SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-QSB
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 2006
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _______________ to ________________
Commission file number 000-29245
GALES INDUSTRIES INCORPORATED
(Exact name of small business as specified in its charter)
Delaware 20-4458244
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
1479 Clinton Avenue, Bay Shore, New York 11706
(Address of principal executive offices)
(631) 968-5000
(Issuer's telephone number, including area code)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 55,632,959 shares of Common
Stock, $.001 per share, as of August 2006.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
GALES INDUSTRIES INCORPORATED
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item: 1 Condensed Consolidated Financial Statements Balance Sheets
as of June 30, 2006 (unaudited) and December 31, 2005
(audited) 3
Statement of Operations for the three month period and the
six month period ended June 30, 2006 and June 30, 2005
(unaudited). 5
Statement of Cash Flow for the six month period ended
June 30, 2006 and June 30, 2005 (unaudited) 6
Notes to Condensed Consolidated Financial Statements 7
Item: 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item: 3 Controls and Procedures 20
PART II. OTHER INFORMATION
Item: 4 Unregistered Sales of Equity Securities 20
Item: 5 Exhibits 22
SIGNATURES 23
2
Item 1:
GALES INDUSTRIES INCORPORATED (1)
Condensed Consolidated Balance Sheet
Pro forma
June 30, Pro forma June 30, December 31,
2006 Adjustments 2006(1) 2005
-----------------------------------------------------------
(Unaudited) (Unaudited) (Unaudited) (Audited)
ASSETS
Current Assets
Cash and Cash Equivalents $ 1,226,308 $ 1,226,308 1,058,416
Accounts Receivable, Net of Allowance for Doubtful
Accounts of $45,000 3,107,123 3,107,123 2,623,612
Inventory 13,607,137 13,607,137 12,603,810
Prepaid Expenses and Other Current Assets 165,345 165,345 210,124
Deposits 91,741 91,741 65,595
-----------------------------------------------------------
Total Current Assets 18,197,654 18,197,654 16,561,557
Property, Plant, and Equipment, net 7,581,956 7,581,956 7,716,469
Cash Surrender Value - Officer's Life 39,983 39,983 66,216
Deferred Financing Costs 420,305 420,305 486,207
Other Assets 41,222 41,222 41,306
Goodwill 1,265,963 1,265,963 1,265,963
-----------------------------------------------------------
TOTAL ASSETS $27,547,083 $27,547,083 $26,137,718
===========================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts Payable and Accrued Expenses $ 5,276,060 $ 5,276,060 $ 5,294,629
Advance Payment - Customers 188,199 188,199 188,199
Notes Payable - Current Portion 7,875,100 7,875,100 6,322,665
Notes Payable - Sellers - Current Portion 240,500 240,500 192,400
Capital Lease Obligations - Current Portion 369,145 369,145 359,197
Due to Sellers 91,084 91,084 91,232
-----------------------------------------------------------
Total current liabilities 14,040,088 14,040,088 12,448,322
Long term liabilities
Notes Payable - Net of Current Portion 3,404,528 3,404,528 3,648,131
Notes Payable - Sellers - Net of Current Portion 1,338,662 1,338,662 1,434,862
Capital Lease Obligations - Net of Current Portion 631,887 631,887 820,375
Deferred Tax Liability 662,821 662,821 676,394
-----------------------------------------------------------
Total liabilities 20,077,986 20,077,986 19,028,084
-----------------------------------------------------------
Commitments and contingencies
Stockholders' Equity
Series A Convertible Preferred - $.001 Par value,
8,003,716 Shares Authorized 1 (1)(1) 0 1
900 Shares Issued and Outstanding as of
June 30, 2006; (No Shares Outstanding For
the Pro Forma June 30, 2006); 900 Shares
Issued and Outstanding December 31,2005;
Liquidation Value, $18,360,000
Common Stock - $.001 Par, 120,055,746 Shares Authorized;
14,723,421 Shares Issued and Outstanding as of
June 30, 2006; (55,632,959 Shares Issued and
Outstanding For The Pro Forma June 30, 2006); And
14,723,421 Shares Issued and Outstanding For
December 31, 2005 14,723 40,910(1) 55,633 14,723
Additional Paid-In Capital 7,928,144 (40,909)(1) 7,887,235 7,844,614
Accumulated Deficit (473,771) (473,771) (749,704)
-----------------------------------------------------------
Total Stockholders' Equity 7,469,097 7,469,097 7,109,634
-----------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $27,547,083 $ 0 $27,547,083 $26,137,718
===========================================================
3
Explanation of Adjustments:
(1) The pro forma condensed consolidated interim balance sheet reflects the
conversion, effective August 4, 2006, of the outstanding 900 shares of the
Company's preferred stock which automatically converted to 40,909,500 shares of
the Company's common stock (plus 38 shares issued upon rounding up of
fractional shares) upon effectiveness of the Company's Registration Statement
(File No, 333-131709). In addition to such 40,909,500 common shares, when
declared, the holders of the preferred stock are entitled to receive 1,636,380
shares of common stock representing the dividend on the 900 shares of preferred
stock from December 15, 2005, to June 15, 2006 and $30,000 representing the
dividend payable in cash for the period from June 16, 2006 through June 30,
2006.
Number of Preferred Shares 900
Conversion rate 45,455
-----------
Common shares 40,909,500
Common stock par value @ $.001 0.001
-----------
Value of Common Stock $ 40,910
===========
See notes to condensed consolidated financial statements
4
Gales Industries Incorporated (1)(2)
Condensed Consolidated Statement of Operations
(Unaudited)
Three months ended Six months ended
June 30 June 30
----------------------------- -----------------------------
Predecessor Predecessor
2006 2005 2006 2005
---------------------------------------------------------------
Net sales $ 9,220,165 $ 7,813,139 $ 18,118,437 $ 14,078,345
Cost of sales 7,467,326 6,994,910 14,852,892 12,273,501
---------------------------------------------------------------
Gross profit 1,752,839 818,229 3,265,545 1,804,844
Operating costs and expenses:
Selling and marketing 142,543 99,350 298,245 169,269
General and administrative 1,024,550 376,373 1,873,933 742,228
---------------------------------------------------------------
Income from operations 585,746 342,506 1,093,367 893,347
Interest and financing costs (362,126) (66,055) (687,176) (247,222)
Gain on sale of life insurance policy -- -- 53,047
Other Income 803 803
---------------------------------------------------------------
Income before income taxes 224,423 276,451 460,041 646,125
Provision for income taxes (2) 84,855 -- 184,108 --
---------------------------------------------------------------
Net income 139,568 $ 276,451 275,933 $ 646,125
============ ============
Less: Dividend attributable to preferred stockholders 180,000 360,000
------------ ------------
Net loss attributable to common stockholders (40,432) ($ 84,067)
============ ============
Loss per share:
Basic $ 0.00 $ 0.00
============ ============
Fully Diluted $ 0.00 $ 0.00
============ ============
Weighted average shares outstanding
Basic 14,723,421 14,723,421
============ ============
Fully Diluted 14,723,421 14,723,421
============ ============
(1) For the period from October 28, 2004 (date of inception) through June 30,
2005 the Company (Gales) had no business activity other than the issuance
of a $22,500 convertible bridge note that accrued approximately $657 and
$325 in interest for the six and three month period ended June 30, 2005
respectively; the note and respective accrued interest were subsequently
converted to shares of the Company's Common Stock as part of the merger.
