UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-KSB

[X]  Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
     1934 For the Fiscal Year Ended September 30, 2004

[ ]  Transition Report Under Section 13 or 15(d) of the Securities
     Exchange Act of 1934
     For the Transition Period from  ________ to ________

                         Commission file number 0-26362
                                                -------

                          ADVANCED NUTRACEUTICALS, INC.
             ------------------------------------------------------
              (Exact name of small business issuer in its charter)


                  Texas                               76-0642336
     -------------------------------     ------------------------------------
     (State or other jurisdiction of     (I.R.S. Employer Identification No.)
     incorporation or organization)


      106 South University Blvd., Unit 14
             Denver, Colorado                                      80209
     ---------------------------------------                     ----------
     (Address of principal executive office)                     (Zip Code)


         Issuer's telephone number, including area code: (303) 722-4008
                                                             --------------

           Securities Registered Pursuant to Section 12(b) of the Act:

                                                 Name of each
                                                    Exchange
           Title of each Class                 on Which Registered
           -------------------                 -------------------
                  None                                None


           Securities Registered Pursuant to Section 12(g) of the Act:

                           $.01 par value common stock
                           ---------------------------
                                (Title of Class)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 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[]

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]

<PAGE>


The Registrant had revenues of $17,638,850 for its most recent fiscal year ended
September 30, 2004.

The aggregate market value of the voting stock held by non-affiliates of the
Registrant on December 30, 2004 was $5,790,000.

The number of shares outstanding of the Registrant's common stock on December
30, 2004 was 5,097,830.


                       DOCUMENTS INCORPORATED BY REFERENCE

                                 Not Applicable

Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]


                 DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

The Company is including the following cautionary statement in this Annual
Report on Form 10-KSB to make applicable and take advantage of the safe harbor
provision of the Private Securities Litigation Reform Act of 1995 for any
forward looking statements made by, or on behalf of the Company. Forward looking
statements include statements concerning plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements
which are other than statements of historical facts. Certain statements
contained herein are forward looking statements and, accordingly, involve risks
and uncertainties which could cause actual results or outcomes to differ
materially from those expressed in the forward looking statements. The Company's
expectations, beliefs and projections are expressed in good faith and are
believed by the Company to have a reasonable basis, including without
limitation, management's examination of historical operating trends, data
contained in the Company's records and other data available from third parties,
but there can be no assurance that management's expectation, beliefs or
projections will result or be achieved or accomplished. Actual events or results
may differ materially as a result of risks facing the Company. Such risks
include, but are not limited to, changes in business conditions, the general
economy, competition, changes in product offerings, as well as regulatory
developments that could cause actual results to vary materially from the future
anticipated results indicated, expressed or implied, in such forward-looking
statements. The Company disclaims any obligation to update any forward-looking
statement to reflect events or circumstances after the date hereof.


                                     PART I

                         ITEM 1. DESCRIPTION OF BUSINESS

Advanced Nutraceuticals, Inc. ("ANI" or the "Company"),
www.advancednutraceuticals.com or www.anii.cc, a holding company, organized in
March 2000, has one operating subsidiary, Bactolac Pharmaceutical Inc.
("Bactolac"), a private label contract manufacturer of vitamins and supplements.
Information contained on the Company's and its subsidiary's web sites do not
comprise a part of this Form 10-KSB.

Bactolac, located in Hauppauge, New York, was founded in 1995 and is engaged in
the formulation, manufacturing, coating and packaging of encapsulated and
compressed tablets and powder blended vitamins and related nutritional
supplements. To support continuing sales increases at Bactolac, in the fall of
2000, its operations were moved to a state of the art, approximately 32,700
square foot facility. Recent investments in high-tech lab equipment, high speed
manufacturing equipment, in-house thin film coating equipment and flexible
packaging equipment have resulted in faster turn around times and greater
control of the quality and production processes. During the third quarter of
fiscal 2004, Bactolac entered into a five-year lease with an unrelated party for
an additional 29,000 sq. ft. facility, to provide additional manufacturing,

                                        2
<PAGE>

materials handling and lab space in a building adjacent to the existing
facility. Bactolac provides private label contract manufacturing services, with
over 1,000 different formulations of vitamins and supplements to various
companies engaged in the marketing and distribution of vitamins, mineral
supplements, herbs and other health and nutrition consumer products.

Bactolac's growth and profitability have been driven by its reputation for
creating exciting, innovative formulas including weight loss, sport nutrition,
energy products, antioxidants, formulas designed specifically for men, women and
children, stress formulas, relaxation formulas, life extension, immune
enhancement, brain products, cleansing products, cholesterol products, liver
formulas, heart formulas and hundreds of herbal remedies. Additionally, Bactolac
custom formulates products in response to, and in conjunction with, customer
demand. Bactolac strives to provide high quality nutritional products that
promote the health and vitality of its users.

On March 23, 2004, the Company completed the sale of substantially all of the
assets and operations of the Company's subsidiary, ANI Pharmaceuticals, Inc.
("ANIP"), formerly also referred to as ASHCO, to an unrelated third party. The
historical operations and results of the sale transaction of ANIP are accounted
for as a discontinued operation within the accompanying consolidated financial
statements.

The Company's near term strategy is to continue to grow its Bactolac subsidiary,
thereby improving the Company's financial position, generating positive cash
flow, and becoming consistently profitable. The Company believes it can
successfully implement this strategy by continuing in its aggressive efforts to
obtain new customers, focusing on expanded sales opportunities with its existing
customers and through emphasizing its competitive manufacturing operations while
at the same time maintaining a stringent cost containment program. The Company
may also consider strategic acquisition opportunities in the manufacturing and
distribution segments of the nutritional industry. The Company intends to
continue to consider other strategic initiatives to enhance shareholder value.

FINANCIAL INFORMATION ABOUT THE COMPANY'S BUSINESS SEGMENTS

Following the completion of the sale of ANIP in March 2004, the Company now
operates in one segment. Bactolac is a private label contract manufacturer of
vitamins and supplements located in Hauppauge, New York. The Company is
committed to providing high quality products including the application of Good
Manufacturing Practices ("GMP") practices at its facilities. Additional
financial information can be found in ITEM 7, FINANCIAL STATEMENTS.

Vitamin and Supplement Segment

Bactolac manufactures a comprehensive assortment of vitamin, mineral and
nutritional supplement products, which include a variety of vitamins,
glucosumine beta carotene, magnesium, folic acid, calcium and potassium, as well
as various herbs such as Echinacea, St. John's Wort, Ginko Biloba, Saw Palmetto,
Ginseng, and various multivitamin combinations, with no single product
generating a sales concentration.

The Company has the capacity to produce millions of tablets per day using
technologically advanced high-speed manufacturing equipment. During 2002 and
2003 Bactolac increased its production capacity through additional equipment
purchases as well as vertically integrating processes that had previously been
performed by outside subcontractors.

Capital expenditures at Bactolac during 2004 approximated $243,000. Capital
expenditures at Bactolac over the past three years have resulted in
significantly higher production capacity, with shorter production turnaround
times, combined with higher levels of quality control. Bactolac custom
formulates products in response to, and in conjunction with, customer demand.
The Company also has developed a fully automated packaging line and has recently
completed an in-house thin film coating line.

Raw materials used in Bactolac's products consist of nutrient powders,
excipients, empty gelatin capsules, and necessary components for packaging and
distribution of finished vitamin and nutritional supplement products. The
nutrient powders and the empty gelatin capsules are purchased from manufacturers

                                        3
<PAGE>

in the United States and foreign countries. All materials procured by Bactolac
undergo quality control review to ensure conformance to product specification
prior to acceptance and release into materials inventory. To date, the Company
has not experienced any material difficulty in obtaining adequate sources of
supply, and generally a number of suppliers are available for most raw
materials. Although there can be no assurance that adequate sources will
continue to be available, Bactolac believes it should be able to secure
sufficient raw materials in the future.

Bactolac generated net sales of $17,639,000 and $12,794,000 for the years ended
September 30, 2004 and 2003. The top three unrelated customers accounted for
approximately 39% of Bactolac's net sales for each of the fiscal years ended
September 30, 2004 and 2003. Seasonality is generally not a major factor in
Bactolac's business, except that revenues during late summer and fall are
typically slightly higher than other periods. Backlog of open orders at Bactolac
is fairly short term in nature due to quick production turn around, with recent
backlog less than one month's sales.

Customers and Markets

The Company manufactures a broad range of products and uses a variety of methods
to market and sell its products and services including experienced sales
personnel, word of mouth referrals from one customer to another, contract sales
representatives, trade show participation, and press publicity, as well as web
site exposure and reliance on name recognition and long standing reputation in
the industry.

Bactolac's customer base includes a wide range of distribution alternatives.
Customers include direct marketing companies, network-marketing companies,
retail chain distribution and customers who re-package bulk products for re-sale
to others. During the current fiscal year, Bactolac concentrated on increasing
its customer base through expanded marketing and sales efforts, including
developing marketing materials in addition to commencing attendance at trade
shows.

The Company's operations are subject to the risks normally associated with
manufacturing vitamins and nutritional products, including shortage of certain
raw materials.

Financial Information Relating to Export Sales - Continuing Operations:

For the year ended September 30, 2004, sales to unaffiliated customers totaled
$17,639,000. Of this total, $1,123,000 related to customers in Russia. For the
year ended September 30, 2003, sales to unaffiliated customers totaled
$12,794,000. Of this total, $574,000 related to a customer in Russia. All
identifiable assets as of September 30, 2004 were located in the United States.


Research and Development

The primary areas of the Company's research and development activities are
focused in working with customers in the development of new products and
expansion of the product line offerings for the private label market. Such
assistance is normally in the form of product component identification and
formulation, as well as product and packaging trends. In addition, as part of
its quality control procedures, the Company produces pilot or sample runs of
product formulation prototypes to ensure stability and/or efficacy and to
determine ingredient interaction. The Company has implemented quality control
procedures to verify that all products comply with established specifications
and standards in compliance with both United States Pharmacopoeia ("USP") and
GMP promulgated by the Food and Drug Administration ("FDA"). Research of this
type is a part of the internal overhead operating expenses incurred by the
Company and the associated incremental outside costs of research and development
activities have not been significant to date.

                                        4
<PAGE>

Competition

The Company's products are sold primarily in domestic as well as limited foreign
markets in competition with other private label manufacturing and marketing
companies. The vitamin and nutritional supplement industries are highly
competitive, and competition continues to increase. Competition for the sale of
products comes from many sources, including companies that sell nutraceuticals
to supermarkets, large chain discount retailers, drug store chains and
independent drug stores, health food stores, and others who sell to wholesalers,
as well as mail order vendors, electronic commerce and network marketing
companies. The Company does not believe it is possible to accurately estimate
the number or size of its many competitors, as the vitamin industry is largely
privately held and highly fragmented.

The Company believes the industries it operates in continue to see significant
changes through merger and acquisition consolidations, as well as contractions
due to a general slowing of the prior growth trend. Many industry experts expect
this trend to continue for the foreseeable future in food and nutrition
companies, multilevel marketing and direct marketing organizations and
electronic commerce firms.

Based on industry data, the botanicals and supplements industry is experiencing
a trend of slowed to contracting growth. The industry, while still estimated at
approximately $20 billion annually, is believed to be moving into a mature stage
where greater price pressure and modest market expansion will continue to
increase competition.

Employees

At September 30, 2004, the Company employed 86 full time and 2 part-time
employees in its operations, with Bactolac employing 84 people and four employed
(2 full-time and 2 part-time) in holding company executive management. The
employees at Bactolac are engaged in management and sales, quality control,
production and administration.

The Company has never experienced a work stoppage, and none of its employees is
currently represented by a union or any other form of collective bargaining
unit. The Company believes its relations with its employees are good.

Government Regulation

The formulation, manufacturing, packaging, labeling, advertising and
distribution of the Company's products are subject to regulation by one or more
federal agencies, including the FDA, the Federal Trade Commission ("FTC"), the
Consumer Product Safety Commission ("CPSC"), the United States Department of
Agriculture ("DOA"), the United States Postal Service ("USPS") and the
Environmental Protection Agency ("EPA"). These activities are also regulated by
various agencies of the states and localities in which the Company's products
are sold, including without limitation the California Department of Health
Services, Food and Drug branch. The FDA and FTC in particular regulate the
advertising, labeling and sales of vitamin and mineral supplements and may take
regulatory action concerning medical claims, misleading or untruthful
advertising, and product safety issues. These regulations include the FDA's GMPs
for foods.

Detailed dietary supplement GMPs have been proposed, but no regulations have
been adopted. Additional dietary supplement regulations were adopted by the FDA
pursuant to the implementation of the Dietary Supplement Health and Education
Act of 1994 ("DSHEA").

The Company may be subject, from time to time, to additional laws or regulations
administered by the FDA or other federal, state or foreign regulatory
authorities, or to revised interpretations of current laws or regulations. The
Company is unable to predict the nature of such future laws, regulations,
interpretations or applications, nor can it predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on its business in the future. They could, however, require the
Company to: reformulate certain products to meet new standards; recall or
discontinue certain products not able to be reformulated; expand documentation
of the properties of certain products; expand or provide different labeling and
scientific substantiation; or, impose additional record keeping requirements.
Any or all such requirements could have a material adverse effect on the
Company's results of operations and financial position.

