The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and six months ended December 31, 2012. 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 2012 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 U.S. 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, the demand for such customers' products, and general industry and economic conditions. Our revenue also includes royalty, licensing revenue, and raw material sales generated from our patent estate pursuant to license and supply agreements with third parties for the distribution and use of the ingredient known as beta-alanine and sold under the CarnoSyn® trade name.

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 by developing relationships with additional, quality-oriented, private label contract manufacturing customers, commercializing our patent estate through contract manufacturing, royalty and license agreements, and developing and growing our own line of branded products.

During the first six months of fiscal 2013, our net sales were 12.6% lower than in the first six months of fiscal 2012. Private label contract manufacturing sales decreased 13.8% due primarily to lower volumes of existing products to existing customers and lower average EUR exchange rate partially offset by new product sales to new customers. Revenue concentration risk for our two largest private label contract manufacturing customers decreased to 72% as a percentage of our total private label contract manufacturing sales for the first six months of fiscal 2013 compared to 77% in the first six months of fiscal 2012. We expect our contract manufacturing revenue concentration percentage for our two largest customers to decrease marginally during the remainder of fiscal 2013 with the anticipated increased sales to other existing customers.

During the first six months of fiscal 2013, CarnoSyn® beta-alanine royalty and licensing revenue increased 7.0% to $2.2 million as compared to $2.1 million for the first six months of fiscal 2012. Included in the royalty and licensing revenue during the first six months of fiscal 2013 was $103,000 of raw material sales of beta-alanine as compared to zero raw material sales in the same period in fiscal 2012. During the second and third quarters of fiscal 2012, we purchased approximately $3.2 million of beta-alanine raw material to help ensure sufficient inventory to meet anticipated future customer demand. During the third and fourth quarters of fiscal 2012, we sold or used a majority of this inventory. As of December 31, 2012, our beta-alanine raw material inventory level had been reduced to zero. We do not anticipate the direct purchase and sale of material quantities of beta-alanine raw material during the remainder of fiscal 2013.

To protect our CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses of approximately $1.4 million during the first six months of fiscal 2013 and $765,000 during the comparable period in fiscal 2012. We describe our efforts to protect our patent estate in more detail under Item 1 of Part II of 2012 Annual Report. Our ability to maintain or further increase our beta-alanine royalty and licensing revenue will depend in large part on the availability of the raw material beta-alanine when and in the amounts needed, the ability to expand distribution of beta-alanine to new and existing customers, maintaining our patent rights, and the continued compliance by third parties with our patent and trademark rights.

Net sales from our branded products declined 15.4% in the first six months of fiscal 2013 as compared to the first six months of fiscal 2012 due to the continued softening of sales of our Pathway to Healing® product line. During fiscal 2011 and 2012, we re-launched our Pathway to Healing® product line with updated product formulation, packaging, and marketing activities.

During the remainder of fiscal 2013, we plan to continue to focus on:

• Leveraging our state of the art, certified facilities to (1) increase the value of the goods and services we provide to our highly valued private label contract manufacturing customers, and (2) assist us in developing relationships with additional quality oriented customers;

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

• Improving operational efficiencies and managing costs and business risks to improve profitability.

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 2012 Annual Report and recent accounting pronouncements are discussed under Note A of our Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report. There have been no significant changes to these policies or pronouncements during the three and six months ended December 31, 2012 other than as listed under Note A of our Notes to Condensed Consolidated Financial Statement contained in this Quarterly Report.

Results of Operations

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



                                                               Three Months Ended                                  Six Months Ended
                                                                  December 31,                                       December 31,
                                                                                         %                                                  %
                                                     2012              2011            Change           2012              2011            Change
Private label contract manufacturing              $  12,524         $  15,038           (16.7)       $  27,268         $  31,644           (13.8)
Patent and trademark licensing                          824               720            14.4            2,198             2,054             7.0
Branded products                                        338               403           (16.1)             680               804           (15.4)

Total net sales                                      13,686            16,161           (15.3)          30,146            34,502           (12.6)
Cost of goods sold                                   11,767            12,808            (8.1)          24,643            26,466            (6.9)

Gross profit                                          1,919             3,353           (42.8)           5,503             8,036           (31.5)
Gross profit %                                         14.0%              20.7%                            18.3%             23.3%
Selling, general & administrative expenses            2,192             2,127             3.1            4,747             4,463             6.4

% of net sales                                         16.0%              13.2%                            15.7%             12.9%
(Loss) income from operations                         (273)             1,226          (122.3)             756             3,573           (78.8)
% of net sales                                         (2.0)%              7.6%                             2.5%             10.4%
Other (income) expense, net                             (7)                27           125.9                5               (56)         (108.9)

(Loss) income before income taxes                     (266)             1,199          (122.2)             751             3,629           (79.3)
% of net sales                                         (1.9)%              7.4%                             2.5%             10.5%
Income tax (benefit) expense                          (368)               414          (188.9)             (48)            1,316          (103.6)

