10-K 1 file001.txt 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, 2006. Commission file number 0-19409 SYNERGY BRANDS INC. (Exact name of registrant as specified in its charter) DELAWARE 22-2993066 (State of incorporation) (I.R.S. Employer Identification No.) 223 Underhill Blvd. Syosset, NY 11791 (Address of corporate offices) Registrant's telephone number, including area code: 516-714-8200 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange Common Stock, $.001 par value NASDAQ/Small-Cap System and Boston Stock Exchange The purpose for this amendment is to include corrected Certifications required by Exchange Act Rule 13a-14(a); no other changes have been made from the original filing. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES __ NO_X____ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. YES___NO__X____ Note-Checking the box will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes_X_ NO__ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes__NO_X_ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES________NO X___ Synergy Brands Inc. revenues for its most recent fiscal year were $71,759,908. On March 30, 2007, the aggregate market value of the voting stock of Synergy Brands Inc., held by non-affiliates of the Registrant was approximately $6,800,000. 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, 2007 was 7,908,292. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Registrant's 2006 Annual Meeting of Stockholders currently scheduled to be held June 2007 are incorporated by reference in Part III (for other documents incorporated by reference refer to Exhibit Index at page and); also committee charters are included verbatim on the Company's website at www.sybr.com and such information and historical organization documentation on the Company are incorporated by referenced to the source thereof, as more particularly set forth in such listing of Exhibits). PART I Other than historical and factual statements, the matters and items discussed in this report on Form 10-K are forward-looking information that involve risks and uncertainties. The Company's actual results may differ materially from the results discussed in the forward-looking statements. Factors that could contribute to such differences are discussed in the forward-looking statements and are summarized in Item 1A "Risk Factors Forward-Looking Information and Cautionary Statements." ITEM 1. DESCRIPTION OF BUSINESS A. OVERVIEW Synergy Brands Inc. (SYBR or the Company) is a holding company that principally operates through a wholly owned subsidiary, PHS Group Inc. ("PHS"), in the wholesale distribution of Groceries and Health and Beauty Aid (HBA) products but operates as well through its wholly owned subsidiary, Gran Reserve corporation, the business of wholesale and on-line distribution of premium cigars and accessories, and through such subsidiary, trading as Beautybuys.com, salon products and luxury goods. It principally focuses on the sale of nationally known brand name consumer products manufactured by major U.S. manufacturers and has also entered the grocery private label market in FY 2006. The consumer products are concentrated within the Grocery and Health & Beauty Aids (HBA) industries. The Company uses logistics based programs to optimize its distribution costs on both wholesale and retail levels. The Company also owns 20% 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 should provide for material future capital appreciation. Synergy Brands does not manage PERX's day-to-day operations. For further information please visit the Company's corporate website at www.sybr.com. -1- PHS GROUP (GROCERY & HBA OPERATIONS). PHS Group distributes Grocery and HBA products to retailers and wholesalers predominately located in the Northeastern United States. PHS is the largest subsidiary of the Company and largest business segment of the Company's business operations, representing about 97% of the overall Company sales and 88% of gross profit. PHS's core sales base remains the distribution of nationally branded consumer products in the grocery and health and beauty (HBA) sectors. PHS has positioned itself as a distributor for major manufacturers as opposed to a full line wholesaler. A full line wholesaler has the responsibility of servicing the entire needs of a retail operation, whereas a distributor caters to specific merchandising categories. As a result, PHS is able to plan the needs of its customers and benefit the manufacturer as the direct supply source and in turn increase sales to its customers at optimized pricing through this unique strategy. PHS concentrates on what it perceives to be faster moving promotional items such as: Tide, Bounty, Nyquil, Pantene, Clorox bleach, Scott tissues, Marcal tissues among many others, and uses promotions, logistics and distribution savings to streamline and reduce its sale prices and increase gross profit thereby. The second business segment within this sector was Proset Hair Systems (Proset). Proset discontinued its operations in the 4th quarter of FY 2006. In the third quarter of 2006 PHS entered the private label grocery market specializing in the distribution of baking mixes and spices to national chains on a proprietary basis. PHS hopes to develop private label programs for national accounts by creating proprietary baking mix products and spice planograms specifically designed for retail need. GRAN RESERVE CORPORATION (PREMIUM CIGAR OPERATIONS) The Company's premium cigar operations are conducted through its wholly owned subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses (under the business names stated) o Cigars Around the World (CAW) sells premium cigars to restaurants, hotels, casinos, country clubs and many other leisure related destinations. This company was acquired in June, 2003. CAW also opened a retail store and lounge in Miami Lakes, Florida selling premium cigars and accessories in March 2006. o CigarGold.com sells premium cigars through the Internet directly to the consumer and through partnership online affiliations. o BeautyBuys.com sells salon hair care products directly to the consumer via the internet and through partnership online affiliations. THE COMPANY'S CORPORATE OFFICES ARE LOCATED AT 223 UNDERHILL BLVD., SYOSSET, NY 11791, AND ITS TELEPHONE NUMBER IS 516-714-8200. THE COMPANY MAINTAINS A CORPORATE WEBSITE AT WWW.SYBR.COM. The Company is a reporting Company as defined in Regulation 12B of the Securities Exchange Act of 1934 and files electronically with the SEC the Company's quarterly 10Q and Year-end 10-K reports and interim Form 8K reports. The general public may read and copy any materials the Company has filed with the SEC at the SEC Public Reference Room at 450 Fifth Street NW, Washington DC. The general public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC which website can be accessed at www.sec.gov. Filed reports by the Company may be viewed at the SEC Edgar filing website to which the Company's homepage website is directly linked. Information on the Company's website is not deemed to be incorporated by reference into this report except as otherwise specifically listed within this report. 2 B. PHS GROUP (Grocery & HBA Operations) PHS Group heading the principal business of the Company representing 97% of total revenues, is involved in the purchase of name brands grocery and Health and Beauty Aids (HBA) products and their further resale to traditional customers utilizing the logistics and networking advantages of electronic commerce and just in time distribution. PHS's core sales base consists of the distribution of nationally branded consumer products in the grocery and HBA sectors and wholesale distribution of grocery items predominantly in the United States, Canada, and other international markets. Reference is made to the financial statements, schedules, and notes to financials wherein more specific disclosure is presented regarding amounts of revenues derived from foreign sales as compared to domestic.Distribution of such products is directed to major retailers and wholesalers from major U.S. and Canadian consumer product manufacturers and distributors. 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 what it perceives to be 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 1000 outlets in the northeastern quadrant of the United States and Canada. PHS utilizes leased trucks in addition to consigning common carriers for overflow sales. In the third quarter of 2006 PHS entered the private label grocery market specializing in the distribution of baking mixes and spices to national chains on a proprietary basis. PHS hopes to develop private label programs for national accounts by creating proprietary baking mix products and spice planograms specifically designed for retail need. C. GRAN RESERVE CORPORATION (Cigar Sector). GRC owns multiple internet domains including Cigargold.com, cigarsaroundtheworld.com and affiliations. GRC focuses on sale of a mix of brand name and private label premium cigar items and cigar related accessories and markets them through these sties. GRC also manages the internet sales of Beautybuys.com which are less than 5% of overall online sales. GRC cigar operations include two businesses. This segment includes Cigars Around the World (CAW) and CigarGold. Cigars Around the World (CAW) was acquired in June of 2003. That Company sells premium cigars to Hotels, Restaurants, Casinos, PGA Clubs and other leisure related destinations. CAW was founded by Bill Rancic, initial winner of the NBC show The Apprentice. Mr. Rancic serves on the Board of Directors of Synergy Brands. CAW sells, its cigars, in large part 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. Its displays range from counter top humidors to Walled Display units. CAW also organizes events such as cigar dinners and merchandising opportunities within its destinations. CigarGold (CG) is the Company's main cigar online unit. CG sells premium cigars online to retail customers throughout the United States. It has a selection of over 1000 products, which include brand-name hand made premium cigars and cigar accessories as well as private label and proprietary products. CigarGold operates under the domain name: www.CigarGold.com. -3- The Company through its websites also 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 cigar 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. CG 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. The system is designed such that at any given time, Company executives can determine the quantity of product stored by item, cost by item, aging and other characteristics necessary for expeditious fulfillment and distribution. A network system of the Company's office and warehousing facilities allows for online assessment and transactional reporting capabilities. It is the Company's policy that all consumer orders are shipped from the Company's warehouse within 3 days of order placement. GRC maintains an inventory on approximately 95% of its product mix; the other 5% is purchased on a just-in-time basis. The distribution facility has sufficient space to handle the Company's anticipated growth in this area of product sales. After an order is shipped, customers can view order tracking information through a customized profile for each customer. As customers use the CG web site, they provide CG with information about their buying preferences and habits. CG then can use this information to develop personalized communications and deliver useful information, special offers and new product announcements to its customers. In addition, CG uses e-mail to alert customers to important developments and merchandising initiatives. 4 CG competes with many and varied sources for cigar products in a small but affluent market which is highly fragmented and which has to date a small on-line presence. No single traditional retailer to the Company's knowledge competes against the Company in all of its product lines and there is an array of developed e-commerce cigar sites. The largest competitor, JR Cigars has developed an e-commerce web site for its product sales as an adjunct to their traditional brick and mortar retail stores and catalogue sales. Traditional pre-internet cigar sales appear to have evolved through the following four categories of retailing, which together remain the main source of cigar marketing: 1. Mom and Pop brick and mortar tobacco shops that typically average 2500 square feet and generate average annual volume of approximately $250,000 per store. 2. Chain and franchise brick and mortar tobacco shops that average 12,000 to 15,000 square feet and generate approximately $1,000,000 in annual volume per store. 3. Catalog and mail order vendors that do monthly mailings to as many as 500,000 customers (in some instances as few as 25,000 customers), which is the portion of the market that the Company believes should be the easiest to convert to ecommerce purchases, and 4. Drug stores and mass market retailers representing a small share of the market. The Company believes that the following are principal competitive advantages present in its operations and product presentation: brand recognition, selection, convenience, price, web site performance and accessibility, customer service, quality of information provided and reliability and speed of order shipment, acute knowledge of cigar brands, quality of products, stable source of supply, editorial contribution regarding cigar news and one on one online customer interaction. Greater than fifty percent of NetCigar customers are repeat customers on a daily basis. Many of the Company's off-line and online competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than CG. 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 FY 2007 the Company desires to and will likely continue implementation of plans to expand on its online partnerships for all its product offerings and expand CAW retail store operations. The second business area of this segment within the Company's B2C sector is sale directly to the consumer of salon products on-line through Beautybuys.com and other on-line partnership affiliations. This latter online unit operates at www.BeautyBuys.com. BeautyBuys.com sells salon hair products directly to the retail consumer. -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 the Company believes should stay stable. Most of the Company's suppliers are regulated under fair trade and pricing regulations. As a result the Company can remain competitive as long as it purchases products at prescribed volume and credit limitation set by the suppliers. E. MAJOR CUSTOMERS. During the year ended December 31, 2006, sales to three customers accounted for 21%, 16% and 12% of the Company's total sales and in 2005 sales to three customers accounted for 12%, 11% and 10% of total sales. These major customers relate to the grocery logistics business within the Company's PHS Group (grocery and HBA operation) sector. F. INFORMATION SYSTEMS AND WEBSITE TECHNOLOGY FOR INTERNET SALES. The various web sites established for sale of the Company's products are of multi-tier construction to allow for ease of administration and record keeping. Behind the screen not visible to the consumer when visiting the Company's various product category websites are internet based marketing and accounting information programs to allow the Company to review interest shown in its websites and account for sales made there from. The Company also maintains its own websites regarding information on the Company as a public entity and its various business interests. The Company's home page website is linked directly to the SEC Edgar based listing of all Company SEC filings where further Company information disclosure as required by the SEC is contained including reference to and listing of various Company committee charters and disclosure policies which charters and policies should also be accessible by link from the Company's website at www.sybr.com. Internet sites presently available regarding Company business and product sales are: BeautyBuys.com SynergyBrands.Com DealbyNet.com Perx.com (managed by Interline Travel & Tours) SYBR.com CIGARGOLD.com CigarsAroundtheWorld.com 6 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 its specialized, proprietary software that the Company believes is unique to its Business. The Company utilizes a computerized web based database management system that collects, integrates and allows analysis of data concerning sales, order processing, shipping, purchasers, receiving, inventories, and financial reporting. At any given time, the database management systems utilized by the Company are designed to allow management to determine the quantity of product stored by item, cost by item, aging and other characteristics necessary for expeditious fulfillment and distribution. The Company has implemented a broad array of services and systems for site management, searching, customer interaction, transaction processing and fulfillment. The Company uses a set of software applications for: accepting and validating customer orders; organizing, placing, and managing orders with vendors and fulfillment partners; receiving product and assigning it to customer orders; and managing shipment of products to customers based on various ordering criteria. The Company's websites can be shopped 24 hours a day, seven days a week from anywhere that a consumer has Internet access. The Company offers a large selection of products and in addition provides various levels of selected product content, buying guides and other tools designed to help consumers make educated purchasing decisions. Additionally, shopping list and e-mail reminders are designed to make it easier for customers to regularly purchase their preferred products. The Company's marketing efforts are aimed at flexibility of presentation to attract new and repeat customers and give ease of access to product availability and information. The Company's online store provides flexibility to change featured products or promotions without having to alter the physical layout of a store. The Company is also able to dynamically adjust its product mix in response to changing customer demand, new seasons or holidays and special promotions. The Company has the ability to offer products to individual customers based on their brand preferences. The Company also cross-sells its departments to promote impulse buying by customers. The Company's proprietary internet technology and that independently developed as utilized by the Company does focus on and gives protection for customers and supplier privacy concerns. 7 The Company also maintains a Virtual Private Network (VPN) and intranet system. This network allows for real time sales and order processing across to Company's regional offices and warehouses. The network has been customized for logistics, warehousing accounting, management information systems, and distribution. G. SEASONALITY Sales by PHS Group and presently Proset usually peak at the end of a calendar quarter, when the Company's suppliers offer promotions which lower prices and, in turn, the Company is able to lower its prices and increase sales volume. Suppliers tend to promote at quarter end and as a result reduced product costs may increase sales. 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 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 direct customer 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 95% of direct customer product inventory is in warehouse stock and 5% is purchased by the Company on an as needed "just in time" basis. The Company is dependent on common carriers and truck leases but also has acquired a fleet of trucks leased and operated directly by the Company. Although the Company can call upon any of several hundred common carriers to distribute its products, from time to time the trucking industry is subject to strikes or work stoppages which could have a material adverse effect on the Company's operations if alternative modes of shipping are not then available. Additionally, the trucking industry is subject to various natural disasters which can close transportation lanes in any given region of the country. To the extent common carriers utilized by the Company are prevented from or delayed in utilizing transportation lanes, the Company may incur higher freight costs due to the limited availability of trucks during any such period that transportation lanes are restricted. Trucking expenses are regulated by the cost of fuel and destination lanes. Increasing fuel prices can cause an increase in shipping rates. The Company attempts to pass along these charges through a fuel surcharge. This charge cannot be passed to the customers on all occasions. I. TRADEMARKS, LICENSES AND PATENTS The Company has obtained rights to various trademarks and tradenames, and domain names in its internet business. The Company has obtained a wholesale controlled substance license through the Drug Enforcement Agency (DEA). The Company has domestic rights to the "Suarez Gran Reserva", "Breton Legend", "Breton Vintage", "Anduleros", "Don Otilio","Alminante" "Nativo" "Ditka" and various other trade names in marketing of premium handmade cigars. GR also owns and utilizes in its cigar distribution business the following trade names: CigarGold, Netcigar, GoldCigar, Cigars Around The World and Cigar Kingdom. PHS is the dominant tradename utilized by the Company in its other business sectors. PHS also has exclusive distributorship rights in the Dominican Republic for "Fitti" diaper brand. J. EMPLOYEES The Company and its subsidiaries in the aggregate as of the date of this report employ and contract approximately 40 full time and part time non Union employees all of whom work in executive, administrative, sales, marketing, data processing, accounting or clerical activities and certain work as Company employees that integrate with the various warehouses where Company products are stored and as drivers and delivery personnel in the Company leased trucks. The Company leases and staffs its warehouses in New York , New Jersey , Pennsylvania and Florida (GRC), and a sales office in Illinois, from where it facilitates storage, sorting, packing and shipping of products sold on its websites. Otherwise warehousing is contracted on an as needed arrangement staffed through the warehousing entity contracted with exception for supervisory personnel hired by the Company. The Company relies on a stable working environment with its contract warehousing and trucking. 8 K. GOVERNMENT REGULATION 1. TOBACCO INDUSTRY REGULATION AND TOBACCO INDUSTRY LITIGATION The tobacco industry is subject to regulation at federal, state and local levels. Federal law has required states, in order to receive full funding for federal substance abuse block grants and other federal assistance , to establish a minimum age of 18 years for the sale of tobacco products, together with an appropriate enforcement program. The recent trend is toward increasing regulation of the tobacco industry, and the increase in popularity of cigars could lead to an increase in regulation of cigars. The Food and Drug Administration (the "FDA") has determined that nicotine is a drug and has asserted that it has jurisdiction over cigarettes and smokeless tobacco products, as nicotine-delivering medical devices, and therefore, promulgated regulations restricting and limiting the sale, distribution and advertising of cigarette and smokeless tobacco products. FDA jurisdiction is also the subject of current federal legislation which will, if and when enacted, codify much of the past regulatory scheme established for tobacco products and as agreed in settlement agreements reached with the tobacco industry to avoid the myriad of lawsuits filed. In the Fall of 2004, the U.S. Senate considered legislation that would grant the FDA authority to regulate tobacco products. Among other things, the legislation called for the prohibition of free samples and self-service displays. The proposed legislation also limited certain advertising and labeling to a text only format and called for a ban on the sale or distribution of non-tobacco items that bear tobacco brand names, such as hats and t-shirts, and would have restricted sponsorship of events to corporate name only. In addition, the FDA was to be empowered to adopt rules regarding the manufacture, ingredient content, and pre-approval of tobacco products. The proposed legislation passed the US Senate, but failed to garner sufficient support in the House of Representatives and was not enacted into law. There remains uncertainty as to whether the U.S. Congress can gain passage of legislation in the future to permit the FDA to regulate tobacco as outlined above or to permit the FDA to regulate tobacco in a different manner. In 2004, Congress passed legislation to eliminate the federal price support system for tobacco farmers and, in its place, provided an estimated US $10.1 billion buy out of tobacco farmers over the next 10 years. The buy out will be funded by quarterly assessments on tobacco manufacturers. Even within this legislation however cigar products are not included but there is no assurance that they may not be included in these or similar regulations in the future. There has been an increased pressure on Congress to enact legislation that would ease State efforts in the collection of taxation on cigarette sales. Although cigar sales are not currently included in the recent regulatory initiatives there may be future action against cigar companies which could have material adverse effect on the Company's business. Recently the US Bureau of Alcohol Tobacco Firearms and Explosives, the major credit card companies and State attorneys general reached agreement to disallow use of credit cards for cigarette purchases over the internet across State lines and to take action against Internet Sellers that authorities identify as violating State and Federal laws regulating cigarette sales. New York was the first State to ban Internet cigarette sales totally. Further States may likely follow suit. Those bans are based both on tax evasion issues and underage purchasing concerns. Such treatment of tobacco product tax issues is not a new phenomena however but a revisiting of and more active promotion of the federal Jenkins Act which originated in 1949 to address interstate tax issues regarding tobacco sales through use of United States mail. Cigars are not specifically included in the FDA's regulations. Present tobacco regulations which do appear applicable to cigars in addition to focusing on cigarettes are the prohibition on retailers from selling cigarettes, cigarette tobacco or smokeless tobacco to persons under the age of 18 and requiring retailers to check the photographic identification of every person under the age of 27 who requests purchases of tobacco products, and requirement that cigars carry warning labels similar to those contained on cigarette packages which Cigar companies are now required to display clearly and permanently on packages, in print ads, on audio and video ads, on point of purchase displays and on the Internet. 9 In addition, as of January 2007, twenty-two states have legislation mandating, in varying degrees, the prohibition of smoking in certain public places. 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). A 2006 U.S. Surgeon General Report ("The Report") detailed the adverse physical impacts of second-hand smoke; thereby invalidating the contention that smoking in public is a "victimless crime." The Report has been a propelling factor in the expansion of anti-smoking legislation. 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. 10 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. At the end of 2006, the Alcohol and Tobacco Tax and Trade Bureau and the Department of Treasury have proposed rule changes to the classifications and labeling of cigars and cigarettes in an effort to reduce possible revenue losses due to misclassification. The rule changes attempt to clarify the classification criteria. From time to time, the imposition of state and local taxes has had some impact on sales regionally. The enactment of new state excise taxes and the increase in existing state excise taxes are likely to have an adverse effect on regional sales as cigar consumption generally declines. 2. OTHER GOVERNMENT REGULATION. The United States Food and Drug Administration through the United States Food, Drug and Cosmetic Act and the Fair Packaging and Labeling Act and other various rules and regulations regulate, among other things, the purity and packaging of HBA products and fragrances and cosmetic products and various aspects of the manufacture and packaging of other grocery items sold by the Company. Similar statutes are in effect in various states. Manufacturers and distributors of such products are also subject to the jurisdiction of the Federal Trade Commission with respect to such matters as advertising content and other trade practices. To the Company's knowledge, it only deals with manufacturers and manufactured products in a manner which complies with such regulations and who periodically submit their products to independent laboratories for testing. However, the failure by the Company's manufacturer or supplier contacts to comply with applicable government regulations could result in product recalls or lack of product availability that could adversely affect the Company's relationships with its customers. In addition, the extent of potentially adverse government regulations which might arise from future legislation or administrative action cannot be predicted. 