Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
(Mark One)
þ Annual report under section 13 or 15(d) of the securities exchange act of 1934
For the fiscal year ended December 31, 2006

o Transition report under section 13 or 15(d) of the securities exchange act of 1934

Commission file number 000-32319

ALLIANCE DISTRIBUTORS HOLDING INC.
(Exact name of registrant as specified in its charter)

Delaware
  
33-0851302
(State or other jurisdiction of
  
(I.R.S. Employer
incorporation or organization)
  
Identification No.)
     
1160 Commerce Avenue, Bronx, New York
  
11462
(Address of principal executive offices)
  
(Zip Code)

(718) 536-2248
(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act:
None
   
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes o No þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer o Accelerated filer o Non-accelerated filer þ 

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter $2,702,000

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date.

48,721,065 shares of common stock, $.01 par value, as of March 19, 2007.

DOCUMENTS INCORPORATED BY REFERENCE
[SEE INDEX TO EXHIBITS] 
PART I

Disclosures in this Form 10-K contain certain forward-looking statements, including without limitation, statements concerning our operations, economic performance, and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “estimate,” “believe,” “expect,” and “anticipate” and other similar expressions generally identify forward-looking statements, which speak only as of their dates.

These forward-looking statements are based largely on our current expectations, and are subject to a number of risks and uncertainties, including without limitation, risks associated with technological change, competitive factors and general economic conditions, changes in marketing and distribution strategies by manufacturers, continued shortages of new platform systems, difficulty in integrating and deriving synergies from acquisitions, potential undiscovered liabilities of companies that we acquire, changes in our business or growth strategy, the emergence of new or growing competitors, various other competitive and technological factors, and other risks and uncertainties set forth under “Risk Factors.”

Our actual results could differ materially from the results referred to in the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the results referred to in the forward-looking statements contained in this release will occur.

We undertake no obligation to update or review any guidance or other forward-looking information, whether as a result of new information, future developments or otherwise.

ITEM 1. DESCRIPTION OF BUSINESS

Alliance Distributors Holding Inc. (the "Company" or "Alliance") is a distributor of video game consoles and video game peripherals, accessories and software. Our offices are located at 1160 Commerce Avenue, Bronx, New York 10462. Our telephone number is (718) 536-2248.

Business Background
 
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 22,028,759 shares of common stock and 346,663 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 February 28, 2007, Jay Gelman's voting proxy covered 5,732,091 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 8,411,765 votes.
 
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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.
 
Our Business

What we Sell

We distribute to retail stores videogame consoles that are manufactured by Sony (primarily the PlayStation(R) 3 Computer Entertainment system or “PS3”, PlayStation(R) 2 Computer Entertainment system or “PS2” and Play Station Portable system or “PSP”), Nintendo of America, Inc. “Nintendo” (including the Wii, Nintendo DS, Game Boy(R) Advance and GameCubeTM systems) and, pursuant to a resale relationship we have with one of Microsoft’s distributors, Microsoft products, including the Xbox 360 (R) and Zune systems. We generally sell these consoles at prices ranging from $70 to $600. We also distribute accessories and game software that are made for these consoles by the console manufacturers and third parties. Accessories include controllers, memory cards, network adaptors, component cables, rechargeable kits and carrying cases. We sell our accessories and software at prices generally ranging from $7.50 to $150. At December 31, 2006, we had available an aggregate of approximately 3,500 products for sale to our customers. 

The Market

According to The NPD Group, Inc. a leading market information provider, the videogame market, which includes gaming hardware, software, and accessories, generated U.S. retail sales of $12.5 billion in 2006. This represented an approximate 19 percent increase over the $10.5 billion sales generated in 2005. According to the International Development Group (“IDG”), the average age of Americans who play video and PC games is 29, and approximately 145 million people play videogames on a regular basis. 

Suppliers

We are direct distributors for Sony Computer Entertainment America Inc. ("Sony") and Nintendo of America Inc. ("Nintendo") and purchase product from them directly. We are also direct distributors for approximately 75 third-party vendors (including Electronic Arts Inc., Take Two Interactive Software, Inc. and THQ Inc.) of accessories and software for video games. We have no relationship with Microsoft for distribution of the Microsoft Xbox 360 (R) and the Zune, and purchase our Xbox 360 (R) and Zune supplies from another distributor.

For the three years ended December 31, 2006, we purchased approximately 20%, 33% and 30% of our products for cash in advance, and the balance on 30 day to 45 day terms.

In addition to manufacturer credit and internally generated funds, we have a financing agreement with a lender under which the lender may in its discretion lend us up to $10,000,000 based on eligible receivables and inventory. We have pledged substantially all of our assets as security for this financing.

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For the year ended 2006, three of our suppliers in the aggregate accounted for approximately 49% of our purchases (with one accounting for 27% alone) and the ten largest suppliers in the aggregate accounted for approximately 74% of our purchases. For the year ended 2005, three of our suppliers in the aggregate accounted for approximately 62% of our purchases (with one accounting for 42% alone), and our ten largest suppliers in the aggregate accounted for 82% of our purchases. For the year ended December 31, 2004, the same three suppliers in the aggregate accounted for approximately 56% of our purchases, and our ten largest suppliers in the aggregate accounted for 77% of our purchases. We have no long term agreement with any of our suppliers, and conduct business with them on an individual purchase order basis. Our business would be materially and adversely affected should any material supplier terminate its relationship with us or modify its relationship with us.

Warehouse and Showroom

In September 2006, we relocated our executive offices, showroom and warehouse to 25,000 square feet of space located at 1160 Commerce Avenue, Bronx, New York 10462. In addition, in September 2006 we opened a 5,000 square foot warehouse and 2,000 square foot showroom in Miami, Florida. We utilize our showrooms to display products to our customers. Our products are either picked up directly by the customer from our showroom or delivered to customers from our warehouses by one of our delivery vehicles or through a third party courier. We deliver products at no additional charge to customers that purchase at least $500 worth of products in the New York metropolitan area and the surrounding tri-state region. We also drop ship certain products directly from the manufacturer to our customers.

Our Customers; Sales and Marketing

Our customers consist primarily of approximately 2,600 retail outlets located throughout the United States and Canada, with a majority being in the New York metropolitan area and the surrounding tri-state region. These customers include independent retailers, regional electronics superstores, entertainment specialty stores, video stores, online retailers, specialty toy retailers, supermarkets, drug stores, department stores, and military bases. We estimate that these stores are owned by approximately 350 to 500 different entities. Between 30% to 40% of our sales are on a cash on delivery basis, and the balance is invoiced primarily on 7 through 30 day terms. To our knowledge, no group of stores under common ownership accounted for 10% or more of our sales in any of the three years in the period ended December 31, 2006.

We sell to our customers through our sales employees, most of whom are paid on a salary plus commission basis. We have no long-term sales agreements.

We market ourselves in part as being engaged in a "Video Game Alliance" with our customers, fostering the sense that we are truly partners with our retailer customers in selling products to the end user. Our showroom is designed in part to help us advise our customers on how best to sell the product they buy from us, and we offer them banners, and point of sale and similar material. In advertisements we list our customers and indicate that the advertisement is "brought to you by Alliance Distributors." We have not to date advertised in the trade press. We have historically attended and exhibited at two trade shows annually.

Warranties and Returns

We offer no warranties to our customers and do not have any facilities for the repair or service of any products. We nevertheless accept returns of product claimed to be defective and reimburse our customers for the full purchase price of these products. Although the majority of our suppliers in turn accept these returns from us, certain suppliers credit us with a fixed allowance for returns and require that we assume any additional risk.

Competition

The products that we distribute are also sold through large retail chain stores, many of which have greater financial, technical, personnel and other resources than we do. Management estimates that the great majority of product sales are made through Wal-Mart, BestBuy, Target, Gamestop and other retailers that buy directly from manufacturers

In addition to Alliance, the dominant independent distributors in our industry include: Mecca Electronics Industries, Inc., Jack of all Games (a subsidiary of Take Two Interactive Software, Inc.), About Time Inc, Pioneer Distributors Inc d/b/a JB Marketing, Florida State Games, SVG Distribution, Inc. and D&H Distributing Co., Inc. These companies have significantly greater financial resources than our company. We compete with these companies on the basis of personalized service, advice and marketing support that we seek to offer to our customers.

Government Regulation

The manufacturers of the products we distribute must test them for compliance with Federal Communications Commission (FCC) standards to avoid radio frequency emissions that could interfere with other radio frequency transmissions or similar regulatory standards in other countries. We are not required to test our products for compliance.

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Trademarks

We hold no patents or material proprietary technology. We have no intellectual property other than a trademark for "Video Game Alliance."

Employees

We currently employ approximately 40 employees; the vast majority of whom are employed on a full time basis.

ITEM 1A. RISK FACTORS

We have a limited operating history and have engaged in our current business only since August 2003. 

In November 2003, under prior management of the Company, we discontinued our business of manufacturing and selling a video controller. Our current videogame distribution business commenced operations on August 11, 2003 and was acquired by us in June 2004. We have not yet demonstrated our ability to operate profitably during a major downturn in our industry.

We may be unable to sell our existing inventory as a result of shortages of new platform systems.

We may be adversely affected if a current industry shortage of certain hardware models continues for a lengthy period of time. Shortages of systems, including shortages of the newly introduced PS3 and of the PS2 product from Sony Corporation, the newly introduced Wii from Nintendo, and Xbox 360 consoles from Microsoft, can cause a significant slowdown in industry revenues. If this were to continue and intensify, there would be a significant negative impact on our and on our customers’ ability to sell existing inventory. As a result, orders by our customers would be reduced significantly, which would greatly limit our ability to sell these products. Furthermore, although major manufacturers have traditionally reduced the prices of their current hardware models in conjunction with the launch of new systems, we cannot assure you that these manufacturers will continue this price reduction strategy. Even if manufacturers do reduce prices, we cannot assure you that any past success will result in increased purchases of existing systems ahead of new platform launches.

We are dependent on the contributions of our key executives and must maintain their services; Not entitled to key man proceeds.

Our success depends in large degree upon the skills of our senior management team and key employees and, in particular, Jay Gelman, our Chairman and CEO, and Andre Muller, our COO. An employment agreement with Mr. Gelman expired on June 30, 2006. Neither of such persons has expressed any intention to terminate services. We have obtained only $1,000,000 in key man insurance on the life of Mr. Gelman, and this policy has been assigned to the Company’s senior lender. The loss of the services of any of these persons would have a material adverse effect on our business.

Gross margins relating to our business have been historically narrow which increases the impact of variations in costs on our operating results.

As a result of intense price competition, our gross margins in our business have historically been narrow and may continue to be narrow in the future. Accordingly, slight variations in operating costs and expenses could result in significant losses in our distribution business from period to period.
 
We depend on a limited number of suppliers and have no long-term agreement with any suppliers.

Our ability to obtain particular products in required quantities and to fulfill customer orders on a timely basis is critical to our success. In most cases, we have no guaranteed price or delivery agreements with suppliers. In certain product categories, limited price concessions or return rights offered by publishers may have a bearing on the amount of product we may be willing to purchase. Our industry may experience significant hardware supply shortages from time to time due to the inability of certain manufacturers to supply certain products on a timely basis. As a result, we have experienced, and may in the future continue to experience, short-term hardware inventory shortages. In addition, we do not develop or manufacture any of the products we sell, but act solely as a distributor for the products of third parties. As such, we are entirely dependent on manufacturers or publishers who currently distribute their products through us, and who may, at any time, decide to distribute, or to substantially increase their existing distribution, through other distributors, or directly to retailers. For the year ended 2006, three of our suppliers in the aggregate accounted for approximately 49% of our purchases (with one accounting for 27% alone) and the ten largest suppliers in the aggregate accounted for approximately 74% of our purchases. Our distribution agreements with our major suppliers are generally terminable at any time by the suppliers on 30 days’ prior written notice. In the event that we are unable to maintain our distribution arrangements with one or more of these significant suppliers, our business would be harmed and may not survive.

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We would be adversely affected by a change in the marketing and distribution of videogame hardware systems and videogames by manufacturers.

Major manufacturers such as Sony, Nintendo and Microsoft, could change their marketing strategies and rely less on their current distributors to sell hardware systems and videogames. Since we depend on the products from these manufacturers for a significant portion of our revenues, this would adversely impact our financial situation, as there would be fewer products available for sale by us and our customers would be forced to look for other sources to procure the types of products we currently sell to them. Although we believe that there is only a limited risk that these manufacturers would significantly reduce their distribution of products through us, because of our high level of product penetration and strong customer base, we cannot assure you that one or more of these manufacturers will not take such action.

We have not entered into any distribution arrangement with Microsoft for distribution of its Xbox® 360 products. 

To date we have no direct business relationship with Microsoft Corporation (“Microsoft”) for the distribution of its Xbox 360 game console. This product currently represents an important segment of the videogame console market. As a result of our inability to obtain a direct distribution arrangement with Microsoft, we have had to purchase Xbox® 360 products from one of Microsoft’s distributors, thereby reducing our margins on these products. In the event that we are unable to acquire a direct distribution arrangement with Microsoft in the near future for the sale of Xbox 360 products, our business could be adversely affected.

Our quarterly operating results may vary significantly, which could cause the price of our Common Stock to decline.

We have experienced and may continue to experience wide fluctuations in quarterly operating results. The interactive entertainment industry is highly seasonal, with sales typically higher during the fourth calendar quarter, due primarily to the increased demand for games during the holiday buying season. Our failure or inability to acquire products on a timely basis to meet seasonal fluctuations in demand may harm our business and operating results. These fluctuations could also cause the price of our Common Stock to decline. Other factors that cause fluctuations include:

 
•
delays in the introduction of new titles;
 
•
the size and timing of product and business acquisitions;
 
•
variations in sales of titles designed to operate on particular platforms;
 
•
availability of hardware platforms;
 
•
product returns and price concessions; and
 
•
the timing of orders from major customers.

Our expense levels are based, in part, on our expectations regarding future sales and therefore our operating results would be harmed by a decrease in sales or a failure to meet our sales expectations. The uncertainties associated with interactive entertainment software development, manufacturing lead times, production delays and the approval process for products by hardware manufacturers and other licensors make it difficult to predict the quarter in which products will ship and therefore may cause us to fail to meet financial expectations. In future quarters our operating results may fall below the expectations of securities analysts and investors. In this event, the market price of our Common Stock could significantly decline.

