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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-K

FOR ANNUAL AND TRANSITIONAL REPORTS
PURSUANT TO SECTIONS 13 AND 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

|(Mark One) |                                                                                         
|---------- | ----------------------------------------------------------------------------------------
|ý          | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934    
|           | For The Fiscal Year Ended December 31, 2002                                             
|OR        
|o          | 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

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NATROL, INC.

(Exact name of registrant as specified in its charter)

Delaware(State of Incorporation)

95-3560780(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

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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 o    No ý

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. o

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 126-2). Yes
o No ý

The
aggregate market value of the shares of the registrant's Common Stock held by non-affiliates of the registrant on June 30, 2002 was approximately
$18.6 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 15, 2003, the registrant had 12,876,720 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement for its 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this
Form 10-K.

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NATROL, INC.  2002 ANNUAL REPORT on Form 10-K

TABLE OF CONTENTS

|         |  |                                                                                       |  | Page
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|PART I   |  | 3                                                                                    
|Item 1.  |  | Business                                                                              |  | 3   
|Item 2.  |  | Properties                                                                            |  | 23  
|Item 3.  |  | Legal Matters                                                                         |  | 23  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  |    
|PART II  |  | 24                                                                                   
|Item 5.  |  | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 24  
|Item 6.  |  | Selected Consolidated Financial Data                                                  |  | 24  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 26  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 35  
|Item 8.  |  | Financial Statements and Supplementary Data                                           |  | 36  
|Item 9.  |  | Changes and Disagreements with Accountants on Accounting and Financial Disclosure     |  | 59  
|PART III |  | Items 10, 11, 12, 13 and 14                                                           |  | 60  
|PART IV  |  | 61                                                                                   
|Item 15. |  | Exhibits, Financial Statements, Schedules, and Reports on Form 8-K                    |  | 61  

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains "forward looking statements." Natrol, Inc., a Delaware corporation organized in 1980, 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," "intend," "estimate," "assume," "plan," or
"anticipates" or the negative thereof, other variations thereon, or comparable terminology, or by discussions of strategy that predict or indicate future events or trends or that are not historical
facts. The Company cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect its current expectations of the approximate outcome
of the matter discussed. The Company does not undertake any obligation and does not currently intend to update any such statements at any time in the future.

The
Company's ability to predict results or the effect of certain events on the Company's operating results is inherently uncertain. Forward-looking statements should not be unduly
relied on since they involve known and unknown risks, uncertainties and other factors, some of which are beyond the Company's control. These risks, uncertainties and other factors may cause actual
results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Therefore, the
Company wishes to caution each reader of this report to carefully consider the following factors and certain other factors discussed herein, including the factors discussed under the caption "Business
Risk Factors & Factors Affecting Forward Looking Statements," and factors discussed in other past reports. The factors discussed herein may not be exhaustive. Therefore, the factors contained
herein should be read together with other reports and documents that are filed by the Company with the SEC from time to time, which may supplement, modify, supersede or update the factors listed in
this document.

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 general downturn or slowing of the growth of the dietary supplement industry;(ii) increased competition from current competitors
and new market entrants including but not limited to increased competition from private label house brands supported by retailers seeking to increase the market share of their proprietary house
brands. Private label brands control the largest share of the vitamin, mineral and supplement (VMHS) sector; (iii) adverse publicity regarding the dietary supplement industry or the Company's
products including recent publicity regarding ephedrine-based products; (iv) exposure to product liability claims including product liability claims from products which include ephedrine or
other products for which the Company has either not been able to secure product liability coverage or been able to secure such coverage at reasonable prices; (v) exposure to and
the expense of resolving and defending potential product liability claims that are left uncovered by insurance; (vi) the Company's dependence upon its ability to develop new products;
(vii) a continued high rate (or increase in the rate) of returns of the Company's products; (viii) the Company's ability to manage inventory or sell its inventory before such inventory
becomes outdated, (xix) the Company's ability to gain or expand or maintain distribution within new or existing customers and new or existing channels of trade; (x) an increase in the
cost of obtaining and maintaining shelf space with major national retailers who demand various forms of incentives from their suppliers such as slotting fees, coop advertising, or rebates;
(xi) adverse changes in government regulation or changes in local or national laws; (xii) dependence on significant customers; (xiii) the Company's ability to keep and attract key
management employees; (xiv) the Company's inability to manage growth and execute its business plan, or the Company's ability to modify its business plan in response to market conditions,
including, but not limited to, its ability to enter into new businesses and capitalize upon new business opportunities; (xv) the Company's ability to consummate future acquisitions and its
ability to integrate acquired businesses, including without limitation Prolab

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Nutrition, Inc. ("Prolab"), acquired in October, 1999 for which the Company took a $20 million impairment charge in the year ended December 31, 2001 due to the write down of
goodwill associated with the acquisition; (xvi) the absence of conclusive clinical studies for many of the Company's products; (xvii) the Company's inability to obtain raw materials that
are in short supply including its ability to obtain garlic powders under its supply agreement with ConAgra for its Essentially Pure Ingredient (EPI) raw material sales division; (xviii) sales
and earnings volatility, (xix) volatility of the stock market; (xx) the Company's ability to manufacture its products efficiently; (xxi) the Company's reliance on independent
brokers to sell its products; (xxii) the inability of the Company to protect its intellectual property; (xxiii) control of the Company by principal shareholders, (xxiv) the
possible sale of large amounts of stock by controlling stockholders; (xxv) a continued general downturn in the national economy as a whole; (xxvi) continued market acceptance of Natrol
supplements, Laci Le Beau teas, Prolab's sports nutrition products, and EPI's raw material products, (xxvii) increases in the cost of borrowings; (xxviii) unavailability of additional
debt or equity capital; (xix) legal actions brought forth by governmental and private agencies; and, (xx) that its investment in a new multi-level marketing company, Annasa Inc.,
will prove to be profitable in the near or long-term.

There
are a number of other factors affecting the Company's business, including the following risk factors of which investors should be aware.

Natrol
and its other brands, Laci LeBeau and Prolab have each sold ephedrine-based products in past years. The volume of such sales has not been large relative to the overall sales of
the Company and as March 31, 2003 the Company no longer sells or manufactures ephedrine-based products. Even so, the Company cannot guarantee that all of the ephedrine-based products produced
and sold to retailers are no longer on retailer shelves and unavailable for sale.

During
2002, product liability insurance for ephedrine-based products was generally unavailable. Occurrence-based product liability insurance became unavailable during the fourth quarter
of 2002. "Claims-made insurance" that was available for these products, was offered to the Company only with substantially lower limits than the Company had carried in prior years and at
rates that were many times higher than those paid in prior years. The Company cannot predict the state of the insurance
market in future years, or for that matter, whether or not insurance will be available to the Company at any price.

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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 subsidiaries.

GENERAL

Natrol manufactures and markets branded, high-quality dietary supplements, herbal teas, nutraceutical ingredients and sports nutrition products under
three labels: the Natrol brand, the Laci Le Beau brand of herbal teas, and the Prolab sports nutrition brand. The Company also markets high quality nutraceutical ingredients to other manufacturers of
supplements or fortified foods through its Essentially Pure Ingredient (EPI) raw material supply division which also markets contract manufacturing services to companies within the nutraceutical
industry.

The
Company's core Natrol brand focuses on supplements that are in high demand as well as specialty niche and proprietary formulations that have potentially strong margins. The Company
positions Natrol as a premium brand of vitamins, minerals and other supplements rather than as a value brand.

Dietary
supplements are sold primarily under the Company's Natrol brand. These supplements include vitamins, minerals, hormonal supplements, herbal products and specialty combination
formulas that contribute to an individual's physical well being. The Company sells its products 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 through international distributors who purchase Natrol's product F.O.B. the United States. The Company's strategy emphasizes building strong recognition of the
Natrol brand across multiple
distribution channels through an advertising strategy that includes print advertising, television advertising, radio advertising and coop advertising spending with customers designed to build consumer
awareness and increase the purchase of its products by consumers.

Herbal
teas are sold under the Company's Laci Le Beau brand. Laci Le Beau teas are flavored herbal teas. The primary tea category is Laci Le Beau Dieter'stea. The Company uses the same sales people and
brokers to sell teas as it does supplements. And, as with its supplement business, the
Company's strategy emphasizes building strong recognition of the Laci Le Beau brand across multiple distribution channels. Laci Le Beau products are sold to retailers by the same sales team that
markets the core Natrol products to the Company's various channels of distribution.

The
Prolab sports nutrition line of products is targeted to body builders and health minded individuals seeking a high degree of physical fitness. Prolab's products include supplements
designed to help these individuals gain and lose weight as well as improve muscle mass and muscle definition. Prolab products are sold through gyms, health food stores, and internationally, through
selected distributors.

The
Company also sells nutraceutical grade ingredients, primarily garlic, vegetable powders, kava kava, melatonin, soy isoflavones and cetyl myristoleate complex to other manufacturers
through its EPI division. The Company's strategy is to establish exclusive relationships with primary manufacturers of raw materials and to sell these ingredients to other users of nutraceutical grade
materials. EPI maintains an independent sales force. EPI, however, shares all of Natrol's other resources including Natrol's headquarters facility, its manufacturing and product development personnel
and expertise, its financial resources, as well as accounting and management resources. The EPI sales force markets

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Natrol's manufacturing capabilities to other nutraceutical businesses that need contract manufacturing support.

Natrol's
consumer products fall into the general definition of vitamin, minerals, herbs and dietary supplements ("VMHS"). Each year, every segment of the Company strives to broaden its
product offerings so as to increase revenue and gross profits while lessening dependence upon any one product.

No
one product represented more than 10% of sales in 2002. The Company's sales of one product comprised 10.1% of gross sales during the year ended December 31, 2001. The Company's
sales of a different product line comprised 11.5% of gross sales during the year ended December 31, 2000.

Business Expansion: New multi-level marketing companyAnnasa, Inc.

During 2002, the Company employed a team of experienced business professionals to research and create a business plan allowing the Company to enter the
multi-level marketing business and to distribute a new proprietary line of nutritional products.

The
business plan called for the Company to invest more than $1 million in 2002 in order to prepare for a full launch of the new business in 2003. The Company used this investment
to develop products, create marketing materials, design a distributor compensation program, create an easily accessible websitewww.Annasa.com, hire full-time staff, and
attract potential distributors.

The
new multi-level marketing company, Annasa, Inc., ("Annasa") was formed as a wholly owned subsidiary of Natrol, Inc., which distributes under the Annasa label.

Approximately
$44,000 of revenue was generated by Annasa in 2002. The Company expects to continue investing in Annasa during 2003 as it builds a base of distributors. Cash flow
break-even is not projected until 2004 and the Company expects to incur expenses of approximately $1-to-$2 million before it reaches cash flow
break-even.

Operating Segments

The Company and its subsidiaries operate as three operating segments: the Natrol operating segment which manufactures and markets Natrol and Laci LeBeau branded
products, and which, under the EPI name contract manufactures products and sells raw material ingredients; Prolab Nutrition, Inc. which develops, manufactures and markets sports nutrition
products; and, Annasa, which was established during 2002 to develop a direct-to-consumer, multi-level marketing business.

The
following table sets forth the percentage of net sales for each of the Company's operating segments:

|       |  | Fiscal Years Ended December 31, |  
|------ |  | ------------------------------- | -
|
|Natrol |  | 73.5                            | %
|Prolab |  | 26.4                            | %
|Annasa |  | 0.1                             | %

SALES

BRANDED PRODUCTS

The Company distributes its Natrol supplements and Laci Le Beau teas primarily to domestic, independent, 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

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distribution, it has built different sales organizations to meet the differing requirements of each channel of trade.

The
Company sells its branded Natrol and Laci Le Beau products to health food stores through leading national distributors, includingUnited Natural
FoodsandTree of Life, as well as directly toGNC(General Nutrition Company).
Natrol and Laci Le Beau products are also sold by health food store chains such asWild Oats Markets,Whole Foods
Market,Hi-Health,Vitamin Cottage,Fred
Meyer Nutrition CentersandVitamin Shoppes, as well as by most independent health food stores.

Within
the health food channel of trade, the Company maintains a sales staff of regional representatives across the country managed by a national manager who reports to the Company's
Vice President of Sales. These sales representatives call on individual storeowners and distributors promoting the Natrol and Laci Le Beau lines.

The
mass-market distribution channel is managed by the Company's Vice President of Sales,a Vice President of National
Accounts 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 asBergen Brunswick,McKessonand Cardinal. Some of the Company's major drug
and mass-market retail customers areWalgreens, CVS,Albertson's,Rite
Aid,Long's Drug,Eckerd,Snyders, Brooks Drug,Wal-Mart,ShopKo, BJ's Wholesale ClubandSam's Clubs. The Company also
sells its products in grocery stores and
supermarkets, includingDominick's,Ralphs,Von's, Schnucks,Cub Foods,Food For Less, Gelsen's Hi VeeandWegmans.

Sales
of vitamins and supplements within the mass-market channel of trade are extremely competitive with all vendors competing vigorously to defend their positions within
each mass-market account. Many mass-market retailers emphasize their own in-house private label brand which creates additional pressure. Vendors to the
mass-market class of trade continually analyze their own shelf space as well as that of their competitors in an effort to maximize profits for themselves and the mass-market
retailer. The result is a natural cycle in which companies such as Natrol prune slower moving items from store shelves, replacing them with faster selling products. The Company's central strategy is
to ensure that its most profitable and rapidly selling items remain on retailers' shelves while it seeks to obtain more shelf space for additional, potentially profitable, items. In addition, the
Company is continually seeking to develop or acquire rights to new products able to capture a substantial consumer following.

Within
the health food store channel of distribution, the Company believes that its product line is under-represented and its strategy within that channel of trade is to ensure that
retail outlets carry a higher percentage of what the Company considers to be its core line of products.

The
Company provides retailers in both the health food store and the mass-market distribution channels 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 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 improve the consumer purchases of Natrol
products and increase the movement of items through each outlet. The objective of these activities is to build strong relationships with the Company's marketing partners, to increase the number of
stores carrying its products and improve the profitability of the items sold within each of the Company's trading partners.

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Prolab
products are sold primarily through gyms, health food stores and internationally through designated distributors. There is little overlap between the Prolab distributors and those
distributors served by the Natrol brand in its health food channel of trade. The typical Prolab distributor specializes in distributing sports nutrition products. Approximately 40.5% of Prolab's sales
are to distributors who sell products to European, Canadian and other non-domestic accounts.The Company has one distributor that they sell
to outside the United States. Prolab's export sales to this distributor were 18.2%, 19.2%, and 14.2% in 2002, 2001, and 2000, respectively.

Prolab's
domestic sales are primarily to wholesalers who in turn service retail accounts. Prolab's wholesaler network focuses on health food stores and gyms that cater to body builders
and other individuals seeking a high level of fitness.

Prolab's
sales force is independent of Natrol's sales force. However, the two sales forces coordinate efforts where appropriate.

One
customer represented 12.3% of net sales in the year ended December 31, 2002. This customer accounted for 13.4% of accounts receivable at December 31, 2002. No other
customers represented more than 10% of net sales in 2002. No customers represented more than 10% of net sales in the years ended December 31, 2001 or 2000.

