**U.S.SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-KSB**

 

**Annual Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the Fiscal Year Ended December 31, 2003**

 

**Commissionfile number 000-33211**

 

**VITALLIVING, INC.**

(Exact name of small business issuer as specified in its charter)

 
| **NEVADA**                                                                                                   |   | **3652**                                                  |   | **88-0485596**                       |
|--------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdictionof incorporation)                                                                |   | (Primary Standard Industrial  Classification Code Number) |   | (I.R.S. Employer Identification No.) |
|                                                                                                         |   |                                                      |   |                                 |
| **VITAL LIVING, INC.  5080 N. 40TH STREET, SUITE 105****PHOENIX, ARIZONA 85018-2147****(602) 952-9909** |
| (Address and telephone number of principal  executive offices)                                               |
|                                                                                                         |   |                                                      |   |                                 |
| Securities registered under Section 12(b) of the Exchange Act:                                          |
| **None**                                                                                                     |
|                                                                                                         |   |                                                      |   |                                 |
| Securities registered under Section 12(g) of the Exchange Act:                                          |
| **Common Stock, $0.001 par value**                                                                           |

 

Checkwhether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the past12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.

 

YESý NO o

 

Checkif there is no disclosure of delinquent filers in response to Item 405 ofRegulation S-B is contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB.

 

YESý NO o

 

Stateissuer’s revenue for the most recent fiscal year: $2,855,123.

 

Asof March 26, 2004, the aggregate market value of the voting and non-votingcommon stock held by non-affiliates of the issuer (based on the closing salesprice as reported by the OTC Bulletin Board) was $23,663,081 assuming allofficers and directors are deemed affiliates for this purpose).

 

Asof March 26, 2004, the issuer had 61,456,004 shares of its common stock,$0.001 par value, outstanding.

 

TransitionalSmall Business Disclosure Format (check one): YES o NO ý

 

 

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**TABLE OF CONTENTS**

 
| ***PART I.***                                                                                                                           |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|
| **ITEM 1. DESCRIPTION OF  BUSINESS**                                                                                                    |   |
| **ITEM 2. DESCRIPTION  OF PROPERTIES**                                                                                                  |   |
| **ITEM 3. LEGAL PROCEEDINGS**                                                                                                           |   |
| **ITEM  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                        |   |
| ***PART II.***                                                                                                                          |   |
| **ITEM  5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**                                                                   |   |
| **ITEM  6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**                                                             |   |
| **ITEM 7. FINANCIAL  STATEMENTS**                                                                                                       |   |
| **ITEM 8. CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**                                  |   |
| ***PART III.***                                                                                                                         |   |
| **ITEM 9. DIRECTORS,  EXECUTIVE OFFICERS, PROMOTORS AND CONTROL PERSONS; COMPLIANCE WITH  SECTION 16(a) OF THE EXCHANGE ACT** |   |
| **ITEM 10. EXECUTIVE  COMPENSATION**                                                                                                    |   |
| **ITEM 11. SECURITY OWNERSHIP  OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**                            |   |
| **ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**                                                                            |   |
| **ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K.**                                                                                         |   |
| **ITEM  14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**                                                                                    |   |
| ***SIGNATURES***                                                                                                                        |   |
| *Section 302  Certification of Principal Executive Officer and Chief Executive Officer*                                            |   |
| *Section 302  Certification of Principal Accounting Officer and Chief Financial Officer*                                           |   |
| *Certification  Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to  Section 906 of Sarbanes-Oxley Act of 2002*         |   |
| *Certification  Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to  Section 906 of Sarbanes-Oxley Act of 2002*         |   |

 

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**FORWARD-LOOKING STATEMENTS**

 

ThisAnnual Report on Form 10-KSB contains forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995 that relateto possible future events, our future performance, and our future operations.In some cases, you can identify these forward-looking statements by the use ofwords such as “may,” “will,” “should,” “anticipates,” “believes,” “expects,”“plans,” “future,” “intends,” “could,” “estimate,” “predict,” “potential,”“continue,” or the negative of these terms or other similar expressions. Thesestatements are only our predictions. Our actual results could and likely willdiffer materially from these forward-looking statements for many reasons,including the risks described herein. We cannot guarantee future results,levels of activities, performance, or achievements. We are under no duty toupdate any of the forward-looking statements after the date of this document toconform them to actual results or to changes in our expectations.

 

**PART I.**

 

**ITEM 1. DESCRIPTION OF BUSINESS**

 

**DESCRIPTION OF BUSINESS**

 

We wereincorporated in the State of Nevada on January 22, 2001 under the nameNutritional Systems, Inc. Effective May 7, 2001, we acquired substantiallyall of the assets of Vital Living, Inc. and on May 20, 2001, changed our nameto Vital Living, Inc. We then merged with VCM Technology Limited, a companyreporting under the Securities and Exchange Act of 1934, on August 16,2001. As set forth in the terms of the merger agreement, we acquired all of theoutstanding shares of common stock of VCM from its sole stockholder in exchangefor 5,062 shares of our restricted common stock. Following the merger, wecontinued as the surviving corporation and commenced reporting under theSecurities and Exchange Act of 1934 by assuming the reporting status of VCM.Our executive offices are located at 5080 North 40th Street, Suite105, Phoenix, Arizona 85018-2147 and its telephone number is (602) 952-9909.  Our website is www.vitalliving.com.

 

Through a varietyof subsidiaries acquired during 2002 and 2003, as described further below, wedevelop or license nutraceuticals and pharmaceutical delivery systems, (ourGEOMATRIX technology) marketing them for distribution through physicians,medical groups, chiropractic offices, and retail outlets. In addition, weformulate, market, and distribute vitamins, herbs, high quality dietarysupplements, and therapeutic and functional food products through similar distributionchannels.

 

Nutraceuticals areproducts that are isolated or purified from foods and generally sold inmedicinal forms not usually associated with foods, including tablets, capsules,or drops. These nutraceuticals may have physiological benefits or have theability to reduce the risk of chronic disease beyond basic nutritionalproducts. We develop and test our nutraceuticals in collaboration with leadingmedical experts in the nutraceuticals field. We have designed them to beincorporated by physicians into a standard physician-patient program in whichpatients supplement doctor-prescribed pharmaceuticals with our nutraceuticals.Our initial areas of focus are cardiovascular health and weight loss.

 

**BUSINESS STRATEGY**

 

Our business strategy is to capitalize on the growing complimentary andalternative medicine market by creating scientifically proven and supportedcondition-specific formulations, offering a broad range of natural, generalhealth nutraceuticals and functional foods/beverages, and exploring alternativedistribution channels by gaining practitioner confidence and support for ourproducts. We plan to focus initially on certain target conditions, providingthe market with high quality, relevant products through key distributionchannels. Our distribution channels can be categorized into three primaryareas:

 

•                  themedical/practitioner channel, which might include physicians, conditionspecialists, chiropractors, nutritionists, or trainers who promote or prescribeour products,

•                  retail, which mayinclude health/nutrition stores, grocery stores, or other retail outlets, and

•                  consumer-direct,such as call centers and websites.

 

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Our initial target conditions, products, and distribution channels aresummarized below:

 
| **Target Conditions** |   | **Current  Products Offered**                                                                                                                                                                                   |   | **Distribution  Channels**                   |
|-----------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|
| Cardiovascular Health |   | Essentum®                                                                                                                                                                                                  |   | Medical/practitioner                         |
| Weight Loss           |   | X-Fat®                                                                                                                                                                                                     |   | Retail, Consumer Direct                      |
| General Health        |   | Christopher’s Original Formulas® herbal line, Dr. Phil’s® and other  functional food/beverage products, Boulder Bars®, Nature’s Dose®  nutraceutical line, GreensFIRST® |   | Medical/practitioner, Retail Consumer Direct |

 

A large part of our strategy relies on a growing patient and consumerinterest in the use of nutritional supplements and alternative medicines tocomplement traditional health care routines. Use of vitamins, minerals, herbs,and other supplements continues to rise as consumers seek nutritional productsto improve general health, increase longevity, and enhance the overall qualityof life. In this industry, sales generally occur through independent healthfood stores and chains, mail order and Internet sites, and mass-market food anddrug outlets.

 

There is also a substantial and growing body of evidence showing thatspecific nutritional programs and properly formulated nutritional supplementshave a significant positive impact on patient health. Supplements that havedemonstrated healthful benefits related to cardiovascular health, for example, inproperly designed and controlled clinical trials include:

 

•                  B vitamins,which have been shown to lower elevated homocysteine and promote cardiovascularhealth;

•                  Plant sterolssuch as phylochemeds, which have been shown to inhibit cholesterol formationand thereby lower “bad” cholesterol and total blood lipids; and

•                  Niacin (B3),which has been shown to promote “good” cholesterol levels.

 

Despite such examples and continued growth in the nutritionalsupplements market, physicians/practitioners have typically been unwilling orunable to respond to the trend, or to patient questions on the subject matter,due in large part to doubt, or lack of substantiation on supplement safety andefficacy, or a lack of knowledge in the area. In the formulation, production,and marketing of our products, we have attempted to address these concerns by:

 

•                  assembling apanel of physicians and practitioners active in the fields in which we seek tosell our products who will endorse and create integrated treatment protocols;

•                  utilizingclinically proven ingredients in our creation of condition-specificformulations;

•                  providingpatient educational tools, logistical, and fulfillment support for our productsto physicians/practitioners, enabling them to focus on their core competencies;and

•                  creating abusiness model similar to the well-established pharmaceutical model (i.e.,physicians/practitioners provide patients with prescriptions fulfilled by thirdparties), which is arguably the strongest and most profitable distributionmodel for drug therapies.

 

**ACQUISITION STRATEGY**

 

In connection with the sale of our Senior Secured Convertible Notesissued in December 2003, we agreed that, until the registration statementthat we filed in January 2004 has been declared effective, we would notenter into any acquisition agreements which, upon consummation, would requireus to file a Current Report on Form 8-K with audited financial statementswithout the prior approval of the holders of such Senior Secured ConvertibleNotes representing at least 50% of the principal amount of notes thenoutstanding.  Further, we agreed that,once the registration statement is declared effective, we would not enter intoan agreement for any material acquisition for a period of at least 60 daysunless the registration statement is on Form S-3 without the prior approval ofthe holders of Senior Secured Convertible Notes representing at least 50% ofthe principal amount of notes then outstanding.

 

Notwithstanding the foregoing, we believe there are many attractiveacquisition candidates in our industry because of the highly fragmentedcomposition of the marketplace, the industry participants’ need for capital,and their owners’ desire for liquidity. If the

 

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restrictions described above are removed, we may pursue a continuedacquisition program to consolidate and enhance our position in our currentmarkets and to acquire operations in new markets.

 

During 2003 and 2002, we completed the acquisition of four companieswith complimentary business or products ranging from start-ups to revenue up to$2.5 million per year. These acquisitions are intended to shift our businesstoward established, higher margin products, or to expand into new productlines. These acquisitions also increased our geographic presence with locationsspanning the Southwest region of the United States. The following informationprovides a summary of our acquisitions:

 

*MAF BioNutritionals, LLC (“MAF”)*. OnNovember 20, 2002, we acquired MAF pursuant to the terms of a StockPurchase Agreement. Upon closing, we acquired 100% of the outstanding members’capital of MAF for consideration of $4,100,000; consisting of 2,500,000 commonshares priced at $1.64 per share. MAF generated actual revenues of approximately$1,370,000 and annualized pro forma revenues of approximately $1,676,000 duringthe years ended December 31, 2003 and 2002, respectively. MAF formulates,markets, and distributes natural and organic food-based, preventativenutraceuticals and therapeutic and functional food products designed to supportproactive human cell maintenance and rehabilitation, essential in theprevention and treatment of disease, as well as overall optimal bodyperformance and metabolic function. MAF’s product line includes variousfunctional foods/beverages (Phil’s Bar®, Phil’s Shake®, Alma Bar®, BoulderBars®) and Nature’s Dose®, a line of nutritional and dietary supplements. Weacquired MAF in an attempt to both broaden our product lines and gaindistribution networks to help distribute our products.

 

*Christopher’s Original Formulas, Inc. (“COF”)*.On July 3, 2003, we acquired certain assets and assumed certainliabilities of COF pursuant to the terms of an Asset Purchase Agreement. Uponclosing, through a wholly owned subsidiary, we acquired certain assets andassumed certain obligations for consideration of $2,808,000; consisting of2,600,000 common shares priced at $1.08 per share and certain earn-outprovisions. COF generated annualized pro forma revenues of approximately$2,039,000 and $2,447,000 during the years ended December 31, 2003 and2002, respectively. Through this acquisition, we gained the exclusive licensingand marketing rights to Christopher’s products, a complete line of over 300herbal formulas and products consisting primarily of naturally occurringorganic substances sold to professionals and at retail locations throughout theUnited States.

 

*E-Nutraceuticals, Inc. (“ENI”)*. OnAugust 20, 2003, we acquired ENI pursuant to the terms of an Agreement andPlan of Merger. Upon closing, we acquired 100% of the outstanding common stockof ENI for consideration of $40,623,159; consisting of 31,248,584 common sharespriced at $1.30 per share. ENI generated annualized pro forma revenues ofapproximately $0 and $21,000 during the years ended December 31, 2003 and2002, respectively. ENI develops safe and effective alternatives toprescription medications for non-life threatening chronic ailments, such asobesity and depression. Through the acquisition, we obtained worldwide patentand licensing rights to X-Fat®, a dietary supplement utilized for weight loss.In addition, through a collaborative partnership with SkyePharma, PLC,(“Skye”), a UK pharmaceuticals company and major shareholder, we are now in theprocess of enhancing existing nutraceuticals via FDA-approved, proprietarydelivery systems. Pursuant to an amended Development and License Agreementbetween the parties, we acquired exclusive rights to Skye’s drug deliverytechnology, GEOMATRIX®, and marketing and royalty rights to pharmaceuticalsales using GEOMATRIX® in the Peoples Republic of China, Taiwan, and Hong Kong.

 

*Doctors For Nutrition, Inc. (“DFN”)*. OnOctober 14, 2003, we acquired DFN pursuant to the terms of a StockPurchase Agreement. Upon closing, we acquired 100% of the outstanding commonstock of DFN for consideration of $2,343,004; consisting of 1,650,003 commonshares priced at $1.42 per share. DFN generated annualized pro forma revenuesof approximately $1,622,000 and $295,000 during the years endedDecember 31, 2003 and 2002, respectively. IDFN’s product line includesGreensFIRST®, a highly concentrated formulation of fruits and vegetables. Oneserving of the product has the antioxidant power of over 10 servings of fruitsand vegetables. Mixed with water, GreensFIRST® contains certified organicfruits, vegetables, and barley grass, which are first juiced and thenspray-dried at low temperature, leaving all the important nutrients and liveenzymes intact. Benefits of usage include increased energy, improved digestion,and enhanced immune response. DFN currently distributes GreensFIRST® throughmore than 1,000 practitioner offices throughout the United States.

 

Should we continue our acquisition strategy in the future, we believethat companies with revenues ranging up to $5 million per annum may bereceptive to our acquisition program, as often they are too small to beidentified as acquisition targets of larger public companies or toindependently attempt their own public offerings. In particular, we intend tofocus on candidates that have strong relationships with key vendors or haveestablished complimentary distribution channels or customers. We believe suchan acquisition strategy could be successfully implemented due to:

 

•                  the highlyfragmented composition of the market;

 

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•                  our strategy forcreating a national company, which should enhance the acquired company’sability to compete in local, regional, and national markets through anexpansion of customer base, distribution channel, and products offered andlower operating costs attained through synergies;

•                  the additionalcapital that management anticipates will become available for internal growth;

•                  the potentialfor increased profitability as a result of our centralization of certainadministrative functions, greater purchasing power, and economies of scale;

•                  our status as apublic corporation;

•                  a decentralizedmanagement strategy, which should, in most cases, enable the acquired company’smanagement to remain involved in the operations; and

•                  the ability toutilize our experienced management in identifying acquisition opportunities.

 

**PRODUCTS**

 

*Product Lines*

 

*Essentum® and EssentumNP®* (collectively“Essentum”) are our proprietary, patent-pending supplements designed bycardiologists to meet specific nutritional needs for cardiovascular health.Cardiovascular disease affects nearly 60 million Americans and is one of theleading causes of death in the United States. The American Heart Associationestimates that 100 million Americans could benefit from improved dietary andexercise regimens to reduce their risk of heart attack. The nutrients inEssentum are clinically proven to support healthy levels of cholesterol,triglycerides, and homocysteine, as well as provide necessary vitamins andminerals. Because physicians formulated it, Essentum will not interact with, orreduce the effectiveness of, typical cardio-related prescription medications.

 

*X-Fat®* is our patented dietary supplementthat uses Kytabsorbe®, a liquid form of the natural fat fighter, chitosan.Chitosan has been studied extensively by the scientific community and has beenshown to bind to a variety of dietary fats. Unlike the pill form of chitosan,which takes hours to activate, Kytabsorbe® is fast acting and is quicklyabsorbed into the blood stream. Kytabsorbe® is all natural and derived solelyfrom shellfish. X-Fat® is expected to result in weight loss and reduced serumlipid levels, which has been shown to result in a lower cholesterol count. Thisproduct became ours through our August 2003 acquisition of ENI and wespent much of the remainder of 2003 planning and expending for a first quarter,2004 product launch. To date, sales have been minimal; however, substantial salesand marketing efforts did not begin until March 2004. X-Fat will be soldprimarily via consumer-direct distribution channels.

 

*GreensFIRST®* is a highly concentratedformulation of fruits and vegetables with natural, organic, whole foods andextracts, or “super foods,” prepared in a powder for mixing with a variety ofliquids. Super foods supply natural vitamins, minerals, plant enzymes,antioxidants, phytonutrients, and symbiotic intestinal flora for more optimalenergy metabolism, fat burning, digestion, detoxification, immunity, repair,recovery, rejuvenation, and vital longevity. GreensFIRST® is currentlydistributed through more than 1,000 practitioner officers throughout the UnitedStates.

 

*Christopher’s Original Formulas®* is ourcomplete and exclusively licensed herbal remedy product line, consistingprimarily of naturally occurring, certified-organic substances that are safeand effective in the treatment of an array of specific conditions and generalhealth maintenance. A sampling of these products includes a variety ofcapsules, ointments, syrups, and extracts sold through retail locationsthroughout the United States, as well as through consumer-direct distributionchannels.

 

*Nature’s Dose®* represents all natural,certified organic, food-based nutraceuticals formulated using peerreview-published scientific research and clinical experience. Specificpatent-pending formulas include Anti-Inflammatory Complex, EPA Formula, andFlax Formula. This product line is distributed through our practitioner,retail, and consumer-direct distribution channels.

 

*Nutritional Bars/Shakes*. We offer avariety of all-natural nutrition bars, including Phil’s Bar®, Phil’s Shake®,Alma Bar®, and Boulder Bars®. Certified-organic and vegan versions of some ofthese products have recently and successfully been developed and distributedinto our markets. These products are distributed through our practitioner,retail, and consumer-direct distribution channels.

 

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**SALES AND MARKETING**

 

As described above, our distribution channels can be categorized intothree primary areas:

 

•                  themedical/practitioner channel, which might include physicians, conditionspecialists, chiropractors, nutritionists, or trainers who promote or prescribeour product,

•                  retail, whichmay include health/nutrition stores, grocery stores, or other retail outlets,and

•                  consumer-direct,such as call centers and websites.

 

Each of these channels is used for certain products and/or productlines and the sales and marketing efforts and methodologies vary.

 

*Medical/Practitioner*

 

We distribute a variety of our products through themedical/practitioner distribution channel, including Essentum, GreensFIRST, anda variety of our Christopher’s Original Formulas and Nature’s Dose or otherrelated products. While each of the latter three is sold through establishedchannels as acquired during 2003 and 2002, the uniqueness of Essentum hascaused us to enter into the following agreements in order to reach a specificmarket:

 

In August 2001, we signed a three-year agreement with the ArizonaHeart Institute (“AHI”), which through its affiliates serves between 22,000 to25,000 new patients each year with a database of over 150,000 heart patients towhich AHI will market and distribute Essentum. Under our agreement, we areobligated to pay royalties to AHI in the amount of 12% or 6% of our net salesof Essentum, depending on their origin. Sales of Essentum accounted forapproximately 2% of total revenue during the year ended December 31, 2003and we paid AHI a commission of approximately $3,600. Also pursuant to theagreement, we issued to AHI an option to purchase 1,000,000 shares of ourcommon stock at an initial exercise price of $0.35 per share. Of the 1,000,000options, the right to purchase 600,000 shares vested when AHI agreed to endorsethe logo material and the remainder vests as follows:

 

•                  the right topurchase 200,000 shares of common stock will vest when aggregate gross sales ofour products by the Institute and its affiliated clinics totals $1.0 million;and

•                  the right topurchase 200,000 shares of common stock will vest when aggregate gross sales ofour products by the Institute and its affiliated clinics totals $1.5 million.

 

In July 2003, we executed an amendment with AHI extending the termfor an additional year, providing a “net exercise” provision for 100,000 sharesof common stock, and various other minor provisions. AHI also agreed not tosell in excess of 25,000 shares received in any rolling 30 day period. InOctober 2003, AHI exercised its rights under the net exercise provisionand was issued 100,000 shares of our common stock in exchange for 132,407options.

 

In August 2001, we entered into a non-exclusive five-yeardistribution agreement with AHI Hong Kong, Ltd. (“AHIHK”), an affiliate of AHI,to market our cardiovascular medical food supplements regimen in China. AHIHKcurrently supplies products and equipment to treat cardiovascular disease toChinese physicians, hospitals, and clinics, and collaborated with the Chinesegovernment to build the first American-style heart hospital, which opened inBeijing in 2003. Under the terms of our agreement, AHIHK is to act in thecapacity of an exclusive distributor of our products in China, Taiwan, and HongKong. The products will be purchased by AHIHK at a designated premium over ourcost. In consideration, we issued AHIHK an option to purchase 1,000,000 sharesof our common stock at an exercise price of $0.35 per share, 300,000 of whichvested immediately, however, are subject to divestiture if gross aggregatesales of our products does not equal or exceed $2.0 million within the first 30months of the agreement. The remainder vests in installments based on attaininggross aggregate sales ranging from $5.0 to $15.0 million. DuringJuly 2003, as part of an amendment to its agreement, the Company agreed toprovide for the vesting of the 300,000 options without divestiture.

 

*Retail*

 

As a result of our acquisition strategy during 2003 and 2002, we haveaccess to an extensive and well-established network, comprised of fifteen largedistribution companies and nine natural-product brokerage firms, including suchwell-known names as United Natural Foods and Tree of Life, companies we believeare among the largest distribution entities in the nutraceuticals industry. Wehave also engaged a third party to manage our distributor and brokerrelationships and expand our marketing presence via established networks andcontacts in the industry.

 

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*Consumer-Direct*

* *

We also have a variety of products that can be marketed and solddirectly to consumers via call centers, websites, or other means. We haverecently engaged a third party to update and consolidate our various companyand product websites in order to cross-sell our product lines. While thisproject is still under way, we are now able to take orders for a majority ofour products via the Internet, including our complete line of Christopher’sOriginal Formulas®, Phil’s Bars/Shakes®, Alma® Bars, Boulder® Bars, and X-Fat®,from a single site, www.HerbShopConnection.com, or sites linked therein.

 

Furthermore, in March 2004 we executed afive-year marketing agreement with a reseller granting them exclusive rights tomarket and sell X-Fat® over the Internet, subject to certain limitedexceptions, and non-exclusive rights to market X-Fat through print ads, radio,and television. We have retained the rights to market X-Fat through our ownwebsites. The reseller must sell minimum levels of X-Fat within certain periodsor we have the right to terminate the exclusivity or the agreement. Inexchange, we issued the reseller an option to purchase 500,000 shares of commonstock, vesting 100,000 shares upon the sale of each $2.5 million in X-Fat salesup to a maximum of $12.5 million in sales.

 

We continue to explore other possibilities with regard to thedistribution of our products nationally and in other countries and we willevaluate the regulatory and distribution structures in Europe, Asia, and othermajor countries to determine the best way to distribute our products in thosemarkets.

 

**COMPETITION**

 

Ourcompetitors vary by the nature of the distribution channel. With respect to themedical/practitioner channel, there exist a limited number of companies sellingsupplements, including Douglas Labs, Integration Therapeutics, Phyto Pharmacia,Metagenics Standard Process, Allergy Research, and Enzymatic Therapy. Withrespect to the retail and consumer direct channel, there are hundreds ofcompetitors, including companies that market herbal nutritional and homeopathictherapies, supplements, and remedies, such as Herb Pharm, Giah Herbs, NaturesWay, and Solaray. Furthermore, there are hundreds of competitors, includingcompanies marketing Power Bar, Cliff Bar, Balance Bar, and Odwalla, with whomwe compete in the functional food and beverage category. Lastly, our X-Fatproduct will compete with many other existing products, as well as a variety ofweight-loss treatments, methodologies, or concepts including such names as TrimSpa, Slim Fast, Jenny Craig, and Weight Watchers.

 

Although many of these competitors are substantially larger than us andhave greater financial resources, we believe that we will be able to competefavorably with the vitamin and nutritional supplement companies based primarilyon our first to market, direct distribution approach through physicians whodesire to have a nutritional line of products to supplement the medical aspectsof their practice. In addition, we believe the unique nature of certain of ourproducts, including X-Fat and GEOMATRIX, will give us a competitive advantagein the market.

 

**OTHER**

 

*Trademarks andPatents*

 

We and our subsidiaries own numerous trademarks registered with theU.S. Patent and Trademark Office and with agencies in certain other majorjurisdictions of the world, including Vital Living® (Serial Nos. 75849529,75845668), Vital Living - The Physician Nutraceutical Company® (plus a logo)(Serial Nos. 78166678, 78975112), Essentum® (Serial No. 76404891), Essentum ForCardiovascular Health® (plus a logo) (Serial Nos. 78975116, 78166675), X-Fat®(Serial No. 75629006), Phil’s Bar® (plus logo) (Serial No. 76338490), Phil’sShake® (plus logo) (Serial No. 76338491), Alma Bar® (Serial No. 76375373),Boulder Bar® (Serial No. 75642792), Boulder Bar Endurance® (Serial No.74648798), Boulder Bar Organic® (Serial No. 78276682), Christopher’s OriginalFormulas® (Serial No. 76413473) and GreensFirst® (Serial No. 76256859).  We also have many common law, unregisteredtrademarks and a patent with respect to our liquid chitosan formula used in ourX-Fat® product (Patent No. 6,323,189).

 

Federally registered trademarks have a perpetual life, as long as theyare renewed on a timely basis and used properly as trademarks, subject to the rightsof third parties to seek cancellation of the marks. We believe that ourregistered and unregistered trademarks, patents, and other proprietary rightsare valuable assets and that they have significant value in the marketing ofour products. Accordingly, we intend to vigorously protect our intellectualproperty against infringement.

 

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*Research andDevelopment*

 

Our efforts are focused on developing, testing, and substantiating theefficacy of new products in response to what we perceive is a need in thetraditional medical distribution channel to complement existing medicalconditions that are currently treated surgically or with prescriptionmedications. We also intend to continually reformulate existing products inresponse to new clinical or scientific literature. Our existing retailsupplements are proven products that require no further testing to be saleable.New condition-specific products that we are developing or producing areassembled by designated manufacturers utilizing proven ingredients that werenot developed by us, but are uniquely blended to our specifications.

 

We believe that flexibility and innovation with respect to new productsare crucial factors in remaining competitive in the field of nutritionalsupplements and being able to produce the most effective products, whichphysicians will be willing to prescribe for their patients for specificconditions. By monitoring market trends and avoiding short-lived “fad”products, we will attempt to anticipate physician demand for certain productcategories. Maintaining flexibility will enable us to capitalize on emergingsciences relative to nutritional products, as well as shifts in patient needs.

 

Researchand development costs amounted to $410,648 and $510,436 for the periods ended December 31, 2003 and 2002, respectively.Through December 31, 2003, research and development costs incurred sinceinception are $958,584.

 

*Raw Materials andQuality Control*

 

The principal raw materials used in the manufacture of our medical foodsupplements are natural ingredients purchased from manufacturers primarily inthe United States, with certain materials imported from other countries. Wepurchase these raw materials directly; therefore, together with our suppliers,we maintain the responsibility for documenting all certificates of analysis forthe materials in accordance with good manufacturing practices (“GMP”) andguidelines. The raw materials are sent directly to us or our manufacturers formilling and other fabrication. We believe that the materials purchased fromsuppliers are readily available from numerous sources and that the loss ofthese suppliers would not adversely affect our operations. Our in-housemanufacturing practices do not currently meet GMP guidelines; however, we areprogressing toward such certification.

 

Historically, we have not experienced difficulties obtaining rawingredients for our products on customary terms. However, the supply of herbalproducts is subject to the same risks normally associated with agriculturalproduction, such as climatic conditions, insect infestations, and availabilityof manual labor or equipment for harvesting. Any significant delay in, ordisruption of, the supply of raw materials could:

 

•                  substantiallyincrease the cost to us of these materials;

•                  require us toreformulate and repackage our products;

•                  require us tofind new suppliers; or

•                  result in asubstantial reduction or termination by us of our sales of certain products.

 

If supply shortages were to occur and we were unable to meet thedemands of our customers, even if for only a short time, the result could be along-term decrease in the anticipated sales of our products. We cannot assureyou that, on a long-term basis, an adequate supply of ingredients will beavailable to us and on terms commercially reasonable in order for us to meetthe supply obligations to our customers.

 

Finished products are produced and delivered from our manufacturers,which maintain modern quality control laboratories and testing facilities. Itis our intent to pay only for the actual milling of the product and itssubsequent packaging. When products are ready for packaging, automatedequipment counts the tablets and capsules, inserts them into packets that arepacked in a convenient dispensing box, which is protected by a tamper-resistantouter safety seal. All of this is done by our manufacturers according tocurrent GMP.

 

*GovernmentRegulation*

 

The formulation, manufacturing, packaging, labeling, advertising,distribution, and sale (hereafter, collectively “sale” or “sold”) of dietaryand nutritional supplements such as those sold by us are subject to regulationby one or more federal agencies, principally the Food and Drug Administration(“FDA”), the Federal Trade Commission (“FTC”), and to a lesser extent theConsumer Product Safety Commission and United States Department of Agriculture.Our activities are also regulated by various governmental agencies for thestates and localities in which our products are sold, as well as bygovernmental agencies in certain countries outside the United States. Amongother matters, regulation by the FDA and FTC

 

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is concerned with product safety and claims made with respect to aproduct’s ability to provide health-related benefits.

 

Federal agencies, primarily the FDA and FTC, have a variety ofprocedures and enforcement remedies available to them, including:

 

•                  initiatinginvestigations,

•                  issuing warningletters and cease and desist orders,

•                  requiringcorrective labeling or advertising,

•                  requiringconsumer redress such as requiring that a company offer to repurchase productspreviously sold to consumers,

•                  seekinginjunctive relief or product seizures,

•                  imposing civilpenalties or

•                  commencingcriminal prosecution.

 

In addition, certain state agencies have similar authority. Thesefederal and state agencies have in the past used these remedies in regulatingparticipants in the dietary supplements industry, including the imposition byfederal agencies of civil penalties in the millions of dollars against a fewindustry participants. We cannot assure you that the regulatory environment inwhich we operate will not change or that such regulatory environment, or anyspecific action taken against us, will not result in a material adverse effecton our operations. In addition, increased sales of, and publicity about,dietary supplements may result in increased regulatory scrutiny of the dietarysupplements industry.

 

The Dietary Supplement Health and Education Act (“DSHEA”) was enactedin 1994, amending the Federal Food, Drug, and Cosmetic Act. We believe theDSHEA is generally favorable to consumers and to the dietary supplementindustry. DSHEA establishes a statutory class of “dietary supplements,” whichincludes vitamins, minerals, herbs, amino acids, and other dietary ingredientsfor human use to supplement the diet. Dietary ingredients on the market as ofOctober 15, 1994 do not require the submission by the manufacturer ordistributor to the FDA of evidence of a history of use or other evidence ofsafety establishing that the ingredient will reasonably be expected to be safe,but a dietary ingredient which was not on the market as of October 15,1994 may need to be the subject of such a submission to FDA at least 75 daysbefore marketing. Among other things, the DSHEA prevents the FDA fromregulating dietary ingredients in dietary supplements as “food additives” andallows the use of statements of nutritional support on product labels. The FDAhas issued proposed and final regulations in this area and indicates thatfurther guidance and regulations are forthcoming. We cannot assure you that theFDA will accept the evidence of safety for any new dietary ingredient that wemay decide to use and the FDA’s refusal to accept such evidence could result inregulation of such dietary ingredients as food additives, requiring FDApre-approval based on newly conducted, costly safety testing. In addition,while the DSHEA authorizes the use of statements of nutritional support in thelabeling of dietary supplements, the FDA is required to be notified of suchstatements. We cannot assure you that the FDA will not consider particularlabeling statements used by us to be drug claims rather than acceptable statementsof nutritional support, thereby necessitating approval of a costly new drugapplication, or re-labeling to delete such statements.

 

In November 1998, the FTC announced new advertising guidelinesspecifically for the dietary supplement industry, entitled “DietarySupplements: An Advertising Guide for Industry.” These guidelines reiteratemany of the policies the FTC has previously announced over the years, includingrequirements for substantiation of claims made in advertising about dietarysupplements.

 

The DSHEA also authorizes the FDA to promulgate GMP guidelines fordietary supplements, which require special quality controls for themanufacture, packaging, storage, and distribution of supplements. Wecontractually require that any independent third party manufacturers doingbusiness with us comply with all existing, or to be promulgated, regulations.The DSHEA further authorizes the FDA to promulgate regulations governing thelabeling of dietary supplements, including claims for supplements pursuant torecommendations made by the Presidential Commission on Dietary SupplementLabels. These rules, which were issued on or after September 23, 1997,entail specific requirements relative to the labeling of our dietarysupplements. The rules also require additional record keeping and claimsubstantiation, reformulation, or discontinuance of certain products, whichwould be a material expense to us.

 

The sale of our products in countries outside the United States isregulated by the governments of those countries. We are not currently marketingour products outside of the United States except in China, Mexico, and theUnited Kingdom. Our plans to commence or expand sales in those countries may beprevented or delayed by such regulation. While compliance with such regulationwill generally be undertaken by international distributors, we may assist withsuch compliance and in certain cases may be liable if a distributor fails tocomply.

 

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We cannot predict the nature of any future laws, regulations,interpretations, or applications, nor can we determine what effect suchadditional regulation, when and if it occurs, would have on our business in thefuture. Such additional regulation could require, however, any or all of theactions listed below, which could have a material adverse effect on ouroperations:

 

•                  thereformulation of certain products to meet new standards,

•                  the recall ordiscontinuance of certain products,

•                  additionalrecord keeping,

•                  expanded documentationof the properties of certain products,

•                  revised,expanded or different labeling or

•                  additionalscientific substantiation.

 

**PERSONNEL**

 

As of March 15, 2004, we employed 55 individuals, 45 of whom werefull time. Of the total, 22 were engaged in sales and marketing, 15 wereengaged in production or operational activities, and 18 were engaged infinance, administration, or management functions. None of our employees issubject to any collective bargaining agreements and we believe our relationshipwith our employees is satisfactory. Our future success will depend, in part, onour ability to attract, retain, and motivate highly qualified personnel.

 

**RISK FACTORS**

 

You should consider carefully the following risk factors and all otherinformation contained herein before purchasing our common stock. Investing inour common stock involves a high degree of risk. We have included in the riskfactors set forth below a discussion of each material risk that we haveidentified as of the date of this document. If any of the following risksactually occur, our business, financial condition or operating results willsuffer. Moreover, the price of our common stock could decline and you couldlose all of your investment.

 

***Risk related to ouroperations***

 

**Our significantlosses and negative cash flow raise questions about our ability to continue asa going concern.**

 

We have only a limited operating history and our business model has notyet been thoroughly tested in the market place. Our annual report must beconsidered in light of the risks, expenses and difficulties frequentlyencountered in establishing a business in the nutraceuticals industry, which ischaracterized by a large number of market participants, intense competition,and a high failure rate. We incurred a net loss of approximately $30.62 millionand $3.95 million for the years ended December 31, 2003 and 2002,respectively. We cannot assure you that we will be able to achieve or sustainrevenue growth, profitability, or positive cash flow on either a quarterly orannual basis or that profitability, if achieved, will be sustained. If we areunable to achieve or sustain profitability, we may not be financially viable inthe future and may have to curtail, suspend, or cease operations. Because ofour recurring operating losses and negative cash flow, the reports of ourindependent accountants relating to the financial statements for the fiscalyears ended December 31, 2003 and 2002 contain an explanatory paragraphstating that they have substantial doubt about our ability to continue as agoing concern.

 

**If we are unable togenerate cash from operations, we may need to raise additional funds in thenear future.**

 

Our capital requirements continue to be adversely affected by ourinability to generate cash from operations. We had working capital (deficit) of$(97,979) and $783,705 at December 31, 2003 and 2002, respectively.Historically, we have been dependent on equity or debt financings to fund ourdevelopment and working capital needs and completed offerings of $4,587,738aggregate principal in Senior Secured Convertible Notes, which includes the conversion of $1,587,738 inBridge Note principal and accrued interest, during the fourth quarter of2003. Due to our continued inability to generate cash from operations, we needto raise additional capital in the near future through either a debt or equityoffering. However, because our Senior Secured Convertible Notes are secured bysubstantially all of our assets, we may have difficulty securing additionaldebt financing on terms favorable to us or at all. We may not be able toconsummate an equity offering either, but if we do, it may be highly dilutiveto existing stockholders. If we continue to be unable to generate cash flowfrom operations and are unable to find sources of funding, it would have anadverse impact on our ability to maintain our operations.

 

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**Our potentialacquisition strategy may subject us to additional risks.**

 

While we recently agreed to forego acquisitions in the short-term inconjunction with obtaining our December 2003 Senior Secured ConvertibleNotes, upon lifting of this temporary ban and securing appropriated funding,one of our potential business strategies is to achieve growth through acquisitions.Due to the early stages of our acquisition program, there can be no assurancesas to the long-term impact of our acquisition strategy on our gross profits ornet income. During 2003, the acquisition strategy may have contributed towardsour net loss in several respects. First, certain of the acquired companies havecontinued to incur losses from operations, or have required significant cashadvances, which, in turn, has adversely affected our results of operations.Second, the acquisition strategy has caused us to significantly increase ourselling, general, and administrative expenses, which has also contributednegatively toward our results of operations. As net sales continue to increase,however, our overhead will be spread over a larger revenue base, which isexpected to have a positive impact on our results of operations.

 

We anticipate that future profitability is likely to depend upon acombination of many factors, including the continued growth of our businessthrough acquisitions, the management of that growth through integration of thebusinesses acquired, and the continued expansion of our higher margin servicebusiness. Continuation of our growth strategy, however, is dependent upon anumber of factors. First, we must continue to have adequate capital resourcesto continue to finance the acquisitions. In view of our recent losses andlimited available financing, our ability to finance cash acquisitions ispresently limited. Second, the continued availability of an adequate supply of acquisitiontargets at reasonable purchase prices. Increased competition for acquisitioncandidates could reduce the pool of available targets and could increaseacquisition prices.

 

In addition, in order to pursue our acquisition strategy in the longterm, we will require additional financing, which we will attempt to securethrough a combination of traditional debt financing, the issuance of ourshares, and the placement of debt and equity securities. To the extentacquisitions can be financed through our securities, the need for cashresources is somewhat mitigated. However, in the event our common stock doesnot attain or maintain a sufficient market value, or potential acquisitioncandidates are otherwise unwilling to accept common stock as part of the considerationfor the sale of their businesses, we will be required to utilize more of ourcash resources, if available, in order to maintain our acquisition program. Ifwe do not have sufficient cash resources, our growth could be limited unless weare able to obtain additional capital through debt or equity financing.

 

**If we are unable torepay our indebtedness and interest obligations when due, our operations may bematerially adversely affected.**

 

In connection with the various acquisitions we completed during 2003and 2002, we have assumed a total of $1,478,928 of indebtedness. We alsorecently issued $4,587,738 aggregate principal amount of Senior SecuredConvertible Notes,which includes the conversion of $1,587,738 in Bridge Note principal andaccrued interest, which are secured by substantially all of our assets.We cannot assure you that our operations will generate funds sufficient torepay these debt obligations as they come due. Additionally, although we haveplaced a portion of the proceeds from our offering of Senior SecuredConvertible Notes into escrow to cover our first year of interest obligationsdue on such notes, we cannot assure you that we will be able to repay futureinterest obligations as they come due. Our failure to repay our indebtednessand make interest payments as required by these debt obligations could resultin an event of default under the Senior Secured Convertible Notes. If thishappened, the holders of our Senior Secured Convertible Notes could force us tosell our assets in order to repay debt owing under the notes.

