U.S. Securities and Exchange Commission
Washington, DC 20549
Form 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 2005
Commission File Number 0-33135
ADSOUTH PARTNERS, INC.
-----------------------------------------------------------
(Name of small business issuer as specified in its charter)
Nevada 68-0448219
------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
1515 N. Federal Highway, Suite 418, Boca Raton, FL 33432
--------------------------------------------------------------------------
(Address of principal executive offices)
(561) 750-0410
--------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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. Yes [X] No [
]
As of August 15, 2005, 2005 there are 7,660,932 shares of the par value
$.0001 common stock outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
Indicate by checkmark whether the Registrant is an accelerated filer as
defined in Rule 12b-2 of the Securities and Exchange Act of 1934. Yes [ ] No [X]
1
ADSOUTH PARTNERS, INC.
Index
PART I. FINANCIAL INFORMATION..................................................3
ITEM 1. FINANCIAL STATEMENTS...................................................3
UNAUDITED CONDENSED SECTOR STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004...................3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004...................4
UNAUDITED CONDENSED SECTOR BALANCE SHEET AS OF JUNE 30, 2005.................5-6
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 2005.............7
UNAUDITED CONDENSED SECTOR STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004.............................8
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004..........................9-10
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDERS' (DEFICIENCY) EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2005.....................................11
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS............................................12-20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.....................................21-29
ITEM 3. CONTROLS AND PROCEDURES...............................................29
PART II OTHER INFORMATION.....................................................29
ITEM 1. LEGAL PROCEEDINGS.....................................................29
ITEM 6. EXHIBITS..............................................................29
SIGNATURES....................................................................30
CERTIFICATIONS.............................................................31-33
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED SECTOR STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2004 2005 2005 2004
----------- ----------- ----------- -----------
ADVERTISING
Revenues $ 277,000 $ 1,481,000 $ 692,000 $ 1,856,000
----------- =========== =========== ===========
Cost and expenses:
Media placement and production costs 192,000 556,000 473,000 759,000
Selling, administrative and other expense
(includes stock based compensation
expense for the three months ended
June 30, 2005 and 2004 of $20,000
and $142,000, respectively, and
for the six months ended June 30,
2005 and
2004 of $43,000 and $3,328,000, respectively) 460,000 456,000 723,000 3,910,000
----------- ----------- ----------- -----------
Total costs and expenses 652,000 1,012,000 1,196,000 4,669,000
----------- ----------- ----------- -----------
Operating (loss) income- Advertising (375,000) 469,000 (504,000) (2,813,000)
Interest expense (42,000) -- (66,000) --
Loss on sale of marketable securities -- -- -- (10,000)
Loss on early debt extinguishment (179,000) -- (179,000) --
----------- ----------- ----------- -----------
Net (loss) income - Advertising (596,000) 469,000 (749,000) (2,823,000)
----------- ----------- ----------- -----------
PRODUCTS
Revenues 1,163,000 6,000 2,469,000 6,000
----------- ----------- ----------- -----------
Cost and expenses:
Cost of sales 757,000 1,000 1,302,000 1,000
Selling, administrative and other expense
(includes stock based compensation
expense for the three months ended
June 30, 2005 and 2004 of $38,000
and $71,000, respectively, and for
the six months ended June 30, 2005
and
2004 of $85,000 and $575,000, respectively) 661,000 223,000 1,117,000 816,000
----------- ----------- ----------- -----------
Total costs and expenses 1,418,000 224,000 2,419,000 817,000
----------- ----------- ----------- -----------
Operating (loss) income- Products (255,000) (218,000) 50,000 (811,000)
Discount on receivables sold to factor (24,000) -- (32,000) --
Interest expense (90,000) -- (143,000) --
Loss on early debt extinguishment (357,000) -- (357,000) --
----------- ----------- ----------- -----------
Net loss- Products (726,000) (218,000) (482,000) (811,000)
----------- ----------- ----------- -----------
TOTAL COMPANY
Net (loss) income 1,322,000) $ 251,000 (1,231,000) (3,634,000)
Deemed dividend-Series B Preferred Stock 1,344,000) -- (1,344,000) --
----------- ----------- ----------- -----------
Net (loss) income attributable
to common stockholders $ 2,666,000) $ 251,000 $(2,575,000) $(3,634,000)
=========== =========== =========== ===========
AMOUNTS PER SHARE OF COMMON STOCK (Loss)
earnings per common share:
Basic $ (0.33)$ 0.04$ (0.34) $ (0.70)
=========== =========== ===========
Diluted $ (0.33)$ 0.04$ (0.34) $ (0.70)
=========== =========== ===========
Weighted average number of common shares 8,009,101 5,809,766 7,499,195 5,179,164
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenues:
Advertising $ 277,000 $ 1,481,000 $ 692,000 $ 1,856,000
Products 1,163,000 6,000 2,469,000 6,000
----------- ----------- ----------- -----------
Total revenues 1,440,000 1,487,000 3,161,000 1,862,000
----------- ----------- ----------- -----------
Cost and expenses:
Media placement and production costs 192,000 556,000 473,000 759,000
Cost of sales 757,000 1,000 1,302,000 1,000
Selling, administrative and other expense
(Includes stock based compensation
expense for the three months ended
June 30, 2005 and 2004 of $58,000
and $213,000, respectively, and for
the six months ended June 30, 2005
and 2004 of $128,000 and $3,903,000
respectively) 1,121,000 679,000 1,840,000 4,726,000
----------- ----------- ----------- -----------
Total costs and expenses 2,070,000 1,236,000 3,615,000 5,486,000
----------- ----------- ----------- -----------
Operating (loss) income (630,000) 251,000 (454,000) (3,624,000)
Loss on sale of marketable securities -- -- -- (10,000)
Discount on receivables sold to factor (24,000) -- (32,000) --
Interest expense (132,000) -- (209,000) --
Loss on early debt extinguishment (536,000) -- (536,000) --
----------- ----------- ----------- -----------
Net (loss) income (1,322,000) $ 251,000 (1,231,000) (3,634,000)
Deemed dividend-Series B Preferred Stock (1,344,000) -- (1,344,000) --
----------- ----------- ----------- -----------
Net (loss) income attributable
to common stockholders $(2,666,000) $ 251,000 $(2,575,000) $(3,634,000)
=========== =========== =========== ===========
AMOUNTS PER SHARE OF COMMON STOCK (Loss)
earnings per common share:
Basic $ (0.33) $ 0.04 $ (0.34) $ (0.70)
=========== =========== ===========
Diluted $ (0.33) $ 0.04 $ (0.34) $ (0.70)
=========== =========== ===========
Weighted average number of common shares 8,009,101 5,809,766 7,499,195 5,179,164
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED SECTOR BALANCE SHEET
--------------------------------------------------------------------------------
June 30,
2 0 0 5
Assets:
ADVERTISING
Current Assets:
Cash $ 625,000
Certificate of deposit (restricted) 102,000
Accounts receivable, net 91,000
Marketable securities 76,000
Current portion of deferred charge, related party 67,000
Prepaid expense and other current assets 8,000
-----------
Total Current Assets-Advertising 969,000
Property and equipment, net 92,000
Deferred charge, related party 133,000
Deposits 9,000
------------
Total Assets-Advertising 1,203,000
-----------
PRODUCTS
Current Assets:
Cash 34,000
Accounts receivable, net 676,000
Due from factor 101,000
Inventory 619,000
Prepaid expense and other current assets 219,000
------------
Total Current Assets-Products 1,649,000
-
Property and equipment, net 26,000
Investment in product line rights, net 171,000
Deposits 5,000
------------
Total Assets-Products 1,851,000
------------
Total Assets $ 3,054,000
============
Liabilities and Stockholders' Equity
ADVERTISING
Current Liabilities:
Accounts payable $ 68,000
Accrued salaries and payroll taxes 38,000
Accrued expenses and other current liabilities 1,000
Current portion of notes payable 2,000
Current portion of capital lease obligations 3,000
------------
Total Current Liabilities - Advertising 112,000
Notes payable, net of current portion 4,000
Capital lease obligations, net of current portion 13,000
------------
Total Liabilities - Advertising 129,000
------------
PRODUCTS
Current Liabilities:
Accounts payable 842,000
Accrued salaries and payroll taxes 108,000
Accrued expenses and other current liabilities 77,000
Bank line of credit 100,000
Current portion of notes payable 4,000
Current portion of capital lease obligations 1,000
------------
Total Current Liabilities - Advertising 1,132,000
Notes payable, net of current portion 9,000
Capital lease obligations, net of current portion 3,000
------------
Total Liabilities - Products 1,144,000
------------
Total Liabilities 1,273,000
------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED SECTOR BALANCE SHEET
--------------------------------------------------------------------------------
June 30,
2 0 0 5
Commitments and contingencies (see Note 8)
Stockholders' Equity:
Preferred stock, $.0001 par value; 5,000,000 shares authorized,
3,500,000 designated as Series A Convertible Preferred Stock,
1,500,000 designated as Series B Convertible Preferred Stock,
1,226,557 shares of Series B Preferred Stock issued and
outstanding as of June 30, 2005 --
