The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis discusses the financial condition and results of our operations on a consolidated basis, unless otherwise indicated.

Overview

We are a developer, manufacturer and marketer of a proprietary line of nutritional supplements addressing basic nutrition, specific wellness needs, weight management and sports nutrition. We also offer a line of skin care and food products under our Relivables brand. We sell our products through an international network marketing system utilizing independent distributors. Sales in the United States represented approximately 78.6% of worldwide net sales for the six months ended June 30, 2012 and 83.9% of worldwide net sales for the six months ended June 30, 2011. Our international operations currently generate sales through distributor networks with facilities in Australia, Canada, Indonesia, Malaysia, Mexico, the Philippines, and the United Kingdom. We also operate on a remote basis in Ireland, Germany, Austria and the Netherlands from our U.K. distribution center, in New Zealand from our Australia office, and in Singapore and Brunei from our Malaysia office.

We derive our revenues principally through product sales made by our global independent distributor base, which, as of June 30, 2012, consisted of approximately 59,230 distributors. Our sales can be affected by several factors, including our ability to attract new distributors and retain our existing distributor base, our ability to properly train and motivate our distributor base and our ability to develop new products and successfully maintain our current product line.

Sales to distributors outside the United States are made in the respective local currency; therefore, our earnings and cash flows are subject to fluctuations due to changes in foreign currency rates as compared to the U.S. dollar. As a result, exchange rate fluctuations may have a varying effect on sales and gross margins. Accounting practices require that our results from operations be converted to U.S. dollars for reporting purposes. Consequently, our reported earnings may be significantly affected by fluctuations in currency exchange rates, generally increasing with a weaker U.S. dollar and decreasing with a strengthening U.S. dollar. Products manufactured by us for sale to our foreign subsidiaries are transacted in U.S. dollars. From time to time, we enter into foreign exchange forward contracts to mitigate our foreign currency exchange risk.

Components of Net Sales and Expense

Product sales represent the actual product purchase price typically paid by our distributors, after giving effect to distributor allowances, which can range from 20% to 40% of suggested retail price, depending on the rank of a particular distributor. Handling and freight income represents the amounts billed to distributors for shipping costs. We record net sales and the related commission expense when the merchandise is shipped.

Our primary expenses include cost of products sold, distributor royalties and commissions and selling, general and administrative expenses.

Cost of products sold primarily consists of expenses related to raw materials, labor, quality control and overhead directly associated with production of our products and sales materials, as well as shipping costs relating to the shipment of products to distributors, and duties and taxes associated with product exports. Cost of products sold is impacted by the cost of the ingredients used in our products, the cost of shipping distributors' orders, along with our efficiency in managing the production of our products.

Distributor royalties and commissions are monthly payments made to Master Affiliates and above, based on products sold in their downline organization. Based on our distributor agreements, these expenses typically approximate 23% of sales at suggested retail. Also, we include other sales leadership bonuses, such as Ambassador bonuses, in this line item. Distributor royalties and commissions are directly related to the level of our sales and, absent any changes in our distributor compensation plan, should continue at comparable levels as a percentage of net sales as in recent periods.

Selling, general and administrative expenses include the compensation and benefits paid to our employees except for those in manufacturing, all other selling expenses, marketing, promotional expenses, travel and other corporate administrative expenses. These other corporate administrative expenses include professional fees, non-manufacturing depreciation and amortization, occupancy costs, communication costs and other similar operating expenses. Selling, general and administrative expenses can be affected by a number of factors, including staffing levels and the cost of providing competitive salaries and benefits; the amount we decide to invest in distributor training and motivational initiatives; and the cost of regulatory compliance.

Results of Operations

The following table sets forth selected results of our operations expressed as a percentage of net sales for the three- and six-month periods ended June 30, 2012 and 2011. Our results of operations for the periods described below are not necessarily indicative of results of operations for future periods.

