Form 10-Q for NUTRACEA

Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

NutraCea is a health-science company focused on the development and distribution of products based upon the use of stabilized rice bran and proprietary rice bran formulations. Rice bran is the outer layer of brown rice which until recently was an underutilized by-product of the commercial rice industry. These products include food supplements and medical foods which provide health benefits for humans and animals (known as "nutraceuticals") as well as cosmetics and beauty aids based on stabilized rice bran, rice bran derivatives and the rice bran oils.

The following is a discussion of the consolidated financial condition of our results of operations for the three and nine months ended September 30, 2007 and 2006.

THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

For the three months ended September 30, 2007, the Company's net loss was ($4,784,000), or ($0.03) per share, compared to income of $641,000 or $0.01 per share, in the same period of 2006, showing a decrease of $5,425,000. The decrease for the quarter was primarily due to a $1,385,000, or 31%, decrease in sales, a return of $1,551,000 of product we previously sold in connection with our purchase of the remaining 50% interest in INFMX (Note 10), offset by a corresponding $900,000, or 35% decrease in our cost of goods sold, an increase of $3,527,000 in operating expenses, a $36,000 charge for the equity loss on our joint venture, offset by an increase of $597,000 of interest income.

In addition, during 2006 we expanded our humanitarian efforts teaming with Raising Malawi, Feed the Children and the Government of Malawi, Africa. This program will feed thousands of children and the health progress will be monitored and documented to track the benefits of this nutritional supplement for children.

Our consolidated net revenues for the three months ended September 30, 2007 of $1,520,000 decreased $3,426,000 from the $4,946,000 consolidated revenues recorded in the same period last year. The decrease is comprised of a $1,422,000 increase in product sales, offset by a $2,807,000 decrease in infomercial sales and a decrease of $490,000 in royalty revenues as shown in the following table:

Gross margins on product sales in the quarter ended September 30, 2007 were ($115,000), or (5.0%), compared to $1,898,000, or 43%, during the same period last year. Gross margins on our various product lines vary widely and the gross margins are impacted from period to period by sales mix and utilization of production capacity. The $2,526,000 decrease for the three months ended September 30, 2007 is comprised of the $753,000 decline corresponding to the decline in sales in the third quarter of 2007, a $1,284,000 decline associated with the return of product noted above, and a $489,000 decline in royality and licensing fees. Our gross margin for the quarter ended September 30, 2007, was 47% compared to 43% in the same period last year.

Research and Development ("R&D") expenses increased from $74,000 for the quarter ended September 30, 2006 to $154,000 for the quarter ended September 30, 2007, or an increase of $80,000. The increase was attributed to higher product development costs and employee related expenses due to increased R&D activities and expanded scientific staff compared to the same period last year. The Company expects to continue research and development expenditures to establish the scientific basis for health claims of existing products and to develop new products and applications.

Sales, General and Administrative ("SG&A") expenses were $4,576,000 and $1,563,000 in the quarterly periods ended September 30, 2007 and 2006 respectively, an increase of $3,013,000, or 193%. This increase is predominately due to expanded investment in personnel, infrastructure, and sales and marketing activities to meet anticipated future demands (with the exception of bad debt expense, as described below). Specific changes in SG&A expense is detailed in the following schedule:

In the three months ended September 30, 2007 our provision for the allowance for bad debt expense was ($255,000) compared to $0 in the three months ended September 30, 2006. This decrease is the result of an $800,000 additional provision offset by a recovery of $1,055,000 previously provided for.

Professional fees increased $433,000 from $314,000 for the quarter ended September 30, 2006 to $747,000 for the quarter ended September 30, 2007. The higher professional fees in 2007 primarily relate to consulting fees incurred in connection with marketing and business development activities and Sarbanes-Oxley Section 404 activities. Professional fees include costs related to accounting, legal and consulting services.

Other income and expense, net, increased by $561,000 in the three months ended September 30, 2007 compared to 2006. This increase is comprised primarily of a $597,000 increase in interest income due to higher cash balances.

NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

For the nine months ended September 30, 2007, the Company's net loss was ($3,028,000), or ($0.02) per share, compared to net income of $807,000, or $0.01 per share, in the same period of 2006, showing a decrease of $3,835,000. The decrease for the nine month period was primarily due to a $10,297,000 increase in operating expenses, a $286,000 loss on our investment in a joint venture, and a $309,000 expense for loss on the retirement of assets when we moved our corporate offices to Phoenix, AZ, offset by a $357,000 decline in our cost of goods sold, an increase of $4,504,000 in royalty revenues, a $1,849,000 increase in interest income, and a $1,250,000 gain on the settlement of a lawsuit.

