**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**(Mark one)**
| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|-----------------------------------------------------------------------------------------------|

 

**FOR THEQUARTERLY PERIOD ENDED MARCH 31, 2007**

 

**OR**
| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|------------------------------------------------------------------------------------------------|

 

**FOR THETRANSITION PERIOD FROM             TO             **

** **

**COMMISSION FILE NO: 0-24567**

**NATROL, INC.**

(Exact name of registrant as specified in its charter)

| **Delaware**                                                     |   | **95-3560780**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (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)

**NotApplicable**

(Former name, former address and former fiscal year,if changed since last report)

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12-B2 ofthe Exchange Act. (check one)
| Large  accelerated filer o |   | Accelerated  filer o |   | or  Non-accelerated filer x |
|----------------------------|--------|----------------------|--------|-----------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the ExchangeAct).  Yes o  No x

As of May 7, 2007, 14,152,227 shares of the registrant’scommon stock were outstanding.

 

 

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**TABLEOF CONTENTS**
|               |   |                                                                                        | ** **                                            | ** ** |
|---------------|--------|---------------------------------------------------------------------------------------------|-------------------------------------------------------|------------|
| PART I        |   | FINANCIAL INFORMATION                                                                       |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item 1.       |   | Financial Statements                                                                        |                                                  |       |
|          |   |                                                                                        |                                                  |       |
|          |   |                                                                                        | Consolidated Balance  Sheets                          |       |   |
|          |   |                                                                                        |                                                  |       |   |
|          |   |                                                                                        | Consolidated  Statements of Income                    |       |   |
|          |   |                                                                                        |                                                  |       |   |
|          |   |                                                                                        | Consolidated  Statements of Cash Flows                |       |   |
|          |   |                                                                                        |                                                  |       |   |
|          |   |                                                                                        | Notes to  Consolidated Unaudited Financial Statements |       |   |
|          |   |                                                                                        |                                                  |       |
| Item 2.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item 3.       |   | Quantitative  and Qualitative Disclosures About Market Risk                                 |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item 4.       |   | Controls and  Procedures                                                                    |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| PART II.      |   | OTHER INFORMATION                                                                           |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item  1A.     |   | Risk  Factors                                                                               |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item 5.       |   | Other Information                                                                           |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Item  6.      |   | Exhibits                                                                                    |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Signature     |   |                                                                                        |                                                  |       |
|          |   |                                                                                        |                                                  |       |
| Exhibit Index |   |                                                                                        |                                                  |       |

 

 

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**PART 1—FINANCIAL INFORMATION**

##### **Item1. Financial Statements**

**Natrol, Inc. and Subsidiaries**

**Consolidated Condensed Balance Sheets**

**(In thousands, except share and per share data)**
| ** **                                                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                             | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                             |       |               |       |                  |       |
| Current assets:                                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                             |       | $                  | 581        |                  | $          | 1,003 |   |
| Accounts  receivable, net of allowances of $237 and $181 at March 31, 2007 and December  31, 2006, respectively                                                                                                        |       | 8,487              |       | 6,485                 |       |
| Inventory                                                                                                                                                                                                              |       | 11,444             |       | 11,788                |       |
| Income taxes  receivable                                                                                                                                                                                               |       | 280                |       | 375                   |       |
| Deferred income  taxes                                                                                                                                                                                                 |       | 1,634              |       | 1,630                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                                             |       | 1,602              |       | 1,743                 |       |
| Total current assets                                                                                                                                                                                                   |       | 24,028             |       | 23,024                |       |
| Property and equipment:                                                                                                                                                                                                |       |               |       |                  |       |
| Building and  improvements                                                                                                                                                                                             |       | 14,991             |       | 14,953                |       |
| Machinery and  equipment                                                                                                                                                                                               |       | 5,816              |       | 5,757                 |       |
| Furniture and  office equipment                                                                                                                                                                                        |       | 3,027              |       | 3,013                 |       |
|                                                                                                                                                                                                                   |       | 23,834             |       | 23,723                |       |
| Accumulated  depreciation and amortization                                                                                                                                                                             |       | (10,220            | )          | (9,912                | )          |
| Property and equipment,  net                                                                                                                                                                                           |       | 13,614             |       | 13,811                |       |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| Restricted cash                                                                                                                                                                                                        |       | 5,250              |       | 5,000                 |       |
| Deferred income taxes                                                                                                                                                                                                  |       | 4,265              |       | 4,265                 |       |
| Goodwill, net of  accumulated amortization and impairment charge                                                                                                                                                       |       | 2,026              |       | 2,026                 |       |
| Trademarks                                                                                                                                                                                                             |       | 5,730              |       | 5,730                 |       |
| Other assets                                                                                                                                                                                                           |       | 933                |       | 744                   |       |
| Total assets                                                                                                                                                                                                           |       | $                  | 55,846     |                  | $          | 54,600 |   |
| ** **                                                                                                                                                                                                             |       |               |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                                                                                         |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                                                   |       |               |       |                  |       |
| Line of credit                                                                                                                                                                                                         |       | $                  | 2,952      |                  | $          | 3,694 |   |
| Accounts payable                                                                                                                                                                                                       |       | 4,274              |       | 3,058                 |       |
| Accrued expenses                                                                                                                                                                                                       |       | 2,763              |       | 2,558                 |       |
| Accrued payroll  and related liabilities                                                                                                                                                                               |       | 1,326              |       | 1,185                 |       |
| Current portion  of long-term debt                                                                                                                                                                                     |       | 423                |       | 414                   |       |
| Total current  liabilities                                                                                                                                                                                             |       | 11,738             |       | 10,909                |       |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| Long-term debt, less  current portion                                                                                                                                                                                  |       | 6,191              |       | 6,301                 |       |
|                                                                                                                                                                                                                   |       |               |       |                  |       |
| 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—14,152,227 and 14,116,148 at      March 31, 2007 and December 31, 2006 respectively |       | 142                |       | 141                   |       |
| Additional  paid-in capital                                                                                                                                                                                            |       | 61,826             |       | 61,638                |       |
| Accumulated  deficit                                                                                                                                                                                                   |       | (24,069            | )          | (24,409               | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                |       | 18                 |       | 20                    |       |
| Total stockholders’  equity                                                                                                                                                                                       |       | 37,917             |       | 37,390                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                        |       | $                  | 55,846     |                  | $          | 54,600 |   |

