YOUTHSTREAM MEDIA NETWORKS, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		13-4082185 (I.R.S. Employer Identification Number)
244 Madison Avenue, PMB #358 New York, New York (Address of Principal Executive Offices)		10016 (Zip Code)

 

(212) 883-0083 (Registrant’s telephone number, including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01 per share

Check whether the issuer in not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act YES o NO x

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 as required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

YES o NO x

Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained herein, 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. o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO x

The issuer’s revenues for the fiscal year ended September 30, 2005 were $69,182,475.

As of May 31, 2006, the aggregate market value of voting and non-voting stock held by non-affiliates of the registrant was $3,754,325 (based on the closing price of the registrant's common stock on such date of $0.12 per share).

As of May 31, 2006, there were 39,242,251 shares of the registrant's common stock issued and outstanding.

Transitional Small Business Disclosure Format (check one): YES o NO x

Documents incorporated by reference: None.

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YOUTHSTREAM MEDIA NETWORKS, INC.

ANNUAL REPORT ON FORM 10-KSB

TABLE OF CONTENTS

Item No.

Page

 

Part I
		1.	Description of Business		1
		1A.	Risk Factors		13
		2.	Description of Property		24
		3.	Legal Proceedings		24
		4.	Submission of Matters to a Vote of Security Holders		24

 

Part II
		5.	Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities		25
		6.	Management's Discussion and Analysis or Plan of Operation		26
		7.	Financial Statements		42
		8.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		42
		8A.	Controls and Procedures		42
		8B.	Other Information		43

 

Part III
		9.	Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act		44
		10.	Executive Compensation		47
		11.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		50
		12.	Certain Relationships and Related Transactions		51
		13.	Exhibits		52
		14.	Principal Accountant Fees and Services		58

 

Index to Consolidated Financial Statements					F-1
Signatures					S-1

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INTRODUCTION

Equity Compensation Plan Information

 

PLAN CATEGORY		NUMBER OF SECURITIES TO BE ISSUED UPON EXERCISE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS	WEIGHTED-AVERAGE EXERCISE PRICE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS			NUMBER OF SECURITIES REMAINING AVAILABLE FOR FUTURE ISSUANCE UNDER EQUITY COMPENSATION PLANS (excluding securities reflected in column(a) )
		(a)	(b)			(c)
Equity compensation plans approved by security holders		1,405,404	$0.18			3,594,596
Equity compensation plans not approved by security holders		-	-			-
Total		1,405,404	$0.18			3,594,596

 

RECENT SALES OF UNREGISTERED SECURITIES

None.

ISSUER PURCHASE OF EQUITY SECURITIES

None.

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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

General Overview:

On February 25, 2004, the Company sold the assets and operations of its Beyond the Wall subsidiary (see “Sale of Assets and Operations of Beyond the Wall, Inc.” below). Beyond the Wall had been engaged in the sale of decorative wall posters through on-campus sales events, retail stores and internet sales, primarily to teenagers and young adults. During the period from October 1, 2003 through February 25, 2004, Beyond the Wall operated 17 stores in 12 states, plus Washington, D.C., throughout the East and mid-West, as well as a warehouse and distribution center in Stroudsburg, Pennsylvania, and was the Company’s only revenue-generating business operation. The consolidated financial statements for the year ended September 30, 2004 present Beyond the Wall’s operations as a discontinued operation as a result of the disposal of its assets and operations on February 25, 2004.

Commencing March 1, 2005, the Company has included the operations of a steel mini-mill located in Ashland, Kentucky, which represents the only business segment in which the Company currently operates, in its consolidated financial statements. The Company completed the acquisition of this steel mini-mill on March 9, 2005 (see “Acquisition of Steel Mini-Mill” below).

Going Concern:

The Company has incurred recurring operating losses since its inception. The Company incurred a net loss of $3,430,562 and a negative cash flow from operating activities of $4,300,395 for the year ended September 30, 2005, and had an accumulated deficit of $347,265,398 and a stockholders' deficiency of $79,600,350 at September 30, 2005. As of September 30, 2005, the Company had insufficient capital to fund all of its obligations on a consolidated basis. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effect of the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty. The Company’s independent registered public accounting firm, in its report dated May 18, 2006, included an explanatory paragraph stating that the Company’s recurring losses and negative cash flow, accumulated deficit, stockholders’ deficiency and working capital deficiency, among other factors, raise substantial doubt about the Company’s ability to continue as a going concern.

On March 9, 2005, the Company completed the acquisition of a steel mini-mill located in Ashland, Kentucky. The Company utilized substantially all of its available cash resources to fund such acquisition and will require additional operating capital to fund corporate general and administrative expenses, which the Company expects to obtain primarily through periodic tax sharing payments from Acquisition Corp. and Atacama KES. In addition, the steel mini-mill restarted operations in late January 2004 after being acquired by the previous owners, and until recently has incurred losses. For the year ended September 30, 2005, operating income was $2,691,955 (which included the operations of the steel mini-mill for the seven month period March through September 2005), exclusive of interest expense. The steel mini-mill relies on cash flows from operations to support a secured line of credit with General Electric Capital Corporation to fund its separate operations. As a result of improved operating performance of the steel mini-mill beginning in late 2005, the Company has been able to increase borrowing availability under this line of credit.

Based on its current level of operations, the Company believes that its current cash resources provided by operations and the secured line of credit will be adequate to fund its operations through September 30, 2006. However, to the extent the Company’s estimates are inaccurate or its assumptions are incorrect, the Company may not have sufficient cash resources to fund its operations. In such event, the Company may have to consider a formal or informal restructuring or reorganization, including a sale or other disposition of its assets.

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The Company’s management may also consider various strategic alternatives in the future, including the acquisition of new business opportunities, which may be from related or unrelated parties.  However, there can be no assurances that such efforts will ultimately be successful.  The Company may finance any acquisitions through a combination of debt and/or equity securities.

Recent Developments:

During September 2005, the Company borrowed $50,000 from certain directors under short-term unsecured notes due December 31, 2005, with interest at 4% per annum, to fund corporate general and administrative expenses. The Company repaid the notes payable to directors subsequent to September 30, 2005 from the proceeds from the settlement of the Beyond the Wall note receivable, which proceeds were received on September 30, 2005, as described below.

 

Sale of Assets and Operations of Beyond the Wall, Inc.:

Effective February 25, 2004, the Company’s wholly-owned subsidiary, Beyond the Wall, Inc. (“BTW”), sold substantially all of its assets and operations to a group unaffiliated with the Company (which included certain former management of BTW), for $1,920,000, consisting of a cash payment of $820,000 and a subordinated secured promissory note (the “Note”) for $1,100,000, with interest at 10% per annum, due October 31, 2006.  The buyer had the right to make certain optional principal pre-payments on the Note by June 30, 2004, which would result in the principal balance of the Note being adjusted downward, in excess of such principal pre-payments, based on an agreed-upon sliding scale as set forth in the Note.

 

On April 30, 2004, the buyer made an optional principal pre-payment on the Note of $400,000.  Accordingly, under the provisions of the sale agreement, the buyer received a credit of $106,800 against the $1,100,000 note (in excess of the $400,000 payment), as well as an additional $150,000 back-end credit on the Note. On October 31, 2004, the buyer made its scheduled principal payment on the Note of $197,734, plus accrued interest of $49,493.

On September 30, 2005, the Company received a cash payment of $258,922 as settlement in full of the outstanding note receivable with a balance, including accrued interest, of $281,654, and recognized a loss in connection therewith of $22,732.

