UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q
       ------------------------------------------------------------------

(Mark One)

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

                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005

                                       OR

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


                          -----------------------------
                         COMMISSION FILE NUMBER 1-15345


                         GALAXY NUTRITIONAL FOODS, INC.
             (Exact name of registrant as specified in its charter)


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

           2441 VISCOUNT ROW
            ORLANDO, FLORIDA                                      32809
(Address of principal executive offices)                        (Zip Code)


                                 (407) 855-5500
              (Registrant's telephone number, including area code)

      Indicate by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. YES |X| NO |_|

      Indicate by check mark whether the registrant is an accelerated  filer (as
defined in Rule 12b-2 of the Exchange Act). YES |_| NO |X|

      On August 18, 2005, there were 20,043,474 shares of common stock, $.01 par
value per share, outstanding.


<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.

                               INDEX TO FORM 10-Q
                       FOR THE QUARTER ENDED JUNE 30, 2005


                                                                        PAGE NO.

PART I. FINANCIAL INFORMATION

      ITEM 1. FINANCIAL STATEMENTS

         Balance Sheets                                                        3
         Statements of Operations                                              4
         Statement of Stockholders' Equity                                     5
         Statements of Cash Flows                                              6
         Notes to Financial Statements                                         7

      ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
              FINANCIAL CONDITION AND RESULTS OF OPERATIONS                   16

      ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      30

      ITEM 4. CONTROLS AND PROCEDURES                                         31

PART II.  OTHER INFORMATION

      ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS     32

      ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                 32

      ITEM 6. EXHIBITS                                                        33

SIGNATURES                                                                    36


                                       2
<PAGE>

<TABLE>
<CAPTION>
                                              PART I. FINANCIAL INFORMATION
                                              GALAXY NUTRITIONAL FOODS, INC.
                                                      BALANCE SHEETS
                                                                                         JUNE 30,             MARCH 31,
                                                                            NOTES          2005                 2005
                                                                           --------  ---------------      ---------------
<S>                                                                        <C>       <C>                  <C>
                                                                                        (UNAUDITED)           RESTATED
                                                          ASSETS
CURRENT ASSETS:

  Cash                                                                               $            --      $       561,782
  Trade receivables, net                                                     12            5,553,245            4,644,364
  Inventories                                                                              4,018,049            3,811,470
  Prepaid expenses and other                                                                 492,078              219,592
                                                                                     ---------------      ---------------
         Total current assets                                                             10,063,372            9,237,208

PROPERTY AND EQUIPMENT, NET                                                   7            9,872,074           18,246,445
OTHER ASSETS                                                                                 414,970              286,013
                                                                                     ---------------      ---------------
         TOTAL                                                                       $    20,350,416      $    27,769,666
                                                                                     ===============      ===============

                                           LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Line of credit                                                              2      $     4,736,456      $     5,458,479
  Book overdraft                                                                             541,317                   --
  Accounts payable                                                                         3,072,601            3,057,266
  Accrued and other current liabilities                                       3            1,660,631            2,130,206
  Current portion of accrued employment contract                             11              586,523              586,523
  Current portion of term notes payable                                       2            7,801,985            1,320,000
  Current portion of obligations under capital leases                                        154,502              194,042
                                                                                     ---------------      ---------------
         Total current liabilities                                                        18,554,015           12,746,516

ACCRUED EMPLOYMENT CONTRACT, less current portion                            11              846,240              993,305
TERM NOTES PAYABLE, less current portion                                      2                   --            6,921,985
OBLIGATIONS UNDER CAPITAL LEASES, less current portion                                        76,883               85,337
                                                                                     ---------------      ---------------
         Total liabilities                                                                19,477,138           20,747,143
                                                                                     ---------------      ---------------
COMMITMENTS AND CONTINGENCIES                                                 4                   --                   --

STOCKHOLDERS' EQUITY:
  Common stock                                                                               200,435              184,115
  Additional paid-in capital                                                              72,336,928           69,358,379
  Accumulated deficit                                                                    (58,771,424)         (49,627,310)
                                                                                     ---------------      ---------------
                                                                                          13,765,939           19,915,184
  Less:   Notes receivable arising from the exercise of stock options        11          (12,772,200)         (12,772,200)
        Treasury stock                                                                      (120,461)            (120,461)
                                                                                     ---------------      ---------------
         Total stockholders' equity                                                          873,278            7,022,523
                                                                                     ---------------      ---------------
         TOTAL                                                                       $    20,350,416      $    27,769,666
                                                                                     ===============      ===============


                                      See accompanying notes to financial statements
</TABLE>


                                                            3
<PAGE>

<TABLE>
<CAPTION>
                                     GALAXY NUTRITIONAL FOODS, INC.
                                        STATEMENTS OF OPERATIONS
                                               (UNAUDITED)

                                                                              THREE MONTHS ENDED
                                                                                   JUNE 30,
                                                                     -----------------------------------
                                                         NOTES             2005                2004
                                                       ---------     --------------       --------------
<S>                                                    <C>           <C>                  <C>
                                                                                             RESTATED

NET SALES                                                            $    9,851,153       $   11,191,678

COST OF GOODS SOLD                                                        7,582,855            8,251,330
                                                                     --------------       --------------
  Gross margin                                                            2,268,298            2,940,348
                                                                     --------------       --------------
OPERATING EXPENSES:
Selling                                                                     936,245            1,460,400
Delivery                                                                    615,471              593,326
General and administrative, including $527,518 and        6
  $162,374 non-cash compensation related to stock
  based transactions                                                      1,261,530              795,716
Research and development                                                     91,042               72,686
Impairment of property and equipment                      7               7,896,554                   --
Cost of disposal activities                               8                 255,011                   --
(Gain)/Loss on sale of assets                                                  (636)                  --
                                                                     --------------       --------------
  Total operating expenses                                               11,055,217            2,922,128
                                                                     --------------       --------------

INCOME (LOSS) FROM OPERATIONS                                            (8,786,919)              18,220

Interest expense                                                            357,195              259,816
Derivative expense                                        5                      --              121,119
                                                                     --------------       --------------
NET LOSS                                                             $   (9,144,114)      $     (362,715)

Less:
Preferred Stock Dividends                                 5                      --               42,392
Preferred Stock Accretion to Redemption Value             5                      --              500,644
                                                                     --------------       --------------
NET LOSS TO COMMON STOCKHOLDERS                                      $   (9,144,114)      $     (905,751)
                                                                     ==============       ==============
BASIC AND DILUTED NET LOSS PER COMMON SHARE               9          $        (0.49)      $        (0.06)
                                                                     ==============       ==============
</TABLE>


                             See accompanying notes to financial statements.


                                                    4
<PAGE>

<TABLE>
<CAPTION>

                                                   GALAXY NUTRITIONAL FOODS, INC.
                                                 STATEMENTS OF STOCKHOLDERS' EQUITY
                                                            (UNAUDITED)

                                                                                             Notes
                            Common Stock                                                   Receivable
                      ---------------------------     Additional      Accumulated        for Common        Treasury
                         Shares       Par Value     Paid-In Capital     Deficit             Stock           Stock          Total
                      -------------------------------------------------------------------------------------------------------------
<S>                   <C>           <C>           <C>                <C>                <C>              <C>           <C>
Balance at March 31,   18,411,474   $  184,115    $    69,358,379    $   (49,627,310)   $  (12,772,200)  $ (120,461)   $  7,022,523
  2005 (RESTATED)

Exercise of warrants    1,630,000       16,300          1,712,700                 --                --           --       1,729,000
Exercise of options         2,000           20              2,540                 --                --           --           2,560
Fair value of
  stock-based
  transactions                 --           --          1,432,750                 --                --           --       1,432,750
Non-cash compensation
  related to variable
  securities                   --           --           (169,441)                --                --           --        (169,441)
Net loss                       --           --                 --         (9,144,114)               --           --      (9,144,114)
                      -------------------------------------------------------------------------------------------------------------
Balance at June 30,
  2005                 20,043,474   $  200,435    $    72,336,928    $   (58,771,424)   $  (12,772,200)  $ (120,461)   $    873,278
                      =============================================================================================================


                                           See accompanying notes to financial statements
</TABLE>


                                                                 5
<PAGE>

<TABLE>
<CAPTION>

                                                GALAXY NUTRITIONAL FOODS, INC.
                                                   STATEMENTS OF CASH FLOWS
                                                         (UNAUDITED)


THREE MONTHS ENDED JUNE 30,                                                        NOTES         2005              2004
                                                                                  -------   --------------     --------------
<S>                                                                               <C>       <C>                <C>
                                                                                                                  RESTATED
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net Loss                                                                                  $   (9,144,114)    $     (362,715)
  Adjustments to reconcile net loss to net cash from (used in)
    operating activities:
      Depreciation and amortization                                                                539,103            546,041
      Amortization of debt discount and financing costs                                             27,422             33,349
      Provision for losses on trade receivables                                                    313,000            107,000
      Impairment of property and equipment and (gain)/loss on sale
        of assets                                                                   7            7,895,919                 --
      Change in fair value of derivative instrument                                 5                   --            121,119
      Non-cash compensation related to stock-based transactions                    1,6             527,518            162,374
      (Increase) decrease in:
        Trade receivables                                                                       (1,221,881)          (976,993)
        Inventories                                                                               (206,579)           (80,798)
        Prepaid expenses and other                                                                (272,486)          (281,686)
      Increase (decrease) in:
        Accounts payable                                                                            15,335          1,297,022
        Accrued and other liabilities                                                              123,360             13,325
                                                                                            --------------     --------------
   NET CASH FROM (USED IN) OPERATING ACTIVITIES                                                 (1,403,403)           578,038
                                                                                            --------------     --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property and equipment                                                               (68,851)           (74,525)
  Proceeds from sale of equipment                                                                    8,200                 --
                                                                                            -----------------  ---------------
   NET CASH FROM (USED IN) INVESTING ACTIVITIES                                                    (60,651)           (74,525)
                                                                                            -----------------  ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:                                               10
  Increase in book overdrafts                                                                      541,317                 --
  Net borrowings (payments) on line of credit                                                     (722,023)            53,574
  Repayments on term notes payable                                                                (440,000)          (150,000)
  Principal payments on capital lease obligations                                                  (47,994)           (67,487)
  Financing costs for long term debt                                                              (160,588)                --
  Costs associated with issuance of common stock                                                        --            (22,500)
  Proceeds from exercise of common stock options                                                     2,560                 --
  Proceeds from exercise of common stock warrants                                   5            1,729,000                 --
                                                                                            --------------     --------------
   NET CASH FROM (USED IN) FINANCING ACTIVITIES                                                    902,272           (186,413)
                                                                                            --------------     --------------
NET INCREASE (DECREASE) IN CASH                                                                   (561,782)           317,100

CASH, BEGINNING OF PERIOD                                                                          561,782            449,679
                                                                                            --------------     --------------
CASH, END OF PERIOD                                                                         $           --     $      766,779
                                                                                            ==============     ==============


                                        See accompanying notes to financial statements
</TABLE>


                                                              6
<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)

(1)   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      The  unaudited   financial   statements   have  been  prepared  by  Galaxy
      Nutritional  Foods, Inc. (the "Company"),  under the rules and regulations
      of the  Securities and Exchange  Commission.  The  accompanying  financial
      statements  contain  all normal  recurring  adjustments  which are, in the
      opinion  of  management,  necessary  for  the  fair  presentation  of such
      financial   statements.   Certain  information  and  disclosures  normally
      included in the financial statements prepared in accordance with generally
      accepted  accounting  principles  have been  omitted  under such rules and
      regulations  although  the  Company  believes  that  the  disclosures  are
      adequate to make the information  presented not misleading.  The March 31,
      2005 balance sheet data was derived from the audited financial statements,
      but does not include all  disclosures  required by  accounting  principles
      generally  accepted  in the  United  States of  America.  These  unaudited
      financial  statements  should be read in  conjunction  with the  financial
      statements and notes included on Form 10-K for the fiscal year ended March
      31, 2005.  Interim results of operations for the three-month  period ended
      June 30,  2005 may not  necessarily  be  indicative  of the  results to be
      expected for the full year.

      Impairment of Long-Lived Assets
      In  accordance  with  SFAS No.  144,  "Accounting  for the  Impairment  of
      Disposal of Long-Lived  Assets," the Company  evaluates the carrying value
      of long-lived  assets when  circumstances  indicate the carrying  value of
      those  assets  may  not  be  fully  recoverable.   The  Company  evaluates
      recoverability  of  long-lived  assets held for use by  comparing  the net
      carrying value of an asset group to the estimated  undiscounted cash flows
      (excluding interest) during the remaining life of the asset group. If such
      an evaluation indicates that the future undiscounted cash flows of certain
      long-lived  asset groups are not  sufficient to recover the carrying value
      of such asset  groups,  the assets are then adjusted to their fair values.
      The Company  recorded an impairment of property and equipment in the first
      quarter of fiscal 2006 as discussed more fully in Note 7.

      Stock Based Compensation
      The Company has three stock-based  employee  compensation  plans. Prior to
      April 1, 2003, the Company accounted for those plans under the recognition
      and measurement  provisions of Accounting Principles Board Opinion No. 25,
      "Accounting  for Stock  Issued to  Employees,"  (APB No. 25),  and related
      Interpretations.

      Effective  April 1, 2003, the Company  adopted the fair value  recognition
      provisions  of Statement of Financial  Accounting  Standards  ("SFAS") No.
      123,  "Accounting  for  Stock-Based  Compensation,"  prospectively  to all
      employee  awards  granted  on or after  April  1,  2003.  Awards  from the
      Company's  plans vest over periods  ranging from  immediate to five years.
      Therefore,  the cost related to stock-based  compensation  included in the
      determination  of net income for  periods in fiscal  2004 and 2005 is less
      than that which would have been  recognized if the fair value based method
      had been applied to all awards since the original  effective  date of SFAS
      No. 123.

      The Company  furnishes the pro forma  disclosures  required under SFAS No.
      123 and applies SFAS No. 148,  "Accounting for Stock-Based  Compensation -
      Transition  and  Disclosure"  on a prospective  basis for all  stock-based
      awards on or after April 1, 2003.  These standards  require the Company to
      provide  pro-forma  information  regarding  net income (loss) and earnings
      (loss) per share  amounts as if  compensation  cost for all the  Company's
      employee and director stock-based awards had been determined in accordance
      with  the fair  value  method  prescribed  in SFAS No.  123.  The  Company
      estimated  the fair value of each  stock-based  award  during the  periods
      presented  by using the  Black-Scholes  pricing  model with the  following
      assumptions:

              Three Months Ended:              June 30,            June 30,
                                                 2005                2004
                                               --------            --------
              Dividend Yield                     None                None
              Volatility                          46.00%              47.80%
              Risk Free Interest Rate              3.45%               2.07%
              Expected Lives in Months              1                   9


                                       7
<PAGE>

      Under the  accounting  provisions  of SFAS No. 123, the Company's net loss
      and net loss per basic and diluted  share  would have been  reduced to the
      pro forma amounts indicated below:

                                                       THREE MONTHS ENDED
                                                            JUNE 30,
                                                  -----------------------------
                                                      2005             2004
                                                  -------------    ------------
      Net loss to common stockholders as          $  (9,144,114)   $   (905,751)
       reported
       Add:  Stock-based compensation
       expense included in reported net loss            527,518         162,374
       Deduct:  Stock-based compensation
       expense determined under fair value
       based method for all awards                     (537,593)       (192,581)
                                                  -------------    ------------
       Pro forma net loss to common
       stockholders                               $  (9,154,189)   $   (935,958)
                                                  =============    ============

      Net loss per common share:
       Basic & Diluted - as reported              $       (0.49)   $      (0.06)
       Basic & Diluted - pro forma                $       (0.49)   $      (0.06)

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

      Use of Estimates
      The  preparation  of financial  statements in conformity  with  accounting
      principles  generally  accepted in the United  States of America  requires
      management  to make  estimates  and  assumptions  that affect the reported
      amounts of assets and liabilities and disclosure of contingent  assets and
      liabilities at the date of the financial  statements and reported  amounts
      of  revenues  and  expense  during the  reporting  period.  The  Company's
      significant   estimates   include  the  allowance  for  doubtful  accounts
      receivable, which is made up of reserves for promotions, discounts and bad
      debts, provision for inventory obsolescence,  valuation of deferred taxes,
      and valuation of stock options and warrants.  Actual  results could differ
      from those estimates.

      Reclassifications
      Certain  items in the  financial  statements of the prior period have been
      reclassified to conform to current period presentation.

      Segment Information
      The Company does not identify separate  operating  segments for management
      reporting  purposes.  The  results  of  operations  are the basis on which
      management  evaluates   operations  and  makes  business  decisions.   The
      Company's  sales are  generated  primarily  within  the  United  States of
      America.

