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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004.
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.)
1175 Walt Whitman Road
Melville, NY 11747
(Address of corporate offices)
Registrant's telephone number, including area code: 1-800-373-7489 ext. 24
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
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
Yes__NO_X_
Synergy Brands Inc. revenues for its most recent fiscal year were
$56,705,044.
On March 30, 2005, the aggregate market value of the voting stock of
Synergy Brands Inc., held by non-affiliates of the Registrant was approximately
$5,013,000. 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, 2005 was 3,298,026.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2004 Annual Meeting of
Stockholders currently scheduled to be held June 2005 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 "Management's Discussion and Analysis of
Financial Condition and Results of Operations - 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
and salon products.. 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 two distinct manners, wholesale and
on-line.
The Company also owns 21.5% 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 represents about 89% of the overall company sales.
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 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 promotions, 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, 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 is a recently acquired company that sells
premium cigars to restaurants, hotels, casinos, country clubs and many
other leisure related destinations. This company was acquired in June,
2003.
o CigarGold.com and NetCigar.com sells premium cigars through the
Internet directly to the consumer.
o BeautyBuys.com sells salon hair care products directly to the
consumer via the internet.
THE COMPANY'S CORPORATE OFFICES ARE LOCATED AT 1175 WALT WHITMAN ROAD
MELVILLE NEW YORK 11747, AND ITS TELEPHONE NUMBER IS (800) 373-7489 ext.24. 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 businesses, 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 and Ontario, Canada. Distribution of such
products is directed to major retailers and wholesalers from major U.S. consumer
product manufacturers and Canadian distribution. 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 Ontario, 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 predominantly to
wholesalers and distributors in the Northeastern part of the United States.
Proset focuses on the sale of brand name salon hair care 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.
The online unit operates at 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.
C. CIGAR OPERATIONS.
GRC manages multiple Internet domains that market directly to the retail
consumer via standard and electronic commerce. GRC owns multiple domains
including Cigargold.com. and Netcigar.com. GRC focuses on sale of a mix of Brand
name and private label premium cigar items and cigar related accessories and
markets them through multiple cigar domains including CigarGold.com and
NetCigar.com.
GRC operations include two businesses. This segment includes Cigars Around
the World (CAW) and CigarGold/NetCigar. 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 it
destinations. 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 as well as private label and proprietary products.
CigarGold operates under the domain names: www.CigarGold.com, www.NetCigar.com,
and www.GoldCigar.com.
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(i) CIGARGOLD.COM
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 precessed 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. Netcigar.com
maintains an inventory on approximately 75% of its product mix; the other 25% 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 CGC web site, they provide NetCigar 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, NetCigar
uses e-mail to alert customers to important developments and merchandising
initiatives.
4
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 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 has 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 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 Netcigar.com. 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. The purchase price paid for such
subsidiary was based on the EBTDA (Earnings Before Taxes, Depreciation and
Amortization)of CAW going forward over a three-year period.
-5-
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 should be 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. During the years ended December 31, 2004
and 2003, the Company purchased approximately 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. The Company
has maintained over a ten year relationship with this vendor and believes that
the relationship with this vendor is satisfactory.
E. MAJOR CUSTOMERS.
During the year ended December 31, 2004, sales to two customers accounted
for 21% and 18% of the Company's total sales and in 2003 sales to two customers
accounted for 11% each 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 therefrom. 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
NetCigar.com
SynergyBrands.Com
DealbyNet.com
Perx.com (managed by Interline Travel & Tours)
SYBR.com
CIGARGOLD.com
Goldcigar.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, management can 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 website 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.
7
The Company also maintains a Virtual Private Network (VPN) and Webex
private network. The 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 the 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. In particular, the second and first quarters are usually
better operating quarters. 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 85% of B2C product
inventory is in warehouse stock and 15% 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 in 2003 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 can not 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" 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.
J. EMPLOYEES
The Company and its subsidiaries in the aggregate as of the date of this
report employ and contract approximately 50 full time and part time 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 , and
Florida (GRC), and sales offices in Pennsylvania, Illinois, Maine and Toronto
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 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. 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 entirely. Recently the US Bureau
of Alcohol Tobacco Firearms and Explosives, the major credit card companies and
State attorneys general reached agreement to dissallow 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.
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.
10
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. For further discussion of other present and
potential government regulation of the Internet see "Forward Looking Information
and Cautionary Statements No.32 Government Regulation of the Internet may impede
the Company's growth or add to its operating costs" infra.
ITEM 2: DESCRIPTION OF PROPERTY
The Company's corporate offices and administrative headquarters are located
in Melville, New York.
The Company maintains satellite and representative offices in New York,
Pennsylvania, New Jersey, Maine, Illinois, Florida, and Ontario, Canada.
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 2004 no matters were submitted for shareholder
approval. In September 2004 by written consent shareholders holding a majority
of the votes approved a reduction in the authorized stock of the Company from
60,000,000 shares to 6,000,000 shares, and in February 2005 by similar
shareholder vote the authorized stock was retroactively corrected to 15,000,000
shares as the status prior to the aforesaid reduction to 6,000,000 shares
(further explained in Item 5 "Market for the Registrant's Common Stock and
Related Stockholder matters" infra.)
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, 2003 3.05 2.47 2.47
June 30, 2003 3.44 2.45 2.67
September 30, 2003 4.49 2.99 3.61
December 31, 2003 4.20 3.40 3.90
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 3.35
On March 30, 2005, the Company had approximately 3200 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.
Effective February 2005 the Company has decreased its authorized stock to
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. Prior thereto the Company was authorized to issue 60,000,000 shares
but such figure was retroactively reduced to 15,000,000 shares to correct the
Company's inadvertent lack of reduction of its authorized stock when it reverse
split its outstanding stock 1 for 4 in February 2003.
11
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 2004. 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
12/31/2004
YEAR ENDED
DECEMBER 31,
2004 2003 2002 2001 2000
CONSOLIDATED STATEMENT OF OPERATIONS:
NET SALES $56,705,044 $40,540,577 $31,540,675 $24,347,928 $20,665,018
COST OF SALES
COST OF PRODUCT $51,907,840 $36,837,796 $29,241,384 $22,347,887 $19,391,844
SHIPPING AND HANDLING COSTS $900,205 $893,582 $600,994 $657,793 $332,845
$52,808,045 $37,731,378 $29,842,378 $23,005,680 $19,724,689
GROSS PROFIT $3,896,999 $2,809,199 $1,698,297 $1,342,248 $940,329
OPERATION EXPENSES
ADVERTISING AND PROMOTIONAL $150,181 $91,634 $469,965 $1,501,267 $2,547,891
GENERAL AND ADMINISTRATIVE $3,605,433 $2,984,663 $3,196,270 $3,072,900 $4,419,753
DEPRECIATION AND AMORTIZATION $659,490 $692,698 $893,935 $1,004,553 $663,146
DEVELOPMENT COSTS $16,133 $632,696
$4,415,104 $3,768,995 $4,560,170 $5,594,853 $8,263,486
OPERATING LOSS -$518,105 -$959,796 -$2,861,873 -$4,252,605 -$7,323,157
OTHER INCOME(EXPENSE)
INTEREST INCOME $4,610 $13,913 $26,695 $128,189 $66,183
OTHER INCOME(EXPENSE) -$46,983 $298,932 $514,860 $23,804 -$55,676
EQUITY IN EARNINGS OF INVESTEE $172,224 $92,424 $67,717 $1,583
INTEREST AND FINANCING EXPENSES -$1,553,521 -$690,038 -$211,279 -$154,745 -$178,964
DIVIDENDS ON PREFERRED STOCK OF SUBSIDARY -$24,500 -$24,500
-$1,423,670 -$284,769 $397,993 -$25,669 -$192,957
LOSS BEFORE INCOME TAXES -$1,941,775 -$1,244,565 -$2,463,880 -$4,278,274 -$7,516,114
MINORITY INTEREST IN LOSS $266,258
INCOME TAX EXPENSE $34,604 $32,658 $22,687 $21,865 $21,433
NET LOSS BEFORE DISCONTINUED OPERATIONS -$1,976,379 -$1,277,223 -$2,486,567 -$4,300,139 -$7,271,289
DISCONTINUED OPERATIONS
LOSS ON DISCONTINUED OPERATIONS OF PCW,
NET OF APPLICABLE BENEFIT OF $0 -$495,534
DIVIDEND-PREFERRED STOCK $156,375 $78,000
NET LOSS ATTRIBUTABLE
TO COMMON STOCKHOLDERS -$2,132,754 -$1,355,223 -$2,486,567 -$4,300,139 -$7,766,823
BASIC AND DILUTED NET LOSS
PER COMMON SHARE: -$0.97 -$0.82 -$1.91 -$4.15 -$9.74
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING 2,209,371 1,652,019 1,302,042 1,035,795 797,193
CONSOLIDATED BALANCE SHEET DATA:
WORKING CAPITAL $3,064,266 $1,041,027 $51,542 $744,710 $1,455,851
TOTAL ASSETS $16,706,423 $10,992,645 $5,871,669 $8,398,310 $12,279,515
LONG TERM OBLIGATIONS $1,196,241 $788,162 $342,750 $801,814 $184,625
TOTAL SHAREHOLDERS' EQUITY $6,573,057 $2,943,832 $2,082,537 $3,027,029 $7,718,673
12
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 and online distribution of premium cigars
and salon products through three business segments. 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 also owns 21.5% 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 has grown at a compounded sequential
growth rate of 36% cumlative since 2002 to $1,069,000 in Fiscal Year 2004.
SYBR's share under the equity method amounted to $172,224 for Fiscal Year 2004
after income taxes. SYBR and PERX have been exploring several opportunities to
optimize the shareholder value of both Companies.
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 89% 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 Hair Systems (Proset). Proset
distributes Salon Hair care products 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 is a recently acquired company that sells
premium cigars to restaurants, hotels, casinos, country clubs and many
other leisure related destinations. The company was acquired in June
2003.
o CigarGold.com and Netcigar.com sells premium cigars through the
Internet directly to the consumer.
o BeautyBuys.com sells salon hair care products directly to the
consumer via the Internet.