The Company has presented the Statements of Operations of Air Industries
machining Corp. (AIM), as the Company has succeeded all of the business
activity of AIM.
(2) AIM was a privately held subchapter S Corporation prior to the merger and
accordingly the financial statements of the Successor and Predecessor are
not comparable in all material respects. Since AIM was an "S" Corporation
a provision for income taxes was not incurred.
See notes to condensed consolidated financial statements
5
GALES INDUSTRIES INCORPORATED (1) (2)
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended June 30,
-------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES: 2006 2005
Predecessor
------------- -------------
Net Income $ 275,933 $ 646,125
Adjustments to Reconcile Net Income to Net
Cash Provided by (Used in) Operating Activities:
Depreciation and amortization of property and equipment 278,449 229,940
Amortization of deferred financing costs 65,902
Deferred taxes (13,573)
Non cash compensation expense 65,405
Warrants issued for services 18,125
Changes in Assets and Liabilities
(Increase) Decrease in Assets:
Accounts receivable (483,511) 70,394
Inventory (1,003,327) (1,285,862)
Prepaid expenses and other current assets 44,779 (52,726)
Deposits (26,146) 37,160
Cash surrender value - officer's life insurance 26,233 (11,708)
Other assets 84 31,278
Decrease (Increase) in Liabilities:
Accounts payable and accrued expenses (18,569) 439,235
------------- -------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (770,216) 103,836
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (143,936) (695,896)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (143,936) (695,896)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments of (and proceeds from) capital lease obligations, net (178,540) 1,239,398
Proceeds from cash overdraft -- 265,541
Repayment of notes payable to sellers (48,248) --
Proceeds from (payment of) notes payable, net 1,308,832 (923,187)
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,082,044 581,752
------------- -------------
Net decrease in cash and cash equivalents 167,892 (10,308)
Cash and cash equivalents at the beginning of period 1,058,416 10,308
------------- -------------
Cash and cash equivalents at the end of period $ 1,226,308 --
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 413,266 $ 197,876
============= =============
(1) For the period from October 28, 2004 (date of inception) through June 30,
2005 the Company had no business activity other than the issuance of a
$22,500 convertible bridge note that accrued approximately $657 and $325
in interest for the six and three month period ended June 30, 2005
respectively; the note and respective accrued interest were subsequently
converted to shares of the Company's Common Stock as part of the merger.
(2) The Company has presented the Statement of Cash Flows of AIM, as the
Company has succeeded to all of the business activity of AIM. AIM was a
privately held subchapter S Corporation prior to the merger and
accordingly the financial statements of the Company and Predecessor are
not comparable in all material respects.
See notes to condensed consolidated financial statements
6
Note 1:
FORMATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Merger and Acquisition
Ashlin Development Corp. (the "Company" or "Ashlin"), a Florida corporation and
its newly-formed subsidiary Merger Sub, entered into a Merger Agreement (the
"Merger Agreement") on November 14, 2005 with Gales Industries Incorporated, a
privately-held Delaware corporation ("Original Gales"). On November 30, 2005
(the "Closing Date") Original Gales merged (the "Merger") into Merger Sub.
Pursuant to the Merger Agreement, the Company issued 10,773,107 shares of Common
Stock (representing 73.6% of Ashlin's outstanding shares) and 900 shares of
Series A Convertible Preferred Stock which was initially convertible into
40,909,500 shares of Common Stock of the Company for all the issued and
outstanding shares of Original Gales the "Successor". As a result of the
transaction, the former stockholders of Original Gales became the controlling
stockholders of Ashlin. Additionally, since Ashlin had no substantial assets
prior to the merger, the transaction was treated for accounting purposes as a
reverse acquisition of a public shell. Accordingly, for financial statement
presentation purposes, Original Gales is the surviving entity.
On February 15, 2006, Ashlin changed its name to Gales Industries Incorporated
and its state of domicile from Florida to Delaware.
Prior to the closing of the Merger, Original Gales, which did not have any
business operations other than in connection with the transactions contemplated
by the Merger Agreement, acquired (the "Acquisition") all of the outstanding
capital stock of Air Industries Machining, Corp. ("AIM"). Because of the change
in ownership, management and control that occurred in connection with the
Acquisition, in accordance with Statement of Financial Accounting Standards
("SFAS") 141, Business Combinations, the transaction was accounted for as a
purchase. Accordingly, the purchase price was allocated to assets acquired and
liabilities assumed based on SFAS No. 141. Simultaneously with the Acquisition,
AIM entered into a bank facility (the "New Loan Facility") and used proceeds
from the facility to acquire real estate (the "Real Estate Acquisition").
Prior to the Acquisition, Original Gales raised bridge financing. In connection
with the Acquisition, Original Gales procured a private placement of Series A
Preferred Stock, the proceeds of which were used to acquire AIM. Immediately
prior to the Merger, Original Gales had outstanding certain bridge notes
convertible into shares of Original Gales' common stock and certain bridge
warrants to purchase shares of Original Gales' common stock.
Original Gales was formed in October 2004 and since prior to the acquisition did
not have any business operations or activity other then the transactions
contemplated with the merger and succeeded substantially all of the business
operations of AIM, AIM is the "Predecessor" to Original Gales. The Company is
required to separately present the historical statement of operations and cash
flows of the Predecessor. The financial information presented in these financial
statements may not reflect their combined financial position. The operating
results and cash flows of the Predecessor and Successor are not compatible in
all material respects.
Certain information and footnote disclosures normally included in the annual
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. The Company believes that the disclosures are adequate to make the
financial information presented not misleading. These condensed consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 2005, filed with the
Securities and Exchange Commission on April 17, 2006. All adjustments were of a
normal recurring nature unless otherwise disclosed. In the opinion of
management, all adjustments necessary for a fair statement of the results of
operations for the interim period have been included. The results of operations
for such interim periods are not necessarily indicative of the results for the
full year.
Reverse stock split
Pursuant to the terms of the Merger Agreement, prior to the Merger, Ashlin
effected a 1-for-1.249419586 reverse split of its Common Stock (the "Reverse
Split"). The Reverse Split became effective November 21, 2005. The Reverse Split
reduced the number of shares of Common Stock which the Company had outstanding
7
on a fully diluted basis to 3,868,000. As a result of the Reverse Split, the
conversion of the outstanding shares of Original Gales pursuant to the Merger
for new shares of the Company's Common Stock was on a one-for-one basis. Any of
the Company's shareholders who, as a result of the Reverse Split, held a
fractional share of Common Stock received a whole share of Common Stock in lieu
of such fractional share. After giving effect to the Reverse Split, prior to the
Merger, the Company had outstanding 3,823,980 shares of Common Stock which
continued to be outstanding after the Merger.