We are subject to the risk that our inventory values may decline and protective terms under supplier arrangements may not adequately cover the decline in values.

The interactive entertainment software and hardware industry is characterized by the introduction of new and enhanced generations of products and evolving industry standards. These changes may cause inventory to decline substantially in value or to become obsolete. We are also exposed to inventory risk in our distribution business to the extent that supplier price concessions are not available on all products or quantities and are subject to time restrictions. In addition, suppliers may become insolvent and unable to fulfill price concession obligations.

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We have no long term agreements with any customer and we are dependent on a limited number of customers.

We do not have long-term purchase and sale agreements with any of our customers, and all of our sales to customers are made on a purchase order by purchase order basis. Although our customer base currently consists of approximately 2,600 retail stores located throughout the United States and Canada, with a majority being in the New York metropolitan area and surrounding tri-state region, during the year ended December 31, 2006, our largest customer accounted for 9% of our total sales, our top five customers accounted for 36% of our sales, our top ten customers accounted for 49% of our sales and our top 25 customers accounted for 65% of our sales. Since we have no long-term commitments with any of the customers to continue to purchase products from us, the loss of any of these customers could have a materially adverse effect on our business.

We hold no patents or material proprietary technology.

We have no intellectual property other than a trademark for “Video Game Alliance.”

Unanticipated warranty costs could affect our ability to operate profitably.

We do not have any facilities for the repair or service of any products, and generally reimburse our customers in full for returns. Although the majority of our suppliers accept these returns from us, certain suppliers credit us with a fixed allowance for returns and require that we assume the risk of excess returns. We will be adversely affected if our returns for these suppliers exceed their return allowances.

Risks Related To Our Industry

Our business operates in a highly competitive environment.

The intense competition that characterizes our industry is based primarily on breadth, availability and quality of product lines; price; terms and conditions of sale; credit terms and availability; speed and accuracy of delivery; and effectiveness of sales and marketing programs. Our competitors include regional, national and international distributors, as well as hardware manufacturers and software publishers. There are several distributors in the United States that have revenues and financial resources and company history substantially greater than us. We are at a disadvantage to these companies and need to compete on the basis of the services we provide to our customers. We may lose market share or be forced in the future to reduce our prices in response to the actions of our competitors, and thereby experience a reduction in our gross margins.

We may be adversely affected if the financial health of the U.S. retail industry should deteriorate.

We are subject to broad economic factors that drive consumer spending and maintain the health of the U.S. retail industry. These factors include, but are not limited to, unemployment rates, consumer credit levels, consumer confidence, and household discretionary income. If any of these or other economic factors should erode, consumer spending would fall and the U.S. retail industry would suffer a downturn. Consequently, our earnings would be adversely impacted by lower sales.
 
We may be adversely affected by the trend towards retail trade consolidation.

As we pursue our retail distribution strategy, our sales will be contingent upon the favorable wholesale prices that we can obtain from retailers. If retailers merge or the retail industry consolidates, the larger, combined retailers will have significant pricing power because of the sheer size of their retail networks. As a result, we may not be able to obtain reasonable prices for the products we distribute. Consequently, our margins will decline and our results of operations would be reduced. There can be no assurance that we will be able to obtain reasonable wholesale prices for the products we distribute under a scenario where retailers merge and consolidate into larger entities.

I-6
The market for the titles we carry is characterized by short product life cycles.

The market for the titles we carry is characterized by short product life cycles and frequent introductions of new products. New products introduced may not achieve significant market acceptance or achieve sufficient sales to permit us to recover the amounts advanced by us to purchase such products, as well as our marketing costs. The life cycle of a game generally involves a relatively high level of sales during the first few months after introduction followed by a decline in sales. Because revenues associated with the initial shipments of a new product generally constitute a high percentage of the total revenues associated with the life of a product, any delay in the introduction of one or more new products or our ability to obtain such products on a timely basis, could adversely affect our operating results for particular periods.

Our business is cyclical, and we may fail to anticipate changing consumer preferences.

Our business is subject to all of the risks generally associated with the interactive entertainment industry, which has been cyclical in nature and has been characterized by periods of significant growth followed by rapid declines. Our future operating results will depend on numerous factors beyond our control, including:

°
the popularity, price and timing of new software and hardware platforms being released and distributed by us and our competitors;

°
international, national and regional economic conditions, particularly economic conditions adversely affecting discretionary consumer spending;

°
war, acts of terrorism and military action, which could adversely affect consumer preferences in entertainment;

°
changes in consumer demographics;

°
the availability and popularity of other forms of entertainment; and

°
critical reviews and public tastes and preferences, all of which change rapidly and cannot be predicted.

In order to plan for acquisition and promotional activities, we must anticipate and respond to rapid changes in consumer tastes and preferences. A decline in the popularity of interactive entertainment or particular platforms could cause sales of the products we distribute to decline dramatically. The period of time necessary to develop new game titles, obtain approvals of manufacturers and produce finished products is unpredictable. During this period, consumer appeal for a particular title may decrease, causing product sales to fall short of expectations.

Rating systems for interactive entertainment software, potential legislation and consumer opposition could inhibit sales of the products we carry.

Trade organizations within the videogame industry require interactive entertainment software publishers to provide consumers with information relating to graphic violence, profanity or sexually explicit material contained in software titles, and impose penalties for noncompliance. We understand that certain countries have also established similar rating systems as prerequisites for sales of interactive entertainment software in such countries. Our suppliers’ software titles receive a rating of “E” (age 6 and older), “T” (age 13 and over) or “M” (age 17 and over). Many of the new titles we carry have received an M rating. We do not know whether our supplies properly comply with such rating systems or properly display the ratings and content descriptions received for our titles.

Several proposals have been made for federal legislation to regulate the interactive entertainment software, motion picture and recording industries, including a proposal to adopt a common rating system for interactive entertainment software, television and music containing violence or sexually explicit material, and the Federal Trade Commission has issued reports with respect to the marketing of such material to under-17 audiences. Consumer advocacy groups have also opposed sales of interactive entertainment software containing graphic violence or sexually explicit material by pressing for legislation in these areas (including legislation prohibiting the sale of certain “M” rated videogames to under-17 audiences) and by engaging in public demonstrations and media campaigns. Retailers may decline to sell interactive entertainment software containing graphic violence or sexually explicit material, which may limit the potential market for the “M” rated products we sell, and adversely affect our operating results. If any groups (including international, national and local political and regulatory bodies) were to target our suppliers’ “M” rated titles, we might be required to discontinue a particular title, which in the case of the best selling titles could seriously hurt our business.

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Our business is subject to sudden changes in the popularity of the products we distribute and to technological changes.

We will be adversely affected by any material decrease in the attractiveness of videogames, or by the availability of equivalent entertainment through the Internet or other channels. The sudden decline in popularity of even one particular video console or game can force us to make a substantial write-down of our inventory of these products.

ITEM 2. DESCRIPTION OF PROPERTIES

On June 8, 2006, we entered into an agreement to lease approximately 25,000 square feet of space at 1160 Commerce Avenue, Bronx, New York 10462, of which approximately 18,000 and 7,000 square feet is utilized for warehouse and office space, respectively. The lease has a five-year term commencing on June 1, 2006 and expiring on May 31, 2011, with an option to extend the term for an additional five-year term expiring on May 31, 2016. Our annual base rent is $295,000 for the first year of the term (which we pay in 12 equal monthly payments of approximately $24,583) and increases 3.5% on June 1st of each year beginning with June 1, 2007. In the event we exercise our option to renew the lease, the annual base rent will continue to increase at the 3.5% annual rate.

In addition, on June 13, 2006, we leased approximately 7,000 square feet of space in Miami, Florida, of which approximately 5,000 square feet is used as a warehouse and the remaining 2,000 as a showroom and offices. The lease has a five-year term commencing on June 1, 2006. The annual base rent is $56,400 for the first two years of the term (payable in monthly payments of $4,700), and increases 2.0% on June 1st of each year beginning with June 1, 2008. In addition, we pay condominium maintenance fees (currently $600 per month), real property taxes (currently $800 per month) and all applicable sales tax.

Our current premises are adequate for our current operations and we do not anticipate that we will require any additional premises in the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

Other than as set forth below, we know of no material, active or pending legal proceedings against our company, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.

In October 2006, we paid $200,000 in settlement of a legal proceeding that had been brought against Essential Reality, Inc. (a predecessor of our Company), Essential Reality, LLC and David Devor, a former officer and a current employee, for rent and costs relating to premises formerly occupied by us. As of 2005, we had accrued $125,000 against the potential outcome of the litigation. In 2006, we recorded an additional $75,000, and paid the entire settlement amount.

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

None

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PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our common stock has traded on the OTC Bulletin Board since April 28, 2005. It traded on the Pink Sheets Electronic Quotation Service from July 2003 to April 27, 2005 and on the OTC Bulletin Board from April 19, 2001 until July 2003. Our current trading symbol is ADTR.OB. The following table sets out the high and low closing bid prices of our common stock during the periods indicated as quoted on the OTC Bulletin Board and the Pink Sheets Electronic Quotation Service. Prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not represent actual transactions.

 
Common Stock
 
Bid Prices
     
2006
High
Low
     
First Quarter
$0.46
$0.20
     
Second Quarter
$0.22
$0.11
     
Third Quarter
$0.18
$0.09
     
Fourth Quarter
$0.18
$0.11
     
2005
High
Low
     
First Quarter
$0.65
$0.11
     
Second Quarter
$0.20
$0.12
     
Third Quarter
$0.45
$0.13
     
Fourth Quarter
$0.47
$0.20

As of March 16, 2007, there were approximately 550 stockholders of record of the Company's Common Stock. This number does not include certain shares held in street name. The Company has not paid cash dividends on its Common Stock and does not plan to pay cash dividends in the foreseeable future.

(d) Securities Authorized for Issuance Under Equity Compensation Plans

Our Alliance Distributors Holding Inc. 2004 Stock Plan (the "2004 Plan") was adopted by our directors on October 25, 2004 and was approved by our stockholders on October 25, 2004. Our 2006 Stock Plan (the “2006 Plan”) was adopted by our directors on October 3, 2006 and was approved by our stockholders on February 1, 2007. Both plans enable us to grant equity and equity-linked awards to our Directors, officers, employees and other persons who provide services to us. The plans are intended to allow us to provide incentives that will (1) strengthen the desire of highly competent persons to provide services to us and (2) further stimulate their efforts on our behalf. We have made no grants under the 2006 Stock Plan.

As of December 31, 2006, we have 6,990,000 options outstanding under the 2004 Plan. The options are ten-year non-qualified options to purchase our common stock, 6,740,000 of the options have an exercise price of $0.325 per share, 150,000 of the options have an exercise price of $0.32 per share, and 100,000 of the options have an exercise price of $0.18 per share. All options vest and become exercisable in 12 equal quarterly installments. Of the total options granted, 1,100,000 options were granted to Jay Gelman, our Chairman of the Board of Directors and Chief Executive Officer, 1,100,000 options were granted to Andre Muller, our President, Chief Operating Officer and director, 100,000 options were granted to Stephen Agress, our Executive Vice President, Chief Financial Officer and Secretary and 150,000 options were granted to each of Thomas Vitiello, Steven H. Nathan and Humbert B. Powell, III, each non-employee members of our Board of Directors. We granted the options in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended.

II-1
Equity Compensation Plan Information
Plan category
Number of Securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation plans
       
Equity compensation under the 2004 Stock Plans approved by security holders
6,990,000
$0.32
3,010,000
       
Equity compensation under the 2006 Stock Plans approved by security holders
-
-
10,000,000


ITEM 6. SELECTED FINANCIAL DATA.

   
Year ended December 31,
  
May 9, 2003 (inception)
to
  
   
2006
  
2005
  
2004
  
Dec. 31, 2003
  
   
(In thousands, except per share data)
  
STATEMENT OF OPERATIONS DATA:
                  
                   
                   
Net sales
  
$
70,318
  
$
58,670
  
$
35,037
  
$
10,513
  
                           
Gross profit
  
$
6,893
  
$
5,938
  
$
3,921
  
$
1,294
  
                           
Income (loss) before provision for (benefit
                          
from) income taxes
  
$
(261
)
$
108
  
$
(228
)
$
208
  
                           
Net income (loss)
  
$
(214
)
$
186
  
$
(242
)
$
200
  
                           
Preferred stock dividends
  
$
-
  
$
-
  
$
164
  
$
-
  
                           
Net Income (loss) available to common stockholders
  
$
(214
)
$
186
  
$
(406
)
$
200
  
                           
Income (loss) available to common stockholders:
                          
Basic
  
$
.00
  
$
.00
  
$
(.01
)
$
.01
  
                           
Diluted
  
$
.00
  
$
.00
  
$
(.01
)
$
.01
  
                           
Cash dividends per share
  
$
.00
  
$
.00
  
$
.00
  
$
00
  

   
December 31,
  
   
2006
  
2005
  
2004
  
2003
  
   
(in thousands)
  
BALANCE SHEET DATA:
                  
                   
Working capital
  
$
2,378
  
$
2,847
  
$
2,587
  
$
501
  
                           
Total assets
  
$
19,117
  
$
12,870
  
$
8,157
  
$
5,516
  
                           
Long term liabilities
  
$
44
  
$
38
  
$
49
  
$
307
  
                           
Total stockholders’ equity
  
$
3,230
  
$
3,251
  
$
3,024
  
$
636
  

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Our distribution revenues are derived from the sale of interactive video games and gaming products for all key manufacturers and third-party software titles, accessories and hardware. Operating margins in our distribution business are dependent on the mix of software and hardware sales, with software and accessories generating higher margins than hardware.

