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 SEPTEMBER 30, 2004
|_| 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
ESSENTIAL REALITY, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 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 ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court.
|_| Yes |_| No
APPLICABLE ONLY TO CORPORATE ISSUERS:
As November 12, 2004 there were 22,000,000 shares of the issuer's Common Stock,
par value $.001 per share, issued and outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT |_| YES |X| NO
1
PART I - FINANCIAL INFORMATION
INDEX
Pages
Part I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Balance Sheet as of September 30, 2004 (Unaudited) 3
Condensed Statements of Operations for the three and nine
months ended September 30, 2004 and 2003 (Unaudited) 4
Condensed Statement of Stockholders' Equity for
the nine months ended September 30, 2004 (Unaudited) 5
Condensed Statement of Cash Flows for the nine months
ended September 30,2004 and 2003 (Unaudited) 6 - 7
Notes to Condensed Financial Statements (Unaudited) 8 - 12
Item 2 - Management's Discussion and Analysis 12 - 14
Item 3 - Controls and Procedures 14
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 14
Item 2 - Changes in Securities 14
Item 3 - Defaults Upon Senior Securities 14
Item 4 - Submission of Matters to a Vote of Security Holders 14
Item 5 - Other Information 14
Item 6 - Exhibits and Reports on Form 8-K 15 - 16
2
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
ESSENTIAL REALITY, INC.
CONDENSED BALANCE SHEET (UNAUDITED)
September 30, 2004
ASSETS
Current Assets
Cash $ 966,492
Accounts receivable, net of allowance for doubtful accounts 988,704
Inventories 3,031,657
Due from vendors 277,173
Prepaid expenses and other current assets 91,616
----------
Total current assets 5,355,642
Equipment and improvements, net of accumulated depreciation 430,926
and amortization
Other assets 21,556
----------
Total assets $5,808,124
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $2,043,101
Due to factor 151,450
Current portion of long term obligations 122,460
Accrued expenses and other current liabilities 96,266
Liabilities payable in common stock 32,200
----------
Total current liabilities 2,445,477
Long term obligations 51,438
----------
Total liabilities 2,496,915
Commitments and contingencies
Stockholders' equity:
Series A 6% Convertible Non-Redeemable Preferred Stock 1,685
$.001 par value; 2,004,401 shares authorized, 1,685,115
issued and outstanding (aggregate liquidation preference
$5,996,811)
Series B Convertible Non-Redeemable Preferred Stock 1,551
$.001 par value; 1,995,599 shares authorized, 1,551,314
issued and outstanding (aggregate liquidation preference
$5,552,678)
Common stock, $0.001 par value; 50,000,000 shares authorized; 22,000
22,000,000 issued and outstanding
Additional paid-in capital 3,152,732
Retained Earnings 133,241
----------
Total stockholders' equity 3,311,209
----------
Total liabilities and stockholders' equity $5,808,124
==========
See notes to condensed financial statements
3
ESSENTIAL REALITY, INC
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003(1) 2004 2003(1)
--------------- --------------- --------------- ---------------
Sales $ 6,924,181 $ 352,710 $ 20,200,199 $ 352,710
Cost of sales 5,966,406 334,184 17,363,624 334,184
--------------- --------------- --------------- ---------------
Gross profit 957,775 18,526 2,836,575 18,526
Selling, general and administrative expenses 980,454 74,977 2,704,112 74,977
--------------- --------------- --------------- ---------------
Income (loss) from operations (22,679) (56,451) 132,463 (56,451)
Interest expense 20,444 64 81,052 64
--------------- --------------- --------------- ---------------
Income (loss) before provision for income taxes (43,123) (56,515) 51,411 (56,515)
Provision for income taxes -- -- 11,167 --
--------------- --------------- --------------- ---------------
Net income (loss) (43,123) (56,515) 40,244 (56,515)
--------------- --------------- --------------- ---------------
Preferred stock dividends 105,977 -- 106,819 --
--------------- --------------- --------------- ---------------
Net loss available to common shareholders $ (149,100) $ (56,515) $ (66,575) $ (56,515)
=============== =============== =============== ===============
Net loss per share - Basic $ -- $ -- $ -- $ --
=============== =============== =============== ===============
Net loss per share - Diluted $ -- $ -- $ -- $ --
=============== =============== =============== ===============
Dividends per share $ -- $ -- $ -- $ --
=============== =============== =============== ===============
NUMBER OF WEIGHTED AVERAGE SHARES - BASIC 2,287,500,300 1,085,919,800 1,493,755,517 1,085,919,800
NUMBER OF WEIGHTED AVERAGE SHARES - DILUTED 2,287,500,300 1,085,919,800 1,493,755,517 1,085,919,800
----------
(1) The three and nine months ended September 30, 2003 includes the results from
August 11, 2003, the date of commencement of operations.
