**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**




(Mark
      One)


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





**For
      the quarterly period ended June 30, 2007**





OR





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





For
      the
      transition period from_______ to ______





**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.
                Employerincorporation
                or organization)
            Identification
                No.)





**5955
                T. G. Lee Blvd., Suite 201****Orlando,
                Florida**
            **32822**(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 þ  NO o





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




Large accelerated filer o
            Accelerated
                filer o
            Non-accelerated
                filerþ




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





On
      August
      10, 2007, there were 17,110,016 shares of common stock, $.01 par value per
      share, outstanding.










**GALAXY** **NUTRITIONAL FOODS, INC.**




**Index
      to Form 10-Q**


**For
      the Quarter Ended June 30, 2007**





**PAGE
                NO.****PART
                I.****FINANCIAL
                INFORMATION****Item
                1. Financial Statements**Balance
                Sheets
            
            3Statements
                of Operations
            
            4Statement
                of Stockholders’ Deficit
            
            5Statements
                of Cash Flows
            
            6Notes
                to Financial Statements
            
            7**Item
                  2. Management's Discussion and Analysis of****Financial
                  Condition and Results of Operations**
            
            14**Item
                3. Quantitative and Qualitative Disclosures About Market
                Risk**
            
            22**Item
                4. Controls and Procedures**
            
            22**PART
                II. OTHER INFORMATION****Item
                1A. Risk Factors**
            
            23**Item
                6. Exhibits**
            
            25**SIGNATURES**
            
            29





2


**PART
      I. FINANCIAL INFORMATION**


**GALAXY
      NUTRITIONAL FOODS, INC.**


**Balance
      Sheets**


**JUNE
                  30,**
              
              **MARCH
                  31,****Notes**
              
              **2007**
              
              **2007****(UNAUDITED)****ASSETS****CURRENT
                  ASSETS:**Cash
              
              
              
              
              $
              496,681
              
              $
              879,487Trade
                  receivables, net
              
              
              
              
              
              2,691,663
              
              
              2,652,845Inventories,
                  net
              
              
              
              
              
              360,556
              
              
              377,432Prepaid
                  expenses and other
              
              
              
              
              
              272,526
              
              
              261,693Total
                  current assets
              
              
              
              
              
              3,821,426
              
              
              4,171,457**PROPERTY
                  AND EQUIPMENT, NET**
              
              
              
              
              
              88,521
              
              
              90,181**OTHER
                  ASSETS**
              
              
              
              
              
              92,081
              
              
              102,980**TOTAL**
              
              
              
              
              $
              4,002,028
              
              $
              4,364,618**LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT****CURRENT
                  LIABILITIES:**Secured
                  borrowings
              
              
              **2**
              
              $
              559,637
              
              $
              556,886Accounts
                  payable
              
              
              
              
              
              1,258,054
              
              
              1,718,088Accrued
                  and other current liabilities
              
              
              
              
              
              623,924
              
              
              823,258Current
                  portion of accrued employment contracts
              
              
              **3**
              
              
              558,615
              
              
              366,305Total
                  current liabilities
              
              
              
              
              
              3,000,230
              
              
              3,464,537**ACCRUED
                  EMPLOYMENT CONTRACTS,**less
                  current portion
              
              
              **3**
              
              
              142,326
              
              
              194,491**RELATED
                  PARTY NOTE PAYABLE**
              
              
              **2**
              
              
              2,680,027
              
              
              2,677,144Total
                  liabilities
              
              
              
              
              
              5,822,583
              
              
              6,336,172**COMMITMENTS
                  AND CONTINGENCIES**
              
              
              **4**
              
              
              —
              
              
              —**STOCKHOLDERS’
                  DEFICIT:**Common
                  stock
              
              
              
              
              
              171,100
              
              
              171,100Additional
                  paid-in capital
              
              
              
              
              
              70,167,149
              
              
              70,167,149Accumulated
                  deficit
              
              
              
              
              
              (72,158,804
              )
              
              (72,309,803
              )Total
                  stockholders’ deficit
              
              
              
              
              
              (1,820,555
              )
              
              (1,971,554
              )**TOTAL**
              
              
              
              
              $
              4,002,028
              
              $
              4,364,618




See
      accompanying notes to financial statements




3


**GALAXY
      NUTRITIONAL FOODS, INC.**


**Statements
      of Operations**


**(UNAUDITED)**


****


**THREE
                MONTHS ENDED**
              **JUNE
                30,****Notes**
            
            **2007**
            
            **2006**Net
                Sales
            
            
            
            
            $
            5,916,137
            
            $
            7,832,562Cost
                of Goods Sold
            
            
            
            
            
            3,460,368
            
            
            5,075,212**Gross
                margin**
            
            
            
            
            
            2,455,769
            
            
            2,757,350**OPERATING
                EXPENSES:**Selling
            
            
            
            
            
            889,408
            
            
            965,979Delivery
            
            
            
            
            
            246,845
            
            
            246,542General
                and administrative, including $0 and $5,830 non-cash compensation
                related
                to stock based transactions
            
            
            **5**
            
            
            623,616
            
            
            984,862Employment
                contract expense-general and administrative
            
            
            
            
            
            346,447
            
            
            —Research
                and development
            
            
            
            
            
            83,277
            
            
            42,334Reserve
                on stockholder note receivable
            
            
            
            
            
            —
            
            
            1,428,000Cost
                of disposal activities
            
            
            **1**
            
            
            —
            
            
            101,744Gain
                on disposal of assets
            
            
            
            
            
            —
            
            
            (12,824
            )Total
                operating expenses
            
            
            
            
            
            2,189,593
            
            
            3,756,637**INCOME
                (LOSS) FROM OPERATIONS**
            
            
            
            
            
            266,176
            
            
            (999,287
            )**OTHER
                INCOME (EXPENSE):**Interest
                expense
            
            
            
            
            
            (115,177
            )
            
            (343,142
            )**NET
                INCOME (LOSS)**
            
            
            
            
            $
            150,999
            
            $
            (1,342,429
            )**BASIC
                NET INCOME (LOSS) PER COMMON SHARE**
            
            
            **6**
            
            $
            0.01
            
            $
            (0.07
            )**DILUTED
                NET INCOME (LOSS) PER COMMON SHARE**
            
            
            **6**
            
            $
            0.01
            
            $
            (0.07
            )




See
        accompanying notes to financial statements.


4




**GALAXY
      NUTRITIONAL FOODS, INC.**


**Statement
      of Stockholders’ Deficit**


**Three
      Months Ended June 30, 2007**


**(UNAUDITED)**





Common
                Stock
            
            Additional
              Paid-In
            
            AccumulatedShares
            
            Par
                Value
            
            Capital
            
            Deficit
            
            TotalBalance
                at March 31, 2007
            
            
            17,110,016
            
            $
            171,100
            
            $
            70,167,149
            
            $
            (72,309,803
            )
            $
            (1,971,554
            )Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            150,999
            
            
            150,999Balance
                at June 30, 2007
            
            
            17,110,016
            
            $
            171,100
            
            $
            70,167,149
            
            $
            (72,158,804
            )
            $
            (1,820,555
            )




See
        accompanying notes to financial statements.


5


**GALAXY
      NUTRITIONAL FOODS, INC.**


**Statements
      of Cash Flows**


**(UNAUDITED)**





**Three
                Months Ended**
              **June
                30,****Notes**
            
            **2007**
            
            **2006****CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                Income (Loss)
            
            
            
            
            $
            150,999
            
            $
            (1,342,429
            )Adjustments
                to reconcile net income (loss) to net cash from (used in) operating
                activities:Depreciation
                and amortization
            
            
            
            
            
            10,971
            
            
            52,822Amortization
                of debt discount and financing costs
            
            
            
            
            
            13,782
            
            
            228,308Provision
                for future credits and doubtful accounts on trade
                receivables
            
            
            
            
            
            (304,000
            )
            
            (774,987
            )Provision
                for loss on stockholder note receivable
            
            
            
            
            
            —
            
            
            1,428,000(Gain)
                loss on disposal of assets
            
            
            
            
            
            —
            
            
            (12,824
            )Non-cash
                compensation related to stock-based transactions
            
            
            
            
            
            —
            
            
            5,830(Increase)
                decrease in:Trade
                receivables
            
            
            
            
            
            265,182
            
            
            1,581,310Inventories,
                net
            
            
            
            
            
            16,876
            
            
            (16,741
            )Prepaid
                expenses and other
            
            
            
            
            
            (10,833
            )
            
            (95,511
            )Increase
                (decrease) in:Accounts
                payable
            
            
            
            
            
            (460,034
            )
            
            (632,364
            )Accrued
                and other liabilities
            
            
            
            
            
            (59,189
            )
            
            (134,206
            )**NET
                CASH FROM (USED IN) OPERATING ACTIVITIES**
            
            
            
            
            
            (376,246
            )
            
            287,208**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchase
                of property and equipment
            
            
            
            
            
            (9,311
            )
            
            —Proceeds
                from sale of equipment
            
            
            
            
            
            —
            
            
            21,855(Increase)
                decrease in other assets
            
            
            
            
            
            —
            
            
            (44,775
            )**NET
                CASH FROM (USED IN) INVESTING ACTIVITIES**
            
            
            
            
            
            (9,311
            )
            
            (22,920
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Net
                borrowings (payments) on secured borrowings
            
            
            
            
            
            2,751
            
            
            168,254Principal
                payments on capital lease obligations
            
            
            
            
            
            —
            
            
            (22,849
            )Financing
                costs for long term debt
            
            
            
            
            
            —
            
            
            (126,137
            )**NET
                CASH FROM (USED IN) FINANCING ACTIVITIES**
            
            
            
            
            
            2,751
            
            
            19,268**NET
                INCREASE (DECREASE) IN CASH**
            
            
            **7**
            
            
            (382,806
            )
            
            283,556**CASH,
                BEGINNING OF PERIOD**
            
            
            
            
            
            879,487
            
            
            435,880**CASH,
                END OF PERIOD**
            
            
            
            
            $
            496,681
            
            $
            719,436





See
      accompanying notes to financial statements.




6


**GALAXY
      NUTRITIONAL FOODS, INC.**


**Notes
      To Financial Statements**


**(UNAUDITED)**





**(1)**  **Summary
      of Significant Accounting Policies**




The
      unaudited financial statements have been prepared by Galaxy Nutritional Foods,
      Inc. (the “Company”), in accordance with accounting principles generally
      accepted in the United States of America (“GAAP”) for interim financial
      information and applicable 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 GAAP
      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, 2007 balance sheet data was derived from the audited
      financial statements, but does not include all disclosures required by GAAP.
      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, 2007. Interim results of operations for the three-month period ended
      June 30, 2007 may not necessarily be indicative of the results to be expected
      for the full year.





Revenue
      Recognition




Sales
      are
      recognized upon shipment of products to customers. The Company offers a right
      of
      return policy on certain products sold to certain retail customers in the
      conventional grocery stores and mass merchandising industry. If the product
      is
      not sold during its shelf life, the Company will allow a credit for the unsold
      merchandise. Since the shelf life of the Company’s products ranges from 6 months
      to one year, the Company historically averages less than 2% of gross sales
      in
      credits for unsold product. The Company’s reserve on accounts receivable takes
      these potential future credits into consideration. Certain expenses such as
      returns, slotting fees, rebates, coupons and other discounts are accounted
      for
      as a reduction to Revenues.





