<PAGE>
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
                                 FORM 10-KSB

[X]      Annual report under section  13 or 15(d) of the Securities Exchange
         Act of 1934 for the fiscal year ended December 31, 2001

         Transition report under section 13 or 15(d) of the Securities
         Exchange Act of 1934 for the transition period from ____________ to
         ________________

                       Commission file number: 0-30568

                         VITAL LIVING PRODUCTS, INC.
--------------------------------------------------------------------------------
            (Exact name of Registrant as specified in its charter)

----------------------------------------    ------------------------------------
                DELAWARE                                 56-1683886
----------------------------------------    ------------------------------------
        (State of incorporation)            (I.R.S. Employer Identification No.)

   5001 SMITH FARM ROAD, MATTHEWS, NC                      28104
----------------------------------------    ------------------------------------
(Address of principal executive offices)                 (Zip Code)

         Company's telephone number, including area code:  (704) 821-3200

         Securities registered pursuant to Section 12(b) of the Act:  None

         Securities registered pursuant to Section 12(g) of the Act: Common
         Stock, par value $.01 per share

         Check whether the issuer: (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act 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   X       No
                   -----        -----

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B is not contained herein, and will not be contained,
to the best of the Company'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. X

         The issuer's revenues for its most recent fiscal year were
$1,684,164. The aggregate market value of shares of the issuer's $.01 par
value Common Stock, its only outstanding class of common equity, held by
non-affiliates as of March 12, 2002 was $3,335,731.

         The number of issued and outstanding shares of the issuer's $.01 par
value Common Stock, its only outstanding class of common equity, as of March
12, 2002 was 17,194,521 shares.

         The indicated portions of the following documents are incorporated by
reference into the indicated parts of this Annual Report on Form 10-K:

<TABLE>
<CAPTION>
                                                                         Parts Into Which
                   Incorporated Documents                                  Incorporated
<S>                                                                     <C>
                   None

         Transitional Small Business Disclosure Format (Check one):  Yes          No   X
                                                                         -----       -----
</TABLE>



<PAGE>

                                    PART I

ITEM 1.           DESCRIPTION OF BUSINESS

         Vital Living Products, Inc. (the "Company", which may be referred to
as "we", "us" or "our"), was incorporated in North Carolina in January 1990.
On December 23, 1991 the Company merged into a Delaware corporation bearing
the same name as a result of which the Company became a Delaware corporation.
We do business under the name American Water Service and sell a variety of
water treatment and testing products and services, including home water test
kits, water treatment equipment and high purity drinking water vended from
machines placed at retail locations.

         We began as a manufacturer and distributor of two proprietary
drinking water programs: The Drinking Water Machine(TM) and The Raindrop
Shoppe(TM). The Drinking Water Machine(TM) was the first in-store water
bottling program for grocery stores. The Raindrop Shoppe(TM) provided
consumers with an in-store water vending program.

         In April 1992, we consummated an initial public offering of our
shares of common stock at $3.25 per share. During the first twelve months of
trading on the Nasdaq Stock Market our stock price fell to $.25 per share. The
following year operational losses completely depleted all cash raised from the
initial public offering.

         In March 1993, the chairman of our board, C. Wilbur Peters, made
changes in management personnel, personally assumed the role of president and
chief executive officer and began funding the Company's operations using his
own financial resources. Soon thereafter, the Company halted placements of the
unprofitable Drinking Water Machine(TM) and Raindrop Shoppe(TM) and began
installing self-serve coin-operated water vending machines on revenue share
programs with retailers. In connection with this shift in focus towards a more
conventional business model we began using the name "American Water Service"
in our dealings with customers and suppliers. However, we have always used our
full corporate name in our dealings with our shareholders and the investment
community in general.

         In March 1994, our common stock, trading as low as $.04 per share,
ceased to be traded on the Nasdaq Stock Market. (Since then it has been traded
on the Nasdaq OTC Bulletin Board, except for the period from May 2000 through
September 2000, when it was quoted in the "pink sheets" maintained by the
National Quotation Bureau, LLC.) Vending machine installations continued to
grow, however, and in 1994 we began selling water treatment equipment for home
and commercial use.

         In 1995 we began developing a line of home water test kits designed
to enable consumers to test the safety and quality of their home's tap water.
In late 1996 we launched the first of our PurTest(R) line of home water
testing products, our PurTest(R) Bacteria test kit. By the fall of 1997 we had
a comprehensive home water test kit product line on the market. Since then,
because we believe the continued development of our PurTest(R) line of
products offers the best opportunity to grow our business, it has been our
primary focus.

         In October 2001 we announced that we were developing a home testing
kit for the anthrax bacteria. Soon after we made a public announcement
concerning our efforts to develop this product, each of the Federal Trade
Commission and the North Carolina Department of Justice's Consumer Protection
Division opened an investigation regarding these efforts and each of the
Securities and Exchange Commission and the National Association of Securities
Dealers, Inc. opened an investigation regarding these efforts and into alleged
unlawful insider trading in our common stock. In addition, the U.S. Attorney's

<PAGE>


Office for the Southern District of New York opened an investigation into
whether our efforts to develop and market PurTest(R) Anthrax Test were part of
a fraudulent criminal scheme as well as whether or not we or certain of our
officers and directors may have violated various securities laws. Each of
these investigations, other than the investigation by the FTC, is currently
pending. In January 2002 we agreed with the FTC on the form of a consent order
that was entered in February 2002. This consent order prohibits us, among
other things, from marketing PurTest(R) Anthrax Test or any similar product or
other biohazard test or device unless we possess competent scientific evidence
substantiating its efficacy. Given the concerns raised by the SEC, the NASD,
the FTC, the North Carolina Department of Justice's Consumer Protection
Division and the U.S. Attorney's Office, we have suspended our efforts to
market PurTest(R) Anthrax Test. (See discussion below under ITEM 3 - LEGAL
PROCEEDINGS.)

WATER TESTING PRODUCTS

         We are currently the only U.S. provider of a comprehensive set of
home water test kits. Our PurTest(R) line of test kits includes: PurTest(R)
Bacteria, Nitrate, Nitrite; PurTest(R) Lead; PurTest(R) Iron Hardness Plus;
PurTest(R) Pesticide; PurTest(R) Arsenic; and PurTest(R) Home Water Analysis
Kit.

         Concern with the safety of water is growing in the United States as
well as in other countries. According to a recent study conducted by the Water
Quality Association, a water industry group, many Americans are concerned
about their water and want to know more about what is in their water. In the
United States there are over 16 million private drinking wells which the
Environmental Protection Agency (the "EPA") recommends be tested annually for
nitrates and coliform bacteria and more frequently for pesticides if a problem
is suspected. We developed our PurTest(R) line of home water test kits to
provide people concerned with the safety of their water with an alternative to
laboratory testing:

         -    Our PurTest(R) Bacteria, Nitrate, Nitrite test kit utilizes EPA
              based methods to determine the absence or presence of coliform
              bacteria and instantly shows whether or not water is above or
              below the EPA safe standards for nitrates or nitrites. This test
              kit typically retails for around $13.00.

         -    Our PurTest(R) Pesticide test kit tests for 13 triazine elements
              and produces results in less than eight minutes. This test kit
              typically retails for around $13.00.

         -    Our PurTest(R) Iron Hardness Plus test kit instantly tests for
              eight items including iron, hardness, copper, nitrates,
              nitrites, chlorine, water pH, and alkalinity. This test kit
              typically retails for around $6.00.

         -    Our PurTest(R) Lead test kit detects lead down to the EPA safe
              standard of 15 ppb (parts per billion) and produces results in
              less than one hour. This test kit typically retails for around
              $15.00.

         -    Our PurTest(R) Arsenic test kit detects arsenic down to the
              World Health Organization safe standard of 10 ppb (parts per
              billion) and produces results in minutes. This test kit
              typically retails for around $13.00.

         -    Our comprehensive PurTest(R) Home Water Analysis kit includes
              the Bacteria, Nitrate, Nitrite kit, Iron Hardness Plus kit, and
              Lead test kit, allowing the user to screen water for 12
              contaminants and conditions without needing to use a laboratory.
              This comprehensive test kit typically retails for around $30.00.


                                      2

<PAGE>


         We market our PurTest(R) line of products as a quick and inexpensive
alternative to laboratory testing. Recommended uses include initial and
regular follow-up testing to ensure continued water safety as well as testing
following the installation of water treatment products to verify treatment
effectiveness. Each of our test kits includes a toll-free number the customer
can call to obtain free advice from our trained employees regarding water
safety and available water treatment products.

         PurTest(R) water testing products are available through our website
(www.purtest.com) and nationwide at retailers including Ace Hardware, Do It
Best, Lowe's, Menards and many Home Depots, as well as water treatment
dealers, water well drillers and other independent retailers and building
centers. Through various international distributors, PurTest(R) products have
been sold internationally in 18 countries.

         We manufacture some component parts for PurTest(R) products
ourselves. Other components are manufactured for us to our specifications by
various suppliers. The principal active components are test strips, chemicals
and powders designed to react with samples. The test strips, chemicals and
powders contain compounds that cause the test strip or sample to change color
to indicate the amount of the items being tested that is contained in the
sample.

         Some of these test strips, chemicals and powders are supplied to us
on an exclusive basis pursuant to marketing and manufacturing agreements we
have entered into with each of Strategic Diagnostics, Inc., ASC Laboratories,
Inc., Universal Supplements Corp. and LaMotte Company which prohibit the
supplier from selling them to other manufacturers or directly to consumers. We
consider such exclusive arrangements to be important because of the time and
effort invested in locating such suppliers, developing specifications and
coordinating product development with such suppliers, and to keep competitors
from obtaining the benefit of our product development work without making such
investment themselves. We have one contract with a supplier of test strips
which has a five-year term expiring in July 2004 and which automatically
renews for one year terms unless it is terminated at least 60 days prior to
its expiration. The remaining three contracts, each with a supplier of powder,
are intended to be long-term but permit the supplier to terminate on 120 days
notice. However, if any such contract is so terminated the supplier is
required to provide us with all technical information necessary for us to
either produce the powder ourselves, or have another supplier produce the
powder for us.

         All component parts we use, including those supplied to us on an
exclusive basis, can be purchased from other manufacturers. We believe the
arrangements we have developed with our suppliers are adequate to meet our
current needs and that if any of these arrangement were terminated, under the
termination provisions of the contracts we would be able to find acceptable
alternative suppliers in time to avoid significant disruption of our business.
We assemble and package the final product at our facilities in Matthews, North
Carolina.

WATER TREATMENT EQUIPMENT AND SERVICES

         We also sell and service water treatment products for both home and
office use. Our PurGuard(R) RO unit utilizes reverse osmosis technology to
produce high purity drinking water at a location's primary drinking water
faucet by filtering out contaminants such as dirt, sediment, dissolved solids,
viruses, organic molecules, pesticides and chlorine. We sell PurGuard(R) RO
units at wholesale to water treatment dealers for about $250 and will sell a
unit to a retail customer with installation for around $600. We also offer
PurGuard(R) RO service plans to customers for $20 to $30 per month. All new
PurGuard(R) RO units we sell to consumers come with a five year limited
warranty.

         Our PurGuard(R) UV unit utilizes ultraviolet technology to treat
bacteria in water and is designed to treat water at its entry point into a
household so that treated water is available throughout the household. We

                                      3

<PAGE>

sell PurGuard(R) UV units at wholesale to water treatment dealers for between
$200 and $300 and will sell a unit to a retail customer with installation for
between $600 and $800. We also offer PurGuard(R) UV service plans to customers
for $19.95 per month. All new PurGuard(R) UV units we sell come with a seven
year limited warranty.

         We also offer a complete line of point of entry water treatment
products including among other items softeners, neutralizers and iron filters
and sell other water treatment products including replacement bulbs and
filters and American Aqua(R) brand counter-top and shower head filtration
products. We offer financing on the installed water treatment products we sell
to customers with satisfactory credit ratings.

         On a parts and labor basis, within the greater Charlotte, North
Carolina region we service all water treatment products we sell as well as all
other water treatment products available on the market.

         Because we install and service most water treatment units we sell
directly, our retail water treatment equipment business is limited
geographically primarily to the greater Charlotte, North Carolina region.
However, our full line of water treatment products is available for purchase
though our website and our PurGuard(R) UV line of products is sold nationwide
by Lowe's and by many water treatment dealers.

         We assemble some of our water treatment units at our facilities in
Matthews, North Carolina. Other units are built for us to our specifications
by various suppliers. We believe other sources of supply for such products are
available and therefore do not believe the loss of any one of our current
suppliers would have a material adverse effect on our operations.

VENDING MACHINES AND MISTING SYSTEMS

         We also sell drinking water dispensed to consumers through
self-service vending machines as well as high purity water used by grocery
stores in produce-misting systems. Our vending machines dispense high quality,
low priced drinking water under the brand name "America's Purist Water." We
charge between $.25 and $.40 per gallon for water dispensed by our machines.

         We place our vending machines inside or outside retail stores and
have revenue sharing arrangements with the stores. Establishments with whom we
have such agreements include K-Mart, Harris Teeter, Kroger, Winn Dixie and
Family Dollar. In some locations, in addition to vending water to consumers,
our machines are used to purify water used in produce-misting systems we
maintain for grocers. In other locations, we place machines used solely to
provide water for produce-misting systems.

         Our vending machines utilize a combination of reverse osmosis,
activated carbon, sediment filtration and/or ultra violet disinfection to
process and treat water.

         We had over 100 vending and misting units in operation as of December
31, 2001 placed in various locations in North Carolina, South Carolina,
Tennessee, Virginia and West Virginia.

         Our water vending and misting units are built for us to our
specifications by various suppliers. We believe other sources of supply are
available and therefore do not believe the loss of any one of our current
suppliers would have a material adverse effect on our operations.

                                      4

<PAGE>

MAJOR CUSTOMERS

         Sales to Lowe's, Nikken and Kroger comprised approximately 23%, 12%
and 10% respectively of our total 2001 sales. Sales to Lowe's and Kroger
comprised approximately 16% and 10% respectively of our total 2000 sales. We
do not have any contracts with any of our major customers.

COMPETITION

         While there are various companies that offer home water testing kits
that compete directly with one or more of our individual PurTest(R) products,
our PurTest(R) product line is the most comprehensive set of home water test
kits available to U.S. retailers and consumers. Because we are able to offer
retailers the ability to purchase a comprehensive line of products from a
single supplier we believe retailers are more likely to purchase products from
us so they may avoid having to deal with multiple suppliers. By adding to
their product offerings, however, other firms could develop similarly
comprehensive lines of products. Also, companies not currently involved in the
home water test kit market could enter it by developing competing lines of
products. Potential competitors could include larger companies which have
greater financial, development, marketing and distribution resources than we
do.