11 The Company is not aware of government regulation directly related to internet sales different from that applicable to traditional marketing but immense interest has been indicated on policing the internet focusing on contact and access but the nature of the products marketed by the Company over the internet does not appear to involve any of such concerns beyond product labeling and advertising content which would apply regardless of the medium in which the products are sold except for developing limitations on internet sales of tobacco products as aforementioned herein. The Company is subject to the same foreign and domestic laws as other companies conducting business on and off the Internet. Today, there are still relatively few laws specifically directed towards online services. However, due to the increasing popularity and use of the Internet and online services, many laws relating to the Internet are being debated at various levels of government and it is possible that such laws and regulations will be adopted. These laws and regulations focus on issues such as user privacy, freedom or expression, pricing, fraud, content and quality of products and services, taxation, advertising, intellectual property rights, and information security. It is not clear how existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel and defamation, obscenity, and personal privacy apply to online businesses. The vast majority of these laws were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Those laws that do reference the Internet such as the U.S. Digital Millennium Copyright Act have begun to be interpreted by the courts and implemented but their applicability and scope remain somewhat uncertain. The application of indirect taxes (such as sales and use tax, value added tax, or VAT, goods and services tax, business tax, and gross receipt tax) to e-commerce business such as that operated by the Company is a complex and evolving issue. Many of the fundamental statutes and regulations that impose these taxes were established before the growth of the Internet and e-commerce. In many cases, it is not clear how existing statutes apply to the Internet or e-commerce. In addition, some jurisdictions have implemented or may implement laws specifically addressing the Internet or some aspect of e-commerce. The application of existing, new, or future laws could have adverse effects on the Company's business. Several proposals have been made at the U.S. state and local level that would impose additional taxes on the sale of goods and services through the Internet. These proposals, if adopted, could substantially impair the growth of e-commerce, and could diminish the Company's opportunity to derive financial benefit from its business activities. In December 2004, the U.S. Federal Government enacted legislation extending the moratorium on states and other local authorities imposing access or discriminatory taxes on the Internet through November 2007. Current legislation before Congress, the Permanent Internet Tax Freedom Act of 2007, proposes to permanently extend the moratorium on discriminatory taxes for Internet purchases. This moratorium does not prohibit federal, state, or local authorities from collecting taxes on the Company's income or from collecting taxes that are due under existing tax rules. In conjunction with the Streamlined Sales Tax Project, the U.S. Congress continues to consider overriding the Supreme Court's Quill decision, which limited the ability of state governments to require sellers outside of their own state to collect and remit sales taxes on goods purchased by in-state residents. An overturning of the Quill decision could harm the Company's business. For further discussion of other present and potential government regulation of the Internet see "Forward Looking Information and Cautionary Statements No.22 Government Regulation of the Internet and E-Commerce is Evolving and Unfavorable Changes Could Harm the Company's Business" infra. 12 ITEM 1A: RISK FACTORS. FORWARD LOOKING INFORMATION AND CAUTIONARY STATEMENTS Other than the factual matters set forth herein, the matters and items set forth in this report are forward-looking statements that involve risks and uncertainties. The Company's actual results may differ materially from the results discussed in the forward-looking statements. These statements relate to future events or the Company's future financial performance and include, but are not limited to, statements concerning: The anticipated benefits and risks of the Company's key strategic partnerships, business relationships and acquisitions; The Company's ability to attract and retain customers; The anticipated benefits and risks associated with the Company's business strategy, including those relating to its distribution and fulfillment strategy and its current and future product and service offerings; The Company's future operating results, its need for and availability of financing to sustain its operations and expand thereon; and the future value of its common stock; The anticipated size or and trends in the market segments in which the Company competes and the anticipated competition in those markets; Potential government regulation; and The Company's future capital requirements and its ability to satisfy its capital needs. Furthermore, in some cases, you can identify forward-looking statements by terminology such as may, will, could, should, expect, plan, intend, anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Factors that could cause such differences include, but are not limited to, those identified herein and other risks included from time to time in the Company's other Securities and Exchange Commission ("SEC") reports and press releases, copies of which are available from the Company upon request. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements and continued availability of logistics and financial support therefore. Moreover the Company assumes no responsibility for the accuracy and completeness of the forward-looking statements to conform such statements to actual results or to changes in its expectations. In addition to the other information in this Form 10-K, the following risk factors should be carefully considered in evaluating the Company business because these factors may have a significant impact on the Company's business, operating results and financial condition. As a result of the risk factors discussed below and elsewhere in this Form 10-K and the risks discussed in the Company's other SEC filings, actual results could differ materially from those projected in any forward-looking statements. 1. THE COMPANY HAS INCURRED OPERATING LOSSES, HAS MATERIAL DEBT, AND HAS BEEN AND IS RELIANT UPON FINANCING TO EXTEND CREDIT TO ITS CUSTOMERS. The Company has a long history of operating losses. To date, a large portion of the Company's expenses have been financed through capital raising activities. Although the Company has narrowed its losses, it still continues to report operating deficits as opposed to profits. A large portion of the Company's historical losses are a direct result of fees and expenses associated with stock and/or other working capital financing. The Company believes that Financing costs must be reduced in order to improve operating results. Failure to reduce financing costs will likely inhibit the Company's growth. There is no assurance that further financing will not be needed for operating purposes, and where needed there can be no assurances of continued availability of financing at affordable levels of expense. 13 THE COMPANY HAS SIGNIFICANT INDEBTEDNESS As of December 31, 2006, the Company had long-term indebtedness of $2.0 million. Although the Company made debt principal reduction payments over the last three years, it may incur substantial additional debt in the future, and in any event a significant portion of the Company's future cash flow from operating activities is likely to remain dedicated to the payment of interest and the repayment of principal on its indebtedness. The Company's indebtedness could limit its ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions or other purposes in the future, as needed; to plan for, or react to, changes in technology and in its business and competition; and to react in the event of an economic downturn. There is no guarantee that the Company will be able to meet its debt service obligations. If the Company is unable to generate sufficient cash flow or obtain funds for required payments, or it we fail to comply with covenants in its indebtedness, the Company will be in default. In addition, the Company may not be able to refinance its indebtedness on terms acceptable to the Company, or at all. Due to the Company's historical losses, its evolving business model, and the unpredictability of its industries, the Company may not be able to accurately forecast its rate of continued growth. The Company bases its current and future expense levels and its investment plans on estimates of future net sales and rate of growth. Its expenses and investments are to a large extent fixed, and the Company may not be able to adjust its spending quickly enough if its net sales fall short of its expectations. The Company's revenue and operating profit growth depends on the continued growth of demand for the products offered by the Company or its sellers, and its business is affected by general economic and business conditions throughout the world. A softening of demand, whether caused by changes in consumer preferences or a weakening of the U.S. or global economies, may result in decreased revenue or growth. Terrorist attacks and armed hostilities create economic and consumer uncertainty that could adversely affect its revenue or growth. Such events could create delays in, and increase the cost of, product shipments, which may decrease demand. Revenue growth may not be sustainable and its company-wide percentage growth rate may decrease in the future. The Company's net sales and operating results will also fluctuate for many other reasons, including: - its ability to expand its network of purchasers and suppliers, and to enter into, maintain, renew, and amend on favorable terms its commercial agreements and strategic alliances; - its ability to acquire merchandise, manage inventory, and fulfill orders; - the introduction by the Company's current or future competitors of websites, products, services, price decreases, or improvements; - changes in usage of the Internet and e-commerce, including in non-U.S. markets; - timing, effectiveness, and costs of upgrades and developments in the Company's systems and infrastructure; - the effects of commercial agreements and strategic alliances and the Company's ability to successfully implement the underlying relationships and integrate them into its business; - the effects of acquisitions, and other business combinations and the Company's ability to successfully integrate them into its business; - the success of the Company's geographic and product line expansions; - technical difficulties, system downtime, or interruptions; - Variations in the mix of products and services the Company sells; - Variations in the Company's level of merchandise and vendor returns; - disruptions in service by shipping carriers; - the extent to which the Company offers free shipping, continues to reduce product prices worldwide, and provides additional benefits to its customers which reduce its gross or operating profits; - the extent the Company invests in technology and content, fulfillment, marketing and other expense categories; - the extent to which the Company provides for and pays taxes; and - an increase in the prices of fuel and gasoline, which are used in the transportation of packages, as well as an increase in the prices of other energy products, primarily natural gas and electricity, and commodities like paper and packing supplies, all of which are used in the Company's operating facilities. 14 2. DEPENDENCE ON PUBLIC TRENDS. The Company's business is subject to the effects of changing customer preferences and the economy, both of which are difficult to predict and over which the Company has no control. A change in either consumer preferences or a down-turn in the economy may affect the Company's business prospects. 3. POTENTIAL PRODUCT LIABILITY. As a participant in the distribution chain between the manufacturer and consumer, the Company would likely be named as a defendant in any product liability action brought by a consumer. To date, no claims have been asserted against the Company for product liability; there can be no assurance, however, that such claims will not arise in the future. Currently, the Company does carry product liability insurance. In the event that any products liability claim is not fully funded by insurance, and if the Company is unable to recover damages from the manufacturer or supplier of the product that caused such injury, the Company may be required to pay some or all of such claims from its own funds. Any such payment could have a material adverse impact on the Company. 4. RELIANCE ON COMMON CARRIERS. Although the Company has in the last few years leased a fleet of trucks operated by the Company to make deliveries, the Company is still dependent, for shipping of product purchased, on common carriers in the trucking industry. Although the Company uses several hundred common carriers, the trucking industry is subject to strikes from time to time, which could have material adverse effect on the Company's operations if alternative modes of shipping are not then available. Additionally the trucking industry is susceptible to various natural disasters which can close transportation lanes in any given region of the country. To the extent common carriers are prevented from or delayed in utilizing local transportation lanes or otherwise trucking services are curtailed because of any other case, the Company will likely incur higher freight costs due to the limited availability of trucks during any such period that transportation lanes are restricted. 5. COMPETITION. The Company is subject to competition in all of its various product sale businesses. While these industries may be highly fragmented, with no one distributor dominating the industry, the Company is subject to competitive pressures from other distributors based on price and service and product quality and origin which reduces the gross profit and may increase inventory risk. The food industry is sensitive to a number of economic conditions such as: (i) food price deflation or inflation, (ii) softness in local and national economies, (iii) increases in commodity prices, (iv) the availability of favorable credit and trade terms, and (v) other economic conditions that may affect consumer buying habits. Any one or more of these economic conditions can affect the demand for products PHS distributes to its customers. The industries in which PHS competes in are extremely competitive. Both the wholesale grocery operation and supply chain services to businesses are subject to competitive practices that may affect: (i) the prices at which PHS is able to sell products to its service area, (ii) sales volume, (iii) the ability of our traditional food distribution customers to sell products PHS supplies, which may affect future orders, and (iv) ability to attract and retain customers. In addition, the nature and extent of consolidation in the food and traditional food distribution industries could affect the competitive position. PHS competes with larger distributors and retailers that have greater resources then the Company. The U.S. market for e-commerce services is extremely competitive. The Company expects competition to intensify as current competitors expand their product offerings and enter the e-commerce market, and new competitors enter the market. 15 The principal competitive factors are the quality and breadth of services provided, potential for successful transaction activity and price. E-commerce markets are characterized by rapidly changing technologies and frequent new product and service introductions. The Company may fail to update or introduce new market pricing formats, selling techniques and/or other mechanics and administrative tools and formats for internet sales consistent with current technology on a timely basis or at all. If its fails to introduce new service offerings or to improve its existing service offerings in response to industry developments, or if its prices are not competitive, the Company could lose customers, which could lead to a loss of revenues. Because there are relatively low barriers to entry in the e-commerce market, competition from other established and emerging companies may develop in the future. Many of the Company's competitors may also have well-established relationships with the Company's existing and prospective customers. Increased competition is likely to result in fee reductions, reduced margins, longer sales cycles for the Company's services and a decrease or loss of its market share, any of which could harm its business, operating results or financial condition. Many of the Company's competitors have, and new potential competitors may have, more experience developing Internet-based software applications and integrated purchasing solutions, larger technical staffs, larger customer bases, more established distribution channels, greater brand recognition and greater financial, marketing and other resources than the Company has. In addition, competitors may be able to develop products and services that are superior to those of the Company or that achieve greater customer acceptance. There can be no assurance that the e-commerce solutions offered by the Company's competitors now or in the future will not be perceived as superior to those of the Company by either businesses or consumers. 6. LITIGATION The Company is subject to legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions should not materially affect the financial position, results of operations or cash flows of the Company, but there can be no assurance as to this. 7. POSSIBLE LOSS OF NASDAQ SMALL CAP LISTING. Synergy's qualification for trading on the NASDAQ system is presently and has in the past been questioned, the focus being on the market quotes for the Company's stock, the current bid price presently being and having for a time in the past been reduced below the applicable 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 had fallen below minimum applicable NASDAQ continued listing standard of $2,500,000. NASDAQ has established, and the Commission has approved, certain maintenance requirements to which the Company must adhere to remain listed, including the requirement that a stock listed in such market have a bid price greater than or equal to $1.00 and the listed Company maintain stockholders equity above $2,500,000. The bid price per share for the Common Stock of Synergy had been below $1.00 in the past and the Common Stock has remained on the NASDAQ Small Cap System because Synergy had complied with alternative criteria which are now eliminated under the new and revised NASDAQ 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 System and thereafter trading would likely be reported in the NASDAQ's OTC Bulletin Board or in the "pink sheets." The Company is presently under warning from NASDAQ to better conform by evidencing and maintaining a bid price at or better than $1 or chance being delisted. (see Item 5-"Market For The Registrant's Common Stock and Related Stockholder Matters" supra for a more in depth discussion of the Company's current NASDAQ listing status)In the event of delisting from the NASDAQ Small Cap System, the Common Stock would become subject to the rules adopted by the Commission regulating broker-dealer practices in connection with transactions in "penny stocks", including what the Company believes to be stringent disclosure rules very different from NASDAQ trading practice procedures. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for a stock that becomes subject to the penny stock rules. If the Common Stock became subject to the penny stock rules, many broker-dealers might be unwilling to engage in transactions in the Company's securities because of the added disclosure requirements, thereby making it more difficult for purchasers of the Common Stock to dispose of their shares. The Company's common stock has historically remained at NASDAQ trading levels above $1 except for limited periods of time. The Company is hopeful of experiencing an increase in its bid price in conformity with applicable NASDAQ listing standards within the time limitations instructed by NASDAQ administration. The Company has also achieved and is confident of maintaining a level of Stockholders' equity above $2,500,000. Historical stability combined with the Company's increasing business share in the market and its continuing establishment as a viable force in the industries wherein it participates gives the Company confidence that its susceptibility to market deficiencies is in a much lessened state then in years past and that it can continue to achieve and maintain NASDAQ listing compliance, but of this there can be no assurance. 16 8. RISKS OF BUSINESS DEVELOPMENT-INTERNET MARKETING -THE COMPANY DEPENDS ON CONTINUED USE OF THE INTERNET AND GROWTH OF THE ONLINE PRODUCT PURCHASE MARKET. Because still the lines of product and product distribution established for the Company regarding its e-commerce marketing are relatively new and different from its historical non-internet product distribution business, the Company's operations in these areas should continue to be considered subject to all of the risks inherent in a new business enterprise, including the absence of an appreciable operating history and the expense of new product development and uncertainties on demand and logistics of delivery and other satisfaction of customer demands. Various problems, expenses, complications and delays may be encountered in connection with the development of the Company's new products and methods of product distribution. These expenses must either be paid out of the proceeds of future equity offerings or out of generated revenues and Company profits and will likely be a drain on Company capital if revenues and revenue collection do not keep pace with Company expenses. There can be no assurance as to the continued availability of funds from revenues or from any other sources. The Company's future potential revenues and profits substantially depend to a great extent upon the widespread acceptance and use of the internet as an effective medium of business and communication by the Company's target customers. Rapid growth in the use of and interest in the Internet has occurred. As a result, acceptance and use continue to develop, and a sufficiently broad base of consumers have adopted, and continue to use, the Internet and other online services as a medium of commerce but there can be no assurance of continued use at the levels anticipated by the Company to sustain its internet business segments. As the Internet and online commerce industry evolve, the Company must license leading technologies useful in its business, enhance its existing services, develop new services and technology that address the increasingly sophisticated and varied needs of its prospective customers and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. The Company may not be able to successfully implement new technologies or adapt its proprietary technology and transaction processing systems to customer requirements or emerging industry standards. If the Company is unable to do so, it could adversely impact its ability to build on its varied businesses and attract and retain customers. The Company's future revenues and profits depend to a large extent upon the widespread acceptance and use of the Internet and other online services as a medium for commerce by merchants and consumers. The use of the Internet and e-commerce may not continue to develop at past rates and a sufficiently broad base of business and individual customers may not adopt or continue to use the Internet as a medium of commerce. The market for the sale of goods and services over the Internet is a relatively new and emerging market. Demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty. Growth in the Company's customer base depends on obtaining businesses and consumers who have historically used traditional means of commerce to purchase goods. For the Company to be successful, the Company believes that these market participants must accept and use the novel ways of conducting business and exchanging information as is provided by the internet. 17 The Internet is still relatively new and rapidly changing technology and continues to experience significant growth in the number of users, frequency of use and bandwidth requirements. There can be no assurance that the infrastructure of the Internet and other online services will be able to support the demands placed upon them and/or that the Company may be able to keep pace therewith. Furthermore, the Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and could face such outages and delays in the future. These outages and delays could adversely affect the level of Internet usage and also the level of traffic and the processing of transactions. In addition, the Internet or other online services could lose their viability due to delays in the development or adoption of new standards and protocols required to handle increased levels of Internet or other online service activity, or due to increased governmental regulation. Changes in or insufficient availability of telecommunications services or other Internet service providers to support the Internet or other online services also could result in slower response times and adversely affect usage of the Internet and other online services generally and the Company's service in particular. If use of the Internet and other online services does not continue to grow or grows more slowly than expected, if the infrastructure of the Internet and other online services does not effectively support growth that may occur, or if the Internet and other online services do not become or sustain as a viable commercial marketplace, the Company will have to adapt its business model to any resulting new environment, which would materially adversely affect its results of operations and financial condition. 9. RAPIDLY CHANGING MARKET MAY IMPACT OPERATIONS. The market for the Company's products is rapidly changing with evolving industry standards and frequent new product introductions. The Company's future success will depend in part upon its continued ability to enhance its existing products and to introduce new products and features to meet changing customer requirements and emerging industry standards and to continue to have access to such products from their sources on a pricing schedule conducive to the Company operating at a profit. The Company will have to continuously develop, change and implement as and where necessary an appropriate marketing strategy for its various products. There can be no assurance that the Company will successfully complete the development of future products or that the Company's current or future products will achieve market acceptance levels and be made available for sale by the Company conducive to the Company's fiscal needs. Any delay or failure of these products to achieve market acceptance or limits on their availability for sale by the Company would adversely affect the Company's business. In addition, there can be no assurance that the products or technologies developed by others will not render the Company's products or technologies non-competitive or obsolete. Management believes actions taken and presently being taken to meet and enhance the Company's operating and financial requirements should assure and provide the opportunity for the Company to continue as a going concern. However, Management cannot predict the outcome of future operations and no adjustments have been made to offset the outcome of this uncertainty. 