ALLIANCECORNER DISTRIBUTORS INC. Financial Statements December 31, 2003 ALLIANCECORNER DISTRIBUTORS INC. Index Page ---- Report of Independent Registered Public Accounting Firm 1 Balance Sheet as of December 31, 2003 2 Statement of Income for the Period from May 9, 2003 (Inception) to December 31, 2003 3 Statement of Stockholders' Equity for the Period from May 9, 2003 (Inception) to December 31, 2003 4 Statement of Cash Flows for the Period from May 9, 2003 (Inception) to December 31, 2003 5-6 Notes to Financial Statements 7-16 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Stockholders AllianceCorner Distributors Inc. We have audited the accompanying balance sheet of AllianceCorner Distributors Inc. as of December 31, 2003, and the related statements of income, stockholders' equity and cash flows for the period from May 9, 2003 (inception) to December 31, 2003. 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 audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AllianceCorner Distributors Inc. as of December 31, 2003, and the results of its operations and its cash flows for the period from May 9, 2003 (inception) to December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ Mahoney Cohen & Company, CPA, P.C. New York, New York February 27, 2004, except for Note 9 for which the dates are June 29, 2004 and July 26, 2004 ALLIANCECORNER DISTRIBUTORS INC. Balance Sheet December 31, 2003 ASSETS (Note 4) Current assets: Cash $ 656,853 Accounts receivable, net of allowance for doubtful accounts of $10,000 180,684 Due from factor (Note 4) 1,283,854 Inventory 2,896,207 Due from vendors 14,400 Prepaid expenses and other current assets 42,074 ---------- Total current assets 5,074,072 Property and equipment, net (Notes 5, 6 and 7) 423,372 Other assets 18,334 ---------- $5,515,778 ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable (Notes 1 and 3) $4,356,341 Capitalized lease obligations - current portion (Note 7) 15,160 Notes payable - current portion (Note 6) 13,170 Accrued expenses and other current liabilities 187,900 ---------- Total current liabilities 4,572,571 Other liabilities: Capitalized lease obligations, net of current portion (Note 7) 20,447 Notes payable, net of current portion (Note 6) 38,943 Other long-term debt (Note 1) 243,750 Deferred rent obligation (Note 8) 4,236 ---------- Total other liabilities 307,376 Commitments and contingencies (Note 8) Stockholders' equity: Common stock, no par value: Authorized, issued and outstanding - 300 shares 300 Additional paid-in capital (Note 1) 435,715 Retained earnings 199,816 ---------- Total stockholders' equity 635,831 ---------- $5,515,778 ========== See accompanying notes. -2- ALLIANCECORNER DISTRIBUTORS INC. Statement of Income For the Period from May 9, 2003 (Inception) to December 31, 2003 Net sales $10,513,231 Cost of goods sold (Note 3) 9,219,064 ----------- Gross profit 1,294,167 Selling, general and administrative expenses 1,077,342 ----------- Income from operations 216,825 Interest expense 9,009 ----------- Income before provision for income taxes 207,816 Provision for income taxes 8,000 ----------- Net income $ 199,816 =========== Basic and diluted net income per common share $ 666.05 =========== Basic and diluted weighted-average common shares outstanding 300 =========== See accompanying notes. -3- ALLIANCECORNER DISTRIBUTORS INC. Statement of Stockholders' Equity For the Period from May 9, 2003 (Inception) to December 31, 2003 Additional Total Common Paid-In Retained Stockholders' Stock Capital Earnings Equity -------- -------- -------- -------- Balance, May 9, 2003 (inception) $ -- $ -- $ -- $ -- Issuance of common stock 300 -- -- 300 Additional paid-in capital contribution -- 435,715 -- 435,715 Net income -- -- 199,816 199,816 -------- -------- -------- -------- Balance, December 31, 2003 $ 300 $435,715 $199,816 $635,831 ======== ======== ======== ======== See accompanying notes. -4- ALLIANCECORNER DISTRIBUTORS INC. Statement of Cash Flows For the Period from May 9, 2003 (Inception) to December 31, 2003 Cash flows from operating activities: Net income $ 199,816 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 26,928 Bad debt expense 10,000 Deferred rent obligation 4,236 Change in assets and liabilities: Accounts receivable (190,684) Due from factor (1,283,854) Inventory (2,896,207) Due from vendors (14,400) Prepaid expenses and other current assets (42,074) Accounts payable 4,600,091 Accrued expenses and other current liabilities 187,900 ----------- Net cash provided by operating activities 601,752 ----------- Cash flows from investing activities: Acquisition of property and equipment (130,044) Other assets (18,334) ----------- Cash used in investing activities (148,378) ----------- Cash flows from financing activities: Proceeds from additional paid-in capital 200,000 Proceeds from notes payable 15,306 Repayment of capital lease obligations (9,064) Repayment of notes payable (2,763) ----------- Net cash provided by financing activities 