Common stock, $.0001 par value; 33,333,333 shares authorized;
7,660,932 issued and outstanding as of June 30, 2005 1,000
Additional paid-in-capital 9,520,000
Note receivable, stockholder (20,000)
Deferred compensation (580,000)
Accumulated deficit (7,042,000)
Accumulated other comprehensive loss:
Unrealized loss from available-for-sale securities (98,000)
-----------
Total Stockholders' Equity 1,781,000
-----------
Total Liabilities and Stockholders' Equity $ 3,054,000
===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
--------------------------------------------------------------------------------
June 30,
2 0 0 5
Assets:
Current Assets:
Cash $ 659,000
Certificate of deposit (restricted) 102,000
Accounts receivable, net 767,000
Due from factor 101,000
Inventory 619,000
Marketable securities 76,000
Current portion of deferred charge, related party 67,000
Prepaid expense and other current assets 227,000
-----------
Total Current Assets 2,618,000
Property and equipment, net 118,000
Deferred charge, related party 133,000
Investment in product line rights, net 171,000
Deposits 14,000
------------
Total Assets $ 3,054,000
============
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 910,000
Accrued salaries and payroll taxes 146,000
Accrued expenses and other current liabilities 78,000
Bank line of credit 100,000
Current portion of notes payable 6,000
Current portion of capital lease obligations 4,000
------------
Total Current Liabilities 1,244,000
Notes payable, net of current portion 13,000
Capital lease obligations, net of current portion 16,000
------------
Total Liabilities 1,273,000
------------
Commitments and contingencies (see Note 8)
Stockholders' Equity:
Preferred stock, $.0001 par value; 5,000,000 shares authorized,
3,500,000 designated as Series A Convertible Preferred Stock,
1,500,000 designated as Series B Convertible Preferred Stock,
1,226,557 shares of Series B Preferred Stock issued and
outstanding as of June 30, 2005 --
Common stock, $.0001 par value; 33,333,333 shares authorized;
7,660,932 issued and outstanding as of June 30, 2005 1,000
Additional paid-in-capital 9,520,000
Note receivable, stockholder (20,000)
Deferred compensation (580,000)
Accumulated deficit (7,042,000)
Accumulated other comprehensive loss:
Unrealized loss from available-for-sale securities (98,000)
-----------
Total Stockholders' Equity 1,781,000
-----------
Total Liabilities and Stockholders' Equity $ 3,054,000
===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
7
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
--------------------------------------------------------------------------------
Six Months Ended Six Months Ended
June 30, June 30,
2 0 0 5 2 0 0 5 2 0 0 4 2 0 0 4
----------- ----------- ----------- -----------
Advertising Products Advertising Products
----------- ----------- ----------- -----------
Products
CASH FLOWS-OPERATING ACTIVITIES
Net loss $ (749,000) $ (482,000) $(2,823,000) $ (811,000)
Adjustments to reconcile net loss
to net cash - operating activities:
Amortization of deferred stock
based compensation 43,000 85,000 3,328,000 575,000
Depreciation 7,000 3,000 2,000 1,000
Amortization of product line rights -- 26,000 -- --
Amortization of debt discount on
convertible notes 53,000 107,000 -- --
Bad debt expense 2,000 -- -- --
Loss from sale of marketable securities -- -- 10,000 --
Loss on early debt extinguishment 178,000 358,000 -- --
Other operating adjustments -- -- (4,000) --
Changes in assets and liabilities:
Accounts receivable (93,000) (640,000) (154,000) (1,000)
Inventory -- (433,000) -- (71,000)
Prepaid expense and other current assets (7,000) (187,000) (467,000) (46,000)
Deferred charge, related party (200,000) -- -- --
Accounts payable (37,000) 475,000 120,000 71,000
Accrued salaries and payroll taxes (205,000) 90,000 40,000 --
Accrued expenses (47,000) 29,000 5,000 --
----------- ----------- ----------- -----------
Net cash - operating activities (1,055,000) (569,000) 57,000 (282,000)
----------- ----------- ----------- -----------
CASH FLOWS - INVESTING ACTIVITIES
Capital expenditures (34,000) (17,000) (31,000) (24,000)
Investment in product line rights -- -- -- (125,000)
Deposits (1,000) (1,000) (7,000) (4,000)
Acquisition of marketable securities -- -- (246,000) --
Proceeds from sale of marketable securities -- -- 236,000 --
Other investing activities (1,000) -- -- --
----------- ----------- -----------
Net cash - investing activities (36,000 (18,000) (48,000) (153,000)
----------- ----------- -----------
CASH FLOWS - FINANCING ACTIVITIES
Deferred financing costs (80,000) (160,000) -- --
Capital lease payments (2,000) -- -- --
Proceeds from notes payable 7,000 13,000 -- --
Repayment of notes payable -- (251,000) -- --
Proceeds from bank line-of-credit -- 100,000 -- --
Repayments on bank line-of-credit -- 100,000 -- --
Due from factor -- (216,000) -- --
Proceeds from the exercise of
stock options and warrants 33,000 107,000 -- --
Proceeds from issuance of common stock -- -- 107,000 444,000
Proceeds from issuance of convertible notes 487,000 973,000 -- --
Repayment of convertible notes (257,000) (513,000) -- --
Cash proceeds from issuance
of preferred stock 1,603,000 897,000 -- --
Offering costs (114,000) (228,000) -- --
----------- ----------- -----------
Net cash - financing activities 1,677,000 622,000 107,000 444,000
-------------------------------------------------------- ----------- ----------- ----------- -----------
Net change in cash 587,000 34,000 116,000 9,000
Cash - beginning of period 38,000 -- 16,000 --
----------- ----------- ----------- -----------
Cash - end of period $ 625,000 $ 34,000 $ 132,000 $ 9,000
=========== =========== =========== ===========
SUPPLEMENTAL CASH FLOW
INFORMATION Cash during the periods for:
Interest expense $ 9,000 $ 29,000 $ -- $ --
----------- ----------- ----------- -----------
Income taxes $ -- $ -- $ -- $ --
----------- ----------- ----------- -----------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
Continued
8
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
--------------------------------------------------------------------------------
Six Months Ended
June 30,
2 0 0 5 2 0 0 4
------- -------
CASH FLOWS-OPERATING ACTIVIITES
Net loss $(1,231,000) $(3,634,000)
Adjustments to reconcile net loss
to net cash - operating activities:
Amortization of deferred stock
based compensation 128,000 3,903,000
Depreciation 10,000 3,000
Amortization of product line rights 26,000 --
Amortization of debt discount on
convertible notes 160,000 --
Bad debt expense 2,000 --
Loss from sale of marketable securities -- 10,000
Loss on early debt extinguishment 536,00 --
Other operating adjustments -- --
Changes in assets and liabilities: (4,000)
Accounts receivable (733,000) (155,000)
Inventory (433,000) (71,000)
Prepaid expense and other current assets (194,000) (513,000)
Deferred charge, related party (200,000) --
Accounts payable 438,000 191,000
Accrued salaries and payroll taxes (115,000) 40,000
Accrued expenses (18,000) 5,000
----------- -----------
Net cash - operating activities (1,624,000) (225,000)
----------- -----------
CASH FLOWS - INVESTING ACTIVITIES
Capital expenditures (51,000) (55,000)
Investment in product line rights -- (125,000)
Deposits (2,000) --
Acquisition of marketable securities -- (246,000)
Proceeds from sale of marketable securities -- 236,000
Other investing activities (1,000) (11,000)
----------- -----------
Net cash - investing activities (54,000) (201,000)
----------- -----------
CASH FLOWS - FINANCING ACTIVITIES
Deferred financing costs (240,000) --
Capital lease payments (2,000) --
Proceeds from notes payable 20,000 --
Repayment of notes payable (251,000) --
Proceeds from bank line-of-credit 100,000 --
Repayments on bank line-of-credit (100,000) --
Due from factor (216,000) --
Proceeds from the exercise of
stock options and warrants 140,000 --
Proceeds from issuance of common stock -- 551,000
Proceeds from issuance of convertible notes 1,460,000
Repayment of convertible notes (770,000)
Cash proceeds from issuance of preferred stock 2,500,000 --
Offering costs (342,000)
----------- -----------
Net cash - financing activities 2,299,000 551,000
----------- -----------
Net change in cash 621,000 125,000
Cash - beginning of period 38,000 16,000
----------- -----------
Cash - end of period $ 659,000 $ 141,000
=========== ===========
SUPPLEMENTAL CASH FLOW
INFORMATION Cash during the periods for:
Interest expense $ 38,000 $ --
----------- -----------
Income taxes $ -- $ --
----------- -----------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
9
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN (CAPITAL DEFICIENCY)
STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF NON CASH INVESTING AND FINANCING ACTIVITIES
During the Six Months Ended June 30, 2005
In January 2005 the Company issued 63,333 shares of common stock valued at
$83,000 to acquire the assets of the Miko Brand.
On February 17, 2005, the Company issued warrants as part of a fee paid in
connection with the issuance of convertible notes. The value of the warrants
approximated $145,000 and was capitalized as a deferred financing cost.
On May 16, 2005, the Company issued warrants as part of a fee paid in
connection with the issuance of convertible notes. The value of the warrants
approximated $61,000 and was capitalized as a deferred financing cost.
On June 17, 2005, the Company issued 300,633 shares of Series B
Convertible Preferred stock in exchange for $800,000 of convertible notes and
$12,000 of interest accrued thereon.
During 2005, the Company issued options to consultants which, using the
Black-Scholes option valuation formula, had an aggregate value of $708,000,
which was recorded as an increase to deferred compensation expense. Such
deferred compensation expense is being amortized pursuant to the terms of the
underlying consulting agreement to which the related options were issued.
