SCHEDULE 14C INFORMATION
INFORMATION STATEMENT PURSUANT TO SECTION 14(C) OF
THE SECURITIES EXCHANGE ACT OF 1934
Check the appropriate box:
|_| PRELIMINARY INFORMATION STATEMENT
|_| Confidential, for Use of the Commission Only (as permitted by Rule
14C-5(D)(2))
|X| Definitive Information Statement
ALLIANCE DISTRIBUTORS HOLDING INC.
(Name of Registrant as Specified in Its Charter)
Payment of filing fee (Check the appropriate box):
|X| No Fee required.
|_| Fee computed on table below per Exchange Act Rules 14c-5(g) and 0-11.
1) Title of each class of securities to which transaction applies:
2) Aggregate number of securities to which transaction applies:
3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:*
4) Proposed maximum aggregate value of transaction:
5) Total fee paid:
|_| Fee paid previously with preliminary materials.
|_| Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the form or schedule and the date of its filing.
1) Amount previously paid:
2) Form, Schedule or Registration Statement No:
3) Filing party:
4) Date filed:
----------
* Set forth the amount on which the filing fee is calculated and state how
it was determined.
ALLIANCE DISTRIBUTORS HOLDING INC.
15-15 132nd Street
College Point, New York 11356
INFORMATION STATEMENT
This Information Statement has been mailed on or about January 27, 2006 to the
stockholders of record as of January 9, 2006 ("Record Date") of Alliance
Distributors Holding Inc.'s (the "Company") common stock, par value $.001 per
share ("common stock") and the Company's Series A Convertible Non Redeemable
Preferred Stock, par value $.001 per share (the "Series A Preferred Shares") in
connection with the action described herein to be taken on or about February 17,
2006, which is 20 days after the mailing of this Information Statement. The
action will be taken pursuant to the written consents by the majority
stockholders of the Company dated as of January 13, 2006.
THIS IS NOT A NOTICE OF A SPECIAL MEETING OF STOCKHOLDERS. NO STOCKHOLDER
MEETING WILL BE HELD TO CONSIDER ANY MATTER WHICH WILL BE DESCRIBED HEREIN.
WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY.
The Company's principal executive office address is 15-15 132nd Street College
Point, New York 11356.
NOTICE OF ACTION TO BE TAKEN PURSUANT TO THE WRITTEN CONSENTS DATED JANUARY 13,
2006 OF MAJORITY STOCKHOLDERS IN LIEU OF A SPECIAL MEETING OF THE STOCKHOLDERS.
TO OUR STOCKHOLDERS:
NOTICE IS HEREBY GIVEN that the following action will be taken on or about
February 17, 2006 pursuant to written consents dated January 13, 2006 by the
majority stockholders, in lieu of a special meeting of the stockholders.
GENERAL
By their written consents, shareholders and a proxy holder (the "Stockholders")
have voted 32,565,220 shares, out of a total of 52,884,164 shares entitled to
vote, or approximately 62% of the Company's total voting power (the total number
of votes that can be cast by the outstanding common stock and Series A Preferred
Shares), in favor of granting the Board of Directors the authority to amend the
Company's Certificate of Incorporation to increase the number of the Company's
authorized shares of common stock from 100,000,000 shares to 500,000,000 shares
(20,000,000 shares to 100,000,000 shares on a post 2006 Reverse Stock Split
basis, as such term is defined below) at such time, if any, as the Board of
Directors shall deem appropriate (the "Amendment"). The vote in favor of the
amendment is greater than a majority of the Company's total voting power and is
sufficient to approve the amendment.
BACKGROUND
In a Stock Purchase Agreement (the "Acquisition Agreement") with Emerich
Goldstein and members of his family ("Sellers"), the Company has agreed to buy
from the Sellers all of the capital stock of Foto Electric Supply Co., Inc., a
New York corporation ("FESCO"). The purchase price will range from a minimum of
$70 million to a maximum of $78 million depending on FESCO's results for 2005,
and will be payable $50 million in cash, $12.5 million in notes, and the balance
in equity securities. The closing of the transaction is contingent, among other
things, on the Company's obtaining equity financing for the $50 million cash
portion of the purchase price and debt financing for a $10 million increase to
the Company's current $10 million credit facility. The Company has received no
commitment for the equity financing or for the debt financing. The equity
securities to be issued to the Sellers as part of the purchase price will be
valued at the valuation that will apply to equity securities that are issued in
any equity financing that the Company consummates to fund the cash portion of
the purchase price. The Acquisition Agreement is more fully described in reports
on Form 8-K that the Company filed with the SEC on January 10, 2006 and January
11, 2006 and that are available at www.sec.gov. The form of the Acquisition
Agreement is included as an exhibit to the Form 8-K that the Company filed with
the SEC on January 10, 2006.
We have not yet determined the nature of the securities, if any, that we will
issue to finance the FESCO acquisition and that we would need to issue to the
FESCO sellers for the equity portion of their purchase price. However, we have
100,000,000 authorized shares of common stock (20,000,000 shares of common stock
on a post 2006 Reverse Stock Split basis as such term is defined below) of which
only 7,530,348 (37,651,740 on a pre 2006 Reverse Stock Split basis) are
currently available for issuance and not reserved for issuance on conversion or
exercise of convertible and exercisable securities, and our shares have been
trading in the range of $0.21 to $0.51 since December 1, 2005. We therefore
assume that our currently available shares of common stock will be insufficient
for issuance to finance and consummate the FESCO acquisition, or to permit
conversion of any preferred shares and other convertible securities and the
exercise of any exercisable securities that we might issue to finance and
consummate the FESCO acquisition.
The Stockholders have voted to increase the number of shares of our authorized
common stock to enable the acquisition and financing of the FESCO acquisition if
the conditions to the acquisition and financing are satisfied. Also, whether or
not the FESCO acquisition is consummated, we think that it is advisable that
there be additional shares of common stock available for issuance by the Company
in future financings and acquisitions and for other corporate purposes described
below.
BUSINESS BACKGROUND
GENERAL
In June 2002, the Company, then named JPAL, Inc. ("JPAL"), a Nevada corporation
which then had no ongoing business or significant assets, acquired Essential
Reality, LLC ("ER, LLC") which had been formed in 1998 as Freedom Multimedia,
LLC in Delaware to develop and market a virtual video game controller. Following
this transaction, JPAL changed its name to Essential Reality, Inc.
("Essential"). In November 2003, we discontinued sales of our virtual video game
controller because of our inability to raise necessary funds.
On June 17, 2004, Essential entered into a Share Exchange Agreement (the
"Exchange Agreement") with Jay Gelman, Andre Muller and Francis Vegliante, the
sole shareholders (the "Stockholders") of AllianceCorner Distributors Inc., a
New York corporation ("AllianceCorner") which had been engaged in the video game
distribution business since August 2003. Pursuant to the Exchange Agreement, the
Company on June 29, 2004 acquired all the outstanding capital stock of
AllianceCorner from the Stockholders and, in exchange for such capital stock,
issued 517,105 Series B Convertible Non Redeemable Preferred Shares ("Series B
Preferred Shares") to Jay Gelman, 517,105 Series B Preferred Shares to Andre
Muller and 517,104 Series B Preferred Shares to Francis Vegliante. On November
22, 2004, the Series B Preferred Shares converted into 8,226,671 shares of
common stock for each of Jay Gelman and Andre Muller and into 8,226,655 shares
of common stock for Francis Vegliante.
In connection with this acquisition, the Company issued the share equivalent of
21,237,101 shares of common stock and 403,335 shares of Series A Convertible Non
Redeemable Preferred Stock and warrants to purchase 1,564,096 shares of common
stock in private placements. Each share of Series A Convertible Non Redeemable
Preferred Stock entitles the holder to 15.91 votes, and votes as one class with
the common stock on as converted basis. Certain holders granted to Jay Gelman an
irrevocable voting proxy to vote their voting stock. As of December 15, 2005,
Jay Gelman's voting proxy covered 9,205,549 shares of common stock, as well as
168,427 shares of Series A Convertible Non Redeemable Preferred Stock that have
2,679,674 votes, for a total voting proxy of 11,885,223 votes.
These transactions diluted the ownership of our shareholders prior to June 2004
to 1.06% of the 47,368,756 shares of common stock outstanding as of December 15,
2005.
We accounted for our acquisition of AllianceCorner as a reverse acquisition as
of June 30, 2004. The pre-acquisition financial statements of AllianceCorner are
treated as historical financial statements of the combined companies.
AllianceCorner was formed in May 2003 under the name Alliance Partners, Inc. The
name of Alliance Partners, Inc. was changed to AllianceCorner Distributors Inc.
in September 2003 and was further changed to Alliance Distributors Holding, Inc.
("Alliance New York") in July 2004. Effective November 17, 2004, Alliance New
York was merged into Alliance Distributors Holding Inc., a Delaware corporation
that was wholly owned by Essential.
Effective November 22, 2004, Essential reincorporated in Delaware and changed
its name to Alliance Distributors Holding Inc. ("Alliance" or the "Company"), by
way of a merger of Essential into Alliance, which was then a wholly owned
Delaware subsidiary of Essential.
On March 7, 2005, Mr. Vegliante sold 4,000,000 shares of common stock to
investors in a private transaction at a purchase price of $0.125 per share.
2
2006 Reverse Stock Split
On December 30, 2005, the Company filed a definitive Schedule 14C Information
Statement with reference to written consents by shareholders and a proxy holder
(the " Stockholders") who owned or had the right to vote a total of 32,565,220
shares out of 52,884,164 shares entitled to vote, or approximately 62% of the
Company's total voting power (the total number of votes that can be cast by the
outstanding common stock and Series A Preferred Shares), in favor of granting
the Board of Directors the authority to amend the Company's Certificate of
Incorporation to effect a reverse stock split of the Company's authorized common
stock and the Company's issued and outstanding common stock on the basis of
one-for-five at such time after January 27, 2006 as the Board of Directors
shall deem appropriate (the "2006 Reverse Stock Split"). The 2006 Reverse Stock
Split is not effective as of the date of this Information Statement.
UNLESS OTHERWISE STATED, ALL INFORMATION IN THIS INFORMATION STATEMENT IS GIVEN
ON A PRE 2006 REVERSE STOCK SPLIT BASIS.
ACTION
The Company currently has authorized capital stock of 100,000,000 shares of
common stock and 8,672,020 shares of preferred stock. There are issued and
outstanding 47,368,756 shares of common stock and 346,663 Series A Preferred
Shares convertible into 5,515,408 shares of common stock as of January 9, 2006.
The par value of each class of capital stock is $.001 per share. By their
written consents, shareholders and a proxy holder (the " Stockholders") have
voted 32,565,220 shares, out of a total of 52,884,164 shares entitled to vote,
or approximately 62% of the Company's total voting power (the total number of
votes that can be cast by the outstanding common stock and Series A Preferred
Shares), in favor of granting the Board of Directors the authority to amend the
Company's Certificate of Incorporation to increase the number of authorized
shares of common stock from 100,000,000 shares to 500,000,000 shares. The vote
in favor of the Amendment is greater than a majority of the Company's total
voting power and is sufficient to approve the amendment.
The text of the amendment to the Certificate of Incorporation increasing the
number of authorized shares of common stock is set forth in Exhibit A to this
Information Statement. The text of the amendment to the Certificate of
Incorporation is subject to modification to include such changes as may be
required by the office of the Secretary of State of the State of Delaware and as
the Board of Directors deems necessary and advisable to effect the amendments.
Of the 500,000,000 shares of common stock to be authorized, 47,368,756 shares
will constitute shares of common stock issued and outstanding prior to the
Amendment, 5,515,408 shares will be available to permit the conversion of the
Series A Preferred Shares, 9,464,096 shares will be available to permit the
exercise of issued and outstanding options and warrants and the balance will be
available for issuance by the Board of Directors.
The terms of the additional shares of common stock will be identical to those of
the currently outstanding shares of common stock. Because holders of common
stock have no preemptive rights to purchase or subscribe for any unissued stock
of the Company, the issuance of additional shares of common stock will reduce
the current stockholders' percentage ownership in the total outstanding shares
of common stock. This Amendment and the creation of additional shares of
authorized common stock will not alter the current number of issued shares. The
relative rights and limitations of the shares of common stock will remain
unchanged under this Amendment.
The increase in the number of authorized but unissued shares of common stock
that would be available for issuance would enable the Company, without further
stockholder approval, to issue shares from time to time as may be required to
consummate the acquisition of FESCO and related financings and for other proper
business purposes, such as raising additional capital for ongoing operations,
business and asset acquisitions, stock splits and dividends, present and future
employee benefit programs and other corporate purposes.
The proposed increase in the authorized number of shares of common stock could
have a number of effects on the Company's stockholders depending upon the exact
nature and circumstances of any actual issuances of authorized but unissued
shares. The increase could have an anti-takeover effect, in that additional
shares could be issued (within the limits imposed by applicable law) in one or
more transactions that could make a change in control or takeover of the Company
more difficult. For example, additional shares could be issued by the Company so
as to dilute the stock ownership or voting rights of persons seeking to obtain
control of the Company, even if the persons seeking to obtain control of the
Company offer an above-market premium that is favored by a majority of the
independent shareholders.
3
Similarly, the issuance of additional shares to certain persons allied with the
Company's management could have the effect of making it more difficult to remove
the Company's current management by diluting the stock ownership or voting
rights of persons seeking to cause such removal. The Company does not have any
other provisions in its articles of incorporation, by-laws, employment
agreements, credit agreements or any other documents that have material
anti-takeover consequences. The Company has no plans or proposals to adopt other
provisions or enter into other arrangements that may have material anti-takeover
consequences. The Board of Directors is not aware of any attempt, or
contemplated attempt, to acquire control of the Company, and this Action is not
being taken with the intent that it be utilized as a type of anti-takeover
device.
Except for the potential issuance of securities in connection with the
acquisition of Fesco and related financings, there are currently no plans,
arrangements, commitments or understandings for the issuance of the additional
shares of common stock or preferred stock.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth, as of January 9, 2006, information regarding the
beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange Act
of 1934) of the Company's Common Stock based upon the most recent information
available to the Company for (i) each person known by the Company to own
beneficially more than five (5%) percent of the Company's outstanding Common
Stock, (ii) each of the Company's officers and directors and (iii) all officers
and directors of the Company as a group. Unless otherwise indicated, each
stockholder's address is c/o the Company, 15-15 132nd Street, College Point, New
York 11356.
Beneficial ownership is determined in accordance with the rules of the SEC, and
for calculating the shares and percentage beneficially owned by each Selling
Security Holder includes any securities which the person has the right to
acquire within 60 days of the date of this Information Statement through the
conversion or exercise of any security or right. The terms of the Series A
Convertible Non Redeemable Preferred Shares ("Series A Preferred Shares")
restrict each holder's right to convert the Series A Preferred Shares to the
extent that beneficial ownership of such holder and its affiliates would exceed
4.999% or 9.999% of the shares of Common Stock that would be outstanding after
giving effect to such conversion. For convenience, the table and the footnotes
are presented as if these restrictions did not apply. For purposes of the table
and the footnotes below, there are deemed outstanding 52,884,164 shares of
common stock, consisting of 47,368,756 shares of common stock currently issued
and outstanding and 5,515,408 shares of common stock issuable on conversion of
346,663 Series A Preferred Shares. Each Series A Preferred Share converts into
15.91 shares of common stock.
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Name and address of beneficial owner Common Stock (% of class)
------------------------------------------------------------------------
Jay Gelman 20,478,561(1) (38.46%)
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(1) Consists of Mr. Gelman's record and beneficial ownership of 8,226,671
shares of common stock, 275,000 shares of common stock issuable upon
exercise of 275,000 options that are currently exercisable, 91,667 shares
of common stock issuable upon exercise of 91,667 options exercisable
within 60 days, and 9,205,549 shares of common stock and 168,427 Series A
Preferred Shares convertible into 2,679,674 shares of common stock that
are subject to a voting proxy. Of the total number of shares of common
stock subject to a voting proxy, Theseus Fund, L.P. (f/k/a Minotaur Fund
LLP) granted to Mr. Gelman a proxy to vote 1,071,335 shares of common
stock.
4
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Andre Muller 8,593,338(2) (16.14%)
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Barbara A. Ras 114,000(3) (0.22%)
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Humbert B. Powell, III 72,728(4) (0.14%)
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Thomas Vitiello 50,000(5) (0.09%)
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Steven H. Nathan 50,000(6) (0.09%)
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All executive officers and 29,358,627 (54.58%)
directors as a group
------------------------------------------------------------------------
Francis Vegliante 4,593,322(7) (8.63%)
------------------------------------------------------------------------
Nathan A. Low (8)
c/o Sunrise Securities 6,969,928(9) (12.88%)
Corp., 641 Lexington
Avenue N.Y., N.Y. 10022
------------------------------------------------------------------------
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(2) Consists of Mr. Muller's record and beneficial ownership of 8,226,671
shares of common stock, 275,000 shares of common stock issuable upon
exercise of 275,000 options that are currently exercisable and 91,667
shares of common stock issuable upon exercise of 91,667 options
exercisable within 60 days.
(3) Consists of Ms. Ras' record and beneficial ownership of 66,000 shares of
common stock and her indirect beneficial ownership of 23,000 shares of
common stock owned by her husband, 16,667 shares of common stock issuable
upon exercise of 16,667 options that are currently exercisable and 8,333
shares of common stock issuable upon exercise of 8,333 options exercisable
within 60 days.
(4) Consists of Mr. Powell's record and beneficial ownership of 22,728 shares
of common stock, 37,500 shares of common stock issuable upon exercise of
37,500 options that are currently exercisable and 12,500 shares of common
stock issuable upon exercise of 12,500 options exercisable within 60 days.
(5) Consists of 37,500 shares of common stock issuable upon exercise of 37,500
options that are currently exercisable and 12,500 shares of common stock
issuable upon exercise of 12,500 options exercisable within 60 days.
(6) Consists of 37,500 shares of common stock issuable upon exercise of 37,500
options that are currently exercisable and 12,500 shares of common stock
issuable upon exercise of 12,500 options exercisable within 60 days.
(7) Consists of Mr. Vegliante's record and beneficial ownership of 4,226,655
shares of common stock, 275,000 shares of common stock issuable upon
exercise of 275,000 options that are currently exercisable and 91,667
shares of common stock issuable upon exercise of 91,667 options
exercisable within 60 days.
(8) Mr. Low has sole dispositive and voting power in Sunrise Securities Corp.
Mr. Low's wife has sole voting and investment power in the shares owned by
Nathan A. Low Family Trust. Mr. Low has shared voting and investment power
in Level Counter LLC, which has sole investment and voting power in the
shares owned by Sunrise Equity Partners. Mr. Low has shared voting and
investment power in the shares owned by Sunrise Foundation Trust. Mr. Low
disclaims beneficial ownership of the shares owned by Nathan A. Low Family
Trust, Sunrise Equity Partners and Sunrise Foundation Trust.
(9) These 6,969,928 shares consist of 83,330 shares of common stock owned by
Sunrise Equity Partners, 245,794 shares of common stock owned by Sunrise
Securities Corp., 756,346 shares of common stock due to the deemed
conversion of 47,539 Series A Convertible Non Redeemable Preferred Stock
("Series A Preferred Shares") owned by Nathan A. Low, 388,315 shares of
common stock due to the deemed conversion of 24,407 Series A Preferred
Shares owned by Nathan A. Low Family Trust, 2,290,515 shares of common
stock due to the deemed conversion of 143,967 Series A Preferred Shares
owned by Nathan A. Low Roth IRA, 346,504 shares of common stock due to the
deemed conversion of 21,779 Series A Preferred Shares owned by Sunrise
Foundation Trust, 366 shares of common stock due to the deemed conversion
of 23 Series A Preferred Shares owned by Sunrise Securities Corp. and
1,634,657 shares of common stock due to the deemed conversion of 102,744
shares of common stock owned by Sunrise Equity Partners. Further includes
800,527 shares of common stock issuable upon exercise of 800,527 warrants
owned by Nathan A. Low, 200,132 shares of common stock issuable upon
exercise of 200,132 warrants owned by Sunrise Foundation Trust and 223,442
shares of common stock issuable upon exercise of 223,442 warrants owned by
Sunrise Securities Corp.
5
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Theseus Fund, L.P.
f/k/a Minotaur Fund LLP 4,400,000(10) (8.32%)
131 Olive Hill Lane, Woodside, CA
94062
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(10) See footnote 1 for information relating to the voting proxy granted to Jay
Gelman by Theseus Fund, L.P. f/k/a Minotaur Fund LLP.
The following table sets forth, as of January 9, 2006, information regarding the
beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange Act
of 1934) of the Company's Series A Non Redeemable Convertible Preferred Stock
("Series A Preferred Shares") based upon the most recent information available
to the Company for (i) each person known by the Company to own beneficially more
than five (5%) percent of the Company's outstanding Series A Preferred Shares,
(ii) each of the Company's officers and directors and (iii) all officers and
directors of the Company as a group.
Beneficial ownership is determined in accordance with the rules of the SEC, and
for calculating the shares and percentage beneficially owned by each Selling
Security Holder includes any securities which the person has the right to
acquire within 60 days of the date of this Information Statement through the
conversion or exercise of any security or right. The terms of the Series A
Preferred Shares restrict each holder's right to convert the Series A Preferred
Shares to the extent that beneficial ownership of such holder and its affiliates
would exceed 4.999% or 9.999% of the shares of Common Stock that would be
outstanding after giving effect to such conversion.
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Name and address of beneficial owner Series A Convertible Non Redeemable
Preferred Shares (% of class)
-------------------------------------------------------------------------
Jay Gelman 168,427(1) (48.59%)
-------------------------------------------------------------------------
All executive officers and 168,427 (48.59%)
directors as a group
-------------------------------------------------------------------------
Nathan A. Low (2)
c/o Sunrise Securities Corp., 340,459(3) (98.21%)
641 Lexington Avenue N.Y., N.Y. 10022
-------------------------------------------------------------------------
Nathan A. Low Roth IRA 143,967(4) (41.53%)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
-------------------------------------------------------------------------
----------
(1) Consists of 24,407 Series A Preferred Shares subject to a voting proxy
granted to Jay Gelman by the Nathan A. Low Family Trust, 143,967 Series A
Preferred Shares subject to a voting proxy granted to Jay Gelman by the
Nathan A. Low Roth IRA and 53 Series A Preferred Shares subject to a
voting proxy granted to Jay Gelman by Northumberland Holdings, LTD.
(2) Mr. Low has sole dispositive and voting power in Sunrise Securities Corp.
Mr. Low's wife has sole voting and investment power in the shares owned by
Nathan A. Low Family Trust. Mr. Low has shared voting and investment power
in Level Counter LLC, which has sole investment and voting power in the
shares owned by Sunrise Equity Partners. Mr. Low has shared voting and
investment power in the shares owned by Sunrise Foundation Trust. Mr. Low
disclaims beneficial ownership of the shares owned by Nathan A. Low Family
Trust, Sunrise Equity Partners and Sunrise Foundation Trust.
(3) Consists of 47,539 Series A Preferred Shares owned by Nathan A. Low,
143,967 Series A Preferred Shares owned by Nathan A. Low Roth IRA, 102,744
Series A Preferred Shares owned by Sunrise Equity Partners, 24,407 Series
A Preferred Shares owned by Nathan A. Low Family Trust, 21,779 Series A
Preferred Shares owned by Sunrise Foundation Trust and 23 Series A
Preferred Shares owned by Sunrise Securities Corp.