18 10.EXTENSIVE AND INCREASING REGULATION OF TOBACCO PRODUCTS AND LITIGATION MAY IMPACT CIGAR INDUSTRY. The tobacco industry in general has been subject to extensive regulation at the federal, state and local levels. Recent trends have increased regulation of the tobacco industry. Although regulation initially focused on cigarette manufacturers, it has begun to have a broader impact on the industry as a whole and may focus more directly on cigars in the future. The increase in popularity of cigars may likely lead to an increase in regulation of cigars. A variety of bills relating to tobacco issues have been introduced in the U.S. Congress, including bills that would (i) prohibit the advertising and promotion of all tobacco products or restrict or eliminate the deductibility of such advertising expense, (ii) increase labeling requirements on tobacco products to include, among others things, addiction warnings and lists of additives and toxins, (iii) shift control of tobacco products and advertisements from the Federal Trade Commission (the "FTC") to the Food and Drug Administration (the "FDA"), (iv) increase tobacco excise taxes and (v) require tobacco companies to pay for health care costs incurred by the federal government in connection with tobacco related diseases. There has also been recent cooperation between federal and State authorities to curtail internet sales of tobacco products because of tax issues as well as underage purchase questions. Future enactment of such proposals or similar bills may have an adverse effect on the results of operations or financial condition of the Company. Although, except for warning labeling and smoke free facilities, current legislation and regulation focuses on cigarette smoking and sales, there is no assurance that the scope of legislation will not be expanded in the future to encompass cigars as well. A majority of states restrict or prohibit smoking in certain public places and restrict the sale of tobacco products to minors. Local legislative and regulatory bodies also have increasingly moved to curtail smoking by prohibiting smoking in certain buildings or areas or by designating "smoking" areas. These restrictions generally do not distinguish between cigarettes and cigars. These restrictions and future restrictions of a similar nature have and likely will continue to have an adverse effect on the Company's sales or operations because of resulting difficulty placed upon advertising and sale of tobacco products, such as restrictions and in many cases prohibition of counter access to or display of premium handmade cigars, and/or decisions by retailers not to advertise for sale and in many cases to sell tobacco products because of public pressure to stop the selling of tobacco products. Numerous proposals also have been and are being considered at the state and local levels, in addition to federal regulations, to restrict smoking in certain public areas, regulating point of sale placement and promotions of tobacco products and requiring warning labels. Increased cigar consumption and the publicity such increase has received may increase the risk of additional regulation. The Company cannot predict the ultimate content, timing or effect of any additional regulation of tobacco products by any federal, state, local or regulatory body, and there can be no assurance that any such legislation or regulation would not have a material adverse effect on the Company's business. In addition numerous tobacco litigation has been commenced and may in the future be instituted, all of which may adversely affect(albeit focusing primarily on cigarette smoking) cigar consumption and sale and may pressure applicable government entities to institute further and stricter legislation to restrict and possibly prohibit cigar sale and consumption, any and all of which may have an adverse affect on Company business (see "Government Regulation - Tobacco Industry Regulation and Tobacco Industry Litigation" supra). 11. NO DIVIDENDS LIKELY. No dividends have been paid on the Common Stock since inception, nor, by reason of its current financial status and its contemplated financial requirements, does Synergy contemplate or anticipate paying any dividends upon its Common Stock in the foreseeable future but the Company does have outstanding preferred stock upon which dividends are paid current. 12. POTENTIAL LIABILITY FOR CONTENT ON THE COMPANY'S WEB SITE. Because the Company posts product information and other content on its Web sites, the Company faces potential liability for negligence, copyright, patent, trademark, defamation, indecency and other claims based on the nature and content of the materials that the Company posts. Such claims have been brought, and sometimes successfully pressed, against other Internet content distributors. In addition, the Company could be exposed to liability with respect to the unauthorized duplication of content or unauthorized use of other parties' proprietary technology or infiltration into the Company's system by unauthorized personnel. The Company is not aware of any present claim of such nature or any current basis therefore but because of the nature of the product marketing techniques utilized by the Company with application of the internet, likelihood of claims of such nature arising in the future cannot be predicted. 19 13. THE COMPANY'S NET SALES WOULD BE HARMED IF IT EXPERIENCES SIGNIFICANT CREDIT CARD FRAUD. A failure to adequately control fraudulent credit card transactions would harm the Company's net sales and results of operations because it does not carry insurance against such risk. Under current credit card practices, the Company may be held liable for fraudulent credit card transactions where it does not obtain a cardholder's signature, a frequent practice in internet sales. 14. POTENTIAL FUTURE SALES OF COMPANY STOCK. The majority of the shares of common stock of the Company outstanding are "restricted securities" as that term is defined in Rule 144 promulgated under the Securities Act of 1933. In general under Rule 144 a person (or persons whose shares are aggregated) who has satisfied a one year holding period may, under certain circumstances, sell within any three month period a number of shares which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of shares by a person who is not an affiliate of the Company and who has satisfied a two year holding period without, any quantity limitation. The majority of holders of the shares of the outstanding common stock of the Company deemed "restricted securities" have already satisfied at least their one year holding period or will do so with the next fiscal year, and such stock is either presently or within the next fiscal year will become eligible for sale in the public market (subject to volume limitations of Rule 144 when applicable). The Company is unable to predict the effect that sales of its common stock under Rule 144, or otherwise, may have on the then prevailing market price of the common stock. However, the Company believes that the sales of such stock under Rule 144 may have a depressive effect upon the market. 15. THE COMPANY MAY NOT BE ABLE TO CONTINUE ATTRACTING NEW CUSTOMERS. The success of the Company's business model depends in large part on its continued ability to maintain and re sell to current customers and to increase its number of customers in the future. The market for its businesses may grow more slowly than anticipated because of or become saturated with competitors, many of which may offer lower prices or broader distribution. The Company is also highly dependant on internet sales which require interest of potential suppliers in the internet mode of product purchasing. Some potential suppliers may not want to join the Company's networks because they are concerned about the possibility of their products being listed together with their competitors' products thus limiting availability of product mix made available by the Company. If the Company cannot continue to bring new customers to its internet sites or maintain its existing customer base or attract listing of a mixture of product, the Company may be unable to offer the benefits of the network model at levels sufficient to attract and retain customers and sustain that aspect of its business. 16. THE COMPANY'S BUSINESS MAY SUFFER IF IT IS NOT ABLE TO PROTECT IMPORTANT INTELLECTUAL PROPERTY. The Company's ability to compete effectively against other companies in its industry will depend, in part, on its ability to protect its proprietary technology and systems designs relating to its technologies. The Company does not know whether it has been or will be completely successful in doing so. Further, its competitors may independently develop or patent technologies that are substantially equivalent or superior to those of the Company so as to effectively compete. 17. THE COMPANY MAY NOT BE ABLE TO MAINTAIN THE CONFIDENTIALITY OF ITS PROPRIETARY KNOWLEDGE. The Company relies, in part, on contractual provisions to protect its trade secrets and proprietary knowledge. These agreements may be breached, and the Company may not have adequate remedies for any breach. Its trade secrets may also be known without breach of such agreements or may be independently discovered by competitors. Its inability to maintain the proprietary nature of its technology could harm its business, results of operations and financial condition by adversely affecting its ability to compete. 20 18. OTHERS MAY ASSERT THAT THE COMPANY'S TECHNOLOGY INFRINGES THEIR INTELLECTUAL PROPERTY RIGHTS. The Company believes that its technology does not infringe the proprietary rights of others. However, the e-commerce industry is characterized by the existence of a large number of patents and trademarks and frequent claims and litigation based on allegations of patent infringement and violation of other intellectual property rights. As the e-commerce market and the functionality of products in the industry continues to grow and overlap, the Company believes that the possibility of an intellectual property claim against it will increase. For example, the Company may inadvertently infringe an intellectual property right of which it is unaware, or there may be applications to protect intellectual property rights now pending of which it is unaware which it may be infringing when they are issued in the future, or the Company's service or systems may incorporate and/or utilize third party technologies that infringe the intellectual property rights of others. The Company has been and expects to continue to be subject to alleged infringement claims. The defense of any claims of infringement made against the Company by third parties, whether or not meritorious, could involve significant legal costs and require the Company's management to divert time and attention from its business operations. Either of these consequences of an infringement claim could have a material adverse effect on the Company's operating results. If the Company is unsuccessful in defending any claims of infringement, it may be forced to obtain licenses or to pay royalties to continue to use its technology. The Company may not be able to obtain any necessary licenses on commercially reasonable terms or at all. If the Company fails to obtain necessary licenses or other rights, or if these licenses are costly, its operating results may suffer either from reductions in revenues through the Company's inability to serve customers or from increases in costs to license third-party technologies. 19. THE COMPANY'S BUSINESS MAY BE ADVERSELY AFFECTED IF IT IS UNABLE TO CONTINUE TO LICENSE SOFTWARE THAT IS NECESSARY FOR ITS SERVICE OFFERING. Through distributors, the Company licenses a variety of commercially available Internet technologies, which are used in its services and systems to perform key functions. As a result, the Company is to a certain extent dependent upon continuing to maintain these technologies. There can be no assurance that the Company would be able to replace the functionality provided by much of its purchased Internet technologies on commercially reasonable terms or at all. The absence of or any significant delay in the replacement of that functionality could have a material adverse effect on the Company's business, financial condition and results of operations. 21 20. THE COMPANY'S SYSTEMS INFRASTRUCTURE MAY NOT KEEP PACE WITH THE DEMANDS OF ITS CUSTOMERS. Interruptions of service as a result of a high volume of traffic and/or transactions could diminish the attractiveness of the Company's services and its ability to attract and retain customers. There can be no assurance that the Company will be able to accurately project the rate or timing of increases, if any, in the use of its service, or that it will be able to expand and upgrade its systems and infrastructure to accommodate such increases in a timely manner. The Company currently maintains systems in the U.S. Any failure to expand or upgrade its systems could have a material adverse effect on its results of operations and financial condition by reducing or interrupting revenue flow and by limiting its ability to attract new customers. Any such failure could also have a material adverse effect on the business of its customers, which could damage the Company's reputation and expose it to a risk of loss or litigation and potential liability. Service offerings involving complex technology often contain errors or performance problems. Many serious defects are frequently found during the period immediately following introduction and initial implementation of new services or enhancements to existing services. Although the Company attempts to resolve all errors that it believes would be considered serious by its customers before implementation, its systems are not error-free. Errors or performance problems could result in lost revenues or cancellation of customer agreements and may expose the Company to litigation and potential liability. In the past, the Company has discovered errors in software used in the Company after its incorporation into Company sites. The Company cannot assure that undetected errors or performance problems in its existing or future services will not be discovered or that known errors considered minor by it will not be considered serious by its customers. The Company has experienced periodic minor system interruptions, which may continue to occur from time to time. The Company's success depends on the efficient and uninterrupted operation of its computer and communications hardware systems. These systems are vulnerable to damage or interruption from natural disasters, fires, power loss, telecommunication failures, break-ins, sabotage, computer viruses, intentional acts of vandalism and similar events. Despite any precautions the Company takes or plans to take, the occurrence of a natural disaster or other unanticipated problems could result in interruptions in its services. In addition, if any hosting service fails to provide the data communications capacity the Company requires, as a result of human error, natural disaster or other operational disruption, interruptions in the Company's services could result. Any damage to or failure of its systems could result in reductions in, or terminations of, its services, which could have a material adverse effect on its business, results of operations and financial condition. 21. THE COMPANY MAY ACQUIRE OTHER BUSINESSES OR TECHNOLOGIES, WHICH COULD RESULT IN DILUTION TO ITS STOCKHOLDERS, OR OPERATIONAL OR INTEGRATION DIFFICULTIES WHICH COULD IMPAIR ITS FINANCIAL PERFORMANCE. If appropriate opportunities present themselves, the Company may acquire complementary or strategic businesses, technologies, services or products that it believes will be useful in the growth of its business. The Company does not currently have any commitments or agreements with respect to any new acquisitions. They may not be able to identify, negotiate or finance any future acquisition successfully. Even if the Company does succeed in acquiring a business, technology, service or product, the process of integration may produce unforeseen operating difficulties and expenditures and may require significant attention from the Company's management that would otherwise be available for the ongoing development of its business. Moreover the anticipated benefits of any acquisition may not be realized or may depend on the continued service of acquired personnel who could choose to leave. If the Company makes future acquisitions, it may issue shares of stock that dilute other stockholders, incur debt, assume contingent liabilities or create additional expenses related to amortizing intangible assets, any of which might harm its financial results and cause its stock price to decline. Any financing that it might need for future acquisitions may only be available to it on terms that restrict its business or that impose on it costs that reduce its revenue. 22. GOVERNMENT REGULATION OF THE INTERNET AND E-COMMERCE IS EVOLVING AND UNFAVORABLE CHANGES COULD HARM THE COMPANY'S BUSINESS The Company is subject to general business regulations and laws, as well as regulations and laws specifically governing the Internet and e-commerce. Such existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel, and personal privacy apply to the Internet and e-commerce. Unfavorable resolution of these issues may harm the Company's business. 22 Like many Internet-based businesses, the Company operates in an environment of tremendous uncertainty as to potential government regulation. The Internet has rapidly emerged as a commerce medium, and governmental agencies have not yet been able to adapt all existing regulations to the Internet environment. Laws and regulations have been introduced or are under consideration and court decisions have been or may be reached in the U.S. and other countries in which the Company does business that affect the Internet or other online services, covering issues such as pricing, user privacy, freedom of expression, access charges, content and quality of products and services, advertising, intellectual property rights and information security. In addition, it is uncertain how existing laws governing issues such as taxation, property ownership, copyrights and other intellectual property issues, libel, obscenity and personal privacy will be applied to the Internet. The majority of these laws were adopted prior to the introduction of the Internet and, as a result, do not address the unique issues of the Internet. Recent laws that contemplate the Internet, such as the Digital Millennium Copyright Act in the U.S., have not yet been fully interpreted by the courts and their applicability is therefore uncertain. The Digital Millennium Copyright Act provides certain "safe harbors" that limits the risk of copyright infringement liability for service providers such as the Company with respect to infringing activities engaged in by users of the service. In the area of user privacy, several states have legislation and/or have proposed legislation that limits or would limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission also has become increasingly involved in this area. The Company does not sell personal user information regarding its customers. The Company does use aggregated data for analysis regarding the Company network, and does use personal user information in the performance of its services for its customers. Since the Company does not control what its customers do with the personal user information they collect, there can be no assurance that its customers' sites will be considered compliant. As online commerce evolves, the Company expects that federal, state or foreign agencies will continue to adopt regulations covering issues such as pricing, content, user privacy, and quality of products and services. Any future regulation may have a negative impact on the Company's business by restricting its methods of operation or imposing additional costs. Although many of these regulations may not apply to its business directly, the Company anticipates that laws regulating the solicitation, collection or processing of personal information could indirectly affect its business. Internet regulation which has met with the most successful challenges is that which touches upon Free Speech. Title V of the Telecommunications Act of 1996, known as the Communications Decency Act of 1996, prohibits the knowing transmission of any comment, request, suggestion, proposal, image or other communication that is obscene or pornographic to any recipient under the age of 18. The prohibitions scope and the liability associated with a violation are currently unsettled. In addition, although substantial portions of the Communications Decency Act of 1996 have been held to be unconstitutional, the Company cannot be certain that similar legislation will not be enacted and upheld in the future. Subsequent attempts at such legislation such as the Child Online Protection Act passed in 1998 have met with similar and successful constitutional attack. It is possible that such legislation could expose companies involved in online commerce to liability, which could limit the growth of online commerce generally. Legislation like the Communications Decency Act and Child Online Protection Act could reduce the growth in Internet usage and decrease its acceptance as a communications and commerce medium. The worldwide availability of Internet web sites often results in sales of goods to buyers outside the jurisdiction in which the Company or its customers are located, and foreign jurisdictions may claim that the Company or its customers are required to comply with their laws. Foreign regulation of internet use has not met with the success of constitutional and other judicial scrutiny that US regulation has been limited by. As an Internet Company, it is also unclear which jurisdictions may find that the Company is conducting business therein. Its failure to qualify to do business in a jurisdiction that requires it to do so could subject the Company to fines or penalties and could result in its inability to enforce contracts in that jurisdiction. The Company is not aware of any recent related legislation other than that specifically referenced herein which may affect the manner in which the Company utilizes the internet in its business but there can be no assurance that future government regulation will not be enacted further restricting use of the internet that might adversely affect the Company's business. 23 23. TAXES MAY BE IMPOSED ON INTERNET COMMERCE. In the U.S., the Company does not collect sales or other similar taxes on goods sold through the Company's internet websites. The Internet Tax Freedom Act of 1998, (extended through November 2003 and internet access tax prohibitions though November 1, 2007), prohibits the imposition of new or discriminatory taxes on electronic commerce by United States federal and State taxing authorities except for taxes caused by nexus of the Seller of the goods in the State. Sales to customers in such States may be taxable, but to date no such taxes have ever been collected by the Company. The Company notes that there is currently Congressional legislation pending, the Permanent Internet Tax Freedom Act of 2007, which is intended to amend the Internet Tax Freedom Act of 1998, thereby placing a permanent moratorium on multiple and discriminatory taxes on electronic commerce and Internet access taxes. Said amendment is currently being considered by the Committee on the Judiciary and the Committee on Commerce, Science, and Transportation in the U.S. House of Representatives and Senate, respectively. Currently, decisions of the U.S. Supreme Court restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, a number of States, as well as the U.S. Congress, have been considering various initiatives that could limit or supersede the Supreme Court's position regarding sales and use taxes on Internet sales. If any of these initiatives addressed the Supreme Court's constitutional concerns and resulted in a reversal of its current position, the Company could be required to collect sales and use taxes. The imposition by State and local governments of various taxes upon Internet commerce could create administrative burdens for the Company and could decrease its future sales. The status of the prohibition is uncertain and States have attempted to impose sales and use tax, often successfully mainly based upon the nexus of the retailer with the State imposing the tax on customers in that State. A number of proposals have been made at the State and local level that would impose additional taxes on the sale of goods and services through the Internet. Such proposals, if adopted and not in conflict with federal prohibitions, could substantially impair the growth of electronic commerce, and could adversely affect the Company's opportunity to derive financial benefit from such activities. There has been recent activity in attempts to increase enforcement of the federal Jenkins Act, which requires persons whom engage in the sale of cigarettes and smokeless tobacco in interstate commerce to report said sale to the buyer's state tobacco tax administrator. A 2003 U.S. Government Accounting Office report found that a significant number of Internet cigarette vendors fail to comply with the Jenkins Act. Although the Jenkins Act and subsequent bills have sought the increased collection of state cigarette taxes, cigars remain outside the scope of the regulation. However, the Company cannot predict the ultimate content, timing or effect of any additional regulation of tobacco products by any federal, state, or local or regulatory body, and there can be no assurance that any such legislation or regulation would not have material adverse effect on the Company's business. In addition, non-U.S. countries may seek to impose service tax (such as value-added tax) collection obligations on companies that engage in or facilitate Internet commerce. A successful assertion by one or more states or any foreign country that the Company should collect sales or other taxes on the sale of merchandise could impair its revenues and its ability to acquire and retain customers. 24. THERE MAY BE SIGNIFICANT SECURITY RISKS AND PRIVACY CONCERNS RELATING TO ONLINE COMMERCE. A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks. A compromise or breach of the technology used to protect the Company's customers' and their end-users' transaction data could result from, among other things, advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments. Any such compromise could have a material adverse effect on the Company's reputation and, therefore, on its business, results of operations and financial condition. Furthermore, a party who is able to circumvent the Company's security measures could misappropriate proprietary information or cause interruptions in its operations. The Company may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by such breaches. Concerns over the security of transactions conducted on the Internet and other online services and the privacy of users may also inhibit the growth of the Internet and other online services generally, especially as a means of conducting commercial transactions. The Company currently has practices and procedures in place to protect the confidentiality of its customers' and their end-users' information. However, its security procedures to protect against the risk of inadvertent disclosure or intentional breaches of security might fail to adequately protect information that it's obligated to keep confidential. The Company may not be successful in adopting more effective systems for maintaining confidential information, and its exposure to the risk of disclosure of the confidential information of others may grow with increases in the amount of information it possesses. To the extent that the Company activities involve the storage and transmission of proprietary information, such as credit card numbers, security breaches could damage its reputation and expose it to a risk of loss or litigation and possible liability. The Company's insurance policies may not be adequate to reimburse it for losses caused by security breaches. 24 25. IF THE COMPANY'S FULFILLMENT CENTERS ARE NOT EFFECTIVELY OPERATED THE COMPANY'S BUSINESS MAY BE ADVERSELY AFFECTED. If the Company does not successfully operate its fulfillment centers such could significantly limit the Company's ability to meet customer's demands, which would likely result in diminished revenues, adversely affecting the Company's business. Because it is difficult to predict sales increases the Company may not manage its facilities in an optimal way which may result in excess inventory, warehousing, fulfillment and distribution capacity having an adverse impact on working capital of the Company, or the lack of sufficiency in such areas causing delays in fulfillment of customer orders adversely affecting customer confidence and loyalty. 26. OUR VENDOR RELATIONSHIPS SUBJECT US TO A NUMBER OF RISKS Although we continue to increase the number of vendors that supply products to us and only two vendors account for 10% or more of our inventory purchases, we have significant vendors that are important to our sourcing. We do not have long-term contracts or arrangements with most of our vendors to guarantee the availability of merchandise, particular payment terms, or the extension of credit limits. If our current vendors were to stop selling merchandise to us on acceptable terms, we may not be able to acquire merchandise from other suppliers in a timely and efficient manner and on acceptable terms. 