UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q







QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934




For The Quarter EndedJune 30, 2009   Commission File Number001-33595









Smart
Balance, Inc.


(Exact
name of registrant as specified in its charter)









Delaware
                
                20-2949397(State
      of or other jurisdiction
                  Of
      incorporation)
                
                (I.R.S.
      Employer
                  Identification
      No.)




115 West Century Road, Suite
      260,
                  Paramus, New Jersey
                
                07652(Address
      of principal executive offices)
                
                (Zip
      code)




Registrant’s
telephone number, including area code: (201) 568-9300







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   ̈.





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.




Large
      Accelerated Filer      ̈
            
            Accelerated
      Filer                       
       xNon-Accelerated
      Filer        ̈ (Do not check if a smaller
      reporting company)
            
            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    ̈   No  x.




As ofAugust 5, 2009the Registrant had62,630,683shares of common stock, par value
$.0001 per share, outstanding.










SMART
BALANCE, INC.




INDEX




PagePart
      I.
                
                Financial
      Information
                1Item 1.
                
                Financial
      Statements
                1Item 2.
                
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                16Item 3.
                
                Quantitative
      and Qualitative Disclosures About Market Risk
                25Item 4.
                
                Controls
      and Procedures
                26Part
      II.
                
                Other
      Information
                27Item 1.
                
                Legal
      Proceedings.
                27Item 1A.
                
                Risk
      Factors.
                27Item 4.
                
                Submission
      of Matters to a Vote of Security Holders.
                27Item 6.
                
                Exhibits.
                28


i


Part
I.        Financial
Information


Item 1.       Financial
Statements




SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Balance Sheets


(In thousands, except share
data)





June 30,
                      
                      
                      December 31,2009
                      
                      
                      2008(unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      5,260
                      
                      
                      $
                      5,492Accounts
      receivable, net of allowance of: 2009 – $318 and 2008 -
    $256
                      
                      
                      13,059
                      
                      
                      
                      14,283Accounts
      receivable - other
                      
                      
                      708
                      
                      
                      
                      692Inventories
                      
                      
                      6,010
                      
                      
                      
                      9,322Prepaid
      taxes
                      
                      
                      1,035
                      
                      
                      
                      709Prepaid
      expenses and other assets
                      
                      
                      10,759
                      
                      
                      
                      1,019Deferred
      tax asset
                      
                      
                      439
                      
                      
                      
                      650Total
      current assets
                      
                      
                      37,270
                      
                      
                      
                      32,167Property
      and equipment, net
                      
                      
                      4,377
                      
                      
                      
                      4,301Other
      assets:Goodwill
                      
                      
                      374,886
                      
                      
                      
                      374,886Intangible
      assets, net
                      
                      
                      153,190
                      
                      
                      
                      155,223Deferred
      costs, net
                      
                      
                      1,475
                      
                      
                      
                      1,737Other
      assets
                      
                      
                      621
                      
                      
                      
                      222Total
      other assets
                      
                      
                      530,172
                      
                      
                      
                      532,068Total
      assets
                      
                      $
                      571,819
                      
                      
                      $
                      568,536Liabilities
      and Stockholders' EquityCurrent
      liabilitiesAccounts
      payable and accrued expenses
                      
                      $
                      25,598
                      
                      
                      $
                      24,938Income
      taxes payable
                      
                      
                      1,407
                      
                      
                      
                      1,080Total
      current liabilities
                      
                      
                      27,005
                      
                      
                      
                      26,018Long
      term debt
                      
                      
                      64,504
                      
                      
                      
                      69,504Derivative
      liability
                      
                      
                      4,075
                      
                      
                      
                      5,132Deferred
      tax liability
                      
                      
                      44,043
                      
                      
                      
                      46,268Other
      liabilities
                      
                      
                      565
                      
                      
                      
                      163Total
      liabilities
                      
                      
                      140,192
                      
                      
                      
                      147,085Commitment
      and contingenciesStockholders'
      equityPreferred
      stock, $.0001 par value, 50,000,000 sharesauthorized
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, $.0001 par value, 250,000,000 shares authorized; 62,630,683 (2009)
      and 62,630,683 (2008) issued and outstanding
                      
                      
                      6
                      
                      
                      
                      6Additional
      paid in capital
                      
                      
                      515,415
                      
                      
                      
                      507,377Retained
      deficit
                      
                      
                      (83,794
                      )
                      
                      
                      (85,932
                      )Total
      stockholders' equity
                      
                      
                      431,627
                      
                      
                      
                      421,451Total
      liabilities and stockholders' equity
                      
                      $
                      571,819
                      
                      
                      $
                      568,536




See
accompanying notes to the consolidated financial statements


1


SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Statements of Operations


(Unaudited)


(In
thousands, except per share data)





Three
                      months
                      ended
                      June 30, 2009
                    
                    
                    Three
                      months
                      ended
                      June 30, 2008
                    
                    
                    Six Months
                      ended
                      June 30, 2009
                    
                    
                    Six Months
                      ended
                      June 30, 2008Net
      sales
                    
                    $
                    58,185
                    
                    
                    $
                    47,990
                    
                    
                    $
                    120,784
                    
                    
                    $
                    98,780Cost
      of goods sold
                    
                    
                    29,912
                    
                    
                    
                    28,113
                    
                    
                    
                    64,257
                    
                    
                    
                    56,053Gross
      profit
                    
                    
                    28,273
                    
                    
                    
                    19,877
                    
                    
                    
                    56,527
                    
                    
                    
                    42,727Operating
      expenses:Marketing
                    
                    
                    8,820
                    
                    
                    
                    7,395
                    
                    
                    
                    17,620
                    
                    
                    
                    14,793Selling
                    
                    
                    4,270
                    
                    
                    
                    3,408
                    
                    
                    
                    8,787
                    
                    
                    
                    7,555General
      and administrative
                    
                    
                    12,664
                    
                    
                    
                    9,574
                    
                    
                    
                    24,393
                    
                    
                    
                    18,920Total
      operating expenses
                    
                    
                    25,754
                    
                    
                    
                    20,377
                    
                    
                    
                    50,800
                    
                    
                    
                    41,268Operating
      income (loss)
                    
                    
                    2,519
                    
                    
                    
                    (500
                    )
                    
                    
                    5,727
                    
                    
                    
                    1,459Other
      income (expense):Interest
      income
                    
                    
                    1
                    
                    
                    
                    13
                    
                    
                    
                    2
                    
                    
                    
                    264Interest
      expense
                    
                    
                    (1,202
                    )
                    
                    
                    (1,989
                    )
                    
                    
                    (2,335
                    )
                    
                    
                    (5,221
                    )Other
      income (expense), net
                    
                    
                    (310
                    )
                    
                    
                    (37
                    )
                    
                    
                    (453
                    )
                    
                    
                    (978
                    )Total
      other income (expense)
                    
                    
                    (1,511
                    )
                    
                    
                    (2,013
                    )
                    
                    
                    (2,786
                    )
                    
                    
                    (5,935
                    )Income
      (loss) before income taxes
                    
                    
                    1,008
                    
                    
                    
                    (2,513
                    )
                    
                    
                    2,941
                    
                    
                    
                    (4,476
                    )Provision
      (benefit) provision for income taxes
                    
                    
                    15
                    
                    
                    
                    (978
                    )
                    
                    
                    802
                    
                    
                    
                    (1,763
                    )Net
      income (loss)
                    
                    $
                    993
                    
                    
                    $
                    (1,535
                    )
                    
                    $
                    2,139
                    
                    
                    $
                    (2,713
                    )Income
      (loss) per share:Basic
                    
                    $
                    0.02
                    
                    
                    $
                    (0.02
                    )
                    
                    $
                    0.03
                    
                    
                    $
                    (0.04
                    )Diluted
                    
                    $
                    0.02
                    
                    
                    $
                    (0.02
                    )
                    
                    $
                    0.03
                    
                    
                    $
                    (0.04
                    )Weighted
      average shares outstanding:Basic
                    
                    
                    62,630,683
                    
                    
                    
                    62,630,683
                    
                    
                    
                    62,630,683
                    
                    
                    
                    62,415,028Diluted
                    
                    
                    62,820,162
                    
                    
                    
                    62,630,683
                    
                    
                    
                    62,764,122
                    
                    
                    
                    62,415,028




See
accompanying notes to the consolidated financial statements


2


SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)


(In
thousands)





Six months
                  ended
                  June 30, 2009
                
                
                Six months
                  ended
                  June 30, 2008Cash
      flows from operating activitiesNet
      income (loss)
                
                $
                2,139
                
                
                $
                (2,713
                )Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                2,693
                
                
                