See accompanying notes

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**Natrol, Inc. and Subsidiaries**

**Consolidated Condensed Statements of Income**

**(Inthousands, except share and per share data)**

**(unaudited)**
| ** **                            | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                                  |       |                                                 |       |   |   |
| Net sales                             |       | $                                                    | 18,707     |   | $ | 16,923 |   |
| Cost of goods  sold                   |       | 9,921                                                |       | 10,029 |   |
| Gross profit                          |       | 8,786                                                |       | 6,894 |   |
| Selling and  marketing expenses       |       | 5,026                                                |       | 4,091 |   |
| General and  administrative expenses  |       | 3,016                                                |       | 2,817 |   |
| Total operating  expenses             |       | 8,042                                                |       | 6,908 |   |
| Operating income  (loss)              |       | 744                                                  |       | (14 | ) |
|                                  |       |                                                 |       |   |   |
| Interest income                       |       | 32                                                   |       | 56 |   |
| Interest expense                      |       | (221                                                 | )          | (154 | ) |
| Gain on sale of  property             |       | —                                               |       | 230 |   |
| Income before  income taxes           |       | 555                                                  |       | 118 |   |
| Income tax  provision                 |       | 215                                                  |       | 45 |   |
| Net income                            |       | $                                                    | 340        |   | $ | 73 |   |
| Income per  share:                    |       |                                                 |       |   |   |
| Basic                                 |       | $                                                    | 0.02       |   | $ | 0.01 |   |
| Diluted                               |       | 0.02                                                 |       | 0.01 |   |
|                                  |       |                                                 |       |   |   |
| Weighted-average  shares outstanding: |       |                                                 |       |   |   |
| Basic                                 |       | 14,145,073                                           |       | 13,534,237 |   |
| Diluted                               |       | 15,226,377                                           |       | 13,805,234 |   |

 

See accompanying notes

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**Natrol, Inc. and Subsidiaries**

**Consolidated Condensed Statements of Cash Flows**

**(Inthousands)**

**(unaudited)**
| ** **                                                                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                                                   | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                                                                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| **Operating  activities**                                                                    |       |                             |       |   |   |
| Net income                                                                                   |       | $                                | 340        |   | $ | 73 |   |
|                                                                                         |       |                             |       |   |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                |       | 346                              |       | 348 |   |
| Foreign currency translation                                                                 |       | (2                               | )          | — |   |
| Provision for bad debts                                                                      |       | 56                               |       | (27 | ) |
| Deferred income taxes                                                                        |       | (4                               | )          | (104 | ) |
| Option Expense                                                                               |       | 131                              |       | 292 |   |
| Changes in  operating assets and liabilities:                                                |       |                             |       |   |   |
| Accounts receivable                                                                          |       | (2,058                           | )          | (1,192 | ) |
| Inventory                                                                                    |       | 344                              |       | (966 | ) |
| Income taxes receivable                                                                      |       | 95                               |       | 134 |   |
| Prepaid expenses and other current assets                                                    |       | 141                              |       | 154 |   |
| Accounts payable                                                                             |       | 1,215                            |       | (335 | ) |
| Accrued expenses                                                                             |       | 205                              |       | 1,069 |   |
| Accrued payroll and related liabilities                                                      |       | 141                              |       | 455 |   |
| Net cash  provided by (used in) operating activities                                         |       | 950                              |       | (99 | ) |
| ** **                                                                                   |       |                             |       |   |   |
| **Investing  activities**                                                                    |       |                             |       |   |   |
| Purchases of  property and equipment                                                         |       | (111                             | )          | (222 | ) |
| Sale of property                                                                             |       | —                           |       | 759 |   |
| Investment in  foreign affiliate                                                             |       | (102                             | )          | — |   |
| Other assets                                                                                 |       | (374                             | )          | 40 |   |
| Net cash  provided by (used in) investing activities                                         |       | (587                             | )          | 577 |   |
| ** **                                                                                   |       |                             |       |   |   |
| **Financing  activities**                                                                    |       |                             |       |   |   |
| Repayment of  line of credit                                                                 |       | (742                             | )          | — |   |
| Repayments on  long-term debt                                                                |       | (102                             | )          | (132 | ) |
| Proceeds from  issuance of common stock                                                      |       | 59                               |       | 35 |   |
| Net cash (used  in) financing activities                                                     |       | (785                             | )          | (97 | ) |
|                                                                                         |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                        |       | (422                             | )          | 381 |   |
| Cash and cash  equivalents, beginning of period                                              |       | 1,003                            |       | 3,097 |   |
| Cash and cash  equivalents, end of period                                                    |       | $                                | 581        |   | $ | 3,478 |   |

See accompanying notes

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**Natrol, Inc. andSubsidiaries**

**Notes to Consolidated Unaudited Financial Statements**

(In thousands,except share and per share data)

1. BASIS OF PRESENTATION

The accompanying consolidated financial statementshave been prepared by Natrol, Inc. (the “Company”), pursuant to the rules andregulations of the Securities and Exchange Commission (SEC). This quarterlyreport on Form 10-Q should be read in conjunction with the Company’s annualreport on Form 10-K for the year ended December 31, 2006. Certain informationand footnote disclosures which are normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted pursuant to SEC rulesand regulations. The information reflects all normal and recurring adjustmentswhich, in the opinion of the Company’s management, are necessary for a fairpresentation of the financial position of the Company and its results ofoperations for the interim periods set forth herein. The results for the threemonths ended March 31, 2007 are not necessarily indicative of the results to beexpected for the full year or any other period.

