PART 1—FINANCIAL INFORMATION

See accompanying notes

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** Includes defeasance paid to retire real estate loans

See accompanying notes

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Natrol, Inc. and Subsidiaries

The total fair value of unvested options as of September 30, 2007 was $753,947. The aggregate intrinsic value of unvested options as of September 30, 2007 was $0.0.

The following summarizes the fair value of the Company’s unvested stock options that vested during the nine months ended September 30, 2007.

The Black-Scholes option-pricing model is used by the Company to determine the weighted average fair value of options, except for the options granted to Wayne Bos. The fair value of options at date of grant and the assumptions utilized to determine such values are indicated in the following table:

These assumptions resulted in a weighted-average fair value of $1.30 and $0.89 respectively, for each stock option valued using the Black-Scholes method and granted in each of the nine month periods ended September 30, 2007 and 2006.

The value of inventory in the quarter was affected by a write down of the value of hoodia material of approximately $800,000.

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4. SHIPPING AND HANDLING COSTS

The Company records all amounts charged to customers for shipping and handling as revenue. All outbound shipping and fulfillment costs are classified as selling and marketing expenses and totaled approximately $0.8 and $2.4 million for the three and nine month periods ending September 30, 2007 and approximately $0.9 and $2.5 million in the three and nine month periods ended September 30, 2006.

5. EARNINGS PER SHARE

The Company calculates income per share in accordance with Statement of Financial Accounting Standard No. 128, Earnings per Share . Basic earnings per share have been computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share have been computed by dividing net income by the weighted average number of common shares and dilutive common stock equivalents (stock options), when dilutive.

As of the three and nine month periods ending September 30, 2007 and 2006, the following options were outstanding and considered anti-dilutive.

For the three months ended September 30, 2007, all outstanding options were considered anti-dilutive because of the Company’s net loss for the period.

6. SENIOR CREDIT FACILITY

The Company is party to a loan and security agreement with Wachovia Capital Finance (Western), as agent, the lenders party thereto, Prolab Nutrition, the Company’s wholly owned subsidiary, and certain of its other subsidiaries, as guarantors. The loan agreement provides for a three-year secured revolving credit facility of up to $10.0 million. Borrowings under the credit facility may be used for ongoing working capital purposes and certain future acquisitions. At September 30, 2007, the Company had no borrowings outstanding under the credit facility.

Under the credit facility, the Company may borrow up to the lesser of $10.0 million or the borrowing base (calculated based upon eligible inventory and eligible accounts). The interest rate on borrowings under the credit facility is equal to: (1) agent’s publicly announced prime rate for prime rate loans or (2) 2.25% plus the applicable Eurodollar rate for any Eurodollar rate loans. Interest is payable monthly in arrears not later than the first day of each calendar month. The agent’s prime rate as of September 30, 2007 was 8.25%. The credit facility requires that all principal be repaid in August 2009. Additionally, borrowings under the credit facility must be repaid when the borrowings exceed the borrowing base.

The credit facility is secured by a first priority lien on all of the Company’s assets and properties (which includes the assets and properties of Prolab Nutrition, the guarantors and the Company’s future subsidiaries), subject to certain exceptions. The obligations under the credit facility are guaranteed by Natrol Products, Inc., Natrol Acquisition Corp. and Natrol Direct, Inc. and by each of the Company’s future subsidiaries.

The credit facility contains covenants restricting the Company’s ability to, among other things: (1) incur or guarantee additional debt; (2) engage in any mergers or acquisitions (subject to certain exceptions); (3) engage

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in any asset sales or dispose of any assets (other than in the ordinary course); (4) engage in transactions with affiliates; (5) incur liens; (6) make any loans or investments; and (7) declare or pay dividends or redeem or repurchase capital stock.

The credit facility also provides for customary events of default, including non-payment defaults, covenant defaults and cross-defaults to the Company’s other material indebtedness.

