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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

or

For the transition period from                      to                     

Commission File Number: 33-7106-A

NATURADE, INC.

(Exact name of registrant as specified in its charter)

14370 Myford Rd., Irvine, California 92606

(Address of principal executive offices) (Zip code)

(714) 573-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of the registrant’s common stock, as of the latest practicable date: 44,533,886 shares as of November 1, 2004.

Table of Contents

FORM 10-Q

QUARTERLY REPORT

Quarter Ended September 30, 2004

TABLE OF CONTENTS

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PART I. Financial Information

NATURADE, INC

Balance Sheets As of September 30, 2004 and December 31, 2003

See accompanying notes to financial statements.

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NATURADE, INC

Statements of Operations for the Three Months and Nine Months Ended September 30, 2004 and September 30, 2003

See accompanying notes to financial statements

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NATURADE, INC

Statements of Cash Flows for the Nine Months Ended September 30, 2004 and September 30, 2003

See accompanying notes to financial statements

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NATURADE, INC.

Notes to Financial Statements

The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein includes all adjustments necessary for the fair presentation of the financial statements. All such adjustments are of a normal recurring nature. These financial statements do not include all disclosures associated with the Company’s annual audited financial statements included in the Company’s Annual Report on Form 10-K and accordingly, should be read in conjunction with such statements.

On August 21, 2003, the Company and the remaining investor agreed to amend the terms of the remaining outstanding Investor Notes totaling $202,345 to include increasing the interest rate to 15% per annum, to be paid in quarterly increments, and setting a principal repayment schedule of $20,000 on each of September 15, 2003 and October 15, 2003, installments of $10,000 per month from January 15, 2004 through July 15, 2004 and a final payment of $92,345 on August 15, 2004. On September 23, 2004, the Investor Notes were further amended modifying the repayment schedule by deferring the June 2004, July 2004 and August 2004 payments until December 31, 2004. As of September 30, 2004, there is $112,345 outstanding on the Investor Notes.

On April 14, 2003, the Company entered into a loan agreement (the “Loan Agreement”) with Health Holdings and certain other lenders (the “Lender Group”), pursuant to which the Lender Group agreed to lend the Company $450,000 and, subject to the discretion of the Lender Group, up to an additional $300,000. All advances under the Loan Agreement bear interest at the rate of 15% per annum, are due on December 31, 2004, are secured by substantially all of the assets of the Company, and are subordinated to the Company’s indebtedness to Wells Fargo Business Credit, Inc. (“Wells Fargo”).

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The advances under the Loan Agreement will be used by the Company for working capital and general corporate purposes. In consideration of the extension of credit under the Loan Agreement, Wells Fargo waived all defaults of the Company as of December 31, 2003 under the Credit and Security Agreement dated as of February 27, 2000 and amended the agreement to, among other things, reduce the covenants regarding minimum net income and minimum book net worth and increased the interest rate to the prime rate plus 4.5%.

On April 14, 2004, the terms of the Loan Agreement were modified by the Joinder of Bill D. Stewart, the Chief Executive officer of the Company, as a member of the Lender Group, subject to all of the terms and conditions of the Loan Agreement, and the Lender Group advanced an additional $200,000, of which Bill D. Stewart advanced $100,000. Further, on May 3, 2004, the Lender Group advanced the Company an additional $100,000. Further, on August 16, 2004, advances allowed under the Loan Agreement were increased to a total of $950,000 and the Lender Group advanced an additional $200,000 to the Company. There are no additional amounts available to advance under the Loan Agreement. Proceeds of the advances have been used for working capital.

As of September 30, 2004 there is $950,000 outstanding under the Loan Agreement.

Line of Credit— On January 27, 2000, the Company entered into a three year Credit and Security Agreement (the “Credit Agreement”) with Wells Fargo, which initially allowed for maximum borrowings of up to $3,000,000, based on certain percentages of eligible accounts receivable and inventories as defined. As more fully described under the heading Private Equity Transaction, on December 20, 2001, the terms of the Credit Agreement were modified to include waiving the enforcement of existing defaults as of December 20, 2001, increasing the credit available to the Company to a maximum of $4,500,000 with an inventory maximum subline of $2,000,000, increasing the floating rate to the prime rate plus 2% and extending the maturity date to December 31, 2003. On September 19, 2002, the terms of the Credit Agreement were modified to include waiving the enforcement of existing defaults, reducing the credit availability of the Company to a maximum of $4,325,000, requiring that the Company maintain certain minimum levels of cash, and reducing the covenants regarding minimum net income and minimum book net worth. In consideration of the extension of credit under the Loan Agreement on April 14, 2003, Wells Fargo waived all defaults of the Company as of December 31, 2002 under the Credit Agreement dated as of January 27, 2000 and amended the agreement to, among other things, reduce the covenants regarding minimum net income and minimum book net worth and increased the interest rate to the prime rate plus 4.5%. On March 29, 2004, the Company completed the Ninth Amendment to Credit and Security Agreement between Naturade, Inc. and Wells Fargo Business Credit Inc. dated as of January 27, 2000. This amendment extended the term of the Credit and Security Agreement to December 31, 2005, reduced maximum borrowings to $3.5 million, and among other things, set the covenants regarding minimum net income and minimum book net worth for 2004. Further, on May 10, 2004, the Company completed the Tenth Amendment to Credit and Security Agreement between Naturade, Inc. and Wells Fargo Business Credit Inc. dated as of January 27, 2000. This amendment provided for the release of certain funds held in reserve accounts by Wells Fargo Business Credit along with conditions requiring replenishment of said reserve accounts.

