UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
Commission File Number: 000-32319
ALLIANCE DISTRIBUTORS HOLDING INC.
(Exact name of small business issuer as specified in its charter)
Delaware 33-0851302
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
15-15 132nd Street
College Point, New York 11356
(Address of Principal Executive Offices)
(718) 747-1500
(Registrant's telephone number, including area code)
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
|X| Yes |_| No
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of May 16, 2005 there were 46,417,098 shares of the issuer's Common Stock,
par value $.001 per share, issued and outstanding.
Transitional Small Business Disclosure Format |_| Yes |X| No
PART I - FINANCIAL INFORMATION
INDEX
Pages
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Balance Sheet as of March 31, 2005 (Unaudited) 3
Statements of Operations for the three
months ended March 31, 2005 and 2004 (Unaudited) 4
Statement of Stockholders' Equity for the three
months ended March 31, 2005 (Unaudited) 5
Statements of Cash Flows for the three months
ended March 31, 2005 and 2004 (Unaudited) 6
Notes to Financial Statements (Unaudited) 7-10
Item 2 - Management's Discussion and Analysis or Plan of Operations 10-13
Item 3 - Controls and Procedures 13
PART II - OTHER INFORMATION 13
Item 6 - Exhibits 14
Signatures 15
2
Part I - Financial Information
Item 1 - Financial Statements
ALLIANCE DISTRIBUTORS HOLDING INC.
Balance Sheet (Unaudited)
March 31, 2005
ASSETS
Current assets:
Cash $ 197,648
Accounts receivable, net of allowance for doubtful
accounts of approximately $133,000 3,989,383
Inventory 4,305,442
Due from vendors 425,083
Prepaid expenses and other current assets 153,616
------------
Total current assets 9,071,172
Property and equipment, net 389,856
Other assets 72,300
------------
$ 9,533,328
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable-bank $ 3,851,490
Accounts payable 2,579,629
Current portion of long term obligations 27,434
Accrued expenses and other current liabilities 124,806
------------
Total current liabilities 6,583,359
Long term obligations 23,935
Deferred lease obligation 20,938
Commitments and contingencies
Stockholders' equity:
Series A Convertible Non-Redeemable Preferred Stock,
$.001 par value - Authorized, 8,833,334 shares;
issued and outstanding, 403,335 shares 403
Common stock, $.001 par value - Authorized, 100,000,000
shares; issued and outstanding 46,417,098 shares 46,417
Additional paid-in capital 3,194,418
Accumulated deficit (336,142)
------------
Total stockholders' equity 2,905,096
------------
$ 9,533,328
============
See notes to financial statements.
3
ALLIANCE DISTRIBUTORS HOLDING INC.
Statements of Operations (Unaudited)
For the three months ended March 31, 2005 and 2004
Three months ended March 31,
---------------------------
2005 2004
------------ ------------
Net sales $ 10,888,835 $ 7,299,641
Cost of goods sold 9,646,498 6,200,621
------------ ------------
Gross profit 1,242,337 1,099,020
Operating expenses:
Selling, general and administrative expenses 1,250,569 920,562
Stock option compensation expense 26,833 --
------------ ------------
Total operating expenses 1,277,402 920,562
------------ ------------
Income (loss) from operations (35,065) 178,458
Interest expense 93,613 27,155
------------ ------------
Income (loss) before provision for income taxes (128,678) 151,303
Provision for income taxes 1,000 12,167
------------ ------------
Net income (loss) available to common shareholders $ (129,678) $ 139,136
============ ============
Net income (loss) per share - basic and diluted $ .00 $ .01
============ ============
Basic and diluted weighted-average common shares
outstanding 46,417,098 24,679,997
============ ============
See notes to financial statements.
4
ALLIANCE DISTRIBUTORS HOLDING INC.
Statement of Stockholders' Equity (Unaudited)
For the three months ended March 31, 2005
Preferred Stock A Common Stock Additional Total
-------------------------- ------------------------- Paid In Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Equity
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, January 1, 2005 564,649 $ 564 43,850,740 $ 43,851 $ 3,186,240 $ (206,464) $ 3,024,191
Conversion of Preferred
Stock A into Common Stock (161,314) (161) 2,566,358 2,566 (2,405) -- --
Registration costs -- -- -- -- (16,250) -- (16,250)
Issuance of stock options
to non-employees -- -- -- -- 26,833 -- 26,833
Net loss -- -- -- -- -- (129,678) (129,678)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, March 31, 2005 403,335 $ 403 46,417,098 $ 46,417 $ 3,194,418 $ (336,142) $ 2,905,096
=========== =========== =========== =========== =========== =========== ===========
See notes to financial statements.
