**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-Q**

**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**forthe Quarterly Period Ended March 31, 2006**

**Commissionfile number 000-23731**

**NUTRACEUTICAL INTERNATIONAL CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                   |   | **87-0515089**                     |
|----------------------------------------------------------------|--------|------------------------------------|
| (State of  incorporation)                                      |   | (IRS Employer  Identification No.) |
| **1400 Kearns Boulevard, 2****nd Floor, Park City, Utah** |   | **84060**                          |
| (Address of  principal executive office)                       |   | (Zip code)                         |

 

**(435) 655-6106**

(Registrant’s telephonenumber, including area code)

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.    YES x*    *NO o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer asdefined in Rule 12b-2 of the Exchange Act (check one):

| Large accelerated  filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).    YES o*    *NO x

At April 27, 2006,the registrant had 11,266,108 shares of common stock outstanding.

 

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**NUTRACEUTICALINTERNATIONAL CORPORATION**

**INDEX**

| Description   | ** ** | ** **             | ** ** | **Page No.**                                                                                                                              | ** ** |
|---------------|------------|------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Part I.  |       | Financial  Information |       |                                                                                                                                           | 3          |   |   |
|          |       | Item  1.          |       | Financial  Statements                                                                                                                          |       |   | 3 |   |   |
|          |       |                   |       | Condensed Consolidated Balance  Sheets—September 30, 2005 and March 31, 2006                                                    |       |   | 3 |   |   |
|          |       |                   |       | Condensed Consolidated Statements of Operations and  Comprehensive Income—Three Months and Six Months Ended March 31, 2005  and 2006 |       |   | 4 |   |   |
|          |       |                   |       | Condensed Consolidated Statements of Cash Flows—Six  Months Ended March 31, 2005 and 2006                                            |       |   | 5 |   |   |
|          |       |                   |       | Notes to Condensed Consolidated Financial Statements                                                                                           |       |   | 6 |   |   |
|          |       | Item 2.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                    |       |   | 11 |   |   |
|          |       | Item 3.           |       | Quantitative and Qualitative Disclosures about Market  Risk                                                                                    |       |   | 18 |   |   |
|          |       | Item  4.          |       | Controls  and Procedures                                                                                                                       |       |   | 18 |   |   |
| Part II. |       | Other Information      |       |                                                                                                                                           | 20         |   |   |
|          |       | Item  1.          |       | Legal Proceedings                                                                                                                              |       |   | 20 |   |   |
|          |       | Item  1A.              |       | Risk Factors                                                                                                                                   |       |   | 20 |   |   |
|          |       | Item 2.           |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                   |       |   | 20 |   |   |
|          |       | Item 4.           |       | Submission of Matters to a Vote of Security Holders                                                                                            |       |   | 20 |   |   |
|          |       | Item 6.           |       | Exhibits                                                                                                                                       |       |   | 21 |   |   |
|               |            |                        |            |                                                                                                                                                |            |  |  |  |  |  |  |  |  |

 

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**PART I—FINANCIALINFORMATION**

**Item 1.**                        FinancialStatements

**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)(dollars in thousands)**

| ** **                                     | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                     | ** ** | **2005(1)**            | ** ** | **2006**           | ** ** |
| **ASSETS**                                     |       |                   |       |               |       |   |   |
| Current assets                                 |       |                   |       |               |       |   |   |
| Cash                                           |       |                   | $          | 3,371              |       |   | $ | 1,925 |   |
| Accounts receivable, net                       |       |                   | 10,586     |               |       | 13,085 |   |
| Inventories, net                               |       |                   | 25,434     |               |       | 29,022 |   |
| Prepaid expenses and other current assets      |       |                   | 2,060      |               |       | 1,695 |   |
| Deferred income taxes                          |       |                   | 1,416      |               |       | 1,419 |   |
| Total current assets                           |       |                   | 42,867     |               |       | 47,146 |   |
| Property, plant  and equipment, net            |       |                   | 25,808     |               |       | 30,154 |   |
| Goodwill                                       |       |                   | 18,387     |               |       | 18,366 |   |
| Intangible  assets, net                        |       |                   | 7,016      |               |       | 6,839 |   |
| Other non-current  assets, net                 |       |                   | 616        |               |       | 508 |   |
| Deferred income  taxes, net                    |       |                   | 6,211      |               |       | 5,611 |   |
|                                           |       |                   | $          | 100,905            |       |   | $ | 108,624 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY** |       |                   |       |               |       |   |   |
| Current liabilities                            |       |                   |       |               |       |   |   |
| Accounts payable                               |       |                   | $          | 10,733             |       |   | $ | 11,539 |   |
| Accrued expenses                               |       |                   | 5,341      |               |       | 4,585 |   |
| Current portion of long-term debt              |       |                   | —     |               |       | 3,000 |   |
| Total current liabilities                      |       |                   | 16,074     |               |       | 19,124 |   |
| Long-term debt                                 |       |                   | 2,000      |               |       | — |   |
| Other non-current  liabilities                 |       |                   | 364        |               |       | 364 |   |
| Total liabilities                              |       |                   | 18,438     |               |       | 19,488 |   |
| Stockholders’ equity                      |       |                   |       |               |       |   |   |
| Common stock                                   |       |                   | 115        |               |       | 113 |   |
| Additional paid-in capital                     |       |                   | 39,317     |               |       | 37,500 |   |
| Retained earnings                              |       |                   | 42,900     |               |       | 51,393 |   |
| Accumulated other comprehensive income         |       |                   | 135        |               |       | 130 |   |
| Total stockholders’ equity                |       |                   | 82,467     |               |       | 89,136 |   |
|                                           |       |                   | $          | 100,905            |       |   | $ | 108,624 |   |

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(1)          The condensedconsolidated balance sheet as of September 30, 2005 has been preparedusing information from the audited financial statements at that date.

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

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**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSAND COMPREHENSIVE INCOME(unaudited)(dollars in thousands, except per share data)**