         In addition, laboratory testing which is available nationwide
competes directly with our water test kit business. In many locations,
laboratory testing is offered by health departments and other governmental
agencies or by local commercial laboratories that will test water for a fee.
There are also a number of laboratories that offer mail-order water testing
services. In many areas water treatment equipment dealers offer free home
water testing as a part of their marketing efforts.

         We believe our home water test kits offer significant competitive
advantages over laboratory testing. Our test kits are generally less expensive
than other available testing services and are also more convenient since the
user performs the test right at the source without needing to bring or mail a
sample to a laboratory or schedule an appointment with a technician. Our
PurTest(R) products also generally produce results much more quickly than
laboratory alternatives. Because PurTest(R) products are utilized at the home
there is no danger of sample contamination as can happen when samples are sent
through the mail to laboratories. Also, users of our PurTest(R) products,
unlike users of the free water testing performed by water treatment dealers,
can quickly and inexpensively test their water without being subject to any
unwanted sales pitch.

         The water treatment industry is highly competitive. Our water
treatment equipment business competes with many local, regional and national
water treatment dealers and their franchisees. Some of our competitors are
larger companies which have significantly greater resources than we do. We
believe that because our current supply arrangements are favorable we are able
to offer more competitive prices on our water treatment products than many of
our competitors and that our PurGuard(R) UV unit features technology superior
to that of many competing products. We also believe our ability to service all
makes and models of water treatment equipment gives us a competitive advantage
over many other water treatment equipment servicers.

         Our water vending business competes in the non-sparkling segment of
the highly competitive bottled water market with companies that deliver water
to homes and offices, off-the-shelf marketers and other vending machine
operators as well as with water treatment products similar to our PurGuard(R)
RO and PurGuard(R) UV units available on the market. Many of our vending
business's competitors, including water vending companies like Glacier Water
Services (Glacier), as well as bottled water companies like the Perrier Group
(Poland Spring), have significantly greater resources than we do. In addition,
there are a number of smaller companies that place water vending machines in
territories we serve and compete directly with

                                      5

<PAGE>

our vending business. Because our vending business's primary competitive
advantage over water delivery services and off-the-shelf marketers is price, a
substantial decline in the price of either delivered or off-the-shelf bottled
water could adversely affect the demand for water dispensed from our vending
machines.

REGULATION

         The water industry is subject to a variety of federal, state and
local laws and regulations. Various state laws and regulations require us to
obtain licenses for our vending machines, pay annual license and inspection
fees, comply with certain detailed design and quality standards regarding our
vending machines and our vended water, and continuously control the quality of
our vended water. In some states our vending machines are subject to routine
and random state-conducted regulatory quality inspections. Installation of our
water treatment products is generally subject to local plumbing codes.
Although we believe we are operating in substantial compliance with these laws
and regulations, they and their interpretations and enforcement are subject to
change. Our water testing products are not currently subject to any direct
government regulation. However, we are bound by a consent order entered into
in February 2002 in connection with the FTC's investigation into our marketing
of PurTest(R) Anthrax Test under which we are prohibited from marketing
PurTest(R) Anthrax Test or any similar product or other biohazard test or
device unless we possess competent scientific evidence substantiating its
efficacy. There can be no assurance that additional or more stringent
requirements will not be imposed on our operations in the future. Failure to
comply with such current or future laws and regulations could result in the
imposition of fines, a temporary shutdown of our vending operations, the loss
of certification to sell our vended water or, even in the absence of
governmental action, a reduction in our profit margins based on increases in
licensing or inspection fees payable by us or other additional compliance
costs.

EMPLOYEES

         As of December 31, 2001, we had a total of 14 full time employees and
two part time employees, and as of March 25, 2002, we had a total of 10 full
time employees and three part time employees. None of our employees is covered
by a collective bargaining agreement. We believe that our relations with our
employees are good.

ITEM 2.           DESCRIPTION OF PROPERTY

         Our principal office and operating facilities are located in
Matthews, North Carolina, in a building that we lease. The building, which
contains approximately 2,300 square feet of office and 10,700 square feet of
warehouse space, is in good condition. Our lease is for a term ending March
31, 2004, subject to extension at our option for an additional two years, at a
monthly rate of $3,600. We believe that our current facilities will be
adequate to meet our needs for the foreseeable future and that suitable
additional or alternative space will be available if needed.

ITEM 3.           LEGAL PROCEEDINGS

         In October 2001 we announced that we were developing a home testing
kit for the anthrax bacteria. Soon after we made a public announcement
concerning our efforts to develop this product, each of the Federal Trade
Commission and the North Carolina Department of Justice's Consumer Protection
Division opened an investigation regarding these efforts and each of the
Securities and Exchange Commission and the National Association of Securities
Dealers, Inc. opened an investigation regarding these efforts and into alleged
unlawful insider trading in our common stock. In addition, the U.S. Attorneys
Office for the Southern District of New York has opened an investigation into
whether our efforts to develop and market PurTest Anthrax(R) Test were part of
a fraudulent criminal scheme as well as into

                                      6
<PAGE>


whether or not we or certain of our officers and directors may have violated
various federal securities laws. Each of these investigations, other than the
investigation by the FTC, is currently pending. On November 30, 2001 the FTC
informed us that it was planning to file a complaint in federal court seeking
an injunction to prevent us from marketing the anthrax test kit. In January
2002 we agreed with the FTC on the form of a consent order that was entered in
February 2002. This consent order prohibits us, among other things, from
marketing PurTest(R) Anthrax test or any similar product or other biohazard
test or device unless we possess competent scientific evidence substantiating
its efficacy. On December 4, 2001 the SEC staff informed us that it had
recommended to the SEC that it file a civil enforcement action against us and
Donald R. Podrebarac, our chief executive officer, for violations of Section
10(b) of the Securities Exchange Act of 1934 (the "Securities Exchange Act")
and Rule 10b-5 thereunder. The remedies the SEC staff is considering
recommending that the SEC seek include an injunction requiring us to not
violate the securities laws in the future, fines and an order preventing Mr.
Podrebarac from being an officer of a public company, which would include the
Company. In connection with the investigation by the U.S. Attorneys Office for
the Southern District of New York, on November 29, 2001 the FBI executed a
search warrant at our offices. As of March 31, 2002, no indictments had been
issued but it is possible that either Mr. Podrebarac or the Company or both
may be indicted in connection with this investigation. These investigations
and related litigation will be very costly to defend and we might not have
sufficient resources to mount successful defenses. Defending this litigation
will require substantial efforts from members of our senior management team
that will to some extent divert them from managing our operations. If we were
to lose or settle any such case, the remedies imposed, which might include
fines and consent orders preventing Mr. Podrebarac from working for the
Company, would likely have a material adverse effect on the Company and we
might not be able to continue to fund our operations.

         In addition, we may from time to time in the future become a party to
various legal proceedings incidental to our business.

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

         Not applicable.
                                     PART II

ITEM 5.           MARKET FOR COMMON EQUITY AND OTHER STOCKHOLDER MATTERS

         As of March 25, 2002, the Company had issued and outstanding
17,194,521 shares of common stock held by approximately 191 holders of record.

         From March 1994 through May 2000 our common stock was quoted on the
Nasdaq OTC Bulletin Board under the symbol "VLPI". From May 2000 through
September 2000 our common stock was quoted in the "pink sheets" maintained by
the National Quotation Bureau, LLC. Since September 2000 our common stock has
been quoted on the Nasdaq OTC Bulletin Board. The range of high and low sales
prices for the common stock as quoted on the OTC Bulletin Board or in the
"pink sheets" are listed below for the periods indicated. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission
and may not represent actual transactions.

<TABLE>
<CAPTION>
Fiscal Year 2000:                   Quarter Ended:                     High:                              Low:
----------------                    -------------                      -----                              ----
<S>                                <C>                                <C>
First Quarter                       March 31, 2000                     $3.38                              $1.75
Second Quarter                      June 30, 2000                      $2.06                              $0.88
Third Quarter                       September 30, 2000                 $1.50                              $0.55
Fourth Quarter                      December 31, 2000                  $1.38                              $0.50
</TABLE>

                                      7

<PAGE>

<TABLE>
<CAPTION>
Fiscal Year 2001:                   Quarter Ended:                     High:                              Low:
----------------                    -------------                      -----                              ----
<S>                                <C>                                <C>
First Quarter                       March 31, 2001                     $0.97                              $0.44
Second Quarter                      June 30, 2001                      $0.97                              $0.26
Third Quarter                       September 30, 2001                 $0.60                              $0.09
Fourth Quarter                      December 31, 2001                  $2.08                              $0.05
</TABLE>

         We have never declared or paid any cash dividends on our common
stock. We currently anticipate that we will retain any future earnings to fund
the development of our business and therefore do not anticipate paying any
cash dividends in the foreseeable future. Our Certificate of Incorporation
provides that we may not pay dividends on our common stock unless we have
first paid all accrued dividends on our Series A, Class B preferred stock and
have first paid dividends of $12.00 per share during the calendar year on our
Series B, Class B preferred stock. Accrued dividends on our Series A, Class B
preferred stock totaled $1,311,000 at December 31, 2001, and no dividends have
been paid on our Series B, Class B preferred stock during 2002 through March
2002. Additionally, under the terms of certain Secured Convertible Debentures
issued by us on February 23, 2001 and June 15, 2001, so long as such
debentures remain outstanding we are prohibited from paying any dividends on
our common stock without the consent of the holders of such debentures.
Payment of future dividends, if any, will be at the discretion of our board of
directors after taking into account various factors, including the
restrictions described above, our earnings, financial conditions, operating
results and current and anticipated cash needs.

ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         The following discussion should be read in conjunction with the
Company's Financial Statements and the related notes thereto attached hereto
beginning at page F-1.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND DECEMBER 31,
2001

         Revenues from operations for 2001 increased 1.6% to $1,684,164 from
$1,658,035 for 2000. The increase in operating revenues was primarily the
result of an 8% increase in sales of our PurTest(R) line of products, which
grew from $950,619 in 2000 to $1,030,075 in 2001. Sales of our PurTest(R)
products improved principally (1) as a result of receiving a large initial
order for $200,000 of test strips during the second quarter of 2001 and (2) in
response to a telemarketing program we launched in late 2000 which succeeded
in increasing reorders from chain stores like Lowes, Ace Hardware and
Do-it-Best. Also contributing to the improvement in operating revenues was an
increase in revenues from the sale and service of water treatment equipment
which were up 3% from $429,847 in 2000 to $443,628 in 2001, mitigated by a
decrease in revenues from our water vending and misting operations which were
down 24% from $277,569 in 2000 to $210,459 in 2001. Revenues from water
vending and misting operations were down chiefly as a result of a shift in
focus and resources toward development of our PurTest(R) line of products.

         Gross margin was 35% in 2001 compared to 28% in 2000.

         Largely as a result of an increase in professional fees, which were
primarily associated with our exploration of additional financing sources (see
discussion below under LIQUIDITY AND CAPITAL RESOURCES) and with
investigations and litigation in connection with our efforts to develop
PurTest(R) Anthrax Test and alleged violations of insider trading laws (see
discussion below under PurTest(R) ANTHRAX TEST), loss from operations only was
$1,134,615 in 2001 compared to a loss of $722,456 in 2000. In-

                                      8

<PAGE>


cluded in professional fees in 2001 were (1) fees associated with negotiation
of the Securities Purchase Agreement we entered into in February 2001 pursuant
to which we sold $450,000 of secured convertible debentures to certain
investors and the preparation of a Registration Statement on Form SB-2
covering the resale of the shares of common stock obtainable upon exercise of
such secured convertible debentures (see discussion below under LIQUIDITY AND
CAPITAL RESOURCES), (2) fees associated with the private placement of shares
of common stock in October and November 2001, (3) $152,600 of non-cash charges
resulting from the issuance of stock and options to various consultants and
(4) fees and expenses associated with the investigations and litigation in
connection with our efforts to develop PurTest(R) Anthrax test and alleged
violations of insider trading laws. The total amount of professional fees in
2001 was $773,596, up from $216,712 in 2000. We anticipate incurring a high
level of professional fees in the first two quarters of 2002 associated
primarily with our defense of the various governmental investigations and
related litigation concerning our efforts to develop PurTest(R) Anthrax Test
and alleged violations of insider trading laws. As reflected in the notes to
our financial statements as of December 31, 2002, we have estimated that we
will incur approximately $178,000 of legal expenses during the first six
months of 2002 related to these investigations and related litigation. Our
balance sheet as of December 31, 2001 reflects a reserve in that amount
related to such costs.

         In February and June 2001 we issued to certain investors $450,000 of
convertible debentures and warrants to purchase an aggregate of 300,000 shares
of common stock (see discussion below under LIQUIDITY AND CAPITAL RESOURCES).
Upon the conversion of the debentures and the exercise of the warrants the
investors may acquire shares of our common stock at a discount below the fair
market value of such shares. Due to the preferential conversion feature of the
debentures and the below fair market value exercise price of the warrants, we
have recorded $450,000 of interest expense and additional paid in capital in
2001. This debt issuance cost represents the value attributed to the
conversion feature of the debentures and the warrants, and it has been limited
to the amount of the proceeds allocated to the securities.

         Primarily as a result of the $450,000 in interest expense we recorded
in connection with the issuance of debentures and our incurring substantial
professional fees as described above transaction, net loss for 2001 was
$1,674,311, compared to net loss for 2000 of $793,761.

PURTEST(R) ANTHRAX TEST

         In October 2001 we announced that we were developing a home testing
kit for the anthrax bacteria. Soon after we made a public announcement
concerning our efforts to develop this product, each of the Federal Trade
Commission and the North Carolina Department of Justice's Consumer Protection
Division opened an investigation regarding these efforts and each of the
Securities and Exchange Commission and the National Association of Securities
Dealers, Inc. opened an investigation regarding these efforts and into alleged
unlawful insider trading in our common stock. In addition, the U.S. Attorneys
Office for the Southern District of New York has opened an investigation into
whether our efforts to develop and market PurTest Anthrax(R) Test were part of
a fraudulent criminal scheme as well as into whether or not we or certain of
our officers and directors may have violated various federal securities laws.
Each of these investigations, other than the investigation by the FTC, is
currently pending. On November 30, 2001 the FTC informed us that it was
planning to file a complaint in federal court seeking an injunction to prevent
us from marketing the anthrax test kit. In January 2002 we agreed with the FTC
on the form of a consent order that was entered in February 2002. This consent
order prohibits us, among other things, from marketing PurTest(R) Anthrax test
or any similar product or other biohazard test or device unless we possess
competent scientific evidence substantiating its efficacy. On December 4, 2001
the SEC staff informed us that it had recommended to the SEC that it file a
civil enforcement action

                                      9

<PAGE>

against us and Donald R. Podrebarac, our chief executive officer, for
violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5
thereunder. The remedies the SEC staff is considering recommending that the
SEC seek include an injunction requiring us to not violate the securities laws
in the future, fines and an order preventing Mr. Podrebarac from being an
officer of a public company, which would include the Company. In connection
with the investigation by the U.S. Attorney's Office for the Southern District
of New York, on November 29, 2001 the FBI executed a search warrant at our
offices. As of March 31, 2002, no indictments had been issued but it is
possible that either Mr. Podrebarac or the Company or both may be indicted in
connection with this investigation. These investigations and related
litigation will be very costly to defend and we might not have sufficient
resources to mount successful defenses.

