**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

----

**FORM 10-Q**

**(Mark one)**
| **x**                                                                                                                                                                                               | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                |       |                                                                                           |
| **FOR THE  QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006**                                                                                                                                              |
|                                                                                                                                                                                                |       |                                                                                           |
| **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: 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 November 13, 2006, 13,717,744shares of the registrant’s common stock were outstanding.

 

----

** **

**TABLEOF CONTENTS**
|                |   |                                                                                        |   | **Page** |
|----------------|--------|---------------------------------------------------------------------------------------------|--------|----------|
| PART I         |   | FINANCIAL INFORMATION                                                                       |   | 1        |
|           |   |                                                                                        |   |     |
| Item 1.        |   | Financial Statements                                                                        |   | 1        |
|           |   |                                                                                        |   |     |
|           |   | Consolidated Balance  Sheets                                                                |   | 1        |
|           |   |                                                                                        |   |     |
|           |   | Consolidated  Statements of Operations                                                      |   | 2        |
|           |   |                                                                                        |   |     |
|           |   | Consolidated  Statements of Cash Flows                                                      |   | 3        |
|           |   |                                                                                        |   |     |
|           |   | Notes to  Consolidated Unaudited Financial Statements                                       |   | 4        |
|           |   |                                                                                        |   |     |
| Item 2.        |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 10       |
|           |   |                                                                                        |   |     |
| Item 3.        |   | Quantitative  and Qualitative Disclosures About Market Risk                                 |   | 17       |
|           |   |                                                                                        |   |     |
| Item 4.        |   | Controls and  Procedures                                                                    |   | 17       |
|           |   |                                                                                        |   |     |
| PART II.       |   | OTHER INFORMATION                                                                           |   | 19       |
|           |   |                                                                                        |   |     |
| Item  1A.      |   | Risk  Factors                                                                               |   | 19       |
|           |   |                                                                                        |   |     |
| Item  6.       |   | Exhibits                                                                                    |   | 20       |
|           |   |                                                                                        |   |     |
| Signature      |   |                                                                                        |   | 21       |
|           |   |                                                                                        |   |     |
| Exhibit  Index |   |                                                                                        |   | 22       |

 

i

----

** **

**PART1—FINANCIAL INFORMATION**

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

**Natrol, Inc.and Subsidiaries**

**Consolidated Balance Sheets**

(In thousands, except share and per share data)
| ** **                                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                       | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                  |       |                   |       |                  |       |
| Cash                                                                                                                                                             |       | $                      | 5,101      |                  | $          | 3,097 |   |
| Accounts  receivable, net of allowances of $197 and $247 at September 30, 2006 and  December 31, 2005, respectively                                         |       | 6,681                  |       | 6,723                 |       |
| Inventory                                                                                                                                                        |       | 10,047                 |       | 11,797                |       |
| Income taxes  receivable                                                                                                                                         |       | 196                    |       | 439                   |       |
| Deferred income  taxes                                                                                                                                           |       | 2,021                  |       | 2,021                 |       |
| Prepaid expenses  and other current assets                                                                                                                       |       | 1,160                  |       | 726                   |       |
| Total current assets                                                                                                                                             |       | 25,206                 |       | 24,803                |       |
| Property and equipment:                                                                                                                                          |       |                   |       |                  |       |
| Building and  improvements                                                                                                                                       |       | 14,939                 |       | 14,930                |       |
| Machinery and  equipment                                                                                                                                         |       | 5,771                  |       | 5,754                 |       |
| Furniture and  office equipment                                                                                                                                  |       | 3,074                  |       | 2,900                 |       |
|                                                                                                                                                             |       | 23,784                 |       | 23,584                |       |
| Accumulated  depreciation and amortization                                                                                                                       |       | (9,657                 | )          | (8,684                | )          |
| Property and equipment,  net                                                                                                                                     |       | 14,127                 |       | 14,900                |       |
|                                                                                                                                                             |       |                   |       |                  |       |
| Property held for sale,  net                                                                                                                                     |       | —                 |       | 761                   |       |
|                                                                                                                                                             |       |                   |       |                  |       |
| Restricted cash                                                                                                                                                  |       | 5,000                  |       | 5,000                 |       |
| Deferred income taxes                                                                                                                                            |       | 4,072                  |       | 3,905                 |       |
| Goodwill, net of  accumulated amortization and impairment charge of $23,015                                                                                      |       | 2,026                  |       | 2,026                 |       |
| Other assets                                                                                                                                                     |       | 170                    |       | 67                    |       |
| Total assets                                                                                                                                                     |       | $                      | 50,601     |                  | $          | 51,462 |   |
| **Liabilities and stockholders’  equity**                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                 |       | $                      | 2,716      |                  | $          | 4,647 |   |
| Accrued expenses                                                                                                                                                 |       | 3,481                  |       | 2,888                 |       |
| Accrued payroll  and related liabilities                                                                                                                         |       | 1,351                  |       | 826                   |       |
| Current portion  of long-term debt                                                                                                                               |       | 406                    |       | 532                   |       |
| Total current  liabilities                                                                                                                                       |       | 7,954                  |       | 8,893                 |       |
| Long-term debt, less  current portion                                                                                                                            |       | 6,408                  |       | 7,165                 |       |
| 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—13,639,148 and 13,535,837 at  September 30, 2006 and December 31, 2005, respectively |       | 136                    |       | 135                   |       |
| Additional  paid-in capital                                                                                                                                      |       | 60,729                 |       | 60,113                |       |
| Accumulated  deficit                                                                                                                                             |       | (24,631                | )          | (24,844               | )          |
| Accumulated  other comprehensive income                                                                                                                          |       | 5                      |       | —                |       |
| Total stockholders’  equity                                                                                                                                 |       | 36,239                 |       | 35,404                |       |
| Total liabilities and stockholders’ equity                                                                                                                  |       | $                      | 50,601     |                  | $          | 51,462 |   |

Seeaccompanying notes

----

** **

**Natrol, Inc. andSubsidiaries**

**Consolidated Statements of Operations**

(In thousands, except share and per share data)