Borrowings under the Credit Agreement, which totaled $1,730,148 at September 30, 2004, are collateralized by substantially all assets of the Company. At September 30, 2004 the prime rate was 4.75% and the interest charge under the Credit and Security Agreement was 9.25%. The Credit Agreement contains covenants, which, among other things, require that certain financial ratios be met. As of September 30, 2004, the Company was not in compliance with the minimum book net worth and the minimum net income covenants. On November 2, 2004, the Company completed the Eleventh Amendment to Credit and Security Agreement between Naturade, Inc. and Wells Fargo Business Credit Inc. dated as of January 27, 2000. This amendment provided, among other things, a waiver of existing covenant defaults, the establishment of new covenants for the periods from October 2004 until March 2005 and the release of certain assets related to the Company’s Aloe Vera Brands. See Note 8-Subesequent Events.

Private Equity Transaction— On January 2, 2002, the Company privately sold 13,540,723 shares of Series B Convertible Preferred Stock (the “Shares”) for $2 million, and warrants, which expire on December 31, 2004, to purchase an additional 33,641,548 shares of Series B Convertible Preferred Stock at an aggregate exercise price of $3.5 million (the “Warrants”), for $500,000. The Shares and Warrants were purchased by Westgate Equity Partners, L.P. (“Westgate”). The Series B Convertible Preferred Stock bears dividends at a rate of 10% per annum, which will accumulate and compound semi-annually if not paid in cash. The Series B Convertible Preferred Stock may be converted into Common Stock at any time at the option of the holder. On the seventh anniversary of its issuance, any unconverted shares of Series B Convertible Preferred Stock will be automatically redeemed by the Company at the original issuance price plus accrued and unpaid dividends, provided the Company is legally able to do so. Two members of the Board of Directors of the Company are elected exclusively by the holders of the Series B Convertible Preferred Stock voting as a separate class.

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The Company may redeem the Series B Convertible Preferred Stock at any time prior to December 31, 2004 if the Company receives a bona fide offer from a third party to invest equity capital in the Company and the holders of the Series B Convertible Preferred Stock do not make a Qualified Counter-Offer. A “Qualified Counter-Offer” is a written offer for an equity investment in the Company that will yield gross proceeds in excess of the third party’s offer (but need not exceed $3,500,000), and which either (A) is accomplished through the exercise of some or all of the Warrants, or (B) will provide capital on the same or better terms as the third party offer. The Series B Convertible Preferred Stock had a beneficial conversion feature of $2,000,000, which was recorded as a discount and is being amortized over seven years.

As part of this transaction (the “Private Equity Transaction”), the Company entered into a Management Services Agreement under which certain principals of Westgate or its affiliates will provide management and consulting services to the Company.

Under the terms of the Private Equity Transaction, if Westgate exercises the warrants in full, Westgate would hold a total of 47,182,271 shares of Series B Convertible Preferred Stock which would be convertible into the same number of shares of Common Stock, subject to adjustment for anti-dilution, or 45.0% of the Company’s Common Stock on a fully diluted basis as of September 30, 2004.

After the completion of the Private Equity Transaction, to accommodate the market rate conversion ratio of certain outstanding notes, the Company and Westgate agreed to adjust the conversion formula for the Series B Convertible Preferred Stock. In addition, Westgate and Health Holdings agreed that (i) the Company may grant additional options to purchase up to 1,250,000 shares of Common Stock to employees in accordance with the Naturade, Inc. 1998 Incentive Stock Option Plan, and (ii) Health Holdings would grant to Westgate a proxy to vote 1.041 shares of Common Stock owned by Health Holdings for each share of Common Stock issued on exercise of the new options.

The Company has used the net proceeds of the transactions for working capital and general corporate purposes.

Employee Stock Option Plan – In February 1998, the Company adopted an Incentive Stock Option Plan (the “Plan”) to enable participating employees to acquire shares of the Company’s Common Stock. The Plan provided for the granting of incentive stock options up to an aggregate of 850,000 shares, as amended. In October 2001, the Company amended the Plan by increasing to 2,000,000 the number of shares of the Company’s Common Stock that may be subject to awards granted pursuant to the Plan. The actual number of incentive stock options that may be granted to employees is determined by the Compensation Committee based on the parameters set forth in the Plan. Under the terms of the Plan, incentive stock options may be granted at not less than 100% of the fair market value at the date of the grant (110% in the case of 10% shareholders). Incentive options granted under the Plan vest over a four-year period from the date of grant. The Company has granted 1,719,500 incentive options under the Plan at the weighted average exercise price per share of $0.14 as of September 30, 2004. These options expire seven years from the date of grant.

Director Stock Options – In October 1999, 87,500 options were issued to each of two then new board members at an exercise price of $1.03.

Warrants – On January 2, 2002, the Company sold warrants to purchase 33,641,548 shares of Series B Convertible Preferred Stock. The aggregate purchase price of the warrants was $500,000 and the aggregate exercise price is $3.5 million. This transaction is described more fully in Note 4, Private Equity Transaction.

In 1999, the Company granted 600,000 warrants in conjunction with certain financing agreements. These warrants expire ten years from the date of grant. As part of the Private Equity Transaction described in Note 4, the holders of the warrants agreed they would be exercisable for Non-Voting Common Stock.