         Given the concerns raised by the SEC, the NASD, the FTC, the North
Carolina Department of Justice's Consumer Protection Division and the U.S.
Attorneys Office and pursuant to the consent order entered into in connection
with the FTC investigation, we have suspended our efforts to market PurTest(R)
Anthrax Test. Additionally, our concentration in focus during the fourth
quarter of 2001 on our attempts to get PurTest(R) Anthrax Test to market and
disruptions caused by the FBI's seizure of many of our files and our computers
negatively impacted sales for the quarter. Similarly, there has been
considerable negative publicity concerning our efforts to develop PurTest(R)
Anthrax Test and the related governmental investigations and related
litigation which negatively impacted sales in the fourth quarter of 2001 and
which might impact sales in the future. As a result, we expect sales in the
first two quarters of 2002 to be lower than sales in the previous year
quarters. Since we have incurred and will continue to incur substantial
expenses in connection with these governmental investigations we expect that
operating loss for the first two quarters of 2002 will increase significantly
compared to the previous year quarters.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31,
2000

         Increasing sales of our PurTest(R) line of products by increasing our
distribution network and developing our product line was our primary focus in
1999 and 2000. We sought to increase sales primarily by developing
relationships with regional chain stores like Menards, which began selling
PurTest(R) products in September 1999. We also sought to increase consumer
awareness of PurTest(R) products by obtaining endorsements from organizations
like the American Quality Institute, which awarded the PurTest(R) product line
its "Consumer Product Award" for 1999 and 2000, and "Today's Homeowner"
magazine which selected our PurTest(R) product line as one of its "Best New
Products for 1999."

         Revenues from operations for 2000 decreased 15% to $1,658,035 from
$1,947,021 in 1999. The decrease in operating revenues was primarily the
result of a 21% decrease in sales of our PurTest(R) line of products, which
fell from $1,196,090 in 1999 to $950,621 in 2000. Sales of our PurTest(R)
products declined principally because in the third quarter of 1999 we had a
large initial PurTest(R) order from a national chain store of $362,261,
whereas in 2000 we did not receive any similar orders. Reorders for PurTest(R)
products from existing customers rose to approximately $800,000 in 2000 from
approximately $650,000 in 1999. Revenues from the sales and service of water
treatment equipment increased 4.4% from $411,563 in 1999 to $429,847 in 2000.
Due chiefly to a shift in focus and resources toward development of our
PurTest(R) line of products, revenues from our water vending and misting
operations decreased 18% from $339,367 in 1999 to $277,569 in 2000.

         Primarily as a result of the decrease in sales of PurTest(R) products
in 2000, gross margin decreased to 28% from 32% in 1999.

         Loss from operations increased to $722,456 in 2000 from $431,572 in
1999. Expense items contributing to this loss included payroll costs of
$389,017 up 11% from $351,961 in 1999; sales and

                                      10

<PAGE>

marketing costs for our PurTest(R) line totaling $256,326 in 2000, down 16%
from $304,936 in 1999; and professional fees, primarily associated with our
filing of a registration statement on Form 10-SB to register our common stock
under the Securities Exchange Act and our exploration of additional financing
sources which were $216,712 in 2000, up from $91,161 in 1999.

         Net loss for 2000 was $793,761, compared to a net loss of $795,119 in
1999. Net loss was impacted by an increase in loss from operations which was
$722,456 in 2000 compared to $431,572 in 1999 mitigated by a decrease in
interest expense from $369,951 in 1999 to $77,329 in 2000. Interest expense
was reduced as a result of the elimination during 1999 of debt owed to C.
Wilbur Peters, Chairman of our board. On June 30, 1999 Mr. Peters forgave
approximately $2,150,000 of our debt to him and on November 5, 1999 Mr. Peters
released and discharged the balance due on our $3,035,535 promissory note to
him in exchange for our issuing 31,290 shares of our Series B, Class B
preferred stock to Mr. Peters.

LIQUIDITY AND CAPITAL RESOURCES

         We have incurred operating losses each year since our inception.
Through 2001 C. Wilbur Peters, chairman of our board, or entities controlled
by Mr. Peters have funded our operations by lending money to us and by leasing
equipment to us used in our business. As of June 30, 1999 our total
indebtedness to Mr. Peters for money borrowed and for accrued and unpaid
amounts due under equipment leases was approximately $5,180,000. On June 30,
1999 Mr. Peters forgave approximately $2,150,000 of our debt to him and on
November 5, 1999 Mr. Peters released and discharged the balance due on our
$3,035,535 promissory note to him in exchange for our issuing 31,290 shares of
our Series B, Class B preferred stock to Mr. Peters. On July 1, 1999, we
established a line of credit with Mr. Peters in the amount of $750,000
evidenced by a promissory note bearing interest at the LIBOR Market Index Rate
plus 1.50%, due and payable on June 30, 2001. On February 21, 2001, Mr. Peters
executed an amendment to the promissory note extending its term to February
23, 2003. On October 22, 2001 Mr. Peters executed another amendment to the
promissory note under which Mr. Peters agreed to accept prepayments on the
note and to re-lend to the Company on demand the amount of any such
prepayments through the term of the note. At March 25, 2002, the outstanding
balance of that note was approximately $761,070. Pursuant to a promissory note
dated September 1, 1992 on such date we borrowed $400,000 from CTF, Inc., a
non-profit corporation controlled by Mr. Peters. This note was originally
payable in full on May 9, 1993. On February 21, 2001, CTF, Inc. executed an
amendment to this note extending its term to February 23, 2003. On July 1,
2001 CTF, Inc. executed another amendment to the promissory note under which
CTF, Inc. agreed to accept prepayments on the note and to re-lend to the
Company on demand the amount of any such prepayments through the term of the
note. This note bears interest at prime plus 2%. At March 25, 2002, the
outstanding balance of that note was approximately $244,118.

         Pursuant to a Securities Purchase Agreement dated February 23, 2001,
on February 23, 2001 we received a $225,000 investment from certain investors
through the issuance of $225,000 aggregate principal amount of 12% Secured
Convertible Debentures due February 23, 2002 and on June 15, 2001 we received
an additional $225,000 investment from the same investment group through the
issuance of $225,000 aggregate principal amount of 12% Secured Convertible
Debentures due June 15, 2002. As of December 31, 2001 these debentures were
convertible into shares of our common stock at a conversion price of the
lesser of $0.06, subject to adjustment under certain antidilution provisions,
and fifty percent of the average of the lowest three inter-day trading prices
for our common stock during the twenty trading day period ending one trading
day prior to the date of conversion. In connection with the sale of the
debentures we also issued to the holders of the secured convertible debentures
three-year warrants which as of December 31, 2001 were exercisable for an
aggregate of 633,129 shares of common stock at an exercise price equal to the
lesser of $0.11, subject to adjustment under certain antidilution provisions,

                                      11

<PAGE>

and the average of the lowest three inter-day trading prices for our common
stock during the ten trading day period ending one trading day prior to the
date of exercise.

         As of March 25, 2002 and including accrued interest, the investors
held a total of approximately $71,812 of secured convertible debentures which
were payable in full on February 23, 2002 and $239,096 of secured convertible
debentures which are payable in full on June 15, 2002. As of March 25, 2002
these debentures were convertible into a minimum of 5,181,800 ($310,908/$0.06)
shares of common stock. Assuming that as of March 25, 2002 the debentures were
fully converted and all 633,129 of the warrants were fully exercised, and
including 357,678 shares of restricted stock held by the investors, the
investors would hold 6,172,607 shares of common stock, which would represent
approximately 36% of our total outstanding shares.

         On November 29, 2001 we received notices of default from the holders
of the secured convertible debentures claiming that because we had failed to
continuously maintain an effective registration statement covering the
securities held by them, we were in default under the debentures. On November
9, 2001, we filed a Registration Statement on Form SB-2 covering such
securities but such registration statement has never been declared effective.
On February 23, 2002 approximately $72,000 of the convertible debentures came
due. Through March 25, 2002 we had not paid this balance due. Under the default
provisions of these debentures, the failure to make a payment when due
constitutes default under all the debentures. Under the terms of the
debentures, upon the occurrence of a default thereunder the holders are
entitled to cause the debentures to become immediately due and payable in an
amount equal to the greater of (i) 130% of the outstanding principal and
interest on the debentures and (ii) the number of shares obtainable upon
exercise of the outstanding principal and interest on the debentures, treating
the date of payment as the conversion date, times the highest closing price for
our common stock during the period beginning on the date of the default through
the date of payment. If we have been in default under the debentures since
November 29, 2001, the date we received the default notice from the holders of
the debentures, the amount due to the holders upon exercise of the foregoing
remedy would be approximately $2,500,000. To date the holders have not invoked
this remedy, but they may do so at any time.

         If the holders of the debentures demand payment thereunder we would
not likely have sufficient funds to meet our payment obligations and we could
be forced into bankruptcy. The debentures are secured by all of the Company's
assets and intellectual property. If the holders elect to exercise their
remedies under the security agreement, our assets would become subject to
foreclosure and it would likely be impossible to remain a going concern.

         In October and November 2001 we raised $690,000 through the private
placement of 9,526,866 shares of common stock. We used the proceeds from the
sale of these securities to temporarily pay down the balance on our notes to
Mr. Peters and CTF, Inc. Pursuant to the amendments to these notes described
above, Mr. Peters and CTF, Inc. are required to re-lend to us on demand
through February 23, 2003 the amount of the payments we made on these notes.
As of March 25, 2002 the amount still available to us under these notes was
approximately $160,000.

         Net cash used by operating activities was $747,938 in 2001 and
$629,162 in 2000. In both such periods cash to fund such negative cash flows
was obtained from the financing arrangements described above. During the first
three months of 2002 and primarily as a result of the expenses we have
incurred in defending the various governmental investigations and related
litigation concerning our efforts to develop PurTest(R) Anthrax Test and
alleged violations of insider trading laws, we have experienced large negative
cash flows from our operations. We expect such large negative cash flows to
continue in the second quarter of 2002 and do not expect positive cash flows
from our operations during 2002. Since as of March 25, 2002 our only
immediately available source of liquidity, other than cash generated from our

                                      12

<PAGE>

operations, is the approximately $160,000 available to be borrowed under our
lending arrangements with CTF, Inc., we will either need to obtain additional
financing in April or May, 2002, or substantially reduce our expenses or we
will cease to have the funds necessary to continue to fund our operations.
Additionally, if the holders of the secured convertible debentures demand
payment thereunder, we will require additional financing to repay the
debentures.

         As of March 25, 2002 we did not have any commitments for additional
funding. We intend to explore various financing alternatives, including the
sale of convertible debt securities and the private placement of our equity
securities. It is not likely, however, that when needed we will be able to
secure additional necessary funding on acceptable terms. If we are unable to
obtain additional financing our financial condition will be materially
adversely affected and in order to continue as a going concern we will need to
substantially reduce expenses by significantly curtailing our operations and
by deregistering under the Securities Exchange Act in order to terminate our
reporting obligations thereunder. However, because we have incurred very
substantial expenses to date in defending the ongoing governmental
investigations and because we expect such expenses to continue, without
additional funding it is unlikely that any such efforts to reduce expenses
will prove sufficient to enable us to continue to fund our operations. If we
are forced to deregister under the Securities Exchange Act, we would cease to
file reports under the Securities Exchange Act and it would be more difficult
to obtain financial and other information regarding the Company. Additionally,
our common stock would be delisted from the Nasdaq OTC Bulletin Board and our
stockholders' ability to sell their shares would be negatively impacted.

CAUTIONARY STATEMENT AS TO FORWARD LOOKING INFORMATION

         Statements in this report as to projections of future financial or
economic performance of the Company, and statements of our plans and
objectives for future operations are "forward looking" statements, and are
being provided in reliance upon the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995. Important factors that could cause
actual results or events to differ materially from those projected, estimated,
assumed or anticipated in any such forward looking statements include:
expenses incurred in connection with governmental investigations and related
litigation concerning our efforts to develop PurTest(R) Anthrax Test; product
liability claims; general economic conditions in our markets including
inflation; recession; loss of key customers; supply interruptions; increased
competition from existing competitors and from any new entrants in our
markets; any loss of key management personnel; changes in governmental
regulations applicable to our business; and the availability of additional
funding necessary to support our operations.

                                      13

<PAGE>


ITEM 7.           FINANCIAL STATEMENTS

The following financial statements are included herein:

<TABLE>
<CAPTION>
                                                                                     Page
<S>                                                                                 <C>
         Independent Auditor's Report                                                F-1

         Balance Sheet                                                               F-2

         Statement of Operations                                                     F-4

         Statement of Changes in Stockholders' Equity                                F-5

         Statement of Cash Flows                                                     F-6

         Notes to Financial Statements                                               F-8
</TABLE>

                                      14

<PAGE>
                          VITAL LIVING PRODUCTS, INC.
                              FINANCIAL STATEMENTS
                           DECEMBER 31, 2001 AND 2000

                               TABLE OF CONTENTS



<TABLE>
<CAPTION>
                                                                                                             PAGE
                                                                                                             ----
<S>                                                                                                          <C>

Independent Auditor's Report .......................................................................          F-1

FINANCIAL STATEMENTS:

Balance Sheet - December 31, 2001 ..................................................................          F-2

Statements of Operations - for the years ended December 31, 2001 and 2000 ..........................          F-4

Statements of Changes in Stockholders' Equity - for the years ended December 31, 2001 and 2000 .....          F-5

Statements of Cash Flows - for the years ended December 31, 2001 and 2000 ..........................          F-6

Notes to Financial Statements - December 31, 2001 and 2000 .........................................          F-8
</TABLE>




<PAGE>




                          INDEPENDENT AUDITOR'S REPORT


To the Stockholders and Board of Directors
  of Vital Living Products, Inc.

