**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**




**FORM
      10-K**




(Mark
      One)


þ Annual
      report under section 13 or 15( d )
      of the
      securities exchange act of 1934


**For
      the fiscal year ended December 31, 2006**





o Transition
      report under section 13 or 15 (d )
      of the
      securities exchange act of 1934





**Commission
      file number** **** 000-32319





**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


(Exact
      name of registrant as specified in its charter)





**Delaware**
            
            **33-0851302**(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                No.)**1160
                Commerce Avenue, Bronx, New York**
            
            **11462**(Address
                of principal executive offices)
            
            (Zip
                Code)





**(718)
      536-2248**


(Registrant’s
      telephone number, including area code)





Securities
                registered under Section 12(b) of the Exchange Act:
            **None**Securities
                registered under Section 12(g) of the Exchange Act:
            **Common
                Stock, $.001 par value**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes o No **þ**





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange Act.


Yes o No **þ**





Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      past twelve 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 **þ** No o





Indicate
      by check mark if disclosure of delinquent filers in response to Item 405 of
      Regulation S-K is not contained herein, and will not 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-K or any amendment to
      this
      Form 10-K. **þ**





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.  See
      definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
      the Exchange Act.


Large
      accelerated filer o Accelerated
      filer o Non-accelerated
      filer **þ**





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes o No **þ**





State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      last sold, or the average bid and asked price of such common equity, as of
      the
      last business day of the registrant's most recently completed second fiscal
      quarter **$2,702,000**





State
      the
      number of shares outstanding of each of the issuer's classes of common equity,
      as of the latest practicable date.





**48,721,065
      shares of common stock, $.01 par value, as of March 19,
      2007** **.**





DOCUMENTS
      INCORPORATED BY REFERENCE


[SEE
      INDEX TO EXHIBITS]





**PART
      I**





*Disclosures
      in this Form 10-K contain certain forward-looking statements, including without
      limitation, statements concerning our operations, economic performance, and
      financial condition. These forward-looking statements are made pursuant to
      the
      safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
      The words “estimate,” “believe,” “expect,” and “anticipate” and other similar
      expressions generally identify forward-looking statements, which speak only
      as
      of their dates.*





*These
      forward-looking statements are based largely on our current expectations, and
      are subject to a number of risks and uncertainties, including without
      limitation, risks associated with technological change, competitive factors
      and
      general economic conditions, changes in marketing and distribution strategies
      by
      manufacturers, continued shortages of new platform systems, difficulty in
      integrating and deriving synergies from acquisitions, potential undiscovered
      liabilities of companies that we acquire, changes in our business or growth
      strategy, the emergence of new or growing competitors, various other competitive
      and technological factors, and other risks and uncertainties set forth under
      “Risk Factors.”*





*Our
      actual results could differ materially from the results referred to in the
      forward-looking statements. In light of these risks and uncertainties, there
      can
      be no assurance that the results referred to in the forward-looking statements
      contained in this release will occur.*





*We
      undertake no obligation to update or review any guidance or other
      forward-looking information, whether as a result of new information, future
      developments or otherwise.*





**ITEM
      1. DESCRIPTION OF BUSINESS**





Alliance
      Distributors Holding Inc. (the "Company" or "Alliance") is a distributor of
      video game consoles and video game peripherals, accessories and software. Our
      offices are located at 1160 Commerce Avenue, Bronx, New York 10462. Our
      telephone number is (718) 536-2248.





**Business
      Background**




In
      June
      2002, the Company, then named JPAL, Inc. ("JPAL"), a Nevada corporation which
      then had no ongoing business or significant assets, acquired Essential Reality,
      LLC ("ER, LLC") which had been formed in 1998 as Freedom Multimedia, LLC in
      Delaware to develop and market a virtual video game controller. Following this
      transaction, JPAL changed its name to Essential Reality, Inc. ("Essential").
      In
      November 2003, we discontinued sales of our virtual video game controller
      because of our inability to raise necessary funds.




On
      June
      17, 2004, Essential entered into a Share Exchange Agreement (the "Exchange
      Agreement") with Jay Gelman, Andre Muller and Francis Vegliante, the sole
      shareholders (the "Stockholders") of AllianceCorner Distributors Inc., a New
      York corporation ("AllianceCorner") which had been engaged in the video game
      distribution business since August 2003. Pursuant to the Exchange Agreement,
      the
      Company on June 29, 2004 acquired all the outstanding capital stock of
      AllianceCorner from the Stockholders and, in exchange for such capital stock,
      issued 517,105 Series B Convertible Non Redeemable Preferred Shares ("Series
      B
      Preferred Shares") to Jay Gelman, 517,105 Series B Preferred Shares to Andre
      Muller and 517,104 Series B Preferred Shares to Francis Vegliante. On November
      22, 2004, the Series B Preferred Shares converted into 8,226,671 shares of
      common stock for each of Jay Gelman and Andre Muller and into 8,226,655 shares
      of common stock for Francis Vegliante.




In
      connection with this acquisition, the Company issued the share equivalent of
      22,028,759 shares of common stock and 346,663 shares of Series A Convertible
      Non
      Redeemable Preferred Stock and warrants to purchase 1,564,096 shares of common
      stock in private placements. Each share of Series A Convertible Non Redeemable
      Preferred Stock entitles the holder to 15.91 votes, and votes as one class
      with
      the common stock on as converted basis.




Certain
      holders granted to Jay Gelman an irrevocable voting proxy to vote their voting
      stock. As of February 28, 2007, Jay Gelman's voting proxy covered 5,732,091
      shares of common stock, as well as 168,427 shares of Series A Convertible Non
      Redeemable Preferred Stock that have 2,679,674 votes, for a total voting proxy
      of 8,411,765 votes.




I-1


We
      accounted for our acquisition of AllianceCorner as a reverse acquisition as
      of
      June 30, 2004. The pre-acquisition financial statements of AllianceCorner are
      treated as historical financial statements of the combined
      companies.




AllianceCorner
      was formed in May 2003 under the name Alliance Partners, Inc. The name of
      Alliance Partners, Inc. was changed to AllianceCorner Distributors Inc. in
      September 2003 and was further changed to Alliance Distributors Holding, Inc.
      ("Alliance New York") in July 2004. Effective November 17, 2004, Alliance New
      York was merged into Alliance Distributors Holding Inc., a Delaware corporation
      that was wholly owned by Essential.




Effective
      November 22, 2004, Essential reincorporated in Delaware and changed its name
      to
      Alliance Distributors Holding Inc. ("Alliance" or the "Company"), by way of
      a
      merger of Essential into Alliance, which was then a wholly owned Delaware
      subsidiary of Essential.




On
      March
      7, 2005, Mr. Vegliante sold 4,000,000 shares of common stock to investors in
      a
      private transaction at a purchase price of $0.125 per share.




**Our
      Business**





**What
      we Sell**





We
      distribute to retail stores videogame consoles that are manufactured by Sony
      (primarily the *PlayStation* *(R)* *3* Computer
      Entertainment system or “ *PS3* ”, *PlayStation* *(R)* *2* Computer
      Entertainment system or “ *PS2* ”
and *Play
      Station Portable* system
      or “PSP”), Nintendo of America, Inc. “Nintendo” (including the *Wii* , *Nintendo
      DS* , *Game
      Boy* *(R)* *Advance* and *GameCube* *TM* ** systems)
      and, pursuant to a resale relationship we have with one of Microsoft’s
      distributors, Microsoft products, including the *Xbox
      360* *(R)*  and *Zune* systems.
      We generally sell these consoles at prices ranging from $70 to $600. We also
      distribute accessories and game software that are made for these consoles by
      the
      console manufacturers and third parties. Accessories include controllers, memory
      cards, network adaptors, component cables, rechargeable kits and carrying cases.
      We sell our accessories and software at prices generally ranging from $7.50
      to
      $150. At December 31, 2006, we had available an aggregate of approximately
      3,500
      products for sale to our customers.





**The
      Market**





According
      to The NPD Group, Inc. a leading market information provider, the videogame
      market, which includes gaming hardware, software, and accessories, generated
      U.S. retail sales of $12.5 billion in 2006. This represented an approximate
      19
      percent increase over the $10.5 billion sales generated in 2005. According
      to
      the International Development Group (“IDG”), the average age of Americans who
      play video and PC games is 29, and approximately 145 million people play
      videogames on a regular basis.





**Suppliers**





We
      are
      direct distributors for Sony Computer Entertainment America Inc. ("Sony") and
      Nintendo of America Inc. ("Nintendo") and purchase product from them directly.
      We are also direct distributors for approximately 75 third-party vendors
      (including Electronic Arts Inc., Take Two Interactive Software, Inc. and THQ
      Inc.) of accessories and software for video games. We have no relationship
      with
      Microsoft for distribution of the Microsoft Xbox 360 (R) and the Zune, and
      purchase our Xbox 360 (R) and Zune supplies from another distributor.





For
      the
      three years ended December 31, 2006, we purchased approximately 20%, 33% and
      30%
      of our products for cash in advance, and the balance on 30 day to 45 day
      terms.





In
      addition to manufacturer credit and internally generated funds, we have a
      financing agreement with a lender under which the lender may in its discretion
      lend us up to $10,000,000 based on eligible receivables and inventory. We have
      pledged substantially all of our assets as security for this financing.





I-2


For
      the
      year ended 2006, three of our suppliers in the aggregate accounted for
      approximately 49% of our purchases (with one accounting for 27% alone) and
      the
      ten largest suppliers in the aggregate accounted for approximately 74% of our
      purchases. For the year ended 2005, three of our suppliers in the aggregate
      accounted for approximately 62% of our purchases (with one accounting for 42%
      alone), and our ten largest suppliers in the aggregate accounted for 82% of
      our
      purchases. For the year ended December 31, 2004, the same three suppliers in
      the
      aggregate accounted for approximately 56% of our purchases, and our ten largest
      suppliers in the aggregate accounted for 77% of our purchases. We have no long
      term agreement with any of our suppliers, and conduct business with them on
      an
      individual purchase order basis. Our business would be materially and adversely
      affected should any material supplier terminate its relationship with us or
      modify its relationship with us.





**Warehouse
      and Showroom**





In
      September 2006, we relocated our executive offices, showroom and warehouse
      to
      25,000 square feet of space located at 1160 Commerce Avenue, Bronx, New York
      10462. In addition, in September 2006 we opened a 5,000 square foot warehouse
      and 2,000 square foot showroom in Miami, Florida. We utilize our showrooms
      to
      display products to our customers. Our
      products are
      either picked up directly by the customer from our showroom or delivered to
      customers from our warehouses by one of our delivery vehicles or through a
      third
      party courier. We deliver products at no additional charge to customers that
      purchase at least $500 worth of products in the New York metropolitan area
      and
      the surrounding tri-state region. We also drop ship certain products directly
      from the manufacturer to our customers.





**Our
      Customers; Sales and Marketing**





Our
      customers consist primarily of approximately 2,600 retail outlets located
      throughout the United States and Canada, with a majority being in the New York
      metropolitan area and the surrounding tri-state region. These
      customers include independent retailers, regional electronics superstores,
      entertainment specialty stores, video stores, online retailers, specialty toy
      retailers, supermarkets, drug stores, department stores, and military
      bases. We
      estimate that these stores are owned by approximately 350 to 500 different
      entities. Between 30% to 40% of our sales are on a cash on delivery basis,
      and
      the balance is invoiced primarily on 7 through 30 day terms. To our knowledge,
      no group of stores under common ownership accounted for 10% or more of our
      sales
      in any of the three years in the period ended December 31, 2006.





We
      sell
      to our customers through our sales employees, most of whom are paid on a salary
      plus commission basis. We have no long-term sales agreements.





We
      market
      ourselves in part as being engaged in a "Video Game Alliance" with our
      customers, fostering the sense that we are truly partners with our retailer
      customers in selling products to the end user. Our showroom is designed in
      part
      to help us advise our customers on how best to sell the product they buy from
      us, and we offer them banners, and point of sale and similar material. In
      advertisements we list our customers and indicate that the advertisement is
      "brought to you by Alliance Distributors." We have not to date advertised in
      the
      trade press. We have historically attended and exhibited at two trade shows
      annually.





**Warranties
      and Returns**





We
      offer
      no warranties to our customers and do not have any facilities for the repair
      or
      service of any products. We nevertheless accept returns of product claimed
      to be
      defective and reimburse our customers for the full purchase price of these
      products. Although the majority of our suppliers in turn accept these returns
      from us, certain suppliers credit us with a fixed allowance for returns and
      require that we assume any additional risk.





**Competition**





The
      products that we distribute are also sold through large retail chain stores,
      many of which have greater financial, technical, personnel and other resources
      than we do. Management estimates that the great majority of product sales are
      made through Wal-Mart, BestBuy, Target, Gamestop and other retailers that buy
      directly from manufacturers





In
      addition to Alliance, the dominant independent distributors in our industry
      include: Mecca
      Electronics Industries, Inc., Jack of all Games (a subsidiary of Take Two
      Interactive Software, Inc.), About Time Inc, Pioneer Distributors Inc d/b/a
      JB
      Marketing, Florida State Games, SVG Distribution, Inc. and D&H Distributing
      Co., Inc. These companies have significantly greater financial resources than
      our company. We compete with these companies on the basis of personalized
      service, advice and marketing support that we seek to offer to our customers.





**Government
      Regulation**





The
      manufacturers of the products we distribute must test them for compliance with
      Federal Communications Commission (FCC) standards to avoid radio frequency
      emissions that could interfere with other radio frequency transmissions or
      similar regulatory standards in other countries. We are not required to test
      our
      products for compliance.





I-3


**Trademarks**





We
      hold
      no patents or material proprietary technology. We have no intellectual property
      other than a trademark for "Video Game Alliance."





**Employees**





We
      currently employ approximately 40 employees; the vast majority of whom are
      employed on a full time basis.





**ITEM
      1A. RISK FACTORS**





**We
      have a limited operating history and have engaged in our current business only
      since August 2003.**





In
      November 2003, under prior management of the Company, we discontinued our
      business of manufacturing and selling a video controller. Our current videogame
      distribution business commenced operations on August 11, 2003 and was acquired
      by us in June 2004. We have not yet demonstrated our ability to operate
      profitably during a major downturn in our industry.





**We
      may be unable to sell our existing inventory as a result of shortages of new
      platform systems.**





We
      may be
      adversely affected if a current industry shortage of certain hardware models
      continues for a lengthy period of time. Shortages of systems, including
      shortages of the newly introduced PS3 and of the PS2 product from Sony
      Corporation, the newly introduced Wii from Nintendo, and Xbox 360 consoles
      from
      Microsoft, can cause a significant slowdown in industry revenues. If this were
      to continue and intensify, there would be a significant negative impact on
      our
      and on our customers’ ability to sell existing inventory. As a result, orders by
      our customers would be reduced significantly, which would greatly limit our
      ability to sell these products. Furthermore, although major manufacturers have
      traditionally reduced the prices of their current hardware models in conjunction
      with the launch of new systems, we cannot assure you that these manufacturers
      will continue this price reduction strategy. Even if manufacturers do reduce
      prices, we cannot assure you that any past success will result in increased
      purchases of existing systems ahead of new platform launches.





**We
      are dependent on the contributions of our key executives and must maintain
      their
      services; Not entitled to key man proceeds.**





Our
      success depends in large degree upon the skills of our senior management team
      and key employees and, in particular, Jay Gelman, our Chairman and CEO, and
      Andre Muller, our COO. An employment agreement with Mr. Gelman expired on June
      30, 2006. Neither of such persons has expressed any intention to terminate
      services. We have obtained only $1,000,000 in key man insurance on the life
      of
      Mr. Gelman, and this policy has been assigned to the Company’s senior lender.
      The loss of the services of any of these persons would have a material adverse
      effect on our business.





**Gross
      margins relating to our business have been historically narrow which increases
      the impact of variations in costs on our operating results.**





As
      a
      result of intense price competition, our gross margins in our business have
      historically been narrow and may continue to be narrow in the future.
      Accordingly, slight variations in operating costs and expenses could result
      in
      significant losses in our distribution business from period to period.




**We
      depend on a limited number of suppliers and have no long-term agreement with
      any
      suppliers.**





Our
      ability to obtain particular products in required quantities and to fulfill
      customer orders on a timely basis is critical to our success. In most cases,
      we
      have no guaranteed price or delivery agreements with suppliers. In certain
      product categories, limited price concessions or return rights offered by
      publishers may have a bearing on the amount of product we may be willing to
      purchase. Our industry may experience significant hardware supply shortages
      from
      time to time due to the inability of certain manufacturers to supply certain
      products on a timely basis. As a result, we have experienced, and may in the
      future continue to experience, short-term hardware inventory shortages. In
      addition, we do not develop or manufacture any of the products we sell, but
      act
      solely as a distributor for the products of third parties. As such, we are
      entirely dependent on manufacturers or publishers who currently distribute
      their
      products through us, and who may, at any time, decide to distribute, or to
      substantially increase their existing distribution, through other distributors,
      or directly to retailers. For the year ended 2006, three of our suppliers in
      the
      aggregate accounted for approximately 49% of our purchases (with one accounting
      for 27% alone) and the ten largest suppliers in the aggregate accounted for
      approximately 74% of our purchases. Our distribution agreements with our major
      suppliers are generally terminable at any time by the suppliers on 30 days’
prior written notice. In the event that we are unable to maintain our
      distribution arrangements with one or more of these significant suppliers,
      our
      business would be harmed and may not survive.





I-4


**We
      would be adversely affected by a change in the marketing and distribution of
      videogame hardware systems and videogames by
      manufacturers.**





Major
      manufacturers such as Sony, Nintendo and Microsoft, could change their marketing
      strategies and rely less on their current distributors to sell hardware systems
      and videogames. Since we depend on the products from these manufacturers for
      a
      significant portion of our revenues, this would adversely impact our financial
      situation, as there would be fewer products available for sale by us and our
      customers would be forced to look for other sources to procure the types of
      products we currently sell to them. Although we believe that there is only
      a
      limited risk that these manufacturers would significantly reduce their
      distribution of products through us, because of our high level of product
      penetration and strong customer base, we cannot assure you that one or more
      of
      these manufacturers will not take such action.





**We
      have not entered into any distribution arrangement with Microsoft for
      distribution of its Xbox® 360 products.**





To
      date
      we have no direct business relationship with Microsoft Corporation (“Microsoft”)
      for the distribution of its Xbox 360 game console. This product currently
      represents an important segment of the videogame console market. As a result
      of
      our inability to obtain a direct distribution arrangement with Microsoft, we
      have had to purchase Xbox® 360 products from one of Microsoft’s distributors,
      thereby reducing our margins on these products. In the event that we are unable
      to acquire a direct distribution arrangement with Microsoft in the near future
      for the sale of Xbox 360 products, our business could be adversely
      affected.





**Our
      quarterly operating results may vary significantly, which could cause the price
      of our Common Stock to decline.**





We
      have
      experienced and may continue to experience wide fluctuations in quarterly
      operating results. The interactive entertainment industry is highly seasonal,
      with sales typically higher during the fourth calendar quarter, due primarily
      to
      the increased demand for games during the holiday buying season. Our failure
      or
      inability to acquire products on a timely basis to meet seasonal fluctuations
      in
      demand may harm our business and operating results. These fluctuations could
      also cause the price of our Common Stock to decline. Other factors that cause
      fluctuations include:





•
            delays
                in the introduction of new titles;•
            the
                size and timing of product and business acquisitions;•
            variations
                in sales of titles designed to operate on particular platforms;•
            availability
                of hardware platforms;•
            product
                returns and price concessions; and•
            the
                timing of orders from major customers.





Our
      expense levels are based, in part, on our expectations regarding future sales
      and therefore our operating results would be harmed by a decrease in sales
      or a
      failure to meet our sales expectations. The uncertainties associated with
      interactive entertainment software development, manufacturing lead times,
      production delays and the approval process for products by hardware
      manufacturers and other licensors make it difficult to predict the quarter
      in
      which products will ship and therefore may cause us to fail to meet financial
      expectations. In future quarters our operating results may fall below the
      expectations of securities analysts and investors. In this event, the market
      price of our Common Stock could significantly decline.





**We
      are subject to the risk that our inventory values may decline and protective
      terms under supplier arrangements may not adequately cover the decline in
      values.**





The
      interactive entertainment software and hardware industry is characterized by
      the
      introduction of new and enhanced generations of products and evolving industry
      standards. These changes may cause inventory to decline substantially in value
      or to become obsolete. We are also exposed to inventory risk in our distribution
      business to the extent that supplier price concessions are not available on
      all
      products or quantities and are subject to time restrictions. In addition,
      suppliers may become insolvent and unable to fulfill price concession
      obligations.





