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FORM 10-Q

Cagle’s, Inc.

October 2, 2010

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CAGLE’S, INC. AND SUBSIDIARY

Condensed Consolidated Balance Sheets

(In Thousands, Except Par Values)

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CAGLE’S, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Operations

(In Thousands, Except Per Share Data)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CAGLE’S, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Cagle’s, Inc. (the “Company”), which began business in 1945 and was first incorporated in Georgia in 1953, and its wholly owned subsidiary Cagle’s Farms, Inc., produce, market, and distribute a variety of fresh and frozen poultry products.  The vertically integrated operations of the Company consist of breeding, hatching, and growing of chickens; feed milling; processing; further processing; and marketing operations.  The Company’s products are sold to national and regional independent and chain supermarkets, food distributors, food processing companies, national fast-food chains, and institutional users, such as restaurants, schools, and distributors, by the Company’s sales staff and through brokers selected by the Company.

All of the Company’s business activities are conducted on a vertically integrated basis within one industry segment, poultry products.  The Company’s various poultry products are closely related, have similar purposes and uses, and are similar in terms of profitability and types and degrees of risks.  In addition, the production processes are similar to the extent that (a) production facilities are shared or are interchangeable and (b) the same types of raw materials, labor, and capital are used.  Markets and marketing methods are comparable for all products to the extent that they are generally sold to the same types of customers by a common sales force and are sensitive to changes in economic conditions to the same degree.

Results of Operations

Net Sales

Revenues for the second quarter were $83.2 million, down 5.0% and pounds sold were down 11.8% reflecting a 13 week period as compared to a 14 week period in the prior fiscal year.  Revenues for the six month period were $161.7 million, down 2.3% and pounds sold were down 7.8% reflecting a 26 week period as compared to a 27 week period in the prior fiscal year.  For the 26 weeks ended October 2, 2010 as compared to the 27 weeks ended October 3, 2009, the Company experienced an increase in sales price for poultry of $0.0246 per pound.

Quoted market prices for products for the second quarter of fiscal 2011 versus the same period last quarter and last year fluctuated as follows:

Cost of sales

Cost of sales for the second quarter were $73.5 million, down 10.1% and pounds produced were down 2.0% reflecting a 13 week period as compared to a 14 week period in the prior fiscal year.  Cost of sales for the six month period were $141.7 million, down 7.7% and pounds produced were up 3.4% reflecting a 26 week period as compared to a 27 week period in the prior fiscal year.  For the 26 weeks ended October 2, 2010 as compared to the 27 weeks ended October 3, 2009, the Company experienced a decrease in cost of sales for poultry of $0.0208 per pound.

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Selling and Delivery

Selling and delivery expenses of $2.7 million increased $380 thousand, or 16.7%, for the 13 weeks ended October 2, 2010 as compared to $2.3 million for the 14 weeks ended October 3, 2009.  This increase is due to a $442 thousand increase in outside storage expenses, from $76 thousand to $518 thousand, during these compared second quarters.  Other changes in selling and delivery expense items amounted to a net decrease of $62 thousand during the two periods.

Selling and delivery expenses of $5.1 million increased $630 thousand, or 14.1%, for the 26 weeks ended October 2, 2010 as compared to $4.5 million for the 27 weeks ended October 3, 2009.  This increase is due to a $682 thousand increase in outside storage expenses, from $117 thousand to $799 thousand, during these compared six month periods.  Other changes in selling and delivery expense items amounted to a net decrease of $52 thousand during the two periods.

General and Administrative

General and administrative expenses of $1.9 million decreased $129 thousand, or 6.5%, for the 13 weeks ended October 2, 2010 as compared to $2.0 million for the 14 weeks ended October 3, 2009.  This decrease is due to several reductions; $203 thousand group medical insurance, $175 thousand insurance, legal and accounting, $94 thousand compensation and related, and $77 thousand various expenses, coupled with a $420 thousand increase in accrued incentive compensation during these compared second quarters.