II-2
YEAR ENDED DECEMBER 31, 2006 AND 2005 

The following tables show 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 Annual Report on Form 10-K:

   
Year ended December 31,
  
   
2006
  
2005
  
   
Dollars in thousands
  
                   
Net sales
  
$
70,318
    
100.0
%
$
58,670
    
100.0
%
                           
Cost of goods sold
    
63,425
    
90.2
%
  
52,732
    
89.9
%
                           
Gross profit
    
6,893
    
9.8
%
  
5,938
    
10.1
%
                           
Operating costs and expenses:
                          
Selling and administrative expenses
    
5,907
    
8.4
%
  
5,061
    
8.6
%
Provision for doubtful accounts
    
147
    
0.2
%
  
247
    
0.4
%
Terminated transaction costs
    
310
    
0.4
%
  
-
    
-
 
                           
Total operating costs and expenses
    
6,364
    
9.0
%
  
5,308
    
9.0
%
                           
Income from operations
    
529
    
0.8
%
  
630
    
1.1
%
                           
Interest expense
    
790
    
1.1
%
  
522
    
0.9
%
                           
(Loss) income before benefit from income taxes
    
(261
)
  
(0.3
)%
  
108
    
0.2
%
                           
Benefit from income taxes
    
(47
)
  
(0.0
)%
  
(78
)
  
(0.1
)%
                           
Net (loss) income
  
$
(214
)
  
(0.3
)%
$
186
    
0.3
%

RESULTS OF OPERATIONS

Net sales increased by $11,648,000 or 20%, from $58,670,000 for the year ended December 31, 2005 to $70,318,000 for the year ended December 31, 2006. 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 $10,693,000 or 20%, from $52,732,000 for the year ended December 31, 2005 to $63,425,000 for the year ended December 31, 2006. The increase in cost of good sold is attributable to and consistent with the increase in sales. Cost of goods sold excludes the distribution costs of purchasing, receiving, inspection, warehousing and handling costs; we include these costs in our selling and administrative expenses. These distribution costs were $1,452,000 and $1,161,000 for the years ended 2006 and 2005, respectively. Our gross profit as a percentage of net sales decreased slightly to 9.8% for the year ended December 31, 2006 from 10.1%, for the year ended December 31, 2005. Our gross profit may not be comparable to those of other entities since some entities include distribution costs in the cost of goods sold.

Selling and administrative expenses increased by $846,000 or 17%, from $5,061,000 for the year ended December 31, 2005 to $5,907,000 for the year ended December 31, 2006. The increase was primarily the result of increases in freight out expenses of approximately $211,000, due to both increased sales volume and fuel cost increases, approximately $379,000 for increased payroll, commissions and related payroll costs, approximately $155,000 related to equity-based compensation resulting from the adoption of SFAS 123(R), and approximately $208,000 in increased rent and utilities attributable to new warehouse and showroom facilities in New York and Florida. These increases were in part offset by a $220,000 gain from insurance proceeds for replacement value of assets in excess of book value that were damaged, and for extra costs incurred, as a result of a fire near our former 132ndstreet location. The balance of the change in selling and administrative expenses was due to various increases in administrative expenses. Selling and administrative expenses as a percentage of net sales decreased to 8.4% for the year ended 2006 from 8.6% for the year ended December 31, 2005. For the year ended December 31, 2006, selling and administrative expenses were comprised of the following: $984,000 in selling expenses, $1,452,000 in distribution costs and $3,471,000 in administrative expenses. For the year ended December 31, 2005, selling and administrative expenses were comprised of the following: $796,000 in selling expenses, $1,161,000 in distribution costs and $3,104,000 in administrative expenses.

II-3
Our provision for doubtful accounts decreased by $100,000, or 40%, from $247,000 in 2005 to $147,000 in 2006. The decrease is principally attributable to a reduction in potentially uncollectible accounts receivable balances.

We expensed terminated transaction costs of $310,000 in 2006 as a result of our decision not to acquire Foto Electric Supply Co., Inc. An agreement by the Company to acquire Fesco had expired by its terms on February 28, 2006, and subsequent discussions to extend and amend the agreement ended.

Interest expense increased by $268,000 or 51%, from $522,000 for the year ended December 31, 2005 to $790,000 for the year ended December 31, 2006. The increase was primarily due to higher interest rates on bank borrowings and increased borrowings. The increased borrowing levels were the result of increased sales volume that required higher inventory levels and increased accounts receivable.

In 2006, the benefit from income taxes was $47,000 or 18% of the loss before taxes compared to a benefit from income taxes of $78,000, or 72% of income before taxes in 2005. The 2006 benefit is lower than the U.S. Federal statutory rate principally due to a provision for local taxes based upon an alternative tax computation, certain expenses not deductible for income tax purposes, and the reduction of the deferred tax valuation allowance associated with net operating loss carryforwards. In 2005, the benefit is higher than the expected provision based upon the U.S. Federal statutory rate principally due to the utilization of net operating loss carryovers and the reduction of a valuation allowance.

YEAR ENDED 2005 AND DECEMBER 31, 2004 

   
Year ended December 31,
  
   
2005
  
2004
  
   
Dollars in thousands
  
                   
Net sales
  
$
58,670
    
100.0
%
$
35,037
    
100.0
%
                           
Cost of goods sold
    
52,732
    
89.9
%
  
31,116
    
88.8
%
                           
Gross profit
    
5,938
    
10.1
%
  
3,921
    
11.2
%
                           
Operating costs and expenses:
                          
Selling and administrative expenses
    
5,061
    
8.6
%
  
3,892
    
11.1
%
Provision for doubtful accounts
    
247
    
0.4
%
  
27
    
0.1
%
                           
Total operating costs and expenses
    
5,308
    
9.0
%
  
3,919
    
11.2
%
                           
Income from operations
    
630
    
1.1
%
  
2
    
0.0
%
                           
Interest expense
    
522
    
0.9
%
  
230
    
0.7
%
                           
Income (loss) before (benefit from) provision for income taxes
    
108
    
0.2
%
  
(228
)
  
(0.7
)%
                           
(Benefit from) provision for income taxes
    
(78
)
  
(0.1
)%
  
14
    
0.0
%
                           
Net income (loss)
  
$
186
    
0.3
%
$
(242
)
  
(0.7
)%

RESULTS OF OPERATIONS

Net sales increased by $23,633,000 or 67%, from $35,037,000 for the year ended December 31, 2004 to $58,670,000 for the year ended 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.

II-4
Cost of goods sold increased by $21,616,000, or 69%, from $31,116,000 for the year ended December 31, 2004 to $52,732,000 for the year ended 2005. The increase was consistent with revenue growth. Gross profit as a percentage of net sales decreased to 10.1% for the year ended 2005 from 11.2% for the year ended December 31, 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 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 $1,161,000 and $994,000 for the year ended 2005 and 2004, respectively.

Selling and administrative expenses increased by $1,169,000, or 30%, from $3,892,000 for the year ended December 31, 2004 to $5,061,000 for the year ended December 31, 2005. The increase was primarily due to the Company's increase in salaries and related payroll taxes of $282,000, advertising and marketing expenses of $195,000, professional fees associated with the Company's expanded operations of $133,000, litigation expenses of $125,000, freight out expenses of $120,000, insurance premiums of $92,000 and stock option compensation expense of $38,000 as a result of 750,000 options that were granted to non-employees who provide services to the Company. Selling and administrative expenses as a percentage of net sales decreased to 8.6% for the year ended December 31, 2005 from 11.1% for the year ended December 31, 2004. For the year ended December 31, 2005, selling and administrative expenses were comprised of the following: $796,000 in selling expenses, $1,161,000 in distribution costs and $3,104,000 in administrative expenses. For the year ended December 31, 2004, selling and administrative expenses were comprised of the following: $497,000 in selling expenses, $994,000 in distribution costs and $2,401,000 in administrative expenses.

Our provision for doubtful accounts increased by $220,000, from $27,000 in 2004 to $247,000 in 2005. The increase is principally attributable to an increase in potentially uncollectible accounts receivable balances.

Interest expense increased by $292,000, or 127%, from $230,000 for the year ended December 31, 2004 to $522,000 for the year ended December 31, 2005. The increase was primarily due to increased borrowings as well as higher interest rates on bank borrowings during the year ended December 31, 2005. The increased borrowing levels were the result of increased sales volume that required higher inventory levels and increased accounts receivable.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities was $1,436,000 for the year ended December 31, 2006, compared to $2,423,000 cash used in operating activities for the year ended December 31, 2005, a decrease of $987,000. The $987,000 decrease is principally attributable to a decrease in amounts due from vendors combined with an increase in accounts payable resulting in a $4,401,000 increase in cash, partially offset by a $214,000 net loss in 2006 compared to $186,000 net income in 2005, and a $2,234,000 increase in cash used in operating activities resulting from an increase in inventory. The remaining difference is principally due to changes in other operating assets and liabilities. The decrease in amounts due from vendors and increase in accounts payable resulted both from growth in the business and an increase in the amount of credit extended by suppliers.

Net cash used in investing activities increased by $276,000, from $144,000 in 2005 to $420,000 in 2006. The increase is principally attributable to an increase in capital expenditures, partially offset by proceeds from an insurance claim in 2006 totaling approximately $305,000. In 2006 we purchased $699,000 of property and equipment, of which approximately $600,000 was in connection with our move to a new warehouse, showroom and executive offices in New York City, and approximately $50,000 was for our new warehouse in Florida, which we opened in September 2006.

Net cash provided by financing activities for the year ended December 31, 2006 decreased by $648,000, from $2,598,000 in 2005 to $1,950,000 in 2006. The decrease was principally due to a decrease in net proceeds from our bank loan approximating $702,000, partially offset by net cash used in other financing activities approximating $54,000.

We have a financing agreement (the “Agreement”) with Rosenthal & Rosenthal, Inc. ("Rosenthal") pursuant to which Rosenthal may in its discretion lend to us 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 our assets, and require us to be in compliance with certain financial covenants. Our CEO and our President have signed limited guaranties in respect of borrowings under the Agreement.

II-5
The Agreement terminates November 30, 2007 unless earlier 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 December 31, 2006, the interest rate on borrowings outstanding was 9.75%. In addition, we are obligated to 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 totaled approximately $96,000, $56,000 and $6,000 for the three years ended December 31, 2006.

In connection with the Agreement, on November 11, 2005 we 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 by Rosenthal at $.10 per share 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). We recorded a deferred financing cost of approximately $60,000 in the fourth quarter 2004, representing the fair value of the warrants, which is amortized over the life of the financing agreement of three years. The financing expense recorded totaled approximately $20,000, $18,000 and $5,000 for the three years ended December 31, 2006, respectively.

Under the terms of the Agreement, we are required to maintain a specified level of net worth, working capital and debt ratios as defined. At various times throughout the Agreement, Rosenthal has amended the covenants. As of December 31, 2006, the Company did not comply with certain financial covenants for which Rosenthal has provided a waiver.

We believe we will have sufficient liquidity for the next twelve months and the foreseeable future. However, our business would be materially and adversely affected if Rosenthal demands payment of these borrowings under the Agreement and if we are unable to refinance these borrowings. We are currently in discussions to renegotiate our existing facility with our current lender and we believe we will be able to secure an extension of the existing agreement or alternative financing when the current line of credit expires.

In September 2006, we relocated our offices, wholesale showroom, and warehouse to a 25,000 square foot facility located at 1160 Commerce Avenue in the Bronx, New York. The new facility, which provides almost 10,000 square feet more than our old facilities, is leased for a five year term with an option for us to extend the term for an additional 5 year term expiring on May 31, 2016. Annual base rent is $295,000 for the first year of the term, with scheduled 3.5% increases each year commencing on June 1, 2007.

In addition, in September 2006 we opened a 7,000 square feet distribution facility and wholesale showroom in Miami, Florida.

Contractual Obligations

The table below reflects our contractual cash obligations, expressed in thousands, at December 31, 2006.

   
Payments Due by Period
  
Contractual Obligations
  
Total
  
Less than
1 year
  
1-3 years
  
4-5 years
  
After
5 years
  
                       
Long-term obligations
  
$
15
  
$
11
  
$
4
  
$
-
  
$
-
  
Operating lease obligations
    
1,668
    
357
    
749
    
562
    
-
  
Note payable - bank
    
7,201
    
7,201
    
-
    
-
    
-
  
Note payable - bank, interest
    
702
    
702
    
-
    
-
    
-
  
                                 
Total contractual cash obligations
  
$
9,586
  
$
8,271
  
$
753
  
$
562
  
$
-
  
                                 
Note payable - bank in the table is shown as a less than one year obligation because the lending bank may demand payment at any time. Interest on the note accrues at the prime rate (but not less than 4.75%) plus 1.5%. At December 31, 2006, the interest rate on borrowings outstanding was 9.75%. Note payable - bank, interest assumes that the principal amount outstanding on the note is paid in full on November 30, 2007 (and refinanced immediately thereafter on comparable terms), that the principal amount outstanding during the period will be $7,201,000, and is based upon our current borrowing rate of 9.75%.
 
II-6
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Certain of our accounting policies require the application of significant judgment by us 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 - We recognize sales upon shipment of products to customers as title and risk of loss pass upon shipment and collectibility is reasonably assured. We provide provisions for estimated uncollectible discounts and rebates to customers, estimated returns and allowances and other adjustments in the same period the related sales are recorded. While such amounts have been within expectations and the provisions established, we cannot guarantee that we 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. We establish credit terms for new clients based upon a review of their credit information and perform ongoing credit evaluations of our customers, adjusting credit terms when we believe 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. We determine 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 us, 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, we cannot guarantee that credit loss rates in the future will be consistent with those experienced in the past. In addition, we have credit exposure if the financial condition of one of our 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 our estimate of the allowance for doubtful accounts will change. As of December 31, 2006 and 2005, our allowance for doubtful accounts approximated $312,000 and $181,000, respectively.
 
Inventories - Inventory is stated at the lower of cost or market, cost being determined on the average cost basis. We receive price protection from certain of our suppliers for merchandise that may be slow moving or aged. We evaluate the adequacy of our slow moving or aged inventory quarterly and write down inventory to fair value based upon the price protection received or current market value. While write-downs have been within expectations and the provisions established, we cannot guarantee that we will continue to experience the same level of write-downs as in the past. We do not offer warranties to our customers but will accept returns of product claimed to be defective and reimburse the customers for the purchase price paid. The majority of our suppliers in turn accept these returns by customers. There are no reserves for warranties as of December 31, 2006 and 2005.

