UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

———————

FORM 10-Q

———————

ü	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
	ACT OF 1934
For the quarterly period ended: September 30, 2008
or
	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
	ACT OF 1934
For the transition period from: _____________ to _____________

Commission File Number: 0-31667

———————

VERTICAL BRANDING, INC.

(Exact name of registrant as specified in its charter)

———————

Delaware	13-3579974
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

16000 Ventura Blvd, Suite 301, Encino, California 91436

(Address of Principal Executive Office) (Zip Code)

(818) 926-4900

(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 for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.			ü	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	(Do not check if a smaller	Smaller reporting company			ü
	reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
			ü	Yes	ü	No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.   As of November 12, 2008, there were 30,024,296 shares of the registrant’s common stock outstanding

VERTICAL BRANDING, INC.

INDEX

			PAGE
PART I — FINANCIAL INFORMATION				1
	Item 1 —	Condensed Consolidated Financial Statements		1
		Condensed Consolidated Balance Sheets at September 30, 2008 and December 31, 2007 (Unaudited)		1
		Condensed Consolidated Statements of Operations for the three months and nine months ended   September 30, 2007 (Unaudited) and 2008 (Unaudited)		2
		Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2008 (Unaudited)		3
		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 (Unaudited) and 2007  (Unaudited)		4
		Notes to Condensed Consolidated Financial Statements  (Unaudited)		5
	Item 2 —	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
	Item 3 —	Quantitative and Qualitative Disclosures about Market Risk		21
	Item 4 —	Controls and Procedures		21
PART II — OTHER INFORMATION				23
	Item 1 —	Legal Proceedings		23
	Item 1A —	Risk Factors		23
	Item 2 —	Unregistered Sales of Equity Securities and Use of Proceeds		23
	Item 3 —	Defaults Upon Senior Securities		24
	Item 4 —	Submission of Matters to a Vote of Security Shareholders		24
	Item 6 —	Exhibits		24
Signatures				25
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

Item 1.

Condensed Consolidated Financial Statements

VERTICAL BRANDING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

	September 30,			December 31,
	2008			2007
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	145		$	30
Accounts receivable, net		5,359			3,387
Inventories		2,127			3,182
Infomercial production costs		410			621
Prepaid expenses and other current assets		503			869
Total current assets		8,544			8,089
Property and equipment, net		311			381
Office building, net		3,853			3,987
Intangible assets, net		1,569			1,719
Goodwill		1,842			1,842
Other		903			1,129
Total assets	$	17,022		$	17,147
Liabilities and Stockholders' Equity
Current liabilities:
Line of credit	$	3,593		$	1,651
Current portion of long-term debt		4,423			1,540
Accounts payable and accrued expenses		4,084			4,587
Other current liabilities		––			67
Total current liabilities		12,100			7,845
Long-term debt		1,804			4,451
Total liabilities		13,904			12,296
Minority interest		500			528
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.001 par value; Authorized - 2,000,000 shares;
Issued and outstanding - 875,000 shares Series A at
September 30, 2008 and 912,500 shares at December 31, 2007		1			1
Common stock - $.001 par value; Authorized - 100,000,000 shares;
Issued and outstanding - 29,895,854 shares at September 30, 2008,
and 29,642,264 shares at December 31, 2007		29			30
Additional paid-in capital		14,882			15,031
Deferred compensation		(413	)		(954	)
Accumulated deficit		(11,881	)		(9,785	)
Total stockholders' equity		2,618			4,323
Total liabilities and stockholders' equity	$	17,022		$	17,147

See accompanying notes to condensed consolidated financial statements.

1

VERTICAL BRANDING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Revenues
Consumer products	$	9,544		$	8,888		$	27,069		$	29,990
Real estate activities		255			182			581			506
Total revenues		9,799			9,070			27,650			30,496
Cost of sales		5,863			3,012			14,303			9,695
Gross profit		3,936			6,058			13,347			20,801
Operating expenses
Selling		1,806			3,970			8,430			13,608
General and administrative		1,614			1,542			5,323			4,857
Depreciation and amortization		321			303			955			930
Other charges		––			177			––			177
Total operating expenses		3,741			5,992			14,708			19,572
Income (loss) from operations		195			66			(1,361	)		1,229
Other income (expense):
Interest expense, net		(306	)		(290	)		(775	)		(977	)
Minority interest		(6	)		29			84			108
Income (loss) from operations before provision
for income taxes		(117	)		(195	)		(2,052	)		360
Provision for income taxes		––			1			9			26
Net (loss) income		(117	)		(196	)		(2,061	)		334
Preferred stock dividends		45			48			136			151
Net (loss) income applicable to common stockholders	$	(162	)	$	(244	)	$	(2,197	)	$	183
Basic and diluted (loss) earnings per common share	$	(0.01	)	$	(0.01	)	$	(0.07	)	$	0.01
Weighted average shares used in computation
of basic (loss) earnings per common share		29,726			23,129			29,565			22,608
Weighted average shares used in computation
of diluted (loss) earnings per common share		29,726			23,129			29,565			23,716

See accompanying notes to condensed consolidated financial statements.

2

VERTICAL BRANDING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands except share amounts)
(Unaudited)

												Additional
	Preferred Stock					Common Stock						Paid-In			Deferred			Accumulated
	Shares			Amount		Shares			Amount			Capital			Compensation			Deficit			Total
Balance, December 31, 2007	912,500			$	1	29,642,264			$	30		$	15,031		$	(954	)	$	(9,785	)	$	4,323
Stock compensation expense		––			––	368,332				––			153			(153	)		––			––
Issuance of stock options		––			––		––			––			173			(173	)		––			––
Common stock issued as payment
for preferred stock dividend		––			––		90,000			––			33			––			(33	)		––
Preferred stock dividend		––			––		––			––			––			––			(2	)		(2	)
Conversion of preferred stock	(37,500		)		––		75,000			––			––			––			––			––
Shares issued for conversion of debt		––			––		164,258			––			79									79
Forfeiture of unvested stock grants		––			––	(444,000		)		(1	)		(324	)		325			––			––
Forfeiture of unvested stock options		––			––		––			––			(174	)		174			––			––
Costs of common stock issuance		––			––		––			––			(89	)		––			––			(89	)
Amortization of deferred compensation		––			––		––			––			––			368			––			368
Net loss		––			––		––			––			––			––			(2,061	)		(2,061	)
Balance, September 30, 2008	875,000			$	1	29,895,854			$	29		$	14,882		$	(413	)	$	(11,881	)	$	2,618

See accompanying notes to condensed consolidated financial statements.