 

**We may record futurelosses because continuing adverse market conditions may require us to record animpairment of goodwill and other intangibles.**

 

We had approximately $4.2 million and $4.9 million of goodwill asDecember 31, 2003 and 2002, respectively, and approximately $41.5 millionand $330,000 of net intangible assets at December 31, 2003 and 2002,respectively, cumulatively accounting for approximately 90% and 73% of ourtotal assets, respectively. We adopted Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets,” and are required toanalyze our goodwill and other intangible assets for impairment issues on anannual basis or when events occur that would indicate that impairment hadoccurred. The value of our goodwill and other intangible assets is exposed tofuture adverse changes if we experience declines in operating results orexperience significant negative industry or economic trends or if futureperformance is below historical trends. We periodically review goodwill andintangible assets for impairment using the guidance of applicable accountingliterature. We are subject to financial statement risk to the extent that thegoodwill and other intangible assets become impaired, and any impairment lossesrelated to goodwill and other intangible assets may result in a non-cash chargeto earnings.

 

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**If we are unable tocompete effectively with existing or new competitors, our existing businesswill decline and our anticipated business plan will not be successfullyimplemented.**

 

We believe the market for nutritional products is continually evolving,and is highly dependent upon changes in the demographic and social trends thathave resulted in tremendous growth for the nutrition industry in the past fewyears. We will encounter aggressive competition from numerous competitors, manyof whom have significantly greater financial, technical, marketing, and otherresources than we do. In making decisions regarding the development of newproducts and the enhancement and extension of our current products, we will becompeting with our competitors, who will also be attempting to anticipate theneeds and preferences of consumers, physicians, and nutritionists. Consumerpreferences, particularly in the health and nutraceuticals market, arecontinuously changing and are difficult to predict. We believe we can competeeffectively by reacting quickly to expected and perceived customer requirementsand desires, maintaining relationships with our existing strategic partners,and identifying and reaching agreements with new partners. However, we cannotassure you that our assessment of the market place is correct, or that ourproducts will be accepted now or in the future.

 

**If we do not gainsupport from the medical community for our products and services, ouranticipated levels of sales would be significantly reduced.**

 

We are marketing ourselves as the “Physician Pharmaceuticals Company.”In connection with our acquisition of ENI, we have obtained licenses forpharmaceutical products in China, as well as other assets, and have built ourbusiness model around the belief that doctors will eventually recommend ourproducts in a manner similar to the prescription of medicine. In the UnitedStates, herbal dietary supplements have been available for many years, but manyphysicians have shown reluctance to recommend them to their patients and therehas been controversy about their use and concerns about their interactions withpharmaceutical products. Accordingly, we cannot assure you that our productswill achieve or sustain market acceptance by either patients or the medicalcommunity. If the medical community does not embrace our concept, we will needto completely re-evaluate our business model and consider other ways to marketour products.

 

**Since we rely onthird parties to market our products, we may be adversely affected if thesethird parties are not effective in their marketing activities.**

 

Other than on our website, we do not directly market our own products;rather we utilize third parties to assist in marketing, selling, anddistributing our products. However, even under our existing arrangements withdistributors, sales of our products are subject to all of the market risksassociated with the introduction of products in new distribution channels.Accordingly, although we intend to enter into additional third partyarrangements for our current or future products that we may develop or acquire,we cannot assure you that third parties will purchase, recommend, or market ourproducts at sufficient levels or provide our products with adequate support. Ifthe companies we rely on to market our products do not do so effectively, wewill not generate significant revenues or profits.

 

**If the Arizona HeartInstitute withdraws support for our products, our business plan could beseverely impacted.**

 

We have an agreement with the Arizona Heart Institute, Inc. (“AHI”),the nation’s first freestanding outpatient clinic devoted solely to theprevention, detection, and treatment of heart and blood vessel diseases, todistribute our product Essentum®. Under our agreement with AHI, which began inAugust 2001, AHI agreed to act in the capacity of a strategic partner inthe distribution of our nutraceuticals products. Additionally, AHI has agreednot to promote or endorse any other line of nutritional products relative tocardiovascular disease. AHI also agreed to provide a marketing platform for thesale of our nutritional products by assisting in clinical trials, in allowingus to use the AHI logo on our products and handling the dissemination ofinformation through their existing database, in addition to other assistance(such as introductions to other heart institutes). Although AHI has agreed notto promote any other products, it is possible that a competitive product couldbe developed that it considers superior to ours. If this occurs, AHI may havean ethical obligation to recommend this product to its customers,notwithstanding the potential that this would be a breach of our agreement.

 

**If we are unable toobtain raw materials for our products, our business will be adversely affected.**

 

Historically, we have not had difficulties obtaining the rawingredients for our products on customary terms. However, the supply of herbalproducts is subject to the same risks normally associated with agriculturalproduction, such as climatic conditions, insect infestations, and availabilityof manual labor or equipment for harvesting. Any significant delay in, ordisruption of, the supply of raw materials could:

 

•                  substantiallyincrease the cost to us of these materials;

•                  require us toreformulate and repackage our products;

•                  require us tofind new suppliers; or

 

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•                  result in asubstantial reduction or termination by us of our sales of certain products.

 

If any of these situations occurred, it could have a material adverseeffect on our business and operations.

 

**Our failure to complywith current or future governmental regulations could adversely affect ourbusiness.**

 

The formulation, manufacturing, packaging, labeling, advertising,distribution, and sale of dietary supplements such as those sold by us aresubject to regulation by a number of federal, state and local agencies,principally, the Food & Drug Administration (“FDA”) and the Federal TradeCommission (“FTC”), as well as foreign agencies in areas where we may operate.Among other matters, this regulation is concerned with product safety andclaims made with respect to a product’s ability to provide health-relatedbenefits. These agencies have a variety of procedures and enforcement remediesavailable to them, including:

 

•                  initiatinginvestigations;

•                  issuing warningletters and cease and desist orders;

•                  requiringcorrective labeling or advertising;

•                  requiringconsumer redress such as requiring that a company offer to repurchase productspreviously sold to consumers;

•                  seekinginjunctive relief or product seizures; and

•                  imposing civilpenalties or commencing criminal prosecution.

 

Federal and state agencies in the past have used these remedies inregulating participants in the dietary supplements industry, including theimposition by federal agencies of civil penalties in the millions of dollarsagainst a few industry participants. In addition, publicity related to dietarysupplements may result in increased regulatory scrutiny of the nutritionalsupplements industry.

 

Our failure to comply with applicable laws could subject us to severelegal sanctions, which could have a material adverse effect on our business andresults of operations. We cannot assure you that the regulatory environment inwhich we operate will not change or that such regulatory environment, or any specificaction taken against us, will not result in a material adverse effect on ourbusiness and operations. We cannot assure you that a state will not interpretclaims presumptively valid under Federal law as illegal under that state’sregulations, or that future FDA regulation or FTC decisions will not restrictthe permissible scope of such claims. Additionally, we cannot assure you thatsuch proceedings or investigations or any future proceedings or investigationswill not have a material adverse effect on our business or operations.

 

**If we are deemed to be subject tothe federal Medicare Anti-Kickback statutes or similar state statutes, it couldhave a material adverse effect on our business and operations.**

** **

The healthcare industry is subject to extensive federal and stateregulation relating to licensure, conduct of operations, ownership offacilities, addition of facilities and services, and payment for services. AsEssentum® is not subject to Medicare or Medicaid reimbursement, we do notbelieve that our activities are subject to regulation under the federalAnti-Kickback statutes. The Anti-Kickback statutes generally prohibit personsfrom knowingly and willfully soliciting, receiving, offering or providingremuneration, directly or indirectly, to induce either the referral of anindividual, or the furnishing, recommending, or arranging for a good orservice, for which payment may be made under a federal healthcare program suchas the Medicare and Medicaid programs. However, the statute was drafted broadlyand it has resulted in many arrangements and practices that are lawful inbusinesses outside of the healthcare industry to be deemed unlawful. As aresult, there has been a lack of uniform interpretation of the Anti-Kickbackstatutes, which make compliance even more difficult. The penalties forviolating these statutes can be severe and include criminal penalties and civilsanctions, fines, imprisonment and possible exclusion from the Medicare andMedicaid programs. Many states have adopted laws similar to the federalAnti-Kickback statutes. Some of these state prohibitions apply to referral ofpatients for healthcare services reimbursed by any source, not only theMedicare and Medicaid programs. Although we believe that we comply with bothfederal and state anti-kickback laws, any finding of a violation of these lawscould subject us to criminal and civil penalties or possible exclusion fromfederal or state healthcare programs. Such penalties would adversely affect ourfinancial performance and our ability to operate our business.

 

**Our insurance may beinadequate to cover us against product liability claims that may be broughtagainst us.**

 

We maintain liability insurance for us and our subsidiaries with policylimits generally of $1.0 million per occurrence and $2.0 million in theaggregate. Our insurance program includes property, casualty, comprehensivegeneral liability, and products liability coverage. We believe that ourinsurance coverage is adequate. The testing, marketing, and sale of health careproducts entail an inherent risk of product liability. We cannot assure youthat product liability claims relating to dietary supplement products will notbe asserted against us, our licensees, or third parties with whom we operate.Many claims related to dietary supplements have already been brought againstbusinesses in our industry, although none against our products or us. Further,we cannot assure you that such insurance will provide adequate coverage againstany potential claims. A product liability claim or product recall could have amaterial adverse effect

 

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on our business, financial condition, or results of operations.

 

**We may havedifficulty effectively managing our growth.**

 

Over the past several years, we have experienced significant growth inour business activities through a variety of transactions, including ouracquisitions of MAF, COF, ENI, and DFN. Although we agreed with the holders ofour Senior Secured Convertible Notes that we would not enter into certainacquisition agreements for specific periods, we expect our business to continueto grow through acquisition in the future. Growth of this nature involvesnumerous risks such as:

 

•                  difficulties andexpenses incurred in connection with the subsequent assimilation of theoperations and services or products of the acquired company;

•                  the potentialloss of key employees of the acquired company; and

•                  the diversion ofmanagement’s attention from other business concerns.

 

If we are unable to effectively address these risks, we may be requiredto restructure the acquired business or write off the value of some or all ofthe assets of the acquired business. Further, this type of growth requiresincreased investments in management personnel, financial and management systemsand controls, and facilities. We cannot assure you that we will experienceparallel growth in these areas. If these areas do not grow at the same time,our operating margins may decline from current levels.

 

**We depend on one ofour key employees and the loss of his services could harm our business.**

 

We are heavily dependent upon Stuart A. Benson, our Chief ExecutiveOfficer and President. We have entered into an employment agreement with Mr.Benson that provides for him to be employed by us through August 2006.However, he may terminate the agreement at any time upon 60 days’ notice to us.The loss of Mr. Benson could have a material adverse effect on us. Under theterms of the employment agreement, we are permitted to apply to obtain, andhave made application with respect thereto, for a “key-man” insurance policyfor Mr. Benson for $1,000,000. We will be the beneficiary of this policy whenand if the insurance is obtained.

 

***Risks related to ourcommon stock***

 

**Our existing stockholderswill experience dilution if we issue additional securities.**

 

In December 2003, our Board of Directors and a majority of ourstockholders approved an increase in our authorized capital from 100,000,000shares of common stock to 150,000,000 shares of common stock. As ofMarch 26, 2004, we have outstanding 61,456,004 shares of common stock(excluding 1,242,887 shares of common stock that will be issued for conversionof our Series A Preferred Stock, which occurred in December 2003),2,500,000 shares of preferred stock currently convertible into 2,500,000 sharesof common stock, options to purchase 3,831,483 shares of common stock, warrantsto purchase shares of common stock and Senior Secured Convertible Notesinitially convertible into 4,587,738 shares of common stock. If we issueadditional shares, or if our existing stockholders exercise or convert theiroutstanding options, warrants, or notes, our other stockholders may find theirholdings drastically diluted, which if it occurs, means that they will own asmaller percentage of our company. Further, any issuance of additionalsecurities to various persons or entities in lieu of cash payments will lead tofurther dilution. If all convertible instruments were converted and alloutstanding warrants and options were exercised, we would have 98,593,764shares of common stock outstanding.

 

**We are party to avoting agreement pursuant to which certain officers and directors can dominateour Board of Directors.**

 

We are party to a voting agreement with Stuart A. Benson, our ChiefExecutive Officer, Donald C. Hannah, a member of our Board of Directors, andSkyePharma, PLC and Fifth Avenue Capital, Inc., both significant stockholders.Under this agreement, the parties have the ability to elect a majority of ourBoard of Directors. As a result, they will be able to approve most, if not all,of our corporate actions, including the appointment of officers.

 

**Because the marketprice of our common stock is highly volatile, it is difficult to determine thetrue value of our company.**

 

Our common stock has been traded on the OTC Bulletin Board sinceMarch 28, 2002. The market price of our common stock has been highlyvolatile and may continue to be volatile in the future. Because of our shareprice volatility, it is difficult to determine the true market value of ourcompany. Significant volatility in the market price of our common stock mayarise due to factors such as:

 

•                  our developingbusiness;

•                  a continuednegative cash flow;

•                  relatively lowprice per share;

 

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•                  relatively lowpublic float;

•                  variations inquarterly operating results;

•                  general trendsin the nutraceuticals and health care industry;

•                  the number ofholders of our common stock; and

•                  the interest ofsecurities dealers in maintaining a market for our common stock.

 

As long as there is only a limited public market for our common stock,the sale of a significant number of shares of our common stock at anyparticular time could be difficult to achieve at the market prices prevailingimmediately before such shares are offered and could cause a severe decline inthe price of our common stock.

 

**If our common stockbecomes subject to the SEC’s penny stock rules, broker-dealers may experiencedifficulty in completing customer transactions and trading activity in oursecurities may be adversely affected.**

 

If at any time we have net tangible assets of $5,000,000 or less andour common stock has a market price per share of less than $5.00, transactionsin our common stock may be subject to the “penny stock” rules promulgated underthe Securities Exchange Act of 1934. Under these rules, broker-dealers whorecommend such securities to persons other than institutional accreditedinvestors:

 

•                  must make aspecial written suitability determination for the purchaser;

•                  receive thepurchaser’s written agreement to a transaction prior to sale;

•                  provide thepurchaser with risk disclosure documents which identify certain risksassociated with investing in “penny stocks” and which describe the market forthese “penny stocks” as well as a purchaser’s legal remedies; and

•                  obtain a signedand dated acknowledgment from the purchaser demonstrating that the purchaserhas actually received the required risk disclosure document before a transactionin a “penny stock” can be completed.

 

If our common stock becomes subject to these rules, broker-dealers mayfind it difficult to effect customer transactions and trading activity in oursecurities may be adversely affected. As a result, the market price of oursecurities may be depressed, and you may find it more difficult to sell oursecurities.

 

**Our pendingregistration of certain shares of common stock may affect the market price andliquidity of our common stock.**

 

In January 2004, we filed a Registration Statement on Form SB-2under the Securities Act of 1933 to register approximately 45 million shares ofcommon stock. Once this registration is effective, which we anticipate to occurduring the second quarter of 2004, the selling stockholders will be able tosell these shares in the public market. The ability on the part of theseselling stockholders to make these sales may have an adverse impact on ourability to raise capital in the public market and may affect the price andliquidity of our common stock in the public market.

 

**No dividends havebeen paid on our common stock.**

 

To date, we have not paid any cash dividends on our common stock and wedo not expect to declare or pay dividends on the common stock in theforeseeable future. In addition, the payment of cash dividends is limited bythe terms of our outstanding preferred stock and Senior Secured ConvertibleNotes.

 

**ITEM 2. DESCRIPTION OF PROPERTIES**

 

Weown no real property and currently lease all of our office facilities. Ourexecutive and administrative offices are located at 5080 North 40thStreet, Phoenix, Arizona with operating subsidiaries located in California andUtah. The respective facilities are leased on terms summarized below:

 
| **Location**     |   | **Square Feet** |   | **Annual Rental** |   | **Lease Expiration** |       |
|------------------|--------|-----------------|--------|-------------------|--------|----------------------|------------|
| Phoenix, AZ      |   | Approx. 4,800   |   | $                 | 96,520 |                 | 10/31/2004 |   |
|             |   |            |   |              |   |                 |       |
| San Diego, CA    |   | Approx. 1,500   |   | $                 | 30,000 |                 | 10/31/2004 |   |
|             |   |            |   |              |   |                 |       |
| Spanish Fork, UT |   | Approx. 16,100  |   | $                 | 58,885 |                 | 11/30/2008 |   |

 

Wepreviously leased additional space in Boonton, NJ, in connection with ourNovember 2002 acquisition of MAF. The facility consisted of approximately3,500 square feet for approximately $2,100 per month. This lease expired inAugust 2003, at which point the operations of MAF were transferred to ourUtah facility and the New Jersey location was abandoned.

 

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Webelieve that we have sufficient space for our current and anticipated near-termneeds.

 

**ITEM 3.LEGAL PROCEEDINGS**

 

Fromtime to time, we and our subsidiaries are parties to a variety of legalproceedings arising out of the normal course of business, including cases inwhich damages may be sought. We believe we have valid defenses and arevigorously defending any pending litigation. While the results of litigationcannot be predicted with certainty, we believe that the outcome of theseproceedings will not have a material adverse effect on our consolidatedfinancial position, results of operations, or cash flows.

 

**ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Nomatters were submitted to our security holders during the fourth quarter of thefiscal year ended December 31, 2003.

 

**PART II.**

 

**ITEM 5.MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

*Market Information*

 

Our common stock has been quoted on the OTC BulletinBoard since March 28, 2002 under the symbol “VTLV.” The following tablesets forth, for the periods indicated, the high and low bids for our commonstock as reported on the OTC Bulletin Board (bids reflect interdealer quotations,without retail mark-ups, mark-downs or commissions, and may not necessarilyrepresent actual transactions):

 
|                                         |   | **High** |   | **Low** |   |
|----------------------------------------------|--------|----------|--------|---------|--------|
| **Fiscal  Year 2002**                        |   |     |   |    |   |
| First Quarter (from  March 28, 2002)    |   | $        | 1.40   |    | $      | 0.85 |   |
| Second Quarter                               |   | $        | 4.05   |    | $      | 0.95 |   |
| Third Quarter                                |   | $        | 2.99   |    | $      | 0.91 |   |
| Fourth Quarter                               |   | $        | 2.01   |    | $      | 0.64 |   |
| **Fiscal  Year 2003**                        |   |     |   |    |   |
| First Quarter                                |   | $        | 1.02   |    | $      | 0.68 |   |
| Second Quarter                               |   | $        | 1.25   |    | $      | 0.46 |   |
| Third Quarter                                |   | $        | 1.52   |    | $      | 1.00 |   |
| Fourth Quarter                               |   | $        | 1.61   |    | $      | 1.10 |   |
| **Fiscal  Year 2004**                        |   |     |   |    |   |
| First Quarter (through  March 26, 2004) |   | $        | 1.19   |    | $      | 0.77 |   |

 

*DividendPolicy*

 

To date, we have not paid any dividends on our common stock. Anypayment of dividends in the future is within the discretion of our Board ofDirectors and will depend on our earnings, if any, our capital requirements,financial condition, and other relevant factors. Our Board of Directors doesnot intend to declare any cash or other dividends in the foreseeable future,but intends instead to retain earnings, if any, for use in our business operations.In addition, our outstanding 12% Senior Secured Convertible Notes provide thatwe may not declare or pay any dividend on our common stock so long as anyamounts are outstanding on the notes.

 

*Transfer Agent*

 

Our common stock transfer agent is Continental Stock Transfer &Trust Company, 17 Battery Place, New York, New York.

 

17

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*Holders*

 

As of March 15, 2004, there were 397 holders of record of ourcommon stock. We believe there are in excess of 700 beneficial owners of ourcommon stock.

 

*Sales ofUnregistered Securities*

 

*Stock Grants*

 

Duringthe years ended December 31, 2003 and 2002, we issued 4,141,100 and343,500 shares of restricted common stock, respectively, in consideration forconsulting, investment banking, or other services rendered, compensation,release of debt, or various other claims which the parties may have had againstus in transactions exempt under Section 4(2) of the Act, as a transactionby an issuer not involving a public offering, as set forth below:

 
|                                      |   | **2003**   |   | **2002**          |      |
|-------------------------------------------|--------|------------|--------|-------------------|-----------|
| **Name**                                  |   | **Shares** |   | **Consideration** |      | **Shares** |   | **Consideration** |   |
| Aegis Capital Corporation(2)              |   | 150,000    |   | $                 | 184,000   |   | 50,000 |   | $ | 68,000 |   |
| Arizona Heart Institute                   |   | 100,000    |   | $                 | 132,000   |   | — |   | — |   |
| Allen, David(1)                           |   | 25,000     |   | $                 | 33,500    |   | — |   | — |   |
| Atlas Capital                             |   | 54,000     |   | $                 | 58,320    |   | — |   | — |   |
| Beadle, Carson(1)                         |   | 85,000     |   | $                 | 106,000   |   | — |   | — |   |
| Behringer, Mark                           |   | —     |   | —            |      | 68,000 |   | $ | 80,920 |   |
| CEO Cast                                  |   | 12,000     |   | $                 | 14,160    |   | — |   | — |   |
| Chen, Stephen S.(4)                       |   | 187,500    |   | $                 | 221,250   |   | — |   | — |   |
| Cranshire Capital, LP                     |   | 71,400     |   | $                 | 82,824    |   | — |   | — |   |
| Crescent International, LTD               |   | 50,000     |   | $                 | 58,000    |   | — |   | — |   |
| Cooke, Robert A.                          |   | —     |   | —            |      | 32,000 |   | $ | 38,080 |   |
| Davidson, Michael H.                      |   | 20,000     |   | $                 | 17,600    |   | — |   | — |   |
| Designees of Aegis Capital Corporation(2) |   | 58,000     |   | $                 | 75,400    |   | — |   | — |   |
| Donner Corporation                        |   | —     |   | —            |      | 2,500 |   | $ | 5,125 |   |
| Edson, Bradley(3)                         |   | 1,300,000  |   | $                 | 1,781,000 |   | — |   | — |   |
| Eide, Robert(1)                           |   | 217,000    |   | $                 | 285,100   |   | 30,000 |   | $ | 51,000 |   |
| Equity International, LTD                 |   | 100,000    |   | $                 | 134,000   |   | — |   | — |   |
| Greer, Carolyn                            |   | 2,400      |   | $                 | 2,784     |   | — |   | — |   |
| Grove, Janet                              |   | 2,400      |   | $                 | 2,784     |   | — |   | — |   |
| Hanna, Donald C.(1)                       |   | 75,000     |   | $                 | 100,500   |   | 30,000 |   | $ | 51,000 |   |
| HCFP/Brenner Securities                   |   | 1,222,600  |   | $                 | 1,513,582 |   | 48,000 |   | $ | 81,600 |   |
| Hickey, Paul                              |   | 50,000     |   | $                 | 35,500    |   | — |   | — |   |
| Kassai, Phillip                           |   | 45,000     |   | $                 | 68,400    |   | — |   | — |   |
| Labella, Charles                          |   | 8,400      |   | $                 | 9,744     |   | — |   | — |   |
| Morris, Stephen(4) (5)                    |   | 25,000     |   | $                 | 33,500    |   | — |   | — |   |
| Myers, Daniel                             |   | 45,000     |   | $                 | 68,400    |   | — |   | — |   |
| Northline Limited                         |   | 50,000     |   | $                 | 59,000    |   | — |   | — |   |
| Prima Consulting                          |   | —     |   | —            |      | 50,000 |   | $ | 140,000 |   |
| Quick, Leslie(1)                          |   | 85,000     |   | $                 | 106,000   |   | — |   | — |   |
| Sloan Securities Corp                     |   | 25,400     |   | $                 | 35,408    |   | — |   | — |   |
| Smith, Gowrie(5)                          |   | 25,000     |   | $                 | 33,500    |   | — |   | — |   |
| Smith, Reed                               |   | 30,000     |   | $                 | 21,300    |   | — |   | — |   |
| Weil Consulting Corporation               |   | —     |   | —            |      | 33,000 |   | $ | 39,270 |   |
| Wernick, Howard                           |   | 20,000     |   | $                 | 17,600    |   | — |   | — |   |
|                                      |   | 4,141,100  |   | $                 | 5,291,156 |   | 343,500 |   | $ | 554,995 |   |

 

18

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----

(1)          Current or former member of our Board ofDirectors.

(2)          Principal is a current or former member of ourBoard of Directors and/or an officer.

(3)          Former Chairman and Chief Executive Officer.

(4)          Is a principal of an entity that is a majorshareholder.

(5)          These shares were issued in error and we arein process of rescinding them.

 

Certain of these issuances werefor services to be provided over a contract period ranging from 12 months tothree years, thus related amounts were capitalized as a component of equity andamortized to expense over the vesting periods. For the years endedDecember 31, 2003 and 2002, $428,335 and $92,785 were amortized toexpense, respectively. The value of unamortized restricted common stock issuedfor services as of December 31, 2003 and 2002 was $390,250 and $249,085,respectively.

 

Certain of these issuances werefor services related to acquisitions, private placements, or debt financing,thus related amounts were capitalized as a component of goodwill or intangibleassets, equity, or deferred debt charges, respectively. Common stock issued forcompensation and other services were generally charged to expense as incurredor amortized to expense based on their vesting. The value of stock issued forsuch services and capitalized accordingly is as follows at December 31:

 
|                             |   | **2003** |      | **2002** |   |
|----------------------------------|--------|----------|-----------|----------|--------|
| Acquisitions                     |   | $        | 1,720,320 |     | $      | 68,000 |   |
| Private Placements               |   | $        | 73,750    |     | $      | — |   |
| Debt  Financing                  |   | $        | 297,840   |     | $      | — |   |
| Compensation  and other services |   | $        | 3,199,246 |     | $      | 486,995 |   |

 

*Options/Warrants Grants*

 

Duringthe years ended December 31, 2003 and 2002, we issued 6,817,900 and3,755,000 options or warrants to purchase shares of restricted common stock,respectively, in consideration for consulting, investment banking, or otherservices rendered, compensation, release of debt, or various other claims whichthe parties may have had against us in transactions exempt underSection 4(2) of the Act, as a transaction by an issuer not involving apublic offering, as set forth below. This table excludes options and warrantsissued in conjunction with various debt and equity offerings and Series APreferred stock conversions of 12,565,561 and 2,735,000 during the years endedDecember 31, 2003 and 2002 respectively.

 

19

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|                      |   | **2003**                 |   | **2002**           |   |
|---------------------------|--------|--------------------------|--------|--------------------|--------|
| **Name**                  |   | **Options or  Warrants** |   | **Exercise Price** |   | **Consideration** |   | **Options or  Warrants** |   | **Exercise Price** |   | **Consideration** |   |
| Aegis Capital Corp(2)     |   | 72,400                   | (4)    | $                  | 1.00   |   | $ | 48,667 |   | — |   | — |   | — |   |
| Agryropolus, D            |   | —                   |   | —             |   | — |   | 120,000 | (5) | $ | 2.80 |   | $ | 138,274 |   |
| Atlas Capital Services    |   | 35,000                   | (4)    | $                  | 1.00   |   | $ | — |   | — |   | — |   | — |   |
| Benson, Stuart(1)         |   | 5,000,000                | (4)    | $                  | 0.01   |   | $ | 6,800,000 |   | 1,340,000 | (4) | $ | 1.50 |   | $ | — |   |
| Burkhart, Brian           |   | —                   |   | —             |   | — |   | 30,000 | (11) | $ | 2.40 |   | $ | — |   |
| Chen, Stephen(3)          |   | 709,500                  | (4)    | $                  | 2.00   |   | $ | 137,926 |   | 200,000 | (5) | $ | 3.00 |   | $ | 230,189 |   |
| Davidson, Michael         |   | —                   |   | —             |   | — |   | 200,000 | (6) | $ | 1.00 |   | $ | 115,450 |   |
| Donner Corp International |   | —                   |   | —             |   | — |   | 30,000 | (4) | $ | 2.05 |   | $ | 17,242 |   |
| Gerst, Martin             |   | —                   |   | —             |   | — |   | 500,000 | (4) | $ | 1.50 |   | $ | 280,580 |   |
| Hayes, Annette            |   | —                   |   | —             |   | — |   | 125,000 | (12) | $ | 1.00 |   | $ | — |   |
| HCFP/Brenner Securities   |   | 345,600                  | (4)    | $                  | 1.00   |   | $ | 177,723 |   | — |   | — |   | — |   |
| Howe, Bruce               |   | 300,000                  | (9)    | $                  | 1.40   |   | $ | 120,129 |   | — |   | — |   | — |   |
| Howe, Maynard             |   | 20,000                   | (8)    | $                  | 1.40   |   | $ | 8,008 |   | — |   | — |   | — |   |
| Howe, Roger               |   | 20,000                   | (8)    | $                  | 1.40   |   | $ | 8,009 |   | — |   | — |   | — |   |
| Krauss, Ronald            |   | —                   |   | —             |   | — |   | 15,000 | (7) | $ | 2.80 |   | $ | 14,226 |   |
| Maron, David              |   | —                   |   | —             |   | — |   | 15,000 | (7) | $ | 2.80 |   | $ | 15,225 |   |
| Michelson, Leslie         |   | —                   |   | —             |   | — |   | 500,000 | (5) | $ | 1.00 |   | $ | 289,000 |   |
| Sloan Securities Corp     |   | 315,400                  | (4)    | $                  | 1.00   |   | $ | 184,733 |   | — |   | — |   | — |   |
| Smith, Brian              |   | —                   |   | —             |   | — |   | 150,000 | (5) | $ | 1.00 |   | $ | 86,218 |   |
| Sprecher, Dennis          |   | —                   |   | —             |   | — |   | 15,000 | (7) | $ | 2.80 |   | $ | 20,498 |   |
| Sutherland, John          |   | —                   |   | —             |   | — |   | 15,000 | (7) | $ | 2.80 |   | $ | 20,498 |   |
| Wallace, Martin           |   | —                   |   | —             |   | — |   | 500,000 | (10) | $ | 1.50 |   | $ | — |   |
|                      |   | 6,817,900                |   | $0.01 - $2.00      |   | $ | 7,485,195 |   | 3,755,000 |   | $1.00 - $3.00 |   | $ | 1,227,400 |   |
|                           |        |                          |        |                    |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Current or former member of our Board ofDirectors and/or a current or former officer.

(2)          Principal is a current or former member of ourBoard of Directors.

(3)          Is a principal of an entity that is a majorshareholder.

(4)          Immediately vested; three to five yearexpirations.

(5)          Vests equally over 18 months; five-yearexpiration.

(6)          Vests equally over 24 months; five-yearexpiration.

(7)          Vests 1,250 per quarter over three years;five-year expiration.

(8)          Vests 1,850 November 1, 2003 and 1,605per quarter thereafter; five-year expiration.

(9)          Vests 100,000 per year contingent upon certainperformance measures of DFN; five-year expiration.

(10)    Vestssemi-annually contingent upon certain performance measures of Essentum®;five-year expiration.

(11)    Vests 2,500per quarter over three years; five-year expiration.

(12)    Vestsquarterly over three years with 40,000 in years one and three and 45,000 inyear two; four-year expiration.

 

Certain of these grants were forservices to be provided over a contract period ranging from 12 months to threeyears, thus related amounts were capitalized as a component of equity andamortized to expense over the vesting periods. For the years endedDecember 31, 2003 and 2002, $542,110 and $494,517 were amortized toexpense, respectively. The value of unamortized options and warrants issued forservices as of December 31, 2003 and 2002 was $206,792 and $732,883,respectively.

 

Additionally, certain of thesegrants were for investment banking or other services related to privateplacements, debt or equity, thus related amounts were capitalized as acomponent of equity or deferred loan costs. The value of stock issued for suchservices capitalized as a component of equity or deferred loan costs was$516,549 at December 31, 2003.

 

20

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*Acquisitions*

 

OnOctober 14, 2003, we completed the acquisition of DFN (the “DFNAcquisition”). The purchase price was 1,650,003 restricted shares of our commonstock, with no registration rights. The issuance of securities in theacquisition was not a public offering, and thus was an exempt offering underSection 4(2) of the Securities Act. Concurrently with the closing of theDFN Acquisition, we authorized the issuance of 50,000 shares of common stockvalued at $59,000 to Northline Limited in connection with investment bankingactivities rendered in the transaction.

 

OnAugust 20, 2003, we completed the acquisition of ENI (the “ENIAcquisition”). The purchase price was 31,248,584 restricted shares of ourcommon stock, with no registration rights, and 251,390 options issued inexchange for existing ENI options, with a fair value of $253,904 at the date ofgrant. The issuance of securitiesin the acquisition was not a public offering, and thus was an exempt offeringunder Section 4(2) of the Securities Act. Concurrently with the closing ofthe ENI Acquisition, we authorized the issuance of 950,000 and 200,000 sharesof common stock valued at $1,495,000 to Brenner Securities and Aegis CapitalCorp, respectively, in connection with investment banking or other activitiesrendered in the transaction.

 

OnJuly 3, 2003, we completed the acquisition of COF (the “COF Acquisition”).The purchase price was 2,600,000 restricted shares of our common stock, with noregistration rights. The issuance of securities in the acquisition was not apublic offering, and thus was an exempt offering under Section 4(2) of theSecurities Act. Concurrently with the closing of the COF Acquisition, weauthorized the issuance of 100,000 and 54,000 shares of common stock with anaggregate value of $166,320 to Aegis Capital Corp and Atlas Capital Services,respectively, in connection with investment banking activities rendered in thetransaction.

 

OnNovember 20, 2002, we completed the acquisition of MAF (the “MAF Acquisition”).The purchase price was 2,500,000 restricted shares of our common stock, with noregistration rights. The issuance of securities in the acquisition was not apublic offering, and thus was an exempt offering under Section 4(2) of theSecurities Act. Concurrently with the closing of the MAF Acquisition, weauthorized the issuance of 50,000 shares of common stock valued at $68,000 toAegis Capital Corp in connection with investment banking activities rendered inthe transaction.

 

*Private Placements*

 

BetweenOctober and December 2003, we borrowed an aggregate principal amountof $1,530,000 in the form of Senior Convertible Notes (the “Bridge Notes”), dueApril 28, 2004, in a private placement subject to certain registrationrights, generating cash proceeds of $1,316,400, net of cash debt issue costs of$213,600. Principal and interest at a rate of 10% per annum is payable in asingle installment on the maturity date in cash or common stock, at ourdiscretion, at a price equal to $1.00 per share. As part of the transactions,Bridge Note holders received 3,060,000 and 1,530,000 warrants to purchasecommon stock at an exercise price of $1.00 and $1.50 per share, respectively.In accordance with the terms of these Bridge Notes, because we consummated adebt financing before the maturity date, the entire principal amount of thenotes plus accrued interest totaling $1,547,738 has been converted into thedebt securities offered in the December 2003 transaction described below.

 

InDecember 2003, we borrowed an aggregate principal amount of $4,587,738 inthe form of Senior Secured Convertible Notes (the “Secured Notes”), dueDecember 17, 2008, in a private placement subject to certain registrationrights, therein converting Bridge Note principal and interest of $1,547,738 asdescribed above, and generating cash proceeds of $2,502,400, net of cash debtissue costs of $537,600. The Secured Notes bear interest at a rate of 12% perannum, 8% of which is payable semi-annually in cash each June andDecember, while 4% per annum may be paid, at our discretion, in cash or commonstock at a price equal to the ten day average trading price of our common stockfive business days prior to the relevant interest payment date.

 

Wemay redeem the Secured Notes commencing December 15, 2004, provided theten-day average trading price of our common stock prior to the redemption is atleast $3.00 per share. The Secured Notes are collateralized by our assets, havepriority in right of payment over all our indebtedness, and include certainprovisions related to change in control, reorganization, recapitalization, andother adjustments. In addition, Secured Note holders received 4,587,738warrants to purchase common stock at an exercise price of $1.00 per share.These offerings were exempt pursuant to Rule 506 of Regulation D,under the Securities Act.

 

On August 20, 2003, concurrent with the ENI Acquisition, we soldto a single investor 1,000,000 shares of Series D Preferred Stock at $1.00 pershare, generating cash proceeds of $815,000, net of cash offering costs of$185,000. Each share of Series D Preferred Stock is convertible into one shareof common stock at the option of the holder at any time. This offering was exempt pursuant toRule 506 of Regulation D, under the Securities Act.

 

On July 9, 2003, we sold to one investor 5 units, each consistingof 100,000 shares of non-voting 50% Series C Preferred Stock, 100,000 Series DWarrants, and 100,000 Series E Warrants, aggregating 500,000 shares of Series CPreferred Stock at $1.00 per share, 500,000 Series D Warrants at an exerciseprice of $1.30 per share, and 500,000 Series E Warrants at an exercise price of$1.60

 

21

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per share, generating cash proceeds of $437,500, net of cash offeringcost of $62,500. The holder of the Series C Preferred Stock is entitled to atwo-time dividend at the rate of 50% per annum, payable in cash or common stockon the first and second anniversary of the issuance date with no obligation topay dividends thereafter. Unpaid and/or undeclared dividends are cumulative.Each share of Series C Preferred Stock is convertible into one share of commonstock at the option of the holder at any time after the first anniversary ofthe date of issuance. This offering was exempt pursuant to Rule 506 of Regulation D,under the Securities Act.

 

On April 16, 2003, we sold to one investor 10 units, eachconsisting of 100,000 shares of non-voting 25% Series B Preferred Stock,100,000 Series D Warrants, and 100,000 Series E Warrants, aggregating 1,000,000shares of Series B Preferred Stock at $1.00 per share, 1,000,000 Series DWarrants at an exercise price of $1.30 per share, and 1,000,000 Series EWarrants at an exercise price of $1.60 per share, generating cash proceeds of$875,000, net of cash offering costs of $125,000. The holder of the Series BPreferred Stock is entitled to a one-time dividend at a rate of 25% per annum,payable in cash or common stock on the one-year anniversary of the issuancedate with no obligation to pay dividends thereafter. Unpaid and/or undeclareddividends are cumulative. Each share of Series B Preferred Stock is convertibleinto one share of common stock at the option of the holder at any time afterthe first anniversary of the date of issuance. The Series B Preferred Stock hasno voting rights, liquidation preferences, or protective provisions. This offering was exempt pursuant toRule 506 of Regulation D, under the Securities Act.

 

On November 20, 2002, concurrent with the MAF Acquisition, we sold19.54 units, each unit consisting of 70,000 shares of common stock, 70,000Series B Warrants, and 70,000 Series C Warrants, aggregating 1,367,500 sharesof common stock at $1.00 per share, 1,367,500 Series B Warrants at an exerciseprice of $1.65 per share, and 1,367,500 Series C Warrants at an exercise priceof $2.14 per share, generating cash proceeds of $1,197,115, net of cashoffering costs of $170,385. This offering was exempt pursuant to Rule 506 of Regulation D,under the Securities Act.

 

Between February and June 2002, we sold 3,712,000 shares of10% Series A Preferred Stock at $1.00 per share, generating cash proceeds of$3,593,807, net of cash offering costs of $118,193. Holders may convert theirshares into a like amount of common stock at any time after the firstanniversary date of issuance and will convert by their terms after 18 months.Upon conversion, holders of Series A Preferred Stock will receive one Series AWarrant per five preferred shares converted to purchase one share of commonstock at an exercise price of $2.00 per share, exercisable one year from thedate of issuance. Theholders of the Series A Preferred Stock have no voting rights, but are entitledto a preferred dividend at the rate of 10% per annum, which iscumulative and shall be paid inadditional shares of preferred stock at a price equal to $1.00 per share andwill contain all the rights and privileges and be subject to all the terms andconditions as set forth herein. Thisoffering was exempt pursuant to Rule 506 of Regulation D, under theSecurities Act.

 

Nounderwriters were involved in connection with the sales of securities referredto in this Item 5.

 

**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATION**

 

*Overview*

* *

Through ouroperating subsidiaries, we develop or license nutraceuticals andpharmaceuticals, marketing them for distribution through physicians, medicalgroups, chiropractic offices, and retail outlets. In addition, we formulate,market, and distribute vitamins, herbs, high quality dietary supplements, andtherapeutic and functional food products through similar distribution channels.Nutraceuticals are products that are isolated or purified from foods andgenerally sold in medicinal forms not usually associated with foods, includingtablets, capsules, or drops. These nutraceuticals may have physiologicalbenefits or have the ability to reduce the risk of chronic disease beyond basicnutritional products. We develop and test our nutraceuticals in collaborationwith leading medical experts in the nutraceuticals field. We have designed themto be incorporated by physicians into a standard physician-patient program inwhich patients supplement doctor-prescribed pharmaceuticals with ournutraceuticals. Our initial areas of focus are cardiovascular health and weightloss.

 

Our business strategy is to capitalize on the growing complimentary andalternative medicine market by creating scientifically proven and supportedcondition-specific formulations, offering a broad range of natural, generalhealth nutraceuticals and functional foods/beverages, and exploring alternativedistribution channels by gaining practitioner confidence and support for ourproducts. We plan to focus initially on certain target conditions, includingcardiovascular disease and obesity, providing the market with high quality,relevant products through key distribution channels.

