SunOpta - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended July 3, 2010

OR

[  ] 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: 001-34198

SUNOPTA INC.
(Exact name of registrant as specified in its charter)

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

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

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

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

The number of shares of the registrant’s common stock outstanding as of August 3, 2010 was 65,228,631.

SUNOPTA INC.
FORM 10-Q
For the quarterly period ended July 3, 2010
TABLE OF CONTENTS

All financial information is expressed in United States Dollars. The closing rate of exchange on August 3, 2010 was CDN $1 = U.S. $0.9767.

Forward-Looking Statements

This quarterly report of SunOpta Inc. (the “Company”) for the quarterly period ended July 3, 2010 contains forward-looking statements which are based on our current expectations and assumptions and involve a number of risks and uncertainties. Generally, forward-looking statements do not relate strictly to historical or current facts and are typically accompanied by words such as “anticipate,” “estimate,” “intend,” “project,” “potential,” “continue,” “believe,” “expect,” “could,” “would,” “should,” “might,” “plan,” “will,” “may,” the negatives of such terms, and words and phrases of similar impact and include, but are not limited to references to proposed operational consolidation, reduction of non-core assets and operations, business strategies, plant and production capacities, revenue generation potential and anticipated construction costs, competitive strengths, goals, capital expenditure plans, business and operational growth and expansion plans, anticipated operating margins and operating income increases, gains or losses associated with business transactions, cost reductions, rationalization and improved efficiency initiatives, proposed new product offerings, and references to the future growth of the business and global markets for the Company’s products. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on certain assumptions and analyses we make in light of our experience and our interpretation of current conditions, historical trends and expected future developments as well as other factors that we believe are appropriate in the circumstance.

Whether actual results and developments will agree with our expectations and predictions is subject to many risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from our expectations and predictions. We believe these factors include, but are not limited to, the following:

• the recent disruption in the overall economy and financial markets;
• restrictions in our credit agreement about how we may operate our business;
• our ability or inability to refinance our term debt when it becomes due;
• we may require additional capital to maintain current growth rates, which may not be available on favourable terms or at all;
• consumer preferences for natural and organic food products are difficult to predict and may change;
• we operate in a highly competitive industry;
• an interruption at one of our manufacturing facilities;
• the loss of service of our key management;
• the management of our supply chain;
• volatility in the prices of raw materials and energy;
• climate change legislation;
• impairment charges in goodwill or other intangible assets;
• technological innovation by our competitors;
• our ability to protect our intellectual property and proprietary rights;
• substantial environmental regulation and policies to which we are subject;
• significant food and health regulations to which SunOpta Foods is subject;
• agricultural policies that influence our operations;
• product liability suits that may be brought against our Company;
• the commercial scale viability of SunOpta BioProcess team explosion technology;
• construction or operational delays within SunOpta BioProcess;
• the repeal or modification of government statutes and programs that could affect the sales and profitability of SunOpta BioProcess;
• failure of future growth in ethanol demand;
• financial exposure related to bonding and guarantees to which we are subject;
• loss of a key customer;
• fluctuations in exchange rates, interest rates and certain commodities;
• our ability to effectively manage our growth and integrate acquired companies;
• adverse weather conditions;
• the volatility of our operating results and share price;
• the achievement of business forecasts;
• construction or installation delays of new equipment; and
• labour issues.

Consequently all forward-looking statements made herein are qualified by these cautionary statements and there can be no assurance that our actual results or the developments we anticipate will be realized. The foregoing factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. For a more detailed discussion of the principal factors that could cause actual results to be materially different, you should read our risk factors in Item 1A, Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

Consolidated Financial Statements

SunOpta Inc.

For the quarter and two quarters ended July 3, 2010 and June 30, 2009

(Unaudited)

SunOpta Inc.
Consolidated Statements of Operations
For the quarter ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Statements of Operations
For the two quarters ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Statements of Comprehensive Earnings (Loss)
For the quarter ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Statements of Comprehensive Earnings (Loss)
For the two quarters ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Balance Sheets
As at July 3, 2010 and December 31, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

Commitments and contingencies (note 9)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Statements of Shareholders’ Equity
As at and for the two quarters ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Consolidated Statements of Cash Flow
For the quarter ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

Supplemental cash flow information (notes 8 and 12)

(See accompanying notes to consolidated financial statements)

SunOpta Inc.
Condensed Consolidated Statements of Cash Flow
For the two quarters ended July 3, 2010 and June 30, 2009
Unaudited
(Expressed in thousands of U.S. dollars, except per share amounts)

Supplemental cash flow information (notes 8 and 12)

(See accompanying notes to consolidated financial statements)

1.         Basis of presentation, fiscal year-end and new accounting pronouncements

Basis of presentation

The interim consolidated financial statements of SunOpta Inc. (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, and in accordance with accounting principles generally accepted in the United States of America. Accordingly, these financial statements do not include all of the disclosures required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included and all such adjustments are of a normal, recurring nature. Operating results for the quarter and two quarters ended July 3, 2010 are not necessarily indicative of the results that may be expected for the full year ending January 1, 2011 or for any other period. For further information, see the Company’s consolidated financial statements, and notes thereto, included in the Annual Report on Form 10-K for the year ended December 31, 2009.

The interim consolidated financial statements include the accounts of the Company and its subsidiaries, and have been prepared on a basis consistent with the financial statements for the year ended December 31, 2009, except for the effects of the sale of the Canadian Food Distribution business, as outlined in note 2. Intercompany accounts and transactions have been eliminated on consolidation.