                3,221Deferred
      income taxes
                
                
                (2,014
                )
                
                
                (2,220
                )Stock
      based compensation
                
                
                8,037
                
                
                
                7,197Interest
      rate swaps
                
                
                (1,057
                )
                
                
                -Changes
      in assets and liabilities:Accounts
      receivable
                
                
                1,224
                
                
                
                1,363Inventories
                
                
                3,311
                
                
                
                (3,764
                )Prepaid
      expenses and other current assets
                
                
                (10,082
                )
                
                
                (4,510
                )Accounts
      payable and accrued expenses
                
                
                990
                
                
                
                592Net
      cash provided by (used in) operating activities
                
                
                5,241
                
                
                
                (834
                )Cash
      flows from investing activitiesPurchase
      of property and equipment
                
                
                (473
                )
                
                
                (1,457
                )Capitalization/recovery
      of legal fees
                
                
                -
                
                
                
                350Net
      cash (used in) investing activities
                
                
                (473
                )
                
                
                (1,107
                )Cash
      flows from financing activitiesRepayment
      of debt
                
                
                (5,000
                )
                
                
                (30,000
                )Net
      cash (used in) financing activities
                
                
                (5,000
                )
                
                
                (30,000
                )Net
      (decrease) in cash for the period
                
                
                (232
                )
                
                
                (31,941
                )Cash
      - Beginning of period
                
                
                5,492
                
                
                
                37,649Cash
      - End of period
                
                $
                5,260
                
                
                $
                5,708Supplemental
      disclosure of cash flow information:Cash
      paid during the period for:Income
      taxes
                
                $
                2,774
                
                
                $
                716Interest
                
                $
                3,208
                
                
                $
                5,211Supplemental
      disclosure of non-cash activity:Conversion
      of Series A Convertible Preferred Stock
                
                $
                -
                
                
                $
                175,659




See
accompanying notes to the consolidated financial statements


3





SMART
BALANCE, INC. AND SUBSIDIARY




Notes
to Consolidated Financial Statements


(Unaudited)


(In
thousands, except share data)




1.
            General




On
May 21, 2007, Smart Balance, Inc. (formerly known as Boulder Specialty
Brands, Inc. or “Boulder”), completed a merger pursuant to an Agreement and Plan
of Merger dated September 25, 2006, as extended by a letter agreement dated
as of February 15, 2007, between Boulder and GFA Holdings, Inc. (“GFA
Holdings”), the sole stockholder of GFA Brands, Inc. (“GFA Brands”) (on May 21,
2007, GFA Holdings was merged into GFA Brands, the surviving company is referred
to herein as “GFA”). Pursuant to the merger agreement, a wholly-owned Delaware
subsidiary of Boulder merged with and into GFA, and GFA became a wholly-owned
subsidiary of Boulder.




Immediately
following the merger, Boulder changed its name to Smart Balance, Inc. All
references to Smart Balance, Inc. (or the “Company”) herein should be considered
to include the predecessor company Boulder.




The
accompanying condensed consolidated financial statements include all adjustments
(consisting only of normal recurring accruals) which are, in the opinion of
management, considered necessary for a fair presentation of the results for the
periods presented. These financial statements should be read in conjunction with
the consolidated financial statements of Smart Balance, Inc. included in the
Company's 2008 annual report on Form 10-K and Amendment No. 1 thereto. Certain
amounts have been reclassified to conform with the current year's
presentation.




The
reported results for the three and six month periods ended June 30, 2009 are not
necessarily indicative of the results to be expected for the full
year.




2.
            Summary of significant
      accounting policies




Cash andCashEquivalents




The
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.




AccountsReceivable




Accounts
receivable are carried at original invoice amount less allowances for cash
discounts and doubtful receivables based on a review of all outstanding amounts.
Management determines the allowance for doubtful accounts by regularly
evaluating individual customer receivables and considering a customer’s
financial condition, credit history and current economic conditions. Accounts
receivable are written off when deemed uncollectible. Recoveries of receivables
previously written off are recorded when received. The Company does not charge
interest on past due receivables.


4




Inventories




Inventories
are stated at the lower of cost (first-in, first-out) or market and consist
primarily of finished goods.




Property andEquipment




Property
and equipment are stated at cost and depreciated using the straight-line method
over the estimated useful lives of the assets ranging from 5 to 10 years.
Leasehold improvements are amortized using the straight-line method over the
shorter of the lease term or the estimated useful life of the
improvement.  The Company capitalized software development costs
related to its Enterprise Resource Planning (ERP) and Trade Promotion Spend
(TPS) management software packages.  Amortization of these costs
commenced in May 2008 and January 2009, respectively, when the programs were
fully ready for their intended use.




Goodwill




Goodwill
is tested annually for impairment or more frequently if events or changes in
circumstances indicate that impairment may have occurred. The impairment
analysis for goodwill includes a comparison of the Company’s carrying value
(including goodwill) to the Company’s estimated fair value. If the fair value of
the Company does not exceed its carrying value, then an additional analysis
would be performed to allocate the fair value to all assets and liabilities of
the Company as if the Company had been acquired in a business combination and
the fair value was its purchase price. If the excess of the fair value of the
Company over the fair value of its identifiable assets and liabilities is less
than the carrying value of recorded goodwill, an impairment charge is recorded
for the difference.




IntangibleAssets




Other
intangible assets are comprised of both definite and indefinite life intangible
assets. Indefinite life intangible assets are not amortized but are tested
annually for impairment, or more frequently if events or changes in
circumstances indicate that the asset might be impaired. In assessing the
recoverability of indefinite life intangible assets, the Company must make
assumptions about the estimated future cash flows and other factors to determine
the fair value of these assets.




An
intangible asset is determined to have an indefinite useful life when there are
no legal, regulatory, contractual, competitive, economic or any other factors
that may limit the period over which the asset is expected to contribute
directly or indirectly to the future cash flows of the Company. In each
reporting period, the Company also evaluates the remaining useful life of an
intangible asset that is not being amortized to determine whether events and
circumstances continue to support an indefinite useful life. If an intangible
asset that is not being amortized is determined to have a finite useful life,
the asset will be amortized prospectively over the estimated remaining useful
life and accounted for in the same manner as intangible assets subject to
amortization.




The
Company has determined that its Smart Balance® and
Earth Balance®
trademarks have indefinite lives and these assets are not being
amortized.  Certain other assets acquired, primarily patent
technology, have been determined to have definite lives ranging from 10 to 20
years and their costs are being amortized over their expected
lives.


5




The
Company generally expenses legal and related costs incurred in defending or
protecting its intellectual property unless it can be established that such
costs have added economic value to the business enterprise, in which case the
Company capitalizes the costs incurred as part of intangible assets. The primary
consideration in making the determination of whether to capitalize the costs is
whether the Company can prove that it has been successful in defending itself
against such intellectual property challenges.  The second
consideration for capitalization is whether such costs have, in fact, increased
the economic value of the Company’s intellectual property.  Legal
defense costs that do not meet the considerations described above are expensed
as incurred.  Recovery of legal expenses as part of a settlement
agreement will be recorded as a reduction of capitalized legal fees with any
excess recorded as income.




DeferredCosts




Deferred
loan costs associated with the secured debt financing are being amortized over
the life of the loan, using the effective interest method.




Stock Based Compensation
Expense




The
Company complies with the requirements of SFAS No. 123(R) “Share-Based Payment,”
for measuring its stock based compensation expense.  SFAS No. 123(R)
requires companies to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value and to
recognize this cost over the requisite service period.




Revenue
Recognition




Revenue
is recognized when the earnings process is complete and the risks and rewards of
ownership have transferred to the customer, which is generally considered to
have occurred upon the receipt of product by the customer. The earnings process
is complete once the customer order has been placed and approved and the product
shipped has been received by the customer. Product is sold to customers on
credit terms established on an individual basis. The credit factors used include
historical performance, current economic conditions and the nature and volume of
the product.




The
Company offers its customers and consumers a variety of sales and incentive
programs, including discounts, allowances, coupons, slotting fees, and co-op
advertising; such amounts are estimated and recorded as a reduction in revenue.
For interim reporting, the Company estimates the total annual sales incentives
for most programs and records a pro rata share in proportion to forecasted
annual revenue.  As a result, the Company has recorded a prepaid asset
at June 30, 2009 of $9,917 which will be charged to expense over the remaining
two quarters.  The Company sells their products to customers without
the right of return and is not obligated to accept any returns.