 

22

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*Resultsof Operations*

* *

The following sets forth selected financial data and its percentage ofnet sales for the years ended December 31:

 
|                                |   | **2003**    |        | **2002** |     |       |   |
|-------------------------------------|--------|-------------|-------------|----------|----------|------------|--------|
|                                |   | **Amount**  |        | **%**    |     | **Amount** |   | **%** |   | **Increase  (Decrease)** |   |
| Revenue                             |   | $           | 2,855,123   |     | 100.0    | %          | $      | 260,844 |   | 100.0 | % | $ | 2,594,279 |   |
| Cost of goods sold                  |   | 1,723,013   |        | 60.3     | %        | 193,032    |   | 74.0 | % | 1,529,981 |   |
| Gross profit                        |   | 1,132,110   |        | 39.7     | %        | 67,812     |   | 26.0 | % | 1,064,298 |   |
| Administrative expenses             |   |        |        |     |     |       |   |   |   |   |   |
| Salaries and benefits               |   | 11,998,759  |        | 420.3    | %        | 1,341,103  |   | 514.1 | % | 10,657,656 |   |
| Professional and consulting fees    |   | 3,261,078   |        | 114.2    | %        | 1,607,621  |   | 616.3 | % | 1,653,457 |   |
| Selling, general and administrative |   | 2,054,526   |        | 72.0     | %        | 510,013    |   | 195.5 | % | 1,544,513 |   |
| Research and development            |   | 410,648     |        | 14.4     | %        | 510,436    |   | 195.7 | % | (99,788 | ) |
| Depreciation and amortization       |   | 1,972,303   |        | 69.1     | %        | 52,959     |   | 20.3 | % | 1,919,344 |   |
| Total                               |   | 19,697,314  |        | 689.9    | %        | 4,022,132  |   | 1542.0 | % | 15,675,182 |   |
|                                |   |        |        |     |     |       |   |   |   |   |   |
| Net loss from operations            |   | (18,565,204 | )           | (650.2%  | )        | (3,954,320 | )      | (1516.0% | ) | (14,610,884 | ) |
| Other income (expense)              |   |        |        |     |     |       |   |   |   |   |   |
| Impairment of goodwill              |   | (6,777,480  | )           | (237.4%  | )        | —     |   | 0.0 | % | (6,777,480 | ) |
| Other expense                       |   | (43,249     | )           | (1.5%    | )        | —     |   | 0.0 | % | (43,249 | ) |
| Interest income                     |   | 5,322       |        | 0.2      | %        | 13,077     |   | 5.0 | % | (7,755 | ) |
| Interest expense                    |   | (5,240,611  | )           | (183.6%  | )        | (8,652     | )      | (3.3% | ) | (5,231,959 | ) |
| Net loss                            |   | $           | (30,621,222 | )        | (1072.5% | )          | $      | (3,949,895 | ) | (1514.3% | ) | $ | (26,671,327 | ) |

 

*Year EndedDecember 31, 2003 Compared to Year Ended December 31, 2002*

 

*Revenue*: Total revenue for the years ended December 31, 2003 and 2002 was $2,855,123 and $260,844, respectively, an increase of $2,594,279. This increase is attributable to our various acquisitionsduring late 2002 and throughout 2003 of MAF, COF, and DFN, each contributingapproximately $1,370,000, $987,000, and $438,000 in revenues during the yearended December 31, 2003, respectively, compared to approximately $138,000of MAF revenue in 2002. The increase is offset to a lesser extent by decreasein sales of Essentum® in 2003.

 

*Cost of Goods Sold and Gross Profit*: Costof goods sold for the years ended December 31, 2003 and 2002 was $1,723,013 and $193,032, respectively, an increase of $1,529,981. This increase corresponds to the increase in revenuesand is related primarily to our acquisitions of MAF, COF, and DFN, eachcontributing approximately $959,000, $525,000, and $239,000 in cost of goodssold during the year ended December 31, 2003, respectively. The grossprofit percentage for the years ended December 31, 2003 and 2002 was 39.7% and 26.0%, respectively, an increase of approximately 14%. Thefavorable variance over prior year is substantially a result of a lower thannormal gross profit percentage in 2002 from higher than expected shipping andproduct storage costs that have not continued. The current year’s adjustedgross profit percentage of approximately 40%, which includes gross profitcontributed from acquired companies, is more indicative of anticipated futureresults.

 

*Administrative Expense*s:

 

***Salary and benefitcosts*** for the years ended December 31, 2003and 2002 were $11,998,759 and $1,341,103, respectively, for anincrease of $10,657,656. Theincrease is attributable to the following primary factors, which occurred andwere recorded during 2003 without similar transactions in the prior year: 1)issuance of 5,000,000 warrants in 2003 to one of our officers, valued at$6,800,000 and recorded as compensation expense; 2) granting of 1,300,000shares of restricted common stock in 2003 to one of our officers, valued at$1,781,000 and recorded as compensation expense, and 3) current year warrant

 

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repricing adjustments in accordance with FIN No. 44(1) of $1,526,461related to 1,340,000 warrants issued to one of our officers in 2002. Theprimary remaining variance in salaries and benefits is attributable to anaggregate cost contribution of approximately $657,000 in 2003 from our variousacquisitions offset to a lesser extent by a decrease in contract labor costsduring 2003.

 

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(1)          Per FIN No. 44, a non-cash charge tocompensation expense is required if the price of our common stock on the lasttrading day of a reporting period is greater than the exercise price of certainstock options and warrants issued to officers or employees. The requirements ofFIN No. 44 may also result in a credit to compensation expense to the extentthat the trading price declines from the trading price as of the end ofprevious reporting period, provided however that a credit is not recorded tothe extent our common stock trades below the exercise price of the options orwarrants. In accordance with FIN No. 44, we adjust compensation expense upwardor downward on a monthly basis based on the trading price at the end of eachperiod.

 

***Professional andconsulting fees***were $3,261,078 and $1,607,621during the years ended December 31, 2003 and 2002, respectively, for anincrease of $1,653,457. Thisincrease is primarily a result of costs associated with the three acquisitions(COF, ENI, and DFN), three preferred stock private placements (Series B, C, andD), and two debt offerings we transacted during 2003. Included in totalprofessional and consulting fees during 2003 and 2002 is $1,695,556 and$732,427, respectively, of non-cash charges for shares of restricted commonstock, options, or warrants issued in exchange for professional servicesrendered in the aforementioned transactions, accounting for a majority of theoverall increase, with the remainder represented by additional cash feesassociated with the transactions.

 

***Selling, general,and administrative expenses*** for the years endedDecember 31, 2003 and 2002 were $2,054,526and $510,013, respectively, foran increase of $1,544,513. Aportion of the overall increase can be attributed to an aggregate costcontribution from acquired entities of approximately $906,000, which includessuch charges as facilities, sales and marketing, and other general andadministrative items. The remaining increase is comprised of additional traveland entertainment costs over prior year associated with our acquisition,private placement, and debt financing activities of approximately $147,000,approximately $132,000 of non-cash charges for common stock issued as acondition to an amendment to our agreement with the Arizona Heart Institute,our distribution partner for Essentum®, and additional marketing andadvertising costs expended in the current year to promote our company and products.

 

***Research anddevelopment costs*** are expensed as incurred andtotaled $410,648 and $510,436 for the years endedDecember 31, 2003 and 2002, respectively, decreasing $99,788. During 2002, research anddevelopment costs primarily included the salary of one employee no longeremployed by us, as well as various consulting and travel expenses. In addition,shares of restricted common stock, options, or warrants were issued during andprior to 2002 for research and development related consulting contracts forwhich the associated costs were amortized over the life of the contracts. Asmost of these contracts expired near the end of 2002 or throughout 2003,related amortization declined, resulting in total charges of approximately$257,000 and $274,000 during the years ended December 31, 2003 and 2002,respectively.

 

***Depreciation andamortization expense*** for the years endedDecember 31, 2003 and 2002 were $1,972,303and $52,959, respectively,increasing $1,919,344. Theincrease is primarily attributable to amortization of intangibles acquired orrecorded as part of acquisitions, as well as increased depreciation related toacquired intangible assets, of approximately $1,906,000.

 

*Impairment of Goodwill and Other IntangibleAssets:* Goodwill and other intangibles created byour acquisitions are tested for impairment at least annually, or uponoccurrence of such events that may indicate impairment exists, in accordancewith SFAS No. 142. Due to lower than expected third and fourth quarteroperating profits and cash flows, we revised our earnings forecast for the nextfive years and, as a result, recorded a goodwill impairment loss of $6,777,480 during the year endedDecember 31, 2003. The change in fair value of each component of goodwillwas estimated using the expected present value of future cash flows based oncertain operational results and assumptions, as described below.

 

***MAF***. The grossvalue of goodwill related to the MAF Acquisition was $4,955,199. During theyear ended December 31, 2003, we experienced operating income ofapproximately $16,000, before depreciation, amortization, and interest chargesand have been unable to generate positive cash flow from operations to date. Webelieve these results are due to increased marketplace competition and relocationof operations from New Jersey to Utah, which caused a temporary lapse in ourfocus on the continued growth of the business. Based on our variousinitiatives, including consolidation of day-to-day operations of acquiredbusinesses, capitalization on subsidiary management expertise, and expansion ofproducts into existing distribution channels of other acquired entities, whilefactoring in the continued increase in competition for similar products, wehave projected MAF’s revenue for the next five years and computed the fairvalue of the goodwill using the expected present fair value of future cashflows. As a result, we determined the goodwill recorded because of the MAFAcquisition is impaired by $4,370,683,which has been recorded as goodwill impairment expense during the year endedDecember 31, 2003.

 

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***NSI***.The gross value of goodwill related to the COF Acquisition was $3,887,797.During the period ended December 31, 2003, we experienced an operating loss ofapproximately $533,000, prior to depreciation, amortization, and interestcharges and the entity has been unable to generate positive cash flow fromoperations to date. In our opinion, NSI experienced these results due primarilyto the use of inadequate manufacturing and distribution facilities, as well aschanges in management subsequent to the acquisition. We have undertaken variousinitiatives to improve NSI’s operating results, including further consolidationof NSI’s manufacturing operations, increasing our use of professionalmanufacturing representatives, where appropriate, and adopting a more strategic and cost-effective approach tonational tradeshows. We have also engaged an industry author and radiotalk show host with whom we will launch a website and certain custom-labeledproducts for marketing and distribution to major metropolitan areas. Based onmarket conditions and our internal initiatives, we have projected NSI’s revenuefor the next five years and computed the fair value of the goodwill using theexpected present fair value of future cash flows. As a result, we determinedthe goodwill recorded because of the COF Acquisition is impaired by $2,406,797, which has been recorded asgoodwill impairment expense during the year ended December 31, 2003.

 

***DFN***.The gross value of goodwill related to the DFN Acquisition is $2,113,416.During the period ended December 31, 2003, we generated operating income ofapproximately $21,000, before depreciation, amortization, and interest charges.We expect continued increasing net cash flows from operations, as we increase the national distribution of GreensFIRST®by cross-selling into distribution channels currently served by othersubsidiaries and expanding sales of GreensFIRST® into Mexico, Canada andoverseas. We also anticipate launching additional products currently underdevelopment. Based on our analysis, which includes detailed calculations ofprojected discounted future cash flows and assumptions discussed herein, webelieve the goodwill amount at December 31, 2003 is not impaired and have notrecorded an adjustment to the carrying value.

 

***ENI***. Our primary intangibles, outside of goodwilldiscussed above, were obtained in the ENI Acquisition and are comprised ofthree licensing and marketing agreements:

 

(1)          GEOMATRIX®, with an associated gross intangible value of $34,661,058 atDecember 31, 2003, is our licensed technology that will enable us to createtime-released nutraceuticals. Pursuant to the terms of the license agreement,GEOMATRIX® is initially being tested in six nutraceuticals products, three ofwhich successfully passed stability testing in February 2004, two areanticipated during second quarter 2004, and the final is to be chosen fordevelopment beginning in June 2004. We intend to utilize a licensing strategyto launch these products, rather than direct manufacturing, due to the intensecapital investment required in the latter. We anticipate the first of theseproducts to reach U.S. markets during 2004. Pursuant to the terms of thelicensing agreement, we were obligated to pay development fees of $250,000 inJanuary 2004. We did not make this payment and are currently in discussions torenegotiate the terms of the contract.

(2)          X-Fat®, with a related gross intangible value of $4,093,118 at December31, 2003, is our patented dietary supplement aimed at weight loss and waslaunched in test markets throughout the U.S. in early March 2004. Marketinginitiatives include radio and television advertisements, as well as the launchof a retail website. Patent rights in major European countries have beensecured, with expansion into these territories expected during the latter halfof 2004 through partnerships with established companies.

(3)          The China Territory Pharmaceuticals marketing agreement, to which agross intangible value of $4,304,438 is attributed at December 31, 2003,provides us with exclusive marketing rights and royalties on existing andfuture pharmaceuticals that use our licensed drug-delivery technologies undercertain terms defined therein. We are utilizing Stephen Chen, a shareholder andstrategic consultant, to facilitate the expansion into these markets bycoordinating initial meetings and establishing relationships with Chinesepharmaceutical companies. The first of these meetings is scheduled for April2004.

 

Fair value was determined atthe date of acquisition based on a valuation study performed by an independentthird party who primarily considered the discounted cash flow and guidelinecompany method. At December 31, 2003, we performed additional analyses, whichinclude detailed calculations of projected discounted future cash flows andassumptions discussed herein. Based on these analyses, we believe theintangibles recorded at December 31, 2003 are not impaired.

 

*Other Income (Expense):*

 

***Interest Expense***for the years ended December 31, 2003 and 2002 was $5,240,611 and $8,652,respectively, for an increase of $5,231,959. While a small portion of theincrease relates to interest on debt assumed in our various acquisitions,approximately $4,493,000 relates to interest expense recorded for thebeneficial conversion feature, detachable warrants, and amortization ofdeferred debt charges from our December 2003 offering of $4,587,738 aggregateprincipal amount of Senior Secured Convertible Notes. In addition, we recordedapproximately $599,000 in interest charges related to shares of our

 

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common stockthat must be issued to shareholders as a penalty due to our failure to timelyfile and have declared effective a registration statement to register theshares of common stock issued in our November 2002 Series A Preferred Stockprivate placement. The remaining increase is a result of interest incurred onour senior convertible notes, which were fully converted into the SeniorSecured Convertible Notes referenced above, as well as other interim financingtransactions.

 

*Net loss*:  Our net loss for the years ended December31, 2003 and 2002 was $30,621,222 and $3,949,895 respectively, for an increaseof $26,671,327. Of these losses, approximately $25,544,044 and $785,386 during2003 and 2002, respectively, relates to non-cash charges described herein andas follows and includes only those items that would not have been wired to besettled in cash or other assets by their original terms:

 
|                                                                                     |   | **2003**   |        | **2002** |   |
|------------------------------------------------------------------------------------------|--------|------------|-------------|----------|--------|
| Net loss                                                                                 |   | $          | (30,621,222 | )        | $      | (3,949,895 | ) |
| Non-cash charges                                                                         |   |       |        |     |   |
| Officer compensation for common stock,  options, warrants and warrant amendments         |   | 10,362,461 |        | —   |   |
| Common stock, options, and warrants issued  for services, including amortization of such |   | 1,695,556  |        | 732,427  |   |
| Impairment loss                                                                          |   | 6,777,480  |        | —   |   |
| Interest and other charges related to debt  financing                                    |   | 4,736,244  |        | —   |   |
| Depreciation and amortization                                                            |   | 1,972,303  |        | 52,959   |   |
| Total non-cash charges                                                                   |   | 25,544,044 |        | 785,386  |   |
|                                                                                     |   |       |        |     |   |
| Net loss excluding non-cash charges                                                      |   | $          | (5,077,178  | )        | $      | (3,164,509 | ) |

 

*Liquidity and CapitalResources*

* *

At December 31, 2003, we hadapproximately $1.7 million in cash, primarily as a result of our December 2003debt financing in the form of Senior Secured Convertible Notes. In addition, wehave approximately $550,000 of prepaid interest in escrow that will be used tomake the 2004 interest payments on such debt. This restricted cash balancerepresents the significant increase in prepaid expenses and other currentassets on our balance sheet at December 31, 2003.

 

Cash flows used in operatingactivities of approximately $4,722,000 and $2,974,000 in 2003 and 2002,respectively, have increased substantially over prior year due to the operatingexpenditures of our acquisitions (MAF, COF, ENI, and DFN), which have not yetbegun to generate positive cash flow from operations. In connection withthese acquisitions, we assumed indebtedness of approximately $1.5 million to beserviced over the next three to four year period. Cash flows used in investingactivities of approximately $483,000 and $181,000 in 2003 and 2002,respectively, relate primarily to the cost of our acquisitions, with theremainder representing capital expenditures. We anticipate a slight increase incapital expenditures during 2004 to facilitate the consolidation of ouroperations and continued growth. Cashflows from financing activities of approximately $5,560,000 and $4,571,000 in2003 and 2002, respectively, have been positively impacted by our debt andequity financings (as outlined below), offset by servicing of indebtednessassumed in our acquisitions.

 

To date, we have funded ouroperations and acquisition activity primarily from cash generated from privateplacements and with funds from borrowings under various debt instruments, assummarized in the table below, generating an aggregate in net cash proceeds of$10,737,222 during 2003 and 2002.

 

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The following summarizes private placementofferings completed during 2003 and 2002:

 
| **Date**                  |   | **Description**       |   | **Shares or  Principal** |   | **Price Per  Share** |   | **Net Cash  Proceeds** |       | **Options  &  Warrants** |      | **Exercise  Price** |      |
|---------------------------|--------|-----------------------|--------|--------------------------|--------|----------------------|--------|------------------------|------------|------------------------------|-----------|---------------------|-----------|
| June, 2002                |   | Series A  Preferred   |   | 3,712,000                |   | $                    | 1.00   |                   | $          | 3,593,807                    |      | 859,420             | (1)       | Series A |   | $ | 2.00 |   |
| November, 2002            |   | Common                |   | 1,367,500                |   | $                    | 1.00   |                   | $          | 1,197,115                    |      | 1,367,500           |      | Series B |   | $ | 1.65 |   |
|                      |   |                  |   |                     |   |                 |   |                   |       | 1,367,500                    |      | Series C            |      | $ | 2.14 |   |
| April, 2003               |   | Series B  Preferred   |   | 1,000,000                |   | $                    | 1.00   |                   | $          | 875,000                      |      | 1,000,000           |      | Series D |   | $ | 1.30 |   |
|                      |   |                  |   |                     |   |                 |   |                   |       | 1,000,000                    |      | Series E            |      | $ | 1.60 |   |
| July, 2003                |   | Series C  Preferred   |   | 500,000                  |   | $                    | 1.00   |                   | $          | 437,500                      |      | 500,000             |      | Series D |   | $ | 1.30 |   |
|                      |   |                  |   |                     |   |                 |   |                   |       | 500,000                      |      | Series E            |      | $ | 1.60 |   |
| August, 2003              |   | Series D  Preferred   |   | 1,000,000                |   | $                    | 1.00   |                   | $          | 815,000                      |      |                |      | N/A |   | N/A |   |
| October -  December, 2003 |   | Bridge  Notes(2)      |   | 1,530,000                |   | $                    | 1.00   |                   | $          | 1,316,400                    |      | 3,060,000           |      | No Series |   | $ | 1.00 |   |
|                      |   |                  |   |                     |   |                 |   |                   |       |                         | 1,530,000 |                | No Series |   | $ | 1.50 |   |
| December, 2003            |   | Senior  Secured Notes |   | 4,587,738                |   | $                    | 1.00   |                   | $          | 2,502,400                    |      | 4,587,738           |      | No Series |   | $ | 1.00 |   |
|                      |   |                  |   |                     |   |                 |   | $                      | 10,737,222 |                         |      |                |      |   |   |   |

 

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(1)          Includes117,021 warrants to be issued upon conversion of 585,111 shares of Series APreferred Stock issued as dividends.

(2)          Principaland accrued interest of $17,738 on the Bridge Notes converted into SeniorSecured Notes.

 

Inaddition to the above offerings, during the fourth quarter of 2003, we enteredinto short-term notes payable with various shareholders and related parties(see ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS), borrowing anaggregate principal amount of $396,672. The notes generally matured in 60 daysand bore interest at stated rates ranging between 10% and 28%, with 12 monthsof interest earned and payable immediately. The notes, including interestearned of $58,672, were paid in full prior to December 31, 2003.

 

*Going concern*

* *

The accompanying consolidatedfinancial statements have been prepared assuming we will continue on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business.We have sufferedrecurring losses from operations, have a working capital deficit, and aredependent on funding from sources other than operations. Sinceinception, we have been required to raise additional capital by the issuance ofboth equity and debt instruments. There are no commitments from prior fundingsources, debt or equity, should cash flows be insufficient to fund ongoingoperations and other cash commitments as they come due. These factors raise substantial doubt about our ability tocontinue as a going concern. We will be required to raise additional capital inthe near term through offerings of securities to fund operations, and willattempt to continue raising capital resources if we do not begin to generaterevenue sufficient to maintain our company as a viable entity. No assurance canbe given that such financing will be available or, if available, that it willbe on commercially favorable terms. Moreover, available financing may bedilutive to current investors.

 

We are in the processof improving, acquiring, or developing products for sale that would generaterevenue to sustain its operations, as well as consolidating its operations inorder to gain cost synergies and efficiencies. If successful, these actions will serve to mitigate the factors thathave raised doubt about our ability to continue as a going concern and increasethe availability of resources for funding of our current operations and futuremarket development. In addition, in March 2004 we entered into aPurchase Agreement with investors and sold 250,000 shares of common stock at$1.00 per share with rights to receive a portion of net revenues, as definedtherein, from the sale of X-Fat®.  The consolidated financial statements do notinclude any adjustments relating to the recoverability and classification ofrecorded assets or liabilities that might be necessary should we be unable tocontinue as a going concern.

 

*Recent accounting pronouncements*

* *

In May 2003, the FASB issued SFAS No. 150, “*Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity*.” SFAS No. 150 clarifies the accounting forcertain financial instruments with characteristics of both liabilities andequity and requires that those instruments be classified as liabilities instatements of financial position. Previously, many

 

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of those financial instruments were classified as equity. SFAS No. 150is effective for financial instruments entered into or modified after May 31,2003 and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003. The adoption of SFAS No. 150 did not have amaterial effect on our financial condition or results of operations.

 

In April 2003, the FASB issued SFAS No. 149, “*Amendment of Statement No. 133 on Derivative Instruments and HedgingActivities*.” SFAS No. 149 amends and clarifies financial accountingand reporting for derivative instruments, including certain derivativeinstruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities under SFAS No. 133, “*Accounting for Derivative Instruments and HedgingActivities*.” This Statement is effective for contracts entered intoor modified after June 30, 2003. The adoption of SFAS No. 149 did not have amaterial effect on our financial condition or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “*Consolidation of Variable Interest Entities*”(“FIN 46”). In general, a variable interest entity is a corporation,partnership, trust, or any other legal entity used for business purposes thateither (a) does not have equity investors with voting rights or (b) has equityinvestors that do not provide sufficient financial resources for the entity tosupport its activities. FIN 46 requires certain variable interest entities tobe consolidated by the primary beneficiary of the entity if the investors inthe entity do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2003. The consolidationrequirements apply to older entities in the first fiscal year or interim periodbeginning after June 15, 2003. Certain of the disclosure requirements apply toall financial statements issued after January 31, 2003, regardless of when thevariable interest entity was established.

 

In December 2003, the FASB issued a revisedInterpretation No. 46 (“FIN 46R”), “*Consolidationof Variable Interest Entities*.” FIN 46R requires companies toconsider whether entities, in which they have financial interests, lacksufficient equity at risk to permit that entity to finance its activitieswithout additional subordinated financial support and to consolidate thoseentities where the company would absorb the majority of any losses. Theconsolidation requirements are effective for interim and annual periods endingafter March 15, 2004. We do not expect the adoption of FIN 46 and FIN 46R tohave a material effect on our future financial condition or results ofoperations.

 

In June 2002, the FASB issued SFAS No. 146, “*Accounting for Exit or Disposal Activities*.” SFAS No. 146addresses significant issues regarding the recognition, measurement andreporting of disposal activities, including restructuring activities that arecurrently covered in EITF Issue No. 94-3, “*LiabilityRecognition for Certain Employee Termination Activity*.” The provisionsof SFAS No. 146 are effective for exit or disposal activities initiated afterDecember 31, 2002. The adoption of SFAS No. 146 did not have a material effecton our financial condition or results of operations.

 

In April 2002, the FASB issued SFAS No. 145, “*Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections*.” This statementrescinds SFAS No. 4, “*Reporting Gains andLosses from Extinguishment of Debt*,” which required all gains andlosses from extinguishment of debt to be aggregated and, if material,classified as an extraordinary item, net of income taxes. As a result, thecriteria in APB No. 30 will now be used to classify those gains and losses. Anygain or loss on the extinguishment of debt that was classified as anextraordinary item in prior periods presented that does not meet the criteriain APB No. 30 for classification as an extraordinary item shall bereclassified. The provisions of this Statement are effective for fiscal yearsbeginning after January 1, 2003. The adoption of SFAS No. 145 did not have amaterial effect on our financial condition or results of operations.

 

In November 2002, the FASB issued FIN 45, “*Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others*,” an interpretation ofFASB Statements No. 5, 57 and 107, and rescission of FIN 34, “*Disclosure of Indirect Guarantees of Indebtedness ofOthers*.” FIN 45 elaborates on the disclosures to be made by the guarantorin its interim and annual financial statements about its obligations undercertain guarantees that it has issued. It also requires that a guarantorrecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee. The initial recognition andmeasurement provisions of this interpretation are applicable on a prospectivebasis to guarantees issued or modified after December 31, 2002, while theprovisions of the disclosure requirements are effective for financialstatements for interim or annual periods ending after December 15, 2002. Theadoption of SFAS No. 145 did not have a material effect on our financialcondition or results of operations.

 

**ITEM 7.FINANCIAL STATEMENTS**

 

See index to Financial Statements andFinancial Statements Schedules beginning on page F-1 of thisForm 10-KSB.

 

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**ITEM 8. CHANGES IN AND****DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 8A.CONTROLS AND PROCEDURES**

 

Our Chief Executive Officer and our ChiefFinancial Officer, after evaluating the effectiveness of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14(c) and15-d-14(c)) as of a date within 90 days of the filing date of this annualreport (the “Evaluation Date”) have concluded that as of the Evaluation Date,our disclosure controls and procedures were adequate and effective to ensurethat material information relating to us and our consolidated subsidiarieswould be made known to them by others within those entities, particularlyduring the period in which this annual report was being prepared.

 

Disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act are recorded, processed,summarized, and reported, within the periods specified in the Securities andExchange Commission’s rules and forms. Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by us in the reports that we file underthe Exchange Act is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

There were no significant changes in ourinternal controls or in other factors that could significantly affect ourinternal controls subsequent to the Evaluation Date, nor any significantdeficiencies or material weaknesses in such controls requiring correctiveactions. As a result, no corrective actions were taken.

 

**PART III.**

 

**ITEM 9. DIRECTORS****, EXECUTIVE OFFICERS,PROMOTORS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGEACT**

 

**OFFICERS ANDDIRECTORS**

 

Set forth below is certain informationconcerning each of our Directors and executive officers:

 
| **Name**              |   | **Age** |   | **Position**                                             |
|-----------------------|--------|---------|--------|----------------------------------------------------------|
| Stuart A.  Benson     |   | 50      |   | Chief  Executive Officer, President, Secretary, Director |
| Mitchel Feinglas      |   | 55      |   | Chief  Operating Officer, Director                       |
| Marcus Feder          |   | 48      |   | Chief  Financial Officer                                 |
| Donald C.  Hannah     |   | 71      |   | Chairman of  the Board                                   |
| Leslie C.  Quick, III |   | 50      |   | Director                                                 |
| Elliot R.  Speiser    |   | 41      |   | Director,  Chairman of the Audit Committee               |
| Carson E.  Beadle     |   | 70      |   | Director                                                 |
| David Allen           |   | 62      |   | Director                                                 |
| Michael  Ashton       |   | 57      |   | Director                                                 |

 

*Officers*

 

*Stuart A. Benson* has served as our Chief Executive Officersince January 2004 and our President and Secretary since March 2002. Mr. Bensonalso served as our vice chair of the Board of Directors from March 2002 throughJanuary 2004 and our executive vice President from June 2001 through March2002. From March 1997 until June 2001, Mr. Benson served as Chairman of theBoard and Chief Executive Officer of Custom Food Concepts, a privately heldchain of restaurants in California. He has also served in both public andprivate companies as Chief Executive Officer and Chairman of the Board,including such companies as The Great Earth Vitamin Store chain and Nathan’sFamous Inc., where he served as their

 

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Chairman of the ExecutiveCommittee, Chairman of the Board, President, and CEO. He is a member of UJA andADL, sponsor of CBA (Caring for Babies with Aids), past Chairman of the 5 TownsUnited Fund Red Feather Ball, and has successfully organized numerous functionsfor the Reno, Nevada chapter of the Make A Wish Foundation.

 

In May 2002, Mr. Benson filedfor personal bankruptcy, primarily because of federal tax liens relating tocertain real estate syndication activities in the 1980’s. These liens relate toapproximately $900 million of recaptured phantom income attributable to Mr.Benson, and his affiliates, as the general partners of various real estatesyndication programs and partnerships, as well as $900,000 of other claims andjudgments. In 1995, IRS liens relating to similar real estate syndicationactivities were discharged by Mr. Benson in a personal filing under Chapter 7.These bankruptcy filings are unrelated to Mr. Benson’s activities with us andwe do not believe that these filings affect Mr. Benson’s ability to perform hisduties as an officer and Director in any material fashion.

 

*Mitchel Feinglas* has been our Chief Operating Officer and amember of our Board of Directors since January 2004. From April 2003 throughJanuary 2004, we engaged him as an independent consultant. From 1999 throughApril 2003, he was an independent consultant for various companies. From 1994through 1999, Mr. Feinglas founded and operated Vitamin Logic, a chain ofretail supplement stores, and Alpine Naturals, a manufacturer and internationaldistributor of supplements. From June 1990 through June 1993, he served asPresident of the Great Earth Vitamin Store Chain, then the second largestretail supplement store chain in the United States.

 

*Marcus Feder* has been our Chief Financial Officer sinceSeptember 2003. From December 2001 through June 2003, Mr. Feder served as ChiefFinancial Officer for Single Crystal Technologies, LLC (SCT), a privately heldsemiconductor technology company where he established key relationships withinvestment banks, high-tech law firms, and venture capital funds. For the prior12 years, Mr. Feder worked at Ernst & Young, a global leader inprofessional services, rising to serve as Senior Manager from 1998 to 2001 inits Audit, Business Advisory Services division. Mr. Feder is a Certified PublicAccountant, Certified Information Systems Auditor, and a Certified InternalAuditor.

 

*Directors*

 

*Donald C. Hannah* has been our Chairman of the Board sinceJanuary 2004 and has been a member of our Board of Directors since June 2002.In 1957, he assumed control of Hannah Marine Company and has since helped turnit into a worldwide marine shipping organization and the largest tugboat andbarge company operating on the Great Lakes. In 1986, Mr. Hannah founded USAuction, Inc., which subsequently became affiliated with Merrill Lynch Realtyin 1988. Mr. Hannah thereafter served as President and Chief Executive Officerof the Merrill Lynch Realty Auction Division until November 1989. In 1989, ThePrudential Insurance Company of America acquired Merrill Lynch Realty alongwith the Auction Division. Mr. Hannah then moved the offices of the company toPhoenix, Arizona in 1992 to focus on government owned properties and changedthe name of the company to US Properties, Inc. Mr. Hannah is Chairman and ChiefExecutive Officer of US Properties, and presently conducts real estate auctionsand often assists in structuring financing of real estate projects. Mr. Hannahis recognized as a pioneer in international marketing programs and was afinalist for Inc. Magazine’s “Entrepreneur of the Year Award” in 1992.

 

*Elliot R. Speiser***joined our Board of Directors, and our AuditCommittee as its Chairman and designated Financial Expert, in March 2004.**Mr. Speiser is the managing partner ofElliott R. Speiser & Associates, a law firm he founded in 2001. Mr. Speiserhas been a practicing attorney since 1996. Prior to practicing law, Mr. Speiserwas engaged full-time as a Certified Public Accountant with Coopers &Lybrand, LLP and Price Waterhouse, LLP where he served publicly traded clients.Mr. Speiser received his B.S. from the California State University at LosAngeles and a J.D. from Western State University College of Law.

 

*Leslie C. Quick, III* has been a member of our Board of Directorssince October 2002 and has served as Chairman of Fleet Securities, Inc., adivision of Fleet Boston Financial Corporation, since April 2001 and previouslyserved as President of U.S. Clearing Corp., a division of Fleet Securities fromMarch 1994 through April 2001. From June 1988 through March 1994, Mr. Quick wasPresident and Chief Operating Officer of The Quick & Reilly Group, Inc. Mr.Quick serves on the Board of Governors of the Chicago Stock Exchange, theHearing Board of the New York Stock Exchange, the Bishop’s Financial Councilfor the Diocese of Metuchen, and is a trustee of Oak Knoll School in Summit,New Jersey. Mr. Quick is also the recipient of the Ellis Island Medal of Honorand holds an honorary degree from St. Bonaventure University.

 

*Carson E. Beadle* has been a member of our Board of Directorssince October 2002. Mr. Beadle has been the President of Carson E. Beadle,Inc., a strategic-planning consulting firm in New York, since April 1998. FromSeptember 1959 through April 1998, Mr. Beadle was affiliated with the Marsh& McLennan Companies where he served as a member of the Board of Directorsof William M. Mercer, Inc., a subsidiary of Marsh & McLennan. As a seniorpartner of the Mercer division, he was

 

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responsible for theconsulting practices of New York and Eastern Canada, as well as other corporatefunctions, with a focus on employee benefits for large employers and strategicdecision-making. Mr. Beadle originated the “flexible benefits” concept inCanada and the “total benefits strategic decision-making” concept in the UnitedStates. A recognized benefits expert, he has given testimony before SenateFinance, House Ways & Means and other government committees. He is theauthor of over 100 articles appearing in The Wall Street Journal, the NewEngland Journal of Medicine, Fortune, the New York Times and many managementand health publications in the United States and Canada. He is Chairman andco-founder of The Health Project, the White House-supported organization thatpresents the annual C. Everett Koop National Health awards. He is also one ofthe founding Directors of the Health Enhancement Research Organization ofBirmingham, among many other member and advisory positions held withinprominent management and healthcare organizations. Mr. Beadle has been a memberof the Board of Directors of Security Mutual Life Insurance Company of New Yorksince 1995 and National Security Life and Annuity Company since 2001.

 

*David Allen* has been a member of our Board of Directorssince August 2003. Mr. Allen has served as managing Director of InvestmentInformation Services, Ltd., a United Kingdom limited company providing fundamentaland technical research to several private banks in London and a group of highnet-worth investors in the United Kingdom and the United States, since January1990. Mr. Allen has also served as President of Investment InformationServices, Inc., a registered investment advisor in Colorado that providesfundamental and technical research to hedge funds and accredited investors,since 1999. Additionally, Mr. Allen has served as the investment consultant toUS Tax and Financial Services, Ltd., a firm of accountants and lawyers inLondon, since 1989.

 

*Michael Ashton* has been a member of our Board of Directorssince January 2004. Mr. Ashton’s career of over 31 years has been dedicated tothe pharmaceutical industry. Mr. Ashton has been Chief Executive Officer ofSkyePharma since November 1998 and a member of its Board of Directors sinceMarch 1997. He is also a Director of Transition Therapeutics, Inc., a TorontoStock Exchange-listed biopharmaceutical company developing therapeutics for thetreatment of multiple sclerosis, diabetes, and restenosis, and AstralisLimited, a public biotechnology company. Mr. Ashton has a Bachelor of PharmacyDegree from Sydney University and a MBA Degree from Rutgers University.

 

Our Directors are electedannually and until the next annual meeting of stockholders and until theirsuccessor is elected and qualified or until their earlier resignation orremoval.

 

*Section 16(a) BeneficialOwnership Reporting Compliance*

 

Section 16(a) of the Securities Exchange Act of 1934requires our officers, directors, and persons who own more than ten percent ofa registered class of our equity securities to file reports of ownership andchanges in ownership with the Securities and Exchange Commission.  Officers, directors, and ten percent stockholdersare required by regulation to furnish us with copies of all Section 16(a) formsthey file.  Based solely on copies ofsuch forms received or written representations from certain reporting personsthat no Form 5s were required for those persons, we believe that, during thefiscal year ended December 31, 2003, all filing requirements applicable to ourofficers, directors, and greater than ten percent beneficial owners werecomplied with.

 

*Audit Committee FinancialExpert*

 

Currently, our audit committee is comprised ofElliot R. Speiser, Donald Hannah, and Leslie C. Quick, III, with Mr. Speiserserving as the Chairman of the audit committee.  The board of directors believes that Mr. Speiser is an “auditcommittee financial expert” (as defined in Regulation 228.401(e)(1)(i)(A) ofRegulation S-B).  The board of directorsalso believes that Mr. Speiser would be considered an “independent” directorunder Item 7(d)(3)(iv) of Schedule 14A of the Securities Exchange Act of 1934.

 

*Code of Ethics*

 

We have not yet adopted a code of ethics.  However, we intend to adopt, during fiscal2004, a code of ethics that complies with the applicable guidelines issued bythe SEC.

 

**ADVISORY BOARDS AND ADVISORS**

 

In addition to our Boardof Directors, we have established strategic relationships with key individualswho serve on one or more of our advisory boards or in a consulting capacity. Weutilize the advice and expertise of this elite group of individuals to assistus in our product formulations, research and development, strategic growthplans, and financial transactions. A brief description of our advisory boardsis listed below, followed by biographical information of select individuals whoassist us in these capacities.

 

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*Scientific Advisory Board (“SAB”)*

 

Our products are formulatedunder the direction of our SAB, originally established in 2001. The SAB reviewsall formulations and ensures that only credible, clinically proven ingredientsat the dosage levels proven to work through accredited clinical trials areused. The SAB meets on an as needed basis, but generally twice per year.

 

*Nutritional Advisory Board (“NAB”)*

 

In 1999, MAF formed our NABfor consultation on specific product formalities or endorsements. Members arenot required to have a specific number of meetings, but meet as deemednecessary. The NAB is primarily involved with products intended fordistribution in the complimentary and alternative medicine markets, as opposedto the SAB, which focuses on the development of products for distribution inthe medical channel.

 

*Board of Scientific and Professional Advisors(“BSPA”)*

 

In connectionwith the DFN Acquisition, we acquired the on-going use of DFN’s pre-existingBSPA, which supports DFN’s on-going research, development, business strategyand objectives and is comprised of a group of experienced and highly qualifiedprofessionals in science, medicine, nutrition, psychology, herbology, business,marketing, and media relations.

 

*Corporate Strategic Advisory Board (“CSAB”)*

 

*The CSAB was developed in October, 2003 to provide services and advicein connection with our strategy and plans for the development andcommercialization of our products and services, including developing,manufacturing, and testing nutraceuticals formulations based on scientificresearch and controlled clinical trials, assisting with design and developmentof compliance and lifestyle programs, and advising us on the needs of potentialclients, partners, or other users. Live meetings of the CSAB are planned onceper year and teleconference meetings three times per year.*

* *

*Select Advisor Biographies*

 

*Paul Leibowitz*serves as our Chief Scientific Officer and is President of Redding ConsultingGroup, Inc., a consulting practice in New York City formed by Dr. Leibowitz in1995. As President of Redding Consulting, Dr. Leibowitz assists small tomidsize public and private companies in the areas of business development andstrategic, operating, and product development planning. Before forming ReddingConsulting, Dr. Leibowitz was chief scientific officer of TSI Corporation,which was the fifth largest independent pre-clinical and clinical contractresearch organization in the world. Dr. Leibowitz also served as Director ofmolecular and analytical biology at Schering-Plough Corporation. While atSchering, he founded its biotechnology department, built the infrastructure forbiotechnology programs in several areas, and led its growth into one of theindustry’s leading forces. Dr. Leibowitz received his Ph.D. from the biologydepartment of the State University of New York at Buffalo in the areas ofatomic energy and particle physics, and postdoctoral training in genetics andmolecular biology at Tufts Medical School and the Massachusetts Institute ofTechnology.

 

*Dr. Maynard Howe*, who**sits on the BSPA and CSAB,has achieved a national and international reputation in Internet/Intranetstrategy, branding, marketing, sales, and motivation. He hasauthored/co-authored three books and has written and produced two award-winningworkshops on customer commitment and violence prevention. Dr. Howe holds aDoctorate of Clinical Psychology and a Masters in Leadership and HumanBehavior. He has consulted to Professional and Olympic athletes and teamsaround the world and is a sought after lecturer and speaker at national andinternational forums.

 

*Dr. Roger Howe*, who sits on the BSPA and CSAB, hasfounded four successful start-up ventures over the past twenty years, his mostrecent of which, Metrix Communications, an Internet services and developmentcompany, was acquired by USWeb. Before these ventures, he served with threeFortune 500 companies in key management and executive positions. Dr. Howe is aformer high school teacher, university professor, and youth athletic coach andhas authored/co-authored various books and articles. Currently, he is a BoardMember of Reliant Medical Technologies, Personnel Decisions International,Inc., Sonora Partners, and the Howe Family Foundation.