During the Six Months Ended June 30, 2004
On March 31, 2004, the Company sold 333,333 shares of common stock to a
related party for $1,000,000 of which $650,000 was paid with the issuance of a
promissory note. On June 23, 2004, 145,363 of such shares were returned in
cancellation of $635,000 of the related promissory note.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
10
ADSOUTH PARTNERS, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN (CAPITAL DEFICIENCY)
STOCKHOLDERS' EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
Series B
Preferred Common
Stock, Stock, Preferred Common Additional Note
Issued and Issued and Stock, Stock, Paid-in Deferred Receivable
Outstanding Outstanding Par Value Par Value Capital Compensation Stock-holder
--------------------------------------------------------------------------------------------------------------------------------
Balance at -- 6,002,214 -- -- $5,274,000 -- ($20,000)
December 31, 2004
Comprehensive loss:
Net loss -- -- -- -- -- --
Unrealized loss from
available-for-sale
securities -- -- -- -- -- -- --
Comprehensive loss
Stock issued to acquire the -- 63,333 -- -- 83,000 -- --
Miko Brand assets
Securities issued in
conjunction
with the issuance of the
convertible notes -- 1,891,033 -- 1,000 1,077,000 -- --
Securities returned upon the
early extinguishment of
the convertible notes -- (570,833) -- -- (936,000) -- --
Issuance of Series B
Convertible Preferred Stock 1,226,557 -- -- -- 3,312,000 -- --
Offering costs -- -- -- -- (343,000) -- --
Grant of stock options to
consultants -- - -- -- 708,000 ($708,000) --
Grant of warrants for
placement fees -- - -- -- 205,000 -- --
Exercise of stock options
and
warrants -- 275,185 -- -- 140,000 -- --
Amortization of deferred
stock
based compensation -- - -- -- -- 128,000 --
--------------------------------------------------------------------------------------------------------------------------------
Balance at 1,226,557 7,660,932 -- $1,000 $9,520,000 ($580,000) ($20,000)
June 30, 2005
--------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Accumulated Comprehensive Comprehensive
Deficit Loss Total Loss
-------------------------------------------------------------------------------------------
Balance at ($5,811,000) -- ($557,000)
December 31, 2004
Comprehensive loss:
Net loss (1,231,000) -- (1,231,000) ($1,231,000)
Unrealized loss from
available-for-sale
securities -- ($98,000) (98,000) (98,000)
-------------
Comprehensive loss -- $1,329,000
-------------
Stock issued to acquire the -- -- 83,000
Miko Brand assets
Securities issued in
conjunction
with the issuance of the
convertible notes -- -- 1,078,000
Securities returned upon the
early extinguishment of
the convertible notes -- -- (936,000)
Issuance of Series B
Convertible Preferred Stock -- 3,312,000
Offering costs -- -- (343,000)
Grant of stock options to
consultants -- -- --
Grant of warrants for
placement fees -- -- 205,000
Exercise of stock options
and
warrants -- -- 140,000
Amortization of deferred
stock
based compensation -- -- 128,000
---------------------------------------------------------------------------
Balance at ($7,042,000) ($98,000) $1,781,000
June 30, 2005
---------------------------------------------------------------------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
11
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Adsouth Partners, Inc. and its wholly owned subsidiaries Adsouth, Inc.,
Dermafresh, Inc. and Miko Distributors, Inc., (collectively the "Company") have
been prepared in accordance with Regulation S-B promulgated by the Securities
and Exchange Commission and do not include all of the information and footnotes
required by generally accepted accounting principles in the United States of
America for complete financial statements. In the opinion of management, these
interim financial statements include all adjustments, which include only normal
recurring adjustments, necessary in order to make the financial statements not
misleading. The results of operations for such interim periods are not
necessarily indicative of results of operations for a full year. The unaudited
condensed consolidated financial statements should be read in conjunction with
the audited financial statements and notes thereto of Adsouth Partners, Inc.
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2004.
On March 25, 2005, the Company effected a one-for-fifteen share reverse
split of the Company's common stock, par value $.0001 per share ("Common Stock")
and a proportionate reduction of the authorized shares outstanding.
Contemporaneously with the reverse split, the reverse split, the number of
authorized shares of Common Stock, par value $.0001 per share was reduced
500,000,000 shares to 33,333,333 shares. All share information and per share
amounts presented in these consolidated financial statements are presented as if
the aforementioned reverse split was effective for all periods presented.
2. Certain Significant Accounting Policies
The accounting policies followed by the Company are set forth in Note 1 to
the Adsouth Partners, Inc. financial statements included in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2004.
(a) Basic and Diluted Income (Loss) Per Share
Basic and diluted per share results for the three and six months ended
June 30, 2005 and 2004 were computed based on the net income allocated to the
Common Stock for the respective period. The weighted average number of shares of
Common Stock outstanding during the period was used in the calculation of basic
earnings per share. In accordance with FAS 128, "Earnings Per Share," the
weighted average number of shares of Common Stock used in the calculation of
diluted per share amounts is adjusted for the dilutive effects of potential
common shares including, (i) the assumed exercise of stock options and warrants
based on the treasury stock method; and (ii) the assumed conversion of
convertible preferred stock only if an entity records earnings from continuing
operations, as such adjustments would otherwise be anti-dilutive to earnings per
share from continuing operations.
For the three months ended June 30, 2004 a portion of such potential
common shares were dilutive. The following table presents a reconciliation of
basic earnings per common share to dilutive earnings per common share.
Weighted Net
Average Income
Shares Per
Three Months Ended June 30, 2004 Net Income Outstanding Share
---------------------------------------------------------------------
Basic earnings per common share $251,000 5,809,766 $.04
Assumed conversion of options and
warrants -- 273,810 *
---------------------------------------------------------------------
Diluted earnings per common share $251,000 6,083,576 $.04
=====================================================================
* - less than $.01
During the three and six months ended June 30, 2005 and the six months
ended June 30, 2004, the Company recorded a loss and as a result, the average
number of common shares used in the calculation of basic and diluted loss per
share is identical and have not been adjusted for the effects of potential
common shares from unexercised stock options, warrants and convertible preferred
stock which were anti-dilutive for such time period. As of June 30, 2005, there
were outstanding options to purchase 4,628,630 shares of common stock, warrants
to purchase 12,954,868 shares of common stock and Series B Preferred stock
convertible into 11,039,016 shares of common stock.
12
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
2. Certain Significant Accounting Policies (continued)
(b) Stock Based Compensation
The Company has elected to use the intrinsic value method of accounting
for stock options in accordance with APB Opinion No. 25 and related
interpretations issued to employees under its stock option plans whereby the
amount of stock-based compensation expense is calculated as the difference
between the fair market value and the exercise price on the date of issuance.
For purposes of pro forma disclosures the amount of stock-based compensation as
calculated using the fair value method of accounting for stock options issued to
employees is amortized over the options' vesting period. The Company's pro forma
information is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2 0 0 5 2 0 0 4 2 0 0 5 2 0 0 4
--------------- --------------- --------------- ---------------
Net (loss) income attributable to
common stockholders $ (2,666,000) $ 251,000 $ (2,575,000) $ (3,634,000)
Deduct: Stock-based employee compensation
as determined under the fair value method (3,000) -- (22,000) (19,000)
--------------- --------------- --------------- ---------------
Pro forma net (loss) income attributable
to common stockholders $ (2,669,000) $ 251,000 $ (2,597,000) $ (3,653,000)
=============== =============== =============== ===============
Basic (loss) earnings per common share
attributable to common stockholders:
As reported $ (0.33) $ 0.04 $ (0.34) $ (0.70)
=============== =============== =============== ===============
Pro forma $ (0.33) $ 0.04 $ (0.35) $ (0.71)
=============== =============== =============== ===============
Diluted (loss) earnings per common share
attributable to common stockholders:
As reported $ (0.33) $ 0.04 $ (0.34) $ (0.70)
=============== =============== =============== ===============
Pro forma $ (0.33) $ 0.04 $ (0.35) $ (0.71)
=============== =============== =============== ===============
(c) Factored Receivables
On September 22, 2004, the Company and a factoring company executed an
Account Transfer and Purchase Agreement pursuant to which the Company may sell
qualified receivables without recourse to the Company. The Company pays a fixed
discount of 1% of the gross amount of any receivables sold and is advanced 80%
of the gross amount of such receivables (the "Initial Payment") and the
remaining 20% of the gross amount of any receivables sold is held as a reserve
by the factoring company until such time as the receivable is collected by the
factoring company. The Company pays a variable discount of a base rate, as
quoted from time to time by the factoring company, plus 2% on the Initial
Payment for the period of time that the Initial Payment remains outstanding. The
effective rate of the variable discount as of June 30, 2005 was 7.75%. During
the three and six months ended June 30, 2005, the Company sold $1,045,000 and
$1,366,000, respectively, of receivables and the total fixed and variable
discounts on receivables sold was $24,000 and $32,000, respectively.
(d) Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk include cash and accounts receivable. As of June
30, 2005, all of the Company's cash is placed with high credit quality financial
institutions. The amount on deposit in any one institution that exceeds
federally insured limits is subject to credit risk. As of June 30, 2005 the
Company has $540,000 cash on deposit in excess of federally insured limits.
During the three months ended June 30, 2005, 22%, 17 %, 10% and 10% of the
Company's total revenues were derived from Wal-Mart Store, Inc., CVS
Corporation, General Nutrition Distribution, L.P. and Brooks Pharmacy,
respectively. During the six months ended June 30, 2005, 23%, 21 % and 12% of
the Company's total revenues were derived from Wal-Mart Store, Inc., CVS
Corporation and SinoFresh Healthcare, Inc., respectively. During the three and
six months ended June 30, 2004 89% and 84%, respectively, of the Company's
revenues were derived from Gameznflix, Inc. At June 30, 2005, 49%, 25% and 11%
of the Company's accounts receivable were due from Wal-Mart Store, Inc., CVS
Corporation and NVE Pharmaceuticals, Inc., respectively. The Company does not
require collateral to support accounts receivable or financial instruments
subject to credit risk.
13
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
2. Certain Significant Accounting Policies (continued)
(e) New Authoritative Guidance
In October 2004, the Financial Accounting Standards Board ("FASB")
ratified the consensus reached in Emerging Issues Task Forces ("EITF") Issue No.
04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings Per
Shares." The EITF states that contingently convertible instruments, such as
contingently convertible debt, contingently convertible preferred stock, and
other such securities should be included in diluted earnings per share (if
dilutive) regardless of whether the market price trigger has been met. The
consensus became effective for reporting periods ending after December 15, 2004.
The adoption of this pronouncement did not have an effect on the Company's
financial statements for the three and six months ended June 30, 2005 as such
convertible instruments would have been anti-dilutive. Such convertible
instruments may dilute earnings per share, if any, in the future.
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 "Accounting Changes and Error Corrections" ("SFAS 154"). SFAS 154
changes the requirements for the accounting for the accounting for and reporting
of a change in accounting principle. SFAS 154 requires that the cumulative
effect of voluntarily changing to a new accounting principle be applied
retrospectively to prior period financial statements. Prior to the effective
date of SFAS 154, the cumulative effect of voluntarily changing to a new
accounting principle was included in the operating results of the period in
which such change was adopted. SFAS 154 is effective for fiscal years beginning
after December 15, 2005. The Company expects that the adoption of SFAS 154 will
not have a significant impact on its financial statements.
3. Private Placements
(a) Convertible Debentures
On February 17 and 22, 2005, the Company completed a private placement of
its securities with ten accredited investors (the "February Private Placement")
pursuant to which, the Company sold, for $810,100, (i) its 10% convertible notes
due December 2006 in the aggregate principal amount of $810,100, (ii) 1,620,200
shares of Common Stock, and (iii) warrants to purchase 675,083 shares of Common
Stock at an exercise price of $1.28 per share. The notes are convertible into
Common Stock at the fixed conversion price of $.60 per share at any time. Atlas
Capital Services, LLC served as placement agent for the financing. As
compensation for its services as placement agent, the Company paid Atlas a fee
of 10% of the gross proceeds raised in the private placement, warrants to
purchase 135,017 shares of Common Stock at an exercise price of $.60 per share.
