via Edgar
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Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: Adsouth Partners, Inc., File No. 0-33135
Form 10-KSB for the year ended December 31, 2004
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Ladies and Gentlemen:
In response to the Commission's letter of comments dated April 29, 2005, we have
the following responses to the staff's comment. As indicated below, where
applicable we have addressed the staff's comments in our Form 10-QSB for the
quarter ended March 31, 2005, which was filed with the Commission via Edgar on
May 16, 2005.
Comment 1
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We confirm to the Commission that the Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are effective in ensuring that material information required to be
disclosed is included in the reports that it files with the Securities and
Exchange Commission.
We complied with this comment in our Form 10-QSB for the quarter ended
March 31, 2005 and we will continue to comply with this Comment 1 in our future
filings.
Comment 2
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We confirm that we are using the definition of disclosure controls and
procedures that are found in Rule 13a-15(e) or 15d-15(e). Our Form 10-QSB for
the quarter ended March 31, 2005 cites, and all future filings will cite Rule
13a-15(e) or 15d-15(e) and will not cite Rule 13a-14(c).
Comment 3
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We confirm that our Chief Executive Officer and Chief Financial Officer
have concluded that the Company's disclosure controls and procedures are
effective in ensuring that material information required to be disclosed is
included in the reports that it files with the Securities and Exchange
Commission. Language to this effect is included in Item 3 of Part II of our Form
10-QSB for the quarter ended March 31, 2005.
Comment 4
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We confirm to the Commission that during the fourth quarter of 2004
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.
We further confirm to the Commission that we complied with Item 308(c)
of Regulation S-B in our Form 10-QSB for the quarter ended March 31, 2005 and we
will comply with Item 308(c) of Regulation S-B in our future filings.
Comment 5
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On September 22, 2004, our wholly owned subsidiary, Adsouth, Inc.
executed an Account Transfer and Purchase Agreement (the "Factoring Agreement")
with Marquette Commercial Finance, Inc. ("Marquette").
We account for receivables factored pursuant to the Factoring Agreement
in accordance with FAS 140: "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities" and we have concluded that factored
receivables should be accounted for as sold.
FAS 140 Guidance:
A transfer of financial assets (or all or a portion of a financial
asset) in which the transferor surrenders control over those financial assets
shall be accounted for as a sale to the extent that consideration other than
beneficial interests in the transferred assets is received in exchange. The
transferor has surrendered control over transferred assets if and only if all of
the following conditions are met:
a. The transferred assets have been isolated from the transferor--put
presumptively beyond the reach of the transferor and its creditors, even in
bankruptcy or other receivership:
b. Each transferee has the right to pledge or exchange the assets it
received, and no condition both constrains the transferee from taking advantage
of its right to pledge or exchange and provides more than a trivial benefit to
the transferor (FAS 140).
c. The transferor does not maintain effective control over the
transferred assets through either (1) an agreement that both entitles and
obligates the transferor to repurchase or redeem them before their maturity or
(2) the ability to unilaterally cause the holder to return specific assets,
other than through a cleanup call (FAS 140).
Application of FAS 140:
The Factoring Agreement states that each account purchased by Marquette
is purchased without recourse against Adsouth, Inc. and that all losses incurred
by Marquette from the financial inability of the applicable account debtor to
pay such account over and above any and all Residual Payments and Reserve
amounts offset shall be borne solely by Marquette.
The Factoring Agreement states that Adsouth, Inc. sells, transfers,
assigns and otherwise conveys to Marquette (as a sale by Adsouth, Inc. and a
purchase by Marquette), and not as security for any indebtedness or other
obligation of Adsouth, Inc. to Marquette, all right, title and interest of
Adsouth, Inc. in and to all accounts accepted by Marquette for purchase.
The Factoring Agreement does not contain any provisions in which
Adsouth, Inc. is required to repurchase or redeem the sold invoices. The
Factoring Agreement does not provide Adsouth, Inc. with the right of return for
any of the invoices that are sold to Marquette. The Factoring Agreement does
provide that in the event that Adsouth, Inc. has breached any material
representation, warranty, covenant or agreement contained in the factoring
agreement, any account is not paid in full within 90 days from the date of
purchase of the account or Marquette deems itself insecure, Marquette may at its
election, withhold and accumulate the payment of the Residual Payment as to any
accounts purchased to the extent necessary to maintain a Reserve in an amount
equal to the sum of (a) the total Initial Payments made by Marquette which
remain uncollected, plus (b) the total of the Marquette Fixed and Variable
Discounts with respect to such accounts and (c) such other amounts which may
become due by Adsouth, Inc. to Marquette. This right to reserve funds by
Marquette does not however give them the right to force Adsouth, Inc. to
repurchase any of the factored invoices.