 

*Michael Davidson, M.D*., a board-certified cardiologist, has beenthe Chairman of our SAB since March 2002. Dr. Davidson is the executive medicalDirector of Protocare Trials and Chief Executive Officer of the Chicago Centerfor Clinical Research. He is also an associate professor in the Department ofMedicine and Director of the Preventive Cardiology Center atRush-Presbyterian-St. Luke’s Medical Center, where he directs the multiple riskfactor reduction lipid clinic. As a prolific author and lecturer on lipiddisorders, nutrition, and arteriosclerosis, Dr. Davidson has coordinated over500 clinical trials in

 

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areas of preventivecardiology and has published more than 100 articles in medical journals,including the Journal of the American Medical Association, the Journal of theAmerican College of Cardiology, Circulation, and Arteriosclerosis. Dr. Davidsonis a fellow of the American College of Cardiology and the American College ofChest Physicians. He holds a medical degree from Ohio State University inColumbus and has completed a cardiology fellowship at Rush-Presbyterian-St.Luke’s Medical Center in Chicago.

 

*Dr. Philip B. Maffetone* is the founder of MAF and has been a memberof the NAB since its formation in 1999. Dr. Maffetone has spent his entirecareer involved with diet, nutrition, stress management, and athletic trainingas a teacher, writer, and in the private practice of complementary medicine.Since 1977, he has been an author and lecturer on health and fitness, diet andnutrition, lifestyle, and stress management. He has also been a consultant tovarious athletic teams, corporations, and athletes specializing in coaching,nutrition, and exercise. He has also consulted for various nutrition companiesresponsible for product development, scientific writing, and marketingmaterials. From 1989 until 1994, he was Chairman and Chief Executive Officer ofthe International College of Applied Kinesiology. He was also the foundingtrustee in 1993 for the Foundation for Allied Conservative Therapies Researchand remained there until 1999. Throughout these activities, Dr. Maffetone’smajor contributions have been in the multifaceted area of human performance asfollows:

 

•                  insight into its physical, biochemical, andmental/emotional aspects;

•                  probing research in diet and nutrition inrelation to disease prevention;

•                  an understanding of neuromuscular function andits relation to healthcare and performance; and

•                  breakthroughs in complementary medicine andits relationship to conventional healthcare.

 

Dr. Maffetone has sixteenpublications dealing with these areas, in addition to over twenty professionalpaper presentations in his field of expertise. Dr. Maffetone attended theRochester Institute of Technology where he received a B.S. in Human Biology anda Doctor of Chiropractic Degree from the National College of Chiropractic,Lombard, IL. He has also received post-doctoral certifications in meridiantherapy (acupuncture), physiotherapy, and applied kinesiology. He has been amember of the International College of Applied Kinesiology since 1980, theNational Athletic Trainers Association since 1987 and was named Coach of theYear by Triathlete Magazine in 1994.

 

*Dr. James Rouse*is a naturopathic physician, entrepreneur, and coach to executives and athletesnationwide who we use as an independent contractor. He is an author and leadingexpert in the field of lifestyle medicine, performance training and is asponsored Ironman triathlete. Dr. Rouse holds a doctorate degree innaturopathic medicine, has done post-doctorate work in acupuncture and Chinesemedicine and has a degree in transpersonal psychology. He maintains a privatenaturopathic medical practice in Denver, Colorado where he is the creator ofDenver’s KUSA TV “Optimum Wellness” program, which airs on the Atlanta, Denver,and Phoenix NBC affiliates. He serves as an advisor representing Vital Living’scompanies. Dr. Rouse is a member of the American Association of NaturopathicPhysicians.

 

*Leslie D. Michelson*,Healthcare Industry Investor and Consultant, is an independent healthcareindustry investor and consultant to emerging healthcare companies. Mr.Michelson is the founder and former Chief Executive Officer of Acurian, aleading provider of clinical trial patient and investigator recruitmentsolutions for the pharmaceutical and biotechnology industries. Before foundingAcurian, Mr. Michelson served as Chairman and Chief Executive Officer of ValueHealth Sciences, a leading disease management company he founded in 1987.Before founding Value Health Sciences, Mr. Michelson was an associate andpartner with SDG Enterprises, a private equity firm, where he specialized inreal estate and early-stage healthcare investing. Mr. Michelson also served asa law clerk for Caleb Wright, emeritus Chief Justice of the U.S. District Courtin Washington, D.C., worked as an associate at the law firm of Wald, Harkrader,& Ross and served as a special assistant to the General Counsel of the U.S.Department of Health and Human Services. Mr. Michelson is a Director and formerChairman of the compensation committee of Catellus Development Corporation, aNew York Stock Exchange-listed real estate development company.

 

*Stephen S. Chen*,Senior Advisor for China, is an international executive who provides consultingservices assisting major U.S. corporations in entering markets in China and theFar East. He is responsible for supervising the introduction of our Essentum®product in China and seeking financing and other opportunities in the Far East.Mr. Chen, the founder of Amerihua International Enterprises, Inc., aconsulting/management company started in 1981, pioneered the initialdevelopment of China International Trust & Investment Corp., which hasbecome China’s largest investment group and holding company. Mr. Chen negotiated,concluded, and implemented many significantly large trading transactions andcooperative programs between China and western companies such as UnitedTechnologies Corp., General Motors, Beatrice Foods, Xerox, Siemens, SAAB,Lockheed, Renault, Terex, Fiat, and many Hong Kong Companies, and has served asan interpreter for China’s state leaders.

 

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Anative of Beijing, China, Mr. Chen graduated from Beijing Foreign LanguageInstitute, attended the Ph.D. program in Oriental Studies of the University ofArizona, and is professor of international economics and international economiccooperation at both the Beijing Foreign Studies University in Beijing, China,and the University of Ningxia, in Yinchuan, Ningxia Province, China. ProfessorChen played a key role in coordinating, negotiating, and establishing the firstU.S.-China joint venture, Beijing Jeep Corp., and has since served as Director,China Program for General Motors, and vice President, Pacific-China Operationsfor Otis Elevator Company.

 

**ITEM 10.EXECUTIVE COMPENSATION**

 

Thefollowing table sets forth all compensation awarded to, earned by, or paid forall services rendered to us during the fiscal years ended December 31, 2003,2002 and 2001, by our chief executive officer and our other executive officerswhose total compensation exceeded $100,000.

 
|                                                                       |   |     |    |                    |    | **Long-Term  Compensation** |      | **All Other  Compensation ($)** |   |
|----------------------------------------------------------------------------|--------|----------|---------|-------------------------|---------|-----------------------------|-----------|---------------------------------|--------|
|                                                                       |   |     |    | **Annual Compensation** |    | **Stock, Options,**         |      |                            |
| **Name/Position**                                                          |   | **Year** |    | **Salary ($)**          |    | **Bonus ($)**               |      | **Warrants (#)**                |   |   |
| Stuart A. Benson  Chief Executive Officer,  President, Secretary, Director |   | 2003     |    | 156,153                 |    | 120,000                     | (7)       | 5,000,000                       | (4)    | — |   |
|                                                                       | 2002   |     | 51,667  |                    | 150,000 | (3)                         | 1,340,000 | (4)                             | 37,000 | (5) |
|                                                                       | 2001   |     | N/A     |                    | N/A     |                        | N/A       |                            | N/A    |   |
| Mitch  Feinglas  Chief Operating Officer,  Director                        |   | 2003     |    | N/A                     |    | N/A                         |      | 100,000                         | (8)    | 116,680 | (5) |
|                                                                       | 2002   |     | N/A     |                    | N/A     |                        | N/A       |                            | N/A    |   |
|                                                                       | 2001   |     | N/A     |                    | N/A     |                        | N/A       |                            | N/A    |   |
| Bradley  D. Edson  Former Chairman, Chief  Executive Officer               |   | 2003     |    | 215,211                 |    | 50,000                      |      | 1,300,000                       | (9)    | — |   |
|                                                                       | 2002   |     | 179,468 |                    | —  |                        | —    |                            | 26,500 | (1) |
|                                                                       | 2001   |     | 45,000  | (2)                     | —  |                        | 1,000,000 | (6)                             | — |   |

 

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(1)          Thisamount represents amounts that were paid by us for the benefit of entitiescontrolled by Mr. Edson. These amounts were not repaid and were written off ascompensation to Mr. Edson.

(2)          Representsaccrued salary that was subsequently paid in 2002.

(3)          Representssigning bonuses paid to Mr. Benson executed as part of his employmentagreement.

(4)          Inconnection with the execution of Mr. Benson’s employment agreement, we grantedMr. Benson a warrant to purchase 1,340,000 shares of common stock at anexercise price of $1.50 per share. In April 2003, we amended the warrant tolower the exercise price to $0.01 per share and to extend the expiration dateto March 31, 2008. In August 2003, as a condition to the consummation of ourENI Acquisition, the warrant was again amended to increase the total number ofshares of common stock purchasable under the warrant to 6,340,000 shares, or anadditional 5,000,000 warrants, 30,000 of which were exercised in 2003.Cumulative compensation expense of $1,526,461 related to repricing andamendments of the warrants was recorded in 2003.  Compensation expense of $6,800,000 was recorded in August 2003 asa result of the new warrants issued.

(5)          Representspayments for consulting services provided to us.

(6)          Inconnection with respective employment agreements effective October 1, 2001,fully vested warrants in the amounts indicated were issued at an exercise priceof $0.35 per share, which approximates market value at that date, expiringSeptember 30, 2004.

(7)          Representsbonus paid to Mr. Benson for successful consummation of various acquisitions.

(8)          Inconnection with a consulting agreement and services provided thereunder, anentity related to Mr. Feinglas received on his behalf 100,000 shares restrictedcommon stock valued at $134,000.

(9)          Inconnection with the ENI Acquisition, Mr. Edson received 1,300,000 shares ofcommon stock valued at $1,781,000.

 

*Employment Agreements*

 

*StuartA. Benson* iscurrently employed by us as our Chief Executive Officer, President, andsecretary through August 2006 pursuant to a written employment agreement, asamended. In connection with the original signing of the agreement in 2002,Mr. Benson received a cash-signing bonus of $150,000. The employmentagreement provides for a base salary of $160,000, $180,000, and $200,000 in thefirst, second, and third years of employment, respectively. Mr. Benson isalso eligible to

 

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participate in any profit sharing plan, standard bonusplans, fringe benefits, expense reimbursements, or other remuneration asperiodically modified and approved by our Board of Directors.

 

The agreement contains a termination without “cause”provision indicating that in such event termination without cause occurs, or ifMr. Benson is not elected to, or is otherwise removed from, the Board ofDirectors, or if a change of control event occurs, as defined in the agreement,we are obligated to pay, within 30 days of termination, the remainingbalance of his base salary for the remainder of the term or for a twelve monthperiod, whichever is longer. The agreement also contains confidentiality andnon-solicitation clauses that survive employment for a period of two years. Furthermore,we are obligated to obtain term life insurance on Mr. Benson in the amount of$1,000,000, for which he may designate the beneficiary of his choice and,likewise, we are entitled to obtain a key man insurance policy on Mr. Benson inthe amount of $1,000,000 with us as beneficiary, as we deem necessary. As ofMarch 30, 2004, no such policies have been procured.

 

In connection with the agreement, we issued Mr. Bensonan immediately exercisable warrant in 2002 to purchase 1,340,000 shares ofcommon stock at an exercise price of $1.50 per share, expiring March 31,2007. In April 2003, we amended the warrant to lower the exercise price to$0.01 per share, extend the expiration date to March 31, 2008, and add ananti-dilution provision such that if we issued any shares of common stock orsecurities convertible into shares of common stock (excluding shares issuedupon a stockholder approved stock option plan) in the future, the number ofshares that could be obtained under the warrant would be automaticallyincreased. In May 2003, Mr. Benson exercised a portion of the warrant topurchase 30,000 shares of common stock at an exercise price of $0.01 per share.In August 2003, as a condition to the consummation of the ENI Acquisition, thewarrant was amended to remove the anti-dilution provision in exchange forincreasing the number of shares of common stock purchasable under the warrantto 6,310,000 shares.

 

*Mitch Feinglas*****was appointed to theposition of Chief Operating Officer and Director in January 2004, for which wehave an employmentletter of understanding that provides for an annual salary of $75,000 and$85,000 through August 2004 and 2005, respectively. In addition, the letter ofunderstanding provides for up to $72,000 and $82,000 per year through August2004 and 2005, respectively, in reimbursable expenses, including lodging,healthcare, and other expenses incurred in the normal course of duties. During2003, Mr. Feinglas performed similar services under a consulting agreement, forwhich he or entities on his behalf, was paid $116,680 and issued 100,000 sharesof restricted common stock valued at $134,000.

 

*Marcus Feder*****is currently employed by usas our Chief Financial Officer, for which we have an employment letter of understanding that providesfor an annual salary of $100,000 plus various fringe benefits. The letter ofunderstanding contains a termination without “cause” provision indicating that,in such event termination without cause occurs, we are obligated to payseverance at amounts ranging from one to four weeks base salary, depending onlength of service during his first six months. Such termination benefits andthe addition of stock options are to be amended by a formal contract at Mr.Feder’s six-month anniversary. Effective March 27, 2004, Mr. Feder’s annualsalary was increased to $140,000.

 

*Severance Agreements with Former Management*

 

*BradleyD. Edson* waspreviously employed by us as our Chairman and Chief Executive Officer throughAugust 2006 pursuant to a written employment agreement, as amended. EffectiveJanuary 12, 2004, Mr. Edson voluntarily resigned from his positions with us topursue other business interests, thus terminating his prior employmentagreement. Pursuant to the terms of his severance agreement, executed February24, 2004, we agreed to pay severance in the amount of $244,068 in cash($119,034 due within eight days of execution, $19,839 due on each first day ofJuly, August, and September 2004, and $21,839 due on each first day of October,November, and December 2004) and 600,000 shares of our common stock, due withineleven days of execution and included in our pending Registration Statementinitially filed January 14, 2004. In addition, we will continue to pay Mr.Edson’s medical benefits until the earlier of (i) July 31, 2005, or (ii) thedate he becomes eligible to be covered under another program. As of March 30,2004, neither the first payment nor shares initially due has been paid orissued.

 

*Option/Warrant Grants*

 

Thefollowing table represents stock options or warrants granted to the namedexecutives set forth in the executive compensation table above in the fiscalyear ended December 31, 2003.

 
| **Name**         |   | **Number of Securities  Underlying Options  Granted** |   | **% of Total Options  Granted in Fiscal  Year** |   | **Exercise Price** |   | **Expiration Date** |     |
|------------------|--------|-------------------------------------------------------|--------|-------------------------------------------------|--------|--------------------|--------|---------------------|----------|
| Stuart A. Benson |   | 6,310,000                                             | (1)    | 100                                             | %      | $                  | 0.01   |                | 03/31/08 |   |
|                  |        |                                                       |        |                                                 |        |                    |        |                     |          |  |

 

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**(1)**          1,340,000 issued in 2002, 5,000,000 issued in 2003,and 30,000 exercised in 2003.

** **

*Option/Warrant Exercises and Values*

 

The followingtable sets forth the number of outstanding options or warrants at December 31,2003, and the dollar value of unexercised, in-the-money options or warrants forthe named executive officers set forth in the executive compensation tableabove.

 
|             |   | **Shares**                     |   |                    |   | **Securities  Underlying  Unexercised Options** |   | **Value of  Unexercised, in-the-  money Options** |   |
|------------------|--------|--------------------------------|--------|-------------------------|--------|-------------------------------------------------|--------|---------------------------------------------------|--------|
| **Name**         |   | **Acquired  on  Exercise (#)** |   | **Value  Realized ($)** |   | **Exercisable  (#)**                            |   | **Unexercisable  (#)**                            |   | **Exercisable  ($)** |   | **Unexercisable  ($)** |   |
| Bradley D. Edson |   | 765,100                        | (1)    | 749,798                 |   | —                                          |   | —                                            |   | — |   | — |   |
| Stuart A. Benson |   | —                         |   | —                  |   | 6,310,000                                       |   | —                                            |   | 7,256,500 |   | — |   |

 

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(1)          Exercised on January 16, 2004.

 

*Stock Option Plans*

 

The2001 Stock Option Plan authorizes the grant of 2,500,000 stock options and the2002 Stock Option Plan authorizes the grant of 2,000,000 stock options. As ofDecember 31, 2003, options to purchase an aggregate of 3,831,483 shares ofcommon stock have been granted at exercise prices ranging from $0.35 to $3.00per share.

 

*Other Warrants*

 

Asof December 31, 2003, we have outstanding other warrants to purchase 25,674,571shares of common stock at exercise prices ranging from $0.01 to $2.14.

 

*Director Compensation*

 

We issue to our non-employee Directors a one-timegrant of 75,000 shares of restricted common stock, 25,000 shares of which vestimmediately upon election to our Board of Directors with the balance vesting inequal installments over the following two years provided they remain members ofour Board of Directors.

 

**ITEM11. SECURITY OWNERSHIP****OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

The following table sets forth certain information as ofMarch 26, 2004 with respect to the beneficial ownership of our common stock by(i) those persons or groups known to beneficially own more than 5% of ourvoting securities, (ii) each of our directors, (iii) each of the executiveofficers named in the Summary Compensation Table above and (iv) all of ourcurrent directors and executive officers as a group.

 
| **Name and Address of Beneficial  Owner(1)** |   | **Amount and  Nature of Beneficial  Ownership(2)** |   | **Percentage  Beneficially Owned(3)** |   |
|----------------------------------------------|--------|----------------------------------------------------|--------|---------------------------------------|--------|
| SkyePharma PLC(4)                            |   | 17,204,548                                         | (5)    | 26.69                                 | %      |
| Stephen Morris (6)                           |   | 8,890,575                                          | (7)    | 14.23                                 | %      |
| Fifth Avenue Capital, Inc. (8)               |   | 8,860,575                                          | (9)    | 14.19                                 | %      |
| Stuart A. Benson                             |   | 6,345,000                                          | (10)   | 9.23                                  | %      |
| Stephen Songsheng Chen(11)                   |   | 4,675,812                                          | (12)   | 7.05                                  | %      |
| Periscope Partners, L.P.(13)                 |   | 5,026,666                                          | (14)   | 7.45                                  | %      |
| Martin J. Gerst                              |   | 3,238,050                                          | (15)   | 5.14                                  | %      |

 

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| **Name and Address of Beneficial  Owner(1)**           |   | **Amount and  Nature of Beneficial  Ownership(2)** |   | **Percentage  Beneficially Owned(3)** |   |
|--------------------------------------------------------|--------|----------------------------------------------------|--------|---------------------------------------|--------|
| Donald C. Hannah                                       |   | 843,425                                            | (16)   | 1.35                                  | %      |
| Leslie C. Quick, III                                   |   | 775,830                                            | (17)   | 1.24                                  | %      |
| Robert J. Eide                                         |   | 519,400                                            | (18)   | *                                     |   |
| Carson E. Beadle                                       |   | 112,000                                            | (19)   | *                                     |   |
| David Allen                                            |   | 25,000                                             | (19)   | *                                     |   |
| Marcus Feder                                           |   | 0                                                  |   | 0                                     | %      |
| Mitchel Feinglas                                       |   | 0                                                  |   | 0                                     | %      |
| Elliot Speiser                                         |   | 0                                                  |   | 0                                     | %      |
| Michael Ashton                                         |   | 0                                                  |   | 0                                     | %      |
| MAF Voting Group(20)                                   |   | 8,028,782                                          | (21)   | 11.56                                 | %      |
| ENI Voting Group(22)                                   |   | 33,052,023                                         | (23)   | 46.04                                 | %      |
| All officers and directors as a group (8  individuals) |   | 8,401,913                                          | (24)   | 12.18                                 | %      |

 

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*                 Lessthan l%.

 

(1)          Unlessotherwise noted, the address of each person is care of Vital Living, Inc., 5080North 40th Street, Suite 105, Phoenix, Arizona 85018.

(2)          Beneficialownership is determined in accordance with Rule 13d-3 under the SecuritiesExchange Act of 1934. The information concerning the stockholders is based uponnumbers reported by the owner in documents publicly filed with the SEC,publicly available information or information made known to us.

(3)          Basedon 62,456,004 shares of common stock which includes 61,456,004 shares of commonstock outstanding as of the date hereof and assumes the conversion of 1,000,000shares of Series D Preferred Stock outstanding as of the date hereof into alike number of shares of common stock which vote on an as-converted basis withthe common stock.

(4)          Thebusiness address of SkyePharma is 105 Piccadilly, London, England W1J 7NJ.

(5)          Represents(i) 14,204,548 shares of common stock, (ii) 1,000,000 shares of common stockcurrently issuable upon conversion of 1,000,000 shares of Series D PreferredStock, (iii) 1,000,000 shares of common stock currently issuable uponconversion of 12% Senior Secured Convertible Notes and (iv) 1,000,000 shares ofcommon stock currently issuable upon exercise of warrants issued in connectionwith the issuance of the 12% notes. Does not include (i) 200,000 shares ofcommon stock that may be issued if wedetermine to pay a portion of the interest owed on the Senior SecuredConvertible Notes in shares of our common stock and (ii) shares ofcommon stock held by the other members of the “ENI Voting Group” describedbelow in footnote 22. The foregoing information was derived from an Amendmentto Schedule 13D/A filed with the SEC on December 19, 2003.

(6)          Mr.Morris’s principal address is 8 the Meadows, Camps Bay, Cape Town, SouthAfrica.

(7)          Represents8,860,575 shares of common stock held by Fifth Avenue Capital, Inc., of whichMr. Morris is the president and sole director, and 30,000 shares of commonstock issuable upon exercise of presently exercisable options held by Mr.Morris. Does not include shares of common stock held by the other members ofthe “ENI Voting Group” described below in footnote 22.

(8)          Thebusiness address of Fifth Avenue Capital is Suite 1601-1603, Kinwick Centre, 32Hollywood Rd., Central Hong Kong.

(9)          StephenMorris, the president and sole director of Fifth Avenue Capital, exercisesvoting and dispositive power over these shares. Does not include shares ofcommon stock held by the other members of the “ENI Voting Group” describedbelow in footnote 22. The foregoing information was derived from an Amendmentto Schedule 13D filed with the SEC on September 3, 2003.

(10)    Includes6,310,000 shares of common stock issuable upon exercise of immediately exercisablewarrants held by Mr. Benson. Does not include shares of common stock held bythe other members of the “MAF Voting Group” and “ENI Voting Group” describedbelow in footnotes 21 and 22.

(11)    Mr.Chen’s address is 2099 Strathshire Hall Lane, Powell, Ohio 43065.

(12)    Includes(i) 187,500 shares of common stock held directly, (ii) 262,500 shares of commonstock issuable upon exercise of options which are immediately exercisable orwill become exercisable within the next 60 days, (iii) 647,000 shares of commonstock issuable upon exercise of immediately exercisable warrants, (iv)3,000,000 shares of common stock issuable upon exercise of immediatelyexercisable warrants held by Strong International, Inc. (“Strong”), of whichMr. Chen is the majority shareholder, and (v) 1,000,000 shares of common stockissuable upon conversion of Series B {referred Stock convertible within thenext 60 days.  Does not include (i)115,672 shares of common stock issuable upon exercise of warrants that are notcurrently exercisable

 

37

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and will not become exercisable within the next 60 days and (ii)1,500,000 shares of common stock issuable upon conversion of Series C PreferredStock held by Strong that are not currently, nor will they become convertiblewithin the next 60 days.

(13)    Thebusiness address of Periscope Partners is 1600 Flatrock Road, Penn Valley, PA19072

(14)    LeonFrenkel, the general partner of Periscope Partners, exercises voting anddispositive power over these shares. Represents(i) 4,013,333 shares of common stock issuable upon exercise of immediatelyexercisable warrants and (ii) 1,013,333 shares of common stock issuable uponconversion of Senior Secured Convertible Notes. Does not include 202,670 sharesof common stock that may be issued if we determine to pay a portion of theinterest owed on the Senior Secured Convertible Notes in shares of our commonstock.

(15)    Includes500,000 shares of common stock issuable upon exercise of immediatelyexercisable warrants. Does not include shares of common stock held by the othermembers of the “MAF Voting Group” described below in footnote 20.

(16)    Includes105,000 shares of restricted stock Mr. Hannah received as a director, 60,000shares of which are still subject to divestiture and 231,525 shares of commonstock held by Mr. Hannah’s children. Does not include (i) 46,305 shares ofcommon stock issuable upon exercise of warrants that are not currentlyexercisable and will not become exercisable within the next 60 days and (ii)shares of Common Stock held by the other members of the “MAF Voting Group” and“ENI Voting Group” described below in footnotes 20 and 22.

(17)    Includes(i) 100,000 shares of common stock issuable upon exercise of Series B Warrants,(ii) 100,000 shares of common stock issuable upon exercise of Series C Warrantsand (iii) 75,000 shares of restricted stock received as a director, 50,000shares of which are still subject to divestiture. Does not include the sharesof common stock held by the other members of the “MAF Voting Group” describedbelow in footnote 20.

(18)    Includes105,000 shares of restricted stock received as a director. Also includes125,000 shares of common stock and 72,400 warrants currently exercisable heldby Aegis Capital Corp., of which Mr. Eide is a principal and the president andchief executive officer. Mr. Eide resigned from our Board of Directors in March2004.

(19)    Includes25,000 shares of restricted stock received as a director.

(20)    The MAF Voting Group consists of Bradley D. Edson, Stuart Benson,Martin Gerst, Donald C. Hannah, William Coppel, Kenneth Martin, Phil Maffetone,Leslie Quick, Thomas Quick, and Vital Living, each of whom is a party to, andhas agreed to vote their shares in accordance with, the MAF Voting Agreement describedbelow. Each of the members of this group shares voting power with respect tothe shares of common stock held by each of the members. The number of sharesset forth in the table includes the shares held by each member.

(21)    Includes7,010,000 shares of Common Stock issuable upon exercise of presentlyexercisable options or warrants.

(22)    TheENI Voting Group consists of Skye, Fifth Avenue Capital, Inc., Stephen Morris,Stuart Benson, and Don Hannah, each of whom is a party to, and has agreed tovote their shares in accordance with, the ENI Voting Agreement described below.Each of the members of this group shares voting power with respect to theshares of Common Stock held by each of the members. The number of shares setforth in the table includes the shares held by each member.

(23)    Includes9,340,000 shares of common stock issuable upon exercise or conversion ofpresently exercisable or convertible options, warrants, Series D PreferredStock, or Senior Secured Convertible Notes.

(24)    Includes and excludes the securities referredto in footnotes 10, 16, 17, 18 and 19 above.

 

*Voting Agreements*

 

*MAF Voting Agreement*.In connection with our November 2002 MAF Acquisition, we entered into astockholders’ agreement with Stuart A. Benson, Donald C. Hannah, Bradley D.Edson, Martin Gerst, William Coppel, Phil Maffetone, Kenneth Martin, Leslie C.Quick, III, and Thomas C. Quick (the “MAF Voting Agreement”). Pursuant to theMAF Voting Agreement:

 

•                  for so long asMessrs. Edson, Benson, Hannah and Gerst beneficially own an aggregate of atleast 65% of the shares of common stock held by them on the date of theagreement, they shall be entitled to nominate and have elected four directorsacceptable to them in their sole discretion; and

•                  for so long asMessrs. Coppel, Maffetone, Quick and Quick beneficially own an aggregate of atleast 65% of the shares of common stock held by them on the date of theagreement, they shall be entitled to nominate and have elected three Directors.

 

Each of the parties to the MAF Voting Agreement has agreed to vote theshares of common stock beneficially owned by them on the date of the agreementin favor of the other group’s nominees. Each of the parties have further agreedthat they will vote in favor of the other parties’ nominee or nominees, andwill not take any action, or cause us to take any action, to remove, with orwithout cause, a Director nominated by any of the parties. Because Messrs.Coppel, Maffetone, Quick, and Quick do not still beneficially own the required65%, they no longer have the right to nominate and have elected any Directors.

 

38

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*ENIVoting Agreement*. In connection with our August 2003 ENIAcquisition, we entered into a stockholders’ agreement with Stuart A. Benson,Donald C. Hannah, SkyePharma PLC, Stephen Morris, and Fifth Avenue Capital,Inc. (the “ENI Voting Agreement”). Pursuant to the ENI Voting Agreement, asamended:

 

•                  for so long as Messrs. Benson andHannah beneficially own an aggregate of at least 65% of the shares of commonstock owned by them on the date of the agreement, they shall be entitled tonominate three directors;

•                  for so long as Stephen Morris andFifth Avenue Capital beneficially own an aggregate of at least 65% of theshares of common stock owned by them on the date of the agreement, they shallbe entitled to nominate one director; and

•                  for so long as SkyePharmabeneficially owns an aggregate of at least 65% of the shares of common stockowned by it on the date of the agreement, it is entitled to nominate onedirector.

 

Each of the parties to the ENI Voting Agreement has agreed to vote theshares of common stock beneficially owned by them on the date of the agreementin favor of the other group’s nominees. Each of the parties have further agreedthat they will vote in favor of the other parties’ nominee or nominees, andwill not take any action, or cause us to take any action, to remove, with orwithout cause, a director nominated by any of the parties.

 

**ITEM 12. CERTAIN RELATIONSHIPS AND RELATED****TRANSACTIONS**

 

From time to time, we engageour directors, shareholders, or other related parties for consulting servicesrelated to investment, acquisition, or other activities in the normal course ofbusiness. We believe that all of these transactions are conducted at an“arms-length”.  Fair market value ofsecurities issued in these transactions, including stock, options, andwarrants, is listed below where applicable and calculated using theBlack-Scholes Pricing Model as of the date of issuance or grant.

 

*Officers and Directors*

 

We haveseveral agreements with Aegis Capital Corp. (“Aegis”) to provide consulting,investment, or financial services. Robert J. Eide, a member of our Board ofDirectors from June 2002 through March 2004, is a principal, Chairman, andChief Executive Officer of Aegis. During the years ended December 31, 2003 and2002, we paid the following amounts to Aegis (or to Mr. Eide, where indicated)in exchange for such services:

 
|                 |   |     |   |     |    |      |    | **Options  & Warrants** |   | **Fair  Market  Value of** |   |
|----------------------|--------|----------|--------|----------|---------|-----------|---------|-----------------------------|--------|----------------------------|--------|
| **Matter**           |   | **Year** |   | **Cash** |    | **Stock** |    | **Number**                  |   | **Exercise  Price**        |   | **Securities** |   |
| Other Services(1)    |   | 2003     |   | $        | 6,000   |      | 142,000 |                        | — |                       | N/A    |   | $ | 184,600 |   |
| Other Services(2)    |   | 2003     |   | —   |    | 58,000    |    | —                      |   | N/A                        |   | $ | 75,400 |   |
| Other Services       |   | 2003     |   | $        | 216,335 |      | 150,000 |                        | 72,400 |                       | $      | 1.00 |   | $ | 232 667 |   |
| Director Services(1) |   | 2003     |   | —   |    | 75,000    |    | —                      |   | N/A                        |   | $ | 100,500 |   |
| Other Services       |   | 2002     |   | $        | 100,000 |      | 50,000  |                        | — |                       | N/A    |   | $ | 68,000 |   |
| Director Services(1) |   | 2002     |   | —   |    | 30,000    |    | —                      |   | N/A                        |   | $ | 51,000 |   |
|                      |        |          |        |          |         |           |         |                             |        |                            |        |  |  |  |  |  |

 

----

(1)                    Paidor granted directly to Mr. Eide.

(2)                    Paidor granted to a designee of Aegis on its behalf.

 

During theyears ended December 31, 2003 and 2002, we made the following payments toDonald C. Hannah, Chairman of our Board of Directors, for services rendered asfollows:

 
|              |   |     |   |     |   |      |   | **Options  & Warrants** |   | **Fair  Market  Value of** |   |
|-------------------|--------|----------|--------|----------|--------|-----------|--------|-----------------------------|--------|----------------------------|--------|
| **Matter**        |   | **Year** |   | **Cash** |   | **Stock** |   | **Number**                  |   | **Exercise  Price**        |   | **Securities** |   |
| Advisory Services |   | 2003     |   | $        | 12,000 |      | — |                        | — |                       | N/A    |   | N/A |   |
| Director Services |   | 2003     |   | —   |   | 75,000    | (1)    | —                      |   | N/A                        |   | $ | 100,500 |   |
| Director Services |   | 2002     |   | —   |   | 30,000    | (2)    | —                      |   | N/A                        |   | $ | 51,000 |   |
|                   |        |          |        |          |        |           |        |                             |        |                            |        |  |  |  |  |

 

39

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(1)          50,000of which are subject to divestiture.

(2)          10,000of which remain unvested at December 31, 2003.

 

During 2003,we issued 85,000, 85,000, and 25,000 shares of restricted common stock toCarson Beadle, Leslie Quick, and David Allen, respectively, in exchange fordirector services for a combined fair market value of $245,500. In addition, wepaid $15,000 to Elliot Speiser, a member of our Board of Directors, forservices rendered in a potential acquisition.

 

In 2003, wehad agreements with Mitch Feinglas, our Chief Operating Officer and member ofour Board of Directors, or various entities related to him or on his behalf, toperform consulting or other services. During 2003, we paid the followingamounts to the parties indicated in exchange for such services:

 
|                        |   |     |    |      |   | **Options  & Warrants** |   | **Fair  Market  Value of** |   |
|-----------------------------|--------|----------|---------|-----------|--------|-----------------------------|--------|----------------------------|--------|
| **Party**                   |   | **Cash** |    | **Stock** |   | **Number**                  |   | **Exercise  Price**        |   | **Securities** |   |
| Eurolink International, LTD |   | $        | 116,680 |      | — |                        | — |                       | N/A    |   | N/A |   |
| Equity International, LTD   |   | —   |    | 100,000   |   | —                      |   | N/A                        |   | $ | 134,000 |   |
|                             |        |          |         |           |        |                             |        |                            |        |  |  |  |  |

 

Pursuant to the terms of a severance agreementexecuted in February 2004 with Brad Edson, our former Chairman and ChiefExecutive Officer, we agreed to pay severance in the amount of $244,068 in cash($119,034 due within eight days of execution, $19,839 due on each first day ofJuly, August, and September 2004, and $21,839 due on each first day of October,November, and December 2004) and 600,000 shares of our common stock, due withineleven days of execution and included in our pending Registration Statementinitially filed January 14, 2004. In addition, we will continue to pay Mr.Edson’s medical benefits until the earlier of (i) July 31, 2005, or (ii) thedate he becomes eligible to be covered under another program. As of March 30,2004, neither the first payment nor shares initially due has been paid orissued.

 

During 2003,we paid $10,000 to Silver Lining Realty, the principal of which is our formerChairman and Chief Executive Officer, Brad Edson, for its realty services inconnection with a new lease for our Utah operations.

 

As part of aresignation agreement executed in July 2003, in which all severance paymentsunder a prior employment agreement were waived, 280,000 shares of restrictedcommon stock were returned to us at no cost and 144,000 shares were repurchasedby us at $0.50 per share from William Coppel, our former President, for totalpayments of $72,000 during 2003. These shares have been returned and recordedas treasury stock as of December 31, 2003.

 

OnApril 4, 2002, we entered into a three-year consulting agreement withMartin Gerst, formerly our secretary, treasurer, and director, to provideservices related to capital formation, strategic relationships, and productbranding. Under the terms of the agreement, Mr. Gerst, in addition tomonthly payments of $2,000, received fully vested warrants to purchase 500,000shares of common stock at a price of $1.50 per share, valued at $280,580 at thedate of grant. This agreement was terminated by the parties effective December31, 2002. We paid approximately $8,000 and $30,000 related to this agreementduring the fiscal year ended December 31, 2003 and 2002, respectively.

 

During 2002,the following obligations to or from various former officers, directors, orentities controlled by former officers or directors, were relieved as follows:

•                  An unsecureddemand note payable to Brad Edson totaling $43,500 with interest accruing at10% was repaid;

•                  Payables to BradEdson, Kenneth Lind, and Eric Anderson totaling $147,926 for unpaid salariesand other reimbursable expenses were repaid;

•                  Severancecompensation of approximately $67,500 was paid to Kenneth Lind in connectionwith the termination of his employment in December 2002;

•                  Facility leaseand office costs of approximately $51,095 was paid to Camper Clubs of America,Inc., an entity controlled by Brad Edson and Martin Gerst;

•                  Advancesreceivable from Brad Edson and Martin Gerst totaling $52,500 with interestaccruing at 6% were repaid; and

•                  Receivables fromCamper Clubs of America, Inc., CCA Products, Inc., and a corporation previouslydoing business as Vital Living, entities controlled by Brad Edson andMartin Gerst, totaling $37,372 were written off.

 

40

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*Shareholders*

* *

We are partyto two voting agreements. These agreements are described under “ITEM 11.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS” herein.

 

In October andNovember 2003, we entered into short-term notes payable with two shareholders,borrowing an aggregate principal amount of $125,000. The notes generallymatured in 60 days and bore interest at a stated rate of 10%, with 12 months ofinterest earned and payable immediately. The notes, including interest earnedof $12,500, were paid in full prior to December 31, 2003.

 

Concurrentwith the MAF Acquisition in November 2002, we executed a three-year consultingagreement with Phillip Maffetone, a shareholder and former owner of MAF, toprovide product development and marketing services in exchange for monthly feesof $8,333. We paid approximately $80,000 and $8,000 to Phillip Maffetone underthe terms of the agreement during the years ended December 31, 2003 and 2002,respectively. We have ceased payments under the contract and are currentlyrenegotiating its terms.

 

On October 14,2003, the Closing Date of the DFN Acquisition, Messrs. Bruce Howe and MaynardHowe entered into a lock-up agreement, representing approximately 65% of the 1,650,003common shares exchanged as purchase consideration. Pursuant to the agreement,the parties collectively agreed to a lock-up of the shares received in the DFNAcquisition, as listed below:

 
| **Reference**           |   | **Period**                                                 |   | **Shares  Available for Disposition** |
|-------------------------|--------|------------------------------------------------------------|--------|---------------------------------------|
| Initial  Lock-Up Period |   | Up to 6  months following Closing Date                     |   | None                                  |
| Second  Lock-Up Period  |   | Up to 6  months following Initial Lock-Up Period           |   | Up to 50%  shares received            |
| Third  Lock-Up Period   |   | Up to 6  months following Second Lock-Up Period            |   | Up to 75%  shares received            |
| Thereafter              |   | Immediately  following Third Lock-Up Period and thereafter |   | Up to 100%  shares received           |

 

We haveseveral agreements with Fifth Avenue Capital, Inc. (“FAC”), a majorshareholder, to provide consulting, investment, or financial services. StephenMorris, a shareholder and member of the ENI Voting Group, is the President andsole Director of FAC. During 2003, we paid cash fees of $22,500 to FAC inexchange for such services and erroneously issued 25,000 shares of restrictedcommon stock, valued at $33,500, to Mr. Morris, which is recorded as “accountsreceivable, related parties” at December 31, 2003. In addition, we have apromissory note payable to FAC assumed as part of our ENI Acquisition in theamount of $100,000 outstanding at December 31, 2003, bearing interest at primeplus 2%.

