**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**










**FORM
      10-KSB**




**S**
            **ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**




**For
      the Fiscal Year Ended December 31, 2006**




Commission
      File Number 000-33211









**VITAL
      LIVING, INC.**


*(Exact
      Name of Small Business Issuer in Its Charter)*




**Nevada**
            **88-0485596***(State
                or Other Jurisdiction of Incorporation or
                Organization)*
            *(I.R.S.
                Employer Identification No.)*




**5080
      North 40** **th** **Street, Suite 105**


**Phoenix,
      Arizona 85018-2147**


**(602)
      389-8600**


*(Address,
      including zip code, and telephone number, including area code, of principal
      executive offices)*




**Securities
      registered under Section 12(b) of the Exchange Act:**




**Title
                of Each Class**
            **Name
                of Each Exchange on Which Registered**None
            Not
                Applicable




**Securities
      registered under Section 12(g) of the Exchange Act:**


Common
      Stock, $0.001 par value


*(Title
      of Class)*




Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act. £




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




Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained in this form, and no disclosure will be contained,
      to
      the best of registrant's knowledge, in definitive proxy or information
      statements incorporated by reference in Part III of this Form 10-KSB or any
      amendment to this Form 10-KSB. £




Indicate
      by check mark whether the registrant is a shell company (as defined by Rule
      12b-2 of the Exchange Act). Yes £ No S




State
      issuer's revenue for the most recent fiscal year: $4,941,000.




As
      of
      March 30, 2007, the aggregate market value of the voting and non-voting common
      stock held by non-affiliates of the issuer (based on the closing sales price
      as
      reported by the OTC Bulletin Board) was $681,000 assuming all officers and
      directors are deemed affiliates for this purpose).




As
      of
      March 30, 2007, the issuer had 164,559,000 shares of its common stock, $0.001
      par value, outstanding.




**Documents
      Incorporated by Reference.** None.










**VITAL
      LIVING, INC.**


**ANNUAL
      REPORT ON FORM 10-KSB**


**FOR
      THE YEAR ENDED DECEMBER 31, 2006**




**TABLE
      OF CONTENTS**


**PART
                  I.**ITEM
                  1.
              DESCRIPTION
                  OF BUSINESS
              3ITEM
                  2.
              DESCRIPTION
                  OF PROPERTY
              16ITEM
                  3.
              LEGAL
                  PROCEEDINGS
              16ITEM
                  4.
              SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY HOLDERS
              16**PART
                  II.**ITEM
                  5.
              MARKET
                  FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS
                  ISSUER
                  PURCHASES OF EQUITY SECURITIES
              16ITEM
                  6.
              MANAGEMENT'S
                  DISCUSSION AND ANALYSIS
              17ITEM
                  7.
              FINANCIAL
                  STATEMENTS
              24ITEM
                  8.
              CHANGES
                  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE
              24ITEM
                  8A.
              CONTROLS
                  AND PROCEDURES
              24ITEM
                  8B.
              OTHER
                  INFORMATION
              24**PART
                  III.**ITEM
                  9.
              DIRECTORS,
                  EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
                  SECTION
                  16(a) OF THE EXCHANGE ACT
              24ITEM
                  10.
              EXECUTIVE
                  COMPENSATION
              27ITEM
                  11.
              SECURITY
                  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                  STOCKHOLDER MATTERS
              29ITEM
                  12.
              CERTAIN
                  RELATIONSHIPS AND RELATED TRANSACTIONS
              30ITEM
                  13.
              EXHIBITS.
              32ITEM
                  14.
              PRINCIPAL
                  ACCOUNTANTS FEES AND SERVICES INDEX TO CONSOLIDATED FINANCIAL
                  STATEMENTS
              34INDEX
                  TO CONSOLIDATED FINANCIAL STATEMENTS
              F-1SIGNATURES




***Statement
      Regarding Forward-Looking Statements***




*The
      statements contained in this report on Form 10-KSB that are not purely
      historical are forward-looking statements within the meaning of applicable
      securities laws. Forward-looking statements include statements regarding our
      "expectations, " "anticipation, " "intentions, " "beliefs, " or "strategies"
      regarding the future. Forward looking statements also include statements
      regarding revenue, margins, expenses, and earnings analysis for fiscal 2006
      and
      thereafter; future products or product development; our product development
      strategies; potential acquisitions or strategic alliances; the success of
      particular product or marketing programs; the amounts of revenue generated
      as a
      result of sales to significant customers; and liquidity and anticipated cash
      needs and availability. All forward-looking statements included in this report
      are based on information available to us as of the filing date of this report,
      and we assume no obligation to update any such forward-looking statements.
      Our
      actual results could differ materially from the forward-looking statements.
      Among the factors that could cause actual results to differ materially are
      the
      factors discussed in Item 1, "Business - Risk Factors. "*







**PART
      I.**




**Item
      1.**  **Description
      of Business**




**Overview**




**Our
      Company**




We
      develop and market nutritional fruit and vegetable supplements, protein
      supplements, and nutraceuticals products. Our principal products currently
      are
      Greensfirst®, Red AlertTM, Dream ProteinTM and Complete EssentialsTM. We distribute
      our products primarily through regional nutritional distributors that market
      our
      proprietary products and patient selling system directly to healthcare
      practitioners who utilize our proprietary selling system to market our products
      directly to consumers.




Nutritional
      supplements represent a convenient and cost-effective way for an individual
      to
      obtain the nutritional benefits of whole foods. Nutritional supplements are
      formulated from whole foods and are intended to provide for improved health,
      reduced risk of diseases, and the delayed onset of age related indicators while
      resulting in little added caloric and fat intake. Nutritional supplements come
      in powder, capsule, cracker, and other forms.




Nutraceuticals,
      consisting of vitamins, minerals, herbs, and supplements, are products that
      are
      isolated or purified from foods and generally sold in medicinal forms not
      usually associated with foods, including tablets, capsules, and drops.
      Nutraceuticals are intended to have physiological benefits or have the ability
      to reduce the risk of chronic disease beyond basic nutritional products. We
      develop and test our nutraceuticals in collaboration with leading medical
      experts in the nutraceuticals field.




We
      have
      designed our products to be incorporated by healthcare practitioners into
      standard patient routines in which healthcare practitioners recommend and sell
      our nutritional supplements and nutraceuticals products to their patients.
      Use
      of vitamins, minerals, herbs, and nutritional supplements continues to rise
      as
      consumers seek nutritional products to improve general health, increase
      longevity, and enhance the overall quality of life.




We
      were
      incorporated in the state of Nevada on January 22, 2001 under the name
      Nutritional Systems, Inc. We acquired substantially all of the assets of Vital
      Living, Inc. effective as of May 7, 2001 and changed our name to Vital Living,
      Inc. on May 20, 2001. On August 16, 2001, we merged with VCM Technology Limited,
      a company reporting under the Securities Exchange Act of 1934. Following the
      merger, we continued as the surviving corporation and commenced reporting under
      the Exchange Act.




Our
      executive offices are located at 5080 North 40th Street, Suite 105, Phoenix,
      Arizona 85018, and our telephone number is (602) 952-9909. Our website is
      located at www.vitalliving.com.




**Strategy**




Our
      goal
      is to become a major participant in the nutritional supplement and nutraceutical
      markets. Key elements of our strategy to achieve this goal include the
      following:




·
            capitalize
                on the growing consumer interest in the use of nutritional supplements
                and
                nutraceuticals to complement traditional health care
                routines,




·
            develop
                products that appeal to health care professionals and
                consumers,




·
            enhance
                our distribution channels and the participants in those channels,
                and




·
            pursue
                strategic acquisitions in the highly fragmented nutritional supplement
                and
                nutraceuticals markets to expand our product offerings, distribution
                channels, and geographic reach.




3


**Products**




Our
      current principal products are GreensFIRST®, Red AlertTM, Dream ProteinTM, and
      Complete EssentialsTM, and ReliefFIRST®. These products represented nearly all of
      our revenue during fiscal 2006.




*GreensFIRST* ®
is
      a
      highly concentrated formulation of fruits and vegetables with natural, organic,
      whole foods and extracts, produced in a powder for mixing with a variety of
      liquids. GreensFIRST® supplies natural vitamins, minerals, plant enzymes,
      antioxidants, phytonutrients, and symbiotic intestinal flora designed to provide
      for more optimal energy metabolism, fat burning, digestion, detoxification,
      immunity, repair, recovery, rejuvenation, and vital longevity. GreensFIRST® is
      currently distributed through more than 8,000 healthcare practitioners
      throughout the United States.




*Red
      Alert* TM
is
      a
      highly concentrated formulation of fruits and vegetables made with organic
      and
      all natural products. Red Alert is a phytonutrient-antioxident energy drink
      formulated to boost energy with no added stimulants. Red Alert may also help
      improve immune function, help support weight management, alkalize and balance
      pH, and aid in healthy digestion.




*Dream
      Protein* TM
is
      a
      whey protein highly concentrated formula, consisting of proprietary hormone
      free, ultra-lowtempTM whey protein isolate. We start with hormone free whey from
      cows that are "meadow fed" and not given any rBGH or BST hormones. Dream Protein
      is also made with an Ultra-Low TempTM process in which the protein is not
      denatured (damaged) from an extensive heat treatment.




*Complete
      Essentials* TM
is
      a
      ultra pure omega 369 dietary supplement that contains essential fatty acids
      derived from organic flaxseed oil, borage seed oil, and deep sea cold water
      fish
      oil. Because the human body cannot manufacture essential fatty acids on its
      own,
      our unique dietary supplement is a blend of healthy oils designed to satisfy
      an
      individual's need for essential fatty acids.




*ReliefFIRST* TM
is
      a
      patented dietary supplement for joint health comprised of a proprietary
      stabilized rice bran derivative, fortified with glucosomines, MSM, and
      additional herbs which may support joint flexibility and promote healthy
      joints.




**Sales
      and Marketing**




We
      market
      our products through the following distribution channels:




·
            healthcare
                practitioners, which includes physicians, condition specialists,
                chiropractors, nutritionists, and trainers, who promote or prescribe
                our
                products; and




·
            regional
                nutritional distributors that market our proprietary products and
                patient
                selling system directly to healthcare practitioners who utilize our
                proprietary selling system to market directly to consumers. We distribute
                a majority of our products, including GreensFIRST®, Red AlertTM, Dream
                ProteinTM, and Complete EssentialsTM, primarily through healthcare
                practitioners. During both 2005 and 2004, our GreensFIRST® product was
                primarily responsible for a significant portion of our
                revenue.




During
      the third quarter of 2004, we entered a joint venture with Wellness Watchers
      Systems providing for the development and marketing of the Healthy Living Kit.
      The Healthy Living Kit creates a Wellness Smoothie, which is a meal replacement
      designed for all types of metabolisms and blood types. It consists of one scoop
      of GreensFIRST® and one scoop of Dream ProteinTM in eight ounces of water along
      with one of our Complete EssentialsTM Ultra Pure Omega 3-6-9 capsules. Each
      Healthy Living Kit Wellness Smoothie meal replacement is a balanced,
      low-calorie, low-glycemic, hypoallergenic, high-antioxidant, nutrient-dense
      food
      source. It is created from a combination of potent organic, hormone and
      pesticide free all-natural foods. The Health Living Kit along with the lifestyle
      program was created to assist healthcare practitioners in dealing with chronic
      diseases, such as cancer, heart disease, and diabetes.




4


We
      continue to explore other possibilities to distribute our products nationally
      and internationally. We may evaluate the regulatory and distribution structures
      in Europe, Asia, and other international markets to determine the best way
      to
      distribute our products in those markets.




**Research
      and Development**




Our
      research and development efforts focus on developing, testing, and
      substantiating the efficacy of new products in response to what we perceive
      is a
      need in the healthcare practitioner distribution channel to complement existing
      product lines currently available to our customers. Additionally, we continually
      reformulate existing products in response to literature and market
      demand.




We
      believe that flexibility and innovation with respect to new products are crucial
      factors in remaining competitive in the nutritional supplements and
      nutraceuticals markets and being able to produce the most effective products,
      which healthcare practitioners will be willing to prescribe for their patients
      for specific conditions. By monitoring market trends and avoiding short-lived
      "fad" products, we attempt to anticipate healthcare practitioners demand for
      certain product categories. Maintaining flexibility is a key to enabling us
      to
      capitalize on emerging sciences relative to nutritional products as well as
      shifts in consumer needs.




Research
      and development costs amounted to $151,000 and $72,000 for 2006 and 2005,
      respectively. Research and development costs incurred from our formation until
      December 31, 2006 were $2.44 million.




**Manufacturing**




We
      utilize independent contract manufacturers to produce all of our products.
      During the first quarter of 2005, we entered into a one-year contractual
      arrangement with one of our primary manufacturers. The potential loss of our
      relationships with our manufacturers or their inability to conduct their
      manufacturing services for us as anticipated in terms of cost, quality and
      product delivery could adversely affect our ability to provide cost-effective,
      high-quality, and timely product delivery to our customers. We depend to a
      great
      extent on our manufacturers for the safety, purity, and potency of our
      products.




**Raw
      Materials and Quality Control**




The
      principal raw materials used in the manufacture of our nutritional supplements
      and nutraceuticals are natural ingredients purchased from manufacturers and
      other suppliers in the United States, with certain materials imported from
      other
      countries. We purchase these raw materials directly or through our manufactures
      and other suppliers. Therefore, with our suppliers and manufacturers, we
      maintain the responsibility for documenting all certificates of analysis for
      the
      materials in accordance with good manufacturing practices ("GMP") and
      guidelines. All raw materials are sent directly to our manufacturers for milling
      and other fabrication. We do not have contracts with any of the suppliers of
      raw
      materials used in the production of our products.




Historically,
      we have not experienced difficulties obtaining raw ingredients for our products
      on customary terms. We believe that the materials used in our products are
      readily available from numerous sources and that the loss of any of our current
      suppliers would not adversely affect our operations. There is no assurance,
      however, that suppliers will continue to provide the raw materials needed by
      us
      in the quantities required or on favorable terms. Because we do not control
      the
      source of these raw materials, we also are subject to delays caused by
      interruptions in production of materials based on conditions outside our
      control. Any significant delay in, or disruption of, the supply of raw materials
      could harm our business. If supply shortages were to occur and we were unable
      to
      meet the demands of our customers, even if for only a short time, the result
      could be a long-term decrease in the sales of our products. We cannot assure
      you
      that, on a long-term basis, an adequate supply of ingredients will be available
      to us on commercially reasonable terms in order for us to meet the supply
      obligations to our customers.




Finished
      products are produced by our manufacturers, which maintain quality control
      laboratories and testing facilities. Our manufactured products are packaged
      by
      and protected by a tamper-resistant outer safety seal. All of this is done
      by
      our manufacturers according to current GMP guidelines *.*




5


**Acquisitions
      and Strategic Initiatives**




We
      have
      completed four acquisitions. We discontinued the operations of two of the
      acquired businesses because the acquisitions did not meet our
      expectations.




On
      August
      17, 2004, we consummated a joint venture with Wellness Watchers International,
      Inc., or WWI, and together formed Wellness Watchers Systems, LLC, or WWS. We
      paid WWI $805,000 for its 50% interest in WWS. The purchase price consisted
      of
      3.0 million shares of our common stock along with a $25,000 cash payment. We
      and
      WWI originally owned 50% of WWS. The operating agreement gave us overall
      operating responsibility. WWS manufactures a proprietary brand of dietary
      protein powder called Dream ProteinTM, which is directly marketed to the health
      practitioners together with our GreensFIRST® product. WWS plans to introduce
      complementary products that will be marketed as part of WWS' Healthy Living
      Program®. Part of WWI's contribution to WWS was the exclusive licensing of
      certain products, client lists and marketing strategies, which included Dream
      ProteinTM. WWS has developed a unique marketing strategy that channels products
      directly to health practitioners. Prior to forming WWS, WWI had no prior
      operating history. During 2004, WWS had total revenue of $400,000. During
      February 2005, we acquired 100% interest in WWS by issuing an additional 1.0
      million shares of our stock. In conjunction with our acquisition of the
      remainder of WWS and certain other marketing and operation strategic
      productivity decisions, during the first quarter of 2005, we have consolidated
      the operations of WWS into DFN.




We
      plan
      to continue our acquisition strategy in the future. In particular, we intend
      to
      focus on candidates that have strong relationships with key vendors or have
      established complimentary distribution channels or customers. We believe that
      a
      number of factors will facilitate our acquisition strategy, including the
      following:




·
            the
                highly fragmented composition of the nutritional supplement and
                nutraceuticals markets;




·
            our
                status as a public corporation;




·
            a
                decentralized management strategy, which facilitates the acquired
                company's management remaining involved in operations should they
                desire
                to do so; and




**·**
            the
                ability of our management to identify acquisition opportunities.
                Trademarks and Patents.




**Trademarks
      and Patents**




We
      own
      numerous trademarks registered with the U.S. Patent and Trademark Office and
      with agencies in certain other major jurisdictions of the world. Our trademarks
      include Vital Living®, Vital Living - The Physician Nutraceutical Company® (plus
      a logo), GreensFIRST®, Dream ProteinTM, and Complete EssentialsTM.




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




**Competition**




Our
      competitors vary by the nature of the distribution channel. In the healthcare
      practitioner and regional nutritional distributor channels, we compete with
      a
      number of companies selling whole foods and nutritional supplements, including
      Douglas Labs, Integration Therapeutics, Phyto Pharmacia, Metagenics Standard
      Process, Allergy Research, and Enzymatic Therapy.




6


Many
      of
      our competitors are substantially larger than we are and have significantly
      greater financial, technical, marketing, and other resources. We compete
      primarily based on our ability to be first to market and the desire of
      healthcare practitioners to have a nutritional line of products to supplement
      their practices.




**Governmental
      Regulation**




The
      formulation, manufacturing, packaging, labeling, advertising, distribution,
      and
      sale [hereafter, collectively "sale" or "sold"] of dietary and nutritional
      supplements, such as those sold by us, are subject to regulation by one or
      more
      federal agencies, principally the Food and Drug Administration, or FDA, the
      Federal Trade Commission, or FTC, and to a lesser extent, the Consumer Product
      Safety Commission and the U.S. Department of Agriculture. Our activities are
      also regulated by various governmental agencies for the states and localities
      in
      which our products are sold, as well as by governmental agencies in certain
      countries outside the United States. Among other matters, regulation by the
      FDA
      and FTC covers product safety and claims made with respect to a product's
      ability to provide health-related benefits.




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




·
            initiating
                investigations,




·
            issuing
                warning letters and cease and desist
                orders,




·
                requiring
                    corrective labeling or
                    advertising,




·
            requiring
                consumer redress, such as requiring that a company offer to repurchase
                products previously sold to
                consumers,




·
            seeking
                injunctive relief or product
                seizures,




·
            imposing
                civil penalties, or




·
            commencing
                civil procedures or criminal
                prosecution.




In
      addition, certain state agencies have similar authority. These federal and
      state
      agencies have in the past used these remedies in regulating participants in
      the
      dietary supplements industry, including the imposition by federal agencies
      of
      civil penalties in the millions of dollars against industry participants. We
      cannot assure you that the regulatory environment in which we operate will
      not
      change or that such regulatory environment, or any specific action taken against
      us, will not result in a material adverse effect on our operations. In addition,
      increased sales of, and publicity about, dietary supplements may result in
      increased regulatory scrutiny of the dietary supplements industry.




The
      Dietary Supplement Health and Education Act, or DSHEA, was enacted in 1994,
      amending the Federal Food, Drug, and Cosmetic Act, or FFD&CA. We believe the
      DSHEA is generally favorable to consumers and to the dietary supplement
      industry. DSHEA establishes a statutory class of "dietary supplements," which
      includes vitamins, minerals, herbs, amino acids, and other dietary ingredients
      for human use to supplement the diet. Dietary ingredients on the market as
      of
      October 15, 1994 do not require the submission by the manufacturer or
      distributor to the FDA of evidence of a history of use or other evidence of
      safety establishing that the ingredient will reasonably be expected to be safe,
      but a dietary ingredient that 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 days before
      marketing. Among other things, the DSHEA prevents the FDA from regulating
      dietary ingredients in dietary supplements as "food additives" and allows the
      use of statements of nutritional support on product labels. The FDA has issued
      proposed and final regulations in this area and indicates that further guidance
      and regulations are forthcoming. We cannot assure you that the FDA will accept
      the evidence of safety for any new dietary ingredient that we may decide to
      use
      and the FDA's refusal to accept such evidence could result in regulation of
      such
      dietary ingredients as food additives, requiring FDA pre-approval based on
      newly
      conducted, costly safety testing. In addition, while the DSHEA authorizes the
      use of statements of nutritional support or "structure/function claims in the
      labels and labeling of dietary supplements, the FDA is required to be notified
      of such statements. We cannot assure you that the FDA will not consider
      particular labeling statements used by us to be drug claims rather than
      acceptable statements of nutritional support, thereby necessitating approval
      of
      a costly new drug application, or re-labeling to delete such statements. We
      do
      believe, however, that we substantially comply with the regulations promulgated
      under DSHEA with regard to labels and labeling of our dietary
      supplements.




7


In
      November 1998, the FTC announced new advertising guidelines specifically for
      the
      dietary supplement industry, entitled "Dietary Supplements: An Advertising
      Guide
      for Industry." These guidelines reiterate many of the policies the FTC has
      previously announced over the years, including requirements for substantiation
      of claims made in advertising about dietary supplements. We make every effort
      to
      ensure we are in compliance with FTC advertising standards.




The
      FFD&CA also authorizes the FDA to promulgate good manufacturing practices,
      or GMP, standards for dietary supplements, which require special quality
      controls for the manufacture, packaging, storage, and distribution of
      supplements. The final version of FDA's GMP regulation has not been published.
      We believe however, that we will be in substantial compliance with the
      regulations once they are issued. We contractually require that any independent
      third party manufacturers doing business with us comply with all existing,
      or to
      be promulgated, regulations. The FFD&CA further authorizes the FDA to
      promulgate regulations governing the labeling of dietary supplements, including
      claims for supplements pursuant to recommendations made by the Presidential
      Commission on Dietary Supplement Labels. These rules, which were issued on
      or
      after September 23, 1997, entail specific requirements relative to the labeling
      of our dietary supplements. The rules also require additional record keeping
      and
      claim substantiation, reformulation, or discontinuance of certain products,
      which would be a material expense to us.




The
      sale
      of our products in countries outside the United States is regulated by the
      governments of those countries. We are not currently marketing our products
      outside of the United States, except in Canada and Mexico. Our plans to commence
      or sales in those countries may be prevented or delayed by such regulation.
      While compliance with such regulation will generally be undertaken by
      international distributors, we may assist with such compliance and in certain
      cases may be liable if a distributor fails to comply.




We
      cannot
      predict the nature of any future laws, regulations, interpretations, or
      applications, nor can we determine what effect such additional regulation,
      when
      and if it occurs, would have on our business in the future. Such additional
      regulation could require, however, any of the following:




·
            the
                reformulation of certain products to meet new
                standards,




·
            the
                recall or discontinuance of certain
                products,




·
            additional
                record keeping,




·
            expanded
                documentation of the properties of certain
                products,




·
            revised,
                expanded or different labeling, or




·
            additional
                scientific substantiation.




**Employees**




As
      of
      March 30, 2007, we had three full-time employees, all of whom are engaged in
      finance, administration, or management functions. None of our employees is
      subject to any collective bargaining agreements with us, and we believe our
      relationship with our employees is satisfactory. Our future success depends,
      in
      part, on our ability to attract, retain, and motivate highly qualified
      personnel.




8


**Properties**




We
      lease
      our corporate offices under a three-year lease, which expires in mid
      2007.




**Legal
      Proceedings**




We
      are
      involved in various legal proceedings arising out of our operations in the
      ordinary course of business. We do not believe that any such proceedings will
      have a material adverse effect on our business, operating results, or financial
      condition.




**RISK
      FACTORS**




*You
      should consider carefully the following risk factors and all other information
      contained herein in evaluating our company and our business. Our common stock
      involves a high degree of risk. If any of the following risks occur, our
      business, financial condition, and operating results will suffer. Moreover,
      the
      price of our common stock could decline and you could lose all of your
      investment.*




***Our
      financial condition raises substantial doubt about our ability to continue
      as a
      going concern, and our independent auditors have issued a going concern opinion
      on our financial statements.***




Our
      consolidated financial statements have been prepared assuming we will continue
      on a going concern basis, which contemplates the realization of assets and
      the
      satisfaction of liabilities in the normal course of business. We have suffered
      recurring losses from operations, have a working capital deficit, and depend
      on
      funding from sources other than operations. Since inception, we have been
      required to raise additional capital by the issuance of both equity and debt
      instruments. There are no commitments from any funding sources should cash
      flows
      be insufficient to fund ongoing operations and other cash commitments as they
      come due. These factors raise substantial doubt about our ability to continue
      as
      a going concern. We will be required to raise additional capital in the near
      term through offerings of securities to fund operations and will attempt to
      continue raising capital resources if we do not begin to generate revenue
      sufficient to maintain our company as a viable entity. No assurance can be
      given
      that such financing will be available or, if available, that it will be on
      commercially favorable terms. Moreover, available financing may be dilutive
      to
      current investors.




