SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Annual report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998.
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.)
40 Underhill Blvd.
Syosset, NY 11791
(Address of corporate offices)
Registrant's telephone number, including area code: 516-682-1980
Securities registered pursuant to Section 12(b) of the
Act:
Title of Each Class Name of Exchange
Common Stock, $.001 par value NASDAQ/Small-Cap System
and Boston Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes_X_ NO__
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
On March 26, 1999, the aggregate market value of the voting stock of
Synergy Brands Inc., held by non-affiliates of the Registrant (based on the
closing price as reported on the NASDAQ for March 26,1999) approximately
$30,253,413. 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 26, 1999 was 8,598,757.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 1998 Annual Meeting of
Stockholders to be held June 1999 are incorporated by reference in Part III (for
other documents incorporated by reference -refer to Exhibit Index at page )
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PART I
Other than historical and factual statements, the matters and items
discussed in this report on Form 10-KSB are forward-looking information that
involves risks and uncertainties. The Company's actual results may differ
materially from the results discussed in the forward-looking statements. Factors
that could contribute to such differences are discussed in the forward-looking
statements and are summarized in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Forward-Looking Information and
Cautionary Statements."
ITEM 1. BUSINESS
A. OVERVIEW
Synergy Brands Inc. ("Synergy")through its subsidiaries (collectively the
"Company") markets national brand name consumer products to numerous US
retailers and wholesalers as well as developing and selling proprietary brand
consumer products to and through the same marketing channels.
In 1998 the Company expanded its product marketing efforts and potential by
establishing an array of internet sites linked to and available through multiple
search engines to afford access to purchase of its products directly by the
consumer. With the addition of internet access many of the Company's products
are now available for retail purchase as well as the traditional wholesale
distribution historically offered by the Company. Internet sales presently
include health and beauty aid (HBA), salon products and cigar products
previously and traditionally offered by the Company through alternative
marketing channels as well as an array of more recently added consumer products
including fragrances and cosmetics and skin care products. These additional
products are offered for sale by the Company through its internet sales network
as well as the Company's historical wholesale distribution channels.
Such businesses of Synergy are segmented, managed and conducted through
corporate subsidiaries whose stock is wholly or majority owned by Synergy , and
the results of whose businesses are consolidated for reporting purposes with the
financial statements of Synergy . The Company operates its core grocery and HBA
product sale and distribution business though three subsidiaries New Era Foods
Inc., Synergy Brands Distribution Inc., and Island Wholesale Groceries Inc. The
Company's other current subsidiaries include NetCigar.Com Inc., (cigar
products), PHS Group Inc. (salon quality hair and skin care products), SYBR.Com
Inc. (internet sales), and Premium Cigar Wrappers Inc. (procurement and sale of
raw tobacco for cigar production). Of these, Synergy Brands Distribution Inc.,
SYBR.Com Inc., and NetCigar.Com Inc. were formed in 1999.
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Historically the Company has developed business relationships through
contacts made with manufacturers and the establishment of sources thereby for
sale of its grocery and HBA products on a wholesale basis with sales made in
bulk from inventory stored in various warehouses. The business conducted was
expanded through adding more wholesale and retail outlets for resale of the
Company goods as the Company became more recognized in its area of business.
Products were purchased from the manufacturer by the Company in bulk and
warehoused in the New York metropolitan area for the Company until anticipated
sale of such goods could transpire. Cigar sales have been manufactured for
retail outlets for further sale to the consumer from product warehoused by the
Company in the US and Dominican Republic.
With the onset of the internet, the potential for low cost mass marketing
has become available and the Company has extended itself into such marketing
direction by establishing its presence on the internet. The Company through
subsidiaries has established web sites on the internet for retail sale of its
health and beauty care, cosmetics and fragrance products, and for its cigar
products directly to the consumer (see "Information Systems", infra for more
detailed discussion in this area).
THE COMPANY'S CORPORATE OFFICE IS LOCATED AT 40 UNDERHILL BLVD., SYOSSET,
NEW YORK 11791, AND ITS TELEPHONE NUMBER IS (516) 682-1980.
B. INTERNET SALES
1. BEAUTYBUYS.COM.
In 1999 the Company established under the tradename BeautyBuys.Com a
website to offer direct to the consumer via internet sales on a non-exclusive
basis a popular selection of nationally branded health and beauty care products,
including professional salon hair and skin care items, designer fragrances and
cosmetics, and consumer health and beauty care products manufactured by Proctor
& Gamble, previously and continuing to be sold by the Company as part of its
traditional grocery and HBA product wholesale distribution business. The Company
has also established web site presence with other internet portals including the
globe.com, Lycos.com and women.com and is striving to further expand onto a
broader array of internet sites. This aspect of the Company's business currently
accounts for only a minor percentage of its product sales income but is expected
to expand in the coming year and to become a material aspect of the Company's
business in the future.
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2. NETCIGAR.COM
In the latter part of 1998, the Company announced its plan to establish
NetCigar.com as a web site for sale of cigar products, which is administered by
the Compnay's subsidiary of similar name. Via its NetCigar.com web site, the
Company will offer information and sales on a variety of cigars and cigar
related products and content, including cigar news and events, editorials, cigar
reviews, cigar chat rooms and a array of cigars and cigar products of both the
Company's propietary labels and other popular brands.
3. FUTURE INTERNET SITES.
In the near future, the Company intends to expand the product base it
offers in retail sales over the Internet. These porducts would include certain
grocery and seafood items currently sold by the Company through its wholesale
distribution network and new products whose feasibility the Company is
exploring, such as vitamins and liquor.
C. WHOLESALE PRODUCT DISTRIBUTION AND SALE
1. PROMOTIONAL GROCERY AND HBA PRODUCT SALES.
The Company continues to expand its traditional core business of wholesale
trade in promotional grocery and HBA products. Since 1989 the Company has been a
distributor of promotional grocery and HBA products. Such aspect of the
Company's business involves the purchase and resale by and on behalf of the
Company of grocery and HBA products promoted by the manufacturers and thereby
available for resale at discounted prices which the Company resells at wholesale
prices to retailers who qualify for promotional allowances offered by the
manufacturers of such goods, and the Company then collects the promotional
rebates and other cash incentives offered by the manufacturers. This core aspect
of the Company's business presently accounts for approximately 50% of the
Company's gross sales.
2. HEALTH AND BEAUTY AIDS WHOLESALE DISTRIBUTION.
The Company presently buys health and beauty aid products at wholesale from
the manufacturer and resells same to retail and other wholesale establishments
mainly in the Northeastern US. The product source most often utilized is Proctor
& Gamble with whom the Company has a long standing relationship. This aspect of
the Company's business presently accounts for approximately 25% of the Company's
gross sales.