Disposal
      Costs




On
      December 8, 2005, the Company completed the sale of substantially all of its
      manufacturing and production equipment to Schreiber Foods, Inc., a Wisconsin
      corporation (“Schreiber”) for $8,700,000 in cash pursuant to an Asset Purchase
      Agreement dated June 30, 2005. In connection with the Asset Purchase Agreement,
      the Company also entered into a Supply Agreement with Schreiber (the “Supply
      Agreement”) on June 30, 2005 pursuant to which, Schreiber became the Company’s
      sole source of supply and distribution for substantially all of its products
      in
      November 2005.





The
      Company accounted for the costs associated with these transactions in accordance
      with SFAS No. 146, “ *Accounting
      for Costs Associated with an Exit or Disposal Activity,”* (“SFAS
      146”) because the above arrangements were planned and controlled by management
      and materially changed the manner in which the Company’s business was conducted.
      In accordance with SFAS 146, costs associated with disposal activities should
      be
      reported as a reduction of income from operations.





The
      Company recorded accruals in connection with the asset sale and outsourcing
      of
      its manufacturing operations in fiscal 2006. The initial accruals included
      estimates pertaining to employee termination costs and abandonment of excess
      equipment and facilities and other potential costs. Given the significance
      and
      complexity of these activities, and the timing of the execution of such
      activities, the accrual process involved periodic reassessments of estimates
      made at the time the original decisions were made, including evaluating
      estimated employment terms, contract cancellation charges and real estate market
      conditions for sub-lease rents. Currently, there are no further costs that
      require estimates and any future disposal costs will be recorded as incurred
      in
      accordance with SFAS 146.





Non-Cash
      Compensation Related to Stock-Based Transactions




Effective
      April 1, 2006, the Company adopted SFAS
      No.
      123 (revised 2004), “ *Share-Based
      Payment,* ”
(“SFAS
      123R”). SFAS
      123R
      requires companies to measure the cost of employee services received in exchange
      for an award of equity instruments, including stock options, based on the
      grant-date fair value of the award and to recognize it as compensation expense
      over the period the employee is required to provide service in exchange for
      the
      award, usually the vesting period.





SFAS
      123R
      applies to new awards and to awards modified, repurchased, or cancelled after
      the effective date, as well as to the unvested portion of awards outstanding
      as
      of the effective date. The Company uses the Black-Scholes option-pricing model to
      value its new stock option grants under SFAS 123R, applying the “modified
      prospective method” for existing grants which requires the Company to value
      stock options prior to its adoption of SFAS 123R under the fair value method
      and
      expense the value over the requisite service period. SFAS 123R also requires
      the
      Company to estimate forfeitures in calculating the expense related to
      stock-based compensation. In addition, SFAS 123R requires the Company to reflect
      cash flows resulting from excess tax benefits related to those options as a
      cash
      inflow from financing activities rather than as a reduction of taxes
      paid.




7





From
      April 1, 2003 through March 31, 2006, the
      Company accounted for stock awards granted to employees and directors under
      the
      fair value recognition provisions of SFAS No. 123, “ *Accounting
      for Stock-Based Compensation,* ”
(“SFAS
      123”) and applied SFAS No. 148, *“Accounting
      for Stock-Based Compensation - Transition and Disclosure,* ”
(“SFAS
      148”), prospectively to all employee and director awards granted on or after
      April 1, 2003. Prior to April 1, 2003, the
      Company accounted for stock awards granted to employees and directors under
      the
      recognition and measurement principles of Accounting Principles Board Opinion
      No. 25, *“Accounting
      for Stock Issued to Employees, and related Interpretations* ,”
(“APB
      25”) as
      interpreted by FASB Interpretation No. 44 (“FIN 44”).





The
      Black-Scholes option-pricing model
      requires subjective assumptions, including future stock price volatility and
      expected time to exercise, which greatly affect the calculated values. The
      risk-free rate is based on the U.S. Treasury zero-coupon rates with a remaining
      term equal to the expected term of the option. Expected volatilities are based
      on the historical volatility of the Company’s stock. Prior to April 1, 2006, the
      Company input the expected term of options granted based on the contractual
      life
      of the options granted. Upon adoption of SFAS 123R, the Company inputs the
      expected term of options granted based on information derived from historical
      data on employee exercises and post-vesting employment termination behavior.
      There is no expected dividend yield.  These factors could change in the
      future, which may affect the stock-based compensation expense in future periods.
      SFAS 123R also requires forfeitures to be estimated at the time of grant and
      revised, if necessary, in subsequent periods if actual forfeitures differ from
      those estimates. There were no issuances of stock awards during the three months
      ended June 30, 2007 and 2006. Therefore, the Company did not make any
      assumptions under the
      Black-Scholes option-pricing  model
      during these periods.





Stock-based
      compensation expense recognized during the period is based on the value of
      the
      portion of share-based payment awards that is ultimately expected to vest during
      the period, which approximates the requisite service period. Stock-based
      compensation expense recognized in the Company's Statements of Operations for
      the periods presented includes compensation expense for share-based payment
      awards granted prior to, but not yet vested as of March 31, 2006 based on the
      grant date fair value estimated in accordance with the pro forma provisions
      of
      SFAS 123 and compensation expense for the share-based payment awards granted
      subsequent to March 31, 2006 based on the grant date fair value estimated in
      accordance with the provisions of SFAS 123R. As stock-based compensation expense
      recognized in the Statement of Operations is based on awards ultimately expected
      to vest and to be exercised, it will be reduced for estimated forfeitures. There
      was
      no forfeiture rate applied to the stock-based compensation expense for the
      three
      months ended June 30, 2007 and 2006 as all options were fully vested and were
      able to be exercised.





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 net 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
      and
      warrants and conversion of convertible debt.





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
      trade receivables, inventory reserves, valuation of deferred taxes and valuation
      of non-cash compensation related to stock-based transactions. Actual results
      could differ from these estimates.





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 sells to customers
      throughout the United States and 12 other countries.




8




Recent
      Accounting Pronouncements




There
      have been no significant new pronouncements since the issuance of the Company’s
      Annual Report on Form 10-K for the fiscal year ended March 31,
      2007.





Income
      Taxes and Recently Adopted Accounting Pronouncement




The
      Company adopted the provisions of FASB issued Interpretation No. 48, *“Accounting
      for Uncertainty in Income Taxes - An Interpretation of FASB Statement No.
      109,”* (“FIN
      48”), on April 1, 2007. FIN
      48
      provides guidance on the financial statement recognition and measurement of
      a
      tax position taken or expected to be taken in a tax return. The
      Company has not recognized a liability as a result of the implementation of
      FIN
      48. A reconciliation of the beginning and ending amount of unrecognized tax
      benefits has not been provided since there is no unrecognized benefit as of
      the
      date of adoption. The Company has not recognized interest expense or penalties
      as a result of the implementation of FIN 48. If there were an unrecognized
      tax
      benefit, the Company would recognize interest accrued related to unrecognized
      tax benefits in interest expense and penalties in operating expenses. The
      Company files income tax returns in the U.S. federal jurisdiction and in various
      states.





Deferred
      income taxes are recognized for the tax consequences of temporary differences
      between the financial reporting bases and the tax bases of the Company’s assets
      and liabilities in accordance with SFAS No. 109, “ *Accounting
      for Income Taxes* .”
      Valuation allowances are established when necessary to reduce deferred tax
      assets to the amount expected to be realized. Income tax expense is the tax
      payable or refundable for the period plus or minus the change during the period
      in deferred tax assets and liabilities.





Financial
      Instruments




SFAS
      No.
      107, “ *Disclosures
      about Fair Value of Financial Instruments* ,”
      requires disclosure of fair value information about financial instruments.
      Fair
      value estimates discussed herein are based upon certain market assumptions
      and
      pertinent information available to management as of June 30, 2007.





The
      respective carrying value of certain on-balance-sheet financial instruments
      approximated their fair values. These financial instruments include cash, trade
      receivables, accounts payable and accrued liabilities. Fair values were assumed
      to approximate carrying values for these financial instruments since they are
      short term in nature and their carrying amounts approximate fair values or
      they
      are receivable or payable on demand. The fair value of the Company’s secured
      borrowings and related party note payable is estimated based upon the quoted
      market prices for the same or similar instruments or on the current rates
      offered to the Company for debt with the same remaining
      maturities.





**(2)**  **Secured
      Borrowings and Related Party Note Payable**




Secured
      Borrowings




On
      June
      23, 2006, the
      Company entered into a Receivables Purchase Agreement with Commercial Finance
      Division, formerly known as Systran
      Financial Services Corporation, a subsidiary of Textron Financial Corporation
      (“Commercial Finance”), whereby Commercial Finance provides financing to the
      Company through advances against certain trade receivable invoices due to the
      Company (the “Commercial Finance Agreement”). The Commercial Finance Agreement
      is secured by the Company’s accounts receivable and all other assets. Generally,
      subject to a maximum principal amount of $3,500,000 which can be borrowed under
      the Commercial Finance Agreement, the amount available for borrowing is equal
      to 85%
      of
      the Company’s eligible accounts receivable invoices less a dilution reserve and
      any required fixed dollar reserves .
      The
      dilution and fixed dollar reserves are currently set at 7% and $100,000,
      respectively. Advances under the Commercial Finance Agreement bear interest
      at
      a variable
      rate equal to the prime rate plus 1.5% per annum (9.75% on June 30, 2007).
      The
      Company is also obligated to pay a $1,500 monthly service fee.





The
      initial term of the Commercial Finance Agreement ends on June 23, 2009 and
      may
      renew automatically for consecutive twelve-month terms unless terminated sooner.
      The Commercial Finance Agreement may be accelerated in the event of certain
      defaults by the Company including among other things, a default in the Company’s
      payment and/or performance of any obligation to Commercial Finance or any other
      financial institution, creditor, or bank; and any change in the conditions,
      financial or otherwise, of the Company which reasonably causes Commercial
      Finance to deem itself insecure. In such an event, interest on the Company’s
      borrowings would accrue at the greater of twelve percent per annum or the
      variable rate of prime plus 1.5% and the Company would be liable for an early
      termination premium ranging from 1% to 3% of the maximum principal amount
      available under the Commercial Finance Agreement. As of June 30, 2007, the
      amount advanced under the Commercial Finance Agreement is $559,637.




9





In
      accordance with SFAS No. 140, *“Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Debt,”* the
      Company accounts for the Commercial Finance Agreement as a liability since
      it is
      a full-recourse agreement and the Company maintains effective control over
      the
      accounts receivable.





Related
      Party Note Payable




Pursuant
      to a Note Purchase Agreement dated July 19, 2006, the Company issued a new
      unsecured convertible note for $2,685,104 (the “Convertible Note”) to Mr.
      Frederick A. DeLuca. The proceeds from the Convertible Note were used to repay
      or refinance several notes totaling $2.4 million that matured on June 15, 2006
      and a $285,104 registration rights penalty owed to Mr. DeLuca. The Convertible
      Note accrues interest at 12.5% per annum. No interest or principal payments
      are
      required under the Convertible Note until its maturity. Principal, together
      with
      any accrued and unpaid interest, on the Convertible Note is convertible at
      any
      time prior to payment into shares of the Company’s common stock at a conversion
      price of $0.35 per share. The closing market price of the Company’s common stock
      as quoted on the OTC Bulletin Board on July 19, 2006 was $0.28. As additional
      consideration for making the loan, the Company issued Mr. DeLuca a warrant
      (the
“Warrant”) to purchase up to 200,000 shares of the Company’s common stock at an
      exercise price equal to $0.35 per share. The Warrant is fully vested and can
      be
      exercised on or before the expiration date of July 19, 2009. In July 2006,
      the
      Company recorded the $18,000 fair value of the Warrant as a discount to debt
      that is being amortized from July 2006 through October 2007.





