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 Ended March 31,
2010 Commission File Number
001-33595









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  o.





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




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




Large Accelerated Filer     o
              Accelerated Filer                     xNon-Accelerated Filer       o (Do not check if a smaller reporting company)
              Smaller Reporting Company  o




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




As of May 3, 2010 the Registrant had
62,630,683 shares of common stock, par value $.0001 per share, outstanding.









SMART
BALANCE, INC.




INDEX




PagePart
      I.
              Financial
      Information
              3Item 1.
              Financial
      Statements
              3Item 2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              19Item 3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              27Item 4.
              Controls
      and Procedures
              28Part
      II.
              Other
      Information
              29Item 1.
              Legal
      Proceedings.
              29Item 1A.
              Risk
      Factors.
              29Item 6.
              Exhibits.
              29




i




Cautionary
Note Regarding Forward Looking Statements




This
document contains forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These
statements may be identified by forward-looking words such as “may,” “expect,”
“anticipate,” “contemplate,” “believe,” “estimate,” “intends,” and “continue” or
similar words.  In addition, forward-looking statements are statements
which





·
            discuss
      future expectations or expansions of business
  lines;




·
            contain
      projections of future results of operations or financial condition;
      or




·
            state
      other “forward-looking”
information.




We
believe that communicating our expectations to our stockholders is important.
However, there are always events in the future that we are not able to
accurately predict or over which we have no control, and consequently, actual
results may differ from those anticipated in the forward-looking
statements.  Important factors that could cause actual results to
differ from our expectations include, but are not limited to, the factors
discussed in the section of this report entitled “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” the “Risk Factors”
section in our annual report on Form 10-K for the year ended December 31, 2009,
as well as, our ability to:




·
            maintain
      margins during periods of commodity cost
  fluctuation;




·
            introduce
      and expand our distribution of new
products;




·
            meet
      marketing and infrastructure needs;




·
            respond
      to changes in consumer demand;




·
            respond
      to adverse publicity affecting our company or
  industry;




·
            comply
      with new regulatory requirements;




·
            maintain
      existing relationships with and secure new
  customers;




·
            continue
      to rely on third party distributors, manufacturers and
      suppliers;  and




·
            grow
      net sales in a competitive environment and with increasingly price
      sensitive consumers.




You are
cautioned not to place undue reliance on our forward-looking statements, which
speak only as of the date of this report.




1





All
forward-looking statements included in this report attributable to us are
expressly qualified in their entirety by the cautionary statements contained or
referred to in this section. Except to the extent required by applicable laws
and regulations, we undertake no obligation to update these forward-looking
statements to reflect events or circumstances after the date of this report or
to reflect the occurrence of unanticipated events.


2


Part
I.            Financial
Information




Item 1.           Financial
Statements




SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Balance Sheets


(In thousands, except share
data)





March
      31,
                            
                            
                            December
      31,2010
                            
                            
                            2009(unaudited)AssetsCurrent
      assets:Cash and cash
      equivalents
                            
                            $
                            14,004
                            
                            
                            $
                            7,538Accounts
      receivable, net of allowance of: $356(2010) and$345
      (2009)
                            
                            
                            15,556
                            
                            
                            
                            11,970Accounts receivable -
      other
                            
                            
                            588
                            
                            
                            
                            650Income taxes
      receivable
                            
                            
                            -
                            
                            
                            
                            1,131Inventories
                            
                            
                            6,230
                            
                            
                            
                            5,812Prepaid
      taxes
                            
                            
                            -
                            
                            
                            
                            405Prepaid expenses and other
      assets
                            
                            
                            7,184
                            
                            
                            
                            3,392Deferred tax
      asset
                            
                            
                            498
                            
                            
                            
                            462Total current
      assets
                            
                            
                            44,060
                            
                            
                            
                            31,360Property
      and equipment,
      net
                            
                            
                            4,865
                            
                            
                            
                            4,634Other
      assets:Goodwill
                            
                            
                            374,886
                            
                            
                            
                            374,886Intangible assets,
      net
                            
                            
                            150,072
                            
                            
                            
                            151,089Deferred costs,
      net
                            
                            
                            2,003
                            
                            
                            
                            2,111Other
      assets
                            
                            
                            2,243
                            
                            
                            
                            985Total other
      assets
                            
                            
                            529,204
                            
                            
                            
                            529,071Total
      assets
                            
                            $
                            578,129
                            
                            
                            $
                            565,065Liabilities
      and Stockholders' EquityCurrent
      liabilitiesAccounts payable and accrued
      expenses
                            
                            $
                            29,787
                            
                            
                            $
                            22,626Income taxes
      payable
                            
                            
                            1,480
                            
                            
                            
                            -Current portion of long term
      debt
                            
                            
                            5,500
                            
                            
                            
                            5,500Total current
      liabilities
                            
                            
                            36,767
                            
                            
                            
                            28,126Long
      term
      debt
                            
                            
                            50,043
                            
                            
                            
                            51,143Deferred
      tax
      liability
                            
                            
                            42,432
                            
                            
                            
                            43,824Other
      liabilities
                            
                            
                            1,121
                            
                            
                            
                            965Total
      liabilities
                            
                            
                            130,363
                            
                            
                            
                            124,058Commitment
      and contingenciesStockholders'
      equityPreferred
      stock, $.0001 par value, 50,000,000 sharesauthorized
                            
                            
                            -
                            
                            
                            
                            -Common stock, $.0001 par value,
      250,000,000 shares authorized; 62,630,683 (2010 and 2009) issued and
      outstanding
                            
                            
                            6
                            
                            
                            
                            6Additional
      paid in
      capital
                            
                            
                            527,245
                            
                            
                            
                            523,467Retained
      deficit
                            
                            
                            (79,485
                            )
                            
                            
                            (82,466
                            )Total stockholders'
      equity
                            
                            
                            447,766
                            
                            
                            
                            441,007Total
      liabilities and stockholders'
      equity
                            
                            $
                            578,129
                            
                            
                            $
                            565,065




See
accompanying notes to the consolidated financial statements


3


SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Statements of Operations


(Unaudited)


(In
thousands, except share data)






Three
      Months Ended
                                                          March
      31,2010
                                                        
                                                        
                                                        2009Net
      sales
                                                        
                                                        $
                                                        63,635
                                                        
                                                        
                                                        $
                                                        62,599Cost
      of goods sold
                                                        
                                                        
                                                        30,287
                                                        
                                                        
                                                        
                                                        34,345Gross
      profit
                                                        
                                                        
                                                        33,348
                                                        
                                                        
                                                        
                                                        28,254Operating
      expenses:Marketing
                                                        
                                                        
                                                        10,423
                                                        
                                                        
                                                        
                                                        8,800Selling
                                                        
                                                        
                                                        5,205
                                                        
                                                        
                                                        
                                                        4,517General and
      administrative
                                                        
                                                        
                                                        11,932
                                                        
                                                        
                                                        
