UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




FORM 10-Q


(Mark One)


x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 28, 2010





OR




o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________




Commission file number 1-16699




OVERHILL FARMS, INC.


(Exact name of registrant as specified in its charter)




Nevada

75-2590292(State or other jurisdiction of

(IRS Employerincorporation or organization)

Identification Number)2727 East Vernon AvenueVernon, California

90058(Address of principal executive offices)

(Zip code)




(323) 582-9977


(Registrant’s telephone number, including area code)




Not applicable


(Former name, former address and former fiscal year, if changed since last report)




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 x   No o




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o




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




Large Accelerated Filer o
Accelerated Filer oNon-Accelerated Filer o
Smaller Reporting Company x


(Do not check if smaller reporting company)




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




As of May 6, 2010, there were 15,823,271 shares of the issuer’s common stock, $.01 par value, outstanding.












OVERHILL FARMS, INC.


FORM 10-Q


QUARTER ENDED MARCH 28, 2010







TABLE OF CONTENTS




Page No.PART I – FINANCIAL INFORMATIONItem 1.  Financial StatementsCondensed Balance Sheets as of March 28, 2010 (unaudited) and September 27, 2009

2Condensed Statements of Income (unaudited) for the Quarters Ended March 28, 2010 and March 29, 2009

4Condensed Statements of Income (unaudited) for the Six Months Ended March 28, 2010 and March 29, 2009

5Condensed Statements of Cash Flows (unaudited) for the Six Months Ended March 28, 2010 and March 29, 2009

6Notes to Condensed Financial Statements (unaudited)

8Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

15Item 3.   Quantitative and Qualitative Disclosures about Market Risk

23Item 4T.   Controls and Procedures

23PART II – OTHER INFORMATIONItem 1.   Legal Proceedings

24Item 5.   Exhibits

25SIGNATURES

26EXHIBITS ATTACHED TO THIS FORM 10-Q

27




1
 Table of Contents


Item 1.   Financial Statements




OVERHILL FARMS, INC.


CONDENSED BALANCE SHEETS




Assets


March 28,

2010


September 27,

2009(Unaudited)Current assets:Cash

$
5,789,548


$
5,430,295Accounts receivable, net of allowance for doubtful accounts of $5,000 and $15,000 at March 28, 2010 and September 27, 2009, respectively


16,664,250



17,854,041Inventories


14,294,961



15,263,224Prepaid expenses and other


2,030,099



1,859,173Deferred income taxes


1,122,211



1,122,211Total current assets


39,901,069



41,528,944Property and equipment, at cost:Fixtures and equipment


25,560,779



24,593,878Leasehold improvements


11,474,659



11,394,840Automotive equipment


92,886



44,60737,128,324



36,033,325Less accumulated depreciation and amortization


(20,883,648
)


(19,196,429
)Total property and equipment


16,244,676



16,836,896Other non-current assets:Goodwill


12,188,435



12,188,435Deferred financing costs, net of accumulated amortization of $459,000 and $419,000 at March 28, 2010 and September 27, 2009, respectively


126,367



166,620Other


2,642,759



2,916,475Total other non-current assets


14,957,561



15,271,530Total assets

$
71,103,306


$
73,637,370




The accompanying notes are an integral part


of these condensed financial statements.


2
 Table of Contents


OVERHILL FARMS, INC.


CONDENSED BALANCE SHEETS (continued)




Liabilities and Stockholders’ Equity


March 28,

2010


September 27,

2009(Unaudited)Current liabilities:Accounts payable

$
9,592,598


$
9,338,604Accrued liabilities


3,547,710



3,272,770Current maturities of long-term debt


2,875,000



5,271,441Total current liabilities


16,015,308



17,882,815Long-term accrued liabilities


500,645



466,987Deferred tax liabilities


1,899,658



1,899,658Long-term debt, less current maturities, net of unamortized debt discount of $372,000 and $535,000 at March 28, 2010 and September 27, 2009, respectively


15,777,569



21,891,204Total liabilities


34,193,180



42,140,664Commitments and contingenciesStockholders’ equity:Preferred stock, $0.01 par value, authorized 50,000,000 shares, 0 shares issued and outstanding


–



–Common stock, $0.01 par value, authorized 100,000,000 shares, 15,823,271 shares issued and outstanding at March 28, 2010 and September 27, 2009


158,233



158,233Additional paid-in capital


11,558,479



11,558,479Retained earnings


25,193,414



19,779,994Total stockholders’ equity


36,910,126



31,496,706Total liabilities and stockholders’ equity

$
71,103,306


$
73,637,370




The accompanying notes are an integral part


of these condensed financial statements.


3
 Table of Contents


OVERHILL FARMS, INC.


CONDENSED STATEMENTS OF INCOME


(Unaudited)




For the Quarter EndedMarch 28,

2010


March 29,

2009Net revenues

$
50,459,303


$
51,583,412Cost of sales


43,640,235



45,815,774Gross profit


6,819,068



5,767,638Selling, general and administrative expenses


2,691,512



2,295,531Operating income


4,127,556



3,472,107Interest expense:Interest expense


(244,209
)


(424,347
)Amortization of debt discount and deferred financing costs


(101,504
)


(101,504
)Total interest expense


(345,713
)


(525,851
)Income before income taxes


3,781,843



2,946,256Income taxes


1,421,217



1,151,986Net income

$
2,360,626


$
1,794,270Net income per share:Basic

$
0.15


$
0.11Diluted

$
0.15


$
0.11Shares used in computing net income per share:Basic


15,823,271



15,823,271Diluted


16,046,275



16,011,493




The accompanying notes are an integral part


of these condensed financial statements.


4
 Table of Contents


OVERHILL FARMS, INC.


CONDENSED STATEMENTS OF INCOME


(Unaudited)




For the Six Months EndedMarch 28,

2010


March 29,

2009Net revenues

$
106,691,840


$
106,855,441Cost of sales


91,986,643



93,580,285Gross profit


14,705,197



13,275,156Selling, general and administrative expenses


5,253,293



4,829,746Operating income


9,451,904



8,445,410Interest expense:Interest expense


(575,323
)


(1,136,931
)Amortization of debt discount and deferred financing costs


(203,008
)


(203,008
)Total interest expense


(778,331
)


(1,339,939
)Other expenses


(1,000
)


–Income before income taxes


8,672,573



7,105,471Income taxes


3,259,153



2,778,239Net income

$
5,413,420


$
4,327,232Net income per share:Basic

$
0.34


$
0.27Diluted

$
0.34


$
0.27Shares used in computing net income per share:Basic


15,823,271



15,823,271Diluted


16,048,947



16,014,916




The accompanying notes are an integral part


of these condensed financial statements.


5
 Table of Contents


OVERHILL FARMS, INC.


CONDENSED STATEMENTS OF CASH FLOWS


(Unaudited)




For the Six Months EndedMarch 28,

2010


March 29,

2009Operating Activities:Net income

$
5,413,420


$
4,327,232Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization


1,980,846



1,678,022Amortization of debt discount and deferred financing costs


203,008



203,008(Gain) loss on asset disposals


(57
)


415(Recovery) provision for doubtful accounts


(10,000
)


9,000Changes in:Accounts receivable


1,199,791



523,329Inventories


968,263



1,020,504Prepaid expenses and other assets


(101,081
)


405,762Accounts payable


253,994



(1,063,651
)Accrued liabilities


274,940



720,895Net cash provided by operating activities


10,183,124



7,824,516Investing Activities:Additions to property and equipment


(1,151,678
)


(362,460
)Proceeds from sale of property, plant and equipment


637



–Net cash used in investing activities


(1,151,041
)


(362,460
)




The accompanying notes are an integral part


of these condensed financial statements.


6
 Table of Contents


OVERHILL FARMS, INC.