| ** **                                          | ** ** | **Three months ended March 31,** | ** ** | **Six months ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                             | ** ** | **2006**                                           | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net sales                                           |       | $                                                    | 38,849     |                                               | $          | 41,025 |   | $ | 74,148 |   | $ | 77,729 |   |
| Cost of sales                                       |       | 18,937                                               |       | 19,272                                             |       | 35,837 |   | 36,832 |   |
| Gross profit                                        |       | 19,912                                               |       | 21,753                                             |       | 38,311 |   | 40,897 |   |
| Operating expenses                                  |       |                                                 |       |                                               |       |   |   |   |   |
| Selling, general and administrative                 |       | 13,922                                               |       | 14,485                                             |       | 27,512 |   | 27,931 |   |
| Amortization of intangible assets                   |       | 94                                                   |       | 94                                                 |       | 188 |   | 188 |   |
| Income from  operations                             |       | 5,896                                                |       | 7,174                                              |       | 10,611 |   | 12,778 |   |
| Interest and  other (income)/expense, net           |       | 228                                                  |       | (1,020                                             | )          | 380 |   | (1,031 | ) |
| Income before  provision for income taxes           |       | 5,668                                                |       | 8,194                                              |       | 10,231 |   | 13,809 |   |
| Provision for  income taxes                         |       | 2,182                                                |       | 3,154                                              |       | 3,939 |   | 5,316 |   |
| Net income                                          |       | $                                                    | 3,486      |                                               | $          | 5,040 |   | $ | 6,292 |   | $ | 8,493 |   |
| Other comprehensive  income/(loss)                  |       |                                                 |       |                                               |       |   |   |   |   |
| Foreign currency translation adjustment, net of tax |       | (6                                                   | )          | 5                                                  |       | 23 |   | (5 | ) |
| Comprehensive  income                               |       | $                                                    | 3,480      |                                               | $          | 5,045 |   | $ | 6,315 |   | $ | 8,488 |   |
| Net income per common  share                        |       |                                                 |       |                                               |       |   |   |   |   |
| Basic                                               |       | $                                                    | 0.30       |                                               | $          | 0.44 |   | $ | 0.55 |   | $ | 0.74 |   |
| Diluted                                             |       | 0.29                                                 |       | 0.43                                               |       | 0.53 |   | 0.73 |   |
| Weighted average common  shares outstanding         |       |                                                 |       |                                               |       |   |   |   |   |
| Basic                                               |       | 11,562,456                                           |       | 11,407,900                                         |       | 11,529,213 |   | 11,439,865 |   |
| Dilutive effect of stock options and warrants  |       | 266,873                                              |       | 185,703                                            |       | 296,937 |   | 175,174 |   |
| Diluted                                             |       | 11,829,329                                           |       | 11,593,603                                         |       | 11,826,150 |   | 11,615,039 |   |

 

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

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**NUTRACEUTICAL INTERNATIONAL CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(dollars in thousands)**

| ** **                                                                        | ** ** | **Six months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                       | ** ** | **2006** | ** ** |
| **Cash flows from operating  activities**                                         |       |                                           |       |   |   |
| Net income                                                                        |       | $                                              | 6,292      |   | $ | 8,493 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities |       |                                           |       |   |   |
| Depreciation and  amortization                                                    |       | 2,220                                          |       | 2,338 |   |
| Amortization of  deferred financing fees                                          |       | 91                                             |       | 91 |   |
| Losses/(gain) on  disposals of property and equipment                             |       | 29                                             |       | (1,100 | ) |
| Deferred income  taxes                                                            |       | 703                                            |       | 597 |   |
| Tax benefit from  stock option exercises                                          |       | 120                                            |       | 4 |   |
| Changes in assets and liabilities, net of effects of  acquisitions                |       |                                           |       |   |   |
| Accounts  receivable, net                                                         |       | (358                                           | )          | (2,499 | ) |
| Inventories, net                                                                  |       | 347                                            |       | (3,588 | ) |
| Prepaid expenses  and other current assets                                        |       | 1,532                                          |       | 365 |   |
| Other non-current  assets, net                                                    |       | (4                                             | )          | 6 |   |
| Accounts payable                                                                  |       | (779                                           | )          | 806 |   |
| Accrued expenses                                                                  |       | (491                                           | )          | (418 | ) |
| Other non-current  liabilities                                                    |       | (24                                            | )          | — |   |
| Net cash provided  by operating activities                                        |       | 9,678                                          |       | 5,095 |   |
| **Cash flows from investing  activities**                                         |       |                                           |       |   |   |
| Acquisitions of  businesses, net of cash acquired                                 |       | (5,911                                         | )          | (95) |   |
| Proceeds from  sale of property and equipment                                     |       | —                                         |       | 4,500 |   |
| Purchases of  property and equipment                                              |       | (2,095                                         | )          | (9,896 | ) |
| Net cash used in  investing activities                                            |       | (8,006                                         | )          | (5,491 | ) |
| **Cash flows from financing  activities**                                         |       |                                           |       |   |   |
| Payments on other  non-current liabilities                                        |       | (225                                           | )          | (225 | ) |
| Proceeds from  long-term debt                                                     |       | 3,500                                          |       | 6,000 |   |
| Payments on  long-term debt                                                       |       | (3,000                                         | )          | (5,000 | ) |
| Proceeds from  issuances of common stock                                          |       | 347                                            |       | 140 |   |
| Purchases of  common stock for treasury                                           |       | (437                                           | )          | (1,969 | ) |
| Tax benefit from  stock option exercises                                          |       | —                                         |       | 6 |   |
| Net cash provided  by (used in) financing activities                              |       | 185                                            |       | (1,048 | ) |
| Effect of  exchange rate changes on cash                                          |       | 2                                              |       | (2 | ) |
| Net increase  (decrease) in cash                                                  |       | 1,859                                          |       | (1,446 | ) |
| Cash at beginning  of period                                                      |       | 2,134                                          |       | 3,371 |   |
| Cash at end of period                                                             |       | $                                              | 3,993      |   | $ | 1,925 |   |

 

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

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (dollars in thousands, except per share data)**

**1.**                 INTERIM CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements include all necessaryadjustments (consisting of normal recurring accruals) to present fairly the consolidatedfinancial position of Nutraceutical International Corporation and itssubsidiaries (the “Company”) as of March 31, 2006, the results of theiroperations for the three months and six months ended March 31, 2005 and2006 and their cash flows for the six months ended March 31, 2005 and2006, in conformity with accounting principles generally accepted in the UnitedStates of America for interim financial information applied on a consistentbasis. Results for the three and six months ended March 31, 2006 are notnecessarily indicative of the results to be expected for the full fiscal year.

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been omitted. Accordingly, these financial statements should beread in conjunction with the Company’s Form 10-K for the Fiscal YearEnded September 30, 2005, which was filed with the Securities and ExchangeCommission on December 1, 2005.

**2.**                 ACCOUNTSRECEIVABLE, NET

Accountsreceivable, net of allowances for sales returns and doubtful accounts,consisted of the following:

| ** **           | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|----------------------|------------|------------------------|------------|--------------------|------------|
| ** **           | ** ** | **2005**               | ** ** | **2006**           | ** ** |
| Accounts  receivable |       |                   | $          | 12,476             |       |   |   | $ | 15,051 |   |   |
| Less allowances      |       |                   | (1,890     | )                  |       |   | (1,966 | ) |   |
|                 |       |                   | $10,586    |               |       |   | $13,085 |   |   |

 

**3.**                 INVENTORIES,NET

Inventories, net of reserves for slow moving, obsoleteand/or damaged inventory, were comprised of the following:

| ** **      | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|-----------------|------------|------------------------|------------|--------------------|------------|
| ** **      | ** ** | **2005**               | ** ** | **2006**           | ** ** |
| Raw materials   |       |                   | $          | 9,495              |       |   |   | $ | 12,438 |   |   |
| Work-in-process |       |                   | 6,800      |               |       |   | 6,500 |   |   |
| Finished goods  |       |                   | 11,123     |               |       |   | 11,951 |   |   |
|            |       |                   | 27,418     |               |       |   | 30,889 |   |   |
| Less reserves   |       |                   | (1,984     | )                  |       |   | (1,867 | ) |   |
|            |       |                   | $25,434    |               |       |   | $29,022 |   |   |

 

**4.**                 ACQUISITION

On March 31, 2006,the Company acquired certain assets of Living Flower Essences, LLC forapproximately $95 in cash. Living Flower Essences, LLC develops and marketsflower essence infused tinctures and salves. This acquisition, which is inkeeping with the Company’s business strategy of 

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

consolidatingthe fragmented industry in which it competes, was accounted for using thepurchase method of accounting with the purchase price of $95 assigned togoodwill.