(4) See footnote 1 for information relating to the voting proxy granted to
Jay Gelman by the Nathan A. Low Roth IRA.
6
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Nathan A. Low Family Trust 24,407(5) (7.04%)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
-------------------------------------------------------------------------
Sunrise Equity Partners 102,744 (29.64%)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
-------------------------------------------------------------------------
Sunrise Foundation Trust 21,779 (6.28%)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
-------------------------------------------------------------------------
Level Counter LLC (6)
641 Lexington Avenue 102,744(7) (29.64%)
25th Floor
N.Y., N.Y. 10022
-------------------------------------------------------------------------
Amnon Mandelbaum (8)
641 Lexington Avenue 102,744(9) (29.64%)
25th Floor
N.Y., N.Y. 10022
-------------------------------------------------------------------------
Marilyn Adler (10)
641 Lexington Avenue 102,744(11) (29.64%)
25th Floor
N.Y., N.Y. 10022
-------------------------------------------------------------------------
----------
(5) See footnote 1 for information relating to the voting proxy granted to
Jay Gelman by the Nathan A. Low Family Trust.
(6) Level Counter LLC has sole investment and voting power in the shares owned
by Sunrise Equity Partners. Level Counter LLC disclaims beneficial
ownership of these shares.
(7) See footnote 6.
(8) Mr. Mandelbaum has shared voting and investment power in Level Counter
LLC, which has sole investment and voting power in the shares owned by
Sunrise Equity Partners. Mr. Mandelbaum disclaims beneficial ownership of
the shares owned by Sunrise Equity Partners.
(9) See footnotes 6 and 8.
(10) Consists of shares owned by Level Counter LLC. Ms. Adler has shared voting
and investment power in Level Counter LLC, which has sole investment and
voting power in the shares owned by Sunrise Equity Partners. Ms. Adler
disclaims beneficial ownership of the shares owned by Sunrise Equity
Partners.
(11) See footnotes 6 and 10.
FINANCIAL AND OTHER INFORMATION
ALLIANCE DISTRIBUTORS HOLDING INC. AUDITED FINANCIAL STATEMENTS
Alliance's audited financial statements for the year ended December 31, 2004 and
the period from May 9, 2003 (inception) to December 31, 2003 are included in
this Information Statement as Exhibit "B". The consent of Mahoney Cohen &
Company, CPA, P.C., Independent Registered Public Accounting Firm to the
inclusion of their opinion on these audited financial statements is included in
this Information Statement as Exhibit "C". In addition, Alliance's unaudited
financial statements for the nine-month period ending September 30, 2005 are
included in this Information Statement as Exhibit "D". You are encouraged to
review the financial statements, related notes and other information included
elsewhere in this Information Statement.
7
FOTO ELECTRIC SUPPLY CO., INC. ("FESCO") AUDITED FINANCIAL STATEMENTS
FESCO's audited financial statements for the years ended December 31, 2004,
2003, and 2002 are included in this Information Statement as Exhibit "E". The
consent of Leshkowitz & Company, LLP to the inclusion of their opinion on these
audited financial statements is included in this Information Statement as
Exhibit "F". In addition, FESCO's unaudited financial statements for the
nine-month period ending September 30, 2005 are included in this Information
Statement as Exhibit "G". You are encouraged to review the financial statements,
related notes and other information included elsewhere in this Information
Statement.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The following discussion should be read in conjunction with our audited
financial statements and the related notes that appear elsewhere in this
Information Statement. The following discussion contains forward-looking
statements that reflect our plans, estimates and beliefs. Our actual results
could differ materially from those discussed in the forward looking statements.
OVERVIEW
See "Business Background," for description of a transaction whereby
AllianceCorner Distributors Inc. ("AllianceCorner") became a New York
wholly-owned subsidiary of Essential. The name of AllianceCorner was changed to
Alliance Distributors Holding, Inc. ("New York Alliance") in July 2004.
Effective November 17, 2004, New York Alliance was merged into Alliance
Distributors Holding Inc., a Delaware corporation that was wholly owned by
Essential. Effective November 22, 2004, Essential reincorporated in Delaware and
changed its name to Alliance Distributors Holding Inc. ("Alliance" or the
"Company"), by way of a merger of Essential into Alliance, which was then a
wholly owned Delaware subsidiary of Essential. The business of AllianceCorner
became our only business. Since the former stockholders of AllianceCorner
acquired a majority of our voting interests, the transaction was treated as a
reverse acquisition of a public shell, with AllianceCorner treated as the
acquirer for accounting purposes. Accordingly, the pre-acquisition financial
statements of AllianceCorner are our historical financial statements. At the
time of the acquisition, the Company had no continuing operations and its
historical results would not be meaningful if combined with the historical
results of AllianceCorner.
RESULTS OF OPERATIONS
The following tables show each specified item as a dollar amount and as a
percentage of net sales for the three and nine months ended September 30, 2005
and 2004, respectively, and should be read in conjunction with the financial
statements included elsewhere in this Information Statement:
Three Months Ended September 30, 2005 compared to Three Months Ended September
30, 2004
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
(THOUSANDS) (THOUSANDS)
------------------------ -----------------------
Net sales $ 13,566 100.0% $ 6,924 100.0%
Cost of goods sold 12,035 88.7% 5,966 86.2%
---------- ---------- ---------- ----------
Gross profit 1,531 11.3% 958 13.8%
Selling, general and
administrative expenses 1,187 8.8% 981 14.1%
---------- ---------- ---------- ----------
Income (loss) from operations 344 2.5% (23) (.3)%
Interest expense 119 0.9% 20 .3%
---------- ---------- ---------- ----------
Income (loss) before income taxes 225 1.6% (43) (.6)%
Income taxes 3 .0% -- .0%
---------- ---------- ---------- ----------
Net income (loss) $ 222 1.6% $ (43) (.6)%
========== ========== ========== ==========
8
Net sales increased by $6,641,660, or 95.9%, from $6,924,181 for the three
months ended September 30, 2004 to $13,565,841 for the three months ended
September 30, 2005. The growth in net sales was primarily due to the increase in
sales with our existing customers, as well as an increase in our customer base.
Cost of goods sold increased by $6,068,441, or 101.7%, from $5,966,406 for the
three months ended September 30, 2004 to $12,034,847 for the three months ended
September 30, 2005. The increase was consistent with revenue growth. Gross
profit as a percentage of net sales decreased to 11.3% for the three months
ended September 30, 2005 from 13.8% for the three months ended September 30,
2004. This decrease was primarily due to the Company's strategy to grow the
customer base and increase revenues by introducing incentive pricing programs to
new and key customers. Cost of goods sold excludes the distribution costs of
purchasing, receiving, inspection, warehousing and handling costs; we include
these costs in our selling, general and administrative expenses. Our gross
margins may not be comparable to those of other entities since some entities
include these distribution costs in the cost of goods sold. These distribution
costs were $288,098 and $229,504 for the quarter ended September 30, 2005 and
2004, respectively.
Selling, general and administrative expenses increased by $206,773, or 21.1%,
from $980,454 for the three months ended September 30, 2004 to $1,187,227 for
the three months ended September 30, 2005. The increase was primarily due to the
Company's increase in salaries and related payroll taxes of $84,961, advertising
and marketing expenses of $46,683, professional fees of $19,295 and website
maintenance fees of $15,208. Selling, general and administrative expenses as a
percentage of net sales decreased to 8.8% for the three months ended September
30, 2005 from 14.1% for the three months ended September 30, 2004. For the three
months ended September 30, 2005, selling, general and administrative expenses
were comprised of the following: $171,859 in selling expenses, $288,098 in
distribution costs and $727,270 in general and administrative expenses. For the
three months ended September 30, 2004, selling, general and administrative
expenses were comprised of the following: $97,335 in selling expenses, $229,504
in distribution costs and $653,615 in general and administrative expenses.
Interest expense increased by $98,754, or 483.0%, from $20,444 for the three
months ended September 30, 2004 to $119,198 for the three months ended September
30, 2005. The increase was primarily due to increased borrowings as well as
higher interest rates on bank borrowings during the third quarter of 2005. The
increased borrowing levels were the result of increased sales volume that
required higher inventory levels and increased accounts receivable.
Nine Months Ended September 30, 2005 compared to Nine Months Ended September 30,
2004
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
(THOUSANDS) (THOUSANDS)
------------------------ -----------------------
Net sales $ 36,680 100.0% $ 20,200 100.0%
Cost of goods sold 32,836 89.5% 17,364 86.0%
---------- ---------- ---------- ----------
Gross profit 3,844 10.5% 2,836 14.0%
Selling, general and
administrative expenses 3,739 10.2% 2,704 13.4%
---------- ---------- ---------- ----------
Income from operations 105 .3% 132 .6%
Interest expense 340 .9% 81 .4%
---------- ---------- ---------- ----------
Income (loss) before income taxes (235) (.6)% 51 .2%
Income taxes 8 .0% 11 .0%
---------- ---------- ---------- ----------
Net income (loss) $ (243) (.6)% $ 40 .2%
========== ========== ========== ==========
9
Net sales increased by $16,479,281, or 81.6%, from $20,200,199 for the nine
months ended September 30, 2004 to $36,679,480 for the nine months ended
September 30, 2005. The growth in net sales was primarily due to the increase in
sales with our existing customers, as well as an increase in our customer base.
Cost of goods sold increased by $15,472,013, or 89.1%, from $17,363,624 for the
nine months ended September 30, 2004 to $32,835,637 for the nine months ended
September 30, 2005. The increase was consistent with revenue growth. Gross
profit as a percentage of net sales decreased to 10.5% for the nine months ended
September 30, 2005 from 14.0% for the nine months ended September 30, 2004. This
decrease was primarily due to the Company's strategy to grow the customer base
and increase revenues by introducing incentive pricing programs to new and key
customers. Cost of goods sold excludes the distribution costs of purchasing,
receiving, inspection, warehousing and handling costs; we include these costs in
our selling, general and administrative expenses. Our gross margins may not be
comparable to those of other entities since some entities include these
distribution costs in the cost of goods sold. These distribution costs were
$803,792 and $733,357 for the nine months ended September 30, 2005 and 2004,
respectively.
Selling, general and administrative expenses increased by $1,034,921, or 38.3%,
from $2,704,112 for the nine months ended September 30, 2004 to $3,739,033 for
the nine months ended September 30, 2005. The increase was primarily due to the
Company's increase in salaries and related payroll taxes of $302,479,
professional fees associated with the Company's expanded operations of $200,056,
advertising and marketing expenses of $155,598, allowance for doubtful accounts
of $100,000, insurance premiums of $96,444 and stock option compensation expense
of $34,499 as a result of 750,000 options that were granted to non-employees who
provide services to the Company. Selling, general and administrative expenses as
a percentage of net sales decreased to 10.2% for the nine months ended September
30, 2005 from 13.4% for the nine months ended September 30, 2004. For the nine
months ended September 30, 2005, selling, general and administrative expenses
were comprised of the following: $542,635 in selling expenses, $803,792 in
distribution costs and $2,392,606 in general and administrative expenses. For
the nine months ended September 30, 2004, selling, general and administrative
expenses were comprised of the following: $355,222 in selling expenses, $733,357
in distribution costs and $1,615,533 in general and administrative expenses.
Interest expense increased by $258,569, or 319.0%, from $81,052 for the nine
months ended September 30, 2004 to $339,621 for the nine months ended September
30, 2005. The increase was primarily due to increased borrowings as well as
higher interest rates on bank borrowings during the nine months ended September
30, 2005. The increased borrowing levels were the result of increased sales
volume that required higher inventory levels and increased accounts receivable.
YEAR ENDED DECEMBER 31, 2004 AND FOR THE PERIOD FROM AUGUST 11, 2003
(COMMENCEMENT OF OPERATIONS) TO DECEMBER 31, 2003
The following table shows each specified item as a dollar amount and as a
percentage of net sales in each fiscal period, and should be read in conjunction
with the financial statements included elsewhere in this Information Statement:
YEAR ENDED FOR THE PERIOD
DECEMBER 31, AUGUST 11, 2003 TO
2004 DECEMBER 31,2003
(THOUSANDS) (THOUSANDS)
------------------- ----------------
Net sales $ 35,037 100.0% $ 10,513 100.0%
Cost of goods sold 31,116 88.8% 9,219 87.7%
-------- -------- --------- --------
Gross profit 3,921 11.2% 1,294 12.3%
Operating Expenses:
Selling, general and
administrative expenses 3,919 11.2% 1,077 10.2%
-------- -------- --------- --------
Income from operations 2 .0% 217 2.1%
Interest expense 230 .7% 9 .1%
-------- -------- --------- --------
Income(loss) before income taxes (228) (.7%) 208 2.00%
Income taxes 14 .0% 79 .8%
-------- -------- --------- --------
Net income (loss) $ (242) (.7)% $ 129 1.2%
======== ======== ========= ========
10
RESULTS OF OPERATIONS
Net Sales. Net sales for the year ended December 31, 2004 were $35,036,991. From
January 1, 2004 to August 10, 2004 net sales were $15,605,584. From August 11,
2004 to December 31, 2004 net sales were $19,431,407, as compared to net sales
of $10,513,231 for the period from August 11, 2003, the date of commencement of
operations, to December 31, 2003. The increase in sales for the period beginning
August 11, 2004 and ending December 31, 2004 primarily resulted from the sales
of new game software (Grand Theft Auto: San Andreas) and PlayStation 2 console
hardware.
Cost of Goods Sold. For the year ended December 31, 2004, cost of goods sold
totaled $31,116,020. From January 1, 2004 to August 10, 2004 cost of goods sold
were $13,339,880, or 14.5% of gross profit. From August 11, 2004 to December 31,
2004 cost of goods sold were $17,776,140, or 8.5% of gross profit, as compared
to $9,219,064 or 12.3% of gross profit for the period from August 11, 2003, the
date of commencement of operations, to December 31, 2003.
The increase in cost of sales for the period beginning August 11, 2004 and
ending December 31, 2004 was primarily due to the lack of Playstation 2 hardware
in the marketplace. The lack of hardware resulted in a decrease in demand for
game software, which in turn resulted in a decrease in profit margin from game
software.
During the fourth quarter of fiscal 2004 the Company conducted its annual
physical inventory. The physical inventory resulted in a difference with the
perpetual inventory system of approximately $269,000, which was recorded as an
expense within cost of goods sold in the accompanying financial statements and
resulted in a corresponding 0.8% decrease on our gross profit for the year ended
December 31, 2004.
Selling, General and Administrative Expenses. For the year ended December 31,
2004 selling, general and administrative expenses totaled $3,919,071, compared
to $1,077,342 for the period from August 11, 2003, the date of commencement of
operations, to December 31, 2003. The major components of selling, general and
administrative expenses for the year ended December 31, 2004 were: (i) selling
expenses, consisting primarily of salaries and commissions and salary related
expenses, of $429,112; (ii) shipping and warehouse expenses, consisting
primarily of salaries and salary related expenses and freight-out, of $637,773
and $244,610 respectively; and (iii) general and administrative expenses,
consisting primarily of salaries and salary - related expenses of $1,335,142,
and insurance, consulting fees, professional fees and rent of $698,127. Included
in professional fees are one time expenses of $163,000.
Interest expense for the year ended December 31, 2004 totaled $229,844, compared
to $9,009 for the period from August 11, 2003, the date of commencement of
operations, to December 31, 2003. Interest expense relates to the note
payable-bank and factor arrangements described below under Liquidity and Capital
Resources.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 2005 net cash used in operating
activities was $231,939. Net cash used in operations for the nine months ended
September 30, 2005 consisted of a net loss of $243,260 and included the
following changes in operating assets and liabilities: a decrease in accounts
receivable of $187,490 offset by an increase in inventory of $603,628, an
increase in due from vendors of $324,300 and an increase in accounts payable of
$487,683. The increases were the result of increased sales volume that required
higher inventory levels.
11
Net cash used in investing activities for the nine months ended September 30,
2005 was $89,172, which was primarily used for the purchase of equipment.
Net cash provided by financing activities for the nine months ended September
30, 2005 was $198,599 which primarily consisted of net proceeds on our note
payable to bank of $237,512.
For the nine months ended September 30, 2004 net cash used in operating
activities was $2,297,858. Net cash used in operations for the nine months ended
September 30, 2004 consisted of net income of $40,244 and included the following
changes in operating assets and liabilities: an increase in accounts receivable
of $808,020, a decrease in accounts payable of $2,360,738, and an increase in
amount due to factor of $1,435,304, due to advances taken during the period.
Net cash used in investing activities for the nine months ended September 30,
2004 was $68,857, which was primarily used for the purchase of equipment.
Net cash provided by financing activities for the nine months ended September
30, 2004 was $2,676,354, which consisted of gross proceeds of $4,000,000 from
the PPO and payments of issuance costs and Essential pre-acquisition liabilities
of $200,500 and $915,329, respectively.
For the year ended December 31, 2004 net cash used in operating activities was
$5,181,707. Net cash used in operations for the year ended December 31, 2004
consisted of a net loss of $241,749 and included the following changes in
operating assets and liabilities: an increase in accounts receivable of
$3,216,014, an increase in inventory of $972,128 a decrease in accounts payable
of $1,889,677 and a decrease in amount due to factor of $1,283,854.
Net cash used in investing activities for the year ended December 31, 2004 was
$987,330, of which $68,952 was used for the purchase of equipment and $915,329
was used for the payment of Essential's pre-acquisition liabilities.
Net cash provided by financing activities for the year ended December 31, 2004
was $5,732,789 which consisted primarily of gross proceeds of $4,000,000 from
the Offering, less payments of issuance costs of $200,500, payments of merger
expenses of $111,963, repayment of long term obligations of $271,624, payment of
deferred financing costs of $50,000 and net proceeds on our note payable to bank
of $2,366,876.
In December 2003, AllianceCorner entered into a factoring arrangement with
Rosenthal & Rosenthal, Inc. ("Rosenthal"), a commercial factor. As set forth in
the next paragraph, this factoring arrangement was replaced with a Financing
Agreement on November 11, 2004. Under the factoring arrangement as in effect
through November 11, 2004, the Company sold a substantial portion of its trade
receivables up to maximum credit limits established by the factor for each
individual account. Receivables sold in excess of these limitations were subject
to recourse in the event of non-payment by the customer. The Company paid
interest at the prime lending rate plus 1.5% for advances made prior to the
collection of the factored accounts receivable. Substantially all of the
Company's assets were pledged as collateral under the factoring agreement. The
Company was required to maintain a specified level of net worth, as defined.
On June 29, 2004 the Company received $2,884,171 in net proceeds from the sale
of 1,124,767 shares of Series A 6% Convertible Non-Redeemable Preferred Shares
of Essential ("Series A 6% Preferred Shares) in a private placement (the
"Offering"). At the same time, substantially all outstanding debt of the Company
was extinguished through either conversion into an aggregate of 452,202 shares
of Series A 6% Preferred Shares or through cash payments.
The Company has entered into a financing agreement with Rosenthal & Rosenthal,
Inc. ("Rosenthal") dated November 11, 2004 and amended on November 1, 2005 (the
"Agreement"). Under the Agreement, Rosenthal may in its discretion lend to the
Company up to $10,000,000, which is the maximum credit under the facility, based
on eligible inventory and receivables. All borrowings are due on demand, are
secured by substantially all of the assets of the Company and are subject to the
Company's compliance with certain financial covenants. The Company's CEO and the
Company's President have signed limited guaranties in respect of borrowings
under the Agreement.
12
The amendment dated November 1, 2005 among other things increased the maximum
credit under the facility from $5,000,000 to $10,000,000 and reduced the
interest rate on borrowings by 0.5%.
The Agreement terminates November 30, 2007 unless terminated by Rosenthal on 30
days' notice. Interest accrues on outstanding borrowings at the prime rate (but
not less than 4.75%) plus 1.5%. At September 30, 2005, the interest rate on
borrowings outstanding was 8.75%. In addition, the Company will pay the lender
on each anniversary date an annual fee of 1% of the maximum credit which is
amortized over one year, and a monthly administrative fee of $1,000. The
financing expense for the annual fee recorded for the three and nine months
ended September 30, 2005 amounted to $12,500 and $37,500, respectively. At
September 30, 2005, the principal amount outstanding under the facility was
$2,604,388.
In connection with the Agreement, the Company issued to Rosenthal a warrant (the
"Warrant") to purchase 500,000 shares of common stock at $0.10 per share. The
Warrant expires on November 30, 2010. On notice by the Company the Warrants will
expire earlier if the closing price of the common stock during a period
designated in the Warrants is not less than $0.40 per share. The Warrants may be
exercised for cash or on a cashless basis (i.e., by deducting from the number of
shares otherwise issuable on exercise a number of shares that have a then market
value equal to the exercise price). The Company recorded a deferred financing
cost of approximately $60,000 in the fourth quarter 2004, representing the fair
value of the warrants, which will be amortized over the life of the financing
agreement of three years. The financing expense recorded for the three and nine
months ended September 30, 2005 amounted to $4,500 and $13,500, respectively.
Under the terms of the Agreement, the Company is required to maintain a
specified level of net worth, working capital and debt ratios as defined. In May
2005, Rosenthal informed the Company that it did not comply with a financial
covenant under the Agreement for the fourth quarter of 2004. Rosenthal has
provided a waiver for this failure to comply. In addition, for the first and
second quarter of 2005, the Company did not comply with certain financial
covenants for which Rosenthal has also provided waivers. On October 31, 2005,
the Company and Rosenthal agreed to amend the covenants, effective September 30,
2005. Based upon this amendment, the Company was in compliance with all of its
covenants at September 30, 2005.
The Company believes that it will have sufficient liquidity for the next twelve
months and the foreseeable future. However, the Company would be materially and
adversely affected if Rosenthal demands payment of these borrowings under the
Agreement and the Company is unable to refinance these borrowings.
CRITICAL ACCOUNTING POLICIES
Certain of the Company's accounting policies require the application of
significant judgment by management in selecting the appropriate assumptions for
calculating financial estimates. By their nature, these judgments are subject to
an inherent degree of uncertainty. These judgments are based on historical
experience, observation of trends in the industry, information provided by
customers and information available from other outside sources, as appropriate.
Critical accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of products to
customers as title and risk of loss pass upon shipment and collectibility is
reasonably assured. Provisions for estimated uncollectible discounts and rebates
to customers, estimated returns and allowances and other adjustments are
provided for in the same period the related sales are recorded. While such
amounts have been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same rates as
in the past.
Accounts Receivable - Accounts Receivable as shown on the Balance Sheet are net
of allowances and anticipated discounts. The Company establishes credit terms
for new clients based upon management's review of their credit information and
projects terms, performs ongoing credit evaluations of its customers, adjusting
credit terms when management believes appropriate based upon payment history and
an assessment of their current credit worthiness. The allowance for doubtful
accounts is determined through analysis of the aging of accounts receivable at
the date of the financial statements for estimated losses resulting from the
inability of its clients to make required payments. The Company determines this
13
allowance by considering a number of factors, including the length of time trade
accounts receivable are past due, previous loss history, estimate of the
client's current ability to pay its obligation to the Company, and the condition
of the general economy and the industry as a whole. While credit losses have
generally been within expectations and the provisions established, the Company
cannot guarantee that credit loss rates in the future will be consistent with
those experienced in the past. In addition, the Company has credit exposure if
the financial condition of one of its major clients were to deteriorate. In the
event that the financial condition of its clients were to deteriorate, resulting
in an impairment of their ability to make payments, additional allowances may be
necessary. It is reasonably possible that the Company's estimate of the
allowance for doubtful accounts will change. The Company increased its allowance
for doubtful accounts by $100,000 during the first quarter of 2005 and maintains
a balance of approximately $133,000 at September 30, 2005.
