SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2006
|_| Transition Report under Section 13 of 15(d) of the Securities Exchange Act
of 1934
For the transition period from ___________ to __________
Commission file number: 000-29245
GALES INDUSTRIES INCORPORATED
(Name of small business issuer in its charter)
Delaware 20-4458244
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1479 North Clinton Avenue, Bay Shore, New York 11706
(Address of principal executive offices) (Zip code)
Issuer's telephone number, including area code: (631) 968-5000
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
N/A N/A
Securities registered under Section 12(g) of the Exchange Act:
Common Stock,
$.001 par value per share
-------------------------
(Title of class)
Check whether the issuer is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act. |_|
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes |X| No
|_|
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this form 10-KSB. |x|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES ____ NO _X___
The issuer's revenues for its most recent fiscal year were $33,044,996.
As of March 26, 2007, the aggregate market value of the issuer's common
equity held by non-affiliates was $13,816,993.52, based on the closing price of
$0.285 for its common stock on the OTC Bulletin Board on March 26, 2007.
Approximately 59,380,036 shares of the issuer's common stock were outstanding as
of March 26, 2007.
DOCUMENTS INCORPORATED BY REFERENCE
N/A
Transitional Small Business Disclosure Formats (check one): Yes |_| No |X|
Cautionary Notice Regarding Forward Looking Statements
Gales Industries Incorporated (referred to herein as "we" or 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.
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.
PART I
Item 1. Description of Business.
Background
Through our wholly-owned subsidiary, Air Industries Machining Corporation
("AIM"), we manufacture aircraft structural parts and assemblies principally for
prime defense contractors in the aerospace industry including, Sikorsky,
Lockheed Martin, Boeing and Northrop Grumman. Approximately 85% of our 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 our revenues. Parts manufactured by us are installed onboard
Sikorky's VH-3D, otherwise known as Marine One, the primary Presidential
helicopter, and onboard Air Force One, Boeing's 747-2000B customized for use by
the President.
On November 30, 2005, we then known as Ashlin Development Corporation,
consummated a Merger Agreement (the "Merger Agreement") with Gales Industries
Incorporated, a privately-held Delaware corporation ("Original Gales") whereby,
we issued 10,673,107 shares of our common stock ("Common Stock") (representing
74% of our outstanding shares as of the date of the Merger) and 900 shares of
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our Series A Convertible Preferred Stock ("Preferred Stock"), initially
convertible into 40,909,500 shares of our Common Stock, for all the issued and
outstanding common shares and preferred shares of Original Gales. As a result of
the transaction, the former stockholders of Original Gales became the
controlling stockholders of our Company. The transaction was treated for
accounting purposes as a reverse acquisition and the transaction has been
accounted for as a recapitalization of Original Gales rather than a business
combination. Consequently, the historical financial statements of Original Gales
are now the historical financial statements of our Company.
Immediately prior to the closing of the Merger, Original Gales acquired
(the "Acquisition") all of the outstanding capital stock of AIM, pursuant to a
Purchase Agreement entered into on July 25, 2005 (the "Purchase Agreement").
Because of the change in ownership, management and control that occurred in
connection with the Acquisition of AIM, for financial reporting purposes the
Acquisition was accounted for as a purchase. Immediately after the Acquisition,
AIM acquired its corporate campus located in Bay Shore, New York, from the
former shareholders of AIM.
Our offices are at 1479 North Clinton Avenue, Bay Shore, New York 11706
and our telephone number is (631) 968-5000.
About AIM
Founded in 1969, AIM manufactures aircraft structural parts and assemblies
principally for prime defense contractors in the defense/aerospace industry
including, Sikorsky, Lockheed Martin, Boeing and Northrop Grumman. 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 such as Boeing. AIM is a provider of flight critical, technically
complex structures: AIM's parts are installed onboard Sikorky's VH-3D, otherwise
known as Marine One, the primary Presidential helicopter and on Air Force One,
Boeing's 747-2000B customized for use by the President.
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, and rotorhub components for Blackhawk helicopters,
rocket launching systems for the F-22 Raptor Advanced Stealth Fighter, arresting
gear for the E2C Hawkeye and US Navy Fighters, vibration absorbing assemblies
for a variety of Sikorsky helicopters, landing gear components for the F-35
Joint Strike Fighter, and many other subassembly packages. AIM's achievements in
manufacturing quality control have enabled it to receive various international
certifications that distinguish it from less qualified manufacturers, as well as
several highly technical, customer-based proprietary quality approvals,
including supplier of the year awards from notable customers such as United
Technologies and Northrop Grumman.
AIM is the largest supplier of flight safety components for Sikorsky.
Sales of parts and services to Sikorsky accounted for approximately 61% of AIM's
revenues during 2006, and are subject to General Ordering Agreements which were
recently renegotiated and extended through 2012.
The parts and subassemblies produced by AIM are built to customer
specifications and are not protected by patents, trademarks or other rights
owned or licensed by AIM. As a result, AIM is not required to procure product
liability insurance for such parts and subassemblies because such insurance is
provided for by the customer. Historically, AIM has spent little or no money on
the development of new proprietary products. We did not have any expenditures
for research and development in 2006 and 2005. In the past AIM has spent capital
to acquire and retool machinery and equipment to enable it to qualify to bid on
contracts to produce parts and subassemblies needed by its customers or, once
such a contract was obtained, to improve its manufacturing efficiencies to
increase its profits from a contractor or ensure that the contract would be
retained as future quantities of the product were required.
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Sales and Marketing
Our approach to sales and marketing can be best understood through the
concept of customer alignment. The aerospace industry is dominated by a small
number of large prime contractors and equipment manufacturers. We seek to
position ourselves within the supply chain of these contractors and
manufacturers to be selected for subcontracted projects as they develop.
Successful positioning requires that a company qualify to be a preferred
supplier by achieving and maintaining independent third party quality approval
certifications, specific customer quality system approvals and top supplier
ratings through strong performance on existing contracts.
In addition to maintaining our status as a preferred supplier, we work
closely with customers to assure that our investments are concentrated in
production capabilities that are aligned with customer sourcing and
subcontracting strategies. Also, we constantly work to support our customers in
their political, industrial and international initiatives.
Initial contracts are usually obtained through competitive bidding against
other qualified subcontractors, while follow-on contracts are usually obtained
by successfully performing initial contracts. Our long-term business base
generally benefits from barriers to entry resulting from investments,
certifications and manufacturing techniques developed during the initial
manufacturing phase.
As our business base grows with targeted customers and significant market
share is obtained, we endeavor to develop our relationship to one of a
partnership where initial contracts are also obtained as single source awards
and follow-on pricing is negotiated on a cost plus basis.
The Market
During most of the 1990s, defense spending remained flat or experienced a
slight decline. In the late 1990's and the early years of the new millennium,
Boeing experienced some market share loss to Airbus which adversely affected the
domestic aerospace business. The events of 9/11 caused a further deterioration
in the domestic commercial aircraft industry, which had been poised for growth
as a result of the anticipated replacement of aging airframes.
More recently, the United States defense budget is at an all time high and
is currently expected to continue at this level through the Bush Administration
and for the next several years. In addition, the world wide commercial aircraft
industry is experiencing an increase in activity as a consequence of significant
growth in passenger flights and air cargo traffic, and the development of the
Boeing 787 Fuel Efficient Dreamliner. Increased utilization of existing
resources in the commercial aircraft industry should result in demand for our
services. More specific to our business, the war on terrorism has hastened the
need to replace older helicopters in the various state Army and Air National
Guard Units with up to date Blackhawk models as these units have been mobilized
to serve in Afghanistan and Iraq. We are the largest supplier of flight critical
parts for the Sikorsky Blackhawk.
Backlog
We have a number of long-term multi-year general purchase agreements with
several of our customers. These agreements specify the part number,
specifications and price of the covered products for a specified period, but do
not authorize immediate shipment. These agreements do not obligate a customer to
buy required products from us. Nevertheless, generally, before a customer will
award such an agreement, we or any other supplier must demonstrate the ability
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to produce products meeting the customer's specifications at an acceptable
price. It is a time consuming process for a customer to qualify us or any other
supplier for a particular part or subassembly, so most customers tend to limit
the number of contracts awarded and, so long as performance is acceptable, will
only seek to re-bid a contract at lengthy intervals. Customers issue release
orders against these contracts periodically to satisfy their needs. In addition
to our long term agreements, we regularly enter into agreements with customers
calling for a specified quantity of a product at a fixed price on firm delivery
dates.
Our "firm backlog" includes all fully authorized orders received for
products to be delivered within the forward 18-month period. The "projected
backlog" includes the firm backlog and forecasted demand from the Company's base
of leading prime aerospace/defense contractors for product releases against
existing general purchase agreements ("GPA's"). Although the forecasted releases
against GPA's within the forward 18-month period are included in the "projected
backlog", the Company may actually receive additional substantial "follow-on"
awards through the balance of a GPA period, some of which currently extend
through 2012. The backlog information set forth herein does not include the
sales that we expect to generate from long-term agreements associated with
long-term production programs but for which we do not have actual purchase
orders with firm delivery dates.
As of March 15, 2007, our 18-month "firm backlog" was approximately $37.3
million and our "projected backlog" as of such date for the same 18-month period
which includes both the firm backlog as well as anticipated order releases
against long term agreements with our prime aerospace contractors was
approximately $60.0 million.
Competition
The markets for our products are highly competitive. For the most part we
manufacture items to customer design and compete against companies that have
similar manufacturing capabilities in a global marketplace. Consequently, our
ability to obtain contracts is tied to our ability to provide quality products
at competitive prices which requires continuous improvements in our capabilities
to assure competitiveness and value to our customers. Our marketing strategy
involves developing long term ongoing working relationships with customers based
on large multi-year agreements which foster mutually advantageous relationships.
Many of our competitors are well-established subcontractors engaged in the
supply of aircraft parts and components to prime military contractors and
commercial aviation manufacturers, including Monitor Aerospace, a division of
Stellex Aerospace, Hydromil, a division of Triumph Aerospace Group, Heroux
Aerospace and Ellanef Manufacturing, a division of Magellan Corporation. Many of
our competitors are divisions of larger companies having significantly larger
infrastructures, greater resources and the capabilities to respond to much
larger contracts.
Raw Materials and Replacement Parts
As a product integrator our manufacturing processes require substantial
purchase of raw materials, hardware and subcontracted details. As a result, much
of our success in meeting customer demand involves effective subcontract
management. Price and availability of many raw materials utilized in the
aerospace industry are subject to volatile global markets. Most suppliers are
unwilling to commit to long-term contracts, which can represent a substantial
risk as our strategy often involves long term fixed pricing with our customers.
We believe that the availability of raw materials to us is adequate to support
our operations.
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We have approximately 14 key sole-source suppliers of various parts that
are important for one or more of our products. These suppliers are our only
source for such parts and, therefore, in the event any of them were to go out of
business or be unable to provide us parts for any reason, our business could be
materially adversely affected.
Future Expansion and Acquisition Strategy
Since the 1990's, the aerospace and defense and industries have undergone
a radical restructuring and consolidation. The largest prime contractors have
merged, resulting in fewer, but larger, entities. A prime example is Boeing,
which acquired McDonnell Douglas. Others include Lockheed Martin, the result of
Lockheed's acquisition of Martin Marietta, and the aerospace divisions of
General Dynamics and Northrop Grumman, which fused together Northrop, Grumman,
Westinghouse and Litton Industries into one entity.
This trend has permeated through the industry eliminating many companies
as the prime contractors streamlined their supply chains. To survive, companies
must invest in systems and infrastructures that align their capabilities with
the needs of the prime contractors. At a minimum, Tier III and IV suppliers must
be fully capable to interactively work within a computer aided three dimensional
automated engineering environment and must have third party quality system
certifications attesting to their abilities.
The industry's drive to efficiency will create enhanced pressures on many
aerospace/defense critical component manufacturers, particularly those with
$15-$100 million in annual sales, referred to herein as the "Tier III/IV
Manufacturing Sector", and these manufacturers will have to either upgrade their
systems to achieve quality approvals or leave the industry.
In response to this drive towards greater operating and economic
efficiency, our objective is to achieve a leading role in the consolidation of
the Tier III and IV Manufacturing Sectors. In this regard, our core strategy
will be to selectively acquire synergistic manufacturers of "lynchpin" products
and technologies, upon which larger, more complex and key defense systems and
platforms can be established. We believe that numerous acquisition opportunities
of such kind exist, particularly given the evolutionary stage of a number of
existing businesses in the sector, the age of many of the owner-principals and
their perceived and stated desire to facilitate a liquidity event for their
investment in the near term. Furthermore, we believe that by executing a
well-defined consolidation strategy in the Tier III and IV Manufacturing
Sectors, we will be able to achieve significant cost savings, operational
efficiencies and overall economic synergies. AIM was our initial strategic
acquisition and will serve as our operating platform for subsequent acquisitions
and organic growth.
The Company will focus on acquiring profitable, privately held entities or
divisions of larger entities with annual sales between $15 and $100 million in
the aerospace and defense-related fields. The Company will initially seek
enterprises whose products are synergistic and complementary to AIM's current
product line and which can benefit from the Company's existing engineering
talents and manufacturing capabilities. The Company will look for candidates
whose products are components of larger mission critical systems and which can
be upgraded from simple parts to complex, higher-margin component system
subassemblies through the use of AIM's engineering talents. The Company intends
to focus on entities with reputations for high quality standards whose
management can be absorbed into the Company. When possible, the Company will
seek to combine existing operations to absorb excess capacity and eliminate
duplicative facilities. It is contemplated that future acquisitions will be
facilitated by using either the Company's stock, cash or debt financing, or some
combination thereof. Given our limited available cash, it is likely that we will
have to rely upon seller financing or debt financing provided by third parties
to complete acquisitions for the foreseeable future. There can be no assurance
that such financing will be made available to us and, our need to rely upon such
sources may make it difficult for us to complete any transaction in competition
with larger better capitalized competitors.
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The Company also intends to expand its operations through internal growth.
The Company will seek to attract new customers through proactive industry
marketing efforts including direct sales programs, participation at trade shows,
technical society meetings and similar activities. Additionally, the Company
will seek to capitalize on its engineering capabilities by partnering with other
lower cost manufacturers which can benefit from the Company's expertise.
Sigma Metals, Inc
On January 2, 2007, the Company entered into a Stock Purchase Agreement
(the "Sigma Agreement") with Sigma Metals, Inc., a New York corporation ("Sigma
Metals"), and the holders of all of the outstanding shares of Sigma Metals (the
"Shareholders"). Pursuant to the Sigma Agreement, subject to the satisfaction of
various terms and conditions, the Company will acquire from the Shareholders all
of the issued and outstanding capital stock of Sigma Metals.
The closing of the Sigma Agreement is scheduled to occur in April 2007 or
on such other date as the Company and the Shareholders may agree. The purchase
price for all of the shares is $7,000,000 plus an amount equal to Sigma Metals'
earnings for the period from January 1, 2007, until the closing, subject to
certain adjustments as set forth in the Sigma Agreement.
Welding Metallurgy, Inc
On March 9, 2007, the Company entered into a Stock Purchase Agreement (the
"Welding Agreement") to acquire Welding Metallurgy, Inc., a New York corporation
("Welding Metuallurgy"), from the holders (the "Shareholders") of all of the
outstanding shares of Welding Metallurgy. Pursuant to the Welding Agreement,
subject to the satisfaction of various terms and conditions, the Company will
acquire from the Shareholders all of the issued and outstanding capital stock of
Welding Metallurgy for aggregate consideration of $6,050,000, subject to
adjustment for working capital, payable in a combination of cash, a secured
promissory note and shares of the Company's common stock.
The closing of the acquisitions of each of Sigma Metals and Welding
Metallurgy are subject to continued due diligence by the Company and various
conditions, including the ability of the Company to obtain the consent of its
lender and such additional debt or equity financing as may be necessary to close
the transactions. There can be no assurance that the Company will be able to
close either or both of these acquisitions on the anticipated closing dates, if
at all.
Government Regulation
Environmental Regulation
We are subject to regulations administered by the United States
Environmental Protection Agency, the Occupational Safety and Health
Administration, various state agencies and county and local authorities acting
in cooperation with federal and state authorities. Among other things, these
regulatory bodies impose restrictions to control air, soil and water pollution,
to protect against occupational exposure to chemicals, including health and
safety risks, and to require notification or reporting of the storage, use and
release of certain hazardous chemicals and substances. The extensive regulatory
framework imposes compliance burdens and risks on us. Governmental authorities
have the power to enforce compliance with these regulations and to obtain
injunctions or impose civil and criminal fines in the case of violations.
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The Comprehensive Environmental Response, Compensation and Liability Act
of 1980 (CERCLA) imposes strict, joint and several liability on the present and
former owners and operators of facilities that release hazardous substances into
the environment. The Resource Conservation and Recovery Act of 1976 (RCRA)
regulates the generation, transportation, treatment, storage and disposal of
hazardous waste. In New York, the handling, storage and disposal of hazardous
substances are governed by the Environmental Conservation Law, which contains
the New York counterparts of CERCLA and RCRA. In addition, the Occupational
Safety and Health Act, which requires employers to provide a place of employment
that is free from recognized and preventable hazards that are likely to cause
serious physical harm to employees, obligates employers to provide notice to
employees regarding the presence of hazardous chemicals and to train employees
in the use of such substances.
Federal Aviation Administration Regulation
We are subject to regulation by the Federal Aviation Administration (FAA)
under the provisions of the Federal Aviation Act of 1958, as amended. The FAA
prescribes standards and licensing requirements for aircraft and aircraft
components. We are subject to inspections by the FAA and may be subjected to
fines and other penalties (including orders to cease production) for
noncompliance with FAA regulations. Our failure to comply with applicable
regulations could result in the termination of or our disqualification from some
of our contracts, which could have a material adverse effect on our operations.
Government Contract Compliance
Our government contracts and those of many of our customers are subject to
the procurement rules and regulations of the United States government, including
the Federal Acquisition Regulations ("FAR"). Many of the contract terms are
dictated by these rules and regulations. During and after the fulfillment of a
government contract, we may be audited in respect of the direct and allocated
indirect costs attributed thereto. These audits may result in adjustments to our
contract costs. Additionally, we may be subject to U.S. government inquiries and
investigations because of our participation in government procurement. Any
inquiry or investigation can result in fines or limitations on our ability to
continue to bid for government contracts and fulfill existing contracts.
We believe that we are in substantial compliance with all federal, state
and local laws and regulations governing our operations and have obtained all
material licenses and permits required for the operation of our business.
Employees
As of December 31, 2006, AIM employed approximately 170 people all of whom
were members of the United Service Workers union with which the Company
maintains what it believes are good relationships. AIM is a party to two
collective bargaining agreements with the United Services Workers, IUJAT, Local
355 (the "Union"), one is dated September 1, 2004, and covers all of AIM's full
time employees (the "2004 Collective Bargaining Agreement") the other is dated
January 1, 2005, and covers all of AIM's administrative employees (the "2005
Collective Bargaining Agreement", together with the 2004 Collective Bargaining
Agreement, the "Collective Bargaining Agreements"). The terms and provisions of
each of the Collective Bargaining Agreements are substantially the same. Each of
the Collective Bargaining Agreements terminates on December 31, 2007; however,
the 2005 Collective Bargaining Agreement automatically renews from year to year
thereafter unless written notice is given by either party not less than sixty
(60) days prior to the termination date of its intention to terminate or modify
the 2005 Collective Bargaining Agreement. AIM is required to make a monthly
contribution to each of the Union's United Welfare Fund and the United Service
Worker's Security Fund. Each of the Collective Bargaining Agreements contains a
"no strike" clause, whereby, during the terms of each of the Collective
Bargaining Agreements, the Union will not strike and AIM will not lockout its
employees. Employees of AIM covered by the 2004 Collective Bargaining Agreement
have a sixty (60) day probationary period where they can be discharged by AIM
for any reason whatsoever; however, employees of AIM covered by the 2005
Collective Bargaining Agreement have a thirty (30) day probationary period. Any
discharge that occurs after the expiration of the probationary period may be
challenged by the Union through the grievance procedure set forth in the
Collective Bargaining Agreements.
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In March 2007, 17 members of the Company's management were removed from
the union. For administrative ease, the Company has contracted with a third
party to administer their benefits and salaries.
Risk Factors
The reader should carefully consider each of the risks described below. If
any of the following risks develop into actual events, our business, financial
condition or results of operations could be materially adversely affected and
the trading price of the Common Stock could decline significantly.
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 a public company,or that the results of operations of AIM prior to the
Merger will not be adversely impacted by the transactions. The process of
combining the organizations of Original Gales, AIM and our Company could cause
fundamental changes in AIM's business, which could have an adverse effect on the
results of operations of AIM. 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 of 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 accounting and financial 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.