Fiscal year-end

On March 9, 2010, the Board of Directors of the Company approved a change to the Company’s fiscal year period from a fiscal year ending on December 31 to a floating year-end on the Saturday closest to December 31, based on a 52 week calendar, wherein every fiscal quarter is comprised of 13 weeks or 91 days. This change is effective for fiscal 2010, resulting in a year-end of January 1, 2011 and the quarterly periods for fiscal 2010 ending on April 3, July 3 and October 2. The fiscal year of Opta Minerals Inc. (“Opta Minerals”), which is 66.4% owned by the Company, ends on December 31, 2010, and its quarterly periods for fiscal 2010 end on March 31, June 30 and September 30. The consolidated statements of operations, cash flows and balance sheets for the Company in the quarter and the two quarters ended July 3 2010 include the results of Opta Minerals through June 30, 2010.

New accounting pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Topic 810 (formerly Statement of Financial Accounting Standard (“SFAS”) No. 167, “Amendments to FASB Interpretation No. 46(R)”). This accounting standard is a revision to a previous FASB Interpretation and changes how a reporting entity evaluates whether an entity is a variable interest entity (“VIE”) and which entity is considered the primary beneficiary of a VIE and is therefore required to consolidate the VIE. This accounting standard will also require continuous reassessments of which party within the VIE is considered the primary beneficiary. ASC 810 became effective January 1, 2010. As a result of adopting this standard, the Company reassessed its investments and did not change its position as the primary beneficiary of its VIE's.

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” which amends ASC Topic 820, “Fair Value Measures and Disclosures.” ASU No. 2010-06 amends the ASC to require disclosure of transfers into and out of Level 1 and Level 2 fair value measurements, and also requires more detailed disclosure about the activity within Level 3 fair value measurements. The Company adopted the guidance in ASU No. 2010-06 on January 1, 2010, except for the requirements related to Level 3 disclosures, which will be effective for annual and interim reporting periods beginning after December 15, 2010 (January 1, 2011 for the Company). This guidance requires expanded disclosures only, and did not have any impact on the Company’s consolidated financial statements.

2.        Divestiture of Canadian food distribution business

On May 10, 2010, the Company entered into an agreement to sell its Canadian Food Distribution assets to UNFI Canada Inc., a wholly-owned subsidiary of United Natural Foods Inc. The transaction closed on June 11, 2010 for cash consideration of Cdn $68,000 (U.S. - $65,809). The net proceeds are subject to post closing adjustments, in accordance with the asset purchase agreement, which are expected to be finalized within the next 12 months. The assets and liabilities of the Canadian Food Distribution business have been reclassified as assets and liabilities held for sale on the Company’s consolidated balance sheet as at December 31, 2009.

The following is a summary of the transaction:

The gain on sale of discontinued operations has been recorded in discontinued operations on the consolidated statements of operations.

The operating results of the Canadian Food Distribution business are included within earnings (loss) from discontinued operations, net of income tax, on the consolidated statements of operations. The summary comparative financial results of discontinued operations were as follows:

2.         Divestiture of Canadian food distribution business, continued

The assets and liabilities classified as held for sale were as follows:

The assets sold were part of the former Distribution Group segment (see note 10).

3.         Inventories

4.         Capital stock

(a)        Capital Stock
Transactions involving capital stock in the quarter ended July 3, 2010 and June 30, 2009 and the two quarters ended July 3, 2010 and June 30, 2009, were as follows:

(b)        Warrants
On February 5, 2010 (the “First Tranche”), and June 11, 2010 (the “Second Tranche”), the Company issued warrants pursuant to an Advisory Services Agreement. A fair value of $441 and $1,722, respectively, was assigned to these warrants, using the Black-Scholes option pricing model, and these amounts were expensed in full during the quarter of issuance with the offset recorded as an increase to additional paid in capital. The Second Tranche of warrants was issued following the consummation of the sale of the Canadian food distribution business (see note 2) and the cost was included as part of the gain on sale of discontinued operations. Inputs used in the Black-Scholes option pricing model for the warrants were as follows:

4.        Capital stock, continued

The fair value of the warrants is based on estimates of the number of warrants that management expects to vest, which was estimated to be 100% of the granted amounts.

(c)        Options
There were 664,000 options granted to employees and directors in the two quarters ended July 3, 2010 (June 30, 2009 – 1,078,000). The inputs used in the Black-Scholes model to determine the fair value of the options granted were as follows:

The weighted average fair value of the options granted during the two quarters ended July 3, 2010 amounted to $2.78 (June 30, 2009 - $1.05) .The fair value of the options is based on estimates of the number of options that management expects to vest, which was estimated to be 85% of the granted amounts.

5.         Earnings per share

The calculation of basic earnings per share is based on the weighted average number of shares outstanding. Diluted earnings per share reflect the dilutive effect of the exercise of warrants and options. The number of shares for the diluted earnings per share was calculated as follows:

For the quarter ended July 3, 2010, options to purchase 1,243,150 (June 30, 2009 – 1,970,875) common shares have been excluded from the calculations of diluted earnings per share due to their anti-dilutive effect. For the two quarters ended July 3, 2010, options to purchase 1,907,950 (June 30, 2009 – 1,970,875) common shares have been excluded from the calculations of diluted earnings per share due to their anti-dilutive effect.