Inventories - Inventory is stated at the lower of cost or market, cost being
determined on the average cost basis. Write-downs for slow moving and aged
merchandise are provided based on historical experience and current product
demand. The Company evaluates the adequacy of the write-downs quarterly. While
write-downs have been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same level of
write-downs as in the past.
LONG TERM OBLIGATIONS
The following table represents certain contractual commitments associated with
operating agreements, obligations to financial institutions and other long-term
debt obligations as of December 31, 2004:
Payment Due by Period (in thousands)
-----------------------------------------------------------------
Less than 1 Over
Total Year 1-3 Years 4-5 Years 5 Years
------------ ----------- --------- --------- -------
Long-term Obligations $ 60 $ 28 $ 32 -- --
Long-term Obligations
interest 2 1 1 -- --
Lease Commitments 991 178 371 202 240
Line of credit 2,367 2,367 -- -- --
Line of credit
interest 194 194 -- -- --
------------ ------------ --------- --------- -------
Totals $ 3,614 $ 2,768 $ 404 202 240
============ ============ ========= ========= =======
Long-term obligations consist of a notes payable in monthly installments of
approximately $1,200 through September 2008, including interest at varying rates
up to 5.5%, secured by related equipment with a carrying value of approximately
$49,000 and future payments of $38,203. Also, includes capital lease obligations
payable in various monthly installments of approximately $1,400 through June
2006, including interest at 5.5%, secured by related equipment with a carrying
value of approximately $26,000 and future payments of $22,843.
The Company leases showroom, office and warehouse space under operating leases
expiring from 2008 through 2013. Lease commitments include future minimum lease
payments, excluding escalation charges.
"Line of credit" in the table is shown as a less than one year obligation
because the lending bank may demand payment at any time. Interest on outstanding
borrowings is payable at a variable rate per annum, equal to the prime rate (but
not less than 4.75%) plus 2.00%. "Line of credit interest" in the table assumes
that the principal amount outstanding on the line is paid in full on December
31, 2005, that the principal amount to be repaid on that date will be
$2,366,876, and assumes that the average prime rate will be 8.19%, average prime
rate of 6.19% plus 2%. The prime rate was 5.25% as of December 31, 2004.
14
SUPPLEMENTARY FINANCIAL INFORMATION
Unaudited quarterly financial information for the nine months ended September
30, 2005, and for the fiscal years ended 2004 and 2003 is set forth in the table
below:
===============================================================================================
FIRST SECOND THIRD FOURTH
NINE MONTHS ENDED SEPTEMBER 30, 2005 QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ ------------
Net sales $ 10,888,835 $ 12,224,803 $ 13,565,841 N/A
Gross profit $ 1,242,337 $ 1,070,511 $ 1,530,994
Net income (loss) available to
common stockholders $ (129,678) $ (335,803) $ 222,223
Basic earnings (loss) per share $ -- $ (0.01) $ --
Weighted average common
shares outstanding-basic 46,417,098 46,417,098 46,417,098
Diluted earnings (loss) per share $ -- $ (0.01) $ --
Weighted average common
shares outstanding-diluted 46,417,098 46,417,098 49,122,008
===============================================================================================
FIRST SECOND THIRD FOURTH
FISCAL 2004 QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ ------------
Net sales $ 7,299,641 $ 5,976,377 $ 6,924,181 $ 14,836,792
Gross profit $ 1,099,020 $ 799,780 $ 957,775 $ 1,064,396
Net income (loss) available to
common stockholders $ 139,136 $ (56,611) $ (149,100) $ (339,705)
Basic earnings (loss) per share $ 0.01 $ -- $ -- $ (0.01)
Weighted average common
shares outstanding - basic 24,679,997 24,909,581 45,572,098 46,353,742
Diluted earnings (loss) per share $ 0.01 $ -- $ -- $ (0.01)
Weighted average common
shares outstanding-diluted 24,679,997 24,909,581 45,572,098 46,353,742
===============================================================================================
FIRST SECOND THIRD FOURTH
FISCAL 2003 * QUARTER QUARTER QUARTER QUARTER
------------ ------------ ------------ ------------
Net sales N/A N/A $ 352,710 $ 10,160,521
Gross profit $ 18,526 $ 1,275,641
Net income (loss) available to
common stockholders $ (56,515) $ 256,331
Basic earnings (loss) per share $ -- $ 0.01
Weighted average common
shares outstanding-basic 24,679,997 24,679,997
Diluted earnings (loss) per share $ -- $ 0.01
Weighted average common
shares outstanding-diluted 24,679,997 24,679,997
----------
* Company commenced operations on August 11, 2003
The sum of the quarterly net earnings per share amounts may not equal the
full-year amount since the computations of the weighted average number of
common-equivalent shares outstanding for each quarter and the full year are made
independently.
15
Pro Forma Financial Information
Unaudited Pro Forma Combined Financial Information
The accompanying unaudited pro forma combined statement of operations for the
year ended December 31, 2004 and for the nine months ended September 30, 2005
give effect to the following events as if each had occurred on January 1, 2004.
The unaudited pro forma balance sheet gives effect to the following events as if
each had occurred on September 30, 2005:
o The sale of $55 million of preferred stock that accrues dividends at
3% -- Stockholders should note that, as set forth earlier in this
Information Statement, the Company has no commitment for any equity
financing, and the terms of any securities that are issued in any
financing may differ materially from the terms assumed here for the
purpose of the unaudited pro forma information;
o The anticipated application of the estimated net proceeds from the
issuance of these securities primarily for the cash portion of the
purchase price payable by the Company for the acquisition of FESCO
and for related expenses;
o The issuance of $7.5 million of preferred stock that accrues
dividends at 3% to the Sellers as the equity portion of the purchase
price payable by the Company for the acquisition of FESCO based on
an assumed minimum purchase price of $70 million; and
o The issuance of $12.5 million 3-year subordinated promissory notes
(the "Acquisition Notes") as the note portion of the purchase price
payable by the Company for the acquisition of FESCO.
The acquisition of FESCO will be accounted for using the purchase method of
accounting. Under the purchase method of accounting, the amount by which the
purchase price exceeds the assets acquired, is allocated to intangible assets
which includes amortizable customer lists and covenants not to compete and
unamortizable goodwill. Pending analysis after the closing, the Company has for
the purpose of the pro forma statements estimated that 30% of the amount by
which the purchase price exceeds the assets acquired will be allocable to
amortizable intangible assets and that the balance will be allocable to
goodwill. The Company's analysis may result in differences from these estimates
and in the pro forma amounts reflected in the unaudited pro forma combined
financial statements.
The unaudited pro forma combined financial statements are based on assumptions
that the Company believes are reasonable under the circumstances. They are not
necessarily indicative of our future financial position or results of operations
that would have actually occurred had the acquisition of FESCO taken place as of
the dates or for the periods presented.
16
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
PRO FORMA PRO FORMA
ALLIANCE FESCO ADJUSTMENTS COMBINED
------------ ------------ ------------ ------------
Net sales $ 35,037 $ 132,038 $ -- $ 167,075
Cost of goods sold 31,116 116,802 -- 147,918
------------ ------------ ------------ ------------
Gross profit 3,921 15,236 -- 19,157
Selling, general and
administrative expenses 3,919 6,084 469 (1) 13,980
3,508 (2)
------------ ------------ ------------ ------------
Income from operations 2 9,152 (3,977) 5,177
Interest expense, net 230 210 668 (3) 1,108
------------ ------------ ------------ ------------
Income (loss) before provision
for income tax (228) 8,942 (4,645) 4,069
Provision for income taxes 14 611 1,003 (4) 1,628
------------ ------------ ------------ ------------
Net income (loss) (242) 8,331 (5,648) 2,441
Preferred stock dividends 164 -- 1,875 (5) 2,039
------------ ------------ ------------ ------------
Net income (loss) available to
common share $ (406) $ 8,331 $ (7,523) $ 402
============ ============ ============ ============
Net income (loss) per share - basic $ (0.01) $ 0.01
Net income (loss) per share -
diluted $ (0.01) $ 0.01
Shares used in the calculation of
income (loss) per share:
Basic 35,623,457 35,623,457
Diluted 35,623,457 (6) 35,873,457
See accompanying notes to Unaudited Pro Forma Combined Financial Statements
17
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
PRO FORMA PRO FORMA
ALLIANCE FESCO ADJUSTMENTS COMBINED
------------ ------------ ------------ ------------
Net sales $ 36,679 $ 90,862 $ -- $ 127,541
Cost of goods sold 32,835 79,812 -- 112,647
------------ ------------ ------------ ------------
Gross profit 3,844 11,050 -- 14,894
Selling, general and administrative
expenses 3,739 3,844 352 (7) 10,566
2,631 (8)
------------ ------------ ------------ ------------
Income from operations 105 7,206 (2,983) 4,328
Interest expense (income), net 340 (156) 650 (9) 834
------------ ------------ ------------ ------------
Income (loss) before provision for
income tax (235) 7,362 (3,633) 3,494
Provision for income taxes 8 489 901 (10) 1,398
------------ ------------ ------------ ------------
Net income (loss) (243) 6,873 (4,534) 2,096
Preferred stock dividends -- -- 1,406 (11) 1,406
------------ ------------ ------------ ------------
Net income (loss) available to
common share $ (243) $ 6,873 $ (5,940) $ 690
============ ============ ============ ============
Net income (loss) per share - basic $ (0.01) $ 0.01
Net income (loss) per share -
diluted $ (0.01) $ 0.01
Shares used in the calculation of
income (loss) per share:
Basic 46,417,098 46,417,098
Diluted 46,417,098 (12) 46,679,003
See accompanying notes to Unaudited Pro Forma Combined Financial Statements
18
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
SEPTEMBER 30, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
PRO FORMA PRO FORMA
ALLIANCE FESCO ADJUSTMENTS COMBINED
------------ ------------ ------------ -----------
Assets
Current Assets:
Cash $ 98 $ 293 $ 50,855 (13) $ 1,096
(50,150)(15)
Accounts receivable, net of allowance for doubtful accounts 3,083 8,023 11,106
Inventory 4,472 15,742 20,214
Marketable securites -- 48 48
Due from vendors 358 -- 358
Prepaid expenses and other current assets 191 109 (41)(15) 259
Prepaid pension costs -- 66 66
Due from related parties:
Mortgage note -- 4,500 (4,500)(14) --
Other receivables -- 2,255 (2,255)(14) --
------------ ------------ ------------ -----------
Total current assets 8,202 31,036 (6,091) $ 33,147
Property and equipment, net 402 659 1,061
Other assets 76 211 287
Intangible assets -- -- 17,538 (15) 17,538
Goodwill -- -- 40,921 (15) 40,921
------------ ------------ ------------ -----------
$ 8,680 $ 31,906 $ 52,368 $ 92,954
============ ============ ============ ===========
Liabilities and Stockholders' Equity
Current Liabilities:
Notes payable-bank $ 2,605 6,800 9,405
Current portion of Acquisition notes -- -- 4,167 (15) 4,167
Accounts payable 3,062 4,723 7,785
Current portion of long term obligations 23 3 26
Accrued expenses and other current liabilities 153 733 886
Customer prepayments -- 95 95
Income taxes payable -- 1,061 1,061
Due to related party -- 103 (103)(14) --
Due to stockholders -- 4,573 (4,573)(14) --
------------ ------------ ------------ -----------
Total current liabilities 5,843 18,091 (509) 23,425
Long term obligations 15 4 19
Deferred lease obligation 24 -- 24
Acquisition notes -- -- 8,333 (15) 8,333
Stockholders' equity:
Series A Convertible Non-Redeemable Preferred Stock,
$.001 par value, Authorized, 8,672,020 shares;
issued and outstanding, 403,335 shares -- -- -- --
Preferred Stock, $.001 par value, Authorized, 62,500 shares;
issued and outstanding, 62,500 shares -- -- -- --
Common Stock, $.001 par value, Authorized, 100,000,000 shares;
issued and outstanding 46,417,098 shares 46 60 (60)(15) 46
Additional paid-in capital 3,202 118 50,855 (13) 61,557
7,382 (15)
Retained earnings (accumulated deficit) (450) 13,600 (2,079)(14) (450)
(11,521)(15)
Accumulated other comprehensive income -- 33 (33)(15) --
------------ ------------ ------------ -----------
Total stockholders' equity 2,798 13,811 44,544 61,153
------------ ------------ ------------ -----------
$ 8,680 $ 31,906 $ 52,368 $ 92,954
============ ============ ============ ===========
See accompanying notes to Unaudited Pro Forma Combined Financial Statements
19
Notes to Unaudited Pro Forma Combined Financial Statements
Year Ended December 31, 2004 Unaudited Pro Forma Combined Statement of
Operations
(1) Reflects the adjustment of rent expense based on the new lease signed in
conjunction with the Acquisition Agreement.
(2) Reflects the adjustment for amortization expense of customer lists and
covenants not to compete acquired on the straight-line basis over five
years.
(3) Reflects the adjustment of interest expense to give effect to the
Acquisition Notes with interest at the rate of 5.34%, average prime rate
of 4.34% plus 1%.
(4) Reflects the adjustment of income tax expense to give effect to an
effective tax rate of 40%.
(5) Reflects the adjustment of the preferred stock dividend on $62,500,000 of
Preferred Stock at 3% assumed to be paid in cash.
(6) Includes the dilutive effect of 500,000 outstanding warrants and does not
include any conversions of Preferred Stock.
Nine Months Ended September 30, 2005 Unaudited Pro Forma Combined Statement of
Operations
(7) Reflects the adjustment of rent expense based on the new lease signed in
conjunction with the Acquisition Agreement.
(8) Reflects the adjustment for amortization expense of customer lists and
covenants not to compete acquired on the straight-line basis over five
years.
(9) Reflects the adjustment of interest expense to give effect to the
Acquisition Notes with interest at the rate of 6.93%, average prime rate
of 5.93% plus 1%.
(10) Reflects the adjustment of income tax expense to give effect to an
effective tax rate of 40%.
(11) Reflects the adjustment of the preferred stock dividend on $62,500,000 of
Preferred Stock at 3% assumed to be paid in cash.
(12) Includes the dilutive effect of 500,000 outstanding warrants and does not
include any conversions of Preferred Stock.
Unaudited Pro Forma Combined Balance Sheet as of September 30, 2005
(13) Reflects the sale of $55,000,000 of Preferred Stock, par value $.001, net
of Placement Agent commissions of $3.85 million and related expenses of
$295.
(14) To eliminate FESCO assets not acquired and liabilities not assumed.
20
(15) Alliance's acquisition of FESCO will be accounted for by the purchase
method of accounting, pursuant to which the acquisition consideration is
allocated among the tangible and intangible assets in accordance with
their estimated fair values on the date of acquisition. The acquisition
consideration and estimated allocation of the acquisition consideration,
which does not reflect any purchase price adjustments based on inventory
or intangible valuations are as follows (in thousands):
Acquisition consideration:
Cash consideration paid $ 50,000
Issuance of Acquisition Notes 12,500
Issuance of $7,500,000 of Preferred Stock 7,500
Transaction related fees 191
------------
Total acquisition consideration $ 70,191
============
Net assets acquired $ 11,732
Estimated amount allocated to customer lists and
covenants not to compete related to the acquisition 17,538
Estimated goodwill related to the acquisition 40,921
------------
$ 70,191
============
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of changes in value of a financial instrument,
derivative or non-derivative, caused by fluctuations in interest rates, foreign
exchange rates and equity prices. The Company has no financial instruments that
give it exposure to foreign exchange rates or equity prices.
The Company's pre-tax earnings and cash flows are exposed to changes in interest
rates as all borrowings under its credit facility bear interest at the prime
rate (but not less than 4.75%) plus 2.0%. A hypothetical 10% adverse change in
such rates would reduce the pre-tax earnings and cash flow for the year ended
December 31, 2004 by approximately $16,000 over a one-year period, assuming the
borrowing level remains consistent with the outstanding borrowings as of
December 31, 2004. The fair value of the borrowings under the credit facility is
not affected by changes in market interest rates.
21
APPROVAL REQUIRED
The approval of a majority of the outstanding stock entitled to vote on the
Record Date was necessary to approve the proposed amendment. As of the Record
Date there were issued and outstanding 47,368,756 shares of Common Stock and
346,663 Series A Preferred Shares convertible into 5,515,408 shares of common
stock for a total of 52,884,164 shares eligible to vote. Each share of common
stock entitles the holder thereof to one vote on each matter that may come
before a meeting of the shareholders. Each Series A Preferred Share is
convertible into 15.91 shares of common stock (on a pre 2006 Reverse Stock Split
basis), votes with the common stock as one class on as converted basis, and
otherwise ranks equally with the common stock on a pari passu as converted
basis. As discussed above, stockholders and a proxy holder with voting authority
for stock representing 32,565,220 shares, out of a total of 52,884,164 shares
entitled to vote, or approximately 62%, of the Company's total voting power,
have consented in writing to the proposed amendment to the Certificate of
Incorporation. The Company does not intend to solicit any proxies or consents
from any other stockholders in connection with these actions.
Documents Incorporated by Reference
Information on "Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure" is incorporated herein by reference to the Company's
report on Form 8-K filed with the Securities and Exchange Commission on July 14,
2004.
22
EXHIBIT A
CERTIFICATE OF AMENDMENT
OF
CERTIFICATE OF INCORPORATION
OF
ALLIANCE DISTRIBUTORS HOLDING INC.
Alliance Distributors Holding Inc., a corporation organized and existing under
and by virtue of the General Corporation Law of the State of Delaware, does
hereby certify:
1. This Certificate of Amendment to the Certificate of Incorporation of the
Corporation has been duly adopted pursuant to the provisions of Section
242 of the Delaware General Corporation Law.
2. Article Four (a) of the Certificate of Incorporation is amended to read in
its entirety as follows:
"(a) The total number of shares of stock which the Corporation shall
have the authority to issue is [_____] shares of Common Stock, par
value $.001 per share ("Common Stock"), and 10,000,000 shares of
Preferred Stock, par value $.001 per share ("Preferred Stock").
IN WITNESS WHEREOF, said Alliance Distributors Holding Inc. has caused this
certificate to be signed by its Chief Executive Officer this day of [________],
200[ ].
Alliance Distributors Holding Inc.
By:___________________________________
Jay Gelman, Chief Executive Officer
EXHIBIT B
INDEX
ALLIANCE DISTRIBUTORS HOLDING INC. (FORMERLY ESSENTIAL REALITY, INC.)
Report of Independent Registered Public Accounting Firm F - 1
Balance Sheet as of December 31, 2004 F - 2
Statements of Operations for the year ended December 31, 2004
and for the Period from May 9, 2003 (Inception) to
December 31, 2003 F - 3
Statements of Stockholders' Equity for the year ended
December 31, 2004 and for the Period from May 9, 2003
(Inception) to December 31, 2003 F - 4
Statements of Cash Flows for the year ended December 31, 2004
and for the Period from May 9, 2003 (Inception) to
December 31, 2003 F - 5 to F - 6
Notes to Financial Statements F - 7 to F - 15
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Stockholders
Alliance Distributors Holding Inc.
(Formerly Essential Reality, Inc.)
We have audited the accompanying balance sheet of Alliance Distributors Holding
Inc. (formerly Essential Reality, Inc.) as of December 31, 2004, and the related
statements of operations, stockholders' equity and cash flows for the year ended
December 31, 2004 and the period from May 9, 2003 (inception) to December 31,
2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Alliance Distributors Holding
Inc. (formerly Essential Reality, Inc.) as of December 31, 2004, and the results
of its operations and its cash flows for the year ended December 31, 2004 and
the period from May 9, 2003 (inception) to December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Mahoney Cohen & Company, CPA, P.C.
New York, New York
March 9, 2005
F - 1
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC.)
Balance Sheet
December 31, 2004
ASSETS
Current assets:
Cash $ 220,605
Accounts receivable, net of allowance for doubtful
accounts of approximately $37,000 3,370,559
Inventory 3,868,335
Due from vendors 34,248
Prepaid expenses and other current assets 177,441
--------------
Total current assets 7,671,188
Property and equipment, net 409,374
Other assets 76,800
--------------
$ 8,157,362
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable-bank $ 2,366,876
Accounts payable 2,574,642
Current portion of long term obligations 28,056
Accrued expenses and other current liabilities 114,212
--------------
Total current liabilities 5,083,786
Long term obligations 31,788
Deferred lease obligation 17,597
Commitments and contingencies
Stockholders' equity:
Series A Convertible Non-Redeemable Preferred Stock,
$.001 par value - Authorized, 8,833,334 shares;
issued and outstanding, 564,649 shares 564
Common stock, $.001 par value - Authorized, 100,000,000
shares; Issued and outstanding 43,850,740, shares 43,851
Additional paid-in capital 3,186,240
Accumulated deficit (206,464)
--------------
Total stockholders' equity 3,024,191
--------------
$ 8,157,362
==============
See notes to financials statements.
F - 2
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC.)
Statements of Operations
For the Year Ended December 31, 2004 and
For the Period from May 9, 2003 (Inception) to December 31, 2003
2004 2003
-------------- --------------
Net sales $ 35,036,991 $ 10,513,231
Cost of goods sold 31,116,020 9,219,064
-------------- --------------
Gross profit 3,920,971 1,294,167
Selling, general and administrative expenses 3,919,071 1,077,342
-------------- --------------
Income from operations 1,900 216,825
Interest expense 229,844 9,009
-------------- --------------
Income (loss) before provision for income taxes (227,944) 207,816
Provision for income taxes 13,805 8,000
-------------- --------------
Net income (loss) (241,749) 199,816
Preferred stock dividends 164,531 --
-------------- --------------
Net loss available to common shareholders $ (406,280) $ 199,816
============== ==============
Net income (loss) per share - Basic and diluted $ (.01) $ .01
============== ==============
Basic and diluted weighted-average
common shares outstanding 35,873,457 24,679,997
============== ==============
See notes to financial statements.