See notes to condensed financial statements.
4
ESSENTIAL REALITY, INC
CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
For the Nine Months Ended September 30, 2004
Preferred Stock A Preferred Stock B Common Stock
--------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
----------- ----------- ----------- ----------- ----------- -----------
Balance, January 1, 2004 -- $ -- -- $ -- 300 $ 300
Exchange of Alliance
shares for Essential shares -- -- 1,551,314 1,551 (300) (300)
Essential shareholders' shares
prior to reverse acquisition -- -- -- -- 18,588,110 18,588
Issuance of shares in exchange
for Essential debt 452,202 452 -- -- 3,411,890 3,412
Essential's debt and
liabilities assumed -- -- -- -- -- --
Proceeds from PPO, net of
cash issuance costs 1,124,767 1,125 -- -- -- --
Shares issued to placement
agent of PPO 108,146 108 -- -- -- --
Merger Expenses -- -- -- -- -- --
Net income -- -- -- -- -- --
Preferred stock dividend -- -- -- -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Balance, September 30,2004 1,685,115 $ 1,685 1,551,314 $ 1,551 22,000,000 $ 22,000
=========== =========== =========== =========== =========== ===========
Additional Total
Paid In Retained Stockholders'
Capital Earnings Equity
----------- ----------- -----------
Balance, January 1, 2004 $ 435,715 $ 199,816 $ 635,831
Exchange of Alliance
shares for Essential shares (1,251) -- --
Essential shareholders' shares
prior to reverse acquisition (18,588) -- --
Issuance of shares in exchange
for Essential debt (3,864) -- --
Essential's debt and
liabilities assumed (1,067,898) -- (1,067,898)
Proceeds from PPO, net of
cash issuance costs 3,798,375 -- 3,799,500
Shares issued to placement
agent for PPO (108) -- --
Merger expenses (96,468) -- (96,468)
Net income -- 40,244 40,244
Preferred stock dividend 106,819 (106,819) --
----------- ----------- -----------
Balance,September 30, 2004 $ 3,152,732 $ 133,241 $ 3,311,209
=========== =========== ===========
See notes to condensed financial statements.
5
ESSENTIAL REALITY, INC.
CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
Nine months ended September 30,
2004 2003 (1)
----------- -----------
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net income (loss) $ 40,244 $ (56,515)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO
NET CASH USED IN OPERATING ACTIVITIES:
Deferred Rent 10,021 --
Depreciation and amortization 58,081 1,255
CHANGES IN ASSETS AND LIABILITIES:
Accounts receivable (808,020) (143,677)
Inventories (135,450) (3,386,601)
Due from vendors (262,773) (54,821)
Prepaid expenses and other current assets (22,110) (18,883)
Accounts payable (2,360,738) 3,461,825
Due from/to factor, net 1,435,304 --
Accrued expenses and other current
liabilities (252,417) 551
----------- -----------
Net cash used in operating activities (2,297,858) (196,866)
----------- -----------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of equipment (65,635) (22,202)
Increase in other Assets (3,222) (10,367)
Payments for pre-acquisition liabilities (915,329) --
----------- -----------
Net cash used in investing activities (984,186) (32,569)
----------- -----------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from sale of securities 4,000,000 --
Payments for issuance costs (200,500) --
Payments for merger costs (35,988) --
Repayment of long-term obligations (171,829) (37,624)
Capital contribution -- 200,000
Proceeds from line-of-credit -- 232,000
----------- -----------
Net cash provided by financing activities 3,591,683 394,376
----------- -----------
NET INCREASE IN CASH 309,639 164,941
CASH, beginning of period 656,853 --
----------- -----------
CASH, end of period $ 966,492 $ 164,941
=========== ===========
----------
(1) The nine months ended September 30, 2003 include the results from August 11,
2003, the date of commencement of operations.
See notes to condensed financial statements.
6
ESSENTIAL REALITY, INC.
CONDENSED STATEMENT OF CASH FLOWS (CONTINUED) (UNAUDITED)
Nine months ended September 30,
2004 2003(1)
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 81,052 $ 63
=========== ===========
Income tax paid - S Corporation related taxes $ 19,222 $ --
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Fair market value of property and equipment contributed $ -- $ 276,138
Capitalized lease obligations assumed $ -- (27,277)
Notes payable assumed $ -- (12,896)
----------- -----------
Net capital contributed $ -- $ 236,015
=========== ===========
Equipment acquired under capital lease obligations $ -- $ 17,444
=========== ===========
Equipment financed by note payable $ -- $ 26,674
=========== ===========
Issuance of Series A 6% Preferred Stock $ 385,000 $ --
to placement agent =========== ===========
Liabilities assumed $ 1,067,898 $ --
=========== ===========
Series A 6% Preferred Stock dividend accrued $ 106,819 $ --
=========== ===========
Merger costs accrued $ 60,480 $ --
=========== ===========
----------
(1) The nine months ended September 30, 2003 include the results from August 11,
2003, the date of commencement of operations.
