EXHIBIT 99.1
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
INDEX
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
PAGE(s)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS...................1
CONSOLIDATED FINANCIAL STATEMENTS
Balance Sheets.......................................................2
Statements of Operations.............................................3
Statements of Stockholders' Equity...................................4
Statements of Cash Flows.............................................5
Notes to Financial Statements...................................6 - 20
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To The Board of Directors and Stockholders
of Alliance Entertainment Corp.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Alliance
Entertainment Corp. & Subsidiaries at December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 1, on December 31, 2004, assets and liabilities of the
Digital Media Infrastructure Services Group were distributed in a spin-off
transaction and are not included in the accompanying consolidated balance sheet
at December 31, 2004.
PricewaterhouseCoopers LLP
Miami, Florida
March 4, 2005
1
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
- --------------------------------------------------------------------------------
<Table>
<Caption>
(in thousands of dollars, except share data) 2004 2003
--------- ---------
ASSETS
Current assets
Cash $ 20,688 $ 9,520
Accounts receivable, net of allowance of
$14,436 and $10,652, respectively 180,728 186,023
Inventory 110,727 97,295
Prepaid expenses and other current assets 1,893 1,790
--------- ---------
Total current assets 314,036 294,628
Property and equipment, net 31,865 52,659
Goodwill 3,876 3,876
Deferred tax asset, net 20,030 --
Intangible assets, net 8,127 15,346
Other assets 1,588 2,235
--------- ---------
$ 379,522 $ 368,744
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 237,170 $ 206,370
Accrued expenses 54,531 87,226
Current portion of long-term debt 8,620 1,389
Current portion of obligations under capital leases 465 640
--------- ---------
Total current liabilities 300,786 295,625
Long-term debt 2,823 11,392
Obligations under capital leases 195 566
Commitments and contingencies
Series A1 Cumulative, 20,000 shares authorized, issued and
outstanding at December 31, 2004 and 2003 35,853 32,853
Series A2 Cumulative, 45,000 shares authorized, 40,967 issued and
outstanding at December 31, 2004 and 2003 70,374 64,229
Series B Cumulative, 9,700,000 shares authorized, 4,540,070
shares issued and outstanding at December 31, 2004 and 2003 17,170 15,550
Stockholders' equity
Common stock, $.0001 par value, 150,000,000 shares authorized,
71,758,845 and 71,738,845 shares issued and outstanding at
December 31, 2004 and 2003, respectively 7 7
Additional paid-in capital 91,953 123,030
Accumulated deficit (139,639) (174,508)
--------- ---------
Total stockholders' equity (47,679) (51,471)
--------- ---------
$ 379,522 $ 368,744
========= =========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
2
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
<Table>
<Caption>
(in thousands of dollars) 2004 2003 2002
--------- --------- ---------
Net sales $ 961,282 $ 869,890 $ 807,773
Cost of goods sold 820,725 759,508 703,788
--------- --------- ---------
Gross profit 140,557 110,382 103,985
Selling, general and administrative expenses 112,409 104,532 99,282
Merger and acquisition fees 2,500 -- --
Severance expenses 772 1,108 --
--------- --------- ---------
Operating income 24,876 4,742 4,703
Interest, net 1,725 2,468 3,602
Other income -- -- (416)
--------- --------- ---------
Income before provision for income taxes 23,151 2,274 1,517
Provision for (benefit from) income taxes (11,718) 1,026 704
--------- --------- ---------
Net income $ 34,869 $ 1,248 $ 813
========= ========= =========
Income (loss) applicable to common shareholders
Net income $ 34,869 $ 1,248 $ 813
Dividends on preferred stock (10,765) (10,608) (10,477)
--------- --------- ---------
Income (loss) applicable to
common shareholders $ 24,104 $ (9,360) $ (9,664)
========= ========= =========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
3
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
<Table>
<Caption>
COMMON STOCK ADDITIONAL
(in thousands of dollars, -------------------------- PAID IN ACCUMULATED
except share data) SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ ---------- ---------- ----------- ----------
BALANCE, DECEMBER 31, 2001 71,738,845 $ 7 $ 144,115 $ (176,569) $ (32,447)
Dividends on preferred stock -- -- (10,477) -- (10,477)
Net income -- -- -- 813 813
---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2002 71,738,845 7 133,638 (175,756) (42,111)
Dividends on preferred stock -- -- (10,608) -- (10,608)
Net income -- -- -- 1,248 1,248
---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2003 71,738,845 7 123,030 (174,508) (51,471)
Issuance of shares 20,000 -- 10 -- 10
Dividends on preferred stock -- -- (10,765) -- (10,765)
Spin-off of AMG and DOD -- -- (20,322) -- (20,322)
Net income -- -- -- 34,869 34,869
---------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 2004 71,758,845 $ 7 $ 91,953 $ (139,639) $ (47,679)
========== ========== ========== ========== ==========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
4
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
<Table>
<Caption>
(in thousands of dollars) 2004 2003 2002
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 34,869 $ 1,248 $ 813
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization of property and equipment 14,459 11,505 11,040
Amortization of deferred financing costs 451 408 623
Bad debt expense 6,310 6,916 7,418
Deferred income taxes (12,771) 907 704
Inventory write-off -- -- 3,296
Loss on disposal of fixed assets 56 -- --
Changes in assets and liabilities:
Accounts receivable (1,014) (29,207) (6,622)
Inventory (13,432) (1,315) (33,904)
Prepaid expenses and other (103) 436 413
Other assets 196 (903) (643)
Accounts payable and accrued expenses (2,948) 49,649 18,988
Change in DMISG assets and liabilities, net (1,181) -- --
------------- ------------- -------------
Net cash provided by operating activities 24,892 39,644 2,126
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (11,736) (13,320) (12,533)
------------- ------------- -------------
Net cash used in investing activities (11,736) (13,320) (12,533)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments on) proceeds from revolving credit facility -- (27,637) 10,344
Proceeds from long-term debt -- 5,151 5,096
Payments on long-term debt (1,338) (681) (710)
Payments on capital leases (660) (652) (570)