203,479 ----------- Net increase in cash 656,853 Cash, beginning of period -- ----------- Cash, end of period $ 656,853 =========== See accompanying notes. -5- ALLIANCECORNER DISTRIBUTORS INC. Statement of Cash Flows (Concluded) For the Period from May 9, 2003 (Inception) to December 31, 2003 Supplemental Disclosure of Cash Flow Information Cash paid during the period for: Interest $ 4,009 ========= Supplemental Schedule of Non-Cash Investing and Financing Activities Fair market value of property and equipment contributed $ 276,138 Capital lease obligations assumed (27,227) Notes payable assumed (12,896) --------- Net capital contributed $ 236,015 ========= Equipment acquired under capital lease obligations $ 17,444 ========= Equipment financed by note payable $ 26,674 ========= See accompanying notes. -6- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 1 - The Company AllianceCorner Distributors Inc. ("Alliance" or the "Company") is a wholesale distributor of video games and accessories, whose operations commenced in August 2003, with a customer base substantially throughout the United States. The Company was incorporated as Alliance Partners, Inc. in May 2003 under the laws of the State of New York and financed with $200,000 of equity. In September 2003, the Company admitted a new stockholder, changed its name to AllianceCorner Distributors Inc. and purchased substantially all of the inventory of Corner Distributors, Inc. ("Corner"), a company previously managed by the new stockholder and owned by a relative of the stockholder, for $3,099,626. The acquisition was financed in accordance with the purchase agreement. In December 2003, the Company and Corner agreed to extend the maturity of $243,750 of the purchase price. At December 31, 2003, approximately $1,303,000 is due to Corner, of which approximately $1,059,000 is included in accounts payable and $243,750 is long-term debt which is due and payable on June 30, 2005. In addition, the following net assets, previously owned by Corner, were contributed to the Company and recorded at their fair market value agreed to by the stockholders: Fair market value of property and equipment contributed $ 276,138 Capital lease obligations assumed (27,227) Notes payable assumed (12,896) --------- Net capital contributed $ 236,015 ========= The Company operates as a single segment. Note 2 - Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements relate primarily to bad debt reserves on accounts receivable. -7- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Inventory Inventory consists entirely of finished goods held for sale and is reported at the lower of cost or market, on the average cost basis. At times, the Company makes advance payments to vendors to procure and ensure delivery of certain high demand products. Such deposits are reflected as due from vendors in the balance sheet. Property and Equipment Contributed property and equipment is recorded at fair market value. Purchased property and equipment is recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased assets at the inception of the lease. Leasehold improvements are amortized over the lesser of the lease terms or the assets' useful lives. When property and equipment is retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated lives of the related assets using the straight-line method. The estimated useful lives for significant property and equipment categories are as follows: Vehicles 4 years Warehouse equipment 3 to 7 years Office furniture and equipment 3 to 7 years Leasehold improvements 5 to 10 years -8- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Impairment of Long-Lived Assets The Company follows Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 requires that long-lived assets, including property and equipment, be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The Company assesses its assets for impairment based on the estimated future undiscounted cash flows expected to result from the use of the asset and records impairment losses when this amount is less than the carrying amount. Impairment losses are recorded for the excess of the assets' carrying amount over their fair value, which is generally determined based on the estimated future discounted cash flows over the remaining useful life of the asset using a discount rate determined by management at the date of the impairment review. Management believes at this time that the carrying value and useful life of long-lived assets continue to be appropriate. Revenue Recognition Sales are recorded when products are shipped to customers. Provisions for discounts and rebates to customers, estimated returns and allowances and other adjustments are provided for in the same period the related sales are recorded. Income Taxes The Company, with the consent of its stockholders, elected to have its income taxed under the provisions of Subchapter S of the Internal Revenue Code and the corresponding provisions of New York State Tax laws. Under