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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
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 relationships, in particular with
Sikorsky Aircraft, and any loss, cancellation, reduction, or interruption in
these relationships could harm our business.
In general, AIM has derived a material portion of its revenues 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. Sikorsky accounts
for approximately 61% of our sales. Any adverse change in our relationship with
such customer 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.
-9-
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 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
indications of performance. Some of the factors that could cause quarterly or
annual operating results to fluctuate include conditions inherent 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 develop or 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
or 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.
-10-
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.
Given the current Middle East and global situation, U.S. defense spending is
generally expected to remain high 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 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.
Our indebtedness may affect operations.
As described below under "Management's Discussion and Analysis or Plan of
Operations - Financial Liquidity and Capital Resources", we have significant
indebtedness. 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, our Loan Facility
is secured by substantially all of our assets. In the case of a continuing
default under our 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 Loan Facility may limit our ability to pay cash
dividends to shareholders and the documents governing the Loan Facility prohibit
the payment of cash dividends in certain situations. Our leverage may also
adversely affect our ability to finance future operations and capital needs, may
limit our ability to pursue business opportunities and may make our results of
operations more susceptible to adverse economic conditions.
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
acquisitions. 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 and 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. This issuance of
debt securities could also impact our ability to obtain additional financing, if
necessary, if the debt security contains covenants restricting our ability to
obtain additional financing while such security is outstanding.
-11-
Because of our limited resources and the significant competition for
acquisitions, we may not be able to consummate an acquisition with growth
potential, if at all.
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
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.
If our common stock becomes subject to the SEC's penny stock rules,
broker-dealers may experience difficulty in completing customer transactions and
trading activity in our securities may be adversely affected.
If at any time we have net tangible assets of $5,000,000 or less and our
common stock has a market price per share of less than $5.00, transactions in
our Common Stock may be subject to the "penny stock" rules promulgated under the
Securities Exchange Act of 1934. If our Common Stock falls within the definition
of penny stock and is subject to rules that impose additional sales practice
requirements on broker-dealers who sell such securities to persons other than
established customers and accredited investors (generally those with assets in
excess of $1,000,000, or annual incomes exceeding $200,000 or $300,000, together
with their spouse).
-12-
For transactions covered by these rules, the broker-dealer must make a
special suitability determination for the purchase of such securities and have
received the purchaser's prior written consent to the transaction. Additionally,
for any transaction, other than exempt transactions, involving a penny stock,
the rules require the delivery, prior to the transaction, of a risk disclosure
document mandated by the SEC relating to the penny stock market. The
broker-dealer also must disclose the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and, if the broker-dealer is the sole market-maker, the broker-dealer
must disclose this fact and the broker-dealer's presumed control over the
market. Finally, monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks. Consequently, the "penny stock" rules may
restrict the ability of broker-dealers to sell the Company's Common Stock and
may affect the ability of investors to sell our Common Stock in the secondary
market. Such rules may also cause fewer broker-dealers to be willing to make a
market in our Common Stock, and it may affect the level of news coverage we
receive.
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. We filed a
Registration Statement on form SB-2 covering the resale by selling security
holders of more than 60,000,000 shares of Common Stock that was declared
effective in August 2006. In addition, we registered 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 March 15, 2007, we have granted stock options to purchase 6,375,000 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 became eligible for public resale under Rule 144 as of November 30,
2006. The number of our shares available for sale pursuant to registration
statements or Rule 144 is enormous relative to the trading volume of our shares.
Any attempt to sell a substantial number if our shares will severely depress the
market price of our common stock. 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.
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 March 15,
2007, 6,375,000 options to purchase shares of common stock were outstanding
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.
-13-
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 were approximately $750,000 during
calendar year 2006, and such cost will likely increase as we adopt procedures
necessary to comply with Section 404 of Sarbanes Oxley.
Item 2. Description of Property.
The Company's headquarters are situated on a 5.4-acre corporate campus in
Bay Shore, New York. On such campus, the Company occupies three buildings
consisting of 76,000 square feet.
On October 24, 2006, the Company sold the buildings and real property
located at its corporate campus ("the "Property") for a purchase price of
$6,200,000.
Simultaneous with the sale of the Property, the Company entered into a
20-year triple-net lease (the "Lease") for the Property. Base annual rent is
approximately $540,000 for the first five years of the Lease, increases to
$621,000 for the sixth year of the term, and thereafter increases 3% per year.
The Lease grants AIM an option to renew the Lease for an additional period of
five years. The Company deposited $127,500 as security for the performance of
its obligations under the Lease, which it subsequently replaced with a $127,500
letter of credit. In addition, the Company deposited with the landlord an
additional $393,000 as security for the completion of certain repairs and
upgrades to the Property. Pursuant to the terms of the Lease, the Company is
required to pay all of the costs associated with the operation of the
facilities, including, without limitation, insurance, taxes and maintenance. The
Lease also contains customary representations, warranties, obligations,
conditions and indemnification provisions and grants the landlord customary
remedies upon a breach of the lease by the Company, including the right to
terminate the Lease and hold the Company liable for any deficiency in future
rent.
Item 3. Legal Proceedings.
A legal action seeking $5,000,000 in damages was brought against AIM in
2001 by an independent contractor for personal injury allegedly caused by a fall
in AIM's premises. The carrier assumed the defense of this action and it was
settled during 2006 by the carrier at no cost to the Company.
The Company was involved in litigation with J.C. Herbert Bryant, III, a
former officer, director and shareholder of the Company, and KMS-Thin Tab 100,
Inc., which was settled in September 2002. As part of the settlement, the
Company entered into a distribution agreement with KMS permitting it to purchase
certain products from the Company and to exclusively distribute those products
in Florida from Orlando south. In October 2003, the Company terminated the
distribution agreement with KMS. On December 1, 2003, the Company filed suit
against KMS in the Palm Beach County Circuit Court for breach of contract,
trademark infringement and for a declaration of rights that the distribution
agreement is terminated. KMS answered the complaint and filed its own
counterclaim for fraud in the inducement, trademark infringement, dilution and
fraudulent misrepresentation; the fraud-based counterclaims were dismissed with
prejudice by the Court on summary judgment. KMS subsequently amended its
counterclaim to allege a breach of contract under the distribution agreement. In
January 2005, the State Court in Florida ruled that neither party should prevail
and rejected a request for attorney's fees by KMS of approximately $60,000. KMS
subsequently filed a notice of appeal. Subsequent to the Company's emergence
from Bankruptcy, KMS requested that the Bankruptcy Court reopen our bankruptcy
case and award it the attorney's fees previously rejected by the Florida State
Court. The Bankruptcy Court granted the motion in so far as it allowed KMS to
prosecute in the Fourth District Court of Appeal in Florida its appeal of the
State Court decision. Subsequently, KMS filed its appeal and brief with the
Fourth District seeking attorney's fees. The Company intends to contest this
claim vigorously, local counsel has responded on behalf of the Company and we
await the decision of the Appellate Division. We note that even if a decision
adverse to the Company was rendered by the Appellate Division, the Bankruptcy
Court could elect to determine that the distribution of assets provided for was
appropriate and KMS would be unable to collect upon its judgment.
-14-
Item 4. Submission of Matters to a Vote of Security Holders.
None.
-15-
PART II
Item 5. Market for Common Equity, Related Stockholder Matters and Small Business
Issuer Purchases of Equity Securities.
Our Common Stock is quoted on the OTC Bulletin Board under the trading
symbol "GLDS" ("ASHN" prior to our name change on February 15, 2006). Prior to
the effectiveness of our Plan of Reorganization, our symbol was "HNNS". The
prices set forth below reflect the quarterly high and low sale price information
for shares of our Common Stock during the last two fiscal years. These
quotations reflect inter-dealer prices, without retail markup, markdown or
commission, and may not represent actual transactions.
2006 Quarter Ended High Low
------------------ ---- ---
December 31, 2006 $0.30 $0.24
September 30, 2006 1.01 0.27
June 30, 2006 1.65 0.76
March 31, 2006 2.25 0.33
2005 Quarter Ended High Low
------------------ ---- ---
December 31, 2005 $0.85 $0.11
September 30, 2005 0.15 0.07
June 30, 2005 0.10 0.06
March 31, 2005 0.18 0.05
As of March 26, 2007, there were two hundred thirteen (213) holders of
record of our Common Stock.
We have not declared or paid any cash dividends on our Common Stock since
our inception, and our Board of Directors currently intends to retain all
earnings for use in the business for the foreseeable future. Any future payment
of dividends will depend upon our results of operations, financial condition,
cash requirements, and other factors deemed relevant by our Board of Directors.
Prior to the Merger, AIM was a Subchapter S corporation and made distributions
to its shareholders to enable them to pay income taxes on their allocable
portion of the Company's income.
-16-
As of March, 26, 2007, approximately 11,284,894 shares of our Common Stock
were subject to issuance upon exercise or conversion of outstanding options or
warrants to purchase, or securities convertible into, share of our Common Stock.
The following table provides information as of December 31, 2006 about our
equity compensation plans and arrangements as of December 31, 2006.
Equity Compensation Plan Information - December 31, 2006
(c)
Number of securities
remaining available for
(a) (b) future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options, securities reflected in
Plan Category warrants and rights warrants and rights column (a))
------------------------------- -------------------------- ---------------------- -------------------------
Equity compensation plans
approved by security holders - $ - -
------------------------------- -------------------------- ---------------------- -------------------------
Equity compensation plans not
approved by security holders
(1) 9,030,436 $.23 5,150,000
------------------------------- -------------------------- ---------------------- -------------------------
Total (1) 9,030,346 $.23 5,150,000
=============================== ========================== ====================== =========================
(1) Shareholder approval of our 2005 Stock Incentive Plan was completed as
of February 15, 2006. In connection with the Merger, our Board adopted our 2005
Stock Incentive Plan, and issued stock options to purchase 4,850,000 shares to
our new executive officers. The vesting and exercise prices of the 4,850,000
options which we granted to executive officers in 2005 are described below in
the footnotes under "Executive Compensation - Aggregated Option Exercises in
last Fiscal Year and Fiscal Year-End Option Values". As of December 31, 2006,
5,150,000 shares remained available for grant under our 2005 Stock Incentive
Plan. Of the 9,030,346 shares included above, (i) 4,138,678 shares underlie
warrants issued to GunnAllen Financial, Inc. exercisable at $0.22 per share and
(ii) 41,668 shares underlie warrants issued to an investor relations company
exercisable at a weighted average price of $0.70 per share.
Recent Sales of Unregistered Securities
All sales of unregistered equity securities of the Company that occurred
during 2006 were previously reported in its Reports on Form 10-QSB or Form 8-K,
as applicable.
-17-
Item 6. Management's Discussion and Analysis or Plan of Operations.
Introduction
AIM manufactures 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 61% of AIM's
revenue in 2006, and are subject to General Ordering Agreements which were
recently renegotiated and extended through 2012.
Prior to the acquisition of AIM, Original Gales had no operating assets.
Because of the change in ownership, management and control that occurred, for
financial reporting purposes, the Acquisition of AIM was accounted for as a
purchase by Original Gales. Accordingly, the purchase price was allocated among
AIM's assets and liabilities based upon their fair values as of the completion
of the Acquisition. Because the purchase price, net of the liabilities assumed,
exceeded the fair value of the assets acquired, Original Gales recorded goodwill
of $1,265,963. Because the acquisition of AIM's corporate campus was completed
subsequent to the Acquisition of AIM, the shareholders of the entities which
owned the real estate were not affiliates of AIM as of the time the real estate
acquisition was completed. Therefore, the acquisition of the real estate was
treated as a purchase by AIM and the purchase price and related acquisition
costs, which approximated the fair market value of the property, were reflected
on Original Gales' financial statements (which now form the basis of our
financial statements) as the basis of the real estate.
As a result of the Merger, the historical financial statements of Original
Gales became the historical financial statements of the Company. Further,
because AIM is a predecessor of Original Gales and hence the Company for
financial reporting purposes, AIM's financial statements for periods prior to
December 1, 2005 have been included herein.
In the table presented below, the financial statements for the year ended
December 31, 2005 are those of Original Gales, inclusive of the activity of AIM
from November 30, 2005. The Management's Discussion and Analysis below includes
the combined results of operations of Original Gales and AIM (unaudited) for the
2005 year as if these entities were combined for that period. To provide a basis
for comparison, there is also included below historical financial information of
AIM for the year ended December 31, 2004. AIM is currently our only operating
business. 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 and the financial statements of AIM set forth in this
prospectus are not indicative of our future results of operations. It should
also be noted that prior to the Acquisition, AIM operated as a Subchapter S
company and incurred no income taxes. For purposes of the following discussion,
we have assumed that AIM incurred income taxes during years 2004 and 2005 at an
effective rate of 40.02%.
-18-
The, following discussion and analysis should be read in conjunction with
the financial statements and notes, included with this report.
Results of Operations
The following table sets forth, for the periods indicated, certain
components of our statements of operations:
----------------------------------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
December 31, 2006 December 31, 2005(1) December 31, 2004(2)
----------------------------------------------------------------------------------------------------------
Net Sales $33,044,996 $30,735,103 $24,818,333
----------------------------------------------------------------------------------------------------------
Cost of Sales 28,002,942 26,426,553 21,400,878
----------------------------------------------------------------------------------------------------------
Gross Profit 5,042,054 4,308,550 3,417,455
----------------------------------------------------------------------------------------------------------
Selling Expenses 601,011 357,854 321,727
G&A Expense 3,789,587 2,440,194 1,356,809
Interest Expense 1,040,108 759,552 505,425
Minority Interest 74,904 131,552
Other Expenses 246,659
Other Income 788,711 2,573
Income before Provision
for taxes 153,400 676,046 1,104,515
Provision for Taxes(3) 489,969 271,770 444,015
----------------------------------------------------------------------------------------------------------
Net Income (3) (336,569) 404,276 660,550
----------------------------------------------------------------------------------------------------------
1) The information for December 31, 2005, combines the operating results of
Original Gales and AIM, operating as a Subchapter S corporation for the
period January 1, 2005 through November 30, 2005.
2) The information for December 31, 2004 are from the audited operating
statements of AIM.
3) Prior to November 30, 2005, AIM elected to be treated under Subchapter "S"
of the Internal Revenue Code and incurred no income taxes For purposes of
presentation, taxes were calculated using an effective 40.02% tax rate in
accordance with FAS 109.
-19-
Year ended December 31, 2006 compared to year ended December 31, 2005 (pro
forma)
Net Sales. Net sales were $33,044,996 in the year ended December 31, 2006
("Fiscal 2006") an increase of $2,309,893 (7.5%) from net sales of $30,735,103
in Fiscal 2005. The increase in net sales was attributable to continued
significant growth in sales in the military aerospace sector resulting from
increased military activity, together with price increases that took effect in
late 2005 and continued through 2006 under a number of our long term agreements
with a significant customer.
The Company's net sales for Fiscal 2006 were substantially greater than
the Company's net sales for Fiscal 2005. Nevertheless, net sales during the
second half of 2006 were less than the amount recorded during the first half of
2006, but modestly higher than net sales in the second half of Fiscal 2005. This
decrease in net sales during the second half of 2006 resulted primarily from the
need to prepare for production of subassemblies for the Joint Strike Fighter
("JSF") landing gear, and the E2D arresting gear. The Company delivered the
first article for the JSF landing gear during December 2006, and the first
article of the E2D arresting gear in the first quarter of 2007.
Sales during the second half of 2006 were also negatively impacted by a
decision by our largest customer to delay deliveries of units previously
projected to be delivered during this time period. These delivery delays have
continued through the first quarter of 2007 and are reflected in higher
inventory levels and lower revenue than anticipated. These delivery delays are
the result of a strike at the aforementioned customer's facility earlier in 2006
and its continued inability to achieve complete production recovery.
Gross Profit. Gross profit was $5,042,054 in Fiscal 2006 (15.3% of net
sales), compared to gross profit of $4,308,550 in Fiscal 2005 (14.0% of net
sales). The increase in gross profit reflects the increase in revenues and as
well as the increase in gross profit as a percentage of sales. The increase in
gross profits as a percentage of sales represents a continuation of the shift in
the Company's production to higher margin military products.
Selling Expenses. Selling expenses were $601,011 in Fiscal 2006, an
increase of $243,157(67.9%) from selling expenses of $357,854 in Fiscal 2005.
The increase in selling expenses reflects an increase in shipping supplies,
transportation expenses and depreciation of transportation equipment partially
offset by decreases in field engineering expenses and out bound freight
expenses.
General and Administrative Expenses. General and administrative expenses
were $3,789,587 in Fiscal 2006, an increase of $1,349,393 (55.3%) from general
and administrative expenses of $2,440,194 in Fiscal 2005. The increase was
primarily due to an increase in officers' salaries, an increase in office
personnel to support the increased sales, an increase in professional fees
attributable to legal, accounting and audit fees and preparations for compliance
with Sarbanes-Oxley, as well as consulting costs incurred in connection with
modifications to AIM's information technology network. In addition, Fiscal 2006
reflects non-cash compensation charges resulting from the grant of options to
management pursuant to the Company's Stock Option Plan. In addition, the Company
incurred a bad debt expense of $177,444 based upon management's assessment of
the collectibility of certain outstanding receivables.
Interest and Amortization Expense. Interest and amortization expense was
$1,040,108 in Fiscal 2006 an increase of $280,556. (36.9%) from interest expense
of $759,552 in Fiscal 2005. The increase in interest expense resulted from an
increase in borrowing rates as well as additional interest expense as a result
of the financing of the Acquisition of AIM and the purchase of AIM's real
estate.
-20-
Minority Interest. Minority interest represents the income attributable to
AIM's real estate realized by the affiliates of AIM that owned the real estate
prior to its acquisition by AIM in 2005. Because the real estate was owned by
AIM at the beginning of 2006 there was no minority interest income in 2006, as
compared to minority interest income of $74,904 in Fiscal 2005.
Income before provision for income taxes was $153,400 in Fiscal 2006 a
decrease of $522,646 (77.3%) from income before income taxes of $676,046 in
Fiscal 2005. The income before taxes in 2005 combines the income earned by AIM
during the eleven month period ended November 30, 2005 of $1,425,750, with a
$749,704 loss incurred during December 2005. The decrease in income during
Fiscal 2006, resulted primarily from the impact on AIM's business of the
Acquisition, together with expenses incurred by the Company to comply with its
reporting obligations as a public entity and orders deferred during the second
half of 2006 due to a strike at the aforementioned customer's facility earlier
in 2006. Income during 2006 was positively impacted by a gain of $300,037 on the
sale of the Company's corporate campus and a gain of $53,047 on the sale of a
life insurance policy. Absent these non-recurring items the Company would have
incurred a pre-tax net loss of $199,684.
Provision for Income Taxes. The increase in the Provision for Income Taxes
to $489,969 for Fiscal 2006 as compared to $271,770 for Fiscal 2005, primarily
reflects the taxes payable as a result of the sale of the Company's corporate
campus partially offset by the reduction in taxes payable as a result of the
decrease in the Company's operating income.
Year ended December 31, 2005 (pro forma) compared to year ended December
31, 2004 (pro forma)
Net Sales. Net sales were $30,735,103 in the year ended December 31, 2005
("Fiscal 2005") an increase of $5,916,700 (23.8%) from net sales of $24,818,333
in Fiscal 2004. The increase in net sales was attributable to continued
significant growth in sales in the military aerospace sector resulting from
increased military activity, together with price increases that took effect in
late 2005 under a number of our long term agreements with a significant
customer.
Gross Profit. Gross profit was $4,308,550 in Fiscal 2005 (14.0% of net
sales), compared to gross profit of $3,417,455 in Fiscal 2004 (13.8% of net
sales). The increase in gross profit reflects the increase in revenues. The
increase in gross profits as a percentage of sales represents a continuation of
the shift in production to higher margin military products.
Selling Expenses. Selling expenses were $357,854 in Fiscal 2005, an
increase of $36,127 (11.2%) from selling expenses of $321,727 in Fiscal 2004.
The increase in selling expenses reflects an increase in shipping supplies,
transportation expenses and depreciation of transportation equipment partially
offset by decreases in field engineering expenses and out bound freight
expenses.
General and Administrative Expenses. General and administrative expenses
were $2,440,194 in Fiscal 2005, an increase of $1,083,385 (79.8%) from general
and administrative expenses of $1,356,809 in Fiscal 2004. The increase was
primarily due to an increase in officers' salaries, an increase in office
personnel to support the increased sales, an increase in professional fees
attributable to legal, accounting and audit fees as well as consulting costs
incurred in connection with modifications to AIM's information technology
network. In addition, in Fiscal 2005 reflects non-cash compensation charges
resulting from the grant of options to management pursuant to the Company's
Stock Option Plan. In addition, the Company incurred a bad debt expense of
$45,000 in Fiscal 2005 based upon management's assessment of the collectibility
of certain outstanding receivables.
