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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                        
                                  ------------
                                        
                                   FORM 10-K
                                        
                      FOR ANNUAL AND TRANSITIONAL REPORTS
                    PURSUANT TO SECTIONS 13 AND 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                                        
             ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                                        
                                        
(Mark One)
/X/       FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
                                        
                                       OR

/ /       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
          SECURITIES EXCHANGE ACT OF 1934

          FOR THE TRANSITION PERIOD FROM _____ TO ______

                           COMMISSION FILE NO: 000-24567
                                     ---------
                                        
                                  NATROL, INC.
                                        
             (Exact name of registrant as specified in its charter)
                                        
       DELAWARE                                    95-3560780
------------------------               ------------------------------------
(State of Incorporation)               (I.R.S. Employer Identification No.)

                                21411 PRAIRIE STREET
                            CHATSWORTH, CALIFORNIA 91311
                      ----------------------------------------
                      (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                   (818) 739-6000
                ----------------------------------------------------
                (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
                                          
                                     ---------

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act: 
  Common Stock, par value $.01 per share
                                          
                                     ---------

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 
405 of Registration S-K is not contained herein, and will not be contained, 
to the best of the registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this form 10-K. [  ]

The aggregate market value of the shares of the registrant's Common Stock 
held by non-affiliates of the registrant on March 24, 1999 was approximately 
$27.8 million based upon the closing price per share of the registrant's 
Common Stock as reported on the Nasdaq National Market on such date. 
Calculations of holdings by non-affiliates is based upon the assumption, for 
these purposes only, that executive officers, directors, and persons holding 
10% or more of the outstanding Common Stock are affiliates. This 
determination of affiliate status is not necessarily a conclusive 
determination for other purposes. 

As of March 24, 1999, the registrant has 13,301,990 shares of Common Stock 
outstanding.
                                       
                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement for its 1999 Annual 
Meeting of Stockholders on Form 10-K are incorporated by reference into Part 
III of this report.

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                                 NATROL, INC.

                        1998 ANNUAL REPORT ON Form 10-K

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>

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PART I

Item 1. Business................................................................    4

Item 2. Properties..............................................................   33

Item 3. Legal Matters...........................................................   34

Item 4. Submission of Matters to a Vote of the Securities Holders...............   34


PART II

Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters.   35

Item 6.   Selected Consolidated Financial Data..................................   37

Item 7.   Management's Discussion and Analysis of Financial Condition and 
          Results of Operations.................................................   38

Item 7A.  Quantitative and Qualatative Disclosures About Market Risk............   49

Item 8.   Financial Statements and Supplementary Data...........................   49

Item 9.   Changes in and Disagreements with Accountants on Accounting and 
          Financial Disclosure..................................................   49

PART III  ......................................................................   50

PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K.......   50

</TABLE>

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains "forward looking statements."  The Company is including 
this statement for the express purpose of availing itself of protections of 
the safe harbor provided by the Private Securities Litigation Reform Act of 
1995 with respect to all such forward looking statements. Examples of forward 
looking statements include, but are not limited to, the use of 
forward-looking terminology such as "believes," "expects," "may," "will," 
"should" or "anticipates" or the negative thereof, other variations thereon, 
or comparable terminology, or by discussions of strategy.  

The Company's ability to predict results or the effect of certain events on 
the Company's operating results is inherently uncertain.  Therefore, the 
Company wishes to caution each reader of this report to carefully consider 
the following factors and certain other factors discussed herein and in other 
past reports, including but not limited to, the Company's Prospectus dated 
July 22, 1998 filed with the Securities and Exchange Commission.

Factors that could cause or contribute to the Company's actual results 
differing materially from those discussed herein or for the Company's stock 
price to be affected adversely include, but are not limited to: - (i) 
industry trends, including a potential general downturn or slowing of the 
growth of the dietary supplement industry, (ii) increased competition from 
current competitors and new market entrants, (iii) adverse publicity 
regarding the dietary supplement industry or the Company's products, (iv) the 
Company's dependence upon its ability to develop new products, (v) government 
regulation, (vi) exposure to product liability claims,(vii) dependence on 
significant customers, (viii) the Company's ability to keep and attract key 
management employees, (ix) the Company's inability to manage growth and 
execute its business plan, (x) the Company's ability to consummate future 
acquisitions and its ability to integrate acquired businesses and to retain 
key personnel associated with any acquisition, (xi) the absence of clinical 
trials for many of the Company's products, (xii) the Company's inability to 
obtain raw materials that are in short supply, (xiii) sales and earnings 
volatility, (xiv) the Company's ability to manufacture its products 
efficiently, (xv) the Company's reliance on independent brokers to sell its 
products, (xvi) the inability of the Company to protect its intellectual 
property, (xvii) control by principal shareholders, (xviii) the possible sale 
of large amounts of stock by controlling shareholders, (xiv) 

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volatility in the stock markets, (xx) a failure of the Company to properly 
address the year 2000 issue and (xxi) a general downturn in the national 
economy as a whole.  These and other such factors are discussed in more 
detail under the caption "Risk Factors" and elsewhere in this report.

PART I

ITEM 1. BUSINESS

The Company's executive offices are located at 21411 Prairie Street, 
Chatsworth, California 91311 and its telephone number is 818-739-6000. Unless 
the context otherwise requires the terms the "Company" and "Natrol" refer to 
Natrol, Inc. and, as applicable, its direct and indirect subsidiaries.

GENERAL

Natrol manufactures and markets branded, high-quality dietary supplements. 
These supplements include vitamins, minerals, hormonal supplements, herbal 
products, and specialty combination formulas that contribute to an 
individual's mental or physical well being. The Company sells its products, 
primarily under the Natrol brand name, through multiple distribution channels 
throughout the United States. These channels include domestic health food 
stores and mass market drug, retail, and grocery store chains.  The Company 
also sells its products through independent catalogs, internet shopping 
sites, and, to a limited degree, within select foreign countries. The 
Company's strategy emphasizes building strong recognition of the Natrol brand 
across multiple distribution channels through a widespread multi-media 
marketing and advertising strategy.

Since its inception, the Company has emphasized the ongoing development and 
marketing of new products in order to capitalize on and create market 
opportunities. As a part of its product development efforts, the Company 
introduced 34 new products in 1997 and approximately 70 new items in 1998. 
Today, the Natrol brand product line includes approximately 190 items which 
are packaged in various sizes (e.g., 30 count, 60 count, etc.), strengths 
(e.g., 50 mg, 100 mg, etc.) and combinations (e.g., multiple vitamins with or 
without iron). These sizes, strengths and combinations create approximately 
500 stockkeeping units (SKUs).

RECENT ACQUISITIONS

In February 1998, the Company acquired Pure-Gar, L.P., ("Pure-Gar") then a 
wholly owned subsidiary of Basic 

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Vegetable Products, L.P., ("BVP"). Pure-Gar mainly sells nutraceutical grade 
vegetable powders and ingredients to manufacturers of nutritional supplements 
of which garlic represents approximately 90% of such sales. At the time of 
the acquisition, Pure-Gar also sold garlic supplements to consumers in health 
store and mass-market outlets under two proprietary labels.  These brands 
have since been replaced with the Natrol brand "Garlipure." Since acquiring 
the Pure-Gar ingredient business, the Company has expanded the base of 
products sold to include Kava Kava and the Company is seeking to expand the 
number of ingredients it can offer its customers.  

In October 1998, the Company broadened its product line by acquiring the tea 
business and certain related assets of the Laci Le Beau Corporation and other 
affiliated entities ("Laci Le Beau"). Laci Le Beau manufactures and 
distributes approximately 20 herbal teas under the Laci Le Beau brand name. 

The Company's strategy has been to aggressively promote the Natrol brand name 
through as many channels of distribution as possible. The Company expects to 
utilize this strategy on the promotion of the Laci Le Beau tea line. Laci Le 
Beau had previously been selling its teas to both mass market and health food 
accounts on a more limited basis due to the relatively small size of its 
sales force. Natrol expects to broaden the Laci Le Beau selling effort by 
capitalizing upon the Natrol team of sales people, managers, brand managers, 
and brokers.  

SALES

BRANDED PRODUCTS

The Company distributes its branded products primarily to domestic health 
food stores and mass market drug, retail and food stores. Although the 
Company sells the same Natrol or Laci Le Beau products to both the health 
food and mass market channels of distribution, it has built different sales 
organizations to meet the differing requirements of each channel of trade.

The health food channel of distribution accounted for approximately 31% of 
the Company's revenues for the year ended December 31, 1998. The Company 
sells its branded Natrol and Laci Le Beau products to health food stores 
through leading national distributors, including UNITED NATURAL FOODS and 
TREE OF LIFE, as well as directly to GNC (General Nutrition Company). Natrol 
products are sold by health food store chains such as WILD OATS MARKETS, 
WHOLE FOODS MARKET, 

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HI-HEALTH, VITAMIN COTTAGE, FRED MEYER NUTRITION CENTERS and VITAMIN SHOPPES, 
as well as most independent health food stores. 

A majority of these outlets buy their product from distributors rather than 
directly from Natrol. The Company maintains a sales staff of more than 20 
representatives across the country who are managed by regional supervisors 
and a national health food sales manager who reports to the Company's Vice 
President of Sales.  These sales representatives call on individual store 
owners and distributors promoting the Natrol and Laci Le Beau lines.

The mass market distribution channel, which accounted for approximately 54% 
of the Company's revenues for the year ended December 31, 1998, is managed by 
the Company's Vice President of Sales and regional managers who work with a 
network of independent brokers. The Company's employees service certain of 
its larger mass market accounts directly while independent brokers service 
others in conjunction with the Company's management. The Company sells its 
products to mass market merchandisers either directly or through distributors 
of vitamins, minerals and other supplement products such as BERGEN BRUNSWICK, 
MCKESSON and CARDINAL. Some of the Company's major mass market retail 
customers are WALGREENS, CVS, AMERICAN DRUG STORES, RITE AID, LONG'S DRUG, 
DRUG EMPORIUM, ECKERD, SNYDERS, BROOKS DRUG, WAL-MART, KMART, TARGET, SHOPKO 
and BJ'S WHOLESALE CLUB. The Company also sells its products in grocery 
stores and supermarkets, including DOMINICK'S, RALPHS, VON'S, SCHNUCKS, CUB 
FOODS, FOOD FOR LESS and WEGMANS. 

Within each channel of trade, the Company believes that there is opportunity 
for growth in that a majority of outlets that carry the Natrol or Laci Le 
Beau lines stock only a small percentage of the products the Company offers. 
A prime objective of the Natrol selling effort is to increase the amount of 
shelf space devoted to Company products at each location.  During 1998, the 
average number of SKUs carried by the mass market retailers that buy products 
directly from the Company increased by approximately 40%. 

The Company provides retailers in both the health food store and the mass 
market distribution channel with a wide array of comprehensive services 
tailored to meet their individual needs. In the health food store channel, 
the Company's dedicated sales force maintains direct and regular contact with 
key store personnel, informing them of new product developments and industry 
trends, aiding them in the design of store sets and creating merchandising 
programs that promote brand and category awareness. The Company's regional 

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sales managers and independent brokers in the mass market distribution 
channel work with corporate buyers focusing on special promotional activities 
and brand and category awareness in order to gain more shelf space. The 
objective of these activities is to build strong relationships with the 
Company's marketing partners and to increase the number of stores carrying 
its products and the amount of space allocated to, and the overall number of, 
the Company's products and SKUs within each store.

The Company had only one customer whose sales amounted to more than 10% of 
the Company's business during 1998. Sales to Walgreens in 1998 amounted to 
$10.9 million, or 15.9% of Natrol's total revenue.  Walgreens is one of the 
largest chains of drug stores in the country with more that 2,700 stores 
nationally. An average Walgreens drug store carries approximately 45 Natrol 
products.

PRIVATE LABEL AND INGREDIENT SUPPLY SALES

The Company manufactures certain products pursuant to contracts with 
customers who distribute the products under their own private labels. Sales 
to private label customers accounted for 3% of the Company's revenues for 
1998. The Company generally does not actively solicit private label business.

In its bulk ingredient business, the Company primarily sells nutraceutical 
grade dehydrated vegetable products, primarily garlic, to other 
manufacturers, distributors and marketers of dietary supplements. The Company 
obtains its bulk ingredients from BVP pursuant to a multi-year supply 
agreement that gives the Company the exclusive right to sell BVP's vegetable 
powders in the dietary supplement industry.

Bulk ingredient sales are the responsibility of the Pure-Gar division 
president as well as two sales persons who report to the president. These 
sales persons call on customers directly and work with brokers to enhance the 
sale of Pure-Gar products.  

The Company currently offers nutraceutical grade Kava Kava to its customers 
and expects to offer other bulk raw materials as opportunities arise.  

MARKETING 

BRANDED PRODUCTS

Management believes the Company's strategy of selling the Natrol or Laci Le 
Beau brand through both the health food store and mass market channels of 
distribution distinguishes 

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the Company from its competition. Most competitors sell products into each 
channel using different brand names within each channel. Oftentimes, in the 
case of the Company's competitors, the brand sold in the health channel is 
positioned as the quality brand while the mass market line is positioned as 
the value brand.

The Company's core strategy is to continue to build the Natrol and Laci Le 
Beau brand names within multiple channels of distribution in order to develop 
increased brand awareness and strong brand recognition among consumers 
seeking products with a reputation for quality. The Company believes it can 
leverage its reputation for high quality products developed within the health 
food distribution channel in the mass market channel by positioning its 
products as a premium, high quality brand rather than a value brand. By 
maintaining a single brand identity, the Company believes it can also 
leverage its advertising budget across multiple distribution channels. 

The Company utilizes print, radio and television advertising as well as 
cooperative and other incentive programs to build consumer awareness and 
generate sales revenue. The Company spent approximately $11 million or nearly 
16% of total sales in 1998 on various marketing and sales incentive programs. 

The Company generally uses targeted, health-oriented magazines, such as 
BETTER NUTRITION, DELICIOUS and GREAT LIFE, to support the health food store 
distribution channel and uses mainstream publications such as PREVENTION, 
HEALTH, USA TODAY, TV GUIDE, MCCALLS, FAMILY CIRCLE, WOMEN'S DAY and major 
airline in-flight publications to support the mass market distribution 
channel. 

Throughout 1998, the Company's television commercials were featured on the 
CNN/Turner Network, including such programs as CNN HEADLINE NEWS, CNN MORNING 
NEWS and BURDEN OF PROOF. In addition, the Natrol logo appeared on HEADLINE 
WEATHER and HEADLINE SPORTS TICKER.     

During 1998, the Company utilized radio advertising including regular radio 
spots that were featured on the DR. LAURA SCHLESSINGER and RUSH LIMBAUGH 
radio shows.

The Company expects to focus on television and print advertising in 1999. 
Natrol launched its 1999 TV season by unveiling a new corporate brand 
commercial featuring founder and CEO, Elliott Balbert. 

The Company's television commercials are scheduled to be shown on CNN's LARRY 
KING LIVE and CNN HEADLINE NEWS along 

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with TNT and TBS programs as well as several game show programs including 
WHEEL OF FORTUNE, JEOPARDY and HOLLYWOOD SQUARES.

In print, Natrol expects to continue with periodic advertisements in 
in-flight airline magazines, popular health magazines like PREVENTION, 
HEALTH, LET'S LIVE and others, as well as main stream publications such as 
READER'S DIGEST, USA WEEKEND and FAMILY CIRCLE.

The Company also actively works to keep the news media aware of product 
developments. During 1998, Company's products have appeared in periodicals 
such as TIME and THE WALL STREET JOURNAL as well as in television footage 
produced by programs such as NBC's DATELINE. 

PRIVATE LABEL AND INGREDIENT SUPPLY SALES

The Company does not actively market its private label business and relies on 
word-of-mouth as well as the delivery of information from it sales staff, 
primarily its Pure-Gar sales people.

The Company's Pure-Gar division relies primarily on visibility developed 
through trade shows, advertising in trade publications and brochures to 
supplement the sales efforts of its sales people.

RESEARCH & PRODUCT DEVELOPMENT

The Company believes it has an excellent reputation among retailers for 
introducing items at the front end of the consumer demand curve and then 
working to develop brand loyalty after product introduction. For example, in 
recent years, the Company was one of the first major supplement manufacturers 
to introduce Melatonin, DHEA, St. John's Wort, 5-HTP, Alpha Lipoic Acid and 
Yohimbe. The Company has also introduced a number of proprietary formulations 
including Kavatrol, Mood Support, Thera-C and a line of women's specialty 
products. The Company's Kava based proprietary product (Kavatrol) was one of 
the first heavily promoted Kava products in the United States and during 1998 
it was featured on NBC's DATELINE when the program produced a segment on the 
effects of Kava as an herb. As a result of its product development efforts, 
the Company introduced 34 new products in 1997 and approximately 70 new 
products in 1998.
 
The Company's Vice President of Marketing and others keep abreast of product 
trends and work to develop and introduce products in response to those 
emerging trends. Management continually evaluates product categories and SKUs 
for trends 

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in sales and profitability, de-emphasizing or dropping products when 
profitability or SKU velocity lags. New products are introduced to replace 
slower moving products, capitalize on market trends and diversify the 
Company's product offerings. In addition, new products often have higher 
gross margins than mature items. 

The Company has established a focused process to anticipate consumer demand, 
monitor product developments within the dietary supplement industry, and 
facilitate the generation of new ideas for product introductions. The 
Company's product development staff constantly reviews periodicals, 
scientific research and relevant clinical studies within medical journals and 
searches on-line databases. The staff meets with vendors and evaluates new 
ingredients. The product development team also consults with a panel of 
scientific advisors. These advisors include: Dr. Terry Willard, a recognized 
herbal expert, an author and president of the Canadian Association of Herbal 
Practitioners; Dr. Alexander Schauss, Director of the Life Sciences Division, 
Natural and Medicinal Products Research of the American Institute for 
Biosocial Research, Inc.; Dr. Ronald R. Watson, a scientist who has published 
more than 150 articles relating to nutrition and immunology; Dr. Bruce 
Hensel, a physician and journalist; and Dr. Anthony Verlangieri, Associate 
Professor of Pharmacology and Toxicology at the University of Mississippi 
School of Pharmacy and an expert in Toxicology. As appropriate, the Company 
also communicates with other scientists on a regular basis regarding new 
product concepts. 

The Company sponsors scientific research by independent researchers as a part 
of its product development efforts. In 1998, the Company sponsored a 
randomized, double-blind, placebo-controlled study at the University of 
Virginia regarding the efficacy of the Company's proprietary Kavatrol 
product, which produced favorable results. The Company has commissioned 
further independent research by the same researchers at the University of 
Virginia on its proprietary Kavatrol product regarding dosage levels. 

Before a product is introduced, the product development team reviews the 
safety and efficacy of ingredients, standards for production, labeling 
information, label claims and potential patent, trademark, legal or 
regulatory issues.

The Company actively participates in and supports a number of scientific and 
educational industry organizations that promote consumer well being.  These 
include the Citizens for Health and the National Nutritional Foods 
Association. The Company is also a founding member of the Corporate Alliance 
for Integrative Medicine, a not-for-profit organization 

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funding research at Harvard University that was created to increase knowledge 
and awareness of the efficacy and safety of vitamins, herbs and other dietary 
supplements.  

Although the Company spends less than 1% of its revenue on clinical and other 
scientific research, it expects the total amount spent on research and 
development to increase as it seeks to develop more proprietary products.
 
PRODUCTS

The Company sells premium dietary supplements and herbal tea products under 
the respective Natrol and Laci Le Beau brand names. The Company focuses on 
supplements that are in high demand as well as specialty niche and 
proprietary formulations that have potentially strong margins. The Company's 
supplement products include vitamins, minerals, herbs, specialty 
formulations, weight control products, hormones and various nutrients. The 
Company positions Natrol as a premium brand of vitamins, minerals and other 
supplements rather than a value brand. The Company manufactures and sells 
more than 190 products packaged into approximately 500 SKUs. The Laci Le Beau 
teas are flavored herbal teas.