See notes to condensed financial statements.
7
ESSENTIAL REALITY, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
September 30, 2004 (UNAUDITED)
1. BASIS OF PRESENTATION, ORGANIZATION AND OTHER MATTERS
On June 17, 2004, Essential Reality, Inc., referred to herein as the
registrant,"Essential" or the "Company," 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 New York corporation ("Alliance"). Alliance had no prior
affiliation with the Company and commenced operations in August 2003. Pursuant
to the Exchange Agreement, the Company on June 29, 2004 acquired all the
outstanding capital stock of Alliance 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
the Company's only business. The transaction was accounted for as a reverse
acquisition as of June 30, 2004 and the pre-acquisition financial statements of
Alliance 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 the Company for
periods prior to the date of the transaction are not presented and (ii) because
Alliance is the accounting acquirer, the Company's historical stockholders'
equity is not carried forward to the merged company as of June 30, 2004. The net
monetary liabilities of the Company assumed in the transaction were
approximately $153,000 after payments of approximately $915,000 (See Note 4).
The name of AllianceCorner Distributors, Inc. was changed to Alliance
Distributors Holding, Inc. after the acquisition and the Company does business
under that name.
The accompanying unaudited condensed financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been omitted. In the opinion of management, all
material adjustments, consisting of normal recurring adjustments, considered
necessary for a fair presentation, have been included in the accompanying
unaudited condensed 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, 2004.
NATURE OF BUSINESS
Essential Reality, LLC ("ER, LLC") was formed as Freedom Multimedia, LLC in the
state of Delaware on July 9, 1998 and began active operations on June 1, 1999.
The Company changed its name to ER, LLC on December 29, 1999. On June 20, 2002,
ER, LLC completed a business combination (recapitalization) with JPAL, Inc.
("JPAL"), a Nevada Corporation (the "Transaction") whereby, all of the members
of ER, LLC contributed their membership interests in ER, LLC to JPAL in exchange
for shares of the JPAL's common stock. Following the Transaction, JPAL changed
its name to Essential Reality, Inc.
On November 6, 2003 the Board of Directors of the Company resolved to
discontinue the sales of the P5(TM) Unit, a virtual controller, because of the
lack of capital and the ability to raise additional funds and resolved to pursue
the Exchange Agreement with Alliance, a privately held wholesale distributor of
interactive video games and gaming products.
PRIVATE PLACEMENT OFFERING
As part of the Exchange Agreement with Alliance, the Company was required to
raise funds to complete the transaction. The Company 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 the Company's liabilities leaving a balance of
$2,884,171, which was transferred to the Company by the escrow agent as of July
1, 2004. At the same time, substantially all outstanding debt of the Company was
extinguished through either conversion into an aggregate of 452,202 Series A
Preferred Shares or through cash payments. (See Note 4)
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 68,820,224 shares of common stock at an
exercise price of $.005 per share on a pre reverse split basis. (see
Stockholders' Equity section).
8
STOCKHOLDER'S 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. Each Series A
Preferred Share and each Series B Preferred Share entitles the holder to 700
votes, and votes as one class with the common stock.
Certain holders of Series A Preferred Shares (the "Proxy Grantors") have granted
to Jay Gelman an irrevocable proxy (the "Voting Proxy") to vote 526,225 Series A
Preferred Shares owned by them and any shares of common stock into which such
Series A Preferred Shares are converted. Since the Series A Preferred Shares are
entitled to 700 votes per share, the Series A Preferred Shares owned by the
Proxy Grantors are entitled in the aggregate to 368,357,500 votes.
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 (the "Reverse Split"). The Company filed a Schedule 14C
relating, in part, to the adoption of the Amendment and the Reverse Split with
the Securities and Exchange Agreement on October 26, 2004 in accordance with the
requirements of Regulation 14C under the Act. (See Item 4) These actions will
not become effective before November 22, 2004, the 21st day following the date
the Company sent an information statement relating to these actions to security
holders entitled to vote. All share and per share data included in future
financial statements will be adjusted for the split.
The Series A Preferred Shares are entitled on conversion to a dividend in kind,
i.e., in Series A Preferred Shares, accruing at the rate of 6% per annum from
June 29, 2004 until the effectiveness of the Amendment.
The Series A Preferred Shares are convertible into 1,179,580,500 shares of
common stock. The Series B Preferred Shares are convertible into 1,085,919,800
shares of common stock. The warrant issued to Sunrise Securities Corp. is
exercisable into 68,820,224 shares of common stock.