(unaudited)
| ** **                                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net sales                                                   |       | $                                                    | 15,660     |                                                | $          | 15,390 |   | $ | 49,171 |   | $ | 52,663 |   |
| Cost of goods sold                                          |       | 8,972                                                |       | 9,884                                               |       | 28,395 |   | 33,365 |   |
| Gross profit                                                |       | 6,688                                                |       | 5,506                                               |       | 20,776 |   | 19,298 |   |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Selling and marketing  expenses                             |       | 3,848                                                |       | 4,360                                               |       | 12,031 |   | 13,405 |   |
| General and  administrative expenses                        |       | 2,688                                                |       | 2,226                                               |       | 8,337 |   | 7,228 |   |
| Total operating  expenses                                   |       | 6,536                                                |       | 6,586                                               |       | 20,368 |   | 20,633 |   |
| Operating income (loss)                                     |       | 152                                                  |       | (1,080                                              | )          | 408 |   | (1,335 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                                             |       | 70                                                   |       | 49                                                  |       | 186 |   | 140 |   |
| Interest expense                                            |       | (149                                                 | )          | (159                                                | )          | (456 | ) | (480 | ) |
| Gain on sale of  property                                   |       | —                                               |       | —                                              |       | 230 |   | — |   |
| Income (loss) before  taxes                                 |       | 73                                                   |       | (1,190                                              | )          | 368 |   | (1,675 | ) |
| Income tax provision  (benefit)                             |       | 33                                                   |       | (448                                                | )          | 155 |   | (632 | ) |
| Net income (loss)                                           |       | $                                                    | 40         |                                                | $          | (742 | ) | $ | 213 |   | $ | (1,043 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Other comprehensive  income                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Foreign currency  translation adjustment                    |       | 5                                                    |       | —                                              |       | 5 |   | — |   |
| Comprehensive income                                        |       | $                                                    | 45         |                                                | $          | (742 | ) | $ | 218 |   | $ | (1,043 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss) per  share:                               |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                       |       | $                                                    | .00        |                                                | $          | (.05 | ) | $ | .02 |   | $ | (.08 | ) |
| Diluted                                                     |       | $                                                    | .00        |                                                | $          | (.05 | ) | $ | .02 |   | $ | (.08 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average shares  outstanding—basic and diluted |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                       |       | 13,604,572                                           |       | 13,519,317                                          |       | 13,573,108 |   | 13,452,794 |   |
| Diluted                                                     |       | 13,711,047                                           |       | 13,519,317                                          |       | 13,931,927 |   | 13,452,794 |   |

 

See accompanying notes

2

----

** **

**Natrol, Inc.and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

(In thousands)

(unaudited)
| ** **                                                                                       | ** ** | **Nine Months Ended   September,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
|                                                                                             |       |                                              |       |   |   |
| **Operating activities**                                                                         |       |                                              |       |   |   |
| Net income (loss)                                                                                |       | $                                                 | 213        |   | $ | (1,043 | ) |
|                                                                                             |       |                                              |       |   |   |
| Adjustments to  reconcile income (loss) to net cash provided by (used in) operating  activities: |       |                                              |       |   |   |
| Depreciation and  amortization                                                                   |       | 1,048                                             |       | 982 |   |
| Foreign currency  translation                                                                    |       | 5                                                 |       | — |   |
| Provision for  bad debts                                                                         |       | (50                                               | )          | 218 |   |
| Deferred income  taxes                                                                           |       | (167                                              | )          | — |   |
| Shares issued  for services                                                                      |       | 32                                                |       | — |   |
| Option expense                                                                                   |       | 460                                               |       | — |   |
| Changes in  operating assets and liabilities:                                                    |       |                                              |       |   |   |
| Accounts  receivable                                                                             |       | 90                                                |       | (152 | ) |
| Inventory                                                                                        |       | 1,750                                             |       | (2,378 | ) |
| Income taxes  receivable/payable                                                                 |       | 243                                               |       | (269 | ) |
| Prepaid expenses  and other current assets                                                       |       | (434                                              | )          | (175 | ) |
| Accounts payable                                                                                 |       | (2,135                                            | )          | 569 |   |
| Accrued expenses                                                                                 |       | 797                                               |       | 1,339 |   |
| Accrued payroll  and related liabilities                                                         |       | 526                                               |       | (430 | ) |
| Net cash provided by  (used in) operating activities                                             |       | 2,378                                             |       | (1,339 | ) |
|                                                                                             |       |                                              |       |   |   |
| **Investing activities**                                                                         |       |                                              |       |   |   |
| Purchases of property  and equipment                                                             |       | (272                                              | )          | (644 | ) |
| Sale of property                                                                                 |       | 759                                               |       | — |   |
| Other assets                                                                                     |       | (103                                              | )          | 47 |   |
| Net cash provided by  (used in) investing activities                                             |       | 384                                               |       | (597 | ) |
|                                                                                             |       |                                              |       |   |   |
| **Financing activities**                                                                         |       |                                              |       |   |   |
| Repayments on long-term  debt                                                                    |       | (884                                              | )          | (362 | ) |
| Proceeds from issuance  of common stock                                                          |       | 126                                               |       | 274 |   |
| Net cash used in  financing activities                                                           |       | (758                                              | )          | (88 | ) |
| Net increase (decrease)  in cash and cash equivalents                                            |       | 2,004                                             |       | (2,024 | ) |
| Cash and cash  equivalents, beginning of period                                                  |       | 3,097                                             |       | 6,022 |   |
| Cash and cash  equivalents, end of period                                                        |       | $                                                 | 5,101      |   | $ | 3,998 |   |
|                                                                                             |       |                                              |       |   |   |
| **Supplemental cash flow  information**                                                          |       |                                              |       |   |   |
| Cash paid during the  year for:                                                                  |       |                                              |       |   |   |
| Interest                                                                                         |       | $                                                 | 457        |   | $ | 480 |   |
| Income taxes                                                                                     |       | $                                                 | 79         |   | $ | 145 |   |

 

See accompanying notes

3

----

 

**Natrol, Inc. andSubsidiaries**

**Notes toConsolidated 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, 2005. 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 and nine months ended September 30, 2006 are not necessarily indicativeof the results to be expected for the full year or any other period.

2. STOCK BASED COMPENSATION

Through the end of 2005, the Company measured compensationfor stock-based incentive programs utilizing the intrinsic value methodprescribed by Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees,*andrelated interpretations. Under this method, the Company did not recordcompensation expense when stock options were granted to eligible participantsas long as the exercise price was not less than the fair market value of thestock when the option was granted. In accordance with Statement of FinancialAccounting Standards (SFAS) No. 123, *Accountingfor Stock-Based Compensation*, (SFAS 123) and SFAS No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure*, the Company disclosed the pro forma net income pershare as if the fair value-based method had been applied in measuringcompensation expense for stock-based incentive awards. No stock-basedcompensation cost was recognized in the Consolidated Statement of Operationsfor the three months and nine months ended September 30, 2005 for optionsgranted under the Company’s stock option plan, as all unvested options grantedhad an exercise price equal to or greater than the fair market value of theunderlying common stock on the date of grant.

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’s 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. Pro forma disclosure offair value recognition, as prescribed under SFAS 123, is no longer analternative.

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 and ninemonths ended September 30, 2006 includes: (a) compensation cost for allshare-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant date fair value estimated in accordance with SFAS 123,and (b) compensation expense for all share-based payments granted subsequent toJanuary 1, 2006, based on the grant-date fair value estimated in accordancewith the provisions of SFAS 123R. Under the modified-prospective-transitionmethod, results for the prior periods have not been restated.

During the three months and nine months endedSeptember 30, 2006, the Company granted options to purchase 610,000 and7,399,999 shares of common stock, respectively. Of the 7,399,999 shares,6,029,500 options were granted to Wayne M. Bos upon his appointment as theCompany’s CEO and President. This option award was approved by the stockholdersof the Company at its 2006 annual meeting of stockholders. The remaining1,370,499 options were granted to other employees and directors. The optionsgranted to Mr. Bos have certain service and performance conditions which havebeen discussed in the Company’s proxy statement for the 2006 annual meeting ofstockholders. These options were fully vested upon grant, and we recognized arelated expense of $0.3 million during the first quarter of 2006. During thethree and nine months ended September 30, 2006, we recognized expenses of $0.1 millionand $0.5 million as a result of the adoption of SFAS 123R.