The Company's consumer products fall into the general definition of vitamin, 
minerals, and supplements. Each year the Company strives to broaden its 
product offering so as to increase revenue and gross profits while lessening 
the Company's dependence upon any one product.

Only two branded products, Ester C and Melatonin, accounted for more than 10% 
of the Company's net revenue in 1998.  

ESTER-C-Registered Trademark-. The Company introduced Ester-C-Registered 
Trademark- in 1986 and in 1998 this product accounted for approximately 14% 
of the Company's net sales revenue. A buffered form of pH-neutral Vitamin C, 
Ester-C-Registered Trademark- is considered a Natrol cornerstone product. 
Although many Natrol competitors sell Ester-C-Registered Trademark-, 
according to Spence Information Services, Natrol's Ester-C-Registered 
Trademark- held approximately 25% of the Vitamin C market in health food 
stores in 1997. The Company has built its market share through heavy 
promotion, associating Ester-C-Registered Trademark- with the Natrol brand. 
The Company sells approximately 45 SKUs of Ester-C-Registered Trademark-, 
each offering a special potency, pill count, delivery system or specialty 
combination, such as Ester-C-Registered Trademark-with zinc. 

MELATONIN. Melatonin helped establish the Company's reputation within the 
mass market channel of distribution. In 1996, the Company received the Rex 
Award for Market Maker of the Year and the Rex Award for Best Nutritional 
Supplement, each from Drug Store News, for its introduction of Melatonin into 
the chain drugstore distribution channel. In 1998, 

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Melatonin accounted for approximately 10% of the Company's net sales revenue.

During the 10 months the Company owned the Pure-Gar ingredients business, 
ingredient sales, consisting of nearly all garlic sales, accounted for 
approximately 10% of the Company's revenue in 1998 and on a pro-forma basis 
sales would have amounted to slightly more than 10% of sales in 1998.

The Laci Le Beau tea business accounted for $1.6 million in revenue during 
the 3 months it was owned by the Company and on a pro-forma basis sales from 
Laci Le Beau for all of 1998 would have amounted to approximately 10% of the 
Company's business.

MANUFACTURING AND PRODUCT QUALITY

DIETARY SUPPLEMENTS

The Company manufactures its branded Natrol and private label supplements at 
its 90,000 square foot manufacturing facility/headquarters located in 
Chatsworth, California. In December 1998, the Company purchased its 
manufacturing facility/headquarters for $5.25 million (see "Properties"). At 
this facility, the Company manufactures both tablets and two piece capsules 
which account for more than 90% of the Company's supplement sales in 1998. 
The Company uses third party vendors to produce its liquid products and 
softgels. 

The Company places a strong emphasis on quality control because it believes 
that quality standards play a critical factor in consumer purchasing 
decisions and in differentiating the Natrol brand. The Company's products are 
manufactured in accordance with current GMPs (Good Manufacturing Practices) 
of the FDA for foods and the applicable regulations of other agencies. 

The Company's manufacturing facility includes an on-site laboratory which is 
staffed by the director of quality assurance, bench chemists and other 
quality control personnel. The Company's laboratory contains equipment for 
performing testing procedures, including high performance liquid 
chromatography, ultra-violet and infra-red spectrophotometer and thin layer 
chromatography. The Company requires all raw materials or finished product 
produced by third party vendors to be placed in quarantine upon receipt and 
tested by the Company's quality control laboratory. The Company conducts 
sample testing, weight testing, purity testing, dissolution testing and, 
where required, microbiological testing. When raw materials are released from 
quarantine, each lot is assigned a unique lot number which is 

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tracked throughout the manufacturing process. Materials are blended, tested 
and then encapsulated or formed into pills which may or may not be coated. 
The Company routinely performs qualitative and quantitative quality control 
procedures on its finished products. 

The Company obtains its raw materials for the manufacture of its products 
from third-party suppliers. Many of the raw materials used in the Company's 
products are harvested internationally. With the exception of bulk garlic and 
Ester-C-Registered Trademark-, the Company does not have contracts with any 
suppliers committing such suppliers to provide the materials required for the 
production of its products. In the last few years, natural vitamin E, beta 
carotene, Melatonin, Kava and St. John's Wort have had significant price 
fluctuations as a result of short supply and/ or increases in demand. The 
Company has experienced occasional shortages of raw materials for a limited 
number of its products, but to date has only encountered short-term 
production interruptions as a result of such shortages. No single supplier 
accounted for more than approximately 10% of the Company's total purchases in 
1998 and only one, Inter-Cal Corporation (Inter-Cal), the Company's source 
for Ester-C-Registered Trademark- accounted for more than 5% of purchases. 
There can be no assurance that suppliers, including suppliers of bulk garlic 
and Ester-C-Registered Trademark-, will provide the raw materials needed by 
the Company in the quantities requested or at a price the Company is willing 
to pay. Because the Company does not control the actual production of these 
raw materials, it is also subject to delays caused by interruption in 
production of materials based on conditions not within its control. Such 
conditions include job actions or strikes by employees of suppliers, weather, 
crop conditions, transportation interruptions and natural disasters or other 
catastrophic events. With respect to products that are sold by the Company 
under the supplier's trademark, such as Ester-C-Registered Trademark- and 
Tonalin, the Company is limited to that single supplier as a source of raw 
materials for that product. As a result, any shortage of raw materials from 
that supplier would adversely affect the Company's ability to manufacture 
that product. The inability of the Company to obtain adequate supplies of raw 
materials for its products at favorable prices, or at all, could have a 
material adverse effect on the Company's business, financial condition and 
results of operations. 

The Company is a party to a multi-year Distributorship/Packager/Supply 
Agreement (the Inter-Cal Agreement) with Inter-Cal under which Inter-Cal is 
required to supply the Company with its requirements of bulk 
Ester-C-Registered Trademark-. Ester-C-Registered Trademark- products 
accounted for nearly 15% of the Company's business in 1998. The Inter-Cal 
Agreement requires the Company to use 

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its best efforts to promote and sell Ester-C-Registered Trademark- vitamin 
products worldwide with the exception of certain specified countries, 
including Australia, New Zealand and certain European countries. The 
Inter-Cal Agreement may be terminated by Inter-Cal immediately if the Company 
violates the terms of certain provisions relating to distribution and 
packaging and may be terminated by either party upon a default of the 
obligations of the other party if the default has not been cured within 60 
days. 

The Company has the current manufacturing capability to produce four million 
tablets and capsules per eight hour shift and 420,000 bottles per week per 
eight hour shift. The Company believes it can triple current sales volumes 
without the necessity of expanding the current manufacturing facility. Such a 
tripling of production would require additional space for the warehousing of 
raw material as well as the addition of some manufacturing and packaging 
equipment.

The Company operates flexible manufacturing lines which enable it to shift 
output efficiently among various pieces of equipment depending upon such 
factors as batch size, tablets or capsule count and labeling requirements. 
The Company strives to fulfill and ship all orders within 48 hours.

During 1998, the Company shipped finished product from its 
manufacturing/headquarters facility.  As of March 1999, the Company began 
leasing 26,000 sq. ft. of space less than one-quarter mile from the 
manufacturing facility for the purpose of storing and shipping finished 
product. Finished goods are transferred from the Company's packaging lines to 
the shipping facility for storage prior to shipment to customers.
  
TEAS

The Company primarily relies upon third parties for the milling, processing 
and packaging of its herbal teas.  The Company directly provides a majority 
of the herbs and other raw materials used in the production of its teas.

INGREDIENT SUPPLY

The Company's Pure-Gar division provides raw material ingredients to the 
Company and approximately 120 other customers. The Company acquires 
nutraceutical grade garlic and other vegetable powders pursuant to a 
multi-year Supply Agreement (the "BVP Agreement") with BVP, which requires 
Basic Vegetable Products to sell and the Company to purchase specified 
amounts of certain vegetable, fruit, herbal and botanical products (the "BVP 
Products"). The BVP Agreement gives the Company the exclusive right to sell 
certain BVP 

                                      14

<PAGE>

Products in the dietary supplement industry. The BVP Agreement may be 
terminated by either party upon a material breach of the obligations of the 
other party, or certain other specified conditions, if the breach is not 
cured within 60 days, or within 15 days in the case of non-payment by the 
Company. 

During 1998, the Company's Pure-Gar division also sourced raw Kava root from 
foreign sources and then engaged processors to process the root into powders 
useable to the Company and other supplement manufacturers.  The Pure-Gar 
division may source other raw ingredients and contract for the processing of 
these ingredients when management feels market conditions are such that the 
purchasing and processing of these materials would be beneficial to the 
Company and its customers.

TRADEMARKS AND PATENTS

The Company regards its trademarks, patent applications and other proprietary 
rights as valuable assets. The Company believes that protecting its key 
trademarks is crucial to its business strategy of building strong brand name 
recognition and that such trademarks have significant value in the marketing 
of its products. The Company may in some cases seek to protect its research 
and development efforts by filing patent applications for proprietary 
products. 

The Company's policy is to pursue registrations for all of the trademarks 
associated with its key products. The Company relies on common law trademark 
rights to protect its unregistered trademarks as well as its trade dress 
rights. Common law trademark rights generally are limited to the geographic 
area in which the trademark is actually used, while a United States federal 
registration of a trademark enables the registrant to stop the unauthorized 
use of the trademark by any third party anywhere in the United States. 
Furthermore, the protection available, if any, in foreign jurisdictions may 
not be as extensive as the protection available to the Company in the United 
States. 

Currently, the Company has received one United States patent for its Kavatrol 
product, has a second United States patent application pending for a method 
of using its Kavatrol product and has received two United States patents on 
its amino acid products, SAF and SAF for Kids. To the extent the Company does 
not have patents on its products, another Company may replicate one or more 
of the Company's products. 

Although the Company seeks to ensure that it does not infringe on the 
intellectual property rights of others, there 

                                      15

<PAGE>

can be no assurance that third parties will not assert intellectual property 
infringement claims against the Company. Natrol was contacted in June 1997 by 
a third party that claimed Natrol's marketing of Melatonin infringed on the 
third party's patents relating to a method of using Melatonin and sought to 
license such patents to Natrol. Since Natrol does not believe its marketing 
of Melatonin infringes on the third party's patent claims, Natrol has 
declined to enter into a license agreement with the third party. Any 
infringement claims by third parties against the Company may have a material 
adverse effect on the Company's business, financial condition and results of 
operations. 

COMPETITION

The dietary supplement industry is highly competitive. Numerous companies, 
many of which have greater size and financial, personnel, distribution and 
other resources than the Company, compete with the Company in the 
development, manufacture and marketing of dietary supplements. The Company's 
principal competition in the health food store distribution channel comes 
from a limited number of large nationally known manufacturers and many 
smaller manufacturers of dietary supplements. In the mass market distribution 
channel, the Company's principal competition comes from broadline 
manufacturers, major private label manufacturers and other companies. In 
recent years, a number of the Company's competitors have begun to market and 
sell their products under different labels in both the health food store and 
the mass market distribution channels. In addition, during 1998 several large 
pharmaceutical companies, including Warner Lambert, Bayer and American Home 
Products, began to compete within the nutritional supplement companies, 
especially the herbal market. The pharmaceutical companies have launched 
aggressive advertising campaigns to support newly launched lines of herbal 
products. Celestial Seasonings, a large supplier of herbal teas, also 
launched a line of herbal supplements during 1998. Increased competition from 
such companies could have a material adverse effect on the Company because 
such companies have greater financial and other resources available to them 
and possess manufacturing, distribution and marketing capabilities far 
greater than those of the Company. The Company also faces competition in both 
the health food store and mass market distribution channels from private 
label dietary supplements and multivitamins offered by health and natural 
food store chains, drugstore chains, mass merchandisers and supermarket 
chains. 

The Company competes on the basis of product quality, pricing, customer service
and marketing support. The Company 

                                      16

<PAGE>

believes that it competes favorably with its competitors on the strength of 
the Company's brand recognition across multiple distribution channels, an 
ability to quickly develop new products with market potential, sophisticated 
marketing, advertising and promotional support, product quality and an 
effective sales force and distribution network. 

REGULATORY MATTERS 

The manufacture, packaging, labeling, advertising, promotion, distribution 
and sale of the Company's products are subject to regulation by numerous 
governmental agencies, the most active of which is the U.S. Food and Drug 
Administration (the "FDA"), which regulates the Company's products under the 
Federal Food, Drug and Cosmetic Act (the "FDCA") and regulations promulgated 
thereunder. The Company's products are also subject to regulation by, among 
other regulatory agencies, the Consumer Product Safety Commission, the U.S. 
Department of Agriculture (the "USDA") and the Environmental Protection 
Agency (the "EPA"). Advertising of the Company's products is subject to 
regulation by the U.S. Federal Trade Commission (the "FTC"), which regulates 
the Company's advertising under the Federal Trade Commission Act (the 
"FTCA"). The manufacture, labeling and advertising of the Company's products 
are also regulated by various state and local agencies as well as each 
foreign country to which the Company distributes its products. 

The Dietary Supplement Health and Education Act of 1994 (DSHEA) revised the 
provisions of the FDCA concerning the regulation of dietary supplements. In 
the judgment of the Company, the DSHEA is favorable to the dietary supplement 
industry. The legislation for the first time defined "dietary supplement." 
The term "dietary supplement" is defined as a product intended to supplement 
the diet that contains one or more of certain dietary ingredients, such as a 
vitamin, a mineral, an herb or botanical, an amino acid, a dietary substance 
for use by man to supplement the diet by increasing the total dietary intake, 
or a concentrate, metabolite, constituent, extract, or combination of the 
preceding ingredients. The substantial majority of the products marketed by 
the Company are regulated as dietary supplements under the FDCA. 

Under the current provisions of the FDCA there are four categories of claims 
that pertain to the regulation of dietary supplements. Health claims are 
claims that describe the relationship between a nutrient or dietary 
ingredient and a disease or health related condition and can be made on the 
labeling of dietary supplements if supported by significant scientific 
agreement and authorized by the FDA in advance via 

                                      17

<PAGE>

notice and comment rulemaking. Nutrient content claims describe the 
nutritional value of the product and may be made if defined by the FDA 
through notice and comment rulemaking and if one serving of the product meets 
the definition. Health claims and nutrient content claims may also be made if 
a scientific body of the U.S. government with official responsibility for the 
public health has made an authoritative statement regarding the claim, the 
claim accurately reflects that statement and the manufacturer, among other 
things, provides the FDA with notice of and the basis for the claim at least 
120 days before the introduction of the supplement with a label containing 
the claim into interstate commerce. Statements of nutritional support or 
product performance, which are permitted on labeling of dietary supplements 
without FDA pre-approval, are defined to include statements that: (i) claim a 
benefit related to a classical nutrient deficiency disease and discloses the 
prevalence of such disease in the United States; (ii) describe the role of a 
nutrient or dietary ingredient intended to affect the structure or function 
in humans; (iii) characterize the documented mechanism by which a dietary 
ingredient acts to maintain such structure or function; or (iv) describe 
general well-being from consumption of a nutrient or dietary ingredient. In 
order to make a nutritional support claim the marketer must possess 
substantiation to demonstrate that the claim is not false or misleading and 
if the claim is for a dietary ingredient that does not provide traditional 
nutritional value, prominent disclosure of the lack of FDA review of the 
relevant statement and notification to the FDA of using the claim is 
required. Drug claims are representations that a product is intended to 
diagnose, mitigate, treat, cure or prevent a disease. Drug claims are 
prohibited from use in the labeling of dietary supplements. 

Claims made for the Company's dietary supplement products may include 
statements of nutritional support and health and nutrient content claims when 
authorized by the FDA or otherwise allowed by law. The FDA's interpretation 
of what constitutes an acceptable statement of nutritional support may change 
in the future thereby requiring that the Company revise its labeling.  The 
FDA recently issued a proposed rule on what constitutes permitted 
structure/function claims as distinguished from prohibited disease claims. 
Although the Company believes its product claims comply with the law, 
depending on the content of the final regulation, it may need to revise its 
labeling. In addition, a dietary supplement that contains a new dietary 
ingredient (i.e., one not on the market before October 15, 1994) must have a 
history of use or other evidence of safety establishing that it is reasonably 
expected to be safe. The manufacturer must notify the FDA at 

                                      18


<PAGE>

least 75 days before marketing products containing new dietary ingredients 
and provide the FDA the information upon which the manufacturer based its 
conclusion that the product has a reasonable expectation of safety. 

The FDA issued final dietary supplement labeling regulations in 1997 that 
require a new format for product labels and will necessitate revising dietary 
supplement product labels by March 23, 1999. All companies in the dietary 
supplement industry are required to comply with these labeling regulations. 
The FDA has also announced that it is considering promulgating new GMPs 
specific to dietary supplements. Such GMPs, if promulgated, may be 
significantly more rigorous than currently applicable GMP requirements and 
contain quality assurance requirements similar to GMP requirements for drug 
products. Therefore, the Company may be required to expend additional capital 
and resources on manufacturing in the future in order to comply with the law. 

The failure of the Company to comply with applicable FDA regulatory 
requirements could result in, among other things, injunctions, product 
withdrawals, recalls, product seizures, fines and criminal prosecutions. 

As a result of the Company's efforts to comply with applicable statutes and 
regulations, the Company has from time to time reformulated, eliminated or 
relabeled certain of its products and revised certain of its advertising 
claims. The Company cannot predict the nature of any future laws, 
regulations, interpretations or applications, nor can it determine 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 reformulation of certain products to meet new standards, 
the recall or discontinuance of certain products not capable of 
reformulation, additional recordkeeping, expanded documentation of the 
properties of certain products, expanded or different labeling, and/or 
scientific substantiation. Any or all of such requirements could have a 
material adverse effect on the Company's business, financial condition and 
results of operations. 

The Company's advertising of its dietary supplement products is subject to 
regulation by the FTC under the FTCA. Section 5 of the FTCA prohibits unfair 
methods of competition and unfair or deceptive acts or practices in or 
affecting commerce. Section 12 of the FTCA provides that the dissemination or 
the causing to be disseminated of any false advertisement pertaining to drugs 
or foods, which would include dietary supplements, is an unfair or deceptive 
act or practice. Under the FTC's Substantiation Doctrine, an 

                                      19

<PAGE>

advertiser is required to have a "reasonable basis" for all objective product 
claims before the claims are made. Failure to adequately substantiate claims 
may be considered either deceptive or unfair practices. Pursuant to this FTC 
requirement the Company is required to have adequate substantiation for all 
material advertising claims made for its products. 

On November 18, 1998, the FTC issued "Dietary Supplements: An Advertising 
Guide for Industry."  This guide provides marketers of dietary supplements 
with guidelines on applying FTC law to dietary supplement advertising.  It 
includes examples of the principles that should be used when interpreting and 
substantiating dietary supplement advertising. Although the guide provides 
additional explanation, it does not substantively change the FTC's existing 
policy that all supplement marketers have an obligation to ensure that claims 
are presented truthfully and to verify the adequacy of the support behind 
such claims.  The Company uses counsel to review its advertising claims and 
believes its current advertising is in substantial compliance with the Guide, 
although no assurance can be given in this regard.

In recent years the FTC has initiated numerous investigations of dietary 
supplement and weight loss products and companies. The FTC is reexamining its 
regulation of advertising for dietary supplements and has announced that it 
will issue a guidance document to assist supplement marketers in 
understanding and complying with the substantiation requirement. Upon release 
of this guidance document Natrol will be required to evaluate its compliance 
with the guideline and may be required to change its advertising and 
promotional practices. 

