General

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

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

We sell branded nutritional supplements and other natural products under the trademarks Solaray®, VegLife®, KAL®, Nature's Life®, Sunny Green®, Action Labs®, Natural Balance®, NaturalMax®, bioAllers®, Herbs for Kids™, Natra-Bio®, NaturalCare®, Zand®, Health from the Sun®, Life-flo®, Larenim®, Living Flower Essences®, Pioneer®, Thompson®, Natural Sport®, Supplement Training Systems®, Premier One®, Montana Big Sky™, ActiPet®, FunFresh Foods™, Dowd & Rogers™, CompliMed®, AllVia™, Oakmont Labs®, Healthway®, Body Gold®, Sayge BioSciences™, Monarch Nutraceuticals™ and Great Basin Botanicals™. Under the name Woodland Publishing™, we publish, print and market a line of books and booklets to, among others, book distributors, national retail bookstores and health and natural food stores. We also distribute branded products of certain third parties.

We own neighborhood natural food markets, which operate under the trade names The Real Food Company™, Thom's Natural Foods™ and Cornucopia Community Market™. We also own health food stores, which operate under the trade names Fresh Vitamins™ and Granola's™.

We were formed in 1993 by senior management and Bain Capital, Inc. to effect a consolidation strategy in the fragmented vitamin, mineral, herbal and other nutritional supplements industry (the "VMS Industry"). Since our formation, we have completed twenty-five acquisitions of assets or stock. As a result of acquisitions, internal growth and cost management, we believe that we are well positioned to continue to capitalize on acquisition opportunities that arise in the VMS Industry.

Critical Accounting Policies

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America required us to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods. Significant estimates included values and lives assigned to acquired intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving and obsolete and/or damaged inventory and valuation and recoverability of long-lived assets. Actual results may differ from these estimates. Our critical accounting policies include the following:

Accounts Receivable-Provision is made for estimated bad debts based on periodic analysis of individual customer balances, including an evaluation of days sales outstanding, payment history, recent payment trends and perceived credit worthiness. If general economic conditions and/or customer financial condition were to change, additional provisions for bad debts may be required, which could have a material impact on the consolidated financial statements.

Inventories-Provision is made for slow moving, obsolete and/or damaged inventory based on periodic analysis of individual inventory items, including an evaluation of historical usage and/or

movement, age, expiration date and general condition. If market demand and/or consumer preferences are less favorable than historical trends or future expectations, additional provisions for slow moving, obsolete and/or damaged inventory may be required, which could have a material impact on the consolidated financial statements.

Property, Plant and Equipment-Depreciation and amortization expense is impacted by our judgments regarding the estimated useful lives of assets placed in service. If the actual lives of assets are significantly less than expected, depreciation and amortization expense would be accelerated, which could have a material impact on the consolidated financial statements.

We evaluate the recoverability of our property, plant and equipment in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). We review property, plant and equipment for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. We measure recoverability of the asset by comparison of its carrying amount to the future undiscounted cash flows we expect the asset to generate. If we consider the asset to be impaired, we measure the amount of any impairment as the difference between the carrying amount and the fair value of the impaired asset.

Goodwill and Intangible Assets-Statement of Financial Accounting Standards No. 141, Business Combinations, and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), require estimates and judgments in determining the initial recognition and measurement of goodwill and intangible assets, including factors and assumptions used in determining fair values and useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with indefinite useful lives are not amortized. Under SFAS 142, goodwill and non-amortizable intangible assets are tested annually for impairment and are tested for impairment between annual tests if an event occurs that would cause us to believe that value is impaired. We perform our annual impairment testing as of September 30 each year, which is the last day of our fiscal year. Amortizable intangible assets are reviewed for impairment when events or changes in circumstances indicate the carrying value may not be recoverable.

Under SFAS 142, a two step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value, including existing goodwill. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment, a second step is performed to measure the amount of the impairment by comparing the implied fair value of the reporting unit's goodwill with its carrying value.