                                                        11,729Total operating
      expenses
                                                        
                                                        
                                                        27,560
                                                        
                                                        
                                                        
                                                        25,046Operating
      income
                                                        
                                                        
                                                        5,788
                                                        
                                                        
                                                        
                                                        3,208Other
      income (expense):Interest income
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        1Interest expense
                                                        
                                                        
                                                        (945
                                                        )
                                                        
                                                        
                                                        (1,679
                                                        )Gain
      on derivative liability
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        546Other expense,
net
                                                        
                                                        
                                                        (367
                                                        )
                                                        
                                                        
                                                        (143
                                                        )Total other income
      (expense)
                                                        
                                                        
                                                        (1,312
                                                        )
                                                        
                                                        
                                                        (1,275
                                                        )Income
      before income taxes
                                                        
                                                        
                                                        4,476
                                                        
                                                        
                                                        
                                                        1,933Provision
      for income taxes
                                                        
                                                        
                                                        1,495
                                                        
                                                        
                                                        
                                                        787Net
      income (loss)
                                                        
                                                        $
                                                        2,981
                                                        
                                                        
                                                        $
                                                        1,146Income
      per share:Basic
                                                        
                                                        $
                                                        0.05
                                                        
                                                        
                                                        $
                                                        0.02Diluted
                                                        
                                                        $
                                                        0.05
                                                        
                                                        
                                                        $
                                                        0.02Weighted
      average shares outstanding:Basic
                                                        
                                                        
                                                        62,630,683
                                                        
                                                        
                                                        
                                                        62,630,683Diluted
                                                        
                                                        
                                                        62,632,799
                                                        
                                                        
                                                        
                                                        62,706,184




See
accompanying notes to the consolidated financial statements


4


SMART
BALANCE, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)


(In
thousands)





Three
      Months Ended
                    March
      31,2010
                  
                  
                  2009Cash
      flows from operating activitiesNet
      income
                  
                  $
                  2,981
                  
                  
                  $
                  1,146Adjustments
      to reconcile net income (loss) to net cashprovided
      by operating activities:Depreciation and
      amortization of intangibles
                  
                  
                  1,301
                  
                  
                  
                  1,210Amortization of
      deferred financing costs
                  
                  
                  126
                  
                  
                  
                  63Deferred income
      taxes
                  
                  
                  (1,429
                  )
                  
                  
                  (962
                  )Stock based
      compensation
                  
                  
                  3,778
                  
                  
                  
                  4,010(Decrease) in
      derivative liabilities
                  
                  
                  -
                  
                  
                  
                  (545
                  )Changes
      in assets and liabilities:Accounts
      receivable
                  
                  
                  (3,586
                  )
                  
                  
                  (549
                  )Inventories
                  
                  
                  (418
                  )
                  
                  
                  900Income taxes
      receivable
                  
                  
                  1,131
                  
                  
                  
                  -Prepaid expenses and
      other current assets
                  
                  
                  (4,526
                  )
                  
                  
                  (9,412
                  )Accounts payable and
      accrued expenses
                  
                  
                  8,741
                  
                  
                  
                  7,065Net
      cash provided by operating activities
                  
                  
                  8,099
                  
                  
                  
                  2,926Cash
      flows from investing activitiesPurchase
      of property and equipment
                  
                  
                  (515
                  )
                  
                  
                  (282
                  )Net
      cash (used in) investing activities
                  
                  
                  (515
                  )
                  
                  
                  (282
                  )Cash
      flows from financing activitiesRepayment
      of debt
                  
                  
                  (1,100
                  )
                  
                  
                  -Payments
      for loan costs
                  
                  
                  (18
                  )
                  
                  
                  -Net
      cash (used in) financing activities
                  
                  
                  (1,118
                  )
                  
                  
                  -Net
      increase in cash for the period
                  
                  
                  6,466
                  
                  
                  
                  2,644Cash
      - Beginning of period
                  
                  
                  7,538
                  
                  
                  
                  5,492Cash
      - End of period
                  
                  $
                  14,004
                  
                  
                  $
                  8,136Cash
      paid during the period for:Income
      taxes
                  
                  $
                  88
                  
                  
                  $
                  344Interest
                  
                  $
                  855
                  
                  
                  $
                  1,588


See
accompanying notes to the consolidated financial statements


5




SMART
BALANCE, INC. AND SUBSIDIARY




Notes
to Consolidated Financial Statements


(Unaudited)


(In
thousands, except share and per share data)




1.
            General




Smart
Balance, Inc. (the “Company”) was incorporated in Delaware on May 31, 2005
under the name Boulder Specialty Brands, Inc. in order to serve as a vehicle for
the acquisition of a then unidentified operating business and/or brand in the
consumer food and beverage industry.  On May 21, 2007, the Company
completed a merger with GFA Brands, Inc. (“GFA”), which owned and marketed the
Smart Balance® line of
products, among others.  GFA became a wholly-owned subsidiary of the
Company.




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 and notes thereto of Smart Balance, Inc.
included in the Company's 2009 annual report on Form 10-K. The reported results
for the three month period ended March 31, 2010 are not necessarily indicative
of the results to be expected for the full year.




2.
            Summary of significant
      accounting policies




Cash and Cash
Equivalents




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




Accounts
Receivable




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.




Inventories




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




6




Property and
Equipment




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 continually evaluates whether events and
circumstances have occurred that indicate the remaining estimated useful life of
long lived assets may warrant revision, or that the remaining balance of these
assets may not be recoverable.  When deemed necessary, the Company
completes this evaluation by comparing the carrying amount of the assets against
the estimated undiscounted future cash flows associated with them.  If
such evaluations indicate that the future undiscounted cash flows of amortizable
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their estimated fair values.




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.  We completed our impairment analysis at June 30,
2009 and concluded that our estimated fair value was greater than the carrying
value of the recorded goodwill.  At December 31, 2009, management
reviewed the Company’s fair value and obtained an independent valuation of our
“control premium” (or acquisition premium) which when added to the Company’s
market capitalization at December 31, 2009 exceeded the Company’s book value by
17%.  The Company also performed several discounted cash flow analyses
which also supported our conclusion that the Company does not have any
indication of impairment.  No events have occurred during the quarter
ended March 31, 2010 that have resulted in the need for the Company to
reevaluate its impairment analysis.  As a result, we have not recorded
any impairment of goodwill. However, if the Company does not achieve its growth
targets, as contemplated, there may be an impairment charge in the future. The
Company will perform its annual impairment analysis on
June 30, 2010.




Intangible
Assets




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.




7




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.




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 if
previously capitalized with any excess recorded as income.




The
Company has not identified any events that would result in the need for the
Company to perform an impairment analysis of its intangible assets during the
quarter ended March 31, 2010.  The Company will perform its
annual assessment of its indefinite lived intangible assets for impairment at
June 30, 2010.




