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GALAXY FOODS CO.
January 21, 1998
Frank P. Giove
Senior Equities Analyst
(770) 321-6799

RATING: STRONG BUY
Sector: Healthy Food Manufacturing
Description: Makes cheese & soy-based foods
DJIA: 9375.0
NASDAQ Comp: 2410.5
NASDAQ (Small Cap): GALXC

WE�RE RAISING OUR RATING TO STRONG BUY ALL DATA HAS BEEN ADJUSTED FOR A 1 FOR 7 REVERSE SPLIT EFFECTIVE February 12, 1999

In our initial report dated December 22, 1998, we alluded to a number of risk factors that might deter GALXC stock from achieving its full potential. We stated our belief that top management "�is considering actions that could reduce or otherwise alleviate at least some of (these) risks." Since then the company has taken positive actions to help enhance shareholder value and plans to take additional action in the future as well.

• A one for seven reverse split has been declared to be effective February 12^th. In order to reduce the stock�s bloated capital structure, which helped precipitate a potential NASDAQ Small Cap exchange delisting, the company announced a reverse stock split, an action to allow the stock to keep its NASDAQ listing. Shareholders will vote on the reverse split on February 11^th.

• The third quarter earnings report beat our forecast. The company reported its seventh straight profitable quarter. Preliminary net earnings were $641,894 or $0.06 an adjusted share; our forecast was $575,000. This gives us much greater confidence in our full fiscal 1998 (year ends March 31, 1999) EPS estimate (after the reverse split) of $0.23 a share. For fiscal 1999 and 2000, our split adjusted EPS forecasts are $0.65 and $1.00.

• The P/E multiple on the stock should start to expand. The reverse split with its higher stock price should place the shares in the radar range of interested institutional buyers. Companies in the "healthy" foods processing industry sell at a P/E of roughly 24 times 1999 EPS projections with an average growth rate of 26%. Galaxy shares command a P/E of a mere 6.7 times our fiscal 1999 forecast with a 30% projected growth rate.

• We�re raising our rating to STRONG BUY based on the revised capital structure and the wide P/E multiple discount. The adjusted share price (i.e. post the 1:7 split) puts the company�s capital structure on par with other companies in the healthy food industry. This supports our target price of an adjusted $14 based on a P/E multiple of 21.5 times or close to the average of the "healthy" foods peer group.

Any recommendation contained in this report may or may not be suitable for all investors. Moreover, although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be guaranteed. National Securities Corporation may make markets and effect transactions, including transactions contrary to any recommendations herein, or have positions in the securities mentioned herein (or options with respect thereto) and also may have performed investment banking services for the issuers of such securities. In addition, employees of National Securities Corporation may have positions and effect transactions in the securities or options of the issuers mentioned herein and may serve as directors of such issuers. Copyright © 1998. All rights reserved

The Company Has Started to Take Positive Shareholder Value Steps

Our initial research report noted a number of risk factors that could detract from GALXC stock achieving its full potential. We stated that "�there is a very large number of outstanding shares (61.7 million as of September 30, 1998) for a company this size." This huge share count hurt the stock�s potential performance in at least three ways. First of all, despite the fact that Galaxy Foods was starting to generate meaningful earnings, they were being diluted into pennies and fractions of pennies per share.

Secondly, the price of the stock was being driven downward, partially due to the lack of per share earnings. This precipitated a NASDAQ advisory that GALXC shares would be delisted from the NASDAQ Small Cap exchange unless the stock trades at the $1 level for a period of time around February 12^th. The proposed one-for-seven split made this threat moot. Finally, a stock price near the $5 mark would allow institutional buyers to purchase GALXC for its strong EPS growth. This could, in turn, result in a higher P/E appraisal to be placed on Galaxy�s earnings commensurate with its "healthy" foods peer group.

We believe there could be other shareholder value issues that may be resolved in a positive manner. Some of the performance-based outstanding warrants could be cancelled due to lack of specific performance. Mr. Angelo S. Morini, Galaxy�s founder, Chairman & CEO, could review his generous performance-oriented option package. In all, with the one for seven reverse split, the company is well on its way to enhancing shareholder value.

