The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and nine months ended March 31, 2009. You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to the condensed consolidated financial statements included under Item 1 in this report, as well as the risk factors and other information included in our 2008 Annual Report and other reports and documents we file with the SEC. Our future financial condition and results of operations will vary from our historical financial condition and results of operations described below based on a variety of factors.

Executive Overview

The following overview does not address all of the matters covered in the other sections of this Item 2 or other items in this report or contain all of the information that may be important to our stockholders or the investing public. This overview should be read in conjunction with the other sections of this Item 2 and this report.

Our primary business activity is providing private label contract manufacturing services to companies that market and distribute vitamins, minerals, herbs and other nutritional supplements, as well as other health care products, to consumers both within and outside the United States. Historically, our revenue has been largely dependent on sales to one or two private label contract manufacturing customers and subject to variations in the timing of such customers' orders, which in turn is impacted by such customers' internal marketing programs, supply chain management, entry into new markets, new product introductions and general industry and economic conditions.

A cornerstone of our business strategy is to achieve long-term growth and profitability and to diversify our sales base. We have sought and expect to continue to seek to diversify our sales both by developing relationships with additional, quality-oriented, private label contract manufacturing customers and developing and growing our own line of branded products. In connection with our efforts to develop and grow our own line of branded products, we have determined to refine the types of products on which we will focus our efforts and in doing so have elected to discontinue certain of our branded products initiatives as described below.

During the fourth quarter of fiscal 2008, in an effort to enhance stockholder value, improve working capital and enable us to focus on our core contract manufacturing business, we elected to narrow our branded products focus and developed a plan to sell the legacy RHL business. On August 4, 2008, RHL sold certain assets related to its catalog and internet business conducted under the name "As We Change®" to Miles Kimball Company for a cash purchase price of $2.0 million. The purchase price was subject to certain post-closing adjustments based on a final accounting of the value of the assets sold to and the liabilities assumed by the buyer at the closing. As a result of the post-closing review, the purchase price was increased by $299,000, resulting in an aggregate purchase price of $2.3 million. We recorded a loss of $226,000 as a result of this sale and recognized $221,000 in severance and related payroll costs during the nine months ended March 31, 2009. We intend to market for sale legacy RHL's remaining business operations during fiscal 2009, with the exception of our Pathway to Healing® product line. The financial information presented in this report has been reclassified to reflect the legacy RHL business as discontinued operations.

As a result of our decision to sell the legacy RHL business, we also initiated an operational consolidation program during the first quarter of fiscal 2009 that transitioned the remaining branded products business operations to our corporate offices. This operational consolidation program was substantially complete as of September 30, 2008 and resulted in a charge to discontinued operations of $866,000 in severance and other business related exit costs during the nine months ended March 31, 2009.

During the three months ended March 31, 2009, RHL's wholesale operation experienced a decline in sales activity from one of its largest customers as a result of the discontinuance of certain RHL product lines. Historically these product sales represented a significant portion of RHL's overall annual sales to this customer. Additionally, during this same period we received feedback from multiple parties related to their preliminary interest in acquiring the RHL operations. Due in part to the expected decline in future RHL sales as noted above and the current depressed worldwide economic conditions, the preliminary purchase price valuations provided by these third parties provided us with an indication that an impairment of the RHL net asset carrying values may exist.

In accordance with SFAS 142 and SFAS 144, we performed an analysis that compared the fair value of RHL's net assets as indicated by the third party purchase price valuations noted above to the current carrying amounts to determine if an impairment of value was evident. As a result of this analysis, we determined the current book value of RHL's net assets exceeded the fair value by approximately $1.8 million and recorded an impairment charge for this amount to discontinued operations for the three month period ended March 31, 2009.

During the first nine months of fiscal 2009, our net sales from continuing operations were 9.4% lower than in the first nine months of fiscal 2008. Private label contract manufacturing sales declined 8.3% primarily due to lower volumes of existing products in existing markets sold to one of our largest customers, unfavorable foreign currency fluctuations, and economic conditions. Net sales from our

branded products declined 32.6% in the first nine months of fiscal 2009 as compared to the first nine months of fiscal 2008 due to the continued softening of our Pathway to Healing® product line.