2. STOCK BASED COMPENSATION

In December 2004, the Financial Accounting StandardsBoard (FASB) issued SFAS 123R, *Share BasedPayment: An Amendment of FASB Statements No. 123 and 95* (SFAS 123R).This statement requires that the cost resulting from all share-based paymenttransactions be recognized in the Company’s consolidated financial statements.In addition, in March 2005, the SEC released SEC Staff Accounting Bulletin No.107, *Share-Based Payment* (SAB107). SAB 107 provides the SEC staff’s position regarding the application ofSFAS 123R and certain SEC rules and regulations, and also provides the staff’sviews regarding the valuation of share-based payment arrangements for publiccompanies. Generally, the approach in SFAS 123R is similar to the approachdescribed in SFAS 123. However, SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their fair values.

In 2006, the Company adopted the fair valuerecognition provisions of SFAS 123R utilizing themodified-prospective-transition method, as prescribed by SFAS 123R. Under thetransition method, compensation cost recognized during the three months endedMarch 31, 2007 and 2006 includes: (a) compensation cost for all share-basedpayments granted prior to, but not yet vested as of January 1, 2006, based onthe grant date fair value estimated in accordance with SFAS 123, and (b)compensation expense for all share-based payments granted subsequent to January1, 2006, based on the grant-date fair value estimated in accordance with theprovisions of SFAS 123R.

During the three months ended March 31, 2007, theCompany granted options to purchase 27,500 shares of common stock. During thethree months ended March 31, 2006 the Company granted options to purchase7,399,999 shares of common stock. Of the 7,399,999 shares, 6,029,500 optionswere granted to Wayne M. Bos upon his appointment as the Company’s CEO andPresident. This option award was approved by the stockholders of the Company atits 2006 annual meeting of stockholders. The remaining 1,370,499 options were grantedto other employees and directors. The options granted to Mr. Bos have certainservice and performance conditions which have been discussed in the Company’sprior SEC filings. These options were fully vested upon grant, and werecognized a related expense of $0.3 million during the first quarter of2006.

The Company used a Monte Carlo method to simulatestock price paths over the term of the 6,029,500 options awarded to Mr. Bos.All other options were valued using a Black-Scholes model. The Monte Carlomethod, which is one acceptable valuation method per SFAS 123R, was used due tomany factors which make utilizing a Black-Scholes model inappropriate for ablock of options of this magnitude. These factors include but are not limitedto the size of the grant in relation to the total shares outstanding, thetrading volume of the Company’s stock and the holder’s ability to resell theshares, and the control factor, which the size of the grant implies. TheCompany used the services of a well-credentialed group of valuation experts toperform the valuation of Mr. Bos’ options. This group developed multiplescenarios, including continuing operation and sale scenarios, to assess thepotential to create shareholder value over the term of the options. The resultingMonte Carlo analysis gave rise to a range of fair values for which the meanamount was utilized in valuing the options for Mr. Bos.

All other stock options were valued using aBlack-Scholes model. Under SFAS 123R, the Company will continue to utilize theBlack-Scholes model to estimate the fair market value related to employee stockoptions after January 1, 2006, unless such method is clearly inappropriate fora significant block of stock options, such as were granted to Mr. Bos. The 

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Company’s assessment ofthe estimated compensation charges for these other stock options is affected byits stock price as well as assumptions regarding a number of complex andsubjective variables and the related tax impact. These variables include, butare not limited to, the Company’s stock price volatility and expected employeestock option behavior.  The Companyrecorded option expenses of $131,000 and $292,000 for the three months endedMarch 31, 2007 and 2006, respectively.

The following summarizesthe Company’s stock option activity for the three months ended March 31, 2007:
| ** **                      | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|---------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                      | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Number of option  shares:       |       |       |       |         |       |            |       |          |       |
| Outstanding at  January 1, 2007 |       | 8,618,256  |       | $            | 2.32       |            |       |          |       |   |
| Granted                         |       | 27,500     |       | 3.32         |       |            |       |          |       |
| Exercised                       |       | 18,500     |       | 1.38         |       |            |       |          |       |
| Canceled or  expired            |       | 50,000     |       | 2.16         |       |            |       |          |       |
| Outstanding at  March 31, 2007  |       | 8,577,256  |       | $            | 2.32       |            | 4.45       |          | $          | 0.0 |   |
| Exercisable at March  31, 2007  |       | 7,507,318  |       | $            | 2.33       |            | 4.12       |          | $          | 0.0 |   |

 

The total fair value of the nonvested options as ofMarch 31, 2007 was $957,433. The aggregate intrinsic value of the nonvestedoptions as of March 31, 2007 was $0.0.