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3. SALON HAIR AND SKIN CARE PRODUCTS.
The Company services on a direct store basis several drug store and
supermarket chains in the Northeast United States and numerous other retail
outlets for the sale of Salon quality hair and skin care products available to
the Company through contacts made in the industry at what the Company believes
are very advantageous prices for bulk purchases. Similar products are also made
available to be sold by the Company direct to the consumer via internet sales
(see "B. Internet Sales" supra). In this product area the Company stocks the
designated store shelves on the design of the Company's planogram which service
the Company offers at no additional charge which aspect of their sales helps the
Company maintain the client as long as the Company remains aware of and remedies
deficiencies in product shelf storage as it occurs. The Company entered this
business in the last quarter of 1998.
4. DISTRIBUTION OF PREMIUM CIGARS.
The Company sells premium hand made cigars manufactured in and from tobacco
grown in the Dominican Republic directly to the consumer, drug stores and
supermarkets and to a variety of smaller individual and chain retail stores. The
Company's sales to retail outlets currently places their cigars in approximately
1000 locations for further sale, as well as internet sales (see "B. Internet
Sales" supra).
The Company has exclusive rights to the manufacture of and private
proprietary labeling for its cigars through an exclusive distribution agreement
with a Dominican Republic tobacco grower and manufacturer. The said manufacturer
owns and/or exclusively leases sufficient land and factory facilities in the
Dominican Republic capable of producing cigars at a capacity of at least 500,000
cigars per month. The distribution agreement is for 25 years with an option for
another 25 years for worldwide distribution to locations directed by the
Company. There is a need in the cigar production and sale business to purchase
raw tobacco material in advance due to lengthy curing requirements that premium
cigars require. There is present tobacco inventory on hand for the production of
cigars for sale by the Company to produce approximately 2,500,000 cigars. The
Company is developing a unique premium wrapper for many of its cigars being
grown in the Dominican Republic known as Corojo which is expected to enhance
cigars sales because of its similarities to wrappers produced from tobacco grown
in Cuba but not allowed to be sold in the United States. The Company also
markets proprietary owned and developed humidors and other cigar storage and
smoking apparatus and related products. This aspect of the Company's business
currently accounts for approximately 5% of product sales but is expected to
increase significantly with the advent of and further progress made in the
internet cigar sales.
5. FROZEN SQUID AND OTHER SEAFOOD.
The Company maintains facilities for the processing of and access to frozen
squid in the Peoples Republic of China (PRC) which is available to the Company
through its developed relationship with a Chinese trading partner, and The
Company sells the squid in the northeastern United States through established
wholesale distribution channels accounts for approximately 15% of the Company's
current income from product sales.
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D. COMPETITION
The Promotional Products business and grocery/HBA product sales generally
is a highly competitive, fragmented business. On a national level, the Company
does not believe that any single wholesaler or retailer has a significant
percentage of market share. The Company competes with a large number of
wholesalers and retailers in the industry, many of whom have substantially
greater financial resources than the Company. These competitors are able to make
larger volume purchases and can finance larger inventories than the Company.
Moreover, some of these competitors will sometimes receive preferential notice
of product promotions prior to the Company. The Company seeks to compete in the
Promotional and other wholesale Grocery/HBA Products distribution industry
primarily on the basis of price and service. The Company seeks to market fast
moving items and purchase them at the best possible prices at which the
manufacturers sell such products; the Company tries to take advantage of buying
opportunities and volume bracket discounts to streamline its available goods for
sale. However, the Company's present resources do not allow it to buy in on a
significant basis that some of its competitors are able to do, which adversely
affects the Company's competitive position in those circumstances.
The Company is small in both physical and financial attributes in
comparison to many of its competitors in the grocery industry and other business
areas in which it participates, and the Company also competes with other more
substantial companies in the sale and distribution of frozen seafood, including
squid, although in this latter area of business the Company believes it may be
among the largest distributors of squid from China. The Company's knowledge and
experience in and devotion to its business, receptiveness to general customers,
service, and its exclusivity arrangement with a major Chinese trading entity
should continue to benefit its operations and continue to allow it to compete
with its more financially endowed competitors
The cigar distribution industry in general is dominated by a small number
of large companies which are well known to the public. Management believes that,
as a distributor of premium handmade cigars, the Company competes with a smaller
number of primarily regional distributors, including Southern Wine and Spirits,
Specialty Cigars, Inc., Cohabico and Old Scottsdale Cigar Company, Inc. and many
other small and large tobacco distributors and jobbers. A number of larger,
well-known cigar manufacturing and wholesale companies, along with major
cigarette manufacturers, have not yet entered the retail distribution market to
any appreciable degree, but may do so in the future. Competitors include JR
Cigar Company, Inc., Consolidated Cigar Corporation, Culbro Corporation, General
Cigar Company, Swisher International Inc., Caribbean Cigar Company and US
Tobacco. The Company has targeted what it feels is a unique market with less
competition by selling premium cigars through supermarkets and chain drug
stores, locations to whom other products of the Company also are sold, and to
other small retail chain stores. Many existing and potential competitors have
larger resources than the Company and would, if they enter the premium handmade
cigars distribution market, constitute formidable competition for the Company's
business. There can be no assurance that the Company will compete successfully
in any market.
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In the Salon Hair and Skin care product market and that for fragrances and
cosmetics the primary thrust of the business, as the Company perceives it, is to
secure market share which once established can be maintained with good service
and maintenance of competitive pricing. The Company in most instances is in
charge of a section within each store where the products are to be shelved for
sale and the Company is expected to keep such shelves full. Once the particular
stores are acquired as clients and the service and price levels are maintained,
it is difficult to lose the account. However, special circumstances beyond the
Company's control such as acquisitions, other financial events, among others may
cause the Company to lose customers.
In internet sales the Company competes to obtain its product from
manufacturers also supplying competing distributors, but there is no security of
product placement as with sale to retail outlets; the leveling factor appears to
be service and exposure on the internet. The Company is striving for expanded
internet exposure and prides itself in offering good prices and service. The
expanding presence of the Company on the Internet should act as a further
balancing factor because of the enhancement of selling efforts such allows
without the need for any corresponding expansion of the Company's physical
business facilities and personnel.