The Company initially recognized a loss of $564,921 with respect to the BTW sale before taking into consideration the effect of the $400,000 principal pre-payment made on April 30, 2004.  Inclusive of such payment, the effect of the accelerated payment credit and the back-end credit resulted in an additional loss of $256,800, which decreased the carrying value of the note receivable from $1,100,000 to $843,200 and increased the loss on the BTW sale from $564,921 to $821,721.  The loss on the BTW sale was reported as a loss on the disposal of discontinued operations for the year ended September 30, 2004.  As a result of the sale, the retail segment operations have been presented as a discontinued operation for the year ended September 30, 2004.

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Acquisition of Steel Mini-Mill:

In September 2003, YouthStream invested $125,000 to acquire a 1.00% membership interest in KES Holdings, LLC, a Delaware limited liability company ("KES Holdings"), which was formed to acquire certain assets of Kentucky Electric Steel, Inc., a Delaware corporation ("KES"), consisting of a steel mini-mill located in Ashland, Kentucky (the “Mill”). On September 2, 2003, KES Holdings, through its subsidiary, KES Acquisition Company, LLC, a Delaware limited liability company ("KES Acquisition"), completed the acquisition of the Mill pursuant to Section 363 of the United States Bankruptcy Code for cash consideration of $2,650,000, which was funded through the capital contributions of the members of KES Holdings. Members’ capital contributions were also used for start-up costs, working capital purposes and payment of deferred maintenance of the Mill. KES had ceased production on or about December 16, 2002 and filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code on February 5, 2003.

The Mill had been in operation for approximately forty years and was refurbished by KES Acquisition subsequent to its acquisition.  The refurbished Mill has been generating revenues since late January 2004. The current production capacity of the Mill for finished products, based on the current operating structure and hours worked, is approximately 200,000 short-tons per year, and the Mill is currently operating at approximately 94% of such annualized capacity. Management is focusing on developing the business and improving operating efficiencies.

The Mill produces bar flats that are produced to a variety of specifications and fall primarily into two general quality levels - merchant bar quality steel bar flats (“MBQ Bar Flats”) for generic types of applications, and special bar quality steel bar flats (“SBQ Bar Flats”), where more precise customer specifications require the use of alloys, customized equipment and special production procedures to insure that the finished product meets critical end-use performance characteristics.

The Mill manufactures over 2,600 different Bar Flat items which are sold to volume niche markets, including the original equipment manufacturers (“OEMs”), cold drawn bar converters, steel service centers and the leaf-spring suspension market for light- and heavy-duty trucks, mini-vans and utility vehicles. The Mill was specifically designed to manufacture wider and thicker bar flats up to three inches in thickness and twelve inches in width that are required by these markets. In addition, the Mill employs a variety of specially designed equipment which is necessary to manufacture SBQ Bar Flats to the specifications of the Mill’s customers.

On March 9, 2005, YouthStream completed the acquisition of KES Acquisition (the "Acquisition"), which was deemed effective March 1, 2005. Pursuant to definitive agreements executed with KES Holdings and Atacama Capital Holdings, Ltd., a British Virgin Islands company ("Atacama", and together with KES Holdings, collectively, the "Sellers"), YouthStream, through its newly-formed subsidiary, YouthStream Acquisition Corp., a Delaware corporation ("Acquisition Corp."), acquired 100% of the membership interests of KES Acquisition by acquiring (i) a 37.45% membership interest from KES Holdings and (ii) all of the capital stock of Atacama KES Holding Corporation, a wholly-owned subsidiary of Atacama (“Atacama KES”) and the owner of the remaining 62.55% membership interest in KES Acquisition. As consideration for the Acquisition, Acquisition Corp. issued to the Sellers (i) $40,000,000 in promissory notes (the “Notes”), (ii) 25,000 shares of 13% Series A Non-Convertible Preferred Stock with an aggregate liquidation value of $25,000,000 (the “13% Series A Preferred Stock”) and (iii) 100% of its authorized shares of Series B Non-Voting Common Stock. With respect to the $65,000,000 of purchase consideration, $19,000,000 of the Notes and $10,000,000 of the 13% Series A Preferred Stock were issued to KES Holdings, and $21,000,000 of the Notes and $15,000,000 of the 13% Series A Preferred Stock were issued to Atacama. YouthStream also contributed an aggregate of $500,000 of cash to Acquisition Corp. as consideration for the issuance by Acquisition Corp. of 100% of its Series A Voting Common Stock. In addition, YouthStream will periodically be required to purchase shares of Series B Preferred Stock of Acquisition Corp. in amounts equal to distributions it receives on its KES Holdings membership interest.

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As a result of these transactions, YouthStream owns 80.01% of the common stock, and 100% of the voting stock, of Acquisition Corp. The remaining 19.99% common stock interest in Acquisition Corp. is owned 62.55% by Atacama and 37.45% by KES Holdings. YouthStream currently has a 2.67% equity interest in KES Holdings (this percentage has increased from 1.00% as a result of the redemption of another member’s interest), as a result of which the Company has eliminated its $507,000 interest in the Notes and $267,000 interest in the 13% Series A Preferred Stock in the consolidated balance sheet at September 30, 2005. YouthStream has consolidated the operations of the Mill through its ownership of KES Acquisition commencing March 1, 2005. As a result of the Acquisition, the Company’s financial statements for periods ending after March 1, 2005 are materially different from and are not comparable to its financial statements prior to that date.

Subsequent to this transaction, the management of the Mill continued unchanged. This transaction did not result in any change in the Mill’s business operations or financial condition, and, other than as set forth herein, the working capital, operating cash flow, debt service obligations and credit profile of the Mill were not affected in any way by this transaction.

As described herein, the Notes and 13% Series A Preferred Stock were issued by Acquisition Corp., the parent company of KES Acquisition. KES Acquisition is a separate legal entity that owns and operates the Mill. The Notes are legal obligations solely of Acquisition Corp., and are not obligations of KES Acquisition, nor are they secured by the assets or cash flows of the Mill. In the future, Acquisition Corp. may grant liens to secure repayment of the Notes, upon the consent of any senior lender to KES Acquisition at that time. In addition, the Notes are non-recourse to the assets of YouthStream, except for the shares of capital stock of Acquisition Corp. that have been pledged by YouthStream to the holders of the Notes. Pursuant to the terms of the transaction documentation in connection with the Acquisition and the loan facility with General Electric Capital Corporation (“GECC”), YouthStream and Acquisition Corp. are currently limited in their ability to receive cash distributions from KES Acquisition, but are permitted to receive tax sharing payments as described below. Any change in control of Acquisition Corp. in the future as a result of the holders of the Notes exercising their legal rights would not reasonably be expected to have a material impact on the operations or financial position of the Mill.

 

The Notes are structurally subordinate in right and payment of up to $40,000,000 of senior debt, including existing debt obligations in favor of GECC. Scheduled principal payments commence in (i) February 2007 with respect to the $19,000,000 principal amount of Notes issued in favor of KES Holdings and (ii) February 2011 with respect to the $21,000,000 principal amount of Notes issued in favor of Atacama. In addition, the Notes require additional quarterly principal payments out of "free cash", as that term is defined in the Note Purchase Agreement. The Notes bear interest at the rate of 8% per annum, payable annually during the first two years of the Note, as provided for in a letter agreement dated as of July 14, 2005 and effective as of February 28, 2005 by and among Acquisition Corp. and the Note holders, and quarterly thereafter. The obligations of Acquisition Corp. under the Notes are secured by a limited guaranty by YouthStream, which guaranty is secured by and limited in recourse solely to a pledge by YouthStream of all of its interest in Acquisition Corp. As of September 30, 2005, the balance outstanding on the Notes was $39,493,000, and related accrued interest payable was $1,852,384.