The following summarizes the fair value of the Company’sunvested stock options that vested during the three months ended March 31,2007.
| ** **                    | ** ** | **Shares** | ** ** | **Weighted  Average  Fair  Value** | ** ** |
|-------------------------------|------------|------------|------------|------------------------------------|------------|
| Nonvested at  January 1, 2007 |       | 1,231,574  |       | $                                  | 0.91       |   |
| Granted                       |       | 27,500     |       | 0.99                               |       |
| Canceled or  expired          |       | 45,000     |       | 1.21                               |       |
| Vested                        |       | 144,136    |       | 0.91                               |       |
| Nonvested at March 31,  2007  |       | 1,069,938  |       | $                                  | 0.89       |   |

 

The Black-Scholes option-pricing model is used by theCompany to determine the weighted average fair value of options except for theWayne Bos options. The fair value of options at date of grant and theassumptions utilized to determine such values are indicated in the followingtable:
| ** **                                                                                              | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                              | ** ** | **March 31,**               | ** ** |
| ** **                                                                                              | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                                                                                    |       |                             |       |   |   |
| Weighted average  fair value at date of grant for options granted during the period using  Black-Sholes |       | $                                | 0.99       |   | $ | 1.14 |   |
| Risk-free interest  rates                                                                               |       | 4.36                             | %          | 4.70 | % |
| Expected stock  price volatility                                                                        |       | 60.28                            |       | 60.74 |   |
| Expected dividend yield                                                                                 |       | 0.0                              | %          | 0.0 | % |
|                                                                                                         |            |                                  |            |  |  |  |  |

 

These assumptions resulted in a weighted-average fairvalue of $0.99 and $0.89, respectively, for each stock option valued using theBlack-Scholes method and granted in each of the three-month periods ended March31, 2007 and 2006.

3. INVENTORY

Inventories consist of the following:

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| ** **                           | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw material and  packaging supplies |       | $                        | 7,457      |                        | $          | 6,778 |   |
| Finished goods                       |       | 4,287                    |       | 5,010                       |       |
| Total inventory                      |       | $                        | 11,744     |                        | $          | 11,788 |   |

 

4. SHIPPING AND HANDLING COSTS

The Company records all amounts charged to customers forshipping and handling as revenue. All outbound shipping and fulfillment costsare classified as selling and marketing expenses and totaled approximately$0.8 million in the three-month periods ended March 31, 2007 and 2006,respectively.

5. EARNINGS PER SHARE

The Company calculates income per share in accordancewith SFAS No. 128, *Earnings per Share*.Basic earnings per share have been computed by dividing net income by theweighted average number of common shares outstanding during the period. Dilutedearnings per share have been computed by dividing net income by the weightedaverage number of common shares and dilutive common stock equivalents (stockoptions), when dilutive.

As of March 31, 2007 and 2006, options to purchase8,577,256 and 2,513,717 shares of common stock were respectively outstanding.For the three months ended March 31, 2007 and 2006, 327,500 and 1,120,000options were respectively considered to be anti-dilutive.

6. SENIOR CREDIT FACILITY

The Company is party to a loan and security agreementwith Wachovia Capital Finance (Western), as agent, the lenders party thereto,Prolab Nutrition, the Company’s wholly owned subsidiary, and certain of itsother subsidiaries, as guarantors. The loan agreement provides for a three-yearsecured revolving credit facility of up to $10 million. Borrowings underthe facility may be used for ongoing working capital purposes and certainfuture acquisitions. At March 31, 2007, the Company had $3.0 million ofborrowings outstanding under the facility.

Under the credit facility, the Company may borrow upto the lesser of $10 million and the borrowing base (calculated based uponeligible inventory and eligible accounts). The interest rate on borrowingsunder the credit facility is equal to: (1) agent’s publicly announced primerate for prime rate loans or (2) 2.25% plus the applicable Eurodollar rate forany Eurodollar rate loans. Interest is payable monthly in arrears not laterthan the first day of each calendar month. The agent’s prime rate as of March31, 2007 was 8.25%. The credit facility requires that all principal be repaidin August 2009. Additionally, borrowings under the credit facility must berepaid when the borrowings exceed the borrowing base.

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

The credit facility contains covenants restricting theCompany’s ability to, among other things: (1) incur or guarantee additionaldebt; (2) engage in any mergers or acquisitions (subject to certainexceptions); (3) engage in any asset sales or dispose of any assets (other thanin the ordinary course); (4) engage in transactions with affiliates; (5) incurliens; (6) make any loans or investments; and (7) declare or pay dividends orredeem or repurchase capital stock.

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

7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS.

The Financial Accounting Standards Board issuedInterpretation No. 48, *Accounting forUncertainty in Income Taxes* (“FIN 48”) in June 2006. Theinterpretation clarifies the accounting for uncertainty in income taxesrecognized in 

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financial statements inaccordance with SFAS 109. FIN 48 is effective for fiscal years beginningafter December 15, 2006. We adopted the provisions of Financial AccountingStandards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”), onJanuary 1, 2007. FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements in accordance withFASB Statement 109, “Accounting for Income Taxes”, and prescribes a recognitionthreshold and measurement process for financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN 48 also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition.

Based on our evaluation, we have concluded that thereare no significant uncertain tax positions requiring recognition in ourfinancial statements. Our evaluation was performed for the tax years endedDecember 31, 2003, 2004, 2005 and 2006, the tax years which remain subject toexamination by major tax jurisdictions as of March 31, 2007.

We may from time to time be assessed interest orpenalties by major tax jurisdictions, although any such assessmentshistorically have been minimal and immaterial to our financial results. In theevent we have received an assessment for interest and/or penalties, it has beenclassified in the financial statements as selling, general and administrativeexpense.

In September 2006, the FASB issued Statement SFASNo. 157 (“FAS 157”), “ *Fair ValueMeasurements*,” which defines fair value, establishesguidelines for measuring fair value and expands disclosures regarding fair valuemeasurements. FAS 157 does not require any new fair value measurements butrather eliminates inconsistencies in guidance found in various prior accountingpronouncements. SFAS 157 is effective for fiscal years beginning afterNovember 15, 2007. Earlier adoption is permitted, provided the company hasnot yet issued financial statements, including for interim periods, for thatfiscal year. The Company is currently evaluating the impact of FAS 157, butdoes not expect the adoption of FAS 157 to have a material impact on itsconsolidated financial position, results of operations or cash flows.