CONTRACT MANUFACTURING AND INGREDIENT SUPPLY SALES: EPI

The Company's contract manufacturing services are primarily marketed through the EPI sales force. The Company manufactures a number of products pursuant to
contracts with customers who distribute the products under their own private labels. As a contract manufacturer, the Company will often assist its customers in the formulation of their products.
Contract manufacturing accounted for approximately 3.9% of the Company's gross sales in 2002.

In
its bulk ingredient business, EPI primarily sells nutraceutical grade dehydrated vegetable products, mostly garlic, to other manufacturers, distributors and marketers of dietary
supplements. Non-vegetable based products include Melatonin and Cetyl Myristoleate. EPI obtains its bulk vegetable ingredients from ConAgra Foods, Inc. (ConAgra) pursuant to a
multi-year supply agreement that gives the Company the exclusive right to sell ConAgra's nutraceutical grade vegetable powders in the dietary supplement industry. This agreement extends
until December 31, 2007 and stipulates certain pricing and volume targets.

Bulk
ingredient sales accounted for 4.7% of the Company's gross sales in 2002. Sales personnel for this division call on customers nationwide.

The
Company's strategy is to establish exclusive relationships with primary manufacturers of raw materials and to sell these ingredients to other users of nutraceutical grade materials
and to broaden its product offerings as favorable distribution opportunities arise.

MARKETING

BRANDED PRODUCTS

Management believes the Company's strategy of selling the Natrol and Laci Le Beau and Prolab brands through all appropriate channels of distribution including the
health, mass-market, convenience store, gym and Internet channels distinguishes the Company from its competition. Most competitors sell products into each channel using different brand
names within each channel.

The
Company's core strategy is to continue to build the Natrol, Laci Le Beau and Prolab 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 and other channels by positioning its products as a high quality brand rather than a value brand.

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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 constantly reviews its media mix for its effectiveness in creating consumer demand. As such, the Company's use of certain media in past operating periods is not necessarily
an indicator of media choices to be made in future operating periods.

INGREDIENT SUPPLY SALES AND CONTRACT MANUFACTURING SALES

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

The
contract manufacturing business relies on trade shows, trade publications, and word-of-mouth as well as the delivery of information from its sales staff,
primarily its Essentially Pure Ingredients sales people.

RESEARCH & PRODUCT DEVELOPMENT

The Company's product development department consists of an internal staff of professionals with extensive nutraceutical and scientific backgrounds. This group of
product development professionals reports to the Vice President of Marketing and works with marketing brand managers to evaluate product categories and SKUs for trends 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.

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
on-line databases. The staff
meets with vendors and evaluates new ingredients. The product development team also consults scientists and employs research consultants on a regular basis regarding new product concepts.

Before
a product is introduced, the product development team reviews the safety and efficacy of ingredients, standards for production, and with assistance from FDA and patent counsel
reviews labeling information, label claims and potential patent, trademark, legal or regulatory issues. The Company's marketing team also attempts to assess potential marketing demand through focus
groups and other research techniques.

The
Company actively participates in and financially supports a number of scientific and educational industry organizations that promote consumer well being. These include the Citizens
for Health, the National Nutritional Foods Association ("NNFA"), American Herbal Products Association, American Herbal Pharmacopoeia, and the American Botanical Council. The Company is also a founding
member of the Dietary Supplement Education Alliance ("DSEA") of which Mr. Balbert serves as the CEO. The DSEA is a not-for-profit organization consisting of more
than 60 companies whose role is to improve public health by communicating the benefits of dietary supplements.

MANUFACTURING AND PRODUCT QUALITY

DIETARY SUPPLEMENTS

The Company manufactures its branded Natrol and private label supplements as well as Prolab tablets and capsules at its 90,000 square foot manufacturing
facility/headquarters located in Chatsworth, California. At this facility, the Company manufactures both tablets and two-piece capsules, which account for more than 90% of the
Company's supplement sales. The Company uses third party vendors to produce its liquid products, bars, powders and softgels.

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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 Good Manufacturing Practices ("GMPs"). The Company maintains an "A" compliance rating within the National
Nutritional Foods Association's GMPs Third Party Certification Program. Based in Newport Beach, CA, the NNFA is the largest dietary supplement trade association, representing 3,000 retailers
and 1,000 manufacturers, suppliers and distributors of health foods, dietary supplements, natural ingredient cosmetics and other natural products. Natrol is one of approximately two dozen companies in
the NNFA membership to be
awarded the prestigious "A" compliance rating. The NNFA GMP Certification Program is designed to verify compliance with a standardized set of GMPs developed by the NNFA.

The
Company's manufacturing facility includes an on-site laboratory, which is staffed by the Director of Quality Assurance, qualified scientists, chemists, technicians and
support personnel to provide GMP compliance services. In support of its commitment to analytical product analysis, the Natrol laboratory uses state of the art computerized instrumentation for
providing reliable, accurate product analysis testing for a single raw material to complex multi-vitamins. The major laboratory instrumentations include the mass spectrophotometer and several high
performance liquid chromatographs. The laboratory is also encompassed by atomic absorption, infrared spectrophotometer, ultraviolet-visible spectrophotometer, Karl Fisher moisture analyzer, density
tester, thin layer chromatography application and stability environmental chamber for product shelf life determination.

The
Company requires all raw materials or finished products 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 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.

During
2002, the Company converted to SAP, one of the most sophisticated integrated computer systems in the world. Through SAP, the Company can efficiently monitor the details of its
production and shipping systems giving managers step by step visibility into each of the Company's production processes.

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, 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, Sam-E, 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. Two suppliers, Century Foods and Inter-Cal Nutroceuticals, Inc., each accounted for more than 10% of the Company's raw
material purchases in 2002. The Company has alternatives to thes suppliers should either of these vendors stop supplying the raw materials they currently supply.

Specialty Suppliers:

ConAgra supplies the Company's EPI division nutraceutical grade vegetable powders, primarily garlic, under an exclusive supply agreement (see INGREDIENT SUPPLY
below). 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

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conditions include job actions or strikes by employees of suppliers, weather, crop conditions, transportation interruptions and natural disasters or other catastrophic events.

The
Company also sells a limited number of products under the supplier's trademark. The most significant of these is the Company's Ester-C® line of products which
accounts for approximately 9% of the Company's gross sales. When the Company markets products under the supplier's trademark, 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. Price increases from these suppliers
could severely impact the profitability of these items. 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 has 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 its 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.

The
Company also owns a 132,000 sq. ft. warehouse facility located less than one-quarter mile from its manufacturing facility. Approximately 52,000 sq. ft. of
this warehouse facility is subleased. Rental income was approximately $460,000, $414,000, $400,000 for the years ended December 31, 2002, 2001, 2000, respectively. The remaining
80,000 sq. ft. is now being used by the Company to ship finished goods to the Company's customers. 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 and processing of its herbal teas. The Company directly provides a majority of the herbs and other
raw materials used in the production of its teas to these third parties. Tea bags produced by these parties are packaged into boxes at the Company's manufacturing facility in Chatsworth, California.

PROLAB

The Company produces, at its headquarters/manufacturing facility, Prolab supplements that are sold in tablet or capsule form. However, the Company relies on third
party vendors to process and package a majority of Prolab's products which consists of powders, nutrition bars and drinks. Prolab owns a 25,000 square foot headquarters facility in Connecticut,
in which it packages a limited amount of powdered product that is manufactured by third party vendors.

INGREDIENT SUPPLY: EPI

The Company's EPI division provides raw material ingredients to the Company and other customers. The Company acquires nutraceutical grade garlic and other
vegetable powders pursuant to a multi-year supply agreement with ConAgra which requires ConAgra to sell and the Company to purchase specified amounts of certain vegetable, fruit, herbal
and botanical product. The agreement with ConAgra gives the Company the exclusive right to sell certain ConAgra products in the dietary supplement industry. This 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

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60 days, or within 15 days in the case of non-payment by the Company. The agreement was originally signed with Basic Vegetable Products ("BVPs") in 1998 when the Company
purchased BVPs' Pure Gar Division. In November 2000, BVP was acquired by ConAgra. As the successor to BVP, ConAgra was obligated to assume the terms and conditions of the original supply
agreement. At that time, Natrol and ConAgra negotiated certain modifications to the original agreement including an extension to 2007 of the supply agreement.

The
EPI 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 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 can be no assurance that third parties will not assert intellectual
property infringement claims against the Company.

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 addition, several large pharmaceutical companies, including Bayer and Wyeth, compete
with the nutritional supplement companies. 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.

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

REGULATORY MATTERS

The manufacture, packaging, labeling, advertising, promotion, distribution and sale of the Company's products are subject to regulation by numerous governmental
agencies which regulate the Company's products. The Company's products are also subject to regulation by, among other regulatory entities, the Consumer Product Safety Commission ("CPSC"), the U.S.
Department of Agriculture ("USDA") and the Environmental Protection Agency ("EPA") and the U.S. Food and Drug Administration ("FDA"). 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 ("FTC"), which regulates these activities under the Federal Trade Commission Act ("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.

The
Dietary Supplement Health and Education Act of 1994 ("DSHEA") revised the provisions of the Federal Food, Drug, and Cosmetic Act ("FFDC Act") 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 FFDC Act.

Under
the current provisions of the FFDC Act 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 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 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 health claim into interstate commerce. For health claims that the FDA has approved, no prior
notification is required. 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 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.

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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. 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 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 has also announced that it's intention to promulgate new GMPs specific to dietary supplements. The FDA is now accepting comments over these newly proposed GMPs which are
in compliance with DSHEA. Once the required 90 day public comment period is over, the FDA will most likely adopt the proposed new GMPs either as is or in some modified form.

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. The Company intends to comply with the new GMPs once they are adopted.

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 record keeping, 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 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's internal staff, in conjunction with outside counsel, reviews its advertising claims for compliance with FTC requirements.

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

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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. Some states also permit these laws to be enforced by Private
Attorneys General. These Private Attorneys Generals may seek relief for consumers, seek class action certifications, seek class-wide damages, seek class-wide refunds and
product recalls of products sold by the Company. In the ordinary course of business, the Company is named as a defendant in these types of Private Attorneys General Actions along with other vitamin
and supplement companies. Until the courts rule that laws have been violated, that the actions can proceed as Private Attorneys General and or Class Actions and that cognizable injuries have occurred,
the Company does not believe such actions will have any material impact on its operations. 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 or sales.

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.

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 record keeping requirements, expanded 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, 2003, the Company had approximately 264 employees. Of such employees, approximately 63 were engaged in marketing and sales, 156 were devoted
to production and distribution and 45 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.

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RISK FACTORS AND FACTORS AFFECTING FORWARD LOOKING STATEMENTS

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 filings with the Securities and Exchange Commission.

Factors
that could cause or contribute to the Company's actual results differing materially from those discussed herein and in any forward looking statement or for the price of the
Company's Common Stock to be affected adversely include but are not limited to:

Industry trends.The total United States retail market for nutritional supplements is highly fragmented. Industry sources
report that the VMHS sector grew substantially during most of the 1990s, in many years at a double digit pace. However, the data during the last several years shows the rate of growth in the industry
became negative and is currently in the low single digit growth range.

Information
Resources, Inc. ("IRI") tracks sales data within the food, drug, and mass-market channels of distribution. For the 52 weeks ending March 3, 2003,
vitamin, mineral and supplement sales in these channels of distribution rose 0.2% when compared to the same period a year earlier. However unit sales were down 1.2%. These trends have adversely
affected Natrol's business and results of operation in 2002 and 2001.

Private
label business has been a significant growth element within the VMHS industry. The growth of private label sales impacts the sales of branded products such as those distributed
by Natrol. Private label sales are, to an ever greater degree, being emphasized by large mass-market retailers. As such, the growth of brands such as Natrol, Laci LeBeau, and Prolab within
food, drug, and general mass-market merchants remains both highly competitive and uncertain.

In
addition to the trends in the nutraceutical industry, the United States economy has experienced a significant weakness throughout 2002 and the first quarter of 2003, in part due to
uncertainty over foreign events, terrorist's activities, and the war with Iraq. A continued sluggish economy would inevitably impact Natrol as well as the entire vitamin, mineral and supplement
sector.

There
can be no assurance that the more robust industry growth rates experienced between 1995 and 1999 can be regained. In addition, there can be no assurance that the industry growth
rate will not decline in the future or that the growth rate of the U.S. economy may not be negative. Such a failure to achieve and sustain growth in the industry or in the U.S. economy as a whole may
have a material adverse effect on the Company's ability to return its results to its historic rates of growth 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 addition, large
pharmaceutical companies compete with the Company and others in the dietary supplement industry. 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. Private
label

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brands at mass-market chains represent substantial sources of income for these merchants and the mass-market merchants often support their own labels at the expense of other
brands.

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 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. For example, during 2002, ephedrine products were routinely criticized in the press due to high profile athlete
deaths that the press assumed were related to ephedrine. The effects of such criticism on weight loss and sports nutrition products in particular or on the supplement industry as a whole is uncertain.
The result of the extremely negative publicity surrounding ephedrine is that product liability insurance coverage for ephedrine based products disappeared and as of the date of this document, the
Company longer sells products containing ephedrine.

Reduced Product Liability Insurance Coverage and Exposure to Product Liability Claims.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 $5.0 million. During 2002, the market for product liability insurance for businesses within the
nutraceutical industry narrowed substantially. Occurrence-based coverage was unavailable to the Company. As a result, the Company was forced to acquire claims-made coverage. The price of
coverage escalated more than five fold and the amount of coverage that was able to be purchased was limited to the amount of insurance actually purchased. Coverage comparable to that purchased in
prior years was simply unavailable to the Company. There can be no assurance that insurance will, in future years, be available at a reasonable cost or available with limits that meet the requirements
of the Company's current customer base, or, if available, will be adequate to cover liabilities. When the Company renewed its product liability coverage during the years 2001 and 2002, it was not able
to renew or find new coverage for its ephedrine-based products. 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 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.

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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. New products can often take substantial periods of time to develop consumer awareness, consumer acceptance and sales volume. Some new products fail
and as a result have to be discontinued. In addition, products currently experiencing strong popularity and rapid growth may not maintain their sales volumes over time.

Product Returns.Product returns are a part of the Company's business. Products may be returned for various reasons including
expiration dates or lack of sufficient sales velocity. The Company accrues a reserve for returns based on historical data. During 2002, returns and charges for damages and outdated products amounted
to approximately 8.7% of gross sales, less than the 14.5% figure for 2001. The Company continually works to lessen the impact of returns through better management of its SKU
count at retail establishments and more effective use of sales and marketing programs. Even so, there is no guarantee that future returns will not equal or exceed the levels experienced in 2001.
Furthermore, the loss of a major account, could result in a substantial amount of returns.

Inventory Risk.The Company's products are tested for stability and each product has associated with it an expiration date
after which the product cannot be sold. Expiration dates can be as short as one year or, in some cases as long as three years. In order to provide the freshest product possible, the Company makes
every attempt to produce a product on a just-in-time basis. However, as sales trends change it is possible for the Company to over-produce finished goods inventory
or have excess raw materials which are not used before their expiration dates. The Company regularly disposes of overstocked finished goods and expired raw material inventory. Should sales trends
change too rapidly or should manufacturing planning be poor, the Company could be subject to larger than normal expenses for writing off inventory which would effect the financial condition of the
Company and results of operations during the period in which larger than expected write downs of inventory were to occur.