E. INFORMATION SYSTEMS
1. INTERNET
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,
and recorded reaction to the sites are used by the Company to further their
marketing efforts. Presently the Company's product sale internet sites are
accessible by link to various servers by being included as specific advertised
sites on such servers websites and also by being included in general product
categories which might be sought by the consumer in search of sources for
products in such categories whereby the potential customer will find the Company
listed as a source having such products available for sale when one accesses
such product area information from the internet server being utilized to surf
the net. Behind the screen visible to the consumer when visiting the Company's
various product category websites are internet based marketing and accounting
information programs to allow the Company to review interest shown in its
websites and account for sales made therefrom. The Company has access to such
information and these behind the scene programs and services are provided to the
Company through various agreements the Company has with internet servers,
providers and administrators and much of the programs utilized to perform such
administrative functions have been designed specifically for the Company and are
proprietary to them. The Company also anticipates in the future to procure
advertising on its own websites as an additional source of income, and
eventually to establish its own server for direct access to its internet sites.
The Company also maintains its own websites regarding information on the Company
as a public entity and its various business interests. Internet sites presently
available for review regarding Company business and product sales are:
BeautyBuys.com
NetCigar.com
GranReserve.com
SynergyBrands.Com
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The Company has utilized several internet design firms to assist the
Company in developing internet web sites in the differing areas of the Company's
product sales. Much of the design work is proprietary to the Company, having
been developed especially to accommodate the specific marketing and record
keeping needs voiced by the Company. The Company is utilizing up to date
technologies in site design, tracking systems and affiliated programs including
EXCITE, ColdFusion, Domino, BFAST, Exodus Communication and web crossing.
Regarding BeautyBuys.Com internet salon quality hair and skin care
products, fragrances and cosmetics product sales, the Company has contracted
with Visualink Technologies Inc. (www.visualink.com) to assist in developing the
website.
Regarding the NetCigar.Com internet cigar product sales the Company has
contracted with The Sphere Information Services, Inc. (www.thesphere.com) for
the development of its on-line site.
The Company utilizes a proprietary computerized data base management system
which collects, integrates and allows for analysis of data concerning sales,
order processing, shipping, purchasers, receiving, inventories, and financial
reporting. At any given time the Company is able to determine the quantity of
product stored by item, Company costs, age and other characteristics necessary
for expeditious distribution. The system has been upgraded to be Y2K compliant
and provides for system networking of the Company's various offices and
warehousing and allows for on-line transnational reporting capabilities.
F. SEASONALITY
Seasonality affects the demand for certain of the grocery products sold by
the Company such as juice drinks in the summer months or hot cereals in the fall
and winter months; however, all these products are available to the Company
throughout the year. Manufacturers also tend to promote more heavily toward the
close of their fiscal quarters and during the spring and early summer months.
Accordingly, the Company is able to purchase more product due to these
promotions. The Company generally experiences lower sales volume in the fourth
quarter due to the reduced number of selling days resulting from the high
concentration of holidays in that quarter.
Seasonality also affects the squid market (and seafood in general) of
products originating in China. Because of time and locality differences, the
optimum timing for catching the seafood and the most popular times for re-sale
in the United States differ significantly and such requires that the seafood be
delivered and stored frozen, in many cases for a significant time. Purchases and
sales are likely to be affected thereby.
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Sales of beauty care products and fragrances increases over traditional
gift giving holidays such as Christmas, Easter, Mother's Day, Father's Day, and
Valentine's Day.
Cigar products sales also increase during holiday periods and summer
months, but also sales spurts occur during periods of special sporting events.
G. SHIPPING AND HANDLING
Products are shipped in bulk from inventory maintained by the Company at
its warehouse facilities by common carriers, unless alternative arrangements are
made to have the product shipped using another service (eg postal carrier or
UPS) the cost of which is added to the acquisition cost of the product to the
purchaser. Regarding internet sales the Company maintains certain inventory and
has arrangements to purchase other products for resale on a "just in time"
basis. All orders are consolidated in a single facility and shipped to the
customer within 7 days mainly by UPS. Approximately 60% of inventory is in
warehouse stock and 40% is purchased by the Company on an as needed "just in
time" basis. The Company does not own its trucks and is dependent on common
carriers in the trucking industry. 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 are prevented from or
delayed in utilizing local transportation lanes, the Company will likely incur
higher freight costs due to the limited availability of trucks during any such
period that transportation lanes are restricted.
The Company generally purchases Promotional Grocery Products and HBA
products for its promotional business in truck-load quantities to take advantage
of better pricing from the supplier and lower freight costs. The Company's
traffic department then arranges for transportation of the product through a
computerized network of several hundred independent truckers coordinated through
its warehouse operation. The Company does not foresee difficulty in arranging
additional trucking if it increases its business volume. The Company has
arranged for warehousing when and where necessary, on a contract basis and has
thereby eliminated the existence of and need for centralized warehousing.
H. TRADEMARKS, LICENSES AND PATENTS
The Company is not reliant upon any copyrights, trademarks, licenses or
patents in its business. The Company has obtained a wholesale pharmaceutical
license through the New York State Department of Education, but to date has not
utilized it. Through its distribution agreements, the Company has US rights to
the "Tenda" "Picolo" name in the marketing of seafood products and "Suarez Gran
Reserva", "Breton Legend", "Anduleros", "Don Otilio","Alminante" "Nativo" and
various other trade names in marketing of premium handmade cigars. The seafood
trademarks are owned by ALT. The cigar tradenames are owed by Gran Reserve Corp.
The Company also is studying the advantages and marketing potential of
establishing private label sales in the health and beauty aids and cosmetics
business areas to take advantage of certain inroads to these type consumer
products the Company has historically located and developed. The Company also
has entered multiple licensing and production agreements regarding the
establishment of internet sites for sale of the Company's products (see "Product
Marketing" infra). The Company has trademarked its websites on the internet.
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I. EMPLOYEES
The Company as of the date of this report employs and contracts 30 full
time/part time persons all of of which work in executive, administrative,
marketing, data processing, accounting or clerical activities and certain work
as Company employees that integrate with the various warehouses where Company
products are stored. The Company does not employ any full time warehouse
personnel but rather contracts with the various warehouses for shipping and
logistical support. In the cigar distribution area there are nearly 25 employees
that work in the Dominican Republic and in Miami, Fla. where cigars and cigar
products are grown, manufactured and warehoused, they either being in the employ
of Fabrica De Tobacco Valle Dorado, SA and /or of the Distributor contracted by
the Company to carry out its distribution obligations contracted with Fabrica.
The Company also utilizes numerous independent commission based brokers and
sales persons.
J. YEAR 2000 ISSUE
The Company's management recognizes the need to ensure that its operations
and relationships with vendors, and other third parties will not be adversely
impacted by software processing errors arising from calculations using the Year
2000 and beyond. Many existing computer programs and databases use only two
digits to identify a year in the date filed (i.e. 98 would represent 1998). If
not corrected, many computer systems could fail or create erroneous results in
the year 2000. The Company believes all of its internal information systems
currently in use are Year 2000 ready. The majority of the Company's critical
business applications have been developed internally, in the past year with Year
2000 ready tools. With respect to non-information technology systems issues, the
Company expects to identify, assess and remedy, if necessary, its building and
utility systems for any Year 2000 issues relating to the functionality of its
facilities during the first half of 1999. All testing and remediation, if
necessary, of non-information technology systems is expected to be completed by
the summer of 1999.