3

VERTICAL BRANDING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(Unaudited)

	For the Nine Months Ended
	September 30,
	2008			2007
Cash flows from operating activities:
Net (loss) income	$	(2,061	)	$	334
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Depreciation and amortization		955			930
Bad debts		125			248
Minority interest in net loss of subsidiary		(84	)		(108	)
Equity based compensation		368			434
Changes in operating assets and liabilities:
Accounts receivable		(2,097	)		(3,256	)
Inventories		1,055			(372	)
Prepaid expenses and other current assets		366			291
Other assets		(97	)		395
Infomercial production costs		211			(373	)
Accounts payable, accrued expenses and taxes		(503	)		(967	)
Other current liabilities		(67	)		(48	)
Net cash used in operating activities		(1,829	)		(2,492	)
Cash flows from investing activities:
Capital expenditures and intangible assets		(64	)		(248	)
Net cash used in investing activities		(64	)		(248	)
Cash flows from financing activities:
Proceeds from notes and loans payable		22,330			9,008
Principal payments on notes and loans payable		(20,311	)		(6,710	)
Due from factor		––			564
Other financing activities		(11	)		(127	)
Net cash provided by financing activities		2,008			2,735
Net increase (decrease) in cash and cash equivalents		115			(5	)
Cash and cash equivalents, beginning of period		30			105
Cash and cash equivalents, end of period	$	145		$	100
Additional cash flow information:
Interest paid	$	776		$	666
Income taxes paid	$	4		$	22

See accompanying notes to condensed consolidated financial statements.

4

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

The condensed consolidated financial statements include the accounts of Vertical Branding, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” and the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited  consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-KSB for the  year ended December 31, 2007, filed with the Securities and Exchange Commission on April 15, 2008. The results of operations for the three months and nine months ended September 30, 2008 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

Reclassifications

During the fourth quarter of 2007, Vertical Branding (the Company, or VBI) consolidated its transactional marketing and retail distribution business into a single segment called consumer products. This change reflects evolution of the manner in which management views and operates its consumer products business, with transactional marketing activities being used to leverage broader distribution, including traditional retail distribution sales and international sales. During 2008, the Company changed the classification of certain operating expenses. Historically, these expenses were reported in cost of sales and in 2008 are now being reported as selling expenses.  This direction was initiated as it more accurately reports expense classification activity resulting from a greater portion of our revenues coming from the wholesale channel of distribution. The reclassification resulted in a decrease to cost of sales, and a corresponding increase to selling costs, of approximately $821,000 and $3,678,000 for the three and nine months ended September 30, 2007. These reclassifications had no impact on the Company’s previously reported net income (loss) or basic and diluted income (loss) per share amounts. As a result of this consolidation, prior periods have been reclassified to conform to the current year’s presentation.

Business Activities of the Company

The Company currently operates two business segments consisting of the consumer products business and the development and rental of real estate in New York and Connecticut.

Revenues in the consumer products business consists of direct to consumer transactional marketing sales and sales to major retail chains, also referred to as retail distribution sales. The Company’s transactional marketing sales and retail distribution sales are also conducted through its affiliates and subsidiaries. The Company is a consumer product branding company specializing in home consumer products.  Typically, the Company obtains the exclusive worldwide marketing, distribution and manufacturing license rights to a particular product from its inventor or a business representative and develops the product brand through marketing campaigns utilizing the internet, television, and print media, ultimately leveraging its retail and international distribution channels for sales directly to consumers or for sales to downstream business customers. On certain of the Company products, a long term annuity stream of revenue is established through what the Company refers to as “Continuity” programs. Through these Continuity programs, customers repurchase a particular product monthly or bi-monthly, thus maximizing the initial media investment to acquire that particular customer.

The Company began its retail distribution sales on August 1, 2006 when it purchased certain assets from Adsouth Partners, Inc., through a newly formed subsidiary, Adsouth Marketing LLC (“ASM”). The Company acquired assets comprising Adsouth's consumer products division and assumed certain liabilities. The Company purchased rights to various consumer products and brands as well as succession to Adsouth’s wholesale and retail distribution channels and relationships.

The Company’s real estate business is conducted through two of its subsidiaries. Yolo Equities Corp., a wholly owned subsidiary (“Yolo”), holds a mortgage on a real estate parcel. The Company owns a forty-nine (49%) percent interest in Gateway Granby, LLC (“Granby”) that owns and operates an office building in East Granby, Connecticut. The office building contains approximately 52,000 square feet of rentable space and is located on 7.7 developable acres. The Company entered into an irrevocable proxy and agreement with certain members of the limited liability company who are stockholders of VBI, which agreement gives the Company voting and operational control of the limited liability company so long as the Company maintains its ownership interest in the limited liability company. Due to such voting control, Granby is consolidated with VBI, and the minority voting interests are recorded separately.

5

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Per Share Computations

Basic and diluted (loss) earnings per common share is calculated by dividing net income allocated to common stock by the weighted average common shares outstanding during the period. In accordance with FAS 128, “Earnings per Share”, the weighted average number of shares of common stock used in the calculation of diluted earnings per share is adjusted for the dilutive effects of potential common shares including, (i) the assumed exercise of stock options and warrants based on the treasury stock method, and (ii) the assumed conversion of convertible notes and convertible preferred stock. Assumed exercise or conversion of potential common shares is included only if the exercise price and the conversion price exceeds the weighted average market price for the period, and that the entity records earnings from continuing operations, as the inclusion of such adjustments would otherwise be anti-dilutive to earnings per share from continuing operations. Potential common shares for the periods presented consist of the following:

	As of
	September 30,
	2008		2007
Convertible preferred stock		1,750,000		1,850,000
Convertible debt		4,077,445		7,225,478
Warrants		12,295,667		5,559,000
Options		2,858,232		2,524,275
Total		20,981,344		17,158,753

During the three months and nine months ended September 30, 2008, the Company recorded a loss available to common shareholders and as a result, the weighted average number of common shares used in the calculation of basic and diluted loss per share is the same, and have not been adjusted for the effects of potential common shares from unexercised stock options and warrants, and the conversion of debt and convertible preferred stock, which were anti-dilutive for such periods.

For the nine months ended September 30, 2007, a portion of potential common shares were dilutive and 12,931,678 were excluded as they were anti-dilutive. The following table presents a reconciliation of basic earnings per common share to dilutive earnings per common share (in thousands, except per share data):

			Weighted		Net
			Average		Income
	Net		Shares		per
Nine months ended September 30, 2007	Income		Outstanding		Share
Basic earnings per common share attributable to common shareholders	$	183		22,608	$	0.01
Assumed conversion of potential shares of
common stock using treasury stock method		––		1,108
Diluted earnings per common share	$	183		23,716	$	0.01

Concentration of Risk

Financial instruments which potentially subject the Company to concentrations of credit risk, consist principally of cash and trade receivables.