General and administrative expenses of $4.0 million increased $304 thousand, or 8.3%, for the 26 weeks ended October 2, 2010 as compared to $3.7 million for the 27 weeks ended October 3, 2009.  This increase is due to a $892 thousand increase in accrued incentive compensation combined with several decreases; $128 thousand group medical insurance, $197 thousand insurance, legal and accounting, $139 thousand compensation and related, and $124 thousand various expenses during these compared six month periods.

Interest Expense

Interest expense of $338 thousand was a decrease of $77 thousand, or 18.6%, for the 13 weeks ended October 2, 2010 as compared to $415 thousand for the 14 weeks ended October 3, 2009.  Interest expense of $719 thousand was a decrease of $138 thousand, or 16.1%, for the 26 weeks ended October 2, 2010 as compared to $857 thousand for the 27 weeks ended October 3, 2009.  This is due to average long-term debt decreasing during the two six month periods.  Long-term debt went from $31.5 million to $28.5 million during the six months ended October 3, 2009.  Long-term debt went from $27.7 million to $20.6 million during the six months ended October 2, 2010.

Other Income (Expense)

Other income (expense) was $34 thousand for the 13 weeks ended October 2, 2010 versus $3 thousand for the 14 weeks ended October 3, 2009.  Other income (expense) was $38 thousand for the 26 weeks ended October 2, 2010 versus $5 thousand for the 27 weeks ended October 3, 2009.  The $34 thousand in the 13 weeks ended October 2, 2010 was due to minor recoverys of written-off receivables and small gains on fixed asset disposals.

Income Taxes

Income tax expense was $1.7 million, or 36.0% of pre-tax income of $4.8 million for the 13 weeks ended October 2, 2010 and $3.7 million, or 36.0% of pre-tax income of $10.3 million for the 26 weeks ended October 2, 2010.  Income tax expense was $388 thousand, or 36.0% of pre-tax income of $1.1 million for the 14 weeks ended October 3, 2009 and $1.1 million, or 36.0% of pre-tax income of $3.1 million for the 27 weeks ended October 3, 2009.  All income tax expense of these periods was

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charged against deferred tax assets, as none is currently payable due to the Company’s federal and state net operating loss and tax credit carryforwards.

As of the fiscal year ended April 3, 2010, the Company had federal net operating loss carryforwards of $12.7 million and federal and state tax credit carryforwards of $9.4 million.  The net operating loss and tax credit carryforwards are available to reduce income taxes through 2029.  Realization of these future tax benefits is dependent on the Company’s ability to generate sufficient taxable income within the carryforward period.  Due to the significant amount of income that would be needed to fully utilize the credits available, the Company has recorded a valuation allowance for a significant portion of the deferred tax asset associated with the tax credit carryforwards.  The Company expects to fully utilize the federal and state net operating loss carryforwards and, accordingly, there is no valuation allowance associated with the net operating loss carryforwards.

The Company uses ASC 740-10, “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the consolidated financial statements.  ASC 740-10 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The Company had no significant unrecognized tax benefits at the date of adoption or as of the fiscal year ended April 3, 2010.  Accordingly, the Company does not have any interest or penalties related to uncertain tax positions.  However, if interest or penalties were to be incurred related to uncertain tax positions, such amounts would be recognized in income tax expense.  Tax periods for all years after 2006 remain open to examination by the federal and state taxing jurisdictions to which it is subject.

Financial Condition and Liquidity

As of October 2, 2010, the Company’s working capital was $19.4 million and its current ratio was 1.65.  The Company’s working capital as of the year ended April 3, 2010 was $16.8 million and its current ratio was 1.62.  As of October 3, 2009, the Company’s working capital was $15.0 million and its current ratio was 1.51.

The Company decreased long-term debt by $2.1 and $7.1 million during the 13 and 26 weeks ended October 2, 2010, respectively.  The Company spent $641 thousand and $3.0 million on capital projects during the 13 and 26 weeks ended October 2, 2010, respectively.  As of October 2, 2010, the Company has remaining availability of $9.9 million on its long-term revolving line of credit facility.