Distribution Gains.One of the Company's prime goals has been to gain additional distribution in all channels of trade that
sell vitamins and supplements to consumers. The Company continues to seek additional avenues to sell its products as well as to gain additional distribution for profitable rapidly selling products in
existing accounts. The Company's failure to make addition distribution gains or to maintain current distribution and expand sales of core product could have an adverse material effect on the Company's
business, financial condition and results of operations.

Cost of Retail Relationships.Many large retailers require various forms of incentive programs in order to develop the brand
with them. These programs include slotting fees, coop advertising programs, rebate incentives, price off promotions, scandowns and other forms of support. The Company must continually evaluate
specific programs to ascertain the profitability of potential business from each retailer. Because of such brand based programs, the Company may ascertain that it cannot profitably do business with a
retailer. This may cause the Company to stop doing business with existing customers or not allow the Company to enter into a business relationship with a potential new customer, each of which in turn
could dampen future revenue growth.

Government Regulation.The manufacture, packaging, labeling, advertising, promotion, distribution and sale of the Company's
products are subject to regulation by numerous governmental agencies which regulate the Company's products. The Company's products are also subject to regulation by, among other regulatory entities,
the CPSC, the USDA, the EPA and the United States FDA. Advertising and other forms of promotion and methods of marketing of the Company's products are subject to regulation by the FTC which regulates
these activities under the FTCA. The manufacture,

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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.

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. Furthermore, 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 GMPs for foods. The FDA has issued an advanced notice of its intention to promulgate
new GMPs which, when finally adopted may be more expensive to follow than prior GMPs. 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 withdrawals, 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 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. 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's internal
staff, in conjunction with outside counsel, reviews its advertising claims.

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

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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 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 DSHEA 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 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.

Dependence on Significant Customers.One major customer during 2002 represented 12.3% of net sales. The Company's top 10
customers accounted for approximately 44% of the Company's business. There is no assurance that the Company's major customers will continue as major customers of the Company. The loss of a significant
number of major customers, or a significant reduction in purchase volume by or financial difficulty of such customer, 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 and retain other
skilled personnel. 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 Business Fluctuations.In reaction to current industry trends and the Company's financial performance, the
Company has worked to manage expenses such as payroll and advertising in order to ensure the profitability of the Company. Such restrictions on expenditures may have a long-term effect on
revenue growth. Should industry and general economic trends for the nation as a whole continue to be difficult, the Company may have to reduce payroll as well as other forms of

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overhead and fixed expenses. Such cutbacks could further affect, in a negative manner, the Company's ability to increase revenues and profits.

Moreover,
in order to grow revenue and profits, the Company has made a calculated decision to enter new marketplaces for its products. The most significant decision has been to enter the
multi-level marketing business by launching Annasa in order to market new and unique products directly to consumers using a sales force of multi-level marketing distributors selling product carrying
the Annasa brand label. In 2002, the Company invested more than $1 million in this business. The Company anticipates investing at least as much until cash flow break even is reached. Cash flow
break even is not anticipated in 2003. While the Company believes the investment in Annasa is sound, the Company cannot guarantee that its investment in this multi-level marketing business will be
successful.

Furthermore,
the Company may have to substantially alter its business strategy to grow the core Natrol and Prolab brands in what has been a difficult business environment during recent
years. Additionally, should national economic trends deteriorate due to conflict in the middle east, the high cost of gasoline and other petroleum-based products, or other reasons, the Company may not
be able to reduce expenses as rapidly as is necessary to maintain profitability. If corporate or industry trends reverse themselves in a strong, positive way resulting in sudden growth of the
Company's revenues, the Company's management, operations, sales and administrative personnel and other resources may be strained in the short term. Given the recent negative industry trends,
attracting, training, motivating, managing and retaining qualified employees may be difficult. No assurance can be given that the Company's business will grow in the future or that the Company will be
able to effectively manage such growth. Nor can assurance be given that if the Company's core business erodes, the Company can stabilize its revenue and manage the Company profitably in the short
term. The Company's inability to manage its growth or negative 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 one acquisition in 1999, two acquisitions in 1998, and, although no
acquisitions were completed during the last three years, the Company expects to pursue additional acquisitions and new business opportunities 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. Should an acquisition opportunity arise, the Company would have to seek outside funding to support such an acquisition.
There is no guarantee that the Company would be able to obtain financing for or otherwise consummate any future acquisitions even if management believes such an acquisition would be beneficial to the
Company. Moreover, future acquisitions would likely require additional financing which would likely result in an increase in the Company's indebtedness or the issuance of additional stock which may be
dilutive to the Company's shareholders. 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. As a general rule, the Company will publicly announce acquisitions only after a definitive
agreement has been signed.

The
Company has faced all of these challenges with its acquisitions, in particular its acquisition of Prolab in October 1999. In 2001, the Company recorded a charge of
$20 million as a result of the impairment of Prolab. While the Company continues to believe that the Prolab business is an important part of the Company's product mix, there can be no guarantee
that Prolab sales will increase or increase at satisfactory rates.

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Current
accounting practices requires the Company to continually evaluate goodwill for impairment on at least an annual basis. On January 1, 2002, the Company adopted SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill not be amortized. In accordance with such adoption, the Company identified all reporting units in
conjunction with the provisions of SFAS No. 142 and allocated all goodwill accordingly. Beginning in 2002, goodwill is evaluated for impairment annually, or whenever events or changes in
circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company tested goodwill for impairment using the two-step process prescribed in SFAS No.142. The
first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company performed the first step of the impairment test, and determined that
the there was no impairment of the Prolab segment, but that there was potential impairment of the Natrol segment. The Company performed the second step as of December 31, 2002 for the Natrol
segment and determined that its goodwill balance of $10,958,000 was impaired. The impairment loss was recorded as a cumulative effect of a change in accounting principle in the accompanying
consolidated statement of operations for the year ended December 31, 2002.

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 further 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.

Regardless
of the potential problems surrounding a potential acquisition, the Company regularly evaluates potential acquisitions of other businesses, products and product lines and may
hold discussions regarding such potential acquisitions.

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 with more recent history of use and effects. Accordingly, the
Company's products, even when used as directed, are evaluated to identify any harmful side effects. Any such unintended and unconnected 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, 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®, 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. During 1999, BVP, the Company's supplier of bulk garlic at that time, experienced work stoppages due to a strike as well as supply problems due to a poor harvest of garlic bulbs.
With respect to products that are sold by the Company under the supplier's trademark, such as Ester-C®, 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. Price increases from such suppliers
would directly affect the Company's profitability should the Company be unable to

20

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pass such price increases on to its direct customers. 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. Although the Company purchases goods from a variety of vendors, two vendors each accounted for more than 10% of
the Company's purchases of raw material in 2002. The loss of either one of these vendors could have a material impact on the Company's ability to source raw material and manufacture finished product
associated with the raw materials supplied by these vendors. The result could be a material and adverse effect on the Company's profitability.

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; (vi) the availability of raw
materials from suppliers; and, (vii) the Company's ability to accurately predict inventory needs so that it does not overstock items which eventually must be written off due to low demand, or,
that it fails to stock enough of an item so that sales are not lost due to lack of supply. 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 historically been subject to wide fluctuations and daily trading volume is currently relatively low.

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. In particular, the stock market has experienced a significant downward trend in recent times due to
many factors including economic trends, trends in certain market sectors such as the high-tech sector and uncertainty regarding future events in world news. In addition, 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 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

21

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operations. The Company does not carry earthquake insurance on its facilities. In addition, the Company's softgel and liquid products, the Laci Le Beau tea products as well as all of Prolab's
non-tablet and capsule products which make up a majority of Prolab's business are manufactured by third party contractors. The Company's profit margins on these products and its ability to
deliver these products on a timely basis are dependent upon 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
first-line 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.

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.

Currently,
the Company has few patents on its products and no material business is derived from those items that are patented. 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.

Risk Associated with Large Controlling Shareholders.Natrol's public float is relatively small, consisting of less than 40%
of the Company's issued shares. More than 60% of the Company's stock is owned by three large shareholders. The decision by any one of these shareholders to sell their interest in the Company could
materially and adversely affect the Company's share price.

Risk Associated with National Trends.Natrol sells its products nationally in several channels of distribution. As such, the
Company is not immune from trends in the national economy. Negative
employment or other economic trends directly affects the average consumer's purchasing ability which in turn can affect Natrol sales. Uncertainty due to the world events such as the war in the Middle
East can affect the general willingness of consumers to spend on any item, including Natrol products, that the consumer may not feel is essential.

Continued Acceptance of Natrol Products.The Company works assiduously to continually burnish the brand image of its
products. Even so, negative events, negative publicity about supplements in particular or in general, and other factors could lead to a future lack of acceptance of the Company's products. Such events
or publicity may not be related to the Company itself. Even so such events or other factors could reduce demand for Natrol products.

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Availability of Capital.Natrol's debt is currently limited to mortgage debt associated with its property. Should the Company
need to borrow, the cost of capital may be high. Traditional debt financing may be unavailable and the Company may have to seek alternative sources of financing, including the issuance of new shares
of stock or preferential stock that could dilute current shareholders.

Risk of Litigations from Private Attorneys General.Advertising and labeling for dietary supplements and conventional foods
are, in addition to the federal government, regulated by state and local authorities. Some states also permit these laws to be enforced by Private Attorneys General. These Private Attorneys Generals
may seek relief for consumers, seek class action certifications, seek class wide damages and product recalls of products sold by the Company. In the ordinary course of business, the Company is named
as a defendant in these types of Private Attorneys General Actions along with other vitamin and supplement companies. Until the courts rule that laws have been violated, that the actions can proceed
as Private Attorneys General Class Actions and that the cognizable injury has occurred, the Company does not believe such actions will have any material impact on its operations. 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 or sales.

Investment in New Ventures.During 2002, Natrol invested more than $1 million to establish its new multi-level
marketing company, Annasa. There is no guarantee that this investment will prove to be profitable. Moreover, the Company intends to invest additional capital into Annasa during 2003 and cash flow
break even is not anticipated until 2004. The Company expenses all of its investment in Annasa as the investment is made which has the effect of lowering consolidated earnings and earnings per share.

ITEM 2.    PROPERTIES

The Company owns its 90,000 square foot manufacturing, distribution and office facility in Chatsworth, California. The Company has occupied this facility since
March 1997. The facility was designed and constructed to the Company's specifications and includes areas for receiving, quarantine of new materials, manufacture, quality control and laboratory
activities, research and development, packaging, warehousing and administrative offices.

The
Company also owns its 132,000 square foot warehouse facility. This facility is located within one-quarter mile of the Company's headquarters facility. The Company leases
52,000 sq. ft. of this space to a third party. The Company also owns a 25,000 sq. ft. light manufacturing and warehouse facility which houses its Prolab operations in Bloomfield, Connecticut.

ITEM 3.    LEGAL MATTERS

From time to time the Company is subject to litigation incidental to its business, including product liability claims, Private Attorneys General Actions and Class
actions. Such claims, if successful, could exceed applicable insurance coverage.

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

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PART II

See Part III, Item 12, for a description of securities authorized for issuance under the Company's equity compensation plans.

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

PRICE RANGE OF COMMON STOCK

The Common Stock of the Company is traded on the NASDAQ National Market under the symbol "NTOL." On March 14, 2003, the last reported sales price of the
Company's Common Stock as reported on the NASDAQ National Market was $1.12. As of March 14, 2003 there were 29 holders of record of the Company's Common Stock.

The
high and low sales closing prices for the Common Stock as reported by the NASDAQ National Market for the years ended December 31, 2002 and 2001 are set below:

Fiscal year ended December 31, 2002High

LowQuarter ended March 31, 2002

$
2.70

$
1.37Quarter ended June 30, 2002


1.75


1.26Quarter ended September 30, 2002


1.80


1.07Quarter ended December 31, 2002


1.65


.96


Fiscal year ended December 31, 2001High

LowQuarter ended March 31, 2001

$
2.13

$
1.31Quarter ended June 30, 2001


2.35


1.25Quarter ended September 30, 2001


4.20


2.14Quarter ended December 31, 2001


3.40


2.35


DIVIDEND POLICY

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.

ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA

The following selected financial data is derived from the audited consolidated financial statements of Natrol and its subsidiaries. The data set forth below
should be read in conjunction with

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"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.

|                                                            |                                                                     | Year Ended December 31,
|----------------------------------------------------------- | ------------------------------------------------------------------- | -----------------------
|
|
|Consolidated Statements of Operations Data:                 |                                                                     |                        
|Net sales(1)                                                |                                                                     | $                      
|Cost of goods sold                                          |                                                                     |                        
|                                                            |                                                                     |                        
|Gross profit                                                |                                                                     |                        
|                                                            |                                                                     |                        
|Selling and marketing expenses                              |                                                                     |                        
|General and administrative expenses                         |                                                                     |                        
|Impairment of goodwill                                      |                                                                     |                        
|                                                            |                                                                     |                        
|Total operating expenses                                    |                                                                     |                        
|                                                            |                                                                     |                        
|Operating income(loss)                                      |                                                                     |                        
|Interest income (expense), net                              |                                                                     |                        
|                                                            |                                                                     |                        
|Income (loss) before income tax provision                   |                                                                     |                        
|Income tax provision (benefit)                              |                                                                     |                        
|                                                            |                                                                     |                        
|Income (loss) before cumulative effect of accounting change |                                                                     |                        
|Cumulative effect of change in accounting principle         |                                                                     |                        
|                                                            |                                                                     |                        
|Net income (loss)                                           |                                                                     | $                      
|                                                            |                                                                     |                        
|Income (loss) per share:                                    |                                                                     |                        
|                                                            | Basic income (loss) before cumulative effect of accounting change   |                        
|                                                            | Diluted income (loss) before cumulative effect of accounting change |                        
|                                                            | Basic earnings (loss) per share                                     |                        
|                                                            | Diluted earnings (loss) per share                                   |                        
|                                                            | Weighted average shares outstandingbasic                           |                        
|                                                            | Weighted average shares outstandingdiluted                         |                        

|                                        |  | December 31,
|--------------------------------------- |  | ------------
|
|
|Consolidated Balance Sheet Data:        |  |             
|Cash and cash equivalents               |  | $           
|Marketable securities                   |  |             
|Working capital                         |  |             
|Total assets                            |  |             
|Long-term debt, less current maturities |  |             
|Total stockholders' equity (deficit)    |  |             

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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, Inc. and subsidiaries (collectively, the "Company") manufactures and markets branded, high-quality dietary supplement products,
including vitamins, minerals, hormonal supplements, herbal products, specialty combination formulations and sports nutrition supplements, through its three operating segments. The segments include:
the Natrol operating segment, which manufactures and markets Natrol and Laci Le Beau branded products, and which, under the EPI name, contract manufactures products and sells raw material ingredients;
Prolab Nutrition, Inc. ("Prolab"), which develops, manufactures and markets sports nutrition products; and Annasa, Inc. ("Annasa"), which was established in 2002, to develop a
direct-to-consumer multi-level marketing business.

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. In addition to the core brand, Natrol sells herbal teas under the Laci Le Beau brand name within the same channels of trade as the Natrol
core brand.

The
Company markets sports nutrition products under the Prolab brand name. Prolab products are sold primarily in health clubs and gyms as well as the health food store channel of trade
and internationally in select countries through international distributors.