**5.**                 PROPERTY,PLANT AND EQUIPMENT

On January 20, 2006, the Company sold its 31,340square foot building located in Park City, Utah for approximately $4,500 incash. At the time of sale, the building had a book value of $3,395. A gain of$1,105 ($680 after tax, or $0.06 per diluted share) was included in interestand other (income)/expense for the three and six months ended March 31,2006.

On March 31, 2006,the Company purchased the Rapid Response Center in Ogden, Utah, which (whenfully converted) will provide the Company approximately 410,000 square feet of grossbuilding space located on 19.2 acres, which includes available land forexpansion, for $4,160 in cash. The Rapid Response Center is the centralfacility where the Company is, and has been, consolidating operations,including raw material warehousing, manufacturing, packaging, distribution and administrativeoffices. The Company was previously leasing most of this facility.

**6.**                 GOODWILL

Thechange in the carrying amount of goodwill from September 30, 2005 to March 31,2006 was as follows:

| ** **                                                          | ** ** | **Goodwill** | ** ** |
|---------------------------------------------------------------------|------------|--------------|------------|
| Balance as of  September 30, 2005                              |       | $            | 18,387     |   |
| Goodwill attributable to fiscal 2006 second quarter  acquisition    |       | 95           |       |
| Purchase accounting adjustments related to  prior acquisitions |       | (116         | )          |
| Balance as of  March 31, 2006                                  |       | $            | 18,366     |   |

 

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

**7.**                 INTANGIBLEASSETS

Thecarrying amounts of intangible assets at September 30, 2005 and March 31,2006 were as follows:

| ** **                                      | ** ** | **September 30, 2005** | ** ** | **March 31, 2006** | ** ** | ** **   | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|--------------|------------|
| ** **                                      | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                      | ** ** | **Gross**                        | ** ** | ** **                   | ** ** | **Net**      | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Average** | ** ** |
| ** **                                      | ** ** | **Carrying**                     | ** ** | **Accumulated**              | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** | **Amortization** | ** ** |
| ** **                                      | ** ** | **Amount**                       | ** ** | **Amortization**             | ** ** | **Amount**   | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Period (Years)** | ** ** |
| Intangible assets subject  to amortization:     |       |                             |       |                         |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-compete agreements                          |       |                             | $          | 1,000                        |       |         |       | $ | (750 | ) |   |   | $ | 250 |   |   |   | $ | 1,000 |   |   |   | $ | (917 | ) |   |   | $ | 83 |   |   |   | 3 |   |   |
| Trademarks/trade names/patents                  |       |                             | 338        |                         |       |         | (250       | ) |   |   | 88 |   |   |   | 349 |   |   |   | (271 | ) |   |   | 78 |   |   |   | 5 |   |   |
|                                            |       |                             | 1,338      |                         |       |         | (1,000     | ) |   |   | 338 |   |   |   | 1,349 |   |   |   | (1,188 | ) |   |   | 161 |   |   |   |   |   |   |
| Intangible assets not  subject to amortization: |       |                             |       |                         |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trademarks/trade names/licenses                 |       |                             | 6,678      |                         |       |         | —     |   |   |   | 6,678 |   |   |   | 6,678 |   |   |   | — |   |   |   | 6,678 |   |   |   |   |   |   |
|                                            |       |                             | $          | 8,016                        |       |         |       | $ | (1,000 | ) |   |   | $ | 7,016 |   |   |   | $ | 8,027 |   |   |   | $ | (1,188 | ) |   |   | $ | 6,839 |   |   |   |   |   |   |

 

Estimatedfuture amortization expense related to the March 31, 2006 net carryingamount of $161 for intangible assets subject to amortization is as follows:

| ** **                                   | ** ** | **Estimated**    | ** ** |
|----------------------------------------------|------------|------------------|------------|
| ** **                                   | ** ** | **Amortization** | ** ** |
| **Year Ending September 30,** | ** ** | ** **       | ** ** | **Expense(1)** | ** ** |
| 2006                                         |       |             | $          | 100 |   |   |
| 2007                                         |       |             | 25         |   |   |
| 2008                                         |       |             | 17         |   |   |
| 2009                                         |       |             | 13         |   |   |
| 2010                                         |       |             | 6          |   |   |
| Thereafter                                   |       |             | —     |   |   |
|                                         |       |             | $161       |   |   |
|                                              |            |                  |            |  |  |  |  |  |

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(1)          Estimatedamortization expense for the year ending September 30, 2006 includes onlyamortization to be recorded after March 31, 2006.

**8.**                 SHAREPURCHASES

During the three monthsended March 31, 2006, the Company purchased 97,066 shares of common stockfor an aggregate price of $1,410, which shares were held in treasury untilbeing retired on March 29, 2006. During the six months endedMarch 31, 2006, the Company purchased a total of 138,609 shares of commonstock for an aggregate price of $1,969. As of March 31, 2006, the Company waspermitted to purchase up to 246,169 additional shares under its approvedpurchase plan.

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

**9.**                 OPERATINGSEGMENTS

Segment identification and selection is consistentwith the management structure used by the Company to evaluate performance andmake decisions regarding resource allocation, as well as the materiality offinancial results consistent with that structure. Based on the Company’smanagement structure and method of internal reporting, the Company has oneoperating segment. The Company does not review operating results on adisaggregated basis; rather, management reviews operating results on anaggregate basis.

Net sales to foreigncountries were less than 10% of consolidated net sales for the three and sixmonths ended March 31, 2005 and 2006. Additionally, certain products aresold domestically to customers who in turn may sell such products into foreigncountries.

**10.**          STOCK-BASEDCOMPENSATION

The Company adopted Statement of Financial AccountingStandards No. 123R, *Share-Based Payment*(“SFAS 123R”) effective October 1, 2005, using the modified prospectiveapplication method. SFAS 123R requires companies to record compensation expensefor the value of all outstanding and unvested share-based payments, includingemployee stock options and similar awards. At the date of adoption, October 1,2005, the Company had no outstanding and unvested share-based payments. On September 30,2005, the Company terminated the 1995 Stock Option Plan, the 1998 StockIncentive Plan and the 1998 Non-Employee Director Stock Option Plan. After September 30,2005, no new awards of any kind will be granted under any of these plans. As aresult, the Company did not recognize any share-based compensation expense inits consolidated financial statements for the three and six months ended March 31,2006.