F - 3
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC)
Statements of Stockholders' Equity
For the Year Ended December 31, 2004
and For the Period from May 9, 2003 (Inception) to December 31, 2003
Preferred Stock A Preferred Stock B Common Stock
---------------------------- ---------------------------- -----------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Balance, May 9, 2003 (Inception) -- $ -- -- $ -- -- $ --
Issuance of common stock 300 300
Additional capital contribution -- -- -- -- -- --
Net income -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, January 1, 2004 -- -- -- -- 300 300
Exchange of Alliance
shares for Essential shares -- -- 1,551,314 1,551 (300) (300)
Essential shareholders' shares
prior to reverse acquisition -- -- -- -- 422,457 422
Issuance of shares in exchange
for Essential debt and Essential's
debt and liabilities assumed 452,202 452 -- -- 77,543 78
Proceeds from PPO, net of
cash issuance costs 1,124,767 1,125 -- -- -- --
Shares issued to placement
agent of PPO, net of merger
expenses of $385,000 108,146 108 -- -- -- --
Preferred stock dividend 46,200 46 -- -- -- --
Conversion of Preferred Stock B
into common stock -- -- (1,551,314) (1,551) 24,679,997 24,680
Conversion of Preferred Stock A
into common stock (1,166,666) (1,167) -- -- 18,560,743 18,561
Shares issued to settle common
stock liability -- -- -- -- 110,000 110
Warrants issued to lender -- -- -- -- -- --
Merger expenses and registration
fees -- -- -- -- -- --
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2004 564,649 $ 564 -- $ -- 43,850,740 $ 43,851
============ ============ ============ ============ ============ ============
Retained
Additional Earnings Total
Paid In (Accumulated Stockholders'
Capital Deficit) Equity
------------ ------------ ------------
Balance, May 9, 2003 (Inception) $ -- $ -- $ --
Issuance of common stock -- -- 300
Additional capital contribution 435,715 -- 435,715
Net income -- 199,816 199,816
------------ ------------ ------------
Balance, January 1, 2004 435,715 199,816 635,831
Exchange of Alliance
shares for Essential shares (1,251) -- --
Essential shareholders' shares
prior to reverse acquisition (422) -- --
Issuance of shares in exchange
for Essential debt and Essential's
debt and liabilities assumed (1,068,428) -- (1,067,898)
Proceeds from PPO, net of
cash issuance costs 3,798,375 -- 3,799,500
Shares issued to placement
agent for PPO, net of merger
expenses of $385,000 (108) -- --
Preferred stock dividend 164,485 (164,531) --
Conversion of Preferred Stock B
into common stock (23,129) -- --
Conversion of Preferred Stock A
into common stock (17,394) -- --
Shares issued to settle common
stock liability 32,090 -- 32,200
Warrants issued to lender 60,000 -- 60,000
Merger expenses and registration
fees (193,693) -- (193,693)
Net loss -- (241,749) (241,749)
------------ ------------ ------------
Balance, December 31, 2004 $ 3,186,240 $ (206,464) $ 3,024,191
============ ============ ============
See notes to financial statements
F - 4
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC.)
Statements of Cash Flows
For the Year Ended December 31, 2004 and
For the Period from May 9, 2003 (Inception) to December 31, 2003
2004 2003
-------------- --------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ (241,749) $ 199,816
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES:
Deferred rent 13,359 4,236
Depreciation and amortization 82,950 26,928
Bad Debt expense 27,050 10,000
Interest amortization of deferred financing costs 10,833 --
CHANGES IN ASSETS AND LIABILITIES:
(Increase) decrease in assets
Accounts receivable (3,216,014) (190,864)
Due from factor 1,283,854 (1,283,854)
Inventory (972,128) 203,419
Due from vendors (19,848) (14,400)
Prepaid expenses and other current assets (64,185) (42,074)
Increase (decrease) in liabilities
Accounts payable (1,889,677) 1,500,465
Accrued expenses and other current
liabilities (195,241) 187,900
-------------- --------------
Net cash provided by (used in)
operating activities (5,181,707) 601,752
-------------- --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment (68,952) (130,044)
Increase in other assets (3,049) (18,334)
Payments for pre-acquisition liabilities (915,329) --
-------------- --------------
Net cash used in investing activities (987,330) (148,378)
-------------- --------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from sale of securities 4,000,000 --
Proceeds from note payable - bank 10,018,726 --
Repayments of note payable - bank (7,651,850) --
Payments for issuance costs (200,500) --
Payments for merger costs (111,963) --
Repayment of long-term obligations (271,624) (11,827)
Capital contribution -- 200,000
Proceeds from notes payable -- 15,306
Payment of deferred financing costs (50,000) --
-------------- --------------
Net cash provided by financing activities 5,732,789 203,479
-------------- --------------
NET INCREASE (DECREASE) IN CASH (436,248) 656,853
CASH, beginning of period 656,853 --
-------------- --------------
CASH, end of year $ 220,605 $ 656,853
============== ==============
See notes to financial statements
F - 5
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC.)
Statements of Cash Flows (Continued)
For the Year Ended December 31, 2004 and
For the Period from May 9, 2003 (Inception) to December 31, 2003
2004 2003
-------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 148,413 $ 4,009
============== ==============
Income tax paid - S Corporation related taxes $ 19,222 $ --
============== ==============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Inventory financed by accounts payable $ -- $ 3,099,626
============== ==============
Fair market value of property and equipment contributed $ -- $ 276,138
Capitalized lease obligations assumed $ -- (27,277)
Notes payable assumed $ -- (12,896)
-------------- --------------
Net capital contributed $ -- $ 236,015
============== ==============
Equipment acquired under capital lease obligations $ -- $ 17,444
============== ==============
Equipment financed by note payable $ -- $ 26,674
============== ==============
Issuance of Series A 6% Preferred Stock
to placement agent $ 385,000 $ --
============== ==============
Pre-acquisition liabilities assumed $ 1,067,898 $ --
============== ==============
Series A 6% Preferred Stock dividend paid in-kind $ 164,531 $ --
============== ==============
Merger and registration costs accrued and in accounts
payable $ 81,730 $ --
============== ==============
Issuance of common stock to settle liability $ 32,200 $ --
============== ==============
Issuance of warrants to lender $ 60,000 $ --
============== ==============
See notes to financial statements
F - 6
ALLIANCE DISTRIBUTORS HOLDING INC.
(FORMERLY ESSENTIAL REALITY, INC.)
Notes to Financial Statements
Note 1 - BASIS OF PRESENTATION, ORGANIZATION AND OTHER MATTERS
Alliance Distributors Holding Inc. (the " Company" or "Alliance"), formerly
Essential Reality, Inc., is a wholesale distributor of video games, consoles,
peripherals, accessories and software to customers throughout the United States
for most key manufacturers and third party publishers in the video game
industry.
On June 17, 2004, Essential Reality, Inc, ("Essential") entered into a Share
Exchange Agreement (the "Exchange Agreement") with Jay Gelman, Andre Muller and
Francis Vegliante, who were the sole shareholders (the "Shareholders") of
AllianceCorner Distributors Inc., a privately held, wholesale distributor
incorporated in New York ("AllianceCorner"). Alliance had no prior affiliation
with Essential and commenced operations in August 2003. Pursuant to the Exchange
Agreement, Essential on June 29, 2004 acquired all the outstanding capital stock
of AllianceCorner from the Shareholders in exchange for 1,551,314 Series B
Convertible Non Redeemable Preferred Shares ("Series B Preferred Shares"). As a
result of the acquisition, the business of Alliance is Essential's only
business. The transaction was accounted for as a reverse acquisition as of June
30, 2004 and the pre-acquisition financial statements of AllianceCorner are
treated as historical financial statements of the combined companies. As the
transaction was accounted for as a reverse acquisition into a public shell, no
goodwill has been recorded and the costs incurred have been accounted for as a
reduction of additional paid-in capital. As a result of the reverse acquisition:
(i) the historical financial statements of Essential for periods prior to the
date of the transaction are not presented and (ii) because AllianceCorner is the
accounting acquirer, Essential's historical stockholders' equity is not carried
forward to the merged company as of June 30, 2004. The net monetary liabilities
of Essential assumed in the transaction were approximately $153,000 after
payments of approximately $915,000.
The name of AllianceCorner Distributors, Inc. was changed to Alliance
Distributors Holding Inc. (d/b/a Alliance Distributors) after the acquisition
and Essential does business under that name. The Company operates as a single
segment.
AllianceCorner Distributors Inc., whose operations commenced in August 2003, was
incorporated as Alliance Partners, Inc. in May 2003 under the laws of the State
of New York and financed with $200,000 of equity. In September 2003, the Company
admitted a new stockholder, changed its name to AllianceCorner Distributors Inc.
and purchased substantially all of the inventory of Corner Distributors, Inc.
("Corner"), a company previously managed by the new stockholder and owned by a
relative of the stockholder, for $3,099,626.
NATURE OF BUSINESS
Essential Reality, LLC ("ER, LLC") was formed as Freedom Multimedia, LLC in the
state of Delaware on July 9, 1998 and began active operations on June 1, 1999.
The Company changed its name to ER, LLC on December 29, 1999. On June 20, 2002,
ER, LLC completed a business combination (recapitalization) with JPAL, Inc.
("JPAL"), a Nevada Corporation (the "Transaction") whereby, all of the members
of ER, LLC contributed their membership interests in ER, LLC to JPAL in exchange
for shares of the JPAL's common stock. Following the Transaction, JPAL changed
its name to Essential Reality, Inc.
On November 6, 2003 the Board of Directors of the Company resolved to
discontinue the sales of the P5(TM) Unit, a virtual controller, because of the
lack of capital and the ability to raise additional funds and resolved to pursue
the Exchange Agreement with AllianceCorner.
PRIVATE PLACEMENT OFFERING
As part of the Exchange Agreement with AllianceCorner, Essential was required to
raise funds to complete the transaction. Essential offered 1,124,767 shares of
Series A 6% Convertible Non Redeemable Preferred Shares (the "Series A Preferred
Shares"), through a private placement offering ("PPO"). The PPO resulted in
gross proceeds of $4,000,000 and net proceeds to the Company of $3,799,500 less
$915,329 for payments of Essential's liabilities. At the same time,
substantially all outstanding debt of Essential was extinguished through either
conversion into an aggregate of 452,202 Series A Preferred Shares or through
cash payments.
Sunrise Securities Corp. ("Sunrise") acted as the placement agent in connection
with the PPO and received (a) an $8,500 nonrefundable retainer fee; and (b) a
commission consisting of 108,146 shares of Series A Preferred Shares and 5 year
warrants due June 29, 2009 to purchase 1,564,096 shares of common stock at an
exercise price of $.22. (See Stockholders' Equity section below).
STOCKHOLDERS' EQUITY
Each share of common stock entitles the holder thereof to one vote on each
matter that may come before a meeting of the shareholders. Any Series A
Preferred Share or Series B Preferred Share entitles the holder to 15.9090
votes, and votes as one class with the common stock.
In the Exchange Agreement, the Shareholders agreed to vote their Series B
Preferred Shares in favor of an amendment to the Company's Articles of
Incorporation that would increase the number of authorized shares of common
stock from 50,000,000 to 4,400,000,000 (the "Amendment"), and in favor of a
simultaneous reverse split of the common stock on the basis of one share for
forty-four shares to 100,000,000
F - 7
authorized shares (the "Reverse Split"). These actions became effective on
November 22, 2004 and all share and per share data included in these financial
statements have been retroactively adjusted for the split.
The Series A Preferred Shares were entitled to a dividend in kind, upon
conversion, accruing at the rate of 6% per annum from June 29, 2004 until the
effectiveness of the Amendment, November 22, 2004. The Company issued 46,200
additional shares of Series A that converted into 735,000 shares of common stock
and recorded a preferred dividend in the amount of $164,531.
The adoption of the Amendment and the Reverse Split resulted in the automatic
conversion of each Series A Preferred Share and each Series B Preferred Share
into 15.91 shares of common stock. However, Series A Preferred Shares owned by a
holder were not to be converted into common stock if and so long as a result of
conversion the holder would beneficially own in excess of 4.999% or 9.999% of
the issued and outstanding shares, respectively. Any Series A Preferred Shares
not converted into the Company's common stock due to the operation of this
restriction (the "4.999% Restriction") will no longer be entitled to the 6%
dividend referred to above.
As of December 31, 2004, the Series A Preferred Shares were converted into
18,560,743 shares of common stock and the Series B Preferred Shares were
converted into 24,679,997 shares of common stock so that there was a total of
43,850,740 issued and outstanding shares of common stock. The warrant issued to
Sunrise Securities Corp. is exercisable into 1,564,096 shares of common stock.
The shares of the Company's common stock issued as a result of the conversion on
November 22, 2004, the common stock underlying the Series A Preferred Shares and
the warrants were entitled to registration rights and the Company filed Form
SB-2 on December 23, 2004.
After giving effect to the transactions contemplated by the Exchange Agreement,
the Reverse Split and the PPO and to the conversion of all Series A Preferred
Shares and Series B Preferred Shares, but not giving effect to warrants issued
to the Placement Agent in connection with the PPO and to the 4.999% Restriction,
the former shareholders of Alliance collectively own 24,679,997 shares of common
stock, or approximately 48% of the outstanding common stock of the Company,
investors in the PPO own approximately 18,685,005 shares of common stock , or
approximately 36% of the outstanding common stock of the Company, investors
converting outstanding debt of Essential in the PPO own 6,135,007 shares of
common stock, or approximately 12% of the outstanding common stock of the
Company, the Placement Agent owns 1,720,505 shares of common stock, or
approximately 3% of the outstanding common stock of the Company and shareholders
who owned Essential shares prior to the PPO own approximately 500,000 shares of
common stock, or approximately 1% of the outstanding common stock of the
Company. Investors in the PPO paid the equivalent of $.22 per share.
Certain holders of Series A Preferred Shares (the "Proxy Grantors") have granted
to Jay Gelman an irrevocable proxy (the "Voting Proxy") to vote 544,591 Series A
Preferred Shares which includes the 6% stock dividend issued on November 22,
2004 owned by them and any shares of common stock into which such Series A
Preferred Shares are converted. After conversion, the Series A Preferred Shares
owned by the Proxy Grantors will be entitled in the aggregate to 8,663,949
votes. Subsequent to December 31, 2004, due to sales of stock by some of the
Proxy Grantors, this was reduced to 7,974,326 votes.
The three former Shareholders of Alliance each owned Series B Preferred Shares
representing 15.8% of the Company's total voting power (the total number of
votes that can be cast by the outstanding common stock, Series A Preferred
Shares and Series B Preferred Shares). Mr. Gelman, as of December 31, 2004,
based on his Series B Preferred Shares and his voting rights pursuant to the
Voting Proxy, had 31.9% of the Company's total voting power. On February 16,
2005 this was 30.66%. The Shareholders in the aggregate as of December 31, 2004
had approximately 63% of the Company's total voting power and control the
Company. On March 11, 2005, one of the shareholders sold 4 million shares
reducing the voting power to 54.23%.
In connection with the Exchange Agreement, the former shareholders of Alliance
have agreed not to dispose of any of their Series B Preferred Shares (or any of
their shares of the Company's common stock received by them upon conversion of
the Series B Preferred Shares) for a period of one year from the closing of the
Exchange Agreement unless approval is obtained through methods defined in the
Exchange Agreement.
Subsequent to December 31, 2004, there were 161,314 shares of Series A Preferred
Shares converted into 2,566,358 shares of common stock; as a result, as of
February 23, 2005, the shares issued and outstanding were 403,335 of Series A
Preferred Shares and 46,417,098 of common stock.
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 reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Significant estimates reflected in these financial statements relate primarily
to bad debt reserves on accounts receivable.
Allowance for Doubtful Accounts
The Company provides an allowance for doubtful accounts equal to estimated
uncollectible accounts. The Company's estimate is based on a regular review of
individual account balances over 90 days, historical collection experience and
consideration of other factors such as a
F - 8
customer's financial status and other business risk. It is reasonably possible
that the Company's estimate of the allowance for doubtful accounts will change.
The Company established allowances of $37,000 at December 31, 2004.
Inventory
Inventory consists entirely of finished goods held for sale and is reported at
the lower of cost or market, on the average cost basis. At times, the Company
makes advance payments to vendors to procure and ensure delivery of certain high
demand products. Such deposits are reflected as due from vendors in the balance
sheet.
Property and Equipment
Property and equipment is recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance and repairs are
charged to expense as incurred. Assets held under capital leases are recorded at
the lower of the net present value of the minimum lease payments or the fair
value of the leased assets at the inception of the lease. Leasehold improvements
are amortized over the lesser of the lease terms or the assets' useful lives.
When property and equipment is retired or otherwise disposed of, the cost and
accumulated depreciation are removed from the accounts and any resulting gain or
loss is included in the results of operations for the respective period.
Depreciation and amortization is provided over the estimated lives of the
related assets using the straight-line method. The estimated useful lives for
significant property and equipment categories are as follows:
Vehicles 4 years
Warehouse equipment 3 to 7 years
Office furniture and equipment 3 to 7 years
Leasehold improvements 5 to 10 years
Impairment of Long-Lived Assets
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No.
144 requires that long-lived assets, including property and equipment, be
reviewed for impairment whenever events or changes in circumstances indicate
that their carrying amount may not be recoverable. The Company assesses its
assets for impairment based on the estimated future undiscounted cash flows
expected to result from the use of the asset and records impairment losses when
this amount is less than the carrying amount. Impairment losses are recorded for
the excess of the assets' carrying amount over their fair value, which is
generally determined based on the estimated future discounted cash flows over
the remaining useful life of the asset using a discount rate determined by
management at the date of the impairment review. Management believes at this
time that the carrying value and useful life of long-lived assets continue to be
appropriate.
Deferred Rent
The Company accounts for scheduled rent increases contained in its leases on a
straight-line basis over the non-cancellable lease term.
Revenue Recognition
The Company recognizes sales upon shipment of products to customers as title and
risk of loss pass upon shipment and collectibility is reasonably assured.
Provisions for estimated discounts and rebates to customers, estimated returns
and allowances and other adjustments are provided for in the same period the
related sales are recorded.
Income Taxes
AllianceCorner, with the consent of its stockholders, elected to have its income
taxed under the provisions of Subchapter S of the Internal Revenue Code and the
corresponding provisions of New York State Tax laws. Under the aforementioned
provisions, corporate income or loss and any tax credits earned are included in
the stockholders' individual federal and state income tax returns. Accordingly,
no provision has been made for federal income taxes for the period from May 9,
2003 (inception) to June 29, 2004. AllianceCorner was subject to New York State
S corporation taxes and New York City corporate income taxes. The provision for
income taxes for this period comprises state and local taxes.
Effective June 29, 2004, the Company is taxed as a C corporation.
The Company follows SFAS No. 109 "Accounting for Income Taxes" and accounts for
income taxes using the liability method which requires the recognition of
deferred tax assets or liabilities for the temporary differences between the
financial reporting and tax bases of the Company's assets and liabilities and
for tax carryforwards at enacted statutory rates in effect for the years in
which the differences are expected to reverse. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date. In addition, valuation allowances are established when necessary
to reduce deferred tax assets to the amounts expected to be realized.
F - 9
Shipping and Handling
The Company includes shipping and handling revenues in net sales. For the year
ended December 31, 2004 and for the period from May 9, 2003 (inception) to
December 31, 2003, shipping and handling revenues were approximately $166,000
and $48,000, respectively. The Company includes shipping and handling costs in
selling, general and administrative expense. For the year ended December 31,
2004 and for the period from May 9, 2003 (inception) to December 31, 2003, the
Company incurred approximately $245,000 and $144,000,of such costs,
respectively.
Advertising Expenses
Advertising expenses are charged to operations in the period in which they are
incurred. Advertising expenses for the year ended December 31, 2004 and for the
period from May 9, 2003 (inception) to December 31, 2003 were approximately
$35,000 and $5,000, respectively.
Fair Value of Financial Instruments
The carrying amounts of significant financial instruments, which includes
accounts receivable, accounts payable and accrued expenses, approximated fair
value as of December 31, 2004 and 2003 due to their short-term maturities.
Advances from the factor and borrowings under the financing agreement
approximate fair value due to their variable interest rate.
Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for the
reporting and display of comprehensive income and its components in the
financial statements. As of December 31, 2004 and 2003, the Company has no items
that represent other comprehensive income.
Net Income Per Share
Basic net income per share is computed by dividing net income by the weighted
average number of common shares outstanding for the period. Diluted net income
per share is computed by dividing the net income by the weighted average number
of common shares and common equivalent outstanding during the period. The
weighted average number of common and common equivalent shares outstanding
reflects the conversion of preferred stock for common stock as of June 29, 2004
(see Note 1) and the 1 for 44 stock split, which occurred in November 2004.
Common equivalents at December 31, 2004 exclude the 500,000 of warrants issued
to the Company's lender, since their effect would be anti-dilutive. There were
no common equivalents at December 31, 2003.
Stock Based Compensation
In March 2005, the Company established a stock option plan (See Note 11). The
Company accounts for stock based employee compensation arrangements under the
intrinsic value method pursuant to APB Opinion No. 25, "Accounting for Stock
Issued to Employees". There were no options issued as of December 31, 2004.
Accordingly, no compensation expense was recorded in the financial statements
with respect to option grants.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of ARB No. 43, Chapter 4". SFAS No. 151 retains the general principle of ARB 43,
Chapter 4, "Inventory Pricing (AC Section I78)", that inventories are presumed
to be stated at cost; however, it amends ARB 43 to clarify that abnormal amounts
of idle facility expense, freight, handling costs, and wasted materials
(spoilage) should be recognized as current-period charges and require the
allocation of fixed production overheads to inventories based on the normal
capacity of the production facilities. The guidance is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. Earlier
application is permitted for inventory costs incurred during fiscal years
beginning after November 23, 2004. The Company does not anticipate the adoption
SFAS No. 151 will have a significant impact on the Company's overall results of
operations or financial position.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 20, Accounting for Nonmonetary
Transactions". The amendments made by SFAS 153 are based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged. Further, the amendments eliminate the narrow exception for
nonmonetary exchanges of similar productive assets and replace it with a broader
exception for exchanges of nonmonetary assets that do not have commercial
substance. A nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result of the
exchange. This statement, shall be applied prospectively and is effective for
nonmonetary asset exchanges occurring in fiscal periods beginning after June 15,
2005. Earlier application is permitted for nonmonetary asset exchanges occurring
in fiscal periods beginning after the date of issuance. The Company does not
anticipate that the adoption of SFAS 153 will have a significant impact on
F - 10
the Company's overall results of operations or financial position.
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". This
statement revises FASB Statement No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123(R) focuses primarily on the accounting for transactions
in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires companies to recognize in the statement
of operations the cost of employee services received in exchange for awards of
equity instruments based on the grant-date fair value of those awards (with
limited exceptions). This Statement, for small business issuers is effective as
of the first reporting period that begins after December 15, 2005. Accordingly,
the Company will adopt SFAS 123(R) in its first quarter of fiscal 2006. The
Company is currently evaluating the provisions of SFAS 123(R) and has not yet
determined the impact that this Statement will have on its future results of
operations or financial position. Since the Company had no options outstanding,
there would be no impact of this new standard, if it had been in effect, on the
net earnings and related per share data amounts of our fiscal years ended 2004
and 2003.
Note 3 - CONCENTRATIONS OF CREDIT RISK AND MAJOR SUPPLIERS
Cash
The Company maintains cash balances at two banks. Accounts at each institution
are insured by the Federal Deposit Insurance Corporation up to $100,000.
Accounts Receivable
Concentrations of credit risk with respect to accounts receivable are limited
because a large number of geographically diverse customers make up the Company's
customer base, thus spreading the trade credit risk. The Company controls credit
risk through credit approvals, credit limits and monitoring procedures. The
Company performs credit evaluations of its customers but generally does not
require collateral to support accounts receivable. The Company's bad debt
experience has been within management's expectations.
Major Suppliers
Other than the purchase of inventory acquired from Corner (see Note 1), for the
period from May 9, 2003 (inception) to December 31, 2003, two suppliers
accounted for approximately 22% of purchases. For the year ended December 31,
2004 three suppliers accounted for approximately 50% of purchases. Management
believes that other suppliers could provide the materials on comparable terms.