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Future scheduled principal payments on the Notes are summarized as follows:

Years Ending September 30,		KES Holdings - $19,000,000 Note			Atacama - $21,000,000 Note

2006		$	---		$	---
2007			1,900,000			---
2008			950,000			---
2009			950,000			---
2010			950,000			---
2011			2,850,000			4,200,000
2012			2,850,000			4,200,000
2013			2,850,000			4,200,000
2014			---			1,264,000
2015			5,700,000			7,136,000
Total		$	19,000,000		$	21,000,000

 

 

Pursuant to a further letter agreement dated April 11, 2006 and effective as of February 27, 2006 by and among Acquisition Corp. and the Note holders, the interest payment of $3,200,000 due on February 27, 2006 was paid by the delivery of short-term notes due February 27, 2007 in the principal amount of $3,200,000, with interest at 8% per annum.

For the nine months ending September 30, 2005, Acquisition Corp., KES Acquisition and Atacama KES are collectively required to have, on a consolidated basis, in excess of $4,000,000 of earnings before interest, taxes, depreciation and amortization, calculated in accordance with generally accepted accounting principles ("EBITDA").  For each of the fiscal years ending on and after September 30, 2006, Acquisition Corp., KES Acquisition and Atacama KES are collectively required to have, on a consolidated basis, in excess of $7,200,000 of EBITDA.  At March 31 of each fiscal year following the fiscal year ending September 30, 2005 in which the obligations under the Notes remain outstanding, Acquisition Corp., KES Acquisition and Atacama KES are collectively required to have, on a consolidated basis, in excess of $3,000,000 of EBITDA for the six months then ended. Effective September 23, 2005, the holders of the Notes executed an agreement to amend the Notes to eliminate the requirement that Acquisition Corp., KES Acquisition and Atacama KES collectively have, on a consolidated basis, in excess of $4,000,000 of EBITDA for the nine months ending September 30, 2005.

 

The holders of each share of 13% Series A Preferred Stock are entitled to receive a cumulative dividend at an annual rate of 13% of the sum of $1,000 and all accrued but unpaid dividends. The 13% Series A Preferred Stock contains a liquidation preference equal to $1,000 per share, plus accrued but unpaid dividends, and is redeemable out of, and to the extent of, legally available funds, at a redemption price equal to the sum of $1,000 and all accrued but unpaid dividends on the earlier to occur of (i) any liquidation of Acquisition Corp., (ii) the occurrence of an event of default under the Note Purchase Agreement pursuant to which the Notes were issued or (iii) the first anniversary of Acquisition Corp.’s full and complete repayment of the Notes. In addition, beginning with the second anniversary of the initial issuance of the 13% Series A Preferred Stock, Acquisition Corp. will be required to use "free cash", as that term is defined in the Securities Purchase Agreement, to commence redeeming shares of 13% Series A Preferred Stock in increments of at least $4,000,000, with limited exceptions. As of September 30, 2005, the balance outstanding on the 13% Series A Preferred Stock was $24,733,000, and related accrued dividends payable were $1,885,129.

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Since the acquisition of the Mill by the Sellers, the Mill has been operating under a Management Services Agreement with Pinnacle Steel, LLC (the "Pinnacle Agreement"), which agreement remained in effect following the closing. The principals of Pinnacle Steel LLC that manage the Mill have significant experience and expertise in the steel industry. The Pinnacle Agreement will remain in effect through January 31, 2009, subject to earlier termination or extension based on the financial performance of the Mill. Pinnacle is entitled to a monthly management fee and a management incentive fee as provided in the Pinnacle Agreement.

Subsequent to the acquisition of the Mill by the Sellers, KES Acquisition issued an aggregate of $7,000,000 of subordinated promissory notes to the Sellers and certain of their respective affiliates (the “Subordinated Promissory Notes”). The proceeds from the Subordinated Promissory Notes were used to accelerate the development and expansion of the Mill’s operations. The Subordinated Promissory Notes bear interest at the rate of 12% per annum, with interest payable monthly, subject to compliance with various agreements and covenants, are secured by a subordinated security interest in all of the assets of KES Acquisition, and are subject to an Intercreditor and Subordination Agreement dated March 24, 2004 with GECC. When originally issued, principal and interest were due and payable upon the earlier to occur of (i) an event of default under the Loan and Security Agreement with GECC or (ii) each note’s respective due date, which ranged from March 31, 2005 to December 31, 2005. As of September 30, 2005, the due dates of the notes had all been extended to December 31, 2006, if not repaid earlier. At September 30, 2005, accrued interest payable with respect to the Subordinated Promissory Notes was $1,085,753, almost all of which was paid subsequent to fiscal year end.

Related parties with respect to this transaction are summarized as follows: Robert Scott Fritz, a director of YouthStream, is an investor in KES Holdings. Hal G. Byer, another director of YouthStream, is an employee of affiliates of Libra/KES Investment I, LLC ("Libra/KES"), the Manager of KES Holdings, and has an economic interest in KES Holdings through his relationship with Libra Securities, LLC ("Libra Securities"). Jess M. Ravich, a director of YouthStream effective June 26, 2006, is a principal of Libra/KES. In addition, affiliates of Mr. Ravich, including a trust for the benefit of Mr. Ravich and certain of his family members (the “Ravich Trust”) are investors in KES Holdings. Mr. Ravich, either directly or through the Ravich Trust, holds 1,860,000 shares of YouthStream's common stock, warrants to purchase 500,000 shares of YouthStream's common stock exercisable through August 31, 2008, 1,000,000 shares of YouthStream's redeemable preferred stock and an option to purchase 200,000 shares of YouthStream’s common stock exercisable through June 26, 2013, which was issued to Mr. Ravich under YouthStream’s 2000 Stock Option Incentive Plan in connection with his election to the Board. Through his positions at Libra/KES, Mr. Ravich managed the business of KES Acquisition through February 28, 2005. Subordinated Promissory Notes with a principal amount of $1,650,000 and $450,000 are payable to the Ravich Trust and Libra Securities Holdings, LLC, the parent of Libra Securities, respectively. Mr. Fritz and Mr. Byer have each previously acquired an option from the Ravich Trust for $2,500 ($0.04 per share) to purchase 62,500 shares of YouthStream's redeemable preferred stock issued to the Ravich Trust in January 2003, exercisable at $0.36 per share until December 31, 2006 or earlier upon the occurrence of certain events.

 

The Acquisition was accounted for as a purchase in accordance with SFAS No. 141, “Business Combinations”, and in accordance with Emerging Issues Task Force (EITF) No. 88-16, “Basis in Leveraged Buyout Transactions”. As a result of the substantial and continuing relationships between YouthStream and the Sellers, and the provisions of EITF 88-16 that are required to be considered when determining the extent of fair value/predecessor basis to be used in recording the transaction, the Acquisition has been recorded at predecessor basis. Since the debt and equity held by the Sellers represented almost the entire amount of capital at risk both before and after the Acquisition, the application of the “monetary test” specified in Section 3 of EITF 88-16, which limits the portion of the purchase consideration that can be valued at fair value to the percentage of the total consideration that is monetary, was utilized by the Company in determining to record the transaction at predecessor basis. The excess of the purchase price over predecessor basis of the net assets acquired has been reflected as a deemed distribution of $63,104,423 to the Sellers at the date of acquisition in the consolidated financial statements.