6




Net Income (Loss)per Share of Common
Stock




Net
income (loss) per share is computed by dividing net income or loss applicable to
common stockholders by the weighted-average shares of common stock outstanding
for the period. Diluted earnings (loss) per share is computed by dividing net
income (loss) by the weighted-average shares outstanding adjusted for any
additional common shares that would have been outstanding if all of the
potential dilutive common shares had been issued. Potential dilutive common
shares outstanding would primarily include stock options and founders’
warrants.  At June 30, 2009, 1,746 stock options were dilutive
because their exercise price was less than the weighted average market price,
including the unrecognized compensation expense related to such
shares.  In addition, the founders’ warrants were dilutive because the
weighted average market price was in excess of their exercise price, which
resulted in 131,693 additional shares being assumed issued during the first half
of 2009.




The
following table summarizes stock options not included in the computation of
diluted earnings per share:




Three months
                  ended
                  June 30, 2009
                
                
                Three months
                  ended
                  June 30, 2008
                
                
                Six months
                  ended
                  June 30, 2009
                
                
                Six months
                  ended
                  June 30, 2008Stock
      options excluded due to option price being greater than market
      value
                
                
                11,690,000
                
                
                
                10,985,000
                
                
                
                11,690,000
                
                
                
                10,985,000Stock
      options excluded due to anti-dilution
                
                
                508,349
                
                
                
                62,500
                
                
                
                515,754
                
                
                
                62,500Founding
      director warrants excluded due to anti-dilution
                
                
                -
                
                
                
                1,000,000
                
                
                
                -
                
                
                
                1,000,000





Segments




SFAS 131,
“Disclosures about Segments of an Enterprise and Related Information” requires
segment information to be prepared using the “management” approach. The
management approach is based on the method that management organizes the
segments within the Company for making operating decisions and assessing
performance. The Company evaluates all products, makes operating decisions and
performance assessments based on a total company approach and therefore
considers itself as having only one segment.




Fair Value of Financial
Instruments




The
Company’s financial instruments consist of cash and cash equivalents, short term
trade receivables, payables and note payables.  The carrying value of
cash and cash equivalents and short term receivables and payables approximate
fair value because of their short maturities.  The Company’s note
payable is determined by quoted market prices that are reset every three months
and, therefore, approximates fair value.  At June 30, 2009 and
December 31, 2008, the Company used the income approach to determine the fair
value of the interest rate swap utilizing the present value techniques and had
recorded $4,075 and $5,132, respectively, as non-current
liabilities.  The fair value measurement used to determine this amount
was based on SFAS 157, “Fair Value Measurements”, which requires a three-tier
fair value hierarchy that prioritizes inputs to measure fair
value.  These tiers include: Level 1, defined as inputs, such as
unadjusted quoted prices in an active market for identical assets or
liabilities; Level 2, defined as inputs other than quoted market prices in
active markets that are either directly or indirectly observable; or Level 3,
defined as unobservable inputs for use when little or no market value exists
therefore requiring an entity to develop its own assumptions.  The
Company used Level 2 inputs to measure fair value at June 30, 2009 and December
31, 2008.


7




Research and
Development




Research
and development expenses are charged to operations when incurred and amounted to
$184 and $49 for the three months ended June 30, 2009 and 2008,
respectively, and $272 and $90 for the six months ended June 30, 2009 and 2008,
respectively.




Derivative
Instruments




The
Company uses certain financial instruments to manage its commodity price and
interest rate risks.  The Company maintains commodity price risk
management strategies that seek to reduce significant, unanticipated earnings
fluctuations that may arise from volatility in commodity prices, principally
through the use of derivative instruments, mostly through the purchase of
forward contracts with its suppliers, or in the case of milk, through the U.S.
commodity markets.  The Company also uses interest rates swaps to
cover its exposure to changes in interest rates.




Except
for the purchase of forward contracts with its suppliers which the Company has
designated as normal course purchases under SFAS No. 133 , and, as such,
recognizes the underlying contract costs as part of its normal inventory
purchases, the Company records derivative financial instruments at fair value in
its consolidated balance sheets as either current assets or current
liabilities.  Cash flows from these hedging instruments are classified
in the same manner as the affected hedged item in the consolidated statements of
cash flows.




The
Company considers all derivative instruments to be economic hedges but has not
designated the instruments for hedge accounting treatment under SFAS No.
133.  As a result, the Company recognizes gains and losses directly as
a component of Other income (expense), except for its purchase of forward
contracts which are treated as described above.




Income
Taxes




Deferred
income taxes are provided for the differences between the basis of assets and
liabilities for financial reporting and income tax purposes. A valuation
allowance is established when necessary to reduce deferred tax assets to the
amount expected to be realized. As of June 30, 2009, no valuation
allowances were recorded.




Advertising




Advertising
costs are charged to operations (classified as marketing expenses) and amounted
to $5,454 and $4,876 for the three months ended June 30, 2009 and 2008,
respectively, and $10,611 and $9,639 for the six months ended June 30, 2009 and
2008, respectively.


8




Use of
Estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.




Concentration of Credit
Risk




Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash, cash equivalents, short term investments and
trade receivables. The Company maintains the majority of its cash and cash
equivalents in the form of demand deposits with financial institutions that
management believes are creditworthy. At June 30, 2009, the cash balances
in these institutions exceeded federally insured amounts. Concentrations of
credit risk relative to trade receivables are limited due to our diverse client
base. The Company does have one customer that accounted for approximately 18%
and 19% of sales during the three and six months ended June 30, 2009,
respectively. The aggregate accounts receivable from this customer amounted to
approximately 15% of the accounts receivable balance outstanding at
June 30, 2009. The Company also has one product, “spreads,” which, for the
three and six months ended June 30, 2009, accounted for approximately 75%
of total revenue.  Approximately 81% of the Company’s revenues during
the three and six months ended June 30, 2009 came from products utilizing a
license from Brandeis University.




Recently Issued Accounting
Pronouncements




In May
2009, the FASB issued SFAS No. 165, “Subsequent Events”, which
defines further disclosure requirements for events which occur after the balance
sheet date but before financial statements are issued.  SFAS No. 165
is effective for the Company beginning on June 30, 2009. In accordance with SFAS
No. 165, the Company’s management has evaluated events subsequent to June 30,
2009 through August 6, 2009, which is the issuance date of this
report.  There has been no material event noted in this period which
would either impact the results effectuated in this report or the Company’s
results going forward.




In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles.” SFAS No. 168 identifies the FASB Accounting Standards
Codification as the authoritative source of generally accepted accounting
principles in the United States.  Rules and interpretive releases of
the Securities and Exchange Commission (SEC) under federal securities laws are
also sources of authoritative GAAP for SEC registrants.  SFAS No. 168
is effective for financial statements issued for interim and annual periods
ending after September 15, 2009.  The Company adopted this SFAS
effective July 1, 2009 and it does not anticipate it having a material impact on
its consolidated financial statements.


9


In April
2009, the FASB issued FASB Staff Position (“FSP”) FSP FAS 107-1 and APB 28-1,
which expands the fair value disclosures required for all financial instruments
within the scope of Statement 107 to interim periods for publicly traded
entities.  The FSP also requires entities to disclose the method(s)
and significant assumptions used to estimate the fair value of financial
instruments in financial statements on an interim basis and to highlight any
changes of the methods and significant assumptions from prior
periods.  It does not require interim disclosures of credit or market
risks also discussed in Statement 107.  The FSP is effective for
interim and annual periods ending after June 15, 2009.  The Company
adopted this FSP effective June 30, 2009 and it did not have a material impact
on its consolidated financial statements.




3.
            Property and
      equipment




Property
and equipment consist of the following:




June 30,
                      2009
                      (unaudited)
                    
                    
                    December 31,
                      2008Software
      development costs
                    
                    $
                    3,529
                    
                    
                    $
                    3,198Equipment
                    
                    
                    462
                    
                    
                    
                    394Furniture
      and fixtures
                    
                    
                    921
                    
                    
                    
                    849Leasehold
      improvements
                    
                    
                    335
                    
                    
                    
                    332Gross
      assets
                    
                    
                    5,247
                    
                    
                    
                    4,773Less:
      accumulated depreciation
                    
                    
                    (870
                    )
                    
                    
                    (472
                    )Property
      and equipment, net
                    
                    $
                    4,377
                    
                    
                    $
                    4,301




Depreciation
expense was $203 and $398 for the three and six months ended June 30,
2009 compared to $89 and $142 for the three and six months ended
June 30, 2008.