Net proceeds from issuance of common stock 10 -- --
------------- ------------- -------------
Net cash (used in) provided by financing activities (1,988) (23,819) 14,160
------------- ------------- -------------
Net increase in cash 11,168 2,505 3,753
Cash, beginning of period 9,520 7,015 3,262
------------- ------------- -------------
Cash, end of period $ 20,688 $ 9,520 $ 7,015
============= ============= =============
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
5
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
1. COMPANY BACKGROUND AND NATURE OF BUSINESS
Alliance Entertainment Corp. and its wholly-owned subsidiaries
("Alliance" or the "Company"), provided services through two operating
segments during 2004: Distribution and Fulfillment Services Group
("DFSG") and Digital Media Infrastructure Services Group ("DMISG"),
formed in conjunction with the 1999 acquisition of Digital On-Demand,
Inc. ("DOD"). On December 31, 2004, DMISG was distributed in a spin-off
of shares of stock in Digital On-Demand, Inc. to stockholders of the
Company. Accordingly, DMISG's results of operations are included within
the accompanying Alliance consolidated financial statements for the
year ended December 31, 2004, 2003 and 2002 and DMISG's assets and
liabilities are likewise included at December 31, 2003; however, the
assets and liabilities of DMISG were eliminated as part of the
spin-off transaction and are not included within the accompanying
consolidated balance sheets at December 31, 2004.
Selected financial information for DMISG at December 31, 2004 and 2003
and for the years ended December 31, 2004, 2003 and 2002 is as follows:
<Table>
<Caption>
2004 2003
------------- ---------
(dollars in thousands)
Total current assets $ 3,908 $ 5,042
Property and equipment, net 18,126 17,105
Total assets 22,090 22,427
Total liabilities 1,768 1,945
</Table>
<Table>
<Caption>
2004 2003 2002
-------------- ---------- -----------
(dollars in thousands)
Net sales $ 17,119 $ 12,356 $ 14,287
Operating loss (3,449) (9,050) (7,734)
Net loss (5,175) (10,301) (7,790)
</Table>
DMISG licenses, distributes and provides multi-media merchandising
stations, which present information and data for use by the end
consumer in retail environments. The end consumer can preview and
select pre-recorded music by searching through digitized audio tracks.
DFSG provides full-service distribution of pre-recorded music, videos,
video games and related accessories and merchandise to retailers and
other customers primarily in North America. DFSG provides product and
commerce solutions to "brick-and-mortar" and e-commerce retailers,
while maintaining trading relationships with major manufacturers of
pre-recorded music, video, and related products. DFSG operates in a
centralized environment and its products and services have
6
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
similar economic characteristics and retail distribution methods.
Accordingly, DFSG reports its operations as a single segment.
As part of the traditional distribution services, and as an integral
part of its service offering, DFSG also provides consumer-direct
fulfillment ("CDF"), and vendor managed inventory ("VMI") solutions to
its customers.
In November 2004, Alliance entered into a merger agreement with Source
Interlink Companies, Inc. (Nasdaq: "SORC") ("Source"). The
equityholders of Alliance and Source will each hold 50% of the fully
diluted capitalization of the combined company at the closing of the
transaction. Subsequent to the approval of the Source stockholders,
this transaction was consummated on February 28, 2005.
During 2003, management decided to phase out One Way Records ("OWR"), a
division within DFSG, due to several years of unsatisfactory financial
performance. The phase out of OWR was completed by the end of 2004. OWR
contributed net losses to the Company's consolidated statements of
operations of $0.9 million, $5.4 million and $4.0 million for the years
ended December 31, 2004, 2003 and 2002, respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and all of its subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
MANAGEMENT ESTIMATES
Significant estimates inherent in the preparation of the accompanying
financial statements include management's forecast of future cash flows
used as a basis to assess recoverability of long-lived assets,
including intangible assets. In addition, Alliance provides for
inventory obsolescence and estimated bad debts on accounts receivable
based on historical experience and periodic reviews of the related
assets.
Sales in the music and video industry generally give certain customers
the right to return products. In addition, the Company's suppliers
generally permit the Company to return products that are in the
supplier's current product listing. Based on historical returns and
review of current catalog lists, management provides for estimated net
returns at the time of sale.
Management periodically reviews its significant accounting estimates
and it is reasonably possible that the recorded amounts may change
based on actual results and other factors.
DERIVATIVE FINANCIAL INSTRUMENTS
In June 2002, in conjunction with the issuance of an $8.5 million
mortgage (Note 6), the Company entered into interest rate swap and cap
agreements to manage the interest rate risk exposures of its
variable-rate based debt portfolio. In addition, the Company will from
time to time enter into monthly LIBOR contracts to reduce the cost of
borrowings under its Revolving Credit Facility (Note 5). The Company
has not designated these instruments as hedges and, accordingly,
records the fair value of these instruments as an asset or liability in
its consolidated balance sheets and interest income/expense in its
consolidated statements of operations. For the years ended December 31,
2004, 2003 and 2002, $0.2 million interest income, $0.1 million
interest income, and $0.4
7
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
million interest expense, respectively, associated with these
agreements was recorded within interest, net in the accompanying
consolidated statements of operations.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of the Company's financial instruments, including
cash, accounts receivable, accounts payable, accrued expenses and other
short and long-term obligations, approximate their fair value.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a
maturity of three months or less at the date of purchase to be cash
equivalents. Negative cash book balances of $0.3 million and $0.6
million at December 31, 2004 and 2003, respectively, have been
presented as accounts payable in the accompanying financial statements.