A summary of the Company’s outstanding stock options activity is as follows:

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The following table summarizes information about stock options outstanding at September 30, 2004

A summary of the Company’s outstanding warrant activity is as follows:

The following table summarizes information about warrants outstanding at September 30, 2004

Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 123, the Company has elected to continue using the intrinsic value method of accounting for stock-based awards granted to employees and directors in accordance with Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in accounting for its stock option plan. Had the compensation cost for the Company stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method of SFAS 123, the Company’s net loss and loss per share would have been the pro forma amounts presented below:

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The Company’s reportable operating segments consist of health food specialty stores and mass market stores. The Company does not allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only sales, cost of sales and gross profit.

Operating segment data for the three and nine months ended September 30, 2004 and September 30, 2003 was as follows:

Sales are attributed to geographic areas based on the location of the entity to which the products were sold. Geographic segment data for the three and nine months ended September 30, 2004 and September 30, 2003 was as follows:

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During the three and nine months ended September 30, 2004 and 2003, the Company had sales to three customers whose purchases exceed 10% of the Company’s total net sales as shown in the table below.

Major Customer Table

Under its bylaws, the Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of an officer’s or director’s serving in such capacity. The term of the indemnification period is the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company has a directors’ and officers’ liability insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal and has no liability recorded for these agreements as of September 30, 2004.

The Company enters into indemnification provisions under (i) its agreements with other companies in its ordinary course of business, typically business partners, contractors, customers and landlords and (ii) its agreements with investors. Under these provisions the Company generally agrees to indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive the termination of the underlying agreement. In addition, in some cases, the Company has agreed to reimburse employees for certain expenses and to provide salary continuation during short-term disability. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the Company believes the estimated fair value of these provisions is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2004.

On November 2, 2004, the Company agreed to the sale of its aloe vera based products in an all cash transaction. The sale includes two product lines sold primarily through health food stores and natural food supermarkets including aloe vera gel concentrate drinks and Aloe Vera 80^® brand topical products. The sale included all inventory, tangible and intangible personal property related to these two brands and resulted in a gain of approximately $1,072,000. The proceeds on the sale were used to reduce borrowings under the Credit Agreement.

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This discussion contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, such statements are inherently subject to risk and the Company can give no assurances that its expectations will prove to be correct. Actual results could differ from those described herein as a result of numerous factors, many of which are beyond the control of the Company. Such factors include, without limitation, the risks set forth below under “Risk Factors.” The Company undertakes no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect actual outcomes.

The following table sets forth, for the periods indicated, the percentage which certain items in the statement of operations data bear to net sales and the percentage dollar increase (decrease) of such items from period to period.

All comparisons below are for the three and nine month periods ended September 30, 2004 compared to the three and nine month periods ended September 30, 2003.

General

The Company is a branded natural product marketing company focused on high growth, innovative products designed to nourish the health and well being of consumers. The Company concentrates on the rapidly expanding soy food market, which reached sales of almost $2.5 billion in 2002, with an emphasis in the Nutritional Supplement sector, which grew 6% in 2003 according to the Nutrition Business Journal. The Company’s products include Naturade Total Soy^®, a full line of nutritionally complete meal replacements available in several flavors of powders, and ready-to-drink products, Diet Lean^® dietary supplements, Naturade Low Carb protein boosters, SportPharma^® sports nutrition products, Aloe Vera 80^® health and beauty care products and other niche nutritional supplements. The Company’s products are sold in over 10,000 supermarkets and drug stores (e.g., Kroger, Fred Meyer, Safeway and Albertson’s, Longs Drug and Sav-On Drug), sports nutrition centers (e.g., GNC), club stores (e.g., Sam’s Clubs and Costco), natural food supermarkets (e.g., Whole Foods and Wild Oats) and over 5,000 independent health food stores.

As reported in the Nutrition Business Journal, the Nutritional Supplement sector grew 6% in 2003. The health food channel grew 12% while the mass market channel declined 1% during the same period. While the Company has focused in the past primarily on meal supplements, which declined 2% in 2003, the movement to Diet Lean and Sports Nutrition products, which grew 14% and 8% respectively, place the Company in a position to capitalize on the growth segments of the market.

Critical Accounting Policies and Use of Estimates

In preparing its financial statements, the Company is required to make estimates and judgments that affect the results of its operations and the reported value of assets and liabilities. Actual results may differ from these estimates. The Company believes that the following summarizes the critical accounting policies that require significant judgments and estimates in the preparation of its financial statements.

Revenue Recognition. Sales are recognized upon shipment and passage of title. The Company accrues for estimated returns at the time of sale. The Company accounts for certain promotional allowances such as consumer coupons and rebates and customer slotting fees as a reduction of sales and new store opening costs are recorded as cost of goods sold in the period incurred in accordance with Emerging Issues Task Force (“EITF”) issue No. 01-09. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, Revenue Recognition (“SAB 101”). SAB 101 summarizes certain of the SEC staff’s views in applying generally accepted accounting principles to selected revenue recognition issues in financial statements. In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB No. 104”), “Revenue Recognition,” which codifies, revises and rescinds certain sections of SAB No. 101, “Revenue Recognition,” in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations.

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The changes noted in SAB No. 104 did not have a material effect on the Company’s consolidated results of operations, consolidated financial position or consolidated cash flows

Inventory Valuation. Merchandise inventories are stated at the lower of cost (first-in, first-out basis) or market. The Company considers cost to include the direct cost of finished goods provided by co-packers as well as the cost of those components supplied to the co-packers. The Company regularly reviews aged and excess inventories to determine if the carrying value of such inventories exceeds market value, and records a reserve to reduce the carrying value to market value if necessary.