At December 31, 2004, the amount due to these suppliers was approximately $
1,339,000 and is included in accounts payable on the accompanying balance sheet.
If a significant supplier terminates or modifies its relationship with the
Company future results could be materially and adversely affected.
Note 4 - PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2004 consists of:
Leasehold improvements $ 239,742
Office furniture and equipment 105,187
Warehouse equipment 54,863
Vehicles 52,226
Equipment under capital leases 67,234
-----------
519,252
Less: Accumulated depreciation
and amortization 109,878
-----------
$ 409,374
===========
Depreciation and amortization expense amounted to $82,950 and $26,928 for the
year ended December 31, 2004 and for the period May 3, 2003 (Inception) to
December 31, 2003, respectively.
F - 11
Note 5 - FINANCING AGREEMENTS
In December 2003, the Company entered into a factoring arrangement with a
commercial factor, Rosenthal & Rosenthal, Inc. ("Rosenthal"). Up to November
2004, the Company sold a substantial portion of its trade receivables up to
maximum credit limits established by the factor for each individual account.
Receivables sold in excess of these limitations were subject to recourse in the
event of non-payment by the customer. Under the terms of the agreement, the
Company paid interest at the prime lending rate plus 1.5% for advances made
prior to the collection of the factored accounts receivable. Substantially all
of the Company's assets were pledged as collateral under the factoring
agreement.
On November 11, 2004, Alliance entered into a Financing Agreement which replaced
the factoring agreement with Rosenthal. Under the Agreement, Rosenthal may in
its discretion lend up to $5,000,000 to Alliance based on eligible inventory and
receivables. All borrowings are due on demand, are secured by substantially all
of the assets of Alliance and are subject to the Company's compliance with
certain financial covenants. The Company's CEO and the Company's President
signed limited guaranties in respect of borrowings under the Agreement.
The Agreement terminates November 30, 2007 unless terminated by Rosenthal on 30
days' notice. Interest on outstanding borrowings is payable at a variable rate
per annum, equal to the prime rate (but not less than 4.75 %) plus 2.00 % (7.25
% as of December 31, 2004). In addition, the Company will pay the lender on each
anniversary date an annual fee of 1% of the Maximum Credit of $5,000,000 in the
amount of $50,000 which is amortized over one year, and a monthly administrative
fee of $1,000. The financing expense for the annual fee recorded for the year
ended December 31, 2004 amount to $6,250. At December 31, 2004, the loan
outstanding amounted to $2,366,876.
In connection with the Agreement, the Company issued to Rosenthal a warrant (the
"Warrant") to purchase 500,000 shares of common stock at $0.10 per share. The
Warrant expires on November 30, 2010. On notice by the Company the Warrants will
expire earlier if the closing price of the common stock during a period
designated in the Warrants is not less than $0.40 per share. The Warrants may be
exercised for cash or on a cashless basis (i.e., by deducting from the number of
shares otherwise issuable on exercise a number of shares that have a then market
value equal to the exercise price). The Company recorded a deferred financing
cost of approximately $60,000 in the fourth quarter, representing the fair value
of the warrants, which will be amortized over the life of the financing
agreement of three years. The financing expense recorded for the year December
31, 2004 amounted to approximately $5,000.
Under the terms of the agreements, the Company is required to maintain a
specified level of net worth, working capital and debt ratios as defined. At
December 31, 2004 the Company is in compliance with these covenants.
Note 6 - LONG TERM OBLIGATIONS
At December 31, 2004, long-term obligations consist of:
Notes payable in monthly installments
of approximately $1,200 through
September 2008, including interest at
varying rates up to 5.5%, secured by
related equipment with a carrying
value of approximately $49,000 $ 38,203
Capital lease obligations payable in
various monthly installments of
approximately $1,400 through June
2006, including interest at 5.5%,
secured by related equipment with a
carrying value of approximately
$26,000 22,843
----------
61,046
Less: Amount representing interest 1,202
----------
59,844
Less: Current portion 28,056
----------
$ 31,788
==========
At December 31, 2004, future payments of long-term obligations are as follows:
Year Ending
December 31,
------------
2005 $ 30,350
2006 18,551
2007 8,130
2008 4,015
---------
$ 61,046
=========
F - 12
Note 7 - INCOME TAXES
The components of the provision for income taxes are as follows:
2004 2003
--------- ---------
Current tax expense:
Federal $ -- $ --
State and local 13,805 8,000
--------- ---------
Total $ 13,805 $ 8,000
========= =========
The Company was taxed as an S Corporation for federal and state purposes for
2003 and for the period January 1, 2004 through June 29, 2004. As such, the
Company's tax provision for this period include New York City taxes, which are
determined as if the Company was a C Corporation. New York City does not
recognize S Corporations. For the period the Company was a C Corporation during
2004, the Company incurred a federal, state and local net operating loss, which
was fully reserved by valuation allowance.
The Company accounts for income taxes using the liability method which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between the financial reporting and tax bases of the Company's
assets and liabilities and for tax carryforwards at enacted statutory rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized. The Company has not recorded income tax expense or benefit as a
result of its available net operating loss carryforwards, which are fully
reserved by a valuation allowance because management does not believe that is it
more likely than not that the deferred tax assets will be utilized.
Significant components of the Company's net deferred income taxes are as follows
at December 31, 2004:
Long-term deferred tax assets:
Net operating loss carryforwards $ 2,100,000
Other 24,000
------------
Total deferred tax assets 2,124,000
Less: Valuation allowance 2,124,000
------------
Net deferred tax assets $ --
============
At December 31, 2004, the Company had federal and state net operating loss
carryforwards of approximately $5,000,000. The federal net operating loss
carryforwards expire through the year 2024 and the state net operating loss
carryforwards expire through 2016. The Company has established a valuation
allowance of $2,124,000 at December 31, 2004 due to the uncertainty surrounding
the realization of such assets. The Tax Reform Act of 1986 contains provisions
that limit the ability to utilize net operating loss carryforwards in the case
of certain events including significant changes in ownership interests. The
Company has not evaluated whether it has undergone an ownership change pursuant
to this act. Based upon the terms of the Exchange agreement, an ownership change
may have occurred. If such ownership changes are found to exist, the net
operating loss carryforwards as reported could be significantly limited.
Note 8 - RETIREMENT PLAN
The Company sponsors a 401(k) contributory plan (the "Plan") for the benefits of
employees who are at least 21 years of age. The Company's management determines,
at its discretion, any annual contributions. The Company elected not to
contribute to the Plan for the year ended December 31, 2004 and for the period
from May 9, 2003 (inception) to December 31, 2003.
F - 13
Note 9 - WARRANTS
All of the warrants granted in conjunction with secured convertible debentures
and notes payable were cancelled as of June 29, 2004.
The Company has outstanding 3 year warrants, which expire on June 20, 2005, with
an exercise price of $57.20 to purchase 7,528 shares of common stock issued to
the financial consultants associated with the JPAL deal on June 20, 2002.
Pursuant to the PPO, the Company issued Sunrise 5 year warrants which expire on
June 29, 2009 to purchase 1,564,096 shares of common stock with an exercise
price of $0.22 per share. (See Note 1)
On November 11, 2004, in connection with the new Financing Agreement, the
Company issued warrants to purchase 500,000 shares of common stock at $0.10 per
share. (See Note 5)
Note 10 - COMMITMENTS AND CONTINGENCIES
Leases
The Company leases showroom, office and warehouse space under operating leases
expiring from 2008 through 2013. The future minimum lease payments, excluding
escalation charges, are as follows:
Year Ending
December 31,
------------
2005 $ 178,000
2006 183,000
2007 188,000
2008 131,000
2009 71,000
Thereafter 240,000
----------
$ 991,000
==========
In accordance with Statement of Financial Accounting Standards No. 13,
"Accounting for Leases," non-cancellable operating leases with scheduled rent
increases require that rent expense be recognized on a straight-line basis over
the lease term. Rent expense for the year ended December 31, 2004 and for the
period from May 9, 2003 (inception) to December 31, 2003 includes approximately
$14,000 and $4,000, respectively, which relates to the amortized portion of the
scheduled rent increases. At December 31, 2004 an obligation of approximately
$18,000 representing future deferred rent payments is reflected in the
accompanying balance sheet.
Total rent expense charged to operations for the year ended December 31, 2004
and for the period from May 9, 2003 (inception) to December 31, 2003 was
approximately $191,000 and $46,000, respectively.
Employment Agreement
On July 26, 2004, the Chief Executive Officer of Alliance signed an employment
agreement for two years with annual compensation of $300,000 per year for the
first year and $350,000 for the second year, and at the discretion of the Board
of Directors, bonuses equal to his salary. In addition, he will receive a
monthly car allowance in the amount of $750 per month.
The Employment Agreement also provides for the Board of Directors to award
discretionary bonuses to Mr. Gelman in an amount equal to his salary. In the
event of a termination of Mr. Gelman's employment by the Company other than for
Cause, as defined under the Employment Agreement, or by Mr. Gelman for Good
Reason, as defined under the Employment Agreement, Mr. Gelman will be entitled
to a lump sum payment equal to three times his base salary for the period from
the date of termination through June 30, 2006. The Employment Agreement contains
a 12-month non-compete provision effective following termination, except for
termination by the Company other than for Cause, or Good Reason by Mr. Gelman.
The Employment Agreement also contains customary confidentiality provisions.
Litigation
On August 19, 2004 a complaint was filed by Radio Wave LLC ("Plaintiff"), in the
Supreme Court of the State of New York, County of New York, against ER, LLC,
Essential and David Devor, a former officer and a current employee of the
Company, for rent, additional rent, cost and
F - 14
fees relating to premises formerly occupied by the Company. Plaintiff seeks to
recover $150,416 for the period up to August 31, 2004, plus additional amounts
to be determined by the Court for the period subsequent to August 31, 2004.
Plaintiff also seeks to recover $50,000 in expenses and attorney fees plus
additional amounts to be determined by the Court. The Company believes that the
suit is without merit and intends to vigorously defend its position.
Note 11 - SUBSEQUENT EVENT
As of March 14, 2005, the Board of Directors of the Company granted a total of
7,550,000 non-statutory options under the Company's Alliance Distributors
Holding Inc. 2004 Stock Plan. The options are ten-year non-qualified options to
purchase the Company's common stock, 7,400,000 of the options have an exercise
price of $0.3250 per share and 150,000 of the options have an exercise price of
$.32 per share, vest and become exercisable in 12 equal quarterly installments
beginning on April 1, 2005. Of the total options granted, 1,100,000 options were
granted to Jay Gelman, the CEO and Chairman of the Board of Directors of the
Company, 1,100,000 options were granted to Andre Muller, the President, COO and
a director of the Company, and 150,000 options were granted to each of Thomas
Vitiello, Steven H. Nathan and Humber B. Powell, III, each a non-employee
director of the Company. The options were granted in reliance on the exemption
from registration provided by Section 4(2) of the Securities Act of 1933, as
amended.
The board also agreed as compensation for the directors to serve as members of
the Board, each member receives annual compensation of $6,000 to attend four
regular meetings a year. No fee will be payable for any other meeting.
Note 12-FOURTH QUARTER ADJUSTMENT
During the fourth quarter of fiscal 2004 the Company conducted its annual
physical inventory. The physical inventory resulted in a difference with the
perpetual inventory system of approximately $269,000, which was recorded as an
expense within cost of sales in the accompanying financial statements.
The Company determined that approximately $198,000 of the difference was due to
an error in the perpetual inventory system which did not properly update certain
sales transactions. The balance was related to shrinkage.
F - 15
Exhibit C
Consent of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Alliance Distributors Holding Inc.:
We hereby consent to the use in the Information Statement Pursuant to Section
14(c) of our report dated March 9, 2005, relating to the financial statements of
Alliance Distributors Holding Inc. (formerly Essential Reality, Inc.), which are
included in this Information Statement.
/s/ Mahoney Cohen & Company, CPA, P.C.
New York, New York
January 17, 2006
EXHIBIT D
INDEX
ALLIANCE DISTRIBUTORS HOLDING INC.
Balance Sheet as of September 30, 2005 (Unaudited) F - 1
Statements of Operations for the three and nine months
ended September 30, 2005 and 2004 (Unaudited) F - 2
Statement of Stockholders' Equity for the nine months
ended September 30, 2005 (Unaudited) F - 3
Statements of Cash Flows for the nine months
ended September 30, 2005 and 2004 (Unaudited) F - 4
Notes to Financial Statements (Unaudited) F - 5 to F - 9
ALLIANCE DISTRIBUTORS HOLDING INC.
Balance Sheet (Unaudited)
September 30, 2005
ASSETS
Current assets:
Cash $ 98,093
Accounts receivable, net of allowance for doubtful
accounts of approximately $133,000 3,083,069
Inventory 4,471,963
Due from vendors 358,548
Prepaid expenses and other current assets 190,822
--------------
Total current assets 8,202,495
Property and equipment, net 401,952
Other assets 75,800
--------------
$ 8,680,247
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable-bank $ 2,604,388
Accounts payable 3,062,325
Current portion of long term obligations 22,701
Accrued expenses and other current liabilities 153,004
--------------
Total current liabilities 5,842,418
Long term obligations 14,480
Deferred lease obligation 24,169
Commitments and contingencies
Stockholders' equity:
Series A Convertible Non-Redeemable Preferred Stock,
$.001 par value - Authorized, 8,672,020 shares;
issued and outstanding, 403,335 shares 403
Common Stock, $.001 par value - Authorized, 100,000,000
shares; issued and outstanding 46,417,098 shares 46,417
Additional paid-in capital 3,202,084
Accumulated deficit (449,724)
--------------
Total stockholders' equity 2,799,180
--------------
$ 8,680,247
==============
See notes to financial statements.
F-1
ALLIANCE DISTRIBUTORS HOLDING INC.
Statements of Operations (Unaudited)
For the three and nine months ended September 30, 2005 and 2004
Three months ended September 30, Nine months ended September 30,
------------------------------- --------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
Net sales $ 13,565,841 $ 6,924,181 $ 36,679,480 $ 20,200,199
Cost of goods sold 12,034,847 5,966,406 32,835,637 17,363,624
-------------- -------------- -------------- --------------
Gross profit 1,530,994 957,775 3,843,843 2,836,575
Selling, general and administrative expenses 1,187,227 980,454 3,739,033 2,704,112
-------------- -------------- -------------- --------------
Income (loss) from operations 343,767 (22,679) 104,810 132,463
Interest expense 119,198 20,444 339,621 81,052
-------------- -------------- -------------- --------------
Income (loss) before provision for income taxes 224,569 (43,123) (234,811) 51,411
Provision for income taxes 2,346 -- 8,449 11,167
-------------- -------------- -------------- --------------
Net income (loss) 222,223 (43,123) (243,260) 40,244
Preferred stock dividends -- 105,977 -- 106,819
-------------- -------------- -------------- --------------
Net income (loss) available to common stockholders $ 222,223 $ (149,100) $ (243,260) $ (66,575)
============== ============== ============== ==============
Net income (loss) available to common stockholders
per share - Basic $ .00 $ .00 $ (.01) $ .00
============== ============== ============== ==============
Net income (loss) available to common stockholders
per share - Diluted $ .00 $ .00 $ (.01) $ .00
============== ============== ============== ==============
Weighted-average common shares outstanding-Basic 46,417,098 45,572,098 46,417,098 31,771,112
============== ============== ============== ==============
Weighted-average common shares outstanding-Diluted 49,122,008 45,572,098 46,417,098 31,771,112
============== ============== ============== ==============
See notes to financial statements.
F-2
ALLIANCE DISTRIBUTORS HOLDING INC.
Statement of Stockholders' Equity (Unaudited)
For the nine months ended September 30, 2005
Preferred Stock A Common Stock Additional Total
--------------------------- --------------------------- Paid In Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Equity
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance, January 1, 2005 564,649 $ 564 43,850,740 $ 43,851 $ 3,186,240 $ (206,464) $ 3,024,191
Conversion of Preferred
Stock A into Common Stock (161,314) (161) 2,566,358 2,566 (2,405) -- --
Registration costs -- -- -- -- (16,250) -- (16,250)
Issuance of stock options
to non-employees -- -- -- -- 34,499 -- 34,499
Net loss -- -- -- -- -- (243,260) (243,260)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2005 403,335 $ 403 46,417,098 $ 46,417 $ 3,202,084 $ (449,724) $ 2,799,180
============ ============ ============ ============ ============ ============ ============
See notes to financial statements.
F-3
ALLIANCE DISTRIBUTORS HOLDING INC.
Statements of Cash Flows
For the nine months ended September 30, 2005 and 2004 (Unaudited)
Nine months ended September 30,
--------------------------------
2005 2004
-------------- --------------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income (loss) $ (243,260) $ 40,244
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH USED IN OPERATING ACTIVITIES:
Deferred rent 6,572 10,021
Depreciation and amortization 84,094 58,081
Bad debt expense 100,000 --
Stock option compensation expense 34,499 --
Amortization of deferred financing costs 51,000 --
CHANGES IN ASSETS AND LIABILITIES:
(Increase) decrease in assets
Accounts receivable 187,490 (808,020)
Inventory (603,628) (135,450)
Due from vendors (324,300) (262,773)
Prepaid expenses and other current assets (50,881) (22,110)
Increase (decrease) in liabilities
Accounts payable 487,683 (2,360,738)
Due to factor -- 1,435,304
Accrued expenses and other current
liabilities 38,792 (252,417)
-------------- --------------
Net cash used in operating activities (231,939) (2,297,858)
-------------- --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment (76,672) (65,635)
Increase in other assets (12,500) (3,222)
-------------- --------------
Net cash used in investing activities (89,172) (68,857)
-------------- --------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from note payable - bank 36,369,314 --
Repayments of note payable - bank (36,131,802) --
Proceeds from sale of securities -- 4,000,000
Payments for registration and issuance costs (16,250) (200,500)
Payments for merger costs -- (35,988)
Payments for pre-acquisition liabilities -- (915,329)
Repayment of long-term obligations (22,663) (171,829)
-------------- --------------
Net cash provided by financing activities 198,599 2,676,354
-------------- --------------
NET INCREASE (DECREASE) (122,512) 309,639
CASH, beginning of period 220,605 656,853
-------------- --------------
CASH, end of period $ 98,093 $ 966,492
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 289,077 $ 81,052
============== ==============
Income tax paid $ 7,373 $ 19,222
============== ==============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of Series A 6% Preferred Stock to placement
agent $ -- $ 385,000
============== ==============
Liabilities assumed $ -- $ 1,067,898
============== ==============
Series A 6% Preferred Stock dividend $ -- $ 106,819
============== ==============
Merger costs accrued $ -- $ 60,480
============== ==============
See notes to financial statements.
F-4
ALLIANCE DISTRIBUTORS HOLDING INC.
Notes to Financial Statements (Unaudited)
Note 1 - BASIS OF PRESENTATION, ORGANIZATION AND OTHER MATTERS
Alliance Distributors Holding Inc. (the "Company" or "Alliance") is a
distributor of video game consoles, peripherals, accessories and software to
customers throughout the United States for most key manufacturers and third
party publishers in the video game industry.
On June 17, 2004, the Company (formerly Essential Reality, Inc. "Essential")
entered into a Share Exchange Agreement (the "Exchange Agreement") with Jay
Gelman, Andre Muller and Francis Vegliante, who were the sole shareholders (the
"Shareholders") of AllianceCorner Distributors Inc., a privately held, wholesale
distributor incorporated in New York ("AllianceCorner"). AllianceCorner had no
prior affiliation with Essential and commenced operations in August 2003.
Pursuant to the Exchange Agreement, Essential on June 29, 2004 acquired all the
outstanding capital stock of AllianceCorner from the Shareholders in exchange
for 1,551,314 Series B Convertible Non Redeemable Preferred Shares ("Series B
Preferred Shares"). As a result of the acquisition, the business of Alliance is
Essential's only business. The transaction was accounted for as a reverse
acquisition as of June 30, 2004 and the pre-acquisition financial statements of
AllianceCorner are treated as historical financial statements of the combined
companies. As the transaction was accounted for as a reverse acquisition into a
public shell, no goodwill has been recorded and the costs incurred have been
accounted for as a reduction of additional paid-in capital. As a result of the
reverse acquisition: (i) the historical financial statements of Essential for
periods prior to the date of the transaction are not presented and (ii) because
AllianceCorner is the accounting acquirer, Essential's historical stockholders'
equity is not carried forward to the merged company as of June 30, 2004.
The name of AllianceCorner was changed to Alliance Distributors Holding, Inc.
("New York Alliance") in July 2004. Effective November 17, 2004, New York
Alliance was merged into Alliance Distributors Holding Inc., a Delaware
corporation that was wholly owned by Essential. Effective November 22, 2004,
Essential reincorporated in Delaware and changed its name to Alliance
Distributors Holding Inc., by way of a merger of Essential into Alliance
Distributors Holding Inc., which was then a wholly owned Delaware subsidiary of
Essential. The Company operates as a single segment.
On July 21, 2005, the Company and Abrams/Gentile Entertainment Inc. ("Age")
entered into an operating agreement ("Agreement") in which the Company and Age
became members in Alliance Age LLC, a limited liability company formed in
Delaware, to set forth the terms on which the parties will develop and
commercialize products they mutually agree upon from time to time. The Company
agreed to pay Age a $4,000 monthly retainer fee on the first day of each month
commencing August 2005, provided, that no fee is payable for any month beginning
with January 2006 upon a determination that no products are then proceeding
towards completion at a proper pace. The Company owns 65% of Alliance Age LLC.
As of September 30, 2005, Alliance Age LLC was inactive and no monthly retainer
fees have yet been paid.
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted. This Form 10-QSB should be read in conjunction with the
Company's financial statements and notes included in the 2004 Annual Report on
Form 10-KSB. In the opinion of management, all material adjustments, consisting
of normal recurring adjustments, considered necessary for a fair presentation,
have been included in the accompanying unaudited financial statements.
The results of operations for the interim periods are not necessarily indicative
of the results that maybe expected for the full year ending December 31, 2005.
PRIVATE PLACEMENT OFFERING
As part of the Exchange Agreement with AllianceCorner, Essential was required to
raise funds to complete the transaction. Essential sold 1,124,767 shares of
Series A 6% Convertible Non Redeemable Preferred Shares (the "Series A Preferred
Shares"), through a private placement offering ("PPO"). The PPO resulted in
gross proceeds of $4,000,000 and net proceeds to the Company of $3,799,500. At
the same time, substantially all outstanding debt of Essential was extinguished
through either issuance by the Company of an aggregate of 452,202 Series A
Preferred Shares or through cash payments which totaled $915,329.
Sunrise Securities Corp. ("Sunrise") acted as the placement agent in connection
with the PPO and received (a) an $8,500 nonrefundable retainer fee; and (b) a
commission consisting of 108,146 shares of Series A Preferred Shares and 5 year
warrants due June 29, 2009 to purchase 1,564,096 shares of common stock at an
exercise price of $.22. (See Stockholders' Equity section below).
STOCKHOLDERS' EQUITY
Each share of common stock entitles the holder thereof to one vote on each
matter that may come before a meeting of the shareholders. Any Series A
Preferred Share or Series B Preferred Share entitles the holder to 15.91 votes,
and votes as one class with the common stock.