On September 29, 2010, the Company entered into Amendment Number 5 to the long-term revolving line of credit agreement.  There were four primary changes to the existing Agreement between the parties: (1) The maturity date of the $21.0 million portion of the revolving credit facility was extended to March 31, 2013.  (2) The $4.15 million supplemental portion of the revolving credit facility was cancelled at the Company’s request and was fully satisfied by the Company.  (3) The capital expenditures covenant as defined in Section 10.10 of the Agreement was increased to $5.5 million from $4.0 million for the fiscal year ending April 2, 2011 and reverts to $4.0 million thereafter.  (4) The release of the Lender’s collateral interest in the Company’s land, building and equipment comprising the Pine Mountain Valley Plant in Harris County, Georgia.  As of October 2, 2010, the Company is in compliance with the long-term revolving line of credit agreement’s covenants.

On November 23, 2009, the Company had entered into Amendment Number 4 to the long-term revolving line of credit agreement, effective as of October 31, 2009.  Two of the primary changes to the existing Agreement between the parties remain in effect: (1) The minimum tangible net worth covenant remained at $30.0 million until July 3, 2010; commencing as of July 4, 2010 and ending on January 3, 2011, the minimum tangible net worth must not be less than $35.0 million at any time; and commencing

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as of January 4, 2011, and at all times thereafter, the minimum tangible net worth must not be less than $40.0 million at any time.  (2) The facility advance rate with respect to eligible inventories was restored to 40% from 60% and the advance rate with respect to eligible receivables is maintained at 80%.  As of October 2, 2010, the Company is in compliance with the long-term revolving line of credit agreement’s covenants.

As of October 2, 2010, and in accordance with the amended long-term revolving line of credit agreement, the lender has issued a $1.0 million letter of credit in favor of a third party related to the Company’s self-insurance workers’ compensation liabilities.

The Company’s inventory and accounts receivable levels support collateralized borrowing of the entire $21.0 million primary revolving master note in the long-term revolving line of credit agreement.  The Company’s $10.1 million principal balance and $1.0 million letter of credit results in $9.9 million of available borrowings on the long-term revolving line of credit as of October 2, 2010.

In addition to the covenants described above, the Company must also comply with certain restrictive covenants associated with the term note payable.  On March 30, 2010, the Company entered into an extension of and covenant revisions to the loan agreement governing the term note payable.  Monthly principal and interest payments of $290 thousand continue through March 1, 2012 with a maturity payment of $6.5 million due on April 1, 2012.  The previous maturity payment was due on April 1, 2011.  The covenants require the Company to maintain (1) a maximum leverage ratio, (2) operating lease expense below certain levels, (3) a minimum current ratio, (4) a minimum fixed charge coverage ratio, (5) a minimum tangible net worth and (6) capital expenditures not to exceed certain limits.  As of October 2, 2010, the Company is in compliance with the term note payable debt covenants.

We expect that cash flow from operations and cash on hand should be sufficient to fund operations, to make all payments of principal and interest when due, and to fund capital expenditures for at least the next twelve months.  We may elect to finance certain capital expenditure requirements through borrowings under our credit facilities or leases.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements and related disclosures 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 the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported.  The Company’s accounting policies involve “critical accounting estimates” because they are particularly dependent on estimates and assumptions made by management about matters that are highly uncertain at the time the accounting estimates are made.  In addition, while we have used our best estimates based on facts and circumstances available to us at the time, different estimates reasonably could have been used in the current period, or changes in the accounting estimates we used are reasonably likely to occur from period to period which may have a material impact on the presentation of our financial condition and results of operations.  We review these estimates and assumptions periodically and reflect the effects of revisions in the period that they are determined to be necessary.  We have disclosed our critical accounting policies in our Annual Report on Form 10-K for the year ended April 3, 2010, and that disclosure should be read in conjunction with this Quarterly Report on Form 10-Q.

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Item 3: Quantitative and Qualitative Disclosures about Market Risk

Risk Factors

Industry cyclicality can affect our earnings, especially due to fluctuations in the commodity prices of feed ingredients and chicken.