The adoption of the Amendment and the Reverse Split will result in the automatic
conversion of each Series A Preferred Share and each Series B Preferred Share
into 15.91 shares of post-split common stock. However, Series A Preferred Shares
owned by a holder will not 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.
The shares of the Company's common stock underlying the Series A Preferred
Shares and Series B Preferred Shares are entitled to registration rights.
After giving effect to the transactions contemplated by the Exchange Agreement,
the Reverse Split and the PPO and to the conversion of all Series A Preferred
Shares and Series B Preferred Shares, but not giving effect to warrants issued
to the Placement Agent in connection with the PPO and to the 4.999% Restriction,
the former shareholders of Alliance collectively own 24,679,995 shares of common
stock, or approximately 48% of the outstanding common stock of the Company,
investors in the PPO own approximately 18,685,005 shares of common stock ,or
approximately 36% of the outstanding common stock of the Company, investors
converting outstanding debt in the PPO own 6,135,007 shares of common stock, or
approximately 12% of the outstanding common stock of the Company, the Placement
Agent owns 1,720,505 shares of common stock, or approximately 3% of the
outstanding common stock of the Company and shareholders who owned the
approximately 22,000,000 pre-split shares outstanding prior to PPO own
approximately 500,000 post-split shares of common stock, or approximately 1% of
the outstanding common stock of the Company. Investors in the PPO paid the
equivalent of $.005 per share of common stock on an as converted pre-split basis
($.22 on a post-split basis).
In connection with the Exchange Agreement, the former shareholders of Alliance
have agreed not to dispose of any of their Series B Preferred Shares (or any of
their shares of the Company's common stock received by them upon conversion of
the Series B Preferred Shares) for a period of one year from the closing of the
Exchange Agreement.
The three former Shareholders of Alliance each own 517,105 Series B Preferred
Shares representing 15.8% of the Company's total voting power (the total number
of votes that can be cast by the outstanding common stock, Series A Preferred
Shares and Series B Preferred Shares). Mr. Gelman, based on his Series B
Preferred Shares and his voting rights pursuant to the Voting Proxy, has 31.9%
of the Company's total voting power. The Shareholders in the aggregate have
approximately 63% of the Company's total voting power and control the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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, Alliance 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.
9
EQUIPMENT AND IMPROVEMENTS
Contributed equipment is recorded at fair market value. Purchased equipment and
improvements are recorded at cost. Expenditures for major additions and
improvements are capitalized and minor replacements, maintenance and repairs are
charged to expense as incurred. Leasehold improvements are amortized over the
lesser of the lease terms or the assets' useful lives. When 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 is provided over the
estimated lives of the related assets using the straight-line method. The
estimated useful lives for equipment and improvements categories are as follows:
Vehicles 4 years
Warehouse equipment 3 to 7 years
Office furniture and equipment 3 to 7 years
Leasehold improvements 5 to 10 years
INCOME TAXES
At December 31, 2003 Essential had pre-acquisition unused net operating loss
carryforwards of approximately $7,500,000 for purposes that maybe applied
against future taxable income and that, if unused, expire 2023. The Company will
evaluate its net operating loss carryforward availability and determine whether
a tax provision is required at year-end. As a result of the Exchange Agreement,
the Company believes it has undergone a change in control. Utilization of the
net operating loss carryforwards will be subject to a substantial annual
limitation due to the ownership change and limitations provided by the Internal
Revenue Code of 1986. The annual limitations may result in the expiration of net
operating loss carryforwards before utilization.
Alliance was a Subchapter S Corporation and accordingly, no provision has been
made for federal income taxes for the periods prior to June 29, 2004. Effective
June 29, 2004, Alliance is subject to federal income taxes. A deferred tax
asset, which would consist primarily of an NOL for Alliance at September 30,
2004, has not been recorded because the likelihood of realization is uncertain.
10
Net Income (Loss) Per Common Share
Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding during the period.
Diluted net income (loss) per share is computed by dividing the net income
(loss) by the weighted average number of common and common equivalent shares
outstanding during the period. Common shares outstanding assume the conversion
of Series A and B Preferred Shares into 700 pre-split shares of Common Stock.
Common equivalents which would include the conversion of Sunrise's warrants have
not been included as their effect would be anti-dilutive for the three and nine
months ending September 30, 2004.
3. DUE TO FACTOR
In December 2003, Alliance entered into a factoring arrangement with a
commercial factor. Alliance sells a substantial portion of its trade receivables
up to maximum credit limits established by the factor for each individual
account. Receivables sold in excess of these limitations are subject to recourse
in the event of non-payment by the customer. Under the terms of the agreement,
Alliance pays interest at the prime lending rate plus 1.5% (6.25% at September
30, 2004) for advances made prior to the collection of the factored accounts
receivable. At September 30, 2004 advances of approximately $1,004,000 were
offset against amounts due to the factor.