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

8. OPERATING SEGMENTS

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

9. SUBSEQUENT EVENTS

In April 2007, wesold our 94,000 square foot manufacturing, distribution and office facility andour 132,000 square foot shipping facility both located in Chatsworth,California.  The sales price for theproperties was $26.0 million.  Afterpaying expenses associated with the transaction, taxes, and extinguishing themortgage debt on the buildings, we netted approximately $12.0 million in cash.

Inconjunction with the sale, we entered into five year leases for each of thebuildings.

Aggregaterental payments for each annual 12-month period are:

|            | ** ** | **(000)** | ** ** |
|------------|------------|-----------|------------|
| Year one   |       | $         | 1,323      |   |
| Year two   |       | 1,363     |       |
| Year three |       | 1,403     |       |
| Year four  |       | 1,445     |       |
| Year five  |       | 1,489     |       |
|            |            |           |            |  |

The leases are triple net leases. We are obligated to pay the lessor a2% management fee and to reimburse the lessor for property taxes and buildingmaintenance expenses.

Inaccordance with SFAS 13, Accounting for Leases, we will record a gain on thesale of approximately $6.0 million during the second quarter of 2007.  The remainder from the sale of the propertieswill be capitalized as a future benefit and will be amortized to reduce rentalexpense during each of the five years of the lease period by approximately $1.1million per year.

*10.  ACQUISITION COMMITMENTS*

Consideration for the acquisition of the NuHair andShen Min brands includes potential incentive payments based upon the net amountof invoiced sales of the NuHair and Shen Min products during fiscal 2007, 2008and 2009.  For 2007, 

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the Company is obligatedto pay the seller of the brands $1.00 (one dollar) for every dollar of netinvoiced sales in excess of $7.6 million, calculated on a quarterly basis. ** ** The potential incentive payment for 2007 maynot exceed $2.0 million.  For 2008, theCompany is obligated to pay the seller 15% of the amount by which net invoicedsales exceed $11.4 million.  For 2009,the Company is obligated to pay the Seller 15% of the amount by which netinvoiced sales exceed $13.68 million. During the first quarter of 2007, net invoiced sales of the NuHair andShen Min brands amounted to $2.3 million.

Consideration for the license of the exclusive U.S.rights to the Promensil and Trinoven brands includes a royalty on net salesrevenue that exceeds $2.0 million.  Until2014, the Company is obligated to pay Novogen a royalty equal to 5.0% of annualnet sales between $2.0 to 3.0 million and a royalty equal to 7.5% of annual netsales in excess of $3.0 million.  After2014, the Company is obligated to pay Seller a royalty equal to 2% of annual netsales between $2.0 to $3.0 million and a royalty equal to 3.0% of annual netsales in excess of $3.0 million.  Duringthe first quarter of 2007, net sales revenue of the Promensil and Trinovenbrands amounted to $0.6 million.

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**Item 2.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**Forward LookingStatements and Certain Risks**

The statements contained in this report that are notpurely historical are “forward-looking statements” within the meaning ofSection 21E of the Securities Exchange Act. These statements are based onour expectations, hopes, beliefs, commitments, intentions, and strategiesregarding the future. They may be identified by the use of words or phrases,such as “believe,” “expect,” “anticipate,” “should,” “plan,” “estimate,” and “potential,”among others. Forward-looking statements include, but are not limited to,statements contained in this Item 2 regarding our financial performance,revenue and expense levels in the future, and the sufficiency of our existingassets to fund future operations and capital spending needs. Actual resultscould differ materially from the anticipated results or other expectationsexpressed in these forward-looking statements as a result of the risks,uncertainties and contingencies discussed below and in our annual report onForm 10-K for the year ended December 31, 2006. The fact that some of therisks, uncertainties and contingencies may be the same or similar to pastreports we have filed with the SEC means only that the risks are present inmultiple periods.

Our ability to predict results or the affect ofcertain events on our future operating results is inherently uncertain.Forward-looking statements should not be unduly relied on, since they involveknown and unknown risks, uncertainties and other factors, some of which arebeyond our control. Therefore, we wish to caution you to carefully consider thefollowing factors discussed in our other SEC reports. The factors discussedherein may not be exhaustive. Therefore, the factors contained herein should beread together with our other reports and documents which are filed by us withthe SEC from time to time, which may supplement, modify, supersede or updatethe factors listed in this report. Factors that could cause or contribute toour actual results differing materially from those discussed herein include,but are not limited to:

·                  our ability todevelop and execute our business plans;

·                  our ability toreplace our Ester-C® business once we have used the remaining inventory ofEster-C;

·                  adversepublicity regarding our products and any similar products distributed byothers;

·                  our ability tomanage the risks associated with our acquisition strategy;

·                  our ability toretain and attract talented management and key employees;

·                  our insurancecoverage or third party indemnification rights may be insufficient to coverlosses that we incur;

·                  we mayexperience greater than expected product returns;

·                  our failure toadequately anticipate sales needs;

·                  any shortage inthe supply of key raw materials;

·                  our ability toprotect our intellectual property;

·                  our exposure toproduct liability claims, as well as the limits of our self insurance programfor products liability claims;

·                  our sales andearnings volatility;

·                  our ability toengage in many transactions prohibited by our senior credit facility;

·                  legal actionsbrought by federal, state and local governmental authorities and privateparties

·                  increasedcompetition from existing competitors and new market entrants, including fromprivate label house brands; and

·                  the impact ofnatural disasters on our manufacturing facility.

The forward-looking statements contained in thisreport are made as of the date of this report, and we assume no obligation toupdate them or to update the reasons why actual results could differ from thoseprojected in these forward-looking statements.

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**OVERVIEW**

**General**

We manufacture and market branded, high-qualitydietary supplements, herbal teas, and sports nutrition products under sixprimary brands: Natrol®, Laci Le Beau®, Prolab®, Nu Hair® , Shen Min®, and  Promensil®. Through our Essentially PureIngredients® (EPI) division we also sell nutraceutical grade ingredients toother manufacturers of nutrition products and provide contract manufacturingservices to companies within the nutraceutical industry.