27. THE COMPANY'S STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE. The stock market, and in particular the market for Internet-related stocks, has, from time to time, experienced extreme price and volume fluctuations. Many factors may cause the market price for the Company's common stock to decline, perhaps substantially, including: - actual or anticipated variations in the Company's quarterly operating results and expected future results; - changes in, or failure to meet, financial estimates by securities analysts; - unscheduled system downtime; - additions or departures of key personnel; - announcements of technological innovations or new services by the Company or its competitors; - initiation of or developments in litigation affecting the Company; - conditions or trends in the Internet and online commerce industries; - changes in the market valuations of other Internet, online commerce, or technology companies; - developments in regulation; - announcements by the Company or its competitors of significant acquisitions, strategic partnerships, joint ventures, new product of capital commitments; - unanticipated economic or political events; - sales of the Company's common stock or other securities in the open market; and - other events or factors, including those described in the "Risk Factors", section and others that may be beyond the Company's control. - failure to meet its development plans; - the demand for its common stock; - downward revision in securities analyst's estimates or changes in general market conditions; - technological innovations by competitors or in competing technologies; and - investor perception of the Company's industry or its prospects. The Company's stock pricing has fluctuated significantly in the past and there is no assurance such trend may not continue in the future. 25 28. INTERNATIONAL BUSINESS RISKS. The Company deals with Companies not located in the United States. Although almost all business activity is conducted in United States Dollars, The Company may be subject to currency risks. The Company has significant assets outside the United States and therefore may be subject to international risks that are not under the jurisdiction of U.S. Laws. In 2006 the Company had transactions with Companies located in Canada, China, Dominican Republic, Colombia, Italy and Israel. ITEM 2: DESCRIPTION OF PROPERTY The Company's corporate offices and administrative headquarters are located in Syosset, New York. The Company maintains satellite and representative offices in New York, Pennsylvania, New Jersey, Illinois, Florida. Warehousing facilities utilized by the Company are located in New Jersey, New York and Florida. The Grocery inventory is warehoused in New York, Salon products are warehoused in New Jersey, and cigars are warehoused in Florida. The facilities operate under contractual warehousing agreements except in Florida and New York which facilities are leased. The Company also uses warehousing facilities on a spot contract basis as needed. ITEM 3: LEGAL PROCEEDINGS The Company is a party to a number of legal proceedings in connection with claims made for goods sold and various other aspects of its business, all of which are considered routine litigation incidental to the business of the Company. The Company is not aware of any other litigation pending which might be considered material and not in the ordinary course of business. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of 2006 no matters were submitted for shareholder approval. 26 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock trades on NASDAQ Small Cap Market under the Symbol "SYBR", and on the Boston Stock Exchange under the Symbol "SYB". The high and low sales prices in the NASDAQ Small Cap Market for the Company's Common Stock, as reported by the NASDAQ for each of the quarters of the Company's two most recent fiscal years are as follows: COMMON STOCK Quarter Ended High Low Close ------------- ------- ------- ------ March 31, 2005 3.71 2.08 2.39 June 30, 2005 2.95 1.62 2.10 September 30, 2005 2.85 1.85 2.07 December 31, 2005 2.66 1.68 1.85 March 31, 2006 1.97 1.22 1.38 June 30, 2006 1.45 1.00 1.12 September 30, 2006 1.17 .93 1.04 December 31, 2006 1.35 .81 .93 On March 30, 2007, 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. There are no unexercised stock options outstanding. The Company is under present warning from NASDAQ administration to achieve and maintain a bid price for its Common Stock above $1 or chance being delisted (see further explanations at Risk Factor 7 "Possible Loss of NASDAQ Small Cap Listing," supra). The Company has authorized stock of 15,000,000 shares divided into 14,000,000 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. 27 Refer to the Company's Consolidated Statement of Changes in Stockholders' Equity in the Company's audited financial statements included in this report for information on issuances of equity securities during fiscal year 2006. 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 YEAR ENDED DECEMBER 31,
2006 2005 2004 2003 2002 CONSOLIDATED STATEMENT OF OPERATIONS: NET SALES $71,759,908 $63,350,182 $52,781,221 $36,869,471 $29,003,459 COST OF SALES COST OF PRODUCT $65,631,282 $58,403,752 $48,701,653 $33,707,053 $27,181,698 SHIPPING AND HANDLING COSTS $1,169,381 $940,316 $770,723 $697,524 $438,754 $66,800,663 $59,344,068 $49,472,376 $34,404,577 $27,620,452 GROSS PROFIT $4,959,245 $4,006,114 $3,308,845 $2,464,894 $1,383,007 OPERATION EXPENSES ADVERTISING AND PROMOTIONAL $234,582 $62,255 $150,181 $91,634 $464,638 GENERAL AND ADMINISTRATIVE $4,052,762 $3,701,271 $3,322,686 $2,554,979 $2,588,520 DEPRECIATION AND AMORTIZATION $245,085 $314,545 $448,570 $479,500 $425,093 $4,532,429 $4,078,071 $3,921,437 $3,126,113 $3,478,251 OPERATING PROFIT(LOSS) $426,816 -$71,957 -$612,592 -$661,219 -$2,095,244 OTHER INCOME(EXPENSE) INTEREST INCOME $147,533 $102,644 $4,610 $13,913 $26,695 OTHER INCOME(EXPENSE) -$22,039 -$20,469 $33,795 $300,420 $521,267 EQUITY IN EARNINGS OF INVESTEE $227,054 $56,311 $172,224 $92,424 $67,717 INTEREST AND FINANCING EXPENSES -$2,050,856 -$1,513,406 -$1,320,608 -$490,146 -$150,943 -$1,698,308 -$1,374,920 -$1,109,979 -$83,389 $464,736 LOSS BEFORE INCOME TAXES -$1,271,492 -$1,446,877 -$1,722,571 -$744,608 -$1,630,508 INCOME TAX EXPENSE $43,976 $82,325 $34,604 $30,457 $22,347 LOSS FROM CONTINUING OPERATIONS -$1,315,468 -$1,529,202 -$1,757,175 -$775,065 -$1,652,855 LOSS FROM DISCONTINUED OPERATIONS -$1,358,478 -$1,029,043 -$219,204 -$499,957 -$833,372 INCOME TAX EXPENSE $986 $2,533 $2,201 $340 LOSS FROM DISCONTINUED OPERATIONS -$1,359,464 -$1,031,576 -$219,204 -$502,158 -$833,712 NET LOSS -$2,674,932 -$2,560,778 -$1,976,379 -$1,277,223 -$2,486,567 DIVIDEND-PREFERRED STOCK $356,500 $317,333 $156,375 $78,000 NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS -$3,031,432 -$2,878,111 -$2,132,754 -$1,355,223 -$2,486,567 BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM CONTINUING OPERATIONS: -$0.33 -$0.48 -$0.87 -$0.52 -$1.27 BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM DISCONTINUED OPERATIONS: -$0.27 -$0.27 -$0.10 -$0.30 -$0.64 BAISIC AND DILUTED NET LOSS PER COMMON SHARE -$0.60 -$0.75 -$0.97 -$0.82 -$1.91 WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 5,080,323 3,820,061 2,209,371 1,652,019 1,302,042 CONSOLIDATED BALANCE SHEET DATA: WORKING CAPITAL $9,285,585 $4,967,712 $4,058,275 $2,245,956 $1,488,699 TOTAL ASSETS $20,867,796 $17,352,638 $16,706,423 $10,992,645 $5,871,669 LONG TERM OBLIGATIONS $7,797,566 $2,668,691 $1,196,241 $788,162 $342,750 TOTAL SHAREHOLDERS' EQUITY $5,660,250 $6,932,701 $6,573,057 $2,943,832 $2,082,537
28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OFOPERATIONS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION OVERVIEW Synergy Brands Inc. (SYBR or the Company) is a holding company that principally operates through a wholly owned subsidiary, PHS Group Inc. ("PHS") in the wholesale distribution of nationally known brands and proprietary private label Groceries and Health and Beauty Aid (HBA) products as well as wholesale luxury goods. It principally focuses on the sale of nationally known brand name consumer products manufactured by major U.S. manufacturers and has begun focusing on the grocery private label market in FY 2006. The Company uses logistics based distribution programs to optimize its costs on both wholesale and retail levels. The Company also owns a wholly owned subsidiary Gran Reserve Corporation that principally operates in the wholesale, retail and online sales of Premium hand made cigars and accessories. The Company also owns 20% 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 should provide for material future capital appreciation. Synergy Brands does not manage PERX's day-to-day operations. For further information please visit the Company's corporate website at www.sybr.com. PHS GROUP (GROCERY & HBA OPERATIONS) PHS Group distributes Grocery and HBA products to retailers and wholesalers predominately located in the Northeastern United States. PHS is the largest business segment of the Company's business operations, representing about 97% of the overall Company sales and 88% of gross profit. PHS's core sales base remains the distribution of nationally branded consumer products in the grocery and health and beauty (HBA) sectors. PHS has positioned itself as a distributor for major manufacturers as opposed to a full line wholesaler. A full line wholesaler has the responsibility of servicing the entire needs of a retail operation, whereas a distributor caters to specific merchandising categories. As a result, PHS is able to better plan for the needs of its specific customers and at the same time benefit the manufacturer as the direct supply source and in turn increase sales to its customers at optimized pricing through this unique strategy. PHS concentrates on what it perceives to be faster moving promotional items such as: Tide, Bounty, Nyquil, Pantene, Clorox bleach, Scott tissues, Marcal tissues among many others, and uses promotions, logistics and distribution savings to streamline and reduce its sale prices and increase gross profit thereby. The second business segment within the Company's sector wherein PHS participates was previously Proset Hair Systems (Proset) but Proset discontinued its operations in the 4th quarter of FY 2006 as further discussed infra. In the third quarter of 2006 PHS entered the private label grocery market specializing in the distribution of baking mixes and spices to national chains on a proprietary basis. PHS hopes to develop private label programs for national accounts by creating proprietary baking mix products and spice plan-o-grams specifically designed for particular retail needs. PHS further hopes to expand its grocery distribution business by complementing the distribution of its promotional grocery and HBA items with higher margin secondary items that would blend a higher margin into PHS operations. GRAN RESERVE CORPORATION (PREMIUM CIGAR OPERATIONS) The Company's premium cigar operations are conducted through its wholly owned subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses (under the business names stated) o Cigars Around the World (CAW) sells premium cigars to restaurants, hotels, casinos, country clubs and many other leisure related destinations. This company was acquired in June 2003. CAW opened a retail store and lounge in Miami Lakes, Florida selling premium cigars and accessories in March 2006 as well as established and furthered a web site related to its operations, www.cigarsaroundtheworld.com. o CigarGold.com sells premium cigars through the Internet directly to the consumer and through partnership online affiliations. o BeautyBuys.com sells salon hair care products directly to the consumer via the Internet and through partnership online affiliations. 29 CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2006 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2005. SUMMARY OF OPERATING SEGMENTS AND SUMMARY CONSOLIDATED RESULTS OF OPERATIONS
OPERATING OPERATING AND SEGMENTS CORPORATE SEGMENTS Y/E 12/31/2006 Revenue $71,759,908 13.27% $ 71,759,908 13.27% Gross Profit 4,959,245 23.79% 4,959,245 23.79% SG&A 2,896,658 -5.48% 4,287,344 13.92% Operating Profit 1,894,202 145.30% 426,816 693.15% Net Profit (loss) from continuing operations attributable to common shareholders 468,424 184.05% (1,671,968) -9.45% Per share continuing operations 0.09 (0.33) Net loss from discontinued operations (1,359,464) 31.79% Per share discontinued operations (0.27) Net loss attributable to shareholders (3,031,432) 5.33% Net loss per common share (0.60) Interest and financing expense 1,403,739 8.20% 2,050,856 35.50% Y/E 12/31/2005 Revenue $63,350,182 $ 63,350,182 Gross Profit 4,006,114 4,006,114 SG&A 3,064,639 3,763,526 Operating Profit (loss) 772,194 (71,957) Net Profit (loss) from continuing operations attributable to common shareholders (557,289) (1,846,535) Per share continuing operations (0.14) (0.48) Net loss from discontinued operations (1,031,576) Per share discontinued operations (0.27) Net loss attributable to shareholders (2,878,111) Net loss per common share (0.75) Interest and financing expense 1,297,348 1,513,406
SYNERGY BRANDS Synergy Brands is a holding Company that operates through its two current segments as previously referred to and described herein. Synergy discontinued its Proset segment in the fourth quarter of 2006. In order to better understand the results of operations, each present segment is analyzed respectively and the discontinued operations summarized with the financial details thereof included as are relevant to discussion of past performance. Overall revenues increased by 13% to $71,759,908 for the year ended December 31, 2006, as compared to $63,350,182 for the year ended December 31, 2005. The largest percentage increase was in the Company's grocery and HBA operations conducted through its wholly owned subsidiary PHS Group. The Company's grocery operation continued to develop additional vendor relationships in the grocery and HBA businesses as well as developed a Private Label grocery business offered to U.S. and Canadian customers. Overall gross profit increased by 24% to $4,959,245 for the year ended December 31, 2006 as compared to $4,006,114 for the year ended December 31, 2005. During the latest annual period the Company invested in its direct store delivery (DSD) operation as well as private label grocery distribution, which have contributed to higher gross margins as compared to the prior fiscal year. Overall Selling General and Administrative expenses (SGA) increased by 14% while revenues increased by 13% for the year ended December 31, 2006 as compared to the year ended December 31, 2005. The largest subsidiary of the Company, PHS Group, decreased its SGA expenses by 3% to $2,161,320 for the year ended December 31, 2006 as compared to $2,211,290 for the year ended December 31, 2005. 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 rose, sales commissions and certain operating expenses resulting from sales increased commensurately. 30 The overall net loss attributable to Common Stockholders of the Company was $3,031,432 for the year ended December 31, 2006 as compared to a net loss of $2,878,111 for the year ended December 31, 2005. Interest and financing costs represents approximately 68% of the total loss. The reasons for the increase in net loss the Company attributes in significant part to a charge of $1.35 million incurred by the Company in connection with discontinuing Proset's operations and $655,020 in non-cash charges. Corporate expenses such as legal, accounting, corporate employees and regulatory costs as well as depreciation costs primarily 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 is and will likely continue to be required to comply with those and additional governance and financial regulations that will likely result in additional corporate expenses. Corporate expenses for the year ended December 31, 2006 totaled $1,390,686, which include legal, accounting, corporate employees, and regulatory expenses as compared to $698,887 for the year ended December 31, 2005. The operating segments of PHS Group and Gran Reserve Corporation are further analyzed herein as relate to the operating performance of the Company as well there following herein a discussion relating to discontinuing Proset operations. 31 Below is a summary of the results of operation by segment: PHS Group: (Grocery and HBA operations) Synergy's Grocery and HBA business improved its operation through an expansion of its DSD and private label wholesale and distribution operations. Sales improved by 14% to $69.8 million and operating profit increased by 83% to $2.2 million. PHS represented 97% of the Company's overall revenues and provides most of the cash flow for the Company's other segments as well as corporate regulatory expenses. PHS plans to continue attempting to build its DSD operations, expand its private label programs, and increase its international sales which are anticipated to help continue its direction toward greater profitability. GRAN RESERVE CORPORATION (Cigar operations) Gran Reserve segment operations headed by GRC consist of subcategories www.CigarGold.com, www.CigarsAroundtheWorld.com, www.BeautyBuys.com, and the retail store operation in Miami Lakes, Florida as well as online partnership programs such as www.Overstock.com and www.Google.com. The principal operation has been relocated in March 2006 to a 6,000 square foot facility in Miami Lakes, Florida, which handles order flow for the operation as well as retail operations. Sales for this segment during this period increased by 1% to $1.9 million while operating loss was reduced by 29% to $303,418. Retail store operations commenced in December of 2005 with a grand opening, which occurred on March 4, 2006. GRC plans to have its retail outlets act as its hubs for expansion in FY 2007. The combination of online sales as well as retail store sales is expected to be the focus for growth in FY 2007. The retail store is an expansion of Bill Rancic's Cigars Around the World (CAW) concept of providing the ultimate destination to a cigar aficionado. The Company has been disappointed by GRC's growth and believes that rapidly changing antismoking legislation may be shifting the Cigar business to be a complete destination business as opposed to a leisurely activity which GRC has commenced focus upon through its retail store operations. Corporate Expenses: The Company's allocation to corporate expenses increased by 99% to $1,390,686. Corporate expenses represent 32% of overall operating expense of the Company. The Company relates the increase in expenses to higher legal, corporate employees, regulatory and accounting expenses as well as management allocations to corporate costs. Operating expenses for all operations including corporate expenses totaled $4.3 million in FY 2006. Below is a detailed review of the Company's performance. In order to better understand the Company's financial historical status and performance a discussion of the Company's segments and their respective financial results follow; PHS GROUP (Grocery and HBA operations) PHS Group distributes Grocery and HBA products to retailers and wholesalers predominately located in the Northeastern United States , as well as in Canada. PHS constitutes the largest segment of the Company's operations from a financial prospective, representing about 97% 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, 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 which in turn is designed to increase sales to its customers through this unique focus. PHS concentrates on what it perceives to be the fastest moving consumer product items and uses promotional savings to streamline and reduce their sale prices. PHS focuses on approximately 1,000 products manufactured by the top Grocery and HBA Companies in the United States and as a result the Company believes that they have a competitive advantage in comparison to the traditional wholesaler, which may concentrate on over 10,000 different items. 32 PHS SEGMENT INFORMATION OF OPERATING BUSINESSES PHS Group CHANGE Year ended December 31, 2006 Revenue 69,840,886 13.65% Gross Profit 4,370,869 27.66% SG&A 2,161,320 -2.66% Operating Profit (loss) 2,197,620 83.16% Net Profit (loss) 779,634 797.45% Interest and financing expenses 1,403,739 8.20% Year ended December 31, 2005 Revenue 61,450,467 Gross Profit 3,423,960 SG&A 2,211,290 Operating Profit (loss) 1,199,866 Net loss (111,784) Interest and financing expenses 1,297,348 PHS increased its revenues by 14% to $69.8 million for year ended December 31, 2006 as compared to $61.4 million for the year ended December 31, 2005. The increase in PHS business is attributable by the Company to the utilization of additional vendors, development of a private label grocery program designed to sell proprietary products, more specifically in the baking mix and spice market, to national chains located in the United States and Canada, and organic growth in sales to its customers in the Northeastern Section of the United States. PHS increased its gross profit by increasing Direct Store Delivery sales, developing a private label market to national chains as well as focusing on promotional merchandise offered by its vendors. The overall gross profit percentage increased to 6.3% in 2006 compared to 5.6% at December 31,2005. In 2006, several PHS vendors created special packaging with promotional pricing that enabled PHS to widen its profit margin. As an example, special packaging was created for Folgers, Marcal paper, Crest displays as well as Gain Detergent among others, with unique retail display features, that PHS has been able to strongly promote during FY 2006 as opposed to marketing those products for normal replenishment. The Company believes that promotional displays allow PHS to sell better mixes of product as well as introduce new items in combination with regularly stocked items. As long as the Company maintains or expands its vendor relationships, management believes that it can continue to improve its operating results. However, the Company is dependant on promotional allowances and any material changes to manufacturers' allowances will likely have a material adverse effect on the Company's operating results. Net profit for this segment was $779,634 for the year ended December 31, 2006 as compared to a loss of $111,784 for the year ended December 31, 2005. 33 GRAN RESERVE SEGMENT INFORMATION OF OPERATING BUSINESSES GRC CHANGE Year ended December 31, 2006 Revenue 1,919,022 1.02% Gross Profit 588,376 1.07% SG&A 735,338 -13.83% Operating Profit(loss) (303,418) -29.05% Net Profit(loss) (311,210) -30.14% Year ended December 31, 2005 Revenue 1,899,715 Gross Profit 582,154 SG&A 853,349 Operating Profit(loss) (427,672) Net Profit(loss) (445,505) The Company's direct to consumers activities are conducted through its wholly owned subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses o Cigars Around the World markets premium cigars to restaurants, hotels, casinos, country clubs and many other leisure related destinations. This company was acquired in June 2003. (www.cigarsaroundtheworld.com) o CigarGol.com markets premium cigars through the Internet directly to the consumer. (www.cigargold.com) o GRC opened its first retail store in Miami Lakes, Florida in March, 2006. The store is expected to be an extension to the CAW operation with the store called Cigars Around the World. o BeautyBuys.com sells salon hair care products directly to the consumer via the Internet. (www.beautybuys.com) o The Company's direct to consumers websites are also expected to generate revenue through affiliates and partnership agreements such as www.overstock.com, www.google.com and paid links. Cigars Around the World (CAW), a wholly owned subsidiary of Synergy Brands, Inc. (NASDAQ: SYBR), officially opened its first retail outlet and cigar club in Miami Lakes, Florida, on March 4, 2006. The 6,000 square-foot facility, located at 15804 57th Ave, in Miami Lakes features more than 1,000 unique cigars that include brand name, hand made premium cigars as well as Gran Reserve Corp's (GRC) proprietary brands as well as Cigar Accessories. The entire facility is temperature and humidity controlled and designed so that all the Cigars can be viewed in a total store experience. In addition, the store houses a Cigar Lounge with presently Free satellite TV and Free Wireless Internet designed to enhance the customer's Cigar smoking and shopping experience. CAW expects to use this facility for Radio remotes for special events, seminars on upcoming news in the Cigar world, and other organized events for its members benefits. CAW features top selling Cigar brands which include Macanudo, Partagas, Montecristo, Cohiba, Arturo Fuentes-Opus X, Hemingway, Padron, Punch, Romeo y' Julietta, Suarez Gran Reserve, Davidoff, Ashton, Mike Ditka and Breton labels among others. The store also offers premium brands of upscale accessories. All the products in the store are available nationally on the Store's website www.CigarsAroundTheWorld.com. Bill Rancic, founder of CAW at www.CigarsAroundTheWorld.com and Donald Trump's first "Apprentice" on the popular NBC-TV program, was on hand for the store's grand opening. One of the attractions of the new store is the membership program, which enables club members to rent a climate-controlled locker to keep their personal cache in an optimally controlled temperature and humidity environment. Management believes that the club has the potential to provide an additional revenue stream to the strong sales we continue to see in the cigar division. 34 Upcoming events include plans for a Father's Day celebration in the lounge of Cigars Around the World similar to the grand opening. Fathers will be given the special treatment the Company believes that they deserve as well as exceptional discounts on their favorite cigars. CAW plans NFL weekends as the football season starts and a Super Bowl event next year. Based upon this model and the perceived results thereof, CAW is exploring other retail opportunities to expand this concept. The store's grand opening celebration received coverage by local media including WSVN-TV, FOX; WPLG-TV, ABC; WAXY-AM, 790 The Ticket; the Miami Herald; the Miami Lakes; and the Miami New Times. Revenues in the Company's B2C operation for the year ended December 31, 2006 were $1,919,022 as compared to $1,899,715 for the year ended December 31, 2005. CAW on a current operating basis represented approximately 56% of B2C revenues for the year ended December 31, 2006. Gross profit for year ended December 31, 2006 was $588,376 as compared to $582,154 for the year ended December 31, 2005. The table above provides comparative details for the Company's B2C operation. CAW is operating profitably, but the logistical needed for support of the Miami Lakes, Florida operations is consuming much of the segment's resources and thereby slowing it to show a profit at those sales levels. The On-line segment has over 20,000 customers, generates an average order of $100, with over a 50% repeat rate and generates at a 99% fulfillment rate. The Company believes that building its B2C segment brands along with popularity of Bill Rancic, the winner of the ABC show "The Apprentice" should bring the segment effective critical mass. DISCONTINUED OPERATIONS The Company discontinued Proset's operation in the fourth quarter of 2006 and such discontinuance is reflected in the financial statements hereinafter provided. The prior Proset segment of the Company's business has never been considered a significant component thereof. After review of the relevant components required for measuring the importance of and particulars of the Proset segment, the Company determined that the lessened value to the Company of Proset's revenues (because of the cost factor) did not warrant continuing its operations because such revenues had not become sufficient to sustain the costs of its operations. Proset has not been able to acquire and sell salon hair care products at costs needed to market those products profitably. In addition, Proset's inventory could not be replenished at appropriate levels to accommodate customers' needs as determined by the Company. Proset has continued to operate at a loss and management believed that there is little likelihood of establishing a plan to bring such segment profitable. Management further believes that the expansion of its profitable grocery operations will provide for vertical growth that may require additional capital that would be better invested in PHS operations rather then Proset operations. The table below summarizes the financial operations of Proset for the period being discussed.