Income Taxes - At December 31, 2006, we had federal and state net operating loss carryforwards (NOL’s) of approximately $5.5 million. In accordance with SFAS No. 109, “Accounting for Income Taxes”, we establish valuation allowances if it is “more likely than not” that we will not be able to utilize the NOLs to offset future taxes. We have established a valuation allowance for the majority of the NOLs due to the uncertainty surrounding the realization of the NOL’s which resulted from a transaction under the Exchange Agreement. Pursuant to IRC Section 382 of the Tax Reform Act of 1986 the utilization of NOL’s is limited in the case of certain transactions including significant changes in ownership interests. We have determined that based upon the terms of the Exchange Agreement, an ownership change pursuant to this Act has occurred and as a result, the NOL’s are significantly limited.

II-7
Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48) “Accounting for Uncertainty in Income Taxes” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Furthermore, FIN 48 provides guidance on the recognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN 48 to have a material impact on our financial statements.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (SAB 108) “Considering the Effects of Prior Year Misstatements in Current Year Financial Statements.” SAB 108 provides guidance on quantifying financial statement misstatements, including the effects of prior year errors on current year financial statements. SAB 108 is effective for periods ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on our financial statements.

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measures” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, however it does not apply to SFAS 123R. This Statement shall be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. The provisions of this statement should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except in some circumstances where the statement shall be applied retrospectively. We do not expect the adoption of SFAS 157 to have a material impact on our financial statements.

FLUCTUATIONS IN OPERATING RESULTS AND SEASONALITY

We have experienced fluctuations in quarterly operating results as a result of the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; order cancellations; and delays in product shipment. Sales of our titles are also seasonal, with peak shipments typically occurring in the fourth calendar quarter as a result of increased demand for titles during the holiday season. Annual comparisons of operating results are not necessarily indicative of future operating results.


ITEM 7A. 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. We have no financial instruments that give us exposure to foreign exchange rates or equity prices.

Our 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 1.5%. As of December 31, 2006, our note payable-bank bore interest at 9.75%. As of December 31, 2006, a hypothetical immediate 10% adverse change in prime interest rates relating to the note would have an approximate $70,000 unfavorable impact on our earnings and cash flows over a one-year period, assuming the borrowing level remains consistent with the outstanding borrowings as of December 31, 2006. The fair value of the borrowings under the credit facility is not affected by changes in market interest rates.

II-8
Item 8. Financial Statements and Supplementary Data.

ALLIANCE DISTRIBUTORS HOLDING INC.
INDEX TO FINANCIAL STATEMENTS

 
PAGE
   
Report of Independent Registered Public Accounting Firm
II-10
   
Balance Sheets as of December 31, 2006 and 2005
II-11
   
Statements of Operations for the three years ended December 31, 2006
II-12
   
Statement of Stockholders’ Equity for the three years ended December 31, 2006
II-13
   
Statements of Cash Flows for the three years ended December 31, 2006
II-15
   
Notes to Financial Statements
II-16
 
 

 
II-9

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Stockholders
Alliance Distributors Holding Inc.

We have audited the accompanying balance sheets of Alliance Distributors Holding Inc. as of December 31, 2006 and 2005, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31 2006. Our audits also included the financial statement schedule listed in the index at item 15 (a) (2) for each of the three years in the period ended December 31. 2006. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule 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 audits 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. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.



 
 
/s/ Mahoney Cohen & Company, CPA, P.C.
 
 
New York, New York
March 29, 2007

II-10
ALLIANCE DISTRIBUTORS HOLDING INC.
BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
(In Thousands, except per share amounts)

   
2006
  
 2005
  
           
           
ASSETS
          
           
CURRENT ASSETS:
          
Cash and equivalents
  
$
346
  
$
252
  
Accounts receivable-net
    
7,922
    
5,526
  
Inventory
    
9,104
    
5,369
  
Due from vendors
    
83
    
739
  
Prepaid acquisition and proposed offering costs
    
-
    
162
  
Prepaid expenses and other current assets
    
615
    
225
  
Deferred income taxes
    
151
    
155
  
               
Total current assets
    
18,221
    
12,428
  
               
PROPERTY AND EQUIPMENT - NET
    
752
    
371
  
               
DEFERRED INCOME TAXES
    
67
    
-
  
               
OTHER ASSETS
    
77
    
71
  
               
TOTAL
  
$
19,117
  
$
12,870
  
               
LIABILITIES AND STOCKHOLDERS' EQUITY
              
               
CURRENT LIABILITIES:
              
Notes payable - bank
  
$
7,201
  
$
5,135
  
Accounts payable
   
8,532
    
4,033
  
Current portion of long term obligations
    
11
    
19
  
Accrued expenses and other current liabilities
    
99
    
394
  
               
Total current liabilities
    
15,843
    
9,581
  
               
DEFERRED LEASE OBLIGATIONS
   
40
    
26
  
               
LONG TERM OBLIGATIONS
    
4
    
12
  
               
STOCKHOLDERS' EQUITY:
              
Series A Convertible Non-Redeemable Preferred Stock, $.001 par value;
             
8,530 and 8,615 shares authorized; 262 and 347 shares issued and
             
outstanding at December 31, 2006 and 2005, respectively
    
-
    
-
  
Common stock, $.001 par value; 100,000 shares authorized; 48,721
              
and 47,369 shares issued and outstanding at December 31, 2006 and
              
2005, respectively
    
49
    
47
  
Additional paid-in capital
    
3,415
    
3,224
  
Accumulated deficit
    
(234
)
  
(20
)
               
Total stockholders’ equity
    
3,230
    
3,251
  
               
TOTAL
  
$
19,117
  
$
12,870
  

See notes to financial statements

II-11
ALLIANCE DISTRIBUTORS HOLDING INC.
STATEMENTS OF OPERATIONS
THREE YEARS ENDED DECEMBER 31, 2006
(In thousands, except per share amounts)


   
2006
  
2005
  
2004
  
               
NET SALES
  
$
70,318
  
$
58,670
  
$
35,037
  
                     
COST OF GOODS SOLD
    
63,425
    
52,732
    
31,116
  
                     
GROSS PROFIT
    
6,893
    
5,938
    
3,921
  
                     
OPERATING COSTS AND EXPENSES:
                    
Selling and administrative expenses
   
5,907
    
5,061
    
3,892
  
Provision for doubtful accounts
    
147
    
247
    
27
  
Terminated transaction costs
    
310
    
-
    
-
  
                     
Total operating expenses
    
6,364
    
5,308
    
3,919
  
                     
INCOME FROM OPERATIONS
    
529
    
630
    
2
  
                     
Interest expense
    
790
    
522
    
230
  
                     
(LOSS) INCOME BEFORE (BENEFIT FROM)
                    
PROVISION FOR INCOME TAXES
    
(261
)
  
108
    
(228
)
                     
(Benefit from) provision for income taxes
    
(47
)
  
(78
)
  
14
  
                     
NET (LOSS) INCOME
    
(214
)
  
186
    
(242
)
                     
Preferred stock dividends
    
-
    
-
    
164
  
                     
NET (LOSS) INCOME AVAILABLE TO
                   
COMMON STOCKHOLDERS
 
$
(214
)
$
186
  
$
(406
)
                     
Net loss per share available to common
stockholders - basic
 
$
-
  
$
-
  
$
(.01
)
Net loss per share available to common
                   
stockholders - diluted
  
$
-
  
$
-
  
$
(.01
)
                     
Weighted average common shares outstanding - basic
    
48,584
    
46,622
    
35,330
  
Weighted average common shares outstanding - diluted
    
48,584
    
47,110
    
35,330
  


See notes to financial statements
 
II-12
ALLIANCE DISTRIBUTORS HOLDING INC.
STATEMENT OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 2006
(In thousands) 
 


   
Preferred Stock
 
Common Stock
          
   
 Shares
  
Amount
  
Shares
  
Amount
  

Additional
Paid in Capital
  

Accumulated
Deficit
  
Total
Stockholders’
Equity
  
                               
                               
Balance, January 1, 2005
    
564
  
$
-
    
43,851
  
$
44
  
$
3,186
  
$
(206
)
$
3,024
  
                                             
Conversion of Preferred Stock A into Common Stock
    
(217
)
        
3,468
    
3
    
(3
)
        
-
  
                                             
Registration Costs
                            
(16
)
        
(16
)
                                             
Issuance of Stock options to non-employees
                            
38
          
38
  
                                             
Shares issued to placement agent of proposed offering
                
50
          
19
          
19
  
                                             
Net Income
    
-
    
-
    
-
    
-
    
-
    
186
   
186
  
Balance, December 31, 2005
    
347
    
-
    
47,369
    
47
    
3,224
    
(20
)
  
3,251
  
                                             
Conversion of Preferred
                                            
Stock A into Common
                                            
Stock
    
(85
)
        
1,352
    
2
    
(2
)
        
-
  
Stock option
                                            
compensation expense
                            
193
          
193
  
Net loss
    
-
    
-
    
-
    
-
    
-
    
(214
)
  
(214
)
                                             
Balance, December 31, 2006
    
262
  
$
-
    
48,721
  
$
49
  
$
3,415
  
$
(234
)
$
3,230
  
 
 
See notes to financial statements

II-13
ALLIANCE DISTRIBUTORS HOLDING INC.
STATEMENT OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 2006 (CONTINUED)
(In thousands)
 
 
     
 Preferred Stock 
    
Common Stock
                    
     
Shares
    
Amount
    
 Shares
    
 Amount
    
Additional
Paid in
Capital
    
Accumulated Deficit
    
Total
Stockholders’ Equity
  
                                             
Balance, January 1, 2004
    
-
  
$
-
    
-
  
$
-
  
$
435
  
$
200
  
$
635
  
                                             
Exchange of Alliance shares for Essential shares
    
1,551
    
2
                
(2
)
        
-
  
                                             
Essential shareholders’ shares prior to reverse acquisition
                
422
    
-
                
-
  
                                             
Issuance of shares in exchange for Essential debt and Essential’s debt and liabilities assumed
    
452
    
-
    
78
    
-
    
(1,068
)
        
(1,068
)
                                             
Proceeds from PPO, net of cash issuance costs
    
1,125
    
1
                
3,799
          
3,800
  
                                             
Shares issued to placement agent of PPO, net of merger expenses
    
108
                                  
-
  
                                             
Preferred stock dividend
    
46
                      
164
    
(164
)
  
-
  
                                             
Conversion of Preferred Stock B into Common Stock
    
(1,551
)
  
(2
)
  
24,680
    
25
    
(23
)
        
-
  
 
                                            
Conversion of Preferred Stock A into Common Stock
    
(1,167
)
  
(1
)
  
18,561
    
19
    
(18
)
        
-
  
                                             
Shares issued to settle Common Stock Liability
                
110
          
32
          
32
  
                                             
Warrants issued to lender
                            
61
          
61
  
                                             
Merger expenses and registration fees
                            
(194
)
        
(194
)
                                             
Net loss
    
-
    
-
    
-
    
-
    
-
    
(242
)
  
(242
)
                                             
Balance, December 31, 2004
    
564
  
$
-
    
43,851
  
$
44
  
$
3,186
  
$
(206
)
$
3,024
  
 
See notes to financial statements

II-14
ALLIANCE DISTRIBUTORS HOLDING INC.
STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31, 2006
(In thousands)
 
               
   
2006
  
2005
  
2004
  
OPERATING ACTIVITIES:
  
 
          
Net (loss) income
  
$
(214
)
$
186
  
$
(242
)
Adjustments to reconcile net (loss) income to net cash
                   
 used in operating activities:
                    
Gain from insurance recovery
    
(220
)
  
-
    
-
  
Deferred rent
    
14
    
8
    
13
  
Depreciation and amortization
    
143
    
115
    
83
  
Provision for doubtful accounts
    
147
    
247
    
27
  
Stock option compensation expense
    
193
    
38
    
-
  
Amortization of deferred financing costs
    
116
    
74
    
11
  
Deferred income taxes
    
(63
)
  
(155
)
  
-
  
Changes in operating assets and liabilities:
                    
Accounts receivable
    
(2,543
)
  
(2,403
)
  
(3,217
)
Due from factor
    
-
    
-
    
1,284
  
Inventory
    
(3,735
)
  
(1,501
)
  
(972
)
Due from vendors
    
656
    
(705
)
  
(20
)
Prepaid acquisition and proposed offering costs
    
162
    
-
    
-
  
Prepaid expenses and other current assets
    
(296
)
  
(3
)
  
(64
)
Accounts payable
    
4,499
    
1,459
    
(1,890
)
Accrued expenses and other current liabilities
    
(295
)
  
217
    
(194
)
                     
 Net cash used in operating activities
    
(1,436
)
  
(2,423
)
  
(5,181
)
                     
INVESTING ACTIVITIES:
                    
Purchase of property and equipment
    
(699
)
  
(77
)
  
(69
)
Proceeds from insurance claim
    
305
    
-
    
-
  
Increase in other assets
   
(26
)
  
(13
)
  
(3
)
Payments for acquisition agreement
    
-
    
(54
)
  
-
  
 
                    
 Net cash used in investing activities
    
(420
)
  
(144
)
  
(72
)
                     
FINANCING ACTIVITIES:
                    
Proceeds from note payable - bank
    
68,646
    
57,695
    
10,019
  
Repayments of note payable - bank
    
(66,580
)
  
(54,927
)
  
(7,652
)
Payments for registration and issuance costs
    
-
    
(16
)
  
(201
)
Payment of long-term obligations
    
(16
)
  
(29
)
  
(272
)
Payment of deferred financing costs
    
(100
)
  
(100
)
  
(50
)
Proceeds from sale of securities
    
-
    
-
    
4,000
  
Payments for proposed offering costs
    
-
    
(25
)
  
-
  
Payments for pre-acquisition liabilities
    
-
    
-
    
(915
)
Payments for merger costs
    
-
    
-
    
(112
)
                     
 Net cash provided by financing activities
   
1,950
    
2,598
    
4,817
  
                     
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    
94
    
31
    
(436
)
                     
CASH AND EQUIVALENTS, BEGINNING OF YEAR
    
252
    
221
    
657
  
                     
CASH AND EQUIVALENTS, END OF YEAR
  
$
346
  
$
252
  
$
221
  

See notes to financial statements

II-15
ALLIANCE DISTRIBUTORS HOLDING INC.
Notes to Financial Statements

Note 1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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. The Company operates as a single segment.

On June 17, 2004, the Company (formerly Essential Reality, Inc. "Essential") entered into a Share Exchange Agreement (the "Exchange Agreement") with 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.