Accounts Receivable Valuation. Accounts receivable is stated net of applicable reserves for returns and allowances, bill backs and doubtful accounts. The Company regularly reviews accounts receivable to determine if the reserve amounts are appropriate by considering historical customer buying patterns, invoice aging, specific promotions and seasonal factors.

Results of Operations

Net Sales

Net sales for three months ended September 30, 2004 decreased $113,016, or 3.0%, to $3,654,751 from $3,767,767 for the same period in 2003. For the nine months ended September 30, 2004, net sales decreased $1,165,225 or 9.9% to $10,551,281 from $11,716,506 for the same period in 2003 The decrease in net sales for both the quarter and the nine month periods was primarily (80%) due to pipeline fill and turn revenues in 2003 to a large mass customer that discontinued distribution of the Company’s products in November of 2003 in a move to a low carbohydrate format for its meal replacement category. In addition, softness in the mass channel principally related to a general decline in the grocery sector, the increased consumer emphasis on low carbohydrate products and a labor strike in the grocery segment which started in the fourth quarter of 2003 and extended through the first quarter of 2004 contributed to the decline in revenues.

Mass Market Net Sales. For the three months ended September 30, 2004, mass market net sales decreased $107,435, or 5.6%, to $1,820,113 from $1,927,548 for the three months ended September 30, 2003. The decrease in the quarter ended September 30, 2004 is primarily due to a large mass customer discontinuing Naturade product distribution in late 2003 as it moved its meal replacement category to a low carbohydrate positioning. This customer accounted for $324,900 in revenues during the quarter ended September 30, 2003. The softness in the mass market channel also related to a general decline in the grocery segment coupled with a prolonged labor strike that started in the fourth quarter of 2003 and extended into the first quarter of 2004. Sales within this segment in the nine months ended September 30, 2004 decreased 16.5%, or $976,476 to $4,948,300 from $5,924,776 over the same period in 2003. Approximately $933,200 or 96 % of the decline in revenues for the nine months ended September 30, 2004 can be attributed to the mass customer withdrawal referred to above.

Health Food Net Sales. For the three months ended September 30, 2004, health food channel net sales decreased $5,581, or 0.3%, to $1,834,638 from $1,840,219 for the three months ended September 30, 2003. Sales within this segment in the nine months ended September 30, 2004 decreased 3.3%, or $188,749 to $5,602,981 from $5,791,730 over the same period in 2003.

Channels of Distribution On a percent of net sales basis, the breakdown of sales between the mass market and health food channels was 50.2% and 53.1% for the health food channel and 49.8% and 46.9% for the mass market channel respectively for the three and nine month periods ended September 30, 2004, compared to 48.8% and 49.4% for the health channel and 51.2% and 50.6% for the mass channel respectively for the same period in 2003. The distribution loss in the mass market channel accounts for the majority of the shift in revenue distribution in 2004.

For the three months ended September 30, 2004, domestic net sales decreased $208,670, or 5.6%, to $3,539,163 from $3,747,833 for the three months ended September 30, 2003. Sales within this segment in the nine months ended September 30, 2004 decreased 11.7%, or $1,349,179 to $10,188,352 from $11,537,531 over the same period in 2003. The decrease in domestic net sales is principally due to the key customer loss in the mass market discussed previously. For the three months ended September 30, 2004, international sales increased $95,655, or 479.9%, to $115,588 from $19,934 while for the nine months ended September 30, 2004, international net sales increased 183,954 or 102.8% to $362,929 from $178,975 as compared to the same period in 2003. The increase in international sales during 2004 was due to pipeline fill related to new distribution in Canada. This new distribution is principally the result of hiring a new broker in Canada and the entering of an agreement with a Canadian distributor to manage the Company’s distribution in Canada. These agreements resulted in a reduction in the costs related to Canadian distribution that allowed the Company to reduce retail prices to a more competitive level.

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Gross Profit

Gross profit as a percentage of net sales for the three months ended September 30, 2004 decreased 0.1% to 47.5% of net sales, from 47.6% for the three months ended September 30, 2003 and gross profit as a percent of sales decreased 0.4% to 45.9% from 46.3% for the nine months ended September 30, 2004 as compared to September 30, 2003. The decrease in gross profit can be principally attributed to raw material price increases from contract manufacturers related to soy protein price increases. The Company has taken action to reduce the effect of future price increase by raising selected wholesale prices and shifting certain products to a new contract manufacturer.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“S, G &A”) for the three months ended September 30, 2004 decreased $298,641 to $1,659,614 or 45.4% of net sales from $1,958,255 or 52.0% of net sales for the three months ended September 30, 2003. S, G & A for the nine months ended September 30, 2004 decreased $453, 817 or 7.7% to $5,446,919 from $5,900,736 for the nine months ended September 30, 2003. The decrease for both the three month and nine month periods is primarily due to decreased promotional expenses related to mass market sales due to the decline in this segment’s sales, in particular the loss of distribution to a large mass customer during 2004. As a percent of sales, brand expenses were 12.5% and 13.6%, respectively, for the nine months ended September 30, 2004 and 2003. The decrease in brand expenses, as a percent of net sales, is primarily due to the lower net sales during the period related to the mass channel and the mass sales the previously discussed decrease in mass market promotional costs.

Interest Expense

Interest expense for the three months ended September 30, 2004 was $78,328 compared to $53,365 for the three months ended September 30, 2003 and for the nine months ended September 30, 2004 was $222,526 compared to $132,282 for the same period in 2003. The increase in interest expense for both the three and nine month periods is principally due to borrowings on the Loan Agreement with related parties, more fully explained in Note 4 to our financial statements, coupled with increased average borrowings on the Company’s credit facility.