4

----

 

The effect of thechange inapplying the original provisions of SFAS 123 resulted in lowering operating income,income before taxes, net income and basic and diluted earnings per share asfollows:
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **September 30, 2006** | ** ** | **September 30, 2006**      | ** ** |
| ** **                                | ** ** | **As per SFAS  123R**  | ** ** | **Change to  three months** | ** ** | **As per SFAS  123R** | ** ** | **Change to  nine months** | ** ** |
| Operating income                          |       | $                                | 152        |                                  | $          | (102 | ) | $ | 408 |   | $ | (460 | ) |
| Income before  provision for income taxes |       | 73                               |       | $                                     | (102       | ) | 368 |   | $ | (460 | ) |
| Net income                                |       | 40                               |       | $                                     | (63        | ) | 213 |   | $ | (285 | ) |
| Net income per  share:                    |       |                             |       |                                  |       |   |   |   |   |
| Basic                                     |       | $                                | .00        |                                  | $          | .00 |   | $ | .02 |   | $ | .02 |   |
| Diluted                                   |       | $                                | .00        |                                  | $          | .00 |   | $ | .02 |   | $ | .02 |   |

 

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. Theresulting Monte Carlo analysis gave rise to a range of fair values for whichthe mean amount 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. TheCompany’s assessment of the estimated compensation charges for these otherstock options is affected by its stock price as well as assumptions regarding anumber of complex and subjective variables and the related tax impact. Thesevariables include, but are not limited to the Company’s stock price volatilityand expected employee stock option behavior.

The following summarizes the Company’s stock optionactivity, not including the Wayne Bos stock options, for the nine months endedSeptember 30, 2006:
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Number of option  shares:          |       |       |       |                                   |       |                                                |       |                            |       |
| Outstanding at  January 1, 2006    |       | 2,310,820  |       | $                                      | 3.13       |                                                |       |                            |       |   |
| Granted                            |       | 1,370,499  |       | 2.18                                   |       |                                                |       |                            |       |
| Exercised                          |       | 65,563     |       | 1.37                                   |       |                                                |       |                            |       |
| Canceled or  expired               |       | 215,000    |       | 2.54                                   |       |                                                |       |                            |       |
| Outstanding at  September 30, 2006 |       | 3,400,756  |       | $                                      | 2.82       |                                                | 5.31       |                            | $          | 0.0 |   |
| Exercisable at  September 30, 2006 |       | 2,014,212  |       | $                                      | 3.21       |                                                | 4.48       |                            | $          | 0.0 |   |

 

5

----

 

The following summarizes the Company’s stock optionactivity, including the Wayne Bos stock options, for the nine months ended September30, 2006:
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Number of option  shares:          |       |       |       |                                   |       |                                                |       |                            |       |
| Outstanding at  January 1, 2006    |       | 2,310,820  |       | $                                      | 3.13       |                                                |       |                            |       |   |
| Granted                            |       | 7,399,999  |       | 2.26                                   |       |                                                |       |                            |       |
| Exercised                          |       | 65,563     |       | 1.37                                   |       |                                                |       |                            |       |
| Canceled or  expired               |       | 215,000    |       | 2.54                                   |       |                                                |       |                            |       |
| Outstanding at  September 30, 2006 |       | 9,430,256  |       | $                                      | 2.48       |                                                | 4.71       |                            | $          | 0.0 |   |
| Exercisable at  September 30, 2006 |       | 8,043,712  |       | $                                      | 2.52       |                                                | 4.40       |                            | $          | 0.0 |   |

 

The following summarizes the fair value of the Company’sstock options for the nine months ended September 30, 2006, not including theWayne Bos stock options.
| ** **                       | ** ** | **Shares** | ** ** | **Weighted  Average  Fair  Value** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | 99,501     |       | $                                  | 1.48       |   |
| Granted                          |       | 1,370,499  |       | $                                  | 0.89       |   |
| Vested                           |       | 153,456    |       | $                                  | 2.52       |   |
| Nonvested at September  30, 2006 |       | 1,316,544  |       | $                                  | 0.93       |   |

 

The following summarizes the fair value of the Company’sstock options for the nine months ended September 30, 2006, including the WayneBos stock options.
| ** **                       | ** ** | **Shares** | ** ** | **Weighted  Average Fair  Value** | ** ** |
|----------------------------------|------------|------------|------------|----------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | 99,501     |       | $                                      | 1.48       |   |
| Granted                          |       | 7,399,999  |       | $                                      | 0.21       |   |
| Vested                           |       | 6,182,956  |       | $                                      | 0.07       |   |
| Nonvested at September  30, 2006 |       | 1,316,544  |       | $                                      | 0.93       |   |

 

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:
| ** **                                                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                                                                                                    |       |                                                |       |   |   |
| Weighted average  fair value at date of grant for options granted during the period using  Black-Sholes |       | $                                                   | 0.89       |   | $ | 1.711 |   |
|                                                                                                    |       |                                                |       |   |   |
| Risk-free  interest rates                                                                               |       | 5.03                                                | %          | 3.72 | % |
| Expected stock  price volatility                                                                        |       | 59.73                                               |       | 63.62 |   |
| Expected dividend yield                                                                                 |       | 0.0                                                 | %          | 0.0 | % |
|                                                                                                         |            |                                                     |            |  |  |  |  |

 

These assumptions resulted in a weighted-average fairvalue of $0.89 and $1.71, respectively, for each stock option valued under theBlack-Scholes method and granted in each of the nine-month periods endedSeptember 30, 2006 and 2005.

The following table illustrates the effect on netincome and earnings per share if the Company had applied the fair

6

----

 

value recognition provisions of SFAS 123R for thethree and nine month periods ended September 30, 2005.
| ** **                                                                                                                                                                   | ** ** | **Three Months**                       | ** ** | **Nine Months** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **Ended September 30, 2005** | ** ** |
| Net income (loss)                                                                                                                                                            |       | $                                           | (742       | )                    | $          | (1,043 | ) |
|                                                                                                                                                                         |       |                                        |       |                 |       |
| Total  stock-based employee compensation expense determined under the fair  value-based method for all awards, net of related tax benefits (“Stock  Compensation”) |       | 23                                          |       | 41                   |       |
| Net income  (loss) — pro forma                                                                                                                                          |       | $                                           | (765       | )                    | $          | (1,084 | ) |
|                                                                                                                                                                         |       |                                        |       |                 |       |
| Net income  (loss) per share:                                                                                                                                                |       |                                        |       |                 |       |
| Basic—as reported                                                                                                                                                       |       | $                                           | (.05       | )                    | $          | (.08 | ) |
| Diluted—as reported                                                                                                                                                     |       | $                                           | (.05       | )                    | $          | (.08 | ) |
| Basic—pro forma                                                                                                                                                         |       | $                                           | (.05       | )                    | $          | (.08 | ) |
| Diluted—pro  forma                                                                                                                                                      |       | $                                           | (.05       | )                    | $          | (.08 | ) |

 

3. INVENTORY

Inventories consist of the following:
| ** **                           | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                 |       |                         |       |                        |       |
| Raw material and  packaging supplies |       | $                            | 5,655      |                        | $          | 7,547 |   |
| Finished goods                       |       | 4,392                        |       | 4,250                       |       |
| Total inventory                      |       | $                            | 10,047     |                        | $          | 11,797 |   |

 

4. SHIPPING AND HANDLING COSTS

The Company records all amounts charged to customers for shipping andhandling as revenue. All outbound shipping and fulfillment costs are classified as sellingand marketing expenses and totaled approximately $2.5 million and $2.4 millionin the nine-month periods ended September 30, 2006 and 2005, respectively.