Deferred
Costs




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




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.




8




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 March 31, 2010 of $5,780 which will be charged to expense over the remaining
three quarters.  The Company sells its products to customers without
a  right of return and is not obligated to accept any
returns.




Earnings per Share of Common
Stock




Basic
earnings per share is computed by dividing net income applicable to common
stockholders by the weighted-average number of shares of common stock
outstanding for the period. Diluted earnings per share is computed by dividing
net income by the number of 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.  At
March 31, 2010, 2,116 stock options were dilutive because the weighted
average market price, including the unrecognized compensation expense related to
such shares, was in excess of their exercise price.




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




Three
      Months Ended
                  March
      31,2010
                
                
                2009Stock
      options excluded due to option price being greater thanmarket
      value
                
                
                12,398,500
                
                
                
                11,897,500Stock
      options excluded due to anti-dilution
                
                
                20,384
                
                
                
                230,000




Segments




Authoritative
accounting guidance 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.  The Company’s buttery spreads business, marketed under Smart
Balance®, Earth Balance®, BestlifeTM, Smart Beat® and Nucoa®, is by far the most
developed product segment and accounted for approximately 75% of 2009 sales and
approximately 75% of sales during the period ended March 31, 2010.




9




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 debt is determined by
comparable quoted market prices and, therefore, approximates fair
value.




Research and
Development




Research
and development expenses are charged to operations when incurred and amounted to
$186 and $88 respectively, for the three months ended March 31, 2010 and
2009.




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 March 31, 2010, no valuation allowances
were recorded.




Advertising




Advertising
costs are charged to operations (classified as marketing expenses) and amounted
to $7,107 and $5,157 for the three months ended March 31, 2010 and 2009,
respectively.




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 March 31, 2010, 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 19% of sales
during the three months ended March 31, 2010. The aggregate accounts receivable
from this customer amounted to approximately 18% of the accounts receivable
balance outstanding at March 31, 2010. The Company also has one product,
“spreads,” which, for the three months ended March 31, 2010, accounted for
approximately 75% of total revenue.  Approximately 75% of the
Company’s revenues during the first quarter of 2010 came from products utilizing
a license from Brandeis University.




10




Recently Issued Accounting
Pronouncements




In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of FASB Statement No. 162”(“SFAS 168”). The FASB Accounting
Standards CodificationTM (“Codification” or “ASC”) became the source of
authoritative GAAP recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the Securities and Exchange
Commission (the “SEC”) under authority of the federal securities laws are also
sources of authoritative GAAP for SEC registrants. On the effective date of SFAS
168, the Codification superseded all then-existing non-SEC accounting and
reporting standards. All other non-grandfathered non-SEC accounting literature
not included in the Codification became non-authoritative.





Following
SFAS 168, the FASB will no longer issue new standards in the form of Statements,
FASB Staff Positions, or Emerging Issues Task Force Abstracts; instead, it will
issue Accounting Standards Updates (ASUs). The FASB will not consider ASUs as
authoritative in their own right; rather, these updates will serve only to
update the Codification, provide background information about the guidance, and
provide the bases for conclusions on the change(s) in the Codification. SFAS No.
168 is incorporated in ASU Topic 105, Generally Accepted Accounting
Principles. The Company adopted SFAS No. 168 for the fiscal year-ended
December 31, 2009.





3.
            Property and
      equipment




Property
and equipment consist of the following:




March
      31,
                    2010
                
                
                December
      31,
                    2009Software
      development costs
                
                $
                4,162
                
                
                $
                3,857Equipment
                
                
                966
                
                
                
                771Furniture
      and fixtures
                
                
                991
                
                
                
                975Leasehold
      improvements
                
                
                342
                
                
                
                3426,461
                
                
                
                5,946Less:
      accumulated depreciation
                
                
                (1,596
                )
                
                
                (1,312
                )Property
      and equipment, net
                
                $
                4,865
                
                
                $
                4,634





Depreciation
expense was $284 for the three months ended March 31, 2010 compared to $194 for
the three months ended March 31, 2009.




11




4.
            Intangible
      assets




The
following is a summary of intangible assets and goodwill as of March 31,
2010:




Gross
                      Carrying
                      Amount
                    
                    
                    Accumulated
                      Amortization
                    
                    
                    Accumulated
                      Adjustments
                    
                    
                    Net
      Balance,
                      March
      31,
                      2010Patent
      technology
                    
                    $
                    40,000
                    
                    
                    $
                    11,466
                    
                    
                    $
                    (68
                    )
                    
                    $
                    28,466Supply
      relationship
                    
                    
                    1,000
                    
                    
                    
                    196
                    
                    
                    
                    -
                    
                    
                    
                    804Trademarks
                    
                    
                    121,152
                    
                    
                    
                    -
                    
                    
                    
                    (350
                    )
                    
                    
                    120,802Goodwill
                    
                    
                    374,886
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    374,886$
                    537,038
                    
                    
                    $
                    11,662
                    
                    
                    $
                    (418
                    )
                    
                    $
                    524,958




Adjustments
to trademarks relate to a legal settlement received of $367 and serve to reduce
related costs previously capitalized. Additional spending of $16 during the
period accounted for the difference.  Amortization expense was $1,017
for the three months ended March 31, 2010 and 2009.




5.
            Accounts payable and
      accrued expenses




Accounts
payable and accrued expenses consist of the following:




March
      31,
                      2010
                    
                    
                    December
      31,
                      2009Accounts
      payable
                    
                    $
                    12,753
                    
                    
                    $
                    8,374Accrued
      expenses
                    
                    
                    17,034
                    
                    
                    
                    14,252Total
                    
                    $
                    29,787
                    
                    
                    $
                    22,626





6.
            Long term
      debt




On
November 4, 2009, the Company, through its wholly-owned subsidiary GFA Brands,
Inc. (the “Borrower”), entered into a Credit Agreement (the “Credit Agreement”)
with the various Lenders named therein (the “Lenders”), and Bank of Montreal, as
Administrative Agent (the “Agent”).  The Credit Agreement provides for
$100 million in secured debt financing consisting of a $55 million term
loan (the “Term Loan”) and a $45 million revolving credit facility (the
“Revolver”).  The Revolver includes a $5 million sublimit for the
issuance of letters of credit and a $5 million sublimit for swing line
loans.  Subject to certain conditions, the Borrower, to the extent
existing Lenders decline to do so by adding additional Lenders, may increase the
Term Loan or increase the commitments under the Revolver (or a combination of
the two) up to an aggregate additional amount of $5 million, at the Borrower’s
option.




The
Credit Agreement replaced the Company’s prior first lien and second lien credit
facilities with Bank of America Securities LLC and Bank of America, N.A. (the
“Prior Facilities”).   Proceeds of the Credit Agreement were used
to repay the debt outstanding under the Prior Facilities and may also be used
for general corporate purposes and general working capital
purposes.