 

We have aconsulting arrangement with Stephen Chen, Chairman and Chief Executive Officerof Strong International, Inc., the sole shareholder of our outstanding Series Band Series C Preferred Stock, to assist us in creating strategic alliances inChina. In 2003, we amended Mr. Chen’s consulting agreement to extend the termof the agreement, providing certain payments in shares of common stock andwarrants as consideration. Mr. Chen also assisted in facilitating the sale ofthe Series B and Series C Preferred Stock to Strong International, for which wemade certain payments in cash, shares of common stock, options, and warrants ascommissions. During 2003, we made cumulative payments related to such mattersto Mr. Chen as follows:

 
|                |   |     |    |      |    | **Options  & Warrants** |    | **Fair  Market  Value of** |               |
|---------------------|--------|----------|---------|-----------|---------|-----------------------------|---------|----------------------------|--------------------|
| **Matter**          |   | **Cash** |    | **Stock** |    | **Number**                  |    | **Exercise  Price**        |               | **Securities** |   |
| Consulting Services |   | $        | 25,000  |      | 125,000 |                        | 197,000 |                       | $1.00 — $2.00 |   | $ | 180,000 |   |
| Investment Services |   | $        | 187,500 |      | 62,500  |                        | 512,500 |                       | $1.00 — $1.30 |   | $ | 195,426 |   |

 

41

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We haveseveral agreements with HCFP/Brenner Securities, LLC (“Brenner”), ashareholder, to provide consulting, investment, or financial services. Duringthe years ended December 31, 2003 and 2002, we paid the following amounts toBrenner in exchange for such services:

 
|                |   |     |   |     |    |      |    | **Options  & Warrants** |    | **Fair  Market  Value of** |   |
|---------------------|--------|----------|--------|----------|---------|-----------|---------|-----------------------------|---------|----------------------------|--------|
| **Matter**          |   | **Year** |   | **Cash** |    | **Stock** |    | **Number**                  |    | **Exercise  Price**        |   | **Securities** |   |
| Consulting Services |   | 2003     |   | $        | 34,245  |      | 235,000 |                        | —  |                       | N/A    |   | $ | 228,950 |   |
| Investment Services |   | 2003     |   | $        | 569,600 |      | 987,600 |                        | 345,600 |                       | $      | 1.00 |   | $ | 1,462,355 |   |
| Consulting Services |   | 2002     |   | $        | 60,000  |      | 48,000  |                        | —  |                       | N/A    |   | $ | 81,600 |   |
|                     |        |          |        |          |         |           |         |                             |         |                            |        |  |  |  |  |  |

 

We haveseveral agreements with Atlas Capital Services, LLC (“Atlas”) to provideconsulting, investment, or financial services, including the valuation relatedto the ENI Acquisition. During 2003, we paid the following amounts to Atlas (orits designees) in exchange for such services:

 
|                |   |     |   |      |   | **Options  & Warrants** |   | **Fair  Market  Value of** |   |
|---------------------|--------|----------|--------|-----------|--------|-----------------------------|--------|----------------------------|--------|
| **Matter**          |   | **Cash** |   | **Stock** |   | **Number**                  |   | **Exercise  Price**        |   | **Securities** |   |
| Investment Services |   | $        | 30,000 |      | 54,000 |                        | 35,000 |                       | $      | 1.00 |   | $ | 58,320 |   |
|                     |        |          |        |           |        |                             |        |                            |        |  |  |  |  |  |

 

We haveseveral agreements with Sloan Securities Corp (“Sloan”) to provide consulting,investment, or financial services. During 2003, we paid the following amountsto Sloan (or its designees) in exchange for such services: 

 
|                |   |     |    |      |    | **Options  & Warrants** |    | **Fair  Market  Value of** |   |
|---------------------|--------|----------|---------|-----------|---------|-----------------------------|---------|----------------------------|--------|
| **Matter**          |   | **Cash** |    | **Stock** |    | **Number**                  |    | **Exercise  Price**        |   | **Securities** |   |
| Investment Services |   | $        | 257,800 |      | 115,400 |                        | 315,400 |                       | $      | 1.00 |   | $ | 356,941 |   |
|                     |        |          |         |           |         |                             |         |                            |        |  |  |  |  |  |

 

Pursuant to aregistration rights agreement related to a November 2002 private placement of1,367,500 shares of common stock, we were required to file and have declaredeffective a registration statement to register the shares of common stockissued and shares that may be issued upon exercise of the Series B Warrants andSeries C Warrants from the private placement prior to March 20, 2003. We failedto have the registration statement declared effective by the deadline; as a result,we owe the investors liquidation damages equal to 2% per month of the purchaseprice of said securities, calculated on a pro rata basis to the date on whichthe registration statement was ultimately declared effective. During 2003, wereached an agreement with some of the investors to pay such damages in sharesof common stock at a ratio of two shares of common stock for every $1 ofliquidation damage earned. For the period through August 21, 2003, we agreed tosettle the penalty amount owed by the issuance of 328,200 shares of our commonstock, valued at approximately $367,000. Of the total shares owed, we issued134,600 shares of our restricted common stock, valued at $156,136, related tothe settlement agreements prior to December 31, 2003. As of December 31, 2003,we owed a remaining 193,600 shares valued at $211,000 and have since issued94,000 of such shares and paid $18,900 in cash to relieve a portion of thisliability. It is expected that additional penalty shares will be issued afterour Registration Statement, filed January 14, 2004, is declared effective. AtDecember 31, 2003, $442,573 has been accrued to settle the additional amountsowed.

 

*Other Related Parties*

 

In October andNovember 2003, we entered into short-term notes payable with three individuals,each of whom are family members of our former Chairman and Chief ExecutiveOfficer, borrowing an aggregate principal amount of $271,672. The notesgenerally matured in 60 days and bore interest at stated rates ranging between10% and 28%, with 12 months of interest earned and payable immediately. Thenotes, including interest earned of $46,172, were paid in full as of December31, 2003.

 

We have hadvarious agreements with Michael Edson, a family member of our former Chairmanand Chief Executive Officer, under which he provides consulting services,including prospecting, establishing, and servicing complementary andalternative healthcare practices and other proprietary distribution channels.In addition, Mr. Edson assisted in various short-term financing activities, forwhich he received commissions. We made payments totaling $63,985 andapproximately $42,118 during the years ended December 31, 2003 and 2002,respectively, for said services and commissions.

 

42

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During 2003and 2002, we paid $5,000 in contract fees and $25,000 as payroll, respectively,to Marie Hughes, a family member of our current Chief Executive Officer andPresident, for various services.

 

**ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K****.**

 

(a)          The following documents are filed as part of this Report:

(1)                                  Financial statements filed as part of thisReport:
| Report of Pannell Kerr Forster of Texas, P.C                                                            |   |
|---------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets  as of December 31, 2003 and 2002                                           |   |
| Consolidated  Statements of OperationsYears  Ended December 31, 2003 and 2002                           |   |
| Consolidated  Statements of Stockholders’ Equity (Deficit)  Years Ended December 31, 2003 and 2002 |   |
| Consolidated  Statements of Cash FlowsYears Ended December 31, 2003 and 2002                            |   |
| Notes to  Consolidated Financial Statements                                                             |   |

 

(2)                                  Exhibits filed as part of this Report:

 
| **Exhibit  No.** |   | **Description**                                                                                                                                 |   | **No. in Document** |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|
| 2.1              |   | Acquisition  Agreement and Plan of Merger, dated as of August 16, 2001, between Vital  Living, Inc. and VCM Technology Limited                  |   | (1)                 |
|             |   |                                                                                                                                            |   |                |
| 2.2              |   | Certificate of  Merger of Vital Living, Inc. and VCM Technology Limited                                                                         |   | (1)                 |
|             |   |                                                                                                                                            |   |                |
| 3.1              |   | Amended and  Restated Articles of Incorporation for Vital Living, Inc.                                                                          |   | (1)                 |
|             |   |                                                                                                                                            |   |                |
| 3.2              |   | Amended and  Restated Bylaws for Vital Living, Inc.                                                                                             |   | (1)                 |
|             |   |                                                                                                                                            |   |                |
| 4.1              |   | Form of Series A  Warrant                                                                                                                       |   | (2)                 |
|             |   |                                                                                                                                            |   |                |
| 4.2              |   | Form of Series B  Warrant                                                                                                                       |   | (3)                 |
|             |   |                                                                                                                                            |   |                |
| 4.3              |   | Form of Series C  Warrant                                                                                                                       |   | (3)                 |
|             |   |                                                                                                                                            |   |                |
| 4.4              |   | Form of Series D  Warrant                                                                                                                       |   | (4)                 |
|             |   |                                                                                                                                            |   |                |
| 4.5              |   | Form of Series E  Warrant                                                                                                                       |   | (5)                 |
|             |   |                                                                                                                                            |   |                |
| 4.6              |   | Form of Series F  Warrant                                                                                                                       |   | (2)                 |
|             |   |                                                                                                                                            |   |                |
| 4.7              |   | Certificate of  Designation of Preferences, Rights and Limitations of 10% Series A Preferred  Stock                                             |   | Filed Herewith      |
|             |   |                                                                                                                                            |   |                |
| 4.8              |   | Certificate of  Designation, Preferences and Relative, Participating, Optional or Other  Special Rights of Series B Convertible Preferred Stock |   | Filed Herewith      |
|             |   |                                                                                                                                            |   |                |
| 4.9              |   | Certificate of  Designation, Preferences and Relative, Participating, Optional or Other  Special Rights of Series C Convertible Preferred Stock |   | Filed Herewith      |
|             |   |                                                                                                                                            |   |                |
| 4.10             |   | Certificate of  Designation, Preferences and Relative, Participating, Optional or Other  Special Rights of Series D Convertible Preferred Stock |   | (5)                 |

 

43

----

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                                               |   | **No. in Document** |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|
| 4.11             |   | Stock Purchase  Agreement, dated as of October 23, 2002, by and among Vital Living, Inc., MAF  BioNutritionals, LLC, William A. Coppel (personally and as a representative  of Kenneth Martin), Phillip B. Maffetone, Leslie C. Quick, III, Thomas C.  Quick and Kenneth Glah |   | (6)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.12             |   | Subscription  Agreement for November 2002 private placement of units                                                                                                                                                                                                          |   | (3)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.13             |   | Form of  Subscription Agreement for Series B Convertible Preferred Stock                                                                                                                                                                                                      |   | (4)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.14             |   | Form of  Subscription Agreement for Series C Convertible Preferred Stock                                                                                                                                                                                                      |   | (7)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.15             |   | Form of  Subscription Agreement for Series D Convertible Preferred Stock                                                                                                                                                                                                      |   | (5)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.16             |   | Registration  Rights Agreement, dated as of November 20, 2002, between Vital Living, Inc.  and those persons listed on Exhibit A attached thereto                                                                                                                             |   | (3)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.17             |   | Stockholders’  Agreement, dated, by and among Vital Living, Inc., Bradley D. Edson, Stuart  A. Benson, Martin Gerst, Donald Hannah, William Coppel, Kenneth Martin, Phil  Maffetone, Leslie C. Quick, III, and Thomas C. Quick                                           |   | (3)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.18             |   | Stockholders’  Agreement, dated August 20, 2003, by and between Vital Living, Inc., Bradley  D. Edson, Stuart A. Benson, Donald Hannah, SkyePharma PLC, Fifth Avenue  Capital, Inc. and Stephen Morris                                                                   |   | (5)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.19             |   | Registration  Rights Agreement, dated as of August 20, 2003, by and between Vital Living,  Inc. and SkyePharma PLC                                                                                                                                                            |   | (5)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.20             |   | Lock Up  Agreement, dated as of May 21, 2001, among Bradley D. Edson Martin Gerst,  Donald Hannah and Kenneth Lind                                                                                                                                                            |   | (8)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.21             |   | Amendment No. 1  to Lock Up Agreement, dated as of May 21, 2001, among Bradley D. Edson Martin  Gerst, Donald Hannah and Kenneth Lind                                                                                                                                         |   | (8)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.22             |   | Form of Securities Purchase Agreement for December 2003 private  offering                                                                                                                                                                                                     |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.23             |   | Form of Senior Secured Convertible Note issued in December 2003  private offering                                                                                                                                                                                             |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.24             |   | Form of Warrant issued in December 2003 private offering                                                                                                                                                                                                                      |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.25             |   | Form of Warrant issued in 2003 offering of senior convertible  promissory notes                                                                                                                                                                                               |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.26             |   | Form of Security Agreement for December 2003 private offering                                                                                                                                                                                                                 |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.27             |   | Form of Registration Rights Agreement for December 2003 private  offering                                                                                                                                                                                                     |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 4.28             |   | Form of Escrow Agreement for December 2003 private offering                                                                                                                                                                                                                   |   | (9)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 10.1             |   | 2001 Stock  Option Plan                                                                                                                                                                                                                                                       |   | (1)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 10.2             |   | Agreement, dated  August 21, 2001, between Vital Living, Inc. and Arizona Heart Institute, Inc.                                                                                                                                                                               |   | (8)                 |
|             |   |                                                                                                                                                                                                                                                                          |   |                |
| 10.3             |   | Addendum, dated  April 4, 2002, to Agreement between Vital Living, Inc. and Arizona Heart  Institute, Inc.                                                                                                                                                                    |   | (10)                |

 

44

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| **Exhibit  No.** |   | **Description**                                                                                                                                                     |   | **No. in Document** |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|
| 10.4             |   | Amendment No. 1,  dated July 15, 2003, to Agreement Vital Living, Inc. and Arizona Heart  Institute, Inc.                                                           |   | (11)                |
|             |   |                                                                                                                                                                |   |                |
| 10.5             |   | Distribution  Agreement, dated August 21, 2001, between Vital Living, Inc. and Advanced  Medical China, Ltd.                                                        |   | (8)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.6             |   | Amendment No. 1  to Distribution Agreement, dated February 26, 2002, between Vital Living,  Inc. and Advanced Medical China, Ltd. and AHI Management Hong Kong Ltd. |   | (12)                |
|             |   |                                                                                                                                                                |   |                |
| 10.7             |   | Employment  agreement, dated October 1, 2001, between Vital Living, Inc. and Bradley D.  Edson                                                                      |   | (8)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.8             |   | Amendment No. 1,  dated October 1, 2002, to Employment Agreement between Vital Living, Inc. and  Bradley D. Edson                                                   |   | (3)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.9             |   | Consultant  Agreement, dated October 1, 2001, between Vital Living, Inc. and Howard Wernick                                                                         |   | (8)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.10            |   | Consulting  Agreement, dated March 20, 2002, between Vital Living, Inc. and Leslie D.  Michelson                                                                    |   | (13)                |
|             |   |                                                                                                                                                                |   |                |
| 10.11            |   | Consulting  Agreement, dated March 20, 2002, between Vital Living, Inc. and Brian C.  Smith                                                                         |   | (13)                |
|             |   |                                                                                                                                                                |   |                |
| 10.12            |   | Consulting  Agreement, dated March 20, 2002, between Vital Living, Inc. and Michael H.  Davidson, M.D.                                                              |   | (13)                |
|             |   |                                                                                                                                                                |   |                |
| 10.13            |   | Form of Clinical  Trial Agreement, between Vital Living, Inc. and the City of Phoenix Fire  Department                                                              |   | (14)                |
|             |   |                                                                                                                                                                |   |                |
| 10.14            |   | Executive  Services Agreement, dated as of November 20, 2002, between Vital Living, Inc.  and Stuart A. Benson                                                      |   | (3)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.15            |   | Amendment No. 1  to Employment Agreement between Vital Living, Inc. and Stuart A. Benson                                                                            |   | Filed Herewith      |
|             |   |                                                                                                                                                                |   |                |
| 10.16            |   | Amendment No. 2  to Employment Agreement between Vital Living, Inc. and Stuart A. Benson                                                                            |   | Filed Herewith      |
|             |   |                                                                                                                                                                |   |                |
| 10.17            |   | Warrant  Agreement, dated November 20, 2002, between Vital Living, Inc. and Stuart A.  Benson                                                                       |   | (10)                |
|             |   |                                                                                                                                                                |   |                |
| 10.18            |   | Amendment No. 1  to Warrant Agreement between Vital Living, Inc. and Stuart A. Benson                                                                               |   | (4)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.19            |   | Amendment No. 2  to Warrant Agreement between Vital Living, Inc. and Stuart A. Benson                                                                               |   | Filed Herewith      |
|             |   |                                                                                                                                                                |   |                |
| 10.20            |   | Financial  Advisor Services Agreement, dated July 29, 2002, between Vital Living, Inc.  and Peck and Grossman, LLC                                                  |   | (14)                |
|             |   |                                                                                                                                                                |   |                |
| 10.21            |   | Agreement, dated  February 3, 2003, between Vital Living, Inc. and CHG Allied Inc.                                                                                  |   | (14)                |
|             |   |                                                                                                                                                                |   |                |
| 10.22            |   | Agreement, dated  September 30, 2002, between Vital Living, Inc. and Medical Resource, LLC,  National Provider Network                                              |   | (14)                |
|             |   |                                                                                                                                                                |   |                |
| 10.23            |   | Consulting  Agreement, dated as of October 8, 2002, between Vital Living, Inc. and  Martin Wallace                                                             |   | (14)                |
|             |   |                                                                                                                                                                |   |                |
| 10.24            |   | Management  Agreement, dated as of April 17, 2003, between Vital Living, Inc. and  Christopher’s Original Formulas, Inc.                                       |   | (4)                 |
|             |   |                                                                                                                                                                |   |                |
| 10.25            |   | Consulting  Agreement, dated May 19, 2002, between Vital Living, Inc. and Stephen  Songsheng Chen                                                                   |   | (4)                 |

 

45

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| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                              |   | **No. in Document** |
|------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|
| 10.26            |   | Warrant  Agreement, dated April 16, 2003, between Vital Living, Inc. and Stephen  Songsheng Chen                                                                                                                                             |   | (4)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.27            |   | Scientific  Advisory Board Agreement, dated May 15, 2002, between Vital Living, Inc. and  Dr. Dennis Sprecher                                                                                                                                |   | (15)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.28            |   | Scientific  Advisory Board Agreement, dated May 30, 2002, between Vital Living, Inc. and  John A. Sutherland                                                                                                                                 |   | (16)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.29            |   | Scientific  Advisory Board Agreement, dated May 16, 2002, among Vital Living, Inc.,  Thomas Allison and the Mayo Foundation for  Medical Education and Research                                                                         |   | (15)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.30            |   | Scientific  Advisory Board Agreement, dated June 17, 2002, between Vital Living, Inc. and  Ronald M. Krauss                                                                                                                                  |   | (17)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.31            |   | Scientific  Advisory Board Agreement, dated May 7, 2002, between Vital Living, Inc.  and  Dr. David Maron                                                                                                                               |   | (4)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.32            |   | Settlement and  Release Agreement, dated June 25, 2003, between Vital Living, Inc. and  William Coppel                                                                                                                                       |   | (18)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.33            |   | Asset Purchase  Agreement, dated as of June 20, 2003, among Vital Living, Inc., Nature’s  Systems, Inc., Christopher’s Original Formulas, Inc., Robert C. Scott and  James R. Jeppson                                              |   | (18)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.34            |   | Form of Escrow  Agreement, dated August 20, 2003, between Vital Living, Inc.,  E-Nutraceuticals, Inc., Stephen Morris and Mercantile National Bank –  California, as escrow agent                                                       |   | (5)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.35            |   | Development and  License Agreement, dated as of December 28, 2001, between E-Nutraceuticals,  Inc. and SkyePharma PLC                                                                                                                        |   | (5)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.36            |   | Amendment No. 1,  dated as of August 20, 2003, to Development and License Agreement by and  among Vital Living, Inc., E-Nutraceuticals, Inc., Jagotec AG and SkyePharma  PLC                                                                 |   | (5)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.37            |   | Stock Purchase  Agreement, dated as of October 14, 2003, among Vital Living, Inc. and the  shareholders set forth on the signature page attached thereto                                                                                     |   | (19)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.38            |   | Escrow Agreement,  dated as of October 14, 2003, among Vital Living, Inc., the shareholders of  Doctors For Nutrition, Inc. and Mercantile National Bank – California                                                                   |   | (19)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.39            |   | Executive  Services Agreement, dated as of October 14, 2003, between Doctors For  Nutrition, Inc. and Bruce Howe                                                                                                                             |   | (19)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.40            |   | Strategic  Advisor Agreement, dated October 14, 2003, between Vital Living, Inc. and Dr.  Roger Howe                                                                                                                                         |   | (19)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.41            |   | Strategic  Advisor Agreement, dated October 14, 2003, between Vital Living, Inc. and Dr.  Maynard Howe                                                                                                                                       |   | (19)                |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.42            |   | Form of  Indemnification Agreement between the Company and each of Bradley D. Edson,  Stuart A. Benson, Donald C. Hannah, Carson E. Beadle, Leslie C. Quick, Robert  J. Eide, David Allen, Marcus Feder, Mitchel Feinglas and Michael Ashton |   | (2)                 |
|             |   |                                                                                                                                                                                                                                         |   |                |
| 10.42.1          |   | Schedule of  Indemnification Agreements in the form of Exhibit 10.42, including material  detail in which such documents differ from Exhibit 10.42                                                                                           |   | (2)                 |

 

46

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| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                            |   | **No. in Document** |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|
| 10.43            |   | Amendment No. 1,  dated as of January 13, 2004, to Stockholders’ Agreement, dated as of August  14, 2003, between each of the Company, Bradley D. Edson, Stuart Benson,  Donald Hannah, Stephen Morris, SkyePharma PLC and Fifth Avenue Capital, Inc. |   | Filed Herewith      |
|             |   |                                                                                                                                                                                                                                                       |   |                |
| 31.1             |   | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                       |   | Filed Herewith      |
|             |   |                                                                                                                                                                                                                                                       |   |                |
| 31.2             |   | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                       |   | Filed Herewith      |
|             |   |                                                                                                                                                                                                                                                       |   |                |
| 32               |   | Certification of  Chief Executive Officer and Chief Financial Officer pursuant to Section 906  of the Sarbanes-Oxley Act of 2002                                                                                                                           |   | Filed Herewith      |

 

----

(1)                                  CurrentReport on Form 8-K dated August 17, 2001 and filed with the SEC on October 1,2001

(2)                                  RegistrationStatement on Form SB-2 (333-111921) filed with the SEC on January 14, 2004

(3)                                  CurrentReport on Form 8-K/A dated November 20, 2002 and filed with the SEC on December5, 2002

(4)                                  AmendmentNo. 2 to Registration Statement on Form SB-2 (333-102106) filed on April 28,2003

(5)                                  CurrentReport on Form 8-K dated August 21, 2003 and filed with the SEC on September 8,2003

(6)                                  CurrentReport on Form 8-K dated October 23, 2002 and filed with the SEC on November 4,2002

(7)                                  AmendmentNo. 3 to Registration Statement on Form SB-2 (333-102106) filed on June 18,2003

(8)                                  CurrentReport on Form 8-K dated August 17, 2001 and filed with the SEC on November 20,2001

(9)                                  CurrentReport on Form 8-K dated December 15, 2003 and filed with the SEC on December19, 2003

(10)                            CurrentReport on Form 8-K dated April 1, 2002 and filed with the SEC on April 16, 2002

(11)                            AmendmentNo. 4 to Registration Statement on Form SB-2 (333-102106) filed on July 23,2003

(12)                            CurrentReport on Form 8-K dated February 27, 2002 and filed with the SEC on February28, 2002

(13)                            AnnualReport on Form 10-KSB for the fiscal year ended December 31, 2001

(14)                            AmendmentNo. 1 to Registration Statement on Form SB-2 (333-102106) filed on March 7,2003

(15)                            CurrentReport on Form 8-K dated May 15, 2002 and filed with the SEC on May 31, 2002

(16)                            CurrentReport on Form 8-K dated May 30, 2002 and filed with the SEC on June 13, 2002

(17)                            CurrentReport on Form 8-K dated June 17, 2002 and filed with the SEC on July 2, 2002

(18)                            CurrentReport on Form 8-K dated July 2, 2003 and filed with the SEC on July 16, 2003

(19)                            CurrentReport on Form 8-K/A dated October 14, 2003 and filed with the SEC on December5, 2003

 

(b)         We filed the following reports on Form 8-K during the quarter endedDecember 31, 2003.

 

(1)                                  AReport on Form 8-K was filed with the Securities and Exchange Commissionon December 19, 2003 relating to a private placement of Senior SecuredConvertible Notes.

(2)                                  A Report on Form 8-K/A was filed with the Securitiesand Exchange Commission on December 5, 2003 amending a Report on Form 8-K filedOctober 29, 2003 relating to the acquisition of Doctors For Nutrition, Inc.

(3)                                  A Report on Form 8-K/A was filed with the Securitiesand Exchange Commission on November 11, 2003 amending a Report on Form 8-Kfiled September 8, 2003 relating to a merger with E-Nutraceuticals, Inc. and acorresponding Series D Preferred Stock private placement.

 

47

----

 

**ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

The aggregate fees billed forprofessional services rendered by the principal accountant for the years endedDecember 31 are as follows:

** **
|                  |   | **2003** |    | **2002** |   |
|-----------------------|--------|----------|---------|----------|--------|
| Audit Fees            |   | $        | 106,628 |     | $      | 7,340 |   |
| Audit-Related Fees(1) |   | 112,668  |    | —   |   |
| Tax Fees              |   | 15,273   |    | —   |   |
| All Other Fees(2)     |   | 71,366   |    | 14,550   |   |
| Total                 |   | $        | 305,935 |     | $      | 21,890 |   |

 

----

(1)          Fees relate to audits of three newly acquired entitiesin 2003 to satisfy reporting and disclosure requirements of Form 8K andcorresponding reviews of Forms 8K filed.

(2)          Fees relate to our filing of Form SB-2, generalconsultation related to merger and acquisition activities, and generalconsulting work for new accounting regulations.

 

In accordance with Section10A(i) of the Securities Exchange Act of 1934, before we engage our independentaccountant to render audit or non-audit services, the engagement is approved byour audit committee. Our audit committee approved all of the fees referred toin the sections entitled “Audit Fees,” “Audit-Related Fees,” “Tax Fees” and“All Other Fees” above.

 

48

----

 

**SIGNATURES**

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the Registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

Date: March 30, 2004

 
| By:    | */s/ Stuart A. Benson*                     |   |
|--------|--------------------------------------------|--------|
|   | Stuart A. Benson, Chief  Executive Officer |

 

Pursuant to the requirements of the SecuritiesAct of 1934, this report been signed by the following persons in the capacitiesand on the dates indicated.

 
| **Signature**                 |   | **Capacity**                                             |   | **Date**       |
|-------------------------------|--------|----------------------------------------------------------|--------|----------------|
|                          |   |                                                     |   |           |
| * /s/ Stuart A. Benson*  |   | Chief Executive Officer,  President, Secretary, Director |   | March 30, 2004 |
|  Stuart A. Benson        |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ Marcus Feder*      |   | Chief Financial Officer,  Treasurer                      |   | March 30, 2004 |
|  Marcus Feder            |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ Mitchel  Feinglas* |   | Chief Operating Officer,  Director                       |   | March 30, 2004 |
|  Mitchel Feinglas        |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ Donald C.  Hannah* |   | Chairman of the Board                                    |   | March 30, 2004 |
|  Donald C. Hannah        |   |                                                     |   |           |
|                          |   |                                                     |   |           |
|                          |   | Director                                                 |   | March 30, 2004 |
|  Leslie C. Quick, III    |   |                                                     |   |           |
|                          |   |                                                     |   |           |
|                          |   | Director                                                 |   | March 30, 2004 |
|  Elliot R. Speiser       |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ Carson E.  Beadle* |   | Director                                                 |   | March 30, 2004 |
|  Carson E.  Beadle       |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ David Allen*       |   | Director                                                 |   | March 30, 2004 |
| * *David Allen           |   |                                                     |   |           |
|                          |   |                                                     |   |           |
| * /s/ Michael Ashton*    |   | Director                                                 |   | March 30, 2004 |
| * *Michael Ashton        |   |                                                     |   |           |

 

49

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IndependentAuditor’s Report

 

To the Board of Directors andStockholders of Vital Living, Inc.

 

We have audited the accompanying consolidatedbalance sheets of Vital Living, Inc. and subsidiaries as of December 31,2003 and 2002 and the related statements of operations, stockholders’ equity,and cash flows for the years then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits in accordance withauditing standards generally accepted in the United States of America. Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the financial positionof Vital Living, Inc. and subsidiaries as of December 31, 2003 and 2002and the results of their operations and their cash flows for the years thenended in conformity with accounting principles generally accepted in the UnitedStates of America.

 

The accompanying financial statements havebeen prepared assuming that the Company will continue as a going concern. Asdiscussed in Note 2 to the financial statements, the Company has sufferedrecurring losses from operations, has a working capital deficit, and isdependent on funding sources from other than operations. Sinceinception, the Company has been required to raise additional capital by theissuance of both equity and debt instruments. There are no commitments fromfunding sources, debt or equity, in the event that cash flows are notsufficient to fund ongoing operations or other cash commitments when they comedue. These factors raisesubstantial doubt about the Company’s ability to continue as a going concern.Management’s plans regarding these matters are also described in Note 2. Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

 
| /s/ Pannell Kerr  Forster of Texas, P.C.                |   |
|--------------------------------------------------------------|--------|
|                                                         |
| Houston, Texas                                               |
| February 27, 2004                                       |
| (except for Note 12, for  which  the date is March 30, 2004) |

 

F-1

----

 

##### **VITALLIVING, INC**

**Consolidated Balance Sheets**

 
|                                                                                                                                              |   | **December  31,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|
|                                                                                                                                              |   | **2003**          |       | **2002** |   |
| **Assets**                                                                                                                                        |   |              | ** ** |   | ** ** |
| Current assets                                                                                                                                    |   |              |       |   |   |
| Cash and cash equivalents                                                                                                                         |   | $                 | 1,729,311  |   | $ | 1,416,073 |   |
| Accounts receivable, trade; net of  allowance for doubtful accounts of $32,000 and $0, respectively                                               |   | 371,586           |       | 68,234 |   |
| Accounts receivable, related parties                                                                                                              |   | 67,000            |       | — |   |
| Inventory, net of reserve of $86,000 and  $0, respectively                                                                                        |   | 557,005           |       | 273,361 |   |
| Prepaid expenses and other current assets                                                                                                         |   | 1,099,767         |       | 25,833 |   |
| Total current assets                                                                                                                              |   | 3,824,669         |       | 1,783,501 |   |
| Other assets                                                                                                                                      |   |              |       |   |   |
| Deferred debt issuance costs, net of  accumulated amortization of $230,871                                                                        |   | 985,636           |       | — |   |
| Property and equipment, net                                                                                                                       |   | 169,107           |       | 172,295 |   |
| Goodwill                                                                                                                                          |   | 4,178,932         |       | 4,893,517 |   |
| License agreement - GEOMATRIX®, net                                                                                                          |   | 33,790,858        |       | — |   |
| License agreement – X-Fat®, net                                                                                                         |   | 3,990,504         |       | — |   |
| Marketing agreements, net                                                                                                                         |   | 3,533,226         |       | — |   |
| Other intangible assets, net                                                                                                                      |   | 188,992           |       | 327,498 |   |
| Other non-current assets                                                                                                                          |   | 46,308            |       | 2,807 |   |
| Total other assets                                                                                                                                |   | 46,883,563        |       | 5,396,117 |   |
|                                                                                                                                              |   |              |       |   |   |
| Total assets                                                                                                                                      |   | $                 | 50,708,232 |   | $ | 7,179,618 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                     |   |              | ** ** |   | ** ** |
| Current liabilities                                                                                                                               |   |              |       |   |   |
| Accounts payable, trade                                                                                                                           |   | $                 | 1,691,602  |   | $ | 428,287 |   |
| Accounts payable, related parties                                                                                                                 |   | —            |       | 22,500 |   |
| Accrued and other current liabilities                                                                                                             |   | 1,386,430         |       | 257,321 |   |
| Current portion of long-term debt                                                                                                                 |   | 584,571           |       | 291,688 |   |
| Notes payable, related parties                                                                                                                    |   | 260,045           |       | — |   |
| Total current liabilities                                                                                                                         |   | 3,922,648         |       | 999,796 |   |
|                                                                                                                                              |   |              |       |   |   |
| Long-term debt                                                                                                                                    |   | 4,980,438         |       | 521,494 |   |
| Total liabilities                                                                                                                                 |   | 8,903,086         |       | 1,521,290 |   |
| Commitments and contingencies                                                                                                                     |   | —            |       | — |   |   |
| Stockholders’ equity                                                                                                                         |   |              |       |   |   |   |
| Preferred stock, $0.001 par value,  50,000,000 shares authorized:                                                                                 |   |              |       |   |   |   |
| Preferred stock - Series A, $0.001 par  value, 10,000,000 shares authorized; 3,410,325 and 3,712,000 shares issued  and outstanding, respectively |   | 3,410             |       | 3,712 |   |   |
| Preferred stock - Series B, $0.001 par  value, 1,000,000 shares authorized; 1,000,000 and 0 shares issued and  outstanding, respectively          |   | 1,000             |       | — |   |   |
| Preferred stock - Series C, $0.001 par  value, 3,000,000 shares authorized; 500,000 and 0 shares issued and  outstanding, respectively            |   | 500               |       | — |   |   |
| Preferred stock - Series D, $0.001 par  value, 1,000,000 shares authorized; 1,000,000 and 0 shares issued and  outstanding, respectively          |   | 1,000             |       | — |   |   |
| Additional paid-in capital - preferred                                                                                                            |   | 8,389,210         |       | 6,972,267 |   |   |
| Discount on preferred stock - unamortized                                                                                                         |   | (126,599          | )          | (1,146,653 | ) |   |
| Common stock, $0.001 par value, 150,000,000  shares authorized; 58,269,466 and 17,842,616 shares issued and outstanding,  respectively            |   | 58,269            |       | 17,843 |   |   |
| Additional paid-in capital - common                                                                                                               |   | 74,268,229        |       | 8,021,453 |   |   |
| Stock, options, and warrants - unamortized                                                                                                        |   | (597,042          | )          | (981,968 | ) |   |
| Treasury stock, 424,000 shares at cost                                                                                                            |   | (72,280           | )          | — |   |   |
| Accumulated other comprehensive income                                                                                                            |   | (42,640           | )          | — |   |   |
| Retained deficit                                                                                                                                  |   | (40,077,911       | )          | (7,228,326 | ) |   |
| Total stockholders’ equity                                                                                                                   |   | 41,805,146        |       | 5,658,328 |   |   |
|                                                                                                                                              |   |              |       |   |   |   |
| Total liabilities and stockholders’ equity                                                                                                   |   | $50,708,232       |       | $7,179,618 |   |   |
|                                                                                                                                                   |        |                   |            |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements.

 

F-2

----

 

###### **VITAL LIVING, INC**

**Consolidated Statements of Operations**

 
|                                                                      |   | **Year Ended  December 31,** |        |
|---------------------------------------------------------------------------|--------|------------------------------|-------------|
|                                                                      |   | **2003**                     |        | **2002** |   |
|                                                                      |   |                         | ** **  |   | ** ** |
| Revenue                                                                   |   | $                            | 2,855,123   |   | $ | 260,844 |   |
| Cost of goods sold                                                        |   | 1,723,013                    |        | 193,032 |   |
| Gross profit                                                              |   | 1,132,110                    |        | 67,812 |   |
|                                                                      |   |                         |        |   |   |
| Administrative expenses                                                   |   |                         |        |   |   |
| Salaries and benefits                                                     |   | 11,998,759                   |        | 1,341,103 |   |
| Professional and consulting fees                                          |   | 3,261,078                    |        | 1,607,621 |   |
| Selling, general and administrative                                       |   | 2,054,526                    |        | 510,013 |   |
| Research and development                                                  |   | 410,648                      |        | 510,436 |   |
| Depreciation and amortization                                             |   | 1,972,303                    |        | 52,959 |   |
| Total administrative expenses                                             |   | 19,697,314                   |        | 4,022,132 |   |
|                                                                      |   |                         | ** **  |   | ** ** |
| Net loss from operations                                                  |   | (18,565,204                  | )           | (3,954,320 | ) |
| Other income (expense)                                                    |   |                         |        |   |   |
| Impairment of goodwill                                                    |   | (6,777,480                   | )           | — |   |
| Other expense                                                             |   | (43,249                      | )           | — |   |
| Interest income                                                           |   | 5,322                        |        | 13,077 |   |
| Interest expense                                                          |   | (5,240,611                   | )           | (8,652 | ) |
| Net loss                                                                  |   | (30,621,222                  | )           | (3,949,895 | ) |
| Deemed dividend associated with beneficial  conversion of preferred stock |   | (1,643,252                   | )           | (2,235,519 | ) |
| Series A preferred stock dividend                                         |   | (585,111                     | )           | — |   |
| Net loss available to common stockholders                                 |   | $                            | (32,849,585 | ) | $ | (6,185,414 | ) |
|                                                                      |   |                         |        |   |   |
| Basic and diluted loss per share                                          |   | $                            | (0.96       | ) | $ | (0.28 | ) |
| Deemed dividend associated with beneficial  conversion of preferred stock |   | (0.05                        | )           | (0.15 | ) |
| Series A Preferred stock dividend                                         |   | (0.02                        | )           | — |   |
| Basic and diluted loss per share available  to common stockholders        |   | $                            | (1.03       | ) | $ | (0.43 | ) |
|                                                                      |   |                         |        |   |   |
| Weighted average basic and diluted common  stock outstanding              |   | 31,992,346                   |        | 14,278,129 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-3

----

 