Prior to the adoption ofSFAS 123R, the Company accounted for its stock-based employee compensationplans using the intrinsic value method prescribed by Accounting PrinciplesBoard Opinion No. 25, *Accounting for StockIssued to Employees*. No stock-based employee compensation cost wasreflected in net income as all options granted under those stock-based employeecompensation plans had exercise prices equal to the market values of theunderlying common shares on the dates of grant. The following table illustratesthe effect on net income and earnings per share as if the Company had appliedthe fair value recognition provisions of SFAS 123 to stock-based employeecompensation.

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**NUTRACEUTICAL INTERNATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) (dollars in thousands, except per share data)**

 

| ** **                                                                                                                                        | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2005**                                         | ** ** | **2006**                                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income, as  reported                                                                                                                          |       | $                                                | 3,486      |                                           | $          | 5,040 |   | $ | 6,292 |   | $ | 8,493 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (124                                             | )          | —                                         |       | (248 | ) | — |   |
| Pro forma net  income                                                                                                                             |       | $                                                | 3,362      |                                           | $          | 5,040 |   | $ | 6,044 |   | $ | 8,493 |   |
| Earnings per  share                                                                                                                               |       |                                             |       |                                           |       |   |   |   |   |
| Basic—as reported                                                                                                                            |       | $                                                | 0.30       |                                           | $          | 0.44 |   | $ | 0.55 |   | $ | 0.74 |   |
| Diluted—as reported                                                                                                                          |       | 0.29                                             |       | 0.43                                           |       | 0.53 |   | 0.73 |   |
| Basic—pro forma                                                                                                                              |       | $                                                | 0.29       |                                           | $          | 0.44 |   | $ | 0.52 |   | $ | 0.74 |   |
| Diluted—pro forma                                                                                                                            |       | 0.28                                             |       | 0.43                                           |       | 0.51 |   | 0.73 |   |

 

Stock options to purchase 901,257 and 876,286 sharesof common stock were outstanding at March 31, 2005 and 2006, respectively.Of these outstanding stock options, 140,915 and 139,290 options to purchasecommon stock at March 31, 2005 and 2006, respectively, were excluded fromthe computation of diluted earnings per share because the exercise prices ofthese stock options were greater than the average share price of the Company’scommon stock and, therefore, the effect would have been antidilutive. Nowarrants were outstanding at March 31, 2005 and 2006. Based on theapplication of the treasury stock method, the dilutive effect of stock optionsand warrants was 266,873 and 185,703 for the three months ended March 31,2005 and 2006, respectively, and 296,937 and 175,174 for the six months ended March 31,2005 and 2006, respectively.

Thefollowing table summarizes stock option activity during the six months ended March 31,2006:

| ** **                                                      | ** ** | ** **         | ** ** | **Weighted-Average** | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                      | ** ** | **Number of** | ** ** | **Exercise**         | ** ** |
| ** **                                                      | ** ** | **Options**        | ** ** | **Price**            | ** ** |
| Options  outstanding and exercisable at September 30, 2005 |       |               | 883,253    |                 |       |   | $ | 9.95 |   |   |
| Exercised                                                       |       |               | (6,067     | )                    |       |   | 9.66 |   |   |
| Forfeited or  expired                                           |       |               | (900       | )                    |       |   | 17.50 |   |   |
| Options outstanding and  exercisable at March 31, 2006     |       |               | 876,286    |                 |       |   | $ | 9.95 |   |   |

 

The weighted-average contractual life of stock optionsoutstanding and exercisable at March 31, 2006 was 5.8 years. At March 31,2006, the aggregate intrinsic value of stock options outstanding andexercisable was $4,487. The intrinsic value is the amount by which the marketvalue of the underlying common stock exceeds the exercise price of therespective stock option. The intrinsic value of stock options exercised duringthe six months ended March 31, 2005 and 2006 was $311 and $27, respectively.

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**Item2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

**General**

The following discussion and analysis should be readin conjunction with this report on Form 10-Q, including Part I,Item 1.

We are an integrated manufacturer, marketer,distributor and retailer of branded nutritional supplements and other naturalproducts sold primarily to and through domestic health and natural food stores.Internationally, we market and distribute branded nutritional supplements andother natural products to and through health and natural product distributorsand retailers. Our core business strategy is to acquire, integrate and operate,from beginning to end, the manufacturing, marketing and distribution of brandednutritional supplement businesses in the natural products industry. We believethat the consolidation and integration of these acquired businesses providesongoing financial synergies through increased scale and market penetration, aswell as strengthened customer relationships.

We sell branded nutritional supplements and othernatural products under the trademarks *Solaray*®, *KAL*®, *Nature’s Life*®,*Natural Balance*®, *NaturalMax*®,*VegLife*®, *Premier One*®,*Pioneer*®, *Sunny Green*®,*Natural Sport*®, *FunFreshFoods*TM, *ActiPet*®, *Action Labs*®, *Thompson*®, *Montana Big Sky*TM, *Body Gold*®, *Healthway*®, *Living Flower Essences*®and *Monarch Nutritional Laboratories*TM. Underthe name *Woodland Publishing*TM, we publish, printand market a line of books and booklets to, among others, book distributors,national retail bookstores and health and natural food stores. We alsodistribute branded products of certain third parties.

We own neighborhood natural food markets, whichoperate under the trade names *The Real FoodCompany*TM, *Thom’s Natural Foods*TMand *Cornucopia Community MarketTM*.We also own health food stores, which operate under the trade names *Arizona Health Foods*TM, *Granola’s*TM and *Pilgrim’s Natureway*TM.

We were formed in 1993 bysenior management and Bain Capital, Inc. to effect a consolidationstrategy in the fragmented vitamin, mineral, herbal and other nutritionalsupplements industry (the “VMS Industry”). Since our formation, we havecompleted the following acquisitions: Solaray, Inc., Premier One Products, Inc.,Makers of KAL, Inc. and Makers of KAL, B.V., Monarch NutritionalLaboratories, Inc., Action Labs, Inc., NutraForce (Canada)International, Inc., Woodland Publishing, Inc. and Summit Graphics, Inc.,Thompson Nutritionals, Inc., The Real Food Company, Inc., Thom’sNatural Foods, M.K. Health Food Distributors, Inc. (dba Nature’s Life),Arizona Health Foods, Inc., Natural Balance, Inc., Montana Naturals, Inc.,Cornucopia Community Market, Inc., Pilgrim’s Natureway LLC, PioneerNutritional Formulas, Inc. and Living Flower Essences, LLC. As a result ofthese acquisitions, internal growth and cost management, we believe that we arewell positioned to continue to capitalize on the consolidation that we believeis occurring in the VMS Industry.

**Critical AccountingPolicies**

The preparation of our financial statements inconformity with accounting principles generally accepted in the United Statesof America required us to make estimates and assumptions that affected thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the dates of the financial statements and the reportedamounts of net sales and expenses during the reported periods. Significantestimates included values and lives assigned to acquired intangible assets,reserves for customer returns and allowances, uncollectible accountsreceivable, slow moving and obsolete and/or damaged inventory. Actual resultsmay differ from these estimates.