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 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.

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 were not entitled to the 6% dividend referred to above.

II-16
On July 21, 2005, the Company and Abrams/Gentile Entertainment Inc. ("Age") entered into an operating 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 owns 65% of Alliance Age LLC. As of December 31, 2006, Alliance Age LLC was inactive.

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements relate primarily to bad debt reserves on accounts receivable and the realization of deferred tax assets.

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. As of December 31, 2006 and 2005, the Company’s allowance for doubtful accounts totaled approximately $312,000 and $181,000, respectively.

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. The Company receives price protection from certain of its suppliers for merchandise that may be slow moving or aged. The Company evaluates the adequacy of its slow moving or aged inventory quarterly and writes down its inventory to fair value based upon the price protection received or current market value. 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. The Company does not offer warranties to its customers but will accept returns of product claimed to be defective and reimburse the customers for the purchase price paid. The majority of the Company’s suppliers in turn accept these returns by customers. There are no reserves for warranties as of December 31, 2006 and 2005.

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.
 
II-17
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
2 to 7 years
Leasehold improvements
5 years
Computer software
2 to 3 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 periods prior to June 29, 2004. Effective June 29, 2004, the Company is taxed as a C corporation.

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 carry forwards 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.

Selling and administrative expenses

The Company includes shipping and handling costs in selling and administrative expense. For the three years in the period ended December 31, 2006, the Company incurred approximately $575,000, $364,000 and $245,000, of such costs, respectively.

Advertising expenses are charged to operations in the period in which they are incurred. Included in selling and administrative expenses for the three years in the period ended December 31, 2006 were advertising expenses approximating $186,000, $170,000 and $35,000, respectively.

Included as a reduction of selling and administrative expense for the year ended December 31, 2006 is a $220,000 gain from insurance proceeds for replacement value of assets in excess of book value that were damaged, and for extra costs incurred, as a result of a fire near the Company’s former offices.

II-18
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, 2006 and 2005 due to their short-term maturities. 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, 2006 and 2005 and for the three years in the period ended December 31, 2006, the Company has no items that represent other comprehensive income.

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 (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted-average number of common shares outstanding during the period increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of the outstanding options is reflected in diluted earnings (loss) per share by application of the treasury stock method. Diluted net loss per share for 2006 and 2004 does not include potential common shares derived from stock options because as a result of the Company incurring losses, their effect would have been antidilutive.
 
The denominator for diluted net income per share for the year ended December 31, 2005 includes 488,000 shares issuable upon conversion of warrants. The denominator for basic net income (loss) per share and weighted average number of shares outstanding for the year ended December 31, 2004 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 year ended December 31, 2006 exclude approximately 242,000 for common shares issuable upon exercise of warrants and approximately 1,700,000 common shares issuable upon conversion of Series A Convertible Non-Redeemable Preferred Stock since their effect would be anti-dilutive. Common equivalents for the year ended December 31, 2004 exclude 250,000 for common shares issuable upon exercise of warrants since their effect would be anti-dilutive.

Stock Based Compensation

Pursuant to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," (“APB 25”) prior to January 1, 2006 the Company accounted for stock based employee compensation arrangements using the intrinsic value method. Accordingly, no compensation expense was recorded in the financial statements with respect to options granted to employees, since the options were granted at or above market value.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (“SFAS No. 123(R)”) which eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The Company has adopted the modified prospective method whereby compensation cost is recognized in the financial statements beginning with the effective date based on the requirements of SFAS No. 123(R) for all share-based payments granted after that date and for all unvested awards granted prior to that date.

For the year ended December 31, 2006, share-based compensation expense related to the Company’s various stock option plans totaling approximately $193,000 is included in selling and administrative expenses. In addition, at December 31, 2006, total compensation cost related to non-vested stock options net yet recognized totaled approximately $200,000. This cost is expected to be recognized over the subsequent 15 months.

II-19
The following table illustrates the effect on net income and income per share for the year ended December 31, 2005 (in thousands, except per share amounts) if the Company had applied the fair value recognition provisions of SFAS No. 123(R) to stock-based employee compensation.

   
2005
  
       
Net income as reported
 
$
186
  
         
Deduct: Total stock-based employee
        
compensation determined under fair value
        
based method, net of related tax effects
    
(122
)
         
         
Pro forma net income
 
$
64
  
         
Income per share:
        
Basic and diluted - as reported
  
$
0.00
  
         
Basic and diluted - pro forma
  
$
0.00
  

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 July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48) “Accounting for Uncertainty in Income Taxes” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Furthermore, FIN 48 provides guidance on the recognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of FIN 48 to have a material impact on its financial statements.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (SAB 108) “Considering the Effects of Prior Year Misstatements in Current Year Financial Statements.” SAB 108 provides guidance on quantifying financial statement misstatements, including the effects of prior year errors on current year financial statements. SAB 108 is effective for periods ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measures” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, however it does not apply to SFAS 123R. This Statement shall be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. The provisions of this statement should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except in some circumstances where the statement shall be applied retrospectively. The Company does not expect the adoption of SFAS 157 to have a material impact on its financial statements.

Note 2 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

Supplemental disclosures of cash flow information (in thousands) are as follows:
               
Cash paid during the year for:
  
2006
  
2005
  
2004
  
Interest
 
$
754
  
$
409
  
$
148
  
Income taxes
  
$
98
  
$
7
  
$
19
  

II-20
The following is a supplemental schedule (in thousands) of non-cash investing and financing activities for the three years ended December 31 2006:

   
2006
  
2005
  
2004
  
Issuance of Common Stock to placement agent
        
$
20
        
Acquisition and proposed offering costs accrued
          
63
        
Issuance of Series A 6% Preferred Stock to placement agent
              
$
385
  
Liabilities Assumed
                
1,068
  
Series A 6% Preferred Stock dividend
                
164
  
Merger costs accrued
                
82
  
Issuance of common stock to settle liability
                
32
  
Issuance of warrants to lender
                
60
  

Note 3 - CONCENTRATIONS OF CREDIT RISK AND MAJOR SUPPLIERS

Cash and Equivalents

The Company maintains cash balances at various banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. The company considers highly liquid investments with original maturities of three months or less to be cash equivalents.

Accounts Receivable

Concentrations of credit risk with respect to accounts receivable are limited because a large number of 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.

Fluctuations in Operating Results and Seasonality

The Company has experienced fluctuations in quarterly operating results as a result of the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; order cancellations; and delays in shipment. Sales of various titles are also seasonal, with peak shipments typically occurring in the fourth calendar quarter as a result of increased demand for titles during the holiday season. Annual comparisons of operating results are not necessarily indicative of future operating results.

Major Suppliers

For the year ended 2006, the Company’s three largest suppliers in the aggregate accounted for approximately 49% of total purchases (with one accounting for 27% alone) and the ten largest suppliers in the aggregate accounted for approximately 74% of total purchases. For the year ended 2005, the Company’s three largest suppliers in the aggregate accounted for approximately 62% of total purchases (with one accounting for 42% alone), and the ten largest suppliers in the aggregate accounted for 82% of total purchases. For the year ended December 31, 2004, the same three suppliers in the aggregate accounted for approximately 56% of total purchases, and the ten largest suppliers in the aggregate accounted for 77% of total purchases. At December 31, 2006 and 2005, the amount due to these three suppliers was approximately$3,559,000 and $1,830,000 respectively, 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.

II-21
Note 4 - PROPERTY AND EQUIPMENT

Property and equipment, stated at cost less accumulated depreciation and amortization (in thousands) consists of the following:

   
December 31,
  
   
2006
  
2005
  
           
Leasehold improvements
  
$
391
  
$
240
  
Computers, office equipment and furniture
    
319
    
104
  
Warehouse equipment
    
79
    
89
  
Vehicles 
    
52
    
52
  
Equipment under capital leases
    
24
    
46
  
Software
    
136
    
65
  
               
               
Total
    
1,001
    
596
  
Less accumulated depreciation and amortization
    
249
    
225
  
               
   
$
752
  
$
371
  

Depreciation and amortization expense approximated $143,000, $115,000 and $83,000 for the three years in the period ended December 31, 2006, respectively.

Note 5 - FINANCING AGREEMENT

The Company has 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%.

The Agreement terminates November 30, 2007 unless earlier 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 December 31, 2006, the interest rate on borrowings outstanding was 9.75%. In addition, the Company is obligated to 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 totaled approximately $96,000, $56,000 and $6,000 for the three years in the period ended December 31, 2006, respectively.

In connection with establishing 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 by Rosenthal at $.10 per share 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 is amortized over the three year life of the financing agreement. The financing expense recorded totaled approximately $20,000, $18,000 and $5,000 for the three years in the period ended December 31, 2006, 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. At various times throughout the Agreement, Rosenthal has amended the covenants. As of December 31, 2006, the Company did not comply with certain financial covenants for which Rosenthal has provided a waiver.
 
II-22
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 if the Company is unable to refinance these borrowings. The Company is currently in discussions to renegotiate its existing facility with its current lender and believes it will be able to secure an extension of the existing agreement or alternative financing when the current line of credit expires.

Note 6 - LONG TERM OBLIGATIONS

At December 31, 2006 and 2005, long-term obligations (in thousands) consist of:

       
   
2006
  
2005
  
           
Notes payable in monthly installments of $1
          
through September 2008, including interest
          
At varying rates up to 5.5%, secured by related
          
equipment with a carrying value of $12
  
$
10
  
$
25
  
               
Capital lease obligations
    
5
    
6
  
 
    
15
    
31
  
               
Less: Current portion
    
11
    
19
  
               
   
$
4
  
$
12
  

At December 31, 2006, future payments of long-term obligations (in thousands) are as follows:

       
2007
  
$
11
  
2008
    
4
  
         
   
$
15
  
         
 
Note 7 - INCOME TAXES

The components of the (benefit from) provision for income taxes are as follow (in thousands):

               
   
2006
  
2005
  
2004
  
               
Current:
              
Federal
  
$
(9
)
$
35
  
$
-
  
State and local
    
25
    
42
    
14
  
     
16
    
77
    
14
  
                     
Deferred:
                    
Federal
    
(56
)
  
(123
)
  
-
  
State and local
    
(7
)
  
(32
)
  
-
  
     
(63
)
  
(155
)
  
-
  
                     
Total
  
$
(47
)
$
(78
)
$
14
  

 
II-23
The Company was taxed as an S Corporation for federal and state purposes for the period January 1, 2004 through June 29, 2004. As such, the Company's tax provision for this period includes only New York City taxes, which are determined as if the Company was a C Corporation. New York City does not recognize S Corporation status. For the period the Company was a C Corporation during 2004, the Company incurred a federal, state and local net operating loss, which was carried forward and reduced the taxable income for fiscal year 2005.

Significant components of the Company's net deferred tax assets at December 31, 2006 and 2005 are as follows (in thousands):


       
   
2006
  
2005
  
Net operating loss carryforwards
  
$
2,342
  
$
2,357
  
Reserves and other items not currently deductible
    
144
    
131
  
Equity compensation not currently deductible
    
79
    
-
  
Costs capitalized to inventory for tax purposes
    
23
    
27
  
Other
    
(36
)
  
(3
)
               
     
2,552
    
2,512
  
               
Less: valuation allowance
    
(2,334
)
  
(2,357
)
               
Net deferred tax assets
  
$
218
  
$
155
  
               
               
Net deferred tax asset - current
  
$
151
  
$
155
  
Net deferred tax asset - non-current
    
67
    
-
  
               
   
$
218
  
$
155
  
               

Reconciliation of the U.S. statutory rate with the Company’s effective tax rate (benefit) is summarized as follows:

               
   
2006
  
2005
  
2004
  
               
Federal statutory rate
   
(34.0
)%
  
34.0
%
  
34.0
%
Increase (decrease) in tax resulting from:
                    
State and local taxes, net of federal benefits
    
4.6
%
  
26.0
%
  
(6.1
)%
Nondeductible expenses
    
11.1
%
  
4.3
%
  
-
  
Utilization of NOL
    
-
    
(69.8
)%
  
-
  
Change in valuation allowance
    
(8.8
)%
  
(69.1
)%
  
(32.9
)%
Other
    
9.1
%
  
3.3
%
  
(1.1
)%
                     
     
(18.0
)%
  
(71.3
)%
  
(6.1
)%
                     

At December 31, 2006, the Company had federal and state net operating loss carryforwards (NOL’s) of approximately $5.5 million. The federal NOL’s expire in 2023 and the state NOL’s expire in 2016. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible and net operating losses are utilized. Based on a consideration of these factors, the Company has established a valuation allowance of approximately $2,334,000 and $2,357,000 at December 31, 2006 and 2005, respectively, due to the uncertainty surrounding the realization of the NOL’s which resulted from the Exchange Agreement. The valuation allowance decreased by $23,000 in 2006 due to the recognition of net operating loss carryforwards. The valuation allowance in 2005 increased by $232,000 primarily due to the Company’s determination of the amount of Essential’s net operating loss carryforward that could not be utilized. Pursuant to IRC Section 382 of the Tax Reform Act of 1986 the utilization of NOL’s is limited in the case of certain transactions including significant changes in ownership interests. The Company has determined that based upon the terms of the Exchange Agreement, an ownership change pursuant to this Act has occurred. As a result, the NOL’s are significantly limited.

II-24
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 three years in the period ended December 31, 2006.

Note 9 - STOCK OPTIONS AND WARRANTS
 
Stock Options

In 2004, the Company established the 2004 Stock Plan (the “2004 Plan”) to grant equity and equity-linked awards up to a maximum of 10,000,000 shares of common stock. In addition, in February 2007, the Company’s stockholders approved the 2006Stock Plan (the “2006 Plan”), which authorizes grants for up to an additional 10,000,000 shares of common stock. The Company has not made any award grants from the 2006 Plan.

Information with respect to stock options granted pursuant to the 2004 Plan is as follows:

   
Shares
(in thousands)
  
Weighted
Average
Exercise Price
  
Outstanding - January 1, 2005
    
--
    
-
  
Granted - 2005
    
7,650
  
$
.325
  
Forfeited - 2005
    
(260
)
$
.325
  
Outstanding - December 31, 2005
    
7,390
  
$
.325
  
               
Granted - 2006
    
100
  
$
.16
  
Forfeited - 2006    
(500
)
$
.325
  
Outstanding - December 31, 2006
    
6,990
  
$
.323
  

All of the issued options are ten-year non-qualified and vest in twelve equal quarterly installments.