**VITALLIVING, INC**

**Consolidated Statements of Stockholders’ Equity**

 
|                                                                                   |   | **Preferred  Stock** |   | **Common  Stock** |   |
|----------------------------------------------------------------------------------------|--------|----------------------|--------|-------------------|--------|
|                                                                                   |   | **Shares**           |   | **Par Value**     |   | **Additional  Paid-  In Capital** |   | **Discount** |   | **Shares** |   | **Par Value** |   | **Additional  Paid-  In Capital** |   |
| Balance December 31, 2001                                                              |   | —               |   | $                 | — |   | $ | — |   | $ | — |   | 13,626,554 |   | $ | 13,627 |   | $ | 946,159 |   |
| Series A Preferred stock issued for cash, net of offering costs of  $118,193           |   | 3,712,000            |   | 3,712             |   | 3,590,095 |   | — |   | — |   | — |   | — |   |
| Series A Preferred stock beneficial conversion feature                                 |   | —               |   | —            |   | 3,382,172 |   | (3,382,172 | ) | — |   | — |   | — |   |
| Amortization of preferred stock beneficial conversion feature                          |   | —               |   | —            |   | — |   | 2,235,519 |   | — |   | — |   | — |   |
| Common stock issued for services and settlements                                       |   | —               |   | —            |   | — |   | — |   | 343,500 |   | 343 |   | 554,652 |   |
| Common stock issued for cash, net of offering costs of $170,385                        |   | —               |   | —            |   | — |   | — |   | 1,367,500 |   | 1,368 |   | 1,195,747 |   |
| Common stock issued for acquisition of VCM                                             |   | —               |   | —            |   | — |   | — |   | 5,062 |   | 5 |   | (5 | ) |
| Common stock issued for acquisition of MAF                                             |   | —               |   | —            |   | — |   | — |   | 2,500,000 |   | 2,500 |   | 4,097,500 |   |
| Options and warrants issued for services                                               |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 1,227,400 |   |
| Amortization of restricted common stock, options, and warrants issued  for services    |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Net loss                                                                               |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Balance December 31, 2002                                                              |   | 3,712,000            |   | $                 | 3,712  |   | $ | 6,972,267 |   | $ | (1,146,653 | ) | 17,842,616 |   | $ | 17,843 |   | $ | 8,021,453 |   |
| Series A Preferred stock conversion                                                    |   | (682,163             | )      | $                 | (682   | ) | $ | (1,303,195 | ) | $ | — |   | 682,163 |   | $ | 682 |   | $ | 1,303,195 |   |
| Series A Preferred stock dividend, including $204,623 dividends  declared but not paid |   | 380,488              |   | 380               |   | 380,108 |   | — |   | — |   | — |   | — |   |
| Series B Preferred stock issued for cash, net of offering costs of  $133,086           |   | 1,000,000            |   | 1,000             |   | 803,420 |   | — |   | — |   | — |   | 70,580 |   |
| Series C Preferred stock issued for cash, net of offering costs of  $233,590           |   | 500,000              |   | 500               |   | 99,412 |   | — |   | 62,500 |   | 62 |   | 337,526 |   |
| Series C Preferred stock beneficial conversion feature                                 |   | —               |   | —            |   | 253,198 |   | (253,198 | ) | — |   | — |   | — |   |
| Series D Preferred stock issued for cash, net of offering costs of  $185,000           |   | 1,000,000            |   | 1,000             |   | 814,000 |   | — |   | — |   | — |   | — |   |
| Series D Preferred stock beneficial conversion feature                                 |   | —               |   | —            |   | 370,000 |   | (370,000 | ) | — |   | — |   | — |   |
| Amortization of preferred stock beneficial conversion features                         |   | —               |   | —            |   | — |   | 1,643,252 |   | — |   | — |   | — |   |
| Common stock issued for services and settlements                                       |   | —               |   | —            |   | — |   | — |   | 1,424,600 |   | 1,424 |   | 1,714,665 |   |
| Common stock issued for compensation                                                   |   | —               |   | —            |   | — |   | — |   | 1,300,000 |   | 1,300 |   | 1,779,700 |   |
| Common stock issued for acquisition of COF                                             |   | —               |   | —            |   | — |   | — |   | 2,754,000 |   | 2,754 |   | 2,971,566 |   |
| Common stock issued for acquisition of ENI                                             |   | —               |   | —            |   | — |   | — |   | 32,398,584 |   | 32,399 |   | 42,339,698 |   |
| Common stock issued for acquisition of DFN                                             |   | —               |   | —            |   | — |   | — |   | 1,700,003 |   | 1,700 |   | 2,400,304 |   |
| Convertible debt beneficial conversion feature                                         |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 2,189,663 |   |
| Convertible debt detachable warrants issued                                            |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 2,072,053 |   |
| Options and warrants exercised                                                         |   | —               |   | —            |   | — |   | — |   | 105,000 |   | 105 |   | 26,445 |   |
| Options and warrants issued for services                                               |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 459,640 |   |
| Options and warrants issued for compensation                                           |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 6,800,000 |   |
| Warrants repriced for an employee                                                      |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 1,526,461 |   |
| Warrant modification for a consultant                                                  |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 255,000 |   |
| Amortization of restricted common stock, options, and warrants issued  for services    |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Treasury stock purchase, 424,000 shares at cost                                        |   | —               |   | —            |   | — |   | — |   | — |   | — |   | 280 |   |
| Comprehensive Income:                                                                  |   |                 |   |              |   |   |   |   |   |   |   |   |   |   |   |
| Change in cumulative translation adjustment                                            |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Net loss                                                                               |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Comprehensive Income                                                                   |   | —               |   | —            |   | — |   | — |   | — |   | — |   | — |   |
| Balance December 31, 2003                                                              |   | 5,910,325            |   | $                 | 5,910  |   | $ | 8,389,210 |   | $ | (126,599 | ) | 58,269,466 |   | $ | 58,269 |   | $ | 74,268,229 |   |

 
|                                                                                   |   | **Stock,  Options  and Warrants  Unamortized** |     | **Treasury  Stock** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Retained  Deficit** |    | **Stockholders’  Equity** |   |
|----------------------------------------------------------------------------------------|--------|------------------------------------------------|----------|---------------------|--------|------------------------------------------------------|--------|-----------------------|---------|--------------------------------|--------|
| Balance December 31, 2001                                                              |   | $                                              | —   |                | $      | —                                               |   | $                     | —  |                           | $      | (1,042,912 | ) | $ | (83,126 | ) |
| Series A Preferred stock issued for cash,  net of offering costs of $118,193           |   | —                                         |     | —              |   | —                                               |   | —                |    | 3,593,807                      |   |
| Series A Preferred stock beneficial  conversion feature                                |   | —                                         |     | —              |   | —                                               |   | —                |    | —                         |   |
| Amortization of preferred stock beneficial  conversion feature                         |   | —                                         |     | —              |   | —                                               |   | (2,235,519            | )       | —                         |   |
| Common stock issued for services and  settlements                                      |   | (341,870                                       | )        | —              |   | —                                               |   | —                |    | 213,125                        |   |
| Common stock issued for cash, net of  offering costs of $170,385                       |   | —                                         |     | —              |   | —                                               |   | —                |    | 1,197,115                      |   |
| Common stock issued for acquisition of VCM                                             |   | —                                         |     | —              |   | —                                               |   | —                |    |                           |   |
| Common stock issued for acquisition of MAF                                             |   | —                                         |     | —              |   | —                                               |   | —                |    | 4,100,000                      |   |
| Options and warrants issued for services                                               |   | (1,227,400                                     | )        | —              |   | —                                               |   | —                |    | —                         |   |
| Amortization of restricted common stock,  options, and warrants issued for services    |   | 587,302                                        |     | —              |   | —                                               |   | —                |    | 587,302                        |   |
| Net loss                                                                               |   | —                                         |     | —              |   | —                                               |   | (3,949,895            | )       | (3,949,895                     | )      |
| Balance December 31, 2002                                                              |   | $                                              | (981,968 | )                   | $      | —                                               |   | $                     | —  |                           | $      | (7,228,326 | ) | $ | 5,658,328 |   |
| Series A Preferred stock conversion                                                    |   | $                                              | —   |                | $      | —                                               |   | $                     | —  |                           | $      | — |   | $ | — |   |
| Series A Preferred stock dividend,  including $204,623 dividends declared but not paid |   | —                                         |     | —              |   | —                                               |   | (585,111              | )       | (204,623                       | )      |
| Series B Preferred stock issued for cash,  net of offering costs of $133,086           |   | —                                         |     | —              |   | —                                               |   | —                |    | 875,000                        |   |
| Series C Preferred stock issued for cash,  net of offering costs of $233,590           |   | —                                         |     | —              |   | —                                               |   | —                |    | 437,500                        |   |
| Series C Preferred stock beneficial  conversion feature                                |   | —                                         |     | —              |   | —                                               |   | —                |    | —                         |   |
| Series D Preferred stock issued for cash,  net of offering costs of $185,000           |   | —                                         |     | —              |   | —                                               |   | —                |    | 815,000                        |   |
| Series D Preferred stock beneficial  conversion feature                                |   | —                                         |     | —              |   | —                                               |   | —                |    | —                         |   |
| Amortization of preferred stock beneficial  conversion features                        |   | —                                         |     | —              |   | —                                               |   | (1,643,252            | )       | —                         |   |
| Common stock issued for services and  settlements                                      |   | (569,502                                       | )        | —              |   | —                                               |   | —                |    | 1,146,587                      |   |
| Common stock issued for compensation                                                   |   | —                                         |     | —              |   | —                                               |   | —                |    | 1,781,000                      |   |
| Common stock issued for acquisition of COF                                             |   | —                                         |     | —              |   | —                                               |   | —                |    | 2,974,320                      |   |
| Common stock issued for acquisition of ENI                                             |   | —                                         |     | —              |   | —                                               |   | —                |    | 42,372,097                     |   |
| Common stock issued for acquisition of DFN                                             |   | —                                         |     | —              |   | —                                               |   | —                |    | 2,402,004                      |   |
| Convertible debt beneficial conversion  feature                                        |   | —                                         |     | —              |   | —                                               |   | —                |    | 2,189,663                      |   |
| Convertible debt detachable warrants issued                                            |   | —                                         |     | —              |   | —                                               |   | —                |    | 2,072,053                      |   |
| Options and warrants exercised                                                         |   | —                                         |     | —              |   | —                                               |   | —                |    | 26,550                         |   |
| Options and warrants issued for services                                               |   | (16,017                                        | )        | —              |   | —                                               |   | —                |    | 443,623                        |   |
| Options and warrants issued for  compensation                                          |   | —                                         |     | —              |   | —                                               |   | —                |    | 6,800,000                      |   |
| Warrants repriced for an employee                                                      |   | —                                         |     | —              |   | —                                               |   | —                |    | 1,526,461                      |   |
| Warrant modification for a consultant                                                  |   | —                                         |     | —              |   | —                                               |   | —                |    | 255,000                        |   |
| Amortization of restricted common stock,  options, and warrants issued for services    |   | 970,445                                        |     | —              |   | —                                               |   | —                |    | 970,445                        |   |
| Treasury stock purchase, 424,000 shares at  cost                                       |   | —                                         |     | (72,280             | )      | —                                               |   | —                |    | (72,000                        | )      |
| Comprehensive Income:                                                                  |   |                                           |     |                |   |                                                 |   |                  |    |                           |   |
| Change in cumulative translation adjustment                                            |   | —                                         |     | —              |   | (42,640                                              | )      | —                |    | (42,640                        | )      |
| Net loss                                                                               |   | —                                         |     | —              |   | —                                               |   | (30,621,222           | )       | (30,621,222                    | )      |
| Comprehensive Income                                                                   |   | —                                         |     | —              |   | —                                               |   | —                |    | (30,663,862                    | )      |
| Balance December 31, 2003                                                              |   | $                                              | (597,042 | )                   | $      | (72,280                                              | )      | $                     | (42,640 | )                              | $      | (40,077,911 | ) | $ | 41,805,146 |   |

 

See accompanying notes toconsolidated financial statements.

 

F-4

----

 

###### **VITAL LIVING, INC**

**Consolidated Statements of Cash Flows**

 
|                                                                                                        |   | **Year Ended  December 31,** |        |
|-------------------------------------------------------------------------------------------------------------|--------|------------------------------|-------------|
|                                                                                                        |   | **2003**                     |        | **2002** |   |
| Cash flows from operating activities:                                                                       |   |                         |        |   |   |
| Net loss                                                                                                    |   | $                            | (30,621,222 | ) | $ | (3,949,895 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                                |   |                         |        |   |   |
| Depreciation and amortization                                                                               |   | 1,972,303                    |        | 52,959 |   |
| Impairment of goodwill                                                                                      |   | 6,777,480                    |        | — |   |
| Warrants issued, beneficial conversion, and  amortization of costs associated with senior convertible notes |   | 4,736,244                    |        | — |   |
| Issuance of common stock for services                                                                       |   | 692,611                      |        | 145,125 |   |
| Issuance of common stock for shareholder  penalty interest on  Series A preferred stock                     |   | 156,136                      |        | — |   |
| Issuance of common stock for compensation                                                                   |   | 1,781,000                    |        | — |   |
| Issuance of warrants for services                                                                           |   | 32,500                       |        | — |   |
| Issuance of warrants for compensation                                                                       |   | 6,800,000                    |        | — |   |
| Repricing of and modifications to warrants                                                                  |   | 1,781,461                    |        | — |   |
| Amortization of restricted common stock,  options and warrants issued for services                          |   | 970,445                      |        | 587,302 |   |
| Allowance for bad debt                                                                                      |   | (32,000                      | )           | — |   |
| Inventory reserve                                                                                           |   | (86,000                      | )           | — |   |
| Loss on disposal of assets                                                                                  |   | 43,547                       |        | — |   |
| Change in operating assets and liabilities:                                                                 |   |                         |        |   |   |
| Accounts receivable                                                                                         |   | 20,460                       |        | (20,286 | ) |
| Accounts receivable, related parties                                                                        |   | (67,000                      | )           | 89,872 |   |
| Inventory                                                                                                   |   | 215                          |        | (164,689 | ) |
| Prepaid expenses and other current assets                                                                   |   | (849,875                     | )           | 9,897 |   |
| Accounts payable                                                                                            |   | 298,205                      |        | 81,842 |   |
| Accrued and other current liabilities                                                                       |   | 856,592                      |        | 193,821 |   |
| Cash used in operating activities                                                                           |   | (4,736,898                   | )           | (2,974,052 | ) |
| Cash flows from investing activities:                                                                       |   |                         |        |   |   |
| Purchases of property and equipment                                                                         |   | (51,292                      | )           | (126,811 | ) |
| Cost of acquisitions, net of cash acquired  of $291,277 and $78,091, respectively                           |   | (416,387                     | )           | (54,287 | ) |
| Cash used in investing activities                                                                           |   | (467,679                     | )           | (181,098 | ) |
|                                                                                                        |   |                         |        |   |   |
| Cash flows from financing activities:                                                                       |   |                         |        |   |   |
| Payment on notes and payables to related  parties, net                                                      |   | (57,428                      | )           | (208,926 | ) |
| Borrowings on long term debt, net                                                                           |   | 4,287,033                    |        | (10,952 | ) |
| Debt issuance costs                                                                                         |   | (751,200                     | )           | — |   |
| Purchase of treasury stock                                                                                  |   | (72,000                      | )           | — |   |
| Proceeds from exercise of options and warrants                                                              |   | 26,550                       |        | — |   |
| Proceeds from sale of common stock, net of  offering costs                                                  |   | —                       |        | 1,197,115 |   |
| Proceeds from sale of preferred stock, net  of offering costs                                               |   | 2,127,500                    |        | 3,593,807 |   |
| Cash provided by financing activities                                                                       |   | 5,560,455                    |        | 4,571,044 |   |
|                                                                                                        |   |                         |        |   |   |
| Net increase in cash                                                                                        |   | 355,878                      |        | 1,415,894 |   |
| Effect of foreign exchange rates on cash                                                                    |   | (42,640                      | )           | — |   |
| Cash at beginning of period                                                                                 |   | 1,416,073                    |        | 179 |   |
| Cash at end of period                                                                                       |   | $                            | 1,729,311   |   | $ | 1,416,073 |   |
|                                                                                                        |   |                         |        |   |   |
| Supplemental cash flow information:                                                                         |   |                         |        |   |   |
| Cash paid for interest                                                                                      |   | $                            | 115,239     |   | $ | 3,786 |   |
|                                                                                                        |   |                         |        |   |   |
| Non-cash investing activities:                                                                              |   |                         |        |   |   |
| Common stock issued for acquisitions and  acquisition costs                                                 |   | $                            | 47,748,421  |   | $ | 4,100,000 |   |
|                                                                                                        |   |                         |        |   |   |
| Non-cash financing activities:                                                                              |   |                         |        |   |   |
| Common stock for services                                                                                   |   | $                            | 1,716,089   |   | $ | 554,995 |   |
| Common stock for compensation                                                                               |   | $                            | 1,781,000   |   | — |   |
| Common stock for Series C Preferred stock  offering costs                                                   |   | $                            | 73,750      |   | — |   |
| Preferred stock for preferred stock  dividend                                                               |   | $                            | 380,488     |   | — |   |
| Warrants and options for services                                                                           |   | $                            | 459,640     |   | $ | 1,227,400 |   |
| Warrants for compensation                                                                                   |   | $                            | 6,800,000   |   | — |   |
| Warrants for preferred stock offerings                                                                      |   | $                            | 228,992     |   | — |   |
| Warrants for preferred stock offering costs                                                                 |   | $                            | 105,426     |   |   |   |
| Warrants for convertible debt offering                                                                      |   | $                            | 2,072,053   |   | — |   |
| Repricing of and amendments to warrants                                                                     |   | $                            | 1,781,461   |   | — |   |
| Deemed dividend associated with beneficial  conversion of preferred stock                                   |   | $                            | 623,198     |   | $ | 3,382,172 |   |
| Conversion of preferred stock to common  stock                                                              |   | $                            | 1,303,877   |   | — |   |
| Conversion of senior notes and accrued interest                                                             |   | $                            | 1,547,738   |   | — |   |
| Beneficial conversion of convertible debt                                                                   |   | $                            | 2,189,663   |   | — |   |

 

See accompanying notes to consolidated financial statements.

 

F-5

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VITAL LIVING, INC.Notes to Consolidated FinancialStatements

 

**Note 1 – Organization and Description ofBusiness**

 

Vital Living, Inc. (the “Company” or “Vital Living”) was incorporatedin the State of Nevada on January 22, 2001 under the name NutritionalSystems, Inc. Effective May 7, 2001, the Company acquired substantiallyall of the assets of Vital Living, Inc. and on May 20, 2001, changed its nameto Vital Living, Inc. The Company then merged with VCM Technology Limited, acompany reporting under the Securities and Exchange Act of 1934, on August 16,2001. As set forth in the terms of the merger agreement, the Company acquiredall of the outstanding shares of common stock of VCM from its sole stockholderin exchange for 5,062 shares of its restricted common stock. Following themerger, Vital Living continued as the surviving corporation and commencedreporting under the Securities and Exchange Act of 1934 by assuming thereporting status of VCM, which inturn provided the Company with the ability to file for quotation on the Overthe Counter Bulleting Board under the ticker symbol “VTLV.”

 

Through a variety ofsubsidiaries acquired during 2003 and 2002, as described further below, VitalLiving develops or licenses nutraceuticals and pharmaceutical drug-deliverysystems, marketing them for distribution through physicians, medical groups,chiropractic offices, and retail outlets. In addition, the Company formulates,markets, and distributes vitamins, herbs, high quality dietary supplements, andtherapeutic and functional food products through similar distribution channels.Nutraceuticals are products that are isolated or purified from foods andgenerally sold in medicinal forms not usually associated with foods, includingtablets, capsules, or drops. These nutraceuticals may have physiologicalbenefits or have the ability to reduce the risk of chronic disease beyond basicnutritional products. The Company develops and tests its nutraceuticals incollaboration with leading medical experts in the nutraceuticals field.  The Company’s initial areas of focus are cardiovascularhealth and weight loss.

 

In November 2002, VitalLiving acquired MAF BioNutritionals, LLC (“MAF”). MAF formulates, markets, anddistributes natural and organic food-based, preventative nutraceuticals andtherapeutic and functional food products designed to support proactive humancell maintenance and rehabilitation, essential in the prevention and treatmentof disease, as well as overall optimal body performance and metabolic function.

 

In July 2003, Vital Livingcompleted the acquisition of the assets and assumption of certain liabilitiesof Christopher’s Original Formulas, Inc. (“COF”). Through this acquisition, theCompany gained the exclusive licensing and marketing rights to Christopher’sproducts, a complete line of over 300 herbal formulas and products consistingprimarily of naturally occurring organic substances and sold to professionalsand at retail locations throughout the United States.

 

In August 2003, Vital Livingcompleted the acquisition of E-Nutraceuticals, Inc. (“ENI”). ENI develops safeand effective alternatives to prescription medications for non-life threateningchronic ailments, such as obesity and depression. Through the acquisition, theCompany obtained worldwide patent and licensing rights to X-FatTM, a dietarysupplement utilized for weight loss. In addition, through a collaborativepartnership with SkyePharma, PLC, (“Skye”), a UK pharmaceuticals company andmajor shareholder, the Company is in the process of enhancing existingnutraceuticals via FDA-approved, proprietary delivery systems. Pursuant to anamended Development and License Agreement between the parties, the Companyacquired exclusive rights to Skye’s drug delivery technology, GEOMATRIXTM, andmarketing and royalty rights to pharmaceutical sales using GEOMATRIXTM in thePeoples Republic of China, Taiwan, and Hong Kong.

 

In October 2003, Vital Livingcompleted the acquisition of Doctors For Nutrition, Inc. (“DFN”). DFN’s productline includes GreensFIRST®, a highly concentrated formulation of fruits andvegetables. One serving of the product has the antioxidant power of over 10servings of fruits and vegetables.  DFNcurrently distributes GreensFIRST® through health practitioner officesthroughout the United States.

 

**Note 2 – Summary of Significant AccountingPolicies**

 

*Consolidation*

 

The consolidated financialstatements include Vital Living, Inc. and its wholly owned domestic and foreignsubsidiaries (collectively, “Vital Living” or the “Company”). Consolidatedfinancial statements are financial statements of a parent company and itssubsidiaries presented as if the entities were a single economic unit. Althoughthe assets, liabilities, revenues, and expenses of all entities are combined toprovide a single set of financial statements, certain eliminations and adjustmentsare made. These eliminations are necessary to ensure that only arm’s-lengthtransactions between independent parties are reflected in the consolidatedstatements; transactions between related parties are eliminated.

 

F-6

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*Going concern*

* *

The accompanying consolidatedfinancial statements have been prepared assuming the Company will continue on agoing concern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business. The Company hassuffered recurring losses from operations, has a working capital deficit, andis dependent on funding from sources other than operations. Sinceinception, the Company has been required to raise additional capital by theissuance of both equity and debt instruments. There are no commitments fromfunding sources, debt or equity, in the event that cash flows are notsufficient to fund ongoing operations or other cash commitments as they comedue. These factors raise substantialdoubt about the Company’s ability to continue as a going concern. Managementwill be required to raise additional capital in the near term through offeringsof securities to fund the Company’s operations, and will attempt to continueraising capital resources in the near term if the Company does not begin togenerate revenue sufficient to maintain itself as a viable entity. No assurancecan be given that such financing will be available or, if available, that itwill be on commercially favorable terms. Moreover, available financing may bedilutive to current investors.

 

The Company is in theprocess of improving, acquiring, or developing products for sale that wouldgenerate revenue to sustain its operations, as well as consolidating itsoperations in order to gain cost synergies and efficiencies. If successful, these actions will serve tomitigate the factors that have raised doubt about the Company’s ability tocontinue as a going concern and increase the availability of resources forfunding of the Company’s current operations and future market development. Inaddition, in March 2004 the Company entered into a Purchase Agreement withinvestors and sold 250,000 shares of its common stock at $1.00 per share withrights to receive a portion of net revenues, as defined therein, from the saleof X-Fat®.  The consolidated financial statements do not include any adjustmentsrelating to the recoverability and classification of recorded assets orliabilities that might be necessary should the Company be unable to continue asa going concern.

 

*Reclassifications*

* *

Certain reclassifications of prior year amounts have been made toconform to current year presentation. These reclassifications had no effect on2002 net loss or stockholders’ equity.

 

*Financial instruments*

* *

The Company’s financial instruments consist of cash, receivables,payables, and long-term debt. The carrying amount of cash, receivables, andpayables approximates fair value because of the short-term nature of theseitems. The carrying amount of long-term debt as of December 31, 2003 and 2002approximates fair value because interest rates are reflective of market rates.

 

*Concentrations of credit risk*

* *

Financial instruments that potentially subject the Company toconcentrations of credit risk consist principally of cash. At various timesduring the year, the Company’s cash balances may be in excess of federallyinsured limits. The Company maintains its cash, which consists primarily ofdemand deposits, with high quality financial institutions, which the Companybelieves limits this risk.

 

*Acquisitions*

 

The Company accounts for acquisitions in accordance with Statement ofFinancial Accounting Standards, (“SFAS”) No. 141 “*Business Combinations*” and accordingly applies the purchasemethod of accounting for all business combinations initiated after June 30,2001 and separately identifies recognized intangible assets that meet thecriteria and amortizes these assets over their determinable useful lives.

 

*Cash and cash equivalents*

* *

The Company’s cash equivalents consist principally of any financialinstrument with maturities of three months or less and cash investments withhigh quality financial institutions. The Company’s investment policy limits theamount of credit exposure to any one financial institution.

 

F-7

----

 

*Inventories*

* *

Inventories are stated at the lower of cost (first-in, first-out method)or market and consist of products available for sale or Raw materials.

 

*Property and equipment*

* *

Property and equipment consists of office furniture, fixtures, andequipment, including computer hardware and software and various leaseholdimprovements. Property and equipment are recorded at cost. Depreciation isprovided on a straight-line basis over the lesser of correlating lease terms orestimated useful lives ranging from 3 to 10 years.

 

*Goodwill*

* *

Goodwill represents theexcess of the aggregate price paid by the Company over the value of the netequity acquired in an acquisition. In accordance with SFAS No. 142, “*Goodwill and Other Intangible Assets*,”management is no longer required to amortize goodwill, but is required toreview goodwill for impairment at least annually, or whenever events indicatethat the carrying amount of the asset may not be recoverable in accordance withSFAS No. 144 “*Accounting for the Impairmentor Disposal of Long-Lived Assets*.” As of December 31, 2003, eventshad occurred that would indicate goodwill had been impaired and, accordingly,an impairment loss was recorded (see Note 5).

 

*Intangible assets*

* *

The Company’s other intangible assets include trademarks, patents,formulations, customer lists, and various marketing and license agreements.Intangible assets are amortized on a straight-line basis over the lesser of thecorrelating agreements or estimated useful lives ranging from 2 to14 years.

 

*Long-lived assets*

* *

Long-lived assets andidentifiable other intangible assets to be held and used are reviewed forimpairment at least annually, or whenever events or changes in circumstancesindicate that the carrying amount may not be recoverable. Goodwill and otherintangible assets arising from various acquisitions are evaluated forimpairment on at least an annual basis or when events occur that would indicatethat impairment had occurred. Impairment is measured by comparing the carryingvalue of the long-lived asset to the estimated undiscounted future cash flowsexpected to result from use of the assets and their eventual disposition. As ofDecember 31, 2003, events had occurred that would indicate goodwill had beenimpaired; accordingly, an impairment loss was recorded (see Note 5).

 

*Deferred charges*

* *

*The Company capitalizes costs associated withthe issuance of debt instruments. These costs are amortized on a straight-linebasis over the term of the debt instruments. Amortization expense for the yearended December 31, 2003 was $230,871 and is recorded as a component of InterestExpense.*

* *

*Accounting estimates*

* *

The preparation of financial statements in conformity with generallyaccepted accounting principles in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period. Some ofthe more significant estimates required to be made by management include thevaluation of inventory, intangible assets, and equity based transactions.Actual results could differ from such estimates.

 

*Income taxes*

* *

The Company accounts forincome taxes in accordance with SFAS No. 109, “*Accountingfor Income Taxes*.” Under the asset and liability approach specifiedby SFAS No. 109, a deferred tax asset or liability is determined based onthe difference between the financial statement and tax basis of assets andliabilities as measured by the enacted rates that will be in effect when thesedifferences reverse. Deferred tax assets are recorded at their likelyrealizable amounts.

 

F-8

----

 

*Revenue recognition*

* *

Revenue is recognized when products are shipped to customers. TheCompany’s return policy provides for an unconditional guarantee to itscustomers for a full refund of any unused product including product that hasexceeded its expiration date. All returns are subject to quality assurancereviews before acceptance. The Company provides an estimate of product returnsas an accrued liability and as a reduction of revenue. The Company offers, fromtime to time, volume and promotional discounts on the products it sells. Thesediscounts are recorded as a reduction of revenue.

 

*Comprehensive income*

* *

SFAS No. 130, “ReportingComprehensive Income,” establishes standards for the reporting and display ofcomprehensive income and its components within the financial statements. Othercomprehensive income is comprised of charges to stockholders’ equity, otherthan contributions from or distributions to stockholders, excluded from thedetermination of net income. The Company’s other comprehensive income iscomprised of foreign currency translations. The Company does not provide for U.S. income taxes on foreign currencytranslation adjustments since it does not provide for such taxes onundistributed earnings of foreign subsidiaries.

 

*Foreign currency translation*

* *

Financial statements of VitalLiving’s foreign subsidiary is prepared using the local currency as thefunctional currency. Translation of these foreign operations to United Statesdollars occurs using the current exchange rate for balance sheet accounts and aweighted average exchange rate for results of foreign operations. Translationgains or losses are recognized in “accumulated other comprehensive income(loss)” as a component of stockholders’ equity in the accompanying consolidatedbalance sheets.

 

*Research and development*

* *

Research and developmentcosts relating to both present and future products are expensed when incurred.Research and development costs amounted to $410,648 and $510,436 for the yearsended December 31, 2003 and 2002, respectively.

 

*Net loss per share*

* *

The Company accounts for itsearnings per share (“EPS”) in accordance with SFAS No. 128, “*Earnings Per Share*,” which establishes therequirements for presenting EPS. SFAS No. 128 requires the presentation of“basic” and “diluted” EPS on the face of the income statement. Basic earningsper share begins with income (loss) applicable to common shareholders (netincome (loss) less preferred stock dividends) and is based on the weightedaverage number of common shares outstanding during each period presented.Diluted EPS assumes the exercise of all stock options and warrants havingexercise prices less than the average market price of the common stock usingthe treasury stock method. In computing basic loss per share in 2003, net losswas increased by the issuance of 380,488 shares of Series A Preferred Stock tosatisfy cumulative dividends on Series A Preferred Stock, valued at $380,488,issued during the first and second quarter. Net loss was further increased by$204,623 for cumulative dividends on Series A Preferred that have been declaredbut not paid for a total dividend of $585,111 for the year (an impact of $0.02per common share). For the purpose of diluted earnings per common share, andonly if such calculation results in dilution, preferred stock dividends willnot reduce earnings; however, the weighted average common shares outstandingwould increase representing the amount of common shares into which suchpreferred stock is currently convertible. During the years ended December 31,2003 and 2002, the Company reported a net loss, thus the effects of dilutivesecurities were anti-dilutive, rendering basic and diluted loss per share thesame. Convertible preferred stock, warrants, and options to purchase commonstock are included as common stock equivalents only when dilutive.

 

*Stock based compensation*

* *

The Company accounts for its stock option plans in accordance with theprovisions of SFAS No. 123, “*Accounting forStock Based Compensation,*” as amended by SFAS No. 148 *“Accounting for Stock-BasedCompensation-Transition and Disclosure.”* SFAS No. 123 permitsentities to recognize as expense over the vesting period the fair value of allstock-based awards on the date of grant. Alternatively, SFAS No. 123 alsoallows entities to apply the provisions of Accounting Principles Board (“APB”)Opinion No. 25, “*Accounting for Stock Issuedto Employees*,” and related interpretations and provide pro forma netincome or loss and pro forma earnings per share disclosures for employee stockoption grants as if the fair-value-based method defined in SFAS No. 123 hadbeen applied.

 

F-9

----

 

The Company is subject toreporting requirements of FASB Financial Interpretation No. (“FIN”) 44, “*Accounting for Certain Transactions Involving StockCompensation,*” which requires a non-cash charge to deferredcompensation expense if the price of the Company’s common stock on the lasttrading day of each reporting period is greater than the exercise price ofcertain stock options. After the first such adjustment is made, each subsequentperiod is adjusted upward or downward to the extent that the trading priceexceeds the exercise price of the options.

 

TheCompany accounts for its Plans under the recognition and measurement principlesof Accounting Principles Board (“APB”) Opinion No. 25, “*Accounting for Stock issued to Employees*,”and related Interpretations. No stock-based employee compensation (except thatrelated to repriced warrants in accordance with FIN No. 44) is reflected in netloss, as all options and warrants granted had an exercise price equal to orbelow the market value of the underlying common stock at the date of grant.

 

The fair valueof the Company’s stock-based awards to employees was estimated using theBlack-Scholes option-pricing model. The Black-Scholes model was developed foruse in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable. In addition, the Black-Scholes modelrequires the input of highly subjective assumptions, including the expectedstock price volatility. Because the Company’s stock-based awards havecharacteristics significantly different from those of traded options andbecause changes in the subjective input can materially affect the fair valueestimate, in management’s opinion, the existing models do not necessarilyprovide a reliable single measure of the fair value of its stock-based awardsto employees. The fair value of the Company’s stock-based awards (includingrepriced warrants discussed above) was estimated assuming no expected dividendsand the following weighted average assumptions for the years ended December 31:

 
|                                  |   | **2003** |   | **2002** |   |
|---------------------------------------|--------|----------|--------|----------|--------|
| Expected life in years                |   | 4.00     |   | 4.00     |   |
| Expected stock price volatility       |   | 33.49    | %      | 30.65    | %      |
| Risk-free interest rate               |   | 3.14     | %      | 3.98     | %      |
| Average fair value per option/warrant |   | $        | 0.68   |     | $      | 1.68 |   |
|                                       |        |          |        |          |        |  |  |

 

For pro formapurposes, the estimated fair value of the Company’s stock-based awards toemployees is amortized over the respective vesting periods.

 

Thefollowing table illustrates the effect on net loss and net loss per share ifthe Company had applied the fair value recognition provisions of Statement ofAccounting Standards (“SFAS”) No. 123, “*Accountingfor Stock-Based Compensation*,” to its stock-based employeecompensation for the years ended December 31:

 
|                                                                                                                    |   | **2003**    |        | **2002**   |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|
| Net loss – as reported                                                                                             |   | $           | (30,621,222 | )          | $      | (3,949,895 | ) |
| Add:                                                                                                                    |   |        |        |       |   |
| Stock based compensation included in  determination of net loss                                                         |   | 1,526,461   |        | —     |   |
| Deduct:                                                                                                                 |   |        |        |       |   |
| Stock based employee compensation  determined under fair value based method for all awards, net of related tax  effects |   | (1,356,281  | )           | (170,180   | )      |
| Net loss – pro forma                                                                                               |   | (30,451,042 | )           | (4,120,075 | )      |
| Deemed dividend associated with beneficial  conversion of preferred stock                                               |   | (1,643,252  | )           | (2,235,519 | )      |
| Series A Preferred stock dividend                                                                                       |   | (585,111    | )           | —     |   |
| Net loss available to common stockholders –  pro forma                                                             |   | $           | (32,679,405 | )          | $      | (6,355,594 | ) |
| Basic and diluted loss per share – as  reported                                                                    |   | $           | (0.96       | )          | $      | (0.28 | ) |
| Basic and diluted loss per share available  to common stockholders – as reported                                   |   | $           | (1.03       | )          | $      | (0.43 | ) |
| Basic and diluted loss per share – pro  forma                                                                      |   | $           | (0.95       | )          | $      | (0.29 | ) |
| Basic and diluted loss per share available  to common stockholders – pro forma                                     |   | $           | (1.02       | )          | $      | (0.45 | ) |
| Weighted average basic and diluted common  stock outstanding                                                            |   | 31,992,346  |        | 14,278,129 |   |

 

F-10

----

 

*Recent accounting pronouncements*

 

In May 2003, the FASB issued SFAS No. 150, “*Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity*.” SFAS No. 150 clarifies the accounting forcertain financial instruments with characteristics of both liabilities andequity and requires that those instruments be classified as liabilities instatements of financial position. Previously, many of those financialinstruments were classified as equity. SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003 and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003. The adoption of SFAS No. 150 did not have a material effect on theCompany.

 

In April 2003, the FASB issued SFAS No. 149, “*Amendment of Statement No. 133 on Derivative Instruments and HedgingActivities*.” SFAS No. 149 amends and clarifies financial accountingand reporting for derivative instruments, including certain derivativeinstruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities under SFAS No. 133, “*Accounting for Derivative Instruments and HedgingActivities*.” This Statement is effective for contracts entered intoor modified after June 30, 2003. The adoption of SFAS No. 149 did not have amaterial effect on the Company.

 

In January 2003, the FASB issued Interpretation No. 46, “*Consolidation of Variable Interest Entities*”(“FIN 46”). In general, a variable interest entity is a corporation,partnership, trust, or any other legal entity used for business purposes thateither (a) does not have equity investors with voting rights or (b) has equityinvestors that do not provide sufficient financial resources for the entity tosupport its activities. FIN 46 requires certain variable interest entities tobe consolidated by the primary beneficiary of the entity if the investors inthe entity do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from otherparties. The consolidation requirements of FIN 46 apply immediately to variableinterest entities created after January 31, 2003. The consolidationrequirements apply to older entities in the first fiscal year or interim periodbeginning after June 15, 2003. Certain of the disclosure requirements apply toall financial statements issued after January 31, 2003, regardless of when thevariable interest entity was established.

 

In December 2003, the FASB issued a revisedInterpretation No. 46 (FIN 46R), “*Consolidationof Variable Interest Entities*.” FIN 46R requires companies toconsider whether entities, in which they have financial interests, lacksufficient equity at risk to permit that entity to finance its activitieswithout additional subordinated financial support and to consolidate thoseentities where the company would absorb the majority of any losses. Theconsolidation requirements are effective for interim and annual periods endingafter March 15, 2004. The Company does not expect the adoption of FIN 46 andFIN 46R to have a material effect on the Company’s future financial conditionor results of operations.

 

In June 2002, the FASB issued SFAS No. 146, “*Accounting for Exit or Disposal Activities*.” SFAS No. 146addresses significant issues regarding the recognition, measurement andreporting of disposal activities, including restructuring activities that arecurrently covered in EITF Issue No. 94-3, “*LiabilityRecognition for Certain Employee Termination Activity*.” Theprovisions of SFAS No. 146 are effective for exit or disposal activities initiatedafter December 31, 2002. The adoption of SFAS No. 146 did not have a materialeffect on the Company.

 

In April 2002, the FASB issued SFAS No. 145, “*Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections*.” This statementrescinds SFAS No. 4, “*Reporting Gains andLosses from Extinguishment of Debt*,” which required all gains andlosses from extinguishment of debt to be aggregated and, if material,

 

F-11

----

 

classified as an extraordinary item, net of income taxes. As a result,the criteria in APB No. 30 will now be used to classify those gains and losses.Any gain or loss on the extinguishment of debt that was classified as anextraordinary item in prior periods presented that does not meet the criteriain APB No. 30 for classification as an extraordinary item shall bereclassified. The provisions of this Statement are effective for fiscal yearsbeginning after January 1, 2003. The adoption of SFAS No. 145 did not have amaterial effect on the Company.

 

In November 2002, the FASB issued FIN 45, “*Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others*,” aninterpretation of FASB Statements No. 5, 57 and 107, and rescission of FIN 34,“*Disclosure of Indirect Guarantees ofIndebtedness of Others*.” FIN 45 elaborates on the disclosures to bemade by the guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also requires thata guarantor recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee. The initialrecognition and measurement provisions of this interpretation are applicable ona prospective basis to guarantees issued or modified after December 31, 2002,while the provisions of the disclosure requirements are effective for financialstatements for interim or annual periods ending after December 15, 2002. Theadoption of SFAS No. 145 did not have a material effect on the Company.

** **

**Note 3 – Mergers and Acquisitions**

** **

During 2003 and 2002, the Company acquiredfour companies. In each transaction, common stock was used as consideration andthe excess of the purchase consideration over the net assets orobligations assumed, after allocation to respective identifiable intangibleassets, was recorded as goodwill as summarized below. A description of eachbusiness combination follows. 

 
|                                      |   | **MAF**    |      | **COF**    |   | **ENI**     |   | **DFN**   |       |
|-------------------------------------------|--------|------------|-----------|------------|--------|-------------|--------|-----------|------------|
| Purchase price paid                       |   | $          | 4,100,000 |       | $      | 3,051,614   |   | $         | 40,877,063 |   | $ | 2,343,004 |   |
| Less:                                     |   |       |      |       |   |        |   |      |       |
| Working capital (assets) liabilities, net |   | 119,400    |      | 163,764    |   | 405,216     |   | (314,325  | )          |
| Property and equipment, net               |   | (8,232     | )         | (70,293    | )      | (1,331      | )      | (7,215    | )          |
| Intangibles, net                          |   | (320,481   | )         | —     |   | (43,058,614 | )      | —    |       |
| Plus:                                     |   |       |      |       |   |        |   |      |       |
| Debt obligations assumed                  |   | 864,134    |      | 464,794    |   | 150,000     |   | —    |       |
| Acquisition costs                         |   | 200,378    |      | 277,918    |   | 1,627,666   |   | 91,952    |       |
| Goodwill at purchase                      |   | 4,955,199  |      | 3,887,797  |   | —      |   | 2,113,416 |       |
| Less: Impairment recorded (see Note 5)    |   | (4,370,683 | )         | (2,406,797 | )      | —      |   | —    |       |
| Goodwill at December 31, 2003             |   | $          | 584,516   |       | $      | 1,481,000   |   | $         | —     |   | $ | 2,113,416 |   |

 

*MAF BioNutritionals, LLC*

 

On November 22, 2002, the Company acquired 100% of members’ equity ofMAF, a privately held New Jersey limited liability company. The acquisitionpurchase price consisted of 2,500,000 shares of the Company’s restricted commonstock valued at $1.64 per share (the average fair market value per share of theCompany’s common stock for a reasonable period before and after the measurementdate, which was November 4, 2002), or $4,100,000, and other acquisition costsof $200,378. Included as other acquisition costs is 50,000 shares of commonstock issued to financial advisors with a fair value of $68,000.  The amortization period for intangibleassets acquired in this transaction is estimated to be approximately threeyears.  Goodwill recorded in thisacquisition is not deductible for federal income tax purposes.

 

*Christopher’sOriginal Formulas, Inc.*

* *

On July 3,2003, the Company formed a new wholly owned corporation, Nature’s Systems, Inc.(“NSI”), and acquired certain assets and assumed certain liabilities of COF.The acquisition purchase price consisted of 2,600,000 shares of the Company’srestricted common stock, of which 650,000 remain in escrow until June 2005pending final purchase price adjustments, valued at $1.08 per share (theaverage fair market value per share of the Company’s common stock for areasonable period before and after the measurement date, which was June 25,2003), or $2,808,000, the assumption of COF advances of $243,614 made by theCompany prior to the closing, and other acquisition costs of $277,918. Includedas other acquisition Goodwill recorded in this transaction is fully deductiblefor federal income tax purposes.

 

F-12

----

 

costs is154,000 shares of common stock issued to financial advisors with a fair valueof $166,320.

 

Concurrentwith the acquisition, the Company executed the NSI Profit Sharing RestrictedStock Plan, which provides for up to 650,000 Bonus Shares of restricted commonstock to retained COF executives contingent on NSI achieving future performancetargets extending through June 2006.

 

*E-Nutraceuticals,Inc.*

 

On August 20, 2003, the Company acquired 100% of the outstanding commonstock of ENI, a privately held Delaware corporation. The acquisition purchaseprice consisted of 31,248,584 shares of the Company’s restricted common stockvalued at $1.30 per share (the average fair market value per share of theCompany’s common stock for a reasonable period before and after the measurementdate, which was August 20, 2003), or $40,623,159, and other acquisition costsof $1,627,666. The purchase price also includes 251,390 options issued inexchange for existing ENI options, which were estimated to have a fair value of$253,938. Other acquisition costs include 1,150,000 shares of the Company’scommon stock valued at $1.30 per share (or $1,495,000) issued to financial advisorsand $132,666 of legal and other related costs paid to professional advisors.

 

The total number of shares issued in this transaction, including theissuance of the Series D Preferred Stock (see Note 8), was 40% of the totalnumber of shares outstanding on a fully diluted basis, which contemplates thatall warrants, options, and various classes of preferred stock are converted tocommon stock.

 

The recordingof the ENI Acquisition was based on a third party business valuation andpurchase price allocation provided by a reputable, independent, full serviceinvestment bank. The primary assets of ENI included the intangible valueassociated with the worldwide patent rights to X-Fat®, a dietary supplementused in weight loss; licensing rights to GEOMATRIX®, a time-released drugdelivery technology; and marketing rights to pharmaceutical sales usingGEOMATRIX® in the Peoples Republic of China, Taiwan, and Hong Kong. Thepurchase price allocation resulted in $43,058,614 being assigned to the valueof these two agreements.  Theamortization period for the China Marketing agreement is approximately twoyears and the amortization period for the X-Fat agreement and the G-BOMATRIKagreement is approximately 14 years. These intangibles are fully deductible for income tax purposes.

 

Goodwillrecorded in this acquisition is not deductible for Federal income tax purposes.

 

*Doctors ForNutrition, Inc.*

 

On October 14, 2003, the Company acquired 100% of the outstanding commonstock of DFN, a privately held California corporation. The acquisition purchaseprice consisted of 1,650,003 shares of the Company’s restricted common stock,valued at $1.42 per share (the average fair market value per share of theCompany’s common stock for a reasonable period before and after the measurementdate, which was October 14, 2003), or $2,343,004, and other acquisition costsof $91,952. Included as other acquisition costs is 50,000 shares of commonstock issued to financial advisors with a fair value of $59,000.

 

Of the total shares issued, 650,000 are held in escrow contingent on DFNachieving certain minimum levels of future earnings (the “Earn Out Shares”),which are included as a component of the cost of the acquisition. In March2004, the Company’s Board of Directors approved that the stipulations of theEarn-Out Shares be lifted and the shares released from escrow as earned.

