SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Annual report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2005.
Commission file number 0-19409
SYNERGY BRANDS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2993066
(State of incorporation) (I.R.S. Employer Identification No.)
223 Underhill Blvd.
Syosset, NY 11791
(Address of corporate offices)
Registrant's telephone number, including area code: 516-714-8200
Securities registered pursuant to Section 12(b) of the
Act:
Title of Each Class Name of Exchange
Common Stock, $.001 par value NASDAQ/Small-Cap System
and Boston Stock Exchange
The purpose for this amendment is to include corrected Certifications
required by Exchange Act Rule 13a-14(a); no other changes have been made from
the original filing.
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES __ NO_X____
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___NO__X____
Note-Checking the box will not relieve any registrant required to file
reports pursuant to Section 13 or 15(d) of the Exchange Act from their
obligations under those Sections.
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 preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes_X_ NO__
Indicate by check mark if disclosure of delinquent filers pursuant 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes__NO_X_
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES________NO X___
Synergy Brands Inc. revenues for its most recent fiscal year were
$64,137,090.
On March 30, 2006, the aggregate market value of the voting stock of
Synergy Brands Inc., held by non-affiliates of the Registrant was approximately
$5,637,000. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The number of outstanding shares of
the Registrant's Common Stock as of March 30, 2006 was 4,613,190.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2005 Annual Meeting of
Stockholders currently scheduled to be held June 2006 are incorporated by
reference in Part III (for other documents incorporated by reference refer to
Exhibit Index at page 44 and 45)
PART I
Other than historical and factual statements, the matters and items
discussed in this report on Form 10-K are forward-looking information that
involve risks and uncertainties. The Company's actual results may differ
materially from the results discussed in the forward-looking statements. Factors
that could contribute to such differences are discussed in the forward-looking
statements and are summarized in Item 1A "Risk Factors Forward-Looking
Information and Cautionary Statements."
ITEM 1. DESCRIPTION OF BUSINESS
A. OVERVIEW
Synergy Brands Inc. (SYBR or the Company) is a holding company that
operates in the wholesale distribution of Groceries and Health and Beauty Aid
(HBA) products as well as wholesale and on-line distribution of premium cigars,
salon products and luxury goods. It principally focuses on the sale of
nationally known brand name consumer products manufactured by major U.S.
manufacturers. The consumer products are concentrated within the Grocery and
Health & Beauty Aids (HBA) industries as well as the premium cigar business. The
Company uses logistics web based programs to optimize its distribution costs on
both wholesale and retail levels. The Company distributes and sells these
products through wholly owned subsidiaries in three distinct manners, wholesale,
on-line and retail.
The Company also owns 22% of the outstanding common stock of Interline
Travel and Tours, Inc. (aka: PERX.com). PERX provides cruise and resort hotel
packages through a proprietary reservation system to airline employees and their
retirees. PERX is believed to be the largest Company in this sector of the
travel industry. Information on PERX can be found at www.perx.com. The Company
believes that its capital investment in this unique travel company could provide
for material future capital appreciation. Synergy Brands does not manage PERX's
day-to-day operations.
For further information please visit our corporate website at www.sybr.com.
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BUSINESS-TO-BUSINESS (B2B): THE COMPANY OPERATES TWO BUSINESSES WITHIN THE
B2B SECTOR. B2B IS DEFINED AS SALES TO NON-RETAIL CUSTOMERS.
PHS Group distributes Grocery and HBA products to retailers and wholesalers
predominately located in the Northeastern United States. PHS is the largest
subsidiary of the Company and largest business segment of the Company's business
operations, representing about 96% of the overall Company sales and 89% of gross
profit. PHS's core sales base remains the distribution of nationally branded
consumer products in the grocery and health and beauty (HBA) sectors. PHS has
positioned itself as a distributor for major manufacturers as opposed to a full
line wholesaler. A full line wholesaler has the responsibility of servicing the
entire needs of a retail operation, whereas a distributor caters to specific
merchandising categories. As a result, PHS is able to plan the needs of its
customers and benefit the manufacturer directly from the source of supply and in
turn increase sales to its customers through this unique strategy. PHS
concentrates on the fastest moving promotional items such as: Tide, Bounty,
Nyquil, Pantene, Clorox bleach, Scott tissues, Marcal tissues among many others,
and uses promotions, logistics and distribution savings to streamline and reduce
its sale prices and increase gross profit thereby. The second business segment
within the Company's B2B sector is Proset Hair Systems (Proset). Proset
distributes salon hair care products and luxury goods to wholesalers, and
distributors in the Northeastern part of the United States.
BUSINESS TO CONSUMER (B2C): THE COMPANY OPERATES THREE BUSINESSES WITHIN
THE B2C SECTOR. B2C IS DEFINED AS SALES TO RETAIL CUSTOMERS.
The Company's B2C activities are conducted through its wholly owned
subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses
o Cigars Around the World (CAW) sells premium cigars to restaurants,
hotels, casinos, country clubs and many other leisure related
destinations. This company was acquired in June, 2003. CAW also opened
a retail store and lounge in Miami Lakes, Florida selling premium
cigars and accessories in March 2006.
o CigarGold.com sells premium cigars through the Internet directly to
the consumer and through partnership online affiliations.
o BeautyBuys.com sells salon hair care products directly to the
consumer via the internet and through partnership online affiliations.
THE COMPANY'S CORPORATE OFFICES ARE LOCATED AT 223 UNDERHILL BLVD.,
SYOSSET, NY 11791, AND ITS TELEPHONE NUMBER IS 516-714-8200. THE COMPANY
MAINTAINS A CORPORATE WEBSITE AT WWW.SYBR.COM. The Company is a reporting
Company as defined in Regulation 12B of the Securities Exchange Act of 1934 and
files electronically with the SEC the Company's quarterly 10Q and Year-end 10-K
reports and interim Form 8K reports. The general public may read and copy any
materials the Company has filed with the SEC at the SEC Public Reference Room at
450 Fifth Street NW, Washington DC. The general public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The SEC also maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers that file
electronically with the SEC which website can be accessed at www.sec.gov. Filed
reports by the Company may be viewed at the SEC Edgar filing website to which
the Company's homepage website is directly linked.
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B. BUSINESS TO BUSINESS OPERATIONS (B2B)
The Company's B2B operations consist of two operating business segments ,
PHS Group and Proset Hair Systems.
PHS Group is the grocery logistics business involved in the purchase of
name brands grocery and Health and Beauty Aids (HBA) products and their further
resale to traditional customers utilizing the logistics and networking
advantages of electronic commerce and just in time distribution. PHS's core
sales base consists of the distribution of nationally branded consumer products
in the grocery and HBA sectors and wholesale distribution of grocery items
predominantly in the United States, Canada and Dominican Republic (DR).
Distribution of such products is directed to major retailers and wholesalers
from major U.S. consumer product manufacturers, Canadian and DR Wholesalers. PHS
has positioned itself as a distributor for major manufacturers as opposed to a
full line wholesaler. A full line wholesaler has the responsibility of servicing
the entire need of a retail operation, whereas a distributor caters to specific
merchandising categories. As a result, PHS is able to plan the needs of its
customers directly from the source of supply and in turn increase sales to its
customers through this unique focus. PHS concentrates on the fastest moving
promotional items and uses logistics and distribution savings to streamline and
reduce its sale prices.
PHS conducts its business through its sales offices in New York. The
Company maintains its information system and warehousing operations in Long
Island, NY. PHS services over 500 customers in the northeastern quadrant of the
United States and Canada. PHS utilizes leased trucks in addition to consigning
common carriers for overflow sales.
The second business segment within the Company's B2B sector is Proset Hair
systems (Proset). Proset distributes Salon hair care products and luxury goods
(such as bags, wallets, brief cases etc.) predominantly to wholesalers retailers
and distributors in the United States. Proset focuses on the sale of brand name
products. Proset purchases these goods in large quantities and thereby at a
volume discount and in turn sells in bulk to regional wholesalers and
distributors. Proset also sells directly to the consumer salon products on-line
through Beautybuys.com and on-line partnership affiliations. This latter online
unit operates at www.BeautyBuys.com. BeautyBuys.com sells salon hair products
directly to the retail consumer.
C. BUSINESS TO CONSUMER OPERATIONS (B2C)
CIGAR OPERATIONS.
GRC owns multiple internet domains including Cigargold.com,
cigarsaroundtheworld.com and affiliations. GRC focuses on sale of a mix of brand
name and private label premium cigar items and cigar related accessories and
markets them through these sties. GRC also manages the internet sales of
Beautybuys.com which are less than 5% of overall online sales.
GRC Cigar operations include two businesses. This segment includes Cigars
Around the World (CAW) and CigarGold. Cigars Around the World (CAW) was acquired
in June of 2003. That Company sells premium cigars to Hotels, Restaurants,
Casinos, PGA Clubs and other leisure related destinations. CAW was founded by
Bill Rancic, winner of the NBC show The Apprentice. Mr. Rancic serves on the
Board of Directors of Synergy Brands. CAW sells its cigars in customized retail
displayed humidors that it provides to its customers. CAW also has its own
retail website that operates under the name www.CigarsAroundTheWorld.com. The
displays range from counter top humidors to Walled Display units. CAW also
organizes events such as cigar dinners and merchandising opportunities within
its destinations. CigarGold (CG) is the Company's main cigar online unit. CG
sells premium cigars online to retail customers throughout the United States. It
has a selection of over 1000 products, which include brand-name hand made
premium cigars and cigar accessories as well as private label and proprietary
products. CigarGold operates under the domain name: www.CigarGold.com.
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In 1999, the Company launched through its GRC subsidiary NetCigar.com Inc.
("NetCigar") a web site created for sale of premium cigar products. The Company
developed another domain name in CigarGold.com (CGC) and the operations of
NetCigar are now processed under that name. Through CigarGold.com the Company
offers information on a variety of cigars and cigar related products as well as
content, including cigar news and events and editorials, and sale of an array of
cigars and cigar products of both proprietary labels and other popular brands.
The Company also markets humidors, and sells golf oriented gifts and apparatus.
The Company has a long-term lease in Miami, Florida for storage of its entire
inventory in a custom designed humidor warehouse. CigarGold's web site adds
convenience to customer and potential customer shopping by being open and
available 24 hours a day, seven days a week for access from anywhere that a
consumer has internet access. A significant portion of CigarGold's web site
design is proprietary and CigarGold has had the site designed and has developed
the site to accommodate specific marketing and record keeping requirements to
enhance their customer service.
CGC utilizes a computerized database management system that collects,
integrates and allows analysis of data concerning sales, order processing,
procurement, shipping, receiving, inventory and financial reporting. At any
given time, Company executives can determine the quantity of product stored by
item, cost by item, aging and other characteristics necessary for expeditious
fulfillment and distribution. A network system of the Company's office and
warehousing facilities allows for online assessment and transactional reporting
capabilities. It is the Company's policy that all consumer orders are shipped
from the Company's warehouse within 3 days of order placement. GRC maintains an
inventory on approximately 90% of its product mix; the other 10% is purchased on
a just-in-time basis. The distribution facility has sufficient space to handle
the Company's anticipated growth in this area of product sales. After an order
is shipped, customers can view order tracking information through a customized
profile for each customer.
As customers use the CGC web site, they provide CGC with information about
their buying preferences and habits. NetCigar then can use this information to
develop personalized communications and deliver useful information, special
offers and new product announcements to its customers. In addition, CGC uses
e-mail to alert customers to important developments and merchandising
initiatives.
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CGC competes with many and varied sources for cigar products in a small but
affluent market which is highly fragmented and which has to date a small on-line
presence. No single traditional retailer to the Company's knowledge competes
against the Company in all of its product lines and there is an array of
developed e-commerce cigar sites. The largest competitor, JR Cigars has
developed an e-commerce web site for its product sales as an adjunct to their
traditional brick and mortar retail stores and catalogue sales.
Traditional pre-internet cigar sales appear to have evolved through the
following four categories of retailing, which together remain the main source of
cigar marketing:
1. Mom and Pop brick and mortar tobacco shops that typically average 2500
square feet and generate average annual volume of approximately $250,000
per store.
2. Chain and franchise brick and mortar tobacco shops that average 12,000
to 15,000 square feet and generate approximately $1,000,000 in annual
volume per store.
3. Catalog and mail order vendors that do monthly mailings to as many as
500,000 customers (in some instances as few as 25,000 customers), which is
the portion of the market that the Company believes should be the easiest
to convert to ecommerce purchases, and
4. Drug stores and mass market retailers representing a small share of the
market.
The Company believes that the following are principal competitive
advantages present in its operations and product presentation: brand
recognition, selection, convenience, price, web site performance and
accessibility, customer service, quality of information provided and reliability
and speed of order shipment, acute knowledge of cigar brands, quality of
products, stable source of supply, editorial contribution regarding cigar news
and one on one online customer interaction. Greater than fifty percent of
NetCigar customers are repeat customers on a daily basis.
Many of the Company's off-line and online competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than CGC. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet. Traditional store-based retailers can
also sell products to address immediate needs, which the Company and other
online sites may not be able to do.
In June 2003 the Company acquired the ownership interest in The Ranley
Group Inc. an Illinois corporation doing business as Cigars Around the World
("CAW") a Chicago based Midwest premium cigar distributor. CAW sells premium
cigars to various leisure related destinations in customized retail displays and
maintains its own internet sales based website.
In FY 2006 the Company desires to and will likely implement plans to expand
on its online partnerships for all its product offerings and expand CAW retail
store operations.
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D. COMPETITION
The Company is smaller in comparison to many of its competitors in the
marketing of grocery and health and beauty care products and cigars. Access to
product remains important but the Company is confident of the continued
availability of product from manufactures, wholesalers, and distributors with
whom the Company has successfully acquainted itself or developed in house.
Source of supplies the Company believes should stay stable. Most of the
Company's suppliers are regulated under fair trade and pricing regulations. As a
result the Company can remain competitive as long as it purchases products at
prescribed volume and credit limitation set by the suppliers.
E. MAJOR CUSTOMERS.
During the year ended December 31, 2005, sales to two customers accounted
for 12% and 10% of the Company's total sales and in 2004 sales to two customers
accounted for 21% and 18% of total sales. These major customers relate to the
grocery logistics business within the Company's B2B sector.
F. INFORMATION SYSTEMS AND WEBSITE TECHNOLOGY FOR INTERNET SALES.
The various web sites established for sale of the Company's products are of
multi-tier construction to allow for ease of administration and record keeping.
Behind the screen not visible to the consumer when visiting the Company's
various product category websites are internet based marketing and accounting
information programs to allow the Company to review interest shown in its
websites and account for sales made there from. The Company also maintains its
own websites regarding information on the Company as a public entity and its
various business interests. The Company's home page website is linked directly
to the SEC Edgar based listing of all Company SEC filings where further Company
information disclosure as required by the SEC is contained including reference
to and listing of various Company committee charters and disclosure policies.
Internet sites presently available regarding Company business and product sales
are:
BeautyBuys.com
SynergyBrands.Com
DealbyNet.com
Perx.com (managed by Interline Travel & Tours)
SYBR.com
CIGARGOLD.com
CigarsAroundtheWorld.com
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The Company's website design work is proprietary. It was developed to
accommodate the specific marketing and record keeping requirements of the
Company. State-of-the-art technology is utilized in site design, tracking
systems, hosting and affiliated programs. The Company strives through internal
development efforts to create and enhance the specialized, proprietary software
that The Company believes is unique to its Business.
The Company utilizes a computerized web based database management system
that collects, integrates and allows analysis of data concerning sales, order
processing, shipping, purchasers, receiving, inventories, and financial
reporting. At any given time, the database management systems utilized by the
Company are designed to allow management to determine the quantity of product
stored by item, cost by item, aging and other characteristics necessary for
expeditious fulfillment and distribution.
The Company has implemented a broad array of services and systems for site
management, searching, customer interaction, transaction processing and
fulfillment. The Company uses a set of software applications for: accepting and
validating customer orders; organizing, placing, and managing orders with
vendors and fulfillment partners; receiving product and assigning it to customer
orders; and managing shipment of products to customers based on various ordering
criteria.
The Company's websites can be shopped 24 hours a day, seven days a week
from anywhere that a consumer has Internet access. The Company offers a large
selection of products and in addition provides various levels of selected
product content, buying guides and other tools designed to help consumers make
educated purchasing decisions. Additionally, shopping list and e-mail reminders
are designed to make it easier for customers to regularly purchase their
preferred products.
The Company's marketing efforts are aimed at flexibility of presentation to
attract new and repeat customers and give ease of access to product availability
and information. The Company's online store provides flexibility to change
featured products or promotions without having to alter the physical layout of a
store. The Company is also able to dynamically adjust its product mix in
response to changing customer demand, new seasons or holidays and special
promotions.
The Company has the ability to offer products to individual customers based
on their brand preferences. The Company also cross-sells its departments to
promote impulse buying by customers.
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The Company also maintains a Virtual Private Network (VPN) and intranet
system. This network allows for real time sales and order processing across to
Company's regional offices and warehouses. The network has been customized for
logistics, warehousing accounting, management information systems, and
distribution.
G. SEASONALITY
Sales by PHS Group and Proset usually peak at the end of a calendar
quarter, when the Company's suppliers offer promotions which lower prices and,
in turn, the Company is able to lower its prices and increase sales volume.
Suppliers tend to promote at quarter end and as a result reduced product costs
may increase sales. Sales of salon care products increase over traditional gift
giving holidays such as Christmas, Mother's Day, Father's Day, and Valentine's
Day.
Cigar product sales also increase during holiday periods and summer months,
as well as around special sporting events. In particular sales are stronger
before Father's Day, the summer golf season and the Christmas holiday season.
H. SHIPPING AND HANDLING
Products sold on a Business to Business (B2B) basis by the Company are
shipped in bulk from inventory maintained by the Company at its warehouse
facilities by leased trucks and common carriers. All B2C orders are consolidated
in Company leased fulfillment facilities; then packed and shipped to the
customer usually within 3 to 7 days mainly by UPS. Approximately 90% of B2C
product inventory is in warehouse stock and 10% is purchased by the Company on
an as needed "just in time" basis. The Company is dependent on common carriers
and truck leases but also has acquired a fleet of trucks leased and operated
directly by the Company. Although the Company can call upon any of several
hundred common carriers to distribute its products, from time to time the
trucking industry is subject to strikes or work stoppages which could have a
material adverse effect on the Company's operations if alternative modes of
shipping are not then available. Additionally, the trucking industry is subject
to various natural disasters which can close transportation lanes in any given
region of the country. To the extent common carriers utilized by the Company are
prevented from or delayed in utilizing transportation lanes, the Company may
incur higher freight costs due to the limited availability of trucks during any
such period that transportation lanes are restricted. Trucking expenses are
regulated by the cost of fuel and destination lanes. Increasing fuel prices can
cause an increase in shipping rates. The Company attempts to pass along these
charges through a fuel surcharge. This charge cannot be passed to the customers
on all occasions.
I. TRADEMARKS, LICENSES AND PATENTS
The Company has obtained rights to various trademarks and tradenames, and
domain names in its internet business. The Company has obtained a wholesale
controlled substance license through the Drug Enforcement Agency (DEA). The
Company has domestic rights to the "Suarez Gran Reserva", "Breton Legend",
"Breton Vintage", "Anduleros", "Don Otilio","Alminante" "Nativo" "Ditka" and
various other trade names in marketing of premium handmade cigars. GR also owns
and utilizes in its cigar distribution business the following trade names:
CigarGold, Netcigar, GoldCigar, and Cigar Kingdom. Proset is the principal
tradename utilized by the Company in its other business sectors. PHS also has
exclusive distributorship rights in the Dominican Republic for "Fitti" diaper
brand.
J. EMPLOYEES
The Company and its subsidiaries in the aggregate as of the date of this
report employ and contract approximately 40 full time and part time non Union
employees all of whom work in executive, administrative, sales, marketing, data
processing, accounting or clerical activities and certain work as Company
employees that integrate with the various warehouses where Company products are
stored and as drivers and delivery personnel in the Company leased trucks.
The Company leases and staffs its warehouses in New York , New Jersey ,
Pennsylvania and Florida (GRC), and a sales office in Illinois, from where it
facilitates storage, sorting, packing and shipping of products sold on its
websites. Otherwise warehousing is contracted on an as needed arrangement
staffed through the warehousing entity contracted with exception for supervisory
personnel hired by the Company. The Company relies on a stable working
environment with its contract warehousing and trucking.
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K. GOVERNMENT REGULATION
1. TOBACCO INDUSTRY REGULATION AND TOBACCO INDUSTRY LITIGATION
The tobacco industry is subject to regulation at federal, state and local
levels. Federal law has required states, in order to receive full funding for
federal substance abuse block grants and other federal assistance , to establish
a minimum age of 18 years for the sale of tobacco products, together with an
appropriate enforcement program. The recent trend is toward increasing
regulation of the tobacco industry, and the increase in popularity of cigars
could lead to an increase in regulation of cigars.
The Food and Drug Administration (the "FDA") has determined that nicotine
is a drug and has asserted that it has jurisdiction over cigarettes and
smokeless tobacco products, as nicotine-delivering medical devices, and
therefore, promulgated regulations restricting and limiting the sale,
distribution and advertising of cigarette and smokeless tobacco products. FDA
jurisdiction is also the subject of current federal legislation which will, if
and when enacted, codify much of the past regulatory scheme established for
tobacco products and as agreed in settlement agreements reached with the tobacco
industry to avoid the myriad of lawsuits filed. In the Fall of 2004, the U.S.
Senate considered legislation that would grant the FDA authority to regulate
tobacco products. Among other things, the legislation called for the prohibition
of free samples and self-service displays. The proposed legislation also limited
certain advertising and labeling to a text only format and called for a ban on
the sale or distribution of non-tobacco items that bear tobacco brand names,
such as hats and t-shirts, and would have restricted sponsorship of events to
corporate name only. In addition, the FDA was to be empowered to adopt rules
regarding the manufacture, ingredient content, and pre-approval of tobacco
products. The proposed legislation passed the US Senate, but failed to garner
sufficient support in the House of Representatives and was not enacted into law.
There remains uncertainty as to whether the U.S. Congress can gain passage of
legislation in the future to permit the FDA to regulate tobacco as outlined
above or to permit the FDA to regulate tobacco in a different manner. In 2004,
Congress passed legislation to eliminate the federal price support system for
tobacco farmers and, in its place, provided an estimated US $10.1 billion buy
out of tobacco farmers over the next 10 years. The buy out will be funded by
quarterly assessments on tobacco manufacturers. Even within this legislation
however cigar products are not included but there is no assurance that they may
not be included in these or similar regulations in the future. There is also a
regulatory move toward taxing internet tobacco sales, which may also include
cigar sales in the future but is presently concentrated on cigarette marketing.
Legislation is also pending to curtail internet tobacco product sales in their
entirety. Recently the US Bureau of Alcohol Tobacco Firearms and Explosives, the
major credit card companies and State attorneys general reached agreement to
disallow use of credit cards for cigarette purchases over the internet across
State lines and to take action against Internet Sellers that authorities
identify as violating State and Federal laws regulating cigarette sales. New
York was the first State to ban Internet cigarette sales totally. Further States
may likely follow suit. Those bans are based both on tax evasion issues and
underage purchasing concerns. Such treatment of tobacco product tax issues is
not a new phenomena however but a revisiting of and more active promotion of the
federal Jenkins Act which originated in 1949 to address interstate tax issues
regarding tobacco sales through use of United States mail. Cigars are not
specifically included in the FDA's regulations. Present tobacco regulations
which do appear applicable to cigars in addition to focusing on cigarettes are
the prohibition on retailers from selling cigarettes, cigarette tobacco or
smokeless tobacco to persons under the age of 18 and requiring retailers to
check the photographic identification of every person under the age of 27 who
requests purchases of tobacco products, and requirement that cigars carry
warning labels similar to those contained on cigarette packages which Cigar
companies are now required to display clearly and permanently on packages, in
print ads, on audio and video ads, on point of purchase displays and on the
Internet.
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In addition, the majority of states restrict or prohibit smoking in certain
public places and restrict the sale of tobacco products to minors. Local
legislative and regulatory bodies have also increasingly moved to curtail
smoking by prohibiting smoking in certain buildings or areas or by requiring
designated "smoking" areas. Numerous proposals also have been considered at the
state and local level restricting smoking in certain public areas, regulating
point of sale placement and promotion and requiring warning labels.
Consideration at both the federal and state level also has been given to
consequences of tobacco on others that are not presently smoking (so-called
"second-hand" smoke).
While the cigar industry historically has not been subject to government
regulatory efforts, focus has increased on possible need to increase regulation
in this area and there can be no assurance that there will not be an increase in
federal regulation in the future against cigar manufacturers or distributors.
The costs to the Company of increased government regulations could have a
material adverse effect on the Company's business and results of operations.