Of the total options granted in 2005, 1,100,000 options were granted to the Chief Executive Officer and Chairman of the Board of Directors of the Company, 100,000 options were granted to the former Chief Financial Officer, 1,100,000 options were granted to the President and Chief Operating Officer and 150,000 options were granted to each of three independent directors of the Company. In 2006, 100,000 options were granted to the Company’s Executive Vice President and Chief Financial Officer.

Of the total 2005 stock options granted, 250,000 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 a three year period. During the year ended December 31, 2006 and 2005, the Company recorded stock-based compensation expense of approximately $15,000 and $38,000, respectively, for these stock options.

For the years ended December 31, 2006 and 2005, share-based compensation expense related to the Company’s 2004 Stock Plan totaling approximately $193,000 and $38,000, respectively, and is included in selling and administrative expenses. In addition, at December 31, 2006, total compensation cost related to non-vested stock options net yet recognized totaled approximately $200,000. This cost is expected to be recognized over a weighted average period of 15 months.

The fair value of the options-pricing model was calculated with the following weighted-average assumptions used for grants during the years ended December 31, 2006 and 2005: risk-free interest rate 4.62% in 2006 and 4.25 to 4.5% in 2005; expected life 6.5 years; expected volatility 186% in 2006 and 55% to 126% in 2005. 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.

II-25
The number and weighted-average grant-date fair value of stock options is as follows:

 
Shares
(in thousands)
Weighted
Average
Grant-Date
Fair Value
     
Non-vested - January 1, 2006
5,551
$.095
Granted in 2006
100
$.160
Unvested portion forfeited in 2006
(325)
$.113
Vested in 2006
(2,363)
$.095
Non-vested - December 31, 2006
2,963
$.096

Information with respect to stock options outstanding at December 31, 2006 is as follows:

Range of Exercise Prices
Number Outstanding
Weighted-Average Remaining Contractual Life in Years
Weighted-Average Exercise Price
Options Exercisable
Weighted-Average Exercise Price
$0.32-$0.325
6,890,000
8.05
$0.325
4,019,000
$0.325
$0.18
100,000
9.75
$0.18
8,000
$0.18

Warrants

Pursuant to the PPO, the Company issued warrants to purchase 1,564,096 shares of common stock at an exercise price of $0.22 per share (See Note 1). The warrants expire on June 29, 2009.

In connection with establishing the Financing Agreement, on November 11, 2004 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 through 2011.

The future minimum lease payments, excluding escalation charges, are as follows (in thousands):

       
Operating leases
      
       
2007
  
$
357
  
2008
    
368
  
2009
    
381
  
2010
    
396
  
2011
    
166
  
         
   
$
1,668
  
         

In accordance with SFAS 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 three years in the period ended December 31, 2006 includes approximately $14,000, $8,000 and $13,000, respectively, which relates to the amortized portion of the scheduled rent increases, and to the first month rent abatement.

Total rent expense charged to operations for the three years in the period ended December 31, 2006 was approximately $361,000, $185,000 and $191,000, respectively.

II-26
Employment Agreement

In October 2006, the Company entered into a two year employment agreement with its Chief Financial Officer (the “Officer”). The agreement provides for annual base compensation of $210,000 per annum as well as for insurance and other fringe benefits, and contains confidentiality and non-compete and non-interference provisions. The Company may terminate the employment under the agreement without cause (as defined) at any time, provided that, in such case, the Company will, as severance, continue to pay an amount equal to his then base salary in normal payroll installments, subject to withholding, for six months or if less until September 30, 2008, plus the cost of COBRA for the period during which severance is payable as aforesaid. In addition, the Company granted an option effective on October 3, 2006 to purchase 100,000 shares of the Company’s common stock under the Company’s stock option plan at an exercise price of $0.18 per share. The option has a 10 year term, and vests in 12 equal installments on the last day of each of the 12 calendar quarters beginning with the calendar quarter that begins on October 1, 2006, but only so long as the Officer is employed by the Company on the last day of such calendar quarter.

Litigation

In October 2006, the Company paid $200,000 in settlement of a legal proceeding that had been brought against Essential Reality, Inc. (a predecessor of the Company), Essential Reality, LLC and a former officer and current employee of the Company, for rent and costs relating to premises formerly occupied by the Company. As of 2005, the Company had accrued $125,000 against the potential outcome of the litigation. For the year ended December 31, 2006, the Company recorded an additional $75,000, and paid the entire settlement amount.

Note 11 - TERMINATED TRANSACTION COSTS

On April 26, 2006, the Company announced that it would not acquire Foto Electric Supply Co., Inc. (Fesco). An agreement by the Company to acquire Fesco had expired by its terms on February 28, 2006, and subsequent discussions to extend and amend the agreement ended. As a result, in 2006 the Company recorded a charge of approximately $310,000 for its costs in the terminated transaction.  

Note 12 - Quarterly Financial Information (unaudited)
 
   
First
Quarter
  
Second
Quarter
  
Third
Quarter
  
Fourth
Quarter
  
   
(in thousands, except per share amounts)
  
2006
  
(unaudited)
  
Net Sales
  
$
13,319
  
$
13,269
  
$
15,453
  
$
28,277
  
Gross profit
  
$
1,559
  
$
1,651
  
$
1,360
  
$
2,323
  
Net income (loss) available to common stockholders
  
$
(94
)
$
73
  
$
(283
)
$
90
  
Basic and diluted income (loss) per share
  
$
(0.00
)
$
(0.00
)
$
(0.01
)
$
0.00
  
2005
                          
Net Sales
  
$
10,889
  
$
12,225
  
$
13,566
  
$
21,990
  
Gross profit
  
$
1,242
  
$
1,071
  
$
1,531
  
$
2,094
  
Net income (loss) available to common stockholders
  
$
(130
)
$
(336
)
$
222
  
$
430
  
Basic and diluted income (loss) per share
  
$
0.00
  
$
(0.01
)
$
0.00
  
$
0.01
  

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A. Controls and Procedures.

An evaluation has been carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and the operation of our "disclosure controls and procedures" (as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934) as of December 31, 2006 (“Evaluation Date”). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the disclosure controls and procedures are reasonably designed and effective to ensure that (i) information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (ii) such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

II-27
PART III

Item 10. Directors, Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.
 
Our directors and executive officers, their ages, positions held and duration each person has held that position, are as follows:

NAME
POSITION HELD WITH THE COMPANY
AGE
DATE FIRST ELECTED OR APPOINTED
Jay Gelman
Chief Executive Officer, Chairman of the Board of Directors and Assistant Secretary
45
Chief Executive Officer on June 29, 2004; Director and Chairman of the Board on October 14, 2004; Assistant Secretary on November 11, 2004;
Andre Muller
Chief Operating Officer, President and Director
42
Chief Operating Officer and President on June 29, 2004; Director on October 14, 2004; Secretary November 11, 2004 to November 30, 2006
Stephen Agress
Executive Vice President, Chief Financial Officer and Secretary
45
Executive Vice President and Chief Financial Officer on October 3, 2006; Secretary on November 30, 2006
Humbert B. Powell, III
Director
68
Director and Chairman of the Board of Directors from July 1, 2002 until October 14, 2004 and currently a Director
Thomas Vitiello
Director
45
Director on October 14, 2004
Steven H. Nathan
Director
57
Director on March 14, 2005

JAY GELMAN

Jay Gelman in 1989 co-founded L & J Marketing, Inc. d/b/a Alliance Distributors, a regional video game software and hardware distributor based in College Point, NY. He served as President, until December of 1997 when Alliance was sold to Take Two Interactive Software, Inc. From 1998 until 2003, Mr. Gelman was employed by Track Data Corporation (NASDAQ: TRAC) where he served as a director and as Executive Vice President. In 2003, Mr. Gelman co-founded Alliance Partners (name later changed to AllianceCorner Distributors Inc.), and served as its President and Chief Executive Officer. Since the acquisition by the Company of AllianceCorner Distributors Inc. on June 29, 2004, Mr. Gelman has served as Chief Executive Officer of the Company and is also currently the Chairman of the Board of Directors.

ANDRE MULLER

For more than five years prior to 2003 Andre Muller was employed as a General Manager by Take Two Interactive Software, Inc. In 2003, Mr. Muller co-founded Alliance Partners (name later changed to AllianceCorner Distributors Inc.), and served as its Chief Operating Officer. Since the acquisition by the Company of AllianceCorner Distributors Inc. on June 29, 2004, Mr. Muller has served as Chief Operating Officer and President of the Company and is also currently a director.

III-1
STEPHEN AGRESS

Stephen Agress was the Vice President - Finance and Chief Accounting Officer of Innodata Isogen, Inc. (“Innodata”) from March 1998 to September 30, 2006, and served as its principal financial officer from May 2001 to December 2005. He served as Innodata’s Corporate Controller from August 1995 until May 2004. Mr. Agress is a certified public accountant and was a senior audit manager in the TRADE Retail & Distribution Services Group at Deloitte & Touche LLP prior to his joining Innodata in 1995.

HUMBERT B. POWELL, III

Humbert B. Powell, III has been a Managing Director at Sanders Morris Harris, a regional investment-banking firm headquartered in Houston, Texas, with a branch in New York City, since November 1996. He is a trustee of Salem-Teikyo University. Mr. Powell served as chief executive officer of the Company from June 20, 2002 until July 1, 2002.

THOMAS VITIELLO

For more than five years, Mr. Vitiello has been the president of VIT Trading, Inc., a trader in precious metals. He graduated from NYU with a BS in Finance in 1985.

STEVEN H. NATHAN

Steven H. Nathan has since 1997 served as President of Progressive Planning, Inc. a tax and financial consulting firm in Jericho, New York. From 1993 through 1997 he was Vice President and Chief Financial Officer of L & J Marketing, Inc. d/b/a Alliance Distributors, a regional video game software and hardware distributor based in College Point, New York. He held similar positions from 1984 to 1993 with Wren/AP Distributors.

Term of Office

Our directors serve for a term of one year and until their successors are duly elected and qualified. Our officers serve at the pleasure of the Board of Directors.

There are no family relationships among directors, nominees or executive officers. We have no arrangements or understandings between any director or executive officer and any other person pursuant to which any director or executive officer was selected as such.

Section 16(a) Beneficial Ownership Reporting Compliance

We believe that during the period from January 1, 2006 through December 31, 2006 all Section 16(a) filing requirements applicable to our officers, directors and greater than ten-percent beneficial owners were complied with.

Code of Ethics

We have a Code of Ethics that applies to all of our employees, including our Chief Executive Officer and Chief Financial Officer, as well as each member of our Board of Directors. The text of our code of ethics is posted on our website at www.alliancedistributors.com. The Company intends to disclose future amendments to, or waivers from, certain provisions of the code of ethics for executive officers and directors in accordance with applicable NASDAQ and SEC requirements.

Item 11. Executive Compensation.

Compensation Discussion and Analysis

Overview

This compensation discussion and analysis describes and analyzes the material elements of compensation awarded to, earned by, or paid to each of our executive officers who served as named executive officers during the last completed fiscal year. This compensation discussion and analysis focuses on the information contained in the following tables and related footnotes and narrative for primarily the last completed fiscal year, but we also describe compensation actions taken before or after the last completed fiscal year to the extent it enhances the understanding of our executive compensation disclosure.

III-2
We do not have a Compensation Committee or any other committee of the Board of Directors performing equivalent functions. Decisions regarding compensation of our named executive officers are made by our Board of Directors. Jay Gelman, our Chief Executive Officer and Chairman of the Board, participated in deliberations of the Board during the fiscal year ended December 31, 2006 concerning executive officer compensation, except that he abstained from deliberations and voting regarding his own compensation. Andre Muller, our President and Chief Operating Officer, did not participate in deliberations concerning his own compensation, and did not participate in deliberations concerning the Chief Executive officer’s compensation.

None of our Board of Directors is an executive officer of a company whose compensation committee or board of directors includes any of our executive officers.

The principal elements of our executive compensation program are base salary, potential for annual incentive compensation award, stock options and other benefits and perquisites. Our other benefits and perquisites consist of automobile payments and related automobile costs, medical and disability insurance payments. Our philosophy is to position the aggregate of these elements at a level that is commensurate with our size and sustained performance.

Compensation Program Objectives and Philosophy

The objectives of our compensation program are to:

·  
Attract, motivate and retain qualified and dedicated executive officers.
·  
Retain talented executives and motivate them to achieve business objectives that will enhance stockholder value.
·  
Provide our executive officers with cash incentives to further the interests of the Company and our stockholders.

Generally, the compensation of our executive officers is composed of a base salary, incentive compensation awards, and equity awards in the form of stock options. In setting base salaries, the Board of Directors generally review the individual contributions of the particular executive.

The following is the compensation committee’s policy for executive officers:

The Board of Directors is responsible for determining the annual salary, incentive compensation awards, stock awards and other compensation of executive officers who do not have employment agreements as well as annual salary increases, stock awards and other compensation of executive officers who have employment agreements. In its deliberations regarding compensation of executive officers, the compensation committee considers the following factors:

·  
Company performance, both separately and in relation to similar companies;
·  
The individual performance, experience and scope of responsibilities of each executive officer;
·  
Compensation and stock award information disclosed in the proxy statements of other companies;
·  
Historical compensation levels and stock awards at the Company;
·  
The overall competitive environment for executives and the level of compensation necessary to attract and retain executive talent; and
·  
The recommendations of management.

Compensation Process

Our Board of Directors approves all elements of compensation of our named executive officers, including the terms of their employment agreements, if any, taking into consideration recommendations from our chief executive officer (for compensation other than his own), as well as competitive market guidance.

Our compensation program for executives principally consists of three elements:
 
·  
base salaries
·  
performance-based annual incentive compensation awards
·  
periodic grants of stock options
 
III-3
Base Salaries

The salaries for the executive officers are designed to retain qualified and dedicated executive officers. Our Board of Directors reviews salary recommendations made by our Chief Executive Officer and evaluates individual responsibility levels, performance and length of service.

Annual Incentive Compensation Awards

Annual incentive compensation awards provide the Company with a means of rewarding performance based upon the attainment of corporate profitability during the year. In 2006, we did not pay cash-based incentive compensation to any executive officer.