During
2002, the Company launched a multi-level marketing company using the Annasa brand name. Annasa, was in the development stage during 2002, with approximately $44,000 in revenue.
The full launch of Annasa commenced in January 2003. The Company expects to continue to invest in Annasa during 2003 and does not expect Annasa to reach cash flow break even until 2004. The
Company expects to incur an additional $1-to-$2 million in expenses before Annasa reaches cash flow break even.

Natrol
products are sold in most mass-market chain drug retail outlets such asWalgreens, Rite Aid, Walmart, Eckerd, CVS,most
health food stores includingWhole Foods Markets, Vitamin Cottage, Hi HealthandWild Oatsand, to a
more limited degree, grocery stores such asKrogerandRalphs.

The
Company was not able to grow its business during 2002. In past years, Natrol's growth was supported by increased penetration into its core mass-market and health food
channels of trade as well as by new product introduction. During 2002, the Company was not able to increase its overall presence within these channels of trade. Faced with increased competition from
other vendors and private label "house" brands which have been strongly supported by the Company's largest mass-market customers, the Company, in a number of instances, intentionally
reduced the number of

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items on the shelves of its customers, deleting slow moving and unprofitable items. The Company did so to improve the overall profitability of the Natrol brand. After careful analysis, the Company
determined that within the mass-market channel of trade, it is often unprofitable to sell secondary and tertiary items (i.e., items without a large following) as the mass market retailers
often promote their own private label products to meet the needs of consumers for these types of products. Profitability in the mass market channel is also affected because of the large amount of
returns of slow moving items. When such products are returned the products generally have limited, if any, value because such products generally have little remaining shelf life.

Product
returns are a recurring part of the Company's business. Products may be returned for various reasons including expiration dates or lack of sufficient sales velocity. During 2002,
returns and reimbursements for damages and outdated products amounted to 8.7% of gross sales, a significant decrease from 2001, when returns represented approximately 14.5% of gross sales. The Company
is continuing to work to reduce the volume of returns through better management of its SKU count at retail establishments and through more effective use of sales and marketing programs. Even so, there
is no guarantee that future returns will not increase to, or exceed, the levels experienced in 2001. Furthermore, the possibility exists that should the Company lose a major account, the Company may
be forced to accept a substantial amount of returns.

Information
Resources, Inc. ("IRI") tracks sales data within the food, drug, and mass-market channels of distribution. For the 52 weeks ending March 3, 2003,
vitamin, mineral and supplement sales in these channels of distribution rose 0.2% when compared to the same period a year earlier. However unit sales were down 1.2%. These trends have adversely
affected Natrol's business and results of operations in 2002 and 2001.

Private
label business has been a significant growth element within the VMHS industry. The growth of private label sales impacts the sales of branded products such as those distributed
by Natrol. As noted above, private label sales are, to an ever greater degree, being emphasized by large mass-market retailers. As such, the growth of brands such as Natrol, Laci Le Beau,
and Prolab within food, drug, and general mass-market merchants remains both highly competitive and uncertain.

CRITICAL ACCOUNTING POLICIES

The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America,
which requires the Company to make certain estimates and assumptions affecting the reported amounts in the consolidated financial statements and accompanying notes. The Company bases its estimates on
historical experience and on various other assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management
believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial
statements.

Revenue Recognition.The Company sells its products to retail outlets through a direct sales force and a national distributor
network. The Company recognizes revenue from sales only after product is shipped. Net sales represent product shipped less returns, estimates for future returns, spoilage allowances, allowances for
product deemed to be unsaleable by customers, free goods shipped to customers for promotional or other purposes and slotting fees. Estimates and allowances are based upon known claims and an estimate
of additional returns.

Our
recognition of revenue from sales to distributors and retailers is impacted by agreements we have giving them rights to return damaged and outdated products as well as the fact that
as a practical

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business matter, the Company and its customers are constantly working to ensure the profitability of its sets within retailers by rotating slow moving items out of stores and replacing these products
with what the Company and the retailer expect will be more profitable, faster selling items. The Company's obligation to accept returns of slow moving items may or may not be contractually bound.

The
Company constantly monitors its historical patterns of returns from customers as well as current and ongoing sales to customers and, when information is available, consumer purchases
of the Company's products from the Company's customers. When historical trends with respect to customer
returns are quantifiable, the Company will create an allowance for future returns at the time sales are made. Should the Company determine that a particular product is slow moving and will eventually
result in significant returns, it will provide for those returns at the time such an assessment is made.

In
recent years, as a result of a combination of the factors described above, we have materially reduced our gross sales to reflect our estimated returns. It is also possible that
returns could increase rapidly and significantly in the future. Accordingly, estimating product returns requires significant management judgment. In addition, different return estimates that we
reasonably could have used would have had a material impact on our reported sales and thus have had a material impact on the presentation of our results of operations. For those reasons, we believe
that the accounting estimate related to product returns is a "critical accounting estimate." Our estimate of product returns is a critical accounting estimate for both of our current operating
segments.

In
preparing our financial statements, the total amount from returns and damages and outdates in 2002, 2001, and 2000, respectively was $6.7 million, $12.5 million, and
$4.0 million. Our estimate for returns at December 31, 2002 was $69,000 greater than our estimate at December 31, 2001 and $907,000 greater than our estimate at
December 31, 2000.

Impairment of Goodwill.The determination as to whether goodwill is impaired requires a great deal of judgment. Prior to
January 1, 2002, the Company evaluated goodwill for impairment whenever events or changes in circumstances indicated that the carrying value may not be recoverable. In 2001, the Company
determined that it was appropriate to write down $20 million of goodwill associated with its Prolab reporting unit. The Company focused on Prolab's declining sales volume, issues surrounding
Prolab's ephedrine-based products, the sports nutrition market as a whole, and undiscounted cash flows. Based on all of these considerations, the Company deemed that in accordance with the then
current accounting rules, a $20 million write down of goodwill was appropriate.

On
January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill not be amortized. In accordance
with such adoption, the Company identified all reporting units in conjunction with the provisions of SFAS No. 142 and allocated all goodwill accordingly. Beginning in 2002, goodwill is
evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company tested goodwill for impairment using
the two-step process prescribed in SFAS No.142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company
performed the first step of the impairment test, and determined that the there was no impairment of the Prolab segment, but that there was potential impairment of the Natrol segment. The Company
performed the second step as of January 1, 2002 for the Natrol segment and determined that its goodwill balance of $10,958,000 was impaired. The impairment loss was recorded as a cumulative
effect of a change in accounting principle in the accompanying consolidated statement of operations for the year ended December 31, 2002.

The
remaining goodwill balance at December 31, 2002 was $4,026,000 and related entirely to Prolab. In accordance with the provisions of SFAS No. 142, the Company will, at a
minimum, perform an annual impairment review of the goodwill of the Prolab reporting unit.

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Income Taxes.Deferred income tax assets have been established for future tax benefits related to
deductible goodwill for
which the Company has recorded an impairment charge. The benefit of which, was approximately $4.1 million. Realization of this benefit is dependent on generating sufficient taxable income in
future periods. Although it is not assured, management believes it is more likely than not that the carrying value of this benefit will be realized. The amount of the benefit that is considered
realizable, however, could change if estimates of future taxable income are adjusted in future periods.

RESULTS OF OPERATIONS

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Net Sales.Net sales in 2002 decreased 2.1%, or $1.5 million, to $70.3 million from $71.8 million in
2001. Net sales in both years were adversely affected by a high level of product returns. The level of returns was approximately 8.7.% of gross sales in 2002 and 14.5% of gross sales in 2001. During
2002, the Company worked to "rationalize" its product offerings in the mass-market channel of trade where returns are most likely to occur. During 2001 it became apparent to the Company
that sales of secondary and tertiary items were not sufficient to prevent significant product returns. This rationalization process directly resulted in lower net revenue since the Company stopped
selling many secondary and tertiary items within mass-market accounts, instead limiting the sale of these items to specialty stores where the volume of sales was sufficient to prevent a
large volume of returns. As a result of this rationalization process, the level of returns was reduced substantially from that experienced in 2001.

The
Company had no products greater than 10% of gross sales in 2002. The Company's gross sales of the MSM-line of joint care products comprised 10.1% in 2001. One customer,
Walmart, accounted for 12.3% of the Company's net sales in 2002. No one customer accounted for more than 10% of net sales in 2001. The Company's top 10 customers accounted for approximately 44% of the
Company's net sales in 2002.

Gross Profit.Gross profit decreased less than 1% or $228,000, to $28.6 million, in 2002 as compared to
$28.8 million in 2001. Gross margin increased to 40.7% in 2002 from 40.1% in 2001. The increase was mainly due to a change in the product mix.

Selling and Marketing Expenses.Selling and marketing expenses decreased 3.8%, or $683,000, to $17.4 million in 2002
from $18.1 million in 2001. As a percentage of net sales, selling and marketing expenses decreased to 24.8% in 2002 from 25.2% of net sales in 2001. Approximately $500,000 of the Company's
selling and marketing expenses were due to the Company's investment in its new multi-level marketing subsidiary, Annasa. Had this investment not occurred, selling and marketing expenses in 2002 would
have been reduced to $16.9 million or 24.0% of net sales. This reduction is primarily due to a decrease in the number of promotions and advertisements run during the year. The Company's selling
and marketing expenses consist primarily of payroll and advertising in traditional media as well as the promotion of its products through targeted and sampling programs created with individual
retailers.

General and Administrative Expenses.General and administrative expenses decreased 3.5% or $339,000 in 2002 from
$9.7 million in 2001 to $9.4 million in 2002. However, consistent with the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," the Company did not amortize goodwill
in 2002. In 2001, the Company incurred $2.3 million of amortization expense related to goodwill, which was included as a component of general and administrative expenses ("G&A expenses"). In
2002, there were approximately $600,000 of G&A expenses attributable to the launch of Annasa. No such expenses were incurred in 2001. Taking these factors into consideration, G&A expenses rose
$1.4 million when compared to 2001. A majority, or $800,000 of the increase was due to legal expenses which increased largely due to the successful defense of label claims and a California

29

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Proposition 65 matter which the Company is resolving. Depreciation increased approximately $96,000 when compared to 2001. During 2002, the Company invested approximately $1.4 million in a new
SAP software system as well as new servers and other peripheral equipment to run the software. SAP is an integrated manufacturing, accounting, and management system. The SAP system was put into
service in November 2002. General business and product liability insurance expenses also rose $115,000 in 2002. The Company experienced a increase in the price of insurance in
November 2002 as it sought to renew its policies. The price of certain types of insurance rose nearly five-fold while the amount of coverage offered within the policies was reduced
sharply. It is estimated that the cost of general business, directors & officers' liability, property and product liability insurance will increase approximately $1 million in 2003 from
the expense incurred in 2002. The remaining increase in G&A expenses in 2002 over 2001 was due to general increases in payroll and the other expenses of maintaining the Company's business.

Impairment of Goodwill.In 2001, the Company determined that it was appropriate to write down $20 million of goodwill
associated with its Prolab reporting unit. The Company focused on Prolab's declining sales volume, issues surrounding Prolab's ephedrine-based products, the sports nutrition market as a whole, and
undiscounted cash flows. Based on all of these considerations, the Company deemed that in accordance with the then current accounting rules, a $20 million write down of goodwill was
appropriate.

On
January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill not be amortized. In accordance
with such adoption, the Company identified all reporting units in conjunction with the provisions of SFAS No. 142 and allocated all goodwill accordingly. Beginning in 2002, goodwill is
evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company tested goodwill for impairment using
the two-step process prescribed in SFAS No.142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company
performed the first step of the impairment test, and determined that the there was no impairment of the Prolab segment, but that there was potential impairment of the Natrol segment. The Company
performed the second step as of January 1, 2002 for the Natrol segment and determined that its goodwill balance of $10,958,000 was impaired. The impairment loss was recorded as a cumulative
effect of a change in accounting principle in the accompanying consolidated statement of operations for the year ended December 31, 2002.

Interest Income (Expense), net.Interest expense in 2002 was $731,000 versus interest expense of $885,000 in 2001. Interest
income in 2002 was $87,000 versus $149,000 in 2001. Interest expense decreased in 2002 as the Company had less debt outstanding. In addition to the debt on its property, during part of 2001, the
Company also paid interest on outstanding borrowings related to its line of credit.

Income Tax Provision (Benefit).Income tax expense was $440,000 in 2002, and the effective income tax rate was approximately
39%. In addition, the Company recorded an income tax benefit of $4,139,000 related to the cumulative effect of the change in an accounting principle (adoption of SFAS No. 142, "Goodwill and
Other Intangible Assets"). Although the Company had a pretax loss of $20,340,000 in 2001, income tax expense was $587,000, as the loss included a charge of $20 million related to
non-deductible goodwill.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

Net Sales.Net sales in 2001 decreased 7.4%, or $5.7 million, to $71.8 million from $77.5 million in
2000. Net sales in both years were adversely affected by a high level of product returns. The level of returns was approximately 14.5% of gross sales in 2001 and 4.3% of gross sales in 2000. The
Company believes these high rates of returns were caused by negative industry trends which caused retailers to

30

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decrease warehouse stocking levels and in some cases to reduce the amount of shelf space devoted to vitamins as well as to the failure of certain products introduced during 1998 and 1999 to gain
popularity with consumers. In addition, the Company believes that, within the mass-market channel of distribution, there was not enough demand for many of the Company's secondary and
tertiary products. This lack of demand when combined with the Company's expanded number of products carried by its
mass-market customers in 1998 and 1999, caused the level of returns to increase substantially in 2001 and 2000.

Only
one line of products, the MSM-line of joint care products, accounted for more than 10% of the Company's gross sales in 2001 and 2000 and no customer accounted for more
than 10% of sales, although the Company's top ten customers accounted for approximately 42% of gross revenue.

Gross Profit.Gross profit increased 5.9%, or $1,605,000 to $28.8 million in 2001 as compared to $27.2 million
in 2000. Gross margin increased to 40.1% in 2001 from 35.1% in 2000. The increase was mainly due to product mix, with an emphasis on selling products that had higher margins, and an effort to control
discounting of product.

Selling and Marketing Expenses.Selling and marketing expenses decreased 22.3%, or $5.2 million, to
$18.1 million in 2001 from $23.3 million in 2000. As a percentage of net sales, selling and marketing expenses decreased to 25.2% in 2001 from 30.0% in 2000, which was the highest in the
Company's history. After experiencing the highest selling and marketing expenses in its history in 2000, the Company focused on reducing these expenditures in 2001. Advertising expenditures were
reduced sharply. Even so, the Company was forced to spend heavily on various promotions in order to support sales in a declining market.

General and Administrative Expenses.General and administrative expenses decreased 5.5% or $572,000, to $9.7 million
in 2001 from $10.3 million in 2000. As a percentage of net sales, general and administrative expenses were13.6% in 2001 and 13.3% in 2000.

Impairment of Goodwill.In 2001, the Company determined that it was appropriate to write down $20 million of goodwill
associated with its Prolab reporting unit. The Company focused on Prolab's declining sales volume, issues surrounding Prolab's ephedrine-based products, the sports nutrition market as a whole, and
undiscounted cash flows. Based on all of these considerations, the Company deemed that in accordance with the then current accounting rules, a $20 million write down of goodwill was
appropriate.