I-5


**We
      have no long term agreements with any customer and we are dependent on a limited
      number of customers.**





We
      do not
      have long-term purchase and sale agreements with any of our customers, and
      all
      of our sales to customers are made on a purchase order by purchase order basis.
      Although our customer base currently consists of approximately 2,600 retail
      stores located throughout the United States and Canada, with a majority being
      in
      the New York metropolitan area and surrounding tri-state region, during the
      year
      ended December 31, 2006, our largest customer accounted for 9% of our total
      sales, our top five customers accounted for 36% of our sales, our top ten
      customers accounted for 49% of our sales and our top 25 customers accounted
      for
      65% of our sales. Since we have no long-term commitments with any of the
      customers to continue to purchase products from us, the loss of any of these
      customers could have a materially adverse effect on our business.





**We
      hold no patents or material proprietary technology.**





We
      have
      no intellectual property other than a trademark for “Video Game Alliance.”





**Unanticipated
      warranty costs could affect our ability to operate profitably.**





We
      do not
      have any facilities for the repair or service of any products, and generally
      reimburse our customers in full for returns. Although the majority of our
      suppliers accept these returns from us, certain suppliers credit us with a
      fixed
      allowance for returns and require that we assume the risk of excess returns.
      We
      will be adversely affected if our returns for these suppliers exceed their
      return allowances.





**Risks
      Related To Our Industry**





**Our
      business operates in a highly competitive environment.**





The
      intense competition that characterizes our industry is based primarily on
      breadth, availability and quality of product lines; price; terms and conditions
      of sale; credit terms and availability; speed and accuracy of delivery; and
      effectiveness of sales and marketing programs. Our competitors include regional,
      national and international distributors, as well as hardware manufacturers
      and
      software publishers. There are several distributors in the United States that
      have revenues and financial resources and company history substantially greater
      than us. We are at a disadvantage to these companies and need to compete on
      the
      basis of the services we provide to our customers. We may lose market share
      or
      be forced in the future to reduce our prices in response to the actions of
      our
      competitors, and thereby experience a reduction in our gross margins.





**We
      may be adversely affected if the financial health of the U.S. retail industry
      should deteriorate.**





We
      are
      subject to broad economic factors that drive consumer spending and maintain
      the
      health of the U.S. retail industry. These factors include, but are not limited
      to, unemployment rates, consumer credit levels, consumer confidence, and
      household discretionary income. If any of these or other economic factors should
      erode, consumer spending would fall and the U.S. retail industry would suffer
      a
      downturn. Consequently, our earnings would be adversely impacted by lower
      sales.




**We
      may be adversely affected by the trend towards retail trade
      consolidation.**





As
      we
      pursue our retail distribution strategy, our sales will be contingent upon
      the
      favorable wholesale prices that we can obtain from retailers. If retailers
      merge
      or the retail industry consolidates, the larger, combined retailers will have
      significant pricing power because of the sheer size of their retail networks.
      As
      a result, we may not be able to obtain reasonable prices for the products we
      distribute. Consequently, our margins will decline and our results of operations
      would be reduced. There can be no assurance that we will be able to obtain
      reasonable wholesale prices for the products we distribute under a scenario
      where retailers merge and consolidate into larger entities.





I-6


**The
      market for the titles we carry is characterized by short product life cycles.**





The
      market for the titles we carry is characterized by short product life cycles
      and
      frequent introductions of new products. New products introduced may not achieve
      significant market acceptance or achieve sufficient sales to permit us to
      recover the amounts advanced by us to purchase such products, as well as our
      marketing costs. The life cycle of a game generally involves a relatively high
      level of sales during the first few months after introduction followed by a
      decline in sales. Because revenues associated with the initial shipments of
      a
      new product generally constitute a high percentage of the total revenues
      associated with the life of a product, any delay in the introduction of one
      or
      more new products or our ability to obtain such products on a timely basis,
      could adversely affect our operating results for particular
      periods.





**Our
      business is cyclical, and we may fail to anticipate changing consumer
      preferences.**





Our
      business is subject to all of the risks generally associated with the
      interactive entertainment industry, which has been cyclical in nature and has
      been characterized by periods of significant growth followed by rapid declines.
      Our future operating results will depend on numerous factors beyond our control,
      including:





°
            the
                popularity, price and timing of new software and hardware platforms
                being
                released and distributed by us and our
                competitors;





°
            international,
                national and regional economic conditions, particularly economic
                conditions adversely affecting discretionary consumer spending;





°
            war,
                acts of terrorism and military action, which could adversely affect
                consumer preferences in entertainment;





°
            changes
                in consumer demographics;





°
            the
                availability and popularity of other forms of entertainment;
                and





°
            critical
                reviews and public tastes and preferences, all of which change rapidly
                and
                cannot be predicted.





In
      order
      to plan for acquisition and promotional activities, we must anticipate and
      respond to rapid changes in consumer tastes and preferences. A decline in the
      popularity of interactive entertainment or particular platforms could cause
      sales of the products we distribute to decline dramatically. The period of
      time
      necessary to develop new game titles, obtain approvals of manufacturers and
      produce finished products is unpredictable. During this period, consumer appeal
      for a particular title may decrease, causing product sales to fall short of
      expectations.





**Rating
      systems for interactive entertainment software, potential legislation and
      consumer opposition could inhibit sales of the products we
      carry** *.*





Trade
      organizations within the videogame industry require interactive entertainment
      software publishers to provide consumers with information relating to graphic
      violence, profanity or sexually explicit material contained in software titles,
      and impose penalties for noncompliance. We understand that certain countries
      have also established similar rating systems as prerequisites for sales of
      interactive entertainment software in such countries. Our suppliers’ software
      titles receive a rating of “E” (age 6 and older), “T” (age 13 and over) or “M”
(age 17 and over). Many of the new titles we carry have received an M rating.
      We
      do not know whether our supplies properly comply with such rating systems or
      properly display the ratings and content descriptions received for our
      titles.





Several
      proposals have been made for federal legislation to regulate the interactive
      entertainment software, motion picture and recording industries, including
      a
      proposal to adopt a common rating system for interactive entertainment software,
      television and music containing violence or sexually explicit material, and
      the
      Federal Trade Commission has issued reports with respect to the marketing of
      such material to under-17 audiences. Consumer advocacy groups have also opposed
      sales of interactive entertainment software containing graphic violence or
      sexually explicit material by pressing for legislation in these areas (including
      legislation prohibiting the sale of certain “M” rated videogames to under-17
      audiences) and by engaging in public demonstrations and media campaigns.
      Retailers may decline to sell interactive entertainment software containing
      graphic violence or sexually explicit material, which may limit the potential
      market for the “M” rated products we sell, and adversely affect our operating
      results. If any groups (including international, national and local political
      and regulatory bodies) were to target our suppliers’ “M” rated titles, we might
      be required to discontinue a particular title, which in the case of the best
      selling titles could seriously hurt our business.





I-7


**Our
      business is subject to sudden changes in the popularity of the products we
      distribute and to technological changes.**





We
      will
      be adversely affected by any material decrease in the attractiveness of
      videogames, or by the availability of equivalent entertainment through the
      Internet or other channels. The sudden decline in popularity of even one
      particular video console or game can force us to make a substantial write-down
      of our inventory of these products.





**ITEM
      2. DESCRIPTION OF PROPERTIES**





On
      June
      8, 2006, we entered into an agreement to lease approximately 25,000 square
      feet
      of space at 1160 Commerce Avenue, Bronx, New York 10462, of which approximately
      18,000 and 7,000 square feet is utilized for warehouse and office space,
      respectively. The lease has a five-year term commencing on June 1, 2006 and
      expiring on May 31, 2011, with an option to extend the term for an additional
      five-year term expiring on May 31, 2016. Our annual base rent is $295,000 for
      the first year of the term (which we pay in 12 equal monthly payments of
      approximately $24,583) and increases 3.5% on June 1 st of each
      year beginning with June 1, 2007. In the event we exercise our option to renew
      the lease, the annual base rent will continue to increase at the 3.5% annual
      rate.





In
      addition, on June 13, 2006, we leased approximately 7,000 square feet of space
      in Miami, Florida, of which approximately 5,000 square feet is used as a
      warehouse and the remaining 2,000 as a showroom and offices. The lease has
      a
      five-year term commencing on June 1, 2006. The annual base rent is $56,400
      for
      the first two years of the term (payable in monthly payments of $4,700), and
      increases 2.0% on June 1 st of each
      year beginning with June 1, 2008. In addition, we pay condominium maintenance
      fees (currently $600 per month), real property taxes (currently $800 per month)
      and all applicable sales tax.





Our
      current premises are adequate for our current operations and we do not
      anticipate that we will require any additional premises in the foreseeable
      future.





**ITEM
      3. LEGAL PROCEEDINGS**





Other
      than as set forth below, we know of no material, active or pending legal
      proceedings against our company, nor are we involved as a plaintiff in any
      material proceeding or pending litigation. There are no proceedings in which
      any
      of our directors, officers or affiliates, or any registered or beneficial
      shareholder, is an adverse party or has a material interest adverse to our
      interest.





In
      October 2006, we paid $200,000 in settlement of a legal proceeding that had
      been
      brought against Essential Reality, Inc. (a predecessor of our Company),
      Essential Reality, LLC and David Devor, a former officer and a current employee,
      for rent and costs relating to premises formerly occupied by us. As of 2005,
      we
      had accrued $125,000 against the potential outcome of the litigation. In 2006,
      we recorded an additional $75,000, and paid the entire settlement
      amount.





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





None





I-8


**PART
      II**





**ITEM
      5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**





Our
      common stock has traded on the OTC Bulletin Board since April 28, 2005. It
      traded on the Pink Sheets Electronic Quotation Service from July 2003 to April
      27, 2005 and on the OTC Bulletin Board from April 19, 2001 until July 2003.
      Our
      current trading symbol is ADTR.OB. The following table sets out the high and
      low
      closing bid prices of our common stock during the periods indicated as quoted
      on
      the OTC Bulletin Board and the Pink Sheets Electronic Quotation Service. Prices
      reflect inter-dealer prices, without retail mark-up, mark-down or commissions,
      and may not represent actual transactions.





**Common
                Stock****Bid
                Prices****2006**
            **High**
            **Low**First
                Quarter
            $0.46
            $0.20Second
                Quarter
            $0.22
            $0.11Third
                Quarter
            $0.18
            $0.09Fourth
                Quarter
            $0.18
            $0.11**2005**
            **High**
            **Low**First
                Quarter
            $0.65
            $0.11Second
                Quarter
            $0.20
            $0.12Third
                Quarter
            $0.45
            $0.13Fourth
                Quarter
            $0.47
            $0.20





As
      of
      March 16, 2007, there were approximately 550 stockholders of record of the
      Company's Common Stock. This number does not include certain shares held in
      street name. The Company has not paid cash dividends on its Common Stock and
      does not plan to pay cash dividends in the foreseeable future.





**(d)
      Securities Authorized for Issuance Under Equity Compensation
      Plans**





Our
      Alliance Distributors Holding Inc. 2004 Stock Plan (the "2004 Plan") was adopted
      by our directors on October 25, 2004 and was approved by our stockholders on
      October 25, 2004. Our 2006 Stock Plan (the “2006 Plan”) was adopted by our
      directors on October 3, 2006 and was approved by our stockholders on
      February 1, 2007. Both plans enable us to grant equity and equity-linked awards
      to our Directors, officers, employees and other persons who provide services
      to
      us. The plans are intended to allow us to provide incentives that will (1)
      strengthen the desire of highly competent persons to provide services to us
      and
      (2) further stimulate their efforts on our behalf. We have made no grants under
      the 2006 Stock Plan.





As
      of
      December 31, 2006, we have 6,990,000 options outstanding under the 2004 Plan.
      The options are ten-year non-qualified options to purchase our common stock,
      6,740,000 of the options have an exercise price of $0.325 per share, 150,000
      of
      the options have an exercise price of $0.32 per share, and 100,000 of the
      options have an exercise price of $0.18 per share. All options vest and become
      exercisable in 12 equal quarterly installments. Of the total options granted,
      1,100,000 options were granted to Jay Gelman, our Chairman of the Board of
      Directors and Chief Executive Officer, 1,100,000 options were granted to Andre
      Muller, our President, Chief Operating Officer and director, 100,000 options
      were granted to Stephen Agress, our Executive Vice President, Chief Financial
      Officer and Secretary and 150,000 options were granted to each of Thomas
      Vitiello, Steven H. Nathan and Humbert B. Powell, III, each non-employee members
      of our Board of Directors. We granted the options in reliance on the exemption
      from registration provided by Section 4(2) of the Securities Act of 1933, as
      amended.





II-1


**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**Equity
                compensation under the 2004 Stock Plans approved by security
                holders
            6,990,000
            $0.32
            3,010,000Equity
                compensation under the 2006 Stock Plans approved by security
                holders
            -
            -
            10,000,000








**ITEM
      6. SELECTED FINANCIAL DATA.**





**Year
                ended December 31,**
            
            **May
                9, 2003 (inception)**
              **to****2006**
            
            **2005**
            
            **2004**
            
            **Dec.
                31, 2003**(In
                thousands, except per share data)**STATEMENT
                OF OPERATIONS DATA:**Net
                sales
            
            $
            70,318
            
            $
            58,670
            
            $
            35,037
            
            $
            10,513Gross
                profit
            
            $
            6,893
            
            $
            5,938
            
            $
            3,921
            
            $
            1,294Income
                (loss) before provision for (benefitfrom)
                income taxes
            
            $
            (261
            )
            $
            108
            
            $
            (228
            )
            $
            208Net
                income (loss)
            
            $
            (214
            )
            $
            186
            
            $
            (242
            )
            $
            200Preferred
                stock dividends
            
            $
            -
            
            $
            -
            
            $
            164
            
            $
            -Net
                Income (loss) available to common stockholders
            
            $
            (214
            )
            $
            186
            
            $
            (406
            )
            $
            200Income
                (loss) available to common stockholders:Basic
            
            $
            .00
            
            $
            .00
            
            $
            (.01
            )
            $
            .01Diluted
            
            $
            .00
            
            $
            .00
            
            $
            (.01
            )
            $
            .01Cash
                dividends per share
            
            $
            .00
            
            $
            .00
            
            $
            .00
            
            $
            00





**December
                31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**(in
                thousands)**BALANCE
                SHEET DATA:**Working
                capital
            
            $
            2,378
            
            $
            2,847
            
            $
            2,587
            
            $
            501Total
                assets
            
            $
            19,117
            
            $
            12,870
            
            $
            8,157
            
            $
            5,516Long
                term liabilities
            
            $
            44
            
            $
            38
            
            $
            49
            
            $
            307Total
                stockholders’ equity
            
            $
            3,230
            
            $
            3,251
            
            $
            3,024
            
            $
            636





**ITEM
      7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF
      OPERATIONS.**





Our
      distribution revenues are derived from the sale of interactive video games
      and
      gaming products for all key manufacturers and third-party software titles,
      accessories and hardware. Operating margins in our distribution business are
      dependent on the mix of software and hardware sales, with software and
      accessories generating higher margins than hardware.





II-2


**YEAR
      ENDED DECEMBER 31, 2006 AND 2005**





The
      following tables show each specified item as a dollar amount and as a percentage
      of net sales in each fiscal period, and should be read in conjunction with
      the
      financial statements included elsewhere in this Annual Report on Form 10-K:





**Year
                ended December 31,****2006**
            
            **2005**Dollars
                in thousandsNet
                sales
            
            $
            70,318
            
            
            100.0
            %
            $
            58,670
            
            
            100.0
            %Cost
                of goods sold
            
            
            63,425
            
            
            90.2
            %
            
            52,732
            
            
            89.9
            %Gross
                profit
            
            
            6,893
            
            
            9.8
            %
            
            5,938
            
            
            10.1
            %Operating
                costs and expenses:Selling
                and administrative expenses
            
            
            5,907
            
            
            8.4
            %
            
            5,061
            
            
            8.6
            %Provision
                for doubtful accounts
            
            
            147
            
            
            0.2
            %
            
            247
            
            
            0.4
            %Terminated
                transaction costs
            
            
            310
            
            
            0.4
            %
            
            -
            
            
            -Total
                operating costs and expenses
            
            
            6,364
            
            
            9.0
            %
            
            5,308
            
            
            9.0
            %Income
                from operations
            
            
            529
            
            
            0.8
            %
            
            630
            
            
            1.1
            %Interest
                expense
            
            
            790
            
            
            1.1
            %
            
            522
            
            
            0.9
            %(Loss)
                income before benefit from income taxes
            
            
            (261
            )
            
            (0.3
            )%
            
            108
            
            
            0.2
            %Benefit
                from income taxes
            
            
            (47
            )
            
            (0.0
            )%
            
            (78
            )
            
            (0.1
            )%Net
                (loss) income
            
            $
            (214
            )
            
            (0.3
            )%
            $
            186
            
            
            0.3
            %





**RESULTS
      OF OPERATIONS**





Net
      sales
      increased by $11,648,000 or 20%, from $58,670,000 for the year ended December
      31, 2005 to $70,318,000 for the year ended December 31, 2006. The growth in
      net
      sales was primarily due to the increase in sales with our existing customers,
      as
      well as an increase in our customer base.





Cost
      of
      goods sold increased by $10,693,000 or 20%, from $52,732,000 for the year ended
      December 31, 2005 to $63,425,000 for the year ended December 31, 2006. The
      increase in cost of good sold is attributable to and consistent with the
      increase in sales. Cost of goods sold excludes the distribution costs of
      purchasing, receiving, inspection, warehousing and handling costs; we include
      these costs in our selling and administrative expenses. These distribution
      costs
      were $1,452,000 and $1,161,000 for the years ended 2006 and 2005, respectively.
      Our gross profit as a percentage of net sales decreased slightly to 9.8% for
      the
      year ended December 31, 2006 from 10.1%, for the year ended December 31, 2005.
      Our gross profit may not be comparable to those of other entities since some
      entities include distribution costs in the cost of goods sold.





Selling
      and administrative expenses increased by $846,000 or 17%, from $5,061,000 for
      the year ended December 31, 2005 to $5,907,000 for the year ended
      December 31, 2006. The increase was primarily the result of increases in freight
      out expenses of approximately $211,000, due to both increased sales volume
      and
      fuel cost increases, approximately $379,000 for increased payroll, commissions
      and related payroll costs, approximately $155,000 related to equity-based
      compensation resulting from the adoption of SFAS 123(R), and approximately
      $208,000 in increased rent and utilities attributable to new warehouse and
      showroom facilities in New York and Florida. These increases were in part offset
      by a $220,000 gain from insurance proceeds for replacement value of assets
      in
      excess of book value that were damaged, and for extra costs incurred, as a
      result of a fire near our former 132 nd street
      location. The balance of the change in selling and administrative expenses
      was
      due to various increases in administrative expenses. Selling and administrative
      expenses as a percentage of net sales decreased to 8.4% for the year ended
      2006
      from 8.6% for the year ended December 31, 2005. For the year ended December
      31,
      2006, selling and administrative expenses were comprised of the following:
      $984,000 in selling expenses, $1,452,000 in distribution costs and $3,471,000
      in
      administrative expenses. For the year ended December 31, 2005, selling and
      administrative expenses were comprised of the following: $796,000 in selling
      expenses, $1,161,000 in distribution costs and $3,104,000 in administrative
      expenses.





II-3


Our
      provision for doubtful accounts decreased by $100,000, or 40%, from $247,000
      in
      2005 to $147,000 in 2006. The decrease is principally attributable to a
      reduction in potentially uncollectible accounts receivable
      balances.





We
      expensed terminated transaction costs of $310,000 in 2006 as a result of our
      decision not to acquire Foto Electric Supply Co., Inc. An agreement by the
      Company to acquire Fesco had expired by its terms on February 28, 2006, and
      subsequent discussions to extend and amend the agreement ended.





Interest
      expense increased by $268,000 or 51%, from $522,000 for the year ended December
      31, 2005 to $790,000 for the year ended December 31, 2006. The increase was
      primarily due to higher interest rates on bank borrowings and increased
      borrowings. The increased borrowing levels were the result of increased sales
      volume that required higher inventory levels and increased accounts
      receivable.





