10-Q 1 allergy_10q-063008.txt U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20429 --------------------------------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2008 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to _________________ Commission File Number 0-27227. -------- ALLERGY RESEARCH GROUP, INC. (Exact name of registrant as specified in its charter) Florida 13-3940486 ------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 2300 North Loop Road, Alameda, California 94502 ----------------------------------------------- (Address of principal executive offices) (Registrant's telephone number) (800) 545-9960. --------------- Check whether the issuer (1) filed all reports required to be filed by Sections 13 or 15(d) of the Exchange Act 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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller Reporting Company [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 14,666,200 shares of Issuer's voting common stock were outstanding on August 4, 2008. ALLERGY RESEARCH GROUP, INC. INDEX TO QUARTERLY REPORT ON FORM 10-Q JUNE 30, 2008 ================================================================================ PART I. FINANCIAL INFORMATION PAGE ITEM 1. Financial Statements Consolidated Balance Sheets................................... 3 Consolidated Income Statements................................ 4 Consolidated Statements of Cash Flows......................... 5 Notes to Consolidated Financial Statements.................... 6 ITEM 2. Management's Discussion and Analysis.......................... 11 ITEM 3. Quantitative and Qualitative Disclosure about Market Risk .... 19 ITEM 4T Controls and Procedures....................................... 19 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings............................................. 21 ITEM 1A Risk Factors.................................................. 21 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds... 21 ITEM 3. Defaults Upon Senior Securities............................... 21 ITEM 4. Submission of Matters to a Vote of Security Holders........... 21 ITEM 5. Other Information............................................. 21 ITEM 6. Exhibits...................................................... 21 SIGNATURE.................................................................. 22 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ALLERGY RESEARCH GROUP, INC. CONSOLIDATED BALANCE SHEETS June 30, December 31, 2008 2007 (Unaudited) (Audited) ----------- ----------- ASSETS ------ Current assets Cash and cash equivalents $ 4,242,373 $ 4,859,156 Accounts receivable, net 1,000,354 972,354 Inventories, net (Note 4) 3,313,931 2,620,337 Prepaid federal and state income taxes 162,980 1,621 Prepaid expenses and other current assets 302,468 218,447 ----------- ----------- Total current assets 9,022,106 8,671,915 ----------- ----------- Property and equipment, net 457,585 477,967 ----------- ----------- Intangible assets, net 13,180 13,180 ----------- ----------- Total assets $ 9,492,871 $ 9,163,062 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities Accounts payable $ 179,098 $ 234,531 Accrued expenses (Note 5) 386,296 262,822 Income taxes payable 2,860 130,767 Deferred tax liability 37,516 45,516 ----------- ----------- Total current liabilities 605,770 673,636 ----------- ----------- Commitments and contingencies (Note 6) Stockholders' equity Preferred stock, $.25 par value, authorized 1,000,000 shares issued and outstanding: none None None Common stock, $.001 par value, authorized 100,000,000 shares Issued: 15,105,355; Outstanding: 14,666,200 (6/30/08) and 14,463,805 (12/31/07) 15,105 15,105 Additional paid in capital 1,204,776 1,158,127 Retained earnings 8,004,215 7,666,413 Less: treasury stock, at cost 439,155 shares (6/30/08) and 641,550 (12/31/07) (336,995) (350,219) ----------- ----------- Total stockholders' equity 8,887,101 8,489,426 ----------- ----------- Total liabilities and stockholders' equity $ 9,492,871 $ 9,163,062 =========== =========== See Notes to Condensed Consolidated Financial Statements. 3 ALLERGY RESEARCH GROUP, INC. CONSOLIDATED INCOME STATEMENTS (UNAUDITED) Three Months Ended Six Months Ended June 30, June 30, 2008 2007 2008 2007 ----------- ----------- ----------- ----------- Net sales $ 4,052,183 $ 4,072,470 $ 8,485,431 $ 8,159,187 Cost of sales 2,514,184 2,482,247 5,334,309 4,988,033 ----------- ----------- ----------- ----------- Gross margin 1,537,999 1,590,223 3,151,122 3,171,154 ----------- ----------- ----------- ----------- Operating expenses Selling, general and administrative 1,361,549 1,163,245 2,559,212 2,247,553 Research and development 60,472 66,333 122,628 132,313 ----------- ----------- ----------- ----------- Total operating expenses 1,422,021 1,229,578 2,681,840 2,379,866 ----------- ----------- ----------- ----------- Earnings from operations 115,978 360,645 469,282 791,288 ----------- ----------- ----------- ----------- Other income Interest expense (94) -- (421) -- Interest income 22,026 48,052 55,349 88,409 ----------- ----------- ----------- ----------- Total other income 21,932 48,052 54,928 88,409 ----------- ----------- ----------- ----------- Earnings before income taxes 137,910 408,697 524,210 879,697 Provision for income taxes 44,608 166,581 186,408 355,672 ----------- ----------- ----------- ----------- Net earnings $ 93,302 $ 242,116 $ 337,802 $ 524,025 =========== =========== =========== =========== Basic and diluted earnings per share (Note 3) $ 0.01 $ 0.02 $ 0.02 $ 0.04 =========== =========== =========== =========== See Notes to Condensed Consolidated Financial Statements. 4 ALLERGY RESEARCH GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, 2008 2007 ----------- ----------- Cash flows from operating activities Net earnings $ 337,802 $ 524,025 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 31,941 33,957 Change in deferred taxes (8,000) (1,227) Changes in assets and liabilities (Increase) decrease in accounts receivable (28,000) 89,817 (Increase) decrease in inventory (693,594) 187,814 (Increase) decrease in prepaid expenses and other current assets (230,980) (1,870) Increase (decrease) in accounts payable and accrued expenses 68,041 255,556 Increase (decrease) in income taxes payable (127,907) 40,697 ----------- ----------- Net cash flows (used in) provided by operating activities (650,697) 1,128,769 ----------- ----------- Cash flows from investing activities Acquisition of property and equipment (11,559) (37,222) ----------- ----------- Net cash flows used in investing activities (11,559) (37,222) ----------- ----------- Cash flows from financing activities Cash paid for the acquisition of treasury shares (39,827) (80,196) Cash received from the exercise of employee stock options 85,300 16,000 ----------- ----------- Net cash flows used in financing activities 45,473 (64,196) ----------- ----------- (Decrease) increase in cash and cash equivalents (616,783) 1,027,351 Cash and cash equivalents, beginning of period 4,859,156 3,159,403 ----------- ----------- Cash and cash equivalents, end of period $ 4,242,373 $ 4,186,754 =========== =========== Supplemental noncash investing and financing activities: Cash advanced to employees for exercise of stock options $ 14,400 -- =========== =========== See Notes to Condensed Consolidated Financial Statements. 5