13
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 (1,032,025) -26.22% (2,132,754) -57.37%
Net loss per common share (0.47) (0.97)
Depreciation and amortization 362,722 -39.62% 659,490 -4.79%
Interest income (4,344) -68.53% (4,610) -66.87%
Interest and financing expenses 1,444,020 109.50% 1,553,521 125.14%
----------- -----------
EBITDA 770,373 68.00% 75,647 456.23%
=========== ===========
EBITDA net income per share 0.35 0.03
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 (817,658) (1,355,223)
Net loss per common share (0.49) (0.82)
Depreciation and amortization 600,730 692,698
Interest income (13,805) (13,913)
Interest and financing expenses 689,286 690,038
----------- -----------
EBITDA 458,553 13,600
=========== ===========
EBITDA net income per share 0.28 0.01
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.
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. 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.
14
Earnings before interest, taxes, depreciation and amortization (EBITDA)
improved to a profit of $75,647 for the year ended December 31, 2004 as compared
to a profit of $13,600 for the year ended December 31, 2003. The improvement is
attributable to an increase in revenues. However, financing costs increased by
125% to $1,553,521. 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.
EBITDA from the Company's operating businesses increased by 68% to a profit of
$770,373 for the year ended December 31, 2004 as compared to a profit of
$458,553 for the year ended December 31,2003.
Earnings before interest, depreciation, amortization (EBITDA) is a
financial measurement used by distribution related companies that function in
the wholesaling of manufactured goods. EBITDA is relevant to the Company's
businesses due to the fact that traditional valuations for measuring the values
of enterprises such as ours are usually based on EBITDA multiples. EBITDA is not
recognized as a GAAP measurement of earnings and should not be relied upon as
such.
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.
15
PHS SEGMENT INFORMATION OF OPERATING BUSINESSES
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%
Depreciation and amortization 6,501 -97.62%
Interest income (4,344) -68.53%
Interest and financing expenses 1,168,607 159.76%
EBITDA 1,002,813 59.42%
Year ended December 31, 2003
Revenue 34,740,999
Gross Profit 1,927,416
SG&A 1,323,887
Operating Profit (loss) 330,717
Net loss (79,864)
Depreciation and amortization 272,812
Interest income (13,805)
Interest and financing expenses 449,876
EBITDA 629,019
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 2003, 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 2003 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. EBITDA increased to
$1,002,813 for the year ended December 31, 2004 as compared to $629,019 for the
year ended December 31, 2003. As long as the Company maintains or expands its
vendor relationships, management believes that it can continue to improve its
operating results. Management needs to also reduce its financing costs for PHS
as they represent 117% of EBITDA and the single highest of the Company's overall
expenditures.
16
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%
Depreciation and amortization 210,920 -1.07%
Interest and financing expenses 232,913 16.52%
EBITDA 224,629 352.20%
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)
Depreciation and amortization 213,198
Interest and financing expenses 199,892
EBITDA (89,068)
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. EBITDA improved from a loss of $89,068 for the year ended December 31,
2003 to a profit at $224,629 for the year ended December 31, 2004. This
improvement was caused by an increase in revenues, a reduction in labor cost,
warehousing expenses and a reduction in freight expenses. 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.
17
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%
Depreciation and amortization 145,301 26.66%
Interest and financing expenses 42,500 7.55%
EBITDA (457,069) -461.52%
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)
Depreciation and amortization 114,720
Interest and financing expenses 39,518
EBITDA (81,398)
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 represents 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. EBITDA decreased by 462% for the same period. The table above
provides comparative details for the Company's B2C operation.
18
CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003
AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2002.
SUMMARY OF OPERATING SEGMENTS AND SUMMARY CONSOLIDATED RESULTS OF OPERATIONS
OPERATING OPERATING AND
SEGMENTS CORPORATE SEGMENTS
Y/E 12/31/2003
Revenue 40,540,577 28.53% 40,540,577 28.53%
Gross Profit 2,809,199 65.41% 2,809,199 65.41%
SG&A 2,641,864 13.11% 3,076,297 -16.09%
Net loss (817,658) 28.43% (1,355,223) 48.64%
Net loss per common share (0.49) 44.32% (0.82) 59.52%
Depreciation and amortization 600,730 -30.89% 692,698 -22.51%
Interest income (13,805) 356.51% (13,913) -47.88%
Interest and financing expenses 689,286 257.27% 690,038 226.60%
---------- ----------
EBITDA 458,553 650.28% 13,600 100.96%
========== ==========
EBITDA net income per share 0.28 533.70% .01 100.92%
Y/E 12/31/2002
Revenue 31,540,675 31,540,675
Gross Profit 1,698,297 1,698,297
SG&A 2,335,719 3,666,235
Net loss (1,142,511) (2,486,567)
Net loss per common share (0.88) (1.91)
Depreciation and amortization 869,273 893,935
Interest income (3,024) (26,695)
Interest and financing expenses 192,931 211,279
---------- ----------
EBITDA (83,331) (1,408,048)
========== ==========
EBITDA net income per share (0.06) (1.08)
Revenues increased by 29% to $40,540,577 for the year ended December 31
2003 as compared $31,540,675 for the year ended December 31, 2002. Revenues
increased across all of the Company's business segments. The largest percentage
increase was in the Company's B2C operations. Revenues increased in this segment
as a result of the Company's acquisition of Cigars Around the World in June of
2003. The Company's grocery operation continued to develop additional vendor
relationships in the grocery and HBA businesses as well as expand its sales in
Canada. Proset increased its revenues by selling its products to larger
distributors as well as retail customers.
Gross profit increased by 65% to $2.8 million in 2003 as compared to 2002.
The overall gross profit percentage increased to 6.9% to from 5.4%. The increase
in gross profit is attributable to better operating margins in the B2B
operations realized through higher vendor allowances as well as an increase of
Direct Store Delivery sales, whose sales generate higher gross margins. The
acquisition of CAW also helped increase gross profit. The following segment
analysis will further define the components, which caused the increase in
operating gross profit. In this period the Company utilized its own truck fleet
and developed a Direct Store Delivery (DSD) warehousing operation which cost the
Company $371,000 as compared to $209,000 in 2002. Management believes that this
operation should increase the Company's sales and gross profit. In order for the
Company to achieve improved profitability it needs to reduce its financing costs
and increase revenues and operating margins.
19
Selling General and Administrative expenses (SGA) were reduced by 16% even
though revenues increased by 28.5% for the period ended December 31, 2003 as
compared to the prior annual period. The Company streamlined its operations by
centralizing all administrative functions at its corporate offices, reduced
staff in its Proset operation through outsourcing, while also reducing the costs
involved in retail sales. The Company reduced its advertising expenses on a
corporate level as well as reduced developmental expenses in its B2C businesses.
The largest subsidiary of the Company, PHS Group increased its SGA expenses by
33.2% to $1,323,877 in 2003 as compared to $993,664 in 2002. The increase in SGA
for PHS group was caused by a 25% increase in revenues. PHS incurs variable
expenses in connection with selling costs as well as its promotional expenses.
As revenues rise, sales commissions and certain operating expenses resulting
from sales increase commensurately.
The net loss of the Company was reduced by 49% to $1,355,223 in 2003 as
compared to a net loss of $2,486,567 in 2002. The loss was reduced through sales
growth, an increase in operating gross profit, a reduction of SG&A expenses and
a significant reduction in corporate expenses. However, financing costs
increased for the year as a result of the Company's growth. Material factors
that affected the Company's costs were increased financing costs and the control
of operating margins. The increase was attributable to the development of the
Company's wholesaling operation. Corporate expenses such as legal, accounting,
and regulatory 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 2003
totaled $434,433, which include legal, accounting and regulatory expenses.
20
Earnings before interest taxes, depreciation and amortization (EBITDA)
improved from a loss of $1,408,048 to a profit of $13,600 for the year ended
December 31, 2003 as compared to December 31, 2002. The improvement is
attributable to an increase in revenues, an increase in operating gross profit
and a reduction in SG&A. However financing costs increased by 226% to $690,038.
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. EBITDA from the
Company's operating businesses increased by 650% to $458,553 in 2003 as compared
to a loss of $83,331 in 2002.
In order to fully understand the company's results a discussion of the
company's segments and their respective results follows;
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 86% 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.
PHS SEGMENT INFORMATION OF OPERATING BUSINESSES
B2B CHANGE
Year ended December 31, 2003
Revenue 34,740,999 25.21%
Gross Profit 1,927,416 77.96%
SG&A 1,323,887 33.24%
Net loss (79,864) 72.75%
Depreciation and amortization 272,812 0.05%
Interest income (13,805) 356.51%
Interest and financing expenses 449,876 375.65%
EBITDA 629,019 784.24%
Year ended December 31, 2002
Revenue 27,745,818
Gross Profit 1,083,069
SG&A 993,644
Net loss (293,088)
Depreciation and amortization 272,667
Interest income (3,024)
Interest and financing expenses 94,582
EBITDA 71,137
21
PHS increased its revenues by 25.2% to $34.7 million for the year ended
December 31, 2003 as compared to the prior year. 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. The Company also benefited from increases in the vendor
allowances it receives from its vendors, thereby providing its customers with
additional discounts. This also resulted in increased sales. Gross profit
increased by 78% to $1.9 million in 2003 as compared to 2002. PHS increased its
gross profit by increasing DSD sales as well as focusing on promotional
merchandise offered by its vendors. In 2003 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 2003 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. Vendor allowances as a result
increased by 69% to $2.7 million in 2003 as compared to $1.6 million in 2002,
thus materially increasing PHS gross profit in 2003. EBITDA increased by 9 times
to $629,019 in 2003 as compared to $71,137 in 2002. As long as the Company
maintains or expands its vendor relationships, management believes that it can
continue to improve its operating results. Management needs to also reduce its
financing costs for PHS as they represent 71% of EBITDA and a substantial
component of the Company's overall expenditures.