Interest Expense. Interest expense was $759,552 in Fiscal 2005 an increase
of $254,127 (50.3%) from interest expense of $505,425 in Fiscal 2004. The
increase in interest expense resulted from an increase in borrowing rates as
well as additional interest expense as a result of the financing of the
Acquisition of AIM and purchase of the real estate.
-21-
Minority Interest. Minority interest represents the income attributable to
AIM's real estate realized by the affiliates of AIM that owned the real estate
prior to its acquisition by AIM in 2005. Minority interest income was $74,904 in
Fiscal 2005 a decrease of $56,648 from $131,552 in Fiscal 2004. The decrease
reflects the elimination of the interest of AIM's affiliates as a result of the
acquisition of the real estate by AIM on November 30, 2005.
Income before provision for income taxes was $676,046 in Fiscal 2005 a
decrease of $428,469 (38.8%) from income before taxes of $1,104,515 in Fiscal
2004. The income before taxes in 2005 combines the income earned by AIM during
the eleven month period ended November 30, 2005 of $1,854,219, with a $749,704
loss incurred during December 2005. The loss resulted primarily from the impact
on AIM's business of the Acquisition, together with expenses relating to the
Company as a new public entity.
Impact of Inflation
Inflation has not had a material effect on our results of operations.
Financial Liquidity and Capital Resources
Prior to its Acquisition by us on November 30, 2005, AIM financed its
operations and investments principally through revenues from operations. As a
private company, AIM did not have many of the expenses which we have as a public
company. In connection with the Acquisition of AIM and AIM's acquisitions of its
headquarters in November 2005, we undertook various significant commitments,
including a secured loan facility with PNC Bank (the "Loan Facility") which
included a $9 million revolving credit facility, a $3,500,000 term loan and a
$1,500,000 equipment line; promissory notes in the principal amount of
$1,627,262 due the former shareholders of AIM and the obligation to pay
dividends (in-kind prior to an event of default) to the holders of the
Convertible Preferred Stock issued to finance the Acquisition of AIM.
In October, 2006, the Company sold and leased back its corporate campus
for gross proceeds of $6,200,000. The Company used a substantial portion of the
net proceeds of this transaction to reduce its obligations under the Loan
Facility. The balance of the term loan was reduced by $2,800,000 and the
remaining balance of $383,330 became an Amended and Restated Term Note providing
for principal payments of $10,648 per month. On January 10, 2007, the Company
and PNC further amended the terms of the Loan Facility to revise the formula to
determine the amounts of revolving advances permitted to be borrowed under the
Loan Facility. The amount that the Company is permitted to borrow as a revolving
advance under the Loan Facility is based on a percentage of the Company's
eligible receivables, which now includes government receivables that have not
been assigned by the Company.
In addition to the reduction in the amount outstanding under the Loan
Facility, as a result of the declaration of the effectiveness of the Company's
Registration Statement in August 2006, the outstanding shares of Preferred Stock
were automatically converted into common stock, eliminating the dividend payable
to the holders of the Preferred Stock other than the amounts accrued during the
period of default.
As a result of the foregoing actions, as of December 31, 2006, the
Company's long term debt consisted of $5,800,697 outstanding under its Loan
Facility, $1,482,962 due on the notes to the former shareholders of AIM (which
amount was reduced in January 2007 by an aggregate of $665,262 when Peter
Rettaliata and Dario Peragallo converted their notes into shares of common stock
of the Company) and capital lease obligations of $959,817. In addition,
reflecting the sale leaseback of its corporate campus, the Company now pays
approximately $45,000 per month as rent, plus $15,662 to fund real estate tax
escrow accounts and other reserves held by the landlord.
-22-
The Loan Facility is secured by a lien on substantially all of the assets
of the Company. Amounts outstanding under the revolving credit portion of the
Loan Facility accrue interest at a fluctuating rate that is paid monthly. The
term loan portion of the Loan Facility is payable in 34 equal monthly payments
of $10,648 plus interest with the balance due at the time of the final payment.
We believe that all of the applicable interest rates under the Loan Facility are
consistent with prevailing interest rates in the lending industry.
Prior to the Acquisition, AIM was a Subchapter S corporation and
periodically made distributions to its shareholders. AIM distributed to its
shareholders $1,175,279 during the eleven months ended November 30, 2005 and
$561,557 during the year ended December 31, 2004. Such distributions were in
amounts sufficient to allow the shareholders of AIM to pay the taxes owed on
their proportionate share of AIM's income from the fiscal year immediately
preceding such distributions and, in the case of certain distributions, to allow
two of AIM's shareholders to pay the purchase price owed to a former shareholder
of AIM who sold all of his shares of AIM to such two shareholders. The Company
does not anticipate paying dividends to its shareholders for the foreseeable
future.
At December 31, 2006, as a result of our loan agreements with PNC bank,
which requirs that all cash balances be swept into our loan accounts, we had no
cash and cash equivalents. Our working capital as of December 31, 2006, was
$4,911,354 as compared to $4,113,235 as of December 31, 2005.
We used approximately $729,526 in our operations during Fiscal 2006 as
compared to $1,162,972 used in operating activities during Fiscal 2005. The use
of cash reflects the net loss incurred by the Company of $336,569, increased by
an increase in accounts receivable of $1,062,789 and an increase in inventory of
$2,653,851, partially offset by an increase in accounts payable of $2,353,797,
an increase of $653,426 in income taxes payable and depreciation of $597,009.
The increase in inventories reflects a decision by one of our largest customers
to delay deliveries of units previously projected to be delivered during the
second half of 2006. These delivery delays are the result of a strike at the
aforementioned customer's facility earlier in 2006.
The Company generated approximately $5,417,704 in Fiscal 2006 through the
sale of its real estate campus, which amount was partially offset by purchases
of equipment in the amount of $812,372 and $448,530 deposited to secure
obligations under the lease for the Company's corporate campus. The funds
generated from the sale of the Company's corporate campus primarily were used to
reduce amounts payable under the Company's Loan Facility by approximately
$4,170,099.
We expect that cash flows from operations and amounts available under our
Loan Facility will be sufficient to pay our obligations for the next twelve
months as they arise. However, we may require additional financing to expand our
business internally and will require additional financing to complete our
contemplated acquisitions. We intend to finance the acquisitions currently
contemplated through a combination of debt and equity. The incurrence of
additional debt will require the consent of PNC and will increase the leverage
of our business. The issuance of equity securities, whether in the form of
common or preferred shares, could dilute the interests of our current
shareholders. There can be no assurance that the necessary debt or equity
financing will be available to us on acceptable terms, if at all. If such
financing is not available, we may not be able to expand our business internally
or make acquisitions.
-23-
Critical Accounting Policies
We have identified the policies below as critical to our business
operations and the understanding of our financial results.
Inventory Valuation
The Company values inventory at the lower of cost on a first-in-first-out
basis or market.
The Company purchases inventory only when it has signed non-cancellable
contracts with its customers for orders of its finished goods. The Company
occasionally produces finished goods in excess of purchase order quantities in
anticipation of future purchase order demands but historically this excess has
been used in fulfilling future purchase orders. The Company occasionally
evaluates inventory items that are not secured by a purchase orders and reserves
for obsolescence accordingly. The Company also reserves an allowance for excess
quantities, slow-moving goods, and obsolete items.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting
Bulletin No. 104, "Revenue Recognition." The Company generally recognizes
revenue when products are shipped and the customer takes ownership and assumes
risk of loss, collection of the relevant receivable is probable, persuasive
evidence of an arrangement exists, and the sales price is fixed or determinable.
Payments received in advance from customers for products delivered are recorded
as customer advance payments until earned, at which time revenue is recognized.
Income Taxes
Income taxes are calculated using an asset and liability approach as
prescribed by SFAS No. 109, Accounting for Income Taxes. The provision for
income taxes includes federal and state taxes currently payable and deferred
taxes, due to temporary differences between financial statement and tax bases of
assets and liabilities. In addition, future tax benefits are recognized to the
extent that realization of such benefits is more likely than not. Valuation
allowances are established when management determines that it is more likely
than not that some portion or all of the deferred asset will not be realized.
The effect of a change in tax rates is recognized as income or expense in the
period of change.
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 $167,126
and $121,297 for the years ended December 31, 2006 and 2005, respectively, in
accordance with the measurement requirements under SFAS No. 123(R)
-24-
Goodwill
Goodwill represents the excess of the acquisition cost of businesses over
the fair value of the identifiable net assets acquired. The Company applies SFAS
No. 142, Goodwill and Other Intangible Assets and accordingly does not amortize
goodwill but tests it for impairment. Impairment testing for goodwill will be
performed annually, or more frequently when indicators of impairment exist,
using a two-step approach. Step one compares the fair value of the net assets of
the relevant reporting unit (calculated using a discounted cash flow method) to
its carrying value, a second step is performed to compute the amount of the
impairment. In this process, a fair value for goodwill is estimated, based in
part on the fair value of the operations, and is compared to its carrying value.
The shortfall of the fair value below carrying value represents the amount of
goodwill impairment. Goodwill is reviewed for potential impairment at the
reporting unit level on an annual basis, or in interim periods if events or
circumstances indicate a potential impairment. The reporting units utilized for
this test were those that are one level below the business segments identified
at the beginning of Business Segment Operations. The impairment test is
performed in two phases. The first step of the Goodwill impairment test compares
the fair value of the reporting unit with its carrying amount, including
Goodwill. If the fair value of the reporting unit exceeds its carrying amount,
Goodwill of the reporting unit is considered not impaired; however, if the
carrying amount of the reporting unit exceeds its fair value, an additional
procedure must be performed. That additional procedure compares the implied fair
value of the reporting unit's Goodwill (as defined in SFAS 142) with the
carrying amount of that Goodwill. An impairment loss is recorded to the extent
that the carrying amount of Goodwill exceeds its implied fair value.
The fair values of the reporting units were determined using a combination
of valuation techniques consistent with the income approach. For purposes of the
income approach, discounted cash flows were calculated by taking the net present
value of estimated cash flows using a combination of historical results,
estimated future cash flows and an appropriate price to earnings multiple. We
use our internal forecasts to estimate future cash flows and actual results may
differ from forecasted results. However, these differences have not been
material and we believe that this methodology provides a reasonable means to
determine fair values. Cash flows were discounted using a discount rate based on
expected equity return rates, which ranged from 5.25% to 9.25% for 2006. Our
evaluations for the year ended December 31, 2006 indicated there was no
impairment of our Goodwill.
Quantitative and Qualitative Disclosure about Market Risk
Our primary exposure to market risk consists of changes in interest rates
on borrowings under the Loan Facility. An increase in interest rates would
adversely affect our operating results and the cash flow available after debt
service to fund operations. We manage exposure to interest rate fluctuations by
optimizing the use of fixed and variable rate debt. Except with respect to the
interest rates under the Loan Facility, we do not have debts or hold instruments
that are sensitive to changes in interest rates, foreign currency exchange rates
or commodity prices.
Item 7. Financial Statements.
The financial information required by this item is set forth beginning on
page F-1.
-25-
GALES INDUSTRIES INCORPORATED
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 and 2005
F-1
GALES INDUSTRIES INCORPORATED
Table of Contents
Consolidated Financial Information Page No.
Report of Independent Registered Public Accounting Firm............ F-3
Balance Sheet...................................................... F-4
Statement of Operations............................................ F-5
Statement of Stockholders' Equity.................................. F-6
Statement of Cash Flows............................................ F-7 - F-8
Notes to Consolidated Financial Statements........................ F-9 - F-29
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Gales Industries Incorporated
We have audited the accompanying consolidated balance sheet of Gales Industries
Incorporated and Subsidiary as of December 31, 2006 and 2005 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated 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 audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Gales
Industries Incorporated and Subsidiary as of December 31, 2006 and 2005, and the
results of their operations and their cash flows for the years then ended, in
conformity with United States generally accepted accounting principles.
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
March 30, 2007
F-3
GALES INDUSTRIES INCORPORATED
Consolidated Balance Sheet At December 31,
2006 2005
ASSETS
Current Assets
Cash and Cash Equivalents -- $ 1,058,416
Accounts Receivable, Net of Allowance for Doubtful Accounts
of $176,458 and $45,000 $ 3,508,957 2,623,612
Inventory 15,257,641 12,603,810
Prepaid Expenses and Other Current Assets 232,749 210,124
Deposits 180,456 65,595
------------ ------------
Total Current Assets 19,179,803 16,561,557
Property, Plant, and Equipment, net 3,565,316 7,716,469
Cash Surrender Value - Officer's Life Insurance -- 66,216
Deferred Financing Costs 369,048 486,207
Other Assets 63,522 41,306
Goodwill 1,265,963 1,265,963
Deposits 448,530 --
------------ ------------
TOTAL ASSETS $ 24,892,182 $ 26,137,718
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts Payable and Accrued Expenses $ 7,648,426 $ 5,294,629
Advance Payment - Customers -- 188,199
Notes Payable - Revolver 5,027,463 6,322,665
Notes Payable - Current Portion 127,776 --
Notes Payable - Sellers - Current Portion 192,400 192,400
Capital Lease Obligations - Current Portion 407,228 359,197
Due to Sellers 53,694 91,232
Dividends Payable 120,003 --
Deferred Gain on Sale - Current Portion 38,033 --
Income Taxes Payable 653,426 --
------------ ------------
Total current liabilities 14,268,449 12,448,322
Long term liabilities
Notes Payable - Net of Current Portion 645,458 3,648,131
Notes Payable - Sellers - Net of Current Portion 1,290,562 1,434,862
Capital Lease Obligations - Net of Current Portion 552,589 820,375
Deferred Tax Liability 512,937 676,394
Deferred Gain on Sale - Net of Current Portion 713,118 --
Deferred Rent 39,371 --
------------ ------------
Total liabilities $ 18,022,484 $ 19,028,084
------------ ------------
Commitments and contingencies
Stockholders' Equity
Series A Convertible Preferred - $.001 Par value, 8,003,716
Shares Authorized, 0 Shares and 900 Shares Issued and Outstanding
as of December 31, 2006 and 2005, respectively
Liquidation Value, $ 18,060,000 -- $ 1
Common Stock - $.001 Par, 120,055,746 Shares Authorized,
57,269,301 and 14,723,421 Shares Issued and Outstanding as of December 31, 2006
and 2005, respectively $ 57,269 14,723
Additional Paid-In Capital 7,898,702 7,844,614
Accumulated Deficit (1,086,273) (749,704)
------------ ------------
Total Stockholders' Equity 6,869,698 7,109,634
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 24,892,182 $ 26,137,718
============ ============
See notes to financial statements
F-4
GALES INDUSTRIES INCORPORATED
Consolidated Statement of Operations for the Year Ended December 31,
2006 2005
Net sales $ 33,044,996 $ 2,777,409
Cost of Sales 28,002,942 2,539,433
------------ ------------
Gross profit 5,042,054 237,976
Operating costs and expenses
Selling and marketing 601,011 34,987
General and administrative 3,789,587 774,401
------------ ------------
Income (Loss) from operations 651,456 (571,412)
Other (income) and expenses:
Interest and financing costs 1,040,108 178,292
Gain on Sale of Life Insurance Policy (53,047) --
Gain on Sale of Real Estate (300,037) --
Other Income (435,627) --
Other Expenses 246,659 --
------------ ------------
Net Income (Loss) before provision for income taxes 153,400 (749,704)
Provision for income taxes 489,969 --
------------ ------------
Net Loss (336,569) (749,704)
------------ ------------
Dividend attributable to preferred stockholders 420,003 60,000
------------ ------------
Net Loss attributable to common stockholders $ (756,572) $ (809,704)
============ ============
Loss per share (basic and diluted) $ (0.02) $ (0.06)
============ ============
Weighted average shares outstanding (basic and diluted) 32,208,029 12,722,060
============ ============
See notes to financial statements
F-5
GALES INDUSTRIES INCORPORATED
Consolidated Statement of Stockholders' Equity For The Years
Ended December 31, 2006 and 2005
Series A
Preferred Stock Common Stock Additional Total
---------------------- --------------------- Paid-in Accumulated Stockholders'
Shares Amount Shares Amount Capital (Deficit) Equity
-------- ----------- ---------- -------- ----------- ------------ -------------
Balance, January 1, 2005 12,529,737 $ 12,530 $ (136,864) $ (124,334)
Issuance of common stock to
merger and acquisition
intermediary on recapitalization 1,477,290 1,477 (1,477) --
Contribution of common stock from
shareholder in connection with
bank financing 71,500 71,500
Value of warrants issued in
connection with bridge financing 43,861 43,861
Beneficial conversion feature on
shares issued in connection with
bridge financing 24,897 24,897
Non-cash stock option compensation 121,297 121,297
Issuance of shares in connection
with convertible note 226,334 226 24,671 24,897
Issuance of common stock to Sellers 490,060 490 489,570 490,060
Private placement issued at
$10,000 per share 900 $ 1 8,999,999 9,000,000
Expenses of private placement (1,792,840) (1,792,840)
Net loss (749,704) (749,704)
-------- ----------- ---------- -------- ----------- ------------ -----------
Balance, Dec. 31, 2005 900 $ 1 14,723,421 $ 14,723 $ 7,844,614 $ (749,704) $ 7,109,634
Non-cash stock option compensation 167,126 167,126
Preferred stock dividend (480,003) (480,003)
Non-cash warrant compensation 49,510 49,510
Conversion of preferred shares to
common shares in connection
with filing of registration (900) (1) 40,909,500 40,910 (40,909) --
statement
Conversion of preferred dividend
to common shares in connection
with filing of registration
statement 1,636,380 1,636 358,364 360,000
Net Loss (336,569) (336,569)
-------- ----------- ---------- -------- ----------- ------------ -----------
Balance, December 31, 2006 -- -- 57,269,301 $ 57,269 $ 7,898,702 $ (1,086,273) $ 6,869,698
======== =========== ========== ======== =========== ============ ===========
See notes to financial statements
F-6
GALES INDUSTRIES INCORPORATED
Consolidated Statement of Cash Flows For the Year Ended December 31,
2006 2005
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $ (336,569) $ (749,704)
Adjustments to Reconcile Net Loss to Net
Cash Used in Operating Activities:
Depreciation and Amortization 597,009 45,406
Write-off of building improvements -- 256,632
Non-Cash Interest Expense -- 93,655
Bad debt expense 177,444 45,000
Non-Cash Compensation Expense 167,126 121,297
Warrants issued for services 49,510 --
Amortization of deferred financing costs 117,159 33,253
Gain on Sale of officer's life insurance (53,047) --
Deferred Tax Liability (163,457) --
Gain on sale of real estate (300,037) --
Changes in Assets and Liabilities, net of effects of Acquisition
and recapitalization:
(Increase) Decrease in Operating Assets -
Accounts Receivable (1,062,789) 534,378
Inventory (2,653,831) (434,362)
Prepaid Expenses and Other Current Assets (22,625) (31,058)
Deposits (114,861) 168,499
Cash Surrender Value - Officer's Life Insurance 33,263 (3,455)
Other Assets (22,216) (41,306)
Increase (Decrease) In Operating Liabilities -
Accounts Payable and Accrued Expenses 2,353,797 (1,389,406)
Income Taxes Payable 653,426 --
Deferred Rent 39,371 --
Advance Payment-Customers (188,199) 188,199
------------ ------------
NET CASH USED IN OPERATING
ACTIVITIES $ (729,526) $ (1,162,972)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash Paid for Deposit on Leasehold Improvements (448,530) --
Cash paid in acquisition, including transaction costs of $1,053,862,
net of cash received of $47,538 -- (4,120,620)
Cash received on sale of real estate 5,417,704
Cash received on recapitalization -- 1,684
Purchase of property and equipment (812,372) (4,322,975)
------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES $ 4,156,802 $ (8,441,911)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of Principal - Capital Lease Obligations (219,755) (29,277)
Repayment of notes payable to Officers and Sellers (181,838) (884,815)
Proceeds from notes payable -- 4,790,796
Repayment of Mortgage Note Payable (4,170,099) --
Proceeds from Private Placement -- 9,000,000
Payment of issuance costs on private placement -- (1,792,840)
Payment of Deferred Financing Costs -- (420,565)
Proceeds from sale of officer's life insurance 86,000 --
------------ ------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES $ (4,485,692) $ 10,663,299
------------ ------------
Net increase (decrease) in cash and cash equivalents (1,058,416) 1,058,416
Cash and cash equivalents at beginning of year $ 1,058,416 --
Cash and cash equivalents at end of year -- $ 1,058,416
============ ============
F-7
GALES INDUSTRIES INCORPORATED
Consolidated Statement of Cash Flows For the Year Ended December 31,
2006 2005
------------ ------------
Supplemental cash flow information
Cash paid during the year for interest $ 828,807 $ 64,078
============ ============
Supplemental cash flow information
Cash paid during the year for Income taxes $ 12,758 --
============ ============
Supplemental schedule of non cash investing and financing activities
Non-cash Dividends on Preferred Stock $ 480,003 --
============ ============
Conversion of Preferred Stock to Common Stock $ 40,909 --
============ ============
Conversion of Preferred Dividends to Common Stock $ 360,000 --
============ ============
Shares issued in connection with deferred financing costs -- $ 71,500
============ ============
Beneficial conversion feature charged as interest on bridge financing -- $ 24,897
============ ============
Common stock issued on conversion of bridge note -- $ 24,897
============ ============
Issuance of warrants in bridge financing -- $ 43,861
============ ============
Common stock issued to Sellers in acquisition -- $ 490,060
============ ============
Net liabilities assumed on recapitalization restated to 2004 -- $ 124,334
============ ============
Notes payable issued for acquisition -- $ 1,627,262
============ ============
The Company purchased all of the outstanding stock of AIM for an
aggregate purchase price of $6,285,480,including transaction costs, and in
conjunction with this acquisition, liabilities assumed were as follows:
Fair value of assets acquired -- $ 20,884,787
Consideration given for acquisition -- 6,285,480
------------ ------------
Liabilities assumed -- $ 14,599,307
============ ============
See notes to financial statements
F-8
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Note 1. FORMATION AND BASIS OF PRESENTATION
Merger and Acquisition
Ashlin Development Corp. (the "Company" or "Ashlin"), a Florida corporation and
its subsidiary Gales Industries Merger Sub, Inc. ("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
10,673,107 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, Corporation ("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 "Loan Facility") and used proceeds from
the Loan 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 it
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 the combined financial position. The operating
results and cash flows of the Predecessor and the Successor are not compatible
in all material respects.