Our revenue concentration risk for our two largest customers decreased to 79% as a percentage of our total sales from continuing operations for the first nine months of fiscal 2009 compared to 82% in the first nine months of fiscal 2008. We expect our contract manufacturing revenue concentration percentage for our two largest customers to remain consistent for the remainder of fiscal 2009.

During fiscal 2008, we invested substantial time and incurred substantial costs associated with hiring and training new quality assurance and other manufacturing support personnel, increased testing activity, and documentation and validation processes related to our Good Manufacturing Practices (GMPs) compliance programs and we expect to continue to make investments related to our GMPs through fiscal 2009. These additional expenses negatively impacted our gross margin from continuing operations during fiscal 2008 and the first nine months of fiscal 2009 and we expect this trend to continue during fiscal 2009 until we increase the volume of our private label business sufficiently to offset our higher fixed overhead structure. Although the cost of GMP compliance is significant, we believe our commitment to quality and our steadfast support of the United States Food and Drug Administration's (FDA) mandated GMPs makes us well positioned to operate within the higher standards of the FDA's GMPs and differentiates us from our competitors.

During our first nine months of fiscal 2009, the continued decline in economic conditions in the United States and the various foreign markets we service negatively impacted our customers' businesses and our operations. As a result, during the second quarter of fiscal 2009 we implemented a cost reduction program that resulted in the elimination of certain personnel and business activities. The cost reduction program is expected to reduce the financial impact of the anticipated reduction in future sales. This program resulted in a charge to our operations of $558,000 during the second quarter of fiscal 2009 and is expected to reduce our operating overhead costs by approximately $3.6 million annually. During the third quarter of fiscal 2009 our cost reduction program resulted in a savings of $1.1 million compared to the cost structure in the comparable prior year period.

Beginning in April 2007, Dr. Cherry ceased airing his weekly television program, which had served as the primary customer acquisition vehicle in marketing the Pathway to Healing® product line. While sales of the product line have been primarily generated by continuity orders from long-standing repeat customers, the loss of the television program has had a negative impact on our ability to acquire new customers. We continue working with Dr. Cherry to evaluate alternative marketing programs and revise marketing plans to support the product line.

During the remainder of fiscal 2009, we plan to continue to focus on:

• Leveraging our state of the art, certified facilities to increase the value of the goods and services we provide to our highly valued private label contract manufacturing customers, and assist us in developing relationships with additional quality oriented customers;

• Implementing focused initiatives to grow our Pathway to Healing® product line; and

• Executing our cost reduction program and improving our operational efficiencies.

During fiscal 2009, in connection with our efforts to leverage our state of the art facilities, we received recertification of our Swissmedic Authority pharmaceutical license for our Manno, Switzerland manufacturing facility and our Therapeutic Goods Administration (TGA) of Australia certification for our Vista, California manufacturing facilities.

Looking forward, as a result of the uncertain near-term economic conditions including unfavorable currency markets, we expect reduced net sales from both our branded products and contract manufacturing businesses along with higher per unit operating costs related to our reduced manufacturing throughput in the fourth quarter of fiscal 2009, as compared to the fourth quarter in fiscal 2008. The negative effect on our operations associated with the anticipated decline in our fourth quarter sales is expected to be offset by the cost reduction program we implemented during the second quarter of fiscal 2009.

Critical Accounting Policies and Estimates

The preparation of our financial statements requires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies that we believe are important to the portrayal of our financial condition and results of operations. These policies require the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions.

Our critical accounting policies are discussed under Item 7 of our 2008 Annual Report. There have been no significant changes to these policies during the nine months ended March 31, 2009.

Results of Operations

The results of our operations for the periods ended March 31 were as follows (in
thousands):



                                                Three Months Ended                     Nine Months Ended
                                                    March 31,                              March 31,
                                                                      %                                      %
                                          2009          2008        Change       2009          2008        Change
Private label contract manufacturing    $ 16,721      $ 17,960          (7 )   $ 52,441      $ 57,166          (8 )
Branded products                             627           961         (35 )      2,049         3,042         (33 )

Total net sales                           17,348        18,921          (8 )     54,490        60,208          (9 )
Cost of goods sold                        14,241        16,356         (13 )     48,211        50,527          (5 )