Interest Income (Expense), net.Net interest expense for 2001 was $736,000 versus $1.2 million in 2000. Interest
expense decreased in 2001 as the Company repaid its line of credit early in the year. A substantial portion of the interest expense during 2000 stemmed from the Company's borrowings under its line of
credit, which had an average outstanding balance of $7.5 million for the year ended December 31, 2000.

Income Tax Provision (Benefit).The Company income tax expense $587,000 in 2001. The impairment of goodwill of
$20 million related to its Prolab acquisition was not tax deductible in 2001. In 2000, the Company recorded an income tax benefit of $2.4 million related to its pre-tax loss
of $7.6 million.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2002, the Company had working capital of $18.7 million, as compared to $18.2 million in working capital at
December 31, 2001. The increase was primarily due to a net increase in trade payables and other short-term liabilities offset by a decrease in receivables, inventory and prepaid
expenses.

31

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Net
cash provided in operating activities was $6.2 million for the year ended December 31, 2002 versus net cash provided of $10.3 million in 2001 and net cash used
of $177,000 in 2000. The increase in net cash provided by operating activities in 2002 was due to income before cumulative effect of a change in accounting principle of $693,000, depreciation and
amortization and other non-cash items of $2.4 million, the reduction of inventory of $1,074,000, a reduction of income tax receivable and the buildup of income taxes payable of
$1.6 million and a net increase in other operating assets and liabilities excluding income taxes of $714,000.

In
2001, cash flows from operations was $10.3 million. Although the Company incurred a net loss was $20.3 million, $20 million related to the write down of goodwill
(a non-cash expense), associated with its 1999 acquisition of Prolab. In total, cash flows from the net loss adjusted for depreciation and amortization, impairment charges and other
non-cash items was $3.6 million. In addition, changes in operating assets and liabilities provided $6.8 million. The significant elements in net cash used in changes in
operating assets and liabilities included a $2.5 decrease in inventory, a $2.4 million decrease in accounts receivable and a $2.7 million decrease in income tax receivables. Offsetting
these items, was a net increase in prepaid expenses of $1.0 million and a decrease of payables and accrued liabilities of $229,000.

At
December 31, 2002, the Company's days sales outstanding in its trade receivable was approximately 35 days versus 33 days in 2001 and 40 days in 2000.

Net
cash used in investing activities was $1.5 million in 2002 versus $368,000 in 2001 and $562,000 in 2000.

All
of the cash used for investing activities in 2002, 2001 and 2000 was for the acquisition of property, plant and equipment. Substantially all of the investment in 2002 related to the
installation of a new integrated SAP software system and related computer equipment to manage the Company's business.

Net
cash used by financing activities was $161,000 in 2002 and $8.5 million for the year ended December 31, 2001 as opposed to net cash provided by financing activities of
$4.3 million in 2000.

During
2002, the Company reduced its debt by $281,000. This use of cash was offset by $120,000 raised through the exercise of employee stock options or the sale of stock to employees
through the Company's Employee Stock Purchase Program. Of the net cash used in financing activities in 2001, $8.3 million was used to pay down the Company's line of credit and $265,000 was used
to reduce the Company's long-term mortgage borrowings.

As
of December 31, 2002, the Company had $8.1 million in outstanding debt versus $8.4 million of outstanding debt and the end of 2001. All of the debt in both years
is related to a mortgage on the Company's manufacturing/headquarters facility and a mortgage on the Company's shipping facility.

The
Company's cash balance at the close of 2002 was approximately $10.1 million. The Company believes that its year end cash balance together with cash generated from operations
will be sufficient to fund its anticipated working capital needs and planned capital expenditures for at least the next 12 months.

The
Company currently has no outstanding debt on its books other than the mortgage debt on its properties. There is no guarantee that, should the Company need additional capital, that
financial institutions will be willing to provide capital to the Company. However, given the strength of the Company's balance sheet, the Company's historical cash flows, and the large number of
unencumbered assets in its possession, the Company believes that it can obtain sufficient financing to maintain its operations from either traditional or alternative financial institutions should that
be necessary.

In
providing the Company with additional funds, potential lenders may seek to institute covenants restricting the Company from certain activities and if the Company deems it necessary to
borrow funds

32

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with these restrictions in place, it may find that its ability to compete effectively in its market sector is hindered.

In
order to meet its long-term liquidity needs or consummate future acquisitions or to continue funding its launch of Annasa, 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 new
acquisitions and could negatively affect its operations in future periods.

RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board ("FASB") approved two new statements: SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires business combinations entered into after June 30, 2001 to be accounted for using the purchase method of
accounting. SFAS No. 142 requires that goodwill not be amortized, but be tested for impairment at least annually. The Company adopted SFAS No. 142 on January 1, 2002. In
accordance with such adoption, the Company identified all reporting units in conjunction with the provisions of SFAS No. 142 and allocated all goodwill accordingly. Beginning in 2002, goodwill
is evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The Company tested goodwill for impairment
using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The
Company performed the first step of the impairment test, and determined that the there was no impairment of the Prolab segment, but that there was potential impairment of the Natrol segment. The
Company performed the second step as of December 31, 2002 for the Natrol segment and determined that its goodwill balance of $10,958,000 was impaired. The impairment loss was recorded as a
cumulative effect of accounting change in the accompanying consolidated statement of operations for the year ended December 31, 2002. The changes in the carrying value of goodwill for the years
ended December 31, 2002 and 2001 are as follows:

|                                                      |  | Natrol |         | Prolab |   | Total   |  
|----------------------------------------------------- |  | ------ | ------- | ------ | - | ------- | -
|
|Balance as of January 1, 2001                         |  | $      | 11,898  |        | $ | 25,366  |  
|Impairment loss                                       |  |        |         |        |   | (20,000 | )
|Amortization expense                                  |  |        | (940    | )      |   | (1,340  | )
|                                                      |  |        |         |        |   |         |  
|Balance at December 31, 2001                          |  |        | 10,958  |        |   | 4,026   |  
|Cumulative effect of a change in accounting principle |  |        | (10,958 | )      |   |         |  
|                                                      |  |        |         |        |   |         |  
|Balance at December 31, 2002                          |  | $      |         |        | $ | 4,026   |  
|                                                      |  |        |         |        |   |         |  

In
accordance with the adoption of SFAS No. 142, on January 1, 2002, the Company no longer amortizes goodwill. The following table reconciles net loss and loss per share as
reported for the years

33

---

ended December 31, 2002, 2001 and 2000, respectively, to net loss and loss per share, as adjusted to exclude goodwill amortization.

|                                                                     |                       | Years Ended December 31, |       
|-------------------------------------------------------------------- | --------------------- | ------------------------ | ------
|
|
|Reported income (loss) before cumulative effect of accounting change |                       | $                        | 693   
|Add back: goodwill amortization                                      |                       |                          |       
|                                                                     |                       |                          |       
|As Adjusted                                                          |                       | $                        | 693   
|                                                                     |                       |                          |       
|Reported net loss                                                    |                       |                          | (6,126
|Add back: Goodwill amortization                                      |                       |                          |       
|                                                                     |                       |                          |       
|As adjusted                                                          |                       |                          | (6,126
|                                                                     |                       |                          |       
|Basic and diluted loss per share:                                    |                       |                          |       
|Reported income (loss) before cumulative effect of accounting change |                       | $                        | 0.05  
|Goodwill amortization                                                |                       |                          |       
|                                                                     |                       |                          |       
|As adjusted                                                          |                       | $                        | 0.05  
|                                                                     |                       |                          |       
|                                                                     | Reported net loss     |                          | $     
|                                                                     | Goodwill amortization |                          |       
|                                                                     |                       |                          |       
|As Adjusted                                                          |                       | $                        | (0.48 
|                                                                     |                       |                          |       

In
November 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No. 01-09, "Accounting for Consideration Given by a Vendor to a Customer or a
Reseller of the Vendor's Products." This new guidance provides that consideration from a vendor to a reseller is presumed to be a reduction of the selling prices of the vendor's products and,
therefore, should be characterized as a reduction of revenue when recognized in the vendor's income statement. On January 1, 2002, the Company adopted EITF Issue No. 01-09
and reclassified incentives paid to resellers of $4,340 in 2001 and $9,528 in 2000, previously reported as a component of selling and marketing expenses, as a reduction in net sales and selling and
marketing expenses.

In
August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses the financial
accounting and reporting issues for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121 but retains the fundamental provisions for
(a) recognition/measurement of impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sales. The
Company adopted SFAS No. 144 effective January 1, 2002.

In
June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that the liability for costs
associated with an exit or disposal activity be initially measured at fair value and recognized when the liability is incurred. The provisions of SFAS No. 146 are required to be applied
prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect that the adoption of SFAS No. 146 will have a material impact on the financial
statements, as there are no exit or disposal activities currently or planned.

In
December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure." This statement amends SFAS No. 123,
to provide alternative methods of voluntary transition to change to the fair value based method of accounting for stock-based employee compensation. Additionally, this statement amends disclosure
requirements of accounting for stock-based employee compensation and the effect of the method used on reporting results. As of December 31, 2002, the Company has adopted the new disclosure
requirements of SFAS No. 148.

34

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CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The following table discloses the Company's obligations and commitments to make future payments under contractual obligations at December 31, 2002 (Amounts
in thousands).

|             |       | Payment Due by Period
|------------ | ----- | ---------------------
|
|Note Payable |       | $                    
|Leases       |       |                      
|             |       |                      
|             | Total |                      
|             |       |                      

IMPACT OF INFLATION

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

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

The Company's exposure to market risks is limited to interest rate risks. The risks related to foreign currency exchange rates are immaterial and the Company does
not use derivative financial instruments.

If
the Company seeks financing or borrows other funds, it may be subject to interest rate market risk associated with a variable rate line of credit or fixed rate long-term
debt. Even so, the Company does not believe the risk associated with such borrowing is significant. Additionally, the Company does not believe that the risk is significant for its
long-term debt due to the low fixed rates and relative insignificance of the fixed long-term debt to the Company's consolidated balance sheet. The Company's
long-term debt is comprised of fixed rate notes collateralized by the Company's facilities. The table below presents principal cash flows and related interest rates by fiscal year of
maturity.

|                 |  | Expected Year of Maturity |     |  |   |    
|---------------- |  | ------------------------- | --- |  | - | ---
|
|
|Notes payable(2) |  | $                         | 301 |  | $ | 325

---

35

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ITEM 8:    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

|Index to Consolidated Financial Statements: |                                                                                                      | 
|------------------------------------------- | ---------------------------------------------------------------------------------------------------- | 
|                                            | Report of Independent AuditorsDeloitte & Touche, LLP                                                | 
|                                            | Report of Independent AuditorsErnst & Young, LLP                                                    | 
|                                            | Consolidated Balance Sheets as of December 31, 2002 and 2001                                         | 
|                                            | Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000           | 
|                                            | Consolidated Statements of Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000 | 
|                                            | Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000           | 
|                                            | Notes to Consolidated Financial Statements                                                           | 

36

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INDEPENDENT AUDITORS' REPORT

To
the Board of Directors and Stockholders of
Natrol, Inc.
Chatsworth, California

We
have audited the accompanying consolidated balance sheet of Natrol, Inc. and subsidiaries (the "Company") as of December 31, 2002, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule for the year ended December 31, 2002 listed at
Item 15(a)(2). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial
statements and the financial statement schedule based on our audit.

We
conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion.

In
our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2002, and the results of its
operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As
discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and other intangible
assets to conform to Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."

GRAPHIC

Los
Angeles, California
April 10, 2003

37

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Report of Independent Auditors

The
Board of Directors
Natrol, Inc.

We
have audited the accompanying consolidated balance sheet of Natrol, Inc. and subsidiaries as of December 31, 2001, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the two years in the period ended December 31, 2001. Our audits also included the financial statement schedule listed at the index in Item 15(a)
as of and for each of the years ended December 31, 2001 and 2000. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

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

In
our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Natrol, Inc. and subsidiaries at
December 31, 2001 and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein as of and for each of the years ended December 31, 2001 and 2000.

GRAPHIC

March 1,
2002
Woodland Hills, California

38

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Natrol, Inc. and Subsidiaries        Consolidated Balance Sheets        (In thousands, except share and per share data)

|                                                                                                                                   |                                                                                                     | December 31                                                                                         |       
|---------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------- | ------
|
|Assets                                                                                                                             |                                                                                                     |                                                                                                     |       
|Current assets:                                                                                                                    |                                                                                                     |                                                                                                     |       
|                                                                                                                                   | Cash and cash equivalents                                                                           |                                                                                                     | $     
|                                                                                                                                   | Accounts receivable, net of allowances of $409 and $363 at December 31, 2002 and 2001, respectively |                                                                                                     |       
|                                                                                                                                   | Inventory                                                                                           |                                                                                                     |       
|                                                                                                                                   | Income taxes receivable                                                                             |                                                                                                     |       
|                                                                                                                                   | Deferred income taxes                                                                               |                                                                                                     |       
|                                                                                                                                   | Prepaid expenses and other current assets                                                           |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Total current assets                                                                                                               |                                                                                                     |                                                                                                     | 27,653
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Property and equipment:                                                                                                            |                                                                                                     |                                                                                                     |       
|                                                                                                                                   | Building and improvements                                                                           |                                                                                                     |       
|                                                                                                                                   | Machinery and equipment                                                                             |                                                                                                     |       
|                                                                                                                                   | Furniture and office equipment                                                                      |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     | 23,677
|Accumulated depreciation and amortization                                                                                          |                                                                                                     |                                                                                                     | (5,867
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     | 17,810
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Deferred income taxes, noncurrent                                                                                                  |                                                                                                     |                                                                                                     | 3,853 
|Goodwill, net of accumulated amortization and impairment charge of $37,381 and $26,423 at December 31, 2002 and 2001, respectively |                                                                                                     |                                                                                                     | 4,026 
|Other assets                                                                                                                       |                                                                                                     |                                                                                                     | 39    
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Total assets                                                                                                                       |                                                                                                     | $                                                                                                   | 53,381
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Liabilities and stockholders' equity                                                                                               |                                                                                                     |                                                                                                     |       
|Current liabilities:                                                                                                               |                                                                                                     |                                                                                                     |       
|                                                                                                                                   | Accounts payable                                                                                    |                                                                                                     | $     
|                                                                                                                                   | Accrued expenses                                                                                    |                                                                                                     |       
|                                                                                                                                   | Accrued payroll and related liabilities                                                             |                                                                                                     |       
|                                                                                                                                   | Income taxes payable                                                                                |                                                                                                     |       
|                                                                                                                                   | Current portion of long-term debt                                                                   |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Total current liabilities                                                                                                          |                                                                                                     |                                                                                                     | 8,952 
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Deferred income taxes, noncurrent                                                                                                  |                                                                                                     |                                                                                                     |       
|Long-term debt, less current portion                                                                                               |                                                                                                     |                                                                                                     | 7,778 
|Commitments and contingencies                                                                                                      |                                                                                                     |                                                                                                     |       
|Stockholders' equity:                                                                                                              |                                                                                                     |                                                                                                     |       
|                                                                                                                                   | 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13,789,000 and 13,712,000 at December 31, 2002 and 2001, respectively |       
|                                                                                                                                   | Additional paid-in capital                                                                          |                                                                                                     |       
|                                                                                                                                   | Accumulated deficit                                                                                 |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     | 39,532
|                                                                                                                                   | Shares held in treasury, at cost922 shares at December 31, 2002 and 2001                           |                                                                                                     |       
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Total stockholders' equity                                                                                                         |                                                                                                     |                                                                                                     | 36,651
|                                                                                                                                   |                                                                                                     |                                                                                                     |       
|Total liabilities and stockholders' equity                                                                                         |                                                                                                     | $                                                                                                   | 53,381
|                                                                                                                                   |                                                                                                     |                                                                                                     |       

See notes to consolidated financial statements.