Net income                                        $     102         $     785           (87.0)       $     799         $   2,313           (65.5)

% of net sales                                          0.7%               4.9%                             2.7%              6.7%

The percentage decrease in contract manufacturing net sales was primarily attributed to the following for the periods ended December 31, 2012:

                                                         Three Months   Six Months
                                                            Ended         Ended
                           Mannatech, Incorporated (1)     (12.2)%        (10.2)%
                           NSA International, Inc. (2)      (4.8)          (4.5)
                           Other customers                   0.3            0.9

                           Total                           (16.7)%        (13.8)%

2 The decrease in net sales to NSA International, Inc. (NSA) for the three months ended December 31, 2012 included a decrease in international sales of 15.2% and a decrease in domestic sales of 2.9%. The decrease in net sales to NSA for the six months ended December 31, 2012 included a decrease in international sales of 14.0% and a decline in domestic sales of 3.4%. The international sales decreases were primarily due to decreased demand by NSA's consumers and lower average EUR exchange rate. The domestic decreases were primarily due to lower average sales prices and lower volumes of existing products.

Net sales from our branded products segment decreased 16.1% during the second quarter of fiscal 2013 as compared to the comparable quarter in fiscal 2012 and 15.4% during the six months ended December 31, 2012 compared to the comparable six month period last year due primarily to the continuing decline in our customer base for this product line.

Gross profit margin decreased 6.7 percentage points during the second quarter of fiscal 2013 from the comparable quarter in fiscal 2012 and 5.0 percentage points during the six months ended December 31, 2012 from the comparable six month period last year. The change in gross profit margin was primarily due to the following for the periods ended December 31, 2012:

                                                 Three Months       Six Months
                                                     Ended            Ended
     Contract manufacturing:
     Shift in sales and material mix (1)               (0.1) %          (1.0) %
     Incremental overhead expenses (1)                 (4.2)            (2.2)
     Incremental direct and indirect labor (1)         (3.7)            (2.8)
     Patent and trademark licensing (2)                 1.5              1.2
     Branded products operations (3)                   (0.2)            (0.2)

     Total                                             (6.7) %          (5.0) %

1 Private label contract manufacturing gross profit margin decreased 8.5 percentage points in the second quarter of fiscal 2013 and 6.4 percentage points in the first six months of fiscal 2013 as compared to the comparable periods in fiscal 2012. The decrease in gross profit as a percentage of sales was primarily due to higher per unit manufacturing costs associated with lower production levels.

2 Patent and trademark licensing gross profit margin increased 3.2 percentage points to 88.2% in the second quarter of fiscal 2013 from 85.0% in the second quarter of fiscal 2012 due to a change in the mix of the source of revenue in fiscal 2013 as compared to fiscal 2012. Revenue for the second quarter of fiscal 2013 included $354,000 of license fee revenue which generated a gross profit margin of 95.0% while beta-alanine license fee revenue was zero during the second quarter of fiscal 2012 During the first six months of fiscal 2013, patent and trademark licensing gross profit margin increased 0.9 percentage points to 82.9% from 82.0% in the first six month of fiscal 2012 due to a change in the mix of the source of revenue in fiscal 2013 as compared to fiscal 2012. Revenue for the first six months of fiscal 2013 included $708,000 of license fee revenue which generated a gross profit margin of 95.0% and $103,000 of beta-alanine raw material sales which generated a gross profit margin of 19.3%. Beta-alanine license fee revenue and beta-alanine raw material sales were zero during the first six months of fiscal 2012.

3 Branded products gross profit margin decreased 7.2 percentage points to 40.5% in the second quarter of fiscal 2013 from 47.7% in the second quarter of fiscal 2012. During the first six months of fiscal 2013, gross profit percentage decreased 6.6 percentage points to 38.7% from 45.4% during the first six months of fiscal 2012. The decrease in gross profit margin is due primarily to sales mix and higher inventory write-offs.

Selling, general and administrative expenses increased $65,000, or 3.1%, during the second quarter fiscal 2013 as compared to the comparable prior year period. This increase was attributed to a $133,000 increase in patent and trademark licensing costs primarily attributed to increased patent litigation and prosecution expenses partially offset by a $45,000 decrease in operating costs from our domestic contract manufacturing operation primarily related to decreased employee compensation. Selling, general and administrative expenses for our branded products business decreased $23,000 as compared to the same prior year period. During the first six months of fiscal 2013, selling, general and administrative expenses increased $284,000, or 6.4%, as compared to the comparable prior year period. This increase was attributed to a $620,000 increase in patent and trademark licensing costs primarily attributed to increased patent litigation and prosecution expenses partially offset by a $280,000 decrease in operating costs from our domestic contract manufacturing operation primarily related to decreased employee compensation. Selling, general and administrative expenses for our branded products business decreased $55,000 as compared to the same prior year period.

Other expense, net decreased $34,000 during the second quarter of fiscal 2013 from the comparable quarter last year primarily due primarily to lower net interest cost related to our for exchange contracts. Other expense, net increased $61,000 during the six month period ended December 31, 2012 from the comparable six month period last year due primarily to unfavorable foreign currency exchange activity.