The Company also paid the subscribers' legal expenses. In connection with the
Company's engagement of Atlas, it issued to Atlas an option to purchase 33,333
shares of Common Stock for nominal consideration. This option was exercised at
or about the closing of the private placement.
On May 16, 2005 and May 20, 2005, the Company completed a private
placement of its securities with two accredited investors (the "May Private
Placement") pursuant to which the Company sold, for $650,000, (i) its 12%
secured convertible notes due March 15, 2007 in the aggregate principal amount
of $650,000, (ii) 270,833 shares of Common Stock, and (iii) warrants to purchase
812,500 shares of Common Stock at an exercise price of $1.275 per share. The
notes are convertible into Common Stock at the fixed conversion price of $.60
per share at any time. In connection with the placement, the Company paid fees
equal to 10% of the gross proceeds raised in the private placement and warrants
to purchase 125,000 shares of Common Stock at an exercise price of $.48 per
share. The Company also reimbursed the investors for legal fees and expenses of
$10,000.
14
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
3. Private Placements (continued)
(a) Convertible Debentures (continued)
The closing costs related to the issuance of the convertible notes were
$445,000 including legal fees, broker fees and the value of broker warrants
issued pursuant to the convertible note offerings. The deferred offering costs
were being amortized on a straight-line basis over the period in which the
convertible notes were outstanding. On June 17, 2005, the Company paid a total
of $792,120 to the holders of the convertible notes in the principal amount of
$660,100. The subscription agreements relating to the issuance of the notes
gives the Company the right to redeem the notes at a premium and gives the
holders of the notes the right to demand redemption of the notes at a premium.
In connection with the payment, the note holders also cancelled warrants to
purchase 550,087 shares of Common Stock. On June 17, 2005, note holders
exchanged a total of $800,000 of principal and $12,000 of accrued interest for
shares of the Series B Preferred Stock. In connection with the exchange, the
note holders also cancelled warrants to purchase 937,500 shares of Common Stock
and returned 570,833 shares of common stock. As a result of the payment and
exchange of this debt the Company incurred a loss of $536,000 from the early
extinguishment of the convertible notes which includes the unamortized balance
of the deferred offering costs.
(b) Series B. Preferred Stock
On June 16, 2005, the Company created the Series B Preferred Stock. The
certificate of designation provides that:
o Each share of Series B Preferred Stock is convertible into nine
shares of Common Stock.
o If, within two years after the closing, the Company issues Common
Stock or options, warrants or other convertible securities at a
price or with a conversion or exercise price less than the
conversion price (initially $.30), with certain specified
exceptions, the number of shares issuable upon conversion of one
share of Series B Preferred Stock is adjusted, using a weighted
average formula, to reflect such issuance.
o No dividends are payable with respect to the Series B Preferred
Stock.
o While the Series B Preferred Stock is outstanding, the Company may
not pay dividends on or redeem shares of Common Stock.
o Upon any voluntary or involuntary liquidation, dissolution or
winding-up, the holders of the Series B Preferred Stock are entitled
to a preference of $2.70 per share before any distributions or
payments may be made with respect to the Common Stock or any other
class or series of capital stock which is junior to the Series B
Preferred Stock upon voluntary or involuntary liquidation,
dissolution or winding-up.
o The holders of the Series B Preferred Stock have no voting rights.
o Without the approval of the holders of 75% of the Series B Preferred
Stock, the Company will not (a) alter or change the powers,
preferences or rights given to the Series B Preferred Stock or alter
or amend the Certificate of Designation relating to the Series B
Preferred Stock, (b) authorize or create any class of stock ranking
as to dividends or distribution of assets upon a liquidation senior
to or otherwise pari passu with the Series B Preferred Stock, or any
class or series of preferred stock possessing greater voting rights
or the right to convert at a more favorable price than the Series B
Preferred Stock, (c) amend its certificate or articles of
incorporation or other charter documents in breach of any of the
provisions hereof, (d) increase the authorized number of shares of
Series B Preferred Stock, or (e) enter into any agreement with
respect to the foregoing.
The holders of the Series B Preferred Stock may not convert the Series B
Preferred Stock to the extent that such conversion would result in the holders
owning more than 4.9% of the outstanding Common Stock. This limitation may not
be amended without the consent of the holders of a majority of the outstanding
Common Stock.
15
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
3. Private Placements (continued)
(c) Private Placement of Series B. Preferred Stock
On June 17, 2005, the Company completed a private placement of its Series
B Preferred Stock with Common Stock purchase warrants pursuant to a purchase
agreement with Barron Partners, LP, Vestal Venture Capital and Richard Molinsky
(the "June Private Placement"). Pursuant to the purchase agreement:
o Barron Partners purchased 925,926 shares of Series B Preferred Stock
and warrants to purchase 9,058,780 shares of the Common Stock for a
purchase price of $2,500,000;
o Vestal received 281,942 shares of Series B Preferred Stock and
warrants to purchase 2,758,378 shares of Common Stock in exchange
for the cancellation of (i) principal and interest on the Company's
promissory notes payable to Vestal in the total principal amount of
$750,000, (ii) warrants to purchase a total of 875,000 shares of
Common Stock, and (iii) 550,000 shares of Common Stock, all of which
were issued to Vestal in the Company's February and May 2005 private
placements.
o Mr. Molinsky received 18,689 shares of Series B Preferred Stock and
warrants to purchase 182,842 shares of Common Stock in exchange for
the cancellation of (i) principal and interest on the Company's
promissory note payable to him in the principal amount of $50,000,
(ii) warrants to purchase a total of 62,500 shares of Common Stock,
and (iii) 20,833 shares of Common Stock, all of which were issued to
Mr. Molinsky in the Company's May 2005 private placement.
o Additional shares of Series B Preferred Stock are to be issued to
the investors if the Company's fully-diluted earnings per share of
Common Stock, computed as provided in the purchase agreement which
excludes certain non-recurring expenses, is $.167 or less for the
year ending December 31, 2005
o The Company agreed that, within 45 days from the closing date, June
17, 2005, it will have appointed such number of independent
directors that would result in a majority of its directors being
independent directors, that the audit committee would be composed
solely of independent directors and the compensation committee would
have a majority of independent directors. Failure of the Company to
meet these requirements would results in the payment of liquidated
damages that are to be paid by the issuance of additional shares of
Series B Preferred Stock. On August 1, 2005, the Company received an
extension until August 10, 2005 to appoint such directors and as of
such date has complied with such requirement.
o The Company and the investors entered into a registration rights
agreement pursuant to which the Company agreed to file, within 30
days after the closing, a registration statement covering the Common
Stock issuable upon conversion of the Series B Preferred Stock and
exercise of the warrants. The failure of the Company to meet this
schedule and other timetables provided in the registration rights
agreement would result in the imposition of liquidated damages. The
Company obtained from the investors, an extension until July 25,
2005 to file the registration statement. The registration statement
became effective on August 3, 2005.
Mr. John C. Cammarano, Jr., president and, effective June 17, 2005, chief
executive officer, and Mr. Anton Lee Wingeier, chief financial officer, each
agreed that (i) he would not publicly sell any shares of the Company's Common
Stock during the two-year period commencing on the date of the purchase
agreement, (ii) notwithstanding any contrary provisions of any employment
agreement or other understanding, he will not receive any bonus except for a
bonus based on growth in earnings per share as determined by a compensation
committee of the board of directors the majority of members of which are
independent directors and (iii) in the event of a termination of his employment,
other than a termination by us that is not for cause or as a result of his death
or disability, his severance will not exceed one year's compensation.
16
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
3. Private Placements (continued)
(c) Private Placement of Series B. Preferred Stock (continued)
o The Company's board of directors approved and agreed to submit to
the Company's stockholders for their approval, an amendment to the
Company's articles of incorporation to (i) eliminate the Series A
Convertible Preferred Stock and give the board of directors the
right to determine the rights, preferences, privileges and
limitations of the 3,500,000 shares of preferred stock presently
designated as Series A Convertible Preferred Stock and (ii) increase
the number of authorized shares of preferred stock to 10,000,000
shares and increase the number of authorized shares of Common Stock
to 60,000,000 shares.
o The Company agreed that, upon the effectiveness of the increase in
the authorized preferred stock, it would increase the number of
authorized shares of Series B Preferred Stock from 1,500,000 shares
to 3,000,000 shares. The investors agreed to consent to such
increase.
The warrants issued to the investors have a term of five years, commencing
June 17, 2005, and have exercise prices of $.65 as to 2,500,000 shares, $1.20 as
to 2,500,000 shares, $1.50 as to 3,500,000 shares and $1.80 as to 3,500,000. If,
while the warrants are outstanding, the Company issues Common Stock or options,
warrants or other convertible securities at a price or with a conversion or
exercise price less than the exercise price, with certain specified exceptions,
the exercise price of the warrants will be reduced using a weighted average
formula, to reflect such issuance. The reduction in the exercise price pursuant
to this provision will not result in an increase in the number of shares of
Common Stock issuable upon such exercise.
Atlas Capital Services, LLC served as placement agent for the financing.
As compensation for its services as placement agent, the Company paid Atlas a
fee of $125,000 and issued to Atlas and its designees warrants to purchase
300,000 shares of Common Stock at $.30 per share. Liberty Company Financial, LLC
served as financial advisor to Barron, and the Company paid Liberty Company
Financial a fee of $125,000 and issued to Liberty warrants to purchase 333,333
shares of Common Stock at $.30 per share. The Company also reimbursed Barron
Partners for its legal fees and other expenses in the amount of $50,000.
The Company determined that the Series B Preferred stock was issued with
an effective beneficial conversion feature of approximately $1,344,000 based
upon the relative fair values of the underlying securities issued. As such, this
beneficial conversion feature is recorded as a deemed preferred stock dividend.