F-5
In the Exchange Agreement, the Shareholders agreed to vote their Series B
Preferred Shares in favor of an amendment to the Company's Articles of
Incorporation that would increase the number of authorized shares of common
stock from 50,000,000 to 4,400,000,000 (the Amendment"), and in favor of a
simultaneous reverse split of the common stock on the basis of one share for
forty-four shares to 100,000,000 authorized shares (the "Reverse Split"). These
actions became effective on November 22, 2004 and all share and per share data
included in these financial statements have been retroactively adjusted for the
split.
The Series A Preferred Shares were entitled to a dividend in kind, upon
conversion, accruing at the rate of 6% per annum from June 29, 2004 until the
effectiveness of the Amendment, November 22, 2004. The Company issued 46,200
additional shares of Series A Preferred Shares that converted into 735,000
shares of common stock and recorded a preferred dividend in the amount of
$164,531.
The adoption of the Amendment and the Reverse Split resulted in the automatic
conversion of each Series A Preferred Share and each Series B Preferred Share
into 15.91 shares of common stock. However, Series A Preferred Shares owned by a
holder were not to be converted into common stock if as a result of such
conversion the holder would beneficially own in excess of 4.999% or 9.999% of
the issued and outstanding shares ("4.999% Restriction"). Series A Preferred
Shares not converted into the Company's common stock due to the operation of the
4.999% Restriction are not entitled to the 6% dividend referred to above.
As of September 30, 2005, there were 46,417,098 shares of common stock issued
and outstanding consisting of 24,679,997 shares of common stock issued upon
conversion of all of the Series B Preferred Shares, 21,127,101 shares of common
stock issued upon conversion of 1,327,980 shares of the Series A Preferred
Shares, 110,000 shares of common stock issued in payment of liabilities and
500,000 shares of common stock issued and outstanding prior to June 2004.
As of September 30, 2005 there were issued and outstanding 403,335 shares of
Series A Preferred Shares convertible into 6,417,060 shares of common stock
subject to the 4.999% Restriction. Subsequent to September 30, 2005, 159,416
shares of Series A Preferred Stock were converted into 2,536,309 shares of
Common Stock.
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Allowance for Doubtful Accounts
The Company establishes credit terms for new clients based upon management's
review of their credit information and projects terms, performs ongoing credit
evaluations of its customers, adjusting credit terms when management believes
appropriate based upon payment history and an assessment of their current credit
worthiness. The Company records an allowance for doubtful accounts for estimated
losses resulting from the inability of its clients to make required payments.
The Company determines this allowance by considering a number of factors,
including the length of time trade accounts receivable are past due, previous
loss history, estimate of the client's current ability to pay its obligation to
the Company, and the condition of the general economy and the industry as a
whole. While credit losses have generally been within expectations and the
provisions established, the Company cannot guarantee that credit loss rates in
the future will be consistent with those experienced in the past. In addition,
the Company has credit exposure if the financial condition of one of its major
clients were to deteriorate. In the event that the financial condition of its
clients were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be necessary. It is reasonably possible that
the Company's estimate of the allowance for doubtful accounts will change. The
Company increased its allowance for doubtful accounts by $100,000 during the
first quarter of 2005 and maintains a balance of approximately $133,000 as of
September 30, 2005.
Major Customer
For the nine months ended September 30, 2005, one customer accounted for
approximately 12% of the Company's sales.
Inventory
Inventory consists entirely of finished goods held for sale and is reported at
the lower of cost or market, on the average cost basis. Write-downs for slow
moving and aged merchandise are provided based on historical experience and
current product demand. The Company evaluates the adequacy of the write-downs
quarterly. While write-downs have been within expectations and the provisions
established, the Company cannot guarantee that it will continue to experience
the same level of write-downs as in the past. At times, the Company makes
advance payments to vendors to procure and ensure delivery of certain high
demand products. Such deposits are reflected as due from vendors in the balance
sheet.
Income Taxes
AllianceCorner, with the consent of its stockholders, elected to have its income
taxed under the provisions of Subchapter S of the Internal Revenue Code and the
corresponding provisions of New York State Tax laws. Under the aforementioned
provisions, corporate income or loss and any tax credits earned are included in
the stockholders' individual federal and state income tax returns. Accordingly,
no provision has been made for federal income taxes for the periods prior to
June 29, 2004. Effective June 29, 2004, the Company is taxed as a C corporation.
F-6
Accordingly, AllianceCorner was subject to New York State S corporation taxes
and New York City corporate income taxes for the period prior to June 29, 2004
and as a C corporation for the period subsequent to June 30, 2004. The provision
for income tax expense for all periods presented comprises state and local
taxes.
The Company accounts for income taxes using the liability method which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between the financial reporting and tax bases of the Company's
assets and liabilities and for tax carryforwards at enacted statutory rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. In addition, valuation allowances are
established when necessary to reduce deferred tax assets to the amounts expected
to be realized.
At December 31, 2004, the Company had approximately $5,000,000 of federal and
state net operating loss carryforwards that expire through 2024. The Company has
established a full valuation allowance of $2,124,000 at December 31, 2004 due to
the uncertainty surrounding the realization of such assets. The Tax Reform Act
of 1986 contains provisions that limit the ability of an entity to utilize net
operating loss carryforwards if there has been a significant change in ownership
in the entity. The Company has not yet completed its Section 382 analysis,
however their preliminary indication is that it is likely that it has undergone
an ownership change within the meaning of the Act by reason of the Exchange
Agreement and related transactions, and that its ability to utilize the net
operating loss carryforwards may be significantly limited.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding for the period. Diluted
net income per share is computed by dividing the net income by the weighted
average number of common shares and common equivalent shares outstanding during
the period. The weighted average number of common and common equivalent shares
outstanding reflects the conversion of Series B Preferred Shares for Common
Stock as of January 1, 2004 and of Series A Preferred Shares for Common Stock as
of June 29, 2004, computed on a post Reverse Split basis (see Note 1).
Common equivalents for the three months ended September 30, 2005 include 261,905
of warrants issued to the Company's lender and 2,443,005 shares of Common Stock
that are eligible for issuance upon conversion of 153,552 Series A Preferred
Shares under the 4.999% Restriction. Common equivalents for the three months
ended September 30, 2004 and for the nine months ended September 30, 2005 and
2004 exclude 403,335 Series A Preferred Shares since their effect would be
anti-dilutive. Common equivalents for the nine months ended September 30, 2005
exclude the 500,000 of warrants that were issued to the Company's lender on
November 11, 2004 since their effect would be anti-dilutive.
Stock Based Compensation
In January 2005, the Company established a stock option plan. The Company
accounts for stock based employee compensation arrangements under the intrinsic
value method pursuant to APB Opinion No. 25, "Accounting for Stock Issued to
Employees". Under this method, compensation cost is the excess, if any, of the
quoted market price of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock. As of September 30,
2005 there were 7,400,000 options issued. The options are ten-year non-qualified
options to purchase the Company's common stock, 7,250,000 of the options have an
exercise price of $0.325 per share and 150,000 of the options have an exercise
price of $.32 per share. All of the issued options vest and become exercisable
in 12 equal quarterly installments. Of the total options granted, 1,100,000
options were granted to Jay Gelman, the CEO and Chairman of the Board of
Directors of the Company, 100,000 options were granted to Barbara A. Ras, the
CFO of the Company, 1,100,000 options were granted to Andre Muller, the
President, COO and a director of the Company, and 150,000 options were granted
to each of Thomas Vitiello, Steven H. Nathan and Humbert B. Powell, III, each a
non-employee director of the Company. The options were granted in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended.
Of the total options granted, 250,000 options were granted to a non-employee who
provided past services to the Company and 500,000 options were granted to
non-employees for future services to be provided over the next three years. The
options are ten-year non-qualified options, have an exercise price of $.325 per
share, and vest and become exercisable in twelve quarterly installments
beginning on April 1, 2005. The fair value of the options-pricing model was
calculated with the following weighted-average assumptions used for the grant:
risk-free interest rate 4.25%; expected life 6.5 years; expected volatility 55%.
During the three and nine months ended September 30, 2005, the Company recorded
stock-based compensation expense of approximately $3,833 and $34,499,
respectively, for these options. The fair value generated by the Black-Scholes
model may not be indicative of the future benefit, if any, that may be received
by the option holder.
Had compensation costs for the Company's stock option grants to employees been
determined based on the fair value at the grant dates for awards under these
plans in accordance with SFAS No. 123, the Company's net income (loss) and basic
and diluted net income (loss) per share would have been reduced to the pro forma
amounts as follows:
F-7
For the Three Months For the Nine Months
Ended September 30, 2005 Ended September 30, 2005
------------------------ ------------------------
(Unaudited) (Unaudited)
Net income (loss), as reported $ 222,223 $ (243,260)
Deduct: Total stock-based employee
compensation expense determined under fair
value based method, net of tax effects (52,916) (160,957)
----------- -----------
Proforma net income (loss) $ 169,307 $ (404,217)
=========== ===========
Net income (loss) per share:
Basic and diluted - as reported $ 0.00 $ (0.01)
=========== ===========
Basic and diluted - proforma $ 0.00 $ (0.01)
=========== ===========
There were no options outstanding at September 30, 2004.
The fair value of the options-pricing model was calculated with the following
weighted-average assumptions used for grants during the nine months ended
September 30, 2005: risk-free interest rate 4.25-4.5%; expected life 6.5 years;
expected volatility 55-126%. The fair value generated by the Black-Scholes model
may not be indicative of the future benefit, if any, that may be received by the
option holder.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". This
statement revises FASB Statement No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123(R) focuses primarily on the accounting for transactions
in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires companies to recognize in the statement
of operations the cost of employee services received in exchange for awards of
equity instruments based on the grant-date fair value of those awards (with
limited exceptions). This Statement, for small business issuers is effective as
of the beginning of the Company's next fiscal year. Accordingly, the Company
will adopt SFAS 123(R) in its first quarter of fiscal 2006. The Company is
currently evaluating the provisions of SFAS 123(R) and has not yet determined
the impact that this Statement will have on its future results of operations or
financial position. The impact of this new standard, if it had been in effect,
on the net income (loss) and related per share amounts for the three and nine
months ended September 30, 2005 is disclosed in Stock Based Compensation, above.
In May 2005, the FASB issued SFAS No. 154, "Accounting for Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS No. 154"). SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes,
and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements, and changes the requirements for the accounting for and reporting of
a change in accounting principle. This Statement applies to all voluntary
changes in accounting principle. It also applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS No. 154 becomes
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.
Note 3 - FINANCING AGREEMENTS
The Company has entered into a financing agreement with Rosenthal & Rosenthal,
Inc. ("Rosenthal") dated November 11, 2004 and amended on November 1, 2005 (the
"Agreement"). Under the Agreement, Rosenthal may in its discretion lend to the
Company up to $10,000,000, which is the maximum credit under the facility, based
on eligible inventory and receivables. All borrowings are due on demand, are
secured by substantially all of the assets of the Company and are subject to the
Company's compliance with certain financial covenants. The Company's CEO and the
Company's President have signed limited guaranties in respect of borrowings
under the Agreement.
The amendment dated November 1, 2005 among other things increased the maximum
credit under the facility from $5,000,000 to $10,000,000 and reduced the
interest rate on borrowings by 0.5%.
F-8
The Agreement terminates November 30, 2007 unless terminated by Rosenthal on 30
days' notice. Interest accrues on outstanding borrowings at the prime rate (but
not less than 4.75%) plus 1.5%. At September 30, 2005, the interest rate on
borrowings outstanding was 8.75%. In addition, the Company will pay the lender
on each anniversary date an annual fee of 1% of the maximum credit which is
amortized over one year, and a monthly administrative fee of $1,000. The
financing expense for the annual fee recorded for the three and nine months
ended September 30, 2005 amounted to $12,500 and $37,500, respectively. At
September 30, 2005, the principal amount outstanding under the facility was
$2,604,388.
In connection with the Agreement, the Company issued to Rosenthal a warrant (the
"Warrant") to purchase 500,000 shares of common stock at $0.10 per share. The
Warrant expires on November 30, 2010. On notice by the Company the Warrants will
expire earlier if the closing price of the common stock during a period
designated in the Warrants is not less than $0.40 per share. The Warrants may be
exercised for cash or on a cashless basis (i.e., by deducting from the number of
shares otherwise issuable on exercise a number of shares that have a then market
value equal to the exercise price). The Company recorded a deferred financing
cost of approximately $60,000 in the fourth quarter 2004, representing the fair
value of the warrants, which will be amortized over the life of the financing
agreement of three years. The financing expense recorded for the three and nine
months ended September 30, 2005 amounted to $4,500 and $13,500, respectively.
Under the terms of the Agreement, the Company is required to maintain a
specified level of net worth, working capital and debt ratios as defined. In May
2005, Rosenthal informed the Company that it did not comply with a financial
covenant under the Agreement for the fourth quarter of 2004. Rosenthal has
provided a waiver for this failure to comply. In addition, for the first and
second quarter of 2005, the Company did not comply with certain financial
covenants for which Rosenthal has also provided waivers. On October 31, 2005,
the Company and Rosenthal agreed to amend the covenants, effective September 30,
2005. Based upon this amendment, the Company was in compliance with all of its
covenants at September 30, 2005.
The Company believes that it will have sufficient liquidity for the next twelve
months and the foreseeable future. However, the Company would be materially and
adversely affected if Rosenthal demands payment of these borrowings under the
Agreement and the Company is unable to refinance these borrowings.
Note 4 - LITIGATION
On August 19, 2004 a complaint was filed by Radio Wave LLC ("Plaintiff"), in the
Supreme Court of the State of New York, County of New York, against Essential
Reality, LLC, Essential and David Devor, a former officer and a current employee
of the Company, for rent and costs relating to premises formerly occupied by the
Company. Plaintiff seeks to recover $150,416 for the period up to August 31,
2004, plus additional amounts to be determined by the Court for the period
subsequent to August 31, 2004. Plaintiff also seeks to recover $50,000 in
expenses and attorney fees plus additional amounts to be determined by the
Court. The Company believes that the suit is without merit and intends to
vigorously defend its position.
Note 5 - LETTER OF INTENT
In September 2005, the Company signed a non-binding letter of intent to purchase
Foto Electric Supply Co., Inc. (Fesco) for $75 million, payable $50 million in
cash, $12.5 million in notes and $12.5 million in equity securities to be valued
in relation to financing for the transaction.
Fesco is a privately held company based in New York City whose primary business
is the distribution of consumer electronics. Fesco's revenues in its most recent
fiscal year were approximately $130 million (unaudited). The Company and Fesco
are negotiating the terms of a definitive acquisition agreement. No assurances
can be given when, if ever, the proposed acquisition will close or the terms
thereof.
In connection with the possible acquisition of Fesco, the Company signed an
Engagement Agreement dated as of October 11, 2005 (the "Engagement Agreement")
with an investment banking firm ("Firm"). The Engagement Agreement provides,
among other things, that the Firm will serve as the Company's financial adviser
and exclusive placement agent for a proposed private placement of approximately
$60 million of Alliance equity securities (the "Proposed Offering"). If the
Proposed Offering is successful, the net proceeds will be used primarily to fund
the cash portion of the Fesco purchase price and related expenses. No assurances
can be given when, if ever, the Proposed Offering will close or the terms. None
of the securities to be sold in the Proposed Offering will be registered under
the Securities Act of 1933, as amended (the "1933 Act") and shall not be offered
or sold in the United States absent registration or an applicable exemption from
the registration requirements of the 1933 Act.
In connection with its agreement with the Firm, the Company agreed to issue to
them 50,000 shares of Alliance Common Stock with an estimated value of $19,500,
to pay designated success fees and warrants to them if the offering is
successfully completed, and to reimburse them for designated expenses. For
accounting purposes, these costs will be offset against any proceeds raised from
the private placement.
F-9
EXHIBIT E
FOTO ELECTRIC SUPPLY CO., INC.
Index
Page
Independent Auditor's Report F - 1
Balance Sheets as of December 31, 2004 and 2003 F - 2
Statements of Income for the years ended December 31, 2004,
2003 and 2002 F - 4
Statements of Changes in Stockholders' Equity for the years ended
December 31, 2004, 2003 and 2002 F - 5
Statements of Cash Flows for the years ended December 31, 2004,
2003 and 2002 F - 6
Notes to Financial Statements F - 7
Independent Auditor's Report
To the Board of Directors and Stockholders
of Foto Electric Supply Co., Inc.:
We have audited the accompanying balance sheets of Foto Electric Supply
Co., Inc. as of December 31, 2004 and 2003, and the related statements of
income, changes in stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the auditing standards of
the Public Company Accounting Oversight Board (United States). Those auditing
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Foto Electric Supply
Co., Inc. as of December 31, 2004 and 2003, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2004, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Leshkowitz & Company, LLP
New York, New York
December 16, 2005, except for Note 11 as to which the date is January 2, 2006
F-1
FOTO ELECTRIC SUPPLY CO., INC.
BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
ASSETS
2004 2003
------------- -------------
Current assets:
Cash $ 3,408,018 $ 814,643
Accounts receivable, less allowance for doubtful
accounts of $130,000 and $125,000, respectively 9,318,494 11,140,269
Marketable securities 39,416 32,761
Merchandise inventory 14,539,748 15,929,221
Prepaid expenses and other current assets 141,258 241,641
Prepaid pension costs 74,312 --
Due from related parties:
Mortgage note 1,500,000 --
Other receivables 3,084,455 677,040
------------- -------------
Total current assets 32,105,701 28,835,575
------------- -------------
Fixed assets, at cost:
Machinery and equipment 90,303 90,303
Furniture and fixtures 495,737 319,700
Auto and trucks 585,233 500,694
Computer equipment and software 176,724 158,152
Leasehold improvements 289,851 289,851
------------- -------------
1,637,848 1,358,700
Less accumulated depreciation and amortization 890,132 719,435
------------- -------------
Net fixed assets 747,716 639,265
Other assets:
Federal tax deposit 122,662 86,862
Security deposits 700 700
------------- -------------
Total fixed and other assets 871,078 726,827
------------- -------------
Total assets $ 32,976,779 $ 29,562,402
============= =============
The accompanying notes are an integral part of these financial statements.
F-2
LIABILITIES AND STOCKHOLDERS' EQUITY
2004 2003
------------- -------------
Current liabilities:
Current obligations under capital leases $ 10,394 $ 17,052
Accounts payable 6,961,407 9,910,455
Accrued expenses payable 594,312 393,001
Accrued pension costs -- 43,893
Customer prepayments 90,594 13,398
Income taxes payable 1,241,813 954,948
Due to related party 60,333 401,197
Due to stockholders 5,088,760 2,578,056
------------- -------------
Total current liabilities 14,047,613 14,312,000
Non-current liabilities:
Long-term obligations under capital
leases, less current portion -- 9,332
------------- -------------
Total liabilities 14,047,613 14,321,332
------------- -------------
Commitments and contingencies
Stockholders' equity:
Common stock, no par value, 200
shares authorized, issued and outstanding 60,000 60,000
Additional paid-in capital 118,000 118,000
Retained earnings 18,726,649 15,045,208
Accumulated other comprehensive income 24,517 17,862
------------- -------------
Total stockholders' equity 18,929,166 15,241,070
------------- -------------
Total liabilities and stockholders' equity $ 32,976,779 $ 29,562,402
============= =============
F-3
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------ ------------ ------------
Net sales $132,038,533 $123,459,646 $ 90,328,800
------------ ------------ ------------
Cost of goods sold:
Beginning inventory 15,929,221 12,292,002 12,268,971
Purchases, net 115,412,825 113,461,725 80,367,674
------------ ------------ ------------
131,342,046 125,753,727 92,636,645
Less ending inventory 14,539,748 15,929,221 12,292,002
------------ ------------ ------------
Cost of goods sold 116,802,298 109,824,506 80,344,643
------------ ------------ ------------
Gross profit 15,236,235 13,635,140 9,984,157
------------ ------------ ------------
Operating expenses:
Selling and warehouse 2,550,402 2,462,373 2,003,033
General and administrative 2,648,548 2,757,163 2,035,949
Interest and bank charges 274,559 180,465 366,930
Taxes, other than income taxes 128,223 123,283 103,084
Pension costs 115,889 109,077 97,088
Bad debt expense 470,476 365,622 208,002
Depreciation and amortization 170,697 146,586 126,216
------------ ------------ ------------
Total operating expenses 6,358,794 6,144,569 4,940,302
------------ ------------ ------------
Operating income 8,877,441 7,490,571 5,043,855
------------ ------------ ------------
Other income:
Special grant relating to September 11, 2001 recovery -- -- 100,000
Other 64,665 -- 6,211
------------ ------------ ------------
Total other income 64,665 -- 106,211
------------ ------------ ------------
Income before provision for income and franchise taxes 8,942,106 7,490,571 5,150,066
Provision for income and franchise taxes 610,665 503,824 406,889
------------ ------------ ------------
Net income $ 8,331,441 $ 6,986,747 $ 4,743,177
============ ============ ============
Basic and diluted net income per share $ 41,657 $ 34,934 $ 23,716
============ ============ ============
Weighted average common shares
outstanding - basic and diluted 200 200 200
============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-4
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Accumulated
Other
Common Additional Retained Comprehensive
Stock Paid-In Capital Earnings Income (Loss) Total
---------------------------------------------------------------------------------------
Balance, January 1, 2002 $ 60,000 $ 118,000 $ 7,165,284 $ 15,926 $ 7,359,210
Comprehensive income for the year
ended December 31, 2002:
Net income 4,743,177 4,743,177
Other comprehensive income:
Unrealized loss on securities (4,515) (4,515)
Minimum pension liability adjustment (12,610) (12,610)
--------------
Total comprehensive income 4,726,052
Less: Dividend distributions during the
year ended December 31, 2002 (2,100,000) (2,100,000)
--------------- ---------------- ---------------- ---------------- --------------
Balance, December 31, 2002 $ 60,000 $ 118,000 $ 9,808,461 $ (1,199) $ 9,985,262
--------------- ---------------- ---------------- ---------------- --------------
Comprehensive income for the year
ended December 31, 2003:
Net income 6,986,747 6,986,747
Other comprehensive income:
Unrealized gain on securities 6,451 6,451
Minimum pension liability adjustment 12,610 12,610
--------------
Total comprehensive income 7,005,808
Less: Dividend distributions during the
year ended December 31, 2003 (1,750,000) (1,750,000)
--------------- ---------------- ---------------- ---------------- --------------
Balance, December 31, 2003 $ 60,000 $ 118,000 $ 15,045,208 $ 17,862 $15,241,070
--------------- ---------------- ---------------- ---------------- --------------
Comprehensive income for the year
ended December 31, 2004:
Net income 8,331,441 8,331,441
Other comprehensive income:
Unrealized gain on securities 6,655 6,655
--------------
Total comprehensive income 8,338,096
Less: Dividend distributions during the
year ended December 31, 2004 (4,650,000) (4,650,000)
--------------- ---------------- ---------------- ---------------- --------------
Balance, December 31, 2004 $ 60,000 $ 118,000 $ 18,726,649 $ 24,517 $18,929,166
=============== ================ ================ ================ ==============
The accompanying notes are an integral part of these financial statements.