                                        5
<PAGE>


Discontinued Operations - ANIP

On March 23, 2004, the Company completed the sale of substantially all of the
assets and operations of the Company's subsidiary, ANIP, to an unrelated third
party. In connection with the sale the Company received cash of approximately
$3.4 million and the buyer assumed approximately $1.7 million in liabilities,
primarily trade accounts payable. The Company used the entire cash proceeds, net
of closing expenses and a $250,000 escrow requirement, to repay the outstanding
balance on the mortgage on the ANIP facility and the balance to reduce the
Company's senior credit facility. As a result of the sale, the Company recorded
a loss of approximately $1,187,000 net of a deferred income tax benefit of
$663,000. ANIP had previously been reported as a separate segment of the Company
and was a contract and private label manufacturer of over-the-counter liquid and
powder pharmaceutical products, primarily liquid stomach remedies, located in
Gulfport, Mississippi. As a result of the sale, the Company's consolidated
financial statements and related notes thereto have been reclassified to present
the operations of ANIP as discontinued operations. The Company now operates in
only one segment.


The agreement for the sale of ANIP included a provision for a potential
post-closing adjustment to the purchase price depending upon the final adjusted
net working capital of the net assets sold, as defined under the agreement. The
parties agreed during the fourth quarter of fiscal 2004 to a final adjusted net
working capital settlement with the buyer remitting approximately $10,000 to the
Company. Under the terms of the purchase agreement typical representations and
warranties were made by the Company to the buyer, which are the only remaining
outstanding items from the sale transaction.


RISK FACTORS

Important factors that could cause actual results to differ materially from the
Company's expectations are disclosed in this Report, including without
limitation in conjunction with the forward-looking statements included in this
Report, and the following risk factors.


Dependence on Significant Customers. Approximately 39% of the Company's revenues
for the year ended September 30, 2004 were generated from three customers and
30% of the Company's total revenues in the fiscal year ended September 30, 2003
were generated from two customers. The Company is aggressively continuing to
attempt to expand its customer base to reduce its dependence on these customers.
The loss of any one of these significant customers could have a material adverse
effect on the Company's business and financial condition.

Dependence on Key Personnel. ANI's future success depends on the continued
availability of certain key management personnel, including Dr. Pailla M. Reddy,
founder of Bactolac and Director of ANI, Greg Pusey, Director and Chief
Executive Officer of ANI and Jeffrey McGonegal, Chief Financial Officer of the
Company. ANI has obtained "key man" insurance on the life of Dr. Reddy. ANI's
growth and profitability also depend on its ability to attract and retain other
key management personnel.

Bulletin Board Listing. The Company's common stock is currently traded under the
symbol "ANII" on the OTC Bulletin Board System. Trading on this system can have
a negative impact on the trading activity and price of the Company's common
stock resulting from a limited trading market for our common stock and certain
trading restrictions placed on broker-dealers recommending the purchase or sale
of securities traded on the Bulletin Board System.

Government Regulations. The manufacturing, processing, formulation and packaging
of the Company's products are subject to regulation by federal, state and
foreign agencies, including the FDA, the FTC, the CPSC, the DOA, the USPS and
the EPA. Such agencies have a variety of remedies and processes available to
them, including initiating investigations, issuing warning letters and cease and
desist orders, requiring corrective labels or advertising, requiring consumer
redress (for example, by requiring that a company offer to repurchase products
previously sold to consumers), seeking injunctive relief or product seizure,
imposing civil penalties, or commencing criminal prosecution.

                                        6
<PAGE>

There can be no assurance that the regulatory environment in which the Company
operates will not change or that such regulatory environment, or any specific
action taken against the Company, will not result in a material adverse effect
on the Company's business, financial condition or results of operations. The
Company also cannot predict whether new legislation regulating its activities
will be enacted, which new legislation could have a material adverse effect on
its operations.

Product Liability. The Company, like other manufacturers and distributors of
products that are ingested, faces an inherent risk of exposure to product
liability claims if, among other things, the use of its products results in
injury. The Company currently has product liability insurance for its operations
in amounts the Company believes are adequate for its operations. There can be no
assurance, however, that such insurance will continue to be available at a
reasonable cost, or if available, will be adequate to cover liabilities.

Ability to Implement Business Strategy; Integration of Acquisitions. The
Company's future results and financial condition are dependent on the successful
implementation of its business strategy. A component of the Company's long-term
business strategy may involve strategic acquisitions.

Risks Related to Working Capital Financing; Leverage. Financing for the
Company's earlier acquisitions, as well as ongoing working capital and capital
equipment needs is provided primarily through a leveraged lending arrangement.
The loan facility is secured by substantially all the assets of the Company and
its subsidiaries. The Company's loan facility contains various covenants that
require the maintenance of certain financial ratios, as well as additional
covenants and significant restrictions on dividend payments, issuance of debt
and equity, mergers, changes in business operations and sales of assets. Should
the Company not be successful in continuing to comply with the covenant
restrictions and repay the obligations under their terms, the financial position
and liquidity of the Company could be adversely affected.

Dividends. The Company has not paid any dividends since 1998. The Company's
credit facility prohibits dividend payments without the consent of the lender.
The determination of whether to pay dividends in the future will be made by the
Board of Directors and will depend on the earnings, capital requirements, and
operating and financial condition of the Company, among other factors. It is not
anticipated that the Company will pay dividends in the fiscal year ending
September 30, 2005 or in the foreseeable future.

Competition. The market for the Company's products is highly competitive. The
Company competes with other dietary supplement producers. Among other factors,
competition among these manufacturers is based upon price. If one or more
manufacturers significantly reduces its prices in an effort to gain market
share, the Company's business, operations and financial condition could be
adversely affected. The Company is a contract manufacturer that sells
substantially all of its supplement products to customers who re-sell and
distribute the products.


                         ITEM 2. DESCRIPTION OF PROPERTY

Properties

Bactolac, headquartered in Hauppauge, New York, conducts its operations in a
leased facility comprising approximately 32,700 square feet. Bactolac's current
monthly rental is approximately $30,000, (of which $6,000 pertains to
improvements made by a related party), that escalates over the remaining term on
the lease, through December 2010. The Company has an additional five-year
renewal option on the facility. Bactolac leases this facility from Shilpa Saketh
Realty, Inc., an entity owned by Dr. Pailla M. Reddy, Chairman of the Board of
Directors of the Company and President of Bactolac. During the third quarter of
2004, Bactolac leased an additional 29,000 square feet under a five-year
agreement, from an unrelated third party, as expansion space. In addition, ANI
currently rents administrative office space in Houston, TX, on a temporary,
short-term basis for approximately $600 per month. The Company believes that its
facilities are suitable and adequate and will be sufficient for anticipated
growth.

                                        7
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See Item 6. "Management's Discussion and Analysis" and Item 7. "Financial
Statements"

                            ITEM 3. LEGAL PROCEEDINGS

Bactolac is a defendant in an action brought by Health Support, Inc., during the
last quarter of 2003 in Nassau County, New York. Health Support appears to seek
damages of $650,000 for each of three causes of action, namely breach of
contract, breach of warranty and damage to good name and reputation. Health
Support alleges that in or about August 2002, a contract was entered into
between the parties providing for Bactolac to produce a dietary supplement
product for Health Support. Bactolac has answered the complaint and denies any
liability. Specifically, Bactolac denies that there is any contractual agreement
between the parties. Bactolac believes that the plaintiff's claims are without
merit and intends to vigorously defend this action and has asserted numerous
affirmative defenses in this matter. The next hearing on this matter is
scheduled for the spring of 2005. It is too early to provide an evaluation of
the likelihood of an unfavorable outcome or an estimate of the amount or range
of potential loss, should Bactolac be unsuccessful in its efforts.

The Company is not a party to any other legal proceedings, the adverse outcome
of which would, in management's opinion, have a material adverse effect on the
Company's business, financial condition and results of operations.


           ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Item not applicable.

                                     PART II

                ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
                           RELATED STOCKHOLDER MATTERS

The Company's Common Stock is traded on the OTC Bulletin Board System under the
symbol "ANII".

 Quarter Ended                              High                     Low
 -------------                              ----                     ---
         Fiscal 2003:
 December 31, 2002                         $1.19                    $0.48
 March 31, 2003                             1.00                     0.44
 June 30, 2003                              1.49                     0.50
 September 30, 2003                         0.75                     0.35

         Fiscal 2004:
 December 31, 2003                          0.75                     0.42
 March 31, 2004                             1.05                     0.55
 June 30, 2004                              5.25                     1.20
 September 30, 2004                         4.70                     2.30

     As of December 30, 2004, there were approximately 1,574 record holders of
common stock.

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No dividends have been declared by the Company in the prior two years. It is not
likely that dividends will be declared in the fiscal year ending September 30,
2005. Under its current loan agreement, the Company may not declare any
dividends without the consent of its lender. Subject to obtaining the lender's
consent, the determination of the payment of dividends in the future will be
within the discretion of the Company's Board of Directors and will depend on the
earnings, capital requirements and operating and financial condition of the
Company, among other factors.


                  ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

Results of Operations

Following is a summary table of the key operating statistics of the Company for
the years ended September 30, 2004 and 2003:



                                     Year ended September 30,
                           -----------------------------------------------
                                   2004                       2003
                           --------------------     ----------------------

     Net sales             $17,639,000   100.0%      $12,794,000    100.0%
     Cost of sales          11,611,000    65.8         8,104,000     63.3
     Gross profit            6,028,000    34.2         4,690,000     36.7


Fiscal Year 2004 Compared to Fiscal Year 2003

Net sales from continuing operations for the 2004 period increased $4,845,000 or
37.9% over the 2003 period. The increase was attributable to an approximate $2.0
million net increase in the sales of products to existing customers and an
approximate increase of $2.5 million in sales to new customers in 2004.

Gross profit from continuing operations for the 2004 period increased to
$6,028,000, a $1,338,000 increase over the 2003 amount. Gross profit as a
percentage of net sales decreased to 34.2% in 2004, as compared to 36.7% in the
2003 period. The majority of the increase in gross profit related to the higher
sales volumes. The decline in gross profit percentage was tied to changes in the
product mix between 2004 and 2003.

Total general and administrative expenses for continuing operations, increased
to $2,849,000 in 2004, from $2,554,000, in 2003. This represents an increase of
$295,000, or 11.6%. The majority of the increase relates to an increase of
approximately $242,000 in administrative payroll costs associated with
additional management personnel and an approximate $190,000 increase in bad
debts primarily associated with higher sales levels, net of a $119,000 reduction
in professional fees and a $125,000 reduction in sales commissions due to
changes in customer mix in 2004.

During the year ended September 30, 2004, a deferred income tax benefit of
$1,362,000 was recorded on continuing operations, resulting primarily from the
recognition of the deferred income tax benefit associated with tax loss
carryforwards. Previously, a valuation allowance had been recorded, as the
Company, until 2004, was not able to determine that it was more likely than not
that such losses would be utilized.

Discontinued Operations

On March 23, 2004, the Company completed the sale of substantially all of the
assets and operations of the Company's subsidiary, ANIP, to an unrelated newly
formed entity. ANIP manufactures high quality pharmaceutical products, primarily
liquid and powder pharmaceutical products. As a result of the sale of ANIP, the
Company's consolidated financial statements and related notes thereto have been
reclassified to present the operations of ANIP as discontinued operations. For
further discussion see Note 2 of the Notes to Consolidated Financial Statements
in Item 7. The Company now operates in only one segment.

A deferred income tax benefit of $663,000 was recorded in connection with the
losses arising from the discontinued operations.

                                        9
<PAGE>

Liquidity and Capital Resources

Prior to the ANIP sale, ANI met its working capital and capital expenditure
requirements, including funding for debt repayments, mainly through net cash
provided under the Company's revolving line of credit. Management plans to
continue to strive to maintain and enhance the profitability of the Bactolac
operation to meet currently anticipated funding requirements.

In March 2003, the Company completed the refinancing of its senior debt facility
with a new lender (the "Agreement"). In December 2003, March 2004 and effective
September 2004, the Agreement was further amended to provide for the ANIP sale.
The Agreement provides the Company with a $3.4 million facility, consisting of a
$2.5 million revolver, a $650,000 equipment term loan and a $257,000 equipment
acquisition line. Interest on the revolver portion is paid monthly and the term
loan portion of the facility provides for monthly principal payments of
approximately $24,000, plus interest. The agreement that matures in March 2006
is collateralized by substantially all of the Company's assets, and bears
interest at rates that fluctuate with the Prime Rate, with the revolver at 2%
over prime (not to be less than a total rate of 6.5%) and the equipment lines at
4.75% over prime (not to be less than a total rate of 9.25%). Due to the "floor"
interest amounts under the Company's credit facility, the 2003-2004 prime rate
levels have not impacted the Company's interest rate. Increases in the prime
rate subsequent to September 30, 2004, have increased the Company's interest
expense.