Gross profit                               3,107         2,565          21        6,279         9,681         (35 )
Gross profit %                              17.9 %        13.6 %                   11.5 %        16.1 %
Selling, general & administrative
expenses                                   1,724         2,921         (41 )      7,180         8,888         (19 )

% of net sales                               9.9 %        15.4 %                   13.2 %        14.8 %
Operating income (loss) from
continuing operations                      1,383          (356 )       488         (901 )         793        (214 )
% of net sales                               8.0 %        (1.9 %)                  (1.7 )%        1.3 %
Other (expense) income, net                 (129 )         165         178         (562 )         146         485

Income (loss) from continuing
operations before income taxes             1,254          (191 )       757       (1,463 )         939        (256 )
% of net sales                               7.2 %        (1.0 %)                  (2.7 )%        1.6 %
(Benefit) provision for income taxes        (183 )        (213 )       (14 )         (3 )          24         113

Income (loss) from continuing
operations                                 1,437            22      (6,432 )     (1,460 )         915        (260 )
Loss from discontinued operations,
net of tax                                (1,941 )        (468 )      (315 )     (3,745 )      (1,118 )      (235 )

Net loss                                $   (504 )    $   (446 )       (13 )   $ (5,205 )    $   (203 )    (2,464 )

% of net sales                              (2.9 %)       (2.4 )%                  (9.6 )%       (0.3 %)

The percentage decrease in contract manufacturing net sales was primarily attributed to the following for the periods ended March 31:

                                          Three Months      Nine Months
                                             Ended             Ended
            Mannatech, Incorporated (1)             (1 )             (8 )
            NSA International, Inc. (1)            (12 )             (5 )
            Other customers (2)                      6                5

            Total                                   (7 )%            (8 )%

1 A decrease in net sales resulted primarily from the impact of the current economic conditions and unfavorable foreign currency fluctuations.

2 An increase in net sales to other customers was primarily due to increased sales from several of our existing customers along with increased sales from a new customer and income related to a sublicense agreement for the distribution of beta-alanine.

Net sales from our branded products segment decreased 35% from the comparable quarter in fiscal 2008 and 33% from the comparable nine month period last year due primarily to the continuing impact of the cessation of the Dr. Cherry weekly television program in April 2007, which had served as the primary acquisition vehicle in marketing the Pathway to Healing® product line.

Gross profit margin increased 4.3 percentage points from the comparable quarter in fiscal 2008 and decreased 4.6 percentage points from the comparable nine month period last year. The change in gross profit margin was primarily due to the following for the periods ended March 31:

                                               Three Months     Nine Months
                                                  Ended            Ended
       Branded products operations                      0.5 %           0.5 %
       Contract manufacturing:
       Shift in sales and material mix                 (0.8 )          (2.2 )
       Decreased overhead expenses                     (1.3 )          (2.7 )
       Incremental direct and indirect labor            5.9             0.2
       Cost reduction program                            -             (0.4 )

       Total                                            4.3 %          (4.6 )%

Selling, general and administrative expenses decreased $1.2 million, or 41%, from the comparable quarter last year and $1.7 million, or 19%, from the comparable year to date period last year. The decrease from the comparable quarter was attributed to a reduction in selling, general and administrative expenses primarily from our branded products business totaling $332,000 associated with our operational consolidation, and a decrease in insurance, investor relations, professional fees, employee compensation and other expenses totaling $864,000. The decrease from the comparable year to date period consisted of a $564,000 reduction in expenses for our branded products business associated with our operational consolidation, and a decrease in insurance, investor relations, employee compensation and other expenses totaling $1.1 million.

Other expense, net increased $294,000 from the comparable quarter last year and $708,000 from the comparable nine month period last year due primarily to unfavorable foreign currency exchange losses associated with the weakening of the Euro and the related impact on the translation of Euro denominated cash and receivables.

Our income tax benefit of $183,000 for the quarter ended March 31, 2009 was the result of $38,000 in tax expense from our foreign subsidiary at a statutory tax rate of 20% and $221,000 in tax benefit from our US-based operations related to a change in the valuation allowance against our net deferred tax asset. Our income tax benefit of $3,000 for the nine months ended March 31, 2009 was the result of $94,000 in tax expense from our foreign subsidiary at a statutory tax rate of 20% and $97,000 in tax benefit from our US-based operations related to the establishment of a valuation allowance against our net deferred tax asset. As a result of our deferred tax asset valuation, we did not record any income tax benefit during the nine months ended March 31, 2009 against our year-to-date US-based losses from operations.