PROSET SEGMENT INFORMATION OF OPERATING BUSINESSES
Salon
products CHANGE
Year ended December 31, 2003
Revenue 3,671,106 44.69%
Gross Profit 344,305 9.20%
SG&A 429,684 -29.91%
Net loss (502,158) 39.77%
Depreciation and amortization 213,198 -54.53%
Interest and financing expenses 199,892 231.30%
EBITDA (89,068) 70.75%
Year ended December 31, 2002
Revenue 2,537,216
Gross Profit 315,290
SG&A 613,077
Net loss (833,712)
Depreciation and amortization 468,842
Interest and financing expenses 60,336
EBITDA (304,534)
22
Proset increased its revenues by 44.7% in 2003 as compared to 2002. The
growth in Proset business is attributable to increased wholesale and
distribution activity, as opposed to Direct Store Delivery (DSD) business. As a
result, the Company's customer base has expanded to include smaller distributors
that purchase salon products in higher quantities, which in turn reduces the
Company's gross profit, but increases revenues. 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 manufacturers, distributors and resellers in order to keep a
supply chain for its customer base. EBITDA improved from a loss of $304,534 in
2002 to a loss of $89,068 in 2003. This improvement was caused by a reduction in
labor cost, warehousing expenses, increased revenues and a reduction in freight
expenses. Financing costs are also an important factor in the operation of
Proset. As revenues increased financing costs increased by 231% to $199,892. In
order to improve the profitability of Proset, management believes that financing
costs need to reduced.
B2C SEGMENT INFORMATION OF OPERATING BUSINESSES
B2C CHANGE
Year ended December 31, 2003
Revenue 2,128,472 69.24%
Gross Profit 537,478 79.20%
SG&A 888,293 21.85%
Net loss (235,636) -1399.82%
Depreciation and amortization 114,720 -10.21%
Interest and financing expenses 39,518 3.96%
EBITDA (81,398) 154.24%
Year ended December 31, 2002
Revenue 1,257,641
Gross Profit 299,938
SG&A 728,998
Net loss (15,711)
Depreciation and amortization 127,764
Interest and financing expenses 38,013
EBITDA 150,066
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 increased by 69.2% to $2.1 million
from 2002 to 2003. The increase is predominately attributable to the acquisition
of CAW. The Company's core operation grew by 25% assuming CAW figures were not
included. CAW on a current operating basis represents approximately 60% of B2C
revenues. Gross profit improved by 79% in FY 2003 as compared to FY 2002. The
increase in gross profit is attributable to higher revenues realized through the
acquisition of CAW in FY 2003. EBITDA improved by 154% for the same period. The
table above provides comparative details for the Company's B2C operation.
23
LIQUIDITY AND CAPITAL RESOURCES
The Company's predominant need for working capital is to finance its
Receivables and Inventory levels. In order to finance its requirements the
Company has relied on secured debt financings, trade financing, equity based
financing as well as its cash flow from operations. The Company's major lender,
International Investment Group Trade Opportunities Fund (IIG), provides
receivable and inventory financing to its three operating segments. In addition,
most of the Company's major vendors provide trade credit for purchases ranging
from COD to 30 days. One vendor to the Company represents over 53% of the
Company's purchases. Loss of this vendor would have a material adverse effect on
the Company's operations.
Liquidity and Capital Resources
Year ended 2004 2003
Working Capital $3,064,266 $ 1,041,027 194.35%
Assets $ 16,706,423 $ 10,992,645 51.98%
Liabilities $ 10,133,366 $ 8,048,813 25.90%
Equity $6,573,057 $ 2,943,832 123.28%
Line of Credit Facility $4,976,610 $ 4,013,680 23.99%
Receivable turnover (days) 47 34
Inventory Turnover (days) 12 20
Tangible Assets $ 14,890,182 $ 9,304,092 60.04%
The Company has a revolving loan and security agreement with IIG for
financing its operations. The line of credit under the loan allows borrowings up
to $8.5 million for accounts receivable, purchase orders, and inventory based
upon a borrowing base formula. The term of the agreement is for one year and
allows for renewals. As of December 31, 2004 the Company's borrowing under its
agreement were $4.9 million an increase of 24% as compared to 2003. In November
of 2003, PHS secured a $2 million stand by letter of credit (LC) for the purpose
of increasing its line of credit to $3.5 million with a major vendor. The LC was
secured by a $500,000 cash deposit as well as certain reserves modified under
the loan and security agreement with IIG. The LC expired in May 2004, at which
time the cash deposit and reserves were released. The increased vendor line of
credit facility has enabled the Company to secure special promotional products
specifically designed for the cold and flu season, which increases the Company's
average purchases from approximately $40,000 per order to approximately $150,000
per order. Management believes that its IIG facility has enabled the Company to
achieve its recent growth. By providing financing on all of the Company's
tangible assets, the Company has been able to expand its sales through
receivable order and inventory financing support. In addition IIG provides the
Company with a financing option in Canada, borrowing against anticipated vendor
allowances as well as securing product through sales order financing. However
IIG's financing rate is 17% and as a result caused financing charges to increase
materially in 2004. Management believes that to achieve profitable operations,
financing costs must be reduced. By improving its operating results and
especially EBITDA, management expects to generate positive cash flow, assuming
financing costs can be reduced. However, there can be no assurance that the
Company will reduce its financing costs, so that it can improve its operating
results. Failure to reduce financing costs will inhibit the Company's growth.
Management believes that its current capital structure needs to be improved in
order to secure a profitable operation.
24
As the Company's operations have grown the Company has been able to raise
additional capital predominately through its shareholders and institutional
placements. In 2003, the Company raised $1.6 million through the issuance of
Series A Class B preferred Stock and $850,000 through 12% notes secured by its
investment in ITT, a 21.5% investee.
In December 2004, the Company sold accounts receivable attributable to a
selected customer base 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 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. Proset further intends to service the salon hair care needs
of BeautyBuys.com and PHS Retail based accounts. The Company beleives that this
transaction should have a positive effect on working capital for its Proset
operation and should reduce the dependence of asset based financing for this
operation.
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.
On March 1, 2004, the Company received $490,000 pursuant to the issuance of
three secured promissory notes from certain shareholders of ITT, a 21.5%
investee. Borrowings under the notes bear interest at a rate of 12%. The Company
is not required to repay any principal until the maturity date of the notes,
February 28, 2006. In 2004, certain shareholders of ITT converted $613,646 of
debt into 153,156 shares of common stock. Also, in 2004, the Company converted
$1,621,000 outstanding debt of IIG into 435,182 shares of common stock.
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 $5.00 per
share 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 $5.00 per share. The Company's common
stock quoted market price at date of closing was $4.15 per share. The debenture
has a three-year term with a coupon rate of prime (5.25% at December 31, 2004)
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. 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 $3.50 per
share or matures January 25, 2008. The debenture provides for monthly payments
of $16,666.67 plus interest, commencing August 1, 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 $2.52 per share. The
debenture has a three-year term with a coupon rate of prime plus 3%. As the
company grows it intends to raise additional capital to accommodate its growth
plans however, there can be no assurance that additional capital can be
attained.
Working capital at December 31, 2004 totaled approximately $3.1 million a
increase of 2.0 million from 2003. The Company's operations require financing of
inventory and receivables. IIG provides the company's operating subsidiaries a
facility that allows for borrowings of up to 85% against eligible accounts
receivables and 50% against eligible inventory and orders in transit. It is
important to note that as the borrowings increase from IIG, commensurate with
increased revenues and additional need for inventory, additional capital will be
needed to support the borrowing base with IIG. Therefore as the financial
leverage of the company increases, additional capital is needed to support the
company's growth. The Company turns its overall inventory on average
approximately every 12 days, its receivables average 47 days of collections the
turn is computed on ending balances.
Management believes that continued cost containment, improved financial and
operating controls, and a focused sales and marketing effort should provide
sufficient cash flow from operations in the near term. Achievement of these
goals, however, will 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.
25
The following table presents the Company's expected cash requirements for
Contractual obligations outstanding as of December 31, 2004.
Payments Due By Period
Contractual Obligations Less Than 1-3 4-5 After 5
1 Year Years Years Years Total
Line-Of-Credit $4,976,610 $4,976,610
Notes Payable $ 384,021 $1,196,241 $1,580,262
Operating Leases $ 35,092 $1,054,110 $684,122 $521,430 $2,294,754
Total Contractual
Cash Obligations $5,395,723 $2,250,351 $684,122 $521,430 $8,851,626
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 is not 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, 2004, the Company has established a full valuation allowance.
26
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.
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 that begins after June 15, 2005. The Company adoption of SFAS No.123(R)
is not expected to have a material impact on the Company's financial position or
results of operations.
27
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.
SEASONALITY
Sales by PHS Group and Proset usually peak at the end of the 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 quarterly end and as a result reduced products
costs may increase sales. In particular, the second and first 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.
28
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 and the future value of its
common stock;
The anticipated size or trends of 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. 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.
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 paid for in
stock and/or other working capital financing. Due to a pattern of
historical losses, there is no assurance that further financing will not be
needed for operating purposes.
2. INTERNET
The internet environment is still relatively new to business and is subject
to inherent risks as in any new developing business including rapidly developing
technology with which to attempt to keep pace and level of acceptance and level
of consumer knowledge regarding its use.
29
3. 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.
4. 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 claim from its own funds. Any
such payment could have a material adverse impact on the Company.
5. 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 purchases, 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, the Company will likely incur higher
freight costs due to the limited availability of trucks during any such period
that transportation lanes are restricted.
6. 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.
7. 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.
30
8. 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 been reduced below the minimum
NASDAQ standard of $1 and having been below such level for an appreciable period
of time, as well as the Company also being notified in the past that
stockholders' equity has fallen below minimum NASDAQ continued listing standard
of $2,500,000. NASDAQ has established, and the Commission has approved, certain
maintenance requirements 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
has been below $1.00 in the past and the Common Stock has remained on the NASDAQ
Small Cap System because Synergy has 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 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 may 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.
9. RISKS OF BUSINESS DEVELOPMENT.
Because still the lines of product and product distribution established for
the Company 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 offerings or out of
generated revenues and Company profits and will likely be a drain on Company
capital if revenue and revenue collection does not keep pace with Company
expenses. There can be no assurance as to the continued availability of funds
from any of these sources.
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10. 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 develop and implement an
appropriate marketing strategy for each of its 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.
11.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).
32
12. 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.
13. 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.
14. 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.