The FTC has a variety of processes and remedies available to it for 
enforcement, both administratively and judicially, including compulsory 
process, cease and desist orders and injunctions. FTC enforcement can result 
in orders requiring, among other things, limits on advertising, corrective 
advertising, consumer redress, divestiture of assets, rescission of contracts 
and such other relief as may be deemed necessary. A violation of such orders 
could have a material adverse effect on the Company's business, financial 
condition and results of operations. 

Advertising and labeling for dietary supplements and conventional foods are 
also regulated by state and local authorities. There can be no assurance that 
state and local authorities will not commence regulatory action which could 
restrict the permissible scope of the Company's product claims. 

                                      20

<PAGE>

Governmental regulations in foreign countries where the Company plans to 
commence or expand sales may prevent or delay entry into the market or 
prevent or delay the introduction, or require the reformulation, of certain 
of the Company's products. Compliance with such foreign governmental 
regulations is generally the responsibility of the Company's distributors for 
those countries. These distributors are independent contractors over whom the 
Company has limited control. 

In addition, the Company has in the past, from time to time, been the subject 
of investigation by the FTC, however, the Company is not currently a party to 
any consent order or other decree of the FTC. The Company may be the subject 
of investigation in the future. The FTC may impose limitations on the 
Company's advertising of its products. Any such limitations could materially 
adversely affect the Company's ability to successfully market its products. 

The Company manufactures certain products pursuant to contracts with 
customers who distribute the products under their own or other trademarks. 
Such private label customers are subject to government regulations in 
connection with their purchase, marketing, distribution and sale of such 
products. The Company is subject to government regulations in connection with 
its manufacture, packaging and labeling of such products. However, the 
Company's private label customers are independent companies, and their 
labeling, marketing and distribution of such products is beyond the Company's 
control. The failure of these customers to comply with applicable laws or 
regulations could have a material adverse effect on the Company's business, 
financial condition and results of operations. 

The Company may be subject to additional laws or regulations by the FDA or 
other federal, state or foreign regulatory authorities, the repeal of laws or 
regulations which the Company considers favorable, such as the Dietary 
Supplement Health and Education Act of 1994, or more stringent 
interpretations of current laws or regulations, from time to time in the 
future. 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 reformulation of certain products to meet new standards, the 
recall or discontinuance of certain products not able to be reformulated, 
imposition of additional recordkeeping requirements, expanded 

                                      21

<PAGE>

documentation of the properties of certain products, expanded or different 
labeling and scientific substantiation. Any or all of such requirements could 
have a material adverse affect on the Company's business, financial condition 
and results of operations.

EMPLOYEES 

As of March 1, 1999, the Company had approximately 291 employees. Of such 
employees, 25 were engaged in marketing and sales, 193 were devoted to 
production and distribution and 73 were responsible for management and 
administration. None of the Company's employees is covered by a collective 
bargaining agreement. The Company considers its relations with its employees 
to be good.

RISK FACTORS

The Company's ability to predict results or the effect of certain events on 
the Company's operating results is inherently uncertain.  Therefore, the 
Company wishes to caution each reader of this report to carefully consider 
the following factors and certain other factors discussed herein and in other 
past reports including, but not limited to, the Company's Prospectus dated 
July 22, 1998 and filed with the Securities and Exchange Commission.

Factors that could cause or contribute to the Company's actual results 
differing materially from those discussed herein or for the Company's stock 
price to be affected adversely include but are not limited to: 

INDUSTRY TRENDS.

Based on estimates in THE U.S. MARKET FOR VITAMINS, SUPPLEMENTS, AND 
MINERALS, a 1997 market report prepared by Packaged Facts (the "Packaged 
Facts Report"), an independent consumer marketing research firm, the retail 
market for vitamins, minerals and other supplements (excluding sports 
nutrition and diet products) has grown at a compound annual rate of 15% from 
$3.7 billion in 1992 to $6.5 billion in 1996 and other industry sources 
estimate the market grew 20% in 1997 to $7.8 billion.  

More recent Information Resources, Inc. ("IRI") data show evidence that this 
rapid growth pace is slowing. Dollar sales for vitamins in the food, drug and 
mass market channel of distribution for the 4 weeks ended January 3, 1999 
were down slightly (.73%) when compared to the same four week period in 1998. 
In addition, when comparing the 12 weeks ending January 3, 1999 against the 
same 12 weeks ending January 3, 1998, dollar sales were up only 1.8%.  Dollar 
sales for mineral 

                                      22

<PAGE>

supplements, which includes herbal products, were up 3.4% in the four week 
period and climbed 5.34 % in the 12 week period.  Both rates are 
substantially less than the growth rates reported in prior years.  

There can be no assurance that the higher industry growth rates of prior 
years can be sustained, or, if not sustained, will return. Such a failure to 
sustain growth in the industry may have a material adverse effect on the 
Company's ability to sustain its historic rates of growth and its results of 
operations.

COMPETITION. The dietary supplement industry is highly competitive. Numerous 
companies, many of which have greater size and financial, personnel, 
distribution and other resources than the Company, compete with the Company 
in the development, manufacture and marketing of dietary supplements. The 
Company's principal competition in the health food store distribution channel 
comes from a limited number of large nationally known manufacturers and many 
smaller manufacturers of dietary supplements. In the mass market distribution 
channel, the Company's principal competition comes from broadline 
manufacturers, major private label manufacturers and other companies. In 
recent years, a number of the Company's competitors have begun to market and 
sell their products under different labels in both the health food store and 
the mass market distribution channels. In addition, large pharmaceutical 
companies have begun to compete with the Company and others in the dietary 
supplement industry, in particular in the more rapidly growing herbal sector 
of the business. Packaged food and beverage companies compete with the 
Company on a limited basis in the dietary supplement market. Increased 
competition from such companies could have a material adverse effect on the 
Company because such companies have greater financial and other resources 
available to them and possess manufacturing, distribution and marketing 
capabilities far greater than those of the Company. The Company also faces 
competition in both the health food store and mass market distribution 
channels from private label dietary supplements and multivitamins offered by 
health and natural food store chains, drugstore chains, mass merchandisers 
and supermarket chains. 

EFFECT OF UNFAVORABLE PUBLICITY.  The Company believes the dietary supplement 
market is significantly affected by national media attention regarding the 
consumption of dietary supplements. Future scientific research or publicity 
may not be favorable to the dietary supplement industry or to any particular 
product, and may not be consistent with earlier favorable research or 
publicity. Because of the Company's dependence on consumers' perceptions, 
adverse publicity associated with illness or other adverse effects resulting 
from the consumption of the Company's products or any similar products 
distributed by other companies and future reports of 

                                      23

<PAGE>

research that are perceived as less favorable or that question earlier 
research could have a material adverse effect on the Company's business, 
financial condition and results of operations. The Company is highly 
dependent upon consumers' perceptions of the safety and quality of its 
products as well as dietary supplements distributed by other companies. Thus, 
the mere publication of reports asserting that such products may be harmful 
or questioning their efficacy could have a material adverse effect on the 
Company's business, financial condition and results of operations, regardless 
of whether such reports are scientifically supported or whether the claimed 
harmful effects would be present at the dosages recommended for such 
products. See "Absence of Conclusive Clinical Studies." 

DEPENDENCE ON NEW PRODUCTS.  The Company believes growth of its net sales is 
substantially dependent upon its ability to introduce new products. The 
Company seeks to introduce additional products each year. The success of new 
products is dependent upon a number of factors, including the Company's 
ability to develop products that will appeal to consumers and respond to 
market trends in a timely manner. There can be no assurance that the 
Company's efforts to develop new products will be successful or that 
consumers will accept the Company's new products. In addition, products 
currently experiencing strong popularity and rapid growth may not maintain 
their sales over time. For example, the Company's net sales of DHEA, a 
specialty dietary supplement introduced by the Company in March 1996, peaked 
at $4.6 million for the three months ended December 31, 1996 and accounted 
for 39.5% of the Company's net sales in such period. In comparison, the 
Company's net sales of DHEA were only $257,000, or 1.3% of the Company's net 
sales, for the three months ended December 31, 1998. 

GOVERNMENT REGULATION.  The manufacture, packaging, labeling, advertising, 
promotion, distribution and sale of the Company's products are subject to 
regulation by numerous governmental agencies, the most active of which is the 
U.S. Food and Drug Administration (the "FDA"), which regulates the Company's 
products under the Federal Food, Drug and Cosmetic Act (the "FDCA") and 
regulations promulgated thereunder. The Company's products are also subject 
to regulation by, among other regulatory entities,  the Consumer Product 
Safety Commission (the "CPSC"), the U.S. Department of Agriculture (the 
"USDA") and the Environmental Protection Agency (the "EPA"). Advertising and 
other forms of promotion and methods of marketing of the Company's products 
are subject to regulation by the U.S. Federal Trade Commission (the "FTC"), 
which regulates these activities under the Federal Trade Commission Act (the 
"FTCA"). The manufacture, labeling and advertising of the Company's products 
are also regulated by various state and local agencies as well as those of 
each foreign country to which the Company distributes its products. 

                                      24

<PAGE>

The Company's products are generally regulated as dietary supplements under 
the FDCA, and are, therefore, not subject to pre-market approval by the FDA. 
However, these products are subject to extensive regulation by the FDA 
relating to adulteration and misbranding. For instance, the Company is 
responsible for ensuring that all dietary ingredients in a supplement are 
safe, and must notify the FDA in advance of putting a product containing a 
new dietary ingredient (i.e., an ingredient not marketed for use as a 
supplement before October 15, 1994) on the market and furnish adequate 
information to provide reasonable assurance of the ingredient's safety.  
Further, if the Company makes statements about the supplement's effects on 
the structure or function of the body, the Company must, among other things, 
have substantiation that the statements are truthful and not misleading.  In 
addition, the Company's product labels must bear proper ingredient and 
nutritional labeling and the Company's supplements must be manufactured in 
accordance with current Good Manufacturing Practice regulations ("GMPs") for 
foods.  The FDA has issued an advanced notice of proposed rulemaking to 
consider whether to develop specific GMP regulations for dietary supplements 
and dietary supplement ingredients. Such regulations, if promulgated, may be 
significantly more rigorous than current requirements and contain quality 
assurance requirements similar to GMPs for drug products. A product can be 
removed from the market if it is shown to pose a significant or unreasonable 
risk of illness or injury. Moreover, if the FDA determines that the "intended 
use" of any of the Company's products is for the diagnosis, cure, mitigation, 
treatment or prevention of disease, the product would meet the definition of 
a drug and would require pre-market approval of safety and effectiveness 
prior to its manufacture and distribution. Failure of the Company to comply 
with applicable FDA regulatory requirements may result in, among other 
things, injunctions, product withrawals, recalls, product seizures, fines and 
criminal prosecutions. 

The Company's advertising of its dietary supplement products is subject to 
regulation by the FTC under the FTCA. Section 5 of the FTCA prohibits unfair 
methods of competition and unfair or deceptive acts or practices in or 
affecting commerce. Section 12 of the FTCA provides that the dissemination or 
the causing to be disseminated of any false advertisement pertaining to, 
among other things, drugs or foods, which includes dietary supplements, is an 
unfair or deceptive act or practice. Under the FTC's "substantiation 
doctrine," an advertiser is required to have a "reasonable basis" for all 
product claims at the time the claims are first used in advertising or other 
promotions. Failure to adequately substantiate claims may be considered 
either as a deceptive or unfair practice. Pursuant to this FTC requirement, 
the Company is required to have adequate 

                                      25

<PAGE>

substantiation for all advertising claims made about its products. The type 
of substantiation will be dependent upon the product claims made. For 
example, a health claim normally would require competent and reliable 
scientific evidence, while a taste claim would require only survey evidence. 

In recent years the FTC has initiated numerous investigations of dietary 
supplement and weight loss products and companies. The FTC is reexamining its 
regulation of advertising for dietary supplements and has announced that it 
will issue a guidance document to assist dietary supplement marketers in 
understanding and complying with the substantiation requirement. Upon release 
of this guidance document, Natrol will be required to evaluate its compliance 
with the guideline and may be required to change its advertising and 
promotional practices. 

On two occasions, claims made by the Company have been the subject of 
investigation by the FTC. In both matters, the FTC terminated its 
investigation without further action or any formal findings. The Company is 
not currently a party to any investigation, consent order or other decree of 
the FTC. The Company may be subject to investigation by the FTC in the 
future. If the FTC has reason to believe the law is being violated (e.g., the 
Company does not possess adequate substantiation for product claims), it can 
initiate enforcement action. The FTC has a variety of processes and remedies 
available to it for enforcement, both administratively and judicially, 
including compulsory process authority, cease and desist orders and 
injunctions.  FTC enforcement could result in orders requiring, among other 
things, limits on advertising, consumer redress, divestiture of assets, 
rescission of contracts and such other relief as may be deemed necessary.  
Violation of such orders could result in substantial financial or other 
penalties. Any such action by the FTC could materially adversely affect the 
Company's ability to successfully market its products. 

The Company manufactures certain products pursuant to contracts with 
customers who distribute the products under their own or other trademarks. 
Such private label customers are subject to government regulations in 
connection with their purchase, marketing, distribution and sale of such 
products, and the Company is subject to government regulations in connection 
with its manufacture, packaging and labeling of such products. However, the 
Company's private label customers are independent companies, and their 
labeling, marketing and distribution of such products is beyond the Company's 
control. The failure of these customers to comply with applicable laws or 
regulations could have a material adverse effect on the Company's business, 
financial condition and results of operations. 

Governmental regulations in foreign countries where the Company plans to 
commence or expand sales may prevent or 

                                      26

<PAGE>

delay entry into the market or prevent or delay the introduction, or require 
the reformulation, of certain of the Company's products. Compliance with such 
foreign governmental regulations is generally the responsibility of the 
Company's distributors in those countries. These distributors are independent 
contractors over whom the Company has limited control. 

The Company may be subject to additional laws or regulations by the FDA or 
other federal, state or foreign regulatory authorities, the repeal of laws or 
regulations which the Company considers favorable, such as the Dietary 
Supplement Health and Education Act of 1994 ("DSHEA"), or more stringent 
interpretations of current laws or regulations, from time to time in the 
future. 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 reformulation of certain products to meet new standards, the 
recall or discontinuance of certain products that cannot be reformulated, 
imposition of additional record keeping requirements, expanded documentation 
of the properties of certain products, or expanded or different labeling or 
scientific substantiation. Any or all of these requirements could have a 
material adverse effect on the Company's business, financial condition and 
results of operations. 

PRODUCT LIABILITY.  The Company, like other retailers, distributors and 
manufacturers of products designed for human consumption, faces an inherent 
risk of exposure to product liability claims in the event that the use of its 
products results in injury. The Company may be subjected to various product 
liability claims, including, among others, that its products include 
inadequate instructions for use or inadequate warnings concerning possible 
side effects and interactions with other substances. In addition, although 
the Company maintains strict quality controls and procedures, including the 
quarantine and testing of raw materials and qualitative and quantitative 
testing of selected finished products, there can be no assurance that the 
Company's products will not contain contaminated substances. In addition, in 
certain cases the Company relies on third party manufacturers for its 
products. With respect to product liability claims, the Company has $2.0 
million in aggregate liability insurance. If such claims should exceed $2.0 
million, the Company has excess umbrella liability insurance of up to $25.0 
million. However, there can be no assurance that such insurance will continue 
to be available at a reasonable cost, or, if available, will be adequate to 
cover liabilities. The Company generally seeks to obtain contractual 
indemnification from parties supplying raw materials for its products or 
manufacturing or marketing its products, and to be added as an additional 
insured under such 

                                      27

<PAGE>

parties' insurance policies. Any such indemnification or insurance, however, 
is limited by its terms and any such indemnification, as a practical matter, 
is limited to the creditworthiness of the indemnifying party. In the event 
that the Company does not have adequate insurance or contractual 
indemnification, product liabilities relating to its products could have a 
material adverse effect on the Company's business, financial condition and 
results of operations.

DEPENDENCE ON SIGNIFICANT CUSTOMERS.  Net sales to Walgreens accounted for 
15.9% of the Company's net sales for the year ended December 31, 1998 and 
17.8% and 12.6% of the Company's net sales in 1997 and 1996, respectively. 
Net sales to Tree of Life accounted for 6.8% of the Company's net sales for 
the year ended December 31, 1998 and 11.6% and 10.2% of the Company's net 
sales in 1997 and 1996, respectively. The Company does not have long-term 
contracts with any of its customers. There can be no assurance that Walgreens 
or the Company's other major customers will continue as major customers of 
the Company. The loss of Walgreens or the loss of a significant number of 
other major customers, or a significant reduction in purchase volume by or 
financial difficulty of such customers, for any reason, could have a material 
adverse effect on the Company's business, financial condition and results of 
operations.

DEPENDENCE ON KEY PERSONNEL.  The Company believes that its continued success 
depends to a significant extent on the management and other skills of Elliott 
Balbert, the Company's Chairman, Chief Executive Officer and President, and 
its senior management team, as well as its ability to attract other skilled 
personnel. Many of the Company's employees are not covered by a 
non-competition agreement, and the ability of the Company to enforce such an 
agreement in California, the state in which the Company's operations are 
principally located, is limited and uncertain. The loss or unavailability of 
the services of Mr. Balbert or the other members of the Company's senior 
management team or the inability to attract other skilled personnel could 
have a material adverse effect on the Company's business, financial condition 
and results of operations. 

ABILITY TO MANAGE GROWTH.  The Company believes that continued growth may 
strain the Company's management, operations, sales and administrative 
personnel and other resources. In order to serve the needs of its existing 
and future customers, the Company has increased and intends to continue to 
increase its workforce, which requires the Company to attract, train, 
motivate, manage and retain qualified employees. The Company's ability to 
manage further growth depends in part upon the Company's ability to expand 
its operating, management, information and financial systems, and production 
capacity, which may significantly increase its future operating expenses. No 
assurance can be given that the 

                                      28

<PAGE>

Company's business will grow in the future or that the Company will be able 
to effectively manage such growth. The Company's inability to manage its 
growth successfully could have a material adverse effect on the Company's 
business, financial condition and results of operations. 

RISKS ASSOCIATED WITH ACQUISITIONS.  The Company completed two acquisitions 
in 1998 and expects to pursue additional acquisitions in the future as a part 
of its business strategy. The Company faces significant competition for 
acquisition opportunities from numerous companies, many of which have greater 
financial resources than the Company. Accordingly, there can be no assurance 
that attractive acquisition opportunities will be available to the Company. 
There can be no assurance that the Company will be able to obtain financing 
for or otherwise consummate any future acquisitions. Moreover, acquisitions 
involve numerous risks, including the risk that the acquired business will 
not perform in accordance with expectations, difficulties in the integration 
of the operations and products of the acquired businesses with those of the 
Company, the diversion of the management's attention from other aspects of 
the Company's business, the risks associated with entering geographic and 
product markets in which the Company has limited or no direct prior 
experience and the potential loss of key employees of the acquired business. 
The acquisition of another business can also subject the Company to 
liabilities and claims arising out of such business. Future acquisitions 
would likely require additional financing, which would likely result in an 
increase in the Company's indebtedness or the issuance of additional capital 
stock, which may be dilutive to the Company's stockholders, including 
purchasers of shares offered hereby. 

The Pure-Gar and Laci Le Beau acquisitions resulted in a significant increase 
in the Company's goodwill and any future acquisitions may result in 
additional goodwill and related amortization expense. At December 31, 1998, 
goodwill on the Company's balance sheet was $13.8 million, representing 20.1% 
of the Company's total assets at that date. In the event of any sale or 
liquidation of the Company or a portion of its assets, there can be no 
assurance that the value of the Company's intangible assets will be realized. 
In addition, the Company continually evaluates whether events and 
circumstances have occurred indicating that any portion of the remaining 
balance of the amount allocable to the Company's intangible assets may not be 
recoverable. When factors indicate that the amount allocable to the Company's 
intangible assets should be evaluated for possible impairment, the Company 
may be required to reduce the carrying value of such assets. Any future 
determination requiring the write-off of a significant portion of unamortized 
intangible assets could have a material adverse effect on the Company's 
business, financial condition and operating results. 