We
      are in
      the process of improving, acquiring, or developing products for sale to generate
      revenue to sustain our operations, as well as consolidating our operations
      in
      order to gain cost synergies and efficiencies. If successful, these actions
      will
      serve to mitigate the factors that have raised doubt about our ability to
      continue as a going concern and increase the availability of resources for
      funding of our current operations and future market development. Our
      consolidated financial statements do not include any adjustments relating to
      the
      recoverability and classification of recorded assets or liabilities that might
      be necessary should we be unable to continue as a going concern.




**Our
      significant losses and negative cash flow raise questions about our ability
      to
      continue as a going concern.**




We
      have
      only a limited operating history. Our business must be considered in light
      of
      the risks, expenses, and difficulties frequently encountered in establishing
      a
      business in the nutritional supplement and nutraceuticals industries, which
      are
      characterized by a large number of market participants, intense competition,
      and
      a high failure rate. We incurred net losses of approximately $82,000 and $21.5
      million in 2006 and 2005, respectively. We cannot assure you that we will be
      able to achieve or sustain revenue growth, profitability, or positive cash
      flow
      on either a quarterly or annual basis or that profitability, if achieved, will
      be sustained. If we are unable to achieve or sustain profitability, we may
      not
      be financially viable in the future and may have to curtail, suspend, or cease
      operations. Because of our recurring operating losses and negative cash flow,
      the audit report of our independent public accountants on our financial
      statements for the fiscal years ended December 31, 2006 and 2005 contains an
      explanatory paragraph stating that the independent auditor has substantial
      doubt
      about our ability to continue as a going concern.




9


**If
      we are unable to generate cash from operations, we may need to raise additional
      funds in the near future.**




We
      had a
      working capital deficit of $302,000 at December 31, 2006. Historically, we
      have
      been dependent on equity or debt financings to fund our operations and working
      capital needs. We completed offerings of 510,000 shares of our common stock
      raising gross proceeds of $510,000 in the first quarter of 2004; an offering
      of
      3.9 million shares of our common stock and 15.6 million warrants, which resulted
      in gross proceeds of $975,000 in June and July of 2004; and a warrant offering,
      which began in November 2004 and concluded in January 2005, that resulted in
      the
      issuance of 7.1 million shares of our common stock and 6.4 million warrants
      that
      generated $717,000 in gross proceeds. Our net cash used in operating activities
      was $0 and $20,000 during the years ended December 31, 2006 and 2005,
      respectively. We may need to raise additional capital in the very near future
      to
      fund our operations and are currently examining various sources of additional
      financings. However, because our Senior Secured Convertible Notes are secured
      by
      substantially all of our assets, we may have difficulty securing additional
      debt
      financing on terms favorable to us or at all. Any equity financing that we
      obtain may be highly dilutive to existing stockholders. Our inability to
      generate cash flow from operations or to find sources of funding would have
      an
      adverse impact on our ability to maintain our operations.




**We
      have substantial indebtedness and interest obligations that we must satisfy
      when
      due.**




We
      have
      substantial indebtedness and interest obligations that we must satisfy in
      accordance with their terms. In connection with the MAF acquisition completed
      during 2002, we have a recorded a related provision of $401,000, which is
      included in our current liabilities. During the third quarter of 2004, we
      entered into an agreement to sell all property, rights, and assets related
      to
      our Boulder Bar product line. The purchaser agreed to assume the debt. However,
      the purchaser has not complied with the terms of the agreement, and we are
      currently seeking legal remedies. In addition, we have outstanding $4.2 million
      aggregate principal amount of Senior Secured Convertible Notes, which are
      secured by substantially all of our assets. In October 2004, we obtained
      majority consent of the holders of the notes to pay the 12% annual interest
      requirement in either cash or shares of our common stock. We cannot assure
      you
      that our operations will generate funds sufficient to repay these debt
      obligations as they come due. Our failure to repay any of our indebtedness
      and
      make required interest payments as required by these debt obligations could
      result in an event of default. In this event, the holders of our debt could
      force us to sell our assets in order to repay obligations owing to
      them.




**We
      may record future losses because of an impairment of goodwill and other
      intangibles.**




We
      had
      approximately $3.3 million of goodwill and $762,000 of net intangible assets
      at
      December 31, 2006, cumulatively accounting for approximately 73% of our total
      assets at December 31, 2006. We adopted Statement of Financial Accounting
      Standards No. 142, "Goodwill and Other Intangible Assets," and are required
      to
      analyze our goodwill and other intangible assets for impairment issues on an
      annual basis or when events occur that would indicate that a intangible asset
      impairment had occurred. The value of our goodwill and other intangible assets
      is exposed to future impairment if we experience declines in operating results
      or experience significant negative industry or economic trends or if future
      performance is below historical trends. We periodically review goodwill and
      intangible assets for impairment using the guidance of applicable accounting
      literature. We are subject to financial statement risk to the extent that the
      goodwill and other intangible assets become impaired, and any impairment losses
      related to goodwill and other intangible assets may result in a non-cash charge
      to earnings. We may, in the future, determine that certain assets classified
      as
      goodwill or intangible are impaired and record the appropriate non-cash charge
      to earnings.




**Any
      acquisitions that we undertake could be difficult to integrate, disrupt our
      business, dilute our stockholder value, and harm our operating
      results.**




We
      plan
      to continue to review opportunities to buy other businesses that would expand
      our product offerings, enhance our product distribution, expand the geographical
      breadth of our markets, or otherwise offer other growth opportunities. In the
      past two years, we have acquired three businesses, and we may acquire additional
      businesses in the future. If we make any future acquisitions, we may issue
      stock
      that would dilute existing stockholders' percentage ownership, incur substantial
      debt, or assume contingent liabilities. Acquisitions involve numerous risks,
      including the following:


·
              problems
                  integrating the purchased products, operations, personnel, distribution
                  channels, and systems with our own;


10




·
              unanticipated
                  costs or undisclosed liabilities associated with the
                  acquisition;


·
            diversion
                of management's attention from our existing
                businesses;




·
            potential
                compliance issues with regard to acquired companies that did not
                have
                adequate internal controls;




·
            adverse
                effects on existing business relationships with suppliers distributors,
                and customers;




·
            risks
                associated with entering markets in which we have no or limited prior
                experience; and




·
            potential
                loss of key employees and customers of purchased
                organizations.




Our
      acquisition strategy entails reviewing and potentially reorganizing acquired
      business operations, corporate infrastructure and systems, and financial
      controls. Unforeseen expenses, difficulties, and delays frequently encountered
      in connection with expansion through acquisitions could inhibit our growth
      and
      negatively impact our profitability. We may be unable to identify suitable
      acquisition candidates or to complete the acquisitions of candidates that we
      identify. Increased competition for acquisition candidates may increase purchase
      prices for acquisitions to levels beyond our financial capability or to levels
      that would not result in the returns required by our acquisition criteria.
      In
      addition, we may encounter difficulties in integrating the operations of
      acquired businesses with our own operations or managing acquired businesses
      profitably without substantial costs, delays, or other operational or financial
      problems.




We
      may
      issue common or preferred stock and incur substantial indebtedness in making
      future acquisitions. The size, timing, and integration of any future
      acquisitions may cause substantial fluctuations in operating results from
      quarter to quarter. Consequently, operating results for any quarter may not
      be
      indicative of the results that may be achieved for any subsequent quarter or
      for
      a full fiscal year. These fluctuations could adversely affect the market price
      of our common stock.




Our
      ability to grow through acquisitions will depend upon various factors, including
      the following:




·
            the
                availability of suitable acquisition candidates at attractive purchase
                prices;




·
            the
                ability to compete effectively for available acquisition opportunities;
                and




·
            the
                availability of funds or common stock with a sufficient market price
                to
                complete the acquisitions.




As
      a part
      of our acquisition strategy, we frequently engage in discussions with various
      companies regarding their potential acquisition by us. In connection with these
      discussions, we and each potential acquisition candidate exchange confidential
      operational and financial information, conduct due diligence inquiries, and
      consider the structure, terms, and conditions of the potential acquisition.
      In
      certain cases, the prospective acquisition candidate may agree not to discuss
      a
      potential acquisition with any other party for a specific period of time, grant
      us an option to purchase the prospective business for a designated price during
      a specific time, and agree to take other actions designed to enhance the
      possibility of the acquisition, such as preparing audited financial information.
      Potential acquisition discussions frequently take place over a long period
      of
      time and involve difficult business integration and other issues, including
      in
      some cases, management succession and related matters. As a result of these
      and
      other factors, a number of potential acquisitions that from time to time appear
      likely to occur do not result in binding legal agreements and are not
      consummated.




11


**We
      rely on others for our production, and any interruptions of these arrangements
      could disrupt our ability to fill our customers' orders.**




We
      outsource through contract manufacturers for all of our production requirements.
      Competitors that manufacture their own products may have an advantage over
      us
      with respect to pricing, availability of products, and other areas through
      their
      control of the manufacturing processes. Any increase in labor, equipment, or
      other manufacturing costs could adversely affect our cost of sales. Qualifying
      new manufacturers is time-consuming and might result in unforeseen manufacturing
      and operations problems. The loss of our relationships with our manufacturers
      or
      their inability to conduct their manufacturing services for us as anticipated
      in
      terms of cost, quality, and timeliness could adversely affect our ability to
      fill customer orders in accordance with required delivery, quality, and
      performance requirements. If this were to occur, the resulting decline in
      revenue would harm our business.




**We
      depend on third parties to maintain satisfactory manufacturing and delivery
      schedules, and their inability to do so could increase our costs, disrupt our
      supply chain, and result in our inability to deliver our products, which would
      adversely affect our results of operations.**




We
      depend
      on our manufacturers to maintain high levels of productivity and satisfactory
      delivery schedules. Although we a have long-term contract with one of our
      manufacturers, the contract does not guarantee adequate production capacity,
      prices, lead times, or delivery schedules. Our manufacturers serve many other
      customers, a number of which may have greater production requirements than
      we
      do. As a result, our manufacturers could determine to prioritize production
      capacity for other customers or reduce or eliminate deliveries to us on short
      notice. At times, we have experienced lower than anticipated manufacturing
      turnarounds and lengthening of delivery schedules. We may encounter
      manufacturing delays and longer delivery schedules in commencing volume
      production of our new products. Any of these problems could result in our
      inability to deliver our products in a timely manner and adversely affect our
      operating results. We depend to a great extent on our manufacturers for the
      safety, purity, and potency of our products.




**We
      depend on a limited number of wholesale distributors to sell a significant
      portion of our products.**




We
      currently market our products on a wholesale basis through our distributors
      operating primarily in the United States. We depend on these distributors to
      sell our products to healthcare practitioners throughout the United States.
      If a
      significant distributor discontinues selling our products, performs poorly,
      does
      not pay for purchased products, reorganizes, or liquidates and is unable to
      continue selling our products, our business, financial condition, and operating
      results could be adversely affected. Our failure or inability to replace poorly
      performing distributors could have a material adverse effect on our business.
      Our sales and receivables is heavily concentrated on one distributor in which
      Stuart Benson, our CEO has a 50% interest (see “Certain Relationships and
      Related Transactions.”.




**Any
      material increase in the cost of the raw materials used to manufacture our
      products could have a material adverse effect on our cost of
      sales.**




We
      do not
      have contracts with all of the suppliers of the raw materials used in the
      production of our products. Historically, we have not experienced any
      difficulties obtaining the raw ingredients for our products on customary terms.
      We are, however, subject to variations in the prices of the raw materials used
      in the manufacture of our products. We may not be able to pass along any cost
      increases to our customers. As a result, any material increase in the cost
      of
      raw materials used in the manufacture of our products could have a material
      adverse effect on our cost of sales.




**If
      we are unable to compete effectively with existing or new competitors, our
      existing business will decline and our anticipated business plan will not be
      successfully implemented.**




We
      believe the market for nutritional supplements and nutraceuticals products
      is
      continually evolving and is highly dependent upon changes in the demographic
      and
      social trends. We compete with numerous competitors, many of which have
      significantly greater financial, technical, marketing, and other resources
      than
      we do. In making decisions regarding the development of new products and the
      enhancement and extension of our current products, we encounter competition
      in
      attempting to anticipate the needs and preferences of healthcare practitioners,
      consumers, and nutritionists. Consumer preferences, particularly in the
      nutritional supplements and nutraceuticals market, are continuously changing
      and
      are difficult to predict. We believe we can compete effectively by reacting
      quickly to expected and perceived customer requirements and desires by
      maintaining relationships with our existing strategic partners, and identifying
      and reaching agreements with new partners. However, we cannot assure you that
      our assessment of the market place is correct, or that our products will be
      accepted now or in the future.




12


**Our
      failure to comply with current or future governmental regulations could
      adversely affect our business.**




The
      formulation, manufacturing, packaging, labeling, advertising, distribution,
      and
      sale of dietary supplements, such as those sold by us, are subject to regulation
      by a number of federal, state and local agencies, principally, the FDA, and
      the
      FTC, as well as foreign agencies in areas where we may operate. Among other
      matters, this regulation is concerned with product safety and claims made with
      respect to a product's ability to provide health-related benefits. These
      agencies have a variety of procedures and enforcement remedies available to
      them, including the following:




·
            initiating
                investigations;




·
            issuing
                warning letters and cease and desist
                orders;




·
            requiring
                corrective labeling or advertising;




·
            requiring
                consumer redress, such as requiring that a company offer to repurchase
                products previously sold to
                consumers;




·
            seeking
                injunctive relief or product seizures;
                and




·
            imposing
                civil penalties or commencing criminal
                prosecution.




Federal
      and state agencies have in the past used these remedies in regulating
      participants in the dietary supplements industry, including the imposition
      by
      federal agencies of civil penalties in the millions of dollars against a few
      industry participants. In addition, publicity related to dietary supplements
      may
      result in increased regulatory scrutiny of the nutritional supplements
      industry.




Our
      failure to comply with applicable laws could subject us to severe legal
      sanctions, which could have a material adverse effect on our business and
      results of operations. The regulatory environment in which we operate could
      change and such regulatory environment, or any specific action taken against
      us,
      could result in a material adverse effect on our business and operations. A
      state could interpret claims presumptively valid under federal law as illegal
      under that state's regulations, and future FDA regulations or FTC decisions
      could restrict the permissible scope of such claims. Any such proceedings or
      investigations or any future proceedings or investigations could have a material
      adverse effect on our business or operations.




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




The
      healthcare industry is subject to extensive federal and state regulation
      relating to licensure, conduct of operations, ownership of facilities, addition
      of facilities and services, and payment for services. As Essentum® is not
      subject to Medicare or Medicaid reimbursement, we do not believe that our
      activities are subject to regulation under the federal Anti-Kickback statutes.
      The Anti-Kickback statutes generally prohibit persons from knowingly and
      willfully soliciting, receiving, offering or providing remuneration, directly
      or
      indirectly, to induce either the referral of an individual, or the furnishing,
      recommending, or arranging for a good or service, for which payment may be
      made
      under a federal healthcare program such as the Medicare and Medicaid programs.
      However, the statute was drafted broadly and it has resulted in many
      arrangements and practices that are lawful in businesses outside of the
      healthcare industry to be deemed unlawful. As a result, there has been a lack
      of
      uniform interpretation of the Anti-Kickback statutes, which make compliance
      even
      more difficult. The penalties for violating these statutes can be severe and
      include criminal penalties and civil sanctions, fines, imprisonment, and
      possible exclusion from the Medicare and Medicaid programs. Many states have
      adopted laws similar to the federal Anti-Kickback statutes. Some of these state
      prohibitions apply to referral of patients for healthcare services reimbursed
      by
      any source, not only the Medicare and Medicaid programs. Although we believe
      that we comply with both federal and state anti-kickback laws, any finding
      of a
      violation of these laws could subject us to criminal and civil penalties or
      possible exclusion from federal or state healthcare programs. Such penalties
      would adversely affect our financial performance and our ability to operate
      our
      business.




13


**Our
      insurance may be inadequate to cover us against product liability claims that
      may be brought against us.**




We
      maintain liability insurance with policy limits generally of $1.0 million per
      occurrence and $2.0 million in the aggregate. Our insurance coverage includes
      property, casualty, comprehensive general liability, and products liability
      insurance. We believe that our insurance coverage is adequate. The testing,
      marketing, and sale of health care products, however, entail an inherent risk
      of
      product liability. Product liability claims relating to dietary supplement
      products could be asserted against us, our licensees, or third parties with
      whom
      we operate. Many claims related to dietary supplements have already been brought
      against businesses in our industry. Further, our insurance may not provide
      adequate coverage against any potential claims. A product liability claim or
      product recall could have a material adverse effect on our business, financial
      condition, and results of operations.




**We
      depend on key employees and the loss of either of their services could harm
      our
      business.**




We
      are
      heavily dependent upon Stuart A. Benson, our President and Chief Executive
      Officer, and Gregg A. Linn, our Chief Operating Officer and Chief Financial
      Officer. We have entered into employment agreements with both Mr. Benson and
      Mr.
      Linn that provide for them to be employed by us through December 2007. The
      agreements, however, cannot assure us of their continued service. The loss
      of
      either Mr. Benson or Mr. Linn could have a material adverse effect on us. Under
      the terms of Mr. Benson's employment agreement, we obtained "key-man" insurance
      policy for Mr. Benson in the amount of $500,000. We are the beneficiary of
      this
      policy.




**Our
      Board of Directors has approved the modification of the terms of our Senior
      Secured Notes and Preferred Stock in a manner that may result in significant
      dilution to our existing stockholders, and our stockholders will experience
      significant dilution if we issue additional securities.**




In
      October 2006, our Board of Directors approved a modification to Senior Secured
      Convertible Notes and Series D Preferred Stock that allows for both of these
      securities to be converted into our common stock at current market price of
      the
      stock as defined in the Senior Secured Convertible Note agreement. In exchange
      for this modification, the holders of such notes and Series D Preferred Stock
      would agree to forego future interest payments and extend the term of the note
      by twelve months. Both Messrs. Benson and Linn, abstained from voting on this
      matter, since they each own 50% of an entity that holders $1.0 million of Senior
      Secured Convertible Notes and 1,000,000 shares of Series D Preferred Stock.
      As
      of March 30, 2007, we have not offered this opportunity to the holders of either
      the notes or the Series D Preferred Stock. As of December 31, 2006, we had
      outstanding 164,559,000 shares of common stock, 1,000,000 shares of Series
      D
      Preferred Stock currently convertible into 1,000,000 shares of common stock,
      options to purchase 10,251,000 shares of common stock, warrants to purchase
      31,680,000 shares of common stock, and Senior Secured Convertible Notes
      convertible into 17,610,000 shares of common stock. If we issue additional
      shares, or if our existing stockholders exercise or convert their outstanding
      options, warrants, preferred stock or notes, our other stockholders may find
      their holdings drastically diluted, which if it occurs, means that they will
      own
      a smaller percentage of our company. Further, any issuance of additional
      securities to various persons or entities in lieu of cash payments will lead
      to
      further dilution. If all convertible instruments were converted and all
      outstanding warrants and options were exercised, notwithstanding the effect
      of
      the modification of the notes or the Series D Preferred Stock, we would have
      224,185,000 shares of common stock outstanding. In the event the holders of
      the
      notes and Series D Preferred Stock converted those securities into shares of
      common stock pursuant to the terms contained in the modifications approved
      by
      our Board, those holders would obtain voting control of our
      company.




14


**We
      have a limited trading market for our stock.**




Our
      common stock has been traded on the OTCBB since March 28, 2002. The market
      price
      of our common stock has been highly volatile and may continue to be volatile
      in
      the future. Many factors could affect the trading price of our common stock,
      including the following:




·
            the
                low price, thin trading volume, and relatively small public float
                of our
                common stock;




·
            variations
                in our quarterly operating results;




·
            introduction
                of new products and customer acceptance of
                products;




·
            general
                trends in the nutritional supplement and nutraceuticals
                markets;




·
            the
                number of holders of our common stock;
                and




·
            the
                interest of securities 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 any particular time could
      be
      difficult to achieve at the market prices prevailing immediately before such
      shares are offered and could cause a severe decline in the price of our common
      stock.




**Because
      our common stock is subject to the SEC's penny stock rules, broker-dealers
      may
      experience difficulty in completing customer transactions and trading activity
      in our securities may be adversely affected.**




Because
      we currently have less than $5,000,000 of net tangible assets and the market
      price of our common stock is less than $5.00 per share, transactions in our
      common stock are subject to the "penny stock" rules promulgated under the
      Securities Exchange Act of 1934. These rules require broker-dealers that
      recommend our securities to persons other than institutional accredited
      investors to do each of the following:




·
            make
                a special written suitability determination for the
                purchaser;




·
            receive
                the purchaser's written agreement to a transaction prior to
                sale;




·
            provide
                the purchaser with risk disclosure documents which identify certain
                risks
                associated with investing in "penny stocks" and which describe the
                market
                for these "penny stocks" as well as a purchaser's legal remedies;
                and




·
            obtain
                a signed and dated acknowledgment from the purchaser demonstrating
                that
                the purchaser has actually received the required risk disclosure
                document
                before a transaction in a "penny stock" can be
                completed.




As
      a
      result, broker-dealers may find it difficult to effectuate customer transactions
      and trading activity in our securities may be adversely affected. Therefore,
      the
      market price of our securities may be depressed, and you may find it more
      difficult to sell our securities.




**We
      have never paid any cash dividends on our common stock.**




We
      have
      never paid any cash dividends on our common stock, and we do not expect to
      pay
      cash dividends on our common stock in the foreseeable future. In addition,
      the
      terms of our outstanding preferred stock and Senior Secured Convertible Notes
      restrict our ability to pay cash dividends.




15


**Item
      2.**  **Description
      of Property**




We
      lease
      our corporate offices under a three-year lease, which expires in mid 2007.
      We
      believe that we will be able to secure additional leased space in the future
      to
      continue our operations.




**Item
      3.**  **Legal
      Proceedings**




We
      are
      involved in various legal proceedings arising out of our operations in the
      ordinary course of business. We do not believe that any such proceedings will
      have a material adverse effect on our business, operating results, or financial
      condition.




**Item
      4.**  **Submission
      of Matters to a Vote of Security Holders**




Not
      applicable.




**PART
      II.**




**Item
      5.**  **Market
      for Common Equity, Related Stockholder Matters, and Small Business Issuer
      Purchases of Equity Securities**




Our
      common stock has been traded in the OTC Bulletin Board under the symbol VTLV.
      OB
      since March 28, 2002. The following table sets forth the high and low sales
      prices of our common stock for each calendar quarter indicated.




**High**
            
            **Low****Year
                ended December 31, 2005:**First
                quarter
            
            $
            0.17
            
            $
            0.06Second
                quarter
            
            $
            0.12
            
            $
            0.05Third
                quarter
            
            $
            0.09
            
            $
            0.03Fourth
                quarter
            
            $
            0.06
            
            $
            0.03**Year
                ended December 31, 2006:**First
                quarter (through March 17, 2006)
            
            $
            0.05
            
            $
            0.03Second
                quarter
            
            $
            0.05
            
            $
            0.05Third
                quarter
            
            $
            0.005
            
            $
            0.005Fourth
                quarter
            
            $
            0.005
            
            $
            0.005**Year
                ended December 31, 2007:**First
                quarter (through March 30, 2007)
            
            $
            0.005
            
            $
            0.003




On
      March
      30, 2007, the closing price of our stock was $0.003 and we had 460 record
      holders of our common stock.




16




**Item
      6.**  **Management's
      Discussion and Analysis**




*Overview*




We
      develop and market fruit and vegetable supplements, protein supplements, and
      nutraceutical products that are marketed for distribution through physicians,
      medical groups, chiropractic offices, and retail outlets. Nutraceuticals are
      products that are isolated or purified from foods and generally sold in
      medicinal forms not usually associated with foods, including tablets, capsules,
      or drops. These nutraceuticals may have physiological benefits or have the
      ability to reduce the risk of chronic disease beyond basic nutritional products.
      We develop and test our nutraceuticals in collaboration with leading medical
      experts in the nutraceuticals field. We have designed them to be incorporated
      by
      healthcare practitioners into a standard patient system where healthcare
      practitioners recommend and sell our whole food and nutraceuticals products
      to
      their patients. Our focus has been with our GreensFIRST®, Red AlertTM, Dream
      ProteinTM, ReliefFIRST® and Complete EssentialsTM products.