The credit facility requires a lockbox arrangement, which requires all receipts
to be swept daily to reduce borrowings outstanding under the credit facility.
This arrangement, combined with a Subjective Acceleration Clause ("SAC") in the
credit facility, cause the revolving credit facility to be classified as a
current liability, per guidance in the FASB's Emerging Issues Task Force Issue
95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving
Credit Agreements that Include Both a Subjective Acceleration Clause and a
Lock-Box Arrangement." However, the Company does not expect to repay, or be
required to repay, within one year, the balance of the revolving credit facility
classified as a current liability. The SAC, which is a typical requirement in
commercial credit agreements, allows the lender to call the loan if it
determines there has been a material adverse effect on the Company's operations,
business, properties, assets, liabilities, condition or prospects. The
classification of the revolving credit facility as a current liability is a
result only of the combination of the two aforementioned factors, the lockbox
arrangement and the SAC. However, the revolving credit facility does not expire
or have a maturity date within one year. Additionally, the Lender has not
notified the Company of any indication of a SAC as of the date of this filing.

The Agreement contains a number of covenants, which include among other items;
maintenance of specified minimum net worth and fixed charge ratios, as well as
limitations on capital expenditures and the payment of dividends.

Initial proceeds under the Agreement were used to payoff the debt obligations to
the then existing Senior Lender, which totaled approximately $1,339,000 at
closing, and to repay the remaining $500,000, plus accrued interest, due under a
note with Dr. Pailla Reddy, a director of the Company, that arose from the
Bactolac acquisition.

In connection with continued expansion and upgrades of the business including
the recent addition of the 29,000 square foot leased facility, the Company
estimates that capital needs for equipment purchases and leasehold improvements
during the 2005 fiscal year will total $300,000 to $450,000. It is expected that
funding for the capital additions will be provided out of working capital with a
portion funded out of the credit facility.


At September 30, 2004, the Company had working capital of $5,983,000. Borrowings
under the revolving portion of the secured credit facility totaled $737,000,
with additional borrowings available of $1,729,000, based upon accounts
receivable and inventory levels.

Operating Activities

Net cash flows from continuing operating activities generated approximately
$2,594,000 and $1,716,000 in 2004 and 2003. The net cash generated in 2004
consisted primarily of the $4,235,000 income from continuing operations plus
the non cash expenses which included $358,000 of depreciation and amortization
expense, a $254,000 decrease in the allowance for doubtful accounts less the
$1,328,000 deferred income tax benefit. This was offset by cash used for
increases of accounts receivable and inventories totaling $1,031,000 and the
$102,000 decrease in accounts payable.

The net cash flow from continuing operating activities in 2003 consisted
primarily of approximately $1,936,000 net income in addition to a $229,000
increase in accounts payable as well as $224,000 in depreciation expense. This
was offset by the $284,000 increase in accounts receivable and a $473,000
increase in inventories.

Discontinued operations consumed $492,000 in 2004 and $1,047,000 in 2003. The
majority of this related to the net loss incurred during the periods net of the
changes in working capital items.

                                       10
<PAGE>

Investing Activities

Investing activities from continuing operations consumed approximately $243,000
in 2004, used for additions to equipment.

Investing activities from continuing operations consumed approximately $201,000
in 2003. This consisted of $184,000 collected on the NFLI Note receivable net of
$386,000 used for additions to equipment.

Discontinued operations generated $3,390,000 in 2004 and $230,000 in 2003. The
2004 amount related primarily to the sale of ANIP and the 2003 amount related to
the sale of ANIP equipment.

Financing Activities

Financing activities from continuing operations consumed approximately $168,000
in 2004. The outstanding balance on the revolving portion of the credit facility
was reduced by $122,000 and other long-term notes payable were reduced by
$82,000 during the year.

Financing activities from continuing operations consumed approximately $507,000
in 2003. The primary uses of cash were the repayment of the $500,000 note
payable to a related party, which was repaid out of the proceeds from the new
credit facility and $227,000 in loan costs paid on the new credit facility. The
outstanding balance on the revolving portion of the credit facility was reduced
by $199,000 and other long-term notes payable were reduced by $29,000 during the
year. The Company borrowed a net additional amount of $448,000 under the
long-term equipment debt portion of our credit facility.

Discontinued operations consumed approximately $4,338,000 in 2004 and generated
$136,000 in 2003. These amounts consisted primarily of debt repayments following
the ANIP sale in 2004 and net borrowings under the Company's debt obligations
for ANIP in 2003.

The Company's revolving credit facility, as amended provides for borrowings,
based upon outstanding amounts of eligible accounts receivable and allowable
inventories. Additionally, there is a term loan facility with the secured lender
that requires principal payments of approximately $24,000 monthly. The Agreement
matures in March 2006. Interest on amounts outstanding under the Agreement is
payable monthly based upon the lender's prime rate plus two percent (2%) for the
revolving portion of the facility and the prime rate plus four and three
quarters percent (4.75%) for the equipment term loan portion. The credit
facility is secured by substantially all of the Company's assets. The Agreement
contains a number of covenants, which include among other items; maintenance of
specified minimum net worth and fixed charge ratios, as well as limitations on
capital expenditures and restrictions on the payment of dividends. The Company
is in compliance with the covenants of the loan agreement as amended.

Capital expenditures, primarily for manufacturing and facility improvement costs
for the fiscal year ending September 30, 2004, were approximately $243,000.

Critical Accounting Policies

The Company's financial position, results of operations and cash flows are
impacted by the accounting policies the Company has adopted. In order to get a
full understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed. A summary of the Company's
critical accounting policies follows:

Accounts Receivable: Accounts receivable balances are stated net of allowances
for doubtful accounts. The Company records allowances for doubtful accounts when
it is probable that the accounts receivable balance will not be collected. When
estimating the allowances for doubtful accounts, the Company takes into
consideration such factors as its day-to-day knowledge of the financial position
of specific clients, the industry and size of its clients. A financial decline
of any one of the Company's large clients could have an adverse and material
effect on the collectibility of receivables and thus the adequacy of the
allowance for doubtful accounts. Increases in the allowance for doubtful
accounts are recorded as charges to bad debt expense and are reflected in other
operating expenses in the Company's consolidated statements of operations.
Write-offs of uncollectible accounts are charged against the allowance for
doubtful accounts.

                                       11
<PAGE>

Inventories: The Company's inventory is a significant component of current
assets and is stated at the lower of cost or market. The Company regularly
reviews inventory quantities on hand and records provisions for excess or
obsolete inventory based primarily on its estimated forecast of product demand,
market conditions, production requirements and technological developments.
Significant or unanticipated changes to the Company's forecasts of these items,
either adverse or positive, could impact the amount and timing of any additional
provisions for excess or obsolete inventory that may be required.

Long-Lived Assets: The Company records property and equipment at cost.
Depreciation of the assets is recorded on the straight-line basis over the
estimated useful lives of the assets. Dispositions of property and equipment are
recorded in the period of disposition and any resulting gains or losses are
charged to income or expense when the disposal occurs. The carrying value of the
Company's long-lived assets is periodically reviewed to determine that such
carrying amounts are not in excess of estimated market value. During the fourth
quarter of the year ended September 30, 2003, the Company recorded a $3,900,000
impairment loss relating to the carrying value of the property and equipment of
ANIP, whose operations are now shown as discontinued due to the sale as
disclosed in Note 2. Goodwill is reviewed annually for impairment by comparing
the carrying value of each reporting unit to the present value of its expected
cash flows. For fiscal 2003, the required annual testing resulted in no
impairment charge. For fiscal 2002, the analysis resulted in the write-off of
the goodwill associated with the ANIP operations, whose operations are now shown
as discontinued due to the sale as disclosed in Note 2, resulting in a charge of
$1.2 million.

Deferred Income Taxes: Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. In addition, a valuation
allowance is established to reduce any deferred tax asset for which it is
determined that it is more likely than not that some portion of the deferred tax
asset will not be realized.

Revenue Recognition: The Company's revenues are recognized when products are
shipped to unaffiliated customers. The Securities and Exchange Commission's
Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition" provides guidance
on the application of generally accepted accounting principles to select revenue
recognition issues. The Company has concluded that its revenue recognition
policy is appropriate and in accordance with SAB No. 104.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123(R) "Share-Based Payment", which addresses the accounting for share-based
payment transactions. SFAS No. 123(R) eliminates the ability to account for
share-based compensation transactions using APB 25, and generally requires
instead that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123(R) will be effective for
public companies that file as small business issuers as of the first interim or
annual reporting period that begins after December 15, 2005. SFAS No. 123(R)
offers the Company alternative methods of adopting this standard. At the present
time, the Company has not yet determined which alternative method it will use
and the resulting impact on its financial position or results of operations.

                                       12
<PAGE>

In December 2003, the FASB issued SFAS Interpretation 46R ("FIN 46R"), a
revision to SFAS Interpretation No. 46 ("FIN 46"), "Consolidation of Variable
Interest Entities". FIN 46R clarifies some of the provisions of FIN 46 and
exempts certain entities from its requirements. FIN 46R is effective at the end
of the first interim period ending after March 15, 2004. Entities that have
adopted FIN 46 prior to this effective date can continue to apply the provision
of FIN 46 until the effective date of FIN 46R or elect early adoption of FIN
46R. The adoption of FIN 46 and FIN 46R did not have a material impact on the
Company's consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". This statement
establishes standards for how an issuer classifies and measures in its financial
position certain financial instruments with characteristics of both liabilities
and equity. In accordance with this standard, financial instruments that embody
obligations of the issuer are required to be classified as liabilities. SFAS No.
150 is effective for all financial instruments entered into or modified after
May 31, 2003, except for those provisions relating to mandatorily redeemable
non-controlling interests, which have been deferred. The Company has adopted the
applicable provisions of SFAS No. 150, however. Management believes if the
deferred provisions are finalized in their current form, the adoption of these
provisions will not have a material impact on the Company's operations or
financial condition.

                                       13
<PAGE>


                          ITEM 7. FINANCIAL STATEMENTS

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


Advanced Nutraceuticals, Inc. Consolidated Financial Statements
                                                                           Page
                                                                           ----

   Report of Independent Registered Public Accounting Firm                 F-2

   Consolidated Balance Sheet as of September 30, 2004                     F-3

   Consolidated Statements of Operations for the Years Ended
     September 30, 2004 and 2003                                           F-4

   Consolidated Statements of Stockholders' Equity for the Years
   Ended September 30, 2004 and 2003                                       F-5

   Consolidated Statements of Cash Flows for the Years Ended
   September 30, 2004 and 2003                                             F-6

   Notes to Consolidated Financial Statements                              F-7


                                       F-1
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors and Stockholders
Advanced Nutraceuticals, Inc. and Subsidiaries


     We have audited the accompanying consolidated balance sheet of Advanced
Nutraceuticals, Inc. (a Texas corporation) and subsidiaries (the "Company") as
of September 30, 2004, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of years in the two-year period
then ended. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Advanced
Nutraceuticals, Inc. and subsidiaries as of September 30, 2004, and the results
of their operations and their cash flows for each of the years in the two-year
period then ended in conformity with accounting principles generally accepted in
the United States of America.


GHP Horwath, P. C.

/s/ GHP Horwath, P. C.
------------------------------------
Denver, Colorado
December 23, 2004, except for Note 6,
     as to which the date is January 6, 2005


                                       F-2
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                           CONSOLIDATED BALANCE SHEET
                               SEPTEMBER 30, 2004



                                     ASSETS

Current Assets:
    Cash and cash equivalents                                    $  1,786,508
    Receivables, net (Note 6)                                       2,936,631
    Inventories (Notes 3 and 6)                                     1,816,076
    Deferred tax assets (Note 5)                                    1,475,000
    Prepaid expenses and other assets                                  20,062
    Net assets held for sale (Note 2)                                 109,118
                                                                 ------------
       Total Current Assets                                         8,143,395

Property and equipment, net (Notes 4 and 6)                         1,119,749
Goodwill                                                            7,563,913
Deferred tax assets - net (Note 5)                                    550,000
Other assets                                                          134,104
                                                                 ------------
                                                                 $ 17,511,161
                                                                 ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
    Accounts payable                                             $    918,383
    Accrued compensation                                              101,720
    Accrued expenses and other liabilities                             99,521
    Credit facility (Note 6)                                        1,025,524
    Current portion of other long-term debt                            15,655
                                                                 ------------
            Total Current Liabilities                               2,160,803

Long-term Debt:
    Credit facility (Note 6)                                          176,820
    Other long-term debt                                                7,774
                                                                 ------------
           Total Liabilities                                        2,345,397
                                                                 ------------

Commitments and contingencies (Note 8)                                     --

Stockholders' Equity (Note 9 and 10):
    Preferred stock, $.001 par value; 1,000,000 shares
            authorized; none issued                                        --
    Common stock; $.01 par value; 20,000,000 shares authorized;
            5,097,830 issued and outstanding                           50,978
    Additional paid-in capital                                     20,356,281
    Accumulated deficit                                            (5,241,495)
                                                                 ------------
           Total Stockholders' Equity                              15,165,764
                                                                 ------------
                                                                 $ 17,511,161
                                                                 ============

          See accompanying notes to consolidated financial statements.