Year ended Dec.31, 2006 Year ended Dec. 31, 2005 Net Sales $1,222,834 $786,908 Cost of sales Cost of product 1,260,694 867,036 Shipping and handling costs 144,772 98,607 ---------- -------- 1,405,466 965,643 Gross Profit (182,632) (178,735) Operating expenses: Advertising and promotion 1,046 900 General and administrative 594,008 291,134 Depreciation and amortization 157,650 183,420 Asset impairment charge 359,353 293,586 ---------- -------- 1,112,057 769,040 Operating profit (loss) (1,294,689) (947,775) Other Income (expenses): Other income (expenses) (1,024) (1,035) Interest and financing expenses (62,765) (80,233) ---------- -------- (63,789) (81,268) Net loss before income taxes (1,358,478) (1,029,043) ---------- -------- Income tax expense 986 2,533 ---------- -------- Net loss from discontinued operations $ (1,359,464) $ (1,031,576) ---------- --------
35 CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2004. SUMMARY OF OPERATING SEGMENTS AND SUMMARY CONSOLIDATED RESULTS OF OPERATIONS
OPERATING OPERATING AND SEGMENTS CORPORATE SEGMENTS Y/E 12/31/2005 Revenue $63,350,182 20.02% $ 63,350,182 20.02% Gross Profit 4,006,114 21.07% 4,006,114 21.07% SG&A 3,064,639 9.09% 3,763,526 8.37% Operating Profit (loss) 772,194 122.08% (71,957) -88.25% Net Profit (loss) from continuing operations attributable to common shareholders (557,289) -31.44% (1,846,535) -3.50% Per share continuing operations (0.14) (0.48) Net loss from discontinued operations (1,031,576) 370.60% Per share discontinued operations (0.27) Net loss attributable to shareholders (2,878,111) 34.95% Net loss per common share (0.75) Interest and financing expense 1,297,348 7.12% 1,513,406 14.60% Y/E 12/31/2004 Revenue $52,781,221 $ 52,781,221 Gross Profit 3,308,845 3,308,845 SG&A 2,809,340 3,472,867 Operating Profit (loss) 347,703 (612,592) Net Profit (loss) from continuing operations attributable to common shareholders (812,821) (1,913,550) Per share continuing operations (0.37) (0.87) Net loss from discontinued operations (219,204) Per share discontinued operations (0.10) Net loss attributable to shareholders (2,132,754) Net loss per common share (0.97) Interest and financing expense 1,211,107 1,320,608
SYNERGY BRANDS Synergy Brands is a holding Company that operates through wholly owned segments. In order to better understand the results of operations, each of these segments is analyzed respectively. Overall revenues increased by 20% to $63,350,182 for the year ended December 31, 2005, as compared to $52,781,221 for the year ended December 31, 2004. The largest percentage increase was in the Company's B2B (PHS) operations. The Company's grocery operation within this segment continued to develop additional vendor relationships in the grocery and HBA businesses as well as expanding its sales in Canada. Overall gross profit increased by 21% to $4,006,114 for the year ended December 31, 2005 as compared to $3,308,845 for the year ended December 31, 2004. The Company invested in its direct store delivery (DSD) operation during this period which have contributed to higher margins as compared to the prior fiscal year. Overall Selling General and Administrative expenses (SGA) increased by 8% while revenues increased by 20% for the year ended December 31, 2005 as compared to the year ended December 31, 2004. The Company streamlined its operations by centralizing all administrative functions at its corporate offices, reduced staff in its then existing Proset operation through outsourcing, and increased its focus on wholesale distribution as opposed to retail store sales. The largest subsidiary of the Company, PHS Group, increased its SGA expenses by 18% to $2,211,290 for the year ended December 31, 2005 as compared to $1,870,312 for the year ended December 31, 2004. The increase in SGA for PHS group was attributed to a 21% increase in revenues. PHS incurs variable expenses in connection with selling costs such as sales commission, drivers, warehousing and administrative personnel as well as its promotional expenses. As revenues have risen sales commissions and certain operating expenses resulting from sales have increased commensurately. 36 The overall net loss attributable to Common Stockholders of the Company was $2,878,111 for the year ended December 31, 2005 as compared to a net loss of $2,132,754 for the year ended December 31, 2004. Interest and financing costs represented 53% of the total loss. The Company believes that the reasons for the increase in net loss relate to one-time non-cash charges. Corporate expenses such as legal, accounting, and regulatory costs as well as depreciation costs represent in significant part 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 is and will likely continue to be required to comply with additional governance and financial regulations that will likely result in additional corporate expenses. Corporate expenses for the year ended December 31, 2005 totaled $698,887, which include legal, accounting and regulatory expenses as compared to $663,527 for the year ended December 31, 2004. Below is a summary of the results of operations by segment: PHS Group: (Grocery and HBA Operations)) Synergy's Grocery and HBA operation (through PHS) improved its operation through an expansion of its Metro NY wholesale operation. Sales improved as between the referenced periods by 21% to $61.4 million and operating profit for this segment increased by 29% to $1.2 million. PHS represented 97% of the Company's overall revenues and provides most of the cash flow for the Company's other segments as well as to cover corporate regulatory expenses. PHS plans to continue attempting to build its Metro NY, operations and increase its international sales to Canada and the Caribbean. Gran Reserve Corporation (Cigar Operations) Gran Reserve operations of the Company as are the focus of this segment consist of www.CigarGold.com, www.CigarsAroundtheWorld.com, www.BeautyBuys.com; retail store operation in Miami Lakes, Florida and online partnership programs such as www.Overstock.com and www.Google.com. The principal operation has been relocated to a 6,000 square foot facility in Miami Lakes Florida, which handles order flow for the operation as well as retail operations. Sales as between the referenced periods deceased by 7% to $1.9 million while operating loss was reduced by 27% to $427,672. Revenues were reduced due in material part to Hurricane Wilma, which disrupted operations in the fourth quarter of 2005. Retail store operations commenced in December of 2005 with a grand opening, which occurred on March 4, 2006. GRC planned its retail outlets to act as its hubs for expansion in FY 2006 and beyond. The combination of online sales as well as retail store sales, as expected was a good part of the focus for growth in FY 2006. The retail store is an expansion of Bill Rancic's Cigars Around the World (CAW) concept of providing the ultimate destination to a cigar aficionado. The Company has been disappointed by GRC's growth and believes that rapidly changing antismoking legislation may have contributed to a likely shift in the Cigar business to a complete destination business as opposed to a leisurely activity. Corporate Expenses: The Company's allocation to corporate expenses increased during the period by 5% to $698,887. Corporate expenses represented 19% of overall operating expense of the Company. Operating expenses for all operations including corporate expenses totaled $4 million in FY 2005. Below is a more detailed review of the Company's performance. In order to better understand the Company's results a discussion of the Company's segments and their respective results during the represented period follow; PHS Group (Grocery and HBA Operations) The Company's grocery and HBA sector for the period consists mainly of one operating business, PHS Group. PHS Group distributes Grocery and HBA products to retailers and wholesalers predominately located in the Northeastern United States as well as in Canada. PHS is the largest subsidiary of the Company and represents on average about 97% 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, 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 which in turn appears to 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. 37 PHS SEGMENT INFORMATION OF OPERATING BUSINESSES PHS Group CHANGE Year ended December 31, 2005 Revenue 61,450,467 21.14% Gross Profit 3,423,960 22.03% SG&A 2,211,290 18.23% Operating Profit (loss) 1,199,866 29.17% Net loss (111,784) -33.44% Interest and financing expenses 1,297,348 11.02% Year ended December 31, 2004 Revenue 50,728,560 Gross Profit 2,805,747 SG&A 1,870,312 Operating Profit (loss) 928,934 Net loss (167,951) Interest and financing expenses 1,168,607 PHS increased its revenues by 21% to $61.4 million for year ended December 31, 2005 as compared to $50.7 million for the year ended December 31, 2004. The increase in PHS business is attributable by the Company to the utilization of additional vendors, development of a wholesale operation and expansion of the Canadian distribution business in Ontario, Canada, increase of its Domestic Wholesale business and expansion of its business into the Dominican Republic. PHS increased its gross profit by increasing Direct Store Delivery sales as well as focusing on promotional merchandise offered by its vendors. The overall gross profit percentage remained consistent at 5.6% for the referenced period . In 2005, several PHS vendors created special packaging with promotional pricing that enabled PHS to widen its margin. As an example, special packaging was created for Folgers, Marcal paper, Crest displays as well as Gain Detergent among others, with unique retail display features, that PHS has been able to strongly promote during FY 2005 as opposed to marketing those products for normal replenishment. Promotional displays allow PHS to sell better mixes of product as well as to introduce new items in combination with regularly stocked items. As long as the Company maintains or expands its vendor relationships, management believes that it can continue to improve its operating results. However, the Company is dependant on promotional allowances and any material changes to manufacturers' allowances will likely have a material adverse effect on the Company's operating results. Net loss was $111,784 for the year ended December 31, 2005 as compared to a loss of $167,951 for the year ended December 31, 2004. 38 GRAN RESERVE SEGMENT INFORMATION OF OPERATING BUSINESSES GRC CHANGE Year ended December 31, 2005 Revenue 1,899,715 -7.45% Gross Profit 582,154 15.71% SG&A 853,349 -9.12% Operating Profit(loss) (427,672) -26.42% Net loss (445,505) -30.92% Interest and financing expenses - -100.00% Year ended December 31, 2004 Revenue 2,052,661 Gross Profit 503,098 SG&A 939,028 Operating Profit(loss) (581,231) Net Profit(loss) (644,870) Interest and financing expenses 42,500 The Company's direct to consumers activities are conducted through its wholly owned subsidiary Gran Reserve Corporation (GRC). GRC operates the following businesses o Cigars Around the World markets premium cigars to restaurants, hotels, casinos, country clubs and many other leisure related destinations. This company was acquired in June 2003. (www.cigarsaroundtheworld.com) o CigarGold.com markets premium cigars through the Internet directly to the consumer. (www.cigargold.com) o GRC opened its first retail store in Miami Lakes, Florida in March, 2006. The store as designed is expected to be an extension to the CAW operation with the store called Cigars Around the World. o BeautyBuys.com sells salon hair care products directly to the consumer via the Internet. (www.beautybuys.com) o The Company's direct to consumers websites are also expected to generate revenue through affiliates and partnership agreements such as www.overstock.com, www.google.com and paid links. Cigars Around the World (CAW), a wholly owned subsidiary of Synergy Brands, Inc. (NASDAQ: SYBR), officially opened its first retail outlet and cigar club in Miami Lakes, Florida, on March 4, 2006 as was contemplated in 2005. CAW features top selling Cigar brands which include Macanudo, Partagas, Montecristo, Cohiba, Arturo Fuentes-Opus X, Hemingway, Padron, Punch, Romeo y' Julietta, Suarez Gran Reserve, Davidoff, Ashton, Mike Ditka and Breton labels among others. The store also offers premium brands of upscale accessories. All the products in the store are available nationally on the Store's website www.CigarsAroundTheWorld.com. Revenues in the Company's direct to consumers operation for the year ended December 31, 2005 were $1,899,715 as compared to $2,052,661 for the year ended December 31, 2004. CAW on a current operating basis represented approximately 59% of B2C revenues for the year ended December 31, 2005. Gross profit for year ended December 31, 2005 was $582,154 as compared to $503,098 for the year ended December 31, 2004. The table above provides comparative details for the Company's B2C operation. CAW is operating profitably, but the logistical support needed for the Miami Lakes, Florida operation is consuming much of the segment's resources and thereby restricting it from show of a profit at those sales levels. The On-line segment has over 20,000 customers, generates an average order of $100, with over a 50% repeat rate and generates at a 99% fulfillment rate. The Company believes that building its B2C segment brands along with popularity of Bill Rancic, the winner of the ABC show "The Apprentice" should bring the segment effective future critical mass. 39 DISCONTINUED OPERATIONS The Company discontinued Proset's operation in the fourth quarter of 2006 and such discontinuance is reflected in the financial statements hereinafter provided. The prior Proset segment of the Company's business has never been considered a significant component thereof. After review of the relevant components required for measuring the importance of and particulars of the Proset segment, the Company determined that the lessened value of the Company of Proset's revenues did not warrant continuing its operations because such revenues (because of the cost factor) had not become sufficient to sustain the costs of its operations. Proset has not been able to acquire and sell salon hair care products at costs needed to market those products profitably. In addition, Proset's inventory could not be replenished at appropriate levels to accommodate customers' needs as determined by the Company. Proset has continued to operate at a loss and management believed that there is little likelihood of establishing a plan to bring such segment profitable. Management further believes that the expansion of its profitable grocery operations will provide for vertical growth that may require additional capital that would be better invested in PHS operations rather then Proset operations. The table below summarizes the historical financial operations of Proset for the period being discussed.
Year ended Dec. 31, 2005 Year ended Dec. 31, 2004 Net Sales $ 786,908 $3,923,823 Cost of sales Cost of product 867,036 3,206,187 Shipping and handling costs 98,607 129,482 ---------- -------- 965,643 3,335,669 Gross Profit (178,735) 588,154 Operating expenses: Advertising and promotion 900 - General and administrative 291,134 282,747 Depreciation and amortization 183,420 210,920 Asset impairment charge 293,586 - ---------- -------- 769,040 493,667 Operating profit (loss) (947,775) 94,487 Other Income (expenses): Other income (expenses) (1,035) (80,778) Interest and financing expenses (80,233) (232,913) ---------- -------- (81,268) (313,691) Net loss before income taxes (1,029,043) (219,204) ---------- -------- Income tax expense 2,533 - ---------- -------- Net loss from discontinued operations $ (1,031,576) $(219,204) ---------- --------
40 LIQUIDITY AND CAPITAL RESOURCES
Year ended 2006 2005 Working Capital $ 9,285,585 $ 4,967,712 Assets 20,867,796 17,352,638 Liabilities 15,207,546 10,419,937 Equity 5,660,250 6,932,701 Line of Credit Facility 5,836,928 4,033,242 Receivable turnover (days) 57 44 Inventory Turnover (days) 7 7 Net cash used in operating activies (4,324,635) (4,064,235) Net cash provided by (used in ) investing activites 420,590 (791,007) Net cash provided by financing activites 4,293,432 4,160,250
The Company's working capital increased by $4.3 million in FY 2006 to $9.3 million due to a combination of several factors including amortization of debt, refinancing of short term debt to long term debts and operating profits from PHS Group. Receivables including trade and other receivables increased by $4.4 million due to revenue increases and vendor rebates. The Company plans to further improve its working capital through conversion of short-term debt to long-term debt, increasing its operating profit, reducing its financing expenses and the utilization of equity financing. The Company needed $4.3 million to support cash needed for operating activities. The predominant need for cash involved the increase of accounts receivable by $4.3 million. The Company supported this need through an increase of its utilization of lines of credit, additional equity and debt instruments. In addition, improved operating performance by PHS Group contributed to the operating needs of the Company. The Company financed its operating activities by issuing $1.75 million in 10% notes in the first quarter of 2006, and utilized its asset based financing facilities and trade financing for $1.8 million in the fourth quarter of 2006. 41 Liquidity for the Company predominately involves the need to finance accounts receivables, inventory, interest and operating expenses. The cash flow realized from the Company's gross profit has been sufficient to cover the Company's operating expenses. However, the Company relies on debt and equity financing in order to support the interest that it pays in support of financing its receivables and inventory. The Company has not been able to date to completely support its financing costs solely from operations and has relied on equity and debt financing to bridge the gap. The Company generated a net loss attributable to Common Shareholders of approximately $3,031,000 in 2006. Financing costs totaled $2,050,856 and non-cash charges totaled approximately $600,000 for the period. Reductions in financing expenses through equity conversions and debt repayments through operating or capital transactions have been and should continue to be beneficial to the Company's performance. The capital resources that were available to the Company consisted of $7.0 million in lines of Credit, $3.7 million in short term notes, $3.65 million of non-redeemable preferred and $2.0 million in long-term notes as of December 31, 2006. The Company's objective is to reduce its notes through the issuance of equity and cash flow as well as refinancing its current obligations with debit with lower rates. Towards such goal, in the first quarter of 2007 the Company refinanced it's $6 million dollar senior line of credit with a $6.5 million 10 year term facility and reduced its interest rate to 11.25%. However there is no assurance that the Company will be able to achieve its stated objectives. Achieving these goals and objectives is believed material to the Company's success. The Company's liquidity relies in material part on the turnover of it inventory and accounts receivable. The Company has for the last fiscal year turned its receivables on average every 57 days and the Company has turned its overall inventory on average approximately every 7 days. The Company believes that its collection procedures and procurement policies are consistent with industry standards. However, nearly 60% of the Company's assets consist of trade receivables and inventory. The Company must maintain a strict policy on insuring collections of receivables and adequate procurement based upon customer demands to optimize its profit potential. The Company's sales are reliant in significant part on extending credit that ranges from 30 to 60 days. As a result, the Company must have financing facilities that will continue to allow the Company to procure inventory and extend accounts receivable credits. The Company has strict credit policies and reviews; however credit extensions may pose material financial risks to the Company. In addition the Company relies on performance incentives from its manufacturers that are based upon sales. Provided the Company maintains its performance standards with the Manufacturers with whom it contracts for procurement of goods its estimates of incentives that are due should remain accurate. However, if the respective manufactures change their policies or the Company does not meet the manufacturers standards, incentives may be reduced. 42 Management believes that continued cost containment, improved financial and operating controls, debt reduction, and a focused sales and marketing effort should provide sufficient cash flow from operations in the near term and the Company is working toward reliance on such financial sources and attributes to cover its cash flow requirements but achievement of these goals, however, will likely continue to be dependent upon the Company's attainment of increased revenues, improved operating costs, reduced financing cost and trade support levels that are consistent with management's plans. Such operating performance will likely continue to be subject to financial, economic and other factors likely to be beyond its control, and there can be no assurance that the Company's goals will be achieved. In the interim while such goals are being pursued achievement of positive cash flow has been and continues to be reliant on equity and debt financing, including the Company's exchange of notes payable for common shares and its issuance of further common and preferred stock in private placements and the Company is hopeful that the market will continue to recognize the Company's stature so that such financing method will continue to be available in the future because, at least in the near future, the Company is likely to continue to use such financing opportunities to maintain adequate cash flow. Expected interest payments on notes payable for the period ended December 31, are as follows: 12/31/07 12/31/08 12/31/09 12/31/10 Total $227,000 $102,000 $74,000 $53,000 $456,000 Variable interest rate on notes of $570,000 was 11.25%. Variable interest rate on note of $500,000 was 7.75%. The following table presents the Company expected cash requirements for contractual obligations outstanding at December 31, 2006. Payments Due By Period
Contractual Obligations Less Than 1-3 4-5 After 5 1 Year Years Years Years Total Line-Of-Credit $5,836,928 $5,836,928 Notes Payable $4,227,000 $1,386,000 $857,000 $6,470,000 Operating Leases $429,746 $835,737 $642,152 $103,714 $2,011,349 Total Contractual Cash Obligations $10,493,674 $2,221,737 $1,499,152 $103,714 $14,318,277
43 CRITICAL ACCOUNTING POLICIES. The discussion and analysis of the Company's financial condition and results of operations are based upon its financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of financial statements requires management to make estimates and disclosures on the date of the financial statements. On an on going basis, management evaluates its estimates. Management uses authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. Actual results could differ from those estimates. Management believes that the following critical accounting policies affect its more significant judgments and estimates in the preparation of the Company's financial statements. ACCOUNTS RECEIVABLE/ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company's accounts receivable are due from businesses engaged in the distribution of grocery, health and beauty products as well as from consumers who purchase health and beauty products and premium handmade cigars from the Company's Web sites. Credit is extended based on evaluation of a customers' financial condition and, generally, collateral may be required. Accounts receivable are due within 10 - 90 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, 2006, the Company has established a full valuation allowance. VALUATION OF LONG-LIVED ASSETS. The Company reviews its long-lived assets periodically to determine potential impairment by comparing the carrying value of the assets with expected net cash flows expected to be provided by the operating activities of the business or related products. Should the sum of the expected future net cash flows be less than the carrying value, the Company would determine whether an impairment loss should be recognized. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the Asset. Long-lived assets and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from use of the assets and their ultimate disposition. To the extent impairment has occurred, the carrying amount of the asset would be written down to an amount to reflect the fair value of the asset. 44 RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD ("FASB") In November 2004, the Financial Accounting Standards Board ("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's adoption of SFAS No.151 did not 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's adoption of SFAS No.153 did not have a material impact on the Company's financial position or result of operations. In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. " ("SFAS 154") This Statement requires retrospective application to prior period financial statements of a voluntary change in accounting principle unless it is impracticable and is effective for fiscal years beginning after December 15, 2005. Previously, most voluntary changes in accounting principle were recognized by including the net income of the period of the change the cumulative effect of change to the new accounting principle. The Company's adoption of SFAS No. 154 did not have a material impact on the Company's financial position or result of operations. In February 2006, FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an Amendment of FASB No. 133 and 140. The purpose of SFAS statement No. 155 is to simplify the accounting for certain hybrid financial instruments by permitting fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 also eliminates the restriction on passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of any entity's first fiscal year beginning after September 15, 2006. We believe that the adoption of this standard on January 1, 2007 will not have a material effect on our consolidated financial statements. 45 In September 2006, the FASB issued No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of their financial instruments according to a fair value hierarchy as defined in the standard. Additionally, companies are required to provide enhanced disclosure regarding financial instruments in one of the categories (level 3), including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We believe that the adoption of SFAS No. 157 will not have a material impact on our consolidated financial statements. In July 2006, the FASB issued FASB Interpretation 48, "Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognizing, classification interest and penalties, accounting in interim periods, disclosure and transition. We believe that the adoption of FIN 48 will not have a material impact of our consolidated financial statements. For our Company, this interpretation will be effective beginning January 1, 2007. The SEC issued Staff Accounting Bulletin No. 108 ("108") in September 2006. SAB 108 expresses the views of the SEC staff regarding the process of quantifying the materiality of financial misstatements. SAB 108 requires both the balance sheet and income statement approaches be used when quantifying the materiality of misstatement amounts. In addition, SAB 108 contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years. SAB 108 was effective in the Company's fourth quarter of 2006. The adoption of SAB 108 did not have a material impact on the Company's consolidated financial statements. SEASONALITY Sales by PHS Group usually peak at the end of the calendar quarter, when the Company's suppliers offer promotions which lower prices and, in turn, the Company is able to lower its prices and increase sales volume. Suppliers tend to promote at quarter end and as a result reduced products costs may increase sales. In particular, the first and second quarters are usually better operating quarters. Sales of beauty care products and fragrances increase over traditional gift giving holidays such as Christmas, Mother's Day, Father's Day, and Valentine's Day. Cigar product sales also increase during holiday periods and summer months as well as around special sporting events. INFLATION The Company believes that inflation, under certain circumstances, could be beneficial to the Company's major business, PHS Group. When inflationary pressures drive product costs up, the Company's customers sometimes purchase greater quantities of product to expand their inventories to protect against further pricing increases. This enables the Company to sell greater quantities of products that are sensitive to inflationary pressures. However, inflationary pressures frequently increase interest rates. Since the Company is dependent on financing, any increase in interest rates will increase the Company's credit costs, thereby reducing its profits. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does rely partly not to any material extent on variable interest rate debt instruments representing less than 10% in amount of all working capital financing, and the Company does not therefore consider there to be any overall material market risk potentially derived from the existence of such loan terms (See MD&A supra for further details regarding existing variable interest rate instruments). The Company does not believe that it has any other potential market risk sensitive financial instruments. 46 ITEM 8. FINANCIAL STATEMENTS The following financial statements of the Company are contained in this Report on the pages indicated: INDEX TO FINANCIAL STATEMENTS
Page Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets as of December 31, 2006 and 2005 F-3-F-4 Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004 F-5 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Loss for the Years Ended December 31, 2006, 2005 and 2004 F-6-F-9 Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004 F-10-F-11 Notes to Consolidated Financial Statements F-12-F-39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE ITEM 9A. CONTROLS AND PROCEDURES As certified herein by the Company's Chief Executive Officer and Chief Financial Officer, they have as of the date of this report evaluated the disclosure controls and procedures of the Company and believe same to be effective to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company sufficient to allow evaluation by the Company of accuracy in their recording, processing, summarizing and reporting financial and other Company information and data, and there do not appear to be any deficiencies in the design or operation of such internal controls which would adversely and materially affect the Company's ability to discover, evaluate and report such information. The Company has adopted an Audit Committee Charter providing expanded authority of such committee and the independent nature and identity of its director participants as required by the enactment of the Sarbanes-Oxley Act. The Company believes that at least one director participant therein will be qualified as an "audit committee financial expert" as defined in such Act. There have been no significant changes in the Registrants internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation thereof, including any corrective actions with regard to significant deficiencies and material weaknesses. The Company's disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in its reports filed under the Exchange Act, such as this Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. The Company's disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to management to allow timely decisions regarding required disclosure. The Company's internal controls are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of its financial statements in conformity with GAAP. 47 The Company's management, including its principal executive officer and the principal financial officer, does not expect that the Company's disclosure controls and procedures and its internal control processes will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. The Company monitors its disclosure controls and procedures and internal controls and makes modifications as necessary; the Company's intent in this regard is that the disclosure controls and procedures and the internal controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant. PART III The information required by items 10-14 are omitted pursuant to general instruction G(3) to Form 10K including executive compensation and auditor fee information . The Company has included this information in its proxy statement expected to be mailed to shareholders and filed with the Commission on or before April 30, 2006. The annual meeting is scheduled to be in June 2007. Such Proxy Statement is expected to be filed with the Commission by April 30, 2007 and is incorporated herein by reference. The Company has established and adopted a Code of Ethics outlining and providing guidelines for executive and employer conduct regarding the disclosure, promotion and handling of Company business and business relationships and a policy for comment and complaint on compliance with applicable conduct codes ("whistleblower policy") and the Company has also established a Nominating Committee of certain of its Directors to assist in the election and succession of members of the Company's Board of Directors and a Compensation Committee to assist in establishing executive compensation. Copies of the Company's Code of Ethics, whistleblower policy, Nominating Committee and Compensation Committee Charters may be found disclosed in the aforesaid Proxy Statement to be confirmed at the relevant shareholders meeting and included by reference thereto on the Company's Internet home page website. 48 ITEM 15. EXHIBITS, and FINANCIAL STATEMENT SCHEDULES (a) financial statements-see Item 8 (b) Exhibits: EXHIBIT INDEX
Exhibit No. Description Page ----------- ----------- ---- 3.1 Certificate of Incorporation and amendments thereto (1) -- 3.2 By-Laws (2) -- 4 Preferred Stock, Common Stock, and Options and Warrants and other Instruments defining rights of security holders, including indentures (3) EX-4 10 Synergy Brands Inc. 1994 Services and Consulting Compensation Plan, as amended (4) 14 Code of Ethics EX-14 EX-14.1 Audit Committee Charter (5) EX-14.1 EX-14.2 Nominating Committee Charter (5) EX-14.2 EX-14.3 Whistleblower Policy (5) EX-14.3 EX-14.4 Nominating Committee Charter (5) EX-14.4 21 Listing of Company Subsidiaries EX-21 23.1 Consent of Holtz Rubenstein Reminick LLP EX-23.1 32.1 Certification Pursuant to 18 U.S.C. Section 1350. As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by the Chief Executive Officer. EX-32.1 32.2 Certification Pursuant to 18 U.S.C. Section 1350. As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by the Chief Financial Officer. EX-32.2 99 Listing of Company Intellectual Properties EX-99