Our
      business strategy is to capitalize on the growing complimentary and alternative
      medicine market by creating condition-specific formulations that offer a broad
      range of benefits. Our products focus on general health by utilizing nutritional
      supplements and nutraceuticals as a means to gain the confidence and support
      of
      healthcare practitioners. We plan to focus on certain target conditions,
      providing the market with high quality, relevant products through our healthcare
      practitioner distribution channels.




**Results
      of Operations**




The
      following sets forth selected financial data and its percentage of net sales
      for
      the years ended December 31, 2006 and 2005:




**2006**
            
            **2005**
            
            **Increase****Amount**
            
            **%**
            
            **Amount**
            
            **%**
            
            **(Decrease)**Revenue
            
            $
            4,941,000
            
            
            100.0
            %
            $
            4,858,000
            
            
            100.0
            %
            $
            83,000Cost
                of goods sold
            
            
            2,255,000
            
            
            45.6
            %
            
            2,301,000
            
            
            47.4
            %
            
            (46,000
            )Gross
                profit
            
            
            2,686,000
            
            
            54.4
            %
            
            2,557,000
            
            
            52.6
            %
            
            129,000Administrative
                expensesSalaries
                and benefits
            
            
            816,000
            
            
            16.5
            %
            
            201,000
            
            
            4.1
            %
            
            615,000Professional
                and consulting fees
            
            
            492,000
            
            
            10.0
            %
            
            723,000
            
            
            14.9
            %
            
            (231,000
            )Selling,
                general and administrative
            
            
            1,014,000
            
            
            20.5
            %
            
            880,000
            
            
            18.1
            %
            
            134,000Research
                and development
            
            
            151,000
            
            
            3.2
            %
            
            72,000
            
            
            1.5
            %
            
            79,000Depreciation
                and amortization
            
            
            11,000
            
            
            .1
            %
            
            2,455,000
            
            
            50.5
            %
            
            (2,444,000
            )Impairment
                of intangibles
            
            
            -
            
            
            -
            %
            
            18,356,000
            
            
            377.9
            %
            
            (18,356,000
            )Total
            
            
            2,484,000
            
            
            50.3
            %
            
            22,687,000
            
            
            467.0
            %
            
            (20,203,000
            )Net
                income (loss) from operations
            
            
            202,000
            
            
            4.1
            %
            
            (20,130,000
            )
            
            -414.4
            %
            
            20,332,000Other
                income (expense)Interest
                expense, net
            
            
            (1,192,000
            )
            
            -24.1
            %
            
            (1,034,000
            )
            
            -21.3
            %
            
            158,000Gain
                on issuance of common stock for accrued research and
                development
            
            
            500,000
            
            
            10.1
            %
            
            -
            
            
            -
            %
            
            500,000Gain
                on the resolution of accounts payable, trade
            
            
            -
            
            
            -
            %
            
            445,000
            
            
            9.2
            %
            
            (445,000
            )Gain
                on settlement of accounts payable, trade
            
            
            402,000
            
            
            8.1
            %
            
            142,000
            
            
            2.9
            %
            
            260,000Loss
                on sale and disposal of marketable securities
            
            
            -
            
            
            -
            %
            
            (1,006,000
            )
            
            -20.7
            %
            
            1,006,000Other
                income (expense), net
            
            
            6,000
            
            
            0.1-
            %
            
            46,000
            
            
            0.9
            %
            
            (40,000
            )Net
                loss from continuing operations
            
            $
            (82,000
            )
            
            (1.9
            )%
            $
            (21,537,000
            )
            
            -443.4
            %
            $
            (21,455,000
            )




17




**Year
      Ended December 31, 2006 Compared With Year Ended December 31,
      2005**




*Revenue*




Total
      revenue for the year ended December 31, 2006 was $4.94 million compared with
      $4.86 million for the year ended December 31, 2005, an increase of $83,000.
      This
      increase was primarily attributable to the growth in our ReliefFIRST® which was
      introduced in June 2006, along with increases in the sales of Dream ProteinTM and
      Red AlertTM, which was introduced during June 2005. Our 2006 revenue included the
      impact of our productivity and cost-savings enhancements in our marketing and
      distribution systems which were introduced during the first quarter of
      2005.




*Cost
      of goods sold and gross profit*




Cost
      of
      goods sold for the year ended December 31, 2006 was $2.26 million compared
      with
      $2.30 million for the year ended December 31, 2005, a decrease of $46,000.
      This
      decrease resulted from the continuing results of cost-cutting measures
      implemented in 2005. The gross profit percentage for the year ended December
      31,
      2006 was 54.4%, compared with 52.6% for the year ended December 31, 2005, The
      1.8% decrease in cost of goods sold in our DFN subsidiary was the result of
      comparative improvements in manufacturing and management’s ability to cost
      effectively source raw materials.




*Administrative
      expenses*




*Salaries
      and benefits*




Salary
      and benefits for the year ended December 31, 2006 was $816,000 compared with
      $201,000 for the year ended December 31, 2005, an increase of $615,000. This
      increase was substantially the result of a non-cash re-pricing adjustments
      $647,000 required in accordance with FIN No. 44 related to warrants issued
      to
      one of our officers during 2003. In accordance with Financial Interpretation
      No.
      ("FIN") 44, " *Accounting
      for Certain Transactions Involving Stock Compensation* ,"
      a
      non-cash charge to compensation expense is required if the price of our common
      stock on the last trading day of a reporting period is greater than the exercise
      price of certain stock options and warrants issued to officers or employees.
      The
      requirements of FIN 44 may also result in a credit to compensation expense
      to
      the extent that the trading price declines from the trading price as of the
      end
      of previous reporting period, except that a credit is not recorded to the extent
      our common stock trades below the exercise price of the options or warrants.
      In
      accordance with FIN 44, we adjust compensation expense upward or downward on
      a
      monthly basis based on the trading price at the end of each period.
      Additionally, during 2005, a $144,000 savings was achieved from reduced head
      count resulting from enhancing our marketing and distribution
      systems.




*Professional
      and consulting*




Professional
      and consulting fees were $492,000 during the year ended December 31, 2006
      compared with $723,000 for the year ended December 31, 2005, a decrease of
      $231,000. This decrease reflects our focus on cost containment and expense
      management.




*Selling,
      general, and administrative*




Selling,
      general, and administrative expenses for the year ended December 31, 2006 were
      $1,014,000 compared with $880,000 for the year ended December 31, 2005, an
      increase of $134,000. The increase resulted from increased costs of providing
      promotional materials to our distributors.




*Research
      and development*




Research
      and development is expensed as incurred and totaled $151,000 for the year ended
      December 31, 2006 compared with $72,000 for the year ended December 31, 2005,
      an
      increase of $79,000. This increase was related to research and development
      during 2006 for new products introduced in December 2006 and the first quarter
      of 2007.




18




*Depreciation
      and amortization*




Depreciation
      and amortization for the year ended December 31, 2006 was $11,000 compared
      with
      $2.5 million for the year ended December 31, 2005, a decrease of $2.4 million.
      The decrease was primarily attributable to the complete amortization of the
      intangible balances related to certain marketing agreements acquired or recorded
      as part of previous acquisitions.




*Impairment
      of intangibles*




We
      test
      goodwill and other intangibles created by our acquisitions for impairment at
      least annually, or upon occurrence of such events that may indicate impairment
      exists, in accordance with SFAS No. 142. As a result of lower than expected
      operating results, we revised our expectations and, as a result, recorded an
      intangibles impairment loss of $18.4 million during 2005. The change in fair
      value of each component of goodwill and other intangibles was estimated using
      certain operational results and assumptions, as described below.




***Doctors
      For Nutrition, Inc.***  ***(“DFN”)*** The
      gross value of goodwill related to the DFN acquisition was $2,113,000. During
      2006 and 2005, we generated operating income of approximately $2,109,000 and
      $2,081,000 respectively, before depreciation, amortization, and interest
      charges. We expect increasing net cash flows from operations, as we increase
      the
      national distribution of GreensFIRST® and Red AlertTM along with our Dream
      ProteinTM and Complete EssentialsTM product lines by cross-selling into
      distribution channels currently and expanding sales of GreensFIRST® into new
      markets. We introduced ReliefFIRST® in June 2006, and anticipate launching
      additional products currently under development. Based on our analysis, we
      do
      not believe the goodwill amount at December 31, 2006 is impaired and have not
      recorded an adjustment to the carrying value.




***Wellness
      Watchers Systems LLC (“WWS”)*** .
      The
      gross value of goodwill related to the WWS acquisition was $875,000. WWS was
      acquired during the second quarter of 2004 and, to date, its products have
      been
      well received by our existing distribution channels and has played a major
      role
      in increasing the number of health practitioners to which we market our
      products. During 2005, we consolidated the operations of WWS into our DFN
      subsidiary. Accordingly, we do not believe the goodwill amount at December
      31,
      2006 is impaired and have not received an adjustment to the carrying
      value.




***E-Nutraceuticals,
      Inc*** ***.
      (“ENI”)*** During
      2005, we determined that the intangible assets were fully impaired, and
      according the remaining assets were completely expensed. Our primary
      intangibles, outside of goodwill discussed above, were obtained in the ENI
      acquisition and consist of several licensing and marketing agreements. The
      GEOMATRIX® system, with an associated net intangible value of $0 and $20.8
      million at December 31, 2005 and 2004, respectively, is our licensed technology.
      We are in dispute with SkyePharma over the terms of the Development and
      Licensing Agreement and failed to make payments of $750,000 called for under
      the
      licensing agreement during 2004. On April 6, 2004, we received a demand letter
      from SkyePharma related to the past due payments under the Development and
      License Agreement, which triggered the 30-day negotiation period under the
      agreement. This 30-day period is required before initiating formal collection
      proceedings. We are currently in discussions to modify both the terms and
      payment schedules under the licensing agreement. Although we believe we will
      reach a settlement of the terms and conditions of the agreement with SkyePharma,
      we cannot assure you that these negotiations will be successful or that we
      will
      reach a satisfactory resolution of this matter. In the event a satisfactory
      resolution can not be reached and SkyePharma exercises its rights of termination
      under the agreement, we may lose substantial and possibly all rights gained
      under this and related contracts with SkyePharma. Accordingly, amounts recorded
      as intangible assets associated with this agreement, which represent
      substantially all of our intangible assets, would be impaired. During 2005
      and
      2004, certain events occurred that caused us to modify the business model
      underlying the original valuation of these intangibles, including the
      anticipated timing of future cash flows and the sources from which revenue
      will
      be derived. As a result, we determined during 2005 that the net book value
      of
      the intangible assets associated with the GEOMATRIX® license and marketing
      agreements was impaired by $18.36 million. During 2004, $11.27 million was
      recorded as impairment expense, $9.55 million relating to GEOMATRIX® and $1.72
      million relating to an associated marketing agreement.




19




*Other
      Income (Expense):*




Interest
      expense, net for the year ended December 31, 2006 was $1.20 million compared
      with $1.03 million for the year ended December 31, 2005, an increase of
      $158,000. The increase resulted primarily from a $262,000 decrease in 2006
      in
      amortization of deferred debt issue costs due to the conversion in 2004 and
      2005
      of certain Senior Secured Notes offset by a $415,000 credit during 2005 that
      eliminated interest accrued for penalties on the timely issuance of common
      stock.




The
      gain
      on the exchange of common stock for accrued research and development was
      $500,000 for 2006. This gain resulted from the issuance of 12,500,000 shares
      of
      our common stock valued at $250,000 as payment of the $750,000 obligation to
      SkyePharma for research and development.




Gain
      on
      resolution of accounts payable of $445,000 for the years ended December 31,
      2005. This resulted from the resolution of certain liabilities recorded as
      part
      of the ENI acquisition.




Gain
      on
      the settlement of accounts payable, trade was $402,000 and $142,000 for the
      years ended December 31, 2005 and 2005, respectively. This gain is the result
      of
      settling certain accounts payable for less than the original amount due. The
      2005 amount was the result of the issuance of 318,750 shares of our common
      stock
      valued at $35,000 in payment of an account payable of $176,000.




Other
      income (expense) was $6,000 and $46,000 for the years ended December 31, 2006
      and 2005 respectively. This decrease resulted from the settlement in 2005 of
      certain liabilities recorded as a result of the DFN acquisition offset by a
      charge for $16,000 relating to the loss on the disposal of fixed
      assets.




*Net
      loss from continuing operations*




Our
      net
      loss for the year ended December 31, 2006 was $82,000 compared with $21.54
      million for the year ended December 31, 2005, a decrease of $21.46 million.
      This
      decrease resulted from the combination of a $129,000 increase in gross profit
      from our DFN subsidiary; a gain of $500,000 from the exchange of common stock
      for the research and development liability; a decrease of $18,356,000 for the
      impairment of intangibles; the decrease in depreciation and amortization of
      $2,444,000; a net decrease of $32,000 in salaries and benefits; a $231,000
      decrease in professional and consulting fees; the reduction of the loss on
      disposal of marketable securities of $1,006,000; offset by a net $158,000
      increase in interest expense; a net $185,000 reduction in the resolution and
      settlement of certain accounts payable; and a $79,000 increase in research
      and
      development costs;




***Liquidity
      and Capital Resources***




At
      December 31, 2006, we had $28,000 in cash.




Cash
      flows used in continuing operating activities amounted to $164,000 and $360,000
      in 2006 and 2005, respectively. This $196,000 decrease is a result of
      consolidating of our entire operations in Phoenix as well as certain expense
      containment and efficiency initiatives implemented during 2005 and 2006. Cash
      flows from financing activities was $20,000 in 2005.




To
      date,
      we have funded our operations and acquisition activity primarily from cash
      generated from private placements and with funds from borrowings under various
      debt instruments, as summarized in the table below, generating an aggregate
      in
      net cash proceeds of $8.0 million during the period 2003 through
      2004.




20




The
      following summarizes private placement offerings completed during 2004 and
      2003:




**Date**
            
            **Description**
            
            **Shares
                or**
              **Principal**
            
            **Price**
              **Per
                Share**
            
            **Net
                Cash**
              **Proceeds**
            
            **Options
                and**
              **Warrants**
            
            **Exercise**
              **Price**April,
                2003
            
            
            Series
                B Preferred
            
            
            1,000,000
            
            $
            1.00
            
            $
            875,000
            
            
            1,000,000
                Series E
            
            $
            1.60500,000
                Series D
            
            $
            1.30July,
                2003
            
            
            Series
                C Preferred
            
            
            500,000
            
            $
            1.00
            
            $
            438,000
            
            
            500,000
                Series E
            
            $
            1.60August,
                2003
            
            
            Series
                D Preferred
            
            
            1,000,000
            
            $
            1.00
            
            $
            815,000
            
            
            N/A
            
            
            N/A3,060,000
                No Series
            
            $
            1.00Oct.
                - Dec. 2003
            
            
            Bridge
                Notes
            
            
            1,530,000
            
            $
            1.00
            
            $
            1,316,000
            
            
            1,530,000
                No Series
            
            $
            1.50December,
                2003
            
            
            Senior
                Secured Notes
            
            
            4,587,738
            
            $
            1.00
            
            $
            2,502,000
            
            
            4,587,738
                No Series
            
            $
            1.00March-April,
                2004
            
            
            Common
                Stock
            
            
            510,000
            
            $
            1.00
            
            $
            469,000
            
            
            N/A
            
            
            N/AJune-July,
                2004
            
            
            Common
                Stock
            
            
            3,900,000
            
            $
            0.25
            
            $
            897,000
            
            
            11,700,000
                Series G
            
            $
            0.253,900,000
                Series H
            
            $
            0.25Nov
                2004-Dec 2004
            
            
            Warrant
                Offering
            
            
            7,056,706
            
            $
            0.10
            
            $
            631,000
            
            
            6,560,000
                No Series
            
            $
            0.10$
            7,943,000




***Going
      concern***




The
      accompanying consolidated financial statements have been prepared assuming
      we
      will continue on a going concern basis, which contemplates the realization
      of
      assets and the satisfaction of liabilities in the normal course of business.
      We
      have suffered recurring losses from operations, have a working capital deficit,
      and depend on funding from sources other than operations. Since inception,
      we
      have been required to raise additional capital by the issuance of both equity
      and debt instruments. There are no commitments from any funding sources should
      cash flows be insufficient to fund ongoing operations and other cash commitments
      as they come due. These factors raise substantial doubt about our ability to
      continue as a going concern. We will be required to raise additional capital
      in
      the near term through offerings of securities to fund operations and will
      attempt to continue raising capital resources if we do not begin to generate
      revenue sufficient to maintain our company as a viable entity. No assurance
      can
      be given that such financing will be available or, if available, that it will
      be
      on commercially favorable terms. Moreover, available financing may be dilutive
      to current investors.




We
      are in
      the process of improving, acquiring, or developing products for sale to generate
      revenue to sustain our operations, as well as consolidating our operations
      in
      order to gain cost synergies and efficiencies. If successful, these actions
      will
      serve to mitigate the factors that have raised doubt about our ability to
      continue as a going concern and increase the availability of resources for
      funding of our current operations and future market development. The
      consolidated financial statements do not include any adjustments relating to
      the
      recoverability and classification of recorded assets or liabilities that might
      be necessary should we be unable to continue as a going concern.




***Critical
      Accounting Policies***




**Acquisitions**




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




**Goodwill**




Goodwill
      represents the excess of the aggregate price paid by us over the value of the
      net equity acquired in an acquisition. In accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets,” we are no longer required to amortize
      goodwill, but are required to review goodwill for impairment at least annually
      or whenever events indicate that the carrying amount of the asset may not be
      recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or
      Disposal of Long-Lived Assets.” As of December 31, 2006 and 2005, no events had
      occurred that would indicate goodwill had been impaired.




21




**Intangible
      assets**




Our
      other
      intangible assets include trademarks, patents, formulations, customer lists,
      and
      various marketing and license agreements. We amortize intangible assets on
      a
      straight-line basis over the lesser of the correlating agreements or estimated
      useful lives ranging from two to 14 years. During 2005 certain events occurred
      that indicated that the intangible assets of ENI had been impaired and charges
      of $18,356,000 were recorded




**Long-lived
      assets**




We
      review
      long-lived assets and identifiable other intangible assets to be held and used
      for impairment at least annually or whenever events or changes in circumstances
      indicate that the carrying amount may not be recoverable. We evaluate goodwill
      and other intangible assets arising from various acquisitions for impairment
      on
      at least an annual basis or when events occur that would indicate that
      impairment had occurred. We measure impairment by comparing the carrying value
      of the long-lived assets to the estimated undiscounted future cash flows
      expected to result from use of the assets and their eventual disposition. As
      of
      December 31, 2005, events had occurred that would indicate goodwill or other
      intangibles had been impaired; accordingly, an impairment loss was
      recorded




**Stock-based
      compensation**




We
      account for our stock option plans in accordance with the provisions of SFAS
      No.
      123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148
“Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No.
      123 permits entities to recognize as expense over the vesting period the fair
      value of all stock-based awards on the date of grant. Alternatively, SFAS No.
      123 also allows entities to apply the provisions of Accounting Principles Board
      (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related
      interpretations and provide pro forma net income or loss and pro forma earnings
      per share disclosures for employee stock option grants as if the
      fair-value-based method defined in SFAS No. 123 had been applied.




We
      are
      subject to reporting requirements of FASB Financial Interpretation No. (“FIN”)
      44, “Accounting for Certain Transactions Involving Stock Compensation,” which
      requires a non-cash charge to compensation expense if the price of our common
      stock on the last trading day of each reporting period is greater than the
      exercise price of certain stock options. After the first such adjustment is
      made, each subsequent period is adjusted upward or downward to the extent that
      the trading price exceeds the exercise price of the options.




We
      adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
      Share-Based Payment (“SFAS 123R”), effective January 1, 2006. SFAS 123R requires
      the recognition of the fair value of stock-based compensation in net income.
      SFAS 123R supersedes Statement of Financial Accounting Standards No. 123,
      Accounting for Stock-Based Compensations (“SFAS 123”) and Accounting Principles
      Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). We
      have adopted SFAS 123R using the modified prospective method. Accordingly,
      prior
      period amounts have not been restated. Under the modified prospective method,
      stock options awards that are granted, modified or settled after December 31,
      2005 will be valued at fair value in accordance with provisions of SFAS 123R
      and
      recognized on a straight line basis over the service period of the entire
      award.




We
      account for our incentive plans under the recognition and measurement principles
      of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock
      issued to Employees,” and related Interpretations. No stock-based employee
      compensation (except that related to re-priced warrants in accordance with
      FIN
      No. 44) is reflected in net loss, as all options and warrants granted had an
      exercise price equal to or below the market value of the underlying common
      stock
      at the date of grant.




***Recent
      accounting pronouncements***




FIN
      48 In
      June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
      Uncertainty in Income Taxes," ("FIN 48") an interpretation of FASB Statement
      No.
      109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold
      and measurement attribute for the financial statement recognition and
      measurement of a tax position taken or expected to be taken in a tax return.
      FIN
      48 requires that the Company recognize in its financial statements, the impact
      of a tax position, if that position is more likely than not of being sustained
      on audit, based on the technical merits of the position. FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods and disclosure. The provisions of FIN 48 are effective beginning
      January 1, 2007 with the cumulative effect of the change in accounting principle
      recorded as an adjustment to the opening balance of retained earnings, goodwill,
      deferred income taxes and income taxes payable in the Consolidated Balance
      Sheets. The Company does not expect that the adoption of FIN 48 will have a
      significant impact on the financial statements of the Company.




22


The
      Company has reviewed other current outstanding statements from the Financial
      Accounting Standards Board and does not believe that any of those statements
      will have a material adverse affect on the financial statements of the Company
      when adopted.




In
      December 2004, the FASB issued SFAS No. 153, *"Exchanges
      of Nonmonetary Assets"* (SFAS
      153). This Statement addresses the measurement of exchanges of nonmonetary
      assets and is effective for nonmonetary asset exchanges occurring in fiscal
      years beginning after June 15, 2005. The adoption of SFAS 153 has not had a
      material effect on the Company's financial position or results of
      operations.




In
      March
      2006, the FASB issued FASB Statement No. 156, “Accounting for Servicing of
      Financial Assets—an amendment of FASB Statement No. 140” (“FASB Statement No.
      156”). FASB No. 156 amends FASB Statement No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities,* with
      respect to the accounting for separately recognized servicing assets and
      servicing liabilities. FASB No. 156 is effective for years beginning after
      September 15, 2006. The Company does not believe FASB No. 156 will have a
      material effect on the Company’s financial statements.




In
      September 2006, the FASB issued Statement No. 157, “Fair Value Measurements”
(“FASB No. 157”). FASB No. 157 defines fair value, establishes a framework for
      measuring fair value in generally accepted accounting principles (GAAP), and
      expands disclosures about fair value measurements. FASB No. 157 applies under
      other accounting pronouncements that require or permit fair value measurements,
      the FASB having previously concluded in those accounting pronouncements that
      fair value is the relevant measurement attribute. Accordingly, this Statement
      does not require any new fair value measurements.




In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* (“SAB 108”).
      SAB 108 provides guidance on consideration of the effects of prior year
      misstatements in quantifying current year misstatements for the purpose of
      a
      materiality assessment. SAB 108 is effective for fiscal years ending after
      November 15, 2006. The adoption of SAB 108 did not have an impact on
      our consolidated financial statements.




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




23




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities* (“SFAS 159”)
      which permits entities to choose to measure many financial instruments and
      certain other items at fair value that are not currently required to be measured
      at fair value. SFAS 159 will be effective for us on January 1, 2008.
      We are currently evaluating the impact of adopting SFAS 159 on our
      financial position, cash flows, and results of operations.




**Item
      7.**  **Financial
      Statements**




See
      index
      to Financial Statements and Financial Statements Schedules beginning on page
      F-1
      of this Form 10-KSB.




**Item
      8.**  **Changes
      and Disagreements with Accountants on Accounting and Financial
      Disclosure**




Not
      applicable.




**Item
      8A.**  **Controls
      and Procedures**




We
      have
      evaluated, with the participation of our Chief Executive Officer and Chief
      Financial Officer, the effectiveness of our disclosure controls and procedures
      as of December 31, 2006. Based on this evaluation, our Chief Executive Officer
      and Chief Financial Officer have each concluded that our disclosure controls
      and
      procedures are effective to ensure that we record, process, summarize, and
      report information required to be disclosed by us in our reports filed under
      the
      Exchange Act within the time periods specified by the Securities and Exchange
      Commission’s rules and forms. During the fiscal year covered by this report,
      there have not been any changes in our internal controls over financial
      reporting that have materially affected, or its reasonably likely to materially
      affect, our internal control over financial reporting.




Subsequent
      to the date of their evaluation, there have not been any significant changes
      in
      our internal controls or in other facts that could significantly affect these
      controls, including any corrective action with regard to significant
      deficiencies and material weaknesses.