CONDENSED STATEMENTS OF CASH FLOWS (continued)


(Unaudited)




For the Six Months EndedMarch 28,

2010


March 29,

2009Financing Activities:Principal payments on debt


(8,250,000
)


(6,189,734
)Principal payments on equipment loans


(422,830
)


(111,404
)Principal payments on capital lease obligation


–



(149,831
)Net cash used in financing activities


(8,672,830
)


(6,450,969
)Net increase in cash


359,253



1,011,087Cash at beginning of period


5,430,295



6,637,576Cash at end of period

$
5,789,548


$
7,648,663Supplemental Schedule of Cash Flow Information:Cash paid during the period for:Interest

$
600,193


$
1,226,729Income taxes

$
3,186,946


$
1,695,000




The accompanying notes are an integral part


of these condensed financial statements.


7
 Table of Contents


OVERHILL FARMS, INC.


NOTES TO CONDENSED FINANCIAL STATEMENTS


March 28, 2010


(Unaudited)






1.NATURE OF BUSINESS AND ORGANIZATIONAL MATTERS




Overhill Farms, Inc. (the “Company” or “Overhill Farms”) is a leading value-added manufacturer of high quality, prepared frozen food products for branded retail, private label, foodservice and airline customers.  The Company’s product line includes entrées, plated meals, bulk-packed meal components, pastas, soups, sauces, poultry, meat and fish specialties, and organic and vegetarian offerings.




2.BASIS OF PRESENTATION




The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the quarter and six months ended March 28, 2010 are not necessarily indicative of the results that may be expected for the year ending September 26, 2010 or for any other period.  Certain prior period amounts have been reclassified to conform to the current period presentation.




The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.




The condensed balance sheet at September 27, 2009 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.




For further information, refer to the financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended September 27, 2009.




3.RECENT ACCOUNTING PRONOUNCEMENTS




In February 2008, the Financial Accounting Standards Board (“FASB”)issued changes to fair value accounting standards that permit a one-year deferral of the application of fair value measurements for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The standard became effective for the Company’s fiscal year that began on September 28, 2009.  The adoption of the standard did not have a material impact on the Company’s financial position or results of operations.




In December 2007, the FASB issued a standard on business combinations that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and the goodwill acquired. The standard also modifies the recognition for preacquisition contingencies, such as environmental or legal issues, restructuring plans and acquired research and development value in purchase accounting.  The standard amends the standard on accounting for income taxes, and requires the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances.  The standard also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. The standard became effective for the Company’s fiscal year that began on September 28, 2009. The adoption of the standard did not have a material impact on the Company’s financial position or results of operations.




8
 Table of Contents





In December 2007, the FASB issued a standard on the accounting for noncontrolling interests, which clarifies the classification of noncontrolling interests in consolidated statements of financial position and the accounting for and reporting of transactions between the reporting entity and holders of such noncontrolling interests.  The standard became effective for the Company’s fiscal year that began on September 28, 2009. The adoption of the standard did not have a material impact on the Company’s financial position or results of operations.




4.INVENTORIES




Inventories are summarized as follows:


March 28,

2010


September 27,

2009Raw ingredients

$
6,112,699


$
6,677,662Finished product


6,204,210



6,658,263Packaging


1,978,052



1,927,299$
14,294,961


$
15,263,224




5.LONG-TERM DEBT




Long-term debt of the Company as of March 28, 2010 and September 27, 2009 is summarized as follows:




March 28,

2010


September 27,
2009Tranche A Term Loans payable to GCF

$
11,175,028


$
14,425,028Tranche B Term Loans payable to GCF


7,850,000



12,850,000Equipment loans


–



422,83019,025,028



27,697,858Less current maturities


(2,875,000
)


(5,271,441
)Less debt discount


(372,459
)


(535,213
)$
15,777,569


$
21,891,204




The Company executed a senior secured credit agreement with Guggenheim Corporate Funding, LLC (“GCF”) on April 17, 2006. Under the credit agreement, GCF acts as collateral agent, administrative agent, arranger and syndication agent in connection with loans made by various lenders, including affiliates of GCF.  The facility was originally structured as a $7.5 million non-amortizing revolving loan, a $25.0 million amortizing Tranche A Term Loan and a $15.0 million non-amortizing Tranche B Term Loan.




On March 9, 2007, the Company executed a second amendment to the senior secured credit agreement allowing for $7.0 million of additional capital expenditures to facilitate new business by increasing plant capacity and improving line efficiency, to be funded by increases of $3.5 million in each of the Tranche A and Tranche B Term Loans.




9
 Table of Contents




As of March 28, 2010, the facility with GCF, reflecting principal payments and the March 9, 2007 amendment, was a $49.7 million senior secured credit facility maturing in May 2011, secured by a first priority lien on substantially all of the Company’s assets.  The facility was structured as a $7.5 million non-amortizing revolving loan, a $26.5 million amortizing Tranche A Term Loan and a $15.7 million non-amortizing Tranche B Term Loan. The facility bears interest, adjustable quarterly, at the London Inter Bank Offered Rate (“LIBOR”) plus the applicable margin for LIBOR loans or, at the Company’s option in the case of the revolving loans, an alternate base rate equal to the greater of the prime rate and the federal funds effective rate plus 0.50%, plus the applicable margin for alternate base rate loans, as follows:




Total Debt to 
EBITDA Ratio 
for Last 
Twelve 
Months

Applicable

Margin for

Alternate Base

Rate

Loans


Applicable Margin for

LIBOR LoansRevolving

Loan


Revolving

Loan


Tranche A

Term Loan


Tranche B

Term LoanGreater than

3.00:1.00


2.50%



3.50%



3.75%



6.25%Greater than or equal to but less than or equal to

2.00:1.00

3.00:1.00


2.25%



3.25%



3.50%



6.00%Less than

2.00:1.00


2.00%



3.00%



3.25%



5.75%




As of March 28, 2010, the Company’s principal balances on the loans totaled $19.1 million, consisting of $11.2 million in Tranche A Term Loans and $7.9 million in Tranche B Term Loans.  At March 28, 2010, interest rates on the Tranche A Term Loans and Tranche B Term Loans were 3.5% and 6.0%, respectively. As of March 28, 2010 and September 27, 2009, the Company’s total debt to EBITDA ratio for the last twelve months was 0.94 and 1.47, respectively. Therefore, for the quarter and six months ended March 28, 2010, the Company qualified for the lowest applicable margin for the alternate base rate and LIBOR loans.  For the first half of fiscal year 2010, the Company incurred $575,000 in interest expense, excluding amortization of deferred financing costs.  For the first half of fiscal year 2009, the Company incurred $1.1 million in interest expense, excluding amortization of deferred financing costs.  During the first half of fiscal year 2010, the outstanding balance of the facility was reduced by voluntary and mandatory principal payments on the Tranche A Term Loan of $2.0 million and $1.3 million, respectively, as well as a voluntary principal payment on the Tranche B Term Loan of $5.0 million.  As of March 28, 2010, the Company had $7.5 million available to borrow under the revolving loan, as the balance was zero.





Initial proceeds from the GCF facility, received on or about May 16, 2006, were used to repay approximately $44.5 million in existing debt and related fees and expenses in connection with the termination of the Company’s former financing arrangements and to pay approximately $1.6 million in fees and expenses relating to the new financing.  Of these fees, $372,000 is recorded as debt discount, net of accumulated amortization, on the accompanying balance sheet as of March 28, 2010.  The Company paid GCF an additional $132,000 in fees and expenses on March 9, 2007 related to the second amendment, which was recorded as a debt discount.




The GCF facility contains covenants whereby, among other things, the Company is required to maintain compliance with agreed levels of earnings before interest, taxes, depreciation and amortization, interest coverage, fixed charge coverage, leverage targets, annual capital expenditures and incremental indebtedness limits. Mandatory prepayments under the facility are required based on excess cash flow, as defined in the agreement, and upon receipt of proceeds from a disposition or payment from a casualty or condemnation of the collateralized assets, and voluntary prepayments under the facility are generally permitted as provided in the agreement.  The facility also contains customary restrictions on incurring indebtedness and liens, making investments, paying dividends and making loans or advances.




As of March 28, 2010, the Company was in compliance with the covenant requirements of the agreement with GCF.  The Company believes it is probable that it will remain in compliance with all of those covenant requirements for the foreseeable future.  However, if the Company fails to achieve certain revenue, expense and profitability levels, a violation of the financial covenants under its financing arrangements could result and interest rate increases and acceleration of maturity of the loans could occur, which could adversely affect its financial condition, results of operations and cash flows.