6

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Major product lines in the consumer products division, which are in excess of 10% of net revenues are presented below:

	Three months ended						Nine months ended
	September 30,						September 30,
	2008			2007			2008			2007
Product line A		––			39.8	%		15.2	%		19.2	%
Product line B		––			37.5	%		14.2	%		62.2	%
Product line C		––			10.3	%		––			––
Product line D		37.2	%		––			30.2	%		––
Product line E		41.7	%		––			25.1	%		––

Major customers in the consumer products division, which are in excess of 10% of net revenues are as follows:

	Three months ended						Nine months ended
	September 30,						September 30,
	2008			2007			2008			2007
Customer A		17.9	%		15.5	%		13.4	%		14.5	%
Customer B		––			20.1	%		––			––
Customer C		17.5	%		––			12.4	%		6.8	%
Customer D		12.5	%		––			––			––

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). The new standard changes the accounting and reporting of noncontrolling interests, which have historically been referred to as minority interests. SFAS 160 requires that noncontrolling interests be presented in the consolidated balance sheets within shareholders’ equity, but separate from the parent’s equity, and that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented in the consolidated statements of income. Any losses in excess of the noncontrolling interest’s equity interest will continue to be allocated to the noncontrolling interest. Purchases or sales of equity interests that do not result in a change of control will be accounted for as equity transactions. Upon a loss of control, the interest sold, as well as any interest retained, will be measured at fair value, with any gain or loss recognized in earnings. In partial acquisitions, when control is obtained, the acquiring company will recognize at fair value, 100% of the assets and liabilities, including goodwill, as if the entire target company had been acquired. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. The new standard will be applied prospectively, except for the presentation and disclosure requirements, which will be applied retrospectively for all periods presented. The Company has not yet determined the impact, if any, that this statement will have on its condensed consolidated financial statements and will adopt the standard at the beginning of fiscal 2009.

In February 2008, FASB Staff Position (FSP) FAS No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”) was issued. FSP 157-2 defers the effective date of SFAS 157 to fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Examples of items within the scope of FSP 157-2 are nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods), and long-lived assets, such as property, plant and equipment and intangible assets measured at fair value for an impairment assessment under SFAS 144. We do not believe the adoption of SFAS 157 for our nonfinancial assets and liabilities, effective January 1, 2009, will have a material impact on our condensed consolidated financial statements.

In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 applies to all entities.  SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  SFAS 161

7

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  SFAS 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company does not believe this pronouncement will have a material effect on its condensed consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with GAAP. This statement will be effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company believes that SFAS 162 will have no effect on its condensed consolidated financial statements.

2. Office Building

The Company owns a forty-nine (49%) percent interest in Gateway Granby, LLC.  (“Gateway”), a Connecticut limited liability company, which owns and operates a two-story office building, located at 2 Gateway Boulevard in East Granby, Connecticut (the “East Granby Property”).  The office building contains approximately 52,000 square feet of rentable space and is located on 7.7 developable acres.  The East Granby Property is owned subject to a non-recourse first mortgage held by TD Banknorth, N.A. and a second mortgage held by California Mortgage & Realty, Inc. Under the first and second mortgages, the outstanding principal balance at September 30, 2008 was approximately $1,901,000 and $1,100,000, respectively. The Company has guaranteed repayment of the second mortgage.

In November 2005, the Company entered into an irrevocable proxy and agreement with certain members of the limited liability company who are stockholders of VBI, which agreement gives the Company voting and operational control of the limited liability company so long as the Company maintains its ownership interest in the limited liability company. Due to such voting control, Granby is consolidated with VBI, and the minority voting interests are recorded separately.

Office Building assets consist of the following (in thousands):

	September 30,			December 31,
	2008			2007
	(Unaudited)
Building	$	3,647		$	3,647
Building improvements		273			273
Land		334			334
Land improvements		63			63
Equipment		74			59
		4,391			4,376
Accumulated depreciation		(538	)		(389	)
Office building, net	$	3,853		$	3,987

Depreciation expense of the East Granby property for the nine months ended September 30, 2008 and 2007 was approximately $149,000 and $142,000, respectively. Depreciation expense of the East Granby property for the three months ended September 30, 2008 and 2007 was approximately $47,000 for both periods.

3. Intangible Assets

A portion of the total cost of the retail distribution business acquired on August 1, 2006, in excess of net assets acquired, was allocated to this intangible asset, recognizing the value of the 18,000 retail store distribution network. The intangible asset is being amortized over ten years, the estimated life of the acquired retail store distribution network. Amortization of retail distribution network for the nine months ended September 30, 2008 and 2007 totaled approximately $150,000 and

8

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

$152,000, respectively. Amortization of retail distribution network for the three months ended September 30, 2008 and 2007 totaled approximately $50,000 for both periods.

The retail distribution network is reviewed for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  When such events or circumstances arise, an estimate of the future undiscounted cash flows produced by the retail distribution network is compared to its carrying value to determine if impairment exists pursuant to the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets".  If the asset is determined to be impaired, the impairment loss is measured based on the excess of its carrying value over its fair value. Amortization expense is estimated to approximate $202,000 per year through 2016.

4. Borrowings

Line of Credit

In June 2007, the Company entered into a Loan and Security Agreement (the “BFI Agreement”) with BFI Business Finance (“Lender”).  Pursuant to the BFI Agreement, upon VBI’s request, Lender will loan the Company up to the lesser of (i) $5,000,000 or (ii) the Borrowing Base. The “Borrowing Base” is defined as (i) 85% of the gross face amount of the eligible accounts receivable of the Company’s Adsouth Marketing, LLC subsidiary (“ASM”), plus (ii) 30% of the current market cost of raw materials and finished goods that constitute ASM’s eligible inventory, not to exceed the lesser of $700,000 or 50% of the eligible accounts receivable borrowing base. VBI has guaranteed ASM’s obligations under the BFI Agreement. The BFI Agreement has an annual renewal term of 12 months, which we exercised in 2008, expiring in June 2009 and thereafter shall automatically renew for successive 12 month periods so long as neither the Company nor Lender delivers written notice of its intention to terminate the BFI Agreement. As of September 30, 2008, approximately $3,593,000 was outstanding under the credit line.

Long-term Debt

Long-term debt consisted of the following (in thousands):

	September 30,			December 31,
	2008			2007
	(Unaudited)
10% Secured convertible notes	$	2,607		$	2,682
Less unamortized note discount		(99	)		(198	)
Less fair value of warrants issued as additional
consideration for 10% secured convertible notes		(136	)		(270	)
Notes payable		554			356
First mortgage payable, office building		1,901			1,971
Second mortgage payable, office building		1,100			1,100
Series A Bonds		275			300
Series B Bonds		25			50
		6,227			5,991
Less current maturities		(4,423	)		(1,540	)
Long-term portion of debt	$	1,804		$	4,451

9

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Aggregate maturities of long-term debt at September 30, 2008 is as follows (in thousands):

Year ending December 31,
2008 (remaining three months)	$	1,834
2009		2,849
2010		105
2011		112
2012		119
2013		127
2014 and thereafter		1,315
Total principal payments		6,461
Less unamortized note discount		(99	)
Less fair value of warrants issued as additional
consideration for 10% secured convertible notes		(135	)
Total debt	$	6,227

5. Stockholders’ Equity

Preferred Stock

During the nine months ended September 30, 2008, two Series A preferred stockholder converted 37,500 shares of Series A preferred stock into 75,000 shares of common stock.  As of September 30, 2008, there were 875,000 shares of Series A Convertible Preferred Stock outstanding.