**Item
      8B.**  **Other
      Information**




Not
      applicable.




**PART
      III.**




**Item
      9.**  **Directors,
      Executive Officers, Promoters and Control Persons; Compliance with Section
      16(a)
      of the Exchange Act**




The
      following table sets forth certain information regarding our directors and
      executive officers.




**Name**
            
            **Age**
            
            **Position**Stuart
                A. Benson
            
            53
            
            Chief
              Executive Officer, President and DirectorGregg
                A. Linn
            
            44
            
            Chief
              Operating Officer, and Chief Financial Officer and DirectorMichael
                Cardamone
            
            57
            
            Director




24




*Stuart
      A. Benson* has
      served as our Chief Executive Officer since January 2004 and our President
      since
      March 2002. Mr. Benson also served as our Vice Chairman of the Board of
      Directors from March 2002 through January 2004 and our Executive Vice President
      from June 2001 until March 2002. From March 1997 until June 2001, Mr. Benson
      served as Chairman of the Board and Chief Executive Officer of Custom Food
      Concepts, Inc., a privately held company that operated a chain of restaurants
      in
      southern California. He has also served in both public and private companies
      as
      Chief Executive Officer and Chairman of the Board, including such companies
      as
      The Great Earth Vitamin Store chain and Nathan's Famous Inc., where he served
      as
      their Chairman of the Executive Committee, Chairman of the Board, President,
      and
      Chief Executive Officer. He is a member of UJA and ADL, sponsor of CBA (Caring
      for Babies with Aids), past Chairman of the 5 Towns United Fund Red Feather
      Ball, and has successfully organized numerous functions for the Reno, Nevada
      chapter of the Make A Wish Foundation. In May 2002, Mr. Benson filed for
      personal bankruptcy, primarily as a result of federal tax liens relating to
      certain real estate syndication activities in the 1980's. These liens relate
      to
      approximately $900 million of recaptured phantom income attributable to Mr.
      Benson and his affiliates, as the general partner of various real estate
      syndication programs and partnerships, as well as $900,000 of other claims
      and
      judgments. In 1995, other IRS liens, relating to similar real estate syndication
      activities, were discharged by Mr. Benson in a prior personal filing under
      Chapter 7. The current bankruptcy filing is unrelated to Mr. Benson's activities
      with us, and we do not believe that this filing will impact Mr. Benson's ability
      to perform his duties as an officer and director in any material
      fashion.




*Gregg
      A. Linn* has
      served as our Chief Operating Officer since September 2005 and as our Chief
      Financial Officer since August 2004. Mr. Linn served as the President of Red
      Rock Management, a private consulting firm located in Scottsdale, Arizona from
      July 2001 to August 2004. Mr. Linn served as the Chief Financial Officer of
      DNA
      Model Management, LLC, a New York based private fashion/entertainment company,
      which he founded, from November 1994 to June 2001. From October 1993 to August
      1994, Mr. Linn served as the Chief Financial Officer of Skyline Multimedia
      Entertainment, Inc., a Nasdaq SmallCap company that operates the New York
      Skyride, a simulator attraction located in the Empire State Building in New
      York
      City.




*Michael
      Cardamone* has
      served as a member of our Board of Directors since September 2004.
      Mr. Cardamone has served as a private financial advisor since 1974. He has
      also served as a director of Accommodations Plus Inc., a company that provides
      and arranges for hotel reservations, since June 1996. In 1978, Mr. Cardamone
      founded M.J. Originals Dresses, a clothing producer, and served as its Chief
      Financial Officer until 1995. In January 2007, Michael Cardamone, a director,
      also became an employee of Wellness Watchers Global, LLC, our major distributor,
      an entity 50% owned by Stuart Benson our CEO.




**Information
      Relating to Corporate Governance and the Board of
      Directors**




Our
      bylaws authorize our Board of Directors to appoint among its members one or
      more
      committees, each consisting of one or more directors. Our Board of Directors
      has
      established four standing committees: an Executive Committee, an Audit
      Committee, a Compensation Committee, and a Nominations and Corporate Governance
      Committee.




Our
      Board
      of Directors has adopted charters for the Audit, Compensation, and Nominations
      and Corporate Governance Committees describing the authority and
      responsibilities delegated to each committee by the board. Our Board of
      Directors has also adopted Corporate Governance Guidelines, a Code of Conduct,
      and a Code of Ethics for the CEO and Senior Financial Officers. We post on
      our
      website at *wwwvitalliving.com* ,
      the
      charters of our Audit, Compensation, and Nominations and Corporate Governance
      Committees; our Corporate Governance Guidelines, Code of Conduct, and Code
      of
      Ethics for the CEO and Senior Financial Officers, and any amendments or waivers
      thereto; and any other corporate governance materials contemplated by SEC or
      NASDAQ regulations. These documents are also available in print to any
      stockholder requesting a copy in writing from our corporate secretary at our
      executive offices set forth in this prospectus.




Interested
      parties may communicate with our Board of Directors or specific members of
      our
      Board of Directors by submitting a letter addressed to the Board of Directors
      of
      Vital Living, Inc. c/o any specified individual director or directors at the
      address listed herein. Any such letters are sent to the indicated
      directors.




*The
      Audit Committee*




25




The
      purpose of the Audit Committee is to oversee the financial and reporting
      processes of our company and the audits of the financial statements of our
      company and to provide assistance to our Board of Directors with respect to
      the
      oversight of the integrity of the financial statements of our company, our
      company’s compliance with legal and regulatory matters, the independent
      auditor’s qualifications and independence, and the performance of our company’s
      independent auditor. The primary responsibilities of the Audit Committee are
      set
      forth in its charter and include various matters with respect to the oversight
      of our company’s accounting and financial reporting process and audits of the
      financial statements of our company on behalf of our Board of Directors. The
      Audit Committee also selects the independent auditor to conduct the annual
      audit
      of the financial statements of our company; reviews the proposed scope of such
      audit; reviews accounting and financial controls of our company with the
      independent auditor and our financial accounting staff; and reviews and approves
      transactions between us and our directors, officers, and their affiliates.




The
      Audit
      Committee currently consists of Mr. Cardamone. Who is not deemed an independent
      director of our company under Nasdaq rules as well as under rules adopted by
      the
      SEC pursuant to the Sarbanes-Oxley Act of 2002. The Board of Directors has
      determined that each of Mr. Cardamone (whose backgrounds are detailed above)
      qualifies as an “audit committee financial expert” in accordance with applicable
      rules and regulations of the SEC.




*The
      Compensation Committee*




The
      purpose of the Compensation Committee includes determining, or recommending
      to
      our Board of Directors for determination, the compensation of the Chief
      Executive Officer and other executive officers of our company and discharging
      the responsibilities of our Board of Directors relating to compensation programs
      of our company. The Compensation Committee currently consists of Mr.
      Cardamone,.




*The
      Nominations and Corporate Governance Committee*




The
      purposes of the Nominations and Corporate Governance Committee include the
      selection or recommendation to the Board of Directors of nominees to stand
      for
      election as directors at each election of directors, the oversight of the
      selection and composition of committees of the Board of Directors, the oversight
      of the evaluations of the Board of Directors and management, and the development
      and recommendation to the Board of Directors of a set of corporate governance
      principles applicable to our company. The Nominations and Corporate Governance
      Committee will consider persons recommended by stockholders for inclusion as
      nominees for election to our Board of Directors if the names, biographical
      data,
      and qualifications of such persons are submitted in writing in a timely manner
      addressed and delivered to our company’s corporate secretary at the address
      listed herein. The Nominations and Corporate Governance Committee identifies
      and
      evaluates nominees for our Board of Directors, including nominees recommended
      by
      stockholders, based on numerous factors it considers appropriate, some of which
      may include strength of character, mature judgment, career specialization,
      relevant technical skills, diversity, and the extent to which the nominee would
      fill a present need on our Board of Directors. *The
      Executive Committee*




The
      Executive Committee has all powers of the Board of Directors between meetings
      of
      the board, subject to applicable law. The members of the Executive Committee
      are
      Messrs., Cardamone, Linn, and Benson, with Mr. Cardamone serving as
      Chairman.




**Director
      Compensation**




In
      addition, for each year of service as a director of our company, we grant to
      each of our directors options to purchase 250,000 shares of common stock. In
      addition to such options, we grant (a) to our Chairman of the Board of
      Directors options to purchase 250,000 shares of common stock annually, and
      (b) to each committee chairman options to purchase 150,000 shares of common
      stock annually. We also pay our non-employee directors $1,400 per day for those
      days that they assist us in activities that are beyond their board-related
      responsibilities. During fiscal 2006, we paid Mr. Hannah, our former chairman,
      approximately $12,000 for such services. During 2006, we paid Michael Cardamone,
      a director, $10,000 for services deemed outside the scope of his role as a
      director.




26




**Item
      10.**  **Executive
      Compensation**




**Summary
      of Cash and Other Compensation**




The
      following table sets forth, for the periods indicated, the total compensation
      earned for services provided to us in all capacities by our Chief Executive
      Officer and our only other executive officer whose aggregate compensation
      exceeded $100,000 during fiscal 2006.




**SUMMARY
      COMPENSATION TABLE**


**Annual
                  Compensation (1)****Name
                  and Principal Position**
              
              **Year**
              
              **Salary
                  ($)**
              
              **Bonus
                  ($)**
              
              **Stock
                  Awards**
              
              **Options
                  (#)**
              
              **Non-equity
                  incentive plan ($)**
              
              **Change
                  in Pension Value and Nonqualified Deferred Compensation Earnings
                  ($)**
              
              **Other
                  Compensation($)**Stuart
                  A. Benson
                Chief
                  Executive Officer,
                President,
                  and Director
              
              
              2006
                2005
              
              $
              250,000
                220,000
              
              $
              100,000
                –
              (2)
              
              –
              
              
              –6,000,000–
              
              
              –
              
              
              –
              
              $
              13,000
                10,336Gregg
                  A. Linn
                Chief
                  Operating Officer and
                Chief
                  Financial Officer
              
              
              2006
                2005
              
              $
              220,000
                173,333
              
              $
              50,0000
              (2)
              
              –
              
              
              –3,500,000–
              
              
              –
              
              
              –
              
              $
              11,000
                –





(1)
            The
                officers also received certain perquisites, the value of which did
                not
                exceed the lesser of $50,000 or 10% of the officer's compensation
                during
                fiscal 2005.




(2)
            .




(2)
              Represents
                  performance bonus for 2006. Amounts remaining to be paid at December
                  31,
                  2006 are approximately $50,000 for Stuart Benson and $25,000 for
                  Gregg
                  Linn.




**Option
      Values and Holdings**




The
      following table sets forth, for the officers listed, the exercisable and
      un-exercisable options held by them as of December 31, 2006. None of the
      officers exercised options during fiscal 2006.




**FISCAL
      YEAR-END OPTION VALUES**




**Number
                  of Securities**
                **Underlying
                  Unexercised**
                **Options
                  at Fiscal Year-End (#)**
              
              **Value
                  of Unexercised**
                **In-The-Money
                  Options at**
                **Fiscal
                  Year-End ($) (1)****Exercisable**
              
              **Un-exercisable**
              
              **Exercisable**
              
              **Un-exercisable**Stuart
                  A. Benson
              
              
              6,000,000
              
              
              –
              
              
              –
              
              
              –Gregg
                  A. Linn
              
              
              3,500,000
              
              
              –
              
              
              –
              
              
              –





(1)
            None
                of the options had value as of December 31, 2006, as the exercise
                price
                per share of the options were greater than $0.03, which was the closing
                price of our common stock quoted on the OTCBB on December 31,
                2006.




27




**Employment
      Agreements**




On
      February 15, 2005, we entered into an employment agreement dated as of January
      1, 2005 with Stuart Benson providing for the employment of Mr. Benson as the
      President and Chief Executive Officer of our company. On February 15, 2005,
      we
      entered into an employment agreement dated as of January 1, 2005 with Gregg
      A.
      Linn providing for the employment of Mr. Linn as the Chief Financial Officer
      of
      our company. We amended Mr. Linn's agreement during January 2006 in connection
      with his appointment as our Chief Operating Officer and Chief Financial Officer.
      The employment agreements have initial terms of three years each, and both
      are
      subject to automatic renewal for successive one-year periods.




Mr.
      Benson’s employment agreement provides for Mr. Benson to receive an annual base
      salary of $220,000 from January 1, 2005 through December 31, 2005; $250,000
      from
      January 1, 2005 through December 31, 2006; and $280,000 commencing on January
      1,
      2007. Mr. Linn’s employment agreement provides for Mr. Linn to receive an annual
      base salary of $230,000 during 2006 and $260,000 during 2007. Both executives
      will also be eligible to receive annual bonuses pursuant to the employment
      agreements in amounts to be determined by the Board of Directors of our
      company.




For
      the
      year ended 2006, the Board of Directors approved bonuses to Mr. Benson and
      Mr.
      Linn of $100,000 and $50,000, respectively. During 2006, about $52,000 was
      paid
      to Mr. Benson and $25,000 to Mr. Linn. The balance of $48,000 due Mr. Benson
      and
      $25,000 due Mr. Linn is included in our accrued liabilities.




As
      part
      of their compensation packages, we granted to Mr. Benson and Mr. Linn, options
      to purchase 3,000,000 shares and 2,000,000 shares, respectively, of our common
      stock at an exercise price equal to the closing price of our common stock on
      the
      date of execution of the agreements. The options were fully vested during
      December 2005.




Under
      the
      employment agreements, we will provide Messrs. Benson and Linn with (1) car
      allowances of $1,200 and $1,000 per month, respectively; (ii) reimbursement
      for
      travel and entertainment expenses incurred in connection with the business
      of
      our company; and (iii) the right to participate in any group insurance,
      hospital, medical, dental, accident, disability pension, retirement, vacation,
      expense reimbursement, and other plans, programs, or benefits as may from time
      to time be provided to other executive employees of our company. Pursuant to
      the
      employment agreements, we will reimburse the executive for premium on disability
      policies providing for coverage at a rate equal to 50% of his base salary in
      effect from time to time under the employment agreement.




In
      addition, during the term of his employment, we will pay premium for two life
      insurance policies of the life of Mr. Benson, one of which policies will have
      a
      face amount of $1,000,000 and will name our company as beneficiary, and one
      will
      have a face amount of $500,000 and will name as beneficiary a person or entity
      designated by Mr. Benson. Under Mr. Linn’s employment agreement, we will pay
      premiums for a life insurance policy on the life of Mr. Linn, which policy
      will
      have a face amount of $400,000 and will name as beneficiary a person or entity
      designated by Mr. Linn. The employment agreements contain provisions that
      prohibit the executives from competing with us or soliciting our personnel
      or
      employees for a period of 18 months following the termination of their
      employment with us.




The
      employment agreements each provide that either we or the executive may terminate
      the agreement at any time. If the executive’s employment is terminated
      unilaterally by us without cause or by us for good reason (as defined in the
      agreement), the executive will receive his base salary for the remainder of
      the
      term of the employment agreement. If the executive is terminated for reason
      of
      death or disability, he or his estate, as the case may be, will receive his
      fixed salary for 90 days after such termination. If the executive’s employment
      is terminated by him voluntarily or by us for cause as a result of certain
      acts
      committed by the executive (as set forth in the agreement), he will receive
      no
      further compensation under the employment agreement.




In
      the
      event of a change of control of our company, the executive may, at his option
      and upon notice to us, terminate his employment. If the executive terminates
      his
      employment due to a change of control, he will receive his base salary for
      the
      longer of the remainder of the employment term or a period of 18 months after
      such termination, as well as any unpaid fringe benefits, and such bonus as
      may
      have been earned prior to the change in control, all within 10 days after the
      termination.




28




**Indemnification
      Under our Certificate of Incorporation and Bylaws**




Our
      certificate of incorporation provides that no director will be personally liable
      to our company or its stockholders for monetary damages for breach of a
      fiduciary duty as a director, except to the extent such exemption or limitation
      of liability is not permitted under the Nevada General Corporation Law. The
      effect of this provision in the certificate of incorporation is to eliminate
      the
      rights of our company and its stockholders, either directly or through
      stockholders' derivative suits brought on behalf of our company, to recover
      monetary damages from a director for breach of the fiduciary duty of care as
      a
      director except in those instances described under the Nevada General
      Corporation Law. In addition, we have adopted provisions in our bylaws and
      entered into indemnification agreements that require us to indemnify our
      directors, officers, and certain other representatives of our company against
      expenses and certain other liabilities arising out of their conduct on behalf
      of
      our company to the maximum extent and under all circumstances permitted by
      law.
      Indemnification may not apply in certain circumstances to actions arising under
      the federal securities laws.




**Equity
      Compensation Plan Information**




The
      following table sets forth information with respect to our common stock that
      may
      be issued upon the exercise of stock options under our incentive stock option
      plans as of December 31, 2006.




**Plan
                Category**
            
            **(a)
                Number of**
              **Securities
                to be**
              **Issued
                Upon Exercise**
              **of
                Outstanding**
              **Options,
                Warrants,**
              **and
                Rights**
            
            **(b)
                Weighted-**
              **Average
                Exercise**
              **Price
                of Outstanding**
              **Options,
                Warrants,**
              **and
                Rights**
            
            **(c)
                Number of Securities**
              **Remaining
                Available for**
              **Future
                Issuance Under**
              **Equity
                Compensation**
              **Plans
                (Excluding**
              **Securities
                Reflected in**
              **Column(a))**Equity
                Compensation
              Plans
                Approved by
              Stockholders
            
            
            10,251,390
            
            $
            0.08
            
            
            6,712,500Equity
                Compensation
              Plans
                Not Approved
              By
                Stockholders
            
            
            30,579,859
            
            $
            0.34
            
            
            ―Total
            
            
            40,830,979
            
            $
            0.26
            
            
            6,712,500




**Item
      11.**  **Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters**




The
      following table sets forth certain information regarding the beneficial
      ownership of our common stock as of December 31, 2006 by




·
            each
                of our directors and executive
                officers,




·
            all
                of our directors and executive officers as a group,
                and




·
            each
                person or entity known by us to own more than 5% of our common
                stock.




**Shares
                Beneficially**
              **Owned****Name
                of Beneficial Owner (1)**
            
            **Number
                (2)**
            
            **Percent
                (3)****Directors
                and Executive Officers:**Stuart
                A. Benson
            
            
            10,980,000
            (5)
            
            8.9
            %Michael
                Cardamone
            
            
            265,000
            (6)
            
            *Gregg
                A. Linn
            
            
            3,500,000
            (7)
            
            3.0
            %VTLV
                LLC
            
            
            14,597,229
            (4)
            
            6.1
            %All
                directors and executive officersas
                a group (three persons)
            
            
            24,342,229
            
            
            9.0
            %**Non-management
                5% stockholders:**Periscope
                Partners, L.P.
            
            
            23,267,106
            (8)
            
            10.4
            %SkyePharma
                PLC
            
            
            30,546,231
            (9)
            
            13.6
            %





*Less
      than 1%.




29




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




(2)
            Includes,
                when applicable, shares owned of record by such person's minor children
                and spouse and by other related individuals and entities over whose
                shares
                of common stock such person has custody, voting control, or power
                of
                disposition. Also includes shares of common stock that the identified
                person had the right to acquire within 60 days of December 31, 2006
                by the
                exercise of vested stock options or warrants or the conversion of
                other
                securities.




(3)
            The
                percentages shown include the shares of common stock that the person
                will
                have the right to acquire within 60 days of December 31, 2006. In
                calculating the percentage of ownership, all shares of common stock
                which
                the identified person will have the right to acquire within 60 days
                of
                December 31, 2006 upon the exercise of vested stock options or warrants
                or
                the conversion of other securities are deemed to be outstanding for
                the
                purpose of computing the percentage of shares of common stock owned
                by
                such person, but are not deemed to be outstanding for the purpose
                of
                computing the percentage of shares of common stock owned by any other
                person.




(4)
            VTLV
                LLC, an entity which is owned 50% each by Stuart Benson and Gregg
                Linn.
                Includes (a) 9,430,562 shares of common stock and (b) 4,166,667 shares
                of
                common stock issuable upon conversion of senior secured convertible
                notes
                and (c) 1,000,000 shares of Series D Preferred stock convertible
                to common
                stock.




(5)
            Includes
                4,950,000 shares of common stock issuable upon exercise of immediately
                exercisable warrants and unvested options to purchase 6,000,000 shares
                of
                common stock.




(6)
            Represents
                shares of restricted stock received upon becoming a director and
                member of
                certain of the committees of our board of directors, which are subject
                to
                vesting. This Includes 100,000 shares of common stock issuable upon
                exercise of stock options.




(7)
            Includes
                3,500,000 shares of common stock issuable upon exercise of stock
                options.




(8)
            Leon
                Frenkel, the general partner of Periscope Partners, exercises voting
                and
                dispositive power over these shares. Represents (a) 4,228,113 shares
                of
                common stock issuable upon exercise of warrants, (b) 4,222,221 shares
                of
                common stock issuable upon conversion of senior secured convertible
                notes,
                and (c) 14,816,772 shares of common stock. Does not include shares
                of
                common stock that may be issued if we determine to pay a portion
                of the
                interest owed on the senior secured convertible notes in shares of
                our
                common stock. The business address of Periscope Partners is 1600
                Flatrock
                Road, Penn Valley, PA 19072.




(9)
            Represents
                (a) 29,493,599 shares of common stock, , and (b) 1,052,632 shares
                of
                common stock currently issuable upon exercise of warrants issued
                in
                connection with the issuance of the notes. Does not include shares
                of
                common stock that may be issued if we determine to pay a portion
                of the
                interest owed on the senior secured convertible notes in shares of
                our
                common stock. The foregoing information was derived from an Amendment
                to
                Schedule 13D/A filed with the SEC on December 19, 2003. The business
                address of SkyePharma is 105 Piccadilly, London, England W1J
                7NJ.




**Item
      12.**  **Certain
      Relationships and Related Transactions**




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




30




Officers
      and Directors




During
      2005 a partnership owned 50% each by Stuart Benson, CEO and Gregg Linn COO/CFO
      acquired a $40,000 Senior Secured Note from the original holder.




In
      2006
      an entity owned 50% each by Stuart Benson, our President and CEO and Gregg
      Linn,
      our COO and CFO acquired the $1,000,000 Series D Preferred Stock and $1,000,000
      of the Senior Secured Convertible Note from the original holder Senior Secured
      Note from the original holder. Prior to purchasing these securities, Mr. Benson
      and Linn offered us the ability to purchase these securities. At such time,
      our
      Board of Director determined that we did not have adequate financial resources
      to purchase these securities and approved the purchase by Mr. Benson and Linn.




During
      2006, we paid Michael Cardamone, a director, $10,000 for services deemed outside
      the scope of his role as a director.




During
      2006, we paid Carson Beadle, a former director, $8,000 for services deemed
      outside the scope of his role as a director




During
      2006 , $12,000 was either paid directly or amounts paid on behalf of Mr. Hannah,
      our former Chairman. These amounts were paid for services requested us that
      were
      deemed outside the scope of his role as Chairman.




In
      November 2006, effective January 2007, our President and CEO, Stuart Benson,
      became a 50% shareholder in our largest distributor Wellness Watchers Global
      LLC
      (“WWG”), which is the successor entity to Wellness Watchers, LLC (“WW”).
      Wellness Watchers, LLC accounted for 82.6% of our sales during 2005 and 90.8%
      of
      our trade receivables at December 31, 2006. Wellness Watchers Global, LLC
      acquired all of the assets and liabilities of Wellness Watchers, LLC. At
      December 31, 2005 WW owed us $933,000. At March 31, 2007 WWG still owed us
      $161,000 of the balance due from WW at December 31, 2006.




In
      January 2006, we entered into a service agreement with Red Rock Advisors, LLC,
      an entity controlled by Gregg Linn, our COO and CFO for outside services related
      to the creation, development and management of an infomercial that utilizes
      our
      product line. These services were deemed outside his role as COO and CFO.
      Pursuant to the agreement, Red Rock Advisors, LLC will be paid $7,500 per month
      for six months, beginning in January 2007 as well as per unit fee for all future
      products sold through the infomercial. As of March 31, 2007, we owe Red Rock
      Advisors, LLC $22,500 for prior services rendered. In January 2006, we entered
      into a talent service agreement with WWG, an entity 50% owned Stuart Benson,
      our
      President and CEO for promotional, talent and acting services related to the
      infomercial that utilizes our product line. Pursuant to the agreement, WWG
      will
      be paid a per unit fee for all future products sold through the infomercial.




In
      January 2007, Michael Cardamone, a director, also became an employee of Wellness
      Watchers Global, LLC, our major distributor, an entity 50% owned by Stuart
      Benson our CEO.




