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EX-31.1 - CERTIFICATION - Zurvita Holdings, Inc.zurvita_10q-ex3101.htm
EX-32.1 - CERTIFICATION - Zurvita Holdings, Inc.zurvita_10q-ex3201.htm
EX-31.2 - CERTIFICATION - Zurvita Holdings, Inc.zurvita_10q-ex3102.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q

(Mark One)                                                                                                                                                                 
x      Quarterly report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended April 30, 2011

o      Transition report pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from _________ to _________
 
Commission file number 333-145898

ZURVITA HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
26-0531863
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)


800 Gessner
Houston, Texas 77024
(Address of principal executive offices) (zip code)

 
(713) 464-5002
(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   o
Accelerated filer  o
Non-accelerated filer    o (Do not check if a smaller reporting company)
Smaller reporting company  x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of June 13, 2011:
61,498,713 shares of common stock, par value $0.0001
 



 
 

 

ZURVITA HOLDINGS, INC.

FORM 10-Q
 
PART I - FINANCIAL INFORMATION

 
Page No.
Item 1.   Financial Statements (Unaudited).
 
   
Condensed Consolidated Balance Sheets – April 30, 2011 and July 31, 2010
3
   
Condensed Consolidated Statements of Operations – For the Three and Nine Months Ended April 30, 2011 and 2010
4
   
Condensed Consolidated Statements of Cash Flows – For the Nine Months Ended April 30, 2011 and 2010
5
   
Condensed Consolidated Statement of Stockholders’ Deficit – For the Nine Months Ended April 30, 2011
6
   
Notes to Interim Condensed Consolidated Financial Statements
7
   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
22
   
Item 3.   Quantitative and Qualitative Disclosures about Market Risk.
30
   
Item 4.   Controls and Procedures.
30

PART II - OTHER INFORMATION

 
Page No.
   
   
Item 1.   Legal Proceedings.
30
   
Item 1a. Risk Factors.
30
   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.
30
   
Item 3.   Defaults Upon Senior Securities.
30
   
Item 4.   Removed and Reserved.
30
   
Item 5.   Other Information.
30
   
Item 6.   Exhibits.
31
   
Signatures
32


 
2

 

ZURVITA HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

             
   
(Unaudited)
       
   
April 30, 2011
   
July 31, 2010
 
ASSETS
           
Current assets
           
Cash
  $ 118     $ 289,442  
Marketable securities (at fair value)
    80,000       480,000  
Security sales proceeds receivable
    -       1,702,000  
Accounts receivable
    171,664       137,123  
Agent advanced compensation
    -       448,553  
Deferred expenses
    12,951       127,351  
Prepaid expenses
    233,459       41,173  
Total current assets
    498,192       3,225,642  
                 
Property, plant and equipment (net)
    77,066       94,965  
                 
Merchant account deposit
    115,333       115,333  
Total assets
  $ 690,591     $ 3,435,940  
                 
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
         
Current liabilities
               
Accounts payable
  $ 240,393     $ 249,762  
Accounts payable - related party
    195,316       127,733  
Advanced security proceeds
    1,000,000       -  
Notes payable - current
    194,764       284,967  
Accrued expenses
    296,944       332,217  
Deferred revenue
    199,153       808,957  
Deferred compensation - related party
    97,546       110,238  
Income tax payable
    5,749       2,628  
Total current liabilities
    2,229,865       1,916,502  
                 
Notes payable - long term
    1,878,427       1,639,268  
Fair value of share conversion feature
    -       462,013  
Fair value of warrants
    307,600       6,370,000  
Total liabilities
    4,415,892       10,387,783  
                 
Redeemable preferred stock
    4,550,747       4,550,747  
                 
Stockholders' deficit
               
Common stock ($.0001 par value, 300,000,000 shares authorized; 69,498,713 and 69,497,713 shares issued and 61,498,713 and 61,497,713 shares outstanding as of April 31, 2011 and July 31, 2010, respectively)
    6,950       6,950  
Treasury stock
    (210,000 )     (210,000 )
Additional paid-in capital
    10,322,450       9,978,738  
Accumulated deficit
    (18,395,448 )     (21,278,278 )
Total stockholders' deficit
    (8,276,048 )     (11,502,590 )
                 
Total liabilities, redeemable preferred stock and stockholders' deficit
  $ 690,591     $ 3,435,940  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


 
3

 
 
ZURVITA HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
For the Three Months Ended
   
For the Nine Months Ended
 
   
April 30, 2011
   
April 30,
 
   
2011
   
2010
   
2011
   
2010
 
REVENUES
                       
Administrative websites
  $ 230,265     $ 519,514     $ 1,081,627     $ 1,517,649  
Advertising sales
    137,074       342,145       591,229       597,736  
Commissions
    91,972       127,123       368,598       283,964  
Consumable products
    463,617       -       490,385       -  
Marketing fees and materials
    191,512       501,538       749,675       1,452,765  
Membership fees
    100,201       216,596       381,580       756,347  
Total revenues
    1,214,641       1,706,916       3,663,094       4,608,461  
                                 
COST OF SALES
                               
Benefit and service cost
    264,513       409,333       886,914       1,039,579  
Consumable product manufacturing costs
    126,895       -       126,895       -  
Sales commissions
    475,042       711,061       1,465,268       2,341,937  
Total cost of sales
    866,450       1,120,394       2,479,077       3,381,516  
                                 
GROSS PROFIT
    348,191       586,522       1,184,017       1,226,945  
                                 
OPERATING EXPENSES
                               
Depreciation
    8,772       9,011       28,089       26,287  
Office related expenses
    144,752       115,872       406,277       284,760  
Payroll and employee benefits
    575,646       435,568       1,689,589       1,198,538  
Professional fees
    168,413       253,413       663,381       1,002,310  
Selling and marketing
    291,160       711,010       1,223,990       2,201,817  
Travel
    55,462       34,624       172,688       140,657  
Total operating expenses
    1,244,205       1,559,498       4,184,014       4,854,369  
                                 
Loss from operations before other expenses income
    (896,014 )     (972,976 )     (2,999,997 )     (3,627,424 )
                                 
OTHER INCOME (EXPENSE)
                               
Gain on change in fair value of share conversion feature
    -       139,190       462,013       171,485  
Gain (loss) on change in fair value of warrants
    154,400       948,435       6,062,400       (3,091,230 )
Gain (loss) on extinguishment of debt
    13,000       (50,000 )     13,000       (50,000 )
Interest expense
    (88,372 )     (82,405 )     (256,221 )     (190,501 )
Interest income
    -       -       4,756       -  
(Loss) gain on change in fair value of marketable securities
    (240,000 )     400,000       (400,000 )     (130,000 )
Total other income (expense)
    (160,972 )     1,355,220       5,885,948       (3,290,246 )
                                 
(Loss) income before income taxes
    (1,056,986 )     382,244       2,885,951       (6,917,670 )
                                 
Income taxes
    448       12,287       3,121       32,429  
                                 
Net (loss) income
  $ (1,057,434 )   $ 369,957     $ 2,882,830     $ (6,950,099 )
                                 
Basic (loss) earnings  per share
  $ ( 0.02 )   $ 0.01     $ 0.05     $ ( 0.12 )
                                 
Basic weighted average number of common shares outstanding
    61,498,713       56,964,734       61,498,713       56,683,117  
                                 
Diluted (loss) earnings per share
  $ ( 0.02 )   $ 0.00     $ 0.05     $ ( 0.12 )
                                 
Diluted weighted average number of common shares outstanding
    61,498,713       104,950,540       61,498,713       56,683,117  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
4

 
 
 
ZURVITA HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
For the Nine Months Ended
 
   
April 30, 2011
   
April 30, 2010
 
Cash flows from operating activities
           
Net income (loss)
  $ 2,882,830     $ (6,950,099 )
Adjustments to reconcile net income (loss) to net cash (used in) operating activities:
               
Amortization of note payable discount
    142,145       95,635  
Amortization of deferred marketing costs
    -       493,050  
Depreciation
    28,089       26,287  
Share-based compensation
    343,212       386,327  
Gain on change in fair value of share conversion feature
    (462,013 )     (171,485 )
(Gain) loss on change in fair value of warrants
    (6,062,400 )     3,091,230  
Gain (loss) on extinguishment of debt
    (13,000 )     50,000  
Loss on change in fair value of marketable securities
    400,000       130,000  
Changes in operating assets and liabilities
               
Increase in accounts receivable
    (34,541 )     (69,480 )
Decrease in agent advanced compensation
    448,553       476,562  
Decrease (increase) in deferred expenses
    114,401       (148,768 )
Increase in prepaid expenses
    (172,658 )     (46,106 )
Increase in accounts payable and accrued expenses
    136,076       12,914  
(Decrease) increase in deferred revenue
    (609,804 )     162,949  
Decrease (increase) in deferred compensation related party
    (12,692 )     64,736  
Net cash (used in) operating activities
    (2,871,802 )     (2,396,248 )
                 
Cash flows from investing activities
               
Proceeds from promissory note recievable
    1,702,000       -  
Purchase of property and equipment
    ( 10,191 )     (7,617 )
Purchase of marketable securities
    -       (770,000 )
Net cash provided by (used in) investing activities
    1,691,809       (777,617 )
                 
Cash flows from financing activities
               
Advanced security proceeds
    1,000,000       -  
Proceeds from borrowings
    30,000       -  
Proceeds from exercise of warrants
    500       -  
Proceeds from sale of preferred stock
    -       3,000,000  
Principal payments made on notes payable
    (139,831 )     (655,310 )
Net cash provided by financing activities
    890,669       2,344,690  
                 
Net change in cash balance
    (289,324 )     (829,175 )
                 
Beginning cash
    289,442       1,390,953  
                 
Ending cash
  $ 118     $ 561,778  
                 
Supplemental disclosure of cash flow information
               
Cash paid for interest
  $ 13,750     $ 17,890  
                 
Cash paid for taxes
  $ -     $ -  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
 
5

 

ZURVITA HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
(Unaudited)

   
Shares
Common Stock
 
Common
Stock
   
Treasury
Stock
   
Additional
Paid-In
Capital
   
Accumulated Deficit
   
Total Stockholder's Deficit
 
Balance, July 31, 2010
    61,497,713     $ 6,950     $ ( 210,000 )   $ 9,978,738     $ ( 21,278,278 )   $ ( 11,502,590 )
                                                 
Share-based compensation
    -       -       -       343,212       -       343,212  
                                                 
Exercise of comon stock warrants
    1,000       -       -       500       -       500  
                                                 
Net income available to common stockholders
    -       -       -       -       2,882,830       2,882,830  
                                                 
Balance, April 30, 2011
    61,498,713     $ 6,950     $ ( 210,000 )   $ 10,322,450     $ ( 18,395,448 )   $ ( 8,276,048 )
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
6

 

 
ZURVITA HOLDINGS, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE 1 – NATURE OF OPERATIONS

Our condensed consolidated financial statements include the accounts of Zurvita Holdings, Inc. (referred to herein as the “Company,” “Zurvita Holdings,” “Zurvita,” “we,” “us” or “our”) and our wholly-owned subsidiary Zurvita, Inc.  Material intercompany transactions and balances have been eliminated upon consolidation.  Zurvita is a direct sales marketing company offering high-quality products and services targeting individuals, families and small businesses.  The Company’s differentiated services feature consumer products and small business solutions offered through a network of independent sales consultants.  Zurvita offers a unique business-to-business strategy with turnkey solutions for commercial energy, advertising, and healthcare services.  The Company also markets numerous low-cost ancillary products, such as legal assistance and restoration services for identity theft and consumer credit.