Stock-based Compensation

Under the Company’s 2006 Equity Incentive Plan (“the 2006 Plan”), the Company may issue up to 5,000,000 shares of common stock in the aggregate pursuant to all awards granted under the 2006 Plan. The awards include nonqualified stock options and incentive stock options, warrants, restricted stock and stock purchases.

The Company's results from operations for the nine months ended September 30, 2008 and 2007 include share-based compensation expense totaling approximately $368,000 and $434,000, respectively. The Company's results from operations for the three months ended September 30, 2008 and 2007 include share-based compensation expense totaling approximately $76,000 and $154,000, respectively. All share-based compensation expense is included in general and administrative expenses. No income tax benefit has been recognized in the income statement for share-based compensation arrangements due to a history of operating losses. Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period.

As of September 30, 2008, there was approximately $483,000 of unrecognized compensation cost, net of estimated forfeitures, related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted average period of approximately 2.1 years.  

Shares Reserved for Future Issuances

As of September 30, 2008, there were outstanding options convertible into 2,858,232 shares of common stock, warrants convertible into 12,295,667 shares of common stock, 875,000 shares of Series A preferred stock convertible into 1,750,000 shares of common stock, and debentures that are convertible into 4,077,445 shares of common stock. As of September 30, 2008 there were 1,336,201 shares available to grant under the 2006 Plan.

10

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6. Income Taxes

The provision for income taxes consists entirely of various state franchise taxes and limited liability company fees. VBI has net operating loss ("NOL") carry-forwards for Federal purposes as follows (in thousands):

Tax period	Net Operating Loss ("NOL")		Annual limitation		Expiration
Pre-merger NOL subject to annual limitation	$	6,177	$	308	December 31, 2025
2006		2,306		––	December 31, 2026
2007		2,185		––	December 31, 2027
	$	10,668

The Company has established a 100% valuation allowance against Federal NOL carry-forwards resulting from the history of losses.

7. Business Segment Information

Operating segments are managed separately and represent separate business units that offer different products and serve different markets. The Company's reportable segments include: (1) consumer product sales, (2) real estate, and (3) other, which is comprised of corporate overhead not allocated to a segment. The consumer products business operates from the Company’s offices in Encino, California and Boca Raton, Florida. The real estate segment operates in New York and Connecticut from an office in New Rochelle, New York.

	Consumer
	Products			Real Estate		Other		Total
Three months ended September 30, 2008:
Housewares	$	9,572		$	––	$	––	$	9,572
Beauty products		(144	)		––		––		(144	)
Other income		116			––		––		116
Rental income		––			255		––		255
Total revenue	$	9,544		$	255	$	––	$	9,799
Three months ended September 30, 2007:
Housewares	$	7,656		$	––	$	––	$	7,656
Beauty products		1,058			––		––		1,058
Other income		174			––		––		174
Rental income		––			182		––		182
Total revenue	$	8,888		$	182	$	––	$	9,070
Nine months ended September 30, 2008:
Housewares	$	26,440		$	––	$	––	$	26,440
Beauty products		162			––		––		162
Other income		467			––		––		467
Rental income		––			581		––		581
Total revenue	$	27,069		$	581	$	––	$	27,650
Nine months ended September 30, 2007:
Housewares	$	26,555		$	––	$	––	$	26,555
Beauty products		2,840			––		––		2,840
Fitness		5			––		––		5
Other income		590			––		––		590
Rental income		––			493		––		493
Interest from mortgages		––			13		––		13
Total revenue	$	29,990		$	506	$	––	$	30,496

11

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7. Business Segment Information (continued):

Business segment information as of September 30, 2008 and for the three months and nine months ended September 30, 2008 follows (in thousands):

	Consumer
	Products			Real Estate			Other			Total
Three months ended September 30, 2008:
Revenues	$	9,544		$	255		$	––		$	9,799
Cost of sales		5,863			––			––			5,863
Gross profit		3,681			255			––			3,936
Operating expenses:
Selling		1,806			––			––			1,806
General and administrative		828			104			682			1,614
Depreciation and amortization		103			67			151			321
Total operating expenses		2,737			171			833			3,741
Income (loss) from operations		944			84			(833	)		195
Other income (expense):
Interest expense, net		(224	)		(71	)		(11	)		(306	)
Minority voting interest in net loss of subsidiary		––			(6	)		––			(6	)
Income (loss) from operations before provision for income taxes		720			7			(844	)		(117	)
Provision for income taxes		––			––			––			––
Net income (loss)	$	720		$	7		$	(844	)	$	(117	)
Nine months ended September 30, 2008:
Revenues	$	27,069		$	581		$	––		$	27,650
Cost of sales		14,303			––			––			14,303
Gross profit		12,766			581			––			13,347
Operating expenses:
Selling		8,430			––			––			8,430
General and administrative		2,532			325			2,466			5,323
Depreciation and amortization		319			205			431			955
Total operating expenses		11,281			530			2,897			14,708
Income (loss) from operations		1,485			51			(2,897	)		(1,361	)
Other income (expense):
Interest expense, net		(521	)		(214	)		(40	)		(775	)
Minority voting interest in net loss of subsidiary		––			84			––			84
Income (loss) from operations before provision for income taxes		964			(79	)		(2,937	)		(2,052	)
Provision for income taxes		1			––			8			9
Net income (loss)	$	963		$	(79	)	$	(2,945	)	$	(2,061	)

12

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7. Business Segment Information (continued):

	Consumer
	Products		Real Estate		Other		Total
Balance Sheet Data as of September 30, 2008:
Current Assets	$	8,236	$	98	$	210	$	8,544
Office building, net		––		3,853		––		3,853
Other assets		3,865		490		270		4,625
Total assets	$	12,101	$	4,441	$	480	$	17,022
Current Liabilities
Line of credit	$	3,593	$	––	$	––	$	3,593
Current portion of long-term debt		2,925		1,198		300		4,423
Other current liabilities		3,316		42		726		4,084
Total current liabilities		9,834		1,240		1,026		12,100
Long-term debt		––		1,804		––		1,804
Total liabilities	$	9,834	$	3,044	$	1,026	$	13,904
Capital expenditures	$	19	$	––	$	45	$	64

13

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7. Business Segment Information (continued):

Business segment information as of September 30, 2007 and for the three months and nine months ended September 30, 2007 follows (in thousands):