 

Concurrentwith the acquisition, the Company executed an employment agreement with a keyexecutive, which provides for certain cash payments and options to acquire upto 300,000 shares of restricted common stock at $1.40 per share contingent onDFN achieving future performance targets extending through September 2006.

 

*Acquisition pro formas*

 

The unaudited pro formaconsolidated results of operations for the years ended December 31, 2003 and2002 have been prepared assuming the acquisitions of MAF, COF, ENI, and DFN,and the corresponding issuance of 37,998,587 shares of common stock issued asconsideration in these acquisitions, had occurred as of January 1, 2002. Thus,the unaudited pro forma consolidated results of operations include thefollowing periods of operation:

 

•                    Vital Living, Inc. for the years endedDecember 31, 2003 and 2002.

•                    MAF for the period from January 1, 2002through November 22, 2002 (date of acquisition).

•                    Boulder Endurance Co., Inc. (“Boulder”) forthe period from January 1, 2002 through April 4, 2002 (the date of acquisitionby MAF).

 

F-13

----

 

•                    COF for the period from January 1, 2003through July 3, 2003 (date of acquisition) and the year ended December 31,2002.

•                    ENI for the period from April 1, 2003 throughAugust 20, 2003 (date of acquisition) and the year ended March 31, 2003.

•                    DFN for the period from January 1, 2003through October 14, 2003 (date of acquisition) and the year ended December 31,2002.

 

Presented below are the unaudited pro forma consolidated results ofoperations for the years ended:

 
|                                                                      |   | **December  31,** |        |
|---------------------------------------------------------------------------|--------|-------------------|-------------|
|                                                                      |   | **2003**          |        | **2002** |   |
| Revenue                                                                   |   | $                 | 4,834,654   |   | $ | 4,562,579 |   |
| Cost of goods sold                                                        |   | 2,878,584         |        | 2,557,491 |   |
| Gross profit                                                              |   | 1,956,070         |        | 2,005,088 |   |
| Operating expenses and other                                              |   | 36,338,744        |        | 11,902,901 |   |
| Net loss                                                                  |   | (34,382,674       | )           | (9,897,813 | ) |
| Deemed dividend associated with beneficial  conversion of preferred stock |   | (1,643,252        | )           | (2,235,519 | ) |
| Series A preferred stock dividend                                         |   | (585,111          | )           | — |   |
| Net loss available to common stockholders                                 |   | $                 | (36,611,037 | ) | $ | (12,133,332 | ) |
|                                                                      |   |              |        |   |   |
| Basic and diluted loss per share                                          |   | $                 | (0.62       | ) | $ | (0.19 | ) |
| Deemed dividend associated with beneficial  conversion of preferred stock |   | (0.03             | )           | (0.04 | ) |
| Preferred stock dividend                                                  |   | (0.01             | )           | — |   |
| Basic and diluted loss per share available  to common stockholders        |   | $                 | (0.66       | ) | $ | (0.23 | ) |
|                                                                      |   |              |        |   |   |
| Weighted average basic and diluted common  stock outstanding              |   | 55,165,425        |        | 52,495,917 |   |

** **

**Note 4 –Property and equipment**

** **

Property and equipment consists of the following at December 31:  

 
|                           |   | **2003** |    | **2002** |   |
|--------------------------------|--------|----------|---------|----------|--------|
| Computer hardware and software |   | $        | 226,079 |     | $      | 191,782 |   |
| Office Furniture and fixtures  |   | 44,365   |    | 36,624   |   |
| Machinery and equipment        |   | 54,597   |    | 27,930   |   |
| Leasehold improvements         |   | 6,545    |    | 13,130   |   |
| Gross property and equipment   |   | 331,586  |    | 269,466  |   |
| Less accumulated depreciation  |   | (162,479 | )       | (97,171  | )      |
| Net property and equipment     |   | $        | 169,107 |     | $      | 172,295 |   |

 

Depreciation expense was $89,772 and $36,505 for the years endedDecember 31, 2003 and 2002, respectively.

 

F-14

----

 

**Note 5 –Intangible assets**

** **

Intangible assets consist of the following at December 31:

 
|                                      |   | **2003**                     |       | **2002**                      |   |
|-------------------------------------------|--------|------------------------------|------------|-------------------------------|--------|
|                                      |   | **Gross  Carrying   Amount** |       | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated    Amortization** |   |
| License agreement – Geomatric®  |   | $                            | 34,661,058 |                          | $      | (870,200 | ) | $ | — |   | $ | — |   |
| License agreement – X–Fat® |   | 4,093,118                    |       | (102,614                      | )      | — |   | — |   |
| Marketing agreement                       |   | 4,304,438                    |       | (771,212                      | )      | — |   | — |   |
| Customer distribution lists               |   | 203,599                      |       | (118,766                      | )      | 203,599 |   | (50,900 | ) |
| Trademarks and patents                    |   | 142,641                      |       | (75,238                       | )      | 142,641 |   | (33,155 | ) |
| Formulations                              |   | 85,672                       |       | (48,916                       | )      | 85,672 |   | (20,359 | ) |
| Total amortizable intangible assets       |   | $                            | 43,490,526 |                          | $      | (1,986,946 | ) | $ | 431,912 |   | $ | (104,414 | ) |
| Unamortizable intangible assets           |   |                         |       |                          |   |   |   |   |   |
| Goodwill                                  |   | $                            | 4,178,932  |                          |   |   | $ | 4,893,517 |   |   |   |
|                                           |        |                              |            |                               |        |  |  |  |  |  |  |  |  |  |  |

 
|                             |   | **Aggregate  Amortization  Expense** |      | **Estimated  Amortization  Expense** |      |
|----------------------------------|--------|--------------------------------------|-----------|--------------------------------------|-----------|
|                             |   |                                 |      |                                 |      |
| For year ended December 31, 2002 |   | $                                    | 16,454    |                                 |      |   |
| For year ended December 31, 2003 |   | $                                    | 1,882,531 |                                 |      |   |
| For year ended December 31, 2004 |   |                                 |      | $                                    | 5,005,553 |   |
| For year ended December 31, 2005 |   |                                 |      | $                                    | 4,132,546 |   |
| For year ended December 31, 2006 |   |                                 |      | $                                    | 2,716,194 |   |
| For year ended December 31, 2007 |   |                                 |      | $                                    | 2,716,194 |   |
| For year ended December 31, 2008 |   |                                 |      | $                                    | 2,716,194 |   |

 

*Impairment Analyses*

 

As required by SFAS No. 142, the Company tested goodwill or otherintangibles created by each acquisition for impairment in the fourthquarter.  These assets are tested forimpairment at least annually, or upon occurrence of such events that mayindicate impairment exists. Management revised the earnings forecast for thenext five years and evaluated the change in fair value of each component ofgoodwill using the expected present value of future cash flows. Impairment wasdue to a combination of factors including, acquisition price, increased marketcompetition, and operating performance. As a result of the Company’s annualreview, a goodwill impairment loss of $6,777,480 was recognized during the yearended December 31, 2003. The remaining goodwill of $4,178,932 is attributable to previous acquisitions asfollows:

 

| **Entity Acquired** |   | **Goodwill** |      |
|---------------------|--------|--------------|-----------|
| DFN                 |   | $            | 2,113,416 |   |
| COF                 |   | 1,481,000    |      |
| MAF                 |   | 584,516      |      |
| Total               |   | $            | 4,178,932 |   |

 

F-15

----

 

The Company’sprimary intangibles other than goodwill discussed above, with a grossintangible value of $43,058,614 at December 31, 2003, were obtained in theAugust 2003 acquisition of ENI and are comprised of licensing and marketingagreements related to three distinct products: X-Fat®, a dietary supplement forweight loss, time released nutraceuticals utilizing the licensed GEOMATRIX®technology, and certain marketing rights to pharmaceutical sales usingGEOMATRIX® in the Peoples Republic of China, Taiwan, and Hong Kong.. Theproducts or activities are scheduled for launch throughout 2004.

 

In order to testfor impairment of these long-lived assets, fair value was determined based on avaluation study performed by an independent third party that primarilyconsidered the discounted cash flow and guideline company method. As a resultof this review, performed in October 2003, none of these long-lived assets wasimpaired. At December 31, 2003, the Company’s management performed additionalanalyses, which include detailed calculations of projected discounted futurecash flows, which took into account delays in marketing initiatives for X-Fatexperienced in the fourth quarter of 2003, as well as risks associated with theCompany not making a required payment under the GEOMATRIX licensing agreementin January 2004. As of February 28, 2004, Management believes that theintangibles recorded at December 31, 2003 are not impaired.

 

**Note6 – Long-Term Debt**

** **

Between October and December2003, the Company borrowed an aggregate principal amount of $1,530,000 in theform of Senior Convertible Notes (the “Bridge Notes”), due April 28, 2004, in aprivate placement subject to certain registration rights, generating cashproceeds of $1,316,400, net of cash debt issue costs of $213,600. Principal andinterest at a rate of 10% per annum is payable in a single installment on thematurity date in cash or the Company’s common stock, at the Company’sdiscretion, at a price equal to $1.00 per share. As part of the transactions,Bridge Note holders received 3,060,000 and 1,530,000 warrants to purchase theCompany’s common stock at an exercise price of $1.00 and $1.50 per share,respectively. The fair value of these warrants of $987,833 has been recorded bythe Company and charged immediately to interest expense as the warrants werefully vested and the related notes fully convertible at the date of issuance.In accordance with the terms of these Bridge Notes, because the Companyconsummated a debt financing before the maturity date, the entire principalamount of the notes plus accrued interest totaling $1,547,738 has beenconverted into the debt securities offered in the December 2003 Secured Notes.

 

Debt issue costs related tothis transaction of $654,826, including cash fees of $213,600, common stockissued valued at $297,840, and the fair value associated with warrants issuedof $143,386 as discussed in Note 9, is recorded in deferred debt issuancecosts, net of amounts charged to interest expense during the year endedDecember 31, 2003 totaling $219,801 before refinancing. The market value of theCompany’s common stock on the dates the Bridge Notes were issued ranged from$1.28 - $1.52 per share. In accordance with EITF 98-5, as amended by EITF00-27, because the convertible debt was sold at a price less than market value,a beneficial conversion to holders of the Bridge Notes occurred. Accordingly, abeneficial conversion amount of $542,165 was recorded to additionalpaid-in-capital and a corresponding amount recorded by the Company to interestexpense, as the debt was immediately convertible at the option of the debtholder.

 

In December 2003, the Companyborrowed an aggregate principal amount of $4,587,738 in the form of SeniorSecured Convertible Notes (the “Secured Notes”), due December 17, 2008, in aprivate placement subject to certain registration rights, therein convertingthe Bridge Notes as described above, generating cash proceeds of $2,502,400,net of cash debt issue costs of $537,600. The Secured Notes bear interest at arate of 12% per annum, 8% of which is payable semi-annually in cash each Juneand December, while 4% per annum may be paid, at the Company’s discretion, incash or the Company’s common stock at a price equal to the ten day average tradingprice of the Company’s common stock five business days prior to the relevantinterest payment date. A total of $549,862, or an amount equal to the first twosemi-annual interest payments at 12%, has been placed in an interest bearingescrow account as of December 31, 2003 and is recorded in Prepaid Expenses andOther Current Assets.

 

The Company may redeem theSecured Notes commencing December 15, 2004, provided the ten-day averagetrading price of the Company’s common stock prior to the redemption is at least$3.00 per share. The Secured Notes are collateralized by assets of the Company,have priority in right of payment over all indebtedness of the Company, andinclude certain provisions related to change in control, reorganization,recapitalization, and other adjustments. In addition, Secured Note holdersreceived 4,587,738 warrants to purchase the Company’s common stock at anexercise price of $1.00 per share. The fair value of these warrants of$1,084,220 has been recorded by the Company and charged immediately to interestexpense as the warrants were fully vested and the related notes fullyconvertible at the date of issuance.

 

F-16

----

 

Debt issue costs related tothe Secured Notes of $741,130, including cash fees of $330,200 and the valueassociated with warrants issued of $167,275 as discussed in Note 9, is recordedin deferred debt issuance costs. Amounts charged to interest expense during theyear ended December 31, 2003 totals $254,846 and includes $243,656 of cash andthe fair value of warrants issued in conjunction with the refinancing of theBridge Notes charged to expense in the period incurred. The market value of theCompany’s common stock on the date the Secured Notes were issued ranged from $1.15- $1.23 per common share. In accordance with EITF 98-5, as amended by EITF00-27, because the convertible debt was sold at a price less than market value,a beneficial conversion to holders of the Secured Notes occurred. Accordingly,a beneficial conversion amount of $1,647,498 was recorded to additionalpaid-in-capital and a corresponding amount recorded by the Company to interestexpense, as the debt is immediately convertible at the option of the debtholder.

 

In connectionwith the Company’s acquisitions in 2003 and 2002, certain of the acquiredcompanies’ long-term debt was assumed, the terms of which are described furtherbelow. Long-term debt consists of the following at December 31:

 
|                                                                                                                                                                                                                                                                                                                              |   | **2003**  |      | **2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------|-----------|----------|--------|
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Senior  Secured Convertible Notes                                                                                                                                                                                                                                                                                                 |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $4,587,738 senior notes payable to shareholders; maturity December  2008; interest at 12% per annum, (8% payable semi-annually in cash each June  and December, 4% may be paid in cash or the Company’s common stock);  principal due at maturity                                                                            |   | $         | 4,587,738 |     | $      | — |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Small Business Administration Loan                                                                                                                                                                                                                                                                                                |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $650,000 note  payable to bank; maturity December 14, 2008; variable interest at prime plus  1.50% (5.50% and 5.75% at December 31, 2003 and 2002, respectively); monthly  principal and interest payments of $9,970; secured by assets of the Company                                                                            |   | 481,363   |      | 574,537  |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Manufacturing  Agreement Debt                                                                                                                                                                                                                                                                                                     |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $346,400 balance  of various debt arrangements assumed as part of NSI Acquisition; maturity  October 25, 2004; interest rates range from 4.75% to 12.00%; monthly payments  primarily interest only and vary, totaling approximately $2,500 per month                                                                             |   | 342,063   |      | —   |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Other NSI  Acquisition Debt                                                                                                                                                                                                                                                                                                       |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $120,850 balance  of personal bank and other debt of former executives assumed; maturities  range from December 2003 through January 2004; interest rates range from  7.25% to 24.0% balances primarily due and payable immediately                                                                                               |   | 112,181   |      | —   |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Promissory Notes  – Related Parties                                                                                                                                                                                                                                                                                          |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $260,045 notes  payable to various related parties; interest rates range from prime to prime  plus 2% (6.00% and 6.25% at December 31, 2003 and 2002, respectively);  principal and interest due upon demand                                                                                                                      |   | 260,045   |      | —   |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| Notes Payable –  Boulder Bar                                                                                                                                                                                                                                                                                                 |   |      |      |     |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $275,000 note  payable to individual; maturity April 8, 2004; interest at 7.00% payable in  two installments April 8, 2003 and 2004; principal payable at $25,000 per  quarter September 9, 2002 through January 8, 2003, $75,000 on April 8, 2002,  and monthly payments of $10,417 thereafter; secured by assets of the Company |   | 41,664    |      | 225,000  |   |
|                                                                                                                                                                                                                                                                                                                              |   |      |      |     |   |
| $40,935 note  payable to individual; maturity April 8, 2003; non interest bearing; monthly  principal payments of $3,411; secured by assets of the Company                                                                                                                                                                        |   | —    |      | 13,645   |   |
|                                                                                                                                                                                                                                                                                                                              |   | 5,825,054 |      | 813,182  |   |
| Less current portion                                                                                                                                                                                                                                                                                                              |   | (844,616  | )         | (291,688 | )      |
|                                                                                                                                                                                                                                                                                                                              |   | $         | 4,980,438 |     | $      | 521,494 |   |

 

F-17

----

 

Aggregate maturities oflong-term debt for the subsequent five years ending December 31 are asfollows:

 
| 2004  |   | $         | 844,616   |   |
|-------|--------|-----------|-----------|--------|
| 2005  |   | 93,352    |      |
| 2006  |   | 100,600   |      |
| 2007  |   | 108,410   |      |
| 2008  |   | 4,678,076 |      |
| Total |   | $         | 5,825,054 |   |

** **

**Note 7 – Commitments and contingencies**

 

From time to time, theCompany is party to a variety of legal proceedings arising out of the normalcourse of business, including cases in which damages may be sought. The Companybelieves it has valid defenses and is vigorously defending any pendinglitigation. While the results of litigation cannot be predicted with certainty,the Company believes that the outcome of these proceedings will not have amaterial adverse effect on its consolidated financial position, results ofoperations, or cash flows.

 

On March 8, 2004, an attorneyrepresenting a former employee notified the Company that he was prepared toinitiate litigation for alleged breach of his employment agreement. On March15, 2004, the same attorney demanded that the Company take certain remedialsteps in connection with certain manufacturing processes and cure allegedbreaches of certain agreements related to the COF Acquisition. As of March 30,2004, formal lawsuits related to these matters had not been filed. The outcomeof these actions is uncertain and an estimate of the amount of a settlement, ifany, cannot be reasonably estimated at this time.

 

Inconnection with the COF Acquisition, the Company became party to aManufacturing Agreement, a Marketing Agreement, and a Multi-Agreement Amendment(collectively, the “COF Agreements”), in which various minimum payments arerequired during the terms therein. In the aggregate, the COF Agreements requireroyalties of $0.25 per licensed product sold with a monthly minimum of $8,000extending through May 30, 2023 with automatic five-year renewals thereafter. Inaddition, the COF Agreements require broker commissions of 5% per invoice ofall raw materials and finished goods sourced by the parties thereto with amonthly minimum of $5,000 extending through December 31, 2006 with automaticfive-year renewals thereafter. Royalty and commission payments in excess ofthose earned as a result of the minimum requirements are cumulatively availablefor credit only to the extent future earned royalties exceed the monthlyminimums. To date, the Company has a cumulative balance in excess of earnedroyalties and commissions of approximately $50,000. Because the royalties andcommissions earned have historically not exceeded the minimum, the futurerealizable value of the asset is uncertain and, as such, has not been recorded.

 

InAugust 2001, the Company signed a three-year agreement with the Arizona HeartInstitute (“AHI”), which through its affiliates serves between 22,000 to 25,000new patients each year with a database of over 150,000 heart patients to whichAHI will market and distribute Essentum. Under the agreement, the Company mustpay royalties to AHI in the amount of 12% or 6% of our net sales of Essentum,depending on their origin.

 

F-18

----

 

TheCompany leases office space and minor amounts of office equipment undernoncancellable operating leases that expire through 2008. Future minimum leasepayments under noncancellable operating leases for the subsequent five years endingDecember 31 are approximately as follows:

 
| 2004  |   | $      | 215,000 |   |
|-------|--------|--------|---------|--------|
| 2005  |   | 66,000 |    |
| 2006  |   | 60,000 |    |
| 2007  |   | 59,000 |    |
| 2008  |   | 54,000 |    |
| Total |   | $      | 454,000 |   |

 

Totalrent expense was $160,633 and $153,271 for the years ended December 31, 2003and 2002, respectively.

 

Inconnection with the ENI Acquisition, the Company became party to a Developmentand License Agreement and subsequent Amendment (collectively, the “ENIAgreements”) with SkyePharma, PLC (“Skye”). The ENI Agreements provide forcertain product identification and license exclusivity rights on nutraceuticalproducts utilizing Skye’s patented drug-delivery technologies, GEOMATRIX®, inexchange for various commitments as follows:

 

•                    In consideration for the Amendment anddevelopment services through 2004 and contingent on additional debt or equityfinancing of $3,000,000, the Company is obligated to pay Skye $1,000,000 infour equal installments beginning January 1, 2004 and each first day of eachcalendar quarter thereafter.

•                    The Company may retain its right to identifynew product candidates and license them exclusively through the later ofDecember 31, 2017 or the expiration of Skye’s corresponding patents, providedat least four such product candidates are identified by the Company andapproved by Skye, or Skye receives $1,000,000 in product development fees, percalendar year beginning January 1, 2005.

•                    The Company is obligated to pay Skye royaltiesequal to 10% of net sales generated from the products, as defined, quarterly inarrears.

 

Shouldthe Company fail to meet the above commitments, product selection and licenseexclusivity rights will terminate at the end of the respective calendar yearwithout effect on rights attained in prior years. As of March 30, 2004, theCompany successfully completed the aforementioned contingent financing,however, failed to make the initial $250,000 payment to Skye on January 1,2004. The Company is in process of renegotiating the related terms and paymentsin order to maintain its rights under the ENI Agreements despite the default.

 

TheENI Agreements also appointed the Company as Skye’s exclusive marketing partnerto pharmaceutical companies for licensing of all of Skye’s Technology in theChinese Territories, as defined therein. The Company is eligible to receive 5%of all gross revenues resulting directly from the Company’s marketing efforts.Receipt of such royalties is contingent, however, on such revenues reaching orexceeding $1,000,000, or in aggregate $2,000,000, by August 2004 and 2005,respectively. Should these revenue goals not be achieved, the Company’sexclusive marketing rights and Skye’s royalty obligation on newly establishedsales will terminate, provided however, that royalties on on-going grossrevenues resulting directly from the Company’s marketing efforts prior to theloss of such rights will continue to be due and payable.

 

In connection with the ENIAcquisition, the Company became party to a Licensing Agreement, granting it anexclusive, worldwide, perpetual license to dietary supplements containingchitosan, or X-Fat® (the “X-Fat License”). The X-Fat License requires theCompany to pay royalties equal to 10% of the first $1,000,000 of net productsales and 5% of such net product sales in excess of $1,000,000, up to a maximumroyalty of $1,250,000 per fiscal year. The Company is required to pay advancedroyalties of $15,000 per quarter to be credited against future royalty payments.At December 31, 2003, the Company had prepaid royalties of $247,172.

 

F-19

----

 

**Note 8 –Capital Stock**

** **

In December2003, the board of directors and a majority of stockholders approved anamendment to the Company’s Articles of Incorporation to increase the number ofauthorized shares of common stock from 100,000,000 to 150,000,000, par value$.001 per share. The Company is currently authorized to issue up to 50,000,000shares of preferred stock, par value $.001 per share. At December 31, 2003, theCompany’s capital stock consisted of:

 
| **Capital Stock**        |   | **Par Value** |   | **Authorized** |        | **Issued  & Outstanding** |       |
|--------------------------|--------|---------------|--------|----------------|-------------|-------------------------------|------------|
| Common Stock             |   | $             | .001   |           | 150,000,000 |                          | 58,269,466 |   |
| Series A Preferred Stock |   | $             | .001   |           | 10,000,000  |                          | 3,410,325  |   |
| Series B Preferred Stock |   | $             | .001   |           | 1,000,000   |                          | 1,000,000  |   |
| Series C Preferred Stock |   | $             | .001   |           | 3,000,000   |                          | 500,000    |   |
| Series D Preferred Stock |   | $             | .001   |           | 1,000,000   |                          | 1,000,000  |   |

 

*COMMON STOCK*

* *

Eachholder of common stock is entitled to one vote per share of common stock heldon all matters submitted to a vote of the Company stockholders. Holders of theCompany’s common stock have no preemptive rights and have no rights to converttheir common stock into any other securities. In the event of dissolution or liquidationor the winding-up of the Company’s business, holders of the Company’s commonstock will be entitled to share ratably in all assets remaining after paymentof all liabilities, subject to any preferential payments to the holders of anySenior Secured Convertible Notes and preferred stock then outstanding. Althoughthe Company is restricted from paying cash dividends under the terms of theSenior Secured Convertible Notes, holders of common stock are entitled toreceive ratably such dividends as may be declared by the Company’s board ofdirectors out of funds legally available therefore. All of the Company’soutstanding common shares are fully paid and nonassessable.

 

*Common Stock Private Placements*

 

On November 20, 2002, concurrent with the MAF Acquisition, the Companysold 19.54 units, each unit consisting of 70,000 shares of common stock,70,000 Series B Warrants, and 70,000 Series C Warrants, aggregating 1,367,500 shares of common stock at $1.00 pershare, 1,367,500 Series B Warrants at an exercise price of $1.65 per share, and1,367,500 Series C Warrants at an exercise price of $2.14 per share, generatingcash proceeds of $1,197,115, net of cash offering costs of $170,385.

 

*Common Stock Issued to an Employee*

 

During the year ended December 31, 2003, the Company issued 1,300,000shares of common stock to an employee valued at $1,781,000 as compensationrelated to the closing of various 2003 acquisitions.

 

*Common Stock Issued for Services andSettlements*

 

In order to fund operating activities, the Company, from time to time,issues common stock in lieu of cash in exchange for goods or services.

 

During the years ended December 31, 2003 and 2002, the Company issued692,000 and 102,500 shares of restricted common stock with a value of $748,610and $213,125, respectively, in consideration for consulting, investmentbanking, or other services rendered, compensation, release of debt, or variousother claims that parties may have had against the Company.

 

During the years ended December 31, 2003 and 2002, 395,000 and 241,000shares of common stock with a value of $513,500 and $341,870, respectively,were issued to directors for director services and to various consultants forvarious consultations and advisory services to be provided over a contractperiod ranging from 12 months to three years. These shares were originallycapitalized as a component of equity and amortized to expense over the vestingperiods. For the years ended December 31, 2003 and 2002, $428,335 and $92,785was amortized to expense, respectively. The value of unamortized restrictedcommon stock issued for services as of December 31, 2003 and 2002 was $390,250and $249,085, respectively.

 

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During the years ended December 31, 2003 and 2002, a total of 1,354,000and 50,000 shares of common stock with an aggregate value of $1,720,320 and$68,000, respectively, were issued for financial advisory services related toour various subsidiary acquisitions. During 2003, 1,150,000 shares of common stockwith a market value of $1.30 per share were issued to financial advisors in theENI Acquisition (valued at $1,495,000), 154,000 shares of common stock with amarket value of $1.08 per share were issued to financial advisors in the COFAcquisition (valued at $166,320) and 50,000 shares of common stock with amarket value of $1.18 per share were issued to a financial advisor in the DFNAcquisition (valued at $59,000).  During2002, 50,000 shares of common stock were issued to a financial advisor in theMAF Acquisition (valued at $68,000). These amounts were capitalized as acomponent of the overall purchase price of the respective entities acquired andallocated to the assets acquired, generally goodwill or intangible assets.

 

During the year ended December 31, 2003, 265,500 shares of common stockwith a value of $371,590 were issued for investment banking or other servicesrelated to private placements of both senior convertible debt and the Series CPreferred stock. The value of the shares were capitalized as a component ofequity if associated with Series C Preferred stock private placement ($73,750),or as deferred loan costs if associated with Senior Convertible Debt privateplacements ($297,840).

 

Pursuant to aregistration rights agreement related to a November 2002 private placement of1,367,500 shares of common stock, the Company was required to file and havedeclared effective a registration statement to register the shares of commonstock issued and shares that may be issued upon exercise of the Series BWarrants and Series C Warrants from the private placement prior to March 20,2003. The Company failed to have the registration statement declared effectiveby the deadline; as a result, the Company owes the investors liquidationdamages equal to 2% per month of the purchase price of said securities,calculated on a pro rata basis to the date on which the registration statementwas ultimately declared effective. During 2003, the Companny reached anagreement with some of the investors to pay such damages in 328,200 shares ofour common stock, valued at approximately $367,000. Of the total shares owed,134,600 shares of restricted common stock were issued, valued at $156,136,related to the settlement agreements prior to December 31, 2003 (see Note 11).

 

*TREASURYSTOCK*

 

As part of a resignation agreement executed in July 2003, in which allseverance payments under a prior employment agreement were waived, 280,000shares of restricted common stock were returned at no cost and 144,000 sharesrepurchased by the Company at $0.50 per share from William Coppel, formerPresident, for total payments of $72,000 during 2003. These shares have beenreturned to and recorded as treasury stock as of December 31, 2003. The 280,000shares of common stock returned by Mr. Coppel were recorded at par value, or$280, with a corresponding adjustment to additional paid in capital.

 

*PREFERRED STOCK*

 

Preferredstock may be issued in one or more series, the terms of which may be determinedat the time of issuance by the Company’s board of directors, without furtheraction by stockholders, and may include voting rights (including the right tovote as a series on particular matters), preferences as to dividends andliquidation, conversion rights, redemption rights and sinking fund provisions.The issuance of shares of preferred stock could adversely affect the rights ofthe holders of common stock and therefore, reduce the value of the commonstock.

 

*Series A Preferred Stock*

 

Between February and June 2002, the Company sold 3,712,000 shares of 10%Series A Preferred Stock at $1.00 per share, generating cash proceeds of$3,593,807, net of cash offering costs of $118,193. Holders may convert theirshares into a like amount of common stock at any time after the firstanniversary date of issuance and will convert by their terms after 18 months.Upon conversion, holders of Series A Preferred Stock will receive one Series AWarrant per five preferred shares converted to purchase one share of commonstock at an exercise price of $2.00 per share, exercisable one year from thedate of issuance. If all Series A Preferred Stock were to convert, it wouldrequire the Company to issue 742,400 Series A Warrants, excluding those to beissued upon conversion of Series A Preferred Stock issued as dividends.

 

Holders ofSeries A Preferred Stock have no voting rights, but are entitled to variousrights, preferences, and restrictions that include, but are not limited to: a10% cumulative dividend payable in additional shares of Series A PreferredStock at $1.00 per share; a preference upon a liquidation, dissolution, orwinding up of the Company’s business; and privileges upon redemption during thefirst twelve months from the date of issuance equal to $1.50 per share.

 

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The market value of the Company’s common stock on the dates Series APreferred Stock was sold ranged between $1.25 - $3.40 per common share. Inaccordance with EITF 98-5, as amended by EITF 00-27, because the Series APreferred Stock was sold at a price less than market value of the underlyingcomponents of the security, a beneficial conversion to holders of the Series APreferred Stock occurred. Accordingly, during 2002 the Company recorded adiscount of $3,382,172 within shareholders’ equity and a corresponding amountto preferred stock additional paid-in-capital. The Series A Preferred Stock isconvertible into common stock at the option of the holder at any time after thefirst anniversary date of its issuance, thus the beneficial conversion isamortized over a one-year period. A total of $1,146,653 and $2,235,519 of theSeries A Preferred Stock discount was amortized during the years ended December31, 2003 and 2002, respectively. At December 31, 2003, the entire amount of theSeries A Preferred discount had been amortized.

 

During 2003, holders of 682,163 shares of Series A Preferred Stockconverted such shares into 682,163 shares of common stock. As a condition toconversion, the Company granted 136,433 warrants with an exercise price of $2.00per share. The value of the converted Series A Preferred Stock was $1,303,877and the value of the warrants was $55,025 using the Black-Scholesoption-pricing model. Dividends are cumulative and are to be paid every sixmonths from the date of issuance for a total of 18 months with no obligation topay dividends thereafter. During June 2003, 380,488 additional shares of SeriesA Preferred Stock valued at $380,488 were issued in satisfaction of dividendsowed to holders of Series A Preferred Stock and at December 31, 2003, declaredand unpaid dividends of $204,623 were accrued and will be paid by the issuanceof Series A Preferred Stock for a total dividend of $585,111 (or $0.02 pershare). At December 31, 2003, 3,410,325 shares of Series A Preferred Stockremain outstanding pending the issuance of a like amount of common stock.

 

*Series B Preferred Stock*

 

On April 16,2003, the Company sold to one investor 10 units, each consisting of 100,000shares of non-voting 25% Series B Preferred Stock, 100,000 Series D Warrants,and 100,000 Series E Warrants, aggregating 1,000,000 shares of Series BPreferred Stock at $1.00 per share, 1,000,000 Series D Warrants at an exerciseprice of $1.30 per share, and 1,000,000 Series E Warrants at an exercise priceof $1.60 per share, generating cash proceeds of $875,000, net of cash offeringcosts of $125,000. The combined fair value at the date of grant of the Series Dand Series E Warrants using the Black-Scholes option-pricing model was $62,494.

 

The holder ofthe Series B Preferred Stock is entitled to a one-time a dividend at a rate of25% per annum, payable in cash or common stock on the one-year anniversary ofthe issuance date with no obligation to pay dividends thereafter. Unpaid and/orundeclared dividends are cumulative. The total amount of dividends not declaredat December 31, 2003 is $177,397 (or $0.01 per common share) and would total$250,000 on an annual basis (or $0.01 per common share). Each share of Series BPreferred Stock is convertible into one share of common stock at the option ofthe holder at any time after the first anniversary of the date of issuance. Inconnection with this offering, 200,000 Series D Warrants with an exercise priceof $1.30 per share (fair value of $8,086) and a cash commission equal to 12.5%of the proceeds (or $125,000) were paid to a shareholder of the Company tofacilitate the transaction, thus increasing the total offering costs to$133,086. The Series B Preferred Stock has no voting rights, liquidationpreferences, or protective provisions.

 

*Series C Preferred Stock*

 

On July 9, 2003, the Company sold to one investor 5 units, eachconsisting of 100,000 shares of non-voting 50% Series C Preferred Stock,100,000 Series D Warrants, and 100,000 Series E Warrants, aggregating 500,000 sharesof Series C Preferred Stock at $1.00 per share, 500,000 Series D Warrants at anexercise price of $1.30 per share, and 500,000 Series E Warrants at an exerciseprice of $1.60 per share, generating cash proceeds of $437,500, net of cashoffering cost of $62,500. The combined fair value at the date of grant of theSeries D and Series E Warrants using the Black-Scholes option-pricing model was$242,275.

 

The holder of the Series C Preferred Stock is entitled to a two-timedividend at the rate of 50% per annum, payable in cash or common stock on thefirst and second anniversary of the issuance date with no obligation to paydividends thereafter. Unpaid and/or undeclared dividends are cumulative. Thetotal amount of dividends not declared at December 31, 2003 is $119,863 (lessthan $0.01 per common share) and would total $250,000 on an annual basis (or$0.01 per common share). Each share of Series C Preferred Stock is convertibleinto one share of common stock at the option of the holder at any time after thefirst anniversary of the date of issuance.

 

In connection with this offering, 250,000 Series D Warrants with anexercise price of $1.30 per share (fair value of $71,510), a cash commissionequal to 12.5% of the proceeds (or $62,500), 62,500 shares of common stock(fair value of $73,750, or

 

F-22

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$1.18 per share), and an option to acquire 62,500 shares of common stockexercisable at $1.00 per share (fair value of $25,830) were granted, paid, orissued to a shareholder of the Company to facilitate the transaction, thusincreasing the total offering costs to $233,590. The Series C Preferred Stockhas no voting rights, liquidation preferences, or protective provisions.

 

The market value of the Company’s common stock on the date the Series CPreferred Stock was sold was $1.18 per common share. In accordance with EITF98-5, as amended by EITF 00-27, because the Series C Preferred Stock was soldat a price less than market value of the underlying components of the security,a beneficial conversion to holders of the Series C Preferred Stock occurred.Accordingly, during 2003 the Company recorded a discount of $253,198 withinshareholders’ equity and a corresponding amount to preferred stock additionalpaid-in-capital. The Series C Preferred Stock is convertible into common stockat the option of the holder at any time after the first anniversary date of itsissuance, thus the beneficial conversion is amortized over a one-year period. Atotal of $126,599 of the Series C Preferred Stock discount was amortized duringthe year ended December 31, 2003 leaving an unamortized balance of $126,599.

 

*Series D Preferred Stock*

 

On August 20, 2003, concurrent with the ENI Acquisition, the Companysold to a single investor 1,000,000 shares of Series D Preferred Stock at $1.00per share, generating cash proceeds of $815,000, net of cash offering costs of$185,000. Each share of Series D Preferred Stock is convertible into one shareof common stock at the option of the holder at any time.

 

The market value of the Company’s common stock on the date the Series DPreferred Stock was sold was $1.37 per common share. In accordance with EITF98-5, as amended by EITF 00-27, because the Series D Preferred Stock was soldat a price less than market value of the underlying components of the security,a beneficial conversion to holders of the Series D Preferred Stock occurred.Accordingly, during 2003 the Company recorded a discount of $370,000 withinshareholders’ equity and a corresponding amount to preferred stock additionalpaid-in-capital. The Series D Preferred Stock is convertible into common stockat the option of the holder at any time, thus the beneficial conversion wasrecorded as a dividend upon issuance.

 

The holder ofthe Series D Preferred Stock is entitled to various rights, preferences, andrestrictions that include, but are not limited to:

 

1.               *Voting*.The Series D Preferred Stock votes on an as-converted basis with the commonstock.

2.               *Dividends*.The holders of the Series D Preferred Stock are entitled to a like dividend ordistribution, pro rata, should there be a cash or property dividend ordistribution to any class of common stock or preferred stock other than theSeries A Preferred Stock, determined on an as converted basis. This does notinclude any dividends paid in shares of common stock to the holders of Series BPreferred Stock and Series C Preferred Stock outstanding as of the date ofissuance.

3.               *LiquidationPreference*. The Series D Preferred Stock is senior to the SeriesB Preferred Stock and Series C Preferred Stock and the common stock uponliquidation and is entitled to an amount equal to the original $1.00 per shareissue price plus any declared and unpaid dividends (as adjusted for stockdividends, combinations, splits, recapitalization, and the like with respect tosuch shares).

4.               *Redemption*.The Company has no rights to redeem the Series D Preferred Stock.

5.               *Conversion*.The holders of Series D Preferred Stock shall have the right to convert intocommon stock at any time. Each share of Series D Preferred Stock is convertibleinto one share of common stock subject to adjustment for declared and unpaiddividends, stock dividends, combinations, splits, recapitalization, and thelike with respect to such shares. The conversion price is initially set at$1.00. The conversion price may be decreased at the end of two years if thecommon Stock is trading at a price below the conversion price then in effect.The floor for such adjustment is $0.25 per share. The conversion price of theSeries D Preferred Stock may also be reduced in certain situations if we issueadditional options, warrants, or rights to purchase common stock at a pricebelow the conversion price of the Series D Preferred Stock. In such event, theconversion price will be decreased by multiplying the conversion price then ineffect by a fraction of which (i) the numerator will be the number ofoutstanding shares of common stock on the date of issuance of the rights plusthe number of shares of common stock which could be purchased at the thenconversion price from the aggregate offering price of the rights and (ii) thedenominator will be the shares of common stock outstanding on the date ofissuance of the rights plus the number of shares of common stock so offered forsubscription or purchase pursuant to such rights.

6.               *ProtectiveProvisions*. So long as any shares of Series D Preferred Stockare outstanding, the Company may not, without the prior affirmative consent orvote of the holders of at least two thirds of the outstanding shares of theSeries D Preferred Stock:

 

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a.               authorize,create, designate, establish or issue shares of, any class or series of capitalstock ranking senior to or on parity with the Series D Preferred Stock orreclassify any shares of common stock into shares having any preference orpriority as to dividends or assets superior to any such preference or priorityof Series D Preferred Stock; or

b.              amend,alter or repeal, whether by merger, consolidation or otherwise, the Company’samended and restated articles of incorporation or bylaws or the resolutionscontained in the certificate of designation of the Series D Preferred Stock andthe powers, preferences, privileges, relative, participating, optional andother special rights and qualifications, limitations and restrictions thereof,which would adversely affect any right, preference, privilege or voting powerof the Series D Preferred Stock, or which would increase the amount of authorizedshares of the Series D Preferred Stock or of any other series of preferredstock ranking senior to the Series D Preferred Stock, with respect to thepayment of dividends (whether or not such series of preferred stock iscumulative or non-cumulative as to payment of dividends) or liquidation.

 

**Note 9 –Stock Options and Warrants**

** **

*Series A Warrants*

* *

Series AWarrants arose in connection with the June 2002 Series A Preferred Stockprivate placement. Upon conversion of every five shares of Series A PreferredStock into common stock, the Company will grant one Series A Warrant topurchase one share of the Company’s common stock, exercisable after one yearfrom the date of grant at an exercise price of $2.00 per share and expiring onthe second anniversary of the date of grant. The exercise price of the warrantsis subject to adjustment for stock splits, dividends, reclassifications, andother adjustments.

 

Uponconversion of the 3,712,000 shares of Series A Preferred Stock andcorresponding stock dividends, the Company will ultimately issue 859,420 SeriesA Warrants. As of December 31, 2003, there are 208,433 Series A Warrantsoutstanding.

 

*Series B and Series C Warrants*

 

Series B andSeries C Warrants arose in connection with the November 2002 common stock privateplacement, concurrent with the MAF Acquisition. The Series B and Series CWarrants have an exercise price of $1.65 and $2.14, respectively, and may beexercised at the option of the holder at any time for a period of five yearsfrom the date of issuance. The exercise prices are subject to adjustment forstock splits, dividends, reclassifications, and other typical corporateactions. If the Company issues additional shares of common stock at a priceless than $1.00 per share, the exercise prices of the warrants upon each suchissuance shall be adjusted and reset to such issuance price; however, thisreset feature does not apply to:

 

1.               anystock splits, dividends, reclassifications, or similar actions, or

2.               anyissuance of shares of common stock (or shares of common stock issuable upon theexercise of securities convertible into shares of common stock with an exerciseprice or a conversion price less than $1.00) if such securities were issued toconsultants, employees or other service providers, or to third party vendors tosatisfy amounts owed; provided that the Company may not issue to suchindividuals, in any rolling 12 month period, more than 1,600,000 shares ofcommon stock or 10% of the actual number of shares of common stock issued andoutstanding (assuming the conversion of the Series A Preferred Stock) and maynot issue to any one individual more than 500,000 shares of common stock.