12




The Term
Loan and the loans made pursuant to the Revolver will mature on November 3,
2013.  The Credit Agreement requires annual principal payments on the
Term Loan of $5.5 million.




Loans
outstanding under the Credit Agreement will bear interest, at the Borrower’s
option, at either a base rate (defined in the Credit Agreement as the greatest
of (i) 2.5%, (ii) the Agent’s prime rate, (iii) the federal funds rate plus
0.50% and (iv) a reserve adjusted one-month LIBOR rate plus 1.0%) or a
Eurodollar rate (of no less than 1.5%), in each case plus an applicable
margin.  The applicable margin is determined under the Credit
Agreement based on the ratio of the Company’s total funded debt to EBITDA for
the prior four fiscal quarters (the “Leverage Ratio”), and may range from 2.25%
to 3.25%, in the case of base rate loans, and 3.25% to 4.25%, in the case of
Eurodollar rate loans.  The Borrower must also pay a commitment fee on
the unused portion of the Revolver (determined under the Credit
Agreement  based on the ratio of the Company’s Leverage Ratio) which
may range from 0.50% to 0.75%.




Subject
to certain conditions, the Borrower may voluntarily prepay the loans under the
Credit Agreement in whole or in part, without premium or penalty (other than
customary breakage costs).  Mandatory prepayments that are required
under the Credit Agreement include:




●
            100%
      of the net cash proceeds (as defined in the Credit Agreement) upon certain
      dispositions of property or upon certain damages or seizures of property,
      subject to limited exceptions;




●
            50%
      of all net cash proceeds from the issuance of additional equity securities
      of the Company, subject to limited exceptions, provided, however, if the
      Company’s Leverage Ratio is less than 2.0 as of the end of the most
      recently ended quarter, the prepayment is limited to 25% of such
      proceeds;




●
            100%
      of the amount of net cash proceeds for certain issuances of additional
      indebtedness for borrowed money;
and




●
            beginning
      on December 31, 2010 and each fiscal year thereafter, an annual prepayment
      equal to 25% of excess cash flow of the Company (as defined in the Credit
      Agreement) for such fiscal year, provided such prepayment is not required
      if the Company has a Leverage Ratio of 2.0 or less, measured as of the end
      of such fiscal year.




The
Credit Agreement contains covenants that are customary for agreements of this
type.  These covenants include, among others: a limitation on the
incurrence of additional indebtedness; a limitation on mergers, acquisitions,
investments and dividend payments; and maintenance of specified financial
ratios.  Under the Credit Agreement, the Company must maintain (1) a
Leverage Ratio that is not greater than 2.75 to 1.0 until December 30, 2011 and
not greater than 2.50 to 1.0 thereafter and (2) a ratio of EBITDA to Debt
Service (as defined in the Credit Agreement), in each case for the prior four
fiscal quarters, of not less than 2.00 to 1.00.  The Company is also
limited to spending not more than $6 million of capital expenditures per year
with any unspent funds carried over to the next twelve months.  At
March 31, 2010, the Company was in compliance with all of its
covenants.




13




The
failure to satisfy covenants under the Credit Agreement or the occurrence of
other specified events that constitute an event of default could result in the
acceleration of the repayment obligations of the Borrower.  The Credit
Agreement contains customary provisions relating to events of default for
agreements of this type. The events of default include, among others: the
nonpayment of any outstanding principal, interest, fees or other amounts due
under the Credit Agreement; certain bankruptcy events, judgments or decrees
against the Company or the Borrower; cross defaults to other indebtedness
exceeding $5.0 million; a change in control (as defined in the Credit Agreement)
of the Company or the Borrower; and the failure to perform or observe covenants
in the Credit Agreement.




The
obligations under the Credit Agreement are guaranteed by the Company and all
existing and future subsidiaries of the Borrower.  The Borrower, the
Company and the other guarantors granted to the Agent, for the benefit of the
Lenders, a security interest in substantially all of its respective assets,
including, among other things, patents, patent licenses, trademarks and
trademark licenses.




After the
close of the transaction, total debt outstanding under the Credit Agreement
totaled approximately $60.6 million comprised of $55 million of Term Loan debt
and $5.6 million of borrowings under the Revolver.  During the fourth
quarter of 2009, the Company paid approximately $4.0 million on its Revolver and
during the first quarter of 2010 it paid $1.1 million of its scheduled
requirements.  On April 30, 2010 the Company paid $6.5 million of
which $1.6 million reduced the Revolver to zero and $4.9 million was applied
against the Term Loan bringing the total debt outstanding to $49.0
million.




The
Company is required to pay the following amounts in each of the next four
years:




2010
                    
                    $
                    4,4002011
                    
                    
                    5,5002012
                    
                    
                    5,5002013
                    
                    
                    40,143Total
                    
                    $
                    55,543





The
interest rate under the Credit Agreement at March 31, 2010 was 4.75% while the
interest rate on the unused line was 0.5%.





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 Awards Plan.  Through March 31,
2010, the Company had granted a total of 11,535,000 stock options under the
Stock and Awards Plan, of which 489,000 were forfeited.




14




In
addition, during the first quarter of 2008, the compensation committee and
sub-committee of the compensation committee approved the issuance of up to
1,375,000 inducement stock options grants 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 utilizes two types of stock options, traditional service-based with a
four year graded vesting (25% vest each year) and market condition-based stock
options which vest when the underlying stock price reaches either $16.75 and
$20.25, respectively, and remains there for 20 out of 30 consecutive trading
days. Stock options are granted to recipients at exercise prices not less than
the fair market value of the Company’s stock at the dates of grant and can
consist solely of the service-based options or market conditions-based options
or a can consist of a combination of both types of options.  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, or as
determined by the Monte Carlo valuation model.





Number
      of
                    Outstanding
                    Shares
                
                
                Weighted
                    Average
                    Exercise
      Price
                
                
                Weighted
                    Average
                    Remaining
                    Life
      (Years)Shares
      at December 31, 2008
                
                
                12,045,000
                
                
                
                9.47
                
                
                
                7.03Options
      granted
                
                
                500,000
                
                
                
                6.46
                
                
                
                9.56Options
      exercised
                
                
                -
                
                
                
                -
                
                
                
                -Options
      canceled/forfeited
                
                
                (289,000
                )
                
                
                9.69
                
                
                
                .92Shares
      at December 31, 2009
                
                
                12,256,000
                
                
                
                9.34
                
                
                
                7.78Options
      granted
                
                
                175,000
                
                
                
                9.34
                
                
                
                9.96Options
      exercised
                
                
                -
                
                
                
                -
                
                
                
                -Options
      canceled/forfeited
                
                
                (10,000
                )
                
                
                8.99
                
                
                
                8.04Shares
      at March 31, 2010
                
                
                12,421,000
                
                
                
                9.34
                
                
                
                7.36Shares
      exercisable at March 31, 2010
                
                
                3,026,750
                
                
                $
                9.61
                
                
                
                7.40





The
weighted-average grant-date fair values of options granted during 2010, 2009 and
2008 were $3.03, $3.20 and $4.17, respectively.