(1) A copy of the Amendment to the Certificate of Incorporation dated September 14, 2004 and Certificates of Correction (3) filed February 25, 2005 are included as exhibits by incorporation by reference to the 10K/A report filed for the Company for the year ended 12/31/04. A copy of the Restated Certificate of Incorporation filed November 10, 2003 and the clarification amendment to the Certificate of Incorporation filed March 2004 are incorporated by reference to the 10KSB filed for the Company for the year ended 12/31/03. The amendments to Certificate of Incorporation filed 7/29/96 and filed 6/24/98 and Certificate of Designation regarding Preferred Stock filed 6/24/98, are incorporated by reference to the exhibits filed to the Form 10K/A of the Company filed 9/3/98. The amendment to the Certificate of Incorporation filed July 2000 is incorporated by reference to the exhibits filed to the form 10KSB/A of the Company filed 8/9/01. The amendment to the Certificate of Incorporation filed April 1, 2001 is incorporated by reference to the exhibits filed to the Form 10-KSB of the Company filed March 2002. The amendment to the Certificate of Incorporation filed February 11, 2003 and the Certificate of Designation regarding Preferred Stock filed March 13, 2003 are incorporated by reference to the 10KSB filed for the Company for the year ended 12/31/02. The original Certificate of Incorporation and other amendments thereto are incorporated by reference to the exhibits filed to the registration statement of the Company on Form S-1 (File No. 33-83226) filed by the Company with the Commission on August 24, 1994. (2) The amendment to the By-Laws approved by the Company's Board of Directors on March 7, 1997 are incorporated by reference to the exhibits filed to the Form 10K/A of the Company filed 9/3/98. The original By-Laws are incorporated by reference to the exhibits filed to the registration statement of the Company on Form S-1 (File No. 33-83226) filed by the Company with the Commission on August 24, 1994 49 (3) Description of rights of Preferred Stock are included in the Restated Certificate of Incorporation filed November 10, 2003 and Clarification Amendment to the Certificate of Incorporation filed March , 2004 and in the Certificate of Designation filed 3/13/03 all incorporated by reference herein (See footnote (1)), and in the Certificate of Designation regarding Preferred Stock, as amended, and included as exhibit to the Form 10K/A of the Company filed 9/3/98 as well as the amendment to the certificate of incorporation filed in July 2000 and included as an exhibit to the Form 10KSB/A of the Company filed 8/9/01 which latter documents are incorporated by reference herein. Description of the Company's Common Stock is incorporated by reference to the description contained in the Company's Registration Statement on Form 8-A (File No. 0-19409) filed with the Commission pursuant to Section 12(b) of the Exchange Act on July 16, 1991, including any amendments or reports filed for the purpose of updating such description. A facsimile of outstanding warrants is included by reference to the similar exhibit in the Company's Form 10-K/A for the fiscal year ended December 31, 2004. In January 2007 the Company entered into a Securities Purchase Agreement with Lloyd Miller, III and affiliated entity thereof under which terms the Company obligated itself to a borrowing of $6.5 million and agreed to issue 1,075,000 shares of its Common Stock, which financial arrangement was disclosed in an 8K filing made by the Company on January 22, 2007 and such filing is incorporated by reference hereafter for further description of the subject transactions. Information and particulars on other long term debt instruments outstanding shall be supplied if and as requested by the Commission as allowed by applicable regulation as on none of such debt instruments on an individual basis does the total amount of securities authorized thereunder exceed 10% of the Company's total assets. Such instruments include approximately $2,225,000 debt remaining as currently owed to Laurus Master Fund, Ltd. arising from Secured Convertible Term Notes dated April 2, 2004, January 25, 2005, June 21, 2005 and March 13, 2006 and $490,000 in total long term debt to three non-affiliated parties by Secured Promissory Notes dated March 1, 2004. (4) Incorporated by reference to the Registration Statement of the Company on Form S-8 (File No. 333-92243) filed with the Commission on 12/17/99, as amended (5) These charters and policies are available in full text on the Company's website and such information is incorporated herein by reference therefrom. (c) Financial Statement Schedules None 50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Synergy Brands Inc. by /s/ Mair Faibish -------------------------------- Mair Faibish Chairman of the Board Dated: March 30, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. by /s/ Mair Faibish ---------------------------------- Mair Faibish Chairman of the Board Dated: March 30, 2007 by /s/ Mitchell Gerstein ---------------------------------- Mitchell Gerstein Chief Financial Officer Dated: March 30, 2007 by /s/ Joel Sebastian ----------------------------------- Joel Sebastian, Director Dated: March 30, 2007 by /s/ Lloyd Miller ----------------------------------- Lloyd Miller, Director Dated: March 30, 2007 by /s/ William Rancic ----------------------------------- William Rancic, Director Dated: March 30, 2007 by /s/ Frank A. Bellis Jr. ----------------------------------- Frank A. Bellis, Director Dated: March 30, 2007 by /s/ Randall J. Perry ----------------------------------- Randall J. Perry, Director 51 Certification I, Mair Faibish, certify that: 1. I have reviewed this annual report on Form 10-K of Synergy Brands, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this annual report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (a) all significant deficiencies and material weaknesses we find in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2007 /s/ Mair Faibish ---------------- Mair Faibish Chief Executive Officer 52 Certification I, Mitchell Gerstein, certify that: 1. I have reviewed this annual report on Form 10-K of Synergy Brands, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this annual report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (a) all significant deficiencies and material weaknesses we find in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information ; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2007 /s/ Mitchell Gerstein --------------------- Mitchell Gerstein Chief Financial Officer 53 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Synergy Brands, Inc. We have audited the accompanying consolidated balance sheets of Synergy Brands, Inc., as of December 31, 2006 and 2005 and the related consolidated statements of operations, stockholders' equity and comprehensive loss, and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Synergy Brands, Inc. as of December 31, 2006 and 2005 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note B to the financial statements, the Company adopted Financial Accounting Standard No. 123(R), "Share-Based Payment", effective January 1, 2006. HOLTZ RUBENSTEIN REMINICK LLP Melville, New York March 9, 2007 F-2 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, 2006 and 2005 ASSETS
CURRENT ASSETS 2006 2005 ---------- --------- Cash and cash equivalents $ 644,870 $ 255,483 Accounts receivable trade, less allowance for doubtful accounts of $127,481 and $127,481 11,165,980 7,478,139 Other receivables 2,453,705 1,730,806 Notes receivable - current 344,699 287,967 Inventory 1,289,221 1,181,223 Prepaid assets and other current assets 669,908 392,789 Assets of discontinued operations 127,182 1,392,551 ---------- --------- Total Current Assets 16,695,565 12,718,958 PROPERTY AND EQUIPMENT, NET 252,950 276,844 OTHER ASSETS 909,454 802,887 NOTES RECEIVABLE 2,207,233 2,691,439 INTANGIBLE ASSETS, net of accumulated amortization of $389,226 and $329,310 288,297 348,213 GOODWILL 514,297 514,297 ---------- --------- TOTAL ASSETS $ 20,867,796 $ 17,352,638 ========== =========
The accompanying notes are an integral part of these statements. F-3 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS (Continued) December 31, 2006 and 2005 LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES 2006 2005 ----------- ----------- Lines of credit $ - $ 4,033,242 Notes payable - current 4,196,757 1,326,000 Accounts payable 2,170,408 1,640,448 Related party note payable 23,706 61,882 Accrued expenses 151,037 36,855 Deferred income 755,503 127,000 Liabilities of Discontinued operations 112,569 525,819 ----------- ----------- Total Current Liabilities 7,409,980 7,751,246 NOTES PAYABLE, net of discount of $313,749 and 46,309, respectively 1,960,638 2,668,691 LINES OF CREDIT 5,836,928 - COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Class A preferred stock - $.001 par value; 100,000 shares authorized; 93,213 and 100,000 shares issued and outstanding; liquidation preference of $10.50 per share 93 100 Class B preferred stock - $.001 par value; 150,000 shares authorized, none issued - - Class B Series A Preferred stock-$.001 par value; 500,000 shares authorized; 285,000 and 330,000 shares issued and outstanding; liquidation preference of $10.00 per share 285 330 Class B Series B Preferred stock-$.001 par value, 250,000 shares authorized; 80,000 shares issued and outstanding; liquidation preference of $10.00 per share 80 80 Common stock - $.001 par value; 14,000,000 shares authorized; 6,484,275 and 4,457,530 shares issued 6,484 4,458 Additional paid-in capital 47,252,064 45,918,817 Deficit (41,585,416) (38,910,484) Unearned Compensation - (67,260) Accumulated other comprehensive loss (8,340) (8,340) ----------- ----------- 5,665,250 6,937,701 Less treasury stock, at cost, 1,000 shares (5,000) (5,000) ----------- ----------- Total Stockholders' Equity 5,660,250 6,932,701 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $20,867,796 $17,352,638 =========== ===========
The accompanying notes are an integral part of these statements. F-4 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31,
2006 2005 2004 ----------- ----------- ------------ Net sales $71,759,908 $63,350,182 $ 52,781,221 ----------- ----------- ------------ Cost of sales Cost of product 65,631,282 58,403,752 48,701,653 Shipping and handling costs 1,169,381 940,316 770,723 ----------- ----------- ------------ 66,800,663 59,344,068 49,472,376 ----------- ----------- ------------ Gross profit 4,959,245 4,006,114 3,308,845 Operating expenses Advertising and promotional 234,582 62,255 150,181 General and administrative 4,052,762 3,701,271 3,322,686 Depreciation and amortization 245,085 314,545 448,570 ----------- ----------- ------------ 4,532,429 4,078,071 3,921,437 ----------- ----------- ------------ Operating Profit (loss) 426,816 (71,957) (612,592) Other income (expense) Interest income 147,533 102,644 4,610 Other income (expense) (22,039) (20,469) 33,795 Equity in earnings of investee 227,054 56,311 172,224 Interest and financing expenses (2,050,856) (1,513,406) (1,320,608) ----------- ----------- ------------ (1,698,308) (1,374,920) (1,109,979) ----------- ----------- ------------ Loss from continuing operations before income taxes (1,271,492) (1,446,877) (1,722,571) Income tax expense 43,976 82,325 34,604 ----------- ----------- ------------ Loss from continuing operations (1,315,468) (1,529,202) (1,757,175) ----------- ----------- ------------ Discontinued operations Loss from operations of discontinued component (1,358,478) (1,029,043) (219,204) Income tax expense 986 2,533 - ----------- ----------- ------------ Loss from discontinued operations (1,359,464) (1,031,576) (219,204) ----------- ----------- ------------ Net Loss (2,674,932) (2,560,778) (1,976,379) Dividend - Preferred Stock (356,500) (317,333) (156,375) ----------- ----------- ------------ Net loss attributable to common stockholders $ (3,031,432) $ (2,878,111) $ (2,132,754) =========== =========== ============ Basic and diluted net loss per common share from continuing operations: $ (0.33) $ (0.48) $ (0.87) Basic and diluted net loss per common share from discontinued operations: $ (0.27) $ (0.27) $(0.10) ----------- ----------- ------------ $ (0.60) $ (0.75) $(0.97) ----------- ----------- ------------ Weighted average shares used in the compution of loss per common shares: Basic and diluted 5,080,323 3,820,061 2,209,371 =========== =========== ============
The accompanying notes are an integral part of these statements. F-5 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS Years ended December 31, 2006, 2005 and 2004
Class A Class B-Series A Class B-Section B Additional Preferred Stock Preferred Stock Preferred Stock Comonn Stock Paid-in Shares Amount Shares Amount Shares Amount Shares Amount Capital ------- ------ ------- -------- ------- -------- --------- ------- ------------ Balance at January 1, 2004 100,000 $100 160,000 $160 - - 1,919,359 $1,919 $ 37,748,004 Amortization of unearned compensation Common stock returned and retired (61,500) (61) 61 Common stock issued 100,000 100 470,685 Net proceeds from issuance of Issuance of common stock in common stock in Connection with private placement 170,000 170 255,000 255 1,454,575 Issuance of common stock for note conversion 688,338 688 2,733,957 Exercise of stock options 110,000 110 102,140 Issuance of common stock for services 58,195 58 190,563 Issuance of common stock in connection with CAW acquisitions 175,000 175 524,825 Issuance of common stock along 19,600 20 74,980 with debt Option Expense 30,750 Preferred stock dividend 156,375) Consulting expense (40,000) Change in unrealized gain on Marketable securities Cumulative translation adjustments Net loss ------- ------ ------- -------- ------- -------- --------- ------- ------------ Comprehensive loss Balance at December 31, 2004 100,000 $100 330,000 $330 - - 3,263,992 $3,264 $ 43,134,165 ======= ====== ======== ======== ======= ======== ========= ======= ============
F-6 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS Years ended December 31, 2006, 2005 and 2004 Continued
Accumulated Other Stockholders Comprehensive Treasury Unearned notes Deficit Income (loss) Stock Compensation receivable ------------- -------------- ---------- ------------ ----------- Balance at January 1, 2004 $(34,373,327) $ (1,772) $ (5,000) $(426,252) - Amortization of unearned compensation 224,496 Common stock returned and retired Common stock issued Net proceeds from issuance of Issuance of common stock in common stock in Connection with private placement Issuance of common stock for note conversion Exercise of stock options Issuance of common stock for services Issuance of common stock in connection with CAW acquisitions Issuance of common stock along with debt Option Expense Preferred stock dividend Consulting expense Change in unrealized gain on Marketable securities 4,105) Cumulative translation adjustments (2,463) Net loss (1,976,379) ------------- -------------- ---------- ------------ ----------- Comprehensive loss Balance at December 31, 2004 $ (36,349,706) $ (8,340) $ (5,000) $ (201,756) - ============= ============== ========== ============ ===========
F-6 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued) Years ended December 31, 2006, 2005 and 2004
Class A Class B-Series A Class B-Section B Additional Preferred Stock Preferred Stock Preferred Stock Comonn Stock Paid-in Shares Amount Shares Amount Shares Amount Shares Amount Capital ------- ------ ------- -------- ------- -------- --------- ------- ------------ Amortization of unearned compensation Common stock issued 454,300 454 537,619 Redemption of preferred stock for shares of common stock (7,000) (7) (45,000) (45) 785,925 786 (734) Issuance of common stock for note conversion 635,610 635 600,565 Issuance of common stock for Services 150,910 151 190,297 Preferred stock dividend (356,500) Issuance of stock warrants 362,000 Net loss ------- ------ ------- -------- ------- -------- --------- ------- ----------- Balance at December 31, 2006 93,000 93 285,000 $285 80,000 $80 6,484,275 $6,484 $47,252,064 ======= ====== ======= ======== ======= ======== ========= ======== ===========
F-7 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued) Years ended December 31, 2006, 2005 and 2004 Continued
Accumulated Other Stockholders Comprehensive Treasury Unearned notes Deficit Income (loss) Stock Compensation receivable ------------- -------------- ---------- ------------ ----------- Amortization of unearned compensation 67,260 Common stock issued Redemption of preferred stock for shares of common stock Issuance of common stock for note conversion Issuance of common stock for Services Preferred stock dividend Issuance of stock warrants Net loss (2,674,932) ------------- -------------- ---------- ----------- ------------ Balance at December 31, 2006 $(41,585,416) $(8,340) $(5,000) ============= =============== ========== =========== ============
F-7 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued) Years ended December 31, 2006, 2005 and 2004 Balance at January 1, 2004 $2,943,832 Amortization of unearned compensation 224,496 Common stock returned and retired - Common stock issued 470,785 Net proceeds from issuance of common stock in connection with private placement 1,455,000 Issuance of common stock for note 2,734,645 conversions Exercise of stock options 102,250 Issuance of common stock for services 190,621 Issuance of common stock in connection with CAW acquisitions 525,000 Issuance of common stock along with debt 75,000 Option Expense 30,750 Preferred stock dividend (156,375) Consulting expense (40,000) Change in unrealized gain on Marketable securities (4,105) $ (4,105) Cumulative translation adjustments (2,463) (2,463) Net loss (1,976,379)(1,976,379) ---------- ----------- Comprehensive loss ($1,982,947) ============ Balance at December 31, 2004 $6,573,057 ========= Comprehensive Loss Amortization of unearned compensation 134,496 Common stock issued 330,925 Net proceeds from issuance of common stock in connection with private placement 798,891 Issuance of common stock for note conversions 1,751,419 Issuance of common stock for services 204,024 Preferred stock dividend (317,333) Issuance of stock warrants 18,000 Net loss (2,560,778)(2,560,778) =========== ========== Comprehensive loss $(2,560,778) =========== Balance at December 31, 2005 $6,932,701 ========== The accompanying notes are an integral part of these statements. F-8 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (continued) Years ended December 31, 2006, 2005 and 2004 Comprehensive Loss Amortization of unearned compensation 67,260 Common stock issued 538,073 Redemption of preferred stock for shares of common stock - Issuance of common stock for note conversions 601,200 Issuance of common stock for services 190,448 Preferred stock dividend (356,500) Issuance of stock warrants 362,000 Net loss (2,674,932) (2,674,932) ------------ ------------ Comprehensive loss $(2,674,932) ============= Balance at December 31, 2006 $ 5,660,250 ============ The accompanying notes are an integral part of these statement F-9 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31,
2006 2005 2004 ------------- -------------- ------------- Cash flows from operating activities Net loss $ (2,674,932) $ (2,560,778) $ (1,976,379) Adjustments to reconcile net loss to net cash used in operating activities Loss on sale of accounts receivable - - 79,134 Depreciation and amortization 245,085 314,545 448,570 Amortization of financing cost 38,059 63,283 90,746 Loss on sale of marketable securities - - 15,793 Equity in earnings of investee (227,054) (56,311) (172,224) Non-cash compensation - - 30,750 Operating expenses paid with common stock and warrants 180,549 104,025 154,620 Changes in operating assets and liabilities (Increase) decrease in Accounts receivable and other receivables (4,410,740) (1,173,399) (7,126,272) Inventory (107,998) (27,055) 474,877 Prepaid expenses, related party note receivable and other assets 71,278 177,396 (66,011) Increase (decrease) in Accounts payable, related party note payable, accrued expenses and other current liabilities 661,647 (1,189,575) (143,425) Deferred Income and other liabilities 727,821 - - Net assets of discontinued operations 1,171,650 283,634 1,229,419 ------------- -------------- ------------- Net cash (used in) operating activities (4,324,635) (4,064,235) (6,960,402) ------------- -------------- ------------- Cash flows from investing activities Payment of security deposit - (17,172) (35,848) Purchase of marketable securities - - (168,377) Proceeds from sale of marketable securities - - 194,515 Purchase of property and equipment (35,684) (72,329) (112,058) Refund of collateral security deposit - - 500,000 Payments received on notes receivable 453,469 284,894 433,033 Issuance of notes receivable (25,995) (1,015,200) - Investee dividend received 28,800 28,800 - ------------- -------------- ------------- Net cash provided by (used in) investing activities 420,590 (791,007) 811,265 ------------- -------------- -------------
F-10 Synergy Brands, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Years ended December 31,
2006 2005 2004 ------------ ------------ ------------ Cash flows from financing activities Borrowings under line of credit 33,593,364 37,488,600 35,608,070 Repayments under line of credit (31,458,478) (37,428,968) (31,804,326) Increase in deferred financing cost (67,750) (57,070) - Proceeds from the issuance of notes payable 6,391,319 3,339,564 1,990,000 Repayments of notes payable (3,777,165) (240,000) (100,000) Proceeds from issuance of common stock 288,173 285,926 462,732 Net proceeds from the issuance of common and Preferred stock in a private placement - 770,000 1,460,000 Proceeds from the exercise of stock purchase options - - 102,250 Payment of dividends (356,500) (317,333) (156,375) Net assets of discontinued operations (319,531) 319,531 (1,219,814) ------------ ------------ ------------ Net cash provided by financing activities 4,293,432 4,160,250 6,342,537 ------------ ------------ ------------ Foreign currency translation - - (2,463) ------------ ------------ ------------ Net Increase (Decrease) In Cash 389,387 (694,992) 190,937 ------------ ------------ ------------ Cash and cash equivalents, beginning of year 255,483 950,475 759,538 ------------ ------------ ------------ Cash and cash equivalents, end of year $ 644,870 $ 255,483 $ 950,475 ------------ ------------ ------------ Supplemental disclosures of cash flow information: Cash paid during the year for Interest $1,219,870 $ 928,597 $ 1,084,238 ============ ============ ============ Income taxes paid $ 44,962 $ 84,858 $ 34,604 ============ ============ ============ Supplemental disclosures of non-cash, investing and financing activities: Common stock issued for acquisition $ - $ - $ 244,068 ============ ============ ============ Common stock issued for note conversions $ 661,200 $ 1,764,354 $ 2,734,646 ============ ============ ============
The accompanying notes are an integral part of these statements F-11 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2006, 2005 and 2004 NOTE A - DESCRIPTION OF THE BUSINESS Synergy Brands, Inc. and its subsidiaries (collectively, "Synergy" or the "Company") is engaged in the distribution of a variety of products, including health and beauty aids and premium handmade cigars, directly to consumers (business to consumer) and to businesses (business to business). In addition, the Company develops and operates Internet platform operations and Internet-based businesses designed to sell these products. Synergy was incorporated on September 26, 1988 in the state of Delaware. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements is as follows: 1. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Synergy, its wholly-owned subsidiaries and majority-owned subsidiary (collectively, the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation. The equity method of accounting is used for investments in 50% or less owned companies over which the Company has the ability to exercise significant influence. 2. Cash and Cash Equivalents The Company considers all highly liquid investments with an initial maturity of three months or less to be cash equivalents. F-12 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 3. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management of the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expense during the reporting period. The most significant estimates relate to reserves for accounts receivable, inventories, and deferred tax assets, and valuation of long-lived assets. Actual results could differ from those estimates. 4. Accounts Receivable Trade The Company's accounts receivable trade are due from businesses engaged in the distribution of grocery, health and beauty products as well as from consumers who purchase health and beauty products and premium handmade cigars either direct or from the Company's Web sites. Credit is extended based on evaluation of a customers' financial condition and, generally, collateral is not required. Accounts receivable are due within 10 - 90 days and are stated at amounts generally due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. Estimates are used in determining the allowance for doubtful accounts based on the Company's historical collections experience, current trends, credit policy and a percentage of its accounts receivable by aging category. In determining these percentages, the Company looks at historical write-offs of its receivables. The Company also looks at the credit quality of its customer base as well as changes in its credit policies. The Company continuously monitors collections and payments from its customers. The Company writes off accounts receivable when they become uncollectible. F-13 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) Accounts receivable trade, net consist of the following components at December 31, 2006 and 2005: 2006 2005 ----------- ---------- Accounts receivable - business to business $11,154,841 $7,484,084 Accounts receivable - business to consumer 138,620 121,536 ----------- ---------- Total $11,293,461 $7,605,620 Less allowance for doubtful accounts (127,481) (127,481) ----------- ---------- $11,165,980 $7,478,139 =========== ========== Changes in the Company's allowance for doubtful accounts during the years ended December 31, 2006 and 2005 are as follows: 2006 2005 Beginning balance $ 127,481 $127,481 Provision for (reduction in) doubtful account - - ---------- -------- Ending balance $ 127,481 $127,481 =========== ======== 5. Business and Credit Concentrations Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable. The Company places its cash and cash equivalents with financial institutions it believes to be of high credit quality. Cash balances in excess of Federally insured limits at December 31, 2006 totaled approximately $600,000. There are no balances in excess of Federally insured limits at December 31, 2005. During the year ended December 31, 2006, sales to three customers accounted for 21%, 16% and 12% of total sales, respectively. Three customers accounted for 27%, 23% and 10%, respectively of accounts receivable at December 31, 2006. These concentrations relate to the Company's PHS Group segment. During the year ended December 31, 2005, sales to three customers accounted for 12%, 11% and 10% of total sales and in 2004, sales to two customers accounted for 21% and 18% of total sales, respectively. Four customers accounted for 22%, 20%, 15% and 12%, respectively of accounts receivable at December 31, 2005. These concentrations relate to the Company's PHS Group segment. During the years ended December 31, 2006, 2005 and 2004, the Company purchased approximately 40%, 40 % and 53%, respectively, of its products from one supplier. If the Company were unable to maintain this relationship, it might have a material impact on future operations. F-14 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) 6. Inventory Inventory is stated at the lower of cost or market. The Company uses the first-in, first-out ("FIFO") cost method of valuing its inventory. 7. Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is computed using the straight-line method over the asset's estimated useful lives, ranging from 3 to 10 years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term. Maintenance and repairs of a routine nature are charged to operations as incurred. Betterments and major renewals that substantially extend the useful life of an existing asset are capitalized and depreciated over the asset's estimated useful life. 8. Vendor Allowances The Company recognizes vendor allowances at the date goods are purchased and recorded under fixed and determined arrangements. The Company receives allowances and credits from suppliers for volume incentives, promotional allowances and, to a lesser extent, new product introductions which are typically based on contractual arrangements covering a period of one year or less. Volume incentives and promotional allowances earned based on quantities purchased and new product allowances are recognized as a reduction to the cost of purchased inventory and recognized when the related inventory is sold. Promotional allowances that are based on the sell-through of products are recognized as a reduction of cost of sales when the products are sold for which the promotional allowances are given. For the years ended December 31, 2006 and 2005, the Company recognized approximately $ 2,272,273 and $2,196,955 in vendor allowances arising from arrangements with a major supplier that met the criteria for being fixed and determinable. Vendor allowances from manufacturers, included in other receivables in the accompanying consolidated balance sheet aggregated $2,453,705 and $1,730,806 at December 31, 2006 and 2005. F-15 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) 9. Intangible Assets and Goodwill Intangible assets include the "Gran Reserve" trade names and customer lists, acquired in November 1999 and certain customer lists, the rights to the use of the trade name. On June 1, 2003, the Company acquired the common stock of Ranley Group, Inc. (d.b.a. Cigars Around the World ("CAW") of Chicago, Illinois). Intangible assets acquired, which consist primarily of customer lists, are being amortized over an eleven (11) year estimated useful life from the date of acquisition. Goodwill is the excess of cost of an acquired entity over the amounts assigned to assets and liabilities assumed in business combination. Effective January 1, 2002, with the adoption of SFAS No.142 "Goodwill and other Intangible Assets", that have an indefinite life are not amortized. Prior to the adoption of Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets," these intangible assets other than Goodwill were amortized over their estimated useful life of five years. As a result of the adoption of SFAS No. 142 in 2002, intangible assets with indefinite useful lives are no longer being amortized but instead are being reviewed for impairment when impairment indicators are present. As a result, the Company's trade names will no longer be amortized. The Company's customer lists have finite lives. Management considered various factors, including appraisals, in determining that a revision to the estimated useful life of the Company's customer lists should be made. Based upon the analysis, it was determined in 2003 that the estimated useful life should be extended prospectively, by a term of six years from the original useful life of five years. As a result, the remaining carrying amount will be amortized prospectively over the remaining useful life. In 2006, 2005, and 2004 the amortization expense recorded for each of the years was $59,916. At December 31, 2006 and 2005, intangible assets are comprised of the following: Amortized intangible assets 2006 2005 ---------- ---------- Customer lists $ 677,523 $ 677,523 Less accumulated amortization (389,226) (329,310) ---------- ---------- Total $288,297 $348,213 ========== ========== Amortization expense for the Company over the next four years is estimated to be approximately $60,000 per year. Amortization expense for 2012 is estimated to be $50,000. F-16 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) 10. Long-lived Assets Long-lived assets and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from use of the assets and their ultimate disposition. To the extent impairment has occurred, the carrying amount of the asset would be written down to an amount to reflect the fair value of the asset. 11. Revenue Recognition The Company recognizes revenue upon shipment of goods when title and risk of loss passes to the customer. Net sales include gross revenue from product sales and related shipping fees, net of discounts and provision for sales returns, and other allowances. Cost of sales consists primarily of costs of products sold to customers, including outbound and inbound shipping costs. Payments received from customers prior to shipment of goods is recorded as deferred revenue.At December 31, 2006 approximately $600,000 was received by the Company for goods to be shipped in January 2007. In addition, the Company at December 31, 2006 and 2005 has recorded deferred revenue of $127,000 in relation to the ITT warrants (see Note H). 12. Advertising The Company expenses advertising and promotional costs as incurred. 13. Income Taxes Deferred income taxes are recognized for temporary differences between financial statement and income tax bases of assets and liabilities and net operating loss carry forwards for which income tax expenses or benefits are expected to be realized in future years. A valuation allowance is established if it is more likely than not that all, or some portion, of deferred tax assets will not be realized. 14. Basic and Diluted Loss Per Share Basic and diluted loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding during each period. Incremental shares from assumed F-17 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) exercises of stock options, warrant and convertible debt and equity securities of 995,749, 1,317,702 and 951,468 for the years ended December 31, 2006, 2005 and 2004, respectively, have been excluded from the calculation of diluted loss per share since their effect would be antidilutive. 15. Stock-Based Compensation Plans At December 31, 2006, the Company has two stock-based employee compensation plans, which are described more fully in Note K. The Company had accounted for stock-based compensation to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations ("APB No. 25") and had adopted the disclosure provisions of SFAS No. 148. Effective January 1, 2006, the provisions of SFAS No. 123(R) were implemented to account for stock-base compensation. Under APB No. 25, when the exercise price of the Company's employee or director stock options equaled the market price of the underlying stock on the date of grant, no compensation expense was recognized. The following table illustrates the effect on net income (loss) and earnings (loss) per share had the Company applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation.