The Company entered into the following amortizing loans with Key Bank to finance the purchase of machinery used for manufacturing processes: a 5-year loan in the principal amount of $324,000 at a fixed interest rate of 7.5% on September 21, 2006, a 5-year loan in the principal amount of $217,000 at a fixed interest rate of 7.5% on November 27, 2006 and a 4-year loan in the principal amount of $476,000 at a fixed interest rate of 7.5% on January 9, 2007.  On February 4, 2010, the Company repaid the balances of all three equipment loans.




10
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The Company amended its existing operating lease agreements with General Electric Capital Corporation on October 2, 2006.  The amended lease resulted in a three-year capital lease in the principal amount of $842,000 at a fixed interest rate of 8.15%, with a $1 bargain purchase option at the expiration of the lease.  The assets acquired under this capital lease have an acquisition cost of $912,000.  On September 2, 2009, the Company purchased the manufacturing equipment from General Electric Capital Corporation.  As of March 28, 2010 the net book value of the assets was $300,000.




6.PER SHARE DATA




The following table sets forth the calculation of earnings per share (“EPS”) for the periods presented:




Quarter EndedMarch 28,

2010


March 29,

2009Basic EPS Computation:Numerator:Net income

$
2,360,626


$
1,794,270Denominator:Weighted average common shares outstanding


15,823,271



15,823,271Total shares


15,823,271



15,823,271Basic EPS

$
0.15


$
0.11Diluted EPS Computation:Numerator:Net income

$
2,360,626


$
1,794,270Denominator:Weighted average common shares outstanding


15,823,271



15,823,271Incremental shares from assumedexercise of stock options


223,004



188,222Total shares


16,046,275



16,011,493Diluted EPS

$
0.15


$
0.11




Six Months EndedMarch 28,

2010


March 29,

2009Basic EPS Computation:Numerator:Net income

$
5,431,420


$
4,327,232Denominator:Weighted average common shares outstanding


15,823,271



15,823,271Total shares


15,823,271



15,823,271Basic EPS

$
0.34


$
0.27Diluted EPS Computation:Numerator:Net income

$
5,431,420


$
4,327,232Denominator:Weighted average common shares outstanding


15,823,271



15,823,271Incremental shares from assumedexercise of stock options


225,676



191,645Total shares


16,048,947



16,014,916Diluted EPS

$
0.34


$
0.27




11
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7.STOCK OPTIONS




The Company measures the cost of all employee stock-based compensation awards based on the grant date fair value of those awards using a Black-Scholes model and records that cost as compensation expense over the period during which the employee is required to perform service in exchange for the award (generally over the vesting period of the award). No options were granted during the quarters or six month periods ended March 28, 2010 or March 29, 2009.  Therefore, there was no impact on the income statement or cash flow statement as a result of stock-based compensation for any of these periods.




8.INCOME TAXES




The Company accounts for uncertainty in income taxes based on a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The balance of unrecognized tax benefits was zero as of March 28, 2010 and September 27, 2009.




The Company recognizes interest and penalties as part of income taxes. The total amount of interest and penalties recognized in the statements of income was zero for the quarters and six months ended March 28, 2010 and March 29, 2009.




The Company does not anticipate any significant change within 12 months of this reporting date of its uncertain tax positions.




The effective tax rates were 37.6% and 39.1% for the first half of fiscal years 2010 and 2009, respectively.




9.CONTINGENCIES




Legal Proceedings




The Company is involved in certain legal actions and claims arising in the ordinary course of business.  Management believes (based, in part, on advice of legal counsel) that such contingencies, including the matters described below, will be resolved without materially and adversely affecting the Company’s financial position, results of operations or cash flows.  The Company intends to vigorously contest all claims and grievances described below.




The following cases arise out of the same background facts. The Company reports wages of its employees to the Internal Revenue Service (“IRS”) using the social security numbers provided by the Company’s employees.  In about January 2009, the IRS threatened to impose substantial penalties against the Company because the IRS said the Company was using invalid social security numbers, which had been provided by a large number of its employees.  On April 6, 2009, the Company gave notice of the invalid social security numbers to approximately 260 employees.  The Company gave each employee approximately 60 days to provide a legitimate explanation for having furnished the Company a false number, but most employees failed to do so.  The Company then terminated the employees who were unable to provide it a legitimate explanation, effective May 31, 2009, after concluding that their continued employment would expose the Company to IRS penalties, scrutiny and potential additional criminal and civil sanctions.




Local 770 v. Overhill Farms.




On April 28, 2009, Local 770 of the United Food and Commercial Workers Union submitted an unsigned grievance regarding “the proposed terminations of workers regarding invalid social security numbers,” which the grievance alleged was a violation of the parties’ collective bargaining agreement.  The Union demanded binding arbitration under the collective bargaining agreement.




On January 11, 2010, an arbitrator dismissed the Union’s grievance.  On January 29, 2010, the Union filed a petition to vacate the arbitration decision.  On March 30, 2010, the Court denied the Union’s petition and dismissed the Union’s case with prejudice.




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Overhill Farms v. Larry (Nativo) Lopez, et al.




On June 30, 2009, the Company filed a lawsuit against Nativo Lopez and six other leaders of what the Company believes to be an unlawful campaign to force the Company to continue the employment of workers who had used invalid social security numbers to hide their illegal work status.  Among other things, the Company alleges that the defendants defamed the Company by calling the Company’s actions “racist” and unlawful.  The Company has asserted claims for defamation, extortion, intentional interference with prospective economic advantage, and intentional interference with contractual relations.  The Company filed the lawsuit in Orange County, California, and seeks damages and an injunction barring the defendants from continuing their conduct.




All of the named defendants tried unsuccessfully to dismiss the action.  In refusing to dismiss the case, the Court ruled on November 13, 2009, that the Company had established a probability of prevailing on the merits, and that the Company had submitted substantial evidence that the defendants’ accusations of racism were not true.




Agustiana, et al. v. Overhill Farms.




On July 1, 2009, Bohemia Agustiana, Isela Hernandez, and Ana Munoz filed a purported “class action” against the Company in which they asserted claims for failure to pay minimum wage, failure to furnish wage and hour statements, waiting time penalties, conversion and unfair business practices.  The plaintiffs are former employees who had been terminated one month earlier because they had used invalid social security numbers in connection with their employment with the Company.  They filed the case in Los Angeles County on behalf of themselves and a class which they say includes all non-exempt production and quality control workers who were employed in California during the four-year period prior to filing their complaint.  The plaintiffs seek unspecified damages, restitution, injunctive relief, attorneys’ fees and costs.




The Company filed a motion to dismiss the conversion claim, and the motion was granted by the court on February 2, 2010.




The parties are engaged in the discovery phase of the case.  The Company believes it has valid defenses to the plaintiffs’ remaining claims and that it paid all wages due to these employees.




Marcelino Arteaga, et al. v. Overhill Farms.




On July 7, 2009, the Company received an unfair labor practice charge that had been filed with the National Labor Relations Board (“NLRB”) on June 29, 2009. The charge was filed by Marcelino Arteaga on behalf of himself and two other ex-employees, Agapita Padilla and Fernando Morales Lira.  In addition, on June 30, 2009, these three ex-employees separately submitted grievances and demanded arbitration arising out of the Company’s decision on June 26, 2009, to terminate their employment because they had publicly accused it of being “racist.”  On August 7, 2009, the NLRB granted the Company’s request to defer further proceedings pending the resolution of the grievance and arbitration process.  The arbitration of these grievances took place on April 14 and 15, 2010, and the arbitration proceeding is not yet completed.




Department of Justice.




On August 7, 2009, the Office of Special Counsel for the Civil Rights Division of the U.S. Department of Justice (“OSC”) requested information from the Company in connection with an investigation about whether the Company terminated employees in May 2009 for whom the Company had received Social Security Administration (“SSA”) no-match letters on the basis of national origin or citizenship status.  The Company responded in detail on September 11, 2009, explaining that all affected employees had been identified by the IRS (not the SSA) as having invalid social security numbers, that the Company did not select them, and that the Company applied the same workplace rules against furnishing false information to all employees, regardless of national origin or citizenship status.