The
following summarizes nonvested share activity as of March 31,
2010:





Shares
                
                
                Grant-Date
                    Fair
      ValueNonvested
      at beginning of year
                
                
                9,433,625
                
                
                $
                4.75Granted
                
                
                175,000
                
                
                
                3.03Vested
                
                
                (208,125
                )
                
                
                4.27Forfeited
                
                
                (6,250
                )
                
                
                4.23Non-vested
      at end of quarter
                
                
                9,394,250
                
                
                $
                4.72




15





As of
March 31, 2010, the total compensation cost related to nonvested awards not yet
recognized was $17.4 million with a weighted average remaining period of 1.35
years over which it is expected to be expensed.





The
Company accounts for its stock-based compensation awards in accordance with
authoritative accounting guidance for share-based payment,which requires
companies to recognize compensation expense for all equity-based compensation
awards issued to employees that are expected to vest. Compensation cost is based
on the fair value of awards as of the grant date.





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




Three
      Months Ended
                        March
      31,2010
                      
                      
                      2009Service
      period-based
                      
                      $
                      1,920
                      
                      
                      $
                      1,871Market
      price-based $16.75
                      
                      
                      965
                      
                      
                      
                      1,228Market
      price-based $20.25
                      
                      
                      893
                      
                      
                      
                      911Total
                      
                      $
                      3,778
                      
                      
                      $
                      4,010




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 of 7 years
for the service-based options and 10 years for the market price-based options,
no dividends and volatility of 35.9% - 52.08%. 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.
            Liquidity and capital
      resources




The
Company’s current cash position at March 31, 2009 was $14,004.  At
March 31, 2010, the Company had current liabilities of $36,767.  The
Company’s short term liabilities exceeded our available cash position by
$22,763.  As noted in the long-term debt footnote, the Company has a
revolving credit facility of $45,000, which it can use in addition to cash flows
generated from operations, to finance working capital requirements.




9.
            Interest rate
      derivatives




In
conjunction with the original variable-rate debt arrangement, which was
terminated on November 4, 2009, the Company entered into a notional $80,000
interest rate swap agreement which was designed to provide a constant interest
rate on the variable interest rate debt.  The swap agreement was
settled when the new financing was put in place on November 4,
2009.




16




10.
            License




A
substantial portion of the Company’s business is dependent on its exclusive
license of certain technology from Brandeis University. This license agreement,
dated June 1996, imposes certain obligations upon the Company, such as
diligently pursuing the development of commercial products under the licensed
technology. The agreement for each country expires at the end of the term of
each patent in such country 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 in the
first quarter of 2010 were approximately $298.




11.
            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 effective tax rate for the first
quarter was 33.4% which benefitted from resolution of prior years’ tax
issues.  The Company’s effective tax rate for the balance of 2010 is
estimated to be 39%.  The deferred tax liability represents primarily
the difference between the tax and accounting basis of intangible assets
acquired in the GFA merger.




12.
            Commitment and
      contingencies




As of
March 31, 2010, the Company had the following commitments and contractual
obligations:




●
            An
      amended lease agreement for the lease of a corporate office facility
      located in Paramus, NJ.  The lease was effective as of June 1,
      2008 and has a seven year life with the option to extend the lease for two
      additional five-year terms.  The annual rental expense is
      approximately $550 for the first five
years.




●
            Three
      lease agreements for the lease of a corporate office facility located in
      Niwot, Colorado.  The leases were effective as of August 1, 2007
      and have a five-year life with the option to extend each lease for two 36
      month terms.  The annual rental expense is approximately $150
      for the first five years.




●
            Forward
      purchase commitments for a portion of the Company's projected requirement
      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 $13.1 million as of March 31,
      2010.  The commitments are expected to be liquidated by the
      third quarter of 2010.




13.
            Legal
      Proceedings




The
Company is currently involved in the following legal proceedings:




17




On
February 8, 2010 a lawsuit was filed against Smart Balance, Inc. in the Federal
District Court for the Central District in California in Santa Ana,
California.  The complaint alleges, among other things, violations of
California’s unfair competition law, false advertising, and consumer remedies
act and seeks to identify all similarly situated plaintiffs and certify them in
a class action.  The Company has not yet answered the complaint, but
intends to vigorously defend itself.  The Company does not expect that
the resolution of this matter will have a material adverse effect on our
business.




In 2007,
three parties filed Oppositions to European Patent No. 820,307 relating to
increasing the HDL level and the HDL/LDL ratio in Human Serum by Balancing
Saturated and Polyunsaturated Dietary Fatty Acids.  We believe that
neither this proceeding, nor its outcome, will have any adverse effect on our
current business.




We are
not a party to any other legal proceeding that we believe would have a material
adverse effect on our business, results of operations or financial
condition.




18


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




This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the March 31, 2010 Condensed
Consolidated Financial Statements and the related Notes contained in this
quarterly report on Form 10-Q and our annual report on Form 10-K for the year
ended December 31, 2009. Forward-looking statements in this section are
qualified by the cautionary statement included under the heading, “Cautionary
Note Regarding Forward Looking Information,” above.




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, milk, sour cream and other
products primarily under the Smart Balance®trademark. In the natural food channel, we sell similar natural and
organic 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 Smart
Balance®, Earth
Balance®,
SmartBeat®,
BestlifeTM and Nucoa®, is by
far our most developed product group and accounted for approximately 75% of
sales for the three months ended March 31, 2010.  Our products are
sold throughout the U.S.  A majority of our products are sold through
supermarket chains and food wholesalers.




We
outsource production of finished goods to third-party
manufacturers.  We do not own or operate any manufacturing
facilities.  Outsourcing allows us to 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
manufacturers supply our products at a price equal to the cost of ingredients
and certain packaging plus a contracted toll charge.  We use third
party distributors and a network of public warehouses to deliver products from
our manufacturers to our customers.




Our goal
is to become a recognized leader in providing nutritious and good tasting
products for a wide variety of consumer needs.  We believe the Smart
Balance®brand
has the potential to become a broad functional foods platform across multiple
food categories.  Our primary growth strategy is two-fold: (1) to
drive consumer and trade awareness of our brands and (2) to increase purchase
frequency by expanding product offerings and distribution in our core category
of spreads and into other dairy categories.  In order to drive
consumer and trade awareness of our brands and add more households that prefer
our products, we will continue to use marketing and promotional programs to
drive trial and encourage brand loyalty. We spent over $40 million in 2008 for
consumer marketing and promotion and over $50 million in 2009.  In
order to increase purchase frequency and expand our product offerings and
distribution, during 2008 we launched a successful distribution initiative to
increase shelf presence in retailers.  The effort substantially
increased the average number of our products that retailers have on the shelf,
especially in the spreads category.