4.
            Accounts payable and
      accrued expenses




Accounts
payable and accrued expenses consist of the following:




June30,
                    2009
                    (unaudited)
                  
                  
                  December31,
                    2008Accounts
      payable
                  
                  $
                  13,339
                  
                  
                  $
                  16,971Trade
      spend accruals
                  
                  
                  6,896
                  
                  
                  
                  3,547Other
      accrued expenses
                  
                  
                  5,363
                  
                  
                  
                  4,420Total
                  
                  $
                  25,598
                  
                  
                  $
                  24,938


10


5.
            Intangible
      assets




The
following is a summary of intangible assets and goodwill as of June 30,
2009:




Gross
                  Carrying
                  Amount
                
                
                Accumulated
                  Amortization
                
                
                Accumulated
                  Adjustments
                
                
                Net Balance,
                  June 30,
                  2009
                  (unaudited)Patent
      technology
                
                $
                40,000
                
                
                $
                8,466
                
                
                $
                -
                
                
                $
                31,534Supply
      relationship
                
                
                1,000
                
                
                
                146
                
                
                
                -
                
                
                
                854Trademarks
                
                
                121,152
                
                
                
                -
                
                
                
                (350
                )
                
                
                120,802Goodwill
                
                
                374,886
                
                
                
                -
                
                
                
                -
                
                
                
                374,886$
                537,038
                
                
                $
                8,612
                
                
                $
                (350
                )
                
                $
                528,076





Adjustments
to trademarks relate to a legal settlement received of $367 and serve to reduce
related costs previously capitalized. Additional spending of $17 during the
period accounted for the difference.  Amortization expense was $1,017
for the three months ended June 30, 2009 and 2008 and $2,033 and $2,039 for
the six months ended June 30, 2009 and 2008, respectively.





6.
            Long term
      debt




In
conjunction with the GFA merger, on May 21, 2007, the Company entered into a
loan arrangement with Banc of America Securities LLC and Bank of America, N.A.
for $180,000 in secured debt financing consisting of:  (1) a
$140,000 first lien facility comprised of a $120,000 term loan and a $20,000
revolver and (2) a second lien facility comprised of a $40,000 term loan.
The first lien facility is secured by a first lien on all of the Company’s
assets and the second lien facility is secured by a second lien on all of the
Company’s assets.  During the second quarter of 2009, the Company
prepaid $5,000 of the first lien debt.  As a result of the prepayment,
the Company wrote off approximately $135 of deferred financing costs, which is
included in other income (expense).  Through June 30, 2009, the
Company paid a total of $95,500, consisting of $65,500 in principal on its first
lien term loan and $30,0000 on its second lien debt.  The term loan of
the first lien facility will mature on May 21, 2014 and the revolving loan under
the first lien facility will mature on May 21, 2013. The term loan of the second
lien facility will mature on November 18, 2014.




In
accordance with a pricing grid based on the Company’s leverage ratio, the
applicable margin is LIBOR plus 3.00% per annum beginning March 28, 2008, which
resulted in an interest rate of 3.60% at June 30, 2009. The  interest
rate on the second lien facility is LIBOR plus an applicable margin of
6.00% per annum, beginning July 1, 2007, which resulted in an interest
rate at June 30, 2009 of 6.60%.




The
Company uses interest rate swaps to effectively manage interest rate exposure by
locking in the variable interest rate on our debt into a fixed rate of
5.05%.  The Company recognizes the mark-to-market movement of the
interest rate swap in income as the rate changes.  As of June 30,
2009, the Company had a derivative liability of $4,075 which represents the
present value of the future quarterly interest payments, through the end of the
swap agreement of September 30, 2010, based on the difference between the three
month LIBOR floating interest at June 30, 2009 and the fixed interest rate
of the debt of 5.05% on $80,000 notional amount. At the end of each quarter, the
Company makes or receives quarterly cash payments based on the actual difference
between these two rates. At June 30, 2009, the Company has opted to let the
notional amount of the interest rate swap exceed the amount of its debt by
approximately $15,500 assuming that the current LIBOR interest rate environment
would increase allowing the Company to pay off the quarterly swap requirements
on more favorable terms.


11


There is
no prepayment penalty for optional prepayments on the first lien facility and
the following penalties for optional prepayments on the second lien facility:
1.00% premium if prepaid before May 21, 2009; and no prepayment penalty
thereafter. As a result of prepaying $30,000 of the second lien facility, the
Company paid a $600 prepayment penalty, which is included in interest expense
for the year ended December 31, 2008.  Mandatory prepayments under the
first lien facility include 50% of excess cash flow (as defined in the credit
agreement) and 50% of all net cash proceeds from the issuance of additional
equity interests by us.  After the first lien facility is re-paid in
full, the second lien facility requires mandatory prepayments, which include 50%
of excess cash flow (as defined in the credit agreement) and 50% of all net cash
proceeds from the issuance of additional equity interests by us.  In
addition, the term loan of the first lien facility is subject to quarterly
amortization of principal with 1.00% of the initial aggregate advances under
such loan to be payable in each of the first six years and the remainder of the
initial aggregate advance to be payable in a balloon payment at
maturity.




The first
and second lien credit facilities can be accelerated upon the occurrence of
certain events, including:




·
            nonpayment
      of debt including interest and
fees;




·
            failure
      to perform or observe covenants;




·
            cross
      defaults to other indebtedness exceeding
$5,000;




·
            bankruptcy
      and insolvency; and




·
            certain
      other events.




The first
lien credit facility requires the Company to comply with certain financial
covenants, such as ratios of Consolidated EBITDA (as defined in the first lien
credit facility) to each of consolidated cash interest charges, total debt and
first lien debt.  The second lien credit facility requires the Company
to comply with one financial covenant consisting of a leverage ratio of total
debt to Consolidated EBITDA (as defined in the second lien credit
facility).  The Company was in compliance with all of its debt
covenants at June 30, 2009.




Under the
terms of both credit facilities, the Company is precluded from reacquiring its
own shares.




The
following is a summary of long-term debt:




June 30,
                    2009
                    (unaudited)
                  
                  
                  December 31,
                    2008First
      lien term loan
                  
                  $
                  54,504
                  
                  
                  $
                  59,504Second
      lien term loan
                  
                  
                  10,000
                  
                  
                  
                  10,000Total
      Debt:
                  
                  
                  64,504
                  
                  
                  
                  69,504Less:
      Current maturities
                  
                  
                  -
                  
                  
                  
                  -Total
      long term debt
                  
                  $
                  64,504
                  
                  
                  $
                  69,504


12




7.
            Stock-based
      compensation




The
Company and its stockholders have authorized the issuance of up to 12,150,000
stock options under its Stock and Award’s Plan.  Through June 30,
2009, the Company had granted a total of 11,082,500 stock options under the
Stock and Awards Plan, of which 250,000 were forfeited.




In
addition, during the first quarter of 2008, the compensation committee and a
sub-committee of the compensation committee approved the issuance of up to
1,375,000 inducement grant stock options to new employees outside of the
Company’s stock plan pursuant to NASDAQ Marketplace Rule 4350. During the twelve
months ended December 31, 2008, the Company issued all of the 1,375,000
inducement grant stock options to new employees.




The
Company has two types of stock options, traditional service-based options with a
four year graded (25% vest each year) vesting and market condition-based stock
options which vest when the underlying stock price reaches either $16.75 or
$20.25, respectively, and remains there for 20 out of 30 consecutive trading
days. Stock options are granted to employees at exercise prices equal to the
fair market value of the Company's stock at the dates of grant. Stock options
granted to employees have a term of 10 years. The Company recognizes
stock-based compensation expense over the requisite service period of the
individual grants, which generally equals the vesting period.




Number of
                    Outstanding
                    Shares
                  
                  
                  Weighted
                    Average
                    Exercise Price
                  
                  
                  Weighted
                    Average
                    Remaining Life
                    (Years)Balance
      at December 31, 2008
                  
                  
                  12,045,000
                  
                  
                  $
                  9.47
                  
                  
                  
                  8.71Granted
      during the six months  ended June 30, 2009
                  
                  
                  222,500
                  
                  
                  
                  7.02
                  
                  
                  
                  9.81Forfeited
      during the six months  ended June 30, 2009
                  
                  
                  (60,000
                  )
                  
                  
                  9.22
                  
                  
                  
                  8.40Exercised
      during the six months  ended June 30, 2009
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Balance
      at June 30, 2009
                  
                  
                  12,207,500
                  
                  
                  $
                  9.43
                  
                  
                  
                  8.24





Pre-tax
stock-based compensation expense included in reported net income (loss) is as
follows:




Three Months Ended
                    June 30,
                  
                  
                  Six Months Ended
                    June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Service
      period-based
                  
                  $
                  1,888
                  
                  
                  $
                  1,666
                  
                  
                  $
                  3,759
                  
                  
                  $
                  3,261Market
      price-based $16.75
                  
                  
                  1,228
                  
                  
                  
                  1,148
                  
                  
                  
                  2,456
                  
                  
                  
                  2,261Market
      price-based $20.25
                  
                  
                  911
                  
                  
                  
                  849
                  
                  
                  
                  1,822
                  
                  
                  
                  1,675Total
                  
                  $
                  4,027
                  
                  
                  $
                  3,663
                  
                  
                  $
                  8,037
                  
                  
                  $
                  7,197


13




For the
traditional service-based stock options, the Company estimated the fair value,
as of the date of grant, using a Black-Scholes pricing model with the following
assumptions: risk-free interest rate of 3.53% - 4.67%, expected life 7
years for the service-based options and 10 years for the market price-based
options, no dividends and volatility of 35.9% - 37.91%. The cost of the
service-based stock options is being amortized over a four year vesting period.
In the case of the market price-based stock options, the Company used the Monte
Carlo valuation model.  The Company recognizes compensation expense
for the market price-based options over the estimated vesting period, which has
been determined to be 2.75 – 4.82 years and 3.68 – 5.53 years for the $16.75 and
$20.25 awards, respectively.