On September 9, 2009, the Company received a second letter from the OSC, which related to its investigation of a discrimination charge filed by an ex-employee, Lucia Vasquez (a/k/a Gyneth Garcia).  On September 25, 2009, the Company responded in detail to this discrimination charge, explaining that it terminated Vasquez’ employment, along with over 200 other employees, because she failed to explain why she had providedan invalid name and social security number at the time of hire, and that the termination decision had nothing to do with her national origin or citizenship status.




The OSC has not made any determination about the merits of the discrimination charge.




In the meantime, Vasquez separately filed a claim for unemployment benefits.  She was initially awarded the benefits, but the Company appealed.  Following an evidentiary hearing before an Administrative Law Judge (“ALJ”) on September 29, 2009, the ALJ rejected Vasquez’s claim for unemployment benefits.  The ALJ found that she had engaged in serious dishonesty, which included both making a false statement at the time of hire in 2003 and lying to the Company in May 2009 when confronted about her false statement.  Vasquez appealed that determination.  On February 2, 2010, the appeals board denied her appeal and rejected her claim for benefits.




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Concentrations of Credit Risk




The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of trade receivables.  The Company performs on-going credit evaluations of each customer’s financial condition and generally requires no collateral from its customers.  A bankruptcy or other significant financial deterioration of any customer could impact its future ability to satisfy its receivables with the Company.  Allowance for doubtful accounts is calculated based primarily upon historical bad debt experience and current market conditions.  For the six months ended March 28, 2010 and March 29, 2009, write-offs, net of recoveries, to the allowance for doubtful accounts were immaterial.




A significant portion of the Company’s total net revenues during the first half of fiscal years 2010 and 2009 was derived from three customers. Panda Restaurant Group, Inc., Jenny Craig, Inc., and Safeway Inc., accounted for approximately 29%, 25%, and 19%, respectively, of the Company’s total net revenues for the six months ended March 28, 2010 and approximately 17%, 24%, and 17%, respectively, of the Company’s total net revenues for the six months ended March 29, 2009.  Receivables related to Panda Restaurant Group, Inc. (through its distributors), Jenny Craig, Inc., and Safeway Inc., accounted for approximately 36%, 23% and 18%, respectively, of the Company’s total accounts receivable balance as of March 28, 2010 and approximately 22%, 18% and 15%, respectively, of the Company’s total accounts receivable balance as of March 29, 2009.




Cash used primarily for working capital purposes is maintained in two accounts with one major financial institution. Account balances as of March 28, 2010 exceeded the Federal Deposit Insurance Corporation insurance limits.  If the financial banking markets experience disruption, the Company may need to temporarily rely on other forms of liquidity, including borrowing under its credit facility.




10.RELATED PARTY TRANSACTIONS




In February 2004, the Company engaged Alexander Auerbach & Co., Inc. (“AAPR”) to provide the Company with public relations and marketing services.  AAPR provides public relations, media relations and communications marketing services to support the Company’s sales activities.  Alexander Auerbach, who is a director and stockholder of the Company, is a stockholder, director and officer of AAPR.  Fees paid to AAPR for services rendered under this engagement during the first half of fiscal years 2010 and 2009 were $21,000 and $15,000, respectively.




11.FAIR VALUE MEASUREMENTS




Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The guidance establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:




Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that can be accessed at the measurement date.





Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).




Level 3 - Unobservable inputs that reflect assumptions about what market participants would use in pricing the asset or liability. These inputs would be based on the best information available, including the Company’s own data.




Cash and cash equivalents are carried at fair value using Level 1 inputs.  The carrying amount of the Company’s other financial instruments, which are not marked to fair value at each reportable date and principally include trade receivables and accounts payable, approximate fair value due to the relatively short maturity of such instruments.  The Company believes the carrying value of the debt approximates fair value due to the relatively short maturity of such instruments. The Company believes the carrying value of the debt approximates the fair value at both March 28, 2010 and September 27, 2009, as the debt bears interest at variable rates based on prevailing market conditions.  As of March 28, 2010, the carrying value of all financial instruments was not materially different from fair value, as the interest rates on variable rate debt approximated rates currently available to the Company.




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Long-lived assets, such as property, plant, and equipment, and purchased intangibles that are subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  The recoverability of assets that are to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by such asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of such asset exceeds its fair value.  The fair value calculation requires management to apply judgment in estimating future cash flows and the discount rates that reflect the risk inherent in the future cash flows.  The estimated cash flows used for this nonrecurring fair value measurement is considered a Level 3 input as defined above.




12.SUBSEQUENT EVENTS





The Company has completed an evaluation of all subsequent events through the issuance date of these financial statements, and concluded no subsequent events occurred that required recognition or disclosure other than the legal matters noted in footnote 9 to these financial statements.




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


Forward-Looking Statements




The following discussion and analysis should be read in conjunction with our condensed financial statements and notes to condensed financial statements included elsewhere in this report. This report, and our condensed financial statements and notes to our condensed financial statements, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which statements generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might earn if we are successful in implementing our business strategies.  The forward-looking statements are based on current expectations or beliefs.  For this purpose, statements of historical fact may be deemed to be forward-looking statements.  Forward-looking statements include statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as  “continue,” “efforts,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “projects,” “forecasts,” “strategy,” “will,” “goal,” “target,” “prospects,” “optimistic,” “confident” or similar expressions.  In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), on-going business strategies or prospects, and possible future company actions, which may be provided by management, are also forward-looking statements.  We caution that these statements by their nature involve risks and uncertainties, and actual results may differ materially depending on a variety of important factors, including, among others:




●
the impact of competitive products and pricing;




●
market conditions that may affect the costs and/or availability of raw materials, fuels, energy, logistics and labor as well as the market for our products, including our customers’ ability to pay and consumer demand;




●
changes in our business environment, including actions of competitors and changes in customer
preferences, as well as disruptions to our customers’ businesses;




●
seasonality in the retail category;




●
loss of key customers due to competitive environment or production being moved in-house by customers;




●
fulfillment by suppliers of existing raw materials contracts;




●
natural disasters that can impact, among other things, costs of fuel and raw materials;




●
the occurrence of acts of terrorism or acts of war;




●
changes in governmental laws and regulations, including income taxes;




●
change in control due to takeover or other significant changes in ownership;




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●
financial viability and resulting effect on revenues and collectability of accounts receivable of our customers during the on-going economic downturn and any future deep recessionary periods;




●
ability to obtain additional financing as and when needed, and rising costs of credit that may be associated with new borrowings;




●
voluntary or government-mandated food recalls;




●
effects of legal proceedings in which we are or may become involved from time to time; and




●
other factors discussed in this report and other reports we file with the Securities and Exchange Commission (“Commission”), including those described in Item 1A of Part I of our annual report on Form 10-K for the fiscal year ended September 27, 2009 and any updates to that report.




We do not undertake to update, revise or correct any forward-looking statements, except as otherwise required by law.




Overview




We are a leading value-added manufacturer of high quality, prepared frozen food products for branded retail, private label, foodservice and airline customers.  Our product line includes entrées, plated meals, bulk-packed meal components, pastas, soups, sauces, poultry, meat and fish specialties, and organic and vegetarian offerings.  Our extensive research and development efforts, combined with our extensive catalogue of recipes and flexible manufacturing capabilities, provide customers with a one-stop solution for new product ideas, formulations and product manufacturing, as well as precise replication of existing recipes.  Our capabilities allow customers to outsource product development, product manufacturing and packaging, thereby avoiding significant fixed-cost and variable investments in resources and equipment.  Our customers include prominent nationally recognized names such as Panda Restaurant Group, Inc., Jenny Craig, Inc., Safeway Inc., H. J. Heinz Company, American Airlines, Inc. and Pinnacle Foods Group LLC.