5
ALLIANCE DISTRIBUTORS HOLDING INC.
Statements of Cash Flows
For the three months ended March 31, 2005
and 2004 (Unaudited)
Three months ended March 31,
----------------------------
2005 2004
------------ ------------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income (loss) $ (129,678) $ 139,136
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH USED IN OPERATING ACTIVITIES:
Deferred rent 3,341 3,341
Depreciation and amortization 25,401 16,962
Bad debt expense 100,000 --
Stock option compensation expense 26,833 --
Interest amortization of deferred financing costs 17,000 --
CHANGES IN ASSETS AND LIABILITIES:
(Increase) decrease in assets
Accounts receivable (718,824) (186,156)
Due from factor -- 992,701
Inventory (437,107) 1,086,737
Other assets -- 698
Due from vendors (390,835) (706,622)
Prepaid expenses and other current assets 11,325 2,425
Increase (decrease) in liabilities
Accounts payable 4,987 (1,762,026)
Accrued expenses and other current
liabilities 10,594 (49,207)
------------ ------------
Net cash used in operating activities (1,476,963) (462,011)
------------ ------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment (5,883) (4,004)
------------ ------------
Net cash used in investing activities (5,883) (4,004)
------------ ------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from note payable - bank 11,343,034 --
Repayments of note payable - bank (9,858,420) --
Payments for registration costs (16,250) --
Repayment of long-term obligations (8,475) (7,469)
------------ ------------
Net cash provided by (used in) financing activities 1,459,889 (7,469)
------------ ------------
NET DECREASE IN CASH (22,957) (473,484)
CASH, beginning of period 220,605 656,852
------------ ------------
CASH, end of period $ 197,648 $ 183,368
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 82,913 $ 27,155
============ ============
Income tax paid $ 2,013 $ 10,075
============ ============
See notes to financial statements.
6
ALLIANCE DISTRIBUTORS HOLDING INC.
Notes to Financial Statements (Unaudited)
Note 1 - BASIS OF PRESENTATION, ORGANIZATION AND OTHER MATTERS
Alliance Distributors Holding Inc. (the "Company" or "Alliance") is a
distributor of video game consoles, peripherals, accessories and software to
customers throughout the United States for most key manufacturers and third
party publishers in the video game industry.
On June 17, 2004, the Company (formerly Essential Reality, Inc. "Essential")
entered into a Share Exchange Agreement (the "Exchange Agreement") with Jay
Gelman, Andre Muller and Francis Vegliante, who were the sole shareholders (the
"Shareholders") of AllianceCorner Distributors Inc., a privately held, wholesale
distributor incorporated in New York ("AllianceCorner"). AllianceCorner had no
prior affiliation with Essential and commenced operations in August 2003.
Pursuant to the Exchange Agreement, Essential on June 29, 2004 acquired all the
outstanding capital stock of AllianceCorner from the Shareholders in exchange
for 1,551,314 Series B Convertible Non Redeemable Preferred Shares ("Series B
Preferred Shares"). As a result of the acquisition, the business of Alliance is
Essential's only business. The transaction was accounted for as a reverse
acquisition as of June 30, 2004 and the pre-acquisition financial statements of
AllianceCorner are treated as historical financial statements of the combined
companies. As the transaction was accounted for as a reverse acquisition into a
public shell, no goodwill has been recorded and the costs incurred have been
accounted for as a reduction of additional paid-in capital. As a result of the
reverse acquisition: (i) the historical financial statements of Essential for
periods prior to the date of the transaction are not presented and (ii) because
AllianceCorner is the accounting acquirer, Essential's historical stockholders'
equity is not carried forward to the merged company as of June 30, 2004.
The name of AllianceCorner Distributors, Inc. was changed to Alliance
Distributors Holding Inc. (d/b/a Alliance Distributors) after the acquisition
and Essential does business under that name. The Company operates as a single
segment.