Our consolidated revenues through September 30, 2007 of $16,513,000 increased $3,619,000, or 28%, from the same period last year. The revenue increase is attributable to a $8,161,000, or 186%, increase in product sales, offset by a decrease of $9,046,000 in infomercial sales, including a $1,551,000 sales return (Note 10), and a $4,504,000 increase in royalty and licensing revenue over the nine months ended September 30, 2006, as shown in the following schedule:

Gross margins on sales in the nine months ended September 30, 2007 were $9,902,000, or 47%, compared to $5,396,000, or 44%, during the same period last year. Gross margins on our various product lines vary widely and the gross margins are impacted from period to period by sales mix and utilization of production capacity. The $3,976,000 increase for the nine months ended September 30, 2007 is comprised of the $756,000 increase corresponding to the sales growth in the nine months ended September 30, 2007, offset by the $1,284,000 decline associated with the return of product noted above, and a $4,504,000 increase in royality and licensing fees.

R&D expenses increased from $259,000 for the nine months ended September 30, 2006 to $446,000 for the nine months ended September 30, 2007, or an increase of $187,000. The increase was attributed to higher product development costs and employee related expenses due to increased R&D activities and expanded scientific staff compared to the same period last year. The Company expects to continue research and development expenditures to establish the scientific basis for health claims of existing products and to develop new products and applications.

SG&A expenses were $12,546,000 and $4,413,000 in the nine months ended September 30, 2007 and 2006 respectively, an increase of $8,133,000, or 184%. This increase is predominately due to expanded investment in personnel, infrastructure, and sales and marketing activities to meet anticipated future demands (with the exception of bad debt expense - see below). Specific changes in SG&A expense is detailed in the following schedule:

In the nine months ended September 30, 2007 our provision for the allowance for bad debt expense was $800,000 (net of $1,055,000 in recoveries) compared to $0 for the nine months ended September 30, 2006. This increase is the result of an $1,855,000 additional provision offset by a recovery of $1,055,000 previously provided for.

Professional fees increased $1,978,000 from $764,000 for the nine months ended September 30, 2006 to $2,742,000 for the nine months ended September 30, 2007. The higher professional fees in 2007 primarily relate to consulting fees incurred in connection with marketing and business development activities and a charge of $750,000 for costs associated with developing our joint venture with Grain Enhancements LLC (Note 10). Professional fees include costs related to accounting, legal and consulting services.

Other income and expense, net, increased by $2,505,000 in the nine months ended September 30, 2007 compared to 2006. This increase is comprised of a $1,850,000 increase in interest income, a $1,250,000 gain on the settlement of a lawsuit (Note 3), offset by a $309,000 charge for the loss on the retirement of assets, and a $286,000 charge for the loss on the equity investment in a joint venture (Note 10).

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2007, our source of liquidity was cash in the amount of $49,546,000. Our cash increased by $34,679,000 in the nine months ended September 30, 2007 from our cash position of $14,867,000 at December 31, 2006.

For the first nine months of 2007, net cash used in operations was $1,566,000, compared to cash used in operations in the same period of 2006 of $213,000, an increase of $1,353,000. This increase in cash used in operations resulted primarily from our net loss of $3,028,000, plus the non-cash charges against income of $1,453,000 for depreciation and amortization, $800,000 for an increase in the provision for doubtful accounts, a $309,000 charge for the loss on the retirement of assets, a $1,667,000 charge for stock-based compensation, a $286,000 charge for the equity loss on our joint venture, and the increase in inventories of $623,000, an increase in accounts receivable of $1,545,000 (net of a conversion of a customers' accounts receivable of $3,881,000 to a short-term note receivable (Note 5), an increase of $400,000 in other current assets, and a decrease of $485,000 in accounts payable and accrued liabilities.

Cash used in investing activities in the first nine months of 2007 was $19,527,000, compared to $6,271,000 for the same period of 2006. This increase of 13,256,000 was primarily caused by $8,208,000 in expenditures for plant expansions and other fixed assets, $802,000 for the purchase of intangible assets, $2,169,000 and $5,143,000 for the purchase Grainnovation, Inc. and the investment in Vital Living, Inc., respectively, net of cash received in those transactions, the $1,500,000 investment in the GE joint venture, and a net outflow of $1,705,000 relating to loans made by us to certain customers, net of $3,881,000 of accounts receivable converted to short-term notes receivable (Note 5).

Cash provided by financing activities for the nine months ended September 30, 2007, was approximately $55,772,000, which reflects proceeds from our February 2007 private placement financing (see below) and proceeds received upon the exercise of common stock options and warrants. This is an increase of $30,867,000 from the private placement financing, and the $8,795,000 increase from the exercise of common stock options, compared to the nine months ended September 30, 2006. Our working capital position as of September 30, 2007 was $56,676,000 compared to $23,320,000 as of December 31, 2006.

On February 15, 2007, we sold an aggregate of 20,000,000 shares of our common stock at a price of $2.50 per share in connection with a private placement for aggregate gross proceeds of $50,000,000 ($46,805,000 after offering expenses). Additionally, the investors were issued warrants to purchase an aggregate of 10,000,000 shares of our common stock at an exercise price of $3.25 per share. An advisor for the financing received a customary 6% cash-fee, based on aggregate gross proceeds received from the investors, reasonable expenses and a warrant to purchase 1,200,000 shares of common stock at an exercise price per share of $3.25. The warrants have a term of five years and are exercisable after August 16, 2007.