5. EARNINGS PER SHARE

The Company calculates income (loss) per share inaccordance with SFAS No. 128, *Earningsper Share*. Basic earnings per share have been computed by dividingnet income (loss) by the weighted average number of common shares outstandingduring the period. Diluted earnings per share have been computed by dividingnet income (loss) by the weighted average number of common shares and dilutivecommon stock equivalents (stock options), when dilutive.

As of September 30, 2006 and September 30, 2005,options to purchase 9,430,256 and 2,302,420 shares of common stock,respectively, were, outstanding. For the three months ended September 30, 2006,9,323,781 options were considered to be anti-dilutive. For the nine monthsended September 30, 2006, 9,234,205 options were considered anti-dilutive. Alloptions outstanding for the three and nine months ended September 30, 2005,were considered anti-dilutive due to the Company’s losses during these periods.

6. 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, the Company’s wholly owned subsidiary, and certainof its other subsidiaries, as guarantors. The loan agreement provides for athree-year secured revolving credit facility of up to $10 million. Borrowingsunder the facility may be used for ongoing working capital purposes and certainfuture acquisitions. At September 30, 2006, the Company had no borrowings underthe 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

7

----

 

equal to: (1) agent’s publicly announced prime ratefor prime rate loans or (2) 2.25% plus the applicable Eurodollar rate for anyEurodollar rate loans. Interest is payable monthly in arrears not later thanthe first day of each calendar month. The agent’s prime rate as of September30, 2006 was 8.25%. The credit facility requires that all principal be repaidin full on the third anniversary of the closing date. Additionally, borrowingsunder the credit facility must be repaid when the borrowings exceed theborrowing 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 and cross-defaultsto the Company’s other material indebtedness. 

7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting StandardsBoard issued two new pronouncements, SFAS No. 157, *Fair ValueMeasurements*, and SFAS No. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans - An Amendment of FASBStatements No. 87, 88, 106, and 132(R)*. The company does not believethat SFAS 157 will have a material impact on its financial statements. SFAS 158does not apply as the Company does not have a defined benefit pension oranother post retirement plan.

In June 2006, the FASB issued FIN No. 48, *Accounting for Uncertainty in Income Taxes – aninterpretation of FASB Statement No. 109,* which clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, *Accounting for Income Taxes.*Theinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 requires recognition of taxbenefits that satisfy a greater than 50% probability threshold. FIN 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.FIN 48 is effective for us beginning January 1, 2007. We arecurrently assessing the potential impact that the adoption of FIN 48 willhave on our 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 October 2006, the Company purchased certain assetsrelated to the Nu Hair® and Shen Min® brands from Biotech InternationalCorporation (“Biotech”) pursuant to an asset purchase agreement dated as ofOctober 13, 2006 among the Company, Biotech and Gregory J. Kelly, as founder ofBiotech.

The Company acquired certain assets of the Nu Hair andShen Min brands, including without limitation the brand’s intellectual propertyrights, inventory, permits, certain contracts and certain unfilled customer andsupply orders. The net purchase price consisted of $5.4 million in cash. TheCompany also agreed to make earnout payments to Biotech, depending upon thetotal amount invoiced to customers of the Nu Hair and Shen Min brands duringeach of the three-year periods after closing.

8

----

 

As part of the acquisition, the Company entered into atwo year consulting agreement with Mr. Kelly. Under the consulting agreement,the Company agreed to pay Mr. Kelly $100,000 per year and granted him anon-qualified stock option to purchase 50,000 shares of the Company’s commonstock at an exercise price of $4.00 per share, vesting quarterly over 2 years.

The Company determined that the assets acquired fromBiotech did not constitute a business using the guidance provided by EITF IssueNo. 98-3, *Determining Whether a NonmonetaryTransaction Involves Receipt of Productive Assets or of a Business.*

In October 2006, the Company licensed the exclusiveU.S. rights to the Promensil® and Trinovin® brands from Novogen Limited(Nasdaq: NVGN), an Australian-based biotechnology company. 

The PromensilÒand TrinovinÒ brands are dietary supplements based on redclover isoflavones that are designed to meet specific health needs of agingadults. PromensilÒ is a dietary supplement, clinically shown torelieve menopausal symptoms, including hot flashes and night sweats, andmaintain bone and heart health. PromensilÒcurrently is distributed through mass and super center, chain drug and grocerystores, the health food channel, and direct sale over the Internet.

Consideration paid for the exclusive U.S. rightsincluded a base payment plus future royalties, which are based on the level offuture sales.

Also in October 2006, the Company entered into amanufacturing and distribution agreement for H57ÔHoodia. Hoodia is South African plant that, when consumed, acts as an appetitesuppressant.

9

----

** **

**Item2.  Management’s Discussion and Analysisof Financial 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 notlimited to, statements contained in this Item 2 regarding our financialperformance, revenue and expense levels in the future, and the sufficiency ofour existing assets to fund future operations and capital spending needs. Actualresults could differ materially from the anticipated results or otherexpectations expressed 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, 2005. 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:

·                     ourability to develop and execute our business plans;

·                     ourability to manage our growth and manage changing market conditions;

·                     ourability to consummate and integrate future acquisitions;

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

·                     adversepublicity regarding the dietary supplement industry or our brands or products;

·                     ourdependence on certain large customers;

·                     ourability to retain and attract talented management and key employees;

·                     ourability to develop new products that receive a high degree of consumeracceptance;

·                     ourability to continue to obtain raw materials for our Ester-C® line of productsat favorable prices or at all;

·                     ourability to gain or expand or maintain distribution and new or existing channelsof trade;

·                     ourability to maintain shelf space with major national retailers;

·       exposureto product liability claims, as well as the limits of our self insuranceprogram for products liability claims;

·       theimpact of natural disasters on our manufacturing facility, as well as our lackof earthquake insurance;

·       industrytrends, including a general downturn or slowing of the dietary supplementindustry;

·       oursales and earnings volatility;

·       ourreliance on independent brokers to sell our products;

·       ourability to protect our intellectual property; and

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

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.

10

----

** **

**General**

We manufacture and market branded, high-qualitydietary supplements, herbal teas, and sports nutrition products under threeprimary brands: Natrol®, Laci Le Beau®, and Prolab®. Through our EssentiallyPure Ingredients® (EPI) division we also sell nutraceutical grade ingredientsto other manufacturers of nutrition products and provide contract manufacturingservices to companies within the nutraceutical industry division.