                                          Three months ended      Six months ended
                                               June 30,               June 30,

                                          2012         2011        2012       2011

Net sales                                100.0%       100.0%      100.0%     100.0%
Costs and expenses:
Cost of products sold                     19.2         21.2        19.5       20.2
Distributor royalties and commissions     37.7         37.5        37.7       37.5
Selling, general and administrative       41.8         41.2        39.7       39.5

Income from operations                     1.3          0.1        3.1        2.8
Interest expense                          (0.2)        (0.2)      (0.2)      (0.2)
Interest and other income (expense)        0.0          0.6        0.0        0.1

Income before income taxes                 1.1          0.5        2.9        2.7
Provision for income taxes                 0.5          0.1        1.2        1.0

Net income                                0.6%         0.4%        1.7%       1.7%

Net Sales. Overall net sales decreased by 6.8% in the three months ended June 30, 2012 compared to the same period in 2011. During the second quarter of 2012, sales in the United States decreased by 12.8%, and international sales increased by 21.6% over the prior-year period. For the six months ended June 30, 2012, consolidated net sales declined 8.0% compared to the same period in 2011. In the first half of 2012, net sales in the United States declined by 13.8% and international sales increased by 22.4% over the same period in 2011.

The following table summarizes net sales by geographic market for the three months ended June 30, 2012 and 2011.

                                        Three months ended June 30,
                                     2012                            2011                  Change from prior year
                                                                          % of Net
                         Amount        % of Net Sales       Amount         Sales           Amount              %
                                          (dollars in thousands)
United States           $  12,943                 77.1 %   $  14,841           82.5 %   $     (1,898 )          (12.8 )%
Australia/New Zealand         480                  2.9           596            3.3             (116 )          (19.5 )
Canada                        439                  2.6           577            3.2             (138 )          (23.9 )
Mexico                        271                  1.6           354            2.0              (83 )          (23.4 )
Europe                      1,741                 10.4           856            4.7              885            103.4
Asia                          907                  5.4           774            4.3              133             17.2

Consolidated total      $  16,781                100.0 %   $  17,998          100.0 %   $     (1,217 )           (6.8 )%

The following table summarizes net sales by geographic market for the six months ended June 30, 2012 and 2011.

                                          Six months ended June 30,
                                      2012                            2011                  Change from prior year
                                                                           % of Net
                          Amount        % of Net Sales       Amount         Sales           Amount              %
                                           (dollars in thousands)
 United States           $  28,713                 78.6 %   $  33,306           83.9 %   $     (4,593 )          (13.8 )%
 Australia/New Zealand       1,020                  2.8         1,215            3.0             (195 )          (16.0 )
 Canada                        989                  2.7         1,175            3.0             (186 )          (15.8 )
 Mexico                        558                  1.6           702            1.8             (144 )          (20.5 )
 Europe                      3,335                  9.1         1,579            4.0            1,756            111.2
 Asia                        1,909                  5.2         1,708            4.3              201             11.8

Consolidated total       $  36,524                100.0 %   $  39,685          100.0 %   $     (3,161 )           (8.0 )%

The following table sets forth, as of June 30, 2012 and 2011, the number of our active distributors and Master Affiliates and above. The total number of active distributors includes Master Affiliates and above. We define an active distributor as one that enrolls as a distributor or renews his or her distributorship during the prior twelve months. Master Affiliates and above are distributors that have attained the highest level of discount and are eligible for royalties generated by Master Affiliate groups in their downline organization. Growth in the number of active distributors and Master Affiliates and above is a key factor in the growth of our business.

                                        June 30, 2012                       June 30, 2011                         % Change
                                                     Master                              Master                               Master
                                Total Active       Affiliates       Total Active       Affiliates       Total Active        Affiliates
                                Distributors       and Above        Distributors       and Above        Distributors        and Above
United States                         42,080            4,790             45,880            5,680               (8.3 )%          (15.7 )%
Australia/New Zealand                  1,940              130              2,120              150               (8.5 )           (13.3 )
Canada                                 1,320              200              1,360              190               (2.9 )             5.3
Mexico                                 1,800              150              1,430              220               25.9             (31.8 )
Europe                                 6,020              600              2,860              280              110.5             114.3
Asia                                   6,070              550              4,800              440               26.5              25.0