Pursuant
      to a Note Modification Agreement dated March 14, 2007, the Company and Mr.
      DeLuca agreed to extend the maturity date of the Convertible Note from October
      19, 2007 to October 19, 2008. All other terms of the Convertible Note remain
      the
      same.





Pursuant
      to the Note Purchase Agreement dated July 19, 2006 and the Note Modification
      Agreement dated March 14, 2007, the Company’s Convertible Note together with any
      accrued and unpaid interest thereon, is convertible at any time prior to payment
      into shares of the Company’s common stock at a conversion price of $0.35 per
      share. As a result of the convertible features of the Convertible Note, Mr.
      DeLuca’s ownership in the Company may increase from approximately 23% to nearly
      52% by October 2008. The calculation of ownership assumes, among other things,
      that Mr. DeLuca converts the entire amount of principal and all accrued interest
      on the Convertible Note through October 19, 2008 into an aggregate of 9,861,364
      shares and exercises of all of his currently outstanding warrants into 500,000
      shares of the Company’s common stock.





The
      Company amortized $2,883 and $126,979 of debt discount to interest expense
      in
      the three months ended June 30, 2007 and 2006, respectively. Additionally,
      the
      Company recorded interest expense related to related party notes of $84,842
      and
      $66,100 in the three months ended June 30, 2007 and 2006, respectively. As
      of
      June 30, 2007, the outstanding principal balance of $2,685,104 on the
      Convertible Note less the remaining debt discount of $5,077 is
      $2,680,027.








**(3)**  **Related
      Party Transactions**




Angelo
      S. Morini




In
      a
      Second Amended and Restated Employment Agreement effective October 13, 2003,
      Angelo S. Morini, the Company’s Founder, resigned from his positions with the
      Company as Vice Chairman and President and he is no longer involved in the
      daily
      operations of the Company. Mr. Morini remained a director of the Company until
      his resignation on March 8, 2007. Mr. Morini continues to be a stockholder
      in
      the Company. Additionally, he may carry out special assignments designated
      to
      him by the Chairman of the Board. The agreement is for a five-year period
      beginning October 13, 2003 and provides for an annual base salary of $300,000,
      plus standard health insurance benefits, club dues and an auto
      allowance.





Because
      Mr. Morini is no longer performing ongoing services for the Company, the Company
      accrued and expensed the five-year cost of this agreement in October 2003. The
      total
      estimated costs expensed under this agreement were $1,830,329 of which $470,355
      remained unpaid but accrued ($366,305 as short-term liabilities and $104,050
      as
      long-term liabilities) as of June 30, 2007. The obligation is being paid out
      in
      nearly equal monthly installments ending in October 2008.





Christopher
      Morini




On
      June
      1, 2007, Christopher Morini resigned from his position as Vice President of
      New
      Business Development in order to pursue other opportunities. In accordance
      with
      the Separation and General Release Agreement which became effective on June
      9,
      2007, between the Company and Mr. C. Morini, the Company accrued $346,447 for
      wages and payroll taxes and expensed them under Employment Contract
      Expense-General and Administrative in the Statement of Operations in June 2007.
      After an initial lump sum payment of approximately $100,087, the remaining
      obligation is being paid out in nearly equal bi-weekly installments through
      September 2008. As of June 30, 2007, $230,586 remained unpaid but accrued
      ($192,310 as short-term liabilities and $38,276 as long-term
      liabilities).





10





**(4)**  **Commitments
      and Contingencies**




Supply
      Agreement




In
      November 2005, Schreiber began manufacturing and distributing substantially
      all
      of the Company’s products in accordance with a Supply Agreement that was signed
      on June 30, 2005. Schreiber uses the Company’s formulas and processes to
      manufacture products for the Company’s customers. The prices for such products
      are based on cost plus a processing fee as determined by the parties from time
      to time. Other material terms of the Supply Agreement are as
      follows:




·  The
      initial term of the Supply Agreement is for a period of five years from the
      effective date of September 1, 2005 and is renewable at the Company’s option for
      up to two additional five-year periods (for a total term up to fifteen
      years). If the
      Company does not exercise its first option to extend the term, then the Company
      will be obligated to pay Schreiber $1,500,000. If the Company exercises its
      first option to extend the term, but does not exercise its second option to
      extend the term, then the Company will be obligated to pay Schreiber $750,000.




·  The
      Supply Agreement originally provided for a contingent short-fall payment
      obligation up to $8,700,000 by the Company if a specified production level
      was
      not met during the one-year period from September 1, 2006 to August 31, 2007.
      If
      a contingent short-fall payment was accrued after such one-year period, it
      could
      be reduced by the amount by which production levels in the one-year period
      from
      September 1, 2007 to August 31, 2008 exceeded the specified target level of
      production, if any. The short-fall payment is based on a formula that calculates
      the payment as follows: ((required pounds shipped - actual pounds shipped)
      /
      required pounds shipped) * $8,700,000. In November 2006, the Supply Agreement
      was amended so that the short-fall payment obligation would not be measured
      until the one-year period from September 1, 2009 to August 31, 2010, and the
      target level of production was reduced by approximately 22%.





Litigation




The
      Company is currently a party to certain legal proceedings, claims, disputes
      and
      litigation arising in the ordinary course of business. The Company currently
      believes that the ultimate outcome of these proceedings, individually and in
      the
      aggregate, will not have a material adverse affect on the Company's financial
      position, results of operations or cash flows. However, because of the nature
      and inherent uncertainties of litigation, should the outcome of these actions
      be
      unfavorable, the Company's business, financial condition, results of operations
      and cash flows could be materially and adversely affected.





In
      June
      2006, a complaint was filed against the Company with the U.S. District Court
      in
      Puerto Rico claiming breach of contract and associated damages related to a
      prior brokerage agreement. The claim dates back to 2003 when a former broker
      of
      the Company passed away. The Company disputes this claim and does not believe
      that it is liable for any additional brokerage fees and/or damages. However,
      at
      this time, the Company cannot determine the probability or the range of any
      potential loss.





**(5)**  **Non-Cash
      Compensation Related to Stock-Based Transactions**




Effective
      April 1, 2006, SFAS 123R applies to new awards and to awards modified,
      repurchased, or cancelled after the effective date, as well as to the unvested
      portion of awards outstanding as of the effective date. The Company uses the
      Black-Scholes option-pricing model to
      value its new stock option grants under SFAS 123R, applying the “modified
      prospective method” for existing grants which requires the Company to value
      stock options prior to its adoption of SFAS 123R under the fair value method
      and
      expense the value over the requisite service period.





Compensation
      cost arising from nonvested stock granted to employees and from non-employee
      stock awards is recognized as expense using the graded vesting attribution
      method over the vesting period. As of March 31, 2007, there was no remaining
      unrecognized compensation cost related to nonvested stock, and there were no
      stock-based transactions during the three months ended June 30, 2007. Therefore,
      there was no stock-based compensation expense nor any unrecognized compensation
      cost related to nonvested stock for the three months ended June 30, 2007. For
      the three months ended June 30, 2006, the Company’s stock-based compensation
      expense related to nonvested stock was $5,830.




11




The
      following table summarizes the Company’s plan
      and
      non-plan stock
      options outstanding as of June 30, 2007, as well as activity during the three
      months then ended:




**Shares**
            
            **Weighted-**
              **Average**
              **Exercise Price**
            
            **Weighted-**
              **Average**
              **Remaining
                Contractual Term in Years**
            
            **Aggregate
                Intrinsic Value**Outstanding
                at March 31, 2007
            
            
            5,290,750
            
            $
            2.86Granted
            
            
            —
            
            
            —Exercised
            
            
            —
            
            
            —Forfeited
                or expired
            
            
            (200,500
            )
            
            2.17Outstanding
                at June 30, 2007
            
            
            5,090,250
            
            $
            2.89
            
            
            2.4
            
            $
            -0-Exercisable
                at June 30, 2007
            
            
            5,090,250
            
            $
            2.89
            
            
            2.4
            
            $
            -0-




There
      were no options granted and thus no weighted-average fair value computed on
      options during the three months ended June 30, 2007 and 2006. At June 30, 2007,
      the aggregate intrinsic value of options outstanding and options exercisable
      was
      zero, because the market value of the underlying stock was below the average
      exercise price of all options. The closing price of the Company’s common stock
      on June 29, 2007 as quoted on the OTC Bulletin Board was $0.54 per share. There
      were no options exercised during the three months ended June 30, 2007 or 2006
      and therefore, no intrinsic value or cash received from option
      exercises.





**(6)**  **Earnings
      Per Share**




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


****


**Three
                Months Ended**
              **June
                30,****2007**
            
            **2006**Net
                income (loss) - basic
            
            $
            150,999
            
            $
            (1,342,429
            )Plus
                interest on convertible related party note payable
            
            
            84,842
            
            
            —Net
                income (loss) - diluted
            
            $
            235,841
            
            $
            (1,342,429
            )Weighted
                average shares outstanding - basic
            
            
            17,110,016
            
            
            19,576,163Potential
                shares issued upon conversion of related party note
                payable
            
            
            8,348,329
            
            
            —Potential
                shares “in-the-money” under stock option and warrant
                agreements
            
            
            740,000
            
            
            —Less:
                Shares assumed repurchased under the treasury stock method
            
            
            (458,507
            )
            
            —Weighted
                average shares outstanding -diluted
            
            
            25,739,838
            
            
            19,576,163Basic
                net income (loss) per common share
            
            $
            0.01
            
            $
            (0.07
            )Diluted
                net income (loss) per common share
            
            $
            0.01
            
            $
            (0.07
            )





Options
      for 4,552,755 shares and warrants for 1,077,857 shares have not been included
      in
      the computation of diluted net income per common share for three months ended
      June 30, 2007 as their effects were antidilutive. Options for 4,813,977 shares
      and warrants for 1,133,142 shares have not been included in the computation
      of
      diluted net loss per common share for the three months ended June 30, 2006,
      as
      their effects were 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.





Three
                months ended
              June
                30,2007
            
            2006**Non-cash
                financing and investing activities:**Purchase
                of equipment through a capital lease
            
            $
            —
            
            $
            3,281Cash
                paid for:Interest
            
            
            16,553
            
            
            115,067




12




**(8)**  **Economic
      Dependence and Segment Information**




The
      Company has one operating segment and sells to customers throughout the United
      States, Puerto Rico, and the U.S. controlled Virgin Islands (together considered
      the United States) and 12 foreign countries. For the three months ended June
      30,
      2007 and 2006, the Company’s gross sales were $6,509,600 and $8,707,646,
      respectively. Gross sales derived from foreign countries were approximately
      $964,000 and $924,000*, representing 15% and 11% of gross sales for the three
      months ended June 30, 2007 and 2006, respectively. Gross sales are attributed
      to
      individual countries based on the customer’s shipping address. The Company has
      no long-term assets located outside of the United States.





The
      following table sets forth the percentage of gross sales to each foreign
      country, which accounted for 10% or more of the Company’s foreign gross sales
      for the three months ended June 30, 2007 and 2006:




**Three
                Months Ended**
                June
                  30,**2007**
            
            **2006***Canada
            
            
            90.0
            %
            
            79.9
            %Other
            
            
            10.0
            %
            
            20.1
            %




*
      The
      sales to foreign countries for the three months ended June 30, 2006, have been
      restated to remove sales to Puerto Rico and the US controlled Virgin Islands
      .
      Sales to Puerto Rico and the
      US
      controlled Virgin Islands are now
      considered to be domestic sales.