As discussed below, we also recently acquired therights to manufacture, market and or sell the following brands:

·       NuHair® and Shen Min® (men’s and women’s hair regrowth products in the naturalproducts category);

·       Promensil®(red clover isoflavones-based products for the relief of menopausal symptomsand maintenance of bone and heart health);

·       Trinovin®(red clover isoflavones-based products for the maintenance of prostate andurinary health); and

·       H57TM Hoodia (South African Hoodia-basedproducts for weight control).

Our products fall into the general definition ofvitamin, minerals, herbs and dietary supplements. We divide our business, otherthan the EPI business, into approximately 50 product categories. The productsin these categories are packaged into approximately 500 stock keeping units(SKUs).

The majority of the dietary supplements we sell aresold under the Natrol brand. Our Natrol brand focuses on supplements that arein high demand as well as specialty niche and proprietary formulations that havepotentially strong margins. We position Natrol as a premium brand ofsupplements rather than as a value brand.

These supplements include vitamins, minerals, hormonalsupplements, herbal products and specialty combination formulas that contributeto an individual’s physical and mental well-being. We sell our products throughmultiple distribution channels throughout the United States. These channelsinclude domestic health food stores and mass-market drug, clubs, retail andgrocery store chains. We also sell our products through independent catalogs,Internet shopping sites, and within approximately 40 foreign countries throughinternational distributors. Our Natrol brand strategy emphasizes buildingstrong recognition of the Natrol brand across multiple distribution channelsthrough a marketing strategy that includes print, television, radio and coopadvertising and public relations campaigns that are designed to build consumerawareness and increase the purchase of our products by consumers.

Herbal teas are sold under the Laci Le Beau brand.Laci Le Beau teas are flavored herbal teas. The primary tea category is ourSuper Dieter’s Tea®. We use the same sales people and brokers to sell herbalteas as supplements. As with our supplement business, our Laci Le Beau strategyemphasizes building strong recognition of the Laci Le Beau brand acrossmultiple distribution channels.

The Prolab sports nutrition line of products istargeted to body builders and health minded individuals seeking a high degreeof physical fitness. Prolab’s products include supplements designed to helpthese individuals gain and lose weight as well as improve muscle mass andmuscle definition. Prolab products are sold primarily through sports nutritionretail stores, fitness centers, websites, health-food stores and,internationally, through designated distributors.

During the third quarter of 2006, we established asubsidiary in the United Kingdom to sell our products in the United Kingdom andthe European Union (EU). This division is currently focused on building oursports nutrition business in Europe but our intention is to also sell Natrolproducts through this division into the EU.

We also sell nutraceutical grade ingredients such asgarlic and arabinogalactan to other manufacturers through our EPI division. TheEPI division also markets Natrol’s manufacturing capabilities to othernutraceutical businesses that need contract manufacturing support. EPI sharesall of Natrol’s resources including Natrol’s headquarters facility, itsmanufacturing and research and development personnel and expertise, itsfinancial resources, as well as accounting and management resources.

11

----

** **

**Management Overview**

We concluded the third quarter of 2006 reporting netincome of $40,000. This was our third successive profitable quarter. Althoughour net sales for the nine months ended September 30, 2006 were $3.5 millionless than our net sales for the same period in 2005, net sales for the threemonths ended September 30, 2006 were $0.3 million greater than thesame period in 2005. More significantly our net income for the three and ninemonths ended September 30, 2006 amounted to $40,000 and $213,000 comparedto losses of $742,000 and $1,043,000 recorded for the same periods in 2005.

Net sales of our core Natrol/Laci Le Beau productlines continued to grow during the third quarter of 2006, increasingapproximately 18.1% compared to the third quarter of 2005. For the nine monthsended September 20, 2006, net sales of our core Natrol/Laci Le Beauproducts were 1.7% more than for the same period in 2005. These increases wereoffset by declines in net sales of our Prolab sports nutrition products anddeclines in our EPI raw material and contract manufacturing business.

Our management believes the following represent someof Natrol’s key strategies or goals:

·       expandingthe distribution of our products to new markets, including internationally;

·       thedevelopment or acquisition of new products and product lines;

·       improvingthe marketing of current and new products; and

·       controlling the cost of doing business inour various channels of trade.

**Key Quarter andSubsequent Events**

The following key events occurred during andsubsequent to the three months ended September 30, 2006:

·      we entered into a three year seniorsecured credit facility with Wachovia for up to $10 million;

·      we established a U.K. subsidiary, Natrol(UK), Ltd. to primarily sell our Prolab sports nutrition line;

·      we entered into a manufacturing anddistribution agreement for H57Ô Hoodia;

·      we acquired the Nu Hair® and Shen Min®brands from Biotech International Corporation; and

·      welicensed the U.S. rights to the Promensil® and Trinovin® brands from NovogenLimited.

*Senior SecuredCredit Facility*

In August 2006, we entered into a loan and securityagreement with Wachovia Capital Finance (Western), a subsidiary of WachoviaBank, N.A. The loan agreement provides for a three-year secured revolvingcredit facility of up to $10 million. Borrowings under the facility may beused for ongoing working capital purposes and certain future acquisitions.

The interest rate on borrowings under the creditfacility is equal to: (1) agent’s publicly announced prime rate for prime rateloans or (2) 2.25% plus the applicable Eurodollar rate for any Eurodollar rateloans. Interest is payable monthly in arrears, not later than the first day ofeach calendar month.

The facility is secured by a first priority lien onall our assets and properties, subject to certain exceptions. The obligationsunder the credit facility are guaranteed by certain of our current and by eachof our future subsidiaries. The credit facility contains certain covenants andalso provides for customary events of default, including non-payment defaults,covenant defaults and cross-defaults to our other material indebtedness.

*UK Subsidiary*

During the third quarter of 2006, we established asubsidiary in the United Kingdom to sell our products in the United Kingdom andthe European Union (EU). This division is currently focused on building oursports nutrition business in Europe, but our intention is to also sell Natrolproducts through this division into the EU.

12

----

 

During the third quarter of 2006, we sold $161,000 ofproduct through the UK subsidiary to accounts in the European Union.

*South African H57*ÔHoodia

In October 2006, we entered into an exclusivemanufacturing and distribution arrangement with H57ÔNutrition for Original South African H57ÔHoodia. Through the strength of H57Ô Nutrition’snational marketing and branding efforts, H57 Hoodia has become one of the topselling brands of weight control supplements in the U.S.

Manufacturing and actual distribution of H57ÔHoodia will begin during the fourth quarter of 2006.

*Acquisition/LicensingTransactions*

*Nu Hair and Shen Min Brands*.  In October 2006, we purchased the Nu Hair andShen Min brands from Biotech, including without limitation the brand’sintellectual property rights, inventory, permits, certain contracts and certainunfilled customer and supply orders. Nu Hair products, distributed within themass market channel, include hair regrowth tablets for men and women, as wellas topical products, such as Thinning Hair Serum and Thickening Shampoo. ShenMin products, marketed primarily within the health food channel, consist of asimilar line of products.