We have audited the accompanying balance sheet of Vital Living Products, Inc. as
of December 31, 2001, and the related statements of operations, changes in
stockholders' equity and cash flows for the years ended December 31, 2001 and
2000. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. 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 Products, Inc. as
of December 31, 2001, and the results of its operations and its cash flows for
the years ended December 31, 2001 and 2000, 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 2 to the
financial statements, the Company has suffered recurring losses from operations,
has a net capital deficiency, and is default on its convertible debentures
payable, all of which raise substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.


Charlotte, North Carolina,                     Wagner Noble & Company
March 13, 2002.


                                      F-1
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                                  BALANCE SHEET

                                DECEMBER 31, 2001


                                     ASSETS


<TABLE>
<S>                                                                              <C>
CURRENT ASSETS:
   Cash                                                                          $  1,057
   Accounts receivable, less allowance for doubtful accounts of $10,011            98,208
   Installment accounts receivable                                                  6,990
   Prepaid expense                                                                    150
   Inventory                                                                      307,969
                                                                                 --------
     Total current assets                                                         414,374

PROPERTY AND EQUIPMENT:
   Office furniture and equipment                                                  43,067
   Warehouse equipment                                                            116,149
   Computer equipment                                                             192,787
   Vehicles                                                                        75,833
   Water service equipment                                                        427,471
   Leasehold improvements                                                          23,563
                                                                                 --------
                                                                                  878,870
   Less accumulated depreciation                                                  720,814
                                                                                 --------
     Net property and equipment                                                   158,056

OTHER ASSETS:
   Installment accounts receivable                                                 10,355
   Deferred costs, net of accumulated amortization of $56,890                      14,337
                                                                                 --------
                                                                                   24,692
                                                                                 --------
                                                                                 $597,122
                                                                                 ========
</TABLE>


         The accompanying notes to financial statements are an integral part of
this statement.


                                      F-2
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                                  BALANCE SHEET

                                DECEMBER 31, 2001


                      LIABILITIES AND STOCKHOLDERS' EQUITY


<TABLE>
<S>                                                                                             <C>
CURRENT LIABILITIES:
   Bank overdrafts                                                                              $      8,948
   Trade accounts payable                                                                            136,399
   Accrued interest payable to related parties                                                        26,022
   Accrued dividends                                                                               1,311,000
   Accrued payroll and payroll taxes                                                                  21,420
   Current portion of long-term notes payable                                                          7,398
   Other accrued liabilities                                                                         180,885
   Convertible debentures payable                                                                    293,532
                                                                                                ------------
     Total current liabilities                                                                     1,985,604

LONG-TERM NOTES PAYABLE:
   Notes payable to related parties                                                                  793,000
   Vehicle loans payable                                                                               1,262
                                                                                                ------------
     Total long-term notes payable                                                                   794,262

REDEEMABLE PREFERRED STOCK, Class A, $.01 par value,
     3,303,375 shares authorized, issued and outstanding                                              33,034

STOCKHOLDERS' EQUITY:
   Common stock, $.01 par value, 50,000,000 shares authorized; 17,518,368
     shares issued and 17,194,521 outstanding                                                         86,814
   Preferred stock - Class B, convertible, $.01 par value, 1,000,000 shares authorized
     Series A -  575,000 shares outstanding                                                        1,150,000
     Series B - 31,290 shares outstanding                                                          1,783,935
   Paid-in capital                                                                                 9,416,011
   Treasury stock, 323,847 shares, at cost                                                           (75,000)
   Retained earnings (deficit)                                                                   (14,577,538)
                                                                                                ------------
     Total stockholders' equity                                                                   (2,215,778)
                                                                                                ------------
                                                                                                $    597,122
                                                                                                ============
</TABLE>


         The accompanying notes to financial statements are an integral part of
this statement.


                                      F-3
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                            STATEMENTS OF OPERATIONS

                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000


<TABLE>
<CAPTION>
                                                                     2001                 2000
                                                                 -----------           -----------
<S>                                                              <C>                   <C>
REVENUES:
   Product sales                                                 $ 1,369,606           $ 1,295,937
   Service revenues                                                  314,558               362,098
                                                                 -----------           -----------
     Total revenues                                                1,684,164             1,658,035

COST OF GOODS SOLD:
   Direct material costs                                             713,234               673,335
   Labor, taxes and fringes                                          278,879               321,006
   Travel, vehicle and other costs                                    84,634               117,207
   Depreciation                                                       36,539                81,187
                                                                 -----------           -----------
     Total cost of goods sold                                      1,113,286             1,192,735
                                                                 -----------           -----------

GROSS MARGIN                                                         570,878               465,300

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
   Salaries, taxes and fringes                                       388,778               389,017
   Sales commissions and brokerage costs                             131,033               115,527
   Marketing, advertising and promotion expenses                     215,837               256,326
   Travel and vehicle costs                                           25,369                40,378
   Professional fees and costs                                       773,596               216,712
   Bad debt expense (recovery)                                        (1,394)                3,413
   Office and telephone costs                                        125,192               128,659
   Depreciation and amortization                                      17,974                16,999
   Insurance and other expenses                                       29,108                20,725
                                                                 -----------           -----------
     Total selling, general and administrative expenses            1,705,493             1,187,756

                                                                 -----------           -----------
INCOME (LOSS) FROM OPERATIONS                                     (1,134,615)             (722,456)

OTHER REVENUES (EXPENSES):
   Interest expense                                                 (553,690)              (77,329)
   Other                                                              13,994                 6,024
                                                                 -----------           -----------
     Total other revenues (expenses)                                (539,696)              (71,305)
                                                                 -----------           -----------

NET INCOME (LOSS) BEFORE INCOME TAXES                             (1,674,311)             (793,761)

INCOME TAX (PROVISION) BENEFIT                                            --                    --
                                                                 -----------           -----------

NET INCOME (LOSS)                                                $(1,674,311)          $  (793,761)
                                                                 ===========           ===========

BASIC INCOME (LOSS) PER COMMON SHARE                             $     (0.30)          $     (0.30)
                                                                 ===========           ===========

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                         6,017,029             3,094,081
                                                                 ===========           ===========
</TABLE>


         The accompanying notes to financial statements are an integral part of
this statement.


                                      F-4
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000


<TABLE>
<CAPTION>
                                                            COMMON STOCK
                                                    -------------------------                                            RETAINED
                                                     NUMBER OF          $.01          PAID-IN          TREASURY          EARNINGS
                                                      SHARES         PAR VALUE        CAPITAL            STOCK          (DEFICIT)
                                                    ----------        -------        ----------        --------       ------------
<S>                                                 <C>              <C>             <C>               <C>            <C>
BALANCE, December 31, 1999                           3,320,298        $33,203        $7,871,605        $(75,000)      $(11,833,466)
Dividends accrued on Series A,
   Class B, preferred stock at
   $.16 per share                                           --             --                --              --           (138,000)

Reclassification of Class A, preferred stock                --             --                --              --                 --

Services provided at no charge by
  stockholder                                               --             --            35,408              --                 --
Options granted to nonemployees for
  services provided                                         --             --            43,238              --                 --

Issue of common stock, 101,875 shares                  101,875          1,018            11,950              --                 --

Net loss for the year ended
   December 31, 2000                                        --             --                --              --           (793,761)

                                                    ----------        -------        ----------        --------       ------------
BALANCE, December 31, 2000                           3,422,173        $34,221        $7,962,201        $(75,000)      $(12,765,227)
                                                    ==========        =======        ==========        ========       ============

Dividends accrued on Series A,
   Class B, preferred stock at
   $.16 per share                                           --             --                --              --           (138,000)

Services provided at no charge by
  stockholder                                               --             --            35,406              --                 --

Issue of common stock for services                     223,190          2,232           107,489              --                 --

Options issued to consultants                               --             --            42,924              --                 --

Paid in capital - Debentures                                --             --           450,000              --                 --

Conversion of debentures  to stock                   4,346,139         43,461           134,891              --                 --

New stock issued                                     9,526,866          6,900           683,100              --                 --

Net loss for the year ended
   December 31, 2001                                        --             --                --              --         (1,674,311)

                                                    ----------        -------        ----------        --------        ------------
BALANCE, December 31, 2001                          17,518,368        $86,814        $9,416,011        $(75,000)       $(14,577,538)
                                                    ==========        =======        ==========        ========        ============

<CAPTION>

                                                     CLASS A          CLASS B        CLASS B, SER B          TOTAL
                                                   PREFERRED         PREFERRED          PREFERRED        STOCKHOLDERS'
                                                      STOCK             STOCK             STOCK             EQUITY
                                                   ----------        ----------      ---------------    --------------
<S>                                                <C>               <C>             <C>                <C>
BALANCE, December 31, 1999                          $ 33,034         $1,150,000        $1,783,935        $(1,036,689)
Dividends accrued on Series A,
   Class B, preferred stock at
   $.16 per share                                         --                 --                --           (138,000)

Reclassification of Class A, preferred stock         (33,034)                --                --            (33,034)

Services provided at no charge by
  stockholder                                             --                 --                --             35,408
Options granted to nonemployees for
  services provided                                       --                 --                --             43,238

Issue of common stock, 101,875 shares                     --                 --                --             12,968

Net loss for the year ended
   December 31, 2000                                      --                 --                --           (793,761)

                                                    --------         ----------        ----------        -----------
BALANCE, December 31, 2000                          $     --         $1,150,000        $1,783,935        $(1,909,870)
                                                    ========         ==========        ==========        ===========

Dividends accrued on Series A,
   Class B, preferred stock at
   $.16 per share                                         --                 --                --           (138,000)

Services provided at no charge by
  stockholder                                             --                 --                --             35,406

Issue of common stock for services                        --                 --                --            109,721

Options issued to consultants                             --                 --                --             42,924

Paid in capital - Debentures                              --                 --                --            450,000

Conversion of debentures  to stock                        --                 --                --            178,352

New stock issued                                          --                 --                --            690,000

Net loss for the year ended
   December 31, 2001                                      --                 --                --         (1,674,311)

                                                    --------         ----------        ----------        -----------
BALANCE, December 31, 2001                          $     --         $1,150,000        $1,783,935        $(2,215,778)
                                                    ========         ==========        ==========        ===========
</TABLE>


         The accompanying notes to financial statements are an integral part of
this statement.


                                      F-5
<PAGE>


                           VITAL LIVING PRODUCTS, INC.

                            STATEMENTS OF CASH FLOWS

                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000


<TABLE>
<CAPTION>
                                                                      2001                2000
                                                                  -----------         -----------

<S>                                                               <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Cash received from customers and others                          $ 1,773,206         $ 1,654,136
 Cash paid to suppliers and employees                              (2,448,161)         (2,219,458)
 Interest paid                                                        (72,982)            (63,840)
                                                                  -----------         -----------
     Net cash used  by operating activities                          (747,937)           (629,162)

CASH FLOWS FROM INVESTING ACTIVITIES:
 Purchase of property and equipment                                   (19,456)            (82,946)
 Payments for trademarks and product design costs                      (1,000)             (4,931)
 Cash received from sale of fixed asset                                 9,575               1,642
                                                                  -----------         -----------
     Net cash used by investing activities                            (10,881)            (86,235)

CASH FLOWS FROM FINANCING ACTIVITIES:
 Draw on bank overdraft, net                                              (21)            (29,657)
 Net proceeds from demand notes payable to related parties           (367,252)            722,500
 Payments on notes payable                                            (13,252)            (19,475)
 Proceeds from new borrowings                                              --              28,800
 Proceeds from issuance of debentures                                 450,000                  --
 Proceeds from common stock issued and options exercised              690,000              12,968
                                                                  -----------         -----------
   Net cash provided by financing activities                          759,475             715,136
                                                                  -----------         -----------

NET INCREASE (DECREASE) IN CASH                                           657                (261)

CASH, beginning of period                                                 400                 661
                                                                  -----------         -----------

CASH, end of period                                               $     1,057         $       400
                                                                  ===========         ===========
</TABLE>

 NONCASH TRANSACTIONS:
  Preferred Series A, Class B dividends of $138,000 were accrued during each
  year ended December 31, 2001 and 2000.

  Certain salaries to Company employees totaling approximately $35,400 were paid
  by a stockholder during each of the years ended December 31, 2001 and 2000.

  Options were granted to nonemployees for services provided during the year
  ended December 31, 2001. The value of the options was approximately $42,900.

  Stock was issued to nonemployees for services provided during the year ended
  December 31, 2001. The value of the stock was approximately $109,700.

  Debentures and accrued interest with a value of $178,352 have been converted
  into 4,346,139 shares of common stock during the year ended December 31,
  2001.


                                    Continued

                                      F-6
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                      STATEMENTS OF CASH FLOWS - CONTINUED

                 FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000


RECONCILIATION OF NET INCOME (LOSS) TO
  NET CASH USED BY OPERATING ACTIVITIES:

<TABLE>
<CAPTION>
                                                                                     2001               2000
                                                                                 -----------         ---------
<S>                                                                              <C>                 <C>
   Net loss                                                                      $(1,674,311)        $(793,761)
   Adjustments to reconcile net loss to net cash
     used by operating activities:
        Depreciation and amortization                                                 54,513            98,186
        Gain on sale of fixed assets                                                  (7,260)             (844)
        Services provided at no charge by stockholder                                 35,406            35,408
        Provision for interest related to issuance of
           debentures and warrants                                                   450,000                --
        Interest accrued on debentures                                                31,154                --
        Stock issued for professional services                                       109,721                --
        Stock options issued for professional services                                42,924            43,238
        (Increase) decrease in accounts receivable                                    82,309            (9,080)
        Increase in inventory                                                        (15,983)          (11,914)
        (Increase) decrease in prepaid expenses                                        2,837            (2,987)
        Increase in payable to related party                                              --             4,231
        Increase (decrease) in trade accounts payable                                (22,242)           46,281
        Increase (decrease)  in accrued interest payable to related party               (446)           13,489
        Increase  in accrued payroll and payroll taxes                                 2,134             2,486
        Increase (decrease) in other accrued liabilities                             161,308           (53,895)
                                                                                 -----------         ---------
           Net cash used  by operating activities                                $  (747,937)        $(629,162)
                                                                                 ===========         =========
</TABLE>


         The accompanying notes to financial statements are an integral part of
this statement.

                                      F-7
<PAGE>

                           VITAL LIVING PRODUCTS, INC.

                          NOTES TO FINANCIAL STATEMENTS

                           DECEMBER 31, 2001 AND 2000



1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

       NATURE OF BUSINESS - Vital Living Products, Inc. sells various water
         testing materials, including kits which test for lead, pesticides,
         bacteria, iron and other substances and conditions; vending machines,
         which dispense purified and filtered water at various locations,
         including grocery stores and shopping centers; and misting apparatus.
         It also sells and services water treatment equipment and water
         softeners and filters. The Company operates under the name American
         Water Service.