Use of Estimates
In preparing the financial statements, management is required to make estimates
and assumptions that affect the reported amounts in the financial statements and
accompanying notes. The more significant management estimates are the useful
lives of property and equipment, provisions for inventory obsolescence,
unamortized finance costs, accrued expenses and various contingencies. Actual
results could differ from those estimates. Changes in facts and circumstances
may result in revised estimates, which are recorded in the period in which they
become known.
Stock-Based Compensation
In December 2004, the FASB issued SFAS 123(R) which is a revision of SFAS No.
123 and supersedes Accounting Principles Board Opinion No. 25. SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values at the date of grant. The Company recorded an expense of $57,625 in the
accompanying statement of operations for the three month period ended June 30,
2006: and an expense of $65,405 for the six month period ended June 30, 2006, in
accordance with the measurement requirements under SFAS No. 123(R)
Note 2:
CASH SURRENDER VALUE - LIFE INSURANCE
During the quarter ended March 31, 2006, the Company sold one of its key-man
life insurance policies. Proceeds from the sale of the insurance policy were
$86,000 which was offset by the cash surrender value of $32,953. The resulting
gain of $53,047 was recognized as Other Non-Operating Income in the accompanying
Statement of Operations for the six month period ended June 30, 2006.
Note 3:
STOCK-BASED COMPENSATION ARRANGEMENTS
During 2005, the Company's Board of Directors approved a stock option plan and
reserved 10,000,000 shares of its Common Stock for issuance under the plan. The
stock option plan permits the Company to grant non-qualified and incentive stock
options to employees, directors, and consultants. Awards granted under the
Company's plans vest over four and seven years.
The Company accounts for its stock option plans under the measurement provisions
of Statement of Financial Accounting Standards No. 123(R) (revised 2004),
Share-Based Payment ("SFAS 123R"). The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model.
During the six months ended June 30, 2006 no stock options were granted.
Certain of the Company's stock options contain features which include
variability in grant prices. A portion of the currently issued stock options
will be issued based on average trading prices of the Company's Common Stock at
the end of a given future period. Due to this variable feature, these stock
options are not deemed to be granted for purposes of applying SFAS 123(R) and
accordingly, their fair value will be calculated and expensed in future periods.
8
A summary of the status of the Company's stock options as of June 30, 2006, and
changes during the period then ended is presented below:
Weighted Weighted
Number Average Average Aggregate
of Exercise Remaining Intrinsic
Shares Price Contractual Term Value
------------ ------------ ------------ ------------
Outstanding at January 1, 2006 1,580,000 $ 0.32
Outstanding at January 1, 2006 3,270,000 *
Granted -- --
Forfeited or expired -- --
Exercised -- --
------------ ------------ ------------ ------------
Outstanding at June 30, 2006 4,850,000 $ 0.32 9.5 $ 219,620
============ ============ ============ ============
Options vested and exercisable at
June 30, 2006 790,000 $ 0.22 9.5 $ 61,620
============ ============ ============ ============
----------
* The exercise price of such options will be based upon future market prices of
the underlying shares.
The Company recorded a compensation expense of $39,500 in its consolidated
condensed statement of operations for the three month period ended June 30,
2006; and a stock option expense of $65,405 for the six month period ended June
30, 2006. The stock option expense relates to stock options granted in the
previous fiscal year. The Company granted no stock options during the quarter
ended June 30, 2006. The following table illustrates stock options granted
through June 30, 2006:
Options Outstanding Options Vested and Exercisable
----------------------------------------------- ---------------------------------
Weighted-
Average
Remaining Weighted-
Contractual Average Weighted-
Number Life Exercise Number Average
Range of Exercise Prices Outstanding (Years) Price Exercisable Exercise Price
----------------------------------------------- ----------- ----------- ----------- -----------
$0.220 790,000 9.5 $ 0.220 790,000 $ 0.22
$0.428 790,000 9.5 $ 0.428 -- --
Based on future market
price 3,270,000 9.5 N/A -- N/A
----------- ----------- ----------- ----------- -----------
4,850,000 9.5 $ 0.32 790,000 $ 0.22
=========== =========== =========== =========== ===========
9
A summary of the status of the Company's non-vested shares as of June 30, 2006
and changes during the three month ended June 30, 2006 is presented below:
Weighted Average
Weighted Average Remaining Contractual Term
Number of Shares Exercise Price Per Share (in years)
--------------------------------------------------------------------------------
Non-vested Shares at
January 1, 2006 790,000 $ 0.428 9.5
Shares based on future
market price 3,270,000 N/A N/A
Options granted -- -- --
Options vested -- -- --
Options forfeited or
expired -- -- --
--------------- --------------- ---------------
Non-vested shares at
June 30, 2006 4,060,000 $ 0.428 9.5
=============== =============== ===============
As of June 30, 2006, there was $32,917 of unrecognized compensation cost related
to non vested stock option awards, which is to be recognized over the remaining
weighted average vesting period of six months.
During the quarter ended June 30, 2006, the company issued to a consulting firm,
in return for services an aggregate of 41,668 warrants, exercisable during a
five year term, to purchase 41,668 shares of the company's Common Stock. Such
warrants have a "cashless exercise" and have varying exercise prices equal to
120% of the average closing price of the Company's Common Stock during the month
immediately preceding the date of issuance. The warrants were valued using the
Black-Scholes model and the Company recorded an expense of $18,125 in its
consolidated condensed statement of operations for the three and six month
period ended June 30, 2006.
The Company has an agreement, which can be terminated by either party, whereby
the Company will issue to the consulting firm additional warrants to purchase
83,332 shares of the Company's Common Stock. The aggregate warrants issued to
the consulting firm will be exercisable into 125,000 shares. These warrants will
be issued each month from July 1, 2006 until February 1, 2007 and each warrant
will have the right to purchase 10,417 shares with the exception of the last
warrant which will have the right to purchase 10,416 shares. These warrants
contain variability in exercise price based on average trading prices of the
Company's common stock during the month immediately preceding the date of
issuance. The Company will record expense on the remaining warrants as they are
issued.
The following table summarizes the Company's outstanding warrants as of June 30,
2006 and changes during the period then ended:
Weighted
Weighted Average
Number Average Remaining
of Exercise Contractual Life
Shares Price (Years)
-------------- -------------- --------------
Outstanding January 1, 2006 5,229,589 $ 0.21 4.4
Granted 41,668 1.44 4.8
Cancelled -- --
Exercised -- --
-------------- -------------- --------------
Outstanding at June 30, 2006 5,271,257 $ 0.22 4.4
============== ============== ==============
10
Item 2.
Management's Discussion and Analysis or Plan of Operation
General
We, through our wholly owned subsidiary AIM, manufacture aircraft
structural parts and assemblies principally for prime defense contractors in the
defense/aerospace industry. Approximately 85% of AIM's revenues are derived from
sales of parts and assemblies directed toward military applications, although
direct sales to the military (U.S. and NATO) constitute less than 8.5% of AIM's
revenues. The remaining 15% of revenues represent sales in the airframe
manufacturing sector to major aviation manufacturers.