the aforementioned provisions, corporate income or loss and any tax credits earned are included in the stockholders' individual federal and state income tax returns. Accordingly, no provision has been made for federal income taxes for the period from May 9, 2003 (inception) to December 31, 2003. The Company is subject to New York State S corporation taxes and New York City corporate income taxes. The provision for income taxes comprises state and local taxes. Shipping and Handling Costs The Company includes shipping and handling costs in selling, general and administrative expense. For the period from May 9, 2003 (inception) to December 31, 2003, the Company incurred approximately $144,000 of such costs. -9- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Advertising Expenses Advertising expenses are charged to operations in the period in which they are incurred. Advertising expenses for the period from May 9, 2003 (inception) to December 31, 2003 were approximately $5,000. Fair Value of Financial Instruments The carrying amounts of significant financial instruments, which includes accounts receivable, accounts payable and accrued expenses, approximated fair value as of December 31, 2003 due to their short-term maturities. Advances from the factor and long-term debt approximate fair value due to their variable interest rate. Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income," establishes standards for the reporting and display of comprehensive income and its components in the financial statements. As of December 31, 2003, the Company has no items that represent other comprehensive income and, therefore, has income in the financial statements. Net Income Per Share Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing the net income by the weighted average number of common and common equivalent shares outstanding during the period. The Company has no common equivalent shares outstanding. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements apply to the first fiscal year or interim period ending after March 31, 2004. The Company believes the adoption of FIN 46 will not affect its financial position or results of operations. -10- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Recent Accounting Pronouncements (Continued) In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No.133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." 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 Company does not expect adoption of SFAS No. 149 to have an impact on the financial statements as the Company does not engage in derivative or hedging activity. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a freestanding financial instrument that is within its scope as a liability (or an asset in some circumstances). The adoption of SFAS No. 150 will not have an impact on the Company's reported financial position or results of operations. Note 3 - Concentrations of Credit Risk and Major Suppliers Cash The Company maintains cash balances at two banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Accounts Receivable Concentrations of credit risk with respect to accounts receivable are limited because a large number of geographically diverse customers make up the Company's customer base, thus spreading the trade credit risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. The Company performs credit evaluations of its customers but generally does not require collateral to support accounts receivable. Credit losses have been within management's expectations. -11- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 3 - Concentrations of Credit Risk and Major Suppliers (Continued) Major Suppliers For the period from May 9, 2003 (inception) to December 31, 2003, two suppliers accounted for approximately 22% of purchases. The Company believes that it does not have an economic dependence upon these vendors as alternative means of sourcing are available. At December 31, 2003, the amount due to these suppliers was approximately $856,000 and is included in accounts payable on the accompanying balance sheet. Note 4 - Due from Factor In December 2003, the Company entered into a factoring arrangement with a commercial factor. The Company sells a substantial portion of its trade receivables up to maximum credit limits established by the factor for each individual account. Receivables sold in excess of these limitations are subject to recourse in the event of non-payment by the customer. Under the terms of the agreement, the Company pays interest at the prime lending rate plus 1.5% (5.5% at December 31, 2003) for advances made prior to the collection of the factored accounts receivable. At December 31, 2003, factor advances of approximately $1,100,000 were offset against amounts due from the factor. Substantially all of the Company's assets have been pledged as collateral under the factoring agreement. Under the terms of the agreement, the Company is required to maintain a specified level of net worth, as defined. At