Galaxy�s Sales and Earnings Momentum is Accelerating

The company�s preliminary results in the third fiscal quarter (ended December 31, 1998) revealed a continuation of strong sales and earnings trends. Sales for the period reached $8 million, up 75% compared to $4.6 million in the like timeframe of 1997. Aided by a very favorable mix of high profit Retail Sales, gross margins soared to 35.9%, against 29.1% last year. Adjusted for the one for seven reverse split, the $641,894 of net earnings resulted in EPS of $0.06, a wide improvement over last year�s $198,600 of earnings, or $0.02 an adjusted share.

For the current quarter (ending March 31, 1999), we believe sales can reach $10 million, or roughly a $750,000 to $800,000 weekly rate. We�re forecasting gross margins of 32.5%, as shown on the Income Statement page of this report. Therfore, net earnings could exceed $900,000, or $0.10 a share. That would bring full fiscal year profits to $2,150,000, or $0.23 a share, implying tax-free net margins of 6.8%. For fiscal 1999, we estimate an average sales rate of $1 million a week, or $52 million. Overall gross margins could reach 33.2%, compared to an estimated 31.6% for this fiscal year. Net earnings, in that scenario, might reach $6.2 million, or tax-free margins of 12%.

For the 2000 fiscal year, sales could grow 35% to $70 million. Some additional margin expansion is indicated which would allow Galaxy to earn about $10 million, or $1.00 a share. This would be a 53% improvement over the prior fiscal year. Beyond fiscal 2000, the tax loss carryforwards, which have sheltered earnings, will have been used up. Even so, profits can still grow at a 30% annual pace.

Comparable Peer Group Valuation Analysis

What is Galaxy�s stock "worth"? This is probably the most asked question investors have about the company. To help answer this, we have found six companies that can truly be deemed "healthy foods" processors by virtue of their product offerings. Briefly, these companies include Gardenburger, Inc. (GBUR), an entity that makes and sells meat replacement alternatives. Products include frozen meatless items that are low in cholesterol and fat.

Hain Food Group (HAIN) produces and markets various categories of specialty foods such as cooking oils, kosher products, diet foods and specialty snack foods. Worthington Foods, Inc. (WFDS) makes and sells zero cholesterol, low fat meat alternatives and egg substitute products. These three companies have sales in the $115 to $145 million range and estimated growth rates of 19% to 32%.

Horizon Organic Holding Corporation (HCOW), public since July 1998, is a very rapidly growing company that processes and markets a line of organic dairy products. Its EPS growth rate is estimated at 42% and the stock is covered by at least five brokerage firms. Horizon�s sales are near $48 million and the stock commands 39 times P/E of its forecasted 1999 earnings.

Lifeway Foods, Inc. (LWAY) and International Yogurt Company (YOCM) are the smallest of Galaxy�s peer group of comparable stocks. Sales are both under $10 million annually and their growth rates are forecasted at 20%. Lifeway produces kefir, a product similar to but distinct from yogurt. International Yogurt, as its name implies, makes yogurt in both a hard pack and soft-serve mode. We believe GALXC�s "fundamentals" exceed those of LWAY and YOCM.

We have shown the pertinent data on these companies below and compared their stocks to GALXC after its one for seven reverse split:

The six-company average EPS forecasted growth rate is 26% while Galaxy has a 30% projected EPS growth rate. The average P/E for their 1999 estimated earnings is 23.6 times, ranging from 16 times for LifewayFoods to 48 times for Gardenburger. The P/E on Galaxy�s fiscal 1999 earnings is a scant 6.7 times.

We realize that Galaxy�s earnings are untaxed and the stock is still relatively unknown due to its under-$1 current price. These circumstances would theoretically detract from attainment of a premium P/E by GALXC. However, this should be offset by a rapidly growing EPS line and a stock that can be purchased by institutions after the one for seven reverse split effective February 12th. In all, we believe the stock can command a P/E of 21.5 times or near the peer group average.

Recommendation-This Stock is a STRONG BUY

In our initial report on December 22, 1998, we rated the stock "Speculative Buy" largely based on the huge capital share structure and GALXC�s low price. However, after the effective date of the one for seven reverse split, we believe the very speculative nature of the stock should subside and GALXC will start seeking its place in its market segment. Consequently, we have raised our rating to Strong Buy!

The stock is now trading at $0.63 before the reverse split which becomes effective on February 12^th. There are some concerns about increased volatility as the effective date approaches. Our advice is this: investors should start adding GALXC to the speculative part of their portfolios in 700 share increments. If any trading weakness develops in the stock as it approaches the effective date, take advantage of it by adding to the position. If no weakness occurs, again, add to the position.

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