As of September 30, 2007, the Company was in default under certain covenants in the credit facility related to investments in new businesses. The Company cannot borrow under the line of credit until Wachovia agrees to waive the event of default and forbear from exercising its default rights. We expect the Company’s ability to borrow against the line of credit to be reinstated in the normal course of review.

7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS.

The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) in June 2006. The interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with Statement of Financial Accounting Standard 109. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, “Accounting for Income Taxes”, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Based on our evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements. Our evaluation was performed for the tax years ended December 31, 2003, 2004, 2005 and 2006, the tax years which remain subject to examination by major tax jurisdictions as of September 30, 2007.

We may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results. In the event we received an assessment for interest and/or penalties, it was classified in the financial statements as “selling, general and administrative expense”.

In February 2007, the FASB issued Statement of Financial Standard No. 159, “ The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115 ” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with unrealized gains and losses related to these financial instruments reported in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact this Statement will have on our consolidated financial statements.

8. FINAL RULE FOR CURRENT GOOD MANUFACTURING PRACTICES FOR DIETARY SUPPLEMENTS

On June 22, 2007, the Food and Drug Administration (“FDA”) issued its final regulations establishing the minimum Current Good Manufacturing Practices (“CGMPs”) necessary for activities related to manufacturing, packaging, labeling, or holding operations for dietary supplements. The final rule applies to all dietary supplements sold or offered for sale in the United States and requires manufacturers to evaluate the identity, purity, strength, and composition of their dietary supplements. An Interim Final Rule has also been issued to allow manufacturers to petition the FDA for an exemption to the 100 percent identity testing requirement for dietary ingredients to be used in dietary supplements; provided that they demonstrate that less than 100 percent identity testing does not materially diminish the assurance that the dietary ingredient is correctly identified. The final CGMP and the interim final rule are effective August 24, 2007 and the compliance date is June 2008, except

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that businesses like the Company that employ fewer than 500 but at least 20 or more full-time equivalent employees have until June 2009 to comply with the regulation. We are currently evaluating the potential impact that the new regulations and any applicable exemptions may have on the Company’s financial position, results of operations, or cash flows.

9. ACQUISITION OF MEDICAL RESEARCH INSTITUTE, INC. (MRI)

On June 1, 2007, we acquired all of the outstanding stock of Medical Research Institute, Inc. for $8.6 million of cash and up to an additional $80.0 million in cash based upon the Earnings Before Interest and Taxes (EBIT), as defined, of MRI during the three years after the acquisition date. The Company allocated the purchase price per SFAS 141 to the fair value of the assets acquired, net of liabilities assumed. Because the net assets acquired were greater than the cash paid, the value of certain fixed assets were adjusted per SFAS 141. These assets will be adjusted should any additional payments be made to the former owners of MRI.

The only consideration used to acquire MRI was cash.

The following table summarizes the allocations of the consideration to the assets acquired net of liabilities assumed.

If the operating results of MRI had been included since the beginning the nine month period ended September 30, 2007 and 2006, the pro forma revenues, net income and net income per share would be as follows:

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Our prime reason for acquiring MRI was MRI’s premiere position in the sports nutrition marketplace, allowing us to strengthen our position within this area of the nutraceutical business.

The balance sheet of MRI is consolidated with our balance sheet. The statement of income of MRI for the period from June 1, 2007 to September 30, 2007 is consolidated with our statement of income for the three and nine month periods ended September 30, 2007. The statement of cash flows for MRI for the period from June 1, 2007 to September 30, 2007 is included with our statement of cash flows for the nine months ended September 30, 2007.