Stock Options

Stock options may be granted to provide the opportunity for long-term compensation based upon the performance of our stock over time. In 2006, we granted 100,000 to our Executive Vice President and Chief Financial Officer as of his hire date.

Employee Benefit and Health Plans

We have a 401(k) plan, which covers substantially all employees. Participants in the plan may contribute a percentage of compensation, but not in excess of the maximum allowed under the Internal Revenue Code. In 2006, we did not make matching contributions to the plan.

We also make available health insurance for full time employees. Both we and the employees contribute to the payment of this plan in accordance with a published schedule as described in the Company’s employment manual.

In addition, in 2006 we paid $13,000 for long term disability insurance premiums on behalf of our Chief Executive Officer and our Chief Operating Officer.

III-4
Summary Compensation Table

The following table sets forth information about compensation paid or accrued by us to our named executive officers.

Name and Position
  
Year
  
Salary
  
Option
  
All Other
  
Total
  
           
Awards (1)
  
Compensation
  
Compensation
  
       
($)
  
($)
  
($)
  
($)
  
                       
Jay Gelman, Chairman of the
    
2006
  
$
350,000
  
$
33,733
  
$
19,813 (2
)
$
403,546
  
Board of Directors and Chief
                                
Executive Officer
                                
                                 
Andre Muller, President, Chief
    
2006
  
$
350,000
  
$
33,733
  
$
18,798 (2
)
$
402,531
  
Operating Officer and Director
                                
                                 
Stephen Agress, Executive Vice
    
2006
  
$
52,500
  
$
1,333
  
$
-
  
$
53,833
  
President, Chief Financial
                                
Officer and Secretary (3)
                                
                                 
Barbara A. Ras, Chief Financial
    
2006
  
$
79,327
  
$
5,000
  
$
-
  
$
84,327
  
and Principal Accounting
                               
Officer (4)
                                

(1) - The amounts reported in the Option Award Column are the same as the compensation cost recognized pursuant to SFAS No. 123(R) in our financial statements, unreduced by the estimated service-based forfeitures. Information concerning these amounts can be found in Item 8, Financial Statements and Supplementary Data, and in the notes to the financial statements in our Annual Report on Form 10-K.

(2) - The amount includes $13,000 payments to each of Jay Gelman and Andre Muller for long term disability premiums. Also includes car payments.

(3) - Hired October 3, 2006

(4) - Resigned September 13, 2006. Options to purchase 100,000 shares of common stock, of which 41,667 had been vested as of the resignation date, were forfeited.
 
Grants of Plan Based Awards Table for the Year ended December 31, 2006

Name
Grant Date
All Other Option Awards; Number of Securities Underlying Options
Exercise or Base Price of Option Award
Grant Date Fair Value of Stock and Option Awards
   
(#)
($/Sh)
  
         
Stephen Agress
10/3/06
100,000
$0.18
$16,000


III-5
Outstanding Equity Awards at December 31, 2006

The following table summarizes the outstanding equity awards held by each named executive officer at year end December 31, 2006.

   
Number of securities underlying unexercised options
  
Option Exercise Price
  
Option Expiration Date
  
Name
  
(#)
  
(#)
  
(#)
      
   
Exercisable
  
Unexercisable
          
                   
Jay Gelman
    
641,667
    
458,333
  
$
0.325
    
1/13/2015
  
Andre Muller
    
641,667
    
458,333
  
$
0.325
    
1/13/2015
  
Stephen Agress
    
8,333
    
91,667
  
$
0.18
    
10/2/2016
  

None of our named executive officers exercised stock options in 2006.

Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Award Table

We currently have no contractual employment obligations with any of the executive officers other than with Stephen Agress. Our employment obligations pursuant to an employment contract with Jay Gelman expired in accordance with its terms on June 30, 2006.

On October 3, 2006, we entered into a two year employment agreement with Stephen Agress to serve as Executive Vice President and Chief Financial Officer. The Agreement provides for annual base compensation of $210,000. The Agreement also provides for insurance and other fringe benefits, and contains confidentiality and non-compete and non-interference provisions. We may terminate Mr. Agress’ employment under the agreement without Cause (as defined) at any time, provided that, in such case, we shall, as severance, continue to pay to Mr. Agress an amount equal to his then base salary in normal payroll installments, subject to withholding, for six months or if less until September 30, 2008. In addition, we shall pay Mr. Agress’ cost of COBRA for the period during which severance is payable as aforesaid.

In connection with our hiring Mr. Agress, on October 3, 2006, our Board of Directors granted Mr. Agress on option to purchase 100,000 shares of our common stock under our stock plan at an exercise price of $0.18 per share. The option has a 10 year term, and vests in 12 equal installments on the last day of each of the 12 calendar quarters beginning with the calendar quarter that begins on October 1, 2006, but only so long as Mr. Agress is employed by us on the last day of such calendar quarter.

On July 26, 2004, Jay Gelman, our Chairman of the Board of Directors and Chief Executive Officer 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 our Board of Directors, bonuses equal to his salary. In addition, the employment agreement provided for a monthly car allowance in the amount of $750 per month. In the event of a termination of Mr. Gelman's employment by us 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 was 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 also 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, and contains customary confidentiality provisions.

Potential Payments Upon Termination without Cause

Pursuant to our employment agreement with Mr. Agress, assuming we were to terminate his employment without cause on December 31, 2006, he would be entitled to six months severance pay totaling $105,000.

III-6
Director’s Compensation

The following table sets forth compensation to members of the Board of Directors, other than those employed by the Company, during the fiscal year ended December 31, 2006.

 
Name
  
Fees Earned or Paid in Cash
  
Option Awards
  
All Other Compensation
  
 
Total
  
   
($)
  
($)
  
($)
  
($)
  
Humbert B. Powell, III
  
$
1,500
  
$
4,600 (1
)
  
-
  
$
6,100
  
Thomas Vitiello
  
$
1,500
  
$
4,600 (1
)
  
-
  
$
6,100
  
Steven H. Nathan
  
$
1,500
  
$
8,900 (2
)
  
-
  
$
10,400
  

(1) - The grant date fair value of the option award computed in accordance with FAS 123(R) was $13,800. A total of 150,000 options are outstanding at December 31, 2006

(2) - The grant date fair value of the option award computed in accordance with FAS 123(R) was $26,700. A total of 150,000 options are outstanding at December 31, 2006

Members of the Board of Directors, other than those employed by us, received a fee of $1,500 for each regularly scheduled board meeting of the Board, limited to 4 regularly scheduled meetings per annum.

Members of the Board of Directors receive no fees if they are employed by us.

Compensation Committee Interlocks and Insider Participation

We do not have a Compensation Committee or any other committee of the Board of Directors performing equivalent functions. Decisions regarding compensation of our named executive officers are made by our Board of Directors. Jay Gelman, our Chief Executive Officer and Chairman of the Board, participated in deliberations of the Board during the fiscal year ended December 31, 2006 concerning executive officer compensation, except that he abstained from deliberations and voting regarding his own compensation. Andre Muller, our President and Chief Operating Officer, did not participate in deliberations concerning his own compensation, and did not participate in deliberations concerning the Chief Executive officer’s compensation.

None of our Board of Directors is an executive officer of a company whose compensation committee or board of directors includes any of our executive officers.

Compensation Committee Report

The following report of the Board of Directors does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates this Report by reference therein. 

The Board of Directors have reviewed and discussed the Compensation Discussion and Analysis with management and recommended that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K for the year ended December 31, 2006, for filing with the Securities and Exchange Commission.

Members of the Board of Directors

Jay Gelman
Andre Muller
Humbert B. Powell, III
Thomas Vitiello
Steven H Nathan

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth, as of March 15, 2007, 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, 1160 Commerce Avenue, Bronx, New York 10462.

III-7
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 March 15, 2007 through the conversion or exercise of any security or right. The terms of the Series A Convertible Non Redeemable Preferred Stock ("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 52,884,123 shares of common stock, consisting of 48,721,065 shares of common stock currently issued and outstanding and 4,163,058 shares of common stock issuable on conversion of 261,663 Series A Preferred Shares. Each Series A Preferred Share converts into 15.91 shares of common stock.

 
 
   
Shares Owned Beneficially
  
Name and Address of
Beneficial Owner
  
Amount and Nature
of Beneficial
Ownership
  
Percent of Class
  
           
Directors and Executive Officers:
          
Jay Gelman (1)
    
17,463,436
    
32.5
%
Andre Muller (2)
    
9,051,671
    
16.9
%
               
Stephen Agress (3)
    
16,667
    
*
  
               
Humbert B. Powell, III (4)
    
135,228
    
*
  
 
              
Thomas Vitiello (5)
    
112,500
    
*
  
 
              
Steven H. Nathan (5)
    
112,500
    
*
  
               
All Executive Officers and Directors
              
As a Group (6 persons) (6)
    
26,892,002
    
49.0
%
Known Beneficial Holders of More
              
Than 5%:
              
               
Francis Vegliante (7)
    
5,051,655
    
9.4
%
               
Nathan A. Low (8)
    
6,106,648
    
11.3
%
               
Theseus Fund, L.P.
              
f/k/a Minotaur Fund LLP (9)
    
5,000,000
   
9.5
%
               
Jim Corfman (10)
    
5,500,000
    
10.4
%
________________________
* Less than 1%.

1. Consists of Mr. Gelman’s record and beneficial ownership of 8,226,671 shares of common stock, currently exercisable options to purchase 825,000 shares of Common Stock, and 5,732,091 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.

2. Consists of Mr. Muller’s record and beneficial ownership of 8,226,671 shares of common stock and currently exercisable options to purchase 825,000 shares of Common Stock.

3. Consists of currently exercisable options to purchase 16,667 shares of Common Stock.

4. Consists of Mr. Powell’s record and beneficial ownership of 22,728 shares of common stock and currently exercisable options to purchase 112,500 shares of Common Stock.

III-8
5. Consists of currently exercisable options to purchase 112,500 shares of Common Stock.

6. Includes currently exercisable options to purchase 2,004,167 shares of Common Stock. Also includes 5,732,091 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 held by Mr. Jay Gelman.

7. Consists of Mr. Vegliante’s record and beneficial ownership of 4,226,655 shares of common stock and currently exercisable options to purchase 825,000 shares of Common Stock.

8. The address of Mr. Low is c/o Sunrise Securities Corp., 641 Lexington Avenue N.Y., N.Y. 10022. 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. These 6,106,648 shares consist of 572,400 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 282,307 shares of common stock due to the deemed conversion of 17,744 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.

9. The address of Theseus Fund, L.P f/k/a Minotaur Fund LLP is 131 Olive Hill Lane, Woodside, CA 94062. 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.

10. Mr. Corfman is the direct beneficial owner of 500,000 shares of common stock and the indirect beneficial owner of 5,000,000 shares of common stock beneficially owned by Theseus Fund, L.P f/k/a Minotaur Fund LLP. Mr. Corfman’s business address is 131 Olive Hill Lane, Woodside, CA 94062.

Beneficial ownership of the Company's Series A Non Redeemable Convertible Preferred Stock:

The following table sets forth, as of March 15, 2007, 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.
 
III-9
 
   
Shares Owned Beneficially
  
   
Series A Convertible Non Redeemable Preferred Shares
  
 
          
Name and address of
beneficial owner
  
Amount of beneficial ownership
  
Percent of Class
  
           
Jay Gelman (11)
    
168,427
    
64.4
%
               
All executive officers and directors as a group (11)
    
168,427
    
64.4
%
               
Nathan A. Low (12) (13)
c/o Sunrise Securities Corp., 641 Lexington Avenue N.Y., N.Y. 10022
    
255,459
    
97.6
%
               
Nathan A. Low Roth IRA (14)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
    
143,967
    
55.0
%
               
Nathan A. Low Family Trust (15)
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
    
24,407
    
9.3
%
               
Sunrise Equity Partners
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
    
17,744
    
6.8
%
               
Sunrise Foundation Trust
c/o Sunrise Securities Corp.
641 Lexington Avenue
N.Y., N.Y. 10022
    
21,779
    
8.3
%
               
Level Counter LLC (16)
641 Lexington Avenue
25th Floor
N.Y., N.Y. 10022
    
17,744
    
6.8
%
               
Amnon Mandelbaum (17)
641 Lexington Avenue
25th Floor
N.Y., N.Y. 10022
    
17,744
    
6.8
%
               
Marilyn Adler (18)
641 Lexington Avenue
25th Floor
N.Y., N.Y. 10022
    
17,744
    
6.8
%

11. 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.

12. 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.

13. 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, 17,744 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.

III-10
14. See footnote 11 for information relating to the voting proxy granted to Jay Gelman by the Nathan A. Low Roth IRA.

15. See footnote 11 for information relating to the voting proxy granted to Jay Gelman by the Nathan A. Low Family Trust.

16. 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.

17. 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.

18. 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.

Item 13. Certain Relationships and Related Transactions, and Director Independence.

We employ Steve Gelman, brother of our Chairman and Chief Executive Officer, as our Vice President of Marketing and Communications. In 2006, Mr. Steve Gelman received salary totaling approximately $158,000, plus standard benefits.

Related Party Transaction Policies and Procedures

Policy

It is the policy of the Board of Directors of Alliance Distributors Holding Inc. (the "Company") that all Interested Transactions with Related Parties, as those terms are defined in this policy, shall be subject to approval or ratification in accordance with the procedures set forth below.

Procedures

The Board of Directors of the Company, or, if directed by the Board of Directors, the Audit Committee or any other independent committee appointed by the Board of Directors, shall review the material facts of all Interested Transactions that require the Committee’s approval and either approve or disapprove of the entry into the Interested Transaction, subject to the exceptions described below. If advance Board or committee approval of an Interested Transaction is not feasible, then the Interested Transaction shall be considered and, if the Board or committee determines it to be appropriate, ratified at the Board’s or committee’s next regularly scheduled meeting. In determining whether to approve or ratify an Interested Transaction, the Board or committee will take into account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction.

The Board of Directors and the Audit Committee have reviewed the Interested Transactions described below in "Standing Pre-Approval for Certain Interested Transactions" and determined that each of the Interested Transactions described therein shall be deemed to be pre-approved or ratified (as applicable) by the Board and the Audit Committee under the terms of this policy.