                                      29

<PAGE>

The Company regularly evaluates potential acquisitions of other businesses, 
products and product lines and may hold discussions regarding such potential 
acquisitions. As a general rule, the Company will publicly announce such 
acquisitions only after a definitive agreement has been signed. 

ABSENCE OF CONCLUSIVE CLINICAL STUDIES.  Although many of the ingredients in 
the Company's products are vitamins, minerals, herbs and other substances for 
which there is a long history of human consumption, some of the Company's 
products contain ingredients for which no such history exists. In addition, 
although the Company believes all of its products are safe when taken as 
directed by the Company, there is little long-term experience with human 
consumption of certain of these product ingredients in concentrated form. 
Accordingly, there can be no assurance that the Company's products, even when 
used as directed, will have the effects intended or will not have harmful 
side effects. Any such unintended effects may result in adverse publicity or 
product liability claims which could have a material adverse effect on the 
Company's business, financial condition and results of operations. 

RISKS ASSOCIATED WITH SUPPLY OF RAW MATERIALS.  The Company obtains all of 
its raw materials for the manufacture of its products from third-party 
suppliers. Many of the raw materials used in the Company's products are 
harvested internationally. With the exception of bulk garlic and 
Ester-C-Registered Trademark-, the Company does not have contracts with any 
suppliers committing such suppliers to provide the materials required for the 
production of its products. In the last few years, natural vitamin E, beta 
carotene and Melatonin have had significant price fluctuations as a result of 
short supply and/ or increases in demand. The Company has experienced 
occasional shortages of raw materials for a limited number of its products. 
There can be no assurance that suppliers, including suppliers of bulk garlic 
and Ester-C-Registered Trademark-, will provide the raw materials needed by 
the Company in the quantities requested or at a price the Company is willing 
pay. Because the Company does not control the actual production of these raw 
materials, it is also subject to delays caused by interruption in production 
of materials based on conditions not within its control. Such conditions 
include job actions or strikes by employees of suppliers, weather, crop 
conditions, transportation interruptions and natural disasters or other 
catastrophic events. With respect to products that are sold by the Company 
under the supplier's trademark, such as Ester-C-Registered Trademark- and 
Tonalin-Registered Trademark-, the Company is limited to that single supplier 
as a source of raw material for that product. As a result, any shortage of 
raw materials from that supplier would adversely affect the Company's ability 
to manufacture that product. The inability of the Company to obtain adequate 
supplies of raw materials for its 

                                      30

<PAGE>

products at favorable prices, or at all, could have a material adverse effect 
on the Company's business, financial condition and results of operations. 

SALES AND EARNINGS VOLATILITY.  The Company's sales and earnings continue to 
be subject to volatility based upon, among other things: (i) trends and 
general conditions in the dietary supplement industry and the ability of the 
Company to recognize such trends and effectively introduce and market new 
products in response to such trends; (ii) the introduction of new products by 
the Company or its competitors; (iii) the loss of one or more significant 
customers; (iv) increased media attention on the use and efficacy of dietary 
supplements; (v) consumers' perceptions of the products and operations of the 
Company or its competitors; and (vi) the availability of raw materials from 
suppliers. Sales and earnings volatility as a result of the foregoing factors 
may affect the Company's operating results from period to period which may 
adversely affect the market price of the Common Stock. 

POSSIBLE VOLATILITY OF STOCK PRICE.  There can be no assurance that an active 
market in the Company's stock will be sustained. The trading price of the 
Common Stock has been subject to wide fluctuations.

The price of the Common Stock may fluctuate in the future in response to 
quarter-to-quarter variations in the Company's operating results, material 
announcements by the Company or its competitors, governmental regulatory 
action, conditions in the dietary supplement industry, or other events or 
factors, many of which are beyond the Company's control. In addition, the 
stock market has historically experienced significant price and volume 
fluctuations which have particularly affected the market prices of many 
dietary supplement companies and which have, in certain cases, not had a 
strong correlation to the operating performance of such companies. The 
Company's operating results in future quarters may be below the expectations 
of securities analysts and investors. In such event, the price of the Common 
Stock would likely decline, perhaps substantially.

RISKS ASSOCIATED WITH MANUFACTURING.  The Company's results of operations are 
dependent upon the continued operation of its manufacturing facility in 
Chatsworth, California, at its current levels. The operation of dietary 
supplement manufacturing plants involves many risks, including the breakdown, 
failure or substandard performance of equipment, natural and other disasters, 
and the need to comply with the requirements of directives of government 
agencies, including the FDA. In particular, the Company's manufacturing 
facility is located in southern California, a geographic area that has 
historically been prone to earthquakes, which in some cases have been 
catastrophic. Prior to the Company's lease and 

                                      31

<PAGE>

build-out of the building in which its manufacturing facility is located, the 
building was severely damaged in a major earthquake on January 17, 1994, the 
epicenter of which was within five miles of the building. Although the 
building was rebuilt with an enhanced ability to withstand earthquakes and 
conforms to current local and state code requirements, the Company's 
manufacturing facility could be damaged or destroyed in the event of an 
earthquake. Any such damage or destruction would have a material adverse 
effect on the Company's business, financial condition and results of 
operations. The Company does not carry earthquake insurance because such 
insurance is unobtainable on commercially reasonable terms in the Company's 
geographic location. In addition, the Company's softgel and liquid products 
are manufactured by outside contractors. The Company's profit margins on 
these products and its ability to deliver these products on a timely basis 
are dependent on the ability of the outside manufacturers to continue to 
supply products that meet the Company's quality standards in a timely and 
cost-efficient manner. The occurrence of any of the foregoing or other 
material operational problems could have a material adverse effect on the 
Company's business, financial condition and results of operations during the 
period of such operational difficulties. 

RELIANCE ON INDEPENDENT BROKERS.  The Company places significant reliance on 
a network of independent brokers to act as its primary sales force to mass 
market retailers. Although the Company employs management personnel, 
including regional sales managers, to closely monitor the brokers, such 
brokers are not employed or otherwise controlled by the Company and are 
generally free to conduct their business at their own discretion. Although 
these brokers enter into contracts with the Company, such contracts typically 
can be terminated upon 30 days notice by the Company or the independent 
broker. The simultaneous loss of the services of a number of these 
independent brokers could have a material adverse effect on the Company's 
business, financial condition and results of operations

INTELLECTUAL PROPERTY PROTECTION.  The Company's policy is to pursue 
registrations for all of the trademarks associated with its key products. The 
Company relies on common law trademark rights to protect its unregistered 
trademarks as well as its trade dress rights. Common law trademark rights 
generally are limited to the geographic area in which the trademark is 
actually used, while a United States federal registration of a trademark 
enables the registrant to stop the unauthorized use of the trademark by any 
third party anywhere in the United States. The Company intends to register 
its trademarks in certain foreign jurisdictions where the Company's products 
are sold. However, the protection available, if any, in such jurisdictions 
may not be as extensive as the protection available to the Company in the 
United States. 

                                      32

<PAGE>

Currently, the Company has received one United States patent for its Kavatrol 
product, has a second United States patent application pending for a method 
of using its Kavatrol product and has received two United States patents on 
its amino acid products, SAF and SAF for Kids. To the extent the Company does 
not have patents on its products, another Company may replicate one or more 
of the Company's products. 

Although the Company seeks to ensure that it does not infringe the 
intellectual property rights of others, there can be no assurance that third 
parties will not assert intellectual property infringement claims against the 
Company. Natrol was contacted in June 1997 by a third party that claimed 
Natrol's marketing of Melatonin infringed the third party's patents relating 
to a method of using Melatonin and sought to license such patents to Natrol. 
Since Natrol does not believe its marketing of Melatonin infringes the third 
party's patent claims, Natrol has declined to enter into a license agreement 
with the third party. Any infringement claims by third parties against the 
Company may have a material adverse effect on the Company's business, 
financial condition and results of operations. 

ITEM 2. PROPERTIES

In December 1998, the Company purchased, for $5.25 million, the 90,000 square 
foot manufacturing, distribution and office facility in Chatsworth, 
California it had been leasing pursuant to a 10 year lease. The Company has 
occupied this facility since March 1997. The facility was designed and 
constructed to the Company's specifications and includes areas for shipping 
and receiving, quarantine of new materials, manufacture, quality control and 
laboratory activities, research and development, packaging, warehousing and 
administrative offices. 

On March 1, 1999 the Company commenced leasing a 26,640 square foot shipping 
facility located within one quarter mile of its headquarters facility in 
Chatsworth, California. The Company stores raw materials and ships finished 
products from this warehouse.  

The Company also leases 6,800 square feet of space in Chatsworth, California 
that it periodically subleases to others. As of the end of December, the 
lease on this property had 2.5 years remaining.  The Company attempts to keep 
this space fully leased but, on occasion, this space remains unoccupied.  The 
Company does not intend to renew this lease once the lease obligation is 
fulfilled.

                                      33

<PAGE>

ITEM 3. LEGAL MATTERS

From time to time the Company is subject to litigation incidental to its
business, including possible product liability claims. Such claims, if
successful, could exceed applicable insurance coverage. 

The Company is not currently a party to any material legal proceedings.

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

During the fourth quarter of the calendar year 1998, no matters were submitted
to a vote of the security holders of the Company.


                                      34


<PAGE>
                                       
                                    PART II
                                          
ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 
          MATTERS

PRICE RANGE OF COMMON STOCK

The Common Stock of the Company has traded on the Nasdaq National Market 
under the symbol "NTOL" since the Company's initial public offering ("IPO") 
in July 1998, in which 3,200,000 shares of Common Stock were issued and sold 
by the Company. The Company sold an additional 295,500 shares in connection 
with the underwriter's exercise of their over-allotment option in the IPO. 
Prior to the IPO, there was no market for the Common Stock.  On March 24, 
1999, the last reported sales price of the Company's Common Stock as reported 
on the Nasdaq National Market was $6.00. As of March 24, 1999 there were 21 
holders of record of the Company's Common Stock.  The high and low sales 
prices for the Common Stock as reported by the Nasdaq National Market for the 
periods since the IPO are summarized below.

<TABLE>
<CAPTION>

Fiscal Year Ended December 31, 1998        High        Low
-----------------------------------        ----        ---
<S>                                     <C>         <C>
Quarter ended September 30, 1998 
(from July 27, 1998)                    $17.875     $7.438
Quarter ended December 31, 1998          15.625      6.125

</TABLE>

DIVIDEND POLICY

In 1996, the Company was taxed under Subchapter S of the Internal Revenue 
Code of 1986, as amended (the "Code") for the period from July 1, 1996 
through September 29, 1996.  During this period, the Company declared and 
paid dividends to its stockholders, including amounts sufficient for its 
stockholders to pay their income taxes on the earnings of the Company that 
were treated as having been earned by the Company's stockholders. The Company 
terminated its "S" corporation status on September 30, 1996.

The Company currently intends to retain earnings to finance its operations 
and future growth and does not anticipate paying dividends on its Common 
Stock in the foreseeable future. Under Delaware law, the Company is permitted 
to pay dividends only out of its surplus, or, if there is no surplus, out of 
its net profits.  The Company currently has no debt obligations whose 
covenants restrict the payment of dividends.  However, in the past, the 
Company has entered into agreements with lenders that have restricted the 
Company's ability to issue dividends and at some future date the Company may 
enter into similar loan agreements limiting 

                                      35
<PAGE>

the ability of the Company to pay dividends. 

RECENT SALES OF UNREGISTERED SECURITIES

The Company has not sold any securities since the IPO that were not 
registered under the Securities Act of 1933, as amended.

USE OF PROCEEDS

The Company completed the IPO in July 1998.  The IPO was made pursuant to a 
Registration Statement on Form S-1, originally filed with the Securities and 
Exchange Commission on May 7, 1998, as amended (Commission File No. 
333-52109), which was declared effective on July 21, 1998.  The IPO commenced 
on July 22, 1998 and terminated shortly thereafter after the sale into the 
public market of all of the registered shares of Common Stock.

The shares of Common Stock sold in the IPO were offered for sale by a 
syndicate of underwriters represented by Adams, Harkness & Hill, Inc., 
NationsBanc Montgomery Securities LLC and Piper Jaffray Inc.

The Company registered an aggregate of 4,531,000 shares of Common Stock 
(including 591,000 shares issuable upon the exercise of the underwriters' 
overallotment option) for sale in the IPO at a per share price of $15.00, for 
an aggregate offering price of approximately $68.0 million.  Of the 4,531,000 
shares sold in the IPO, 3,495,500 shares were registered for the Company's 
account.

The Company incurred the following expenses in connection with the IPO:

<TABLE>
<S>                                          <C>
Underwriting discounts and commissions       $3.67 million
Other expenses                               $1.05 million
                                             -------------
Total expenses                               $4.72 million
</TABLE>

After deducting the expenses set forth above, the Company received 
approximately $47.7 million in net proceeds from the IPO. The Company used 
approximately (a) $8.4 million of the proceeds to repay in July 1998 
borrowings under the Company's then existing senior credit facility with 
Wells Fargo Bank, N.A., including fees and accrued and unpaid interest, (b) 
$6.0 million to redeem all of the outstanding shares of the Company's 
Redeemable Preferred Stock in July 1998, (c) $7.5 million to complete the 
acquisition of the Laci Le Beau tea business in October 1998, and (d) $5.25 
million to purchase its headquarters/ manufacturing facility in December 
1998.     

                                      36

<PAGE>

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected financial data for the four years ended December 31, 
1998 is derived from consolidated financial statements of Natrol, Inc. and 
subsidiaries, which have been audited by Ernst & Young LLP, independent 
auditors. The selected financial data for the year ended December 31, 1994 is 
derived from unaudited financial statements. The unaudited consolidated 
financial statements have been prepared by the Company on a basis consistent 
with the Company's audited financial statements and, in the opinion of 
management, include all adjustments, consisting only of normal recurring 
accruals, necessary for a fair presentation of the Company's consolidated 
financial position and results of operations for the year ended 1994. The 
data set forth below should be read in conjunction with "Management's 
Discussion and Analysis of Financial Condition and Results of Operations" and 
the Consolidated Financial Statements of the Company and Notes thereto 
included herein. 

<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                 ----------------------------------------------
                                  1994      1995       1996     1997     1998
                                 -------   -------  --------  -------   -------
                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                              <C>       <C>       <C>      <C>       <C>
CONSOLIDATED STATEMENT OF
 INCOME DATA:
Net sales                        $12,214   $23,566   $40,802  $42,875   $68,207
Cost of goods sold                 7,106    12,214    18,497   19,800    32,012
                                 -------   -------  --------  -------   -------
     Gross profit                  5,108    11,352    22,305   23,075    36,195
                                 -------   -------  --------  -------   -------
Selling and marketing expenses     2,552     4,458     8,736   11,398    17,757
General and administrative                                            
 expenses                          1,739     3,378     5,431    4,450     6,513
                                 -------   -------  --------  -------   -------
     Total operating expenses      4,291     7,836    14,167   15,848    24,270
                                 -------   -------  --------  -------   -------
Operating income                     817     3,516     8,138    7,227    11,925
                                 -------   -------  --------  -------   -------
Interest income (expense), net      (25)      (19)        54    (220)     (197)
                                 -------   -------  --------  -------   -------
Income before income tax                                              
 provision                           792     3,497     8,192    7,007    12,122
Income tax provision                 301     1,453  2,299(1)    2,816     4,606
                                 -------   -------  --------  -------   -------
Net income                          $491    $2,044    $5,893   $4,191    $7,516
                                 -------   -------  --------  -------   -------

Basic earnings per share           $0.08     $0.34     $0.94    $0.59     $0.76

Diluted earnings per share         $0.08     $0.34     $0.83    $0.41     $0.63

Weighted average shares                                               
 outstanding-basic                 6,000     6,000     6,275    7,100     9,854
Weighted average shares                                               
 outstanding-diluted               6,000     6,000     7,065   10,273    11,891

</TABLE>

                                       37

<PAGE>

<TABLE>
<CAPTION>

                                                    DECEMBER 31,
                                 ----------------------------------------------
                                  1994      1995       1996     1997     1998
                                 -------   -------  --------  -------   -------
                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                              <C>       <C>       <C>      <C>       <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents           $560      $515      $285   $1,800      $559
Marketable securities                  -         -         -        -    19,010
Working capital                      926     2,741     4,496    8,424    35,673
Total assets                       3,972     7,608    11,345   19,716    68,708
Long-term debt, less current                                           
 maturities                           84        67       405    2,606         -
Convertible participating 
 preferred stock                       -         -    12,000   12,000         -
Total stockholders' equity 
 (deficit)                         1,259     3,303    (5,755)  (1,564)   59,641
Cash dividend declared per 
 common share                      $0.00     $0.00     $0.55    $0.00     $0.00

</TABLE>
--------------
(1)  In 1996, the Company was taxed under Subchapter S of the Code for the
     period from July 1, 1996 through September 29, 1996, and was taxed under
     Subchapter C of the Code for the period from January 1, 1996 through
     June 30, 1996 and for the period from September 30, 1996 through
     December 31, 1996. Accordingly, the provision for income taxes for the
     period in which the Company was taxed as a Subchapter S corporation
     reflects primarily state income tax, if any. If the Company had been
     subject to taxation under Subchapter C of the Code for the entire year
     ended December 31, 1996, the pro forma provision for income taxes would
     have been $3.2 million and pro forma basic earnings per share and pro forma
     diluted earnings per share would have been $0.80 and $0.71, respectively. 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
        FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION 
OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE "SELECTED CONSOLIDATED 
FINANCIAL DATA" AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF THE 
COMPANY AND THE NOTES THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT.

OVERVIEW

Natrol's core business is the manufacturing and marketing of branded, 
high-quality dietary supplements. 

                                      38

<PAGE>


The Company sells its core products under the Natrol brand name through 
multiple distribution channels throughout the United States, including 
domestic health food stores and mass market drug, retail and grocery store 
chains. 

The growth in Natrol brand sales historically has been a result of the 
introduction of new products on an ongoing basis and the expansion of sales 
through additional channels of distribution. During the last three years, the 
Company's net sales have been affected by the success of certain products, 
including Melatonin, DHEA and St. John's Wort, which were introduced in 1995, 
1996 and 1997, respectively. Melatonin was introduced in the third quarter of 
1995 and generated $6.7 million in revenue that year. In 1996, Melatonin and 
DHEA gained substantial popularity with the general public and accounted for 
$22.9 in million revenues, more than 50% of the Company's net sales in that 
year. However, during 1997 the net sales volume of these two products 
declined by an aggregate of $9.8 million, or 42.9%. When consumer products 
experience heightened public popularity, it is not uncommon for them to enjoy 
peaks of pipeline sales followed by declines. Accordingly, the Company 
anticipated a decline in net sales of Melatonin and DHEA and introduced 34 
new products in 1997, which accounted for $8.9 million, or 20.7%, of net 
sales in 1997.  One major item in this product introduction mix was St. 
John's Wort, which was launched in the third quarter of 1997 and generated 
$3.8 million in sales. Growth in existing product lines in 1997 added an 
additional $6.8 million to 1997 net sales. 

During 1998, the Company introduced approximately 70 new items. The Natrol 
brand product line currently includes approximately 190 items which are 
packaged in various sizes (e.g., 30 count, 60 count, etc.), strengths (e.g., 
50 mg, 100 mg, etc.), and combinations (e.g., multiple vitamins with or 
without iron).  These sizes, strengths and combinations create approximately 
500 stockkeeping units (SKUs).