Our estimates and judgments related to our criticalaccounting policies, including factors and assumptions considered in makingthese estimates and judgments, did not vary significantly for the periods 

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presented and had nomaterial impact on the consolidated financial statements as reported. Ourcritical accounting policies include the following:

*AccountsReceivable—**Provision is made for estimated bad debts based onperiodic analysis of individual customer balances, including an evaluation ofdays sales outstanding, payment history, recent payment trends and perceivedcredit worthiness. If general economic conditions and/or customer financialcondition were to change, additional provisions for bad debts may be required,which could have a material impact on the consolidated financial statements.*

*Inventories—*Provision is made for slow moving, obsolete and/ordamaged inventory based on periodic analysis of individual inventory items,including an evaluation of historical usage and/or movement, age, expirationdate and general condition. If market demand and/or consumer preferences areless favorable than historical trends or future expectations, additionalprovisions for slow moving, obsolete and/or damaged inventory may be required,which could have a material impact on the consolidated financial statements.

*Property, Plant andEquipment—*Depreciation andamortization expense is impacted by our judgments regarding the estimateduseful lives of assets placed in service. If the actual lives of assets aresignificantly less than expected, depreciation and amortization expense wouldbe accelerated, which could have a material impact on the consolidatedfinancial statements.

*Goodwill andIntangible Assets—*Statementof Financial Accounting Standards No. 141, Business Combinations, and Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets (“SFAS142”), require estimates and judgments in determining the initial recognitionand measurement of goodwill and intangible assets, including factors andassumptions used in determining fair values and useful lives. Intangible assetswith finite useful lives are amortized, while intangible assets with indefiniteuseful lives are not amortized. In addition, SFAS 142 requires ongoing,periodic impairment testing, which relies on such factors and assumptions asidentified reporting units, as well as expected future net cash flows relativeto recorded book values. If an asset impairment were identified, a loss wouldbe recorded, which could have a material impact on the consolidated financialstatements.

*Revenue Recognition—*Revenue is recognized in accordance with StaffAccounting Bulletin No. 104, Revenue Recognition, which states that revenue should be recognized whenthe following criteria are met:  (1) persuasiveevidence of an arrangement exists; (2) the product has been shipped andthe customer takes ownership and assumes the risk of loss; (3) the sellingprice is fixed or determinable; and (4) collection of the resultingreceivable is reasonably assured. We believe that these criteria are satisfiedupon shipment from our facilities or, in the case of our neighborhood naturalfood markets and health food stores, at the point of sale within these stores. Revenueis reduced by provisions for estimated returns and allowances, which are basedon historical averages that have not varied significantly for the periodspresented, as well as specific known claims, if any. No other significantdeductions from revenue must be estimated at the point in time that revenue isrecognized.

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**Results ofOperations**

Thefollowing table sets forth certain consolidated statements of operations dataas a percentage of net sales for the periods indicated:

| ** **                                | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                         | ** ** | **2006**                                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net sales                                 |       | 100.0                                            | %          | 100.0                                          | %          | 100.0 | % | 100.0 | % |
| Cost of sales                             |       | 48.7                                             | %          | 47.0                                           | %          | 48.3 | % | 47.4 | % |
| Gross profit                              |       | 51.3                                             | %          | 53.0                                           | %          | 51.7 | % | 52.6 | % |
| Selling, general  and administrative      |       | 35.8                                             | %          | 35.3                                           | %          | 37.1 | % | 35.9 | % |
| Amortization of  intangible assets        |       | 0.3                                              | %          | 0.2                                            | %          | 0.3 | % | 0.3 | % |
| Income from  operations                   |       | 15.2                                             | %          | 17.5                                           | %          | 14.3 | % | 16.4 | % |
| Interest and  other (income)/expense, net |       | 0.6                                              | %          | (2.5                                           | )%         | 0.5 | % | (1.3 | )% |
| Income before  provision for income taxes |       | 14.6                                             | %          | 20.0                                           | %          | 13.8 | % | 17.7 | % |
| Provision for  income taxes               |       | 5.6                                              | %          | 7.7                                            | %          | 5.3 | % | 6.8 | % |
| Net income                                |       | 9.0                                              | %          | 12.3                                           | %          | 8.5 | % | 10.9 | % |
| EBITDA(1)                                 |       | 18.0                                             | %          | 20.4                                           | %          | 17.3 | % | 19.4 | % |

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(1)          See“—EBITDA.”

**Comparison of theThree Months Ended March 31, 2006 to the Three Months Ended March 31,2005**

*NetSales.*   Net sales increased by $2.2 million, or5.6%, to $41.0 million for the three months ended March 31, 2006 (“secondquarter of fiscal 2006”) from $38.8 million for the three months ended March 31,2005 (“second quarter of fiscal 2005”). Net sales of branded nutritionalsupplements and other natural products increased by $2.3 million, or 6.8%, to$36.6 million for the second quarter of fiscal 2006 from $34.3 million for thesecond quarter of fiscal 2005. This increase in net sales was primarily relatedto the integration of the March 2005 acquisition of the *Pioneer*® brand and to anincrease in sales in certain brands and customers within health and naturalfood stores. Other net sales remained relatively flat at $4.4 millionfor the second quarter of fiscal 2006 compared to $4.5 million for the secondquarter of fiscal 2005.

*GrossProfit.*   Gross profit increased by $1.9 million,or 9.2%, to $21.8 million for the second quarter of fiscal 2006 from $19.9million for the second quarter of fiscal 2005. This increase in gross profitwas primarily attributable to the increase in net sales. As a percentage of netsales, gross profit increased to 53.0% for the second quarter of fiscal 2006compared to 51.3% for the second quarter of fiscal 2005. This increase in grossprofit as a percentage of net sales was primarily attributable to decreasedmaterial costs as a percentage of net sales.

*Selling,General and Administrative.*   Selling, general andadministrative expenses increased by $0.6 million, or 4.0%, to $14.5 millionfor the second quarter of fiscal 2006 from $13.9 million for the second quarterof fiscal 2005. This increase in selling, general and administrative expenseswas primarily attributable to the increase in net sales. As a percentage of netsales, selling, general and administrative expenses decreased to 35.3% for thesecond quarter of fiscal 2006 compared to 35.8% for the second quarter offiscal 2005.

*Amortizationof Intangibles.*   Amortization of intangibles was$0.1 million for the second quarter of fiscal 2006 and 2005. For each period,amortization expense was primarily related to intangible assets recorded inconnection with acquisitions.

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*Interestand Other (Income)/Expense, Net.*   Net interestand other (income)/expense for the second quarter of fiscal 2006 included otherincome of $1.1 million ($0.7 million after tax, or $0.06 per dilutedshare) related to the gain on the sale of our 31,340 square foot buildinglocated in Park City, Utah. Exclusive of this gain, net interest and other(income)/expense was $0.1 million for the second quarter of fiscal 2006 and$0.2 million for the second quarter of fiscal 2005 and primarily consisted ofinterest expense on indebtedness under our revolving credit facility.

*Provision for Income Taxes.*   Oureffective tax rate was 38.5% for the second quarter of fiscal 2006 and for thesecond quarter of fiscal 2005. In each period, our effective tax rate washigher than the federal statutory rate primarily due to state taxes.