Consolidated total                    59,230            6,420             58,450            6,960                1.3 %            (7.8 )%

In the United States, net sales were down 12.8% in the second quarter of 2012 compared to the same period in 2011. Sales declined in the second quarter of 2012 as distributor activity in United States was less than anticipated. This decline is shown in the form of a decrease in the number of active distributors and distributors at the level of Master Affiliate and above, along with a decrease in the number of new distributor enrollments. The net number of active distributors in the United States as of June 30, 2012 decreased by 8.3% to 42,080, compared to the number of active distributors as of June 30, 2011. During the second quarter of 2012, approximately 3,146 new distributors were enrolled, compared to 3,218 new distributor enrollments in the prior-year quarter, a decline of 2.2%. Another factor in the decline in sales in the United States was a smaller number of distributors reaching the level of Master Affiliate. In the second quarter of 2012, approximately 332 distributors qualified as new Master Affiliates, compared to approximately 403 in the prior-year quarter, a decline of 17.6%. As a result, the number of Master Affiliates and above as of June 30, 2012 decreased by 15.7% as compared to the number of Master Affiliates and above as of June 30, 2011. Distributor retention was 67.9% for the first six months of 2012 compared to a rate of 67.4% for all of 2011. For the six-month period ended June 30, 2012, the decline in net sales in the United States compared to the prior-year period were due to these same factors, as new distributor enrollments and new Master Affiliate qualifications in the first half of 2012 declined by 7.4% and 25.6%, respectively, compared to the same period in 2011.

In the second quarter of 2012, we processed approximately 54,490 orders in the United States for products at an average order of $306 at suggested retail. In the same period of 2011, we processed approximately 59,700 product orders at an average order of $317 at suggested retail. This decline in the number of orders processed is attributable to the decline in distributor activity.

Our efforts in the United States to increase distributor activity and ordering focuses on product innovation. Using LunaRichTM, an enhanced soy powder, we have introduced reformulations of four of our products, Reliv NOW, SoySentials, Reliv NOW for Kids, and GlucAffect. LunaRich was created through our research and development partnership with the Missouri Plant Science Center and it delivers five to ten times more lunasin than standard soy powders. Lunasin is the peptide scientists have identified as the key to many of soy's documented health benefits, including cholesterol management, cell health and more. As a result of these reformulations, Reliv NOW became our best-selling product in the United States in the second quarter of 2012, exceeding the sales of Classic. We intend to introduce additional LunaRich-based reformulations in the United States and elsewhere in our existing markets in the coming months.

During the three months ended June 30, 2012, net sales in our international operations increased in aggregate by 21.6% to $3.84 million compared to $3.16 million for the three months ended June 30, 2011. For the six-month period ended June 30, 2012, international net sales increased by 22.4% to $7.81 million compared to $6.38 million in the same period in 2011. When measured on a constant currency basis, sales increased in Europe and Asia, but were offset by declines in Australia/New Zealand, Canada, and Mexico during the first half of 2012. When net sales are converted using the 2011 exchange rate for both 2011 and 2012, international net sales increased by 24.6% for the first half of 2012 compared to the first half of the prior year. Regional sales results on a constant currency basis for the first six months of 2012 compared to the same period of 2011 were as follows: Australia/New Zealand net sales decreased 16.5%, Canada net sales decreased 13.4%, Mexico net sales decreased 11.7%, Europe net sales increased 116.3%, and Asian sales increased 10.1%. In Australia/New Zealand, and Canada, new distributor enrollments and new Master Affiliate qualifications were down in the second quarter of 2012 commensurate to the decline of sales in the respective markets.

In Europe, strong distributor activity and growth continued in the second quarter of 2012 and resulted in a 109.4% increase in net sales in the second quarter of 2012 and an increase of 116.3% for the first half of 2012,when measured on a constant currency basis, compared to the prior-year periods. New distributor enrollments were 3,103 in the first half of 2012, compared to 1,177 in the same period in 2011, an increase of 164%; and new Master Affiliate qualifications were 274 in the first half of 2012, compared to 88 in the same period in 2011, an increase of 211%.