6.        Bank indebtedness

6.         Bank indebtedness, continued

(a)        Canadian Line of Credit Facility:

The Company has a Canadian line of credit of Cdn $20,000 (U.S. - $18,825). As at July 3, 2010, $nil (2009 - $nil) of this facility was utilized, and there were no amounts committed through letters of credit. Interest on borrowings under this facility accrues at the borrower’s option based on various reference rates including Canadian or U.S. bank prime, or Canadian bankers’ acceptances, plus a margin based on certain financial ratios. At July 3, 2010, the interest rate on this facility was 5.00% (June 30, 2009 – 7.50%), calculated as Canadian prime plus a premium of 2.50%. The maximum availability of this line is based on a borrowing base which includes certain accounts receivables and inventories of the Company’s Canadian business as defined in the Credit Agreement. At July 3, 2010, the borrowing base supported draws to $11,314. At July 3, 2010, 0.87% of undrawn balances on this facility are charged to the Company as standby fees, based on the Credit Agreement.

(b)        U.S. Line of Credit Facility:

The Company has a U.S. line of credit of $80,000. As at July 3, 2010, $2,375 (2009 - $45,754) of this facility was utilized, representing $2,375 (2009 - $1,624) committed through letters of credit. Cash proceeds from the sale of the Canadian Food Distribution Assets (see note 2), were used to repay the outstanding balance. Interest on borrowings under this facility accrues at the borrower’s option based on various reference rates including U.S. bank prime, or U.S. LIBOR, plus a margin based on certain financial ratios. At July 3, 2010, the weighted average interest rate on this facility was 3.85% based on LIBOR plus a premium of 3.50%. The maximum availability of this line is based on the borrowing base which includes certain accounts receivables and inventories of the Company’s U.S. business as defined in the Credit Agreement. At July 3, 2010, the borrowing base supported draws to $61,669, however, as a result of the long-term debt repayment (note 7(a)) on July 16, 2010, this availability increased by $8,239. At July 3, 2010, 0.87% of undrawn balances on this facility are charged to the Company as standby fees based on the Credit Agreement.

The above line of credit facilities as well as certain long-term debt balances (see note 7) are collateralized by a first priority security interest against substantially all of the Company’s assets in Canada, the United States and Mexico, excluding the assets of Opta Minerals, SunOpta BioProcess and The Organic Corporation.

The Company has certain financial covenants that it is measured against quarterly. See note 7 for a discussion of the Company’s compliance with respect to these covenants.

(c)        Opta Minerals Canadian Line of Credit Facility:

Opta Minerals has a line of credit facility of Cdn $15,000 (U.S. - $14,119). At June 30, 2010, Cdn $5,951 (U.S. - $5,676) (2009 - Cdn $4,686 (U.S. - $4,459)) of this facility has been utilized, including letters of credit in the amount of Cdn $1,165 (U.S. - $1,111) (2009 - Cdn $1,160 (U.S. - $1,104)). Interest on borrowings under this facility accrues at the borrower's option based on various reference rates including prime, U.S. dollar base rate, bankers' acceptances or LIBOR plus a margin based on certain financial ratios of the Company. At June 30, 2010, the weighted average interest rate on this facility was 6.17% (2009 – 7.50%).

Opta Minerals’ line of credit facility, along with its unused portion of the revolving acquisition facility (note 7(c)), is subject to annual extensions, and were extended on July 15, 2010 to August 16, 2011.

6.         Bank indebtedness, continued

(d)        TOC Line of Credit Facilities:

The Organic Corporation (“TOC”) has a line of credit facility of €30,000 (U.S. - $37,650). At July 3, 2010, €19,545 (U.S. - $24,529) (2009 - €12,746 (U.S. - $18,247) of this facility had been utilized, including letters of credit in the amount of €3,359 (U.S. - $4,215) (2009 - €2,119 (U.S. - $3,034)). Interest on borrowings under this facility accrues at the borrower’s option based on various reference rates including U.S. LIBOR and Euro LIBOR plus a premium of 1.85%. At July 3, 2010, the weighted average interest rate on this facility was 2.36%. The maximum availability of this line is based on a borrowing base which includes certain accounts receivables and inventories of TOC and its subsidiaries. At July 3, 2010, the borrowing base securing this facility supported draws to €21,586 (U.S. - $27,090) (2009 - €17,019 (U.S. - $24,364)).

A less-than-wholly owned subsidiary of TOC has two line of credit facilities with availability of $1,347 (2009 - $1,394) which are fully guaranteed by TOC. As at July 3, 2010, $1,206 (2009 - $783) of these facilities had been used. Interest on borrowings under these facilities accrues at either a base rate of 0.4% plus a premium of 6.00%, or a fixed rate of 9.75%. At July 3, 2010, the weighted average interest rate on these facilities was 8.4% (2009 – 8.6%) and TOC is in compliance with all requirements under this facility.

7.         Long-term debt

Details of the Company’s long-term debt are as follows:

(a)        Term loan facility:

The term loan facility balance at both July 3, 2010 and June 30, 2009 was $45,000 (2009 - $45,000). The entire loan principal is due December 20, 2010 and, at that time, is renewable at the option of the lender and the Company. Interest on the term loan facility is payable at a fixed rate of 6.44% plus a margin of up to 360 basis points based on certain financial ratios of the Company. As at July 3, 2010, the interest rate was 9.24% (2009 - 9.74%) . As a result of the sale of the Canadian Food Distribution assets (see note 2), $11,284 was repaid on July 16, 2010 in accordance with the terms of the loan agreement.

7.          Long-term debt, continued

The term loan facility, and the U.S. line of credit facility (see note 6), are collateralized by a first priority security interest against substantially all of the Company’s assets in Canada, the United States and Mexico, excluding the assets of Opta Minerals, SunOpta BioProcess and TOC.

