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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.
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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