SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q
       __________________________________________________________________

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

               FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2003

                          _____________________________

                         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 February 20, 2004,  there were 15,579,155  shares of Common Stock,  $.01
par value per share, outstanding.

                                       1
<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.

                               INDEX TO FORM 10-Q
                       FOR QUARTER ENDED DECEMBER 31, 2003




                                                                        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 OPERATION                   17

      ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK     29

      ITEM 4.  CONTROLS AND PROCEDURES                                        29

PART II. OTHER INFORMATION

      ITEM 1.  LEGAL PROCEEDINGS                                              30

      ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS                      30

      ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                31

      ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS            31

      ITEM 5.  OTHER INFORMATION                                              31

      ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                               33

SIGNATURES                                                                    36

                                       2
<PAGE>

                          PART I. FINANCIAL INFORMATION
                          -----------------------------
                          GALAXY NUTRITIONAL FOODS, INC.
                                  BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                     DECEMBER 31,       MARCH 31,
                                                               NOTES    2003              2003
                                                               ----- ------------     ------------
                                                                     (UNAUDITED)
                          ASSETS
CURRENT ASSETS:
<S>                                                                  <C>              <C>
   Cash                                                              $    476,740     $      1,598
   Trade receivables, net                                               4,240,708        5,109,247
   Inventories                                                          4,086,305        5,294,500
   Prepaid expenses and other                                             359,328          553,396
                                                                     ------------     ------------

           Total current assets                                         9,163,081       10,958,741

PROPERTY AND EQUIPMENT, NET                                            20,686,284       22,168,404
OTHER ASSETS                                                              397,158          274,918
                                                                     ------------     ------------

           TOTAL                                                     $ 30,246,523     $ 33,402,063
                                                                     ============     ============

            LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
   Book overdrafts                                                   $         --     $  1,151,276
   Line of credit                                                 2     4,389,978        4,939,894
   Accounts payable                                                     1,471,195        2,622,996
   Accrued liabilities                                            8     2,129,293        1,891,773
   Current portion of term notes payable                          2     1,136,000        1,497,760
   Current portion of subordinated note payable                   2            --        2,000,000
   Current portion of obligations under capital leases                    244,744          363,152
                                                                     ------------     ------------

           Total current liabilities                                    9,371,210       14,466,851

ACCRUED EMPLOYMENT CONTRACT, less current portion                 8     1,388,026               --
TERM NOTES PAYABLE, less current portion                          2     8,571,985        7,786,985
SUBORDINATED NOTE PAYABLE                                         2            --        2,000,000
OBLIGATIONS UNDER CAPITAL LEASES, less current portion                    203,797          383,210
                                                                     ------------     ------------

           Total liabilities                                           19,535,018       24,637,046
                                                                     ------------     ------------

COMMITMENTS AND CONTINGENCIES                                     3            --               --

REDEEMABLE CONVERTIBLE PREFERRED STOCK                            4     3,213,849        2,324,671

STOCKHOLDERS' EQUITY:                                             4
   Common stock                                                           154,948          127,617
   Additional paid-in capital                                          64,407,314       59,800,732
   Accumulated deficit                                                (44,171,945)     (40,595,342)
                                                                     ------------     ------------

                                                                       20,390,317       19,333,007
   Less:  Notes receivable arising from the exercise of stock    5,8
           options and sale of common stock                          (12,772,200)     (12,772,200)
         Treasury stock, 26,843 shares, at cost                         (120,461)        (120,461)
                                                                    ------------     ------------

           Total stockholders' equity                                  7,497,656        6,440,346
                                                                    ------------     ------------

           TOTAL                                                    $ 30,246,523     $ 33,402,063
                                                                    ============     ============
</TABLE>

                 See accompanying notes to financial statements.

                                       3
<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.
                            STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED                NINE MONTHS ENDED
                                                  DECEMBER 31,                      DECEMBER 31,
                                         -----------------------------     -----------------------------
                                             2003             2002             2003             2002
                                         ------------     ------------     ------------     ------------
<S>                                      <C>              <C>              <C>              <C>
NET SALES                                $  9,638,571     $  9,755,729     $ 27,664,259     $ 29,795,764

COST OF GOODS SOLD                          6,715,750        6,805,863       19,096,843       21,089,597
                                         ------------     ------------     ------------     ------------
  Gross margin                              2,922,821        2,949,866        8,567,416        8,706,167
                                         ------------     ------------     ------------     ------------

OPERATING EXPENSES:
Selling                                     1,110,097        1,240,544        3,870,829        3,575,859
Delivery                                      544,930          478,331        1,430,706        1,561,847
Non-cash compensation related to
   options & warrants (NOTE 1 AND
   NOTE 5)                                   (255,712)         190,720        1,179,677       (2,794,630)
Employment contract expense (NOTE 8)        1,830,329               --        1,830,329               --
General and administrative                    752,123          864,399        2,621,621        2,453,148
Research and development                       65,474           60,674          191,466          174,888
                                         ------------     ------------     ------------     ------------
  Total operating expenses                  4,047,241        2,834,668       11,124,628        4,971,112
                                         ------------     ------------     ------------     ------------

INCOME (LOSS) FROM OPERATIONS              (1,124,420)         115,198       (2,557,212)       3,735,055

Interest expense                             (253,934)        (536,766)      (1,019,391)      (2,404,868)
Other expense                                      --          (55,000)              --          (55,000)
                                         ------------     ------------     ------------     ------------

NET INCOME (LOSS)                        $ (1,378,354)    $   (476,568)    $ (3,576,603)    $  1,275,187

Preferred Stock Dividends (NOTE 4)             48,556           69,020          157,172          209,020
Preferred Stock Accretion to
   Redemption Value (NOTE 4)                  131,076        1,278,022        1,677,409        1,737,999
                                         ------------     ------------     ------------     ------------

NET LOSS AVAILABLE TO COMMON
   SHAREHOLDERS                          $ (1,557,986)    $ (1,823,610)    $ (5,411,184)    $   (671,832)
                                         ============     ============     ============     ============

BASIC AND DILUTED NET LOSS PER COMMON
   SHARE (NOTE 6)                        $      (0.10)    $      (0.15)    $      (0.37)    $      (0.06)
                                         ============     ============     ============     ============
</TABLE>

                 See accompanying notes to financial statements.

                                       4
<PAGE>

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

<TABLE>
<CAPTION>
                                    Common Stock                                            Notes
                             ---------------------------    Additional     Accumulated  Receivable for    Treasury
                                 Shares       Par Value   Paid-In Capital    Deficit     Common Stock       Stock          Total
                             -------------------------------------------------------------------------------------------------------
<S>                            <C>          <C>            <C>            <C>            <C>            <C>            <C>
Balance at March 31, 2003      12,761,685   $    127,617   $ 59,800,732   $(40,595,342)  $(12,772,200)  $   (120,461)  $  6,440,346

Exercise of warrants              200,000          2,000        358,000             --             --             --        360,000
Issuance of common stock        2,226,830         22,268      3,976,393             --             --             --      3,998,661
Conversion of preferred
   stock                          306,254          3,063        527,562             --             --             --        530,625
Fair value of warrants
   and employee options
   issued                              --             --        685,308             --             --             --        685,308
Non-cash compensation
   related to variable
   securities                          --             --        540,613             --             --             --        540,613
Dividends on preferred
   stock                               --             --       (157,172)            --             --             --       (157,172)
Accretion of discount on
   preferred stock                     --             --     (1,324,122)            --             --             --     (1,324,122)
Net loss                               --             --             --     (3,576,603)            --             --     (3,576,603)
                             -------------------------------------------------------------------------------------------------------

Balance at December 31,
   2003                        15,494,769   $    154,948   $ 64,407,314   $(44,171,945)  $(12,772,200)  $   (120,461)  $  7,497,656
                             ======================================================================================================
</TABLE>

                 See accompanying notes to financial statements.

                                       5
<PAGE>

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

<TABLE>
<CAPTION>
NINE MONTHS ENDED DECEMBER 31,                                  NOTES        2003             2002
                                                                -----    ------------     ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                      <C>              <C>
   Net Income (Loss)                                                     $ (3,576,603)    $  1,275,187
   Adjustments to reconcile net income (loss) to
     net cash from (used in) operating activities:
       Depreciation and amortization                                        1,657,431        1,707,586
       Amortization of debt discount and financing costs                      192,078        1,120,145
       Provision for losses on trade receivables                               14,000         (136,700)
       Non-cash compensation related to options and warrants     1,5        1,179,677       (2,794,630)
       (Increase) decrease in:
         Trade receivables                                                    854,539        1,104,625
         Inventories                                                        1,208,195          620,921
         Prepaid expenses and other                                            26,492          (44,253)
       Increase (decrease) in:
         Accounts payable                                                  (1,151,801)      (1,054,170)
         Accrued liabilities                                      8         1,564,055          195,700
                                                                         ------------     ------------

   NET CASH FROM (USED IN) OPERATING ACTIVITIES                             1,968,063        1,994,411
                                                                         ------------     ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of property and equipment                                        (175,311)        (195,868)
   Decrease in other assets                                                     1,806               --
                                                                         ------------     ------------

   NET CASH FROM (USED IN) INVESTING ACTIVITIES                              (173,505)        (195,868)
                                                                         ------------     ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Book overdrafts                                                         (1,151,276)        (615,998)
   Net payments on lines of credit                                           (549,916)      (1,357,791)
   Repayments on subordinated note payable                        2        (4,000,000)              --
   Borrowings on term note payable                                2         2,000,000          500,000
   Repayments on term notes payable                                        (1,246,760)      (1,336,363)
   Principal payments on capital lease obligations                           (297,821)        (339,636)
   Financing costs for long term debt                                        (232,230)        (128,289)
   Proceeds from issuance of common stock, net of offering costs  4         3,798,587        1,480,994
   Proceeds from exercise of common stock warrants                2           360,000               --
                                                                         ------------     ------------

   NET CASH FROM (USED IN) FINANCING ACTIVITIES                            (1,319,416)      (1,797,083)
                                                                         ------------     ------------

NET INCREASE (DECREASE) IN CASH                                               475,142            1,460

CASH, BEGINNING OF PERIOD                                                       1,598              168
                                                                         ------------     ------------

CASH, END OF PERIOD                                               7      $    476,740     $      1,628
                                                                         ============     ============
</TABLE>

                 See accompanying notes to financial statements.

                                       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 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,  2003  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,  2003.  Interim  results  of  operations  for  the
      nine-month   period  ended  December  31,  2003  may  not  necessarily  be
      indicative of the results to be expected for the full year.

      Stock Based Compensation
      ------------------------
      The Company accounts for its stock-based employee compensation plans under
      the accounting  provisions of Accounting  Principles Board Opinion No. 25,
      "Accounting  for Stock Issued to  Employees",  and has  furnished  the pro
      forma  disclosures   required  under  Statement  of  Financial  Accounting
      Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", and
      SFAS No. 148,  "Accounting for  Stock-Based  Compensation - Transition and
      Disclosure".

      SFAS No. 123,  "Accounting  for Stock Based  Compensation",  requires  the
      Company to provide pro forma  information  regarding net income (loss) and
      earnings  (loss)  per  share  amounts  as if  compensation  cost  for  the
      Company's  employee  and director  stock  options had been  determined  in
      accordance with the fair market  value-based method prescribed in SFAS No.
      123.  The  Company  estimates  the fair value of each stock  option at the
      grant date by using a Black-Scholes  option-pricing  model.  The following
      assumptions were used for options issued during the periods:

            Nine Months Ended             December 31, 2003    December 31, 2002
                                          -----------------    -----------------
            Dividend Yield                       None                 None
            Volatility                        41% to 45%           37% to 44%
            Risk Free Interest Rate         2.01% to 4.28%       1.71% to 5.03%
            Expected Lives in Months           36 to 120            60 to 120

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

<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED                NINE MONTHS ENDED
                                                               DECEMBER 31,                      DECEMBER 31,
                                                      -----------------------------     -----------------------------
                                                          2003             2002             2003             2002
                                                      ------------     ------------     ------------     ------------
<S>                                                   <C>              <C>              <C>              <C>
      Net loss to common shareholders as reported     $ (1,557,986)    $ (1,823,610)    $ (5,411,184)    $   (671,832)
         Add: Stock-based compensation expense
         included in reported net loss                    (255,712)         190,720        1,179,677       (2,794,630)
         Deduct:  Stock-based compensation expense
         determined under fair value based method
         for all awards                                    181,865       (1,846,247)      (1,525,891)      (3,146,880)
                                                      ------------     ------------     ------------     ------------
         Pro forma net loss to common shareholders    $ (1,631,833)    $ (3,479,137)    $ (5,757,398)    $ (6,613,342)
                                                      ============     ============     ============     ============
      Net loss per common share:
         Basic - as reported                          $      (0.10)    $      (0.15)    $      (0.37)    $      (0.06)
         Basic - pro forma                            $      (0.11)    $      (0.29)    $      (0.39)    $      (0.56)
         Diluted - as reported                        $      (0.10)    $      (0.15)    $      (0.37)    $      (0.06)
         Diluted - pro forma                          $      (0.11)    $      (0.29)    $      (0.39)    $      (0.56)
</TABLE>

                                       7
<PAGE>

      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,   provision  for  inventory  obsolescence,  and  valuation  of
      deferred taxes, employee options and warrants. Actual results could differ
      from those estimates.

      New Accounting Pronouncements
      -----------------------------
      In December  2002,  the FASB issued  SFAS No. 148,  "Accounting  for Stock
      Based  Compensation--Transition and Disclosure--an Amendment to SFAS 123."
      SFAS 148  provides two  additional  transition  methods for entities  that
      adopt the preferable  method of accounting  for stock based  compensation.
      Further,  the statement requires disclosure of comparable  information for
      all  companies  regardless  of whether,  when, or how an entity adopts the
      preferable,  fair value based method of accounting.  These disclosures are
      now required  for interim  periods in addition to the  traditional  annual
      disclosure.  The  amendments to SFAS 123,  which  provides for  additional
      transition  methods,  are effective for fiscal years ending after December
      15, 2002, although earlier application is permitted. The amendments to the
      disclosure  requirements  are required for  financial  reports  containing
      condensed  financial   statements  for  interim  periods  beginning  after
      December 15, 2002.  Effective  April 1, 2003, the Company adopted the fair
      value  method  of  recording  compensation  expense  related  to all stock
      options granted after March 31, 2003, in accordance with SFAS 123 and SFAS
      148 (the prospective  method,  as defined by SFAS 148).  Accordingly,  the
      fair value of stock  options as  determined on the date of grant using the
      Black-Scholes  option-pricing  model,  will be  expensed  over the vesting
      period of the  related  stock  options.  The  negative  impact on  diluted
      earnings per share  related to the issuance of employee  stock  options in
      fiscal 2004 is estimated to be approximately  $0.01. The actual impact may
      differ  from this  estimate  as this  estimate  is based  upon a number of
      factors including, but not limited to, the number of stock options granted
      and the fair value of the stock options on the date of grant.