In
      2006,
      the benefit from income taxes was $47,000 or 18% of the loss before taxes
      compared to a benefit from income taxes of $78,000, or 72% of income before
      taxes in 2005. The 2006 benefit is lower than the U.S. Federal statutory rate
      principally due to a provision for local taxes based upon an alternative tax
      computation, certain expenses not deductible for income tax purposes, and the
      reduction of the deferred tax valuation allowance associated with net operating
      loss carryforwards. In 2005, the benefit is higher than the expected provision
      based upon the U.S. Federal statutory rate principally due to the utilization
      of
      net operating loss carryovers and the reduction of a valuation
      allowance.





**YEAR
      ENDED 2005 AND DECEMBER 31, 2004**





**Year
                ended December 31,****2005**
            
            **2004**Dollars
                in thousandsNet
                sales
            
            $
            58,670
            
            
            100.0
            %
            $
            35,037
            
            
            100.0
            %Cost
                of goods sold
            
            
            52,732
            
            
            89.9
            %
            
            31,116
            
            
            88.8
            %Gross
                profit
            
            
            5,938
            
            
            10.1
            %
            
            3,921
            
            
            11.2
            %Operating
                costs and expenses:Selling
                and administrative expenses
            
            
            5,061
            
            
            8.6
            %
            
            3,892
            
            
            11.1
            %Provision
                for doubtful accounts
            
            
            247
            
            
            0.4
            %
            
            27
            
            
            0.1
            %Total
                operating costs and expenses
            
            
            5,308
            
            
            9.0
            %
            
            3,919
            
            
            11.2
            %Income
                from operations
            
            
            630
            
            
            1.1
            %
            
            2
            
            
            0.0
            %Interest
                expense
            
            
            522
            
            
            0.9
            %
            
            230
            
            
            0.7
            %Income
                (loss) before (benefit from) provision for income taxes
            
            
            108
            
            
            0.2
            %
            
            (228
            )
            
            (0.7
            )%(Benefit
                from) provision for income taxes
            
            
            (78
            )
            
            (0.1
            )%
            
            14
            
            
            0.0
            %Net
                income (loss)
            
            $
            186
            
            
            0.3
            %
            $
            (242
            )
            
            (0.7
            )%





**RESULTS
      OF OPERATIONS**





Net
      sales
      increased by $23,633,000 or 67%, from $35,037,000 for the year ended December
      31, 2004 to $58,670,000 for the year ended 2005. The growth in net sales was
      primarily due to the increase in sales with our existing customers, as well
      as
      an increase in our customer base.





II-4


Cost
      of
      goods sold increased by $21,616,000, or 69%, from $31,116,000 for the year
      ended
      December 31, 2004 to $52,732,000 for the year ended 2005. The increase was
      consistent with revenue growth. Gross profit as a percentage of net sales
      decreased to 10.1% for the year ended 2005 from 11.2% for the year ended
      December 31, 2004. This decrease was primarily due to the Company's strategy
      to
      grow the customer base and increase revenues by introducing incentive pricing
      programs to new and key customers. Cost of goods sold excludes the distribution
      costs of purchasing, receiving, inspection, warehousing and handling costs;
      we
      include these costs in our selling and administrative expenses. Our gross
      margins may not be comparable to those of other entities since some entities
      include these distribution costs in the cost of goods sold. These distribution
      costs were $1,161,000 and $994,000 for the year ended 2005 and 2004,
      respectively.





Selling
      and administrative expenses increased by $1,169,000, or 30%, from $3,892,000
      for
      the year ended December 31, 2004 to $5,061,000 for the year ended
      December 31, 2005. The increase was primarily due to the Company's
      increase in salaries and related payroll taxes of $282,000, advertising and
      marketing expenses of $195,000, professional fees associated with the Company's
      expanded operations of $133,000, litigation expenses of $125,000, freight out
      expenses of $120,000, insurance premiums of $92,000 and stock option
      compensation expense of $38,000 as a result of 750,000 options that were granted
      to non-employees who provide services to the Company. Selling and administrative
      expenses as a percentage of net sales decreased to 8.6% for the year ended
      December 31, 2005 from 11.1% for the year ended December 31, 2004. For
      the year ended December 31, 2005, selling and administrative expenses
      were comprised of the following: $796,000 in selling expenses, $1,161,000 in
      distribution costs and $3,104,000 in administrative expenses. For the year
      ended
      December 31, 2004, selling and administrative expenses were comprised of the
      following: $497,000 in selling expenses, $994,000 in distribution costs and
      $2,401,000 in administrative expenses.





Our
      provision for doubtful accounts increased by $220,000, from $27,000 in 2004
      to
      $247,000 in 2005. The increase is principally attributable to an increase in
      potentially uncollectible accounts receivable balances.





Interest
      expense increased by $292,000, or 127%, from $230,000 for the year ended
      December 31, 2004 to $522,000 for the year ended December 31, 2005.
      The increase was primarily due to increased borrowings as well as higher
      interest rates on bank borrowings during the year ended
      December 31, 2005. The increased borrowing levels were the result of
      increased sales volume that required higher inventory levels and increased
      accounts receivable.





**LIQUIDITY
      AND CAPITAL RESOURCES**





Net
      cash
      used in operating activities was $1,436,000 for the year ended December 31,
      2006, compared to $2,423,000 cash used in operating activities for the year
      ended December 31, 2005, a decrease of $987,000. The
      $987,000 decrease is principally attributable to a decrease in amounts due
      from
      vendors combined with an increase in accounts payable resulting in a $4,401,000
      increase in cash, partially offset by a $214,000 net loss in 2006 compared
      to
      $186,000 net income in 2005, and a $2,234,000 increase in cash used in operating
      activities resulting from an increase in inventory. The remaining difference
      is
      principally due to changes in other operating assets and liabilities. The
      decrease in amounts due from vendors and increase in accounts payable resulted
      both from growth in the business and an increase in the amount of credit
      extended by suppliers.





Net
      cash
      used in investing activities increased by $276,000, from $144,000 in 2005 to
      $420,000 in 2006. The increase is principally attributable to an increase in
      capital expenditures, partially offset by proceeds from an insurance claim
      in
      2006 totaling approximately $305,000. In 2006 we purchased $699,000 of property
      and equipment, of which approximately $600,000 was in connection with our move
      to a new warehouse, showroom and executive offices in New York City, and
      approximately $50,000 was for our new warehouse in Florida, which we opened
      in
      September 2006.





Net
      cash
      provided by financing activities for the year ended December 31, 2006 decreased
      by $648,000, from $2,598,000 in 2005 to $1,950,000 in 2006. The decrease was
      principally due to a decrease in net proceeds from our bank loan approximating
      $702,000, partially offset by net cash used in other financing activities
      approximating $54,000.





We
      have a
      financing agreement (the “Agreement”) with Rosenthal & Rosenthal, Inc.
      ("Rosenthal") pursuant to which Rosenthal may in its discretion lend to us
      up to
      $10,000,000, which is the maximum credit under the facility, based on eligible
      inventory and receivables. All borrowings are due on demand, are secured by
      substantially all of our assets, and require us to be in compliance with certain
      financial covenants. Our CEO and our President have signed limited guaranties
      in
      respect of borrowings under the Agreement.





II-5


The
      Agreement terminates November 30, 2007 unless earlier terminated by Rosenthal
      on
      30 days' notice. Interest accrues on outstanding borrowings at the prime rate
      (but not less than 4.75%) plus 1.5%. **** At
      December 31, 2006, the interest rate on borrowings outstanding was 9.75%. In
      addition, we are obligated to pay the lender on each anniversary date an annual
      fee of 1% of the maximum credit which is amortized over one year, and a monthly
      administrative fee of $1,000. The financing expense for the annual fee recorded
      totaled approximately $96,000, $56,000 and $6,000 for the three years ended
      December 31, 2006.





In
      connection with the Agreement, on November 11, 2005 we issued to Rosenthal
      a
      warrant (the "Warrant") to purchase 500,000 shares of common stock at $0.10
      per
      share. The Warrant expires on November 30, 2010. On notice by the Company the
      Warrants will expire earlier if the closing price of the common stock during
      a
      period designated in the Warrants is not less than $0.40 per share. The Warrants
      may be exercised by Rosenthal at $.10 per share for cash or on a cashless basis
      (i.e., by deducting from the number of shares otherwise issuable on exercise
      a
      number of shares that have a then market value equal to the exercise price).
      We
      recorded a deferred financing cost of approximately $60,000 in the fourth
      quarter 2004, representing the fair value of the warrants, which is amortized
      over the life of the financing agreement of three years. The financing expense
      recorded totaled approximately $20,000, $18,000 and $5,000 for the three years
      ended December 31, 2006, respectively.





Under
      the
      terms of the Agreement, we are required to maintain a specified level of net
      worth, working capital and debt ratios as defined. At various times throughout
      the Agreement, Rosenthal has amended the covenants. As of December
      31, 2006, the Company did not comply with certain financial covenants for
      which Rosenthal has provided a waiver.





We
      believe we will have sufficient liquidity for the next twelve months and the
      foreseeable future. However, our business would be materially and adversely
      affected if Rosenthal demands payment of these borrowings under the Agreement
      and if we are unable to refinance these borrowings. We are currently in
      discussions to renegotiate our existing facility with our current lender and
      we
      believe we will be able to secure an extension of the existing agreement or
      alternative financing when the current line of credit expires.





In
      September 2006, we relocated our offices, wholesale showroom, and warehouse
      to a 25,000
      square foot facility located at 1160
      Commerce Avenue in the Bronx, New York. The new facility, which provides almost
      10,000 square feet more than our old facilities, is leased for a five year
      term
      with an option for us to extend the term for an additional 5 year term expiring
      on May 31, 2016. Annual
      base rent is $295,000 for the first year of the term, with scheduled 3.5%
      increases each year commencing on June 1, 2007.





In
      addition, in September 2006 we opened a 7,000
      square feet distribution
      facility and wholesale showroom in Miami, Florida.





**Contractual
      Obligations**





The
      table
      below reflects our contractual cash obligations, expressed in thousands, at
      December 31, 2006.





**Payments
                Due by Period****Contractual
                Obligations**
            
            **Total**
            
            **Less
                than**
              **1
                year**
            
            **1-3
                years**
            
            **4-5
                years**
            
            **After**
              **5
                years**Long-term
                obligations
            
            $
            15
            
            $
            11
            
            $
            4
            
            $
            -
            
            $
            -Operating
                lease obligations
            
            
            1,668
            
            
            357
            
            
            749
            
            
            562
            
            
            -Note
                payable - bank
            
            
            7,201
            
            
            7,201
            
            
            -
            
            
            -
            
            
            -Note
                payable - bank, interest
            
            
            702
            
            
            702
            
            
            -
            
            
            -
            
            
            -Total
                contractual cash obligations
            
            $
            9,586
            
            $
            8,271
            
            $
            753
            
            $
            562
            
            $
            -


Note
      payable - bank in the table is shown as a less than one year obligation because
      the lending bank may demand payment at any time. Interest on the note accrues
      at
      the prime rate (but not less than 4.75%) plus 1.5%. At December 31, 2006, the
      interest rate on borrowings outstanding was 9.75%. Note payable - bank, interest
      assumes that the principal amount outstanding on the note is paid in full on
      November 30, 2007 (and refinanced immediately thereafter on comparable terms),
      that the principal amount outstanding during the period will be $7,201,000,
      and
      is based upon our current borrowing rate of 9.75%.




II-6


**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





Certain
      of our accounting policies require the application of significant judgment
      by us
      in selecting the appropriate assumptions for calculating financial estimates.
      By
      their nature, these judgments are subject to an inherent degree of uncertainty.
      These judgments are based on historical experience, observation of trends in
      the
      industry, information provided by customers and information available from
      other
      outside sources, as appropriate. Critical accounting policies include:





Revenue
      Recognition - We recognize sales upon shipment of products to customers as
      title
      and risk of loss pass upon shipment and collectibility is reasonably assured.
      We
      provide provisions for estimated uncollectible discounts and rebates to
      customers, estimated returns and allowances and other adjustments in the same
      period the related sales are recorded. While such amounts have been within
      expectations and the provisions established, we cannot guarantee that we will
      continue to experience the same rates as in the past.





Accounts
      Receivable - Accounts Receivable as shown on the Balance Sheet are net of
      allowances and anticipated discounts. We establish credit terms for new clients
      based upon a review of their credit information and perform ongoing credit
      evaluations of our customers, adjusting credit terms when we believe appropriate
      based upon payment history and an assessment of their current credit worthiness.
      The allowance for doubtful accounts is determined through analysis of the aging
      of accounts receivable at the date of the financial statements for estimated
      losses resulting from the inability of its clients to make required payments.
      We
      determine this allowance by considering a number of factors, including the
      length of time trade accounts receivable are past due, previous loss history,
      estimate of the client's current ability to pay its obligation to us, and the
      condition of the general economy and the industry as a whole. While credit
      losses have generally been within expectations and the provisions established,
      we cannot guarantee that credit loss rates in the future will be consistent
      with
      those experienced in the past. In addition, we have credit exposure if the
      financial condition of one of our major clients were to deteriorate. In the
      event that the financial condition of its clients were to deteriorate, resulting
      in an impairment of their ability to make payments, additional allowances may
      be
      necessary. It is reasonably possible that our estimate of the allowance for
      doubtful accounts will change. As of December 31, 2006 and 2005, our allowance
      for doubtful accounts approximated $312,000 and $181,000,
      respectively.




Inventories
      - Inventory is stated at the lower of cost or market, cost being determined
      on
      the average cost basis. We receive price protection from certain of our
      suppliers for merchandise that may be slow moving or aged. We evaluate the
      adequacy of our slow moving or aged inventory quarterly and write down inventory
      to fair value based upon the price protection received or current market value.
      While write-downs have been within expectations and the provisions established,
      we cannot guarantee that we will continue to experience the same level of
      write-downs as in the past. We do not offer warranties to our customers but
      will
      accept returns of product claimed to be defective and reimburse the customers
      for the purchase price paid. The majority of our suppliers in turn accept these
      returns by customers. There are no reserves for warranties as of December 31,
      2006 and 2005.





Income
      Taxes - At December 31, 2006, we had federal and state net operating loss
      carryforwards (NOL’s) of approximately $5.5 million. In accordance with SFAS No.
      109, “Accounting for Income Taxes”, we establish valuation allowances if it is
“more likely than not” that we will not be able to utilize the NOLs to offset
      future taxes. We have established a valuation allowance for the majority of
      the
      NOLs due to the uncertainty surrounding the realization of the NOL’s which
      resulted from a transaction under the Exchange Agreement. Pursuant to IRC
      Section 382 of the Tax Reform Act of 1986 the utilization of NOL’s is limited in
      the case of certain transactions including significant changes in ownership
      interests. We have determined that based upon the terms of the Exchange
      Agreement, an ownership change pursuant to this Act has occurred and as a
      result, the NOL’s are significantly limited.


II-7


**Recent
      Accounting Pronouncements**





In
      July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48)
“Accounting for Uncertainty in Income Taxes” which prescribes a recognition
      threshold and measurement process for recording in the financial statements
      uncertain tax positions taken or expected to be taken in a tax return.
      Furthermore, FIN 48 provides guidance on the recognition, classification,
      accounting in interim periods and disclosure requirements for uncertain tax
      positions. The accounting provisions of FIN 48 are effective for fiscal years
      beginning after December 15, 2006. We do not expect the adoption of
      FIN 48 to have a material impact on our financial statements.





In
      September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
      Accounting Bulletin No. 108 (SAB 108) “Considering the Effects of Prior Year
      Misstatements in Current Year Financial Statements.” SAB 108 provides guidance
      on quantifying financial statement misstatements, including the effects of
      prior
      year errors on current year financial statements. SAB 108 is effective for
      periods ending after November 15, 2006. The adoption of SAB 108 did not
      have a material impact on our financial statements.





In
      September 2006, the FASB issued SFAS No. 157 “Fair Value Measures” (“SFAS 157”).
      SFAS 157 defines fair value, establishes a framework for measuring fair value,
      and expands disclosures about fair value measurements. This statement applies
      under other accounting pronouncements that require or permit fair value
      measurements, however it does not apply to SFAS 123R. This Statement shall
      be
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. Earlier
      application is encouraged, provided that the reporting entity has not yet issued
      financial statements for that fiscal year, including any financial statements
      for an interim period within that fiscal year. The provisions of this statement
      should be applied prospectively as of the beginning of the fiscal year in which
      this Statement is initially applied, except in some circumstances where the
      statement shall be applied retrospectively. We do not expect the adoption of
      SFAS 157 to have a material impact on our financial statements.





**FLUCTUATIONS
      IN OPERATING RESULTS AND SEASONALITY**





We
      have
      experienced fluctuations in quarterly operating results as a result of the
      timing of the introduction of new titles; variations in sales of titles
      developed for particular platforms; market acceptance of our titles; sequels
      or
      enhancements of existing titles; projected and actual changes in platforms;
      the
      timing and success of title introductions by our competitors; product returns;
      changes in pricing policies by us and our competitors; order cancellations;
      and
      delays in product shipment. Sales of our titles are also seasonal, with peak
      shipments typically occurring in the fourth calendar quarter as a result of
      increased demand for titles during the holiday season. Annual comparisons of
      operating results are not necessarily indicative of future operating results.








**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK.**





Market
      risk represents the risk of changes in value of a financial instrument,
      derivative or non-derivative, caused by fluctuations in interest rates, foreign
      exchange rates and equity prices. We have no financial instruments that give
      us
      exposure to foreign exchange rates or equity prices.





Our
      pre-tax earnings and cash flows are exposed to changes in interest rates as
      all
      borrowings under its credit facility bear interest at the prime rate (but not
      less than 4.75%) plus 1.5%. As of December 31, 2006, our note payable-bank
      bore
      interest at 9.75%. As of December 31, 2006, a hypothetical immediate 10% adverse
      change in prime interest rates relating to the note would have an approximate
      $70,000 unfavorable impact on our earnings and cash flows over a one-year
      period, assuming the borrowing level remains consistent with the outstanding
      borrowings as of December 31, 2006. The fair value of the borrowings under
      the
      credit facility is not affected by changes in market interest
      rates.


II-8


**Item
      8. Financial Statements and Supplementary Data** **.**





**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**INDEX
      TO FINANCIAL STATEMENTS**





**PAGE**Report
                of Independent Registered Public Accounting Firm
            II-10Balance
                Sheets as of December 31, 2006 and 2005
            II-11Statements
                of Operations for the three years ended December 31, 2006
            II-12Statement
                of Stockholders’ Equity for the three years ended December 31,
                2006
            II-13Statements
                of Cash Flows for the three years ended December 31, 2006
            II-15Notes
                to Financial Statements
            II-16









II-9





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





The
      Stockholders


Alliance
      Distributors Holding Inc.





We
      have
      audited the accompanying balance sheets of Alliance Distributors Holding Inc.
      as
      of December 31, 2006 and 2005, and the related statements of operations,
      stockholders' equity and cash flows for each of the three years in the period
      ended December 31 2006. Our audits also included the financial statement
      schedule listed in the index at item 15 (a) (2) for each of the three years
      in
      the period ended December 31. 2006. These financial statements and financial
      statement schedule are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements and
      financial statement schedule 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 audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. The Company is not
      required to have, nor were we engaged to perform, an audit of its internal
      control over financial reporting. Our audits included consideration of internal
      control over financial reporting as a basis for designing audit procedures
      that
      are appropriate in the circumstances, but not for the purpose of expressing
      an
      opinion on the effectiveness of the Company's internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also 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
      audits provide a reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Alliance Distributors Holding
      Inc.
      as of December 31, 2006 and 2005, and the results of its operations and its
      cash
      flows for each of the three years in the period ended December 31, 2006 in
      conformity with accounting principles generally accepted in the United States
      of
      America. Also, in our opinion, the financial statement schedule, when considered
      in relation to the basic financial statements taken as a whole, presents fairly
      in all material respects the information set forth therein.











/s/
                Mahoney Cohen & Company, CPA, P.C.
              