       RECEIVABLES, INSTALLMENT RECEIVABLES AND RESERVE FOR BAD DEBTS - The
         Company records amounts receivable for all earned revenues which have
         not been collected. Installment receivables result from installment
         equipment purchase contracts. These contracts generally have terms from
         36 to 60 months, require interest payments calculated at 16% and
         require monthly installment payments of principal and interest. The
         purchased equipment under contract secures these receivables. The
         Company maintains an allowance for bad debts to reflect all receivables
         at estimated collectible balances.

       INVENTORY - Inventories include both raw materials and finished goods,
         each at first-in first-out cost, which is not in excess of market. The
         valuation of finished goods inventory includes the labor and overhead
         required for its production.

       PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost.
         Depreciation is provided by using both straight-line and accelerated
         methods over the estimated useful lives of the assets, which are:

<TABLE>
         <S>                                          <C>
         Office furniture and equipment               5 to 7 years
         Warehouse equipment                          7 years
         Computer equipment                           5 years
         Vehicles                                     5 years
         Water service equipment                      4 years
         Leasehold improvements                       39 years
</TABLE>

       DEFERRED COSTS - The Company has incurred certain costs related to
         product design, patents and trademarks. Management believes that these
         costs will be recovered through future operations, and accordingly, has
         capitalized them as described in Note 5.

       REVENUE RECOGNITION - Service revenues are from equipment which is
         installed in customers' facilities. This equipment may be rented from
         month-to-month and service revenues are recognized as earned and billed
         monthly. Revenues from product sales are recognized when such products
         are sold and shipped to customers.


                                      F-8
<PAGE>

       WARRANTY COSTS - The Company sells certain water purification equipment
         subject to warranties which extend from five to seven years. Warranty
         costs are nominal and are recorded in the period in which they are
         incurred.

       MARKETING, ADVERTISING AND PROMOTION COSTS - The Company expenses all
         marketing, advertising and promotion costs as incurred.

       STOCK-BASED COMPENSATION - The Company has a compensatory stock option
         plan under which it grants options to employees and agents. As all
         options granted to employees are at exercise prices which are equal to
         or greater than fair market value of the stock, the Company records no
         expense related to such grants (see Note 8). Stock options granted are
         valued using the Black Scholes valuation model and quoted prices for
         the Company's stock. When options are granted to non-employees, the
         transaction is accounted for based on the fair value of the
         consideration (goods and services) received or the fair value of the
         options granted, whichever is more reliably measurable.

       INCOME TAXES - Income taxes are provided for the tax effects of
         transactions reported in the financial statements and consist of taxes
         currently due plus deferred taxes related primarily to certain related
         party payables not currently deductible for tax return purposes and to
         net operating loss carryforwards available to offset income in future
         years. The deferred tax assets represent the future tax return
         consequences of those differences. Valuation allowances are
         established, if necessary, to reduce the deferred tax assets to the
         amount that will more likely than not be realized.

       LOSS CONTINGENCIES - As discussed in Note 15, the Company expects to
         incur certain legal costs in connection with the investigations
         described there. The Company's accounting policy regarding such costs
         relating to loss contingencies is to provide for the estimated expense
         and related accrued liability in the period when events occur which
         give rise to the expense. As discussed in Note 15, estimated amounts
         for the expense of these investigations were recorded in the year ended
         December 31, 2001.

       CASH AND CASH EQUIVALENTS - For purposes of the statements of cash flows,
         the Company considers all highly liquid debt instruments to be cash
         equivalents.

       ESTIMATES - The preparation of financial statements in conformity with
         generally accepted accounting principles requires management to make
         estimates that affect the reported amounts of assets and liabilities
         and disclosure of contingent assets and liabilities at the date of the
         financial statements and the reported amounts of revenues and expenses
         during the reporting period. Actual results could differ from those
         estimates.


2.  COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN:

       As shown in the accompanying financial statements, the Company has
         incurred recurring losses from operations and resulting cash flow
         deficits. It also has current liabilities significantly in excess of
         current assets and a significant deficit in total stockholders' equity.
         Also as discussed below, the Company is in default on its convertible
         debentures payable. These factors raise


                                      F-9
<PAGE>

         substantial doubt about the Company's ability to continue as a going
         concern as of December 31, 2001.

       Management continues to focus on its marketing and sales of water testing
         kits. Management believes that this line will help the Company to
         achieve profitability. The Company's ultimate ability to become
         profitable, however, is contingent on its achieving significantly
         higher sales levels. Until that occurs and until the Company generates
         positive cash flow from operations, additional outside funding will
         continue to be required.

       During 2001, the Company has received funding from two private placement
         transactions. In February 2001, the Company entered into an equity
         financing agreement with a private equity investment fund, whereby the
         Company has received $450,000 in exchange for its issuance of
         convertible debentures and warrants to the investment fund (see Note
         6). In October and November 2001, the Company received $690,000 through
         a private placement of 9,526,866 shares of common stock (see Note 8).

       Substantial amounts of the cash generated through this funding will be
         required by the Company to defend itself against investigations which
         have been undertaken by the Securities and Exchange Commission, the
         National Association of Securities Dealers, Inc., the Federal Bureau of
         Investigation and the U.S. Attorneys Office for the Southern District
         of New York regarding its efforts to develop and market a home testing
         kit for the anthrax bacteria as well as alleged unlawful insider
         trading in the Company's common stock (see Note 15).

       Additionally, the Company has received notices of default from each of
         the holders of its convertible debentures (see Note 6) because it has
         failed to continuously maintain an effective registration statement
         covering the securities related to such debentures. If the holders of
         those debentures do not convert substantially all of the outstanding
         principal and interest on the debentures and demand payment thereunder,
         the Company would not likely have sufficient funds to meet its payment
         obligations and could be forced into bankruptcy. The debentures are
         secured by all of the Company's assets and intellectual property. The
         Company has failed to make payments that were due in February 2002 on
         approximately $72,000 of the convertible debentures and accrued
         interest. If the debenture holders choose to exercise their rights
         under the default, then its assets would become subject to foreclosure
         and it would likely be impossible to remain a going concern.

       Management expects to require additional financing to fund the Company's
         operations at some point no later than spring of 2002 and, to the
         extent that the secured convertible debentures have not been converted
         into shares of its common stock, it will require additional financing
         to repay the debentures when due, whether upon acceleration or at
         maturity (February 2002 and June 2002). Management intends to explore
         various financing alternatives, including the sale of convertible debt
         securities and the private placement of equity securities. No assurance
         can be given, however, that additional funds will be available.

       If, under these new financing agreements and/or subsequent financing
         agreements, the Company cannot meet its cash requirements, its
         financial condition and results of operations could be materially
         adversely affected and it may be unable to continue as a going concern.
         The financial


                                      F-10
<PAGE>

         statements do not include any adjustments that might be necessary if
         the Company is unable to continue as a going concern.



3.  RELATED PARTY TRANSACTIONS:

      At December 31, 2001, the Company had approximately $750,000 in borrowings
         outstanding on a $750,000 revolving line of credit from Wilbur Peters.
         This loan is due in February 2003. This line of credit is unsecured and
         provides that advances will be made at the discretion of the lender and
         requires monthly interest payments at the LIBOR rate plus 1.5%. During
         2001, Mr. Peters executed an amendment to the promissory note under
         which Mr. Peters agreed to accept prepayments on the note and to
         re-lend to the Company on demand the amount of any such prepayments
         through the term of the note. Interest accrued at December 31, 2001,
         was $12,224. Interest expense on this note totals approximately $41,600
         and $33,300 for the years ended December 31, 2001 and 2000,
         respectively.

      At December 31, 2001, the Company had borrowings from CTF, Inc., an
         affiliate of Mr. Peters, of $43,000. The unsecured note is due in
         February 2003 and has an interest rate of prime plus 2%. During 2001,
         CTF, Inc. executed an amendment to the promissory note under which CTF
         agreed to accept prepayments to the note and to re-lend to the Company
         on demand the amount of any such prepayments through the term of the
         note. Interest accrued at December 31, 2001, was $4,528. Interest
         expense on this note totals approximately $29,300 and $44,000 for the
         years ended December 31, 2001 and 2000, respectively.

      CTF, Inc. owns the preferred Series A, Class B stock and is owed
         $1,311,000 in accrued dividends (see Note 9).

      The salaries for the chief financial officer and vice-president of the
         Company and certain accounting personnel were paid by companies with
         which Mr. Peters is affiliated. These salaries, which were
         approximately $35,400 for each of the years ended December 31, 2001 and
         2000, have been recorded in the statements of operations, and the
         Company has also recorded additional capital contributions from Mr.
         Peters in these amounts.

      During the year ended December 31, 2000, the Company entered into a
         $100,000 line of credit arrangement with CTF, Inc. The line matured on
         May 1, 2001. Interest expense on this note totals approximately $1,680
         and $30 for the years ended December 31, 2001 and 2000, respectively.


4.  INVENTORY:

         The Company's inventories as of December 31, 2001, consisted of the
         following components:

<TABLE>
                     <S>                                <C>
                     Water testing kits                 $221,871
                     Water treatment parts                74,936
                     Vending parts                        11,162
                                                        --------
                                                        $307,969
                                                        ========
</TABLE>


                                      F-11
<PAGE>


5.  DEFERRED COSTS:

       Deferred costs as of December 31, 2001, consists of the items shown
         below. These are being amortized on a straight-line basis over their
         estimated useful lives of from 5 to 17 years. Amortization expense
         recorded during the year ended December 31, 2001, totaled $6,193.

<TABLE>
                     <S>                                     <C>
                     Product design costs                    $13,157
                     Patents and trademarks                   37,370
                     Non-compete agreement                    14,500
                     Other                                     6,200
                                                             -------
                                                              71,227
                     Less accumulated amortization            56,890
                                                             -------
                      Net deferred costs                     $14,337
                                                             =======
</TABLE>

6.   CONVERTIBLE DEBENTURES AND WARRANTS:

       During 2001, the Company borrowed $450,000 from an investment group under
         convertible debentures. These debentures, which require the payment of
         interest at 12% per year, will become due in February 2002. They are
         secured by substantially all company assets and provide for certain
         restrictions on additional borrowings, issuance of equity securities,
         and payment of dividends on common stock. The debentures were initially
         convertible into the Company's common stock at the lesser of $.278 per
         share or 50% of market price for that stock, as defined. As a result of
         certain antidilution adjustments, as of December 31, 2001, the
         remaining $302,802 balance of debentures and accrued interest was
         convertible into common stock at a conversion price equal to the lesser
         of $0.06 or 50% of the market price, as defined.

       As a part of this transaction, the debenture holders received warrants to
         purchase up to 300,000 shares of the Company's common stock. These
         warrants may be exercised at any time within three years of their
         issuance at prices initially equal to the lesser of $.229 per share or
         50% of market price, as defined. As a result of certain antidilution
         adjustments, the warrants are exercisable as of December 31, 2001, for
         an aggregate of 633,129 shares of common stock at an exercise price
         equal to the lesser of $0.11, subject to adjustment under certain
         antidilution provisions, or the average of the lowest three inter-day
         trading prices of the Company's common stock during the ten trading day
         period ending one trading day prior to the date of exercise.

       As of December 31, 2001, debentures for $156,468 and accrued interest on
         the debentures of $21,884 had been converted into 4,346,139 shares of
         common stock. Based on stock prices prior to December 31, 2001, the
         remaining debentures could be converted into approximately 5,046,700
         shares of the Company's common stock. In the cases of both the
         debentures and warrants, investors may acquire shares of the Company's
         common stock at discounts below their market value. Due to the
         preferential conversion feature of the debentures, the Company recorded
         $450,000 of interest expense and additional paid-in capital at the time
         of their issuance.


                                      F-12
<PAGE>


       The Company has received notices of default from each of the holders of
         the convertible debentures claiming that because it had failed to
         continuously maintain an effective registration statement covering the
         securities associated with the debentures that it is in default under
         the debentures. Upon the occurrence of a default under the debentures,
         the debenture holders are entitled to accelerate the conversion of all
         debentures immediately due and payable in an amount equal to the
         greater of (i) 130% of the outstanding principal and interest on the
         debentures and (ii) the number of shares obtainable upon exercise of
         the outstanding principal and interest on the debentures, treating the
         date of payment as the conversion date, times the highest closing price
         for the Company's common stock during the period beginning on the date
         of the default through the date of payment, which is calculated to be
         approximately $2,500,000 as of the date of this report. In addition, on
         February 23, 2002, approximately $72,000 of the convertible debentures
         came due. The Company failed to pay this balance due and is in default
         under all debentures. To date the debenture holders have not invoked
         their acceleration right, but they may do so at any time.


7.  LONG-TERM DEBT:

       The Company had a note payable to a bank at December 31, 2001, totaling
         $8,659. The interest rate on the note is 3.9%. Monthly payments of
         principal and interest total $634. This loan is secured by a vehicle at
         December 31, 2001 and matures as follows:

<TABLE>
<CAPTION>
                          Year            Amount
                          ----           -------
                          <S>            <C>
                          2002           $ 7,398
                          2003             1,262
                                         -------
                                         $ 8,660
                                         =======
</TABLE>

       See Note 3 for discussion of related party notes payable.


8.  COMMON STOCK OUTSTANDING, STOCK OPTION PLAN AND LOSS PER COMMON SHARE:

       The Company has 50,000,000 shares of authorized common stock, of which
         17,194,521 shares are issued and outstanding and 323,847 shares are
         issued and held as treasury shares. A total of 19,868,181 common shares
         have been reserved for future issuance of stock through the exercise of
         stock options and the conversion of Class B preferred stock and
         debentures and warrants, as described below.

       During 2001, the Company issued 9,526,866 shares of common stock in
         private placement transactions for aggregate consideration of $690,000.

       During 2001, the Company issued 223,190 shares of stock to vendors for
         services rendered. This transaction was valued at approximately
         $109,721, based on the market values of shares issued to the vendors at
         the dates awarded. Accordingly, expense in this amount was recorded on
         the income statement for the year ended December 31, 2001.


                                      F-13
<PAGE>

       Additionally, the Company has reserved 15,000,000 shares for issuance in
         connection with the convertible debentures and warrants described in
         Note 6.

       The 1991 Stock Option Plan provides for granting options for up to
         3,150,000 shares of the Company's common stock to key employees,
         directors, consultants, and agents of the Company. Options to be
         granted may be either incentive or non-statutory stock options, and
         restrictions apply to both the grant and exercise of options. As of the
         date of this report, options for 1,931,668 shares have been granted to
         employees and agents. Options extend contractually for ten years.
         Non-qualified options vest fully at the time of grant while incentive
         stock options issued to employees vest ratably over four years. The
         following is a summary of option activity during the years ended
         December 31, 2001 and 2000.