ACCOUNTS RECEIVABLE
The Company is subject to credit risk through sales to and trade
receivables from retailers. The Company routinely assesses the
financial strength of its significant customers to limit its exposure
to risk with respect to its trade accounts receivable.
INVENTORY
Inventory, primarily consisting of distributed products, is stated at
the lower of cost or market, with cost determined principally on the
average cost basis.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets. Property under capital leases is amortized using the
straight-line method over the shorter of the estimated useful lives of
the assets or the lease term. Upon retirement or sale, the cost and
accumulated depreciation are eliminated from the accounts and the gain
or loss, if any, is included in the statement of operations. Software
development reflects internally developed computer software that is
capitalized and amortized on the straight-line method over periods not
exceeding five years.
INTERNAL USE SOFTWARE COSTS
In accordance with AICPA Statement of Position 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use,"
certain external direct costs of materials and services, internal
payroll and payroll related costs and other qualifying costs incurred
in connection with developing or obtaining internal use software are
capitalized. Alliance capitalizes qualifying costs to internally
construct certain distribution equipment and internally generate the
Company's entertainment database software. Such capitalized costs
include certain payroll-related and contracted programming costs. Costs
to subsequently maintain the distribution equipment are expensed as
incurred. For the years ended December 31, 2004, 2003 and 2002,
capitalized payroll and payroll costs relating to internal use software
costs totaled $4.3 million, $5.2 million and $5.5 million,
respectively.
GOODWILL
Goodwill represents the excess of the purchase price over the fair
market value of net assets acquired. Goodwill is not amortized, but is
assessed for impairment annually in accordance with SFAS 142, "Goodwill
and Other Intangible Assets".
8
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
INTANGIBLE ASSETS
Intangible assets are comprised of reorganization value in excess of
amounts allocable to identifiable assets.
In connection with the Company's reorganization and emergence from
bankruptcy in August 1998, the portion of the Company's reorganization
value, which could not be attributed to specific assets, was previously
reported as an intangible asset and was being amortized over ten years.
Upon adoption of SFAS No. 142 on January 1, 2002, reorganization value
was no longer amortized, but assessed annually for impairment.
DEFERRED FINANCING COSTS
The Company incurred $0.3 million and $1.0 million, respectively, in
financing costs during 2004 and 2003 associated with the amendment of
its asset based revolving credit facility. Given the increased
borrowing capacity of the amended credit facility, these costs were
deferred and are being amortized using a method that approximates the
interest method. As of December 31, 2004 and 2003, $0.9 million and
$1.1 million, respectively, is included in other assets in the
accompanying consolidated balance sheets, net of amortization.
REVENUE RECOGNITION
Revenue from the sale and distribution of pre-recorded music and video,
music accessories and other related product is recognized when
pervasive evidence of an arrangement exists, delivery has occurred, the
fee is fixed or determinable and collection is probable, generally upon
shipment. Most of the Company's sales are made to customers under
agreements permitting certain limited rights of return based upon the
prior months sales. Generally, it is the Company's policy not to accept
product returns that cannot be returned to the Company's vendors.
Revenue from product sales is recognized net of estimated returns and
other allowances primarily consisting of volume rebates and timely pay
discounts. Returns are estimated based on historical experience and are
generally limited by a customer's previous months sales and to product
that may be returned to Alliance's vendors. Revenue from licensing
DMISG's database is recognized based upon the relevant terms of the
licensing agreements.
ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising costs included
in selling, general and administrative expenses totaled $6.0 million,
$4.9 million and $3.6 million for the years ended December 31, 2004,
2003 and 2002, respectively.
SEVERANCE EXPENSES
During 2004 and 2003, the Company reviewed the operations of its DFSG
and DMISG segments, and as a result, eliminated certain positions. This
resulted in severance charges of $0.8 million, $1.1 million and $0 for
the years ended December 31, 2004, 2003 and 2002, respectively.
INCOME TAXES
Income taxes are computed under an asset and liability approach whereby
deferred tax assets and liabilities are recognized based on the
difference between the financial statement and the tax bases of assets
and liabilities using tax rates in effect for the year in which the
differences are expected to reverse. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in
9
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
income in the period that includes the enactment date. A valuation
allowance reduces deferred tax assets when it is deemed likely that a
portion or all of the deferred tax assets will not be realized.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued a revision of SFAS No. 123,
"Statement of Financial Accounting Standards No. 123 (Revised 2004):
Share-Based Payment," which requires that the cost resulting from all
share-based payment transactions be recognized in the financial
statements. This Statement establishes fair value as the measurement
objective in accounting for share-based payment arrangements and
requires all entities to apply a fair-value-based measurement method in
accounting for share-based payment transactions with employees except
for equity instruments held by employee share ownership plans. This
Statement is effective as of the beginning of the first interim or
annual reporting period that begins after June 15, 2005. The Company is
in the process of determining how the method of valuing stock-based
compensation prescribed by this Statement will be applied and the
impact the recognition of compensation expense related to such stock
awards will have on its financial statements.