15. THE COMPANY DEPENDS ON CONTINUED USE OF THE INTERNET AND GROWTH OF THE
ONLINE PRODUCT PURCHASE MARKET.
The Company's future revenues and profits, if any, substantially depend
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 only recently. As a result,
acceptance and use may not continue to develop at historical rates, and a
sufficiently broad base of consumers may not adopt, and continue to use, the
Internet and other online services as a medium of commerce.
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 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 necessary for reliable Internet access and
services and hopeful continued shifting of potential customers shopping
preferences to the internet.
16. IF THE COMPANY DOES NOT RESPOND TO RAPID TECHNOLOGY CHANGES, ITS
SERVICES COULD BECOME OBSOLETE AND ITS BUSINESS WOULD BE SERIOUSLY
HARMED.
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.
33
17. 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.
18. 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 increase its number of customers. 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
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 its business.
19. BECAUSE THE COMPANY'S INDUSTRY IS HIGHLY COMPETITIVE AND HAS LOW
BARRIERS TO ENTRY, THE COMPANY MAY NOT BE ABLE TO EFFECTIVELY COMPETE.
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.
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.
34
20. 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.
21. 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.
22. 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.
23. 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.
24. 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.
35
25. A SYSTEM FAILURE COULD CAUSE DELAYS OR INTERRUPTIONS OF SERVICE TO THE
COMPANY'S CUSTOMERS.
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.
26. THE FUNCTIONING OF THE COMPANY'S SYSTEMS OR THE SYSTEMS OF THIRD
PARTIES ON WHICH IT RELIES COULD BE DISRUPTED BY FACTORS OUTSIDE THE
COMPANY'S CONTROL.
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.
27. 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.
28. THE COMPANY'S SUCCESS DEPENDS ON THE CONTINUED GROWTH OF THE INTERNET
AND ONLINE COMMERCE.
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, these market participants must accept and use novel ways of
conducting business and exchanging information.
36
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 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.
29. THE COMPANY'S SUCCESS DEPENDS ON THE CONTINUED RELIABILITY OF THE
INTERNET.
The Internet 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. 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 a viable commercial marketplace, the Company will have to adapt its
business model to the new environment, which would materially adversely affect
its results of operations and financial condition.
37
30. GOVERNMENT REGULATION OF THE INTERNET MAY IMPEDE THE COMPANY'S GROWTH
OR ADD TO ITS OPERATING COSTS.
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.
38
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.
31. 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. 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.
32. 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.
33. 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.
39
34. 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:
- 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.
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, 2004 and 2003 F-4-F-5
Consolidated Statements of Operations for the Years Ended
December 31, 2004, 2003 and 2002 F-6
Consolidated Statements of Changes in Stockholders' Equity
and Comprehensive Loss for the
Years Ended December 31, 2004, 2003 and 2002 F-7-F-10
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004, 2003 and 2002 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
40
PART III
The information required by items 10-13 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, 2005. The annual meeting is scheduled to be in June 2005. Such Proxy
Statement is expected to be filed with the Commission by April 30, 2005 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.
ITEM 14. CONTROLS AND PROCEDURES
As certified herein by the Company's Chief Executive Officer and Chief
Financial Officer, they have within 90 days of the date of this report evaluated
the disclosure controls and procedures of the Company and believe same to be
adequate 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.
41
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.
ITEM 15. EXHIBITS, LIST AND REPORTS ON FORM 8-K
1. (a) Exhibits:
See Index to Exhibits
2. Reports on Form 8-K
On November 4, 2004 the Company filed an 8K Report disclosing certain
unregistered sales of equity securities made in a 4(2) exempt offering of units
consisting of preferred stock and Common Stock resulting in gross proceeds to
the Company of $1,500,000 and disclosure of the press release made by the
Company relating thereto, and on November 19, 2004 the Company filed an 8K
Report disclosing further sales of securities from the earlier disclosed
placement to the extent of at an additional $200,000 to make the total gross
proceeds received to $1,700,000 and including disclosure of the relevant press
release made. On November 15, 2004 the Company disclosed and filed as an exhibit
thereto its press release commenting on its third quarter 2004 financial
results. Such were the only 8K reports filed during the fourth quarter of 2004.
3. Financial Statement Schedules
None
42
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: March 30, 2005
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
Signed: March 30, 2005
by /s/ Mitchell Gerstein
----------------------------------
Mitchell Gerstein
Chief Financial Officer
Signed: March 30, 2005
by /s/ Joel Sebastian
-----------------------------------
Joel Sebastian, Director
Signed: March 30, 2005
by /s/ Lloyd Miller
-----------------------------------
Lloyd Miller, Director
Signed: March 30, 2005
by /s/ Dominic Marsicovetere
-----------------------------------
Dominic Marsicovetere, Director
Signed: March 30, 2005
by /s/ William Rancic
-----------------------------------
William Rancic, Director
Signed: March 30, 2005
by /s/ Frank A. Bellis Jr.
-----------------------------------
Frank A. Bellis, Director
Signed: March 30, 2005
by /s/ Randall J. Perry
-----------------------------------
Randall J. Perry, Director
43
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Synergy Brands, Inc.
We have audited the accompanying consolidated balance sheet of Synergy Brands,
Inc. as of December 31, 2004 and the related consolidated statements of
operations, stockholders' equity and comprehensive loss and cash flows for the
year 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 audit.
We conducted our audit in accordance with auditing 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 audit 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, 2004 and the results of its operations and its cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
HOLTZ RUBENSTEIN REMINICK LLP
Melville, New York
March 17, 2005
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Synergy Brands, Inc.
We have audited the accompanying consolidated balance sheet of Synergy Brands,
Inc. and Subsidiaries (the "Company") as of December 31, 2003, and the related
consolidated statements of operations, changes in stockholders' equity and
comprehensive loss and cash flows for each of the two years in the period 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 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 financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit 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 beleive that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Synergy Brands,
Inc. and Subsidiaries as of December 31, 2003, and the consolidated results of
their operations and their consolidated cash flows for each of the two years in
the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.
/S/ GRANT THRONTON LLP
- ----------------------
GRANT THORNTON LLP
New York, New York
March 5, 2004
F-3
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
ASSETS
CURRENT ASSETS 2004 2003
---------- ---------
Cash and cash equivalents $ 945,806 $ 777,522
Cash collateral security deposit - 500,000
Marketable securities - 46,035
Accounts receivable trade, less allowance for doubtful accounts of
$ 127,481 and $127,481 7,227,489 3,630,007
Other receivables 1,264,242 674,519
Notes receivable 314,285 -
Inventory 1,826,274 2,164,116
Prepaid assets and other current assets 423,295 509,479
---------- ---------
Total Current Assets 12,001,391 8,301,678
PROPERTY AND EQUIPMENT, NET 366,510 379,224
OTHER ASSETS 632,466 186,057
NOTES RECEIVABLE 1,889,815 437,133
INTANGIBLE ASSETS, net of accumulated amortization of
$2,003,048 and $1,780,736 1,301,944 1,524,256
GOODWILL 514,297 164,297
---------- ---------
TOTAL ASSETS $ 16,706,423 $ 10,992,645
========== =========
The accompanying notes are an integral part of this statement.
F-4
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS (Continued)
December 31, 2004 and 2003
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES 2004 2003
----------- -----------
Lines of credit $ 4,976,610 $ 4,013,680
Notes payable - current 384,021 -
Accounts payable 3,482,456 3,108,695
Related party note payable 56,972 100,800
Accrued expenses 37,066 37,476
----------- -----------
Total Current Liabilities 8,937,125 7,260,651
NOTES PAYABLE 1,196,241 788,162
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 - $.001 par value; 900,000 shares authorized, none issued - -
Class B Series A Preferred stock-$.001 per value; 500,000 shares authorized;
330,000 and 160,000 shares issued and outstanding; liquidation preference of
$10.00 per share 330 160
Common stock - $.001 par value; 5,000,000 shares authorized;
3,263,992 and 1,919,359 shares issued 3,264 1,919
Additional paid-in capital 43,134,165 37,748,004
Deficit (36,349,706) (34,373,327)
Unearned Compensation (201,756) (426,252)
Accumulated other comprehensive loss (8,340) (1,772)
----------- -----------
6,578,057 2,948,832
Less treasury stock, at cost, 1,000 shares (5,000) (5,000)
----------- -----------
Total Stockholders' Equity 6,573,057 2,943,832
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 16,706,423 $10,992,645
=========== ===========
The accompanying notes are an integral part of this statement.