       Activity for non-qualified stock options (primarily non-employees) was as
follows:

<TABLE>
<CAPTION>
                                                   December 31, 2001                      December 31, 2000
                                            -------------------------------        ---------------------------------
                                                                  Exercise                                 Exercise
                                             Shares                Price*            Shares                  Price*
                                            ---------            ----------        ----------             ----------
<S>                                         <C>                  <C>               <C>                    <C>
Outstanding at beginning of year            1,873,668            $    0.214         1,953,668             $    0.192
Granted                                        25,000                 0.613            10,000                  1.500
Granted                                        50,000                 0.613            10,000                  2.500
Granted                                        12,000                 0.688                --                     --
Exercised                                          --                    --          (100,000)                 0.125
                                            ---------            ----------        ----------             ----------
Outstanding at end of year                  1,960,668            $    0.233         1,873,668             $    0.214
                                            =========            ==========        ==========             ==========
Exercisable at end of year                  1,960,668            $    0.233         1,873,668             $    0.214
                                            =========            ==========        ==========             ==========
</TABLE>


*weighted average

         Activity for incentive stock options (granted to employees) was as
follows:

<TABLE>
<CAPTION>
                                                   December 31, 2001                      December 31, 2000
                                            ------------------------------        ------------------------------
                                                                 Exercise                               Exercise
                                             Shares               Price*           Shares                Price*
                                            ---------           ----------        --------            ----------
<S>                                         <C>                 <C>               <C>                 <C>
Outstanding at beginning of year             52,625             $    0.810         32,500             $    0.250
Granted                                      42,000                  0.688         22,000                  1.560
Granted                                       2,000                  0.860             --                     --
Exercised                                        --                     --         (1,875)                 0.250
Expired or forfeited                         (6,000)                 1.560
Expired or forfeited                         (9,000)                 0.688             --                     --
Expired or forfeited                         (5,625)                 0.250             --                     --
                                            -------             ----------        -------             ----------
Outstanding at end of year                   76,000             $    0.732         52,625             $    0.810
                                            =======             ==========        =======             ==========
Exercisable at end of year                   22,750             $    0.144         14,375             $    0.250
                                            =======             ==========        =======             ==========
</TABLE>


                                      F-14
<PAGE>


Exercise prices for options outstanding at December 31, 2001, range from $.125
to $2.50 per share. Total shares by exercise price are as follows:

<TABLE>
<CAPTION>
                                          Options               Options          Remaining
                  Exercise Price        Outstanding           Exercisable     Contractual Life*
                  ---------------       -----------           -----------     -----------------
                  <S>                   <C>                   <C>             <C>
                      $0.125              1,720,000            1,720,000           6 yrs
                       1.120                121,668              121,668           1 yr
                       0.250                 27,000               20,750           7 yrs
                       0.613                 75,000               75,000          10 yrs
                       0.688                 45,000               12,000          10 yrs
                       0.860                  2,000                   --          10 yrs
                       1.000                 10,000               10,000           8 yrs
                       1.500                 10,000               10,000           9 yrs
                       1.560                 16,000                4,000           9 yrs
                       2.500                 10,000               10,000           9 yrs
                                          ---------            ---------
                                          2,036,668            1,983,418
                                          =========            =========
</TABLE>

               *weighted average

       The Company has recorded no compensation expense under this plan during
         2001 or 2000, as options have been granted at prices which are greater
         than or equal to fair market value of the stock at the dates of the
         grant. Since the Company is not required to adopt the fair value based
         recognition provisions prescribed under Statement of Financial
         Accounting Standards No. 123, Accounting for Stock-Based Compensation,
         it has elected only to comply with the disclosure requirements set
         forth in the statement.

       During 2000, the Company granted options for 20,000 shares to a vendor.
         Exercise price of these options is $1.50 and $2.50 per share for each
         set of 10,000 options. At the grant dates, the fair market value of the
         Company's common stock was $2.12 and $1.75 per share. Based on the
         value of services received from this vendor and the amount paid in cash
         by the Company, the Company determined the value of the options granted
         to approximate $43,200. Accordingly, expense in this amount was
         recorded on the income statement for the year ended December 31, 2000.

       During 2000, the Company granted options for 22,000 shares to employees.
         Using the Black Scholes valuation model, it calculated the value of
         those options to be approximately $1.57 each ($34,500 in total). This
         valuation included the following assumptions: risk-free interest rate -
         6.0%; expected life - 4 years; expected volatility - 105%; expected
         dividends - none. The Company estimated that 60% of these options will
         vest. Exercise price of these options is $1.56 per share. At the grant
         date, the fair market value of the Company's common stock was
         approximately $1.56 per share.

       During 2001, the Company granted two sets of options for 54,000 and 2,000
         shares to employees. Using the Black Scholes valuation model, it
         calculated the value of those options to be approximately $37,300 and
         $1,700, respectively. This valuation included the following
         assumptions: risk-free interest rate - 3.5% and 3.89%, respectively;
         expected life - 4 years; expected volatility - 100%; expected dividends
         - none. The Company estimated that 60% of these options will vest.
         Exercise price of these options is approximately $0.69 and $0.86 per


                                      F-15
<PAGE>

         share, respectively. At the grant dates, the fair market value of the
         Company's common stock was approximately $0.69 and $0.86 per share,
         respectively.

       Had the Company recorded expense for these grants under FASB Statement
         123, it would have recorded additional compensation cost of $13,148 and
         $6,994 in 2001 and 2000, respectively. Pro-forma net income (loss) and
         per share amounts for each year would be as follows:

<TABLE>
<CAPTION>
                                                      2001            2000
                                                   -----------      ---------
              <S>                                  <C>              <C>
              Net Income (Loss), as reported       $(1,674,311)     $(793,761)
              Pro-forma Net Income (Loss)          $(1,687,459)     $(800,755)

              Pro-forma Basic Income (Loss)
                per Common Share                   $     (0.30)     $   (0.30)
</TABLE>

       Basic earnings (loss) per common share has been computed based on the
         weighted average number of common shares outstanding. Weighted average
         shares outstanding for 2001 and 2000 is determined by calculating the
         number of months the respective shares were outstanding during the
         year, multiplying by the number of shares outstanding and dividing by
         twelve.

       No calculation has been presented for diluted earnings per share for
         either period. The inclusion of shares for the effect of any options or
         preferred stock would be anti-dilutive because the Company has losses
         for both years. The calculation of basic earnings (loss) per common
         share is based on the Company's net income (loss) adjusted for the
         amount of preferred dividends accrued ($138,000) during each of the
         years ended December 31, 2001 and 2000.


9.  PREFERRED STOCK:

       During 1992, the Company authorized 3,303,375 shares of Class A preferred
         stock with a par value of one cent per share. Each share of this class
         of stock, which is non-voting and has no dividend rights, has a
         liquidation preference of $.01 per share and is convertible at the
         holder's option into one share of the Company's common stock.

       However, all outstanding shares of Class A preferred stock are currently
         held in escrow under an agreement with its original holders which
         prohibits the holders from converting the shares as long as they are
         being held in escrow. Since certain financial thresholds were not met
         in prior years, under the terms of the escrow agreement the shares of
         Class A preferred stock are required to be released from escrow to the
         Company and the Company is required to redeem such shares at $.01 per
         share ($33,034 in the aggregate). During 2000, the Company's Board of
         Directors approved the release of the certificates representing the
         outstanding shares of Class A preferred stock so that it may redeem
         such shares. Such preferred stock has been reclassified from
         stockholders' equity in the accompanying balance sheets as a result of
         the Board's actions. These shares have not yet been released by the
         escrow agent, and they are still subject to redemption.

       Also, the Company has authorized 1,000,000 shares of Class B preferred
         stock with a par value of one cent per share. Its Series A shares have
         a liquidation preference of $.01 per share ($5,750 in


                                      F-16
<PAGE>

         aggregate), provide for the payment of dividends at 12% per annum, are
         redeemable at any time at the Company's option at $2.00 per share
         ($1,150,000 in aggregate), and are convertible by the holder into
         shares of common stock at a ratio of 4/9 of a share of common for each
         preferred share tendered. Holders of this Series A, Class B preferred
         stock have the right to elect a majority of the Board of Directors.
         Dividends accrued on these shares through December 31, 2001, totaled
         $1,311,000 ($2.28 per share), including dividends accrued of $138,000
         for each year 2001 and 2000.

       In November 1999, the Company issued 31,290 shares of its new Series B,
         Class B preferred shares in exchange for a note payable and equipment
         held by Wilbur Peters. The note totaled $3,035,535, and the Company
         discounted the preferred stock exchanged for these to $1,783,935, to
         reflect the estimated fair market value of the stock. This new series
         of stock is non-voting. Dividends are non-cumulative, and any dividends
         to be paid on these shares are subordinate to all accrued dividends on
         the Company's Series A, Class B preferred stock. Dividends on these
         shares may not exceed $12 per year per share.

       The Class B, Series B shares carry a $10 per share ($312,900 in
         aggregate) liquidation preference, and they may be redeemed by the
         Company at $100 per share ($3,129,000 in aggregate). After one year
         from the date of issuance, each share became convertible by the holder
         into 50 shares of the Company's common stock. No dividends have been
         declared on this class of stock since its issuance.


10.  FINANCIAL INSTRUMENTS:

       Except for accrued dividends, the Company estimates the fair value of all
         financial instruments to be equal to the book value reflected in the
         accompanying financial statements. The Company estimates that the fair
         value of accrued dividends is less than their carrying amount as they
         cannot be paid until future periods. As the timing of such payment
         cannot presently be determined, it is not practicable to calculate a
         net present value of the liability or to estimate its fair value.


11.  OPERATING LEASES:

       The Company leases its office and warehouse space under a lease which
         extends through March 31, 2004. This lease requires monthly payments of
         $3,400. Rent expense, for the years ended December 31, 2001 and 2000,
         was approximately $40,800 and $40,200, respectively. Future rent
         payments under the terms of the lease agreement for the years ending
         December 31, 2002, 2003 and 2004 are approximately $42,600, $43,200 and
         $10,800, respectively.


12.  INCOME TAXES:

       At December 31, 2001, net noncurrent deferred tax assets of approximately
         $3,110,000 resulted primarily from net operating losses. A valuation
         allowance for the entire $3,110,000 has also been established due to
         the Company's uncertain financial condition (see Note 2).


                                      F-17
<PAGE>

       The components of the net noncurrent deferred tax assets and related
         valuation allowance are as follows:


<TABLE>
                     <S>                                      <C>
                   Deferred tax assets:
                        Federal                               $2,950,000
                        State                                    160,000
                                                              ----------
                          Total deferred tax assets            3,110,000
                      Valuation allowance                      3,110,000
                                                              ----------
                           Net deferred tax assets            $       --
                                                              ==========
</TABLE>

       At December 31, 2000, the Company had net noncurrent deferred tax assets
         of approximately $2,777,000, along with a corresponding valuation
         allowance of the same amount. The $333,000 increase in the noncurrent
         deferred tax assets as of December 31, 2001, and the deferred tax
         provision which would be reflected on the Company's statement of
         operations has been offset by a corresponding increase in the valuation
         allowance. The statement of operations therefore reflects no deferred
         tax provision.

       As the Company has essentially no taxable income to date on a cumulative
         basis, it has recorded no current provision for income taxes for the
         years ended December 31, 2001 and 2000. For the ended December 31, 2001
         and 2000, there were no significant differences between losses reported
         in the Company's financial statements and its tax return.

       As of December 31, 2001, the Company has net operating loss carry
         forwards of approximately $9,114,000 for federal income tax purposes.

       Various state net operating loss carryforwards are also available for use
         in reducing apportioned state taxable income. The most significant of
         these is approximately $2,100,000 in North Carolina.

       The deferred tax benefit (provision) for the years ended December 31,
2001 and 2000 are as follows:

<TABLE>
<CAPTION>
                                                                2001                  2000
                                                             ---------             ---------
               <S>                                           <C>                   <C>
               Deferred tax benefit (provision) -
                    Federal                                  $ 280,000             $ 120,000
                    State                                       53,000                47,000
                                                             ---------             ---------
                                                               333,000               167,000
               Change in valuation allowance                  (333,000)             (167,000)
                                                             ---------             ---------
               Net deferred tax provision                    $      --             $      --
                                                             =========             =========
</TABLE>

       The deferred provisions for 2001 and 2000 differ from amounts which would
         be calculated at statutory rates due to changes in the valuation
         allowance and the expiration of loss carryforwards for state purposes.


                                      F-18
<PAGE>



       Federal net operating loss carryforwards expire as follows:

<TABLE>
<CAPTION>
                       Year of           Net Operating
                      Expiration          Loss Amount
                      ----------         -------------
                      <S>                <C>
                         2006              $1,007,000
                         2007               3,574,000
                         2008                 835,000
                         2009                 541,000
                         2010                 559,000
                         2011                 242,000
                         2017                 441,000
                         2018                 280,000
                         2020                 642,000
                         2021                 993,000
                                           ----------
                                           $9,114,000
                                           ==========
</TABLE>


13.  SUPPLEMENTARY FINANCIAL INFORMATION:

       Marketing, advertising and promotion costs include the following for the
         years ended December 31, 2001 and 2000:

<TABLE>
<CAPTION>
                                                       2001                2000
                                                     --------            --------
               <S>                                   <C>                 <C>
               Advertising                           $ 75,308            $ 58,159
               Promotions                               7,079              22,527
               Trade shows                             23,930              62,576
               Public relations and other             109,520             113,064
                                                     --------            --------
                                                     $215,837            $256,326
                                                     ========            ========
</TABLE>


14.  MAJOR CUSTOMERS AND SEGMENT INFORMATION:

       Sales to three major customers comprised approximately 23%, 12% and 10%,
         respectively, of total sales for the year ended December 31, 2001.
         Sales to two major customers comprised approximately 16% and 10%,
         respectively, of total sales for the year ended December 31, 2000.

       Segment information has been prepared in accordance with SFAS No. 131,
         "Disclosure about Segments of an Enterprise and Related Information."
         The Company has three reportable segments: water testing products,
         water treatment equipment and services, and vending machines and
         misting systems. These segments were determined based upon the types of
         products produced and sold by each segment. Segment performance is
         evaluated based on income from operations, excluding interest expense.
         Income from operations for each includes sales, direct expenses, and
         certain allocated expenses applicable to the segment. Expenses for
         management salaries, public and stockholder relations, and corporate
         matters, which are not applicable to the product based segments, are
         shown in the reconciliations below as corporate items. No income tax
         provision by segment is shown as the Company's combined statement of
         operations reflects a


                                      F-19
<PAGE>

         zero tax provision. Substantially all sales are in the United States,
         and all assets are located in the United States. There are no
         intersegment sales.