              
              New
                York, New York
              March
                29, 2007


II-10


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**BALANCE
      SHEETS**


**DECEMBER
      31, 2006 AND 2005**


**(In
      Thousands, except per share amounts)**





**2006**
            
            ******2005****ASSETS****CURRENT
                ASSETS:**Cash
                and equivalents
            
            $
            346
            
            $
            252Accounts
                receivable-net
            
            
            7,922
            
            
            5,526Inventory
            
            
            9,104
            
            
            5,369Due
                from vendors
            
            
            83
            
            
            739Prepaid
                acquisition and proposed offering costs
            
            
            -
            
            
            162Prepaid
                expenses and other current assets
            
            
            615
            
            
            225Deferred
                income taxes
            
            
            151
            
            
            155**Total
                current assets**
            
            
            18,221
            
            
            12,428**PROPERTY
                AND EQUIPMENT - NET**
            
            
            752
            
            
            371**DEFERRED
                INCOME TAXES**
            
            
            67
            
            
            -**OTHER
                ASSETS**
            
            
            77
            
            
            71**TOTAL**
            
            $
            19,117
            
            $
            12,870**LIABILITIES
                AND STOCKHOLDERS' EQUITY****CURRENT
                LIABILITIES:**Notes
                payable - bank
            
            $
            7,201
            
            $
            5,135Accounts
                payable
            
            
            8,532
            
            
            4,033Current
                portion of long term obligations
            
            
            11
            
            
            19Accrued
                expenses and other current liabilities
            
            
            99
            
            
            394**Total
                current liabilities**
            
            
            15,843
            
            
            9,581**DEFERRED
                LEASE OBLIGATIONS**
            
            
            40
            
            
            26**LONG
                TERM OBLIGATIONS**
            
            
            4
            
            
            12**STOCKHOLDERS'
                EQUITY:**Series
                A Convertible Non-Redeemable Preferred Stock, $.001 par value;8,530
                and 8,615 shares authorized; 262 and 347 shares issued andoutstanding
                at December 31, 2006 and 2005, respectively
            
            
            -
            
            
            -Common
                stock, $.001 par value; 100,000 shares authorized; 48,721and
                47,369 shares issued and outstanding at December 31, 2006
                and2005,
                respectively
            
            
            49
            
            
            47Additional
                paid-in capital
            
            
            3,415
            
            
            3,224Accumulated
                deficit
            
            
            (234
            )
            
            (20
            )**Total
                stockholders’ equity**
            
            
            3,230
            
            
            3,251**TOTAL**
            
            $
            19,117
            
            $
            12,870





See
      notes
      to financial statements


II-11


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**STATEMENTS
      OF OPERATIONS**


**THREE
      YEARS ENDED DECEMBER 31, 2006**


**(In
      thousands, except per share amounts)**








**2006**
            
            **2005**
            
            **2004****NET
                SALES**
            
            $
            70,318
            
            $
            58,670
            
            $
            35,037**COST
                OF GOODS SOLD**
            
            
            63,425
            
            
            52,732
            
            
            31,116**GROSS
                PROFIT**
            
            
            6,893
            
            
            5,938
            
            
            3,921**OPERATING
                COSTS AND EXPENSES:**Selling
                and administrative expenses
            
            
            5,907
            
            
            5,061
            
            
            3,892Provision
                for doubtful accounts
            
            
            147
            
            
            247
            
            
            27Terminated
                transaction costs
            
            
            310
            
            
            -
            
            
            -**Total
                operating expenses**
            
            
            6,364
            
            
            5,308
            
            
            3,919**INCOME
                FROM OPERATIONS**
            
            
            529
            
            
            630
            
            
            2Interest
                expense
            
            
            790
            
            
            522
            
            
            230**(LOSS)
                INCOME BEFORE (BENEFIT FROM)****PROVISION
                FOR INCOME TAXES**
            
            
            (261
            )
            
            108
            
            
            (228
            )(Benefit
                from) provision for income taxes
            
            
            (47
            )
            
            (78
            )
            
            14**NET
                (LOSS) INCOME**
            
            
            (214
            )
            
            186
            
            
            (242
            )Preferred
                stock dividends
            
            
            -
            
            
            -
            
            
            164**NET
                (LOSS) INCOME AVAILABLE TO****COMMON
                STOCKHOLDERS**
            
            $
            (214
            )
            $
            186
            
            $
            (406
            )**Net
                loss per share available to common**
              **stockholders
                - basic**
            
            $
            -
            
            $
            -
            
            $
            (.01
            )**Net
                loss per share available to common****stockholders
                - diluted**
            
            $
            -
            
            $
            -
            
            $
            (.01
            )**Weighted
                average common shares outstanding - basic**
            
            
            48,584
            
            
            46,622
            
            
            35,330**Weighted
                average common shares outstanding - diluted**
            
            
            48,584
            
            
            47,110
            
            
            35,330








See
      notes
      to financial statements




II-12


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**STATEMENT
      OF STOCKHOLDERS' EQUITY**


**THREE
      YEARS ENDED DECEMBER 31, 2006**


**(In
      thousands)**




Preferred
                    Stock
                
                Common
                    StockShares
                
                Amount
                
                Shares
                
                Amount
                
                Additional
                      Paid
                        in Capital
                
                Accumulated
                      Deficit
                
                Total
                        Stockholders’
                        EquityBalance,
                    January 1, 2005
                
                
                564
                
                $
                -
                
                
                43,851
                
                $
                44
                
                $
                3,186
                
                $
                (206
                )
                $
                3,024Conversion
                    of Preferred Stock A into Common Stock
                
                
                (217
                )
                
                
                
                
                3,468
                
                
                3
                
                
                (3
                )
                
                
                
                
                -Registration
                    Costs
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (16
                )
                
                
                
                
                (16
                )Issuance
                    of Stock options to non-employees
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                38
                
                
                
                
                
                38Shares
                    issued to placement agent of proposed offering
                
                
                
                
                
                
                
                
                50
                
                
                
                
                
                19
                
                
                
                
                
                19Net
                    Income
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                186
                
                
                186Balance,
                    December 31, 2005
                
                
                347
                
                
                -
                
                
                47,369
                
                
                47
                
                
                3,224
                
                
                (20
                )
                
                3,251Conversion
                    of PreferredStock
                    A into CommonStock
                
                
                (85
                )
                
                
                
                
                1,352
                
                
                2
                
                
                (2
                )
                
                
                
                
                -Stock
                    optioncompensation
                    expense
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                193
                
                
                
                
                
                193Net
                    loss
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (214
                )
                
                (214
                )Balance,
                    December 31, 2006
                
                
                262
                
                $
                -
                
                
                48,721
                
                $
                49
                
                $
                3,415
                
                $
                (234
                )
                $
                3,230




See
        notes
        to financial statements


II-13


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**STATEMENT
      OF STOCKHOLDERS' EQUITY**


**THREE
      YEARS ENDED DECEMBER 31, 2006 (CONTINUED)**


**(In
      thousands)**





Preferred
                    Stock
                
                
                Common
                    StockShares
                
                
                Amount
                
                
                Shares
                
                
                Amount
                
                
                Additional
                    Paid
                      in
                    Capital
                
                
                Accumulated
                    Deficit
                
                
                Total
                    Stockholders’
                      EquityBalance,
                    January 1, 2004
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                $
                435
                
                $
                200
                
                $
                635Exchange
                    of Alliance shares for Essential shares
                
                
                1,551
                
                
                2
                
                
                
                
                
                
                
                
                (2
                )
                
                
                
                
                -Essential
                    shareholders’ shares prior to reverse acquisition
                
                
                
                
                
                
                
                
                422
                
                
                -
                
                
                
                
                
                
                
                
                -Issuance
                    of shares in exchange for Essential debt and Essential’s debt and
                    liabilities assumed
                
                
                452
                
                
                -
                
                
                78
                
                
                -
                
                
                (1,068
                )
                
                
                
                
                (1,068
                )Proceeds
                    from PPO, net of cash issuance costs
                
                
                1,125
                
                
                1
                
                
                
                
                
                
                
                
                3,799
                
                
                
                
                
                3,800Shares
                    issued to placement agent of PPO, net of merger expenses
                
                
                108
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Preferred
                    stock dividend
                
                
                46
                
                
                
                
                
                
                
                
                
                
                
                164
                
                
                (164
                )
                
                -Conversion
                    of Preferred Stock B into Common Stock
                
                
                (1,551
                )
                
                (2
                )
                
                24,680
                
                
                25
                
                
                (23
                )
                
                
                
                
                -Conversion
                    of Preferred Stock A into Common Stock
                
                
                (1,167
                )
                
                (1
                )
                
                18,561
                
                
                19
                
                
                (18
                )
                
                
                
                
                -Shares
                    issued to settle Common Stock Liability
                
                
                
                
                
                
                
                
                110
                
                
                
                
                
                32
                
                
                
                
                
                32Warrants
                    issued to lender
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                61
                
                
                
                
                
                61Merger
                    expenses and registration fees
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (194
                )
                
                
                
                
                (194
                )Net
                    loss
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (242
                )
                
                (242
                )Balance,
                    December 31, 2004
                
                
                564
                
                $
                -
                
                
                43,851
                
                $
                44
                
                $
                3,186
                
                $
                (206
                )
                $
                3,024
  See
        notes
        to financial statements


II-14


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**STATEMENTS
      OF CASH FLOWS**


**THREE
      YEARS ENDED DECEMBER 31, 2006**


**(In
      thousands)**




**2006**
            
            **2005**
            
            **2004****OPERATING
                ACTIVITIES:**Net
                (loss) income
            
            $
            (214
            )
            $
            186
            
            $
            (242
            )Adjustments
                to reconcile net (loss) income to net cashused
                in operating activities:Gain
                from insurance recovery
            
            
            (220
            )
            
            -
            
            
            -Deferred
                rent
            
            
            14
            
            
            8
            
            
            13Depreciation
                and amortization
            
            
            143
            
            
            115
            
            
            83Provision
                for doubtful accounts
            
            
            147
            
            
            247
            
            
            27Stock
                option compensation expense
            
            
            193
            
            
            38
            
            
            -Amortization
                of deferred financing costs
            
            
            116
            
            
            74
            
            
            11Deferred
                income taxes
            
            
            (63
            )
            
            (155
            )
            
            -Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (2,543
            )
            
            (2,403
            )
            
            (3,217
            )Due
                from factor
            
            
            -
            
            
            -
            
            
            1,284Inventory
            
            
            (3,735
            )
            
            (1,501
            )
            
            (972
            )Due
                from vendors
            
            
            656
            
            
            (705
            )
            
            (20
            )Prepaid
                acquisition and proposed offering costs
            
            
            162
            
            
            -
            
            
            -Prepaid
                expenses and other current assets
            
            
            (296
            )
            
            (3
            )
            
            (64
            )Accounts
                payable
            
            
            4,499
            
            
            1,459
            
            
            (1,890
            )Accrued
                expenses and other current liabilities
            
            
            (295
            )
            
            217
            
            
            (194
            )Net
                cash used in operating activities
            
            
            (1,436
            )
            
            (2,423
            )
            
            (5,181
            )**INVESTING
                ACTIVITIES:**Purchase
                of property and equipment
            
            
            (699
            )
            
            (77
            )
            
            (69
            )Proceeds
                from insurance claim
            
            
            305
            
            
            -
            
            
            -Increase
                in other assets
            
            
            (26
            )
            
            (13
            )
            
            (3
            )Payments
                for acquisition agreement
            
            
            -
            
            
            (54
            )
            
            -****Net
                cash used in investing activities
            
            
            (420
            )
            
            (144
            )
            
            (72
            )**FINANCING
                ACTIVITIES:**Proceeds
                from note payable - bank
            
            
            68,646
            
            
            57,695
            
            
            10,019Repayments
                of note payable - bank
            
            
            (66,580
            )
            
            (54,927
            )
            
            (7,652
            )Payments
                for registration and issuance costs
            
            
            -
            
            
            (16
            )
            
            (201
            )Payment
                of long-term obligations
            
            
            (16
            )
            
            (29
            )
            
            (272
            )Payment
                of deferred financing costs
            
            
            (100
            )
            
            (100
            )
            
            (50
            )Proceeds
                from sale of securities
            
            
            -
            
            
            -
            
            
            4,000Payments
                for proposed offering costs
            
            
            -
            
            
            (25
            )
            
            -Payments
                for pre-acquisition liabilities
            
            
            -
            
            
            -
            
            
            (915
            )Payments
                for merger costs
            
            
            -
            
            
            -
            
            
            (112
            )Net
                cash provided by financing activities
            
            
            1,950
            
            
            2,598
            
            
            4,817**INCREASE
                (DECREASE) IN CASH AND EQUIVALENTS**
            
            
            94
            
            
            31
            
            
            (436
            )**CASH
                AND EQUIVALENTS, BEGINNING OF YEAR**
            
            
            252
            
            
            221
            
            
            657**CASH
                AND EQUIVALENTS, END OF YEAR**
            
            $
            346
            
            $
            252
            
            $
            221





See
      notes
      to financial statements


II-15


**ALLIANCE
      DISTRIBUTORS HOLDING INC.**


**Notes
      to Financial Statements**





**Note
      1 - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES**





Alliance
      Distributors Holding Inc. (the "Company" or "Alliance") is a distributor of
      video game consoles, peripherals, accessories and software to customers
      throughout the United States for most key manufacturers and third party
      publishers in the video game industry. The Company operates as a single segment.





On
      June
      17, 2004, the Company (formerly Essential Reality, Inc. "Essential") entered
      into a Share Exchange Agreement (the "Exchange Agreement") with the sole
      shareholders (the "Shareholders") of AllianceCorner Distributors Inc., a
      privately held, wholesale distributor incorporated in New York
      ("AllianceCorner"). AllianceCorner had no prior affiliation with Essential
      and
      commenced operations in August 2003. Pursuant to the Exchange Agreement,
      Essential on June 29, 2004 acquired all the outstanding capital stock of
      AllianceCorner from the Shareholders in exchange for 1,551,314 Series B
      Convertible Non Redeemable Preferred Shares ("Series B Preferred Shares").
      As a
      result of the acquisition, the business of Alliance is Essential's only
      business. The transaction was accounted for as a reverse acquisition as of
      June
      30, 2004 and the pre-acquisition financial statements of AllianceCorner are
      treated as historical financial statements of the combined companies. As the
      transaction was accounted for as a reverse acquisition into a public shell,
      no
      goodwill has been recorded and the costs incurred have been accounted for as
      a
      reduction of additional paid-in capital. As a result of the reverse acquisition:
      (i) the historical financial statements of Essential for periods prior to the
      date of the transaction are not presented and (ii) because AllianceCorner is
      the
      accounting acquirer, Essential's historical stockholders' equity is not carried
      forward to the merged company as of June 30, 2004.





The
      name
      of AllianceCorner was changed to Alliance Distributors Holding, Inc. ("New
      York
      Alliance") in July 2004. Effective November 17, 2004, New York Alliance was
      merged into Alliance Distributors Holding Inc., a Delaware corporation that
      was
      wholly owned by Essential. Effective November 22, 2004, Essential reincorporated
      in Delaware and changed its name to Alliance Distributors Holding Inc., by
      way
      of a merger of Essential into Alliance Distributors Holding Inc., which was
      then
      a wholly owned Delaware subsidiary of Essential.





As
      part
      of the Exchange Agreement with AllianceCorner, Essential was required to raise
      funds to complete the transaction. Essential sold 1,124,767 shares of Series
      A
      Convertible Non Redeemable Preferred Shares (the "Series A Preferred Shares"),
      through a private placement offering ("PPO"). The PPO resulted in gross proceeds
      of $4,000,000 and net proceeds to the Company of $3,799,500. At the same time,
      substantially all outstanding debt of Essential was extinguished through either
      issuance by the Company of an aggregate of 452,202 Series A Preferred Shares
      or
      through cash payments which totaled $915,329.





Sunrise
      Securities Corp. ("Sunrise") acted as the placement agent in connection with
      the
      PPO and received (a) an $8,500 nonrefundable retainer fee; and (b) a commission
      consisting of 108,146 shares of Series A Preferred Shares and 5 year warrants
      due June 29, 2009 to purchase 1,564,096 shares of common stock at an exercise
      price of $.22.





In
      the
      Exchange Agreement, the Shareholders agreed to vote their Series B Preferred
      Shares in favor of an amendment to the Company's Articles of Incorporation
      that
      would increase the number of authorized shares of common stock from 50,000,000
      to 4,400,000,000 (the "Amendment"), and in favor of a simultaneous reverse
      split
      of the common stock on the basis of one share for forty-four shares to
      100,000,000 authorized shares (the "Reverse Split"). These actions became
      effective on November 22, 2004 and all share and per share data included in
      these financial statements have been retroactively adjusted for the split.





The
      Series A Preferred Shares were entitled to a dividend in kind, upon conversion,
      accruing at the rate of 6% per annum from June 29, 2004 until the effectiveness
      of the Amendment, November 22, 2004. The Company issued 46,200 additional shares
      of Series A Preferred Shares that converted into 735,000 shares of common stock
      and recorded a preferred dividend in the amount of $164,531.





The
      adoption of the Amendment and the Reverse Split resulted in the automatic
      conversion of each Series A Preferred Share and each Series B Preferred Share
      into 15.91 shares of common stock. However, Series A Preferred Shares owned
      by a
      holder were not to be converted into common stock if as a result of such
      conversion the holder would beneficially own in excess of 4.999% or 9.999%
      of
      the issued and outstanding shares (“4.999% Restriction”). Series A Preferred
      Shares not converted into the Company's common stock due to the operation of
      the
      4.999% Restriction were not entitled to the 6% dividend referred to above.





II-16


On
      July
      21, 2005, the Company and Abrams/Gentile Entertainment Inc. ("Age") entered
      into
      an operating agreement in which the Company and Age became members in Alliance
      Age LLC, a limited liability company formed in Delaware, to set forth the terms
      on which the parties will develop and commercialize products they mutually
      agree
      upon from time to time. The Company owns 65% of Alliance Age LLC. As of December
      31, 2006, Alliance Age LLC was inactive.





**Use
      of Estimates**





In
      preparing financial statements in conformity with accounting principles
      generally accepted in the United States of America, management is required
      to
      make 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 amounts of revenues and expenses
      during the reporting period. Actual results could differ from those estimates.
      Significant estimates reflected in these financial statements relate primarily
      to bad debt reserves on accounts receivable and the realization of deferred
      tax
      assets.





**Allowance
      for Doubtful Accounts**





The
      Company establishes credit terms for new clients based upon management's review
      of their credit information and projects terms, performs ongoing credit
      evaluations of its customers, adjusting credit terms when management believes
      appropriate based upon payment history and an assessment of their current credit
      worthiness. The Company records an allowance for doubtful accounts for estimated
      losses resulting from the inability of its clients to make required payments.
      The Company determines this allowance by considering a number of factors,
      including the length of time trade accounts receivable are past due, previous
      loss history, estimate of the client's current ability to pay its obligation
      to
      the Company, and the condition of the general economy and the industry as a
      whole. While credit losses have generally been within expectations and the
      provisions established, the Company cannot guarantee that credit loss rates
      in
      the future will be consistent with those experienced in the past. In addition,
      the Company has credit exposure if the financial condition of one of its major
      clients were to deteriorate. In the event that the financial condition of its
      clients were to deteriorate, resulting in an impairment of their ability to
      make
      payments, additional allowances may be necessary. It is reasonably possible
      that
      the Company's estimate of the allowance for doubtful accounts will change.
      As of
      December 31, 2006 and 2005, the Company’s allowance for doubtful accounts
      totaled approximately $312,000 and $181,000, respectively.





**Inventory**





Inventory
      consists entirely of finished goods held for sale and is reported at the lower
      of cost or market, on the average cost basis. The Company receives price
      protection from certain of its suppliers for merchandise that may be slow moving
      or aged. The Company evaluates the adequacy of its slow moving or aged inventory
      quarterly and writes down its inventory to fair value based upon the price
      protection received or current market value. While write-downs have been within
      expectations and the provisions established, the Company cannot guarantee that
      it will continue to experience the same level of write-downs as in the past.
      At
      times, the Company makes advance payments to vendors to procure and ensure
      delivery of certain high demand products. Such deposits are reflected as due
      from vendors in the balance sheet. The Company does not offer warranties to
      its
      customers but will accept returns of product claimed to be defective and
      reimburse the customers for the purchase price paid. The majority of the
      Company’s suppliers in turn accept these returns by customers. There are no
      reserves for warranties as of December 31, 2006 and 2005.