Our goal is to continue as a leading developer and manufacturer of value-added food products and provider of custom prepared frozen foods.  We intend to create superior value for our stockholders by continuing to execute our growth and operating strategies, including:




●
diversifying and expanding our customer base by focusing on sectors we believe have attractive growth characteristics, such as foodservice and retail;




●
investing in and operating efficient production facilities;




●
providing value-added ancillary support services to customers;




●
offering a broad range of products to customers in multiple channels of distribution; and




●
exploring strategic acquisitions and investments.




Net revenues for the second quarter of fiscal year 2010, which ended March 28, 2010, continued to be affected by the economic recession.  Net revenues of $50.5 million declined $1.1 million, or 2.1% compared to the second quarter of fiscal year 2009, which ended March 29, 2009.  The retail category declined $3.0 million, primarily from reduced sales to one of our customers who lost a portion of their club store distribution.   Declines in other retail accounts were mostly offset by increased sales to Safeway Inc.  In addition, continued softness in the airline industry exacerbated by a weak economy contributed $610,000 to the decrease in net revenues.  These declines were partially offset by a $2.5 million increase in sales in the foodservice category.




Our continued sales efforts have led to new retail business with an existing customer that is scheduled for production starting in the latter part of the third quarter of fiscal year 2010.  This new business is expected to partially offset the loss of business from H.J. Heinz Company, who moved a large portion of its production to its own facilities.  We are in the final stages of initiating several new product launches for both new and existing customers, which we hope will offset the economy’s continuing effect on sales, and the continuing reduction of customer held inventories.




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For the first half of fiscal year 2010, net revenues of $106.7 million reflected a decrease of less than 0.2% compared to the first half of fiscal year 2009.  Retail sales declined $10.4 million due to a previously announced anticipated reduced volume from H. J. Heinz Company, who moved a large portion of its production to its own facilities and one other retail account who lost a portion of their club store distribution.  Airline net sales were down $2.0 million.  These declines were largely offset by an increase in the foodservice category, which was up $12.3 million.




Gross profit was $6.8 million for the second quarter of fiscal year 2010, compared to $5.8 million for the second quarter of fiscal year 2009.  Gross profit increased as a percentage of net revenues during the second quarter of fiscal year 2010 to 13.5% from 11.2% for the second quarter of fiscal year 2009.  Although net revenues decreased for the second quarter of fiscal year 2010 compared to the second quarter of fiscal year 2009, gross profit as a percentage of revenues increased due to continuous process improvements, improved efficiencies and yields and favorable commodity prices.




Gross profit was $14.7 million for the first half of fiscal year 2010, compared to $13.3 million for the first half of fiscal year 2009.  Although net revenues remained flat for the first half of fiscal year 2010 compared to the first half of fiscal year 2009, gross profit as a percentage of net revenues increased to 13.8% from 12.4% for the first half of fiscal year 2009.  This was due to continuous process improvements, improved efficiencies and yields and favorable commodity prices.




Operating income for the second quarter of fiscal year 2010 was $4.1 million (8.1% of net revenues) compared to $3.5 million (6.8% of net revenues) for the second quarter of fiscal year 2009 due primarily to improvements in gross profit margins as noted above.  Selling, general and administrative (“SG&A”) expenses as a percentage of net revenues increased to 5.3% for the second quarter of fiscal year 2010 compared to 4.5% for the second quarter of fiscal year 2009.  SG&A expenses were driven by higher legal fees of $198,000 relating primarily to litigation described in Item 1 of Part II of this report and higher brokerage fees stemming from higher sales to Safeway Inc.  Net income for the second quarter of fiscal year 2010 was $2.4 million (4.8% of net revenues) compared to $1.8 million (3.5% of net revenues) for the second quarter of fiscal year 2009 due to higher gross profit and to lower interest expense as a result of pay downs under our credit facility.




Operating income for the first half of fiscal year 2010 was $9.5 million (8.9% of net revenues), compared to $8.4 million (7.9% of net revenues) for the first half of fiscal year 2009 due primarily to improvements in gross profit margins.  SG&A expenses as a percentage of net revenues increased to 5.0% for the first half of fiscal year 2010 compared to 4.5% for the first half of fiscal year 2009.  SG&A expenses were driven by higher legal fees of $382,000 relating primarily to litigation described in Item 1 of Part II of this report and higher brokerage fees stemming from higher sales to Safeway Inc.  Net income for the first half of fiscal year 2010 was $5.4 million (5.1% of net revenues) compared to $4.3 million (4.0% of net revenues) for the first half of fiscal year 2009 due to higher gross profits and to lower interest expense as a result of pay downs under our credit facility.




Critical Accounting Policies




Management’s discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of our financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  See Note 2 to the financial statements contained in our annual report on Form 10-K for the year ended September 27, 2009 for a summary of our significant accounting policies.  Management believes the following critical accounting policies are related to our more significant estimates and assumptions used in the preparation of our financial statements.




Inventories.  Inventories, which include material, labor and manufacturing overhead, are stated at the lower of cost, which approximates the first-in, first-out (“FIFO”) method, or market.  We use a standard costing system to estimate our FIFO cost of inventory at the end of each reporting period.  Historically, standard costs have been materially consistent with actual costs.  We periodically review our inventory for excess items, and write it down based upon the age of specific items in inventory and the expected recovery from the disposition of the items.




We write-down our inventory for the estimated aged surplus, spoiled or damaged products and discontinued items and components.  We determine the amount of the write-down by analyzing inventory composition, expected usage, historical and projected sales information and other factors.  Changes in sales volume due to unexpected economic or competitive conditions are among the factors that could result in material increases in the write-down of our inventory.




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Property and Equipment.The cost of property and equipment is depreciated over the estimated useful lives of the related assets, which range from three to ten years.  Leasehold improvements to our Plant No. 1 in Vernon, California are amortized over the lesser of the initial lease term plus one lease extension period, initially totaling 15 years, or the estimated useful lives of the assets.  Other leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful lives of the assets.  Depreciation is generally computed using the straight-line method.




We assess property and equipment for impairment whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable.




Expenditures for maintenance and repairs are charged to expense as incurred.  The cost of materials purchased and labor expended in betterments and major renewals are capitalized.  Costs and related accumulated depreciation of properties sold or otherwise retired are eliminated from the accounts, and gains or losses on disposals are included in operating income.




Goodwill.We evaluate goodwill at least annually for impairment.  We have one reporting unit and estimate fair value based on a variety of market factors, including discounted cash flow analysis, market capitalization, and other market-based data.  As of March 28, 2010, we had goodwill of $12.2 million.  A deterioration of our operating results and the related cash flow effect could decrease the estimated fair value of our business and, thus, cause our goodwill to become impaired and cause us to record a charge against operations in an amount representing the impairment.




Income Taxes.We evaluate the need for a valuation allowance on our deferred tax assets based on whether we believe that it is more likely than not that all deferred tax assets will be realized.  We consider future taxable income and on-going prudent and feasible tax planning strategies in assessing the need for valuation allowances.  In the event we were to determine that we would not be able to realize all or part of our deferred tax assets, we would record an adjustment to the deferred tax asset and a charge to income at that time.




We account for uncertainty in income taxes based on a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The balance of unrecognized tax benefits was zero as of March 28, 2010 and September 27, 2009.




We recognize interest and penalties as part of income taxes.  No interest and penalties were recognized in the statement of income for the first half of fiscal year 2010.




Concentrations of Credit Risk




Our financial instruments that are exposed to concentrations of credit risk consist primarily of trade receivables.  We perform on-going credit evaluations of each customer’s financial condition and generally require no collateral from our customers.  A bankruptcy or other significant financial deterioration of any customer could impact its future ability to satisfy its receivables with us.  Our allowance for doubtful accounts is calculated based primarily upon historical bad debt experience and current market conditions. For the first half of fiscal years 2010 and 2009, our write-offs, net of recoveries, to the allowance for doubtful accounts were immaterial.