F-5
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
2004 2003 2002
------------ ----------- -----------
Net sales $ 56,705,044 $40,540,577 $31,540,675
------------ ----------- -----------
Cost of sales
Cost of product 51,907,840 36,837,796 29,241,384
Shipping and handling costs 900,205 893,582 600,994
------------ ----------- -----------
52,808,045 37,731,378 29,842,378
------------ ----------- -----------
Gross profit 3,896,999 2,809,199 1,698,297
Operating expenses
Advertising and promotional 150,181 91,634 469,965
General and administrative 3,605,433 2,984,663 3,196,270
Depreciation and amortization 659,490 692,698 893,935
------------ ----------- -----------
4,415,104 3,768,995 4,560,170
------------ ----------- -----------
Operating loss (518,105) (959,796) (2,861,873)
Other income (expense)
Interest income 4,610 13,913 26,695
Other income (expense) (46,983) 298,932 514,860
Equity in earnings of investee 172,224 92,424 67,717
Interest and financing expenses (1,553,521) (690,038) (211,279)
------------ ----------- -----------
(1,423,670) (284,769) 397,993
------------ ----------- -----------
Loss before income taxes (1,941,775) (1,244,565) (2,463,880)
Income tax expense 34,604 32,658 22,687
------------ ----------- -----------
Net loss (1,976,379) (1,277,223) (2,486,567)
Dividend-Preferred Stock (156,375) (78,000) -
------------ ----------- -----------
Net loss attributable to common stockholders $ (2,132,754) $ (1,355,223) $ (2,486,567)
============ =========== ===========
Basic and diluted net loss per common share: $(0.97) $(0.82) $(1.91)
============ =========== ===========
Weighted-average shares used in the computation of loss per
common share:
Basic and diluted 2,209,371 1,652,019 1,302,042
============ =========== ===========
The accompanying notes are an integral part of these statements
F-6
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
Years ended December 31, 2004, 2003 and 2002
Class A Class B - Series A
----------------- --------------------
preferred stock Preferred stock Common stock
----------------- -------------------- -------------------
Shares Amount Shares Amount Shares Amount
------ ------- ------- ------- ------- -------
Balance at January 1, 2002 100,000 $100 1,237,621 $1,238
Common stock and options issued
in connection with compensation
Plan 85,500 85
Intrinsic value of stock options
issued in connection with
compensation plan
Issuance of restricted stock 1,250 1
Purchase of treasury stock
Sale of treasury stock
Retirement of treasury stock
Extinguishment of notes receivable 25,000 25
Extinguishment of advertising and
in-kind services receivable from
stockholder 18,750 19
Change in unrealized gain on
marketable securities
Cumulative translation adjustments
Net loss
-------- ------ ------- ---- --------- ------
Comprehensive loss
Balance at December 31, 2002 100,000 $ 100 -- -- 1,368,121 $1,368
======== ====== ======= ==== ========= ======
Common stock and options issued
in connection with compensation
plan 93,438 93
Common stock issued 30,000 30
Net proceeds from issuance of
common stock in
Connection with private placement 160,000 160 160,000 160
Issuance of common stock in
satisfaction of note 15,300 15
Issuance of restricted stock in
Connection with notes payable 42,500 43
Issuance of common stock for services 185,000 185
Issuance of common stock in
connection with CAW acquisition 25,000 25
Purchase of Treasury stock
Sale of treasury stock
Preferred stock dividend
Consulting expense
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
======== ====== ======= ==== ========= ======
F-7
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS
Years ended December 31, 2004, 2003 and 2002
CONTINUED
Accumulated
Additional other Stockholders'
paid-in comprehensive Treasury Unearned notes
capital Deficit income (loss) stock Compensation receivable
----------- ------------- ------------- ---------- ----------- ----------
Balance at January 1, 2002 $34,795,297 $(30,609,537) $ 1,685 $(251,135) $(115,629)
Common stock and options issued
in connection with compensation
Plan 301,360 (2,500)
Intrinsic value of stock options
issued in connection with
compensation plan 49,825
Issuance of restricted stock 4,199
Purchase of treasury stock (75,752)
Sale of treasury stock (24,451) 130,948
Retirement of treasury stock (167,500) 167,500
Extinguishment of notes receivable 99,975 113,129
Extinguishment of advertising and
in-kind services receivable from
stockholder 151,981
Change in unrealized gain on
marketable securities (1,583)
Cumulative translation adjustment (176)
Net loss (2,486,567)
----------- ------------- ------- ---------- -------- ----------
Comprehensive loss
Balance at December 31, 2002 $35,210,686 $(33,096,104) $ (74) $ (28,439) -- $ (5,000)
=========== ============= ======= =========== ======== =========
Common stock and options issued
in connection with compensation
plan 212,133 5000
Common stock issued 47,170
Net proceeds from issuance of
common stock in
Connection with private placement 1,509,680
Issuance of common stock in
satisfaction of note payable 39,985
Issuance of restricted stock in
Connection with notes payable 97,957
Issuance of common stock for services 493,315 (493,500)
Issuance of common stock in
connection with CAW acquistion 99,975
Purchase of Treasury stock (122,779)
Sale of treasury stock 115,103 146,218
Preferred stock dividend (78,000)
Consulting expense 67,248
Change in unrealized gain on
Marketable securities 4,003
Cumulative translation adjustments (5,701)
Net loss (1,277,223)
----------- ------------- ------- ---------- -------- ----------
Comprehensive loss
Balance at December 31, 2003 $37,748,004 $(34,373,327) $(1,772) $(5,000) $(426,252) --
============ ============= ======= ========== ======== ==========
F-7
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (continued)
Years ended December 31, 2004, 2003 and 2002
Class A Class B - Series A
---------------- -------------------
preferred stock Preferred stock Common stock
---------------- ------------------- ------------------
Shares Amount Shares Amount Shares Amount
------- -------- -------- ------- ------- -------
Amortization of unearned compensation
Common stock returned and retired (61,500) (61)
Common stock issued 100,000 100
Net proceeds from issuance of
common stock in
Connection with private placement 170,000 170 255,000 255
placement
Issuance of common stock for note
conversions 688,338 688
Exercise of stock options 110,000 110
Issuance of common stock 58,195 58
for services
Issuance of common stock in
connection with CAW acquisitions 175,000 175
Issuance of common stock along 19,600 20
with debt
Option Expense
Preferred stock dividend
Consulting expense
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
======== ===== ====== ====== ========== =======
F-8
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (continued)
Years ended December 31, 2004, 2003 and 2002
CONTINUED
Accumulated
Additional other Stockholders'
paid-in comprehensive Treasury Unearned notes
capital Deficit income (loss) stock Compensation receivable
----------- ------------- ------------- ---------- ----------- ----------
Amortization of unearned compensation 224,496
Common stock returned and retired 61
Common stock issued 470,685
Net proceeds from issuance of
common stock in
Connection with private placement 1,454,575
placement
Issuance of common stock for note
conversions 2,733,957
Exercise of stock options 102,140
Issuance of common stock for services 190,563
Issuance of common stock in
connection with CAW acquisitions 524,825
Issuance of common stock along 74,980
with debt
Option Expense 30,750
Preferred stock dividend (156,375)
Consulting expense (40,000)
Change in unrealized gain on
Marketable securities (4,105)
Cumulative translation (2,463)
adjustments
Net loss (1,976,379)
----------- ------------- ------------- ---------- ----------- ----------
Comprehensive loss
Balance at December 31, 2004 $43,134,165 $(36,349,706) $(8,340) $(5,000) $(201,756) --
=========== ============= ============= ========== =========== ==========
F-8
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2004, 2003 and 2002
Stockholder's
advertising
and in-kind Total
services stockholder's Comprehensive
receivable equity loss
--------------- ------------- -------------
Balance at January 1, 2002 $ (794,990) $ 3,027,029
Common stock and options issued
in connection with compensation
Plan 298,945
Intrinsic value of stock options
issued in connection with
compensation plan 49,825
Issuance of restricted stock 4,200
Purchase of treasury stock (75,752)
Sale of treasury stock 106,497
Retirement of treasury stock -
Extinguishment of notes receivable 213,129
Extinguishment of advertising and
in-kind services receivable from
stockholder 794,990 946,990
Change in unrealized gain on
marketable securities (1,583) $ (1,583)
Cumulative translation adjustments (176) (176)
Net loss (2,486,567) (2,486,567)
--------------- ------------- -------------
Comprehensive loss $(2,488,326)
===========
Balance at December 31, 2002 $ - $ 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
acquistion 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
=============== ===============
The accompanying notes are an integral point of this statement
F-9
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 2004, 2003 and 2002
Stockholder's
advertising
and in-kind Total
services stockholder's Comprehensive
receivable equity loss
------------- ------------- -------------
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 acquisition 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
===========
The accompanying notes are an integral point of this statement
F-10
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
2004 2003 2002
------------ ------------- -------------
Cash flows from operating activities
Net loss $(1,976,379) $ (1,277,223) $ (2,486,567)
Adjustments to reconcile net loss to net cash
used in operating activities
Loss on sale of accounts receivable 79,134 - -
Depreciation and amortization 659,490 625,450 893,935
(Recovery of)/Provision for doubtful accounts - (35,090) 112,351
Amortization of financing cost 90,746 82,142 -
Loss (gain) on sale of marketable securities 15,793 (10,828) 71,237
Loss on sale of preferred stock of investee - 57,600
Equity in earnings of investee (172,224) (92,424) (67,717)
Loss on forgiveness of stockholder's note - - 213,129
receivable
Loss on forgiveness of advertising receivable - - 290,217
from a stockholder
Gain on dissolution of subsidiary - - (215,250)
Gain on settlement of liabilities due to vendors - (282,750) (592,689)
Dividends on preferred stock of subsidiary - 6,125
Non-cash compensation 30,750 67,248 49,825
Operating expenses paid with common stock and
warrants 154,620 100,725 303,145
Changes in operating assets and liabilities
Net (increase) decrease in
Accounts receivable and other receivables (6,466,339) (2,095,518) (1,440,824)
Inventory 337,842 (1,089,208) 265,263
Prepaid expenses, related party note
receivable and other assets (66,011) (122,354) 26,050
Net increase (decrease) in
Accounts payable, related party note
payable, 329,523 1,231,455 (605,182)
accrued expenses and other current
liabilities
Other liabilities - - 282,750
------------ ------------- -------------
Net cash used in operating activites (6,983,055) (2,898,375) (2,836,602)
------------ ------------- -------------
Cash flows from investing activities
Payment of security deposit (35,848) - -
Purchase of business, net of cash acquired - (414,000) -
Purchase of marketable securities (168,377) (488,868) (979,379)
Proceeds from sale of marketable securities 194,515 460,060 2,635,571
Purchase of property and equipment (112,058) (28,638) (14,342)
Payment of collateral security deposit - (500,000) -
Refund of collateral security deposit 500,000 - 658,542
Proceeds from sale of preferred stock of investee - - 230,400
Purchase of customer lists - - (250,000)
Payments received on notes receivable 433,033 2,267 -
Issuance of notes receivable, net loss - (329,000) (110,400)
------------ ------------- -------------
Net cash provided by (used in) investing activities 811,265 (1,298,179) 2,170,392
------------ ------------- -------------
F-11
Synergy Brands, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended December 31,
2004 2003 2002
------------ ------------ -----------
Cash flows from financing activities
Borrowings under line of credit 35,608,070 $19,432,524 $10,486,724
Repayments under line of credit (33,024,140) (17,172,964) (9,130,942)
Increase in deferred financing cost - (18,750) -
Proceeds from the issuance of notes payable 1,990,000 850,000 722,778
Repayments of notes payable (100,000) (20,000) (662,778)
Due from broker - - (1,216,733)
Proceeds from issuance of common stock 462,732 47,200 -
Net proceeds from the issuance of common and preferred stock in
a private placement 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 - 261,321 106,497
Proceeds from stock subscription - 5,000 -
Purchase of treasury stock - (122,779) (75,752)
Payment of dividends (156,375) (78,000) -
------------ ------------ -----------
Net cash provided by financing activities 6,342,537 4,805,052 229,794
------------ ------------ -----------
Foreign currency translation (2,463) (5,700) (176)
------------ ------------ -----------
Net Increase (Decrease) In Cash 168,284 602,798 (436,592)
------------ ------------ -----------
Cash and cash equivalents, beginning of year 777,522 174,724 611,316
------------ ------------ -----------
Cash and cash equivalents, end of year $ 945,806 $ 777,522 $ 174,724
------------ ------------ -----------
Supplemental disclosures of cash flow information:
Cash paid during the year for
Interest $ 1,317,151 $ 590,126 $ 164,000
============ ============ ===========
Income taxes paid $ 34,604 $ 32,658 23,000
============ ============ ===========
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 $ 102
============ ============ ===========
Common stock issued for notes receivable $ - $ - $ 2,500
============ ============ ===========
Common stock issued in satisfaction of note payable $ - $ 40,000 $ -
============ ============ ===========
Common stock issued in connection with consulting agreement and $ - $ 493,500 $ -
============ ============ ===========
services
Common stock issued for note conversions $ 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
December 31, 2004, 2003 and 2002
NOTE A - DESCRIPTION OF THE BUSINESS
Synergy Brands, Inc. and its subsidiaries (collectively, "Synergy" or the
"Company") is engaged in the distribution business. In addition, the
Company develops and operates Internet platform operations and
Internet-based businesses designed to sell 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). 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"). During the year ended December 31, 2002, the
Company dissolved its majority-owned subsidiary (see Note K). 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)
December 31, 2004, 2003 and 2002
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. At December 31, 2004, all marketable securities
held by the Company have been sold. At December 31, 2003 , 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.