10. ACQUISITION COMMITMENTS

Nu Hair and Shen Min Brands

Consideration for the acquisition of the NuHair and Shen Min brands includes potential incentive payments based upon the net amount of invoiced sales of the NuHair and Shen Min products during fiscal 2007, 2008 and 2009. For 2007, the Company is obligated to pay the seller of the brands $1.00 (one dollar) for every dollar of net invoiced sales in excess of $7.6 million, calculated on a quarterly basis. The potential incentive payment for 2007 may not exceed $2.0 million. For 2008, the Company is obligated to pay the seller 15% of the amount by which net invoiced sales exceed $11.4 million. For 2009, the Company is obligated to pay the Seller 15% of the amount by which net invoiced sales exceed $13.7 million. As of September 30, 2007, we do not believe that the incentive payments to the former owners of the NuHair and Shen Min brands will be material as net invoiced sales for the nine months ended September 30, 2007 amounted to slightly less than $5.8 million.

Promensil and Trinovin

Consideration for the license of the exclusive U.S. rights to the Promensil and Trinovin brands includes a royalty on net sales revenue that exceeds $2.0 million. Until 2014, the Company is obligated to pay Novogen a royalty equal to 5.0% of annual net sales between $2.0 to $3.0 million and a royalty equal to 7.5% of annual net sales in excess of $3.0 million. After 2014, the Company is obligated to pay Seller a royalty equal to 2% of annual net sales between $2.0 to $3.0 million and a royalty equal to 3.0% of annual net sales in excess of $3.0 million. During the nine months ended September 30, 2007, net sales revenue of the Promensil and Trinovin brands amounted to $1.7 million and, as a result we do not believe that the incentive payments to the licensor will be material.

Medical Research Institute

Consideration for the acquisition of MRI, includes incentive payments that would allow the former owners of MRI to earn an additional $80.0 million if the earnout conditions are met.

Year one incentives.

If earnings before interest and taxes prior to general corporate allocations for the twelve (12) month period following the Closing Date (“ Year One EBIT ”) is between $2.5 million and $4.0 million, the former owners of MRI will be paid an incentive payment of between $4.7 million and $7.5 million. As of September 30, 2007 we believe that it is highly likely that an incentive payment will be made and that the amount will be at the mid to higher end of the range.

Also, if Year One EBIT reaches $5.0 million, additional incentives may be earned by the former owners of MRI. These incentives begin at $5.0 million and could exceed $21.5 million depending upon EBIT performance. As of September 30, 2007, it is uncertain as to whether the $5.0 EBIT level will be reached and, as such it is uncertain as to whether an additional incentive payment will be made.

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Year two and three incentives.

Year two and year three incentive payments are described more fully in our other filings with the SEC. In order to earn incentives in year two, EBIT for year two, as defined, must reach $6.5 million. In order to earn incentives in year three, EBIT for year three as defined must reach $14.0 million. Total incentive payments for the three years in which incentives can be earned could total as much as $80.0 million if all incentive payment conditions are met.

11. SALE AND LEASEBACK TRANSACTION

In April 2007 the company sold its manufacturing and distribution facilities in Chatsworth, California for $26 million, giving rise to a gain of approximately $12 million. Since the facilities are leased back from the buyer, $5.5 million of the gain is deferred and recognized over the lease term, in accordance with SFAS No. 13 and 98. The $6.1 million balance of the gain in excess of the net present value of the lease payments, was recognized upon the sale. During the three months ended September 30, 2007, we offset approximately $92,000 of the future lease benefits against our lease expense, thereby lowering our lease expense.

The forward-looking statements contained in this report are made as of the date of this report, and we assume no obligation to update or revise them to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time or to update the reasons why actual results could differ from those projected in these forward-looking statements.

OVERVIEW

General

We manufacture and market branded, high-quality dietary supplements, herbal teas, and sports nutrition products under seven primary brands: Natrol®, Laci Le Beau®, Prolab®, Nu Hair® , Shen Min®, Promensil® and MRI. Through our Essentially Pure Ingredients® (EPI) division we also sell nutraceutical grade ingredients to other manufacturers of nutrition products and provide contract manufacturing services to companies within the nutraceutical industry.