Management’s Assessment of Liquidity

Since the Company’s inception, the Company has primarily met its operating cash requirements through equity contributions from The Amacore Group, Inc. (Amacore), who was the Company’s sole shareholder prior to July 30, 2009.  Subsequent to July 30, 2009, the Company has sold several series of preferred stock for gross proceeds of $6.8 million to another related party. We are using the proceeds from the sale of preferred stock to subsidize the Company’s operations as the Company’s revenues and operating cash flows are not currently sufficient to support the Company’s current operations.

At April 30, 2011, the Company had negative working capital of approximately $1.7 million, an accumulated deficit of approximately $18.3 million and negative cash flows from operating activities of approximately $2.9 million. Since the date of inception, the Company has used approximately $9.2 million in operations.

The Company believes that without the support of its related party stockholders its cash resources would be insufficient to sustain current planned operations for the next 12 months. Additional cash resources may be required should the Company not meet its sales targets, exceed its projected operating costs, wish to accelerate sales or complete one or more acquisitions or if unanticipated expenses arise or are incurred.  

The Company does not currently maintain a line of credit or term loan with any commercial bank or other financial institution and has not made any other arrangements to obtain additional financing.  We can provide no assurance that we will not require additional financing.  Likewise, we can provide no assurance that if we need additional financing that it will be available in an amount or on terms acceptable to us, if at all.  If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us, we may be unable to execute our business plan or pay our costs and expenses as they are incurred, which could have a material, adverse effect on our business, financial condition and results of operations.

These issues raise substantial doubt about our ability to continue as a going concern for a reasonable period.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
In June 2009, the Financial Accounting Standards Board (“FASB”) approved FASB Accounting Standards Codification (“Codification”) as the single source of authoritative accounting guidance used in the preparation of financial statements in conformity with U.S. GAAP for all non-governmental entities. Codification, which changed the referencing and organization of accounting guidance without modification of existing U.S. GAAP, is effective for interim and annual periods ending after September 15, 2009.  Since it did not modify existing U.S. GAAP, Codification did not have any impact on the Company’s financial condition or results of operations.

Revenue Recognition

Administrative Websites

Company’s independent representatives pay a fee to the Company entitling them to use of websites that facilitate their business operations.  This revenue is recognized ratably over the website subscription period.

Advertising Sales

The Company markets subscriptions to a service that facilitates the ability of customers, typically small business owners, to display commercial advertising via an on-line search directory.  This revenue is recognized ratably over the advertising subscription period.

 
7

 


Commissions

The Company is paid a commission for its sales of third-party products. Commissions are recognized as products are sold and services performed and the Company has accomplished all activities necessary to complete the earnings process.  

Consumable Products

The company markets a nutritional drink called “Zeal”.  Revenue from the sale of this consumable product is recognized upon shipment of the product.

Marketing Fees and Materials

The Company markets certain of its products through a multi-level sales organization whereby independent distributors establish their own network of associates.  The independent distributors pay the Company an annual fee to become marketing representatives on behalf of the Company.  In exchange, the representatives receive access, on an annual basis, to various marketing and promotional materials and tools as well as access to a customized management reporting platform; accordingly, revenue from marketing fees is recognized over an annual period.  The Company also earns ancillary revenue from the sale of marketing materials to third parties.  Revenue is recognized when marketing materials are delivered.

Membership Fees

The Company recognizes revenues from membership fees as earned for the sales of other lifestyle discount benefit programs, such as household protection and personal financial services.  These arrangements are generally renewable monthly and revenue is recognized over the renewal period.  These products often include elements sold through contracts with third-party providers.  Based on consideration of each contractual arrangement, revenue is reported on a gross basis.

Refunds and Chargebacks

The Company records a reduction in revenue for estimated refunds and chargebacks from credit card companies based upon actual history and management’s evaluation of current facts and circumstances.   Refunds and chargebacks totaled approximately $24 thousand and $144 thousand for the three months ended April 30, 2011 and 2010, respectively, and $108 thousand and $316 thousand for the nine months ended April 30, 2011and 2010, respectively, and were recorded as a reduction of revenue in the accompanying statements of operations.  Estimates for an allowance for refunds and chargebacks totaled approximately $10 thousand and $14 thousand is included in accrued expenses in the accompanying condensed consolidated balance sheets as of April 30, 2011 and July 31, 2010, respectively.

Selling and Marketing Costs
  
The Company classifies merchant account fees, fulfillment costs and lead cost not identifiable with specific product sales within selling and marketing costs within the Statement of Operations.

Concentration of Credit Risk

All of the Company’s credit card processing is with one merchant processor, as well as all marketing sales commission payments are calculated by a third-party service provider.

Use of Estimates
 
The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including the allowance for sales refunds and chargebacks, capitalization of certain assets, depreciable/amortizable lives, impairment of long-lived assets, determination of amount of allowance for doubtful accounts, the fair value of marketable securities, the expected volatility of common stock, and the fair value of common stock and warrants as well as the allocation of proceeds from the issuance of debt and equity instruments.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.
 
Marketable Securities

The Company’s marketable securities consist of non-registered common stock. The Company fair values these securities on a recurring basis and has accounted for these securities as trading securities in accordance with U.S. GAAP.  These investments are carried in the accompanying consolidated balance sheet at fair value, with the difference between cost and fair value (unrealized gains and losses) included in the Statement of Operations.  Marketable securities are classified as current assets as they are available to meet the current operating needs of the Company.

 
8

 


Accounts Receivable
 
Accounts receivable are stated at estimated net realizable value.  Accounts receivable are primarily comprised of balances due from memberships, net of estimated allowances for uncollectible accounts.  In determining collectability, historical trends are evaluated and specific customer issues are reviewed to arrive at appropriate allowances.  At April 30, 2011 and July 31, 2010, no allowance was recorded.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost.  The cost of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred.  The Company provides for depreciation and amortization using the straight-line method over the estimated useful lives of the property as follows: computer hardware, 3 years; furniture and fixtures, 7 years; equipment and machinery, 5 years; and leasehold improvements, the shorter of the term of the lease or the life of the asset.  When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are eliminated from the accounts and the resulting gain or loss is reflected in the results of operations.

Share-Based Compensation

The Company recognizes the cost resulting from all share-based payment transactions in the financial statements using a fair-value-based measurement method.  The Company uses the Black-Scholes Option Pricing Model in computing the fair value of warrant instrument issuances.

The measurement date for valuing share-based payments made to non-employees is the earlier of the date at which a commitment for performance by the counterparty to earn the equity instruments is reached or the date at which the counterparty’s performance is complete.

Convertible Instruments

The Company reviews the terms of convertible debt and preferred stock for indications requiring bifurcation, and separate accounting for the embedded conversion feature. Generally, embedded conversion features where the ability to physical or net-share settle the conversion option is not within the control of the Company or the number of shares is variable are bifurcated and accounted for as derivative financial instruments. (See Derivative Financial Instruments below). Bifurcation of the embedded derivative instrument requires allocation of the proceeds first to the fair value of the embedded derivative instrument with the residual allocated to the host instrument.  The resulting discount to the debt instrument or to the redemption value of convertible preferred securities is accreted through periodic charges to interest expense over the term of the note or to dividends over the period to earliest conversion date using the effective interest rate method, respectively.

Derivative Financial Instruments

The Company does not use derivative financial instruments to hedge exposures to cash-flow or market risks. However, certain other financial instruments, such as warrants to purchase the Company’s common stock and the embedded conversion features of debt and preferred instruments that are not considered indexed to the Company’s common stock are classified as liabilities when either (a) the holder possesses rights to net-cash settlement, (b) physical or net share settlement is not within the control of the Company, or (c) based on its anti-dilutive provisions.  In such instances, net-cash settlement is assumed for financial accounting and reporting. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value at the close of each reporting period. Fair value for option-based derivative financial instruments is determined using the Black-Scholes Option Pricing Model.

Income Taxes
 
The Company accounts for income taxes using an asset and liability method pursuant to which deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided against deferred tax assets based on the weight of available evidence when it is more likely than not that some or all of the deferred tax assets will not be realized.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, we believe it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as income tax expense in the statement of operations.

 
9

 


Fair Value Measurements

U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability to a third party with the same credit standing (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In many cases, the exit price and the transaction (or entry) price will be the same at initial recognition. However, in certain cases, the transaction price may not represent fair value. Fair value is a market-based measurement determined based on a hypothetical transaction at the measurement date, considered from the perspective of a market participant, not based solely upon the perspective of the reporting entity. When quoted prices are not used to determine fair value, consideration is given to three broad valuation techniques: (i) the market approach, (ii) the income approach, and (iii) the cost approach. Entities are required to determine the most appropriate valuation technique to use, given what is being measured and the availability of sufficient inputs. Inputs to fair valuation techniques are prioritized, allowing for the use of unobservable inputs to the extent that observable inputs are not available. The applicable guidance establishes a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. The input levels are defined as follows:

Level 1
Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2
Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1, quoted prices in markets that are not active, or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3
Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities.  Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.  Level 3 assets and liabilities include those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as those for which the determination of fair value requires significant management judgment or estimation.