(b)        Opta Minerals Term Loan Facility:

The term loan facility has a maximum available borrowing amount of Cdn $8,393 (U.S. - $8,006). This facility matures on August 30, 2012, is renewable at the option of the lender and Opta Minerals, and has quarterly principal repayments of Cdn $312 (U.S. - $298). At June 30, 2010, the term loan facility was fully drawn (2009 - Cdn $9,280 (U.S. - $8,830)). At June 30, 2010, the weighted average interest rate on this facility was 7.59% (2009 – 7.50%).

(c)        Opta Minerals Revolving Acquisition Facility:

The revolving acquisition facility has a maximum available borrowing amount of Cdn $14,043 (U.S. - $13,395) to finance future acquisitions and capital expenditures. Principal is payable quarterly equal to 1/40 of the drawdown amount. Any remaining outstanding principal under this facility is due upon maturity. The facility is revolving for one year, with a five year term out option. The outstanding balance on the revolving acquisition facility at June 30, 2010 was Cdn $12,348 (U.S. - $11,623) (2009 - Cdn $12,992 (U.S. - $12,362)). At June 30, 2010, the weighted average interest rate on this facility was 7.21% (2009 - 6.99%).

The Opta Minerals’ credit facilities described above are collateralized by a first priority security interest against substantially all of the Opta Minerals assets in both Canada and the United States.

Opta Minerals entered into a cash flow hedge in 2007. The cash flow hedge entered into exchanged a notional amount of Cdn $17,200 (U.S. - $16,190) from a floating rate to a fixed rate of 5.25% from August 2008 to August 2012. The estimated fair value of the interest rate swap at June 30, 2010 was a loss of $1,187 (2009 - loss of $1,387). The incremental gain in fair value of $140 (net of income taxes of $60) has been recorded in other comprehensive loss for the period. The fair value liability is included in long-term liabilities on the consolidated balance sheets.

(d)        Subordinated debt to former shareholders of TOC:

In conjunction with the acquisition of TOC on April 2, 2008, its former shareholders provided a subordinated loan to TOC in the amount of €3,000 (U.S. - $3,765). The loan bears interest at 7% payable to the former shareholders on a semi-annual basis. The subordinated loan, as well as €453 (U.S. - $569) previously loaned to TOC, is repayable in full on March 31, 2011.

(e)        Promissory Notes:

Promissory notes consist of notes issued to former shareholders as a result of business acquisitions. As consideration in the acquisition of TOC, the Company issued a total of €9,000 (U.S. - $11,295) in promissory notes which are secured by a pledge of the common shares of TOC. Of the €9,000 (U.S. - $11,295) issued, €1,000 (U.S. - $1,436) was paid in cash on April 5, 2010, with the remaining €8,000 (U.S. - $10,040) due March 31, 2011. Due to TOC’s opening balance sheet not meeting pre-determined working capital targets, and an undisclosed liability that existed prior to the Company’s April 2, 2008 acquisition, €528 (U.S. - $663) of the promissory notes due March 31, 2011 will not be paid.

In addition, $2,780 remains owing to various former shareholders at a weighted average interest of 4.9%. Of the $12,156 in total promissory notes, $11,602 are due in the next 12 months, with the remaining balances due in varying installments through 2012.

7.         Long-term debt, continued

(f)        Other long-term debt:

A less-than-wholly owned subsidiary of TOC has a maximum borrowing amount of 6,500 Ethiopia Birr (“ETB”) (U.S. - $453). The outstanding balance at July 3, 2010, was $369 (2009 - $380). At July 3, 2010, the weighted average interest rate on borrowed funds was 10.3% (2009 - 10.1%).

(g)        Term Loans Payable:

Term loans payable bear a weighted average interest rate of 5.3% (2009 – 4.9%) due in varying installments through 2013 with principal payments of $13 due in the next 12 months.

(h)        Capital Lease Obligations:

Capital lease obligations are due in monthly payments, with a weighted average interest rate of 7.0% (2009 – 6.9%).

The long-term debt and capital leases described above have required repayment terms in the next five years ending July 3, as follows:

At July 3, 2010, the Company was in compliance with its financial covenants, which relate to the Canadian line of credit facility, the U.S. line of credit facility (see notes 6(a) and (b)), as well as the term loan facilities. In addition, Opta Minerals was in compliance with its financial covenants which relate to the Canadian Line of Credit Facility (see note 6(c)), as well as the term loan facility and revolving acquisition facility.

8.         Supplemental cash flow information

9.         Commitments and contingencies

(a)        Securities class action lawsuits

The Company and certain officers (one of whom is a director) and a former director were named as defendants in proposed class action lawsuits in the United States District Court for the Southern District of New York and Ontario Superior Court of Justice (collectively, the “courts”) on behalf of shareholders who acquired securities of the Company from February 23, 2007 to January 27, 2008, inclusive. Cleugh’s Frozen Foods, Inc. and Pacific Fruit Processors, Inc. (each of which are now part of the merged subsidiary, SunOpta Fruit Group, Inc.) and Organic Ingredients, Inc. (which is now known as SunOpta Global Organic Ingredients, Inc.), were also named as defendant in the U.S. action.

On September 24, 2009 the Company announced that it entered into a tentative agreement to settle all claims raised in these class action proceedings. In return for the dismissal of the class actions and releases from proposed class members of settled claims against the Company and other named defendants, the settlement agreement provided for a total cash contribution of $11,250 to a settlement fund, the adoption of certain governance enhancements to the Company’s Audit Committee charter and Internal Audit Charter and the adoption of an enhanced information technology conversion policy. The settlement has been entirely funded by the Company’s insurers.