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 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.
F-14
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE B (continued)
Accounts receivable trade, net consist of the following components at
December 31, 2004 and 2003
2004 2003
------------ ----------
Accounts receivable - business to business $ 7,218,366 $3,635,741
Accounts receivable - business to consumer 136,604 121,747
------------ ----------
Total 7,354,970 3,757,488
Less allowance for doubtful accounts (127,481) (127,481)
------------ ----------
$ 7,227,489 $3,630,007
============ ==========
Changes in the Company's allowance for doubtful accounts during the years
ended December 31, 2004 and 2003 are as follows:
2004 2003
----------- ----------
Beginning balance $ 127,481 $ 162,571
Provision for (reduction in) doubtful accounts - (35,090)
----------- ----------
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, marketable securities 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 and 2003 totaled $756,150 and $629,164.
Marketable securities are potentially subject to concentration of credit
risk, but such risk is limited due to such amounts being invested in
investment grade securities.
During the year ended December 31, 2004, sales to two customers accounted
for 21% and 18% of total sales, respectively. Four customers accounted for
26%, 26%, 22% and 11%, respectively of accounts receivable at December 31,
2004.
During the year ended December 31, 2003, sales to two customers each,
accounted for 11% of total sales, and in 2002, sales for one customer
accounted for 11% of total sales, respectively. Two customers accounted for
30% and 21%, respectively of accounts receivable at December 31, 2003.
These concentrations relate to the Company's PHS Group segment. In
addition, one customer in the Proset segment accounted for 12% of accounts
receivable at December 31, 2003 (See Note S.)
During the years ended December 31, 2004, 2003 and 2002, the Company
purchased approximately 53 %, 71% and 77%, 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)
December 31, 2004, 2003 and 2002
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, 2004 and 2003, the Company recognized
approximately $913,000 and $318,000 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
$1,246,697 and $674,519 at December 31, 2004 and 2003.
F-16
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE B (continued)
11. Intangible Assets and Goodwill
Intangible assets consist of the "Proset" and "Gran Reserve" trade names
and customer lists acquired in November 1999. The Company re-evaluates the
carrying value of these intangible assets when factors indicating
impairment are present, using an undiscounted operating cash flow
assumption. In February 2002, the Company acquired certain customer lists,
the rights to the use of the trade names Fine Perfume and Fineperfume.com
and the ownership of the Internet domain, www.fineperfume.com for aggregate
consideration of $250,000.
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", Goodwill is 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 will no longer be
amortized but instead will be reviewed for impairment at least annually and
more often 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 that the estimated useful life should be extended
prospectively, by a term of six years from the original useful life of five
years. This modification decreased amortization expense by approximately
$129,000 during the year ended December 31, 2002. As a result, the
remaining carrying amount will be amortized prospectively over the
remaining useful life. In 2004 and 2003, the amortization expense recorded
for the years was $222,312 and $192,354.
At December 31, 2004 and 2003, intangible assets are comprised of the
following:
Amortized intangible assets 2004 2003
------------ ------------
Customer lists $ 3,214,592 $ 3,114,629
Less accumulated amortization (2,003,048) (1,680,773)
------------ ------------
1,211,544 1,433,856
Unamortized intangible assets
Trade names 90,400 90,400
------------ ------------
Total $ 1,301,944 $ 1,524,256
============ ============
Amortization expense for the Company over the next five years is estimated
to be approximately $222,000 per year.
F-17
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
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 $ 150,000, $91,000
and $470,000 for the years ended December 31, 2004, 2003 and 2002.
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. Stock Split
On September 30, 2002, the Company's Board of Directors authorized a
1-for-4 reverse split of its common stock. Share and per share amounts in
the accompanying consolidated financial statements have been retroactively
adjusted for the reverse split.
17. 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)
December 31, 2004, 2003 and 2002
NOTE B (continued)
exercises of stock options and warrants of 681,650, 596,650 and 586,759 for
the years ended December 31, 2004, 2003 and 2002, respectively, have been
excluded from the calculation of diluted loss per share since their effect
would be antidilutive.
18. Stock-Based Compensation Plans
At December 31, 2004, the Company has two stock-based employee compensation
plans, which are described more fully in Note M. 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.
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,
2004 2003 2002
------------ ----------- -----------
$(1,976,379) $(1,277,223) $(2,486,567)
Net loss, as reported
Add: Total stock-based employee
compensation expense included -
in reported net loss 49,825
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method for all
awards - - (601,250)
------------ ----------- -----------
Pro forma net loss $(1,976,379) $(1,277,223) $(3,037,992)
------------ ----------- -----------
Loss per share
Basic and diluted - as reported $(0.97) $(0.82) $(1.91)
------------ ----------- -----------
Basic and diluted - pro forma $(0.97) $(0.82) $(2.33)
------------ ----------- -----------
F-19
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
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:
2002
-------
Dividend yield 0%
Expected volatility 114%
Risk-free rate of return 4.0%
Expected life 3 years
Weighted-average option fair value $2.79
No stock options were granted during the year ended December 31, 2004 and
2003.
19. 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)
December 31, 2004, 2003 and 2002
NOTE B (CONTINUED)
20. 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 that begins after June 15,
2005. The Company adoption of SFAS No.123(R) is not expected to have a
material impact on the Company's financial position or results of
operations.
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.
F-21
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE C - ACQUISTION
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). CAW is
a leading supplier of premium hand made cigars to some of the most
prestigious hotels, restaurants, casinos and golf 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 shares. The shares
were valued at $425,000, and recorded as additional Goodwill of $250,000,
and prepaid compensation of $175,000.
The acquisition of CAW has been accounted for as a purchase pursuant to
SFAS No. 141, " 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 initial allocation of the aggregate
purchase price of $425,000, including contingent consideration.
Cash $ 11,000
Accounts Receivable 374,000
Other Assets 9,000
Customer List 361,000
Goodwill 64,000
Accounts Payable (331,000)
Other Current Liabilities (35,000)
Other Long-Term Liabilities (28,000)
-----------
$ 425,000
===========
The intangible assets acquired consist principally of customer lists, which
are being amortized over an 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)
December 31, 2004, 2003 and 2002
NOTE C (continued)
Summarized below are the unaudited pro forma results of operations of the
Company as if CAW had been acquired at the beginning of the years
presented:
Year Ended December 31,
2003 2002
-------------- -----------
Net sales $41,066,000 $32,935,000
Net loss per common shareholder (1,342,000) (2,477,000)
Net loss per common share:
Basic $(0.81) $(1.90)
Diluted $(0.81) $(1.90)
The pro forma financial information presented above for the year ended
December 31, 2003 and 2002 are not necessarily indicative of either the
results of operations that would have occurred had the acquisition taken
place at the beginning of the periods presented or of future operating
results of the combined companies.
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.
F-23
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE E - MARKETABLE SECURITIES
The cost, gross unrealized gains, gross unrealized losses and fair market
value for marketable securities by major security type at December 31, 2003
are as follows:
2003
-----------------------------------------------------
Gross Gross Fair
unrealized unrealized market
Cost gains losses value
--------- ----------- ---------- ---------
Available-for-sale securities
Equity securities $41,930 $4,105 - $46,035
There were no securities available for sale at December 31, 2004.
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, 2003 and 2002 are as follows:
2004 2003 2002
Available-for-sale securities
Proceeds $194,515 $460,060 $2,635,571
Gross realized gains 19,973 27,713 66,414
Gross realized losses (35,766) (16,885) (137,651)
NOTE F - INVENTORY
Inventory as of December 31, 2004 and 2003 consisted of the following:
2004 2003
----------- ----------
Grocery, health and beauty products $1,375,165 $1,845,308
Tobacco finished goods 451,109 318,808
$1,826,274 $2,164,116
----------- ----------
F-24
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE G - PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2004 and 2003 consisted of the
following:
2004 2003
---------- ---------
Office equipment $204,610 $ 204,610
Furniture and fixtures 231,265 231,266
Leasehold improvements 523,731 411,673
---------- ---------
959,606 847,549
Less accumulated depreciation and amortization (593,096) (468,325)
---------- ---------
$ 366,510 $ 379,224
---------- ---------
Depreciation and amortization expense on property and equipment for the
years ended December 31, 2004, 2003 and 2002 was approximately $125,000,
$123,000 and $118,000, respectively.