The Company has begun communications with its vendors and other third
parties to determine the extent that these related systems may not be Year 2000
ready. Because the Company is still in the initial stages of these
communications the Company can not determine if such failures are possible and,
if so, the extent that such failures would impact the Company. If one of the
Company's primary suppliers were to have Year 2000 problems, it is possible that
these problems could have a material effect on the Company's operations.
Management expects the total cost associated with Year 2000 identification,
remediation and testing to be between $50,000 and $100,000 of which $50,000 was
spent in 1998. The expected cost represents approximately 10% of the total
information technology budget and includes all costs to be incurred through the
utilization of internal employees and consultants.
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Should any or all of the applications fail to perform properly on January
1, 2000, the Company will resort to temporary manual processing, which is not
expected to have a material adverse impact on its short-term operations. Failure
to achieve Year 2000 readiness by any of the Company's vendors, while expected
to cause some disruption to operations in the short-term, is not expected to
have a material impact on the Company's operations.
K. GOVERNMENT REGULATION
1. TOBACCO INDUSTRY REGULATION AND TOBACCO INDUSTRY LITIGATION
Regulation. The tobacco industry is subject to regulation at federal, state
and local levels. Federal law has recently required states, in order to receive
full funding for federal substance abuse block grants, 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.
In August 1996, the Food and Drug Administration (the "FDA") determined
that nicotine is a drug and that it had 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. Cigars
were not included in the FDA's regulations. 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 became effective on February 28, 1997.
Additional efforts by the FDA to increase regulation over tobacco and
tobacco-related products have been forestalled by a recent decision in the
Fourth Circuit of the U.S. Court of Appeals. In August 1998, that court ruled
that the FDA lacks jurisdiction to regulate tobacco products and struck down all
the provisions of the FDA's 1996 regulations. Brown & Williamson v. FDA, 153
f.3d 155 (4th Cir. 1998). The Fourth Circuit denied a U.S. Department of Justice
petition for rehearing by the Panel or en banc.
On January 19, 1999, the Solicitor General filed a petition for a writ of
cetiorari requesting the U.S. Supreme Court review the August 1998 decision of
The Fourth Circuit. A ruling on the petition is expected in the near future. The
FDA's age and identification regulations will remain in effect pending the
outcome of this litigation.
The U. S. Department of Health and Human Services ( the "HHS") Inspector
General issued a report in February 1999, urging the Federal Trade Commission to
require cigars to carry warning labels similar to those contained on cigarette
packages. This report marks the first time that cigars have specifically been
identified for increased regulatory oversight by a federal health agency.
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While the cigar industry has not been subject to federal regulatory efforts
to date, there can be no assurance that there will not be an increase in federal
regulation in the future against cigar manufacturers or distributors. The HHS
report indicates that federal regulatory effort directed toward cigar
manufacturers and distributors may be increasingly likely. The costs to the
Company of increased government regulations could have a material adverse effect
on the Company's business and results of operation.
In addition, the majority of states restrict or prohibit smoking in certain
public places and restrict the sale of tobacco products to minors. Local
legislative and regulatory bodies have also increasingly moved to curtail
smoking by prohibiting smoking in certain buildings or areas or by requiring
designated "smoking" areas. Further restrictions of a similar nature could have
an adverse effect on the sales or operations of the Company. 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.
Federal law has required health warnings on cigarettes since 1965 and on
smokeless tobacco since 1986. Although there is no federal law currently
requiring that cigars or pipe tobacco carry such warnings, California has
enacted legislation requiring that "clear and reasonable" warnings be given to
consumers who are exposed to chemicals known to the State to cause cancer or
reproductive toxicity, including tobacco smoke and several of its constituent
chemicals. Violations of this law, known as Proposition 65, can result in a
civil penalty not to exceed $2,500 per day for each violation. Although similar
legislation has been introduced in other states, no action has been taken. There
can be no assurance that such legislation introduced in other states will not be
passed in the future or that other states will not enact similar legislation.
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). There can be no assurance that regulations relating to
second-hand smoke will not be adopted or that such regulations or related
litigation would not have a material adverse effect on the Company's results of
operations or financial condition.
The U.S. Environmental Protection Agency (the "EPA") published a report in
January 1993 with respect to the respiratory health effects of second-hand
smoke, which concluded that widespread exposure to environmental tobacco smoke
presents a serious and substantial public health concern. Issuance of the
report, which is based primarily on studies of passive cigarette smokers, may
lead to further legislation designed to protect non-smokers. Also, a study
recently published in the journal Science reported that a chemical found in
cigarette smoke has been found to cause genetic damage in lung cells that is
identical to damage observed in many malignant tumors of the lung and, thereby,
directly links lung cancer to smoking. The study and these reports could affect
pending and future tobacco regulation and litigation.
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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. Historically, the cigar industry has experienced less
health-related litigation than the cigarette and smokeless tobacco industries
have experienced.
Litigation against the cigarette industry has historically been brought by
individual cigarette smokers. In 1992, the United States Supreme Curt in
Cippollone v. Liggett Group, Inc. ruled that federal legislation relating to
cigarette labeling requirements preempts claims based on failure to warn
consumer about the health hazards of cigarette smoking, but does not preempt
claims based on express warranty, misrepresentation, fraud, or conspiracy. To
date, individual cigarette smokers' claims against the cigarette industry have
been generally unsuccessful. A jury n Florida, however, recently determined that
a cigarette manufacturer was negligent in the production and sale of its
cigarettes and sold a product that was unreasonably dangerous and defective,
awarding the plaintiffs a total of $750,000 in compensatory damages.
Current tobacco litigation generally falls within one of three categories:
class actions, individual actions (which have been filed mainly in the State of
Florida) or actions brought by individual states generally to recover Medicaid
costs allegedly attributable to tobacco-related illnesses. The pending actions
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 vigorously defending these actions.
In May 1996, the Fifth Circuit Court of Appeals in Castano v. American
Tobacco, et al. reversed a Louisiana District Court's certification of a
nationwide class consisting essentially of nicotine dependent cigarette smokers.
Notwithstanding the dismissal, new class actions asserting claims similar to
those in Castano have recently been filed in certain states. To date, two
pending class actions against major cigarette manufacturers have been certified.
The first case is limited to Florida citizens allegedly injured by their
addiction to cigarettes; the other is limited to flight attendants allegedly
injured through exposure to second-hand smoke.
The tobacco industry recently 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.