Liquidity and Capital Resources

Our primary sources of liquidity and capital resources are cash flows provided by operating activities and the availability of borrowings under our credit facility. Net cash provided by operating activities was $784,000 for the nine months ended March 31, 2009 compared to net cash provided by operating activities of $2.3 million in the comparable period in the prior year.

At March 31, 2009, changes in accounts receivable, consisting primarily of amounts due from our private label contract manufacturing customers, provided $656,000 in cash during the nine months ended March 31, 2009 compared to providing $485,000 in the comparable period in the prior year. Cash provided by accounts receivable in the nine months ended March 31, 2009 was the result of lower sales and increased collections of prior period accounts receivable as compared to the comparable prior year period. Days sales outstanding was 31 days as of March 31, 2009 compared to 22 days as of March 31, 2008.

Approximately $1.1 million of our operating cash flow was generated by NAIE in the nine months ended March 31, 2009. As of March 31, 2009, NAIE's undistributed retained earnings were considered indefinitely reinvested.

Capital expenditures were $3.9 million during the nine months ended March 31, 2009 compared to $1.3 million in the comparable period in the prior year. Capital expenditures during the nine months ended March 31, 2009 and March 31, 2008 were primarily for manufacturing equipment in our Vista, California and Manno, Switzerland facilities. Additionally, during the nine months ended March 31, 2009, we invested $699,000 in a six month certificate of deposit and we received $2.2 million in proceeds related to the sale of our As We Change business.

Our consolidated debt increased to $3.4 million at March 31, 2009 from $2.7 million at June 30, 2008 primarily due to borrowings on our working capital line of credit offset by payments on our term loans.

As of March 31, 2009, we had a bank credit facility of $9.1 million, comprised of a $7.5 million working capital line of credit and $1.6 million in outstanding term loans. The working capital line of credit is secured by our accounts receivable and other rights to payment, general intangibles, inventory and equipment, has a fluctuating or fixed interest rate as elected by NAI from time to time and described in more detail below, and borrowings are subject to eligibility requirements for current accounts receivable and inventory balances. As of March 31, 2009 the outstanding balances on the term loans consisted of a $250,000, 15 year term loan due June 2011, secured by our San Marcos building, at an interest rate of 8.25%; a $530,000, 10 year term loan due May 2014 with a twenty year amortization, secured by our San Marcos building, at an interest rate of LIBOR plus 2.25%; a $60,000, five year term loan due May 2009, secured by equipment, at an interest rate of LIBOR plus 2.10%; and a $780,000, four year term loan due December 2009, secured by equipment, at an interest rate of LIBOR plus 2.10%. Monthly payments on the term loans are approximately $124,000 plus interest. As of March 31, 2009, we had $1.8 million outstanding on the working capital line of credit.

On January 24, 2007, we amended our credit facility to extend the maturity date for the working capital line of credit from November 1, 2007 to November 1, 2008, and maintain the ratio of total liabilities/tangible net worth covenant at 1.25/1.0 for the remainder of the term of the credit facility.

On December 18, 2007, we further amended our credit facility to (i) extend the maturity date for the working capital line of credit from November 1, 2008 to November 1, 2009; (ii) reduce the maximum principal amount available under the working capital line of credit from $12.0 million to $7.5 million; (iii) reduce the maximum borrowings against inventory from $6.0 million to $3.75 million, provided any such borrowings do not at any time exceed eligible accounts receivable; and (iv) extend the availability of the Foreign Exchange Facility from November 1, 2007 to November 1, 2008 and the allowable contract term thereunder from November 1, 2008 to November 1, 2009. Our lender agreed to extend the availability of the Foreign Exchange Facility from November 1, 2008 to November 1, 2010 effective as of November 1, 2008.