Substantially all of Alliance's assets have been pledged as collateral under the
factoring agreement.
Under the terms of the agreement, Alliance is required to maintain a specified
level of net worth, as defined. At September 30, 2004, Alliance is in compliance
with this covenant.
Subsequently, on November 11, 2004, the factoring agreement was replaced with a
new Financing Agreement. (See note 8)
4. SETTLEMENT OF ESSENTIAL'S PRE-ACQUISITION LIABILITIES
OUTSTANDING LIABILITIES TO VENDORS, RELATED PARTIES, EMPLOYEES AND OTHER
The outstanding Company liabilities to vendors, related parties, employees and
others, were resolved as follows as a result of the Exchange Agreement:
OUTSTANDING AT
JUNE 28, 2004 PRIOR CONVERTED TO RELEASE OF UNPAID
TO EXCHANGE AGREEMENT PAID STOCK BALANCE
--------------------- ---------- ---------- -----------------
Accounts payable $1,567,987* $ 468,583 $ 54,250 $1,045,154
Related parties 503,699 19,035 -- 484,664
Employees 201,011 43,382 73,850 83,779
Other 126,870 120,000 -- 6,870
---------- ---------- ---------- ----------
Total $2,399,567 $ 651,000 $ 128,100 $1,620,467
========== ========== ========== ==========
----------
* Net of $47,498 remaining in Accounts payable at June 30, 2004.
SECURED CONVERTIBLE DEBENTURE:
As of June 30, 2004, pursuant to the Exchange Agreement and the PPO, the
debenture holders agreed to convert the outstanding principal in the amount of
$1,000,000 into 80,285 Series A 6% Convertible Non Redeemable Preferred Stock
and provided a release for the accrued interest in the amount of $119,593.
NOTES PAYABLE:
As of June 30, 2004, pursuant to the Exchange Agreement and the PPO, note
holders with outstanding principal in the amount of $2,366,285 agreed to receive
$264,330 in cash, converted $1,562,551 of principal into 355,063 Series A 6%
Convertible Non Redeemable Preferred Stock and provided a release for $539,404
in principal and accrued interest in the amount of $333,396.
5. LIABILITIES TO BE PAID IN COMMON STOCK
As of September 30, 2004 pursuant to the Exchange Agreement the Company will
issue 110,000, post-split, common stock for services rendered in the amount of
$32,200.
11
6. WARRANTS
Pursuant to the PPO, the Company issued Sunrise 5 year warrants due June 29,
2009 to purchase 68,820,224 shares of common stock with an exercise price of
$0.005 per share on a pre-reverse split basis.
In addition, the Company has outstanding 3 year warrants due June 20, 2005 with
an exercise price of $1.30 to purchase 331,211 pre-reverse split common stock
issued to the financial consultants associated with the JPAL deal on June 20,
2002.
Subsequently, on November 11, 2004, in connection with the new Financing
Agreement, the Company issued warrants to purchase 500,000 shares of common
stock at $0.10 per share. (See Note 8)
7. 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.
8. SUBSEQUENT EVENT
On November 11, 2004, Alliance entered into a Financing Agreement which replaces
the factoring agreement with Rosenthal & Rosenthal Inc. ("Rosenthal"). Under the
Agreement, Rosenthal may in its discretion lend up to $5 million 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 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 percent) plus 2.00 percent (7.00
per cent as of November 11, 2004). The Company's CEO and the Company's President
signed limited guaranties in respect of borrowings under the Agreement. 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. All
share and dollar amounts give effect to the proposed 1 for 44 reverses split of
common stock that is referred to in the Company filing on Form 14C on October
26, 2004.
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 will record an interest charge
for the fair value of the warrants in the fourth quarter.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
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, 2003.
OVERVIEW
As a result of the Exchange Agreement, on June 29, 2004, Alliance became our
wholly-owned subsidiary and the business of Alliance became our only business.
Since the former stockholders of Alliance acquired a majority of our voting
interests, the transaction was treated as a reverse acquisition of a public
shell, with Alliance treated as the acquirer for accounting purposes.
Accordingly, the pre-acquisition financial statements of Alliance are our
historical financial statements. At the time of the acquisition, the Company had
no continuing operations and its historical results would not be meaningful if
combined with the historical results of Alliance.