F-9
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
The financial statements presented are those of Original Gales and its wholly
owed subsidiary AIM from the date of acquisition, November 30, 2005, to December
31, 2005 and its full year of operations for 2006. Original Gales was formed in
October 2004 and prior to the Acquisition did not have any business operations
or other activity. For presentation purposes, see Note 15 for the results of pro
forma operations if the acquisition occurred on January 1, 2005.
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
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.
Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principal Business Activity
The Company is primarily engaged in manufacturing aircraft structural parts and
assemblies principally for prime defense contractors in the aerospace industry
in the United States. The Company's customer base consists mainly of publicly
traded companies in the aerospace industry.
Principles of Consolidation
The accompanying consolidated financial statements include accounts of the
Company and Merger Sub and Merger Sub's wholly owned subsidiary, AIM.
Significant inter company accounts and transactions have been eliminated in
consolidation. The operations of the Company are conducted principally through
AIM.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid instruments with an original
maturity of three months or less. All cash is applied on a daily basis to
amounts outstanding under the revolving portion of our Loan Facility.
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances
net of allowances for bad debt. The Company provides for allowances for
uncollectible receivables based on management's estimate of uncollectible
amounts at year-end, considering age, collection history, and any other factors
considered appropriate.
F-10
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Inventory Valuation
The Company values inventory at the lower of cost on a first-in-first-out basis
or market.
The Company purchases inventory only when it has signed non-cancellable
contracts with its customers for orders of its finished goods. The Company
periodically produces finished goods in excess of purchase order quantities in
anticipation of future purchase order demands but historically this excess has
been used in fulfilling future purchase orders. The Company occasionally
evaluates inventory items that are not secured by purchase orders and reserves
for obsolescence accordingly. The Company also reserves an allowance for excess
quantities, slow-moving goods, and obsolete items.
Property and Equipment
Property and equipment are carried at cost net of accumulated depreciation and
amortization. Repair and maintenance charges are expensed as incurred. Property,
equipment, and improvements are depreciated using the straight-line method over
the estimated useful lives of the assets. Expenditures for repairs and
improvements in excess of $1,000 that add to the productive capacity or extend
the useful life of an asset are capitalized. Upon disposition, the cost and
related accumulated depreciation are removed from the accounts and any related
gain or loss is reflected in earnings.
Impairment of Long Live Assets
The Company reviews long-lived assets for impairment at the facility level
annually or if events or circumstances indicate that the carrying value of such
assets may not be fully recoverable. Impairment is evaluated based on the sum of
undiscounted estimated future cash flows expected to result from use of the
assets compared to its carrying value. The carrying amount of a long-lived asset
is not recoverable if it exceeds the sum of the undiscounted cash flows expected
to result from the use and eventual disposition of the asset. If impairment is
recognized, the carrying value of the impaired asset is reduced to its fair
value, based on discounted estimated future cash flows.
Deferred Financing Cost
Costs connected with obtaining and executing debt arrangements are capitalized
and amortized on the straight-line basis over the term of the related debt.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin No.
104, "Revenue Recognition." The Company generally recognizes revenue when
products are shipped and the customer takes ownership and assumes risk of loss,
collection of the relevant receivable is probable, persuasive evidence of an
arrangement exists, and the sales price is fixed or determinable. Payments
received in advance from customers for products delivered are recorded as
customer advance payments until earned, at which time revenue is recognized.
F-11
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Cost of Goods Sold
Costs for goods sold includes all direct material, labor costs, and those
indirect costs related to manufacturing, such as indirect labor, supplies,
tools, repairs and depreciation costs.
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, 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.
Credit Risk
Financial instruments involving potential credit risk include accounts
receivable. Of the accounts receivable balance outstanding as of December 31,
2006 approximately 34%, 17%, and 16% are attributable to three customers
respectively. Of the account receivable balance at December 31, 2005,
approximately 23% and 10% are attributable to two customers, respectively.
One customer accounted for approximately 61% and 57% of the total revenues for
the years ended December 31, 2006 and 2005, respectively.
Fair Value of Financial Instruments
The Company has estimated the fair value of financial instruments using
available market information and other valuation methodologies in accordance
with SFAS No. 107, "Disclosures about Fair Value of Financial Instruments."
Management of the Company believes that the fair value of financial instruments,
consisting of cash, accounts receivable, accounts payable and accrued
liabilities, approximates carrying value due to the immediate or short-term
maturity associated with these instruments and that the notes payable
approximate fair value in that they carry market-based interest rates.
Income Taxes
Income taxes are calculated using an asset and liability approach as prescribed
by SFAS No. 109, Accounting for Income Taxes. The provision for income taxes
includes federal and state taxes currently payable and deferred taxes, due to
temporary differences between financial statement and tax bases of assets and
liabilities. In addition, future tax benefits are recognized to the extent that
realization of such benefits is more likely than not. Valuation allowances are
established when management determines that it is more likely than not that some
portion or all of the deferred asset will not be realized. The effect of a
change in tax rates is recognized as income or expense in the period of change.
F-12
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Earnings per share
Basic earnings per share is computed by dividing the net income applicable to
common stockholders by the weighted-average number of shares of common stock
outstanding for the period. Potentially dilutive shares, using the treasury
stock method, are included in the diluted per-share calculations for all periods
when the effect of their inclusion is dilutive.
The Company did not include 5,318,985 warrants and 4,850,000 options to purchase
the Company's common stock for the year ended December 31, 2006 and 5,229,589
warrants and 4,850,000 options to purchase the Company's common stock for the
year ended December 31, 2005 in the calculation of diluted earnings per share
because the effects of their inclusion would have been anti-dilutive.
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 statement of operations based on their
fair values at the date of grant. The Company recorded in the accompanying
statement of operations an expense of $167,126 and $121,297 for the years ended
December 31, 2006 and 2005, respectively, in accordance with the measurement
requirements under SFAS No. 123(R). The Company adopted SFAS No. 123(R),
effective in 2005.
Goodwill
Goodwill represents the excess of the acquisition cost of businesses over the
fair value of the identifiable net assets acquired. The Company applies SFAS No.
142, Goodwill and Other Intangible Assets and accordingly does not amortize
goodwill but tests it for impairment. Goodwill is reviewed for potential
impairment at the reporting unit level on an annual basis, or in interim periods
if events or circumstances indicate a potential impairment. The reporting units
utilized for this test were those that are one level below the business segments
identified at the beginning of Business Segment Operations. The impairment test
is performed in two phases. The first step of the Goodwill impairment test
compares the fair value of the reporting unit with its carrying amount,
including Goodwill. If the fair value of the reporting unit exceeds its carrying
amount, Goodwill of the reporting unit is considered not impaired; however, if
the carrying amount of the reporting unit exceeds its fair value, an additional
procedure must be performed. That additional procedure compares the implied fair
value of the reporting unit's Goodwill (as defined in SFAS 142) with the
carrying amount of that Goodwill. An impairment loss is recorded to the extent
that the carrying amount of Goodwill exceeds its implied fair value.
The fair values of the reporting units were determined using a combination of
valuation techniques consistent with the income approach. For purposes of the
income approach, discounted cash flows were calculated by taking the net present
value of estimated cash flows using a combination of historical results,
estimated future cash flows and an appropriate price to earnings multiple. We
use our internal forecasts to estimate future cash flows and actual results may
differ from forecasted results. However, these differences have not been
material and we believe that this methodology provides a reasonable means to
determine fair values. Cash flows were discounted using a discount rate based on
expected equity return rates, which ranged from 5.25% to 9.25% for 2006. Our
evaluations for the year ended December 31, 2006 indicated there was no
impairment of our Goodwill.
F-13
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Recently Issued Accounting Standards
In June 2006, Financial Accounting Standards Board ("FASB") Interpretation
("FIN") No. 48, "Accounting for Uncertainty in Income Taxes--An Interpretation
of FASB Statement No. 109," was issued regarding accounting for, and disclosure
of, uncertain tax positions. This interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprise's financial statements
in accordance with FASB Statement No. 109, "Accounting for Income Taxes," and
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. The interpretation also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. This interpretation is effective for fiscal
years beginning after December 15, 2006. The Company is currently evaluating the
impact of this statement to its consolidated financial position and results of
operations.
In September 2006, the FASB issued SFAS No. 158, "Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans--An Amendment of SFAS No.
87, 88, 106 and 132(R)" ("SFAS No. 158"). The statement requires employers to
recognize the overfunded and underfunded portion of a defined benefit plan as an
asset or liability, respectively, and any unrecognized gains and losses or prior
service costs as a component of accumulated other comprehensive income. SFAS No.
158 also requires a plan's funded status to be measured at the employer's fiscal
year-end. The requirement to recognize the funded status of a defined benefit
plan and the disclosure requirements of SFAS No. 158 are effective for the
Company as of December 31, 2006. The requirement to measure plan assets and
benefit obligations as of the date of the employer's fiscal year end is
effective for the Company in 2008. The adoption of the requirements of SFAS No.
158 that became effective on December 31, 2006 did not have a material impact to
the financial position, results of operations or cash flows of the Company.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Liabilities" ("SFAS No. 159"). SFAS No. 159 provides
companies with an option to report selected financial assets and liabilities at
fair value, and establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. The new guidance is
effective for fiscal years beginning after November 15, 2007. The Company is
currently evaluating the potential impact of the adoption of SFAS No. 159 on its
financial position and results of operations.
Note 3. INVENTORY
The components of inventory consisted of the following:
December 31, 2006 December 31, 2005
----------------- -----------------
Raw Materials $ 2,234,175 $ 2,319,523
Work in Progress 7,546,178 4,905,535
Finished Goods 5,477,288 5,378,752
------------- -------------
Total Inventory $ 15,257,641 $ 12,603,810
============= =============
F-14
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Note 4. PROPERTY AND EQUIPMENT
The components of property and equipment, at cost, consisted of the following:
December 31, 2005 December 31, 2005 Useful Lives
----------------- ----------------- -------------
Land $ -- $ 1,075,589 --
Building -- 3,226,767 25-31.5 years
Machinery and Equipment 2,117,441 1,766,829 5 - 8 years
Capital Lease Machinery and Equipment 1,164,671 1,145,171 5 - 8 years
Tools and Instrument 555,164 253,994 3 - 7 years
Building Improvements -- 17,700 25 years
Automotive Equipment 30,227 26,827 5 years
Furniture and fixtures 274,837 248,998 5 - 8 years
Leasehold Improvements 3,583 -- 5 years
----------- -----------
Total property, plant, and equipment 4,145,923 7,761,875
Less: Accumulated Depreciation (580,607) (45,406)
----------- -----------
Property, plant, and equipment, net $ 3,565,316 $ 7,716,469
=========== ===========
Depreciation and amortization expense for the year ended December 31, 2006 and
2005, amounted to $597,009 and $45,406, respectively.
Note 5. SALE-LEASEBACK TRANSACTION
On October 24, 2006, the Company consummated its agreement with STNLA-SPVEF Bay
Shore, LLC, successor in interest to Net Lease Advisors LLC (the "Purchaser"),
whereby the Company sold the buildings and real property located at its
corporate headquarters in Bay Shore, New York (the "Property") to the Purchaser
for a purchase price of $6,200,000. As a result, of this transaction the Company
had a gain on the sale of approximately $1,051,188 of which we recognized
$300,037 during the year ended December 31, 2006. The remaining $751,151 will be
recognized ratably over the remaining term of our twenty year lease, and is
included it the caption Deferred Gain on Sale of Real Estate in the accompanying
Balance Sheet.
Simultaneous with the closing of the sale of the Property, the Company entered
into a 20-year triple-net lease (the "Lease") with the Purchaser for the
property. Base annual rent is approximately $540,000 for the first five years of
the Lease, increases to $621,000 for the sixth year of the term, and thereafter
increases 3% per year. The Lease grants AIM an option to renew the Lease for an
additional period of five years. The Company deposited with the Purchaser
$127,500 as security for the performance of its obligations under the Lease,
which it subsequently replaced with a $127,500 letter of credit. In addition,
the Company deposited with the landlord $393,000 (Deposits) as security for the
completion of certain repairs and upgrades to the Property. This amount is
included in the caption Deposits on the accompanying Balance Sheet. Pursuant to
the terms of the Lease, the Company is required to pay all of the costs
associated with the operation of the facilities, including, without limitation,
insurance, taxes and maintenance, these costs will be offset against the funds
that are deposited with out landlord. The lease also contains customary
representations, warranties, obligations, conditions and indemnification
provisions and grants the Purchaser customary remedies upon a breach of the
Lease by the Company, including the right to terminate the Lease and hold the
Company liable for any deficiency in future rent. (See Note 11).
F-15
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Note 6. NOTES PAYABLE - BANKS AND CREDIT FACILITY
On November 30, 2005 the Company executed a credit facility with PNC Bank N.A.
(the "Loan Facility"), secured by all of its assets (see Note 14).
The Loan Facility provided for a maximum loan amount of $14,000,000 consisting
of (i) a $9,000,000 revolving loan, (ii) a $3,500,000 term loan, and (iii) a
$1,500,000 equipment financing loan. In connection with the Loan Facility the
Company paid a finder's fee of $196,500, consisting of $125,000 in cash and
325,000 shares of Common Stock, which is included in deferred financing costs.
The shares paid to the finder were valued at $0.22 per share and were
contributed by one of the Company's senior executives and accounted for as a
capital contribution.
The revolving loans bear interest, at the option of the Company, that is based
on (i) the higher of (A) PNC's base commercial lending rate as published from
time to time ("PNC Rate") plus 0.25% or (B) the Federal Funds rate plus 0.5%, or
(ii) the Eurodollar Rate for the Interest Period selected by the Company plus
2.5%. The revolving loans had an interest rate of 8.50% per annum on December
31, 2006 and an outstanding balance of $5,027,463. The revolving loans,
equipment loans and the term loan are payable in full on November 30, 2009
("Termination Date") unless PNC agrees to extend the Termination Date.
The term loan is for a period of 4 years and bears interest, at the option of
the Company at the end of an interest period, at the (i) PNC Rate plus 0.50% per
annum or (ii) the Eurodollar Rate for the interest period selected by the
Company plus 2.75 %. In October 2006 the Term Note was reduced by $2,800,000 and
the remaining balance of $383,330 became an Amended and Restated Term Note in
the principal amount of $383,330 providing for principal payments of $10,648 per
month and the Maturity Date was amended to become the first business day of
October 2009. At December 31, 2006, the balance of the term loan was $362,034
In addition to the foregoing, the Loan Facility was further amended to allow for
the Company to borrow or to obtain the issuance, renewal, extension and increase
of standby letters of credit, up to an aggregate availability of $500,000, for
its account until the Termination Date, which will occur on November 30, 2009.
The equipment loans bear interest, at the option of the Company, that is based
on (i) the PNC Rate plus 0.50% per annum or (ii) the Eurodollar Rate for the
interest period selected plus 2.75% per annum. The equipment loan had an
interest rate of 8.75% per annum at December 31, 2006. Such equipment financing
is limited to an aggregate of $750,000 in any fiscal year and amortized in equal
installments of sixty months following the close of each "borrowing period", the
first of which ended December 31, 2006. Each subsequent "borrowing period" ends
on each December 31 thereafter. All equipment loans are due and payable on
November 30, 2009. As of December 31, 2006, the equipment financing loan had a
balance of $411,200.
To the extent that the Company may dispose of collateral used to secure any of
the Loan Facility, other than inventory, the Company must promptly repay the
draws on the credit facility in amount equal to the net proceeds of such sale.
The terms of the Loan Facility require that, among other things, the Company
maintain certain financial ratios and levels of working capital. As of December
31, 2006 the Company has met these terms. The Loan Facility is also secured by
all assets of the Company and the Company's receivables are payable directly
into a lockbox controlled by PNC (subject to the terms of the Loan Facility).
PNC may use some elements of subjective business judgment in determining whether
a material adverse change has occurred in the Company's condition, results of
operations, assets, business, properties or prospects allowing it to demand
repayment of the Loan Facility, as such, the revolving loan has been classified
as a current liability.
On January 10, 2007, the Company and PNC further amended the terms of the Loan
Facility to revise the formula to determine the amounts of revolving advances
permitted to be borrowed under the Loan Facility. The amount that the Company is
permitted to borrow as a revolving advance under the Loan Facility is based on a
percentage of the Company's eligible receivables, which now includes government
receivables that have not been assigned by the Company.
F-16
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Interest expense related to these credit facilities amounted to $686,917 for the
year ended December 31, 2006.
The Company incurred an aggregate of $492,065 in finders' fees and legal costs
in connection with the Loan Facility which is being amortized over the 48 month
term of the Loan Facility. At December 31, 2005, the Company amortized $123,017
of these costs.
As of December 31, 2006, future minimum principal payments are as follows:
Year Amount
---------- ----------
2007 $ 127,776
2008 127,776
2009 517,682
----------
773,234
Less: Current portion (127,776)
----------
Long-term portion $ 645,458
==========
Note 7. CASH SURRENDER VALUE - OFFICER'S LIFE INSURANCE
During the year ended December 31, 2006, the Company sold 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 $33,263. The resulting gain of
$53,047 was recognized as Other Non-Operating Income in the accompanying
Statement of Operations for the year ended December 31, 2006.
Note 8. CAPITAL LEASES PAYABLE-EQUIPMENT
The Company is committed under several capital leases for manufacturing and
computer equipment. All leases have bargain purchase options exercisable at the
termination of each lease. Capital lease obligations totaled $959,817 and
$1,179,572 as of December 31, 2006 and 2005, respectively.
F-17
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
As of December 31, 2006, future minimum lease payments, including imputed
interest, with remaining terms of greater than one year are as follows:
Year Amount
------ ----------
2007 $ 469,986
2008 468,212
2009 79,515
2010 42,396
----------
Total future minimum lease payments 1,060,109
Less: imputed interest (100,292)
Less: current portion (407,228)
----------
Total long-term capital lease obligation $ 552,589
==========
Note 9. NOTES PAYABLE - SELLERS
On November 30, 2005, as part of the stock purchase between Gales and AIM (See
Note 14), Gales issued notes payable for an aggregate of $1,627,262 to three
former AIM shareholders, two of whom have become part of the Company's senior
management and are also stockholders in the Company.