**Property
      and Equipment**





Property
      and equipment is recorded at cost. Expenditures for major additions and
      improvements are capitalized and minor replacements, maintenance and repairs
      are
      charged to expense as incurred. Assets held under capital leases are recorded
      at
      the lower of the net present value of the minimum lease payments or the fair
      value of the leased assets at the inception of the lease. Leasehold improvements
      are amortized over the lesser of the lease terms or the assets' useful lives.
      When property and equipment is retired or otherwise disposed of, the cost and
      accumulated depreciation are removed from the accounts and any resulting gain
      or
      loss is included in the results of operations for the respective period.
      Depreciation and amortization is provided over the estimated lives of the
      related assets using the straight-line method.




II-17


The
      estimated useful lives for significant property and equipment categories are
      as
      follows:





Vehicles
            4
                yearsWarehouse
                equipment
            3
                to 7 yearsOffice
                furniture and equipment
            2
                to 7 yearsLeasehold
                improvements
            5
                yearsComputer
                software
            2
                to 3 years





**Impairment
      of Long-Lived Assets**





The
      Company follows Statement of Financial Accounting Standards ("SFAS") No. 144,
      "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No.
      144
      requires that long-lived assets, including property and equipment, be reviewed
      for impairment whenever events or changes in circumstances indicate that their
      carrying amount may not be recoverable. The Company assesses its assets for
      impairment based on the estimated future undiscounted cash flows expected to
      result from the use of the asset and records impairment losses when this amount
      is less than the carrying amount. Impairment losses are recorded for the excess
      of the assets' carrying amount over their fair value, which is generally
      determined based on the estimated future discounted cash flows over the
      remaining useful life of the asset using a discount rate determined by
      management at the date of the impairment review. Management believes at this
      time that the carrying value and useful life of long-lived assets continue
      to be
      appropriate.





**Deferred
      Rent**





The
      Company accounts for scheduled rent increases contained in its leases on a
      straight-line basis over the non-cancellable lease term.





**Revenue
      Recognition**





The
      Company recognizes sales upon shipment of products to customers as title and
      risk of loss pass upon shipment and collectibility is reasonably assured.
      Provisions for estimated discounts and rebates to customers, estimated returns
      and allowances and other adjustments are provided for in the same period the
      related sales are recorded.





**Income
      Taxes**





AllianceCorner,
      with the consent of its stockholders, elected to have its income taxed under
      the
      provisions of Subchapter S of the Internal Revenue Code and the corresponding
      provisions of New York State Tax laws. Under the aforementioned provisions,
      corporate income or loss and any tax credits earned are included in the
      stockholders' individual federal and state income tax returns. Accordingly,
      no
      provision has been made for federal income taxes for the periods prior to June
      29, 2004. Effective June 29, 2004, the Company is taxed as a C
      corporation.





The
      Company accounts for income taxes using the liability method which requires
      the
      recognition of deferred tax assets or liabilities for the temporary differences
      between the financial reporting and tax bases of the Company's assets and
      liabilities and for tax carry forwards at enacted statutory rates in effect
      for
      the years in which the differences are expected to reverse. The effect on
      deferred taxes of a change in tax rates is recognized in income in the period
      that includes the enactment date. In addition, valuation allowances are
      established when necessary to reduce deferred tax assets to the amounts expected
      to be realized.





**Selling
      and administrative expenses**





The
      Company includes shipping and handling costs in selling and administrative
      expense. For the three years in the period ended December 31, 2006, the Company
      incurred approximately $575,000, $364,000 and $245,000, of such costs,
      respectively.





Advertising
      expenses are charged to operations in the period in which they are incurred.
      Included in selling and administrative expenses for the three years in the
      period ended December 31, 2006 were advertising expenses approximating $186,000,
      $170,000 and $35,000, respectively.





Included
      as a reduction of selling and administrative expense for the year ended
      December 31, 2006 is a $220,000 gain from insurance proceeds for replacement
      value of assets in excess of book value that were damaged, and for extra costs
      incurred, as a result of a fire near the Company’s former offices.





II-18


**Fair
      Value of Financial Instruments**





The
      carrying amounts of significant financial instruments, which includes accounts
      receivable, accounts payable and accrued expenses, approximated fair value
      as of
      December 31, 2006 and 2005 due to their short-term maturities. Borrowings under
      the financing agreement approximate fair value due to their variable interest
      rate.





**Comprehensive
      Income**





SFAS
      No.
      130, "Reporting Comprehensive Income," establishes standards for the reporting
      and display of comprehensive income and its components in the financial
      statements. As of December 31, 2006 and 2005 and for the three years in the
      period ended December 31, 2006, the Company has no items that represent other
      comprehensive income.





**Net
      Income (Loss) Per Share**





Basic
      net
      income (loss) per share is computed by dividing net income (loss) by the
      weighted average number of common shares outstanding for the period. Diluted
      net
      income (loss) per share is computed by dividing income (loss) available to
      common shareholders by the weighted-average number of common shares outstanding
      during the period increased to include the number of additional common shares
      that would have been outstanding if the dilutive potential common shares had
      been issued. The dilutive effect of the outstanding options is reflected in
      diluted earnings (loss) per share by application of the treasury stock method.
      Diluted net loss per share for 2006 and 2004 does not include potential common
      shares derived from stock options because as a result of the Company incurring
      losses, their effect would have been antidilutive.




The
      denominator for diluted net income per share for the year ended December 31,
      2005 includes 488,000 shares issuable upon conversion of warrants. The
      denominator for basic net income (loss) per share and weighted average number
      of
      shares outstanding for the year ended December  31, 2004
      reflects the conversion of Series B Preferred Shares for Common Stock as of
      January 1, 2004 and of Series A Preferred Shares for Common Stock as of June
      29,
      2004, computed on a post Reverse Split basis (see Note 1).





Common
      equivalents for the year ended December 31, 2006 exclude approximately 242,000
      for common shares issuable upon exercise of warrants and approximately 1,700,000
      common shares issuable upon conversion of Series A Convertible Non-Redeemable
      Preferred Stock since their effect would be anti-dilutive. Common equivalents
      for the year ended December 31, 2004 exclude 250,000 for common shares issuable
      upon exercise of warrants since their effect would be anti-dilutive.





**Stock
      Based Compensation**





Pursuant
      to Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
      to
      Employees," (“APB 25”) prior to January 1, 2006 the Company accounted for stock
      based employee compensation arrangements using the intrinsic value method.
      Accordingly, no compensation expense was recorded in the financial statements
      with respect to options granted to employees, since the options were granted
      at
      or above market value.





Effective
      January 1, 2006, the Company adopted Statement of Financial Accounting Standards
      No. 123(R), “Share Based Payment” (“SFAS No. 123(R)”) which eliminates the use
      of APB 25 and the intrinsic value method of accounting, and requires companies
      to recognize the cost of employee services received in exchange for awards
      of
      equity instruments, based on the grant date fair value of those awards, in
      the
      financial statements. The Company has adopted the modified prospective method
      whereby compensation cost is recognized in the financial statements beginning
      with the effective date based on the requirements of SFAS No. 123(R) for all
      share-based payments granted after that date and for all unvested awards granted
      prior to that date.





For
      the
      year ended December 31, 2006, share-based compensation expense related to the
      Company’s various stock option plans totaling approximately $193,000 is included
      in selling and administrative expenses. In addition, at
      December 31, 2006, total compensation cost related to non-vested stock
      options net yet recognized totaled approximately $200,000. This cost is expected
      to be recognized over the subsequent 15 months.





II-19


The
      following table illustrates the effect on net income and income per share for
      the year ended December 31, 2005 (in thousands, except per share
      amounts) if the Company had applied the fair value recognition provisions of
      SFAS No. 123(R) to stock-based employee compensation.





**2005**Net
                income as reported
            
            $
            186Deduct:
                Total stock-based employeecompensation
                determined under fair valuebased
                method, net of related tax effects
            
            
            (122
            )Pro
                forma net income
            
            $
            64Income
                per share:Basic
                and diluted - as reported
            
            $
            0.00Basic
                and diluted - pro forma
            
            $
            0.00





There
      were no options issued as of December 31, 2004. Accordingly, no compensation
      expense was recorded in the financial statements with respect to option grants.





**Recent
      Accounting Pronouncements**





In
      July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48)
“Accounting for Uncertainty in Income Taxes” which prescribes a recognition
      threshold and measurement process for recording in the financial statements
      uncertain tax positions taken or expected to be taken in a tax return.
      Furthermore, FIN 48 provides guidance on the recognition, classification,
      accounting in interim periods and disclosure requirements for uncertain tax
      positions. The accounting provisions of FIN 48 are effective for fiscal years
      beginning after December 15, 2006. The Company does not expect the adoption
      of FIN 48 to have a material impact on its financial
      statements.





In
      September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
      Accounting Bulletin No. 108 (SAB 108) “Considering the Effects of Prior Year
      Misstatements in Current Year Financial Statements.” SAB 108 provides guidance
      on quantifying financial statement misstatements, including the effects of
      prior
      year errors on current year financial statements. SAB 108 is effective for
      periods ending after November 15, 2006. The adoption of SAB 108 did not
      have a material impact on its financial statements.





In
      September 2006, the FASB issued SFAS No. 157 “Fair Value Measures” (“SFAS 157”).
      SFAS 157 defines fair value, establishes a framework for measuring fair value,
      and expands disclosures about fair value measurements. This statement applies
      under other accounting pronouncements that require or permit fair value
      measurements, however it does not apply to SFAS 123R. This Statement shall
      be
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. Earlier
      application is encouraged, provided that the reporting entity has not yet issued
      financial statements for that fiscal year, including any financial statements
      for an interim period within that fiscal year. The provisions of this statement
      should be applied prospectively as of the beginning of the fiscal year in which
      this Statement is initially applied, except in some circumstances where the
      statement shall be applied retrospectively. The Company does not expect the
      adoption of SFAS 157 to have a material impact on its financial
      statements.





**Note
      2 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:**





Supplemental
      disclosures of cash flow information (in thousands) are as follows:


Cash
                paid during the year for:
            
            **2006**
            
            **2005**
            
            **2004**Interest
            
            $
            754
            
            $
            409
            
            $
            148Income
                taxes
            
            $
            98
            
            $
            7
            
            $
            19


II-20


The
      following is a supplemental schedule (in thousands) of non-cash investing and
      financing activities for the three years ended
      December 31 2006:





**2006**
            
            **2005**
            
            **2004**Issuance
                of Common Stock to placement agent
            
            
            
            
            $
            20Acquisition
                and proposed offering costs accrued
            
            
            
            
            
            63Issuance
                of Series A 6% Preferred Stock to placement agent
            
            
            
            
            
            
            
            $
            385Liabilities
                Assumed
            
            
            
            
            
            
            
            
            1,068Series
                A 6% Preferred Stock dividend
            
            
            
            
            
            
            
            
            164Merger
                costs accrued
            
            
            
            
            
            
            
            
            82Issuance
                of common stock to settle liability
            
            
            
            
            
            
            
            
            32Issuance
                of warrants to lender
            
            
            
            
            
            
            
            
            60





**Note
      3 - CONCENTRATIONS OF CREDIT RISK AND MAJOR SUPPLIERS**





**Cash
      and Equivalents**





The
      Company maintains cash balances at various banks. Accounts at each institution
      are insured by the Federal Deposit Insurance Corporation up to $100,000. The
      company considers highly liquid investments with original maturities of three
      months or less to be cash equivalents.





**Accounts
      Receivable**





Concentrations
      of credit risk with respect to accounts receivable are limited because a large
      number of customers make up the Company's customer base, thus spreading the
      trade credit risk. The Company controls credit risk through credit approvals,
      credit limits and monitoring procedures. The Company performs credit evaluations
      of its customers but generally does not require collateral to support accounts
      receivable.





**Fluctuations
      in Operating Results and Seasonality**





The
      Company has experienced fluctuations in quarterly operating results as a result
      of the timing of the introduction of new titles; variations in sales of titles
      developed for particular platforms; market acceptance of our titles; sequels
      or
      enhancements of existing titles; projected and actual changes in platforms;
      the
      timing and success of title introductions by our competitors; product returns;
      changes in pricing policies by us and our competitors; order cancellations;
      and
      delays in shipment. Sales of various titles are also seasonal, with peak
      shipments typically occurring in the fourth calendar quarter as a result of
      increased demand for titles during the holiday season. Annual comparisons of
      operating results are not necessarily indicative of future operating
      results.





**Major
      Suppliers**





For
      the
      year ended 2006, the Company’s three largest suppliers in the aggregate
      accounted for approximately 49% of total purchases (with one accounting for
      27%
      alone) and the ten largest suppliers in the aggregate accounted for
      approximately 74% of total purchases. For the year ended 2005, the Company’s
      three largest suppliers in the aggregate accounted for approximately 62% of
      total purchases (with one accounting for 42% alone), and the ten largest
      suppliers in the aggregate accounted for 82% of total purchases. For the year
      ended December 31, 2004, the same three suppliers in the aggregate accounted
      for
      approximately 56% of total purchases, and the ten largest suppliers in the
      aggregate accounted for 77% of total purchases. At December 31, 2006 and 2005,
      the amount due to these three suppliers was approximately$3,559,000 and
      $1,830,000 respectively, and is included in accounts payable on the accompanying
      balance sheet. If a significant supplier terminates or modifies its relationship
      with the Company future results could be materially and adversely affected.





II-21


**Note
      4 - PROPERTY AND EQUIPMENT**





Property
      and equipment, stated at cost less accumulated depreciation and amortization
      (in
      thousands) consists of the following:





**December
                31,****2006**
            
            **2005**Leasehold
                improvements
            
            $
            391
            
            $
            240Computers,
                office equipment and furniture
            
            
            319
            
            
            104Warehouse
                equipment
            
            
            79
            
            
            89Vehicles
            
            
            52
            
            
            52Equipment
                under capital leases
            
            
            24
            
            
            46Software
            
            
            136
            
            
            65Total
            
            
            1,001
            
            
            596Less
                accumulated depreciation and amortization
            
            
            249
            
            
            225$
            752
            
            $
            371





Depreciation
      and amortization expense approximated $143,000, $115,000 and $83,000 for the
      three years in the period ended December 31, 2006, respectively.





**Note
      5 - FINANCING AGREEMENT**





The
      Company has a financing agreement with Rosenthal & Rosenthal, Inc.
      ("Rosenthal") dated November 11, 2004 and amended on November 1, 2005 (the
      “Agreement”).  Under the Agreement, Rosenthal may in its discretion lend to
      the Company up to $10,000,000, which is the maximum credit under the facility,
      based on eligible inventory and receivables. All borrowings are due on demand,
      are secured by substantially all of the assets of the Company and are subject
      to
      the Company's compliance with certain financial covenants. The Company's CEO
      and
      the Company's President have signed limited guaranties in respect of borrowings
      under the Agreement.





The
      amendment dated November 1, 2005 among other things increased the maximum credit
      under the facility from $5,000,000 to $10,000,000 and reduced the interest
      rate
      on borrowings by 0.5%.





The
      Agreement terminates November 30, 2007 unless earlier terminated by Rosenthal
      on
      30 days' notice. Interest accrues on outstanding borrowings at the prime rate
      (but not less than 4.75%) plus 1.5%. **** At
      December 31, 2006, the interest rate on borrowings outstanding was 9.75%. In
      addition, the Company is obligated to pay the lender on each anniversary date
      an
      annual fee of 1% of the maximum credit which is amortized over one year, and
      a
      monthly administrative fee of $1,000. The financing expense for the annual
      fee
      recorded totaled approximately $96,000, $56,000 and $6,000 for the three years
      in the period ended December 31, 2006, respectively.





In
      connection with establishing the Agreement, the Company issued to Rosenthal
      a
      warrant (the "Warrant") to purchase 500,000 shares of common stock at $0.10
      per
      share. The Warrant expires on November 30, 2010. On notice by the Company the
      Warrants will expire earlier if the closing price of the common stock during
      a
      period designated in the Warrants is not less than $0.40 per share. The Warrants
      may be exercised by Rosenthal at $.10 per share for cash or on a cashless basis
      (i.e., by deducting from the number of shares otherwise issuable on exercise
      a
      number of shares that have a then market value equal to the exercise price).
      The
      Company recorded a deferred financing cost of approximately $60,000 in the
      fourth quarter 2004, representing the fair value of the warrants, which is
      amortized over the three year life of the financing agreement. The financing
      expense recorded totaled approximately $20,000, $18,000 and $5,000 for the
      three
      years in the period ended December 31, 2006, respectively.





Under
      the
      terms of the Agreement, the Company is required to maintain a specified level
      of
      net worth, working capital and debt ratios as defined. At various times
      throughout the Agreement, Rosenthal has amended the covenants. As of December
      31, 2006, the Company did not comply with certain financial covenants for
      which Rosenthal has provided a waiver.




II-22


The
      Company believes that it will have sufficient liquidity for the next twelve
      months and the foreseeable future. However, the Company would be materially
      and
      adversely affected if Rosenthal demands payment of these borrowings under the
      Agreement and if the Company is unable to refinance these borrowings. The
      Company is currently in discussions to renegotiate its existing facility with
      its current lender and believes it will be able to secure an extension of the
      existing agreement or alternative financing when the current line of credit
      expires.





**Note
      6 - LONG TERM OBLIGATIONS**





At
      December 31, 2006 and 2005, long-term obligations (in thousands) consist
      of:





**2006**
            
            **2005**Notes
                payable in monthly installments of $1through
                September 2008, including interestAt
                varying rates up to 5.5%, secured by relatedequipment
                with a carrying value of $12
            
            $
            10
            
            $
            25Capital
                lease obligations
            
            
            5
            
            
            615
            
            
            31Less:
                Current portion
            
            
            11
            
            
            19$
            4
            
            $
            12





At
      December 31, 2006, future payments of long-term obligations (in thousands)
      are
      as follows:





2007
            
            $
            112008
            
            
            4$
            15




**Note
      7 - INCOME TAXES**





The
      components of the (benefit from) provision for income taxes are as follow (in
      thousands):





**2006**
            
            **2005**
            
            **2004**Current:Federal
            
            $
            (9
            )
            $
            35
            
            $
            -State
                and local
            
            
            25
            
            
            42
            
            
            1416
            
            
            77
            
            
            14Deferred:Federal
            
            
            (56
            )
            
            (123
            )
            
            -State
                and local
            
            
            (7
            )
            
            (32
            )
            
            -(63
            )
            
            (155
            )
            
            -Total
            
            $
            (47
            )
            $
            (78
            )
            $
            14







II-23


The
      Company was taxed as an S Corporation for federal and state purposes for the
      period January 1, 2004 through June 29, 2004. As such, the Company's
      tax provision for this period includes only New York City taxes, which are
      determined as if the Company was a C Corporation. New York City does not
      recognize S Corporation status. For the period the Company was a C Corporation
      during 2004, the Company incurred a federal, state and local net operating
      loss,
      which was carried forward and reduced the taxable income for fiscal year 2005.





Significant
      components of the Company's net deferred tax assets at December 31, 2006 and
      2005 are as follows (in thousands):








**2006**
            
            **2005**Net
                operating loss carryforwards
            
            $
            2,342
            
            $
            2,357Reserves
                and other items not currently deductible
            
            
            144
            
            
            131Equity
                compensation not currently deductible
            
            
            79
            
            
            -Costs
                capitalized to inventory for tax purposes
            
            
            23
            
            
            27Other
            
            
            (36
            )
            
            (3
            )2,552
            
            
            2,512Less:
                valuation allowance
            
            
            (2,334
            )
            
            (2,357
            )Net
                deferred tax assets
            
            $
            218
            
            $
            155Net
                deferred tax asset - current
            
            $
            151
            
            $
            155Net
                deferred tax asset - non-current
            
            
            67
            
            
            -$
            218
            
            $
            155





Reconciliation
      of the U.S. statutory rate with the Company’s effective tax rate (benefit) is
      summarized as follows:





**2006**
            
            **2005**
            
            **2004**Federal
                statutory rate
            
            
            (34.0
            )%
            
            34.0
            %
            
            34.0
            %Increase
                (decrease) in tax resulting from:State
                and local taxes, net of federal benefits
            
            
            4.6
            %
            
            26.0
            %
            
            (6.1
            )%Nondeductible
                expenses
            
            
            11.1
            %
            
            4.3
            %
            
            -Utilization
                of NOL
            
            
            -
            
            
            (69.8
            )%
            
            -Change
                in valuation allowance
            
            
            (8.8
            )%
            
            (69.1
            )%
            
            (32.9
            )%Other
            
            
            9.1
            %
            
            3.3
            %
            
            (1.1
            )%(18.0
            )%
            
            (71.3
            )%
            
            (6.1
            )%





At
      December 31, 2006, the Company had federal and state net operating loss
      carryforwards (NOL’s) of approximately $5.5 million. The federal NOL’s
      expire in 2023 and the state NOL’s expire in 2016. In assessing the realization
      of deferred tax assets, management considers whether it is more likely than
      not
      that all or some portion of the deferred tax assets will not be realized. The
      ultimate realization of the deferred tax assets is dependent upon the generation
      of future taxable income during the periods in which temporary differences
      are
      deductible and net operating losses are utilized. Based on a consideration
      of
      these factors, the Company has established a valuation allowance of
      approximately $2,334,000 and $2,357,000 at December 31, 2006 and 2005,
      respectively, due to the uncertainty surrounding the realization of the NOL’s
      which resulted from the Exchange Agreement. The valuation allowance decreased
      by
      $23,000 in 2006 due to the recognition of net operating loss carryforwards.
      The
      valuation allowance in 2005 increased by $232,000 primarily due to the Company’s
      determination of the amount of Essential’s net operating loss carryforward that
      could not be utilized. Pursuant to IRC Section 382 of the Tax Reform Act of
      1986
      the utilization of NOL’s is limited in the case of certain transactions
      including significant changes in ownership interests. The Company has determined
      that based upon the terms of the Exchange Agreement, an ownership change
      pursuant to this Act has occurred. As a result, the NOL’s are significantly
      limited.