The settlement has been approved by the United States District Court for the Southern District of New York and Ontario Superior Court of Justice and the terms of the settlement have become effective, including the dismissal of the U.S. and Ontario class actions and releases of settled claims against the Company and other named defendants.

(b)        Formal investigation by the SEC

In 2008 the Company received letters from the SEC requesting additional information in connection with the restatement of the Company’s filings for each of the quarterly periods ended March 31, 2007, June 30, 2007, and September 30, 2007. The SEC has conducted interviews with certain current and past employees, current and former members of the Company’s Audit Committee, as well as the Company’s previous external auditors. The Company continues to cooperate with the requests from the SEC in connection with its formal investigation. An enforcement action by the SEC could result in expense in the form of sanctions, fines or other levies. Management cannot conclude whether the prospect of an unfavourable outcome in this matter is probable, or estimate the loss, if any, that might arise from any enforcement action taken against the Company or its officers. Accordingly, no accrual has been made at this time for this contingency.

(c)        Vargas Class Action

In September 2008, a single plaintiff and a former employee filed a wage and hour dispute, against SunOpta Fruit Group, Inc., as a class action alleging various violations of California’s labour laws (the “Vargas Class Action”). A tentative settlement of all claims was reached at mediation on January 15, 2010 and the parties executed a settlement agreement resolving all claims of the class. The terms of the proposed settlement are scheduled to be reviewed by the court for preliminary approval on August 19, 2010. As a result of the tentative settlement, the Company accrued a liability of $1,200 as at December 31, 2009.

(d)        Colorado Sun Oil Processors, LLC dispute

Colorado Mills LLC (“Colorado Mills”) and Sunrich LLC, a wholly-owned subsidiary of the Company, organized a joint venture in 2008 to construct and operate a vegetable oil refinery next to Colorado Mills’ sunflower seed crush plant located in Lamar, Colorado. During the relationship, disputes have arisen between the parties concerning management of the joint venture, record-keeping practices, certain unauthorized expenses incurred on behalf of the joint venture by Colorado Mills, procurement of crude oil by Sunrich from Colorado Mills for processing at the joint venture refinery, and the contract price of crude oil offered for sale under the joint venture agreement.

9.        Commitments and contingencies, continued

The parties initiated a dispute resolution process as set forth in the joint venture agreement, which Colorado Mills aborted prematurely through the initiation of suit in Colorado State Court. Subsequent to the filing of that suit, Colorado Mills acted with an outside creditor of the joint venture to put the joint venture into involuntary bankruptcy. The involuntary bankruptcy has been opposed by Sunrich. After a preliminary hearing on Sunrich’s motion to dismiss the involuntary bankruptcy, the bankruptcy court has scheduled the matter for a final evidentiary hearing on October 21 and 22, 2010. The joint venture remains deadlocked and has been ordered dissolved, pursuant to the parties’ Joint Venture Agreement, by the Colorado State Court. No discovery has yet been taken or exchanged in either lawsuit. Management cannot conclude whether the prospect of an unfavourable outcome in this matter is probable, or estimate the loss, if any, that might arise from an unfavourable outcome. Accordingly, no accrual has been made at this time for this contingency.

(e)        Other claims

In addition, various claims and potential claims arising in the normal course of business are pending against the Company. It is the opinion of management that these claims or potential claims are without merit and the amount of potential liability, if any, to the Company is not determinable. Management believes the final determination of these claims or potential claims will not materially affect the financial position or results of the Company.

10.        Segmented information

The Company operates in three industries divided into seven operating segments:

(a) SunOpta Foods sources, processes, packages, markets and distributes a wide range of natural, organic and specialty food products and ingredients with a focus on soy, corn, sunflower, fruit, fiber and other natural and organic food and natural health products. There are four operating segments within SunOpta Foods:

(b) Opta Minerals processes, distributes and recycles silica-free loose abrasives, roofing granules, industrial minerals and specialty sands for the foundry, steel, roofing shingles and bridge and ship-cleaning industries.

(c) SunOpta BioProcess provides a wide range of research and development and engineering services and owns a number of patents on its proprietary steam explosion pretreatment technology and downstream processes. It designs and subcontracts the manufacture of these systems, which are used for processing biomass for use in the biofuel, paper, food and other industries.

(d) Corporate Services provide a variety of management, financial, information technology, treasury and administration services to the operating segments from the head office in Ontario, Canada, and information and shared services offices in Minnesota, U.S.A.

10.        Segmented information, continued

Effective July 3, 2010, the former SunOpta Distribution Group was eliminated as an operating segment due to the sale of the Canadian food distribution assets (see note 2). In addition, the Company merged its natural health products division with the former International Sourcing and Trading Group to create a new operating segment called the International Foods Group. This realignment of operating segments effectively merges our international operations into one reporting group. The segmented information for the quarter and two quarters ended June 30, 2009 have been updated to reflect the current year’s segment presentation.

The Company’s assets, operations and employees are principally located in the United States, Canada, Europe, Mexico, China and Africa. Revenues are allocated to the United States, Canada and Europe and other external markets based on the location of the customer. Other expense (income) net, interest expense, net, and provision for (recovery of) income taxes are not allocated to the segments.

The following segmented information relates to each of the Company’s segments for the quarter ended July 3, 2010.