      Recent Accounting Pronouncements
      In November  2004,  the FASB issued SFAS No.  151,  "Inventory  Costs,  an
      amendment of Accounting Research Bulletin No. 43, Chapter 4." SFAS No. 151
      requires that abnormal amounts of idle facility expense, freight, handling
      costs and wasted  materials  (spoilage)  be  recorded  as  current  period
      charges and that the allocation of fixed production overheads to inventory
      be based on the normal capacity of the production facilities. SFAS No. 151
      is effective  during fiscal years beginning after June 15, 2005,  although
      earlier  application is permitted.  The Company believes that the adoption
      of this  Statement  will not have a  significant  impact on the  financial
      position, results of operations or cash flows of the Company.

      In  December  2004,   the  FASB  issued  SFAS  No.  123  (revised   2004),
      "Share-Based  Payment"  ("SFAS No. 123R"),  which addresses the accounting
      for share-based payment  transactions in which a company receives employee
      services  in  exchange  for (a) equity  instruments  of the company or (b)
      liabilities  that  are  based on the fair  value of the  company's  equity
      instruments or that may be settled by the issuance of equity  instruments.
      SFAS No.  123R  supercedes  APB  Opinion  No. 25 and  amends  SFAS No. 95,
      "Statement of Cash Flows." Under SFAS No. 123R,  companies are required to
      record compensation expense for all share-based payment award transactions
      measured  at fair  value  as  determined  by an  option  valuation  model.
      Currently,  the Company uses the Black-Scholes  pricing model to calculate
      the  fair  value  of  its  share-based  transactions.  This  statement  is
      effective  for  fiscal  years  beginning  after June 15,  2005.  Since the


                                       8
<PAGE>

      Company  currently  recognizes  compensation  expense  at fair  value  for
      share-based  transactions  in  accordance  with SFAS No.  123, it does not
      anticipate adoption of this standard will have a significant impact on its
      financial position,  results of operations,  or cash flows.  However,  the
      Company is still evaluating all aspects of the revised standard.

      In December 2004, the FASB issued SFAS No. 153,  "Exchanges of Nonmonetary
      Assets an  Amendment  of APB  Opinion  No.  29." SFAS No.  153  amends APB
      Opinion No. 29 to eliminate  the exception  for  nonmonetary  exchanges of
      similar  productive  assets from being measured based on the fair value of
      the assets  exchanged.  SFAS No. 153 now provides a general  exception for
      exchanges of  nonmonetary  assets that do not have  commercial  substance.
      SFAS No. 153 is  effective  for fiscal  periods  beginning  after June 15,
      2005.  The Company  believes that the adoption of this  Statement will not
      have a significant impact on its financial position, results of operations
      or cash flows.

      In May 2005, the FASB issued SFAS No. 154,  "Accounting  Changes and Error
      Corrections  - a  replacement  of APB Opinion No. 20 and SFAS No. 3." SFAS
      No. 154 changes the requirements for the accounting for and reporting of a
      change in  accounting  principle  and a change  required by an  accounting
      pronouncement when the pronouncement does not include specific  transition
      provisions.  SFAS No. 154 requires retrospective application of changes as
      if the new  accounting  principle  had always  been used.  SFAS No. 154 is
      effective for fiscal years  beginning after December 15, 2005. The Company
      is still  evaluating  all  aspects  of the  revised  standard  in order to
      evaluate the impact on its financial position and results of operations.

(2)   LINE OF CREDIT, NOTES PAYABLE AND GOING CONCERN

      On May 27, 2003, the Company obtained from Textron  Financial  Corporation
      ("Textron")  a  revolving  credit  facility  (the  "Textron  Loan") with a
      maximum  principal  amount  of  $7,500,000   pursuant  to  the  terms  and
      conditions  of a Loan and  Security  Agreement  dated  May 27,  2003  (the
      "Textron  Loan  Agreement").  The Textron Loan is secured by the Company's
      inventory, accounts receivable and all other assets. Generally, subject to
      the maximum principal amount, which can be borrowed under the Textron Loan
      and  certain  reserves  that  must be  maintained  during  the term of the
      Textron Loan, the amount available under the Textron Loan for borrowing by
      the  Company  from  time to time is equal to the sum of (i) 85% of the net
      amount of its eligible accounts  receivable plus (ii) 60% of the Company's
      eligible  inventory not to exceed  $3,500,000.  Advances under the Textron
      Loan bear interest at a variable rate,  adjusted on the first (1st) day of
      each month, equal to the prime rate plus 1.75% per annum (8.0% at June 30,
      2005)  calculated on the average cash borrowings for the preceding  month.
      The initial term of the Textron  loan ends on May 26, 2006,  but this loan
      automatically  renews for additional one-year periods unless terminated by
      our Company or Textron  through a written  notice 90-days prior thereto or
      as  otherwise  provided in the loan  agreement.  In  accordance  with EITF
      95-22,  "Balance  Sheet  Classification  of Borrowings  Outstanding  under
      Revolving  Credit  Agreements that involve both a Subjective  Acceleration
      Clause and a Lock-Box Arrangement," the balance is reflected as current on
      the balance sheet. As of June 30, 2005, the outstanding  principal balance
      on the Textron Loan was $4,736,456.

      The Textron  Loan  Agreement  contains  certain  financial  and  operating
      covenants. On June 3, 2005, the Company executed a fourth amendment to the
      Textron Loan that  provided a waiver on all the existing  defaults for the
      fiscal  quarters  ended  December 31, 2004 and March 31, 2005, and amended
      the fixed  charge  coverage  ratio  and the  adjusted  tangible  net worth
      requirements  for periods after March 31, 2005.  Additionally,  the fourth
      amendment  allowed the Textron Loan to be in an over-advance  position not
      to exceed  $750,000  until July 31,  2005.  In exchange for the waiver and
      amendments, the Company's interest rate was set at Prime plus 4.75% on the
      Textron  Loan  and  the  Company  paid a fee of  $50,000  in  four  weekly
      installments of $12,500.

      On June 16,  2005,  the Company  used a portion of the  proceeds  from the
      warrant exercises described in Note 5 to satisfy the $750,000 over-advance
      with Textron. In connection with the satisfaction of the over-advance, the
      Company agreed to immediately terminate Textron's obligation to permit any
      over-advances  under the Textron Loan,  which  obligation was to expire on
      July 31, 2005.  With the  termination of the  over-advance  facility,  the
      interest  rate on the  Textron  Loan  returned to its prior level of Prime
      plus 1.75%. On June 30, 2005,  Textron reduced our borrowing  availability
      under our line by $200,000  until they have time to review and approve our
      financial   forecasts   that  reflect  the  asset  sale  and   outsourcing
      arrangements.  However,  there is no  guarantee  if or when they will lift
      this  restriction  on our  borrowing  availability.  Additionally,  we may
      experience further  restrictions by Textron by virtue of reserves they may
      require,  receivables  they may deem  ineligible or other rights they have
      under the Textron Loan Agreement.

      In August 2005,  due to the cost of disposal  activities and impairment of
      property  and  equipment  (as  discussed  in Notes 7 and 8),  the  Company
      determined  that it fell  below  the  requirement  for  the  fixed  charge
      coverage ratio and the adjusted tangible net worth  requirements under the
      Textron Loan for the quarter ended June 30, 2005. Although these covenant

                                       9
<PAGE>

      violations  placed the  Company  in  technical  default  on the loan,  the
      Company has not received a notice of an event of default from Textron. The
      Company is currently  discussing its financial  forecasts that reflect the
      asset sale and  outsourcing  arrangements  and  certain  waivers  and loan
      modifications  to the  Textron  Loan  Agreement.  Until  such  time as the
      Company has received  formal  waivers and loan  modifications,  Textron is
      allowing  us to operate in a  position  of  default.  The  existence  of a
      default  under the Textron Loan would allow  Wachovia,  another one of our
      lenders,  as  described  below,  to declare an event of default  under the
      existing  term  loan  based on a  cross-default  provision  in their  loan
      agreement.  If an agreement  cannot be reached on the loan  modifications,
      Textron and Wachovia could exercise  their  respective  rights under their
      loan documents to, among other things,  declare a default under the loans,
      accelerate  the  outstanding   indebtedness  such  that  it  would  become
      immediately  due and  payable,  and pursue  foreclosure  of the  Company's
      assets,  which are pledged as collateral for such loans.  If such an event
      occurred with either Textron or Wachovia,  it would be substantially  more
      difficult  for the Company to  effectively  continue the  operation of its
      business, and it is unlikely that the Company would be able to continue as
      a going concern.

      Simultaneous  with the closing of the Textron  Loan in May 2003,  Wachovia
      Bank, N.A.  successor by merger to SouthTrust Bank  ("Wachovia")  extended
      the Company a new term loan in the principal  amount of  $2,000,000.  This
      term loan was  consolidated  with the Company's  March 2000 term loan with
      Wachovia, which had a then outstanding principal balance of $8,131,985 for
      a total term loan amount of $10,131,985.  This term loan is secured by all
      of the Company's equipment and certain related assets.  Additionally,  the
      term loan bears  interest at  Wachovia's  Base Rate plus 1% (7.25% at June
      30, 2005). As a result of the cross-default  provision,  the Wachovia term
      loan balance of $7,801,985 is classified as a current liability as of June
      30, 2005.

      On June 30, 2005, the Company entered into a Loan  Modification  Agreement
      with  Wachovia  regarding  its  term  loan.  The  agreement  modified  the
      following  terms of the loan:  1) the loan will  mature  and be payable in
      full on July 31, 2006 instead of June 1, 2009; 2) the  principal  payments
      will remain at $110,000 per month with accrued interest at Wachovia's Base
      Rate plus 1% instead of increasing to $166,250 on July 1, 2005 as provided
      by the  terms of the  promissory  note  evidencing  the  loan;  and 3) all
      covenants related to the Company's  tangible net worth,  total liabilities
      to tangible net worth, and maximum funded debt to EBITDA ratios are waived
      and compliance is not required by the Company  through the maturity of the
      loan on July 31,  2006.  In  connection  with the  agreement,  the Company
      agreed to pay  $60,000,  of which  $30,000 was paid upon  execution of the
      agreement and $30,000 was paid on August 1, 2005. As required by the terms
      of the  agreement,  if the Company sells the equipment  securing the loan,
      the loan will be due and payable in full at the time of sale.

(3)   ACCRUED AND OTHER CURRENT LIABILITIES

      Accrued and other current liabilities are summarized as follows:

                                                  June 30, 2005  March 31, 2005
                                                  -------------  --------------
      Tangible personal property taxes            $   1,132,083  $    1,049,841
      Warrant liability                                      --         740,000
      Other                                             528,548         340,365
                                                  -------------  --------------
      Total                                       $   1,660,631  $    2,130,206
                                                  =============  ==============

(4)   COMMITMENTS AND CONTINGENCIES

      In accordance with a registration  rights agreement dated October 6, 2004,
      the Company  agreed that within 180 days it would file with the Securities
      and  Exchange  Commission  and  obtain  effectiveness  of  a  registration
      statement that included 2,000,000 shares issued in a private placement and
      500,000 shares related to a stock purchase  warrant.  Per the terms of the
      agreement,  if a registration  statement was not filed,  or did not become
      effective  within  180 days,  then in  addition  to any other  rights  the
      investor may have, the Company would be required to pay certain liquidated
      damages.  The Company filed a registration  statement on Form S-3 on March
      14, 2005. However,  this registration  statement has not yet been declared
      effective.  The Company  received  from the  investor an extension of time
      until  September  1,  2005 to have  the  registration  statement  declared
      effective by the SEC.  Additionally,  the investor  waived all damages and
      remedies for failure to have an  effective  registration  statement  until
      September  1, 2005.  In the event that the  registration  statement is not
      effective by September 1, 2005,  the Company will be liable to pay $71,875
      (2.5% times the  product of  2,500,000  registerable  shares and the share
      price of $1.15  per  share)  every  thirty  days  until  the  registration
      statement becomes effective unless an additional extension is granted.

(5)   CAPITAL STOCK

      Common Stock Issuances
      In accordance  with a warrant  agreement dated April 10, 2003, the Company
      issued to Mr. Frederick DeLuca, a greater than 10% shareholder,  a warrant
      to  purchase  up to 100,000  shares of common  stock of the  Company at an
      exercise  price of $1.70 per share.  Additionally,  in  accordance  with a
      warrant  agreement dated October 6, 2004, the Company issued to Mr. DeLuca
      a warrant to purchase up to 500,000  shares of common stock of the Company
      at an exercise  price of $1.15 per share.  Subsequently  in June 2005, the
      Company agreed to reduce the per-share exercise price on these warrants to
      $1.36 and $0.92,  respectively,  in order to induce Mr. DeLuca to exercise
      his  warrants.  All of the  warrants  were  exercised on June 16, 2005 for
      total proceeds of $596,000.


                                       10
<PAGE>

      On each of April 24, 2003 and October 6, 2004, BH Capital Investments,  LP
      and Excalibur Limited Partnership each received warrants to purchase up to
      250,000  shares of common  stock at an exercise  price of $2.00 per share.
      Also,  Excalibur Limited Partnership  received a warrant to purchase up to
      30,000  shares of common stock at an exercise  price of $2.05 per share on
      June 26, 2002. Subsequently in June 2005, the Company agreed to reduce the
      per-share  exercise price on all such warrants to $1.10 in order to induce
      BH Capital  Investments,  LP and Excalibur Limited Partnership to exercise
      their  warrants.  All of the warrants were  exercised on June 16, 2005 for
      total proceeds of $1,133,000.

      The Company used a portion of the proceeds  from the warrant  exercises to
      satisfy the  $750,000  over-advance  provided by Textron  under the Fourth
      Amendment and Waiver to the Textron Loan Agreement, as described in Note 2
      and the  remaining  proceeds  from the  warrant  exercises  were  used for
      working capital purposes.

      In accordance with the accounting  provisions of SFAS No. 123, the Company
      recorded  $1,024,500  in  non-cash  compensation  expense  related  to the
      reduction in the exercise price of the warrants in June 2005.

      Preferred Stock Issuances and Restatement
      On April 6, 2001, the Company received from BH Capital Investments, LP and
      Excalibur Limited  Partnership (the "Series A Preferred Holders") proceeds
      of  approximately  $3,082,000  less costs of $181,041  for the issuance of
      72,646 shares of the Company's Series A convertible preferred stock with a
      face value of $3,500,000 and warrants to purchase  shares of the Company's
      common stock. The shares were subject to certain designations, preferences
      and rights  including  the right to convert  such  shares  into  shares of
      common stock at any time. The per share  conversion price was equal to the
      quotient of $48.18,  plus all accrued and unpaid  dividends for each share
      of the Series A convertible  preferred stock, divided by the lesser of (x)
      $1.75 or (y) 95% of the  average of the two lowest  closing  bid prices of
      the Company's common stock on the American Stock Exchange  ("AMEX") out of
      the fifteen trading days immediately prior to conversion.

      In total,  the Series A Preferred  Holders  converted 42,330 shares of the
      Series  A  convertible  preferred  stock  plus  accrued  dividends,   into
      1,806,210  shares of common stock prior to the redemption of the preferred
      stock on October 6, 2004. The conversion prices ranged from $1.07 to $1.75
      based on the above formula.

      In connection with a Stock Repurchase Agreement dated October 6, 2004, the
      Company  redeemed the  remaining  30,316  Series A  convertible  preferred
      shares  held by the  Series  A  Preferred  Holders  for a total  price  of
      $2,279,688.  All previously outstanding shares of the Series A convertible
      preferred stock of the Company have now been cancelled.

      The  Company  originally  concluded  under  EITF  00-19,  "Accounting  for
      Derivative  Financial  Instruments  Indexed To, and Potentially Settled in
      the Company's Own Stock," that the conversion feature was conventional and
      that there was no need to bifurcate the conversion right during the period
      the Series A convertible preferred shares were outstanding.  Subsequent to
      the redemption of the remaining  preferred  shares, it has been determined
      that  certain  features of the  conversion  option  resulted in  treatment
      different from that historically reflected.