In Asia, the increase in regional sales was driven by a 59.4% increase in sales in the Philippines in the first half of 2012. Sales of Reliv NOW, lemon-flavored Innergize, and Fibrestore in single-serving packs continue to gain momentum in that market.

Cost of Products Sold. Cost of products sold as a percentage of net sales was 19.2% for the three-month period ended June 30, 2012, compared to 21.2% for the same period in 2011. For the six-month period ended June 30, 2012, cost of products sold as a percentage of net sales was 19.5%, compared to 20.2% in the prior-year period. Gross margins improved slightly in the first six months of 2012 compared to the same period in 2011 due to reductions in some key raw materials and efficiencies in production. However, we believe that prices for key raw materials could be negatively impacted over the latter half of 2012 and into 2013 due to the impact of the drought in the United States on soybean and corn prices, which are two of the key raw materials used in our production.

Distributor Royalties and Commissions. Distributor royalties and commissions as a percentage of net sales were 37.7% for both the three- and six-month periods ended June 30, 2012 compared to 37.5% for both the three- and six-month periods in 2011. Distributor royalties and commissions are directly related to the level of our sales and, absent any changes in our distributor compensation plan, should continue at comparable levels as a percentage of net sales as in recent periods. The slight increase in the percentage in the three- and six-month periods of 2012 is due to a higher average level of distributor discounts at the time of purchase in 2012, compared to the prior-year quarter and six-month period. Distributor royalties are based on product prices at suggested retail price.

Selling, General and Administrative Expenses. For the three months ended June 30, 2012, selling, general and administrative, or SGA, expenses decreased by $386,000, compared to the same period in 2011. SGA expenses as a percentage of net sales were 41.8% and 41.2% for the three-month periods ended June 30, 2012 and 2011, respectively. For the six-month period ended June 30, 2012, SGA expenses decreased by $1.18 million when compared to the same period in 2011. SGA expenses as a percentage of net sales were 39.7% and 39.5% for the six-month periods ended June 30, 2012 and 2011, respectively.

Sales and marketing expenses decreased by approximately $423,000 in the first half of 2012, compared to the prior-year period. Distributor bonuses and other expenses directly related to the level of sales decreased by approximately $292,000. Other changes included a decrease in conference and meeting expenses of $107,000.

Salaries, benefits, and incentive compensation decreased by $373,000 in the first half of 2012, compared to the prior-year period, due in part to the headcount reductions in the fourth quarter of 2011. Distribution and warehouse expenses decreased by $75,000 and other general and administrative expenses decreased by approximately $309,000 in the first half of 2012, compared to the prior-year period. The decrease in other general and administrative expenses is the result of reductions in a number of expenses, including office rental expenses in Australia and Malaysia, consulting fees, directors' fees, and fees paid to our medical advisory board which was disbanded in 2011.

Interest Expense. Interest expense decreased to $62,000 during the first half of 2012 compared to $72,000 in the same period of 2011. The lower interest expense is the result of a decrease in the amount of debt compared to the prior year.

Other Income/Expense. Other income/expense in the first half of 2012 was a net amount of expense of $61,000, compared to a net amount of income of $14,000 in the first half of 2011. The first half 2012 net expense is primarily the result of foreign currency losses in certain of our subsidiaries.

Income Taxes. We recorded income tax expense of $424,000 for the first six months of 2012, an effective rate of 40.0%. In the same period in 2011, we recorded income tax expense of $395,000, which represented an effective rate of 36.8%. Our effective rate is higher in 2012 due to a higher effective rate for state income taxes in 2012, coupled with reductions in income tax expense in 2011 as the result of re-measurements made to our uncertain tax positions.

Net Income. Our net income for the three and six months ended June 30, 2012 was $103,000 ($0.01 per share basic and diluted) and $635,000 ($0.05 per share basic and diluted), respectively, compared to $69,000 ($0.01 per share basic and diluted) and $679,000 ($0.05 per share basic and diluted) for the same periods in 2011. Profitability improved slightly in the second quarter of 2012 when compared to the prior-year period as the reductions in SGA expenses offset the decline in net sales in the United States. For the six-month periods, net income in 2012 is slightly less than the same period in 2011 as net sales decreased in the United States as discussed above. The impact of the decline in net sales was partially offset by the reduction in SGA expenses.