Primarily as a result of the ongoing U.S. and global economic recession and the related turmoil in the equity markets, there has been a significant and prolonged decrease in our stock price and related market capitalization over the past six months. The ongoing economic recession also has negatively impacted us during this period, both domestically and internationally. Based on these factors, we determined that an interim goodwill impairment analysis was necessary and performed this goodwill impairment analysis on each of our reporting units during the second quarter of fiscal 2009. Reporting unit fair values were determined using an equal weighting of the income approach, which estimates fair value based on expected future discounted cash flows, and the market approach, which estimates fair value based on comparable market prices. The income approach included assumptions for, among others, forecasted revenues, gross profit margins, operating profit margins, working capital cash flow and long-term discount rates, all of which require significant judgments by management. Long-term discount rates used in the estimation of reporting unit fair values were determined based on the expected weighted average cost of capital for each reporting unit. Long-term discount rates have increased since our last annual impairment test (in the fourth quarter of fiscal 2008) due to increased risk premiums and significant tightening of the credit markets. Based on the valuation findings, we

determined that we had an indication of goodwill impairment related to our branded reporting unit and our natural food markets reporting unit in accordance with the first step of the goodwill impairment test described in SFAS 142.

We then performed the second step of the impairment test under SFAS 142 to measure the amount of the non-cash impairment charge which was determined to be $37.5 million ($27.3 million after tax, or $2.51 per diluted share for the three months and six months ended March 31, 2009). Of this total non-cash impairment charge, $35.4 million related to our branded reporting unit and $2.1 million related to our natural food markets reporting unit. The charge related to our branded reporting unit represented the entire carrying value of its goodwill. Our natural food markets reporting unit had a remaining goodwill carrying value of $0.3 million and represented the only reporting unit with a remaining goodwill carrying value at March 31, 2009. The non-cash impairment charge had no impact on our compliance with debt covenants, cash flows or available liquidity.

Prior to the interim assessment of goodwill impairment performed during the second quarter of fiscal 2009, the Company also assessed its non-amortizable intangible assets in accordance with SFAS 142 and performed recoverability testing of its long-lived assets in accordance with SFAS 144 and determined there was no additional impairment.

The ongoing uncertainty in general and economic conditions may continue to impact retail and consumer demand, as well as the market price of our common stock, and could negatively impact our future operating performance, cash flow and/or stock price and could result in additional goodwill and/or intangible asset impairment charges being recorded in future periods which could materially impact our consolidated financial statements. The valuation of goodwill and intangible assets is subject to a high degree of judgment and complexity.

Revenue Recognition-Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which states that revenue should be recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the product has been shipped and the customer takes ownership and assumes the risk of loss; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. We believe that these criteria are satisfied upon shipment from our facilities or, in the case of our neighborhood natural food markets and health food stores, at the point of sale within these stores. Revenue is reduced by provisions for estimated returns and allowances, which are based on historical averages that have not varied significantly for the periods presented, as well as specific known claims, if any. No other significant deductions from revenue must be estimated at the point in time that revenue is recognized.

Other than our previous discussion of goodwill impairment, our estimates and judgments related to our critical accounting policies, including factors and assumptions considered in making these estimates and judgments, did not vary significantly for the periods presented and had no material impact on the consolidated financial statements as reported.

Results of Operations

    The following table sets forth certain consolidated statements of operations
data as a percentage of net sales for the periods indicated:

                                                Three Months             Six Months
                                              Ended March 31,         Ended March 31,
                                              2008        2009        2008        2009
  Net sales                                     100.0 %    100.0 %      100.0 %    100.0 %
     Cost of sales                               44.8 %     46.5 %       45.2 %     46.2 %

  Gross profit                                   55.2 %     53.5 %       54.8 %     53.8 %
     Selling, general and administrative         38.2 %     37.5 %       39.3 %     38.6 %
     Amortization of intangible assets            0.4 %      0.4 %        0.4 %      0.4 %
     Impairment of goodwill                         - %     89.4 %          - %     46.0 %