      The preferred  stock was a  fixed-income  security  with no  participating
      rights  and the  dividend  was 10% per annum in the first  year and 8% per
      annum in the second,  third and fourth years.  Therefore,  consistent with
      paragraph 61(l) of SFAS No. 133,  "Accounting  for Derivative  Instruments
      and Hedging  Activities,"  the Company has concluded  that the  conversion
      option  was not  clearly  and  closely  related  to the  host  instrument.
      Ordinarily, an issuer does not need to bifurcate a conversion right from a
      convertible  instrument.  However,  in accordance with paragraph 4 of EITF
      00-19,  the Company has determined  that due to the fact that the embedded
      conversion  option  contained  a provision  that could have  resulted in a
      conversion  into an  indeterminable  numbers of commons  shares,  that the
      conversion  feature  was in  fact  "unconventional".  Further,  since  the
      conversion  right  embedded in the preferred  stock has been  considered a
      derivative,   the  related   dividends  are  also  considered   derivative
      instruments. As a result, the embedded derivative was a liability that was
      required to be  bifurcated  from the  preferred  stock and this  liability
      should have been marked to market during reporting periods.  Based on this
      determination,   the  Company  has  reflected  offsetting  adjustments  to
      additional  paid-in-capital  and  accumulated  deficit  in the  amount  of
      $1,703,246 as of March 31, 2005. For the three months ended June 30, 2004,
      the  Company  has  restated  to record a  derivative  expense of  $121,119
      related  to the  change  in the  fair  value  of the  embedded  derivative
      instruments.


                                       11
<PAGE>

      The following table  summarizes the changes in the Statement of Operations
      as of June 30, 2004:

<TABLE>
<CAPTION>
                                                  AS PREVIOUSLY
                                                   REPORTED        ADJUSTMENT     AS RESTATED
                                                  -------------  --------------  --------------
<S>                                               <C>            <C>             <C>
      Income From Operations                      $      18,220  $           --  $       18,220
       Interest Expense                                 259,816              --         259,816
       Derivative Expense                                    --         121,119         121,119
                                                  -------------  --------------  --------------
      Net Loss                                         (241,596)       (121,119)       (362,715)
       Less:
       Preferred Stock Dividends                         42,392              --          42,392
       Preferred Stock Accretion to
          Redemption Value                              512,175          11,531         500,644
                                                  -------------  --------------  --------------
      Net Loss to Common Stockholders             $    (796,163) $     (109,588) $     (905,751)
                                                  =============  ==============  ==============
      Basic and Diluted Net Loss per Common Share $       (0.05) $        (0.01) $        (0.06)
                                                  =============  ==============  ==============
</TABLE>

      The Series A Preferred Holders had the right to receive on any outstanding
      Series A convertible preferred stock a ten percent dividend on the shares,
      payable one year after the issuance of such preferred  stock, and an eight
      percent  dividend for the subsequent  three years  thereafter,  payable in
      either cash or shares of preferred  stock. For the three months ended June
      30, 2004,  the Company  recorded  preferred  dividends of $42,392,  on the
      outstanding shares of the Series A convertible preferred stock.

      On April 6, 2001, the Company  recorded the initial  carrying value of the
      preferred  stock as  $521,848.  Each  quarter  the Company  calculated  an
      estimated  redemption  value of the  remaining  preferred  stock  and then
      calculated  the  difference  between the initial  carrying  value and this
      estimated  redemption  value.  The  difference  was then accreted over the
      redemption period (48 months beginning April 2001) using the straight-line
      method,  which  approximates the effective  interest method. For the three
      months ended June 30, 2004, the Company recorded $500,644,  related to the
      accretion of the redemption value of preferred stock.

(6)   NON-CASH COMPENSATION RELATED TO STOCK-BASED TRANSACTIONS

      Effective  April 1,  2003,  the  Company  elected  to record  compensation
      expense  measured  at fair value for all  stock-based  award  transactions
      (including,  but not limited to,  restricted  stock  awards,  stock option
      grants,  and  warrant  issuances)  on or after  April 1,  2003  under  the
      provisions  of SFAS No.  123.  Prior to April 1, 2003,  the  Company  only
      recorded the fair value of stock-based  awards granted to non-employees or
      non-directors  under the provisions of SFAS No. 123. The fair value of the
      stock-based   award  is   determined  on  the  date  of  grant  using  the
      Black-Scholes pricing model and is expensed over the vesting period of the
      related  award.  Prior to April 1, 2003,  the  Company  accounted  for its
      stock-based employee and director  compensation plans under the accounting
      provisions  of APB No. 25 as  interpreted  by FASB  Interpretation  No. 44
      ("FIN 44"). Any  modifications of fixed stock options or awards granted to
      employees  or  directors  originally  accounted  for  under APB No. 25 may
      result in additional  compensation expense under the provisions of FIN 44.
      FIN 44 covers  specific  events that occurred  after December 15, 1998 and
      was effective as of July 1, 2000.

      In accordance with the above accounting standards,  the Company calculates
      and records non-cash compensation related to its securities in the general
      and administrative expense line item in the Statements of Operations based
      on two primary items:

      A.    STOCK-BASED AWARD ISSUANCES

      During the three months ended June 30, 2005 and 2004, the Company recorded
      $1,036,959  and $4,208,  respectively,  in non-cash  compensation  expense
      related  to  stock-based  transactions  that were  issued to and vested by
      employees,  officers,  directors and consultants.  During the three months
      ended June 30, 2005 and 2004,  the  Company  recorded  ($340,000)  and $0,
      respectively,   in  non-cash  compensation   expense/(income)  related  to
      stock-based  transactions that are adjusted each period for changes in the
      price of the Company's common stock.

      B.    OPTION  MODIFICATIONS  FOR AWARDS  GRANTED TO EMPLOYEES OR DIRECTORS
            UNDER APB NO. 25

      On October 11, 2002, the Company repriced all outstanding  options granted
      to employees prior to October 11, 2002 (4,284,108  shares at former prices
      ranging  from $2.84 to  $10.28)  to the  market  price of $2.05 per share.
      Prior to the repricing  modification,  the options were accounted for as a
      fixed award under APB No. 25. In accordance  with FIN 44, the repricing of


                                       12
<PAGE>

      the employee stock options requires additional  compensation expense to be
      recognized and adjusted in subsequent  periods for changes in the price of
      the Company's  common stock that are in excess of the $2.05 stock price on
      the  date of  modification  (additional  intrinsic  value).  If there is a
      decrease in the market price of the Company's common stock compared to the
      prior reporting period,  the reduction is recorded as compensation  income
      to reverse all or a portion of the expense  recognized  in prior  periods.
      Compensation  income is limited to the original base  exercise  price (the
      intrinsic value) of the options.  This variable  accounting  treatment for
      these  modified  stock options  began with the quarter ended  December 31,
      2002 and such  variable  accounting  treatment  will  continue  until  the
      related  options  have been  cancelled,  expired or  exercised.  There are
      3,499,841  outstanding  modified  stock  options  remaining as of June 30,
      2005.

      The Company recorded non-cash compensation  expense/(income) of ($169,441)
      and  $158,166  for  the  three  months  ended  June  30,  2005  and  2004,
      respectively, related to the modified options described above.

(7)   IMPAIRMENT OF PROPERTY AND EQUIPMENT

      In light of the Asset Sale and Outsourcing  Arrangements discussed in Note
      8, the Company  determined that it is more likely than not that a majority
      of its fixed  assets  related  to  production  activities  will be sold or
      disposed  prior to the end of their  useful life.  These assets  represent
      approximately  98% of the value of Property and  Equipment.  Based on this
      determination, SFAS No. 144, "Accounting for the Impairment of Disposal of
      Long-Term  Assets,"  requires that the Company write down the value of its
      assets to their  estimated  fair values as of June 30,  2005.  The Company
      will  continue to hold and use the assets until they are sold.  Therefore,
      all assets will continue to be reported and depreciated under Property and
      Equipment in the Balance Sheet until they are sold. The Company  estimated
      the  fair  value  based  on  the  sales  price  discussed  below  and  the
      anticipated sales price related to any other assets plus future cash flows
      related  to the  assets  from July 1, 2005  until the sale.  Based on this
      estimate,  the Company recorded an impairment of property and equipment of
      $7,896,554 in order to reflect a net fair value for Property and Equipment
      of $9,872,074 at June 30, 2005.

(8)   ASSET SALE AND OUTSOURCING ARRANGEMENTS

      On June 30, 2005, the Company entered into an Outsourcing Supply Agreement
      (the  "Outsourcing  Agreement") with Schreiber Foods,  Inc.  ("Schreiber")
      whereby  Schreiber  will  manufacture  and distribute all of the Company's
      products.  The  Company  simultaneously  entered  into an  Asset  Purchase
      Agreement with Schreiber whereby Schreiber will purchase substantially all
      of the  Company's  production  machinery  and  equipment  for a  total  of
      $8,700,000.

      The Asset Purchase Agreement is scheduled to close on or about November 1,
      2005. The closing is subject to the  satisfaction  of various  conditions,
      including approval of the sale by the Company's  stockholders and approval
      by the Company's lenders.

      The  Outsourcing  Agreement  is for an initial  five-year  period from the
      effective  date of September  1, 2005 and is  renewable  at the  Company's
      option for up to two additional  five-year periods.  On or before November
      1, 2005,  Schreiber  will purchase the Company's  remaining raw materials,
      ingredients and packaging at the Company's  cost.  Schreiber will bill the
      Company  when it ships each order of  finished  products to the Company or
      its customers, based on a pre-determined price matrix.

      The Outsourcing  Agreement  provides for a contingent  short-fall  payment
      obligation  by the  Company  if a  specified  production  level is not met
      during the  second  year of the  Outsourcing  Agreement.  If a  contingent
      short-fall  payment is accrued after the second year, it may be reduced at
      the end of the third year if the  production  level  during the third year
      exceeds the specified  level of  production.  If the sale of the assets to
      Schreiber for $8,700,000 as contemplated  by the Asset Purchase  Agreement
      is not consummated,  then the Company will not be required to pay any such
      short-fall payment.

      If the  Company  does not  exercise  its  option to renew the  Outsourcing
      Agreement  at  the  end  of  the  initial  five-year  period,  there  is a
      cancellation  charge of $1.5 million. If the Company does not exercise its
      option  to  renew  the  Outsourcing  Agreement  at the  end of the  second
      five-year period, there is a cancellation charge of $750,000.  If the sale
      of the assets to Schreiber  for  $8,700,000 as  contemplated  by the Asset
      Purchase  Agreement  is not  consummated,  then  the  Company  will not be
      required to pay any such cancellation charge.


                                       13
<PAGE>

      The above transactions were communicated to the employees on July 6, 2005.
      The  Company  is  currently  reviewing  the costs  associated  with  these
      anticipated  transactions  and  believes  that they  will have a  material
      impact on the Company's  financial  position,  results of operations,  and
      cash flows during its fiscal year ending March 31, 2006.  The Company will
      account for the costs  associated  with these  transactions  in accordance
      with  SFAS No.  146,  "Accounting  for  Costs  Associated  with an Exit or
      Disposal  Activity,"  because  the  above  arrangements  are  planned  and
      controlled by  management  and  materially  change the manner in which the
      Company's  business  will be conducted.  In accordance  with SFAS No. 146,
      costs  associated  with  disposal  activities  should  be  reported  as  a
      reduction of income from  operations.  For the three months ended June 30,
      2005,  the Company  incurred  and  reported  $255,011 as Costs of Disposal
      Activities in the Statement of Operations.

(9)   EARNINGS PER SHARE

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

                                                        THREE MONTHS ENDED
                                                              JUNE 30,
                                                  -----------------------------
                                                       2004           2003
                                                  -------------  --------------
      Net loss to common stockholders             $  (9,144,114) $     (905,751)
                                                  =============  ==============
      Weighted average shares outstanding -
       basic and diluted                             18,663,485      15,666,399
                                                  =============  ==============

      Basic and diluted net loss per common share $       (0.49) $        (0.06)
                                                  =============  ==============

      Options for 5,059,809 shares and warrants for 655,356 shares have not been
      included in the  computation of diluted net income (loss) per common share
      for the  three  months  ended  June 30,  2005,  as their  effect  would be
      antidilutive. Potential conversion of Series A convertible preferred stock
      for  1,478,815  shares,  options for  4,742,201  shares and  warrants  for
      1,242,856  shares have not been included in the computation of diluted net
      income  (loss) per common  share for the three months ended June 30, 2004,
      as their effect would be antidilutive.

(10)  SUPPLEMENTAL CASH FLOW INFORMATION

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

      Three months ended June 30,                      2005           2004
      -------------------------------------------------------------------------

      NON-CASH FINANCING AND INVESTING ACTIVITIES:

         Accrued preferred stock dividends        $          --  $       42,392
         Accretion of discount on preferred stock            --         500,644

         Cash paid for:
         Interest                                       403,347         221,350

(11)  RELATED PARTY TRANSACTIONS

      Angelo S. Morini
      In a Second Amended and Restated  Employment  Agreement  effective October
      13,  2003,  Angelo S.  Morini the  Company's  Founder,  Vice-Chairman  and
      President  resigned from his  positions  with the Company as Vice Chairman
      and President and he is no longer involved in the daily  operations of the
      Company.  He  retains  the title of Founder  and has been  named  Chairman
      Emeritus.  Mr. Morini  continues to be a member of the Company's  Board of
      Directors.  Additionally,  he may carry out special assignments designated
      to him by the  Chairman  of the Board.  The  agreement  is for a five-year
      period  beginning  October 13, 2003 and provides for an annual base salary
      of $300,000,  plus standard health  insurance  benefits,  club dues and an
      auto allowance.

      Because Mr. Morini is no longer  performing  regular ongoing  services for
      the Company,  the Company  accrued and expensed the five-year cost of this
      agreement in the quarter  ended  December 31,  2003.  The total  estimated
      costs expensed  under this  agreement are  $1,830,329 of which  $1,201,399
      remained  unpaid but  accrued  ($366,305  as  short-term  liabilities  and
      $835,094 as  long-term  liabilities)  as of June 30, 2005.  The  long-term
      portion will be paid out in nearly equal  monthly  installments  ending in
      October 2008.


                                       14
<PAGE>

      In June 1999,  in  connection  with an  amended  and  restated  employment
      agreement for Mr. Morini, the Company consolidated two full recourse notes
      receivable  ($1,200,000  from November 1994 and  $11,572,200  from October
      1995) related to the exercise of 2,914,286  shares of the Company's common
      stock into a single note  receivable in the amount of $12,772,200  that is
      due on June  15,  2006.  This  single  consolidated  note is  non-interest
      bearing and non-recourse and is secured by the 2,914,286 underlying shares
      of the Company's  common stock.  Per the terms of the June 1999 Employment
      Agreement that was amended and restated by the October 2003 Second Amended
      and Restated Employment Agreement between the Company and Mr. Morini, this
      loan may be forgiven upon the  occurrence of any of the following  events:
      1) Mr. Morini is terminated  without cause;  2) there is a material breach
      in the terms of Mr. Morini's employment agreement; or 3) there is a change
      in control of the Company  for which Mr.  Morini did not vote "FOR" in his
      capacity as a director or a stockholder.

      In the event that the  $12,772,200  loan is  forgiven,  the Company  would
      reflect  this  amount  as a  forgiveness  of  debt  in  the  Statement  of
      Operations.  In the event  that Mr.  Morini is unable to pay the loan when
      due and the Company  forecloses on the shares,  the Company will reflect a
      loss on collection for the amount, if any, that the value of the 2,914,286
      underlying collateral shares are below the value of the note. Assuming the
      market price on June 30, 2005 of $2.08,  the Company  would reflect a loss
      of approximately $6,710,000 in the Statement of Operations.  Although both
      of these  scenarios  will  result  in  material  losses  to the  Company's
      operations,  it will not have any affect on the  balance  sheet  since the
      $12,772,200  loan amount is already shown as a reduction to  Stockholders'
      Equity.

      Christopher J. New
      On July 8, 2004,  Christopher  J. New resigned  from his position as Chief
      Executive  Officer in order to pursue other  opportunities.  In accordance
      with the Separation and Settlement  Agreement  between the Company and Mr.
      New, the Company  recorded  $444,883  related to the  employment  contract
      expense in July 2004.  This  settlement  will be paid out in nearly  equal
      installments  over two years  payable  on the  Company's  regular  payroll
      dates.  As of June 30, 2005,  the remaining  balance  accrued was $231,364
      ($220,218 in short-term liabilities and $11,146 in long-term liabilities).

(12)  ECONOMIC DEPENDENCE

      The Company had one customer that accounted for nearly 12% of sales in the
      quarter ended June 30, 2005. As of June 30, 2005, the amount due from this
      customer is approximately 10% of the balance of accounts  receivable.  The
      Company had one  customer  that  accounted  for nearly 11% of sales in the
      quarter ended June 30, 2004. As of June 30, 2004, the amount due from this
      customer is approximately 16% of the balance of accounts receivable.


                                       15
<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.