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For taxable periods beginning after February 28, 2005, Acquisition Corp. and Atacama KES are included in the consolidated federal income tax return filed by YouthStream as the common parent.  Acquisition Corp. and Atacama KES have entered into a Tax Sharing Agreement with YouthStream, pursuant to which they have agreed to pay YouthStream an amount equal to 50% of their respective “separate company tax liability”, subject to compliance with the GECC secured line of credit.  The term “separate company tax liability” is defined as the amount, if any, of the federal income tax liability (including, without limitation, liability for any penalty, fine, additions to tax, interest, minimum tax and other items applicable to such subsidiary in connection with the determination of the subsidiary’s tax liability), which such subsidiary would have incurred if its federal income tax liability for the periods during which it is includible in a consolidated federal income tax return with YouthStream were determined generally in the same manner in which its separate return liability would have been calculated under Section 1552(a)(2) of the Internal Revenue Code of 1986, as amended.  YouthStream has approximately $255,000,000 of federal net operating loss carryovers currently available to offset the consolidated federal taxable income of the affiliated group in the future.

The total purchase price of $65,000,000, as well as the terms and conditions of the Notes and 13% Series A Preferred Stock issued to the Sellers, were determined to be at fair value based on reports prepared by an independent valuation firm. The following table summarizes the assets acquired and liabilities assumed at predecessor basis at February 28, 2005.

Assets Acquired:
Cash		$	913,194
Accounts receivable			10,781,836
Allowance for doubtful accounts			(328,351	)
Inventories			18,762,218
Prepaid expenses and other current assets			904,271
Property, plant and equipment			6,630,012
Accumulated depreciation and amortization			(639,254	)
Due from YouthStream Acquisition Corp.			187,702
Other non-current assets			721,393
Total assets acquired			37,933,021
Liabilities Assumed:
Accounts payable			9,566,327
Accrued expenses			1,267,016
Accrued interest payable			593,260
Deferred rent			165,413
Subordinated promissory notes payable			7,000,000
Line of credit			15,495,095
Equipment contract payable			291,223
Capital lease obligation			1,877,179
Total liabilities assumed			36,255,513
Net assets acquired			1,677,508
Adjustment to recognize minority interest			(331,981	)
		$	1,345,527
Total purchase consideration, net of intercompany eliminations of 2.67% interest held by KES Holdings:
8% Subordinated secured promissory notes payable		$	39,493,000
13% Series A preferred stock			24,733,000
Net purchase consideration			64,226,000
Minority interests in equity			223,950
Adjustment to record deemed distribution to Sellers			(63,104,423	)
		$	1,345,527

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The amount due from Acquisition Corp. of $187,702 represents costs incurred by KES Acquisition with respect to the Acquisition, which were included in the $1,171,406 of transaction costs related to the Acquisition charged to operations during the year ended September 30, 2005.

As of September 30, 2004, the Company had incurred $175,144 of costs with respect to the Acquisition, which were presented as deferred costs in the Company’s consolidated balance sheet at such date. These costs were included in the $1,171,406 of transaction costs related to the Acquisition charged to operations during the year ended September 30, 2005.

Minority interest - related parties was $430,931 on February 28, 2005. For the year ended September 30, 2005, the net loss of Acquisition Corp. allocable to the 19.99% minority shareholders was $681,698, but the reduction to minority interest - related parties was limited to the balance at February 28, 2005 of $430,931. Accordingly, the remainder of the net loss of Acquisition Corp. allocable to the 19.99% minority shareholders for the year ended September 30, 2005 of $250,767 was included in the Company’s consolidated statement of operations for the year ended September 30, 2005, and will be recovered to the extent that Acquisition Corp. generates net income in future periods.

Pro Forma Information

The following pro forma operating data presents the results of operations for the years ended September 30, 2005 and 2004, as if the Acquisition had occurred on the last day of the immediately preceding fiscal year. Accordingly, transaction costs of $1,171,406 related to the Acquisition for the year ended September 30, 2005 are not included in the net loss from continuing operations shown below. In addition, discontinued operations for the year ended September 30, 2004 are not included. The Mill commenced generating revenues in late January 2004. The pro forma results are not necessarily indicative of the financial results that might have occurred had the Acquisition actually taken place on the respective dates, or of future results of operations. Pro forma information for the years ended September 30, 2005 and 2004 is summarized as follows:

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		2005			2004
Net sales		$	113,786,971		$	48,944,338
Cost of sales			105,265,441			51,158,622
Gross margin (deficit)			8,521,530			(2,214,284	)
Operating income (loss)			3,169,836			(7,469,548	)
Interest expense			(9,469,875	)		(7,243,971	)
Minority interest			199,109			199,109
Net loss from continuing operations		$	(5,786,987	)	$	(14,134,628	)
Basic and diluted net loss per common share		$	(0.15	)	$	(0.36	)
Weighted average common shares outstanding			39,242,251			39,242,251

Critical Accounting Policies and Estimates:

The Company prepared its financial statements in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.

The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s financial statements.

 

Revenue Recognition:

 

The Company recognizes revenue when there is persuasive evidence that an arrangement exists, delivery of the product has occurred and title has passed, the selling price is both fixed and determinable, and collectibility is reasonably assured, all of which generally occur either upon shipment of the Company’s product or delivery of the product to the destination specified by the customer.

Accounts Receivable:

The Company grants credit to its customers generally in the form of short-term trade accounts receivable. Management evaluates the credit risk of its customers utilizing historical data and estimates of future performance. Accounts receivable are stated at the amount management expects to collect from outstanding balances. When appropriate, management provides for probable uncollectible amounts through a provision for doubtful accounts and an adjustment to a valuation allowance. Management reviews and adjusts this allowance periodically based on the aging of accounts receivable balances, historical write-off experience, customer concentrations, customer creditworthiness, and current industry and economic trends. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.

Inventories:

Inventories are comprised of raw materials (consisting of billets and scrap metal), semi-finished goods and finished goods. Inventory costs include material, labor and manufacturing overhead. Inventories are valued at the lower of average cost or market. The average cost of the billets and scrap metal is adjusted quarterly.

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Impairment of Assets:

Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. An asset is considered impaired if its carrying amount exceeds the future net cash flow the asset is expected to generate. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. The recoverability of long-lived assets is assessed by determining whether the unamortized balances can be recovered through undiscounted future net cash flows of the related assets. The amount of impairment, if any, is measured based on projected discounted future net cash flows using a discount rate reflecting the Company’s average cost of capital.

Income Taxes:

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Under this method, deferred income taxes are provided for differences between the carrying amounts of the Company’s assets and liabilities for financial reporting purposes and the amounts used for income tax purposes using expected tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. KES Acquisition Company is a limited liability company and as such does not provide for federal and state income taxes. Rather, its income is taxed to its members.

The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. In the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax assets would be credited to operations in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to operations in the period such determination was made.

Recent Accounting Pronouncements and Developments:

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123R”), a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. SFAS No. 123R requires that the Company measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards. The cost will be recognized as compensation expense over the vesting period of the awards. The Company was required to adopt SFAS No. 123R effective January 1, 2006. Under this method, the Company will begin recognizing compensation cost for equity-based compensation for all new or modified grants after the date of adoption. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. In addition, the Company will recognize the unvested portion of the grant date fair value of awards issued prior to adoption based on the fair values previously calculated for disclosure purposes over the remaining vesting period of the outstanding options and warrants.

 

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Public companies are permitted to adopt the requirements of SFAS No. 123R using one of two methods:

 

(1) A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123R for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date.