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted. This Form 10-QSB should be read in conjunction with the
Company's financial statements and notes included in the 2004 Annual Report on
Form 10-KSB. In the opinion of management, all material adjustments, consisting
of normal recurring adjustments, considered necessary for a fair presentation,
have been included in the accompanying unaudited financial statements.
The results of operations for the interim periods are not necessarily indicative
of the results that maybe expected for the full year ending December 31, 2005.
PRIVATE PLACEMENT OFFERING
As part of the Exchange Agreement with AllianceCorner, Essential was required to
raise funds to complete the transaction. Essential offered 1,124,767 shares of
Series A 6% Convertible Non Redeemable Preferred Shares (the "Series A Preferred
Shares"), through a private placement offering ("PPO"). The PPO resulted in
gross proceeds of $4,000,000 and net proceeds to the Company of $3,799,500 less
$915,329 for payments of Essential's liabilities. At the same time,
substantially all outstanding debt of Essential was extinguished through either
conversion into an aggregate of 452,202 Series A Preferred Shares or through
cash payments.
Sunrise Securities Corp. ("Sunrise") acted as the placement agent in connection
with the PPO and received (a) an $8,500 nonrefundable retainer fee; and (b) a
commission consisting of 108,146 shares of Series A Preferred Shares and 5 year
warrants due June 29, 2009 to purchase 1,564,096 shares of common stock at an
exercise price of $.22. (See Stockholders' Equity section below).
STOCKHOLDERS' EQUITY
Each share of common stock entitles the holder thereof to one vote on each
matter that may come before a meeting of the shareholders. Any Series A
Preferred Share or Series B Preferred Share entitles the holder to 15.909 votes,
and votes as one class with the common stock.
In the Exchange Agreement, the Shareholders agreed to vote their Series B
Preferred Shares in favor of an amendment to the Company's Articles of
Incorporation that would increase the number of authorized shares of common
stock from 50,000,000 to 4,400,000,000 (the "Amendment"), and in favor of a
simultaneous reverse split of the common stock on the basis of one share for
forty-four shares to 100,000,000 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.
7
The adoption of the Amendment and the Reverse Split resulted in the automatic
conversion of each Series A Preferred Share and each Series B Preferred Share
into 15.91 shares of common stock. However, Series A Preferred Shares owned by a
holder were not to be converted into common stock if and so long as a result of
conversion the holder would beneficially own in excess of 4.999% or 9.999% of
the issued and outstanding shares, respectively. Any Series A Preferred Shares
not converted into the Company's common stock due to the operation of this
restriction (the "4.999% Restriction") will no longer be entitled to the 6%
dividend referred to above.
As of March 31, 2005, the Series A Preferred Shares were converted into
21,127,101 shares of common stock and the Series B Preferred Shares were
converted into 24,679,997 shares of common stock, making up most of the
46,417,098 issued and outstanding shares of common stock.
The shares of the Company's common stock issued as a result of the conversion on
November 22, 2004, the common stock underlying the Series A Preferred Shares and
the warrants were entitled to registration rights and the Company filed Form
SB-2 on December 23, 2004.
During the first quarter of 2005 there were 161,314 shares of Series A Preferred
Shares converted into 2,566,358 shares of common stock; as a result, as of March
31, 2005, the shares issued and outstanding were 403,335 of Series A Preferred
Shares and 46,417,098 of common stock.
Note- 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Allowance for Doubtful Accounts
The Company provides an allowance for doubtful accounts equal to estimated
uncollectible accounts. The Company's estimate is based on a regular review of
individual account balances, historical collection experience and consideration
of other factors such as a customer's financial status and other business risk.
It is reasonably possible that the Company's estimate of the allowance for
doubtful accounts will change. The Company increased its allowance for doubtful
accounts by $100,000 during the three months ended March 31, 2005 and maintains
a balance of approximately $133,000 at March 31, 2005.
Inventory
Inventory consists entirely of finished goods held for sale and is reported at
the lower of cost or market, on the average cost basis. At times, the Company
makes advance payments to vendors to procure and ensure delivery of certain high
demand products. Such deposits are reflected as due from vendors in the balance
sheet.