ALLERGY RESEARCH GROUP, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2008 (UNAUDITED) Note 1 - Basis of Presentation ------------------------------ The accompanying unaudited Consolidated Financial Statements of Allergy Research Group, Inc. ("the Company") have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. In the opinion of management, the accompanying unaudited financial statements included in this Form 10-Q reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of operations for the periods presented. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Examples include provisions for returns, accounting for income taxes, bad debts, length of product life cycles, and property, plant and equipment lives for depreciation purposes. Actual results may differ from these estimates. The results of operations for the period ended June 30, 2008 are not necessarily indicative of the operating results that may be expected for the entire year ending December 31, 2008. These financial statements should be read in conjunction with the financial statements included in the Company's Annual Report on Form 10-KSB as of and for the year ended December 31, 2007, filed with the Securities and Exchange Commission ("SEC") on March 31, 2008. The consolidated financial statements include the accounts of Allergy Research Group, Inc. and its subsidiary. All significant intercompany transactions and balances have been eliminated. Note 2 - Recent Accounting Pronouncements ----------------------------------------- In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," ("SFAS 141(R)"). This Statement replaces the original FASB Statement No. 141. This Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting (which Statement 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. The objective of this SFAS 141(R) is to improve the relevance and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. To accomplish that, SFAS 141(R) establishes principles and requirements for how the acquirer: (1) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (2) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (3) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and may not be applied before that date. The Company does not currently expect the new standard to have any material impact on its financial statements. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51" ("SFAS 160"). This Statement amends the original Accounting Review Board (ARB) No. 51 "Consolidated Financial Statements" to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and may not be applied before that date. The Company does not currently expect the new standard to have any material impact on its financial statements. 6 In March 2008, the FASB issued SFAS No. 161, "DISCLOSURES ABOUT DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES-AN AMENDMENT OF FASB STATEMENT NO. 133" ("SFAS 161"). SFAS 161 requires enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial reporting. Under SFAS 161, entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedge items are accounted for under SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 133"), and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 must be applied prospectively to all derivative instruments and non-derivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under SFAS 133 for all financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not currently expect the new standard to have any material impact on its financial statements. In April 2008, the FASB issued Staff Position ("FSP") No. 142-3 "DETERMINATION OF THE USEFUL LIFE OF INTANGIBLE ASSETS ("FSP NO. 142-3"). FSP No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142 "GOODWILL AND OTHER INTANGIBLE ASSETS". FSP No. 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The Company does not currently expect the new standard to have any material impact on its financial statements. In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). Statement 162 will become effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." We do not expect the adoption of SFAS 162 to have a material effect on our consolidated results of operations and financial condition. In May 2008, the FASB issued FSP Accounting Principles Board ("APB") 14-1 "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer's non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis. We do not expect the adoption of FSP APB 14-1 to have any effect on our consolidated results of operations and financial condition. In May 2008, FASB issued Financial Accounting Standards No. 163, "Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60." Diversity exists in practice in accounting for financial guarantee insurance contracts by insurance enterprises under FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises. That diversity results in inconsistencies in the recognition and measurement of claim liabilities because of differing views about when a loss has been incurred under FASB Statement No. 5, Accounting for Contingencies. This Statement requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Those clarifications will increase comparability in financial reporting of financial guarantee insurance contracts by insurance enterprises. This Statement requires expanded disclosures about financial guarantee insurance contracts. The accounting and disclosure requirements of the Statement will improve the quality of information provided to users of financial statements. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. We do not expect the adoption of SFAS 163 to have any effect on our consolidated results of operations and financial condition. Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force ("EITF")), the American Institute of Certified Public Accountants ("AICPA"), and the SEC did not or are not believed by management to have a material impact on the Company's present or future financial statements. 7 Note 3 - Earnings Per Share --------------------------- Basic earnings per share ("EPS") is based on the weighted average number of common shares outstanding. Diluted EPS is based on the weighted average number of common shares outstanding and dilutive common stock equivalents. The computation of basic and diluted earnings per share is as follows: Three Months Three Months Six Months Six Months Ended Ended Ended Ended 6/30/08 6/30/07 6/30/08 6/30/07 ----------- ----------- ----------- ----------- Numerator-net earnings $ 93,302 $ 242,116 $ 337,802 $ 524,025 =========== =========== =========== =========== Denominator: Weighted average shares used in computing basic EPS 14,556,703 14,546,315 14,498,671 14,534,029 Net effect of dilutive common shares -- 149,976 -- 159,752 ----------- ----------- ----------- ----------- Weighted average shares used in computing diluted EPS 14,556,703 14,696,291 14,498,671 14,693,781 Basic earnings per share $ 0.01 $ 0.02 $ 0.02 $ 0.04 =========== =========== =========== =========== Diluted earnings per share $ 0.01 $ 0.02 $ 0.02 $ 0.04 =========== =========== =========== ===========