      In May  2003,  the FASB  issued  SFAS No.  150,  "Accounting  for  Certain
      Financial   Instruments  with  Characteristics  of  both  Liabilities  and
      Equity." The Statement  establishes standards for how an issuer classifies
      and  measures in its  statement of financial  position  certain  financial
      instruments  with  characteristics  of both  liabilities  and  equity.  It
      requires that an issuer classify a financial instrument that is within its
      scope as a  liability  (or an asset in some  circumstances)  because  that
      financial  instrument  embodies an obligation of the issuer.  Many of such
      instruments  were  previously  classified  as  equity.  The  statement  is
      effective for financial instruments entered into or modified after May 31,
      2003,  and  otherwise is effective at the  beginning of the first  interim
      period  beginning  after June 15, 2003,  except for  mandatory  redeemable
      financial instruments of nonpublic entities. On November 7, 2003, the FASB
      deferred the classification and measurement  provisions of SFAS No. 150 as
      they apply to certain mandatorily  redeemable  non-controlling  interests.
      This deferral is expected to remain in effect while these  provisions  are
      further evaluated by the FASB. The application of the requirements of SFAS
      150 did not have any impact on the Company's  financial position or result
      of operations as the Company's Series A convertible preferred stock is not
      mandatorily redeemable.

      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.

(2)   LINE OF CREDIT AND NOTES PAYABLE
      --------------------------------
      Effective  May 30,  2003,  the Company  obtained  from  Textron  Financial
      Corporation  ("Textron") a revolving  credit facility (the "Textron Loan")
      in the maximum  principal  amount of $7,500,000  pursuant to the terms and
      conditions of a Loan and Security  Agreement dated May 27, 2003 (the "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,

                                       8
<PAGE>

      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)  eighty-five  percent  (85%)  of the net
      amount of its eligible  accounts  receivable plus (ii) sixty percent (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 one and
      three-quarter  percent  (1.75%)  per annum  (5.75% at December  31,  2003)
      calculated on the average cash  borrowings  for the preceding  month.  The
      Textron  Loan  matures  and all amounts are due and payable in full on May
      26, 2006.  The Textron  Loan  replaced the  Company's  asset-based  credit
      facility with FINOVA  Capital  Corporation  on May 30, 2003,  which had an
      outstanding principal balance of $4,254,667 at the time of replacement. As
      of December 31, 2003,  the  outstanding  principal  balance on the Textron
      Loan was $4,389,978.

      The Textron Loan described above contains certain  financial and operating
      covenants. In August 2003, the Company notified Textron that it had failed
      to comply with the fixed charge coverage ratio in June 2003. Pursuant to a
      certain  Waiver Letter dated August 13, 2003,  Textron agreed to waive the
      requirement  to meet the fixed  charge  coverage  ratio  for each  monthly
      period through September 30, 2003. Additionally, Textron agreed that after
      August 13, 2003,  all of the financial  covenants  required of the Company
      under Section 7.6 of the Loan  Agreement  will be measured and tested on a
      quarterly  rather than monthly  basis.  Due to the $1.8 million  charge to
      operations  related to the Amended and Restated  Employment  Agreement for
      Angelo  Morini,  the Company fell below the  requirement  for the adjusted
      tangible net worth and the fixed charge  coverage ratio  covenants for the
      quarter  ended  December  31,  2003.  Pursuant to  discussions  with and a
      written  confirmation  from  Textron,  Textron has agreed in  principle to
      amend the loan covenants  effective as of December 31, 2003, the effect of
      which would bring the Company into  compliance with both ratios as of that
      date.  The Company  anticipates  that it will be in compliance  with these
      ratios, as amended, for the foreseeable future based on current forecasts.

      On September 30, 1999, the Company obtained a $4 million subordinated loan
      from FINOVA  Mezzanine to finance  additional  working capital and capital
      improvement  needs.  This loan was paid in full as of May 30,  2003 by the
      proceeds from a new loan from  SouthTrust  Bank, as discussed  below,  and
      from the equity proceeds raised in the private  placements in May 2003, as
      discussed  in  Note  4.  In  accordance  with a  warrant  agreement  dated
      September 30, 1999, the exercise  price on 200,000  warrants still held by
      FINOVA  Mezzanine  on May 30,  2003,  was reduced  from $3.41 to $1.80 per
      share based on the sales price of the Company's  common stock in May 2003.
      FINOVA  Mezzanine  exercised these warrants to purchase  200,000 shares of
      the  Company's  common  stock on June 2, 2003.  The Company  received  net
      proceeds of $119,000  after a deduction of $241,000 due to FINOVA  Capital
      Corporation  for waiver fees  pursuant to a certain  Amendment and Limited
      Waiver to Security Agreement dated June 26, 2002.

      Simultaneous with the closing of the Textron Loan in May 2003,  SouthTrust
      Bank  extended  the  Company  a new term loan in the  principal  amount of
      $2,000,000.  This loan was consolidated with the Company's March 2000 term
      loan with SouthTrust Bank, which had a then outstanding  principal balance
      of  $8,131,985  for a total term loan amount of  $10,131,985.  The revised
      term loan bears interest at SouthTrust  Bank's prime rate of interest plus
      1%  (5% at  December  31,  2003),  and  is  due  in  increasing  principal
      installments  by June 2009.  Each month,  the Company will pay the accrued
      interest on the loan plus principal amounts as follows:  $75,000 from July
      2003 to June 2004, $110,000 from July 2004 to June 2005, and $166,250 from
      July 2005 until maturity in June 2009.  This note is secured by all of the
      Company's  equipment and certain related  assets.  The proceeds of the new
      term loan,  together with the proceeds from certain sales of the Company's
      common stock  conducted in May 2003 (as discussed in Note 4), were used to
      repay the Company's $4,000,000  mezzanine loan from FINOVA Mezzanine.  The
      balance  outstanding  on the new term  loan as of  December  31,  2003 was
      $9,606,985.

      The  SouthTrust  term  loan  contains  certain   financial  and  operating
      covenants.  Due to the $1.8 million  charge to  operations  related to the
      Amended and Restated  Employment  Agreement for Angelo Morini, the Company
      fell below the  requirement  for the tangible  net worth  covenant for the
      quarter  ended  December  31,  2003.  Pursuant to  discussions  with and a
      written  confirmation from SouthTrust,  SouthTrust has agreed in principle
      to amend the loan covenant  effective as of December 31, 2003,  the effect
      of which  would bring the Company  into  compliance  with this ratio as of
      that date. The Company anticipates that it will be in compliance with this
      ratio, as amended, for the foreseeable future based on current forecasts.

      In October  2000,  the Company  obtained a $1.5  million  bridge loan from
      SouthTrust  Bank,  which is guaranteed by Angelo S. Morini,  the Company's
      founder,  and secured by the pledge of one million shares of the Company's
      common stock owned by him.  Interest on this note is at the prime rate (4%
      at December 31,  2003).  The loan is being paid down by monthly  principal
      payments of $50,000 plus interest.  In May 2003,  SouthTrust  Bank amended
      this loan to extend the

                                       9
<PAGE>

      maturity  date from  October  2003 to April  2004.  Principal  payments of
      $50,000  are due each month  beginning  June 1, 2003 until  maturity.  The
      balance outstanding on this note as of December 31, 2003 was $101,000.  In
      consideration  of his  guarantee and stock pledge in respect to this loan,
      the Company issued an option to acquire  343,125 shares of common stock to
      Mr. Morini on December 15, 2000. The option has an exercise price of $3.88
      per share,  which is equal to the fair value of the Company's common stock
      at the date of the grant. Such options shall expire on December 15, 2010.

      In connection  with the  consolidations  and  extensions of the SouthTrust
      Bank loans as described  above,  the Company  issued a warrant to purchase
      100,000 shares of the Company's common stock to SouthTrust Bank on May 29,
      2003. The warrant is  exercisable  until June 1, 2009 at an exercise price
      of $1.97 per  share.  The fair  value of this  warrant  was  estimated  at
      $101,000  and will be amortized  as non-cash  compensation  over 72 months
      beginning in May 2003.

      In March 2002, Angelo S. Morini, the Company's founder, loaned $330,000 to
      the Company in order for it to pay down  certain  notes  payable that were
      coming  due.  This loan bore  interest at the prime rate and was due on or
      before June 15, 2006.  In  connection  with a Second  Amended and Restated
      Employment Agreement effective October 13, 2003 between Mr. Morini and the
      Company,  the Company offset $167,603 of unreimbursed  advances owed to it
      by Mr. Morini prior to June 2002 and certain  family  members  against the
      balance  of the loan and  issued  an  aggregate  of  55,087  shares of the
      Company's  common  stock  (valued  at  approximately  $2.95 per  share) as
      payment in full.

      On  August  15,  2002,  the  Company  executed  and  delivered  to  Target
      Container, Inc. a $347,475 promissory note in satisfaction of its accounts
      payable obligation to this vendor. This note bore interest at 7% per annum
      and was due in twelve equal monthly installments of $30,066. This note was
      paid in full by September 30, 2003.

(3)   COMMITMENTS AND CONTINGENCIES
      -----------------------------
      On May 17, 2002,  Schreiber Foods, Inc. of Green Bay,  Wisconsin,  filed a
      lawsuit against the Company in the federal  district court for the Eastern
      District of Wisconsin  ("Wisconsin  lawsuit"),  being Case No.  02-C-0498,
      alleging various acts of patent  infringement.  The Complaint alleges that
      the  Company's   machines  for  wrapping  of  individual   cheese  slices,
      manufactured by Kustner Industries,  S.A. of Switzerland,  known as models
      KE and KD, and the Company's machines for producing  individually  wrapped
      slices  manufactured  by Hart Design Mfg.,  Inc. of Green Bay,  Wisconsin,
      infringe  certain  claims  of  U.S.  Patents  Nos.  5,112,632,  5,440,860,
      5,701,724 and  6,085,680.  Schreiber  Foods is seeking a  preliminary  and
      permanent injunction  prohibiting the Company from further infringing acts
      and is also  seeking  damages  in the  nature of either  lost  profits  or
      reasonable  royalties.  While the Complaint does not specify the amount of
      money  damages  Schreiber  Foods  plans  to  seek  at the  time  of  trial
      connection  with its claims,  Schreiber  Foods has retained an accountant,
      Joseph Gemini, who has opined recently that Schreiber Foods is entitled to
      money damages of approximately $17 million plus interest.

      The  '860  and  '724  Patents--and  the  Kustner  machines  for  producing
      individually  wrapped  slices--were the subject of a lawsuit  commenced by
      Schreiber  in 1997  against  Beatrice  Foods  and  others  in the  Eastern
      District of Wisconsin,  being Case No.  97-CV-11.  Schreiber Foods alleges
      that the  machines  that  were at issue in that  case are  similar  to the
      Kustner  machines in use by the Company.  In the 1997 lawsuit,  the matter
      was tried to a jury,  which  found the Kustner  machines  to infringe  and
      awarded  Schreiber  Foods $26 million in a verdict of August 25, 1998.  On
      March 30,  2000,  however,  the judge  reversed  that  verdict,  entered a
      finding of no  infringement  on the part of Beatrice,  and  dismissed  the
      case.  Schreiber Foods appealed that order to the Court of Appeals for the
      Federal  Circuit,  which  entered its  judgment on appeal on February  27,
      2002. The appeals court reversed the action of the trial court, found that
      substantial  evidence  supported the jury's finding of  infringement,  and
      ordered the jury verdict reinstated. However, the Company understands that
      a motion to  rescind  the  verdict  and  judgment  is  currently  pending.
      Schreiber Foods has also commenced a similar action against Borden,  Inc.,
      and  others,  in March 2002,  but no result has yet been  reached in those
      cases.

      Several years prior to the filing of the lawsuit against the Company,  the
      Company modified its Kustner  machines.  The two Hart Design machines were
      modified by the manufacturer  from the standard Hart Design  configuration
      and were delivered to the Company as modified.  The Company  believes that
      the modifications to the machines take them even further outside the ambit
      of the Schreiber Foods' patents at issue.

      As well, the Company has, through legal counsel,  advised the Court of the
      scope it  believes  should be given to the claims at issue in the  lawsuit
      (as part of the so-called  Markman briefing  process).  Patent counsel has
      advised that, in his opinion, the patent claim interpretation  asserted by
      the Company in the Markman briefing process was the correct

                                       10
<PAGE>

      one, and that the Company's  machines do not infringe the patent claims if
      that claim  interpretation  was adopted by the Court.  Schreiber Foods has
      taken a different view of the claims. The Court conducted a hearing on the
      issue on August 4, 2003,  and the Company  received the Court's  ruling on
      August 13, 2003.  The Court adopted  Schreiber  Foods' view on many of the
      claim terms at issue.  Following the Court's  ruling and in light thereof,
      the Company  obtained from patent counsel an opinion that the Company does
      not  infringe the  asserted  claims of the patents,  and that the asserted
      claims are invalid.

      The Company  and  Schreiber  Foods are  currently  involved in  settlement
      negotiations  with respect to the  Wisconsin  lawsuit and, at the parties'
      request,  the Court has recently  removed the upcoming trial date from its
      docket calendar. The details of the settlement are still being negotiated.

      In the event the parties are unable to reach a settlement, the proceedings
      will continue.  The Company is not in a position at this time to express a
      view on the  likelihood  that it will succeed in its position,  nor in the
      amount  of  damages  that  might  be  awarded  against  it  should  it  be
      unsuccessful  in that  regard.  In the event the  Company is found to have
      infringed the  Schreiber  Foods'  patents,  in addition to being liable to
      Schreiber Foods for damages which may be substantial, the Company may also
      be prohibited from using in the future any wrapping machine which is found
      to be infringing,  or,  alternatively,  the Company may be required to pay
      Schreiber Foods a royalty on the Company's  individually  wrapped products
      produced  with the  infringing  machines on an ongoing  basis.  Any of the
      foregoing could have a material adverse effect on the Company's results of
      operations and financial condition.

(4)   CAPITAL STOCK
      -------------
      Series A Convertible Preferred Stock
      ------------------------------------
      On April 6, 2001, in accordance with an exemption from registration  under
      Regulation D promulgated under the Securities Act of 1933, as amended, the
      Company received from BH Capital  Investments,  L.P. 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 are  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 is now equal to the quotient of
      $48.18,  plus all accrued dividends that are then unpaid for each share of
      the Series A convertible preferred stock then held by the holder,  ($59.74
      at December 31, 2003), divided by the lower 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.  The Series A Preferred Holders have the
      right  to  require  the  Company  to  redeem  their  shares  of  Series  A
      convertible  preferred  stock on April 6, 2005 or upon occurrence of other
      specified events.

      As of December  31,  2003,  the Series A Preferred  Holders had  converted
      24,290  shares of the Series A  convertible  preferred  stock plus accrued
      dividends,  into 931,190  shares of common stock.  The  conversion  prices
      ranged from $1.3633 to $1.75 and were based on the lower of (a) 95% of the
      average of the two lowest  closing  bid prices on the AMEX for the fifteen
      trading days immediately prior to conversion or (b) $1.75. From January 1,
      2004 through February 17, 2004, the Series A Preferred  Holders  converted
      2,462 shares of the Series A  convertible  preferred  stock,  plus accrued
      dividends,  into 84,386  shares of common stock at a  conversion  price of
      $1.75.