Our income tax expense decreased $782,000 to a benefit during the second quarter of fiscal 2013 and $1.4 million during the six months ended December 31, 2012 as compared to the same periods in the prior fiscal year. The decreases were primarily due to lower pre-tax income as compared to the comparable prior year periods.

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 $4.2 million for the six months ended December 31, 2012 compared to $3.1 million used by operating activities in the comparable period in the prior year.

At December 31, 2012, changes in accounts receivable, consisting primarily of amounts due from our private label contract manufacturing customers and our patent and trademark licensing activities, provided $5.4 million in cash during the six months ended December 31, 2012 compared to using $1.7 million in the comparable period in the prior year. The increase in cash provided by accounts receivable during the six months ended December 31, 2012 was the result of lower private label contract manufacturing sales and the collection of amounts due from sales of beta-alanine raw materials. Days sales outstanding was 37 days as of December 31, 2012 compared to 22 days as of December 31, 2011.

At December 31, 2012, changes in inventory used $1.1 million in cash as compared to using $6.2 million of cash in the comparable prior year period. The decrease in cash used by inventory during the six months ended December 31, 2012 was primarily related to timing of inventory shipments and receipts, cessation of beta-alanine raw material purchases and decreased sales demand.

Approximately $996,000 of our operating cash flow was generated by NAIE in the six months ended December 31, 2012. As of December 31, 2012, NAIE's undistributed retained earnings were considered indefinitely reinvested.

Capital expenditures were $1.1 million during the six months ended December 31, 2012 compared to $1.0 million in the comparable period in the prior year. Capital expenditures during the six months ended December 31, 2012 and December 31, 2011 were primarily for manufacturing equipment in our Vista, California and Manno, Switzerland facilities

We did not have any consolidated debt as of either December 31, 2012 or June 30, 2012.

On December 16, 2010, we executed a Credit Agreement ("Credit Agreement") with Wells Fargo Bank, National Association. This Credit Agreement replaced our previous credit facility and provides us with a line of credit of up to $5.0 million. The line of credit may be used to finance working capital requirements. In consideration for granting the line of credit and each subsequent extension amendment, we pay an annual commitment fee of $12,500. There are no amounts currently drawn under the line of credit.

Under the terms of the Credit Agreement, borrowings are subject to eligibility requirements including maintaining (i) net income after taxes of not less than $750,000 on a trailing four quarter basis as of the end of each calendar quarter beginning with the four quarter period ended December 31, 2010; and (ii) a ratio of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time. Any amounts outstanding under the line of credit will bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of interest. If elected, the fluctuating rate per annum would be equal to 2.75% above the daily one month LIBOR rate as in effect from time to time. If a fixed rate is elected, it would equal a per annum rate of 2.50% above the LIBOR rate in effect on the first day of the applicable fixed rate term. Any amounts outstanding under the line of credit must be paid in full on or before November 1, 2014; provided, however, that we must maintain a zero balance on advances under the line of credit for a period of at least 30 consecutive days during each fiscal year. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of $100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which the then applicable fixed rate term matures.

Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general intangibles, inventory, equipment and fixtures. We also have a foreign exchange facility with Wells Fargo in effect until November 1, 2013, and with Bank of America, N.A. in effect until March 15, 2013.

On December 31, 2012, we were in compliance with all of the financial and other covenants required under the Credit Agreement.

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 1.3 million, or approximately $1.4 million, which was the initial maximum aggregate amount that could be outstanding at any one time under the credit facility. This maximum amount is reduced annually by CHF 160,000, or approximately $175,000. 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 $547,000. As of December 31, 2012, there was no outstanding balance under this 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 repaid early at NAIE's election or in connection with the termination of the credit facility, NAIE will be charged a pre-payment penalty equal to 0.1% of the principal amount of the fixed loan or CHF 1,000 (approximately $1,094), whichever is greater. The bank reserves the right to refuse individual requests for an advance under the credit facility, although its exercise of such right will not have the effect of terminating the credit facility as a whole.

As of December 31, 2012, we had $17.0 million in cash and cash equivalents and $5.5 million available under our credit facilities. Of these amounts, $7.1 million of cash and cash equivalents and $547,000 of the amount available under our credit facilities were held by NAIE. Our intent is to permanently reinvest all of our earnings from foreign operations, and we do not currently anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund our U.S. operations, we may be required to accrue and pay additional U.S. taxes to repatriate any such funds. Overall, we believe our available cash, cash equivalents and potential cash flows from operations will be sufficient to fund our current working capital needs and capital expenditures through at least the next 12 months.

Off-Balance Sheet Arrangements

As of December 31, 2012, we did not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses material to investors.

Recent Accounting Pronouncements

Recent accounting pronouncements are discussed in the notes to our consolidated financial statements included under Item 1 of this report. Other than those pronouncements, we are not aware of any other pronouncements that materially affect our financial position or results of operations.