The balance of the notes payable to the two senior management members as of
December 31, 2006 aggregated $665,262. These notes bear an interest rate equal
to Prime Rate plus 0.5% per annum, (8.75% at December 31, 2006) and mature on
November 30, 2010. Interest shall accrue on any portion of the principal amount
of these notes outstanding after November 30, 2010 until payment thereof in
full, at a floating rate equal to the Prime Rate plus 7% per annum. All of the
outstanding principal amounts of these notes together with accrued interest are
convertible, at the option of the Company, into shares of the Company's common
stock at $0.40 per share. From and after the earlier of (i) January 1, 2007, and
(ii) the first date on which the Company intends to effect any capital
reorganization of the Company, any reclassification or recapitalization of the
capital stock of the Company, any merger, or consolidation or other combination
of the Company with or into any other Company, or any sale or transfer of all or
substantially all of the assets of the Company, the outstanding principal amount
of these notes together with interest accrued thereon is convertible, at the
option of the holder, into the Company's Common Stock at $0.40 per share.
The remaining note of $962,000 matures on September 30, 2010 is subordinated to
all of Gale's senior debt and is payable in twenty consecutive calendar quarters
of equal installments of principal plus accrued interest commencing on December
31, 2005. The interest rate on this note is equal to Prime Rate plus 0.5% per
annum (8.75% at December 31, 2006). Interest on outstanding balances at
September 30, 2010, in the event of nonpayment, shall accrue at a floating rate
equal to the Prime Rate plus 7% per annum. As of December 31, 2006, future
minimum principal payments on these notes to the three former shareholders are
as follows:
F-18
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Year Amount
------ -----------
2007 $ 192,400
2008 192,400
2009 192,400
2010 192,400
2011 713,362
-----------
1,482,962
Less: Current portion (192,400)
-----------
Long-term portion $ 1,290,562
===========
Interest expense on these notes amounted to $132,193 and $10,711 for the year
ended December 31, 2006 and 2005 respectively.
On January 26, 2007, the two senior management members exercised their right to
convert their $665,262 notes plus accrued interest of $54,511 into an aggregate
of 1,799,432 shares of common stock at a conversion price of $0.40 per share.
(See Note 16)
Note 10. EMPLOYEE BENEFITS PLANS
The Company has a defined contribution plan under Section 401(k) of the Internal
Revenue Code (the "Plan"). Pursuant to the Plan qualified employees may
contribute a percentage of their pretax eligible compensation to the Plan. The
Company does not match any contributions that employees may make to the Plan.
The Employees of the Company are members of the United Service Workers Union
TUJAT Local 355 (the "Union"), which provided medical benefit plans at defined
rates which are contributed in their entirety by the Company. The company paid
$2,275,295 and $133,570 in union benefits during the years ended December 31,
2006 and 2005 respectively.
Note 11. COMMITMENTS AND CONTINGENCIES
The Company leases its facilities under an operating lease agreement, which
contain renewal options and escalation provisions. Rent expense was $111,775 and
$0 for the years ended December 31, 2006 and 2005, respectively. The Company is
responsible for paying all operating costs under the term of the lease. As of
December 31, 2006, future minimum lease payments are as follows:
-------------------------------------
Year Amount
-------------------------------------
2007 $ 540,000
-------------------------------------
2008 540,000
-------------------------------------
2009 540,000
-------------------------------------
2010 540,000
-------------------------------------
2011 563,824
-------------------------------------
Thereafter 11,737,644
-------------------------------------
$14,461,468
-------------------------------------
The lease provides for scheduled increases in base rent. Rent expense is charged
to operations using the straight-line method over the term of the lease which
results in rent expense being charged to operations from inception of the lease
in excess of required lease payments. At December 31, 2006, this excess of
$39,371 is shown as deferred rent in the accompanying balance sheet.
F-19
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Litigation
A legal action was brought against the Company for personal injures sustained by
an independent contractor as a result of a fall on the Company's premises. The
carrier assumed the defense of this action and it was settled during 2006 by the
carrier at no cost to the Company.
The Company was involved in litigation with J.C. Herbert Bryant, III, a former
officer, director and shareholder of the Company, and KMS-Thin Tab 100, Inc.,
which was settled in September 2002. As part of the settlement, the Company
entered into a distribution agreement with KMS permitting it to purchase certain
products from the Company and to exclusively distribute those products in
Florida from Orlando south. In October 2003, the Company terminated the
distribution agreement with KMS. On December 1, 2003, the Company filed suit
against KMS in the Palm Beach County Circuit Court for breach of contract,
trademark infringement and for a declaration of rights that the distribution
agreement is terminated. KMS answered the complaint and filed its own
counterclaim for fraud in the inducement, trademark infringement, dilution and
fraudulent misrepresentation; the fraud-based counterclaims were dismissed with
prejudice by the Court on summary judgment. KMS subsequently amended its
counterclaim to allege a breach of contract under the distribution agreement. In
January 2005, the State Court in Florida ruled that neither party should prevail
and rejected a request for attorney's fees by KMS of approximately $60,000. KMS
subsequently filed a notice of appeal. Subsequent to the Company's emergence
from Bankruptcy, KMS requested that the Bankruptcy Court reopen our bankruptcy
case and award it the attorney's fees previously rejected by the Florida State
Court. The Bankruptcy Court granted the motion in so far as it allowed KMS to
prosecute in the Fourth District Court of Appeal in Florida its appeal of the
State Court decision. Subsequently, KMS filed its appeal and brief with the
Fourth District seeking attorney's fees. The Company intends to contest this
claim vigorously, local counsel has responded on behalf of the Company and we
await the decision of the Appellate Division. We note that even if a decision
adverse to the Company was rendered by the Appellate Division, the Bankruptcy
Court could elect to determine that the distribution of assets provided for was
appropriate and KMS would be unable to collect upon its judgment.
Customer Audits
The Company's government contracts and those of many of its customers are
subject to the procurement rules and regulations of the United States
government, including the Federal Acquisition Regulations ("FAR"). Many of the
contract terms are dictated by these rules and regulations. During and after the
fulfillment of a government contract, the Company may be audited in respect of
the direct and allocated indirect costs attributed thereto. These audits may
result in adjustments to its contract costs. Additionally, the Company may be
subject to U.S. government inquiries and investigations because of its
participation in government procurement. Any inquiry or investigation can result
in fines or limitations on the Company's ability to continue to bid for
government contracts and fulfill existing contracts.
F-20
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
The Company believes that it is in substantial compliance with all federal,
state and local laws and regulations governing its operations and has obtained
all material licenses and permits required for the operation of its business.
Employment Contracts
In September 2005, the Company entered into employment agreements (the
"Agreements") with four senior executives that became effective November 30,
2005. The Agreements are for a period of approximately eight years.
Additionally, the Agreements provide for annual base compensation aggregating
$940,000. The Board, at its sole discretion, determines whether a bonus is
issued, provided that in the case of two executives, the amount of the bonus
shall be predicated on their performance and the achievement by the Company of
its operating targets set forth in its annual budget, in the case of these two
executives, provided further, in no event shall the amount of their bonuses be
less than 50% of their salary at that time. For the years ended December 31,
2006 and 2005 no bonuses were paid. Each senior executive's agreement also call
for grants of stock options to purchase the Company's common stock aggregating
4,850,000 shares of which 2,370,000 have been granted as of December 31, 2006.
Subsequent to year-end the Company and one of its four senior executives entered
into a Separation Agreement and General Release (the "Separation Agreement")
effective March 16, 2007, whereby the executive resigned from his positions with
the Company. Pursuant to the Separation Agreement, the Employment Agreement
between the executive and the Company terminated effective March 16, 2007. In
lieu of the compensation payable to the executive pursuant to his Employment
Agreement, from March 16, 2007, to November 30, 2010, the executive will be paid
$100,000 per annum; from December 1, 2010 to May 31, 2011, he will be paid
$50,000. In addition, if the Company achieves certain agreed-upon levels of
performance he may receive up to an additional $50,000. Upon the execution of
his employment agreement the Company granted this executive options to purchase
1,250,000 shares of Common Stock, subject to an agreed upon vesting schedule and
exercisable over a ten-year period commencing on the date of grant. Pursuant to
the Separation Agreement, all unvested options held by this executive vested as
of March 16, 2007, and the right to exercise all of his options will terminate
as of March 16, 2008.
Note 12. INCOME TAXES:
The provision for income taxes at December 31, 2006 consists of the following:
Current
Federal $ 504,585
State 148,841
----------
Total Current Provision 653,426
----------
Deferred
Federal (127,595)
State (35,862)
----------
Total Deferred Taxes (163,457)
----------
Net Provision for Income Taxes $ 489,969
==========
F-21
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
The components of deferred income tax assets as of December 31, 2006 and 2005,
are as follows:
2006 2005
---- ----
Federal loss after M-1 adjustments -- $ 81,022
Bad debts $ 76,080 38,804
Inventory - 263A Adjustment 338,092 145,776
Non-cash compensation - warrants 40,121 18,774
Non-cash compensation - options 124,354 52,297
Deferred Rent 16,977 --
Deferred gain on sale of real estate 323,859 --
Federal tax benefit of State Tax (64,790) (24,200)
Total deferred tax asset 854,693 312,473
Valuation allowance (854,693) (312,473)
--------- ---------
Net deferred tax asset $ -- $ --
========= =========
The component of the deferred tax liability as of December 31, 2006 and 2005 is
as follows:
2006 2005
---- ----
Property and equipment $512,937 $676,394
-------- --------
Total deferred tax liability $597,671 $676,394
======== ========
The difference between income taxes computed at the statutory federal rate and
the provison for income taxes for the years ended December 31, 2006 and 2005
relates to the following:
2006 2005
---- ----
Tax benefit at federal statutory rate 34.00% 34.00%
State income taxes, net of federal
income tax benefit 6.02% 6.02%
Permanent differences 6.66% --
True-up (84.37)% --
Change in valuation allowance 357.10% --
-------- --------
Total 319.41% 40.02%
Valuation allowance -- (40.02)%
-------- --------
Total effective tax rate 319.41 --
======== ========
F-22
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Realization of deferred tax assets is dependent on future earnings. Due to the
uncertainty of realization of the net deferred tax assets, the Company has
provided a valuation allowance. In assessing the realizability of it, management
considers whether it is more likely than not that some or all of the deferred
tax asset will not be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making the assessment.
Note 13. STOCK-BASED COMPENSATION ARRANGEMENTS
During 2005, the Company's Board of Directors approved a stock option 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 123(R)"). The weighted average fair values of options
granted for December 31, 2006 and 2005 are $0.38 and $0.17. During the twelve
months December 31, 2006 no stock options were exercised.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model using weighted average assumptions for grants
in the years ended December 31, 2006 and 2005 is as follows:
2006 2005
---- ----
Risk Free Interest Rates 4.77% 4.095 - 4.375%
Expected Dividend Yields n/a n/a
Expected Terms to Exercise 9 10
Expected Volatility 180% 35%
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.
At December 31, 2006 and 2005, 1,580,000 and 790,000 options are vested and
exercisable, respectively. The weighted average exercise price of exercisable
options at December 31, 2006 and 2005 was $0.32 and $0.22 per share,
respectively.
F-23
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
A summary of the status of the Company's stock options as of December 31, 2006,
and changes during the year then ended is presented below:
Weighted Weighted Average
Number Average Remaining Aggregate
of Exercise Contractual Intrinsic
Shares Price Term Value
--------- --------- ----------- ---------
Outstanding at January 1, 2006 2,370,000 $ 0.38
Reserved for grant based on future
market price 2,480,000
--------- --------- --------- ---------
Outstanding at December 31, 2006 4,850,000 $ 0.38 9 20,540
========= ========= ========= =========
Options vested and exercisable
At December 31,2006 1,580,000 $ 0.32 9 20,540
========= ========= ========= =========
The Company recorded expenses of $167,126 and $121,297 in its consolidated
statement of operations, which reflects the value of granted stock options over
the vesting period in accordance with SFAS No. 123R, for the years ended
December 31, 2006 and 2005, respectively.
The following table summarizes information about stock options at December 31,
2006:
Options Outstanding Options Exercisable
--------------------------------------- ----------------------------
Weighted-
Average Weighted-
Remaining average Weighted-
Number Contractual Exercise Number average
Range of Exercise Prices Outstanding Life (Years) Price Exercisable Exercise Price
------------------------ ----------- ------------ --------- ----------- --------------
$0.220 790,000 9 $ 0.220 790,000 $ 0.220
$0.428 790,000 9 0.428 790,000 0.428
$0.480 790,000 9 0.480 -- --
Based on future market price 2,480,000 9 N/A -- --
---------- -------- -------- --------- ---------
4,850,000 9 $ 0.380 790,000 $ 0.324
========== ======== ======== ========= =========
F-24
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
A summary of the status of the Company's non-vested options as of December 31,
2006 and changes during the twelve months ended is presented below:
Weighted Weighted Average
Average Remaining
Number of Exercise Price Contractual Term
Options Per Option (in years)
---------- ---------- ----------------
Non-vested Options at
January 1, 2006 1,580,000 $ 0.453 10
Options based on future
market price 2,480,000 N/A N/A
Options granted -- -- --
Options vested (790,000) $ 0.428 --
Options forfeited or
expired -- -- --
---------- ---------- ----------
Non-vested Options at
December 31, 2006 3,270,000 $ 0.450 9
========== ========== ==========
As of December 31, 2006, there was $166,329 of unrecognized compensation cost
related to non vested stock option awards, which is to be recognized over the
remaining weighted average vesting period of eight months.
During the year ended December 31, 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" feature 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 $49,510 in
its consolidated statement of operations for the year ended December 31, 2006.
The Company's agreement with this consultant was terminated during the first
week of September 2006.
F-25
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
The following table summarizes the Company's outstanding warrants as of December
31, 2006 and changes during the year then ended:
Weighted Weighted
Number Average Average Remaining
of Exercise Contractual Life
Shares Price (Years)
--------- --------- -----------------
Outstanding at beginning of year 5,229,589 $ 0.21 4.1
Granted 41,668 $ 0.97 4.8
Cancelled -- --
Exercised -- --
--------- --------- ---------
Outstanding at end of year 5,271,257 $ 0.22 4.9
========= ========= =========
Note 14. EQUITY TRANSACTONS AND ASSET ACQUISITION
Private Placement
Immediately prior to, and shortly after the completion of the Merger, Original
Gales received gross proceeds of $9,000,000 from the closing of a private
placement ("Private Placement") to accredited investors of 900 shares of
convertible preferred stock at $10,000 per share which, pursuant to the Merger,
were exchanged for shares of the Company's Preferred Stock, $.001 par value per
share. The shares of Preferred Stock issued in connection with such private
placement are convertible into 40,909,500 shares of the Company's Common Stock.
The proceeds of the Private Placement, in general, were used for paying the cash
portion of the purchase price of the Acquisition, for paying expenses relating
to the Private Placements, Acquisition, Merger, and related transactions, for
the repayment of $150,000 in promissory note obligations which Gales incurred in
bridge financings, and for working capital for the Company.
The Placement Agent received 4,090,950 warrants, exercisable during a five year
term, to purchase 4,090,950 shares of the Company's Common Stock. Such warrants
have a "cashless exercise" feature and are exercisable at $0.22 per share. These
warrants were valued at $201,402 using the Black-Scholes model.
Acquisition
Pursuant to a stock purchase agreement between Gales and AIM dated July 25,
2005, original Gales acquired 100% of the capital stock of AIM. The total
aggregate price original Gales paid to acquire AIM was $5,231,618 as follows:
(i) $3,114,296 in cash, (ii) $1,627,262 in principal amount of promissory notes,
and (iii) 490,060 shares of Common Stock valued at a negotiated rate of $1.00
per share (concluded prior to the merger with the public company). The results
of AIM's operations have been included in the consolidated financial statements
since that date. A portion of the proceeds from original Gales' Private
Placement was used to pay such purchase price (See "Private Placement"),
including transaction costs of $1,053,862. This stock acquisition was accounted
for under the purchase method of accounting in accordance with SFAS No. 141,
Business Combinations. Under the purchase method of accounting, the total
purchase price was allocated to the assets acquired and liabilities assumed
based upon the fair values as of the completion of the acquisitions. As a result
of the stock purchase, the Company recorded $1,265,963 in goodwill which
represents the excess of the fair market value over book value of the assets
acquired and liabilities assumed from AIM. The liabilities assumed also included
$676,394 of a deferred tax liability representing book to tax differences on
assets acquired.
F-26
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of stock acquisition:
Current assets $15,640,164
Other assets 283,128
Property and equipment 3,695,532
-----------
Total assets acquired 19,618,824
-----------
Current liabilities 8,277,921
Long-term debt 5,644,992
Deferred tax liability 676,394
-----------
Total liabilities assumed 14,599,307
-----------
Net assets acquired 5,019,517
Consideration given 6,285,480
-----------
Goodwill $ 1,265,963
===========
Real estate acquisition
Contemporaneously with the close of the Merger and the Acquisition: (i) AIM
completed the acquisition from affiliates of AIM, for an aggregate purchase
price of $4,190,000, of three buildings and land which was being leased prior to
the closing of the Merger and the Acquisition by AIM (the "Real Estate
Acquisition"). The purchase price and related acquisition costs approximated the
appraised value of both the buildings and land (ii) AIM entered into the Loan
Facility with PNC Bank (See Note 6).
Preferred Stock
The Company currently has no shares of Preferred Stock outstanding. The 900
shares of preferred stock issued in connection with its private placement were
automatically converted into 40,909,500 shares of common stock upon the
effectiveness of its registration statement in August of 2006.
F-27
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Note 15. UNAUDITED PRO-FORMA FINANCIAL STATEMENTS
The accompanying unaudited pro forma condensed statement of operations gives
effect to the Merger Agreement, Acquisition, and Real Estate Acquisition as if
they occurred on January 1, 2005. The Acquisition was accounted for under the
purchase method of accounting in accordance with SFAS No. 141. Under the
purchase method of accounting, the total purchase price was allocated to the
assets acquired and liabilities assumed based upon the fair values at the
completion of the acquisitions.
The unaudited pro forma condensed combined statement of operations has been
prepared for illustrative purposes and are not necessarily indicative of the
condensed consolidated results of operations in future periods or the results
that actually would have been realized had the acquisition actually occurred on
January 1, 2005. The pro forma adjustments are based on the information
available at the time of the preparation of this document.
The unaudited pro forma condensed combined statement of operations should be
read in conjunction with the audited consolidated financial statements of Gales
Industries Incorporated as of December 31, 2005.
Year Ended
December 31, 2005
-----------------
(Unaudited)
-----------
Net sales $30,735,103
Cost of Sales 26,361,387
-----------
Gross profit 4,373,716
Operating costs and expenses
Selling and marketing 357,854
General and Administrative 2,583,375
-----------
Income from operations 1,432,487
Other expenses
Interest and financing costs 1,056,317
-----------
Income before income taxes 376,170
Provision for income taxes 151,031
-----------
Net Income $ 225,139
===========
Earnings per share
Basic $ 0.02
===========
Diluted $ 0.01
===========
Weighted average shares
outstanding Basic 14,723,421
===========
Diluted 40,282,810
===========
F-28
GALES INDUSTRIES INCORPORATED
Notes to the Consolidated Financial Statements
Note 16. SUBSEQUENT EVENTS
Sigma Metals, Inc
On January 2, 2007, the Company entered into a Stock Purchase Agreement (the
"Sigma Agreement") with Sigma Metals, Inc., a New York corporation ("Sigma
Metals"), and the holders of all of the outstanding shares of Sigma Metals (the
"Shareholders"). Pursuant to the Sigma Agreement, subject to the satisfaction of
various terms and conditions, the Company will acquire from the Shareholders all
of the issued and outstanding capital stock of Sigma Metals.
The closing of the Sigma Agreement is scheduled to occur in April 2007 or on
such other date as the Company and the Shareholders may agree. The purchase
price for all of the shares is $7,000,000 plus an amount equal to Sigma Metals'
earnings for the period from January 1, 2007, until the closing, subject to
certain adjustments as set forth in the Sigma Agreement.
Conversion of Notes Payable
On January 26, 2007, the two senior management members exercised their right to
convert their $665,262 notes plus accrued interest of $54,511 into an aggregate
of 1,799,432 shares of common stock at a conversion price of $0.40 per share.
(See Note 9)
Welding Metallurgy, Inc
On March 9, 2007, the Company entered into a Stock Purchase Agreement (the
"Welding Agreement") to acquire Welding Metallurgy, Inc., a New York corporation
("Welding Metuallurgy"), from the holders (the "Shareholders") of all of the
outstanding shares of Welding Metallurgy. Pursuant to the Welding Agreement,
subject to the satisfaction of various terms and conditions, the Company will
acquire from the Shareholders all of the issued and outstanding capital stock of
Welding Metallurgy for aggregate consideration of $6,050,000, subject to
adjustment for working capital, payable in a combination of cash, a secured
promissory note and shares of the Company's common stock.
