential issuance, of a significant amount of equity securities that will cause substantial dilution to our stockholders, particularly given the current low trading price of our common stock.

We may be required to repay our convertible note to Mr. DeLuca and may not have the ability to do so.

Pursuant to a Note Purchase Agreement dated July 19, 2006 as modified on March 14, 2007, we issued a new unsecured convertible note for $2,685,104 (the “Convertible Note”) to Mr. Frederick A. DeLuca. The Convertible Note together with any accrued and unpaid interest thereon, is convertible at the election of Mr. DeLuca, at any time on or prior to October 19, 2008 into shares of our common stock at a conversion price of $0.35 per share. If Mr. DeLuca does not choose to convert this Convertible Note into stock and does not extend the maturity date of the Convertible Note, then we will be required to pay principal plus accrued interest thereon in the amount of $3,451,478 on October 19, 2008. With our current cash balances and the ability to borrow additional funds on our Commercial Finance Agreement, we have the ability to repay a substantial portion of this obligation, but it will not be enough to repay the entire amount owed. If Mr. DeLuca does not convert some or all of the Convertible Note or we do not repay, refinance or amend the existing Convertible Note, then our inability to pay would trigger a default. In addition to Mr. DeLuca pursuing remedies for collection of such indebtedness, interest would begin accruing at the rate of 17.5%.

28

Additionally, a default on the Convertible Note would trigger a cross default in our Commercial Finance Agreement which can then be terminated by Commercial Finance. Any outstanding balance owed under the Commercial Finance Agreement could become immediately due and payable and bear interest at 12% in addition to other fees and penalties. Therefore, a default on the Convertible Note would have a material adverse affect on the liquidity and financial condition of our Company and we may not be able to continue as a going concern. Management will be initiating discussions with Mr. DeLuca regarding extending the maturity, refinancing and/or converting all or a portion of the Convertible Note into equity on or before its maturity in October 2008, but there can be no assurances that we will be successful in our negotiations.

We may not be able to implement Section 404 of the Sarbanes-Oxley Act on a timely basis.

The Securities and Exchange Commission (the “SEC”), as directed by Section 404 of The Sarbanes Oxley Act (“SOX 404”), adopted rules generally requiring each public company to include a report of management on the company’s internal controls over financial reporting in its annual report on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal controls over financial reporting. This requirement will first apply to our annual report on Form 10-K for the fiscal year ending March 31, 2008. In addition, the company’s independent registered accounting firm must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting. This requirement will first apply to our annual report on Form 10-K for the fiscal year ending March 31, 2009. The SEC has proposed a one-year extension for the auditor attestation requirement. If this proposal is approved, we will not be required to acquire an auditor attestation until our fiscal year ending March 31, 2010.

We have not yet completed SOX 404 implementation. In the past, we have discovered, and may in the future discover, areas of our internal controls that need improvement. We have engaged an outside consultant and will be incurring incremental costs in order to complete the work required by Section 404. However, there can be no assurance that we will be able to complete implementation of SOX 404 on a timely basis.

Additionally, upon completion of a SOX 404 plan, we may not be able to conclude that our internal controls over financial reporting are effective, or in the event that we conclude that our internal controls are effective, our independent accountants may disagree with our assessment beginning with the fiscal year ending March 31, 2009 and may issue a report that is qualified. This could subject our Company to regulatory scrutiny and a loss of public confidence in our internal controls. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could negatively affect our operating results or cause us to fail to meet our reporting obligations.

29

ITEM 4.Submission of Matters to a Vote of Security Holders

We held our annual stockholder meeting on January 18, 2008. As of the record date on December 3, 2007, there were 17,110,016 shares of our common stock issued, outstanding and eligible to vote. In this meeting, the shareholders voted on and approved the following proposals:

1. To elect four directors for a term of one year each, until the next annual meeting of stockholders and until their successors are elected and qualify. The board members were voted in with the following number of votes for their election:

	Votes Cast	Votes
Director	FOR	WITHHELD
David H. Lipka	12,904,268	659,131
Michael E. Broll	12,998,532	564,867
Peter J. Jungsberger	13,015,294	548,105
Robert S. Mohel	13,011,687	551,712

2. To ratify the retention of Cross, Fernandez and Riley, LLP as the independent registered public accounting firm of the Company for the fiscal year ending March 31, 2008. The vote tabulation for this proposal was as follows: VOTES CAST FOR - 13,433,438; VOTES CAST AGAINST - 104,609; ABSTENTIONS - 25,352; BROKER NON-VOTES - none.