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 three months ended
March 31, 2004. AllianceCorner was subject to New York State S corporation taxes
and New York City corporate income taxes. The provision for income taxes for the
three months ended March 31, 2004 comprises state and local taxes.
Effective June 29, 2004, the Company is taxed as a C corporation.
The Company follows SFAS No. 109 "Accounting for Income Taxes" and accounts for
income taxes using the liability method which requires the recognition of
deferred tax assets or liabilities for the temporary differences between the
financial reporting and tax bases of the Company's assets and liabilities and
for tax carryforwards at enacted statutory rates in effect for the years in
which the differences are expected to reverse. The effect on deferred taxes of a
change in tax rates is recognized in income in the period that includes the
enactment date. In addition, valuation allowances are established when necessary
to reduce deferred tax assets to the amounts expected to be realized.
At December 31, 2004, the Company had federal and state net operating loss
carryforwards of approximately $5,000,000, expiring through 2024. The Company
has established a full valuation allowance of $2,124,000 at December 31, 2004
due to the uncertainty surrounding the realization of such assets. The Tax
Reform Act of 1986 contains provisions that limit the ability to utilize net
operating loss carryforwards in the case of certain events including significant
changes in ownership interests. The Company has not evaluated whether it has
undergone an ownership change pursuant to this act. Based upon the terms of the
Exchange agreement, an ownership change may have occurred. If such ownership
changes are found to exist, the net operating loss carryforwards as reported
could be significantly limited.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding for the period. Diluted
net income per share is computed by dividing the net income by the weighted
average number of common shares and common equivalent shares outstanding during
the period. The weighted average number of common and common equivalent shares
outstanding reflects the conversion of preferred stock for common stock as of
June 29, 2004 (see Note 1) and the 1 for 44 stock split, which occurred in
November 2004.
8
Common equivalents at March 31, 2005 exclude the 500,000 of warrants issued to
the Company's lender and the 403,335 Series A Preferred Shares not eligible for
conversion due to the 4.999% Restriction, since their effect would be
anti-dilutive. There were no common equivalents at March 31, 2004.
Stock Based Compensation
In January 2005, the Company established a stock option plan. The Company
accounts for stock based employee compensation arrangements under the intrinsic
value method pursuant to APB Opinion No. 25, "Accounting for Stock Issued to
Employees". Under this method, compensation cost is the excess, if any, of the
quoted market price of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock. As of March 31, 2005
there were 7,550,000 options issued. The options are ten-year non-qualified
options to purchase the Company's common stock, 7,400,000 of the options have an
exercise price of $0.325 per share and 150,000 of the options have an exercise
price of $.32 per share, vest and become exercisable in 12 equal quarterly
installments beginning on April 1, 2005. Of the total options granted, 1,100,000
options were granted to Jay Gelman, the CEO and Chairman of the Board of
Directors of the Company, 1,100,000 options were granted to Andre Muller, the
President, COO and a director of the Company, and 150,000 options were granted
to each of Thomas Vitiello, Steven H. Nathan and Humber B. Powell, III, each a
non-employee director of the Company. The options were granted in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended.
Of the total options granted, 250,000 options were granted to a non-employee who
provided past services to the Company and 500,000 options were granted to
non-employees for future services to be provided over the next three years. The
options are ten-year non-qualified options, have an exercise price of $.325 per
share, and vest and become exercisable in twelve quarterly installments
beginning on April 1, 2005. The fair value of the options-pricing model was
calculated with the following weighted-average assumptions used for the grant:
risk-free interest rate 4.25%; expected life 6.5 years; expected volatility 55%.
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. During the
three months ended March 31, 2005, the Company recorded stock-based compensation
expense of approximately $26,833 in relation to these options.
Had compensation costs for the Company's stock option grants to employees been
determined based on the fair value at the grant dates for awards under these
plans in accordance with SFAS No. 123, the Company's net loss and basic and
diluted net loss per share would have been reduced to the pro forma amounts as
follows:
For the Three Months
Ended March 31,
2005
--------------------
(Unaudited)
Net loss, as reported $(129,678)
Deduct: Total stock-based employee compensation expense
determined under fair value based method, net of tax effects (53,208)
---------
Proforma net loss $(182,886)
=========
Net loss per share:
---------
Basic and diluted - as reported $ 0.00
=========
Basic and diluted - proforma $ 0.00
=========
There were no options outstanding at March 31, 2004.