AIM has evolved from being an individual parts manufacturer to being a
manufacturer of subassemblies (i.e. being an assembly constructor) and being an
engineering integrator. AIM currently produces over 2,400 individual products
(SKU's) that are assembled by a skilled labor force into electromechanical
devices, mixer assemblies, rotorhub components, rocket launching systems,
arresting gear, vibration absorbing assemblies, landing gear components and many
other subassembly packages.
Sales of parts and services to one customer accounted for approximately
66% of AIM's revenue in the second quarter of 2006, and are subject to General
Ordering Agreements which were recently renegotiated and extended through 2010.
During the six month period ending June 30, 2006, the Company received an
initial contract applicable to the Memorandum of Agreement from The Goodrich
Corporation for the manufacture of A380 (AirBus) Drag Brace assemblies. This
Memorandum of Agreement covers approximately five years starting in 2006 through
2011. The value of deliveries currently projected for the time period covered by
the Agreement is estimated to reach $20,450,000. As orders for A380 aircraft
increase, delivery obligations and revenues for Air Industries will increase
correspondingly. In addition to this A380 contract Air Industries received
approximately $26 million in contracts from other aerospace customers during the
period. Correspondingly, the company's projected backlog increased during the
first half of 2006 from $39 million to approximately $54 million.
AIM historically operated as a private company. There can be no assurance
that our future operating results will be comparable to those achieved by AIM in
the past. It should also be noted that, prior to the Acquisition, AIM operated
as a Subchapter "S" company and incurred no income taxes.
The Company's registration statement, covering selling stockholder shares,
became effective as of August 4, 2006 and, accordingly, the shares held by the
selling stockholders became eligible for public resale.
Results of Operations
Prior to the acquisition of AIM, the Company had limited business
operations or activities other than the transactions contemplated by the Merger
Agreement between the Company and Gales Industries. See Note 1 to the condensed
consolidated financial statements. As the Company succeeded to substantially all
of the business operations of AIM and AIM represents substantially all of the
Company's current operations. AIM is considered to be the Predecessor to the
Company and for financial reporting purposes the Company is required to present
the historical statement of operations and cash flows of AIM for periods prior
to its acquisition by the Company. The financial information of AIM for the
period ended June 30, 2006, presented in the condensed consolidated financial
statements is not comparable in all material respects to the financial
information of the Company for subsequent periods as adjustments resulting from
the Merger, the Acquisition and the Real Estate Acquisition are not reflected in
the Predecessor financial statements. These adjustments include, among others,
interest expense from the refinancing, taxes from the change in "S" to "C"
Corporation status, increased amortization due to a step-up in the basis of
certain assets, additional officer's salaries, and the change in officer's
functions which caused a reallocation of salary expense from cost of goods sold
to general and administrative expense.
11
Three months ended June 30, 2006 compared with the three months ended June 30,
2005.
Net Sales. Net sales were $9,220,165 for the three months ended June 30
2006 (Second Quarter 2006"), an increase of $1,407,026, or 18.0%from net sales
of $7,813,139 for the three months ended June 30, 2005 ("Second Quarter 2005").
The increase in net sales was attributable to increased shipments of parts and
related defense components to one customer which caused the portion of our
revenues derived from such customer to increase from approximately 50% in 2005
to approximately 66% in the Second Quarter 2006.
Gross Profit. Gross profit was $1,752,839 for the three months ended June
30, 2006, 19.0% of net sales, compared to gross profit of $818,229 for the three
months ended June 30, 2005, 10.5% of net sales. The increase in gross profit
primarily reflects the increase in net sales. The increase in gross profit as a
percentage of net sales represents a slight increase in the sales of higher
margin products, as well as the elimination of rent paid on the Company's
facilities as a result of the Real Estate Acquisition, partially offset by the
mortgage interest and depreciation of the Company's facilities allocated to
sales, and lower salaries as a result of the reallocation of the costs of
certain executives.
Selling and Marketing Expenses. Selling and marketing expenses were
$142,543 for the three months ended June 30, 2006, an increase of 43.5% from
selling and marketing expenses of $99,350 for the three months ended June 30,
2005. The increase in selling and marketing expenses reflects the up-front
recognition of costs related to leased automobiles for the Company's executives
and increased travel and entertainment expenses related to increased sales
activity.
General and Administrative Expenses. General and administrative expenses
were $1,024,550 the three months ended June 30, 2006, an increase of $648,177,
or 172.2%, from general and administrative expenses of $376,373 for the three
months ended June 30, 2005. The increase reflects (i) higher depreciation
relating to the step-up in basis of the Company's real property, partially
offset by the elimination of rent expense, (ii) higher salaries as a result of
the reallocation of the costs of certain executives and (iii) higher
professional fees due to the increase in accounting, legal and consulting
expenses associated with being a public company.
Interest and Financing Costs. Interest and financing costs were $362,126
for the three months ended June 30, 2006; an increase of $296,071, or 448.2 %,
from interest and financing costs of $66,055 for the three months ended June 30,
2005. The increase in interest and financing costs resulted from higher interest
rates, interest accruing on the promissory notes issued to the former
shareholders of AIM in connection with the AIM Acquisition, interest accruing on
the new term loan and larger revolving credit facility, portions of which were
used to finance the costs of the Acquisition and the Real Estate Acquisition.
Income before Income Taxes. Net income before provision for income taxes
was $224,423 for the three months ended June 30, 2006 and $276,451 for the three
months ended June 30, 2005.
Net Income. Net income was $139,568 for the three months ended June 30,
2006. A comparison of net income with prior year's net income is not informative
because the predecessor company was an "S" Corporation.
Net Income Attributable to Common Stock. The dividend payable on the
Company's preferred stock for the Second quarter 2006 exceeded the Company's net
income during such period.
Six months ended June 30, 2006 compared with the six months ended June 30, 2005.
Net Sales. Net sales were $18,118,437 for the six months ended June 30,
2006 ("First Half 2006"); an increase of $4,040,092, or 28.7%, from net sales of
$14,078,345 for the six months ended June 30, 2005 ("First Half 2005"). The
increase in net sales was attributable to increased shipments of parts and
related defense components to one customer which caused the portion of our
revenues derived from such customer to increase from approximately 50% in 2005
to approximately 66% in the First Half 2006.
Gross Profit. Gross profit was $3,265,545 in First Half 2006 (18.0% of net
sales), compared to gross profit of $1,804,844, (12.8% of net sales), in First
Half 2005. The increase in gross profit primarily reflects the increase in net
sales. The increase in gross profit as a percentage of net sales represents a
slight increase in the sales of higher margin products, as well as the
elimination of rent paid on the Company's facilities as a result of the Real
12
Estate Acquisition, partially offset by the mortgage interest and depreciation
of the Company's facilities allocated to sales, and lower salaries as a result
of the reallocation of the costs of certain executives.
Selling and Marketing Expenses. Selling and marketing expenses were
$298,245 in First Half 2006, an increase of 76.2% from selling and marketing
expenses of $169,269 in First Half 2005. The increase in selling and marketing
expenses reflects the up-front recognition of costs related to leased
automobiles for the Company's executives and increased travel and entertainment
expenses related to increased sales activity.