In November 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 151,
"Inventory Costs." SFAS No. 151 clarifies the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted
material by requiring these items to be recognized as current-period
charges. SFAS No. 151 is effective for inventory costs incurred during
fiscal years beginning after June 15, 2005, with earlier application
permitted. Management expects that SFAS No. 151 will not have a
material impact on the Company's financial position, results of
operations or cash flows.
In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition," which
supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB
104's primary purpose is to rescind accounting guidance contained in
SAB 101 related to multiple element revenue arrangements, superceded as
a result of the issuance of the Emerging Issues Task Force ("EITF")
00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." The issuance of SAB 104 reflects the concepts contained
in EITF 00-21; the other revenue recognition concepts contained in SAB
101 remain largely unchanged. The issuance of SAB 104 did not have a
material impact on the Company's financial position, results of
operations or cash flows.
In April 2003, Statement of Financial Accounting Standards No. 149,
"Amendment of Statement 133 on Derivative Instruments and Hedging
Activities," was issued. SFAS No. 149 amends and clarifies accounting
for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No.
133. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June
30, 2003. The adoption of this statement did not impact the Company's
financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 establishes standards for how companies classify
and measure certain financial instruments with characteristics of both
liabilities and equity. It requires companies to classify a financial
instrument that is within its scope as a
10
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
liability (or an asset in some circumstances). SFAS No. 150 is
effective for nonpublic entities after January 1, 2004. The adoption of
SFAS No. 150 did not impact the Company's financial position, results
of operations or cash flows presented herein.
In January 2003, the FASB issued Interpretation (FIN) 46,
"Consolidation of Variable Interest Entities," which provides guidance
on when to consolidate variable interest entities. In December 2003,
the FASB revised FIN 46 with FIN 46(R). In addition to conforming to
previously issued FASB Staff Positions, FIN 46(R) deferred the
implementation date for certain variable interest entities. FIN 46(R)
is effective for non public entities for the fiscal period beginning
after December 15, 2004. Management does not believe that FIN No. 46(R)
will have a material impact on the Company's financial position,
results of operations or cash flows.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<Table>
<Caption>
2004 2003 2002
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Cash paid for interest ................................................ $ 1,700 $ 1,951 $ 3,283
Cash paid for income taxes ............................................ $ 240 $ 77 $ --
Supplemental schedule of noncash investing and financing activities:
Obligations under capital leases incurred for the purchase of new
equipment .......................................................... $ 114 $ 1,299 $ 324
Spin-off of net assets of DMISG...................................... $ 20,322 $ -- $ --
</Table>
3. PROPERTY AND EQUIPMENT
At December 31, 2004 and 2003, property and equipment consisted of the
following (dollars in thousands):
<Table>
<Caption>
USEFUL
LIVES
(YEARS) 2004 2003
------- ----------- -----------
Buildings and improvements............................................... 39 $ 17,213 $ 16,978
Machinery and equipment.................................................. 5 - 7 29,159 34,320
Office equipment......................................................... 2 - 5 8,246 12,146
Furniture and fixtures................................................... 5 - 7 6,192 4,965
Software development..................................................... 2 - 5 4,645 29,871
----------- -----------
65,455 98,280
Less: Accumulated depreciation and amortization.......................... (35,834) (48,991)
Construction in progress................................................. 429 1,555
Land..................................................................... 1,815 1,815
----------- -----------
$ 31,865 $ 52,659
=========== ===========
</Table>
Depreciation and amortization expense was approximately $14.5 million,
$11.5 million and $11.0 million for the years ended December 31, 2004,
2003 and 2002, respectively.
The Company leases certain of its equipment under capital leases. At
December 31, 2004 and 2003, equipment obtained under capital leases was
recorded at $0.7 million and $1.2 million,
11
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
respectively, net of related accumulated depreciation of $1.2 million
and $4.9 million, respectively, and was included in property and
equipment.
4. INTANGIBLE ASSETS
Reorganization value in excess of amounts allocable to identifiable
assets at December 31, 2004 and 2003 totaled $8.1 million and $15.3
million, respectively, net of $9.3 million of accumulated amortization
(see Note 8). With the implementation of SFAS 142 in 2002, the Company
no longer amortizes reorganization value but tests for impairment
annually. As of December 31, 2004, the Company believed no impairment
existed.
5. REVOLVING CREDIT FACILITY
AEC One Stop Group, Inc. ("AEC"), part of DFSG, has an asset-based
revolving credit facility ("Credit Facility"), which provides for
borrowings of up to $135.0 million. This Credit Facility matures on
August 19, 2006 and includes a $12.5 million letter of credit
sub-facility.
Interest on the outstanding balance under the Credit Facility is
calculated on the London Interbank Offered Rate (LIBOR) or the prime
rate plus applicable margins based upon the outstanding balance and
certain interest coverage ratios. There was no outstanding balance
under the Credit Facility as of December 31, 2004 and 2003. Interest
was calculated based on Prime plus .25% (5.50%) and Prime plus .25%
(4.25%), at December 31, 2004 and 2003, respectively.
Availability: AEC's availability under the Credit Facility is subject
to a borrowing base of eligible accounts receivable and eligible
inventory. The borrowing base is reduced by outstanding letters of
credit, which are used to support outstanding insurance exposure. At
December 31, 2004 availability under the Credit Facility was $129.4
million.
Collateral: With the exception of certain real property, machinery and
equipment and capital leases, all of the existing and after acquired or
created assets of the Company are pledged as collateral for the Credit
Facility. The obligations of DFSG are collateralized by a guaranty from
DFSG as well as the Company.