                                       F-3
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                        FOR THE YEARS ENDED SEPTEMBER 30,


                                                         2004           2003
                                                     ------------   ------------
Net sales                                            $ 17,638,850   $12,794,268
Cost of sales                                          11,610,918     8,104,449
                                                     ------------   ------------
Gross profit                                            6,027,932     4,689,819

General and administrative expenses                     2,849,244     2,554,186
                                                      ------------  ------------
Operating income                                        3,178,688     2,135,633
                                                      ------------  ------------
Other income (expense):
    Interest expense, net                                (281,202)     (201,669)
    Other, net                                              5,652         1,626
                                                      ------------  ------------
                                                         (275,550)     (200,043)
                                                      ------------  ------------
Income from continuing operations
    before income tax benefit                           2,903,138     1,935,590

Income tax benefit (Note 5)                             1,332,161          --
                                                     ------------   ------------
Income from continuing operations                       4,235,299     1,935,590

Discontinued operations (Note 2):
    Loss from discontinued operations                  (1,849,611)   (5,779,394)
    Income tax benefit - deferred                         663,000           --
                                                     ------------   ------------
Loss from discontinued operations                      (1,186,611)   (5,779,394)
                                                     ------------   ------------


Net income (loss)                                    $ 3,048,688    $(3,843,804)
                                                     ============   ===========

Basic income (loss) per common share:
    Income from continuing operations                $      .84     $       .39
    Loss from discontinued operations                      (.23)          (1.16)
                                                     ------------   -----------
          Net income (loss)                          $      .61     $      (.77)
                                                     ============   ===========

Diluted income (loss) per common share:
    Income from continuing operations                $     .74      $       .38
    Loss from discontinued operations                     (.21)           (1.13)
                                                     ------------   -----------
          Net income (loss)                          $     .53      $      (.75)
                                                     ============   ===========
Weighted average number of common shares outstanding:
     Basic                                             5,028,907      4,992,789
                                                     ============   ===========
     Diluted                                           5,728,969      5,118,363
                                                     ============   ===========

          See accompanying notes to consolidated financial statements.

                                       F-4
<PAGE>

<TABLE>
                          ADVANCED NUTRACEUTICALS, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003

<CAPTION>

                                                                Additional                             Total
                                        Common Stock             Paid-In        Accumulated        Stockholders'
                                   Shares          Amount        Capital          Deficit            Equity
                                ------------    ------------    ------------   -------------      ------------
<S>                             <C>             <C>            <C>             <C>                 <C>

Balance at
     September 30, 2002           4,992,789     $    49,928    $ 20,322,048    $ (4,446,379)       $ 15,925,597

Net loss for the year                   --              --              --       (3,843,804)         (3,843,804)
                                ------------    ------------   ------------     ------------       ------------
Balance at
     September 30, 2003           4,992,789          49,928      20,322,048      (8,290,183)         12,081,793

Common stock issued upon
     exercise of options and
     warrants (Note 9)              105,041           1,050          34,233           --                 35,283

Net income for the year                 --              --              --        3,048,688           3,048,688
                                ------------    ------------   ------------     ------------       ------------
Balance at
     September 30, 2004           5,097,830     $    50,978    $ 20,356,281    $ (5,241,495)       $ 15,165,764
                                ============    ============   ============    ============        ============
</TABLE>
          See accompanying notes to consolidated financial statements.

                                       F-5
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                        FOR THE YEARS ENDED SEPTEMBER 30,

                                                        2004           2003
                                                     -----------    -----------
Cash flows from operating activities:
    Income from continuing operations                $ 4,235,299    $ 1,935,590
    Adjustments to reconcile income from continuing
         operations to net cash provided by (used in)
         operating activities:
          Depreciation and amortization                  357,758        224,247
          Bad debt provision                             254,000         96,000
          Deferred tax benefit                        (1,362,000)          --
          Changes in assets and liabilities:
              Receivables                               (474,543)      (283,676)
              Inventories                               (556,165)      (472,782)
              Prepaid and other assets                   108,462         25,403
              Accounts payable                          (102,132)       229,488
              Accrued expenses and other liabilities     133,632        (38,389)
                                                     -----------    -----------
       Net cash flows from continuing operations       2,594,311      1,715,881
       Net cash flows from discontinued operations      (492,276)    (1,047,371)
                                                     -----------    -----------

Net cash flows from operating activities               2,102,035        668,510
                                                     -----------    -----------
Cash flows from investing activities:
       Collection of notes receivable                       --          184,282
       Acquisition of property and equipment            (243,167)      (385,712)
                                                     -----------    -----------
       Net cash flows from continuing operations        (243,167)      (201,430)
       Net cash flows from discontinued operations     3,389,906        229,965
                                                     -----------    -----------

Net cash flows from investing activities               3,146,739         28,535
                                                     -----------    -----------
Cash flows from financing activities:
       Net payments on credit facility                  (121,608)      (198,775)
       Borrowings on long-term debt                         --          448,240
       Payments of long-term debt - related parties         --         (500,000)
       Payment of long-term debt                         (81,799)       (28,967)
       Proceeds from issuance of common stock             35,283           --
       Loan costs paid and other                            --         (227,287)
                                                     -----------    -----------
       Net cash flows from continuing operations        (168,124)      (506,789)
       Net cash flows from discontinued operations    (4,338,067)       135,803
                                                     -----------    -----------
Net cash flows from financing activities              (4,506,191)      (370,986)
                                                     -----------    -----------
Net increase in cash and cash equivalents                742,583        326,059

Cash and cash equivalents, beginning of year           1,043,925        717,866
                                                     -----------    -----------

Cash and cash equivalents, end of year               $ 1,786,508    $ 1,043,925
                                                     ===========    ===========

          See accompanying notes to consolidated financial statements.

                                       F-6
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- ORGANIZATION, BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Advanced Nutraceuticals, Inc. ("ANI" or the "Company"), a Texas corporation, was
formed in 2000. On March 23, 2004, the Company completed the sale of
substantially all of the assets and operations of the Company's subsidiary, ANI
Pharmaceuticals, Inc., ("ANIP") to an unrelated newly formed entity (Note 2).
The Company now operates as a contract and private label manufacturer of
nutritional products through its operating subsidiary, Bactolac Pharmaceutical
Inc.

Principles Of Consolidation

The consolidated financial statements include the accounts of the Company and
its wholly- owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

Cash And Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on
hand and in short-term, interest bearing deposits with maturities of three
months or less at the time of purchase.

Fair Value Of Financial Instruments

The Company's financial instruments include accounts receivable, accounts
payable, and long-term debt. The fair value of accounts receivable and accounts
payable approximate their carrying values because their maturities are generally
less than one year. The fair value of debt obligations are estimated to
approximate their carrying values based upon their stated interest rates.

Revenue Recognition

The Company sells its products to retailers and distributors primarily located
in the United States. Revenues from the sale of products are recognized upon
shipment to the customer. The Company records freight-out expenses as a general
and administrative expense. For the years ended September 30, 2004 and 2003,
freight out expenses (continuing operations) totaled $6,000 and $14,000.

Accounts receivable are customer obligations due under normal trade terms.
Generally the Company does not require collateral. Management provides an
estimated allowance for uncollectable accounts based upon an assessment of
amounts outstanding and evaluation of specific customer account balances.
Write-offs of uncollectible accounts are charged against the allowance. The
allowance for doubtful accounts at September 30, 2004 was $280,000.

Inventories

Inventories are valued primarily at the lower of cost (first-in, first-out
basis) or market.

Deferred loan costs

Deferred loan costs, which have a carrying value at September 30, 2004 of
$87,000, are included in other assets and are amortized on a straight-line basis
over the three-year term of the respective debt agreement.

                                       F-7
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Long-lived Assets

The Company reviews the carrying value of its long-lived assets, including
property and equipment, whenever events or changes in circumstances indicate
that the carrying value of the assets may not be recovered. An impairment loss
may be recognized when estimated undiscounted future cash flows expected to
result from the use of the asset, including disposition, is less than the
carrying value of the asset. The measurement of the impairment losses to be
recognized is based on the difference between the fair value and the carrying
amounts of the assets. In order to determine if an asset has been impaired,
assets are tested by operating segment and geographic location. During the year
ended September 30, 2003, the Company recorded an impairment of certain
long-lived assets held by ANIP (Note 2).

Property and Equipment

Property and equipment are stated at cost. Depreciation on property and
equipment is provided using the straight-line method over the estimated useful
lives of the assets. Leasehold improvements are amortized over the terms of the
respective leases, not in excess of their estimated useful lives. For income tax
purposes, depreciation on fixed assets is calculated using accelerated methods.

Intangible Assets

Intangible assets consist of the excess of cost over net assets acquired,
"goodwill". Management of the Company evaluates the carrying value of goodwill
annually or whenever a possible impairment is indicated.

Stock Options and Warrants

The Company accounts for stock options issued to employees in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). During the years ended September 30, 2004 and 2003, all
options issued to officers and employees were granted at an exercise price which
equaled or exceeded the market price per share at the date of grant and
accordingly, based upon an intrinsic valuation, no compensation expense was
recorded relative to those grants.

The Company has adopted the disclosure requirements of Statement of Financial
Accounting Standards ("SFAS") No.123 "Accounting for Stock-based Compensation"
("SFAS No. 123"). This statement requires that the Company provide proforma
information regarding net income (loss) and basic and diluted earnings (loss)
per share as if compensation cost for the Company's employee stock options
granted had been determined in accordance with the fair value based method
prescribed in SFAS No. 123. Additionally, SFAS No. 123 generally requires that
the Company record options issued to non-employees, based on the fair value of
the options.

SFAS NO. 123 Pro Forma Computation

The Company estimates the fair value of each stock option at the grant date by
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 2004 and 2003: a dividend yield of 0%; a
risk-free interest rate of 4.2% and 4.4%; an expected life ranging from 5-10
years; and an expected volatility of 114% and 111%, respectively. Had
compensation cost been determined on the basis of fair value pursuant to SFAS
No. 123 for stock options issued to employees, net income (loss) and earnings
(loss) per share for the years ended September 30, 2004 and 2003 would have been
as follows:

                                       F-8
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


                                                    2004             2003
                                                -------------    -------------

Net income (loss) as reported                   $   3,049,000    $  (3,844,000)
    Add: Stock-based employee compensation
      expense included in reported net income
      (loss), net of related tax effects                 --               --
    Deduct: Total stock-based employee
      compensation expense determined
      under fair value method for all awards,
      net of related tax effects                     (418,400)        (206,300)
                                                -------------    -------------
     Pro forma                                  $   2,630,600    $  (4,050,300)
                                                =============    =============
Income (loss) per share:
     As reported:
         Basic                                  $         .61    $        (.77)
         Diluted                                $         .53    $        (.75)
                                                =============    =============

     Pro forma:
         Basic                                  $         .52    $        (.81)
         Diluted                                $         .46    $        (.79)
                                                =============    =============
Income Taxes

The Company recognizes income tax expense using the liability method of
accounting for deferred income taxes. A deferred tax asset or liability is
recorded based upon the tax effect of temporary differences between the tax
bases of assets and liabilities and their carrying value for financial reporting
purposes. Deferred tax expense or benefit is the result of changes in the
deferred tax assets and liabilities during the year. The Company adjusts the
deferred tax asset valuation allowance based upon the anticipated future
realization of the deferred tax benefits supported by demonstrated trends in the
Company's operating results.

Earnings (Loss) Per Common Share

Basic earnings (loss) per share includes no dilution and is computed by dividing
net earnings (loss) available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted earnings per share
reflects the potential dilution of securities that could share in the Company's
earnings. Options to purchase 700,062 shares of common stock were included in
the dilutive EPS calculation for the year ended September 30, 2004 using the
treasury stock method.

Options to purchase 125,574 shares of common stock were included in the dilutive
EPS calculation for the year ended September 30, 2003 using the treasury stock
method.

Management's Estimates and Assumptions

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America ("US
GAAP") requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. The
actual results could differ from those estimates.

Reclassifications

Certain amounts in the 2003 financial statements have been reclassified to
conform to the presentation used in 2004.

                                       F-9
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123(R) "Share-Based Payment", which addresses the accounting for share-based
payment transactions. SFAS No. 123(R) eliminates the ability to account for
share-based compensation transactions using APB 25, and generally requires
instead that such transactions be accounted and recognized in the statement of
operations based on their fair value. SFAS No. 123(R) will be effective for
public companies that file as small business issuers as of the first interim or
annual reporting period that begins after December 15, 2005. SFAS No. 123(R)
offers the Company alternative methods of adopting this standard. At the present
time, the Company has not yet determined which alternative method it will use
and the resulting impact on its financial position or results of operations.


In December 2003, the FASB issued SFAS Interpretation 46R ("FIN 46R"), a
revision to SFAS Interpretation No. 46 ("FIN 46"), "Consolidation of Variable
Interest Entities". FIN 46R clarifies some of the provisions of FIN 46 and
exempts certain entities from its requirements. FIN 46R is effective at the end
of the first interim period ending after March 15, 2004. Entities that have
adopted FIN 46 prior to this effective date can continue to apply the provision
of FIN 46 until the effective date of FIN 46R or elect early adoption of FIN
46R. The adoption of FIN 46 and FIN 46R did not have a material impact on the
Company's consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". This statement
establishes standards for how an issuer classifies and measures in its financial
position certain financial instruments with characteristics of both liabilities
and equity. In accordance with this standard, financial instruments that embody
obligations of the issuer are required to be classified as liabilities. SFAS No.
150 is effective for all financial instruments entered into or modified after
May 31, 2003, except for those provisions relating to mandatorily redeemable
non-controlling interests, which have been deferred. The Company has adopted the
applicable provisions of SFAS No. 150. Management believes that if the
deferred provisions are finalized in their current form, the adoption of these
provisions will not have a material impact on the Company's operations or
financial condition.