19




2009 was
an important year in creating a foundation necessary to support growth over the
next several years.  We increased our market share and profitability
in the core spreads category, established our dairy initiative, lead by our
enhanced milk products, and refinanced our credit facility with a strategically
flexible capital structure.




In our
core spreads category, for the year ended December 31, 2009 our dollar market
share was up a full point to 14.6% according to Information Resources
Incorporated data for the food channel.  Accordingly, we
were first among competitors in dollar share growth in 2009 and second
behind private label in unit share growth, a solid accomplishment for a premium
priced product in this economy.  We are now the number two marketer of
spreads in the U.S. on a dollar basis. In the first three months of 2010, our
market share was 15.2%, unchanged from the same period in the prior
year.  Our strategy has always been to maintain price and product
positioning as a premium brand.  As a result, we lost some volume
opportunities over the last nine months as consumers continued to be price
sensitive and competitors sought to increase unit share through price
promotion





For our
dairy initiative in 2009, we expanded distribution of milks to the Northeast,
beyond the initial Florida market.  We launched sour cream products
later in the year to increase our positioning in the dairy aisle.  Our
current dairy aisle initiative is the critical part of our growth
plan.  Centered on the high purchase frequency of the milk category,
we believe success in expanding in the diary aisle will be the driver toward our
growth goals.




In
2009, our gross margins improved substantially from 2008, and for the first
quarter ended March 31, 2010, our gross margins improved from the same period
ended 2009.  During 2009 and through the first quarter ended 2010, we
benefited from lower and stable oil prices compared to the unprecedented levels
witnessed during 2008.  Milk prices were also considerably lower in
2009 compared to 2008.  Both oil and milk are expected to trend up in
2010 and the Company uses various financial tools including hedging to ensure
supply at stable prices. During 2009, we saw significant increases in trade and
consumer promotion costs that negatively impacted both net sales and gross
margin.  These spending increases were designed to offer pricing
relief to our core consumers, as well as drive trial of our new
products.




We
restructured our long-term debt in November 2009 to give the Company greater
flexibility in strategic areas such as acquisitions and capital structure with
higher available credit and less restrictive financial covenants than our
previous facility.  At the end of March 2010 our debt was $55.5
million.  On April 30, 2010, we repaid $6.5 million of debt bringing
the balance to $49.0 million.  Our board authorized a two-year, $25
million stock repurchase program, which became effective starting in March
2010.  However, no amounts have been repurchased at March 31,
2010.




In 2009,
we signed an exclusive license agreement to use the BestlifeTM brand across
virtually all food and beverage categories.  The Best Life® program
was developed by Bob Greene, Oprah’s trainer and nutritional
advisor.  We believe that this relationship provides us with a
significant opportunity to use a targeted marking approach to penetrate the
value segment of the spreads category and other categories where the Smart
Balance® does not participate.




20




In 2010,
we are expanding milk and sour cream nationally and using advertising and other
marketing to drive trial. To continue to grow our presence in the spreads
category, we have developed our three-tier strategy, which allows us to compete
in multiple segments in the spreads category, with our Earth Balance® brand
in the super premium segment,  our Smart Balance®brand
in the healthy premium segment and our new BestlifeTM brand in the value
segment.  We expect pricing pressure in the spreads category to
continue for at least several quarters due to the economic conditions and
competitive promotional activity that started mid-year in 2009.




Results
of Operations




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.




Results
of Operations for the Three Months Ended March 31, 2010 Compared to the Three
Months Ended March 31, 2009




(In
      millions except share data)
                  
                  Three
      Months Ended
                    March
      31,2010
                  
                  
                  2009Net
      sales
                  
                  $
                  63.6
                  
                  
                  $
                  62.6Cost
      of goods sold
                  
                  
                  30.3
                  
                  
                  
                  34.3Gross
      profit
                  
                  
                  33.3
                  
                  
                  
                  28.3Operating
      expenses
                  
                  
                  27.5
                  
                  
                  
                  25.1Operating
      income
                  
                  
                  5.8
                  
                  
                  
                  3.2Other
      expenses, net
                  
                  
                  (1.3
                  )
                  
                  
                  (1.3
                  )Income
      before income taxes
                  
                  
                  4.5
                  
                  
                  
                  1.9Provision
      for income taxes
                  
                  
                  1.5
                  
                  
                  
                  0.8Net
      income
                  
                  $
                  3.0
                  
                  
                  $
                  1.1Net
      income per common share
                    -
      basic and diluted
                  
                  $
                  0.05
                  
                  
                  $
                  0.02





Net
Sales:




Our net
sales for the three months ended March 31, 2010 increased 1.7% to $63.6 million
from $62.6 million for the three months ended March 31, 2009.  The
increase was primarily due to higher volumes, largely offset by increased trade
and product introduction costs.  The increase in volume was due
primarily to the national expansion of milk distribution, growth in the spreads
category, and the impact of the introduction of sour cream, partially offset by
a 16% decline in case shipments of all other products.  Our spreads
volume increased by 4% due to the distribution of new spreads products,
including the Smart Balance calcium added variety and the BestlifeTM line of
spreads.




21




Cost
of Goods Sold:




Cost of
goods sold for the three months ended March 31, 2010 was $30.3 million, a 11.7%
decrease from the same period in 2009.  The decrease was due to lower
input costs, notably vegetable oils used in the Company’s products, partially
offset by an increase in volume.




Gross
Profit:




Our gross
profit increased $5.0 million to $33.3 million for the three months ended March
31, 2010 from $28.3 million from the same period in 2009, due to the benefit of
favorable input costs and an increase in volume, partially offset by higher
trade promotion costs and product introduction costs.




Gross
profit as a percentage of net sales was 52.4% for the three months ended March
31, 2010 compared to 45.1% during the same period in 2009.  This
increase was due primarily to the benefit of lower input costs, partially offset
by higher trade promotion costs and product introduction
costs.




Operating
Expenses:




Total
operating expenses for the three months ended March 31, 2010 were $27.5 million
compared to $25.1 million for the corresponding period in 2009, an increase of
$2.4 million.  The operating expenses include selling, marketing and
general and administrative expenses.  The increase reflected higher
marketing investments behind product expansions and increased selling expense
due to product mix (higher milk shipments).




Operating
Income:




Our
operating income was $5.8million for the three
months ended March 31, 2010 compared with operating income of $3.2 million for
the corresponding period in 2009.  Operating income increased $2.6
million, as the $5.0 million increase in gross margin was partially offset by a
$2.4 million increase in operating expenses, reflecting higher marketing
investments to support growth and higher selling expenses due to the increased
shipments of dairy products.