RESULTS OF OPERATIONS
Overview of Third Quarter and Nine Months Ended September 30, 2004 Compared to
the Period from August 11, 2003, the date of Commencement of Operations, to
September 30, 2003
Sales. For the three and nine months ended September 30, 2004 the Company
recognized product-related revenues in the amount of $6,924,181 and $20,200,199,
respectively as compared to $352,710 for the period from August 11, 2003, the
date of commencement of operations, to September 30, 2003. The Company targets
key retailers who are independent operators and carry a full line of products to
include software, hardware and accessories enabling it to be a full service
supplier.
Cost of Sales. For the three and nine months ended September 30, 2004, cost of
sales totaled $5,966,406 and $17,363,624, respectively, as compared to
$334,184 for the period from August 11, 2003, the date of commencement of
operations, to September 30, 2003. For the three and nine months ended September
30, 2004, gross profit was 13.8% and 14.0% of net sales, respectively, which is
where the company budgeted its margin to be.
Selling, general and administrative expenses. For the three and nine months
ended September 30, 2004 selling, general and administrative expenses totaled
$980,454 and $2,704,112, respectively, compared to $74,977 for the period from
August 11, 2003, the date of commencement of operations, to September 30, 2003.
The Company's major components for the three and nine months ended September 30,
2004, are as follows: selling, consisting primarily of salaries and commissions,
of $75,771 and $293,349, respectively; shipping and warehouse, consisting
primarily of salaries and freight-out, of $180,350 and $599,846, respectively;
and general and administrative, consisting primarily of salaries , insurance,
consulting fees, professional fees and rent, of $516,698 and $1,204,871,
respectively.
Interest expense for the three and nine months ended September 30, 2004 totaled
$20,444 and $81,052, respectively, compared to $64 for the period from August
11, 2003, the date of commencement of operations, to September 30, 2003.
Interest expense relates to the factor arrangement described below under
Liquidity and Capital Resources.
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LIQUIDITY AND CAPITAL RESOURCES
On June 29, 2004 the Company received $2,884,171 in net proceeds from the sale
of 1,124,767 Series A 6% Convertible Non-Redeemable Preferred Shares in a
private placement (the "Offering"). At the same time, substantially all
outstanding debt of the Company was extinguished through either conversion into
an aggregate of 452,202 Series A Preferred Shares or through cash payments.
For the nine months ended September 30, 2004 net cash used in operating
activities was $2,297,858.Net cash used in operations for the nine months ended
September 30, 2004 consisted of net income of $40,244 and included the following
changes in operating assets and liabilities: an increase in accounts receivable
of $808,020, a decrease in accounts payable of $2,360,738 and an increase in
amount due to factor of $1,435,304, due to advances taken during the period.
Net cash used in investing activities for the nine months ended September 30,
2004 was $984,186, primarily for the purchase of equipment and Essential's
pre-acquisition liabilities of $65,635 and $915,329, respectively.
Net cash for financing activities, raised by the PPO, for the nine months ended
September 30, 2004 was $3,591,683 which consisted of primarily of gross proceeds
of $4,000,000 from the PPO, and payments of issuance costs of $200,500, as well
as $171,829 of repayment of long term obligations.
In December 2003, AllianceCorner Distributors, Inc. ("Alliance") entered into a
factoring arrangement with a commercial factor. Alliance sells a substantial
portion of its trade receivables up to maximum credit limits established by the
factor for each individual account. Receivables sold in excess of these
limitations are subject to recourse in the event of non-payment by the customer.
Under the terms of the agreement, Alliance pays interest at the prime lending
rate plus 1.5% (6.25% as of September 30, 2004) for advances made prior to the
collection of the factored accounts receivable. As of September 30, 2004, factor
advances of approximately $1,004,000 were offset against amounts due to the
factor. Substantially all of Alliance's assets have been pledged as collateral
under the factoring agreement. Under the terms of the agreement, Alliance is
required to maintain a specified level of net worth, as defined. As of September
30, 2004, Alliance is in compliance with this covenant.
On November 11, 2004, Alliance entered into a Financing Agreement which replaces
the factoring agreement with the Rosenthal & Rosenthal, Inc. ("Rosenthal").
Under the Agreement, Rosenthal may in its discretion lend up to $5 million 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
Agreement terminates November 30, 2007 unless terminated either 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 (7.00 per cent as of November 11, 2004). The Company's CEO and the
Company's President signed limited guaranties in respect of borrowings under the
Agreement.
In addition, Alliance owes a note payable in the amount of $93,789 to Corner
Distributors, Inc. ("Corner"), which is due and payable on June 30, 2005, in
connection with a purchase agreement by and between Alliance and Corner, dated
as of March 4, 2004.
The Company believes that it has sufficient liquidity for the next twelve months
based upon its existing cash and availability under the factor agreement. In
addition, the Company is currently exploring alternate financing arrangements
with its lender to replace its existing factoring arrangement with an asset
based lending facility to provide additional liquidity.