NOTE 2 - SALE OF ANI PHARMACEUTICALS, INC. - DISCONTINUED OPERATIONS

On March 23, 2004, the Company completed the sale of substantially all of the
assets and operations of the Company's subsidiary, ANIP, to an unrelated newly
formed entity. The terms of the sale were cash of approximately $3.4 million and
the assumption by the buyer of approximately $1.7 million in liabilities,
primarily trade accounts payable. The Company used the entire cash proceeds, net
of closing expenses and a $250,000 escrow requirement, to repay the outstanding
balance on the mortgage on the ANIP facility and the balance to reduce the
Company's senior credit facility. The funds under the escrow requirement were
released to the Company in September 2004. As a result of the sale of the
assets, the Company recorded a loss of approximately $1,187,000 net of a
deferred income tax benefit of $663,000. ANIP had previously been reported as a
separate segment of the Company and was a contract and private label
manufacturer of over-the-counter liquid and powder pharmaceutical products,
primarily liquid stomach remedies, located in Gulfport, Mississippi. As a result
of the sale of ANIP, the Company's consolidated financial statements and related
notes thereto have been reclassified to present the operations of ANIP as
discontinued operations. The Company now operates in only one segment.

                                      F-10
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     Certain information with respect to discontinued operations of ANIP for the
years ended September 30 follows. The 2004 operating results are through the
date of sale.

                                                   2004                2003
                                               -----------         -----------
     Net sales                                 $ 4,776,078         $11,886,768
                                               -----------         -----------
     Gross profit                                  921,283           2,683,829

     Operating expenses                          1,732,430           3,916,150
     Impairment loss on long-lived assets                            3,900,000
                                               -----------         -----------
     Operating loss                               (811,147)         (5,132,321)

     Other expenses, including interest           (260,758)           (647,073)
     Loss on disposal                             (777,706)                 --
                                               -----------         -----------
     Loss before income taxes                   (1,849,611)         (5,779,394)

     Income tax benefit - deferred                 663,000                  --
                                               -----------         -----------
     Loss from discontinued operations         $(1,186,611)        $(5,779,394)
                                               ===========         ===========

During the fourth quarter of the fiscal year ended September 30, 2003, an
impairment of $3,900,000 was recorded against the carrying amounts of the
Company's long-lived assets associated with the Company's ANIP subsidiary, whose
operations are now shown as discontinued due to the sale. ANIP's land and
building were determined to be impaired by $1,730,000 and the ANIP equipment was
impaired by $2,170,000. The impairment was recorded based upon a review by
management of ANIP's results of operations and carrying values of the ANIP
assets. The impairment charge was determined based upon estimated current market
values of the assets as compared to their carrying values.

The agreement for the sale of ANIP included a provision for a potential
adjustment to the purchase price depending upon the final adjusted net working
capital as defined under the agreement. The buyer and the Company agreed during
the fourth quarter of fiscal 2004 to a final adjusted net working capital
settlement with the buyer remitting approximately $10,000 to the Company. Under
the terms of the purchase agreement, typical representations and warranties were
made by the Company to the buyer, which are the only remaining outstanding items
from the sale transaction.

As of September 30, 2004, the only remaining asset from the former ANIP segment
was a parcel of undeveloped land that was carried at its estimated market value
of approximately $109,000, and was held for sale. In November 2004, the Company
sold the land. Gross proceeds from the sale totaled $125,000, and after
deducting expenses, the transaction resulted in no material gain or loss.



NOTE 3 -- INVENTORIES

Inventories, at September 30, 2004 consisted of the following:


       Finished goods                $  464,066
       Work in process                  319,940
       Raw materials                  1,032,070
                                      ---------
       Total inventories             $1,816,076
                                      =========

                                      F-11
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 -- PROPERTY AND EQUIPMENT

As of September 30, 2004, property and equipment and their estimated useful
lives are summarized as follows:

                                                     Lives
                                                    -------

Equipment                                            7-12          $  1,598,811
Leasehold improvements                                  7               400,716
Furniture and fixtures                               5-10                21,401
                                                                   ------------
                                                                      2,020,928

Less: Accumulated depreciation and amortization                        (901,179)
                                                                   ------------
                                                                   $  1,119,749
                                                                   ============

NOTE 5 -- INCOME TAXES

Deferred income taxes are determined based on the temporary differences between
the financial statement and income tax basis of assets and liabilities as
measured by the enacted tax rates, which are estimated to be in effect when
these differences reverse.

The (benefit) provision for income taxes on continuing operations for the years
ended September 30, 2004 and 2003 consisted of the following:

                                                    2004         2003
                                                -----------   ----------
Federal tax (benefit) - current                 $       --    $    --
Federal tax (benefit) - deferred                 (1,362,000)       --
State tax (benefit) expense                          29,839        --
                                                -----------   ----------
                                                $(1,332,161)  $    --
                                                ===========   ==========


The following reconciles federal income tax expense (benefit) computed at the
statutory rate with income taxes as reported for continuing operations for the
years ended September 30:

                                                    2004          2003
                                                 -----------  ------------
Expected income tax expense (benefit) at 34%     $   987,000  $   658,000
State taxes, net of federal benefit                   29,839         --
Decrease in valuation allowance                   (3,016,000)        --
Utilization of loss carryforwards                    765,000     (639,000)
Other items, net                                     (98,000)     (19,000)
                                                 -----------  ------------
Income tax (benefit) expense                     $(1,332,161) $     --
                                                 ===========  ============


Deferred tax assets and liabilities consisted of the following net tax effects
of operating losses and temporary differences between the carrying amounts of
assets and liabilities for financial reporting and tax purposes at September 30,
2004:

                                      F-12
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Current assets:
Loss carryforwards                                 $ 2,420,000
Receivable allowance for doubtful accounts             112,000
Inventory valuation write-offs                           4,000
Other                                                   29,000
                                                   -----------
Deferred tax assets                                  2,565,000
Less valuation allowance                            (1,090,000)
                                                   -----------
Net current deferred tax assets                      1,475,000
                                                   ===========

Non-current assets:
Loss carryforwards                                     928,000
Fixed assets                                           (37,000)
Less valuation allowance                              (341,000)
                                                   -----------
Net non-current deferred tax assets                $   550,000
                                                   ===========

At September 30, 2004, the Company has a net operating loss carryforward of
approximately $5.5 million, which expires through 2022. Additionally, the
Company has obtained net operating losses of approximately $2.3 million, which
expire primarily in 2011 and are subject to annual usage limitations. The
Company also has capital loss carryforwards of approximately $1.2 million,
expiring through 2005, which may only be used to offset capital gains during the
carryforward period. As the Company is unable to determine that it is more
likely than not that the future taxable income of the Company will be sufficient
to utilize the operating loss carryforwards subject to the annual usage
limitations and the capital loss carryforwards, a valuation allowance has been
established against those assets. The net change during the year in the
valuation allowance was $3,016,000.

NOTE 6 - CREDIT FACILITY

In March 2003, the Company completed the refinancing of its senior debt facility
with a new lender (the "Agreement"). In December 2003, March 2004, and effective
September 2004, the Agreement was amended to revise certain financial covenants
and provide for the ANIP sale. The amended Agreement provides the Company with a
$3.4 million facility, consisting of a $2.5 million revolver, a $650,000
equipment term loan and a $257,000 equipment acquisition line. Interest on the
revolver portion is paid monthly and the term loan portion of the facility
provides for monthly principal payments of approximately $24,000, plus interest.
Borrowings under the agreement mature in March 2006, are collateralized by
substantially all of the Company's assets, and bear interest at rates that
fluctuate with the Prime Rate, with the revolver at 2% over prime (not to be
less than a total rate of 6.5%) and the equipment lines at 4.75% over prime (not
to be less than a total rate of 9.25%). Due to the "floor" interest amounts
under the Company's credit facility, the 2003-2004 prime rate levels have not
impacted the Company's interest rate. Increases in the prime rate subsequent to
September 30, 2004, have increased the Company's interest expense. The credit
facility requires a lockbox arrangement, which requires all receipts to be swept
daily to reduce borrowings outstanding under the credit facility. This
arrangement, combined with a Subjective Acceleration Clause ("SAC") in the
credit facility, cause the revolving credit facility to be classified as a
current liability, per guidance in the FASB's Emerging Issues Task Force Issue
95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving
Credit Agreements that Include Both a Subjective Acceleration Clause and a
Lock-Box Arrangement." However, the Company does not expect to repay, or be
required to repay, within one year, the balance of the revolving credit facility
classified as a current liability. The SAC, which is a typical requirement in
commercial credit agreements, allows the lender to call the loan if it
determines there has been a material adverse effect on the Company's operations,
business, properties, assets, liabilities, condition or prospects. The
classification of the revolving credit facility as a current liability is a

                                      F-13
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


result only of the combination of the two aforementioned factors, the lockbox
arrangement and the SAC. However, the revolving credit facility does not expire
or have a maturity date within one year. Additionally, the Lender has not
notified the Company of any indication of a SAC as of the date of this filing.

The Agreement contains a number of covenants, which include among other items;
maintenance of specified minimum net worth and fixed charge ratios, as well as
limitations on capital expenditures and the payment of dividends.

Initial proceeds under the Agreement were used to payoff the debt obligations to
the then existing senior lender, which totaled approximately $1,339,000 at
closing, and to repay the remaining $500,000, plus accrued interest, due under a
note with Dr. Pailla Reddy, a director of the Company, that arose from the
Bactolac acquisition.

As of September 30, 2004, the Company was in compliance with the covenants of
the Agreement. As of September 30, 2004, the total balance outstanding under the
facility, including $465,000 outstanding under the term loan portion, amounted
to $1,202,000, with additional borrowings available under the revolving loan of
$1,729,000, based upon accounts receivable and inventory levels.


NOTE 7 - INDUSTRY SEGMENTS AND MAJOR CUSTOMERS

Segments

As described in Note 2, on March 23, 2004, the Company completed the sale of
substantially all of the assets and operations of the Company's subsidiary,
ANIP, to an unrelated newly formed entity. Accordingly, the operations of ANIP
are accounted for as a discontinued operation within these financial statements.
The Company's operations are currently conducted through its operating
subsidiary, Bactolac. The Company determines its operating segment results
consistent with its management reporting and consolidated accounting policies.
All of the assets and operating results as presented in the accompanying
financial statements from continuing operations are associated with the Bactolac
operation.

Major Customers

Other than as detailed under foreign sales, the Company's revenues from
continuing operations are generated from customers located in the United States.
The following represents customers comprising more than 10% of the Company's net
sales from continuing operations:

                        Customer                 2004        2003
                        -----------------       ------      ------
                           A-                   15.3%        9.6%
                           B-                   12.8%       15.0%
                           C-                   10.5%       14.6%

Foreign Sales

Export sales from continuing operations were approximately $1,123,000 and
$574,000 for the years ended September 30, 2004 and 2003, arising primarily
from customers in Russia. The Company has no foreign assets.

                                      F-14
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 8 -- COMMITMENTS AND CONTINGENCIES

Contingencies

The Company's subsidiary, Bactolac, has pending legal actions and claims
incurred in the normal course of business. One action from a former customer
seeks claims exceeding $650,000 on three causes of action. During the period
subsequent to when the former customer alleges that Bactolac violated a
production agreement, Bactolac produced less than $450 for this customer and
during the Company's entire relationship with the customer, less than $3,000 in
product was sold to them. The next hearing on this matter has been scheduled for
the spring of 2005. The Company believes that these actions, to the extent that
they are material, are without merit and is actively pursuing the defense
thereof. The Company believes that the ultimate resolution of these matters will
not have a material effect on the Company's financial condition, results of
operations or cash flows. Depending however, on the amount and timing of an
unfavorable resolution of these items, it is possible that the Company's future
results of operations or cash flows could be materially impacted in a particular
period.

401(k) Plan

In July 1998 the Company established a 401(k) plan (the "Plan") which covered
all of the Company's full-time eligible employees. The plan was terminated
during 2004. The Plan provided for discretionary contributions by the Company;
through the date of termination, the Company had made no such discretionary
contributions.

Operating Leases

The Company has non-cancelable operating leases, primarily for manufacturing and
office space and equipment. Rental expense under operating leases for the years
ended September 30, 2004 and 2003 amounted to approximately $456,000 and
$412,000, primarily paid under the related party lease agreement. The lease for
the Bactolac facility is with an entity owned by a member of the Company's Board
of Directors. The lease requires monthly payments through December 2010 and
contains a renewal option for an additional five-year term.

During the third quarter of 2004, Bactolac leased an additional 29,000 square
feet under a five-year agreement, from an unrelated third party, as expansion
space.

Future minimum rental payments required under operating leases that have initial
or remaining non-cancelable lease terms in excess of one year are as follows for
the years ending September 30:

                         Related            Third
                          party             party             Totals
                        ----------        ----------       -----------
                 2005   $  350,000        $  160,000        $  510,000
                 2006      300,000           170,000           470,000
                 2007      310,000           170,000           480,000
                 2008      310,000           180,000           490,000
                 2009      310,000           120,000           430,000
                 2010      320,000               --            320,000
                 2011      290,000               --            290,000
                        ----------        ----------       -----------
                        $2,190,000        $ 800,000         $2,990,000
                        ==========        =========         ==========

                                      F-15
<PAGE>


                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Employment Agreements

The Company has employment agreements with certain of its management personnel.
The agreements contain customary provisions regarding employment terms,
confidentiality and non-solicitation provisions. Two of the agreements provide
for a commitment extending beyond one year, requiring monthly payments of
approximately $33,300 to January 2005, and thereafter decreasing to $21,000 per
month through November 2005.