ITEM 5.Other Information

On November 28, 2007, the Board, through a Written Unanimous Consent, amended ARTICLE VI, Section 1 as reported on Form 8-K filed on December 3, 2007. On February 6, 2008, the Board approved the Amended and Restated Bylaws of Galaxy Nutritional Foods, Inc. dated February 6, 2008 which is attached as Exhibit 3.2 of this Quarterly Report on Form 10-Q. This Amended and Restated Bylaws for our Company updated multiple sections, including the name of our Company, substantially rewrote Article V related to indemnification, and modernized the language from our prior bylaws dated May 15, 1987.

30

Item 6.Exhibits

The following exhibits are filed as part of this Form 10-Q:

Exhibit No		Exhibit Description
*	3.1	Restated Certificate of Incorporation of the Company as filed with the Secretary of State of the State of Delaware on December 23, 2002 (Filed as Exhibit 3.2 on Form 10-Q for the fiscal quarter ended December 31, 2002.)
	3.2	Amended and Restated Bylaws of Galaxy Nutritional Foods, Inc. dated February 6, 2008 (Filed herewith.)
*	4.18	Securities Purchase Agreement dated as of October 6, 2004 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 4.18 on Form 8-K filed October 8, 2004.)
*	4.19	Registration Rights Agreement dated as of October 6, 2004 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 4.19 on Form 8-K filed October 8, 2004.)
*	4.20	Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as of October 6, 2004 in favor of Frederick A. DeLuca (Filed as Exhibit 4.20 on Form 8-K filed October 8, 2004.)
*	4.21	Stock Repurchase Agreement dated as of October 6, 2004 by and among Galaxy Nutritional Foods, Inc., BH Capital Investments L.P. and Excalibur Limited Partnership (Filed as Exhibit 4.21 on Form 8-K filed October 8, 2004.)
*	4.22	Registration Rights Agreement dated as of October 6, 2004 by and among Galaxy Nutritional Foods, Inc., BH Capital Investments L.P. and Excalibur Limited Partnership (Filed as Exhibit 4.22 on Form 8-K filed October 8, 2004.)
*	4.23	Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as of October 6, 2004 in favor of BH Capital Investments L.P. (Filed as Exhibit 4.23 on Form 8-K filed October 8, 2004.)
*	4.24	Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as of October 6, 2004 in favor of Excalibur Limited Partnership (Filed as Exhibit 4.24 on Form 8-K filed October 8, 2004.)
*	4.25	Investor relations contract between Galaxy Nutritional Foods, Inc. and R.J. Falkner dated as of September 29, 2004 (Filed as Exhibit 4.25 on Form S-3 filed March 14, 2005.)
*	4.26	Asset Purchase Agreement dated June 30, 2005 between Galaxy Nutritional Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit 4.25 on Form 8-K filed July 6, 2005.)
*	4.27	Warrant to Purchase Securities of Galaxy Nutritional Foods, Inc. dated July 19, 2006 in favor of Frederick A. DeLuca (Filed as Exhibit 4.27 on Form 8-K filed July 25, 2006.)
*	4.28	Convertible Note in the principal amount of $2,685,104.17 dated as of July 19, 2006 by Galaxy Nutritional Foods, Inc. in favor of Frederick A. DeLuca (Filed as Exhibit 4.26 on Form 8-K filed July 25, 2006.)
*	10.1	Loan and Security Agreement dated as of May 27, 2003 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.1 on Form 8-K filed June 2, 2003.)
*	10.2	Patent, Copyright and Trademark Collateral Security Agreement dated as of May 27, 2003 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.2 on Form 8-K filed June 2, 2003.)