The
      Company had one customer that accounted for approximately 16% of gross sales
      for
      the three months ended June 30, 2007. The Company had two customers that
      accounted for approximately 22% of gross sales for the three months ended June
      30, 2006. There were no customers whose balance outstanding was greater than
      10%
      of accounts receivable as of June 30, 2007 and 2006.





Pursuant
      to the Supply Agreement with Schreiber, the Company purchased approximately
      96%
      and 100% of its total raw material purchases from Schreiber for the three months
      ended June 30, 2007 and 2006, respectively.




13


**GALAXY
      NUTRITIONAL FOODS, INC.**





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





Information
      in this Management’s Discussion and Analysis of Financial Condition and Results
      of Operations (“MD&A”) is intended to enhance a reader’s understanding of
      the financial condition, changes in financial condition and results of
      operations of our company. This MD&A is a supplement to and should be read
      in conjunction with our financial statements and notes thereto appearing
      elsewhere in this report. This Form 10-Q & MD&A contain forward-looking
      statements within the meaning of the federal securities laws that relate to
      future events or our future financial performance. These forward-looking
      statements are based on our current expectations, estimates and projections
      about our industry, management’s beliefs and certain assumptions made by our
      company. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,”
“seek,” “project,” “estimate,” “may,” “will,” “could,” “should,” “potential,” or
“continue” or the negative or variations of these words or similar expressions
      are intended to identify forward-looking statements. Additionally, these
      forward-looking statements include, but are not limited to statements
      regarding:





·
            Improving
                cash flows from operations;




·
            Marketing
                our existing products and those under
                development;




·
            Our
                estimates of future revenue and
                profitability;




·
            Our
                expectations regarding future expenses, including cost of goods sold,
                delivery, selling, general and administrative, research and development
                expenses, and disposal costs;




·
            Our
                estimates regarding capital requirements and need for additional
                financing; and




·
            Competition
                in our market.




Although
      we believe that these forward-looking statements are reasonable at the time
      they
      are made, these statements are not guarantees of future performance and are
      subject to certain risks, uncertainties and assumptions that are difficult
      to
      predict. Therefore, actual results may differ materially from our historical
      results and those expressed or forecasted in any forward-looking statements
      as a
      result of a variety of factors, including those set forth under “Risk Factors”
and elsewhere in, or incorporated by reference into, this Form 10-Q and our
      Form
      10-K for the fiscal year ended March 31, 2007. We are not required and undertake
      no obligation to publicly update or revise any forward-looking statements for
      any reason, even if new information becomes available or other events occur
      in
      the future.





Terms
      such as “fiscal 2008”, “fiscal 2007” or “fiscal 2006” refer to our fiscal years
      ending March 31, 2008, 2007 and 2006, respectively. Terms such as “first
      quarter,” “second quarter,” “third quarter,” or “fourth quarter” refer to the
      fiscal quarters ending June 30, September 30, December 31, or March 31,
      respectively.





This
      MD&A contains the following sections:




·
            Business
                Environment


·
            Critical
                Accounting Policies


·
            Results
                of Operations


·
            Liquidity
                and Capital Resources


·
            Recent
                Accounting Pronouncements




**Business
      Environment**





***General***




Galaxy
      Nutritional Foods, Inc. (our “Company”) is principally engaged in developing and
      globally marketing plant-based cheese alternatives, organic dairy and other
      organic and natural food products to grocery and natural foods retailers, mass
      merchandisers and foodservice accounts. *Veggie* ,
      the
      leading brand in the grocery cheese alternative category
      and our  Company’s
      top selling product group, is primarily merchandised in the produce section
      and
      provides calcium and protein without cholesterol, saturated fat or trans-fat.
      Other popular brands include: *Rice,
      Veggy, Vegan, Rice Vegan* and *Wholesome
      Valley* .
      We are
      dedicated to developing nutritious and delicious food products made with high
      quality natural ingredients that exceed the expectations of today’s health
      conscious consumers. Our Company headquarters are located in Orlando,
      Florida.




14





In
      fiscal
      2006, we determined that our manufacturing capacity was significantly in excess
      of our requirements and that it would be advantageous to outsource our
      manufacturing and distribution operations. On June 30, 2005, we entered into
      a
      Supply Agreement with Schreiber Foods, Inc., a Wisconsin corporation
      (“Schreiber”), whereby we agreed that Schreiber would become our sole source of
      supply for substantially all of our products. The initial term of the Supply
      Agreement is for a period of five years from the effective date of September
      1,
      2005 and is renewable at our option for up to two additional five-year periods
      (for a total term up to fifteen years). Schreiber uses our formulas and
      processes to manufacture our products for our customers. In November 2005,
      Schreiber began to deliver such products directly to our customers.




On
      December 8, 2005, we completed the sale of substantially all of our
      manufacturing and production equipment to Schreiber for $8,700,000 in cash
      pursuant to an Asset Purchase Agreement dated June 30, 2005. Our Company has
      now
      converted from a manufacturing company into a branded marketing company that
      will continue to develop, market and sell our products.




***Cheese
      Alternative Category***




We
      are
      the market leader within our cheese alternative category niche, but in being
      so,
      the category increases or decreases partly as a result of our marketing and
      pricing efforts. We believe that the greatest source of future growth in the
      cheese alternative category will come through consumers shifting to cheese
      alternatives from natural cheese. Our products typically sell at a premium
      over
      the price of natural cheese. Our strategy is to broaden the consumer base to
      include younger, less price sensitive consumers seeking products with overall
      health and nutrition attributes. Historically, our products and marketing
      efforts appealed to older consumers purchasing cheese alternatives for specific
      dietary concerns.





***Marketing***




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





In
      our
      fiscal 2007 marketing campaign, we worked to optimize our price based promotions
      by focusing on deeper, less frequent in-store discounts. Additionally, we
      continued special event marketing efforts. In the second half of fiscal 2007,
      we
      began an ongoing consumer print advertising campaign in national health and
      fitness publications including Weight Watchers and Shape. Product attributes
      and
      location were incorporated into a unified marketing message in our efforts
      to
      increase consumer education and awareness of cheese alternatives. We expect
      to
      continue and expand similar advertising in fiscal 2008 as we seek new consumers.





As
      we
      grow our marketing initiatives, valuable insights on campaign efficacy are
      gained and used to fine-tune our efforts. Such information is then used to
      increase our return on marketing expenditures by focusing on those efforts
      that
      increase brand and product awareness, increase consumer education and ultimately
      broaden the consumer base within the cheese alternative category.





***Measurements
      of Financial Performance***




On
      a
      monthly basis, we compare the statements of operations, balance sheets and
      statements of cash flows to budgeted expectations to identify variances and
      opportunities for cost savings. In addition, we analyze sales and profitability
      relative to budgeted amounts for individual products, brand groups, channels
      of
      distribution and individual customers. These reports are also tailored to
      provide us with information on promotional costs by product and customers.
      Areas
      that are performing below expectations are reviewed to determine actions that
      we
      can take to improve performance. Additionally, marketing uses this information
      to tailor our promotions to make them more effective and
      profitable.





We
      focus
      on several items in order to measure our performance. We are working towards
      obtaining and maintaining positive trends in the following areas:




·
            Operating
                cash flow


·
            Gross
                margin in dollars and % of gross sales


·
            Operating
                income excluding non-cash compensation related to stock-based transactions
                and disposal costs


·
            EBITDA
                excluding non-cash compensation related to stock-based transactions
                and
                disposal costs


·
            Volume
                and margin analysis by individual inventory
                items


·
            Key
                financial ratios (such as accounts receivable and accounts payable
                turnover ratios)





15





**Critical
      Accounting Policies**





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and reported amounts of income and expense during
      the
      reporting periods presented. Our significant estimates include the allowance
      for
      trade receivables which is made up of reserves for promotions, discounts and
      bad
      debts, inventory reserves, valuation of deferred taxes and valuation of
      compensation expense on stock-based awards. Although we believe that these
      estimates are reasonable, actual results could differ from those estimates
      given
      a change in conditions or assumptions that have been consistently
      applied.





Our
      critical and significant accounting policies are described in Note 1 of our
      financial statements. The critical accounting policies used by management and
      the methodology for its estimates and assumptions are as follows:





***Valuation
      of Accounts Receivable and Chargebacks***




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





Based
      on
      the age of the receivable, cash collection history and past dilution in the
      receivables, we make an estimate of our anticipated bad debt, anticipated future
      authorized deductions due to current period activity and anticipated collections
      on non-authorized amounts that customers have currently deducted on past
      invoices. Based on this analysis, we reserved $1,194,000 and $994,000 for known
      and anticipated future credits and doubtful accounts at June 30, 2007 and 2006,
      respectively. We believe that this estimate is reasonable, but there can be
      no
      assurance that our estimate will not change given a change in economic
      conditions or business conditions within the food industry, our individual
      customer base or our Company.





***Inventory***




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





***Deferred
      Taxes***




Valuation
      allowances are established when necessary to reduce deferred tax assets to
      the
      amount expected to be realized. We have reserved our net deferred tax assets
      in
      full.





***Valuation
      of Non-Cash Stock-Based Compensation***




Effective
      April 1, 2006, we adopted Statement
      of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), “ *Share-Based
      Payment,* ”
(“SFAS
      123R”). SFAS
      123R
      requires companies to measure the cost of employee services received in exchange
      for an award of equity instruments, including stock options, based on the
      grant-date fair value of the award and to recognize it as compensation expense
      over the period the employee is required to provide service in exchange for
      the
      award, usually the vesting period.





SFAS
      123R
      applies to new awards and to awards modified, repurchased, or cancelled after
      the effective date, as well as to the unvested portion of awards outstanding
      as
      of the effective date. We use the Black-Scholes option-pricing model to
      value our new stock option grants under SFAS 123R, applying the “modified
      prospective method” for existing grants which requires us to value stock options
      prior to our adoption of SFAS 123R under the fair value method and expense
      the
      value over the requisite service period. SFAS 123R also requires us to estimate
      forfeitures in calculating the expense related to stock-based compensation.
      In
      addition, SFAS 123R requires us to reflect cash flows resulting from excess
      tax
      benefits related to those options as a cash inflow from financing activities
      rather than as a reduction of taxes paid.




From
      April 1, 2003 through March 31, 2006, we
      accounted for stock awards granted to employees and directors under the fair
      value recognition provisions of SFAS No. 123, “ *Accounting
      for Stock-Based Compensation,* ”
(“SFAS
      123”) and applied SFAS No. 148, *“Accounting
      for Stock-Based Compensation - Transition and Disclosure,* ”
(“SFAS
      148), prospectively to all employee and director awards granted on or after
      April 1, 2003. Prior to April 1, 2003, we
      accounted for stock awards granted to employees and directors under the
      recognition and measurement principles of Accounting Principles Board Opinion
      No. 25, *“Accounting
      for Stock Issued to Employees, and related Interpretations* ,”
(“APB
      25”) as
      interpreted by Financial Accounting Standards Board (“FASB”) Interpretation No.
      44 (“FIN 44”).