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Recent reports indicate that the federal government intends to sue the
tobacco industry seeking reimbursement for billions of dollars spent by
government held programs to treat smoking-related illnesses. A federal
government task force has been formed to make a recommendation to the U.S.
Justice Department on when and where to file the lawsuit. Furthermore, the
inability of the federal government to obtain a portion of the funds from the
state settlements with the tobacco industry may increase the likelihood of
federal government litigation against the industry. The 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 of
distributors. The costs to the Company of defending prolonged litigation and an
settlement or successful prosecution of any health-related litigation could have
a material adverse effect on the Company's business and results of operation.
2. MISCELLANEOUS 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 manufacturer 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 manufacturers or
suppliers to comply with applicable government regulations could result in
product recalls 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.
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ITEM 2: PROPERTIES
The Company's corporate offices and administrative headquarters are located
in Syosset, New York.
The Company maintains satellite offices in Pennsylvania, New Jersey,
Florida and the Dominican Republic.
Product warehousing when necessary, is done on a contract basis per pallet
of product stored and is stored in expandable public warehouses primarily
located in New Jersey. The Company stores at its expense grocery, and health and
beauty aids products which the Company sells in bulk to further wholesalers and
retail outlets independent of the Company. The Company has standing orders with
independent product sources for the availability of and delivery of product to
the Company which is not to be resold in bulk and to accommodate the sales of
product direct to the consumer via internet sales where shipping of product to
fulfill orders for consumers requires diversity of products shipped in each
package as ordered. Certain of the more popular products, as viewed from the
concentration of internet orders for such products, are warehouse stored for the
Company in the warehousing facilities more adapted to the "pick and pack"
retrieval and shipping character of consumer internet sales practices of the
Company . Otherwise the Company arranges to have the products shipped directly
to the consumer from the manufacturer using standard delivery services and/or
the US postal service which cost is built into the price charged for the product
and that paid by the Company to the manufacturer. Currently the Company
maintains warehousing space under the above referenced arrangements in New
Jersey for warehousing of products to be sold wholesale in bulk and for internet
and other specialized sales. Squid and other seafood acquired from China to be
redistributed by the Company in the United States is stored freezers of the
warehouse facilities in Perth Amboy, New Jersey. There are also several
humidified warehouses in Florida and the Dominican Republic to store cigars
supervised by Company officials and several warehouses in the Dominican Republic
to store raw tobacco for cigar production which are independently operated.
ITEM 3: LEGAL PROCEEDINGS
The Company is a party to a number of legal proceedings as either plaintiff
or defendant 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.
No other legal proceedings were terminated during the fiscal quarter ended
December 31, 1998 (other than routine litigation incidental to the business of
the Company).
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998 no matters were submitted for shareholder
approval during the fourth quarter.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock were traded on NASDAQ Small-Cap through June
1998 under the symbol "KRAN", and on the Boston Stock Exchange under the symbol
"KRN" and thereafter on NASDAQ Small Cap under the Symbol "SYBR", and on the
Boston Stock Exchange under the Symbol "SYN", recognizing the change in
corporate name of the Registrant to Synergy Brands Inc. effective June 24, 1998.
The NASDAQ Stock Market, which began operation in 1971, is the world' . first
electronic securities market and the fastest growing stock market in the U.S.
NASDAQ utilizes today's information technologies -computer and
telecommunications- to unite its participants in a screen-based, floorless
market. It enables market participants to compete with each other for investor
orders in each NASDAQ security and surveillance of thousands of securities. This
competitive marketplace, along with the many products and services available to
issuers and their shareholders, attracts today's largest and fastest growing
companies to NASDAQ. These include industry leaders in computers,
pharmaceutical, telecommunications, biotechnology, and financial services. More
domestic and foreign companies list on NASDAQ than on all other U.S. stock
markets combined. 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
- ------------- ------- -------
March 31, 1997 4.63 1.50
June 30, 1997 3.37 .75
September 30, 1997 1.44 .97
December 31, 1997 3.19 1.03
March 31, 1998 2.50 1.59
June 30, 1998 3.00 1.38
September 30, 1998 1.75 .38
December 31, 1998 3.13 .28
March 31, 1999 6.47 2.50
On March 26, 1999, the Company had approximately 5000 shareholders of
record, with much of the stock being held in street name. The Company is
currently listed on NASDAQ Small Cap. In May 1997 the Company reverse split its
common stock 1 for 25. The figures shown are split adjusted.
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.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN
OF OPERATIONS
OVERVIEW
Synergy Brands Inc. ("Synergy")through its subsidiaries (collectively the
"Company") markets national brand name consumer products to numerous US
retailers and wholesalers as well as developing and selling proprietary brand
consumer products to and through on line channels.
In late 1998 the Company expanded its product marketing efforts and
potential by establishing an array of internet sites linked to and available
through multiple search engines to afford access to purchase of its products
directly by the consumer. With the addition of internet access many of the
Company's offered products are now available for retail purchase as well as the
traditional wholesale distribution historically offered by the Company. Internet
sales presently include health and beauty aid salon products and cigar products
previously and traditionally offered by the Company through alternative
marketing channels as well as an array of more recently added consumer products
including fragrances and cosmetics and skin care products. These additional
products are offered or sale by the Company through its internet sales network
as well as the Company's historical wholesale distribution channels.
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Such businesses of Synergy are segmented, managed and conducted through
corporate subsidiaries whose stock is wholly or majority owned by Synergy , and
the results of whose businesses are consolidated for reporting purposes with the
financial statements of Synergy . The Company operates its core grocery and HBA
product sale and distribution business though three subsidiaries New Era Foods
Inc., Synergy Brands Distribution Inc., and Island Wholesale Groceries Inc. The
Company's other current subsidiaries include Net Cigar.Com Inc., (cigar
products), PHS Group Inc. (salon quality hair and skin care products), SYBR.Com
Inc. (internet sales), and Premium Cigar Wrappers Inc. (procurement and sale of
raw tobacco for cigar production).
RESULTS OF OPERATIONS
The following table sets forth selected operational data of the Company,
expressed as a percentage of revenues for the periods indicated below:
Years Ended December 31,
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of Sales (89.3) (87.9) (106.2) (77.8) (88.6)
Operating Expenses (10.6) (8.1) (12.6) (17.2) (10.0)
Other Income (expense) (3.7) (1.6) (2.7) 0.5 1.4
---- ---- ---- ---- ----
Income(loss)from
Operations Before
Income Tax (3.6) 2.4 (21.5) 5.5 2.8
Income Tax
(Expense)Benefit 1.2 (0.8) (0.3) -- (.1)
Discontinued Operations -- (0.3) (129.9) (2.4) 0
Extraordinary Item 0.6 -- -- -- --
---- ---- ---- ---- -----
Net Income(Loss) (1.8)% 1.3% (151.7)% 3.1% 2.7%
Year Ended December 31, 1998
Compared to Year Ended December 31, 1997
Revenues increased by 120.7% to $11.01 million as compared to the prior
year. The Company attributes the increase to a significant increase in the
grocery and health and beauty aid (HBA) businesses; as a result of increased
business with Proctor & Gamble in particular.