       The water testing products segment (water testing) includes the sale of a
         comprehensive line of home water testing kits. These are sold through
         the Company's website, and nationwide at retailers, water treatment
         dealers, water well drillers and other independent retailers and
         building centers. The water treatment equipment and services segment
         (water treatment) includes the sale of water treatment products to
         water treatment dealers and to retail customers. Purification units
         utilize reverse osmosis technology to filter out contaminants and
         ultraviolet technology to treat bacteria in water. It includes a line
         of point of entry water treatment products such as softeners,
         neutralizers and iron filters. The company services all water treatment
         products that it sells as well as other water treatment products
         available on the market. The vending machines and misting systems
         segment (vending) consists of the sale of drinking water dispensed to
         consumers through self-service vending machines as well as high purity
         water used by grocery stores in produce-misting systems. The Company
         places vending machines inside or outside retail stores and has revenue
         sharing arrangements with the stores. In some locations, in addition to
         vending water to consumers, the machines are used to purify water used
         in produce-misting systems maintained for grocers.

       Financial information by segment is as follows:

<TABLE>
<CAPTION>
                                                 For the year ended December 31, 2001
       -----------------------------------------------------------------------------------------------------------------
                                               Water            Water
                                              Testing         Treatment       Vending        Corporate          Total
                                              -------         ---------       -------        ---------          -----

          <S>                               <C>               <C>             <C>           <C>              <C>
          Segment sales                     $ 1,030,077       $ 443,628       $210,459              --       $ 1,684,164
          Operating income (loss)               103,004          80,464         81,298      (1,399,381)       (1,134,615)
          Interest expense                      261,953         175,327         28,190          88,220           553,690
          Interest income                            --           6,734             --              --             6,374
          Net income (loss)                    (158,949)        (80,869)        53,108      (1,487,601)       (1,674,311)

          Segment assets                        282,500         189,079         30,401          95,142           597,122
          Capital asset additions                    --          16,108             --           2,976            19,084
          Depreciation and amortization           6,193          15,170         18,484          14,666            54,513
</TABLE>


                                      F-20
<PAGE>


<TABLE>
<CAPTION>
                                                 For the year ended December 31, 2000
         ----------------------------------------------------------------------------------------------------
                                            Water         Water
                                           Testing      Treatment      Vending     Corporate         Total
                                           -------      ---------      -------     ---------         -----

         <S>                               <C>          <C>            <C>         <C>            <C>
         Segment sales                     $950,619     $ 429,847      $277,569           --      $ 1,658,035
         Operating income (loss)             95,860        12,567        32,884     (863,767)        (722,456)
         Interest expense                    35,585        22,138         8,011       11,595           77,329
         Interest income                         --         5,178            --           --            5,178
         Net income (loss)                   60,275        (3,547)       24,872     (875,361)        (793,761)

         Segment assets                     323,044       200,971        72,728      105,257          702,000
         Capital asset additions                 --        13,047        21,497       70,950          105,494
         Depreciation and amortization        5,218        25,746        55,441       11,781           98,186
</TABLE>


15.  COMMITMENTS AND CONTINGENCIES:

       In October 2001, the Company announced that it was developing a home
         testing kit for the anthrax bacteria. Soon after it made a public
         announcement concerning its efforts to develop the product the
         Securities and Exchange Commission, and the National Association of
         Securities Dealers, Inc. each opened investigations regarding these
         efforts as well as alleged unlawful insider trading in the Company's
         common stock. Each of these investigations is currently pending and the
         SEC staff has informed the Company that it has recommended to the SEC
         that it file a civil enforcement action against the Company and Donald
         R. Podrebarac, its chief executive officer, for violations of Section
         10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
         The remedies the SEC staff is considering recommending that the SEC
         seek include an injunction requiring the Company to not violate the
         securities laws in the future, fines and an order preventing Mr.
         Podrebarac from working for a public company, which would include the
         Company.

       In addition, the U.S. Attorneys Office for the Southern District of New
         York has opened an investigation into whether efforts to develop and
         market PurTest Anthrax(R) Test were part of a fraudulent criminal
         scheme as well as into whether the Company may have violated various
         federal securities laws. On November 29, 2001 the FBI executed a search
         warrant at the Company's offices in connection with this investigation.
         These investigations and related litigation will be very costly to
         defend. If the Company were to lose or settle any such case, the
         remedies imposed would likely have a material adverse effect on the
         Company.

       Also in connection with the Company's development of the anthrax testing
         kit, investigations were undertaken by Federal Trade Commission and the
         North Carolina Department of Justice's Consumer Protection Division.
         While the investigation by the North Carolina Department of Justice's
         Consumer Protection Division remains open, the Company has entered into
         a settlement with the Federal Trade Commission under which it will not
         produce or market the anthrax test or any other biohazard test or
         device unless it possesses competent scientific evidence substantiating
         its efficacy.


                                      F-21
<PAGE>


       The Company's balance sheet as of December 31, 2001, reflects a reserve
         of approximately $178,000 for estimated costs related to the
         investigations described above which are expected to be incurred during
         the first six months of 2002. Management believes that it is not
         possible at this time to estimate costs related to the investigation
         which may be incurred beyond June 2002 or any subsequent litigation.

       A significant portion of the Company's sales market is in hardware and
         home center stores. Therefore, the Company's ability to make future
         sales is dependent upon these retail markets.



                                      F-22
<PAGE>


ITEM 8.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                  AND FINANCIAL DISCLOSURES.

         Not applicable.

                                   PART III

ITEM 9.           DIRECTORS, EXECUTIVES OFFICERS, PROMOTERS AND CONTROL
                  PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

         Our directors and executive officers are as follows:

<TABLE>
<CAPTION>
  NAME & DIRECTOR SINCE             AGE             POSITION
  ---------------------             ---             --------
<S>                                <C>             <C>
  Donald R. Podrebarac              52              Chief Executive Officer, President and Director
  1993

  C. Wilbur Peters                  79              Chairman of the Board, Treasurer and Director
  1990

  Larry C. Pratt                    52              Vice President, Secretary and Director
  1990

  Duane G. Hansen                   69              Director
  1993

  Phil Divine                       56              Director
  1993
</TABLE>

         Our board of directors has five members. All directors currently hold
office until the next annual meeting of stockholders or until their successors
have been elected and qualified. There are no family relationships between any
of our directors or executive officers.

         Donald R. Podrebarac has served as our Chief Executive Officer and
President since 1996 and has also served on our board of directors since 1993.
Mr. Podrebarac served as Executive Vice President from 1994 to 1996. From 1992
to 1994 Mr. Podrebarac served as a consultant to the Company. From 1991 to
1992 Mr. Podrebarac served as President of Alaska Falls Bottling Company, a
bottled water company and a wholly-owned subsidiary of Liqui-box Corporation,
a publicly-traded bottled water company. From 1982 to 1989 Mr. Podrebarac
served as President of Ambrosia Premium Water Company, a bottled water company
founded by Mr. Podrebarac.

         C. Wilbur Peters has served as a director since our inception in
1990.  He has served as Chairman of the Board and Treasurer since 1993.  From
1993 to 1996 Mr. Peters served as Chief Executive Officer and President.  Mr.
Peters was the founder, Chief Executive Officer and President of Minnesota
Fabrics, Inc., a publicly-traded piece goods retail company which was acquired
by Hancock Fabrics, Inc., a fabric retailer, in 1985.  Since 1985 Mr. Peters
has been President and director of CTF, Inc., a non-profit corporation that
supports missionary activities.

         Larry C. Pratt has served as a director since our inception in 1990.
He has served as Vice President and Secretary since 1993. Since 1989 Mr. Pratt
has served as a venture consultant for C. Wilbur Peters in

                                      15

<PAGE>

connection with Mr. Peters' private investments. From 1985 to 1989 Mr. Pratt
served as Administrative Manager of Hancock Fabrics, Inc, a fabric retailer.

         Duane G. Hansen joined our board of directors in 1993.  Mr. Hansen
was Group Vice President of Minnesota Fabrics, Inc. at the time of its
acquisition by Hancock Fabrics, Inc. in 1985 and continued as Vice President
until his retirement in 1987.  Since 1987 Mr. Hansen has been engaged in
volunteer work and from 1991 to 1996 he served as York County (S.C.)
Republican Chairman.

         Phil Divine joined our board of directors in 1993.  Since February
2001, Mr. Divine has served as Director of Human Resources for Calvary Church,
located in Matthews, North Carolina.  From 1999 to 2001, Mr. Divine served as
Director of Management Development and Training for Osprey Systems, Inc., an
electronic commerce consulting firm.  From 1997 to 1999 Mr. Divine served as
Chief Information Officer for Osprey Systems.  From 1996 to 1997 Mr. Divine
served as Practice Manager for Osprey Systems.  From 1995 to 1996 Mr. Divine
was a consultant for Phil Divine, Inc., a management consulting firm.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

         Section 16(a) of the Securities Exchange Act of 1934 requires our
Directors and executive officers to file reports of holdings and transaction
in Common Stock with the SEC. Based on our records and other information, we
believe that in 2001 our Directors, executive officers and beneficial owners
of more than 10% of our outstanding shares of common stock met all applicable
SEC filing requirements.

ITEM 10.          EXECUTIVE COMPENSATION

         Executive Compensation.  Mr. Podrebarac is our only employee who
receives compensation in excess of $100,000 per year.  Mr. Podrebarac's salary
is $126,600 per year.  We pay the premiums on a $500,000 term life insurance
for the benefit of Mr. Podrebarac and reimburse him for operating and
maintenance expenses on his vehicle.  We also may from time to time in our
discretion pay performance bonuses to Mr. Podrebarac.  Mr. Podrebarac is
eligible to receive options to purchase shares of our common stock pursuant to
our 1991 Stock Option Plan.

         Director Compensation. We pay each outside director a $500 fee for
each meeting of the board of directors attended. Directors who are officers or
employees of the Company receive no additional compensation for serving as
directors. We reimburse all directors for all reasonable out-of-pocket
expenses incurred in attending meetings of our board of directors and any of
its committees.

         The following table shows the compensation paid by us for each of the
years ended December 31, 2001, December 31, 2000 and December 31, 1999,
respectively, to or for the account of Donald R. Podrebarac, our Chief
Executive Officer.

                          SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                 LONG-TERM
                                                                            COMPENSATION AWARDS        ALL OTHER
 NAME AND PRINCIPAL POSITION     FISCAL YEAR    SALARY ($)     BONUS ($)        OPTIONS (#)         COMPENSATION ($)
 ---------------------------     -----------    ----------     ---------        -----------         ----------------
<S>                             <C>            <C>            <C>          <C>                     <C>
Donald R. Podrebarac                2001          135,656         --                 --                  998(1)
President & CEO                     2000          126,654        5,000               --                  998(1)
                                    1999          121,962         --                 --                  998(1)
</TABLE>

--------------------
(1)      Represents value of term life insurance premiums paid by us for the
         benefit of Mr. Podrebarac.

                                      16

<PAGE>

The following table sets forth information relating to the exercise of options
by Mr. Podrebarac during the year ended December 31, 2001 and the year-end
value of his unexercised stock options.

                        AGGREGATED OPTION EXERCISES IN
                       2001 AND YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                                     NUMBER OF SHARES          VALUE OF UNEXERCISED
                              SHARES ACQUIRED                     UNDERLYING UNEXERCISED     IN-THE-MONEY OPTIONS AT
            NAME                ON EXERCISE     VALUE REALIZED    OPTIONS AT YEAR-END (#)          YEAR-END ($)
            ----                -----------     --------------    -----------------------          ------------
                                                                       EXERCISABLE/                EXERCISABLE/
                                                                       UNEXERCISABLE              UNEXERCISABLE
                                                                       -------------              -------------
<S>                          <C>               <C>               <C>                         <C>
Donald R. Podrebarac                 --               --                 400,000/0                    0(1)/0
</TABLE>

-------------------
(1)    Based on the closing price of the Company's common stock as quoted on the
       Nasdaq OTC Bulletin Board on December 31, 2001 ($0.09 per share).

ITEM 11.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

         The following table sets forth information as of December 31, 2001
with respect to the beneficial ownership of our common stock by:

              -   each person or group of affiliated persons we know to be the
                  beneficial owner of 5% or more of our outstanding shares of
                  common stock;

              -   each director;

              -   each executive officer; and

              -   all directors and executive officers as a group.

The information about ownership was furnished to the Company by the indicated
beneficial owners. All shares are owned directly and with sole voting and
dispositive power except as otherwise noted.

<TABLE>
<CAPTION>
                                                                         AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER                TITLE OF CLASS       BENEFICIAL OWNERSHIP      PERCENT OF CLASS
------------------------------------                --------------       --------------------      ----------------
<S>                                                <C>                  <C>                       <C>
C. Wilbur Peters
2004 Valencia Terrace
Charlotte, NC 28226                                     Common               3,858,577(1)               19.3%

Donald R. Podrebarac
1154 Baron Road                                         Common                606,700(2)                 3.5%
Weddington, NC 28173

Larry C. Pratt
5001 Smith Farm Road                                    Common                364,888(3)                 2.1%
Matthews, NC 28104
</TABLE>

                                      17

<PAGE>

<TABLE>
<S>                                                <C>                  <C>                       <C>
Duane G. Hansen
1999 Candlewick Drive                                   Common                 6,000(4)                 --(8)
Fort Mill, SC 29715

Phil Divine
2235 Ramblewood Lane                                    Common                 6,000(5)                 --(8)
Charlotte, NC 28210

CTF, Inc.
2004 Valencia Terrace                                   Common               1,294,057(6)                7.4%
Charlotte, NC 28226

Bessie Peters
2004 Valencia Terrace                                   Common               1,294,057(7)                7.4%
Charlotte, NC 28226

All Directors and executive officers as a group         Common                 4,848,145                23.5%
(5 persons)                                                                 (1)(2)(3)(4)(5)
</TABLE>

--------------------

(1)      Includes 1,038,501 shares held by CTF, Inc. and 255,556 shares
         issuable upon conversion of 575,000 shares of Series A, Class B
         preferred stock owned by CTF, Inc. as well as 1,564,500 shares
         issuable upon conversion of 31,290 shares of Series B, Class B
         preferred stock and 1,000,000 shares subject to presently exercisable
         options owned directly by Mr. Peters.  Mr. Peters and his wife,
         Bessie Peters, are the sole directors of CTF, Inc., a non-profit
         corporation.  As such they have share power to vote and dispose of
         the shares owned by CTF, Inc.

(2)      Includes 206,700 shares owned jointly by Mr. Podrebarac and his wife,
         Buntin S. Podrebarac, and 400,000 shares subject to presently
         exercisable options held by Mr. Podrebarac.

(3)      Includes 300,000 shares subject to presently exercisable options held
         by Mr. Pratt.