**Comparison of theSix Months Ended March 31, 2006 to the Six Months Ended March 31,2005**

*NetSales.*   Net sales increased by $3.6 million, or4.8%, to $77.7 million for the six months ended March 31, 2006 from $74.1million for the six months ended March 31, 2005. Net sales of branded nutritionalsupplements and other natural products increased by $3.5 million, or 5.3%, to$69.0 million for the six months ended March 31, 2006 from $65.5 millionfor the six months ended March 31, 2005. This increase in net sales was primarilyrelated to the integration of the March 2005 acquisition of the *Pioneer*® brand and to an increase in sales in certainbrands and customers within health and natural food stores. Other netsales remained relatively flat at $8.7 million for the six months ended March 31,2006 compared to $8.6 million for the six months ended March 31, 2005,which included the benefit of the fiscal 2005 acquisition of Pilgrim’sNatureway LLC.

*GrossProfit.*   Gross profit increased by $2.6 million,or 6.8%, to $40.9 million for the six months ended March 31, 2006 from$38.3 million for the six months ended March 31, 2005. This increase ingross profit was primarily attributable to the increase in net sales. As apercentage of net sales, gross profit increased to 52.6% for the six monthsended March 31, 2006 compared to 51.7% for the six months ended March 31,2005. This increase in gross profit as a percentage of net sales was primarilyattributable to decreased material costs as a percentage of net sales.

*Selling,General and Administrative.*   Selling, general andadministrative expenses remained relatively flat at $27.9 million for the sixmonths ended March 31, 2006 compared to $27.5 million for the six monthsended March 31, 2005. As a percentage of net sales, selling, general andadministrative expenses decreased to 35.9% for the six months ended March 31,2006 from 37.1% for the six months ended March 31, 2005. This decrease inselling, general and administrative expenses as a percentage of net sales wasprimarily attributable to the increase in net sales and year-over-year costimprovements in various areas, including legal.

*Amortizationof Intangibles.*   Amortization of intangibles was$0.2 million for the six months ended March 31, 2006 and 2005. For eachperiod, amortization expense was primarily related to intangible assetsrecorded in connection with acquisitions.

*Interestand Other (Income)/Expense, Net.*   Net interestand other (income)/expense for the six months ended March 31, 2006included other income of $1.1 million ($0.7 million after tax, or $0.06per diluted share) related to the gain on the sale of our 31,340 square footbuilding located in Park City, Utah as well as $0.1 for payments received assettlement of litigation to which we were a plaintiff. Exclusive of theseitems, net interest and other (income)/expense was $0.2 million for the sixmonths ended March 31, 2006 and $0.4 million for the six months ended March 31,2005 and primarily consisted of interest expense on indebtedness under ourrevolving credit facility.

*Provisionfor Income Taxes.*   Our effective tax rate was38.5% for the six months ended March 31, 2006 and for the six months endedMarch 31, 2005. In each period, our effective tax rate was higher than thefederal statutory rate primarily due to state taxes.

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**EBITDA**

EBITDA (a non-GAAPmeasure) is defined as earnings before net interest and other (income)/expense,taxes, depreciation and amortization. EBITDAhas some inherent limitations in measuring operating performance due to theexclusion of certain financial elements such as depreciation and amortization andis not necessarily comparable to other similarly titled captions of othercompanies due to potential inconsistencies in the method of calculation. Furthermore,EBITDA is not intended to be a substitute for cash flows from operatingactivities, as a measure of liquidity, or an alternative to net income indetermining our operating performance in accordance with generally acceptedaccounting principles. Our use of EBITDA should be considered within the followingcontext:

·       Weacknowledge that plant and equipment (while less important in our line ofbusiness due to outsourcing alternatives) are necessary to earn revenue basedon our current business model.

·       Ouruse of EBITDA as a measure of operating performance is not based on any beliefabout the reasonableness of excluding depreciation and amortization whenmeasuring financial performance.

·       Ouruse of EBITDA is supported by the importance of EBITDA to the following keystakeholders:

·        **Analysts**—whoestimate our projected EBITDA and other EBITDA-based metrics in theirindependently developed financial models for investors;

·        **Creditors**—whoevaluate our operating performance based on compliance with certainEBITDA-based debt covenants;

·        **InvestmentBankers**—who use EBITDA and other EBITDA-based metrics in theirwritten evaluations and comparisons of companies within our industry; and

·        **Board ofDirectors and Executive Management**—who use EBITDA as an essentialmetric for evaluating management performance relative to our operating budgetand bank covenant compliance, as well as our ability to service debt and raisecapital for growth opportunities, including acquisitions, which are a criticalcomponent to our business strategy. Historically, we have recorded a monthlyaccrual for incentive compensation as a percentage of EBITDA, which has beenpaid out to executive management, as well as other employees upon completion ofour annual audit.

Thefollowing table sets forth a reconciliation of net income to EBITDA for eachperiod included herein:

| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** | **Six months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                         | ** ** | **2006**                                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Net income                                   |       | $                                                | 3,486      |                                           | $          | 5,040 |   | $ | 6,292 |   | $ | 8,493 |   |
| Provision for  income taxes                  |       | 2,182                                            |       | 3,154                                          |       | 3,939 |   | 5,316 |   |
| Interest and  other (income)/expense, net(1) |       | 228                                              |       | (1,020                                         | )          | 380 |   | (1,031 | ) |
| Depreciation and  amortization               |       | 1,101                                            |       | 1,197                                          |       | 2,220 |   | 2,338 |   |
| EBITDA                                       |       | $                                                | 6,997      |                                           | $          | 8,371 |   | $ | 12,831 |   | $ | 15,116 |   |

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(1)          Includes amortization ofdeferred financing fees and losses associated with fixed asset disposals. Thethree and six months ended March 31, 2006 also include a gain of $1,105 onthe sale of a building, which gain is excluded in determining EBITDA.

Our EBITDA increased to $8.4 million for the secondquarter of fiscal 2006 from $7.0 million for the second quarter of fiscal 2005.EBITDA as a percentage of net sales increased to 20.4% for the second quarterof fiscal 2006 from 18.0% for the second quarter of fiscal 2005.

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Our EBITDA increased to$15.1 million for the six months ended March 31, 2006 from $12.8 millionfor the six months ended March 31, 2005. EBITDA as a percentage of netsales increased to19.4% for the six months ended March 31, 2006 from 17.3%for the six months ended March 31, 2005.

**Seasonality**

We believe that ourbusiness is characterized by minor seasonality. However, sales to anyparticular customer can vary substantially from one quarter to the next basedon such factors as industry trends, timing of promotional discounts,international economic conditions and acquisition-related activities. Excludingthe effect of acquisitions, we have historically recorded higher brandedproducts sales volume during the second fiscal quarter (January through March) dueto increased interest in health-related products among consumers following theholiday season.

**Liquidity andCapital Resources**

We had working capital of $28.0 million as of March 31,2006 compared to $26.8 million as of September 30, 2005. This increase inworking capital was primarily the result of increases in accounts receivableand inventories and a decrease in accrued expenses, partially offset by adecrease in cash and increases in accounts payable and the current portion oflong-term debt.