CRITICAL ACCOUNTING POLICIES
Certain of the Company's accounting policies require the application of
significant judgment by management in selecting the appropriate assumptions for
calculating financial estimates. By their nature, these judgments are subject to
an inherent degree of uncertainty. These judgments are based on historical
experience, observation of trends in the industry, information provided by
customers and information available from other outside sources, as appropriate.
Critical accounting policies include:
Revenue Recognition - The Company recognizes sales upon shipment of products to
customers as title and risk of loss pass upon shipment. 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 and Due to Factor - Accounts Receivable and due to factor 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
since the Company sells a substantial portion of its trade receivables to a
commercial factor, without recourse, up to maximum credit limits established by
the factor for each individual account. Receivables sold in excess of these
limitations are subject to recourse in the event of non-payment by the customer.
Principally, the Company's historical estimates of these costs have not differed
materially from actual results.
Inventories - Inventory is stated at the lower of cost or market, cost being
determined on the average cost basis. Writedowns for slow moving and aged
merchandise are provided based on historical experience and current product
demand. The Company evaluates the adequacy of the writedowns 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.
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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 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 September 30, 2004 ("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. There has
been no significant changes in the Company's internal controls during the
quarter ended September 30, 2004.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On August 19, 2004 a complaint was filed by Radio Wave LLC ("Plaintiff"), in the
Supreme Court of the State of New York, County of New York, against Essential
Reality, LLC, Essential Reality, Inc. 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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
See Note 1 to the Condensed Financial Statements for information on a
prospective one for 44 reverse split and on transactions in which the Company
issued (i) 1,551,314 Series B Preferred Shares to Jay Gelman, Andre Muller and
Francis Vegliante in exchange for their stock in Alliance (ii) 1,124,767 Series
A Preferred Shares in a private placement at $3.56 per Series A Preferred Share
($.005) per each share of common stock on a pre-split as converted basis), (iii)
108,146 shares of Preferred A Shares to Sunrise together with five-year warrants
due June 29, 2009 to purchase 68,820,224 shares of common stock at an exercise
price of $0.005 per share on a pre-reverse split basis (together with the other
consideration set forth in such Note), and (iv) 452,202 Series A Preferred
Shares in settlement of notes, liabilities and claims.
The Series A Preferred Shares issued for cash were sold to the following
investors: AJAX Partners, Nathan A. Low IRA, Bridges & Pipes, Cary D. Pinkowski,
CDT Management LTC., DKR Sound Shore Oasis Holding Fund, Ltd., Iroquois Capital
LP, Jackson Steinem Inc., M. Paul Tompkins, Nadine Smith, Richard Genovese,
Robert Feig, RP Capital LLC, Shai Stern, Smithfield Fiduciary, LLC, South Ferry
#2 L.P., SRG Capital, LLC, Sunrise Equity Partners, Vitel Ventures Corp.,
William Saggio and Winton Capital Holdings Ltd.
These issuances were made as private placements pursuant to the provisions of
Section 4(2) of the Securities Act of 1933, as amended and Rule 506 of
Regulation D promulgated by the Securities and Exchange Commission thereunder.
As more fully set forth in Note 1 to the Condensed Financial Statements, after
giving effect to the conversion of the preferred shares into common stock and to
the prospective reverse split, the approximately 22,000,000 pre-split shares
currently outstanding and traded on the pink sheets will be converted into
500,000 shares of common stock out of 51,988,644 before dilution. Investors in
the private placement in June 2004 purchased their shares at the equivalent of
$.005 per share of common stock on an as converted pre-split basis (or $.22 on a
post-split basis).
On November 11, 2004 the Company issued to Rosenthal & Rosenthal ("Rosenthal") a
warrant (the "Warrant") to purchase 500,000 shares of common stock at $0.10 per
share. All share and dollar amounts give effect to the proposed 1 for 44 reverse
split of common stock that is referred to in the Form 14C that the Company filed
on October 26, 2004. The warrant was issued in a private placement under the
exemption set forth in Section 4(2) of the Securities Act of 1933 (the "Act").
The Company agreed to register the shares issuable on exercise of the Warrant.
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 will record an interest charge
for the fair value of the warrants in the fourth quarter.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
Under the Exchange Agreement, Jay Gelman, Andre Muller and Thomas Vitiello
("Shareholders") were designated on June 29, 2004 to constitute a majority of
the directors of the Company. Messrs. Gelman, Muller and Vitiello took office as
directors 10 days after the Company filed a 14f-1 information statement with the
Securities and Exchange Commission and transmitted the information statement to
all holders of record of securities of the Company entitled to vote at a meeting
for election of directors.