4. Acquisition of Miko Brand
On January 13, 2005, the Company executed an asset purchase agreement to
acquire assets of Miko Brands, LLC. The Miko Brand products consist of a line of
marinade and dressing sauces. Pursuant to the asset purchase agreement, the
Company issued 63,333 shares of Common Stock having a fair value of $83,000 to
the sole member of Miko Brands, LLC. In conjunction with the acquisition of the
Miko Brand, the Company entered into a two year consulting agreement with Miko's
sole member pursuant to which the Company granted to him an option to purchase
26,667 shares of Common Stock for $1.31 per share, being the fair market value
on the date of grant. In addition, the Company entered into a manufacturing
license agreement with an entity formed by Miko's sole member which grants that
entity certain manufacturing rights for the Miko brand.
17
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
5. Deferred Compensation
As discussed in Note 3, on January 13, 2005, the Company granted an option
to the former owner of the Miko Brand to purchase 26,667 shares of Common Stock
for $1.31 per share, and on January 25, 2005, granted to a consultant, pursuant
to a three month financial services consulting agreement, an option to purchase
185,185 shares of Common Stock for $.60 per share, which was exercised on
January 26, 2005. On April 13, 2005, the Company entered into a one year
investors relations consulting agreement pursuant to which the Company will pay
the consultant $7,000 per month and granted the firm an option to purchase
200,000 shares of Common Stock for $.788 per share, the market price on the date
of grant, pursuant to the 2005 Stock Option Plan. On June 17, 2005, pursuant to
a consulting agreement dated that date and which replaced an employment
agreement, the Company issued to a principal stockholder and former chief
executive officer of the Company, an option to purchase 2,000,000 shares of
Common Stock at $.65 per share (see Note 8.(a)). Using the Black-Scholes option
valuation formula, these option grants were valued at an aggregate of $708,000
of which $58,000 and $128,000 was expensed during the three and six months ended
June 30, 2005, respectively.
6. 2005 Stock Option Plan
On April 13, 2005 the Company's board of directors adopted and on June 16,
2005, the board of directors amended and restated the 2005 Long-Term Incentive
Plan covering 1,870,000 share of common stock (the "2005 Plan"). The 2005 Plan
provides for the grant of incentive and non-qualified options, stock grants,
stock appreciation rights and other equity-based incentives to employees,
including officers, and consultants. The 2005 Plan is to be administered by a
committee of three directors of which a majority is to be independent directors.
In the absence of a committee, the plan is administered by the board of
directors. Independent directors are not eligible for discretionary options.
Each newly elected independent director receives, at the time of his election, a
five-year option to purchase 50,000 shares of common stock at the market price
on the date of his or her election. In addition, the plan provides for the
annual grant of an option to purchase 10,000 shares of common stock on April 1st
of each year, commencing April 1, 2006 to each independent director. Pursuant to
the 2005 Plan, the Company granted options to purchase an aggregate of 798,628
shares of common stock as of June 30, 2005, including options to purchase 49,314
shares of common stock which vested upon issuance and were issued to each of the
former chief executive officer and chief financial officer pursuant to their
employment agreements and an option which vests evenly over the related three
year employment term to purchase 500,000 shares of common stock to a key
marketing executive.
7. Segment Information
The Company's operating activity consists of two operating sectors or
segments, Advertising and Products. Segment selection is based upon the
organizational structure that the Company's management uses to evaluate
performance and make decisions on resource allocation, as well as availability
and materiality of separate financial results consistent with that structure.
The Advertising sector consists of the placement of advertising, the production
of advertising and creative advertising consulting. The Products sector includes
all activities related to the sale of the Dermafresh product line and the sale
of other products for which the Company has obtained distribution rights.
Corporate and general expenses of the Company are allocated to the Company's
segments based on an estimate of the proportion that such allocable amounts
benefit the segments.
18
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
8. Commitments and Contingencies
(a) Consulting Agreement
On June 17, 2005, in connection with the private placement, the Company
entered into a consulting agreement with John P. Acunto, Jr. Pursuant to the
consulting agreement:
o Mr. Acunto, who was chairman of the board, chief executive officer
and a director, resigned as an officer and director of the Company.
o Mr. Acunto agreed to serve on a substantially full-time basis as a
consultant to the Company with principal emphasis in marketing the
Company's advertising and direct mail business for a term of three
years and continuing thereafter on a year-to-year basis unless
terminated by either Mr. Acunto or the Company on 90 days prior
written notice.
o As compensation for his services, Mr. Acunto received an initial
payment of $200,000, and he will receive a non-refundable monthly
draw of $17,000 against commissions earned. The $200,000 initial
payment will be expensed over the three year term of the consulting
agreement, and the $17,000 will be a monthly expense beginning July
2005.
o The Company agreed to pay Mr. Acunto a commission equal to 5% of the
gross profit on covered accounts, as defined in the agreement.
o The Company granted Mr. Acunto a non-qualified stock option to
purchase 2,000,000 shares of common stock at an exercise price of
$.65 per share, which is exercisable immediately (subject to an
increase in the number of authorized shares of Common Stock) as to
500,000 shares and thereafter in quarterly installments based on the
Company's gross profit for the quarter. The fair value of the
option, as calculated pursuant to the Black-Scholes option valuation
formula approximates $480,000 which will be expensed over the term
of the consulting agreement.
o Mr. Acunto agreed to a restriction on his ability to compete with
the Company or solicit its employees or clients.
o Mr. Acunto agreed and obtained the agreement of his wife not to sell
any of the 933,334 shares of common stock that each of them received
in the reverse merger in January 2004 prior to June 17, 2007 and
that during such two-year period they would not sell any other
shares of common stock owned by them except with the limitations of
Rule 144 of the Securities and Exchange Commission pursuant to the
Securities Act of 1933, as amended.
o Commencing June 17, 2007, Mr. and Mrs. Acunto will continue to be
restricted to the Rule 144 limitation as long as they own, in the
aggregate, at least 10% of the Company's outstanding common stock.
19
ADSOUTH PARTNERS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------------------------------------------
8. Commitments and Contingencies (continued)
(a) Consulting Agreement (continued)
o Mr. Acunto has the right, during the term of the agreement, to
designate one individual reasonably acceptable to the Company to
serve as a director provided that such person meets the test for
independence under the rules of the Nasdaq Stock Market.
o The obligations of both Mr. Acunto and the Company under Mr.
Acunto's employment agreement were terminated, except for certain
specified obligations on Mr. Acunto's part, including his
non-disclosure and non-competition covenants.
Contemporaneously with Mr. Acunto's resignation, Mr. John Cammarano, Jr.,
who is the Company's president, was elected as chief executive officer and was
granted non-qualified stock options to purchase 800,000 shares of common stock
at $.65 per share. Mr. Cammarano will continue to serve as the Company's
president. The intrinsic value of the option issued to Mr. Cammarano
approximates $8,000 which will be expensed as the option vests. Mr. Cammarano's
annual compensation was increased to $250,000, effective June 17, 2005.
(b) Employment Agreements
As of June 27, 2005, the Comapny entered into a three-year employment
agreement with a key marketing employee at an annual salary of $145,000. In
connection with her employment, the Company granted her an option to purchase
500,000 shares of Common Stock pursuant to the 2005 Plan at an exercise price of
$.65.
Mr. John C. Cammarano, Jr., president and, effective June 17, 2005, chief
executive officer, and Mr. Anton Lee Wingeier, chief financial officer, each
agreed that (i) he would not publicly sell any shares of the Company's common
stock during the two-year period commencing on the date of the purchase
agreement, (ii) notwithstanding any contrary provisions of any employment
agreement or other understanding, he will not receive any bonus except for a
bonus based on growth in earnings per share as determined by a compensation
committee of the board of directors the majority of members of which are
independent directors and (iii) in the event of a termination of his employment,
other than a termination by us that is not for cause or as a result of his death
or disability, his severance will not exceed one year's compensation.
(c) Litigation
The Company is involved from time to time in routine legal matters
incidental to the business. Based upon available information, the Company
believes that the resolution of such matters will not have a material adverse
effect on the financial statements, financial position or results of operations.
On or about November 5, 2004, Plan*It Strategic Marketing, Inc. commenced
an action in the Circuit Court, Palm Beach County, Florida against the Company,
its subsidiary Dermafresh, Inc., John Cammarano, and others, including Think
Tek, Inc., the company that sold Dermafresh, Inc. and the Dermafresh
microdermabrasion product to the Company, claiming that the sale to the Company
violated an agreement between the plaintiff and Think Tek, Inc. Mr. Cammarano
became the Company's president subsequent to the Company's acquisition of
Dermafresh, Inc., and was an officer, director and stockholder of Dermafresh,
Inc. at the time Dermafresh, Inc. was sold to the Company. The plaintiff is
seeking monetary damages and equitable relief, including a temporary and
permanent injunction, rescission and the imposition of an equitable trust. A
hearing on plaintiff's request for a temporary injunction was held on November
15, 2004. On November 16, 2004, the Company received notice from the Circuit
Court, Palm Beach County, that the plaintiff's motion for temporary injunction
was denied. On July 8, 2005, our litigation with Plan*It Strategic Marketing,
Inc. was dismissed with prejudice following our payment of $25,000, which was
expensed in the second quarter of 2005.
9. Subsequent Event
On August 10, 2005, Mr. Harlan I. Press and Mr. Jerry Horowitz were
elected to the board of directors and Mr. Lee Wingeier resigned as a director.
Since the Company's by-laws provide for only three directors, Mr. Wingeier
resigned in order that a majority of the Company's directors could be
independent directors.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Statement Regarding Forward Looking Disclosure
This Quarterly Report of Adsouth Partners, Inc. on Form 10-QSB, including
this section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations," may contain "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include, but are not limited to, statements that
express our intentions, beliefs, expectations, strategies, predictions or any
other statements relating to our future activities or other future events or
conditions. These statements are based on current expectations, estimates and
projections about our business based, in part, on assumptions made by
management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may, and probably will, differ materially
from what is expressed or forecasted in the forward-looking statements due to
numerous factors, including those risks discussed under "Risk Factors" in our
Form 10-KSB annual report for the year ended December 31, 2004 and those
described in any other filings which we make with the SEC, as well as the
disclosure contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Form 10-KSB for 2004 and the Form
10-QSB for the quarter ended June 30, 2005. In addition, such statements could
be affected by risks and uncertainties related to our financial conditions, the
availability of financing, the ability to generate clients and revenue for the
direct response marketing business and the ability to successfully develop our
products business and other factors which affect the industries in which we
conduct business, market and customer acceptance, competition, government
regulations and requirements and pricing, as well as general industry and market
conditions and growth rates, and general economic conditions. Any
forward-looking statements speak only as of the date on which they are made, and
we do not undertake any obligation to update any forward-looking statement to
reflect events or circumstances after the date of this report.