The majority of our dietary supplements are sold under the Natrol brand, but we are continuing to acquire new brands that we expect will eventually contribute significantly to our product mix sales. Our Natrol brand focuses on supplements that are in high demand as well as specialty niche and proprietary formulations that have potentially strong margins. These supplements include vitamins, minerals, hormonal supplements, herbal products and specialty combination formulas that contribute to an individual’s physical and mental well-being. On June 1, 2007, we acquired Medical Research, Inc, (MRI) which develops and markets products under the MRI brand. Our MRI brand supplies high-quality sports nutrition products including CE2®, NO2®, Pro-Nos(TM) and Anabolic Switch(TM). These products are primarily designed to enhance the workout performance of athletes.

The key elements of our business strategy are to

•                   Control our cost and improve margins;

•                   Develop or acquire new products and product lines that can help us capitalize upon our infrastructure;

•                   Expand the distribution of our products to new markets, including internationally; and,

•                   Improve the marketing of our products.

Management Overview

During the third quarter of 2007, we recorded a net loss of approximately $3.2 million. There are many reasons for the loss, but the most significant causes reflect specific events that management considers uncommon in the ordinary course of business.

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In 2006, we entered into an exclusive manufacturing and distribution arrangement with H57 Nutrition for Original South African H57™ Hoodia (“H57”). During 2007, sales of H57 were far less than anticipated and we made the decision to limit future losses by immediately taking steps to reduce the Company’s exposure in connection with the hoodia business. As a result, we expensed approximately $2.3 million during the quarter related to the promotional cost of reducing inventories at customer locations, anticipated future returns, impairment charges for raw material inventory with current value less than when purchased, and the write off of an advance payment to the owners of H57 Nutrition that we have concluded is not collectible. These expenses reduced our gross margin approximately $1.7 million or 7.0% and increased our general and administrative expenses by $620,000.

During the third quarter we also increased our reserves by approximately $1.8 million because one of our larger customers reduced our product set. The reduction negatively affects revenue by approximately $2.0 million on an annualized basis or 2.5% of our business. The reserves are for anticipated returns and promotional expenses we expect to incur in connection with the elimination of inventory at the retailer. This expense reduced our gross margin in the third quarter by approximately 5.9%.

As noted in our past filings our customers generally do not have an absolute right to return product, but, as a practical business matter, we often work with customers and accept returns as we try to obtain new placements for different products that can replace revenue lost due to discontinuations. We regularly monitor our historical patterns of returns from customers as well as current and ongoing sales to customers and, when information is available, consumer purchases of the Company’s products from our customers.

In order to reduce the amount of subjectivity when analyzing sales trends and reserving for future returns, we perform a detailed analyses of trends at each of our major customers, i.e., those customers who have historically accounted for the bulk of returns. This analyses takes into account sales patterns of individual products at each customer on a customer-by-customer basis as well as: inventory levels at the customer, scheduled promotional events, and the probability that items will be discontinued. And, we believe that this analysis provides appropriate estimates of necessary future reserves. The Company’s use of the term returns includes estimates of its liability for damaged and outdated product within its channels of trade.

Unfortunately, the reduction in the product set that occurred during the third quarter of 2007, did not, in our estimation, follow patterns that have been well established for many years. However, in following our policy of reserving for the impact of negative financial events as soon as the impact is estimatable, we expensed the full impact of the item discontinuations in the third quarter of 2007.

A third factor affecting the quarter was legal expenses. The Company settled its last unresolved suit involving ephedrine-based products and incurred legal costs in connection with that case, as well as in connection with a number of business transactions involving the Company during the third quarter. Combined, those events resulted in legal expenses of approximately $725,000. Our policy is to expense the cost of legal settlements as soon as they can be reasonably estimated and attorney’s fees and costs as soon as incurred.