39

---

Natrol, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except share and per share data)

|                                                                                               |  | Years Ended December 31, |           
|---------------------------------------------------------------------------------------------- |  | ------------------------ | ----------
|
|Net sales                                                                                      |  | $                        | 70,331    
|Cost of goods sold                                                                             |  |                          | 41,727    
|                                                                                               |  |                          |           
|Gross profit                                                                                   |  |                          | 28,604    
|                                                                                               |  |                          |           
|Selling and marketing expenses                                                                 |  |                          | 17,420    
|General and administrative expenses                                                            |  |                          | 9,407     
|Impairment of goodwill                                                                         |  |                          |           
|                                                                                               |  |                          |           
|Total operating expenses                                                                       |  |                          | 26,827    
|                                                                                               |  |                          |           
|Operating income (loss)                                                                        |  |                          | 1,777     
|Interest income                                                                                |  |                          | 87        
|Interest expense                                                                               |  |                          | (731      
|                                                                                               |  |                          |           
|Income (loss) before income tax provision (benefit) and cumulative effect of accounting change |  |                          | 1,133     
|Income tax provision (benefit)                                                                 |  |                          | 440       
|                                                                                               |  |                          |           
|Income (loss) before cumulative effect of change in accounting principle                       |  |                          | 693       
|Cumulative effect of change in accounting principle, net of income tax benefit of $4,139       |  |                          | (6,819    
|                                                                                               |  |                          |           
|Net loss                                                                                       |  | $                        | (6,126    
|                                                                                               |  |                          |           
|Income (loss) per share before cumulative effect of change in accounting principle             |  | $                        | 0.05      
|Income (loss) per share attributable to cumulative effect of change in accounting principle    |  | $                        | (0.53     
|                                                                                               |  |                          |           
|Loss per share                                                                                 |  | $                        | (0.48     
|                                                                                               |  |                          |           
|Weighted-average shares outstandingbasic and diluted shares                                   |  |                          | 12,852,008
|                                                                                               |  |                          |           

See notes to consolidated financial statements.

40

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Natrol, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)

|                           |                                                             | Common Stock |         |   |     | Retained
Earnings
(Accumulated
Deficit) |   |        |     |   |         |         |  
|-------------------------- | ----------------------------------------------------------- | ------------ | ------- | - | --- | --------------------------------------- | - | ------ | --- | - | ------- | ------- | -
|
|
|Balance, January 1, 2000   |                                                             | 13,474,035   |         | $ | 135 |                                         | $ | 61,334 |     | $ | 9,071   |         | $
|                           | Shares issued in exchange for services                      |              | 25,919  |   |     | 1                                       |   |        | 128 |   |         |         |  
|                           | Exercise of stock options                                   |              | 133,500 |   |     | 1                                       |   |        | 263 |   |         |         |  
|                           | Issuance of common stock under employee stock purchase plan |              | 25,366  |   |     |                                         |   |        | 57  |   |         |         |  
|                           | Payments on shareholder loan                                |              |         |   |     |                                         |   |        |     |   |         |         |  
|                           | Net loss                                                    |              |         |   |     |                                         |   |        |     |   |         | (5,216  | )
|                           |                                                             |              |         |   |     |                                         |   |        |     |   |         |         |  
|Balance, December 31, 2000 |                                                             | 13,658,820   |         |   | 137 |                                         |   | 61,782 |     |   | 3,855   |         |  
|                           | Shares issued in exchange for services                      |              |         |   |     |                                         |   |        |     |   |         |         |  
|                           | Exercise of stock options                                   |              | 32,000  |   |     |                                         |   |        | 58  |   |         |         |  
|                           | Shares issued in exchange for services                      |              | 4,491   |   |     |                                         |   |        | 8   |   |         |         |  
|                           | Issuance of common stock under employee stock purchase plan |              | 17,043  |   |     |                                         |   |        | 21  |   |         |         |  
|                           | Net loss                                                    |              |         |   |     |                                         |   |        |     |   |         | (20,340 | )
|                           |                                                             |              |         |   |     |                                         |   |        |     |   |         |         |  
|Balance, December 31, 2001 |                                                             | 13,712,354   |         |   | 137 |                                         |   | 61,869 |     |   | (16,485 | )       |  
|                           | Exercise of stock options                                   |              | 49,166  |   |     | 1                                       |   |        | 92  |   |         |         |  
|                           | Shares issued in exchange for services                      |              | 12,480  |   |     |                                         |   |        | 17  |   |         |         |  
|                           | Issuance of common stock under employee stock purchase plan |              | 14,720  |   |     |                                         |   |        | 27  |   |         |         |  
|                           | Net loss                                                    |              |         |   |     |                                         |   |        |     |   |         | (6,126  | )
|                           |                                                             |              |         |   |     |                                         |   |        |     |   |         |         |  
|Balance, December 31, 2002 |                                                             | 13,788,720   |         | $ | 138 |                                         | $ | 62,005 |     | $ | (22,611 | )       | $
|                           |                                                             |              |         |   |     |                                         |   |        |     |   |         |         |  

See notes to consolidated financial statements.

41

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Natrol, Inc. and Subsidiaries        Consolidated Statements of Cash Flows        (In thousands)

|                                                                                                                                                          |                                              | Years ended December 31                   |       
|--------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ------
|
|Operating activities                                                                                                                                      |                                              |                                           |       
|Net loss                                                                                                                                                  |                                              | $                                         | (6,126
|Cumulative effect of change in accounting principle, net of income taxes benefit of $4,139 in 2002                                                        |                                              |                                           | 6,819 
|                                                                                                                                                          |                                              |                                           |       
|Income (loss) before cumulative effect of change in accounting principle                                                                                  |                                              |                                           | 693   
|                                                                                                                                                          |                                              |                                           |       
|Adjustments to reconcile income (loss) before cumulative effect of change in accounting principle to net cash provided by (used in) operating activities: |                                              |                                           |       
|                                                                                                                                                          | Depreciation and amortization                |                                           |       
|                                                                                                                                                          | Amortization of goodwill                     |                                           |       
|                                                                                                                                                          | Provision for bad debts                      |                                           |       
|                                                                                                                                                          | Gain on disposal of property and equipment   |                                           |       
|                                                                                                                                                          | Deferred income taxes                        |                                           |       
|                                                                                                                                                          | Shares issued for services                   |                                           |       
|                                                                                                                                                          | Impairment of goodwill                       |                                           |       
|                                                                                                                                                          | Changes in operating assets and liabilities: |                                           |       
|                                                                                                                                                          |                                              | Accounts receivable                       |       
|                                                                                                                                                          |                                              | Inventory                                 |       
|                                                                                                                                                          |                                              | Income taxes receivable/payable           |       
|                                                                                                                                                          |                                              | Prepaid expenses and other current assets |       
|                                                                                                                                                          |                                              | Accounts payable                          |       
|                                                                                                                                                          |                                              | Accrued expenses                          |       
|                                                                                                                                                          |                                              | Accrued payroll and related liabilities   |       
|                                                                                                                                                          |                                              |                                           |       
|Net cash provided by (used in) operating activities                                                                                                       |                                              |                                           | 6,221 
|                                                                                                                                                          |                                              |                                           |       
|Investing activities                                                                                                                                      |                                              |                                           |       
|Purchases of property and equipment                                                                                                                       |                                              |                                           | (1,496
|Proceeds for sale of property and equipment                                                                                                               |                                              |                                           | 13    
|Other assets                                                                                                                                              |                                              |                                           | 15    
|                                                                                                                                                          |                                              |                                           |       
|Net cash used in investing activities                                                                                                                     |                                              |                                           | (1,468
|                                                                                                                                                          |                                              |                                           |       
|Financing activities                                                                                                                                      |                                              |                                           |       
|Net borrowings under (repayments on) line of credit                                                                                                       |                                              |                                           |       
|Repayments on long-term debt                                                                                                                              |                                              |                                           | (281  
|Purchases of treasury shares                                                                                                                              |                                              |                                           |       
|Proceeds from issuance of common stock                                                                                                                    |                                              |                                           | 120   
|                                                                                                                                                          |                                              |                                           |       
|Net cash (used in) provided by financing activities                                                                                                       |                                              |                                           | (161  
|                                                                                                                                                          |                                              |                                           |       
|Net increase in cash and cash equivalents                                                                                                                 |                                              |                                           | 4,592 
|Cash and cash equivalents, beginning of year                                                                                                              |                                              |                                           | 5,485 
|                                                                                                                                                          |                                              |                                           |       
|Cash and cash equivalents, end of year                                                                                                                    |                                              | $                                         | 10,077
|                                                                                                                                                          |                                              |                                           |       

42

---

|                                                  |  | Years ended December 31
|------------------------------------------------- |  | -----------------------
|
|Supplemental disclosures of cash flow information |  |                        
|Cash paid during the year for:                    |  |                        
|Interest                                          |  | $                      
|Income taxes                                      |  | $                      

Supplemental non-cash transactions

In February 2001, the Company repurchased 296,000 shares of common stock for $554,000 from an officer of the Company in exchange for an outstanding note
receivable due from the officer.

See notes to consolidated financial statements.

43

---



Natrol, Inc.        Notes to Consolidated Financial Statements

1. Business and Summary of Significant Accounting Policies

Description of Business

Natrol, Inc. and subsidiaries (collectively, the "Company") manufactures and markets branded, high-quality dietary supplement products,
including vitamins, minerals, hormonal supplements, herbal products, specialty combination formulations and sports nutrition supplements, through its three operating segments. The segments include:
the Natrol operating segment, which manufactures and markets Natrol and Laci LeBeau branded products, and which, under the EPI name contract, manufactures product and sells raw material ingredients;
Prolab Nutrition Inc. ("Prolab"), which develops, manufactures and markets sports nutrition products; and Annasa, Inc. ("Annasa"), which was established in 2002 to develop a
direct-to-consumer multi-level marketing business. The Natrol, Prolab and Laci LeBeau products are sold through multiple distribution channels throughout the United States,
including domestic health food stores and mass-market drug, retail and grocery store chains.

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

Significant Risks and Uncertainties

Product returns are a recurring part of the Company's business. Estimating product returns requires significant management judgement. Products may be returned for
various reasons including expiration dates or lack of sufficient sales. During 2002, returns and reimbursements for damages and outdated products amounted to 8.7% of gross sales, a significant
decrease from 2001, when returns represented approximately 14.5% of gross sales. There is no guarantee that future returns will not increase to, or exceed, the levels experienced in 2001. Furthermore,
the possibility exists that should the Company lose a major account, the Company may be forced to accept a substantial amount of returns.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments with original maturity dates of three months or less when purchased to be cash equivalents. At
December 31, 2002 and 2001, there were no cash equivalents.

Inventory

Inventory is stated at the lower of cost (first-in, first-out method) or market.

44

---

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets
ranging from five-to-10 years for furniture, machinery and
equipment. Buildings are being depreciated over 40 years, and improvements are depreciated over five to 40 years, using the straight-line method. Amortization of leasehold
improvements is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the lease terms.

Long-Lived Assets

The Company evaluates long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value.

Goodwill

Goodwill represents the excess of the purchase price over the estimated fair value of the net assets acquired and was being amortized, through December 31,
2001, on a straight-line basis over periods ranging from 15-to-20 years. In addition, prior to December 31, 2001, the Company evaluated goodwill for
impairment whenever events or changes in circumstances indicated that the carrying value may not be recoverable. In 2001, the Company recorded a charge of $20 million to reduce goodwill during
the fourth quarter of 2001, based on the amount by which the carrying amount of these assets exceeded their estimated fair value (see note 8).

In
June 2001, the Financial Accounting Standards Board ("FASB") approved two new statements: Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS
No. 142,Goodwill and Other Intangible Assets. SFAS
No. 141 requires business combinations entered into after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 requires that goodwill not be
amortized, but be tested for impairment at least annually. The Company adopted SFAS No. 142 on January 1, 2002. In accordance with such adoption, the Company identified all reporting
units in conjunction with the provisions of SFAS No. 142 and allocated all goodwill accordingly. Beginning in 2002, goodwill is evaluated for impairment annually. The Company tested goodwill
for impairment using the two-step process prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second step measures the amount of the
impairment, if any. The Company performed the first step of the impairment test and determined that the there was no impairment of the Prolab segment, but that there was potential impairment of the
Natrol segment. The Company performed the second step as of December 31, 2002 for the Natrol segment and determined that its goodwill balance of $10,958,000 was impaired. The impairment loss
was recorded as a cumulative effect of accounting change in the accompanying consolidated statement of operations for

45

---

the year ended December 31, 2002. The changes in the carrying value of goodwill for the years ended December 31, 2002 and 2001 are as follows:

|                                                    |  | Natrol |         | Prolab |   | Total   |  
|--------------------------------------------------- |  | ------ | ------- | ------ | - | ------- | -
|
|Balance, January 1, 2001                            |  | $      | 11,898  |        | $ | 25,366  |  
|Impairment losses                                   |  |        |         |        |   | (20,000 | )
|Amortization expense                                |  |        | (940    | )      |   | (1,340  | )
|                                                    |  |        |         |        |   |         |  
|Balance, December 31, 2001                          |  |        | 10,958  |        |   | 4,026   |  
|Cumulative effect of change in accounting principle |  |        | (10,958 | )      |   |         |  
|                                                    |  |        |         |        |   |         |  
|Balance, December 31, 2002                          |  | $      |        |        | $ | 4,026   |  
|                                                    |  |        |         |        |   |         |  

In
accordance with the adoption of SFAS No. 142, on January 1, 2002, the Company no longer amortizes goodwill. The following table reconciles income (loss) before
cumulative change in accounting principle, to income (loss) per share as reported for the years ended December 31, 2002, 2001 and 2000, respectively, to amounts, as adjusted, to exclude
goodwill amortization.

|                                                                                  |                       | Years Ended December 31, |       
|--------------------------------------------------------------------------------- | --------------------- | ------------------------ | ------
|
|
|Reported income (loss) before cumulative effect of change in accounting           |                       | $                        | 693   
|Add back: goodwill amortization                                                   |                       |                          |       
|                                                                                  |                       |                          |       
|As adjusted                                                                       |                       | $                        | 693   
|                                                                                  |                       |                          |       
|Reported net loss                                                                 |                       | $                        | (6,126
|Add back: Goodwill amortization                                                   |                       |                          |       
|                                                                                  |                       |                          |       
|As adjusted                                                                       |                       | $                        | (6,126
|                                                                                  |                       |                          |       
|Basic and diluted loss per share:                                                 |                       |                          |       
|Reported income (loss) before cumulative effect of change in accounting principle |                       | $                        | 0.05  
|Goodwill amortization                                                             |                       |                          |       
|                                                                                  |                       |                          |       
|As adjusted                                                                       |                       | $                        | 0.05  
|                                                                                  |                       |                          |       
|                                                                                  | Reported net loss     |                          | $     
|                                                                                  | Goodwill amortization |                          |       
|                                                                                  |                       |                          |       
|As Adjusted                                                                       |                       | $                        | (0.48 
|                                                                                  |                       |                          |       

Income Taxes

Deferred income taxes are provided for temporary differences between the financial statement and income tax bases of assets and liabilities, based on enacted tax
rates. Management provides a valuation allowance when it believes, it is more likely than not that some portion or all of the deferred income tax assets will not be realized.