Note 4 - Inventories -------------------- Inventories consist of the following: June 30, 2008 December 31, 2007 ------------- ----------------- Raw materials $ 1,474,547 $ 1,719,426 Finished goods 1,734,460 842,700 Supplies 154,924 108,211 Reserve for obsolescence (50,000) (50,000) ----------- ----------- $ 3,313,931 $ 2,620,337 =========== =========== Note 5 - Accrued Expenses ------------------------- Accrued expenses consist of the following: June 30, 2008 December 31, 2007 ------------- ----------------- Operating expenses $ 97,251 $ 167,719 Vacation and bonus 251,000 48,000 Payroll 35,214 40,614 Sales tax 2,831 6,489 ------------ ------------ $ 386,296 $ 262,822 ============ ============ Note 6 - Commitments and Contingencies -------------------------------------- Line of Credit The Company has a Merrill Lynch Working Capital Management Account (WCMA) which provides for a line of credit up to $1,500,000 bearing interest at the London Interbank Offered Rate (LIBOR) plus 2.75%, due monthly. The LIBOR plus 2.75% at June 30, 2008 was 5.22%. The note is secured by substantially all of the assets of the Company. The WCMA immediately pays down the line of credit when deposits are received. When checks are issued, the line of credit is utilized if no cash is available. If the line of credit has a zero balance, the WCMA pays interest on deposits at Merrill Lynch's money market rate, which as of June 30, 2008 was 2.47%. The entire line was available for use as of June 30, 2008. 8 Purchase Obligations As of June 30, 2008, the Company had inventory purchase obligations incurred in the normal course of business of $1,026,929 representing outstanding purchase orders for inventory. Operating Lease (A Related Party Transaction) On January 4, 2005, the Company entered into a lease with AriBen Corporation, a related party 100% owned by Susan and Stephen Levine, the Company's Vice President and CEO/CFO, respectively, and collectively, as husband and wife, the majority stockholders of the Company, for approximately 29,821 square feet of office and industrial space. The lease, which has a term of ten years with options to renew for two subsequent periods of ten and five years, respectively, has a base monthly rent of $24,000 for the initial period, $30,000 for the first option period and $35,000 for the second option period. Rent will be adjusted annually during the second five years of each 10-year lease period based on the consumer price index, with a minimum increase of three percent. No security deposit was required under the lease. Rent expense charged to operations during the second quarter of 2008 was $72,000 (2007: $72,000). Future minimum rental commitments under non-cancelable leases for the next five years are $288,000 per year. Asserted and Unasserted Claims From time to time the Company is subject to certain asserted and unasserted claims encountered in the normal course of business. It is the Company's belief that the resolution of these matters will not have a material adverse effect on our financial position or results of operations; however, we cannot provide assurance that damages resulting in a material adverse effect on our financial position or results of operations will not be imposed in these matters. The Company accounts for contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. On or about November 1, 2007, Steven and Kimberly Bronson (the "Bronsons") filed a Complaint for Court-Ordered Inspection of Corporate Records with the Circuit Court of the 15th Judicial District in and for Palm Beach, Florida. The complaint alleges that the Bronsons are entitled to inspect and make copies of corporate and accounting records of the Company which are not publicly available. The request for inspection submitted by the Bronsons was denied by the Company based on the inability of the Company to disclose these records without violating Regulation FD of the Securities Exchange Act of 1934, as amended, and because of the prior publication of correspondence and documents exchanged between the Company and the Bronsons by Mr. Bronson. It is also our position that Mr. Bronson is not entitled to obtain these records because the purposes stated can be satisfied through information which has already been made publicly available by the Company. This is not a damage lawsuit, but a books and records proceeding, where the Bronsons attempt to obtain access to certain books and records of the company. We intend to vigorously defend against this action. No adjustments were made to our consolidated financial statements for the outcome of this uncertainty. In March 2006, the Company received a summons from the United States District Court for the District of Colorado in an action filed by Pure Research Products, LLC, a division of J.A. Sichel & Associates. The complaint alleges that the Company violated certain trademarks and exclusive license rights held by Pure Research Products, LLC during negotiations between the parties and following the dissolution of those negotiations. The plaintiff in the action is seeking various forms of injunctive relief against the Company as well as damages to be proven at trial. The complaint includes a request for treble damages in the event the plaintiff is successful. We have made a motion for summary judgment regarding the claims. We intend to vigorously defend against the allegations and have countersued for breach of contract. Because we believe that the plaintiff's claim has no merit, no adjustments were made to our consolidated financial statements for the outcome of this uncertainty. 9 Note 7 - Concentration of Credit Risk ------------------------------------- The Company is subject to a wide variety of risks in the ordinary course of its business, including concentration of sales and vendors, as follows: SALES. There were three customers that each accounted for more than 10% of the Company's ending trade receivables balance at June 30, 2008. Trade receivables from these three customers totaled approximately $517,000. All of the Company's trade receivables are unsecured. Approximately 12% of the Company's total sales for the six months ended June 30, 2008 (2007: 13%) were attributable to the same single distributor. In the event the Company were to lose that account, management anticipates that it would be able to convert the business to sales directly to the customers of that distributor. As converted sales would be at a higher margin, management does not believe the loss of the account would have a material negative impact on sales. However, no assurance can be given that, if the Company were to lose this distributor, all or any of the customers would transfer directly to the Company or that current sales from this group would be maintained at current levels. PURCHASES. The Company purchases raw materials and uses outside vendors for the manufacture of its products. For the six months ended June 30, 2008, the Company had a concentration of approximately 41% of manufacturing with three separate vendors, who individually account for more than ten percent of our purchases. For the six months ended June 30, 2007, the Company had a concentration of approximately 50% of manufacturing with three separate vendors, who individually accounted for more than ten percent of our purchases. The Company does not currently have written contracts with any of its manufacturers, but relies on long-term personal and professional relationships. Management believes that, due to the large number of businesses performing this type of service in the industry, it would have little difficulty in finding viable alternatives in the event any one of these vendors became unable or determined not to continue manufacturing the Company's products. However, there can be no assurance that suitable, alternative manufacturers would be available to the Company when needed or that such alternative manufacturers would not result in an increase in costs or a change in the quality of the Company's products. PRODUCT. None of the Company's products for the six months ended June 30, 2008 or 2007 individually accounted for more than 10% of its sales dollars. Note 8 - Stockholders' Equity ----------------------------- COMMON STOCK: The Company has authorized 1,000,000 shares of common stock for issuance to key employees under the 1998 Stock Option Plan (the "plan"). The objectives of the plan include attracting and retaining the best personnel, providing for additional performance incentives, and promoting the success of the Company by providing key employees the opportunity to acquire common stock under the plan. The following is a summary of stock option transactions: Shares under Weighted Average option Exercise Price ------------- -------------- Oustanding - 12/31/07 293,750 $0.40 Exercised (249.250) $0.40 Forfeited (10,000) $0.40 Granted -- -- ------------- ------------ Outstanding - 6/30/08 -- -- ============= ============ During the six months ended June 30, 2008, employee stock options were exercised for the purchase of 249,250 shares of common stock at $.40 per share for cash proceeds of $85,300 and 13-month loans to non-officer employees of $14,400 with interest set at the company's borrowing rate as of May 12, 2008 (5.34%). As part of the loan agreement, the shares are held as collateral until the loan is paid in full. Of the options exercised on May 12, 2008, 5,000 of the shares that were issued were relinquished a few days later and the related loan to the employee was canceled. The exercise was considered canceled and the options were accounted for as forfeited. Upon exercise, anyone with material financial information signed an agreement which prohibits trading of the shares issued for six months. 