	Consumer
	Products			Real Estate			Other			Total
Three months ended September 30, 2007:
Revenues	$	8,888		$	182		$	––		$	9,070
Cost of sales		3,012			––			––			3,012
Gross profit		5,876			182			––			6,058
Operating expenses:
Selling		3,970			––			––			3,970
General and administrative		895			103			544			1,542
Depreciation and amortization		104			65			134			303
Other charges		177			––			––			177
Total operating expenses		5,146			168			678			5,992
Income (loss) from operations		730			14			(678	)		66
Other income (expense):
Interest expense, net		(211	)		(69	)		(10	)		(290	)
Minority voting interest in net loss of subsidiary		––			29			––			29
Income (loss) from operations before provision for income taxes		519			(26	)		(688	)		(195	)
Provision for income taxes		(1	)		––			2			1
Net income (loss)	$	520		$	(26	)	$	(690	)	$	(196	)
Nine months ended September 30, 2007:
Revenues	$	29,990		$	506		$	––		$	30,496
Cost of sales		9,695			––			––			9,695
Gross profit		20,295			506			––			20,801
Operating expenses:
Selling		13,608			––			––			13,608
General and administrative		2,764			312			1,781			4,857
Depreciation and amortization		340			198			392			930
Other charges		177									177
Total operating expenses		16,889			510			2,173			19,572
Income (loss) from operations		3,406			(4	)		(2,173	)		1,229
Other income (expense):
Interest expense, net		(738	)		(210	)		(29	)		(977	)
Minority voting interest in net loss of subsidiary		––			108			––			108
Income (loss) from operations before provision for income taxes		2,668			(106	)		(2,202	)		360
Provision for income taxes		16			1			9			26
Net income (loss)	$	2,652		$	(107	)	$	(2,211	)	$	334

14

VERTICAL BRANDING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7. Business Segment Information (continued):

	Consumer
	Products		Real Estate		Other		Total
Balance Sheet Data as of September 30, 2007:
Current Assets	$	9,471	$	99	$	125	$	9,695
Office building, net		––		4,023		––		4,023
Other assets		5,196		566		473		6,235
Total assets	$	14,667	$	4,688	$	598	$	19,953
Current Liabilities
Line of credit	$	3,650	$	––	$	––	$	3,650
Current portion of long-term debt		2,586		102		350		3,038
Other current liabilities		3,093		109		355		3,557
Total current liabilities		9,329		211		705		10,245
Long-term debt		2,022		2,990		––		5,012
Total liabilities	$	11,351	$	3,201	$	705	$	15,257
Capital expenditures	$	247	$	––	$	1	$	248

15

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

All statements contained herein that are not historical facts, including but not limited to, statements regarding future operations, financial condition and liquidity, future borrowing, capital requirements, and our future development and growth plans, are based on current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the headings “Risks Factors” in our Form 10-KSB for the year ended December 31, 2007 and other risk factors described herein and our reports filed and to be filed from time to time with the Commission and the cautionary note regarding “Forward-Looking Statements.” The discussion and analysis below is based on the Company's unaudited consolidated financial statements for the three months and nine months ended September 30, 2008 and 2007. The following should be read in conjunction with the Management's Discussion and Analysis of results of operations and financial condition included in Form 10-KSB for the year ended December 31, 2007.

Overview

We are a consumer products company focused on selling high quality household, personal care, and other products at affordable prices.  In addition to our consumer products business, we operate a smaller, non-integrated business which entails the ownership and leasing of certain real estate holdings in Granby, Connecticut.  

Our model for successfully bringing the products that we develop or license to market typically begins with what we refer to as a “transactional marketing” campaign, which is designed to build product and brand awareness while at the same time generating sales.  Our transactional marketing campaigns are conducted in as many channels of consumer media as are viable for generating immediate sales in response to our product advertisements, including television, print, radio and the internet.

Our ultimate goal is to leverage product and brand awareness generated from transactional marketing into wholesale sales of our products to resellers, which include national retail and drugstore chains as well as home shopping channels, catalog publishers and international distributors.  In addition, based on results achieved and relationships established through this channel, we have begun developing, licensing and selling products that are intended for retail distribution only, a trend we expect to continue through 2008.  We currently have products placed with many of the nation’s largest retail outlets, including WalMart, Target, Sears and Bed Bath and Beyond, as well the nation’s major drug chains such as CVS, Walgreens and RiteAid.  

Our financial results are presented in two segments: consumer products and real estate.  Beginning with our acquisition of Worldwide Excellence (“WWE”) in November 2005 (at which time our historical results of operation became those of WWE), and continuing through July 2006, we reported results in a direct response (or transactional) marketing segment and a real estate segment.  With our acquisition of the assets of the consumer products business of Adsouth Partners, Inc. in August 2006, including the retail distribution relationships and network we acquired, we began reporting a third segment named “retail distribution.”

Due to changes in the way we viewed and used transactional marketing in the latter part of 2007 and going forward, we made the decision to present transactional marketing and retail distribution as a comprehensive consumer products segment.  This change arose from developments in our business and the marketplace in which we operate.  We believe that our transactional marketing efforts support sales in our other channels of distribution, operating synergistically as opposed to independently.  Furthermore, increasing costs of television media have made it more and more difficult to conduct profitable transactional marketing campaigns, causing us to concentrate on further developing wholesale channels of distribution where we experience lower gross margins but higher net margins.  For this and other reasons, our wholesale sales, in particular to our retail store accounts, have become an increasing percentage of overall sales, which we expect will continue through 2008.  Direct sales to consumers through transactional marketing remains a source of revenue and an important part of our business strategy, but one that we increasingly view more as a method of advertising our consumer products to build brand awareness in support of our retail distribution channel.

In 2007, we experienced significant revenue growth, driven largely by the roll-out of new products and increased distribution to retailers.  Our strategy for continued sales growth in 2008 includes the introduction of 4-6 new products in categories suitable for distribution to most of our existing retail customers as well to new major retail outlets such as office supply stores and electronic stores.  In addition, our focus in the latter part of 2007, continuing in 2008, is on products with retail price points between $9.99 and $29.99, which we believe to be better positioned than higher price point products in the current economic environment.  Finally, as we continue to pursue new channels of distribution, we expect continued growth in international and home shopping sales.

Critical Accounting Policies

Management's discussion and analysis of its financial position 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 financial statements requires management to make estimates and judgments that affect the

16

reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Our critical accounting policies are detailed in our Annual Report on Form 10-KSB for the year ended December 31, 2007.

Effects of New Accounting Pronouncements

We describe recent accounting pronouncements in Item 1 — “Condensed Consolidated Financial Statements — Notes to Condensed Consolidated Financial Statements.”

RESULTS OF OPERATIONS

Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007.

Revenues and Gross Profit

Consumer Products

The following table summarizes our changes in net revenues and gross profit from the sale of consumer products (in thousands) for the periods indicated:

	Three months ended
	September, 30
	Q3			Q3			Change
	2008			2007			$			%
Net revenue	$	9,544		$	8,888		$	656		7	%
Cost of sales		5,863			3,012			2,851		95	%
Gross profit	$	3,681		$	5,876		$	(2,195	)	(37	)%
Gross profit %		39	%		66	%

Net Revenues

Net revenues from consumer product sales for the three months ended September 30, 2008 (“Q3 2008”) was approximately $9.5 million, an increase of $0.6 million, or 7%, compared to net revenue for the three months ended September 30, 2007 (“Q3 2007”) of approximately $8.9 million. The increase in revenues during Q3 2008 was supported by the 2008 product launches of MyPlace and SteamBuddy, which contributed $7.5 million in revenues offset by: (i) a $5.6 million decrease in sales of Hercules Hook and ZorbEEZ, due to the maturity of these products and a reduction in their marketing campaigns, and (ii) a $1.1 million  decrease in sales of StarMaker, a beauty product. The reduction in StarMaker sales is a result of our decision to focus more of our marketing efforts on housewares products as compared to beauty products.