On February 13, 2007, each of the non-management members of the Board was issued
an option to purchase 100,000 shares of the common stock of the Company. The
options will vest in equal thirds on March 1, 2007, 2008 and 2009 and are
exercisable at a price of $0.27 per share until March 1, 2014.
In March 2007, the Company entered into an Agreement to compensate James Brown
for services to be rendered as a director of the Company. Pursuant to such
Agreement Mr. Brown will receive a cash payment of $15,000 and will be
compensated at a rate of $175,000 per annum until December 31, 2007, or if prior
to December 31, 2007, until such date as he shall cease to serve as Chairman. In
addition to his cash compensation, Mr. Brown was issued 200,000 shares of common
stock of the Company, pursuant to a Restricted Stock Agreement, of which 100,000
vested on the date of grant and the second 100,000 shall vest on December 31,
2007.
The Company and Michael A. Gales entered into a Separation Agreement and General
Release (the "Separation Agreement") effective March 16, 2007, whereby Mr. Gales
resigned from his positions with the Company. Pursuant to the Separation
Agreement, the Employment Agreement between Mr. Gales and the Company terminated
effective March 16, 2007. In lieu of the compensation payable to Mr. Gales
pursuant to his Employment Agreement, from March 16, 2007, to November 30, 2010,
Mr. Gales will be paid $100,000 per annum; from December 1, 2010 to May 31,
2011, he will be paid $50,000. In addition, if the Company achieves certain
agreed-upon levels of performance he may receive up to an additional $50,000.
Upon the execution of his employment agreement the Company granted Mr. Gales
options to purchase 1,250,000 shares of Common Stock, subject to an agreed upon
vesting schedule and exercisable over a ten-year period commencing on the date
of grant. Pursuant to the Separation Agreement, all unvested options held by Mr.
Gales vested as of March 16, 2007, and the right to exercise all of his options
will terminate as of March 16, 2008.
F-29
AIR INDUSTRIES MACHINING, CORP.
Predecessor to Gales Industries Incorporated
FINANCIAL STATEMENTS
(PRIOR TO MERGER)
NOVEMBER 30, 2005
F-30
AIR INDUSTRIES MACHINING, CORP.
Predecessor to Gales Industries Incorporated
TABLE OF CONTENTS
November 30, 2005
PAGES
Accountants' Report F-32
Consolidated Balance Sheet F-33
Consolidated Statement of Income and Retained Earnings F-35
Comparative Statement of Cash Flows F-36
Notes to Financial Statements F-37 to F-44
F-31
Independent Accountants' Report
To the Board of Directors and Stockholders of Air Industries Machining
Corporation
We have audited the accompanying Consolidated Balance Sheets of Air
Industries Machining Corporation as of November 30, 2005, and the related
Consolidated Statement of Income and Retained Earnings and Cash Flows for the
eleven months ended November 30, 2005. These consolidated financial statements
are the responsibility of the Air Industries Machining Corporation management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with auditing standards of the Public
Company Accounting Oversight Board. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. 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 consolidated financial statements referred above
present fairly, in all material respects, the financial position of Air
Industries Machining Corporation as of November 30, 2005, and the results of its
operations and its cash flows for the eleven months then ended in conformity
with accounting principles generally accepted in the United States.
Respectfully submitted,
BILDNER & GIANNASCO, LLP
Certified Public Accountants
Jericho, New York
February 28, 2006
F-32
AIR INDUSTRIES MACHINING CORPORATION
Consolidated Balance Sheet
ASSETS November 30, 2005
-----------------
Current Assets
Cash and Cash Equivalents $ 71,197
Accounts Receivable 3,202,991
Inventory 11,588,521
Prepaid Expenses 174,850
Other Current Assets 4,215
Deposits 192,972
-----------
Total Current Assets $15,234,746
Property, plant and equipment, net 3,919,599
Security Deposits 34,522
Cash Surrender Value - Officer's Life 62,761
Unamortized Finance Costs 102,187
-----------
Total Assets $19,353,815
===========
The accompanying audit report and notes are an integral part of these
statements.
F-33
AIR INDUSTRIES MACHINING CORPORATION
Consolidated Balance Sheet
LIABILITIES AND STOCKHOLDERS' EQUITY November 30, 2005
-----------------
Current Liabilities
Accounts Payable $ 4,429,016
Advance Payment - Customer 293,226
Mortgage Payable - Current 96,000
Dividends Payable
511,055
Obligations Under Capital Lease - Current 359,197
Notes Payable - Banks 5,180,000
Accrued Operating Expenses 1,074,025
------------
Total Current Liabilities 11,942,519
Long Term Liabilities
Advances From Shareholders 464,992
Mortgage Payable 1,145,813
Obligations Under Capital Lease - Long Term 849,652
------------
Total Long Term Liabilities 2,460,457
------------
Total liabilities 14,402,976
------------
Commitments and contingencies
Minority interest 446,805
Stockholders' Equity
Capital Stock - 200 Shares Authorized
No Par Value, 95 Shares Issued and Outstanding
As of November 30, 2005 32,223
Additional Paid-In Capital 221,580
Retained Earnings 4,346,231
Less: Treasury Stock at Cost (96,000)
------------
Total Stockholders' Equity 4,950,839
------------
Total Liabilities and Stockholders' Equity $ 19,353,815
============
The accompanying audit report and notes are an integral part of these
statements.
F-34
AIR INDUSTRIES MACHINING CORPORATION
Consolidated Statements of Income and Retained Earnings
Audited Unaudited Pro Forma (1)
ELEVEN MONTHS ENDED ELEVEN MONTHS ENDED
November 30, 2005 November 30, 2005
Net sales $27,957,694 $27,957,694
Cost of sales 23,887,120 23,887,120
----------- -----------
Gross profit 4,070,574 4,070,574
----------- -----------
Operating expenses
Selling 322,867 $ 322,867
General and administrative 1,665,793 1,665,793
----------- -----------
Total operating expenses 1,988,660 1,988,660
----------- -----------
Income from operations 2,081,914 2,081,914
Interest and financing costs 605,602 605,602
----------- -----------
Income before minority interest and
income taxes 1,476,312 1,476,312
Less: minority interest 74,904 74,904
----------- -----------
Income before provision for income taxes 1,401,408 1,401,408
Provision for income taxes (1) -- 560,843
----------- -----------
Net Income 1,401,408 $ 840,565
----------- ===========
Retained Earnings, Beginning of Period 4,120,102
Deduct: Distribution to Shareholders (1,175,279)
-----------
Retained Earnings, End of Period $ 4,346,231
===========
(1) Since our inception we have elected to be treated as a Subchapter " S"
corporation of the Internal Revenue Code and incurred no income taxes. The pro
forma amounts include income taxes that would have been incurred if the Company
had been a "C" corporation. The effective rate of the pro forma income tax is
40.02% and is based upon the combined Federal and State tax rates that were in
effect for the period December 1, 2005 to December 31, 2005 when the company
became a "C" corporation.
F-35
AIR INDUSTRIES MACHINING CORPORATION
Comparative Statements of Cash Flows
Eleven Months
Ended
November 30,
2005
-----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 1,401,408
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation And Amortization 522,299
Minority Interest in Net Income 74,904
Non Cash Interest Expense 24,342
Changes in Assets and Liabilities:
(Increase) Decrease In Assets-
Accounts Receivable (559,455)
Inventory (730,065)
Prepaid Expenses (42,582)
Other Current Assets 1,264
Deposits (171,812)
Cash Surrender Value - Officer's Life 200,875
Increase (Decrease) In Liabilities-
Accounts Payable 736,956
Dividends Payable 390,599
Advance Payments - Customers (1,061,040)
Accrued Expenses 570,347
Advances from Shareholders 197,435
-----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,555,475
-----------
CASH FLOWS (USED) IN INVESTING ACTIVITIES
Purchase of Equipment (301,051)
-----------
NET CASH (USED) IN INVESTING ACTIVITIES (301,051)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Credit Line Facilities 304,388
Principle Payments of Capital Lease Obligations (264,396)
Principle Payments of Mortgage (81,973)
Repayment of Notes Payable (100,000)
Distribution to Shareholders (1,090,521)
-----------
NET CASH (USED) IN FINANCING ACTIVITIES (1,232,502)
-----------
Net increase in cash and cash equivalents 21,922
Cash and cash equivalents, beginning of year 49,275
-----------
Cash and cash equivalents, end of year $ 71,197
===========
Supplementary disclosure of cash flow information
Cash Paid During The Year For Interest $ 566,467
===========
Supplementary noncash disclosure of financing activities
Equipment acquisition through capital lease financing $ 449,559
===========
The accompanying audit report and notes are an integral part of these
statements.
F-36
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
1- SIGNIFICANT ACCOUNTING POLICIES
Background of Company
Air Industries Machining Corporation ("Air" or "The Company"), founded in 1969,
was incorporated in the State of New York and maintains its principal place of
business in Bay Shore, New York. The Corporation is primarily engaged in
manufacturing aircraft structural parts and assemblies principally for prime
defense contractors in the aerospace industry machining parts for the aerospace
industry predominantly located in the United States. The Company's customer base
consists mainly of publicly traded companies in the aerospace industry.
Principles of Consolidation
The Company's consolidated financial statements include those of variable
interest entities ("VIEs"). Conditions in which the Company would consolidate
VIE's are cases in which the Company is the primary beneficiary. Conditions
under which the Company would consolidate entities that are not VIE's are cases
in which the Company would maintain a controlling interest (50% or more)
investment or exert significant management influence. (See Note 11).
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid debt instruments with an
original maturity of three months or less. Cash consists of aggregate cash
balances in the Company's bank accounts and cash equivalents consist primarily
of money market accounts.
Accounts Receivable
Accounts receivable are reported at their outstanding unpaid principal balances.
The Company writes off accounts when they are deemed to be uncollectible. The
Company has experienced insignificant amounts of bad debts in such accounts.
Inventories
The Company values inventory at the lower of cost on a first-in-first-out basis
or market.
The Company purchases inventory only when it has signed non-cancellable
contracts with its customers for orders of its finished goods. The Company
occasionally produces finished goods in excess of purchase order quantities in
anticipation of future purchase order demands but historically this excess has
been used in fulfilling future purchase orders. The Company occasionally
evaluates inventory items that are not secured by a purchase orders and reserves
for obsolescence accordingly. The Company also reserves an allowance for excess
quantities, slow-moving goods, and obsolete items.
Property, Plant and Equipment
Property, plant and equipment are carried at cost less accumulated depreciation
and amortization. The Company maintains a policy to capitalize all property and
equipment purchases in excess of $1,000. Expenditures for repairs and
improvements in excess of $1,000 that add to the productive capacity or extend
the useful life of an asset are capitalized. Repair and maintenance charges are
expensed as incurred. Property under a capital lease is capitalized and
amortized over the lease terms. Upon disposition, the cost and related
accumulated depreciation are removed from the accounts and any related gain or
loss is reflected in earnings. Depreciation on plant and equipment is calculated
on the straight-line method over the estimated useful lives of the assets.
F-37
The useful lives of property, plant and equipment for purposes of computing
depreciation are:
Tools and instruments ................ 7 Years
Leasehold improvements................ 25 Years
Machinery and equipment .............. 5-8 Years
Automotive Equipment.................. 5 Years
Furniture and fixtures................ 5-8 Years
Buildings............................. 25-31.5 Years
Impairment of Long Live Assets
The Company reviews long-lived assets for impairment at the facility level
annually or if events or circumstances indicate that the carrying value of such
assets may not be fully recoverable. Impairment is evaluated based on the sum of
undiscounted estimated future cash flows expected to result from use of the
assets compared to its carrying value. If impairment is recognized, the carrying
value of the impaired asset is reduced to its fair value, based on discounted
estimated future cash flows.
Finance Costs
Costs connected with obtaining and executing debt arrangements are capitalized
and amortized on the straight-line basis over the term of the related debt.
Revenue Recognition
The Company generally recognizes revenue when products are shipped and the
customer takes ownership and assumes risk of loss, collection of the relevant
receivable is probable, persuasive evidence of an arrangement exists, and the
sales price is fixed or determinable. Payments received in advance from
customers for products delivered are recorded as customer advance payments until
earned, at which time revenue is recognized.
Cost of Goods Sold
Costs for goods sold includes all direct material, labor costs, tooling and
those indirect costs related to manufacturing, such as indirect labor, supplies,
tools, repairs and depreciation costs.
Expenses
Selling, general, and administrative costs are charged to expense as incurred.
F-38
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
Income Taxes
The Company, with the consent of its stockholders, elected under the Internal
Revenue Code and New York State law to be taxed as an "S" corporation. In lieu
of corporate income taxes, the stockholders are taxed on their proportionate
share of the company's net income. Accordingly, no provision for federal income
taxes has been made in the accompanying financial statements.
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.
Credit Risk
Financial instruments involving potential credit risk include accounts
receivable. Of the accounts receivable balance outstanding as of November 30,
2005, approximately 54% is attributed to two customers.
Treasury Stock
The Company records treasury stock under the cost method.
Fair Value of Financial Instruments
The Company has estimated the fair value of financial instruments using
available market information and other valuation methodologies in accordance
with Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments." Management of the Company believes that
the fair value of financial instruments, consisting of cash, accounts
receivable, accounts payable and accrued liabilities, approximates carrying
value due to the immediate or short-term maturity associated with these
instruments and that the notes payable is carried at fair value in that it
carries interest rates that are comparable to similar instruments with similar
maturities.
Reclassifications
Certain reclassifications have been made to prior year's financial statement
information to conform to the current year presentation.
F-39
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
2- INVENTORY
The components of inventory consisted of the following as of November 30, 2005:
November 30, 2005
-----------------
Raw Materials $ 2,294,020
Work in Progress 2,639,006
Finished Goods 6,655,495
-------------
Total Inventory $ 11,588,521
=============
3- PROPERTY, PLANT AND EQUIPMENT
The components of property and equipment as of November 30, 2005 include:
November 30, 2005
-----------------
Land $ 134,922
Building 3,173,071
Machinery and Equipment 8,541,083
Tools and Instrument 279,803
Leasehold Improvements 515,211
Automotive Equipment 290,083
Furniture and fixtures 872,112
------------
Total property, plant, and equipment 13,806,285
------------
------------
Less: Accumulated Depreciation (9,886,686)
------------
------------
Property, plant, and equipment, net $ 3,919,599
============
Depreciation and amortization expense for the eleven months ended November 30,
2005 was $477,827.
F-40
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
4- NOTES PAYABLE - BANKS
The Company has negotiated a credit facility dated August of 2003 with a major
lending institution with a termination date of March of 2006. The facility is
secured by a first priority interest in all accounts receivable, inventory and
equipment presently owned or hereafter acquired by the Company. The indebtedness
bears interest at the rate of 1/2 percent above the prime rate of interest or a
libor margin of 3%.
The terms of the facility require that, among other things, the Company maintain
certain financial ratios and levels of working capital. As of November 30, 2005,
the Company has met these terms.
The loans are guaranteed jointly and severally by the principals of the Company,
as well as the affiliated companies KPK Realty Corporation and DPPR Realty Corp.
(See Note 9)
Interest expense related to the notes payable - bank amounted to $337,447 for
the eleven months ended November 30, 2005.
5- ADVANCES FROM SHAREHOLDERS
Advances represent non-interest bearing advances from shareholders to cover the
Company's working capital needs. The Company imputed as interest based on the
prime rate and recorded as interest expense and additional paid in capital an
amount of $24,342 for the eleven months ended November 30, 2005.
5A- DISTRIBUTIONS TO SHAREHOLDERS
The Company distributed to its shareholders $1,175,279 during the eleven months
ended November 30, 2005. These distributions were made from time to time to the
Company's shareholders in proportion to their ownership interests in the Company
at such times as it had sufficient cash on hand or availability under its lines
of credit.
6- MORTGAGE PAYABLE
As the Company consolidates the assets and liabilities of variable interest
entities (see Note 11) it has two mortgages covering buildings and land. These
mortgages carry interest rates of 6.15% and 7.18% per annum.
F-41
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
Future mortgage payments are as follows for the period ended November 30, 2005:
Year Amount
---- ----------
2006 $ 126,000
2007 128,000
2008 139,000
2009 133,000
2010 142,000
Thereafter 573,813
----------
1,241,813
Less: current maturities: 96,000
----------
Long term $1,145,813
==========
6A. CASH SURRENDER VALUE - LIFE INSURANCE
The Company is the owner and beneficiary of key-man life insurance policies
carried on the lives of certain key executives with cash surrender values. The
aggregate face amounts of the policies were $4,250,000 for the eleven months
ended November 30, 2005. There are loans in place against these policies. As of
November 30, 2005 the cash surrender value was $62,761, net of $226,632 in
loans. As the Company has the right to offset the loans against the cash
surrender value of the policies, the Company presents the net asset in its
consolidated financial statements.
7- CAPITAL LEASES PAYABLE-EQUIPMENT
The Company is committed under several capital leases for manufacturing
equipment and computer equipment. All leases have bargain purchase options that
the Company expects to exercise at the termination of each lease. Capital lease
obligations totaled $1,208,849 as of November 30, 2005.
As of November 30, 2005, future minimum lease payments, including imputed
interest, with remaining terms of greater than one year are as follows:
Year Amount
---- ----------
2006 $ 404,000
2007 428,000
2008 427,000
2009 106,000
----------
Total future minimum lease payments 1,365,000
Less: imputed interest (156,151)
Less: current maturities (359,197)
----------
Total long-term capital lease obligation $ 849,652
==========
F-42
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
8- EMPLOYEE BENEFITS PLANS
On January 1, 1997, the Company instituted a defined contribution plan under
Section 401(k) of the Internal Revenue Code ("the Plan"). Pursuant to the Plan
qualified employees may contribute a percentage of their pretax eligible
compensation to the Plan. The Company does not match any contributions that
employees may make to the Plan.
The employees of the Company are members of the United Service Workers Union
IUJAT Local 355 (the "Union'), which provides a medical benefit plan at defined
rates which are contributed in their entirety by the Company. For the
eleven-month period ending November 30, 2005, the Company contributed $1,279,743
to the plan.
9- RELATED PARTY TRANSACTIONS
The following transactions occurred between the Company and certain related
parties.
The Company presently leases manufacturing and office space from KPK Realty
Corp. a corporation in which 49% is owned by the majority stockholder of the
Company.
Additionally, the Company leases manufacturing space from DPPR Realty Corp.
which is 100% owned by two of the shareholders of the Corporation who in the
aggregate own 36.84% of the Company.
KPK Realty Corp. and DPPR Realty Corp. are considered variable interest entities
under FIN 46 (See Note 11) and accordingly, their assets, liabilities and
results of operations have been consolidated into the Company's financial
statement.
10- COMMITMENTS AND CONTINGENCIES
Litigation
A legal action has been brought against the Company for personal injuries
sustained by an independent contractor as a result of a fall on the Company's
premises. The Company has insurance coverage for this claim in the amount of
$4,000,000. The carrier has assumed the defense of this action and at a
settlement mediation, the plaintiff made a demand of $2,000,000 which was
rejected by the carrier. The Company believes that any judgement or settlement
in this matter will be paid by the carrier.
F-43
AIR INDUSTRIES MACHINING CORPORATION
Notes to the Consolidated Financial Statements
November 30, 2005
11- VARIABLE INTEREST ENTITIES
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities.
Under FIN 46, we are required to consolidate variable interest entities for
which we are deemed to be the primary beneficiary by the third quarter of 2003,
and disclose information about those in which we have significant variable
interests effective immediately.
The Company has leasing arrangements for its operating and manufacturing
facilities with two lessors. Under FIN 46 these lessors are Variable Interest
Entities and the Company is the primary beneficiary. Therefore, the Company has
consolidated the respective lessors' assets and debt into these consolidated
statements. At November 30, 2005, these entities had gross assets of $1,900,000
and gross liabilities of $985,000. These facilities were subsequently purchased
in connection with a merger transaction in November 2005. The minority interest
on the Company's financial statements consists of the non-controlling portion of
these respective entities (See Note 9).
12- SUBSEQUENT EVENTS
On November 30, 2005 merger agreements were consummated between the Company and
an Acquisition Entity and between the Acquisition Entity and a Public Entity
whose stock is traded in Over the Counter Market. Contemporaneously with the
merger agreements, the Company secured $14,000,000 in debt facilities from a
major lending institution and used funds from the facility to purchase real
property that it had subsequently leased and paid off debts to its prior lender.
As part of the merger agreements, the Acquisition Entity completed the first of
two closings of private placement stock offerings which grossed $9,000,000 in
the aggregate. These transactions and their associated costs have not been
reflected in these financial statements.
F-44
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 8A. Controls and Procedures.