ITEM 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Information in this Management's  Discussion and Analysis of Financial Condition
and  Results  of   Operations   ("MD&A")  is  intended  to  enhance  a  reader's
understanding  of the financial  condition,  changes in financial  condition and
results of operations of our Company. This MD&A is a supplement to and should be
read in conjunction  with our Financial  Statements and notes thereto  appearing
elsewhere  in  this  report.   The   following   discussion   contains   certain
forward-looking  statements,  within the meaning of the "safe-harbor" provisions
of the Private  Securities  Reform Act of 1995, the attainment of which involves
various risks and uncertainties. These statements relate to future events or our
future financial performance.  These forward-looking statements are based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions made by our company. Words such as "anticipate,"
"expect,"  "intend," "plan," "believe,"  "seek,"  "project,"  "estimate," "may,"
"will," and  variations  of these words or similar  expressions  are intended to
identify  forward-looking  statements.  These  statements  are not guarantees of
future  performance  and  are  subject  to  certain  risks,   uncertainties  and
assumptions that are difficult to predict.  Therefore, actual results may differ
materially from our historical  results and those expressed or forecasted in any
forward-looking  statements  as a result of a variety of factors,  including but
not  limited  to,  competition  in the market for our  products,  dependence  on
suppliers,  our manufacturing  experience,  production delays or inefficiencies,
and changes in  accounting  standards.  We undertake no  obligation  to publicly
update or revise any  forward-looking  statements  for any  reason,  even if new
information becomes available or other events occur in the future.

Terms such as "fiscal  2006" or "fiscal  2005" refer to our fiscal  years ending
March 31, 2006 and 2005,  respectively.  Terms such as "first quarter,"  "second
quarter,"  "third  quarter," or "fourth  quarter"  refer to the fiscal  quarters
ending June 30, September 30, December 31 or March 31, respectively.

This MD&A contains the following sections:

o     Business Environment

o     Critical Accounting Policies

o     Recent Accounting Pronouncements

o     Results of Operations

o     Liquidity and Capital Resources

BUSINESS ENVIRONMENT

GENERAL
Galaxy  Nutritional  Foods,  Inc.  (our  "Company")  is  principally  engaged in
developing,  manufacturing  and marketing a variety of healthy  cheese and dairy
related  products,  as well  as  other  cheese  alternatives,  and is a  leading
producer of dairy  alternative  products made with soy. These healthy cheese and
dairy related  products  include low or no fat, no saturated  fat, no trans-fat,
low or no  cholesterol  and  lactose-free  varieties.  These  products  are sold
throughout the United States and  internationally to customers in the retail and
food service markets.  The Company's  headquarters and manufacturing  facilities
are located in Orlando, Florida.

HEALTHY CHEESE AND ALTERNATIVE CHEESE INDUSTRY
We are the market leader within our alternative  cheese  category niche,  but in
being  so,  the  category  increases  or  decreases  partly  as a result  of our
marketing  efforts.  We believe that the greatest source of future growth in the
cheese  alternative  category  will come  through  customers  shifting to cheese
alternatives  from natural cheese.  Rather than focusing  primarily on consumers
with a preference or medical condition predisposing them to non-dairy cheese and
comparing our products to other cheese alternative brands, we intend to focus on
educating  cheese  consumers on the healthy  attributes  of cheese  alternatives
versus traditional cheese.

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


                                       16
<PAGE>

Beginning in the second  quarter of fiscal 2006, we will launch a sales campaign
focused  on  the  following  three  primary   strategies:

      o     Consumer  focused   advertising.   We  plan  to  increase   consumer
            advertising (in TV,  magazine,  and event  sponsorship) and consumer
            promotions  (for example,  on-pack "cents off" coupons,  "cents off"
            coupons  delivered via newspapers,  in-store product  sampling,  and
            product benefit  communication at the point of purchase/shelf)  that
            highlight and  communicate  the benefits of our products to meet the
            consumer demand for low carbohydrate and high protein products.

      o     Increase  retailer  penetration and  geographical  distribution.  By
            increasing  our presence on the store  shelves,  we seek to increase
            household penetration and build market share in specific markets.

      o     Increase  brand  awareness.  We seek to increase sales by increasing
            our customer base and generating  consumer awareness of new products
            or  flavors  through  product  trials  and  generating  more  repeat
            purchases on our Veggie(TM) and Wholesome  Valley(R)  brands through
            improved taste, color, aroma, texture and packaging.

We believe that the combination of "healthy" product attributes,  improved taste
and product functionality will lead to better than expected consumer experiences
with our products.  Our focus is to transfer those improved consumer experiences
into enhanced market share and increased sales of our higher margin products.

RECENT MATERIAL DEVELOPMENTS

      The Schreiber Transactions

      Asset Purchase Agreement

On June 30, 2005,  we entered into an Asset  Purchase  Agreement for the sale of
certain of our manufacturing and production  equipment to Schreiber Foods, Inc.,
a Wisconsin corporation ("Schreiber"), for $8.7 million in cash.

Other key terms of the transaction are as follows:

o     Since the  transaction may constitute a sale of  substantially  all of our
      assets,  the  transaction  will be subject to obtaining  approval from our
      stockholders.

o     The  transaction  is  subject  to  other  closing  conditions,   including
      obtaining  approval from our lenders,  Textron  Financial  Corporation and
      Wachovia Bank (formerly SouthTrust Bank).

o     Subject to the  satisfaction  of the conditions  described above and other
      conditions as set forth in the Asset Purchase  Agreement,  the anticipated
      closing date is November 1, 2005.

o     If our  stockholders  do not approve the  transaction,  the Asset Purchase
      Agreement provides for an alternative transaction whereby we would sell to
      Schreiber  a smaller  portion of the assets,  which  would not  constitute
      substantially   all  of  our  assets  and  therefore   would  not  require
      stockholder  approval.  The purchase price for this alternative sale would
      be $2,115,000. This alternative sale is subject to obtaining approval from
      our lenders.

o     If we are unable to obtain  approval from our lenders with respect to this
      alternative  sale,  then we will negotiate in good faith with Schreiber to
      make the smaller  portion of the assets  available for  Schreiber's use on
      reasonably  acceptable  terms,  not to  exceed  a term of 180  days.  This
      alternative  arrangement  is also subject to obtaining  approval  from our
      lenders.

      The Outsourcing Agreement
On June 30, 2005, our Company and Schreiber entered into a Supply Agreement (the
"Outsourcing  Agreement"),  whereby we will purchase all of our requirements for
products from  Schreiber,  and Schreiber will  manufacture and distribute all of
our products.

Other key terms of the transaction are as follows:

o     The initial term of the  Outsourcing  Agreement is for five years from the
      effective date of September 1, 2005, and is renewable at our option for up
      to two additional five-year periods.

o     After  November 1, 2005 and  throughout  the remainder of the  Outsourcing
      Agreement's  term,  Schreiber  will be the sole  source  of  supply of our
      products.


                                       17
<PAGE>

o     If we do not exercise our option to renew the Outsourcing Agreement at the
      end of the initial  five-year  period,  there is a cancellation  charge of
      $1.5  million.  If we do not exercise our option to renew the  Outsourcing
      Agreement  at  the  end  of  the  second  five-year  period,  there  is  a
      cancellation  charge of  $750,000.  If the sale of the assets to Schreiber
      for $8,700,000 as contemplated by the Asset Purchase  Agreement  described
      above  is not  consummated,  then  we  will  not be  required  to pay  any
      cancellation charge.

o     On or before  November 1, 2005,  Schreiber  will  purchase  our  remaining
      usable raw materials, ingredients and packaging at our cost.

o     The Outsourcing  Agreement  provides for a contingent  short-fall  payment
      obligation  by our  Company  if a  specified  production  level is not met
      during  the  second  year  after  the  effective  date.  If  a  contingent
      short-fall  payment is accrued after the second year, it may be reduced at
      the end of the third year if the  production  level  during the third year
      exceeds the specified  level of  production.  If the sale of the assets to
      Schreiber for $8,700,000 as contemplated  by the Asset Purchase  Agreement
      is not  consummated,  then  we  will  not be  required  to  pay  any  such
      short-fall payment.

o     Schreiber is required to deliver  products to our Company or our customers
      that are in  compliance  with our  standards  and  specifications  and all
      applicable  laws.  Schreiber will deliver all products  within 10 business
      days of the effective date of such order,  which is one business day after
      receipt of the order.

o     After the  transfer of all  production  responsibilities  to  Schreiber on
      November 1, 2005,  we may not  manufacture  any  products  governed by the
      Outsourcing Agreement during the term of the Outsourcing Agreement.

o     Schreiber may not manufacture our products or use any of our  intellectual
      property other than pursuant to the terms of the Outsourcing Agreement.

o     We may  terminate the  Outsourcing  Agreement if our  stockholders  do not
      approve the transaction  contemplated by the Asset Purchase  Agreement (as
      described  above),  by providing notice to Schreiber within 30 days of the
      date that our stockholders  vote on, but do not approve,  the transactions
      contemplated by the Asset Purchase  Agreement.  The  effectiveness of such
      termination may not be more than 180 days after the date of such notice.

o     If we do not  terminate  the  Outsourcing  Agreement  and we are unable to
      consummate an alternative  transaction with Schreiber (as described above)
      prior to January 1, 2006,  then  Schreiber may  terminate the  Outsourcing
      Agreement by providing  written notice to our Company prior to February 1,
      2006. The  effectiveness of such termination may not be less than 180 days
      after the date of such notice.

As indicated  above,  there are a number of conditions that must be met prior to
the consummation of these  transactions.  There can be no guarantee that we will
satisfy these  conditions  and,  therefore,  there can be no guarantee  that the
transactions will be consummated.

     Transition Challenges
The asset sale and  outsourcing  arrangement  with  Schreiber  are  subject to a
number  of  conditions  that  must be met  prior  to the  consummation  of these
transactions.  In addition to the closing  conditions  described  above, we will
face additional challenges during the transition.  These challenges include, but
are not limited to, the following:

o     Coordinating   customer  shipments  while  the  inventory  and  production
      equipment is in transit from our facilities to the Schreiber facilities;

o     Reserving  enough   inventory   on-hand  to  fill  customer  orders  while
      production equipment is in transit;

o     Maintaining  consistent  formulas  and quality in our  products  after the
      transition;

o     Having enough cash to build  inventory and pay any severance  arrangements
      during the transition;

o     Reduction of production  personnel and severance  arrangements  related to
      these personnel; and

o     In the event of a sale of the assets  whereby we would not receive  enough
      sale proceeds to pay off our debt to our lenders in full, we would need to
      negotiate with our lenders so that they would agree to release their liens
      on the  assets.  If they will not agree to do so,  we may be  required  to
      raise  additional funds to pay our lenders in full prior to their maturity
      dates.

o     We may be required to negotiate with the landlords of our leased  premises
      the possibilities of early lease termination or subleasing our facilities.


                                       18
<PAGE>

Each one of these events must be  carefully  timed and  coordinated  in order to
avoid problems with cash flow,  litigation,  loss of customer  sales,  and other
tangible and intangible affects. However, we believe that the long-term benefits
in the transition from a manufacturing  company to a branded  marketing  company
will far outweigh  the  short-term  challenges  of the  transition.  Without the
cash-flow burden of carrying inventory and managing  manufacturing  overhead and
production  issues, we believe that we can focus a substantially  greater amount
of time and  resources  on the sale of our  products.  Additionally,  we plan to
enhance our  marketing  efforts in order to increase our consumer base and sales
volume.

      Transaction Effect
Assuming  that the sale of assets to Schreiber is completed in  accordance  with
the Asset  Purchase  Agreement and we continue to operate under the  Outsourcing
Agreement  with  Schreiber,  some of the effects of the  transaction  will be as
follows:

o     We will no longer be a manufacturing company, but will be solely a branded
      marketing company.

o     We have two  facilities  that we  lease in  Orlando,  Florida.  After  all
      production is moved  completely  to Schreiber,  we may be required to have
      discussions with our landlords regarding the use of our facilities. We are
      still exploring our options regarding the facilities,  which include,  but
      are  not  limited  to:  1)  negotiating  an  early  termination  with  the
      landlords; 2) continuing to make lease payments until the end of the lease
      terms; or 3) subleasing the facilities.

o     We will be eliminating 115 employee  positions and creating 5 new employee
      positions.  Our  anticipated  total  number of full-time  employees  after
      December 1, 2005 will be 31.

o     It is likely that the majority,  if not all, of the proceeds from the sale
      of the assets  will be paid to our  lenders.  In  particular,  our debt to
      Wachovia  Bank  will be  required  to be paid in  full.  Repayment  of the
      Wachovia  Bank debt will  result in a  reduction  of annual  debt  service
      payments in excess of $1,800,000.

o     We will no longer have the  carrying  value of  inventory  nor need to use
      asset based  financing  to support the  production  of  inventory.  In the
      recent past, we averaged 50 to 60 days of sales in inventory.

o     We will be able to take advantage of Schreiber's  lower  production  costs
      rather  than the high  production  costs of our  underutilized  production
      facility.

o     We  anticipate  substantial  savings on  delivery  charges  related to the
      distribution of our products to our customers.

     Debt Maturity Issues
We have  incurred  substantial  debt in  connection  with the  financing  of our
business.  The  aggregate  principal  amount  outstanding  under our two  credit
facilities  is  approximately  $12,764,538  as of August 18,  2005.  This amount
includes  a  revolving  line  of  credit  from  Textron  Financial   Corporation
("Textron")  in the amount of  $5,072,553  and a note  payable to Wachovia  Bank
("Wachovia")  in the amount of $7,691,985.  We anticipate that the proceeds from
the sale of our assets to  Schreiber  will pay the  Wachovia  term loan in full.
However,  in the event that the sale is not  completed as  anticipated,  we will
need to refinance  the Wachovia term loan on or before its maturity date of July
31, 2006.  The initial  term of the Textron loan ends on May 26, 2006,  but this
loan automatically  renews for additional  one-year periods unless terminated by
our Company or Textron  through a written  notice  90-days  prior  thereto or as
otherwise provided in the loan agreement.

In June 2005,  Textron  reduced  our  borrowing  availability  under our line by
$200,000 until they have time to review and approve our financial forecasts that
reflect  the  asset  sale and  outsourcing  arrangements.  However,  there is no
guarantee  if  or  when  they  will  lift  this  restriction  on  our  borrowing
availability. Additionally, we may experience further restrictions by Textron by
virtue of reserves  they may require,  receivables  they may deem  ineligible or
other rights they have under the Textron Loan Agreement.

     Loan Defaults and Going Concern
In  August  2005,  due to the Cost of  Disposal  Activities  and  Impairment  of
Property and Equipment, we determined that we fell below the requirement for the
fixed charge  coverage  ratio and the adjusted  tangible net worth  requirements
under the  Textron  Loan for the quarter  ended June 30,  2005.  Although  these
covenant  violations  placed us in  technical  default on the loan,  we have not
received  a  notice  of an event  of  default  from  Textron.  We are  currently
discussing our financial  forecasts that reflect the asset sale and  outsourcing
arrangements  and certain  waivers and loan  modifications  to the Textron  Loan
Agreement.  Until  such  time  as we  have  received  formal  waivers  and  loan
modifications,  Textron is allowing us to operate in a position of default.  The
existence of a default under the Textron Loan would allow Wachovia,  another one
of our lenders,  as described  below,  to declare an event of default  under our
existing term loan based on a  cross-default  provision in their loan agreement.
If an  agreement  cannot  be  reached  on the loan  modifications,  Textron  and
Wachovia could exercise their  respective  rights under their loan documents to,
among  other  things,  declare  a  default  under  the  loans,   accelerate  the
outstanding  indebtedness such that it would become immediately due and payable,
and pursue  foreclosure of our assets,  which are pledged as collateral for such
loans.  As a result of the  cross-default  provision,  the  Wachovia  balance of
$7,801,985 is classified as a current liability as of June 30, 2005.

If any such events occur with either  Textron or Wachovia,  and we are unable to
refinance or renew our existing credit facilities, or if additional financing is
not  available  on  terms  acceptable  to us,  it would  be  substantially  more
difficult for us to effectively  continue the operation of our business,  and it
is unlikely that we would be able to continue as a going concern.


                                       19
<PAGE>

     Del Sunshine LLC
Pursuant to an oral contract manufacturing and distribution  arrangement between
our Company, Del Sunshine LLC ("Del"), a Delaware limited liability company, and
Non-Dairy Specialty Foods, LLC ("Non-Dairy"), a Nevada limited liability company
and affiliate of Del, we began manufacturing  certain private label products for
Del and  delivering  them  directly to Del's  customers,  including  Del's major
customer,  Wal-Mart,  Inc. in April 2004.  These  private  label  products  were
produced  using  label  and  packaging  trademarks  owned  by Del.  Sales to Del
accounted  for 12% of our sales during fiscal 2005,  which  attributed to 65% of
the increase in sales over fiscal 2004. In the fourth quarter of fiscal 2005, we
reserved  nearly  $1,550,000  in accounts  receivable  and wrote off $210,000 in
inventory  related  to Del  based  upon our  determination  in April  2005  that
collection from Del was questionable as of March 31, 2005.