Increased cigar consumption and the publicity that such increase has
received may increase the risk of additional regulation. There can be no
assurance as to the ultimate content, timing, or effect of any additional
regulation of tobacco products by any federal, state, local or regulatory body,
and there can be no assurance that any such legislation or regulation would not
have a material adverse effect on the Company's business.
Litigation against the cigarette industry has historically been brought by
individual cigarette smokers. The United States Supreme Court has ruled that
federal legislation relating to cigarette labeling requirements preempts claims
based on failure to warn consumers about the health hazards of cigarette
smoking, but does not preempt claims based on express warranty,
misrepresentation, fraud, or conspiracy.
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Current tobacco litigation generally falls within one of three categories:
class actions, individual actions or actions brought by individual States
generally to recover Medicaid costs allegedly attributable to tobacco-related
illnesses. Related litigation complaints allege a broad range of injuries
resulting from the use of tobacco products or exposure to tobacco smoke and seek
various remedies, including compensatory and, in some cases, punitive damages
together with certain types of equitable relief such as the establishment of
medical monitoring funds and restitution. The major tobacco companies are and
have been vigorously pursuing defense to and otherwise the termination of these
actions.
The tobacco industry has negotiated settlements totaling more than $240
billion with the States seeking reimbursement for expenditures by state-funded
medical programs for treatment of tobacco related illnesses and in addition
within such settlements have agreed to end all outdoor advertising and severely
restrict other traditional marketing practices such as a ban on promoting
tobacco products in media events and productions, to prohibit on brand name
tobacco sponsorship of team sports and sport facilities and further agreed to
fund a national research foundation as well as to prohibit advertising,
promotions and marketing that target youth; and to give access by tobacco
companies to the public of related litigation documentation; and strictly
curtails traditional lobbying activities on behalf of the tobacco industry.
The federal government has sued the tobacco industry seeking reimbursement
for billions of dollars spent by government held programs to treat
smoking-related illnesses. This type litigation could have a material adverse
affect on the profitability of tobacco and tobacco related products.
While the cigar industry has not been subject to similar health-related
litigation to date, there can be no assurance that there will not be an increase
in health-related litigation in the future against cigar manufacturers or
distributors. The costs to the Company and/or other suppliers of cigar products
marketed by the Company of defending prolonged litigation and settlement or
successful prosecution of any health-related litigation could have a material
adverse effect on the Company's business and results of operations.
Cigars long have been subject to federal, state and local excise taxes, and
such taxes frequently have been increased or proposed to be increased, in some
cases significantly, to fund various legislative initiatives. The federal excise
tax rate on large cigars (weighing more than three pounds per thousand cigars)
is a material component of the manufacturer's selling price.
The Company believes that the enactment of significantly increased excise
taxes could have a material adverse effect on the business of the Company. The
Company is unable to predict the likelihood of the passage or the enactment of
future increases in tobacco excise taxes as they relate to cigars.
Tobacco products also are subject to certain state and local taxes. An
example is the passage of the Proposition 10 referendum in California, an act
used to fund early childhood development programs, children's health and
development concerns at the state level. The majority of states now impose
excise taxes on cigars. In certain of the states without tobacco taxes proposals
are pending to add such taxes. State cigar excise taxes are not necessarily
subject to caps similar to the federal excise tax. From time to time, the
imposition of state and local taxes has had some impact on sales regionally. The
enactment of new state excise taxes and the increase in existing state excise
taxes are likely to have an adverse effect on regional sales as cigar
consumption generally declines.
2. OTHER GOVERNMENT REGULATION.
The United States Food and Drug Administration through the United States
Food, Drug and Cosmetic Act and the Fair Packaging and Labeling Act and other
various rules and regulations regulate, among other things, the purity and
packaging of HBA products and fragrances and cosmetic products and various
aspects of the manufacture and packaging of other grocery items sold by the
Company. Similar statutes are in effect in various states. Manufacturers and
distributors of such products are also subject to the jurisdiction of the
Federal Trade Commission with respect to such matters as advertising content and
other trade practices. To the Company's knowledge, it only deals with
manufacturers and manufactured products in a manner which complies with such
regulations and who periodically submit their products to independent
laboratories for testing. However, the failure by the Company's manufacturer or
supplier contacts to comply with applicable government regulations could result
in product recalls or lack of product availability that could adversely affect
the Company's relationships with its customers. In addition, the extent of
potentially adverse government regulations which might arise from future
legislation or administrative action cannot be predicted.
11
The Company is not aware of government regulation directly related to
internet sales different from that applicable to traditional marketing but
immense interest has been indicated on policing the internet focusing on contact
and access but the nature of the products marketed by the Company over the
internet does not appear to involve any of such concerns beyond product labeling
and advertising content which would apply regardless of the medium in which the
products are sold except for developing limitations on internet sales of tobacco
products as aforementioned herein. The Company is subject to the same foreign
and domestic laws as other companies conducting business on and off the
Internet. Today, there are still relatively few laws specifically directed
towards online services. However, due to the increasing popularity and use of
the Internet and online services, many laws relating to the Internet are being
debated at various levels of government and it is possible that such laws and
regulations will be adopted. These laws and regulations focus on issues such as
user privacy, freedom or expression, pricing, fraud, content and quality of
products and services, taxation, advertising, intellectual property rights, and
information security. It is not clear how existing laws governing issues such as
property ownership, copyrights and other intellectual property issues, taxation,
libel and defamation, obscenity, and personal privacy apply to online
businesses. The vast majority of these laws were adopted prior to the advent of
the Internet and related technologies and, as a result, do not contemplate or
address the unique issues of the Internet and related technologies. Those laws
that do reference the Internet such as the U.S. Digital Millennium Copyright Act
have begun to be interpreted by the courts and implemented but their
applicability and scope remain somewhat uncertain. The application of indirect
taxes (such as sales and use tax, value added tax, or VAT, goods and services
tax, business tax, and gross receipt tax) to e-commerce business such as that
operated by the Company is a complex and evolving issue. Many of the fundamental
statutes and regulations that impose these taxes were established before the
growth of the Internet and e-commerce. In many cases, it is not clear how
existing statutes apply to the Internet or e-commerce. In addition, some
jurisdictions have implemented or may implement laws specifically addressing the
Internet or some aspect of e-commerce. The application of existing, new, or
future laws could have adverse effects on the Company's business. Several
proposals have been made at the U.S. state and local level that would impose
additional taxes on the sale of goods and services through the Internet. These
proposals, if adopted, could substantially impair the growth of e-commerce, and
could diminish the Company's opportunity to derive financial benefit from its
business activities. In December 2004, the U.S. Federal Government enacted
legislation extending the moratorium on states and other local authorities
imposing access or discriminatory taxes on the Internet through November 2007.
This moratorium does not prohibit federal, state, or local authorities from
collecting taxes on the Company's income or from collecting taxes that are due
under existing tax rules. In conjunction with the Streamlined Sales Tax Project,
the U.S. Congress continues to consider overriding the Supreme Court's Quill
decision, which limited the ability of state governments to require sellers
outside of their own state to collect and remit sales taxes on goods purchased
by in-state residents. An overturning of the Quill decision could harm the
Company's business. For further discussion of other present and potential
government regulation of the Internet see "Forward Looking Information and
Cautionary Statements No.22 Government Regulation of the Internet and E-Commerce
is evolving and unfavorable changes could harm the Company's business" infra.
12
ITEM 1A: RISK FACTORS.
FORWARD LOOKING INFORMATION AND CAUTIONARY STATEMENTS
Other than the factual matters set forth herein, the matters and items set
forth in this report are forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. These statements relate to
future events or the Company's future financial performance and include, but are
not limited to, statements concerning:
The anticipated benefits and risks of the Company's key strategic
partnerships, business relationships and acquisitions;
The Company's ability to attract and retain customers;
The anticipated benefits and risks associated with the Company's
business strategy, including those relating to its distribution and
fulfillment strategy and its current and future product and service
offerings;
The Company's future operating results, its need for and availability
of financing to sustain its operations and expand thereon; and the
future value of its common stock;
The anticipated size or and trends in the market segments in which the
Company competes and the anticipated competition in those markets;
Potential government regulation; and
The Company's future capital requirements and its ability to satisfy
its capital needs.
Furthermore, in some cases, you can identify forward-looking statements by
terminology such as may, will, could, should, expect, plan, intend, anticipate,
believe, estimate, predict, potential or continue, the negative of such terms or
other comparable terminology. These statements are only predictions. Actual
events or results may differ materially. Factors that could cause such
differences include, but are not limited to, those identified herein and other
risks included from time to time in the Company's other Securities and Exchange
Commission ("SEC") reports and press releases, copies of which are available
from the Company upon request.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, it cannot guarantee future results,
levels of activity, performance or achievements and continued availability of
logistics and financial support therefore. Moreover the Company assumes no
responsibility for the accuracy and completeness of the forward-looking
statements to conform such statements to actual results or to changes in its
expectations.
In addition to the other information in this Form 10-K, the following risk
factors should be carefully considered in evaluating the Company business
because these factors may have a significant impact on the Company's business,
operating results and financial condition. As a result of the risk factors
discussed below and elsewhere in this Form 10-K and the risks discussed in the
Company's other SEC filings, actual results could differ materially from those
projected in any forward-looking statements.
1. THE COMPANY HAS INCURRED OPERATING LOSSES, HAS MATERIAL DEBT, AND HAS
BEEN AND IS RELIANT UPON FINANCING.
The Company has a long history of operating losses. To date, a large
portion of the Company's expenses have been financed through capital raising
activities. Although the Company has narrowed its losses, it still continues to
report operating deficits as opposed to profits. A large portion of the
Company's historical losses are a direct result of fees and expenses associated
with stock and/or other working capital financing. The Company believes that
Financing costs must be reduced in order to improve operating results. Failure
to reduce financing costs will likely inhibit the Company's growth. There is no
assurance that further financing will not be needed for operating purposes, and
where needed there can be no assurances of continued availability of financing
at affordable levels of expense.
13
THE COMPANY HAS SIGNIFICANT INDEBTEDNESS
As of December 31, 2005, the Company had long-term indebtedness of $2.7
million. Although the Company made debt principal reduction payments over the
last two years, it may incur substantial additional debt in the future, and in
any event a significant portion of the Company's future cash flow from operating
activities is likely to remain dedicated to the payment of interest and the
repayment of principal on its indebtedness. The Company's indebtedness could
limit its ability to obtain additional financing for working capital, capital
expenditures, debt service requirements, acquisitions or other purposes in the
future, as needed; to plan for, or react to, changes in technology and in its
business and competition; and to react in the event of an economic downturn.
There is no guarantee that the Company will be able to meet its debt service
obligations. If the Company is unable to generate sufficient cash flow or obtain
funds for required payments, or it we fail to comply with covenants in its
indebtedness, the Company will be in default. In addition, the Company may not
be able to refinance its indebtedness on terms acceptable to the Company, or at
all.
Due to the Company's limited operating history, its evolving business
model, and the unpredictability of its industries, the Company may not be able
to accurately forecast its rate of growth. The Company bases its current and
future expense levels and its investment plans on estimates of future net sales
and rate of growth. Its expenses and investments are to a large extent fixed,
and the Company may not be able to adjust its spending quickly enough if its net
sales fall short of its expectations.
The Company's revenue and operating profit growth depends on the continued
growth of demand for the products offered by the Company or its sellers, and its
business is affected by general economic and business conditions throughout the
world. A softening of demand, whether caused by changes in consumer preferences
or a weakening of the U.S. or global economies, may result in decreased revenue
or growth. Terrorist attacks and armed hostilities create economic and consumer
uncertainty that could adversely affect its revenue or growth. Such events could
create delays in, and increase the cost of, product shipments, which may
decrease demand. Revenue growth may not be sustainable and its company-wide
percentage growth rate may decrease in the future.
The Company's net sales and operating results will also fluctuate for many
other reasons, including:
- its ability to expand its network of purchasers and suppliers, and to
enter into, maintain, renew, and amend on favorable terms its commercial
agreements and strategic alliances;
- its ability to acquire merchandise, manage inventory, and fulfill orders;
- the introduction by the Company's current or future competitors of
websites, products, services, price decreases, or improvements;
- changes in usage of the Internet and e-commerce, including in non-U.S.
markets;
- timing, effectiveness, and costs of upgrades and developments in the
Company's systems and infrastructure;
- the effects of commercial agreements and strategic alliances and the
Company's ability to successfully implement the underlying relationships
and integrate them into its business;
- the effects of acquisitions, and other business combinations and the
Company's ability to successfully integrate them into its business;
- the success of the Company's geographic and product line expansions;
- technical difficulties, system downtime, or interruptions;
- Variations in the mix of products and services the Company sells;
- Variations in the Company's level of merchandise and vendor returns;
- disruptions in service by shipping carriers;
- the extent to which the Company offers free shipping, continues to reduce
product prices worldwide, and provides additional benefits to its customers
which reduce its gross or operating profits;
- the extent the Company invests in technology and content, fulfillment,
marketing and other expense categories;
- the extent to which the Company provides for and pays taxes; and
- an increase in the prices of fuel and gasoline, which are used in the
transportation of packages, as well as an increase in the prices of other
energy products, primarily natural gas and electricity, and commodities
like paper and packing supplies, all of which are used in the Company's
operating facilities.
14
2. DEPENDENCE ON PUBLIC TRENDS.
The Company's business is subject to the effects of changing customer
preferences and the economy, both of which are difficult to predict and over
which the Company has no control. A change in either consumer preferences or a
down-turn in the economy may affect the Company's business prospects.
3. POTENTIAL PRODUCT LIABILITY.
As a participant in the distribution chain between the manufacturer and
consumer, the Company would likely be named as a defendant in any product
liability action brought by a consumer. To date, no claims have been asserted
against the Company for product liability; there can be no assurance, however,
that such claims will not arise in the future. Currently, the Company does carry
product liability insurance. In the event that any products liability claim is
not fully funded by insurance, and if the Company is unable to recover damages
from the manufacturer or supplier of the product that caused such injury, the
Company may be required to pay some or all of such claims from its own funds.
Any such payment could have a material adverse impact on the Company.
4. RELIANCE ON COMMON CARRIERS.
Although the Company has in the last few years leased a fleet of trucks
operated by the Company to make deliveries, the Company is still dependent, for
shipping of product purchased, on common carriers in the trucking industry.
Although the Company uses several hundred common carriers, the trucking industry
is subject to strikes from time to time, which could have material adverse
effect on the Company's operations if alternative modes of shipping are not then
available. Additionally the trucking industry is susceptible to various natural
disasters which can close transportation lanes in any given region of the
country. To the extent common carriers are prevented from or delayed in
utilizing local transportation lanes or otherwise trucking services are
curtailed because of any other case, the Company will likely incur higher
freight costs due to the limited availability of trucks during any such period
that transportation lanes are restricted.
5. COMPETITION.
The Company is subject to competition in all of its various product sale
businesses. While these industries may be highly fragmented, with no one
distributor dominating the industry, the Company is subject to competitive
pressures from other distributors based on price and service and product quality
and origin.
The food industry is sensitive to a number of economic conditions such as:
(i) food price deflation or inflation, (ii) softness in local and national
economies, (iii) increases in commodity prices, (iv) the availability of
favorable credit and trade terms, and (v) other economic conditions that may
affect consumer buying habits. Any one or more of these economic conditions can
affect the demand for products PHS distributes to its customers.
The industries in which PHS competes in are extremely competitive. Both the
wholesale grocery operation and supply chain services to businesses are subject
to competitive practices that may affect: (i) the prices at which PHS is able to
sell products to its service area, (ii) sales volume, (iii) the ability of our
traditional food distribution customers to sell products PHS supplies, which may
affect future orders, and (iv) ability to attract and retain customers. In
addition, the nature and extent of consolidation in the food and traditional
food distribution industries could affect the competitive position. PHS competes
with larger distributors and retailers that have greater resources then the
Company.
The U.S. market for e-commerce services is extremely competitive. The
Company expects competition to intensify as current competitors expand their
product offerings and enter the e-commerce market, and new competitors enter the
market.
15
The principal competitive factors are the quality and breadth of services
provided, potential for successful transaction activity and price. E-commerce
markets are characterized by rapidly changing technologies and frequent new
product and service introductions. The Company may fail to update or introduce
new market pricing formats, selling techniques and/or other mechanics and
administrative tools and formats for internet sales consistent with current
technology on a timely basis or at all. If its fails to introduce new service
offerings or to improve its existing service offerings in response to industry
developments, or if its prices are not competitive, the Company could lose
customers, which could lead to a loss of revenues.
Because there are relatively low barriers to entry in the e-commerce
market, competition from other established and emerging companies may develop in
the future. Many of the Company's competitors may also have well-established
relationships with the Company's existing and prospective customers. Increased
competition is likely to result in fee reductions, reduced margins, longer sales
cycles for the Company's services and a decrease or loss of its market share,
any of which could harm its business, operating results or financial condition.
Many of the Company's competitors have, and new potential competitors may
have, more experience developing Internet-based software applications and
integrated purchasing solutions, larger technical staffs, larger customer bases,
more established distribution channels, greater brand recognition and greater
financial, marketing and other resources than the Company has. In addition,
competitors may be able to develop products and services that are superior to
those of the Company or that achieve greater customer acceptance. There can be
no assurance that the e-commerce solutions offered by the Company's competitors
now or in the future will not be perceived as superior to those of the Company
by either businesses or consumers.
6. LITIGATION
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability with respect to these actions should not materially affect
the financial position, results of operations or cash flows of the Company, but
there can be no assurance as to this.
7. POSSIBLE LOSS OF NASDAQ SMALL CAP LISTING.
Synergy's qualification for trading on the NASDAQ Small Cap system has in
the past been questioned, the focus being on the market quotes for the Company's
stock, the current bid price having for a time in the past been reduced below
the minimum NASDAQ standard of $1 and had been below such level for an
appreciable period of time, as well as the Company also being notified in the
past that stockholders' equity had fallen below minimum NASDAQ continued listing
standard of $2,500,000. NASDAQ has established, and the Commission has approved,
certain maintenance requirements to which the Company must adhere to remain
listed, including the requirement that a stock listed in such market have a bid
price greater than or equal to $1.00 and the listed Company maintain
stockholders equity above $2,500,000. The bid price per share for the Common
Stock of Synergy had been below $1.00 in the past and the Common Stock has
remained on the NASDAQ Small Cap System because Synergy had complied with
alternative criteria which are now eliminated under the new rules. If the bid
price dips below $1.00 per share, and is not brought above such level for a
sustained period of time or the Company fails to maintain stockholders' equity
at a level of at least $2,500,000 the Common Stock could be delisted from the
NASDAQ Small Cap System and thereafter trading would likely be reported in the
NASDAQ's OTC Bulletin Board or in the "pink sheets." (see Item 5-"Market For The
Registrant's Common Stock and Related Stockholder Matters" supra for a more in
depth discussion of the Company's current NASDAQ listing status)In the event of
delisting from the NASDAQ Small Cap System, the Common Stock would become
subject to the rules adopted by the Commission regulating broker-dealer
practices in connection with transactions in "penny stocks", including what the
Company believes to be stringent disclosure rules very different from NASDAQ
trading practice procedures. These disclosure requirements may have the effect
of reducing the level of trading activity in the secondary market for a stock
that becomes subject to the penny stock rules. If the Common Stock became
subject to the penny stock rules, many broker-dealers might be unwilling to
engage in transactions in the Company's securities because of the added
disclosure requirements, thereby making it more difficult for purchasers of the
Common Stock to dispose of their shares. The Company's common stock has
historically remained at NASDAQ trading levels above $1 except for limited
periods of time and the Company has achieved and is confident of maintaining a
level of Stockholders' equity above $2,500,000. Historical stability combined
with the Company's increasing business share in the market and its continuing
establishment as a viable force in the industries wherein it participates gives
the Company confidence that its susceptibility to market deficiencies is in a
much lessened state then in years past and that it can continue to achieve and
maintain NASDAQ listing compliance, but of this there can be no assurance.
16
8. RISKS OF BUSINESS DEVELOPMENT-INTERNET MARKETING -THE COMPANY DEPENDS ON
CONTINUED USE OF THE INTERNET AND GROWTH OF THE ONLINE PRODUCT PURCHASE MARKET.
Because still the lines of product and product distribution established for
the Company regarding its e-commerce marketing are relatively new and different
from its historical non-internet product distribution business, the Company's
operations in these areas should continue to be considered subject to all of the
risks inherent in a new business enterprise, including the absence of an
appreciable operating history and the expense of new product development and
uncertainties on demand and logistics of delivery and other satisfaction of
customer demands. Various problems, expenses, complications and delays may be
encountered in connection with the development of the Company's new products and
methods of product distribution. These expenses must either be paid out of the
proceeds of future equity offerings or out of generated revenues and Company
profits and will likely be a drain on Company capital if revenues and revenue
collection do not keep pace with Company expenses. There can be no assurance as
to the continued availability of funds from revenues or from any other sources.
The Company's future potential revenues and profits substantially depend to
a great extent upon the widespread acceptance and use of the internet as an
effective medium of business and communication by the Company's target
customers. Rapid growth in the use of and interest in the Internet has occurred.
As a result, acceptance and use continue to develop, and a sufficiently broad
base of consumers have adopted, and continue to use, the Internet and other
online services as a medium of commerce but there can be no assurance of
continued use at the levels anticipated by the Company to sustain its internet
business segments.
In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially inadequate
development of the necessary network infrastructure or delayed development of
enabling technologies and performance improvements, ease of use restrictions,
and/or potential customer continued preferences for more traditional see and
touch purchasing. The Company's success will depend, in large part, upon third
parties maintaining the Internet infrastructure to provide a reliable network
backbone with the speed, data capacity, security and hardware and education
regarding and ease of use thereof as necessary for reliable Internet access and
services and hopeful continued shifting of potential customers shopping
preferences to the internet.
As the Internet and online commerce industry evolve, the Company must
license leading technologies useful in its business, enhance its existing
services, develop new services and technology that address the increasingly
sophisticated and varied needs of its prospective customers and respond to
technological advances and emerging industry standards and practices on a
cost-effective and timely basis. The Company may not be able to successfully
implement new technologies or adapt its proprietary technology and transaction
processing systems to customer requirements or emerging industry standards. If
the Company is unable to do so, it could adversely impact its ability to build
on its varied businesses and attract and retain customers.
The Company's future revenues and profits depend to a large extent upon the
widespread acceptance and use of the Internet and other online services as a
medium for commerce by merchants and consumers. The use of the Internet and
e-commerce may not continue to develop at past rates and a sufficiently broad
base of business and individual customers may not adopt or continue to use the
Internet as a medium of commerce. The market for the sale of goods and services
over the Internet is a relatively new and emerging market. Demand and market
acceptance for recently introduced services and products over the Internet are
subject to a high level of uncertainty. Growth in the Company's customer base
depends on obtaining businesses and consumers who have historically used
traditional means of commerce to purchase goods. For the Company to be
successful, the Company believes that these market participants must accept and
use the novel ways of conducting business and exchanging information as is
provided by the internet.
17
E-commerce may not prove to be a viable medium for purchasing for the
following reasons, any of which could seriously harm the Company's business:
- the necessary infrastructure for Internet communications may not
develop adequately;
- the Company's potential customers, buyers and suppliers may have
security and confidentiality concerns;
- complementary products, such as high-speed modems and high-speed
communication lines, may not be developed or be adequately available;
- alternative-purchasing solutions may be implemented;
- buyers may dislike the reduction in the human contact and product
review attendant to internet sales, different from that inherent in
traditional purchasing methods;
- use of the Internet and other online services may not continue to
increase or may increase more slowly than expected;
- the development or adoption of new technology standards and protocols
may be delayed or may not occur; and
- new and burdensome governmental regulations may be imposed.
The Internet is still relatively new and rapidly changing technology and
continues to experience significant growth in the number of users, frequency of
use and bandwidth requirements. There can be no assurance that the
infrastructure of the Internet and other online services will be able to support
the demands placed upon them and/or that the Company may be able to keep pace
therewith. Furthermore, the Internet has experienced a variety of outages and
other delays as a result of damage to portions of its infrastructure, and could
face such outages and delays in the future. These outages and delays could
adversely affect the level of Internet usage and also the level of traffic and
the processing of transactions. In addition, the Internet or other online
services could lose their viability due to delays in the development or adoption
of new standards and protocols required to handle increased levels of Internet
or other online service activity, or due to increased governmental regulation.
Changes in or insufficient availability of telecommunications services or other
Internet service providers to support the Internet or other online services also
could result in slower response times and adversely affect usage of the Internet
and other online services generally and the Company's service in particular. If
use of the Internet and other online services does not continue to grow or grows
more slowly than expected, if the infrastructure of the Internet and other
online services does not effectively support growth that may occur, or if the
Internet and other online services do not become or sustain as a viable
commercial marketplace, the Company will have to adapt its business model to any
resulting new environment, which would materially adversely affect its results
of operations and financial condition.