Net income applicable to common stock increased from a loss of
$(50,090)(-.03 per share) to a profit of $297,508 ($.06 per share). The
Company's profit is attributable to the following factors:
(a) a significant reduction in financing costs.
(b) a significant increase in revenues
(c) elimination of losses in connection with discontinued
operations.
The Company's income was reduced by a one time charge in connection with
rebate adjustments in the amount of $220,000 and other charges totaling
$199,000.
In 1999 the Company is developing E-commece sites for the purpose of
expanding its distribution to the consumer market through on-line channels. The
Company will devote a significant amount of resources and may require additional
capital to achieve its goals.
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Year Ended December 31, 1997
Compared to Year Ended December 31, 1996
Revenues from continued operations decreased for the year ended December
31, 1997 to $5.4 million, a (27%) decrease as compared to the prior period. The
decrease in revenues is related to discontinuing IFD's business and operations
and the recognition of commission income as opposed to direct sales. The
Company's sales increased materially in the second half of 1997. The Company was
able to re-establish direct vendor contacts, especially with its largest vendor,
Proctor & Gamble thereby reducing overall product cost. The Company believes
that in 1998 sales growth should substantially exceed 1996 and 1997 levels.
Net income from continuing operations increased to $299,682 ($.05 per
share) compared to a loss of $1.6 million ($5.5 per share). The Company
attributes its profitability to:
a) Closing its kosher business (IFD).
b) signing a Distributorship Agreement with its Chinese trading
partner to re-enter the promotional grocery business. This
Agreement allowed the Company to reestablish vendor contacts
and obtain financing for product purchases for re-sale to its
customers in the promotional grocery and health & beauty aid
(HBA) business.
c) increasing commission sales of squid manufactured by ALT at
higher margins.
d) streamlining its corporate overhead by establishing profit
centers in each business segment with separate operating
budgets.
e) outsourcing all primary services relating sales, freight,
warehousing and management information systems.
f) significant utilization of the internet for sales, marketing
and corporate exposure.
One time charges from discontinued operations totaled $130,632 ($.08 per
share) as compared to $9.6 million ($29 per share). As a result net loss
applicable to common stock totaled $ 50,950 ($.03 per share) as compared to a
loss of $11.4 million ($34.5 per share). The Company does not expect its future
expenses from discontinued operations to be material to its future business.
Liquidity and Capital Resources
The Company's working capital increased to $2 million at December 31, 1998.
Reaching this level of working capital is a significant milestone for the
Company. The Company raised enough capital and turned its operations to
profitability which significantly enhanced the liquidity of the Company. As a
result the Company has secured vendor credits and secured financing to grow its
operating business. The Company believes that it has sufficient working capital
to fund its continuing operations but requires additional financing to expand.
The Company plans on expanding its core grocery, HBA and squid businesses
through its distribution agreement and on-line channels. However, the Company
believes it will need additional financing in the form of subordinated debt or
equity to finance its expansion plans. See "Forward-Looking Information and
Cautionary Statements."
The Company has streamlined its financing requirements by repaying its
revolving secured debt and established secured term financing. The Company
currently borrows $1.6 million at a 12% fixed rate. The current maturities of
the term loans extend from August 1999 to October 2000. The Company plans to
increase its maturities to 2001 and reduce the interest rate on its term loans.
However, there can be no assurances that either can be achieved.
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The Company's internet budget is significant for 1999. The Company plans to
incur a significant amount of expense in developing marketing and advertising
its websites both on the internet and traditional media outlets. As a result the
Company plans on raising additional capital to support its anticipated
expenditures. Failure to raise additional capital to support the internet
business may adversely effect the Company's overall business.
Management is not aware of negative trends in the Company's area of
business or other economic factors which may cause a significant change in the
Company's viability or financial stability, except as specified herein and in
"Forward-Looking Information and Cautionary Statements." Management has no plans
to alter the nature of its business.
Subject to available financing, the Company intends to further expand its
continuing business through its distribution agreement by merchandising well
accepted readily marketable promotional brand-name grocery products, frozen
squid and handmade premium cigars. However, there can be no assurance that the
Company's proposed expansion plans will be successful.
SEASONALITY
Seasonality affects the demand for certain products sold by the Company,
such as juice drinks in the summer months or hot cereals in fall and winter
months. However, all these products are available to the Company throughout the
year. Manufacturers also tend to promote more heavily towards the close of the
fiscal quarters and during the spring and early summer months. Accordingly, the
Company is able to purchase more products, increase sales during these periods
and reduce its product cost due to these promotions. The Company generally
experiences lower sales volume in the fourth quarter due to the reduced number
of selling days resulting from the concentration of holidays in the quarter.
Sale of frozen squid is more significant in the third and fourth quarters due to
the seasonal catch which occurs in the second quarter.
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INFLATION
The Company believes that inflation, under certain circumstances, could be
beneficial to the Company's business. 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.
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. Factors that could cause or
contribute to such differences include, but are not limited to, the following:
1. INTERNET
The internet environment is new to business and is subject to inherent
risks as in any new developing business including rapidly developing technology
with which to attempt to keep pace and level of acceptance and level of consumer
knowledge regarding its use.
2. CASH FLOW.
The Company has experienced cash shortages which continue to adversely
affect its business. See "Liquidity and Capital Resources". The Company requires
additional working capital in order to maintain and expand its business.
3. DEPENDENCE ON PUBLIC TRENDS.
The Company's business is subject to the effects of changing customer
preferences and the economy, both of which are difficult to predict and over
which the Company has no control. A change in either consumer preferences or a
down-turn in the economy may affect the Company's business prospects.
4. POTENTIAL PRODUCT LIABILITY.
As a participant in the distribution chain between the manufacturer and
consumer, the Company would likely be named as a defendant in any product
liability action brought by a consumer. To date, no claims have been asserted
against the Company for products liability; there can be no assurance, however,
that such claims will not arise in the future. Currently, the Company does not
carry product liability insurance. In the event that any products liability
claim is not fully funded by insurance, and if the Company is unable to recover
damages from the manufacturer or supplier of the product that caused such
injury, the Company may be required to pay some or all of such claim from its
own funds. Any such payment could have a material adverse impact on the Company.