8.
            Derivative
      Instruments




Interest
rate cash flow hedges:




In
conjunction with the fixed-rate debt arrangements noted above the Company
entered into notional $80,000 of interest rate swaps on August 16, 2007,
which is designed to provide a constant interest rate on the variable rate debt.
Under these swaps, the Company receives or pays the difference between its
fixed-rate interest payments and floating-rate payments based on LIBOR. The
effect of this is to convert floating-rate interest expense based on LIBOR into
fixed-rate interest expense. The arrangements settle on the last day of each
calendar quarter. For the quarter ended June 30, 2009, the Company paid 5.05%
and received 1.22% with the difference increasing interest paid by
$775.  In addition, the Company recorded the change in fair value of
the interest rate swap of $263, which is included as a charge in interest
expense. The Company measures the changes in the fair value of the interest rate
swaps using Level 2 inputs (see note 2 under sub-heading “Fair Value of
Financial Instruments”).




Commodity
cash flow hedges:




For its
milk commodity hedges the Company considered  them economic hedges but
did not designate them for hedge accounting treatment under SFAS No. 133, the
impact to earnings was insignificant in 2009.  The Company did not
enter into any similar derivative instruments in 2008.  The Company
uses Level 1 inputs to measure fair value at June 30, 2009.




As of
June 30, 2009, the Company had hedged forecasted commodity transactions for
periods not exceeding the next 9 months.  These commodity hedges are
considered economic hedges but are exempt from hedge accounting as normal
forward purchases.




9.
            License




A
substantial portion of the Company’s business is dependent on its exclusive
license of certain technology from Brandeis University (“Brandeis”). This
license agreement, dated June 1996, imposes certain obligations upon the
Company, such as diligently pursuing the development of commercial products
under the license products. The agreement expires at the end of each patent
period of seventeen years after the agreement execution date for products which
do not have patents and contains no minimum commitments. The amount of royalties
due is based on a formula of the percentage of oil and/or fat utilized in the
licensed products. Should Brandeis believe that the Company has failed to meet
its obligations under the license agreement, Brandeis could seek to limit or
terminate the Company’s license rights. Royalties earned by Brandeis for the
three and six months ended June 30, 2009 were $176 and $465,
respectively.  Royalties earned by Brandeis for the three and six
months ended June 30, 2008 were $183 and $407, respectively.


14




10.
            Income
      taxes




The
Company’s effective tax rate for the year is dependent on many factors,
including the impact of enacted tax laws in jurisdictions in which it operates
and the amount of taxable income it earns. The Company’s effective tax rate for
2009 is estimated to be 34%, which benefited in the second quarter from the
positive resolution of a liability recorded in conjunction with an uncertain tax
position as required by FIN 48.  This lowers the effective rate for
the quarter from the normalized effective rate of approximately 41% to virtually
zero.  The effective tax rate for the year because of this benefit is
expected to be 34%.  The deferred tax liability represents primarily
the difference between the tax and accounting basis of intangible assets
acquired in the GFA merger.




11.
            Commitment and
      contingencies




As of
June 30, 2009, the Company had the following commitments and contractual
obligations:




·
            A
      lease agreement for the lease of a corporate office facility located in
      Paramus, NJ.  The lease has an approximate five-year life with
      the option to extend the lease for two additional five-year
      terms.  The annual rental expense is approximately $300 for
      the first five years.




·
            Three
      lease agreements for the lease of a corporate office facility located in
      Niwot, Colorado.  The leases have an approximate five-year life
      with the option to extend each lease for 36 months.  The annual
      rental expense is approximately $120 for the first five
      years.




·
            Forward
      purchase commitments for a portion of the Company's projected requirements
      for peanuts and for palm, soy and canola oil.  These commitments
      may be stated at a firm price, or as a discount or premium from a future
      commodity market price.  Based on the most recent prices, these
      commitments would total approximately $26.8 million as of June 30,
      2009.  The commitments are expected to be liquidated by the
      second quarter of 2010 with the majority being liquidated by December
      2009.




·
            Futures
      purchases and collars (puts and calls) for a portion of the Company’s
      projected requirement for milk.  These instruments net settle in
      cash and are classified as derivatives in accordance with SFAS No.
      133.  As of June 30, 2009, these commitments total approximately
      $950.




·
            The
      Company uses interest rate swaps to cover exposure to changes in interest
      rates on its secured debt financing (see note
  6).




The
Company is party to various legal proceedings arising in the ordinary course of
business. Management believes that the resolution of these matters will not have
a material adverse affect on the Company’s financial position, results of
operations or cash flow.


15


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




Forward
Looking Statements




Certain
information included in this “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” contains forward-looking statements made
in reliance upon the safe harbor provisions of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These statements may be identified by the use
of words, such as “anticipate,” “estimates,” “should,” “expect,” “guidance,”
“project,” “intend,” “plan,” “believe” and other words and terms of similar
meaning, in connection with any discussion of our future business, results of
operations, liquidity and operating or financial performance. Such
forward-looking statements involve significant material known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. These
risks should be considered in connection with any written or oral
forward-looking statement that we or any person acting on our behalf may issue
in this document or otherwise, now or in the future. Further, certain
information contained in this document is a reflection of our intention as of
the date of this filing and is based upon, among other things, the existing
regulatory environment, industry conditions, market conditions and prices, the
economy in general and our assumptions as of such date. We may change our
intentions based upon any changes in such factors, in our assumptions or
otherwise.




We
undertake no obligation to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise.
We cannot assure you that any future results, performance or achievements will
be achieved. For a discussion of these risks, uncertainties and other factors,
see the “Risk Factors” and “Cautionary Note Regarding Forward-Looking
Statements” sections included in our annual report on Form 10-K for the year
ended December 31, 2008 and Amendment No. 1 thereto.




GFA
Merger




We were
incorporated in Delaware on May 31, 2005 under the name Boulder Specialty
Brands, Inc. On May 21, 2007, we completed a merger with GFA Brands, Inc.
(“GFA”), which owns and markets the Smart Balance® line of
products, among others. GFA is our wholly-owned subsidiary. After the merger,
the corporate name was changed from Boulder Specialty Brands, Inc. to Smart
Balance, Inc. (“Smart Balance” or the “Company”). Pursuant to the merger
agreement with GFA, we paid an aggregate of $491 million in cash (which included
post-closing bonus payments net of tax benefits) as merger consideration. The
cash consideration for the merger was funded with cash held in the trust account
established in connection with our initial public offering, the proceeds of a
private placement and a secured debt financing.


16




Company
Overview




We are a
consumer food products company that competes primarily in the retail branded
food products industry and focuses on providing value-added, functional food
products to consumers. Functional food is defined as a food or a food ingredient
that has been shown to affect specific functions or systems in the body and may
play an important role in disease prevention. We market buttery spreads,
popcorn, peanut butter, cooking oil, mayonnaise and other products primarily
under the Smart Balance®
trademark. In the natural food channel, we sell similar natural and organic
spreads products under the Earth Balance®
trademark. Our trademarks are of material importance to our business and are
protected by registration or other means in the United States and a number of
international markets. Our buttery spreads business, marketed under
SmartBalance®, Earth
Balance®,
SmartBeat® and
Nucoa®, is by
far the most developed product segment and accounted for approximately 75% of
sales for the three and six months ended June 30, 2009.




Our
products are sold in all 50 states, with little international sales presence. We
sell our products in mass merchandise, grocery, natural food and club stores
throughout the U.S, with a majority of products sold through supermarket chains
and food wholesalers. We utilize regional sales managers who are full-time
employees and work with food brokers to sell our products. In September 2007, we
entered into an agreement with Acosta, Inc. to become our national sales agency.
Additionally, we sell a small portion of our products through independent food
distributors. Our largest customer, Wal-Mart Stores, Inc. and its affiliates,
accounted for approximately 18% and 19% of net sales for the three and six
months ended June 30, 2009, respectively.