      The  Series  A  Preferred  Holders  have  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 nine months
      ended December 31, 2003 and 2002, the Company recorded preferred dividends
      of $157,172 and $209,020, respectively, in connection with the issuance of
      the preferred stock on April 6, 2001.

      On April 6, 2001, the Company  recorded the initial  carrying value of the
      preferred  stock as  $521,848.  Each  quarter  the Company  calculates  an
      estimated  redemption  value of the  remaining  preferred  stock  and then
      calculates  the  difference  between the initial  carrying  value and this
      estimated  redemption  value.  The  difference  is then  accreted over the
      redemption period (48 months beginning April 2001) using the straight-line
      method,  which  approximates the effective  interest method.  For the nine
      months ended December 31, 2003 and 2002, the Company  recorded  $1,677,409
      and $1,737,999,  respectively,  related to the accretion of the redemption
      value of preferred stock and the beneficial  conversion feature of accrued
      dividends.  As of December 31,  2003,  the value of the  remaining  48,356
      shares of redeemable convertible preferred stock is $3,213,849.

                                       11
<PAGE>

      On November 7, 2002, the Series A Preferred  Holders exercised their right
      under the  Purchase  Agreement  to require  the  Company  to  solicit  the
      approval  of its  shareholders  for the  Company's  issuance of all of the
      shares of common stock potentially  issuable upon conversion of the Series
      A convertible  preferred stock in full and the exercise of their warrants.
      The Company was  required to hold a  shareholders  meeting to solicit such
      approval  on or before  February 5, 2003.  Pursuant to the Stock  Purchase
      Option Agreement  described below, the Series A Preferred  Holders agreed,
      among other  things,  to extend the  deadline to September  30,  2003.  On
      September 30, 2003, the Company's shareholders, by majority vote, approved
      the issuance by the Company of all required common stock in the event of a
      conversion of the Company's Series A Convertible  Preferred Stock and upon
      the exercise of certain warrants held by the Series A Preferred Holders.

      On April 24, 2003, the Company and the Series A Preferred  Holders entered
      into that certain Stock Purchase Option Agreement, whereby the Company was
      granted  the  option  to  purchase  all of the  shares  of  the  Series  A
      convertible preferred stock owned by such holders at the time the purchase
      is consummated. The option expired on September 30, 2003. Pursuant to such
      agreement,  the holders of the Series A convertible  preferred  stock also
      agreed to extend the deadline to hold a shareholders  meeting to September
      30,  2003.  In  exchange  for the option and the  extension  of the annual
      meeting date,  the Company issued  warrants to purchase  250,000 shares of
      the  Company's  common  stock to both BH  Capital  Investments,  L.P.  and
      Excalibur Limited  Partnership.  These warrants are exercisable until July
      15,  2006 at an exercise  price equal to $2.00 per share,  which price was
      greater than the market value of the  Company's  common stock on April 24,
      2003.  The fair value of these  warrants was estimated at $230,000 and was
      recorded as non-cash  compensation  expense in the quarter  ended June 30,
      2003.

      On April 10, 2003, the Company entered into a credit  arrangement with one
      of its greater  than 5%  shareholders  pursuant  to which the  shareholder
      purchased raw  materials  for the Company in an aggregate  amount that did
      not exceed  $500,000.  In  consideration  of the credit  arrangement,  the
      Company issued to the shareholder a warrant to purchase  100,000 shares of
      the Company's common stock at an exercise price of $1.70.

      Pursuant to the  Company's  Restated  Certificate  of  Incorporation,  the
      warrant  issued to the above  shareholder  caused the  maximum  conversion
      price of the Series A  convertible  preferred  stock to decrease to $1.75,
      such that the conversion rate of the Series A convertible  preferred stock
      to common stock is currently equal to the quotient of (i) $48.18, plus all
      accrued  dividends  that are then  unpaid  for each  share of the Series A
      convertible  preferred stock then held by the holder,  divided by (ii) 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 AMEX  out of the  fifteen
      trading days immediately prior to conversion.

      Common Stock Issuances
      ----------------------
      Pursuant to seven Securities  Purchase  Agreements dated May 21, 2003, the
      Company issued a total of 2,138,891  shares of its common stock at a price
      per share equal to $1.80 for  aggregate  gross  proceeds to the Company of
      $3,850,000.  Sales  to  related  parties  under  the  Securities  Purchase
      Agreements  include:  555,556  shares of common stock sold at an aggregate
      sales  price  of  $1,000,000  to  Frederick  DeLuca,  a  greater  than  5%
      shareholder;  55,556  shares of common  stock sold at an  aggregate  sales
      price of $100,000 to David H. Lipka, a Director of the Company; 83,333 and
      55,556 shares of common stock sold at an aggregate sales price of $150,000
      and  $100,000,  respectively,  to Ruggieri of  Windermere  Family  Limited
      Partnership and Ruggieri  Financial  Pension Plan,  respectively,  each an
      affiliate  of John  Ruggieri,  the  Company's  former  Vice  President  of
      Manufacturing; 1,111,112 shares of common stock sold at an aggregate sales
      price of  $2,000,000 to  Fromageries  Bel S.A., a leading  branded  cheese
      company  in  Europe  which  signed a  Master  Distribution  and  Licensing
      Agreement  effective May 22, 2003 with the Company.  Sales to  non-related
      parties under the Securities Purchase  Agreements include:  138,889 shares
      of common  stock  sold at an  aggregate  sales  price of  $250,000  Apollo
      Capital  Management  Group;  and 138,889 shares of common stock sold at an
      aggregate sales price of $250,000 Apollo MicroCap Partners, L.P.

      The Company used $2,000,000 of the proceeds  generated from these May 2003
      private placements to pay down the balance of the Company's mezzanine loan
      from  FINOVA  Mezzanine  Capital,   Inc.  The  Company  then  applied  the
      additional  proceeds from the new loan from SouthTrust  Bank, as discussed
      in Note 2, to pay the remaining  $2,000,000 on the FINOVA  Mezzanine loan.
      The Company utilized the remainder of the private  placement  proceeds for
      working capital and general corporate purposes.

                                       12
<PAGE>

(5)   NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS
      -----------------------------------------------------
      Notes Receivable for Common Stock
      ---------------------------------
      The Financial  Accounting  Standards  Board issued  Interpretation  No. 44
      ("FIN 44"),  which clarifies the application of APB Opinion 25 relating to
      the  accounting  consequences  of  various  modifications  to fixed  stock
      options.  FIN 44 covers  specific  events that occurred after December 15,
      1998 and was effective as of July 2, 2000.  FIN 44 clarified  that when an
      option is  repriced,  it is treated as a variable  option and is marked to
      market each quarter.  Accordingly, any increase in the market price of the
      Company's common stock over the exercise price of the options that was not
      previously recorded is recorded as compensation  expense at each reporting
      period. 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.  Compensation income is limited to the original base
      exercise  price (the "Floor") of the options.  In accordance  with FIN 44,
      the underlying  shares related to the $12,772,200 note receivable from the
      Company's  founder,  Angelo S. Morini, as disclosed in Note 8, are treated
      as variable due to the nature of the note being  non-interest  bearing and
      non-recourse. There was no non-cash compensation expense or income related
      to these shares recorded during the nine months ended December 31, 2003 as
      the price of the  Company's  common stock at the  beginning and end of the
      period was below the Floor.  The Company  recorded  non-cash  compensation
      income of zero and $3,060,000 for the three and nine months ended December
      31, 2002,  respectively,  based on the decrease in the market price of the
      Company's  common  stock from $5.43 at March 31, 2002 to $2.28 at December
      31,  2002.  The Company did not record any further  non-cash  compensation
      income once the stock price fell below the Floor of $4.38  during the nine
      months ended  December  31, 2002 and  remained  below the Floor during the
      nine months ended December 31, 2003.

      Option and Warrant Repricing
      ----------------------------
      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.  In
      addition,  the Company  repriced the outstanding  warrants held by current
      consultants  as of  October  11,  2002  (291,429  shares at former  prices
      ranging from $3.31 to $5.50) to the market price of $2.05 per share.  This
      stock option repricing resulted in variable accounting treatment for these
      stock options  beginning with the quarter ended December 31, 2002 and such
      variable accounting treatment will continue until the related options have
      been cancelled,  expired or exercised. On December 4, 2002, as a result of
      discussions  and  negotiations  with  certain  major   shareholders,   the
      Company's  founder,  Angelo S. Morini,  agreed to reverse the repricing of
      his 3,692,035  options for the purpose of improving  shareholder value and
      lessening  potential  financial  statement expense.  Although the exercise
      prices of the options were reversed back to their  original  amounts,  the
      Company is still required to account for any  outstanding  options related
      to these reversed-repriced  options in accordance with variable accounting
      standards each quarter.

      The Company recorded non-cash compensation income of $379,428 and non-cash
      compensation  expense of $540,613  related to these  variable  options and
      warrants  in  the  three  and  nine  months   ended   December  31,  2003,
      respectively.  The Company  recorded  $188,395  as  non-cash  compensation
      expense  related to these  variable  options and warrants in the three and
      nine months ended  December 31, 2002. The remaining  outstanding  variable
      options and warrants as of December 31, 2003 were 3,882,092.

      Option and Warrant Issuances
      ----------------------------
      The Company  recorded  $123,716  and  $639,064  as  non-cash  compensation
      expense related to employee  stock,  options and warrants that were issued
      and vested  during the three and nine  months  ended  December  31,  2003,
      respectively.   The  Company  recorded  $2,325  and  $76,975  as  non-cash
      compensation  expense  related to employee  options and warrants that were
      issued and vested  during the three and nine  months  ended  December  31,
      2002, respectively.

                                       13
<PAGE>

(6)   EARNINGS PER SHARE
      ------------------
      The following is a  reconciliation  of basic net earnings (loss) per share
      to diluted net earnings (loss) per share:

<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED                NINE MONTHS ENDED
                                                                 DECEMBER 31,                      DECEMBER 31,
                                                        -----------------------------     -----------------------------
                                                            2003             2002             2003             2002
<S>                                                     <C>              <C>              <C>              <C>
      Net loss per common share                         $ (1,557,986)    $ (1,823,610)    $ (5,411,184)    $   (671,832)
                                                        ============     ============     ============     ============

      Average shares outstanding - basic and diluted      15,401,972       12,139,619       14,720,618       11,898,580
                                                        ============     ============     ============     ============

      Basic and diluted net income (loss) per
         common share                                   $      (0.10)    $      (0.15)    $      (0.37)    $      (0.06)
</TABLE>

      Potential conversion of Series A convertible preferred stock for 1,652,296
      shares,  options for 4,742,201  shares and warrants for  1,242,856  shares
      have not been included in the  computation  of diluted net loss per common
      share for the three and nine months ended December 31, 2003, respectively,
      as their effect would be  antidilutive.  Potential  conversion of Series A
      preferred  stock for 1,114,647  shares,  options for 4,554,771  shares and
      warrants for 644,856  shares have not been included in the  computation of
      diluted  net loss per  common  share for the three and nine  months  ended
      December 31, 2002, as their effect would be antidilutive.

(7)   SUPPLEMENTAL CASH FLOW INFORMATION
      ----------------------------------
      For purposes of the statement of cash flows, all highly liquid investments
      with a maturity  date of three  months or less are  considered  to be cash
      equivalents.

<TABLE>
<CAPTION>
      Nine months ended December 31,                                                2003           2002
      ----------------------------------------------------------------------------------------------------
<S>                                                                            <C>             <C>
      Non-cash financing and investing activities:
      Fair value of options and warrants issued                                $    685,308    $    70,000
      Accrued preferred stock dividends                                             157,172        209,020
      Beneficial conversion feature related to preferred stock dividends             78,906         55,564
      Accretion of discount on preferred stock                                    1,598,503      1,682,435
      Purchase of equipment through capital lease obligations and term notes
        payable                                                                          --         94,763
      Reduction in accounts payable through issuance of notes payable                    --        347,475
      Reduction in accounts payable through issuance of common stock                     --        839,158
      Reduction in notes payable through issuance of common stock                   162,424             --

      Cash paid for:
      Interest                                                                      861,126      1,284,723
      Income taxes                                                                       --         51,037
</TABLE>

(8)   RELATED PARTY TRANSACTIONS
      --------------------------
      Morini Transactions
      -------------------
      In June 1999,  in  connection  with an  amended  and  restated  employment
      agreement  for  Angelo S.  Morini,  the  Company's  Founder,  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
      new  consolidated  note is non-interest  bearing and  non-recourse  and is
      secured  by the  2,914,286  shares  of  common  stock.  Per the June  1999
      employment contract,  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  shareholder.
      In October  2000,  the Company  obtained a $1.5  million  bridge loan from
      SouthTrust  Bank,  which is  guaranteed by Angelo S. Morini and secured by
      one  million  of his above  mentioned  2,914,286  shares of the  Company's
      common stock.  These one million shares are expected to be released to the
      Company upon full payment of the bridge loan.

                                       14
<PAGE>

      In March 2002, Angelo S. Morini, the Company's Founder, loaned $330,000 to
      the Company in order for it to pay down  certain  notes  payable that were
      coming  due.  This loan was paid in October  2003 in  accordance  with the
      Second Amended and Restated Employment Agreement as detailed below.

      In a Second Amended and Restated  Employment  Agreement (the  "Agreement")
      effective  October  13,  2003,  Angelo S.  Morini the  Company's  Founder,
      Vice-Chairman  and President  resigned from his positions with the Company
      as President and Vice-Chairman and will no longer be involved in the daily
      operations  of the  Company.  He will  retain the title of Founder and has
      been named Chairman Emeritus.  Mr. Morini will continue as an employee and
      as 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.  Other  material
      provisions of the Agreement are as follows:

      1. For the term of Mr.  Morini's  employment,  the Company shall cause Mr.
      Morini to be nominated for election to the Company's Board of Directors as
      a member of the slate of  directors  proposed  by the Company in its proxy
      statement for any meeting of the Company's  stockholders whereby directors
      shall be elected.  Notwithstanding the foregoing,  in the event Mr. Morini
      is not  elected  to the  Board of  Directors  by the  stockholders  at any
      meeting  of the  Company's  stockholders  for which  the  proxy  statement
      indicates Mr. Morini is nominated for election as a member of the slate of
      directors  proposed by the Company,  such  obligations  shall  immediately
      cease.

      2. The Company will obtain,  and maintain in effect during the term of Mr.
      Morini's  employment,  for the  benefit of Mr.  Morini (or  reimburse  Mr.
      Morini  for the cost  of) a Two  Million  Dollar  ($2,000,000)  term  life
      insurance  policy insuring Mr. Morini's life, the  beneficiaries  of which
      shall be designated by Mr. Morini.