9. RAPIDLY CHANGING MARKET MAY IMPACT OPERATIONS.
The market for the Company's products is rapidly changing with evolving
industry standards and frequent new product introductions. The Company's future
success will depend in part upon its continued ability to enhance its existing
products and to introduce new products and features to meet changing customer
requirements and emerging industry standards and to continue to have access to
such products from their sources on a pricing schedule conducive to the Company
operating at a profit. The Company will have to continuously develop, change and
implement as and where necessary an appropriate marketing strategy for its
various products. There can be no assurance that the Company will successfully
complete the development of future products or that the Company's current or
future products will achieve market acceptance levels and be made available for
sale by the Company conducive to the Company's fiscal needs. Any delay or
failure of these products to achieve market acceptance or limits on their
availability for sale by the Company would adversely affect the Company's
business. In addition, there can be no assurance that the products or
technologies developed by others will not render the Company's products or
technologies non-competitive or obsolete.
Management believes actions taken and presently being taken to meet and
enhance the Company's operating and financial requirements should assure and
provide the opportunity for the Company to continue as a going concern. However,
Management cannot predict the outcome of future operations and no adjustments
have been made to offset the outcome of this uncertainty.
18
10.EXTENSIVE AND INCREASING REGULATION OF TOBACCO PRODUCTS AND LITIGATION
MAY IMPACT CIGAR INDUSTRY.
The tobacco industry in general has been subject to extensive regulation at
the federal, state and local levels. Recent trends have increased regulation of
the tobacco industry. Although regulation initially focused on cigarette
manufacturers, it has begun to have a broader impact on the industry as a whole
and may focus more directly on cigars in the future. The increase in popularity
of cigars may likely lead to an increase in regulation of cigars. A variety of
bills relating to tobacco issues have been introduced in the U.S. Congress,
including bills that would (i) prohibit the advertising and promotion of all
tobacco products or restrict or eliminate the deductibility of such advertising
expense, (ii) increase labeling requirements on tobacco products to include,
among others things, addiction warnings and lists of additives and toxins, (iii)
shift control of tobacco products and advertisements from the Federal Trade
Commission (the "FTC") to the Food and Drug Administration (the "FDA"), (iv)
increase tobacco excise taxes and (v) require tobacco companies to pay for
health care costs incurred by the federal government in connection with tobacco
related diseases. There has also been recent cooperation between federal and
State authorities to curtail internet sales of tobacco products because of tax
issues as well as underage purchase questions. Future enactment of such
proposals or similar bills may have an adverse effect on the results of
operations or financial condition of the Company. Although, except for warning
labeling and smoke free facilities, current legislation and regulation focuses
on cigarette smoking and sales, there is no assurance that the scope of
legislation will not be expanded in the future to encompass cigars as well.
A majority of states restrict or prohibit smoking in certain public places
and restrict the sale of tobacco products to minors. Local legislative and
regulatory bodies also have increasingly moved to curtail smoking by prohibiting
smoking in certain buildings or areas or by designating "smoking" areas. These
restrictions generally do not distinguish between cigarettes and cigars. These
restrictions and future restrictions of a similar nature have and likely will
continue to have an adverse effect on the Company's sales or operations because
of resulting difficulty placed upon advertising and sale of tobacco products,
such as restrictions and in many cases prohibition of counter access to or
display of premium handmade cigars, and/or decisions by retailers not to
advertise for sale and in many cases to sell tobacco products because of public
pressure to stop the selling of tobacco products. Numerous proposals also have
been and are being considered at the state and local levels, in addition to
federal regulations, to restrict smoking in certain public areas, regulating
point of sale placement and promotions of tobacco products and requiring warning
labels.
Increased cigar consumption and the publicity such increase has received
may increase the risk of additional regulation. The Company cannot predict the
ultimate content, timing or effect of any additional regulation of tobacco
products by any federal, state, local or regulatory body, and there can be no
assurance that any such legislation or regulation would not have a material
adverse effect on the Company's business.
In addition numerous tobacco litigation has been commenced and may in the
future be instituted, all of which may adversely affect(albeit focusing
primarily on cigarette smoking) cigar consumption and sale and may pressure
applicable government entities to institute further and stricter legislation to
restrict and possibly prohibit cigar sale and consumption, any and all of which
may have an adverse affect on Company business (see "Government Regulation -
Tobacco Industry Regulation and Tobacco Industry Litigation" supra).
11. NO DIVIDENDS LIKELY.
No dividends have been paid on the Common Stock since inception, nor, by
reason of its current financial status and its contemplated financial
requirements, does Synergy contemplate or anticipate paying any dividends upon
its Common Stock in the foreseeable future but the Company does have outstanding
preferred stock upon which dividends are paid current.
12. POTENTIAL LIABILITY FOR CONTENT ON THE COMPANY'S WEB SITE.
Because the Company posts product information and other content on its Web
sites, the Company faces potential liability for negligence, copyright, patent,
trademark, defamation, indecency and other claims based on the nature and
content of the materials that the Company posts. Such claims have been brought,
and sometimes successfully pressed, against other Internet content distributors.
In addition, the Company could be exposed to liability with respect to the
unauthorized duplication of content or unauthorized use of other parties'
proprietary technology or infiltration into the Company's system by unauthorized
personnel. The Company is not aware of any present claim of such nature or any
current basis therefore but because of the nature of the product marketing
techniques utilized by the Company with application of the internet, likelihood
of claims of such nature arising in the future cannot be predicted.
19
13. THE COMPANY'S NET SALES WOULD BE HARMED IF IT EXPERIENCES SIGNIFICANT
CREDIT CARD FRAUD.
A failure to adequately control fraudulent credit card transactions would
harm the Company's net sales and results of operations because it does not carry
insurance against such risk. Under current credit card practices, the Company
may be held liable for fraudulent credit card transactions where it does not
obtain a cardholder's signature, a frequent practice in internet sales.
14. POTENTIAL FUTURE SALES OF COMPANY STOCK.
The majority of the shares of common stock of the Company outstanding are
"restricted securities" as that term is defined in Rule 144 promulgated under
the Securities Act of 1933. In general under Rule 144 a person (or persons whose
shares are aggregated) who has satisfied a one year holding period may, under
certain circumstances, sell within any three month period a number of shares
which does not exceed the greater of 1% of the then outstanding shares of common
stock or the average weekly trading volume during the four calendar weeks prior
to such sale. Rule 144 also permits, under certain circumstances, the sale of
shares by a person who is not an affiliate of the Company and who has satisfied
a two year holding period without, any quantity limitation. The majority of
holders of the shares of the outstanding common stock of the Company deemed
"restricted securities" have already satisfied at least their one year holding
period or will do so with the next fiscal year, and such stock is either
presently or within the next fiscal year will become eligible for sale in the
public market (subject to volume limitations of Rule 144 when applicable). The
Company is unable to predict the effect that sales of its common stock under
Rule 144, or otherwise, may have on the then prevailing market price of the
common stock. However, the Company believes that the sales of such stock under
Rule 144 may have a depressive effect upon the market.
15. THE COMPANY MAY NOT BE ABLE TO CONTINUE ATTRACTING NEW CUSTOMERS.
The success of the Company's business model depends in large part on its
continued ability to maintain and re sell to current customers and to increase
its number of customers in the future. The market for its businesses may grow
more slowly than anticipated because of or become saturated with competitors,
many of which may offer lower prices or broader distribution. The Company is
also highly dependant on internet sales which require interest of potential
suppliers in the internet mode of product purchasing. Some potential suppliers
may not want to join the Company's networks because they are concerned about the
possibility of their products being listed together with their competitors'
products thus limiting availability of product mix made available by the
Company. If the Company cannot continue to bring new customers to its internet
sites or maintain its existing customer base or attract listing of a mixture of
product, the Company may be unable to offer the benefits of the network model at
levels sufficient to attract and retain customers and sustain that aspect of its
business.
16. THE COMPANY'S BUSINESS MAY SUFFER IF IT IS NOT ABLE TO PROTECT
IMPORTANT INTELLECTUAL PROPERTY.
The Company's ability to compete effectively against other companies in its
industry will depend, in part, on its ability to protect its proprietary
technology and systems designs relating to its technologies. The Company does
not know whether it has been or will be completely successful in doing so.
Further, its competitors may independently develop or patent technologies that
are substantially equivalent or superior to those of the Company so as to
effectively compete.
17. THE COMPANY MAY NOT BE ABLE TO MAINTAIN THE CONFIDENTIALITY OF ITS
PROPRIETARY KNOWLEDGE.
The Company relies, in part, on contractual provisions to protect its trade
secrets and proprietary knowledge. These agreements may be breached, and the
Company may not have adequate remedies for any breach. Its trade secrets may
also be known without breach of such agreements or may be independently
discovered by competitors. Its inability to maintain the proprietary nature of
its technology could harm its business, results of operations and financial
condition by adversely affecting its ability to compete.
20
18. OTHERS MAY ASSERT THAT THE COMPANY'S TECHNOLOGY INFRINGES THEIR
INTELLECTUAL PROPERTY RIGHTS.
The Company believes that its technology does not infringe the proprietary
rights of others. However, the e-commerce industry is characterized by the
existence of a large number of patents and trademarks and frequent claims and
litigation based on allegations of patent infringement and violation of other
intellectual property rights. As the e-commerce market and the functionality of
products in the industry continues to grow and overlap, the Company believes
that the possibility of an intellectual property claim against it will increase.
For example, the Company may inadvertently infringe an intellectual property
right of which it is unaware, or there may be applications to protect
intellectual property rights now pending of which it is unaware which it may be
infringing when they are issued in the future, or the Company's service or
systems may incorporate and/or utilize third party technologies that infringe
the intellectual property rights of others. The Company has been and expects to
continue to be subject to alleged infringement claims. The defense of any claims
of infringement made against the Company by third parties, whether or not
meritorious, could involve significant legal costs and require the Company's
management to divert time and attention from its business operations. Either of
these consequences of an infringement claim could have a material adverse effect
on the Company's operating results. If the Company is unsuccessful in defending
any claims of infringement, it may be forced to obtain licenses or to pay
royalties to continue to use its technology. The Company may not be able to
obtain any necessary licenses on commercially reasonable terms or at all. If the
Company fails to obtain necessary licenses or other rights, or if these licenses
are costly, its operating results may suffer either from reductions in revenues
through the Company's inability to serve customers or from increases in costs to
license third-party technologies.
19. THE COMPANY'S BUSINESS MAY BE ADVERSELY AFFECTED IF IT IS UNABLE TO
CONTINUE TO LICENSE SOFTWARE THAT IS NECESSARY FOR ITS SERVICE OFFERING.
Through distributors, the Company licenses a variety of commercially
available Internet technologies, which are used in its services and systems to
perform key functions. As a result, the Company is to a certain extent dependent
upon continuing to maintain these technologies. There can be no assurance that
the Company would be able to replace the functionality provided by much of its
purchased Internet technologies on commercially reasonable terms or at all. The
absence of or any significant delay in the replacement of that functionality
could have a material adverse effect on the Company's business, financial
condition and results of operations.
21
20. THE COMPANY'S SYSTEMS INFRASTRUCTURE MAY NOT KEEP PACE WITH THE DEMANDS
OF ITS CUSTOMERS.
Interruptions of service as a result of a high volume of traffic and/or
transactions could diminish the attractiveness of the Company's services and its
ability to attract and retain customers. There can be no assurance that the
Company will be able to accurately project the rate or timing of increases, if
any, in the use of its service, or that it will be able to expand and upgrade
its systems and infrastructure to accommodate such increases in a timely manner.
The Company currently maintains systems in the U.S. Any failure to expand or
upgrade its systems could have a material adverse effect on its results of
operations and financial condition by reducing or interrupting revenue flow and
by limiting its ability to attract new customers. Any such failure could also
have a material adverse effect on the business of its customers, which could
damage the Company's reputation and expose it to a risk of loss or litigation
and potential liability.
Service offerings involving complex technology often contain errors or
performance problems. Many serious defects are frequently found during the
period immediately following introduction and initial implementation of new
services or enhancements to existing services. Although the Company attempts to
resolve all errors that it believes would be considered serious by its customers
before implementation, its systems are not error-free. Errors or performance
problems could result in lost revenues or cancellation of customer agreements
and may expose the Company to litigation and potential liability. In the past,
the Company has discovered errors in software used in the Company after its
incorporation into Company sites. The Company cannot assure that undetected
errors or performance problems in its existing or future services will not be
discovered or that known errors considered minor by it will not be considered
serious by its customers. The Company has experienced periodic minor system
interruptions, which may continue to occur from time to time.
The Company's success depends on the efficient and uninterrupted operation
of its computer and communications hardware systems. These systems are
vulnerable to damage or interruption from natural disasters, fires, power loss,
telecommunication failures, break-ins, sabotage, computer viruses, intentional
acts of vandalism and similar events. Despite any precautions the Company takes
or plans to take, the occurrence of a natural disaster or other unanticipated
problems could result in interruptions in its services. In addition, if any
hosting service fails to provide the data communications capacity the Company
requires, as a result of human error, natural disaster or other operational
disruption, interruptions in the Company's services could result. Any damage to
or failure of its systems could result in reductions in, or terminations of, its
services, which could have a material adverse effect on its business, results of
operations and financial condition.
21. THE COMPANY MAY ACQUIRE OTHER BUSINESSES OR TECHNOLOGIES, WHICH COULD
RESULT IN DILUTION TO ITS STOCKHOLDERS, OR OPERATIONAL OR INTEGRATION
DIFFICULTIES WHICH COULD IMPAIR ITS FINANCIAL PERFORMANCE.
If appropriate opportunities present themselves, the Company may acquire
complementary or strategic businesses, technologies, services or products that
it believes will be useful in the growth of its business. The Company does not
currently have any commitments or agreements with respect to any new
acquisitions. They may not be able to identify, negotiate or finance any future
acquisition successfully. Even if the Company does succeed in acquiring a
business, technology, service or product, the process of integration may produce
unforeseen operating difficulties and expenditures and may require significant
attention from the Company's management that would otherwise be available for
the ongoing development of its business. Moreover the anticipated benefits of
any acquisition may not be realized or may depend on the continued service of
acquired personnel who could choose to leave. If the Company makes future
acquisitions, it may issue shares of stock that dilute other stockholders, incur
debt, assume contingent liabilities or create additional expenses related to
amortizing intangible assets, any of which might harm its financial results and
cause its stock price to decline. Any financing that it might need for future
acquisitions may only be available to it on terms that restrict its business or
that impose on it costs that reduce its revenue.
22. GOVERNMENT REGULATION OF THE INTERNET AND E-COMMERCE IS EVOLVING AND
UNFAVORABLE CHANGES COULD HARM THE COMPANY'S BUSINESS
The Company is subject to general business regulations and laws, as well as
regulations and laws specifically governing the Internet and e-commerce. Such
existing and future laws and regulations may impede the growth of the Internet
or other online services. These regulations and laws may cover taxation, user
privacy, data protection, pricing, content, copyrights, distribution, electronic
contracts and other communications, consumer protection, the provision of online
payment services, broadband residential Internet access, and the characteristics
and quality of products and services. It is not clear how existing laws
governing issues such as property ownership, sales and other taxes, libel, and
personal privacy apply to the Internet and e-commerce. Unfavorable resolution of
these issues may harm the Company's business.
22
Like many Internet-based businesses, the Company operates in an environment
of tremendous uncertainty as to potential government regulation. The Internet
has rapidly emerged as a commerce medium, and governmental agencies have not yet
been able to adapt all existing regulations to the Internet environment. Laws
and regulations have been introduced or are under consideration and court
decisions have been or may be reached in the U.S. and other countries in which
the Company does business that affect the Internet or other online services,
covering issues such as pricing, user privacy, freedom of expression, access
charges, content and quality of products and services, advertising, intellectual
property rights and information security. In addition, it is uncertain how
existing laws governing issues such as taxation, property ownership, copyrights
and other intellectual property issues, libel, obscenity and personal privacy
will be applied to the Internet. The majority of these laws were adopted prior
to the introduction of the Internet and, as a result, do not address the unique
issues of the Internet. Recent laws that contemplate the Internet, such as the
Digital Millennium Copyright Act in the U.S., have not yet been fully
interpreted by the courts and their applicability is therefore uncertain. The
Digital Millennium Copyright Act provides certain "safe harbors" that limits the
risk of copyright infringement liability for service providers such as the
Company with respect to infringing activities engaged in by users of the
service.
In the area of user privacy, several states have legislation and/or have
proposed legislation that limits or would limit the uses of personal user
information gathered online or require online services to establish privacy
policies. The Federal Trade Commission also has become increasingly involved in
this area. The Company does not sell personal user information regarding its
customers. The Company does use aggregated data for analysis regarding the
Company network, and does use personal user information in the performance of
its services for its customers. Since the Company does not control what its
customers do with the personal user information they collect, there can be no
assurance that its customers' sites will be considered compliant.
As online commerce evolves, the Company expects that federal, state or
foreign agencies will continue to adopt regulations covering issues such as
pricing, content, user privacy, and quality of products and services. Any future
regulation may have a negative impact on the Company's business by restricting
its methods of operation or imposing additional costs. Although many of these
regulations may not apply to its business directly, the Company anticipates that
laws regulating the solicitation, collection or processing of personal
information could indirectly affect its business.
Internet regulation which has met with the most successful challenges is
that which touches upon Free Speech. Title V of the Telecommunications Act of
1996, known as the Communications Decency Act of 1996, prohibits the knowing
transmission of any comment, request, suggestion, proposal, image or other
communication that is obscene or pornographic to any recipient under the age of
18. The prohibitions scope and the liability associated with a violation are
currently unsettled. In addition, although substantial portions of the
Communications Decency Act of 1996 have been held to be unconstitutional, the
Company cannot be certain that similar legislation will not be enacted and
upheld in the future. Subsequent attempts at such legislation such as the Child
Online Protection Act passed in 1998 have met with similar and successful
constitutional attack. It is possible that such legislation could expose
companies involved in online commerce to liability, which could limit the growth
of online commerce generally. Legislation like the Communications Decency Act
and Child Online Protection Act could reduce the growth in Internet usage and
decrease its acceptance as a communications and commerce medium.
The worldwide availability of Internet web sites often results in sales of
goods to buyers outside the jurisdiction in which the Company or its customers
are located, and foreign jurisdictions may claim that the Company or its
customers are required to comply with their laws. Foreign regulation of internet
use has not met with the success of constitutional and other judicial scrutiny
that US regulation has been limited by. As an Internet Company, it is also
unclear which jurisdictions may find that the Company is conducting business
therein. Its failure to qualify to do business in a jurisdiction that requires
it to do so could subject the Company to fines or penalties and could result in
its inability to enforce contracts in that jurisdiction.
The Company is not aware of any recent related legislation other than that
specifically referenced herein which may affect the manner in which the Company
utilizes the internet in its business but there can be no assurance that future
government regulation will not be enacted further restricting use of the
internet that might adversely affect the Company's business.
23
23. TAXES MAY BE IMPOSED ON INTERNET COMMERCE.
In the U.S., the Company does not collect sales or other similar taxes on
goods sold through the Company's internet websites. The Internet Tax Freedom Act
of 1998, (extended through November 2003 and internet access tax prohibitions
though November 1, 2007), prohibits the imposition of new or discriminatory
taxes on electronic commerce by United States federal and State taxing
authorities except for taxes caused by nexus of the Seller of the goods in the
State. Sales to customers in such States may be taxable, but to date no such
taxes have ever been collected by the Company. The Company is not aware of any
further extensions of this legislation but understands that more permanent
application of the aforesaid Internet Tax Freedom Act is currently being
discussed in the federal legislature and further extension has been recommended
by the Advisory Commission on Electronic Commerce established by US Congress to
further review application of the statute. Currently, decisions of the U.S.
Supreme Court restrict the imposition of obligations to collect state and local
sales and use taxes with respect to sales made over the Internet. However, a
number of States, as well as the U.S. Congress, have been considering various
initiatives that could limit or supersede the Supreme Court's position regarding
sales and use taxes on Internet sales. If any of these initiatives addressed the
Supreme Court's constitutional concerns and resulted in a reversal of its
current position, the Company could be required to collect sales and use taxes.
The imposition by State and local governments of various taxes upon Internet
commerce could create administrative burdens for the Company and could decrease
its future sales. The status of the prohibition is uncertain and States have
attempted to impose sales and use tax, often successfully mainly based upon the
nexus of the retailer with the State imposing the tax on customers in that
State. A number of proposals have been made at the State and local level that
would impose additional taxes on the sale of goods and services through the
Internet. Such proposals, if adopted and not in conflict with federal
prohibitions, could substantially impair the growth of electronic commerce, and
could adversely affect the Company's opportunity to derive financial benefit
from such activities. There has been recent activity in attempts to enforce the
federal Jenkins Act which historically allowed State taxation of sales of goods
made through use of the United States mails and is currently being reviewed
toward possibly allowing the States to tax internet sales. . In addition,
non-U.S. countries may seek to impose service tax (such as value-added tax)
collection obligations on companies that engage in or facilitate Internet
commerce. A successful assertion by one or more states or any foreign country
that the Company should collect sales or other taxes on the sale of merchandise
could impair its revenues and its ability to acquire and retain customers.
24. THERE MAY BE SIGNIFICANT SECURITY RISKS AND PRIVACY CONCERNS RELATING
TO ONLINE COMMERCE.
A significant barrier to online commerce and communications is the secure
transmission of confidential information over public networks. A compromise or
breach of the technology used to protect the Company's customers' and their
end-users' transaction data could result from, among other things, advances in
computer capabilities, new discoveries in the field of cryptography, or other
events or developments. Any such compromise could have a material adverse effect
on the Company's reputation and, therefore, on its business, results of
operations and financial condition. Furthermore, a party who is able to
circumvent the Company's security measures could misappropriate proprietary
information or cause interruptions in its operations. The Company may be
required to expend significant capital and other resources to protect against
security breaches or to alleviate problems caused by such breaches. Concerns
over the security of transactions conducted on the Internet and other online
services and the privacy of users may also inhibit the growth of the Internet
and other online services generally, especially as a means of conducting
commercial transactions. The Company currently has practices and procedures in
place to protect the confidentiality of its customers' and their end-users'
information. However, its security procedures to protect against the risk of
inadvertent disclosure or intentional breaches of security might fail to
adequately protect information that it's obligated to keep confidential. The
Company may not be successful in adopting more effective systems for maintaining
confidential information, and its exposure to the risk of disclosure of the
confidential information of others may grow with increases in the amount of
information it possesses. To the extent that the Company activities involve the
storage and transmission of proprietary information, such as credit card
numbers, security breaches could damage its reputation and expose it to a risk
of loss or litigation and possible liability. The Company's insurance policies
may not be adequate to reimburse it for losses caused by security breaches.
24
25. IF THE COMPANY'S FULFILLMENT CENTERS ARE NOT EFFECTIVELY OPERATED THE
COMPANY'S BUSINESS MAY BE ADVERSELY AFFECTED.
If the Company does not successfully operate its fulfillment centers such
could significantly limit the Company's ability to meet customer's demands,
which would likely result in diminished revenues, adversely affecting the
Company's business. Because it is difficult to predict sales increases the
Company may not manage its facilities in an optimal way which may result in
excess inventory, warehousing, fulfillment and distribution capacity having an
adverse impact on working capital of the Company, or the lack of sufficiency in
such areas causing delays in fulfillment of customer orders adversely affecting
customer confidence and loyalty.
26. OUR VENDOR RELATIONSHIPS SUBJECT US TO A NUMBER OF RISKS
Although we continue to increase the number of vendors that supply products
to us and only two vendors account for 10% or more of our inventory purchases,
we have significant vendors that are important to our sourcing. We do not have
long-term contracts or arrangements with most of our vendors to guarantee the
availability of merchandise, particular payment terms, or the extension of
credit limits. If our current vendors were to stop selling merchandise to us on
acceptable terms, we may not be able to acquire merchandise from other suppliers
in a timely and efficient manner and on acceptable terms.
27. THE COMPANY'S STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.
The stock market, and in particular the market for Internet-related stocks,
has, from time to time, experienced extreme price and volume fluctuations. Many
factors may cause the market price for the Company's common stock to decline,
perhaps substantially, including:
- actual or anticipated variations in the Company's quarterly operating
results and expected future results;
- changes in, or failure to meet, financial estimates by securities
analysts;
- unscheduled system downtime;
- additions or departures of key personnel;
- announcements of technological innovations or new services by the
Company or its competitors;
- initiation of or developments in litigation affecting the Company;
- conditions or trends in the Internet and online commerce industries;
- changes in the market valuations of other Internet, online commerce,
or technology companies;
- developments in regulation;
- announcements by the Company or its competitors of significant
acquisitions, strategic partnerships, joint ventures, new product of
capital commitments;
- unanticipated economic or political events;
- sales of the Company's common stock or other securities in the open
market; and
- other events or factors, including those described in the "Risk
Factors", section and others that may be beyond the Company's control.
- failure to meet its development plans;
- the demand for its common stock;
- downward revision in securities analyst's estimates or changes in
general market conditions;
- technological innovations by competitors or in competing
technologies; and
- investor perception of the Company's industry or its prospects.