 

Provided thata registration statement covering the shares underlying the warrants iseffective, the Company may redeem any or all of the warrants, at any time, at$0.05 per warrant if:

 

1.               theclosing price for the Company’s common stock on any 20 trading days within aperiod of 30 consecutive trading days ending on the date of the notice of thecall has been in excess of 150% of the then effective exercise price, and

2.               noless than four of such 20 days occur during the last five trading days endingon the date of the notice of the redemption.

 

As of December31, 2003, there are 1,367,500 Series B Warrants and 1,367,500 Series C Warrantsoutstanding.

* *

*Series D and Series E Warrants*

* *

Series D andSeries E Warrants arose in connection with the April 2003 Series B PreferredStock and July 2003 Series C Preferred Stock private placements. The Series Dand Series E Warrants have an exercise price of $1.30 and $1.60, respectively,and may be exercised at the option of the holder at any time for a period offive years from the date of issuance.

 

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The exerciseprices are subject to adjustment for stock splits, dividends,reclassifications, and other typical corporate actions. As of December 31,2003, there are 1,950,000 Series D Warrants and 1,500,000 Series E Warrantsoutstanding.

 

*Series F Warrants*

* *

Series FWarrants arose in connection with the July 2003 amendment of one of theCompany’s strategic consulting agreements. The Series F Warrants have anexercise price of $1.00 per share and may be exercised at the option of theholder at any time for a period of five years from the date of issuance. Theexercise price is subject to adjustment for stock splits, dividends,reclassifications, and other typical corporate actions. As of December 31,2003, there are 125,000 Series F Warrants outstanding.

 

*Other Warrants*

* *

In connection withthe Bridge Notes and Senior Secured Notes (see Note 6) during 2003, the Companygranted note holders an aggregate of 7,647,738 and 1,530,000 warrants at anexercise price of $1.00 and $1.50 per share, respectively. The warrants may beexercised immediately, expire on the fifth anniversary of the date of issuance,and the exercise price is subject to adjustment for stock splits, dividends,reclassifications, and other typical corporate actions. As of December 31,2003, there are 9,177,738 of these warrants outstanding.

 

Additionally,the Company granted 203,000 warrants to financial advisors associated with theissuance of the Bridge Notes, which had a fair value of $143,326. Financialadvisors associated with the Secured Notes were granted 536,400 warrants with afair value of $268,530. Of the warrants granted in the Secured Notes, 200,000warrants with a fair value of $101,256 were issued in conjunction with therefinancing of the Bridge Notes.

 

*Stock Option Plans*

 

On August 1, 2001, the Board of Directors adopted the Company’s2001 Stock Option Plan pursuant to which incentive stock options ornon-statutory stock options to purchase up to 2,500,000 shares of common stockcan be granted to employees, officers, directors, consultants, and independentcontractors or other service providers.

 

On May 3, 2002, the Board of Directors adopted the Company’s 2002Stock Option Plan pursuant to which incentive stock options or non-statutorystock options to purchase up to 2,000,000 shares of common stock can be grantedto employees, officers, directors, consultants, independent contractors, orother service providers.

 

On a combined basis, the plans had 3,831,483 and 3,385,000 optionsoutstanding at December 31, 2003 and 2002, respectively, with exercise pricesranging from $0.35 to $3.00. At December 31, 2003, there are an aggregate of668,517 options available under the plans for future grant.

 

*Options and Warrants Issued for Services*

 

In order to fund operating activities, the Company, from time to time,grants options or warrants to purchase common stock in lieu of cash inconsideration for consulting, investment banking, or other services rendered,compensation, release of debt, or various other claims which parties may haveagainst the Company. The Company granted options and warrants to purchasecommon stock during the years ended December 31, as follows:

 
|     |   | **2003**            |   | **2002**       |       |
|----------|--------|---------------------|--------|----------------|------------|
|     |   | **Number  Granted** |   | **Fair Value** | ** ** | **Exercise  Price** | ** ** | **Number  Granted** | ** ** | **Fair Value** | ** ** | **Exercise  Price** | ** ** |
| Options  |   | 40,000              |   | $              | 16,018     |   | $ | 1.40 |   | 1,080,000 |   | $ | 554,360 |   | $ 1.00 - $3.00 |   |
| Warrants |   | 743,400             |   | 443,622        |       | $ | 1.00 |   | 1,180,000 |   | 673,040 |   | $ 1.00 -  $2.05 |   |
|     |   | 783,400             |   | $              | 459,640    |   |   |   | 2,260,000 |   | $ | 1,227,400 |   |   |   |
|          |        |                     |        |                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The fair value of certain of these options and warrants are beingamortized over their respective vesting periods, which range from zero to 36months. For the years ended December 31, 2003 and 2002, $542,110 and $494,517was amortized to

 

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expense, respectively. The fair value of unamortized options andwarrants issued for services at December 31, 2003 and 2002 was $206,792 and$732,883, respectively.

 

DuringNovember and December 2003 in connection with the Bridge Notes and SeniorSecured Notes, the Company granted an aggregate of 583,400 warrants to acquirecommon stock, valued at $411,123, to various investment advisors with anexercise price of $1.00 per share. The fair value of these warrants wascapitalized as component of deferred debt issuance costs and will be amortizedover the life of the debt instruments.

 

During September and October 2003, a total of 75,000 common stockoptions previously issued to three consultants were exercised, generating grossproceeds of $26,250.

 

During August 2003, the Board of Directors approved the repricing of anexisting warrant to acquire 120,000 shares of the Company’s common stock at anoriginal exercise price of $2.80 to $2.00 per share. The repricing of thiswarrant requires variable accounting as prescribed by FIN 44. The fair value ofthe repriced warrants was deemed to be lower than the original fair value of$138,274 using the Black-Scholes option-pricing model, thus no furtheradjustment to expense was required. As required by FIN 44, these warrants willbe subject to revaluation at each reporting period and, if the fair value ofthe underlying warrants were to exceed $138,274, an additional charge toexpense would be required.

 

During July2003, the Company granted a Series F Warrant to acquire 125,000 shares of theCompany’s common stock with an exercise price of $1.00 per share to one of theCompany’s strategic consultants in conjunction with an amendment to an existingconsulting agreement.  The fair value ofthese warrants was calculated using the Black-Scholes pricing model and wasdetermined to be $32,500, which was recorded as consulting expense.

 

In July 2003,the Company executed an amendment to an agreement with Arizona Heart Institute,Inc. (“AHI”) extending the term for an additional year. In consideration forthe extension, AHI received the right to exercise 100,000 shares of commonstock through a “net exercise” provision and the option exercise period wasextended to three years. AHI also agreed not to sell in excess of 25,000 sharesin any rolling 30-day period. Consideration to be received would be in the formof relinquishment of the right by AHI to purchase a particular number ofshares. In October 2003, AHI exercised its rights under the net exerciseprovision and was issued 100,000 shares of common stock in exchange for 132,407options.

 

In July 2003,the Company executed an amendment to an agreement with AHI Management HongKong, Ltd. (“AHIHK”) to provide the immediate vesting of previously issuedoptions to acquire 300,000 shares of our common stock at $0.35 per share andthe eliminate any lock-up period relating thereto. Options require an outrightpurchase for cash consideration and are then subject to SEC Rule 144. Inconsideration for the amendment, AHIHK agreed to eliminate their right to actas our exclusive distributor in China, enabling the Company to seek otherdistributors in the territory on a non-exclusive basis.

 

Per FIN No.44, “*Accounting for Certain TransactionsInvolving Stock Compensation*,” a non-cash charge to expense isrequired if the price of the Company’s common stock on the last trading day ofa reporting period is greater than the exercise price of certain stock optionsand warrants issued. The requirements of FIN No. 44 may also result in a creditto expense to the extent that the trading price declines from the trading priceas of the end of the previous reporting period, provided however that a creditis not recorded to the extent our common stock trades below the exercise priceof the options or warrants. In accordance with FIN No. 44, the Company adjustsexpense upward or downward on a monthly basis based on the trading price at theend of each period. As a result, the Company recorded expense of $255,000during the year ended December 31, 2003, which represents the fair value of theeffective repricing of the options using the Black-Scholes option-pricing modelat the date of the amendments.

 

On April 3, 2003, the Board of Directors approved the granting of 35,000warrants to acquire common stock of the Company with an exercise price of $1.00per warrant to an agent who assisted in the private placement offering of1,367,500 shares of common stock completed during October 2002.  The fair value of the warrant was calculatedusing the Black-Scholes pricing model and was determined to be zero.

 

*Options and Warrants Issued to Employees*

 

During October 2003, the Company granted 300,000 options to an executivein conjunction with an employment agreement executed concurrent with the DFNAcquisition. The options have an exercise price of $1.40 per share, expire infive years, and vest based upon reaching certain performance milestones.

 

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InApril 2003, the Board of Directors approved the repricing of 1,340,000 warrantsissued to an officer of the Company in connection with an April 2002 employmentagreement (the “Officer Warrants”). The warrants were 100% vested on the dateof grant and had an original exercise price of $1.50 per warrant. The warrantswere amended to include, among other things, a reduction of the exercise priceto $0.01, a full-ratchet dilution provision, as defined, a waiver of theCompany’s 50% funding obligation of the exercise price, and an extension of theterm of the warrant agreement for one additional year. The dilution provisionprovides that, upon exercise of the warrant, the officer shall be able toacquire the same percentage of common stock as that represented by thepercentage calculated as the number of shares which the officer would acquireon the date of the amendment compared to the total number of actual shares ofcommon stock outstanding on such date.

 

In accordancewith FIN No. 44, the Company adjusts expense upward or downward on a monthlybasis based on the trading price at the end of each period. As a result, theCompany recorded net compensation expense of $1,508,461 during the year endedDecember 31, 2003, and $18,000 of compensation expense upon the exercise of30,000 warrants by this executive during May 2003.

 

During August 2003, concurrent with the ENI Acquisition and the Series DPreferred Stock private placement, the Company executed a second amendment tothe Officer Warrants that provided for the granting of an additional 5,000,000warrants with an exercise price of $0.01 per share and eliminated thefull-ratchet dilution provision, as defined. The new warrants were 100% vestedon the date of grant and had a fair value of $6,800,000, which was charged tocompensation expense during the year ended December 31, 2003.

 

In July 2002, the Company granted 30,000 options to an employeewith an exercise price of $2.40, vesting quarterly over a three-year periodcommencing October 17, 2002. The options were cancelled in 2002.

 

In January 2002, the Company issued 125,000 options to an employeeunder the Company’s 2001 Stock Option Plan. The options have an exercise priceof $1.00 per share, expire in four years, and vest quarterly, 40,000 in thefirst year, 45,000 in the second year, and 40,000 in the third year. The fairvalue of the options using the Black-Scholes option-pricing model wasdetermined to be zero.

 

*Summary of Options and Warrants*

 

Asummary of stock option activity for the years ended December 31 is as follows:

 
|                                |   | **2003**   |       | **2002**                              |       |
|-------------------------------------|--------|------------|------------|---------------------------------------|------------|
|                                |   | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Outstanding at beginning of  period |   | 3,385,000  |       | $                                     | 0.87       |   | 2,180,000 |   | $ | 0.35 |   |
| Granted                             |   | 653,890    |       | $                                     | 1.21       |   | 1,235,000 |   | $ | 1.82 |   |
| Cancelled                           |   | —     |       | —                                |       | (30,000 | ) | $ | 2.40 |   |
| Exercised                           |   | (207,407   | )          | $                                     | 0.35       |   | — |   | — |   |
| Outstanding at end of period        |   | 3,831,483  |       | $                                     | 0.93       |   | 3,385,000 |   | $ | 0.87 |   |
|                                |   |       |       |                                  |       |   |   |   |   |
| Exercisable at end of period        |   | 1,763,516  |       | $                                     | 1.10       |   | 1,266,147 |   | $ | 0.71 |   |

 

F-27

----

 

Informationabout stock options outstanding at December 31, 2003 is as follows:

 
|                           |   | **Options  Outstanding** |   | **Options Exercisable**                            |   |
|--------------------------------|--------|--------------------------|--------|----------------------------------------------------|--------|
| **Range of   Exercise Prices** |   | **Shares  Outstanding**  |   | **Weighted  Average  Remaining  Contractual Life** |   | **Weighted  Average Exercise Price** |   | **Shares  Exercisable** |   | **Weighted  Average Exercise Price** |   |
| $ 0.35 - $1.00                 |   | 2,611,483                |   | 2.11                                               |   | $ | 0.51 |   | 1,426,483 |   | $ | 0.69 |   |
| $ 1.40 - $1.50                 |   | 840,000                  |   | 4.03                                               |   | $ | 1.46 |   | 3,700 |   | $ | 1.40 |   |
| $ 2.00 - $3.00                 |   | 380,000                  |   | 3.38                                               |   | $ | 2.65 |   | 333,333 |   | $ | 2.84 |   |
|                           |   | 3,831,483                |   |                                               |   | $ | 0.93 |   | 1,763,516 |   | $ | 1.10 |   |

 

Asummary of warrant activity for the years ended December 31 is as follows:

 
|                                |   |       | ** ** | **2003**   | ** ** | **2002**                              | ** ** |
|-------------------------------------|--------|------------|------------|------------|------------|---------------------------------------|------------|
|                                |   |       | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Outstanding at beginning of  period |   | 6,975,000  |       | $          | 1.32       |                                  | 1,750,000  |   | $ | 0.35 |   |
| Granted                             |   | 18,729,571 |       | $          | 0.87       |                                  | 5,255,000  |   | $ | 1.65 |   |
| Cancelled                           |   | —     |       | —     |       | (30,000                               | )          | $ | 2.05 |   |
| Exercised                           |   | (30,000    | )          | $          | 0.01       |                                  | —     |   | — |   |
| Outstanding at end of period        |   | 25,674,571 |       | $          | 0.91       |                                  | 6,975,000  |   | $ | 1.32 |   |
|                                |   |       |       |       |       |                                  |       |   |   |
| Exercisable at end of period        |   | 25,538,138 |       | $          | 0.91       |                                  | 6,686,120  |   | $ | 1.33 |   |

 

Informationabout warrants outstanding at December 31, 2003 is as follows:

 
|                          |   | **Warrants  Outstanding** | ** ** | **Warrants  Exercisable**                          | ** ** |
|-------------------------------|--------|---------------------------|------------|----------------------------------------------------|------------|
| **Range of  Exercise Prices** |   | **Shares  Outstanding**   | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Shares  Exercisable** | ** ** | **Weighted  Average Exercise  Price** | ** ** |
| $ 0.01 - $0.35                |   | 8,060,000                 |       | 1.55                                               |       | $ | 0.08 |   | 8,060,000 |   | $ | 0.08 |   |
| $ 1.00                        |   | 9,191,138                 |       | 4.38                                               |       | $ | 1.00 |   | 9,191,138 |   | $ | 1.00 |   |
| $ 1.30 - $1.65                |   | 6,847,500                 |       | 3.65                                               |       | $ | 1.49 |   | 6,847,500 |   | $ | 1.49 |   |
| $ 2.00 - $2.14                |   | 1,575,933                 |       | 1.89                                               |       | $ | 2.12 |   | 1,439,500 |   | $ | 2.13 |   |
|                          |   | 25,674,571                |       |                                               |       | $ | 0.91 |   | 25,538,138 |   | $ | 0.91 |   |

 

F-28

----

 

**Note 10 –Income Taxes**

** **

Components of the deferred tax asset (liabilities) as ofDecember 31 are as follows:

 
|                             |   | **2003**    |      | **2002**   |   |
|----------------------------------|--------|-------------|-----------|------------|--------|
| Net operating loss carryforwards |   | $           | 6,362,000 |       | $      | 1,706,886 |   |
| Deferred compensation            |   | 3,108,000   |      |       |   |
| Amortizable intangibles          |   | 1,079,000   |      | (9,332     | )      |
| Other temporary differences      |   | 61,000      |      |       |   |
|                             |   | 10,610,000  |      | 1,697,554  |   |
| Less valuation allowance         |   | (10,610,000 | )         | (1,697,554 | )      |
|                             |   | $           | —    |       | $      | — |   |

 

Net operating loss carryforwards are available to reduce future taxableincome.  However, a change in ownership,as defined by federal income tax regulations, could significantly limit theCompany’s ability to utilize its U.S. net operating loss carryforwards.Additionally, because federal tax laws limit the time during which the netoperating loss carryforwards may be applied against future taxes, if theCompany fails to generate taxable income prior to the expiration dates, it maynot be able to fully utilize the net operating loss caryforwards to reducefuture income taxes.

 

As the Company has had cumulative losses and there is no assurance offuture taxable income, valuation allowances have been recorded to fully offsetthe deferred tax asset at December 31, 2003 and 2002. The valuation allowanceincreased $8,912,446 during 2003 due to the Company’s current period netloss.  Due to this increase in thevaluation allowance, the effective tax rate has been reduced to 0% for theyears ended December 31, 2003 and 2002. As of December 31, 2003, theCompany has net operating loss carry forwards for federal income tax reportingpurposes of approximately $18,713,000, which expire through 2023. Theutilization of such operating losses may be limited.

 

**Note 11 –Related Party Transactions**

 

From time to time, the Companyengages its directors, shareholders, or other related parties for consultingservices related to investment, acquisition, or other activities in the normalcourse of business. Management believes that all of these transactions areconducted at an “arms-length.”  Fairmarket value of securities issued in these transactions, including stock,options, and warrants, is listed below where applicable and calculated usingthe Black-Scholes Pricing Model as of the date of issuance or grant.

 

*Officers and Directors*

 

The Companyhas several agreements with Aegis Capital Corp. (“Aegis”) to provideconsulting, investment, or financial services. Robert J. Eide, a member of theCompany’s Board of Directors from June 2002 through March 2004, is a principal,Chairman, and Chief Executive Officer of Aegis. During the years ended December31, 2003 and 2002, the Company paid the following amounts to Aegis (or to Mr.Eide, where indicated) in exchange for such services:

 
| **Matter**           |   | **Year**            | ** ** | **Cash** | ** ** | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market  Value of  Securities** | ** ** |
|----------------------|--------|---------------------|------------|----------|------------|-----------|------------|-----------------------------|------------|----------------------------------------|------------|
| **Number**           |   | **Exercise  Price** |       |
| Other Services(1)    |   | 2003                |       | $        | 6,000      |      | 142,000    |                        | —     |                                   | N/A        |   | $ | 184,600 |   |
| Other Services(2)    |   | 2003                |       | —   |       | 58,000    |       | —                      |       | N/A                                    |       | $ | 75,400 |   |
| Other Services       |   | 2003                |       | $        | 216,335    |      | 150,000    |                        | 72,400     |                                   | $          | 1.00 |   | $ | 232 667 |   |
| Director Services(1) |   | 2003                |       | —   |       | 75,000    |       | —                      |       | N/A                                    |       | $ | 100,500 |   |
| Other Services       |   | 2002                |       | $        | 100,000    |      | 50,000     |                        | —     |                                   | N/A        |   | $ | 68,000 |   |
| Director Services(1) |   | 2002                |       | —   |       | 30,000    |       | —                      |       | N/A                                    |       | $ | 51,000 |   |
|                      |        |                     |            |          |            |           |            |                             |            |                                        |            |  |  |  |  |  |

 

F-29

----

----

(1)                    Paidor granted directly to Mr. Eide.

(2)                    Paidor granted to a designee of Aegis on its behalf.

 

During theyears ended December 31, 2003 and 2002, the Company made the following paymentsto Donald C. Hannah, Chairman of the Company’s Board of Directors, for servicesrendered as follows:

 
| **Matter**        |   | **Year**            | ** ** | **Cash** | ** ** | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market Value of Securities** | ** ** |
|-------------------|--------|---------------------|------------|----------|------------|-----------|------------|-----------------------------|------------|--------------------------------------|------------|
| **Number**        |   | **Exercise  Price** |
| Advisory Services |   | 2003                |       | $        | 12,000     |      | —     |                        | —     |                                 | N/A        |   | N/A |   |
| Director Services |   | 2003                |       | —   |       | 75,000(1  | )          | —                      |       | N/A                                  |       | $ | 100,500 |   |
| Director Services |   | 2002                |       | —   |       | 30,000(2  | )          | —                      |       | N/A                                  |       | $ | 51,000 |   |
|                   |        |                     |            |          |            |           |            |                             |            |                                      |            |  |  |  |  |

 

----

(1)                    50,000of which are subject to divestiture.

(2)                    10,000of which remain unvested at December 31, 2003.

 

During2003, the Company issued 85,000, 85,000, and 25,000 shares of restricted commonstock to Carson Beadle, Leslie Quick, and David Allen, respectively, inexchange for director services for a combined fair market value of $245,500. Inaddition, the Company paid $15,000 to Elliot Speiser, a member of the Company’sBoard of Directors, for services rendered in a potential acquisition.

 

In2003, the Company had agreements with Mitch Feinglas, the Company’s ChiefOperating Officer and member of its Board of Directors, or various entities onhis behalf, to perform consulting or other services. During 2003, the Companypaid the following amounts to the parties indicated in exchange for suchservices: 

 
| **Party**                   |   | **Cash**            | ** ** | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market  Value of  Securities** | ** ** |
|-----------------------------|--------|---------------------|------------|-----------|------------|-----------------------------|------------|----------------------------------------|------------|
| **Number**                  |   | **Exercise  Price** |
| Eurolink International, LTD |   | $                   | 116,680    |      | —     |                        | —     |                                   | N/A        |   | N/A |   |
| Equity International, LTD   |   | —              |       | 100,000   |       | —                      |       | N/A                                    |       | $ | 134,000 |   |
|                             |        |                     |            |           |            |                             |            |                                        |            |  |  |  |  |

 

During 2003,the Company paid $10,000 to Silver Lining Realty, the principal of which is ourformer Chairman and Chief Executive Officer, Brad Edson, for its realtyservices in connection with a new lease for our Utah operations.

 

As part of aresignation agreement executed in July 2003, in which all severance paymentsunder a prior employment agreement were waived, 280,000 shares of restrictedcommon stock were returned at no cost and 144,000 shares were repurchased bythe Company at $0.50 per share from William Coppel, former President, for totalpayments of $72,000 during 2003. These shares have been returned and recordedas treasury stock as of December 31, 2003.

 

OnApril 4, 2002, the Company entered into a three-year consulting agreementwith Martin Gerst, former secretary, treasurer, and director, to provideservices related to capital formation, strategic relationships, and productbranding. Under the terms of the agreement, Mr. Gerst, in addition tomonthly payments of $2,000, received fully vested warrants to purchase 500,000shares of common stock at a price of $1.50 per share, valued at $280,580 at thedate of grant. This agreement was terminated by the parties effective December31, 2002. The Company paid approximately $8,000 and $30,000 related to thisagreement during the fiscal year ended December 31, 2003 and 2002,respectively.

 

F-30

----

 

During 2002,the following obligations to or from various former officers, directors, orentities controlled by former officers or directors, were relieved as follows:

 

•                    Anunsecured demand note payable to Brad Edson totaling $43,500 with interestaccruing at 10% was repaid;

•                    Payablesto Brad Edson, Kenneth Lind, and Eric Anderson totaling $147,926 for unpaidsalaries and other reimbursable expenses were repaid;

•                    Severancecompensation of approximately $67,500 was paid to Kenneth Lind in connectionwith the termination of his employment in December 2002;

•                    Facilitylease and office costs of approximately $51,095 was paid to Camper Clubs ofAmerica, Inc., an entity controlled by Brad Edson and Martin Gerst;

•                    Advancesreceivable from Brad Edson and Martin Gerst totaling $52,500 with interestaccruing at 6% were repaid; and

•                    Receivablesfrom Camper Clubs of America, Inc., CCA Products, Inc., and a corporationpreviously doing business as Vital Living, entities controlled byBrad Edson and Martin Gerst, totaling $37,372 were written off.

 

*Shareholders*

* *

The Company isparty to two voting agreements as follows:

 

*MAF Voting Agreement*.In connection with our November 2002 MAF Acquisition, we entered into astockholders’ agreement with Stuart A. Benson, Donald C. Hannah, Bradley D.Edson, Martin Gerst, William Coppel, Phil Maffetone, Kenneth Martin, Leslie C.Quick, III, and Thomas C. Quick (the “MAF Voting Agreement”). Pursuant to theMAF Voting Agreement:

 

•                    forso long as Messrs. Edson, Benson, Hannah and Gerst beneficially own anaggregate of at least 65% of the shares of common stock held by them on thedate of the agreement, they shall be entitled to nominate and have elected fourdirectors acceptable to them in their sole discretion; and

•                    forso long as Messrs. Coppel, Maffetone, Quick and Quick beneficially own anaggregate of at least 65% of the shares of common stock held by them on thedate of the agreement, they shall be entitled to nominate and have electedthree Directors.

 

Each of the parties to the MAF Voting Agreement has agreed to vote theshares of common stock beneficially owned by them on the date of the agreementin favor of the other group’s nominees. Each of the parties have further agreedthat they will vote in favor of the other parties’ nominee or nominees, andwill not take any action, or cause us to take any action, to remove, with orwithout cause, a Director nominated by any of the parties. Because Messrs.Coppel, Maffetone, Quick, and Quick do not still beneficially own the required65%, they no longer have the right to nominate and have elected any Directors.

 

*ENIVoting Agreement*. In connection with our August 2003 ENIAcquisition, we entered into a stockholders’ agreement with Stuart A. Benson,Donald C. Hannah, SkyePharma PLC, Stephen Morris, and Fifth Avenue Capital,Inc. (the “ENI Voting Agreement”). Pursuant to the ENI Voting Agreement, asamended:

 

•                    forso long as Messrs. Benson and Hannah (the “Founders”) beneficially own anaggregate of at least 65% of the shares of common stock owned by them on thedate of the agreement, they shall be entitled to nominate three directors;

•                    forso long as Stephen Morris and Fifth Avenue Capital beneficially own anaggregate of at least 65% of the shares of common stock owned by them on thedate of the agreement, they shall be entitled to nominate one director; and

•                    forso long as SkyePharma beneficially owns an aggregate of at least 65% of theshares of common stock owned by it on the date of the agreement, it is entitledto nominate one director.

 

Each of the parties to the ENI Voting Agreement has agreed to vote theshares of common stock beneficially owned by them on the date of the agreementin favor of the other group’s nominees. Each of the parties have further agreedthat they will vote in favor of the other parties’ nominee or nominees, andwill not take any action, or cause us to take any action, to remove, with or withoutcause, a Director nominated by any of the parties.

 

F-31

----

 

In October andNovember 2003, the Company entered into short-term notes payable with twoshareholders, borrowing an aggregate principal amount of $125,000. The notesgenerally matured in 60 days and bore interest at a stated rate of 10%, with 12months of interest earned and payable immediately. The notes, includinginterest earned of $12,500, were paid in full prior to December 31, 2003.

 

Concurrentwith the MAF Acquisition in November 2002, the Company executed a three-yearconsulting agreement with Phillip Maffetone, a shareholder and former owner ofMAF, to provide product development and marketing services in exchange formonthly fees of $8,333. We paid approximately $80,000 and $8,000 to PhillipMaffetone under the terms of the agreement during the years ended December 31,2003 and 2002, respectively. The Company has ceased payments under the contractand is currently renegotiating its terms.

 

On October 14,2003, the Closing Date of the DFN Acquisition, Messrs. Bruce Howe and MaynardHowe entered into a lock-up agreement, representing approximately 65% of the1,650,003 common shares exchanged as purchase consideration. Pursuant to theagreement, the parties collectively agreed to a lock-up of the shares receivedin the DFN Acquisition, as listed below:

 
| **Reference**          |   | **Period**                                                 |   | **Shares  Available for Disposition** |   |
|------------------------|--------|------------------------------------------------------------|--------|---------------------------------------|--------|
| Initial Lock-Up Period |   | Up to 6 months following Closing Date                      |   | None                                  |   |
| Second Lock-Up Period  |   | Up to 6  months following Initial Lock-Up Period           |   | Up to 50%  shares received            |   |
| Third Lock-Up Period   |   | Up to 6  months following Second Lock-Up Period            |   | Up to 75%  shares received            |   |
| Thereafter             |   | Immediately  following Third Lock-Up Period and thereafter |   | Up to 100%  shares received           |   |

 

The Companyhas several agreements with Fifth Avenue Capital, Inc. (“FAC”), a majorshareholder, to provide consulting, investment, or financial services. StephenMorris, a shareholder and member of the ENI Voting Group, is the President andsole Director of FAC. During 2003, the Company paid cash fees of $22,500 to FACin exchange for such services and erroneously issued 25,000 shares ofrestricted common stock, valued at $33,500, to Mr. Morris, which is recorded as“accounts receivable, related parties” at December 31, 2003. In addition, theCompany has a promissory note payable to FAC assumed as part of the ENIAcquisition in the amount of $100,000 outstanding at December 31, 2003, bearinginterest at prime plus 2%.

 

The Companyhas a consulting arrangement with Stephen Chen, Chairman and Chief ExecutiveOfficer of Strong International, Inc., the sole shareholder of the outstandingSeries B and Series C Preferred Stock, to assist in creating strategicalliances in China. In 2003, Mr. Chen’s consulting agreement was amended toextend the term of the agreement, providing certain payments in shares ofcommon stock and warrants as consideration. Mr. Chen also assisted infacilitating the sale of the Series B and Series C Preferred Stock to StrongInternational, for which he received certain payments in cash, shares of commonstock, options, and warrants as commissions. During 2003, the Company madecumulative payments related to such matters to Mr. Chen as follows: 

 
| **Matter**                  |   | **Cash**            |    | **Stock** |    |   |    |   |           | **Fair  Market  Value of  Securities** |   |
|-----------------------------|--------|---------------------|---------|-----------|---------|--------|---------|--------|----------------|----------------------------------------|--------|
| **Options  & Warrants** |
| **Number**                  |   | **Exercise  Price** |
| Consulting Services         |   | $                   | 25,000  |      | 125,000 |   | 197,000 |   | $ 1.00 - $2.00 |                                   | $      | 180,000 |   |
| Investment Services         |   | $                   | 187,500 |      | 62,500  |   | 512,500 |   | $ 1.00 - $1.30 |                                   | $      | 195,426 |   |

 

F-32

----

 

The Companyhas several agreements with HCFP/Brenner Securities, LLC (“Brenner”), ashareholder, to provide consulting, investment, or financial services. Duringthe years ended December 31, 2003 and 2002, the following amounts were paid toBrenner in exchange for such services: 

 
| **Matter**          |   | **Year**            |   | **Cash** |    | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market   Value of  Securities** | ** ** |
|---------------------|--------|---------------------|--------|----------|---------|-----------|------------|-----------------------------|------------|-----------------------------------------|------------|
| **Number**          |   | **Exercise  Price** |
| Consulting Services |   | 2003                |   | $        | 34,245  |      | 235,000    |                        | —     |                                    | N/A        |   | $ | 228,950 |   |
| Investment Services |   | 2003                |   | $        | 569,600 |      | 987,600    |                        | 345,600    |                                    | $          | 1.00 |   | $ | 1,462,355 |   |
| Consulting Services |   | 2002                |   | $        | 60,000  |      | 48,000     |                        | —     |                                    | N/A        |   | $ | 81,600 |   |
|                     |        |                     |        |          |         |           |            |                             |            |                                         |            |  |  |  |  |  |

 

The Companyhas several agreements with Atlas Capital Services, LLC (“Atlas”) to provideconsulting, investment, or financial services, including the valuation relatedto the ENI Acquisition. During 2003, the following amounts were paid to Atlas(or its designees) in exchange for such services: 

 
| **Matter**          |   |                |   | **Cash** |   | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market   Value of  Securities** | ** ** |
|---------------------|--------|---------------------|--------|----------|--------|-----------|------------|-----------------------------|------------|-----------------------------------------|------------|
| **Number**          |   | **Exercise  Price** |
| Investment Services |   |                |   | $        | 30,000 |      | 54,000     |                        | 35,000     |                                    | $          | 1.00 |   | $ | 58,320 |   |
|                     |        |                     |        |          |        |           |            |                             |            |                                         |            |  |  |  |  |  |

 

The Companyhas several agreements with Sloan Securities Corp (“Sloan”) to provideconsulting, investment, or financial services. During 2003, the followingamounts were paid to Sloan (or its designees) in exchange for such services: 

 
| **Matter**          |   |                |   | **Cash** |    | **Stock** | ** ** | **Options  & Warrants** | ** ** | **Fair  Market   Value of  Securities** | ** ** |
|---------------------|--------|---------------------|--------|----------|---------|-----------|------------|-----------------------------|------------|-----------------------------------------|------------|
| **Number**          |   | **Exercise  Price** |
| Investment Services |   |                |   | $        | 257,800 |      | 115,400    |                        | 315,400    |                                    | $          | 1.00 |   | $ | 356,941 |   |
|                     |        |                     |        |          |         |           |            |                             |            |                                         |            |  |  |  |  |  |

 

Pursuant to aregistration rights agreement related to a November 2002 private placement of1,367,500 shares of common stock, the Company was required to file and havedeclared effective a registration statement to register the shares of commonstock issued and shares that may be issued upon exercise of the Series BWarrants and Series C Warrants from the private placement prior to March 20,2003. The Company failed to have the registration statement declared effectiveby the deadline; as a result, the investors are owed liquidation damages equalto 2% per month of the purchase price of said securities, calculated on a prorata basis to the date on which the registration statement was ultimatelydeclared effective. During 2003, an agreement was reached with some of theinvestors to pay such damages in shares of common stock at a ratio of twoshares of common stock for every $1 of liquidation damage earned. For theperiod through August 21, 2003, the Company agreed to settle the penalty amountowed by the issuance of 328,200 shares of our common stock, valued atapproximately $367,000. Of the total shares owed, 134,600 shares of ourrestricted common stock were issued, valued at $156,136, related to thesettlement agreements prior to December 31, 2003. As of December 31, 2003, theCompany owed a remaining 193,600 shares valued at $211,000 and has since issued94,000 of such shares and paid $18,900 in cash to relieve a portion of thisliability. It is expected that additional penalty shares will be issued afterthe Registration Statement, filed January 14, 2004, is declared effective. AtDecember 31, 2003, $442,573 has been accrued to settle the additional amountsowed.

* *

*Other Related Parties*

* *

In October andNovember 2003, the Company entered into short-term notes payable with threeindividuals, each of whom are family members of the former Chairman and ChiefExecutive Officer, borrowing an aggregate principal amount of $271,672. The notesgenerally matured in 60 days and bore interest at stated rates ranging between10% and 28%, with 12 months of interest earned and payable immediately. Thenotes, including interest earned of $46,172, were paid in full as of December31, 2003.

 

The Companyhas had various agreements with Michael Edson, a family member of the formerChairman and Chief Executive Officer, under which he provides consultingservices, including prospecting, establishing, and servicing complementary andalternative healthcare practices and other proprietary distribution channels.In addition, Mr. Edson assisted in various short-term financing activities, forwhich he received commissions. Payments totaling $63,985 and $42,118 were madeduring the years ended December 31, 2003 and 2002, respectively, for saidservices and commissions.

 

F-33

----

 

During 2003and 2002, the Company paid $5,000 in contract fees and $25,000 as payroll,respectively, to Marie Hughes, a family member of the Company’s current ChiefExecutive Officer and President, for various services.

 

**Note 12 – Subsequent Events**

 

*Executive Management and Operational Changes*

 

In January 2004, the Company announced its plans toconsolidate its Phoenix, Arizona operations into its Salt Lake City, Utahfacility as part of a cost-saving strategy during the first half of 2004.Simultaneously, Brad Edson, the Company’s Chief Executive Officer and Chairman,voluntarily resigned from his positions with the Company to pursue other businessinterests. The Board of Directors immediately appointed Stuart Benson, theCompany’s President, into the role of Chief Executive Officer and Vice Chairmanand Donald Hanna, a Director, as Chairman of the Board of Directors. Inaddition, the board appointed Mitch Feinglas, previously a consultant to theCompany, to the positions of Chief Operating Officer and Director.

 

In connection with Mr. Edson’s departure, the Companyexecuted a severance agreement that provides for cash payments of $244,068($119,034 due within eight days of execution, $19,839 due on each first day ofJuly, August, and September 2004, and $21,839 due on each first day of October,November, and December 2004) and 600,000 shares of the Company’s common stock,due within eleven days of execution and included in a pending RegistrationStatement initially filed January 14, 2004. In addition, the Company agreed tocontinue to pay Mr. Edson’s medical benefits until the earlier of (i) July 31,2005, or (ii) the date he becomes eligible to be covered under another program.As of March 30, 2004, neither the first payment nor common shares initially duehas been paid or issued.

 

*Litigation*

* *

On March 8, 2004, an attorney representing a former employee notified usthat he was prepared to initiate litigation for alleged breach of hisemployment agreement. On March 15, 2004, we received a letter from the sameattorney demanding that we take certain remedial steps in connection with ourmanufacturing processes and that we cure alleged breaches of certain agreementsrelated to the COF Acquisition. As of March 30, 2004, formal lawsuits relatedto these matters had not been filed. The outcome of these actions is uncertainand an estimate of the amount of a settlement, if any, cannot be reasonablyestimated at this time.

* *

*Stock Issuances*

 

Between January 1 and March 26, 2004, the Company issued shares ofcommon stock and granted options or warrants as follows with their fair marketvalue as of the date of grant, where appropriate:

 
| **Matter**                                                                 |   | **Stock**           | ** ** | **Options &  Warrants** | ** ** | **Fair  Market Value of Securities** | ** ** |
|----------------------------------------------------------------------------|--------|---------------------|------------|-----------------------------|------------|--------------------------------------|------------|
| **Number**                                                                 |   | **Exercise  Price** |
| Series A Preferred Stock conversions and  required warrant dividend of 20% |   | 2,167,438           |       | 433,488                     |       | $                                    | 2.00       |   | $ | 2,167,438 |   |
| Net warrant exercise                                                       |   | 765,100             |       | —                      |       | N/A                                  |       | $ | — |   |
| Strategic Asset Management - settlement                                    |   | 140,000             |       | —                      |       | N/A                                  |       | $ | 162,400 |   |
| Registration rights penalty shares                                         |   | 94,000              |       | —                      |       | N/A                                  |       | $ | 92,120 |   |
| Consulting services                                                        |   | 20,000              |       | —                      |       | N/A                                  |       | $ | 25,100 |   |
|                                                                       |   | 3,186,538           |       | 433,488                     |       |                                 |       | $ | 2,447,058 |   |
|                                                                            |        |                     |            |                             |            |                                      |            |  |  |  |  |

 

*X-Fat Agreements*

 

In March 2004, the Company entered into a Purchase Agreement withinvestors and sold 250,000 shares of the Company’s common stock at $1.00 pershare with rights to receive a portion of the Company’s net revenues, asdefined therein, from the sale of X-Fat® (“the Royalty Rights”).  The investors shall receive Royalty

 

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Rights on a pro-rata basis of 10% and 3% on the first $15,000,000 andsubsequent $85,000,000 of X-Fat® net revenues, respectively, during the two-yearperiod commencing April 1, 2004 and terminating March 31, 2006. 

 

Royalty payments on the first $15,000,000 and subsequent $85,000,000 ofnet revenues shall be made in cash and shares of common stock valued at $1.00per share, respectively. Cash payments must be made within 50 days after theend of each calendar quarter and within 105 days after the end of each year.Finder’s fees will be paid to certain individuals as compensation equal to cashof eight percent of monies raised and shares of the Company’s common stockequal to eight percent of the number of shares issued under the agreement.

 

In March 2004, the Company signed a Marketing Agreement with SciberHealth, LLC (“Reseller”) that grants certain exclusive rights to market andsell X-Fat® over the Internet and non-exclusive rights to market X-Fat throughprint ads, radio, and television. The Company has retained the rights to marketX-Fat through its own websites. Under the agreement, which has a five-yearterm, the Reseller must sell minimum levels of X-Fat within certain periods orthe Company has the right to terminate the exclusivity or the Agreement. Aspayment for reselling the product, the Reseller will receive 50% of the grosssales of the product, as defined therein. During the 18-month period followingexecution, the Company will grant the Reseller 100,000 stock options at $1.00per share for each $2,500,000 in gross sales received, up to a maximum of500,000 stock options should gross sales equal or exceed $12,000,000. The stockfor any stock options granted has registration rights as specified in theagreement. As of March 30, 2004, no gross sales subject to the agreement hadoccurred.

 

In March 2004 in a separate but related agreement, the Company executeda Call Center Agreement with Globex Marketing, LLC (“Globex”), under which theCompany has agreed to pay Globex 7% of all orders handled and processed, plus afee related to processing time. The Call Center Agreement has a one-year termwith automatic renewals unless cancelled 30 days prior to the renewal date. Asof March 30, 2004, there were no orders handled and processed by Globex.

 

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