Our
signature buttery spreads and popcorn products utilize a proprietary licensed,
patented technology that is free of manufactured trans fats and enhances HDL to
LDL cholesterol ratios. In 1996, Brandeis University licensed to GFA certain
technology relating to the use of a balanced proportion of saturated and
polyunsaturated fatty acids from one or more vegetable oil sources for
incorporation in food products to increase HDL and HDL/LDL cholesterol ratio.
Our agreement with Brandeis provides us with an exclusive license to a number of
patents until April 7, 2015, at which time the patents will expire.
 In addition, we have proprietary trade secrets, technology, know-how
processes and other intellectual property rights that are not
registered.




Our
primary growth strategy is to continue to drive consumer and trade awareness of
our brands, increase distribution of our existing products, and continue to
launch additional line extensions and new products. We actively advertise via
network and cable TV, radio, coupons, and in-store promotions. We have also
benefited from favorable trends in the food industry regarding the required
labeling of trans fats levels in food products and increased consumer awareness
of the negative health implications of trans fats in foods.




We
outsource finished goods through third-party manufacturers. We do not own or
operate any manufacturing facilities. Outsourcing is designed to allow us to
enhance production flexibility and capacity, leverage working capital, and focus
our energy and resources on marketing and sales, while substantially reducing
capital expenditures and avoiding the complication of managing a production work
force. Our buttery spreads are produced by two manufacturers with multiple
locations. Most of our other products are each supplied by a separate sole
source. In the event of an interruption in supply, we believe we could arrange
for additional suppliers to provide the affected products. While we believe our
manufacturers have the capacity to fulfill our current production needs and are
willing to increase capacity as we grow, we will monitor capacity, service and
costs and will qualify alternative sources of supply as needed.


17




Our
manufacturers supply our products at a price equal to the cost of ingredients
and certain packaging plus a fixed toll charge. Except in unusual circumstances,
we provide no raw materials to our manufacturers. However, we work with our
manufacturers to source high quality ingredients at attractive pricing. The
prices paid for raw materials used in our products generally reflect factors
such as weather, commodity market fluctuations, currency fluctuations, tariffs,
and the effects of governmental agricultural programs. Although the prices of
raw materials can be expected to fluctuate as a result of these factors, we
believe such raw materials to be in adequate supply and generally available from
numerous sources. We also negotiate certain commodities and packaging costs
directly with the suppliers. Manufacturers are required by contract to announce
changes in ingredient prices in advance. Toll charges cannot be unilaterally
increased by the manufacturers, however, some manufacturers are able to increase
toll charges after giving us notice of the increase at least six months in
advance. We bear all freight costs associated with shipping finished
products.




We use
third party distributors and a network of public warehouses to deliver product
from our manufacturers to our customers. We rely primarily on two third party
distributors to deliver all of our spreads and other refrigerated products. All
freight costs associated with shipping finished products are borne by
us.




The food
industry is highly competitive and numerous multinational, regional and local
firms currently compete, or are capable of competing, with us. Our products
compete with branded products as well as generic and private-label products of
food retailers, wholesalers and cooperatives. We compete primarily on the basis
of product quality, brand recognition, brand loyalty, service, marketing,
advertising, patent protections and price. Some competitors may have different
profit or strategic objectives than we do. Substantial advertising and
promotional expenditures are required to maintain or improve a brand’s market
position or to introduce a new product. Our primary competitors are Unilever,
Kraft Foods, and ConAgra Foods, each of whom has substantially greater market
presence, longer operating histories, better distribution, more significant
customer bases and greater financial, marketing, capital and other resources
than us.




Results
of Operations




The
following discussion includes the operating results of GFA, the Company’s
wholly-owned subsidiary.  The following discussion should be read in
conjunction with our unaudited consolidated financial statements and related
notes thereto included elsewhere in this Form 10-Q.  Unless otherwise
indicated, all dollar amounts are presented in millions.


18




Results
of Operations for the Three and Six Months Ended June 30, 2009 and
2008




(in
      millions except per share)
                
                Three Months Ended
                  June 30,
                
                
                Six Months Ended
                  June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Net
      sales
                
                $
                58.2
                
                
                $
                48.0
                
                
                $
                120.8
                
                
                $
                98.8Cost
      of goods sold
                
                
                29.9
                
                
                
                28.1
                
                
                
                64.3
                
                
                
                56.1Gross
      profit
                
                
                28.3
                
                
                
                19.9
                
                
                
                56.5
                
                
                
                42.7Operating
      expenses
                
                
                25.8
                
                
                
                20.4
                
                
                
                50.8
                
                
                
                41.3Operating
      income (loss)
                
                
                2.5
                
                
                
                (0.5
                )
                
                
                5.7
                
                
                
                1.4Other
      (expenses) income, net
                
                
                (1.5
                )
                
                
                (2.0
                )
                
                
                (2.8
                )
                
                
                (5.9
                )Income
      (loss) before income taxes
                
                
                1.0
                
                
                
                (2.5
                )
                
                
                2.9
                
                
                
                (4.5
                )Provision
      (benefit) for income taxes
                
                
                -
                
                
                
                (1.0
                )
                
                
                0.8
                
                
                
                (1.8
                )Net
      income (loss)
                
                $
                1.0
                
                
                $
                (1.5
                )
                
                $
                2.1
                
                
                $
                (2.7
                )Net
      income (loss) per common share
                
                $
                0.02
                
                
                $
                (0.02
                )
                
                $
                0.03
                
                
                $
                (0.04
                )





Results
of Operations for the Three Months Ended June 30, 2009 Compared to the Three
Months Ended June 30, 2008




Net
sales:




Our net
sales for the three months ended June 30, 2009 increased 21.3% to $58.2 million
from $48.0 million for the three months ended June 30, 2008.  The
increase was primarily due to a combination of higher selling prices and a 15%
increase in unit volumes.




Cost
of goods sold:




Cost of
goods sold for the three months ended June 30, 2009 was $29.9 million, a 6.4%
increase from the same period in 2008.  The increase was due mostly to
increased volumes and slightly higher input costs in 2009.




Gross
profit:




Our gross
profit increased $8.4 million to $28.3 million for the three months ended June
30, 2009 from $19.9 million in 2008 due to higher selling prices and increased
volumes.




Gross
profit as a percent of net sales was 48.6% for the three months ended June 30,
2009 compared to 41.5% last year, as the benefit of price increases staged in
the latter half of 2008 more than offset higher commodity costs.  This
contrasts with 2008 when price increases could not keep pace with increases in
commodity costs.




Operating
expenses:




Total
operating expenses for the three months ended June 30, 2009 were $25.8 million
compared to $20.4 million for the corresponding period in 2008, an increase of
$5.4 million.  The operating expenses include selling, marketing and
general and administrative expenses.  The increase reflected higher
marketing investments behind product expansions.  Included in general
and administrative costs in 2009 were approximately $4.0 million of stock-based
compensation expense, as determined under Statement of Financial Reporting
Standard (SFAS) No. 123R, and $1.4 million in depreciation and
amortization.  In 2008 there were $3.7 million of stock-based compensation
expense and $1.2 million of depreciation and amortization.


19




Operating
income (loss):




Our
operating income was $2.5million for the three
months ended June 30, 2009 compared with an operating loss of $0.5 million for
the corresponding period in 2008.  Operating income increased $3.0
million, as the $8.4 million increase in gross margin was partially offset by a
$5.4 million increase in operating expenses.  Excluding non-cash
charges for stock based-compensation and depreciation and amortization of
$5.4 million in 2009 and $4.9 million in 2008, operating income increased $3.5
million to $7.9 million in 2009 from $4.4 million in 2008.




Other
income (expense):




We
incurred other expenses of $1.5 million for the three months ended June 30, 2009
compared to other expenses of $2.0 million in the corresponding period in
2008.  The results for 2009 and 2008 included net interest expense of
$1.2 and $2.0million,
respectively.  Included in the 2009 net interest expense is a $0.3
million loss on derivatives related to our interest rate swap.




Income
taxes:




The
provision for income taxes for the three months ended June 30, 2009 was $0.0
million compared with a benefit of $1.0 million for the corresponding period in
2008.  A state net tax refund of approximately $0.4 million in the
second quarter of 2009 resulting from the favorable resolution of an uncertain
tax position as required by FIN 48 lowered the effective tax rate for the
quarter from the normal effective rate of approximately 41% to virtually
zero.  In the second quarter of 2008 the effective tax rate was
approximately 40%.