In April 2007, we acquired shares of convertible preferred stock and secured convertible notes of Vital Living, Inc. from the holders of those outstanding securities, for an aggregate of $5,226,000 (Note 10).

On May 1, 2007, we purchased the outstanding stock of Grainnovation, Inc. ("GI") and certain assets used in the business of GI. The purchase enables us to produce pellets for the equine market. The purchase agreement provides for a cash purchase price of $2,150,000, and allows NutraCea to require the former shareholders of GI to repurchase from NutraCea the stock of GI if certain post-closing covenants are not satisfied by GI in the six month period following the closing of the transaction (Note 10).

In June 2007, we entered into a joint venture with PAHL to form Grain Enhancement LLC (Note 10). This joint venture required a $1,500,000 capital contribution which was made in July 2007. Additional capital contributions of $2,000,000 and $1,500,000 are due from each member in October 2007 and August 2008, respectively. As of November 2, 2007 neither party to the LLC has made the October 2007 scheduled contribution as the capital infusion was not needed as of that date, and both parties are discussing deferring that contribution until a later date to be agreed upon.

We believe we have sufficient cash reserves to meet all anticipated short-term operating requirements.

OFF BALANCE SHEET ARANGEMENTS

We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risk, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing and liquidity support or market risk or credit risk support to the Company.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon unaudited consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures on the date of the financial statements. On an on-going basis, we evaluate the estimates, including, but not limited to, those related to revenue recognition. We use authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. Actual results could differ from those estimates.

For further information about other critical accounting policies, see the discussion of critical accounting policies in our 2006 Form 10-K for the fiscal year ended December 31, 2006.

Acquisitions

We account for acquisitions in accordance with Statement of Financial Accounting Standards ("SFAS"), No. 141 "Business Combinations" and accordingly apply the purchase method of accounting for all business combinations initiated after September 30, 2001 and separately identify recognized intangible assets that meet certain criteria, amortizing these assets over their determinable useful lives.

During the nine months ended September 30, 2007, we implemented the following new critical accounting policy:

In December 2003, the Financial Accounting Standards Board ("FASB") issued SFAS Interpretation No. 46R, Consolidation of Variable Interest Entities ("FIN 46R). Under FIN 46R, if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. An enterprise that consolidates a variable interest entity is the primary beneficiary of the variable interest entity. FIN 46R became applicable to the Company during the six months ended June 30, 2007. See footnote 10 for more information.

Recent accounting pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No.157, "Fair Value Measurement" (FAS 157). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company has not determined the effect that the adoption of FAS 157 will have on its consolidated financial position, results of operations or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for the Company's year ending September 30, 2009. The Company is currently evaluating the impact of SFAS 159 on the Company's financial statements. Put in recent pronouncements

In June 2006, the FASB issued Interpretation No.48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109, (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes". FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of an uncertain tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN 48 provides guidance on de-recognition, statement of operations classification of interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 as of January 1, 2007, as required. The adoption of FIN 48 did not have a material impact on the Company's financial position or results of operations.

In December 2006, the FASB issued FASB Staff Position EITF 00-19-2, Accounting for Registration Payment Arrangements ("FSP EITF 00-19-2"), which provides guidance on the accounting for registration payment arrangements. FSP EITF 00-19-2 specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies. A registration payment arrangement is defined in FSP EITF 00-19-2 as an arrangement with both of the following characteristics: (1) the arrangement specifies that the issuer will endeavor (a) to file a registration statement for the resale of specified financial instruments and/or for the resale of equity shares that are issuable upon exercise or conversion of specified financial instruments and for that registration statement to be declared effective by the Securities and Exchange Commission within a specified grace period, and/or (b) to maintain the effectiveness of the registration statement for a specified period of time (or in perpetuity); and (2) the arrangement requires the issuer to transfer consideration to the counterparty if the registration statement for the resale of the financial instrument or instruments subject to the arrangement is not declared effective or if effectiveness of the registration statement is not maintained. FSP EITF 00-19-2 is effective for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to December 21, 2006. For registration payment arrangements and financial instruments subject to those arrangements that were entered into prior to the issuance of FSP EITF 00-19-2, this guidance is effective for financial statements issued for fiscal years beginning after December 15, 2006, and interim periods within those fiscal years. The adoption of FSP EITF 00-19-2 on January 1, 2007 did not have a material impact on the Company's financial position or results of operations.

About NutraCea

NutraCea is a leader in stabilized rice bran nutrient research and dietary supplement development. Through its wholly owned subsidiary, RiceX, the Company manufactures and distributes products and food ingredients made from rice bran through its proprietary technology and processes. NutraCea has developed intellectual properties to create a range of proprietary product formulations, delivery systems and whole food nutrition products. The Company’s proprietary technology enables the creation of food and nutrition products from rice bran, normally an underutilized by-product of standard rice processing. In addition to its whole foods products, NutraCea develops families of health-promoting "nutraceuticals," including natural arthritis relief and cholesterol-lowering products. More information can be found in the Company's filings with the SEC and at its Web site http://www.NutraCea.com.