(Loss) Earnings Per Share

Basic (loss) earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings (loss) per share is calculated by dividing the net (loss) income by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of common stock equivalents, using the treasury stock method. Convertible debt and warrants, officer, employee and non-employee stock options that are considered potentially dilutive are included in the fully diluted shares calculation as long as the effect is not anti-dilutive.  Contingently issuable shares are included in the computation of basic loss per share when the issuance of the shares is no longer contingent.  For the three and nine months ended April 30, 2011, securities that could potentially dilute earnings per share in the future were not included within the Company’s (loss) earnings per share calculation as their effect would be anti-dilutive.
 
Recent Accounting Pronouncements
 
The Company does not believe that there will be any impace from the new standards.

Subsequent Events

Management has evaluated subsequent events through the date the financial statements were issued.

NOTE 3 – NON CASH INVESTING AND FINANCING ACTIVITIES

The following table presents a summary of the various noncash investing and financing transactions that the Company entered into during the three months ended:

 
10

 



   
April 30, 2011
   
April 30, 2010
 
             
             
Embedded conversion feature on note payable issued
  $ -     $ 593,426  
                 
Financed insurance agreement
    19,627       22,031  
                 
Accrued interest converted to principal
    97,014       61,127  
                 
Note payable issued in exchange for marketing services agreement
    -       1,406,574  
                 
Reclassification of warrants from liability to equity
    -       63,713  

NOTE 4 – AGENT ADVANCED COMPENSATION

The Company entered into loan agreements with certain of its independent sales agents which represent advanced compensation.  The agreements have an approximately 2 year term; however, if an agent is still selling for the Company at the maturity date then the note is forgiven.  Therefore, the Company is expensing them over the term of the loan.  The expense is recognized in selling and marketing expenses on the statement of operations as it is not directly related to sales of product or services.  Approximately $61 thousand and $676 thousand of expense was recognized for three and nine months ended April 30, 2011, respectively, as compared to $306 thousand and $837 thousand was recognized for three and nine months ended April 30, 2010, respectively.  As of April 30, 2011, all notes had matured and were forgiven.  At July 31, 2010, the balance of the loans was approximately $449 thousand.
 
NOTE 5 – DEFERRED EXPENSES

For sales of subscriptions for which the terms cross reporting periods, the associated commissions paid to the Company’s sales representatives are deferred and amortized over the subscription period.  As of April 30, 2011 and July 31, 2010, the balances of the deferred commissions were approximately $13 thousand and $127 thousand, respectively, and are classified as a current asset.

NOTE 6 – NOTES PAYABLE

Notes payable consist of the following:

 
11

 


   
April 30, 2011
   
July 31, 2010
 
             
             
Related party convertible note payable; face amount $2 million; bearing interest of 6% per annum; secured; principal payment due on October 9, 2012
  $ 1,878,427     $ 1,639,268  
                 
Financing agreement; bearing interest at 5.25% per annum; payable in monthly installments of approximately $2.5 thousand due through July 2011
    6,637       -  
                 
Related party Promissory note payable; bearing interest of 15% per annum; unsecured; due on demand
    30,000       -  
                 
Promissory note payable; bearing interest of 7.5% per annum; unsecured; principal payments due monthly approximately $27 thousand through July 2011
    158,127       284,967  
                 
                 
Total notes payable
    2,073,191       1,924,235  
                 
Less current portion
    194,764       284,967  
                 
Total long-term debt
  $ 1,878,427     $ 1,639,268  

The convertible note’s principal balance is due three years from the date of issuance and convertible at any time at the option of the holder at a conversion price of $0.25 per share.  The Company has accounted for the conversion feature as an embedded derivative instrument requiring it to be separated from the note payable and reported at fair value.  The fair value of the conversion feature at issuance date was approximately $593 thousand.  The separation of the conversion feature from the note payable resulted in a discount on the note payable and a share conversion liability in the amount of approximately $593 thousand.  The share conversion liability is subject to recurring fair value adjustments each reporting period (see Note 10 - Assets and Liabilities Measured at Fair Value).  The discount is amortized over the life of the note payable using the effective interest method and recorded as interest expense in the statement of operations.  During the three and nine months ended April 30, 2011, total interest expense related to the convertible note payable was approximately $81 thousand and $239 thousand, respectively.   For the three and nine months ended April 30, 2010, total interest expense was approximately $74 thousand and $164 thousand, respectively.  Of the interest expense recognized for the nine months ended April 30, 2011 and 2010, approximately $97 thousand and $61 thousand, respectively, was elected by the Company to be deferred and added to the principal of the note.

At April 30, 2011, the said note was convertible into approximately 8.8 million shares of common stock with a market value of approximately $264 thousand as of April 30, 2011.

The following is a schedule of the future maturity payments required under the Company’s promissory notes payable.

Current
  $ 194,764  
2012
    2,189,401  
      2,384,165  
Net of discount on convertible note payable
    (310,974 )
    $ 2,073,191  
 
Of the notes payable, approximately $195 thousand is classified as current maturities as of April 30, 2011.


 
12

 


NOTE 7 - ACCRUED EXPENSES

Accrued expenses consist of the following at April 30, 2011 and July 31, 2010:
 
   
April 30, 2011
   
July 31, 2010
 
Commissions
  $ 120,476     $ 173,314  
Interest
    10,989       7,672  
Marketing materials
    1,674       37,830  
Payroll
    72,023       41,549  
Professional fees
    10,000       2,500  
Refund reserve
    10,000       14,192  
Rent
    5,957       8,340  
Sales tax payble
    24,570       19,004  
Unclaimed property
    41,255       27,816  
Total
  $ 296,944     $ 332,217  
 
NOTE 8 - DEFERRED REVENUE

Deferred revenue consists of the following at April 30, 2011 and July 31, 2010:
 
   
April 30, 2011
   
July 31, 2010
 
Advertising sales
  $ 36,290     $ 80,563  
Consumable products
    6,825       -  
Conferences and training
    1,660       -  
Direct response media
    26,439       29,674  
Marketing fees
    77,869       582,955  
Member fees
    50,070       115,765  
Total
  $ 199,153     $ 808,957  

NOTE 9 – DEFERRED COMPENSATION

Deferred compensation is made up of compensation due to Mark Jarvis, Co-Chief Executive Officer, and a consultant.  These two individuals deferred their compensation in an effort to manage cash flow while the Company undertook several capital intensive initiatives.  As of April 30, 2011 and July 31, 2010, the balance of deferred compensation was approximately $98 thousand and $110 thousand, respectively.


NOTE 10 – ASSETS AND LIABILITIES MEASURED AT FAIR VALUE

Financial instruments which are measured at estimated fair value on a recurring basis in the consolidated financial statements include marketable securities, non-compensatory warrants and an embedded share conversion feature.  The fair value of the marketable securities was determined by the market price as quoted on the OTC.  The fair value of the warrants and share conversion feature was determined by an independent expert valuation specialist using the Black-Scholes Option Pricing Model.


 
13

 


Assets and liabilities measured at estimated fair value and their corresponding fair value hierarchy is summarized as follows:
 
April 30, 2011
Fair Value Measurements at Reporting Date Using
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant
Unobservable
Inputs
(Level 3)
 
Total
Fair Value
 
                       
Marketable securities
  $ 80,000     $ - $ 80,000        
Total Assets
  $ 80,000     $ -     $ 80,000  
                         
Share conversion feature
  $ -     $ -     $ -  
Warrants
  $ -     $ 307,600     $ 307,600  
Total liabilities
  $ -     $ 307,600     $ 307,600  

 
   
July 31, 2010
Fair Value Measurements at Reporting Date Using
 
   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant
Unobservable
Inputs
(Level 3)
   
Total
Fair Value
 
Marketable securities
  $ 480,000     $ -     $ 480,000  
Total Assets
  $ 480,000     $ -     $ 480,000  
                         
Share conversion feature
  $ -     $ 462,013     $ 462,013  
Warrants
  $ -     $ 6,370,000     $ 6,370,000  
Total liabilities
  $ -     $ 6,832,013     $ 6,832,013  
 
The Company has categorized its assets and liabilities measured at fair value into the three-level fair value hierarchy, as defined in Note 2, based upon the priority of inputs to respective valuation techniques.  Assets included in the level 1 of the fair value hierarchy include marketable securities which are fair valued on a recurring basis using quoted market prices.  Liabilities included within level 3 of the fair value hierarchy presented in the preceding table include noncompensatory warrants and a share conversion feature.  The valuation methodology for liabilities within level 3 uses a combination of observable and unobservable inputs in calculating fair value.

The Company recorded an unrealized loss of $240 thousand and $400 thousand on its marketable securities for the three and nine months ended April 30, 2011, respectively, and  an unrealized gain of $400 thousand and unrealized loss of $130 thousand  for the three and nine months ended April 30, 2010, respectively.  These losses and gains have been included in the Statement of Operations caption “(Loss) gain on change in fair value of marketable securities.”

The changes in level 3 liabilities measured at fair value on a recurring basis during the three and nine months ended April 30, 2011 and for the year ended July 31, 2010 are summarized as follows:

 
14

 

Fair Value Measurements
 
Using Significant Unobservable Inputs
 
(Level 3)
 
                               
   
Balance Beginning of Period
 
Reclassification of Liability Warrants to Equity
 
Issuance
   
(Gain) or Loss Recognized in Earnings from Change in Fair Value
   
Balance End of Period
 
For the three months ended April 30, 2011
             
Share conversion feature
  $ -     $ -     $ -     $ -     $ -  
Warrants
  $ 462,000     $ -     $ -     $ (154,400 )   $ 307,600  
                                         
For the nine months ended April 30, 2011
                       
Share conversion feature
  $ 462,013     $ -     $ -     $ (462,013 )   $ -  
Warrants
  $ 6,370,000     $ -     $ -     $ (6,062,400 )   $ 307,600  
                                         
For the Year Ended July 31, 2010
                         
Share conversion feature
  $ -     $ -     $ 593,426     $ (131,413 )   $ 462,013  
Warrants
  $ 549,780     $ (186,353 )   $ 2,025,993     $ 3,980,580     $ 6,370,000  

For the three and nine months ended April 30, 2011, an  unrealized gain of approximately $0 and $462 thousand, respectively, is included in earnings within the Statement of Operations caption “Gain on change in fair value of share conversion feature.”  For the three and nine months ended April 30, 2011, an unrealized gain of $154 thousand and $6.1 million, respectively, is included in earnings within the Statement of Operations caption “Gain (loss) on change in fair value of warrants.”  The unrealized gains from the change in the fair value of warrants is a result of a decrease in the Company’s  share price from $0.24 to $0.04 which is used as an input  in the share price used in valuing the warrants.