General and Administrative Expenses. General and administrative expenses
were $1,873,933 in First Half 2006, an increase of $1,131,705, or 152.5%, from
general and administrative expenses of $742,228 in First Half 2005. The increase
reflects (i) higher depreciation relating to the step-up in basis of the
Company's real property, partially offset by the elimination of rent expense,
and (ii) higher salaries as a result of the reallocation of the costs of certain
executives and (iii) higher professional fees due to the increase in accounting,
legal and consulting expenses associated with being a public company.
Interest and Financing Costs. Interest and financing costs were $687,176
in First Half 2006, an increase of $439,954, or 178.0%, from interest and
financing costs of $247,222 in First Half 2005. The increase in interest and
financing costs resulted from higher interest rates, interest accruing on the
promissory notes issued to the former shareholders of AIM in connection with the
AIM Acquisition, interest accruing on the new term loan and larger revolving
credit facility.
Gain on the Sale of Life Insurance Policy. Gain on the sale of life
insurance policy was $53,047 in First Half 2006 and was a one-time gain.
Income before Income Taxes. Net income before provision for income taxes
was $460,041 in First Half 2006 and $646,125 in First Half 2005.
Net Income. Net income was $275,933 in First Half 2006. A comparison of
net income with the prior year's net income is not informative because the
predecessor company was an "S" Corporation.
Net Loss Attributable to Common Stock. The dividend payable on the
Company's preferred stock for the First Half 2006 exceeded the Company's net
income during such period.
Impact of Inflation
Inflation has not had a material effect on our financial position, results
of operations, or cash flows.
Liquidity and Capital Resources
We used approximately $770,216 in our operations during the six months
ended June 30, 2006. The use of cash in operations reflects the increase in our
accounts receivable and inventory of $483,511 and $1,003,327 respectively offset
by net income after non cash adjustments.
At June 30, 2006, we had cash and cash equivalents of $1,226,308 and
working capital of $4,157,566 as compared to $1,058,416 and $4,113,235 as of
December 31, 2005. We believe that our cash requirements in the next twelve
months will be met by our revenues from operations, our cash reserves, and the
amounts available under the New Loan Facility put in place in connection with
the acquisition of AIM and its corporate company.
AIM had financed its operations and investments up to the Closing Date
principally through revenues from operations. As a private company, AIM did not
have many of the expenses which we have as a public company. As a result of the
AIM Acquisition, we have significantly increased cash requirements relating to
the filing of financial statements, our compliance with requirements under the
Securities Exchange Act of 1934, the registration of shares under the Securities
Act of 1933, and other requirements applicable to public companies. We expect
such increased cash requirements to be approximately $750,000 in 2006, subject
to a substantial increase if we become obligated to comply with Section 404 of
Sarbanes-Oxley.
13
In connection with the Acquisition of AIM, we incurred notes payable
obligations in the aggregate principal amount of $1,627,262, of which $665,262
are in the form of convertible promissory notes which we may convert into shares
of our Common Stock at $.40 per share now that the Registration Statement is
effective as of August 4, 2006, which was filed on Form SB-2 under the
Securities Act of 1933. The remaining $962,000 principal amount of note is
repayable by us in 20 equal quarterly installments of $48,100 principal plus
interest.
The terms of the New Loan Facility are set forth in our Consolidated
Financial Statements included in our Annual Report on Form 10-KSB for the year
ended December 31, 2005. Under the New Loan Facility, as of June 30, 2006, we
had revolving loan balances of $5,942,661 and $1,552,435, a term loan balance of
$380,004 and an equipment loan balance of $411,200.
As of June 30, 2006, we had capital lease obligations totaling $1,001,032.
As of June 30, 2006, one customer accounted for approximately 50% of our
accounts receivable. In addition, this customer accounted for approximately 66%
of our total revenue for the quarter ended June 30, 2006. In the event such
customer is unable or unwilling to pay us our accounts receivable from such
customer, or in the event our relationship with such customer is severed or
negatively affected, our results of operations will be materially adversely
affected and we may not have the resources to meet our capital obligations.
On June 5, 2006, the Company entered into an Agreement to sell its
corporate headquarters and related real property in Bay Shore, New York, for
$6.2 million. As a condition to the sale of its property, the Company will enter
into a lease whereby it will lease such property from the buyer for an initial
term of 20 years. The lease will be a "triple net lease" pursuant to which, in
addition to basic rent, the Company will remain liable for maintenance and taxes
on the property. The basic rent under the proposed lease will be $540,000 for
the first five years of the lease, $621,000 for the sixth year of the term and
will increase by 3% for each year thereafter. During its initial due diligence
period the buyer has the right to terminate the Agreement of Sale without any
liability to the Company. There can be no assurance that the contemplated sale
of the Company's property will be consummated or, if consummated, that there
will not be material changes in the terms of Agreement of Sale or lease adverse
to the Company's interest.
Forward Looking Statements
The Company desires to take advantage of the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. This report contains a
number of forward-looking statements that reflect management's current views and
expectations with respect to our business, strategies, future results and events
and financial performance. All statements made in this Report other than
statements of historical fact, including statements that address operating
performance, events or developments that management expects or anticipates will
or may occur in the future, including statements related to distributor
channels, volume growth, revenues, profitability, adequacy of funds from
operations, statements expressing general optimism about future operating
results and non-historical information, are forward looking statements. In
particular, the words "believe," "expect," "intend," " anticipate," "estimate,"
"may," "will," variations of such words, and similar expressions identify
forward-looking statements, but are not the exclusive means of identifying such
statements and their absence does not mean that the statement is not
forward-looking. These forward-looking statements are subject to certain risks
and uncertainties, including those discussed below. Our actual results,
performance or achievements could differ materially from historical results as
well as those expressed in, anticipated or implied by these forward-looking
statements. We do not undertake any obligation to revise these forward-looking
statements to reflect any future events or circumstances.
14
Readers should not place undue reliance on these forward-looking
statements, which are based on management's current expectations and projections
about future events, are not guarantees of future performance, are subject to
risks, uncertainties and assumptions (including those described below) and apply
only as of the date of this report. Our actual results, performance or
achievements could differ materially from the results expressed in, or implied
by, these forward-looking statements. Factors that could cause or contribute to
such differences include, but are not limited to, those discussed below in "Risk
Factors" as well as those discussed elsewhere in this report, and the risks
discussed in our press releases and other communications to shareholders issued
by us from time to time which attempt to advise interested parties of the risks
and factors that may affect our business. We undertake no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
Risk Factors
If any of the events described below occurs, our operating results would
be dramatically adversely affected, which in turn could cause the price of our
Common Stock to decline, perhaps significantly. Further, we may not be able to
continue our operations.