16





The
      Black-Scholes option-pricing model
      requires subjective assumptions, including future stock price volatility and
      expected time to exercise, which greatly affect the calculated values. The
      risk-free rate is based on the U.S. Treasury zero-coupon rates with a remaining
      term equal to the expected term of the option. Expected volatilities are based
      on the historical volatility of our stock. Prior to April 1, 2006, we input
      the
      expected term of options granted based on the contractual life of the options
      granted. For any new awards, we input the expected term of options granted
      based
      on information derived from historical data on employee exercises and
      post-vesting employment termination behavior. There is no expected dividend
      yield.  These factors could change in the future, which may affect the
      stock-based compensation expense in future periods. SFAS 123R also requires
      forfeitures to be estimated at the time of grant and revised, if necessary,
      in
      subsequent periods if actual forfeitures differ from those
      estimates.  There
      were no issuances of stock awards during the three months ended June 30, 2007
      and 2006. Therefore, we did not make any assumptions under the
      Black-Scholes option-pricing  model
      during these periods.





On
      an
      option with a risk-free interest rate of 5%, volatility of 45% and a term of
      60
      months, we would experience a $.01 change in the fair value if we were to change
      our estimate of the interest rate by two percentage points, the volatility
      percentage by five percentage points, or the expected term by five months.








**Results
      of Operations**





**3-Months
                Ended June 30,****2007**
            
            **2006**
            
            **$
                Change**
            
            **%
                Change**Net
                Sales
            
            
            5,916,137
            
            
            7,832,562
            
            
            (1,916,425
            )
            
            -24.5
            %Cost
                of Goods Sold
            
            
            3,460,368
            
            
            5,075,212
            
            
            (1,614,844
            )
            
            -31.8
            %**Gross
                Margin**
            
            
            2,455,769
            
            
            2,757,350
            
            
            (301,581
            )
            
            -10.9
            %**Gross
                Profit %**
            
            
            41.5
            %
            
            35.2
            %





***Sales***




For
      the
      three months ended June 30, 2007 and 2006, our gross sales before discounts,
      returns and allowances were $6,509,600 and $8,707,646, respectively. The
      following chart sets forth the percentage of gross sales derived from our
      product brands during the three months ended June 30, 2007 and 2006: ****





Three
                Months Ended
              June
                30,Brand
            
            2007
            
            2006Veggie
            
            
            66.7
            %
            
            55.3
            %Private
                Label, Imitation and Other
            
            
            11.0
            %
            
            24.5
            %Rice
            
            
            12.5
            %
            
            10.6
            %Veggy
            
            
            4.1
            %
            
            4.1
            %Wholesome
                Valley Organic
            
            
            2.1
            %
            
            2.8
            %Vegan
            
            
            3.6
            %
            
            2.7
            %





Net
      sales, after discounts, returns and allowances, in the three months ended June
      30, 2007 decreased 25% from net sales in the three months ended June 30, 2006
      principally as a result of a strategic elimination of marginally profitable
      and
      unprofitable private label and imitation products that
      began in the first quarter of fiscal 2007 .
      Sales
      of private label and imitation products were down approximately 66% from the
      three month period ended June 30, 2006 to the three month period ended June
      30,
      2007. Sales of branded products were down approximately 12% over the same
      period. The decrease in branded sales is primarily a result of lost distribution
      after the outsourcing of our manufacturing process. In the early stages of
      the
      outsourcing program, there were various quality issues with some of our branded
      products and we believe these quality issues caused us to lose distribution
      to
      certain retailers. As a result, fewer of our products were selling at the retail
      level and some retail outlets chose to discontinue selling our products. Those
      quality issues have since been resolved and marketing efforts are underway
      to
      attract those consumers back to our products.




17





We
      anticipate that our sales in fiscal 2008 will be lower than sales reported
      in
      fiscal 2007 reflecting the lower baseline sales projected after the elimination
      of the majority of the private label and imitation business.





***Cost
      of Goods Sold***




Cost
      of
      goods sold was approximately 58% and 65% of net sales in the three months ended
      June 30, 2007 and 2006, respectively. This decrease in cost of goods sold is
      primarily due to the decrease in sales, as well as the increased margin as
      a
      result of the sales mix moving more heavily toward higher-margin branded
      products and away from lower-margin imitation and private label
      products.





We
      anticipate that the cost of goods sold in fiscal 2008 will remain consistent
      with our fiscal 2007 annual average assuming a similar product mix and assuming
      that there is no significant increase in the raw material costs used by our
      outsourcing manufacturers. However, actual results could differ from our
      expectations.





***Gross
      Margin***




Despite
      a
      $1.9 million decline in net sales, gross margin dollars in the three months
      ended June 30, 2007 declined only $301,581 or 11% compared to the three months
      ended June 30, 2006 due to the elimination of certain low margin private label
      and non-branded imitation business, reflecting the change in our product mix.
      However, gross margin increased from 35% during the three months ended June
      30,
      2006 to 42% during the three months ended June 30, 2007. This increase in gross
      margin percentage was a result of the change in our sales mix as discussed
      above.





In
      fiscal
      2008, our anticipated higher margin sales combined with our lower overhead
      burden should continue to produce gross margins as a percentage of sales
      consistent with our fiscal 2007 annual average.





***EBITDA***




We
      utilize certain GAAP measures such as Operating Income and Net Income and
      certain non-GAAP measures, in order to compute key financial measures that
      are
      reviewed by management, lenders and investors in order to effectively review
      our
      current on-going operations and analyze trends related to our financial
      condition and results of operations. The non-GAAP measures are key factors
      upon
      which we prepare and review our budgets and forecasts. In our calculation of
      key
      financial non-GAAP measures for adjusted Operating Income, adjusted Net Income
      and adjusted EBITDA, we exclude items such as non-cash compensation and reserves
      related to stock-based transactions, disposal costs and fixed asset impairment
      and disposal charges. These adjusted measures are not in accordance with, or
      an
      alternative for, generally accepted accounting principles and may be different
      from non-GAAP measures reported by other companies.





**3-Months
                Ended June 30,**
            
            **2007**
            
            **2006****2007**
            
            **2006**
            
            **$
                Change**
            
            **%
                Change**
            
            **%
                of Sales**
            
            **%
                of Sales**Net
                Sales
            
            
            5,916,137
            
            
            7,832,562
            
            
            (1,916,425
            )
            
            -24.5
            %
            
            100.0
            %
            
            100.0
            %Cost
                of Goods Sold
            
            
            3,460,368
            
            
            5,075,212
            
            
            (1,614,844
            )
            
            -31.8
            %
            
            58.5
            %
            
            64.8
            %**Gross
                Margin**
            
            
            2,455,769
            
            
            2,757,350
            
            
            (301,581
            )
            
            -10.9
            %
            
            41.5
            %
            
            35.2
            %**Operating
                Expenses:**Selling
            
            
            889,408
            
            
            965,979
            
            
            (76,571
            )
            
            -7.9
            %
            
            15.0
            %
            
            12.3
            %Delivery
            
            
            246,845
            
            
            246,542
            
            
            303
            
            
            0.1
            %
            
            4.2
            %
            
            3.1
            %General
                and administrative, including $0 and $5,830 non-cash stock
                compensation(1)
            
            
            623,616
            
            
            984,862
            
            
            (361,246
            )
            
            -36.7
            %
            
            10.5
            %
            
            12.6
            %Employment
                contract expense(2)
            
            
            346,447
            
            
            -
            
            
            346,447
            
            
            100.0
            %
            
            5.9
            %
            
            0.0
            %Research
                and development
            
            
            83,277
            
            
            42,334
            
            
            40,943
            
            
            96.7
            %
            
            1.4
            %
            
            0.5
            %Reserve
                on stockholder note
              receivable(2)
            
            
            -
            
            
            1,428,000
            
            
            (1,428,000
            )
            
            -100.0
            %
            
            0.0
            %
            
            18.2
            %Cost
                of disposal activities(2)
            
            
            -
            
            
            101,744
            
            
            (101,744
            )
            
            -100.0
            %
            
            0.0
            %
            
            1.3
            %(Gain)/loss
                on disposal of assets(2)
            
            
            -
            
            
            (12,824
            )
            
            12,824
            
            
            -100.0
            %
            
            0.0
            %
            
            -0.2
            %Total
                operating expenses
            
            
            2,189,593
            
            
            3,756,637
            
            
            (1,567,044
            )
            
            -41.7
            %
            
            37.0
            %
            
            48.0
            %**Income
                (Loss) from Operations**(3)
            
            
            266,176
            
            
            (999,287
            )
            
            1,265,463
            
            
            -126.6
            %
            
            4.5
            %
            
            -12.8
            %**Other
                Income (Expense), Net**Interest
                expense, net
            
            
            (115,177
            )
            
            (343,142
            )
            
            227,965
            
            
            -66.4
            %
            
            -1.9
            %
            
            -4.4
            %Total
            
            
            (115,177
            )
            
            (343,142
            )
            
            227,965
            
            
            -66.4
            %
            
            -1.9
            %
            
            -4.4
            %**NET
                INCOME (LOSS)**
            
            
            150,999
            
            
            (1,342,429
            )
            
            1,493,
                428
            
            
            -111.2
            %
            
            2.6
            %
            
            -17.1
            %Interest
                expense, net
            
            
            115,177
            
            
            343,142
            
            
            (227,965
            )
            
            -66.4
            %
            
            1.9
            %
            
            4.4
            %Depreciation
            
            
            10,971
            
            
            52,822
            
            
            (41,851
            )
            
            -79.2
            %
            
            0.2
            %
            
            0.7
            %**EBITDA**(*a
                non-GAAP measure)*
            
            
            277,147
            
            
            (946,465
            )
            
            1,223,612
            
            
            -129.3
            %
            
            4.7
            %
            
            -12.1
            %





(1)
            In
                our calculation of key financial measures, we exclude the non-cash
                compensation related to stock-based transactions because we believe
                that
                this item does not accurately reflect our current on-going operations.
                Many times non-cash compensation is calculated based on fluctuations
                in
                our stock price, which can skew the financial results dramatically
                up and
                down. The market price of our common shares is outside our control
                and
                typically does not reflect our current operations.




18




(2)
            In
                our calculation of key financial measures, we exclude the employment
                contract expenses related to Christopher Morini, the reserve on
                stockholder note receivable, disposal costs and fixed asset impairment
                charges because we believe that these items do not reflect expenses
                related to our current on-going operations. See below for a detailed
                description of these items.


(3)
            Operating
                Income has increased due to the completion of certain non-standard
                expenses such as the reserve on stockholder note receivable and disposal
                costs.





***Selling***




Selling
      expense is partly a function of sales through variable costs such as brokerage
      commissions and promotional costs and partly fixed with certain fixed costs
      for
      marketing campaigns and employee salaries and benefits. While overall selling
      expenses are down approximately 8%, selling expense as a percentage of net
      sales
      increased three percentage points from 12% in the three months ended June 30,
      2006 to 15% in the three months ended June 30, 2007. This change is attributable
      to the shift in sales mix toward branded products and away from imitation and
      private label products. Historically, very little advertising and promotion
      costs were associated with the imitation and private label costs. Accordingly,
      the elimination of these low-margin sales has very little impact on our selling
      expenses. Advertising and promotion costs for our branded products remained
      relatively consistent from the three months ended June 30, 2006 to the three
      months ended June 30, 2007. However, those expenditures are now on a lower
      sales
      base resulting in selling expenses being a higher percentage of sales.





We
      expect
      that fixed selling expenses for advertising and market research in fiscal 2008
      will be higher than in fiscal 2007. Therefore, we expect that fiscal 2008
      selling expenses will increase as a percentage of sales compared to fiscal
      2007.