Fair Value of Financial Instruments

The fair values of accounts receivable, accounts payable and accrued expenses approximate their carrying values due to the short term nature of these instruments.  The fair values of notes payable approximate their carrying amounts as interest rates on these obligations are representative of estimated market rates available to the Company on similar instruments.


NOTE 11—REDEEMABLE PREFERRED STOCK

The Company is authorized to issue 10 million shares of preferred stock with a par value of $0.0001 per share.  The following table summarizes the Preferred Stock issuances and number of Preferred Shares outstanding:

       
Shares Outstanding at
Preferred Stock
 
Date of
       
Issuance
 
Issuance
 
April 30, 2011
 
July 31, 2010
Series A
 
July 30, 2009
 
                   1,750,000
 
               1,750,000
Series B
 
October 6, 2009
 
                   2,000,000
 
               2,000,000
Series C
 
January 29, 2010
 
                   1,000,000
 
               1,000,000
Series C
 
June 3, 2010
 
                   2,300,000
 
               2,300,000
       
                   7,050,000
 
               7,050,000

Series A, Series B and Series C Convertible Preferred Stock is collectively referred to herein as “Convertible Preferred Stock.”

Significant rights of the Convertible Preferred Stock are discussed below:

 
15

 

Dividends

The Convertible Preferred Stock does not accrue dividends.

Voting Rights

Each holder of the shares of Convertible Preferred Stock shall have the right to the number of votes equal to the number of Conversion Shares then issuable upon conversion of the Convertible Preferred Stock held by such holder in all matters as to which shareholders are required or permitted to vote, and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled to vote, together with the holders of Common Stock as a single class, with respect to any question upon which holders of Common Stock have the right to vote; provided, however, as to any holder of Convertible Preferred Stock, the right to vote such shares shall be limited to the number of shares issuable to such holder pursuant to certain beneficial ownership limitations (as listed below) as of the record date for such vote.  To the extent permitted under applicable corporate law, but subject to certain limitations on corporate actions as disclosed below, the Corporation’s shareholders may take action by the affirmative vote of a majority of all shareholders of the Company entitled to vote on an action.  Without limiting the generality of the foregoing, the Company may take any of the actions by the affirmative vote of the holders of a majority of the Convertible Preferred Stock and the Common Stock and other voting common stock equivalents, voting together as one class.

As long as any shares of Convertible Preferred Stock are outstanding, the Company shall not, without the written consent or affirmative vote of the holders of no-less than 51 percent of the then outstanding stated value of the Convertible Preferred Stock consenting or voting as a separate class from the common stock, the Company shall not, either directly or by amendment, merger, consolidation or otherwise:

(i) amend its certificate or articles of incorporation in any manner that adversely affects the rights of the holders of Convertible Preferred Stock;
 
(ii) alter or change adversely the voting or other powers, preferences, rights, privileges, or restrictions of the  Convertible Preferred Stock;
 
(iii) increase the authorized number of shares of preferred stock or  Convertible Preferred Stock or reinstate or issue any other series of preferred stock;
 
(iv)  redeem, purchase or otherwise acquire directly or indirectly any junior securities or any shares pari passu with the Convertible Preferred Stock;
 
(v) directly or indirectly pay or declare any dividend or make any distribution in respect of, any junior securities, or set aside any monies for the purchase or redemption (through a sinking fund or otherwise) of any junior securities or any shares pari passu with the Convertible Preferred Stock;
 
(vi) authorize or create any class of stock ranking as to dividends, redemption or distribution of assets upon a liquidation senior to or otherwise pari passu with the Convertible Preferred Stock; or
 
(vii) enter into any agreement with respect to any of the foregoing.

Liquidation Preferences

Upon any liquidation, dissolution or winding-down of the Company, whether voluntary or involuntary (a “Liquidation”), the holders of the shares of Convertible Preferred Stock shall be paid in cash, before any payment shall be paid to the holders of common stock, or any other junior stock, an amount for each share of Convertible Preferred Stock held by such holder equal to the sum of the Stated Value thereof (such applicable amount payable with respect to a share of Convertible Preferred Stock sometimes being referred to as the “Individual Preferred Liquidation Preference Payment” and with respect to all shares of Convertible Preferred Stock in the aggregate sometimes being referred to as the “Aggregate Liquidation Preference Payment”).  If, upon such liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, the assets to be distributed among the holders of shares of Convertible Preferred Stock shall be insufficient to permit payment to the holders of Convertible Preferred Stock of an aggregate amount equal to the Aggregate Liquidation Preference Payment, then the entire assets of the Corporation to be so distributed shall be distributed ratably among the holders of Convertible Preferred Stock (based on the Individual Preferred Liquidation Preference Payments due to the respective holders of Convertible Preferred Stock).

The liquidation value of Series A, Series B and Series C Convertible Preferred Stock was $1.75 million, $2 million and $3.3 million, respectively, as of April 30, 2011.

Conversion Rights

Each share of Convertible Preferred Stock shall be convertible, at the option of the holder thereof, at any time after the original issue date (subject to beneficial ownership limitations as listed below), and without the payment of additional consideration by the holder thereof, into such number of fully-paid and nonassessable shares of common stock as is determined by dividing the Stated Value per share, by the Conversion Price in effect at the time of conversion.  The Conversion Price originally for Series A, B and C shall be $0.0625, $0.25 and $0.25, respectively; provided, however, that the Conversion Price, and the rate at which shares of Convertible Preferred Stock may be converted into shares of common stock, shall be subject to adjustment as a result of stock dividends, stock splits, and subsequent equity sales at a price lower than the Convertible Preferred Stock’s Conversion Price. Shares of Convertible Preferred Stock converted into common stock shall be canceled and shall not be reissued.

 
16

 


At April 30, 2011, Series A, Series B and Series C Convertible Preferred Stock is convertible into 28 million, 8 million and 19.2 million common shares, respectively.  If the Convertible Preferred Stock had been converted as of April 30, 2011, the aggregate market price of the common shares for Series A, Series B and Series C would have been approximately $1.1 million, $320 thousand, and $528 thousand, respectively.

Beneficial Ownership Limitations

The Company shall not affect any conversion of the Convertible Preferred Stock, and a holder shall not have the right to convert any portion of the Convertible Preferred Stock, to the extent that, after giving effect to the conversion, such holder (together with such holder’s affiliates, and any other person or entity acting as a group together with such holder or any of such holder’s affiliates) would beneficially own in excess 4.99% of the number of shares of the common stock outstanding immediately after giving effect to the issuance of shares of common stock issuable upon conversion of Convertible Preferred Stock held by the applicable holder.  The Beneficial Ownership Limitation provisions may be waived by such holder, at the election of such holder, upon not less than sixty one (61) days’ prior notice to the Company, to change the Beneficial Ownership Limitation to 9.99% of the number of shares of the common stock outstanding immediately after giving effect to the issuance of shares of common stock upon conversion of Convertible Preferred Stock held by the applicable holder and the provisions of this section shall continue to apply.  Upon such a change by a holder of the Beneficial Ownership Limitation from such 4.99% limitation to such 9.99% limitation, the Beneficial Ownership Limitation shall not be further waived by such holder.

Redemption Rights of the Company

Shares of the Convertible Preferred Stock shall be redeemable, in whole or in part, at the option of the Company, by resolution of its Board of Directors at any time after the original issue date and before the first (1st) anniversary of the original issue date at a price equal to one hundred and ten percent (110%) of the Stated Value.

Redemption Rights of Holder

The Convertible Preferred Stock is redeemable for cash in an amount representing the Stated Value of outstanding Convertible Preferred Stock. The following events give rise to a redemption triggering event:

 
·
The Company shall be party to a change of control transaction;
 
·
The Company shall fail to have available a sufficient number of authorized and unreserved shares of common stock to issue to such  holder upon a conversion;
 
·
Unless specifically addressed elsewhere in the Convertible Preferred Stock’s Certificate of Designation as a Triggering Event, the Corporation shall fail to observe or perform any other covenant, agreement or warranty contained in the Certificate of Designation, and such failure or breach shall not, if subject to the possibility of a cure by the Company, have been cured within 20 calendar days after the date on which written notice of such failure or breach shall have been delivered;
 
·
There shall have occurred a bankruptcy event or material monetary judgment;


If the Company fails to pay the redemption amount as a result of a triggering event on the date it is due, interest will accrue at a rate equal to the lesser of 18% per year, or the maximum rate permitted by applicable law, accruing daily from the date of the triggering event until the amount is paid in full.

Events that may result in the redemption for cash of preferred stock, and that are not within a company’s control may require the preferred stock to be classified outside of stockholders’ equity (in the mezzanine section). All of the above triggering events are presumed not to be within our control.  Accordingly, these instruments are recorded in our balance sheet in the caption Redeemable Preferred Stock, which is outside of stockholders’ equity.  Management estimates the probability of the triggering events to be remote due to the Company’s affiliation with stockholders that represent a majority of the outstanding common and preferred stock.  Therefore, the carrying value of the preferred stock has not been increased to the full redemption value.  The reason the carrying value is not equal to the redemption amount is due to the allocation of value to certain warrants issued in connection with the preferred stock. The following table summarizes for each preferred stock issuance the value allocated to the warrants and preferred stock:

 
17

 


     
Total
   
Value
   
Preferred Stock
 
Preferred Stock
Date of
 
Proceeds
   
Allocated to
   
Carrying
 
Issuance
Issuance
 
Received
   
Warrants
   
Amount
 
Series A
July 30, 2009
  $ 1,750,000     $ 539,000     $ 1,211,000  
Series B
October 6, 2009
  $ 2,000,000     $ 930,838     $ 1,069,162  
Series C
January 29, 2010
  $ 1,000,000     $ 431,415     $ 568,585  
Series C
June 3, 2010
  $ 2,300,000     $ 598,000     $ 1,702,000  

NOTE 12 - COMMON STOCK

The Company has authorized 300 million common shares with a par value of $0.0001 per share.   On all matters required by law to be submitted to a vote of the holders of common stock, each share of common stock is entitled to one vote per share.