Risks of the Acquisition
There can be no assurance that any benefits to AIM's business will be
achieved from its acquisition by Original Gales and the merger of Original Gales
into the Company, the Real Estate Acquisition or the New Loan Facility (the
"Transactions") or that the results of operations of AIM prior to the Merger
will not be adversely impacted by the Transactions. As of November 30, 2005,
Luis Peragallo and Jorge Peragallo, formerly the principal shareholders of AIM,
resigned from their positions with AIM. Even though Peter Rettaliata and Dario
Peragallo, two of AIM's officers (President and Executive Vice President,
respectively), will continue to serve as officers of AIM and will serve as
officers of our Company, there can be no assurance that the management of our
company will have the necessary experience to operate AIM's business. The
process of combining the organizations of Original Gales, AIM and our Company
could interrupt the activities of part or all of AIM's business, and could cause
fundamental changes in AIM's business, which could have an adverse effect on the
results of operations. The past results of AIM's operations are not necessarily
indicative of the future results of our operations. In addition, AIM's results
of operations will be affected by the significant increase in expenses relating
to financial statements preparation and other requirements applicable to
publicly traded companies.
The inability to successfully manage the growth of our business may have a
material adverse effect on our business, results or operations and financial
condition.
We expect to experience growth in the number of employees and the scope of
our operations as a result of internal growth and acquisitions. Such activities
could result in increased responsibilities for management.
Our future success will be highly dependent upon our ability to manage
successfully the expansion of operations. Our ability to manage and support our
growth effectively will be substantially dependent on our ability to implement
adequate improvements to financial, inventory, management controls, reporting,
union relationships, order entry systems and other procedures, and hire
sufficient numbers of financial, accounting, administrative, and management
personnel. There can be no assurance that we will be able to identify, attract
and retain experienced personnel.
Our future success depends on our ability to address potential market
opportunities and to manage expenses to match our ability to finance operations.
The need to control our expenses will place a significant strain on our
management and operational resources. If we are unable to control our expenses
effectively, our business, results of operations and financial condition may be
adversely affected.
The unsuccessful integration of a business or business segment we acquire could
have a material adverse effect on our results.
As part of our business strategy, we expect to acquire assets and
businesses relating to or complementary to our operations. These acquisitions
will involve risks commonly encountered in acquisitions. These risks include,
among other things, exposure to unknown liabilities of the acquired companies,
additional acquisition costs and unanticipated expenses. Our quarterly and
annual operating results will fluctuate due to the costs and expenses of
15
acquiring and integrating new businesses. We may also experience difficulties in
assimilating the operations and personnel of acquired businesses. Our ongoing
business may be disrupted and our management's time and attention diverted from
existing operations. Our acquisition strategy will likely require additional
debt or equity financing, resulting in additional leverage or dilution of
ownership. We cannot assure you that any future acquisition will be consummated,
or that if consummated, that we will be able to integrate such acquisition
successfully.
Any reduction in government spending on defense could materially adversely
impact our revenues, results of operations and financial condition.
There are risks associated with programs that are subject to appropriation
by Congress, which could be potential targets for reductions in funding to pay
for other programs. Future reductions in United States Government spending on
defense or future changes in the kind of defense products required by United
States Government agencies could limit demand for our products, which would have
a materially adverse effect on our operating results and financial condition.
In addition, potential shifts in responsibilities and functions within the
defense and intelligence communities could result in a reduction of orders for
defense products by segments of the defense industry that have historically been
our major customers. As a result, demand for our products could decline,
resulting in a decrease in revenues and materially adversely affecting our
operating results and financial condition.
We depend on revenues from a few significant customer relationships and any
loss, cancellation, reduction, or interruption in these relationships could harm
our business.
As of June 30, 2006, one customer accounted for approximately 50% of our
accounts receivable. In addition, this customer accounted for approximately 66%
of our total revenue for the quarter ended June 30, 2006. In the event such
customer is unable or unwilling to pay us our accounts receivable from such
customer, or in the event our relationship with such customer is severed or
negatively affected, our results of operations will be materially adversely
affected and we may not have the resources to meet our capital obligations.
In general, AIM has derived a material portion of its revenue from one or
a limited number of customers. We expect that in future periods we may enter
into contracts with customers which represent a significant concentration of our
revenues. If such contracts were terminated, our revenues and net income could
significantly decline. Our success will depend on our continued ability to
develop and manage relationships with significant customers. Any adverse change
in our relationship with our significant customers could have a material adverse
effect on our business. Although we are attempting to expand our customer base,
we expect that our customer concentration will not change significantly in the
near future. The markets in which we sell our products are dominated by a
relatively small number of customers who have contracts with United States
governmental agencies, thereby limiting the number of potential customers. We
cannot be sure that we will be able to retain our largest customers or that we
will be able to attract additional customers, or that our customers will
continue to buy our products in the same amounts as in prior years. The loss of
one or more of our largest customers, any reduction or interruption in sales to
these customers, our inability to successfully develop relationships with
additional customers or future price concessions that we may have to make, could
significantly harm our business.
Continued competition in our markets may lead to a reduction in our revenues and
market share.
The defense and aerospace component manufacturing market is highly
competitive and we expect that competition will continue to increase. Current
competitors have significantly greater technical, manufacturing, financial and
marketing resources than we do. We expect that more companies will enter the
defense and aerospace component manufacturing market. We may not be able to
compete successfully against either current or future competitors. Increased
competition could result in reduced revenue, lower margins or loss of market
share, any of which could significantly harm our business.
Our future revenues are inherently unpredictable; our operating results are
likely to fluctuate from period to period and if we fail to meet the
expectations of securities analysts or investors, our stock price could decline
significantly.
Our quarterly and annual operating results are likely to fluctuate
significantly in the future due to a variety of factors, some of which are
outside our control. Accordingly, we believe that period-to-period comparisons
of our results of operations are not meaningful and should not be relied upon as
future indications of performance. Some of the factors that could cause
quarterly or annual operating results to fluctuate include conditions inherent
16
in government contracting and our business such as the timing of cost and
expense recognition for contracts, the United States Government contracting and
budget cycles, introduction of new government regulations and standards,
contract closeouts, variations in manufacturing efficiencies, our ability to
obtain components and subassemblies from contract manufacturers and suppliers,
general economic conditions and economic conditions specific to the defense
market. Because we base our operating expenses on anticipated revenue trends and
a high percentage of our expenses are fixed in the short term, any delay in
generating or recognizing forecasted revenues could significantly harm our
business. Fluctuations in quarterly results, competition or announcements of
extraordinary events such as acquisitions or litigation may cause earnings to
fall below the expectations of securities analysts and investors. In this event,
the trading price of our Common Stock could significantly decline. In addition,
there can be no assurance that an active trading market will be sustained for
our Common Stock. These fluctuations, as well as general economic and market
conditions, may adversely affect the future market price of our Common Stock, as
well as our overall operating results.
We may lose sales if our suppliers fail to meet our needs.
Although we procure most of our parts and components from multiple sources
or believe that these components are readily available from numerous sources,
certain components are available only from sole sources or from a limited number
of sources. While we believe that substitute components or assemblies could be
obtained, use of substitutes would require development of new suppliers or would
require us to re-engineer our products, or both, which could delay shipment of
our products and could have a materially adverse effect on our operating results
and financial condition.
Attracting and retaining key personnel is an essential element of our future
success.