Liquidity and Capital Resources

The Company’s operations provided cash of $198,650 in the nine months ended September 30, 2004, compared to $521,960 of cash used in operating activities for the nine months ended September 30, 2003. This increase in cash provided by operating activities primarily results from the reduction in the Company’s accounts receivable related to the reduction in sales in the period as compared to the same period in 2003, coupled with an increase in accounts payable related to new product purchases, partially offset by the increase in net loss of $210,437 and an increase in inventories to supply new product distribution.

Net cash used by inventories was $302,206 for the nine months ended September 30, 2004 compared to net cash provided by inventories of $607,574 for the nine months ended September 30, 2003 primarily due to lower December sales in 2002 compared to December 2003, which resulted in higher inventory levels at the beginning of the nine months ended September 30, 2003. These inventory levels were reduced during the nine month period ended September 30, 2003. In addition, the Company introduced two new product lines in 2004 and introduced distribution in a major sports nutrition retailer requiring consignment of inventory. Both the new products and the consigned inventory requirement resulted in additional inventory levels to meet customer requirements.

Net cash provided by accounts receivable was $735,303 for the nine month period ended September 30, 2004 compared to net cash provided by accounts receivable of $95,516 for the same period of 2003, principally due to increased sales volume in December 2003 compared to the same period in 2002. This higher sales level resulted in increased cash generation from the receivables paid during the first quarter of 2004. Customer terms have remained constant.

Net cash provided by accounts payable and accrued expenses was $654,508 for the nine month period ended September 30, 2004 compared to net cash used of $420,101 the same period of 2003, principally due to abnormally high accounts payable at December 31, 2002 resulting from lower than anticipated sales in December 2002. The Company negotiated extended terms with vendors that were paid during the first quarter of 2003 resulting in a use of cash. Accounts payable levels did not fluctuate significantly from December 31, 2003 to September 30, 2004. However, the addition of two new product lines required additional inventory and resulted in additional accounts payable to finance the higher inventory levels.

The Company’s working capital decreased $838,561 from ($1,789,482) at December 31, 2003 to ($2,628,043) at September 30, 2004. This decrease was largely due to the decrease in receivables and inventory as a result of collections and an increase in borrowings from shareholders partially offset by a decrease in borrowings on the Company’s credit facility.

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The Company’s cash used in financing activities was $75,483 for the nine months ended September 30, 2004, compared to cash used in financing activities of $10,796 for the same period of 2003. The increase resulted from additional net borrowings under the Company’s credit facility coupled with payments on other long-term debt partially offset by the issuance of debt to related parties.

As of September 30, 2004, the Company was in default of the Minimum Net Worth Covenant and Minimum Net Income covenants of the Credit and Security Agreement with Wells Fargo. The Company has obtained a written waiver from Wells Fargo. See Notes 4 and 8 to the Financial Statements.

The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. At September 30, 2004, the Company has an accumulated deficit of $23,127,298, a net working capital deficit of $2,628,043, a stockholders’ capital deficiency of $4,135,375, and has incurred recurring net losses. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company’s independent auditors qualified their opinion on the Company’s December 31, 2003 financial statements by including an explanatory paragraph in which they expressed substantial doubt about the Company’s ability to continue as a going concern

The Company believes that its existing cash balances and financing arrangements will provide it with sufficient funds to finance its operations during the next twelve months, provided Wells Fargo does not exercise its right to terminate, or demand immediate payment of all amounts outstanding under the Credit Agreement. However, the Company may seek to raise additional funds through the sale of public or private equity and/or debt financings or from other sources. No assurance can be given that additional financing will be available in the future or that, if available, such financing will be obtainable on terms acceptable to the Company or its stockholders.

Impact of Contractual Obligations and Commercial Commitments

The following summarizes the Company’s contractual obligations at September 30, 2004 and the effects such obligations are expected to have on liquidity and cash flow in future periods.

Recently Issued Statements of Financial Accounting Standards

In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB No. 104”), “Revenue Recognition,” which codifies, revises and rescinds certain sections of SAB No. 101, “Revenue Recognition,” in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on the Company’s consolidated results of operations, consolidated financial position or consolidated cash flows.

In December 2003, the FASB issued Interpretation No. 46 (“FIN 46R”) (revised December 2003), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 (“ARB 51”), which addresses how a business enterprise should evaluate whether it has a controlling interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46 (“FIN 46”), which was issued in January 2003. Before concluding that it is appropriate to apply the ARB 51 voting interest consolidation model to an entity, an enterprise must first determine that the entity is not a variable interest entity. As of the effective date of FIN 46R, an enterprise must evaluate its involvement with all entities or legal structures created before February 1, 2003, to determine whether consolidation requirements of FIN 46R apply to those entities. There is no grandfathering of existing entities. Public companies must apply either FIN 46 or FIN 46R immediately to entities created after December 15, 2003 and no later than the end of the first reporting period that ends after March 15, 2004 to entities considered to be special purpose entities. The adoption of FIN 46R had no effect on the Company’s consolidated financial position, results of operations, or cash flows.

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Risk Factors

The short and long-term success of the Company is subject to certain risks, many of which are substantial in nature. Stockholders and prospective stockholders in the Company should consider carefully the following risk factors, in addition to other information contained herein. This Form 10-Q contains forward-looking statements, which are subject to a variety of risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below.