On December 29, 2008, we again amended our credit facility to (i) extend the maturity date for the working capital line of credit from November 1, 2009 to November 1, 2010; (ii) modify the interest rate payable on the line of credit from a rate equal to the Prime Rate or LIBOR plus 1.75%, as elected by NAI from time to time, to a rate equal to either a fluctuating rate per annum equal to 2.75% to 3.75% above the Daily One Month LIBOR Rate in effect from time to time or a fixed rate per annum equal to 2.50% to 3.50% above LIBOR, as elected by NAI from time to time, in each case with the percentage above the applicable LIBOR determined based on NAI's fixed charge coverage ratio; (iii) modify the fiscal year end net income requirement for fiscal 2009 from net income after taxes of not less than $750,000 to a net loss not to exceed $2,500,000; (iv) modify the fixed charge coverage ratio for the quarter ending March 31, 2009 from not less than 1.25 to 1.0 to not less than 0.50 to 1.0; and (v) eliminate the fixed charge coverage ratio and net income requirements that would have applied to the second quarter of fiscal 2009. In consideration of such amendments, NAI paid a $25,000 amendment fee to the lender.

As of March 31, 2009 and June 30, 2008, we were not in compliance with our quarterly net income financial covenant under our credit facility, which requires quarterly net income after taxes of at least $1.00. We were also not in compliance with our quarterly fixed charge coverage ratio as of March 31, 2009, which requires a quarterly fixed charge coverage ratio of no less than 1.0 to
0.5. Our lender agreed to waive its default rights as a result of these covenant violations as of March 31, 2009, for a $25,000 waiver fee, and as of June 30, 2008. As a condition of the March 31, 2009 bank waiver, our credit facility is required to be modified on or before May 22, 2009. This modification will include (i) reduction in our borrowing base inventory advance rate to 35% of eligible raw materials inventory and 40% on eligible finished goods inventory;
(ii) modify the interest rate payable on the line of credit from a rate equal to either a fluctuating rate per annum equal to 2.75% to 3.75% above the Daily One Month LIBOR Rate in effect from time to time or a fixed rate per annum equal to 2.50% to 3.50% above LIBOR, as elected by NAI from time to time, in each case with the percentage above the applicable LIBOR determined based on NAI's fixed charge coverage ratio, to a rate equal to either a fluctuating rate per annum equal to 2.75% to 4.25% above the Daily 90-Day LIBOR Rate in effect from time to time or a fixed rate per annum equal to 2.50% to 4.00% above LIBOR, as elected by NAI from time to time, in each case with the percentage above the applicable LIBOR determined based on NAI's fixed charge coverage ratio; and (iii) increase in the annual loan fee margin to 1.25% if the fixed charge coverage ratio is less than 1.25 to 1.0. If this loan modification was effective as of March 31, 2009 our available unused line of credit amount would have been reduced by approximately $1.0 million to $3.5 million. Based on the impact of our deferred tax asset valuation (as described under Note J below) and our cumulative losses from operations over the previous four fiscal quarters, we do not expect to meet our fixed charge coverage ratio or net income covenants as of June 30, 2009. If we fail to meet any of these covenants, we intend to request a waiver from our lender but there is no assurance when or if or on what terms a waiver will be provided. Therefore, in accordance with SFAS No. 78, Classification of Obligations that are Callable by the Creditor (SFAS 78), we have reclassified all of our long-term debt to current debt at March 31, 2009 and June 30, 2008.

On September 22, 2006, NAIE, our wholly owned subsidiary, entered into a credit facility to provide it with a credit line of up to CHF 1,300,000, or approximately $1.1 million, which is the initial maximum aggregate amount that can be outstanding at any one time under the credit facility. This maximum amount was reduced by CHF 160,000, or approximately $139,000, as of December 31, 2007 and will be reduced by an additional CHF 160,000 at the end of each succeeding calendar year. On February 19, 2007, NAIE amended its credit facility to provide that the maximum aggregate amount that may be outstanding under the facility cannot be reduced below CHF 500,000, or approximately $435,000. As of March 31, 2009, there was no outstanding balance under the credit facility.

Under its credit facility, NAIE may draw amounts either as current account loan credits to its current or future bank accounts or as fixed loans with a maximum term of 24 months. Current account loans will bear interest at the rate of 5% per annum. Fixed loans will bear interest at a rate determined by the parties based on current market conditions and must be repaid pursuant to a repayment schedule established by the parties at the time of the loan. If a fixed loan is . . .