 

(2) A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

The Company will adopt SFAS No. 123R effective January 1, 2006 and will use the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123R for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. Although the expense for stock options that may be vested or granted in future periods cannot be determined at this time due to the uncertainty of the vesting or timing of future grants, the Company’s future stock price, and the related fair value calculation, the adoption of SFAS No. 123R could have a material effect on the Company’s future financial statements.

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (SFAS No. 151). SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, SFAS No. 151 requires that allocation of fixed and production facilities overhead to conversion costs should be based on normal capacity of the production facilities. The provisions in SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Accordingly, the Company adopted SFAS No. 151 effective October 1, 2005. The adoption of SFAS No. 151 did not have any impact on the Company’s financial statement presentation or disclosures.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment to APB Opinion No. 29” (“SFAS No. 153”). SFAS No. 153 amends Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions”, to require that exchanges of nonmonetary assets be measured and accounted for at fair value, rather than at carryover basis, of the assets exchanged. Nonmonetary exchanges that lack commercial substance are exempt from this requirement. SFAS No. 153 is effective for nonmonetary exchanges entered into in fiscal periods beginning after June 15, 2005. Accordingly, the Company adopted SFAS No. 153 effective July 1, 2005. The adoption of SFAS No. 153 did not have any impact on the Company’s financial statement presentation or disclosures.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”). SFAS No. 154 is a replacement of APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements - (an Amendment of APB Opinion No. 28)” and provides guidance on the accounting for and reporting of accounting changes and error corrections. SFAS No. 154 establishes retrospective application as the required method for reporting a change in accounting principle, and provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. Retrospective application is the application of a different accounting principle to a prior accounting period as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. SFAS No. 154 also addresses the reporting of the correction of an error by restating previously issued financial statements. SFAS No. 154 is effective for accounting changes and error corrections occurring in fiscal years beginning after December 15, 2005. Accordingly, the Company will adopt the provisions of SFAS No. 154 effective October 1, 2006. The adoption of SFAS No. 154 is not expected to have any impact on the Company’s financial statement presentation or disclosures.

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On September 22, 2005, the Securities and Exchange Commission (“SEC”) issued rules to delay by one-year the required reporting by management on internal controls over financial reporting for non-accelerated filers. The new SEC rule extends the compliance date for such registrants to fiscal years ending on or after July 15, 2007. Accordingly, the Company qualifies for the deferral until its year ending September 30, 2007 to comply with the internal control reporting requirements.

 

Results of Operations:

The operations of Beyond the Wall have been presented as a discontinued operation in 2004. Accordingly, for the year ended September 30, 2004, the Company did not have any revenues or cost of revenues from continuing operations.

The refurbished Mill restarted operations in late January 2004 and completed its ramp-up phase and reached full operating status in August 2004. The Company acquired the Mill effective February 28, 2005, and the operations of the Mill have been consolidated commencing March 1, 2005. Sales and cost of sales were generated by the operations of the Mill during 2005. The Company’s results of operations for the year ended September 30, 2005 include the Mill’s operations for seven months (March through September 2005). As a result of the acquisition of the Mill, the Company’s financial statements for periods ending after March 1, 2005 are materially different from and are not comparable to its financial statements prior to that date.

 

Years Ended September 30, 2005 and 2004:

Net Sales. Net sales were $69,182,475 for the year ended September 30, 2005, an average of $9,883,211 per month for the seven months that the Company owned the Mill. If the Company had owned the Mill for the full years ended September 30, 2005 and 2004, pro forma net sales would have been $113,786,971 for 2005 (an average of $9,482,248 per month), as compared to pro forma net sales of $48,944,338 for 2004 (an average of $4,078,695 per month), since the Mill restarted operations in late January 2004 and did not reach full operating status until August 2004.

Cost of Sales. Cost of sales was $62,939,014 for the year ended September 30, 2005, resulting in gross profit of $6,243,461 and a gross profit margin of 9.0%. If the Company had owned the Mill for the full year ended September 30, 2005, pro forma gross profit margin would have been 7.5%. Due to the restart of Mill operations in late January 2004, a comparison of 2004 cost of sales amounts (assuming that the Company had owned the Mill for the full year ended September 30, 2004) to 2005 cost of sales amounts would not be meaningful, since pro forma gross profit and gross margin were negative in 2004.

Selling Expenses. For the year ended September 30, 2005, selling expenses were $735,381 or 1.1% of sales. The Company did not have any selling expenses for the year ended September 30, 2004. Selling expenses consist primarily of sales commissions and personnel-related costs.

Selling, General and Administrative Expenses. For the year ended September 30, 2005, general and administrative expenses were $2,816,125 or 4.1% of sales. The Company incurred corporate general and administrative expenses during the entire year ended September 30, 2005, but only had operating revenues for the last seven months of the year ended September 30, 2005. For the year ended September 30, 2004, general and administrative expenses were $1,090,256, which reflected corporate general and administrative expenses, including management compensation, legal and accounting fees and insurance costs.

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Operating Income. Operating income was $2,691,955 for the year ended September 30, 2005, as compared to an operating loss of $1,090,256 for the year ended September 30, 2004.

Interest Income. Interest income was $45,542 for the year ended September 30, 2005, as compared to $49,566 for the year ended September 30, 2004.

Interest Expense. For the year ended September 30, 2005, interest expense was $5,607,454, which included interest expense related to the 8% notes payable of $1,852,384 and the 13% Series A Preferred Stock of $1,885,129 issued in conjunction with the acquisition of the Mill, the 12% notes payable of $492,493 and the 4% notes payable of $42,758. For the year ended September 30, 2004, interest expense was $41,509.

Transaction Costs Related to KES Acquisition. The Company incurred $1,171,406 of costs with respect to the acquisition of the Mill (primarily legal and accounting fees), which were charged to operations during the year ended September 30, 2005. Included in such costs was $187,702 of transaction costs incurred by KES Acquisition prior to February 28, 2005.

Gain on Settlement of Compensation Obligations. During the year ended September 30, 2005, the Company recognized a gain on settlement of compensation obligations of $225,948 as a result of the settlement of various contractual compensation obligations at less than amounts that had been previously accrued.

Other Income (Expense). For the year ended September 30, 2005, other expense was $46,078. There was no other income (expense) for the year ended September 30, 2004.

Loss before Income Taxes and Minority Interest. The loss before income taxes and minority interest was $3,861,493 for the year ended September 30, 2005, as compared to $1,082,199 for the year ended September 30, 2004.

Income Taxes. For the year ended September 30, 2004, the Company recorded a benefit from income taxes of $88,372. The Company did not record any provision for or benefit from income taxes for the year ended September 30, 2005.

Loss before Minority Interest. The loss before minority interest was $3,861,493 for the year ended September 30, 2005, as compared to $993,827 for the year ended September 30, 2004.

Minority Interest - Related Parties. For the year ended September 30, 2005, minority interest was $430,931, reflecting the minority interest’s share in the loss of YouthStream Acquisition Corp., an 80.01%-owned consolidated subsidiary.

Loss from Continuing Operations. The loss from continuing operations was $3,430,562 for the year ended September 30, 2005, as compared to $993,827 for the year ended September 30, 2004.

Loss from Discontinued Operations. For the year ended September 30, 2004, the Company had a loss from discontinued operations of $1,371,793, which related to the former operations of Beyond the Wall. The loss from discontinued operations of $550,072 for the year ended September 30, 2004 consisted of an operating loss of $1,050,072, offset by a gain of $500,000 resulting from the reduction of a prior accrual with respect to the closing of retail stores as a result of the Company completing settlements with landlords below what had been originally accrued. The Company also had a loss on the disposal of discontinued operations of $821,721 for the year ended September 30, 2004, as a result of the sale of the assets and operations of Beyond the Wall in February 2004.