31

*	10.3	Second Amended and Restated Employment Agreement dated as of October 13, 2003 between Galaxy Nutritional Foods, Inc. and Angelo S. Morini (Filed as Exhibit 10.1 on Form 8-K filed October 20, 2003.)
*	10.12	Second Amendment to Loan and Security Agreement dated June 25, 2004 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.12 on Form 10-K for the fiscal year ended March 31, 2004.)
*	10.13	Third Amendment to Lease Agreement dated June 10, 2004 between Galaxy Nutritional Foods, Inc. and Cabot Industrial Properties, L.P. (Filed as Exhibit 10.13 on Form 10-K for the fiscal year ended March 31, 2004.)
*	10.14	Separation and Settlement Agreement dated July 8, 2004 between Galaxy Nutritional Foods, Inc. and Christopher J. New (Filed as Exhibit 10.14 on Form 8-K filed July 13, 2004.)
*	10.15	Employment Agreement dated July 8, 2004 between Galaxy Nutritional Foods, Inc. and Michael E. Broll (Filed as Exhibit 10.15 on Form 8-K filed July 13, 2004.)
*	10.16	Third Amendment to Loan and Security Agreement dated November 10, 2004 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.16 on Form 10-Q for the fiscal quarter ended December 31, 2004.)
*	10.17	Fourth Amendment to Loan and Security Agreement dated June 3, 2005 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.17 on Form 8-K filed June 22, 2005.)
*	10.18	Letter Agreement dated June 17, 2005 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.18 on Form 8-K filed June 22, 2005.)
*	10.19	Supply Agreement dated June 30, 2005 between Galaxy Nutritional Foods, Inc. and Schreiber Foods, Inc. Portions of the Supply Agreement have been omitted as indicated by asterisks pursuant to a request for confidential treatment in accordance with Section 552(b)(4) of the Freedom of Information Act ("FOIA"), 5 U.S.C. 552(b)(4) (Filed as Exhibit 10.19 on Form 8-K filed July 6, 2005.)
*	10.20	Loan Modification Agreement June 30, 2005 between Galaxy Nutritional Foods, Inc. and Wachovia Bank N.A (formerly SouthTrust Bank). (Filed as Exhibit 10.20 on Form 8-K filed July 6, 2005.)
*	10.21	Termination, Settlement and Release Agreement dated July 20, 2005 between Galaxy Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as Exhibit 10.21 on Form 8-K filed July 26, 2005.)
*	10.22	Note and Warrant Purchase Agreement dated September 12, 2005 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 10.22 on Form 8-K filed September 16, 2005.)
*	10.23	Note and Warrant Purchase Agreement dated September 28, 2005 between Galaxy Nutritional Foods, Inc. and Conversion Capital Master, Ltd. (Filed as Exhibit 10.23 on Form 8-K filed October 4, 2005.)
*	10.24	Note and Warrant Purchase Agreement dated September 28, 2005 between Galaxy Nutritional Foods, Inc. and SRB Greenway Capital, L.P. (Filed as Exhibit 10.24 on Form 8-K filed October 4, 2005.)
*	10.25	Note and Warrant Purchase Agreement dated September 28, 2005 between Galaxy Nutritional Foods, Inc. and SRB Greenway Capital (Q.P.), L.P. (Filed as Exhibit 10.25 on Form 8-K filed October 4, 2005.)
*	10.26	Note and Warrant Purchase Agreement dated September 28, 2005 between Galaxy Nutritional Foods, Inc. and SRB Greenway Offshore Operating Fund, L.P. (Filed as Exhibit 10.26 on Form 8-K filed October 4, 2005.)