December 31, 2003, the Company is in compliance with this covenant. Note 5 - Property and Equipment Property and equipment consists of: Leasehold improvements $226,754 Office furniture and equipment 51,913 Warehouse equipment 73,663 Vehicles 51,630 Equipment under capital leases 46,340 -------- 450,300 Less: Accumulated depreciation and amortization 26,928 -------- $423,372 ======== -12- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 6 - Notes Payable The Company financed the acquisition of certain equipment with notes payable. The notes are secured by related equipment and require total monthly payments of $1,201 including principal and interest. The interest rates of notes range from 0% to 5.5%. At December 31, 2003, maturities of notes payable for each of the next five years are as follows: Year Ending December 31, ------------ 2004 $ 13,170 2005 13,611 2006 12,467 2007 8,125 2008 4,740 ---------- $ 52,113 ========== Note 7 - Capitalized Lease Obligations Capitalized lease obligations consist of: Capitalized lease obligations payable in various monthly installments totalling $1,395, including principal and interest through June 2006, bearing interest at 5.5%. The leases are secured by equipment with a net book value of approximately $40,000 at December 31, 2003 $ 35,607 Less: Current portion 15,160 ---------- $ 20,447 ========== -13- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 7 - Capitalized Lease Obligations (Continued) Minimum future lease payments under the capital leases as of December 31, 2003 are as follows: Year Ending December 31, ------------ 2004 $ 16,691 2005 15,168 2006 6,086 ---------- Total minimum lease payments 37,945 Less: Amount representing interest 2,338 ---------- Present value of net minimum lease payment $ 35,607 ========== Note 8 - Commitments and Contingencies Leases The Company leases showroom, office and warehouse space and various equipment under operating leases expiring from 2005 through 2013. The future minimum lease payments, excluding escalation charges, are as follows: Year Ending December 31, 2004 $ 179,000 2005 185,000 2006 186,000 2007 188,000 2008 131,000 Thereafter 311,000 -------------- $ 1,180,000 ============== -14- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 8 - Commitments and Contingencies (Continued) Leases (Continued) In accordance with Statement of Financial Accounting Standards No. 13, "Accounting for Leases," non-cancellable operating leases with scheduled rent increases require that rent expense be recognized on a straight-line basis over the lease term. Rent expense for the period from May 9, 2003 (inception) to December 31, 2003 includes approximately $4,000 which relates to the amortized portion of the scheduled rent increases. At December 31, 2003, an obligation of approximately $4,000 representing future deferred rent payments is reflected in the accompanying balance sheet. Total rent expense charged to operations for the period from May 9, 2003 (inception) to December 31, 2003 was approximately $46,000. Contingent Bonus Pursuant to an agreement among the stockholders, one of the stockholders is entitled to a bonus contingent upon the Company's earnings. In any calendar year through December 31, 2008, if the Company achieves a certain level of earnings, the stockholder will receive a bonus as defined in the agreement. For the period from May 9, 2003 (inception) to December 31, 2003, no bonus has been earned. Sale by Estate If any stockholder should die, the estate of such deceased stockholder has the ability to sell the stockholder's interests to the Company. The Company is required to purchase the stockholder's interest at a price, as defined. The Company believes that it maintains sufficient insurance coverage for this contingency. Note 9 - Subsequent Event On June 29, 2004, Alliance and Essential Reality, Inc. ("Essential"), an SEC registrant, completed a reverse acquisition pursuant to a Share Exchange Agreement (the "Exchange Agreement") whereby the stockholders of Alliance exchanged all of their capital stock for 1,551,314 shares of Essential's Series B Convertible, Non-Redeemable Preferred Stock and Alliance became a wholly-owned subsidiary of Essential. The net monetary liabilities of Essential assumed in the transaction were approximately $153,000. -15- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 9 - Subsequent Event (Continued) The stockholders of Alliance, after giving effect to all the transactions in the Exchange Agreement, which include the conversion of all Series A and Series B Preferred Stock and a reverse split, will own 24,679,995 shares of common stock of Essential, or 48%. Additionally, holders of Essential's Series A 6% Convertible, Non-Redeemable Preferred Stock, who collectively own the right to vote approximately 16% of common stock, have granted an irrevocable proxy to vote their shares in all matters to the Chief Executive Officer of Alliance, thereby giving the stockholders of Alliance, in the aggregate, the