On April 11, 2005,  we executed  with Del a Trademark  License  Agreement and an
Assignment of Accounts Receivable  Agreement.  Pursuant to the Trademark License
Agreement,  Del  licensed  to us the rights in  certain  Del  trademarks,  which
allowed us to sell products  directly to Del's  customers,  including  Wal-Mart,
Inc. and other food retailers,  using such trademarks.  In consideration for the
license, we agreed to pay to Del a 5% royalty on the net sales of such products.
In accordance with the Trademark License Agreement,  we can offset any royalties
that we may owe to Del under the agreement  against our account  receivable  and
other amounts owed to us by Del.

Pursuant to the Assignment of Accounts Receivable Agreement,  Del assigned to us
any and all accounts  receivable  owed to Del by  Wal-Mart,  Inc. and other food
retailers,  plus  monies  owed to Del  under  current  purchase  orders.  It was
intended  that the  assignment  of the accounts  receivable  and purchase  order
amounts would offset,  in part, our account  receivable from Del. We also agreed
not to  commence  any legal  proceedings  against  Del or  Non-Dairy  to collect
amounts owed to us by them, excluding defenses and counterclaims  against Del or
Non-Dairy made in any legal proceeding brought by them.

The  effectiveness  of the Trademark  License  Agreement  and the  Assignment of
Accounts Receivable  Agreement was conditioned upon Del providing us with proof,
satisfactory  to us,  that  (a)  Del  would  be  transferring  to us  under  the
Assignment of Accounts  Receivable  Agreement  accounts  receivable and purchase
orders  in excess  of Four  Hundred  Thousand  Dollars  ($400,000)  and (b) that
Wal-Mart,  Inc.  would  consent  to the  transactions  contemplated  under  both
agreements.  Del has not satisfied either of the foregoing  conditions and we do
not believe that it is likely that Del will be able to satisfy the conditions in
the  future.  Although  we have  waived  the  conditions  as they  relate to the
Trademark  License  Agreement,  we have not  waived  them  with  respect  to the
Assignment of Accounts  Receivable  Agreement.  Currently,  we are exploring our
options in  addressing  the issues  with Del  related to the  effectiveness  and
continuation  of the  Assignment  of  Accounts  Receivable  Agreement  and Del's
payment of our account  receivable.  During the first quarter of fiscal 2006, we
accrued approximately $40,000 in royalties under the Trademark License Agreement
and offset them against the  receivable  owed to us by Del. On or about June 15,
2006, we ceased selling products under Del's trademarks,  although the Trademark
License  Agreement  will  continue in effect until  September 30, 2005 unless we
extend it for up to two additional  6-month periods or terminate it sooner.  The
net amount owed to us by Del is approximately  $1.6 million as of June 30, 2005.
This amount has been fully reserved as uncollectible at June 30, 2005.

MEASUREMENTS OF FINANCIAL PERFORMANCE
We focus on several items in order to measure our performance. In the short term
(1 to 3  years),  we  are  working  towards  obtaining  positive  trends  in the
following  areas:

o     Operating cash flow

o     Gross margin in dollars and % of gross sales

o     Operating  income  excluding  certain  employment  contract  expenses  and
      non-cash compensation related to stock based transactions

o     EBITDA  excluding  certain  employment   contract  expenses  and  non-cash
      compensation related to stock based transactions

o     Liquidity

o     Net sales trends (as it relates to consumer demand)

o     Key financial  ratios (such as accounts  receivable,  accounts payable and
      inventory turnover ratios)

o     Other operating ratios and statistics

In the long term (over 3 years),  we are  striving  to generate  consistent  and
predictable net sales growth with increased gross margins,  while  incrementally
enhancing net cash flow from operations.


                                       20
<PAGE>

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles
generally  accepted in the United States of America requires  management to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the financial  statements and reported  amounts of income and expense during the
reporting periods presented. Our significant estimates include the allowance for
doubtful accounts  receivable,  provision for obsolete  inventory,  valuation of
deferred  taxes and valuation of  compensation  expense on options and warrants.
Although we believe that these  estimates are  reasonable,  actual results could
differ from those  estimates  given a change in conditions or  assumptions  that
have been consistently applied.

The critical  accounting  policies used by management  and the  methodology  for
estimates and assumptions are as follows:

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

Based on the age of the receivable, cash collection history and past dilution in
the  receivables,  we make an estimate of our anticipated bad debt,  anticipated
future  authorized  deductions  due to current period  activity and  anticipated
collections on non-authorized  amounts that customers have currently deducted on
past invoices.  Based on this analysis,  we reserved $2,612,000 and $740,000 for
known and anticipated  future credits and doubtful accounts at June 30, 2005 and
2004, respectively.  The reserve is higher at June 30, 2005 primarily due to the
$1.6  million  reserve  for Del  Sunshine as  described  under  Recent  Material
Developments.  We believe that this estimate is reasonable,  but there can be no
assurance  that  our  estimate  will  not  change  given a  change  in  economic
conditions  or business  conditions  within the food  industry,  our  individual
customer base or our Company.

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

DEFERRED TAXES
Valuation  allowances  are  established  when  necessary to reduce  deferred tax
assets to the amount  expected  to be  realized.  Income tax  expense is the tax
payable or refundable  for the period plus or minus the change during the period
in deferred tax assets and liabilities.

VALUATION OF NON-CASH COMPENSATION
We have three stock-based  employee  compensation plans. Prior to April 1, 2003,
we accounted for those plans under the recognition and measurement provisions of
Accounting  Principles  Board  Opinion No. 25,  "Accounting  for Stock Issued to
Employees," (APB No. 25), and related Interpretations.

Effective  April 1, 2003,  we adopted the fair value  recognition  provisions of
Statement of Financial  Accounting  Standards ("SFAS") No. 123,  "Accounting for
Stock-Based  Compensation," and apply SFAS No. 148,  "Accounting for Stock-Based
Compensation - Transition and Disclosure,"  prospectively to all employee awards
granted on or after  April 1,  2003.  Awards  from our plans  vest over  periods
ranging from immediate to five years. Therefore, the cost related to stock-based
compensation  included in the  determination of net income for periods in fiscal
2004 and 2005 is less than that  which  would have been  recognized  if the fair
value based method had been  applied to all awards since the original  effective
date of SFAS No. 123. The fair value of the stock-based  award  (including,  but
not limited to,  restricted  stock  awards,  stock  option  grants,  and warrant
issuances) is determined  on the date of grant using the  Black-Scholes  pricing
model  and is  expensed  over the  vesting  period  of the  related  award.  The
difference  between the proforma and reported net loss per common share  related
to the issuance of employee stock options during the three months ended June 30,
2005 and 2004 was nearly zero.

Several  management  estimates  are  needed  to  compute  the fair  value of the
stock-based  transactions  including anticipated life, risk free interest rates,
and volatility of our stock price. Currently, we estimate the life of all awards
granted  assuming  that the award will remain  outstanding  and not be exercised
until the end of its term.  This  results in the highest  possible  value of the


                                       21
<PAGE>

award. If we were to change our estimate of the  anticipated  lives to something
less than the maximum term, then the fair value expense per share would decrease
by  approximately  $.01 to $.02 per month.  If we were to change our estimate of
the  volatility  percentage,  the fair value  expense per share would  change by
approximately $.02 per percentage change in the volatility. If we were to change
our estimate of the interest rate, the fair value expense per share would change
by approximately $.03 per percentage change in the interest rate.

SFAS No. 123 requires that we provide pro-forma information regarding net income
(loss) and earnings (loss) per share amounts as if compensation cost for all our
employee and director  stock-based awards had been determined in accordance with
the fair value method prescribed in SFAS No. 123. We estimated the fair value of
each stock-based award (i.e.  restricted stock awards,  stock option grants, and
warrant  issuances)  during the  periods  presented  by using the  Black-Scholes
pricing model with the following assumptions:

      Three Months Ended:                         June 30, 2005  June 30, 2004
                                                  -------------  --------------
      Dividend Yield                                       None            None
      Volatility                                          46.00%          47.80%
      Risk Free Interest Rate                              3.45%           2.07%
      Expected Lives in Months                             1               9

In  addition  to  non-cash  compensation  expense  related  to  new  stock-based
transactions,  we also record non-cash  compensation  expense in accordance with
the  Financial  Accounting  Standards  Board  Interpretation  No. 44 ("FIN  44")
related to  modifications  in stock-based  transactions.  FIN 44 only relates to
original  stock-based  transactions  with our employees and directors  that were
granted  prior to April 1,  2003 that were  accounted  for under the  accounting
provisions of APB No. 25.

FIN 44  states  that  when an  option  is  repriced  or  there  are  items  that
effectively  reduce the price of an option,  it is treated as a variable  option
that is marked to market each quarter.  Accordingly,  any increase in the market
price of our common  stock over the  exercise  price of the option  that was not
previously  recorded  is  recorded  as  compensation  expense at each  reporting
period.  If there is a decrease in the market price of our common stock compared
to the prior reporting period, the reduction is recorded as compensation  income
to  reverse  all or a  portion  of the  expense  recognized  in  prior  periods.
Compensation  income  is  limited  to the  original  base  exercise  price  (the
intrinsic  value) of the options.  Each period we record  non-cash  compensation
expense or income  related to our analysis on  approximately  3.5 million option
shares.  Assuming that the stock price  exceeds the  intrinsic  value on all the
variable  option shares,  a $0.01 increase or decrease in our common stock price
results in an expense or income, respectively, of $35,000. Due to the volatility
of the market price of our common stock, we are incapable of predicting  whether
this expense will increase or decrease in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB issued SFAS No. 151,  "Inventory  Costs, an amendment
of Accounting  Research  Bulletin No. 43, Chapter 4." SFAS No. 151 requires that
abnormal amounts of idle facility  expense,  freight,  handling costs and wasted
materials  (spoilage)  be  recorded  as  current  period  charges  and  that the
allocation  of fixed  production  overheads  to inventory be based on the normal
capacity of the production  facilities.  SFAS No. 151 is effective during fiscal
years beginning after June 15, 2005,  although earlier application is permitted.
We believe  that the  adoption  of this  Statement  will not have a  significant
impact on our financial position, results of operations or cash flows.

In December  2004,  the FASB issued SFAS No. 123  (revised  2004),  "Share-Based
Payment"  ("SFAS No. 123R"),  which  addresses the  accounting  for  share-based
payment  transactions in which a company receives  employee services in exchange
for (a) equity  instruments of the company or (b) liabilities  that are based on
the fair value of the company's equity instruments or that may be settled by the
issuance of equity instruments.  SFAS No. 123R supercedes APB Opinion No. 25 and
amends SFAS No. 95,  "Statement of Cash Flows."  Under SFAS No. 123R,  companies
are required to record  compensation  expense for all share-based  payment award
transactions  measured at fair value as determined by an option valuation model.
Currently, we use the Black-Scholes pricing model to calculate the fair value of
its  share-based  transactions.  This  statement is  effective  for fiscal years
beginning after June 15, 2005. Since we currently recognize compensation expense
at fair value for  share-based  transactions in accordance with SFAS No. 123, we
do not  anticipate  adoption of this standard will have a significant  impact on
our financial position,  results of operations,  or cash flows.  However, we are
still evaluating all aspects of the revised standard.


                                       22
<PAGE>

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
an  Amendment  of APB Opinion No. 29." SFAS No. 153 amends APB Opinion No. 29 to
eliminate the exception for nonmonetary  exchanges of similar  productive assets
from being  measured based on the fair value of the assets  exchanged.  SFAS No.
153 now provides a general exception for exchanges of nonmonetary assets that do
not have  commercial  substance.  SFAS No. 153 is effective  for fiscal  periods
beginning  after June 15, 2005.  We believe that the adoption of this  Statement
will not  have a  significant  impact  on our  financial  position,  results  of
operations or cash flows.

In May  2005,  the FASB  issued  SFAS No.  154,  "Accounting  Changes  and Error
Corrections - a replacement  of APB Opinion No. 20 and SFAS No. 3." SFAS No. 154
changes the  requirements  for the  accounting  for and reporting of a change in
accounting  principle and a change required by an accounting  pronouncement when
the pronouncement does not include specific transition provisions.  SFAS No. 154
requires retrospective application of changes as if the new accounting principle
had always been used. SFAS No. 154 is effective for fiscal years beginning after
December 15, 2005. We are still  evaluating all aspects of the revised  standard
in order to  evaluate  the  impact on our  financial  position  and  results  of
operations.


RESULTS OF OPERATIONS

<TABLE>
<CAPTION>
                                       3-MONTHS ENDED
                       ------------------------------------------------ 2005     2004
                                                   $           %        % OF    % OF
JUNE 30,                  2005        2004       CHANGE      CHANGE     SALES   SALES
----------------------------------------------------------------------------------------
<S>                    <C>         <C>          <C>         <C>         <C>     <C>
Net Sales              9,851,153   11,191,678  (1,340,525)     -12.0%    100.0%  100.0%
Cost of Goods Sold     7,582,855    8,251,330    (668,475)      -8.1%     77.0%   73.7%
                       -----------------------------------------------------------------
GROSS MARGIN           2,268,298    2,940,348    (672,050)     -22.9%     23.0%   26.3%
                       =================================================================
</TABLE>

NET SALES
Net sales in the first  quarter of fiscal 2006  decreased  12% from net sales in
the first quarter of fiscal 2005  primarily due to a loss in sales volume during
the transition from indirect sales to Wal-Mart  through a private label customer
to direct  sales to Wal-Mart in April 2005.  During the first  quarter of fiscal
2005, this private label customer  accounted for approximately 11% of net sales.
However,  we are no  longer  selling  to this  customer  due to a shift in sales
between  customers (See Del Sunshine LLC under Recent Material  Developments for
further  details).  During the first  quarter of fiscal 2006,  sales to Wal-Mart
accounted for approximately 12% of net sales.  Private label and imitation sales
consist  primarily of products  that generate high sales volumes but lower gross
margins.  Sales also decreased in the first quarter of fiscal 2006 due to a lack
of significant promotions in this period compared to the first quarter of fiscal
2005 (see Selling below for further details).

Certain key  initiatives  and  tactical  actions  were  initiated by our Company
during  fiscal  2005 and will be  continued  throughout  fiscal  2006.  Such key
initiatives  and tactical  actions for fiscal 2006 include,  but are not limited
to, the following:

      o     Creating and  communicating a new more meaningful brand position for
            our flagship  Veggie(TM)  Brand and adding new products.  The recent
            focus is to  highlight  the  superior  nutritional  factors  such as
            cholesterol  and  trans-fat  free,  as well as  targeting  a broader
            universe of  consumers.  We are  attempting  to attract  incremental
            users by  convincing  prior  users and light  users of  conventional
            cheese that the Veggie(TM)  brand items can satisfy their needs with
            great tasting  nutrition.  This is a departure from our past product
            positioning where physiological and medical  requirements were a key
            driver in why consumers should buy the "healthy alternatives."

      o     Improving  product  quality  in terms of taste,  color,  aroma,  and
            texture of our Veggie(TM) and Rice slices product line.

      o     Reducing or eliminating most of our contract manufacturing customers
            due to the continued high cost of certain raw materials which result
            in gross margins that are below our acceptance level.

      o     Continued emphasis and resource allocation of our marketing strategy
            to increase sales through consumer advertising (in TV, magazine, and
            event  sponsorship)  and consumer  promotions (for example,  on-pack
            "cents off" coupons,  "cents off" coupons  delivered via newspapers,
            in-store  product  sampling,  product benefit  communication  at the
            point of  purchase/shelf).  These marketing campaigns will launch in
            the  second  quarter  of  fiscal  2006.  In fiscal  2005,  we saw an
            increase in sales through our consumer  advertising  and promotions,
            which  highlighted and  communicated the benefits of our products to
            meet the  consumer  demand  for low  carbohydrate  and high  protein
            products.  We  experienced an average 17% increase in sales in those
            markets where there were consumer- advertising  promotions in fiscal
            2005.


                                       23
<PAGE>

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

We  anticipate  that our direct sales to Wal-Mart will increase from 2% of sales
in fiscal  2005 to a range  between  10% and 15% of sales in fiscal  2006.  This
increase is due to a shift in sales between customers rather than an increase in
product sales.  Prior to fiscal 2006, we produced certain private label products
for Del Sunshine who then sold the product to Wal-Mart.  Del Sunshine  accounted
for 12% of sales in fiscal 2005. In fiscal 2006, we began selling these products
directly to Wal-Mart instead of through Del Sunshine (See Del Sunshine LLC under
Recent Material Developments for further details),  and our sales to Wal-Mart in
the first quarter of fiscal 2006 accounted for 12% of our total net sales.