SunOpta Foods has the following segmented reporting for the quarter ended July 3, 2010:

10.         Segmented information, continued

The following information relates to each of the Company’s segments for the quarter ended June 30, 2009.

SunOpta Foods has the following segmented reporting for the quarter ended June 30, 2009:

10.         Segmented information, continued

The following information relates to each of the Company’s segments for the two quarters ended July 3, 2010.

SunOpta Foods has the following segmented reporting for the two quarters ended July 3, 2010:

10.         Segmented information, continued

The following information relates to each of the Company’s segments for the two quarters ended June 30, 2009.

SunOpta Foods has the following segmented reporting for the two quarters ended June 30, 2009:

11.         Other expense (income), net

(a)        Rationalizations

During the fourth quarter of 2009, the Company approved the decision to permanently close a distribution center in Toronto, Canada, consolidate manufacturing facilities from British Columbia, Canada to Omak, Washington, and cease processing of fresh fruit at a leased facility in Buena Park, California. In the second quarter of 2010, the Company approved a rationalization plan at a distribution facility in Acton, Ontario, Canada to reduce selling and administrative costs in response to market conditions, and the sale of the Canadian food distribution assets.

The Company closed the distribution center in Toronto, Canada in the first quarter of 2010. In addition, the consolidation of the British Columbia manufacturing facility is expected to be completed in the third quarter, and additional severance, property, plant and equipment dismantling, moving and installation costs are expected to be incurred. Future costs will be recorded as incurred. The Company also ceased production of fresh fruit processing at a leased facility in Buena Park, California, during the fourth quarter of 2009 and incurred costs to move assets to another facility during the first quarter of 2010. The Company also plans to exit packaging at this facility and relocate to an improved site during the first quarter of 2011.

A summary of the expected total costs, and costs incurred to date included in other expense with respect to each of the rationalizations, is included below:

Costs recognized in other expense in the two quarters ended July 3, 2010 include $865 for severance and $64 of period costs to transfer property, plant and equipment to another location, and $267 of other closure costs recorded as incurred.

Of the costs incurred in the two quarters ended July 3, 2010, $560 related to the Fruit Group and $636 related to the International Foods Group.

As at July 3, 2010, there were $636 in accrued severance related to rationalization activities.

11.         Other expense (income), net, continued

(b)        Gain on investment and equity losses

During the second quarter of 2010, SunOpta BioProcess’ interest in the integrated xylitol production technology that was developed with its partner, Sweet Diabetic Delight Foods, Inc., doing business as Xylitol Canada (“XC”), was exchanged with XC in return for 50% of the entity. Concurrent with this transaction, the shares of XC were sold to Chudleigh Ventures Inc (“CVI”), a capital pool company listed on TSX Venture Exchange, and additional capital was raised in CVI through a private placement. Following these transactions, SunOpta BioProcess retained common shares in CVI representing approximately 31.4% of the outstanding capital. As a result of the dilution in ownership in CVI, SunOpta BioProcess recorded a non-taxable dilution gain of $1,242. SunOpta BioProcess accounts for its investment in CVI under the equity method.

Offsetting this gain is SunOpta BioProcess’ share of losses on its investment in CVI of $133 during the quarter and two quarters ended July 3, 2010.

(c)        Impairment charges

In the first quarter of 2010, the Company incurred a non-cash impairment charge of $139 for the write-off of long-lived assets within the SunOpta Ingredients Group.

12.         Cash and cash equivalents

Included in cash and cash equivalents is $19,175 (2009 - $19,735) in funds that cannot be utilized by the Company for general corporate purposes, and are maintained in separate bank accounts of the legal entities.

SunOpta BioProcess has $17,974 (2009 - $18,954) of cash, which is specific to SunOpta BioProcess.

Also included in cash and cash equivalents is $1,201 (2009 - $781) that is specific to Opta Minerals.

13.         Derivative financial instruments and fair value measurement

Effective January 1, 2008, the Company adopted the provisions of ASC 820-10-55 (formerly FASB FSP 157-2/SFAS 157, “Effective Date of FASB Statement No. 157”) applicable to financial assets and liabilities and to certain non-financial assets and liabilities that are measured at fair value on a recurring basis. Additionally, the Company applies the provisions of this standard to financial and non-financial assets and liabilities. This standard defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. In addition, this standard requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

13.         Derivative financial instruments and fair value measurement, continued

This standard also provides a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions with respect to how market participants would price an asset or liability. These two inputs used to measure fair value fall into the following three different levels of the fair value hierarchy:

• Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that are observable
• Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities that are non-active; inputs other than quoted prices that are observable and derived from or are corroborated by observable market data
• Level 3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable due to little or no market activity

This hierarchy requires the use of observable market data when available.

The following table presents for each of the fair value hierarchies, the assets and liabilities that are measured at fair value on a recurring basis as of July 3, 2010:

(a) Commodity futures and forward contracts
The Company’s derivative contracts that are measured at fair value include exchange-traded commodity futures and forward commodity purchase and sale contracts. Exchange-traded futures are valued based on unadjusted quotes for identical assets priced in active markets and are classified as level 1. Fair value for forward commodity purchase and sale contracts is estimated based on exchange-quoted prices adjusted for differences in local markets. Based on historical experience with the Company’s suppliers and customers, the Company’s own credit risk, and the Company’s knowledge of current market conditions, the Company does not view non-performance risk to be a significant input to fair value for the majority of its forward commodity purchase and sale contracts. Local market adjustments use observable inputs or market transactions for similar assets or liabilities, and, as a result, are classified as level 2.