The purchase price consisted of $5.4 million incash. We also agreed to make earnout payments to Biotech, depending upon thetotal amount invoiced to customers of the Nu Hair and Shen Min brands duringeach of the three-year periods after closing. As part of the acquisition, wealso entered into a two-year consulting agreement with Gregory J. Kelly,Biotech’s founder. Under the consulting agreement, we agreed to pay Mr. Kelly$100,000 per year and granted him a non-qualified stock option to purchase50,000 shares of Natrol common stock at an exercise price of $4.00 per share,vesting quarterly over two years.

The Company determined that the assets acquired fromBiotech did not constitute a business using the guidance provided by EITF IssueNo. 98-3, *Determining Whether a NonmonetaryTransaction Involves Receipt of Productive Assets or of a Business.*

*Promensil**Ò and Trinovin**Ò Brands.  *In October 2006, welicensed the U.S. rights to the PromensilÒand TrinovinÒ brands from Novogen Limited, and acquiredsubstantially all of the U.S. inventory for the brands. The PromensilÒand TrinovinÒ brands are dietary supplements based on redclover isoflavones that are designed to meet the specific health needs of agingadults.

**Results ofOperations**

**Three months endedSeptember 30, 2006 compared to September 30, 2005**

NET SALES.  We recognize revenue from salesonly after product is shipped. We have no consignment sales. Net sales representproduct shipped less actual and estimated future returns, spoilage allowances,allowances for product deemed to be unsaleable by customers, goods shipped tocustomers for promotional or other purposes, rebates, slotting fees and otherpromotional expenditures. Estimates and allowances are based upon known claimsand an estimate of additional returns when the amount of future returns fromcustomers can be reasonably estimated.

Net salesincreased 1.8%, or $0.3 million, to $15.7 million for the three monthsended September 30, 2006 from $15.4 million for the three monthsended September 30, 2005. Net sales in the quarter were positivelyaffected by an 18.1%, or approximately $2.0 million, increase in the netsales of Natrol and Laci Le Beau products. However, these net sales increaseswere offset by a 34.7%, or $1.2 million, decrease in the net sales ofProlab and a 46.8%, or $0.4 million, decrease in the net sales of EPI. Netsales by our primary brands during the three months ended September 30,2006 and September 30, 2005 are as follows:
| ** ** | ** ** | **Three Months Ended  September 30,  (millions)** | ** ** |
|------------|------------|------------------------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                                         | ** ** | **2005** | ** ** |
| Natrol     |       | $                                                                | 12.8       |   | $ | 10.9 |   |
| Prolab     |       | 2.4                                                              |       | 3.6 |   |
| EPI        |       | 0.5                                                              |       | 0.9 |   |
| Total      |       | $                                                                | 15.7       |   | $ | 15.4 |   |

 

13

----

 

In August 2006, as part of our efforts to enhance theProlab brand, we began selling Prolab product in the United Kingdom through ournewly formed UK subsidiary. During the quarter, we sold $0.2 million ofProlab product in the UK. Net sales of our EPI business have been consistentlylower in 2006 compared to 2005 due to our 2005 decision to de-emphasize theservices offered by EPI and to eliminate EPI’s unprofitable contractmanufacturing arrangements.

GROSS PROFIT.  Gross profit increased 21.5%,or $1.2 million, to $6.7 million for the three months ended September 30,2006 from $5.5 million for the three months ended September 30, 2005.The increase was due to a lower cost of raw materials, in particular CoQ10, aswell as increased labor efficiency. Product mix was also a factor in that ahigher percentage of our sales were from the shipment of higher margin Natroland Laci Le Beau products than from lower margin Prolab or EPI products. Theresult was an increase in gross margin to 42.7% during the three months ended September 30,2006 from 35.8% in the same period in 2005.

SELLING AND MARKETING EXPENSES.  Selling andmarketing expenses consist primarily of advertising and promotional expenses,cost of distribution, and related payroll expenses and commissions. Selling andmarketing expenses decreased 11.7%, or $0.5 million, to $3.8 millionfor the three months ended September 30, 2006 from $4.3 million forthe three months ended September 30, 2005. The lower expense in 2006 wasthe result of spending less on adverting during the three months ended September 30,2006 compared to the same period in 2005 when we were promoting theintroduction of our brainSpeed product line through the use of radio and printmedia.

GENERAL AND ADMINISTRATIVE EXPENSES.  Generaland administrative expenses consist primarily of personnel costs related togeneral management functions, finance, accounting and information systems, aswell as professional fees related to legal, audit and tax matters, depreciationand option expenses. General and administrative expenses increased 20.8%, or$0.5 million to $2.7 million for the three months ended September 30,2006 from $2.2 million for the three months ended September 30, 2005.Payroll during the third quarter of 2006 was approximately $0.3 millionmore than in the third quarter of 2005 due to increased staffing at theexecutive level. The remainder of the increase was primarily due to additionalconsulting expenses related to the establishment of our UK subsidiary, and,$0.1 million of option expenses recorded as a result of the adoption of SFAS 123R.

INTEREST EXPENSE.  We recorded interestexpense of $149,000 for the three months ended September 30, 2006 ascompared to interest expense of $159,000 for the three months ended September 30,2005.

INCOME TAX EXPENSE.  Our effective tax ratewas 45.2% for the three months ended September 30, 2006 and 37.7% for thethree months ended September 30, 2005. We do not consider this differenceto be material due to the small amount of income earned. In periods when incomeis low, the differences between taxable income and reported income can, inpercentage terms, become greater causing the period’s reported tax rate toincrease.

**Nine months ended September 30,2006 compared to September 30, 2005**

NET SALES.  Netsales decreased 6.6%, or $3.5 million, to $49.2 million for the ninemonths ended September 30, 2006 from $52.7 million for the ninemonths ended September 30, 2005. Net sales during the nine month periodwere positively affected by a 1.7%, or approximately $0.6 million,increase in the net sales of Natrol and Laci Le Beau products. However, thesenet sales increases were offset by a 24.8%, or $3.0 million, decrease inProlab’s net sales and a 36.2%, or $1.4 million, decrease in EPI’s netsales. Net sales by our primary brands during the nine months ended September 30,2006 and September 30, 2005 are as follows:
| ** ** | ** ** | **Nine Months Ended  September 30,  (millions)** | ** ** |
|------------|------------|-----------------------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                                        | ** ** | **2005** | ** ** |
| Natrol     |       | $                                                               | 37.5       |   | $ | 36.8 |   |
| Prolab     |       | 9.2                                                             |       | 11.9 |   |
| EPI        |       | 2.5                                                             |       | 3.9 |   |
| Total      |       | $                                                               | 49.2       |   | $ | 52.6 |   |

 

14

----

 

GROSS PROFIT.  Gross profit increased 7.7%,or $1.5 million, to $20.8 million for the nine months ended September 30,2006 from $19.3 million for the nine months ended September 30, 2005despite the decrease in net sales due to the improvement in gross margin. Grossmargin increased to 42.3% for the nine months ended September 30, 2006from 36.6% for the nine months ended September 30, 2005. During 2006, wehave been focused on reducing material cost and improving efficiency within ourmanufacturing, planning and procurement areas.

SELLING AND MARKETING EXPENSES.  Selling andmarketing expenses decreased 10.3%, or $1.4 million, to approximately$12.0 million for the nine months ended September 30, 2006 from $13.4 millionfor the nine months ended September 30, 2006. The higher expenditures in2005 were directly related to the introduction of new products in 2005, whichresulted in our spending more for media in 2005 than in 2006.