During 1998 approximately 14% of the Company's revenues were generated by 
these new Natrol brand items. Ester-C-Registered Trademark- and Melatonin 
generated 14% and 10% of revenues, respectively. The Company continues to 
believe that introducing new products is important to the Company's growth 
and to maintaining what it believes to be an excellent reputation for being 
an innovative Company within the nutritional supplement industry and as such 
the Company expects to introduce more new products in 1999.
 
Prior to 1995, most of the Company's distribution was within the health food 
channel of trade.  Today, the health food 

                                      39

<PAGE>

channel of trade accounts for approximately 31% of the Company's branded 
Natrol business. A majority of the remaining sales are to mass market 
accounts. Net sales to Walgreens accounted for 15.9% of the Company's net 
sales for 1998 and 17.8% and 12.6% of the Company's net sales in 1997 and 
1996, respectively. No other customer accounted for more than 10% in 1998. 

ACQUISITIONS DURING 1998

During 1998, the Company completed two acquisitions. 

On February 27, 1998, the Company acquired substantially all of the assets 
and certain liabilities of Pure-Gar, L.P. The acquisition involved the 
purchase of two brands of garlic supplements, Quintessence and Highgar Farms, 
as well as a bulk ingredient business. In connection with the acquisition, 
the Company recorded a purchase price of $11.0 million with $9.0 million of 
goodwill which is being amortized on a straight line basis over 15 years, 
amounting to $600,000 of annual amortization expense. Upon completing the 
acquisition, the Company began the process of developing its own Garlipure 
line of Natrol garlic supplements and then filling shelf space formerly 
allocated by retailers to the acquired Highgar Farms and Quintessence lines 
with its Garlipure line. The Company also began to aggressively promote its 
ingredient supply business. Sales of garlic supplements prior to the 
acquisition were nominal. In 1998, the Company sold approximately $2.2 
million in garlic supplements.

Many of the Company's ingredient customers are direct competitors to the 
Company's core branded Natrol business and as such the Company maintains a 
"Chinese Wall" between its Pure-Gar division and the rest of the Company. The 
purpose is to ensure that Pure-Gar customer sales information is not 
transferred to the rest of the Company. The Company's Pure-Gar ingredient 
supply business contributed approximately $6.5 million to revenues and $3.4 
million to the Company's gross margin during the period from when the Company 
acquired Pure-Gar through December 31, 1998.

On October 1, 1998, the Company acquired certain of the assets of Laci Le 
Beau which consisted of Laci Le Beau Corporation as well as certain related 
companies. The total purchase price for the acquisition was $7.5 million in 
cash.  Laci Le Beau is a formulator, packager and distributor of specialty 
teas sold through the health channel of distribution as well as in food 
stores, drug stores and mass market merchandisers. These channels of 
distribution are essentially the same as those used by the Company's Natrol 
branded products. Under the terms of the acquisition agreement, the Company 
acquired no accounts receivable, nor did it assume any liabilities of Laci Le 
Beau.  The acquisition is being accounted for using the purchase 

                                      40

<PAGE>

method, and, accordingly, the assets acquired are recorded at their estimated 
fair values.  The excess of the cost of the acquisition over the fair value 
of the assets purchased was approximately $5.0 million and is being amortized 
over 15 years. 

The Laci Le Beau tea business contributed $1.6 million in revenue for the
quarter and year ended December 31, 1998.

CAPITAL ADDITIONS

During 1997 the Company invested heavily in corporate infrastructure and the 
building out and equipping of a 90,000 square foot manufacturing and 
headquarters facility. The facility has improved manufacturing efficiency, 
and management believes the facility provides the flexibility to service 
customers more effectively and respond rapidly to increases in demand for 
particular products. 

The Company purchased the headquarters facility on December 24, 1998 for 
$5.25 million in cash. The Company is now in the process of financing 75% of 
the purchase price via a non-recourse fixed rate, fixed payment loan to be 
amortized over 15 years. The estimated rate for the loan is between 7.25% and 
7.75%.  The Company's depreciation expense will increase as a result of the 
purchase. Other capital additions in fiscal 1998 amounted to $861,000. 
     
RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

NET REVENUE. Net Revenue in 1998 increased 58.9% to $68.2 million from $42.9 
million in 1997.  Of the $25.3 million increase, $6.5 million was due to the 
sale of raw material ingredients, primarily nutraceutical grade garlic, 
attributable to the acquisition of Pure-Gar. Another $1.6 million in sales 
were generated through the sale of Laci Le Beau teas.  The remaining $17.2 
million represents a 40% increase in sales of Natrol branded products.  The 
increase was achieved through distribution gains at the retail level as well 
as additional sales from existing and new products.

Two product groupings represented 10% or more of sales in 1998; 
Ester-C-Registered Trademark- with approximately 14% of revenue and Melatonin 
with approximately 10% of revenue.

Sales to Walgreens equaled 15.9% of the Company's revenue. No other customer 
accounted for more than 10% of the Company's revenues in 1998.

                                      41

<PAGE>

GROSS PROFIT. Gross profit increased 56.8% to $36.2 million, or $13.1 
million, in 1998 versus $23.1 million in 1997. The gross margin decreased 
slightly to 53.1% in 1998 from 53.8% in 1997. The decrease was due primarily 
to shifts in product mix, including the addition of the Pure-Gar ingredient 
supply business and the Laci Le Beau tea business. 

SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased 
56.1%, or $6.4 million, to $17.8 million in 1998 from $11.4 million in 1997. 
As a percentage of net sales, selling and marketing expenses decreased to 
26.0% in 1998 from 26.6% in 1997. The decrease was due to sales growth being 
more rapid in percentage terms than the growth in corresponding payroll or 
consumer marketing expenses. 

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses 
increased 44.4%, or $2.0 million, to $6.5 million in 1998 from $4.5 million 
in 1997. As a percentage of net sales, general and administrative expenses 
decreased to 9.6% in 1998 from 10.4% in 1997. Of the absolute dollar 
increase, 30%, or $600,000, was due to the amortization of goodwill recorded 
as a result of the acquisition of Pure-Gar and Laci Le Beau.  The remainder 
was due to increased general and administrative expenses incurred because of 
the two acquisitions as well as additional personnel and overhead that were 
added to support the Company's growth during the year.

INTEREST INCOME (EXPENSE), NET.  Net interest income for 1998 was $197,000 
versus a net expense of $220,000 in 1997. Immediately after the Company's 
IPO, which was completed in July, 1998, the Company retired all of its debt 
and began investing its surplus cash in interest bearing investments. Total 
interest expense for 1998 amounted to $407,000. Interest earned amounted to 
$604,000.  A portion of the interest earned was taxable as income to the 
corporation and a portion was non-taxable. 

INCOME TAX PROVISION.  Provision for income taxes increased 64.2%, or $1.8 
million, to $4.6 million in 1998 from $2.8 million in 1997. The effective tax 
rate for 1998 was 38.0% compared to 40.2% for 1997. 

YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996

NET SALES.  Net sales increased 5.1%, or $2.1 million, to $42.9 million in 
1997 from $40.8 million in 1996. The increase was due to net sales of $8.9 
million attributable to products introduced in 1997 and a $3.0 million 
overall increase in net sales of existing products, which more than offset a 
$9.8 million decrease in net sales of two products, Melatonin and DHEA, whose 
sales peaked in 1996. The net increase in net sales of new and existing 
products (other 

                                      42

<PAGE>

than Melatonin and DHEA ) was primarily due to increased penetration and 
expanded presence in both the health food store and mass market distribution 
channels. 

GROSS PROFIT.  Gross profit increased 3.5%, or $771,000, to $23.1 million in 
1997 from $22.3 million in 1996. Gross margin decreased to 53.8% for 1997 
from 54.7% for 1996. The decrease was primarily due to a shift in product mix 
as a result of a decrease in sales in the Company's higher gross margin 
specialty dietary supplements category, principally Melatonin and DHEA. 

SELLING AND MARKETING EXPENSES.  Selling and marketing expenses increased 
30.5%, or $2.7 million, to $11.4 million in 1997 from $8.7 million in 1996. 
As a percentage of net sales, selling and marketing expenses increased to 
26.6% in 1997 from 21.4% in 1996. The increase was primarily due to increases 
in spending to support increased net sales, in particular increases in print, 
radio and television advertising, and other promotional expenses and payroll 
expenses. 

GENERAL AND ADMINISTRATIVE EXPENSES.  General and administrative expenses 
decreased 18.2%, or $981,000, to $4.5 million in 1997 from $5.4 million in 
1996. As a percentage of net sales, general and administrative expenses 
decreased to 10.4% in 1997 from 13.3% in 1996. This decrease was primarily 
attributable to increased payroll expenses as a result of significantly 
higher management performance-based incentive bonuses in 1996. 

INTEREST INCOME (EXPENSE), NET.  Interest expense increased $274,000 to 
$220,000 in 1997 from interest income of $54,000 in 1996. The increase  net 
was primarily due to increased borrowings to fund capital expenditures. 

INCOME TAX PROVISION.  Provision for income taxes increased 22.5%, or 
$518,000, to $2.8 million in 1997 from $2.3 million in 1996. The effective 
tax rate for 1997 was 40.2%, compared to 28.0% for 1996. The Company was 
taxed under Subchapter S of the Code for the period from July 1, 1996 through 
September 30, 1996, at which time the Company ceased to qualify as an S 
corporation. As a result, the Company paid no federal income taxes for the 
third calendar quarter of 1996. If the Company had been required to pay 
federal income taxes during such quarter, the provision for income taxes 
would have been $3.2 million and the effective tax rate would have been 
38.6%. The increase in the effective tax rate in 1997 from the pro forma tax 
rate in 1996 was primarily due to the differences in the various income tax 
rates in the states in which the Company did business.

                                      43

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

Prior to its IPO, the Company had financed its operations and capital 
requirements primarily through funds from operations and, to a lesser extent, 
borrowings. At December 31, 1998, the Company had working capital of $35.7 
million, as compared to $8.4 million in working capital at December 31, 1997. 
The increase was primarily due to net proceeds from the IPO, after paying 
down long-term debt and the redemption of preferred stock.

On July 27, 1998, the Company completed the IPO of 3,940,000 shares of Common 
Stock priced at $15.00 per share.  Of the total shares offered, 3,200,000 
shares were sold by the Company.  The Company sold an additional 295,500 
shares of Common Stock on August 6, 1998, pursuant to the underwriters' 
exercise of the overallotment option granted in the IPO.  The net proceeds to 
the Company from the IPO were $47.7 million, including the shares sold 
pursuant to the underwriters' exercise of the overallotment option.  Of the 
net proceeds to the Company, $8.4 million was used to repay in full long-term 
debt.  As more fully described in Natrol's prospectus dated July 22, 1998, 
all of the 27,000 shares of convertible participating preferred stock 
purchased by certain investors in September 1996 were converted into 
2,700,000 shares of Common Stock of the Company and shares of redeemable 
preferred stock, which were immediately redeemed for a total of $6.0 million. 
The redemption price of the redeemable preferred stock was funded from the 
proceeds of the IPO.

Net cash provided by operating activities was $4.5 million for the year ended 
December 31, 1998 versus cash provided of $2.1 million and $3.8 million in 
1997 and 1996, respectively. The increase in net cash provided by operating 
activities in 1998 compared to 1997 was primarily due to higher levels of 
depreciation and amortization, an increase in provisions to reserves for 
doubtful accounts and other reserves and an increase in accounts payable and 
other accruals which were partially offset by higher levels of inventory 
balances and accounts receivable. The increase in inventory balances, from 
$6.9 million to $13.4 million, was primarily due to the purchase of larger 
quantities of raw materials to obtain favorable volume discounts and the 
necessity to carry additional inventory to support the Company's broader 
product offerings with its introduction of several new products during the 
year. The increase in accounts receivable was the result of increased sales 
by the Company.  At December 31, 1998, the Company's average trade receivable 
aging was approximately 54 days versus 1997 when the average receivable aging 
was 46 days. The lengthening of the average accounts receivable aging is due 
in part to changes in the Company's customer mix, which includes ingredient 
supply customers and a high proportion of mass market business where, in each 

                                      44

<PAGE>

case, payment terms are typically longer than in the rest of the Company's 
business. 

The decrease in net cash provided by operating activities in 1997 compared to 
1996 was primarily due to a decrease in net income and reflects higher levels 
of accounts receivable and inventory balances, partially offset by higher 
levels of depreciation and amortization, provision for reserves for doubtful 
accounts and other reserves and accounts payable. The increase in inventory 
balances was primarily due to the purchase of larger quantities of raw 
materials to obtain favorable volume discounts and the purchase of raw 
materials for new products in anticipation of new product introductions 
scheduled for 1998. The increase in accounts receivable was the result of 
increased sales by the Company during such period to mass market retailers 
from whom accounts receivable are on average outstanding for a longer period 
of time.

Net cash used in investing activities was $43.8 million for the year ended 
1998 and $3.2 million and $1.9 in 1997 and 1996, respectively. Of the net 
cash used in investing activities in 1998, the Company used $11.1 million to 
consummate the Pure-Gar acquisition, $7.6 million to complete the Laci Le 
Beau acquisition, $5.3 million to purchase its corporate headquarters 
facility and invested $861,000 in plant and equipment. The remainder of cash 
used in investing activities, or $19.0 million net, was used to purchase 
marketable securities. Substantially all net cash used in investing 
activities in 1997 and 1996 constituted capital expenditures made in 
connection with the build-out of the Company's manufacturing 
facility/headquarters, which the Company began in 1996. 

Net cash provided by financing activities was $38.1 million for the year 
ended December 31, 1998 and $2.6 million and ($2.1 million) in 1997 and 1996, 
respectively. Net cash provided by financing activities in the year ended 
December 31, 1998 consisted of net proceeds of $47.7 million from the 
Company's IPO, which was completed on July 27, 1998, as well as $9.0 million 
of borrowings to finance the acquisition of Pure-Gar in late February 1998. 
This inflow of funds was offset by the repayment of $4.2 million of debt 
prior to the IPO as well as the repayment of all of the Company's outstanding 
debt of $8.4 million in July 1998 and the redemption of $6.0 million of 
redeemable preferred stock as described above. 

Net cash provided by financing activities in 1997 was comprised of net 
borrowings of $3.0 million to finance capital expenditures made in connection 
with the build-out and equipping of the Company's manufacturing facility, 
which was partially offset by $400,000 used to pay dividends to stockholders 
declared in 1996. 

                                      45

<PAGE>

Net cash used in financing activities in 1996 was comprised of net borrowings 
of $415,000 used for capital expenditures and proceeds of $854,000 from the 
sale by the Company of 1,921.9 shares of convertible participating preferred 
stock. These amounts were more than offset by $503,000 (net of $349,000 of 
compensation expense) used to redeem shares of Common Stock from a 
stockholder and $2.9 million used to pay dividends to stockholders. 

As of the end of 1998, the Company had no outstanding debt, nor did it have 
any credit facilities in place. The Company is currently negotiating with its 
prime bank, Wells Fargo, to refinance the acquisition of its headquarters 
building which was completed on December 24, 1998.  The Company expects to 
have this financing in place during the second quarter of 1999.

The Company's cash and marketable securities balances combined at the close 
of 1998 was approximately $19.6 million. The Company believes that this 
amount, together with cash generated from operations and the cash it will 
receive from financing its headquarters facility, will be sufficient to fund 
its anticipated working capital needs and capital expenditures (other than 
financing necessary to complete future acquisitions, if any) for at least the 
next 12 months. Future acquisitions, if any, could be funded with cash from 
operations as well as future borrowings. Future borrowings may include 
covenants restricting the Company's ability to issue dividends or to make 
additional acquisitions. There can be no assurance that attractive 
acquisition opportunities will be available to the Company or will be 
available at prices and upon such other terms that are attractive to the 
Company. The Company regularly evaluates the potential acquisition of other 
businesses, products and product lines and may hold discussions regarding 
such potential acquisitions. As a general rule, the Company will publicly 
announce such acquisitions only after a definitive agreement has been signed. 
The Company currently has no commitments or agreements with respect to any 
acquisition. In addition, in order to meet its long-term liquidity needs or 
consummate future acquisitions, the Company may be required to incur 
additional indebtedness or issue additional equity and debt securities, 
subject to market and other conditions. There can be no assurance that such 
additional financing will be available on terms acceptable to the Company or 
at all. The failure to raise the funds necessary to finance its future cash 
requirements or consummate future acquisitions could adversely affect the 
Company's ability to pursue its strategy and could negatively affect its 
operations in future periods. 

IMPACT OF INFLATION

Generally, inflation has not had a material impact on the Company's 
historical operations or profitability. 

                                      46

<PAGE>

YEAR 2000 READINESS DISCLOSURE

The statements in the following section include "Year 2000 readiness 
disclosure" within the meaning of the Year 2000 Information and Readiness 
Disclosure Act.
     
Many existing computer programs and databases use two digits to identify a 
year in the date field (i.e., 98 would represent 1998).  These programs and 
databases were designed and developed without considering the impact of the 
upcoming millennium.  If not corrected, many computer systems could fail or 
create erroneous results relating to the year 2000. If the Company, its 
significant customers, or suppliers fail to make necessary modifications and 
conversions on a timely basis, the year 2000 issue could have a material 
adverse effect on Company operations.  However, the impact cannot be 
quantified at this time. The Company believes that its competitors face a 
similar risk.
      
The Company has developed plans to address the possible exposures related to 
the impact on its computer systems of the year 2000 issue.  Key financial, 
information and operational systems, including equipment with embedded 
microprocessors, have been or are currently being inventoried and assessed, 
and detailed plans have been or are currently being developed for the 
required systems modifications or replacements.  Progress against these plans 
is monitored and reported to management on a regular basis. Implementation of 
required changes to critical systems is expected to be completed during the 
first half of 1999.  The Company is also focusing on major customers and 
suppliers to assess their compliance. The Company has received assurances 
from customers that such customers expect to be Year 2000 compliant and is 
seeking such assurances from its other material customers and suppliers.  
Nevertheless, there can be no assurance that there will not be a material 
adverse effect on the Company if third party, governmental or business 
entities do not convert or replace their systems in a timely manner and in a 
way that is compatible with the Company's systems.  In the event a material 
customer or supplier is not Year 2000 compliant, the Company's business, 
financial condition and results of operations could be materially and 
adversely affected.
      
The costs incurred to date related to these programs have not been material 
and the Company does not expect its future costs related to these programs to 
be material.  Such costs have been and will continue to be funded through 
operating cash flows. The Company presently believes that the total cost of 
achieving year 2000 compliant systems is not expected to be material to its 
financial condition, liquidity, or results of operations.
     
Time and cost estimates are based on currently available information. 
Developments that could affect estimates 

                                      47
<PAGE>

include, but are not limited to, the availability and cost of trained 
personnel; the ability to locate and correct all relevant computer code and 
systems; and remediation success of the Company's customers and suppliers.
     
The preceding "Year 2000 Readiness Disclosure" contains various 
forward-looking statements within the meaning of Section 21E of the 
Securities Exchange Act of 1934 and the Section 27A of the Securities Act of 
1933. These forward-looking statements represent the Company's beliefs or 
expectations regarding future events. When used in the "Year 2000 Readiness 
Disclosure", the words "believes," "expects," "estimates" and similar 
expressions are intended to identify forward-looking statements. 
Forward-looking statements include, without limitation, the Company's 
expectations as to when it will complete the modification and testing phases 
of its Year 2000 project plan as well as its Year 2000 contingency plans; its 
estimated cost of achieving Year 2000 readiness; and the Company's belief 
that its internal systems will be Year 2000 compliant in a timely manner. All 
forward-looking statements involve a number of risks and uncertainties that 
could cause the actual results to differ materially from the projected 
results. Factors that may cause these differences include, but are not 
limited to, the availability of qualified personnel and other information 
technology resources; the ability to identify and remediate all date 
sensitive lines of computer code or to replace embedded computer chips in 
affected systems or equipment; and the actions of governmental agencies or 
other third parties with respect to Year 2000 problems.