Government Regulations

The Company's activities are subject to regulations by various federal and state
agencies, including the Food and Drug Administration (the "FDA"). The Company
believes that it is in compliance with all federal and state regulations.
However, the Company cannot predict whether new legislation regulating its
activities will be enacted, which could have a material adverse effect on the
Company.


NOTE 9 - STOCKHOLDERS' EQUITY

During April 2004, the holders of options outstanding under the Company's 1995
Stock Option Plan exercised their options and acquired 35,833 shares of common
stock with the Company receiving cash proceeds of $35,283.

In connection with loans that the Company received prior to October 2002, that
were subsequently converted into common shares of the Company, warrants to
purchase 85,000 shares were issued to those lenders to allow them to acquire
shares of common stock at $1.00 per share. During June 2004, these warrants were
converted into 68,653, shares of the Company's common stock on a cashless basis,
as provided for under the terms of the warrant agreements.


NOTE 10 -- STOCK OPTIONS AND WARRANTS

1995 Discretionary Plan

The Company's 1995 Stock Option Plan (the "1995 Plan") as amended provides for a
total of 1,250,000 shares of common stock to be reserved for the grant of
options to purchase common stock of the Company. The terms of the options
generally provide for grants by the Board at fair market value and such options
are subject to vesting and expire if an employee leaves the Company. At
September 30, 2004, there were 1,163,720 shares reserved for the grant of
options under the 1995 plan.



The following is a summary of the status of options and warrants during the
years ended September 30:

<TABLE>
<CAPTION>
                                                        Options                          Warrants
                                                 -----------------------          -----------------------
                                                                 Weighted                        Weighted
                                                   Number         Average         Number          Average
                                                     of          Exercise           of           Exercise
                                                   Shares          Price          Shares           Price
                                                 ---------       -------          --------       --------
<S>                                              <C>             <C>              <C>            <C>

         Outstanding as of September 30, 2002      974,669        $ 2.09           157,500        $10.67
           Granted                                 125,000        $  .87                --            --
           Exercised                                  --              --                --            --
           Forfeited                              (177,817)       $  .75                --            --
           Cancelled                                  --              --                --            --
                                                  ---------                        --------
         Outstanding as of September 30, 2003     921,852         $ 1.59           157,500        $10.67

          Granted                                 464,260         $  .71                --            --
           Exercised                               (35,833)       $  .98           (85,000)        $1.00
           Forfeited                              (186,559)       $ 1.53           (72,500)       $22.00
           Cancelled                                    --            --                --            --
                                                  ---------                       --------
         Outstanding as of September 30, 2004    1,163,720        $ 1.28                --            --
                                                 ==========                       ========
</TABLE>

                                      F-16
<PAGE>

                          ADVANCED NUTRACEUTICALS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

<S>                                                       <C>              <C>              <C>            <C>
          Exercisable as of September 30,
           2003                                             534,326        $ 2.35           157,500        $10.67
           2004                                           1,016,305        $ 1.39                --            --


         Weighted average fair value of grants
            during the year ended September 30,
              2003                                                         $  .87                             --
              2004                                                         $  .71                             --
                                                                           ======                          ======
</TABLE>


<TABLE>
<CAPTION>

                        Options Outstanding                                               Options Exercisable
                        -------------------                                               -------------------
                                         Weighted-Average
                                             Remaining
       Range of                          Contractual Life     Weighted-Average                      Weighted-Average
      Exercise Prices         Number          (years)          Exercise Price          Number        Exercise Price
  -------------------         ------          -------          --------------          ------        --------------
<S>                           <C>             <C>              <C>                     <C>           <C>
$   .46 -    $   1.50       1,067,145            8.0               $   .76             919,730           $   .80
   1.51 -        3.00          25,000            6.1                  2.25              25,000              2.25
   3.01 -       11.36          71,575            4.6                 10.17              71,575             10.17

                            ---------            ---               -------            --------          --------
                            1,163,720            7.7               $  1.28           1,016,305          $   1.39
                            =========            ===               =======           =========          ========
</TABLE>


NOTE 11 - SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental disclosure of non-cash investing and financing activities:

                                                           2004         2003
                                                        --------      --------
     Issuance of 68,653 shares of common stock in 2004
        for cashless exercise of warrants               $     --      $   --

     Supplemental disclosure of cash flow information:

       Federal and state income taxes paid              $ 14,000      $ 21,000

       Interest paid                                    $514,000      $632,000


                                      F-17
<PAGE>


ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

On September 10, 2003, the Company dismissed Grant Thornton LLP ("GT") as the
Company's principal accountant. The decision to change accountants was approved
by the Audit Committee of the Board of Directors of the Company.

The reports of GT on the financial statements of the Company for the fiscal year
ended September 30, 2002 contained an explanatory paragraph stating that the
Company changed its method of accounting for goodwill and other intangible
assets for the year ended September 30, 2002. With the exception of the
foregoing, the reports of GT on the financial statements of the Company for
either of the past two fiscal years ended September 30, 2002 and 2001 did not
contain an adverse opinion or disclaimer of opinion, and were not qualified or
modified as to uncertainty, audit scope or accounting principles.

On September 12, 2003, the Company engaged GHP Horwath, P.C. ("GHP") as the
Company's certifying accountants to audit the financial statements of the
Company for its fiscal year ending September 30, 2003. During the Company's two
most recent fiscal years and the interim period prior to its agreement to engage
GHP as the Company's principal accountants, neither the Company nor anyone on
its behalf had consulted GHP on either (i) the application of accounting
principles to any transaction (completed or proposed) or (ii) the type of audit
report that might be rendered on the Company's financial statements, or (iii)
any matter that was either the subject of a disagreement or reportable event as
such terms are defined in Item 304 of Regulation S-K.

There have been no disagreements between the Company and its independent
accountants on any matter of accounting principles or practices or financial
statement disclosure.

Item 8 A.  CONTROLS AND PROCEDURES

(a)  Evaluation of Disclosure Controls and Procedures

The management of the Company, including the Chief Executive Officer and the
Chief Financial Officer, has conducted an evaluation of the effectiveness of the
Company's disclosure controls and procedures pursuant to Rule 13a-14 under the
Securities Exchange Act of 1934 as of a date (the "Evaluation Date") within 90
days prior to the filing date of this report. Based on that evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that, as of
the Evaluation Date, the Company's disclosure controls and procedures were
effective in ensuring that all material information relating to the Company
required to be filed in the annual report has been made known to them in a
timely manner.

(b)  Changes in Internal Controls

There have been no significant changes made in the Company's internal controls
or in other factors that have significantly affected internal controls
subsequent to the Evaluation Date.

                                       14
<PAGE>

                                    PART III

ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

Directors
---------

Set forth below is biographical information regarding the members of the Board
of Directors of Advanced Nutraceuticals, Inc. ("ANI" or the "Company"). The
Company reorganized into a holding company structure in 2000 and NFLI became a
wholly-owned subsidiary. NFLI was sold by the Company in 2001. References to the
"Company" include Nutrition For Life International, Inc. ("NFLI").

F. Wayne Ballenger, age 57, serves as a loan officer for Small Business Loan
Source, LLC, a position he has held since 2003. From 2000 to 2003 he served as a
consultant in various financial consulting capacities. He served as President of
First Commercial Capital from 1995 to 2000. He has also served as President of
Puncture Guard LLC since December 1994. From March 1992 to December 1994, he
served as director of sales and marketing for Petrolon, Inc., a multi-level
marketing organization. Immediately prior thereto, he served as a vice president
of Southwest Bank of Texas with commercial lending responsibilities. Mr.
Ballenger received a B.B.A. degree from the University of the South in 1968. Mr.
Ballenger became a director of the Company in November 1995.

Randall D. Humphreys, age 49, is Chairman and Managing Director of Glenwood
Capital, LLC., a position he had held since 2001. From 1997 to 2001 he was the
Chairman and Managing Director of Enterprise Merchant Banc, L.L.C. During 1997
he led the diversification effort of St. Joseph Light and Power, a New York
Stock Exchange listed utility. During 1996 he served as a financial consultant.
From 1986 through 1995, Mr. Humphreys served as the Senior Operations Officer of
Brierly Investments Limited. Mr. Humphreys is a graduate of Kansas State
University. Mr. Humphreys became a director of the Company in June 2001.

David E. Welch, age 57, has been a director of the Company since February 2003.
Mr. Welch has served as Vice President and Chief Financial Officer of American
Millennium Corporation, Inc., a public company located in Golden, Colorado,
since April 2004. He also is a self-employed financial consultant. From July
1999 to June 2002, Mr. Welch served as Chief Financial Officer, Secretary and
Treasurer of Active Link Communications, Inc., another publicly traded company.
During 1998, he served as Chief Information Officer for Language Management
International, Inc., a multinational translation firm located in Denver,
Colorado. From 1996 to 1997, he was Director of Information Systems for
Mircromedex, Inc., an electronic publishing firm, located in Denver, Colorado.
Mr. Welch also serves on the Boards of Directors of AspenBio, Inc., and
Communication Intelligence Corporation, both publicly traded companies.

Gregory Pusey, age 52, has been a director of the Company since November 1999.
Until May 31, 2004, he also served as Chairman of the Board of Directors of the
Company. Effective June 1, 2004 he was elected Chief Executive Officer and
President of the Company. Mr. Pusey served as an officer and director of the
company formerly known as Advanced Nutraceuticals, Inc. ("Old ANI") since
December 1997. Old ANI was acquired by the Company in November 1999. He has
served as President of Livingston Capital, Ltd., a private venture capital firm
since 1987. From 1986 to 1994, he served as a consultant to the Company and from
1994 to 1998, he served as a director and consultant to the Company. Since 1988,
Mr. Pusey has been the President and a director of Cambridge Holdings, Ltd., a
publicly held real estate and business development firm. Mr. Pusey also serves
as Chairman and a director of AspenBio, Inc., a publicly traded company and A4S
Technologies, Inc. Mr. Pusey graduated summa cum laude from Boston College with
a B.S. degree in finance in 1974.

                                       15
<PAGE>

Pailla M. Reddy, age 44, has been a director of the Company since 1999 and is
currently Chairman of the Board of Directors of the Company and Chief Executive
Officer and President of Bactolac Pharmaceutical Inc. The Company acquired
Bactolac in November 1999. Dr. Reddy founded Bactolac and has served as an
officer and director of Bactolac since 1995. From 1991 to 1995, he was
production manager for Max Pharmaceutical, Inc. From 1983 to 1991, Dr. Reddy
held various positions with Wellcome Pharmaceuticals Ltd., including research
chemist and production manager. Dr. Reddy received a B.Sc. degree in chemistry
from Osmania University in India, and M.Sc. and Ph.D. degrees in organic
chemistry from Kanpur University in India.

Officers
--------

Our Board has elected the following executive officer who is not a member of the
Board. It is expected that the Board will elect officers annually following each
annual meeting of shareholders.

Jeffrey G. McGonegal, age 53, became Senior Vice President - Finance of the
Company in February 2000. Mr. McGonegal also serves as Secretary of the Company.
Since 1997, Mr. McGonegal has served as Managing Director of McGonegal and Co.,
a company engaged in providing accounting and business consulting services. Mr.
McGonegal served as a consultant to us in connection with the acquisitions we
made in 1999. From 1974 to 1997, Mr. McGonegal was an accountant with BDO
Seidman LLP. While at BDO Seidman LLP, Mr. McGonegal served as managing partner
of the Denver, Colorado office. Mr. McGonegal also serves as Chief Financial
Officer of AspenBio, Inc., a publicly held biotechnology company. Mr. McGonegal
is a member of the board of directors of The Rockies Venture Club, Inc. He
received a B.A. degree in accounting from Florida State University.

Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------

Based solely on the Company's review of copies of Section 16(a) reports filed by
officers, directors and greater than 10% shareholders with the Securities and
Exchange Commission, which have been received by the Company and written
representations from these persons that no other reports were required for those
persons, the Company believes that all filing requirements applicable to those
persons were complied with for the fiscal year ended September 30, 2003.

Audit Committee Composition

The Company has a separately designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). David E Welch (Chairman), Randall D. Humphreys and
F. Wayne Ballenger are members of the audit committee. The Board has determined
that at least one person on the Audit Committee, David E. Welch, qualifies as a
"financial expert" as defined by Item 401 of Regulation S-B of the
Sarbanes-Oxley Act. Mr. Welch also meets the SEC definition of an "independent"
director.
<PAGE>

Code of Ethics

The Company has adopted a Code of Ethics (as defined in Item 406 of Regulation
S-B) that applies to its principal executive, financial and accounting officers.
Advanced Nutraceuticals, Inc. will provide a copy of its code of ethics, without
charge, to any investor that requests it. Requests should be addressed in
writing to Mr. Jeffrey G. McGonegal, Senior Vice President - Finance, 106 South
University Unit #14, Denver, CO 80209.

                                       16
<PAGE>

                         ITEM 10. EXECUTIVE COMPENSATION

The following table sets forth certain information regarding compensation paid
by us to the chief executive officer and each of the other executive officers of
the Company (the "named executive officers") during the fiscal years ended
September 30, 2002, 2003 and 2004.