      3. Mr. Morini and the Company  agreed that Mr.  Morini and certain  family
      members  received   advances  from  the  Company  of  which  $167,603  was
      unreimbursed as of October 13, 2003, and (ii) the Company owed $330,000 to
      Mr. Morini pursuant to a loan on March 28, 2002 to the Company. Mr. Morini
      and the Company  agreed to offset the  unreimbursed  advances  against the
      amounts  owed by the Company,  and, in  repayment of the  remainder of the
      amounts  owed by the  Company,  the Company  issued an aggregate of 55,087
      shares  of  the  Company's   common  stock  to  Mr.   Morini   (valued  at
      approximately  $2.95 per share based on the average of the closing  prices
      for the five trading days preceding the effective date of the Agreement).

      4. Mr. Morini has agreed that during the term of his employment, and for a
      period of one (1) year  following his  termination  of employment  for any
      reason other than pursuant to termination without cause, a material breach
      in the Agreement,  or a change of control (as defined in the Agreement) in
      the  Company  for  which  he did  not  vote,  he  will  not,  directly  or
      indirectly, either as an employee, employer, consultant, agent, principal,
      partner, stockholder (other than owning fewer than one percent (1%) of the
      outstanding shares of a public corporation),  corporate officer, director,
      or any other individual or representative capacity,  engage or participate
      in any business that directly competes with the Company within those areas
      in the United States in which the Company is doing business as of the date
      of termination.

      5. If the Agreement is terminated by the Company without cause, Mr. Morini
      shall:  (a) be entitled to continued  payment of his annual  compensation,
      health  insurance  benefits,  club dues, auto allowance and life insurance
      benefits for the remainder of the term of the Agreement,  (b) become fully
      "vested"  under the  terms of any stock  option  agreements  executed  and
      delivered prior to, along with, or after the Agreement and (c) be released
      from the terms of the  $12,772,200  Loan Agreement dated June 15, 1999 and
      all monies  outstanding  thereunder  will be forgiven by the Company.  The
      provisions of the Agreement  related to the forgiveness of the $12,772,200
      loan  remain  unchanged  from the first  Amended and  Restated  Employment
      Agreement dated June 15, 1999. Mr. Morini  acknowledges that his change in
      role does not constitute a termination of Mr. Morini by the Company, under
      the First Amended and Restated Employment Agreement dated June 15, 1999.

      6. If Mr.  Morini  terminates  his  employment in any manner other than in
      connection  with a material  breach of the  Agreement by the  Company,  he
      shall not be entitled to receive any  further  compensation  or  benefits,
      except that if he terminates his employment in connection with a change of
      control (as defined in the  Agreement) in the Company for which he did not
      vote, he will be released from the terms of the $12,772,200 Loan Agreement
      dated June 15, 1999 and all monies outstanding thereunder will be forgiven
      by the Company. The provisions of the Agreement related to the forgiveness
      of the  $12,772,200  loan  remain  unchanged  from the first  Amended  and
      Restated Employment Agreement dated June 15, 1999.

                                       15
<PAGE>

      Due to the accounting treatment of the Agreement,  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 $75,998 was paid during the quarter ended December
      31,  2003  and  $1,754,331   remained  unpaid  but  accrued  ($366,305  as
      short-term accrued liabilities and $1,388,026 as long-term liabilities) as
      of December 31,  2003.  The  long-term  portion will be paid out in nearly
      equal monthly installments ending in October 2008.

      Other Related Party Transactions
      --------------------------------
      Beginning January 13, 2003, the Company entered into a vendor  arrangement
      with one of its  employees  pursuant to which the employee  purchased  raw
      materials for the Company approximating $500,000. The amounts paid for the
      purchased  materials,  plus  interest at the rate of 15% per annum on such
      amounts, was due and paid in full by May 31, 2003.

      On April 10, 2003, the Company entered into a credit  arrangement with one
      of its greater  than 5%  shareholders  pursuant  to which the  shareholder
      purchased raw  materials  for the Company in an aggregate  amount that did
      not exceed $500,000.  The amounts paid for the purchased  materials,  plus
      interest at the rate of 15% per annum on such amounts, was due and payable
      in full on July 9, 2003. In consideration of the credit  arrangement,  the
      Company issued to the shareholder a warrant to purchase  100,000 shares of
      the Company's  common stock at an exercise price of $1.70.  The fair value
      of this  warrant was  estimated  at $63,000  and was  recorded as non-cash
      compensation  expense in the quarter ended June 30, 2003. All amounts owed
      under  the  credit  arrangement  were  repaid  in  full  and  such  credit
      arrangement was terminated on June 27, 2003.

      On May 22,  2003,  the  Company  entered  into a Master  Distribution  and
      Licensing Agreement (the "Agreement") with Fromageries Bel S.A. ("Bel"), a
      leading branded cheese company in Europe.  The Agreement  became effective
      upon the closing of the Textron  Financial  Corporation  asset based loan,
      the new $2 million loan from  SouthTrust  Bank and the private  placements
      described  above.  Under  the  Agreement,  the  Company  has  granted  Bel
      exclusive  distribution rights for the Company's products (the "Products")
      in a territory  comprised of the European Union States and to more than 21
      other European  countries and territories (the  "Territory").  The Company
      has also granted Bel the exclusive option during the term of the Agreement
      to elect to manufacture the Products designated by Bel for distribution in
      the  Territory.  The term of the  Agreement  is ten years,  provided  that
      either of the parties may elect to terminate  the Agreement by delivery of
      notice  to the  other  between  March  24,  2007 and May 22,  2007,  which
      termination  shall be effective as of first anniversary of the date of the
      notice of  termination.  Alternatively,  the parties may mutually agree to
      continue  operating  under the  Agreement,  to convert the  Agreement to a
      manufacturing and license agreement, or to terminate the Agreement.

                                       16
<PAGE>

                         GALAXY NUTRITIONAL FOODS, INC.

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

The following  discussion and analysis  should be read in  conjunction  with the
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
forward-looking  statements  are based on the  Company's  current  expectations,
estimates and projections about the Company's industry, management's beliefs and
certain assumptions made by us. Forward-looking  statements may be identified by
the  use  of  forward-looking  terminology  such  as  "may",  "will",  "expect",
"believe", "estimate", "anticipate", "continue", or similar terms, variations of
these terms or the negative of those terms.  These statements are not guarantees
of future  performance  and are  subject to  certain  risks,  uncertainties  and
assumptions  that are  difficult to predict.  Therefore,  the  Company's  actual
results may differ  materially  from those  described  in these  forward-looking
statements  due to among other  factors,  competition  in the Company's  product
markets,  dependence on suppliers, the Company's manufacturing  experience,  and
production  delays or  inefficiencies.  The Company  undertakes no obligation to
update  publicly  any  forward-looking  statements  for any reason,  even if new
information becomes available or other events occur in the future.

The Company is principally engaged in developing,  manufacturing and marketing a
variety of healthy food and beverage products. The Company is a leading producer
of  alternative  dairy products  containing  soy protein or soy isolates.  These
healthy cheese and dairy related  alternative  products include benefits such as
reduced,  low or no fat; reduced,  low or no saturated fat;  reduced,  low or no
cholesterol;  and reduced or  lactose-free  varieties.  These  products are sold
throughout  the United  States and  internationally  to  customers in the retail
grocery, natural food outlets, military commissaries,  mass merchandisers,  club
stores,  drug stores and food service  markets.  The Company's  headquarters and
manufacturing facilities are located in Orlando, Florida.

Currently,  71% of the  Company's  sales are derived from sales of sliced cheese
products. However, the Company is in the process of diversifying,  strengthening
and balancing the Company's product segmentation between various forms of cheese
such  as  slices,  shreds,  and  chunks,  and in its  other  non-cheese  related
products.  This  diversification  will help the Company  extend  consumer  usage
occasions beyond lunch-time and sandwich usage. For example, the Company may add
new products that appeal to younger  consumers  and have portable  functionality
(that is, "on-the-go" users).

Management   focuses  on  several  items  in  order  to  measure  the  Company's
performance.  In the short term (1 to 3 years),  management  is 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 options and warrants
     o    EBITDA excluding  certain  employment  contract  expenses and non-cash
          compensation related to options and warrants
     o    Liquidity
     o    Key financial ratios (AR/AP/Inventory turnover)
     o    Net sales trends (as it relates to consumer demand)

In the long term (over 3 years),  management is striving to generate  consistent
and  predictable  net sales growth while  incrementally  enhancing net cash flow
from operations.

The  principal raw material  used by the Company is casein,  which  accounts for
approximately  34% of the  Company's  raw  material  purchases.  As  casein is a
significant  component  of the  Company's  product  formulation,  the Company is
vulnerable  to changes in casein  pricing  over time,  which,  at times has been
volatile.  Management  will be  focusing on pursuing  new  business  models that
create  less of a  dependency  on casein and trying to  incorporate  alternative
sources  of  protein  that  maintain  the  integrity  of the  Company's  product
benefits, as well as the cost base of producing the Company's products.

Management  believes  that since the Company is now properly  funded and has the
working capital and production  capacity  required to meet consumer  demand,  it
will be able to maintain and improve upon the  operating  cash flow  performance
demonstrated  in the  results  during the first three  quarters of fiscal  2004.
Although the Company's expansion of its private label and imitation business may
result in a decrease in the Company's overall gross margin percentage, it should
contribute  incremental  gross  margin  dollars  through  increased  net  sales.
Management will balance the additional private label and

                                       17
<PAGE>

imitation  business  growth by reinvesting  the gross margin obtained from these
sales  against  its core  brands.  Management  plans to build  the  business  by
leveraging a premium brand  approach that begins with superior  product  quality
over most of the direct  alternative  cheese  competition.  Superior quality and
improved  quality  versus  conventional  cheese  competition  leads to  superior
consumer experiences and thus better market share. This market share leads to an
ability to charge  premium  prices for the Company's  branded  products and thus
deliver superior and enhanced  margins.  The enhanced margins will be reinvested
into the core brands and new products to produce additional earnings.

The Company's  results of operations  for the fiscal  quarter ended December 31,
2003 were materially  impacted by a $1,830,329 expense related to the accounting
treatment of the recently amended and restated employment  agreement between the
Company and the Company's  founder,  Angelo S. Morini,  which is described under
Item 5 of Part II,  "Other  Information."  Accounting  rules  dictated  that the
Company  accrue and expense the five-year  cost of this agreement in the quarter
ended December 31, 2003.

RESULTS OF OPERATIONS

<TABLE>
<CAPTION>
                                  THREE MONTHS ENDED DECEMBER 31,                        NINE MONTHS ENDED DECEMBER 31,
                          --------------------------------------------------   -------------------------------------------------
                               2003         2002         CHANGE        %            2003          2002         CHANGE       %
                          --------------------------------------------------   -------------------------------------------------
<S>                          <C>          <C>           <C>          <C>                                                  <C>
      NET SALES              9,638,571    9,755,729     (117,158)    (1.2%)      27,664,259    29,795,764   (2,131,505)   (7.2%)
      COST OF GOODS SOLD     6,715,750    6,805,863      (90,113)    (1.3%)      19,096,843    21,089,597   (1,992,754)   (9.5%)
                          ----------------------------------------             -----------------------------------------
      GROSS MARGIN           2,922,821    2,949,866      (27,045)    (0.9%)       8,567,416     8,706,167     (138,751)   (1.6%)
                          ========================================             =========================================
      GROSS MARGIN %           30%           30%                                    31%           29%
                          ==========================                           ===========================
</TABLE>

In the second quarter of fiscal 2003,  management  made a strategic  decision to
turn away lower margin  private  label  imitation  cheese and  imitation  cheese
sandwich  slice  business in order to  reallocate  the  Company's  limited  cash
resources (prior to the financial restructuring that was completed at the end of
the first  quarter of fiscal 2004) for  production  of higher  margin  "branded"
items.  While the effect of this  decision  caused net sales to  diminish,  this
approach  was the key factor that  enabled the  Company's  gross  margin to stay
fairly  consistent and gross profit to improve 2% even with a 7% decrease in net
sales in the nine months  ended  December  31, 2003  compared to the nine months
ended  December 31, 2002.  The 2%  improvement  in gross profit  during the nine
months ended  December 31, 2003  compared to the nine months ended  December 31,
2002,  was a function of selling  higher margin items and the decreased  cost of
raw  materials in the items that were sold.  The price of casein,  the Company's
primary  ingredient in a majority of its  products,  decreased 16% for the first
three  quarters  of fiscal 2004  compared to the first three  quarters of fiscal
2003,  resulting in a savings of approximately  $860,000.  Management expects to
see an  increase  in its casein  prices of up to 15% during  fiscal  2005 and is
striving to offset these price  increases  with  efficiencies  in production and
cost savings in the  purchase of other raw  materials,  along with  substituting
additional sources of protein into its products, as discussed above.  Management
monitors its costs and production  efficiencies through various ratios including
pounds  produced  per hour and cost per pound sold and uses these ratios to make
decisions in purchasing, production and setting sales prices.

To make the most of every sales order,  management  regularly reviews statistics
such as case  fill  rates  and  order  fill  rates.  These  rates  show of every
case/item  ordered,  what  percentage  was shipped  complete  and of every order
placed,  what  percentage was shipped 100% complete,  respectively.  In the nine
months ended  December 31, 2003  compared to the nine months ended  December 31,
2002, the case fill rate was 99.9% and 96.6%,  respectively,  and the order fill
rate was 99.1% and 74.4%,  respectively.  The high levels of  completion  on the
fill rates  indicates  that the  reduction  in sales is a function  of  external
consumer demand and behavior versus internal operational constraints.

Management uses 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,  management makes decisions on which brands to
promote and analyzes trends in the consumer marketplace.

The Company's management has identified several market factors that they believe
have had a negative affect on the Company's  business.  First,  consumers eating
habits are changing with the publicly  recognized trend toward  low-carbohydrate
meal preparation during all meals (breakfast,  lunch,  snack, and dinner).  This
has led to  decreased  consumption  of  items  such as bread  and the  Company's
primary complementary product of cheese slices. Second, the

                                       18
<PAGE>

number of  consumers  shopping in the retail  grocery and natural food stores is
down versus the prior year due to the further national emergence and presence of
Wal*Mart  superstores  and other similar  superstores  which  include  extensive
grocery  operations.  The  Company's  product  selection is growing but is still
limited at Wal*Mart. Therefore, the Company's sales growth with this account has
not been able to fully counter the decline in retail grocery trends. In response
to this change in consumer shopping, the Company is redesigning its products and
packaging formats to specifically target growth opportunities in the "warehouse"
club and mass merchandiser markets (such as Kmart, Target, and Wal*Mart). Third,
the Veggie brand sales were down due to market place  abnormalities  such as the
Southern California retail grocery labor strike.