Profitability in the chicken industry is materially affected by the commodity prices of chicken and feed ingredients, which are determined by supply and demand factors, which result in cyclical earnings fluctuations.  The production of feed ingredients is positively or negatively affected primarily by weather patterns throughout the world, the global level of supply inventories and demand for feed ingredients, and the agricultural policies of the United States and foreign governments.  In particular, weather patterns often change agricultural conditions in an unpredictable manner.  A sudden and significant change in weather patterns could affect supplies of feed ingredients, as well as both the industry’s and our ability to obtain feed ingredients, grow chickens, and deliver products.  High feed ingredient prices have had a material adverse effect on our operating results in the past. We periodically seek, to the extent available, to enter into advance purchase commitments for the purchase of feed ingredients in an effort to manage our feed ingredient costs.  The use of such instruments may not be successful.

Raw Materials

The primary raw materials used by the Company are corn, soybean meal, and other ingredients; packaging materials; cryogenic materials; and breeder chicks.  The Company believes the sources of supply for these materials are adequate and does not expect significant difficulty in acquiring required supplies.  The major source of supply is the midwestern grain belt of the United States, although local supplies are utilized when available.  Prices for the feed ingredients are sensitive to supply fluctuations worldwide, and weather conditions, especially drought, can cause significant price volatility.  Since feed is the most significant factor in the cost of producing a broiler chicken, those fluctuations can have significant effects on margins.  The Company also purchases poultry products from outside vendors for further processing requirements.

The Company may choose to utilize derivatives as offered on the Chicago Board of Trade for the purpose of protecting the feed cost for fixed price sales commitments negotiated with our customers.  The Company’s two primary feed ingredients are corn and soybean meal.  A $0.10 per bushel price change in corn or a $10 per ton price change in soybean meal impacts our cost of sales $0.75 million dollars per year.  The Company currently has no commodity contracts.

Interest Rates

We currently have a term note payable with no exposure to interest rate fluctuations, as our existing indebtedness carries a fixed interest rate.  We have a revolving credit facility which carries a variable interest rate equal to the 90-day LIBOR rate published by the Wall Street Journal, plus 3.5%.

The Company had variable interest rate exposure on the revolving credit facility at October 2, 2010.  The Company’s theoretical interest rate exposure on variable rate borrowings at October 2, 2010, would be, with a one percentage point increase in average interest rates on the Company’s borrowings would increase future interest expense by $8.4 thousand per month and a two percentage point increase would increase future interest expense by $16.9 thousand per month.  The Company determined these amounts based on $10.1 million of variable rate borrowings at October 2, 2010, multiplied by 1.0% and 2.0%, respectively, and divided by twelve.  The Company is currently not using any interest rate collars, hedges, or other derivative financial instruments to manage or reduce interest rate risk.  As a result, any increase in interest rates on the Company’s variable rate borrowings would increase interest expense and reduce net income.

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Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables or other financial instruments with a variety of customers and cash and cash investment deposited with financial institutions.

Concentrations of credit risk, with respect to accounts receivable and other financial instruments, are limited because a large number of geographically diverse customers make up the Company’s customer base, thus spreading the trade credit risk.  The Company controls credit risk through credit approvals, credit limits and monitoring procedures.  The Company performs ongoing credit evaluations of its customers, but generally does not require collateral to support accounts receivable.

Item 4.  Controls and Procedures

Evaluation of disclosure controls and procedures

The term “disclosure controls and procedures” (defined in SEC Rule 13a-15(e)) refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within required time periods. The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report (the “Evaluation Date”).   Based on that evaluation, management, including the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, such controls and procedures were effective.

Changes in internal controls

The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers to the process of a company that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, have evaluated any changes in the Company’s internal control over financial reporting that occurred during the period covered by this quarterly report, and they have concluded that there was no change to the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II.  OTHER INFORMATION

Item 1.  Legal Proceedings

The Company is routinely involved in various lawsuits and legal matters on an ongoing basis as a result of day to day operations; however, the Company does not believe that the ultimate resolution of these matters will have a material adverse effect on the Company or its business.