Future losses and ability to continue as a going concern

Naturade’s independent accountants have qualified their opinion on the Company’s December 31, 2003 financial statements, expressing substantial doubt concerning the Company’s ability to continue as a going concern. At September 30, 2004, the Company had an accumulated deficit of $23,127,298, net working capital deficit of $2,628,043 and a stockholders’ capital deficiency of $4,135,375. The Company’s balance sheet does not reflect adjustments in valuation that would be necessary if it became clear that the Company could not continue as a going concern. The Company anticipates that it will incur net losses for the foreseeable future and will need access to additional financing for working capital and to expand its business. Management has taken a number of steps to address this situation, including the Private Equity Transaction completed on January 2, 2002, the Loan Agreement entered into on April 14, 2003 under which the Company has borrowed $950,000, and efforts to decrease operating losses by expanding sales and reducing costs. Nevertheless, the Company expects to incur operating losses for some time in the future and cannot give assurance that additional financing will be available when needed or that it will obtain needed waivers or modifications of the Credit and Security Agreement. If unsuccessful in those efforts, Naturade could be forced to cease operations and investors in Naturade’s Common Stock could lose their entire investment.

Dependence on current and ongoing financing

The Company’s success is dependent on its current financing as well as new financing to support its working capital requirements and fund its operating losses. As of September 30, 2004, the Company was not in compliance with the minimum book net worth and the minimum net income covenants. The Company has acquired a written waiver from Wells Fargo for the noncompliance. The Company may need similar waivers in the future, and cannot assure you that the waivers will be granted. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and Notes 4 and 8 to the Financial Statements.

Dependence on continued business from the Company’s key customers

The Company’s three largest customers together account for 56% of sales revenue for the nine months ended September 30, 2004. One mass market customer represented approximately 21% of Naturade’s total sales, and two health food distributors accounted for 35% of total sales during the nine months ended September 30, 2004. The loss of any of these customers could have a material adverse effect on the Company’s results of operations. From time to time, major customers of Naturade have experienced financial difficulties. Naturade does not have long-term contracts with any of its customers and, accordingly, there can be no assurance that any customer will continue to place orders with Naturade to the same extent it has in the past, or at all.

Dependence on third-party manufacturers

The use of contract manufacturers and the resulting loss of direct control over production could result in the Company’s failure to receive timely delivery of products of acceptable quality. Although the Company believes that alternative sources of contract manufacturing services are available, the loss of one or more contract manufacturers could have a material adverse effect on the Company’s results of operations until an alternative source is located and has commenced producing the Company’s products. The Company’s use of contract manufacturers could also reduce its gross profits if the manufacturers raise prices and management cannot find alternative, less costly sources or pass price increases on to customers.

Although the Company requires that its contract manufacturers comply with the U.S. Food and Drug Administration (the “FDA”) manufacturing guidelines, Naturade cannot assure that these third-party companies will always act in accordance to these regulations. If the manufacturing facilities used by the Company’s third-party manufacturers did not meet those standards, the production of the Company’s products could be delayed until the necessary modifications are made to comply with those standards or alternate manufacturers are located. Furthermore, the potential exists for circumstances to arise which would require Naturade to seek out alternate manufacturers who operate in compliance with the FDA’s requirements.

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Impact of government regulation

The Company’s operations, properties and products are subject to regulation by various foreign, federal, state and local government entities and agencies, including the FDA and the U.S. Federal Trade Commission (the “FTC”). Among other matters, such regulation is concerned with statements and claims made in connection with the packaging, labeling, marketing and advertising of the Company’s products. The governmental agencies have a variety of processes and remedies available to them, including initiating investigations, issuing warning letters and cease and desist orders, requiring corrective labeling or advertising, requiring consumer redress, seeking injunctive relief or product seizure, imposing civil penalties and commencing criminal prosecution.

As a result of the Company’s efforts to comply with changes in applicable statutes and regulations, the Company has from time to time reformulated, eliminated or relabeled certain of its products and revised certain aspects of its sales, marketing and advertising programs. The Company may be subject in the future to additional laws or regulations administered by federal, state, local or foreign regulatory authorities, the repeal or amendment of laws or regulations which the Company considers favorable, such as the Dietary Supplement Health and Education Act (“DSHEA”), or more stringent interpretations of current laws or regulations. The Company cannot predict the nature of future laws, regulations, interpretations or applications, nor can the Company predict what effect additional governmental regulations or administrative orders, when and if promulgated, would have on the Company’s business in the future. Such future laws and regulations could, however, require the reformulation of products to meet new standards, the recall or discontinuance of products that cannot be reformulated, the imposition of additional record keeping requirements, expanded documentation of product efficacy, expanded or modified labeling and scientific substantiation, including health warnings or restrictions on benefits described for the Company’s products. Any of or all of such requirements could hurt sales of the Company’s products or increase the Company’s costs, resulting in material harm to the Company’s results of operations and financial condition.

Naturade may not be able to identify suitable strategic partners to realize the Company’s growth strategy.

In addition to internal expansion of its existing business, The Company has a strategy to expand its business externally by identifying compatible companies for strategic alliances and strategic investments in The Company. The Company may not succeed in identifying these potential strategic partners or may be unable to conclude agreements with them. If so, The Company’s future growth may be limited, and it may be unable to achieve profitability.

Competition

The market for nutraceutical products is highly competitive. Many of the Company’s competitors have substantially greater capital resources, research and development capabilities, and manufacturing and marketing resources, capabilities and experience than the Company. The Company’s competitors may succeed in developing products that are more effective or less costly than any products developed by the Company.