Gross Profit

Gross profit decreased $2.2 million, or 37%, to $3.7 million for Q3 2008, from $5.9 million for the comparable prior year period, primarily as a result of the planned change in channel mix revenues as discussed above. The gross profit margin decreased to 39%, from 66% over the comparable prior year period. This change was consistent with our plan to transition to a greater proportion of retail sales which inherently carry lower gross margins than our direct to consumer sales but have significantly lower selling expenses associated with each sale, and resulting in higher net margins. As we increase sales in future periods, we believe this strategy will allow us to better leverage our fixed operating expenses and thereby improve our operating margin.

Real Estate

Revenue was approximately $0.3 million in Q3 2008, an increase of $0.1 million, compared to net revenue of approximately $0.2 million in Q3 2007. There has been no change in the occupancy of the office building we own and operate in East Granby, Connecticut.  

17

Operating Expenses

The following table summarizes our changes in operating expenses (in thousands) for the periods indicated:

	Three months ended
	September, 30
	Q3		Q3		Change
	2008		2007		$			%
Selling	$	1,806	$	3,970	$	(2,164	)	(55	)  %
General and administrative:
Consumer products		828		895		(67	)	(7	)%
Real estate		104		103		1		1	%
Corporate expenses		682		544		138		25	%
Total general and administrative		1,614		1,542		72		5	%

Selling Expenses

Consumer Products

For Q3 2008, selling expenses decreased by $2.2 million, or 55%, to $1.8 million, from $4.0 million for the comparable prior year period. As a percentage of revenues, selling expenses for Q3 2008 decreased to 19%, from 45% for the comparable prior year period.  As discussed above, this is consistent with management’s strategy to transition to a higher proportion of retail sales which require less selling expenses when compared to direct to consumer sales. As a result, our media expenses decreased $1.5 million in Q3 2008 and our selling expenses associated with certain mature products also declined. We monitor our media spending in relation to consumer acceptance of the product and their related willingness to purchase the product through our retail distribution channel.

General and Administrative Expenses

General and administrative (G&A) expenses consist primarily of compensation paid to administrative personnel, professional service fees and public company costs. For Q3 2008, G&A expenses increased by $0.1 million, or 5%, to $1.6 million, from $1.5 million for the comparable prior year period. As a percentage of revenues, G&A expenses for Q3 2008 decreased to 16%, from 17% for the comparable prior year period.  As a percentage of sales, we expect G&A to decrease as we continued to leverage our administrative infrastructure and realize the benefits of restructuring activities undertaken throughout 2008 and which are expected to continue in our fourth quarter of 2008.

Interest Expense

Interest expense in Q3 2008 and Q3 2007 was approximately $0.3 million in both periods.

Provision for Income Taxes

We have recorded a 100% valuation allowance against our current year tax loss and prior years net operating loss carry forwards based on the criteria contained in FAS 109 of the realized value of these deferred tax assets.   Notwithstanding management’s view of future profitability, in determining whether or not a valuation allowance is necessary, forecasts of future taxable income are generally not considered sufficient evidence to outweigh a history of losses.

Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007.

18

Revenues and Gross Profit

Consumer Products

The following table summarizes our changes in net revenues and gross profit from the sale of consumer products (in thousands) for the periods indicated:

	Nine months ended
	September, 30
	YTD			YTD			Change
	2008			2007			$			%
Net revenue	$	27,069		$	29,990		$	(2,921	)	(10	)%
Cost of sales		14,303			9,695			4,608		48	%
Gross profit	$	12,766		$	20,295		$	(7,529	)	(37	)%
Gross profit %		47	%		68	%

Net revenues from consumer product sales for the nine months ended September 30, 2008 (“2008”) was approximately $27.1 million, a decrease of $2.9 million, or 10%, compared to net revenue for the nine months ended September 30, 2007 (“2007”) of approximately $30.0 million.  The decrease in revenues in 2008 was attributable to: (i) a $16.4 million decrease in sales of Hercules Hook and ZorbEEZ, due to the maturity of these products and a reduction in their marketing campaigns, and (ii) a $2.7 decrease in our beauty product sales, due to our decision to concentrate more of our marketing efforts on housewares products as compared to beauty products.

Gross Profit

Gross profit decreased $7.5 million, or 37%, to $12.8 million in 2008 from $20.3 million for the comparable prior year period, primarily as a result of the planned change in channel mix revenues as discussed above. The gross profit margin decreased to 47%, from 68% over the comparable prior year period. This change was consistent with our plan to transition to a greater proportion of retail sales which inherently carry lower gross margins than our direct to consumer sales but have significantly lower selling expenses associated with each sale, and resulting in higher net margins. As we increase sales in future periods, we believe this strategy will allow us to better leverage our fixed operating expenses and thereby improve our operating margin.

Real Estate

Revenue was approximately $0.6 million in 2008, an increase of $0.1 million, compared to net revenue of approximately $0.5 million in 2007. There has been no change in the occupancy of the office building we own and operate in East Granby, Connecticut.  

Operating Expenses

The following table summarizes our changes in operating expenses (in thousands) for the periods indicated:

	Nine months ended
	September, 30
	YTD		YTD		Change
	2008		2007		$			%
Selling	$	8,430	$	13,608	$	(5,178	)	(38	)  %
General and administrative:
Consumer products		2,532		2,764		(232	)	(8	)  %
Real estate		325		312		13		4	%
Corporate expenses		2,466		1,781		685		38	%
Total general and administrative		5,323		4,857		466		10	%

Selling Expenses

Consumer Products

For 2008, selling expenses decreased by $5.2 million, or 38%, to $1.8 million, from $13.6 million for the comparable prior year period. As a percentage of revenues, selling expenses in 2008 decreased to 31%, from 45% for the comparable prior year period.  As discussed above, this is consistent with management’s strategy to transition to a higher proportion of retail sales which require less selling expenses when compared to direct to consumer sales. As a result, our media expenses decreased $4.3 million in 2008 and our selling expenses associated with certain mature products also declined. We monitor our media spending in

19

relation to consumer acceptance of the product and their related willingness to purchase the product through our retail distribution channel.

General and Administrative Expenses

General and administrative (G&A) expenses consist primarily of compensation paid to administrative personnel, professional service fees and public company costs. In 2008, G&A expenses increased by $0.4 million, or 10%, to $5.3 million, from $4.9 million for the comparable prior year period. The increase was primarily due to $0.2 million of severance expenses and accelerated vesting of stock options in connection with the separation agreement with us and our former President who resigned on March 15, 2008. As a percentage of revenues, G&A expenses in 2008 increased to 19%, from 16% for the comparable prior year period. As a percentage of sales, we expect G&A to decrease in future periods as we continued to leverage our administrative infrastructure and realize the benefits of restructuring activities undertaken throughout 2008 and which are expected to continue in our fourth quarter of 2008.