The majority of our dietary supplements are sold underthe Natrol brand. Our Natrol brand focuses on supplements that are in highdemand as well as specialty niche and proprietary formulations that havepotentially strong margins. These supplements include vitamins, minerals,hormonal supplements, herbal products and specialty combination formulas thatcontribute to an individual’s physical and mental well-being.

The key elements of our business strategy are to:

·                  Control our costand improve margins;

·                  Develop oracquire new products and product lines that can help us capitalize upon ourinfrastructure;

·                  Expand thedistribution of our products to new markets, including internationally; and,

·                  Improve themarketing of our products.

**Management Overview**

We concluded the first quarter of 2007 with net incomeof $340,000. This was our fifth successive profitable quarter.

Our net sales for the three months ended March 31,2007 were 10.5% or $1.8 million more than our net sales for the sameperiod in 2006. The prime reason for the increase in net revenue was theacquisition of the NuHair, Shen Min and Promensil brands in October 2006.

The newly acquired brands have stronger gross marginsthan the core Natrol and Prolab brands. Due to the favorable effects of the newproduct mix, as well as increased manufacturing efficiency, our gross margin inthe quarter ended March 31, 2007 increased to 47.0% from 40.7% in the quarterended March 31, 2006, and the gross margin for the first quarter of 2007 isalso more than the 43.4% recorded for the year ended December 31, 2006.

During the quarter we controlled our costs.  General and administrative expenses increased$199,000 in absolute dollar terms but declined in percentage terms, from 16.6%of net revenue in the quarter ended March 31, 2006 to 16.1% for the quarterended March 31, 2007, despite the increased administrative costs of ouracquisitions and increased administrative costs resulting from theestablishment of a subsidiary in the United Kingdom during the third-quarter of2006.  Net revenue from our UK subsidiaryamounted to $389,000 for the quarter. While the subsidiary is not yet profitable, our operating loss from theUK subsidiary was not large, amounting to $18,000.  Management continues to believe that thisinvestment in the UK will be beneficial to the Company’s long-term growth.

Total selling and marketing cost increased  as a percentage of revenue.  We added some personnel to support our newbrands as well as our operations in the United Kingdom and we spentapproximately $170,000 more in the first quarter of 2007 than the first quarterof 2006 on coop advertising expenses. But, more significantly we invested in marketing.  Our marketing expenditures increasedapproximately $636,000 during the first quarter of 2007 when compared to thefirst quarter of 2006.  The expenditurewas made to support our brands.

An important part of our business strategy is todevelop or acquire new products with strong margins that can capitalize uponour infrastructure.  Senior management isfocused on this effort.  Our policy itnot to announce any potential acquisition until an acquisition agreement hasbeen signed.

At the end of March 2007, we invested $102,000 toacquire a 51% interest in a Hong Kong affiliate.  Because operational control of the subsidiarywill remain with our Hong Kong business partners, the investment will beaccounted for using the equity method of consolidation.  The Company does not believe that, in theshort-term, revenue, profits or losses 

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generated by thesubsidiary will be material. We believe that in the long-term, our having apresence in Asia and our having a means of selling product in China isimportant.

Another aspect of our core strategy is to ensure thatour core brands continue to prosper.  Wecontinue to try to expand the distribution of all of our brands across thechannels of distribution in which we compete and to improve the profitabilityof each segment of our business.

An important challenge in the months ahead will be toreplace our Ester-C® business. Ester-C® has represented more than 10% of ourrevenue in each of the last three years. In 2006, the manufacturer and patentholder of Ester-C® was acquired by NBTY (Nasdaq: NTY), a competitor of ours.NBTY has indicated that it does not intend to continue selling Ester-C® tothird party manufacturers beyond the term of existing supply contracts. Oursupply agreement extends through March, 2008.  However, due to our not being able to sell Ester-C beyond the terms ofour supply agreement, we do not believe that promoting Ester-C is beneficial tous and, as a result, there is a strong likelihood that the amount of Ester-Csales will decline in the months ahead. While we have a strategy to replace the lost Ester-C sales, it isunlikely that any strategy will, in the short-term, replace all of the lostEster-C business.

**Results of Operations**

**THREEMONTHS ENDED MARCH 31, 2007 AND MARCH 31, 2006**

NET SALES. We recognize revenue from sales only after product isshipped. We have no consignment sales. Net sales represent product shipped lessactual and estimated future returns, spoilage allowances, allowances forproduct deemed to be unsaleable by customers, free goods shipped to customersfor promotional or other purposes, rebates, slotting fees and other promotionalexpenditures. Estimates and allowances are based upon known claims and anestimate of additional returns when the amount of future returns from customerscan be reasonably estimated.

Net salesincreased 10.5%, or $1.8 million, to $18.7 million for the three months endedMarch 31, 2007 from $16.9 million for the three months ended March 31, 2006.Sales of $2.5 million from the acquired NuHair, Shen Min and Promensil brandswere partially offset by a decline of approximately $450,000 in EPI revenue anda decline of approximately $560,000 of Prolab revenue.

GROSS PROFIT.Gross profit increased 27.4%, or $1.9 million, to $8.8 million for the threemonths ended March 31, 2007 from $6.9 million for the three months ended March31, 2006. Gross margin increased to 47.0% for the three months ended March 31,2007 from 40.7% for the three months ended March 31, 2006. The increase ingross margin was primarily due to product mix as well as improved manufacturingefficiency.  The change in product mixwas due to the acquisition of the NuHair, Shen Min and Promensil brands, eachof which maintain higher gross margin percentages than the average of all ofour products.