RISK FACTORS

The Company's ability to predict results or the effect of certain events on 
the Company's operating results is inherently uncertain.  Therefore, the 
Company wishes to caution each reader of this report to carefully consider 
the following factors and certain other factors discussed herein and in other 
past reports including but not limited to the Company's Prospectus dated July 
22, 1998 and filed with the Securities and Exchange Commission.

Factors that could cause or contribute to the Company's actual results 
differing materially from those discussed herein or for the Company's stock 
price to be affected adversely include but are not limited to, - (i) industry 
trends, including a potential general downturn or slowing of the growth of 
the dietary supplement industry, (ii) increased competition from current 
competitors and new market entrants, (iii) adverse publicity regarding the 
dietary supplement industry or the Company's products, (iv) the Company's 
dependence upon its ability to develop new

                                      48
<PAGE>

products, (v) government regulation, (vi) exposure to product liability 
claims,(vii) dependence on significant customers, (viii) the Company's 
ability to keep and attract key management employees, (ix) the Company's 
inability to manage growth and execute its business plan, (x) the Company's 
ability to consummate future acquisitions and its ability to integrate 
acquired businesses and to retain key personnel associated with any 
acquisition, (xi) the absence of clinical trials for many of the Company's 
products, (xii) the Company's inability to obtain raw materials that are in 
short supply, (xiii) sales and earnings volatility, (xiv) the Company's 
ability to manufacture its products efficiently, (xv) the Company's reliance 
on independent brokers to sell its products, (xvi) the inability of the 
Company to protect its intellectual property, (xvii) control by principal 
shareholders, (xviii) the possible sale of large amounts of stock by 
controlling shareholders, (xiv) volatility in the stock markets, (xx) a 
failure of the Company to properly address the year 2000 issue, and (xxi) a 
general downturn in the national economy as a whole.  These and other such 
factors are discussed in more under the caption "Risk Factors" and elsewhere 
in this report.

ITEM 7A:  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The following discussion about the Company's market risk disclosures involves 
forward-looking statements.  Actual results could differ materially from 
those projected in the forward-looking statements.  The Company is exposed to 
market risk related to changes in interest rates.

The Company maintains a portfolio of highly liquid cash equivalents and 
marketable securities.  Marketable securities consist primarily of 
certificates of deposits, commercial paper and corporate and municipal bonds. 
Given the short-term nature and liquidity of these investments, and that the 
Company has no borrowings outstanding, the Company is not subject to 
significant interest rate risk.

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Report of Independent Accountants and the Consolidated Financial 
Statements and notes thereto are presented under Item 14 of this Report.

ITEM 9:   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
          FINANCIAL DISCLOSURE

Not Applicable

                                      49
<PAGE>

PART III

Information required under Part III (Items 10, 11, 12, and 13) is 
incorporated herein by reference to the Company's definitive proxy statement 
to be filed with the Securities and Exchange Commission within 120 days after 
the year covered by this Form 10-K with respect to its Annual Meeting of 
Stockholders to beheld on June 2, 1999.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 (a)(1)       INDEX TO CONSOLIDATED FINANCIAL STATEMENTS:             PAGE(S)
              Report of Independent Auditors                            55
              Consolidated Balance Sheets as of December 31, 1998   
                   and 1997                                             56

              Consolidated Statements of Income for the years       
                   ended December 31, 1998, 1997 and 1996               57
              Consolidated Statements of Stockholders' Equity       
                   (Deficit) for the years ended December 31,       
                   1998, 1997 and 1996                                  58

              Consolidated Statements of Cash Flows for the years   
                   ended December 31, 1998, 1997 and 1996               59
              Notes to Consolidated Financial Statements                60


 (a)(2)       Index to Consolidated Financial Statement Schedules:


              All schedules for which provision is made in the applicable
              accounting regulations of the Securities and Exchange Commission
              are not required under the related instructions or are not
              material, and therefore have been omitted.

 (a)(3) INDEX TO EXHIBITS:

        (2)   Plan of Acquisition, Reorganization, Arrangement, Liquidation or
              Succession:

                     2.1    Asset Purchase Agreement by and among Natrol 
                            Acquisition Corp., the Company, Laci Le Beau 
                            Corporation, Shay Lee Corporation, and the 
                            Nutrition Products Trust of 1995 dated as of 
                            September 18, 1998 (incorporated herein by reference
                            to Item 7(c) of the Company's Current Report on 
                            Form 8-K report filed October 9, 1998)

        (3)   Articles of Incorporation and By-Laws:

                     3.1    The Third Amended and Restated 

                                      50
<PAGE>

                            Certificate of Incorporation of the Company is 
                            filed herewith as exhibit 3.1

                     3.2    The Amended and Restated By-Laws of
                            the Company (incorporated herein by
                            reference to Exhibit 3.6 to the
                            Company's Registration Statement on
                            Form S-1, as amended, File No. 333-52109).

        (4)   Instruments Defining the Rights of Security Holders,
              Including Indentures:

                     4.1    Specimen Stock Certificate for shares of Common
                            Stock, $.01 par value, of the Company (incorporated
                            herein by reference to Exhibit 4.1 to the Company's
                            Registration Statement on Form S-1, as amended, File
                            No. 333-52109).

        (10)  Material Contracts

                     10.1   Natrol, Inc. Amended and Restated 1996 Stock
                            Option Plan (incorporated herein by reference
                            to Exhibit 10.2 to the Company's Registration
                            Statement on Form S-1, as amended, File No.
                            333-52109);

                     10.2   Natrol, Inc. 1998 Employee Stock Purchase
                            Plan (incorporated herein by reference to
                            Exhibit 10.3 to the Company's Registration
                            Statement on Form S-1, as amended, File No.
                            333-52109);
              
                     10.3   Form of Indemnification Agreement between
                            Natrol, Inc. and each of its directors
                            (incorporated herein by reference to Exhibit
                            10.4 to the Company's Registration Statement
                            on Form S-1, as amended, File No. 333-52109);
              
                     10.4   Restricted Stock Agreement, dated November
                            14, 1996, by and between Natrol, Inc. and
                            Dennis R. Jolicoeur (incorporated herein by
                            reference to Exhibit 10.5 to the Company's
                            Registration Statement on Form S-1, as
                            amended, File No. 333-52109);
              
                     10.5   Promissory Note of Dennis R. Jolicoeur, 

                                      51
<PAGE>

                            dated November 14, 1996 (incorporated herein by
                            reference to Exhibit 10.6 to the Company's
                            Registration Statement on Form S-1, as
                            amended, File No. 333-52109);
              
                     10.6   Pledge Agreement, dated November 14, 1996, by
                            and between Natrol, Inc. and Dennis R.
                            Jolicoeur (incorporated herein by reference
                            to Exhibit 10.7 to the Company's Registration
                            Statement on Form S-1, as amended, File No.
                            333-52109);
              
                     10.7   Form of Stock Option Agreement (incorporated
                            herein by reference to Exhibit 10.9 to the
                            Company's Registration Statement on Form S-1,
                            as amended, File No. 333-52109);
              
                     10.8   Supply Agreement, dated as of February 8,
                            1998, by and between the Company and Basic
                            Vegetable Products, L.P. (incorporated herein
                            by reference to Exhibit 10.10 to the
                            Company's Registration Statement on Form S-1,
                            as amended, File No. 333-52109);
              
                     10.9   Distributorship/Packager/Supply Agreement,
                            dated as of January 1, 1995, by and between
                            the Company and Inter-Cal Corporation
                            (incorporated herein by reference to Exhibit
                            10.11 to the Company's Registration Statement
                            on Form S-1, as amended, File No. 333-52109);
              
                     10.10  Letter Agreement dated July 18, 1997 between
                            the Company and Jon J. Denis (incorporated
                            herein by reference to Exhibit 10.12 to the
                            Company's Registration Statement on Form S-1,
                            as amended, File No. 333-52109);
              
                     10.11  Description of Salary and Incentive Bonus
                            Arrangements for Dennis R. Jolicoeur, Cheryl R.
                            Richitt and Gary P. DeMello (incorporated herein by
                            reference to Exhibit 10.13 to the Company's
                            Registration Statement on Form S-1, as amended, File
                            No. 333-52109);
              
                     10.12  Purchase and Sale Agreement between WHLW Real
                            Estate Limited Partnership, 

                                      52
<PAGE>


                            Natrol Real Estate, Inc. and Natrol, Inc. is filed
                            herewith as Exhibit 10.12. 

              
        (21)         Subsidiaries of Natrol, Inc.: A list of Subsidiaries of the
                     Company is filed herewith as Exhibit 21.1.

        (23)         Consent of Experts and Counsel: Consent of Ernst & Young
                     LLP is filed herewith as Exhibit 23.1.

        (27)         Financial Data Schedule: The Financial Data Schedule is
                     filed herewith as Exhibit 27.1.

        (b)          REPORTS ON FORM 8-K:

                     The registrant filed the following Current Reports
                     on Form 8-K during the three month period ended
                     December 31, 1998:

                     1.     On October 9, 1998, the Company filed a
                            Current Report on Form 8-K announcing that on
                            September 30, 1998, the Company, through its
                            wholly-owned subsidiary Natrol Acquisition
                            Corp., acquired substantially all of the
                            assets and properties of Laci Le Beau
                            Corporation, Shay Lee Corporation and the
                            Nutrition Products Trust of 1995 pursuant to
                            an Asset Purchase Agreement dated as of
                            September 18, 1998. 
                                   
                     2.     On December 14, 1998, the Company filed an
                            amendment to a Current Report on Form 8-K/A
                            filing the Combined Financial Statements of
                            Laci Le Beau Corporation and Related Entities
                            as of September 30, 1998 and for the nine
                            months then ended as Exhibit 99.1 and the
                            Unaudited Pro Forma Consolidated Financial
                            statements of Natrol, Inc. as of and for the
                            nine months ended September 30, 1998 and
                            Consolidated Statement of Income for the year
                            ended December 31, 1997 as Exhibit 99.2.

                                      53
<PAGE>

                                          
                                          
                                     SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, this __ day of March,
1999.

                                       Natrol, Inc.

                                       By: /s/ ELLIOTT BALBERT
                                          -----------------------------
                                          Elliott Balbert
                                          President and Chief         
                                          Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this 
report has been signed below by the following persons on behalf of the 
Registrant and in the capacities indicated and on the dates indicated.

SIGNATURES                         TITLE                           DATE SIGNED
----------                         -----                           -----------

/s/ Elliott Balbert
------------------------   Chairman of the Board,                 March 30, 1998
Elliott Balbert            Chief Executive Officer, 
                           President and Director
                           (Principal Executive Officer)
/s/ Dennis R. Jolicoeur
------------------------   Chief Financial Officer,               March 30, 1998
Dennis R. Jolicoeur        Executive Vice President    
                           and Director (Principal
                           Financial Officer and 
                           Principal Accounting
                           Officer)
/s/ Norman Kahn 
------------------------   Director                               March 30, 1998
Norman Kahn               
                          
/s/ David Laufer                                        
------------------------   Director                               March 30, 1998
David Laufer              
                          
/s/ P. Andrews McLane                          
------------------------   Director                               March 30, 1998
P. Andrews McLane


                                      54

<PAGE>

                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors
Natrol, Inc.

We have audited the accompanying consolidated balance sheets of Natrol, Inc. 
and subsidiaries as of December 31, 1998 and 1997, and the related 
consolidated statements of income, stockholders' equity (deficit) and cash 
flows for each of the years in the three year period ended December 31, 1998. 
These 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 generally accepted auditing 
standards. 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 financial statements referred to above present fairly, in 
all material respects, the consolidated financial position of Natrol, Inc. 
and subsidiaries at December 31, 1998 and 1997 and the consolidated results 
of its operations and its cash flows for each of the years in the three year 
period ended December 31, 1998, in conformity with generally accepted 
accounting principles.

Woodland Hills, California
February 16, 1999

                                       55
<PAGE>


                                 Natrol, Inc.

                         Consolidated Balance Sheets


<TABLE>
<CAPTION>

                                                                     DECEMBER 31
                                                                 1998          1997
                                                             -------------------------
<S>                                                          <C>            <C>
ASSETS                                                                 
Current assets:                                                        
  Cash and cash equivalents                                     $559,424    $1,800,202
  Marketable securities                                       19,010,826             -
  Accounts receivable, net of allowances of $332,000                     
   and $262,000 at December 31, 1998 and 1997,           
   respectively                                                9,987,002     5,396,625
  Inventories                                                 13,437,455     6,934,181
  Deferred taxes                                               1,214,076       553,890
  Prepaid expenses and other current assets                      499,366       340,649
                                                             -------------------------
Total current assets                                          44,708,149    15,025,547
Property and equipment:                                                
  Building and improvements                                    6,881,707     1,875,625
  Machinery and equipment                                      3,826,351     2,804,346
  Furniture and office equipment                               1,238,749       871,048
                                                             -------------------------
                                                              11,946,807     5,551,019
  Accumulated depreciation and amortization                   (1,756,182)     (922,839)
                                                             -------------------------
                                                              10,190,625     4,628,180
                                                         
Goodwill, net of accumulated amortization of $588,168         13,774,701             -
Other assets                                                      34,365        62,373
                                                             -------------------------
Total assets                                                 $68,707,840   $19,716,100
                                                             -------------------------
                                                             -------------------------
                                                         
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)           
Current liabilities:                                     
  Accounts payable                                            $5,943,224    $3,867,846
  Accrued expenses                                             2,066,935       899,311
  Accrued payroll and related liabilities                        804,623       413,687
  Income taxes payable                                           220,135       422,083
  Current portion of long-term debt                                    -       998,611
                                                             -------------------------
Total current liabilities                                      9,034,917     6,601,538
Deferred income taxes, noncurrent                                 32,013        72,774
Long-term debt, less current portion                                   -     2,606,250
Convertible participating preferred stock, $0.01 par                   
 value per share, none and 27,000 shares authorized,                    
 issued and outstanding as of December 31, 1998 and                    -    12,000,000
 1997, respectively 
Commitments  
Stockholders' equity (deficit):
  Preferred stock, par value of $0.01 per share:
    Authorized shares - 2,000,000
    Issued and outstanding shares - none                               -             -
  Common Stock, par value of $0.01 per share:
    Authorized shares - 50,000,000
    Issued and outstanding shares - 13,301,990 and 
      7,100,000 at December 31, 1998 and 1997, 
      respectively                                               133,020        71,000
  Additional paid-in capital                                  60,187,301       559,500
  Retained earnings (deficit)                                   (116,911)   (1,632,462)
                                                             -------------------------
                                                              60,203,410    (1,001,962)
  Receivable from stockholder                                   (562,500)     (562,500)
                                                             -------------------------
Total stockholders' equity (deficit)                          59,640,910    (1,564,462)
                                                             -------------------------
Total liabilities and stockholders' equity (deficit)         $68,707,840   $19,716,100
                                                             -------------------------
                                                             -------------------------
</TABLE>

SEE ACCOMPANYING NOTES.

                                       56

<PAGE>

                                 Natrol, Inc.

                      Consolidated Statements of Income


<TABLE>
<CAPTION>

                                                YEAR ENDED DECEMBER 31
       
                                           1998          1997          1996
                                        ----------------------------------------
<S>                                     <C>           <C>           <C>
Net sales                               $ 68,206,585  $ 42,874,759  $ 40,802,352
Cost of goods sold                        32,011,641    19,799,712    18,497,818
                                        ----------------------------------------
Gross profit                              36,194,944    23,075,047    22,304,534


Selling and marketing expenses            17,757,395    11,398,390     8,735,815
General and administrative expenses        6,513,094     4,450,244     5,431,368
                                        ----------------------------------------
Total operating expenses                  24,270,489    15,848,634    14,167,183
                                        ----------------------------------------
Operating income                          11,924,455     7,226,413     8,137,351


Interest income                              604,871        20,695       109,102
Interest expense                           (407,452)     (240,250)      (55,472)
                                        ----------------------------------------
Income before income tax provision        12,121,874     7,006,858     8,190,981
Income tax provision                       4,606,323     2,816,158     2,298,593
                                        ----------------------------------------
Net income                               $ 7,515,551   $ 4,190,700   $ 5,892,388
                                        ----------------------------------------
                                        ----------------------------------------

Pro forma net income data (NOTE 5):                               
       Income before provision for      
              income taxes              $ 12,121,874   $ 7,006,858   $ 8,190,981
       Pro forma income tax provision                             
              (actual for the years        
              ended 1998 and 1997)         4,606,323     2,816,158     3,159,793
                                        ----------------------------------------
       Pro forma net income              $ 7,515,551   $ 4,190,700   $ 5,031,188
                                        ----------------------------------------
                                        ----------------------------------------

Basic earnings per share                       $0.76         $0.59         $0.94
                                        ----------------------------------------
                                        ----------------------------------------

Diluted earnings per share                     $0.63         $0.41         $0.83
                                        ----------------------------------------
                                        ----------------------------------------

Weighted average shares outstanding        
       basic                               9,854,411     7,100,000     6,275,000
                                        ----------------------------------------
                                        ----------------------------------------

Weighted average shares outstanding       
       diluted                            11,890,513    10,272,859     7,065,385
                                        ----------------------------------------
                                        ----------------------------------------

</TABLE>


SEE ACCOMPANYING NOTES.

                                      57
<PAGE>


                                  Natrol, Inc.