Based on our  current  projections,  we  anticipate  a moderate  growth in sales
through  improved  distribution  and  penetration  of our core  brands  into the
mainstream consumer markets.

COST OF GOODS SOLD
Cost of goods sold  increased  from 74% to 77% of net sales in the first quarter
of  fiscal  2005  compared  to the first  quarter  of fiscal  2006.  This  three
percentage  point increase in cost of goods sold was primarily due to the higher
raw  material  costs of casein.  However,  such costs were  partially  offset by
reduced  labor and  overhead  costs.  In  total,  cost of goods  sold  decreased
approximately  $668,000 due to approximately  $642,000 from lower sales volumes,
$170,000 from reduced direct labor expenses,  $287,000 in reduced overhead costs
offset by higher raw material costs of $431,000.  We experienced  lower costs in
direct labor and overhead costs as a result of improved production  efficiencies
and a change in the  method of  allocating  certain  overhead  costs to  various
departments.  Certain  allocation  costs are allocated based on a square footage
method.  As a result of lower square footage in our  production  areas in fiscal
2006  compared to prior fiscal years,  there is a higher  percentage of overhead
allocated to non-production departments beginning in April 2005.

The principal raw material  used by our Company is casein,  which  accounted for
approximately 55% and 42% of our raw material  purchases in the first quarter of
fiscal 2006 and 2005, respectively.  As casein is a significant component of our
product  formulation,  we are vulnerable to short-term and long-term  changes in
casein pricing, which at times has been volatile.

We  experienced a 20% increase in average  casein prices in the first quarter of
fiscal 2006 compared to average casein prices in fiscal 2005,  which resulted in
an increase in cost of goods of approximately  $2.7 million.  In fiscal 2006, we
are continuing to experience high casein prices. Based on current pricing trends
with our  suppliers,  we believe  that casein  prices will remain at  historical
highs at least through  September 30, 2005.  Every 10% increase in casein prices
over the  fiscal  2005  average  will  result  in an  annual  cost  increase  of
approximately  $1,100,000  assuming  the same amount of pounds  purchased  as in
fiscal 2005.  Casein prices are still high due to greater  worldwide  demand, as
well as lower  foreign  government  subsidies  and the  decline in the US Dollar
value  versus  the  Euro.  In order to  offset  the high  casein  costs,  we are
incorporating  alternative formula  modifications that maintain the integrity of
our product  benefits as well as reducing  costs in several  other raw materials
and  operational  labor  categories.  We  have  also  passed  along  some of the
increased  costs  to  our  customers  during  fiscal  2005  and  will  implement
additional price increases as appropriate.  However, these price increases often
cannot be passed on to the  customers at the same time or in  proportion  to the
increase in our costs and,  therefore,  we experience lower margins on the sales
of our products.

We  monitor  our  costs  and  production  efficiencies  through  various  ratios
including  pounds produced per hour and cost per pound sold and use these ratios
to make decisions in purchasing, production and setting sales prices.

In fiscal 2006, we expect our annual gross profit percentage to improve over the
annual fiscal 2005 levels despite the continued  increases in raw material costs
because we have implemented price increases on some of our products,  additional
sales growth is expected in our higher  margin  products and we have  eliminated
certain low margin private label manufacturing accounts.


                                       24
<PAGE>

<TABLE>
<CAPTION>

EBITDA, (A NON-GAAP MEASURE):
                                               3-MONTHS ENDED
                              --------------------------------------------------  2005     2004
                                                              $           %       % OF    % OF
JUNE 30,                           2005        2004         CHANGE     CHANGE     SALES   SALES
------------------------------------------------------------------------------------------------
<S>                           <C>         <C>           <C>             <C>       <C>     <C>
GROSS MARGIN                   2,268,298   2,940,348     (672,050)       -22.9%     23.0%   26.3%
                              ------------------------------------------------------------------
OPERATING EXPENSES:
Selling                          936,245   1,460,400     (524,155)       -35.9%      9.5%   13.0%
Delivery                         615,471     593,326       22,145          3.7%      6.2%    5.3%
Employment contract expense (3)       --          --           --          0.0%      0.0%    0.0%
General and administrative,
including $527,518 and $162,374
non-cash stock
compensation (2)               1,261,530     795,716      465,814         58.5%     12.8%    7.1%
Impairment of property &
equipment                      7,896,554          --    7,896,554          0.0%     80.2%    0.0%
(Gain)Loss on disposal of
assets                              (636)         --         (636)         0.0%      0.0%    0.0%
Cost of disposal activities      255,011          --      255,011          0.0%      2.6%    0.0%
Research and development          91,042      72,686       18,356         25.3%      0.9%    0.6%
                              ------------------------------------------------------------------
Total operating expenses      11,055,217   2,922,128    8,133,089        278.3%    112.2%   26.1%
                              ------------------------------------------------------------------
INCOME (LOSS) FROM
OPERATIONS(1,4)               (8,786,919)     18,220   (8,805,139)    -48326.8%    -89.2%    0.2%

OTHER INCOME (EXPENSE), NET
Interest expense, net           (357,195)   (259,816)     (97,379)        37.5%     -3.6%   -2.3%
Derivative expense
                                      --    (121,119)     121,119       -100.0%      0.0%   -1.1%
Other                                 --          --           --          0.0%      0.0%    0.0%
                              ------------------------------------------------------------------
Total                           (357,195)   (380,935)      23,740         -6.2%     -3.6%   -3.4%
                              ------------------------------------------------------------------
NET INCOME (LOSS) (1)         (9,144,114)   (362,715)  (8,781,399)      2421.0%    -92.8%   -3.2%

Interest expense, net            357,195     259,816       97,379         37.5%      3.6%    2.3%
Depreciation                     539,103     546,041       (6,938)        -1.3%      5.5%    4.9%
                              ------------------------------------------------------------------
EBITDA,
(a non-GAAP measure)(1)       (8,247,816)    443,142   (8,690,958)     -1961.2%    -83.7%    4.0%
                              ==================================================================
</TABLE>


----------
(1)   We utilize  certain GAAP measures such as Operating  Income and Net Income
      and  certain  non-GAAP  measures  such  as  EBITDA  and  exclude  non-cash
      compensation  related to stock based transactions  included in general and
      administrative  expenses and certain employment contract expenses in order
      to compute our key  financial  measures  that are reviewed by  management,
      lenders and investors in order to effectively  review our current on-going
      operations  and analyze  trends  related in our  financial  condition  and
      results of operations.  Additionally,  these measures are key factors upon
      which we  prepare  our  budgets  and  forecasts,  calculate  bonuses,  and
      evaluate loan  covenants.  These  adjusted  measures are not in accordance
      with, or an alternative for, generally accepted accounting  principles and
      may be different from non-GAAP measures reported by other companies.
(2)   In our  calculation  of key  financial  measures,  we exclude the non-cash
      compensation  related to stock-based  transactions because we believe that
      this item does not  accurately  reflect our current  on-going  operations.
      Many times non-cash  compensation  is calculated  based on fluctuations in
      our stock price, which can skew the financial results  dramatically up and
      down.  The price of our  common  shares as traded on AMEX is  outside  our
      control  and   typically   does  not   reflect  our  current   operations.
      Additionally,  this  item is  excluded  by our  lenders  when  calculating
      compliance with loan covenants.
(3)   In our  calculation of key financial  measures,  we exclude the employment
      contract  expenses  related  to Angelo S.  Morini and  Christopher  J. New
      because we believe that these items do not reflect expenses related to our
      current on-going operations. Additionally, these items are excluded by our
      lenders when calculating compliance with loan covenants.
(4)   Operating  Income (Loss) has declined due to less dollars  contributed  by
      gross margin as discussed above under sales and cost of goods sold and due
      to the increase in non-cash stock compensation  expense as discussed below
      under general and administrative.


                                       25
<PAGE>

SELLING
Selling  expenses were lower in the first quarter of fiscal 2006 compared to the
first  quarter of fiscal 2005 due to lower  promotion,  demonstration  and print
advertising  costs in the first quarter of fiscal 2006.  We anticipate  that the
selling  expenses will increase over 30% due to large  promotion and advertising
campaigns  that will be launched in the second  quarter of fiscal 2006.  We sell
our products through our internal sales force and an independent broker network.

DELIVERY
Delivery expense is primarily a function of sales. In the past, delivery expense
remained consistent at approximately 5% of net sales. However, this increased to
6% of net sales in the first  quarter of fiscal  2006 due to higher  fuel prices
and  surcharges  charged  by the  transportation  companies  and  due to  higher
overhead allocation charges as discussed under Cost Of Goods Sold.

After  the  anticipated  transfer  of all  production  and  distribution  of our
products to  Schreiber  by November  2005,  we expect our  delivery  expenses to
decrease significantly as a result of an agreed upon delivery price per pound of
product with Schreiber that is lower than our current delivery cost per pound of
product.

GENERAL AND ADMINISTRATIVE
General and  administrative  expenses  increased  by  approximately  $365,000 in
non-cash  compensation related to stock-based  transactions,  as detailed below,
$33,000  in  insurance  costs due to higher  coverages  and  increased  premiums
effective in April 2005,  and $63,000 in  professional  fees for legal and audit
services due to additional contracts and SEC filings during the first quarter of
fiscal 2006.

Excluding  the  effects  of  non-cash   compensation   related  to   stock-based
transactions,  which  cannot  be  predicted,  we  anticipate  that  general  and
administrative  expenses  will be higher  than prior  year  levels for the first
three  quarters of fiscal 2006 due to the higher  insurance  costs and increased
audit  services  required.  However,  we expect that general and  administrative
expenses in the fourth quarter of fiscal 2006 will be significantly  reduced due
to the  non-recurrence  of the $1.6 million in bad debt expense that occurred in
the fourth quarter of fiscal 2005.

The change in non-cash compensation related to stock-based transactions that are
included in general and administrative expenses are detailed as follows:

                                               3-MONTHS ENDED
                              -----------------------------------------------
JUNE 30,                         2005        2004      CHANGE     % CHANGE
-----------------------------------------------------------------------------
Stock-based award
compensation - initial
issuance                       1,036,959       4,208  1,032,751      24542.56%
Stock-based award
compensation - adjust to
market                          (340,000)         --   (340,000)          0.0%
Option modifications under
APB 25 awards                   (169,441)    158,166   (327,607)      -207.13%
                              -----------------------------------------------
Non-cash compensation related
to stock based transactions      527,518     162,374    365,144        224.88%
                              ===============================================

Effective April 1, 2003, we elected to record  compensation  expense measured at
fair value for all stock-based award  transactions  (including,  but not limited
to, restricted stock awards,  stock option grants,  and warrant issuances) on or
after  April 1, 2003 under the  provisions  of SFAS No.  123.  Prior to April 1,
2003,  we only  recorded  the  fair  value  of  stock-based  awards  granted  to
non-employees  or  non-directors  under the provisions of SFAS No. 123. The fair
value of the  stock-based  award is  determined  on the date of grant  using the
Black-Scholes  pricing  model and is  expensed  over the  vesting  period of the
related award. Prior to April 1, 2003, we accounted for our stock-based employee
and director compensation plans under the accounting provisions of APB No. 25 as
interpreted by FASB Interpretation No. 44 ("FIN 44"). Any modifications of fixed
stock options or awards granted to employees or directors  originally  accounted
for under APB No. 25 may result in  additional  compensation  expense  under the
provisions of FIN 44. FIN 44 covers specific events that occurred after December
15, 1998 and was effective as of July 1, 2000.

In  accordance  with the above  accounting  standards,  we calculate  and record
non-cash   compensation   related  to  our   securities   in  the   general  and
administrative  line item in our  Statements of Operations  based on two primary
items:


                                       26
<PAGE>

      a.    Stock-Based Award Issuances
      During  the  three  months  ended  June 30,  2005 and  2004,  we  recorded
      $1,036,959  and $4,208,  respectively,  in non-cash  compensation  expense
      related  to  stock-based  transactions  that were  issued to and vested by
      employees,  officers,  directors and consultants.  During the three months
      ended June 30, 2005 and 2004, we recorded ($340,000) and $0, respectively,
      in  non-cash   compensation   expense/(income)   related  to   stock-based
      transactions that are adjusted each period for changes in the price of our
      common stock.

      b.    Option  Modifications  for Awards  granted to Employees or Directors
            under APB No. 25
      On October  11,  2002,  we repriced  all  outstanding  options  granted to
      employees  prior to October 11, 2002  (4,284,108  shares at former  prices
      ranging  from $2.84 to  $10.28)  to the  market  price of $2.05 per share.
      Prior to the repricing  modification,  the options were accounted for as a
      fixed award under APB No. 25. In accordance  with FIN 44, the repricing of
      the employee stock options requires additional  compensation expense to be
      recognized and adjusted in subsequent  periods for changes in the price of
      our common  stock that are in excess of the $2.05  stock price on the date
      of modification  (additional  intrinsic  value). If there is a decrease in
      the  market  price of our common  stock  compared  to the prior  reporting
      period, the reduction is recorded as compensation income to reverse all or
      a portion of the expense recognized in prior periods.  Compensation income
      is limited to the original base exercise  price (the  intrinsic  value) of
      the options.  This variable accounting  treatment for these modified stock
      options began with the quarter  ended  December 31, 2002 and such variable
      accounting  treatment  will continue  until the related  options have been
      cancelled,  expired or exercised. There are 3,499,841 outstanding modified
      stock options remaining as of June 30, 2005.

We recorded non-cash  compensation  expense/(income)  of ($169,441) and $158,166
for the three months ended June 30, 2005 and 2004, respectively,  related to the
modified options described above.

IMPAIRMENT OF PROPERTY AND EQUIPMENT
In light of the Asset Sale and  Outsourcing  Arrangements  discussed above under
Recent Material Developments, we determined that it is more likely than not that
a majority of our fixed assets related to production  activities will be sold or
disposed  prior  to  the  end of  their  useful  life.  These  assets  represent
approximately  98% of the  value  of  property  and  equipment.  Based  on  this
determination,  SFAS No.  144,  "Accounting  for the  Impairment  of Disposal of
Long-Term  Assets," requires that we write down the value of our assets to their
fair  values as of June 30,  2005.  We will  continue to hold and use the assets
until they are sold.  Therefore,  all assets will  continue  to be reported  and
depreciated  under  Property and  Equipment in the Balance  Sheet until they are
sold. We estimated the fair value based on the sales price in the Asset Purchase
Agreement  and the  anticipated  sales  price  related to any other  assets plus
future cash flows related to the assets from July 1, 2005 until the sale.  Based
on this  estimate,  we  recorded an  impairment  of property  and  equipment  of
$7,896,554 in the first quarter ended June 30, 2005.

RESEARCH AND DEVELOPMENT
Research and  development  expense  increased  approximately  $15,000 due to the
addition of one employee to the  department  during the first  quarter of fiscal
2006.  The  remaining  $3,000  increase  was due  primarily  to higher  overhead
allocation  charges  during the first quarter of fiscal 2006 as discussed  under
Cost Of Goods Sold.

We  anticipate  that  there  may  be a  significant  increase  in  research  and
development  expenses  in  fiscal  2006  due to an  increase  in the  number  of
personnel in the department and renewed focus on developing new products for the
market.

INTEREST AND DERIVATIVE EXPENSE
Interest expense increased  approximately  $97,000 due to higher prime rates (on
average  1.75%  higher)  and  3%  higher  rates  charged  by  Textron  Financial
Corporation  during May and June as further  described  below.  We are incurring
increased interest expense,  and anticipate further increases during fiscal 2006
compared to fiscal 2005 due to increases in the floating  interest rates used by
our lenders which are based on prevailing market interest rates.

Derivative expense represents the adjustment for the change in the fair value of
the embedded  derivative in our Series A convertible  preferred stock, which met
the criteria for  bifurcation  and separate  accounting  under SFAS No. 133. The
fair value of the  embedded  derivative  was computed  based on several  factors
including the  underlying  value of our common stock at the end of each quarter.
This expense was $121,119 in the first quarter of fiscal 2005,  but there was no
expense in the first  quarter of fiscal 2006  because  the Series A  convertible
preferred  stock was partially  converted and the remaining  shares  redeemed on
October 6, 2004.


                                       27
<PAGE>

Assuming the  consummation  of the Asset Purchase  Agreement as discussed  under
Recent Material  Developments,  we expect that our debt to Wachovia Bank will be
paid in full and there will be a significant  reduction in interest  expense due
to lower debt balances in fiscal 2006 as compared to fiscal 2005.