Other
Income (Expense):




We
incurred other expenses of $1.3 million for the three months ended March 31,
2010 and in the corresponding period in 2009.  The results for 2010
and 2009 included net interest expense of $1.0 and $1.1million,
respectively.  Included in the 2009 net interest expense was a $0.5
million gain on derivatives related to our interest rate swap.




Income
Taxes:




The
provision for income taxes for the three months ended March 31, 2010 was $1.5
million compared with $0.8 million for the corresponding period in
2009.  The effective tax rate for the three months ended March 21,
2010 was 33.4% benefitting from resolution of prior years’ tax
issues.




22




Net
Income:




Our net
income for the first three months of 2010 was $3.0 million compared with $1.1
million for the corresponding period in 2009, an increase of $1.9 million,
reflecting the higher operating income and lower tax rate.




Net
Income Per Common Share:




Our basic
and diluted net income per share in the first quarter of 2010 was $0.05 compared
to $0.02 in the corresponding period in 2009, based on the basic and
diluted weighted average shares outstanding of 62.6 million and 62.7 million, in
the first quarter of 2010 and 2009 respectively.  The improvement in
earnings per share was due to lower product unit costs and increased volume,
partially offset by higher marketing, trade and product introduction
costs.




Organization
Realignment




The
Company announced an organizational realignment together with the retirement of
Robert Gluck, chief operating officer and vice chairman.  Effective
immediately, all functional leadership of the Company will report to Steve
Hughes, chief executive officer.  There are several other changes
within the organization.




Ongoing
cash saving from the realignment is estimated to be $2.7 million
annually.  Associated with these changes, there will be a charge to
earnings in the second quarter of $3.0 to $3.5 million.  Total general
and administrative expenses are expected to range from $48 to $49 million for
2010, excluding any charges for the realignment, reflecting a half-year of
savings.  These estimates may change depending on the final details of
the organizational changes.




Part of
the changes in expense will be to the 123r stock option expense, which is a
non-cash charge.  That expense is estimated to be approximately $2.3
million in the second quarter and about $12 million for 2010.  The
expense steps down to approximately $6.5 million in 2011 and 2.2 million in
2012.  These estimates may change depending on the final details of
the organization realignment and don’t anticipate future organization
changes.




Any
savings from the organization realignment in 2010 is expected to be used to
support business growth.




Going
forward, general expenses after the savings will increase due to inflation and
support for growth as needed, but will decrease as a percent to net sales as the
business grows.




Cash
Flows




Cash
provided by operating activities was $8.1million for the three
months ended March 31, 2010 compared to $2.9 million in the corresponding
period in 2009.  For the first three months of 2010, we had net income
of $3.0 million, which included $3.8 million of non-cash stock-based
compensation expenses and $1.3 million of depreciation expense, offset by
increased working capital needs of $1.3 million.  For the first three
months of 2009, we had net income of $1.1 million, which included $4.0 million
of non-cash stock-based compensation expenses and $1.2 million of depreciation
expense, offset by increased working capital needs of $2.0 million.




23




Cash used
in investing activities totaled $0.5 million for the three months ended
March 31, 2010, compared to $0.3 million during the three months ended
March 31, 2009 which resulted mostly from purchase of software development
costs.




Cash used
in financing activities for the three months ended March 31, 2010 was $1.1
million, compared to nothing for the corresponding period in 2009, resulting
from the repayment of debt.




Cash Operating
Income




The
Company uses the term “cash operating income” as an important measure of
profitability and performance.   Cash operating income is a non-GAAP
measure defined as operating income excluding stock based compensation,
depreciation, and amortization of intangibles.  Our cash operating
income was $10.9 million in the first quarter of 2010 compared to $8.4 million
in the first quarter of 2009.  Our management uses cash operating
income for planning purposes, and we believe this measure provides investors and
securities analysts with important supplemental information regarding the
Company’s profitability and operating performance.  However, non-GAAP
financial measures such as cash operating income should be viewed in addition
to, and not as an alternative for, the Company's results prepared in accordance
with GAAP.  In addition, the non-GAAP measures the Company uses may differ
from non-GAAP measures used by other companies.  We have included
reconciliations of cash operating income to operating income as calculated in
accordance with GAAP.







Three Months Ended(in millions)
                          
                          March 31,
                            2010
                          
                          
                          March 31,
                            2009Operating
      income
                          
                          $
                          5.8
                          
                          
                          $
                          3.2Add
      back:Depreciation
      and amortization of intangibles
                          
                          
                          1.3
                          
                          
                          
                          1.2Stock
      option expense
                          
                          
                          3.8
                          
                          
                          
                          4.0Cash
      Operating Income
                          
                          $
                          10.9
                          
                          
                          $
                          8.4




24




Liquidity and Capital
Resources




Liquidity:




Our
liquidity planning is largely dependent on our 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. Our
principal liquidity requirements are to finance current operations, pay down
existing indebtedness and fund future expansion.  Under our Credit
Agreement the Company can also repurchase common stock subject to a
determination of its excess cash flow as defined in that agreement. In December
2009, the Board approved the repurchase of up to $25 million of shares over a
two year period.  Currently, our primary source of liquidity 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
next twelve months.  As of March 31, 2010, $43.4 million was available
for borrowing under our Revolver and we had $14 million of
cash.  Developing and bringing to market other new brands and business
opportunities may require additional outside funding, which may require us to
seek out additional financing arrangements.





Secured
Debt Financing:




On
November 4, 2009, the Company, through its wholly-owned subsidiary GFA Brands,
Inc. (the “Borrower”), entered into a Credit Agreement (the “Credit Agreement”)
with the various Lenders named therein (the “Lenders”), and Bank of Montreal, as
Administrative Agent (the “Agent”).  The Credit Agreement provides for
$100 million in secured debt financing consisting of a $55 million term
loan (the “Term Loan”) and a $45 million revolving credit facility (the
“Revolver”).  The Revolver includes a $5 million sublimit for the
issuance of letters of credit and a $5 million sublimit for swing line
loans.  Subject to certain conditions, the Borrower, to the extent
existing Lenders decline to do so by adding additional Lenders, may increase the
Term Loan or increase the commitments under the Revolver (or a combination of
the two) up to an aggregate additional amount of $5 million, at the Borrower’s
option.




The
Credit Agreement replaced the Company’s prior first lien and second lien credit
facilities with Bank of America Securities LLC and Bank of America, N.A. (the
“Prior Facilities”).  Proceeds of the Credit Agreement were used to
repay the debt outstanding under the Prior Facilities and may also be used for
general corporate purposes and general working capital purposes.




The Term
Loan and the loans made pursuant to the Revolver will mature on November 3,
2013.  The Credit Agreement requires annual principal payments on the
Term Loan of $5.5 million.