Restrictive Covenants: The Company is required to achieve certain
minimum performance objectives, based upon its forecasted results of
operations. While management believes these objectives are reasonable,
actual results may differ materially from those projected which may
adversely affect the Company's ability to meet one or more of the
financial covenants. The Company's business is historically seasonal
and the achievement of forecasted objectives requires a strong fourth
quarter performance. If a violation of one or more of the financial
covenants occurs, the Company would be required to obtain a waiver from
the lenders and there can be no assurance that such a waiver can be
obtained. The Company was in compliance with such financial covenants
at December 31, 2004.
12
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
6. LONG-TERM DEBT
In June of 2002, the Company, through its subsidiary, AE Land Corp.,
replaced its taxable bond from the city of Coral Springs, Florida with
an $8.5 million conventional mortgage loan through SunTrust Bank (the
"SunTrust Mortgage"). The SunTrust Mortgage is collateralized by the
land and building at the Company's Coral Springs location. The
principal balance of the taxable bond at the time of repayment was $3.9
million.
The SunTrust Mortgage matures on June 1, 2005 and has monthly principal
payments of approximately $31,000 plus interest at a rate of LIBOR plus
2 1/2 percent with an interest rate of 4.81% and 3.67% at December 31,
2004 and 2003, respectively. The principal payments were determined
based on a 15-year amortization of the outstanding principal amount of
the SunTrust Mortgage. On the maturity date, the aggregate unpaid
principal balance of the mortgage, accrued and unpaid interest and all
costs and expenses due under the SunTrust Mortgage terms shall be due
and payable. The total principal balance of $7.6 million is classified
as current at December 31, 2004.
In March of 2003, the Company, through AEC One Stop Group, Inc.,
entered into a loan agreement with SunTrust Leasing Corporation (the
"SunTrust Loan") for the purchase of equipment to be used at the
Company's various locations. A credit line of $6.8 million was approved
under the SunTrust Loan, with repayment terms for three promissory
notes ranging from three to five years. The total principal balance of
the SunTrust Loan outstanding as of December 31, 2004 and 2003,
representing the three promissory notes, was $3.9 million and $4.8
million, respectively, including the current portion of $1.1 million
and $1.0 million, respectively, with an interest rate of 5.15% and
4.50% at December 31, 2004 and 2003, respectively.
The maturity schedule of the Company's long-term debt is as follows
(dollars in thousands):
<Table>
<Caption>
AMOUNT
----------
2005.................................................................... $ 8,620
2006.................................................................... 1,118
2007.................................................................... 1,002
2008.................................................................... 657
2009.................................................................... 46
Thereafter.............................................................. --
----------
11,443
Less: current portion................................................... 8,620
----------
Long-term debt.......................................................... $ 2,823
==========
</Table>
7. EMPLOYEE BENEFIT PLANS
The Company provides its employees with the option to participate in
its Internal Revenue Code Section 401(k) Plan, the Alliance
Entertainment Corp. 401(k) Savings Plan. Participation in the 401(k)
Plan is available to substantially all employees after a certain period
of employment. Generally, employees may contribute up to 15% of their
annual compensation to the 401(k) Plan on a pretax basis, subject to a
limitation. Under the 401(k) Plan, Alliance makes matching
contributions of 50% of the employees' contributions (highly
compensated employees are limited in their contributions), up to a
maximum of 5% of the eligible participants' annual compensation. The
Company's contribution to the 401(k) Plan for the years ended December
31, 2004, 2003 and 2002 totaled $0.7 million, $0.6 million and $0.6
million, respectively.
13
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
8. INCOME TAXES
At December 31, 2004 and 2003, the Company had deferred tax assets of
approximately $22.1 million and $67.9 million, deferred tax liabilities
of $2.1 million and $11.2 million and a valuation allowance of $0 and
$56.7 million, respectively. In a spin-off transaction more fully
described in Note 1, Alliance distributed deferred tax assets of
approximately $23.2 million and deferred tax liabilities of
approximately $6 million and a valuation allowance of $17.2 million.
In July 1997, Alliance and fourteen of its wholly-owned subsidiaries
filed voluntary petitions for relief under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the
Southern District of New York in order to facilitate the reorganization
of its primary businesses and to restructure its long-term debt. The
Company emerged from bankruptcy in August of 1998.
As a result of the 1998 reorganization, the Company is treated as
having experienced an "ownership change" under Internal Revenue Code
Section 382. Accordingly, under Section 382, the Company's ability to
offset income in each post-reorganization taxable year by its then
remaining NOLs and certain built-in losses (including depreciation and
amortization deductions of any portion of the company's basis in assets
with built-in-losses) is limited.
The provision for income tax for the years ended December 31, 2004,
2003 and 2002 includes current tax expense of $1.1 million, $0.1
million and $0, respectively, and net deferred tax (benefit) expense of
($12.8) million, $0.9 million and $0.7 million, respectively. Included
in the deferred tax benefit for the year ended December 31, 2004 is the
reversal of the valuation allowance remaining after the distribution of
deferred tax assets associated with the spin-off and current period
true-up and utilization. Additionally, in accordance with SOP 90-7,
$7.2 million of the deferred provision, representing the utilization of
remaining pre-bankruptcy deferred tax assets, has been credited to
"reorganization value in excess of amounts allocable to identifiable
assets".