Through December 28, 2003 IRI (Information Resources Incorporated) scanner data,
which measures retail grocery consumption,  indicates that the major competitors
in the  conventional  cheese  slice,  private  label cheese slice and  imitation
cheese slice cheese segments have all experienced  declining  consumption versus
the same  period a year ago in terms of dollar  sales.  The range in declines is
from  1%  to  21%  depending  on  the  brand  and  consumer  support  (that  is,
advertising,  promotion, and brand building efforts).  Consumption in dollars of
Veggie slices,  the Company's major product line, was down  approximately  6% in
the first three  quarters  of fiscal  2004  compared to the same period one year
ago. Alternatively,  Veggie consumption in dollars increased approximately 7% in
shred form and 3% in chunk form during the first  three  quarters of fiscal 2004
compared  to the same  period  one  year  ago.  Management  believes  this  data
demonstrates  that pressure on Veggie slice  consumption  is a function of usage
occasion and not a result of overall consumer dissatisfaction with the Company's
brand.

Although  net sales  during the first  three  quarters of fiscal 2004 were lower
than net sales during the first three  quarters of fiscal 2003, net sales during
the first three quarters of fiscal 2004 have  increased  quarter over quarter as
key initiatives  and tactical  actions  implemented  during the year have helped
counter  the  market  factors  negatively  impacting  the  business.   Such  key
initiatives and tactical actions include but are not limited to:

     1)   Created and  communicated a new more meaningful brand position for the
          Company's flagship Veggie Brand and new products.  The recent focus is
          to  highlight  the good  levels of  carbohydrates  and  protein in the
          Company's products and to target a broader universe of consumers.  The
          Company is attempting to attract incremental users by convincing prior
          users and light users of  conventional  cheese  that the Veggie  brand
          items can satisfy their needs with great tasting nutrition.  This is a
          departure   from  the  Company's   past  product   positioning   where
          physiological  and  medical  requirements  were  a key  driver  in why
          consumers should buy the "healthy alternatives."

     2)   Added approximately  15,000 points of new distribution with a focus on
          slices,  shreds, and chunk cheese.  During the first three quarters of
          fiscal 2004, it has proved much more  difficult  than expected to gain
          points of distribution  on the three core items noted above;  however,
          the Company  actually  achieved  much  greater  success on new product
          distribution  through  crumbles and string cheese.  It should be noted
          that, typically,  crumbles and string cheese velocity (sales per point
          of  distribution)  is  significantly  lower  than that of the  slices,
          shreds,   and  chunks  and  therefore  the  Company's  new  points  of
          distribution were not as productive  overall as was anticipated by the
          Company's original plan.

     3)   Created and tested  regionally a consumer  driven  marketing  campaign
          that  provided  valuable  insights  into  sales  growth  opportunities
          relative to its overall marketing strategy (trade/retailer  incentives
          versus consumer  advertising/promotion)  going forward. These insights
          led to better  consumer  marketing,  which helped stem consumer  sales
          decline in the regions where testing was performed.

     4)   Improved  gross  margin  through  purchase  savings,  product mix, and
          efficiencies in price related promotions.

     5)   Improved product quality in terms of taste,  color, aroma, and texture
          on the Company's Veggie and Rice slices product line.

The Company  anticipates  that the annual net sales for fiscal 2004 will be down
5% to 9%  compared  to annual  net sales for fiscal  2003.  This  reduced  sales
forecast  compared  to prior  expectations  of an equal to or 5% increase in net
sales  reflects  stronger  than  expected  sales  reductions on slices in retail
grocery and natural  food  channels  due to (a)  ongoing  changes in  consumer's
eating and shopping  behavior;  (b) slower than expected timing for securing new
strategic   accounts  and  product   opportunities;   (c)  lower  than  expected
performance  from additional  points of  distribution  of the Company's  branded
items;  and (d) the  impact of the  Southern  California  retail  grocery  labor
strike.

In order to positively impact sales volumes in the fourth quarter of fiscal 2004
and throughout fiscal 2005, the Company is focusing on three primary areas:

     o    The Company is shifting the emphasis  and resource  allocation  of its
          marketing     strategy     from    vendor     promotions     (retailer
          publications/flyers  featuring price reductions and on-shelf temporary
          price  reductions)  to increase  sales  through  consumer  advertising
          (magazine,  radio,  event sponsorship,  etc.) 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)  while highlighting and
          communicating the benefits of the

                                       19
<PAGE>

          Company's  products to meet the consumer  demand for low  carbohydrate
          and high protein products. This is a significant strategy shift and is
          based upon retail  consumption  data purchased  from IRI  (Information
          Resources  Incorporated) that indicates increased sales potential from
          consumer focused  marketing efforts versus similar dollars being spent
          toward price related vendor advertising and promotions.

     o    The Company  will also focus its efforts  toward  generating  consumer
          awareness,  conducting  product  trials,  and  generating  more repeat
          purchases for its brands.

     o    Due to the  completion  of the  financial  restructuring  in the first
          quarter of fiscal  2004,  the  Company  has begun to pursue  strategic
          opportunities,  which  it  previously  turned  away or did not  pursue
          earlier  due to cash  constraints.  This will  enable  the  Company to
          better utilize some of its excess production  capacity.  These efforts
          should  result in greater  operating  cash flow and a higher return on
          invested  capital  in future  periods.  As the  Company  adds  certain
          private label business to its product mix, the Company's  gross margin
          percentage  may decrease.  However,  the overall gross margin  dollars
          should increase due to higher net sales volumes.

<TABLE>
<CAPTION>
                                        THREE MONTHS ENDED DECEMBER 31,                      NINE MONTHS ENDED DECEMBER 31,
                                 -----------------------------------------------    ------------------------------------------------
                                   2003         2002         CHANGE         %         2003          2002         CHANGE         %
                                 -----------------------------------------------    ------------------------------------------------
<S>                               <C>          <C>            <C>        <C>         <C>           <C>           <C>         <C>
        GROSS MARGIN               2,922,821    2,949,866       (27,045)   (0.9%)      8,567,416     8,706,167     (138,751)  (1.6%)
        LESS:

           SELLING EXPENSES        1,110,097    1,240,544      (130,447)  (10.5%)      3,870,829     3,575,859      294,970    8.3%
           DELIVERY                  544,930      478,331        66,599    13.9%       1,430,706     1,561,847     (131,141)  (8.4%)
           EMPLOYMENT CONTRACT
           EXPENSE                 1,830,329           --     1,830,329                1,830,329            --    1,830,329
           NON-CASH COMPENSATION
           RELATED TO OPTIONS
           AND WARRANTS             (255,712)     190,720      (446,432) (234.1%)      1,179,677    (2,794,630)   3,974,307  142.2%
           G&A                       752,123      864,399      (112,276)  (13.0%)      2,621,621     2,453,148      168,473    6.9%
           R&D                        65,474       60,674         4,800     7.9%         191,466       174,888       16,578    9.5%
                                 ---------------------------------------            ----------------------------------------
        OPERATING INCOME          (1,124,420)     115,198    (1,239,618)  (1076%)     (2,557,212)    3,735,055   (6,292,267)(168.5%)
                                 =======================================            ========================================
        ADJUSTED OPERATING
        INCOME, A NON-GAAP
        FINANCIAL MEASURE   (1)      450,197      305,918       144,279    47.2%         452,794       940,425     (487,631) (51.9%)
                                 =======================================            ========================================
</TABLE>

(1) Adjusted  Operating Income is operating income excluding certain  employment
contract  expenses and non-cash  compensation  related to options and  warrants.
Although Adjusted Operating Income is not a financial measure that is calculated
in accordance with GAAP, management believes that it provides useful information
to management and investors in order to accurately  review the Company's current
on-going  operations and business trends related to its financial  condition and
results of  operations.  Additionally,  this measure is one of the primary means
upon which the Company  prepares  its  budgets,  forecasts  and  evaluates  loan
covenants.  With respect to non-cash  compensation,  it is  calculated  based on
fluctuations  in the  Company's  stock  price,  which are outside the  Company's
control and typically do not reflect the Company's  operations.  The  employment
contract  expense  reflects  the total costs that will be paid out over the next
five years  pursuant to the Amended and Restated  Employment  Agreement  for the
Company's  founder,  Angelo S. Morini,  which became effective October 13, 2003.
The Company expensed and accrued the $1,830,329 five-year cost of this agreement
in the quarter ended December 31, 2003.

The  $144,279  increase in adjusted  operating  income in the three months ended
December  31,  2003  compared to the three  months  ended  December  31, 2002 is
primarily  the result of a decrease in selling  and  general and  administrative
expenses.  In accordance with  management's  change in promotional  tactics from
vendor based promotions to a customer  marketing and advertising  campaign,  the
Company's   promotional   expenses  (primarily  related  to  vendors)  decreased
approximately $168,000 while customer based advertising increased  approximately
$71,000 in the third  quarter of fiscal 2004  compared  to the third  quarter of
fiscal 2003. Additionally, commissions for sales brokers decreased approximately
$47,000 in correlation  with the decrease in sales.  During the third quarter of
fiscal  2004,  general and  administrative  expenses  experienced  decreases  in
employment  compensation  of $76,000 as  described  under  "Employment  contract
expense", audit

                                       20
<PAGE>

fees of $45,000, and other general office  administration costs of approximately
$44,000.  These decreases were offset by an increase of approximately $53,000 in
director and related  insurance  expenses due to the expanded Board of Directors
and their  activity in the third quarter of fiscal 2004.  The Board  expanded at
the end of the third quarter in fiscal 2003 and the insurance increases occurred
in the first quarter of fiscal 2004.

Delivery  expenses  typically  range from 4.5% to 5.5% of net sales each period.
However, delivery expenses in the third quarter of fiscal 2004 approximated 5.7%
of net sales.  This increase in delivery  costs is primarily due to the increase
in fuel  costs  and rate  changes  in  anticipation  of the new  laws  regarding
limitation of driver hours.  The Company  anticipates  that delivery  costs will
continue to remain  slightly higher in future periods and range from 5% to 6% of
net sales.

The  $487,631  decrease in adjusted  operating  income in the nine months  ended
December 31, 2003  compared to December  31, 2002,  primarily is a result of the
increases in selling expenses and general and  administrative  expenses.  In the
nine  months  ended  December  31,  2003,  the  Company  recorded  increases  of
approximately  $119,000 in promotional costs and $335,000 in advertising  costs.
The  largest  percentage  of these costs  occurred in the first two  quarters of
fiscal 2004. These costs were limited in the first three quarters of fiscal 2003
due to the prior  financial  constraints  of the  Company.  The Company  noted a
decrease of  approximately  $185,000 in brokerage costs  corresponding  with the
decrease in sales in the nine months  ended  December  31, 2003  compared to the
nine months  ended  December 31,  2002.  For the nine months ended  December 31,
2003,  there was an increase of  approximately  $218,000 in legal fees primarily
due to the ongoing  Schreiber  lawsuit,  refinancing  activities  and additional
reporting   requirements  during  the  first  three  quarters  of  fiscal  2004.
Additionally  in the nine months ended  December  31,  2003,  the Company had an
increase of approximately  $153,000 in director and related  insurance  expenses
due to the  expanded  Board of Directors  and their  activity in the first three
quarters of fiscal 2004.  These  general and  administrative  increases  for the
first  three  quarters of fiscal 2004 were  offset by  decreases  in  employment
compensation of $76,000 as described  under  "Employment  contract  expense" and
telephone expenses of $65,000.

The Company  expects that fiscal 2004 selling  expenses  will remain higher than
fiscal  2003  expenses  based  on  the  Company's  current  plan  for  expanding
distribution  of strategic  products,  and  reallocation  of trade  spending for
advertising  and  promotional  allowances  that  are  focused  towards  specific
regions, products and customers.  Additionally, selling expenses should increase
in  fiscal  2005  as a  function  of the  anticipated  increase  in  net  sales.
Management  believes  that legal fees  should  decrease  significantly  when the
Schreiber lawsuit has been fully resolved.  Management is focused on controlling
general  and  administrative  expenses  and  expects to see  further  reductions
through cost saving measures and as a result of the revised employment  contract
with its founder, Angelo S. Morini.

<TABLE>
<CAPTION>
                                       THREE MONTHS ENDED DECEMBER 31,                     NINE MONTHS ENDED DECEMBER 31,
                               ------------------------------------------------  -------------------------------------------------
                                  2003         2002         CHANGE         %        2003          2002         CHANGE         %
                               ------------------------------------------------  -------------------------------------------------
<S>                             <C>            <C>          <C>        <C>        <C>            <C>          <C>         <C>
      NET INCOME                (1,378,354)    (476,568)     (901,786) (189.2%)   (3,576,603)     1,275,187   (4,851,790) (380.5%)
      PLUS:
         EMPLOYMENT CONTRACT
         EXPENSE                 1,830,329           --     1,830,329              1,830,329             --    1,830,329
         NON-CASH COMPENSATION
         RELATED TO OPTIONS
         AND WARRANTS             (255,712)     190,720      (446,432) (234.1%)    1,179,677     (2,794,630)   3,974,307   142.2%
        INTEREST                   253,934      536,766      (282,832)  (52.7%)    1,019,391      2,404,868   (1,385,477)  (57.6%)
        DEPRECIATION               548,632      568,641       (20,009)   (3.6%)    1,657,431      1,707,586      (50,155)   (2.9%)
                               ----------------------------------------          -----------------------------------------
      EBITDA EXCLUDING
      EMPLOYMENT CONTRACT
      EXPENSE AND NON-CASH
      COMPENSATION                 998,829      819,559       179,270    21.9%     2,110,225      2,593,011     (482,786)  (18.6%)
                               ========================================          =========================================
      % OF NET SALES                 10.4%         8.4%                                 7.6%           8.7%
                               ==========================                        ===========================
</TABLE>

Management   excludes  certain   employment   contract   expenses  and  non-cash
compensation related to options and warrants from its analysis of EBITDA because
it  provides  useful  information  to  management  and  investors  in  order  to
accurately review the Company's current on-going  operations and business trends
related to its financial condition and results of

                                       21
<PAGE>

operations.  Additionally,  this measure is one of the primary  means upon which
the Company prepares its budgets, forecasts and evaluates loan covenants.

The $482,786 decline in EBITDA, as adjusted,  for the nine months ended December
31,  2003  compared  to 2002 is  primarily  the result of the large  increase in
selling (up approximately  $300,000) and general and administrative expenses (up
approximately  $141,000)  that  occurred in the first  quarter of fiscal 2004 as
more fully detailed above.

EMPLOYMENT  CONTRACT  EXPENSE - Due to the  accounting  treatment  of the Second
Amended and Restated  Employment  Agreement (the "Agreement")  between Angelo S.
Morini and the Company,  which  Agreement is described  under Item 5 of Part II,
"Other Information", 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 $75,998 was paid during
the quarter ended December 31, 2003 and $1,754,331  remained  unpaid but accrued
($366,305  as  short-term  accrued   liabilities  and  $1,388,026  as  long-term
liabilities) as of December 31, 2003. The long-term  portion will be paid out in
nearly equal monthly installments ending in October 2008.