A significant portion of our total net revenues during the first half of fiscal years 2010 and 2009 was derived from three customers. Panda Restaurant Group, Inc., Jenny Craig, Inc., and Safeway Inc., accounted for approximately 29%, 25%, and 19%, respectively, of our total net revenues for the first half of fiscal year 2010 and approximately 17%, 24%, and 17%, respectively, of our total net revenues for the first half of fiscal year 2009. Receivables related to Panda Restaurant Group, Inc. (through its distributors), Jenny Craig, Inc., and Safeway Inc., accounted for approximately 36%, 23% and 18%, respectively, of our total accounts receivable balance as of March 28, 2010 and approximately 22%, 18% and 15%, respectively, of our total accounts receivable balance as of March 29, 2009.




Cash used primarily for working capital purposes is maintained in two accounts with one major financial institution. Account balances as of March 28, 2010 exceeded the Federal Deposit Insurance Corporation insurance limits.  If the financial banking markets experience disruption, we may need to temporarily rely on other forms of liquidity, including borrowing under our credit facility.




Results of Operations




While we operate as a single business unit, manufacturing various products on common production lines, revenues from similar customers are grouped into the following natural categories: retail, foodservice and airlines.




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Quarter Ended March 28, 2010 Compared to Quarter Ended March 29, 2009




The quarters ended March 28, 2010 and March 29, 2009 were both 13-week periods.




Net Revenues.Net revenues for the second quarter of fiscal year 2010 decreased $1.1 million or 2.1% (0.6% was attributed to a volume/mix decrease and 1.5% was attributed to a pricing decrease) to $50.5 million from $51.6 million for the second quarter of fiscal year 2009 due to a decrease in airline and retail net revenues that was partially offset by an increase in foodservice net revenues.




Retail net revenues decreased $3.0 million (8.2%) to $33.8 million for the second quarter of fiscal year 2010 from $36.8 million for the second quarter of fiscal year 2009.  The decrease in net revenues was due to $3.3 million in reduced sales to one of our customers who lost a portion of their club store distribution.  Most other retail accounts declined but the reductions were offset by increased sales to Safeway Inc.   As previously disclosed, H. J. Heinz Company informed us that it intended to move most of its remaining volume to self-manufacture beginning after their contract expired at the end of calendar year 2009.  The second quarter of fiscal year 2010 includes $3.5 million in net revenues from sales to Heinz, as Heinz was delayed in transitioning to its own plants.  We plan to continue to produce limited products for H. J. Heinz Company on an on-going basis and we are continuing to work with them on potential new products.




Foodservice net revenues increased $2.5 million (20.7%) to $14.6 million for the second quarter of fiscal year 2010 from $12.1 million for the second quarter of fiscal year 2009.  The increase was attributable to introduction of new products and increased volume from an existing customer.




Airline net revenues decreased $610,000 (23.5%) to $2.0 million for the second quarter of fiscal year 2010 from $2.6 million for the second quarter of fiscal year 2009.  Due to the current economic downturn and airline initiatives to cut costs, going forward we expect a further decline in airline net revenues.




Gross Profit.  Gross profit for the second quarter of fiscal year 2010 increased by $1.0 million (17.2%) to $6.8 million from $5.8 million for the second quarter of fiscal year 2009. Gross profit as a percentage of net revenues increased to 13.5% for the second quarter of fiscal year 2010 from 11.2% for the second quarter of fiscal year 2009 due largely to continuous process improvements, improved efficiencies and yields and favorable commodity prices.




Selling, General and Administrative Expenses. SG&A expenses increased $396,000 (17.4%) to $2.7 million (5.3% of net revenues) for the second quarter of fiscal year 2010 from $2.3 million (4.5% of net revenues) for the second quarter of fiscal year 2009.  SG&A expenses were driven by higher legal fees of $198,000 relating primarily to litigation described in Item 1 of Part II of this report and higher brokerage fees stemming from higher sales to Safeway Inc.




Operating Income.Operating income increased $655,000 (18.7%) to $4.1 million for the second quarter of fiscal year 2010 from $3.5 million for the second quarter of fiscal year 2009.  The increase in operating income was the result of the increase in gross profit as noted above.




Total Interest Expense. Total interest expense for the second quarter of fiscal year 2010 was $346,000, compared to $526,000 for the second quarter of fiscal year 2009.  The decrease in interest expense is due to lower debt balances and lower variable interest rates.  We expect interest to decline going forward as we continue to accelerate our debt repayment.




Income Tax Provision.  Income tax expense was $1.4 million for the second quarter of fiscal year 2010, compared to $1.2 million for the second quarter of fiscal year 2009.  The difference was a result of income before taxes increasing $836,000 from $2.9 million for the second quarter of fiscal year 2009 to $3.8 million for the second quarter of fiscal year 2010.  The effective tax rates were 37.6% for the second quarter of fiscal year 2010 and 39.1% for the second quarter of fiscal year 2009.




Net Income.Net income for the second quarter of fiscal year 2010 was $2.4 million, or $0.15 per basic and diluted share, compared to net income of $1.8 million, or $0.11 per basic and diluted share, for the second quarter of fiscal year 2009.




Six Months Ended March 28, 2010 Compared to Six Months Ended March 29, 2009




The six month periods ended March 28, 2010 and March 29, 2009 were both 26-week periods.




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Net Revenues.Net revenues decreased $163,000 or 0.2% (a 0.8% pricing decrease was offset by a 0.6% volume/mix increase) to $106.7 million for the first half of fiscal year 2010 from $106.9 million for the first half of fiscal year 2009, due to a decrease in retail and airline net revenues that was offset by an increase in foodservice net revenues.




Retail net revenues decreased $10.4 million (13.1%) to $68.9 million for the first half of fiscal year 2010 from $79.3 million for the first half of fiscal year 2009.  The decrease in retail net revenues was largely due to the anticipated reduced volume from H.J. Heinz Company (a decrease of $8.8 million compared to the first half of fiscal year 2009) because they moved a large portion of their production to their own facilities, and to reduced sales to one of our customers who lost a portion of their club store business (a decrease of $3.7 million).  These declines were partially offset by increases in Safeway Inc. and Jenny Craig, Inc.  For the first half of fiscal year 2010, H.J. Heinz Company accounted for $7.5 million in net revenues.  The decline in net revenues was less than expected as H. J. Heinz Company was delayed in its transition plan.  We plan to continue to produce limited products for H. J Heinz Company on an on-going basis and we are continuing to work with them on potential new products.




Foodservice net revenues increased $12.3 million (56.9%) to $33.9 million for the first half of fiscal year 2010 from $21.6 million for the first half of fiscal year 2009.  The increase was attributable to introduction of new products and increased volume from an existing customer.  The increase in net revenues for the foodservice category offset the decreases from both the retail and airline categories.  For the first half of fiscal year 2010, the foodservice category as a percentage of net revenues increased to 32% from 20%.  We continue our sales efforts in this category and continue to believe that foodservice represents a significant opportunity for us.




Airline net revenues decreased $2.0 million (33.9%) to $3.9 million for the first half of fiscal year 2010 from $5.9 million for the first half of fiscal year 2009.  Given the current economic downturn and airline initiatives to cut costs, going forward we expect a further decline in airline net revenues.




Gross Profit.Gross profit increased by $1.4 million (10.5%) to $14.7 million for the first half of fiscal year 2010 from $13.3 million for the first half of fiscal year 2009. Gross profit as a percentage of net revenues increased to 13.8% for the first half of fiscal year 2010 from 12.4% for the first half of fiscal year 2009, due largely to continuous process improvements, improved efficiencies and yields and favorable commodity prices.




Selling, General and Administrative Expenses. SG&A expenses increased $423,000 (8.8%) to $5.3 million (5.0% of net revenues) for the first half of fiscal year 2010 from $4.8 million (4.5% of net revenues) for the first half of fiscal year 2009.  SG&A expenses were driven by higher legal fees of $382,000 relating primarily to litigation described in Item 1 of Part II of this report and higher brokerage fees stemming from higher sales to Safeway Inc.




Operating Income.Operating income increased $1.0 million (11.9%) to $9.4 million for the first half of fiscal year 2010 from $8.4 million for the first half of fiscal year 2009.  The increase in operating income was the result of the increase in gross profit margin as noted above.