In
      February 2007, VTLV II LLC, an entity controlled by Stuart Benson, made a
      payment of $25,000 on our behalf to one of our suppliers. The $25,000 is
      recorded as a liability to VTLV II LLC.




In
      January 2007 an entity owned 100% by Stuart Benson, our President and CEO
      acquired a $192,000 of Senior Secured Convertible Notes from the original holder
      Senior Secured Note from the original holder for $40,000




31




During
      the first quarter of 2007, we made rent payments totaling $3,000 for office
      space for our President and CEO in Boca Raton, FL. This office is the same
      office of Wellness Watchers Global, LLC, our major distributor, an entity 50%
      owned by Stuart Benson, our President and CEO.




**Item
      13.**  **Exhibits.**




*(a)*  *Financial
      Statements and Financial Statement Schedules*




(1)  Financial
      Statements are listed in the Index to Consolidated Financial Statements on
      page
      F-1 of this report.




(2)  No
      financial statement schedules are included because such schedules are not
      applicable, are not required, or because required information is included in
      the
      consolidated financial statements or notes thereto.




*(b)*  *Exhibits*




**Exhibit****No.**
            
            **Description**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)4.10
            
            Certificate
                of Designation, Preferences and Relative, Participating, Optional
                or Other
                Special Rights of 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)4.22
            
            Form
                of Securities Purchase Agreement for December 2003 private offering
                (6)4.23
            
            Form
                of Senior Secured Convertible Note issued in December 2003 private
                offering (6)4.24
            
            Form
                of Warrant issued in December 2003 private offering (6)4.25
            
            Form
                of Warrant issued in 2003 offering of senior convertible promissory
                notes
                (6)4.26
            
            Form
                of Security Agreement for December 2003 private offering
                (6)4.27
            
            Form
                of Registration Rights Agreement for December 2003 private offering
                (6)4.28
            
            Form
                of Escrow Agreement for December 2003 private offering
                (6)4.29
            
            Form
                of Purchase Agreement for March 2004 private offering
                (11)




32




**Exhibit****No.**
            
            **Description**4.30
            
            Form
                of Securities Purchase Agreement for June 2004 private offering
                (11)4.31
            
            Form
                of Series G Warrant (11)4.32
            
            Form
                Series H Warrant (11)4.33
            
            Form
                of Registration Rights Agreement for June 2004 private offering
                (11)4.34
            
            Asset
                Purchase Agreement, dated September 30, 2004, among Vital Living,
                Inc.,
                MAF BioNutritional, LLC and Radha Krishna Heartly Blessings, Inc.
                (12)10.1
            
            2001
                Stock Option Plan (1)10.17
            
            Warrant
                Agreement, dated November 20, 2002, between Vital Living, Inc. and
                Stuart
                A. Benson (7)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
                (10)10.26
            
            Warrant
                Agreement, dated April 16, 2003, between Vital Living, Inc. and Stephen
                Songsheng Chen (4)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 (8)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 stockholders set forth on the signature page attached thereto
                (9)10.42
            
            Form
                of Indemnification Agreement between the Company and each of Stuart
                A.
                Benson, Donald C. Hannah, Carson E. Beadle, 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)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. (10)10.44
            
            Warrant
                Agreement, dated as of April 19, 2004, between the Company and Nest
                Ventures, LLC (13)10.45
            
            Settlement
                and Release Agreement, dated July 9, 2004, between the Company, Natures
                Systems, Inc., Christopher’s Original Formulas, Inc., Christopher
                Enterprises, Inc., Robert Scott, James Jeppson,, Norman Barala, Ruth
                Christopher and Stuart Benson (11)10.46
            
            Employment
                Agreement between Vital Living, Inc. and Stuart Benson, dated January
                1,
                2005 effective as of February 15, 2005 (14)10.47
            
            Employment
                Agreement between Vital Living, Inc. and Gregg Linn, dated January
                1, 2005
                effective as of February 15, 2005 (14)10.48
            
            2005
                Incentive Compensation Plan (15)10.49
            
            Warrant
                issued to Howard Wernick (15)10.50
            
            Amendment
                No. 1 to Employment Agreement, effective January 1, 2006, between
                the
                Company and Gregg A. Linn (15)21
            
            List
                of Subsidiaries (15)




33




**Exhibit****No.**
            
            **Description**23.1
            
            Consent
                of Epstein Weber & Conover PLC31.1
            
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200231.2
            
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200232.1
            
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                200232.2
            
            Certification
                of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 905 of the Sarbanes-Oxley Act of
                2002





(1)
            Incorporated
                by reference to Current Report on Form 8-K dated August 17, 2001
                and filed
                with the SEC on October 1, 2001


(2)
            Incorporated
                by reference to Registration Statement on Form SB-2 (333-111921)
                filed
                with the SEC on January 14, 2004


(3)
            Incorporated
                by reference to Current Report on Form 8-K/A dated November 20, 2002
                and
                filed with the SEC on December 5, 2002


(4)
            Incorporated
                by reference to Amendment No. 2 to Registration Statement on Form
                SB-2
                (333-102106) filed on April 28, 2003


(5)
            Incorporated
                by reference to Current Report on Form 8-K dated August 21, 2003
                and filed
                with the SEC on September 8, 2003


(6)
            Incorporated
                by reference to Current Report on Form 8-K dated December 15, 2003
                and
                filed with the SEC on December 19, 2003


(7)
            Incorporated
                by reference to Current Report on Form 8-K dated April 1, 2002 and
                filed
                with the SEC on April 16, 2002


(8)
            Incorporated
                by reference to Current Report on Form 8-K dated July 2, 2003 and
                filed
                with the SEC on July 16, 2003


(9)
            Incorporated
                by reference to Current Report on Form 8-K/A dated October 14, 2003
                and
                filed with the SEC on December 5, 2003


(10)
            Incorporated
                by reference to Annual Report on Form 10-KSB for the fiscal year
                ended
                December 31, 2003


(11)
            Incorporated
                by reference to the Registration Statement on Form SB-2 (Reg. No.
                333-102106) filed on August 3, 2004


(12)
            Incorporated
                by reference to Current Report on Form 8-K dated September 30, 2004
                and
                filed with the SEC on October 20, 2004


(13)
            Amendment
                No. 1 to Registration Statement on Form SB-2 filed on May 12,
                2004


(14)
            Incorporated
                by reference to Current Report on Form 8-K dated February 15, 2005
                and
                filed with the SEC on February 18, 2005


(15)
            Incorporated
                by reference to the Registrant’s Registration Statement on Form SB-2 (Reg.
                No. 333-131839) filed with the SEC on February 14,
                2006.




**Item
      14.**  **Principal
      Accountants Fees and Services**




The
      aggregate fees billed to our company by Epstein, Weber & Conover, PLC for
      the fiscal years ended December 31, 2006 and 2005 are as follows:




**2006**
            
            **2005**Audit
                Fees (1)
            
            $
            36,000
            
            $
            53,000Audit-Related
                Fees (2)
            
            
            19,000
            
            
            19,000Tax
                Fees (3)
            
            
            —
            
            
            —All
                Other Fees
            
            
            5,000
            
            
            5,000Total
            
            $
            77,000
            
            $
            77,000




34




**Audit
      Committee Pre-Approval Policies**




The
      charter of our Audit Committee provides that the duties and responsibilities
      of
      our Audit Committee include the pre-approval of all audit, audit-related, tax,
      and other services permitted by law or applicable SEC regulations (including
      fee
      and cost ranges) to be performed by our independent auditor. Any pre-approved
      services that will involve fees or costs exceeding pre-approved levels will
      also
      require specific pre-approval by the Audit Committee. Unless otherwise specified
      by the Audit Committee in pre-approving a service, the pre-approval will be
      effective for the 12-month period following pre-approval. The Audit Committee
      will not approve any non-audit services prohibited by applicable SEC regulations
      or any services in connection with a transaction initially recommended by the
      independent auditor, the purpose of which may be tax avoidance and the tax
      treatment of which may not be supported by the Internal Revenue Code and related
      regulations.




To
      the
      extent deemed appropriate, the Audit Committee may delegate pre-approval
      authority to the Chairman of the Audit Committee or any one or more other
      members of the Audit Committee provided that any member of the Audit Committee
      who has exercised any such delegation must report any such pre-approval decision
      to the Audit Committee at its next scheduled meeting. The Audit Committee will
      not delegate to management the pre-approval of services to be performed by
      the
      independent auditor.




Our
      Audit
      Committee requires that our independent auditor, in conjunction with our Chief
      Financial Officer, be responsible for seeking pre-approval for providing
      services to us and that any request for pre-approval must inform the Audit
      Committee about each service to be provided and must provide detail as to the
      particular service to be provided




35




**SIGNATURES**




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


VITAL
                LIVING, INC./s/ 
STUART
              A. BENSONStuart
                A. Benson*President
                and Chief Executive Officer*




Date:
  April 13, 2007




In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed by the following persons on behalf of the registrant
      and in the capacities and on the dates indicated.


**Signature**
              
              **Capacity**
              
              **Date**/s/
                  Stuart A. Benson
                Stuart
                  A. Benson
              
              President,
                  Chief Executive Officer, and Director (Principal Executive
                  Officer)
              
              April
            13 , 2007/s/
                  Gregg A. Linn
                Gregg
                  A. Linn
              
              Chief
                  Operating Officer, Chief Financial Officer (Principal Accounting
                  and
                  Financial Officer) and Director
              
              April
            13, 2007/s/
                  Michael Cardamone
                Michael
                  Cardamone
              
              Director
              
              April
            13, 2007









**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and


Stockholders
      of Vital Living, Inc.





We
      have
      audited the accompanying consolidated balance sheet of Vital Living, Inc. and
      subsidiaries as of December 31, 2006 and the consolidated statements of
      operations, stockholders’ equity (deficit), and cash flows for the two years
      ended December 31, 2006 and 2005. These financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. The Company is not
      required to have, nor were we engaged to perform, an audit of its internal
      control over financial reporting. Our audit included consideration of internal
      control over financial reporting as a basis for designing audit procedures
      that
      are appropriate in the circumstances, but not for the purpose of expressing
      an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit includes examining,
      on a test basis, evidence supporting the amounts and disclosures in the
      financial statements. An audit also includes assessing the accounting principles
      used and significant estimates made by management, 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 statements referred to above present fairly, in all
      material respects, the financial position of Vital Living, Inc. and subsidiaries
      as of December 31, 2006 and the results of their operations and their cash
      flows for the two years ended December 31, 2006 and 2005, in conformity with
      accounting principles generally accepted in the United States of
      America.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 1 to the financial
      statements, the Company has suffered recurring losses from operations, has
      a
      working capital deficit, and is dependent on funding sources from other than
      operations. Since inception, the Company has been required to raise additional
      capital by the issuance of both equity and debt instruments. There are no
      commitments from funding sources, debt or equity, in the event that cash flows
      are not sufficient to fund ongoing operations or other cash commitments when
      they come due. These factors raise substantial doubt about the Company’s ability
      to continue as a going concern. Management’s plans regarding these matters are
      also described in Note 1. The financial statements do not include any
      adjustments that might result from the outcome of this uncertainty.





As
      described in Note 2 to the consolidated financial statements, the Company
      adopted a new principle of accounting for share-based payments in accordance
      with Financial Accounting Standards Board Statement No. 123R, *Share-Based
      Payment.*








/s/ Epstein
      Weber & Conover, PLC





Scottsdale,
      Arizona


March
      27,
      2007





F-1




**VITAL
                  LIVING, INC. AND SUBSIDIARIES****Consolidated
                  Balance Sheet**
  December
                  31,2006AssetsCurrent
                  AssetsCash
                  and cash equivalents
              
              
              
              
              $
              28,000Accounts
                  receivable, trade; net of allowance for doubtfullaccounts
                  of $53,000
              
              
              
              
              
              1,025,000Inventory,
                  net of reserve of $360,000
              
              
              
              
              
              32,000Prepaid
                  expenses and other current assets
              
              
              
              
              
              13,000Total
                  Current Assets
              
              
              
              
              
              1,098,000Other
                  AssetsDeferred
                  debt issuance costs, net of accumulatedamortization
                  of $588,000
              
              
              
              
              
              354,000Property
                  and equipment, net
              
              
              
              
              
              17,000Goodwill
              
              
              
              
              
              3,296,000License
                  agreement
              
              
              
              
              
              750,000Other
                  intangibles, net
              
              
              
              
              
              12,000Other
                  non-current assets
              
              
              
              
              
              24,000Total
                  other assets
              
              
              
              
              
              4,453,000Total
                  assets
              
              
              
              
              $
              5,551,000Liabilities
                  and Stockholders EquityCurrent
                  liabilitiesAccounts
                  payable, trade
              
              
              
              
              $
              724,000Accrued
                  and other currrent liabilities
              
              
              
              
              
              202,000Notes
                  payable
              
              
              
              
              
              401,000Long-term
                  notes payable - less current portion
              
              
              
              
              
              72,000Total
                  current liabilities
              
              
              
              
              
              1,399,000Long-term
                  debt, net of debt discount of $948,001
              
              
              
              
              
              3,278,000Long-term
                  notes payable - current portion
              
              
              
              
              
              678,000Total
                  liabilities
              
              
              
              
              
              5,355,000Commitments
                  and contingenciesStockholders'
                  equityPreferred
                  Stock, $0.001 par value, 50,000,000 shares authorized:Preferred
                  stock, Series D, $0.001 par value, 1,000,000 shares
                  authorized:1,000,000
                  shares issued and outstanding
              
              
              
              
              
              1,000Common
                  stock, $0.001 par value, 500,000,000 shares authorized:164,559,000
                  shares issued and outstanding
              
              
              
              
              
              165,000Additional
                  paid-in capital - common
              
              
              
              
              
              88,619,000Stock,
                  options, and warrants - unamortized
              
              
              
              
              
              (609,000
              )Treasury
                  stock, 424,000 shares at cost
              
              
              
              
              
              (72,000
              )Accumulated
                  other comprehensive income
              
              
              
              
              
              (49,000
              )Retained
                  deficit
              
              
              
              
              
              (87,859,000
              )Total
                  stockholders' equity
              
              
              
              
              
              196,000Total
                  liabilities and stockholders' equity
              
              
              
              
              $
              5,551,000


See
        accompanying consolidated notes to financial statements
  F-2




**VITAL
        LIVING, INC. AND SUBSIDARIES**
 **Consolidated
        Statements of Operations**
 
 **Year
                  Ended December 31,****2006**
              
              **2005**Revenue,
                  net
              
              $
              4,941,000
              
              $
              4,858,000Cost
                  of goods sold
              
              
              2,255,000
              
              
              2,301,000Gross
                  profit
              
              
              2,686,000
              
              
              2,557,000Administrative
                  expensesSalaries
                  and benefits
              
              
              816,000
              
              
              201,000Professional
                  and consulting fees
              
              
              492,000
              
              
              723,000Selling,
                  general, and administrative
              
              
              1,014,000
              
              
              880,000Research
                  and development
              
              
              151,000
              
              
              72,000Depreciation
                  and amortization
              
              
              11,000
              
              
              2,455,000Impairment
                  of intangibles
              
              
              -
              
              
              18,356,000Total
                  administrative expenses
              
              
              2,484,000
              
              
              22,687,000Net
                  gain (loss) from continuing operations
              
              
              202,000
              
              
              (20,130,000
              )Other
                  income (expense)Interest
                  expense, net
              
              
              (1,192,000
              )
              
              (1,034,000
              )Gain
                  on resolution of accrued research and development
              
              
              500,000
              
              
              -Gain
                  on resolution of accounts payable, trade
              
              
              -
              
              
              445,000Gain
                  on settlement of accounts payable, trade
              
              
              402,000
              
              
              142,000Loss
                  on sale and disposal of marketable securities
              
              
              -
              
              
              (1,006,000
              )Other
                  income/(expense) net
              
              
              6,000
              
              
              46,000Net
                  other expense
              
              
              (284,000
              )
              
              (1,407,000
              )Net
                  Loss
              
              
              (82,000
              )
              
              (21,537,000
              )Preferred
                  stock dividend
              
              
              -
              
              
              (125,000
              )Net
                  loss available to common stockholders
              
              $
              (82,000
              )
              $
              (21,662,000
              )Basic
                  and diluted loss per share
              
              
              ($0.00
              )
              
              ($0.21
              )Preferred
                  stock dividend
              
              $
              0.00
              
              
              ($0.00
              )Basic
                  and diluted loss per share available to common
                  stockholders
              
              
              ($0.00
              )
              
              ($0.21
              )Weighted
                  average basic and diluted common stock outstanding
              
              
              147,048,000
              
              
              101,426,000
 
 See
          accompanying notes to consolidated financial statements.
  F-3


**VITAL
                LIVING, INC. AND SUBSIDIARIES****Consolidated
                Statements of Cash Flows**




**Year
                Ended December 31,****2006**
            
            **2005**Cash
                flows from operating activities:Net
                loss
            
            $
            (82,000
            )
            $
            (21,537,000
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            11,000
            
            
            2,455,000Impairment
                of intangible assets
            
            
            0
            
            
            18,356,000Interest
                and amortization of costs associated with senior convertible
                notes
            
            
            679,000
            
            
            925,000Gain
                on issuance of common stock for accrued research and
                development
            
            
            (500,000
            )
            
            -Gain
                on settlement of accounts payable, trade
            
            
            -
            
            
            (142,000
            )Repricing
                of and modifications to warrants
            
            
            -
            
            
            (648,000
            )Amortization
                of restricted common stock, options and warrants issued for
                services
            
            
            6,000
            
            
            155,000Loss
                on sale of marketable securities
            
            
            -
            
            
            471,000Loss
                on disposal of marketable securities
            
            
            -
            
            
            535,000Gain
                on write off of accounts payable
            
            
            -
            
            
            (445,000
            )Bad
                debt expense
            
            
            -
            
            
            121,000Loss
                on disposal of property and equipment
            
            
            -
            
            
            14,000Change
                in operating assets and liabilities:Accounts
                receivable, trade
            
            
            (537,000
            )
            
            (163,000
            )Inventory
            
            
            79,000
            
            
            30,000Prepaid
                expenses and other current assets
            
            
            62,000
            
            
            (12,000
            )Accounts
                payable, trade
            
            
            (379,000
            )
            
            (233,000
            )Accrued
                liabilities
            
            
            497,000
            
            
            (242,000
            )Net
                cash used in operating activities
            
            
            (164,000
            )
            
            (360,000
            )Cash
                flows from investing activities:Proceeds
                from sale of property and equipment
            
            
            -
            
            
            2,000Proceeds
                from sale of marketable securities
            
            
            -
            
            
            64,000Cash
                provided by (used in) investing activities
            
            
            -
            
            
            66,000Cash
                flows from financing activities:Proceeds
                from sale of common stock, options, and warrants, net of offering
                costs
            
            
            -
            
            
            20,000Cash
                provided by financing activities
            
            
            -
            
            
            20,000Net
                decrease in cash
            
            
            (164,000
            )
            
            (274,000
            )Cash
                at beginning of period
            
            
            192,000
            
            
            466,000Cash
                at end of period
            
            $
            28,000
            
            $
            192,000




See
                accompanying notes to consolidated financial
                statements.




F-4




**Vital
        Living, Inc.**
 **Consolidated
        Statements of Cash Flows**
 **(continued)**


**Year
                Ended December 31,****2006**
            
            **2005****Supplemental
                cash flow information**Interest
                paid
            
            $
            3,000
            
            $
            3,000**Non
                cash investing activities**Issuance
                of common stock for interest
            
            $
            512,000
            
            $
            515,000Issuance
                of common stock for intangibles
            
            $
            -
            
            $
            70,000Conversion
                of Series C Preferred to common
            
            $
            -
            
            $
            500,000Conversion
                of senior notes and accrued interest
            
            $
            -
            
            $
            60,000


See
        accompanying notes to consolidated financial statements.


F-5


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Consolidated
        Statements of Stockholders’ Equity (Deficit)**


Preferred
                  Stock
              
              Common
                  StockShares
              
              Par
                  Value
              
              Discount
              
              Shares
              
              Par
                  Value
              
              Additional
                  Paid-in-Capital, Common and Preferred
              
              Stock,
                  Options and Warrants Unamortized
              
              Treasury
                  Stock
              
              Accumulated
                  Other Comprehensive Income (Loss)
              
              Accumulated
                  Deficit
              
              Total
                  Stockholders Equity (Deficit)Balance
                  December 31, 2004
              
              
              1,500,000
              
              $
              1,000
              
              $
              0
              
              
              99,016,000
              
              $
              99,000
              
              $
              87,037,000
              
              
              ($214,000
              )
              
              ($72,000
              )
              
              ($946,000
              )
              
              ($65,990,000
              )
              $
              19,915,000Conversion
                  of Series C Preferred stock to common stock
              
              
              (500,000
              )
              
              —
              
              
              —
              
              
              500,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Common
                  stock issued as dividend on Series C Preferred
              
              
              —
              
              
              —
              
              
              —
              
              
              250,000
              
              
              —
              
              
              250,000
              
              
              —
              
              
              —
              
              
              —
              
              
              (250,000
              )
              
              —Common
                  stock issued for services
              
              
              —
              
              
              —
              
              
              —
              
              
              150,000
              
              
              —
              
              
              6,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              6,000Common
                  stock issued for settlements of accounts payable
              
              
              —
              
              
              —
              
              
              —
              
              
              528,000
              
              
              1,000
              
              
              56,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              57,000Commons
                  stock issued for payment of interest on Senior Secured
                  Notes
              
              
              —
              
              
              —
              
              
              —
              
              
              8,972,000
              
              
              9,000
              
              
              506,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              515,000Common
                  stock issued for acquisitions of intangibles
              
              
              —
              
              
              —
              
              
              —
              
              
              1,000,000
              
              
              1,000
              
              
              69,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              70,000Common
                  stock issued in exchange for Senior Secured Convertible
                  Notes
              
              
              —
              
              
              —
              
              
              —
              
              
              250,000
              
              
              1,000
              
              
              60,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              61,000Sale
                  of common stock
              
              
              —
              
              
              —
              
              
              —
              
              
              357,000
              
              
              —
              
              
              20,000
              
              
              —
              
              
              —
              
              
              —
              
              
              
              
              
              20,000Forfeitable
                  stock awards
              
              
              —
              
              
              
              
              
              
              
              
              1,102,000
              
              
              1,000
              
              
              (105,000
              )
              
              104,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —Amortization
                  of restricted common stock, options, and warrants issued for
                  services
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              149,000
              
              
              —
              
              
              —
              
              
              —
              
              
              149,000Re-pricing
                  of options
              
              
              —
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              —
              
              
              (648,000
              )
              
              —
              
              
              —
              
              
              —
              
              
              (648,000
              )Net
                  loss
              
              
              —
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (21,537,000
              )
              
              (21,537,000
              )Comprehensive
                  loss:
              
              
              —
              
              
              —
              
              
              —
              
              
              
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Sale
                  of marketable securities
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              448,000
              
              
              —Loss
                  on marketable securities
              
              
              —
              
              
              —
              
              
              —
              
              
              
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              449,000
              
              
              —Comprehensive
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              897,000
              
              
              —
              
              
              897,000Balance
                  December 31, 2005
              
              
              1,000,000
              
              $
              1,000
              
              $
              0
              
              $
              112,125,000
              
              $
              112,000
              
              $
              87,899,000
              
              
              ($609,000
              )
              
              ($72,000
              )
              
              ($49,000
              )
              
              ($87,777,000
              )
              
              ($495,000
              )—
              
              
              
              
              
              
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Common
                  stock issued for services
              
              
              —
              
              
              —
              
              
              —
              
              
              95,000
              
              
              —
              
              
              3,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              3,000Common
                  stock issued for payment of interest on SR Secured Notes
              
              
              —
              
              
              —
              
              
              —
              
              
              39,964,000
              
              
              40,000
              
              
              476,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              516,000Common
                  stock issued in exchange for research and developemnent
                  liability
              
              
              —
              
              
              —
              
              
              —
              
              
              12,500,000
              
              
              13,000
              
              
              238,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              251,000Common
                  stock issued as payment of penalty due on timely registration of
                  stock in
                  2004
              
              
              —
              
              
              —
              
              
              —
              
              
              307,000
              
              
              —
              
              
              3,000
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              3,000Recovery
                  of stock issued in 2004 private placement
              
              
              
              
              
              
              
              
              
              
              
              (432000
              )Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (82,000
              )
              
              (82,000
              )Balance
                  December 31, 2006
              
              
              1,000,000
              
              $
              1,000
              
              $
              0
              
              $
              164,559,000
              
              $
              165,000
              
              $
              88,619,000
              
              
              ($609,000
              )
              
              ($72,000
              )
              
              ($49,000
              )
              
              ($87,859,000
              )
              $
              196,000


See
        accompanying notes to consolidated financial statements.