5. RELIANCE ON COMMON CARRIERS.
The Company does not utilize its own trucks in its business and is
dependent, for shipping of product purchases, on common carriers in the trucking
industry. Although the Company uses several hundred common carriers, the
trucking industry is subject to strikes from time to time, which could have
material adverse effect on the Company's operations if alternative modes of
shipping are not then available. Additionally the trucking industry is
susceptible to various natural disasters which can close transportation lanes in
any given region of the country. To the extent common carriers are prevented
from or delayed in utilizing local transportation lanes, the Company will likely
incur higher freight costs due to the limited availability of trucks during any
such period that transportation lanes are restricted.
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6. COMPETITION.
The Company is subject to competition in its promotional grocery, squid,
and premium handmade cigars businesses. While these industries may be highly
fragmented, with no one distributor dominating the industry, the Company is
subject to competitive pressures from other distributors based on price and
service and product quality and origin.
7. TRADE RELATIONS WITH CHINA.
The Company is dependent on trade with the People's Republic of China
(PRC). The Company's financing arrangements and distribution contracts with ALT
involve a Chinese trading company and squid, which is directly supplied through
the PRC. Any government sanctions that cause an interruption of trade or
prohibit trade with PRC through higher duties or quotas could have a material
adverse effect on the Company's business. China currently maintains a Most
Favored Nation status with the United States, which it has maintained
continuously since 1980, renewal of which is done on an annual basis each May,
Loss of such status could have a material adverse affect on Company business.
8. 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 will not materially affect the
financial position, results of operations or cash flows of the Company, but
there can be no assurance as to this.
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9. POSSIBLE LOSS OF NASDAQ SMALL CAP LISTING.
Synergy currently qualifies for trading on the Nasdaq Small Cap system.
Nasdaq has adopted, and the Commission has approved, certain changes to its
maintenance requirements which became effective as of February 28, 1998,
including the requirement that a stock listed in such market have a bid price
greater than or equal to $1.00. The bid price per share for the Common Stock of
Synergy has been below $1.00 in the past and the Common Stock has remained on
the Nasdaq Small Cap System because Synergy has complied with the alternative
criteria which are now eliminated under the new rules. If the bid price
continues below $1.00 per share, the Common Stock could be delisted from the
Nasdaq Small Cap System and thereafter trading would be reported in the NASD's
OTC Bulletin Board or in the "pink sheets." In the event of delisting from the
Nasdaq Small Cap System, the Common Stock would become subject to rules adopted
by the Commission regulating broker-dealer practices in connection with
transactions in "penny stocks." The disclosure rules applicable to penny stocks
require a broker-dealer, prior to a transaction in a penny stock not otherwise
exempt from the rules, to deliver a standardized list disclosure document
prepared by the Commission that provides information about penny stocks and the
nature and level of risks in the penny stock market. In addition, the
broker-dealer must identify its role, if any, as a market maker in the
particular stock, provide information with respect to market prices of the
Common Stock and the amount of compensation that the broker-dealer will earn in
the proposed transaction. The broker-dealer must also provide the customer with
certain other information and must make a special written determination that the
penny stock is a suitable investment for the purchaser and receive the
purchaser's written agreement to the transaction. Further, the rules require
that following the proposed transaction the broker-dealer provide the customer
with monthly account statements containing market information about the prices
of the securities. These disclosure requirements may have the effect of reducing
the level of trading activity in the secondary market for a stock that becomes
subject to the penny stock rules. If the Common Stock became subject to the
penny stock rules, many broker-dealers may be unwilling to engage in
transactions in the Company's securities because of the added disclosure
requirements, thereby making it more difficult for purchasers of the Common
Stock in this offering to dispose of their shares of the Common Stock.
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10. RISKS OF BUSINESS DEVELOPMENT.
The Company has ventured into new lines of product and product distribution
(see "Item I C 4 (Cigars) (1997) and C5 (Squid) (1996)" and B1 (salon HBA
products (1999) and internet sales-see B (Internet Sales) (1998) and such
product and product distribution lines are expected to constitute a material
part of the Company's revenue stream. The Company has not restored its level of
product sales to that of previous years but with the addition of these new
product and product distribution lines the Company is hopeful of reaching and
hopefully exceeding those prior levels. Because of the newness of these lines of
products to the Company, the Company's operations in these areas should be
considered subject to all of the risks inherent in a new business enterprise,
including the absence of a profitable operating history and the expense of new
product development. Various problems, expenses, complications and delays may be
encountered in connection with the development of the Company's new products.
These expenses must either be paid out of the proceeds of future offerings or
out of generated revenues and Company profits. There can be no assurance as to
the availability of funds from either of these sources.
11. 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. The Company will have to develop
and implement an appropriate marketing strategy for each of its products. There
can be no assurance that the Company will successfully complete the development
of future products or that the Company's current or future products will achieve
market acceptance levels conducive to the Company's fiscal needs. Any delay or
failure of these products to achieve market acceptance 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.
The Company's revenue base has been slowly recovering from losses of 1996
generating from the discontinuation of its Kosher Food business. In order for
the Company to increase grocery sales, it must reestablish it's relationships
with the major grocery manufactures. The Company is vigorously attempting to
reestablish these ties to prior customers as well as develop new ones. Failure
to re-establish these ties would have an adverse effect on the Company.
Furthermore, the Company has entered new markets which include squid, premium
handmade cigars and salon quality HBA products for sale to its existing
customers and newly found sources. These product lines have lower sales volume
than the Company's traditional business, but higher margins and greater
advertising and promotional expenses. The Company believes that developing
proprietary products is in the best interest of the Company's expansion. The
existence of and relationship with the Company's Chinese Trading Partner and use
of new internet sales and marketing avenues has and will significantly decrease
the Company's cost of goods sold. Failure to secure market penetration in the
new product lines would however have an adverse effect on the Company's
profitability. Management believes actions presently being taken to revise the
Company's operating and financial requirements should 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.
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12. DEPENDENCE UPON ATTRACTING AND HOLDING.
The Company's future success depends in large part on the continued service
of its key technical, marketing, sales and management personnel and on its
ability to continue to attract, motivate and retain highly qualified employees.
Although the Company's key employees have stock options, its key employees may
voluntarily terminate their employment with the Company at any time. Competition
for such employees is intense and the process of locating technical and
management personnel with the combination of skills and attributes required to
execute the Company's strategy is often lengthy. Accordingly, the loss of the
services of key personnel could have a material adverse effect upon the
Company's operating efforts and on its research and development efforts. The
Company does not have key person life insurance covering its management
personnel or other key employees.
13. 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 recent increase in
popularity of cigars could 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. Future enactment of such proposals or similar bills
may have an adverse effect on the results of operations or financial condition
of the Company.