The Company's stock pricing has fluctuated significantly in the past and
there is no assurance such trend may not continue in the future.
25
ITEM 2: DESCRIPTION OF PROPERTY
The Company's corporate offices and administrative headquarters are located
in Syosset, New York.
The Company maintains satellite and representative offices in New York,
Pennsylvania, New Jersey, Illinois, Florida.
Warehousing facilities utilized by the Company are located in New Jersey,
New York and Florida. The Grocery inventory is warehoused in New York, Salon
products are warehoused in New Jersey, and cigars are warehoused in Florida. The
facilities operate under contractual warehousing agreements except in Florida
and New York which facilities are leased. The Company also uses warehousing
facilities on a spot contract basis as needed.
ITEM 3: LEGAL PROCEEDINGS
The Company is a party to a number of legal proceedings in connection with
claims made for goods sold and various other aspects of its business, all of
which are considered routine litigation incidental to the business of the
Company. The Company is not aware of any other litigation pending which might be
considered material and not in the ordinary course of business.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2005 no matters were submitted for shareholder
approval. However, on September 7, 2005 a majority of the Company's shareholders
by written consent approved that an amendment be filed to the Company's
Certificate of Incorporation to increase the amount of stock the Company has
authorization to issue which filing of the approved amendment awaits
distribution of the information Statement the Company presently has on file with
the Commission to be distributed to its shareholders not having voted on the
matter.
26
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's common stock trades on NASDAQ Small Cap Market under the
Symbol "SYBR", and on the Boston Stock Exchange under the Symbol "SYB". The high
and low sales prices in the NASDAQ Small Cap Market for the Company's Common
Stock, as reported by the NASDAQ for each of the quarters of the Company's two
most recent fiscal years are as follows:
COMMON STOCK
Quarter Ended High Low Close
- ------------- ------- ------- ------
March 31, 2004 5.69 3.75 3.96
June 30, 2004 4.72 2.75 2.89
September 30, 2004 3.22 2.13 2.30
December 31, 2004 7.25 1.66 3.38
March 31, 2005 3.71 2.08 2.39
June 30, 2005 2.95 1.62 2.10
September 30, 2005 2.85 1.85 2.07
December 31, 2005 2.66 1.68 1.85
On March 30, 2006, the Company had approximately 3100 shareholders of
record.
The Company has never paid any dividends on its Common Stock and does not
presently intend to pay any dividends on the Common Stock in the foreseeable
future. The Company does pay a dividend on its preferred stock.
The Company has authorized stock of 6,000,000 shares divided into 5,000,000
Common Stock $.001 par value, 100,000 shares of Class A Preferred Stock par
value $.001 and 900,000 shares of Class B Preferred Stock, 500,000 shares of
which are designated Series A Class B Preferred. The Company is currently
processing an increase in such authorized stock to 15 million shares by
amendment to its Certificate of Incorporation which the Company anticipates to
be effective in April 2006.
27
Refer to the Company's Consolidated Statement of Changes in Stockholders'
Equity in the Company's audited financial statements included in this report for
information on issuances of equity securities during fiscal year 2005. These
issuances were made either under exemption from registration allowed under
Section 4 (2) or Regulation D of the Securities Act of 1933 as amended.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is derived from the Company's
financial statements. This data should be read in conjunction with Item 7
Management's Discussion and Analysis of Financial Condition and Plan of
Operations.
SYNERGY BRANDS INC
SELECTED FINANCIAL DATA
12/31/2005
YEAR ENDED DECEMBER 31,
2005 2004 2003 2002 2001
CONSOLIDATED STATEMENT OF OPERATIONS:
NET SALES $64,137,090 $56,705,044 $40,540,577 $31,540,675 $24,347,928
COST OF SALES
COST OF PRODUCT $59,270,788 $51,907,840 $36,837,796 $29,241,384 $22,347,887
SHIPPING AND HANDLING COSTS $1,038,923 $900,205 $893,582 $600,994 $657,793
$60,309,711 $52,808,045 $37,731,378 $29,842,378 $23,005,680
GROSS PROFIT $3,827,379 $3,896,999 $2,809,199 $1,698,297 $1,342,248
OPERATION EXPENSES
ADVERTISING AND PROMOTIONAL $63,155 $150,181 $91,634 $469,965 $1,501,267
GENERAL AND ADMINISTRATIVE $3,992,405 $3,605,433 $2,984,663 $3,196,270 $3,072,900
DEPRECIATION AND AMORTIZATION $497,965 $659,490 $692,698 $893,935 $1,004,553
ASSET IMPAIRMENT CHARGE $293,586
DEVELOPMENT COSTS $16,133
$4,847,111 $4,415,104 $3,768,995 $4,560,170 $5,594,853
OPERATING LOSS -$1,019,732 -$518,105 -$959,796 -$2,861,873 -$4,252,605
OTHER INCOME(EXPENSE)
INTEREST INCOME $102,644 $4,610 $13,913 $26,695 $128,189
OTHER INCOME(EXPENSE) -$21,504 -$46,983 $298,932 $514,860 $23,804
EQUITY IN EARNINGS OF INVESTEE $56,311 $172,224 $92,424 $67,717 $1,583
INTEREST AND FINANCING EXPENSES -$1,593,639 -$1,553,521 -$690,038 -$211,279 -$154,745
DIVIDENDS ON PREFERRED STOCK OF SUBSIDARY -$24,500
-$1,456,188 -$1,423,670 -$284,769 $397,993 -$25,669
LOSS BEFORE INCOME TAXES -$2,475,920 -$1,941,775 -$1,244,565 -$2,463,880 -$4,278,274
INCOME TAX EXPENSE $84,858 $34,604 $32,658 $22,687 $21,865
NET LOSS BEFORE DISCONTIUED OPERATIONS -$2,560,778 -$1,976,379 -$1,277,223 -$2,486,567 -$4,300,139
DIVIDEND-PREFERRED STOCK $317,333 $156,375 $78,000
NET LOSS ATTRIBUTABLE
TO COMMON STOCKHOLDERS -$2,878,111 -$2,132,754 -$1,355,223 -$2,486,567 -$4,300,139
BASIC AND DILUTED NET LOSS
PER COMMON SHARE: -$0.75 -$0.97 -$0.82 -$1.91 -$4.15
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING 3,820,061 2,209,371 1,652,019 1,302,042 1,035,795
CONSOLIDATED BALANCE SHEET DATA:
WORKING CAPITAL $4,450,709 $3,064,266 $1,041,027 $51,542 $744,710
TOTAL ASSETS $17,352,638 $16,706,423 $10,992,645 $5,871,669 $8,398,310
LONG TERM OBLIGATIONS $2,668,691 $1,196,241 $788,162 $342,750 $801,814
TOTAL SHAREHOLDERS' EQUITY $6,932,701 $6,573,057 $2,943,832 $2,082,537 $3,027,029
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
PLAN OFOPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
Synergy Brands, Inc. (SYBR or the Company) is a holding company that
operates in the wholesale and online distribution of Groceries and Health &
Beauty Aid (HBA) as well as wholesale, retail and online distribution of premium
cigars and salon & luxury products through three business segments. It
principally focuses on the sale of nationally known brand name grocery and HBA
consumer products manufactured by major U.S. manufacturers. The company uses
supply based logistics to optimize its distribution costs on both wholesale and
retail channels.
The Company also owns 22% of the outstanding common stock of Interline
Travel and Tours, Inc. (AKA: PERX). PERX provides cruise and resort hotel
packages through a proprietary reservation system to airline employees and their
retirees. PERX is believed to be the largest Company in this sector of the
travel industry. Information on PERX can be found at www.perx.com. The Company
believes that its capital investment in this unique travel Company could provide
for material future capital appreciation. Synergy Brands does not manage PERX's
day-to day operations. Perx pre-tax profit for the fiscal year 2005 was
$512,000. SYBR's share under the equity method amounted to $56,311 for fiscal
year 2005 after income taxes. SYBR and PERX have been exploring several
opportunities to optimize the shareholder value of both Companies. SYBR made a
$1 million investment in a private placement in the fourth quarter of FY 2005
for the purpose of expanding PERX operations through acquisitions.
Business-to-Business (B2B): The Company operates two businesses segments
within the B2B sector. B2B is defined as sales to non-retail customers.
PHS Group ("PHS") distributes Grocery and HBA products to retailers and
wholesalers predominately located in the Northeastern United States and Canada.
PHS is the largest subsidiary of the Company and represents about 96% of the
overall Company sales. PHS's core sales base continues to be the distribution of
nationally branded consumer products in the grocery and (HBA) sectors. PHS has
positioned itself as a distributor for major manufacturers as opposed to a full
line wholesaler. A full line wholesaler has the responsibility of servicing the
entire needs of a retail operation, whereby a distributor caters to specific
merchandising categories. As a result, PHS is able to plan the needs of its
customers directly from the source of supply and in turn increase sales to its
customers through this unique focus. PHS concentrates on the fastest moving
promotional items such as: Tide, Bounty, Nyquil, Pantene, Clorox bleach, Scott
tissues, Marcal tissues among many others, and uses logistics and distribution
savings to streamline and reduce its sale prices. The second business segment
within the Company's B2B sector is Proset. Proset imports and distributes Salon
Hair care products and luxury goods to wholesalers and distributors, in the
Northeastern part of the United States.
Business to Consumer (B2C): The Company operates three businesses within
the B2C segment. B2C is defined as sales to retail customers.
The Company's B2C activities are conducted through its wholly owned
subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses
o Cigars Around the World sells premium cigars to restaurants, hotels,
casinos, country clubs and many other leisure related destinations. The
company was acquired in June 2003. (www.cigarsaroundtheworld.com)
------------------------------
o CigarGold.com sells premium cigars through the Internet directly to the
consumer. (www.cigargold.com)
-------------------
o GRC opened its first retail store in Miami, Florida in March, 2006. The
store is expected to be an extension to CAW operation and the store is
called "Cigars Around the World."
o BeautyBuys.com sells salon hair care products directly to the consumer
via the Internet. (www.beautybuys.com)
--------------------
o The Company's B2C websites also expects to generate revenue through
affiliates and partnership agreements such as www.overstock.com,
------------------
www.google.com .
--------------
29
CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005
AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2004.
OPERATING OPERATING AND
SEGMENTS CORPORATE SEGMENTS
Y/E 12/31/2005
Revenue $64,137,090 13.11% $64,137,090 13.11%
Gross Profit 3,827,379 -1.79% 3,827,379 -1.79%
SG&A 3,356,673 8.56% 4,055,560 7.99%
Operating Profit (loss) (175,581) -139.71% (1,019,732) -96.82%
Net loss attributable to
common stockholders (1,588,865) -53.96% (2,878,111) -34.95%
Net loss per common share (0.42) (0.75)
Interest and financing expenses 1,377,581 -4.60% 1,593,639 2.58%
Y/E 12/31/2004
Revenue $56,705,044 $56,705,044
Gross Profit 3,896,999 3,896,999
SG&A 3,092,087 3,755,614
Operating Profit (loss) 442,190 (518,105)
Net loss attributable to
common stockholders (1,032,025) (2,132,754)
Net loss per common share (0.47) (0.97)
Interest and financing expenses 1,444,020 1,553,521
Synergy Brands
Synergy Brands is a holding Company that operates through wholly owned
segments. In order to fully understand the results of operations, each segment
is analyzed respectively.
Revenues increased by 13% to $64,137,090 for the year ended December 31,
2005, as compared to $56,705,044 for the year ended December 31, 2004. The
largest percentage increase was in the Company's B2B operations. The Company's
grocery operation continued to develop additional vendor relationships in the
grocery and HBA businesses as well as materially expanded its sales in Canada.
Gross profit remained flat at $3,827,379 for the year ended December 31,
2005 as compared to $3,896,999 for the year ended December 31, 2004. Proset
increased its reserves to $190,000 in FY 2005, and took an impairment charge to
its intangible assets in the amount of $293,586. The salon business did not
secure sufficient product flow to service Proset's customers during the year.
Gross profit would have increased by 3% without the additional reserves.
Selling General and Administrative expenses (SGA) increased by 8% while
revenues increased by 13% for the year ended December 31, 2005 as compared to
the year ended December 31, 2004. The Company streamlined its operations by
centralizing all administrative functions at its corporate offices, reduced
staff in its Proset operation through outsourcing, and increased its focus on
wholesale distribution as opposed to retail store sales. The largest subsidiary
of the Company, PHS Group, increased its SGA expenses by 18% to $2,211,290 for
the year ended December 31, 2005 as compared to $1,870,312 for the year ended
December 31, 2004. The increase in SGA for PHS group was caused by a 21%
increase in revenues. PHS incurs variable expenses in connection with selling
costs such as sales commission, drivers, warehousing and administrative
personnel as well as its promotional expenses. As revenues rise sales
commissions and certain operating expenses resulting from sales increase
commensurately.
The net loss attributable to Common Stockholder of the Company was
$2,878,111 for the year ended December 31, 2005 as compared to a net loss of
$2,132,754 for the year ended December 31, 2004. Interest and financing costs
represents 55% of the total loss. The reasons for the increase in net loss
relate to one-time non-cash charges. Corporate expenses such as legal,
accounting, and regulatory costs as well as depreciation costs represent the
difference between the Company's consolidated results and operating results.
Management believes that its corporate expenses may increase as a result of
additional regulatory requirements that have been enacted by the Securities and
Exchange Commission (SEC). The Company will be required to comply with
additional governance and financial regulations that will likely result in
additional corporate expenses. Corporate expenses for the year ended December
31, 2005 totaled $698,887, which include legal, accounting and regulatory
expenses as compared to $663,527 for the year ended December 31, 2004.
30
BELOW IS A SUMMARY OF THE RESULTS OF OPERATION BY SEGMENT:
PHS Group: (B2B Operations)
Synergy's Grocery operation improved its operation through an expansion of
its Metro NY wholesale operation. Sales improved by 21% to $61.4 million and
operating profit increased by 29% to $1.2 million. PHS represented 96% of the
Company's overall revenues and provides the most of the cash flow for the
Company's other segments as well as corporate regulatory expenses. PHS plans to
continue attempting to build its Metro NY, operations and increase its
international sales to Canada and the Caribbean.
B2C operations. (Gran Reserve Corporation supra GRC)
B2C operations consist of www.CigarGold.com, www.CigarsAroundtheWorld.com,
www.BeautyBuys.com; retail store operation in Miami and online partnership
programs such as www.Overstock.com and www.Google.com. The operation has
relocated to a 6,000 square foot facility in Miami Lakes Florida, which handles
order flow for the operation as well as retail operations. Sales deceased by 7%
to $1.9 million while operating loss was reduced by 27% to $427,672. Revenues
were reduced due in material part to Hurricane Wilma, which disrupted operations
in the fourth quarter of 2005. Retail store operations commenced in December of
2005 with a grand opening, which occurred on March 4, 2006. GRC plans to have
its retail outlets act as its hubs for expansion in FY 2006. The combination of
online sales as well as retail store sales is expected to be the focus for
growth in FY 2006. The retail store is an expansion of Bill Rancic's Cigars
Around the World (CAW) concept of providing the ultimate destination to a cigar
aficionado. The Company has been disappointed by GRC's growth and believes that
rapidly changing antismoking legislation may shift the Cigar business to be a
complete destination business as opposed to a leisurely activity.
Proset operations
Proset had a disappointing year in FY 2005. Proset developed additional
sources for its goods predominately in Europe, but access to goods have been
limited in FY 2005. However, in the first quarter of 2006, the Company secured
direct contacts in Europe for Luxury Goods and secured Costco and other
customers for the distribution of these goods. These goods include some of the
most respected producers for Bags, wallets, briefcases, and eyewear in Europe.
Management expects that Proset-operating results should significantly improve in
FY 2006. Furthermore, Proset-operating structure has been integrated into PHS
Group, thus allowing for logistics to be integrated into PHS operations. Proset
is expected to have a record first quarter in FY 2006. The flow of luxury goods
has materialized in the first quarter and Costco has already received numerous
deliveries.
Corporate Expenses:
The Company's allocation to corporate expenses was increased by 5% to
$698,887. Corporate expenses represent 17% of overall operating expense of the
Company. Operating expenses for all operations including corporate expenses
totaled $4 million in FY 2005.
31
BELOW IS A DETAILED REVIEW OF THE COMPANY'S PERFORMANCE.
IN ORDER TO FULLY UNDERSTAND THE COMPANY'S RESULTS A DISCUSSION OF THE
COMPANY'S SEGMENTS AND THEIR RESPECTIVE RESULTS FOLLOW;
B2B OPERATIONS
The Company's B2B operations consist of two operating businesses, PHS Group
and Proset. PHS Group distributes Grocery and HBA products to retailers and
wholesalers predominately located in the Northeastern United States and Canada.
PHS is the largest subsidiary of the Company and represents about 96% of the
overall company sales. PHS's core sales base remain the distribution of
nationally branded consumer products in the grocery and health and beauty (HBA)
sectors. PHS has positioned itself as a distributor for major manufacturers as
opposed to a full line wholesaler. A full line wholesaler has the responsibility
of servicing the entire needs of a retail operation, where as a distributor
caters to specific merchandising categories. As a result, PHS is able to plan
the needs of its customers directly from the source of supply and in turn
increase sales to its customers through this unique focus. PHS concentrates on
the fastest moving promotional items and uses logistics and distribution savings
to streamline and reduce its sale prices. The second business segment within the
company's B2B sector is Proset Hair Systems (Proset). Proset imports and
distributes salon hair care products and luxury goods to wholesalers and
distributors, in the northeastern part of the United States.
PHS SEGMENT INFORMATION OF OPERATING BUSINESSES
PHS Group CHANGE
Year ended December 31, 2005
Revenue 61,450,467 21.14%
Gross Profit 3,423,960 22.03%
SG&A 2,211,290 18.23%
Operating Profit (loss) 1,199,866 29.17%
Net loss (111,784) -33.44%
Interest and financing expenses 1,297,348 11.02%
Year ended December 31, 2004
Revenue 50,728,560
Gross Profit 2,805,747
SG&A 1,870,312
Operating Profit (loss) 928,934
Net loss (167,951)
Interest and financing expenses 1,168,607
PHS increased its revenues by 21% to $61.4 million for year ended December
31, 2005 as compared to $50.7 million for the year ended December 31, 2004. The
increase in PHS business is attributable to the utilization of additional
vendors, development of a wholesale operation and expansion of the Canadian
distribution business in Ontario, Canada increase of its Domestic Wholesale
business and expansion into the Dominican Republic. PHS increased its gross
profit by increasing Direct Store Delivery sales as well as focusing on
promotional merchandise offered by its vendors. The overall gross profit
percentage remained consistent at 5.6%. In 2005, several PHS vendors created
special packaging with promotional pricing that enabled PHS to widen its margin.
As an example, special packaging was created for Folgers, Marcal paper, Crest
displays as well as Gain Detergent among others, with unique retail display
features, that PHS has been able to strongly promote during FY 2005 as opposed
to marketing those products for normal replenishment. Promotional displays allow
PHS to sell better mixes of product as well as introduce new items in
combination with regularly stocked items. As long as the Company maintains or
expands its vendor relationships, management believes that it can continue to
improve its operating results. However, the Company is dependant on promotional
allowances and any material changes to manufacture's allowance will likely have
a material adverse effect to the Company's operating result. Net loss was
$111,784 for the year ended December 31, 2005 as compared to a loss of $167,951
for the year ended December 31, 2004.
32
PROSET SEGMENT INFORMATION OF OPERATING BUSINESSES
Salon
Year ended December 31, 2005 products CHANGE
Revenue 786,908 -79.95%
Gross Profit (178,735) -130.39%
SG&A 292,034 3.28%
Operatimg Profit(loss) (947,775) -1103.07%
Net loss (1,031,576) -370.60%
Interest and financing expenses 80,233 -65.55%
Year ended December 31, 2004
Revenue 3,923,823
Gross Profit 588,154
SG&A 282,747
Operatimg Profit(loss) 94,487
Net Profit(loss) (219,204)
Interest and financing expenses 232,913
Proset revenues decreased by 80% for the year ended December 31, 2005 as
compared to the year ended December 31, 2004. Proset reserved $190,000 against
its inventory and took a $293,586 impairment charge to its customer list in FY
2005. During FY 2005 Proset failed to secure product through its normal channels
and as a result Proset was not able to service its customers. However, Proset
was able to secure reliable channels of distributors and procurement to luxury
goods in the end of FY 2005. Proset has started to explore the importation of
luxury products from Europe in the middle of FY 2006. It has secured supply
specifically designated for Costco's use. Proset believes that the Designer
Luxury goods, which include handbags, wallets, briefcases, Eyewear among others
is a fast growing category that Mass Merchandisers can benefit from. Proset will
comply with all requests made by its vendors for the effective distribution of
these goods and is bound by restriction in the event that it does not comply.
SG&A increased by 3% to $292,034 for the year ended December 31, 2005 as
compared to $282,747 for the year ended December 31, 2004. Management has been
disappointed with Proset's operation for the year ended December 31, 2005.
Proset's backlog of orders has not materialized, and as a result operating
results were below expectations. Proset's management believes that the delay in
order flow should be corrected, but there is no assurance that it will. Results
of operations would have been improved if Proset's business expectations would
have materialized. Proset represented about 1.2% of the Company's sales for the
year, but it represented 36% of the overall net loss of the Company. Over 63% of
the charges related to Proset loss were non-cash charges.
33
B2C SEGMENT INFORMATION OF OPERATING BUSINESSES
B2C CHANGE
Year ended December 31, 2005
Revenue 1,899,715 -7.45%
Gross Profit 582,154 15.71%
SG&A 853,349 -9.12%
Operating Profit(loss) (427,672) -26.42%
Net loss (445,505) -30.92%
Interest and financing expenses - -100.00%
Year ended December 31, 2004
Revenue 2,052,661
Gross Profit 503,098
SG&A 939,028
Operating Profit(loss) (581,231)
Net Profit(loss) (644,870)
Interest and financing expenses 42,500
The Company's B2C activities are conducted through its wholly owned
subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses
o Cigars Around the World sells premium cigars to restaurants, hotels,
casinos, country clubs and many other leisure related destinations. The
company was acquired in June 2003. (www.cigarsaroundtheworld.com)
o CigarGold.com sells premium cigars through the Internet directly to the
consumer. (www.cigargold.com)
o GRC opened its first retail store in Miami, Florida in March, 2006. The
store is expected to be an extension to CAW operation and the store is
called Cigars Around the World.
o BeautyBuys.com sells salon hair care products directly to the consumer
via the Internet. (www.beautybuys.com)
o The Company's B2C websites also expects to generate revenue through
affiliates and partnership agreements such as www.overstock.com,
www.google.com and paid links.
Cigars Around the World (CAW), a wholly owned subsidiary of Synergy Brands,
Inc. (NASDAQ: SYBR), officially opened its first retail outlet and cigar club in
Miami Lakes Florida, on March 4, 2006. The 6,000 square-foot facility, located
at 15804 57th Ave, in Miami Lakes features more than 1,000 unique cigars that
include brand name, hand made premium cigars as well as Gran Reserve Corp's
(GRC) proprietary brands as well as Cigar Accessories. The entire facility is
temperature and humidity controlled so all the Cigars can be viewed in a total
store experience. In addition, the store houses a Cigar Lounge with Free
satellite TV and Free Wireless Internet which will enhance the customer's Cigar
smoking and shopping experience. CAW expects to use its facility for Radio
remotes for special events, seminars on upcoming news in the Cigar world, and
other organized events for its members.
34
CAW features the top selling Cigar brands which include Macanudo, Partagas,
Montecristo, Cohiba, Arturo Fuentes-Opus X, Hemingway, Padron, Punch, Romeo y'
Julietta, Suarez Gran Reserve, Davidoff, Ashton, Mike Ditka and Breton labels
among others. The store will also offer premium brands of upscale accessories.
All the products in the store are available nationally on the Store's website
www.CigarsAroundTheWorld.com.
Bill Rancic, founder of CAW at www.CigarsAroundTheWorld.com and Donald
Trump's first "Apprentice" on the popular NBC-TV program, was on hand for the
store's grand opening. One of the attractions of the new store is the membership
program which enables club members to rent a climate controlled locker to keep
their personal cache in a perfectly controlled temperature and humidity
environment. Management believes that the club has the potential to provide an
additional revenue stream to the strong sales we continue to see in the cigar
division.
Upcoming events include plans for a Father's Day celebration in the lounge
of Cigars Around the World similar to the grand opening. Fathers will be given
the special treatment they deserve as well as exceptional discounts on their
favorite cigars. CAW plans NFL weekends as the football season starts and a
Super Bowl event next year. Based upon this model, CAW is exploring other retail
opportunities to expand this concept.
The store's grand opening celebration received coverage by local media
including WSVN-TV, FOX; WPLG-TV, ABC; WAXY-AM, 790 The Ticket; the Miami Herald;
the Miami Laker; and the Miami New Times.