Item 1.A.  Risk Factors

Leverage

Our indebtedness could adversely affect our financial condition.  We presently have, and expect to continue to have, an amount of indebtedness.  Our indebtedness could have important consequences to stockholders.  For example, it could: increase our vulnerability to general adverse economic conditions; require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and for other general corporate purposes; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; place us at a competitive disadvantage compared to our competitors that have less debt; limit, along with the financial and other restrictive covenants in our indebtedness, our ability to borrow additional funds, and failing to comply with those covenants could result in an event of default or require redemption of indebtedness.  Either of these events could have a material adverse effect on us.  Our ability to make payments on and to refinance our indebtedness will depend on our ability to generate cash in the future, which is dependent on various factors.  These factors include the commodity prices of feed ingredients and chicken and general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control.

Additional Borrowings Available

Despite our indebtedness, we are not prohibited from incurring additional indebtedness in the future.

Contamination of Products

If our products become contaminated, we may be subject to product liability claims and product recalls.

Livestock and Poultry Disease

Outbreaks of livestock diseases, in general, and poultry disease, in particular, can significantly restrict our ability to conduct our operations.  We take all reasonable precautions to ensure that our flocks are healthy and that our processing plants and other facilities operate in a sanitary and environmentally sound manner.  However, events beyond our control, such as the outbreak of disease, could significantly restrict our ability to conduct our operations.  Furthermore, an outbreak of disease could result in governmental restrictions on the import and export of our fresh chicken, to or from our suppliers, facilities, or customers, or require us to destroy one or more of our flocks.  This could result in the cancellation of orders by our customers and create adverse publicity that may have a material adverse effect on our ability to market our products successfully and on our business, reputation, and prospects.

Insurance

We are exposed to risks relating to product liability, product recall, property damage, and injuries to persons for which insurance coverage is expensive, limited, and potentially inadequate.

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Significant Competition

Competition in the chicken industry with other vertically integrated poultry companies could adversely affect our business.

Government Regulation

Regulation, present and future, is a constant factor affecting our business.  The chicken industry is subject to federal, state, and local governmental regulation, including health and environmental areas.  We anticipate increased regulation by various agencies concerning food safety, the use of medication in feed formulations, and the disposal of poultry by-products and wastewater discharges. Unknown matters, new laws and regulations, or stricter interpretations of existing laws or regulations may materially affect our business or operations in the future.

Deterioration of Economic Conditions

Our business may be adversely affected by changes in national or global economic conditions, including inflation, interest rates, availability of capital markets, consumer spending rates, energy availability and costs (including fuel surcharges) and the effects of governmental initiatives to manage economic conditions.  Any such changes could adversely affect the demand for our poultry products, or the cost and availability of our needed raw materials and packaging materials, thereby negatively affecting our financial results.

The recent disruptions in credit and other financial markets and deterioration of national and global economic conditions, could, among other things:

Changes in Consumer Preference

The food industry in general is subject to changing consumer trends, demands, and preferences.  Trends within the food industry change often, and failure to identify and react to changes in these trends could lead to, among other things, reduced demand and price reductions for our products, and could have an adverse effect on our financial results.

The Loss of One or More of Our Largest Customers

Our business could suffer significant set backs in sales and operating income if our customers’ plans and/or markets should change significantly, or if we lost one or more of our largest customers.   Many of our agreements with our customers are generally short-term, primarily due to the nature of our products, industry practice, and the fluctuation in demand and price for our products.  One of our largest customers did not renew their sales contract for calendar 2010.  However, the Company has been able to attract new contract-based customers of similar volume that will approximate this former customer’s sales volume.  These new customers should provide a market for our products without a significant deterioration in operating income.  We continually monitor our production output and will adjust accordingly.

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Item 6.  Exhibits

3.1 Articles of Incorporation of the Registrant.  (2)

3.2 Bylaws of the Registrant.  (3)

14.1 Code of Ethics.  (4)

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a).  (1)

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a).  (1)

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.  (1)

32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.  (1)

(1) Filed herewith.

(2) Previously filed and incorporated by reference herein from the Registrant’s Form 10-K for the year ended April 2, 2005.

(3) Previously filed and incorporated by reference herein from the Registrant’s Form 10-Q for the quarter ended October 2, 2004.

(4) Previously filed and incorporated by reference herein from the Registrant’s Form 10-K for the year ended April 3, 2004.

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.

Cagle’s, Inc.  (Registrant)

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