F-6


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


**Note
      1 - Organization and Description of Business**





We
      were
      incorporated in the state of Nevada on January 22, 2001 under the name
      Nutritional Systems, Inc. We acquired substantially all of the assets of Vital
      Living, Inc. effective May 7, 2001 and changed our name to Vital Living, Inc.
      on
      May 20, 2001. We then merged with VCM Technology Limited, a company reporting
      under the Securities Exchange Act of 1934, on August 16, 2001. As set forth
      in
      the terms of the merger agreement, we acquired all of the outstanding shares
      of
      common stock of VCM from its sole stockholder in exchange for 5,062 shares
      of
      restricted common stock. Following the merger, we continued as the surviving
      corporation and commenced reporting under the Securities Exchange Act of 1934
      by
      assuming the reporting status of VCM, which in turn provided us with the ability
      to file for quotation on the Over-the- Counter Bulleting Board under the symbol
      “VTLV”.





Through
      a
      series of various acquisition and divestiture activities, as described further
      below, we develop and market nutritional supplements and nutraceuticals products
      for distribution primarily through healthcare practitioners. Through a licensing
      agreement, we also have certain rights for the use of a pharmaceutical delivery
      system known as “GEOMATRIX®.” Our principal products currently are GreensFIRST®,
      Dream ProteinTM, Red AlertTM, and Complete EssentialsTM.




Nutritional
      supplements represent a convenient and cost-effective way for an individual
      to
      obtain the nutritional benefits of whole foods. Nutritional supplements are
      formulated from whole foods and are intended to provide for improved health,
      reduced risk of diseases, and the delay onset of age related indicators while
      resulting in little added caloric and fat intake. Nutritional supplements come
      in powder, capsule, cracker, and other forms. Nutraceuticals, consisting of
      vitamins, minerals, herbs, and supplements, are products that are isolated
      or
      purified from foods and generally sold in medicinal forms not usually associated
      with foods, including tablets, capsules, and drops. Nutraceuticals are intended
      to have physiological benefits or have the ability to reduce the risk of chronic
      disease beyond basic nutritional products. We develop and test our
      nutraceuticals in collaboration with leading medical experts in the
      nutraceuticals field. We have designed our products to be incorporated by
      healthcare practitioners into standard patient routines in which healthcare
      practitioners recommend and sell our nutritional supplements and nutraceuticals
      products to their patients. Use of vitamins, minerals, herbs, and nutritional
      supplements continues to rise as consumers seek nutritional products to improve
      general health, increase longevity, and enhance the overall quality of life.




In
      November 2002, we acquired M.A.F. BioNutritionals, LLC, or “MAF”. MAF
      formulates, markets, and distributes natural and organic food-based,
      preventative nutraceuticals and therapeutic and functional food products
      designed to support proactive human cell maintenance and rehabilitation,
      essential in the prevention and treatment of disease, as well as overall optimal
      body performance and metabolic function. As further described in Note 9, we
      sold
      the primary assets of MAF and discontinued its operations in September
      2004.





In
      July
      2003, we completed the acquisition of the assets and assumption of certain
      liabilities of Christopher’s Original Formulas, Inc., or “COF”. Through this
      acquisition, we gained the exclusive licensing and marketing rights to
      Christopher’s products, a line of over 300 herbal formulas and products,
      consisting primarily of naturally occurring organic substances, sold to
      professionals and at retail locations throughout the United States. The COF
      operations were accounted for under our Natures’ Systems, Inc., or “NSI”,
      subsidiary. The COF operations comprised NSI’s sole activity. As described in
      Note 9, we sold certain assets and liabilities of NSI back to the previous
      owners of COF and discontinued its operations in July 2004.





In
      August
      2003, we completed the acquisition of E-Nutraceuticals, Inc., or “ENI”. In
      addition, through a collaborative partnership with SkyePharma, PLC, (“Skye”), a
      UK pharmaceuticals company and a major shareholder of ours, we are exploring
      opportunities that utilize Skye’s FDA-approved, proprietary delivery systems.
      Pursuant to an amended Development and License Agreement between the parties,
      we
      acquired exclusive rights to Skye’s drug delivery technology, GEOMATRIX® (see
      note 7), and marketing and royalty rights to pharmaceutical sales using
      GEOMATRIX® in the Peoples Republic of China, Taiwan, and Hong Kong. During 2005
      we recorded a gain from the resolution of $445,000 of accounts payable related
      to the ENI acquisition as a result of the resolution of those
      payables.





In
      October 2003, we completed the acquisition of Doctors For Nutrition, Inc.,
      or
“DFN”. DFN’s product line includes GreensFIRST®, a highly concentrated
      formulation of fruits and vegetables. One serving of the product has the
      antioxidant power of over 10 servings of fruits and vegetables. We currently
      distribute GreensFIRST® through health practitioner offices throughout the
      United States. DFN introduced Red AlertTM, a complementary product in June
      2005.





In
      August
      2004, we consummated a joint venture with Wellness Watchers International,
      Inc.,
      or WWI, and together formed Wellness Watchers Systems, LLC, or WWS. We and
      WWI
      originally each owned 50% of WWS. The operating agreement gave us overall
      operating responsibility. WWS manufactures a proprietary brand of dietary
      protein powder called Dream ProteinTM, which is directly marketed to the health
      practitioners together with our GreensFIRST® product. WWS plans to introduce
      complementary products that will be marketed as part of WWS’ Healthy Living
      Program®. Part of WWI’s contribution to WWS was the exclusive licensing of
      certain products, client lists and marketing strategies, which included Dream
      ProteinTM. WWS has developed a unique marketing strategy that channels products
      directly to health practitioners. Prior to forming WWS, WWI had no prior
      operating history. During February 2005, we purchased WWI’s 50% interest in WWS.
      In conjunction with our acquisition of the remainder of WWS and certain other
      marketing and operation strategic productivity decisions, during the first
      quarter of 2005, we consolidated the operations of WWS into DFN.




F-7


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


Going
      concern





The
      accompanying consolidated financial statements have been prepared assuming
      we
      will continue on a going concern basis, which contemplates the realization
      of
      assets and the satisfaction of liabilities in the normal course of business.
      We
      have suffered recurring losses from operations, have a working capital deficit,
      and have depended on funding from sources other than operations. Since
      inception, we have been required to raise additional capital by the issuance
      of
      both equity and debt securities. There are no commitments from funding sources,
      debt or equity, in the event that cash flows are not sufficient to fund ongoing
      operations or other cash commitments as they come due. These factors raise
      substantial doubt about our ability to continue as a going concern. We may
      be
      required to raise additional capital in the near term through offerings of
      securities to fund our operations and will attempt to continue raising capital
      resources if we do not begin to generate revenue sufficient to maintain
      ourselves as a viable entity. No assurance can be given that such financing
      will
      be available or, if available, that it will be available on commercially
      favorable terms. Moreover, available financing may be dilutive to current
      investors.





We
      are in
      the process of improving, acquiring, or developing products for sale that would
      generate revenue to sustain our operations, as well as consolidating our
      operations in order to gain cost synergies and efficiencies. If successful,
      these actions will serve to mitigate the factors that have raised doubt about
      our ability to continue as a going concern and increase the availability of
      resources for funding of our current operations and future market development.
      The consolidated financial statements do not include any adjustments relating
      to
      the recoverability and classification of recorded assets or liabilities that
      might be necessary should we be unable to continue as a going
      concern.





**Note
      2 - Summary of Significant Accounting Policies**





Principles
      of consolidation





The
      consolidated financial statements include Vital Living, Inc. and its wholly
      owned domestic subsidiaries (collectively, “We”,"Vital Living", or the
      "Company"). Consolidated financial statements are financial statements of a
      parent company and its subsidiaries presented as if the entities were a single
      economic unit. Although the assets, liabilities, revenues, and expenses of
      all
      entities are combined to provide a single set of financial statements, certain
      eliminations and adjustments are made. These eliminations are necessary to
      ensure that only arm's-length transactions between independent parties are
      reflected in the consolidated statements; transactions between the parent and
      its’ subsidiaries are eliminated.





Accounts
      receivable, trade





The
      company extends unsecured credit to its’ customers under normal trade agreements
      which generally require payment within 30-90 days. We determine any required
      allowance by considering numerous factors, including the length of time trade
      accounts receivable are past due and our loss history. Receivables are
      considered past due when they are unpaid greater than 30 days from the due
      date.
      We record an allowance for accounts when they become uncollectible, and payments
      subsequently received on such accounts are reflected as a reduction of that
      allowance. The allowance for doubtful accounts was $53,000 at December 31,
      2006.
      Bad debt expense amounted to $0 and $121,000 in 2006 and 2005,
      respectively.





Inventory





Inventory
      is stated at the lower of cost (first-in, first-out method) or market, and
      consist of products available for sale and raw materials. At December 31, 2006,
      inventory amounted to $32,000, net of a reserve of $360,000.




Property
      and equipment





Property
      and equipment consists of office furniture, fixtures, and equipment, including
      computer hardware and software and various leasehold improvements. We record
      Property and equipment at cost. We provide for depreciation and amortization
      on
      a straight-line basis over the estimated useful lives ranging from three to
      ten years.




F-8


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


Goodwill





Goodwill
      represents the excess of the aggregate price paid by us over the value of the
      net equity acquired in an acquisition. In accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets,” we are no longer required to amortize
      goodwill, but are required to review goodwill for impairment at least annually
      or whenever events indicate that the carrying amount of the asset may not be
      recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or
      Disposal of Long-Lived Assets.” As of December 31, 2006, no events had occurred
      that would indicate goodwill had been impaired. As of December 31, 2005, events
      had occurred that indicate goodwill had been impaired; accordingly, an
      impairment loss was recorded (see Note 5).





License
      agreement and other Intangible assets





These
      assets include trademarks, patents, formulations, customer lists, and various
      marketing and license agreements. We amortize intangible assets on a
      straight-line basis over the lesser of the correlating agreements or estimated
      useful lives ranging from two to 14 years. As of December 31, 2006, no events
      had occurred that would indicate any of these assets were impaired.





During
      2006, we entered into two licensing agreements for $300,000 and $450,000 with
      Nutracea, Inc. The agreements give us the right to market two products, Relief
      First Capsules and Relief First Cream. Payments on these agreements will begin
      in September 2007 and continue for three (3) and five (5) years. We are in
      the
      process of completing a comprehensive marketing plan for the aforementioned
      products and have not determined the useful life or value of these agreements.
      Accordingly, we have not began to amortize the cost of these licensing
      agreements (See Note 6).





Long-lived
      assets





We
      review
      long-lived assets and identifiable other intangible assets to be held and used
      for impairment at least annually or When
      ever
      events or changes in circumstances indicate that the carrying amount may not
      be
      recoverable. We evaluate goodwill and other intangible assets arising from
      various acquisitions for impairment on at least an annual basis or when events
      occur that would indicate that impairment had occurred. We measure impairment
      by
      comparing the carrying value of the long-lived assets to the estimated
      undiscounted future cash flows expected to result from use of the assets and
      their eventual disposition.





Deferred
      charges





We
      capitalize costs associated with the issuance of debt instruments. We amortize
      these costs on a straight-line basis over the term of the debt instruments.
      Amortization expense was $679,000 and $925,000 for the years ended for the
      year
      ended December 31, 2006 and 2005, respectively. These amounts are recorded
      as a
      component of interest expense on the accompanying consolidated statement of
      operations.





Accounts
      Payable





During
      2006, we recognized a net gain of $402,000 related to the settlement of certain
      accounts payable. Included in that gain was $253,000 that was derived from
      estimated settlement amounts for payables deemed under statute as no longer
      our
      liability. The balance of the gain represents an original $217,000 payable
      that
      we settled for $68,000. We believe that our net accounts payable is adequately
      stated and that all amounts written off were proper.





Financial
      instruments





Our
      financial instruments consist of cash, receivables, payables, and long-term
      debt. The carrying amount of cash, receivables, and payables approximates fair
      value because of the short-term nature of these items. The carrying amount
      of
      long-term debt as of December 31, 2006 approximates fair value because interest
      rates and debt discounts are reflective of market rates.





Concentrations
      of credit risk





Financial
      instruments that potentially subject us to concentrations of credit risk consist
      principally of cash. At various times during the year, our cash balances may
      be
      in excess of federally insured limits. We maintain our cash, which consists
      primarily of demand deposits, with high-quality financial institutions, which
      we
      believe limits this risk.




F-9


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


During
      2006 one customer was responsible for 82.6% of our sales and accounted for
      90.8%
      of our trade accounts receivable as of December 31, 2006. In January 2007,
      Stuart Benson, our CEO acquired a 50% interest in this customer (see Note 12).





During
      2006 four vendors supplied all of our products for sale. One of these vendors
      accounted for 69.7% of our product purchases.





Acquisitions





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





Accounting
      estimates





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





Income
      taxes





We
      account for income taxes in accordance with SFAS No. 109, “Accounting for Income
      Taxes.” Under the asset and liability approach specified by SFAS No. 109, a
      deferred tax asset or liability is determined based on the difference between
      the financial statement and tax basis of assets and liabilities as measured
      by
      the enacted rates that will be in effect when these differences reverse.
      Deferred tax assets are recorded at their likely realizable
      amounts.




Revenue
      recognition





We
      recognize revenue when products are shipped to customers. Our return policy
      provides for an unconditional guarantee to our customers for a full refund
      of
      any unused product, including product that has exceeded its expiration date.
      All
      returns are subject to quality assurance reviews before acceptance. When
      necessary, we provide an allowance for returned product as a reduction of
      revenue based on estimates and historical experience with individual customers.
      We offer, from time to time, volume and promotional discounts on the products
      we
      sell. We record these discounts as a reduction of revenue.





Comprehensive
      income





SFAS
      No.
      130, "Reporting Comprehensive Income," establishes standards for the reporting
      and display of comprehensive income and its components within the financial
      statements. Other comprehensive income consists of charges to stockholders'
      equity, other than contributions from or distributions to stockholders, excluded
      from the determination of net income. Our other comprehensive income consists
      of
      unrealized gains and losses on available for sale securities and foreign
      currency translations. We do not provide for U.S. income taxes on foreign
      currency translation adjustments since we do not provide for such taxes on
      undistributed earnings of foreign subsidiaries.





Research
      and development





We
      expense research and development costs relating to both present and future
      products when incurred. Research and development
      costs amounted to $151,000 and $72,000 for the years ended December 31,
      2006 and 2005, respectively.





Net
      earnings per share





We
      account for earnings per share (“EPS”) in accordance with SFAS No. 128,
“Earnings Per Share,” which establishes the requirements for presenting EPS.
      SFAS No. 128 requires the presentation of “basic” and “diluted” EPS on the face
      of the income statement. Basic earnings per share begins with income (loss)
      applicable to common stockholders (net income (loss) less preferred stock
      dividends) and is based on the weighted average number of common shares
      outstanding during each period presented. Diluted EPS assumes the exercise
      of
      all stock options and warrants having exercise prices less than the average
      market price of the common stock using the treasury stock method. For the
      purpose of diluted earnings per common share, and only if such calculation
      results in dilution, preferred stock dividends will not reduce earnings;
      however, the weighted average common shares outstanding would increase
      representing the amount of common shares into which such preferred stock is
      currently convertible. During the years ended December 31, 2006 and 2005, we
      reported a net loss from operations; thus, the effects of dilutive securities
      were anti-dilutive, rendering basic and diluted loss per share the same.
      Convertible preferred stock, warrants, and options to purchase common stock
      are
      included as common stock equivalents only when dilutive. Potentially dilutive
      securities excluded from the loss per share calculation for the years ended
      December 31, 2006 and 2005 are as follows:


2006
              
              2005Convertible
                  preferred stock
              
              
              1,000,000
              
              
              1,000,000Convertible
                  debt
              
              
              17,610,000
              
              
              17,610,000Warrants
              
              
              31,680,000
              
              
              30,580,000Employee
                  options
              
              
              10,251,000
              
              
              13,801,00060,541,000
              
              
              62,991,000




F-10


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




Stock
      based compensation





We
      account for our stock option plans in accordance with the provisions of SFAS
      No.
      123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148
“Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No.
      123 permits entities to recognize as expense over the vesting period the fair
      value of all stock-based awards on the date of grant. Alternatively, SFAS No.
      123 also allows entities to apply the provisions of Accounting Principles Board
      (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related
      interpretations and provide pro forma net income or loss and pro forma earnings
      per share disclosures for employee stock option grants as if the
      fair-value-based method defined in SFAS No. 123 had been applied.





We
      are
      subject to reporting requirements of FASB Financial Interpretation No. (“FIN”)
      44, “Accounting for Certain Transactions Involving Stock Compensation,” which
      requires a non-cash charge to compensation expense if the price of our common
      stock on the last trading day of each reporting period is greater than the
      exercise price of certain stock options. After the first such adjustment is
      made, each subsequent period is adjusted upward or downward to the extent that
      the trading price exceeds the exercise price of the options.





We
      adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
      Share-Based Payment (“SFAS 123R”), effective January 1, 2006. SFAS 123R requires
      the recognition of the fair value of stock-based compensation in net income.
      SFAS 123R supersedes Statement of Financial Accounting Standards No. 123,
      Accounting for Stock-Based Compensations (“SFAS 123”) and Accounting Principles
      Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). The
      Company has adopted SFAS 123R using the modified prospective method.
      Accordingly, prior period amounts have not been restated. Under the modified
      prospective method, stock options awards that are granted, modified or settled
      after December 31, 2005 will be valued at fair value in accordance with
      provisions of SFAS 123R and recognized on a straight line basis over the service
      period of the entire award.





We
      account for our incentive plans under the recognition and measurement principles
      of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock
      issued to Employees,” and related Interpretations. No stock-based employee
      compensation (except that related to re-priced warrants in accordance with
      FIN
      No. 44) is reflected in net loss, as all options and warrants granted had an
      exercise price equal to or below the market value of the underlying common
      stock
      at the date of grant.





The
      fair
      value of our stock-based awards to employees was estimated using the
      Black-Scholes option-pricing model. The Black-Scholes model was developed for
      use in estimating the fair value of traded options that have no vesting
      restrictions and are fully transferable. In addition, the Black-Scholes model
      requires the input of highly subjective assumptions, including the expected
      stock price volatility. Because our stock-based awards have characteristics
      significantly different from those of traded options and because changes in
      the
      subjective input can materially affect the fair value estimate, in our opinion,
      the existing models do not necessarily provide a reliable single measure of
      the
      fair value of our stock-based awards to employees. The fair value of our
      stock-based awards (including re-priced warrants discussed above) was estimated
      assuming no expected dividends and the following weighted average assumptions
      for the years ended December 31, 2005:


Expected
                  life in years
              
              
              3.00Expected
                  stock price volatility
              
              
              180.00
              %Risk-free
                  interest rate
              
              
              4.00
              %Average
                  fair value per option/warrant
              
              $
              0.05




F-11


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**




There
      were no stock-based awards in 2006.





For
      pro
      forma purposes, the estimated fair value of our stock-based awards to employees
      is amortized over the respective vesting periods.





The
      following table illustrates the effect on net loss and net loss per share if
      we
      had applied the fair value recognition provisions of Statement of Accounting
      Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to our
      stock-based employee compensation for the year ended December 31,
      2005:


2005Net
                  Loss as reported
              
              $
              (21,537,000
              )Add:Stock
                  based compensation included in determination of net loss
              
              
              -Re-pricing
                  of warrants
              
              
              (648,000
              )Deduct:Stock
                  based employee compensation determined under fair valuebased
                  method for all awards, net of related tax effects
              
              
              (689,000
              )Net
                  loss - pro forma
              
              
              (22,874,000
              )Net
                  loss available to common shareholders - pro forma
              
              $
              (22,874,000
              )Basic
                  and diluted loss per shareBasic
                  and diluted loss per share available to common shareholders - as
                  reported
              
              $
              (0.21
              )Basic
                  and diluted loss per share - pro forma
              
              $
              (0.23
              )Basic
                  and diluted loss per share available to common shareholders - pro
                  forma
              
              $
              (0.23
              )Weighted
                  average basic and diluted common stock outstanding
              
              
              101,426,000




We
      granted warrants to our CEO in 2003. These warrants were subsequently re-priced.
      As a result of this re-pricing, the award is now accounted as a variable award. Due
      to a
      decline in the trading price of our common stock, there was a reduction in
      salaries and wages $648,000 for the adjustments of the variable award for the
      years ended December 31, 2005.





We
      adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
      Share-Based Payment (SFAS 123R), effective January 1, 2006. SFAS 123R requires
      the recognition of the fair value of stock-based compensation in net income.
      Stock-based compensation primarily consists of stock options. Stock options
      are
      granted to employees at exercise prices equal to the fair market value of our
      stock at the dates of grant. Generally, options fully vest immediately and
      expire 30 days after the employee leaves the company. We recognize the
      stock-based compensation expense over the requisite service period of the
      individual grantees, which generally equals the vesting period. We provide
      newly
      issued shares to satisfy stock option exercises. As there were no option awards
      granted during 2006 and all prior option awards were fully vested prior to
      January 1, 2006 there was no effect due to the implementation of SFAS 123R
      in
      the year ended December 31, 2006.





F-12


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**





Recent
      accounting pronouncements





FIN
      48 In
      June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
      Uncertainty in Income Taxes," ("FIN 48") an interpretation of FASB Statement
      No.
      109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold
      and measurement attribute for the financial statement recognition and
      measurement of a tax position taken or expected to be taken in a tax return.
      FIN
      48 requires that the Company recognize in its financial statements, the impact
      of a tax position, if that position is more likely than not of being sustained
      on audit, based on the technical merits of the position. FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods and disclosure. The provisions of FIN 48 are effective beginning
      January 1, 2007 with the cumulative effect of the change in accounting principle
      recorded as an adjustment to the opening balance of retained earnings, goodwill,
      deferred income taxes and income taxes payable in the Consolidated Balance
      Sheets. The Company does not expect that the adoption of FIN 48 will have a
      significant impact on the financial statements of the Company.





The
      Company has reviewed other current outstanding statements from the Financial
      Accounting Standards Board and does not believe that any of those statements
      will have a material adverse affect on the financial statements of the Company
      when adopted.





In
      December 2004, the FASB issued SFAS No. 153, *"Exchanges
      of Nonmonetary Assets"* (SFAS
      153). This Statement addresses the measurement of exchanges of nonmonetary
      assets and is effective for nonmonetary asset exchanges occurring in fiscal
      years beginning after June 15, 2005. The adoption of SFAS 153 has not had a
      material effect on the Company's financial position or results of
      operations.




In
      March
      2006, the FASB issued FASB Statement No. 156, “Accounting for Servicing of
      Financial Assets—an amendment of FASB Statement No. 140” (“FASB Statement No.
      156”). FASB No. 156 amends FASB Statement No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities,* with
      respect to the accounting for separately recognized servicing assets and
      servicing liabilities. FASB No. 156 is effective for years beginning after
      September 15, 2006. The Company does not believe FASB No. 156 will have a
      material effect on the Company’s financial statements.





In
      September 2006, the FASB issued Statement No. 157, “Fair Value Measurements”
(“FASB No. 157”). FASB No. 157 defines fair value, establishes a framework for
      measuring fair value in generally accepted accounting principles (GAAP), and
      expands disclosures about fair value measurements. FASB No. 157 applies under
      other accounting pronouncements that require or permit fair value measurements,
      the FASB having previously concluded in those accounting pronouncements that
      fair value is the relevant measurement attribute. Accordingly, this Statement
      does not require any new fair value measurements.




In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin No. 108, *Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements* (“SAB 108”).
      SAB 108 provides guidance on consideration of the effects of prior year
      misstatements in quantifying current year misstatements for the purpose of
      a
      materiality assessment. SAB 108 is effective for fiscal years ending after
      November 15, 2006. The adoption of SAB 108 did not have an impact on
      our consolidated financial statements.




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




F-13


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities* (“SFAS 159”)
      which permits entities to choose to measure many financial instruments and
      certain other items at fair value that are not currently required to be measured
      at fair value. SFAS 159 will be effective for us on January 1, 2008.
      We are currently evaluating the impact of adopting SFAS 159 on our
      financial position, cash flows, and results of operations.





**Note
      3 - Mergers and** **acquisitions**




Wellness
      Watchers Systems, LLC.




In
      August
      2004, we consummated a joint venture with Wellness Watchers International,
      Inc.,
      or WWI, and together formed Wellness Watchers Systems, LLC, or WWS. We
      originally paid WWI $805,000 for our 50% interest in WWS. The purchase price
      consisted of 3,000,000 shares of our common stock along with a $25,000 cash
      payment made in August 2004. During 2005, we purchased WWI’s 50% interest in WWS
      by issuing an additional 1,000,000 shares of common stock recorded as a $70,000
      increase in goodwill.