On July 30, 2009, the Company granted Mr. Jarvis 1.8 million shares of common stock, to be held in escrow, in connection with the execution of an employment agreement.  These shares will be issued to Mr. Jarvis in accordance with the vesting period or upon completion of certain performance measures.  Due to the forward stock split, the amount of shares was increased to 7.2 million shares of common stock.  The shares are subject to a vesting period in which 3.6 million shares vest on July 30, 2010 and July 30, 2011, respectively.  The grant date fair value was approximately $306 thousand.

For the three and nine months ended April 30, 2011, approximately $19 thousand and $57 thousand, respectively, of stock-based compensation expense was recognized, as a result of these share issuances. For the three and nine months ended April 30, 2010 approximately $57 thousand and $172 thousand, respectively, of stock-based compensation was recognized.

NOTE 13–WARRANTS

During 2009,  Zurvita’s Board of Directors adopted the 2009 Incentive Stock Plan (the 2009 Plan), pursuant to which we reserved for issuance 6 million shares of Zurvita common stock to be used as awards to employees, directors, consultants, and other service providers. The purpose of the 2009 Plan is to provide an incentive to attract and retain officers, consultants, advisors and employees whose services are considered valuable, to encourage a sense of proprietorship and to stimulate an active interest of such persons into Zurvita’s development and financial success.  Under the 2009 Plan, Zurvita is authorized to issue incentive stock options intended to qualify under Section 422 of the Code, non-qualified stock options, stock appreciation rights, performance shares, restricted stock and long term incentive awards. The 2009 Plan is administered by the Board’s designated Compensation Committee.  As of April 30, 2011, approximately 5.2 million total options were issued under the 2009 Plan.

The following table summarizes the status of all warrants outstanding and exercisable at April 30, 2011.
 
 
 
  Outstanding Warrants  
Range of
Exercise Prices
   
Number of
Warrants
   
Weighted
Average
Exercise Price
   
Weighted Average
Remaining
Contractual Life in
Years
 
$0.01 to $0.49       54,275,000     $ 0.15       5.60  
$0.50 to $0.99       100,000     $ 0.75       4.03  
          54,375,000     $ 0.15       5.60  

 
  Exercisable Warrants  
Range of
Exercise Prices
   
Number of
Warrants
   
Weighted
Average
Exercise Price
   
Weighted Average
Remaining
Contractual Life in
Years
 
$0.01 to $0.49       52,552,298     $ 0.15       5.39  
$0.50 to $0.99       100,000     $ 0.75       3.78  
          52,652,298     $ 0.15       5.39  
 
 
 
 
18

 



Compensatory Equity Warrants

During the nine month period ended April 30, 2011, the Company issued compensatory equity warrants to purchase an aggregate of approximately 450 thousand shares of common stock.

Assumptions used to determine the fair value of the compensatory warrants granted during the nine months ended April 30, 2011 and the year ended July 31, 2010 are as follows.
 
 
April 30, 2011
  July 31, 2010
       
Expected dividends
0%
 
0%
Expected volatility
65%
 
65%
Risk free interest rate
1.27% - 1.99%
 
0.22% - 1.65%
Expected life
5 years
 
6 months to 5 years
 
The following table summarizes the activity for compensatory warrants classified as equity for the nine months ended April 30, 2011.

   
Compensatory
Equity
Warrants
   
Weighted
Average
 Exercise
 Price
   
Weighted
 Average
 Remaining
 Contractual
Term
   
Aggregate
 Intrinsic
 Value
 
Outstanding at July 31, 2010
    5,795,526     $ 0.28       3.94     $ 593,250  
Issued
    450,000       0.24       -       -  
Exercised
    (1,000 )     0.50       -       -  
Cancelled or Expired
    (1,069,526 )     -       -       -  
Outstanding at April 30, 2011
    5,175,000     $ 0.22       4.14     $ -  
Exercisable at April 30, 2011
    3,452,298     $ 0.23       4.07     $ -  
 
There were approximately 1 thousand warrants exercised during the nine months ended April 30, 2011 with no associated intrinsic value at the date of exercise.  The total fair value of warrants vested during the nine months ended April 30, 2011 was approximately $183 thousand.  The weighted average grant date fair value of warrants granted during the nine months ended April 30, 2011 and 2010 was $0 and $0.04, respectively.

A summary of the status of the Company's non-vested compensatory equity warrants as of April 30, 2011, and of the changes during the nine months ended April 30, 2011, is presented below.
 
   
Compensatory Equity
Warrants
   
Weighted
Average
Grant-Date
Fair Value
 
Non-vested at July 31, 2010
    2,620,467     $ 0.16  
Issued
    450,000       0.24  
Exercised
    -       -  
Expired
    -       -  
Vested
    (1,347,765 )     0.29  
Non-vested at April 30, 2011
    1,722,702     $ 0.14  
 
Non-compensatory Liability Warrants

There were approximately 55.2 million non-compensatory warrants outstanding as of April 30, 2011, all of which were classified as liabilities.  These warrants are classified as liability instruments as net share settlement is not considered within the Company’s control or certain exercise prices are not fixed which has the potential to cause a variable number of shares and/or value exchange upon exercise.

The fair value of each option award classified as a liability on the balance sheets is estimated on the date of the grant using the Black-Scholes Pricing Model and the assumptions noted in the following table.  The stock price used approximates the market price less a marketability discount of 30%.  Expected volatility was determined by independent valuation specialist.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury Strip yield curve in effect at the time of grant.  The expected term of options granted represents the period of time that options granted are expected to be outstanding.

 
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Assumptions used to determine the fair value of the non-compensatory warrants outstanding at and during the nine months ended April 30, 2011 and granted at and during the year ended July 31, 2010 are as follows.

 
April 30, 2011
 
July 31, 2010
       
Expected dividends
0%
 
0%
Expected volatility
65%
 
65%
Risk free interest rate
2.08% - 2.34%
 
2.01% - 2.29%
Expected life
7 years
 
5-7 years
 
There were no non-compensatory liability issuances, exercises or expirations during the nine months ended April 30, 2011.
 
Amacore Stock Warrants Issued
 
During 2008, The Amacore Group, Inc (“Amacore”) granted to Mr. Jarvis 800 thousand warrants to purchase common stock in connection with his employment agreement with the Company.  In the event the warrants are exercised, Amacore will issue the corresponding authorized and available common stock to Mr. Jarvis.  The contractual term of the warrants issued was five years.
 
Amacore had accelerated the vesting conditions of the original award prior to July 31, 2009 and, therefore, no compensation expense is recorded in fiscal 2010.  As of April 30, 2011 there were 800 thousand warrants outstanding and exercisable.  No warrants expired, nor were any warrants exercised or forfeited during the nine months ended April 30, 2011 and, therefore, no intrinsic value was realized.  As of April 30, 2011 the weighted average exercise price of warrants granted was $0.60.  The grant date fair value of the warrants granted was $0.43.
 
Stock-Based Compensation Expense
 
For the three and nine months ended April 30, 2011 and 2010, the Company recognized stock-based compensation expense, including both expense related to compensatory warrants and expense related to share awards, with the Statement of Operations as follows:
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
April 30,
   
April 30,
 
   
2011
   
2010
   
2011
   
2010
 
Stock-based compensation:
             
Payroll and employee benefits
  $ 80,992     $ 57,402     $ 343,212     $ 237,945  
Professional fees
    -       28,343       -       28,343  
Total
  $ 80,992     $ 85,745     $ 343,212     $ 266,288  
 
 
NOTE 14 - RELATED PARTY TRANSACTIONS
 
Commissions Paid

There are immediate family members of Mr. Jarvis who operate as Independent Business Owners (“IBO”) who receive leader subsidies and commission compensation which amounted to approximately $2 thousand and $30 thousand, respectively, and approximately $11 thousand and $61 thousand, respectively, for the three and nine months ended April 30, 2011, for work in which they performed on behalf of the Company.

Leader subsidies and commission compensation for work performed for the three and nine months ended April 30, 2010, were approximately $9 and $19 thousand, respectively, and approximately $32 thousand and $92 thousand, respectively.

Interest on Note Payable to Infusion Brands International, Inc. f/k/a OmniReliant Holdings, Inc.

The Company recognized interest expense with respect to the note payable due to Infusion Brands, who is a significant shareholder of the company.  For the three and nine months ended April 30, 2011 interest expense was approximately $81 thousand and $239 thousand, respectively, and approximately $74 thousand and $164 thousand for the three and nine months ended April 30, 2010, respectively.  Of the interest expense recognized, approximately $126 thousand and $96 thousand relates to the amortization of the discount and approximately $97 thousand and $61 was added to the principal of the note for the nine months ended April 30, 2011 and 2010, respectively.

 
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Agreement with Amacore

The Company entered into a Marketing and Sales Agreement on July 31, 2009, pursuant to which Amacore agreed to provide certain services to Zurvita.  In addition, pursuant to the Agreement, Zurvita shall continue to have the right to benefit from certain agreements which Amacore maintains with product and service providers.  For the three and nine months ended April 30, 2011, Zurvita paid Amacore $135 thousand and $395 thousand, respectively, for these services, as compared to $89 thousand and $362 thousand for the same periods.
 
The Company entered into an on-demand promissory note issued on August 11, 2010 between the Company and Amacore.  Amacore paid the promissory note in full plus accumulated 6% per annum interest, of approximately $16 thousand, on August 17, 2010.

The Company entered into an on-demand promissory note issued on January 14, 2011 between the Company and Amacore.  Zurvita paid the promissory note in full plus accumulated 15% interest, of approximately $5 thousand, on March 16, 2011.