32

*	10.27	First Amendment to Note and Warrant Purchase Agreement dated October 7, 2005 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 10.27 on Form 10-Q for the fiscal quarter ended September 30, 2005.)
*	10.28	Fifth Amendment to Loan and Security Agreement dated November 14, 2005 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.28 on Form 10-Q for the fiscal quarter ended September 30, 2005.)
*	10.29	Sixth Amendment to Loan and Security Agreement dated May 26, 2006 between Galaxy Nutritional Foods, Inc. and Textron Financial Corporation (Filed as Exhibit 10.29 on Form 8-K filed June 1, 2006.)
*	10.30	Receivables Purchase Agreement, together with Addendum, dated June 23, 2006 between Galaxy Nutritional Foods, Inc. and Systran Financial Services Corporation (Filed as Exhibit 10.30 on Form 8-K filed June 29, 2006.)
*	10.31	Note Purchase Agreement dated July 19, 2006 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 10.31 on Form 8-K filed July 25, 2006.)
*	10.32	Termination Agreement dated July 31, 2006 between Galaxy Nutritional Foods, Inc. and CLP Industrial Properties (Filed as Exhibit 10.32 on Form 8-K filed August 3, 2006.)
*	10.33	Non-plan Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated August 7, 2006 in favor of Peter J. Jungsberger (Filed as Exhibit 10.33 on Form 10-Q for the fiscal quarter ended June 30, 2006.)
*	10.34	Non-plan Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated August 7, 2006 in favor of Robert S. Mohel (Filed as Exhibit 10.34 on Form 10-Q for the fiscal quarter ended June 30, 2006.)
*	10.35	Non-plan Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated August 17, 2006 in favor of David H. Lipka (Filed as Exhibit 10.35 on Form 8-K filed August 21, 2006.)
*	10.36	Non-plan Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated August 17, 2006 in favor of Michael E. Broll (Filed as Exhibit 10.36 on Form 8-K filed August 21, 2006.)
*	10.37	Non-plan Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated August 17, 2006 in favor of Angelo S. Morini (Filed as Exhibit 10.37 on Form 8-K filed August 21, 2006.)
*	10.38	Sublease Agreement dated October 3, 2006 between Galaxy Nutritional Foods, Inc. and Oracle Corporation (Filed as Exhibit 10.38 on Form 8-K filed October 10, 2006.)
*	10.39	Letter Agreement accepted November 9, 2006 between Galaxy Nutritional Foods, Inc. and Schreiber Foods, Inc. amending the Supply Agreement dated June 30, 2005 between the parties. Portions of the Letter Agreement have been omitted as indicated by asterisks pursuant to a request for confidential treatment in accordance with Section 552(b)(4) of the Freedom of Information Act ("FOIA"), 5 U.S.C. 552(b)(4) (Filed as Exhibit 10.39 on Form 10-Q for the fiscal quarter ended September 30, 2006.)
*	10.40	Note Modification Agreement dated March 14, 2007 between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 10.40 on Form 8-K filed March 20, 2007.)
*	10.41	Second Amendment to the Employment Agreement dated May 3, 2007 between Galaxy Nutritional Foods, Inc. and Michael E. Broll. (Filed as Exhibit 10.38 on Form 8-K filed May 9, 2007.)
*	10.42	First Amendment to Receivables Purchase Agreement dated March 28, 2007 between Galaxy Nutritional Foods, Inc. and Systran Financial Services Corporation (Filed as Exhibit 10.42 on Form 10-K filed June 7, 2007.)
*	10.43	Separation and General Release Agreement dated June 1, 2007 between Galaxy Nutritional Foods, Inc. and Christopher Morini (Filed as Exhibit 10.43 on Form 10-K filed June 7, 2007.)

33

	10.44	Third Amendment to the Employment Agreement dated December 10, 2007 between Galaxy Nutritional Foods, Inc. and Michael E. Broll (Filed herewith.)
	10.45	Stay, Severance and Sales Bonus Plan effective December 10, 2007 (Filed herewith.)
*	14.1	Code of Ethics (Filed as Exhibit 14.1 on Form 10-K filed June 7, 2007.)
*	16.1	Letter from BDO Seidman, LLP to the SEC dated July 24, 2006 (Filed as Exhibit 16.1 on Form 8-K filed July 24, 2006.)
*	16.2	Letter from Cross, Fernandez & Riley, LLP to the SEC dated July 24, 2006 (Filed as Exhibit 16.1 on Form 8-K filed July 24, 2006.)
*	20.1	Audit Committee Charter (Filed as Exhibit 20.1 on Form 10-Q for the fiscal quarter ended September 30, 2003.)
*	20.2	Compensation Committee Charter (Filed as Exhibit 20.2 on Form 10-Q for the fiscal quarter ended September 30, 2003.)
	31.1	Section 302 Certification of our Chief Executive Officer (Filed herewith.)
	31.2	Section 302 Certification of our Chief Financial Officer (Filed herewith.)
	32.1	Section 906 Certification of our Chief Executive Officer (Filed herewith.)
	32.2	Section 906 Certification of our Chief Financial Officer (Filed herewith.)
*		Previously filed and incorporated herein by reference.

34

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	GALAXY NUTRITIONAL FOODS, INC.
Date: February 12, 2008	/s/ Michael E. Broll
	Michael E. Broll
	Chief Executive Officer
	(Principal Executive Officer)
Date: February 12, 2008	/s/ Salvatore J. Furnari
	Salvatore J. Furnari
	Chief Financial Officer
	(Principal Accounting and
	Financial Officer)

35