On October 25, 2004, the Shareholders, holding 1,454,277,300 shares in the
corporation, or 63% of the total outstanding shares entitled to vote, voted to:
1. amend the Corporation's Articles of Incorporation to first increase
the number of authorized shares of common stock, par value $0.001
per share (the "common stock"), from 50,000,000 shares to
4,400,000,000 shares, and to increase the number of authorized
shares of preferred stock, par value $0.001 per share from 5,000,000
shares to 10,000,000 shares;
2. further amend the Corporation's Articles of Incorporation to reverse
split the number of authorized shares of common stock and the
outstanding shares of common stock on the basis of one share for 44
shares;
3. merge the Corporation into its Delaware wholly owned subsidiary,
Alliance Distributors Holding Inc. and terminate its corporate
existence in the State of Nevada; and
4. adopt the Alliance Distributors Holding Inc. 2004 Stock Plan.
These actions will not become effective before November 22, 2004, the 21st day
following the date the Company sent an information statement relating to these
actions to security holders entitled to vote.
ITEM 5. OTHER INFORMATION.
NONE
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8 K
15
(a) Exhibits.
EXHIBIT INDEX
NUMBER DESCRIPTION
--------- -----------
2.1 Exchange Agreement between Essential Reality 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").
3.1 Amended and Restated Articles of Incorporation of the Company.
Incorporated herein by reference from Exhibit 3.1 to the Company's
Registration Statement on Form SB-2 filed on August 18, 2000 ("2000
SB-2").
3.2 Amendment to Articles of Incorporation filed June 20, 2002 with the
State of Nevada. Incorporated herein by reference from Exhibit 3.2
to the Company's Registration Statement on Form SB-2 filed on July
19, 2002 ("2002 SB-2").
3.3 Amendment to Articles of Incorporation filed June 21, 2002 with the
State of Nevada. Incorporated herein by reference from Exhibit 3.3
to the 2002 SB-2. 3.4 Bylaws of the Company. Incorporated herein by
reference from Exhibit 3.2 to the 2000 SB-2. 4.1 Certificate of
Designation of the Company's Series A Convertible Non Redeemable
Preferred Shares. Incorporated by reference from Exhibit 4.1 to the
Form 8-K.
4.1 Form of Warrant issued to Rosenthal & Rosenthal. Incorporated by
reference from Exhibit 4.1 to the Company's Form 8-K filed on
November 15, 2004.
4.2 Amendment Number 1 to the Certificate of Designation of the
Company's Series A 6% Convertible Non Redeemable Preferred Shares.
Incorporated by reference from Exhibit 4.2 to the Form 8-K.
9.1 Irrevocable Proxy given in favor of Jay Gelman. Incorporated by
Reference from Exhibit 9.1 to the Form 8-K.
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 for the period ended June 30, 2004, 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 by
reference from Exhibit 99.1 to the Form 8-K.
10.4 Subscription Agreement Supplement No. 1 between the Investors listed
on Schedule I thereto and Essential Reality, Inc. Incorporated 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 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 by reference from Exhibit 99.4 to the
Form 8-K.
10.7 Form of Financing Agreement issued to Rosenthal & Rosenthal.
Incorporated by reference from Exhibit 10.1 to the Company's Form
8-K filed on November 15, 2004.
10.8 Form of Security Agreement issued to Rosenthal & Rosenthal.
Incorporated by reference from Exhibit 10.2 to the Company's Form
8-K filed on November 15, 2004.
10.9 Form of Guaranty issued to Rosenthal & Rosenthal. Incorporated by
reference from Exhibit 10.3 to the Company's Form 8-K filed on
November 15, 2004.
10.10 Form of Registration Rights Agreement issued to Rosenthal &
Rosenthal. Incorporated by reference from Exhibit 10.4 to the
Company's Form 8-K filed on November 15, 2004.
11. Statement re Computation of Per Share Earnings.**
31.1* Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.1* Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
The company filed the following Current Reports on Form 8-K during the quarter
ended September 30, 2004:
1. July 2, 2004, reporting under item 5 and 7 the Company completed an
acquisition and a private placement of preferred stock and warrants.
2. July 14, 2004, reporting under items 1,2,4,5,and 7 the changes in
Control, acquisition of assets, change in accountants and other
information.
3. August 17, 2004, reporting under items 5 and 7 its second quarter
financials and other information.
4. September 1, 2004, reporting under items 5.01 and 9.01 the change in
Control and financial statements related to the acquisition reported
July 2, 2004.
* Filed herewith.
** Information required to be presented in Exhibit 11 is now provided in the
Condensed Statements of Operations on Page 4 of the financial statements.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
Company has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Essential Reality, Inc., a Nevada corporation
(Company)
Date: November 15, 2004
By: /s/ Jay Gelman
-------------------------------------
Its: Chief Executive Officer and Principal
Financial Officer
16