Despite the Company’s poor overall performance, gross shipments in the quarter increased 47.4% when compared to the third quarter of 2006, or $8.6 million. Approximately $6.5 million of the increase was due to the acquisition of MRI. Natrol’s gross shipments declined $1.4 million due to a decrease of $1.9 million in Ester-C sales, a product line we will be unable to sell after March 2008. Prolab shipments, including the sales of Prolab products by our subsidiary in the United Kingdom, increased approximately $1.3 million in the quarter. The balance of the growth in shipments was due to the NuHair, Shen Min, Promensil and Trinovin brands that were acquired in October of 2006.

Compared to the third quarter of 2006, net sales revenue in the quarter grew 24.3%, versus the 47.4% increase in shipments, due to the expenses recorded for H57 and the reduction in our vitamin set described above.

As noted, our gross margins were reduced approximately 10.9% due to the above-described events. We expect our margins to return to historical norms in future quarters.

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Overall, general and administrative expenses increased $2.3 million when compared to the third quarter of 2006. Approximately $1.0 million of the increase was due to the acquisition of MRI. Net of the $0.7 million extra legal cost outlined above and the $0.6 million charge for H57, general and administrative expenses were approximately the same during the third quarter of 2007 as in the third quarter of 2006, despite the addition of the NuHair, Shen Min, Promensil and Trinovin brands.

Total selling and marketing expense were $2.0 million greater in the third quarter of 2007 than in the third quarter of 2006. Approximately $0.6 million was due to the acquisition of MRI, $0.5 million was due to the acquisition of the NuHair, Shen Min and Promensil brands, $0.3 million was due to increased Prolab expenditures in the UK and the United States, and the remainder was due to increased advertising and coop spending on the Natrol brands.

The largest immediate challenges for our business include: continuing to managing through the loss of our Ester-C business; to replace the revenue lost from the reset of our shelf space noted above; to fully integrate MRI; and, to identify products and product lines that would positively affect the business if acquired or developed internally. We will continue to work to improve internal efficiencies and to strengthen our core business by following our business plan.

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Results of Operations

THREE MONTHS ENDED SEPTEMBER 30, 2007 AND SEPTEMBER 30, 2006

NET SALES. We recognize revenue from sales only after product is shipped. We have no consignment sales. Net sales represent product shipped less actual and estimated future returns, spoilage allowances, allowances for product deemed to be unsaleable by customers, free goods shipped to customers for promotional or other purposes, rebates, slotting fees and other promotional expenditures. Estimates and allowances are based upon known claims and an estimate of additional returns when the amount of future returns from customers can be reasonably estimated.

Net sales increased 22.3%, or $3.5 million, to $19.2 million for the three months ended September 30, 2007 from $15.7 million for the three months ended September 30, 2006. Increased sales of $7.3 million from the acquired NuHair, Shen Min, Promensil and MRI brands and an increase in Prolab product sales of approximately $1.2 million were partially offset by a decline in the remaining Natrol segment business. Natrol’s net revenue was affected by returns in the quarter, accruals for promotional activity instituted to reduce the economic impact of returns, as well as a decline of $1.9 million in Ester-C sales. Ester-C is being discontinued because the supplier of Ester-C will no longer sell raw material to us after March 2008. Returns were $2.3 million more in the third quarter of 2007 than in the third quarter of 2006. The primary reason is a reduction of the number of items that will be carried by one of our customers in 2008. The items involved, accounted for approximately 2.5% of invoiced revenue during the 12 months ended September 30, 2007. A second, but important reason for the high returns were accruals for the eventual return of H-57 hoodia.