(4)      Includes 6,000 shares subject to presently exercisable options held
         by Mr. Hansen.

(5)      Includes 6,000 shares subject to presently exercisable options held
         by Mr. Divine.

(6)      Includes 255,556 shares obtainable upon conversion of 575,000 shares
         of Series A, Class B preferred stock owned by CTF, Inc.

(7)      Includes 1,038,501 shares held by CTF, Inc. and 255,556 shares
         issuable upon conversion of 575,000 shares of Series A, Class B
         preferred stock owned by CTF, Inc.  Mrs. Peters and her husband, C.
         Wilbur Peters, are the sole directors of CTF, Inc., a non-profit
         corporation.  As such they have share power to vote and dispose of
         the shares owned by CTF, Inc.

(8)      Less than 1%.

ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         Since our inception our primary lender has been C. Wilbur Peters,
chairman of our board, or entities controlled by Mr. Peters. As of June 30,
1999 our total indebtedness to Mr. Peters for money borrowed and for accrued
and unpaid amounts due under equipment leases was approximately $5,180,000. On
June 30, 1999 Mr. Peters forgave approximately $2,150,000 of our debt to him
and on November 5, 1999 Mr. Peters released and discharged the balance due on
our $3,035,535 promissory note to him in exchange for our issuing 31,290
shares of our Series B, Class B preferred stock to Mr. Peters. On July 1,
1999, we established a line of credit with Mr. Peters in the amount of
$750,000 evidenced by a promissory note bearing interest at the LIBOR Market
Index Rate plus 1.50%, due and payable on June 30, 2001. On February 21, 2001,
Mr. Peters executed an amendment to the promissory note extending its

                                      18

<PAGE>

term to February 23, 2003. On October 22, 2001 Mr. Peters executed another
amendment to the promissory note under which Mr. Peters agreed to accept
prepayments on the note and to re-lend to the Company on demand the amount of
any such prepayments through the term of the note. In each of 2001 and 2000
interest paid on this note was $38,809 and $24,097, respectively. At March 25,
2002, the outstanding balance of that note was approximately $761,070.
Pursuant to a promissory note dated September 1, 1992 on such date we borrowed
$400,000 from CTF, Inc., a non-profit corporation controlled by Mr. Peters.
This note was originally payable in full on May 9, 1993. On February 21, 2001,
CTF, Inc. executed an amendment to this note extending its term to February
23, 2003. On July 1, 2001 CTF, Inc. executed another amendment to the
promissory note under which CTF, Inc. agreed to accept prepayments on the note
and to re-lend to the Company on demand the amount of any such prepayments
through the term of the note. This note bears interest at prime plus 2%. At
March 25, 2002, the outstanding balance of that note was approximately
$244,118. In each of 2001 and 2000 interest paid on this note was $32,464 and
$43,183, respectively. Additionally, during the first quarter of 2001 CTF,
Inc. made total demand loans to the Company of $117,748. We have repaid in
full all such demand loans.

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

(a)      Exhibits

<TABLE>
<CAPTION>
         Exhibit No.       Document Description
         -----------       --------------------
<S>                       <C>
         3.1               Certificate of Incorporation (Exhibit 2.1 to the
                           Company's Form 10-SB filed March 14, 2000)

         3.2               Certificate of Amendment to Certificate of
                           Incorporation (Exhibit 3.2 to the Company's Form
                           SB-2 filed November 9, 2001)

         3.3               Certificate of Designation Setting Forth the
                           Preferences, Rights and Limitations of Series A,
                           Class B Preferred Stock of Vital Living Products,
                           Inc. (Exhibit 2.2 to the Company's Form 10-SB filed
                           March 14, 2000)

         3.4               Certificate of Designation of Series B, Class B
                           Preferred Stock Setting Forth the Powers,
                           Preferences, Rights, Qualifications, Limitations
                           and Restrictions of such Series of Class B
                           Preferred Stock (Exhibit 2.3 to the Company's Form
                           10-SB filed March 14, 2000)

         3.5               Bylaws of Vital Living Products, Inc. (Exhibit 2.4
                           to the Company's Form 10-SB filed March 14, 2000)

         4.1               Form of Secured Convertible Debenture dated as of
                           February 23, 2001 (Exhibit 4.1 to the Company's
                           Form 8-K filed March 1, 2001)

         4.2               Schedule identifying omitted Secured Convertible
                           Debentures dated as of February 23, 2001 which are
                           substantially identical to the Form of Secured
                           Convertible Debenture described in Exhibit 4.1
                           (previously filed)

         10.1*             Vital Living Products, Inc. 1991 Stock Option Plan
                           (Exhibit 6.1 to the Company's Form 10-SB filed
                           March 14, 2000)
</TABLE>


                                      19

<PAGE>

<TABLE>
<S>                       <C>
         10.2              Instrument of Forgiveness of Indebtedness dated
                           June 30, 1999 by C. Wilbur Peters (Exhibit 6.2 to
                           the Company's Form 10-SB filed March 14, 2000)

         10.3              Note in favor of C. Wilbur Peters dated June 30,
                           1999 (Exhibit 6.3 to the Company's Form 10-SB filed
                           March 14, 2000)

         10.4              Revolving Credit Note dated July 1, 1999 in favor
                           of C. Wilbur Peters (Exhibit 6.4 to the Company's
                           Form 10-SB filed March 14, 2000)

         10.5              Exchange Agreement dated November 5, 1999 between
                           the Company and C. Wilbur Peters (Exhibit 6.5 to
                           the Company's Form 10-SB filed March 14, 2000)

         10.6              Promissory Note in favor of CTF, Inc. dated
                           September 1, 1992 (Exhibit 6.6 to the Company's
                           Form 10-SB filed March 14, 2000)

         10.7              Escrow Agreement dated March 31, 1992 between the
                           Company, Henry H. Mummaw, Brian E. Huey, Joseph W.
                           Mummaw, Larry C. Pratt, CTF, Inc., J.W. Gant &
                           Associates, Inc. and First Union National Bank
                           (Exhibit 6.7 to the Company's Form 10-SB filed
                           March 14, 2000)

         10.8              First Amendment to Promissory Note in favor of CTF,
                           Inc. dated February 21, 2001 (previously filed)

         10.9              First Amendment to Promissory Note in favor of C.
                           Wilbur Peters dated February 21, 2001 (previously
                           filed)

         10.10             Securities Purchase Agreement dated as of February
                           23, 2001between the Company, AJW Partners, LLC,
                           Millennium Capital Partners II, LLC and Equilibrium
                           Equity, LLC (Exhibit 10.1 to the Company's Form 8-K
                           filed March 1, 2001)

         10.11             Registration Rights Agreement dated as of February
                           23, 2001between the Company, AJW Partners, LLC,
                           Millennium Capital Partners II, LLC and Equilibrium
                           Equity, LLC (Exhibit 10.2 to the Company's Form 8-K
                           filed March 1, 2001)

         10.12             Form of Stock Purchase Warrant dated as of February
                           23, 2001 (Exhibit 10.3 to the Company's Form 8-K
                           filed March 1, 2001)

         10.13             Schedule identifying omitted Stock Purchase
                           Warrants dated as of February 23, 2001 which are
                           substantially identical to the Form of Stock
                           Purchase Warrant described in Exhibit 10.12
                           (previously filed)

         10.14             Security Agreement dated as of February 23, 2001
                           between the Company, AJW Partners, LLC, Millennium
                           Capital Partners II, LLC and Equilibrium Equity,
                           LLC (previously filed)

         10.15             Second Amendment to Promissory Note in favor of
                           CTF, Inc. dated July 1, 2001 (Exhibit 10.15 to the
                           Company's Form SB-2 filed November 9, 2001)

         10.16             Second Amendment to Promissory Note in favor of C.
                           Wilbur Peters dated October 22, 2001 (Exhibit 10.16
                           to the Company's Form SB-2 filed November 9, 2001)
</TABLE>

                                      20

(b)      Reports on Form 8-K

         The Company did not file any reports on Form 8-K during the last
quarter of 2001.

----------
         * Indicates a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Form 10-K.


                                      21
<PAGE>


                                  SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Form 10-KSB to be
signed on its behalf by the undersigned, thereunto duly authorized.

                                  VITAL LIVING PRODUCTS, INC.


                                  By: /s/ Donald R. Podrebarac
                                      ------------------------------------------
                                        Donald R. Podrebarac
                                        Chief Executive Officer and President

Dated:  April 1, 2002


         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report has been signed below by the following persons on behalf of
the Company and in the capacities and on the date indicated.

<TABLE>
<CAPTION>
         Signature                                   Capacity                                  Date
         ---------                                   --------                                  ----
<S>                                            <C>                                       <C>
/s/ Donald R. Podrebarac                        Director, Chief                           April 1, 2002
------------------------------------
Donald R. Podrebarac                            Executive Officer and President
                                                (Principal Executive Officer)


/s/ C. Wilbur Peters                            Director, Chairman and Treasurer          April 1, 2002
------------------------------------
C. Wilbur Peters



/s/ Larry C. Pratt                              Vice President, Secretary and             April 1, 2002
------------------------------------
Larry C. Pratt                                  Director (Principal Financial
                                                Officer)



/s/ Phil Divine                                 Director                                  April 1, 2002
------------------------------------
Phil Divine



/s/ Duane G. Hansen                             Director                                  April 1, 2002
------------------------------------
Duane G. Hansen
</TABLE>


                                      22

<PAGE>


                      SECURITIES AND EXCHANGE COMMISSION
                              Washington, D. C.

                         ANNUAL REPORT ON FORM 10-KSB

                                                                    Commission
For the fiscal year ended                                          File Number
December 31, 2001                                                      0-30568

                         VITAL LIVING PRODUCTS, INC.

                                EXHIBIT INDEX

<TABLE>
<CAPTION>
   Exhibit No.    Document Description
   -----------    --------------------
<S>              <C>
   3.1            Certificate of Incorporation (Exhibit 2.1 to the Company's
                  Form 10-SB filed March 14, 2000)

   3.2            Certificate of Amendment to Certificate of Incorporation
                  (Exhibit 3.2 to the Company's Form SB-2 filed November 9,
                  2001)

   3.3            Certificate of Designation Setting Forth the Preferences,
                  Rights and Limitations of Series A, Class B Preferred Stock
                  of Vital Living Products, Inc. (Exhibit 2.2 to the Company's
                  Form 10-SB filed March 14, 2000)

   3.4            Certificate of Designation of Series B, Class B Preferred
                  Stock Setting Forth the Powers, Preferences, Rights,
                  Qualifications, Limitations and Restrictions of such Series
                  of Class B Preferred Stock (Exhibit 2.3 to the Company's
                  Form 10-SB filed March 14, 2000)

   3.5            Bylaws of Vital Living Products, Inc. (Exhibit 2.4 to the
                  Company's Form 10-SB filed March 14, 2000)

   4.1            Form of Secured Convertible Debenture dated as of February
                  23, 2001 (Exhibit 4.1 to the Company's Form 8-K filed March
                  1, 2001)

   4.2            Schedule identifying omitted Secured Convertible Debentures
                  dated as of February 23, 2001 which are substantially
                  identical to the Form of Secured Convertible Debenture
                  described in Exhibit 4.1 (previously filed)

   10.1           Vital Living Products, Inc. 1991 Stock Option Plan (Exhibit
                  6.1 to the Company's Form 10-SB filed March 14, 2000)

   10.2           Instrument of Forgiveness of Indebtedness dated June 30,
                  1999 by C. Wilbur Peters (Exhibit 6.2 to the Company's Form
                  10-SB filed March 14, 2000)

   10.3           Note in favor of C. Wilbur Peters dated June 30, 1999
                  (Exhibit 6.3 to the Company's Form 10-SB filed March 14,
                  2000)

   10.4           Revolving Credit Note dated July 1, 1999 in favor of C.
                  Wilbur Peters (Exhibit 6.4 to the Company's Form 10-SB filed
                  March 14, 2000)
</TABLE>

                                      23

<PAGE>

<TABLE>
<S>              <C>
   10.5           Exchange Agreement dated November 5, 1999 between the
                  Company and C. Wilbur Peters (Exhibit 6.5 to the Company's
                  Form 10-SB filed March 14, 2000)

   10.6           Promissory Note in favor of CTF, Inc. dated September 1,
                  1992 (Exhibit 6.6 to the Company's Form 10-SB filed March
                  14, 2000)

   10.7           Escrow Agreement dated March 31, 1992 between the Company,
                  Henry H. Mummaw, Brian E. Huey, Joseph W. Mummaw, Larry C.
                  Pratt, CTF, Inc., J.W. Gant & Associates, Inc. and First
                  Union National Bank (Exhibit 6.7 to the Company's Form 10-SB
                  filed March 14, 2000)

   10.8           First Amendment to Promissory Note in favor of CTF, Inc.
                  dated February 21, 2001 (previously filed)

   10.9           First Amendment to Promissory Note in favor of C. Wilbur
                  Peters dated February 21, 2001 (previously filed)

   10.10          Securities Purchase Agreement dated as of February 23,
                  2001between the Company, AJW Partners, LLC, Millennium
                  Capital Partners II, LLC and Equilibrium Equity, LLC
                  (Exhibit 10.1 to the Company's Form 8-K filed March 1, 2001)

   10.11          Registration Rights Agreement dated as of February 23,
                  2001between the Company, AJW Partners, LLC, Millennium
                  Capital Partners II, LLC and Equilibrium Equity, LLC
                  (Exhibit 10.2 to the Company's Form 8-K filed March 1, 2001)

   10.12          Form of Stock Purchase Warrant dated as of February 23, 2001
                  (Exhibit 10.3 to the Company's Form 8-K filed March 1, 2001)

   10.13          Schedule identifying omitted Stock Purchase Warrants dated
                  as of February 23, 2001 which are substantially identical to
                  the Form of Stock Purchase Warrant described in Exhibit
                  10.12 (previously filed)

   10.14          Security Agreement dated as of February 23, 2001between the
                  Company, AJW Partners, LLC, Millennium Capital Partners II,
                  LLC and Equilibrium Equity, LLC (previously filed) 10.15
                  Second Amendment to Promissory Note in favor of CTF, Inc.
                  dated July 1, 2001 (Exhibit 10.15 to the Company's Form SB-2
                  filed November 9, 2001)

   10.15          Second Amendment to Promissory Note in favor of CTF, Inc.
                  dated July 1, 2001 (Exhibit 10.15 to the Company's Form SB-2
                  filed November 9, 2001)

   10.16          Second Amendment to Promissory Note in favor of C. Wilbur
                  Peters dated October 22, 2001 (Exhibit 10.16 to the
                  Company's Form SB-2 filed November 9, 2001)
</TABLE>

                                      24