Our management is responsible for establishing and maintaining adequate
internal controls over financial reporting. Such controls are intended to
provide reasonable assurance regarding the reliability of our financial reports
for external reporting purposes and for purposes of monitoring operations.
On November 30, 2005, we acquired Original Gales, then a privately held
company, which immediately prior to such acquisition had acquired AIM, also a
privately held company. At such time AIM's system of financial controls and
procedures were adopted as those of our Company. Immediately following the
acquisitions of Original Gales and AIM, our management evaluated the
effectiveness of AIM's disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities and Exchange Act of 1934). Based upon that
evaluation, our management concluded that AIM's disclosure controls and
procedures were effective as of such date for timely gathering, analyzing and
disclosing the information we are required to disclose in our reports filed
under the Exchange Act. Nevertheless, because AIM's controls and procedures were
not designed to facilitate the external financial reporting required of a
publicly held company, our management determined to complete the implementation
of a total financial and operating control system that AIM installed during 2005
and to hire support personnel experienced with the reporting requirements
imposed upon public companies to facilitate the timely preparation of accurate
financial reports.
Our Chief Executive Officer and our Chief Financial Officer commenced an
evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934) as of
December 31, 2006. Based upon that evaluation, our Chief Executive Officer and
our Chief Financial Officer have concluded that our disclosure controls and
procedures were effective as of such date for timely gathering, analyzing and
disclosing the information we are required to disclose in our reports filed
under the Exchange Act. Although no material weaknesses were found in our
disclosure controls and procedures as of December 31, 2006, to ensure the
reliability of future financial reports and compliance with the more stringent
requirements of Sarbanes-Oxley, our management has determined to continue to
augment the financial reporting system inherited from AIM, including the
installation of a fully-integrated operating and financial control system.
-26-
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.
The following table sets forth information with respect to our directors and
executive officers.
Name of Individual Age Position with the Company
----------------------------------- --- ----------------------------------------------------
James A. Brown 54 Chairman
Louis A. Giusto 64 Vice Chairman, Chief Financial Officer and Treasurer
Peter D. Rettaliata 56 Director, Chief Executive Officer and President
Dario A. Peragallo 42 Director and Executive Vice President, Manufacturing
Stephen M. Nagler 68 Director and Secretary
Seymour G. Siegel 64 Director
Rounsevelle W. Schaum 73 Director
M.Gen. Ira A. Hunt, Jr. (USA, Ret.) 81 Director
The business experience of each of our directors and executive officers is
set forth below. Each of our directors and executive officers, except Mr. James
A. Brown, began his service with our Company as of November 30, 2005.
Mr. Brown became our Chariman in March of 2007, and was Ashlin's Chief
Executive Officer and Secretary from September 2004 to November 30, 2005 and was
Ashlin's Chairman of the Board from May 2003 to November 30, 2005. Since
November 30, 2005, Mr. Brown has served as a member of our Board of Directors.
Ashlin filed for bankruptcy protection while Mr. Brown was its Chairman and CEO.
Mr. Brown served as the Chief Operating Officer of Private Investor Reserves
Corp., a financial services firm, from May 2000 through 2004. Mr. Brown
co-founded A.S. Partners.com, Inc., an internet application service provider,
and served as its Chief Executive Officer from December 1998 to April 2000.
Mr. Giusto, our Vice Chairman, Chief Financial Officer and Treasurer since
November 30, 2005, has over 30 years of financial control experience with
foreign and domestic banks, non-bank financial service entities and consumer
product companies. From 2003 to November 2005 Mr. Giusto acted as an independent
consultant to a number of private businesses. From 2000 to 2003, Mr. Giusto was
an Account Manager for a public accounting firm and the SVP Finance and
Operations of Credit2B.com a web-based internet company. Before joining C2B, Mr.
Giusto served for fourteen years in various positions with Fleet Bank and, prior
to its acquisition by Fleet Bank, NatWest PLC, London. During his tenure at
NatWest, Mr. Giusto served as Senior Financial Officer and Treasurer of NatWest
Commercial Services, Inc. (a billion dollar wholly owned subsidiary of NatWest
PLC, London) and a Credit Administrator (Risk Manager) with Fleet Bank. Mr.
Giusto serves as a director of Long Island Consultation Center, a not-for-profit
psychiatric care facility. Mr. Giusto graduated from New York University with a
BS in Economics and Accounting and from Long Island University (with
Distinction) with an MBA in Finance.
Mr. Rettaliata has been our President and Chief Executive Officer, and
also a member of our Board of Directors, since November 30, 2005. He has been
the President of AIM and has served in such capacity since 1994. Prior to his
involvement at AIM, Mr. Rettaliata was employed by Grumman Aerospace Corporation
for twenty-two years. Professionally, Mr. Rettaliata is the Chairman of "ADAPT",
an organization of regional aerospace companies, a past member of the Board of
Governors of the Aerospace Industries Association, and a member of the Executive
Committee of the AIA Supplier Council. Recently, Mr. Rettaliata testified to the
President's Commission on aerospace in Washington, D.C. He is a graduate of
Niagara University where he received a B.A. in History and the Harvard Business
School where he completed the PMD Program. Upon completion of the Acquisition,
Mr. Rettaliata continued to serve as President of AIM and assumed the positions
of CEO and President of the Company.
-27-
Mr. Peragallo, who since November 30, 2005 has been our Executive Vice
President and a member of our Board of Directors, is also the Executive Vice
President of Manufacturing for AIM. Mr. Peragallo has been associated with AIM
for over 25 years. He was elevated in 2000 to Director of Manufacturing. In
addition, he has helped develop and maintain AIM's current business systems. Mr.
Peragallo has been the company "Lean Advocate" since the inception of the
program at AIM to decrease its inventory and increase productivity. He has led
AIM on its "Lean" course of evolution and has participated in seventeen "Lean"
events. Mr. Peragallo became Executive Vice President with overall
responsibility for engineering, manufacturing and customer-critical technical
matters (including "Lean" and "Supply Chain" activities) in 2003. He has been an
active member of Diversity Business since 2000, which is an organization
specializing in the promotion of small and minority owned businesses. He is a
graduate of SUNY Farmingdale where he received a B.A. in Manufacturing
Engineering. Mr. Peragallo oversees all engineering and production matters
relating to AIM.
Mr. Nagler, who has been a member of our Board of Directors and our
Secretary since November 30, 2005, is a member of Eaton & Van Winkle LLP, a law
firm in New York City which he joined as a Partner in October 2004. Prior to
joining Eaton & Van Winkle, Mr. Nagler was affiliated with Phillips Nizer LLP as
Counsel since 1995. Mr. Nagler chairs TriState Ventures LLC, an angel investor
group in the New York area. Mr. Nagler is a graduate of the City College of New
York and NYU School of Law. The firm of Eaton & Van Winkle LLP served as counsel
to Original Gales and will be serving as counsel to the Company.
Mr. Siegel, a member of our Board since November 30, 2005, has been a
principal in the Business Consulting Group of Rothstein, Kass & Company, P.C.
since April 2000. Rothstein, Kass is a national firm of accountants and
consultants with approximately 800 members and offices in 8 cities. He
specializes in providing strategic advice to business owners including mergers
acquisitions; succession planning; capital introductions and long range
planning. In 1974, Mr. Siegel founded, and from 1974 to 1990 was managing
partner of, Siegel Rich and Co, P.C., CPAs. In 1990, Siegel Rich merged into
Weiser LLP, then known as M.R.Weiser & Co., LLC, a large regional firm where he
had been a senior partner. In 1995, Mr. Siegel founded another firm called
Siegel Rich, which became a division of Rothstein, Kass in April 2000. Mr.
Siegel has been a director, trustee and officer of numerous businesses,
philanthropic and civic organizations. He serves as a director and audit
committee chairman of Hauppauge Digital Inc. and Emerging Vision Incorporated
and has served in a similar capacity at Oak Hall Capital Fund, Prime Motor Inns
Limited Partnership, Noise Cancellation Technologies and Barpoint.com and serves
as the chairman of the audit committee and as a member of the compensation
committee for Global Aircraft Solutions Incorporated. Mr. Siegel is the Chairman
of the Audit Committee of the Board.
Mr. Schaum has been a member of our Board since November 30, 2005. Since
1993, Mr. Schaum has served as Chairman of Newport Capital Partners, a private
investment banking and financial advisory firm specializing in providing
assistance to emerging growth companies in private placements, corporate
governance and negotiation of mergers and acquisitions. Mr. Schaum also serves
as a director and Chairman of the Audit and Compensation Committees of the
Quigley Corporation (NASDAQ: "QGLY"), and as a director of Camelot Entertainment
Group, Inc (OTC:BB "CMEG"). Mr. Schaum was a founder, director and treasurer of
Streaming Media Corporation, and has also served as Chairman and CEO of
BusinessNet Holdings Corporation; as a crisis manager for Heller Financial
Corporation; as Chairman of the California Small Business Development
-28-
Corporation, a private venture capital syndicate; and was the founder and
Managing Director of the Center of Management Sciences, a consulting firm
serving the aerospace industry. He has been a consultant on project management
procedures to the Departments of the Army, Navy and Air Force, and numerous
defense contractors, including General Dynamics, MacDonald-Douglas, Raytheon,
Hughes Aircraft and the Logistics Management Institute. Mr. Schaum is a graduate
of Phillips Andover Academy and holds a Bachelor of Science degree in Mechanical
Engineering from Stanford University and an MBA degree from the Harvard Business
School. He was also a member of the faculty and Defense Research Staff of the
Massachusetts Institute of Technology, where he participated in the development
of the computer programs for the Ballistic Missile Early Warning System.
General Hunt, a member of our Board since November 30, 2005, graduated
from the United States Military Academy in 1945 and subsequently served
thirty-three years in various command and staff positions in the U.S. Army,
retiring from active military service as a Major General in 1978. His last
military assignment was as Director of the Office of Battlefield Systems
Integration. Subsequently, General Hunt was president of Pacific Architects and
Engineers in Los Angeles and Vice President of Frank E. Basil, Inc. in
Washington, D.C. Since 1990, General Hunt has been a director of SafeNet Inc.
(Nasdaq: SFNT), an information security technology company. He is a Freeman
Scholar of the American Society of Civil Engineers and has a M.S. in Civil
Engineering from the Massachusetts Institute of Technology, a M.B.A. from the
University of Detroit; a Doctor of the University Degree from the University of
Grenoble, France and a Doctor of Business Administration Degree from the George
Washington University. General Hunt is a member of the Compensation Committee of
the Board.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our
directors, executive officers and beneficial owners of more than 10% of our
Common Stock to file with the SEC reports of their holdings of, and transactions
in, our Common Stock. Based solely upon our review of copies of such reports and
written representations from reporting persons that were provided to us, we
believe that our officers, directors and 10% stockholders complied with these
reporting requirements with respect to 2006.
The Audit Committee
Our Audit Committee consists of Messrs. Siegel and Hunt. Mr. Siegel is our
audit committee financial expert and is "independent" as defined in Item
7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, as
amended.
Code of Ethics
We have adopted a written code of ethics that applies to our principal
executive officer, senior financial officers and persons performing similar
functions. Upon written request to our corporate secretary by U.S. mail, we will
provide, at no charge, a copy of such code of ethics to any person requesting a
copy.
Item 10. Executive Compensation.
The following table shows for fiscal years ended December 31, 2006, 2005
and 2004, respectively, certain compensation which we (including AIM) awarded or
paid to, or which was earned from us by, the following persons (collectively,
the "Named Executive Officers").
o James A. Brown, currently our Chairman, who served as our Chief
Executive Officer from September 26, 2004 to November 30, 2005;
o Michael A. Gales, our former Executive Chairman who is no longer employed
by us;
o Louis A. Giusto, our Vice Chairman, Chief Financial Officer and Treasurer
since November 30, 2005;
o Peter D. Rettaliata, our Chief Executive Officer and President since
November 30, 2005 and officer of AIM;
o Dario A. Peragallo, our Executive Vice President since November 30, 2005
and officer of AIM;
o Luis Peragallo, a former officer of AIM who is not employed by us; and
o Jorge Peragallo, a former officer of AIM who is not employed by us.
-29-
Summary Compensation Table
-----------------------------------------------------------------------------------------------------------------------------------
Name Year Salary Bonus Stock Option Non-Equity Change in All Other Total
and ($) ($) Awards Awards Incentive Plan Pension Value Compensation ($)
Principal ($) ($) Compensation and ($)
Position ($) Nonqualified
Deferred
Compensation
Earnings
($)
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
-----------------------------------------------------------------------------------------------------------------------------------
Michael A. 2006 $250,000 - - 52,888 (1) - - 15,938 (2) 318,826
Gales, 2005 $ 21,233 (1) - - 38,384 (1) - - - 59,617
Executive 2004 - - - - - - - -
Chairman of the
Company
-----------------------------------------------------------------------------------------------------------------------------------
Louis A. 2006 $230,000 - - 50,772 (1) - - 14,768 (2) 295,540
Giusto, 2005 $ 19,534 (2) - - 36,850 (1) - - - 56,384
Vice Chairman, 2004 $ - - - - - - - -
Chief Financial
Officer and
Treasurer
-----------------------------------------------------------------------------------------------------------------------------------
Peter D. 2006 $230,000 - - 31,733 (1) - - - 261,733
Rettaliata, 2005 $241,510 - - 23,031 (1) - - - 265,541
Chief Executive 2004 $217,724 - - - - - - 217,724
Officer of the
Company
-----------------------------------------------------------------------------------------------------------------------------------
Dario A. 2006 $230,000 - - 31,773 (1) - - - 261,733
Peragallo, 2005 $242,344 - - 23,031 (1) - - - 265,375
Executive Vice 2004 $197,211 - - - - - - 197,211
President of
the CompanyB
-----------------------------------------------------------------------------------------------------------------------------------
Luis Peragallo, 2006 $ - - - - - - - -
Former officer 2005 $297,063 - - - - - - 297,063
of AIM 2004 $219,449 - - - 219,449
-----------------------------------------------------------------------------------------------------------------------------------
Jorge 2006 $ - - - - - - - -
Peragallo, 2005 $226,563 - - - - - - 226,563
Former officer 2004 $219,449 - - - - - - 219,449
of AIM
-----------------------------------------------------------------------------------------------------------------------------------
James A. Brown, 2006 $ - - - - - 15,637 (3) 15,637
Former Chief 2005 $ 95,646 - 51,000 (4) - - - - 95,646
Executive Office 2004 27,817 (5) - - - - - - 27,817
-----------------------------------------------------------------------------------------------------------------------------------
-30-
----------
(1) Consist of stock options to purchase shares of Common Stock, the vesting
schedule and other terms of which are set forth in the footnotes to the
table below under the caption "Aggregated Option Exercises in Last Fiscal
Year and Fiscal Year-End Option Values".
(2) Consists of automobile leasing, maintenance, parking and insurance.
(3) Consists of fees paid to Mr. Brown for services as a director
(4) Consists of shares of restricted stock and not stock options. As of August
13, 2003, Mr. Brown received 80,038 restricted shares of Common Stock,
valued at $10,000. Of the 596,231 restricted shares of Common Stock
granted to Mr. Brown in 2005, 100,000 shares, with a fair value of $7,000,
were issued to him as of November 2005 in connection with the Merger,
240,112 shares were issued to him in January 2005 (with a fair value of
$12,000) upon our emergence from bankruptcy protection, and 256,119 shares
(with a fair value of $32,000) were issued to him in March 2005.
(5) Prior to becoming Chief Executive Officer, Mr. Brown received
approximately $59,000 in consulting fees in 2004 in consideration for his
services.
Incentive Plans
Prior to January 28, 2005, the effective date of our Plan of
Reorganization, we had outstanding stock options under our 1998 Stock Option
Plan. None of such options were exercised and all of such options have expired
or have been cancelled.
Option Grants in Last Fiscal Year
In 2006, none of our Executive Officers were granted options.
Outstanding Equity Awards at Fiscal Year-End
-----------------------------------------------------------------------------------------------------------------------------------
Option Awards Stock Awards
-----------------------------------------------------------------------------------------------------------------------------------
Name Number of Number of Equity Option Option Number Market Equity Equity
Securities Securities incentive Exercise Expiration of Value Incentive Incentive
Underlying Underlying Plan Price Date Shares of Plan Plan
Unexercised Unexercised Awards: ($) or Units Shares Awards: Awards:
Options Options Number of of or Number Market
(#) (#) Securities Stock Units of or Payout
Exercisable Unexercisable Underlying That of Unearned Value of
Unexercised Have Stock Shares, Unearned
Unearned Not That Units or Shares,
Options Vested Have Other Units or
(#) (#) Not Rights Other
Vested That Rights
($) Have Not That
Vested Have Not
(#) Vested
($)
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
-----------------------------------------------------------------------------------------------------------------------------------
Michael A. Gales (1) 500,000 750,000 - (1) 03/16/2008 - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Louis A. Giusto (2) 480,000 720,000 - (2) 11/30/2015 - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Peter D. Rettaliata
(3) 300,000 900,000 - (3) 11/30/2015 - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Dario A. Peragallo (3) 300,000 900,000 - (3) 11/30/2015 - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Luis Peragallo - - - - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------
Jorge Peragallo - - - - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------
James A. Brown - - - - - - - - -
-----------------------------------------------------------------------------------------------------------------------------------
-31-
(1) These represent options granted to Mr. Gales pursuant to his Employment
Agreement. One fifth of such options vested as of November 30, 2005 at an
exercise price of $0.22 per share and another 250,000 vested on September
15, 2006 at an exercise price of $0.428 per share. Mr. Gales terminated
his Employment Agreement with the Company effective March 16, 2007.
Pursuant to the Separation Agreement between him and the Company, 750,000
options vested on March 16, 2007, and all of his options are exercisable
through March 16, 2008.
(2) One-fifth of such options vested as of November 30, 2005 at an exercise
price of $0.22 per share and another 240,000 vested on September 15, 2006
at an exercise price of $0.428 per share. The balance will vest in equal
increments of 240,000 shares each on the second through fourth
anniversaries of September 15, 2005. The exercise price of the options
vesting on each of September 15, 2007, 2008 and 2009 will be the higher of
(a) $0.22 per share or (b) the average trading price of the Common Stock
for the thirty trading days ending September 15, 2007, 2008 and September
15, 2009, respectively.
(3) One-eighth of such options vested as of November 30, 2005 at an exercise
price of $0.22 per share and another 150,000 vested on September 15, 2006,
at an xersice price of $0.428 per share. The balance will vest in equal
increments of 150,000 shares each on the second through seventh
anniversaries of September 15, 2005. The exercise price of the options
vesting on each of September 15, 2007, 2008, 2009, 2010, 2011 and 2012
will be the higher of (a) $0.22 per share or (b) the average trading price
of the Common Stock for the thirty trading days ending September 15, 2007,
2008, 2009, 2010, 2011 and September 15, 2012, respectively.
The last sale price of the Common Stock was $0.25 on December 29, 2006, the last
trading day of 2006.
Employment Agreements
The employment agreement of Louis Giusto became effective as of November
30, 2005 and will terminate five years thereafter, but will be extendable for
successive three one-year renewal periods at the option of Mr. Giusto and the
Company. Pursuant to his employment agreement, Mr. Giusto will receive a base
salary at an annual rate of $230,000, which will increase a minimum of 10% per
year if our operating profits have increased by at least 5% over the preceding
12-month period. Mr. Giusto will be entitled to an annual bonus to be determined
by our Board of Directors but which must equal at least 50% of his annual base
salary. If he is dismissed without cause, Mr. Giusto would be entitled to
receive salary and benefits for the period which is the greater of the remaining
initial term (or renewal period, as the case may be) of his employment agreement
or one year. In addition, we granted to Mr. Giusto, upon the execution of his
employment agreement, options to purchase 1,200,000 shares of Common Stock,
exercisable over a ten-year period commencing on the date of grant. See the
applicable footnote under the foregoing table captioned, "Outstanding Equity
Awards at Fiscal Year-End". Mr. Giusto's employment agreement also contains
restrictive covenants prohibiting Mr. Giusto (i) from directly or indirectly
competing with the Company, (ii) from soliciting any customer of the Company or
AIM for any competitive purposes and (iii) from employing or retaining any
employee of the Company or AIM or soliciting any such employee to become
affiliated with any entity other than the Company or AIM during the twelve-month
period commencing upon the termination of his agreement (the "Employee
Restrictive Covenants").
-32-
The employment agreement of Peter D, Rettaliata became effective as of
November 30, 2005, and will terminate five years thereafter, but will be
extendable for successive three one-year periods unless he or the Company
decides not to extend the agreement. Pursuant to his employment agreement, Mr.