GENERAL AND ADMINISTRATIVE EXPENSES.  Generaland administrative expenses increased 15.3%, or $1.1 million to $8.3 millionfor the nine months ended September 30, 2006 from $7.2 million forthe nine months ended September 30, 2005. The increase was primarily dueto increased payroll, primarily at the executive level, which was due tomanagement changes and the recording of $0.5 million of options expensesas a result of the adoption of SFAS 123R.

INTEREST EXPENSE.  We recorded interestexpense of $456,000 for the nine months ended September 30, 2006 ascompared to interest expense of $480,000 for the nine months ended September 30,2005.

INCOME TAX EXPENSE.  Our effective tax ratewas 42.2% for the nine months ended September 30, 2006 and 37.8% for thenine months ended September 30, 2005. We do not consider this differenceto be material due to the small amount of income earned. In periods when incomeis low, the differences between taxable income and reported income can, inpercentage terms, become greater causing the period’s reported tax rate tovary.

SALE OF BUILDING.  During the nine monthsended September 30, 2006, we sold a building we owned in Bloomfield,Connecticut that was formerly used as a shipping facility for our Prolab brand.The approximate net book value of the property, plant and plant improvementsthat were sold was $759,000 and the gain, net of brokerage, legal and otherrelated expenses was approximately $230,000.

**Liquidity andCapital Resources**

As of September 30, 2006, we had working capitalof $17.3 million as compared to $15.9 million in working capital at December 31,2005. Our cash balance at September 30, 2006 was approximately $5.1 million.

**OperatingActivities**

Net cash provided by operating activities was $2.4 millionfor the nine months ended September 30, 2006 compared to net cash used ofapproximately $1.3 million for the nine months ended September 30,2005. Cash used by operating activities during the nine months ended September 30,2006 consisted primarily of cash provided by non-cash charges of $1.3 millionand cash provided because of changes in operating assets and liabilities of$0.8 million and by our profit of $0.2 million.

During the nine months ended September 30, 2006we implemented SFAS 123R and expensed stock options. This expense amounted to$0.5 million, but was a non-cash charge. Depreciation and amortizationprovided $1.0 million of cash. These non-cash sources of cash were offsetby an increase in deferred tax assets of $0.2 million and a decrease inallowances for bad debts. Cash provided by operating assets and liabilitiesconsisted primarily of an decrease in accounts receivable of $0.1 million,a decrease in inventory of $1.8 million, a decrease in income taxesreceivable of $0.2 million, an increase in accrued expenses of $0.8 million,an increase in accrued payroll of $0.5 million offset by a decrease inaccounts payable of $2.1 million and an increase in prepaid expenses of$0.4 million.

15

----

 

**InvestingActivities**

Net cash provided by investing activities was $0.4 millionfor the nine months ended September 30, 2006 compared to net cash used of$0.6 million during the nine months ended September 30, 2005. Duringthe nine months ended September 30, 2006, we sold our warehouse inBloomfield, Connecticut. The net book value of the property sold wasapproximately $0.8 million. Other investment activity consisted primarilyof the acquisition of $0.3 million of equipment.

**FinancingActivities**

Net cash used by financing activities was $0.8 millionfor the nine months ended September 30, 2006 compared to cash used of $0.1during the nine months ended September 30, 2005. During the nine monthsended September 30, 2006, we repaid $0.9 million of long-term debt. Duringthe third quarter of 2006, we paid off our term loan with City National Bank,which, at the end of the second quarter of 2006 amounted to $525,000. We repaidthe debt in conjunction with establishing our line of credit with WachoviaCapital Finance.

As of September 30, 2006, we had $6.8 millionof outstanding debt.

**Long Term Debt**

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 a three-yearsecured revolving credit facility of up to $10 million. Borrowings underthe facility will be used for ongoing outstanding working capital purposes andcertain future acquisitions. AtNovember 13, 2006, we had $5.0 million of borrowings under the facility.

Under the credit facility, we may borrow up to thelesser 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 credit facility requires that all principal berepaid in full on the third anniversary of the closing date. Additionally,borrowings under the credit facility must be repaid when the borrowings exceedthe borrowing base.

The facility is secured by a first priority lien onall our assets and properties (which includes the assets and properties ofProlab Nutrition, the guarantors and our future subsidiaries), subject tocertain exceptions. The obligations under the credit facility are guaranteed byNatrol Products, Inc., Natrol Acquisition Corp. and Natrol Direct, Inc. and byeach of our future subsidiaries.

The credit facility contains covenants restricting ourability to, among other things: (1) incur or guarantee additional debt; (2)engage in any mergers or acquisitions (subject to certain exceptions); (3)engage in any asset sales or dispose of any assets (other than in the ordinarycourse); (4) engage in transactions with affiliates; (5) incur liens; (6) makeany loans or investments; and (7) declare or pay dividends or redeem orrepurchase capital stock.

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

In order to meet our long-term liquidity needs, we maybe required to incur additional indebtedness or issue additional equity anddebt securities, subject to market and other conditions. There can be noassurance that such additional financing will be available on terms acceptableto us or at all. The failure to raise the funds necessary to finance its futurecash requirements or consummate future acquisitions could adversely affect ourability to pursue new acquisitions and could negatively affect our operationsin future periods.

We believe that our cash balance together with cashgenerated from operations and the potential to borrow funds and raise capitalshould be sufficient to fund our anticipated working capital needs and plannedcapital expenditures for the next

16

----

 

12 months. However, if we do not meet our operatingplan, we may be required to obtain additional borrowings to fund workingcapital needs.

**New AccountingStandards**

We adopted Statement of Financial Accounting StandardsNo. 123R, *Share-Based Payment*(“SFAS 123R”) effective January 1, 2006 using the modified prospectiveapplication method. SFAS 123R requires companies to record compensation expensefor the value of all outstanding and unvested share-based payments, includingemployee stock options and similar awards.

In September 2006, the Financial AccountingStandards Board issued two new pronouncements, SFAS No. 157, Fair ValueMeasurements, and SFAS No. 158, Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans - An Amendment of FASB Statements No.87, 88, 106, and 132(R). The company does not believe that SFAS 157 will have amaterial impact on its financial statements. SFAS 158 does not apply as theCompany does not have a defined benefit pension or another post retirementplan.

In June 2006, the FASB issued FIN No. 48, *Accounting for Uncertainty in Income Taxes – aninterpretation of FASB Statement No. 109,* which clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, *Accounting for Income Taxes.*Theinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 requires recognition of taxbenefits that satisfy a greater than 50% probability threshold. FIN 48also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition.FIN 48 is effective for us beginning January 1, 2007. We arecurrently assessing the potential impact that the adoption of FIN 48 willhave on our financial statements.

**CriticalAccounting Policies**

Management’s beliefs regarding significant accountingpolicies have not changed significantly from those discussed in Item 7 of ourannual report on Form 10-K for the year ended December 31, 2005.