These exchange-traded commodity futures and forward commodity purchase and sale contracts are used as part of the Company’s risk management strategy, and represent economic hedges to limit risk related to fluctuations in the price of certain commodity grains. These derivative instruments are not designated as hedging instruments. For the quarter and two quarters ended July 3, 2010, a $954 loss and $1,009 loss, respectively, is recorded in cost of goods sold on the consolidated statements of operations related to changes in the fair value of these derivatives.

13.         Derivative financial instruments and fair value measurement, continued

At July 3, 2010, the notional amounts of open commodity futures and forward purchase and sale contracts were as follows:

(b) Inventories carried at market
Grains inventory carried at fair value is determined using quoted market prices from the Chicago Board of Trade (“CBoT”). Estimated fair market values for grains inventory quantities at period end are valued using the quoted price on the CBoT adjusted for differences in local markets, and broker or dealer quotes. These assets are placed in level 2 of the fair value hierarchy, as there are observable quoted prices for similar assets in active markets. Gains and losses on commodity grains inventory are included in cost of sales on the consolidated statements of operations. At July 3, 2010, the Company had 259 bushels of commodity corn and 495 bushels of commodity soybeans, in inventories carried at market.

(c) Interest rate swap
Opta Minerals entered into an interest rate swap to minimize its exposure to interest rate risk. A notional amount of Cdn $17,200 (U.S. - $16,190) of floating rate debt was effectively converted to fixed rate debt at a rate of 5.25% for the period August 2008 to August 2012. At each period end, management calculates the mark-to-market fair value using a valuation technique using quoted observable prices for similar instruments as the primary input. Based on this valuation, the previously recorded fair value is adjusted to the current mark-to-market position. The mark-to-market gain or loss is placed in level 2 of the fair value hierarchy. The interest rate swap is designated as a cash flow hedge for accounting purposes and accordingly, gains and losses on changes in the fair value of the interest rate swap are included in other comprehensive income on the consolidated statements of operations. For the quarter and two quarters ended July 3, 2010, a $20 gain and $140 gain (net of income taxes of $9 and $60, respectively) has been recorded in other comprehensive earnings due to the change in fair value for this derivative.

(d) Foreign forward currency contracts
As part of its risk management strategy, the Company enters into forward foreign exchange contracts to reduce its exposure to fluctuations in foreign currency exchange rates. For any open forward foreign exchange contracts at period end, the contract rate is compared to the forward rate, and a gain or loss is recorded. These contracts are placed in level 2 of the fair value hierarchy, as the inputs used in making the fair value determination are derived from and are corroborated by observable market data. These forward foreign exchange contracts represent economic hedges and are not designated as hedging instruments. At July 3, 2010 the Company had open forward foreign exchange contracts with a notional value of €10,791, Cdn $1,728 and U.S. $7,478 that resulted in an unrealized gain of $751 which is included in foreign exchange gain (loss) on the consolidated statements of operations.

PART I - FINANCIAL INFORMATION

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

All financial numbers presented in this “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” are expressed in thousands of U.S. dollars

Significant Developments During the Second Quarter of 2010

On May 19, 2010 we announced that both the Ontario Superior Court of Justice and the United States District Court for the Southern District of New York approved an agreement to settle all claims raised in class action proceedings previously announced arising from the our restatement of interim financial results for the first three quarters of 2007. The settlement became effective on May 17, 2010, upon expiry of the period for filing an appeal. In return for the dismissal of the Class Actions and releases from Class Members of settled claims against the Company and the named defendants, the settlement agreement provided for a total cash contribution of US $11,250 (funded entirely by our insurer) to a settlement fund and the adoption of certain corporate governance enhancements. The settlement agreement contains no admission of wrongdoing by SunOpta or any of the other named defendants.

On June 14, 2010 we announced the completion of the divestiture of our Canadian Food Distribution Assets to UNFI Canada, Inc., a wholly owned subsidiary of United Natural Foods, Inc. for cash consideration of $65,809 (CDN $68,000). We realized a net gain on the sale of these assets, after tax, of $13,809. The divestiture of the Canadian Food Distribution Assets was an important step in our strategy to focus on our core food manufacturing platform, further strengthening our balance sheet and positioning the SunOpta for the future. The Food Distribution Assets included in the sale formed part of the former SunOpta Distribution Group. Our Canadian based natural health products distribution and manufacturing assets were not included in the sale.

On June 29, 2010 we announced that we had entered into an exclusive agreement with Clearwater Country Foods of Genesee, Idaho, to market and distribute Clearwater's Garden Green Garbanzo™. Clearwater is a pioneer of sustainable green garbanzo bean production in the United States. Under the terms of the agreement, we will be responsible for global sales and distribution of the Garden Green Garbanzo™ and Clearwater will provide exclusive sourcing and supply services. Prior to signing the agreement we had been working with Clearwater for approximately eighteen months, performing extensive market analysis to assess the potential of the sustainable and healthy green garbanzo and hummus markets including applications for retail, food service and industrial customers. This new product will be launched in the third quarter of 2010. Although revenues from this product will depend on market demand and other factors, we currently anticipate profitable revenues of approximately $10,000 over the first full year of commercialization.

On July 8, 2010 we announced the appointment of Mr. Alan Murray to our Board of Directors. Mr. Murray brings strong business experience to the SunOpta Board of Directors with a background in manufacturing, business turn-around situations, business integration and profitable organic growth. Mr. Murray has lived and worked abroad including Western and Eastern Europe and Africa. Most recently Mr. Murray served as President and CEO of Tetra Pak, North America.