NON-CASH COMPENSATION RELATED TO OPTIONS AND WARRANTS

<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED DECEMBER 31,   NINE MONTHS ENDED DECEMBER 31,
                                          -------------------------------   ------------------------------
                                               2003             2002            2003            2002
                                           ------------     ------------    ------------    ------------
<S>                                        <C>              <C>             <C>             <C>
      Notes Receivable for Common Stock    $         --     $         --    $         --    $ (3,060,000)
      Option and Warrant Repricing             (379,428)         188,395         540,613         188,395
      Option and Warrant Issuances              123,716            2,325         639,064          76,975
                                           ------------     ------------    ------------    ------------
          Total Non-Cash Compensation      $   (255,712)    $    190,720    $  1,179,677    $ (2,794,630)
         (Income)/Expense                  ============     ============    ============    ============
</TABLE>

The Company values the non-cash  compensation related to its securities on three
primary items:

      a.  Notes Receivable for Common Stock
      -------------------------------------
      The Financial  Accounting  Standards  Board issued  Interpretation  No. 44
      ("FIN 44"),  which clarifies the application of APB Opinion 25 relating to
      the  accounting  consequences  of  various  modifications  to fixed  stock
      options.  FIN 44 covers  specific  events that occurred after December 15,
      1998 and was effective as of July 2, 2000.  FIN 44 clarified  that when an
      option is  repriced,  it is treated as a variable  option and is marked to
      market each quarter.  Accordingly, any increase in the market price of the
      Company's common stock over the exercise price of the options that was not
      previously recorded is recorded as compensation  expense at each reporting
      period. 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.  Compensation income is limited to the original base
      exercise  price (the "Floor") of the options.  In accordance  with FIN 44,
      the underlying  shares related to the $12,772,200 note receivable from the
      Company's  founder,  Angelo S. Morini, as disclosed in Note 8, are treated
      as variable due to the nature of the note being  non-interest  bearing and
      non-recourse. There was no non-cash compensation expense or income related
      to these shares recorded during the nine months ended December 31, 2003 as
      the price of the  Company's  common stock at the  beginning and end of the
      period was below the Floor.  The Company  recorded  non-cash  compensation
      income of zero and $3,060,000 for the three and nine months ended December
      31, 2002,  respectively,  based on the decrease in the market price of the
      Company's  common  stock from $5.43 at March 31, 2002 to $3.14 at December
      31,  2002.  The Company did not record any further  non-cash  compensation
      income once the stock price fell below the Floor of $4.38  during the nine
      months ended  December  31, 2002 and  remained  below the Floor during the
      nine months ended December 31, 2003.  Variable  accounting  treatment will
      result  in  unpredictable   stock-based  compensation  expense  or  income
      depending on fluctuations in quoted prices for the Company's common stock.
      A $0.01  increase or decrease in the Company's  common stock price results
      in an expense or income, respectively, of approximately $29,000.

      b.  Option and Warrant Repricing
      --------------------------------
      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.  In
      addition,  the Company  repriced the outstanding  warrants held by current
      consultants  as of  October  11,  2002  (291,429  shares at former  prices
      ranging from $3.31 to $5.50) to the market price of $2.05 per share.  This
      stock option repricing resulted in variable accounting treatment for these
      stock options  beginning with the quarter ended December 31, 2002 and such
      variable accounting treatment will continue until the related options have
      been cancelled, expired or exercised. On

                                       22
<PAGE>

      December 4, 2002, as a result of discussions and negotiations with certain
      major  shareholders,  the Company's founder,  Angelo S. Morini,  agreed to
      reverse  the  repricing  of his  3,692,035  options  for  the  purpose  of
      improving  shareholder value and lessening  potential  financial statement
      expense. Although the exercise prices of the options were reversed back to
      their original  amounts,  the Company is still required to account for any
      outstanding  options  related  to  these   reversed-repriced   options  in
      accordance with variable accounting standards each quarter.

      The Company recorded non-cash compensation income of $379,428 and non-cash
      compensation  expense of $540,613  related to these  variable  options and
      warrants  in  the  three  and  nine  months   ended   December  31,  2003,
      respectively.  The Company  recorded  $188,395  as  non-cash  compensation
      expense  related to these  variable  options and warrants in the three and
      nine months ended December 31, 2002.  Variable  accounting  treatment will
      result  in  unpredictable   stock-based  compensation  expense  or  income
      depending on fluctuations in quoted prices for the Company's common stock.
      During the third  quarter  of fiscal  2004,  the  Company's  common  stock
      declined  from $2.90 at September  30, 2003 to $2.51 at December 31, 2003.
      During the third  quarter  of fiscal  2003,  the  Company's  common  stock
      declined  from $3.14 at September  30, 2002 to $2.28 at December 31, 2002.
      Assuming no further options or warrants are exercised or cancelled and all
      are vested,  a $0.01  increase or  decrease in the  Company's  stock price
      results in a non-cash  compensation  expense or income,  respectively,  of
      approximately $39,000.

      c.  Option and Warrant Issuances
      --------------------------------
      The Company  recorded  $123,716  and  $639,064  as  non-cash  compensation
      expense related to employee  stock,  options and warrants that were issued
      and vested  during the three and nine  months  ended  December  31,  2003,
      respectively.   The  Company  recorded  $2,325  and  $76,975  as  non-cash
      compensation  expense  related to employee  options and warrants that were
      issued and vested  during the three and nine  months  ended  December  31,
      2002, respectively.

INTEREST  EXPENSE - During the nine months ended  December 31, 2002, the Company
amortized to interest  expense  $614,230  related to debt discounts on its prior
mezzanine loan from FINOVA Mezzanine Capital,  Inc. ("FINOVA  Mezzanine").  This
non-cash  amortization ended in September 2002 and did not occur during the nine
months ended  December 31, 2003. The Company also noted a decrease in loan costs
of  approximately  $91,000  and  $314,000  for the three and nine  months  ended
December 31, 2003 compared to the three and nine months ended December 31, 2002,
respectively. The remaining decrease in interest expense was the result of lower
debt balances,  and lower interest rates on the outstanding debt balances partly
due to a reduction in the prime rate during the nine months  ended  December 31,
2003 compared to the nine months ended December 31, 2002.  See "Debt  Financing"
below for further detail on the Company's  outstanding  debts and interest rates
thereon.

LIQUIDITY AND CAPITAL RESOURCES

<TABLE>
<CAPTION>
                                                 NINE MONTHS ENDED DECEMBER 31,
                                  ---------------------------------------------------------
                                          2003           2002          CHANGE          %
                                    -------------------------------------------------------
<S>                                     <C>            <C>             <C>            <C>
         Cash collected from
         customers                        28,518,798     30,900,389    (2,381,591)    7.7%
         Cash paid to employees
         and other suppliers of
         goods and services             (25,612,611)   (27,566,255)      1,953,644    7.1%
         Cash paid under
         employment contract                (75,998)             --       (75,998)   --
         Litigation settlement
         expenses                                 --       (55,000)         55,000   --
         Interest paid                     (862,126)    (1,284,723)        422,597   32.9%
                                    -----------------------------------------------
      CASH PROVIDED BY OPERATING
      ACTIVITIES                          1,968,063      1,994,411       (26,348)   (1.3%)
                                    ===============================================
      CASH USED IN INVESTING
      ACTIVITIES                           (173,505)      (195,868)         22,363   11.4%
                                    ===============================================
      CASH PROVIDED BY FINANCING
      ACTIVITIES                         (1,319,416)    (1,797,083)        477,667   26.6%
                                    ===============================================
</TABLE>

                                       23
<PAGE>

OPERATING  ACTIVITIES - Net cash provided by operating activities was $1,968,063
and   $1,994,411  in  the  nine  months  ended   December  31,  2003  and  2002,
respectively.  The decrease in cash  collected  from  customers and cash paid to
employees and suppliers was in direct proportion to the decrease in sales during
the nine months  ended  December  31, 2003  compared to the same period one year
ago. The reduction in sales proceeds was offset by the  substantial  decrease in
cash paid for interest on the Company's credit  facilities as discussed above so
that the change to cash provided by operating activities was minimal.

During the three  quarters of fiscal  2004,  the Company saw an increase in cash
provided from inventories of nearly  $600,000,  but a reduction in cash provided
by accounts receivable of approximately  $250,000.  The Company anticipates that
inventories  and accounts  receivables are at low levels and that in the future,
these balances will increase with the anticipated increases in sales and will be
a use of cash  instead of a  provision  of cash.  The Company  anticipates  that
operating activities should continue to provide positive cash for operations.

INVESTING ACTIVITIES - The decrease in cash used for investing activities during
the nine months  ended  December  31, 2003 as compared to the nine months  ended
December 31, 2002 primarily  resulted from less purchases of fixed assets during
the period. There are no plans for large future capital expenditures.

FINANCING  ACTIVITIES  - During the first  quarter of fiscal  2004,  the Company
raised $3,850,000 through the issuance of common stock and $2,000,000 from a new
term loan with SouthTrust  Bank, as described below. The Company used $4,000,000
of these proceeds to pay in full the principal balance owed to FINOVA Mezzanine.
The  remaining   proceeds  were  used  to  further  reduce  the  Company's  book
overdrafts,  accounts  payable  and debt  balances.  Additionally,  the  Company
obtained  from Textron  Financial  Corporation  ("Textron")  a revolving  credit
facility  that replaced the Company's  asset-based  credit  facility with FINOVA
Capital  on  May  30,  2003,  which  had an  outstanding  principal  balance  of
$4,254,667 at the time of replacement, as further described below.

During the first quarter of fiscal 2003, the Company received loan proceeds from
Excalibur Limited Partnership in the amount of $500,000 in cash. The proceeds of
which were used to pay down a portion of the  Company's  outstanding  debt under
its term loan from SouthTrust Bank. Additionally, in the first quarter of fiscal
2003, the Company raised $1,500,000  through the issuance of common stock. These
proceeds were used to pay off the  Company's  term loan from  Excalibur  Limited
Partnership  and for working  capital  purposes.  The Company used its cash from
operating  activities  to reduce its book  overdrafts  and loan  balances on the
Company's outstanding debt.

Debt Financing
--------------
Effective May 30, 2003, the Company obtained from Textron Financial  Corporation
("Textron") a revolving  credit  facility  (the  "Textron  Loan") in the maximum
principal  amount of $7,500,000  pursuant to the terms and  conditions of a Loan
and Security  Agreement dated May 27, 2003 (the "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)
eighty-five  percent (85%) of the net amount of its eligible accounts receivable
plus (ii) sixty percent (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 one
and  three-quarter  percent  (1.75%)  per annum  (5.75% at  December  31,  2003)
calculated on the average cash borrowings for the preceding  month.  The Textron
Loan  matures and all amounts are due and payable in full on May 26,  2006.  The
Textron Loan  replaced the  Company's  asset-based  credit  facility with FINOVA
Capital  on  May  30,  2003,  which  had an  outstanding  principal  balance  of
$4,254,667 at the time of replacement.  As of December 31, 2003, the outstanding
principal balance on the Textron Loan was $4,389,978.

The Textron Loan  described  above  contains  certain  financial  and  operating
covenants.  In August 2003, the Company  notified  Textron that it had failed to
comply with the fixed charge coverage ratio in June 2003.  Pursuant to a certain
Waiver Letter dated August 13, 2003,  Textron agreed to waive the requirement to
meet the fixed charge  coverage ratio for each monthly period through  September
30, 2003.  Additionally,  Textron  agreed that after August 13, 2003, all of the
financial  covenants  required  of the  Company  under  Section  7.6 of the Loan
Agreement will be measured and tested on a quarterly  rather than monthly basis.
Due to the $1.8 million charge to operations related to the Amended and Restated
Employment  Agreement for Angelo Morini,  the Company fell below the requirement
for the  adjusted  tangible  net  worth  and the  fixed  charge  coverage  ratio
covenants for the quarter ended December 31, 2003.  Pursuant to discussions with
and a written  confirmation  from  Textron,  Textron has agreed in  principle to
amend the loan covenants  effective as of December 31, 2003, the effect of which
would bring the Company into  compliance  with both ratios as of that date.  The
Company anticipates that it will be in compliance with these ratios, as amended,
for the foreseeable future based on current forecasts.

                                       24
<PAGE>

On September 30, 1999, the Company obtained a $4 million  subordinated loan from
FINOVA Mezzanine to finance additional  working capital and capital  improvement
needs. This loan was paid in full as of May 30, 2003 by the proceeds from a loan
from  SouthTrust  Bank  and from  the  equity  proceeds  raised  in the  private
placements  in May  2003,  as  discussed  below.  In  accordance  with a warrant
agreement dated September 30, 1999, the exercise price on 200,000 warrants still
held by FINOVA  Mezzanine on May 30,  2003,  was reduced from $3.41 to $1.80 per
share based on the sales price of the Company's common stock in May 2003. FINOVA
Mezzanine  exercised these warrants to purchase  200,000 shares of the Company's
common  stock on June 2, 2003.  The Company  received  net  proceeds of $119,000
after a deduction of $241,000 due to FINOVA Capital  Corporation for waiver fees
pursuant to a certain  Amendment and Limited Waiver to Security  Agreement dated
June 26, 2002.

Simultaneous  with the closing of the Textron Loan in May 2003,  SouthTrust Bank
extended the Company a new term loan in the principal amount of $2,000,000. This
loan was  consolidated  with the Company's  March 2000 term loan with SouthTrust
Bank, which had a then outstanding  principal  balance of $8,131,985 for a total
term loan  amount of  $10,131,985.  The  revised  term loan  bears  interest  at
SouthTrust  Bank's prime rate of interest plus 1% (5% at December 31, 2003), and
is due in  increasing  principal  installments  by June 2009.  Each  month,  the
Company  will pay the  accrued  interest on the loan plus  principal  amounts as
follows:  $75,000 from July 2003 to June 2004,  $110,000  from July 2004 to June
2005,  and  $166,250  from July 2005 until  maturity in June 2009.  This note is
secured by all of the  Company's  equipment  and  certain  related  assets.  The
proceeds of the new term loan,  together with the proceeds from certain sales of
the  Company's  common  stock  conducted  in May  2003,  were  used to repay the
Company's  $4,000,000   mezzanine  loan  from  FINOVA  Mezzanine.   The  balance
outstanding on this new term loan as of December 31, 2003 was $9,606,985.

The  SouthTrust  term  loan  described  above  contains  certain  financial  and
operating covenants. Due to the $1.8 million charge to operations related to the
Amended and Restated  Employment  Agreement for Angelo Morini,  the Company fell
below the  requirement for the tangible net worth covenant for the quarter ended
December 31, 2003. Pursuant to discussions with and a written  confirmation from
SouthTrust,  SouthTrust  has  agreed in  principle  to amend  the loan  covenant
effective as of December  31, 2003,  the effect of which would bring the Company
into compliance with this ratio as of that date. The Company anticipates that it
will be in compliance  with this ratio, as amended,  for the foreseeable  future
based on current forecasts.

In October 2000, the Company obtained a $1.5 million bridge loan from SouthTrust
Bank,  which is  guaranteed  by Angelo S. Morini,  the  Company's  founder,  and
secured by the pledge of one million shares of the Company's  common stock owned
by him.  Interest on this note is at the prime rate (4% at December  31,  2003).
The loan is being  paid down by  monthly  principal  payments  of  $50,000  plus
interest.  In May 2003, SouthTrust Bank amended this loan to extend the maturity
date from October 2003 to April 2004. Principal payments of $50,000 are due each
month  beginning June 1, 2003 until  maturity.  The balance  outstanding on this
note as of December 31, 2003 was $101,000.