Total Interest and Other Expense.Interest expense for the first half of fiscal year 2010 was $778,000, compared to $1.3 million for the first half of fiscal year 2009.  The decrease in interest expense was due to lower debt balances and lower variable interest rates.




Income Tax Provision.  Income tax expense was $3.3 million for the first half of fiscal year 2010, compared to $2.8 million for the first half of fiscal year 2009. The difference was a result of income before taxes increasing $1.6 million from $7.1 million for the first half of fiscal year 2009 to $8.7 million for the first half of fiscal year 2010.  The effective tax rates were 37.6% for the first half of fiscal year 2010 and 39.1% for the first half of fiscal year 2009.




Net Income.Net income for the first half of fiscal year 2010 was $5.4 million, or $0.34 per basic and diluted share, compared to net income of $4.3 million, or $0.27 per basic and diluted share, for the first half of fiscal year 2009.




Liquidity and Capital Resources





During the first half of fiscal years 2010 and 2009, our operating activities provided cash of $10.2 million and $7.8 million, respectively.  Cash generated from operations before working capital changes for the first half of fiscal year 2010 was $7.6 million.  Cash provided by changes in working capital was $2.6 million during the first half of fiscal year 2010 and resulted from decreases in accounts receivable, inventory, accounts payable and accrued liabilities of $1.2 million, $968,000, $254,000 and $275,000, respectively, as well as an increase in prepaid expenses of $101,000.  As of March 28, 2010, we had working capital of $23.9 million compared to working capital of $23.6 million at fiscal year end 2009.  We were able to fund our operations in the first half of fiscal year 2010 internally while decreasing our external debt.




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During the first half of fiscal year 2010, our investing activities, consisting primarily of capital expenditures, resulted in a net use of cash of approximately $1.2 million, compared to a net use of cash of approximately $362,000 during the first half of fiscal year 2009.  The property and equipment additions were made to accommodate additional business opportunities, meet anticipated growth and improve operating efficiency.  We anticipate that cash generated from operating activities and borrowing availability under our existing credit facilities will fund revenue growth and working capital needs in the near term.




During the first half of fiscal year 2010, our financing activities resulted in a use of cash of $8.7 million, compared to a use of cash of $6.5 million during the first half of fiscal year 2009.  The increased use of cash was largely due to a $5.0 million voluntary principal payment we made on our Tranche B Term Loan in addition to voluntary and required principal payments of $2.0 million and $1.3 million, respectively, we made on our Tranche A Term Loan as of March 28, 2010.




We believe that our cash and financial liquidity positions are sufficient to fund current working capital needs and future growth initiatives.  We intend to reduce our debt with regularly scheduled debt reduction payments and additional voluntary prepayments where liquidity and loan agreements allow.  In April 2010, we made a $1.5 million voluntary principal prepayment that was applied to our Tranche A Term Loan balance.




On March 9, 2007, we executed a second amendment to the senior secured credit agreement with Guggenheim Corporate Funding, LLC (“GCF”), our principal lender, allowing for $7.0 million of additional capital expenditures to facilitate new business by increasing plant capacity and improving line efficiency, to be funded by increases of $3.5 million in each of the Tranche A and Tranche B Term Loans.




As of March 28, 2010, the facility with GCF, reflecting principal payments and the March 9, 2007 amendment, was a $49.7 million senior secured credit facility maturing in May 2011, secured bya first priority lien on substantially all of our assets.  The facility was structured as a $7.5 million non-amortizing revolving loan, a $26.5 million amortizing Tranche A Term Loan and a $15.7 million non-amortizing Tranche B Term Loan.  The facility bears interest, adjustable quarterly, at the London Inter Bank Offered Rate (“LIBOR”) plus the applicable margin (listed below) for LIBOR loans or, at our option in the case of the revolving loans, an alternate base rate equal to the greater of the prime rate and the federal funds effective rate plus 0.50%, plus an applicable margin, as follows:




Total Debt to 
EBITDA Ratio 
for Last 
Twelve 
Months

Applicable 
Margin for 
Alternate Base 
Rate Loans


Applicable Margin for LIBOR LoansRevolving

Loan


Revolving

Loan


Tranche A

Term Loan


Tranche B

Term LoanGreater than

3.00:1.00


2.50%



3.50%



3.75%



6.25%Greater than or equal to but less than or equal to

2.00:1.00

3.00:1.00


2.25%



3.25%



3.50%



6.00%Less than

2.00:1.00


2.00%



3.00%



3.25%



5.75%




As of March 28, 2010, our principal balances on the loans totaled $19.1 million, consisting of $11.2 million in Tranche A Term Loans and $7.9 million in Tranche B Term Loans.  At March 28, 2010, interest rates on the Tranche A Term Loans and Tranche B Term Loans were 3.5% and 6.0%, respectively. As of March 28, 2010 and September 27, 2009, our total debt to EBITDA ratio for the last twelve months was 0.94 and 1.47, respectively. Therefore, for the second quarter and first half of fiscal year 2010, we qualified for the lowest applicable margin for the alternate base rate and LIBOR loans.  For the first half of fiscal year 2010, we incurred $575,000 in interest expense, excluding amortization of deferred financing costs.  For the first half of fiscal year 2009, we incurred $1.1 million in interest expense, excluding amortization of deferred financing costs.  During the first half of fiscal year 2010, the outstanding balance of the facility was reduced by voluntary and mandatory principal payments on the Tranche A Term Loan of $2.0 million and $3.2 million, respectively, as well as a voluntary principal payment on the Tranche B Term Loan of $5.0 million.  As of March 28, 2010, we had $7.5 million available to borrow under the revolving loan, as the balance was zero.




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Initial proceeds from the GCF facility, received on or about May 16, 2006, were used to repay approximately $44.5 million in existing debt and related fees and expenses in connection with the termination of our former financing arrangements and to pay approximately $1.6 million in fees and expenses relating to the new financing.  Of these fees, $372,000 is recorded as debt discount, net of accumulated amortization, on our balance sheet as of March 28, 2010.  We paid GCF an additional $132,000 in fees and expenses on March 9, 2007 related to the second amendment, which we recorded as a debt discount.




The GCF facility contains covenants whereby, among other things, we are required to maintain compliance with agreed levels of earnings before interest, taxes, depreciation and amortization, interest coverage, fixed charge coverage, leverage targets, annual capital expenditures and incremental indebtedness limits.  Mandatory prepayments under the facility are required based on excess cash flow, as defined in the agreement, and upon receipt of proceeds from a disposition or payment from a casualty or condemnation of the collateralized assets, and voluntary prepayments under the facility are generally permitted as provided in the agreement.  The facility also contains customary restrictions on incurring indebtedness and liens, making investments, paying dividends and making loans or advances.




As of March 28, 2010, we were in compliance with the covenant requirements of the agreement with GCF.  We believe it is probable that we will remain in compliance with all of those covenant requirements for the foreseeable future.  However, if we fail to achieve certain revenue, expense and profitability levels, a violation of the financial covenants under our financing arrangements could result and interest rate increases and acceleration of maturity of the loans could occur, which could adversely affect our financial condition, results of operations or cash flows.




We entered into the following amortizing loans with Key Bank to finance the purchase of machinery used for manufacturing processes: a 5-year loan in the principal amount of $324,000 at a fixed interest rate of 7.5% on September 21, 2006, a 5-year loan in the principal amount of $217,000 at a fixed interest rate of 7.5% on November 27, 2006 and a 4-year loan in the principal amount of $476,000 at a fixed interest rate of 7.5% on January 9, 2007.  On February 4, 2010, we repaid the balances of all three equipment loans.




We amended our existing operating lease agreements with General Electric Capital Corporation on October 2, 2006.  The amended lease resulted in a three-year capital lease in the principal amount of $842,000 at a fixed interest rate of 8.15%, with a $1 bargain purchase option at the expiration of the lease.  The assets acquired under this capital lease have an acquisition cost of $912,000.  On September 2, 2009, we purchased the manufacturing equipment from General Electric Capital Corporation.  As of March 28, 2010 the net book value of the assets was $300,000.