10 TREASURY STOCK. The Company acquired 46,855 shares of outstanding common stock at $0.85 per share for an aggregate purchase price of $39,827 from an unrelated party on February 15, 2008. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION INTRODUCTION ------------ Management's discussion and analysis of results of operations and financial condition ("MD&A") is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of Allergy Research Group, Inc.'s (the "Company") financial condition, changes in financial condition and results of operations. The MD&A is organized as follows: o CAUTION CONCERNING FORWARD-LOOKING STATEMENTS AND RISK FACTORS. This section discusses how certain forward-looking statements made by the Company throughout the MD&A and in the consolidated financial statements are based on our present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances. o OVERVIEW. This section provides a general description of the Company's business, as well as recent developments that we believe are important in understanding the results of operations and to anticipate future trends in those operations. o RESULTS OF OPERATIONS. This section provides an analysis of our results of operations for the six-month period ended June 30, 2008 compared to the same period in 2007. A brief description is provided of transactions and events that impact the comparability of the results being analyzed. o LIQUIDITY AND CAPITAL RESOURCES. This section provides an analysis of our financial condition and cash flows as of and for the six months ended June 30, 2008, including related party transactions. o CRITICAL ACCOUNTING POLICIES. This section provides an analysis of the significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS AND RISK FACTORS -------------------------------------------------------------- The following discussion should be read in conjunction with the Company's financial statements and the notes thereto and the other financial information appearing elsewhere in this document. In addition to historical information, the following discussion and other parts of this document contain certain forward-looking information. When used in this discussion, the words "believes," "anticipates," "expects," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected due to a number of factors beyond our control. The Company does not undertake to publicly update or revise any of its forward-looking statements even if experience or future changes show that the indicated results or events will not be realized. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. You are also urged to carefully review and consider our discussions regarding the various factors that affect our business, included in this section and elsewhere in this report. In June 2007, the Food and Drug Administration announced a final rule establishing regulations to require current good manufacturing practices ("cGMP") for dietary supplements. The regulations establish the cGMP needed to ensure quality throughout the manufacturing, packaging, labeling, and storing of dietary supplements. The final rule includes requirements for establishing quality control procedures, designing and constructing manufacturing plants, and testing ingredients and the finished product. It also includes requirements for recordkeeping and handling consumer product complaints. The rule has a three-year phase in period for small business with companies of our size having until June 2009 to comply. We are currently evaluating the potential impact of the packaging, labeling and storing portions of the regulations on our financial 11 statements and operations. Because we do not currently manufacture our vitamin and nutritional supplement products, our outside vendors will be required to comply with all applicable governmental regulations, including cGMP. It is possible that our manufacturers and vendors will pass on the cost of compliance with these regulations by raising their prices. In that event, we would need to evaluate the competitive market to determine whether those costs can be passed on to our own customers. If not, increased prices from our manufacturers and vendors may adversely affect our own profit margins. In July 2005, the Codex Alimentarius Commission adopted Guidelines for Vitamin and Mineral Food Supplements (the "Guidelines"). The Guidelines only apply to supplements that contain vitamins and minerals that are regulated as foods. The Guidelines provide criteria for establishing maximum amounts of vitamins and minerals per daily portion of the supplement as recommended by the manufacturer. They also address the packaging and labeling of supplements. The restrictions are expected to lower the dosage of U.S.-manufactured products to standards set by foreign jurisdictions. The FDA has stated that the Codex Guidelines will not affect the availability of supplement products to U.S. consumers. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can we determine what effect additional governmental regulations or administrative orders, when and if promulgated, would have on the Company's business in the future. They could require the reformulation of certain products to meet new standards, the recall or discontinuance of certain products not capable of reformulation, additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling, and/or scientific substantiation. Any or all of such requirements could have a material adverse effect on our results of operations and financial condition. Currently, we do not believe that compliance with the provisions of national, state and local environmental laws and regulations will have a material adverse effect upon the capital expenditures, earnings, financial position, liquidity or competitive position of the Company. We face an inherent risk of exposure to product liability claims in the event that the use of our products results in injury. Such claims may include, among others, that our products contain contaminants or include inadequate instructions as to use or inadequate warnings concerning side effects and interactions with other substances. We do not anticipate obtaining contractual indemnification from parties supplying raw materials or marketing our products. In any event, any such indemnification if obtained would be limited by our terms and, as a practical matter, to the creditworthiness of the indemnifying party. In the event that we do not have adequate insurance or contractual indemnification, product liabilities relating to defective products could have a material adverse effect on our operations and financial condition. Because of our dependence upon consumer perceptions, adverse publicity associated with illness or other adverse effects resulting from the consumption of our products or any similar products distributed by other companies could have a material adverse effect on our operations. Such