NOTE H - OTHER ASSETS
Other assets consist of the following at December 31, 2004 and 2003:
2004 2003
--------- ---------
Investment (a) $336,828 $164,604
CAW purchase agreement; net of accumulated amortization
of $29,163 145,837 -
Website development costs, net of accumulated
amortization of $929,479 and $924,104 - 5,375
Deferred financing net of accumulated
amortization of $32,625 97,875 -
Other 51,926 16,078
--------- ---------
$ 632,466 $ 186,057
========= =========
(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, 2004, the Companies investment in ITT is
approximately 21.5% 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 also purchased 288,000
shares of nonvoting redeemable preferred stock of the investee. The
aggregate cost of the investment was $290,880. The Company accounts for
this investment under the equity method. During the year ended December 31,
2002, the Company sold the 288,000 shares of nonvoting redeemable preferred
stock for aggregate proceeds of $230,400. The Company recorded a loss of
$57,600 in conjunction with this sale. The Company recorded equity in the
net earnings of investee of $172,224, $92,424 and $67,717 during the years
ended December 31, 2004, December 31, 2003 and
F-25
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE H (continued)
2002, respectively. At December 31, 2004, the Company's investment exceeded
its shares of the underlying net assets of ITT by $65,000. The excess is
attributable to the goodwill of IIT.
Summarized unaudited financial information of this investee as of December
31, 2004, 2003 and 2002 and for the years ended is as follows::
Financial position: 2004 2003 2002
------------ ---------- ----------
Current assets $ 2,020,000 $1,511,000 $1,545,000
Property and equipment 290,000 147,000 207,000
Other assets 267,000 306,000 345,000
------------ ---------- ----------
Total assets $ 2,577,000 $1,964,000 $2,097,000
============ ========== ==========
Current liabilities $ 1,322,000 $ 972,000 $ 737,000
Long-term debt - 82,000 524,000
Other long-term liabilities 4,000 9,000 3,000
------------ ---------- ----------
Total liabilities $ 1,326,000 $1,063,000 $1,264,000
============ ========== ==========
Results of operations: 2004 2003 2002
------------ ---------- ----------
Revenues $10,883,000 $ 9,602,000 $ 8,167,000
Total expenses (9,934,000) (8,906,000) (7,637,000)
Other income 111,000 54,000 44,000
------------ ---------- ----------
Income before income taxes 1,069,000 750,000 574,000
Income tax expense (359,000) (268,000) (210,000)
------------ ---------- ----------
Net income $ 701,000 $ 482,000 $ 364,000
============ ========== ==========
F-26
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
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 promissory note,
which is secured by accounts receivable and inventory, bears interest at
4%. The principle balance of $429,600 was paid March 31, 2004.
In December 2004, the Company sold accounts receivable attributable to a
selected customer base 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 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.
NOTE J - LINE OF CREDIT AGREEMENT, NOTES PAYABLE AND NOTE PAYABLE
TO STOCKHOLDER
In 2002, the Company entered into a promissory note with a lender that
provide for borrowings of $60,000 which, bore interest at a rate of 9% per
annum and was due on December 31, 2004. On March 31, 2003 the Company
entered into a modification agreement with the lender pursuant to which the
Company exchanged the note for 15,300 shares of common stock valued at
$40,000 and $20,000 in cash.
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 September 2004, under the loans allow
for the borrowing of up to $8,500,000 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. The terms of the agreements are for one year and provide for
automatic renewals unless written consent by either the Company or the
Lender is provided within 60 days of the renewal date. As amended, the
agreements extend through May 31, 2005. Interest accrues on outstanding
borrowings at the greater of (i) 8% per annum in excess of the prime rate
or (ii) 17% per annum. The minimum interest to be paid for any year under
the line of credit is $320,000. At December 31, 2004, the interest rate on
outstanding borrowings was 17%. 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. The Company has guaranteed
these loans on an unsecured basis. In November 2003, the Company secured a
$2 million stand by letter of credit (LC) for the purpose of increasing its
line of credit to $3.5 million with a major vendor. The LC was secured by a
$500,000 cash deposit as well as certain reserves modified under the loan
and security agreement with the Lender. The LC expired in May 2004, at
which time the cash deposit and reserves were released. 525,000 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 L).
F-27
Synergy
Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
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 21.5%
investee. Borrowings under the notes bear interest at a rate of 12%. The
Company is not required to repay any principal until the maturity date of
the notes, February 4, 2006 as amended. 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 will be amortized over the life
of these notes payable. In 2004, the Company converted $263,646 of this
outstanding debt into 66,756 shares of common stock (see note L).
Amortization expense recorded in 2004 and 2003 was approximately $28,000
and $26,000. As security for the notes, the Company pledged as collateral
its investment in the common stock of ITT.
On July 1, 2003, the Company received $350,000 pursuant to the issuance of
three secured promissory notes from certain shareholders of ITT, a 21.5%
investee. Borrowings under the notes bear interest at a rate of 12%. The
Company is not required to repay any principal until the maturity date of
the notes, June 30, 2005. 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 will 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 L). Amortization recorded in 2004 and 2003 was
approximately $31,000 and $10,000.
1. On March 1, 2004, the Company received $490,000 pursuant to the issuance
of three secured promissory notes from certain shareholders of ITT, a 21.5%
investee. Borrowings under the notes bear interest at a rate of 12%. The
Company is not required to repay any principal until the maturity date of
the notes, February 28, 2006. 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 recorded
in 2004 was approximately $31,000.
2. 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 $5.00 per share 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 warrants to purchase up to 100,000
shares of common stock at an exercise price of $5.00 per share. The
Company's common stock quoted market price at the date of closing was $4.15
per share. The debenture has a three-year term with a coupon rate of prime
(5.25% at December 31, 2004) 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.
Aggregate maturities of notes payable at December 31, 2004 are as follows:
Year Ending December 31,
2005 $ 384,021
2006 $ 1,046,241
2007 $ 150,000
Total $1,580,262
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 $3.50
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. 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 $2.52 per share. The debenture has a
three-year term with a coupon rate of prime plus 3%.
F-28
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE K - MINORITY INTEREST
Premium Cigar Wrappers, Inc. ("PCW") was incorporated in October 1997 with
7,750 shares of authorized $.001 par value common stock for the purpose of
producing premium cigar wrappers in the Dominican Republic. PCW had 1,000
shares of common stock outstanding, which were issued at par value. The
Company owned 66% of the common stock and an outside investor owns the
minority interest. In addition, PCW had 2,250 shares of authorized $.001
par value preferred stock issued and outstanding at December 31, 1998. PCW
issued 1,750 shares of preferred stock at inception to two unrelated
individuals at $60 per share, and 500 shares to the Company for a 22%
minority interest in the preferred stock. The holders of PCW preferred
stock were entitled to receive cumulative dividends at the rate of $14 per
share before any dividends on the common stock are paid. The Company's
portion of the dividends have been eliminated in consolidation. In the
event of dissolution of PCW, the holders of the preferred shares are
entitled to receive $60 per share together with all accumulated dividends,
before any amounts can be distributed to the common stockholders. The
shares were convertible only at the option of PCW at $120 per share.
In May 2002, the shareholders of PCW authorized a dissolution of PCW as PCW
had discontinued its operations during the year ended December 31, 2000.
Upon the dissolution of PCW, there were no assets available for
distribution. As a result, the Company recorded a gain of $215,250, which
is included as a component of other income (expense) in the 2002
accompanying consolidated statement of operations, or $.17 per share on the
dissolution of PCW, related to cumulative dividends payable of $110,250 and
capital contributed by the minority shareholders of $105,000.
NOTE L - STOCKHOLDERS' EQUITY
The Company has 100,000 authorized and outstanding shares of Class A
preferred stock with a par value of $.001; 13-to-one voting rights;
liquidation of $10.50 per share and before common stock and redemption at
option of Company at $10.50 per share.
On September 30, 2002, the Company exchanged in full its outstanding note
payable and accrued interest of $656,773 through a revision agreement with
SBG for the termination of $794,990 of its outstanding unused advertising
credits with Sinclair. In addition, the Company issued 75,000 shares of
stock and 31,250 warrants exercisable at $5.00 to Sinclair in conjunction
with this transaction. The Company recorded a charge to earnings of
$290,218 as the fair market value of the consideration given exceeded the
unused advertising credits.
In January 2002, the Company issued 25,000 shares of common stock and
forgave $113,129 in shareholder indebtedness to the Company in exchange for
the cancellation of 61,222 outstanding cashless warrants. A charge to
operations of $213,129 was recorded in connection with this transaction.
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. 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.
F-29
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE L (continued)
In January 2003, the Board of Directors of the Company approved a private
placement of securities ("2003 Private Placement") in which 100,000 units
were offered, with each unit consisting of one share of unregistered Class
B, Series A Preferred Stock and one share of unregistered restricted common
stock, at a purchase price of $10.00 per unit. In February 2003, the
Company sold 60,000 units and received aggregate proceeds of $600,000 as a
result of the 2003 Private Placement.
In June 2003, the Board of Directors approved a second Private Placement in
which 100,000 units were offered, with each unit consisting of one share of
unregistered Class B, Series A preferred Stock and one share of
unregistered restricted Common Stock at a purchase price of $10.00 per
unit. In June and July 2003, the Company sold 10,000 and 90,000, units and
received aggregate proceeds of $100,000 and $900,000 respectively. In
connection with the January and June private placements, the Company
incurred $90,000 in legal fees which are netted against the proceeds.
In July 2003, the Company issued 150,000 shares of common stock in
connection with an agreement for consulting services for the three year
period ending June 30, 2006. The Company recorded $403,500 as unearned
compensation and recorded compensation expense of $67,248 for during 2003
and $134,496 for 2004.
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 2004, certain shareholders of ITT converted $613,646 of debt into
153,156 shares of common stock. In 2004, Laurus Master Funds converted
$500,000 of debt into 100,000 shares of common stock. Also, in 2004, the
Company converted $1,621,000 outstanding debt of IIG into 435,182 shares of
common stock (see Note J).