LIQUIDITY AND CAPITAL RESOURCES

                                                   3-MONTHS ENDED
                                  ----------------------------------------------
                                                               $           %
JUNE 30,                             2005        2004       CHANGE      CHANGE
--------------------------------------------------------------------------------
Cash from (used in) operating
activities                         (1,403,403)   578,038    (1,981,441)  -342.8%
Cash from (used in) investing
activities                            (60,651)   (74,525)       13,874    -18.6%
Cash from (used in) financing
activities                            902,272   (186,413)    1,088,685   -584.0%
                                  ----------------------------------------------
Net increase (decrease) in cash      (561,782)   317,100      (878,882)  -277.2%
                                  ==============================================

OPERATING AND INVESTING ACTIVITIES
Cash from  operating  activities  declined  in the first  quarter of fiscal 2006
primarily due to accounts  receivable  returning to its  historical  level.  The
accounts  receivable balance as of March 31, 2005 was lower than average for the
sales volume due to a large  reserve of nearly $1.6 million that was recorded as
of March 31, 2005 (See Del Sunshine LLC under Recent Material  Developments  for
further details). We are continually reviewing our collection practices, payment
terms to  vendors  and  inventory  levels  in order to  maximize  cash flow from
operations.

Cash used in investing  activities  primarily  relates to our purchase of office
and  manufacturing  equipment in each fiscal  period.  We do not  anticipate any
large  capital  expenditures  during  fiscal 2006,  but rather expect to receive
substantial  cash provided by investing  activities in the sale of a majority of
our production assets to Schreiber in the third quarter of fiscal 2006.

We expect to report positive cash flows from ongoing operations for fiscal 2006.
However,  we  anticipate  a decrease in cash flow as we begin to  outsource  our
production  late in the second quarter of fiscal 2006 as part of the outsourcing
transition described under Recent Material Developments. We will need additional
cash to build up finished good inventory  levels to maintain  standard orders to
customers  and to pay one-time  costs  associated  with the  transition  such as
severance  arrangements,  and contract  and lease  cancellation  fees.  Based on
current projections, we expect that much of the additional cash requirements, if
not all,  will be returned in the sale of our usable raw materials and packaging
inventory and  production  equipment to Schreiber in the third quarter of fiscal
2006.

FINANCING ACTIVITIES
                                                       3-MONTHS ENDED
                                  ---------------------------------------------
JUNE 30,                             2005        2004     $ CHANGE    % CHANGE
-------------------------------------------------------------------------------
Net borrowings (payments) on
line of credit and bank overdrafts   (180,706)    53,574      (234,280)  -437.3%
Payments of debt and capital
leases & associated costs            (648,582)  (217,487)     (431,095)   198.2%
Issuances of stock & associated
costs                               1,731,560    (22,500)    1,754,060  -7795.8%
                                  ---------------------------------------------
Cash from (used in) financing
activities                            902,272   (186,413)    1,088,685   -584.0%
                                  =============================================

      DEBT FINANCING
On May 27, 2003, we obtained from Textron  Financial  Corporation  ("Textron") a
revolving  credit facility (the "Textron Loan") with a maximum  principal amount
of  $7,500,000  pursuant  to the terms  and  conditions  of a Loan and  Security
Agreement dated May 27, 2003 (the "Textron Loan Agreement"). The Textron Loan is
secured by our inventory,  accounts receivable and all other assets.  Generally,
subject to the maximum principal amount, which can be borrowed under the Textron
Loan and certain reserves that must be maintained during the term of the Textron
Loan, the amount  available  under the Textron Loan for borrowing by our Company
from  time to  time is  equal  to the  sum of (i) 85% of the net  amount  of its
eligible  accounts  receivable  plus (ii) 60% of our eligible  inventory  not to
exceed  $3,500,000.  Advances under the Textron Loan bear interest at a variable
rate,  adjusted on the first  (1st) day of each  month,  equal to the prime rate
plus 1.75% per annum (8.0% at June 30,  2005)  calculated  on the  average  cash
borrowings for the preceding month. The initial term of the Textron Loan ends on
May 26, 2006, but this loan automatically renews for additional one-year periods
unless  terminated by our Company or Textron  through a written  notice  90-days
prior  thereto or as otherwise  provided in the loan  agreement.  As of June 30,
2005, the outstanding principal balance on the Textron Loan was $4,736,456.


                                       28
<PAGE>

The Textron Loan Agreement  contains certain financial and operating  covenants.
On June 3,  2005,  we  executed  a fourth  amendment  to the  Textron  Loan that
provided a waiver on all the  existing  defaults for the fiscal  quarters  ended
December  31, 2004 and March 31,  2005,  and amended the fixed  charge  coverage
ratio and the adjusted  tangible net worth  requirements for periods after March
31, 2005.  Additionally,  the fourth amendment allowed the Textron Loan to be in
an over-advance position not to exceed $750,000 until July 31, 2005. In exchange
for the waiver and amendments,  our interest rate was set at Prime plus 4.75% on
the  Textron  Loan and we paid a fee of $50,000 in four weekly  installments  of
$12,500.

On June 16, 2005, we used a portion of the proceeds  from the warrant  exercises
described below under Equity Financing to satisfy the $750,000 over-advance with
Textron.  In connection with the satisfaction of the over-advance,  we agreed to
immediately terminate Textron's obligation to permit any over-advances under the
Textron  Loan,  which  obligation  was to  expire  on July  31,  2005.  With the
termination of the over-advance  facility, the interest rate on the Textron Loan
returned  to its prior  level of Prime plus  1.75%.  On June 30,  2005,  Textron
reduced our borrowing  availability  under our line by $200,000  until they have
time to review and approve our financial  forecasts  that reflect the asset sale
and  outsourcing  arrangements.  However,  there is no guarantee if or when they
will lift this restriction on our borrowing availability.  Additionally,  we may
experience  further  restrictions  by  Textron  by virtue of  reserves  they may
require,  receivables  they may deem  ineligible or other rights they have under
the Textron Loan Agreement.

In  August  2005,  due to the Cost of  Disposal  Activities  and  Impairment  of
Property and Equipment, we determined that we fell below the requirement for the
fixed charge  coverage  ratio and the adjusted  tangible net worth  requirements
under the  Textron  Loan for the quarter  ended June 30,  2005.  Although  these
covenant  violations  placed us in  technical  default on the loan,  we have not
received  a  notice  of an event  of  default  from  Textron.  We are  currently
discussing our financial  forecasts that reflect the asset sale and  outsourcing
arrangements  and certain  waivers and loan  modifications  to the Textron  Loan
Agreement.  Until  such  time  as we  have  received  formal  waivers  and  loan
modifications,  Textron is allowing us to operate in a position of default.  The
existence of a default under the Textron Loan would allow Wachovia,  another one
of our lenders,  as described  below,  to declare an event of default  under our
existing term loan based on a  cross-default  provision in their loan agreement.
If an  agreement  cannot  be  reached  on the loan  modifications,  Textron  and
Wachovia could exercise their  respective  rights under their loan documents to,
among  other  things,  declare  a  default  under  the  loans,   accelerate  the
outstanding  indebtedness such that it would become immediately due and payable,
and pursue  foreclosure of our assets,  which are pledged as collateral for such
loans.  If such an event occurred with either Textron or Wachovia and additional
financing is not available on terms  acceptable to us, it would be substantially
more difficult for us to effectively continue the operation of our business, and
it is unlikely that we would be able to continue as a going concern.

Simultaneous  with the closing of the Textron Loan in May 2003,  Wachovia  Bank,
N.A. successor by merger to SouthTrust Bank ("Wachovia")  extended our Company a
new  term  loan in the  principal  amount  of  $2,000,000.  This  term  loan was
consolidated  with our March  2000 term  loan  with  Wachovia,  which had a then
outstanding  principal  balance of  $8,131,985  for a total term loan  amount of
$10,131,985.  This term loan is  secured  by all of our  equipment  and  certain
related  assets.  Additionally,  the term loan bears interest at Wachovia's Base
Rate plus 1% (7.25% at June 30, 2005). The balance  outstanding on the term loan
as of June 30, 2005 was  $7,801,985.  This  balance is  classified  as a current
liability due to the cross-default provision described above.

On June 30, 2005, we entered into a Loan  Modification  Agreement  with Wachovia
regarding its term loan. The agreement modified the following terms of the loan:
1) the loan will mature and be payable in full on July 31, 2006  instead of June
1, 2009;  2) the  principal  payments  will  remain at  $110,000  per month with
accrued  interest  at  Wachovia's  Base Rate plus 1%  instead of  increasing  to
$166,250  on July 1,  2005 as  provided  by the  terms  of the  promissory  note
evidencing  the loan;  and 3) all  covenants  related to our tangible net worth,
total  liabilities  to tangible  net worth,  and  maximum  funded debt to EBITDA
ratios are waived and  compliance  is not required by us through the maturity of
the loan on July 31, 2006. In connection  with the  agreement,  we agreed to pay
$60,000,  of which $30,000 was paid upon  execution of the agreement and $30,000
was paid on August 1, 2005.  As  required by the terms of the  agreement,  if we
sell  our  equipment   securing  the  loan  as  discussed  under  the  Schreiber
Transactions in Recent  Material  Developments  above,  the loan will be due and
payable in full at the time of sale.

      EQUITY FINANCING
In accordance  with a warrant  agreement  dated April 10, 2003, we issued to Mr.
Frederick  DeLuca, a greater than 10%  shareholder,  a warrant to purchase up to
100,000  shares of our  common  stock at an  exercise  price of $1.70 per share.
Additionally,  in accordance with a warrant  agreement dated October 6, 2004, we
issued to Mr.  DeLuca a warrant to purchase  up to 500,000  shares of our common
stock at an exercise  price of $1.15 per share.  Subsequently  in June 2005,  we
agreed to reduce the  per-share  exercise  price on these  warrants to $1.36 and
$0.92, respectively, in order to induce Mr. DeLuca to exercise his warrants. All
of the warrants were exercised on June 16, 2005 for total proceeds of $596,000.


                                       29
<PAGE>

On each of April 24, 2003 and October 6, 2004,  BH Capital  Investments,  LP and
Excalibur  Limited  Partnership each received warrants to purchase up to 250,000
shares  of our  common  stock at an  exercise  price of $2.00 per  share.  Also,
Excalibur Limited Partnership received a warrant to purchase up to 30,000 shares
of our common  stock at an exercise  price of $2.05 per share on June 26,  2002.
Subsequently  in June 2005, we agreed to reduce the per-share  exercise price on
all such  warrants  to $1.10 in order to induce BH Capital  Investments,  LP and
Excalibur  Limited  Partnership to exercise their warrants.  All of the warrants
were exercised on June 16, 2005 for total proceeds of $1,133,000.

In  accordance  with the  accounting  provisions  of SFAS No.  123,  we recorded
$1,024,500  in non-cash  compensation  expense  related to the  reduction in the
exercise price of the above mentioned warrants in June 2005.

We used a portion of the  proceeds  from the  warrant  exercises  to satisfy the
$750,000  over-advance provided by Textron under the Fourth Amendment and Waiver
to the  Textron  Loan  Agreement,  as  described  under Debt  Financing  and the
remaining  proceeds  from the warrant  exercises  were used for working  capital
purposes.

In accordance  with a registration  rights  agreement dated October 6, 2004 with
Mr.  Frederick  DeLuca,  we agreed  that  within 180 days we would file with the
Securities and Exchange  Commission and obtain  effectiveness  of a registration
statement  that  included  2,000,000  shares  issued in a private  placement and
500,000  shares  related  to a stock  purchase  warrant.  Per the  terms  of the
agreement,  if a  registration  statement  was  not  filed,  or did  not  become
effective  within 180 days,  then in addition to any other rights Mr. DeLuca may
have,  we  would be  required  to pay  certain  liquidated  damages.  We filed a
registration statement on Form S-3 on March 14, 2005. However, this registration
statement  has not yet been declared  effective.  We received from Mr. DeLuca an
extension  of time until  September 1, 2005 to have the  registration  statement
declared effective by the SEC.  Additionally,  Mr. DeLuca waived all damages and
remedies for failure to have an effective registration statement until September
1, 2005.  In the event  that the  registration  statement  is not  effective  by
September 1, 2005,  we will be liable to pay $71,875  (2.5% times the product of
2,500,000  registerable  shares and the share  price of $1.15 per  share)  every
thirty  days  until  the  registration  statement  becomes  effective  unless an
additional extension is granted.

SUMMARY
Assuming that Textron allows us to continue to operate in a default position and
no further  material  restrictions or changes from our lenders,  we believe that
with the cash available on our credit  facilities and proceeds received from the
equity financings together with cash flow from current operations,  we will have
enough cash to meet our current liquidity needs for general  operations  through
June 30, 2006.

Based on current projections, we expect that much, if not all, of the additional
cash  requirements  for the  transition  charges  will come from the sale of our
usable raw  materials  and  packaging  inventory  and  production  equipment  to
Schreiber in the third quarter of fiscal 2006.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our  exposure to market risk results  primarily  from  fluctuations  in interest
rates.  The interest rates on our outstanding  debts to Wachovia and Textron are
floating and based on the prevailing  market  interest rates.  For  market-based
debt, interest rate changes generally do not affect the market value of the debt
but do impact  future  interest  expense  and  hence  earnings  and cash  flows,
assuming other factors remain  unchanged.  A theoretical 1% increase or decrease
in market  rates in effect on June 30, 2005 with  respect to our debt as of such
date would  increase or decrease  interest  expense and hence reduce or increase
the net income of our Company by approximately  $125,000 per year or $31,250 per
quarter.

Our  sales  during  the  quarters  ended  June 30,  2005 and  2004,  which  were
denominated  in a currency other than U.S.  Dollars,  were less than 5% of gross
sales and no net assets were  maintained in a functional  currency other than U.
S. Dollars during such periods.  However, further declines in the U.S. Dollar on
the  international  market,  may cause our foreign  suppliers of raw  materials,
particularly  casein, to increase their U.S. Dollar prices on future orders from
our Company.  Therefore, while we believe that the effects of changes in foreign
currency exchange rates have not historically been significant to our operations
or net assets,  we are unable to  forecast  the effects  that  foreign  currency
exchange rates may have on our future operations.


                                       30
<PAGE>

ITEM 4. CONTROLS AND PROCEDURES

As of June 30, 2005, an evaluation was performed  under the supervision and with
the  participation  of our  management,  including the Chief  Executive  Officer
("CEO"),  and the Chief Financial  Officer ("CFO"),  of the effectiveness of the
design and operation of our  disclosure  controls and  procedures to insure that
the Company records, processes, summarizes and reports in a timely and effective
manner  the  information  required  to be  disclosed  in  reports  filed with or
submitted to the Securities and Exchange  Commission.  Based on that evaluation,
our  management,  including  the CEO and  CFO,  concluded  that  our  disclosure
controls and  procedures  were effective in timely  bringing to their  attention
material  information  related to our  Company  required  to be  included in our
periodic  Securities  and Exchange  Commission  filings.  Since the date of this
evaluation,  there  have been no changes in our  internal  controls  or in other
factors that are reasonably likely to materially affect those controls.


                                       31
<PAGE>

                           PART II. OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

In accordance  with a warrant  agreement  dated April 10, 2003, we issued to Mr.
Frederick  DeLuca, a greater than 10%  shareholder,  a warrant to purchase up to
100,000  shares  of our  common  stock at an  exercise  price of $1.70 per share
expiring on April 10, 2006. Additionally, in accordance with a warrant agreement
dated  October 6, 2004,  we issued to Mr.  DeLuca a warrant  to  purchase  up to
500,000  shares  of our  common  stock at an  exercise  price of $1.15 per share
expiring on October 6, 2009.  Subsequently in June 2005, we agreed to reduce the
per-share exercise price on these warrants to $1.36 and $0.92, respectively,  in
order to induce Mr.  DeLuca to exercise his  warrants.  All of the warrants were
exercised on June 16, 2005 for total proceeds of $596,000.

On each of April 24, 2003 and October 6, 2004,  BH Capital  Investments,  LP and
Excalibur  Limited  Partnership each received warrants to purchase up to 250,000
shares  of our  common  stock at an  exercise  price of $2.00 per  share.  These
warrants  were to expire on July 15,  2006 and  October 6,  2009,  respectively.
Also,  on June 26, 2002,  Excalibur  Limited  Partnership  received a warrant to
purchase up to 30,000  shares of our common stock at an exercise  price of $2.05
per share  expiring on June 26, 2007.  Subsequently  in June 2005,  we agreed to
reduce the  per-share  exercise  price on all such warrants to $1.10 in order to
induce BH Capital Investments,  LP and Excalibur Limited Partnership to exercise
their  warrants.  All of the warrants were  exercised on June 16, 2005 for total
proceeds of $1,133,000.

We used a portion of the  proceeds  from the  warrant  exercises  to satisfy the
$750,000  over-advance provided by Textron under the Fourth Amendment and Waiver
to the Textron Loan Agreement, as described under Debt Financing in Part I, Item
2, and the remaining  proceeds from the warrant  exercises were used for working
capital purposes.