46

---

Revenue Recognition

The Company sells its products to retail outlets through a direct sales force and a national broker network. The Company recognizes revenue from sales when
product is shipped. Net sales represent product shipped less returns, estimates for future returns, spoilage allowances, allowances for product deemed to be unsalable by customers, free goods shipped
to customers for promotional or other purposes and slotting fees. Estimates and allowances are based upon known claims and an estimate of additional returns.

Advertising Costs

Advertising and promotional costs are expensed at first showing. Advertising and promotional costs were (in thousands) $6,778, $7,345 and $10,773 for the years
ended December 31, 2002, 2001 and 2000, respectively. These amounts are exclusive of promotional and other expenses that are netted against sales revenue.

Research and Development Costs

The Company incurs research and development costs in support of the development of its dietary research and development costs, which are expensed as incurred and
amounted to (in thousands) $681, $551 and $650 for the years ended December 31, 2002, 2001 and 2000, respectively. Research and development costs are included in general and administrative
expenses on the consolidated statements of operations.

Shipping and Handling Costs

The Company records all amounts charged to customers for shipping and handling as revenue. All shipping and fulfillment costs are classified as cost of sales and
totaled (in thousands) $2,505, $2,959 and $3,087 for the years ended December 31, 2002, 2001 and 2000, respectively.

Stock-Based Compensation

The Company accounts for its employee stock option plan under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations.

The
Company has a stock-based compensation plan, which is described more fully in Note 5. The Company's operating results do not include a compensation charge related to this
plan, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on the operating results
and per share amounts, if the

47

---

fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, had been applied to stock-based employee
compensation.

|                                                                                                                                                                |                               | Years Ended December 31, |       
|--------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------- | ------------------------ | ------
|
|
|Income (loss) before cumulative effect of accounting change                                                                                                     |                               | $                        | 693   
|Total stock-based employee compensation expense determined under the fair value-based method for all awards, net of related tax benefits ("Stock Compensation") |                               |                          | (692  
|                                                                                                                                                                |                               |                          |       
|Income (loss) before cumulative effect of accounting changepro forma                                                                                           |                               | $                        | 1     
|Net loss                                                                                                                                                        |                               | $                        | (6,126
|Stock Compensation                                                                                                                                              |                               |                          | (692  
|                                                                                                                                                                |                               |                          |       
|Net losspro forma                                                                                                                                              |                               | $                        | (6,818
|Income (loss) per share before cumulative of accounting change:                                                                                                 |                               |                          |       
|                                                                                                                                                                | Basic and dilutedas reported |                          | $     
|                                                                                                                                                                | Basic and dilutedpro forma   |                          | $     
|Net loss per share:                                                                                                                                             |                               |                          |       
|                                                                                                                                                                | Basic and dilutedas reported |                          | $     
|                                                                                                                                                                | Basic and dilutedpro forma   |                          | $     

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

|                                |  | Years Ended December 31, |  
|------------------------------- |  | ------------------------ | -
|
|Expected dividend yield         |  | 0.0                      | %
|Expected stock price volatility |  | 73.3                     |  
|Risk free interest rate         |  | 4.2                      | %
|Expected life of options        |  | 5 years                  |  

These
assumptions resulted in weighted-average fair values of $0.87, $1.05 and $2.04 for each stock option granted in 2002, 2001 and 2000, respectively.

Income (Loss) Per Share

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

Stock
options to purchase 2,916,000, 2,696,000 and 1,987,000 shares of common stock in 2002, 2001 and 2000, respectively, were outstanding but considered to be anti-dilutive.

48

---

Fair Value of Financial Instruments

The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximates
fair market value based on their short-term nature. The fair value of the Company's long-term notes payable is 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 approximates their fair value at
December 31, 2002.

Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, and accounts
receivable. Cash and cash equivalents are placed with high credit-quality institutions and the amount of credit exposure to any one institution is limited. Significant portions of the Company's sales
are made directly to mass merchandisers and national retailers. Due to the increased volume of sales to these channels, the Company has experienced an increased concentration of credit risk, and as a
result, may at anytime have individually significant receivable balances with such mass merchandisers and national retailers. While the Company monitors and manages this risk, financial difficulties
on the part of one or more major customers may have a material adverse effect on the Company. The Company performs ongoing credit evaluations of customers and maintains an allowance for potential
credit losses.

One
customer represented 12.3% of net sales in the year ended December 31, 2002. This customer accounted for 13.4% of accounts receivable at December 31, 2002. No other
customers represented more than 10% of gross sales in 2002. No customers represented more than 10% of gross sales in either 2001 or 2000.

Recently Issued Accounting Standards

In November 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No. 01-09, "Accounting for Consideration Given by a Vendor
to a Customer or a Reseller of the Vendor's Products." This new guidance provides that consideration from a vendor to a reseller is presumed to be a reduction of the selling prices of the vendor's
products and, therefore, should be characterized as a reduction of revenue when recognized in the vendor's income statement. On January 1, 2002, the Company adopted EITF Issue
No. 01-09 and reclassified incentives paid to resellers of $4,164 in 2001 and $9,337 in 2000, previously reported as a component of selling and marketing expenses, as a reduction in
net sales and selling and marketing expenses.

In
August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.
SFAS No. 144 addresses the financial accounting and reporting issues for the impairment or
disposal of long-lived assets. This statement supersedes SFAS No. 121 but retains the fundamental provisions for (a) recognition/measurement of impairment of
long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. The Company adopted SFAS No. 144 effective
January 1, 2002 with no material impact.

In
June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS
No. 146 requires that the liability for costs associated with an exit or disposal activity be initially measured at fair value and recognized when the liability is incurred. The provisions of
SFAS

49

---

No. 146 are required to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect that the adoption of SFAS No. 146
will have a material impact on the financial statements, as there are no exit or disposal activities currently planned.

In
December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based CompensationTransition and
Disclosure. This statement amends SFAS No. 123 to provide alternative methods of voluntary transition to change to the fair value-based method of accounting for
stock-based employee compensation. Additionally, this statement amends disclosure requirements of accounting for stock-based employee compensation and the effect of the method used on reporting
results. As of December 31, 2002, the Company has adopted the new disclosure requirements of SFAS No. 148.

Reclassifications

Certain reclassifications have been made to the 2001 and 2000 consolidated financial statements to conform to the presentation in 2002.

2. Inventory

Inventory consists of the following:

|                                    |  | December 31
|----------------------------------- |  | -----------
|
|
|Raw material and packaging supplies |  | $          
|Finished goods                      |  |            
|                                    |  |            
|                                    |  | $          
|                                    |  |            

3. Financing (in thousands)

During 1999, the Company entered into two mortgage notes payable in the aggregate amount of $8,900, collateralized by the Company's facilities. These notes are
payable in monthly installments of approximately $74 in the aggregate, including interest ranging from 7.75% to 8.32%, maturing in 2014 and 2019.

Future
maturities of long-term debt at December 31, 2002 are as follows:

2003

$
3012003


3252004


3532005


3822006


414Thereafter


6,304$
8,079


50

---



4. Income Taxes (in thousands)

The income tax (benefit) provision consists of the following:

|                                                                                                    |         | Years Ended December 31, |       
|--------------------------------------------------------------------------------------------------- | ------- | ------------------------ | ------
|
|Current:                                                                                            |         |                          |       
|                                                                                                    | Federal |                          | $     
|                                                                                                    | State   |                          |       
|                                                                                                    |         |                          |       
|                                                                                                    |         |                          | (254  
|Deferred:                                                                                           |         |                          |       
|                                                                                                    | Federal |                          |       
|                                                                                                    | State   |                          |       
|                                                                                                    |         |                          |       
|                                                                                                    |         |                          | 694   
|                                                                                                    |         |                          |       
|Total income tax provision (benefit) on income (loss) before cumulative effect of accounting change |         |                          | 440   
|Deferred income tax benefit on cumulative effect of change in accounting principle                  |         |                          | (4,139
|                                                                                                    |         |                          |       
|Total income tax (benefit) provision                                                                |         | $                        | (3,699
|                                                                                                    |         |                          |       

The
difference between actual income tax provision (benefit) and the amount computed using the U.S. federal statutory income tax rate is as follows:

|                                                                                      |  | Years Ended December 31, |    
|------------------------------------------------------------------------------------- |  | ------------------------ | ---
|
|Statutory rate applied to income (loss) before cumulative effect of accounting change |  | $                        | 385
|Nondeductible goodwill                                                                |  |                          |    
|State tax provision                                                                   |  |                          | 41 
|Other                                                                                 |  |                          | 14 
|                                                                                      |  |                          |    
|Income tax provision (benefit)                                                        |  | $                        | 440
|                                                                                      |  |                          |    

51

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

|                                 |                                | December 31, |      
|-------------------------------- | ------------------------------ | ------------ | -----
|
|Deferred income tax assets:      |                                |              |      
|                                 | Accounts receivable allowances |              | $    
|                                 | Inventory                      |              |      
|                                 | Accrued liabilities            |              |      
|                                 | Goodwill impairment            |              |      
|                                 | State credits                  |              |      
|                                 | Start-up costsAnnasa          |              |      
|                                 | Net operating lossesstate     |              |      
|                                 |                                |              |      
|                                 |                                |              | 5,068
|Deferred tax income liabilities: |                                |              |      
|                                 | Federal effect of state taxes  |              |      
|                                 | Depreciation                   |              |      
|                                 |                                |              |      
|                                 |                                | $            | 4,518
|                                 |                                |              |      

The
Company has state net operating loss carryforwards of approximately $1,448 expiring beginning in fiscal 2007.

5. Stockholders' Equity

Stock Repurchase Program

In April 2000, the Board of Directors of the Company authorized a stock repurchase program for the Company's common stock. Under the stock repurchase
program, the Company can effect common stock repurchases from time to time up to an aggregate of $10,000,000. The stock repurchase program does not have an expiration date. During the years ended
December 31, 2001 and 2000, the Company repurchased 296,000 and 625,900 shares of its common stock, respectively, at a cost of $554,000 and $2,327,000. No such repurchases were made in 2002.

Stock Options

Under the Company's 1996 Stock Option and Grant Plan, as amended (the "Plan"), the Board of Directors of the Company is authorized 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 to be issued under the Plan is 3,368,233 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 10 years.

52

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A
summary of the Company's stock option activity and related information is as follows (in thousands, except per share data):

|                                 |           | Number
of
Options |       | Weighted-Average
Exercise Price
Per Share |      | Exercise
Price Per
Share
|-------------------------------- | --------- | ----------------- | ----- | ----------------------------------------- | ---- | ------------------------
|Outstanding at January 1, 2000   |           | 1,616             |       | 7.28                                      |      | $                       
|                                 | Granted   |                   | 1,182 |                                           | 2.87 |                         
|                                 | Forfeited |                   | (677  | )                                         | 7.74 |                         
|                                 | Exercised |                   | (134  | )                                         | 1.98 |                         
|                                 |           |                   |       |                                           |      |                         
|Outstanding at December 31, 2000 |           | 1,987             |       | 4.59                                      |      | $                       
|                                 | Granted   |                   | 1,000 |                                           | 1.63 |                         
|                                 | Forfeited |                   | (259  | )                                         | 1.81 |                         
|                                 | Exercised |                   | (32   | )                                         | 3.01 |                         
|                                 |           |                   |       |                                           |      |                         
|Outstanding at December 31, 2001 |           | 2,696             |       | 3.58                                      |      | $                       
|                                 | Granted   |                   | 700   |                                           | 1.37 |                         
|                                 | Forfeited |                   | (431  | )                                         | 3.41 |                         
|                                 | Exercised |                   | (49   | )                                         | 1.88 |                         
|                                 |           |                   |       |                                           |      |                         
|Outstanding at December 31, 2002 |           | 2,916             |       | 3.10                                      |      | $                       
|                                 |           |                   |       |                                           |      |                         

At
December 31, 2002, 446,000 shares were available for future grant. The weighted-average remaining contractual life for the outstanding options in years was 7.71, 8.37 and 8.82
at December 31, 2002, 2001 and 2000, respectively.

|             |  |           |  |     |  |   |      | Options Exercisable
|------------ |  | --------- |  | --- |  | - | ---- | -------------------
|
|
|
|$1.10$2.75  |  | 2,233,000 |  | 9.0 |  | $ | 1.61 |                    
|$2.76$6.86  |  | 297,500   |  | 7.3 |  | $ | 4.64 |                    
|$6.87$13.00 |  | 385,000   |  | 5.5 |  | $ | 9.89 |                    
|             |  |           |  |     |  |   |      |                    
|             |  | 2,915,500 |  | 7.7 |  | $ | 3.10 |                    
|             |  |           |  |     |  |   |      |                    

53

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6. Commitments and Contingencies

The Company leases certain equipment and facilities under noncancelable operating leases that expire in various years through 2006. Rent expense under operating
leases totaled approximately $117,000, $108,000 and $118,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

Future
minimum lease payments under noncancelable operating leases with initial terms of one year or more consisted of the following at December 31, 2002 (in thousands):

2003

$
1592004


1392005


462006


20Total minimum lease payments

$
364


The
Company is a party to certain legal actions arising in the normal course of business. In the opinion of management, the ultimate outcome of such litigation will not have a material
adverse effect on the financial position or results of operations of the Company.

7. Employee Benefits 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
approximately $14,000, $20,000 and $10,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

In
May 1998, the Board of Directors approved the Natrol, Inc. Employee Stock Purchase Plan ("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, 2002 and 2001, 138,356 and 163,816 shares are available for issuance under this plan. For the year ended
December 31, 2002, 14,720 shares were issued at prices ranging from $1.68 to $1.85 per share under the plan. For the year ended December 31, 2001, 17,043 shares were issued at prices
ranging from $1.28 to $2.00 per share under the plan. For the year ended December 31, 2000, 25,366 shares were issued at prices ranging from $1.28 to $2.76 per share under the plan.

8. Impairment of Goodwill

The Company, as part of its review of financial results for 2001, performed an assessment of the carrying value of the Company's long-lived assets to
be held and used, including significant amounts of goodwill recorded in connection with its various acquisitions. The assessment was performed pursuant to SFAS No. 121 because of the
significant negative industry and economic trends affecting both the Company's operations and expected future sales as well as the general decline in market valuations. As a result, the Company
recorded a charge of $20 million to reduce goodwill during the fourth quarter of

54

---

2001, based on the amount by which the carrying amount of these assets exceeded their estimated fair value.