The important factors that could cause actual results to differ from those
in the forward-looking statements herein (the "cautionary statements") are more
fully described in our Form 10-KSB for the year ended December 31, 2004, in our
registration statement on Form SB-2, which was declared effective by the SEC on
August 3, 2005 and in any other filings we make with the SEC.
Investors should evaluate any statements made by the Company in light of
these important factors.
Introduction
We are in two distinct business sectors or segments - advertising and
product sales. Our advertising sector includes the placement of advertising in
different media, the production of direct marketing commercials, and the
planning and implementation of direct marketing programs for our clients. Both
our revenue and our gross margins reflect services in addition to those of a
typical advertising agency since the gross margin on advertising revenue is
typically a percentage of the amount paid for the advertisement. To the extent
that we are able to provide additional services, our margins can improve. Our
advertising clients are generally smaller companies, many of which may be
undercapitalized, and that require services in addition to those of a typical
advertising agency. In 2004, a major client, that accounted for approximately
67% of our total revenue in 2004, because of economic conditions affecting its
business, was unable to pay a significant portion of the money it owed us.
In our products sector we sell, both through our direct marketing
operations and our sales to retail stores, a range of different products, some
of which are not related to the others and have different distribution channels.
During 2004, we generated revenue from only one product line, our Dermafresh
product line, which we acquired in February 2004 and introduced to the market in
June 2004. Since December 31, 2004, we have either acquired or obtained
marketing rights to a number of additional products and our strategy
contemplates that we will seek to acquire additional products. There is
typically a period of several months from the time that we acquire a product
until we generate revenue from that product. During this period, we are engaged
in marketing activities and thus are incurring costs before we can generate any
revenue from a product. Before we sell our products to retail accounts, we use
our direct marketing capability to introduce the product to market.
In April 2005, we introduced the Simon Solutions lip enhancement product
that is endorsed by Pamela Sue Anderson.
21
We have no manufacturing or production facilities, and we purchase our
products from third parties. The price we pay for our products is affected by
the amount of our purchases. To the extent that we increase our volume we may be
able to take advantage of more favorable pricing for the products we sell. Other
than products that we own, we have exclusive distribution rights for only a
short term.
Our available cash has affected our ability to purchase products and
generate sales. Although we have a factoring agreement, we can only receive
funds under that agreement after we have shipped goods pursuant to purchase
orders and generated accounts receivable. We do not have a credit facility which
would enable us to purchase inventory in order to fill orders we have received.
The lack of inventory financing together with the failure of a major advertising
client to pay a significant receivable impaired our ability to purchase
inventory and make sales during the fourth quarter of 2004 and the first month
and a half of 2005. The receipt of net proceeds of approximately $700,000 in mid
February 2005 enabled us to increase our purchases of inventory, resulting in
increased sales, particularly sales for the lip enhancement product, which was
introduced in April 2005.
The terms on which we sell products to retailers provide for payment from
30 to 60 days from shipment. Generally, our product and packaging purchases
require us to pay a deposit ranging from 25% to 50% of the purchase price with
the balance being due 30 to 60 days from the shipment date. As a result of these
terms, we are required to pay for a significant portion of our cost of goods in
advance of receiving payment from our retail customers. In order to shorten the
time period in which we receive cash on our retail shipments we have sold
invoices of certain of our retail customers to a factoring company. The terms of
our factoring agreement allow us to receive an advance payment of 80% of the
invoice amounts for approved customers. However, under the agreement with the
factor, we do not receive any funds from the factor until the products are
shipped and invoiced. We believe that the money we raised in our private
placements during the first half of 2005 will provide us with sufficient cash to
enable us meet our estimated cash requirements, including the purchase of
inventory, at least through June 2006.
All of our present distribution agreements have terms of one or two years,
and some include extension rights if volume levels are reached. One of these
agreements, the agreement with Simon Solutions, permits either party to
terminate the agreement on six months notice. As a result, if we are successful
in selling a product, we may not be able to take advantage of the good will that
we have built up for the products unless we are able to obtain an extension of
our distribution rights. Because of the short-term nature of our distribution
rights, we must continually obtain rights to new products and successfully
market these products if we are to be successful over the long term.
When discussing our performance, we discuss loss before non-cash
stock-based compensation which is a non-GAAP financial measure.
In connection with a private placement in June of 2005, John P. Acunto,
Jr. resigned as an officer and director and we entered into a consulting
agreement with him. Mr. Acunto's consulting agreement provided for an initial
payment of $200,000, which will be amortized over the three year term of the
consulting agreement, and granted him a non-qualified stock option to purchase
2,000,000 shares of common stock at an exercise price of $.65 per share. Because
Mr. Acunto is a consultant rather than an employee, the fair value of the
option, as calculated pursuant to the Black-Scholes option valuation formula
approximates $480,000, and will be amortized over the term of the consulting
agreement. We also granted Mr. Cammarano an option to purchase 800,000 shares of
common stock at an exercise price of $.65 per share. The value of the option, as
calculated using the intrinsic value method approximates $8,000, and will be
expensed as the option vests.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires our management to
make assumptions, estimates and judgments that affect the amounts reported in
the financial statements, including the notes thereto, and related disclosures
of commitments and contingencies, if any. We consider our critical accounting
policies to be those that are complex and those that require significant
judgments and estimates in the preparation of our financial statements,
including the following: recognition of revenues, accounting for stock-based
compensation, and accounting for income taxes. We rely on historical experience
and on other assumptions we believe to be reasonable under the circumstances in
making our judgment and estimates. Actual results could differ materially from
those estimates. There have been no significant changes in the assumptions,
estimates and judgments in the preparation of these financial statements from
the assumptions, estimates and judgments used in the preparation of our 2004
audited financial statements.
22
Revenue Recognition
We derive revenue from; (i) the placement of advertising in television,
internet and print media outlets; (ii) the production of advertising content
including television commercials, print advertising and other graphics design
literature; (iii) advertising and marketing consulting services; and (iv) the
sale of products. Our advertising services revenue is derived from billings that
are earned when the media is placed, from fees earned as advertising services
are performed and from production services rendered. In addition, incentive
amounts may be earned based on qualitative and/or quantitative criteria. In the
case of media placements, revenue is recognized as the media placements appear.
We are the primary obligor and carry all of the credit risk for the media
placements and accordingly, record the full amount of such billings from the
media placements as revenue in accordance with Emerging Issues Task Force Issue
No. 99-19. In the case of consulting and production arrangements, the revenue is
recognized as the services are performed. Our creative consulting revenue is
generally earned on a fee basis, and in certain cases incentive amounts may also
be earned. As with fee arrangements in advertising, such revenue is recognized
as the work is performed. Incentive amounts for advertising and marketing
services are recognized upon satisfaction of the qualitative and/or quantitative
criteria, as set out in the relevant client contract. Deferred revenues are
recognized as a liability when billings are received in advance of the date when
revenues are earned. Revenues from the sale of products are recognized upon the
shipment of the goods being sold and are net of estimated returns and other
promotional allowances.
Stock-Based Compensation
Our most significant expense in the first half of 2004 was $3,903,000 of
non-cash stock based compensation expense representing the fair value of common
stock that was granted to employees, including officers, and consultants during
2004. The stock grants were used to obtain consulting services from third
parties and to attract qualified employees..
In December 2004, the FASB issued SFAS No.123 (revised 2004), "Share-Based
Payment." Statement 123(R) will provide investors and other users of financial
statements with more complete financial information by requiring that the
compensation cost relating to share-based payment transactions be recognized in
financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. Statement 123(R) covers a wide range of
share-based compensation arrangements including stock options, restricted stock
plans, performance-based awards, stock appreciation rights, and employee stock
purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. Statement 123, as originally issued in 1995,
established as preferable a fair-value-based method of accounting for
share-based payment transactions with employees. However, that statement
permitted entities the option of continuing to apply the guidance in Opinion 25,
as long as the footnotes to financial statements disclosed what net income would
have been had the preferable fair-value-based method been used. Public entities
that are small business issuers will be required to apply Statement 123(R) as of
the first interim or annual reporting period that begins after December 15,
2005. Currently we recognize the expense of options or similar instruments
issued to employees using the intrinsic value based method. Beginning with the
first quarter of 2006, we will be required to recognize expense of options or
similar instruments issued to employees using the fair-value-based method of
accounting for stock-based payments.
Income Taxes
We provide for federal and state income taxes currently payable, as well
as for those deferred because of temporary differences between reporting income
and expenses for financial statement purposes versus tax purposes. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the carrying amount of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. Deferred tax assets and liabilities are measured using the enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recoverable or settled. The effect of a change in
tax rates is recognized as income or expense in the period of the change. A
valuation allowance is established, when necessary, to reduce deferred income
taxes to the amount that is more likely than not to be realized. As of December
31, 2004, we had net operating loss carry-forwards approximating $1,641,000.
Pursuant to Section 382 of the Internal Revenue Code, utilization of these
losses may be limited in the event of a change in control, as defined in the
Treasury regulations. There was no tax benefit or expense for the three and six
month periods ended June 30, 2005.
23
New Accounting Pronouncements
In October 2004, the Financial Accounting Standards Board ("FASB")
ratified the consensus reached in Emerging Issues Task Forces ("EITF") Issue No.
04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings Per
Shares." The EITF states that contingently convertible instruments, such as
contingently convertible debt, contingently convertible preferred stock, and
other such securities should be included in diluted earnings per share (if
dilutive) regardless of whether the market price trigger has been met. The
consensus became effective for reporting periods ending after December 15, 2004.
The adoption of this pronouncement did not have an effect on the Company's
financial statements for the three and six months ended June 30, 2005 as such
convertible instruments would have been anti-dilutive. Such convertible
instruments may dilute earnings per share, if any, in the future.