Financial Condition, Liquidity and Capital Resources

During the first six months of 2012, we generated $1.35 million of net cash from operating activities, used $2.45 million in investing activities, and used $586,000 in financing activities. This compares to $1.78 million of net cash provided by operating activities, $444,000 used in investing activities, and $709,000 used in financing activities in the same period of 2011. Cash and cash equivalents decreased by $1.67 million to $5.51 million as of June 30, 2012 compared to $7.17 million as of December 31, 2011.

Significant changes in working capital items consisted of an increase in inventory of $172,000, an increase in prepaid expenses/other current assets of $401,000, and an increase in accounts payable and accrued expenses of $911,000 in the first six months of 2012. The increase in inventory is to support the sales growth in Europe, and the increase in prepaid expenses/other current assets represents the annual premium payments made in the first quarter on most of the corporate insurance policies. The increase in accounts payable and accrued expenses is partially related to a financing arrangement for our annual corporate insurance policy renewals, coupled with various annual accruals and the increase in inventory.

Investing activities during the first six months of 2012 consisted of the purchase of a note and mortgage for $2 million, a net investment of $192,000 for capital expenditures, and $259,000 for key-man life insurance. Financing activities during the first six months of 2012 consisted of principal payments of $289,000 on long-term borrowings, $250,000 in cash dividends paid, and $47,000 in treasury stock purchased. The purchase of the note and mortgage is discussed further in Note 3 of the Consolidated Financial Statements.

Stockholders' equity increased to $15.00 million at June 30, 2012 compared to $14.49 million at December 31, 2011. The increase is due to our net income during the first six months of 2012 of $635,000 and an improvement in the cumulative foreign currency translation adjustment of $59,000 due to the general weakening of the United States dollar, offset by cash dividends paid of $250,000. Our working capital balance was $5.70 million at June 30, 2012 compared to $7.30 million at December 31, 2011. The current ratio at June 30, 2012 was 1.81 compared to 2.19 at December 31, 2011.

On November 30, 2010, we entered into a term loan with our primary lender ("the Bank") in the principal amount of $3.66 million. The loan was renegotiated from a loan that originated with the Bank on June 29, 2009. The term of the loan is for a period of three years with interest accruing on the outstanding principal balance at a floating interest rate based on the 30-day LIBOR plus 2.0%. Monthly principal and interest payments are based on approximately a nine-year amortization. The aggregate outstanding balance of principal and interest is due and payable on November 30, 2013.

We also renewed a revolving credit facility for $5 million with the Bank in October 2011. The credit facility accrues interest on the outstanding principal balance at a floating interest rate based on 30-day LIBOR plus 1.85% and has a maturity date of September 30, 2012. As of June 30, 2012, there were no outstanding borrowings on the revolving credit facility.

The amended terms of the term loan and revolving credit facility are reflected in separate promissory notes dated November 30, 2010 between us and the Bank. A separate letter agreement stating the financial covenants related to the term loan and revolving credit facility was updated and amended on April 4, 2012 and continues in effect.

Under the terms of the amended letter agreement, we have agreed to financial covenants under which we are required to (i) maintain at all times a tangible net worth of not less than $11 million and (ii) maintain at all times a ratio of Total Funded Debt to EBITDA of not greater than 2.5 to 1. The term loan and revolving credit facility are secured by all of our tangible and intangible assets and also by a mortgage on our building and real estate located in Chesterfield, Missouri. As of June 30, 2012, we were in compliance with all financial covenants.

Management believes that our internally generated funds coupled with cash on hand and the bank loan facilities will be sufficient to meet working capital requirements for the remainder of 2012.

Critical Accounting Policies

A summary of our critical accounting policies and estimates is presented on pages 24-26 of our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 23, 2012.