FAS 140 Guidance:
Upon completion of a transfer of assets that satisfies the conditions
to be accounted for as a sale, the transferor (seller) shall:
a. Derecognize all assets sold
b. Recognize all assets obtained and liabilities incurred in
consideration as proceeds of the sale, including cash, put or call options held
or written (for example, guarantee or recourse obligations), forward commitments
(for example, commitments to deliver additional receivables during the revolving
periods of some securitizations), swaps (for example, provisions that convert
interest rates from fixed to variable), and servicing liabilities, if
applicable.
c. Initially measure at fair value assets obtained and liabilities
incurred in a sale or, if it is not practicable to estimate the fair value of an
asset or a liability, apply alternative measures.
d. Recognize in earnings any gain or loss on the sale.
Application of FAS 140:
Pursuant to the factoring agreement, the purchase price for each
account purchased consists of the Initial Payment and the Residual Payment. The
Initial Payment consists of 80% of the gross face value of the invoice purchased
and is payable by Marquette to Adsouth, Inc. on the business day that Marquette
accepts the account for purchase. The Residual Payment is payable by Marquette
to Adsouth, Inc. within five business days after Marquette receives the proceeds
of collection for the subject account in an amount equal to the gross face value
of such account, less all permitted discounts, deductions and allowances, less
Fixed and Variable Discounts, less the Initial Payment, and less any attorney's
fees and costs of collection. Upon the sale of an invoice we derecognize the
asset sold.
By way of example assume that Adsouth, Inc. sells an invoice for
$10,000 to Marquette. The journal entry upon the sale is as follows:
Debit Credit
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Cash $8,000
Fixed discount (other $100
Due from Factor $1,900
Accounts receivable $10,000
When the factor collects payments on the factored invoices, a reserve
settlement is paid to Adsouth by Marquette which consists of the reserve less
fixed variable discounts. In our example the variable reserve is assumed to be
7.2% for 30 days or $60 [$10,000 * 7.2% * (30/360)]. The journal entry upon
receipt of the reserve settlement is as follows:
Debit Credit
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Cash $1,840
Variable discount (other $60
Due from Factor $1,900
For all reporting periods we accrue the variable discount on
outstanding factored invoices.
Purpose of 20% Reserve
Upon the sale of an invoice, Marquette sends Adsouth, Inc., 80% of the
gross invoice. Upon collection of the invoice by Marquette, Adsouth, Inc.
receives a residual payment. The residual payment is the amount of the initial
20% reserve less fixed and variable discounts and any sales discounts or
allowances taken by the Adsouth customer. The purpose of the 20% reserve by
Marquette is to ensure that the net collection on the invoices covers the fixed
and variable discounts owed to it.
Classification of Discounts as Interest Expense
In our 10-QSB for the quarter ended September 30, 2004 and in our 10KSB
for the year ended December 31, 2004 the discounts were included in interest
expense as such amounts represent a cost of funds. Beginning with the 10-QSB for
the quarter ended March 31, 2005, and for all future filings, we are classifying
the discount separate from interest expense in other expenses. The total factor
discounts included in interest expense for both the three and nine months ended
September 30, 2004 was $9,000. The total factor discounts included in interest
expense for the year ended December 31, 2004 was $15,000.
Due to Factor at December 31, 2004
During December of 2004, we agreed to provide a customer with a
$120,000 advertising allowance to be included in the customer's advertising
program. When Adsouth, Inc. agreed to the advertising allowance, it believed
that the allowance would be deducted from future invoices. However, the
allowance was deducted by the customer from an accounts receivable payment on
invoices which had previously been factored by Marquette. As a result, as of
December 31, 2004, Adsouth, Inc. owed Marquette for the amount of the
advertising allowance. Such amount was subsequently re-paid to Marquette in 2005
from customer collections that were submitted directly to the factor.
Amount of Receivables Sold During 2004
For the year ended December 31, 2004, the total receivables sold to
Marquette were $928,000. In all future filings we will include such disclosure.
This disclosure for the first quarter of 2005 is included in Note 2(f) of Notes
to Unaudited Condensed Consolidated Interim Financial Statements in our Form
10-QSB for the quarter ended March 31, 2005.
Comment 6
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We account for our investments in product line rights pursuant to FAS
142.
In February 2004, we acquired 100% of the net equity of Dermafresh,
Inc. for $125,000. Dermafresh, Inc. was organized by its sellers in January 2004
for the sole purpose of transferring the rights to the Dermafresh Line which
included a microdermabrasion unit which was then being marketed by the sellers
under the name of Dermafresh. On the date of acquisition, Dermafresh, Inc. had
no liabilities, no operating activities and its only asset was the right to the
Dermafresh microdermabrasion unit. The substance of the transaction was not a
business combination but was the acquisition of an asset since Dermafresh, Inc.
was organized for the sole purpose of transferring such rights to us.