The fair value of the options-pricing model was calculated with the following
weighted-average assumptions used for the grant: risk-free interest rate
4.25-4.5%; expected life 6.5 years; expected volatility 55-115%. The fair value
generated by the Black-Scholes model may not be indicative of the future
benefit, if any, that may be received by the option holder.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". This
statement revises FASB Statement No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123(R) focuses primarily on the accounting for transactions
in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires companies to recognize in the statement
of operations the cost of employee services received in exchange for awards of
equity instruments based on the grant-date fair value of those awards (with
limited exceptions). This Statement, for small business issuers is effective as
of the beginning of the Company's next fiscal year. Accordingly, the Company
will adopt SFAS 123(R) in its first quarter of fiscal 2006. The Company is
currently evaluating the provisions of SFAS 123(R) and has not yet determined
the impact that this Statement will have on its future results of operations or
financial position. The impact of this new standard, if it had been in effect,
on the net loss and related per share amounts of our fiscal quarter ended March
31, 2005 is disclosed in Stock Based Compensation, above.
9
Note 3 - FINANCING AGREEMENTS
On November 11, 2004, the Company entered into a Financing Agreement
("Agreement") with Rosenthal & Rosenthal, Inc. ("Rosenthal"), which replaced an
earlier factor agreement with Rosenthal. Under the Agreement, Rosenthal may in
its discretion lend up to $5,000,000 to Alliance based on eligible inventory and
receivables. All borrowings are due on demand, are secured by substantially all
of the assets of Alliance and are subject to the Company's compliance with
certain financial covenants. The Company's CEO and the Company's President
signed limited guaranties in respect of borrowings under the Agreement.
The Agreement terminates November 30, 2007 unless terminated by Rosenthal on 30
days' notice. Interest on outstanding borrowings is payable at a variable rate
per annum, equal to the prime rate (but not less than 4.75 %) plus 2.00 % (7.75
% as of March 31, 2005). In addition, the Company will pay the lender on each
anniversary date an annual fee of 1% of the Maximum Credit of $5,000,000 in the
amount of $50,000 which is amortized over one year, and a monthly administrative
fee of $1,000. The financing expense for the annual fee recorded for the three
months ended March 31, 2005 amount to $12,500. At March 31, 2005, the loan
outstanding amounted to $3,851,490.
In connection with the Agreement, the Company issued to Rosenthal a warrant (the
"Warrant") to purchase 500,000 shares of common stock at $0.10 per share. The
Warrant expires on November 30, 2010. On notice by the Company the Warrants will
expire earlier if the closing price of the common stock during a period
designated in the Warrants is not less than $0.40 per share. The Warrants may be
exercised for cash or on a cashless basis (i.e., by deducting from the number of
shares otherwise issuable on exercise a number of shares that have a then market
value equal to the exercise price). The Company recorded a deferred financing
cost of approximately $60,000 in the fourth quarter 2004, representing the fair
value of the warrants, which will be amortized over the life of the financing
agreement of three years. The financing expense recorded for the three months
ended March 31, 2005 amounted to approximately $4,500.
Under the terms of the Agreement, the Company is required to maintain a
specified level of net worth, working capital and debt ratios as defined. In May
2005, Rosenthal informed the Company that it did not comply with a financial
covenant under the Agreement for the fourth quarter of 2004. Rosenthal has
provided a waiver for this failure to comply. In addition, for the first quarter
of 2005, the Company did not comply with certain financial covenants for which
Rosenthal has also provided a waiver.
The Company and Rosenthal are currently renegotiating the terms and covenants of
the Agreement and the Company anticipates that such renegotiation will be
successful. Subject to the execution of this revised agreement, the Company
believes that it will have sufficient liquidity for the next twelve months and
the foreseeable future. However, the Company would have to scale down its
operations if it is unsuccessful in renegotiating the borrowing base and
financial covenants. Furthermore, the Company would be materially and adversely
affected if Rosenthal demands payment of these borrowings under the Agreement
and the Company is unable to refinance these borrowings.