During the years ended December 31, 2003 and 2002, the Company repurchased
47,866 and 21,329 shares of treasury stock for an aggregate amount of
$122,779 and $75,752, respectively. The Company sold 54,366 shares of its
treasury stock during the year ended December 31, 2003, for aggregate
proceeds of $261,321.
For the years ended December 31, 2004 and 2003, the Company issued 58,195
and 65,938 shares of common stock as compensation for past and future
service and recorded a charge to operations of $150,621 and $93,125 and
unearned compensation of $90,000 in 2003. In 2003 the Company also issued
options to purchase 75,000 shares of its common stock at a exercise price
of $4.00 per share, with a fair value of $7,500, to a principal at a major
customer in Canada and issued 30,000 shares of common stock to an unrelated
third party for $47,200.
For the year 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, 2004, 2003 and 2002.
F-30
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
Weighted-
Number average
of shares exercise price
-------------- ----------------
Outstanding at January 1, 2002 281,250 $ 12.27
Granted 31,250 5.00
Cancelled/forfeited (85,000) (19.41)
--------------
Outstanding at December 31, 2002 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
============== ----------------
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 2004 life (years) price 2004 price
----------------- -------------- -------------- ---------- --------------- --------
$5.00 273,750 3.45 $ 5.00 173,750 $ 5.00
10.00 - $12.00 31,250 .97 10.40 31,250 10.40
30.00 - 40.00 5,000 .33 30.00 5,000 30.00
-------------- -------------- ---------- --------------- --------
310,000 3.15 $ 5.95 310,000 $ 5.95
============== ============== ========== =============== =========
Shares issuable under outstanding options, warrants, and convertible
securities at December 31, 2004 approximated 1,028,660.
F-31
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE M - 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 1,181,033 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, 2004, 2003 and 2002, the Company issued
42,195, 65,938 and 85,500 shares of its common stock, respectively, to
various service providers and has recorded a charge to earnings of
$150,621, $93,125 and $298,945. 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. During the year ended
December 31, 2002, the Company recorded a charge to operations of $49,825,
which represented the intrinsic value of stock options granted to employees
and directors in January 2002. There were no options issued during the
years ended December 31, 2004 and 2003.
The following is a summary of such stock option transactions for the years
ended December 31, 2004, 2003 and 2002 in accordance with the Plan and
other restricted stock option agreements:
Weighted-
Number average
of shares exercise price
------------- --------------
Outstanding at January 1, 2002 140,809 $ 32.12
Cancelled/forfeited (13,175) (34.66)
Granted 356,625 2.81
------------- --------------
Outstanding at December 31, 2002 484,259 10.46
Granted 85,000 3.53
Cancelled/forfeited (25,109) (9.08)
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
============= ==============
Shares available for grant
December 31, 2004 7,218,967
=============
December 31, 2003 7,261,162
=============
December 31, 2002 7,457,291
=============
F-32
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE M (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 2004 life (years) price 2004 price
------------------ ----------------- -------------- ----------- -------------- ----------
$ 1.00 - $ 4.00 266,125 .12 $ 3.85 266,125 $ 3.85
18.00 - 20.00 29,000 .35 18.34 29,000 18.34
25.00 - 35.60 36,275 .31 27.36 36,275 27.36
40.00 - 50.00 8,500 .01 42.94 8,500 42.94
60.00 - 70.00 31,750 .38 61.57 31,750 61.57
================= ============== =========== ============== ==========
371,650 .18 $ 13.10 371,650 $ 13.10
================= ============== =========== ============== ==========
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, 2004 and 2003.
NOTE N - TRANSACTIONS WITH RELATED PARTIES
The Company pays 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 and 2002 aggregated
approximately $55,000 and $134,000 respectively.
At December 31, 2002, there was an amount receivable from the entity that
is owned by the Company's Chairman and Chief Executive Officer aggregating
$44,750. In the first quarter of 2003, the receivable was repaid. At
December 31, 2004 and 2003, $56,972 and $100,800 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)
December 31, 2004, 2003 and 2002
NOTE O - OTHER INCOME (EXPENSE)
Other income (expense) is comprised of the following:
2004 2003 2002
----------- --------- --------
Gain on settlements of liabilities due to vendors $ - $282,750 $592,689
(Note R-3)
Gain on dissolution of subsidiary (Note K) - - 215,250
Loss on forgiveness of notes receivable from a
shareholder (Note L) - - (113,129)
Gain (loss) on sales of marketable securities (Note E) (15,793) 10,828 (71,237)
Loss on sale of preferred stock of an investee (Note H) - - (57,600)
Other 47,944 5,354 (51,113)
Loss on sale of accounts receivable (79,134) - -
----------- --------- --------
$ (46,983) $298,932 $514,860
=========== ========= ========
NOTE P - INCOME TAXES
At December 31, 2004, the Company had a net operating loss carry forward of
approximately $32,042,000 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, 2004 were
approximately as follows:
Net operating loss carryforwards 10,894,000
Fixed assets and intangibles 1,000
Allowance for doubtful accounts 43,000
Inventory 42,000
Capital losses 56,000
Other (74,000)
Valuation allowance (10,962,000)
------------
$ -
============
Income taxes expense for the years ended December 31, 2004, 2003 and 2002
consisted of the following:
2004 2003 2002
-------- ------- --------
State and local $ 34,604 $32,658 $22,687
======== ======= ========
F-34
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE P (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, 2004, 2003 and 2002 are as follows:
2004 2003 2002
------ ------- ------
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 Q - QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Quarterly financial results for the years ended December 31, 2004 and 2003
are as follows:
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
INCOME(LOSS) BEFORE EXTRAORDINARY ITEMS $ (457,974) $ (700,008) $ (170,230) $ (804,542) $ 2,132,754)
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)
THREE MONTHS ENDED
3/31/03 6/30/03 9/30/03 12/31/03 TOTAL
SALES $ 9,079,644 $ 8,755,226 $10,278,027 $12,427,680 $ 40,540,577
GROSS PROFIT $ 509,778 $ 914,334 $ 619,625 $ 765,462 $ 2,809,199
INCOME(LOSS) BEFORE EXTRADORDINARY ITEMS $ (132,818) $ (97,551) $ (627,923) $ (496,931) $ (1,355,223)
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDER $ (132,818) $ (97,551) $ (627,923) $ (496,931) $ (1,355,223)
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (0.09) $ (0.07) $ (0.34) $ (0.32) $ (0.82)
NOTE R - RETIREMENT PLAN
On January 1, 2002, the Company established the Synergy Brands, Inc. 401(k)
Profit Sharing Plan (the "Plan") covering employees 21 years of age and
older who have completed six months of continuous service. The Plan is a
defined contribution plan which provides for voluntary employee
contributions and discretionary employer contributions. Employees become
fully vested in employer contributions after three years. The Company's
discretionary matching and profit-sharing contributions to the Plan were
$19,838, $13,252 and $18,846 for the years ended December 31, 2004, 2003
and 2002, respectively.
F-35
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE S - 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 expiring in 2004. Future minimum lease
payments under noncancelable operating leases as of December 31, 2004 were
as follows:
Year ending December 31,
2005 $ 384,609
2006 358,444
2007 346,148
2008 341,158
2009 342,964
-----------
$1,773,323
===========
Rent expense under operating leases for the years ended December 31, 2004,
2003 and 2002 was approximately $190,000, $112,000 and $130,000,
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
Since 1999, the Company has disputed services performed by two vendors. In
December 31, 2002, the Company and one 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
service that it had disputed. The Company recorded a gain of $592,689 as a
result of the release by the vendor.
During the first quarter of 2003, the Company has entered into a settlement
and release agreement in which the Company paid $13,000 to a vendor and the
Company has been 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)
December 31, 2004, 2003 and 2002
NOTE T - 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, 2004
2003 and 2002, as shown below:
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 stockholder (219,204) (167,951) (644,870) (1,100,729) (2,132,754)
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 1,732,066 3,590,427 16,600,491
Additions to long-lived assets - 85,980 175,000 29,078 290,058
Investment in affiliate - - - 336,829 336,829
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 stockholder (502,158) (79,864) (235,636) (537,565) (1,355,223)
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
Year ended December 31, 2002
Revenue $2,537,216 $27,745,818 $ 1,257,641 - $31,540,675
Net loss attributable to common (833,712) (293,088) (15,711) (1,344,056) (2,486,567)
stockholder
Depreciation and amortization 468,842 272,667 127,764 24,662 893,935
Interest income - 3,024 - 23,671 26,695
Other income (expense) (6,407) (18,056) 579,482 (40,159) 514,860
Equity in earnings of investee - - - 67,717 67,717
Interest and financing expenses 60,336 94,582 38,013 18,348 211,279
Identifiable assets 2,193,471 2,477,292 711,531 489,375 5,871,669
Additions to long-lived assets - 2,150 10,964 251,228 264,342
Investment in affiliate - - - 72,180 72,180
F-37
Synergy Brands, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 2004, 2003 and 2002
NOTE T (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, 2004, 2003 and 2002, is as follows:
2004 2003 2002
------------ ------------ -----------
Revenue
United States $30,774,482 $34,076,666 $30,555,151
Canada 25,930,562 6,463,911 985,524
------------ ------------ -----------
$56,705,044 $40,540,577 $31,540,675
============ ============ ===========
Accounts receivable
United States $ 1,144,373 $1,822,677 $ 1,256,041
Canada 6,210,597 1,934,811 776,628
------------ ------------ -----------
$ 7,354,970 $3,757,488 $ 2,032,669
============ ============ ===========
Identifiable assets
United States $16,706,423 $10,818,667 $ 5,824,230
Canada - 173,978 47,439
------------ ------------ -----------
$16,706,423 $10,992,645 $ 5,871,669
============ ============ ===========
F-38
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 defining rights of security holders (3) EX-4
10.3 Synergy Brands Inc. 1994 Services and Consulting Compensation
Plan, as amended (4)
21 Listing of Company Subsidiaries EX-21
32 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
31.2 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-32.1
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. 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
44
(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 herein as
an exhibit. 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 none of such debt on an individual
basis exceeds 10% of the Company's current assets. Such instruments
include $900,000 debt currently owed to Laurus Master Fund, Ltd.
arising from Secured Convertible Term Note dated April 2, 2004, 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
45