Summary Compensation Table
<TABLE>
<CAPTION>
                                                                                      LONG TERM COMPENSATION
                                                                                ----------------------------------
                                          ANNUAL COMPENSATION                   AWARDS                     PAYOUTS
                                          --------------------                  -------                    -------
                                                                 Other Annual
                                                                   Compen-      Restricted                           All other
 Name and Principal Position              Salary                    sation      Stock Awards  Options/SARs  LTIP     Compensation
                                  Year    ($)         Bonus                                                 Payouts
<S>                               <C>    <C>       <C>           <C>            <C>           <C>           <C>      <C>
Greg Pusey
President, and                    2002  $101,122   $      -      $       -      $     -         75,000      $   -    $       -
Chairman of the Board             2003   144,711      4,808              -            -              -          -            -
of Directors of ANI               2004   127,404     19,808              -            -         75,000          -            -
                                                                                                                             -

Jeffrey G. McGonegal
Senior Vice President             2002   134,776          -              -            -         75,000          -            -
- Finance of ANI                  2003   150,000     20,769              -            -              -          -            -
                                  2004   152,885     40,769              -            -         75,000          -            -


Pailla M. Reddy (1)
Chairman of the Board of ANI,
President, Chief Executive        2002   242,298          -              -            -        100,000          -            -
Officer and Chairman of the       2003   250,000      9,616              -            -              -          -            -
Board of Directors of             2004   254,808    109,615              -            -        150,000          -            -
Bactolac
</TABLE>

(1) The Company has obtained a life insurance policy on Dr. Pailla M. Reddy. The
benefit amount of $7,000,000 constitutes "key-man" insurance and is payable to
the Company.

Employment Agreements
---------------------

In connection with the acquisition of Bactolac in 1999, the Company entered into
a two year employment agreement with Dr. Pailla Reddy, the President of
Bactolac. In November 2001 a new two year agreement was signed and in March 2003
an amendment to the agreement was signed. Dr. Reddy currently receives an annual
salary of $250,000 and may receive a performance bonus at the Company's
discretion. He is also entitled to continued use of the vehicle that is leased
by Bactolac.

In February 2003, the Company entered into an employment agreement with Jeffrey
G. McGonegal, Senior Vice President - Finance for a two year term under which he
currently receives an annual salary of $150,000 and may receive a performance
bonus at the Company's discretion

<PAGE>
Equity Compensation Plan Information
------------------------------------
The following table gives information about the Company's common stock that may
be issued upon the exercise of options under the 1995 Stock Option Plan as of
September 30, 2004.

                                       17
<PAGE>

<TABLE>
<CAPTION>

                                                                            (c) Number of
                                                                             Securities
                                                                              Remaining
                                                                            Available for
                                 (a) Number of          (b) Weighted       Future Issuance
                                Securities to be      Average Exercise      Under Equity
                              Issued Upon Exercise        Price of       Compensation Plans
                                 of Outstanding         Outstanding          (Excluding
                             Options, Warrants and   Options, Warrants       Securities       (d) Total of Securities
                                     Rights              and Rights         Reflected in        Reflected in Columns
       Plan Category                                                         Column (a))            (a) and (c)
       -------------         ---------------------   ------------------      -----------            -----------
<S>                               <C>                       <C>           <C>                    <C>
Equity Compensation Plans
Approved by Shareowners         1,163,720                   $ 1.28             86,280               1,250,000

Equity Compensation Plans
Not Approved  by
Shareowners                        None                       --                  --                     --
                                ---------                   ------            --------              ---------

TOTAL                           1,163,720                   $ 1.28             86,280               1,250,000
                                =========                   ======            ========              =========
</TABLE>


Option Grants in Fiscal Year Ended September 30, 2004
-----------------------------------------------------

The following table sets forth information with respect to stock option grants
to the named executive officers during the fiscal year ended September 30, 2004:

<TABLE>
<CAPTION>

<PAGE>

                                                                                        Potential Realizable Value at
                                                                                           Assumed Annual Rates of
                                  Individual Grants                                       Stock Price Appreciation
                                                                                               For Option Term
                            Number of      Percent of
                            Securities     Total            Exercise or
         Name               underlying     options/SARs     base price    Expiration         5% ($)         10% ($)
                           Options/SARs    granted to          ($/Sh)         date
                           granted (#)     employees in
                                           fiscal year

<S>                        <C>                    <C>           <C>        <C>                   <C>             <C>
Gregory Pusey                    -             16%            $.74             2009           $15,284         $33,913
Jeffrey G. McGonegal             -             16%            $.67             2014           $31,759         $80,484
Pailla M. Reddy                  -             32%            $.74             2009           $30,695         $67,828

</TABLE>


Option Exercises and Year-End Values
------------------------------------

The following table shows option exercises by the named executive officers
during the fiscal year ended September 30, 2004 and the number and value of
unexercised options at September 30, 2004.

                                       18
<PAGE>

<TABLE>
<CAPTION>

                                                                                                     Value of
                                Number of                              Number of                   Unexercised
                              Shares Under-        Value          Unexercised Options              In-the-Money
           Name               Lying Options       Realized          At Year End (#)                 Options at
           -----              Exercised (#)         ($)              Exercisable/                  Year End ($)
                              -------------         ---             Unexercisable                  Exercisable/
                                                                    --------------                Unexercisable(1)
                                                                                                  ----------------
<S>                                 <C>              <C>             <C>    <C>                        <C>
Gregory Pusey                          0                0              200,000/25,000         $409,150/$62,350
Jeffrey G. McGonegal                   0                0             225,000/25,000          $412,250/$63,500
Pailla M. Reddy                        0                0              83,333/91,667          $643,175/$83,125
</TABLE>

------------------------
(1) Based on the price of the common stock of $ 3.00 on September 30, 2004 as
reported by the OTC Bulletin Board.

Compensation Committee Report
-----------------------------

The compensation committee (the "Committee") of the Board has been established
by the Board to periodically review the compensation philosophy for our
executives, and to recommend to the Board compensation packages for our
executives. The Committee also reviews and recommends to the Board any additions
to or revisions of our stock option plans. The Committee consists exclusively of
non-employee directors, appointed by resolution of the entire Board.

The Committee's objective is to set executive compensation at levels which (i)
are fair and reasonable to the shareholders, (ii) link executive compensation to
long-term and short-term interest of the shareholders, and (iii) are sufficient
to attract, motivate and retain outstanding individuals for executive positions.

Fairness to the shareholders is balanced with the need to attract, retain and
motivate outstanding individuals by comparing our executive compensation with
the compensation of executives at other companies. The Committee's overall goal
is to achieve strong performance by the Company and its executives by affording
the executives the opportunity to be rewarded for strong performance. The
Committee attempts to provide both short-term and long-term incentive pay. To
accomplish its objectives, the Committee has structured the executive
compensation program with three primary components. These primary components are
base salary, annual incentives, and long-term incentives.

                                       19
<PAGE>

The Committee periodically reviews executive salaries. In addition to the
external competitive compensation market, base salary levels reflect each
officer's performance over time and each individual's role in the Company.
Consequently, employees with higher levels of sustained performance over time
and/or employees assuming greater responsibilities will typically be paid
correspondingly higher salaries. Individual performance criteria used to assess
performance include leadership, professionalism, initiative and dependability.
However, individual performance assessments are made qualitatively and in total,
and no specific weightings are attached to these performance indicators, nor is
a formula utilized in determining appropriate salary increases or salary levels.
Information regarding salary levels is included in the Executive Compensation
Table.

The Committee periodically reviews the performance of executive officers to
determine whether bonuses should be paid to those persons. The Committee has not
established specific performance measures for determining the award of bonuses.
The Committee believes that bonuses should be provided to reward key employees
based on Company and individual performance and to provide competitive cash
compensation opportunities to the Company's executives. During June 2001,
following the closing of the sale of NFLI, bonuses of $75,000, $50,000 and
$30,000 were paid to Messrs. Bertrand, Pusey and McGonegal, respectively. In
September 2001, a bonus of 103,000 shares of our common stock (valued at
$97,850) was approved for Dr. Reddy, and the shares were issued subsequent to
the fiscal year-end. During the year ended September 30, 2003, bonuses of
$9,615, $4,808 and $20,769 were paid to Messrs. Reddy, Pusey and McGonegal,
respectively. During the year ended September 30, 2004, bonuses of $109,615,
$19,808 and $40,769 were paid to Messrs. Reddy, Pusey and McGonegal,
respectively.

Our stock option plans are designed to focus executive efforts on our long-term
goals and to maximize total return to our shareholders. The Committee believes
that stock options advance the interests of employees and shareholders by
providing value to the executives through stock price appreciation only. Options
terminate if the employee's employment with us is terminated. All options
awarded must have an exercise price of at least 100% of fair market value on the
date of grant.

The exact number of shares granted to a particular participant reflects both the
participant's performance and role in the Company, as well as our financial
success, and our future business plans. All of these factors are assessed
subjectively and are not weighted. In determining each grant, the Committee also
considers the number of stock options which are outstanding, and the total
number of options to be awarded.

In making grants during the fiscal year ended September 30, 2004, the Committee
also considered the number of outstanding options previously granted to each
officer. The Committee believes that its awards were consistent with our
compensation philosophy to increase the emphasis placed on long-term incentives
and to be competitive in its total compensation program.

Under Section 162(m) of the Internal Revenue Code of 1986, as amended, public
companies are precluded from receiving a tax deduction on compensation paid to
executive officers in excess of $1,000,000, unless the compensation is excluded
from the $1,000,000 limit as a result of being classified performance-based. At
this time, our executive officers cash compensation levels do not exceed the
payment limit and will most likely not be affected by the regulations in the
near future. Nonetheless, the Committee intends to review its executive pay
plans over time in light of these regulations.

                                            COMPENSATION COMMITTEE

                                              F. Wayne Ballenger
                                              Randall D. Humphreys

Compensation of Directors
-------------------------

Effective in November 2001, our policy is to pay directors who are not employees
of the Company $12,000 per year, payable monthly. Directors who are also
employees of the Company receive no additional compensation for serving as
directors. We reimburse our directors for expenses incurred for attendance at
meetings of the Board.

During the fiscal year ended September 30, 2001, we granted options to purchase
12,500 shares of Common Stock at a price of $1.16 per share to F. Wayne
Ballenger and 12,500 shares of Common Stock at a price of $1.26 per share to
Randall D. Humphreys. During the fiscal year ended September 30, 2002, we
granted options to each of these non-employee directors to purchase 10,000
shares of Common Stock at a price of $.46 per share. During the year ended
September 30, 2003, we granted options to purchase 10,000 shares of Common Stock
at a price of $.63 per share to David E. Welch, upon his becoming a director of
the Company. During the fiscal year ended September 30, 2004, we granted options

                                       20
<PAGE>

to purchase 15,000 shares of Common Stock (10,000 at a price of $.52 and 5,000
at a price of $.72 per share) to F. Wayne Ballenger, 15,000 shares of Common
Stock (10,000 at a price of $.52 and 5,000 at a price of $.72 per share) to
David E. Welch, and 15,000 shares of Common Stock (10,000 at a price of $.52 and
5,000 at a price of $.72 per share) to Randall D. Humphreys. The option grants
were made pursuant to the Company's 1995 Stock Option Plan, as amended. Each
option will expire ten years from the date of grant, except that an option will
expire, if not exercised, 30 days after the optionee ceases to be a consultant
to the Company. Each grant was made at an expense price equivalent to the
trading price of the Common Stock at the date of grant.


ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
         RELATED STOCKHOLDER MATTERS

The following table sets forth, as of December 30, 2004, the ownership of our
common stock held by:

     (1) Each person who owns of record or who is known by us to own
beneficially more than 5% of such stock;

     (2) Each of the directors and nominees for election as directors;

     (3) Each of the current executive officers; and

     (4) All of our directors and executive officers as a group.

     The number of shares and the percentage of the class beneficially owned by
the persons named in the table and by all directors and executive officers as a
group, includes, in addition to shares actually issued and outstanding, unissued
shares which are subject to issuance upon exercise of certain options or
warrants described in the notes of the table.

   Beneficial Owner                   Number of Shares            Percentage
                                            Owned                 of Ownership
   ----------------                   ----------------            ------------

Pailla M. Reddy                            2,725,948(1)                  50.6%
7 Oser Avenue
Hauppauge, NY  11788

Gregory Pusey                                998,362(2)                  19.3%
106 S. University, #14
Denver, CO  80209

Cambridge Holdings, Ltd.                     670,085                     13.1%
106 S. University, #14
Denver, CO  80209

Jeffrey G. McGonegal                         258,363(3)                   4.9%
1905 West Valley Vista
Drive
Castle Rock, CO  80109

F. Wayne Ballenger                            30,417(4)                   0.6%
3134 Meadway Drive
Houston, TX  77082

Randall D. Humphreys                         372,937(5)                   7.3%
9150 Glenwood
Overland Park, KS  66212

                                       21
<PAGE>

David E. Welch                                18,333(6)                   0.4%
1729 E. Otero Ave.
Centennial, CO 80122

All Officers and                           4,404,360                     74.8%
Directors as a Group
(6 Persons)

--------------------------------

(1)      Includes options to acquire (i) 75,000 shares of common stock at $1.16
         per share, (ii) 66,667 shares of Common Stock at $.506 per share, (iii)
         100,000 shares at $.715, and 50,000 shares of Common Stock at $.792 per
         share. Does not include options to acquire 33,333 shares at $.506 per
         share which become exercisable in September 2005.