Revenues in the Company's B2C operation for the year ended December 31,
2005 were $1,899,715 as compared to $2,052,661 for the year ended December 31,
2004. CAW on a current operating basis represents approximately 59% of B2C
revenues for the year ended December 31, 2005. Gross profit for year ended
December 31, 2005 was $582,154 as compared to $503,098 for the year ended
December 31, 2004. The table above provides comparative details for the
Company's B2C operation.
CAW is operating profitably, but the logistical support in Miami, Florida
is consuming the segment's resources and thereby not allowing it to show a
profit at those sales levels. The On-line segment has over 20,000 customers,
generates an average order of $100, with over a 50% repeat rate and generates at
a 99% fulfillment rate. The Company believes that building its B2C segment
brands along with popularity of Bill Rancic, the winner of the ABC show "The
Apprentice" should bring the segment effective critical mass.
35
CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2004
AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2003.
OPERATING OPERATING AND
SEGMENTS CORPORATE SEGMENTS
Y/E 12/31/2004
Revenue 56,705,044 39.87% 56,705,044 39.87%
Gross Profit 3,896,999 38.72% 3,896,999 38.72%
SG&A 3,092,087 17.04% 3,755,614 22.08%
Operating Profit (loss) 442,190 202.03% (518,105) 46.02%
Net loss attributable to
common stockholder (1,032,025) -26.22% (2,132,754) -57.37%
Net loss per common share (0.47) (0.97)
Interest and financing expenses 1,444,020 109.50% 1,553,521 125.14%
Y/E 12/31/2003
Revenue 40,540,577 40,540,777
Gross Profit 2,809,199 2,809,199
SG&A 2,641,864 3,076,297
Operating Profit (loss) (433,395) (959,796)
Net loss attributable to
common stockholder (817,658) (1,355,223)
Net loss per common share (0.49) (0.82)
Interest and financing expenses 689,286 690,038
Revenues increased by 40% to $56,705,044 for the year ended December 31,
2004, as compared to $40,540,577 for the year ended December 31, 2003. The
largest percentage increase was in the Company's B2B operations. The Company's
grocery operation continued to develop additional vendor relationships in the
grocery and HBA businesses as well as materially expanded its sales in Canada.
Gross profit increased by 39% to $3,896,999 for the year ended December 31,
2004 as compared to $2,809,199 for the year ended December 31, 2003. The
increase in gross profit was in direct relationship to increased sales.
Selling General and Administrative expenses (SGA) increased by 22% while
revenues increased by 40% for the year ended December 31, 2004 as compared to
the year ended December 31, 2003. The Company streamlined its operations by
centralizing all administrative functions at its corporate offices, reduced
staff in its Proset operation through outsourcing, and increasing sales focus on
wholesale distribution as opposed to retail store sales. The largest subsidiary
of the Company, PHS Group, increased its SGA expenses by 41% to $1,870,312 for
the year ended December 31, 2004 as compared to $1,323,887 for the year ended
December 31, 2003. The increase in SGA for PHS group was caused by a 46%
increase in revenues. PHS incurs variable expenses in connection with selling
costs such as sales commission, drivers, warehousing and administrative
personnel as well as its promotional expenses. As revenues rise sales
commissions and certain operating expenses resulting from sales increase
commensurately.
36
The net loss for the Company was $2,132,754 for the year ended December 31,
2004 as compared to a net loss of $1,355,223 for the year ended December 31,
2003. In the first quarter of 2003, the Company realized a one time gain of
$282,750 in connection with the extinguishment of online advertising payables in
2003. The Company also had the benefit of an allowance paid in the second
quarter of 2003 totaling $415,000 that will be paid over the course of
subsequent period. Other material factors that affected the Company's costs were
increased financing costs resulting from increased borrowings. The increase was
attributable to the development of the Company's wholesaling operation as well
as materially higher financing costs. Interest and financing costs jumped by
125% to $1,553,521 for the year ended December 31, 2004. Corporate expenses such
as legal, accounting, and regulatory costs as well as depreciation costs
represent the difference between the Company's consolidated results and
operating results. Management believes that its corporate expenses may increase
as a result of additional regulatory requirements that have been enacted by the
Securities and Exchange Commission (SEC). The Company will be required to comply
with additional governance and financial regulations that will likely result in
additional corporate expenses. Corporate expenses for the year ended December
31, 2004 totaled $663,527, which include legal, accounting and regulatory
expenses as compared to $434,443 for the year ended December 31, 2003.
Management believes that financing costs were increased as a result of
revenue growth. As a result, the Company was required to utilize its line of
credit to support account receivable and inventory growth. Although the working
capital needed to support revenue growth is directly related to the growth in
accounts receivable and inventory, the Company has invested in capital assets,
such as warehousing and trucks to support the growth of the business.
In order to fully understand the Company's results a discussion of the
Company's segments and their respective results follow;
B2B OPERATIONS
The Company's B2B operations consist of two operating businesses, PHS Group
and Proset Hair Systems. PHS Group distributes Grocery and HBA products to
retailers and wholesalers predominately located in the Northeastern United
States and Canada. PHS is the largest subsidiary of the Company and represents
about 89% of the overall company sales. PHS's core sales base remain the
distribution of nationally branded consumer products in the grocery and health
and beauty (HBA) sectors. PHS has positioned itself as a distributor for major
manufacturers as opposed to a full line wholesaler. A full line wholesaler has
the responsibility of servicing the entire needs of a retail operation, where as
a distributor caters to specific merchandising categories. As a result, PHS is
able to plan the needs of its customers directly from the source of supply and
in turn increase sales to its customers through this unique focus. PHS
concentrates on the fastest moving promotional items and uses logistics and
distribution savings to streamline and reduce its sale prices. The second
business segment within the company's B2B sector is Proset Hair Systems
(Proset). Proset distributes Salon Hair care products to wholesalers,
distributors, chain drug stores and supermarkets in the Northeastern part of the
United States.
37
PHS Group CHANGE
Year ended December 31, 2004
Revenue 50,728,560 46.02%
Gross Profit 2,805,747 45.57%
SG&A 1,870,312 41.27%
Operating Profit (loss) 928,934 180.88%
Net loss (167,951) -110.30%
Interest and financing expenses 1,168,607 159.76%
Year ended December 31, 2003
Revenue 34,740,999
Gross Profit 1,927,416
SG&A 1,323,887
Net loss (79,864)
Interest and financing expenses 449,876
PHS increased its revenues by 46.0% to $50.7 million for year ended
December 31, 2004 as compared to $34.7 million for the year ended December 31,
2003. The increase in PHS business is attributable to the utilization of
additional vendors, development of a wholesale operation and expansion of the
Canadian distribution business in Ontario, Canada. PHS increased its gross
profit by increasing Direct Store Delivery sales as well as focusing on
promotional merchandise offered by its vendors. The overall gross profit
percentage remained consistent at 5.5%. In 2004, several PHS vendors created
special packaging with promotional pricing that enabled PHS to widen its margin.
As an example, special packaging was created for Nyquil, Marcal paper, Clorox
displays as well as Herbal Essence shampoos among others, with unique retail
display features, that PHS has been able to strongly promote during FY 2004 as
opposed to marketing those products for normal replenishment. Promotional
displays allow PHS to sell better mixes of product as well as introduce new
items in combination with regularly stocked items. As long as the Company
maintains or expands its vendor relationships, management believes that it can
continue to improve its operating results.
38
PROSET SEGMENT INFORMATION OF OPERATING BUSINESSES
Salon
Year ended December 31, 2004 products CHANGE
Revenue 3,923,823 6.88%
Gross Profit 588,154 70.82%
SG&A 282,747 -34.20%
Operatimg Profit(loss) 94,487 131.65%
Net loss (219,204) 56.35%
Interest and financing expenses 232,913 16.52%
Year ended December 31, 2003
Revenue 3,671,106
Gross Profit 344,305
SG&A 429,684
Operatimg Profit(loss) (298,577)
Net Profit(loss) (502,158)
Interest and financing expenses 199,892
Proset revenues increased by 6.9% for the year ended December 31, 2004 as
compared to the year ended December 31, 2003. Proset has transitioned its
business model from retail services to wholesale distribution. Gross profit has
increased by 71% to $588,154 for the year ended December 31, 2004 as compared to
$344,305 for the year ended December 31, 2003. At the same time SG&A dropped by
34% to $282,747 for year ended December 31, 2004. As a result of this
transition, the Company's customer base has expanded to include smaller
distributors that purchase salon products in higher quantities, which in turn
optimizes the gross profit. However, distributor sales require less labor,
warehousing and distribution costs, but rely on optimal market conditions and
product availability. The salon business is highly fragmented and very
competitive. Proset must maintain strong vendor relations, which include
distributors and resellers in order to keep a supply chain for its customer
base. Financing costs are also an important factor in the operation of Proset.
Financing costs increased by 17% to $232,913. Wholesalers are provided better
credit terms then retailers since they need to maintain greater inventories. In
order to improve the profitability of Proset, management believes that financing
costs need to reduced.
39
B2C SEGMENT INFORMATION OF OPERATING BUSINESSES
B2C CHANGE
Year ended December 31, 2004
Revenue 2,052,661 -3.56%
Gross Profit 503,098 -6.40%
SG&A 939,028 5.71%
Operatimg Profit(loss) (581,231) 24.85%
Net loss (644,870) -173.67%
Interest and financing expenses 42,500 7.55%
Year ended December 31, 2003
Revenue 2,128,472
Gross Profit 537,478
SG&A 888,293
Operatimg Profit(loss) (465,535)
Net Profit(loss) (235,636)
Interest and financing expenses 39,518
The Company's B2C segment includes three businesses, which include Cigars
Around the World, CigarGold and BeautyBuys. Cigars Around the World (CAW) was
acquired in June of 2003. CAW sells premium cigars to Hotels, Restaurants,
Casinos, PGA Clubs and other leisure related destinations. CAW sells its cigars
in through customized retail displayed humidors. CAW also has its own retail
website that operates under the name www.CigarsAroundTheWorld.com. The displays
range from counter top humidors to Walled Display units. CigarGold (CG) is the
Company's cigar online unit. CG sells premium cigars online to retail customers
throughout the United States. It has a selection of over 1000 products, which
include brand-name hand made premium cigars and cigar accessories. CigarGold
operates under the domain names: www.CigarGold.com, www.NetCigar.com, and
www.GoldCigar.com. The online unit also operates www.BeautyBuys.com.
BeautyBuys.com sells salon hair products to the retail consumer. Previously the
operation also sold fragrances and cosmetics to retail customers. However, the
Company decided in 2003 to limit its selection to salon hair care products,
since those items are already carried and stocked within its wholesale salon
operation, Proset Hair Systems.
Revenues in the Company's B2C operation for the year ended December 31,
2004 were $2,052,661 as compared to $2,128,472 for the year ended December 31,
2003. CAW on a current operating basis represented approximately 64% of B2C
revenues for the year ended December 31, 2004. Gross profit for year ended
December 31, 2004 was $503,098 as compared to $537,478 for the year ended
December 31, 2003. The table above provides comparative details for the
Company's B2C operation.
40
LIQUIDITY AND CAPITAL RESOURCES
Year end 2005 2004
Working Capital $ 4,450,709 $ 3,064,266
Assets 17,352,638 16,706,423
Liabilities 10,419,937 10,133,366
Equity 6,932,701 6,573,057
Line of Credit Facility 4,033,242 4,976,610
Receivable turnover (days) 43 49
Inventory Turnover (days) 12 12
Net cash used in operating activies 4,051,495 6,983,055
Net cash (used in) provided by
investing activities (791,007) 811,265
Net cash provided by financing activites 4,160,250 6,342,537
The Company reduced its cash requirements from operating activities by 42%
from $7 million to $4.1 million from 2004 to 2005. The reason was a net decrease
of $5.6 million in the net increase of accounts receivables and other
receivables from $6.5 million to $900,000.
Liquidity for the Company predominately involves the need to finance
accounts receivables, inventory, financing costs and operating expenses. The
cash flow realized from the Company's gross profit was not sufficient to cover
the Company's operating expenses. The Company generated a net loss of
approximately $2.6 million. Financing costs totaled $1.6 million and represented
the largest cost center for the Company. Reductions in financing expenses would
be beneficial to the Company's performance. This reduction could be achieved
through equity-based transactions, refinancing at lower rates and a reduction of
the Company's inventory and accounts receivables. Management believes that
equity based transactions and refinancing should be the objectives for the
Company. A reduction in receivables and inventory may cause a reduction in
revenue, which would reduce operating margins.
Although the Company improved its cash flow from operating activities by
$2.9 million, it needed to secure funds from financing activities to cover its
operating needs. The Company financed its operating activities by issuing $3.7
million in notes and $770,000 in Preferred Stock.
The Company's working capital improved by $1.4 million to $4.5 million due
to a $900,000 reduction in the Company's line of credit and a $1.6 million
reduction in accounts payable. Receivables increased by $900,000 due to revenue
increases and vendor rebates.
Notes receivable increased by $800,000 predominately due to the Company's
investment in PERX. Notes payable had a corresponding increase due to the
proceeds derived in a loan from a major shareholder.
The Company raised $2.8 million is equity predominately due to note
conversions under existing agreements. The Company acquired sufficient capital
to cover its operating expenses and had unused availability of $1.2 million
under its line of credit. The Company believes that it has sufficient
availability under its line of credit and an ability to raise sufficient capital
to cover its operating losses. However, the Company believes that it needs to
generate an operating profit and not rely on external financing whether debt or
equity.
41
The capital resources available to the Company consist of $6.3 million in
lines of Credit, $2.7 million in long-term notes and $4 million in Preferred
Stock. The Company's objective is to reduce its notes through the issuance of
equity and cash flow as well as refinancing its current obligations with lower
rates. However there is no assurance that the Company would be able to achieve
its objectives.
The Company's liquidity relies on the turnover of it inventory and accounts
receivables. The Company reduced its receivable turnover from 49 days to 43 days
and its inventory turnover remained flat at 12 days. The Company believes that
its collection procedures and procurement policies are consistent with industry
standards. However, nearly 70% of the Company's assets consist of trade
receivables and inventory. The Company must maintain a strict policy on insuring
collections of receivables and adequate procurement based upon customer demands.
Management believes that continued cost containment, improved financial and
operating controls, debt reduction, and a focused sales and marketing effort
should provide sufficient cash flow from operations in the near term and the
Company is working toward reliance on such financial sources and attributes to
cover its cash flow requirements but achievement of these goals, however, will
likely continue to be dependent upon the Company's attainment of increased
revenues, improved operating costs, reduced financing cost and trade support
levels that are consistent with management's plans. Such operating performance
will be subject to financial, economic and other factors beyond its control, and
there can be no assurance that the Company's goals will be achieved. In the
interim while such goals are being pursued achievement of positive cash flow has
been reliant on equity and debt financing, including the Company's exchange of
notes payable for common shares and its issuance of further common and preferred
stock in private placements and the Company is hopeful that the market will
continue to recognize the Company's stature so that such financing method will
continue to be available in the future because, at least in the near future, the
Company is likely to continue to use such financing opportunities to maintain
adequate cash flow.
Expected interest payments on notes payable for the period ended December
31, are as follows:
12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 Total
$373,000 $206,000 $108,000 $80,000 $60,000 $827,000
Variable interest rate on notes of $1,275,000 was 10.25%. Variable interest
rate on note of $995,531 was 7.25%.
The following table presents the Company expected cash requirements for
contractual obligations outstanding at December 31, 2005.
Payments Due By Period
Contractual Obligations Less Than 1-3 4-5 After 5
1 Year Years Years Years Total
Line-Of-Credit $4,033,242 $4,033,242
Notes Payable $1,645,531 $1,715,000 $1,000,000 $4,360,531
Operating Leases $ 435,161 $ 842,177 $ 811,539 $337,476 $2,426,353
Total Contractual
Cash Obligations $6,113,934 $2,557,177 $1,811,539 $337,476 $10,820,126
42
CRITICAL ACCOUNTING POLICIES.
The discussion and analysis of the Company's financial condition and
results of operations are based upon its financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of financial statements requires management to
make estimates and disclosures on the date of the financial statements. On an on
going basis, management evaluates its estimates. Management uses authoritative
pronouncements, historical experience and other assumptions as the basis for
making judgments. Actual results could differ from those estimates. Management
believes that the following critical accounting policies affect its more
significant judgments and estimates in the preparation of the Company's
financial statements.
ACCOUNTS RECEIVABLE/ALLOWANCE FOR DOUBTFUL ACCOUNTS.
The Company's accounts receivable are due from businesses engaged in the
distribution of grocery, health and beauty products as well as from consumers
who purchase health and beauty products and premium handmade cigars from the
Company's Web sites. Credit is extended based on evaluation of a customers'
financial condition and, generally, collateral may be required. Accounts
receivable are due within 10 - 60 days and are stated at amounts due from
customers net of an allowance for doubtful accounts. Accounts outstanding longer
than the contractual payment terms are considered past due. Estimates are used
in determining the allowance for doubtful accounts based on the Company's
historical collections experience, current trends, credit policy and a
percentage of its accounts receivable by aging category. In determining these
percentages, the Company looks at historical write-offs of its receivables. The
Company also looks at the credit quality of its customer base as well as changes
in its credit policies. The Company continuously monitors collections and
payments from its customers. The Company writes off accounts receivable when
they become uncollectible, and payments subsequently received on such
receivables are credited to the allowance for doubtful accounts.
VALUATION OF DEFERRED TAX ASSETS.
Deferred tax assets and liabilities represent temporary differences between
the basis of assets and liabilities for financial reporting purposes and tax
purposes. Deferred tax assets are primarily comprised of reserves, which have
been deducted for financial statement purposes, but have not been deducted for
income tax purposes as well as net operating loss carry forwards. The Company
annually reviews the deferred tax asset accounts to determine if is appears more
likely than not that the deferred tax assets will be fully realized. At December
31, 2005, the Company has established a full valuation allowance.
VALUATION OF LONG-LIVED ASSETS.
The Company reviews its long-lived assets periodically to determine
potential impairment by comparing the carrying value of the assets with expected
net cash flows expected to be provided by the operating activities of the
business or related products. Should the sum of the expected future net cash
flows be less than the carrying value, the Company would determine whether an
impairment loss should be recognized. An impairment loss would be measured by
comparing the amount by which the carrying value exceeds the fair value of the
Asset. Long-lived assets and intangible assets are reviewed for impairment
whenever events or changes in circumstances indicate the carrying value may not
be recoverable. Impairment is measured by comparing the carrying value of the
long-lived assets to the estimated undiscounted future cash flows expected to
result from use of the assets and their ultimate disposition. To the extent
impairment has occurred, the carrying amount of the asset would be written down
to an amount to reflect the fair value of the asset.
43
RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD ("FASB")
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services. This statement focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value
of such equity instruments be recognized as an expense in the historical
financial statements as services are performed. Prior to SFAS No. 123(R), only
certain pro forma disclosures of fair value were required. The provisions of
this statement are effective as of the beginning of the first interim reporting
period for fiscal years beginning after June 15, 2005. The Company adoption of
SFAS No.123(R) will have an impact on the Company's financial position and
results of operations similar to the pro forma disclosure in NOte 17B to the
Financial Statements.
In November 2004, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 151 "Inventory Costs." This statement amends Accounting
Research Bulletin No. 43, Chapter 4, "Inventory Pricing" and removes the "so
abnormal" criterion that under certain circumstances could have led to the
capitalization of these items. SFAS No. 151 requires that idle facility expense,
excess spoilage, double freight and re-handling costs be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal." SFAS 151 also requires that allocation of fixed production overhead
expenses to the costs of conversion be based on the normal capacity of the
production facilities. The provisions of this statement shall be effective for
all fiscal years beginning after June 15, 2005. The Company adoption of SFAS
No.151 has not had a material impact on the Company's financial position or
results of operations.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchange of
Non-monetary Assets", an amendment of Accounting Principles Board ("APB")
Opinion No. 29, which differed from the International Accounting Standards
Board's ("IASB") method of accounting for exchanges of similar productive
assets. Statement No. 153 replaces the exception from fair value measurement in
APB No. 29, with a general exception from fair value measurement for exchanges
of non-monetary assets that do not have commercial substance. The statement is
to be applied prospectively and is effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company adoption
of SFAS No.153 has not had a material impact on the Company's financial position
or result of operations.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections a replacement of APB Opinion No. 20 and FASB Statement No. 3."
("FAS 154"). This Statement requires retrospective application to prior period
financial statements of a voluntary change in accounting principle unless it is
impracticable and is effective for fiscal years beginning after December 15,
2005. Previously, most voluntary changes in accounting principle were recognized
by including in net income of the period of the change the cummulative effect of
changing to the new accounting principle. The Company will comply with the
provisions of FAS 154 although the impact of such adoption is not determinable
at this time.
SEASONALITY
Sales by PHS Group and Proset usually peak at the end of the calendar
quarter, when the Company's suppliers offer promotions which lower prices and,
in turn, the Company is able to lower its prices and increase sales volume.
Suppliers tend to promote at quarter end and as a result reduced products costs
may increase sales. In particular, first and second quarters are usually better
operating quarters. Sales of beauty care products and fragrances increase over
traditional gift giving holidays such as Christmas, Mother's Day, Father's Day,
and Valentine's Day.
Cigar product sales also increase during holiday periods and summer months
as well as around special sporting events.
INFLATION
The Company believes that inflation, under certain circumstances, could be
beneficial to the Company's major business, PHS Group. When inflationary
pressures drive product costs up, the Company's customers sometimes purchase
greater quantities of product to expand their inventories to protect against
further pricing increases. This enables the Company to sell greater quantities
of products that are sensitive to inflationary pressures.
However, inflationary pressures frequently increase interest rates. Since
the Company is dependent on financing, any increase in interest rates will
increase the Company's credit costs, thereby reducing its profits.
44
ITEM 8. FINANCIAL STATEMENTS
The following financial statements of the Company are contained in this
Report on the pages indicated:
INDEX TO FINANCIAL STATEMENTS
Page
Reports of Independent Registered Public Accounting Firms F-2 - F-3
Consolidated Balance Sheets as of December 31, 2005 and 2004 F-4 - F-5
Consolidated Statements of Operations for the Years Ended
December 31, 2005, 2004 and 2003 F-6
Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the
Years Ended December 31, 2005, 2004 and 2003 F-7 - F-10
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2005, 2004 and 2003 F-11 - F-12
Notes to Consolidated Financial Statements F-13 - F-38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE
ITEM 9A. CONTROLS AND PROCEDURES
As certified herein by the Company's Chief Executive Officer and Chief
Financial Officer, they have as of the date of this report evaluated the
disclosure controls and procedures of the Company and believe same to be
effective to ensure that material information relating to the Company, including
its consolidated subsidiaries, is made known to the Company sufficient to allow
evaluation by the Company of accuracy in their recording, processing,
summarizing and reporting financial and other Company information and data, and
there do not appear to be any deficiencies in the design or operation of such
internal controls which would adversely and materially affect the Company's
ability to discover, evaluate and report such information.
The Company has adopted an Audit Committee Charter providing expanded
authority of such committee and the independent nature and identity of its
director participants as required by the recent enactment of the Sarbanes-Oxley
Act. The Company believes that at least one director participant therein will be
qualified as an "audit committee financial expert" as defined in such Act.
There have been no significant changes in the Registrants internal controls
or in other factors that could significantly affect these controls subsequent to
the date of the evaluation thereof, including any corrective actions with regard
to significant deficiencies and material weaknesses.
The Company's disclosure controls and procedures are designed to provide
reasonable assurance that information required to be disclosed in its reports
filed under the Exchange Act, such as this Form 10-K, is recorded, processed,
summarized and reported within the time periods specified in the SEC rules and
forms. The Company's disclosure controls and procedures are also designed to
ensure that such information is accumulated and communicated to management to
allow timely decisions regarding required disclosure. The Company's internal
controls are designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of its financial statements in
conformity with GAAP.
45
The Company's management, including its principal executive officer and the
principal financial officer, does not expect that the Company's disclosure
controls and procedures and its internal control processes will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected. The
Company monitors its disclosure controls and procedures and internal controls
and makes modifications as necessary; the Company's intent in this regard is
that the disclosure controls and procedures and the internal controls will be
maintained as dynamic systems that change (including with improvements and
corrections) as conditions warrant.
PART III
The information required by items 10-14 are omitted pursuant to general
instruction G(3) to Form 10K including executive compensation and auditor fee
information . The Company has included this information in its proxy statement
expected to be mailed to shareholders and filed with the Commission on or before
April 30, 2006. The annual meeting is scheduled to be in June 2006. Such Proxy
Statement is expected to be filed with the Commission by April 30, 2006 and is
incorporated herein by reference. The Company has established and adopted a Code
of Ethics outlining and providing guidelines for executive and employer conduct
regarding the disclosure, promotion and handling of Company business and
business relationships and a policy for comment and complaint on compliance with
applicable conduct codes ("whistleblower policy") and the Company has also
established a Nominating Committee of certain of its Directors to assist in the
election and succession of members of the Company's Board of Directors and a
Compensation Committee to assist in establishing executive compensation. Copies
of the Company's Code of Ethics, whistleblower policy, Nominating Committee and
Compensation Committee Charters may be found disclosed in the aforesaid Proxy
Statement to be confirmed at the relevant shareholders meeting and included by
reference thereto on the Company's Internet home page website.