Year ended December 31, 2005 2004 Net loss, as reported $ (2,560,778) $(1,976,379) Add: Total stock-based employee compensation expense included in reported net loss Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards (27,184) - ------------- ------------- Pro forma net loss $ (2,587,962) $(1,976,379) ============== ============= Loss per share attributable to common shareholders Basic and diluted - as reported from continuing operations $ ( 0.48) $ (0.87) ============== ============= Basic and diluted - as reported from discontinued operations $ ( 0.27) $ (0.10) ============== ============= Basic and diluted - pro forma from continuing operations $ (0.49) $ (0.87) ============== ============= Basic and diluted - pro forma from discontinued operations $ (0.27) $ (0.10) ============== =============
F-18 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (continued) Pro forma compensation expense may not be indicative of pro forma expense in future years. For purposes of estimating the fair value of each option on the date of grant, the Company utilized the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The weighted-average option fair values and the assumptions used to estimate these values are as follows: 2005 ------ Dividend yield 0% Expected volatility 40% Risk-free rate of return 4.0% Expected life 1 year Weighted-average option fair value $2.07 On October 1, 2005 performance stock options to purchase 300,000 shares of common stock at $2.07 per share were granted to employees. These options were cancelled in January 2006. There were no stock options granted in 2006 and 2004. 16. Segment Information Segment information is presented in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This standard is based on a management approach, which requires segmentation based upon the Company's internal organization that is used for making operating decisions and assessing performance as the source of the Company's reportable operating segments. SFAS No. 131 also requires disclosures about products and services, geographic areas and major customers. Proset segment of business has been eliminated from the segment reporting (see Note S). F-19 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (CONTINUED) 17. Recent Accounting Pronouncements In November 2004, the Financial Accounting Standards Board ("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's adoption of SFAS No.151 did not 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's adoption of SFAS No.153 did not have a material impact on the Company's financial position or result of operations. In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3." ("SFAS 154") This Statement requires retrospective application to prior period financial statements of a voluntary change in accounting principle unless it is impracticable and is effective for fiscal years beginning after December 15, 2005. Previously, most voluntary changes in accounting principle were recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. The Company's adoption of SFAS 154 did not have a material impact on the Company's financial position or results of operations. F-20 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE B (CONTINUED) In February 2006, FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments - An Amendment of FASB No. 133 and 140. The purpose of SFAS statement No. 155 is to simplify the accounting for certain hybrid financial instruments by permitting fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 also eliminates the restriction on passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of any entity's first fiscal year beginning after September 15, 2006. We believe that the adoption of this standard on January 1, 2007 will not have a material effect on our consolidated financial statements. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of their financial instruments according to a fair value hierarchy as defined in the standard. Additionally, companies are required to provide enhanced disclosure regarding financial instruments in one of the categories (level 3), including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We believe that the adoption of SFAS No. 157 will not have a material impact on our consolidated financial statements. In July 2006, the FASB issued FASB Interpretation 48, "Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides a guidance on derecognition, classification interest and penalties, accounting in interim periods, disclosure and transition. We believe that the adoption of FIN 48 will not have a material impact on our consolidated financial statements. For our Company, this interpretation will be effective beginning January 1, 2007. The SEC issued Staff Accounting Bulletin No. 108 ("SAB 108") in September 2006. SAB 108 expresses the views of the SEC staff regarding the process of quantifying the materiality of financial misstatements. SAB 108 requires both the balance sheet and income statement approaches be used when quantifying the materiality of misstatement amounts. In addition, SAB 108 contains guidance on correcting errors under the dual approach and provides transition guidance for correcting errors existing in prior years. SAB 108 was effective in the Company's fourth quarter of 2006. The adoption SAB 108 did not have a material impact on the Company's consolidated financial statements. 18. Reclassifications Certain 2004 and 2005 balances have been reclassified to conform with 2006 classifications, including presenting the operations of the Pro-Set segment (see Note S). F-21 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE C - FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents, marketable securities and accounts receivable and accounts payable approximates fair value due to the short-term maturities of the instruments. The carrying amounts of borrowings under the line of credit agreement and notes receivable and notes payable approximate their fair values. NOTE D - MARKETABLE SECURITIES At December 31, 2006 and 2005, the Company has no marketable securities. In the past, the Company accounted for marketable securities as available-for-sale securities. In accordance with FASB 115, these equity securities were accounted for at fair market value and any unrealized gains (losses) were treated as an increase or decrease to equity. Proceeds from the sale of available-for-sale securities and the resulting net realized gains included in the determination of net loss for the years ended December 31, 2004. 2004 Available-for-sale securities --------- Proceeds $194,515 Gross realized gains 19,973 Gross realized losses (35,766 F-22 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE E - INVENTORY Inventory as of December 31, 2006 and 2005 consisted of the following: 2006 2005 --------- -------- Grocery, health and beauty products $802,090 $739,769 Tobacco finished goods 487,131 441,454 ---------- -------- $1,289,221 $1,181,223 =========== ========== The allowance for slow moving and obsolete inventory approximated $35,000 and $35,000 at December 31, 2006 and 2005, respectively. NOTE F - PROPERTY AND EQUIPMENT Property and equipment as of December 31, 2006 and 2005 consisted of the following: 2006 2005 --------- --------- Office equipment $205,742 $205,742 Furniture and fixtures 84,196 84,196 Leasehold improvements 422,538 386,854 --------- --------- 712,476 676,792 Less accumulated depreciation and amortization (459,526) (399,948) --------- --------- $252,950 $276,844 ========= ========= Depreciation and amortization expense on property and equipment for the years ended December 31, 2006, 2005 and 2004 was approximately $60,000, $62,000 and $76,000, respectively. F-23 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE G - OTHER ASSETS Other assets consist of the following at December 31, 2006 and 2005:
2006 2005 --------- --------- Investment (a) $562,593 $364,340 Investment in warrants (b) 127,000 127,000 CAW purchase agreement; net of accumulated amortization of $145,827 and $87,495 29,173 87,505 Deferred financing net of accumulated amortization of $204,660 and $103,555 Other 121,591 154,945 69,097 69,097 --------- --------- $ 909,454 $ 802,887 ========= =========
(a) In December 2001, the Company made an investment in Interline Travel and Tour. Inc. ("ITT") for approximately 20% of the outstanding common stock. At December 31, 2006, the Companies investment in ITT is approximately 20% of the outstanding common stock. ITT provides cruise and resort hotel packages through a proprietary reservation system to airline employees and their retirees. The Company recorded equity in the net earnings of investee of $227,054, $56,311 and $172,224 during the years ended December 31, 2006, 2005 and 2004, respectively. At December 31, 2006, the investment in ITT is $562,593 as included in "Other Assets" on the accompanying balance sheet. (b) In October, 2005 SYBR.com Inc., a wholly owned subsidiary of the Company, invested $1 million in a Private Placement of Senior Subordinated Debentures issued by ITT. The investment consists of a five year 8% Note (ITT Note), and 200,000 warrants exercisable into 200,000 common shares of ITT stock at $5.00 per share (ITT Warrants). The Company financed this investment with a $1 million fully recourse note with a major Shareholder under the same terms and conditions as the ITT Note and assigned to such shareholder the ITT Warrants. As consideration for the financing, the Company has retained the benefit to be derived from 100,000 of the warrants received from ITT (see Note I). In relation to the ITT warrants, Company has recorded deferred income of $127,000. F-24 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE G (continued) Summarized audited financial information of this investee as of December 31, 2006, 2005, and 2004 and for the years then ended is as follows: Financial position: 2006 2005 ------------ ------------ Current assets $5,334,000 $4,229,000 Property and equipment 666,000 735,000 Other assets 5,728,000 4,720,000 ------------ ------------ Total assets $11,728,000 $9,684,000 ------------ ------------ Current liabilities $4,977,000 $3,823,000 Long-term debt 4,289,000 4,983,000 ------------ ------------ Total liabilities $9,266,000 $8,806,000 ------------ ------------
Results of operations: 2006 2005 2004 ------------ ------------ ------------ Revenues $32,464,000 $14,715,000 $10,883,000 Total expenses (30,993,000) (14,528,000) (9,934,000) Other income 322,000 325,000 111,000 ------------ ------------ ------------ Income before income taxes 1,793,000 512,000 1,069,000 Income tax expense (632,000) (211,000) (359,000) ------------ ------------ ------------ Net income $ 1,161,000 $ 301,000 $ 701,000 ------------ ------------ ------------
F-25 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE H - NOTES RECEIVABLE In December 2004, the Company sold accounts receivable attributable to West Coast Supplies, Inc. for $2,200,000. This promissory note, which is secured by the accounts receivable, requires monthly payments of principal and interest at 4% for seven years, beginning in January 2005. As a condition for the sale, the Company issued 150,000 shares of common stock to the note holder. The value of the shares ($200,000) was treated as a reduction of sales price. Sales of selected products to this customer base approximated $3,180,000 in 2004. The Company recorded a loss of $79,134 related to the sale of the accounts receivable to West Cost Supplies, Inc. in 2004. The balance of the Note Receivable at December 31, 2006 was $1,635,340. In October, 2005 SYBR.com Inc., a wholly owned subsidiary of the Company, invested $1 million in a Private Placement of Senior Subordinated Debentures issued by ITT. The investment consists of a five year 8% Note (ITT Note), and 200,000 warrants exercisable into 200,000 common shares of ITT stock at $5.00 per share (ITT Warrants). The Company financed this investment with a $1 million fully recourse note with a major Shareholder /Director under the same terms and conditions as the ITT Note and assigned to such shareholder the ITT Warrants. As consideration for the financing, the Company has retained the benefit to be derived from 100,000 of the warrants received from ITT (see Note I). In relation to the ITT warrants, Company has recorded deferred income of $127,000. On September 29, 2006, $142,857 was paid by ITT to reduce the loan balance. As of December 31, 2006 the outstanding loan balance was $857,143. As part of the Company's agreement, the Company paid $142,857 on the note payable. The outstanding balance of the note payable at December 31, 2006 was $857,143. NOTE I - LINE OF CREDIT AGREEMENT, NOTES PAYABLE AND NOTE PAYABLE TO STOCKHOLDER In 2002, two of the Company's subsidiaries entered into two revolving loan and security agreements with the same financial institution (the "Lender"). The lines of credit, as amended in July 2006, allow for the borrowing of up to $6,000,000 based on the sum of 85% of the net face amount of eligible accounts receivable, as defined, plus the lesser of (1) $2,750,000 or (2) eligible inventory and eligible goods in transit, as defined. $5,836,928 was outstanding under the agreements at December 31, 2006. As amended, the agreement extended through December 31, 2007. The Company is seeking to refinance its secured financing needs through other asset based Lenders (see Note T). Interest accrues on outstanding borrowings at the greater of (i) 5% per annum in excess of the prime rate or (ii) 10.5% per annum. At December 31, 2006, the interest rate on outstanding borrowings was 13.25%. Outstanding borrowings are collateralized by a continuing security interest in all of the subsidiaries' accounts receivable, chattel paper, inventory, equipment, instruments, investment property, documents and general intangibles. In addition, 202,120 shares of the Company's common stock remain as collateral on the outstanding borrowings. The agreements provide for minimum annual interest charges. In 2006, the lender converted $331,200 of outstanding debt into 289,080 shares of common stock (see note J). In 2005, the lender converted $1,003,000 of outstanding debt into 427,532 shares of common stock (see Note J). F-26 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE I (continued) On March 1, 2004, the Company received $490,000 pursuant to the issuance of three secured promissory notes from certain shareholders of ITT, a 20% investee. Borrowings under the notes bear interest at a rate of 12%. The notes were extended and the Company is not required to repay any principal until the maturity date of the notes, February 28, 2007. In addition, 19,600 restricted shares of the Company's common stock were also issued as part of the financing. The relative estimated fair value of the common stock that was issued of $75,000 was recorded as debt discount and will be amortized over the life of the notes payable. As security for the notes, the Company pledged as collateral its investment in the common stock of ITT (see Note G). Amortization expense recorded in 2006, 2005 and 2004 was approximately $6,259, $37,500, and $31,000 respectively. At December 31, 2006 the outstanding balance was $490,000. On April 2, 2004 the Company completed a financing with Laurus Master Funds ("Laurus"). The financing consisted of a $1.5 million secured convertible debenture that converts into common stock under certain conditions at $1.75 per share as amended, and matures on April 2, 2007. The debenture provides for monthly payments of $50,000, plus interest commencing October 1, 2004. In addition, Laurus was issued 100,000 warrants exercisable at $3.00 per share. The debenture has a three-year term with a coupon rate of prime plus 3%. The Company has filed an S-3 registration statement, which has been granted effectiveness to register the common stock underlying the debenture and warrant. In 2004, the Company converted $500,000 of this outstanding debt into 100,000 shares of common stock. In March 2005, the Company converted $525,000 of this outstanding debt into 150,000 shares of common stock. In 2006 the Company converted $150,000 of this outstanding debt into 159,574 shares of common stock. The conversion price was reduced from $1.75 to $0.94. The Company repaid $175,000 of this debt at December 31, 2006. At December 31, 2006, the outstanding balance was $150,000. On January 25, 2005, the Company completed a second financing with Laurus. The financing consisted of a $500,000 secured convertible debenture that converts into common stock under certain conditions at $1.75 per share as amended, and matures on January 25, 2008. The financing provides Laurus with registration rights for common shares it is issued under conversion. The debenture provides for monthly payments of $16,666.67 plus interest, commencing August 1, 2005. The Company repaid $83,334 of this debt at December 31, 2005 and $150,000 during 2006. In July 2006, the Company converted $50,000 of this outstanding debt into 50,000 shares of common stock. The conversion price was reduced from $1.75 to $1.00. In December 2006, the Company converted $40,000 of this outstanding debt into 43,478 shares of common stock. The conversion price was reduced from $1.75 to $ 0.92. In addition, Laurus was issued 33,333 warrants exercisable at $3.50 per share. The debenture has a three-year term with a coupon rate of prime plus 3%. The conversion prices on the Laurus debentures were always above the current stock price at the closing date. At December 31, 2006 the outstanding balance was $176,666. F-27 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE I (continued) In January 2005, the Company entered into a promissory note with major regional bank for $1,000,000. Borrowing under the note bears interest at prime (7.75% at December 31, 2006). This note was extended and the Company is not required to repay any principal until the maturity date of the note, September 1, 2007. As security for the note, a pledge agreement was entered by certain Shareholders of ITT. Borrowings at December 31, 2006 were $500,000. On April 6, 2005, the Company received $500,000 pursuant to the issuance of three secured promissory notes from certain shareholders of ITT, a 20% investee. Borrowings under the notes bear interest at a rate of 9%. The Company is not required to repay any principal until the maturity date of the notes, April 5, 2007. In addition, 25,000 restricted shares of the Company's common stock were also issued as part of the financing. The relative estimated fair value of the common stock that was issued of $54,000 was recorded as debt discount and will be amortized over the life of the notes payable. As security for the notes, the Company pledged as collateral its investment in the common stock of ITT (see Note G). Amortization expense recorded in 2006 and 2005 was approximately $27,000 and $20,250. On May 5, 2005, the Company received $100,000 pursuant to the issuance of one secured promissory note from a certain stockholder of ITT, a 20% investee. Borrowings under the note bear interest at a rate of 9%. The Company is not required to repay any principal until the maturity date of the note, May 4, 2007. In addition, 5,000 restricted shares of the Company's common stock were also issued as part of the financing. The relative estimated fair value of the common stock that was issued of $9,500 was recorded as debt discount and will be amortized over the life of the notes payable. As security for the notes, the Company pledged as collateral its investment in the common stock of ITT (See Note G). Amortization expense recorded in 2006 and 2005 was approximately $4,800 and $3,200. On June 21, 2005, the Company completed a third financing with Laurus. The financing consisted of a $500,000 secured convertible debenture that converts into common stock under certain conditions at $1.75 per share as amended, and matures on June 21, 2008. The financing provides Laurus with registration rights for common shares it is issued under conversion. The debenture provides for monthly payments of $16,666.67 plus interest, commencing December 1, 2005. The Company repaid $16,667 of the debt at December 31, 2005 and $150,000 during 2006. In July 2006, the Company converted $50,000 of this outstanding debt into 50,000 shares of common stock. The conversion price was reduced from $1.75 to $1.00. In December 2006, the Company converted $40,000 of this outstanding debt into 43,478 shares of common stock. The conversion price was reduced from $1.75 to $0.92. In addition, Laurus was issued 33,333 warrants exercisable at $ 3.50 per share. The Company's common stock quoted market price at the date of closing was $2.15 per share. The debenture has a three-year term with a coupon rate of prime plus 3%. The Company recorded a charge of $18,000 as prepaid expense for the fair value of the warrants, and this amount will be amortized over the life of the note. At December 31, 2006 the outstanding balance was $243,333. In October 2005 SYBR.com Inc., a wholly owned subsidiary of the Company, received $1 million, pursuant to the issuance of one senior secured promissory note from a certain stockholder and director. Borrowings under the note bearing interest at 8%, and the note is due October 7, 2010. The Company has secured this borrowing with a $1 million wholly recourse note from ITT (see Note H). On March 14, 2006 the Company closed a $1.75 million junior secured three year loan with an Laurus bearing a fixed interest rate of 10%. Payments will be made at a rate of $32,000 per month starting October 1, 2006. The lender was issued a warrant to acquire 270,000 shares of the Company's common stock valued at $362,000. The relative fair value of the warrant of $362,000 is being charged to operations as additional interest over the term of the loan. The Company repaid $96,000 of this debt at December 31, 2006. At December 31, 2006 the outstanding balance was $1,654,000. In the fourth quarter of 2006, the Company secured $1,800,000 from shareholders of short term financing that matures in the first quarter of 2007. The advance may be extended by mutual consent. Principal repayments of notes payable at December 31, 2006 are as follows: Year Ending December 31, 2007 $ 4,227,000 2008 $ 500,000 2009 $ 886,000 2010 $ 857,000 ------------- $ 6,470,000 Discounts $ (312,000) ------------ Total $ 6,158,000 ============ F-28 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE J - STOCKHOLDERS' EQUITY The Company has 100,000 authorized and outstanding shares of Class A preferred stock with a par value of $.001; 13-to-1 voting rights; liquidation of $10.50 per share before common stock and redemption at option of Company at $10.50 per share. In November 2006, 6,787 Class A preferred stock was redeemed into 75,009 common shares. In January 2003, the Company