Rettaliata will receive a base salary at an annual rate of $230,000, which will
increase a minimum of 5% per year if our operating profits have increased by at
least 5% over the preceding 12-month period, and such bonus compensation as the
Board of Directors may determine. The terms of Mr. Rettaliata's employment
agreement relating to severance upon termination without cause are the same as
those provided for in Mr. Giusto's employment agreement. In addition, the
Company granted to Mr. Rettaliata, upon the execution of his employment
agreement, options to purchase 1,200,000 shares of Common Stock, exercisable
over a ten-year period commencing on the date of grant. Please see the
applicable footnote under the foregoing table captioned, "Outstanding Equity
Awards at Fiscal Year-End". Mr. Rettaliata's employment agreement also contains
the Employee Restrictive Covenants.
The employment agreement of Dario A. Peragallo became effective as of
November 30, 2005, and will terminate five years thereafter, but will be
extendable for successive three one-year periods unless he or the Company
decides not to extend the agreement. Pursuant to his employment agreement, Mr.
Peragallo will receive a base salary at an annual rate of $230,000, which will
increase a minimum of 5% per year if our operating profits have increased by at
least 5% over the preceding 12-month period, and such bonus compensation as the
Board of Directors may determine. The terms of Mr. Peragallo's employment
agreement relating to severance upon termination without cause are the same as
those provided for in Mr. Giusto's employment agreement. In addition, the
Company granted to Mr. Peragallo, upon the execution of his employment
agreement, options to purchase 1,200,000 shares of Common Stock, exercisable
over a ten-year period commencing on the date of grant. The vesting schedule and
exercise price relating to Mr. Peragallo's options are the same as those
relating to Mr. Rettaliata's options set forth above. Mr. Peragallo's employment
agreement also contains the Employee Restrictive Covenants.
The Company has agreed with GunnAllen Financial, Inc. (the "Placement
Agent") that the employment agreements of the above-mentioned individuals will
not be changed or amended without the prior consent of the Placement Agent
during the two year period following the completion of the Offering and no
further stock options will be granted to such individuals during such time
period without the prior consent of the Placement Agent.
Pursuant to our Plan of Reorganization, Ashlin had entered into an
employment agreement with James A. Brown, who at the time was Ashlin's chairman
and chief executive officer. As a result of the Merger, such employment
agreement was terminated as of November 30, 2005 and Mr. Brown waived all of his
rights under such employment agreement. In March 2007, the Company entered into
an Agreement with Mr. Brown providing for compensation to be received for his
service as Chairman of the Company. Pursuant to such Agreement Mr. Brown
received a cash payment of $15,000 and will be compensated at a rate of $175,000
per annum until December 31, 2007, or if prior to December 31, 2007, until such
date as he shall cease to serve as Chairman. In addition to his cash
compensation, Mr. Brown was issued 200,000 shares pursuant to a Restricted Stock
Agreement of which 100,000 vested on the date of grant and the second 100,000
will vest as of December 31, 2007.
Prior to March 16, 2007, Michael A. Gales was employed by the Company
pursuant to an Employment Agreement effective November 30, 2005. The Company and
Michael A. Gales entered into a Separation Agreement and General Release (the
"Separation Agreement") effective March 16, 2007, whereby Mr. Gales resigned
from his positions with the Company. Pursuant to the Separation Agreement, the
Employment Agreement between Mr. Gales and the Company terminated effective
March 16, 2007. In lieu of the compensation payable to Mr. Gales pursuant to his
Employment Agreement, from March 16, 2007, to November 30, 2010, Mr. Gales will
be paid $100,000 per annum; from December 1, 2010 to May 31, 2011, he will be
paid $50,000. In addition, if the Company achieves certain agreed-upon levels of
performance he may receive up to an additional $50,000. Upon the execution of
his employment agreement the Company granted Mr. Gales options to purchase
1,250,000 shares of Common Stock, subject to an agreed upon vesting schedule and
exercisable over a ten-year period commencing on the date of grant. Pursuant to
the Separation Agreement, all unvested options held by Mr. Gales vested as of
March 16, 2007, and the right to exercise all of his options will terminate as
of March 16, 2008.
-33-
Director Compensation
For services rendered from the commencement of their terms through the
next annual meeting of the stockholders of the Company each of the then
non-management directors (Messrs. Brown, Hunt, Nagler and Siegel) was granted an
option to purchase 100,000 shares of the common stock of the Company. The
options granted to the directors vest in equal increments on March 1 of each of
2007, 2008 and 2009 and are exercisable at a price of $0.27 per share for a
period of seven years from the date of grant.
For their services, each non-management director will receive a base fee
of $18,000 per year and $1,000 for each Board meeting attended. In addition, the
Chairman of the Audit Committee will receive $12,000 for serving in such
capacity and the Chairman of each of the Compensation and Nominating Committees
will receive $6,000 for serving in such capacity. Beginning in December 2006 and
continuing into 2007 Mr. Schaum has been providing certain per diem services to
the Company. The fees for such services during 2006 are included in the table
below.
During 2006, the Company paid directors fees as set forth in the table
below:
Director Compensation Table
----------------------------------------------------------------------------------------------------------------------------------
Name Fees Stock Option Non-Equity Change in All Other Total
Earned Awards Awards Incentive Plan Pension Value Compensation ($)
or Paid ($) ($) Compensation and ($)
in Cash ($) Nonqualified
($) Deferred
Compensation
Earnings
(a) (b) (c) (d) (e) (f) (g) (h)
----------------------------------------------------------------------------------------------------------------------------------
Michael A. Gales - - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
James A. Brown 15,831 - - - - - 15,831
----------------------------------------------------------------------------------------------------------------------------------
Louis A. Giusto - - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
Peter D. Rettaliata - - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
Dario A. Peragallo - - - - - - -
----------------------------------------------------------------------------------------------------------------------------------
Stephen M. Nagler 15,831 - - - - 15,831
----------------------------------------------------------------------------------------------------------------------------------
Seymour G. Siegel 24,231 - - - - - 24,231
----------------------------------------------------------------------------------------------------------------------------------
Rounsevelle W. Schaum 26,498 - - - - - 26,498
----------------------------------------------------------------------------------------------------------------------------------
M.Gen. Ira A Hunt, Jr.
(USA Ret.) 15,831 - - - - - 15,831
----------------------------------------------------------------------------------------------------------------------------------
-34-
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The following table sets forth information known to us regarding
beneficial ownership of our Common Stock as of March 19, 2007 by (i) each person
known by us to own beneficially more than 5% of the outstanding Common Stock,
(ii) each of our directors and executive officers, and (iii) all of our officers
and directors as a group. Except as otherwise indicated, we believe, based on
information provided by each of the individuals named in the table below, that
such individuals have sole investment and voting power with respect to such
shares, subject to community property laws, where applicable.
As of March 26, 2007, there were 59,380,036 shares of Common Stock
outstanding, without giving any effect to the 11,284,894 shares issuable
pursuant to options and warrants currently outstanding exercisable at a range of
prices from $.22 to $.55 per share.
Percentage of
Name Number of Shares Shares Outstanding
---- ---------------- ------------------
Michael A. Gales 5,326,219 (1) 8.8%
Louis A. Giusto 3,884,538 (2) 6.5%
Peter Rettaliata 1,468,139 (3) 2.5%
Dario Peragallo 1,468,139 (4) 2.5%
Seymour G. Siegel 133,333 (5) *
Rounsevelle W. Schaum 100,000 *
Ira A. Hunt, Jr 842,430 (5)(7) 1.4%
Stephen Nagler 178,788 (5)(6) *
James A. Brown 709,601 (5) 1.2%
All Directors and
Officers as a group, 8 persons 8,784,968 (2)(3)(4)(5)(6) 14.5%
----------
* Less than 1%
(1) Includes 1,250,000 shares underlying the options granted to Mr. Gales
pursuant to his Employment Agreement that pursuant to his Separation Agreement
are exercisable until March 16, 2008.
(2) Includes 480,000 shares of Common Stock underlying the vested portion
of the 1,200,000 options granted to Mr. Giusto pursuant to his Employment
Agreement.
-35-
(3) Includes 300,000 shares of Common Stock underlying the vested portion
of the 1,200,000 options granted to Mr. Rettaliata pursuant to his Employment
Agreement.
(4) Includes 300,000 shares of Common Stock underlying the vested portion
of the 1,200,000 options granted to Mr. Peragallo pursuant to his Employment
Agreement.
(5) Includes, in each case, 33,333 shares underlying the vested protion of
the 100,000 options granted to Messrs. Brown, Hunt, Nagler and Siegel on
February 13,2007.
(6) Includes 45,455 shares of Common Stock issuable upon exercise of
warrants held by Mr. Nagler. Does not include 150,000 shares of Common Stock
held by Eaton & Van Winkle LLP, a law firm of which Mr. Nagler is a partner.
(7) Includes 709,097 shares owned by Mr. Hunt's spouse.
Item 12. Certain Relationships and Related Transactions.
On November 30, 2005, in connection with the Company's acquisition of its
wholly-owned subsidiary, Air Industries Machining, Corp. ("AIM"), the Company
issued $332,631 principal amount convertible promissory notes to each of Peter
Rettaliata, our Chief Executive Officer and a Director, and Dario Peragallo, our
Executive Vice President and a Director, convertible into shares of our common
stock at the conversion price of $0.40 per share.
On January 26, 2007, each of Mr. Rettaliata and Mr. Peragallo exercised
their right to convert their $359,866 notes plus accrued interest of $27,255
into 899,716 shares of common stock. In consideration for the shares of common
stock issued, all indebtedness of the Company under the company promissory notes
was cancelled. These shares of common stock were issued pursuant to an exemption
under Section 4(2) under the Securities Act.
On February 13, 2007, each of the non-management members of the Board was
issued an option to purchase 100,000 shares of the common stock of the Company.
The options will vest in equal thirds on March 1, 2007, 2008 and 2009 and are
exercisable at a price of $0.27 per share until March 1, 2014.
In March 2007, the Company entered into an Agreement to compensate James
Brown for services to be rendered as a director of the Company. Pursuant to such
Agreement Mr. Brown will receive a cash payment of $15,000 and will be
compensated at a rate of $175,000 per annum until December 31, 2007, or if prior
to December 31, 2007, until such date as he shall cease to serve as Chairman. In
addition to his cash compensation, Mr. Brown was issued 200,000 shares of the
Company's common stock pursuant to the Restricted Stock Agreement, of which
100,000 vested on the date of grant and the second 100,000 will vest as of
December 31, 2007.
-36-
The Company and Michael A. Gales entered into a Separation Agreement and
General Release (the "Separation Agreement") effective March 16, 2007, whereby
Mr. Gales resigned from his positions with the Company. Pursuant to the
Separation Agreement, the Employment Agreement between Mr. Gales and the Company
terminated effective March 16, 2007. In lieu of the compensation payable to Mr.
Gales pursuant to his Employment Agreement, from March 16, 2007, to November 30,
2010, Mr. Gales will be paid $100,000 per annum; from December 1, 2010 to May
31, 2011, he will be paid $50,000. In addition, if the Company achieves certain
agreed-upon levels of performance he may receive up to an additional $50,000.
Upon the execution of his employment agreement the Company granted Mr. Gales
options to purchase 1,250,000 shares of Common Stock, subject to an agreed upon
vesting schedule and exercisable over a ten-year period commencing on the date
of grant. Pursuant to the Separation Agreement, all unvested options held by Mr.
Gales vested as of March 16, 2007, and the right to exercise all of his options
will terminate as of March 16, 2008.
-37-
Item 13. Exhibits.
2.1 Debtor's Amended Plan of Reorganization (incorporated by
reference to Exhibit 2.1 of Registrant's Form 8-K, filed January
14, 2005).
2.2 Merger Agreement, dated as of November 14, 2005, among Original
Gales, two of its stockholders, Gales Industries Merger Sub,
Inc., and Ashlin Development Corporation (incorporated herein by
reference to Exhibit 10.1 of Registrant's Form 8-K report filed
November 21, 2005).
3.1 Certificate of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 of Registrant's Form 8-K report, filed
February 15, 2006).
3.2 By-Laws of the Registrant (incorporated by reference to Exhibit
3.2 of the Registrant's Form 8-K report, filed February 15,
2006).
4.1 Convertible Promissory Note, dated November 30, 2005, in the
amount of $332,631, from Original Gales (and assumed by the
Registrant) to Peter Rettaliata (incorporated by reference to
Exhibit 4.1 of the Registrant's Form 8-K report, filed December
6, 2005).
4.2 Convertible Promissory Note, dated November 30, 2005, in the
amount of $332,631, from Original Gales (and assumed by the
Registrant) to Dario Peragallo (incorporated by reference to
Exhibit 4.2 of the Registrant's Form 8-K report, filed December
6, 2005).
4.3 Form of Warrant issued by the Registrant to GunnAllen Financial,
Inc. (incorporated by reference to Exhibit 4.3 of the
Registrant's Form 8-K report, filed December 6, 2005).
4.4* Form of Warrant issued by Original Gales to Atlas Private Equity,
LLC (and assumed by the Registrant).
4.5 Form of Warrant issued by Original Gales (and assumed by the
Registrant) to investors in the $45,000 Bridge Financing in or
about August 2005 (incorporated by reference to Exhibit 4.5 of
the Registrant's Form 8-K report, filed December 6, 2005).
4.6 Form of Warrant issued by Original Gales (and assumed by the
Registrant) to investors in the $105,000 Bridge Financing in or
about September, 2005 (incorporated by reference to Exhibit 4.6
of the Registrant's Form 8-K report, filed December 6, 2005).
10.1 Secured Subordinated Promissory Note, dated November 30, 2005, in
the amount of $962,000, from Original Gales (and assumed by the
Registrant) to Luis Peragallo (incorporated by reference to
Exhibit 10.3 of the Registrant's Form 8-K report, filed December
6, 2005).
-38-
10.2 Security Agreement, dated as of November 30, 2005, by and between
Original Gales (and assumed by the Registrant) and Luis Peragallo
(incorporated by reference to Exhibit 10.4 of the Registrant's
Form 8-K report, filed December 6, 2005).
10.3 Employment Agreement, dated as of September 26, 2005, by and
between Original Gales (and assumed by the Registrant) and
Michael A. Gales (incorporated by reference to Exhibit 10.7 of
the Registrant's Form 8-K report, filed December 6, 2005).
10.4 Stock Option Agreement, dated as of September 26, 2005, by
Original Gales (and assumed by the Registrant) with Michael A.
Gales (incorporated by reference to Exhibit 10.15 of the
Registrant's Form 8-K report, filed December 6, 2005).
10.5 First Amendment to Revolving Credit, Term Loan, Equipment Line of
Credit and Security Agreement dated November (incorporated by
reference to Exhibit 10.XX of the Registrant's Form 8-K report,
filed
10.6 Agreement of Sale, dated June 5, 2006, between Air Industries
Machining Corp. and Net Lease Advisors LLC
(predecessor-in-interest to STNLA-SPVEF Bay Shore, LLC).
(incorporated by reference to Exhibit 10.01 of the Registrant's
Form 8-K report, filed October 24, 2006).
10.7 Lease, dated October 24, 2006, between Air Industries Machining,
Corp, as tenant, and STNLA-SPVEF Bay Shore, LLC, as Landlord.
(incorporated by reference to Exhibit 10.02 of the Registrant's
Form 8-K report, filed October 24,, 2006).
10.8 Stock Purchase Agreement, dated January 2, 2007, between Gales
Industries Incorporated, Sigma Metals, Inc. ("Sigma Metals"), and
George Elkins, Carole Tate and Joseph Coonan, the Shareholders of
Sigma Metals. (incorporated by reference to Exhibit 10.01 of the
Registrant's Form 8-K report, filed January 2. 2007).
10.9 Stock Purchase Agreement, dated March 9, 2007, between Gales
Industries Incorporated and John Gantt and Lugenia Gantt, the
Shareholders of Welding Metallurgy, Inc. (incorporated by
reference to Exhibit 10.1 of the Registrant's Form 8-K report,
filed March 14, 2007).
10.10 Separation Agreement dated March 16, 2007 between Michael A.
Gales and Gales Industries Incorporated (incorporated by
reference to Exhibit 10.1 of Registrant's Form 8-K report, filed
March 20, 2007).
10.11* Agreement dated March 30, 2007 between Gales Industries
Incorporated and James A. Brown.
10.12* Restricted Stock Agreement dated March 30, 2007 between Gales
Industries Incorporated and James A. Brown.
14.1 Code of Ethics (incorporated by reference to Exhibit 14.1 of
Registrant's Report on Form 10-KSB, filed on April 14, 2004;
Registrant was then known as Health & Nutrition Systems
International).
21.1 List of Subsidiaries (incorporated by reference to Exhibit 21.1
of the Registrant's Form 8-K report, filed December 6, 2005).
-39-
31.1* Certification of Chief Executive Officer required by Rule
13a-14(a) under the Exchange Act.
31.2* Certification of Chief Financial Officer required by Rule
13a-14(a) under the Exchange Act.
32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
32.2* Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
Numbers with (*) indicate Exhibits that are filed herewith.
-40-
Item 14. Principal Accountant Fees and Services.
Fees Paid to Principal Accountant
Goldstein Golub Kessler LLP ("GGK") has been our principal accounting firm
since December 15, 2005 and also worked for Original Gales prior to November 30,
2005. During fiscal year 2006 and fiscal year 2005, the aggregate fees which we
paid to or were billed by GGK for professional services, which only included
audit fees, were as follows:
--------------------------------------------------------------------------------
Fiscal Year Ended
--------------------------------------------------------------------------------
December 31, 2006 December 31, 2005
--------------------------------------------------------------------------------
Audit Fees (1) $341,879 $220,018
--------------------------------------------------------------------------------
Audit-Related Fees $-0- $-0-
--------------------------------------------------------------------------------
Tax Fees $-0- $-0-
--------------------------------------------------------------------------------
All Other Fees $-0- $-0-
--------------------------------------------------------------------------------
Daszkal Bolton LLP was our principal accounting firm in 2004 and from January 1,
2005 to December 15, 2005. During fiscal year 2006 and fiscal year 2005, the
aggregate fees which we paid to Daszkal Bolton LLP for professional services
were as follows:
--------------------------------------------------------------------------------
Fiscal Year Ended
--------------------------------------------------------------------------------
December 31, 2006 December 31, 2005
--------------------------------------------------------------------------------
Audit Fees (1) $-0- $38,539.00 (2)
--------------------------------------------------------------------------------
Audit-Related Fees $-0- $-0-
--------------------------------------------------------------------------------
Tax Fees (2) $-0- $5,568.00
--------------------------------------------------------------------------------
All Other Fees (3) $-0- $ 720.00
--------------------------------------------------------------------------------
(1) Fees for audit services include fees associated with the annual audit and
the review of the Company's quarterly reports on Form 10-QSB.
(2) Tax services consisted primarily of filing tax returns.
(3) The $720 paid to our principal accounting firm in 2005 was for its review
of our bankruptcy filing and related sale of assets to determine potential
tax consequences.
-41-
Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Registered Public Accounting Firm.
As required by the Audit Committee charter, the Audit Committee
pre-approved the engagement of Daszkal Bolton LLP and GGK for all audit and
permissible non-audit services. The Audit Committee annually reviews the audit
and permissible non-audit services performed by our principal accounting firm
and reviews and approves the fees charged by our principal accounting firm. The
Audit Committee has considered the role of Daszkal Bolton LLP and GGK in
providing tax and audit services and other permissible non-audit services to the
Company and has concluded that the provision of such services, if any, was
compatible with the maintenance of such firm's independence in the conduct of
its auditing functions.
-42-
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
GALES INDUSTRIES INCORPORATED
Date: March 30, 2007 By /s/ Peter D. Rettaliata
------------------------------
President and Chief
Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Date
--------- ----
/s/ Louis A. Giusto March 30, 2007
----------------------------------------------------
Louis A. Giusto
Vice Chairman, Chief Financial Officer and Treasurer
/s/ Peter D. Rettaliata March 30, 2007
----------------------------------------------------
Peter D. Rettaliata
Director, President and Chief Executive Officer
/s/ Dario Peragallo March 30, 2007
----------------------------------------------------
Dario Peragallo
Director, Executive Vice President
/s/ Seymour G. Siegel March 30, 2007
----------------------------------------------------
Seymour G. Siegel
Director
/s/ Rounsevelle W. Schaum March 30, 2007
----------------------------------------------------
Rounsevelle W. Schaum
Director
/s/ Ira A. Hunt Jr. March 30, 2007
----------------------------------------------------
Ira A. Hunt Jr.
Director
/s/ Stephen M. Nagler March 30, 2007
----------------------------------------------------
Stephen M. Nagler
Director, Secretary
/s/ James A. Brown March 30, 2007
----------------------------------------------------
James A. Brown
Director
-43-