Our future success depends to a significant extent upon the continued
service of our executive officers and other key management and technical
personnel and on our ability to continue to attract, retain and motivate
executive and other key employees, including those in managerial, technical,
marketing and information technology support positions. Attracting and retaining
skilled workers and qualified sales representatives is also critical to us.
Experienced management and technical, marketing and support personnel in the
defense and aerospace industries are in demand and competition for their talents
is intense. The loss of the services of one or more of our key employees or our
failure to attract, retain and motivate qualified personnel could have a
material adverse effect on our business, financial condition and results of
operations.
Terrorist acts and acts of war may seriously harm our business, results of
operations and financial condition.
United States and global responses to the Middle East conflict, terrorism,
perceived nuclear, biological and chemical threats and other global crises
increase uncertainties with respect to U.S. and other business and financial
markets. Several factors associated, directly or indirectly, with the Middle
East conflict, terrorism, perceived nuclear, biological and chemical threats,
and other global crises and responses thereto, may adversely affect the Company.
While some of our products may experience greater demand as a result of
increased U.S. Government defense spending, various responses could realign U.S.
Government programs and affect the composition, funding or timing of our
government programs and those of our customers. U.S. Government spending could
shift to defense programs in which we and our customers do not participate. As a
result of the September 11th terrorist attacks and given the current Middle East
and global situation, U.S. defense spending is generally expected to increase
over the next several years. Increased defense spending does not necessarily
correlate to increased business, because not all the programs in which we
participate or have current capabilities may be earmarked for increased funding.
Terrorist acts of war (wherever located around the world) may cause damage
or disruption to us, our employees, facilities, partners, suppliers,
distributors and resellers, and customers, which could significantly impact our
revenues, expenses and financial condition. The terrorist attacks that took
place in the United States on September 11, 2001 were unprecedented events that
have created many economic and political uncertainties. The potential for future
terrorist attacks, the national and international responses to terrorist
attacks, and other acts of war or hostility have created many economic and
political uncertainties, which could adversely affect our business and results
of operations in ways that cannot presently be predicted. In addition, as a
company with headquarters and significant operations located in the United
States, we may be impacted by actions against the United States.
17
Our indebtedness may affect operations.
We incurred significant indebtedness under the New Loan Facility. This
indebtedness far exceeds the amount of pre-Merger debt of AIM. As a result, we
are significantly leveraged and our indebtedness is substantial in relation to
our stockholders' equity. Our ability to make principal and interest payments
will depend on future performance, which is subject to many factors, some of
which are outside our control. In addition, the New Loan Facility is secured by
substantially all of our assets, including the real estate acquired in the Real
Estate Acquisition. In the case of a continuing default under the New Loan
Facility, the lender will have the right to foreclose on AIM's assets, which
would have a material adverse effect on the Company. Payment of principal and
interest on the New Loan Facility may limit our ability to pay cash dividends to
shareholders and the documents governing the New Loan Facility will prohibit the
payment of cash dividends. Our leverage may also adversely affect our ability to
finance future operations and capital needs, may limit our ability to pursue
other business opportunities and may make our results of operations more
susceptible to adverse economic conditions.
Absence of Principal Shareholders' Guarantees and Financial Accommodations
Historically, AIM obtained money and achieved other financial
accommodations through arrangements guaranteed by the AIM's former shareholders.
Since they sold their shares of AIM in connection with the Acquisition, such
former shareholders of AIM will not be providing any financial assistance to us
or AIM on a going-forward basis. Consequently, we are no longer able to rely
upon the credit of AIM's former shareholders when seeking to borrow money or
obtain other financial accommodations.
We may issue shares of our capital stock or debt securities to complete an
acquisition, which would reduce the equity interest of our stockholders.
We will, in all likelihood, issue additional shares of our Common Stock or
preferred stock, or a combination of common and preferred stock, to complete an
acquisition. The issuance of additional shares of our Common Stock or any number
of shares of our preferred stock may significantly reduce the equity interest of
our current stockholders, may subordinate the rights of holders of our Common
Stock if preferred stock is issued with rights senior to the Common Stock and
may adversely affect prevailing market prices for our Common Stock.
Similarly, if we issue debt securities, it could result in default and
foreclosure on our assets if our operating revenues after an acquisition were
insufficient to pay our debt obligations, could result in the acceleration of
our obligations to repay the indebtedness even if we have made all principal and
interest payments when due if the debt security contains covenants that require
the maintenance of certain financial ratios or reserves and any such covenant is
breached without a waiver or renegotiation of that covenant, and could result in
our inability to obtain additional financing if the debt security contains
covenants restricting our ability to obtain additional financing while such
security is outstanding.
Because of our limited resources and the significant competition for
acquisitions, we may not be able to consummate an acquisition with growth
potential.
We expect to encounter intense competition from other entities having a
business objective similar to ours, including venture capital funds, leveraged
buyout funds and operating businesses competing for acquisitions. Many of these
entities are well established and have extensive experience in identifying and
effecting business combinations directly or through affiliates. Many of these
competitors possess greater technical, human and other resources than we do and
our financial resources will be relatively limited when contrasted with those of
many of these competitors. While we believe that there are numerous potential
target businesses that we could acquire, our ability to compete in acquiring
certain target businesses will be limited by our available financial resources.
This inherent competitive limitation gives others an advantage in pursuing the
acquisition of certain target businesses.
We may be unable to obtain additional financing, if required, to complete an
acquisition or to fund the operations and growth of any business acquired, which
could compel us to abandon a particular prospective acquisition.
If we require additional financing to complete an acquisition, we cannot
assure you that such financing would be available on acceptable terms, if at
all. To the extent that additional financing proves to be unavailable when
needed to consummate a particular acquisition, we would be compelled to
18
restructure the transaction or abandon that particular acquisition. In addition,
if we consummate an acquisition, we may require additional financing to fund the
operations or growth of the business acquired. The failure to secure additional
financing could have a material adverse effect on the continued development or
growth of our business.
There is only a limited public market for our securities.
The trading market for our Common Stock is limited and conducted on the
OTC Bulletin Board. Our Common Stock is very thinly traded. There can be no
assurance that we will ever achieve a listing of our securities on NASDAQ or a
stock exchange or that a more active trading market will ever develop, or, if
developed, that it will be sustained.
Potential Adverse Effect on Market Price of Securities from Future Sales of
Common Stock.
Future sales of Common Stock pursuant to a registration statement or Rule
144 under the Securities Act, or the perception that such sales could occur,
could have an adverse effect on the market price of the Common Stock. Our
Registration Statement on Form SB-2 covering the resale by selling security
holders of more than 60,000,000 shares of Common Stock was declared effective on
August 4, 2006. Relative to the number of shares of our freely-trading Common
Stock which had been outstanding prior to such declaration of effectiveness,
which we estimate to be approximately 2.52 million shares, the number of shares
which may be sold into the marketplace pursuant to our current Registration
Statement is enormous.