Net
income (loss):




Our net
income for the three months ended June 30, 2009 was $1.0 million compared with a
loss of $1.5 million for the corresponding period in 2008, an increase of $2.5
million, reflecting the improvement in operating results and the favorable tax
benefit in the quarter.




Net
income (loss) per common share:




Our basic
and diluted net income per share in the second quarter of 2009 was $0.02
compared to a net loss of $(0.02) in the corresponding period in 2008 based on
the basic and diluted weighted average shares outstanding of 62.6 million and
62.8 million, respectively, in the second quarter of 2009 and 62.6 million basic
and diluted shares outstanding in the second quarter of 2008.


20




Results
of Operations for the Six Months Ended June 30, 2009 Compared to the Six Months
Ended June 30, 2008




Net
Sales:





Our net
sales for the six months ended June 30, 2009 increased 22.3% to $120.8 million
from $98.8 million for the six months ended June 30, 2008.  The
increase was primarily due to higher selling prices and increased unit
volumes.




Cost
of goods sold:




Cost of
goods sold for the six months ended June 30, 2009 was $64.3 million, a 14.6%
increase from the same period in 2008.  The increase was mostly due to
higher volumes.




Gross
profit:




Our gross
profit increased $13.8 million to $56.5 million for the six months ended June
30, 2009 from $42.7 million in 2008 due to the improvement in selling
prices and increased volumes compared to the second half of 2008.




Gross
profit as a percent of net sales was 46.8% for the six months ended June 30,
2009 compared to 43.3% in 2008, as the benefit of price increases and volume
gains which more than offset higher input costs.




Operating
expenses:




Total
operating expenses for the six months ended June 30, 2009 were $50.8 million
compared to $41.3 million for the corresponding period in 2008, an increase of
$9.5 million.  The operating expenses include selling, marketing and
general and administrative expenses.  The increase reflected higher
marketing investments behind product expansions and higher general and
administrative costs in 2009.  Depreciation and amortization was
approximately $0.5 lower in 2009 than 2008.




Operating
income (loss):




Our
operating income was $5.7million for the six months
ended June 30, 2009 compared to $1.4 million for the corresponding period in
2008.  Operating income increased $4.3 million, as the $13.8 million
increase in gross margin was largely offset by a $9.5 million increase in
operating expenses.  Excluding non-cash charges for stock
based-compensation and depreciation and amortization of $10.7 million in
2009 and $10.4 million in 2008, operating income increased $4.6 million to $16.4
million in 2009 from $11.8 million in 2008.




Other
income (expense):




We
incurred other expenses of $2.8 million for the six months ended June 30, 2009
compared to other expenses of $5.9 million in the corresponding period in
2008.  The results for 2009 and 2008 included net interest expense of
$2.3 and $5.0million,
respectively.  Included in the 2009 net interest expense is a $0.4
million loss on derivatives related to our interest rate swap.


21




Income
taxes:




The
provision for income taxes for the six months ended June 30, 2009 was $0.8
million compared with a benefit of $1.8 million for the corresponding period in
2008. As mentioned above, included in the second quarter of 2009 was a favorable
settlement of an uncertain tax position in the amount of $0.4 million which
resulted in an effective tax rate of approximately 28% for the six months ended
June 30, 2009.  This compares to 40% in the same period last
year.




Net
income (loss):




Our net
income for the six months ended June 30, 2009 was $2.1 million compared with a
loss of $2.7 million for the corresponding period in 2008, an increase of $4.8
million, reflecting the benefits of higher selling prices and unit sales as well
as a refund of state income taxes.




Net
income (loss) per common share:




Our basic
and diluted net income per share for the six months ended June 30, 2009 was
$0.03 compared to a net loss of $(0.04) in the corresponding period in 2008
based on the basic and diluted weighted average shares outstanding of 62.6
million and 62.8 million, respectively, in 2009 and 62.4 million basic and
diluted shares outstanding in 2008.




Cash
Flows




Cash
provided by operating activities was $5.2million for the six months
ended June 30, 2009 compared to cash used in operating activities of $0.8
million in the corresponding period in 2008.  For the first six months
of 2009, we had a net income of $2.1 million, which included $8.0 million of
non-cash stock-based compensation expenses and $2.7 million of depreciation and
amortization, offset by increased working capital of $4.6 million and changes in
deferred taxes and derivative liability of $3.1 million.  For the
first six months of 2008, we had net losses of $2.7 million, which included $7.2
million of stock-based compensation expenses and $3.2 million of depreciation
and amortization.  Higher working capital needs in the first half of
2008 more than offset the benefit of these non-cash charges.




Cash used
in investing activities totaled $0.5million for the six months
ended June 30, 2009, compared to $1.1million during the six
months ended June 30, 2008 which resulted from purchase of software development
costs of $1.5 million and other fixed assets offset by recovery of certain legal
costs related to protecting our intangible assets.




Cash used
in financing activities for the six months ended June 30, 2009 was $5.0 million,
compared to $30.0 million used in financing activities for the corresponding
period in 2008, resulting from the repayment of debt in both
periods.


22




Liquidity and Capital
Resources




Liquidity:




Our
liquidity and capital resource planning is largely dependent on the generation
of operating cash flows, which is highly sensitive to changes in demand and to a
lesser extent, pricing, for our major products. While changes in key operating
costs, such as outsourced production, advertising, promotion and distribution,
may adversely affect cash flows, we generate significant cash flows as demand
for our products grows. For interim reporting, the Company estimates the total
annual sales incentives for most programs and records a pro rata share in
proportion to forecasted annual revenue.  As a result, the Company has
paid $9.9 million through June 30, 2009, which will be charged to expense over
the remaining two quarters.  Our principal liquidity requirements are
to finance current operations, pay down existing indebtedness and fund future
expansion. Currently, our primary source of liquidity to meet these needs is
cash generated by operations.




We
believe that cash flows generated from operations, existing cash and cash
equivalents, and borrowing capacity under the revolving credit facility should
be sufficient to finance working capital  requirements for our
business for the foreseeable future.  As of June 30, 2009, $20 million
was available for borrowing under our revolving credit
facility.  Developing and bringing to market other new brands and
business opportunities may require additional outside funding, which may require
us to seek out additional borrowing arrangements.




Secured
Debt Financing:




In
conjunction with the GFA merger, on May 21, 2007, the Company entered into a
loan arrangement with Banc of America Securities LLC and Bank of America, N.A.
for $180 million in secured debt financing consisting
of:  (1) a $140 million first lien facility comprised of a
$120 million term loan and a $20 million revolver and (2) a
second lien facility comprised of a $40 million term loan. The first lien
facility is secured by a first lien on all of the Company’s assets and the
second lien facility is secured by a second lien on all of the Company’s
assets.  Through June 30, 2009, the Company paid a total of $95.5
million, consisting of $65.5 million in principal on its first lien term loan
and $30.0 million on its second lien debt.  During the second quarter
of 2009, the Company prepaid $5 million of the first lien debt.  As a
result of the prepayment, the Company wrote off approximately $0.1 million of
deferred financing costs, which is included in other income
(expense).  The term loan of the first lien facility will mature on
May 21, 2014 and the revolving loan under the first lien facility will mature on
May 21, 2013. The term loan of the second lien facility will mature on November
18, 2014.




In
accordance with a pricing grid based on the Company’s leverage ratio, the
applicable margin is LIBOR plus 3.00% per annum beginning March 28, 2008, which
resulted in an interest rate of 3.60% at June 30, 2009. The  interest
rate on the second lien facility is LIBOR plus an applicable margin of
6.00% per annum, beginning July 1, 2007, which resulted in an interest
rate at June 30, 2009 of 6.60%.




The
Company uses interest rate swaps to effectively manage interest rate exposure by
locking in the variable interest rate on our debt into a fixed rate of
5.05%.  The Company recognizes the mark-to-market movement of the
interest rate swap in income as the rate changes.  As of June 30,
2009, the Company had a derivative liability of $4.1 million which represents
the present value of the future quarterly interest payments, through the end of
the swap agreement of September 30, 2010, based on the difference between the
three month LIBOR floating interest at June 30, 2009 and the fixed interest rate
of the debt of 5.05% on $80 million notional amount. At the end of each quarter,
the Company makes or receives quarterly cash payments based on the actual
difference between these two rates. At June 30, 2009, the Company has opted to
let the notional amount of the interest rate swap exceed the amount of its debt
by approximately $15.5 million assuming that the current LIBOR interest rate
environment would increase allowing the Company to pay off the quarterly swap
requirements on more favorable terms.