In connection  with the  consolidations  and extensions of the  SouthTrust  Bank
loans as  described  above,  the Company  issued a warrant to  purchase  100,000
shares of the  Company's  common stock to SouthTrust  Bank on May 29, 2003.  The
warrant  is  exercisable  until June 1, 2009 at an  exercise  price of $1.97 per
share. In accordance with SFAS 123, the fair value of this warrant was estimated
at  $101,000  and will be  amortized  as  non-cash  compensation  over 72 months
beginning in May 2003.

In March 2002, Angelo S. Morini, the Company's  founder,  loaned $330,000 to the
Company in order for it to pay down certain  notes payable that were coming due.
This loan bore  interest  at the  prime  rate and was due on or before  June 15,
2006.  In connection  with a Second  Amended and Restated  Employment  Agreement
effective  October 13,  2003  between Mr.  Morini and the  Company,  the Company
offset $167,603 of unreimbursed  advances owed to it by Mr. Morini prior to June
2002 and certain  family  members  against the balance of the loan and issued an
aggregate  of  55,087   shares  of  the   Company's   common  stock  (valued  at
approximately $2.95 per share) as payment in full.

On August 15, 2002, the Company executed and delivered to Target Container, Inc.
a $347,475 promissory note in satisfaction of its accounts payable obligation to
this vendor. This note bore interest at 7% per annum and was due in twelve equal
monthly  installments  of $30,066.  This note was paid in full by September  30,
2003.

In January 2003, Ruggieri of Windermere Family Limited Partnership, an affiliate
of Mr. John  Ruggieri,  the Company's  former Vice  President of  Manufacturing,
entered  into a  credit  arrangement  with the  Company  pursuant  to which  the
partnership purchased for the Company raw materials  approximating $500,000. The
amounts paid for the purchased  materials,  plus interest at the rate of 15% per
annum on such amounts, was due and paid in full by May 31, 2003.

                                       25
<PAGE>

On April 10,  2003,  the  Company  entered  into a credit  arrangement  with Mr.
Frederick Deluca, one of its greater than 5% shareholders, pursuant to which Mr.
Deluca  purchased raw materials for the Company in an aggregate  amount that did
not exceed $500,000. The amounts paid for the purchased materials, plus interest
at the rate of 15% per annum on such  amounts,  was due and  payable  in full on
July 9, 2003. All amounts owed under the credit  arrangement were repaid in full
and such credit arrangement was terminated on June 27, 2003.

Equity Financing
----------------
On April 6, 2001,  in  accordance  with an  exemption  from  registration  under
Regulation D  promulgated  under the  Securities  Act of 1933,  as amended,  the
Company  received  from BH  Capital  Investments,  L.P.  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 Series A
Preferred  Holders  have  the  right  to  receive  on any  outstanding  Series A
convertible preferred stock a ten percent stock dividend on the shares,  payable
one year after the issuance of such preferred  stock, and an eight percent stock
dividend for the subsequent  three years  thereafter,  payable in either cash or
shares of preferred stock.  The Series A convertible  preferred stock is subject
to certain  designations,  preferences  and  rights  set forth in the  Company's
Restated  Certificate  of  Incorporation,  including  the right to convert  such
shares into shares of common  stock at any time,  at a current  conversion  rate
(subject  to  appropriate   adjustment  for  stock  splits,   stock   dividends,
recapitalizations  and other events) of the number of shares of common stock for
each share of Series A convertible preferred stock equal to the quotient of:

$48.18,  plus all accrued  dividends  that are then unpaid for each share of the
Series A convertible preferred stock then held by the holder,

      divided by,

the lesser of (x) $1.75 or (y) 95% of the average of the two lowest  closing bid
prices on the  American  Stock  Exchange of the common  stock out of the fifteen
trading days immediately prior to conversion.

As of December 31, 2003,  the Series A Preferred  Holders had  converted  24,290
shares of the Series A convertible preferred stock plus accrued dividends,  into
931,190  shares of common stock.  The  conversion  prices ranged from $1.3633 to
$1.75 and were  based on the lower of (a) 95% of the  average  of the two lowest
closing bid prices on the AMEX for the fifteen trading days immediately prior to
conversion  or (b) $1.75.  From January 1, 2004 through  February 17, 2004,  the
Series A Preferred  Holders  converted  2,462 shares of the Series A convertible
preferred stock, plus accrued dividends, into 84,386 shares of common stock at a
conversion price of $1.75.

The Series A Preferred  Holders  have the right to require the Company to redeem
their  shares of Series A  convertible  preferred  stock on April 6,  2005.  The
redemption  price shall be paid in cash at a price per preferred  share equal to
the greater of (a) 100% of the preference amount ($48.18 plus accrued dividends)
or (b) an amount  equal to the  number of shares of common  stock  that would be
then issuable upon  conversion of the Series A convertible  preferred  stock and
times the market price on the date of redemption. The market price is based on a
five-day  average of the closing bid prices for the five  trading  days prior to
the date of redemption.  As of February 17, 2004,  there are still 45,894 shares
of the  Series A  convertible  preferred  stock  outstanding.  Assuming  that no
further  conversions  were made and the conversion  price remained at $1.75, the
Series A Preferred Holders would have the right to require the Company to redeem
these shares at the greater of (a)  $2,962,917  (100% of the  preference  amount
plus  accrued  dividends  through  April 6, 2005 - $64.56  per share) or (b) the
value of 1,693,085  shares of common stock times the market price on the date of
redemption  (currently estimated at $4,551,012 using the closing market price of
the Company's common stock from February 9-13,  2004). The Company is seeking to
obtain the  necessary  funds  through  its  positive  cash flows from  operating
activities,  existing credit  facilities,  equity  financing,  and/or finding an
investor(s)  to buy out the Series A Preferred  Holders  directly.  There are no
assurances,  however, that such financing,  if available will be at a price that
will not  cause  substantial  dilution  to the  Company's  shareholders.  If the
Company is not able to  generate  sufficient  cash  through  its  operating  and
financing  activities in fiscal 2005, it will not be able to pay its debt to the
Series A Preferred  Holders in a timely  manner.  Any unpaid  amount  shall bear
interest at the rate of 3% per month until paid in full.

On November 7, 2002, the Series A Preferred  Holders exercised their right under
the  Purchase  Agreement  to require the Company to solicit the  approval of its
shareholders  for the  Company's  issuance of all of the shares of common  stock
potentially issuable upon conversion of the Series A convertible preferred stock
in full and the exercise of their  warrants.  The Company was required to hold a
shareholders  meeting to solicit  such  approval on or before  February 5, 2003.
Pursuant

                                       26
<PAGE>

to the Stock Purchase Option  Agreement  described below, the Series A Preferred
Holders  agreed,  among other  things,  to extend the deadline to September  30,
2003.  On September  30, 2003,  the Company's  shareholders,  by majority  vote,
approved the  issuance by the Company of all required  common stock in the event
of a conversion of the Company's  Series A convertible  preferred stock and upon
the exercise of certain warrants held by the Series A Preferred Holders.

On April 24, 2003, the Company and the Series A Preferred  Holders  entered into
that certain Stock Purchase  Option  Agreement,  whereby the Company was granted
the option to purchase all of the shares of the Series A  convertible  preferred
stock owned by such holders at the time the purchase is consummated.  The option
expired  on  September  30,  2003.  Pursuant  to such  agreement,  the  Series A
Preferred  Holders  also agreed to extend the  deadline  to hold a  shareholders
meeting to September  30, 2003.  In exchange for the option and the extension of
the annual meeting date, the Company issued warrants to purchase  250,000 shares
of the Company's common stock to both BH Capital Investments, L.P. and Excalibur
Limited  Partnership.  These warrants are exercisable  until July 15, 2006 at an
exercise price equal to $2.00 per share, which price was greater than the market
value of the  Company's  common stock on April 24,  2003.  These  warrants  were
included on a Registration Statement on Form S-3, SEC File No. 333-109649, which
was filed on October 10, 2003 and declared  effective  on November 19, 2003.  In
accordance  with SFAS 123,  the fair value of these  warrants  was  estimated at
$230,000 and was recorded as non-cash  compensation expense in the first quarter
of fiscal 2004.

On April 10,  2003,  the  Company  entered  into a credit  arrangement  with Mr.
Frederick Deluca, one of its greater than 5% shareholders, pursuant to which Mr.
Deluca  purchased raw materials for the Company in an aggregate  amount that did
not exceed $500,000. The amounts paid for the purchased materials, plus interest
at the rate of 15% per annum on such  amounts,  was due and  payable  in full on
July 9, 2003. In consideration of the credit arrangement,  the Company issued to
Mr. Deluca a warrant to purchase 100,000 shares of the Company's common stock at
an exercise price of $1.70.  In accordance with SFAS 123, the fair value of this
warrant  was  estimated  at $63,000 and was  recorded  as non-cash  compensation
expense in the first  quarter of fiscal 2004.  All amounts owed under the credit
arrangement  were repaid in full and such credit  arrangement  was terminated on
June 27, 2003.

Pursuant to the Company's  Restated  Certificate of  Incorporation,  the warrant
issued  to Mr.  Deluca  caused  the  maximum  conversion  price of the  Series A
convertible  preferred stock to decrease to $1.75, such that the conversion rate
of the Series A convertible  preferred  stock to common stock is currently equal
to the quotient of (i) $48.18,  plus all accrued  dividends that are then unpaid
for each  share of the  Series A  convertible  preferred  stock then held by the
holder, divided by (ii) 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 AMEX out of the
fifteen trading days immediately prior to conversion.

In accordance with an exemption from registration under Regulation D promulgated
under the Securities Act of 1933, as amended,  and pursuant to seven  Securities
Purchase  Agreements  dated May 21, 2003, the Company sold and issued a total of
2,138,891  shares of its  common  stock at a price per share  equal to $1.80 for
aggregate  gross proceeds to the Company of $3,850,000.  These  securities  were
included on a Registration Statement on Form S-3, SEC File No. 333-109649, which
was filed on October 10, 2003 and declared effective on November 19, 2003. Sales
to related parties under the Securities  Purchase  Agreements  include:  555,556
shares of  common  stock  sold at an  aggregate  sales  price of  $1,000,000  to
Frederick  DeLuca, a greater than 5% shareholder;  55,556 shares of common stock
sold at an  aggregate  sales price of $100,000 to David H. Lipka,  a Director of
the Company; 83,333 and 55,556 shares of common stock sold at an aggregate sales
price of $150,000 and $100,000,  respectively,  to Ruggieri of Windermere Family
Limited Partnership and Ruggieri Financial Pension Plan,  respectively,  each an
affiliate  of  John   Ruggieri,   the   Company's   former  Vice   President  of
Manufacturing; 1,111,112 shares of common stock sold at an aggregate sales price
of $2,000,000  to  Fromageries  Bel S.A., a leading  branded  cheese  company in
Europe which signed a Master  Distribution and Licensing Agreement effective May
22, 2003 with the Company.  Sales to  non-related  parties under the  Securities
Purchase Agreements include: 138,889 shares of common stock sold at an aggregate
sales price of $250,000 Apollo Capital  Management  Group; and 138,889 shares of
common  stock sold at an  aggregate  sales  price of  $250,000  Apollo  MicroCap
Partners, L.P.

The  Company  used  $2,000,000  of the  proceeds  generated  from these May 2003
private placements to pay down the balance of the Company's  mezzanine loan from
FINOVA Mezzanine Capital,  Inc. The Company then applied the additional proceeds
from the new loan from SouthTrust Bank, as discussed above, to pay the remaining
$2,000,000 on the FINOVA  Mezzanine loan. The Company  utilized the remainder of
the  private  placement  proceeds  for working  capital  and  general  corporate
purposes.

                                       27
<PAGE>

Summary
-------
The  Company  is faced with risks  every day in  regards  to  consumer  demands,
quality of its products, competition from larger and more established companies,
and production malfunctions,  among others. However, management believes that it
monitors  these  changing  factors on a regular  basis and takes  proactive  and
preventative measures to counter these risks.  Management believes that with the
proceeds  already  received from its equity  financings and financing  available
from its credit facilities combined with the positive cash flow anticipated from
current and future  operations,  the  Company  will have enough cash to meet its
current liquidity needs based on planned operational levels.  There are no plans
for large future capital  expenditures or increases in production  levels beyond
what can be met with the existing Textron Loan and operating cash flow.

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 revenues and expense during the
reporting period. The Company's  significant estimates include the allowance for
doubtful  accounts  receivable,   provision  for  inventory  obsolescence,   and
valuation of deferred taxes, employee options and warrants. Actual results could
differ from those estimates.

The Company  records  revenue  upon  shipment of products to its  customers  and
reasonable  assurance of  collection  on the sale.  It provides  credit terms to
customers  usually based on net 30 days.  The Company  performs  ongoing  credit
evaluations of its accounts receivable and makes reserves for anticipated future
credits that will be issued to its customers for promotions,  discounts, spoils,
etc., based on historical  experience.  In addition,  the Company  evaluates the
accounts  for  potential   uncollectible   amounts.  The  reserve  for  accounts
receivable is then adjusted to reflect these estimates. At December 31, 2003 and
March 31, 2003,  the Company had reserved  $501,000 and $487,000,  respectively,
for known and anticipated future promotional credits and doubtful accounts.  The
Company utilizes a detailed  customer invoice  promotion  settlement  process to
methodically  predict,  track, manage, and resolve invoicing issues.  Actual bad
debt  expense  during  the nine  months  ended  December  31,  2003 and 2002 was
approximately $7,000 and $21,267, respectively.

Inventories  are  valued  at  the  lower  of  cost  (weighted   average,   which
approximates FIFO) or market.  The Company reviews its inventory  valuation each
month  and  writes  down  the  inventory  for  potential  obsolete  and  damaged
inventory.  In addition, the inventory value is reduced to market value when the
known sales price is less than the cost of the inventory.

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.

Statement of Financial  Accounting  Standards No. 123 ("SFAS 123"),  "Accounting
for Stock  Based  Compensation",  requires  the  Company  to  provide  pro-forma
information regarding net income (loss) and earnings (loss) per share amounts as
if compensation  cost for the Company's  employee and director stock options had
been determined in accordance with the fair market value-based method prescribed
in SFAS No. 123.  The Company  estimates  the fair value of each stock option at
the grant date by using a  Black-Scholes  option-pricing  model.  The  following
assumptions were used for options issued during the periods:

      Nine Months Ended                  December 31, 2003     December 31, 2002
                                         ------------------   ------------------
      Dividend Yield                     None                 None
      Volatility                         41% to 45%           37% to 44%
      Risk Free Interest Rate            2.01% to 4.28%       1.71% to 5.03%
      Expected Lives in Months           36 to 120            60 to 120

                                       28
<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's  exposure to market risk results  primarily from  fluctuations  in
interest rates. The interest rates on most of the Company's  outstanding  debts,
including its debt to SouthTrust  Bank 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 December 31, 2003 with respect to the Company's anticipated debt as of
such date would  increase  or  decrease  interest  expense  and hence  reduce or
increase net income of the Company by approximately $35,000 per quarter.