Operations for the quarter ended July 3, 2010 compared to the quarter ended June 30, 2009

(Operating Income is defined as “Earnings before the following” excluding the impact of “Other expense (income), net”)

Revenues for the second quarter of 2010 increased by 9.2% to $235,939 from $216,099 during the second quarter of 2009. Revenues in SunOpta Foods increased by 5.5% to $212,744, revenues in Opta Minerals increased by 47.4% to $21,141 and revenues in SunOpta BioProcess increased to $2,054. The increased revenue is due entirely to internal growth as there have been no acquisitions to contribute to the increased revenue. Internal growth includes the impact of foreign exchange movements and its effect on translation of foreign denominated revenue to U.S. dollars and the impact of changes in commodity prices. Excluding the impact of changes in foreign exchange and commodity prices, revenues increased approximately 10.5% over the prior year.

Gross margins increased $10,237, or 36.1%, in the second quarter of 2010 to $38,588 from $28,351 during the second quarter of 2009. As a percentage of revenues, gross margin in the second quarter of 2010 was 16.4% compared to 13.1% in the second quarter of 2009, an increase of 3.3%. In the second quarter of 2010, we experienced increased gross margin in all of our operating segments Within SunOpta Foods, higher volumes of fiber, fruit ingredient products, sunflower and consumer products and plant efficiencies all contributed to the increased gross margin. Also contributing to the increase in gross margin was a rebound in the steel and foundry markets for Opta Minerals and gross margin realized on an active supply contract in SunOpta BioProcess.

Warehouse and Distribution (“W&D”) costs for the second quarter of 2010 were $1,122, an increase of $148, compared to $974 in the second quarter of 2009. These costs are solely related to the International Foods Group and specifically the Group’s Canadian based natural health product distribution operation as warehousing and distribution costs for all other operations are considered part of cost of goods sold.

Selling, General and Administrative costs (“SG&A”) including intangible asset amortization increased $2,459 to $25,908 in the second quarter of 2010 compared to $23,449 in the second quarter of 2009. The stronger Canadian dollar in the second quarter of 2010 led to a $1,072 increase in SG&A on Canadian borne costs. The remaining increase in SG&A costs of $1,387 relates to higher compensation costs, professional fees, and general overhead expenses. As a percentage of revenues, SG&A and intangible asset amortization costs were 11.0% in the second quarter of 2010 compared to 10.9% in the second quarter of 2009.

Foreign exchange gains were $193 in the second quarter of 2010 as compared to a gain of $672 in the second quarter of 2009. The decrease is primarily due to less favourable exchange rate movements for the Canadian dollar and the Euro relative to the U.S. dollar.

Operating income increased by $7,151 to $11,751 in the second quarter of 2010 compared to operating income of $4,600 in the second quarter of 2009 due to the factors noted above. As a percentage of revenue, operating income was 5.0% in the second quarter of 2010, compared to 2.1% in the second quarter of 2009. Further details on revenue, gross margins and operating income variances are provided in the Segmented Operations Information provided below under “Segmented Operations Information”.

Other income of $65 in the quarter ended July 3, 2010 reflects costs related to rationalization efforts that began in fiscal 2009 and continued into the second quarter of 2010 as well as the rationalization efforts at our natural health products division that began in the second quarter of 2010, offset by a dilution gain at SunOpta BioProcess. Included in the current period are $1,044 of severance, non-cash packaging inventory write-offs and other period costs expensed as incurred. Non-cash income of $1,109 related to SunOpta BioProcess’ equity investment and gain on dilution of Xylitol Canada is also included in other income in the current quarter.

Interest expense was $2,618 during the second quarter of 2010 compared to $3,470 in the second quarter of 2009, a decrease of $852. Borrowing costs were lower in the second quarter of 2010 due to lower debt levels and LIBOR based interest charges, improved interest costs on our pricing grid due to improved results, and $450 of non-cash interest charges incurred in the second quarter of 2009 related to the waiver and amendment of our credit facilities, which occurred on April 30, 2009.

Income tax provision for the quarter ended July 3, 2010 was $1,895 compared to $388 in the prior period, due to the higher consolidated earnings before tax in the current period. The expected annual effective income tax rate for 2010 is between 28% and 30%.

Earnings from continuing operations for the second quarter of 2010 were $7,303 as compared to $626 in the second quarter of 2009, an increase of $6,677. Basic and diluted earnings per share from continuing operations was $0.11 for the second quarter of 2010 compared to $0.01 for the second quarter of 2009.

Earnings attributable to non-controlling interest for the quarter ended July 3, 2010 were $186 compared to losses of $234 in the second quarter of 2009. The $420 increase is due to higher net earnings in our less than wholly-owned subsidiaries.

Losses from discontinued operations, net of income taxes, were $460 for the quarter ended July 3, 2010 compared to earnings of $920 for the quarter ended June 30, 2009. The $1,380 decrease is due to costs of $1,289 incurred as a result of the sale including retention bonuses, severances and mandatory interest payments, as well as lower operating margins from the Canadian food distribution business.

Gain on the sale of discontinued operations of $13,809 represents the after tax gain realized on the disposition of the Canadian food distribution assets.

On a consolidated basis, earnings, basic and diluted earnings per share were $20,466, $0.32 and $0.31 respectively, for the quarter ended July 3, 2010, compared to $1,780, $0.03 and $0.03, respectively, for the quarter ended June 30, 2009.

Adjusted Earnings from Operations