46
ITEM 15. EXHIBITS, and FINANCIAL STATEMENT SCHEDULES
(a) financial statements-see Item 8
(b) Exhibits:
EXHIBIT INDEX
Exhibit No. Description Page
- ----------- ----------- ----
3.1 Certificate of Incorporation and amendments thereto (1) --
3.2 By-Laws (2) --
4 Preferred Stock, Common Stock, and Options and
Warrants and other Instruments defining rights of security
holders, including indentures (3) EX-4
10 Synergy Brands Inc. 1994 Services and Consulting Compensation
Plan, as amended (4)
14 Code of Ethics EX-14
21 Listing of Company Subsidiaries EX-21
23.1 Consent of Holtz Rubenstein Reminick LLP EX-23.1
23.2 Consent of Grant Thornton LLP EX-23.2
32.1 Certification Pursuant to 18 U.S.C. Section 1350. As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by the Chief Executive Officer. EX-32.1
32.2 Certification Pursuant to 18 U.S.C. Section 1350. As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by the Chief Financial Officer. EX-32.2
99 Listing of Company Intellectual Properties EX-99
(1) A copy of the Amendment to the Certificate of Incorporation dated
September 14, 2004 and Certificates of Correction (3) filed February
25, 2005 are included as exhibits by incorporation by reference to the
10K/A report filed for the Company for the year ended 12/31/04. A copy
of the Restated Certificate of Incorporation filed November 10, 2003
and the clarification amendment to the Certificate of Incorporation
filed March 2004 are incorporated by reference to the 10KSB filed for
the Company for the year ended 12/31/03. The amendments to Certificate
of Incorporation filed 7/29/96 and filed 6/24/98 and Certificate of
Designation regarding Preferred Stock filed 6/24/98, are incorporated
by reference to the exhibits filed to the Form 10K/A of the Company
filed 9/3/98. The amendment to the Certificate of Incorporation filed
July 2000 is incorporated by reference to the exhibits filed to the
form 10KSB/A of the Company filed 8/9/01. The amendment to the
Certificate of Incorporation filed April 1, 2001 is incorporated by
reference to the exhibits filed to the Form 10-KSB of the Company filed
March 2002. The amendment to the Certificate of Incorporation filed
February 11, 2003 and the Certificate of Designation regarding
Preferred Stock filed March 13, 2003 are incorporated by reference to
the 10KSB filed for the Company for the year ended 12/31/02. The
original Certificate of Incorporation and other amendments thereto are
incorporated by reference to the exhibits filed to the registration
statement of the Company on Form S-1 (File No. 33-83226) filed by the
Company with the Commission on August 24, 1994.
(2) The amendment to the By-Laws approved by the Company's Board of
Directors on March 7, 1997 are incorporated by reference to the
exhibits filed to the Form 10K/A of the Company filed 9/3/98. The
original By-Laws are incorporated by reference to the exhibits filed to
the registration statement of the Company on Form S-1 (File No.
33-83226) filed by the Company with the Commission on August 24, 1994
47
(3) Description of rights of Preferred Stock are included in the Restated
Certificate of Incorporation filed November 10, 2003 and Clarification
Amendment to the Certificate of Incorporation filed March , 2004 and in
the Certificate of Designation filed 3/13/03 all incorporated by
reference herein (See footnote (1)), and in the Certificate of
Designation regarding Preferred Stock, as amended, and included as
exhibit to the Form 10K/A of the Company filed 9/3/98 as well as the
amendment to the certificate of incorporation filed in July 2000 and
included as an exhibit to the Form 10KSB/A of the Company filed 8/9/01
which latter documents are incorporated by reference herein.
Description of the Company's Common Stock is incorporated by reference
to the description contained in the Company's Registration Statement on
Form 8-A (File No. 0-19409) filed with the Commission pursuant to
Section 12(b) of the Exchange Act on July 16, 1991, including any
amendments or reports filed for the purpose of updating such
description. A facsimile of outstanding warrants is included by
reference to the similar exhibit in the Company's Form 10-K/A for the
fiscal year ended December 31, 2004. Information and particulars on
long term debt instruments outstanding shall be supplied if and as
requested by the Commission as allowed by applicable regulation as on
none of such debt instruments on an individual basis does the total
amount of securities authorized thereunder exceed 10% of the Company's
total assets. Such instruments include $2,925,000 debt remaining as
currently owed to Laurus Master Fund, Ltd. arising from Secured
Convertible Term Notes dated April 2, 2004, January 25, 2005, June 21,
2005 and March 13, 2006 and $490,000 in total long term debt to three
non-affiliated parties by Secured Promissory Notes dated March 1, 2004.
(4) Incorporated by reference to the Registration Statement of the Company
on Form S-8 (File No. 333-92243) filed with the Commission on 12/17/99,
as amended
(c) Financial Statement Schedules
None
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Synergy Brands Inc.
by /s/ Mair Faibish
--------------------------------
Mair Faibish
Chairman of the Board
Dated: April 12, 2006
Pursuant to the requirements of 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.
by /s/ Mair Faibish
----------------------------------
Mair Faibish
Chairman of the Board
Dated: April 12, 2006
by /s/ Mitchell Gerstein
----------------------------------
Mitchell Gerstein
Chief Financial Officer
Dated: April 12, 2006
by /s/ Joel Sebastian
-----------------------------------
Joel Sebastian, Director
Dated: April 12, 2006
by /s/ Lloyd Miller
-----------------------------------
Lloyd Miller, Director
Dated: April 12, 2006
by /s/ William Rancic
-----------------------------------
William Rancic, Director
Dated: April 12, 2006
by /s/ Frank A. Bellis Jr.
-----------------------------------
Frank A. Bellis, Director
Dated: April 12, 2006
by /s/ Randall J. Perry
-----------------------------------
Randall J. Perry, Director
49
Certification
I, Mair Faibish, certify that:
1. I have reviewed this annual report on Form 10-K of Synergy Brands, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:
(a) designed such disclosure controls and procedures or caused such disclosure
controls and procedures to be designed under our supervision to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures as of the end of the period covered by
this report based on such evaluation; and
(c) disclosed in this annual report any changes in the registrant's internal
control over financial reporting that occured during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarer in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors
(a) all significant deficiencies and material weaknesses we find in the design
or operation of internal controls over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls over
financial reporting; and
Date: April 12, 2006
/s/ Mair Faibish
- ----------------
Mair Faibish
Chief Executive Officer
50
Certification
I, Mitchell Gerstein, certify that:
1. I have reviewed this annual report on Form 10-K of Synergy Brands, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15 (e) and 15d-15(e)) for the registrant and we have:
(a) designed such disclosure controls and procedures or caused such disclosure
controls and procedures to be designed under our supervision to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures as of the end of the period covered by
this report based on such evaluation; and
(c) disclosed in this annual report any changes in the registrant's internal
control over financial reporting that occured during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarer in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors
(a) all significant deficiencies and material weaknesses we find in the design
or operation of internal controls over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information ; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls over
financial reporting; and
Date: April 12, 2006
/s/ Mitchell Gerstein
- ---------------------
Mitchell Gerstein
Chief Financial Officer
51
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Synergy Brands, Inc.
We have audited the accompanying consolidated balance sheets of Synergy Brands,
Inc., as of December 31, 2005 and 2004 and the related consolidated statements
of operations, stockholders' equity and comprehensive loss and cash flows for
the two years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Synergy Brands, Inc.
as of December 31, 2005 and 2004 and the results of its operations and its cash
flows for the two years then ended in conformity with accounting principles
generally accepted in the United States of America.
HOLTZ RUBENSTEIN REMINICK LLP
Melville, New York
March 10, 2006 (except for Note T, as to which the date is March 14, 2006)
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Synergy Brands, Inc.
We have audited the accompanying consolidated statements of operations, changes
in stockholders' equity and comprehensive loss, and cash flows of Synergy
Brands, Inc. and Subsidiaries (the "Company") for the year ended December 31,
2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit 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, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and consolidated
cash flows of Synergy Brands, Inc. and Subsidiaries for the year ended December
31, 2003, in conformity with accounting principles generally accepted in the
United States of America.
/S/GRANT THORNTON LLP
March 5, 2004
New York, New York
F-3
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004
ASSETS
CURRENT ASSETS 2005 2004
------------- ------------
Cash and cash equivalents $ 263,554 $ 945,806
Accounts receivable trade, less allowance for doubtful accounts of
$ 127,481 and $127,481 7,494,324 7,476,444
Other receivables 1,848,369 1,015,287
Notes receivable - current 287,967 314,285
Inventory 1,909,315 1,826,274
Prepaid assets and other current assets 398,426 423,295
------------- ------------
Total Current Assets 12,201,955 12,001,391
PROPERTY AND EQUIPMENT, NET 356,014 366,510
OTHER ASSETS 802,887 632,466
NOTES RECEIVABLE 2,691,439 1,889,815
INTANGIBLE ASSETS, net of accumulated amortization of
$2,518,946 and $2,003,048 786,046 1,301,944
GOODWILL 514,297 514,297
------------- ------------
TOTAL ASSETS $ 17,352,638 $ 16,706,423
============= ============
The accompanying notes are an integral part of these statements.
F-4
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS (Continued)
December 31, 2005 and 2004
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES 2005 2004
----------- -----------
Lines of credit $ 4,033,242 $ 4,976,610
Notes payable - current 1,645,531 384,021
Accounts payable 1,846,736 3,482,456
Related party note payable 61,882 56,972
Accrued expenses 36,855 37,066
Deferred income 127,000 -
----------- -----------
Total Current Liabilities 7,751,246 8,937,125
NOTES PAYABLE 2,668,691 1,196,241
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Class A preferred stock - $.001 par value; 100,000 shares authorized
and outstanding; liquidation preference of $10.50 per share 100 100
Class B preferred stock - $.001 par value; 150,000 shares authorized, none issued - -
Class B Series A Preferred stock-$.001 par value; 500,000 shares authorized;
330,000 shares issued and outstanding; liquidation preference of
$10.00 per share 330 330
Class B Series B Preferred stock-$.001 par value, 250,000 shares authorized;
80,000 and 0 shares issued and outstanding; liquidation preference of
$10.00 per share 80 -
Common stock - $.001 par value; 5,000,000 shares authorized;
4,457,530 and 3,263,992 shares issued 4,458 3,264
Additional paid-in capital 45,918,817 43,134,165
Deficit (38,910,484) (36,349,706)
Unearned Compensation (67,260) (201,756)
Accumulated other comprehensive loss (8,340) (8,340)
----------- -----------
6,937,701 6,578,057
Less treasury stock, at cost, 1,000 shares (5,000) (5,000)
----------- -----------
Total Stockholders' Equity 6,932,701 6,573,057
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,352,638 $ 16,706,423
=========== ===========
The accompanying notes are an integral part of these statements.
F-5
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
2005 2004 2003
----------- ------------- -----------
Net sales $64,137,090 $ 56,705,044 $40,540,577
----------- ------------- -----------
Cost of sales
Cost of product 59,270,788 51,907,840 36,837,796
Shipping and handling costs 1,038,923 900,205 893,582
----------- ------------- -----------
60,309,711 52,808,045 37,731,378
----------- ------------- -----------
Gross profit 3,827,379 3,896,999 2,809,199
Operating expenses
Advertising and promotional 63,155 150,181 91,634
General and administrative 3,992,405 3,605,433 2,984,663
Depreciation and amortization 497,965 659,490 692,698
Asset impairment charge 293,586 - -
----------- ------------- -----------
4,847,111 4,415,104 3,768,995
----------- ------------- -----------
Operating loss (1,019,732) (518,105) (959,796)
Other income (expense)
Interest income 102,644 4,610 13,913
Other income (expense) (21,504) (46,983) 298,932
Equity in earnings of investee 56,311 172,224 92,424
Interest and financing expenses (1,593,639) (1,553,521) (690,038)
----------- ------------- -----------
(1,456,188) (1,423,670) (284,769)
----------- ------------- -----------
Loss before income taxes (2,475,920) (1,941,775) (1,244,565)
Income tax expense 84,858 34,604 32,658
----------- ------------- -----------
Net loss (2,560,778) (1,976,379) (1,277,223)
Dividend-Preferred Stock (317,333) (156,375) (78,000)
----------- ------------- -----------
Net loss attributable to common stockholders $ (2,878,111) $ (2,132,754) $ (1,355,223)
=========== ============= ===========
Basic and diluted net loss per common share: $ (0.75) $(0.97) $(0.82)
=========== ============= ===========
Weighted-average shares used in the computation of
loss per common share:
Basic and diluted 3,820,061 2,209,371 1,652,019
=========== ============= ===========
The accompanying notes are an integral part of these statement
F-6
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
Years ended December 31, 2005, 2004 and 2003
Class A Class B-Series A Class B- Series B Additional
Preferred Stock Preferred Stock Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Shares Amount Shares Amount Capital
Balance at January 1, 2003 100,000 $100 - - - - 1,368,121 $1,368 $35,210,686
Common sock and options issued
In connection with compensation
plan 93,438 93 212,133
Common stock issued 30,000 30 47,170
Net proceeds from issuance of
common stock in
Connection with private placement 160,000 160 160,000 160 1,509,680
Issuance of common stock in
satisfaction of note payable 15,300 15 39,985
Issuance of restricted stock in
Connection with notes payable 42,500 43 97,957
Issuance of common stock for service 185,000 185 493,315
Issuance of common stock in
connection with CAW acquisition 25,000 25 99,975
Purchase of Treasury stock
Sale of treasury stock
Preferred stock dividend 115,103
Consulting expense (78,000)
Change in unrealized gain on
Marketable securities
Cumulative translation adjustments
Net loss
Comprehensive loss
-------- ---- ------- ----- ----- ---- ---------- ------ -----------
Balance at December 31, 2003 100,000 $100 160,000 $160 - - 1,919,359 $1,919 $37,748,004
-------- ---- ------- ----- ----- ---- ---------- ------ -----------
Amortization of unearned compensation
Common stock returned and retired (61,500) (61) 61
Common stock issued
Net proceeds from issuance of 100,000 100 470,685
Issuance of common stock in
common stock in
Connection with private placement 170,000 170 255,000 255 1,454,575
Issuance of common stock for note
conversion 688,338 688 2,733,957
Exercise of stock options 110,000 110 102,140
Issuance of common stock for services 58,195 58 190,563
Issuance of common stock in
connection with CAW acquisitions 175,000 175 524,825
Issuance of common stock along 19,600 20 74,980
with debt
Option Expense 30,750
Preferred stock dividend (156,375)
Consulting expense (40,000)
Change in unrealized gain on
Marketable securities
Cumulative translation adjustments
Net loss
Comprehensive loss
-------- ---- ------- ----- ----- ---- ---------- ------ -----------
Balance at December 31, 2004 100,000 $100 330,000 $330 - - 3,263,992 $3,264 $43,134,165
-------- ---- ------- ----- ----- ---- ---------- ------ -----------
F-7
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
Years ended December 31, 2005, 2004 and 2003
Continued
Accumulated
Other Stockholders
Comprehensive Treasury Unearned Notes
Deficit Income (loss) Stock Compensation Receivable
Balance at January 1, 2003 $(33,096,104) $(74) $(28,439) - $(5,000)
Common sock and options issued
In connection with compensation
plan 5,000
Common stock issued
Net proceeds from issuance of
common stock in
Connection with private placement
Issuance of common stock in
satisfaction of note payable
Issuance of restricted stock in
Connection with notes payable
Issuance of common stock for service (493,500)
Issuance of common stock in
connection with CAW acquisition
Purchase of Treasury stock (122,779)
Sale of treasury stock 146,218
Preferred stock dividend
Consulting expense
Change in unrealized gain on 67,248
Marketable securities 4,003
Cumulative translation adjustments (5,701)
Net loss (1,277,223)
Comprehensive loss
-------------- --------- ---------- ---------- ------
Balance at December 31, 2003 $(34,373,327) $(1,772) $(5,000) $(426,252) -
-------------- --------- ---------- ---------- ------
Amortization of unearned compensation 224,496
Common stock returned and retired
Common stock issued
Net proceeds from issuance of
Issuance of common stock in
common stock in
Connection with private placement
Issuance of common stock for note
conversion
Exercise of stock options
Issuance of common stock for services
Issuance of common stock in
connection with CAW acquisitions
Issuance of common stock along
with debt
Option Expense
Preferred stock dividend
Consulting expense
Change in unrealized gain on
Marketable securities (4,105)
Cumulative translation adjustments (2,463)
Net loss (1,976,379)
Comprehensive loss
-------------- --------- ---------- ---------- ------
Balance at December 31, 2004 $(36,349,706) $(8,340) $(5,000) $(201,756) -
F-7
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2005, 2004 and 2003
Class A Class B-Series A Class B- Series B Additional
Preferred Stock Preferred Stock Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Shares Amount Shares Amount Capital
Amortization of unearned compensation
Common stock issued 220,000 220 330,705
Net proceeds from issuance of
common stock in connection
with private placement 80,000 80 202,500 203 798,608
Issuance of common stock for
note conversion 672,074 673 1,750,746
Issuance of common stock for
services 98,964 98 203,926
Preferred stock dividend (317,333)
Issuance of stock warrants 18,000
Net loss
--------- ----- -------- ----- -------- ---- -------- ------ -----------
Balance at December 31, 2005 100,000 $100 330,000 $330 80,000 $80 4,457,530 $4,458 45,918,817
--------- ----- -------- ----- -------- ---- -------- ------ -----------
F-8
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2005, 2004 and 2003
continued
Accumulated
Other Stockholders
Comprehensive Treasury Unearned Notes
Deficit Income (loss) Stock Compensation Receivable
Amortization of unearned compensation 134,496
Common stock issued
Net proceeds from issuance of
common stock in connection
with private placement
Issuance of common stock for
note conversion
Issuance of common stock for
services
Preferred stock dividend
Issuance of stock warrants
Net loss (2,560,778)
------------- --------- ---------- ----------- ----------
Balance at December 31, 2005 ($38,910,484) $(8,340) $ (5,000) $ (67,260) -
------------- --------- ---------- ----------- ----------
F-8
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2005, 2004 and 2003
Total
stockholder's Comprehensive
equity loss
-------------- -------------
Balance at January 1, 2003 $ 2,082,537
Common stock and options issued
in connection with compensation plan 217,226
Common stock issued 47,200
Net proceeds from issuance of common stock in
Connection with private placement 1,510,000
Issuance of common stock in satisfaction of note payable 40,000
Issuance of restricted stock in
Connection with notes payable 98,000
Issuance of common stock for services
Issuance of common stock in connection with CAW
acquisition 100,000
Purchase of treasury stock (122,779)
Sale of treasury stock 261,321
Preferred Stock Dividend (78,000)
Consulting expense 67,248
Change in unrealized gain on
Marketable securities 4,003 4,003
Cumulative translation adjustments (5,701) (5,701)
Net loss (1,277,223) (1,277,223)
-------------- -------------
Comprehensive loss ($1,278,921)
=============
Balance at December 31, 2003 $2,943,832
==============
Amortization of unearned compensation 224,496
Common stock returned and retired -
Common stock issued 470,785
Net proceeds from issuance of
common stock in
connection with private placement 1,455,000
Issuance of common stock for note 2,734,645
conversions
Exercise of stock options 102,250
Issuance of common stock for services 190,621
Issuance of common stock in
connection with CAW acquisitions 525,000
Issuance of common stock along
with debt 75,000
Option Expense 30,750
Preferred stock dividend (156,375)
Consulting expense (40,000)
Change in unrealized gain on
Marketable securities (4,105) $ (4,105)
Cumulative translation adjustments (2,463) (2,463)
Net loss (1,976,379) (1,976,379)
-------------- -------------
Comprehensive loss ($1,982,947)
=============
Balance at December 31, 2004 $6,573,057
==============
F-9
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2005, 2004 and 2003
Comprehensive
loss
-------------
Amortization of unearned compensation 134,496
Common stock issued 330,925
Net proceeds from issuance of
common stock in
connection with private placement 798,891
Issuance of common stock for note
conversions 1,751,419
Issuance of common stock for services 204,024
Preferred stock dividend (317,333)
Issuance of stock warrants 18,000
Net loss (2,560,778) (2,560,778)
----------- ------------
Comprehensive loss $(2,560,778)
============
Balance at December 31, 2005 $6,932,701
==========
The accompanying notes are an integral part of these statements.
F-10
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
2005 2004 2003
------------ ------------ -------------
Cash flows from operating activities
Net loss $ (2,560,778) $ (1,976,379) $ (1,277,223)
Adjustments to reconcile net loss to net cash
used in operating activities
Loss on sale of accounts receivable - 79,134 -
Depreciation and amortization 497,965 659,490 625,450
Asset impairment charge 293,586 - -
(Recovery of)/Provision for doubtful accounts - - (35,090)
Amortization of financing cost 63,283 90,746 82,142
Loss (gain) on sale of marketable securities - 15,793 (10,828)
Equity in earnings of investee (56,311) (172,224) (92,424)
Gain on settlement of liabilities due to vendors - - (282,750)
Non-cash compensation - 30,750 67,248
Operating expenses paid with common stock and warrants
104,025 154,620 100,725
Changes in operating assets and liabilities
Net (increase) decrease in
Accounts receivable and other receivables (850,962) (6,466,339) (2,095,518)
Inventory (83,041) 337,842 (1,089,208)
Prepaid expenses, related party note receivable and
other assets 171,759 (66,011) (122,354)
Net increase (decrease) in
Accounts payable, related party note payable,
accrued expenses and other current liabilities (1,631,021) 329,523 1,231,455
------------ ------------ -------------
Net cash used in operating activities (4,051,495) (6,983,055) (2,898,375)
============ ============ =============
Cash flows from investing activities
Payment of security deposit (17,172) (35,848) -
Purchase of business, net of cash acquired - - (414,000)
Purchase of marketable securities - (168,377) (488,868)
Proceeds from sale of marketable securities - 194,515 460,060
Purchase of property and equipment (72,329) (112,058) (28,638)
Payment of collateral security deposit - - (500,000)
Refund of collateral security deposit - 500,000 -
Payments received on notes receivable 284,894 433,033 2,267
Issuance of notes receivable (1,015,200) - (329,000)
Investee dividend received 28,800 - -
------------ ------------ -------------
Net cash (used in) provided by investing activities (791,007) 811,265 (1,298,179)
------------ ------------ -------------
F-11
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended December 31,
2005 2004 2003
------------ ------------ -------------
Cash flows from financing activities
Borrowings under line of credit 37,488,600 35,608,070 $19,432,524
Repayments under line of credit (37,428,968) (33,024,140) (17,172,964)
Increase in deferred financing cost (57,070) - (18,750)
Proceeds from the issuance of notes payable 3,659,095 1,990,000 850,000
Repayments of notes payable (240,000) (100,000) (20,000)
Proceeds from issuance of common stock 285,926 462,732 47,200
Net proceeds from the issuance of common and preferred stock in
a private placement 770,000 1,460,000 1,510,000
Proceeds from the exercise of stock purchase options - 102,250 111,500
Proceeds from the sale of treasury stock - - 261,321
Proceeds from stock subscription - - 5,000
Purchase of treasury stock - - (122,779)
Payment of dividends (317,333) (156,375) (78,000)
------------ ------------ -------------
Net cash provided by financing activities 4,160,250 6,342,537 4,805,052
------------ ------------ -------------
Foreign currency translation - (2,463) (5,700)
------------ ------------ -------------
Net (Decrease) Increase In Cash (682,252) 168,284 602,798
------------ ------------ -------------
Cash and cash equivalents, beginning of year 945,806 777,522 174,724
------------ ------------ -------------
Cash and cash equivalents, end of year $ 263,554 $ 945,806 $ 777,522
============ ============ =============
Supplemental disclosures of cash flow information:
Cash paid during the year for
Interest $ 972,830 $ 1,317,151 $ 590,126
============ ============ =============
Income taxes paid $ 84,858 $ 34,604 $ 32,658
============ ============ =============
Supplemental disclosures of non-cash, investing
and financing activities:
Common stock issued for acquisition $ - $ 244,068 $ 100,000
============ ============ =============
Unrealized gains on marketable securities $ - $ - $ 4,105
============ ============ =============
Common stock issued in satisfaction of note payable $ - $ - $ 40,000
============ ============ =============
Common stock issued in connection with consulting agreement
and services $ - $ - $ 493,500
============ ============ =============
Common stock issued for note conversions $1,764,354 $ 2,734,646 $ -
============ ============ =============
The accompanying notes are an integral part of these statements.