Future sales of equity securities could dilute the Company’s Common Stock

The Company may seek to obtain new financing from various sources, including the sale of its securities. Future sales of Common Stock or securities convertible into Common Stock at or below recent market prices could result in dilution of the Common Stock. In addition, the conversion of the 13.5 million shares of Series B Convertible Preferred Stock sold to Westgate on January 2, 2002, for $2 million, together with conversion of the 35,989,555 shares of Series B Convertible Preferred Stock issuable on exercise of warrants, which expire on December 31, 2004, are held by Westgate, and which have an exercise price of approximately $0.104 per share (and, including the original cost of the warrant, a total consideration of approximately $0.119 per share), has resulted in dilution of the Common Stock. The perceived risk of dilution may cause some of the Company’s stockholders to sell their shares, which could further reduce the market price of the Common Stock.

Dependence on qualified personnel

The Company’s success depends upon its ability to attract and retain qualified sales, marketing, scientific and executive management personnel. To commercialize its products and product candidates, the Company must maintain and expand its personnel, particularly in the areas of product sales and marketing. The Company faces intense competition for such personnel from other companies, academic institutions, government entities and other research organizations. There can be no assurance that the Company will be successful in hiring or retaining qualified personnel. Moreover, managing the integration of such new personnel could pose significant risks to the Company’s development and progress and increase its operating expenses.

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Expanding the Company’s sales in the mass market resulted in less stable demand for the Company’s products.

The Company, traditionally a marketer for the health food market, has recently built a presence in the mass market. While yielding increased revenue, selling to the mass market has also resulted in significant risks for the Company. Compared to sales in the health food market, the aggregate volume of mass market orders can vary significantly from period to period and tends to be more sensitive to short term or local variations in market conditions. The instability can make planning difficult and can cause unexpected reductions in sales, or in orders that exceed the Company’s short-term capacity, in either case resulting in lost revenue. Failure to manage the costs and risks associated with the mass market could cause material adverse harm to the Company’s business.

Closely controlled stock

At September 30, 2004, Westgate beneficially owned approximately 54.4% of the Company’s Common Stock, Health Holdings beneficially owned 92.2% of the Company’s Common Stock, and executive officers and directors of the Company as a group beneficially owned 97.5% of the Company’s Common Stock. Shares “beneficially owned” include shares that a person owns or has a right to acquire within 60 days, either directly or through affiliates. Accordingly, Westgate and Health Holdings have the ability to control the outcome on all matters requiring stockholder approval, including, but not limited to, the election and removal of directors, any merger, sale, consolidation or sale of substantially all of the assets of the Company, and to control the Company’s management and affairs.

Technological changes

The Company currently is engaged in developing nutraceuticals, which are characterized by extensive and costly research efforts and rapid technological progress and change. New process developments are expected to continue at a rapid pace in both industry and academia. The Company’s future success will depend on its ability to develop and commercialize its existing product candidates and to develop new products. There can be no assurance that the Company will successfully complete the development of any of its existing product candidates or that any of its future products will be commercially viable or achieve market acceptance. In addition, research and development and discoveries by others could render some or all of the Company’s programs or potential product candidates uncompetitive or obsolete.

The Company may face interruption of production and services due to increased security measures in response to terrorism

The Company’s business depends on the free flow of products and services through the channels of commerce. Recently, in response to terrorist activities and threats aimed at the U.S., transportation, mail, financial and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on the Company’s business, results of operations and financial condition. Furthermore, the Company may experience an increase in operating costs, such as costs for transportation, insurance and security, as a result of the terrorist activities and potential terrorist activities. The Company may also experience delays in receiving payments from payers that have been affected by terrorist activities and potential terrorist activities. The U.S. economy in general is being adversely affected by the terrorist activities and potential terrorist activities and any economic downturn could adversely impact the Company’s results of operations, impair its ability to raise capital or otherwise adversely effect its ability to grow its business.

Variability of quarterly results

The Company has experienced, and expects to continue to experience, variations in its net sales and operating results from quarter to quarter. The Company believes that the factors that influence this variability of quarterly results include the timing of the Company’s introduction of new product lines, the level of consumer acceptance of each product line, general economic and industry conditions that affect consumer spending and retailer purchasing, the availability of manufacturing capacity, the timing of trade shows, the product mix of customer orders, the timing of placement or cancellation of customer orders, the weather, transportation delays, the occurrence of chargebacks in excess of reserves and the timing of expenditures in anticipation of increased sales and actions of competitors. Accordingly, a comparison of the Company’s results of operations from period to period is not necessarily meaningful, and the Company’s results of operations for any period are not necessarily indicative of future performance.

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Product liability exposure

Product liability risk is inherent in the testing, manufacture, marketing and sale of the Company’s products and product candidates, and there can be no assurance that the Company will be able to avoid significant product liability exposure. The Company may be subject to various product liability claims, including, among others, that its products include inadequate instructions for use or inadequate warnings concerning possible side effects and interactions with other substances. The Company currently maintains a general liability insurance policy and a product liability insurance policy. There can be no assurance that the Company will be able to maintain insurance in sufficient amounts to protect the Company against such liabilities at a reasonable cost. Any future product liability claim against the Company could result in the Company paying substantial damages, which may not be covered by insurance and may have a material adverse effect on the business and financial condition of the Company.

The dietary supplement industry as a whole is experiencing a decline in sales

The Company’s business consists primarily of selling natural products and functional foods, including soy protein-based products. The soy foods category as a whole has recently experienced decreased sales. Other categories of dietary supplements have experienced reduced sales in recent periods after several years of dramatic growth. In particular, revenues in both the herbal and health food store categories have had periods of significant decline. There can be no assurance that this general consumer trend will not be experienced by the Company’s product categories as well. Even if the Company is successful in increasing sales within its market category, a decline in the overall market for natural products or functional foods could have a material adverse affect on the Company’s business.