SELLING AND MARKETINGEXPENSES. Selling and marketing expenses consist primarily of advertising andpromotional expenses, costs of distribution, and related payroll expenses andcommissions. Selling and marketing expenses increased 22.9%%, or $0.9 million,to $5.0 million for the three months ended March 31, 2007 from $4.1 million forthe three months ended March 31, 2006. Selling expenses increased approximately $0.3 million due to increasedstaffing and promotion required by our acquisitions and the establishment of asubsidiary in the United Kingdom. Marketing expenses increased approximately $0.6 million due to increasedexpenditures on traditional media and trade shows.

GENERAL ANDADMINISTRATIVE EXPENSES. General and administrative expenses consist primarilyof personnel costs related to general management functions, finance, accountingand information systems, as well as professional fees related to legal, auditand tax matters and depreciation. General and administrative expenses increased7.1%, or $0.2 million to $3.0 million for the three months ended March 31, 2007from $2.8 million for the three months ended March 31, 2006. The reason for theincrease was the infrastructure and payroll necessary to support ouracquisitions and our subsidiary in the United Kingdom.

INTEREST EXPENSE.We recorded interest expense of $221,000 for the three months ended March 31,2007 as compared to interest expense of $154,000 for the three months endedMarch 31, 2006.  The increase was due toborrowings under our line of credit.  Thisadditional interest expense was partially offset by our repayment of a termnote in October 2006.

INCOME TAXEXPENSE. Our effective tax rate was 38.9% in the three months ended March 31,2007 and 38.0% in the three months ended March 31 2006.  The difference is partially due to thedifferences in tax rates between the United States and the United Kingdom.  We do not consider the change material.

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SALEOF BUILDING. During the first quarter of 2006, we sold a building we owned inBloomfield, Connecticut that was formerly used as a shipping facility for ourProlab brand. The approximate net book value of the property, plant and plantimprovements that were sold was $759,000 and the gain, net of brokerage, legaland other related expenses was approximately $230,000.

**Liquidity and CapitalResources**

At March 31, 2007, we had working capital of$12.3 million as compared to $12.1 million in working capital atDecember 31, 2006. Our cash balance at March 31, 2007 was approximately$0.6 million.

**Operating Activities**

Net cash provided by operating activities was$1.0 million for the three months ended March 31, 2007 compared to netcash used of approximately $0.1 million for the three months ended March31, 2006. Cash provided by operating activities during the three months endedMarch 31, 2007 consisted primarily of cash provided by non-cash charges of$0.5 million and cash provided because of changes in operating assets andliabilities of $0.1 million and by our profit of $0.3 million.

During the three months ended March 31, 2007,depreciation and amortization provided $0.3 million of cash, the expensingof stock options $0.1 million of cash, and, increasing the provision for baddebts provided $0.1 million.  Thesenon-cash sources of cash were offset by a small decrease in foreign currencytranslation and a small increase in deferred income taxes.

Cash provided by operating assets and liabilitiesconsisted primarily of an increase in accounts payable of $1.2 million, anincrease in accrued expenses of $0.2 million, an increase in accrued payroll of$0.1 million, a decrease in inventory of $0.3 million, a decrease of $0.1million in income taxes receivable, and, a decrease in prepaid expenses of $0.1million offset by an increase in accounts receivable of $2.1 million.  The increase in accounts receivable is due tothe timing of sales. The increase in accounts payable is also due to timing andpayables are uniformly within vendor terms.

**Investing Activities**

Net cash used by investing activities was$0.6 million for the three months ended March 31, 2007 compared to netcash provided of $0.6 million during the three months ended March 31,2006. During the three months ended March 31, 2007, we invested $0.1 million innew equipment and $0.1 million in acquiring a 51% interest in a Hong Kong basedaffiliate  We also increased restrictedcash used to support our self insurance program by $0.3 million and invested$0.1 million in miscellaneous other assets.

**Financing Activities**

Net cash used by financing activities was $0.8 millionfor the three months ended March 31, 2007 compared to cash used of $0.1 duringthe three months ended March 31, 2006. During the three months ended March 31,2007, we repaid $0.7 million of our line of credit and $0.1 million of ourlong-term debt. During the three months ended March 31, 2007, we received $0.1million from the exercise of stock options. As of March 31, 2007, we had$6.6 million of long-term debt and $3.0 million of short-term debt underour line of credit.  All long-term andshort-term debt was paid off in April 2007 when we sold our headquarters andshipping facilities. (*See Subsequent Events*.)

**Senior Credit Facility**

In August 2006, we entered into a loan and securityagreement with Wachovia Capital Finance (Western), as agent, the lenders partythereto, Prolab Nutrition, our wholly owned subsidiary, and certain of ourother subsidiaries, as guarantors. The loan agreement provides for athree-year, secured, revolving credit facility of up to $10 million.Borrowings under the facility will be used for ongoing outstanding workingcapital purposes and certain future acquisitions. At April 30, 2007, we had noborrowings under the facility.

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Under the creditfacility, we may borrow up to the lesser of $10 million and the borrowingbase (calculated based upon eligible inventory and eligible accounts). Theinterest rate on borrowings under the credit facility is equal to: (1) agent’spublicly announced prime rate for prime rate loans or (2) 2.25% plus theapplicable Eurodollar rate for any Eurodollar rate loans. Interest is payablemonthly in arrears not later than the first day of each calendar month.

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

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

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

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

In order to meet ourlong-term liquidity needs, we may be required to incur additional indebtednessor issue additional equity and debt securities, subject to market and otherconditions. There can be no assurance that such additional financing will beavailable on terms acceptable to us or at all. The failure to raise the fundsnecessary to finance its future cash requirements or consummate futureacquisitions could adversely affect our ability to pursue new acquisitions andcould negatively affect our operations in future periods.