Interest Expense

Interest expense in 2008 was $0.8 million compared to interest expense of $1.0 million in 2007. The $0.2 million decrease in interest expense was primarily due to a reduction in the principal balance of our 10% secured convertible debt.

Provision for Income Taxes

We have recorded a 100% valuation allowance against our current year tax loss and prior years net operating loss carry forwards based on the criteria contained in FAS 109 of the realized value of these deferred tax assets.   Notwithstanding management’s view of future profitability, in determining whether or not a valuation allowance is necessary, forecasts of future taxable income are generally not considered sufficient evidence to outweigh a history of losses.

Liquidity and Capital Resources

Our business requires sufficient capital to cover the costs of product development, production of marketing materials, the purchase of transactional advertising media (such as television, internet, print and radio), and the purchase of product inventory. While a large component of our cash requirements are often associated with advertising media, the terms we receive and the relatively quick return on that investment in the form of product sales associated with those expenditures does not typically result in liquidity constraints. Our biggest capital commitment is the purchase of inventory for sales to our retail chain customers and transactional marketing customers.

In June 2007, we entered into a Loan and Security Agreement (the “BFI Agreement”) with BFI Business Finance (“Lender”). Pursuant to the BFI Agreement, Lender will loan us up to the lesser of (i) $5.0 million or (ii) the Borrowing Base. The “Borrowing Base” is defined as (i) 85% of the gross face amount of the eligible accounts receivable of our Adsouth Marketing, LLC subsidiary (“ASM”), plus (ii) 30% of the current market cost of raw materials and finished goods that constitute ASM’s eligible inventory, not to exceed the lesser of $700,000 or 50% of the eligible accounts receivable borrowing base. We have guaranteed ASM’s obligations under the BFI Agreement. As of September 30, 2008, the balance of the line of credit was $3.6 million, which was approximately 71% of the $5.0 million maximum amount established under the BFI Agreement. We generally run an outstanding balance position as a percentage of available borrowing base of 95% to 100% to support our cash demands.  The available borrowing base changes daily influenced by accounts receivable aging, concentration on a customer by customer basis to total accounts receivable, and other factors.

Loans extended pursuant to the BFI Agreement bear interest at a rate per annum of 2.0% above the greater of the prime rate as reported in the western edition of the Wall Street Journal from time to time but never less than 6.5%. Interest is payable monthly in arrears and we are required to pay at least $7,500 a month in interest regardless of the amounts outstanding under the BFI Agreement at any particular time. We are required to pay an annual loan fee equal to 1% of the maximum amount of the credit line. The BFI Agreement has a term of 12 months expiring in June 2009 and thereafter shall automatically renew for successive 12 month periods (each a “Renewal Term”) so long as neither we nor Lender delivers written notice of its intention to terminate the BFI Agreement.

As of September 30, 2008, we had a working capital deficit of $3.6 million. Included in the working capital deficit are debt obligations that mature with in one year. The second mortgage balance of $1.1 million on our East Granby Property matures on August 1, 2009. We will seek to extend the maturity date, refinance this obligation or sell the office building on or before the maturity date. Our 10% Secured convertible notes with a balance of $2.6 million requires principal payments through maturity on July 31, 2009. We are currently seeking to refinance this obligation or renegotiate the terms. Based on our anticipated growth, we believe that our cash requirements will increase. We require significant up-front cash disbursements to operate our business, most notably in connection with the purchase of product inventory.  Our current working capital resources, comprised of our present cash resources and bank lines of credit, will be insufficient to fund additional growth of our operations over the next 12 months. We will seek to fund additional growth with increases to our credit line by using our receivables and inventory as

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collateral, and by seeking alternate debt or equity financing.  Securing such financing with favorable terms has been and may remain challenging in the context of the general slowdown of the economy and related global credit crisis.  Our failure to raise the necessary additional capital resources or to renegotiate the terms of our debt could affect our ability to generate revenue and could require us to scale down some of our operations. 

Net cash used by operations in 2008 was $1.8 million, as compared to $2.5 million used in 2007. The $0.7 million decrease in the use of cash in 2008 was due to: (i) an accounts receivable increase in 2008 of $2.1 million compared to an increase of $3.3 million in 2007, (ii) an inventory decrease in 2008 of $1.1 million compared to an increase of $0.4 million in 2007, (iii) an increase in accounts payable of $0.5 million in 2008, compared to an increase of $1.0 million in 2007, offset by a decrease in earnings of $2.5 million, net of adjustments for non-cash-items.

Net cash provided by financing activities was $2.0 million in 2008 as compared to $2.7 million provided in 2007. The $0.7 million decrease in 2008 was primarily due to a larger use of our credit line in 2008 as compared to the factoring agreements utilized in 2007.

Off Balance Sheet Arrangements

None.

Item  3.

Quantitative and Qualitative Disclosures about Market Risk

As a smaller reporting company, the registrant is not required to provide a response to Item 3.

Item  4.

Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

 As of September 30, 2008, the end of the period covered by this report, our management, including our Chief Executive Officer and our Chief Financial Officer, reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Such disclosure controls and procedures are designed to ensure that material information we must disclose in this report is recorded, processed, summarized and filed or submitted on a timely basis. Based upon that evaluation our management, Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2008.

(b) Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

As previously reported in our Annual Report on Form 10-KSB for the year ended December 31, 2007, we determined that, as of that date, our internal control over financial reporting was not effective. Our Chief Executive Officer and Chief Financial Officer concluded that we had a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management identified significant deficiencies, when aggregated, resulted in a material weakness in our internal control over financial reporting as of December 31, 2007. Our Annual Report on Form 10-KSB for the year ended December 31, 2007 did 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 permitted the Company to provide only management's report in its Annual Report on Form 10-KSB for the year ended December 31, 2007. As of June 30, 2008, the material weakness in our internal controls over financial reporting have been remediated.

Information Technology

As of December 31, 2007, we identified certain control procedures that were not sufficiently documented relating to Entity Level management of our information technology functions and logical access to financial applications and Company wide networks. In 2008, our IT management and applications administrators have and will continue to incorporate the performance of periodic reviews of user permissions and inactive user accounts into the formal IT Information Security Policies and Procedures.

Control Environment

As of December 31, 2007, we did not maintain an effective control environment. Specifically, we did not ensure that: (1) customer purchase orders were compared to deal sheets for accuracy of pricing, and (2) allowances, customer deductions and credit memos were compared to deal sheets or properly authorized. We determined that our reliance on reports from third party

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warehouse and fulfillment vendors may not ensure that all information required to be disclosed by us in the reports we file or submit under the Exchange Act are accurately recorded, processed, summarized and reported. In addition, controls were not in place to ensure that the valuation allowance for the deferred tax asset was reviewed on a timely basis.