Note 4 - LITIGATION
On August 19, 2004 a complaint was filed by Radio Wave LLC ("Plaintiff"), in the
Supreme Court of the State of New York, County of New York, against ER, LLC,
Essential and David Devor, a former officer and a current employee of the
Company, for rent, additional rent, cost and fees relating to premises formerly
occupied by the Company. Plaintiff seeks to recover $150,416 for the period up
to August 31, 2004, plus additional amounts to be determined by the Court for
the period subsequent to August 31, 2004. Plaintiff also seeks to recover
$50,000 in expenses and attorney fees plus additional amounts to be determined
by the Court. The Company believes that the suit is without merit and intends to
vigorously defend its position.
Note 5 - SUBSEQUENT EVENT
On April 7, 2005, the Company appointed Barbara A. Ras as its Chief Financial
Officer under a letter agreement signed by the Company on that date. Ms. Ras'
employment is on a part-time, at will basis, for annual compensation of
$125,000. The Company granted to Ms. Ras 100,000 options under a separate grant
letter. The options will be exercisable at $0.325 per share, and will vest
quarterly over a three year period while Ms. Ras is employed by the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
FORWARD - LOOKING STATEMENTS
The following discussion of our financial condition and results of operations
should be read together with the financial statements and related notes included
elsewhere in this report. Some of the statements in this section that are not
historical facts are forward-looking statements. You are cautioned that the
forward-looking statements contained in this section are estimates and
predictions, and that our actual results could differ materially from those
anticipated in the forward-looking statements due to risks, uncertainties or
actual events differing from the assumptions underlying these statements. The
risks, uncertainties, and assumptions include, but are not limited to, those
disclosed in our annual report on Form 10-KSB for our fiscal year ended December
31, 2004.
10
OVERVIEW
See "Note 1", for description of a transaction whereby AllianceCorner
Distributors Inc. ("AllianceCorner") became a New York wholly-owned subsidiary
of Essential. The name of AllianceCorner was changed to Alliance Distributors
Holding, Inc. ("New York Alliance") in July 2004. Effective November 17, 2004,
New York Alliance was merged into Alliance Distributors Holding Inc., a Delaware
corporation that was wholly owned by Essential. Effective November 22, 2004,
Essential reincorporated in Delaware and changed its name to Alliance
Distributors Holding Inc. ("Alliance" or the "Company"), by way of a merger of
Essential into Alliance, which was then a wholly owned Delaware subsidiary of
Essential. The business of AllianceCorner became our only business. Since the
former stockholders of AllianceCorner acquired a majority of our voting
interests, the transaction was treated as a reverse acquisition, with
AllianceCorner treated as the acquirer for accounting purposes. Accordingly, the
pre-acquisition financial statements of AllianceCorner are our historical
financial statements. At the time of the acquisition, Essential had no
continuing operations and its historical results would not be meaningful if
combined with the historical results of AllianceCorner.
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 generating
higher margins than hardware.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Certain of the Company's accounting policies require the application of
significant judgment by management in selecting the appropriate assumptions for
calculating financial estimates. By their nature, these judgments are subject to
an inherent degree of uncertainty. These judgments are based on historical
experience, observation of trends in the industry, information provided by
customers and information available from other outside sources, as appropriate.
Critical accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of products to
customers as title and risk of loss pass upon shipment and collectibility is
reasonably assured. Provisions for estimated uncollectible discounts and rebates
to customers, estimated returns and allowances and other adjustments are
provided for in the same period the related sales are recorded. While such
amounts have been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same rates as
in the past.
Accounts Receivable - Accounts Receivable as shown on the Balance Sheet are net
of allowances and anticipated discounts. An allowance for doubtful accounts is
determined through analysis of the aging of accounts receivable at the date of
the financial statements, assessments of collectibility based on historic trends
and an evaluation of the impact of economic conditions. The allowance for
doubtful accounts is not significant. Principally, the Company's historical
estimates of these costs have not differed materially from actual results. The
Company controls credit risk through credit approvals, credit limits and
monitoring procedures. The Company performs credit evaluations of its customers
but generally does not require collateral to support accounts receivable. The
Company increased its allowance for doubtful accounts by $100,000 during the
three months ended March 31, 2005 and maintains a balance of approximately
$133,000 at March 31, 2005.