  Income/(loss) from operations                  16.6 %    (73.8 )%      15.1 %    (31.2 )%
     Interest and other (income)/expense,         0.9 %      0.6 %        1.0 %      0.9 %
     net

  Income/(loss) before                           15.7 %    (74.4 )%      14.1 %    (32.1 )%
  provision/(benefit) for income taxes
     Provision/(benefit) for income taxes         5.9 %    (18.7 )%       5.3 %     (7.3 )%

  Net income/(loss)                               9.8 %    (55.7 )%       8.8 %    (24.8 )%

  Adjusted EBITDA(1)                             19.8 %     19.6 %       18.3 %     18.8 %

Comparison of the Three Months Ended March 31, 2009 to the Three Months Ended March 31, 2008

Net Sales. Net sales decreased by $2.4 million, or 5.6%, to $42.0 million for the three months ended March 31, 2009 ("second quarter of fiscal 2009") from $44.4 million for the three months ended March 31, 2008 ("second quarter of fiscal 2008"). Net sales of branded nutritional supplements and other natural products decreased by $2.1 million, or 5.2%, to $37.9 million for the second quarter of fiscal 2009 compared to $40.0 million for the second quarter of fiscal 2008. The decrease in net sales of branded nutritional supplements and other natural products was primarily related to a decrease in sales volume of branded products to many customers due in large part to the continuing U.S. and global economic recession. This decrease in net sales volume was partially offset by a $1.8 million increase in net sales related to price changes as well as the net sales contribution of the Health from the Sun® brand acquired during the second quarter of fiscal 2008. Other net sales remained relatively flat at $4.1 million for the second quarter of fiscal 2009 compared to $4.4 million for the second quarter of fiscal 2008.

Gross Profit. Gross profit decreased by $2.1 million, or 8.5%, to $22.4 million for the second quarter of fiscal 2009 from $24.5 million for the second quarter of fiscal 2008. This decrease in gross profit was primarily attributable to the decrease in net sales. As a percentage of net sales, gross profit decreased to 53.5% for the second quarter of fiscal 2009 from 55.2% for the second quarter of fiscal 2008. This decrease in gross profit percentage was primarily attributable to increased material costs as a percentage of net sales.

Selling, General and Administrative. Selling, general and administrative expenses decreased by $1.3 million, or 7.5%, to $15.7 million for the second quarter of fiscal 2009 from $17.0 million for the second quarter of fiscal 2008. As a percentage of net sales, selling, general and administrative expenses decreased to 37.5% for the second quarter of fiscal 2009 compared to 38.2% for the second quarter of fiscal 2008. This decrease in selling, general and administrative expenses was primarily attributable to a

reduction in operational and transitional costs related to businesses acquired in fiscal 2007 and fiscal 2008 as well as year-over-year cost improvements in many areas.

Amortization of Intangibles. Amortization of intangibles was $0.2 million for the second quarter of fiscal 2009 and 2008. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.

Impairment of Goodwill. Primarily as a result of the ongoing U.S. and global economic recession and the related turmoil in the equity markets, there has been a significant and prolonged decrease in our stock price and related market capitalization over the past six months. The ongoing economic recession also has negatively impacted us during this period, both domestically and internationally. Based on these factors, we determined that an interim goodwill impairment analysis was necessary under SFAS 142 and performed this goodwill impairment analysis on each of our reporting units during the second quarter of fiscal 2009. Based on the valuation findings, we determined that we had an indication of goodwill impairment related to our branded reporting unit and our natural food markets reporting unit in accordance with the first step of the goodwill impairment test described in SFAS 142.

We then performed the second step of the impairment test under SFAS 142 to measure the amount of the non-cash impairment charge which was determined to be $37.5 million ($27.3 million after tax, or $2.51 per diluted share for the three months ended March 31, 2009). Of this total non-cash impairment charge, $35.4 million related to our branded reporting unit and $2.1 million related to our natural food markets reporting unit. The charge related to our branded reporting unit represented the entire carrying value of its goodwill. Our natural food markets reporting unit had a remaining goodwill carrying value of $0.3 million and represented the only reporting unit with a remaining carrying value at March 31, 2009. The non-cash impairment charge had no impact on our compliance with debt covenants, cash flows or available liquidity.