**Note
      4 - Property and equipment**


****  ****


Property
      and equipment consists of the following at December 31:


2006Computer
                  hardware and software
              
              $
              62,000Office
                  furniture and fixtures
              
              
              24,000Machinery
                  and equipment
              
              
              2,000Gross
                  property and equipment
              
              
              88,000Less
                  accumulated depreciation
              
              
              (71,000
              )Net
                  property and equipment
              
              $
              17,000





Depreciation
      and amortization expense was $11,000 and $25,000 for the years ended December
      31, 2006 and 2005, respectively.





F-14




**VITAL
      LIVING, INC. AND SUBSIDIARIES**


**Notes
      to Consolidated Financial Statements**




**Note
      5 - Intangible assets**


****  ****


Intangible
      assets consisted of the following at December 31, 2006:


Un-Amortizable
                  intangible assetsGoodwill
              
              $
              3,296,000Gross
                  Carrying
              
              
              Accumulated
                    Amortization and
              
              
              Net
                  CarryingAmortizable
                  intangible assets
              
              
              Amount
              
              
              Impairment
              
              
              AmountLicense
                  agreement
              
              $
              34,661,000
              
              $
              (34,661,000
              )
              $
              -License
                  agreement
              
              
              4,093,000
              
              
              (4,093,000
              )
              
              -License
                  agreements
              
              
              750,000
              
              
              -
              
              
              750,000Marketing
                  agreement
              
              
              4,304,000
              
              
              (4,304,000
              )
              
              -Trademarks
                  and patents
              
              
              20,000
              
              
              (8,000
              )
              
              12,000Total
                  amortizable intangible assets
              
              $
              43,828,000
              
              $
              (43,066,000
              )
              $
              762,000Estimated
              
              
              AccumulatedAmortization
              
              
              AmortizationExpense
              
              
              ExpenseFor
                  the year ended December 31, 2007
              
              $
              152,000
              
              $
              43,218,000For
                  the year ended December 31, 2008
              
              
              151,000
              
              
              43,369,000For
                  the year ended December 31, 2009
              
              
              152,000
              
              
              43,521,000For
                  the year ended December 31, 2010
              
              
              151,000
              
              
              43,672,000For
                  the year ended December 31, 2011
              
              
              151,000
              
              
              43,823,000For
                  the year ended December 31, 2012
              
              
              1,000
              
              
              43,824,000For
                  the year ended December 31, 2013
              
              
              1,000
              
              
              43,825,000For
                  the year ended December 31, 2014
              
              
              2,000
              
              
              43,827,000For
                  the year ended December 31, 2015
              
              
              1,000
              
              
              43,828,000For
                  the year ended December 31, 2016
              
              
              -
              
              
              43,828,000Totals
              
              $
              762,000
              
              $
              43,828,000




Impairment
      Analysis





As
      required by SFAS No. 142, we continually test goodwill or other intangibles
      created by each acquisition for impairment. These assets are tested for
      impairment at least annually, or upon occurrence of such events that may
      indicate impairment exists. We revised the earnings forecast for the next five
      years and evaluated the change in fair value of each component of goodwill
      using
      the expected present value of future cash flows. Impairment was due to a
      combination of factors, including acquisition price, increased market
      competition, and operating performance. As a result of this process, during
      2005, we determined that certain intangible assets were impaired. Accordingly,
      during 2005, we recorded an impairment charge of $18,356,000 relating to the
      GEOMATRIX® licensing agreement.





As
      a
      result of our review, goodwill and all other intangible assets were deemed
      not
      to be impaired at December 31, 2006. The goodwill of $3,296,000 is attributable
      to previous acquisitions as follows:


DFN
              
              $
              2,421,000WWS
              
              
              875,000Total
              
              $
              3,296,000


F-15


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




**Note
      6 - Long-Term Debt**





In
      December 2003, we borrowed an aggregate principal amount of approximately $4.58
      million in the form of Senior Secured Convertible Notes (the “Secured Notes”),
      due December 17, 2008, in a private placement, subject to certain registration
      rights, generating cash proceeds of $2.5 million, net of cash debt issue costs
      of $538,000. At time of issuance the Secured Notes bore interest at a rate
      of
      12% per annum, 8% of which was payable semi-annually in cash each June and
      December, while 4% per annum could be paid, at our discretion, in cash or our
      common stock at a price equal to the ten-day average trading price of our common
      stock five business days prior to the relevant interest payment date. In October
      2004, we agreed with the holders of the Secured Notes and warrants to reduce
      the
      conversion price and exercise price of those securities to $0.24 per share.
      There was no expense recorded relative to the reduction in the conversion price.
      The reduction of the conversion price is permanent and there was no time limit
      placed on the reduced conversion price, therefore it was determined not to
      be a
      an inducement to convert as that term is defined in Statement of Financial
      Accounting Standards No. 84 Induced Conversions of Convertible Debt . In
      exchange for this reduction:





We
      agreed
      to include the additional shares of common stock that are now issuable upon
      conversion of the outstanding Secured Notes as a result of the reduction in
      the
      conversion price in the next registration statement we file with the Securities
      and Exchange Commission ("New Registration Statement"). The shares of common
      stock originally convertible under the Secured Notes are registered for resale
      under our Registration Statement on Form SB-2 (SEC File No. 333-111921)
      ("Registration Statement"), which was declared effective by the SEC on August
      13, 2004. We are now entitled to pay all 12% interest due on the Secured Notes
      in either cash or shares of our common stock, at our sole option, commencing
      with the interest payment due in December 2004. We were originally required
      to
      pay the 12% interest on the senior convertible promissory notes at the rate
      of
      8% per annum in cash and had the option to pay the remaining interest at the
      rate of 4% per annum in cash or shares of common stock. The shares of common
      stock representing the 4% interest payments are registered for resale under
      the
      Registration Statement. We have agreed to include the additional shares of
      common stock representing the 8% interest payments in the New Registration
      Statement; and all penalties that we were required to pay as a result of our
      failure to have the Registration Statement declared effective by April 15,
      2004
      will be payable by our in shares of common stock ("Penalty Stock") at a price
      equal to $0.258. Such shares will be included on the New Registration Statement.





In
      2005
      certain note holders converted $60,000 of their note into common
      stock.





We
      may
      redeem the Secured Notes commencing December 15, 2004, provided the ten-day
      average trading price of our common stock prior to the redemption is at least
      $3.00 per share. The Secured Notes are collateralized by our assets, have
      priority in right of payment over all our indebtedness, and include certain
      provisions related to change in control, reorganization, recapitalization,
      and
      other adjustments. In addition, the Secured Note holders received 4,588,000
      warrants to purchase shares of common stock at an exercise price of $1.00 per
      share. The fair value of these warrants of $1,084,000 was recorded and charged
      immediately to interest expense during 2003 as the warrants were fully vested
      and the related notes fully convertible at the date of issuance.





In
      October 2006, our Board of Directors approved a modification to Senior Notes
      and
      Series D Preferred Stock that allows for both of these securities to be
      converted into our common stock at current market price of the stock as defined
      in the Senior Note agreement. In exchange for this modification, the holders
      of
      such notes and Series D Preferred Stock would agree to forego future interest
      payments and extend the term of the note by twelve months. Both Messrs. Benson
      and Linn, abstained from voting on this matter, since they each own 50% of
      an
      entity that holders $1.0 million of Senior Notes and 1,000,000 shares of Series
      D Preferred Stock. As of March 30, 2007, we have not offered this opportunity
      to
      the holders of either the notes or the Series D Preferred Stock.




Amounts
      charged to interest expense is $1,192,000 and $1,034,000 for 2006 and 2005,
      respectively. In 2006, the balance included amortization of debt discount and
      deferred issue cost of $495,000 and $184,000, respectively. During 2005, the
      balance included amortization of debt discount and deferred issue cost of
      $697,000 and $228,000, respectively.





In
      connection with our 2002 MAF acquisition, we began making payments on a
      pre-existing SBA loan. We have made no payments of principal or interest against
      this loan since September 2004 (see Note 7). We entered into an agreement to
      sell the Boulder Bar product line and the purchaser assumed this debt. However,
      the purchaser has not complied with the terms of the agreement and we are
      seeking legal remedies. The principal balance of the loan is approximately
      $398,000 at December 31, 2006 and accrues interest at 8.25%. We have $401,000
      included in our current liabilities related to this obligation.




F-16


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




In
      September and December 2006, we entered into supply and licensing agreements
      that grants us trademark rights. The agreements require us to pay $750,000
      over
      five years beginning in the fourth quarter of 2007. These agreements include
      un-secured notes payable of $300,000 and $450,000 at 5% and 8% respectively,
      with payments beginning in September, 2007 through August 2011 as summarized
      in
      the table below.





Long-term
      debt consists of the following at December 31, 2006:




Notes$4,226,000
                  Secured Notes; maturity December 2008;interest
                  at 12% per annum (may be paid in cash orcommon
                  stock); principal due at December 17, 2008
              
              $
              4,226,000Long-term
                  notes payable - License agreement
              
              
              750,000Total
              
              
              4,976,000Lees
                  - current portion long-term notes payable
              
              
              (72,000
              )Less
                  unamortized debt discount
              
              
              (948,000
              )Net
                  long-term debt
              
              $
              3,956,000


Aggregate
      maturities of long-term debt for the subsequent five years ending December
      31
      are as follows:


Senior
              
              Un-securedSecured
                  Notes
              
              Notes
                  Payable
              
              Total2007
              
              $
              -
              
              $
              72,000
              
              $
              72,0002008
              
              
              4,226,000
              
              
              216,000
              
              
              4,442,0002009
              
              
              -
              
              
              216,000
              
              
              216,0002010
              
              
              -
              
              
              186,000
              
              
              186,0002011
              
              
              -
              
              
              60,000
              
              
              60,000Total
              
              $
              4,226,000
              
              $
              750,000
              
              $
              4,976,000




**Note
      7 - Commitments and contingencies**





From
      time
      to time, we are party to a variety of legal proceedings arising out of the
      normal course of business, including cases in which damages may be sought.
      We
      believe we have a valid defense and are vigorously defending any pending
      litigation. While the results of litigation cannot be predicted with certainty,
      we do not believe that the outcome of these proceedings will have a material
      adverse effect on our consolidated financial position, results of operations,
      or
      cash flows.





Weare
      in
      legal proceedings with the previous owners of COF over the re-purchase by them
      of the COF operations. On May 6 th ,
      2005
      Christophers’ Original Formulas, SFMB, Inc., Robert C Scott, Norman Bacala, and
      Ruth Christopher filed a complaint against Vital Living, Inc., Natures Systems,
      Inc., James R Jeppson, Stuart Benson, and Donald Hannah in the Third Judicial
      District Court for Salt Lake County, State of Utah. The Complaint alleges
      damages in excess of $400,000 relating to alleged breaches of a Settlement
      and a
      Release Agreement dated July 9, 2004. We and the other defendants have filed
      a
      Motion to Dismiss the action based on a variety of legal theories. We along
      with
      the related defendants also intend to vigorously defend against the claims
      of
      the plaintiffs. No evaluation presently can be made as to the final outcome
      of
      this case or the likelihood or range of potential recovery loss, if any, to
      us.





In
      October 2006, Timekeeping systems, Inc. (“TKI”) filed suit against us alleging
      that we conspired with Mitch Feinglass, our former COO, to hide certain assets
      for the purpose of frustrating TKI’s efforts to collect on TKI’s judgment
      against Mr. Feinglass in Ohio. Specifically TKI alleges that we paid certain
      consulting fees to two companies that Mr. Feinglass allegedly controlled, which
      TKI claims were offshore operations. TKI alleges that these funds should have
      been paid to Mr. Feinglass directly, and that paying them to the purported
      offshore entities amounted to a “conspiracy to commit a fraudulent conveyance.”
TKI seeks damages against the company in an amount equal to TKI’s Ohio judgment
      of $105,000 plus interest for 6 years at 10%, attorneys’ fees, and costs. This
      suit is still in the initial pleading stage. We have filed an answer that denies
      all material allegations of the complaint, and intends to vigorously defend
      this
      suit.




F-17


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**


In
      connection with our purchase of M.A.F. Group, LLC (“MAF”) in late 2002, we
      signed a document title “Unlimited Continuing Guaranty” (“Guaranty”) under which
      we agreed to unconditionally perform all of M.A.F.’s obligations under an SBA
      loan. This document was prepared by M.A.F.s counsel for the purpose of inducing
      the Commerce Bank (“Commerce”) to approve the sale of MAF to Vital Living, Inc.
      which required Commerces’ express approval under the terms of the SBA loan.
      Ultimately, MAF never sought Commerces’ approval, this document was never
      delivered to Commerce, and we assumed that the Guaranty had been discarded.
      In
      September 2004 we ceased making payments against the SBA loan (see Note 6 and
      9)
      and eventually Commerce began pursuing William Coppel (former owner of MAF,
      and
      a former officer of VLI for a time after the acquisition of MAF before leaving
      us). We have an accrual of $401,000 included in our current liabilities relating
      to this obligation. In July 2006, Coppel, through counsel, wrote a letter to
      us
      demanding that the Company honor the Guaranty and satisfy his indebtedness
      under
      the SBA loan. We responded to the demand, outlining the reasons why the Guaranty
      is unenforceable and noting that we have a potential counterclaim against Mr.
      Coppel based upon his breaches of the separation agreement in connection with
      his resignation. Since our response in August 2006, Mr. Coppel has not made
      any
      further efforts to enforce the purported Guaranty against us. We intend to
      vigorously defend a lawsuit to enforce the Guaranty, should one ever be
      filed.





We
      lease
      office space under non-cancelable operating leases that expire in 2007. Future
      minimum lease payments under non-cancelable operating leases for the subsequent
      five years ending December 31 are approximately as
      follows:


2007
              
              $
              36,0002008
              
              
              -2009
              
              
              -2010
              
              
              -2011
              
              
              -Total
              
              $
              36,000


Total
      rent expense was $135,000 and $103,000 for the years ended December 31, 2006
      and
      2005, respectively.





In
      connection with the ENI acquisition, we acquired certain rights to SkyePharma,
      PLC’s (“Skye”) GEOMATRIX® drug-delivery technology. In conjunction with that
      agreement we incurred $1.0 million in research and development liabilities,
      of
      which $750,000 remained un-paid at December 31, 2005. In June 2006 we exchanged
      12,500,000 shares of our common stock valued at $250,000 for the $750,000
      liability resulting in a gain of $500,000.




In
      September and December 2006, we entered into supply and licensing agreements
      that grants us trademark rights. The agreements require us to pay $750,000
      over
      five years beginning in the fourth quarter of 2007 (see note
      5).





**Note
      8 - Capital Stock**




In
      July
      2006, the board of directors and our stockholders approved an amendment to
      our
      Articles of Incorporation to increase the number of authorized shares of common
      stock from 150,000,000 to 500,000,000, par value $.001 per share. We are
      currently authorized to issue up to 50,000,000 shares of preferred stock, par
      value $.001 per share. At December 31, 2006, our capital stock consisted of
      the
      following:


Capital
                  Stock
              
              Par
                  Value
              
              Authorized
              
              Issued
                  & OutstandingCommon
                  Stock
              
              $
              0.001
              
              
              500,000,000
              
              
              164,559,000Preferred
                  Stock
              
              $
              0.001
              
              
              50,000,000
              
              
              1,000,000


Common
      Stock





Each
      holder of common stock is entitled to one vote per share on all matters
      submitted to a vote of our stockholders. Holders of our common stock have no
      preemptive rights and have no rights to convert their common stock into any
      other securities. In the event of dissolution or liquidation or the winding-up
      of our company, holders of our common stock will be entitled to share ratably
      in
      all assets remaining after payment of all liabilities, subject to any
      preferential payments to the holders of any Secured Notes and preferred stock
      then outstanding. Although we are restricted from paying cash dividends under
      the terms of the Secured Notes, holders of common stock are entitled to receive
      ratably such dividends as may be declared by our board of directors out of
      funds
      legally available therefore. All of our outstanding common shares are fully
      paid
      and non-assessable.




F-18


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**


During
      2006, 432,000 shares of common stock previously issued was cancelled. These
      shares were eventually deemed to be erroneously recorded as issued by us, but
      were never physically issued by our transfer agent.





During
      2005 we negotiated a settlement of a $177,000 accounts payable balance for
      318,750 shares of common stock with a value of $35,000 resulting in a gain
      of
      $142,000.





Common
      Stock Issued for interest





All
      the
      following common stock issuances were calculated by using a formula based on
      the
      fair market value of our common stock at the time of payment.




During
      January 2006, we issued 70,000 shares of our common stock in payment of $3,000
      of interest due for the December 2005 semi-annual interest on our Senior Secured
      Convertible Notes.




During
      June 2006, we issued 13,424,322 shares of our common stock in payment of
      $256,404 of interest due for the June 2006 semi-annual interest on our Senior
      Secured Notes.





During
      December 2006, we issued 26,469,450 shares of our common stock in payment of
      $256,404 of interest due for the December 2006 semi-annual interest on our
      Senior Secured Notes.





During
      December 2006, we issued 307,493 shares of our common stock with a value of
      $3,000 in interest due to shareholders as a penalty due to our failure to timely
      file and have declared effective a registration statement for common stock
      issued during our November 2002 private placement and interest charges related
      to a penalty due to our failure to timely file and have declare effective a
      registration statement to register the shares of common stock issued in the
      December 20003 offering.




Common
      Stock Issued in Exchange for Research and Development Liability




During
      June 2006, we issued 12,500,000 shares of our common stock valued at $250,000
      as
      payment for the $750,000 liability for research and development due to
      SkyePharma resulting in a gain of $500,000.





Common
      Stock Issued for Services and
      Settlements





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





During
      the year ended December 31, 2005 we issued 528,000 shares of restricted common
      stock with a value of $58,000 in consideration for consulting, investment
      banking, or other services rendered, compensation, release of debt, and various
      other claims that parties may have had against us.




During
      the years ended December 31, 2006 and 2005, 95,000 and 250,000 shares of common
      stock with a value of $4,000 and $12,000 respectively, were issued to directors
      for director services and to various consultants for various consultations
      and
      advisory services to be provided over a period ranging from 12 months to two
      years. These shares were originally capitalized as a component of equity and
      amortized to expense over the vesting periods. For the years ended December
      31,
      2006 and 2005, $3,000 and, $93,000, respectively was amortized to expense.
      The
      value of unamortized restricted common stock issued for services as of December
      31, 2006 and 2005 was $0.





Preferred
      Stock





Preferred
      stock may be issued in one or more series, the terms of which may be determined
      at the time of issuance by our board of directors, without further action by
      stockholders, and may include voting rights (including the right to vote as
      a
      series on particular matters), preferences as to dividends and liquidation,
      conversion rights, redemption rights and sinking fund provisions. The issuance
      of shares of preferred stock could adversely affect the rights of the holders
      of
      common stock and therefore, reduce the value of the common stock. In June 2006
      the Series D Preferred Stock was acquired by a partnership controlled by the
      CEO
      and COO/CFO (see Note 12).





Series
      C Preferred Stock





On
      July
      9, 2003, we sold to one investor five units, each consisting 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 shares of Series C Preferred
      Stock at $1.00 per share, 500,000 Series D Warrants at an exercise price of
      $1.30 per share, and 500,000 Series E Warrants at an exercise price of $1.60
      per
      share, generating cash proceeds of $438,000, net of cash offering cost of
      $63,000. The combined fair value at the date of grant of the Series D and Series
      E Warrants using the Black-Scholes option-pricing model was
      $242,000.




F-19


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**


The
      holder of the Series C Preferred Stock is entitled to a two-time dividend at
      the
      rate of 50% per annum, payable in cash or common stock on the first and second
      anniversary of the issuance date with no obligation to pay dividends thereafter.
      Unpaid and/or undeclared dividends are cumulative. The total amount of dividends
      not declared at December 31, 2004 was $370,000. Each share of Series C Preferred
      Stock is convertible into one share of common stock at the option of the holder
      at any time after the first anniversary of the date of issuance.





In
      connection with this offering, 250,000 Series D Warrants with an exercise price
      of $1.30 per share (fair value of $72,000), a cash commission equal to 12.5%
      of
      the proceeds (or $63,000), 63,000 shares of common stock (fair value of $74,000,
      or $1.18 per share), and an option to acquire 63,000 shares of common stock
      exercisable at $1.00 per share (fair value of $26,000) were granted, paid,
      or
      issued to a stockholder to facilitate the transaction, thus increasing the
      total
      offering costs to $234,000. The Series C Preferred Stock has no voting rights,
      liquidation preferences, or protective provisions.





The
      market value of our common stock on the date the Series C Preferred Stock was
      sold was $1.18 per share. In accordance with EITF 98-5, as amended by EITF
      00-27, because the Series C Preferred Stock was sold at 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,
      we
      recorded a discount of $253,000 within stockholders’ equity and a corresponding
      amount to preferred stock additional paid-in-capital. The Series C Preferred
      Stock is convertible into common stock at the option of the holder at any time
      after the first anniversary date of its issuance, thus the beneficial conversion
      is amortized over a one-year period. The entire $253,000 balance was amortized
      during 2004 and 2003.





During
      July 2005, 250,000 shares of common stock were issued in payment of the 50%
      dividend due on the second anniversary date. Immediately thereafter all the
      500,000 shares of Series C Preferred Stock were converted into 500,000 shares
      of
      common stock.





Series
      D Preferred Stock





On
      August
      20, 2003, concurrent with the ENI Acquisition, we sold to a single investor
      1,000,000 shares of Series D Preferred Stock at $1.00 per 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 share of common stock at the
      option of the holder at any time.





The
      market value of our common stock on the date the Series D Preferred Stock was
      sold was $1.37 per common share. In accordance with EITF 98-5, as amended by
      EITF 00-27, because the Series D Preferred Stock was sold at 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 we recorded a discount of $370,000 within stockholders’ equity and a
      corresponding amount to preferred stock additional paid-in-capital. The Series
      D
      Preferred Stock is convertible into common stock at the option of the holder
      at
      any time, thus the beneficial conversion was recorded as a dividend upon
      issuance.





In
      June
      2006 the Series D Preferred Stock was acquired by a partnership owned 50% each
      by Stuart Benson and Gregg Linn (see Note 12).





The
      holder of the Series D Preferred Stock is entitled to various rights,
      preferences, and restrictions that include the following:





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




2.
            Dividends.
                The holders of the Series D Preferred Stock are entitled to a like
                dividend or distribution, pro rata, should there be a cash or property
                dividend or distribution to any class of common stock or preferred
                stock
                other than the Series A Preferred Stock, determined on an as converted
                basis. This does not include any dividends paid in shares of common
                stock
                to the holders of Series B Preferred Stock and Series C Preferred
                Stock
                outstanding as of the date of
                issuance.




3.
            Liquidation
                Preference.
                The Series D Preferred Stock is senior to the Series B Preferred
                Stock and
                Series C Preferred Stock and the common stock upon liquidation and
                is
                entitled to an amount equal to the original $1.00 per share issue
                price
                plus any declared and unpaid dividends (as adjusted for stock dividends,
                combinations, splits, recapitalization, and the like with respect
                to such
                shares).




F-20


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**


4.
            Redemption.
                We have no rights to redeem the Series D Preferred
                Stock.




5.
            Conversion.
                The holders of Series D Preferred Stock have the right to convert
                into
                common stock, at any time. Each share of Series D Preferred Stock
                is
                convertible into one share of common stock subject to adjustment
                fordeclaredand unpaid dividends, stock dividends, combinations, splits,
                recapitalization, and the like 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 the common 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 the Series D Preferred Stock may
                also
                be reduced in certain situations if we issue additional options,
                warrants,
                or rights to purchase common stock at a price below the conversion
                price
                of the Series D Preferred Stock. In such event, the conversion price
                will
                be decreased by multiplying the conversion price then in effect by
                a
                fraction of which (i) the numerator will be the number of outstanding
                shares of common stock on the date of issuance of the rights plus
                the
                number of shares of common stock which could be purchased at the
                then
                conversion price from the aggregate offering price of the rights
                and (ii)
                the denominator will be the shares of common stock outstanding on
                the date
                of issuance of the rights plus the number of shares of common stock
                so
                offered for subscription or purchase pursuant to such
                rights.




6.
            Protective
                Provisions.
                So long as any shares of Series D Preferred Stock are outstanding,
                we may
                not, without the prior affirmative consent or vote of the holders
                of at
                least two thirds of the outstanding shares of the Series D Preferred
                Stock:




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




b.
            amend,
                alter, or repeal, whether by merger, consolidation, or otherwise,
                our
                amended and restated articles of incorporation or bylaws or the
                resolutions contained in the certificate of designation of the Series
                D
                Preferred Stock and the powers, preferences, privileges, relative,
                participating, optional and other special rights and qualifications,
                limitations, and restrictions thereof, which would adversely affect
                any
                right, preference, privilege, or voting power of the Series D Preferred
                Stock, or which would increase the amount of authorized shares of
                the
                Series D Preferred Stock or of any other series of preferred stock
                ranking
                senior to the Series D Preferred Stock, with respect to the payment
                of
                dividends (whether or not such series of preferred stock is cumulative
                or
                non-cumulative as to payment of dividends) or
                liquidation.