II-24


**Note
      8 - RETIREMENT PLAN**





The
      Company sponsors a 401(k) contributory plan (the "Plan") for the benefits of
      employees who are at least 21 years of age. The Company's management determines,
      at its discretion, any annual contributions. The Company elected not to
      contribute to the Plan for the three years in the period ended December 31,
      2006.





**Note
      9 - STOCK OPTIONS AND WARRANTS**




**Stock
      Options**





In
      2004,
      the Company established the 2004 Stock Plan (the “2004 Plan”) to grant equity
      and equity-linked awards up to a maximum of 10,000,000 shares of common stock.
      In addition, in February 2007, the Company’s stockholders approved the
      2006Stock Plan (the “2006 Plan”), which authorizes grants for up to an
      additional 10,000,000 shares of common stock. The Company has not made any
      award
      grants from the 2006 Plan.





Information
      with respect to stock options granted pursuant to the 2004 Plan is as
      follows:





Shares
              (in
                thousands)
            
            Weighted
              Average
              Exercise
                PriceOutstanding
                - January 1, 2005
            
            
            --
            
            
            -Granted
                - 2005
            
            
            7,650
            
            $
            .325Forfeited
                - 2005
            
            
            (260
            )
            $
            .325Outstanding
                - December 31, 2005
            
            
            7,390
            
            $
            .325Granted
                - 2006
            
            
            100
            
            $
            .16Forfeited
              - 2006
            
            
            (500
            )
            $
            .325Outstanding
                - December 31, 2006
            
            
            6,990
            
            $
            .323





All
      of
      the issued options are ten-year non-qualified and vest in twelve equal quarterly
      installments.





Of
      the
      total options granted in 2005, 1,100,000 options were granted to the Chief
      Executive Officer and Chairman of the Board of Directors of the Company, 100,000
      options were granted to the former Chief Financial Officer, 1,100,000 options
      were granted to the President and Chief Operating Officer and 150,000 options
      were granted to each of three independent directors of the Company. In 2006,
      100,000 options were granted to the Company’s Executive Vice President and Chief
      Financial Officer.





Of
      the
      total 2005 stock options granted, 250,000 were granted to a non-employee who
      provided past services to the Company and 500,000 options were granted to
      non-employees for future services to be provided over a three year period.
      During the year ended December 31, 2006 and 2005, the Company recorded
      stock-based compensation expense of approximately $15,000 and $38,000,
      respectively, for these stock options.





For
      the
      years ended December 31, 2006 and 2005, share-based compensation expense related
      to the Company’s 2004 Stock Plan totaling approximately $193,000 and $38,000,
      respectively, and is included in selling and administrative expenses. In
      addition, at December 31, 2006, total compensation cost related to
      non-vested stock options net yet recognized totaled approximately $200,000.
      This
      cost is expected to be recognized over a weighted average period of 15
      months.





The
      fair
      value of the options-pricing model was calculated with the following
      weighted-average assumptions used for grants during the years ended December
      31,
      2006 and 2005: risk-free interest rate 4.62% in 2006 and 4.25 to 4.5% in 2005;
      expected life 6.5 years; expected volatility 186% in 2006 and 55% to 126% in
      2005. The fair value generated by the Black-Scholes model may not be indicative
      of the future benefit, if any, that may be received by the option holder.





II-25


The
      number and weighted-average grant-date fair value of stock options is as
      follows:





Shares
              (in
                thousands)
            Weighted
              Average
              Grant-Date
              Fair
                ValueNon-vested
                - January 1, 2006
            5,551
            $.095Granted
                in 2006
            100
            $.160Unvested
                portion forfeited in 2006
            (325)
            $.113Vested
                in 2006
            (2,363)
            $.095Non-vested
                - December 31, 2006
            2,963
            $.096





Information
      with respect to stock options outstanding at December 31, 2006 is as
      follows:





**Range
                of Exercise Prices**
            **Number
                Outstanding**
            **Weighted-Average
                Remaining Contractual Life in Years**
            **Weighted-Average
                Exercise Price**
            **Options
                Exercisable**
            **Weighted-Average
                Exercise Price**$0.32-$0.325
            6,890,000
            8.05
            $0.325
            4,019,000
            $0.325$0.18
            100,000
            9.75
            $0.18
            8,000
            $0.18





**Warrants**





Pursuant
      to the PPO, the Company issued warrants to purchase 1,564,096 shares of common
      stock at an exercise price of $0.22 per share (See Note 1). The warrants expire
      on June 29, 2009.





In
      connection with establishing the Financing Agreement, on November 11, 2004
      the
      Company issued warrants to purchase 500,000 shares of common stock at $0.10
      per
      share (See Note 5).





**Note
      10 - COMMITMENTS AND CONTINGENCIES**





**Leases**





The
      Company leases showroom, office and warehouse space under operating leases
      expiring through 2011.





The
      future minimum lease payments, excluding escalation charges, are as follows
      (in
      thousands):





**Operating
                leases**2007
            
            $
            3572008
            
            
            3682009
            
            
            3812010
            
            
            3962011
            
            
            166$
            1,668





In
      accordance with SFAS No. 13, "Accounting for Leases," non-cancellable operating
      leases with scheduled rent increases require that rent expense be recognized
      on
      a straight-line basis over the lease term. Rent expense for the three years
      in
      the period ended December 31, 2006 includes approximately $14,000, $8,000
      and $13,000, respectively, which relates to the amortized portion of the
      scheduled rent increases, and to the first month rent abatement.





Total
      rent expense charged to operations for the three years in the period ended
      December 31, 2006 was approximately $361,000, $185,000 and $191,000,
      respectively.





II-26


**Employment
      Agreement**





In
      October 2006, the Company entered into a two year employment agreement with
      its
      Chief Financial Officer (the “Officer”). The agreement provides for annual base
      compensation of $210,000 per annum as well as for insurance and other fringe
      benefits, and contains confidentiality and non-compete and non-interference
      provisions. The Company may terminate the employment under the agreement without
      cause (as defined) at any time, provided that, in such case, the Company will,
      as severance, continue to pay an amount equal to his then base salary in normal
      payroll installments, subject to withholding, for six months or if less until
      September 30, 2008, plus the cost of COBRA for the period during which severance
      is payable as aforesaid. In addition, the Company granted an option effective
      on
      October 3, 2006 to purchase 100,000 shares of the Company’s common stock under
      the Company’s stock option plan at an exercise price of $0.18 per share. The
      option has a 10 year term, and vests in 12 equal installments on the last day
      of
      each of the 12 calendar quarters beginning with the calendar quarter that begins
      on October 1, 2006, but only so long as the Officer is employed by the Company
      on the last day of such calendar quarter.





**Litigation**





In
      October 2006, the Company paid $200,000 in settlement of a legal proceeding
      that
      had been brought against Essential Reality, Inc. (a predecessor of the Company),
      Essential Reality, LLC and a former officer and current employee of the Company,
      for rent and costs relating to premises formerly occupied by the Company. As
      of
      2005, the Company had accrued $125,000 against the potential outcome of the
      litigation. For the year ended December 31, 2006, the Company recorded an
      additional $75,000, and paid the entire settlement amount.





**Note
      11 - TERMINATED TRANSACTION COSTS**





On
      April
      26, 2006, the Company announced that it would not acquire Foto Electric Supply
      Co., Inc. (Fesco). An agreement by the Company to acquire Fesco had expired
      by
      its terms on February 28, 2006, and subsequent discussions to extend and amend
      the agreement ended. As a result, in 2006 the Company recorded a charge of
      approximately $310,000 for its costs in the terminated transaction. ****





**Note
      12 - Quarterly Financial Information (unaudited)**




**First**
              **Quarter**
            
            **Second**
              **Quarter**
            
            **Third**
              **Quarter**
            
            **Fourth**
              **Quarter****(in
                thousands, except per share amounts)****2006**
            
            (unaudited)Net
                Sales
            
            $
            13,319
            
            $
            13,269
            
            $
            15,453
            
            $
            28,277Gross
                profit
            
            $
            1,559
            
            $
            1,651
            
            $
            1,360
            
            $
            2,323Net
                income (loss) available to common stockholders
            
            $
            (94
            )
            $
            73
            
            $
            (283
            )
            $
            90Basic
                and diluted income (loss) per share
            
            $
            (0.00
            )
            $
            (0.00
            )
            $
            (0.01
            )
            $
            0.00**2005**Net
                Sales
            
            $
            10,889
            
            $
            12,225
            
            $
            13,566
            
            $
            21,990Gross
                profit
            
            $
            1,242
            
            $
            1,071
            
            $
            1,531
            
            $
            2,094Net
                income (loss) available to common stockholders
            
            $
            (130
            )
            $
            (336
            )
            $
            222
            
            $
            430Basic
                and diluted income (loss) per share
            
            $
            0.00
            
            $
            (0.01
            )
            $
            0.00
            
            $
            0.01





**Item
      9. Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure.**





None





**Item
      9A. Controls and Procedures.**





An
      evaluation has been carried out under the supervision and with the participation
      of our management, including our Chief Executive Officer and Chief Financial
      Officer, of the effectiveness of the design and the operation of our "disclosure
      controls and procedures" (as such term is defined in Rules 13a-15(e) under
      the
      Securities Exchange Act of 1934) as of December 31, 2006 (“Evaluation Date”).
      Based on such evaluation, our Chief Executive Officer and Chief Financial
      Officer have concluded that, as of the Evaluation Date, the disclosure controls
      and procedures are reasonably designed and effective to ensure that (i)
      information required to be disclosed by us in the reports we file or submit
      under the Securities Exchange Act of 1934 is recorded, processed, summarized
      and
      reported within the time periods specified in the SEC's rules and forms, and
      (ii) such information is accumulated and communicated to our management,
      including our Chief Executive Officer and Chief Financial Officer, as
      appropriate to allow timely decisions regarding required
      disclosure.





II-27


**PART
      III**





**Item
      10. Directors, Officers, Promoters and Control Persons; Compliance with Section
      16(a) of the Exchange Act.**




Our
      directors and executive officers, their ages, positions held and duration each
      person has held that position, are as follows:





NAME
            POSITION
                HELD WITH THE COMPANY
            AGE
            DATE
                FIRST ELECTED OR APPOINTEDJay
                Gelman
            Chief
                Executive Officer, Chairman of the Board of Directors and Assistant
                Secretary
            45
            Chief
                Executive Officer on June 29, 2004; Director and Chairman of the
                Board on
                October 14, 2004; Assistant Secretary on November 11,
                2004;Andre
                Muller
            Chief
                Operating Officer, President and Director
            42
            Chief
                Operating Officer and President on June 29, 2004; Director on October
                14,
                2004; Secretary November 11, 2004 to November 30, 2006Stephen
                Agress
            Executive
                Vice President, Chief Financial Officer and Secretary
            45
            Executive
                Vice President and Chief Financial Officer on October 3, 2006;
                Secretary on November 30, 2006Humbert
                B. Powell, III
            Director
            68
            Director
                and Chairman of the Board of Directors from July 1, 2002 until October
                14,
                2004 and currently a DirectorThomas
                Vitiello
            Director
            45
            Director
                on October 14, 2004Steven
                H. Nathan
            Director
            57
            Director
                on March 14, 2005





JAY
      GELMAN





Jay
      Gelman in 1989 co-founded L & J Marketing, Inc. d/b/a Alliance Distributors,
      a regional video game software and hardware distributor based in College Point,
      NY. He served as President, until December of 1997 when Alliance was sold to
      Take Two Interactive Software, Inc. From 1998 until 2003, Mr. Gelman was
      employed by Track Data Corporation (NASDAQ: TRAC) where he served as a director
      and as Executive Vice President. In 2003, Mr. Gelman co-founded Alliance
      Partners (name later changed to AllianceCorner Distributors Inc.), and served
      as
      its President and Chief Executive Officer. Since the acquisition by the Company
      of AllianceCorner Distributors Inc. on June 29, 2004, Mr. Gelman has served
      as
      Chief Executive Officer of the Company and is also currently the Chairman of
      the
      Board of Directors.





ANDRE
      MULLER





For
      more
      than five years prior to 2003 Andre Muller was employed as a General Manager
      by
      Take Two Interactive Software, Inc. In 2003, Mr. Muller co-founded Alliance
      Partners (name later changed to AllianceCorner Distributors Inc.), and served
      as
      its Chief Operating Officer. Since the acquisition by the Company of
      AllianceCorner Distributors Inc. on June 29, 2004, Mr. Muller has served as
      Chief Operating Officer and President of the Company and is also currently
      a
      director.





III-1


STEPHEN
      AGRESS





Stephen
      Agress was the Vice President - Finance and Chief Accounting Officer of Innodata
      Isogen, Inc. (“Innodata”) from March 1998 to September 30, 2006, and served as
      its principal financial officer from May 2001 to December 2005. He served as
      Innodata’s Corporate Controller from August 1995 until May 2004. Mr. Agress is a
      certified public accountant and was a senior audit manager in the TRADE Retail
      & Distribution Services Group at Deloitte & Touche LLP prior to his
      joining Innodata in 1995.





HUMBERT
      B. POWELL, III





Humbert
      B. Powell, III has been a Managing Director at Sanders Morris Harris, a regional
      investment-banking firm headquartered in Houston, Texas, with a branch in New
      York City, since November 1996. He is a trustee of Salem-Teikyo University.
      Mr.
      Powell served as chief executive officer of the Company from June 20, 2002
      until
      July 1, 2002.





THOMAS
      VITIELLO





For
      more
      than five years, Mr. Vitiello has been the president of VIT Trading, Inc.,
      a
      trader in precious metals. He graduated from NYU with a BS in Finance in
      1985.





STEVEN
      H.
      NATHAN





Steven
      H.
      Nathan has since 1997 served as President of Progressive Planning, Inc. a tax
      and financial consulting firm in Jericho, New York. From 1993 through 1997
      he
      was Vice President and Chief Financial Officer of L & J Marketing, Inc.
      d/b/a Alliance Distributors, a regional video game software and hardware
      distributor based in College Point, New York. He held similar positions from
      1984 to 1993 with Wren/AP Distributors.





**Term
      of Office**





Our
      directors serve for a term of one year and until their successors are duly
      elected and qualified. Our officers serve at the pleasure of the Board of
      Directors.





There
      are
      no family relationships among directors, nominees or executive officers. We
      have
      no arrangements or understandings between any director or executive officer
      and
      any other person pursuant to which any director or executive officer was
      selected as such.





**Section
      16(a) Beneficial Ownership Reporting Compliance**





We
      believe that during the period from January 1, 2006 through December 31, 2006
      all Section 16(a) filing requirements applicable to our officers, directors
      and
      greater than ten-percent beneficial owners were complied with.





**Code
      of Ethics**





We
      have a
      Code of Ethics that applies to all of our employees, including our Chief
      Executive Officer and Chief Financial Officer, as well as each member of our
      Board of Directors. The text of our code of ethics is posted on our website
      at
      www.alliancedistributors.com. The Company intends to disclose future amendments
      to, or waivers from, certain provisions of the code of ethics for executive
      officers and directors in accordance with applicable NASDAQ and SEC
      requirements.





**Item
      11. Executive Compensation.**





**Compensation
      Discussion and Analysis**





*Overview*





This
      compensation discussion and analysis describes and analyzes the material
      elements of compensation awarded to, earned by, or paid to each of our executive
      officers who served as named executive officers during the last completed fiscal
      year. This compensation discussion and analysis focuses on the information
      contained in the following tables and related footnotes and narrative for
      primarily the last completed fiscal year, but we also describe compensation
      actions taken before or after the last completed fiscal year to the extent
      it
      enhances the understanding of our executive compensation
      disclosure.





III-2


We
      do not
      have a Compensation Committee or any other committee of the Board of Directors
      performing equivalent functions. Decisions regarding compensation of our named
      executive officers are made by our Board of Directors. Jay Gelman, our Chief
      Executive Officer and Chairman of the Board, participated in deliberations
      of
      the Board during the fiscal year ended December 31, 2006 concerning executive
      officer compensation, except that he abstained from deliberations and voting
      regarding his own compensation. Andre Muller, our President and Chief Operating
      Officer, did not participate in deliberations concerning his own compensation,
      and did not participate in deliberations concerning the Chief Executive
      officer’s compensation.





None
      of
      our Board of Directors is an executive officer of a company whose compensation
      committee or board of directors includes any of our executive
      officers.





The
      principal elements of our executive compensation program are base salary,
      potential for annual incentive compensation award, stock options and other
      benefits and perquisites. Our other benefits and perquisites consist of
      automobile payments and related automobile costs, medical and disability
      insurance payments. Our philosophy is to position the aggregate of these
      elements at a level that is commensurate with our size and sustained
      performance.





*Compensation
      Program Objectives and Philosophy*





The
      objectives of our compensation program are to:





·
            Attract,
                motivate and retain qualified and dedicated executive
                officers.


·
            Retain
                talented executives and motivate them to achieve business objectives
                that
                will enhance stockholder value.


·
            Provide
                our executive officers with cash incentives to further the interests
                of
                the Company and our stockholders.





Generally,
      the compensation of our executive officers is composed of a base salary,
      incentive compensation awards, and equity awards in the form of stock options.
      In setting base salaries, the Board of Directors generally review the individual
      contributions of the particular executive.





The
      following is the compensation committee’s policy for executive officers:





The
      Board
      of Directors is responsible for determining the annual salary, incentive
      compensation awards, stock awards and other compensation of executive officers
      who do not have employment agreements as well as annual salary increases, stock
      awards and other compensation of executive officers who have employment
      agreements. In its deliberations regarding compensation of executive officers,
      the compensation committee considers the following factors:





·
            Company
                performance, both separately and in relation to similar
                companies;


·
            The
                individual performance, experience and scope of responsibilities
                of each
                executive officer;


·
            Compensation
                and stock award information disclosed in the proxy statements of
                other
                companies;


·
            Historical
                compensation levels and stock awards at the
                Company;


·
            The
                overall competitive environment for executives and the level of
                compensation necessary to attract and retain executive talent;
                and


·
            The
                recommendations of management.





*Compensation
      Process*





Our
      Board
      of Directors approves all elements of compensation of our named executive
      officers, including the terms of their employment agreements, if any, taking
      into consideration recommendations from our chief executive officer (for
      compensation other than his own), as well as competitive market
      guidance.





Our
      compensation program for executives principally consists of three
      elements:




·
            base
                salaries


·
            performance-based
                annual incentive compensation
                awards


·
            periodic
                grants of stock options




III-3


*Base
      Salaries*





The
      salaries for the executive officers are designed to retain qualified and
      dedicated executive officers. Our Board of Directors reviews salary
      recommendations made by our Chief Executive Officer and evaluates individual
      responsibility levels, performance and length of service.





*Annual
      Incentive Compensation Awards*





Annual
      incentive compensation awards provide the Company with a means of rewarding
      performance based upon the attainment of corporate profitability during the
      year. In 2006, we did not pay cash-based incentive compensation to any executive
      officer.





*Stock
      Options*





Stock
      options may be granted to provide the opportunity for long-term compensation
      based upon the performance of our stock over time. In 2006, we granted 100,000
      to our Executive Vice President and Chief Financial Officer as of his hire
      date.