GROSS PROFIT. Gross profit declined 9.0%, or $0.6 million, to $6.1 million for the three months ended September 30, 2007, from $6.7 million for the three months ended September 30, 2006. Gross margin decreased to 31.5% for the three months ended September 30, 2007, from 42.7% for the three months ended September 30, 2006. The decrease was primarily due to the large difference in the quarter between gross revenue and net revenue caused by large accruals promotional expenditures and returns for the reasons noted in the overview section of this document. Those accruals due to H57 hoodia reduced the gross margin 7.0% and accruals due to the reduction of the number of items being carried from a significant customer reduced the gross margin by 5.9%.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist primarily of advertising and promotional expenses, costs of distribution, and related payroll expenses and commissions. Selling and marketing expenses increased 54.7%, or $2.1 million, to $5.9 million for the three months ended September 30, 2007, from $3.8 million for the three months ended September 30, 2006. Selling and marketing expenses increased approximately $1.2 million due to increased staffing and promotion required by our MRI, NuHair, Shen Min, and Promensil acquisitions and the establishment of a subsidiary in the United Kingdom. The remainder of the increase was primarily due to additional cooperative advertising expenditures in the mass market channel of trade.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of personnel costs related to general management functions, finance, accounting and information systems, as well as professional fees related to legal, audit and tax matters and depreciation. General and administrative expenses increased 88.3%, or $2.3 million to $5.0 million for the three months ended September 30, 2007 from $2.7 million for the three months ended September 30, 2006. The settlement of the last of the ephedrine based lawsuits against the Company and other transactional legal fees accounted for $0.7 million of the increase; the write down as a bad debt of an advance payment to the owners of the H-57 brand accounted for $0.6 million of the increase; and, the acquisition of NuHair, Shen Min, Promensil, and MRI accounted for a $1.1 million increase in general and administrative expenses. These increase were offset slightly by miscellaneous other savings.

INTEREST EXPENSE. We recorded interest expense of $18,000 for the three months ended September 30, 2007 as compared to interest expense of $149,000 for the three months ended September 30, 2006. The decrease was due to the low level of debt during the quarter.

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INCOME TAX EXPENSE. Our effective tax rate was 35.2 % in the three months ended September 30, 2007 and 45.2% in the three months ended September 30, 2006. The differences are primarily due to the different levels of income and loss and the relative differences in deductible and non-deductible items relative to the overall level of income or loss.

NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO SEPTEMBER 30, 2006

Net sales increased 16.9%, or $8.3 million, to $57.5 million for the nine months ended September 30, 2007 from $49.2 million for the nine months ended September 30, 2006. Sales of $14.0 million from the acquired NuHair, Shen Min, Promensil and MRI brands and an increase in our Prolab business of $0.8 million, were partially offset by a declines in other segments of our business. We sold $2.6 million less Ester-C during the first three quarters of 2007 and in the first three quarters of 2006. During the same period, net sales from our EPI division has fallen

GROSS PROFIT. Gross profit increased 16.1%, or $3.3 million, to $24.1 million for the nine months ended September 30, 2007 from $20.8 million for the nine months ended September 30, 2006. Gross margin decreased to 42.0% for the nine months ended September 30, 2007 from 42.3% for the nine months ended September 30, 2006. Although the gross margin for the nine months ended September 30, 2007 was essentially the same as for the nine months ended September 30, 2006, it is substantially lower than the gross margin for the six months ended June 30, 2007 due to the events of the third quarter when return and promotional expenses increased the difference between gross sales and net revenue. Also affecting our gross margin was the write down of our hoodia inventory which caused us to expense $1.1 million to cost of goods sold during the nine months ended September 30, 2007.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased 37.4%, or $4.5 million, to $16.5 million for the nine months ended September 30, 2007 from $12.0 million for the nine months ended September 30, 2006. Selling and marketing expenses increased approximately $2.8 million due to our acquisitions and the establishment of a subsidiary in the United Kingdom. Prolab marketing expenditures increased $0.4 million and the balance of the increase was a result of increased cooperative advertising for the Natrol brand.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 32.8%, or $2.7 million to $11.0 million for the nine months ended September 30, 2007 from $8.3 million for the nine months ended September 30, 2006. Legal expenses during the third quarter accounted for $0.7 million of the increase and expenses for H-57 including the bad debt of $0.6 million recorded in the third quarter also accounted for $0.7 million. Our acquisitions and the establishment of a subsidiary in the UK accounted for another $1.6 million of additional expenditures. These increases were offset by savings in other areas.