power to vote approximately 64% of the common stock and control Essential. Following the transaction, the Company changed its name to Alliance Distributors Holding, Inc. On July 26, 2004, the Chief Executive Officer of Alliance signed an employment agreement for two years with annual compensation of $300,000 per year for the first year and $350,000 for the second year, and at the discretion of the Board of Directors, bonuses equal to his salary. In addition, he will receive a monthly car allowance in the amount of $750 per month and stock options in amounts and terms to be determined by the Board of Directions upon the adoption of the Essential 2004 Stock Option Plan. -16- ALLIANCECORNER DISTRIBUTORS INC. Financial Statements March 31, 2004 ALLIANCECORNER DISTRIBUTORS INC. Index Page Balance Sheet as of March 31, 2004 (Unaudited) 1 Statement of Income for the Three Months Ended March 31, 2004 (Unaudited) 2 Statement of Cash Flows for the Three Months Ended March 31, 2004 (Unaudited) 3 Notes to Financial Statements 4-5 ALLIANCECORNER DISTRIBUTORS INC. Balance Sheet March 31, 2004 (Unaudited) ASSETS Current assets: Cash $ 183,368 Accounts receivable, net 366,840 Due from factor 291,153 Inventory 1,809,470 Due from vendors 721,022 Prepaid expenses and other current assets 39,649 ---------- Total current assets 3,411,502 Property and equipment, net 410,414 Other assets 17,636 ---------- $3,839,552 ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $2,594,315 Current portion of long term obligations 28,647 Accrued expenses and other current liabilities 138,693 ---------- Total current liabilities 2,761,655 Long term obligations 302,931 Commitments and contingencies Stockholders' equity: Common stock, no par value: Authorized, issued and outstanding - 300 shares 300 Additional paid-in capital 435,715 Retained earnings 338,951 ---------- Total stockholders' equity 774,966 ---------- $3,839,552 ========== See accompanying notes. -1- ALLIANCECORNER DISTRIBUTORS INC. Statement of Income For the Three Months Ended March 31, 2004 (Unaudited) Net sales $7,299,641 Cost of goods sold 6,200,621 ---------- Gross profit 1,099,020 Selling, general and administrative expenses 920,562 ---------- Income from operations 178,458 Interest expense 27,155 ---------- Income before provision for income taxes 151,303 Provision for income taxes 12,167 ---------- Net income $ 139,136 ========== Basic and diluted net income per common share $ 463.79 ========== Basic and diluted weighted-average common shares outstanding 300 ========== See accompanying notes. -2- ALLIANCECORNER DISTRIBUTORS INC. Statement of Cash Flows For the Three Months Ended March 31, 2004 (Unaudited) Cash flows from operating activities: Net income $ 139,136 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 16,961 Deferred rent obligation 3,341 Change in assets and liabilities: Accounts receivable (186,156) Due from factor 992,701 Inventory 1,086,737 Due from vendors (706,622) Prepaid expenses and other current assets 2,425 Other assets 698 Accounts payable (1,762,026) Accrued expenses and other current liabilities (49,207) ----------- Net cash used in operating activities (462,012) ----------- Cash flows used in investing activities: Acquisition of property and equipment (4,004) ----------- Cash flows from financing activities: Repayment of capital lease obligations (3,278) Repayment of notes payable (4,191) ----------- Cash used in financing activities (7,469) ----------- Net decrease in cash (473,485) Cash, beginning of year 656,853 ----------- Cash, end of period $ 183,368 =========== Supplemental Disclosure of Cash Flow Information Cash paid during the period for: Interest $ 27,155 Income taxes $ 10,075 See accompanying notes. -3- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 1 - The Company AllianceCorner Distributors Inc. ("Alliance" or the "Company") is a wholesale distributor of video games and accessories, whose operations commenced in August 2003, with a customer base substantially throughout the United States. The Company operates in a single segment. The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the Unites States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying financial statements and notes should be read in conjunction with the audited financial statements and notes of the Company for the fiscal year ended December 31, 2003. In the opinion of management, all material adjustments consisting of normal recurring adjustments, considered necessary for a fair presentation have been included in the accompanying unaudited financial statements. The results of operations for the interim periods are not necessarily indicative of the results that maybe expected for the full year ending December 31, 2004. Note 2 - Summary of Significant Accounting Policies Inventory Inventory consists entirely of finished goods held for sale and is reported at the lower of cost or market, on the average cost basis. At times, Alliance makes advance payments to vendors to