The following table presents the principal reasons for the difference
between the effective tax rate and the U.S. federal statutory income
tax rate:
<Table>
<Caption>
2004 2003 2002
---------- ---------- ----------
U.S. federal statutory tax ............................................... 35.0% 35.0% 35.0%
State and local taxes .................................................... 5.3% 5.1% 5.4%
Reorganization value in excess of amounts allocable to identifiable assets 0.0% 5.0% 6.0%
Release of deferred tax valuation allowance .............................. (90.9%) 0.0% 0.0%
---------- ---------- ----------
Provision for (benefit from) income taxes ................................ (50.6%) 45.1% 46.4%
========== ========== ==========
</Table>
The components of deferred tax assets and liabilities are as follows:
<Table>
<Caption>
2004 2003
------------ ------------
Deferred income tax assets and liabilities
Bad debt reserves ................................... $ 5,736 $ 4,373
Inventory reserves .................................. 2,471 3,983
Intangible assets ................................... 2,915 3,241
Net operating loss/credit carry forwards ............ 5,156 49,026
Other ............................................... 5,814 7,272
Property and equipment .............................. (2,062) (11,190)
Valuation allowance ................................. -- (56,705)
------------ ------------
Net deferred tax assets ............................... $ 20,030 $ --
============ ============
</Table>
14
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
9. COMMITMENTS AND CONTINGENCIES
The Company leases facilities as well as computer and other equipment
under various capital and operating leases. Lease expense related to
operating leases was $2.5 million, $3.7 million and $2.5 million for
the years ended December 31, 2004, 2003 and 2002, respectively. Future
minimum payments under capital and noncancelable operating leases with
terms of one year or more at December 31, 2004 consist of the following
(dollars in thousands):
<Table>
<Caption>
OPERATING CAPITAL
LEASES LEASES
------------ ------------
2005 ............................................................. $ 1,711 $ 490
2006 ............................................................. 1,489 184
2007 ............................................................. 1,083 18
2008 ............................................................. 764 --
2009 ............................................................. 258
Thereafter ....................................................... -- --
------------ ------------
$ 5,305 692
============
Less: Amounts representing interest .............................. (32)
------------
Present value of net minimum lease payments ...................... 660
Less: Current portion of obligations under capital leases ........ (465)
------------
Long-term portion of obligations under capital leases ............ $ 195
============
</Table>
During 2003, the courts dismissed a claim filed in 1999 alleging
copyright infringement and anti-trust violations relating to the
Company's proprietary database with Alliance named as a co-defendant.
The cases were stayed in May 2001, pending discussions between the
parties, and dismissed in 2003.
The Company is also involved in various claims and possible actions
arising out of the normal course of its business, none of which, in the
opinion of the Company, based upon knowledge of facts and the advice of
counsel, will result in a material adverse effect on the Company's
financial position, results of operations or cash flows.
10. SIGNIFICANT CONCENTRATIONS OF BUSINESS AND CREDIT RISK
Alliance's customers are primarily chain and independent traditional
retailers and Internet based e-tailers. Evaluations of customers'
financial condition are performed regularly and, generally, no
collateral is required. Alliance maintains reserves for potential
credit losses and such losses, in the aggregate, have generally not
exceeded management's estimates.
Competition results in changes in the Company's customer base over
time, and it is therefore possible that the Company may lose one or
more of its largest customers and, as a result, operations could be
materially impacted. Pursuant to an agreement active through June 2004
and renewed through March 2006 (Note 13), one customer and this
customer's subsidiaries accounted for approximately 35.3%, 33.9%, and
32.3% of net sales in the years ended December 31, 2004, 2003 and 2002,
respectively. At December 31, 2004 and 2003, this customer and this
customer's subsidiaries owed Alliance $70.4 million and $61.2 million,
respectively. This agreement provides for exclusive distribution of CDs
and DVDs.
15
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
Alliance sells products throughout the world, including to certain
countries in South America and Asia. Alliance's financial results and
financial condition have not been negatively impacted by the economic
difficulties experienced by these countries as a result of the limited
credit being extended to customers in these countries.
The Company's headquarters and operating facilities are all located in
the United States. While the principal markets for the Company's
products and services are in the United States, the Company recognized
net revenues of $122.1 million, $107.1 million and $84.7 million from
international sources in the years ended December 31, 2004, 2003 and
2002, respectively, and had accounts receivable related to such
transactions totaling $18.0 million and $16.7 million at December 31,
2004 and 2003, respectively.
11. MANDATORILY REDEEMABLE PREFERRED STOCK
Alliance's Series A1, A2 and Series B Cumulative Preferred Stock, more
fully described below, contain certain optional redemption provisions.
As the holders of the Series A1 and A2 Cumulative Preferred Stock
control the Company, these optional redemption rights are deemed
mandatory. Accordingly, these securities are not considered as part of
permanent equity in the accompanying consolidated balance sheets.
PREFERRED STOCK
The Company has 20,000 shares authorized and outstanding of its Series
A1 Cumulative Preferred Stock (the "Series A1 Preferred Stock") and
45,000 shares authorized, 40,967 shares outstanding, of its Series A2
Cumulative Preferred Stock (the "Series A2 Preferred Stock") at
December 31, 2004 and December 31, 2003. The Series A1 Preferred Stock
is currently redeemable by the Company and ranks prior to all other
classes and series of equity securities other than the Series B
Preferred Stock and ranks pari passu to the Series A2 Preferred Stock,
with respect to dividend rights, rights on liquidation, winding up and
dissolution. In the event of Company redemption, voluntary or
involuntary liquidation, dissolution or winding up of the affairs of
the Company, the holders of Series A1 Preferred Stock shall be entitled
to be paid out of the assets of the Company available for distribution
to its stockholders an amount in cash equal to $1,000 per share of
Series A1 Preferred Stock outstanding plus an amount in cash equal to
all accrued and unpaid dividends.