Net cash provided by operating activities for the sixmonths ended March 31, 2006 was $5.1 million compared to $9.7 million forthe comparable period in fiscal 2005. This decrease in net cash provided byoperating activities for the six months ended March 31, 2006 was primarilyattributable to a decrease in cash provided by changes in assets andliabilities, net of effects of acquisitions, as well as the gain related to thesale of our building located in Park City, Utah, partially offset by anincrease in net income.

Net cash used in investing activities was $5.5 millionfor the six months ended March 31, 2006 and $8.0 million for thecomparable period in fiscal 2005. Our investing activities during these periodsconsisted primarily of acquisitions of businesses, capital expenditures and forthe six months ended March 31, 2006, proceeds of $4.5 million related tothe sale of our building. Capital expenditures during these periods relatedprimarily to distribution and manufacturing equipment, building improvementsrelated to facility consolidation efforts and information systems, includingretail technology. On March 31, 2006, we purchased the Rapid ResponseCenter in Ogden, Utah, which (when fully converted) will provide usapproximately 410,000 square feet of gross building space located on 19.2 acres,which includes available land for expansion, for $4,160 in cash. The RapidResponse Center is the central facility where we are, and have been,consolidating operations, including raw material warehousing, manufacturing,packaging, distribution and administrative offices. We were previously leasing mostof this facility. We intend to finance anticipated capital expenditures throughinternally generated cash flow and, if necessary, through funds provided underour revolving credit facility.

Net cash provided by (used in) financing activitieswas ($1.0) million for the six months ended March 31, 2006 compared to$0.2 million for the comparable period in fiscal 2005. During these periods,financing activities primarily related to borrowings and repayments under ourrevolving credit facility, purchases of common stock for treasury and proceedsfrom the issuance of common stock.

Our current revolving credit facility had a totalcredit limit of $48.75 million at March 31, 2006. The total credit limitis reduced quarterly by $1.25 million with the next reduction occurring in June 2006.Borrowings under the revolving credit facility are collateralized bysubstantially all our assets. At our election, borrowings bear interest at theapplicable Eurodollar Rate plus a variable margin or at a base rate, which isthe higher of the Federal Funds Rate plus 0.5% or the Prime Lending Rate, plusa variable margin. At March 31, 2006, the applicable weighted-averageinterest rate for borrowings was 6.22%. We are also required to pay a variablequarterly fee on the unused balance under the revolving credit facility. At March 31,2006, the applicable rate was 0.25%. Accrued interest on Eurodollar Rateborrowings is 

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payable based on electedintervals of one, two or three months. Accrued interest on base rate borrowingsis payable quarterly. The revolving credit facility matures on January 28,2007, and we are required to repay all principal outstanding under therevolving credit facility on such date. We are in the process of amending orreplacing this credit facility.

The revolving credit facility contains restrictivecovenants, including restrictions on incurring other indebtedness, limitationson capital expenditures and requirements that we maintain certain financialratios. As of March 31, 2006, we were in compliance with these restrictivecovenants. Upon the occurrence of a default, the lender has various remedies orrights, which may include proceeding against the collateral or requiring us torepay all amounts outstanding under the revolving credit facility.

A key component of our business strategy is to seek tomake additional acquisitions, which may require that we obtain additionalfinancing, which could include the incurrence of substantial additionalindebtedness or the issuance of additional stock. We believe that borrowingsunder our current revolving credit facility or a replacement credit facility,together with cash flows from operations, will be sufficient to make requiredpayments under the current credit facility or a replacement credit facility,and to make anticipated capital expenditures and fund working capital needs forfiscal 2006.

Oursignificant non-cancelable contractual obligations as of March 31, 2006were as follows:

| ** **                       | ** ** | **Payments Due By Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | ** **                                | ** ** | **Less Than** | ** ** | **1-3** | ** ** | **4-5** | ** ** | **After** | ** ** |
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
| ** **                       | ** ** | **(dollars in thousands)**      | ** ** |
| Long-term debt                   |       | $                                         | 3,000      |   |   | $ | 3,000 |   |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Interest on  long-term debt(a)   |       | 266                                       |       |   | 266 |   |   | — |   | — |   |   | — |   |   |
| Operating leases                 |       | 5,216                                     |       |   | 2,000 |   |   | 2,121 |   | 928 |   |   | 167 |   |   |
| Total                            |       | $                                         | 8,482      |   |   | $ | 5,266 |   |   | $ | 2,121 |   | $ | 928 |   |   | $ | 167 |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(a)           Representsestimated interest obligations associated with our outstanding revolving creditfacility balance of $3.0 million at March 31, 2006, assuming no principalpayments are made before maturity, a weighted-average interest rate of 6.22%and an underutilization fee rate of 0.25%.

**New AccountingStandards**

We adopted Statement of Financial Accounting StandardsNo. 123R, *Share-Based Payment* (“SFAS 123R”)effective October 1, 2005, using the modified prospective applicationmethod. SFAS 123R requires companies to record compensation expense for thevalue of all outstanding and unvested share-based payments, including employeestock options and similar awards. As of October 1, 2005, we had nooutstanding and unvested share-based payments. Also, on September 30,2005, we terminated the 1995 Stock Option Plan, the 1998 Stock Incentive Planand the 1998 Non-Employee Director Stock Option Plan. After September 30,2005, no new awards of any kind will be granted under any of these plans. As aresult, we did not recognize any compensation expense related to share-basedpayments in our consolidated financial statements for the three and six monthsended March 31, 2006.

Based on our review ofother new accounting standards released during the quarter ended March 31,2006, we did not identify any standard requiring adoption that would have asignificant impact on our consolidated financial statements for the periodsreported.

**Inflation**

Inflation affects the costof raw materials, goods and services used by us. In recent years, inflation hasbeen modest. The competitive environment somewhat limits our ability to recoverhigher costs resulting from inflation by raising prices. We seek to mitigatethe adverse effects of inflation primarily through 

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improvedproductivity and cost containment programs. We do not believe that inflationhas had a material impact on our results of operations for the periodspresented, except with respect to increased costs in manufacturing, packagingand distribution resulting from increased fuel and other petrochemical costs,as well as payroll-related costs, insurance premiums and other costs arisingfrom or related to government imposed regulations.

**Forward-LookingStatements**

This Form 10-Qcontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934. These statements relate to our future plans, objectives, expectations,intentions and financial performance and the assumptions that underlie thesestatements. These statements involve known and unknown risks, uncertainties andother factors that may cause actual results, level of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by these statements.We undertake no obligation to update forward-looking statements to reflectevents or circumstances occurring after the date this Form 10-Q wasfirst filed with the SEC. Important factors that may cause results to differfrom these forward-looking statements include, but are not limited to,government regulations,  productliability claims and litigation, insurance coverage issues, a decrease in orslowing of the growth rate of the vitamin, mineral and supplement market, thesuccess of the healthy foods channel, consumer perception of the safety andquality of our products and similar products, competition, intellectualproperty rights of other parties, the loss of key personnel, disruptions fromacquisitions, issues with obtaining raw materials of adequate quality orquantity, problems with information management systems, manufacturingefficiencies and operations, litigation generally, the volatility of the stockmarket generally and of our stock specifically, a general lack of adequateindustry analyst coverage, and other factors indicated from time to time in ourSEC reports, copies of which are available upon request from our investorrelations group or which may be obtained at the SEC’s website (www.sec.gov).