Interest and Other (Income)/Expense, Net. Net interest and other (income)/expense was $0.3 million for the second quarter of fiscal 2009 and $0.4 million for the second quarter of fiscal 2008 and primarily consisted of interest expense on indebtedness under our revolving credit facility, with the decrease being primarily related to a reduction in interest rates.

Provision/(Benefit) for Income Taxes. Our effective tax rate was (25.2%) for the second quarter of fiscal 2009 and 37.5% for the second quarter of fiscal 2008. During the second quarter of fiscal 2009, we recorded a non-cash goodwill impairment charge of $37.5 million of which $11.0 million related to non-tax-deductible goodwill and reduced our effective tax rate from 37.7% to (25.2%). As a result of this goodwill impairment charge, we recognized a deferred tax benefit of $10.2 million due to the impairment of $26.5 million of tax-deductible goodwill.

Comparison of the Six Months Ended March 31, 2009 to the Six Months Ended March 31, 2008

Net Sales. Net sales decreased by $3.9 million, or 4.6%, to $81.6 million for the six months ended March 31, 2009 from $85.5 million for the six months ended March 31, 2008. Net sales of branded nutritional supplements and other natural products decreased by $3.4 million, or 4.4%, to $73.4 million for the six months ended March 31, 2009 compared to $76.8 million for the six months ended March 31, 2008. The decrease in net sales of branded nutritional supplements and other natural products was primarily related to a decrease in sales volume of branded products to many customers due in large part to the continuing U.S. and global economic recession. This decrease in net sales volume was partially offset by a $3.1 million increase in net sales related to price changes as well as the net sales contributions of the businesses acquired during fiscal 2008. Other net sales were $8.2 million for the six months ended March 31, 2009 compared to $8.7 million for the six months ended March 31, 2008.

Gross Profit. Gross profit decreased by $2.9 million, or 6.3%, to $43.9 million for the six months ended March 31, 2009 from $46.8 million for the six months ended March 31, 2008. This decrease in gross profit was primarily attributable to the decrease in net sales. As a percentage of net sales, gross profit decreased to 53.8% for the six months ended March 31, 2009 from 54.8% for the six months ended March 31, 2008. This decrease in gross profit percentage was primarily attributable to increased material costs as a percentage of net sales.

Selling, General and Administrative. Selling, general and administrative expenses decreased by $2.1 million, or 6.3%, to $31.5 million for the six months ended March 31, 2009 from $33.6 million for the six months ended March 31, 2008. As a percentage of net sales, selling, general and administrative expenses decreased to 38.6% for the six months ended March 31, 2009 compared to 39.3% for the six months ended March 31, 2008. This decrease in selling, general and administrative expenses was primarily attributable to a reduction in operational and transitional costs related to businesses acquired in fiscal 2007 and fiscal 2008 as well as year-over-year cost improvements in many areas.

Amortization of Intangibles. Amortization of intangibles was $0.3 million for the six months ended March 31, 2009 and 2008. For each period, amortization expense was primarily related to intangible assets recorded in connection with acquisitions.

Impairment of Goodwill. Primarily as a result of the ongoing U.S. and global economic recession and the related turmoil in the equity markets, there has been a significant and prolonged decrease in our stock price and related market capitalization over the past six months. The ongoing economic recession also has negatively impacted us during this period, both domestically and internationally. Based on these factors, we determined that an interim goodwill impairment analysis was necessary under SFAS 142 and performed this goodwill impairment analysis on each of our reporting units during the second quarter of fiscal 2009. Based on the valuation findings, we determined that we had an indication of goodwill impairment related to our branded reporting unit and our natural food markets reporting unit in accordance with the first step of the goodwill impairment test described in SFAS 142.