The Company entered into an on-demand promissory note issued on April 29, 2011 between the Company and Amacore for $30 thousand plus accumulated 15% per annum interest.  As of April 30, 2011 the Company has paid nothing.

NOTE 15- SUBSEQUENT EVENTS

On June 9, 2011, the Company entered into a Securities Purchase Agreement with an accredited investor (the “Purchase Agreement”),  pursuant to which the Company issued and sold 1.5 million shares of its Series C Convertible Preferred Stock (the “Series C Preferred Stock”) and Series C Common Stock Purchase Warrants to purchase an aggregate of 6 million shares of the Company’s common stock (the “Series C Warrants” and, together with the Series C Preferred Stock, the “Private Placement Securities”).
 
On June 9, 2011, the Company filed the Second Amended and Restated Series C Convertible Preferred Stock Certificate of Designation to increase the number of shares designated as such from 3.3 million shares to 4.8 million shares. 
 
Pursuant to the Purchase agreement, the aggregate purchase price for the Private Placement Securities was $1.5 million (the “Purchase Price”), which Purchase Price was previously advanced to the Company.  On March 16, 2011, the Company received $1 million of the Purchase Price.  On May 3, 2011, the Company received $500 thousand of the Purchase Price. 
 
The Company has accounted for this subsequent event as a material transaction requiring the modification of the balance sheet as of April 30, 2011.   The proceeds received on March 16, 2011 were recorded as a current liability and presented as Advanced Security Proceeds in the current liability section. 
 

 
21

 


Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Information contained in this discussion, other than historical information, is considered “forward-looking statements” that are subject to risks and uncertainties.  These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives including, without limitation, statements about the Company’s ability to continue operations through April 30, 2012, the liability of the Company for claims made in pending litigation, plans for future products, strengthening our relationship with our various sales organizations, our marketing intentions, our anticipated products, efforts to expand distribution channels, Zurvita Holdings. Inc. (referred to herein as the “Company,” “Zurvita Holdings,” “Zurvita,” “we,” “us” or “our”) anticipated growth in sales and margins, and our ability to achieve profitability. In some cases, you may identify forward-looking statements by words such as “may,” “should,” “plan,” “intend,” “potential,” “continue,” “believe,” “expect,” “predict,” “anticipate” and “estimate,” the negative of these words or other comparable words.  These statements are only predictions.  One should not place undue reliance on these forward-looking statements.  The forward-looking statements are qualified by their terms and/or important factors, many of which are outside the Company’s control, involve a number of risks, uncertainties and other factors that could cause actual results and events to differ materially from the statements made.  The forward-looking statements are based on the Company’s beliefs, assumptions and expectations of our future performance, taking into account information currently available to the Company.  These beliefs, assumptions and expectations can change as a result of many possible events or factors, including those events and factors described in “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended July 31, 2010 filed with the Securities and Exchange Commission on December 7, 2010 (the “2010 Annual Report”), not all of which are known to the Company.  If a change occurs, the Company’s business, financial condition, liquidity and results of operations may vary materially from those expressed in the aforementioned forward-looking statements. The Company will update this forward-looking information only to the extent required under applicable securities laws.  Neither the Company nor any other person assumes responsibility for the accuracy or completeness of these forward-looking statements.
 
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto, and other financial information included elsewhere in this Form 10-Q.

Introduction

Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to and should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included elsewhere herein to help provide an understanding of our financial condition and results of our operations.  The MD&A is organized as follows:

 
·
Overview – This section provides a general description of our business.

 
·
Results of operations – This section provides an analysis of our results of operations comparing the three and nine months ended April 30, 2011 and 2010.  This analysis is provided on a consolidated basis.

 
·
Liquidity and capital resources – This section provides an analysis of our cash flows for the nine months ended April 30, 2011 and 2010 as well as a discussion of our liquidity and capital resources.

Overview

Description of Business

Zurvita is a direct sales marketing company offering high-quality products and services targeting individuals, families and small businesses.  The Company’s differentiated services feature consumer products and small business solutions offered through a network of independent sales consultants.  Zurvita offers a unique business-to-business strategy with turnkey solutions for commercial energy, advertising and healthcare services.  Zurvita also markets numerous low-cost ancillary products, such as legal assistance and restoration services for identity theft and consumer credit.

Business Strategy

Zurvita’s business model embraces a direct sales approach that utilizes the power of network marketing.  The business strategy relies on a marketing sales force that compensates independent business owners (“Consultants”) not only for sales of Company products and services they personally generate, but also for the sales of other Consultants whom they introduced to the business, creating a sales organization of Consultants and a hierarchy of multiple levels of compensation.  The products, services and business opportunities are typically marketed directly to potential business partners, consumers and small businesses by means of referrals, national advertising, video promotions, conferences, the Internet, and word-of-mouth marketing.

Consultants become associated with the Company through an independent contractor relationship and receive remuneration for selling products and services and for expanding their network of people doing the same by promoting Zurvita’s business opportunity.

 
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Strategically, Zurvita utilizes service and technology platforms whereby Consultants market products and services that target consumers and small businesses at many levels.  This creates a Consultant sales organization that in turn sponsors other motivated Consultants.  Under the Company’s business model, each independent sales Consultant has an opportunity to make a living on a full-time basis and to obtain long-term financial security by marketing products that have growing demand in the market place and create long-term residual income.

Zurvita has developed business processes to dramatically increase performance success:

Create Leads

Zurvita entered into an Advertising and Marketing Agreement with Infusion Brands International, Inc. f/k/a OmniReliant Holdings, Inc., (“Infusion Brands”), pursuant to which Zurvita agreed to provide placement of advertising for Infusion Brands on its website and Infusion Brands agreed to provide the Company with certain marketing services.  The marketing services to be provided by Infusion Brands include the production of infomercials, video production services, management of call centers, and buying and fulfillment services.  

Strengthen Brand Recognition

National and regional marketing efforts are administrated to support corporate and “personal” branding initiatives.  Inherent to the network marketing industry is the axiom that people don’t follow products or features, but rather the people with whom they relate to on a personal level.  Zurvita not only invests resources to promote its corporate brand, but has developed a technological platform allowing Consultants to build web-based personal branded sites enhancing their position as affiliate marketers of Zurvita programs and services.

Increase Product and Service Offerings

Zurvita continues to explore the marketplace for new products and services that are anticipated by consumers. These are essential, best-in-class consumer and business solutions in large and growing markets. The network marketing industry mandates a state of continuous improvement by offering its Consultants and customers products and services that offer time, value and conveniences at cost competitive prices.

Zurvita entered into the growing Health & Wellness industry with its recent launch of “Zeal”, a nutritional drink.  The Company retained an industry formulator to create a proprietary formula that promotes general, long-term health benefits.
 
Marketing

Zurvita’s marketing strategies open new, innovative marketing and sales avenues for Consultants to build income through expansion of their sales organization and the residual benefits offered through the sale of products and services.  The marketing strategy features unique components beyond the traditional approach indicative of most network marketing companies.

Media

Our agreement with Infusion Brands brings strength and uniqueness to Zurvita’s overall marketing strategy.  The synergistic relationship brings the strength of television production and national media placement to drive prospects to Zurvita and to fuel interest in Zurvita programs that are distributed as leads to thousands of Consultants.  Infusion Brands offers a host of products that create additional product options for Zurvita.

Technology

Zurvita recognizes the Internet is a powerful platform for the network marketer.  The highly social aspect of the Internet lends itself as a natural marketing vehicle and continuously opens a new population of prospects.  Zurvita offers Consultants robust “back office” support complimented with sales and marketing tools.

Training and Support

The success of an external marketing program is only as effective as the internal marketing strategies to keep Consultants informed and engaged.  Zurvita is committed to a variety of communication initiatives that promote leadership and business effectiveness.  Weekly telephone/webinar meetings as well as informational seminars create opportunities to develop leaders and to promote Zurvita’s business opportunity.  National conferences and regional events further support Zurvita’s efforts to train and develop its national sales force.


 
23

 


RESULTS OF OPERATIONS

Results of Operations
 
   
For the Three Months Ended April 30,
   
For the Nine Months Ended April 30,
 
               
Increase
               
Increase
 
   
2011
   
2010
   
(Decrease)
   
2011
   
2010
   
(Decrease)
 
                                     
Revenues
  $ 1,214,641     $ 1,706,916     $ (492,275 )   $ 3,663,094     $ 4,608,461     $ (945,367 )
Cost of Sales
    866,450       1,120,394       (253,944 )     2,479,077       3,381,516       (902,439 )
                                                 
Gross Profit
    348,191       586,522       (238,331 )     1,184,017       1,226,945       (42,928 )
                                                 
Operating Expenses
    1,244,205       1,559,498       (315,293 )     4,184,014       4,854,369       (670,355 )
Operating Loss
    (896,014 )     (972,976 )     (76,962 )     (2,999,997 )     (3,627,424 )     (627,427 )
                                                 
Other Expenses (income)
    (160,972 )     1,355,220       (1,516,192 )     5,885,948       (3,290,246 )     9,176,194  
                                                 
(Loss) Income Before Income Taxes
    (1,056,986 )     382,244       (1,439,230 )     2,885,951       (6,917,670 )     9,803,621  
                                                 
Income Taxes
    448       12,287       (11,839 )     3,121       32,429       (29,308 )
                                                 
Net (Loss) Income
  $ (1,057,434 )   $ 369,957     $ (1,427,391 )   $ 2,882,830     $ (6,950,099 )   $ 9,832,939  
                                                 
Basic (Loss) Earnings  Per Share
  $ (0.02 )   $ 0.01             $ 0.05     $ (0.12 )        
                                                 
Diluted (Loss) Earnings Per Share
  $ (0.02 )   $ 0.00             $ 0.05     $ (0.12 )        
 
Revenue:

For the three and nine months ended April 30, 2011, revenue was approximately $1.2 million and $3.7 million, respectively, as compared to approximately $1.7 million and $4.6 million for the three and nine months ended April 30, 2010, respectively, a decrease of approximately $492 thousand and $945 thousand, respectively.
 