F-12
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2005, 2004 and 2003
NOTE A - DESCRIPTION OF THE BUSINESS
Synergy Brands, Inc. and its subsidiaries (collectively, "Synergy" or the
'Company") is engaged in the distribution of a variety of products, including
health and beauty aids and premium handmade cigars, directly to consumers
(business to consumer) and to businesses (business to business). In addition,
the Company develops and operates Internet platform operations and
Internet-based businesses designed to sell these products. Synergy was
incorporated on September 26, 1988 in the state of Delaware.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies applied in the preparation of
the accompanying consolidated financial statements is as follows:
1. Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Synergy, its wholly-owned subsidiaries and majority-owned subsidiary
(collectively, the "Company"). All significant intercompany accounts and
transactions have been eliminated in consolidation. The equity method of
accounting is used for investments in 50% or less owned companies over which the
Company has the ability to exercise significant influence.
2. Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity, at the
purchase date, of three months or less to be cash equivalents.
F-13
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
3. Marketable Securities
The Company determines the appropriate classification of securities at the time
of purchase and reassesses the appropriateness of the classification at each
reporting date. All marketable securities held by the Company have been
classified as available-for-sale and, as a result, are stated at fair value.
Unrealized gains and losses on available-for-sale securities are recorded as a
separate component of stockholders' equity. Realized gains and losses on the
sale of securities, as determined on a specific identification basis, are
included in the consolidated statements of operations. At December 31, 2005 and
2004, the Company had no marketable securities.
4. Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management of the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expense during the reporting
period. The most significant estimates relate to reserves for accounts
receivable, inventories, and deferred tax assets, and valuation of long-lived
assets. Actual results could differ from those estimates.
5. Accounts Receivable Trade
The Company's accounts receivable trade are due from businesses engaged in the
distribution of grocery, health and beauty products as well as from consumers
who purchase health and beauty products and premium handmade cigars either
direct or from the Company's Web sites. Credit is extended based on evaluation
of a customers' financial condition and, generally, collateral is not required.
Accounts receivable are due within 10 - 60 days and are stated at amounts
generally due from customers net of an allowance for doubtful accounts. Accounts
outstanding longer than the contractual payment terms are considered past due.
Estimates are used in determining the allowance for doubtful accounts based on
the Company's historical collections experience, current trends, credit policy
and a percentage of its accounts receivable by aging category. In determining
these percentages, the Company looks at historical write-offs of itsreceivables.
The Company also looks at the credit quality of its customer base as well as
changes in its credit policies. The Company continuously monitors collections
and payments from its customers. The Company writes off accounts receivable when
they become uncollectible, and payments subsequently received on such
receivables are credited to the allowance for doubtful accounts.
F-14
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
Accounts receivable trade, net consist of the following components at December
31, 2005 and 2004:
2005 2004
---------- -----------
Accounts receivable - business to business $7,500,269 $7,467,321
Accounts receivable - business to consumer 121,536 136,604
---------- -----------
Total $7,621,805 7,603,925
Less allowance for doubtful accounts (127,481) (127,481)
---------- ----------
$7,494,324 $7,476,444
========== ==========
Changes in the Company's allowance for doubtful accounts during the years ended
December 31, 2005 and 2004 are as follows:
2005 2004
--------- --------
Beginning balance $ 127,481 $127,481
Provision for (reduction in) doubtful account - -
--------- --------
Ending balance $ 127,481 $127,481
========= ========
6. Business and Credit Concentrations
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and cash equivalents, and accounts
receivable. The Company places its cash and cash equivalents with financial
institutions it believes to be of high credit quality. Cash balances in excess
of Federally insured limits at December 31, 2004 totaled $756,150.
During the year ended December 31, 2005, sales to two customers accounted for
12% and 10% of total sales, respectively. Four customers accounted for 22%, 20%,
15% and 12%, respectively of accounts receivable at December 31, 2005. These
concentrations relate to the Company's PHS Group segment.
During the year ended December 31, 2004, sales to two customers accounted for
21% and 18% of total sales, and in 2003 sales to two customers each, accounted
for 11% of total sales, respectively. Four customers accounted for 26%, 26%, 22%
and 11%, respectively of accounts receivable at December 31, 2004. These
concentrations relate to the Company's PHS Group segment.
During the years ended December 31, 2005, 2004 and 2003, the Company purchased
approximately 40 %, 53% and 71%, respectively, of its products from one
supplier. If the Company were unable to maintain this relationship, it might
have a material impact on future operations.
F-15
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
7. Inventory
Inventory is stated at the lower of cost or market. The Company uses the
first-in, first-out ("FIFO") cost method of valuing its inventory.
8. Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is computed using the straight-line method over the asset's estimated
useful lives, ranging from 3 to 10 years. Leasehold improvements are amortized
over the shorter of their estimated useful lives or the lease term.
Maintenance and repairs of a routine nature are charged to operations as
incurred. Betterments and major renewals that substantially extend the useful
life of an existing asset are capitalized and depreciated over the asset's
estimated useful life.
9. Web Site Development Costs
Capitalized website cost are amortized using the straight-line method over the
estimated useful lives of the Web sites, not to exceed three years.
10. Vendor Allowances
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
the application of EITF No. 02-16 "Accounting by a Customer" (including a
reseller) for Certain Consideration Received from a Vendor. EITF No. 02-16
addresses how a reseller of vendor products should account for cash
consideration recorded from a vendor. The Company adopted EITF No. 02-16 and
recognizes vendor allowances, at the date goods are purchased and recorded under
fixed and determined arrangements. The Company receives allowances and credits
from suppliers for volume incentives, promotional allowances and, to a lesser
extent, new product introductions which are typically based on contractual
arrangements covering a period of one year or less. Volume incentives and
promotional allowances earned based on quantities purchased and new product
allowances are recognized as a reduction to the cost of purchased inventory and
recognized when the related inventory is sold. Promotional allowances that are
based on the sell-through of products are recognized as a reduction of cost of
sales when the products are sold for which the promotional allowances are given.
For the years ended December 31, 2005 and 2004, the Company recognized
approximately $ 2,196,955 and $913,000 in vendor allowances arising from
arrangements with a major supplier that met the criteria for being fixed and
determinable. Vendor allowances from manufacturers, included in other
receivables in the accompanying consolidated balance sheet aggregated $1,730,806
and $1,015,287 at December 31, 2005 and 2004.
F-16
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
11. Intangible Assets and Goodwill
Intangible assets include of the "Proset" and "Gran Reserve" trade names and
customer lists acquired in November 1999 and certain customer lists, the rights
to the use of the trade name "Fineperfume.com" and the ownership of the internet
domain www.fineperfume.com acquired for aggregate consideration of $250,000 in
February 2002. The Company re-evaluates the carrying value of these intangible
assets when factors indicating impairment are present, using an undiscounted
operating cash flow assumption.
On June 1, 2003, the Company acquired the common stock of Ranley Group, Inc.
(d.b.a. Cigars Around the World ("CAW") of Chicago, Illinois). Intangible assets
acquired, which consist primarily of customer lists, are being amortized over an
eleven (11) year estimated useful life from the date of acquisition. (see Note
C)
Goodwill is the excess of cost of an acquired entity over the amounts assigned
to assets and liabilities assumed in business combination. Effective January 1,
2002, with the adoption of SFAS No.142 "Goodwill and other Intangible Assets",
that have an indefinite life are not amortized.
Prior to the adoption of Statement of Financial Accounting Standards No. 142
("SFAS No. 142"), "Goodwill and Other Intangible Assets," these intangible
assets other than Goodwill were amortized over their estimated useful life of
five years. As a result of the adoption of SFAS No. 142 in 2002, intangible
assets with indefinite useful lives are no longer be amortized but instead are
being reviewed for impairment when impairment indicators are present. As a
result, the Company's trade names will no longer be amortized. The Company's
customer lists have finite lives. Management considered various factors,
including appraisals, in determining that a revision to the estimated useful
life of the Company's customer lists should be made. Based upon the analysis, it
was determined in 2003 that the estimated useful life should be extended
prospectively, by a term of six years from the original useful life of five
years. As a result, the remaining carrying amount will be amortized
prospectively over the remaining useful life. In 2005, 2004, and 2003 the
amortization expense recorded for the years were $222,312, $222,312 and
$192,354. During the fourth quarter of fiscal 2005, the Company determined that,
based on estimated future cash flows, the carrying amount of the Proset customer
list exceeded its fair value by $293,586; accordingly, an impairment loss of
that amount was recognized.
At December 31, 2005 and 2004, intangible assets are comprised of the following:
Amortized intangible assets 2005 2004
------------- --------------
Customer lists $ 3,214,592 $ 3,214,592
Less accumulated amortization (2,225,360) (2,003,048)
Less impairment writedown ( 293,586) -
------------- --------------
695,646 1,211,544
Unamortized intangible assets
Trade names 90,400 90,400
------------ -------------
Total $786,046 $ 1,301,944
============ =============
Amortization expense for the Company over the next four years is estimated to be
approximately $160,000 per year. Amortization expense for 2010 is estimated to
be $50,000.
F-17
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
12. Long-lived Assets
Long-lived assets and intangible assets are reviewed for impairment whenever
events or changes in circumstances indicate the carrying value may not be
recoverable. Impairment is measured by comparing the carrying value of the
long-lived assets to the estimated undiscounted future cash flows expected to
result from use of the assets and their ultimate disposition. To the extent
impairment has occurred, the carrying amount of the asset would be written down
to an amount to reflect the fair value of the asset.
13. Revenue Recognition
The Company recognizes revenue upon shipment of goods when title and risk of
loss passes to the customer. Net sales include gross revenue from product sales
and related shipping fees, net of discounts and provision for sales returns, and
other allowances. Cost of sales consists primarily of costs of products sold to
customers, including outbound and inbound shipping costs.
14. Advertising
The Company expenses advertising and promotional costs as incurred. Advertising
and promotional expenses were approximately $ 63,000, $ 150,000 and $91,000 for
the years ended December 31, 2005, 2004 and 2003.
15. Income Taxes
Deferred income taxes are recognized for temporary differences between financial
statement and income tax bases of assets and liabilities and net operating loss
carry forwards for which income tax expenses or benefits are expected to be
realized in future years. A valuation allowance is established if it is more
likely than not that all, or some portion, of deferred tax assets will not be
realized.
16. Basic and Diluted Loss Per Share
Basic and diluted loss per share is calculated by dividing the net loss by the
weighted-average number of common shares outstanding during each period.
Incremental shares from assumed
F-18
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
exercises of stock options and warrants of 580,416, 681,650 and 596,650 for the
years ended December 31, 2005, 2004 and 2003, respectively, have been excluded
from the calculation of diluted loss per share since their effect would be
antidilutive.
17. Stock-Based Compensation Plans
At December 31, 2005, the Company has two stock-based employee compensation
plans, which are described more fully in Note L. The Company accounts for
stock-based compensation to employees and directors using the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations ("APB
No. 25") and has adopted the disclosure provisions of SFAS No. 148. Effective
January 1, 2006, the provisions of SFAS No. 123(R) will be implemented to
account for stock-base compensation. Under APB No. 25, when the exercise price
of the Company's employee or director stock options equals the market price of
the underlying stock on the date of grant, no compensation expense is
recognized.
The following table illustrates the effect on net income (loss) and earnings
(loss) per share had the Company applied the fair value recognition provisions
of Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
Year ended December 31,
2005 2004 2003
-------------- ----------- ------------
$ (2,560,778) $(1,976,379) $(1,277,223)
Net loss, as reported
Add: Total stock-based employee
compensation expense included
in reported net loss
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method for all
awards $ (27,184) _ -
-------------- ----------- ------------
Pro forma net loss $ (2,587,962) $(1,976,379) $(1,277,223)
============== =========== ============
Loss per share attributable to common shareholders
Basic and diluted - as reported $ ( 0.75) $(0.97) $(0.82)
============== =========== ============
Basic and diluted - pro forma $ ( 0.76) $(0.97) $(0.82)
============== =========== ============
F-19
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (continued)
Pro forma compensation expense may not be indicative of pro forma expense in
future years. For purposes of estimating the fair value of each option on the
date of grant, the Company utilized the Black-Scholes option-pricing model.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The weighted-average option fair values and the assumptions used to estimate
these values are as follows:
2005
Dividend yield 0%
Expected volatility 40%
Risk-free rate of return 4.0%
Expected life 1 year
Weighted-average option fair value $2.07
On October 1, 2005 performance stock options to purchase 300,000 shares of
common stock at $2.07 per share were granted to employees. These options will
expire on October 1, 2006. The option is deemed to be vested and granted. There
were no stock options granted in 2004 and 2003.
18. Segment Information
Segment information is presented in accordance with SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." This standard is based
on a management approach, which requires segmentation based upon the Company's
internal organization that is used for making operating decisions and assessing
performance as the source of the Company's reportable operating segments. SFAS
No. 131 also requires disclosures about products and services, geographic areas
and major customers.
F-20
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE B (CONTINUED)
19. Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for Stock-Based
Compensation" ("SFAS No. 123(R)"). SFAS No. 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services. This statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires that the fair value of such equity
instruments be recognized as an expense in the historical financial statements
as services are performed. Prior to SFAS No. 123(R), only certain pro forma
disclosures of fair value were required. The provisions of this statement are
effective as of the beginning of the first interim reporting period for fiscal
years beginning after June 15, 2005. The Company adoption of SFAS No.123(R) will
have an impact on the Company's financial position and results of operations
similar to the pro forma disclosure in note 17B to the financial statements.
In November 2004, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 151 "Inventory Costs." This statement amends Accounting Research
Bulletin No. 43, Chapter 4, "Inventory Pricing" and removes the "so abnormal"
criterion that under certain circumstances could have led to the capitalization
of these items. SFAS No. 151 requires that idle facility expense, excess
spoilage, double freight and re-handling costs be recognized as current-period
charges regardless of whether they meet the criterion of "so abnormal." SFAS 151
also requires that allocation of fixed production overhead expenses to the costs
of conversion be based on the normal capacity of the production facilities. The
provisions of this statement shall be effective for all fiscal years beginning
after June 15, 2005. The Company adoption of SFAS No.151 is not expected to have
a material impact on the Company's financial position or results of operations.
On December 16, 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary
Assets", an amendment of Accounting Principles Board ("APB") Opinion No. 29,
which differed from the International Accounting Standards Board's ("IASB")
method of accounting for exchanges of similar productive assets. Statement No.
153 replaces the exception from fair value measurement in APB No. 29, with a
general exception from fair value measurement for exchanges of non-monetary
assets that do not have commercial substance. The statement is to be applied
prospectively and is effective for non-monetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. The Company adoption of SFAS
No.153 is not expected to have a material impact on the Company's financial
position or result of operations.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3.
"("FAS 154") This Statement requires retrospective application to prior period
financial statements of a voluntary change in accounting principle unless it is
impracticable and is effective for fiscal years beginning after December 15,
2005. Previously, most voluntary changes in accounting principle were recognized
by including in net income of the period of the change the cumulative effect of
changing to the new accounting principle. The Company will comply with the
provisions of FAS 154 although the impact of such adoption is not determinable
at this time.
20. Reclassifications
Certain 2004 balances have been reclassified to conform with 2005
classifications.
F-21
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE C - ACQUISTION
On June 1, 2003, the Company acquired from Bill Rancic("Seller") the common
stock of the Ranley Group, Inc., (d.b.a. Cigars Around the World ("CAW") of
Chicago, Illinois). CAW is a leading supplier of premium hand made cigars to
some of the most prestigious hotels, restaurants, casinos and gold clubs in the
United States. The initial purchase price for the common stock acquired was
$425,000. Additional consideration of up to $450,000, to be paid through the
issuance of Class B, Series A Preferred stock, cash or common stock, is payable
based upon the achievement of certain targeted operating results of CAW. In
December 2003, 25,000 shares of common stock were issued valued at $100,000, the
quoted market price, and recorded as additional Goodwill for the purpose of
satisfying the anticipated consideration due the Seller by March 31, 2004, based
upon the operating results of CAW through December 31, 2003. In February 2004,
the Company issued an additional 25,000 shares in anticipation of satisfying the
initial annual EBTDA requirements. These shares were valued at $100,000, the
quoted market price, and recorded as additional Goodwill. In June 2004, the
Company issued an additional 150,000 shares, of which 88,235 shares were used in
anticipation of satisfying the CAW acquisition and 61,765 shares were issued for
future services to be provided by the Seller. These shares are not forfeitable
or recoverable by the Company in the event the Seller terminates his consulting
position. These shares were valued at $425,000, and recorded as additional
Goodwill of $250,000, and prepaid compensation of $175,000. The prepaid
compensation will be charged to operations over the three-year period of the
consulting arrangement.
The acquisition of CAW has been accounted for as a purchase pursuant to SFAS No.
121, "Business Combinations." The operations of CAW have been included in the
Company's statement of operations since the acquisition date. The following
table summarizes the assets and liabilities acquired from CAW based upon the
Company's allocation of the aggregate purchase price of $875,000, including
contingent consideration.
Cash $ 11,000
Accounts receivable 374,000
Other Assets 9,000
Customer List 361,000
Goodwill 514,000
Accounts Payable (331,000)
Other Current Liabilities (35,000)
Other Long-Term Liabilities (28,000)
------------
$ 875,000
============
The intangible assets acquired consist principally of customer lists, which are
being amortized over a eleven year estimated useful life from the date of
acquisition, and Goodwill. The primary reason for the acquisition of CAW and the
main factor that contributed to a purchase price in excess of the net assets
acquired is that CAW is expected to positively impact the Company's results of
operations, in that CAW is expected to have limited selling, general and
administrative expenses, as such business is a strategic addition to the
Company's current internet operations. CAW distribution is being handled at
Synergy's current cigar distribution facilities in Florida. The Company's cigar
operations are conducted through Gran Reserve Corporation ("GRC"), which is
wholly owned by the Company.
F-22
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005 2004 and 2003
NOTE D - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, marketable securities and
accounts receivable and accounts payable approximates fair value due to the
short-term maturities of the instruments. The carrying amounts of borrowings
under the line of credit agreement and notes receivable and notes payable
approximate their fair values.
NOTE E - MARKETABLE SECURITIES
At December 31, 2005, the Company has no marketable securities. In the past, the
Company accounted for marketable securities as available-for-sale securities. In
accordance with FASB 115, these equity securities were accounted for at fair
market value and any unrealized gains (losses) were treated as an increase or
decrease to equity.
Proceeds from the sale of available-for-sale securities and the resulting net
realized gains included in the determination of net loss for the years ended
December 31, 2004 and 2003 are as follows:
2004 2003
---------- ----------
Available-for-sale securities
Proceeds $194,515 $460,060
Gross realized gains 19,973 27,713
Gross realized losses (35,766) (16,885)
F-23
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE F - INVENTORY
Inventory as of December 31, 2005 and 2004 consisted of the following:
2005 2004
----------- -----------
Grocery, health and beauty products $1,467,861 $1,375,165
Tobacco finished goods 441,454 451,109
----------- -----------
$1,909,315 $1,826,274
=========== ===========
The allowance for slow moving and obsolete inventory approximated $225,000 and
$30,000 at December 31, 2005 and 2004, respectively.
NOTE G - PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2005 and 2004 consisted of the
following:
2005 2004
--------- --------
Office $210,885 $204,610
equipment
Furniture and fixtures 234,196 231,265
Leasehold improvements 586,854 523,731
--------- --------
1,031,935 959,606
Less accumulated depreciation and amortization (675,921) (593,096)
--------- --------
$356,014 $ 366,510
========= ========
Depreciation and amortization expense on property and equipment for the years
ended December 31, 2005, 2004 and 2003 was approximately $83,000, $125,000 and
$123,000, respectively.
F-24
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE H - OTHER ASSETS
Other assets consist of the following at December 31, 2005 and 2004:
2005 2004
----------- ----------
Investment (a) $364,340 $336,828
Investment in warrants (b) 127,000 -
CAW purchase agreement; net of accumulated amortization of $58,332 and
$29,163 87,505 145,837
Deferred financing net of accumulated
amortization of $70,930 and $32,625
Other 154,945 97,875
69,097 51,926
----------- ----------
$ 802,887 $ 632,466
=========== ==========
(a) In December 2001, the Company made an investment in Interline Travel and
Tour. Inc. ("ITT") for approximately 20 % of the outstanding common stock. At
December 31, 2005, the Companies investment in ITT is approximately 22% of the
outstanding common stock. ITT provides cruise and resort hotel packages through
a proprietary reservation system to airline employees and their retirees. The
Company recorded equity in the net earnings of investee of $56,311, $172,224 and
$92,424 during the years ended December 31, 2005, 2004 and 2003, respectively.
(b) In October, 2005 SYBR.com Inc., a wholly owned subsidiary of the Company,
invested $1 million in a Private Placement of Senior Subordinated Debentures
issued by ITT. The investment consists of a five year 8% Note (ITT Note), and
200,000 warrants exercisable into 200,000 common shares of ITT stock at $5.00
per share (ITT Warrants). The Company financed this investment with a $1 million
fully recourse note with a major Shareholder under the same terms and conditions
as the ITT Note and assigned to such shareholder the ITT Warrants. As
consideration for the financing, the Company has retained the benefit to be
derived from 100,000 of the warrants received from ITT (see Note J). In relation
to the ITT warrants, Company has recorded deferred income of $127,000.
F-25
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE H (continued)
Summarized unaudited financial information of this investee as of December 31,
2005, 2004, 2003 and for the years then ended is as follows:
Financial position: 2005 2004
----------- -----------
Current assets $4,229,000 $2,020,000
Property and equipment 735,000 290,000
Other assets 4,720,000 267,000
----------- -----------
Total assets $9,684,000 $2,577,000
=========== ===========
Current liabilities $3,823,000 $1,322,000
Long-term debt 4,983,000 -
Other long-term liabilities - 4,000
----------- -----------
Total liabilities $8,806,000 $1,326,000
=========== ===========
Results of operations: 2005 2004 2003
----------- ----------- ------------
Revenues $14,715,000 $10,883,000 $ 9,602,000
Total expenses (14,528,000) (9,934,000) (8,906,000)
Other income 325,000 111,000 54,000
----------- ----------- ------------
Income before income taxes 512,000 1,069,000 750,000
Income tax expense (211,000) (359,000) (268,000)
----------- ----------- ------------
Net income $ 301,000 $ 701,000 $ 482,000
=========== =========== ============
F-26
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE I - NOTES RECEIVABLE
Through December 31, 2003, the Company provided $429,600 in financing to a
significant customer who is a distributor of the Company's products in Canada
and is expanding its distribution channel. The principle balance of $429,600 was
paid March 31, 2004.
In December 2004, the Company sold accounts receivable attributable to West
Coast Supplies, Inc. for $2,200,000. This promissory note, which is secured by
the accounts receivable, requires monthly payments of principle and interest at
4% for seven years, beginning in January 2005. As a condition for the sale, the
Company is obligated to issue West Coast 50,000 shares of common stock, which
will vest through April 1, 2006. In the event the value of the shares is less
than $200,000 at April 1, 2006, the Company will be obligated to pay the
difference in cash or additional shares. The value of the shares ($200,000) was
treated as a reduction of sales price. The Company does not anticipate selling
selected products to this customer base in the future. Sales of selected
products to this customer base approximated $3,180,000 in 2004. The Company
recorded a loss of $79,134 related to the sale of the accounts receivable to
West Cost Supplies, Inc. The balance of the Note Receivable at December 31, 2005
was $1,923,306.
In October, 2005 SYBR.com Inc., a wholly owned subsidiary of the Company,
invested $1 million in a Private Placement of Senior Subordinated Debentures
issued by ITT. The investment consists of a five year 8% Note (ITT Note), and
200,000 warrants exercisable into 200,000 common shares of ITT stock at $5.00
per share (ITT Warrants). The Company financed this investment with a $1 million
fully recourse note with a major Shareholder under the same terms and conditions
as the ITT Note and assigned to such shareholder the ITT Warrants. As
consideration for the financing, the Company has retained the benefit to be
derived from 100,000 of the warrants received from ITT (see Note J). In relation
to the ITT warrants, Company has recorded deferred income of $127,000.
NOTE J - LINE OF CREDIT AGREEMENT, NOTES PAYABLE AND NOTE PAYABLE TO STOCKHOLDER
In 2002, two of the Company's subsidiaries entered into two revolving loan and
security agreements with the same financial institution (the "Lender"). The
lines of credit, as amended in December 2005, allow for the borrowing of up to
$5,300,000 based on the sum of 85% of the net face amount of eligible accounts
receivable, as defined, plus the lesser of (1) $2,750,000 or (2) eligible
inventory and eligible goods in transit, as defined. As amended, the agreement
extends through December 31, 2006. The Company is seeking to refinance its
secured financing needs through other asset based Lenders. There is no assurance
that the Company will be successful and it may need to continue to incur high
financing costs. Interest accrues on outstanding borrowings at the greater of
(i) 5% per annum in excess of the prime rate or (ii) 10.5% per annum. At
December 31, 2005, the interest rate on outstanding borrowings was 12.25%.
Outstanding borrowings are collateralized by a continuing security interest in
all of the subsidiaries' accounts receivable, chattel paper, inventory,
equipment, instruments, investment property, documents and general intangibles.