**Note
      9 - Discontinued Operations**





On
      September 30, 2004, MAF entered into an agreement to sell all properties, rights
      and assets used or useful in connection with its product line, Boulder Bar.
      This
      was the primary asset in MAF. MAF received a $50,000 cash payment, a $50,000
      promissory note and the purchaser has agreed to continue serving the SBA debt
      obligation of approximately $419,000 at December 31, 2005 (see note 7), accruing
      interest at 9.75%, which is secured by the aforementioned asset. As a result
      of
      this transaction, during 2004, the Company recorded an impairment charge related
      to the remaining $104,000 of intangible assets related to the MAF acquisition
      and a charge of $38,000 related to other MAF assets deemed to be of no remaining
      value. Additionally, during 2005 we accrued a charge of $50,000 to bad debt
      expense for the balance of the note receivable which remains un-collected.





**Note
      10 - Stock Options and Warrants**





Series
      A Warrants





Series
      A
      Warrants were issued in connection with the June 2002 Series A Preferred Stock
      private placement. Upon conversion of every five shares of Series A Preferred
      Stock into common stock, we will grant one Series A Warrant to purchase one
      share of our common stock, exercisable after one year from the date of grant
      at
      an exercise price of $2.00 per share and expiring on the second anniversary
      of
      the date of grant. The exercise price of the warrants is subject to adjustment
      for stock splits, dividends, reclassifications, and other adjustments.





Upon
      conversion of the 3,712,000 shares of Series A Preferred Stock and corresponding
      stock dividends, we will ultimately issue 859,422 Series A Warrants. During
      2004, pursuant to the warrant offering in November and December 2004, one holder
      of the Series A warrants exercised 277,831 warrants at $0.10 per warrant
      resulting in gross proceeds of approximately $28,000. As of December 31, 2006,
      there were 581,591 Series A Warrants outstanding.




F-21


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**




Series
      B and Series C Warrants





Series
      B
      and Series C Warrants were issued in connection with the November 2002 common
      stock private placement, concurrent with the MAF Acquisition. The Series B
      and
      Series C Warrants have exercise prices of $0.214 and may be exercised at the
      option of the holder at any time for a period of five years from the date of
      issuance. The exercise prices are subject to adjustment for stock splits,
      dividends, reclassifications, and other typical corporate actions. If we issue
      additional shares of common stock at a price less than $1.00 per share, the
      exercise prices of the warrants upon each such issuance will be adjusted and
      reset to such issuance price; however, this reset feature does not apply to
      the
      following:





1.
            any
                stock splits, dividends, reclassifications, or similar actions, or





2.
            any
                issuance of shares of common stock (or shares of common stock issuable
                upon the exercise of securities convertible into shares of common
                stock
                with an exercise price or a conversion price less than $1.00) if
                such
                securities were issued to consultants, employees, service providers,
                or to
                a third party to satisfy amounts owed; provided that we may not issue
                to
                such individuals, in any rolling 12-month period, more than 1,600,000
                shares of common stock or 10% of the actual number of shares of common
                stock issued and outstanding (assuming the conversion of the Series
                A
                Preferred Stock) and may not issue to any one individual more than
                500,000
                shares of common stock.





As
      long
      as a registration statement covering the shares underlying the warrants is
      effective, we may redeem any or all of the warrants, at any time, at $0.05
      per
      warrant if:





1.
            the
                closing price for our common stock on any 20 trading days within
                a period
                of 30 consecutive trading days ending on the date of the notice of
                the
                call has been in excess of 150% of the then effective exercise price,
                and





2.
            no
                less than four of such 20 days occur during the last five trading
                days
                ending on the date of the notice of the redemption.





As
      of
      December 31, 2006, there were 1,367,500 Series B Warrants and 1,367,500 Series
      C
      Warrants outstanding.





Series
      D and Series E Warrants





Series
      D
      and Series E Warrants were issued in connection with the April 2003 Series
      B
      Preferred Stock and July 2003 Series C Preferred Stock private placements.
      The
      Series D and Series E Warrants have exercise prices of $1.30 and $1.60,
      respectively, and may be exercised at the option of the holder at any time
      for a
      period of five years from the date of issuance. The exercise prices are subject
      to adjustment for stock splits, dividends, reclassifications, and other typical
      corporate actions. As of December 31, 2006, there were 1,950,000 Series D
      Warrants and 1,500,000 Series E Warrants outstanding.





Series
      F Warrants





Series
      F
      Warrants were issued in connection with the July 2003 amendment of one of our
      strategic consulting agreements. The Series F Warrants have an exercise price
      of
      $1.00 per share and may be exercised at the option of the holder at any time
      for
      a period of five years from the date of issuance. The exercise price is subject
      to adjustment for stock splits, dividends, reclassifications, and other typical
      corporate actions. As of December 31, 2006, there were 125,000 Series F Warrants
      outstanding.





Series
      G and H Warrants





Series
      G
      and H Warrants were issued in connection with the sale of
      our common stock in June and July 2004. We sold units, each unit consisting
      of
      one share of common stock, three Series G Warrants, and one Series H Warrant,
      aggregating 3,900,000 shares of common stock at $0.25 per share, 11,700,000
      Series G Warrants at an exercise price of $0.25 per share, and 3,900,000 Series
      H Warrants at an exercise price of $0.24 per share, generating cash proceeds
      of
      $772,000, net of cash offering costs of $125,000. In addition, during 2004,
      265,000 shares of common stock and 1,950,000 warrants, with a combined fair
      market value at the date of issuance of $549,000 were issued to financial
      advisors to facilitate the transaction, thus increasing the total offering
      costs
      to $599,000.





In
      December 2004, the holders of the G warrants exercised their right to convert
      the warrant in 5.8 million shares of our common stock. As of December 31, 2006,
      no G warrants and 3.9 million H warrants were outstanding. We received no
      consideration related to the G warrant conversion into our common stock. There
      were no transactions involving G or H warrants during 2005 and
      2006.




F-22


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**




Other
      Warrants





In
      connection with the Bridge Notes and Senior Secured Notes (see Note 6) during
      2003, we granted note holders an aggregate of 9,516,000 warrants at original
      exercise prices that ranged from $1.00 to $1.50 per share. The warrants may
      be
      exercised 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, and as of December
      31,
      2005 is set at $0.24.





Additionally,
      during 2003, we granted 214,000 warrants to financial advisors associated with
      the issuance of the Bridge Notes. Financial advisors associated with the Secured
      Notes were granted 558,000 warrants.





In
      conjunction with warrant exercises in November and December of 2004, 6,560,000
      of these warrants were exercised at $0.10 per warrant generating gross cash
      proceeds of $695,000. Certain holders of these exercised warrants will receive
      a
      new warrant with an exercise price of $0.10. In conjunction with this offering,
      we paid to financial advisors to help facilitate the transaction $68,000 in
      cash
      consideration and will issue 656,000 new warrants with an exercise price of
      $0.10. Effectively, we sold common stock for $0.10 per share and extend the
      terms and reduced the price of the warrants.





In
      August
      2004 we issued 125,000 warrants with an exercise price of $0.26 to one of our
      employees in connection with our joint venture with Wellness Watchers Systems
      LLC.





In
      January 2006 we granted 1,000,000 warrants to purchase common stock at $0.001
      per share to Atlas Capital as part of our agreement with them to provide
      investment banking services to us. The
      current value of these warrants was immaterial.





In
      January 2006, we granted 100,000 warrants to purchase common stock at prices
      ranging from $0.20 to $0.30 per share to an employee of one of our distributors.





In
      aggregate, as of December 31, 2006, there were 20,888,000 of these warrants
      outstanding.





Stock
      Option Plans





On
      August 1, 2001, the Board of Directors adopted our 2001 Stock Option Plan
      pursuant to which incentive stock options or non-statutory stock options to
      purchase up to 2,500,000 shares of common stock can be granted to employees,
      officers, directors, consultants, and independent contractors and other service
      providers.





On
      May 3, 2002, the Board of Directors adopted our 2002 Stock Option Plan
      pursuant to which incentive stock options or non-statutory stock options to
      purchase up to 2,000,000 shares of common stock can be granted to employees,
      officers, directors, consultants, independent contractors, and other service
      providers.





On
      July 15, 2005, the Board of Directors adopted our 2005 Stock Option Plan
      pursuant to which incentive stock options or non-statutory stock options to
      purchase up 16,819,000 shares of common stock can be granted to employees,
      officers, directors, consultants, independent contractors, and other service
      providers.




The
      combined plans had 10,251,000 options outstanding at December 31, 2006 and
      2005,
      with exercise prices ranging from $0.04 to $1.00. At December 31, 2006, there
      were an aggregate of 14,145,000 options available under the plans for future
      grant.





Options
      and Warrants Issued for Services





In
      order
      to fund operating activities, we, from time to time, grant options or warrants
      to purchase common stock in lieu of cash in consideration for consulting,
      investment banking, or other services rendered, compensation, release of debt,
      and various other claims that parties may have against us. We granted options
      and warrants to purchase common stock during the years ended December 31, as
      follows:


**2006**
              
              **2005**Number
                  Granted
              
              Fair
                  Value
              
              Exercise
                  Price
              
              Number
                  Granted
              
              Fair
                  Value
              
              Exercise
                  PriceOptions
                  & Warrants
              
              
              1,100,000
              
              $
              4,900
              
              $
              0.001-0.30
              
              
              3,550,000
              
              $
              142,000
              
              $
              0.041,100,000
              
              $
              4,900
              
              
              
              
              
              3,550,000
              
              $
              142,000




F-23


**VITAL
          LIVING, INC. AND SUBSIDIARIES**
 **Notes
          to Consolidated Financial Statements**


The
      fair
      value of certain of these options and warrants are being amortized over their
      respective vesting periods, which range from zero to 36 months. For the year
      ended December 31, 2005, $51,000 was amortized to expense. The fair value of
      unamortized options and warrants issued for services at December 31, 2006 and
      2005 was $0.00.





In
      December 2005, we issued 3,550,000 options to board members with an exercise
      price of $0.04 for services





During
      June and July 2004, in connection with the common stock offering, we granted
      an
      aggregate of 2,000,000 warrants to acquire common stock to investment advisors
      with an exercise price of $1.25 per share. Additionally, during 2004, we issued
      300,000 warrants to acquire common stock with exercise prices that ranged from
      $0.25 to $1.29 per share to various advisors.





In
      2004,
      we granted 150,000 options to an advisor to purchase common stock at an exercise
      price of $0.65 per share.





Per
      FIN
      No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” a
      non-cash charge to expense is required if the price of our common stock on
      the
      last trading day of a reporting period is greater than the exercise price of
      certain stock options and warrants issued. The requirements of FIN No. 44 may
      also result in a credit to expense to the extent that the trading price declines
      from the trading price as of the end of the previous reporting period, provided
      however that a credit is not recorded to the extent our common stock trades
      below the exercise price of the options or warrants. In accordance with FIN
      No.
      44, we adjust expense upward or downward on a monthly basis based on the trading
      price at the end of each period. Due to a decline in the trading price of the
      Company’s common stock, there was a reduction in consulting expense of $0 and
      $156,000 for the adjustments of the variable award in the years ended December
      31, 2005 and 2004, respectively.





Options
      and Warrants Issued to Employees





In
      February 2005 and December 2005, we granted to officers and employees 5,100,000
      options with an exercise price of $0.08 and 4,750,000 options with an exercise
      price of $0.04, respectively, as part of our employee stock option plan. All
      of
      these options were fully vested as of December 31, 2005.





During
      2004, we granted 80,000 warrants with an exercise price of $0.54 per share
      to
      several employees.





In
      accordance with FIN No. 44, we adjust expense upward or downward on a monthly
      basis based on the trading price at the end of each period. As a result, we
      recorded a net credit to salaries and benefits expense of approximately $648,000
      during the year ended December 31, 2005. We adopted Statement of Financial
      Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS
      123R”), effective January 1, 2006. SFAS 123R requires the recognition of the
      fair value of stock-based compensation in net income. SFAS 123R supersedes
      Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
      Compensations (“SFAS 123”) and Accounting Principles Board Opinion No. 25,
      Accounting for Stock Issued to Employees (“APB 25”). The Company has adopted
      SFAS 123R using the modified prospective method. Accordingly, prior period
      amounts have not been restated. Under the modified prospective method, stock
      options awards that are granted, modified or settled after December 31, 2005
      will be valued at fair value in accordance with provisions of SFAS 123R and
      recognized on a straight line basis over the service period of the entire
      award.. As there were no option awards granted in the twelve months ended
      December 31, 2006 and all prior option awards were fully vested prior to January
      1, 2006 there was no effect due to the implementation of SFAS 123R in twelve
      months ended December 30, 2006.





In
      January 2002, we issued 125,000 options to an employee under our 2001 Stock
      Option Plan. The options have an exercise price of $1.00 per share, expire
      in
      four years, and vest quarterly, 40,000 in the first year, 45,000 in the second
      year, and 40,000 in the third year. The fair value of the options using the
      Black-Scholes option-pricing model was determined to be zero. The current
      aggregate intrinsic value of the options outstanding and exercisable is
      $0.




F-24


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**




Summary
      of Options and Warrants





A
      summary
      of stock option activity for employees and directors for the years ended
      December 31 is as follows:


**2006**
              
              **2005****Shares**
              
              **Weighted
                  Average****Exercise
                  Price**
              
              **Shares**
              
              **Weighted
                  Average****Exercise
                  Price**Outstanding
                  at beginning of period
              
              
              13,801,000
              
              $
              0.09
              
              
              401,000
              
              $
              0.09Granted
              
              
              -
              
              
              
              
              
              13,400,000Cancelled
              
              
              (3,550,000
              )
              
              
              
              
              -
              
              $
              0.09Exercised
              
              
              -
              
              
              
              
              
              -Outstanding
                  at end of period
              
              
              10,251,000
              
              $
              0.09
              
              
              13,801,000
              
              $
              0.09Exercisable
                  at end of period
              
              
              10,251,000
              
              $
              0.09
              
              
              13,801,000
              
              $
              0.09




Information
      about stock options outstanding at December 31, 2006 is as follows:


Options
                  Outstanding
              
              
              
              
              
              Options
                  ExercisableRange
                  of Exercise Prices
              
              Shares
                  Outstanding
              
              Weighted
                  Average Remaining Contractual
                  Life
              
              Weighted
                  Average Exercise
                  Price
              
              Shares
                  Exercisable
              
              Weighted
                  Average Exercise
                  Price$0.65
                  - $1.00
              
              
              401,000
              
              
              1.75
              
              $
              0.87
              
              
              401,000
              
              $
              0.91$0.04
                  - $0.08
              
              
              9,850,000
              
              
              0
              
              $
              0.06
              
              
              9,850,000
              
              $
              0.0610,251,000
              
              
              
              
              
              
              
              
              10,251,000


A
      Summary
      of warrant activity for non-employees for the years ended December 31 is as
      follows:


**2006**
              
              **2005****Shares**
              
              **Weighted
                  Average****Exercise
                  Price**
              
              **Shares**
              
              **Weighted
                  Average****Exercise
                  Price**Outstanding
                  at beginning of period
              
              
              30,580,000
              
              $
              0.46
              
              
              31,815,000
              
              $
              0.46Granted
              
              
              1,100,000
              
              
              0.001
              
              
              -
              
              
              -Cancelled
              
              
              -
              
              
              -
              
              
              (1,235,000
              )
              
              -Exercised
              
              
              -
              
              
              -
              
              
              -
              
              
              -Outstanding
                  at end of period
              
              
              31,680,000
              
              $
              0.46
              
              
              30,580,000
              
              $
              0.46Exercisable
                  at end of period
              
              
              31,680,000
              
              $
              0.46
              
              
              30,580,000
              
              $
              0.46




F-25


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


Information
      about warrants outstanding at December 31, 2006 is as follows:


Warrants
                  Outstanding & ExercisableWeightedAverage
              
              WeightedRange
                  of
              
              
              
              Remaining
              
              AverageExercise
              
              Shares
              
              Contractual
              
              ExercisePrices
              
              Outstanding
              
              Life
              
              Price$0.01
                  - $0.35
              
              
              27,523,000
              
              
              3.10
              
              $
              0.13$0.54
                  - $1.00
              
              
              125,000
              
              
              1.98
              
              $
              -$1.30
                  - $1.65
              
              
              3,450,000
              
              
              2.52
              
              $
              0.16$2.00
              
              
              582,000
              
              
              1.42
              
              $
              0.0431,680,000
              
              
              3.00
              
              $
              0.34





**Note
      11 - Income Taxes**





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


**2006**
              
              **2005**Net
                  operating loss carryforwards
              
              $
              12,496,000
              
              $
              11,715,000Marketable
                  securities
              
              
              214,000
              
              
              214,000Accounts
                  receivable
              
              
              161,000
              
              
              161,000Deferred
                  compensation
              
              
              3,038,000
              
              
              3,038,000Inventories
              
              
              -
              
              
              0Amortizable
                  intangibles
              
              
              14,861,000
              
              
              15,600,000Other
                  temporary differences
              
              
              20,000
              
              
              42,00030,790,000
              
              
              30,770,000Less
                  valuation allowance
              
              
              (30,790,000
              )
              
              (30,770,000
              )$
              -
              
              $
              -





Net
      operating loss carry forwards are available to reduce future taxable income.
      However, a change in ownership, as defined by federal income tax regulations,
      could significantly limit our ability to utilize our U.S. net operating loss
      carry forwards. Additionally, because federal tax laws limit the time during
      which the net operating loss carry forwards may be applied against future taxes,
      if we fail to generate taxable income prior to the expiration dates, we may
      not
      be able to fully utilize the net operating loss carry forwards to reduce future
      income taxes.





As
      we
      have had cumulative losses and there is no assurance of future taxable income,
      valuation allowances have been recorded to fully offset the deferred tax asset
      at December 31, 2006 and 2005. During the years ended December 31, 2006 and
      2005, a current income tax benefit of $20,000 and $8,601,000, respectively,
      was
      offset by an equal deferred income tax provision primarily related to the
      increase in the valuation allowance. The valuation allowance increased $20,000
      during 2006 due to our current period net loss. Due to this increase in the
      valuation allowance, the effective tax rate has been reduced to 0% for the
      years
      ended December 31, 2006 and 2005. As of December 31, 2006, we had net
      operating loss carry forwards for federal income tax reporting purposes of
      approximately $34,100,000 which expire at varies periods through 2025. The
      utilization of such operating losses may be limited.





A
      reconciliation of statutory to effective income tax rates is as follows for
      years ended December 31:


2005
              
              2004Federal
                  statutory rates
              
              
              -34
              %
              $
              (28,000
              )
              
              -34
              %
              $
              (9,578,000
              )State
              
              
              -6
              %
              
              (5,000
              )
              
              -6
              %
              
              (1,690,000
              )Valuation
                  allowance
              
              
              40
              %
              
              21,000
              
              
              40
              %
              
              11,201,000Other
              
              
              -
              
              
              12,000
              
              
              -
              
              
              67,000Effective
                  rate
              
              
              0
              %
              $
              -
              
              
              0
              %
              $
              -
  F-26
  **VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**





**Note
      12 - Related Party Transactions**


****


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





Officers
      and Directors





During
      2005 a partnership owned 50% each by Stuart Benson, CEO and Gregg Linn COO/CFO
      acquired a $40,000 from the original holder of the Senior Secured Note.





In
      2006
      an entity owned 50% each by Stuart Benson, our President and CEO and Gregg
      Linn,
      our COO and CFO acquired the $1,000,000 Series D Preferred Stock and $1,000,000
      of the Senior Secured Convertible Note from the original holder Senior Secured
      Note for $417,000. Prior to purchasing these securities, Mr. Benson and Linn
      offered us the ability to purchase these securities, which we declined. Our
      Board of Director determined that we did not have adequate financial resources
      to purchase these securities and approved the purchase by Mr. Benson and Linn.
      Mr. Benson and Linn abstained from voting on this transaction.





During
      2005, we issued 100,000 and 150,000 shares of restricted common stock to then
      Directors, Carson Beadle and David Allen, respectively, in exchange for director
      services for a combined fair market value of $12,000. During 2004 we issued
      165,000 shares to Michael Cardamone in exchange for director services with
      a
      fair market value of $35,000.





During
      2006 and 2005, $12,000 and $14,000, respectively was either paid directly or
      amounts paid on behalf of Mr. Hannah, our former Chairman. These amounts were
      paid for services requested by management that were deemed outside the scope
      of
      his role as Chairman.





During
      2006, we paid Michael Cardamone, a director, $10,000 for services deemed outside
      the scope of his role as a director.





During
      2006, we paid Carson Beadle, a former director, $8,000 for services deemed
      outside the scope of his role as a director.




In
      November 2006, effective January 2007, our President and CEO, Stuart Benson,
      became a 50% shareholder in our largest distributor Wellness Watchers Global
      LLC
      (“WWG”), which is the successor entity to Wellness Watchers, LLC (“WW”). WWG
      accounted for 82.6% of our sales during 2006 and 90.8% of our trade receivables
      at December 31, 2006. WWG acquired all of the assets and liabilities of WW.
      We
      expect that substantially all of our going forward sales in 2007 are with this
      related party. In November 2006, our Board of Directors acknowledged both the
      related party nature of the transaction as well as the potential conflict of
      interest and approved Mr. Benson entering into this arrangement to acquire
      WWG
      with us. Mr. Benson abstained from voting on this transaction. At December
      31,
      2006 WWG owed the Company $933,000. At March 31, 2007, WWG still owed us
      $161,000 of the balance due from WWG at December 31, 2006.





In
      January 2006, we entered into a service agreement with Red Rock Advisors, LLC,
      an entity controlled by Gregg Linn, our COO and CFO for outside services related
      to the creation, development and management of an infomercial that utilizes
      our
      product line. These services were deemed outside his role as COO and CFO.
      Pursuant to the agreement, Red Rock Advisors, LLC will be paid $7,500 per month
      for six months, beginning in January 2007 as well as per unit fee for all future
      products sold through the infomercial. As of March 31, 2007, we owe Red Rock
      Advisors, LLC $22,500 for prior services rendered. Our Board of Directors
      acknowledged both the related party nature of this transaction as well as the
      potential conflict of interest and approved Mr. Linn entering into this
      transaction. Mr. Linn abstained from
      voting on this transaction.





In
      January 2006, we entered into a talent service agreement with WWG, an entity
      50%
      owned Stuart Benson, our President and CEO for promotional, talent and acting
      services related to the infomercial that utilizes our product line. Pursuant
      to
      the agreement, WWG will be paid a per unit fee for all future products sold
      through the infomercial.





In
      January 2007 an entity owned 100% by Stuart Benson, our President and CEO
      acquired a $192,000 of Senior Secured Convertible Notes from the original holder
      Senior Secured Note from the original holder for $40,000.




F-27


**VITAL
        LIVING, INC. AND SUBSIDIARIES**
 **Notes
        to Consolidated Financial Statements**


In
      January 2007, Michael Cardamone, a director, also became an employee of Wellness
      Watchers Global, LLC, our major distributor, an entity 50% owned by Stuart
      Benson our President and CEO.





In
      February 2007, VTLV II LLC, an entity controlled by Stuart Benson, made a
      payment of $25,000 on our behalf to one of our suppliers. The $25,000 is
      recorded as a liability to VTLV II LLC.





During
      the first quarter of 2007, we made rent payments totaling $3,000 for office
      space for our President and CEO in Boca Raton, FL. This office is the same
      office of Wellness Watchers Global, LLC, our major distributor, an entity 50%
      owned by Stuart Benson, our President and CEO.




Shareholders




In
      2006
      we granted Atlas Capital Services LLC, a stockholder, 1,000,000 warrants at
      an
      exercise price of $0.001 in conjunction with an agreement with them to provide
      consulting, investment and financial services. During 2006 we paid Atlas $67,500
      for such services We
      have
      several agreements with HCFP/Brenner Securities, LLC (“Brenner”), a stockholder,
      to provide consulting, investment, or financial services. During 2005 we paid
      Brenner $75,000 for such services.





**Note
      13 -** **Concentrations**





During
      2006 one customer was responsible for 82.6% of our sales and accounted for
      90.8%
      of our trade accounts receivable as of December 31, 2006. In January 2006 Stuart
      Benson, CEO acquired a 50% interest in this customer (see Note 12).





During
      2006 four vendors supplied all of our products for sale. One of these vendors
      one accounted for 69.7% of our product purchases.




F-28