The holders of the Series A1 Preferred Stock are entitled to receive
cumulative dividends when, and if, declared by the Board of Directors
at the annual rate of $125.00 per share until May 18, 2001 and $150.00
per share thereafter. The redemption value is based upon the stated
redemption price of $1,000 per share plus accrued and unpaid dividends.
At December 31, 2004 and December 31, 2003, the redemption value of the
Series A1 Preferred Stock is $35.9 million and $32.9 million,
respectively, and includes cumulative undeclared dividends of $15.9
million and $12.9 million, respectively.
The Series A2 Preferred Stock is currently redeemable by the Company
and ranks prior to all other classes and series of equity securities
other than the Series B Preferred Stock and ranks pari passu to the
Series A1 Preferred Stock, with respect to dividend rights, rights on
liquidation, winding up and dissolution. In the event of Company
redemption, voluntary or involuntary liquidation, dissolution or
winding up of the affairs of the Company, the holders of Series A2
Preferred Stock shall be entitled to be paid out of the assets of the
Company available for distribution to its stockholders an amount in
cash equal to $1,000 per share of Series A2 Preferred Stock outstanding
plus an amount in cash equal to all accrued and unpaid dividends. The
Series A1 and Series A2
16
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
Preferred Stock may also be converted into shares of Alliance Common
Stock at any time after November 18, 2000. For the purposes of
conversion each share of Series A1 and Series A2 Preferred Stock shall
be valued at liquidation preference, which shall be divided by the
conversion price (currently $5.00 per share) in effect on the
conversion date to determine the number of shares of Alliance Common
Stock issuable upon conversion.
The holders of the Series A2 Preferred Stock are entitled to receive
cumulative dividends when, and if, declared by the Board of Directors
at the annual rate of $125.00 per share until May 18, 2001 and $150.00
per share thereafter. Its redemption value is based upon the stated
redemption price of $1,000 per share plus accrued and unpaid dividends.
At December 31, 2004 and December 31, 2003, the redemption value of the
Series A2 Preferred Stock is $70.4 million and $64.2 million,
respectively, and includes cumulative undeclared dividends of $29.4
million and $23.3 million, respectively.
The Series A1 and Series A2 Preferred Stock may also be converted at
the option of the holder into shares of Alliance Common Stock at any
time after November 18, 2000. For the purposes of conversion each share
of Series A1 and Series A2 Preferred Stock shall be valued at $1,000
plus unpaid dividends, which shall be divided by the conversion price
(currently $5.00 per share) in effect on the conversion date to
determine the number of shares of Alliance Common Stock issuable upon
conversion.
The Series B Preferred Stock ranks senior to all other classes or
series of the Company's equity securities with respect to dividend
rights and the rights to distributions, whether upon liquidation,
winding up or otherwise. The dividend rate for the Series B Preferred
Stock is 10% of the original purchase price, payable quarterly and
distributed as declared by the Board of Directors. The Series B
Preferred Stock may be redeemed at the Company's option any time after
January 15, 2003 at $2.60 per share, together with dividends thereon
accrued and unpaid (whether or not declared). Holders of Series B
Preferred Stock may convert such shares of Series B Preferred Stock
into shares of the Company's Common Stock at an initial price of $2.60
per share which represents the initial fair value based on the
Company's valuation, making each share of Series B Preferred Stock
convertible into one (1) share of Common Stock. The holders of Series B
Preferred Stock will have no voting rights, except as provided by
applicable law. As of December 31, 2004 and 2003, there were $5.4
million and $3.7 million, respectively, of cumulative undeclared
dividends. These shares are primarily held by the Company's majority
stockholder.
12. STOCKHOLDERS' EQUITY
COMMON STOCK AND PAID-IN-CAPITAL
As of December 31, 2004 and 2003, there were 71,758,845 and 71,738,845
shares, respectively, of the Company's Common Stock outstanding.
Included in paid-in-capital prior to the spin-off of DMISG at December
31, 2004 are 1,104,375 shares of the Company's Common Stock
representing shares reserved for issuance as part of the purchase
consideration in the Company's 1999 acquisition of DOD. These 1,104,375
shares remain unissued as of December 31, 2004, but are expected to be
issued in 2005 and revert to former DOD shareholders.
17
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
Included in paid-in-capital prior to the spin-off of DMISG at December
31, 2004 are 1,278 shares of Series A2 Preferred Stock representing
shares reserved for issuance as part of the purchase consideration in
the Company's 1999 acquisition of DOD. These 1,278 shares remain
unissued as of December 31, 2004, but are expected to be issued in 2005
and revert to former DOD shareholders. The unrecorded dividends
associated with these 1,278 Series A2 Preferred shares are $0.6 million
and $0.4 million, as of December 31, 2004 and 2003, respectively.
STOCK OPTIONS
The Company's 1999 Equity Participation Plan (the "Old 1999 Equity
Plan") provided for the issuance of incentive stock options and
non-qualified stock options. The Old 1999 Equity Plan provided for
administration by the Company's Board of Directors, which, subject to
the terms of the Old 1999 Equity Plan, determines to whom grants are
made, and the vesting, timing, amounts and other terms of such grants.
Incentive stock options may be granted only to employees of the
Company, while non-qualified stock options may be granted to the
Company's employees, officers, directors, consultants and advisors. The
exercise price of incentive stock options may be less than the fair
market value of the Company's Common Stock on the date of grant. The
term of these options may not exceed 10 years. The Old 1999 Equity Plan
had no remaining options available for new grants as of December 31,
2001.