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Net Loss. Net loss was $3,430,562 for the year ended September 30, 2005, as compared $2,365,620 for the year ended September 30, 2004.

Liquidity and Capital Resources - September 30, 2005:

On March 9, 2005, YouthStream completed the acquisition of the Mill. In connection with the Company’s acquisition and consolidation of the Mill, the Company also acquired $913,194 of cash. The Company used substantially all of its available cash resources to fund the acquisition of the Mill, including its contribution of an aggregate of $500,000 of cash to Acquisition Corp. and the payment of the costs related to the transaction. Accordingly, the Company will require additional operating capital to fund corporate general and administrative expenses, which the Company expects to obtain primarily through periodic tax sharing payments from Acquisition Corp. and Atacama KES. The Mill relies on cash flows from operations to support a secured line of credit with GECC to fund its separate operations. As a result of improved operating performance of the Mill beginning in late 2005, the Company has been able to increase borrowing availability under this line of credit.

As of September 30, 2005, the balance outstanding on the line of credit was $19,009,379, which has been presented as a current liability in the consolidated balance sheet at such date due to the collateral securing such line of credit consisting primarily of current assets and the continuing uncertainty with respect to the Company’s ability to maintain compliance under the terms and conditions of the line of credit.

 

At March 31, 2005, KES Acquisition was not in compliance with the fixed charge coverage ratio based on its consolidated financial statements as originally filed, in part relating to changes to its accounting procedures as a result of the review of its financial statements conducted in conjunction with its acquisition by YouthStream, and subsequently received a waiver of default from GECC. At June 30, 2005, KES Acquisition was in compliance with the fixed charge coverage ratio based on its consolidated financial statements as originally filed. However, KES Acquisition was not in compliance with the fixed charge coverage ratio at June 30, 2005 based on its revised consolidated financial statements, as a result of a determination by management to re-characterize a lease for certain equipment used by KES Acquisition as a capital lease rather than an operating lease. In addition, KES Acquisition was not in compliance with its obligation to deliver audited financial statements in the form and time period as set forth in the loan agreement. On June 26, 2006, the Company received a waiver of default from GECC with respect to the fixed charge coverage ratio for the restated March 31, 2005 and June 30, 2005 interim financial statements, as well as with respect to the form and timeliness of the September 30, 2005 annual audited financial statements being provided to GECC.  

 

At September 30, 2005, KES Acquisition was in compliance with the fixed charge coverage ratio based on its consolidated financial statements.

In the event that KES Acquisition is not in compliance with the fixed charge coverage ratio in any future period, the Company intends to seek a further waiver of any default from GECC, and if no such waiver is received, GECC would have the right to accelerate the maturity of the line of credit at that time.

To the extent that the Mill generates taxable income in the future, the Tax Sharing Agreement with Acquisition Corp. and Atacama KES will generate cash payments to YouthStream equal to 50% of their respective “separate company tax liability”, subject to compliance with the GECC secured line of credit. At September 30, 2005, the estimated tax sharing payment due to YouthStream was approximately $342,000, which was received in early 2006. YouthStream has approximately $255,000,000 of federal net operating loss carryovers currently available to offset any federal income tax liability of Acquisition Corp and Atacama KES in subsequent periods. YouthStream expects that its federal net operating loss carryovers will be sufficient to absorb most of any future federal income tax liability of Acquisition Corp. and Atacama KES.

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The Mill restarted operations in January 2004 after being acquired by the previous owners, and has incurred losses until recently. The long-term economic viability of the Mill and its ability to fund its operations and debt service requirements, including maintaining compliance with various debt covenants and servicing the interest and principal obligations on the Notes and the dividends and redemption features on the 13% Series A Preferred Stock issued in connection with the acquisition of the Mill, is dependent on various internal and external factors, including the Mill’s ability to operate on a sustained basis at 80% or more of its annual capacity of 200,000 tons per year, as currently configured. To the extent that the Mill is not able to maintain this operating threshold, the ability of the Mill to generate sufficient cash flows to fund its operations and debt service requirements and maintain compliance with various debt covenants may be impaired. In such event, the Company may have to consider a formal or informal restructuring or reorganization, including a sale or other disposition of its assets.

Almost all of the Company’s net assets are owned by KES Acquisition, a consolidated subsidiary.  As a result of various contractual restrictions contained in various financing agreements (as previously described) and documents relating to the Acquisition, there are limits on the Company’s ability to transfer assets from KES Acquisition to Youthstream, whether in the form of loans and advances, cash dividends, tax-sharing payments, or otherwise, without notice to and/or consent of one or more third parties.  A summary of the Company’s restricted and unrestricted assets, liabilities and equity at September 30, 2005 is presented below.

 

		Unrestricted			Restricted			As Reported
Current assets		$	261,740		$	35,453,821		$	35,715,561
Property, plant and equipment, net			-			5,567,745			5,567,745
Other assets			-			638,948			638,948
Total assets		$	261,740		$	41,660,514		$	41,922,254
Current liabilities		$	4,224,995		$	30,411,237		$	34,636,232
Non-current liabilities			78,257,234			8,629,138			86,886,372
Equity:
Retained earnings (accumulated deficit)			(348,435,183	)		1,169,785			(347,265,398	)
Other			266,214,694			1,450,354			267,665,048
Total liabilities and equity		$	261,740		$	41,660,514		$	41,922,254

Operating Activities. During the year ended September 30, 2005, the Company used $4,300,395 of cash in operating activities, both to fund the corporate overhead of YouthStream for the year ended September 30, 2005 and to fund the operations of the Mill for a period of seven months from the date of acquisition through September 30, 2005. During the year ended September 30, 2004, the Company used $901,442 of cash in operating activities, primarily to fund its loss from continuing operations of $993,827 for the year ended September 30, 2004, which consisted of corporate general and administrative expenses.

Investing Activities. During the year ended September 30, 2005, net cash provided by investing activities of $506,149 consisted of principal and interest payments on the Beyond the Wall note receivable that the Company received in the February 2004 sale of the assets and operations of Beyond the Wall. During the year ended September 30, 2004, net cash provided by investing activities of $1,044,856 consisted of the proceeds received from the sale of the Beyond the Wall assets and operations in February 2004 of $820,000 and principal payments on the Beyond the Wall note receivable of $400,000, reduced by deferred costs related to the KES transaction of $175,144.

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Financing Activities. During the year ended September 30, 2005, net cash provided by financing activities was $3,205,007, consisting of $3,389,284 from increased borrowings under the secured line of credit with GECC and $50,000 from the proceeds from short-term notes payable issued to certain directors, reduced by payments on an equipment contract payable and capital lease obligation of $234,277. During the year ended September 30, 2004, the Company did not generate or use any cash in financing transactions.