Loans
outstanding under the Credit Agreement will bear interest, at the Borrower’s
option, at either a base rate (defined in the Credit Agreement as the greatest
of (i) 2.5%, (ii) the Agent’s prime rate, (iii) the federal funds rate plus
0.50% and (iv) a reserve adjusted one-month LIBOR rate plus 1.0%) or a
Eurodollar rate (of no less than 1.5%), in each case plus an applicable
margin.  The applicable margin is determined under the Credit
Agreement based on the ratio of the Company’s total funded debt to EBITDA for
the prior four fiscal quarters (the “Leverage Ratio”), and may range from 2.25%
to 3.25%, in the case of base rate loans, and 3.25% to 4.25%, in the case of
Eurodollar rate loans.  The Borrower must also pay a commitment fee on
the unused portion of the Revolver determined under the Credit
Agreement  based on the ratio of the Company’s Leverage Ratio and may
range from 0.50% to 0.75%.




25




Subject
to certain conditions, the Borrower may voluntarily prepay the loans under the
Credit Agreement in whole or in part, without premium or penalty (other than
customary breakage costs).  Mandatory prepayments that are required
under the Credit Agreement include:




●
            100%
      of the net cash proceeds (as defined in the Credit Agreement) upon certain
      dispositions of property or upon certain damages or seizures of property,
      subject to limited exceptions;




●
            50%
      of all net cash proceeds from issuance of additional equity securities of
      the Company, subject to limited exceptions, provided, however, if the
      Company’s Leverage Ratio is less than 2.0 as of the end of the most
      recently ended quarter, the prepayment is limited to 25% of such
      proceeds;




●
            100%
      of the amount of net cash proceeds for certain issuances of additional
      indebtedness for borrowed money;
and




●
            Beginning
      on December 31, 2010 and each fiscal year thereafter, an annual prepayment
      equal to 25% of excess cash flow of the Company (as defined in the Credit
      Agreement) for such fiscal year, provided such prepayment is not required
      if the Company has a Leverage Ratio of 2.0 or less, measured as of the end
      of such fiscal year.




The
Credit Agreement contains covenants that are customary for agreements of this
type.  These covenants include, among others: a limitation on the
incurrence of additional indebtedness; a limitation on mergers, acquisitions,
investments and dividend payments; and maintenance of specified financial
ratios.  Under the Credit Agreement, the Company must maintain (1) a
Leverage Ratio that is not greater than 2.75 to 1.0 until December 30, 2011 and
not greater than 2.50 to 1.0 thereafter and (2) a ratio of EBITDA to Debt
Service (as defined in the Credit Agreement), in each case for the prior four
fiscal quarters, of not less than 2.00 to 1.00.  The Company is also
limited to spending not more than $6 million of capital expenditures per year
with any unspent funds carried over to the next twelve months.  At
March 31, 2010, the Company was in compliance with all of its
covenants.




The
failure to satisfy covenants under the Credit Agreement or the occurrence of
other specified events that constitute an event of default could result in the
acceleration of the repayment obligations of the Borrower.  The Credit
Agreement contains customary provisions relating to events of default for
agreements of this type. The events of default include, among others: the
nonpayment of any outstanding principal, interest, fees or other amounts due
under the Credit Agreement; certain bankruptcy events, judgments or decrees
against the Company or the Borrower; cross defaults to other indebtedness
exceeding $5.0 million; a change in control (as defined in the Credit Agreement)
of the Company or the Borrower; and the failure to perform or observe covenants
in the Credit Agreement.




26


The
obligations under the Credit Agreement are guaranteed by the Company and all
existing and future subsidiaries of the Borrower.  The Borrower, the
Company and the other guarantors granted to the Agent, for the benefit of the
Lenders, a security interest in substantially all of its respective assets,
including, among other things, patents, patent licenses, trademarks and
trademark licenses.




After the
close of the transaction, total debt outstanding under the Credit Agreement
totaled approximately $60.6 million comprised of $55 million of Term Loan debt
and $5.6 million of borrowings under the Revolver.  During the fourth
quarter of 2009, the Company paid approximately $4.0 million on its Revolver and
during the first quarter of 2010 it paid $1.1 million of its scheduled
requirements.  On April 30, 2010 the Company paid $6.5 million of
which $1.6 million reduced the Revolver to zero and $4.9 million was applied
against the Term Loan bringing the total debt outstanding to $49.0
million.




The
Company is required to pay the following amounts in each of the next four
years:




2010
                    
                    $
                    4,4002011
                    
                    
                    5,5002012
                    
                    
                    5,5002013
                    
                    
                    40,143Total
                    
                    $
                    55,543





The
interest rate under the Credit Agreement at March 31, 2010 was 4.75% while the
interest rate on the unused line was 0.5%.


Contractual
Obligations




There
has been no material change to our contractual obligations as disclosed in the
fiscal year 2009 Form 10-K filed with the SEC on March 10, 2010.




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 are
exposed to financial market risks due primarily to changes in interest rates on
our variable interest rate debt.  Under our Credit Agreement, we are
subject to changes in interest rates, but are not required to enter into an
interest rate swap until the market LIBOR rate exceeds 1.5%.  The
three-month LIBOR rate at March 31, 2010 was 0.31 %.




We
purchase significant amounts of soy, palm and canola oil products to support the
needs of our brands. The price and availability of these commodities directly
impacts our results of operations and can be expected to impact our future
results of operations. 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 existing authoritative accounting guidance, namely,
“Accounting for Derivative Instruments and Hedging Activities.”  Based
on the most recent prices for soy, palm and canola oil products, as of March 31,
2010 we had commitments of $13.1 million.




27




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 of approximately $1.5
million per year.  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.




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 March 31, 2010. 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 Officer, as appropriate to
allow timely decisions regarding required disclosure. 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 March 31, 2010, our Chief Executive
Officer and Principal Financial Officer concluded that, as of such date, our
disclosure controls and procedures were effective.




Changes in internal control over
financial reporting.During the fiscal quarter ended March 31, 2010,
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.




28


Part
II.            Other
Information




Item 1.             Legal
Proceedings.




The
Company is currently involved in the following legal proceedings:




On
February 8, 2010 a lawsuit was filed against Smart Balance, Inc. in the Federal
District Court for the Central District in California in Santa Ana,
California.  The complaint alleges, among other things, violations of
California’s unfair competition law, false advertising, and consumer remedies
act and seeks to identify all similarly situated plaintiffs and certify them in
a class action.  The Company has not yet answered the complaint, but
intends to vigorously defend itself.  The Company does not expect that
the resolution of this matter will have a material adverse effect on our
business.




In 2007,
three parties filed Oppositions to European Patent No. 820,307 relating to
increasing the HDL level and the HDL/LDL ratio in Human Serum by Balancing
Saturated and Polyunsaturated Dietary Fatty Acids.  We believe that
neither this proceeding, nor its outcome, will have any adverse effect on our
current business.




We are
not a party to any other legal proceeding that we believe would have a material
adverse effect on our business, results of operations or financial
condition.




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,
2009.




Item 6.             Exhibits.




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




29


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.




May
      6, 2010
            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)




30


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




31