procure and ensure delivery of certain high demand products. Such deposits are reflected as due from vendors in the balance sheet. -4- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Property and Equipment Contributed property and equipment is recorded at fair market value. Purchased property and equipment is recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased assets at the inception of the lease. Leasehold improvements are amortized over the lesser of the lease terms or the assets' useful lives. When property and equipment is retired or otherwise disposed of, the cost and accumulated depreciation from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated lives of the related assets using the straight-line method. The estimated useful lives for property and equipment categories are as follows: Vehicles 4 years Warehouse equipment 3 to 7 years Office furniture and equipment 3 to 7 years Leasehold improvements 5 to 10 years Income Taxes The Company, with the consent of its stockholders, elected to have its income taxed under the provisions of Subchapter S of the Internal Revenue Code and the corresponding provisions of New York State Tax laws. Under the aforementioned provisions, corporate income or loss and any tax credits earned are included in the stockholders' individual federal and state income tax returns. Accordingly, no provision has been made for federal income taxes for the three months ended March 31, 2004. The Company is subject to New York State S corporation taxes and New York City corporate income taxes. The provision for income taxes comprises state and local taxes. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements relate primarily to bad debt reserves on accounts receivable. -5- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 2 - Summary of Significant Accounting Policies (Continued) Net Income Per Common Share Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income by the weighted average number of common and common equivalent shares outstanding during the period. The Company has no common equivalent shares outstanding. Note 3 - Due from Factor In December 2003, the Company entered into a factoring arrangement with a commercial factor. The Company sells a substantial portion of its trade receivables up to maximum credit limits established by the factor for each individual account. Receivables sold in excess of these limitations are subject to recourse in the event of non-payment by the customer. Under the terms of the agreement, the Company pays interest at the prime lending rate plus 1.5% (5.5% at March 31, 2004) for advances made prior to the collection of the factored accounts receivable. At March 31, 2004, factor advances of approximately $1,230,000 were offset against amounts due from the factor. Substantially all of the Company's assets have been pledged as collateral under the factoring agreement. Under the terms of the agreement, the Company is required to maintain a specified level of net worth, as defined. At March 31, 2004, the Company is in compliance with this covenant. Note 4 - Subsequent Events On June 29, 2004, Alliance and Essential Reality, Inc. ("Essential"), a SEC registrant, completed a reverse acquisition pursuant to a Share Exchange Agreement (the "Exchange Agreement') whereby the stockholders of Alliance exchanged all of their capital stock for 1,551,314 shares of Essential's Series B Convertible, Non-Redeemable Preferred Stock and Alliance became a wholly-owned subsidiary of Essential. The net monetary liabilities of Essential assumed in the transaction were approximately $153,000. The stockholders of Alliance, after giving effect to all the transactions in the Exchange Agreement, which include the conversion of all Series A and Series B Preferred Stock and a reverse split, will own 24,679,995 shares of common stock of Essential, or 48%. Additionally, holders of Essential's Series A 6% Convertible, Non-Redeemable Preferred Stock, who collectively own the right to vote approximately 16% of common stock, have granted an irrevocable proxy to vote their shares in all matters to the Chief Executive Officer of Alliance, thereby giving the stockholders of -6- ALLIANCECORNER DISTRIBUTORS INC. Notes to Financial Statements Note 4 - Subsequent Events (Continued) Alliance, in the aggregate, the power to vote approximately 64% of the common stock and control Essential. Following the transaction, the Company changed its name to Alliance Distributors Holding, Inc. On July 26, 2004, the Chief Executive Officer of Alliance signed an employment agreement for two years with annual compensation of $300,000 per year for the first year and $350,000 for the second year, and at the discretion of the Board of Directors, bonuses equal to his salary. In addition, he will receive a monthly car allowance in the amount of $750 per month and stock options in amounts and terms to be determined by the Board of Directions upon the adoption of the Essential 2004 Stock Option Plan. -7-