(2)      Includes 20,328 shares held by his wife, individually and as custodian
         for their minor children, 670,085 shares held by Cambridge Holdings,
         Ltd., a corporation in which he is a principal shareholder, and options
         to acquire (i) 12,500 shares of Common Stock at $11.36 per share (ii)
         62,500 shares of Common Stock at $1.16 per share, (iii) 50,000 shares
         of Common Stock at $.506 per share, (iv) 100,000 shares of Common Stock
         at $.72 per share, and (v) 50,000 shares of Common Stock at $.792 per
         share. Does not include options to acquire 25,000 shares at $.506 per
         share which become exercisable in September 2005.


(3)      Includes 2,663 shares held in the name of McGonegal Family Partnership
         and options to acquire (i) 25,000 shares of Common Stock at $9.00 per
         share (ii) 25,000 shares at $2.25 per share (iii) 50,000 shares of
         Common Stock at $1.16 per share (iv) 50,000 shares of Common Stock at
         $.46 per share, (v) 50,000 shares at $.65 per share, and (vi) 25,000
         shares at $.72 per share. Does not include options to acquire 25,000
         shares at $.46 per share which become exercisable in September 2005.

(4)      Includes options to acquire (i) 6,250 shares of Common Stock at $11.36
         per share, (ii) 12,500 shares at $1.16 per share, (iii) 6,667 shares at
         $.46 per share, and (iv) 5,000 shares at $.72. Does not include options
         to acquire 3,333 shares at $.46 per share which become exercisable in
         September 2005, nor options to acquire 10,000 shares at $.52 per share
         which become exercisable in one-third annual installments commencing in
         December 2004.

(5)      Includes 348,770 shares of common stock held by Glenwood Capital
         Partners I, LP, a partnership in which he is the general partner,
         options to acquire (i) 12,500 shares of common stock at $1.26 per
         share, (ii) 6,667 shares of Common Stock at $.46 per share, and (iii)
         5,000 shares at $.72 per share. Does not include options to acquire
         3,333 shares at $.46 per share, which become exercisable in September
         2005, nor options to acquire 10,000 shares at $.52 per share which
         become exercisable in one third annual installments commencing in
         December 2004.

(6)      Includes options to acquire (i) 3,333 shares of Common Stock at $.63
         per share and (ii) 5,000 shares at $.72 per share. Does not include
         options to acquire 3,333 shares at $.46 per share which become
         exercisable in February 2005, nor options to acquire 10,000 shares at
         $.52 per share which become exercisable in one third annual
         installments commencing in December 2004.

                                       22
<PAGE>

ITEM 12. CERTAIN RELATIONSHPS AND RELATED TRANSACTIONS

Bactolac, headquartered in Hauppauge, New York, conducts its operations in a
facility leased from its President, Pailla M. Reddy, comprising approximately
32,700 square feet. Bactolac's current monthly rental is approximately $30,000,
of which $6,000 pertains to improvements made by an entity owned by Dr. Reddy,
that escalates over the remaining term on the lease through December 2010.
Bactolac has a five-year renewal option on the facility.

During March 2003, the remaining $500,000 Note payable to Dr. P. M. Reddy, was
repaid. The Note arose from the November 1999 purchase of Bactolac.

During March 2003, Bactolac and Dr. Reddy entered into an amended employment
agreement extending to November 1, 2005. In addition to a base annual salary of
$250,000, and performance bonus features, the agreement contains customary
confidentiality and benefit provisions.

In February 2003, the Company entered into an employment agreement with Jeffrey
G. McGonegal, Senior Vice President for a two year term under which he currently
receives an annual salary of $150,000 and may receive a performance bonus at the
Company's discretion

During January 2002, the Company borrowed $250,000 from Cambridge Holdings, Ltd.
The 7% note was scheduled to mature in one year, and was convertible at the
option of the holder into shares of ANI Common Stock at $1.00 per share, which
conversion subsequently occurred. The Company also issued a warrant to allow
Cambridge to acquire 50,000 shares of ANI Common Stock at $1.00 per share,
through June 2004. Gregory Pusey and Jeffrey G. McGonegal, officers of the
Company, are also officers and directors of Cambridge. These transactions were
approved by a disinterested majority of the Company's Board and the Board
believes that the terms are at least as favorable as could have been obtained
from an unaffiliated party.

During June 2004, 85,000 warrants that were held by Cambridge Holdings, Ltd. and
Glenwood Capital Partners I, LP were converted into 68,653 shares of the
Company's Common Stock on a cashless basis, as provided for under the terms of
the warrant agreements.


ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) and (2) See Item 8.

(3) Exhibits

Exhibit 2.1     Agreement and Plan of Reorganization, filed as a Exhibit to
                the Registration Statement on Form S-4 (file no. 33-70312),
                which Exhibit is incorporated herein by this reference.

Exhibit 2.2     Agreement and Plan of Merger, dated as of November 5, 1999,
                among Nutrition For Life International, Inc., Advanced
                Nutraceuticals, Inc., BPI Acquisition Company, Bactolac
                Pharmaceutical Inc. and Pailla M. Reddy, filed as an Exhibit to
                the Report on Form 8-K, filed on December 2, 1999, which Exhibit
                is incorporated herein by this reference.

Exhibit 2.3     Agreement and Plan of Merger, dated as of October 20, 1999,
                among Nutrition For Life International, Inc., Advanced
                Nutraceuticals, Inc., NL Acquisition Company, Gregory Pusey and
                Barry C. Loder, filed as an Exhibit to the Report on Form 8-K,
                filed on December 2, 1999, which Exhibit is incorporated herein
                by this reference.

                                       23
<PAGE>

Exhibit 2.4     Agreement and Plan of Merger, dated as of October 25, 1999,
                among Nutrition For Life International, Inc., Advanced
                Nutraceuticals, Inc., AC Acquisition Company, Allan I. Sirkin
                and Neil Sirkin (the "Ash Merger Agreement"), filed as an
                Exhibit to the Report on Form 8-K, filed on December 15, 1999,
                which Exhibit is incorporated herein by this reference.

Exhibit 2.5     Amendment to Agreement and Plan of Merger, dated November
                24, 1999, to the Ash Merger Agreement, filed as an Exhibit to
                the Report on Form 8-K, filed on December 15, 1999, which
                Exhibit is incorporated herein by this reference.

Exhibit 2.6     Agreement and Plan of Merger dated March 13, 2000 among
                Nutrition For Life International, Inc., Advanced Nutraceuticals,
                Inc. and NFLI Merger Sub, Inc., filed as an Exhibit to the
                Report on Form 8-K, filed on March 21, 2000, which Exhibit is
                incorporated herein by reference.

Exhibit 3.1     Articles of Incorporation of Nutrition For Life International,
                Inc., as amended*

Exhibit 3.2     Bylaws of Nutrition For Life International, Inc., filed as an
                Exhibit to the Registration Statement on Form S-4 (file no. 33-
                70312), which Exhibit is incorporated herein by this reference.

Exhibit 3.3     Articles of Incorporation of Advanced Nutraceuticals, Inc.,
                filed as an Exhibit to the Report on Form 8-K, filed on March
                21, 2000, which Exhibit is incorporated herein by this reference

Exhibit 3.3     (a) Amendment to Articles of Incorporation of Advanced
                Nutraceuticals, Inc. ****

Exhibit 3.4     Bylaws of Advanced Nutraceuticals, Inc., filed as an Exhibit to
                the Report on Form 8-K, filed on March 21, 2000, which Exhibit
                is incorporated herein by this reference

Exhibit 4.1     Specimen Certificate of Nutrition for Life International,
                Inc.'s Common Stock*

Exhibit 4.4     Statement Establishing a Series of Shares (Series A
                Preferred Stock), filed as an Exhibit to the Report on Form 8-K,
                filed on December 2, 1999, which Exhibit is incorporated herein
                by this reference.

Exhibit 10.2    1995 Stock Option Plan, as amended.****

Exhibit 10.32   Employment Agreement, dated November 17, 1999, between Bactolac
                Pharmaceutical Inc. and Pailla Reddy.**

Exhibit 10.53   Agreement, dated July 7, 2000, between Shilpa-Saketh
                Realty, Inc. and Bactolac Pharmaceutical Inc. ***

Exhibit 10.62   Employment Agreement dated, November 18, 2001, between Bactolac
                Pharmaceutical Inc., and Pailla M. Reddy.****

Exhibit 10.68   Loan and Security Agreement among CapitalSource Finance LLC,
                Advanced Nutraceuticals, Inc., Bactolac Pharmaceutical Inc.
                and ANI Pharmaceuticals, Inc. filed on Form 8-K dated
                March 27, 2003, and incorporated by reference herein.

                                       24
<PAGE>


Exhibit 10.68   (a)First Amendment to Loan and Security Agreement with
                CapitalSource Finance, LLC, dated December 31, 2003.******

Exhibit 10.68   (b)Third Amendment to Loan and Security Agreement with
                CapitalSource Finance, LLC, dated January 6, 2005, filed
                herewith.

Exhibit 14      Code of Ethics of Advanced Nutraceuticals, Inc. ******

Exhibit 21      Subsidiaries of the Company.

Exhibit 23.1    Consent of GHP Horwath, P. C.

Exhibit 31.1    Chief Executive Officer certification pursuant to Section
                302 of the Sarbanes-Oxley Act of 2002.

Exhibit 31.2    Chief Financial Officer certification pursuant to Section
                302 of the Sarbanes-Oxley Act of 2002.

Exhibit 32      Chief Executive Officer and Chief Financial Officer
                certification pursuant to Section 906 of the Sarbanes-Oxley Act
                of 2002.

     *    These exhibits were previously filed as exhibits to the Company's
          Registration Statement on Form SB-2 (File No. 33-92274), and are
          incorporated herein by reference.

     **   These exhibits were previously filed as exhibits to the Company's
          Report on Form 10-K for the fiscal year ended September 30, 1999, and
          are incorporated herein by reference.

     ***  These exhibits were previously filed as exhibits to the Company's
          Report on Form 10-K/A for the fiscal year ended September 30, 2000,
          and are incorporated herein by reference.

     **** These exhibits were previously filed as exhibits to the Company's
          Report on Form 10-K for the fiscal year ended September 30, 2001, and
          are incorporated herein by reference.

    ***** These exhibits were previously filed as exhibits to the Company's
          Report on Form 10-K for the fiscal year ended September 30, 2002, and
          are incorporated herein by reference.

   ****** These exhibits were previously filed as exhibits to the Company's
          Report on Form 10-K for the fiscal year ended September 30, 2003, and
          are incorporated herein by reference.


(b) Reports on Form 8-K

     a.   On August 16, 2004, the Company filed an 8-K Report reporting under
          Items 12, 5 and 7, the issuance of a press release regarding third
          quarter results.

     b.   On October 6, 2004, the Company filed an 8-K Report reporting under
          Items 2.01, 8.01 and 9.01, the issuance of a press release covering
          the release of escrow funds from the prior sale of ANI
          Pharmaceuticals and other corporate matters.

                                       25
<PAGE>

     c.   On October 25, 2004, the Company filed an 8-K Report reporting under
          Items 8.01 and 9.01, entering into an agreement with The Seidler
          Companies.

(c) Exhibits

     (a)(3)above

     (d) Financial Statement Schedules See Item 8 above.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

During fiscal 2004 and 2003, we retained our principal auditor, GHP Horwath, P.
C., to provide services. Aggregate fees were billed in the following categories
and amounts:

                                              Years Ended September 30,
                                              -------------------------
                                                 2004           2003
                                              ---------       ---------
          Audit Fees                          $  55,000       $  81,000
          Audit Related Fees                          0               0
          Tax Related Fees                            0               0
          All Other Fees                              0               0

All of the services described above were approved by the Company's audit
committee and prior to performance. The audit committee has determined that the
payments made to its independent accountants for these services are compatible
with maintaining such auditors' independence.


                                       26
<PAGE>

                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                          ADVANCED NUTRACEUTICALS, INC.
                                          (Registrant)


Date:    January 13, 2005                By: /s/ Gregory Pusey
                                              -----------------------------
                                              Gregory Pusey, President and
                                              Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.


Date:    January 13, 2005                 /s/ Gregory Pusey
                                          --------------------------------------
                                          Gregory Pusey, President,
                                          Chief Executive Officer and Director


Date:    January 13, 2005                 /s/ Jeffrey G. McGonegal
                                          --------------------------------------
                                          Jeffrey G. McGonegal, Senior Vice
                                          President of Finance, Chief Financial
                                          Officer and Secretary


Date:    January 13, 2005                 /s/ F. Wayne Ballenger
                                          --------------------------------------
                                          F. Wayne Ballenger, Director


Date:    January 13, 2005                 /s/ Randall D. Humphries
                                          --------------------------------------
                                          Randall D. Humphries, Director


Date:    January 13, 2005                 /s/ David E. Welch
                                          --------------------------------------
                                          David E. Welch, Director


Date:    January 13, 2005                 /s/ Pailla Reddy
                                          --------------------------------------
                                          Pailla Reddy, Director

                                       27