23




There is
no prepayment penalty for optional prepayments on the first lien facility and
the following penalties for optional prepayments on the second lien facility:
1.00% premium if prepaid before May 21, 2009; and no prepayment penalty
thereafter. As a result of prepaying $30.0 million of the second lien facility,
the Company paid a $0.6 million prepayment penalty, which is included in
interest expense for the year ended December 31, 2008.  Mandatory
prepayments under the first lien facility include 50% of excess cash flow (as
defined in the credit agreement) and 50% of all net cash proceeds from the
issuance of additional equity interests by us.  After the first lien
facility is re-paid in full, the second lien facility requires mandatory
prepayments, which include 50% of excess cash flow (as defined in the credit
agreement) and 50% of all net cash proceeds from the issuance of additional
equity interests by us.  In addition, the term loan of the first lien
facility is subject to quarterly amortization of principal with 1.00% of the
initial aggregate advances under such loan to be payable in each of the first
six years and the remainder of the initial aggregate advance to be payable in a
balloon payment at maturity.




The first
and second lien credit facilities can be accelerated upon the occurrence of
certain events, including:




·
            nonpayment
      of debt including interest and
fees;




·
            failure
      to perform or observe covenants;




·
            cross
      defaults to other indebtedness exceeding $5.0
  million;




·
            bankruptcy
      and insolvency; and




·
            certain
      other events.




The first
lien credit facility requires the Company to comply with certain financial
covenants, such as ratios of Consolidated EBITDA (as defined in the first lien
credit facility) to each of consolidated cash interest charges, total debt and
first lien debt.  The second lien credit facility requires the Company
to comply with one financial covenant consisting of a leverage ratio of total
debt to Consolidated EBITDA (as defined in the second lien credit
facility).  The Company was in compliance with all of its debt
covenants at June 30, 2009.




Under the
terms of both credit facilities, the Company is precluded from reacquiring its
own shares.


24




The
following is a summary of long-term debt (in thousands):




June 30,
                      2009
                      (unaudited)
                    
                    
                    December 31,
                      2008First
      lien term loan
                    
                    $
                    54,504
                    
                    
                    $
                    59,504Second
      lien term loan
                    
                    
                    10,000
                    
                    
                    
                    10,000Total
      Debt:
                    
                    
                    64,504
                    
                    
                    
                    69,504Less:
      Current maturities
                    
                    
                    -
                    
                    
                    
                    -Total
      long term debt
                    
                    $
                    64,504
                    
                    
                    $
                    69,504




Off Balance Sheet
Arrangements




We do not
have off-balance sheet arrangements, financings, or other relationships with
unconsolidated entities or other persons, also known as “variable interest
entities.”




Item 3.        Quantitative
and Qualitative Disclosures About Market Risk




We
purchase significant amounts of soy, palm and canola oil products and peanuts to
support the needs of our brands. The price and availability of these commodities
directly impacts the results of operations and can be expected to impact the
future results of operations. For these raw materials, we do not engage in any
hedging activities because we enter into agreements that qualify as normal
purchases and sales in the normal course of business.  Accordingly,
the agreements do not qualify as derivatives under SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities.” Based on the most recent prices
for soy, palm and canola oil products and peanuts, we have commitments of
$26.8 million.




During
the second quarter of 2009, we entered into futures contracts to cover our
exposure to milk commodity costs.  These contracts, which have a
notional value at June 30, 2009 of approximately $1.0 million, cover
approximately 50% of 2009 requirements.  We have recognized a small
loss in other income and expenses related to the market-to-market movement in
these positions.  We did not elect for cash flow hedging accounting
treatment for these hedges under SFAS 133.




In
conjunction with the fixed-rate debt arrangements discussed elsewhere in this
report, we entered into $80 million of interest rate swaps on August 16, 2007,
which are designed to fix the interest rate of the variable rate debt. Under
these swaps, we receive or pay the difference between our fixed-rate interest
payments and floating-rate payments based on LIBOR. The effect of this is to
convert floating-rate interest expense based on LIBOR into fixed-rate interest
expense. The arrangements settle on the last day of each calendar quarter. For
the quarter ended June 30, 2009, the Company paid $1.0 million and received $0.2
million with the difference increasing interest paid by $0.8 million. In
addition, the Company recorded the change in fair value of the interest swap of
$0.3 million, which is included as a charge in interest expense.




We are
exposed to market risk from changes in interest rates charged on our
debt.  The impact on earnings is subject to change as a result of
movements in market rates.  A hypothetical increase in interest rates
of 100 basis points would result in potential reduction of future pre-tax
earnings, exclusive of the impact of the interest rate derivative, of
approximately $0.1 million per year for every $10.0 million outstanding under
our first lien credit facility and approximately $0.1 million per year under our
second lien credit facility.  Our ability to meet our debt service
obligations will be dependent upon our future performance which, in turn, is
subject to future economic conditions and to financial, business and other
factors.


25




Item 4.         Controls
and Procedures




Conclusion regarding the
effectiveness of disclosure controls and procedures. Our management, with
the participation of our Chief Executive Officer and Principal Financial and
Accounting Officers, evaluated the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of June 30, 2009. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by the Company in the reports that we file or submit under the
Exchange Act is accumulated and communicated to our management, including our
Principal Executive Officer and Principal Financial and Accounting Officers, as
appropriate to allow timely decisions regarding required disclosure. In
addition, as a result of the amendment to Form 10-K for the year ended December
31, 2008, the Company re-evaluated the effectiveness of its disclosure
controls. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on management’s evaluation of our disclosure controls and procedures as of
June 30, 2009, our Chief Executive Officer and Principal Financial and
Accounting Officers concluded that, as of such date, our disclosure controls and
procedures were effective at the reasonable assurance level.




Changes in internal control over
financial reporting.During the fiscal quarter ended June 30, 2009,
there was no change in our internal control over financial reporting that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.


26


Part
II.         Other
Information




Item 1.          Legal
Proceedings.




There
have been no material changes to the litigation we previously reported under
Item 3 in our annual report on Form 10-K for the year ended December 31, 2008
and Amendment No. 1 thereto.




Item 1A.       Risk
Factors.




An
investment in our securities involves a high degree of risk. There have been no
material changes to the risk factors previously reported under Item 1A of
our annual report on Form 10-K for the year ended December 31, 2008
and Amendment No. 1 thereto.




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




On
May 20, 2009, the Company held an annual meeting of its stockholders.
The annual meeting was held in order to vote on the following
matters:




Proposal 1: The
board of directors nominated Robert J. Gillespie, Robert F. McCarthy and
Michael R. O’Brien to stand for re-election at the annual meeting and each
of the three director nominees were elected by a plurality of votes cast by
shares entitled to vote at the meeting. Therefore, in accordance with the voting
results listed below, all three director nominees were re-elected to serve a
three-year term and until their successors have been elected and
qualified.  The votes on this proposal were cast as
follows:




Nominee:
                        
                        Votes
      For:
                        
                        
                        Votes
      Withheld:Robert
      J. Gillespie
                        
                        
                        52,437,964
                        
                        
                        
                        5,356,116Robert
      F. McCarthy
                        
                        
                        43,312,685
                        
                        
                        
                        14,481,395Michael
      R. O’Brien
                        
                        
                        54,492,136
                        
                        
                        
                        3,301,944




There
were no broker non-votes.




Proposal 2:The board of directors
selected Ehrhardt Keefe Steiner & Hottman PC to serve as the independent
registered public accountants for the Company in 2009. The board of directors
directed that the appointment of the independent accountants be submitted for
ratification by the shareholders at the annual meeting. Therefore, in accordance
with the voting results listed below, Ehrhardt Keefe Steiner & Hottman PC
will serve as the independent registered public accountants for the Company in
2009. The votes on this proposal were cast as follows:




For:
                        
                        
                        57,194,008Against:
                        
                        
                        548,233Abstain:
                        
                        
                        51,838




There
were no broker non-votes.


27





Item 6.          Exhibits.




See the
exhibit index located elsewhere in this quarterly report on Form
10-Q.


28


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.




August
      6, 2009
              SMART
      BALANCE, INC.
                (Registrant)/s/ Stephen B. HughesStephen
      B. Hughes
                Chairman
      and Chief Executive Officer
                (Authorized
      officer of Registrant)/s/ Alan S. GeverAlan
      S. Gever
                Executive
      Vice President and
                Chief
      Financial Officer
                (Principal
      financial officer of
Registrant)




29


Exhibit
Index:




31.1
              Certification
      of Principal Executive Officer Pursuant to Exchange Act Rules 13a-14(a)
      and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2
              Certification
      of Principal Financial Officer Pursuant to Exchange Act Rules 13a-14(a)
      and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
              Certification
      of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      200232.2
              Certification
      of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002




30