In accordance  with a registration  rights  agreement dated October 6, 2004 with
Mr.  Frederick  DeLuca,  we agreed  that  within 180 days we would file with the
Securities and Exchange  Commission and obtain  effectiveness  of a registration
statement  that  included  2,000,000  shares  issued in a private  placement and
500,000  shares  related  to a stock  purchase  warrant.  Per the  terms  of the
agreement,  if a  registration  statement  was  not  filed,  or did  not  become
effective within 180 days, then in addition to any other rights the investor may
have,  we  would be  required  to pay  certain  liquidated  damages.  We filed a
registration statement on Form S-3 on March 14, 2005. However, this registration
statement  has not yet been declared  effective.  We received from Mr. DeLuca an
extension  of time until  September 1, 2005 to have the  registration  statement
declared effective by the SEC.  Additionally,  Mr. DeLuca waived all damages and
remedies for failure to have an effective registration statement until September
1, 2005.  In the event  that the  registration  statement  is not  effective  by
September 1, 2005,  we will be liable to pay $71,875  (2.5% times the product of
2,500,000  registerable  shares and the share  price of $1.15 per  share)  every
thirty  days  until  the  registration  statement  becomes  effective  unless an
additional extension is granted.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

On May 27, 2003, we obtained from Textron  Financial  Corporation  ("Textron") a
revolving  credit facility (the "Textron Loan") with a maximum  principal amount
of  $7,500,000  pursuant  to the terms  and  conditions  of a Loan and  Security
Agreement dated May 27, 2003 (the "Textron Loan Agreement"). The Textron Loan is
secured by our inventory,  accounts receivable and all other assets.  Generally,
subject to the maximum principal amount, which can be borrowed under the Textron
Loan and certain reserves that must be maintained during the term of the Textron
Loan, the amount  available  under the Textron Loan for borrowing by our Company
from  time to  time is  equal  to the  sum of (i) 85% of the net  amount  of its
eligible  accounts  receivable  plus (ii) 60% of our eligible  inventory  not to
exceed  $3,500,000.  Advances under the Textron Loan bear interest at a variable
rate,  adjusted on the first  (1st) day of each  month,  equal to the prime rate
plus 1.75% per annum (8.0% at June 30,  2005)  calculated  on the  average  cash
borrowings for the preceding month. The initial term of the Textron Loan ends on
May 26, 2006, but this loan automatically renews for additional one-year periods
unless  terminated by our Company or Textron  through a written  notice  90-days
prior  thereto or as otherwise  provided in the loan  agreement.  As of June 30,
2005, the outstanding principal balance on the Textron Loan was $4,736,456.

In  August  2005,  due to the Cost of  Disposal  Activities  and  Impairment  of
Property and Equipment, we determined that we fell below the requirement for the
fixed charge  coverage  ratio and the adjusted  tangible net worth  requirements
under the  Textron  Loan for the quarter  ended June 30,  2005.  Although  these
covenant  violations  placed us in  technical  default on the loan,  we have not
received  a  notice  of an event  of  default  from  Textron.  We are  currently
discussing our financial  forecasts that reflect the asset sale and  outsourcing
arrangements  and certain  waivers and loan  modifications  to the Textron  Loan
Agreement.  Until  such  time  as we  have  received  formal  waivers  and  loan
modifications,  Textron is allowing us to operate in a position of default.  The
existence of a default under the Textron Loan would allow Wachovia,  another one
of our  lenders,  to declare an event of default  under our  existing  term loan
based on a  cross-default  provision  in their loan  agreement.  If an agreement
cannot be reached on the loan modifications, Textron and Wachovia could exercise
their  respective  rights under their loan  documents  to,  among other  things,
declare a default under the loans, accelerate the outstanding  indebtedness such
that it would become immediately due and payable,  and pursue foreclosure of our
assets,  which  are  pledged  as  collateral  for such  loans.  If such an event
occurred  with  either  Textron or  Wachovia  and  additional  financing  is not
available on terms  acceptable to us, it would be  substantially  more difficult
for us to effectively continue the operation of our business, and it is unlikely
that we  would  be able to  continue  as a going  concern.  As a  result  of the
cross-default  provision,  the Wachovia balance of $7,801,985 is classified as a
current liability as of June 30, 2005.


                                       32
<PAGE>

ITEM 6.  EXHIBITS

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

EXHIBIT NO  EXHIBIT DESCRIPTION
----------  --------------------------------------------------------------------

*  3.1      Restated  Certificate of  Incorporation of the Company as filed with
            the Secretary of State of the State of Delaware on December 23, 2002
            (Filed as  Exhibit  3.2 on Form 10-Q for the  fiscal  quarter  ended
            December 31, 2002.)

*  3.2      By-laws  of  the  Company,  as  amended  (Filed  as  Exhibit  3.2 to
            Registration Statement on Form S-18, No. 33-15893-NY.)

*  4.1      Stock Purchase  Option  Agreement and Stock Purchase  Warrant by and
            between  Excalibur Limited  Partnership and BH Capital  Investments,
            L.P. and Galaxy  Nutritional Foods dated as of April 24, 2003 (Filed
            as Exhibit 10.52 on Form 10-Q for the fiscal  quarter ended June 30,
            2003.)

*  4.2      Warrant to Purchase  Securities of Galaxy  Nutritional  Foods,  Inc.
            dated as of May 29, 2003 in favor of Wachovia Bank (Filed as Exhibit
            10.7 on Form 8-K filed June 2, 2003.)

*  4.3      Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and Fromageries Bel S.A. (Filed as
            Exhibit 10.8 on Form 8-K filed June 2, 2003.)

*  4.4      Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and Fromageries Bel S.A. (Filed as
            Exhibit 10.9 on Form 8-K filed June 2, 2003.)

*  4.5      Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and  Frederick A. DeLuca (Filed as
            Exhibit 10.10 on Form 8-K filed June 2, 2003.)

*  4.6      Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and  Frederick A. DeLuca (Filed as
            Exhibit 10.11 on Form 8-K filed June 2, 2003.)

*  4.7      Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional Foods, Inc. and Apollo Capital Management Group,
            L.P. (Filed as Exhibit 10.12 on Form 8-K filed June 2, 2003.)

*  4.8      Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional Foods, Inc. and Apollo Capital Management Group,
            L.P. (Filed as Exhibit 10.13 on Form 8-K filed June 2, 2003.)

*  4.9      Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy Nutritional  Foods, Inc. and Apollo MicroCap  Partners,  L.P.
            (Filed as Exhibit 10.14 on Form 8-K filed June 2, 2003.)

*  4.10     Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy Nutritional  Foods, Inc. and Apollo MicroCap  Partners,  L.P.
            (Filed as Exhibit 10.15 on Form 8-K filed June 2, 2003.)

*  4.11     Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and Ruggieri of Windermere  Family
            Limited  Partnership  (Filed as Exhibit 10.16 on Form 8-K filed June
            2, 2003.)

*  4.12     Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc. and Ruggieri of Windermere  Family
            Limited  Partnership  (Filed as Exhibit 10.17 on Form 8-K filed June
            2, 2003.)

*  4.13     Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods, Inc. and Ruggieri Financial Pension Plan
            (Filed as Exhibit 10.18 on Form 8-K filed June 2, 2003.)

*  4.14     Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods, Inc. and Ruggieri Financial Pension Plan
            (Filed as Exhibit 10.19 on Form 8-K filed June 2, 2003.)


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<PAGE>

*  4.15     Securities  Purchase  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc.  and David Lipka (Filed as Exhibit
            10.20 on Form 8-K filed June 2, 2003.)

*  4.16     Registration  Rights  Agreement  dated  as of May 21,  2003  between
            Galaxy  Nutritional  Foods,  Inc.  and David Lipka (Filed as Exhibit
            10.21 on Form 8-K filed June 2, 2003.)

*  4.17     Stockholder  Agreement  dated as of October 13, 2003 between  Galaxy
            Nutritional Foods, Inc. and Angelo S. Morini (Filed as Exhibit 10.55
            on Form 10-Q for the fiscal quarter ended September 30, 2003.)

*  4.18     Securities  Purchase  Agreement  dated as of October 6, 2004 between
            Galaxy  Nutritional  Foods,  Inc. and  Frederick A. DeLuca (Filed as
            Exhibit 4.18 on Form 8-K filed October 8, 2004.)

*  4.19     Registration  Rights  Agreement  dated as of October 6, 2004 between
            Galaxy  Nutritional  Foods,  Inc. and  Frederick A. DeLuca (Filed as
            Exhibit 4.19 on Form 8-K filed October 8, 2004.)

*  4.20     Warrant to Purchase  Securities of Galaxy  Nutritional  Foods,  Inc.
            dated as of October 6, 2004 in favor of Frederick  A. DeLuca  (Filed
            as Exhibit 4.20 on Form 8-K filed October 8, 2004.)

*  4.21     Stock Repurchase  Agreement dated as of October 6, 2004 by and among
            Galaxy  Nutritional  Foods,  Inc., BH Capital  Investments  L.P. and
            Excalibur  Limited  Partnership  (Filed as Exhibit  4.21 on Form 8-K
            filed October 8, 2004.)

*  4.22     Registration  Rights  Agreement  dated as of  October 6, 2004 by and
            among Galaxy Nutritional  Foods,  Inc., BH Capital  Investments L.P.
            and Excalibur Limited Partnership (Filed as Exhibit 4.22 on Form 8-K
            filed October 8, 2004.)

*  4.23     Warrant to Purchase  Securities of Galaxy  Nutritional  Foods,  Inc.
            dated as of October 6, 2004 in favor of BH Capital  Investments L.P.
            (Filed as Exhibit 4.23 on Form 8-K filed October 8, 2004.)

*  4.24     Warrant to Purchase  Securities of Galaxy  Nutritional  Foods,  Inc.
            dated  as  of  October  6,  2004  in  favor  of  Excalibur   Limited
            Partnership  (Filed as  Exhibit  4.24 on Form 8-K filed  October  8,
            2004.)

*  4.25     Asset  Purchase   Agreement  dated  June  30,  2005  between  Galaxy
            Nutritional  Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit
            4.25 on Form 8-K filed July 6, 2005.)

*  10.1     Master  Distribution and License  Agreement dated as of May 22, 2003
            between Galaxy  Nutritional  Foods,  Inc. and  Fromageries  Bel S.A.
            (Filed as Exhibit 10.22 on Form 8-K filed June 2, 2003.)

*  10.2     Loan and Security  Agreement dated as of May 27, 2003 between Galaxy
            Nutritional Foods, Inc. and Textron Financial  Corporation (Filed as
            Exhibit 10.1 on Form 8-K filed June 2, 2003.)

*  10.3     Patent,  Copyright and Trademark Collateral Security Agreement dated
            as of May 27,  2003  between  Galaxy  Nutritional  Foods,  Inc.  and
            Textron  Financial  Corporation  (Filed as Exhibit  10.2 on Form 8-K
            filed June 2, 2003.)

*  10.4     Renewal  Promissory Note in the principal  amount of  $10.131,984.85
            dated as of May 28, 2003 by Galaxy  Nutritional Foods, Inc. in favor
            of Wachovia  Bank  (Filed as Exhibit  10.3 on Form 8-K filed June 2,
            2003.)

*  10.5     Renewal Promissory Note in the principal amount of $501,000.00 dated
            as of May 28,  2003 by Galaxy  Nutritional  Foods,  Inc. in favor of
            Wachovia  Bank  (Filed as  Exhibit  10.4 on Form 8-K  filed  June 2,
            2003.)

*  10.6     Amendment of Loan Agreement  dated as of May 28, 2003 between Galaxy
            Nutritional  Foods, Inc. and Wachovia Bank (Filed as Exhibit 10.5 on
            Form 8-K filed June 2, 2003.)

*  10.7     Amendment  of Security  Agreement  dated as of May 28, 2003  between
            Galaxy  Nutritional  Foods, Inc. and Wachovia Bank (Filed as Exhibit
            10.6 on Form 8-K filed June 2, 2003.)


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<PAGE>

*  10.8     Waiver  Letter from  Textron  Financial  Corporation  to the Company
            dated  August 13, 2003 (Filed as Exhibit  10.53 on Form 10-Q for the
            fiscal quarter ended June 30, 2003.)

*  10.9     Second Amended and Restated Employment Agreement dated as of October
            13, 2003 between Galaxy Nutritional Foods, Inc. and Angelo S. Morini
            (Filed as Exhibit 10.1 on Form 8-K filed October 20, 2003.)

*  10.10    Settlement  Agreement  dated May 6, 2004 between Galaxy  Nutritional
            Foods, Inc. and Schreiber Foods, Inc. (Filed as Exhibit 10.1 on Form
            8-K filed May 11, 2004.)

*  10.11    Modification  Letter on the Security  Agreement  dated as of May 21,
            2004 between Galaxy Nutritional Foods, Inc. and Wachovia Bank (Filed
            as Exhibit  10.11 on Form 10-K for the fiscal  year ended  March 31,
            2004.)

*  10.12    Second Amendment to Loan and Security  Agreement dated June 25, 2004
            between  Galaxy   Nutritional  Foods,  Inc.  and  Textron  Financial
            Corporation (Filed as Exhibit 10.12 on Form 10-K for the fiscal year
            ended March 31, 2004.)

*  10.13    Third  Amendment  to Lease  Agreement  dated June 10,  2004  between
            Galaxy Nutritional Foods, Inc. and Cabot Industrial Properties, L.P.
            (Filed as Exhibit 10.13 on Form 10-K for the fiscal year ended March
            31, 2004.)

*  10.14    Separation  and  Settlement  Agreement  dated  July 8, 2004  between
            Galaxy  Nutritional  Foods,  Inc. and  Christopher  J. New (Filed as
            Exhibit 10.14 on Form 8-K filed July 13, 2004.)

*  10.15    Employment  Agreement dated July 8, 2004 between Galaxy  Nutritional
            Foods, Inc. and Michael E. Broll (Filed as Exhibit 10.15 on Form 8-K
            filed July 13, 2004.)

*  10.16    Third  Amendment to Loan and Security  Agreement  dated November 10,
            2004 between Galaxy  Nutritional  Foods,  Inc. and Textron Financial
            Corporation  (Filed as  Exhibit  10.16 on Form  10-Q for the  fiscal
            quarter ended December 31, 2004.)

*  10.17    Fourth  Amendment to Loan and Security  Agreement dated June 3, 2005
            between  Galaxy   Nutritional  Foods,  Inc.  and  Textron  Financial
            Corporation  (Filed  as  Exhibit  10.17 on Form 8-K  filed  June 22,
            2005.)

*  10.18    Letter  Agreement  dated June 17, 2005  between  Galaxy  Nutritional
            Foods,  Inc.  and Textron  Financial  Corporation  (Filed as Exhibit
            10.18 on Form 8-K filed June 22, 2005.)

*  10.19    Supply  Agreement  dated June 30, 2005  between  Galaxy  Nutritional
            Foods,  Inc. and Schreiber  Foods,  Inc.  (Filed as Exhibit 10.19 on
            Form 8-K filed July 6, 2005.)

*  10.20    Loan Modification Agreement June 30, 2005 between Galaxy Nutritional
            Foods, Inc. and Wachovia Bank N.A (formerly SouthTrust Bank). (Filed
            as Exhibit 10.19 on Form 8-K filed July 6, 2005.)

*  14.1     Code of Ethics  (Filed as  Exhibit  14.1 on Form 10-K for the fiscal
            year ended March 31, 2005.)

*  20.1     Audit Committee  Charter (Filed as Exhibit 20.1 on Form 10-Q for the
            fiscal quarter ended September 30, 2003.)

*  20.2     Compensation  Committee  Charter (Filed as Exhibit 20.2 on Form 10-Q
            for the fiscal quarter ended September 30, 2003.)

   31.1     Section 302  Certification  of our Chief  Executive  Officer  (Filed
            herewith.)

   31.2     Section 302  Certification  of our Chief  Financial  Officer  (Filed
            herewith.)

   32.1     Section 906  Certification  of our Chief  Executive  Officer  (Filed
            herewith.)

   32.2     Section 906  Certification  of our Chief  Financial  Officer  (Filed
            herewith.)

----------
*     Previously filed and incorporated herein by reference.


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<PAGE>

                                   SIGNATURES


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


                                     GALAXY NUTRITIONAL FOODS, INC.


Date: August 22, 2005                /s/ Michael E. Broll
                                     -------------------------------------------
                                     Michael E. Broll
                                     Chief Executive Officer
                                    (Principal Executive Officer)


Date: August 22, 2005                /s/ Salvatore J. Furnari
                                     -------------------------------------------
                                     Salvatore J. Furnari
                                     Chief Financial Officer
                                    (Principal Accounting and Financial Officer)


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