***Delivery***




Delivery
      expense is primarily a function of sales, and historically ranged from
      approximately 5% to 6% of net sales. In the three months ended June 30, 2006,
      delivery expense decreased to 3% of net sales due to the outsourcing of our
      manufacturing operations pursuant to our Supply Agreement with Schreiber. The
      Supply Agreement fixed the delivery charges based on a per pound rate that
      was
      lower than our historical delivery cost per pound. However, this rate can be
      adjusted by the parties as agreed upon from time to time.





In
      September 2006, the parties adjusted the rate to reflect current market
      conditions. As a result, in the three months ended June 30, 2007, delivery
      expense increased to 4% of net sales. We anticipate delivery expense will remain
      at an average of 4% of net sales in fiscal 2008. This average is still lower
      than our delivery expense prior to the outsourcing of our manufacturing
      operations.





***General
      and administrative***




During
      the three months ended June 30, 2007, general and administrative expenses
      decreased approximately $361,000 compared to the three months ended June 30,
      2006. The main contributors to this decrease were lower legal costs, lower
      audit
      and accounting costs and reduced occupancy costs. Legal costs were higher in
      the
      prior year period as a result of continued legal fees related to our exploration
      of strategic alternatives (including the potential sale of our Company that
      was
      abandoned in April 2006). No similar legal expenditures were necessary in the
      current period. As a result of the outsourcing of our manufacturing process,
      as
      well as the restructuring of our outstanding debt in June 2006, many of the
      time-consuming and complex accounting issues related to our operations were
      eliminated. This has resulted in a reduction of our audit and other
      accounting-related fees. Occupancy costs have decreased from the prior year
      as a
      result of the move of our corporate headquarters to a smaller facility in
      October 2006.




19


Excluding
      the effects of non-cash compensation related to stock-based transactions, which
      cannot be predicted, we anticipate that in fiscal 2008 general and
      administrative expenses will remain consistent with the total expense in fiscal
      2007. However, we anticipate that we will begin incurring additional costs
      related to the implementation of the requirements of Section 404 of The Sarbanes
      Oxley Act throughout fiscal 2008.





***Employment
      Contract Expense***




On
      June
      1, 2007, Christopher Morini resigned from his position as Vice President of
      New
      Business Development in order to pursue other opportunities. In accordance
      with
      the Separation and General Release Agreement which became effective on June
      9,
      2007, between our Company and Mr. C. Morini, we accrued $346,447 for wages
      and
      payroll taxes and expensed them under Employment Contract Expense-General and
      Administrative in the Statement of Operations in June 2007. After an initial
      lump sum payment of approximately $100,087, the remaining obligation is being
      paid out in nearly equal bi-weekly installments through September 2008.





***Research
      and Development***




Research
      and development expenses increased by nearly $41,000 or 97% primarily as a
      result of costs associated with the reformulation of our Rice products to make
      those products even more appealing to healthy food consumers and the development
      of a new product line for our Wholesome Valley Organic brand during the three
      months ended June 30, 2007.





***Reserve
      on stockholder note receivable***




In
      June
      1999, in connection with an amended and restated employment agreement for Angelo
      S. Morini, our founder and original Chief Executive Officer, we consolidated
      two
      full-recourse notes receivable ($1,200,000 from November 1994 and $11,572,200
      from October 1995) related to his purchase of 2,914,286 shares of our common
      stock into a single stockholder note receivable in the amount of $12,772,200
      that was due on June 15, 2006. This stockholder note receivable was non-interest
      bearing and non-recourse and was secured by the 2,914,286 shares of our common
      stock (the “Shares”).





For
      the
      fiscal year ended March 31, 2006, we reserved $10,120,200 against this
      stockholder note receivable under the assumption that we would not be able
      to
      collect proceeds in excess of the $2,652,000 value of the Shares as of such
      date. The value of the Shares was computed using the closing price of our common
      stock on March 31, 2006 of $0.91 multiplied by the 2,914,286 shares.





On
      June
      16, 2006, Mr. Morini failed to repay the non-recourse note obligation to our
      Company. On June 20, 2006, we delivered notice to Mr. Morini that we intended
      to
      exercise our rights to the Shares and retain all the Shares in full satisfaction
      of his obligations under the stockholder note receivable. On July 6, 2006,
      Mr.
      Morini consented to our acceptance of the Shares in full satisfaction of his
      obligations under the stockholder note receivable. Based upon the $0.42 closing
      price of our common stock as quoted on the OTC Bulletin Board on June 16, 2006,
      the Shares had an approximate value of $1,224,000 on such date. Accordingly,
      we
      recorded an additional expense of $1,428,000 in June 2006 in order to record
      the
      additional decline in the value of the Shares from its $2,652,000 value as
      of
      March 31, 2006. In July 2006, we cancelled the Shares along with 30,443 other
      treasury shares.





Although
      this expense resulted in a material loss to our operations, it did not have
      any
      affect on the balance sheet since the stockholder note receivable was already
      shown as a reduction to Stockholders’ Deficit.





***Cost
      of disposal activities***




We
      accounted for the costs associated with the disposal of our manufacturing
      operations in accordance with SFAS No. 146, “ *Accounting
      for Costs Associated with an Exit or Disposal Activity,”* because
      the arrangements were planned and controlled by management and materially
      changed the manner in which our business was conducted. We report our disposal
      costs for the period as Costs of Disposal Activities in the Statement of
      Operations. There were no further disposal costs in the three months ended
      June
      30, 2007. Disposal costs during the three months ended June 30, 2006 were
      $101,744. Currently, we do not anticipate any additional disposal costs, but
      if
      they do occur, we intend to expense them as incurred.





***Interest
      expense***




Interest
      expense decreased nearly $228,000 or 66% in the three months ended June 30,
      2007
      compared to the three months ended June 30, 2006. In the three months ended
      June
      30, 2007, we experienced a decrease in interest expense related to our debt
      facilities of approximately $13,000 due to lower average outstanding principal
      balances. Amortization of loan costs decreased by approximately $90,000 due
      to
      lower loan fees charged by our new lenders. Additionally, pursuant to several
      Note and Warrant Purchase Agreements entered into in fiscal 2006 and fiscal
      2007, we issued warrants to purchase up to 800,000 shares of our common stock.
      We recorded the initial fair value of the warrants of $18,000 and $444,731
      in
      fiscal 2007 and fiscal 2006, respectively, as a discount to debt. Amortization
      of this non-cash debt discount decreased by approximately $124,000 in the three
      months ended June 30, 2007 compared to the three months ended June 30,
      2006.




20




We
      anticipate that our interest expense will decrease an average of nearly 40%
      in
      fiscal 2008, due to lower debt balances, lower loan fees and lower non-cash
      debt
      discount amortization. Our current loan facility with Commercial Finance accrues
      interest based on a variable prime plus rate. Prime rate is currently at 8.25%
      and it is uncertain if this will change in fiscal 2008. Any changes in the
      prime
      rate would further affect our interest expense in fiscal 2008.








**Liquidity
      and Capital Resources**




**3-Months
                Ended June 30,****2007**
            
            **2006**
            
            **$
                Change**
            
            **%
                Change**Cash
                from (used in) operating activities
            
            
            (376,246
            )
            
            287,208
            
            
            (663,454
            )
            
            -231.0
            %Cash
                from (used in) investing activities
            
            
            (9,311
            )
            
            (22,920
            )
            
            13,609
            
            
            -59.4
            %Cash
                from (used in) financing activities
            
            
            2,751
            
            
            19,268
            
            
            (16,517
            )
            
            -85.7
            %Net
                increase (decrease) in cash
            
            
            (382,806
            )
            
            283,556
            
            
            (666,362
            )
            
            -235.0
            %





***Future
      Capital Needs***




With
      the
      reduction in overall debt and lender fees, we expect to see annual interest
      savings of approximately $300,000 in fiscal 2008. Additionally, we anticipate
      that stabilized gross margins and reduced operating expenses will continue
      to
      provide positive operating cash flow in fiscal 2008. With these improvements,
      we
      believe that we will have enough cash to meet our current liquidity needs in
      fiscal 2008.





***Operating
      and Investing Activities***




Cash
      used
      for operating activities in the first quarter of fiscal 2008 was primarily
      used
      to pay down accounts payable which decreased from $1,718,000 at March 31, 2007
      to $1,258,000 at June 30, 2007. We have payment terms of 20 days after shipment
      from the primary supplier of our products. Depending upon the timing of sales
      and shipments, our accounts payable balance with this vendor can change
      significantly on a day-to-day basis. The reduction of our overall accounts
      payable balance, and the cash used to reduce that balance, from March 31, 2007
      to June 30, 2007 is a reflection of the timing of shipments and payments during
      the first quarter of fiscal 2008.





In
      the
      first quarter of fiscal 2008, cash used in investing activities primarily
      related to our purchase of office equipment. Cash used in investing activities
      primarily related to additional security deposits that we paid in the first
      quarter of fiscal 2007 for our leased facilities and a small amount of proceeds
      received on the sale of our remaining assets held for sale. We do not anticipate
      any large capital expenditures or deposits during fiscal 2008.





***Financing
      Activities***




**3-Months
                Ended June 30,****2007**
            
            **2006**Net
                borrowings (payments) on line of credit and bank
                overdrafts
            
            
            2,751
            
            
            42,117Payments
                of capital leases
            
            
            -
            
            
            (22,849
            )Cash
                from financing activities
            
            
            2,751
            
            
            19,268





Debt
      Financing




*Secured
      Borrowings*




On
      June
      23, 2006, we
      entered into a Receivables Purchase Agreement with Commercial Finance Division,
      formerly known as Systran
      Financial Services Corporation, a subsidiary of Textron Financial Corporation
      (“Commercial Finance”), whereby Commercial Finance provides financing to our
      Company through advances against certain trade receivable invoices due to our
      Company (the “Commercial Finance Agreement”). The Commercial Finance Agreement
      is secured by our accounts receivable and all other assets. Generally, subject
      to a maximum principal amount of $3,500,000 which can be borrowed under the
      Commercial Finance Agreement, the amount available for borrowing is equal to 85%
      of our eligible accounts receivable invoices less a dilution reserve and any
      required fixed dollar reserves .
      The
      dilution and fixed dollar reserves are currently set at 7% and $100,000,
      respectively. Advances under the Commercial Finance Agreement bear interest
      at
      a variable rate equal to the prime rate plus 1.5% per annum (9.75% on June 30,
      2007). We are also obligated to pay a $1,500 monthly service fee.




21




The
      initial term of the Commercial Finance Agreement ends on June 23, 2009 and
      may
      renew automatically for consecutive twelve-month terms unless terminated sooner.
      The Commercial Finance Agreement may be accelerated in the event of certain
      defaults by our Company including among other things, a default in our payment
      and/or performance of any obligation to Commercial Finance or any other
      financial institution, creditor, or bank; and any change in the conditions,
      financial or otherwise, of our Company which reasonably causes Commercial
      Finance to deem itself insecure. In such an event, interest on our borrowings
      would accrue at the greater of twelve percent per annum or the variable rate
      of
      prime plus 1.5% and we would be liable for an early termination premium ranging
      from 1% to 3% of the maximum principal amount available under the Commercial
      Finance Agreement. As of June 30, 2007, the amount advanced under the Commercial
      Finance Agreement is $559,637. The net amount of cash provided under the
      Commercial Finance Agreement for the three months ended June 30, 2007 and 2006
      was $2,751 and $42,117, respectively.