            Consolidated Statements of Stockholders' Equity (Deficit)

<TABLE>
<CAPTION>
                                             REDEEMABLE PREFERRED     ORIGINALLY ISSUED
                                                    STOCK                COMMON STOCK            COMMON STOCK       ADDITIONAL
                                            ----------------------  ----------------------  ----------------------    PAID-IN
                                              SHARES      AMOUNT     SHARES      AMOUNT      SHARES      AMOUNT       CAPITAL
                                            -----------  ---------  ---------  -----------  ---------  -----------  -----------
<S>                                         <C>          <C>        <C>        <C>          <C>        <C>          <C>
Balance at January 1, 1996                          --   $      --  6,000,000   $  10,000          --   $      --    $  50,000
Dividends, $0.55 per share                          --          --         --          --          --          --           --
Exchanged shares in exchange for new
   shares                                           --          -- (6,000,000)    (10,000)  7,027,780      70,278      (50,000)
Repurchase from stockholder                         --          --         --          --    (227,780)     (2,278)          --
Restricted stock issued                             --          --         --          --     300,000       3,000      559,500
Adjustment for redemption value of
   convertible participating preferred
   stock                                            --          --         --          --          --          --           --
Net income                                          --          --         --          --          --          --           --
                                            -----------  ---------  ---------  ----------   ---------- -----------  ----------
Balance at December 31, 1996                        --          --         --          --   7,100,000      71,000      559,500
Net income                                          --          --         --          --          --          --           --
                                            -----------  ---------  ---------  ----------   ---------- -----------  ----------
Balance at December 31, 1997                        --          --         --          --   7,100,000      71,000      559,500
Issuance of Common Stock at $15 per share
   (net of approximately $4,720,000 of
   offering costs)                                  --          --         --          --   3,495,500      34,955   47,605,218
Conversion of convertible participating
   preferred stock to Common Stock                  --          --         --          --   2,700,000      27,000   11,973,000
Conversion of convertible participating
   stock to redeemable preferred stock          13,500   6,000,000         --          --          --          --           --
Redemption of redeemable preferred stock       (13,500) (6,000,000)        --          --          --          --           --
Issuance of Common Stock under employee
   stock purchase plan                              --          --         --          --       6,490          65       49,583
Net income                                          --          --         --          --          --          --           --
                                            -----------  ---------  ---------  ----------   ---------- -----------  ----------
Balance at December 31, 1998                        --   $      --         --   $      --   13,301,990   $ 133,020  60,187,301
                                            -----------  ---------  ---------  ----------   ---------- -----------  ----------
                                            -----------  ---------  ---------  ----------   ---------- -----------  ----------

<CAPTION>

                                            RETAINED     RECIVABLE
                                            EARNINGS       FROM
                                            (DEFICIT)   STOCKHOLDER     TOTAL
                                            ---------  -------------  ---------
<S>                                         <C>        <C>            <C>
Balance at January 1, 1996                  $3,243,45    $      --   $3,303,450
Dividends, $0.55 per share                 (3,300,000)          --   (3,300,000)
Exchanged shares in exchange for new
   shares                                     (13,250)          --       (2,972)
Repurchase from stockholder                  (502,900)          --     (505,178
Restricted stock issued                            --     (562,500)          --
Adjustment for redemption value of
   convertible participating preferred
   stock                                  (11,142,850)          --  (11,142,850)
Net income                                  5,892,388           --    5,892,388
                                            ---------    ---------  -----------
Balance at December 31, 1996               (5,823,162)    (562,500)  (5,755,162)
Net income                                  4,190,700           --    4,190,700
                                            ---------    ---------  -----------
Balance at December 31, 1997               (1,632,462)    (562,500)  (1,564,462)
Issuance of Common Stock at $15 per share
   (net of approximately $4,720,000 of
   offering costs)                                 --           --   47,640,173
Conversion of convertible participating
   preferred stock to Common Stock                 --           --   12,000,000
Conversion of convertible participating
   stock to redeemable preferred stock     (6,000,000)          --           --
Redemption of redeemable preferred stock           --           --   (6,000,000)
Issuance of Common Stock under employee
   stock purchase plan                             --           --       49,648
Net income                                  7,515,551           --    7,515,551
                                            ---------    ---------  -----------
Balance at December 31, 1998                $(116,911)   $(562,500) $59,640,910
                                            ---------    ---------  -----------
                                            ---------    ---------  -----------
</TABLE>

SEE ACCOMPANYING NOTES.

                                      58

<PAGE>


                                     Natrol, Inc.

                        Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>

                                                  YEAR ENDED DECEMBER 31
                                             1998         1997          1996
                                         ----------------------------------------
<S>                                      <C>          <C>           <C>
OPERATING ACTIVITIES                                               
       
Net income                               $  7,515,551 $  4,190,700  $  5,892,388
Adjustments to reconcile net income to                             
 net cash provided by operating 
 activities:
   Depreciation and amortization              837,014      690,335       364,158
   Amortization of goodwill                   588,168            -             -
   Provision for bad debts                     69,230    1,002,683       314,820
   Deferred taxes                            (700,947)     138,163      (397,461)
   Changes in operating assets and                                 
     liabilities:
     Accounts receivable                   (3,387,913)  (1,440,220)      (88,178)
     Inventories                           (3,335,621)  (3,059,881)   (1,770,548)
     Income taxes receivable/payable         (201,948)     600,944    (1,031,246)
     Prepaid expenses and other current     
      assets                                 (158,717)    (140,126)      (52,632)
     Other assets                              24,337        9,570       (40,757)
     Accounts payable                       1,686,466      878,849       549,052
     Accrued expenses                       1,167,624     (899,368)       (3,475)
Accrued payroll and related liabilities       390,936      167,183        35,201
                                           ----------   ----------    ----------
Net cash provided by operating              4,494,180    2,138,832     3,771,322
  activities

INVESTING ACTIVITIES                                               
Assets purchased, net of liabilities                               
assumed in connection with acquisitions   (18,697,869)           -             -
Purchases of marketable securities        (99,153,298)           -             -
Sales of marketable securities             80,142,472            -             -
Purchases of property and equipment        (6,111,223)  (3,219,650)   (1,865,099)
                                           ----------   ----------    ----------
Net cash used in investing activities     (43,819,918)  (3,219,650)   (1,865,099)
       
                                                                   
FINANCING ACTIVITIES                                               
Proceeds from long-term debt                9,000,000    4,000,000       750,000
Repayments on long-term debt              (12,604,861)  (1,004,167)     (207,639)
Proceeds from issuance of Common Stock,                            
  net of issuance costs                    47,689,821            -             -
Redemption of redeemable preferred stock   (6,000,000)           -             -
Repayments on line of credit, net                   -            -      (127,778)
       
Convertible participating preferred                 -            -       
  stock sold                                                             854,178
       
Repurchase of Common Stock                          -            -      (505,178)
Dividends paid to stockholders                      -     (400,000)   (2,900,000)
                                           ----------   ----------    ----------
Net cash provided by (used in) financing   
  activities                               38,084,960    2,595,833    (2,136,417)
                                           ----------   ----------    ----------
Net increase (decrease) in cash and cash 
  equivalents                              (1,240,778)   1,515,015      (230,194)
Cash and cash equivalents, beginning of     
  year                                      1,800,202      285,187       515,381
                                           ----------   ----------    ----------
Cash and cash equivalents, end of year    $   559,424  $ 1,800,202    $  285,187
                                           ----------   ----------    ----------
                                           ----------   ----------    ----------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW                              
  INFORMATION:
  Cash paid during the year for:                                   
  Interest                               $    407,452  $   240,250  $     55,472
   Income taxes                          $  5,509,261  $ 2,215,000  $  3,770,000

</TABLE>

SUPPLEMENTAL NONCASH TRANSACTION:

During the year ended December 31, 1996, the Company adjusted retained earnings
(deficit) for $11,142,850, which increases the convertible participating
preferred stock to its redemption value.

In July 1998, upon completion of the Company's initial public offering, all of
the convertible participating preferred stock converted into 2,700,000 shares of
Common Stock and 13,500 shares of redeemable preferred stock.


SEE ACCOMPANYING NOTES.


                                      59
<PAGE>
                                       
                                  Natrol, Inc.

                   Notes to Consolidated Financial Statements
                                          
                                December 31, 1998



1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF THE BUSINESS

Natrol, Inc. (collectively with its subsidiaries, referred to as the Company) 
manufactures and markets branded, high-quality dietary supplement products, 
including vitamins, minerals, hormonal supplements, herbal products and 
specialty combination formulations. The Company primarily sells its products 
under the Natrol brand name through multiple distribution channels throughout 
the United States, including domestic health food stores and mass market 
drug, retail and grocery store chains. 

On July 1, 1996, the Company elected to be treated as an S Corporation for 
federal income and California franchise tax purposes under Subchapter S of 
the Internal Revenue Code and the corresponding provisions of the California 
statute. Accordingly, the stockholders reported their equity in the earnings 
or losses of the Company on their individual tax returns. In connection with 
this election, the Company changed its year end from June 30 to a calendar 
year end. 

On September 30, 1996, the Company filed an amendment to its charter whereby 
all outstanding shares of Common Stock were split-up and converted to shares 
of Common Stock and 25,078.1 shares of convertible participating preferred 
stock. The original stockholders subsequently sold all of their convertible 
participating preferred stock to unrelated third parties (the new 
stockholders). The Company also sold an additional 1,921.9 shares of the 
convertible participating preferred stock to the new stockholders. Upon 
completion of the transactions, the new stockholders held 27,000 shares of 
convertible participating preferred stock which were convertible into 
approximately 27% of the then outstanding shares of Common Stock and 13,500 
shares of redeemable preferred stock. 

Upon the creation and issuance of the convertible participating preferred 
stock on September 30, 1996, the Company was required to change its status 
for income tax purposes back to a C Corporation. 

PRESENTATION

For purposes of comparability to the year ended December 31, 1998 and 1997, 
the consolidated financial information for 1996 has been restated to include 
the twelve month period ended December 31, 1996. This twelve month period is 
referred to in the consolidated financial statements and the following notes 


                                      60


<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

to the consolidated financial statements as the year ended December 31, 1996. 

On January 15, 1998, the Company reincorporated itself in the State of 
Delaware. Effective with the reincorporation, a ten-for-one reverse stock 
split occurred affecting all classes of stock then outstanding.  The 
Company's Board of Directors approved a one hundred-for-one stock split of 
the Company's Common Stock which became effective on June 19, 1998. All 
references in the accompanying consolidated financial statements to the 
number of shares of Common Stock and per common share amounts have been 
retroactively adjusted to reflect the stock splits. In addition, the 
Company's capital structure was changed effective June 19, 1998 to reflect 
50,000,000 shares of Common Stock and was further changed to authorize an 
additional 2,000,000 shares of preferred stock. The Board of Directors has 
authority to fix the rights, preferences, privileges and restrictions, 
including voting rights, of these shares of preferred stock without any 
future vote or action by the shareholders. 

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts and operations of
Natrol, Inc. and its wholly owned subsidiaries. All significant intercompany
accounts have been eliminated in consolidation. 

ESTIMATES AND ASSUMPTIONS

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates, although management does not believe that any differences would
materially affect the Company's consolidated financial position or results of
operations. 


                                      61


<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CASH EQUIVALENTS

The Company considers all highly liquid instruments with a maturity of three
months or less when purchased to be cash equivalents. 

MARKETABLE SECURITIES

Marketable securities consist of certificates of deposits, commercial paper 
and corporate and municipal bonds in the amounts of $4,086,958, $2,458,846 
and $12,465,022, respectively.

In accordance with Statement on Financial Accounting Standards (SFAS) No. 
115, "Accounting for Certain Investments in Debt and Equity Securities," the 
Company determines the appropriate classification of debt and equity 
securities at the time of purchase and re-evaluates such designation as of 
each balance sheet date.  All marketable securities were classified as 
"available-for-sale" securities at December 31, 1998. Available-for-sale 
securities are carried at fair value with unrealized gains and losses 
reported as other comprehensive income.  Net unrealized gains and losses were 
not material to the consolidated financial statements as of December 31, 
1998, and therefore no amounts are recorded in other comprehensive income.  
Realized gains and losses on investment transactions are recognized when 
realized based on settlement dates and recorded as interest income.  Interest 
and dividends on securities are recognized when earned.

INVENTORIES

Inventories are carried at the lower of cost (first-in, first-out method) or 
market. 

PROPERTY AND EQUIPMENT

Property and equipment are stated on the basis of cost. Depreciation is 
computed using the straight-line method over the estimated useful lives of 
the assets ranging from five to ten years for furniture, machinery and 
equipment. Buildings and improvements are depreciated using straight-line 
methods over five to forty years. Amortization of leasehold improvements is 
computed using the straight-line method over the shorter of the estimated 
lives of the assets or the lease terms. 


                                      62

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

TRADEMARKS AND PATENTS

Costs of obtaining trademarks and patents are capitalized and amortized using
the straight-line method over the estimated useful life of eleven years.
Trademarks and patents are included in other assets at $40,499 at December 31,
1998 and 1997, respectively, net of accumulated amortization of $25,295 and
$21,624 at December 31, 1998 and 1997, respectively. The costs of servicing the
Company's patents and trademarks are expensed as incurred.

LONG-LIVED ASSETS

The Company reviews for the impairment of long-lived assets and certain 
identifiable intangibles whenever events or changes in circumstances indicate 
that the carrying amount of any asset may not be recoverable. An impairment 
loss would be recognized when the estimated undiscounted future cash flows 
expected to result from the use of the asset and its eventual disposition is 
less than the carrying amount. If an impairment is indicated, the amount of 
the loss to be recorded is based upon an estimate of the difference between 
the carrying amount and the fair value of the asset. Fair value is based upon 
discounted estimated cash flows expected to result from the use of the asset 
and its eventual disposition and other valuation methods. No such impairment 
losses have been identified by the Company. 

INCOME TAXES

The Company accounts for income taxes under the liability method. Under this 
method, deferred tax assets and liabilities are determined based on 
differences between enacted rates and laws that will be in effect when the 
differences are expected to reverse. Deferred taxes arising from temporary 
differences that are not related to an asset or liability are classified as 
current or noncurrent depending on the periods in which the temporary 
differences are expected to reverse. 

REVENUE RECOGNITION

The Company sells its products to retail outlets through a direct sales force 
and a national broker network. Sales are recorded when products are shipped 
to customers by the Company. Net sales represent products shipped, less 
estimated returns and allowances for which provisions are made at the time of 
sale. Generally the returns and allowances are limited to damaged goods and 
the estimates recorded are based upon known claims and an estimate of 
additional returns. 


                                      63


<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

ADVERTISING COSTS

Advertising and promotional costs are expensed at first showing. In addition, 
the Company advertises on a cooperative basis by accruing an obligation to 
reimburse retailers for qualified advertising of Company products. The 
Company provides for cooperative advertising obligations in the same period 
as the related revenue is recognized. Advertising and promotional costs 
amounted to $10,942,024, $6,944,454 and $5,638,500 for the years ended 
December 31, 1998, 1997 and 1996, respectively.

RESEARCH AND DEVELOPMENT COSTS

The Company incurs research and development costs relating to the development 
of its dietary supplement products. Research and development costs are 
expensed as incurred and amounted to $433,549, $357,064 and $117,184 for the 
years ended December 31, 1998, 1997 and 1996, respectively. Research and 
development costs are included in general and administrative expenses on the 
consolidated statements of income.

STOCK-BASED COMPENSATION

SFAS No. 123, "Accounting for Stock-Based Compensation" encourages, but does 
not require, companies to record compensation cost for stock-based employee 
compensation plans at fair value. The Company has chosen to continue to 
account for stock-based compensation using the intrinsic value method 
prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting 
for Stock Issued to Employees." 

EARNINGS PER SHARE

The Company calculates earnings per share in accordance with SFAS No. 128 
"Earnings per Share." Basic earnings per share have been computed by dividing 
net income by the weighted average number of common shares outstanding. 
Diluted earnings per share have been computed by dividing net income by 
securities or other contracts to issue Common Stock as if these securities 
were exercised or converted to Common Stock. 

The following table sets forth the calculation for basic and diluted earnings 
per share for the periods indicated:


                                      64


<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

EARNINGS PER SHARE (CONTINUED)

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31
                                                         1998        1997        1996
                                                    ------------------------------------
        <S>                                         <C>           <C>         <C>
        Earnings:                                                               
         Net income                                  $7,515,551   $4,190,700  $5,892,388
                                                    ------------------------------------
                                                    ------------------------------------
        Shares:
        Weighted average shares for basic
          earnings per share                          9,854,411    7,100,000   6,275,000
        Conversion of convertible                                               
          participating preferred stock               1,494,247    2,700,000     675,000
        Share equivalent for redeemable                                         
          preferred stock                               255,247      461,538     115,385
        Stock options                                   286,429       11,321           -
                                                    ------------------------------------
        Weighted average shares for diluted                                     
          earnings per share                         11,890,513   10,272,859   7,065,385
                                                    ------------------------------------
                                                    ------------------------------------
</TABLE>

Shares issuable under stock options of 445,000 in fiscal 1998 have been 
excluded from the computation of diluted earnings per share because the 
effect would be antidilutive.

As discussed further in Notes 1 and 5, the Company elected to be taxed as an 
S Corporation for federal income and California franchise tax purposes for 
the period from July 1, 1996 through September 29, 1996, and was taxed as a C 
Corporation for all the other periods in the year ended December 31, 1996. 
Accordingly, the provision for income taxes for the period in which the 
Company was taxed as an S Corporation reflects primarily state income tax, if 
any. If the Company had been subject to tax as a C Corporation for the entire 
year ended December 31, 1996, pro forma basic and diluted earnings per share 
would have been $0.80 and $0.71, respectively. 

COMPREHENSIVE INCOME

In June 1997, SFAS 130 "Reporting Comprehensive Income" was issued.  The 
provisions of SFAS 130 require companies to classify items of comprehensive 
income by their nature in financial statements and display the accumulated 
balance of other comprehensive income separately from retained earnings in 
the financial statements.  The Company's comprehensive income items are not 
material at December 31, 1998, 1997 or 1996 and therefore no disclosures have 
been made.


                                      65

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

MAJOR CUSTOMERS

The Company had net sales to one customer which individually represented 
15.9% of net sales during the year ended December 31, 1998. The Company had 
net sales to two customers which individually represented 17.8% and 11.6%, 
respectively, of total Company net sales during the year ended December 31, 
1997. The Company had net sales to three customers which individually 
represented 14.5%, 12.6% and 10.2%, respectively, of total Company net sales 
during the year ended December 31, 1996. 

MAJOR PRODUCTS

The Company's sales of two products each comprised approximately 14.0% and 
10.0%, respectively, of net sales during the year ended December 31, 1998. 
The Company's sales of two products each comprised approximately 17.1% and 
17.7%, respectively, of net sales during the year ended December 31, 1997. 
The Company's sales of three products each comprised approximately 36.0%, 
18.8% and 18.1%, respectively, of net sales during the year ended December 
31, 1996.

CONCENTRATIONS OF CREDIT RISK

Concentrations of credit risk with respect to trade receivables, other than 
significant customers previously discussed, are limited, due to the 
distribution of sales over a large customer base. The Company performs 
periodic credit evaluations of its customers' financial conditions and 
generally does not require collateral. Credit losses have been within 
management's expectations. 

SEGMENT REPORTING

Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures 
about Segments of an Enterprise and Related Information."  SFAS No.131 
establishes standards for the way that public business enterprises report 
information about operating segments in annual financial statements and 
requires that those enterprises report selected information about operating 
segments in interim financial reports. SFAS No. 131 also establishes 
standards for related disclosures about products and services, geographic 
areas and major customers. The adoption of SFAS No. 131 did not affect the 
reported results of operations or financial position.  In addition, the 
adoption of the new statements did not affect disclosures of segment 
information as the Company is engaged principally in one line of business, 
the manufacturing and marketing of branded, high-quality dietary supplement


                                      66

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

SEGMENT REPORTING (CONTINUED)

products, including vitamins, minerals, herbs and specialty formulations, 
weight control products and hormones, which represents more than 85% of 
consolidated sales.  

RECLASSIFICATIONS

Certain reclassifications have been made to the prior years consolidated 
financial statements to conform to the presentation in 1998.

2. ACQUISITIONS

On October 31, 1998, the Company completed the acquisition of certain of the 
assets of Laci Le Beau Tea Company of Fresno, California, which consists of 
Laci Le Beau, Inc., a California corporation, as well as certain related 
companies (Laci Le Beau).  The total purchase price for the acquisition was 
$7,500,000 in cash. Laci Le Beau is a formulator, packager and distributor of 
specialty teas sold through the health channel of distribution as well as in 
food stores, drug stores and mass market merchandisers.  These channels of 
distribution are essentially the same as the Company's channels of 
distribution. Assets purchased consisted primarily of inventories of 
$2,146,526, as well as fixed assets of $153,474 and intangible assets of the 
business of $5,200,000.  No liabilities were assumed. The acquisition was 
accounted for using the purchase method, and accordingly, the acquired assets 
are recorded at their estimated fair values with revenues and expenses from 
the date of acquisition included in the consolidated statement of income. The 
excess of cost over the fair value of assets acquired will be amortized over 
fifteen years. Amortization expense for the year ended December 31, 1998 was 
$88,168 and is included in general and administrative expenses.