The
write-down was related to the goodwill recorded in connection with the Company's acquisition of Prolab. The charge is included in the caption impairment of goodwill on
the statements of operations. Fair value was determined based on discounted future cash flows for the operating entity. The cash flow period used was six years using an annual growth rate of 5%. The
discount rate used was 20% for each of the six years. The assumptions supporting the estimated future cash flows reflect management's best estimates. The discount rate was based upon the
risk-free rate as adjusted for the risks associated with the operations.

9. Operating Segments

During 2002, the Company reassessed its segment disclosures and concluded that it currently has three operating segments: the Natrol operating segment, which
manufactures and markets Natrol and Laci LeBeau branded products, and which, under the EPI name, contract manufactures product and sells raw material ingredients; Prolab Nutrition, Inc., which
develops, manufactures and markets sports nutrition products; and Annasa, Inc., which during 2002 was established to develop a direct-to-consumer multi-level marketing
business.

The
accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates the financial performance of its business
units based on operating income of the respective business units. The segment information for the years ended December 31, 2001 and 2000 has been reclassified to conform to the
December 31, 2002 presentation.

Segment
information for the years ended December 31, 2002, 2001 and 2000 is as follows (in thousands):

|                                    |  | Natrol |        | Prolab |   | Annasa |   | Total |       
|----------------------------------- |  | ------ | ------ | ------ | - | ------ | - | ----- | ------
|2002                                |  |        |        |        |   |        |   |       |       
|Net sales                           |  | $      | 51,674 |        | $ | 18,613 |   | $     | 44    
|Gross profit                        |  |        | 24,595 |        |   | 3,977  |   |       | 32    
|Income (loss) from operations       |  |        | 3,783  |        |   | (937   | ) |       | (1,069
|Other (expense) income              |  |        | (680   | )      |   | 36     |   |       |       
|Income (loss) before taxes          |  |        | 3,103  |        |   | (901   | ) |       | (1,069
|Depreciation and amortization       |  |        | 1,346  |        |   | 82     |   |       | 1     
|Segment assets                      |  |        | 40,147 |        |   | 13,108 |   |       | 126   
|Additions to property and equipment |  |        | 1,457  |        |   | 17     |   |       | 22    

55

---

|2001                                |  |  |        |   |  |         |   |  |  |  |  |         |  
|----------------------------------- |  |  | ------ | - |  | ------- | - |  |  |  |  | ------- | -
|Net sales                           |  |  | 53,667 |   |  | 18,154  |   |  |  |  |  | 71,821  |  
|Gross profit                        |  |  | 24,132 |   |  | 4,700   |   |  |  |  |  | 28,832  |  
|Income (loss) from operations       |  |  | 3,001  |   |  | (22,018 | ) |  |  |  |  | (19,017 | )
|Other (expense) income              |  |  | (826   | ) |  | 90      |   |  |  |  |  | (736    | )
|Income (loss) before taxes          |  |  | 2,176  |   |  | (21,929 | ) |  |  |  |  | (19,753 | )
|Depreciation and amortization       |  |  | 1,312  |   |  | 82      |   |  |  |  |  | 1,394   |  
|Segment assets                      |  |  | 45,935 |   |  | 13,422  |   |  |  |  |  | 59,357  |  
|Additions to property and equipment |  |  | 308    |   |  | 71      |   |  |  |  |  | 379     |  
|2000                                |  |  |        |   |  |         |   |  |  |  |  |         |  
|Net sales                           |  |  | 58,815 |   |  | 18,746  |   |  |  |  |  | 77,561  |  
|Gross profit                        |  |  | 21,296 |   |  | 5,931   |   |  |  |  |  | 27,227  |  
|Loss from operations                |  |  | (4,608 | ) |  | (1,746  | ) |  |  |  |  | (6,354  | )
|Other (expense) income              |  |  | (1,305 | ) |  | 74      |   |  |  |  |  | (1,231  | )
|Loss before taxes                   |  |  | (5,913 | ) |  | (1,672  | ) |  |  |  |  | (7,585  | )
|Depreciation and amortization       |  |  | 1,281  |   |  | 80      |   |  |  |  |  | 1,361   |  
|Segment assets                      |  |  | 54,041 |   |  | 33,880  |   |  |  |  |  | 87,921  |  
|Additions to property and equipment |  |  | 566    |   |  | 22      |   |  |  |  |  | 588     |  

10. Selected Quarterly Financial Data (unaudited)

As discussed in Note 1, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. As initially applied,
the Company reclassified approximately $3.6 million out of goodwill and into a separately identified intangible asset related to a supply contract. The supply contract had originally been
acquired as part of the Company's acquisition of EPI. The supply contract had a remaining life of six years, and in each of the three quarters in the period ended September 30, 2002, the
Company had recorded amortization expense related to the contract of $150,000. During the fourth quarter of 2002, the Company determined that the supply contract should not have been reclassified out
of goodwill as it had not been assigned a cost equal to its estimated fair value at the
date the EPI acquisition was initially recorded, and because the amount had not been separately identified in the accounting records or previously amortized over its useful life. As a result, the
$3.6 million was reallocated to goodwill retroactive to January 1, 2002. Pursuant to the requirements of SFAS No. 142, goodwill is not amortized, but is subject to an annual
impairment test. As discussed in Note 1, the Company recorded an impairment charge of $10,958,000 as a cumulative effect of change in accounting principle in the first quarter of fiscal 2002.
The $3.6 million described above was included in that amount.

The
interim financial statements for each of the three quarters in the period ended September 30, 2002 have been restated to reflect a quarterly reduction in amortization expense
of $150,000 and a related increase in the quarterly income tax provision of $56,000.

56

---

The
following is a summary of the interim financial information for each of the quarters in the years ended December 31, 2002 and 2001. The information for the quarters in the
year ended December 31, 2002 includes both the amounts as restated and as previously reported.

|                                                                                        |  | 2002 Quarters Ended
|--------------------------------------------------------------------------------------- |  | -------------------
|
|
|Net sales                                                                               |  | 17,539             
|Gross profit                                                                            |  | 6,579              
|Income (loss) before cumulative effect of change in accounting principle                |  | 121                
|Net income (loss)                                                                       |  | (6,698             
|Basic and diluted income (loss) per share before cumulative effect of accounting change |  | 0.01               
|Income (loss) per share                                                                 |  | (0.52              

|                                              |  | 2002 Quarters Ended | 
|--------------------------------------------- |  | ------------------- | 
|
|
|Net sales                                     |  | 17,539              | 
|Gross profit                                  |  | 6,579               | 
|Net income (loss)                             |  | 27                  | 
|Net income (loss) per sharebasic and diluted |  | 0.00                | 

|                                              |  | 2001 Quarters Ended | 
|--------------------------------------------- |  | ------------------- | 
|
|Net sales                                     |  | 19,056              | 
|Gross profit                                  |  | 7,783               | 
|Net income (loss)                             |  | 657                 | 
|Net income (loss) per sharebasic and diluted |  | 0.05                | 

57

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Natrol, Inc. and Subsidiaries        Schedule IIValuation and Qualifying Accounts        Years Ended December 31, 2002, 2001 and 2000

|Description                      |                              | Balance at
Beginning
of Year |   | Charged to
Cost and
Expense |  | Additions
Charged to
Acquisitions |        | Deductions |   | Balance at
End of Year
|-------------------------------- | ---------------------------- | ---------------------------- | - | --------------------------- |  | --------------------------------- | ------ | ---------- | - | ----------------------
|Allowance for Doubtful Accounts: |                              |                              |   |                             |  |                                   |        |            |   |                       
|                                 | Year ended December 31, 2000 |                              | $ | 503                         |  | $                                 | 400    |            | $ |                      
|                                 | Year ended December 31, 2001 |                              | $ | 479                         |  | $                                 | 438    |            | $ |                      
|                                 | Year ended December 31, 2002 |                              | $ | 363                         |  | $                                 | 233    |            | $ |                      
|Allowance for Sales Returns:     |                              |                              |   |                             |  |                                   |        |            |   |                       
|                                 | Year ended December 31, 2000 |                              | $ | 1,244                       |  | $                                 | 9,308  |            | $ |                      
|                                 | Year ended December 31, 2001 |                              | $ | 1,460                       |  | $                                 | 12,490 |            | $ |                      
|                                 | Year ended December 31, 2002 |                              | $ | 1,020                       |  | $                                 | 6,700  |            | $ |                      

---

58

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

On December 10, 2002, the Audit Committee of the Board of Directors of Natrol informed Ernst & Young, LLP, the Company's independent public
accountants for the fiscal year ended December 31, 2001, of its decision to no longer engage Ernst & Young as the Company's independent public accountants. On December 10, 2002,
the Company engaged Deloitte & Touche, LLP to serve as the Company's independent public accountants for the fiscal year ended December 31, 2002. On December 11, 2002, Natrol filed
a Form 8-K announcing this change in independent public accountants. A subsequent form 8k-A was filed on January 7, 2003.

Ernst &
Young's reports on the Company's consolidated financial statements for each of the fiscal years ended December 31, 2001, 2000, and 1999 did not contain an adverse
opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles.

During
the fiscal years ended December, 31, 2001 and 2000, there were no disagreements with Ernst & Young on any matter of accounting principle or practice, financial statement
disclosure, or auditing scope or procedure which, if not resolved to Ernst & Young's satisfaction, would have caused them to make reference to the subject matter in connection with their report
on the Company's consolidated financial statements for such years; and there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.

During
the years ended December 31, 2001 and 2000 and through December 31, 2002, the Company did not consult Deloitte & Touche, LLP with respect to the application
of accounting principles to a specific transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company's consolidated financial statements, or any other
matters or reportable events as set forth in Items 304(a) (2) (i) and (ii) of Regulation S-K.

59

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PART III

Information required under Part III (Items 10, 11, 12 other than the information required by Item 201(d) of Regulation S-K for Item 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 be held on June 14, 2001.

ITEM 12:    SECURITES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The flowing table provides information as of December 31, 2002 regarding shares of common stock of the Company that may be used under our existing equity
compensation plans, including the Company's 1996 Stock Option and Grant Plan (the "1996 Plan") and the Company's 1998 Employee Stock Purchase Plan (the "ESPP").

Equity Compensation Plan Information TableOverview

|                                                           |  | Equity Compensation Plan Information | 
|---------------------------------------------------------- |  | ------------------------------------ | 
|
|Plan category                                              |  |                                      | 
|Equity compensation plans approved by security holders(2)  |  | 2,915,500                            | 
|Equity compensation Plans not approved by security holders |  |                                      | 
|                                                           |  |                                      | 
|Total                                                      |  | 2,915,500                            | 
|                                                           |  |                                      | 

---

ITEM 14. CONTROLS AND PROCEDURES

(a)  Evaluation of disclosure controls and procedures.

As required by new Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to this report, we carried out an
evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we and our management recognize that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating and
implementing possible controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that they believe that, as of the date of completion
of the evaluation, our disclosure controls and procedures were reasonably effective

60

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to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in
the Securities and Exchange Commission's rules and forms. In connection with the new rules, we will continue to review and document our disclosure controls and procedures, including our internal
controls and procedures for financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with out
business.

(b)  Changes in internal controls.

None.

PART IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

|(a)(1) |  | Consolidated Financial Statements                                                                                                                                                                                                        |  |    
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---
|       |  | The financial statements included in this Annual Report on Form 10-K are provided under Item 8.                                                                                                                                          |  |    
|(a)(2) |  | Index to Consolidated Financial Statement Schedules:                                                                                                                                                                                     |  |    
|       |  | Schedule IIValuation and Qualifying Accounts                                                                                                                                                                                            |  | S-1
|       |  | All other 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:                                                                                                                                                                                                                       |  |    

Articles
of Incorporation and By-Laws:

|3.1                                                                        |  | The Third Amended and Restated Certificate of Incorporation of the Company incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K, as amended, filed on March 31, 1999.                
|-------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.2                                                                        |  | The Amended and Restated By-Laws of the Company (incorporated herein by reference to Exhibit 3.6 to the Company's Amendment No. 2 to Registration Statement on Form S-1, as amended, File No. 333-52109).                   
|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).
|Material Contracts                                                        
|10.1                                                                       |  | Natrol, Inc. Amended and Restated 1996 Stock Option Plan (incorporated herein by reference to Appendix A filed on May 2, 2000 Proxy Statement);                                                                             
|10.2                                                                       |  | Natrol, Inc. 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);                                           
|                                                                           |  |                                                                                                                                                                                                                             

61

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|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 |  | Form of Incentive Stock Option Agreement of the Natrol, Inc. Stock Option and Grant Plan (incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1, as amended, File No. 333-52109);                       
|10.5 |  | Amended and Restated Credit Agreement with Wells Fargo Bank, N. A (incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1, as amended, File No. 333-52109);                                              
|10.6 |  | Credit Agreement with Wells Fargo Bank, N.A., dated as of March 1, 2001; (incorporated herein by reference to Exhibit 10.6 to the Company's Form 10-K) filed on March 30, 2001.                                                                        
|10.7 |  | Revolving Line of Credit Agreement with Wells Fargo Bank, N.A., dated as of March 1, 2001, (incorporated herein by reference to Exhibit 10.7 to the Company's Form 10-K filed March 30, 2001.                                                          
|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 |  | Assignment and Amendment to Supply and Royalty Supply Agreement, dated as of November 7, 2000 by and between the Company and ConAgra Foods, Inc., (incorporated by reference to Exhibit 10.9 to the Company's Form 10-K filed on March 30,
2001.       
|16.1 |  | Letter re change in certified accountants                                                                                                                                                                                                              
|21.1 |  | Subsidiaries of Natrol, Inc.                                                                                                                                                                                                                           
|23.1 |  | Consent of Experts and Counsel: Consent of Deloitte & Touche, LLP is filed herewith as Exhibit 23.1.                                                                                                                                                   
|23.2 |  | Consent of Experts and Counsel: Consent of Ernst & Young, LLP is filed herewith as Exhibit 23.2                                                                                                                                                        

62

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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 30th day of March, 2003.

| |  | NATROL, INC.
| |  | ------------
| |  | By:         

63

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CERTIFICATION

I,
Dennis R. Jolicoeur, Chief Financial Officer and Executive Vice President of Natrol, Inc., certify that:





|Date: 4/10/2003 |  | By: | /s/DENNIS R. JOLICOEURDennis R. Jolicoeur Chief Financial Officer and Executive Vice
President
|--------------- |  | --- | ----------------------------------------------------------------------------------------------

64

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CERTIFICATION

I,
Elliott Balbert, President, Chief Executive Officer and Chairman of Natrol Inc., certify that:





|Date: 4/10/2003 |  | By: | /s/ELLIOTT BALBERTElliott Balbert President/CEO/Chairman
|--------------- |  | --- | --------------------------------------------------------

65

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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 Signed   |  | Title                                                                                                                         |  | Date          
|------------------- |  | ----------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Elliott Balbert     |  | Chairman of the Board, Chief Executive Officer, President March 30, 2003 and Director (Principal Executive Officer)           |  | March 30, 2003
|Dennis R. Jolicoeur |  | Chief Financial Officer, Executive Vice President and Director (Principal Financial Officer and Principal Accounting Officer) |  | March 30, 2003
|Vernon Brunner      |  | Director                                                                                                                      |  | March 30, 2003
|Gordon Brunner      |  | Director                                                                                                                      |  | March 30, 2003
|Dennis DeConcini    |  | Director                                                                                                                      |  | March 30, 2003

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