INTEREST EXPENSE. We recorded interest expense of $309,000 for the nine months ended September 30, 2007 as compared to interest expense of $456,000 for the nine months ended September 30, 2006. The decrease was due to the reduction of our debt.

INCOME TAX EXPENSE. Our effective tax rate was 46.5% in the nine months ended September 30, 2007 and 42.2% in the nine months ended September 30, 2006. The differences are primarily due to the different levels of income and loss and the relative differences in deductible and non-deductible items relative to the overall level of income or loss.

SALE OF BUILDINGS. During the first nine months of 2006, we sold a building we owned in Bloomfield, Connecticut that was formerly used as a shipping facility for our Prolab brand. The approximate net book value of the property, plant and plant improvements that were sold was $759,000 and the gain, net of brokerage, legal and other related expenses was approximately $230,000.

In April 2007, we sold our 94,000 square foot manufacturing, distribution and office facility and our 132,000 square foot shipping facility both located in Chatsworth, California. The sales price for the properties was $26.0 million. After paying expenses associated with the transaction, taxes, and extinguishing the mortgage debt on the

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buildings, we netted approximately $12.0 million in cash. We recorded a gain of approximately $6.1 million and a future lease benefit of $5.5 million, which will be amortized over 5 years.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2007, we had working capital of $24.6 million as compared to $12.1 million in working capital at December 31, 2006. Our cash balance at September 30, 2007 was approximately $5.9 million.

Operating Activities

Net cash used by operating activities was $6.8 million for the nine months ended September 30, 2007 compared to net cash provided of approximately $2.4 million for the nine months ended September 30, 2006. Cash used by operating activities during the nine months ended September 30, 2007 consisted of our profit of $1.3 million offset by non-cash charges of $4.7 million and by cash used because of changes in operating assets and liabilities of $3.4 million.

During the nine months ended September 30, 2007, non-cash charges for depreciation and amortization had the effect of providing $0.9 million of cash, the expensing of stock options provided $0.4 million of cash, and a small increase in the provision for bad debts and foreign currency translation had the effect of providing $0.1 million. The gain on the sale of our property of $6.1 million had the effect of using cash. This use was offset by the proceeds for the sale of the property of $26.0 million described under investing activities.

Cash used by operating assets and liabilities consisted primarily of an increase in accounts payable of $2.5 million, an increase in accrued expenses of $2.3 million, an increase in accrued payroll of $0.4 million, and a decrease in prepaid expenses of $1.1 million, each of which provided cash, offset by a decrease of $2.0 million in income taxes payable, an increase in accounts receivable of $1.1 million and an increase in inventory of $6.8 million. The large changes in accounts receivable, accounts payable and inventory were primarily due to the acquisition of MRI.

Investing Activities

Net cash provided by investing activities was $21.8 million for the nine months ended September 30, 2007 compared to net cash provided of $0.4 million during the nine months ended September 30, 2006. During the nine months ended September 30, 2007, we invested $0.2 million in new equipment and realized $26.0 from the sale of property which was partially offset by a net cash outlay of $3.2 million for the acquisition of MRI. The acquisition of other assets used $0.7 million of cash.

Financing Activities

Net cash used by financing activities was $10.2 million for the nine months ended September 30, 2007 compared to cash used of $0.8 during the nine months ended September 30, 2006. During the nine months ended September 30, 2007, we repaid $3.7 million of our line of credit and $6.7 million of our long-term debt. During the nine months ended September 30, 2007, we received $0.2 million from the exercise of stock options. All of our long and short-term debt was extinguished during the nine months ended September 30, 2007 other than a small automobile loan acquired as part of the MRI transaction.