We then performed the second step of the impairment test under SFAS 142 to measure the amount of the non-cash impairment charge which was determined to be $37.5 million ($27.3 million after tax, or $2.51 per diluted share for the six months ended March 31, 2009). Of this total non-cash impairment charge, $35.4 million related to our branded reporting unit and $2.1 million related to our natural food markets reporting unit. The charge related to our branded reporting unit represented the entire carrying value of its goodwill. Our natural food markets reporting unit had a remaining goodwill carrying value of $0.3 million and represented the only reporting unit with a remaining carrying value at March 31, 2009. The non-cash impairment charge had no impact on our compliance with debt covenants, cash flows or available liquidity.

Interest and Other (Income)/Expense, Net. Net interest and other (income)/expense was $0.8 million for the six months ended March 31, 2009 and 2008 and primarily consisted of interest expense on indebtedness under our revolving credit facility.

Provision/(Benefit) for Income Taxes. Our effective tax rate was (22.8%) for the six months ended March 31, 2009 and 37.5% for the six months ended March 31, 2008. During the six months ended March 31, 2009, we recorded a non-cash goodwill impairment charge of $37.5 million of which $11.0 million related to non-tax-deductible goodwill and reduced our effective tax rate from 37.7% to (22.8%). As a result of this goodwill impairment charge, we recognized a deferred tax benefit of $10.2 million due to the impairment of $26.5 million of tax-deductible goodwill.

Adjusted EBITDA

Adjusted EBITDA (a non-GAAP measure) is defined in our debt covenants and performance measures as earnings before net interest and other (income)/expense, taxes, depreciation, amortization

and goodwill and intangible asset impairment. Adjusted EBITDA has some inherent limitations in measuring operating performance due to the exclusion of certain financial elements such as depreciation and amortization and is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation. Furthermore, Adjusted EBITDA is not intended to be a substitute for cash flows from operating activities, as a measure of liquidity, or an alternative to net income in determining our operating performance in accordance with generally accepted accounting principles. Our use of an EBITDA-based metric should be considered within the following context:

º •
º We acknowledge that plant and equipment (while less important in our line of business due to outsourcing alternatives) are necessary to earn revenue based on our current business model.

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º Our use of an EBITDA-based measure of operating performance is not based on any belief about the reasonableness of excluding depreciation and amortization when measuring financial performance.

º •
º Our use of an EBITDA-based measure is supported by its importance to the following key stakeholders:

º •
º Analysts-who estimate our projected Adjusted EBITDA and other EBITDA-based metrics in their independently developed financial models for investors;

º •
º Creditors-who evaluate our operating performance based on compliance with certain EBITDA-based debt covenants;

º •
º Investment Bankers-who use EBITDA-based metrics in their written evaluations and comparisons of companies within our industry; and

º •
º Board of Directors and Executive Management-who use EBITDA-based metrics for evaluating management performance relative to our operating budget and bank covenant compliance, as well as our ability to service debt and raise capital for growth opportunities, including acquisitions, which are a critical component of our stated strategy. Historically, we have recorded a monthly accrual for incentive compensation as a percentage of Adjusted EBITDA, which has been paid out to executive management, as well as other employees, upon completion of our annual audit.

The following table sets forth a reconciliation of net income/(loss) to Adjusted EBITDA for each period included herein:

                                           Three Months Ended       Six Months Ended
                                               March 31,               March 31,
                                           2008         2009        2008       2009
                                                    (dollars in thousands)
    Net income/(loss)                     $  4,352    $ (23,359 ) $  7,563   $ (20,247 )
    Provision/(benefit) for income           2,611       (7,855 )    4,538      (5,977 )
    taxes
    Interest and other                         405          264        785         774
    (income)/expense, net(1)
    Depreciation and amortization            1,430        1,642      2,742       3,276
    Impairment of goodwill(2)                    -       37,519          -      37,519

    Adjusted EBITDA                       $  8,798    $   8,211   $ 15,628   $  15,345

. . .