*Employee
      Benefit and Health Plans*





We
      have a
      401(k) plan, which covers substantially all employees. Participants in the
      plan
      may contribute a percentage of compensation, but not in excess of the maximum
      allowed under the Internal Revenue Code. In 2006, we did not make matching
      contributions to the plan.





We
      also
      make available health insurance for full time employees. Both we and the
      employees contribute to the payment of this plan in accordance with a published
      schedule as described in the Company’s employment manual.





In
      addition, in 2006 we paid $13,000 for long term disability insurance premiums
      on
      behalf of our Chief Executive Officer and our Chief Operating
      Officer.





III-4


*Summary
      Compensation Table*





The
      following table sets forth information about compensation paid or accrued by
      us
      to our named executive officers.





Name
                and Position
            
            Year
            
            Salary
            
            Option
            
            All
                Other
            
            TotalAwards
                (1)
            
            Compensation
            
            Compensation($)
            
            ($)
            
            ($)
            
            ($)Jay
                Gelman, Chairman of the
            
            
            2006
            
            $
            350,000
            
            $
            33,733
            
            $
            19,813
                (2
            )
            $
            403,546Board
                of Directors and ChiefExecutive
                OfficerAndre
                Muller, President, Chief
            
            
            2006
            
            $
            350,000
            
            $
            33,733
            
            $
            18,798
                (2
            )
            $
            402,531Operating
                Officer and DirectorStephen
                Agress, Executive Vice
            
            
            2006
            
            $
            52,500
            
            $
            1,333
            
            $
            -
            
            $
            53,833President,
                Chief FinancialOfficer
                and Secretary (3)Barbara
                A. Ras, Chief Financial
            
            
            2006
            
            $
            79,327
            
            $
            5,000
            
            $
            -
            
            $
            84,327and
                Principal AccountingOfficer
                (4)





(1)
      - The
      amounts reported in the Option Award Column are the same as the compensation
      cost recognized pursuant to SFAS No. 123(R) in our financial statements,
      unreduced by the estimated service-based forfeitures. Information concerning
      these amounts can be found in Item 8, Financial Statements and Supplementary
      Data, and in the notes to the financial statements in our Annual Report on
      Form
      10-K.





(2)
      - The
      amount includes $13,000 payments to each of Jay Gelman and Andre Muller for
      long
      term disability premiums. Also includes car payments.





(3)
      -
      Hired October 3, 2006





(4)
      -
      Resigned September 13, 2006. Options to purchase 100,000 shares of common stock,
      of which 41,667 had been vested as of the resignation date, were
      forfeited.




*Grants
      of Plan Based Awards Table for the Year ended December 31,
      2006*





Name
            Grant
                Date
            All
                Other Option Awards; Number of Securities Underlying
                Options
            Exercise
                or Base Price of Option Award
            Grant
                Date Fair Value of Stock and Option Awards(#)
            ($/Sh)Stephen
                Agress
            10/3/06
            100,000
            $0.18
            $16,000








III-5


*Outstanding
      Equity Awards at December 31, 2006*





The
      following table summarizes the outstanding equity awards held by each named
      executive officer at year end December 31, 2006.





**Number
                of securities underlying unexercised options**
            
            **Option
                Exercise Price**
            
            **Option
                Expiration Date****Name**
            
            **(#)**
            
            **(#)**
            
            **(#)****Exercisable**
            
            **Unexercisable**Jay
                Gelman
            
            
            641,667
            
            
            458,333
            
            $
            0.325
            
            
            1/13/2015Andre
                Muller
            
            
            641,667
            
            
            458,333
            
            $
            0.325
            
            
            1/13/2015Stephen
                Agress
            
            
            8,333
            
            
            91,667
            
            $
            0.18
            
            
            10/2/2016





None
      of
      our named executive officers exercised stock options in 2006.





*Narrative
      Disclosure to Summary Compensation Table and Grants of Plan-Based Award
      Table*





We
      currently have no contractual employment obligations with any of the executive
      officers other than with Stephen Agress. Our employment obligations pursuant
      to
      an employment contract with Jay Gelman expired in accordance with its terms
      on
      June 30, 2006.





On
      October 3, 2006, we entered into a two year employment agreement with Stephen
      Agress to serve as Executive Vice President and Chief Financial Officer. The
      Agreement provides for annual base compensation of $210,000. The Agreement
      also
      provides for insurance and other fringe benefits, and contains confidentiality
      and non-compete and non-interference provisions. We may terminate Mr. Agress’
employment under the agreement without Cause (as defined) at any time, provided
      that, in such case, we shall, as severance, continue to pay to Mr. Agress an
      amount equal to his then base salary in normal payroll installments, subject
      to
      withholding, for six months or if less until September 30, 2008. In addition,
      we
      shall pay Mr. Agress’ cost of COBRA for the period during which severance is
      payable as aforesaid.





In
      connection with our hiring Mr. Agress, on October 3, 2006, our Board of
      Directors granted Mr. Agress on option to purchase 100,000 shares of our common
      stock under our stock plan at an exercise price of $0.18 per share. The option
      has a 10 year term, and vests in 12 equal installments on the last day of each
      of the 12 calendar quarters beginning with the calendar quarter that begins
      on
      October 1, 2006, but only so long as Mr. Agress is employed by us on the last
      day of such calendar quarter.





On
      July
      26, 2004, Jay Gelman, our Chairman of the Board of Directors and Chief Executive
      Officer signed an employment agreement for two years with annual compensation
      of
      $300,000 per year for the first year and $350,000 for the second year, and,
      at
      the discretion of our Board of Directors, bonuses equal to his salary. In
      addition, the employment agreement provided for a monthly car allowance in
      the
      amount of $750 per month. In the event of a termination of Mr. Gelman's
      employment by us other than for Cause, as defined under the employment
      agreement, or by Mr. Gelman for Good Reason, as defined under the employment
      agreement, Mr. Gelman was entitled to a lump sum payment equal to three times
      his base salary for the period from the date of termination through June 30,
      2006. The employment agreement also contains a 12-month non-compete provision
      effective following termination, except for termination by the Company other
      than for Cause, or Good Reason by Mr. Gelman, and contains customary
      confidentiality provisions.





*Potential
      Payments Upon Termination without Cause*





Pursuant
      to our employment agreement with Mr. Agress, assuming we were to terminate
      his
      employment without cause on December 31, 2006, he would be entitled to six
      months severance pay totaling $105,000.





III-6


**Director’s
      Compensation**





The
      following table sets forth compensation to members of the Board of Directors,
      other than those employed by the Company, during the fiscal year ended December
      31, 2006.





**Name**
            
            **Fees
                Earned or Paid in Cash**
            
            **Option
                Awards**
            
            **All
                Other Compensation**
            
            **Total**($)
            
            ($)
            
            ($)
            
            ($)Humbert
                B. Powell, III
            
            $
            1,500
            
            $
            4,600
                (1
            )
            
            -
            
            $
            6,100Thomas
                Vitiello
            
            $
            1,500
            
            $
            4,600
                (1
            )
            
            -
            
            $
            6,100Steven
                H. Nathan
            
            $
            1,500
            
            $
            8,900
                (2
            )
            
            -
            
            $
            10,400





(1)
      - The
      grant date fair value of the option award computed in accordance with FAS 123(R)
      was $13,800. A total of 150,000 options are outstanding at December 31,
      2006





(2)
      - The
      grant date fair value of the option award computed in accordance with FAS 123(R)
      was $26,700. A total of 150,000 options are outstanding at December 31,
      2006





Members
      of the Board of Directors, other than those employed by us, received a fee
      of
      $1,500 for each regularly scheduled board meeting of the Board, limited to
      4
      regularly scheduled meetings per annum.





Members
      of the Board of Directors receive no fees if they are employed by
      us.





**Compensation
      Committee Interlocks and Insider Participation**





We
      do not
      have a Compensation Committee or any other committee of the Board of Directors
      performing equivalent functions. Decisions regarding compensation of our named
      executive officers are made by our Board of Directors. Jay Gelman, our Chief
      Executive Officer and Chairman of the Board, participated in deliberations
      of
      the Board during the fiscal year ended December 31, 2006 concerning executive
      officer compensation, except that he abstained from deliberations and voting
      regarding his own compensation. Andre Muller, our President and Chief Operating
      Officer, did not participate in deliberations concerning his own compensation,
      and did not participate in deliberations concerning the Chief Executive
      officer’s compensation.





None
      of
      our Board of Directors is an executive officer of a company whose compensation
      committee or board of directors includes any of our executive
      officers.





**Compensation
      Committee Report**





The
      following report of the Board of Directors does not constitute soliciting
      material and should not be deemed filed or incorporated by reference into any
      other Company filing under the Securities Act of 1933 or the Securities Exchange
      Act of 1934, except to the extent the Company specifically incorporates this
      Report by reference therein.





The
      Board
      of Directors have reviewed and discussed the Compensation Discussion and
      Analysis with management and recommended that the Compensation Discussion and
      Analysis be included in this Annual Report on Form 10-K for the year ended
      December 31, 2006, for filing with the Securities and Exchange Commission.





Members
      of the Board of Directors





Jay
      Gelman


Andre
      Muller


Humbert
      B. Powell, III


Thomas
      Vitiello


Steven
      H
      Nathan





**Item
      12. Security Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.**





The
      following table sets forth, as of March 15, 2007, information regarding the
      beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange
      Act
      of 1934) of the Company's Common Stock based upon the most recent information
      available to the Company for (i) each person known by the Company to own
      beneficially more than five (5%) percent of the Company's outstanding Common
      Stock, (ii) each of the Company's officers and directors and (iii) all officers
      and directors of the Company as a group. Unless otherwise indicated, each
      stockholder's address is c/o the Company, 1160 Commerce Avenue, Bronx, New
      York
      10462.





III-7


Beneficial
      ownership is determined in accordance with the rules of the SEC, and for
      calculating the shares and percentage beneficially owned by each Selling
      Security Holder includes any securities which the person has the right to
      acquire within 60 days of the date of March 15, 2007 through the conversion
      or
      exercise of any security or right. The terms of the Series A Convertible Non
      Redeemable Preferred Stock ("Series A Preferred Shares") restrict each holder's
      right to convert the Series A Preferred Shares to the extent that beneficial
      ownership of such holder and its affiliates would exceed 4.999% or 9.999% of
      the
      shares of Common Stock that would be outstanding after giving effect to such
      conversion. For convenience, the table and the footnotes are presented as if
      these restrictions did not apply. For purposes of the table and the footnotes
      below, there are deemed outstanding 52,884,123 shares of common stock,
      consisting of 48,721,065 shares of common stock currently issued and outstanding
      and 4,163,058 shares of common stock issuable on conversion of 261,663 Series
      A
      Preferred Shares. Each Series A Preferred Share converts into 15.91 shares
      of
      common stock.









**Shares
                Owned Beneficially****Name
                and Address of**
              **Beneficial
                Owner**
            
            **Amount
                and Nature**
              **of
                Beneficial**
              **Ownership**
            
            **Percent
                of Class****Directors
                and Executive Officers:**Jay
                Gelman (1)
            
            
            17,463,436
            
            
            32.5
            %Andre
                Muller (2)
            
            
            9,051,671
            
            
            16.9
            %Stephen
                Agress (3)
            
            
            16,667
            
            
            *Humbert
                B. Powell, III (4)
            
            
            135,228
            
            
            *Thomas
                Vitiello (5)
            
            
            112,500
            
            
            *Steven
                H. Nathan (5)
            
            
            112,500
            
            
            *All
                Executive Officers and DirectorsAs
                a Group (6 persons) (6)
            
            
            26,892,002
            
            
            49.0
            %**Known
                Beneficial Holders of More****Than
                5%:**Francis
                Vegliante (7)
            
            
            5,051,655
            
            
            9.4
            %Nathan
                A. Low (8)
            
            
            6,106,648
            
            
            11.3
            %Theseus
                Fund, L.P.f/k/a
                Minotaur Fund LLP (9)
            
            
            5,000,000
            
            
            9.5
            %Jim
                Corfman (10)
            
            
            5,500,000
            
            
            10.4
            %


________________________


*
      Less
      than 1%.





1.
      Consists of Mr. Gelman’s record and beneficial ownership of 8,226,671 shares of
      common stock, currently exercisable options to purchase 825,000 shares of Common
      Stock, and 5,732,091 shares of common stock and 168,427 Series A Preferred
      Shares convertible into 2,679,674 shares of common stock that are subject to
      a
      voting proxy. Of the total number of shares of common stock subject to a voting
      proxy, Theseus Fund, L.P. (f/k/a Minotaur Fund LLP) granted to Mr. Gelman a
      proxy to vote 1,071,335 shares of common stock.





2.
      Consists of Mr. Muller’s record and beneficial ownership of 8,226,671 shares of
      common stock and currently exercisable options to purchase 825,000 shares of
      Common Stock.





3.
      Consists of currently exercisable options to purchase 16,667 shares of Common
      Stock.





4.
      Consists of Mr. Powell’s record and beneficial ownership of 22,728 shares of
      common stock and currently exercisable options to purchase 112,500 shares of
      Common Stock.





III-8


5.
      Consists of currently exercisable options to purchase 112,500 shares of Common
      Stock.





6.
      Includes currently exercisable options to purchase 2,004,167 shares of Common
      Stock. Also includes 5,732,091 shares of common stock and 168,427 Series A
      Preferred Shares convertible into 2,679,674 shares of common stock that are
      subject to a voting proxy held by Mr. Jay Gelman.





7.
      Consists of Mr. Vegliante’s record and beneficial ownership of 4,226,655 shares
      of common stock and currently exercisable options to purchase 825,000 shares
      of
      Common Stock.





8.
      The
      address of Mr. Low is c/o Sunrise Securities Corp., 641 Lexington Avenue N.Y.,
      N.Y. 10022. Mr. Low has sole dispositive and voting power in Sunrise Securities
      Corp. Mr. Low's wife has sole voting and investment power in the shares owned
      by
      Nathan A. Low Family Trust. Mr. Low has shared voting and investment power
      in
      Level Counter LLC, which has sole investment and voting power in the shares
      owned by Sunrise Equity Partners. Mr. Low has shared voting and investment
      power
      in the shares owned by Sunrise Foundation Trust. Mr. Low disclaims beneficial
      ownership of the shares owned by Nathan A. Low Family Trust, Sunrise Equity
      Partners and Sunrise Foundation Trust. These 6,106,648 shares consist of 572,400
      shares of common stock owned by Sunrise Equity Partners, 245,794 shares of
      common stock owned by Sunrise Securities Corp., 756,346 shares of common stock
      due to the deemed conversion of 47,539 Series A Convertible Non Redeemable
      Preferred Stock ("Series A Preferred Shares") owned by Nathan A. Low, 388,315
      shares of common stock due to the deemed conversion of 24,407 Series A Preferred
      Shares owned by Nathan A. Low Family Trust, 2,290,515 shares of common stock
      due
      to the deemed conversion of 143,967 Series A Preferred Shares owned by Nathan
      A.
      Low Roth IRA, 346,504 shares of common stock due to the deemed conversion of
      21,779 Series A Preferred Shares owned by Sunrise Foundation Trust, 366 shares
      of common stock due to the deemed conversion of 23 Series A Preferred Shares
      owned by Sunrise Securities Corp. and 282,307 shares of common stock due to
      the
      deemed conversion of 17,744 shares of common stock owned by Sunrise Equity
      Partners. Further includes 800,527 shares of common stock issuable upon exercise
      of 800,527 warrants owned by Nathan A. Low, 200,132 shares of common stock
      issuable upon exercise of 200,132 warrants owned by Sunrise Foundation Trust
      and
      223,442 shares of common stock issuable upon exercise of 223,442 warrants owned
      by Sunrise Securities Corp.





9.
      The
      address of Theseus Fund, L.P f/k/a Minotaur Fund LLP is 131 Olive Hill Lane,
      Woodside, CA 94062. See footnote 1 for information relating to the voting proxy
      granted to Jay Gelman by Theseus Fund, L.P. f/k/a Minotaur Fund LLP.





10.
      Mr.
      Corfman is the direct beneficial owner of 500,000 shares of common stock and
      the
      indirect beneficial owner of 5,000,000 shares of common stock beneficially
      owned
      by Theseus Fund, L.P f/k/a Minotaur Fund LLP. Mr. Corfman’s business address is
      131 Olive Hill Lane, Woodside, CA 94062.





**Beneficial
      ownership of the Company's Series A Non Redeemable Convertible Preferred
      Stock:**





The
      following table sets forth, as of March 15, 2007, information regarding the
      beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange
      Act
      of 1934) of the Company's Series A Non Redeemable Convertible Preferred Stock
      ("Series A Preferred Shares") based upon the most recent information available
      to the Company for (i) each person known by the Company to own beneficially
      more
      than five (5%) percent of the Company's outstanding Series A Preferred Shares,
      (ii) each of the Company's officers and directors and (iii) all officers and
      directors of the Company as a group.





Beneficial
      ownership is determined in accordance with the rules of the SEC, and for
      calculating the shares and percentage beneficially owned by each Selling
      Security Holder includes any securities which the person has the right to
      acquire within 60 days of the date of this Information Statement through the
      conversion or exercise of any security or right. The terms of the Series A
      Preferred Shares restrict each holder's right to convert the Series A Preferred
      Shares to the extent that beneficial ownership of such holder and its affiliates
      would exceed 4.999% or 9.999% of the shares of Common Stock that would be
      outstanding after giving effect to such conversion.




III-9






**Shares
                Owned Beneficially****Series
                A Convertible Non Redeemable Preferred Shares******
            ****
            ****
            ****
            ******Name
                  and address of****beneficial
                owner**
            ****
            **Amount
                of beneficial ownership**
            
            **Percent
                of Class**Jay
                Gelman (11)
            
            
            168,427
            
            
            64.4
            %All
                executive officers and directors as a group (11)
            
            
            168,427
            
            
            64.4
            %Nathan
                A. Low (12) (13)
              c/o
                Sunrise Securities Corp., 641 Lexington Avenue N.Y., N.Y.
                10022
            
            
            255,459
            
            
            97.6
            %Nathan
                A. Low Roth IRA (14)
              c/o
                Sunrise Securities Corp.
              641
                Lexington Avenue
              N.Y.,
                N.Y. 10022
            
            
            143,967
            
            
            55.0
            %Nathan
                A. Low Family Trust (15)
              c/o
                Sunrise Securities Corp.
              641
                Lexington Avenue
              N.Y.,
                N.Y. 10022
            
            
            24,407
            
            
            9.3
            %Sunrise
                Equity Partners
              c/o
                Sunrise Securities Corp.
              641
                Lexington Avenue
              N.Y.,
                N.Y. 10022
            
            
            17,744
            
            
            6.8
            %Sunrise
                Foundation Trust
              c/o
                Sunrise Securities Corp.
              641
                Lexington Avenue
              N.Y.,
                N.Y. 10022
            
            
            21,779
            
            
            8.3
            %Level
                Counter LLC (16)
              641
                Lexington Avenue
              25thFloor
              N.Y.,
                N.Y. 10022
            
            
            17,744
            
            
            6.8
            %Amnon
                Mandelbaum (17)
              641
                Lexington Avenue
              25thFloor
              N.Y.,
                N.Y. 10022
            
            
            17,744
            
            
            6.8
            %Marilyn
                Adler (18)
              641
                Lexington Avenue
              25thFloor
              N.Y.,
                N.Y. 10022
            
            
            17,744
            
            
            6.8
            %





11.
      Consists of 24,407 Series A Preferred Shares subject to a voting proxy granted
      to Jay Gelman by the Nathan A. Low Family Trust, 143,967 Series A Preferred
      Shares subject to a voting proxy granted to Jay Gelman by the Nathan A. Low
      Roth
      IRA and 53 Series A Preferred Shares subject to a voting proxy granted to Jay
      Gelman by Northumberland Holdings, LTD.





12.
      Mr.
      Low has sole dispositive and voting power in Sunrise Securities Corp. Mr. Low's
      wife has sole voting and investment power in the shares owned by Nathan A.
      Low
      Family Trust. Mr. Low has shared voting and investment power in Level Counter
      LLC, which has sole investment and voting power in the shares owned by Sunrise
      Equity Partners. Mr. Low has shared voting and investment power in the shares
      owned by Sunrise Foundation Trust. Mr. Low disclaims beneficial ownership of
      the
      shares owned by Nathan A. Low Family Trust, Sunrise Equity Partners and Sunrise
      Foundation Trust.