Senior Credit Facility

In August 2006, we entered into a loan and security agreement with Wachovia Capital Finance (Western), as agent, the lenders party thereto, Prolab Nutrition, our wholly owned subsidiary, and certain of our other subsidiaries, as guarantors. The loan agreement provides for a three-year, secured, revolving credit facility of up to $10.0 million. Borrowings under the facility will be used for ongoing outstanding working capital purposes and certain future acquisitions. At September 30, 2007, we had no borrowings under the facility.

Under the credit facility, we may borrow up to the lesser of $10.0 million or the borrowing base

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(calculated based upon eligible inventory and eligible accounts). The interest rate on borrowings under the credit facility is equal to: (1) agent’s publicly announced prime rate for prime rate loans or (2) 2.25% plus the applicable Eurodollar rate for any Eurodollar rate loans. Interest is payable monthly in arrears not later than the first day of each calendar month.

The credit facility requires that all principal be repaid in full on the third anniversary of the closing date. Additionally, borrowings under the credit facility must be repaid when the borrowings exceed the borrowing base.

The credit facility is secured by a first priority lien on all our assets and properties (which includes the assets and properties of Prolab Nutrition, the guarantors and our future subsidiaries), subject to certain exceptions. The obligations under the credit facility are guaranteed by Natrol Products, Inc., Natrol Acquisition Corp. and Natrol Direct, Inc. and by each of our future subsidiaries.

The credit facility contains covenants restricting our ability to, among other things: (1) incur or guarantee additional debt; (2) engage in any mergers or acquisitions (subject to certain exceptions); (3) engage in any asset sales or dispose of any assets (other than in the ordinary course); (4) engage in transactions with affiliates; (5) incur liens; (6) make any loans or investments; and (7) declare or pay dividends or redeem or repurchase capital stock.

The credit facility also provides for customary events of default, including non-payment defaults, covenant defaults and cross-defaults to our other material indebtedness.

As of September 30, 2007, the Company was in default under certain covenants in its credit facility related to investments in new businesses and cannot borrow under the line of credit until Wachovia agrees to waive the event of default and forbear from exercising its default rights. Wachovia is now reviewing the acquisition of Medical Research Institute, Inc. on June 1, 2007, which triggered the event of default. The Company expects its ability to borrow against the line of credit to be reinstated in the normal course of review.

In order to meet our long-term liquidity needs which include the potential payment of certain incentives related to our acquisitions, we may be required to incur additional indebtedness or issue additional equity and debt securities, subject to market and other conditions. There can be no assurance that such additional financing will be available on terms acceptable to us or at all. The failure to raise the funds necessary to finance our future cash requirements or consummate future acquisitions could adversely affect our ability to pursue new acquisitions and could negatively affect our operations in future periods.

We believe that our cash balance together with cash generated from operations and the potential to borrow funds and raise capital should be sufficient to fund our anticipated working capital needs and planned capital expenditures for the next 12 months. However, if we do not meet our operating plan, we may be required to obtain additional borrowings to fund working capital needs.

New Accounting Standards

The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) in June 2006. The interpretation clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with Statement of Financial Accounting Standard 109. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, “Accounting for Income Taxes”, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

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Based on our evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements. Our evaluation was performed for the tax years ended December 31, 2003, 2004, 2005 and 2006, the tax years which remain subject to examination by major tax jurisdictions as of September 30, 2007.

We may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results. In the event we received an assessment for interest and/or penalties, it was classified in the financial statements as “selling, general and administrative expense”.

In February 2007, the FASB issued Statement of Financial Standard No. 159, “ The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115 ” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with unrealized gains and losses related to these financial instruments reported in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact this Statement will have on our consolidated financial statements.

Critical Accounting Policies

Management’s beliefs regarding significant accounting policies have not changed significantly from those discussed in Item 7 of our annual report on Form 10-K for the year ended December 31, 2006.

Attached as exhibits to this Form 10-Q are certifications of the Company’s Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934. This “Controls and Procedures” section includes information concerning the controls and evaluation thereof referred to in the attached certifications, and it should be read in conjunction with the attached certifications for a more complete understanding of the topics presented.