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Following is a summary of our contractual obligations at March 28, 2010:




Payments Due By PeriodContractual

Obligations

Total


Remainder of Fiscal Year 2010


2-3 Years


4-5 Years


More than

5 YearsDebt maturities

$
19,025,028


$
1,375,000


$
17,650,028


$
–


$
–Interest expense


1,637,000



721,000



916,000



–



–Operating leaseobligations (2)


13,342,648



1,690,679



5,738,654



3,756,273



2,157,042Other contractualobligations


879,085



251,167



627,918



–



–Open purchase orders


5,458,428



5,359,396



99,032



–



–Total contractualobligations

$
40,342,189


$
9,397,242


$
25,031,632


$
3,756,273


$
2,157,042








(1)
Assumes only mandatory principal pay-downs and the use of LIBOR as of March 28, 2010 on the GCF debt.


(2)
Includes real estate leases.




Item 3.    Quantitative and Qualitative Disclosures about Market Risk





Interest Rate Risk – Obligations. We are subject to interest rate risk on variable interest rate obligations.  A hypothetical 10% increase in average market interest rates would increase by approximately $91,534 the annual interest expense on our debt outstanding as of March 28, 2010.




Item 4T.   Controls and Procedures


Our Chief Executive Officer and Interim Chief Financial Officer (our principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of March 28, 2010, that the design and operation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) are effective at a reasonable assurance level to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, including to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.




During the quarter ended March 28, 2010, there were no changes in our “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II - OTHER INFORMATION




Item 1.     Legal Proceedings


We are involved in certain legal actions and claims arising in the ordinary course of business. We believe (based, in part, on advice of legal counsel) that such contingencies, including the matters described below, will be resolved without materially and adversely affecting our financial position, results of operations or cash flows.  We intend to vigorously contest all claims and grievances described below.





The following cases arise out of the same background facts. We report wages of our employees to the Internal Revenue Service (“IRS”) using the social security numbers provided to us by our employees. In about January 2009, the IRS threatened to impose substantial penalties against us because the IRS said we were using invalid social security numbers, which had been provided by a large number of our employees. On April 6, 2009, we gave notice of the invalid social security numbers to approximately 260 employees. We gave each employee approximately 60 days to provide a legitimate explanation for having furnished a false number to us, but most employees failed to do so. We then terminated the employees who were unable to provide a legitimate explanation, effective May 31, 2009, after concluding that their continued employment would expose us to IRS penalties, scrutiny and potential additional criminal and civil sanctions.


Local 770 v. Overhill Farms.




On April 28, 2009, Local 770 of the United Food and Commercial Workers Union submitted an unsigned grievance regarding “the proposed terminations of workers regarding invalid social security numbers,” which the grievance alleged was a violation of the parties’ collective bargaining agreement.  The Union demanded binding arbitration under the collective bargaining agreement.




On January 11, 2010, an arbitrator dismissed the Union’s grievance.  On January 29, 2010, the Union filed a petition to vacate the arbitration decision.  On March 30, 2010, the Court denied the Union’s petition and dismissed the Union’s case with prejudice.




Overhill Farms v. Larry (Nativo) Lopez, et al.




On June 30, 2009, we filed a lawsuit against Nativo Lopez and six other leaders of what we believe to be an unlawful campaign to force us to continue the employment of workers who had used invalid social security numbers to hide their illegal work status.  Among other things, we allege that the defendants defamed us by calling our actions “racist” and unlawful. We have asserted claims for defamation, extortion, intentional interference with prospective economic advantage, and intentional interference with contractual relations. We filed the lawsuit in Orange County, California, and seek damages and an injunction barring the defendants from continuing their conduct.




All of the named defendants tried unsuccessfully to dismiss the action.  In refusing to dismiss the case, the Court ruled on November 13, 2009, that we had established a probability of prevailing on the merits, and that we had submitted substantial evidence that the defendants’ accusations of racism were not true.




Agustiana, et al. v. Overhill Farms.




On July 1, 2009, Bohemia Agustiana, Isela Hernandez, and Ana Munoz filed a purported “class action” against us in which they asserted claims for failure to pay minimum wage, failure to furnish wage and hour statements, waiting time penalties, conversion and unfair business practices.  The plaintiffs are former employees who had been terminated one month earlier because they had used invalid social security numbers in connection with their employment with us.  They filed the case in Los Angeles County on behalf of themselves and a class which they say includes all non-exempt production and quality control workers who were employed in California during the four-year period prior to filing their complaint.  The plaintiffs seek unspecified damages, restitution, injunctive relief, attorneys’ fees and costs.




We filed a motion to dismiss the conversion claim, and the motion was granted by the court on February 2, 2010.




The parties are engaged in the discovery phase of the case.  We believe we have valid defenses to the plaintiffs’ remaining claims and that we paid all wages due to these employees.




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Marcelino Arteaga, et al. v. Overhill Farms.




On July 7, 2009, we received an unfair labor practice charge that had been filed with the National Labor Relations Board (“NLRB”) on June 29, 2009. The charge was filed by Marcelino Arteaga on behalf of himself and two other ex-employees, Agapita Padilla and Fernando Morales Lira.  In addition, on June 30, 2009, these three ex-employees separately submitted grievances and demanded arbitration arising out of our decision on June 26, 2009, to terminate their employment because they had publicly accused us of being “racist.”  On August 7, 2009, the NLRB granted our request to defer further proceedings pending the resolution of the grievance and arbitration process.  The arbitration of these grievances took place on April 14 and 15, 2010, and the arbitration proceeding is not yet completed.




Department of Justice.




On August 7, 2009, the Office of Special Counsel for the Civil Rights Division of the U.S. Department of Justice (“OSC”) requested information from us in connection with an investigation about whether we terminated employees in May 2009 for whom we had received Social Security Administration (“SSA”) no-match letters on the basis of national origin or citizenship status.  We responded in detail on September 11, 2009, explaining that all affected employees had been identified by the IRS (not the SSA) as having invalid social security numbers, that we did not select them, and that we applied the same workplace rules against furnishing false information to all employees, regardless of national origin or citizenship status.




On September 9, 2009, we received a second letter from the OSC, which related to its investigation of a discrimination charge filed by an ex-employee, Lucia Vasquez (a/k/a Gyneth Garcia).  On September 25, 2009, we responded in detail to this discrimination charge, explaining that we terminated Vasquez’ employment, along with over 200 other employees, because she failed to explain why she had provided an invalid name and social security number at the time of hire, and that the termination decision had nothing to do with her national origin or citizenship status.




The OSC has not made any determination about the merits of the discrimination charge.




In the meantime, Vasquez separately filed a claim for unemployment benefits.  She was initially awarded the benefits, but we appealed.  Following an evidentiary hearing before an Administrative Law Judge (“ALJ”) on September 29, 2009, the ALJ rejected Vasquez’s claim for unemployment benefits. The ALJ found that she had engaged in serious dishonesty, which included both making a false statement at the time of hire in 2003 and lying to us in May 2009 when confronted about her false statement.  Vasquez appealed that determination.  On February 2, 2010, the appeals board denied her appeal and rejected her claim for benefits.




Item 5.     Exhibits


Exhibit

Number


Description10.1(1)

Employment Agreement dated as of February 18, 2010 between Overhill Farms, Inc. and James Rudis31.1(2)

Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2(2)

Certification of Interim Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232(2)

Certification of Chief Executive Officer and Interim Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  
 (1)
Incorporated by reference to Exhibit 10.1 to the Form 8-K for February 18, 2010 filed by Overhill Farms, Inc. on February 18, 2010.(2)
Attached hereto.




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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.




OVERHILL FARMS, INC.(Registrant)Date:  May 6, 2010

By:
/s/ James RudisJames RudisChairman, President andChief Executive OfficerDate:  May 6, 2010

By:
/s/ Tracy E. QuinnTracy E. QuinnInterim Chief Financial Officer




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EXHIBITS ATTACHED TO THIS FORM 10-Q




Exhibit 
Number


Description31.1

Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2

Certification of Interim Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232

Certification of Chief Executive Officer and Interim Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002






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