**Recent
      Accounting Pronouncements**




There
      have been no significant new pronouncements since the issuance of our Annual
      Report on Form 10-K for the fiscal year ended March 31, 2007.




**Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk**





Our
      exposure to market risk results primarily from fluctuations in interest rates.
      The interest rate on our outstanding debt to Commercial Finance as of June
      30,
      2007 is floating and based on the prevailing market interest rate. For
      market-based debt, interest rate changes generally do not affect the market
      value of the debt but do impact future interest expense and hence earnings
      and
      cash flows, assuming other factors remain unchanged. A theoretical 1% increase
      or decrease in market rates in effect on June 30, 2007 with respect to our
      debt
      balances as of such date would increase or decrease interest expense and hence
      reduce or increase the net income of our Company by approximately $5,600 per
      year.




Our
      sales
      during the three months ended June 30, 2007 and 2006, which were denominated
      in
      a currency other than U.S. Dollars, were less than 6% of gross sales and no
      net
      assets were maintained in a functional currency other than U. S. Dollars during
      such periods. While we believe that the effects of changes in foreign currency
      exchange rates have not historically been significant to our operations or
      net
      assets, we are unable to forecast the effects that foreign currency exchange
      rates may have on our future operations.




**Item
      4. Controls and Procedures**





As
      of
      June 30, 2007, an evaluation was performed under the supervision and with the
      participation of our management, including the Chief Executive Officer ("CEO"),
      and the Chief Financial Officer ("CFO"), of the effectiveness of the design
      and
      operation of our disclosure controls and procedures to insure that we record,
      process, summarize and report in a timely and effective manner the information
      required to be disclosed in reports filed with or submitted to the Securities
      and Exchange Commission. Based on that evaluation, our management, including
      the
      CEO and CFO, concluded that our disclosure controls and procedures were
      effective in timely bringing to their attention material information related
      to
      our Company required to be included in our periodic Securities and Exchange
      Commission filings. During the quarter ended June 30, 2007, there were no
      changes in our internal controls over financial reporting or in other factors
      that materially affected, or are reasonably likely to materially affect those
      controls.




22


**PART
      II. OTHER INFORMATION**





**Item
      1A.**  **Risk
      Factors**





Statements
      other than historical information contained in this Form 10-Q are considered
      “forward-looking statements” as defined under the Private Securities Litigation
      Reform Act of 1995. These statements relate to future events or our future
      financial performance. These forward-looking statements are based on our current
      expectations, estimates and projections about our industry, management’s beliefs
      and certain assumptions made by our Company. Words such as “anticipate,”
“expect,” “intend,” “plan,” “believe,” “seek,” “project,” “estimate,” “may,”
“will,” “could,” “should,” “potential,” or “continue” or the negative or
      variations of these words or similar expressions are intended to identify
      forward-looking statements. Although we believe that these forward-looking
      statements are reasonable at the time they are made, these statements are not
      guarantees of future performance and are subject to certain risks, uncertainties
      and assumptions that are difficult to predict. Therefore, actual results may
      differ materially from our historical results and those expressed or forecasted
      in any forward-looking statement as a result of a variety of factors as set
      forth below. We are not required and undertake no obligation to publicly update
      or revise any forward-looking statements for any reason, even if new information
      becomes available or other events occur in the future.





In
      addition to the other information in this Form 10-Q and risk factors previously
      disclosed in our Annual Report on Form 10-K for the year ended March 31, 2007,
      the following are some of the factors as of August 10, 2007, that could cause
      our Company’s actual results to differ materially from the expected results
      described in or underlying our Company’s forward-looking statements. These
      factors should be considered carefully while evaluating our business and
      prospects. If any of the following risks actually occur, they could seriously
      harm our business, financial condition, results of operations or cash flows.





***We
      may be required to pay substantial penalties under our Supply Agreement and
      may
      not have the ability to do so.***




The
      initial term of the Supply Agreement with Schreiber is for a period of five
      years from the effective date of September 1, 2005 and is renewable at our
      option for up to two additional five-year periods (for a total term up to
      fifteen years). If we do not exercise our first option to extend the term,
      then
      we will be obligated to pay Schreiber $1,500,000. If we exercise our first
      option to extend the term, but do not exercise our second option to extend
      the
      term, then we will be obligated to pay Schreiber $750,000.




Additionally,
      the Supply Agreement originally provided for a contingent short-fall payment
      obligation up to $8,700,000 by our Company if a specified production level
      was
      not met during the one-year period from September 1, 2006 to August 31, 2007.
      If
      a contingent short-fall payment was accrued after such one-year period, it
      could
      be reduced by the amount by which production levels in the one-year period
      from
      September 1, 2007 to August 31, 2008 exceeded the specified target level of
      production, if any. The short-fall payment is based on a formula that calculates
      the payment as follows: ((required pounds shipped - actual pounds shipped)
      /
      required pounds shipped) * $8,700,000. In November 2006, the Supply Agreement
      was amended so that the short-fall payment obligation would not be measured
      until the one-year period from September 1, 2009 to August 31, 2010, and the
      target level of production was reduced by approximately 22%.




Although
      we have significantly improved our gross margins by discontinuing production
      of
      low margin products, our total sales (and the corresponding volume of our
      products being produced) have been substantially reduced.  We will need to
      greatly increase our present production volume before the measuring period
      from
      September 1, 2009 to August 31, 2010 in order to avoid a substantial shortfall
      payment.  Based on our present production volume, the estimated short-fall
      payment could exceed $6,000,000 .





In
      either event, we may not have the ability to pay the required penalty and
      Schreiber may use its contractual rights in order to collect and may cease
      production and shipment of our products. Such an action would have a material
      adverse affect on the liquidity and financial condition of our Company and
      it is
      unlikely that we would be able to continue as a going concern .




23




***A
      private investor owns a large percentage of the outstanding shares, which could
      materially limit the ownership rights of investors.***




As
      of
      August 10, 2007, Frederick DeLuca, a private investor, owned approximately
      23%
      of our outstanding common stock and held warrants and a convertible note which,
      if exercised with accrued and unpaid interest on the convertible note as of
      such
      date and assuming the exercise of no other outstanding options or warrants,
      would give him ownership of approximately 50% of our outstanding common stock.
      Investors who purchase common stock in our Company may be unable to elect any
      specific members of the board of directors or exercise significant control
      over
      us or our business as a result of Mr. Deluca’s ownership. Additionally, Mr.
      DeLuca may be able to exercise significant influence over our policies and
      Board
      composition.





***Stockholders
      may experience further dilution.***




We
      have a
      substantial number of outstanding options and warrants and a convertible note
      to
      acquire shares of common stock. As of August 10, 2007, we have a total of
      15,475,404 shares reserved for future issuance upon exercise of options or
      warrants and conversion of the convertible note. Of this total, 8,939,950 are
      exercisable securities that are “in the money.” “In the money” generally means
      that the current market price of the common stock is above the exercise price
      of
      the shares subject to the option, warrant or note conversion. The issuance
      of
      common stock upon the exercise of these options and warrants or note conversion
      could adversely affect the market price of the common stock or result in
      substantial dilution to our existing stockholders. In addition, any future
      securities issuances by our Company could
      result in the issuance, or potential issuance, of a significant amount of equity
      securities that will cause substantial dilution to our stockholders,
      particularly given the current low trading price of our common
      stock.





***We
      may not be able to implement Section 404 of the Sarbanes-Oxley Act on a timely
      basis.***




The
      Securities and Exchange Commission (the “SEC”), as directed by Section 404 of
      The Sarbanes Oxley Act, adopted rules generally requiring each public company
      to
      include a report of management on the company’s internal controls over financial
      reporting in its annual report on Form 10-K that contains an assessment by
      management of the effectiveness of the company’s internal controls over
      financial reporting. This requirement will first apply to our annual report
      on
      Form 10-K for the fiscal year ending March 31, 2008. In addition, the company’s
      independent registered accounting firm must attest to and report on management’s
      assessment of the effectiveness of the company’s internal controls over
      financial reporting. This requirement will first apply to our annual report
      on
      Form 10-K for the fiscal year ending March 31, 2009.





We
      have
      not yet completed a Section 404 implementation plan. In the past, we have
      discovered, and may in the future discover, areas of our internal controls
      that
      need improvement. We have engaged an outside consultant and will be incurring
      incremental costs in order to complete the work required by Section 404.
      However, there can be no assurance that we will be able to complete a Section
      404 plan on a timely basis.





Additionally,
      upon completion of a Section 404 plan, we may not be able to conclude that
      our
      internal controls over financial reporting are effective, or in the event that
      we conclude that our internal controls are effective, our independent
      accountants may disagree with our assessment and may issue a report that is
      qualified. This could subject our Company to regulatory scrutiny and a loss
      of
      public confidence in our internal controls. Any failure to implement required
      new or improved controls, or difficulties encountered in their implementation,
      could negatively affect our operating results or cause us to fail to meet our
      reporting obligations.





24


**Item
      6.**  **Exhibits**





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




***Exhibit
                No***
            
            ***Exhibit
                Description****
            3.1
            
            Restated
                Certificate of Incorporation of the Company as filed with the Secretary
                of
                State of the State of Delaware on December 23, 2002 (Filed as Exhibit
                3.2
                on Form 10-Q for the fiscal quarter ended December 31,
                2002.)*
            3.2
            
            By-laws
                of the Company, as amended (Filed as Exhibit 3.2 to Registration
                Statement
                on Form S-18, No. 33-15893-NY.)*
            4.18
            
            Securities
                Purchase Agreement dated as of October 6, 2004 between Galaxy Nutritional
                Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 4.18 on Form
                8-K
                filed October 8, 2004.)*
            4.19
            
            Registration
                Rights Agreement dated as of October 6, 2004 between Galaxy Nutritional
                Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 4.19 on Form
                8-K
                filed October 8, 2004.)*
            4.20
            
            Warrant
                to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as
                of
                October 6, 2004 in favor of Frederick A. DeLuca (Filed as Exhibit
                4.20 on
                Form 8-K filed October 8, 2004.)*
            4.21
            
            Stock
                Repurchase Agreement dated as of October 6, 2004 by and among Galaxy
                Nutritional Foods, Inc., BH Capital Investments L.P. and Excalibur
                Limited
                Partnership (Filed as Exhibit 4.21 on Form 8-K filed October 8,
                2004.)*
            4.22
            
            Registration
                Rights Agreement dated as of October 6, 2004 by and among Galaxy
                Nutritional Foods, Inc., BH Capital Investments L.P. and Excalibur
                Limited
                Partnership (Filed as Exhibit 4.22 on Form 8-K filed October 8,
                2004.)*
            4.23
            
            Warrant
                to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as
                of
                October 6, 2004 in favor of BH Capital Investments L.P. (Filed as
                Exhibit
                4.23 on Form 8-K filed October 8, 2004.)*
            4.24
            
            Warrant
                to Purchase Securities of Galaxy Nutritional Foods, Inc. dated as
                of
                October 6, 2004 in favor of Excalibur Limited Partnership (Filed
                as
                Exhibit 4.24 on Form 8-K filed October 8, 2004.)*
            4.25
            
            Investor
                relations contract between Galaxy Nutritional Foods, Inc. and R.J.
                Falkner
                dated as of September 29, 2004 (Filed as Exhibit 4.25 on Form S-3
                filed
                March 14, 2005.)*
            4.26
            
            Asset
                Purchase Agreement dated June 30, 2005 between Galaxy Nutritional
                Foods,
                Inc. and Schreiber Foods, Inc. (Filed as Exhibit 4.25 on Form 8-K
                filed
                July 6, 2005.)*
            4.27
            
            Warrant
                to Purchase Securities of Galaxy Nutritional Foods, Inc. dated July
                19,
                2006 in favor of Frederick A. DeLuca (Filed as Exhibit 4.27 on Form
                8-K
                filed July 25, 2006.)*
            4.28
            
            Convertible
                Note in the principal amount of $2,685,104.17 dated as of July 19,
                2006 by
                Galaxy Nutritional Foods, Inc. in favor of Frederick A. DeLuca (Filed
                as
                Exhibit 4.26 on Form 8-K filed July 25, 2006.)*
            10.1
            
            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.)*
            10.2
            
            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.)