In addition, 1,175,000 shares of the Company's common stock have also been
pledged as collateral on the outstanding borrowings. In 2004 the lender
converted $1,621,000 of outstanding debt into 435,182 shares of common stock
(see Note K) and in 2005, the lender converted $1,003,000 of outstanding debt
into 427,532 shares of common stock (see Note K).
F-27
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE J (continued)
On February 5, 2003, the Company received $500,000 pursuant to the issuance of
two secured promissory notes from certain shareholders of ITT, a 22% investee.
Borrowings under the notes bear interest at a rate of 12%. The Company was not
required to repay any principal until the maturity date of the notes, February
4, 2006. 25,000 restricted shares of the Company's common stock were also issued
as part of the financing. The relative estimated fair value of the common stock
that was issued of $56,000 was recorded as debt discount and was amortized over
the life of the notes payable. As security for the notes, the Company pledged as
collateral its investment in the common stock of ITT. (See Note H). In 2004, the
Company converted $263,646 of the debt into 66,756 shares of common stock. In
March 2005, the Company converted the balance of this debt $236,354 into 94,542
shares of common stock. Amortization expense recorded in 2005 and 2004 was
approximately $2,333 and $28,000.
On July 1, 2003, the Company received $350,000 pursuant to the issuance of three
secured promissory notes from certain shareholders of ITT, a 22% investee.
Borrowings under the notes bear interest at a rate of 12%. The Company was not
required to repay any principal until the maturity date of the notes, June 30,
2005. In addition, 17,500 restricted shares of the Company's common stock were
also issued as part of the financing. The relative estimated fair value of the
common stock that was issued of $42,000 was recorded as debt discount and was to
be amortized over the life of the notes payable. In 2004, the Company converted
all of this outstanding debt into 86,400 shares of common stock (see Note K).
Amortization expense recorded in 2004 and 2003 was approximately $31,000 and
$10,000.
On March 1, 2004, the Company received $490,000 pursuant to the issuance of
three secured promissory notes from certain shareholders of ITT, a 22% investee.
Borrowings under the notes bear interest at a rate of 12%. The note was extended
and the Company is not required to repay any principal until the maturity date
of the notes, February 28, 2007. In addition, 19,600 restricted shares of the
Company's common stock were also issued as part of the financing. The relative
estimated fair value of the common stock that was issued of $75,000 was recorded
as debt discount and will be amortized over the life of the notes payable. As
security for the notes, the Company pledged as collateral its investment in the
common stock of ITT (see Note H). Amortization expense recorded in 2005 and 2004
was approximately $37,500 and $31,000. At December 31, 2005 the outstanding
balance was $490,000.
On April 2, 2004 the Company completed a financing with Laurus Master Funds
("Laurus"). The financing consisted of a $1.5 million secured convertible
debenture that converts into common stock under certain conditions at $3.00 per
share as amended, and matures on April 2, 2007. The debenture provides for
monthly payments of $50,000, plus interest commencing October 1, 2004. In
addition, Laurus was issued 100,000 warrants exercisable at $3.00 per share. The
debenture has a three-year term with a coupon rate of prime plus 3%. The Company
has filed an S-3 registration statement, which has been granted effectiveness to
register the common stock underlying the debenture and warrant. In 2004, the
Company converted $500,000 of this outstanding debt into 100,000 shares of
common stock. The Company repaid $100,000 of this debt in 2004. In March 2005,
the Company converted $525,000 of this outstanding debt into 150,000 shares of
common stock. At December 31, 2005, the outstanding balance was $375,000.
On January 25, 2005, the Company completed a financing with Laurus Master Funds
("Laurus"). The financing consisted of a $500,000 secured convertible debenture
that converts into common stock under certain conditions at $3.00 per share and
matures on January 25, 2008. The financing provides Laurus with registration
rights for common shares it is issued under conversion. The debenture provides
for monthly payments of $16,666.67 plus interest, commencing August 1, 2005. The
Company repaid $83,334 of this debt at December 31, 2005. In addition, Laurus
was issued 33,333 warrants exercisable at $3.50 per share. The debenture has a
three-year term with a coupon rate of prime plus 3%. The conversion prices on
the Laurus debentures were always above the current stock price at the closing
date. At December 31, 2005 the outstanding balance was $416,666.
F-28
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE J (continued)
In January 2005, the Company entered into a promissory note with major regional
bank for $1,000,000. Borrowing under the note bears interest at prime (7.25% at
December 31, 2005). This note was extended and the Company is not required to
repay any principal until the maturity date of the note, September 1, 2006. As
security for the note, a pledge agreement was entered by certain Shareholders of
ITT. Borrowings at December 31, 2005 were $995,531.
On April 6, 2005, the Company received $500,000 pursuant to the issuance of
three secured promissory notes from certain shareholders of ITT, a 22% investee.
Borrowings under the notes bear interest at a rate of 9%. The Company is not
required to repay any principal until the maturity date of the notes, April 5,
2007. In addition, 25,000 restricted shares of the Company's common stock were
also issued as part of the financing. The relative estimated fair value of the
common stock that was issued of $54,000 was recorded as debt discount and will
be amortized over the life of the notes payable. As security for the notes, the
Company pledged as collateral its investment in the common stock of ITT (see
Note H). Amortization expense recorded in 2005 was approximately $20,250.
On May 5, 2005, the Company received $100,000 pursuant to the issuance of one
secured promissory note from a certain stockholder of ITT, a 22% investee.
Borrowings under the note bear interest at a rate of 9%. The Company is not
required to repay any principal until the maturity date of the note, May 4,
2007. In addition, 5,000 restricted shares of the Company's common stock were
also issued as part of the financing. The relative estimated fair value of the
common stock that was issued of $9,500 was recorded as debt discount and will be
amortized over the life of the notes payable. As security for the notes, the
Company pledged as collateral its investment in the common stock of ITT (See
Note H). Amortization expense recorded in 2005 was approximately $3,200.
On June 21, 2005, the Company completed a financing with Laurus Master Funds
("Laurus"). The financing consisted of a $500,000 secured convertible debenture
that converts into common stock under certain conditions at $3.00 per share and
matures on June 21, 2008. The financing provides Laurus with registration rights
for common shares it is issued under conversion. The debenture provides for
monthly payments of $16,666.67 plus interest, commencing December 1, 2005. The
Company repaid $16,667 of the debt at December 31, 2005. In addition, Laurus was
issued 33,333 warrants exercisable at $ 3.50 per share. The Company's common
stock quoted market price at the date of closing was $2.15 per share. The
debenture has a three-year term with a coupon rate of prime plus 3%. The Company
recorded a charge of $18,000 as prepaid expense for the fair value of the
warrants, and this amount will be amortized over the life of the note. At
December 31, 2005 the outstanding balance was $483,333.
In October, 2005 SYBR.com Inc., a wholly owned subsidiary of the Company,
received $1 million, pursuant to the issuance of one senior secured promissory
note from a certain stockholder. Borrowings under the note bearing interest at
8%, and the note is due October 7, 2010. The Company has secured this borrowing
with a $1 million wholly recourse note from ITT (see Note I).
Aggregate maturities of notes payable at December 31, 2005 are as follows:
Year Ending December 31,
2006 $ 1,645,531
2007 $ 1,568,691
2008 $ 100,000
2009 $ -
2010 $ 1,000,000
------------
Total $ 4,314,222
============
NOTE K - STOCKHOLDERS' EQUITY
The Company has 100,000 authorized and outstanding shares of Class A preferred
stock with a par value of $.001; 13-to-1 voting rights; liquidation of $10.50
per share before common stock and redemption at option of Company at $10.50 per
share.
F-29
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE K (continued)
In January 2003, the Company designated 100,000 shares of Class B Preferred
stock, par value $.001 per share to be designated as Class B, Series A Preferred
Stock and in June 2003, the Company increased the authorized Class B, Series A
preferred stock to 500,000 shares. The holders of Class B, Series A Preferred
Stock have no voting rights with respect to general corporate matters. The
holders of Class B, Series A Preferred Stock are entitled to receive dividends
at the annual rate of $.90 per share per annum. The Company may, as its option,
at any time in whole, or from time to time in part, out of earned funds, capital
and surplus of the Corporation, redeem the Class B, Series A Preferred Stock on
any date set by the Board of Directors, at $10.00 per share plus, in each case,
an amount equal to all dividends of Class B, Series A Preferred Stock accrued
and unpaid thereon, pro rata to the date of redemption. If, however, as to each
share of Class B, Series A Preferred Stock outstanding, if not redeemed by the
Company within 2 years of the issuance of such shares, the Company will be
obligated to issue to the then holder of record of such outstanding Class B,
Series A Preferred Stock, half a share of the Company's unissued restricted
Common Stock per share of Class B, Series A Preferred Stock for each year that
said share is not redeemed. The Company issued 30,000 common shares to Class B
Series A Preferred shareholders in January 2005 in compliance with the
subscription agreements dated February 26, 2003 and 50,000 common shares to
Class B Series A Preferred Shareholder in July 2005 in compliance with the
subscription agreements dated July 2, 2003. No more that 19.9% of the Company's
stock can be issued in connection with stock dividend payments against the Class
B, Series A Preferred Stock.
In November 2004, the Board of Directors approved a Private Placement in which
17 units were offered, with each unit consisting of 10,000 shares of
unregistered Class B, Series A Preferred Stock and 15,000 shares of unregistered
restricted Common Stock at a purchase price of $100,000 per unit. In November
2004, the Company sold 17 units and received aggregate proceeds of $1,700,000.
Also in November 2004, the Company exchanged $245,000 compensation due to
William Rancic for two units of Class B Series A Preferred stock at $100,000 per
unit.
In March 2005, the Company designated 250,000 shares of Class B Preferred Stock,
par value $.001 per share to be designated as Class B, Series B Preferred Stock.
On July 22, 2005, the Company completed an $800,000 private placement of
Preferred Stock and Common Stock consisting of 80,000 shares of Series B Class B
Preferred Stock and 88,000 shares of restricted Common Stock. The holders of
Class B Series B Preferred Stock have no voting rights with respect to general
corporate matters. The holders of Class B Series B Preferred Stock are entitled
to receive dividends at the annual rate of $.80 per share per annum. The Company
may, as its option, at any time in whole, or from time to time in part, out of
earned funds of the Corporation, redeem the Class B, Series B Preferred Stock on
any date set by the Board of Directors, at $10.00 per share plus, in each case,
an amount equal to all dividends of Class B, Series B Preferred Stock accrued
and unpaid thereon, pro rata to the date of redemption. If however, as to each
share of Class B, Series B Preferred Stock outstanding, if not redeemed by the
Company within 2 years of the issuance of such shares, the Company will be
obligated to issue to the then holder of record of such outstanding Class B,
Series B Preferred Stock, half a share of the Company's unissued restricted
Common Stock per share of Class B, Series B Preferred Stock for each year that
said share is not redeemed within limits as provided under applicable law.
In 2005, certain shareholders of ITT converted $236,354 of debt into 94,542
shares of common stock and in 2004, certain shareholders of ITT converted
$613,646 of debt into 153,156 shares of common stock. In 2005, Laurus Master
Funds converted $525,000 of debt into 150,000 shares of common stock and in
2004, Laurus Master Funds converted $500,000 of debt into 100,000 shares of
common stock. Also, in 2005, the Company converted $1,003,000 outstanding debt
of IIG into 427,532 shares of common stock and in 2004 the Company converted
$1,621,000 outstanding debt of IIG into 435,182 shares of common stock (see Note
J).
For the years ended December 31, 2005 and 2004, the Company issued 98,964 and
58,195 shares of common stock as compensation for past and future service and
recorded a charge to operations of $104,025 and $154,620.
F-30
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE K (continued)
For the years ended December 31, 2004 and 2003 , the Company received proceeds
of $102,250 and $111,500 from the exercise of stock options to purchase 110,000
and 62,500 shares of the Company's common stock. In connection with such options
of which 15,000 were modified, in 2004 the Company recorded compensation expense
and a credit to additional paid-in capital of $30,750.
The following is a summary of transactions involving warrants to purchase common
stock for the years ended December 31, 2005, 2004 and 2003.
Weighted-
Number average
of shares exercise price
----------- --------------
Outstanding at January 1, 2003 227,500 $ 8.60
Cancelled/Forfeited (17,500) (35.00)
-----------
Outstanding at December 31, 2003 210,000 $ 6.40
Granted 100,000 5.00
-----------
Outstanding at December 31, 2004 310,000 $ 5.95
Granted 66,666 1.00
Cancelled/Forfeited (96,250) (6.75)
----------- --------------
Outstanding at December 31, 2005 280,416 $ 4.38
=========== ==============
The following table summarizes information concerning currently outstanding and
exercisable stock purchase warrants:
Warrants outstanding Warrants exercisable
Weighted-
Number average Weighted- Number Weighted-
outstanding at remaining average exercisable at average
Ranges of December 31, contractual exercise December 31, exercise
exercise prices 2005 life (years) price 2005 price
------------------ --------------- -------------- ---------- ------------- ---------
$1.00-4.00 166,666 6.16 $3.20 166,666 $3.20
$5.00-$12.00 113,750 .09 5.50 113,750 5.50
--------------- -------------- ---------- ------------- ---------
280,416 3.50 $4.38 280,416 $4.38
=============== ============== ========== ============= =========
F-31
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE L - STOCK COMPENSATION PLANS
In 1994, Synergy adopted the 1994 Services and Consulting Compensation Plan (the
"Plan"). Under the Plan, as amended, 8,400,000 shares of common stock have been
reserved for issuance. The Plan terminates with respect to the granting of
common stock and options in 2009. Since the inception of the Plan, Synergy has
issued 1,279,997 shares for payment of services to employees and professional
service providers such as legal, marketing, promotional and investment
consultants. Common stock issued in connection with the Plan was valued at the
fair value of the common stock at the date of issuance or at an amount equal to
the service provider's invoice amount. During the years ended December 31, 2005,
2004 and 2003, the Company issued 98,964, 42,195 and 65,938 shares of its common
stock, respectively, to various service providers and has recorded a charge to
earnings of $104,025, $150,621 and $93,125. Under the Plan, Synergy has granted
options to selected employees and professional service providers. The maximum
term of options granted under the Plan is ten years. There were no options
issued during the years ended December 31, 2005 and 2004.
The following is a summary of such stock option transactions for the years ended
December 31, 2005, 2004 and 2003 in accordance with the Plan and other
restricted stock option agreements:
Weighted
Number average
of shares exercise
price
----------- ------------
Outstanding at January 1, 2003 484,259 $ 10.46
Cancelled/Forfeited (25,109) (9.08)
Granted 85,000 3.53
Exercised (62,500) 1.84
----------- ------------
Outstanding at December 31, 2003 481,650 $ 10.42
Exercised (110,000) (3.68)
----------- ------------
Outstanding at December 31, 2004 371,650 $ 13.10
Granted 300,000 2.07
Cancelled/Forfeited (371,650) (12.15)
----------- ------------
Outstanding at December 31, 2005 300,000 $ 2.07
=========== ============
Shares available for grant
December 31, 2005 7,120,003
=========
December 31, 2004 7,218,967
=========
December 31, 2003 7,261,162
=========
F-32
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE L (continued)
The following table summarizes information concerning currently outstanding and
exercisable stock options:
Options outstanding Options exercisable
Weighted-
Number average Weighted- Number Weighted-
outstanding at remaining average exercisable at average
Ranges of December 31, contractual exercise December 31, exercise
exercise prices 2005 life (years) price 2005 price
$ 1.00 - $ 4.00 300,000 1.0 $2.07 300,000 $2.07
The Company has also reserved 100,000 shares for a stock option plan ("Option
Plan") for nonemployee, independent directors, which entitles each nonemployee,
independent director an option to purchase 10,000 shares of the Company's stock
immediately upon election or re-election to the Board of Directors. Options
granted under the Option Plan will be at the fair market value on the date of
grant, immediately exercisable, and have a term of ten years. The Company had no
options outstanding and exercisable and 84,000 shares available for grant at
December 31, 2005 and 2004.
NOTE M - TRANSACTIONS WITH RELATED PARTIES
The Company paid consulting fees to two entities, one of which is owned by the
Company's Chairman and Chief Executive Officer and the other is owned by the
Company's President and Chief Operating Officer. Consulting fees paid during the
years ended December 31, 2003 aggregated approximately $55,000.
At December 31, 2005 and 2004, $61,882 and $56,972 is payable to the Company's
Chairman and Chief Executive Officer for short-term advances made to the
Company.
F-33
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE N - OTHER INCOME (EXPENSE)
Other income (expense) is comprised of the following:
2005 2004 2003
----------- ------------ ---------
Gain on settlements of liabilities due to vendors $ - $ - $282,750
(Note R-3)
Gain (loss) on sales of marketable securities (Note E) - (15,793) 10,828
Other (21,504) 47,944 5,354
Loss on sale of accounts receivable - (79,134) -
----------- ------------ ---------
$(21,504) $ (46,983) $298,932
========== ============ ==========
NOTE O - INCOME TAXES
At December 31, 2005, the Company had a net operating loss carry forward of
approximately $33,700,000 which, if not utilized, will begin expiring in 2011.
Utilization of these losses may be limited if the Company undergoes an ownership
change pursuant to Internal Revenue Code Section 382. The components of the
deferred tax asset at December 31, 2005 were approximately as follows:
Net operating loss carry forwards 11,514,000
Fixed assets and intangibles 100,000
Allowance for doubtful accounts 43,000
Inventory 109,000
Capital losses 56,000
Other (145,000)
Valuation allowance (11,677,000)
-------------
$ -
The valuation allowance increased by $715,000 in 2005.
Income taxes expense for the years ended December 31, 2005, 2004 and 2003
consisted of the following:
2005 2004 2003
---------- --------- ---------
State and local $84,858 $ 34,604 $32,658
========== ========= =========
F-34
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE O (continued)
A reconciliation of income tax expense computed at the U.S. Federal statutory
rate of 34% and the Company's effective tax rate for the years ended December
31, 2005, 2004 and 2003 are as follows:
2005 2004 2003
--------- --------- ------
Federal income tax expense at statutory rate (34)% (34)% (34)%
Increase (decrease) resulting from
Increase in valuation allowance 34 34 34
State and local income taxes, net of Federal
benefit .9 .9 .9
--------- --------- ------
.9 % .9 % .9%
========= ========= ======
NOTE P - QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Quarterly financial results for the years ended December 31, 2005 and 2004 are
as follows:
THREE MONTHS ENDED
3/31/2005 6/30/2005 9/30/2005 12/31/2005 TOTAL
SALES $14,934,354 $15,890,490 $17,122,629 $16,189,617 $ 64,137,090
GROSS PROFIT $ 805,200 $ 1,182,574 $1,169,966 $ 669,639 $ 3,827,379
NET INCOME(LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDER $ (692,147) $(280,870) $(396,272) $(1,508,822) $(2,878,111)
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (0.21) $ (0.08) $ (0.09) $ (0.37) $ (0.75)
THREE MONTHS ENDED
3/31/2004 6/30/2004 9/30/2004 12/31/2004 TOTAL
SALES $13,307,183 $12,860,329 $13,759,995 $16,777,537 $56,705,044
GROSS PROFIT $ 817,524 $ 698,205 $1,299,230 $1,082,040 $ 3,896,999
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDER $ (457,974) $(700,008) $(170,230) $(804,542) $(2,132,754)
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (0.23) $ (0.34) $ (0.08) $ (0.32) $ (0.97)
NOTE Q - RETIREMENT PLAN
On January 1, 2002, the Company established the Synergy Brands, Inc. 401(k) Plan
(the "Plan") covering employees 21 years of age and older who have completed six
months of continuous service. For the year ended 2005, 2004 and 2003 the Company
match was $23,587, $19,838 and $13,252.
F-35
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE R - COMMITMENTS AND CONTINGENCIES
1. Lease Commitments
The Company leases office and warehouse space under operating leases expiring at
various dates through June 2011. The Company is also leasing vehicles under
operating leases. Future minimum lease payments under noncancelable operating
leases as of December 31, 2005 were as follows:
Year ending December 31,
2006 $ 435,161
2007 $ 425,147
2008 $ 417,031
2009 $ 407,673
2010 $ 403,867
thereafter $ 337,476
----------
$2,426,355
Rent expense under operating leases for the years ended December 31, 2005, 2004
and 2003 was approximately $375,000, $190,000 and $112,000 respectively.
2. Litigation
The Company is subject to legal proceedings and claims, which arise, in the
ordinary course of its business. In the opinion of management, the amount of
ultimate liability, if any, with respect to these actions will not materially
affect the Company's financial position, results of operations or cash flows.
3. Other Liabilities
During the first quarter of 2003, the Company entered into a settlement and
release agreement in which the Company paid $13,000 to a vendor and the Company
released of its liability to that vendor. The Company has recorded a gain of
$155,750 as a result of this release during the first quarter of 2003. In March
2003, the Company and another vendor executed a settlement and release
agreement. Pursuant to the terms of the settlement and release agreement, the
Company was relieved of its obligation to pay for the services that was
disputed. The Company recorded a gain of $127,000 as a result of the release by
this vendor. These gains were recorded as a component of other income (expense)
in the consolidated statements of operations.
F-36
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE S- SEGMENT AND GEOGRAPHICAL INFORMATION
The Company offers a broad range of Internet access services and related
products to businesses and consumers throughout the United States and Canada.
Management evaluates the various segments of the Company based on the types of
products being distributed which were, as of December 31, 2005, 2004 and 2003,
as shown below:
Proset PHS Group B2C Corporate Total
Year ended December 31, 2005
Revenue $786,908 $61,450,467 $1,899,715 - $64,137,090
Net loss attributable to common (1,031,576) (111,784) (445,505) (1,289,246) (2,878,111)
stockholder
Depreciation and amortization 183,420 12,804 156,477 145,264 497,965
Asset impairment charge 293,586 - - - 293,586
Interest income - - - 102,644 102,644
Other income (expense) (1,035) (3,581) (16,888) - (21,504)
Equity in earnings of investee - - - 56,311 56,311
Interest and financing expenses 80,233 1,297,348 - 216,058 1,593,639
Identifiable assets 1,392,551 10,056,544 1,715,940 4,187,603 17,352,638
Additions to long-lived assets - 10,735 61,594 - 72,329
Investment in affiliate 364,340 364,340
Proset PHS Group B2C Corporate Total
Year ended December 31, 2004
Revenue $3,923,823 $50,728,560 $2,052,661 - $56,705,044
Net loss attributable to common (219,204) (167,951) (644,870) (1,100,729) (2,132,754)
stockholder
Depreciation and amortization 210,920 6,501 145,301 296,768 659,490
Interest income - 4,344 - 266 4,610
Other income (expense) (80,778) 71,586 (21,139) (16,652) (46,983)
Equity in earnings of investee - - - 172,224 172,224
Interest and financing expenses 232,913 1,168,607 42,500 109,501 1,553,521
Identifiable assets 2,117,631 9,160,367 1,837,998 3,590,427 16,706,423
Additions to long-lived assets - 85,980 175,000 29,078 290,058
Investment in affiliate - - - 336,828 336,828
Proset PHS Group B2C Corporate Total
Year ended December 31, 2003
Revenue $3,671,106 $34,740,999 $2,128,472 - $40,540,577
Net loss attributable to common (502,158) (79,864) (235,636) (537,565) (1,355,223)
stockholder
Depreciation and amortization 213,198 272,812 114,720 91,968 692,698
Interest income - 13,805 - 108 13,913
Other income (expense) (1,488) 25,490 271,603 3,327 298,932
Equity in earnings of investee - - - 92,424 92,424
Interest and financing expenses 199,892 449,876 39,518 752 690,038
Identifiable assets 2,874,102 6,236,552 1,253,920 628,071 10,992,645
Additions to long-lived assets 2,220 818 386,302 - 389,340
Investment in affiliate 164,604 164,604
F-37
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years ended December 31, 2005, 2004 and 2003
NOTE S (continued)
All of the Company's identifiable assets and results of operations are located
in the United States and Canada. Geographic data, as of and for the years ended
December 31, 2005, 2004 and 2003, is as follows:
2005 2004 2003
------------ ------------ -------------
Revenue
United States $31,890,610 $30,774,482 $34,076,666
Canada 32,246,480 25,930,562 6,463,911
------------ ------------ -------------
$64,137,090 $56,705,044 $ 40,540,577
============ ============ =============
Accounts receivable
United States $ 939,404 $ 1,393,328
Canada 6,682,401 6,210,59
------------ ------------
$ 7,621,805 $ 7,603,925
============ ============
Identifiable assets
United States $17,352,638 $16,706,423
Canada - -
------------ ------------
$17,352,638 $16,706,423
============ ============
NOTE T - SUBSEQUENT EVENTS
On March 14, 2006 the Company closed a $1.75 million junior secured five year
loan with an existing lender bearing a fixed interest rate of 10%. Payments will
be made at a rate of $32,000 per month starting October 1, 2006.
F-38