F-5
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------- ------------- -------------
Cash flows from operating activities:
Net income $ 8,331,441 $ 6,986,747 $ 4,743,177
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 170,697 146,586 126,216
Gain on disposition of asset (6,211)
Net change in allowance for doubtful accounts 5,000 35,000 5,000
Changes in operating assets and liabilities:
Accounts receivable 1,816,775 (3,351,717) (57,064)
Merchandise inventory 1,389,473 (3,637,219) (23,031)
Prepaid expenses and other current assets 100,383 (158,003) (16,467)
Accrued / prepaid pension costs (118,205) (74,140) 37,671
Federal tax deposit (35,800) (12,071) (4,300)
Security deposit -- -- (700)
Accounts payable (2,949,048) 3,667,410 1,110,023
Accrued expenses payable 201,311 171,626 100,981
Customer prepayments 77,196 (160,214) 173,612
Income taxes payable 286,865 240,822 203,272
------------- ------------- -------------
Net cash provided by operating activities 9,276,088 3,854,827 6,392,179
------------- ------------- -------------
Cash flows from investing activities:
Purchase of fixed assets (279,148) (111,168) (282,657)
------------- ------------- -------------
Net cash used in investing activities (279,148) (111,168) (282,657)
------------- ------------- -------------
Cash flows from financing activities:
Net decrease (increase) in amounts due from related parties:
Mortgage note (1,500,000) -- --
Other receivables (2,748,279) 538,762 299,582
Net decrease in short-term bank note -- (1,000,000) (3,894,000)
Net increase (decrease) in amounts due to stockholders 2,510,704 (787,749) (299,938)
Payment of capital lease obligations (15,990) (12,651) (123,537)
Dividend distributions to stockholders (4,650,000) (1,750,000) (2,100,000)
------------- ------------- -------------
Net cash used in financing activities (6,403,565) (3,011,638) (6,117,893)
------------- ------------- -------------
Net increase (decrease) in cash 2,593,375 732,021 (8,371)
Cash at beginning of year 814,643 82,622 90,993
------------- ------------- -------------
Cash at end of year $ 3,408,018 $ 814,643 $ 82,622
============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-6
FOTO ELECTRIC SUPPLY CO., INC.
NOTES TO FINANCIAL STATEMENTS
1) ORGANIZATION, NATURE OF OPERATIONS AND BASIS OF PRESENTATION:
Organization and Nature of Operations - Foto Electric Supply Co., Inc.
(The Company) was incorporated in the State of New York in June, 1980, and is
engaged in the sale and distribution of consumer electronics and other related
products on a wholesale basis. The Company operates as a single segment.
Basis of Presentation - The financial statements are presented on a
December 31 calendar year basis. For income tax reporting, the Company has a
fiscal year end of November 30.
2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The following summary of the Company's major accounting policies is
presented to assist in the interpretation of the financial statements:
Merchandise Inventory - The merchandise inventory is stated at the
lower of cost or market, based on the average cost method. The Company decreases
the value of inventory for estimated obsolescence equal to the difference
between the cost of inventory and the estimated net realizable value (market
value) based upon an aging analysis of the inventory on hand, specifically known
inventory-related risks, and assumptions about future demand and market
conditions.
Property and Equipment - Property and equipment are recorded at cost.
The Company calculates depreciation using primarily the straight-line method
over the useful lives of the assets which range from five to seven years.
Amortization of leasehold improvements is computed on the straight-line method
over the life of the lease or the expected useful life of the improvement
whichever is shorter. Expenditures for major renewals and improvements that
extend the useful life of property and equipment are capitalized. Expenditures
for maintenance and repairs are charged to expense as incurred. For tax
purposes, depreciation and amortization are computed in accordance with
applicable provisions of the Internal Revenue Code.
Impairment of Long-Lived Assets - The Company follows Statement of
Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 requires that long-lived assets,
including property and equipment, be reviewed for impairment whenever events or
changes in circumstances indicate that their carrying amount may not be
recoverable. The Company assesses its assets for impairment based on the
estimated future undiscounted cash flows expected to result from the use of the
asset and records impairment losses when this amount is less than the carrying
amount. Impairment losses are recorded for the excess of the assets' carrying
amount over their fair value, which is generally determined based on the
estimated future discounted cash flows over the remaining useful life of the
asset using a discount rate determined by management at the date of the
impairment review. Management believes at this time that the carrying value and
useful life of long-lived assets continue to be appropriate.
F-7
Revenue Recognition - Revenue is recognized when products are shipped
and title is passed to the customer. Vendor rebates are recorded as adjustments
to product cost in the period their collection is assured.
Shipping and Handling Costs - Shipping and handling fees related to
sales transactions are billed to customers and are recorded as sales revenue.
Shipping and handling costs incurred are recorded as a selling expense and
totaled $110,446, $120,451 and $109,252 for the years ended December 31, 2004,
2003 and 2002, respectively.
Income Taxes - Effective June 1, 1992, the Company elected to be
treated as an "S" corporation under Federal and New York State tax law. As an
"S" corporation, the Company is not subject to any Federal or New York State
income taxes, except that it is subject to the special New York State franchise
tax surcharge. Accordingly, no provision for Federal income tax has been made,
since this tax is imposed on the stockholders in proportion to their stock
ownership percentage. New York State special franchise tax, New York City
general corporation tax and New Jersey "S" corporation business tax have been
provided for in the financial statements.
Current income taxes payable at December 31, 2004 and 2003 in the
amounts of $1,241,813 and $954,948, respectively, include unpaid taxes accrued
on the current period's income, plus the effect of the timing difference
relating to prior years' income.
Deferred income taxes reflect the impact of temporary differences
between the assets and liabilities recognized for financial reporting purposes
and amounts recognized for tax purposes. The principal temporary differences
consist of different methods of depreciation, capitalization of additional
inventory costs for tax purposes and provision for bad debts versus the direct
write off method. Deferred income taxes for the period are immaterial.
Federal Tax Deposit - As part of the "S" Corporation election, the
Company was allowed to retain its fiscal year-end of November 30, in accordance
with the provisions of the Revenue Act of 1987. The election to retain a
non-December 31 fiscal year-end required that the Company establish a refundable
tax deposit account with the Internal Revenue Service. The refundable tax
deposit totaled $122,662 and $86,862 at December 31, 2004 and 2003,
respectively.
Allowance for Doubtful Accounts - The Company provides for accounts
receivable that could become uncollectible in the future by establishing an
allowance to reduce the carrying value of such receivables to their estimated
net realizable value. The Company estimates this allowance based on the specific
customer circumstances, aging of its accounts receivable and its historical
collection experience. During the years ended December 31, 2004 and 2003, the
Company wrote off $465,476 and $330,622, respectively, and increased its
allowance for doubtful accounts to $130,000 and $125,000, respectively.
Pension Plan - The Company maintains a Defined Benefit Pension Plan and
a Profit Sharing Plan covering its eligible employees (See Note 8).
Advertising Expenses - The Company expenses advertising costs as
incurred. Advertising expense for the years ended December 31, 2004, 2003 and
2002 totaled $10,402, $12,149 and $8,118, respectively.
F-8
Fair Value of Financial Instruments - The carrying amounts of
significant financial instruments, which includes accounts receivable, accounts
payable and accrued expenses, approximated fair value as of December 31, 2004
and 2003 due to their short-term maturities. Borrowings under the financing
agreement approximate fair value due to their variable interest rates.
Net Income Per Share - Basic net income per share is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted net income per share is computed by dividing the net
income by the weighted average number of common shares and common equivalent
outstanding during the period. There were no common equivalents at December 31,
2004, 2003 and 2002.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
Recent Accounting Pronouncements - In April 2002, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections" ("SFAS 145"). SFAS 145 rescinds the provisions of SFAS No. 4 that
require companies to classify certain gains and losses from debt extinguishment
as extraordinary items, eliminates the provisions of SFAS No. 44 regarding the
Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. The
provisions of SFAS 145, relating to the classification of debt extinguishment,
were effective for fiscal years beginning after May 15, 2002. Reclassification
of the gains and losses related to debt extinguishment are required for all
prior periods presented in comparative financial statements. The adoption of
SFAS 145 did not have an impact on the Company's financial position, results of
operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), replacing Emerging
Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." SFAS 146 requires that a liability
for a cost associated with an exit or disposal activity be recognized when the
liability is incurred instead of at the date an entity commits to an exit plan.
This statement also established that fair value is the objective for initial
measurement of the liability. The provisions of SFAS 146 were effective for exit
or disposal activities that were initiated after December 31, 2002. The adoption
of SFAS 146 did not have an impact on the Company's financial position, results
of operations or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued and requires that they be recorded at fair value. The initial
recognition and measurement provisions of this interpretation were to be applied
only on a prospective basis to guarantees issued or modified after December 31,
2002. The disclosure requirements of this interpretation were effective for
financial statements of interim or annual periods ending after December 15,
2002. There is no material impact on the Company's financial position, results
of operations or cash flows based upon this interpretation. The Company has no
guarantees as defined by FIN 45.
F-9
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of SFAS No. 123" ("SFAS 148"). This statement amends
FASB Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this statement amends the
disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The amendments to SFAS 123 regarding disclosure were effective for
financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS 148 has not had a material impact on the Company's financial
position, results of operations or cash flows. The Company does not have any
stock option plans.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a
variable interest entity be consolidated by a company if that company is subject
to a majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the entity's residual returns or both. The
consolidation requirements apply to the first fiscal year or interim period
ending after March 31, 2004. The adoption of FIN 46 did not have a material
effect on the Company's financial position, results of operations or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
No. 133 on Derivative Instruments and Hedging Activities." This statement amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133. This statement was effective for contracts entered into or
modified after June 30, 2003, except for provisions that relate to SFAS No. 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003, which should continue to be applied in accordance with
their respective dates. The adoption of SFAS No.149 did not have a material
effect on the Company's financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 requires that certain financial instruments that, under
previous guidance, issuers could account for as equity, be classified as
liabilities in statements of financial position. Most of the guidance in SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS 150 did not have a
material effect on the Company's financial position, results of operations or
cash flows.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4" (SFAS 151). SFAS 151 retains the general
principle of ARB 43, Chapter 4, Inventory Pricing (AC Section I78)," that
inventories are presumed to be stated at cost; however, it amends ARB 43 to
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and require the allocation of fixed production overheads to inventories based on
the normal capacity of the production facilities. The guidance is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Earlier application is permitted for inventory costs incurred during fiscal
years beginning after November 23, 2004. Management has evaluated SFAS 151 and
does not anticipate that its adoption will have a significant impact on the
Company's financial position, results of operations or cash flows.
F-10
In December 2004, the FASB issued SFAS No. 153, Exchanges of
Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for
Nonmonetary Transactions (SFAS 153). The amendments made by SFAS 153 are based
on the principle that exchanges of nonmonetary assets should be measured based
on the fair value of the assets exchanged. Further, the amendments eliminate the
narrow exception for nonmonetary exchanges of similar productive assets and
replace it with a broader exception for exchanges of nonmonetary assets that do
not have commercial substance. A nonmonetary exchange has commercial substance
if the future cash flows of the entity are expected to change significantly as a
result of the exchange. This statement shall be applied prospectively and is
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. Earlier application is permitted for nonmonetary asset
exchanges occurring in fiscal periods beginning after the date of issuance. The
Company does not anticipate that the adoption of SFAS 153 will have a
significant impact on its financial position, results of operations or cash
flows.
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based
Payment" (SFAS 123(R)). This statement revises FASB Statement No. 123,
"Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123(R) focuses primarily on the
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS 123(R) requires companies to recognize in
the statement of operations the cost of employee services received in exchange
for awards of equity instruments based on the grant-date fair value of those
awards (with limited exceptions). This Statement is effective as of the
beginning of the first fiscal year beginning after December 15, 2005. The
Company does not anticipate that the adoption of SFAS 123(R) will have an impact
on its future results of operations or financial position as the Company does
not have any stock option plans.
In May 2005, the FASB issued SFAS No. 154, "Accounting for Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and
FASB Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements, and changes the requirements for the accounting for and reporting of
a change in accounting principle. This Statement applies to all voluntary
changes in accounting principle. It also applies to changes required by an
accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS 154 becomes
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.
F-11
3) CONCENTRATION OF CREDIT RISK:
Cash - The Company maintains its cash balances at several financial
institutions. Accounts at each institution are insured by the Federal Deposit
Insurance Corporation up to $100,000. At times, the balances may be in excess of
the FDIC insurance.
Credit - The Company sells its products to a large number of customers
and performs ongoing credit evaluations of its customers' financial condition.
Credit to approved customers is generally granted based on 30 to 60 day terms.
Financial instruments which potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. During the years
ended December 31, 2004, 2003 and 2002, one customer (a related party) accounted
for approximately 13%, 19% and 20%, respectively, of period sales and the same
customer accounted for approximately 10% and 18%, respectively, of total
accounts receivable at December 31, 2004 and 2003.
Vendors - Four vendors accounted for approximately 90% of the
merchandise purchased by the Company during each of the three years in the
period ended December 31, 2004.
4) MARKETABLE SECURITIES
The Company classifies its investment in marketable equity securities
as available-for-sale securities in accordance with the provisions of Statement
of Financial Accounting No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". These securities are carried at their fair market value,
with unrealized gains and losses reported in other comprehensive income. At
December 31, 2004 the cost basis of these investments was $14,899. The net
cumulative unrealized gains at December 31, 2004, 2003 and 2002 totaled $24,517,
$17,862 and $11,411, respectively, and are included in accumulated other
comprehensive income.
5) RELATED PARTY TRANSACTIONS:
The balances due from related parties and other receivables, are
summarized as follows:
2004 2003
---------- ----------
a) Due from related parties $ 877,040 $ 677,040
b) Other receivable from related party 2,207,415 --
---------- ----------
Total due from related parties and
other receivable $3,084,455 $ 677,040
========== ==========
a) Due from related parties - The Company advances funds, and shares
office space and administrative personnel with several related companies through
common ownership, engaged in the wholesale distribution of audio product,
telephones and electronic personal hygiene products. Funds are transferred on an
as-available basis and the balances are due on demand. The balances due from
BNA, LLC bears interest at 6% per annum. The balances due from Happy Lady, Inc.
(Happy Lady) and Record-A-Phone Corp. are non-interest bearing.
F-12
The balances due from these related companies are as follows:
2004 2003
----------- -----------
BNA, LLC $ 760,000 $ 500,000
Happy Lady 77,640 127,640
Record-A-Phone Corp. 39,400 49,400
----------- -----------
Total due from related parties $ 877,040 $ 677,040
=========== ===========
b) Mortgage note and other receivable from related party - STH
Associates, LLC (STH) is a limited liability company, certain of whose members
are also stockholders of the Company. In connection with a 2004 purchase of real
estate by STH, Foto Electric loaned STH $1,500,000 and received back by
assignment a mortgage of $1,500,000 on the property acquired by STH. The loan
bears interest at 8.5% per annum and is due June 30, 2005. In September 2004,
the Company committed to lend STH up to an additional $3,000,000, with interest
at 8.5% per annum. An additional $2,207,415 was loaned to STH through December
31, 2004. The loan bears interest at 8.5% per annum and is due on demand.
Accordingly, this balance is included in due from related parties at December
31, 2004 as a current asset.
Subsequently, the Company continued to make additional loans in 2005,
and in June 2005, in connection with these loans, the Company took back an
unrecorded mortgage on the same property in the amount of $3,000,000 and
consolidated it with the maturing $1,500,000 mortgage mentioned above. The
consolidated mortgage note in the amount of $4,500,000 requires payments of
interest only at 8.5% per annum, to be paid monthly beginning August 1, 2005,
with the entire balance due June 30, 2006. The loans bear interest at 8.5%, per
annum.
c) Due to related party - At December 31, 2004 and 2003, a total of
$60,333 and $401,197, respectively, is due to 1 Rewe Street Realty LLC (1 Rewe
Street), a related entity through common ownership, from whom the Company leases
its warehouse and office space (See Note 9). The balances are non-interest
bearing and are due on demand.
d) Sales to affiliate - The Company sells merchandise at significantly
less than its normal gross profit to an affiliate through common ownership.
During the years ended December 31, 2004, 2003 and 2002, sales to this affiliate
totaled approximately $17,000,000, $23,000,000 and $18,000,000, respectively.
The balances due from the affiliate totaling $972,371 and $1,927,673 at December
31, 2004 and 2003, respectively, are included in accounts receivable.
e) Due to stockholders - The balances due to stockholders at December
31, 2004 and 2003 totaled $5,088,760 and $2,578,056, respectively. The amounts
are non-interest bearing and are due on demand.
6) DUE TO BANK LEUMI USA:
Pursuant to a financing arrangement with Bank Leumi USA (Bank Leumi),
the Company has available an overall line of credit of up to $9,000,000 for
short-term working capital loans, subject to a financial covenant relating to
the maintenance of minimum net worth and certain formula limitations. The loans
bear interest at the rate of 1/2% above Bank Leumi's prime rate. As part of the
agreement, the Company granted Bank Leumi a continuing security interest in all
inventory, accounts receivable and other assets, and certain of the Company's
stockholders and related parties guaranteed the financing arrangement. There was
no outstanding balance due at December 31, 2004 and 2003.
F-13
The Company's credit facility with Bank Leumi includes a $500,000
sublimit, whereby Happy Lady may utilize up to $500,000 of the Company's credit
facility as a co-borrower. At December 31, 2004, there was no balance owed by
Happy Lady to Bank Leumi under this facility. At December 31, 2003, the balance
owed by Happy Lady to Bank Leumi under this facility totaled $240,000.
7) OBLIGATIONS UNDER CAPITAL LEASES:
In October 2000, the Company entered into a capital lease for office
equipment. The lease requires monthly payments aggregating $215 including
interest at 5.93% on the other. The equipment of $10,320 was capitalized and is
being amortized over its useful life, and such amortization is included in
depreciation expense. At December 31, 2004 and 2003 the accumulated depreciation
of the equipment was $9,415 and $8,273, respectively.
In October 2000, the Company entered into a capital lease for
transportation equipment. The lease requires monthly payments of $1,204
including interest at10.12%. Total equipment of $63,173 was capitalized and is
being amortized over its useful life, and such amortization is included in
depreciation expense. At December 31, 2004 and 2003, accumulated depreciation of
the equipment was $57,896 and $50,861, respectively.
See Note 9(a) for schedule of future minimum lease payments as of
December 31, 2004.
8) PENSION PLAN:
Defined Benefit Plan - During 1980, the Company adopted a Defined
Benefit Pension Plan for its eligible employees. The Company uses November 30 as
its measurement date for the pension plan. Effective November 30, 1994, the
defined benefit pension plan was frozen and there are no further benefit
accruals after such date. Accordingly, the projected and accumulated benefit
obligations are the same. The only participants of the plan are the two primary
principals of the Company.
Pension expense amounted to $22,187, $19,983 and $17,201 for the years
ended December 31, 2004, 2003 and 2002, respectively.
The following summarizes information about the funded status of the
defined benefit pension plan at its year end of November 30, 2004 and 2003,
accounted for in accordance with Statement of Financial Accounting Standards No.
87 "Employer's Accounting for Pensions" (SFAS 87) based on information provided
by the plan's independent certified actuaries:
F-14
The reconciliation of the benefit obligation and funded status of the
pension plan as of November 30, 2004 and 2003 is as follows:
2004 2003
----------- -----------
Change in benefit obligation
Benefit obligation at beginning of year $ 578,244 $ 531,172
Service cost 28,385 24,331
Interest cost 31,803 31,870
Actuarial (gain)loss (11,081) (9,129)
Benefits paid -- --
----------- -----------
Benefit obligation at end of year $ 627,351 $ 578,244
=========== ===========
Change in plan assets
Fair value of plan assets at beginning of
year $ 592,507 $ 480,416
Actual return on plan assets 213,827 25,234
Employer contributions -- 86,857
Benefits paid -- --
Expenses paid -- --
----------- -----------
Fair value of plan assets at year end $ 806,334 $ 592,507
=========== ===========
Funded status $ 178,983 $ 14,263
Unrecognized net actuarial (gain) loss (155,969) 30,938
----------- -----------
Net amount recognized $ 23,014 45,201
=========== ===========
Amounts recognized in the statements of
financial position consist of:
Prepaid benefit cost $ 23,014 $ 45,201
Accumulated other comprehensive income -- --
----------- -----------
Net amount recognized $ 23,014 $ 45,201
=========== ===========
The projected and accumulated benefit obligation and fair value of plan
assets at November 30, 2004 and 2003 are as follows:
2004 2003
----------- -----------
Projected and accumulated benefit obligation $ 627,351 $ 578,244
Fair value of plan assets $ 806,334 $ 592,507
F-15
Net periodic pension cost for the years ended November 30, 2004, 2003
and 2002 include the following components:
2004 2003 2002
----------- ----------- -----------
Service cost $ 25,385 $ 24,331 $ 23,324
Interest cost 31,803 31,870 30,065
Expected return on plan assets 32,588 (33,819) (28,163)
Amortization of prior service (2,413) (2,399) (2,398)
cost
Amortization of transition -- -- (7,111)
asset
Amortization of loss -- -- 1,484
----------- ----------- -----------
Net periodic pension cost $ 22,187 $ 19,983 $ 17,201
=========== =========== ===========
In the year ended November 30, 2004 there was no change in the minimum
pension liability included in other comprehensive income. The change in minimum
liability included in other comprehensive income (loss) was ($12,610) and
$12,610 for the years ended November 30, 2003 and 2002, respectively.
The Company's assumptions used as of November 30, 2004, 2003 and 2002
in determining the periodic pension cost and benefit obligation were as follows:
2004 2003 2002
------------- ------------- -------------
Discount rate on 5.50% 6.00% 5.50%
investments
Expected long-term rate of 5.50% 6.00% 5.50%
return
The expected long-term rate of return on plan assets was determined
based on long-term return analysis of equity, debt and other securities as well
as historical returns. Long-term trends are evaluated relative to market factors
such as inflation and interest rates.
F-16
The Company's pension plan assets as of November 30, 2004 and 2003, by
asset categories, are as follows:
2004 2003
------------- -------------
Cash 2% 4%
Mortgages 74% --
Insurance cash values 24% 28%
Real estate -- 68%
------------- -------------
Total 100% 100%
============= =============
The Company's investment policy for plan assets is to manage the
portfolio to preserve principal and liquidity while maximizing the return on the
investment portfolio through the full investment of available funds.
There were no employer or participant contributions and no benefits
paid out during 2004 and 2003.
The following benefit payments are expected to be paid:
2005 $ --
2006 56,496
2007 56,496
2008 56,496
2009 56,496
2010 - 2014 282,480
Concerning future benefits payments refer to Note 11 - Subsequent
Event.
Defined Contribution Plan - Effective December 1, 1994, the Company
adopted a defined contribution plan. Under the provisions of the Plan, the
Company may contribute at its discretion up to 15% of the aggregate compensation
of eligible participants, subject to certain limitations as outlined in the Plan
document. For the plan years ended November 30, 2004, 2003 and 2002, the expense
totaled $93,702, $89,094 and $79,887, respectively.
F-17
9) COMMITMENTS AND CONTINGENCIES:
a) Leases - Effective March 2003, the Company revised a lease agreement
with 1 Rewe Street Realty LLC, an affiliate through common ownership, for its
warehouse and office space. The lease which expires in February 2018, requires
an annual base rent of $630,000, and beginning in 2005 is subject to annual
adjustments for the Company's proportionate share of real estate taxes (See
Notes 9(e) and 11 - Subsequent Event).