In May 2005, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 154 "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 changes the requirements for the accounting
for the accounting for and reporting of a change in accounting principle. SFAS
154 requires that the cumulative effect of voluntarily changing to a new
accounting principle be applied retrospectively to prior period financial
statements. Prior to the effective date of SFAS 154, the cumulative effect of
voluntarily changing to a new accounting principle was included in the operating
results of the period in which such change was adopted. SFAS 154 is effective
for fiscal years beginning after December 15, 2005. We expect that the adoption
of the foregoing new statement will not have a significant impact on our
financial statements.
Results of Operations
The following table sets forth selected financial information for our two
operating segments for the three and six months ended June 30, 2005 and 2004.
Advertising Products Total
-----------------------------------------------------------------------------
Three Months Ended June 30, 2005:
Revenues $ 277,000 $ 1,163,000 $ 1,440,000
Costs and expenses (excluding
non cash stock based
compensation expense and
non-recurring payments) (532,000) (1,355,000) (1,887,000)
-----------------------------------------------------------------------------
(255,000) (192,000) (447,000)
Payments to settle arbitration
and litigation matters (100,000) (25,000) (125,000)
Non cash stock based
compensation (20,000) (38,000) (58,000)
-----------------------------------------------------------------------------
Operating loss (375,000) (255,000) (630,000)
Interest expense and factor
discounts (42,000) (114,000) (156,000)
Loss on early debt
extinguishment (179,000) (357,000) (536,000)
-----------------------------------------------------------------------------
Net loss $ (596,000) $ (726,000) $(1,322,000)
=============================================================================
Three Months Ended June 30, 2004:
Revenues $ 1,481,000 $ 6,000 $ 1,487,000
Costs and expenses (excluding
non cash stock based
compensation) (870,000) (153,000) (1,023,000)
-----------------------------------------------------------------------------
611,000 (147,000) 464,000
Non cash stock based
compensation (142,000) (71,000) (213,000)
-----------------------------------------------------------------------------
Net income (loss) $ 469,000 $ (218,000) $ 251,000
=============================================================================
24
Advertising Products Total
-----------------------------------------------------------------------------
Six Months Ended June 30, 2005:
Revenues $ 692,000 $ 2,469,000 $ 3,161,000
Costs and expenses (excluding
non cash stock based
compensation expense and
non-recurring payments) (1,053,000) (2,309,000) (3,362,000)
-----------------------------------------------------------------------------
(361,000) 160,000 (201,000)
Payments to settle arbitration
and litigation matters (100,000) (25,000) (125,000)
Non cash stock based
compensation (43,000) (85,000) (128,000)
-----------------------------------------------------------------------------
Operating (loss) income (504,000) 50,000 (454,000)
Interest expense and factor
discounts (66,000) (175,000) (241,000)
Loss on early debt
extinguishment (179,000) (357,000) (536,000)
-----------------------------------------------------------------------------
Net loss $ (749,000) $ (482,000) $(1,231,000)
=============================================================================
Six Months Ended June 30, 2004:
Revenues $ 1,856,000 $ 6,000 $ 1,862,000
Costs and expenses (excluding
non cash stock based
compensation expense) (1,341,000) (242,000) (1,583,000)
-----------------------------------------------------------------------------
515,000 (236,000) 279,000
Non cash stock based
compensation (3,328,000) (575,000) (3,903,000)
-----------------------------------------------------------------------------
Operating loss (2,813,000) (811,000) (3,624,000)
Loss on sale of marketable
securities (10,000) -- (10,000)
-----------------------------------------------------------------------------
Net loss $(2,823,000) $ (811,000) $(3,634,000)
=============================================================================
Advertising
Advertising revenues in the second quarter of 2005 decreased $1,204,000,
or 81%, to $277,000, compared to $1,481,000 for the second quarter of 2004.
During the second quarter of 2005, marketing, consulting and media placement
services revenues were generated from eight customers of which 41% was from NVE
Pharmaceuticals, Inc., 29% was from Simon Cosmetics LLC and 20% was from
SinoFresh Healthcare, Inc. Substantially all of the advertising revenues for the
second quarter of 2004 were from Gameznflix, Inc., which is no longer a client.
The principal cost of revenue in the advertising segment is media placement and
production costs, which decreased $364,000, or 65%, from $556,000 in the second
quarter of 2004 to $192,000 for the second quarter of 2005. The advertising
revenues in the second quarter of 2005 compared to the second quarter of 2004
were more heavily concentrated in media placement as compared to commercial
production which resulted in a lower overall return from 62% to 31%.
Advertising revenues in the first half of 2005 decreased $1,164,000, or
62%, to $692,000, compared to $1,856,000 for the first half of 2004. During the
first half of 2005, marketing, consulting and media placement services revenues
were generated from fourteen customers of which 56% was from SinoFresh
Healthcare, Inc., 16% was from NVE Pharmaceuticals, Inc. and 12% was from Simon
Cosmetics LLC. Substantially all of the advertising revenues for the first half
of 2004 were from Gameznflix, Inc., which is no longer a client. The media
placement and production costs decreased $286,000, or 38%, from $759,000 in the
first half of 2004 to $473,000 for the first half of 2005. The advertising
revenues in the first half of 2005 compared to the first half of 2004 were more
heavily concentrated in media placement as compared to commercial production
which resulted in a lower overall return from 59% to 32%.
We are continuing our efforts to broaden our customer base for the
advertising segment, and we are seeking to use our advertising program for our
product division as a promotion for our advertising services for other potential
new direct response marketing clients.
Selling, administrative and other expenses for the second quarter of 2005
for our advertising segment were $460,000, compared to $456,000 for the second
quarter of 2004, an increase of $4,000. Advertising's operating expenses during
the second quarter of 2004 include $142,000 of non-cash stock-based compensation
expense which resulted from the issuance of stock grants to our officers and
other key employees and stock option grants that to consultants, compared to
$20,000 for the second quarter of 2005. The second quarter's selling, general
and administrative expense of the Advertising segment includes $100,000 related
to an arbitration settlement with the Screen Actors Guild. Other significant
components of advertising's selling, general and other expenses for the second
quarter of 2005 includes $182,000 of salaries and related payroll taxes, $27,000
of travel and entertainment expense, $23,000 of occupancy costs and $32,000 of
legal and accounting fees. Significant components of advertising's selling,
general and other expenses, other than the $142,000 of non-cash stock-based
compensation expense, for the second quarter of 2004 includes $124,000 of
salaries and related payroll taxes, $55,000 of travel and entertainment expense,
and $5,000 of legal and accounting fees.
25
Selling, administrative and other expenses for the first half of 2005 for
our advertising segment were $723,000, compared to $3,910,000 for the first half
of 2004, a decrease of $3,187,000. Advertising's operating expenses during the
first half of 2004 include $3,328,000 of non-cash stock-based compensation
expense compared to $43,000 for the first half of 2005. Other significant
components of advertising's selling, general and other expenses for the first
half of 2005 includes $100,000 for the settlement with the Screen Actors Guild,
$296,000 of salaries and related payroll taxes, $66,000 of travel and
entertainment expense, $46,000 of occupancy costs and $48,000 of legal and
accounting fees. Significant components of advertising's selling, general and
other expenses, other than the $3,324,000 of non-cash stock-based compensation
expense, for the second quarter of 2004 includes $295,000 of salaries and
related payroll taxes, $97,000 of travel and entertainment expense, and $66,000
of legal and accounting fees.
Advertising's interest expense during the second quarter and first half of
2005 was $42,000 and $66,000, respectively, which relates to the convertible
notes that were issued in February and May of 2005 and includes $33,000 and
$54,000, respectively, of amortized discount on the convertible note issuance.
Advertising did not have interest expense during the second quarter and first
half of 2004.
On June 17, 2005, we completed a private placement of our Series B
Preferred Stock of which a portion of the proceeds were used to pay our
convertible notes that were issued in February and May 2005. As a result of such
early extinguishment, for the second quarter and first half of 2005, the
Advertising segment record a loss on early debt extinguishment of $179,000.
Advertising's net loss for the second quarter of 2005 was $596,000
compared to net income of $469,000 for the second quarter of 2004. Advertising's
net loss for the first half of 2005 was $749,000 compared to $2,823,000 for the
first half of 2004.
Products
Our first product was the Dermafresh microdermabrasion kit skin care
product, which we acquired in February 2004 and introduced in June 2004. As a
result, we did not generate any revenue or incur any expenses from our products
until the last month of the second quarter of 2004. Product revenues during the
second quarter of 2005 were $1,163,000, of which 27% was from sales to Wal-Mart
Store, Inc., 21% was from sales to CVS Corporation, 13% was from sales to Brooks
Pharmacies and 13% was from sales to General Nutrition Distribution, L.P. Our
cost of revenue for the second quarter of 2005 was $757,000, which resulted in a
gross margin of 35%. Product revenues during the first half of 2005 were
$2,469,000, of which 29% was from sales to Wal-Mart Store, Inc. and 27% was from
sales to CVS Corporation. Our cost of revenue for the first half of 2005 was
$1,302,000, which resulted in a gross margin of 47%. Our gross margin on product
sales for the second quarter of 2005 was lower than the gross margin for the
first quarter of 2005 which was 58%. Our product shipments during the first
quarter of 2005 included a higher concentration of direct response sales than
during the second quarter of 2005. We generate higher per unit sales prices on
direct response sales than our wholesale prices to our retail customers
resulting in a greater gross margin. In addition, during the second quarter of
2005, as compared to the first quarter of 2005, we sold a greater concentration
of the Lip Solution product as opposed to the Dermafresh line of products and
our margin on the Lip Solution Product is significantly lower than on our other
products due to higher costs. Further, one of our retail customers was given a
lower price per unit on the Lip Solution during the second quarter of 2005 from
the price they were charged during the first quarter of 2005. The overall
decline in gross revenues from the first quarter to the second quarter of 2005
of $143,000, was due to the fact that approximately $161,000 of two products
were shipped to two large national retailers on a pay on scan basis. As a
result, we do not recognize sales until such retailers sell the items to the
consumers. We believe that it was important to establish a presence for our
products in such markets and that the ultimate sell through by such pay on scan
retailers will help us achieve our long-term sales objectives.