Inventories - Inventory is stated at the lower of cost or market, cost being
determined on the average cost basis. Write-downs for slow moving and aged
merchandise are provided based on historical experience and current product
demand. The Company evaluates the adequacy of the write-downs quarterly. While
writedowns have been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same level of
writedowns as in the past.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". This
statement revises FASB Statement No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123(R) focuses primarily on the accounting for transactions
in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires companies to recognize in the statement
of operations the cost of employee services received in exchange for awards of
equity instruments based on the grant-date fair value of those awards (with
limited exceptions). This Statement, for small business issuers is effective as
of the beginning of the Company's next fiscal year. Accordingly, the Company
will adopt SFAS 123(R) in its first quarter of fiscal 2006. The Company is
currently evaluating the provisions of SFAS 123(R) and has not yet determined
the impact that this Statement will have on its future results of operations or
financial position. The impact of this new standard, if it had been in effect,
on the net loss and related per share amounts of our fiscal quarter ended March
31, 2005 is disclosed in Stock Based Compensation, above.
RESULTS OF OPERATIONS
The following table shows each specified item as a dollar amount and as a
percentage of net sales for the three months ended March 31, 2005 and 2004, and
should be read in conjunction with the financial statements included elsewhere
in this Quarterly Report on Form 10-QSB:
11
Three months Three months
Ended ended
March 31, March 31,
2005 2004
(Thousands) (Thousands)
------------------------ -----------------------
Net sales $ 10,889 100.0% $ 7,300 100.0%
Cost of goods sold 9,647 88.6% 6,201 84.9%
---------- ---------- ---------- ----------
Gross profit 1,242 11.4% 1,099 15.1%
Operating expenses:
Selling, general and
administrative expenses 1,250 11.5% 921 12.6%
Stock option compensation expense 27 .2% -- .0%
---------- ---------- ---------- ----------
Total operating expenses 1,277 11.7% 921 12.6%
---------- ---------- ---------- ----------
Income (loss) from operations (35) (.3%) 178 2.5%
Interest expense 94 .9% 27 .4%
---------- ---------- ---------- ----------
Income (loss) before income taxes (129) (1.2%) 151 2.1%
Income taxes 1 .0% 12 .2%
---------- ---------- ---------- ----------
Net income (loss) $ (130) (1.2)% $ 139 1.9%
========== ========== ========== ==========
Three Months Ended March 31, 2005 compared to Three Months Ended March 31, 2004
Net sales increased by $3,589,194, or 49.2%, from $7,299,641 for the three
months ended March 31, 2004 to $10,888,835 for the three months ended March 31,
2005. The growth in net sales was primarily due to the increase in sales with
our existing customers, as well as in our customer base. In addition, the launch
of the Playstation Portable System in late March 2005 resulted in hardware sales
of approximately $1,554,000.
Cost of goods sold increased by $3,445,877, or 55.6%, from $6,200,621 for the
three months ended March 31, 2004 to $9,646,498 for the three months ended March
31, 2005. The increase was consistent with revenue growth. Gross profit as a
percentage of net sales decreased to 11.4% for the three months ended March 31,
2005 from 15.1% for the three months ended March 31, 2004. This decrease was
primarily due to the shortage of hardware in first quarter 2005 which drives
higher margin software sales, and the reduction in the availability of higher
margin budget software.
Selling, general and administrative expenses increased by $330,007, or 35.8%,
from $920,562 for the three months ended March 31, 2004 to $1,250,569 for the
three months ended March 31, 2005. The increase was primarily due to the
Company's increase in the allowance for doubtful accounts of $100,000, salaries
and related payroll taxes of $70,556, insurance premiums of $51,213 and
professional fees associated with the Company's expanded operations of $63,082.
Selling, general and administrative expenses as a percentage of net sales
decreased to 11.5% for the three months ended March 31, 2005 from 12.6% for the
three months ended March 31, 2004. For the three months ended March 31, 2005,
selling, general and administrative expenses were comprised of the following:
$164,758 in selling expenses, $216,092 in warehouse expenses and $869,719 in
general and administrative expenses. For the three months ended March 31, 2004,
selling, general and administrative expenses were comprised of the following:
$134,813 in selling expenses, $265,748 in warehouse expenses and $520,001 in
general and administrative expenses.