**Item 3.Quantitative and 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.

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 notes with a total principal balance ofapproximately $6.9 million collateralized by our headquarters building andour shipping facility and one variable rate note with a principal balance ofapproximately $0.5 million collateralized by our general assets. Theinterest rate on the fixed rate notes associated with our real estate average8.0%. The interest rate in the variable rate note is equal to the Prime LendingRate.

**Item 4. Controlsand Procedures**

*Evaluation of Disclosure Controlsand Procedures.  *We maintain disclosure controlsand procedures that are designed to ensure that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and formsand that such information is accumulated and communicated to our management,including our principal executive and principal financial officers, asappropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, we recognizethat any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives,and we are required to apply our judgment in evaluating the cost-benefitrelationship 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 the

17

----

 

foregoing, our principal executive and principalfinancial officers have concluded that our disclosure controls and procedureswere effective.

*Changes in Internal Control OverFinancial Reporting.  *There were no changes in ourinternal control over financial reporting that occurred during the last fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

18

----

** **

**PART II-OTHERINFORMATION**

**Item 1A.  Risk Factors**

Information concerning certain risks and uncertaintiesappears in Part I, Item 1A “Risk Factors” of our annual report on Form 10-K forthe year ended December 31, 2005 (as updated below in this Item 1A). You shouldcarefully consider these risks and uncertainties before making an investmentdecision with respect to shares of our common stock. Such risks anduncertainties could materially adversely affect our business, financialcondition or operating results.

During the nine months ended September 30, 2006, therehas been no material change from the risk factors previously disclosed in ourannual report on Form 10-K for the year ended December 31, 2005, except for theaddition of the following risk factors:

**If we fail tosuccessfully implement our business strategies, our ability to increase ourrevenues and operating profits could be adversely affected and our overallbusiness could be harmed.**

Our current business strategies involve (1) developingNatrol as a solid, profitable growth company, (2) expanding our internationaloperations and (3) making acquisitions which support the strategic direction ofthe Company. Our business strategies include realizing cost savings fromoperational efficiency improvements by implementing processes designed toimprove the efficiency level of our manufacturing facilities. We may have toincur costs to achieve our potential cost savings. These costs not fullyachieve our expected cost savings and efficiency improvements.

We are planning to expand our internationaloperations. Operations in foreign markets may be affected by currencyfluctuations, different consumer preferences, government regulation and localmarket conditions. To the extent that we open new international operations inforeign markets, we may not experience the operating margins we expect, and ourexpected growth in our results of operations may be negatively impacted.

Additionally, there can be no assurance that we willbe able to identify new international markets which meet our criteria, or if wefind such markets, that we will successfully implement our expansion goals.

**If we are unableto retain key personnel, our ability to manage our business effectively andcontinue our growth could be negatively impacted.**

Key management employees include Wayne M. Bos, CraigCameron, Dennis R. Jolicoeur and certain other employees. These key managementemployees are primarily responsible for our day-to-day operations, and webelieve our success depends in large part on our ability to retain them and tocontinue to attract additional qualified individuals to our management team. Wedo not have an employment agreement with any of our key management employees,other than Mr. Bos. The loss or limitation of the services of any of ourkey management employees or the inability to attract additional qualifiedpersonnel could have a material adverse effect on our business, financialcondition, and result of operations.

**We may be unableto continue to obtain raw materials for our Ester-C® line of products atfavorable prices or at all, which could adversely affect our business andoperating results.**

We both license the intellectual property rights aswell as obtain all of the raw material for our Ester-C® product line from athird party licensor. Our Ester-C® product line accounted for approximately10.8% of invoiced sales for the nine months ended September 30, 2006, 12.2% ofgross sales in fiscal 2005 and 11.0% of gross sales in fiscal 2004.

In October 2006, the licensor of Ester-C sold itsdietary supplement and raw material business to one of our competitors. Although we have a supply and licensingarrangement for Ester-C through March 2008, we cannot be certain that we willbe able to obtain raw material for Ester-C at favorable prices prior to orcontinue to sell Ester-C after this date. If we were unable to obtain Ester-Craw material at favorable prices or unable to continue to sell Ester-C afterMarch 2008, this could have a material adverse affect on our business andoperating results.

19

----

** **

**Debt covenants andthe requirement to pay interest and service our debt may restrict our abilityto grow and may adversely affect our business and results of operations.**

As with prior revolving lines of credit we haveentered into, the terms of our senior credit facility impose operating andfinancial restrictions on us and our subsidiaries which could have a negativeimpact on our business, financial condition and results of operations bylimiting or prohibiting us from taking certain actions or engaging in certaintransactions without bank consent, including:

·       incurringor guaranteeing additional indebtedness;

·       issuingor selling capital stock by us or our subsidiaries;

·       transferringor selling assets currently held by us;

·       repurchasingstock and certain indebtedness;

·       engagingin transactions with affiliates; and

·       engaging in mergers, acquisitions orconsolidations.

We will need cash to service our debt. Our ability togenerate cash depends on our successful financial and operating performance, inparticular the positive integration of the transactions for which we haveborrowed money to complete. If we are not successful, or if factors outside ofour control cause us to generate insufficient cash, the need to service ourdebt may hinder our ability to execute our business plans and our results ofoperation and financial condition may be adversely affected.

As of November 13, 2006, we had outstanding borrowingsof $5.0 million under our senior secured credit facility.

**Item 6. Exhibits**
| Exhibit No.  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                         |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                                    |
| Exhibit 10.1 |       | Loan and Security Agreement dated August 25, 2006 by  and among Wachovia Capital Finance Corporation (Western), as agent (“Agent”),  lenders signatory thereto (“Lenders”), Natrol, Inc. and Prolab Nutrition,  Inc., as Borrowers, and Natrol Products, Inc., Natrol Acquisition Corp. and  Natrol Direct, Inc., as Guarantors (1) |
| Exhibit 10.2 |       | Guaranty dated August 25, 2006 by Natrol Products,  Inc., Natrol Acquisition Corp. and Natrol Direct, Inc., in favor of Agent and  Lenders (1)                                                                                                                                                                                                          |
| 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.                                                                                                                                                                                                                                                    |

 

(1)    Incorporatedby reference to our current report on Form 8-K filed with the SEC on August 31,2006.

20

----

** **

**SIGNATURE**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
| Date:  November 14, 2006 |   |   |   | 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) |

 

21

----

** **

**EXHIBIT INDEX**
| Exhibit No.  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                         |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                                    |
| Exhibit 10.1 |       | Loan and Security Agreement dated August 25, 2006 by  and among Wachovia Capital Finance Corporation (Western), as agent  ("Agent"), lenders signatory thereto ("Lenders"), Natrol,  Inc. and Prolab Nutrition, Inc., as Borrowers, and Natrol Products, Inc.,  Natrol Acquisition Corp. and Natrol Direct, Inc., as Guarantors (1) |
| Exhibit 10.2 |       | Guaranty dated August 25, 2006 by Natrol Products,  Inc., Natrol Acquisition Corp. and Natrol Direct, Inc., in favor of Agent and  Lenders (1)                                                                                                                                                                                                          |
| 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.                                                                                                                                                                                                                                                    |

 

(1)    Incorporatedby reference to our current report on Form 8-K filed with the SEC on August 31,2006.

22

----