Principal Commitments:

At September 30, 2005, the Company’s principal commitments consisted of the following obligations:

					Payments Due by Years Ending September 30,
Contractual cash obligations (in thousands)		Total			2006			2007			2008			2009			2010			There-after
4% notes payable		$	4,917		$	-		$	-		$	-		$	-		$	-		$	4,917
Notes payable to directors			50			50			-			-			-			-			-
12% subordinated promissory notes payable			7,000			-			7,000			-			-			-			-
8% subordinated secured promissory notes payable			39,493			-			1,849			925			925			925			34,869
Secured line of credit			19,009			-			19,009			-			-			-			-
Operating leases			1,593			426			406			390			371			-			-
Capital lease obligation			1,684			372			432			502			378			-			-
Equipment contact payable			250			77			85			88			-			-			-
Management services agreement			2,858			700			700			700			700			58			-
4% Series A Preferred Stock subject to mandatory redemption			5,269			-			-			-			-			-			5,269
13% Series A Preferred Stock of subsidiary subject to mandatory redemption, excluding accrued dividends (assumes adequate defined “free cash flow” to fund payments)			26,618			-			3,958			3,958			3,958			3,958			10,786
Total contractual cash obligations		$	108,741		$	1,625		$	33,439		$	6,563		$	6,332		$	4,941		$	55,841

At September 30, 2005, the Company does not have any material commitments for capital expenditures.

At September 30, 2005, the Company has various short-term commitments for the purchase of materials, supplies and energy arising in the ordinary course of business which aggregated approximately $7,962,000.

Off-Balance Sheet Arrangements:

The Company does not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements at September 30, 2005.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(Revised 2004), "Share-Based Payment". SFAS No. 123(R) revises SFAS No. 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" and amends SFAS No. 95, "Statement of Cash Flows". SFAS No. 123(R) focuses primarily on the accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires companies to recognize in the statement of operations the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123(R) is effective as of the Company's first interim or annual reporting period that begins after December 15, 2005. Accordingly, the Company will adopt SFAS No. 123(R) effective January 1, 2006. The Company is currently evaluating the provisions of SFAS No. 123(R) and has not yet determined the impact, if any, that SFAS No. 123(R) will have on its financial statement presentation or disclosures.

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In November 2004, the FASB issued SFAS No. 151, "Inventory Costs — An Amendment of ARB No. 43, Chapter 4" (SFAS No. 151). SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, SFAS No. 151 requires that allocation of fixed and production facilities overhead to conversion costs should be based on normal capacity of the production facilities. The provisions in SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Accordingly, the Company will adopt SFAS No. 151 effective October 1, 2005. The Company is currently evaluating the provisions of SFAS No. 151 and has not yet determined the impact, if any, that SFAS No. 151 will have on its financial statement presentation or disclosures.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets, an amendment to APB Opinion No. 29" ("SFAS 153"). SFAS No. 153 amends Accounting Principles Board Opinion No. 29, "Accounting for Nonmonetary Transactions", to require that exchanges of nonmonetary assets be measured and accounted for at fair value, rather than at carryover basis, of the assets exchanged. Nonmonetary exchanges that lack commercial substance are exempt from this requirement. SFAS No. 153 is effective for nonmonetary exchanges entered into in fiscal periods beginning after June 15, 2005. Accordingly, the Company will adopt SFAS No. 153 effective July 1, 2005. The Company is currently evaluating the provisions of SFAS No. 153, and has not yet determined the impact, if any, that it will have on the Company's financial statement presentation or disclosures.

Name		Age		Position
Jonathan V. Diamond		47		Chairman of the Board of Directors (Class III Director) and Chief Executive Officer
Robert N. Weingarten		52		Chief Financial Officer and Secretary
Hal G. Byer		48		Class II Director
Robert Scott Fritz		49		Class I Director
Patrick J. Panzarella		40		Class II Director
James N. Lane		55		Class I Director
Jess M. Ravich		48		Class III Director

The Company's Board of Directors is divided into three classes, with one class being elected each year and members of each class holding office for a three-year term. All of the directors serve until their terms expire and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal.

In connection with the January 2003 debt restructuring transactions, all of the Company's previous directors and officers resigned, and three directors were appointed. Jonathan V. Diamond, who had previously served as a director and interim Chief Executive Officer of the Company, was appointed as Chairman of the Board of Directors, and Hal G. Byer and Robert Scott Fritz were appointed as directors. Mr. Fritz has been designated as a Class I director and Mr. Byer has been designated as a Class II director. Mr. Diamond had been previously designated as a Class III director. Mr. Panzarella was appointed to the Board of Directors in June 2004 as a Class II director, Mr. Lane was appointed to the Board of Director in February 2005 as a Class I director and Mr. Ravich was appointed to the Board of Directors in June 2006 as a Class III director.

The Class I directors’ terms will expire at the annual meeting to be held subsequent to the fiscal year ended September 30, 2006. The Class II directors’ terms were set to expire at the annual meeting to be held subsequent to the fiscal year ended September 30, 2004. However, no annual meeting was held subsequent to the fiscal year ended September 30, 2004. The Class III director's term will expire at the annual meeting to be held subsequent to the fiscal year ended September 30, 2005.

Messrs. Diamond and Weingarten have each tendered their resignations as officers of the Company and each of its subsidiaries, effective as of August 31, 2006 or earlier if requested by the Company’s Board of Directors. Mr. Diamond will continue to serve as the Company’s Chairman of the Board of Directors. The Board of Directors anticipates filling these executive positions concurrent with their vacancy and in any event on or before August 31, 2006.

 

The Board of Directors has established Audit, Compensation and Stock Option Committees. Messrs. Byer and Fritz currently serve on the Audit, Compensation and Stock Option Committees. The Board of Directors is currently contemplating reconfiguring its committee membership to more fully comply with various regulatory requirements.

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Due to the delay in finalizing the Company's audited financial statements for the fiscal year ended September 30, 2005, the Company has not been able to acquire an audit committee financial expert to serve on its Audit Committee. The Company intends to attempt to add a qualified board member to serve as an audit committee financial expert in the future.

The following is a brief summary of the background of the Company's directors and executive officers.

Directors

Jonathan V. Diamond. Mr. Diamond has served as Chairman of the Board and Chief Executive Officer of the Company since January 30, 2003. Mr. Diamond previously served as a director from April 4, 2001 to December 2, 2002, and as interim Chief Executive Officer from August 17, 2002 to December 2, 2002. From September 2003 to the present, he has served as the Chief Executive Officer and a director of ARTISTdirect, Inc., a publicly traded digital media entertainment company. He was the co-founder of N2K, Inc. and served as its Vice Chairman and Chief Executive Officer through its 1999 merger with CDnow, Inc., an e-commerce company. He continued to serve as Chairman of the combined company until its sale to Bertelsmann Music Group in August 2000. Mr. Diamond was a founder of GRP Records, an independent music label acquired by MCA in 1990. Mr. Diamond holds an M.B.A. from the Columbia University Graduate School of Business and a B.A. in Economics and Music from the University of Michigan Honors College. Mr. Diamond has resigned from all executive positions that he holds in the Company and its subsidiaries, effective as of August 31, 2006, or earlier if requested by the Board of Directors. Mr. Diamond will continue to serve as the Company's Chairman of the Board.

Hal G. Byer. Mr. Byer has served as a director of the Company since January 30, 2003. Mr. Byer joined Libra Securities, LLC ("Libra Securities"), a broker-dealer registered with the Securities and Exchange Commission and an NASD member, in May 2001, and has been a Senior Vice President since January 2002. From 1995 to 2003, Mr. Byer was Chief Executive Officer of Byer Distributing Co., a snack food distribution company. From 2000 to 2003, Mr. Byer was also the Chief Operating Officer of eGreatcause.com, an internet start-up involved in fundraising for charitable and non-profit organizations that is no longer active.

Robert Scott Fritz. Mr. Fritz has served as a director of the Company since January 30, 2003. Mr. Fritz is the president and owner of Robert Fritz and Sons Sales Company, a food broker and paper distributor located in New Jersey, and has operated in that capacity since 1976.