Stock option compensation expense increased by $26,833 for the three months
ended March 31, 2005 as a result of 750,000 options that were granted to
non-employees who provide services to the Company. The options have an exercise
price of $.325 per share. (See Note 2).
Interest expense increased by $66,458, or 244.7%, from $27,155 for the three
months ended March 31, 2004 to $93,613 for the three months ended March 31,
2005. The increase was primarily due to increased borrowings as well as higher
interest rates on bank borrowings during the first quarter 2005. The increased
borrowing levels were the result of increased sales volume that required higher
inventory levels. Interest expense relates to the note payable-bank described
below under Liquidity and Capital Resources.
12
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended March 31, 2005 net cash used in operating activities
was $1,476,963. Net cash used in operations for the three months ended March 31,
2005 consisted of a net loss of $129,678 and included the following changes in
operating assets and liabilities: an increase in accounts receivable of
$718,824, an increase in inventory of $437,107, and an increase in due from
vendors of $390,835. These increases were the result of increased sales volume.
Net cash used in investing activities for the three months ended March 31, 2005
was $5,883, which was used for the purchase of equipment.
Net cash provided by financing activities for the three months ended March 31,
2005 was $1,459,889 which primarily consisted of net proceeds on our note
payable to bank of $1,484,614.
On November 11, 2004, the Company, entered into a Financing Agreement
("Agreement") with Rosenthal & Rosenthal Inc. ("Rosenthal"). Under the
Agreement, Rosenthal may in its discretion lend up to $5 million to the Company
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 Agreement
terminates November 30, 2007 unless terminated sooner by Rosenthal on 30 days'
notice. Interest on outstanding borrowings is payable at a variable rate per
annum, equal to the prime rate (but not less than 4.75 percent) plus 2.00
percent (7.75 percent as March 31, 2005). The Company's CEO and the Company's
President signed limited guaranties in respect of borrowings under the
Agreement.
Under the terms of the Agreement, the Company is required to maintain a
specified level of net worth, working capital and debt ratios as defined. In May
2005, Rosenthal informed the Company that it did not comply with a financial
covenant under the Agreement for the fourth quarter of 2004. Rosenthal has
provided a waiver for this failure to comply. In addition, for the first quarter
of 2005, the Company did not comply with certain financial covenants for which
Rosenthal has also provided a waiver.
The Company and Rosenthal are currently renegotiating the terms and covenants of
the Agreement and the Company anticipates that such renegotiation will be
successful. Subject to the execution of this revised agreement, the Company
believes that it will have sufficient liquidity for the next twelve months and
the foreseeable future. However, the Company would have to scale down its
operations if it is unsuccessful in renegotiating the borrowing base and
financial covenants. Furthermore, the Company would be materially and adversely
affected if Rosenthal demands payment of these borrowings under the Agreement
and the Company is unable to refinance these borrowings.
ITEM 3. 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
Principal 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 March 31,
2005 ("Evaluation Date"). Based on such evaluation, our Chief Executive Officer
and Principal 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 Principal Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
Additionally in 2005, the Company is implementing periodic observation of
inventory through the use of computerized equipment and will conduct periodic
reconciliation to the perpetual inventory file. These changes will have the
effect of ensuring that account reconciliation operational controls are
operating as designed and will reduce the probability of human error. The
Company introduced these controls after learning of the errors described in Note
12 of the Financial Statements in the Annual Report on Form 10-KSB.
Other than the changes noted above, there have been no changes in the Company's
internal control over financial reporting identified in connection with the
evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the
Exchange Act that occurred during the Company's fiscal quarter that has
materially affected, or is reasonable likely to materially affect, the Company's
internal control over financial reporting.
PART 2. OTHER INFORMATION
Item numbers 1, 2, 3, 4 and 5 are not applicable and have been omitted.
13
ITEM 6. EXHIBITS.
Exhibits.
EXHIBIT INDEX
NUMBER DESCRIPTION
- --------- --------------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
14
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
May 16, 2005
Alliance Distributors Holding Inc.
By: /s/ Jay Gelman
-------------------------------------------
Jay Gelman
CEO and Chairman of the Board
By: /s/ Barbara A. Ras
-------------------------------------------
Barbara A. Ras
Chief Financial Officer (Principal Financial and
Accounting Officer)
15