25




*
            10.3
            
            Second
                Amended and Restated Employment Agreement dated as of October 13,
                2003
                between Galaxy Nutritional Foods, Inc. and Angelo S. Morini (Filed
                as
                Exhibit 10.1 on Form 8-K filed October 20, 2003.)*
            10.12
            
            Second
                Amendment to Loan and Security Agreement dated June 25, 2004 between
                Galaxy Nutritional Foods, Inc. and Textron Financial Corporation
                (Filed as
                Exhibit 10.12 on Form 10-K for the fiscal year ended March 31,
                2004.)*
            10.13
            
            Third
                Amendment to Lease Agreement dated June 10, 2004 between Galaxy
                Nutritional Foods, Inc. and Cabot Industrial Properties, L.P. (Filed
                as
                Exhibit 10.13 on Form 10-K for the fiscal year ended March 31,
                2004.)*
            10.14
            
            Separation
                and Settlement Agreement dated July 8, 2004 between Galaxy Nutritional
                Foods, Inc. and Christopher J. New (Filed as Exhibit 10.14 on Form
                8-K
                filed July 13, 2004.)*
            10.15
            
            Employment
                Agreement dated July 8, 2004 between Galaxy Nutritional Foods, Inc.
                and
                Michael E. Broll (Filed as Exhibit 10.15 on Form 8-K filed July 13,
                2004.)*
            10.16
            
            Third
                Amendment to Loan and Security Agreement dated November 10, 2004
                between
                Galaxy Nutritional Foods, Inc. and Textron Financial Corporation
                (Filed as
                Exhibit 10.16 on Form 10-Q for the fiscal quarter ended December
                31,
                2004.)*
            10.17
            
            Fourth
                Amendment to Loan and Security Agreement dated June 3, 2005 between
                Galaxy
                Nutritional Foods, Inc. and Textron Financial Corporation (Filed
                as
                Exhibit 10.17 on Form 8-K filed June 22, 2005.)*
            10.18
            
            Letter
                Agreement dated June 17, 2005 between Galaxy Nutritional Foods, Inc.
                and
                Textron Financial Corporation (Filed as Exhibit 10.18 on Form 8-K
                filed
                June 22, 2005.)*
            10.19
            
            Supply
                Agreement dated June 30, 2005 between Galaxy Nutritional Foods, Inc.
                and
                Schreiber Foods, Inc. Portions of the Supply Agreement have been
                omitted
                as indicated by asterisks pursuant to a request for confidential
                treatment
                in accordance with Section 552(b)(4) of the Freedom of Information
                Act
                ("FOIA"), 5 U.S.C. 552(b)(4) (Filed as Exhibit 10.19 on Form 8-K
                filed
                July 6, 2005.)*
            10.20
            
            Loan
                Modification Agreement June 30, 2005 between Galaxy Nutritional Foods,
                Inc. and Wachovia Bank N.A (formerly SouthTrust Bank). (Filed as
                Exhibit
                10.20 on Form 8-K filed July 6, 2005.)*
            10.21
            
            Termination,
                Settlement and Release Agreement dated July 20, 2005 between Galaxy
                Nutritional Foods, Inc. and Fromageries Bel S.A. (Filed as Exhibit
                10.21
                on Form 8-K filed July 26, 2005.)*
            10.22
            
            Note
                and Warrant Purchase Agreement dated September 12, 2005 between Galaxy
                Nutritional Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit
                10.22 on
                Form 8-K filed September 16, 2005.)*
            10.23
            
            Note
                and Warrant Purchase Agreement dated September 28, 2005 between Galaxy
                Nutritional Foods, Inc. and Conversion Capital Master, Ltd. (Filed
                as
                Exhibit 10.23 on Form 8-K filed October 4, 2005.)*
            10.24
            
            Note
                and Warrant Purchase Agreement dated September 28, 2005 between Galaxy
                Nutritional Foods, Inc. and SRB Greenway Capital, L.P. (Filed as
                Exhibit
                10.24 on Form 8-K filed October 4, 2005.)*
            10.25
            
            Note
                and Warrant Purchase Agreement dated September 28, 2005 between Galaxy
                Nutritional Foods, Inc. and SRB Greenway Capital (Q.P.), L.P. (Filed
                as
                Exhibit 10.25 on Form 8-K filed October 4, 2005.)*
            10.26
            
            Note
                and Warrant Purchase Agreement dated September 28, 2005 between Galaxy
                Nutritional Foods, Inc. and SRB Greenway Offshore Operating Fund,
                L.P.
                (Filed as Exhibit 10.26 on Form 8-K filed October 4,
                2005.)




26




*
            10.27
            
            First
                Amendment to Note and Warrant Purchase Agreement dated October 7,
                2005
                between Galaxy Nutritional Foods, Inc. and Frederick A. DeLuca (Filed
                as
                Exhibit 10.27 on Form 10-Q for the fiscal quarter ended September
                30,
                2005.)*
            10.28
            
            Fifth
                Amendment to Loan and Security Agreement dated November 14, 2005
                between
                Galaxy Nutritional Foods, Inc. and Textron Financial Corporation
                (Filed as
                Exhibit 10.28 on Form 10-Q for the fiscal quarter ended September
                30,
                2005.)*
            10.29
            
            Sixth
                Amendment to Loan and Security Agreement dated May 26, 2006 between
                Galaxy
                Nutritional Foods, Inc. and Textron Financial Corporation (Filed
                as
                Exhibit 10.29 on Form 8-K filed June 1, 2006.)*
            10.30
            
            Receivables
                Purchase Agreement, together with Addendum, dated June 23, 2006 between
                Galaxy Nutritional Foods, Inc. and Systran Financial Services Corporation
                (Filed as Exhibit 10.30 on Form 8-K filed June 29,
                2006.)*
            10.31
            
            Note
                Purchase Agreement dated July 19, 2006 between Galaxy Nutritional
                Foods,
                Inc. and Frederick A. DeLuca (Filed as Exhibit 10.31 on Form 8-K
                filed
                July 25, 2006.)*
            10.32
            
            Termination
                Agreement dated July 31, 2006 between Galaxy Nutritional Foods, Inc.
                and
                CLP Industrial Properties (Filed as Exhibit 10.32 on Form 8-K filed
                August
                3, 2006.)*
            10.33
            
            Non-plan
                Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated
                August 7, 2006 in favor of Peter J. Jungsberger (Filed as Exhibit
                10.33 on
                Form 10-Q for the fiscal quarter ended June 30, 2006.)*
            10.34
            
            Non-plan
                Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated
                August 7, 2006 in favor of Robert S. Mohel (Filed as Exhibit 10.34
                on Form
                10-Q for the fiscal quarter ended June 30, 2006.)*
            10.35
            
            Non-plan
                Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated
                August 17, 2006 in favor of David H. Lipka (Filed as Exhibit 10.35
                on Form
                8-K filed August 21, 2006.)*
            10.36
            
            Non-plan
                Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated
                August 17, 2006 in favor of Michael E. Broll (Filed as Exhibit 10.36
                on
                Form 8-K filed August 21, 2006.)*
            10.37
            
            Non-plan
                Option to Purchase Securities of Galaxy Nutritional Foods, Inc. dated
                August 17, 2006 in favor of Angelo S. Morini (Filed as Exhibit 10.37
                on
                Form 8-K filed August 21, 2006.)*
            10.38
            
            Sublease
                Agreement dated October 3, 2006 between Galaxy Nutritional Foods,
                Inc. and
                Oracle Corporation (Filed as Exhibit 10.38 on Form 8-K filed October
                10,
                2006.)*
            10.39
            
            Letter
                Agreement accepted November 9, 2006 between Galaxy Nutritional Foods,
                Inc.
                and Schreiber Foods, Inc. amending the Supply Agreement dated June
                30,
                2005 between the parties. Portions of the Letter Agreement have been
                omitted as indicated by asterisks pursuant to a request for confidential
                treatment in accordance with Section 552(b)(4) of the Freedom of
                Information Act ("FOIA"), 5 U.S.C. 552(b)(4) (Filed as Exhibit 10.39
                on
                Form 10-Q for the fiscal quarter ended September 30,
                2006.)*
            10.40
            
            Note
                Modification Agreement dated March 14, 2007 between Galaxy Nutritional
                Foods, Inc. and Frederick A. DeLuca (Filed as Exhibit 10.40 on Form
                8-K
                filed March 20, 2007.)*
            10.41
            
            Second
                Amendment to the Employment Agreement dated May 3, 2007 between Galaxy
                Nutritional Foods, Inc. and Michael E. Broll. (Filed as Exhibit 10.38
                on
                Form 8-K filed May 9, 2007.)*
            10.42
            
            First
                Amendment to Receivables Purchase Agreement dated March 28, 2007
                between
                Galaxy Nutritional Foods, Inc. and Systran Financial Services Corporation
                (Filed as Exhibit 10.42 on Form 10-K filed June 7,
                2007.)*
            10.43
            
            Separation
                and General Release Agreement dated June 1, 2007 between Galaxy
                Nutritional Foods, Inc. and Christopher Morini (Filed as Exhibit
                10.43 on
                Form 10-K filed June 7, 2007.)*
            14.1
            
            Code
                of Ethics (Filed as Exhibit 14.1 on Form 10-K filed June 7,
                2007.)




27




*
            16.1
            
            Letter
                from BDO Seidman, LLP to the SEC dated July 24, 2006 (Filed as Exhibit
                16.1 on Form 8-K filed July 24, 2006.)*
            16.2
            
            Letter
                from Cross, Fernandez & Riley, LLP to the SEC dated July 24, 2006
                (Filed as Exhibit 16.1 on Form 8-K filed July 24,
                2006.)*
            20.1
            
            Audit
                Committee Charter (Filed as Exhibit 20.1 on Form 10-Q for the fiscal
                quarter ended September 30, 2003.)*
            20.2
            
            Compensation
                Committee Charter (Filed as Exhibit 20.2 on Form 10-Q for the fiscal
                quarter ended September 30, 2003.)31.1
            
            Section
                302 Certification of our Chief Executive Officer (Filed
                herewith.)31.2
            
            Section
                302 Certification of our Chief Financial Officer (Filed
                herewith.)32.1
            
            Section
                906 Certification of our Chief Executive Officer (Filed
                herewith.)32.2
            
            Section
                906 Certification of our Chief Financial Officer (Filed
                herewith.)*
            Previously
              filed and incorporated herein by
              reference.




28




**SIGNATURES**




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




**GALAXY
                NUTRITIONAL FOODS, INC.**Date: August 14, 2007
            
            
            /s/
              Michael E.
              BrollMichael
                E. BrollChief Executive Officer
              (Principal Executive Officer)Date: August 14, 2007
            
            
            /s/ Salvatore J. FurnariSalvatore
              J. FurnariChief Financial Officer
              (Principal Accounting and Financial
                Officer)




29