Patrick J. Panzarella. Mr. Panzarella has served as a director of the Company since June 3, 2004. Mr. Panzarella has served as the Chief Executive Officer of Pacific Entertainment Group, a global entertainment corporation with interests in artist management, marketing, promotion, publishing, and production, since May 2001. Prior to joining Pacific Entertainment Group, Mr. Panzarella served as Partner and Co-Chairman of the Board of Sheridan Square Entertainment, a global music company, from April 1999 to May 2002. Mr. Panzarella also served as Partner, President and Chief Executive Officer of C&P Investment Properties, a private investment fund focused on the entertainment industry, from November 1991 to December 2002. This fund participated in numerous acquisitions and start ups over an eleven year period. Mr. Panzarella received a B.A. in Business from University of Southern California in 1988.

James N. Lane.  Mr. Lane has served as a director of the Company since February 15, 2005.  He has also been a director of ARTISTdirect, Inc., a publicly traded digital media entertainment company, since May 2005.  Mr. Lane has been Managing Partner of Devonwood Capital Partners LLC, a private equity firm, since 2002, a Senior Advisor to Ripplewood Holdings LLC, a private equity firm, since September 2005 and also Chairman of NanoHoldings, LLC, a nanotechnology venture fund, since July 2005.  From 1997 to 2002, Mr. Lane served as Chairman and CEO of SG Capital Partners, a private equity firm affiliated with Societe General and SG Cowen Securities.  Prior to establishing SG Capital Partners, Mr. Lane’s career spanned approximately twenty years at Goldman Sachs & Co. where he was a General Partner and a founding member of the firm’s private equity business. Mr. Lane received a B.A. degree from Wheaton College and a M.B.A. from Columbia University.

 

Jess M. Ravich.  Mr. Ravich has served as a director of the Company since June 26, 2006. Mr. Ravich is the Chairman and Chief Executive Officer of Libra Securities, a Los Angeles based investment banking firm that focuses on capital raising and financial advisory services for middle market corporate clients and the sales and trading of debt and equity securities for institutional investors. Prior to founding Libra Securities in 1991, Mr. Ravich was an Executive Vice President at Jefferies & Co., Inc. and a Senior Vice President at Drexel Burnham Lambert. Mr. Ravich serves on the board of directors of Cherokee Inc. and Continental AFA Dispensing Company and on the board of managers of OpBiz, LLC. In addition to his professional responsibilities, Mr. Ravich is also on the Undergraduate Executive Board of the Wharton School and the Board of Trustees of the Archer School for Girls.

 

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Other Executive Officer

Robert N. Weingarten. Mr. Weingarten was appointed Chief Financial Officer of the Company on February 6, 2003. From July 1992 to present, Mr. Weingarten has been the sole shareholder of Resource One Group, Inc., a financial consulting and advisory company. From January 2004 to present, he has served as the Chief Financial Officer and Secretary of ARTISTdirect, Inc., a publicly traded digital media entertainment company. Since 1979, Mr. Weingarten has served as a consultant to numerous public companies in various stages of development, operation or reorganization. Mr. Weingarten received an M.B.A. Degree in Finance from the University of Southern California in 1975 and a B.A. Degree in Accounting from the University of Washington in 1974. Mr. Weingarten currently serves as a director of Resource Ventures, Inc., a non-trading public company.  Mr. Weingarten has resigned as Chief Financial Officer and Secretary of the Company and its subsidiaries, effective as of August 31, 2006, or earlier if requested by the Board of Directors. 

 

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires a company's directors and executive officers, and beneficial owners of more than 10% of the common stock of such company to file with the Securities and Exchange Commission initial reports of ownership and periodic reports of changes in ownership of the company's securities. Based upon a review of the copies of such forms furnished to the Company and written representations from the Company's executive officers and directors, the Company believes that during the fiscal year ended September 30, 2005, all Forms 3, 4 and 5 were filed on a timely basis for the Company's executive officers and directors. To the knowledge of the Company, Joseph Corso, Jr., a beneficial owner of more than 10% of the Company’s common stock who reports his stock ownership on Schedule 13g, has never filed a Form 3, 4 or 5 in connection with his stock holdings in the Company.

Family Relationships among Directors and Executive Officers

There were no family relationships among directors and executive officers during the fiscal year ended September 30, 2005.

Code of Ethics

Annual Compensation

Long-Term Compensation

									Securities Underlying Options/SARs		All Other Compensation
		Year		Salary			Bonus
Jonathan V. Diamond Chairman of the Board and Chief Executive Officer (1)		2005 2004 2003		$ $ $	120,000 120,000 98,000		0 0 0		0 50,000 300,000		$	0 0 11,000	(5)
Robert N. Weingarten Chief Financial Officer and Secretary (3)		2005 2004 2003		$ $ $	60,000 85,000 90,000	(6) (6) (6)	0 0 0		0 0 175,000			0 0 0
Harlan Peltz Former Chief Corporate Strategist and Chairman (4)		2003		$	135,417	(2)	0		0			0

(1) Mr. Diamond served as interim Chief Executive Officer from August 17, 2002 to December 2, 2002, and was named Chief Executive Officer on January 30, 2003.

(2) Mr. Peltz's compensation is calculated for the period July 1, 2002 through January 24, 2003.

(3) Mr. Weingarten has served as Chief Financial Officer since February 6, 2003.

(4) Mr. Peltz's employment with the Company terminated on January 24, 2003.

(5) Pursuant to Mr. Diamond's agreement with the Company, the Company recorded a liability for $11,000 at September 30, 2003, to be used as a credit against the exercise price of any of Mr. Diamond's stock options in the future.

(6) Mr. Weingarten was compensated at an effective rate of $120,000 per annum during the fiscal year ended September 30, 2003. Mr. Weingarten's compensation decreased to an effective rate of $60,000 per annum effective March 1, 2004, as a result of the sale of the assets and operations of the Company's Beyond the Wall, Inc. subsidiary in February 2004. Mr. Weingarten’s annual salary was adjusted to $102,000 effective November 1, 2005.

 

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

 

The following table sets forth information concerning the exercise of stock options during the fiscal year ended September 30, 2005 with respect to the Company's executive officers and the fiscal year-end value of unexercised options. No options were granted to, or exercised by any of the Company's executive officers during the fiscal year ended September 30, 2005.

 

		Number of Securities Underlying Unexercised Options at September 30, 2005						Value of Unexercised In-The-Money Options at September 30, 2005 (1)
Name		Exercisable			Unexercisable			Exercisable			Unexercisable
Jonathan V. Diamond			430,404			—		$	18,000			—
Robert N. Weingarten			175,000			—		$	10,500			—

 

(1) Based on September 30, 2005 closing stock price of $0.10 per share.

 

STOCK OPTION PLAN

The Compensation Committee reviews and approves the compensation and benefits of its key executive officers, administers its employee benefit plans and makes recommendations to the Board regarding such matters. The members of the Compensation Committee are Messrs. Byer and Fritz. The Compensation Committee did not hold any meetings during the fiscal year ended September 30, 2005.

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Nominating Committee

The Company does not currently have a Nominating Committee. Board of Director nominations are recommended by a majority of directors. In making its nominations, the Board of Director identifies candidates who meet the current challenges and needs of the Board of Directors. In determining whether it is appropriate to add or remove individuals, the Board of Directors will consider issues of judgment, diversity, age, skills, background and experience. In making such decisions, the Board of Directors considers, among other things, an individual's business experience, industry experience, financial background and experiences.

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ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT