10-Q 1 l10q093009.txt ZEALOUS, INC. FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2009 [ ] Transition Report pursuant to 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period to __________ Commission File Number: 000-26383 ZEALOUS, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) NEVADA 000-26383 88-0325940 ------------------------------------------------------------ (State or other (Commission File (IRS Employer Jurisdiction Number) I.D. No.) of Incorporation or organization) 9550 Warner Avenue, Suite 250 Fountain Valley, CA 92705 --------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (949) 471-0123 15641 Red Hill Avenue, Suite 200 Tustin, CA 92780 ---------------------------------------------------- (Former name or former address, if changed since last report) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days [X] Yes [ ] No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. [ ] Large accelerated filer Accelerated filer [ ] Non-accelerated filer [X] Smaller reporting company Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 632,662,856 shares as of November 21, 2009. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Page Item 1: Financial Statements F1 - F4 Item 2: Management's Discussion and Analysis of F18 Financial Condition and Results of Operations Item 3: Quantitative and Qualitative Disclosures F24 About Market Risk Item 4T: Controls and Procedures F24 PART II - OTHER INFORMATION Item 1: Legal Proceedings F25 Item 1A: Risk Factors F31 Item 2: Unregistered Sales of Equity Securities F31 and Use of Proceeds Item 3: Defaults Upon Senior Securities F32 Item 4: Submission of Matters to a Vote of Security Holders F32 Item 5: Other Information F32 Item 6: Exhibits F32 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ZEALOUS, INC. AND SUBSIDIARIES (FORMERLY, ADULT ENTERTAINMENT CAPITAL, INC.) INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Page Condensed Consolidated Statements of Financial Condition F-1 as of September 30, 2009 (unaudited) and December 31, 2008 (audited) Condensed Consolidated Statements of Operations for the three F-2 and nine months ended September 30, 2009 and 2008 (unaudited) Condensed Consolidated Statement of Stockholders' Deficit for the nine months ended September 30, 2009 (unaudited) F-3 Condensed Consolidated Statements of Cash Flows for the nine F-4 months ended September 30, 2009 and 2008 (unaudited) Notes to Condensed Consolidated Financial Statements as of September 30, 2009 (unaudited) F-5 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS

FINANCIAL STATEMENTS. F-1

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. F-2

ZEALOUS, INC. AND SUBSIDIARIES (FORMERLY, ADULT ENTERTAINMENT CAPITAL, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2009 NOTE 1. INCORPORATION, NATURE AND CONTINUANCE OF OPERATIONS INCORPORATION AND NATURE OF OPERATIONS Zealous, Inc., is a holding company previously known as Adult Entertainment Capital, Inc. and Zealous Trading Group, Inc. Zealous, Inc. ("the Company"), conducts business through its various subsidiaries and was originally incorporated under the laws of the state of Nevada on September 25, 1978. Through the years the Company has gone through various name changes as a result of its different business plans. Zealous Holdings Inc., a subsidiary of the Company, is a holding company whose subsidiaries were engaged in various financial services businesses including investment banking, trading services, and asset management services. Zealous Holdings Inc. raised capital for small and microcap public companies and select private issuers and was also involved in the development of its Zealous Alternative Trading System ("ZATS"). During the fourth quarter of 2008 as the economic conditions and uncertain investment climate worsened, the Company was no longer able to obtain the necessary financing to continue to fund its financial services operations and maintain the capital requirement of Zealous Capital Markets, LLC, its broker-dealer subsidiary. These conditions caused the Company to shut down the operations of Zealous Capital Markets, LLC in January 2009. On April 2, 2009, the Board of Directors of the Company agreed to cease the business activities of, close down and dissolve its wholly owned subsidiary Zealous Real Estate Consulting, LLC., a consumer mortgage negotiations company, effective May 31, 2009. During the nine months ended September 30, 2009, the Company established Health and Wellness Partners, Inc. which is engaged in distribution of all natural herbal products that improve the body, mind and spirit of consumers. These health and wellness products which include Liquid Ice (an energy drink) and Rock Hard Weekend (a male performance pill) and Surge, a line of sexual performance supplements for both men and women. The Company also established Zealous Interactive, Inc. which operates a multiple media related business, including a print publication and Internet URLs. GOING CONCERN At September 30, 2009, the Company had not achieved profitable operations, had insufficient working capital to fund ongoing operations and expects to incur further losses. These circumstances raise a substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern is dependent upon its ability to generate future profitable operations and to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations. Management believes that the Company may not be able to obtain additional funds from debt or equity financing due to current economic conditions. Page F-5 After evaluating the current economic circumstances and investment climate, management believes that it is in the best interest of the Company to exit the financial services business. Management plans to generate revenue through sale of health and wellness products and a multiple media related business, including a print publication and Internet URLs. These interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to a going concern, which assumes that the Company will be able to meet its obligations and continue its operations. Realization values may be substantially different from carrying values as shown. These interim condensed consolidated financial statements do not give effect to adjustments that would be necessary to the carrying values and classification of assets and liabilities should the Company be unable to continue as a going concern. NOTE 2. SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION These interim consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Zealous Holdings, Inc., Zealous Capital Markets, LLC, Zealous Asset Management, LLC, Zealous Real Estate Consulting, LLC, Zealous ATS, LLC, Health and Wellness Partners, Inc. and Zealous Interactive, Inc. All intercompany balances and transactions have been eliminated in consolidation. BASIS OF PRESENTATION While the information presented in the accompanying interim consolidated financial statements is unaudited, it includes all adjustments, which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented in accordance with accounting principles generally accepted in the United States of America. These interim financial statements follow the same accounting policies and methods of their application as the Company's December 31, 2008 audited annual financial statements. All adjustments are of a normal recurring nature. It is suggested that these interim financial statements be read in conjunction with the Company's December 31, 2008 annual financial statements filed on Form 10-K with the Securities and Exchange Commission on May 18, 2009. Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that can be expected for the year ending on December 31, 2009. Page F-6 USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenditures during the reporting period. A precise determination of many assets and liabilities is dependent upon future events. Actual results may vary from these estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include highly liquid investments with original maturities of three months or less. BASIC AND DILUTED NET LOSS PER SHARE The Company computes net loss per share in accordance with SFAS No. 128, "Earnings Per Share". SFAS No. 128 requires presentation of both basic and diluted earnings per share ("EPS") on the face of the statements of operations. Basic EPS is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period including stock options and warrants, using the treasury stock method and convertible debt using the if-converted method. Common stock equivalents were not included in the calculation of diluted loss per share as their effect would be anti-dilutive. REVENUE RECOGNITION The Company recognizes sales of health and wellness products as they are shipped. Shipping and delivery costs are included in cost of sales. Real estate consulting fees are recognized when earned. All commission expense, if any, associated with revenues are recorded in general and administrative expenses. INCOME TAXES The Company adopted the SFAS No. 109, "Accounting for Income Taxes". Pursuant to SFAS No. 109, deferred income tax assets and liabilities are computed for differences between the financial statement carrying amounts and the respective tax bases. Deferred tax assets and liabilities are measured using enacted or substantially enacted tax rates expected to apply to the taxable income in the periods in which those differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. Potential benefits of net operating losses have not been recognized in the financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses carried forward in future years. Page F-7 On January 1, 2007, the Company adopted FIN 48, "Accounting for Uncertainties in Income Taxes". FIN 48 clarifies the requirements of SFAS No. 109, Accounting for Income Taxes, relating to the recognition of income tax benefits. FIN 48 provides a two step approach to recognizing and measuring tax benefits when the benefits' realization is uncertain. The first step is to determine whether the benefit is to be recognized, the second step is to determine the amount to be recognized. Income tax benefits should be recognized when, based on technical merits of a tax position, the company believes that if a dispute arose with the taxing authority and were taken to a court of last resort, it is more likely than not that the tax position would be sustained as filed; and if the position is determined to be more likely than not of being sustained, the reporting company should recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority. The Company's adoption of FIN 48 did not have any impact on its financial statements. INVENTORIES Inventories consist primarily of cases of Liquid Ice energy drink and packets of Rock Hard Weekend pills. Inventories are valued at lower of cost or market, determined using the first-in first-out method. RECENT ACCOUNTING PRONOUNCEMENTS The following Recent Accounting Pronouncements are disclosed as they may be applicable to the Company's operations and could have an impact on the Company's financial statements. In September 2009, the FASB Emerging Issues Task Force, or EITF, reached a consensus on ASC Update 2009-13 (Topic 605), Multiple-Deliverable Revenue Arrangements, or ASC Update 2009-13. ASC Update 2009-13 applies to multiple- deliverable revenue arrangements that are currently within the scope of ASC 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist and how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for the Company no later than the first quarter of fiscal 2011. The adoption Page F-8 of ASC Update 2009-13 will not have a material impact on the Company's financial position or results of operations for future collaborations arrangements. In June 2009, the FASB issued Statement of Financial Accounting Standards No. 165, "Subsequent Events," ("SFAS No. 165"). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 applies to both interim financial statements and annual financial statements. SFAS 165 is effective for interim or annual financial periods ending after June 15, 2009. SFAS 165 does not have a material impact on our financial statements. In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, "Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140," ("SFAS 166"). SFAS 166 eliminates the concept of a "qualifying special-purpose entity," changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity's continuing involvement in and exposure to the risks related to transferred financial assets. SFAS 166 is effective for fiscal years beginning after November 15, 2009. The Company will adopt SFAS 166 in fiscal 2010. The Company does not expect that the adoption of SFAS 166 will have a material impact on the financial statements. In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, "Amendments to FASB Interpretation No. 46(R)," ("SFAS 167"). The amendments include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. SFAS 167 is effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. The Company will adopt SFAS 167 in fiscal 2010. The Company does not expect that the adoption of SFAS 167 will have a material impact on the financial statements. In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles," ("SFAS 168"). SFAS 168 replaces FASB Statement No. 162, "The Hierarchy of Generally Accepted Accounting Principles", and establishes the FASB Accounting Standards Codification ("Codification") as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles ("GAAP"). SFAS 168 is effective for interim and annual periods ending after September 15, 2009. The Company will begin to use the new Codification when referring to GAAP in its annual report on Form 10-K for the fiscal year ending December 31, 2009. This will not have an impact on the results of the Company. In August 2009, the FASB updated the fair value measurement guidance to clarify how an entity should measure liabilities at fair value. The update reaffirms fair value is based on an orderly transaction between market participants, even though liabilities are Page F-9 infrequently transferred due to contractual or other legal restrictions. However, identical liabilities traded in the active market should be used when available. When quoted prices are not available, the quoted price of the identical liability traded as an asset, quoted prices for similar liabilities or similar liabilities traded as an asset, or another valuation approach should be used. This update also clarifies that restrictions preventing the transfer of a liability should not be considered as a separate input or adjustment in the measurement of fair value. We will adopt the provisions of this update for fair value measurements of liabilities effective October 1, 2009, which we do not expect to have a material impact on consolidated financial statements. RECLASSIFICATIONS Certain comparative figures have been reclassified to conform to the current period's presentation. NOTE 3. STOCKHOLDERS' DEFICIT Equity issuances During the nine months ended September 30, 2009, the Company issued 166,311,335 shares of its common stock for conversion of $3,114,491 of its convertible debt and $95,281 of accrued interest on convertible debt into equity. The Company also issued 12,000,000 shares of its common stock to one of its shareholders for repayment of debt in the amount of $10,000. During the nine months ended September 30, 2009, the Company issued 42,100,000 shares towards payroll payable valued at $42,100. NOTE 4. DEPOSIT WITH CLEARING BROKER The Company was a party to Clearing Agreements with Wedbush Morgan Securities, Inc. and Legent Securities on a fully disclosed basis to provide custodial and clearing services for the Company's financial services business. These custodial and clearing services included custody of customer securities and funds, providing written statements, confirmation of trades, account and security transfers, monitoring of compliance with Federal Reserve regulations, clearance and settlements of transactions hypothecation and lending of securities as well as standard clearing firm and custodial services. The Clearing Agreements were cancelled during the nine months ended September 30, 2009. The Company had $25,953 and $104,730 of funds with these clearing brokers as of September 30, 2009 and December 31, 2008, respectively. Page F-10 NOTE 5. NON-CONVERTIBLE NOTES PAYABLE Non-convertible notes payable at September 30, 2009 and December 31, 2008 are comprised of the following: September 30, December 31, 2009 2008 ------------ ----------- Short-Term Borrowings: Notes Payable - Stockholders (1) $ 2,460,825 $ 2,056,039 Notes Payable - Related Parties (2) 1,600,331 1,571,518 ------------ ----------- Total Short-Term Borrowings 4,061,156 3,627,557 ------------ ----------- Long-Term Borrowings: Note Payable - Stockholders (1) 480,000 480,000 ------------ ----------- Total Long-Term Borrowings 480,000 480,000 ------------ ----------- Total Notes Payable $ 4,541,156 $ 4,107,557 ------------ ----------- (1)The Company has notes payable to stockholders that are unsecured, interest bearing, notes having interest rates ranging from 7% to 24%. All except for $480,000 of these notes payable are in default as of September 30, 2009. These notes mature at various times between June 2006 and December 2015. (2)The Company had notes payable to related parties that are interest bearing, demand notes having interest rates ranging from 5% to 12%. All notes payable to related parties are in default as of September 30, 2009. One of the notes payable to a related party grants the holder a senior security interest in all of the assets, proceeds of those assets and equity of the Company. NOTE 6. LINE OF CREDIT The Company has two revolving lines of credit for $500,000 each, from Citibank and First Tennessee Bank. The line of credit from Citibank was established by individuals affiliated to a stockholder and assigned to the Company on July 24, 2006. The line of credit from First Tennessee Bank was established by the same individuals and later assigned to the Company on July 7, 2007. The interest rates on the Citibank and First Tennessee lines of credit are at Prime Rate and Prime Rate plus 1%, respectively. The balances on the lines of credit were $998,416 and $998,416 as of September 30, 2009 and December 31, 2008, respectively. These lines are in default as of September 30, 2009. NOTE 7. CONVERTIBLE DEBT The Company has various convertible notes payable amounting to $547,500. These convertible notes were issued in 2007 by the public shell into which the Company was merged during 2008. The notes whose face value aggregated $5,122,500 at issuance were Page F-11 to mature at various dates through October 2008, they had interest rates ranging from 5% to 15% and included an option to convert into common stock at a conversion price of $0.02 per share. During the nine months ended September 30, 2009, the company issued 166,311,335 shares of its common stock for conversion of $3,114,491 of this convertible debt into equity. The remaining balance of $547,500 was therefore in default as a result of the Company's inability to pay by September 30, 2009. In connection with the issuance of convertible notes, the company issued a total of 119,992,500 warrants convertible at $0.02, $0.03 and $0.05 per share with terms of three to five years. Additionally, the Company issued 5,406,249 warrants convertible at $0.03 per share within five years, exercisable one year from the issuance of the note as long as the holder did not demand payment or exercise the option under the note prior to the maturity date of the note. In connection with securing the original financing pursuant to these notes, the Company paid $299,250 in cash and issued 24,275,000 warrants. These amounts were recorded as deferred financing costs and have been completely amortized over the terms of the notes. The following table shows the amount of convertible notes payable and secured convertible debentures as on September 30, 2009: Convertible notes payable $ 442,500 Secured convertible debentures 105,000 ----------- Total as on September 30, 2009 $ 547,500 ----------- These convertible notes are in default as on September 30, 2009. NOTE 8. WARRANTS In March 2008, the Company had issued 2,125,000 warrants in connection with the sale of 4,250,000 shares of its common stock. These warrants have a life of 5 years from the date of issuance. In connection with the notes issued in 2007 as discussed in Note 6 above, the Company issued warrants to purchase 125,398,749 shares of common stock at $0.02 to $0.05 per share over five years. The Company also issued 24,275,000 warrants as financing costs related to these notes. Page F-12 The following table summarizes information on stock warrants outstanding at September 30, 2009:

NOTE 9. STOCK OPTIONS On October 19, 2007, the Board of Directors of Zealous Holdings adopted the 2007 Equity Incentive Plan (the "2007 Plan") which reserved a total of 4,000,000 shares of common stock for issuance. If an incentive award granted under the 2007 Plan expired, terminated, was unexercised or was forfeited, such award and related surrendered shares would become available for future awards under the 2007 Plan. In 2008, in connection with the merger with the public shell, the public shell issued 1,600,000 stock options from its Stock Incentive Plan to holders of options of the Zealous Holdings, Inc. 2007 Plan at an exercise price of $1.00 and a term of 10 years. The Company uses the Fair Value Method in accordance with SFAS 123R for accounting of stock based compensation. The fair value of these stock options was determined using the Company's historical stock prices and the Black- Scholes option-pricing model with the following assumptions: Risk free rate 4% Dividend yield 0% Weighted average expected volatility 123.41% Weighted average expected option life 10 yrs Page F-13 The following table shows the total number of options outstanding as on September 30, 2009: Shares ------ Total options outstanding as on December 31, 2008 1,600,000 Add: Options issued in 2009 - --------- Total Options outstanding as on September 30, 2009 1,600,000 ========= Total number of options exercisable as on September 30, 2009 817,500 ========= Weighted Average exercise price of options outstanding as on September 30, 2009 is $1.00 per share. NOTE 10. COMMITMENTS AND CONTINGENCIES Legal matters The Company is subject to litigation from time to time in the normal course of business. During the year ended December 31, 2008, the Company was served as a co- defendant with a complaint by a former director and stockholder. The complaint seeks damages in the amount of $600,000 plus interest and attorney fees. In July 2008, the Company entered a settlement agreement for $350,000. The Company has currently been served with a complaint as a co-defendant to enforce the settlement agreement and is pursuing settlement discussions. The other co- defendants in this case have agreed to assume any and all damages arising from this settlement and therefore the company has not accrued this judgment as of September 30, 2009. Company was served as a co-defendant with a complaint by a former director and stockholder. The complaint seeks recovery of $1,500,000, relating to prior equity and unsecured debt investments, plus attorneys fees and costs. The complaint alleges violations of federal and state securities laws. The Company cannot determine the merit of the case at this time. The Company was served as a co-defendant with a verified complaint by a creditor for Unlawful Detainer. The Company has filed an answer asserting affirmative defenses on December 8, 2008. Plaintiff issued discovery requests to the Company on December 23, 2008. Subsequent to further negotiations, the Plaintiff refunded a security deposit of $262,500 plus accrued interest to the Company in January, 2009. The Company is in the process of propounding and responding to discovery and is also engaged in settlement discussions. Page F-14 Professional Offshore Opportunities Fund Limited, a secured creditor, filed a complaint against the Company on July 23, 2008. Professional Offshore Opportunities Fund Limited's causes of action against the Company include negligent misrepresentation, breach of the duty of good faith and fair dealing, and breach of the debenture. On January 30, 2009, the New York Court entered Judgment against Defendant in favor of Plaintiff. On February 3, 2009, Plaintiff filed a Restraining Notice against the Company to prevent the sale of certain property. On February 23, 2009, Plaintiff filed with the Court a Notice of Entry of Default, dated January 16, 2009, against Defendants for the principal amount of $200,000, plus interest, costs and disbursements. The Company is pursuing settlement negotiations and drafting a Motion to Set Aside Default. Kent G. Wyatt, Sr., former CEO and Chairman of the board of the public shell (pre-merger) filed a Complaint against the Company on October 24, 2008 for alleged breach of promissory note, breach of consulting agreement, unpaid loans and NSF checks, declaratory relief, breach of implied covenant of good faith and fair dealing, intentional misrepresentation, negligent misrepresentation, accounting, and conversion. On December 26, 2008, the Court entered Default Judgment against all Defendants for the principal plus interests totaling $270,259.15. Defendants engaged in a settlement NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) Legal matters (continued) conference with Plaintiff on March 30, 2009 and are continuing to pursue settlement discussions. On February 6, 2009, a shareholder filed a Complaint with the Company as co- defendant alleging negligent misrepresentation, breach of fiduciary duty, breach of 6 contracts, breach of implied covenant of good faith and fair dealing of six contracts and violations of Corporate Code 25400, 25401, 25500, 25501 25504, fraud, unjust enrichment on two contracts, equitable indemnity, constructive trust, and unfair business practices. The Company is engaged in settlement discussion, preparing responsive pleadings, and completing discovery responses. On August 12, 2009, Alpha Capital Anstalt Hedge Fund et al ("Plaintiff") has filed a suit against Milton ("Todd") Ault III ("Defendant") in the New York State Supreme Court. The case number for this litigation is 602444/09. Plaintiff is seeking $4.2M plus damages. Defendant has answered, and is in the process of selecting Counsel to handle litigation. No dates have been set by the Court. Defendant maintains that Plaintiff has received over $1M in repayment and that all allegations are baseless while the Plaintiff has impugned the reputation of Mr. Ault in the press. Plaintiffs maintain investment was to support ZATS which never worked or was completed. Defendant has proof that many of the Plaintiffs actually conducted business on ZATS in 2008 and the Company received earned commissions from these transactions. Defendants deny all allegations of the Plaintiffs. Page F-15 The Company was served as a co-defendant with a verified complaint by a creditor on February 4, 2009. The Plaintiff alleges that Defendants failed to repay Plaintiff in accordance with an executed Promissory Note, and Defendants failed to pay a Guarantee as executed between Plaintiff and Defendants. Plaintiff is alleging damages in an amount of $500,000.00, pre and post- judgment interest and attorneys' fees and costs. Defendants are preparing responsive pleadings bringing affirmative defenses. In April 2009, Defendants also began settlement discussions with Plaintiffs. On November 7, 2007, the Company entered into a Letter of Agreement with The Investor Relations Group, Inc. ("IRG") in which IRG is to provide a comprehensive corporate communications program. The term of the agreement is one (1) year unless sooner terminated and the Company shall pay on a monthly basis $13,500. The Company was served as a defendant with a complaint by IRG. The complaint seeks damages in the amount of $40,000 plus interest and costs. On November 14, 2008, the New York Supreme Court entered default against Defendant for failure to answer the Complaint. The Company is evaluating the merits of the case and researching the advantages to filing a Motion to Set Aside Default. The Company is also discussing settlement possibilities with the Plaintiff. A former employee of the Company filed a claim for non-payment of wages against the Company with the Labor Commissioner, State of California alleging that the Company owes him $4,000 in wages. The Company terminated his at-will employment and believes that he is not owed any wages since he had been paid in full through his termination date. The Company is drafting responsive pleadings and will oppose the claim at any future hearings. A former employee of the Company filed a claim for non-payment of wages against the Company with the Labor Commissioner, State of California alleging that the Company owes him $4,500 in wages. The Company terminated his at-will employment and believes that he is not owed any wages since he had been paid in full through his termination date. The Company is pursuing settlement discussions. The Company is also drafting responsive pleadings and will oppose the claim at any future hearings. NOTE 11. RELATED PARTY TRANSACTIONS The Company engages in various transactions and financing activities with related parties which include amongst others stockholders of the Company and other related businesses and acquaintances of stockholders, prior officers and the Company's Chief Executive Officer. (See note 5 Non-convertible notes payable) NOTE 12. INCOME TAXES Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes". The Interpretation provides clarification on accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB No. 109, "Accounting for Income Taxes." The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be Page F-16 taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the Company's evaluation of the implementation of FIN 48, no significant income tax uncertainties were identified. Therefore, the Company recognized no adjustment for unrecognized income tax benefits for the three months ended September 30, 2009 and 2008. The tax years subject to examination by the taxing authorities are the years ended December 31, 2008, 2007, 2006 and 2005. In May 2007, the FASB issued FASB Staff Position ("FSP") FIN 48-1 "Definition of Settlement in FASB Interpretation No. 48" (FSP FIN 48-1). FSP FIN 48-1 provides guidance on how to determine whether a tax position is effectively settled for purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January 1, 2007. The implementation of this standard did not have a material impact on our consolidated financial position or results of operation. On September 30, 2009, the Company will have federal net operating loss carryforward of approximately $19.7 million. Current federal tax law limits the amount of loss available to offset future taxable income when a substantial change in ownership occurs. Therefore the amount available to offset future taxable income may be limited. The federal net operating losses expire by 2029. NOTE 13. OTHER INCOME During the quarter ended September 30, 2009, the Company sold 75,797 shares of Patient Safety Technologies, Inc. ("PST") for a gain of $50,603. The Company had previously held warrants from PST that were attributed no value. On July 29, 2009, the Company entered into an Exchange Agreement with PST in which all warrants held were converted into shares of PST common stock. These shares were subsequently sold on September 1, 2009 and September 21, 2009 as noted above. NOTE 14. SUBSEQUENT EVENTS The Company has evaluated subsequent events through November 23, 2009, the date which the financial statements were available to be issued. On November 9, 2009 Zealous Inc. and its subsidiaries relocated their offices after attempts to renegotiate the lease failed. The company no longer requires as large an office since it has been consistently reducing its staff size throughout 2009. The Company has a new address and phone number. Page F-17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward- looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward- looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC. RESULTS OF OPERATION: RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008 We generated $3,128 in operating revenues for the three months ended September 30, 2009 compared to $326,021 in operating revenues for the three months ended September 30, 2008. This is because of lesser brokerage commissions generated during the three months ended September 30, 2009 compared to three months ended September 30, 2008. During the three months ended September 30, 2009 and September 30, 2008, we incurred operating expenses of $303,230 and $1,210,245, respectively, a decrease of $907,015 because of decreased operating activities. We incurred $257,449 in interest expense during the three months ended September 30, 2009 compared to $2,022,559 in interest expense during the three months ended September 30, 2008 because of interest expense on the reduced liabilities as on September 30, 2009. Interest expense of $257,449 included a non-cash component attributable to increase in principle amount of a note Page F18 payable to a shareholder as penalty. The net operating loss figures for the three months ended September 30, 2009 and 2008 were $513,545 and $2,950,060, respectively. RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008 We generated $63,841 in operating revenues for the nine months ended September 30, 2009 compared to $694,219 in operating revenues for the nine months ended September 30, 2008. This is because of lesser brokerage commissions generated during the nine months ended September 30, 2009 compared to nine months ended September 30, 2008. During the nine months ended September 30, 2009 and September 30, 2008, we incurred operating expenses of $1,368,623 and $3,517,857, respectively, a decrease of $2,149,234 because of decreased operating activities. We incurred $674,428 in interest expense during the nine months ended September 30, 2009 compared to $3,671,148 in interest expense during the nine months ended September 30, 2008 because of interest expense on the reduced liabilities as on September 30, 2009. Interest expense of $674,428 included a non-cash component attributable to increase in principle amount of a note payable to a shareholder as penalty. The net operating loss figures for the nine months ended September 30, 2009 and 2008 were $1,934,145 and $6,509,220, respectively. LIQUIDITY AND CAPITAL RESOURCES We had a bank overdraft of $24,668 and a cash balance of $4,217 as on September 30, 2009 and December 31, 2008, respectively. We had $0 in restricted cash as on September 30, 2009 and $268,399 in restricted cash on December 31, 2008. Payable to clearing broker and managed funds were $8,637 on September 30, 2009 as compared to $9,853 on December 31, 2008. Investments in affiliated entities on September 30, 2009 stood at $4,667 as compared to $6,680 on December 31, 2008. The company is party to Clearing Agreements with Wedbush Morgan Securities, Inc. and Legent Securities on a fully disclosed basis to provide custodial and clearing services for the Company. These custodial and clearing services include custody of customer securities and funds, providing written statements, confirmation of trades, account and security transfers, monitoring of compliance with Federal Reserve regulations, clearance and settlements of transactions hypothecation and lending of securities as well as standard clearing firm and custodial services. The Clearing Agreements can be cancelled at any time for cause or upon 31 days written notice. The Company was required to maintain a minimum deposit of $100,000 with its clearing broker, the remaining balance of which is included in deposit with clearing broker in the accompanying statement of financial condition. Deposit with clearing brokers as on September 30, 2009 was $25,953 as compared to $104,730 as on December 31, 2008. Loans and receivables as on September 30, 2009 were $4,408 as compared to $0 as on December 31, 2008. Net investment in fixed assets as on September 30 2009 was $229,525 as compared to $293,779 as on December 31, 2008. Accounts payables and accrued liabilities as on September 30, 2009 were $3,424,123 as compared to $2,479,820 on December 31, 2008. Non-convertible notes payable as on September 30, 2009 were $4,541,156 compared to $4,107,557 as on December 31, 2008. Lines of credit as on September 30, 2009 were $998,416 compared to $998,416 as on December 31, 2008. In 2008, we issued various Page F19 convertible notes payable amounting to $5,122,500. These convertible notes mature at various times within one year from date of issuance, have an interest rate ranging from 5% to 15% and include an option to convert the notes to common stock at a conversion price of $0.02 per share. The balance on these convertible notes payable as on September 30, 2009 was $547,500. Convertible notes payable as on December 31, 2008 were $3,661,991. During the nine months ended September 30, 2009, we issued 166,311,335 shares of our common stock to convert the principle balance of $3,114,491 of our convertible notes and related accrued interest of $95,281 into stock of the company. All notes, except for $749,000 non-convertible notes, are in default as on September 30, 2009. We are currently negotiating with various secured and unsecured creditors to settle the notes in default by refinancing and/or renegotiating the terms of repayment of such notes. In connection with these convertible notes, we issued a total of 119,992,500 warrants convertible at $0.02, $0.03 and $0.05 per share with terms of three to five years. Additionally, the Company issued 5,406,249 warrants convertible at $0.03 per share within five years, exercisable one year from the issuance of the note as long as the holder did not demand payment or exercise the option under the note prior to the maturity date of the note. We accounted for the convertible notes payable in accordance with Emerging Issues Task Force Issue 98-5, Accounting for Convertible Securities with a Beneficial Conversion Features or Contingently Adjustable Conversion Ratios ("EITF 98-5"), and recognized an imbedded beneficial conversion feature present in the convertible note. We recognized and measured an aggregate of $5,122,500 of the proceeds, which is equal to the intrinsic value of the imbedded beneficial conversion feature, to additional paid in capital with a discount against the convertible note. The debt discount attributed to the beneficial conversion feature has been amortized over the maturity period as non-cash interest expense. In connection with securing the financing pursuant to these notes, we paid $299,250 in cash and issued 24,275,000 warrants. These amounts were recorded as deferred financing costs and have been amortized over the terms of the notes. The following table shows the amount of convertible notes payable and secured convertible debentures as on September 30, 2009: Convertible notes payable $ 442,500 Secured convertible debentures 105,000 ---------- Total as on September 30, 2009 $ 547,500 ========== STOCK OPTIONS The Company's Board of Directors and stockholders adopted the 2007 Equity Incentive Plan, or the 2007 Plan, on October 19, 2007 which reserves a total of 4,000,000 shares of Common Stock for issuance under the 2007 Plan. If an incentive award granted under the Page F20 2007 Plan expires, terminates, is unexercised or is forfeited, or if any shares are surrendered to us in connection with an incentive award, the shares subject to such award and the surrendered shares will become available for further awards under the 2007 Plan. During 2008, in connection with the Merger, the Company issued 1,600,000 stock options pursuant to its Stock Incentive Plan to holders of options from Zealous Holdings that were previously issued at an exercise price of $1.00 and a term of 10 years as follows: Number of Options Vesting Schedule Grant Date ----------------- ----------------------- ---------- 467,500 2 years from Grant Date 02/11/08 427,500 Vested 02/11/08 75,000 2 years from Grant Date 12/01/07 25,000 2 years from Grant Date 12/12/07 50,000 Vested 02/11/08 40,000 Vested 01/22/08 100,000 Vested 12/01/07 100,000 Vested 12/12/07 40,000 4 year from Grant Date 02/11/08 50,000 Vested 05/09/08 225,000 *See Below 02/11/08 *50,000 vests upon registration statement becoming effective; 50,000 vests upon one full year from September 3, 2008 of Company not receiving an "E"; and 125,000 upon Company being listed on a national stock exchange. The Company uses the Fair Value Method in accordance with SFAS 123R for accounting of stock based compensation. The fair value of these stock options was determined using the Company's historical stock prices and the Black- Scholes option-pricing model with the following assumptions: Risk free rate 4% Dividend yield 0% Weighted average expected volatility 123.41% Weighted average expected option life 10 yrs We do not foresee any forfeiture of options. The following table shows the total number of options outstanding as on September 30, 2009: Shares --------- Total options outstanding as on December 31, 2008 1,600,000 Add: Options issued in 2009 - ========= Total Options outstanding as on September 30, 2009 1,600,000 --------- Total number of options exercisable as on September 30, 2009 817,500 --------- Page F21 Weighted Average exercise price of options outstanding as on September 30, 2009 is $1.00 per share. SUBSEQUENT EVENTS On October 5, 2009 Health and Wellness Partners, Inc. received its first unsolicited purchase on its new website, www.FeeltheSurge.com. On October 14, 2009 Health and Wellness Partners, Inc. placed an additional order of 600,000 capsules of Surge for Women and launched the next day, October 15, 2009 the website, www.FeeltheSurge.com. Over 203 news outlets covered this launch. On October 21 a representative of the FDA visited Health and Wellness Partners, Inc. investigating the efficacy of RockHard Weekend. It was recommended that Health and Wellness Partners, Inc. cease distributing the product due to potential harm to the public and the fact the product included an undisclosed pharmaceutical analog which could be harmful to the public. Subsequently on November 9, 2009 RockHard Labs issued a voluntary recall of its product and distribution was curtailed nationwide. The Company is returning all of its remaining inventory for a full refund plus costs. Further negotations with RockHard Labs as the manufacturer originally misrepresented itself at the time the exclusive contract was signed and product was purchased for distribution. During the month of October and November 2009 Health and Wellness Partners, Inc. received many testimonials from consumers recommending the product and attesting to its effectiveness. The Company has posted 8 of these testimonials on the website, www.FeeltheSurge.com and will continue to do so. On November 5, 2009 Health and Wellness Partners received its first shipment of 140,000 capsules of Surge for Women. On November 12, 2009 Zealous Interactive, Inc. re-launched its Beta1 version of TheAdultSpot.com, its adult portal and social network improving its Alexa rating by over 1,000% within its first 10 days. RISK FACTORS We expect significant operating expenditures during the next 12 months for working capital requirements. We have insufficient funds to conduct our operations and to fully realize our operating goals for the next twelve months. We will therefore be required to seek additional financing. There can be no assurance that additional financing will be available in amounts or on terms acceptable to us, if at all. By adjusting our operations to the level of capitalization, we believe we have insufficient capital resources to meet projected cash flow deficits. If during that period or thereafter, we are not successful in generating sufficient liquidity from operations or in raising sufficient capital resources, on terms acceptable to us, this could have a material adverse effect on our business, results of operations, liquidity and financial condition. Page F22 We presently do not have any available credit, bank financing or other external sources of liquidity. Due to our brief history and historical operating losses, our operations have not been a source of liquidity. We will need to obtain additional capital in order to expand operations and become profitable. In order to obtain capital, we may need to sell additional shares of our common stock or borrow funds from private lenders. There can be no assurance that we will be successful in obtaining additional funding. Zealous, Inc. prior to December 31, 2008 was operated by a series of partners with Milton C. Ault III. Subsequent to the world economic downturn and the collapse of the U.S. Stock Market in October 2008, Mr. Ault continued to manage the Company and its non-financial oriented subsidiaries. Stephen Bodnar, a partner prior to 2008, filed a lawsuit subsequent to the Company's name change to Adult Entertainment Capital. Mr. Ault's long time partners of many years, Ms. Melanie Glazer and Dr. Louis Glazer resigned and filed lawsuits against the Company and Mr. Ault. This set of litigation has proven to be financially debilitating and exhaustive. The Company has entered negotiations with these partners, however, these efforts may proof unsuccessful. If unsuccessful, the Company may seek relief in U.S. Bankruptcy Court to restructure the Company. We will still need additional investments in order to continue operations until we are able to achieve positive operating cash flow. Additional investments are being sought, but we cannot guarantee that we will be able to obtain such investments. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock and a downturn in the U.S. stock and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. If additional financing is not available or is not available on acceptable terms, we will have to curtail our operations. To date, we have generated minimal revenues and have incurred operating losses in every quarter. These factors among others may raise substantial doubt about our ability to continue as a going concern. OFF BALANCE SHEET ARRANGEMENTS As of September 30, 2009, there were no off balance sheet arrangements. Page F23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A smaller reporting company is not required to provide the information required by this Item. ITEM 4T. CONTROLS AND PROCEDURES (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Our Chief Executive Officer and Chief Financial Officer, (i) are responsible for establishing and maintaining adequate internal control over financial reporting of the Company and (ii) have evaluated the effectiveness of our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the 1934 Act as of the end of the period covered by this Quarterly Report ("Evaluation Date"). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as the Evaluation Date, our disclosure controls and procedures are not effective in alerting them on a timely basis to material information relating to us required to be included in our reports filed or submitted under the 1934 Act, except as discussed below. The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as required by Sarbanes- Oxley (SOX) Section 404 A. The Company's internal control over financial reporting is a process designed under the supervision of the Company's Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external purposes in accordance with U.S. generally accepted accounting principles (GAAP) As of September 30, 2009, management assessed the effectiveness of the Company's internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control-- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO) and SEC guidance on conducting such assessments. Based on that evaluation, they concluded that, during the period covered by this report, such internal controls and procedures were not effective to detect the inappropriate application of US GAAP rules as more fully described below. This was due to deficiencies that existed in the design or operation of our internal control over financial reporting that adversely affected our internal controls and that may be considered to be material weaknesses. The matters involving internal controls and procedures that the Company's management considered to be material weaknesses under the standards of the Public Company Accounting Oversight Board were : (1) lack of a functioning audit committee and lack of majority of outside directors on the Company's board of directors, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures, and, (2) inadequate segregation of duties consistent with control objectives. The aforementioned material weaknesses were identified by the Company's Chief Financial Officer in connection with the review of our financial statements as of September 30, 2009 and communicated to our management. Page F24 Management believes that the material weaknesses set forth in items (1) and (2) above did not have an affect on the Company's financial results. However, management believes that the lack of a functioning audit committee and lack of a majority of outside directors on the Company's board of directors could result in ineffective oversight in the establishment and monitoring of required internal controls and procedures. Management's goals are to have a functional audit committee and a majority of outside directors on the Company's board of directors when funds are available. This report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this report. (b) CHANGES IN INTERNAL CONTROLS. In addition, no change in our internal control over financial reporting (as defined in Rules 13a-15 or 15d-15 under the 1934 Act) occurred during the quarter ended September 30, 2009, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Detailed below are our ongoing legal proceedings. I. BODNAR CAPITAL MANAGEMENT, LLC V. AULT GLAZER CAPITAL PARTNERS, LLC, ET AL. United States District Court, CONNECTICUT CASE No: 3:08CV199 (JBA) On February 6, 2008, Bodnar Capital Management, LLC ("Plaintiff") filed a Complaint against Ault Glazer Capital Partners, LLC, Zealous Asset Management LLC, and Milton Ault, III ("Defendants") in the United States District Court, District of Connecticut under the case number 3:08CV199 (JBA). On June 27, 2008, all parties entered into a confidential settlement agreement. On August 7, 2008, the Court granted Plaintiff's motion to enforce the settlement agreement and entered judgment in Plaintiff's favor in the amount of $350,000, plus interest to run from June 27, 2008, against Ault Glazer Capital Partners LLC, Zealous Asset Management, LLC and Milton "Todd" Ault, III, jointly and severally. On September 23, 2008, the Court granted the motion for amendment of judgment to include reasonable attorney fees of $6,160.00. Plaintiffs sought to enforce the judgment in California and on April 28, 2009, Defendant Milton Ault, III was deposed in a debtor's examination at the United States District Court, Central District in California. Defendants are asserting the automatic stay with regard to Zealous Holdings and entities in lieu of the Chapter 11 bankruptcy filing. The Company has not received any correspondence regarding the matter since that time. Page F25 II. BODNAR CAPITAL MANAGEMENT, LLC V. MILTON AULT, III, ET AL. United States District Court, District of Connecticut Case No.: 3:08CV1601 (AWT) On October 20, 2008, Bodnar Capital Management, LLC ("Plaintiff") filed a Complaint against Milton Ault, III, William B. Horne, Lynne Silverstein, Melanie Glazer, Sothi Thillairajah, Scott Livingston, Zealous Holdings, Inc., Ault Glazer Bodnar Investment Management, LLC, Ault Glazer & Co., LLC, and Adult Entertainment Capital, Inc. ("Defendants") for fraud, breach of fiduciary duty, and breach of contract. Plaintiff alleges that Defendants violated the Company's Private Placement Memorandum, the Subscription Agreement, and other documents related to investing in the Company, and consequently, Plantiff is seeking $1,523,103.60 in damages. Plaintiff filed this case under the United States District Court, District of Connecticut, under case number 3:08CV1601 (AWT). On February 23, 2009, Plaintiff filed a Motion for a Joint and Several Judgment against Milton Ault, III. Defendants are asserting the automatic stay with regard to Zealous Holdings and entities in lieu of the Chapter 11 bankruptcy filing. The Company is awaiting correspondence regarding the Motion to Set Aside Default and/or a change of venue per the signed Partnership Agreement. III. MOTIVATED MINDS, LLC V. AULT GLAZER CAPITAL PARTNERS, LLC, ET AL. Superior Court of Arizona Case No.: CV2009-003478. Motivated Minds, LLC ("Plaintiff") filed a Complaint against Ault Glazer Capital Partners, LLC and Ault Glazer Asset Management, LLC (collectively referred as "Defendants"). On February 4, 2009, Plaintiff filed a Complaint against Defendants in the Superior Court of Arizona for Breach of Contract. The case number is CV2009-003478. Plaintiff alleges that Defendants failed to repay Plaintiff in accordance with an executed Promissory Note, and Defendants failed to pay a Guarantee as executed between Plaintiff and Defendants. Plaintiff is alleging damages in an amount of $500,000.00, pre and post- judgment interest and attorneys' fees and costs. Defendants are preparing responsive pleadings bringing affirmative defenses. In April 2009, Defendants also began settlement discussions with Plaintiffs. The Company has not received any correspondence regarding the matter since that time. IV. INVESTOR RELATIONS GROUP, INC. V. ZEALOUS TRADING GROUP, INC. New York State Supreme Court Case No.: 602014108. The Investor Relations Group, Inc. ("Plaintiff") filed a complaint against Zealous Trading Group, Inc. ("Defendant") on July 2, 2008, in the Supreme Court of the State of New York, under case number 602014108. In their Complaint, Plaintiff alleges breach of contract, quantum meruit, and account states. Plaintiff alleges that Defendants failed to pay Plaintiff for services performed in accordance with the investor relations services contract between Plaintiff and Defendants. Plaintiff is seeking compensatory damages in an amount of $41,457.14 and the accrued interest. On November 14, 2008, the New York Supreme Court entered default against Defendant in an amount of $41,457.14 for failure to answer the Complaint. Additionally, Defendant is pursuing settlement possibilities with Plaintiff. The Company is awaiting correspondence regarding the Motion to Stay in the State of Connecticut and/or a change of venue per the signed Partnership Agreement. The Company has not received any correspondence regarding the matter since that time. Page F26 V. MOTIVATED MINDS, LLC V. GLOBAL AUTHENTICATIONS HOLDINGS, INC., ET AL. Orange County Superior Court Case No.: 30-2008 00234518. Motivated Minds, LLC ("Plaintiff") filed a Complaint against Global Authentication Holdings, Inc. and Ault Glazer Capital Partners, LLC (collectively referred as "Defendants"), on December 30, 2008. Plaintiff filed a Limited Civil Complaint against Defendants in the Superior Court of California, in Orange County for breach of promissory note and money lent. The case number is 30-2008 00234518. Plaintiff alleges damages in an amount of $25,000.00, pre and post-judgment interest and attorneys' fees and costs. Defendants asserted the automatic stay of the chapter 11 bankruptcy. Defendants are also engaging in settlement discussions with Plaintiffs. On September 1, 2009, Plaintiff requested the Orange County Superior Court to enter default against Defendant. VI. CALIFORNIA STATE TEACHERS' RETIREMENT SYSTEM V. ZEALOUS TRADING GROUP, INC., ET AL. Los Angeles County Superior Court Case No.: SC100669 California State Teachers' Retirement System ("Plaintiff") filed a Verified Complaint against Zealous Trading Group, Inc., Initiative Legal Group, LLP, Younesi & Yoss, LLC and REM ("Defendants") for Unlawful Detainer. Plaintiff filed their Complaint on November 20, 2008 in the Superior Court of California in Los Angeles County under case number SC100669. Plaintiff alleges that Defendant permitted an improper sublease and although the improper subtenant has vacated, Plaintiff wants to complete the unlawful detainer. Plaintiff is seeking damages in an amount of $1,166.89 per day from November 18, 2008. Defendants filed an answer asserting affirmative defenses on December 8, 2008. Plaintiff issued discovery requests to Defendants on December 23, 2008. Defendants are in the process of propounding and responding to discovery. Defendants are also engaged in settlement discussions with Plaintiff. Subsequent to further negotiations, the Plaintiff released the Company's security deposit of $262,500 and accrued interest on the deposit of $5,899 from escrow to the Company in January 2009. Defendants are also engaged in settlement discussions with Plaintiff. VII. SECTOR 33 CREATIVE V. ADULT ENTERTAINMENT CAPITAL, INC., ET AL. Burbank Small Claims Court Case No.: BUR 08S00608 Sector 33 Creative ("Plaintiff") filed a small claims case against Adult Entertainment Capital, Inc. dba Rock Candy Entertainment, under case number BUR08S00608 in California North Central District Court on October 6, 2008. Plaintiff alleges Defendant failed to pay Plaintiff for services rendered in the development of websites, and Plaintiff is seeking $5,000.00 in compensatory damages. Judgment was entered against Defendants on December 5, 2008. Defendants are pursuing settlement negotiations and drafting a Motion to Set Aside Default. Page F27 VIII. PROFESSIONAL OFFSHORE OPPORTUNITIES FUND LIMITED V. ZEALOUS TRADING GROUP, INC. New York State Supreme Court Case No.: 650260 Professional Offshore Opportunities Fund Limited ("Plaintiff") filed a Complaint against Zealous Trading Group, Inc. ("Defendant") in the Supreme Court of the State of New York on July 23, 2008. The case number for this litigation is 650260. Plaintiff's causes of action against Defendant include negligent misrepresentation, breach of the duty of good faith and fair dealing, and breach of the debenture. Plaintiff alleges that Defendants misled Plaintiff as to the nature of their convertible debentures, Defendant incorrectly told Plaintiff that the shares were eligible for Rule 144 treatment, and Defendants failed to abide by the default provision of the debenture. Plaintiff is seeking $53,171.60 plus pre-judgment interests for Defendants' trading breach and $206,972.22 plus default interests for Defendants' breach of the executed debenture. On January 30, 2009, the New York Court entered Judgment against Defendant in favor of Plaintiff. On February 3, 2009, Plaintiff filed a Restraining Notice against Plaintiff to prevent the sale of certain property. On February 23, 2009, Plaintiff filed with the Court a Notice of Entry of Default, dated January 16, 2009, against Defendants for the principal amount of $200,000.00, plus interest at the rate of five (5) percent from October 17, 2007 to June 24, 2008, plus interest at a rate of 18 percent from June 24, 2008 to the date of entry of judgment (January 16, 2009), plus the amount of $53,171.60, with interest at the statutory rate from July 23, 2008 to the date of the entry of judgment (January 16, 2009), costs and disbursements. Defendant has advised Plaintiff of the Chapter 11 automatic stay. The Company has not received any correspondence regarding the matter since that time. IX. IN RE: ZEALOUS HOLDINGS, INC. Central District of California Bankruptcy Court, Case No. 09-11425-ES On February 20, 2009, Zealous Holdings ("Holdings"), a wholly owned subsidiary of Zealous, Inc., filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Central District of California Santa Ana Division (the "Bankruptcy Court"), Case No. 09-11425 ES. On May 1, 2009, the Bankruptcy Court, on its own initiative, filed a motion to convert the bankruptcy to a Chapter 7 bankruptcy. Holdings was notified of this change on May 8, 2009, via PACER. Holdings believes that it is now in a position to start settling and paying its debts. Therefore, Holdings would like to dismiss the bankruptcy action. Pursuant to this desire, Holdings filed an Emergency Hearing to Dismiss the Bankruptcy on May 11, 2009. That request was denied. Therefore, on May 12, 2009 Holdings filed a motion requesting that the Bankruptcy Court schedule a Hearing on the Motion to Dismiss the Voluntary Bankruptcy Petition for June 11, 2009. A judgment on the company's Voluntary Bankruptcy petition is yet to be reached and the company is seeking dismissal of its Voluntary Bankruptcy petition. A continued 341 meeting of creditors was set for October 14, 2009, with Revised schedules are to be filed. The 341 meeting is continued to November 23, 2009. Page F28 X. KENT G. WYATT, SR. V. ADULT ENTERTAINMENT CAPITAL, INC., ET AL. Eighth Judicial District of Nevada Case No.: A574309 Kent G. Wyatt, Sr. ("Plaintiff") filed a Complaint against Adult Entertainment Capital, Inc. and Zealous Trading Group, Inc. ("Defendants") in the Eighth Judicial District of Nevada under case number A574309 on October 24, 2008. Plaintiff's complaint alleges breach of promissory note, breach of consulting agreement, unpaid loans and NSF checks, declaratory relief, breach of implied covenant of good and fair dealing, intentional misrepresentation, negligent misrepresentation, accounting, and conversion. Plaintiff then took a default judgment against both Defendants. Plaintiff alleges that Defendants failed to repay Plaintiff in accordance with the promissory notes, failed to pay Plaintiff in accordance with the consulting agreement, failed to pay back loans, and failed to abide by their fiduciary duty to pay Plaintiff the money owed. On December 26, 2008, the Court entered Default Judgment against all Defendants for the principal plus interests totaling $270,036.65, plus costs of $222.50 for a total of $270,259.15. Defendants engaged in a settlement conference with Plaintiff on March 30, 2009 and are continuing to pursue settlement discussions. While Defendants have reached a tentative settlement of the entire litigation, Plaintiff continues to pursue collection efforts. XI. LOUIS GLAZER, ET AL. V. MILTON AULT III, ET AL. Los Angeles County Superior Court Case No.: BC 407274 On February 6, 2009, Louis Glazer and Melanie Glazer, Plaintiffs, filed a Complaint in Los Angeles County Superior Court against Milton Charles Ault III, Kristine Larsen Ault, Adult Glazer & Co., Zealous Holdings, Inc., Zealous Inc, Zealous Asset Management LLC, and Zealous Capital Markets LLC. The case number is Los Angeles County Superior Court case number BC 407274. Plaintiffs' complaint alleges negligent misrepresentation, breach of fiduciary duty, breach of 6 contracts, breach of implied covenant of good faith and fair dealing of 6 contracts, violations of Corp Code (section) (section) 25400, 25401, 25500, 25501, 25504, fraud, unjust enrichment on 2 contracts, equitable indemnity, constructive trust, and unfair business practices. Plaintiffs allege that Defendants, individually and/or separately, fraudulently induced Plaintiffs to invest in the Defendant companies, failed to repay in accordance with promissory note, failed to pay management fees and violated Corporations Codes in certain mergers. Plaintiffs are seeking damages according to proof at trial and equitable relief that the Court deems just and proper. A Trial Date of February 2, 2010 has been set by the Court. Defendants are engaged in settlement discussion with Plaintiffs, who seek $1.6M in damages, preparing responsive pleadings and completing discovery responses. Defendants have responded to Plaintiffs' Requests for Admissions and are in the process of completing additional discovery. Defaults of Kristy Ault and Zealous Inc., and Ault, Glazer& Co, Inc, will be set aside and answers filed. Defendants will also assert the Arbitration Clause in the signed Partnership Agreement. Page F29 XII. ALPHA CAPITAL ANSTALT. V MILTON `TODD' AULT III New York State Supreme Court Case No.: 602444/09 On August 12, 2009, Alpha Capital Anstalt Hedge Fund ("Plaintiff") has filed a suit against Milton ("Todd") Ault III ("Defendant") in the New York State Supreme Court. The case number for this litigation is 602444/09. Plaintiff is seeking $4.2M plus damages. Defendant has answered, and is in the process of selecting Counsel to handle litigation. No dates have been set by the Court. Defendant maintains that Plaintiff has received over $1M in repayment and that all allegations are baseless while the Plaintiff has impugned the reputation of Mr. Ault in the press. Plaintiffs maintain investment was to support ZATS which never worked or was completed. Defendant has proof that many of the Plaintiffs actually conducted business on ZATS in 2008 and the Company received earned commissions from these transactions. Defendants deny all allegations of the Plaintiffs. CALIFORNIA LABOR COMMISSIONER CASES: I. HEE KWON V. ADULT ENTERTAINMENT CAPITAL/ZEALOUS INC. Labor Commissioner Case No.: 18-75589 KV Hee Kwon, Plaintiff, filed a claim for non-payment of wages against Adult Entertainment Capital, Inc. with the Labor Commissioner, State of California. The case number is 18-75589 KV. Plaintiff alleges that defendants owe him $4,000.00 in wages. Defendants terminated Plaintiff's at-will employment and allege that they do not owe him any wages because they have paid him in full through his terminated date. The case was dismissed. II. NANDITA KUMARASWAMY V. AULT GLAZER & CO., INC. Labor Commissioner Case No.: 18-76139 KV Nandita Kumaraswamy, Plaintiff, filed a claim for non-payment of wages against Ault Glazer & Co., Inc. with the Labor Commissioner, State of California. The case number is 18-76139 KV. Plaintiff alleges that defendants owe her $9,388.88 in wages. Defendants terminated Plaintiff's at-will employment and allege that they do not owe her any wages because they have paid her in full through her termination date. A hearing was set for October 19, 2009. Subsequently, the case was dismissed. III. JEANNIE LO BUE V. ZEALOUS, INC. Labor Commissioner Case No.: -76295 KV Jeannie Lo Bue, Plaintiff, filed a claim for non-payment of wages against Zealous, Inc. with the Labor Commissioner, State of California. The case number is 76295 KV. Plaintiff alleges that defendants owe her $1,434.79.00 in wages. Defendants terminated Plaintiff's at-will employment and allege that they do not owe her any wages because they have paid her in full through her termination date. A hearing was set for October 19, 2009. Subsequently, the case was dismissed. Page F30 IV. LEONARD KIM V. ADULT ENTERTAINMENT CAPITAL/ZEALOUS INC Labor Commissioner Case No.: 18-75590 KV Leonard Kim, Plaintiff, filed a claim for non-payment of wages against Adult Entertainment Capital, Inc. with the Labor Commissioner, State of California. The case number is 18-75590 KV. Plaintiff's alleges that defendants owe him $4,500.00 in wages. Defendants terminated Plaintiff's at-will employment and allege that they do not owe him any wages because they have paid him in full through his termination date. A hearing was set for October 19, 2009. Subsequently, the case was dismissed. V. STEVE RAFALORICH V. AULT GLAZER & CO., INC. Labor Commissioner Case No.: 18-76138 KV Steve Rafalorich, Plaintiff, filed a claim for non-payment of wages against Ault Glazer & Co., Inc. with the Labor Commissioner, State of California. The case number is 18-76138 KV. Plaintiff alleges that defendants owe him $30,708.63 in wages. Defendants terminated Plaintiff's at-will employment and allege that they do not owe him any wages because they have paid him in full through his termination date. A hearing was set for October 19, 2009. Subsequently, the case was dismissed. VI. ROGER COE V. ZEALOUS CAPITAL, INC. Docket Number.: 525988 Roger Coe, Plaintiff, filed a claim for non-payment of wages against Zealous Capital with the Massachusetts Department of Workforce, in appeal of ruling regarding an earlier start date. The docket number for this case is 525988. The Company has not received any correspondence regarding the matter since that time. VII. GREG FIERROS V. ZEALOUS CAPITAL MARKETS Labor Commissioner Case No.: 18-75462 KV Greg Fierros, Plaintiff, filed a claim for non-payment of wages against Capital Markets with the Labor Commissioner, State of California. The case number is 18-75462 KV. Plaintiff alleges that defendants owe him $2,000.00 in wages. . Defendants terminated Plaintiff's at-will employment and allege that they do not owe him any wages because they have paid him in full through his termination date. A hearing occurred on July 13, 2009. The Company has not received any correspondence regarding the matter since that time. ITEM 1A: RISK FACTORS A smaller reporting company is not required to provide the information required by this Item. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS No activity during the three month period ended September 30, 2009. Page F31 ITEM 3. DEFAULTS UPON SENIOR SECURITIES On October 15, the Company issued 166,311,335 shares of common stock to its former secured note holders as part of a forced conversion of their outstanding debt of $3,114,491 and interest accrued thereon of $95,281 under the terms of their agreement. Following a period of negotiation with these note holders in which no agreement was reached, the company issued the share certificates on February 26, 2009. The former secured note holders continue to dispute the propriety of the conversion of their outstanding debt to equity and thus the matter remains open. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters have been submitted to our security holders for a vote, through the solicitation of proxies or otherwise, during the quarterly period ended September 30, 2009. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS EXHIBIT DESCRIPTION OF EXHIBIT NUMBER 31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page F32 SIGNATURES In accordance with the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ZEALOUS, INC. Date: November 23, 2009 By: /s/Milton C. Ault, III -------------------------- Milton C. Ault, III Title: CHIEF EXECUTIVE OFFICER AND DIRECTOR Date: November 23, 2009 By: /s/Gary Gottlieb -------------------- Gary Gottlieb Title: CHIEF FINANCIAL OFFICER

ZEALOUS, INC. 10-Q