The product sector's selling, administrative and other expense for the
second quarter of 2005 was $661,000 compared to $223,000 for the second quarter
of 2004. Significant components of these expenses for the second quarter of 2005
include $211,000 of salaries and related payroll taxes, $48,000 of sales
commissions and royalties, $134,000 of advertising expense, $22,000 of occupancy
costs, $29,000 of indirect warehousing and order processing costs, $38,000 from
the amortization of deferred stock-based compensation expense, $25,000 from the
settlement of litigation and $59,000 of legal and accounting fees. The product
sector's selling, administrative expenses for the second quarter of 2004 include
$71,000 from the amortization of deferred stock-based compensation expense,
$60,000 of salaries and related payroll taxes, $29,000 of advertising expense,
$5,000 of legal and accounting fees and $18,000 of indirect warehousing costs.
26
The product sector's selling, administrative and other expense for the
first half of 2005 was $1,117,000 compared to $816,000 for the first half of
2004. Significant components of these expenses for the first half of 2005
include $404,000 of salaries and related payroll taxes, $91,000 of sales
commissions and royalties, $153,000 of advertising expense, $37,000 of occupancy
costs, $54,000 of indirect warehousing and order processing costs, $85,000 from
the amortization of deferred stock-based compensation expense and $101,000 of
legal and accounting fees. The product sector's selling, administrative expenses
for the first half of 2004 include $575,000 from the amortization of deferred
stock-based compensation expense, $25,000 from the settlement of litigation,
$62,000 from salaries and related payroll taxes, $29,000 from advertising
expense, $5,000 from legal and accounting fees and $18,000 from indirect
warehousing costs.
The product sector's interest expense during the second quarter and first
half of 2005 was $90,000 and $143,000, respectively, which relates primarily to
the convertible notes that were issued in February and May of 2005 and includes
$68,000 and $106,000, respectively, of amortized discount on the convertible
note issuance. The product sector did not have interest expense during the
second quarter and first half of 2004.
Discounts on receivables sold to a factor were $24,000 and $32,000,
respectively, for the second quarter and first half of 2005. We pay a variable
discount of a base rate, as quoted from time to time by the factoring company,
plus 2% on the amounts that are initially advanced to us for the period of time
that such amounts remain outstanding. The effective rate of the variable
discount as of June 30, 2005 was 7.75%. During the second quarter and first half
of 2005, we sold $1,045,000 and $1,366,000, respectively, of receivables to the
factor.
On June 17, 2005, we completed a private placement of our Series B
Preferred Stock of which a portion of the proceeds were used to pay all our
convertible notes that were issued in February and May 2005. As a result of such
early extinguishment, for the second quarter and first half of 2005, the product
sector recorded a loss on early debt extinguishment of $357,000.
The product sector's net loss for the second quarter of 2005 was $726,000
compared to $218,000 for the second quarter of 2004. The product sector's net
loss for the first half of 2005 was $482,000 compared to $811,000 for the first
half of 2004.
Overall
As a result of the foregoing, we incurred a consolidated net loss for the
second quarter of 2005 of $1,322,000 as contrasted with net income of $251,000
for the second quarter of 2004 and a consolidated net loss for the first half of
2005 of $1,231,000 as contrasted with $3,634,000 for the first half of 2004. In
connection with the private placement completed on June 17, 2005, the fair value
of the securities issued (including the preferred stock and warrants to purchase
common stock) when compared to the net proceeds resulted in a beneficial
conversion feature that approximated $1,344,000. For purposes of calculating the
net loss attributable to common stockholders, such beneficial conversion feature
is considered a deemed dividend and is deducted from the net loss for purposes
of calculating basic and fully diluted loss per share. As a result of the deemed
dividend, the net loss attributable to common stockholders for the second
quarter and first half of 2005 was $2,666,000 and $2,575,000, respectively, and
the basic and fully diluted loss for such periods was $.33 and $.34,
respectively.
27
Financial Condition
At June 30, 2005, we had available working capital of approximately
$1,374,000 compared to a working capital deficiency of $916,000 at December 31,
2004. The following table details changes in components of working capital
during the first half of 2005.
June 30, December 31,
2005 2004 Change
---- ---- ------
Cash $ 659,000 $ 38,000 $ 621,000
Certificate of deposit
(restricted) 102,000 100,000 2,000
Accounts receivable - net 767,000 36,000 731,000
Due from factor 101,000 -- 101,000
Inventory 619,000 186,000 433,000
Marketable securities 76,000 -- 76,000
Other current assets 294,000 34,000 260,000
Accounts payable (910,000) (475,000) (435,000)
Accrued salaries and
payroll taxes (146,000) (261,000) 115,000
Current debt (110,000) (354,000) 244,000
Other current liabilities (78,000) (220,000) 142,000
-------------------------------------------------------------------------------
Working capital (deficiency) $ 1,374,000 $ (916,000) $ 2,290,000
===============================================================================
The most significant increases to working capital were accounts receivable
and cash. At June 30, 2005, 49%, 25% and 11% of our accounts receivable were due
from Wal-Mart Store, Inc., CVS Corporation and NVE Pharmaceuticals, Inc.,
respectively. During the last three months of 2004 product shipments were not
significant and all but $36,000 of the invoices related to 2004 shipments had
been collected as of December 31, 2004. During the first half of 2005 product
shipments were $2,469,000, of which $608,000 was shipped in June 2005 and were
included in outstanding receivables as of June 30, 2005. During July 2005,
approximately $429,000 of the June 30, 2005 receivables was sold to our factor.
The increase in cash reflected the receipt of the net proceeds from our private
placements of securities during the first half of 2005.
On September 22, 2004, we executed an agreement with our factor pursuant
to which we may sell qualified receivables without recourse to us. We pay a
fixed discount of 1% of the gross amount of any receivables sold and are
advanced 80% of the gross amount of such receivables. The remaining 20% of the
gross amount of any receivables sold is held as a reserve by the factoring
company until such time as the receivable is collected by the factoring company.
We pay a variable discount of a base rate, as quoted from time to time by the
factoring company, plus 2% on the amounts that are initially advanced to us
until the factor collects the receivable from the customer. The effective rate
of the variable discount as of June 30, 2005 was 7.75%. During the first half of
2005, we sold $1,366,000 of receivables to the factor.
The terms that we have with the retailers for our product shipments range
from 30 to 60 days from shipment. We generally receive advance deposits from our
advertising clients, which are treated as deferred revenue until the airing or
on-sale dates.
The increase in our inventory is due primarily to purchases of our lip
solution product which we sell pursuant to an exclusive distribution agreement
with Simon Cosmetics and which we formally introduced in April 2005.
The increase in other current assets is from deposits to media companies
for advertising and to vendors for product purchases.
The significant increase in accounts payable is due to primarily to our
increased purchases of inventory as well as payments due to media placement
agencies for the advertising we placed for our Product's sector during the first
half of 2005. Generally, our product and packaging suppliers require us to pay a
deposit ranging from 25% to 50% of the purchase price with the balance being due
30 to 60 days from the shipment date. Media placement costs for television
advertising generally require full payment in advance of the airing dates. Media
placement costs for print media require us to pay deposits of 25% to 50% with
the balance being due prior to the on-sale or distribution date of the materials
in which the ads are placed. Deposits which are paid in advance to our vendors
are included in prepaid and other assets.
Current debt decreased by $244,000. During the first half months of 2005
we repaid a $250,000 promissory note which was issued in July 2004. In addition,
during the first half of 2005 we obtained a vehicle loan of which the current
portion is $6,000 as of June 30, 2005. As of June 30, 2005, the outstanding
balance on our bank line-of-credit is $100,000. The bank line-of-credit expired
on July 8, 2005 and was renewed by the bank until July 8, 2006, and is fully
collateralized with a $100,000 certificate of deposit held by the bank.
28
In February, May and June we received net proceeds, after payment of
brokerage and legal fees, of approximately $3.3 million from the sale of our
securities. Although we believe that these financing will provide us with
sufficient funds to enable us to continue our operations at least through mid
2006, it is possible that we may require additional funds before that time, and
we cannot assure you that we will be able to raise any funds which we may
require. The terms of our private placement completed in June 2005 may make it
difficult to raise funds from any other source.
Guidance and Outlook
Providing long-term future guidance continues to be challenging. The
economy is improving, but still remains difficult to forecast. While we
anticipate the Company's second half of calendar 2005 to be strong, we are
decreasing our previously-issued guidance for revenues, and we are suspending
any guidance on earnings. Based on our orders in house and anticipated orders,
we believe that our revenue for 2005 will be at least $12 million. The decline
in previously issued guidance is primarily attributable to the following factors
in addition to general economic factors
o delays in anticipated product introductions, which is reflected in
both a lower level of revenues and expenses incurred in connection
with the new product lines that are not absorbed by revenue;
o delays in expanding our advertising customer base;
o changes in management and sales personnel, including the sudden
death of our vice-president of sales
o an increase in actual product shipments that are made pursuant to
terms which result in revenue not being recognized by us until the
products have been sold by the retailer to its consumers. We believe
that it is important to establish a presence for our products in
such markets and that the ultimate sell through by the retailers
will help us establish new accounts and expand our existing
relationships in the retail market place.
o Non-cash charges resulting from the terms of our private placements
during the first half of 2005, which are reflected in our financial
statements for the first half of 2005 and may have an impact in
subsequent quarters.
Since we are a small but growing company, the effect of any of these
factors on our operations may be magnified, since we do not have a sustained
base of revenue and earnings.
Item 3. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer
evaluated the Company's disclosure controls and procedures as of the end of the
period covered by this quarterly report. Based upon the evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective.
During the quarterly period covered by this report, there were no changes
in our internal controls over financial reporting that materially affected, or
are reasonable likely to materially affect, our internal controls over financial
reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
On July 8, 2005, our previously-reported litigation with Plan*It Strategic
Marketing, Inc. was settled by our payment of $25,000 and the action was
dismissed.
Item 6. Exhibits and Reports on Form 8-K
31.1 Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act
32 Certifications of CEO and CFO pursuant to Section 906 of the
Sarbanes-Oxley Act
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ADSOUTH PARTNERS, INC.
/S/ John Cammarano Chief Executive Officer and August 15, 2005
Director
(Principal Executive and
Accounting Officer)
/S/ Anton Lee Wingeier Chief Financial Officer August 15, 2005
(Chief Accounting Officer)
30