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

**NewAccounting Standards**

The Financial AccountingStandards Board issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (“FIN 48”) inJune 2006. The interpretation clarifies the accounting for uncertainty inincome taxes recognized in financial statements in accordance with SFAS 109.FIN 48 is effective for fiscal years beginning after December 15,2006. We have not determined the effect, if any, the adoption of FIN 48will have on our consolidated financial statements. We adopted the provisionsof Financial Accounting Standards Board (“FASB”) Interpretation No. 48,“Accounting for Uncertainty in Income Taxes-an interpretation of FASB StatementNo. 109” (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement 109, “Accounting for Income Taxes”, andprescribes a recognition threshold and measurement process for financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition.

Based on our evaluation,we have concluded that there are no significant uncertain tax positionsrequiring recognition in our financial statements. Our evaluation was performedfor the tax years ended December 31, 2003, 2004, 2005 and 2006, the tax yearswhich remain subject to examination by major tax jurisdictions as of March 31,2007.

We may from time to timebe assessed interest or penalties by major tax jurisdictions, although any suchassessments historically have been minimal and immaterial to our financialresults. In the event we have received an assessment for interest and/orpenalties, it has been classified in the financial statements as selling,general and administrative expense.

In September 2006,the FASB issued Statement SFAS No. 157 (“FAS 157”), “ *Fair Value Measurements*,” which definesfair value, establishes guidelines for measuring fair value andexpands disclosures regarding fair value measurements. FAS 157 does not requireany new fair value measurements but rather eliminates inconsistencies inguidance found in various prior accounting pronouncements. SFAS 157 iseffective for fiscal years beginning after November 15, 2007. Earlieradoption is permitted, provided the company has not yet issued financialstatements, including for interim periods, for that fiscal year. The Company iscurrently evaluating the impact of FAS 157, but does not expect the adoptionof FAS 157 to have a material impact on its consolidated financialposition, results of operations or cash flows.

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

**CriticalAccounting Policies**

Management’s beliefsregarding significant accounting policies have not changed significantly fromthose discussed in Item 7 of our annual report on Form 10-K for the year endedDecember 31, 2006.

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

Our exposure to market risks is limited to interestrate risks. The risks related to foreign currency exchange rates are immaterialand we do not use derivative financial instruments.

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We are subject to interest rate market risk associatedwith our bank debt. Even so, we do not believe the risk associated with suchborrowing is significant. Additionally, we do not believe that the risk issignificant for our long-term debt due to the low fixed rates and relativeinsignificance of the fixed long-term debt to our balance sheet. Our long-termdebt is comprised of two fixed rate mortgage notes with a total principalbalance of approximately $6.6 million collateralized by our headquartersbuilding and our shipping facility.  Wealso have $3.0 million of short-term debt associated with our line of creditwhose interest is variable at the prime rate. The line of credit is collateralized by our general assets. The twomortgage notes and the line of credit were paid off in conjunction with thesale of our headquarters and shipping facility in April 2007 We continue tomaintain the line of credit.

**Item 4.**                          Controlsand Procedures

*Evaluationof Disclosure Controls and Procedures.  *We maintaindisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the SEC’srules and forms and that such information is accumulated and communicatedto our management, including our principal executive and principal financialofficers, as appropriate, to allow for timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,we recognize that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and we are required to apply our judgment in evaluating thecost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we carried outan evaluation, under the supervision and with the participation of ourmanagement, including our principal executive and principal financial officers,of the effectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based on theforegoing, our principal executive and principal financial officers haveconcluded that, as of the period covered by this report,  our disclosure controls and procedures wereeffective.

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

# **Item5.    Other Information**

Our2007 annual meeting of stockholders will be delayed by more than 30 days fromJune 8, the anniversary date of the 2006 annual meeting of stockholders.  Our board of directors has not yet determinedthe date of the 2007 annual meeting of stockholders.  We will provide all required informationabout the 2007 annual meeting of stockholders when it becomes available.

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**PART II-OTHERINFORMATION**

**Item 1A.**                 Risk Factors

Information concerningcertain risks and uncertainties appears in Part I, Item 1A “Risk Factors” ofour annual report on Form 10-K for the year ended December 31, 2006). Youshould carefully consider these risks and uncertainties before making aninvestment decision with respect to shares of our common stock. Such risks anduncertainties could materially adversely affect our business, financialcondition or operating results.

During the three monthsended March 31, 2007, there has been no material change from the risk factorspreviously disclosed in our annual report on Form 10-K for the year endedDecember 31, 2006

**Item6.    Exhibits**
| Exhibit No.   | ** ** | **Description**                                                                                                                                                                 |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 10.19 |       | Purchase Agreement dated as of March 29, 2007  between Natrol Real Estate, Inc. and Natrol Real Estate II, Inc., as seller,  and Realty Associates Advisors, LLC, as purchaser. |
| Exhibit 10.20 |       | Standard Industrial/Commercial Single-Tenant Lease —  Net dated March 6, 2007 between VRS Chatsworth LLC and Natrol, Inc.,  including addendum (Prairie).                  |
| Exhibit 10.21 |       | Standard Industrial/Commercial Single-Tenant Lease —  Net dated March 6, 2007 between VRS Chatsworth LLC and Natrol, Inc.,  including addendum (Owensmouth).               |
| Exhibit 31.1  |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                            |
| Exhibit 31.2  |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                            |
| Exhibit 32.1  |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                            |
| Exhibit 32.2  |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                            |

 

**SIGNATURE**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| Date: May 14, 2007 | NATROL, INC. |
|--------------------|--------------|
|               |         |   |
|               | By:          | /s/ Dennis R. Jolicoeur |
|               |         | Dennis R. Jolicoeur |
|               |         | Chief Financial Officer, Treasurer and Executive   Vice President (Duly Authorized Officer and   Principal Financial and Accounting Officer) |

 

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