We concluded that the rights acquired had a finite life as opposed to
an indefinite life. In making this determination, we considered the effects of
obsolescence, demand, competition, and other economic factors. In particular,
the economic impact of product life cycles as dictated by consumer demand in the
skin care industry historically have resulted in product companies phasing out a
particular product as new products are introduced to the skin care line and
thereby creating new demand for the product line as a whole. Pursuant to FAS 142
intangible assets that are determined to have a finite life are subject to
amortization. Accordingly, we are amortizing the cost of such rights as an
expense against future sales under the Dermafresh product line.
FAS 142 states that if an intangible asset has a finite useful life,
but the precise length of that life is not known, that intangible asset shall be
amortized over the best estimate of its useful life. The method of amortization
shall reflect the pattern in which the economic benefits of the intangible asset
are consumed or otherwise used up. We concluded that the economic benefits of
the Dermafresh rights correspond most directly with the pattern of revenues that
will be derived from the Dermafresh Line. Accordingly, we are amortizing the
cost of the Dermafresh rights as determined by dividing the Dermafresh revenues
of the reporting period by the estimated lifetime Dermafresh revenues multiplied
by the capitalized cost of the Dermafresh rights.
In determining a reasonable estimate of the lifetime revenues of the
Dermafresh Line we considered the level of initial orders received from the
retailers, anticipated replenishment orders based on discussions with our
customers and the sell through rates of our direct response test campaign
launch. Based on this evaluation we calculated the future estimated revenues by
multiplying estimated unit sales by average anticipated sales prices.
On a quarterly basis we review our initial assumptions and conclusions
in order to determine whether events and circumstances warrant a revision to the
remaining period of amortization. As a part of such review we also evaluate the
Dermafresh rights in order to determine if any impairment has occurred in
accordance with FAS 144.
Comment 7
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In January 2005, we formed Miko Distributors, Inc. as a wholly owned
subsidiary of the Company and used such entity to acquire certain assets of Miko
Brands, LLC. Miko Brands, LLC's sole asset acquired was the Miko Brand name and
product formulations which we now have rights to. Based on the nature of the
Miko Brand, which is a line of marinade and dressing sauces, and the length of
time for which it has been sold by the prior owners, we have determined that the
Miko Brand will have an indefinite life. Accordingly, pursuant to FAS 142 such
asset will not be amortized, and will be reviewed quarterly for impairment
pursuant to FAS 144. In the first quarter of 2005 we recorded the product right
asset at $83,000, the fair value of the stock issued to acquire such asset.
To date we have not paid any fees or consideration for marketing rights
other than the Dermafresh and Miko brands, which we purchased. Our other product
distribution agreements provide us either exclusive or non-exclusive rights to
distribute the products owned by the entity with which we have the agreements.
Generally, the distribution agreements provide us with the right to purchase
their products at a contractual price and distribute them in the geographic
areas designated in the agreements. Based on the nature and content of such
distribution agreements and the absence of any payment for the marketing or
other rights there is no accounting other than the recording of purchases and
sales when such transactions occur.
Comment 8
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During 2004, $2.7 million, or 67%, of our total revenue was derived
from one advertising customer. As of September 30, 2004, this customer had
timely paid its invoices and had confirmed to us that the balance of its
outstanding receivables of $742,000 would be paid in the last week of November
of 2004. SAB's 101 and 104 addresses revenue recognition and states that revenue
is generally realized or realizable and earned when all of the following have
been met: (i) Persuasive evidence of an arrangement exists; (ii) delivery has
occurred or services have been rendered; (iii) the seller's price to the buyer
is fixed or determinable; and, (iv) collectibility is reasonably assured. At the
time the revenue was recognized we had signed sales orders for the advertising
services, the advertising media had aired, the media costs had been paid to the
networks by Adsouth and the prices for such services had been fixed pursuant to
the signed sales orders.
From January 1, 2004 to September 30, 2004, we received payment for the
services provided to the customer in amounts aggregating $1.9 million. We
received an additional payment of $100,000 on the balances that were owed on
December 21, 2004. At the end of December 2004, it was determined that the
customer was having liquidity problems and in January 2005 we accepted certain
restricted company stock, valued at fair value, as a partial payment on the
balance owed at such time. Based on doubts about collection of the $482,000
remaining balance we reserved such balance as of December 31, 2004. Such amounts
that were reserved at December 31, 2004 related to revenues recognized in the
third quarter of 2004. Based on the customer's prior payment history the Company
was reasonably assured that, at September 30, 2004, the amounts due for the
services rendered at that date were collectible and based on such assessment
recognized the revenues in the same manner as the services provided to such
customer in the past.