Administrative websites sales and marketing fees were approximately $230 thousand and $192 thousand for the three months ended April 30, 2011, respectively, as compared to approximately $520 thousand and $502 thousand, respectively, for the three months ended April 30, 2010.  For the nine months ended April 30, 2011, administrative websites and marketing fees were approximately $1.1 million and $750 thousand, respectively, as compared to $1.5 million and $1.5 million, respectively, for the nine months ended April 30, 2010.  The aggregate decrease in administrative website sales and marketing fees was approximately $599 thousand and $1.2 million for the three and nine months ended April 30, 2011.  The decrease in administrative website sales and marketing fees is a result of a reduction in Consultants joining the Company and attrition of the existing Consultant base during the three and nine months ended April 30, 2011 as compared to April 30, 2010.  The Company’s lack of a broad based-product and certain product issues contributed to the declines.  During the third quarter, the Company formally launched “Zeal”, a nutritional drink, as the Company’s primary network marketing product as it has the potential to appeal to a larger Consultant base and offers a less complicated sales process.  The Company realized $463 thousand and $490 thousand of Zeal revenue for the three and nine months ended April 30, 2011, respectively.
 
The Company’s advertising sales decreased $205 thousand for the three months ended April 30, 2011.  The advertising sales technology platform had technical shortcomings that led to adverse refund and persistency rates that made selling the product difficult. The Company is addressing these issues by redesigning the ZLinked technology platform to lower operating cost, to allow for more competitive product pricing, and to provide enhanced functions and services that are expected to increase the product’s performance and market value.
 
The Company was unable to gain entry into the California energy market which caused a significant decrease in overall recruitment.  The Company’s focus on promoting Zeal caused a $35 thousand decrease in energy sales activity for the three months ended April 30, 2011.
 
The Company has also revised its selling model for its advertising and energy products.  The Company has created several separate professional sales channels outside the network marketing division that focus on selling these business-to-business products..
 

 
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The Company’s membership fees were approximately $100 thousand and approximately $382 for the three and nine months ended April 30, 2011, respectively, as compared to approximately $217 thousand and approximately $756 thousand for three and nine months ended April 30, 2010, respectively.  The decrease in membership revenue is a result of the Company’s efforts to focus on the sale of advertising, energy and nutritional drink.
 
Cost of Sales:

Cost of sales includes the benefit and service costs associated with the membership products and services, consumable product manufactured cost and sales commissions paid to consultants. For the three and nine months ended April 30, 2011, cost of sales was approximately $866 thousand and $2.5 million, a decrease of approximately $254 thousand and $902 thousand, respectively, from the respective period in 2010.  The decreases were mostly a result of lower sales commissions due to lower overall revenue.

Gross Profit:

For the three and nine months ended April 30, 2011, gross profit was approximately $348 thousand or 29% and $1.2 million or 32%, respectively, as compared to a gross profit of approximately $587 thousand or 34% and $1.2 million or 27% for the three and nine months ended April 30, 2010, respectively.  The decrease in gross profit for the three month period is due to the decline in total revenues as well as certain promotions offered to kick off the launch of the Company’s new consumable product.  While revenues for the nine month period decreased, the Company was able to achieve a comparable level of gross margin as well as an increase in gross margin percentage.  This was accomplished through the sale of higher margin products and less use of sales incentives.

Operating Expenses:

Our operating expenses for the three and nine months ended April 30, 2011 were $1.2 million and $4.2 million, respectively, as compared to $1.6 million and $4.9 million for the three and nine months ended April 30, 2010.

The table below sets forth components of our operating expenses for the three and nine months ended April 30, 2011 compared to the corresponding prior year period:

   
Three Months Ended April 30,
   
Nine Months Ended April 30,
 
   
2011
   
2010
   
Increase
 (Decrease)
   
2011
   
2010
   
Increase
 (Decrease)
 
                                     
Depreciation
  $ 8,772     $ 9,011     $ (239 )   $ 28,089     $ 26,287     $ 1,802  
Office Related Expenses
    144,752       115,872       28,880       406,277       284,760       121,517  
Payroll and Benefits
    575,646       435,568       140,078       1,689,589       1,198,538       491,051  
Professional Fees
    168,413       253,413       (85,000 )     663,381       1,002,310       (338,929 )
Selling and Marketing
    291,160       711,010       (419,850 )     1,223,990       2,201,817       (977,827 )
Travel
    55,462       34,624       20,838       172,688       140,657       32,031  
                                                 
Total operating expenses
  $ 1,244,205     $ 1,559,498     $ (315,292 )   $ 4,184,014     $ 4,854,369     $ (670,356 )
 
Depreciation expense for the three and nine months ended April 30, 2011, was approximately $9 thousand and $28 thousand, respectively, a decrease of approximately $239 and an increase of $2 thousand over the same prior year periods.   The decrease for the three months ended April 30, 2011 is due to certain computer equipment becoming fully depreciated. The increase is related to the purchase of computer hardware and other office equipment needed to accommodate the Company’s personnel growth.

Office related costs include rent, insurance, utilities and office maintenance. For the three month period ended April 30, 2011 these costs were approximately $28 thousand, $14 thousand, $20 thousand, and $83 thousand, respectively.   For the nine months ended April 30, 2011, these costs were approximately $110 thousand, $35 thousand, $42 thousand and $219 thousand, respectively.  The overall increase of approximately $29 thousand and $122 thousand is directly related to the additional IT services added related to maintaining the Zlinked technology platform.
 
Payroll and related expenses for the three and nine months ended April 30, 2011 were approximately $576 thousand and $1.7 million, respectively, an increase of approximately $140 thousand and $491 thousand over the same prior year periods.  For the three months ended April 30, 2011, the increase was as a result of additional operations personnel.  The nine month increase of approximately $491 thousand is related to approximately $77 thousand of share-based compensation and approximately $414 thousand is attributable to the hiring of a Vice President of Marketing, as well as transitioning certain Zlinked consultants to full-time employees.

 
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Professional fees consist of consulting, accounting fees, contract labor and legal costs. For the three month period ended April 30, 2011, these costs were approximately $32 thousand, $50 thousand, $44 thousand and $42 thousand, respectively.  For the nine month period ended April 30, 2011, these costs were approximately $146 thousand, $229 thousand, $180 thousand and $108 thousand, respectively.  Significant reductions in consulting and legal expenses were achieved through cost reduction efforts, despite an increase in accounting fees and contract labor costs, led to an overall professional fees decrease of approximately $339 thousand.  The increase in accounting fees was due to the Company changing its auditors and the predecessor auditor’s inability to provide consent to the use of their opinion on prior year financial statements which led to a re-audit of the prior year financial statements by the current auditor.  Contract labor costs increased as a result of having to contract certain services to maintain the Zlinked technology.

Selling and marketing expenses for the three and nine months ended April 30, 2011 were $291 thousand and $1.2 million, respectively, as compared to $711 thousand and $2.2 million for the three and nine months ended April 30, 2010, a decrease of approximately $420 thousand and $978 thousand over the prior period.  The decrease is due to less amortization of deferred costs such as agent advanced compensation and other prepaid marketing costs between the periods.

Business travel expenses for the three and nine months ended April 30, 2011 were approximately $55 thousand and $173 thousand, respectively, an increase of $21 thousand and $32 thousand, as compared to the three and nine months ended April 30, 2010.  The increase in business travel expenses for the three months ended April 30, 2011 is due to the timing of when the Company’s national convention was held.  The increase in business travel expenses for the nine months ended April 30, 2011 is due to the Company’s efforts to conduct more regional meetings to increase Consultant recruitment.

Other Income (Expense):

Gain on change in fair value of embedded share conversion feature

An embedded share conversion feature exists within the Company’s convertible note payable.  The Company has determined the conversion feature to be a derivative instrument and has estimated its at fair value at the time of issuance and at each subsequent reporting period.  We recorded an unrealized gain on the conversion feature for the three and nine months ended April 30, 2011 of approximately $0 and $462 thousand, respectively, as compared to the unrealized gain for the three and nine months ended April 30, 2010 of approximately $139 thousand and $171 thousand, respectively.  These unrealized gains are a non-cash item not impacting operating cash flows or results of operations before other income and expenses. See Note 10 – Assets and Liabilities Measured at Fair Value, to financial statements contained within Item 1 of Part 1 of this Form 10Q for additional information with respect to the estimation of the fair value of this conversion feature.

Gain (loss) on change in fair value of warrants

The Company’s liability warrants are recorded at fair value.  Their fair value is subject to remeasurement on a recurring basis.  For the three months ended April 30, 2011 and 2010, the change in fair value of these warrants was approximately a gain of $154 thousand and a gain of $948 thousand, respectively.  For the nine months ended April 30, 2011 and 2010, the change in fair value of these warrants was approximately a gain of $6.1 million and a loss of $3.0 million, respectively.  The gain in fair value for the three and nine months end April 30, 2011 is a result of the significant decline in share price from $0.24 to $0.04 which is used as an input in fair valuing the warrants.  The loss in fair value for the three and nine months ended April 30, 2010 is (1) a result of the 4-to-1 forward share split that occurred on August 11, 2009 that had the effect of increasing the number of outstanding warrants by 21.42 million and (2) using a comparatively higher share price as an input in fair valuing the warrants.  These gains and losses are a non-cash item not impacting operating cash flows or results of operations before other income and expenses. See Note 10 – Assets and Liabilities Measured at Fair Value, to financial statements contained within Item 1 of Part 1 of this Form 10Q for additional information with respect to the estimation of the fair value of these warrants.

Interest expense

Interest expense for the three and nine months ended April 30, 2011 were approximately $88 thousand and $256 thousand, as compared to $82 thousand and $190 thousand for the three and nine months ended April 30, 2010.  The increase in interest expense is a result of accreting the discount recognized on the Company’s $2 million interest bearing convertible note issued on October 9, 2009.  Accretion of $81 thousand and $240 thousand is included within interest expense for the three and nine months ended April 30, 2011, respectively, as compared to $74 thousand and $164 thousand of accretion included within interest expense for the three and nine months ended April 30, 2010, respectively.