The Company is party to various operating leases for autos and office
equipment with lease terms of between two and four years.
The following is a schedule of future minimum lease payments as of
December 31, 2004:
Noncancellable
Capital Operating
Year Leases Leases
--- --------------- ----------------
2005 $ 10,837 $ 669,676
2006 - 647,780
2007 - 634,078
2008 - 630,000
2009 - 630,000
--------- ---------------
Total minimum payments 10,837 $ 3,211,534
================
Less interest portion of
payments 443
---------
Present value of future
minimum payments $ 10,394
=========
b) Guarantees - See Note 5.
c) Litigation - The Company is involved in litigation incidental to the
conduct of its business. It is the opinion of management that the outcome of
such litigation will not have a material adverse effect on the financial
position of the Company.
d) Distribution Agreements - The Company is party to distribution
agreements with several major brand name manufacturers in the consumer
electronics industry, which are subject to periodic renewal.
e) Recapture of Certain Tax and Other Incentive Benefits - In
connection with the 1996 purchase of the building housing the Company's
warehouse and offices (See Note 9a),the leasing arrangement between New York
City Industrial Development Agency (IDA) and the Company's landlord, and the
application for certain tax benefits derived from such purchase, the Company
guaranteed certain payments, obligations, covenants and agreements entered into
between 1 Rewe Street and the IDA.
Should the contemplated transaction with Alliance Distributors
Holdings, Inc. (Alliance), close (See Note 11 - Subsequent Event), management
will request the continuation of the IDA related benefits on the basis that the
fundamental purpose for which benefits were granted has not changed. There is no
assurance that the IDA will permit the substitution of Alliance for the Company
as the tenant of the subject premises. Should IDA benefits be revoked, then the
potential reclamation is estimated to total in excess of $500,000. Pursuant to
an agreement with 1 Rewe Street, the Company would not be responsible for any
such reclamation.
F-18
10) CASH FLOW INFORMATION:
Cash payments for interest and income taxes for the years ended
December 31, 2004, 2003 and 2002, respectively, are as follows:
2004 2003 2002
------------- ------------- -------------
Interest $ 55,519 $ 23,678 $ 245,730
Income taxes 323,800 262,998 200,428
There were no noncash investing and financing activities for the years
ended December 31, 2004, 2003 and 2002, respectively.
11) SUBSEQUENT EVENT:
In 2006, the Company entered into a stock purchase agreement with
Alliance (Distributors Holdings, Inc. (Alliance),) whereby Alliance will acquire
all of the outstanding stock of the Company from the present stockholders
subject to the conditions set forth in the agreement. In connection with the
agreement the lease for the Company's premises will be revised.
F-19
Exhibit F
Consent of Independent Public Accounting Firm
To the Board of Directors and Stockholders
Alliance Distributors Holding Inc.:
We hereby consent to the use in the Information Statement Pursuant to Section
14(c) of our report dated December 16, 2005, except for Note 11 as to which the
date is January 2, 2006, relating to the financial statements of Foto Electric
Supply Co., Inc. , which are included in this Information Statement.
/s/ Leshkowitz & Company, LLP
New York, New York
January 17, 2006
EXHIBIT G
FOTO ELECTRIC SUPPLY CO., INC.
Index
Page
Balance Sheet as of September 30, 2005 (unaudited) F - 1
Statement of Income for the nine months ended
September 30, 2005 (unaudited) F - 3
Statement of changes in Stockholders' Equity
for the nine months ended September 30, 2005 (unaudited) F - 4
Statement of Cash Flows for the nine months ended
September 30, 2005 (unaudited) F - 5
Notes to Financial Statements F - 6
FOTO ELECTRIC SUPPLY CO., INC.
BALANCE SHEET
SEPTEMBER 30, 2005
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash $ 293,140
Accounts receivable, less allowance for
doubtful accounts of $130,000 8,022,542
Marketable securities 48,485
Merchandise inventory 15,741,778
Prepaid expenses and other current assets 109,152
Prepaid pension costs 66,095
Due from related parties:
Mortgage note 4,500,000
Other receivables 2,255,130
--------------
TOTAL CURRENT ASSETS 31,036,322
--------------
FIXED ASSETS, AT COST:
Machinery and equipment 99,780
Furniture and fixtures 495,737
Auto and trucks 585,233
Computer equipment and software 206,408
Leasehold improvements 289,851
--------------
1,677,009
Less accumulated depreciation and amortization 1,017,851
--------------
NET FIXED ASSETS 659,158
OTHER ASSETS:
Federal tax deposit 210,223
Security deposits 700
--------------
TOTAL FIXED AND OTHER ASSETS 870,081
--------------
TOTAL ASSETS $ 31,906,403
==============
See notes to financial statements.
F-1
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Due to Bank Leumi USA $ 6,800,000
Current obligations under capital leases 3,078
Accounts payable 4,722,879
Accrued expenses payable 733,367
Customer prepayments 94,644
Income taxes payable 1,060,697
Due to related party 102,833
Due to stockholders 4,573,311
--------------
TOTAL CURRENT LIABILITIES 18,090,809
NON-CURRENT LIABILITIES:
Long-term obligations under capital
leases, less current portion 4,442
--------------
TOTAL LIABILITIES 18,095,251
--------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, no par value, 200
shares authorized, issued and outstanding 60,000
Additional paid-in capital 118,000
Retained earnings 13,599,566
Accumulated other comprehensive income 33,586
--------------
TOTAL STOCKHOLDERS' EQUITY 13,811,152
--------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 31,906,403
==============
F-2
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
NET SALES $ 90,861,970
--------------
Cost of goods sold:
Beginning inventory 14,539,748
Purchases, net 81,013,854
--------------
95,553,602
Less ending inventory 15,741,778
--------------
Cost of goods sold 79,811,824
--------------
GROSS PROFIT 11,050,146
--------------
OPERATING EXPENSES:
Selling and warehouse 1,934,887
General and administrative 1,573,437
Interest and bank charges 300,950
Taxes, other than income taxes 107,002
Pension costs 86,919
Bad debt expense 14,523
Depreciation and amortization 127,719
--------------
Total operating expenses 4,145,437
--------------
Operating income 6,904,709
--------------
OTHER INCOME - RELATED PARTIES:
Interest income 419,424
Management fee income 38,000
--------------
Total other income 457,424
--------------
Income before provision for income and franchise taxes 7,362,133
Provision for income and franchise taxes 489,216
--------------
NET INCOME $ 6,872,917
==============
Basic and diluted net income per share $ 34,365
==============
Weighted average common shares
outstanding - basic and diluted 200
==============
See notes to financial statements.
F-3
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Income TOTAL
-------------- -------------- -------------- -------------- --------------
Balance, January 1, 2005 $ 60,000 $ 118,000 $ 18,726,649 $ 24,517 $ 18,929,166
--------------
Comprehensive income for the nine months
ended September 30, 2005:
Net income 6,872,917 6,872,917
Other comprehensive income:
Unrealized gain on securities 9,069 9,069
--------------
Total Comprehensive Income 6,881,986
Less: Dividend distributions during the
nine months ended September 30, 2005: (12,000,000) (12,000,000)
-------------- -------------- -------------- -------------- --------------
Balance, September 30, 2005 $ 60,000 $ 118,000 $ 13,599,566 $ 33,586 $ 13,811,152
============== ============== ============== ============== ==============
See notes to financial statements.
F-4
FOTO ELECTRIC SUPPLY CO., INC.
STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,872,917
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 127,719
Changes in operating assets and liabilities:
Accounts receivable 1,295,952
Merchandise inventory (1,202,030)
Prepaid expenses and other current assets 32,106
Prepaid pension costs 8,217
Federal tax deposit (87,561)
Accounts payable (2,238,528)
Accrued expenses payable 139,055
Customer prepayments 4,050
Income taxes payable (181,116)
--------------
Net cash provided by operating activities 4,770,781
--------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (29,684)
--------------
Net cash used in investing activities (29,684)
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in short-term bank debt 6,800,000
Net change in amounts due from related parties:
Mortgage note (3,000,000)
Other receivables 895,825
Net decrease in amounts due to stockholders (539,449)
Payment of capital lease obligations (12,351)
Dividend distributions to stockholders (12,000,000)
--------------
Net cash used in financing activities (7,855,975)
--------------
Net decrease in cash (3,114,878)
Cash at beginning of period 3,408,018
--------------
CASH AT END OF PERIOD $ 293,140
==============
See notes to financial statements.
F-5
FOTO ELECTRIC SUPPLY CO., INC.
NOTES TO FINANCIAL STATEMENTS
1) ORGANIZATION, NATURE OF OPERATIONS AND BASIS OF PRESENTATION:
Organization and Nature of Operations - Foto Electric Supply Co., Inc.
(The Company) was incorporated in the State of New York in June, 1980, and is
engaged in the sale and distribution of consumer electronics and other related
products on a wholesale basis. The Company operates as a single segment.
Basis of Presentation - The financial statements are presented for the
nine months ended September 30, 2005. For income tax reporting, the Company has
a fiscal year end of November 30.
The accompanying unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been omitted. In the opinion of management, all material
adjustments, consisting of normal recurring adjustments, considered necessary
for a fair presentation, have been included in the accompanying unaudited
financial statements. The results of operations for the interim period are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2005.
2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The following summary of the Company's major accounting policies is
presented to assist in the interpretation of the financial statements:
Merchandise Inventory - The merchandise inventory is stated at the
lower of cost or market, based on the average cost method. The Company decreases
the value of inventory for estimated obsolescence equal to the difference
between the cost of inventory and the estimated net realizable value (market
value) based upon an aging analysis of the inventory on hand, specifically known
inventory-related risks, and assumptions about future demand and market
conditions.
Property and Equipment - Property and equipment are recorded at cost.
The Company calculates depreciation using primarily the straight-line method
over the useful lives of the assets which range from five to seven years.
Amortization of leasehold improvements is computed on the straight-line method
over the life of the lease or the expected useful life of the improvement
whichever is shorter. Expenditures for major renewals and improvements that
extend the useful life of property and equipment are capitalized. Expenditures
for maintenance and repairs are charged to expense as incurred. For tax
purposes, depreciation and amortization are computed in accordance with
applicable provisions of the Internal Revenue Code.
F-6
Impairment of Long-Lived Assets - The Company follows Statement of
Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 requires that long-lived assets,
including property and equipment, be reviewed for impairment whenever events or
changes in circumstances indicate that their carrying amount may not be
recoverable. The Company assesses its assets for impairment based on the
estimated future undiscounted cash flows expected to result from the use of the
asset and records impairment losses when this amount is less than the carrying
amount. Impairment losses are recorded for the excess of the assets' carrying
amount over their fair value, which is generally determined based on the
estimated future discounted cash flows over the remaining useful life of the
asset using a discount rate determined by management at the date of the
impairment review. Management believes at this time that the carrying value and
useful life of long-lived assets continue to be appropriate.
Revenue Recognition - Revenue is recognized when products are shipped
and title is passed to the customer. Vendor rebates are recorded as adjustments
to product cost in the period their collection is assured.
Shipping and Handling Costs - Shipping and handling fees related to
sales transactions are billed to customers and are recorded as sales revenue.
Shipping and handling costs incurred are recorded as a selling expense and
totaled $ 137,808 for the nine months ended September 30, 2005.
Income Taxes - Effective June 1, 1992, the Company elected to be
treated as an "S" corporation under Federal and New York State tax law. As an
"S" corporation, the Company is not subject to any Federal or New York State
income taxes, except that it is subject to the special New York State franchise
tax surcharge. Accordingly, no provision for Federal income tax has been made,
since this tax is imposed on the stockholders in proportion to their stock
ownership percentage. New York State special franchise tax, New York City
general corporation tax and New Jersey "S" corporation business tax have been
provided for in the financial statements.
Current income taxes payable in the amount of $1,060,697 includes
unpaid taxes accrued on the current period's income, plus the effect of the
timing difference relating to prior years' income.
Deferred income taxes reflect the impact of temporary differences
between the assets and liabilities recognized for financial reporting purposes
and amounts recognized for tax purposes. The principal temporary differences
consist of different methods of depreciation, capitalization of additional
inventory costs for tax purposes and provision for bad debts versus the direct
write off method. Deferred income taxes for the period are immaterial.
Federal Tax Deposit - As part of the "S" Corporation election, the
Company was allowed to retain its fiscal year-end of November 30, in accordance
with the provisions of the Revenue Act of 1987. The election to retain a
non-December 31 fiscal year-end required that the Company establish a refundable
tax deposit account with the Internal Revenue Service. The refundable tax
deposit totaled $210,223 at September 30, 2005.
F-7
Allowance for Doubtful Accounts - The Company provides for accounts
receivable that could become uncollectible in the future by establishing an
allowance to reduce the carrying value of such receivables to their estimated
net realizable value. The Company estimates this allowance based on the specific
customer circumstances, aging of its accounts receivable and its historical
collection experience. During the period, the Company wrote off $14,524 and
maintained $130,000 as its allowance for doubtful accounts.
Pension Plan - The Company maintains a Defined Benefit Pension Plan and
a Profit Sharing Plan covering its eligible employees (See Note 8).
Advertising Expenses - The Company expenses advertising costs as
incurred. Advertising expense for the nine months ended September 30, 2005
totaled $6,411.
Fair Value of Financial Instruments - The carrying amounts of
significant financial instruments, which includes accounts receivable, accounts
payable and accrued expenses, approximated fair value as of September 30, 2005
due to their short-term maturities. Borrowings under the financing agreement
approximate fair value due to their variable interest rate.
Net Income Per Share - Basic net income per share is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted net income per share is computed by dividing the net
income by the weighted average number of common shares and common equivalent
outstanding during the period. There were no common equivalents at September 30,
2005.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
Recent Accounting Pronouncements - In May 2005, the FASB issued SFAS
No. 154, "Accounting for Changes and Error Corrections - a replacement of APB
Opinion No. 20 and FASB Statement No. 3" (SFAS 154). SFAS 154 replaces APB
Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, and changes the requirements
for the accounting for and reporting of a change in accounting principle. This
Statement applies to all voluntary changes in accounting principle. It also
applies to changes required by an accounting pronouncement in the unusual
instance that the pronouncement does not include specific transition provisions.
When a pronouncement includes specific transition provisions, those provisions
should be followed. SFAS 154 becomes effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
F-8
3) CONCENTRATION OF CREDIT RISK:
Cash - The Company maintains its cash balances at several financial
institutions. Accounts at each institution are insured by the Federal Deposit
Insurance Corporation up to $100,000. At times, the balances may be in excess of
the FDIC insurance.
Credit - The Company sells its products to a large number of customers
and performs ongoing credit evaluations of its customers' financial condition.
Credit to approved customers is generally granted based on 30 to 60 day terms.
Financial instruments which potentially subject the Company to concentrations of
credit risk consist primarily of trade accounts receivable. For the nine months
ended September 30, 2005, one customer (a related party) accounted for
approximately 11% of period sales and the same customer accounted for
approximately 7% of total accounts receivable at September 30, 2005.
Vendors - During the nine months ended September 30, 2005, four vendors
accounted for approximately 90% of the merchandise purchased by the Company.
4) MARKETABLE SECURITIES
The Company classifies its investment in marketable equity securities
as available-for-sale securities in accordance with the provisions of Statement
of Financial Accounting No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". These securities are carried at their fair market value,
with unrealized gains and losses reported in other comprehensive income. At
September 30, 2005 the cost basis of these investments was $14,899. The net
cumulative unrealized gain at September 30, 2005 totaled $33,586 and is included
in accumulated other comprehensive income.
5) RELATED PARTY TRANSACTIONS:
The balances due from related parties and other receivable are
summarized as follows:
a) Due from related parties $ 823,715
b) Other receivable from related party 1,431,415
-----------------
Total due from related parties and
other receivable $ 2,255,130
=================
a) Due from related parties - The Company advances funds, and shares
office space and administrative personnel with several related companies through
common ownership, engaged in the wholesale distribution of audio product,
telephones and electronic personal hygiene products. Funds are transferred on an
as-available basis and the balances are due on demand. The balance due from BNA,
LLC bears interest at 6% per annum. The balances due from Happy Lady, Inc.
(Happy Lady) and Record-A-Phone Corp. are non-interest bearing.
F-9
The balances due from these related companies are as follows:
BNA, LLC $ 766,075
Happy Lady 57,640
-----------------
Total due from related parties $ 823,715
================
b) Mortgage note and other receivable from related party - STH
Associates, LLC (STH) is a limited liability company, certain of whose members
are also stockholders of the Company. In connection with a 2004 purchase of real
estate by STH, the Company loaned STH $1,500,000 and received back by assignment
a mortgage of $1,500,000 on the property acquired by STH. The loan bears
interest at 8.5% per annum and was due June 30, 2005. In September 2004, the
Company committed to lend STH up to an additional $3,000,000, with interest at
8.5% per annum. The Company made additional loans in 2004 and in 2005 totaling
$4,431.415 . In June 2005, in connection with these loans, the Company took back
an unrecorded mortgage on the same property in the amount of $3,000,000 and
consolidated it with the maturing $ 1,500,000 mortgage mentioned above. The
consolidated mortgage note in the amount of $4,500,000 requires payments of
interest only at 8.5% per annum, to be paid monthly beginning August 1, 2005,
with the entire balance due June 30, 2006. Accordingly, the full $4,500,000
mortgage note receivable is classified as a current asset. The balance due from
STH in excess of the $4,500,000 mortgage note, totaled $1,431,415 at September
30, 2005, including accrued interest of $24,000. The loans are due on demand and
earned interest of $207,000 for the nine months ended September 30, 2005.
c) Due to related party - At September 30, 2005, a total of $102,833 is
due to 1 Rewe Street Realty, LLC (1 Rewe Street), a related entity through
common ownership, from whom the Company leases its warehouse and office space
(See Note 9). The balance is non-interest bearing and is due on demand.
d) Sales to affiliate - The Company sells merchandise at significantly
less than its normal gross profit to an affiliate through common ownership.
During the nine months ended September 30, 2005, sales to this affiliate totaled
approximately $9,600,000. The balance due from the affiliate, totaling $538,787
at September 30, 2005, is included in accounts receivable.
e) Due to stockholders - The balances due to stockholders at September
30, 2005 totaled $4,573,311. Certain of the balances bear interest at rates
ranging from 1% to 1.5% above the prime rate and are due on demand.
6) DUE TO BANK LEUMI USA:
Pursuant to a financing arrangement with Bank Leumi USA (Bank Leumi),
the Company has available an overall line of credit of up to $9,000,000 for
short-term working capital loans, subject to a financial covenant relating to
the maintenance of minimum net worth and certain formula limitations. The loans
bear interest at the rate of 1/2% above Bank Leumi's prime rate. As part of the
agreement, the Company granted Bank Leumi a continuing security interest in all
inventory, accounts receivable and other assets, and certain of the Company's
stockholders and related parties guaranteed the financing arrangement.
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7) OBLIGATIONS UNDER CAPITAL LEASES:
In January 2005 the Company entered into a capital lease for additional
office equipment. The lease requires monthly payments aggregating $291 including
interest at 6.75%. Total equipment of $9,477 was capitalized and is being
amortized over its useful life, and such amortization is included in
depreciation expense. At September 30, 2005, accumulated depreciation of the
equipment was $1,422. See Note 9 for schedule of future minimum lease payments
as of September 30, 2005.
8) PENSION PLAN:
Components of Net Periodic Benefit Cost
Net periodic pension cost for the year ended November 30, 2004, the
latest period for which information was available, includes the following
components:
Service cost benefits earned during year $ 25,385
Interest cost on projected benefit obligation 31,803
Estimated return of plan assets (32,588)
Prior service cost amortization (2,413)
-------------------
Net periodic pension cost $ 22,187
==================
There were no employer or participant contributions and no benefits
paid out during the nine months ended September 30, 2005.
For the nine months ended September 30, 2005, $16,641 was accrued as an
estimate for pension expense for the Defined Benefit Plan.
Defined Contribution Plan - Effective December 1, 1994, the Company
adopted a defined contribution plan. Under the provisions of the Plan, the
Company may contribute at its discretion up to 15% of the aggregate compensation
of eligible participants, subject to certain limitations as outlined in the Plan
document. For the nine months ended September 30, 2005, $70,278 was accrued as
an estimate for pension expense for the Defined Contribution Plan.
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9) COMMITMENTS AND CONTINGENCIES:
a) Leases - Effective March 2003, the Company revised a lease agreement
with 1 Rewe Street Realty LLC, an affiliate through common ownership, for its
warehouse and office space. The lease which expires in February 2018, requires
an annual base rent of $630,000, and beginning in 2005 is subject to annual
adjustments for the Company's proportionate share of real estate taxes (See
Notes 9(d) and 11 - Subsequent Event).
The Company is party to various operating leases for autos and office
equipment with lease terms of between two and four years.
The following is a schedule of future minimum lease payments as of
September 30, 2005:
Noncancellable
Capital Operating
Year Leases Leases
--- --------------- ----------------
2005 $ 877 $ 161,971
2006 3,636 647,780
2007 3,636 634,078
2008 - 630,000
2009 - 630,000
--------------- ----------------
Total minimum payments 8,149 $ 2,073,829
================
Less interest portion of
payments 629
---------------
Present value of future
minimum payments $ 7,520
==============
b) Litigation - The Company is involved in litigation incidental to the
conduct of its business. It is the opinion of management that the outcome of
such litigation will not have a material adverse effect on the financial
position of the Company.
c) Distribution Agreements - The Company is party to distribution
agreements with several major brand name manufacturers in the consumer
electronics industry, which are subject to periodic renewal.
d) Recapture of Certain Tax and Other Incentive Benefits - In
connection with the purchase of the building housing the Company's warehouse and
offices (See Note 9a),the leasing arrangement between New York City Industrial
Development Agency (IDA) and the Company's landlord, and the application for
certain tax benefits derived from such purchase, the Company guaranteed certain
payments, obligations, covenants and agreements entered into between 1 Rewe
Street and the IDA.
Should the contemplated transaction with Alliance Distributors
Holdings, Inc. (Alliance) close (See Note 11 - Subsequent Event), management
will request the continuation of the IDA related benefits on the basis that the
fundamental purpose for which benefits were granted has not changed. There is no
assurance that the IDA will permit the substitution of Alliance for the Company
as the tenant of the subject premises. Should IDA benefits be revoked, then the
potential reclamation is estimated to total in excess of $500,000. Pursuant to
an agreement with 1 Rewe Street, the Company would not be responsible for any
such reclamation.
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10) CASH FLOW INFORMATION:
Cash payments for interest and income taxes for the nine months ended
September 30, 2005 are as follows:
Interest $ 155,891
Income taxes 685,924
During the nine months ended September 30, 2005, the Company had a
noncash investing and financing activity relating to a capital lease for office
equipment in the amount of $9,477 (See Note 7).
11) SUBSEQUENT EVENT:
In 2006, the Company entered into a stock purchase agreement with
Alliance Distributors Holdings, Inc. (Alliance), whereby Alliance will acquire
all of the outstanding stock of the Company from the present stockholders
subject to the conditions set forth in the agreement. In connection with the
agreement the lease for the Company's premises will be revised.
F-13