No Director shall participate in any discussion or approval of an Interested Transaction for which he or she is a Related Party, except that the Director shall provide all material information concerning the Interested Transaction to the Board or the committee.

If an Interested Transaction will be ongoing, the Board may establish guidelines for the Company’s management to follow in its ongoing dealings with the Related Party. Thereafter, the Board, on at least an annual basis, shall review and assess ongoing relationships with the Related Party to see that they are in compliance with these guidelines and that the Interested Transaction remains appropriate.

III-11
Definitions

An “Interested Transaction” is any transaction, arrangement or relationship or series of similar transactions, arrangements or relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related Party has or will have a direct or indirect material interest (other than solely as a result of being a director or a less than 10 percent beneficial owner of another entity).

A “Related Party” is any (a) person who is or was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, Director or nominee for election as a Director, (b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such person’s home (other than a tenant or employee).

Standing Pre-Approval for Certain Interested Transactions

The Board and the Audit Committee have reviewed the types of Interested Transactions described below and determined that each of the following Interested Transactions shall be deemed to be pre-approved by the Committee, even if the aggregate amount involved will exceed $120,000.

1. Employment of executive officers. Any employment by the Company of an executive officer of the Company if:

a. the related compensation is required to be reported in the Company’s proxy statement under Item 402 of the Securities and Exchange Commission’s ("SEC’s") compensation disclosure requirements (generally applicable to "named executive officers"); or

b. the executive officer is not an immediate family member of another executive officer or Director of the Company, the related compensation would be reported in the Company’s proxy statement under Item 402 of the SEC’s compensation disclosure requirements if the executive officer was a "named executive officer", and the Company’s Compensation Committee approved (or recommended that the Board approve) such compensation.

2. Director compensation. Any compensation paid to a Director if the compensation is required to be reported in the Company’s proxy statement under Item 402 of the SEC’s compensation disclosure requirements;

3. Certain transactions with other companies. Any transaction with another company at which a Related Person’s only relationship is as an employee (other than an executive officer), Director or beneficial owner of less than 10% of that company’s shares;

4. Transactions where all shareholders receive proportional benefits. Any transaction where the Related Person’s interest arises solely from the ownership of the Company’s common stock and all holders of the Company’s common stock received the same benefit on a pro rata basis (e.g. dividends);

5. Transactions involving competitive bids. Any transaction involving a Related Party where the rates or charges involved are determined by competitive bids.

Director Independence

Our Board of Directors has determined that each of Humbert B. Powell, III, Thomas Vitiello and Steven H. Nathan is an “independent director” as defined in Rule 4200(a)(15) of the listing standards of the National Association of Securities Dealers.
 
We have a separately designated standing audit committee established in March 2005 in accordance with Section 3(a)(58)(A) of the Exchange Act. Serving on the Committee are Steven H. Nathan and Thomas Vitiello. Our board of Directors has determined that we have an audit committee financial expert serving on the audit committee, Steven H. Nathan.

Our board of directors have determined that Steven H. Nathan is an independent director based on Rule 4200 of the National Association of Securities Dealers' listing standards and is qualified as an "Audit Committee Financial Expert" as defined in Item 7(d)(3)(iv) of Schedule 14A.

III-12
Item 14. Principal Accountant Fees and Services.

Set forth below is certain information concerning fees by Mahoney Cohen & Company, CPA, P.C. in respect of services provided for 2006 and 2005. The Audit Committee has determined that the provision of all services is compatible with maintaining the independence of Mahoney Cohen & Company, CPA, P.C.

Audit Fees. Mahoney Cohen & Company, CPA, P.C. billed us approximately $121,000 for professional services rendered for (1) the audit of the annual financial statements for 2006, (2) the reviews of the financial statements included in reports on Form 10-Q for periods within 2006 and (3) related regulatory filings for periods within 2006; and approximately $119,000 for professional services rendered for (1) the audit of the annual financial statements for 2005, (2) the reviews of the financial statements included in reports on Form 10-QSB for periods within 2005 and (3) related regulatory filings for periods within 2005.

Audit Related Fees. Mahoney Cohen & Company CPA, P.C. did not provide any audit related services in 2006 and 2005, respectively.

Tax Fees. Mahoney Cohen & Company, CPA, P.C. did not provide any tax services in 2006 and 2005, respectively.

Tax and Other Fees. In 2006 and 2005, Mahoney Cohen & Company, CPA, P.C. billed us approximately $29,000 and $14,000, respectively, for services in connection with our potential acquisition of Foto Electric Supply Co., Inc.

The Audit Committee is directly and solely responsible for oversight, engagement and termination of any independent registered public accounting firm employed by the Company for the purpose of preparing or issuing an audit report or related work.

The Audit Committee (i) meets with the independent registered public accounting firm prior to the audit and discusses the planning and staffing of the audit; (ii) approves in advance the engagement of the independent registered public accounting firm for all audit services and non-audit services and approves the fees and other terms of any such engagement; (iii) obtains periodically from the independent registered public accounting firm a formal written statement of the matters required to be discussed by Independent Standards Board Statement No. 1, and, in particular, describing all relationships between the auditor and the Company; (iv) discusses with the independent registered public accounting firm any disclosed relationships or services that may impact auditor objectivity and independence; and (v) conducts periodic meetings with the independent registered public accounting firm regarding maters required to be discussed under Statements on Auditing Standards No. 61, as amended.


III-13
PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a)  
1. Financial Statements. See Item 8. Index to Financial Statements.
2. Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts
3. Exhibits
 
Exhibits which are indicated as being included in previous filings are incorporated herein by reference.
 
Exhibit Number
Description
   
2.1
Exchange Agreement between Essential Reality, Inc. and Messrs. Jay Gelman, Andre Muller and Francis Vegliante dated as of June 17, 2004. Incorporated herein by reference from Exhibit 2.1 to the Company's Form 8-K filed on July 14, 2004 (the "Form 8-K").
   
2.2
Form of Agreement and Plan of Merger dated as of October 25, 2004 by and between Essential Reality, Inc. and Alliance Distributor Holding Inc. Incorporated herein by reference from Exhibit 2 to the Company's Form 8-K filed on November 23, 2004.
   
3.1
Certificate of Incorporation of Alliance Distributors Holding Inc. Incorporated herein by reference from Exhibit 3.1 to the Company’s Form 8-K filed on November 23, 2004.
   
3.2
By-Laws of Alliance Distributors Holding Inc. Incorporated herein by reference from Exhibit 3.2 to the Company's Form 8-K filed on November 23, 2004.
   
4.1
Alliance Distributors Holding Inc. 2004 Stock Plan. Incorporated herein by reference from Exhibit 3.3 to the Company's Form 8-K filed on November 23, 2004.
   
4.2
Form of Stock Option Agreement. Incorporated herein by reference from Exhibit 4.2 to the Company's Form 10K-SB filed on March 30, 2005.
   
4.3
Form of Warrant issued to Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 4.1 to the Company's Form 8-K filed on November 15, 2004.
   
4.4
Form of Warrants issued to Legend Merchant Group, Inc. and Coniston Investment Corp. Incorporated herein by reference from Exhibit 4.1 to the Company's Form SB-2 filed on July 19, 2002.
   
4.5
Form of Warrant issued to Sunrise Securities Corp. Incorporated herein by reference from Exhibit 99.4 to the Company's Form 8-K filed on July 14, 2004.
   
9.1
Irrevocable Proxy given in favor of Jay Gelman. Incorporated herein by reference from Exhibit 9.1 to the Form 8-K.
   
9.2
Form of Irrevocable Proxy dated December 15, 2005 given in favor of Jay Gelman, filed herewith.
   
10.1
Retainer Agreement dated as of June 29, 2004 between Essential Reality, Inc. and IVC Group. Incorporated herein by reference from Exhibit 10.1 to the Company's Form 10-QSB for the period ended June 30, 2004, filed on August 17, 2004.
   
10.2
Employment Agreement, dated as of July 26, 2004 between Essential Reality Inc. and Jay Gelman, President and CEO of Essential Reality Inc. Incorporated herein by reference from Exhibit 10.2 to the Company's Form 10-QSB filed on August 17, 2004.
   
10.3
Subscription Agreement among the Investor's listed on Schedule I thereto, Essential Reality, Inc. and Jay Gelman. Incorporated herein by reference from Exhibit 99.1 to the Form 8-K.
 
IV-1
 
   
10.4
Subscription Agreement Supplement No. 1 between the Investors listed on Schedule I thereto and Essential Reality, Inc. Incorporated herein by reference from Exhibit 99.2 to the Form 8-K.
   
10.5
Registration Rights Agreement between Essential Reality and the Investors listed on Schedule I to the Subscription Agreement. Incorporated herein by reference from Exhibit 99.3 to the Form 8-K.
   
10.6
Stock Purchase Warrant between Essential Reality, Inc. and Sunrise Securities Corp. Incorporated herein by reference from Exhibit 99.4 to the Form 8-K.
   
10.7
Investment Banking Agreement between Essential Reality, Inc. and Sunrise Securities Corp. Incorporated herein by reference from Exhibit 99.5 to the Form 8-K.
   
10.8
Form of Financing Agreement between the Company and Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 10.1 to the Company’s Form 8-K filed on November 16, 2004.
   
10.9
Amendment dated November 1, 2005 to the Financing Agreement between the Company and Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 10.2 to the Company’s Form 10-QSB filed on November 7, 2005.
   
10.10
Amendment dated October 31, 2005 to the Financing Agreement between the Company and Rosenthal & Rosenthal, filed herewith.
   
10.11
Form of Amendment dated March 21, 2006 to the Financing Agreement between the Company and Rosenthal & Rosenthal, filed herewith.
   
10.12
Form of Security Agreement issued to Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 10.2 to the Company's Form 8-K filed on November 15, 2004.
   
10.13
Form of Guaranty issued to Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 10.3 to the Company's Form 8-K filed on November 15, 2004.
   
10.14
Form of Registration Rights Agreement issued to Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit 10.4 to the Company's Form 8-K filed on November 15, 2004.
   
10.15
Lease Agreement dated as of July 28, 2003 between KIM Management, LLC, and Big Brother World, Inc. Incorporated herein by reference from Exhibit 10.12 to the Company's Form SB-2 filed on December 23, 2004.
   
10.16
Lease Agreement dated as of December 1, 2003 between Angelo Pegno et. al. and AllianceCorner Distributors Inc. Incorporated herein by reference from Exhibit 10.13 to the Company's Form SB-2 filed on December 23, 2004.
   
10.17
Lease Agreement dated as of July 1, 2003 between Angelo Pegno Et. al. and Alliance Partners, Inc. Incorporated herein by reference from Exhibit 10.14 to the Company's Form SB-2 filed on December 23, 2004.
   
10.19
Operating Agreement of Alliance Age LLC between Alliance Distributors Holding Inc. and Abrams/Gentile Entertainment Inc. dated July 21, 2005. Incorporated herein by reference from Exhibit 99.1 to the Company's Form 10-QSB filed on August 15, 2005.
   
10.20
Stock Purchase Agreement dated January 2, 2006 by and among the Company and the Sellers set forth therein. Incorporated herein by reference from Exhibit 10.1 to the Company’s Form 8-K filed on January 10, 2006.
 
IV-2
 
   
10.21
Form of Employment Agreement between the Company and Stephen Agress dated October 3, 2006. Incorporated herein by reference from Exhibit 10.1 to the Company’s Form 8-K filed on October 6, 2006
   
10.22
Form of Stock Option Agreement to Stephen Agress dated October 3, 2006. Incorporated herein by reference from Exhibit 10.3 to the Company’s Form 8-K filed on October 6, 2006
14
Code of Ethics. Incorporated herein by reference from Exhibit 14 to the Company's Form 8-K filed on March 16, 2005.
   
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, filed herewith.
   
31.2
Certification of Chief Financial Officer/Principal Financial and Accounting Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, filed herewith.
   
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
   
32.2
Certification of Chief Financial Officer/Principal Financial and Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

 

IV-3
SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

March 29, 2007
Alliance Distributors Holding Inc.



By: /s/ Jay Gelman
-------------------------------------------
Jay Gelman
Chairman of the Board and
Chief Executive Officer




In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


/s/ Jay Gelman
Date: March 29, 2007
------------------------------------------
  
Jay Gelman, Chairman of the Board
  
and Chief Executive Officer
 
   
   
/s/ Andre Muller
Date: March 29, 2007
------------------------------------------
  
Andre Muller, President, Chief
  
Operating Officer and Director
  
   
/s/ Stephen Agress
Date: March 29, 2007
-------------------------------------------
 
Stephen Agress
  
Executive Vice President, Chief Financial
 
and Principal Accounting Officer, and Secretary
  
   
   
/s/ Humbert B. Powell, III
Date : March 29, 2007
------------------------------------------
  
Humbert B. Powell, III, Director
  
   
   
/s/ Steven H. Nathan
Date : March 29, 2007
------------------------------------------
  
Steven H. Nathan, Director
  
   
   
/s/ Thomas Vitiello
Date: March 29, 2007
------------------------------------------
  
Thomas Vitiello, Director
  


IV-4
 

ALLIANCE DISTRIBUTORS HOLDING INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(Dollars in Thousands)



   
Balance at
 
Charged to
     
Balance at
 
   
Beginning of Year
  
Costs and Expenses
  
Deductions (b)
  
End of Year
  
                   
Year ended December 31, 2006
                  
                   
Allowance for Doubtful Accounts
  
$
181
  
$
147
  
$
(16
)
$
312
  
Deferred tax valuation allowance
  
$
2,357
  
$
(23) (a
)
      
$
2,334
  
                           
Year ended December 31, 2005
                          
                           
Allowance for Doubtful Accounts
  
$
39
  
$
247
  
$
(105
)
$
181
  
Deferred tax valuation allowance
  
$
2,124
  
$
233 (a
)
      
$
2 ,357
  
                           
Year ended December 31, 2004
                          
                           
Allowance for Doubtful Accounts
  
$
10
  
$
27
  
$
(2
)
$
39
  
Deferred tax valuation allowance
  
$
-
  
$
2,124 (a
)
      
$
2,124
  


(a) Represents the recording of a (benefit) provision associated with the deferred tax asset for net operating loss carryforwards

(b) Represents the use of the established reserve