In connection with the acquisition by AEC Associates in May 1999, the
option program was augmented by a new option plan called The Company's
1999 Employee Equity Participation and Incentive Plan (the "New 1999
Equity and Incentive Plan"), which provides for the issuance of
incentive stock options and non-qualified stock options. Under the
terms of the New 1999 Equity and Incentive Plan, a maximum of 7,582,518
shares of the Company's Common Stock may be issued upon the exercise of
stock options granted thereunder. As of December 31, 2004 and 2003,
7,391,258 options have been granted under the New 1999 Equity and
Incentive Plan and 191,260 options remain available for future grants.
The New 1999 Equity and Incentive Plan provides for administration by
the Company's Board of Directors which, subject to the terms of the New
1999 Equity and Incentive Plan, determines to whom grants are made and
the vesting, timing, amounts and other terms of such grants.
Information with regard to the stock options outstanding is as follows:
<Table>
<Caption>
WEIGHTED WEIGHTED WEIGHTED
AVG. AVG. AVG.
EXERCISE EXERCISE EXERCISE
2004 PRICE 2003 PRICE 2002 PRICE
---------- -------- --------- -------- --------- --------
Options outstanding at beginning
of year .............................. 6,029,213 $ 2.29 6,625,244 $ 2.31 7,355,358 $ 2.26
Exercised .............................. (20,000) 0.50 -- -- -- --
Cancelled .............................. (3,118,058) 2.57 (596,031) 1.72 (730,114) 1.92
Granted ................................ -- -- -- -- -- --
---------- -------- --------- -------- --------- --------
Options outstanding at
end of year ........................... 2,891,155 $ 2.00 6,029,213 $ 2.29 6,625,244 $ 2.31
========== ======== ========= ======== ========= ========
Options exercisable at
end of year ........................... 2,891,155 $ 2.00 5,989,063 $ 2.29 5,753,092 $ 2.28
========== ======== ========= ======== ========= ========
</Table>
18
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
In accordance with SFAS No. 123 "Accounting for Stock-Based
Compensation", (SFAS No. 123), the Company has accounted for
stock-based compensation grants issued to non-employees as provided for
by SFAS No. 123. The Company has elected to continue to account for its
stock-based compensation grants to employees and directors in
accordance with the provisions of APB Opinion No. 25 "Accounting for
Stock Issued to Employees". However, in accordance with SFAS No. 123,
the pro forma effect of the issuance of such options is set forth
below.
The fair value of each option granted to non-employees and employees
has been estimated as of the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
risk-free interest rates ranging from 4.2 percent through 4.3 percent
for 2004, 4.2 percent through 4.3 percent for 2003 and 3.9 percent
through 4.1 percent for 2002, dividend yield of zero percent for all
years; expected lives ranging from 4 to 10 years for 2004, 2003 and
2002, and volatility of zero percent for 2004, 2003 and 2002.
The compensation expense, if recognized, would have resulted in pro
forma amounts based on weighted average fair value of options granted
of $0.98, $0.95 and $1.12 for the years ended December 31, 2004, 2003
and 2002, respectively, as indicated below:
<Table>
<Caption>
2004 2003 2002
---------- ---------- --------
Net income -- as reported................................... $ 34,869 $ 1,248 $ 813
Net income (loss) -- pro forma.............................. 32,715 (3,822) (4,602)
</Table>
13. RELATED PARTY TRANSACTIONS
Pursuant to a management agreement entered into in connection with the
1999 purchase of 90% the Company's shares by AEC Associates, L.L.C.
("AEC Associates") the Company is charged an annual management fee in
the amount of $0.5 million. In addition, the Company must pay a
financial advisory and consulting fee on certain acquisition and
disposition transactions in which AEC Associates provides advisory or
consulting services. The Company did not pay a financial advisory and
consulting fee to AEC Associates during the year ended December 31,
2004, however, in connection with the merger with Source Interlink to
take place in 2005, the Company expects to pay $4.0 million upon
consummation of the merger. There were no charges for advisory and
consulting services during the year ended December 31, 2003. The
Company paid AEC Associates $0.3 million for services in connection
with the Company's proposed merger during the year ended December 31,
2002. In addition, the Company paid an affiliate of AEC Associates $0.2
million and $58,000, respectively, during the years ended December 31,
2004 and 2003 relating to services provided by the interim chief
executive officer of Alliance.
Pursuant to an agreement active through June of 2004 and renewed
through March 2006 , the Company conducts significant business with one
customer (Note 10). The Chairman and major stockholder of this customer
is a significant stockholder of AEC Associates. The Company had net
sales of $338.9 million, $295.1 million and $260.8 million to this
customer and this customer's subsidiaries for the years ended December
31, 2004, 2003 and 2002, respectively.
The Company, through a subsidiary, paid licensing royalties on a per
units sold basis to a third party, which is 40% owned by a previous
member of the subsidiary's management team. Total licensing royalties
paid under this agreement for the years ended December 31, 2004, 2003
and 2002 were $0, $0 and $12,000, respectively. An incremental
distribution fee paid to this third party was $24,000, $0.1 million and
$0.1 million for the years ended December 31, 2004, 2003
19
ALLIANCE ENTERTAINMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
and 2002, respectively. In addition, the Company paid $0.3 million
during the year ended December 31, 2002 to this third party for a
three-year agreement granting the Company exclusive licensing rights to
the title and trademark associated with a certain compilation.
The Company previously leased warehouse space from a former member of
its senior management team. This lease was negotiated as part of the
acquisition of OWR. During the years ended December 31, 2004, 2003 and
2002, the Company paid $0.2 million, $0.3 million and $0.3 million,
respectively, in rent associated with this lease. The lease expired in
August 2004, and OWR was phased out during 2004.
20