In order to address the foregoing deficiencies, we re-trained our staff in the second quarter of 2008 to ensure that deal sheets and changes in terms are approved by management, that sales order entry personnel compare customer purchase orders to deal sheets, and that our accounts receivable personnel review deductions from customers’ payments and compare them to the deal sheets to make sure terms are being followed and deductions are properly approved.  With respect to third-party vendor reports, we have implemented and expect to continue to implement site visits, reconciliations and other controls which we believe will remediate this deficiency. Beginning in the second quarter of 2008, our Chief Financial Officer and a tax professional have implemented controls over income tax accounting to ensure that recorded deferred tax assets, net of the valuation allowance, are recoverable.

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PART II OTHER INFORMATION

Item  1.

Legal Proceedings

From time to time, we may be involved in litigation with customers, vendors, suppliers and others in the ordinary course of business.  Any such existing proceedings are not expected to have a material adverse impact on our results of operations or financial condition.  In addition, we are a party to the proceedings discussed below.

On March 27, 2007, Diversified Investors Capital Services of N.A., Inc. ("Diversified") instituted an action against Vertical Branding, Inc. and Worldwide Excellence, Inc. (WWE”) a wholly owned subsidiary in the Supreme Court of the State of New York (County of New York) (Case No. 07-601008).  Diversified alleges breach of a “Management and Consulting Agreement” entered into with WWE in May of 2005 (the “Consulting Agreement”), as well as a subsequent letter agreement with WWE dated October 23, 2005 (the “Letter Agreement”). The Consulting Agreement contemplates the provision by Diversified of merger and acquisition and finance-related services to WWE, with various payments contingent upon our acquisition of WWE and/or our raising at least $1.5 million in financing proceeds. The Letter Agreement similarly relates to fees to be paid to Diversified in connection with our sale of 10% Convertible Preferred Stock at or about the time of our acquisition of WWE. Diversified seeks monetary damages of approximately $617,000, of which $90,000 is alleged to be due as consulting fees under the Consulting Agreement, $233,000 is alleged to be due under the Letter Agreement as commissions in connection with our sale of preferred stock in November and December of 2005, and $288,750 is alleged to be due under the Letter Agreement as commission in connection with our sale of 10% convertible debentures in August and September 2006. Diversified also seeks the issuance, pursuant to the Consulting Agreement, of a warrant to purchase 200,000 shares of our common stock at $1 per share, and the issuance, pursuant to the Letter Agreement, of a warrant to purchase 107,500 of our “preferred units.” We and WWE dispute the validity of the subject agreements, our obligation to make payments in the amounts or kinds claimed, or at all, and we intend to vigorously defend ourselves in the matter.  Our position and defense is premised on, among other things, that fact that Diversified seeks compensation for services that were never performed nor for which the applicable agreements entitle Diversified to compensation, and that Diversified materially misrepresented, and failed disclose information about, its ability and qualifications with respect to the services to be performed.  The litigation is presently in the discovery phase and no trial date has been set.

In March of 2004, Buckhead Marketing and Distribution LLC, PAP Systems LLC and Nancy Duitch individually, among others, entered into a voluntary consent order with the Federal Trade Commission arising out of the FTC’s investigation into marketing claims made in connection with the Peel Away the Pounds Weight Loss System.  The order contains no admission of wrongdoing and no finding of liability and was entered into for settlement purposes only.  The Order is binding upon the corporate successors and assigns.  The order also applies in certain instances to any business in which Nancy Duitch is an officer or director, or has a majority ownership interest in, directly or indirectly controls, or any other business in which Nancy Duitch is engaged in activity related to the marketing of any product, service or program that provides health benefits, including weight or inch loss or related benefits, or the marketing of any food, drug or cosmetic where certain claims are made, but only to the extent that such business acts in active concert or participation with Ms. Duitch.  Ms. Duitch is a director, our Chief Executive Officer, and through the Duitch Family Trust, beneficially owns approximately 15.5% of our outstanding common stock.  The order prohibits certain weight loss representations and requires that other specified weight loss, fat loss and similar claims made in future advertising and claims regarding the results of tests or studies be substantiated by competent and reliable scientific evidence.  This is generally consistent with the standard for substantiating claims currently required by the FTC for all weight loss and dietary supplement products. 

Item 1A.

Risk Factors

As a smaller reporting company, the registrant is not required to provide a response to Item 1A.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

During the nine months ended September 30, 2008, the Company issued an aggregate of 43,332 shares of common stock valued at $18,000 as stock based compensation to two consultants.

The shares were issued in reliance on upon the exemption from registration as set forth in Section 4(2) of the Securities Act of 1933, as amended, and/or Rule 506 of Regulation D.

Dividend on Preferred Stock

Under the terms of our 10% Series A Convertible Preferred Stock, we, at our option, may meet our  dividend payment obligation by electing any of, or a combination of, the following options: (i) paying the cash dividend payment on or before the date due; or (ii) issuing our Common Stock to the holder of the Convertible Preferred Stock based on our Common Stock being valued at the greater of (i) $1.00 or (ii) 50% of the fair market value of the our Common Stock on date the applicable dividend is due and

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payable (the “Valuation”). The fair market value is the trailing average closing bid price for the 20 consecutive trading days prior to the dividend payment date.

We elected to pay the dividend that was due on May 29, 2008 by issuing 90,000 shares VBI Common Stock, valued at $1.00 per share to the preferred stockholders in accordance with the terms of the Valuation in the above paragraph. The closing price of VBI common stock on the dividend payment date was $.37 per share. The issuance was made pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933.

Item 3.

Defaults Upon Senior Securities

None.

Item  4.

Submission of Matters to a Vote of Security Holders

None.

Item  6.

Exhibits

Exhibit No.	Exhibit	Method of Filing
3.1	Certificate of Amendment of Certificate of Incorporation dated August 8, 2000.	Incorporated by reference to Exhibit 3.1 to the Company’s Form 10 dated September 29, 2000.
3.2	Amended and Restated Bylaws.	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed August 2, 2006.
3.3	Form of Certificate of Determination of Series A Preferred.	Incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form SB-2 filed on September 14, 2006.
3.4	1st Amendment to Amended Certificate of Incorporation dated October 30, 2006.	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed November 2, 2006.
3.5	Amended and Restated Bylaws.	Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed April 1, 2008.
4.1	Amendment 1 to Registration Rights Agreement, by and between the Company and Renaissance Capital Growth & Income Fund III, Inc., Renaissance US Growth Investment Trust PLC, US Special Opportunities Trust PLC and Premier RENN US Emerging Growth Fund Limited..	Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed February 25, 2008.
10.1	Employment Agreement dated as of May 16, 2008 with Daniel McCleerey	Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on May 20, 2008.
10.2	Employment Agreement dated as of October 1, 2008 with Nancy Duitch	Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 6, 2008.
31.1	Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.
31.2	Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.
32.1	Pursuant to Section 906 of the Sarbanes Certification by the Chief Executive Officer and Chief Financial Officer Pursuant to Section 18 U.S.C. Section 1350 Adopted -Oxley Act of 2002.	Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	VERTICAL BRANDING, INC.
November 14, 2008	By:	/s/ DANIEL MCCLEEREY
		Daniel McCleerey
		Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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