Effect of adverse publicity

The Company’s products are formulated with vitamins, minerals, herbs and other ingredients that the Company regards as safe when taken as recommended by the Company and that scientific studies have suggested may involve health benefits. While the Company conducts extensive quality control testing on its products, the Company generally does not conduct or sponsor clinical studies relating to the benefits of its products. The Company is highly dependent upon consumers’ perception of the overall integrity of its business, as well as the safety and quality of its products and similar products distributed by other companies which may not adhere to the same quality standards as the Company. The Company could be adversely affected if any of the Company’s products, or any similar products distributed by other companies, should prove harmful or be asserted to be harmful to consumers, or should scientific studies provide unfavorable findings regarding the effectiveness of such products. The Company’s ability to attract and retain distributors could be adversely affected by negative publicity relating to it or to other direct sales organizations or by the announcement by any governmental agency of investigatory proceedings regarding the business practices of the Company or other direct sales organizations.

Intellectual property protection

The Company’s success depends in part on the Company’s ability to preserve the Company’s trade secrets and know-how, and operate without infringing on the property rights of third parties. The Company does not have any patents, and as a result another company could replicate one or more of the Company’s products. The Company’s policy is to pursue registrations for all of the trademarks associated with its key products. The Company relies on common law trademark rights to protect its unregistered trademarks as well as its trade dress rights. Common law trademark rights generally are limited to the geographic area in which the trademark is actually used, while a U.S. federal registration of a trademark enables the registrant to stop the unauthorized use of the trademark by any third party anywhere in the U. S. The Company intends to register its trademarks in certain foreign jurisdictions where the Company’s products are sold. However, the protection available, if any, in such jurisdictions may not be as extensive as the protection available to the Company in the U.S.

Currently, the Company has U.S. trademarks as well as a California registration on four trademarks. The Company also maintains trademark registrations in approximately eleven foreign countries. Because of its limited financial resources, the Company cannot in all cases exhaustively monitor the marketplace for trademark violations. It will evaluate and pursue potential infringement on a case-by-case basis in accordance with its business needs and financial resources. If the Company is not aware of some infringing uses or elects not to pursue them, the value of its trademarks could be substantially weakened. If the Company takes action to enforce its intellectual property rights, litigation may be necessary. Any such litigation could be very costly and could distract the Company’s personnel. Due to limited financial resources, The Company may be unable to pursue some litigation matters. In matters it does pursue, the Company can provide no assurance of a favorable outcome. An unfavorable outcome in any proceeding could have a material adverse effect on the Company’s business, financial condition and results of operations.

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New products are expensive to introduce and may not be successful

Each year, the Company introduces new products to meet consumer demands and counter competitive threats. These new products include product line extensions, such as new flavors to currently existing products, as well as new formulations or configurations, such as ready-to-drink products and bars. The Company experiences significant costs in formulating new products, designing packaging and merchandising. While the Company conducts extensive market research to determine consumer trends in both the mass market and health food market, there can be no assurance that consumers and retailers will accept the Company’s new products. In addition, there can be no assurance that once new products are initially distributed to mass market and health food retailers, there will be repeat orders for these new products. Furthermore, expensive introductory retailer charges for additional shelf space may negate any initial increase in sales.

Stock price

The market price of the Company’s Common Stock is likely to be volatile and could be subject to significant fluctuations in response to factors such as quarterly variations in operating results, operating results which vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by the Company or its competitors of a material nature, loss of one or more customers, additions or departures of key personnel, future sales of Common Stock and stock market price and volume fluctuations. Also, general political and economic conditions such as recession, or interest rate or currency rate fluctuations may adversely affect the market price of the Company’s Common Stock.

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The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s long-term debt. The Company’s long-term debt at September 30, 2004, primarily consists of a $4.5 million line of credit originally entered into on January 27, 2000 and amended on April 14, 2003, a $950,000 Loan Agreement entered into on April 14, 2003 with a majority stockholder and other investors and $112,345 in Investor Notes, after giving affect to the Health Holdings debt-to equity conversion on January 2, 2002 as part of the Private Equity Transaction as described more fully in Note 4 to the Financial Statements. The line of credit bears interest at prime rate plus 4.5%. The Loan Agreement with a majority stockholder and other investors bears interest at 15% per annum and is due on December 31, 2004. The Investor Notes bear interest at 15% per annum with, payment in full due December 31, 2004. However, given the fixed interest rate on the Loan Agreement, interest rate changes generally will have no effect on the interest rates under the Loan Agreement or on the Company’s results of operations. Given the variable interest rate on the line of credit, the impact of interest rate changes on the line of credit could have a material impact on the Company’s results of operations. For the nine month period ended September 30, 2004 the interest expense on the line of credit was $78,963. If the interest rate on the line of credit for the nine month period ended September 30, 2004 had increased by one percent to prime rate plus 5.5%, this would result in an interest expense of $87,737.

The Company’s Chief Executive Officer, Bill D. Stewart, and Chief Financial Officer, Stephen M. Kasprisin, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 15d-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such a simple errors or mistakes or intentional circumvention of the established process.

There was no change in the Company’s internal control over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer that occurred during the period covered by the report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. Other Information

NONE

NONE.

As of September 30, 2004, the Company was in default of the Minimum Net Worth and Minimum Net Income Covenants of the Credit and Security Agreement with Wells Fargo. The Company has obtained a written waiver from Wells Fargo. See Note 8 to the Financial Statements.