(Loss) gain on change in fair value of marketable securities

The Company’s marketable securities consist of non-registered common stock. The Company fair values these securities on a recurring basis.  The Company recorded an unrealized loss of $240 thousand and an unrealized gain of $400 thousand for the three months ended April 30, 2011 and 2010, respectively. The Company recorded an unrealized loss of $400 thousand and $130 thousand for the nine months ended April 30, 2011 and 2010, respectively.  These unrealized gains and losses are a non-cash item not impacting operating cash flows or results of operations before other income and expenses. See Note 10– Assets and Liabilities Measured at Fair Value, to financial statements contained within Item 1 of Part 1 of this Form 10Q for additional information with respect to the determination of fair value for the Company’s marketable securities.

 
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Income Taxes:

For the three and nine months ended April 30, 2011, the Company estimated approximately $448  and $3 thousand, respectively, in tax expense as compared to $12 thousand and $32 thousand for the three and nine months ended April 30, 2010, respectively.  The decrease between the periods is a result of the Company changing its method for estimating its Texas gross margin tax accrual as a result of access to improved data inputs used in estimating the tax accrual.  The Company realized no federal tax benefit from the deferred tax asset resulting from net operating losses carryforward as the deferred tax asset is fully reserved.

Net (Loss) Income:

The Company had net loss of approximately $1.1 million and net income of approximately $2.9 million for the three and nine months ended April 30, 2011, respectively, as compared to a net income of approximately $370 thousand and a net loss of $6.9 million for the three and nine months ended April 30, 2010, respectively.  The decrease in net income for the three months ended April 30, 2011 is attributable to less unrealized gains recognized between the periods on the Company’s liability warrants and marketable securities. The increase in net income for the nine months ended April 30, 2011 is attributable to unrealized gains recognized on Company’s liability warrants.

OFF BALANCE SHEET ARRANGEMENTS

We do not have any off balance sheet arrangements as of April 30, 2011.

LIQUIDITY AND CAPITAL RESOURCES

The following table compares our cash flows for the nine month period ended April 30, 2011 to the corresponding prior period:
 
   
April 30, 2011
   
April 30, 2010
 
             
Net cash used in operating activities
  $ (2,871,802 )   $ (2,396,248 )
Net cash provided by (used in) investing activities
    1,691,809       (777,617 )
Net cash provided by financing activities
    890,669       2,344,690  
                 
Net decrease in cash
  $ (289,324 )   $ (829,175 )

Future minimum rental payments required under the Company’s operating leases that have initial or remaining non-cancelable lease terms in excess of one year on a fiscal year basis are as follows:
 
As of April 30, 2011:
 
       
Current
  $ 26,702  
2012
    106,808  
Thereafter
    -  
    $ 133,510  
 
Since its inception, the Company has met its capital needs principally through sale of its equity securities and the issuance of debt.  The proceeds from the sale of these securities have been used for the Company’s operating expenses, such as salary expenses, professional fees, rent expenses and other general and administrative expenses discussed above.  At April 30, 2011, the Company had negative working capital of approximately $225 thousand, an accumulated deficit of approximately $18.3 million and negative cash flows from operating activities of approximately $2.9 million. Since its inception, the Company has used approximately $9.2 million in operations.

We believe that without significant equity and debt investment from outside sources, the Company will not be able to sustain its current planned operations for the next 12 months.  During fiscal 2010, the Company has raised from a shareholder $5.3 million of equity funding.  During fiscal 2011, the Company has raised from a shareholder $1.5 million of equity funding.  In order to raise capital, the Company may sell additional equity or issued additional convertible debt securities which would result in additional dilution to our stockholders. The issuance of additional debt would result in increased expenses and could subject us to covenants that may have the effect of restricting our operations.  We can provide no assurance that additional financing will be available in an amount or on terms acceptable to us, if at all. If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us, we may be unable to execute upon our business plan or pay our costs and expenses as they are incurred, which could have a material, adverse effect on our business, financial condition and results of operations.   Currently, the Company does not maintain a line of credit or term loan with any commercial bank or other financial institution.  The Company has approximately $2.0 million of outstanding notes payable as of April 30, 2011.  These issues raise substantial doubt about our ability to continue as a going concern for a reasonable period.

 
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CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including the allowance for sales refunds and chargebacks, capitalization of certain assets, depreciable/amortizable lives, impairment of long-lived assets, determination of amount of allowance for doubtful accounts, the fair value of marketable securities, the expected volatility of common stock, and the fair value of common stock and warrants as well as the allocation of proceeds from the issuance of debt and equity instruments.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.

While all of our accounting policies impact the consolidated financial statements, certain policies are viewed to be critical. Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and that require management’s most subjective or complex judgments and estimates. Management believes the policies that fall within this category are the policies on revenue recognition and accounts receivable and other intangible assets, investments, financial and derivative instruments.

Revenue Recognition

Administrative Websites

Company’s independent representatives pay a fee to the Company entitling them to use of websites that facilitate their business operations.  This revenue is recognized ratably over the website subscription period.

Advertising Sales

The Company markets subscriptions to a service that facilitates the ability of customers, typically small business owners, to display commercial advertising via an on-line search directory.  This revenue is recognized ratably over the advertising subscription period.

Commissions

The Company is paid a commission for its sales of third-party products. Commissions are recognized as products are sold and services performed and the Company has accomplished all activities necessary to complete the earnings process.  

Consumable Products

The company markets a nutritional drink called “Zeal”.  Revenue from the sale of this consumable product is recognized upon shipment of the product.

Marketing Fees and Materials

The Company markets certain of its products through a multi-level sales organization whereby independent distributors establish their own network of associates.  The independent distributors pay the Company an annual fee to become marketing representatives on behalf of the Company.  In exchange, the representatives receive access, on an annual basis, to various marketing and promotional materials and tools as well as access to a customized management reporting platform; accordingly, revenue from marketing fees is recognized over an annual period.  The Company also earns ancillary revenue from the sale of marketing materials to third parties.  Revenue is recognized when marketing materials are delivered.

Membership Fees

The Company recognizes revenues from membership fees as earned for the sales of other lifestyle discount benefit programs, such as household protection and personal financial services.  These arrangements are generally renewable monthly and revenue is recognized over the renewal period.  These products often include elements sold through contracts with third-party providers.  Based on consideration of each contractual arrangement, revenue is reported on a gross basis.


 
 
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Fair Value Measurements
 
U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability to a third party with the same credit standing (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In many cases, the exit price and the transaction (or entry) price will be the same at initial recognition. However, in certain cases, the transaction price may not represent fair value. Fair value is a market-based measurement determined based on a hypothetical transaction at the measurement date, considered from the perspective of a market participant, not based solely upon the perspective of the reporting entity. When quoted prices are not used to determine fair value, consideration is given to three broad valuation techniques: (i) the market approach, (ii) the income approach, and (iii) the cost approach. Entities are required to determine the most appropriate valuation technique to use, given what is being measured and the availability of sufficient inputs. Inputs to fair valuation techniques are prioritized, allowing for the use of unobservable inputs to the extent that observable inputs are not available. The applicable guidance establishes a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. The input levels are defined as follows:
 
Level 1
Unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2
Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1, quoted prices in markets that are not active, or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3
Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as those for which the determination of fair value requires significant management judgment or estimation.
 

 
RECENTLY ADOPTED ACCOUNTING PROUNCEMENTS
 
The Company does not believe that there will be any impact from the new standards.
 
 
 
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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q.  Based on this evaluation, our principal executive and principal financial officer concluded that our disclosure controls and procedures are ineffective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.  Presently, our disclosure controls and procedures are not designed adequately to provide reasonable assurance that such information is accumulated and communicated to our management.  This conclusion was based on the material weaknesses identified with regard to internal controls over financial reporting, as described in the Company’s Annual Report for the year ended July 31, 2010.

There was no change in our internal control over financial reporting that occurred during the quarter covered by this Quarterly Report on Form 10-Q that materially affected, or is reasonably likely to materially affect, our control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

As of April 30, 2011, there was no material changes in the Company’s legal proceedings as previously disclosed in the Company’s 2010 Annual Report.

Item 1a. Risk Factors

Not applicable.

Item 2. Unregistered Sales of Equity and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Removed and Reserved

Item 5. Other Information.

None.

 

 
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Item 6. Exhibits
 
(a) Exhibits:
 
 
10.1
Agreement of Conveyance, Transfer and Assignment of Assets and Assumptions of Obligations by and between the Company and OmniReliant Holdings, Inc., dated December 2, 2010 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2010).
   
10.2
Security Agreement between the Company and OmniReliant Holdings, Inc. dated December 2, 2010 (incorporated by reference to Exhibit10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2010).
   
10.3
Securities Purchase Agreement by and between the Company and Vicis Capital Master Fund dated June 9, 2011 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011).
   
10.4
Second Amended and Restated Series C Convertible Preferred Stock Certificate of Designation, dated June 9, 2011 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011)
   
10.5
Form of Series C Common Stock Purchase Warrant Certificate between the Company and Vicis Capital Master Fund, dated June 9, 2011 (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011).
   
31.1
Certification of the Co-Chief Executive Officer pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2
Certification of Chief Financial Officer pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
32.1
Certification pursuant to Section 906 Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
 



 
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SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: June 14, 2011
/s/ Jay Shafer
 
Jay Shafer
 
Co-Chief Executive Officer
   
   
Dated: June 14, 2011
/s/ Jason Post
 
Jason Post
 
Chief Financial Officer
 
 
 
 
 
 
 
 
 
 

 
 
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EXHIBIT INDEX

10.1
Agreement of Conveyance, Transfer and Assignment of Assets and Assumptions of Obligations by and between the Company and OmniReliant Holdings, Inc., dated December 2, 2010 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2010).
   
10.2
Security Agreement between the Company and OmniReliant Holdings, Inc. dated December 2, 2010 (incorporated by reference to Exhibit10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on December 8, 2010).
   
10.3
Securities Purchase Agreement by and between the Company and Vicis Capital Master Fund dated June 9, 2011 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011).
   
10.4
Second Amended and Restated Series C Convertible Preferred Stock Certificate of Designation, dated June 9, 2011 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011)
   
10.5
Form of Series C Common Stock Purchase Warrant Certificate between the Company and Vicis Capital Master Fund, dated June 9, 2011 (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed with the Securities and Exchange Commission on June 10, 2011).
   
31.1
Certification of the Co-Chief Executive Officer pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2
Certification of Chief Financial Officer pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002