13.
      Consists of 47,539 Series A Preferred Shares owned by Nathan A. Low, 143,967
      Series A Preferred Shares owned by Nathan A. Low Roth IRA, 17,744 Series A
      Preferred Shares owned by Sunrise Equity Partners, 24,407 Series A Preferred
      Shares owned by Nathan A. Low Family Trust, 21,779 Series A Preferred Shares
      owned by Sunrise Foundation Trust and 23 Series A Preferred Shares owned by
      Sunrise Securities Corp.





III-10


14.
      See
      footnote 11 for information relating to the voting proxy granted to Jay Gelman
      by the Nathan A. Low Roth IRA.





15.
      See
      footnote 11 for information relating to the voting proxy granted to Jay Gelman
      by the Nathan A. Low Family Trust.





16.
      Level
      Counter LLC has sole investment and voting power in the shares owned by Sunrise
      Equity Partners. Level Counter LLC disclaims beneficial ownership of these
      shares.





17.
      Mr.
      Mandelbaum has shared voting and investment power in Level Counter LLC, which
      has sole investment and voting power in the shares owned by Sunrise Equity
      Partners. Mr. Mandelbaum disclaims beneficial ownership of the shares owned
      by
      Sunrise Equity Partners.





18.
      Consists of shares owned by Level Counter LLC. Ms. Adler has shared voting
      and
      investment power in Level Counter LLC, which has sole investment and voting
      power in the shares owned by Sunrise Equity Partners. Ms. Adler disclaims
      beneficial ownership of the shares owned by Sunrise Equity Partners.





**Item
      13. Certain Relationships and Related Transactions, and Director
      Independence.**





We
      employ
      Steve Gelman, brother of our Chairman and Chief Executive Officer, as our Vice
      President of Marketing and Communications. In 2006, Mr. Steve Gelman received
      salary totaling approximately $158,000, plus standard benefits.





Related
      Party Transaction Policies and Procedures





Policy





It
      is the
      policy of the Board of Directors of Alliance Distributors Holding Inc. (the
      "Company") that all Interested Transactions with Related Parties, as those
      terms
      are defined in this policy, shall be subject to approval or ratification in
      accordance with the procedures set forth below.





Procedures





The
      Board
      of Directors of the Company, or, if directed by the Board of Directors, the
      Audit Committee or any other independent committee appointed by the Board of
      Directors, shall review the material facts of all Interested Transactions that
      require the Committee’s approval and either approve or disapprove of the entry
      into the Interested Transaction, subject to the exceptions described below.
      If
      advance Board or committee approval of an Interested Transaction is not
      feasible, then the Interested Transaction shall be considered and, if the Board
      or committee determines it to be appropriate, ratified at the Board’s or
      committee’s next regularly scheduled meeting. In determining whether to approve
      or ratify an Interested Transaction, the Board or committee will take into
      account, among other factors it deems appropriate, whether the Interested
      Transaction is on terms no less favorable than terms generally available to
      an
      unaffiliated third-party under the same or similar circumstances and the extent
      of the Related Person’s interest in the transaction.





The
      Board
      of Directors and the Audit Committee have reviewed the Interested Transactions
      described below in "Standing Pre-Approval for Certain Interested Transactions"
      and determined that each of the Interested Transactions described therein shall
      be deemed to be pre-approved or ratified (as applicable) by the Board and the
      Audit Committee under the terms of this policy.





No
      Director shall participate in any discussion or approval of an Interested
      Transaction for which he or she is a Related Party, except that the Director
      shall provide all material information concerning the Interested Transaction
      to
      the Board or the committee.





If
      an
      Interested Transaction will be ongoing, the Board may establish guidelines
      for
      the Company’s management to follow in its ongoing dealings with the Related
      Party. Thereafter, the Board, on at least an annual basis, shall review and
      assess ongoing relationships with the Related Party to see that they are in
      compliance with these guidelines and that the Interested Transaction remains
      appropriate.





III-11


Definitions





An
      “Interested Transaction” is any transaction, arrangement or relationship or
      series of similar transactions, arrangements or relationships (including any
      indebtedness or guarantee of indebtedness) in which (1) the aggregate amount
      involved will or may be expected to exceed $120,000 in any calendar year, (2)
      the Company is a participant, and (3) any Related Party has or will have a
      direct or indirect material interest (other than solely as a result of being
      a
      director or a less than 10 percent beneficial owner of another
      entity).





A
      “Related Party” is any (a) person who is or was (since the beginning of the last
      fiscal year for which the Company has filed a Form 10-K and proxy statement,
      even if they do not presently serve in that role) an executive officer, Director
      or nominee for election as a Director, (b) greater than 5 percent beneficial
      owner of the Company’s common stock, or (c) immediate family member of any of
      the foregoing. Immediate family member includes a person’s spouse, parents,
      stepparents, children, stepchildren, siblings, mothers- and fathers-in-law,
      sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing
      in such person’s home (other than a tenant or employee).





Standing
      Pre-Approval for Certain Interested Transactions





The
      Board
      and the Audit Committee have reviewed the types of Interested Transactions
      described below and determined that each of the following Interested
      Transactions shall be deemed to be pre-approved by the Committee, even if the
      aggregate amount involved will exceed $120,000.





1.
      Employment of executive officers. Any employment by the Company of an executive
      officer of the Company if:





a.
      the
      related compensation is required to be reported in the Company’s proxy statement
      under Item 402 of the Securities and Exchange Commission’s ("SEC’s")
      compensation disclosure requirements (generally applicable to "named executive
      officers"); or





b.
      the
      executive officer is not an immediate family member of another executive officer
      or Director of the Company, the related compensation would be reported in the
      Company’s proxy statement under Item 402 of the SEC’s compensation disclosure
      requirements if the executive officer was a "named executive officer", and
      the
      Company’s Compensation Committee approved (or recommended that the Board
      approve) such compensation.





2.
      Director compensation. Any compensation paid to a Director if the compensation
      is required to be reported in the Company’s proxy statement under Item 402 of
      the SEC’s compensation disclosure requirements;





3.
      Certain transactions with other companies. Any transaction with another company
      at which a Related Person’s only relationship is as an employee (other than an
      executive officer), Director or beneficial owner of less than 10% of that
      company’s shares;





4.
      Transactions where all shareholders receive proportional benefits. Any
      transaction where the Related Person’s interest arises solely from the ownership
      of the Company’s common stock and all holders of the Company’s common stock
      received the same benefit on a pro rata basis (e.g. dividends);





5.
      Transactions involving competitive bids. Any transaction involving a Related
      Party where the rates or charges involved are determined by competitive
      bids.





**Director
      Independence**





Our
      Board
      of Directors has determined that each of Humbert B. Powell, III, Thomas Vitiello
      and Steven
      H.
      Nathan is
      an
“independent director” as defined in Rule 4200(a)(15) of the listing standards
      of the National Association of Securities Dealers.




We
      have a
      separately designated standing audit committee established in March 2005 in
      accordance with Section 3(a)(58)(A) of the Exchange Act. Serving on the
      Committee are Steven H. Nathan and Thomas Vitiello. Our board of Directors
      has
      determined that we have an audit committee financial expert serving on the
      audit
      committee, Steven H. Nathan.





Our
      board
      of directors have determined that Steven H. Nathan is an independent director
      based on Rule 4200 of the National Association of Securities Dealers' listing
      standards and is qualified as an "Audit Committee Financial Expert" as defined
      in Item 7(d)(3)(iv) of Schedule 14A.





III-12


**Item
      14. Principal Accountant Fees and Services.**





Set
      forth
      below is certain information concerning fees by Mahoney Cohen & Company,
      CPA, P.C. in respect of services provided for 2006 and 2005. The Audit Committee
      has determined that the provision of all services is compatible with maintaining
      the independence of Mahoney Cohen & Company, CPA, P.C.





*Audit
      Fees* .
      Mahoney
      Cohen & Company, CPA, P.C. billed us approximately $121,000 for professional
      services rendered for (1) the audit of the annual financial statements for
      2006,
      (2) the reviews of the financial statements included in reports on Form 10-Q
      for
      periods within 2006 and (3) related regulatory filings for periods within 2006;
      and approximately $119,000 for professional services rendered for (1) the audit
      of the annual financial statements for 2005, (2) the reviews of the financial
      statements included in reports on Form 10-QSB for periods within 2005 and (3)
      related regulatory filings for periods within 2005.





*Audit
      Related Fees.* Mahoney
      Cohen & Company CPA, P.C. did not provide any audit related services in 2006
      and 2005, respectively.





*Tax
      Fees.* Mahoney
      Cohen & Company, CPA, P.C. did not provide any tax services in 2006 and
      2005, respectively.





*Tax
      and Other Fees.* In 2006
      and 2005, Mahoney Cohen & Company, CPA, P.C. billed us approximately $29,000
      and $14,000, respectively, for services in connection with our potential
      acquisition of Foto Electric Supply Co., Inc.





The
      Audit
      Committee is directly and solely responsible for oversight, engagement and
      termination of any independent registered public accounting firm employed by
      the
      Company for the purpose of preparing or issuing an audit report or related
      work.





The
      Audit
      Committee (i) meets with the independent registered public accounting firm
      prior
      to the audit and discusses the planning and staffing of the audit; (ii) approves
      in advance the engagement of the independent registered public accounting firm
      for all audit services and non-audit services and approves the fees and other
      terms of any such engagement; (iii) obtains periodically from the independent
      registered public accounting firm a formal written statement of the matters
      required to be discussed by Independent Standards Board Statement No. 1, and,
      in
      particular, describing all relationships between the auditor and the Company;
      (iv) discusses with the independent registered public accounting firm any
      disclosed relationships or services that may impact auditor objectivity and
      independence; and (v) conducts periodic meetings with the independent registered
      public accounting firm regarding maters required to be discussed under
      Statements on Auditing Standards No. 61, as amended.








III-13


**PART
      IV**





**Item
      15. Exhibits, Financial Statement Schedules and Reports on Form
      8-K.**





(a)
            
            1.
                Financial Statements. See Item 8. Index to Financial
                Statements.
              2.
                  Financial Statement Schedules. Schedule II - Valuation and Qualifying
                  Accounts
                3.**Exhibits**
              
              Exhibits which are indicated
                as being
                included in previous filings are incorporated herein by reference.




Exhibit
                Number
            Description2.1
            Exchange
                Agreement between Essential Reality, Inc. and Messrs. Jay Gelman,
                Andre
                Muller and Francis Vegliante dated as of June 17, 2004. Incorporated
                herein by reference from Exhibit 2.1 to the Company's Form 8-K filed
                on
                July 14, 2004 (the "Form 8-K").2.2
            Form
                of Agreement and Plan of Merger dated as of October 25, 2004 by and
                between Essential Reality, Inc. and Alliance Distributor Holding
                Inc.
                Incorporated herein by reference from Exhibit 2 to the Company's
                Form 8-K
                filed on November 23, 2004.3.1
            Certificate
                of Incorporation of Alliance Distributors Holding Inc. Incorporated
                herein
                by reference from Exhibit 3.1 to the Company’s Form 8-K filed on November
                23, 2004.3.2
            By-Laws
                of Alliance Distributors Holding Inc. Incorporated herein by reference
                from Exhibit 3.2 to the Company's Form 8-K filed on November 23,
                2004.4.1
            Alliance
                Distributors Holding Inc. 2004 Stock Plan. Incorporated herein by
                reference from Exhibit 3.3 to the Company's Form 8-K filed on November
                23,
                2004.4.2
            Form
                of Stock Option Agreement. Incorporated herein by reference from
                Exhibit
                4.2 to the Company's Form 10K-SB filed on March 30,
                2005.4.3
            Form
                of Warrant issued to Rosenthal & Rosenthal. Incorporated herein by
                reference from Exhibit 4.1 to the Company's Form 8-K filed on November
                15,
                2004.4.4
            Form
                of Warrants issued to Legend Merchant Group, Inc. and Coniston Investment
                Corp. Incorporated herein by reference from Exhibit 4.1 to the Company's
                Form SB-2 filed on July 19, 2002.4.5
            Form
                of Warrant issued to Sunrise Securities Corp. Incorporated herein
                by
                reference from Exhibit 99.4 to the Company's Form 8-K filed on July
                14,
                2004.9.1
            Irrevocable
                Proxy given in favor of Jay Gelman. Incorporated herein by reference
                from
                Exhibit 9.1 to the Form 8-K.9.2
            Form
                of Irrevocable Proxy dated December 15, 2005 given in favor of Jay
                Gelman,
                filed herewith.10.1
            Retainer
                Agreement dated as of June 29, 2004 between Essential Reality, Inc.
                and
                IVC Group. Incorporated herein by reference from Exhibit 10.1 to
                the
                Company's Form 10-QSB for the period ended June 30, 2004, filed on
                August
                17, 2004.10.2
            Employment
                Agreement, dated as of July 26, 2004 between Essential Reality Inc.
                and
                Jay Gelman, President and CEO of Essential Reality Inc. Incorporated
                herein by reference from Exhibit 10.2 to the Company's Form 10-QSB
                filed
                on August 17, 2004.10.3
            Subscription
                Agreement among the Investor's listed on Schedule I thereto, Essential
                Reality, Inc. and Jay Gelman. Incorporated herein by reference from
                Exhibit 99.1 to the Form 8-K.




IV-1




10.4
            Subscription
                Agreement Supplement No. 1 between the Investors listed on Schedule
                I
                thereto and Essential Reality, Inc. Incorporated herein by reference
                from
                Exhibit 99.2 to the Form 8-K.10.5
            Registration
                Rights Agreement between Essential Reality and the Investors listed
                on
                Schedule I to the Subscription Agreement. Incorporated herein by
                reference
                from Exhibit 99.3 to the Form 8-K.10.6
            Stock
                Purchase Warrant between Essential Reality, Inc. and Sunrise Securities
                Corp. Incorporated herein by reference from Exhibit 99.4 to the Form
                8-K.10.7
            Investment
                Banking Agreement between Essential Reality, Inc. and Sunrise Securities
                Corp. Incorporated herein by reference from Exhibit 99.5 to the Form
                8-K.10.8
            Form
                of Financing Agreement between the Company and Rosenthal & Rosenthal.
                Incorporated herein by reference from Exhibit 10.1 to the Company’s Form
                8-K filed on November 16, 2004.10.9
            Amendment
                dated November 1, 2005 to the Financing Agreement between the Company
                and
                Rosenthal & Rosenthal. Incorporated herein by reference from Exhibit
                10.2 to the Company’s Form 10-QSB filed on November 7,
                2005.10.10
            Amendment
                dated October 31, 2005 to the Financing Agreement between the Company
                and
                Rosenthal & Rosenthal, filed herewith.10.11
            Form
                of Amendment dated March 21, 2006 to the Financing Agreement between
                the
                Company and Rosenthal & Rosenthal, filed herewith.10.12
            Form
                of Security Agreement issued to Rosenthal & Rosenthal. Incorporated
                herein by reference from Exhibit 10.2 to the Company's Form 8-K filed
                on
                November 15, 2004.10.13
            Form
                of Guaranty issued to Rosenthal & Rosenthal. Incorporated herein by
                reference from Exhibit 10.3 to the Company's Form 8-K filed on November
                15, 2004.10.14
            Form
                of Registration Rights Agreement issued to Rosenthal & Rosenthal.
                Incorporated herein by reference from Exhibit 10.4 to the Company's
                Form
                8-K filed on November 15, 2004.10.15
            Lease
                Agreement dated as of July 28, 2003 between KIM Management, LLC,
                and Big
                Brother World, Inc. Incorporated herein by reference from Exhibit
                10.12 to
                the Company's Form SB-2 filed on December 23, 2004.10.16
            Lease
                Agreement dated as of December 1, 2003 between Angelo Pegno et. al.
                and
                AllianceCorner Distributors Inc. Incorporated herein by reference
                from
                Exhibit 10.13 to the Company's Form SB-2 filed on December 23, 2004.10.17
            Lease
                Agreement dated as of July 1, 2003 between Angelo Pegno Et. al. and
                Alliance Partners, Inc. Incorporated herein by reference from Exhibit
                10.14 to the Company's Form SB-2 filed on December 23,
                2004.10.19
            Operating
                Agreement of Alliance Age LLC between Alliance Distributors Holding
                Inc.
                and Abrams/Gentile Entertainment Inc. dated July 21, 2005. Incorporated
                herein by reference from Exhibit 99.1 to the Company's Form 10-QSB
                filed
                on August 15, 2005.10.20
            Stock
                Purchase Agreement dated January 2, 2006 by and among the Company
                and the
                Sellers set forth therein. Incorporated herein by reference from
                Exhibit
                10.1 to the Company’s Form 8-K filed on January 10,
                2006.




IV-2




10.21
            Form
                of Employment Agreement between the Company and Stephen Agress dated
                October 3, 2006. Incorporated herein by reference from Exhibit
                10.1 to the Company’s Form 8-K filed on October 6, 200610.22
            Form
                of Stock Option Agreement to Stephen Agress dated
                October 3, 2006. Incorporated herein by reference from Exhibit
                10.3 to the Company’s Form 8-K filed on October 6, 200614
            Code
                of Ethics. Incorporated herein by reference from Exhibit 14 to the
                Company's Form 8-K filed on March 16, 2005.31.1
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
                Exchange Act of 1934, filed herewith.31.2
            Certification
                of Chief Financial Officer/Principal Financial and Accounting Officer
                pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934,
                filed
                herewith.32.1
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
                herewith.32.2
            Certification
                of Chief Financial Officer/Principal Financial and Accounting Officer
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002, filed
                herewith.










IV-3


**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
      the
      Registrant caused this Report on Form 10-K to be signed on its behalf by the
      undersigned, thereunto duly authorized.





March
      29,
      2007


Alliance
      Distributors Holding Inc.











By:
      /s/
      Jay Gelman


-------------------------------------------


Jay
      Gelman


Chairman
      of the Board and


Chief
      Executive Officer














In
      accordance with the Securities Exchange Act of 1934, this report has been signed
      below by the following persons on behalf of the registrant and in the capacities
      and on the dates indicated.








/s/
                Jay Gelman
            Date:
                March 29, 2007------------------------------------------Jay
                Gelman, Chairman of the Boardand
                Chief Executive Officer/s/
                Andre Muller
            Date:
                March 29, 2007------------------------------------------Andre
                Muller, President, ChiefOperating
                Officer and Director/s/
                Stephen Agress
            Date:
                March 29, 2007-------------------------------------------Stephen
                AgressExecutive
                Vice President, Chief Financialand
                Principal Accounting Officer, and Secretary/s/
                Humbert B. Powell, III
            Date
                : March 29, 2007------------------------------------------Humbert
                B. Powell, III, Director/s/
                Steven H. Nathan
            Date
                : March 29, 2007------------------------------------------Steven
                H. Nathan, Director/s/
                Thomas Vitiello
            Date:
                March 29, 2007------------------------------------------Thomas
                Vitiello, Director








IV-4




**ALLIANCE
        DISTRIBUTORS HOLDING INC.**
 **SCHEDULE
        II**
 **VALUATION
        AND QUALIFYING ACCOUNTS**
 **(Dollars
        in Thousands)**
 
 
 
 Balance
                  at
              
              Charged
                  to
              
              
              
              Balance
                  atBeginning
                  of Year
              
              Costs
                  and Expenses
              
              Deductions
                  (b)
              
              End
                  of YearYear
                  ended December 31, 2006Allowance
                  for Doubtful Accounts
              
              $
              181
              
              $
              147
              
              $
              (16
              )
              $
              312Deferred
                  tax valuation allowance
              
              $
              2,357
              
              $
              (23)
                  (a
              )
              
              
              
              $
              2,334Year
                  ended December 31, 2005Allowance
                  for Doubtful Accounts
              
              $
              39
              
              $
              247
              
              $
              (105
              )
              $
              181Deferred
                  tax valuation allowance
              
              $
              2,124
              
              $
              233
                  (a
              )
              
              
              
              $
              2
                  ,357Year
                  ended December 31, 2004Allowance
                  for Doubtful Accounts
              
              $
              10
              
              $
              27
              
              $
              (2
              )
              $
              39Deferred
                  tax valuation allowance
              
              $
              -
              
              $
              2,124
                  (a
              )
              
              
              
              $
              2,124
 
 
 (a)
        Represents the recording of a (benefit) provision associated with the deferred
        tax asset for net operating loss carryforwards
 
 (b)
        Represents the use of the established reserve