adverse publicity could arise even if the adverse effects associated with such products resulted from consumers' failure to consume such products as directed. In addition, we may not be able to counter the effects of negative publicity concerning the efficacy of our products. Any such occurrence could have a negative effect on our operations. Other key factors that affect our operating results are as follows: o Overall customer demand for our various products. o Volume of products ordered. o Mix of products purchased by our customers. o Prices at which we sell our products. o Our ability to manage our cost structure for capital expenditures and operating expenses such as salaries and benefits, freight and royalties. o Our ability to match operating costs to shifting volume levels. o Increases in the cost of raw materials and other supplies, which may impact pricing and our ability to compete or result in lower profit margins if prices are not raised on related products. o The impact of competitive products. o Adequacy and availability of insurance coverage. o Our inability to gain and/or hold market share. o Exposure to and expense of resolving and defending product liability claims and other litigation. o Consumer acceptance of our products. o Managing and maintaining growth. o Customer demands and changes in industry trends. 12 o Market and industry conditions including pricing, demand for products, levels of trade inventories and raw materials availability and changes in applicable laws and government regulation. o The success of product development and new product introductions into the marketplace. o Slow or negative growth in the nutritional supplement industry. o The departure of key members of management. o Our ability to efficiently manufacture our products. o Unexpected customer bankruptcy. o Our board of directors is not independent. On July 21, 2008 we added an additional independent director making fifty percent of the board independent. o Limitations on future financing. o Increases in the cost of borrowings and unavailability of debt or equity capital. o Costs of implementing internal financial controls required by Section 404 of the Sarbanes-Oxley Act of 2002. o Costs of compliance with new cGMP regulations. OVERVIEW -------- BUSINESS DESCRIPTION. Allergy Research Group, Inc. (SYMBOL: ALRG) (the "Company" or "ARG"), together with its wholly-owned subsidiary, Nutricology, Inc., strives to be an innovative leader in nutraceutical research and product formulation. Our common stock is traded on the Financial Industry Regulatory Authority's ("FINRA") Over-The-Counter Bulletin Board. Since 1980, we have produced quality, hypoallergenic nutritional supplements and supplied products to physicians and health care practitioners worldwide. We develop, contract manufacture, market and sell vitamins and nutritional supplements throughout the world under the NutriCology(R) and Allergy Research Group(R) labels. Our products are distributed through distributors to medical and professional accounts, retail stores, and directly to consumers. We offer a line of approximately 280 products, including vitamins in both multivitamin and single-entity formulas, minerals, and herbals. Our products are manufactured in various forms, including capsules, tablets, softgels, powders (drink mixes) and liquids. We also distribute certain third-party manufactured products under our labels. These products account for approximately 20% of all products offered by the Company. Our principal executive offices are located at 2300 North Loop Road, Alameda, California 94502 and our telephone number is (800) 545-9960. FUTURE OPERATIONS. The success of our future operations will depend to a great extent on the operations, financial condition, and management of the Company. We intend to expand our position in the vitamin and nutritional supplements markets. Specifically, our strategy continues to be to: (i) develop new brands and product line extensions, as well as new products, through our commitment to research and development; (ii) continue the growth of our balanced distribution network; (iii) build our execution skills through new operations processes and decision support systems; (iv) achieve cost superiority through formal productivity benchmarking and continuous improvement programs; and (v) continue to improve upon our comprehensive e-commerce plan, which includes a user-friendly and marketing-driven website that has the ability to accommodate wholesale orders. We believe that our history and reputation in the field, multiple distribution channels, broad portfolio of products and packaging and distribution capabilities position us to be a long-term competitor in the vitamin and nutritional supplements industries. We are still collaborating with several entrepreneurs of cutting-edge science-based products, who have limited resources to bring their products to market. We look towards working partnerships and/or acquisition of these businesses to broaden our product line of innovative nutraceuticals. There is potential for real growth in sales and profit while providing products that promote general health. The Company's distribution channel to the medical and professional-practitioners market is key to the successful introduction of unique products. We believe that the Company has good relations with all of its current manufacturers and suppliers. We do not currently have written contracts with any of our manufacturers, but rely on long-term personal and professional relationships with our vendors. We believe that, due to the large number of businesses performing this type of service in the industry, the Company would have little difficulty in finding viable alternatives in the event any one of these vendors became unable or determined not to continue manufacturing our products. Of course, we can give no assurance that this would be the case. 13 RESULTS OF OPERATIONS Please refer to the consolidated financial statements, which are a part of this report, for further information regarding the results of operations of the Company. PERIOD ENDED JUNE 30, 2008 COMPARED TO JUNE 30, 2007 RESULTS OF OPERATIONS The following table and discussion is a summary of our consolidated results of operations: Three months ended June 30, Six months ended June 30, --------------------------- ------------------------- $ % $ % Change Change Change Change from from from from 2008 2007 2007* 2007* 2008 2007 2007* 2007* Revenues $4,052,183 $4,072,470 -20,287 -0% $8,485,431 $8,159,187 +326,244 +4% Cost of sales 2,514,184 2,482,247 -31,937 -1% 5,334,309 4,988,033 -346,276 -7% --------- --------- --------- --------- Gross profit 1,537,999 1,590,223 3,151,122 3,171,154 --------- --------- --------- --------- Gross profit as a % of sales 38.0% 39.0% 37.1% 38.9% Operating expenses: Selling, general and Administrative 1,361,549 1,163,245 -198,304 -17% 2,559,212 2,247,553 -311,659 -14% Research and development 60,472 66,333 +5,861 +9% 122,628 132,313 +9,685 +7% ------ ------ ------- ------- Operating expenses 1,422,021 1,229,578 -192,443 -16% 2,681,840 2,379,866 -301,974 -13% --------- --------- --------- --------- Earnings from operations 115,978 360,645 469,282 791,288 Interest expense (94) -94 (421) -421 Interest income 22,026 48,052 -26,026 -54% 55,349 88,409 -33,060 -37% ------ ------ ------ ------ Net earnings before tax 137,910 408,697 524,210 879,697 Provision for income tax 44,608 166,581 +121,973 +73% 186,408 355,672 +169,264 +48% ------ ------- ------- ------- Net earnings $93,302 $242,116 -148,814 -61% $337,802 $524,025 -186,223 -36% ======= ======== ======== ========

__________________ * + = Favorable change to NET EARNINGS; - = Unfavorable change to NET EARNINGS. REVENUES. Our revenues decreased slightly during the second quarter of 2008 and increased at a modest rate during the first six months of the year. The year-to-date increase was driven by increased sales to our wholesale customers and to distributors. We attribute the increase in sales to a combination of the results of our promotional efforts and the upward trend in ordering patterns of the distributors. COSTS OF SALES. Cost of sales increased for the six-month period as a direct result of the increase in sales compounded by increased cost of materials. We continue to make a concerted effort to determine that our manufacturers are maintaining the high standards we and our customers expect. We expect our cost of sales as a percentage of net sales to fluctuate somewhat as our product mix fluctuates. Gross profit margins decreased for the period over period comparison primarily as a result of increased sales to distributors at lower margins than retail customers or wholesale accounts and increased costs of certain raw materials. Beginning July 1, 2008 we raised the prices of our products in order to maintain our margins. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses consist primarily of costs associated with our executive, financial, human resources, and customer account management functions such as compensation costs, including benefits, facilities-related expenses, advertising and promotions of our products, including our attendance at tradeshows, and outside professional services such as legal and accounting. Selling, general and administrative expenses increased during the quarter and the six -month period primarily due to increased legal fees and costs associated with pending lawsuits, increased payroll expenses associated with the addition of a graphic artist and technical support position, and increased medical 14 insurance costs. We anticipate that selling, general and administrative expenses will continue to increase over the long term as our business continues to grow and the costs associated with being a public company continue to increase as a result of our required reporting requirements, including but not limited to expenses incurred to comply with the Sarbanes-Oxley Act of 2002 (including, among other things, compliance with Item 404 financial controls). RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased slightly due to a reallocation of resources. However, we anticipate that research and development expense could increase over the long term as a result of the growth of the products we offer, new product opportunities and our continued efforts to invest in the future and strengthen our position within the nutritional and supplement market. INTEREST INCOME. Due to our decreased cash balance, decrease in interest rates and because we placed excess cash in lower yielding Merrill Lynch institutional tax-exempt funds, we experienced a decrease in interest income. PROVISION FOR INCOME TAXES. Provision for income taxes represents federal and state income taxes based on earnings and changes to deferred taxes. NET EARNINGS. Net earnings decreased due to the increase in general and administrative expenses. SEASONALITY. Historically, we have experienced little seasonal fluctuation in revenues; however, during the spring and fall we traditionally attend two trade shows geared toward the retail market. Show discounts are offered and the retail distributors tend to purchase higher quantities due to the discounts. We attend trade shows geared toward the professional market throughout the year, but the shows are smaller and tend to not have an immediate effect on sales. These shows are useful because they provide personal contact with the professional market and potentially increase sales in the long run. As of June 30, 2008, to the best of our knowledge, no known trends or demands, commitments, events or uncertainties, except as discussed below, have existed which will have a material effect on our liquidity. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Current Financial Condition During the six-month period ended June 30, 2008, our working capital increased by approximately $418,057 to $8,416,336, compared to a working capital at December 31, 2007 of $7,998,279. Current assets mainly consist of approximately $4.24 million in cash, $1.00 million in accounts receivable, and $3.31 million in inventory. We continue to finance our inventory and accounts receivable through cash generated by operating activities. We believe that the Company's operating cash flow, cash and cash equivalents, and borrowing capacity under committed bank credit agreements is sufficient to fund our capital and liquidity needs for the next twelve months. Off-Balance Sheet Arrangements At June 30, 2008, we did not have any relationship with unconsolidated entities or financial partnerships which other companies have established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. Cash Flows OPERATING ACTIVITIES. Net cash provided by operating activities for both periods primarily reflects net earnings and net changes in operating assets and liabilities such as accounts receivable, inventory and accounts payable. Cash used by operating activities in 2008 was used to increase inventory levels to take advantage of favorable pricing and to buy ahead to ensure availability on certain imported items, increased prepaid assets due to tax payments and by a decrease in income taxes payable offset by an increase in accounts payable and accrued liabilities. Cash generated by operating activities for 2007 was primarily a result of a decrease in inventory levels due to the utilization of inventory on hand, an increase in accounts payable due to the overall varied timing of payments and purchases, and increases in accrued expenses because bonuses are paid at the end of the previous year. 15 INVESTING ACTIVITIES. Net cash flows used in investing activities for the six months ended June 30, 2008 resulted from cash paid to replace a damaged air compressor. Net cash flows used in investing activities for the six months ended June 30, 2007 resulted from payments for a new label printer and a new server. FINANCING ACTIVITIES. Net cash flows provided by financing activities for the six months ended June 30, 2008 represents proceeds from the exercise of stock options of $85,300 offset by $39,827 in cash paid for the purchase of 46,855 shares of our common stock from one of our unaffiliated shareholders. Net cash flows used by financing activities for the six months ended June 30, 2007 represents $80,196 in cash paid for the purchase of 97,800 shares of our common stock offset by cash proceeds received of $16,000 for exercise of employee stock options. There were no cash flows from financing activities during 2006. CONCENTRATION OF RISK The Company is subject to a wide variety of risks in the ordinary course of its business. Some of the more significant of these risks include heavy concentrations of sales with a few key customers; heavy concentrations of raw material purchases with a few key suppliers; regulation by various federal, state and local agencies with regards to the manufacture, handling, storage and safety of products; and regulation by various agencies with regards to the labeling and certification of products. The Company is also subject to competition from other nutritional supplement companies and is dependent on the continued demand for nutritional supplements by consumers. SALES. Approximately 12% of our total sales for the six months ended June 30, 2008 (2007: 13%) were attributable to the same single distributor. In the event we were to lose that account, we anticipate that we would be able to convert the business to sales directly to the customers of that distributor. As converted sales would be at a higher margin, we do not believe the loss of the account would have a material negative impact on sales. However, we cannot assure you that, if we were to lose this distributor, all or any of the customers would transfer directly to us or that current sales from this group would be maintained at current levels. PURCHASES. We purchase raw materials and use outside vendors for the manufacture of our products. For the six months ended June 30, 2008, we had a concentration of approximately 41% of our manufacturing with three separate vendors who individually account for more than ten percent of our purchases. For the six months ended June 30, 2007, the Company had a concentration of approximately 50% of manufacturing with three separate vendors, who individually accounted for more than ten percent of our purchases. We do not currently have written contracts with any of our manufacturers, but rely on long-term personal and professional relationships. We believe that, due to the large number of businesses performing this type of service in the industry, we would have little difficulty in finding viable alternatives in the event any one of these vendors became unable or decided not to continue manufacturing our products. However, we can give no assurance that suitable, alternative manufacturers would be available to us when needed or that such alternative manufacturers would not result in an increase in costs. PRODUCT. None of our products in 2008 or 2007 individually accounted for more than ten percent of our sales dollars. 16 CONTRACTUAL OBLIGATIONS. The Company's Contractual Obligations and Commercial Commitments are detailed below: ------------------------------ --------------------------------------------------------------------------- Contractual Obligations Payments Due by Period ------------------------------ --------------------------------------------------------------------------- Less Than 1 1-3 4 - 5 After 5 Total Year Years Years Years ------------------------------ --------------- --------------- -------------- -------------- ------------- Line of Credit (1) - - - - - ------------------------------ --------------- --------------- -------------- -------------- ------------- Operating Leases (2) $1,980,000 $288,000 $864,000 $576,000 $252,000 ------------------------------ --------------- --------------- -------------- -------------- ------------- Purchase Obligations (3) $1,026,929 1,026,929 - - - ------------------------------ --------------- --------------- -------------- -------------- ------------- Total Cash Contractual Obligations $3,006,929 $1,314,929 $864,000 $576,000 $252,000 ------------------------------ --------------- --------------- -------------- -------------- -------------

(1) This represents the Company's borrowings under its line of credit with Merrill Lynch, which had a zero balance as of June 30, 2008. The line was used briefly in April 2008 due to timing for the liquidation of investments. The Merrill Lynch line of credit provides for maximum financing of $1,500,000, bearing interest at the London Interbank Offered Rate (LIBOR) plus 2.75%, computed on a monthly basis. As of June 30, 2008, the interest rate on the line of credit was 5.22% per annum. Because the line of credit is secured by substantially all of the assets of the Company, if the Company were to fall into default under the terms of our agreement with Merrill Lynch it could have material adverse impact on our business and financial position. (2) Represents our building lease with AriBen Corporation, a related party. See "Related Party Transactions" below. The current monthly obligation for the base rent on the lease is $24,000 for approximately 29,821 square feet. (3) Represents outstanding purchase orders for inventory. RELATED PARTY TRANSACTIONS. Dr. Stephen Levine, the Company's Chief Executive Officer, Chief Financial Officer and Chairman of the Board of Directors, and Susan Levine, the Company's Vice President and Secretary, are husband and wife. On January 4, 2005, we entered into a lease with AriBen Corporation, a related party 100% owned by Susan and Stephen Levine, for approximately 29,821 square feet of office and industrial space. The lease, which has a term of ten years with options to renew for two subsequent periods of ten and five years, respectively, has a base monthly rent of $24,000 for the initial period, $30,000 for the first option period and $35,000 for the second option period. Rent will be adjusted annually during the second five years of each 10-year lease period based on the consumer price index, with a minimum increase of three percent. No security deposit was required under the lease. LIQUIDITY RESOURCES. We have approximately $4.24 million in cash and cash equivalents as of June 30, 2008, which we believe is sufficient to satisfy our cash requirements over the next twelve months without use of our available line of credit based our current operating levels. Our future funding requirements will depend on numerous factors, some of which are beyond our control. These factors include our ability to operate profitably, our ability to maintain, recruit and train management and personnel, legal fees and costs associated with ongoing litigation and our ability to compete with other, better-capitalized and more established competitors who offer alternative or similar products. We believe that, given our positive working capital position, we can satisfy our cash requirements over the next twelve months from operations if we continue to operate at a profit. Cash flow from operations is expected to provide us with our capital resources and liquidity needs. The Company expects to continue to purchase equipment and hire new employees as is commensurate with the growth of the business. In addition, we will continue to invest time and effort in research for product development. We know of no trends that are expected to affect the cost of labor or materials, and sales are expected to be stable over the next twelve months. See "CAUTION CONCERNING FORWARD-LOOKING STATEMENTS/RISK FACTORS" above for some of the other variables that may affect our business and financial results. 17 CRITICAL ACCOUNTING POLICIES ---------------------------- Our discussion and analysis is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our consolidated financial statements; however, management does not consider any of the estimates and assumptions to be highly uncertain. INCOME TAXES SFAS 109, ACCOUNTING FOR INCOME TAXES, establishes financial accounting and reporting standards for the effect of income taxes. Accruals for uncertain tax positions are provided for in accordance with the requirements of FIN 48. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations. ALLOWANCE FOR DOUBTFUL ACCOUNTS We evaluate the collectibility of our trade receivables based on a combination of factors. We regularly analyze our significant customer accounts, and, when we become aware of a specific customer's inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer's operating results or financial position, we record a specific reserve for bad debt to reduce the related receivable to the amount we reasonably believe is collectible. The allowances are calculated based on detailed review of certain individual customer accounts, historical rates and an estimation of the overall economic conditions affecting our customer base. We review a customer's credit history before extending credit. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. In the event that our trade receivables become uncollectible, we would be forced to record additional adjustments to receivables to reflect the amounts at net realizable value. The accounting effect of this entry would be a charge to earnings, thereby reducing our net earnings. Although we consider the likelihood of this occurrence to be remote based on past history and the current status of our accounts, there is a possibility of this occurrence. 18 INVENTORY Our inventory purchases and commitments are made in order to build inventory to meet future shipment schedules based on forecasted demand for our products. We perform a detailed assessment of inventory for each period, which includes a review of, among other factors, demand requirements, product life cycle and development plans, component cost trends, product pricing and quality issues. Based on this analysis, we record adjustments to inventory for excess, obsolescence or impairment, when appropriate, to reflect inventory at net realizable value. Revisions to our inventory adjustments may be required if actual demand, component costs or product life cycles differ from our estimates. In the event we were unable to sell our products, the demand for our products diminished, other competitors offered similar or better products, and/or the product life cycles deteriorated causing quality issues, we would be forced to record an adjustment to inventory for impairment or obsolescence to reflect inventory at net realizable value. The effect of this entry would be a charge to earnings, thereby reducing our net earnings. Although we consider the likelihood of this occurrence to be remote based on our forecasted demand for our products, there is a possibility of this occurrence. CONTINGENCIES From time to time, we are involved in disputes, litigation and other legal proceedings and the outcomes of potential legal proceedings and claims brought against us are subject to significant uncertainty. SFAS 5, ACCOUNTING FOR CONTINGENCIES, requires that an estimated loss from a loss contingency such as a legal proceeding or claim should be accrued by a charge to earnings if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. However, the actual liability in any such litigation may be materially different from our estimates, which could result in the need to record additional costs. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations. See Part II, Item 1 of this report entitled "LEGAL PROCEEDINGS" for a description of ongoing litigation and related accounting adjustments. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK This disclosure is not required for smaller reporting companies. ITEM 4T. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Based on the management's evaluation (with the participation of our President and Chief Financial Officer), our President and Chief Financial Officer has concluded that as of June 30, 2008, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange of 1934 (the "Exchange Act") are effective to provide reasonable assurance that the information required to be disclosed in this quarterly report on Form 10-Q is recorded, processed, summarized and reported within the time period specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. 19 (b) Internal control over financial reporting MANAGEMENT'S QUARTERLY REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting should include those policies and procedures that: (0) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (0) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and the Board of Directors; and (0) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Under the supervision and with the participation of our management, including Stephen Levine, our Chief Executive Officer and Chief Financial Officer; Fred Salomon, our President and Laura Johnson, our Controller, We have evaluated the effectiveness of our internal control over financial reporting and preparation of our quarterly financial statements as of June 30, 2008 and believe they are effective. While we believe the present control design and procedures are effective, future events affecting our business may cause the Company to modify its controls and procedures. ATTESTATION REPORT OF THE REGISTERED PUBLIC ACCOUNTING FIRM This quarterly report does not include an attestation report of the company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this quarterly report. CHANGES IN INTERNAL CONTROLS Based on the evaluation as of June 30, 2008, Stephen Levine our Chief Executive Officer and Chief Financial Officer has concluded that there were no significant changes in our internal controls over financial reporting or in any other areas that could significantly affect our internal controls subsequent to the date of his most recent evaluation and there were no corrective actions during the quarter with regard to significant deficiencies or material weaknesses. 20 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On or about November 1, 2007, Steven and Kimberly Bronson filed a Complaint for Court-Ordered Inspection of Corporate Records with the Circuit Court of the 15th Judicial District in and for Palm Beach, Florida. The complaint alleges that the Bronsons are entitled to inspect and make copies of corporate and accounting records of the Company which are not publicly available. The request for inspection submitted by the Bronsons was denied by the Company based on the inability of the Company to disclose these records without violating Regulation FD of the Securities Exchange Act of 1934, as amended, and because of the prior publication of correspondence and documents exchanged between the Company and the Bronsons by Mr. Bronson. It is also our position that Mr. Bronson is not entitled to obtain these records because the purposes stated can be satisfied through information which has already been made publicly available by the Company. This is not a damage lawsuit, but a books and records proceeding, where the Bronsons attempt to obtain access to certain books and records of the Company. We intend to vigorously defend against this action. No adjustments were made to our consolidated financial statements for the outcome of this uncertainty. In March 2006, the Company received a summons from the United States District Court for the District of Colorado in an action filed by Pure Research Products, LLC, a division of J.A. Sichel & Associates. The complaint alleges that the Company violated certain trademarks and exclusive license rights held by Pure Research Products, LLC during negotiations between the parties and following the dissolution of those negotiations. The plaintiff in the action is seeking various forms of injunctive relief against the Company as well as damages to be proven at trial. The complaint includes a request for treble damages in the event the plaintiff is successful. We have made a motion for summary judgment regarding the claims. The Company intends to vigorously defend itself against the allegations and is countersuing for breach of contract. Because the Company believes that the plaintiff's claim has no merit, no adjustments were made to our consolidated financial statements for the outcome of this uncertainty. ITEM 1A. RISK FACTORS This disclosure item is not required for smaller reporting companies. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. Item 5. OTHER INFORMATION Not Applicable. Item 6. EXHIBITS Exhibits filed herewith 31 Certificate of Stephen A. Levine required by Rule 13a-14(a) or Rule 15d-14(a) of The Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certificate of Stephen A. Levine Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 21 ALLERGY RESEARCH GROUP, INC. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ALLERGY RESEARCH GROUP, INC. Registrant Dated: August 8, 2008 By: /s/ Stephen A. Levine ------------------------------- Chief Executive Officer and Chief Financial Officer 22

ALLERGY RESEARCH GROUP INC 10-Q