Comment 9
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We recognize revenues for our product shipments upon shipment of the
goods, net of estimated returns allowances. As of December 31, 2004, we had
shipped product to one customer for which the customer had a right of return and
we had an obligation to accept return of the product until such time as the
product was sold by the customer to an end user of the product. On such sales,
we did not recognize the
revenue until we received notification from the customer that the product has
been sold to the end user. Such shipments approximated $12,000 during 2004.
For all other product sales, the selling price to the customer is fixed
at the date of sale, the customer is obligated to pay the Company and such
payment is not contingent on the customer's resale of the product, all damages
allowances, if any, are known upfront and are not recognized as revenues, the
customers are generally large well known and established retailers who have
significant economic substance not related to the purchases they make from the
Company, the Company does not have significant obligations to bring about the
resale of the product by its customers and the amount of any future returns can
be reasonable estimated. The Company does not have any "bill and hold'
arrangements with its customers. Based on these facts, the Company's revenue
recognition policies are consistent with paragraph 6 of FAS 48 and the "delivery
and acceptance" criteria addressed in SAB's 101 and 104.
On a quarterly basis, we calculate an estimate of returns and accrue
for such estimate along with promotional allowances. Promotional allowances are
based on known amounts that are given to our customers and are generally based
on a planned advertising campaign to promote the sell through of the products in
the retail stores. The estimate of sales returns is based on a number of factors
including the results of our initial tests performed through direct response
advertising, feedback we receive from our customer's buyers as to current sell
through of the product and an evaluation of historical returns. During 2004,
substantially all of our product revenues were generated from sales of the
Dermafresh line of products. We addressed the guidance as provided by paragraph
8 FAS 48 in calculating our estimates of returns as follows:
(a) External Factors - The Dermafresh line is not significantly
susceptible to technological obsolescence or changes in demand over the time
period in which returns of the product may be reasonably expected. The
Microdermabrasion unit is not a mechanically complex unit and various brands of
the unit have been on the market for several years and demand has remained
strong. The facial blanket utilizes collagen as its primary ingredient. The
positive effects of collagen have been long proven and it is likely that a
collagen treatment will remain the preeminent ingredient for facial treatments.
The facial blanket has the added benefit of its unique application which is in a
thin blanket form as opposed to a "mud" type treatment which is expected to aid
in ensuring its continued demand due to its ease of use. The ingredient make-up
of the anti-wrinkle and firming serum product is sublicensed from Procter and
Gamble through the manufacturer. Anti-wrinkle products have been a proven
consumer product for decades and there continues to be increasing demand for
products of this nature.
(b) Expected Returns Period - At such time as the consumer purchases
the product the likelihood of return is significantly reduced. As such, the
positive sell through of the product line has diminished the exposure for future
returns. We strategically limited the initial shipment of product to our
customers to six deep for each of the three products for each store. This
strategy was purposely employed to reduce the risk of large returns until the
sell though rate could be proven and to ensure that all products shipped would
be on the shelves and would not represent excess inventory, sometimes referred
to as channel stuffing.
(c) Historical Experience - Our President has significant experience in
product marketing campaigns. In addition, he is a former owner of the company
from which the Dermafresh product was purchased and he has direct experience
with the sales of similar microdermabrasion products. Also, his experience
includes a sales history with our existing customers. Based on his experience
and knowledge, the President has a historical perspective from which to analyze
the likelihood of the returns of the Dermafresh product line. Based on
information that he receives from the customers, and an analysis of the reorders
from the customers, he is able to develop reasonable assumptions and estimates
with regards to sales returns.
(d) Homogeneous Transactions - The Company's products sales represent a
large volume of homogenous transactions.
Comment 10
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We confirm that the chief financial officer meant to certify "this
annual report" on Form 10KSB", rather than "this quarterly report" in our
Exhibit 31.2 attached to the 2004 10KSB.
Comment 11
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We confirm that in all future filings we will remove exhibits from the
body of the periodic report and that any exhibits will be filed separately and
tagged on EDGAR as exhibits. We have complied with this comment in our Form
10-QSB for the quarter ended March 31, 2005.
ACKNOWLEDGEMENTS
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We acknowledge the following:
* The Company is responsible for the adequacy and accuracy of
the disclosure in the filings;
* Staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any
action with respect to the filings; and
* The Company may not assert staff comments as a defense in
any proceedings initiated by the Commission or any person
under the federal securities laws of the United States.
Sincerely,
/S/ John P. Acunto, Jr.
Chief Executive Officer
/S/ Anton Lee Wingeier
Chief Financial Officer