**Item 3.**                        Quantitativeand Qualitative Disclosures about Market Risk

At our election, borrowings under our revolving creditfacility bear interest at the applicable Eurodollar Rate plus a variable marginor at a base rate, which is the higher of the Federal Funds Rate plus 0.5% orthe Prime Lending Rate, plus a variable margin. At March 31, 2006, theapplicable weighted-average interest rate for borrowings was 6.22% and we hadtotal borrowings outstanding of $3.0 million. To date, we have not obtainedinterest rate protection with respect to these borrowings.

With respect to ourinternational operations, we are subject to currency fluctuations; however, wedo not believe that these fluctuations would have a material adverse impact onour financial position because the majority of our net sales to foreigncountries are transacted in U.S. dollars. To date, we have not hedged any ofour potential foreign currency exposures.

**Item 4.**                        Controlsand Procedures

*Evaluationof Disclosure Controls and Procedures.**  *We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our principal executive and principal financial officers,as appropriate, to allow for timely decisions regarding required disclosure.

In designing and evaluating the disclosure controlsand procedures, we recognize that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of 

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achieving the desiredcontrol objectives, and we are required to apply our judgment in evaluating thecost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), wecarried out an evaluation, under the supervision of and with the participationof our management, including our principal executive and principal financialofficers, of the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered by this report.Based on the foregoing, our principal executive and principal financialofficers have concluded that our disclosure controls and procedures wereeffective.

*Changesin Internal Control Over Financial Reporting.*   Therewere no changes in our internal control over financial reporting that occurredduring the last fiscal quarter that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**Item 1.**                        LegalProceedings

As discussed in our other filings, we are subject toregulation by a number of federal, state and foreign agencies and are involvedin various legal matters arising in the normal course of business.

We carry insurance coverage in the types and amountsthat we consider reasonably adequate to cover the risks we face in the industryin which we compete. However, our current liability policy excludes claimsrelated to certain ingredients, including products containing ephedra.

In our opinion, theoutcomes of individual regulatory and legal matters in which we are presentlyinvolved are not probable and no estimate can be made of the range of potentialgains or losses. While incapable of estimation, in the opinion of management,the individual regulatory and legal matters in which we are involved are notexpected to have a material adverse effect on our financial position, resultsof operations or cash flows.

**Item 1A.**                RiskFactors

**Therehave been no material changes in our risk factors from those disclosed in our2005 Annual Report on Form 10-K.**

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds

We did not sell any unregistered equity securitiesduring the period covered by this Form 10-Q for the Quarterly PeriodEnded March 31, 2006.

Duringfiscal 2000, our Board of Directors approved a share purchase programauthorizing us to buy up to 1,500,000 shares of our common stock, of which246,169 shares may yet be purchased as of March 31, 2006. Purchases underthis program during the three months ended March 31, 2006 occurred in February andMarch as follows:

| ** **        | ** ** | ** **            | ** ** | ** **             | ** ** | **Total Number** | ** ** | ** **               | ** ** |
|-------------------|------------|-----------------------|------------|------------------------|------------|-----------------------|------------|--------------------------|------------|
| ** **        | ** ** | ** **            | ** ** | ** **             | ** ** | **of Shares**    | ** ** | **Maximum**              | ** ** |
| ** **        | ** ** | ** **            | ** ** | ** **             | ** ** | **Purchased as** | ** ** | **Number of**       | ** ** |
| ** **        | ** ** | ** **            | ** ** | ** **             | ** ** | **Part of**      | ** ** | **Shares that**     | ** ** |
| ** **        | ** ** | **Total Number** | ** ** | **Average Price** | ** ** | **Publicly**          | ** ** | **May Yet Be** | ** ** |
| ** **        | ** ** | **of Shares**    | ** ** | **Paid Per**      | ** ** | **Announced**         | ** ** | **Purchased Under** | ** ** |
| **Period**        | ** ** | ** **            | ** ** | **Purchased**          | ** ** | **Share**             | ** ** | **Plan**                 | ** ** | **the Plan** | ** ** |
| 2/1/06 to 2/28/06 |       |                  | 44,956     |                   |       |                  | $          | 14.25                    |       |   |   | 44,956 |   |   |   |   |   |   |
| 3/1/06 to 3/31/06 |       |                  | 52,110     |                   |       |                  | 14.75      |                     |       |   | 52,110 |   |   |   |   |   |   |
| Total             |       |                  | 97,066     |                   |       |                  | $          | 14.52                    |       |   |   | 97,066 |   |   |   | 246,169 |   |   |
|                   |            |                       |            |                        |            |                       |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

The Annual Meeting of Stockholders of the Company washeld on February 2, 2006, at which meeting the stockholders voted to electtwo individuals to serve as Class II Directors of the Company and toratify the appointment of PricewaterhouseCoopers LLP as the Company’sindependent auditors for the fiscal year ending September 30, 2006.

Thenominees for election as Class II Directors of the Company are listedbelow. The results were as follows:

| **Nominee**      | ** ** | ** ** | ** ** | **For** | ** ** | **Against/ Withheld** | ** ** | **Abstain** | ** ** |
|------------------|------------|------------|------------|---------|------------|----------------------------|------------|-------------|------------|
| Michael D. Burke |       | 10,958,205 |       |    | 12,280     |                       |       | 467,622     |       |
| James D. Stice   |       | 10,957,616 |       |    | 12,869     |                       |       | 467,622     |       |

 

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The names of otherDirectors of the Company whose term of office continued after the meeting areas follows:

Gregory M. Benson

J. Kimo Esplin

Frank W. Gay II

Jeffrey A. Hinrichs

J. Steven Young

Othermatters voted upon at the meeting and the results of those votes were asfollows:

| ** **                                                                             | ** ** | **For**    | ** ** | **Against/ Withheld** | ** ** | **Abstain** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|-------------|------------|
| Ratification of PricewaterhouseCoopers  LLP as the Company’s independent auditors |       | 10,913,311 |       |                       | 54,592     |        |       | 470,204 |   |
|                                                                                        |            |            |            |                            |            |             |            |  |  |

 

**Item6.**                        Exhibits

| 31.1 |   | Certifications Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                      |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------|
| 32.1 |   | Certifications Pursuant  to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURE**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

|        |   |                | NUTRACEUTICAL INTERNATIONAL CORPORATION |
|--------|--------|---------------------|-----------------------------------------|
|   |   |                | (Registrant)                            |
| Date:  |   | April 27, 2006 | By:                                     | /s/ LESLIE M. BROWN, JR. |
|   |   |                |                                    | Leslie M. Brown, Jr. |
|   |   |                |                                    | Senior Vice President, Finance, |
|   |   |                |                                    | Chief Financial Officer and Assistant Secretary |
|   |   |                |                                    | (Principal Financial and Accounting Officer) |

 

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