We believe that any significant sales of our Common Stock may severely
depress the market price of our Common Stock. We also intend to register on Form
S-8 under the Securities Act an additional 10,000,000 shares of Common Stock,
which are the shares available for issuance under our 2005 Stock Incentive Plan,
of which, as of June 30, 2006, we have granted stock options to purchase
4,850,000 shares of our Common Stock. In addition, shares of our Common Stock
held for one year or more will be eligible for public resale pursuant to Rule
144. In general, the shares of Common Stock which we issued in connection with
the Merger and the Acquisition will become eligible for public resale under Rule
144 as of November 30, 2006. In addition, we may use our capital stock in the
future to finance acquisitions and to compensate employees and management, which
will further dilute the interests of our existing shareholders and could
eventually significantly depress the trading price of our Common Stock.
Dilution from Shares to Be Issued in Potential Acquisitions
Our business plan calls for our making acquisitions in the future. We will
very likely issue a significant number of shares of our capital stock to pay for
each such acquisition. Such issuances of shares will dilute the interests of our
existing shareholders and could depress the trading price of our Common Stock.
Effect of Stock Options
Our 2005 Stock Incentive Plan allows for the issuance of up to 10,000,000
shares of Common Stock, either as stock grants or options, to employees,
officers, directors, advisors and consultants of the Company. As of November 30,
2005, options to purchase 4,850,000 shares of Original Gales' common stock
became options to purchase shares of our Common Stock under our 2005 Stock
Incentive Plan. The committee administering such plans will have sole authority
and discretion to grant options under such plans. We may grant options which
become immediately exercisable in the event of a change in control of the
Company and in the event of certain mergers and reorganizations of the Company.
The existence of such options could limit the price that certain investors might
be willing to pay in the future for shares of our Common Stock and may have the
effect of delaying or preventing a change in control of the Company. The
issuance of additional shares upon the exercise of such options could also
decrease the amount of earnings and assets available for distribution to the
holders of the Common Stock and could result in the dilution of voting power of
the Common Stock.
The Series A Convertible Preferred Stock
On August 4, 2006, as a result of the effectiveness of our registration
statement on Form SB-2 as of such date, our 900 outstanding shares of Series A
Convertible Preferred Stock ("Preferred Stock") were automatically converted
into an aggregate of 40,909,538 shares of Common Stock. Those who previously
19
held our Preferred Stock now, as a group, control a majority of the voting
shares of the Company and have the ability to elect a majority of the members of
our Board of Directors and otherwise control the Company.
Prior to November 30, 2005, AIM was not subject to Sarbanes-Oxley regulations
and, therefore, may have lacked the financial controls and procedures of public
companies.
Prior to November 30, 2005, AIM did not have the internal or financial
control infrastructure necessary to meet the standards of a public company,
including the standards required by the Sarbanes Oxley Act of 2002 ("Sarbanes
Oxley"). Because AIM was not subject to Sarbanes Oxley, its internal and
financial controls reflected its status as a non-public company. AIM did not
have the internal infrastructure necessary to complete an attestation about its
financial controls that would be required under Section 404 of Sarbanes Oxley.
We are now required to comply with portions of Sarbanes Oxley and currently
estimate that the costs of complying with Sarbanes Oxley and other requirements
associated with being a public company will be $750,000 during calendar year
2006, and such cost will likely increase at such time as we are required to
comply with Section 404 of Sarbanes Oxley.
Item 3: Controls and Procedures
As of the end of the period covered by this report, our management,
including our principal executive officer and our principal financial officer,
have conducted an evaluation of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15 under the Securities Exchange Act of
1934). Based upon that evaluation, our principal executive officer and our chief
financial officer have concluded that our disclosure controls and procedures are
effective in timely alerting them of material information relating to us that is
required to be disclosed by us in the reports we file or submit under the
Exchange Act.
Because AIM was subject to stringent performance criteria imposed by its
customers and as a consequence of its government contracts, in our management's
estimation, its disclosure controls and procedures were superior to those of
most privately held companies of comparable size. Nevertheless, its controls and
procedures were not designed to facilitate the external financial reporting
required of a publicly held company. Although no material weaknesses were found
in our disclosure controls and procedures as of June 30, 2006, to ensure the
reliability of future financial reports, our management has determined to
complete the implementation of a total financial and operating control system
that AIM installed during 2005. In addition, management has determined to hire
support personnel experienced with the reporting requirements imposed upon
public companies to facilitate the timely preparation of accurate financial
reports. Except for these planned changes and those resulting from the
acquisition of AIM and the substitution of its accounting procedures for those
of ours in effect prior to November 30, 2005, there have been no significant
changes made in our internal controls or in other factors that could
significantly affect our internal controls subsequent to June 30, 2006 or during
the quarter ended June 30, 2006.
PART II
OTHER INFORMATION
Item 4: Unregistered Sales of Equity Securities
We issued as of April 1, 2006 to a consulting firm, in return for services
on public relations matters, a warrant to purchase 10,417 shares of our Common
Stock at the exercise price of $0.73 per share and a warrant to purchase 10,417
shares of our Common Stock at the exercise price of $1.56 per share. We issued
to the same firm as of May 1, 2006 a warrant to purchase 10,417 shares of our
Common Stock at the exercise price of $1.82 per share and as of June 1, 2006 a
warrant to purchase 10,417 shares of our Common Stock at the exercise price of
$1.64 per share. All of such warrants expire five years after the date as of
which they were issued and provide for cashless exercise and piggyback
registration rights with respect to new registration statements which we may
file in the future. We will be issuing to the same firm a warrant for the same
number of shares (10,417) of our Common Stock as of the first day of each month
following June 1, 2006 until February 1, 2007 (except that the February 1, 2007
warrant will have the right to purchase 10,416 shares). The exercise price per
share for each such warrant to be issued will equal 120% of the average closing
price of the Common Stock during the month immediately preceding the date as of
which such warrant is issued and will have all other terms which are the same as
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the terms of the April 1, 2006, May 1, 2006 and June 1, 2006 warrants. In all,
we will have issued 12 warrants to the same firm which are exercisable into an
aggregate of 125,000 shares of Common Stock.
Such issuances of warrants to our consulting firm were, and will be,
exempt from registration pursuant to Section 4(2) under the Securities Act of
1933, as amended.
The 900 shares of convertible preferred stock accumulated $360,000 in 8%
Payable-In-Kind (PIK) dividends. This Payable-In-Kind dividend was earned during
the six month period from December 15, 2005 to June 15, 2006 and is equal to 36
shares of preferred stock convertible into 1,636,363 shares of common stock.
Such dividends, as well as the outstanding Preferred Stock, automatically
converted into shares of Common Stock when our registration statement on Form
SB-2 became effective on August 4, 2006.
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August 2006.
Item 5. Exhibits
The following exhibits are filed as part of this report:
Exhibit No. Description of Exhibit
31.1 -- Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2 -- Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1 -- Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.2 -- Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: August 14, 2006
GALES INDUSTRIES INCORPRATED
By: /s/ Michael A. Gales
---------------------------------
Michael A. Gales,
Executive Chairman
/s/ Louis A. Giusto
---------------------------------
Louis A. Giusto,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
Exhibit No. Description of Exhibit
31.1 -- Certification of Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2 -- Certification of Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934.
32.1 -- Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.2 -- Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
24