The Company's  sales during the  nine-month  periods ended December 31, 2003 and
2002 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.  Therefore, the effects of changes
in foreign currency exchange rates have not historically been significant to the
Company's operations or net assets.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the fiscal  quarter ended  December 31, 2003, an evaluation was
performed  under the  supervision  and with the  participation  of the Company's
management,  including  the  Chief  Executive  Officer  ("CEO"),  and the  Chief
Financial  Officer ("CFO"),  of the effectiveness of the design and operation of
the Company's  disclosure controls and procedures to ensure that the information
required to be  disclosed by the Company in the reports that it files or submits
under the Securities Exchange Act of 1934, as amended,  is recorded,  processed,
summarized and reported within the time periods  specified in the Securities and
Exchange  Commission's rules and forms. Based on that evaluation,  the Company's
management,  including the CEO and CFO, concluded that the Company's  disclosure
controls and  procedures  were  effective as of the end of the period covered by
this report.

There was no change in the Company's  internal control over financial  reporting
that  occurred  during the  fiscal  quarter  ended  December  31,  2003 that has
materially  affected,  or is reasonably  likely to materially  affect,  internal
control over financial reporting.

                                       29
<PAGE>

                           PART II. OTHER INFORMATION
                           --------------------------

ITEM 1. LEGAL PROCEEDINGS

On May 17, 2002, Schreiber Foods, Inc. of Green Bay, Wisconsin,  filed a lawsuit
against the Company in the federal  district  court for the Eastern  District of
Wisconsin ("Wisconsin lawsuit"), being Case No. 02-C-0498, alleging various acts
of patent  infringement.  The Complaint alleges that the Company's  machines for
wrapping of individual cheese slices,  manufactured by Kustner Industries,  S.A.
of  Switzerland,  known as  models KE and KD,  and the  Company's  machines  for
producing  individually wrapped slices manufactured by Hart Design Mfg., Inc. of
Green Bay,  Wisconsin,  infringe certain claims of U.S. Patents Nos.  5,112,632,
5,440,860, 5,701,724 and 6,085,680. Schreiber Foods is seeking a preliminary and
permanent injunction prohibiting the Company from further infringing acts and is
also  seeking  damages  in the  nature  of either  lost  profits  or  reasonable
royalties.  While the  Complaint  does not specify  the amount of money  damages
Schreiber  Foods plans to seek at the time of trial  connection with its claims,
Schreiber  Foods has  retained  an  accountant,  Joseph  Gemini,  who has opined
recently that Schreiber Foods is entitled to money damages of approximately  $17
million plus interest.

The '860 and '724  Patents--and the Kustner machines for producing  individually
wrapped  slices--were  the subject of a lawsuit  commenced  by Schreiber in 1997
against  Beatrice Foods and others in the Eastern  District of Wisconsin,  being
Case No. 97-CV-11.  Schreiber Foods alleges that the machines that were at issue
in that case are similar to the Kustner  machines in use by the Company.  In the
1997 lawsuit,  the matter was tried to a jury,  which found the Kustner machines
to infringe and awarded  Schreiber  Foods $26 million in a verdict of August 25,
1998. On March 30, 2000,  however,  the judge  reversed that verdict,  entered a
finding of no  infringement  on the part of Beatrice,  and  dismissed  the case.
Schreiber  Foods  appealed  that order to the Court of Appeals  for the  Federal
Circuit,  which entered its judgment on appeal on February 27, 2002. The appeals
court reversed the action of the trial court,  found that  substantial  evidence
supported  the jury's  finding of  infringement,  and ordered  the jury  verdict
reinstated.  However,  the  Company  understands  that a motion to  rescind  the
verdict and judgment is currently pending.  Schreiber Foods has also commenced a
similar action against  Borden,  Inc., and others,  in March 2002, but no result
has yet been reached in those cases.

Several  years  prior to the filing of the  lawsuit  against  the  Company,  the
Company  modified  its  Kustner  machines.  The two Hart  Design  machines  were
modified by the  manufacturer  from the standard Hart Design  configuration  and
were  delivered  to the  Company as  modified.  The  Company  believes  that the
modifications  to the machines  take them even further  outside the ambit of the
Schreiber Foods' patents at issue.

As well, the Company has, through legal counsel,  advised the Court of the scope
it  believes  should be given to the claims at issue in the  lawsuit (as part of
the so-called Markman briefing process). Patent counsel has advised that, in his
opinion, the patent claim interpretation  asserted by the Company in the Markman
briefing  process was the correct  one, and that the  Company's  machines do not
infringe  the patent  claims if that  claim  interpretation  was  adopted by the
Court.  Schreiber  Foods has taken a  different  view of the  claims.  The Court
conducted a hearing on the issue on August 4, 2003, and the Company received the
Court's  ruling on August 13, 2003. The Court adopted  Schreiber  Foods' view on
many of the claim  terms at issue.  Following  the  Court's  ruling and in light
thereof,  the Company  obtained from patent  counsel an opinion that the Company
does not  infringe the  asserted  claims of the  patents,  and that the asserted
claims are invalid.

The  Company  and  Schreiber   Foods  are   currently   involved  in  settlement
negotiations with respect to the Wisconsin lawsuit and, at the parties' request,
the Court has recently removed the upcoming trial date from its docket calendar.
The details of the settlement are still being negotiated.

In the event the parties are unable to reach a settlement,  the proceedings will
continue. The Company is not in a position at this time to express a view on the
likelihood  that it will succeed in its  position,  nor in the amount of damages
that might be awarded against it should it be  unsuccessful  in that regard.  In
the event the Company is found to have infringed the Schreiber  Foods'  patents,
in  addition  to being  liable  to  Schreiber  Foods  for  damages  which may be
substantial,  the  Company may also be  prohibited  from using in the future any
wrapping machine which is found to be infringing, or, alternatively, the Company
may be required to pay Schreiber  Foods a royalty on the Company's  individually
wrapped products produced with the infringing  machines on an ongoing basis. Any
of the foregoing could have a material  adverse effect on the Company's  results
of operations and financial condition.

                                       30
<PAGE>

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

NA

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Effective May 30, 2003, the Company obtained from Textron Financial  Corporation
("Textron") a revolving  credit  facility  (the  "Textron  Loan") in the maximum
principal  amount of $7,500,000  pursuant to the terms and  conditions of a Loan
and Security  Agreement dated May 27, 2003 (the "Loan  Agreement").  The Textron
Loan contains  certain  financial and operating  covenants.  In August 2003, the
Company  notified  Textron  that it had failed to comply  with the fixed  charge
coverage  ratio in June 2003.  Pursuant to a certain  Waiver Letter dated August
13,  2003,  Textron  agreed to waive the  requirement  to meet the fixed  charge
coverage ratio for each monthly period through September 30, 2003. Additionally,
Textron  agreed  that after  August 13,  2003,  all of the  financial  covenants
required of the Company under Section 7.6 of the Loan Agreement will be measured
and tested on a quarterly  rather than  monthly  basis.  Due to the $1.8 million
charge to operations  related to the Amended and Restated  Employment  Agreement
for Angelo  Morini,  the Company  fell below the  requirement  for the  adjusted
tangible net worth and the fixed charge coverage ratio covenants for the quarter
ended December 31, 2003. Pursuant to discussions with and a written confirmation
from  Textron,  Textron  has  agreed in  principle  to amend the loan  covenants
effective as of December  31, 2003,  the effect of which would bring the Company
into compliance with both ratios as of that date. The Company  anticipates  that
it will be in compliance  with these  ratios,  as amended,  for the  foreseeable
future based on current forecasts.

In May  2003,  SouthTrust  Bank  extended  the  Company  a new term  loan in the
principal amount of $2,000,000.  This loan was  consolidated  with the Company's
March  2000  term  loan  with  SouthTrust  Bank,  which  had a then  outstanding
principal balance of $8,131,985 for a total term loan amount of $10,131,985. The
SouthTrust term loan contains certain financial and operating covenants.  Due to
the $1.8  million  charge to  operations  related to the  Amended  and  Restated
Employment  Agreement for Angelo Morini,  the Company fell below the requirement
for the tangible net worth  covenant  for the quarter  ended  December 31, 2003.
Pursuant  to  discussions  with  and a  written  confirmation  from  SouthTrust,
SouthTrust  has agreed in principle to amend the loan  covenant  effective as of
December 31, 2003,  the effect of which would bring the Company into  compliance
with this  ratio as of that date.  The  Company  anticipates  that it will be in
compliance  with this ratio,  as amended,  for the  foreseeable  future based on
current forecasts.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

NA

ITEM 5. OTHER INFORMATION

On December 17, 2003,  the  Company's  Board of Directors  appointed  Michael E.
Broll to fill the  vacancy  on the  Board  left  upon  the  death of C.  Anthony
Wainwright  in October  2003.  Mr.  Broll was also  appointed as a member of the
Company's Audit Committee.

In  a  Second  Amended  and  Restated  Employment  Agreement  (the  "Agreement")
effective   October  13,  2003,   Angelo  S.  Morini  the   Company's   Founder,
Vice-Chairman  and President  resigned  from his  positions  with the Company as
President  and  Vice-Chairman  and  will no  longer  be  involved  in the  daily
operations  of the  Company.  He will  retain the title of Founder  and has been
named Chairman Emeritus. Mr. Morini will continue as an employee and as 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. Other material provisions of the Agreement are as follows:

1. For the term of Mr. Morini's  employment,  the Company shall cause Mr. Morini
to be nominated for election to the Company's  Board of Directors as a member of
the slate of directors  proposed by the Company in its proxy  statement  for any
meeting  of the  Company's  stockholders  whereby  directors  shall be  elected.
Notwithstanding  the  foregoing,  in the event Mr.  Morini is not elected to the
Board  of  Directors  by the  stockholders  at  any  meeting  of  the  Company's
stockholders for which the proxy statement indicates Mr. Morini is nominated for
election as a member of the slate of  directors  proposed by the  Company,  such
obligations shall immediately cease.

                                       31
<PAGE>

2. The  Company  will  obtain,  and  maintain  in effect  during the term of Mr.
Morini's employment,  for the benefit of Mr. Morini (or reimburse Mr. Morini for
the cost of) a Two  Million  Dollar  ($2,000,000)  term  life  insurance  policy
insuring Mr.  Morini's life, the  beneficiaries  of which shall be designated by
Mr. Morini.

3. Mr. Morini and the Company  agreed that Mr. Morini and certain family members
received  advances  from the Company of which  $167,603 was  unreimbursed  as of
October 13, 2003, and (ii) the Company owed $330,000 to Mr. Morini pursuant to a
loan on March 28, 2002 to the  Company.  Mr.  Morini and the  Company  agreed to
offset the unreimbursed  advances against the amounts owed by the Company,  and,
in  repayment of the  remainder of the amounts owed by the Company,  the Company
issued an aggregate of 55,087 shares of the Company's common stock to Mr. Morini
(valued at  approximately  $2.95 per share  based on the  average of the closing
prices for the five trading days preceding the effective date of the Agreement).

4. Mr.  Morini has agreed  that  during  the term of his  employment,  and for a
period of one (1) year  following his  termination  of employment for any reason
other than  pursuant to  termination  without  cause,  a material  breach in the
Agreement,  or a change of control (as defined in the  Agreement) in the Company
for which he did not vote,  he will not,  directly or  indirectly,  either as an
employee, employer,  consultant,  agent, principal,  partner, stockholder (other
than owning  fewer than one percent (1%) of the  outstanding  shares of a public
corporation),   corporate  officer,   director,   or  any  other  individual  or
representative  capacity,  engage or  participate  in any business that directly
competes  with the Company  within those areas in the United States in which the
Company is doing business as of the date of termination.

5. If the  Agreement is  terminated  by the Company  without  cause,  Mr. Morini
shall: (a) be entitled to continued payment of his annual  compensation,  health
insurance  benefits,  club dues, auto allowance and life insurance  benefits for
the remainder of the term of the Agreement,  (b) become fully "vested" under the
terms of any stock  option  agreements  executed and  delivered  prior to, along
with,  or  after  the  Agreement  and (c) be  released  from  the  terms  of the
$12,772,200  Loan  Agreement  dated  June 15,  1999 and all  monies  outstanding
thereunder  will be forgiven by the Company.  The  provisions  of the  Agreement
related to the  forgiveness of the  $12,772,200  loan remain  unchanged from the
first Amended and Restated Employment  Agreement dated June 15, 1999. Mr. Morini
acknowledged  that his change in role does not  constitute a termination  of Mr.
Morini by the Company, under the First Amended and Restated Employment Agreement
dated June 15, 1999.

6.  If Mr.  Morini  terminates  his  employment  in any  manner  other  than  in
connection with a material breach of the Agreement by the Company,  he shall not
be entitled to receive any further  compensation or benefits,  except that if he
terminates his employment in connection  with a change of control (as defined in
the  Agreement)  in the Company  for which he did not vote,  he will be released
from the terms of the  $12,772,200  Loan  Agreement  dated June 15, 1999 and all
monies outstanding thereunder will be forgiven by the Company. The provisions of
the  Agreement  related  to the  forgiveness  of  the  $12,772,200  loan  remain
unchanged from the first Amended and Restated  Employment  Agreement  dated June
15, 1999.

                                       32
<PAGE>

ITEM 6.        EXHIBITS AND REPORTS ON FORM 8-K

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
               SouthTrust  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.)

*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.)

                                       33
<PAGE>

*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.)

*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 SouthTrust 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 SouthTrust 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  SouthTrust  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  SouthTrust  Bank (Filed as
               Exhibit 10.6 on Form 8-K filed June 2, 2003.)

*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.)

*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  the  Company's  Chief  Executive
               Officer (Filed herewith.)

31.2           Section  302  Certification  of  the  Company's  Chief  Financial
               Officer (Filed herewith.)

32.1           Section  906  Certification  of  the  Company's  Chief  Executive
               Officer (Filed herewith.)

32.2           Section  906  Certification  of  the  Company's  Chief  Financial
               Officer (Filed herewith.)

*    Previously filed and incorporated herein by reference.

                                       34
<PAGE>

REPORTS ON FORM 8-K
-------------------

      On October 20,  2003,  the Company  filed a Current  Report on Form 8-K to
      disclose  the  resignation  of  Angelo S.  Morini  from his  positions  as
      President  and Vice  Chairman of the Board.  On  November  17,  2003,  the
      Company  filed a Current  Report on Form 8-K to disclose the press release
      announcing the Company's  financial  results for its second fiscal quarter
      ended September 30, 2003.

                                       35
<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: February 20, 2004       /s/ Christopher J. New
                              ------------------------------
                              Christopher J. New
                              Chief Executive Officer
                              (Principal Executive Officer)


Date: February 20, 2004       /s/ Salvatore J. Furnari
                              ------------------------------
                              Salvatore J. Furnari
                              Chief Financial Officer
                              (Principal Accounting and Financial Officer)

                                       36
<PAGE>