designated 100,000 shares of Class B Preferred stock, par value $.001 per share to be designated as Class B, Series A Preferred Stock and in June 2003, the Company increased the authorized Class B, Series A preferred stock to 500,000 shares. The holders of Class B, Series A Preferred Stock have no voting rights with respect to general corporate matters. The holders of Class B, Series A Preferred Stock are entitled to receive dividends at the annual rate of $.90 per share per annum. The Company may, as its option, at any time in whole, or from time to time in part, out of earned funds, capital and surplus of the Corporation, redeem the Class B, Series A Preferred Stock on any date set by the Board of Directors, at $10.00 per share plus, in each case, an amount equal to all dividends of Class B, Series A Preferred Stock accrued and unpaid thereon, pro rata to the date of redemption. If, however, as to each share of Class B, Series A Preferred Stock outstanding, if not redeemed by the Company within 2 years of the issuance of such shares, the Company will be obligated to issue to the then holder of record of such outstanding Class B, Series A Preferred Stock, half a share of the Company's unissued restricted Common Stock per share of Class B, Series A Preferred Stock for each year that said share is not redeemed. The Company issued 30,000 common shares to Class B Series A Preferred shareholders in March 2006 and January 2005 in compliance with the subscription agreements dated February 26, 2003 and 50,000 common shares to Class B Series A Preferred Shareholder in July 2006 and July 2005, in compliance with the subscription agreements dated July 2, 2003. No more than 19.9% of the Company's stock can be issued in connection with stock dividend payments against the Class B, Series A Preferred Stock. In November 2004, the Board of Directors approved a Private Placement in which 17 units were offered, with each unit consisting of 10,000 shares of unregistered Class B, Series A Preferred Stock and 15,000 shares of unregistered restricted Common Stock at a purchase price of $100,000 per unit. In November 2004, the Company sold 17 units and received aggregate proceeds of $1,700,000. Also in November 2004, the Company exchanged $245,000 compensation due to William Rancic for two units of Class B Series A Preferred stock at $100,000 per unit. The Company issued 112,500 shares to Class B Series A Preferred shareholders in November 2006 in compliance with the subscription agreement dated November 1, 2004. In November 2006, 45,000 Class B, Series A Preferred stock was redeemed into 473,416 shares of common stock. In March 2005, the Company designated 250,000 shares of Class B Preferred Stock, par value $.001 per share to be designated as Class B, Series B Preferred Stock. On July 22, 2005, the Company completed an $800,000 private placement of Preferred Stock and Common Stock consisting of 80,000 shares of Series B Class B Preferred Stock and 88,000 shares of restricted Common Stock. The holders of Class B Series B Preferred Stock have no voting rights with respect to general corporate matters. The holders of Class B Series B Preferred Stock are entitled to receive dividends at the annual rate of $.80 per share per annum. The Company may, as its option, at any time in whole, or from time to time in part, out of earned funds of the Corporation, redeem the Class B, Series B Preferred Stock on any date set by the Board of Directors, at $10.00 per share plus, in each case, an amount equal to all dividends of Class B, Series B Preferred Stock accrued and unpaid thereon, pro rata to the date of redemption. If however, as to each share of Class B, Series B Preferred Stock outstanding, if not redeemed by the Company within 2 years of the issuance of such shares, the Company will be obligated to issue to the then holder of record of such outstanding Class B, Series B Preferred Stock, half a share of the Company's unissued restricted Common Stock per share of Class B, Series B Preferred Stock for each year that said share is not redeemed within limits as provided under applicable law. In 2006, Laurus Master Funds converted $330,000 of debt into 346,530 of shares of common stock and in 2005, Laurus Master Funds converted $525,000 of debt into 150,000 shares of common stock. Also in 2006, the Company converted $331,200 outstanding debt of IIG into 289,080 shares of common stock and in 2005, the Company converted $1,003,000 outstanding debt of IIG into 427,532 shares of common stock. In 2005, certain shareholders of ITT converted $236,354 of debt into 94,452 shares of common stock (see Note I). For the years ended December 31, 2006 and 2005, the Company issued 150,910 and 98,964 shares of common stock as compensation for past and future service and recorded a charge to operations of $180,549 and $104,025. For the year ended December 31, 2006 the Company issued 499,300 shares of common stock in connection with the sale of securities and the satisfaction of certain obligations which included 130,000 shares to satisfy certain liabilities (See Note H). F-29 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE J (continued) Effective January 2006, the Company cancelled options to acquire 300,000 shares of common stock held by employees. There are no option outstanding with employees at December 31, 2006. For the years ended December 31, 2004 the Company received proceeds of $102,250 from the exercise of stock options to purchase 110,000 shares of the Company's common stock. In connection with such options of which 15,000 were modified, in 2004 the Company recorded compensation expense and a credit to additional paid-in capital of $30,750. The following is a summary of transactions involving warrants to purchase common stock for the years ended December 31, 2006, 2005 and 2004. Weighted- Number average of shares exercise price ---------- -------------- Outstanding at January 1,, 2004 210,000 $ 6.40 Granted 100,000 5.00 ---------- Outstanding at December 31, 2004 310,000 $ 5.95 Granted 66,666 1.00 Cancelled/Forfeited (96,250) (6.75) ---------- Outstanding at December 31, 2005 280,416 $ 4.38 Granted 270,000 - Cancelled/Forfeited (82,500) (6.52) ---------- ------------ Outstanding at December 31, 2006 467,916 $1.47 ========== ============ The following table summarizes information concerning currently outstanding and exercisable stock purchase warrants:
Warrants outstanding Warrants exercisable ------------------------------------------- ---------------------------- Weighted- Number average Weighted- Number Weighted- outstanding at remaining average exercisable at average Ranges of December 31, contractual exercise December 31, exercise exercise prices 2006 life (years) price 2006 price ---------------- --------------- -------------- ------------ ---------------- ----------- $0.00-$0.99 270,000 4.25 $0.0010 270,000 $0.0010 $1.00-$4.00 166,666 5.16 $ 3.20 166,666 $ 3.20 $5.00-$12.00 31,250 5.16 5.50 31,250 5.50 --------------- -------------- ------------ ---------------- ----------- 467,916 4.85 $ 1.47 467,916 $ 1.47 =============== ============== ============ ================ ===========
F-30 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE K - STOCK COMPENSATION PLANS In 1994, Synergy adopted the 1994 Services and Consulting Compensation Plan (the "Plan"). Under the Plan, as amended, 8,400,000 shares of common stock have been reserved for issuance. The Plan terminates with respect to the granting of common stock and options in 2009. Since the inception of the Plan, Synergy has issued 1,430,907 shares for payment of services to employees and professional service providers such as legal, marketing, promotional and investment consultants. Common stock issued in connection with the Plan was valued at the fair value of the common stock at the date of issuance or at an amount equal to the service provider's invoice amount. During the years ended December 31, 2006, 2005 and 2004, the Company issued 150,910, 98,964 and 42,195 shares of its common stock, respectively, to various service providers and has recorded a charge to earnings of $180,549, $104,025 and $150,621. Under the Plan, Synergy has granted options to selected employees and professional service providers. The maximum term of options granted under the Plan is ten years. There were no options issued during the years ended December 31, 2006 and 2005. The following is a summary of such stock option transactions for the years ended December 31, 2006, 2005 and 2004 in accordance with the Plan and other restricted stock option agreements: Weighted- Number average of shares exercise price ----------- ------------------ Outstanding at January 1, 2004 481,650 $ 10.42 Exercised (110,000) (3.68) ----------- ------------------ Outstanding at December 31, 2004 371,650 $ 13.10 Granted 300,000 2.07 Cancelled/Forfeited (371,650) (12.15) ----------- ------------------ Outstanding at December 31, 2005 300,000 $ 2.07 Cancelled/Forfeited (300,000) (2.07) ----------- ------------------ Outstanding at December 31, 2006 - - =========== ================== Shares available for grant December 31, 2006 7,270,913 ========= December 31, 2005 7,120,003 ========= December 31, 2004 7,218,967 ========= F-31 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE K (continued) The Company has also reserved 100,000 shares for a stock option plan ("Option Plan") for nonemployee, independent directors, which entitles each nonemployee, independent director an option to purchase 10,000 shares of the Company's stock immediately upon election or re-election to the Board of Directors. Options granted under the Option Plan will be at the fair market value on the date of grant, immediately exercisable, and have a term of ten years. The Company had no options outstanding and exercisable and 84,000 shares available for grant at December 31, 2006 and 2005. NOTE L - TRANSACTIONS WITH RELATED PARTIES At December 31, 2006 and 2005, $23,706 and $61,882 is payable to the Company's Chairman and Chief Executive Officer for short-term advances made to the Company. Two of the Company's directors were members of the board of directors of a significant customer of the Company. These individuals terminated their board membership in the customer in 2006. F-32 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE M - OTHER INCOME (EXPENSE) Other income (expense) is comprised of the following:
2006 2005 2004 --------- ---------- ---------- Gain (loss) on sales of marketable securities (Note D) - - (15,793) Other (22,039) (20,469) 49,588 --------- ---------- ---------- $(22,039) $(20,469) $ 33,795 ========= ========== ==========
NOTE N - INCOME TAXES At December 31, 2006, the Company had a net operating loss carry forward of approximately $34,200,000 which, if not utilized, will begin expiring in 2011. Utilization of these losses may be limited if the Company undergoes an ownership change pursuant to Internal Revenue Code Section 382. The components of the deferred tax asset at December 31, 2006 were approximately as follows: Net operating loss carry forwards $ 11,628,000 Fixed assets and intangibles 484,000 Allowance for doubtful accounts 166,000 Inventory 126,000 Capital losses 56,000 Other (200,000) Valuation allowance (12,260,000) --------------- $ - =============== The valuation allowance increased by approximately $ 583,000 in 2006. Income taxes expense for the years ended December 31, 2006, 2005 and 2004 including amounts attributable to discontinued operations consisted, of the following: 2006 2005 2004 -------- -------- ---------- State and local $44,962 $84,858 $ 34,604 ======== ======== ========== F-33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE N (continued) A reconciliation of income tax expense computed at the U.S. Federal statutory rate of 34% and the Company's effective tax rate for the years ended December 31, 2006, 2005 and 2004 are as follows:
2006 2005 2004 ------- ----- ------ Federal income tax expense at statutory rate (34)% (34)% (34)% Increase (decrease) resulting from Increase in valuation allowance 34 34 34 State and local income taxes, net of Federal benefit .9 .9 .9 ------- ----- ------ .9% .9% .9%
NOTE O - QUARTERLY FINANCIAL RESULTS (UNAUDITED) Quarterly financial results for the years ended December 31, 2006 and 2005 are as follows: THREE MONTHS ENDED
3/31/2006 6/30/2006 9/30/2006 12/31/2006 TOTAL SALES $ 14,878,155 $ 15,679,679 $18,607,807 $22,594,267 $ 71,759,908 GROSS PROFIT $ 1,074,371 $ 1,148,123 $ 1,288,286 $ 1,448,465 $ 4,959,245 NET INCOME (LOSS) FROM CONTINUING OPERATIONS $ (375,272) $ (260,145) $ (247,924) $ (432,127) $(1,315,468) NET INCOME (LOSS) FROM DISCONTINUED OPERATING $ (3,414) $ (55,519) $ (108,306) $(1,192,225) $(1,359,464) ------------- ------------- ------------ ----------- ------------- NET LOSS $ (378,686) $ (315,664) $ (356,230) $(1,624,352) $(2,674,932) BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM CONTINUING OPERATING: $ (0.10) $ (0.07) $ (0.06) $ (0.10) $ (0.33) BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM DISCONTINUED OPERATIONS: $ - $ (0.02) $ (0.02) $ (0.23) $ (0.27) ------------- ------------- ------------ ----------- ------------- TOTAL $ (0.10) $ (0.09) $ (0.08) $ (0.33) $ (0.60) DIVIDEND PREFERED STOCK $ 90,250 $ 90,250 $ 85,750 $ 90,250 $ 356,500
THREE MONTHS ENDED
3/31/2005 6/30/2005 9/30/2005 12/31/2005 TOTAL SALES $ 14,757,963 $ 15,339,974 $ 16,864,434 $16,387,811 $ 63,350,182 GROSS PROFIT $ 803,000 $ 1,154,480 $ 1,167,950 $ 880,684 $ 4,006,114 NET INCOME (LOSS) FROM CONTINUING OPERATIONS $ (493,472) $ (99,331) $ (176,660) $ (759,739) $ (1,529,202) NET INCOME (LOSS) FROM DISCONTINUED OPERATING $ (124,425) $ (107,289) $ (141,029) $ (658,833) $ (1,031,576) ------------- ------------- ------------ ----------- ------------- NET LOSS $ (617,897) $ (206,620) $ (317,689) $1,418,572) $ (2,560,778) BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM CONTINUING OPERATING: $ (0.17) $ (0.05) $ (0.06) $ (0.20) $ (0.48) BASIC AND DILUTED NET LOSS PER COMMON SHARE FROM DISCONTINUED OPERATIONS: $ (0.04) $ (0.03) $ (0.03) $ (0.17) $ (0.27) TOTAL $ (0.21) $ (0.08) $ (0.09) $ (0.37) $ (0.75) DIVIDEND - PREFERED STOCK $ 74,250 $ 74,250 $ 78,583 $ 90,250 $ 317,333
F-34 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE P - RETIREMENT PLAN On January 1, 2002, the Company established the Synergy Brands, Inc. 401(k) Plan (the "Plan") covering employees 21 years of age and older who have completed six months of continuous service. For the year ended 2006, 2005 and 2004 the Company match was $28,627, $20,812 and $17,275. NOTE Q - COMMITMENTS AND CONTINGENCIES 1. Lease Commitments The Company leases office and warehouse space under operating leases expiring at various dates through June 2011. The Company is also leasing vehicles under operating leases. Future minimum lease payments under noncancelable operating leases as of December 31, 2006 were as follows: Year ending December 31, 2007 $429,747 2008 $422,420 2009 $413,317 2010 $408,390 2011 $233,762 thereafter $103,71 Rent expense under operating leases for the years ended December 31, 2006, 2005 and 2004 was approximately $382,000, $375,000 and $190,000 respectively. 2. Litigation The Company is subject to legal proceedings and claims, which arise, in the ordinary course of its business. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not materially affect the Company's financial position, results of operations or cash flows. F-35 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE R- SEGMENT AND GEOGRAPHICAL INFORMATION The Company offers a broad range of Internet access services and related products to businesses and consumers throughout the United States and Canada. Management evaluates the various segments of the Company based on the types of products being distributed which were, as of December 31, 2006, 2005 and 2004, as shown below the segment information does not include the discontinued segment of Proset:
PHS Group GRC Corporate Total ------------ ------------ ------------ ----------- Year ended December 31, 2006 Revenue $69,840,886 $1,919,022 - $71,759,908 Net profit (loss) attributable to 779,634 (311,210) (2,140,392) (1,671,968) common stockholder Depreciation and amortization 11,929 156,456 76,700 245,085 Interest income - - 147,533 147,533 Other income (expense) (14,247) (7,792) - (22,039) Equity in earnings of investee - - 227,054 227,054 Interest and financing expenses 1,403,739 - 647,117 2,050,856 Identifiable assets 15,609,833 1,594,373 3,536,408 20,740,614 Additions to long-lived assets 35,684 - - 35,684 Investment in affiliate - - 562,593 562,593 PHS Group GRC Corporate Total ------------ ------------ ------------ ----------- Year ended December 31, 2005 Revenue $61,450,467 $1,899,715 - $63,350,182 Net loss attributable to common (111,784) (445,505) (1,289,246) (1,846,535) stockholder Depreciation and amortization 12,804 156,477 145,264 314,545 Interest income - - 102,644 102,644 Other income (expense) (3,581) (16,888) - (20,469) Equity in earnings of investee - - 56,311 56,311 Interest and financing expenses 1,297,348 - 216,058 1,513,406 Identifiable assets 10,056,544 1,715,940 4,187,603 15,960,087 Additions to long-lived assets 10,735 61,594 - 72,329 Investment in affiliate - - 364,340 364,340 PHS Group GRC Corporate Total ------------ ------------ ------------ ----------- Year ended December 31, 2004 Revenue $50,728,560 $2,052,661 - $52,781,221 Net loss attributable to common Stockholder $ (167,951) (644,870) (1,100,729) (1,913,550) Depreciation and amortization 6,501 145,301 296,768 448,570 Interest income 4,344 - 266 4,610 Other income (expense) 71,586 (21,139) (16,652) 33,795 Equity in earnings of investee - - 172,224 172,224 Interest and financing expenses 1,168,607 42,500 109,501 1,320,608 Identifiable assets 9,160,367 1,837,998 3,590,427 14,588,792 Additions to long-lived assets 85,980 175,000 29,078 290,058 Investment in affiliate - - 336,828 336,828
F-36 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE R (continued) All of the Company's identifiable assets and results of operations are located in the United States and Canada. Geographic data, as of and for the years ended December 31, 2006, 2005 and 2004, is as follows:
2006 2005 2004 -------------- -------------- ------------- Revenue United States $ 49,041,460 $ 31,103,702 $ 26,850,659 Canada 22,718,448 32,246,480 25,930,562 -------------- -------------- ------------- $71,759,908 $ 63,350,182 $ 52,781,221 ============== ============== =============
Accounts receivable United States $6,005,782 $ 795,738 Canada 5,160,198 6,682,401 -------------- -------------- $11,165,980 $ 7,478,139 ============== ============== Identifiable assets of continuing operations United States $20,740,614 $15,960,087 Canada - - -------------- -------------- $20,740,614 $ 15,960,087 ============== ============== F-37 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE S - Discontinued Operations In December 2006, the Company instituted a plan to discontinue the Pro-Set segment. Accordingly, the operating results of Pro-set segment for each of the three years ended December 31, 2006 has been presented as "(Loss) income from discontinued operations, net of income taxes". Net assets and liabilities to be disposed of or liquidated, at their book value, have been separately classified in the accompanying balance sheets at December 31, 2006 and December 31, 2005. The Company recorded impairment loss of (i) 293,586, for the year ended December 31, 2005 and (ii) an additional impairment loss of $359,353 during the year ended December 31, 2006, in connection with the write-down of the assets that were to be disposed of. During the year ended December 31, 2006, the Company recorded a loss of $58,305 in connection with the write-down of fixed assets. Also in 2006, $485,000 was recorded as additional reserves of accounts receivables, other receivables, and inventory. Due to operating losses, there was no income tax benefit from the write-down and disposal of these assets. Summarized financial information of the Pro-Set segment as discontinued operations for each of the three years ended as follows:
Year ended Year ended Year ended ------------- --------------- ---------------- Dec.31, 2006 Dec. 31, 2005 Dec. 31, 2004 ------------- --------------- ---------------- Net Sales $ 1,222,834 $ 786,908 $3,923,823 Cost of sales Cost of product 1,260,694 867,036 3,206,187 Shipping and handling costs 144,772 98,607 129,482 ------------- --------------- ---------------- 1,405,466 965,643 3,335,669 Gross Profit (182,632) (178,735) 588,154 Operating expenses: Advertising and promotion 1,046 900 - General and administrative 594,008 291,134 282,747 Depreciation and amortization 157,650 183,420 210,920 Asset impairment charge 359,353 293,586 - ------------- --------------- ---------------- 1,112,057 769,040 493,667 Operating profit (loss) (1,294,689) (947,775) 94,487 Other Income (expenses): Other income (expenses) (1,024) (1,035) (80,778) Interest and financing expenses (62,765) (80,233) (232,913) ------------- --------------- ---------------- (63,789) (81,268) (313,691) Net loss before income taxes (1,358,478) (1,029,043) (219,204) Income tax expense 986 2,533 - ------------- --------------- ---------------- Net loss from discontinued operations $ (1,359,464) $ (1,031,576) $ (219,204) ============= =============== ================
F-38 Synergy Brands, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Years ended December 31, 2006, 2005 and 2004 NOTE S (continued) Dec.31, 2006 Dec. 31, 2005 -------------- -------------- ASSETS: CURRET ASSETS: CASH AND CASH EQUIVALENTS $ 1,782 $ 8,071 ACCOUNTS RECEIVABLE TRADE 44,632 16,185 OTHER RECEIVABLES 28,563 117,563 INVENTORY 52,205 728,092 PREPAID ASSETS AND OTHER CURRENT ASSETS - 5,637 PROPERTY AND EQUIPMENT, NET - 79,170 INTANGIBLE ASSETS,NET OF ACCUMULATED AMORITIZATION OF $ 2,627,469 AND $ 2,189,639 - 437,833 -------------- -------------- TOTAL ASSETS $ 127,182 $1,392,551 -------------- -------------- LIABILITIES: NOTES PAYABLE $ - $ 319,531 ACCOUNTS PAYABLE 112,569 206,288 -------------- -------------- TOTAL LIABILITIES $ 112,569 $ 525,819 ============== ============== NOTE T - SUBSEQUENT EVENTS Effective January 19, 2007, Synergy Brands Inc. completed a $6.5 million secured financing with Lloyd I. Miller, a major shareholder and a director of Synergy Brands for its main operating subsidiary PHS Group Inc. The financing consisted of $6.5 million in secured term notes to be amortized over a 5 year period, with a balloon payment of $3,250,000 in January 2012 at an interest rate of 11.25%, that may be reduced to 11% under certain conditions. The agreement further involved a securities purchase agreement that added 1,075,000 common shares of Synergy Brands to Lloyd Miller and retired all warrants beneficially owned by Mr. Miller. F-39