On February 27, 1998, the Company purchased substantially all of the assets 
and assumed certain liabilities of Pure-Gar L.P. (Pure-Gar), a distributor of 
bulk dehydrated vegetable products and dietary supplements, for a total 
purchase price of $11,085,736, which included $85,736 of deferred acquisition 
costs. Assets purchased include accounts receivable of $1,271,694 and 
inventories of $1,021,127, as adjusted for purchase price accounting 
adjustments through December 31, 1998, as well as fixed assets of $131,091 
and intangible assets of the business of $8,965,000. Liabilities assumed 
consisted primarily of trade payables of $388,912. In addition, the Company 
entered into long-term supply and royalty agreements with the 


                                      67

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)


2. ACQUISITIONS (CONTINUED)

seller. The supply agreement requires the seller to sell and the Company to 
purchase specified amounts of certain vegetable, fruit, herbal and botanical 
products (the "Products") manufactured by the seller. The supply agreement 
gives the Company the exclusive right to sell certain Products in the dietary 
supplement industry. The supply agreement may be terminated by either party 
upon a material breach of the obligations of the other party, or certain 
other specified conditions, if the breach is not cured within 60 days, or 15 
days in the case of nonpayment by the Company. The acquisition was accounted 
for using the purchase method, and accordingly, the acquired assets and 
liabilities are recorded at their estimated fair values with revenues and 
expenses from the date of acquisition included in the consolidated statement 
of income. The excess of cost over the fair value of assets acquired will be 
amortized over fifteen years. Amortization expense for the year ended 
December 31, 1998 was $500,000 and is included in general and administrative 
expenses. 

The following pro forma information presents a summary of consolidated 
results of operations of the Company as if the acquisitions described above 
had occurred at the beginning of the years ended December 31, 1998 and 1997, 
with pro forma adjustments for the amortization of goodwill, interest expense 
for the acquisition of Pure-Gar and certain income tax adjustments.  The pro 
forma financial information is not necessarily indicative of the results of 
operations as they would have been had the acquisitions been effected on the 
assumed dates or of future results of the combined entities.

<TABLE>
<CAPTION>

                                         FOR THE YEAR ENDED
                                             DECEMBER 31
                                    -----------------------------
                                        1998              1997
                                    -----------------------------
                                             (Unaudited)
<S>                                 <C>               <C>
Revenues                            $73,007,000       $58,477,000

Income from operations               12,607,000         7,537,000

Net income                            7,834,000         3,831,000

Basic earnings per share                  $0.80             $0.54

Diluted earnings per share                $0.66             $0.37
</TABLE>


                                      68
<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


3. INVENTORIES

Inventories consist of the following: 

<TABLE>
<CAPTION>

                                                          DECEMBER 31
                                                        1998         1997
                                                    ------------------------
      <S>                                           <C>           <C>
      Raw materials and packaging supplies          $ 7,549,122   $3,837,856
      Finished goods                                  5,888,333    3,096,325
                                                    ------------------------
                                                    $13,437,455   $6,934,181
                                                    ------------------------
                                                    ------------------------
</TABLE>

4. FINANCING

Long-term debt consists of the following: 

<TABLE>
<CAPTION>

                                                                  DECEMBER 31
                                                              1998           1997
                                                              ----------------------
<S>                                                           <C>         <C>
Note payable to a bank, payable in monthly                       
 installments of $41,667, beginning October 31, 1997,            
 plus interest at the prime rate plus 0.25%, paid in             
 full in July 1998                                            $  -        $1,875,000
Note payable to a bank, payable in monthly                       
 installments of $25,000, beginning June 30, 1997,               
 plus interest at the prime rate plus 0.25%, paid in             
 full in July 1998                                               -         1,325,000
Note payable to a bank, payable in monthly                       
 installments of $11,458, beginning July 1, 1996,                
 plus interest at the prime rate plus 0.75%, paid in             
 full in July 1998                                               -           343,750
Other notes payable, due November 1, 1998, paid in               
 full in July 1998                                               -            61,111
                                                              ----------------------
                                                                 -         3,604,861
Less current portion                                             -           998,611
                                                              ----------------------
                                                              $  -        $2,606,250
                                                              ----------------------
                                                              ----------------------
</TABLE>

On February 27, 1998, the Company entered into an amended credit facility 
(Loan Agreement) with a bank that provides for a revolving line of credit for 
borrowings up to $8,000,000, based on a formula, through April 30, 2001. The 
Loan Agreement amends and restates a previous revolving line of credit 
agreement with the bank. Advances under the Loan Agreement bear interest at 
the bank's adjusted LIBOR rate plus 1.25% or the bank's prime rate at the 
option of the Company. Proceeds from the initial funding under the Loan 
Agreement were used to assist in the funding of the Pure-Gar acquisition. 


                                      69

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          

4. FINANCING (CONTINUED)

The credit facility was subsequently repaid in full in July, 1998 and 
terminated in August 1998.  Interest expense related to the Loan Agreement 
was $161,306 for the year ended December 31, 1998.

In addition to providing for the revolving loans, the Loan Agreement provided 
for a term loan of $9,000,000 to be used for financing the acquisition of 
Pure-Gar. The term loan calls for monthly installments of $125,000 during the 
period March 1, 1998 through February 28, 2004 and bears interest at the 
bank's adjusted LIBOR rate plus 1.25% or the bank's prime rate at the option 
of the Company. Mandatory prepayments are required on the term loan based on 
excess cash flows, as defined.  The term loan was repaid in full in July 
1998. Interest expense related to the term loan was $246,146 for the year 
ended December 31, 1998.

In 1997 and through the date of the Loan Agreement, the Company had an 
agreement with a bank in addition to the notes payable, which provided for 
maximum borrowings on a revolving line of credit up to $2,500,000, based on a 
formula, with interest at the prime rate plus 0.5%. No amounts were 
outstanding under this agreement at December 31, 1997. The agreement provided 
for a letter of credit up to a maximum of $250,000, of which no amounts were 
outstanding at December 31, 1997. Interest expense related to the revolving 
line of credit and notes payable was $240,250 for the year ended December 31, 
1997.

5. INCOME TAXES

The income tax provision consists of the following: 

<TABLE>
<CAPTION>
                                            YEAR ENDED DECEMBER 31
                                      1998           1997          1996
                                   ---------------------------------------
      <S>                          <C>            <C>           <C>
      Current:                                             
             Federal               $4,468,728     $2,161,400    $2,078,292
             State                    838,542        516,595       617,762
                                   ---------------------------------------
                                    5,307,270      2,677,995     2,696,054
       
      Deferred:                                            
             Federal                 (608,481)        72,202      (303,734)
             State                    (92,466)        65,961       (93,727)
                                   ---------------------------------------
                                     (700,947)       138,163      (397,461)
                                   ---------------------------------------
      Total income tax provision   $4,606,323     $2,816,158    $2,298,593
                                   ---------------------------------------
                                   ---------------------------------------
</TABLE>


                                       70

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


5. INCOME TAXES (CONTINUED)

As described in Note 1 to the consolidated financial statements, in 1996, the 
Company elected to be treated as an S Corporation for federal income and 
California franchise tax purposes under Subchapter S of the Internal Revenue 
Code and the corresponding provisions of the California statute. Upon the 
creation and issuance of the convertible participating preferred stock as 
discussed in Notes 1 and 6 to the consolidated financial statements, the 
Company was required to change its status for income tax purposes back to a C 
corporation. The following unaudited pro forma income tax information has 
been determined as if the Company operated as a C corporation for the entire 
year ended December 31, 1996. The pro forma information presented below 
represents actual amounts for the years ended December 31, 1998 and 1997 as 
the Company was operating as a C corporation during those periods. 

<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31
                                                   1998           1997         1996
                                               ---------------------------------------
      <S>                                      <C>            <C>           <C>
      Federal tax provision                    $3,860,247     $2,233,602    $2,599,860
      State income taxes net of federal                                
       benefit                                    746,076        582,556       559,933
                                               ---------------------------------------
      Total pro forma income tax provision     $4,606,323     $2,816,158    $3,159,793
                                               ---------------------------------------
                                               ---------------------------------------
</TABLE>

The difference between actual income tax expense and the U.S. Federal statutory
income tax rate is as follows: 

<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31
                                                1998        1997        1996
                                               ------------------------------
      <S>                                      <C>         <C>         <C>
      Statutory rate                           34.0%       34.0%        34.0%
      State tax provision                       4.0         6.2          4.0
      S Corporation status                        -           -        (10.0)
                                               ------------------------------
      Effective tax rate                       38.0%       40.2%        28.0%
                                               ------------------------------
                                               ------------------------------
</TABLE>

The significant components of the Company's deferred tax assets and liabilities
are as follows: 

                                      71

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


5. INCOME TAXES (CONTINUED)

<TABLE>
<CAPTION>
                                                              DECEMBER 31
                                                            1998       1997
                                                        ---------------------
      <S>                                               <C>          <C>
      Deferred tax assets:                                             
       Accounts receivable reserves                     $  139,279   $ 69,455
       Inventory reserves                                   98,105     46,486
       Various accrued liabilities                         695,762    315,297
       State taxes                                         280,930    122,652
                                                        ---------------------
                                                         1,214,076    553,890
      Deferred tax liability:                                          
       Depreciation                                        (32,013)   (72,774)
                                                        ---------------------
                                                        $1,182,063   $481,116
                                                        ---------------------
                                                        ---------------------
</TABLE>

6. STOCKHOLDERS' EQUITY

In July 1998, the Company completed its initial public offering in which it 
sold 3,495,500  shares of Common Stock at a price of $15.00 per share, with 
aggregate net proceeds to the Company of $47,640,174. At the time of the 
initial public offering, all of the convertible participating preferred stock 
converted into 2,700,000 shares of Common Stock and 13,500 shares of 
redeemable preferred stock. The shares of redeemable preferred stock were 
then immediately redeemed by the Company for $6,000,000 in cash.

In September 1996, the shares of Common Stock held by the original 
stockholders were split up and converted into 7,027,780 shares of Common 
Stock and 25,078.1 shares of convertible participating preferred stock. In 
addition, the Company sold an additional 1,921.9 shares of its convertible 
participating preferred stock to third party investors. The total of 27,000 
shares of convertible participating preferred stock purchased by the 
investors are convertible into (i) approximately 27% of the then outstanding 
shares of Common Stock of the Company on a fully diluted basis and (ii) 
shares of redeemable preferred stock which are redeemable for a total of $6.0 
million. The total consideration paid by the investors for the convertible 
participating preferred stock was $12.0 million. 

Each share of convertible participating preferred stock is convertible based 
on a formula upon the written election of not less than 66 2/3% of the 
outstanding shares of convertible participating preferred stock such that 
each outstanding share of convertible participating preferred stocks will 
convert into one share of Common Stock (prior to giving effect the 100-for-1 
stock split) and one-half of one share of redeemable preferred stock, subject 
to adjustment for stock splits, stock dividends, recapitalizations 


                                      72

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


6. STOCKHOLDERS' EQUITY (CONTINUED)

and similar transactions. The convertible participating preferred stock has 
an automatic conversion feature which provides for each share of convertible 
participating preferred stock to be automatically converted into shares of 
Common Stock and redeemable preferred stock based on the then effective 
conversion price immediately upon the closing of the Company's first firm 
commitment public offering pursuant to an effective registration statement 
under the Securities Act of 1933, as amended, provided that such registration 
statement covers the offer and sale of Common Stock of which the aggregate 
net proceeds exceeds $15 million at a price per share reflecting a valuation 
of the Company's equity of at least $50 million. 

The convertible participating preferred stock contains a liquidation 
preference of $444.445 per share, adjusted for any stock splits, stock 
dividends, recapitalizations, plus any declared but unpaid dividends. The 
convertible participating preferred stock contains voting rights equal to the 
number of full shares of Common Stock they are convertible into. 

Upon the occurrence of certain events on or after September 26, 2002, the 
Company is required to redeem all of the outstanding shares of convertible 
participating preferred stock at the liquidation preference value. Therefore, 
at the time of the issuance of the convertible participating preferred stock, 
the Company adjusted retained earnings (deficit) by $11,142,850, which 
represents the difference between the proceeds received for the convertible 
participating preferred stock by the Company and its redemption value. Thus, 
the convertible participating preferred stock is recorded at its redemption 
value at December 31, 1997. 

RECEIVABLE FROM STOCKHOLDER

The receivable from stockholder represents an interest bearing note from a 
stockholder in the amount of $562,500 issued by the stockholder to finance in 
part the purchase of 300,000 shares of the Company's Common Stock. The note 
bears interest at 6.60% per year with interest payments due annually. The 
note is due within ten days of the receipt by the stockholder of proceeds 
from the sale of the Company's Common Stock or November 14, 2006, whichever 
occurs first. Included in interest income is $37,125 for the years ended 
December 31, 1998 and 1997, for interest from this stockholder. 


                                     73

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


6. STOCKHOLDERS' EQUITY (CONTINUED)

STOCK OPTIONS

The Company has adopted the 1996 Stock Option and Grant Plan, as amended (the 
Plan), which authorizes the Board of Directors of the Company to grant 
incentive stock options or non-qualified stock options. Incentive stock 
options may be granted only to employees of the Company. Non-qualified stock 
options may be granted to officers and employees of the Company as well as to 
non-employees. The maximum number of shares of Common Stock to be issued 
under the Plan is 2,294,325 shares, as amended. All options granted under the 
Plan have been made at prices not less than the estimated fair market value 
of the stock at the date of grant. Generally the options granted under the 
Plan vest over three to five years. Options granted under the plan have a 
term of not more than ten years. 

A summary of the Company's stock option activity, and related information is 
as follows: 

<TABLE>
<CAPTION>
                                                     WEIGHTED
                                                      AVERAGE
                                        NUMBER    EXERCISE PRICE   EXERCISE PRICE
                                      OF OPTIONS     PER SHARE       PER SHARE
                                      -------------------------------------------
<S>                                   <C>         <C>            <C>
Outstanding at January 1, 1996                -      $    -              $     -
 Granted                                200,000        1.88                 1.88
                                      -------------------------------------------
Outstanding at December 31, 1996        200,000        1.88                 1.88
 Granted                                200,000        2.10                 2.10
                                      -------------------------------------------
Outstanding at December 31, 1997        400,000        1.99        1.88 -   2.10
 Granted                                445,000       10.87       10.40 -  13.00
                                      -------------------------------------------
Outstanding at December 31, 1998        845,000      $ 6.67      $ 1.88 -  13.00
                                      -------------------------------------------
                                      -------------------------------------------
Exerciseable at:                                                          
 December 31, 1996                       70,000      $ 1.88               $ 1.88
 December 31, 1997                      116,250      $ 1.88      $ 1.88 - $ 2.10
 December 31, 1998                      304,663      $ 4.78      $ 1.88 - $13.00
                                      -------------------------------------------
                                      -------------------------------------------
</TABLE>

At December 31, 1998, 1,449,325 shares were available for future grant. The 
weighted average remaining contractual life for the outstanding options in 
years was 8.91, 9.38 and 10.00 at December 31, 1998, 1997 and 1996, 
respectively. 

If the Company had elected to recognize compensation expense based on the fair
value of the options granted at grant date for its stock-based compensation
plans consistent with the method prescribed by SFAS No. 123,


                                      74

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


6. STOCKHOLDERS' EQUITY (CONTINUED)

the Company's net income would have been reduced to the pro forma amounts
indicated below:  

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31
                                               1998         1997         1996
                                           -------------------------------------
      <S>                                  <C>           <C>          <C>
      Net income:                                                       
       As reported                         $7,515,551    $4,190,700   $5,892,388
       Pro forma                           $7,367,551    $4,185,800   $5,892,288

      Earnings per share:                                               
       As reported - basic                 $     0.76    $     0.59   $     0.94
       Pro forma - basic                   $     0.75    $     0.59   $     0.94
       As reported - diluted               $     0.63    $     0.41   $     0.83
       Pro forma - diluted                 $     0.62    $     0.41   $     0.83
</TABLE>

The fair value of the options is estimated using a Black-Scholes option-pricing
model with the following weighted average assumptions for grants:

<TABLE>
<CAPTION>
                                                 1998          1997         1996
                                               ----------------------------------
      <S>                                      <C>            <C>          <C>
      Expected dividend yield                     0.0%          3.0%         6.0%
      Expected stock price volatility            37.5%           -            -
      Risk free interest rate                     6.0%          6.0%         6.3%
      Expected life of options                  5 Years       5 Years      6 Years
</TABLE>

These assumptions resulted in weighted average fair values of $3.35, $0.27 
and $0.03 for each stock option granted in 1998, 1997 and 1996, respectively.

7. COMMITMENTS

The Company leases certain equipment and facilities under noncancelable 
operating leases that expire in various years through 2002. Rent expense 
under operating leases totaled $570,325, $641,731 and $406,446, for the years 
ended December 31, 1998, 1997 and 1996, respectively. In August 1996, the 
Company entered into a 120-month lease for an operating facility with an 
option to extend the term of the lease for 60 months at 95% of the then 
market value for similar space. This facility was purchased by the Company in 
December, 1998.

Future minimum lease payments under noncancelable operating leases with initial
terms of one year or more consisted of the following at December 31, 1998:


                                     75

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          

7. COMMITMENTS (CONTINUED)

<TABLE>
          <S>                                     <C>
          1999                                      $85,710
          2000                                       80,175
          2001                                       54,062
          2002                                        3,566
                                                   --------
          Total minimum lease payments             $223,513
                                                   --------
                                                   --------
</TABLE>

8. EMPLOYEE BENEFIT PLANS

The Company has a profit sharing 401(k) plan that covers substantially all of 
its employees. Eligible employees may contribute up to 10% of their 
compensation. Contributions are discretionary, however, the Company generally 
matches 10% of the employees' contributions up to the maximum of 1% of 
eligible compensation. Amounts recognized as expense were $10,409, $0 and 
$12,764 for the years ended December 31, 1998, 1997 and 1996, respectively.

In May, 1998, the Board of Directors approved the Natrol, Inc. Employee Stock 
Purchase Plan (the ESPP) which allows substantially all employees to purchase 
shares of Common Stock of the Company, through payroll deductions, at 85% of 
the fair market value of the shares at the beginning or end of the offering 
period, whichever is lower. The ESPP provides for employees to authorize 
payroll deductions of up to 10% of their compensation for each pay period. In 
conjunction with the ESPP, the Company registered with the Securities and 
Exchange Commission 225,000 shares of the Company's Common Stock reserved for 
purchase under the ESPP.  As of December 31, 1998, 218,510 shares are 
available for issuance under this plan.  For the year ended December 31, 
1998, 6,490 shares were issued at $7.65 per share under the plan.

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS: the carrying amount approximates fair value.

MARKETABLE SECURITIES: the carrying amount approximates fair value based upon
quoted market prices.

ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE: the carrying amount approximates fair
value.


                                    76

<PAGE>

                                  Natrol, Inc.

              Notes to Consolidated Financial Statements (Continued)
                                          


9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

LONG-TERM DEBT: the fair values of the Company's long-term notes payable are 
estimated using discounted cash flow analyses, based on the Company's current 
incremental borrowing rates for similar types of borrowing arrangements. The 
carrying amount of long-term notes payable approximate their fair value at 
December 31, 1997. 

10. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
                                          Three Months Ended
                            ----------------------------------------------
                            March 31    June 30 September 30   December 31
                            ----------------------------------------------
                                 (in thousands, except per share data)
<S>                         <C>         <C>        <C>           <C>
1998
Net sales                   $13,169     $16,344    $19,501       $19,193
Gross profit                  7,017       8,788     10,174        10,217
Net income                    1,175       1,578      2,517         2,245
Basic earnings per share    $  0.17     $  0.22    $  0.21       $  0.17
Diluted earnings per share  $  0.11     $  0.15    $  0.20       $  0.16

1997
Net sales                   $ 9,909     $ 8,191    $11,392       $13,382
Gross profit                  5,434       4,376      6,024         7,240
Net income                      810         277      1,324         1,779
Basic earnings per share    $  0.11     $  0.04    $  0.19       $  0.25
Diluted earnings per share  $  0.08     $  0.03    $  0.13       $  0.17
</TABLE>

Certain reclassifications have been made to the quarterly information as
previously reported by the Company in the table above to conform to the
presentation for the year ended December 31, 1998.


                                      77