In addition, 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. Further restrictions of a similar nature could have an adverse
effect on the Company's sales or operations, such as banning counter access to
or display of premium handmade cigars, or decisions by retailers because of
public pressure to stop selling all tobacco products. Numerous proposals also
have been considered at the state and local level restricting smoking in certain
public areas, regulating point of sale placement and promotions and requiring
warning labels.
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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 the 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).
14. RISKS RELATING TO MARKETING OF CIGARS.
The Company primarily will distribute premium handmade cigars which are
hand-rolled and use tobacco aged over one year. The Company believes that there
is an abundant supply of tobacco available through its supplier in the Dominican
Republic for the types of premium handmade cigars the Company primarily will
sell. However, there can be no assurance that increases in demand would not
adversely affect the Company's ability to acquire higher priced premium handmade
cigars.
While the cigar industry has experienced increasing demand for cigars
during the last several years, there can be no assurance that the trend will
continue. If the industry does not continue as the Company anticipates or if the
Company experiences a reduction in demand for whatever reason, the Company's
supplier may temporarily accumulate excess inventory which could have an adverse
effect on the Company's business or results of operations.
15. SOCIAL, POLITICAL, AND ECONOMIC RISKS ASSOCIATED WITH
FOREIGN TRADE MAY ADVERSELY IMPACT BUSINESS.
The Company purchases all of its premium handmade cigars from manufacturers
located in countries outside the United States. In addition, the Company
acquires squid through the People's Republic of China ("PRC"). Social and
economic conditions inherent in foreign operations and international trade may
change, including changes in the laws and policies that govern foreign
investment and international trade. To a lesser extent social, political and
economic conditions may cause changes in United States laws and regulations
relating to foreign investment and trade. Social, political or economic changes
could, among other things, interrupt cigar supply or cause significant increases
in cigar prices. In particular, political or labor unrest in the Dominican
Republic could interrupt the production of premium handmade cigars, which would
inhibit the Company from buying inventory. Any government sanctions that cause
an interruption of trade or prohibit trade with the PRC through higher duties or
quotas could have a material adverse effect on the Company's business.
Accordingly, there can be no assurance that changes in social, political or
economic conditions will not have a material adverse affect on the Company's
business.
-25-
<PAGE>
16. SEASONALITY.
Seasonality affects the demand for certain products sold by the Company,
such as juice drinks in the summer months or hot cereals in fall and winter
months, cosmetics and fragrances during certain holidays, and cigar products
sale in coordination with sporting events. However, all these products are
available to the Company throughout the year. Manufacturers also tend to promote
more heavily towards the close of the fiscal quarters and during the spring and
early summer months. Accordingly, the Company is able during these periods to
purchase more products, increase sales during these periods and reduce its
product cost due to these promotions. The Company generally experiences lower
sales volume in the fourth quarter due to the reduced number of selling days
resulting from the concentration of holidays in the quarter. Sale of frozen
squid is more significant in the third and fourth quarters due to the seasonal
catch which occurs in the second quarter.
17. 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.
PART III
The information required by items 10-13 are omitted pursuant to general
instruction G(3) to form 10K. The Company has included this information in its
proxy statement to be mailed and filed with the Commission on or before April
30, 1999. The annual meeting is scheduled to be in June 1999. Such Proxy
Statement expected to be filed with the Commission by April 30, 1999 is
incorporated herein by reference.
PART IV
ITEM 8. FINANCING STATEMENTS AND SUPPLEMENTARY DATA
1. FINANCIAL STATEMENTS
The following financial statements of the Company are contained in Item 8
of this Report on the pages indicated:
Page
----
Independent Auditors Reports F1
Balance Sheet -
December 31, 1998 F2
Statements of Operations -
Years ended December 31, 1998 and 1997 F3 - F4
Statements of Changes in Stockholders'
Equity - Years ended December 31, 1998 and 1997 F5 - F6
Statements of Cash Flows - Years
ended December 31, 1998 and 1997 F7 - F8
Notes to Financial Statements as of
December 31, 1998 F9- F18
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
ITEM 14. EXHIBITS, FINANCING STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
1. (a) Exhibits:
See Index to Exhibits
2. Reports on Form 8-K
There were no reports on Form 8-K filed during the fourth quarter of
1998.
3. Financial Statement Schedules
none
-26-
<PAGE>
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
Executive Vice President
Dated: , 1999
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
Executive Vice President
Principal Financial Officer
and Director
Signed: , 1999
by /s/ Mitchell Gerstein
----------------------------------
Mitchell Gerstein, Director
Signed: , 1999
-27-
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
Synergy Brands, Inc.
We have audited the accompanying consolidated balance sheet of Synergy
Brands, Inc. (formerly Krantor Corporation) and Subsidiaries (the Company) as of
December 31, 1998, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for the years ended December 31,
1998 and 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe 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. and Subsidiaries as of December 31, 1998, and the results of its
operations and its cash flows for the years ended December 31, 1998 and 1997, in
conformity with generally accepted accounting principles.
BELEW AVERITT LLP
Dallas, Texas
March 20, 1999
F-1
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
December 31, 1998
ASSETS
<TABLE>
<CAPTION>
<S> <C>
CURRENT ASSETS
Cashand cash equivalents $ 325,699
Accounts receivable (Note 5) 3,020,010
Inventory (Notes 4 and 5) 1,374,808
Other current assets 53,650
-------------
Total current assets 4,774,167
COLLATERAL SECURITY DEPOSIT (Note 10) 1,802,995
PROPERTY AND EQUIPMENT, net (Note 3) 120,059
OTHER ASSETS 56,891
-------------
$ 6,754,112
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt (Note 5) $ 1,475,000
Accounts payable and accrued expenses (Note 6) 1,240,079
Income taxes payable (Note 9) 12,794
-------------
Total current liabilities 2,727,873
VENDOR DEBT DUE AFTER ONE YEAR (Note 6) 128,384
LONG-TERM DEBT (Note 5) 400,000
COMMITMENTS AND CONTINGENCIES (Note 10) -
PREFERRED STOCK OF SUBSIDIARY (Note 7) 135,625
STOCKHOLDERS' EQUITY (Note 8)
Class A preferred stock - $.001 par value; 100,000 shares authorized 100
Common stock - $.001 par value; 29,900,000 shares authorized 6,327
Additional paid-in capital 15,724,196
Deficit (12,200,893)
-------------
3,529,730
Less treasury stock, at cost, 1,400 shares (167,500)
-------------
Total stockholders' equity 3,362,230
-------------
$ 6,754,112
=============
</TABLE>
See accompanying notes to consolidated financial statements
F-2
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
------------- ------------
REVENUE
Net sales (Note 11) $ 11,055,549 $ 5,007,336
Commission income (Note 10) - 382,025
------------- ------------
11,055,549 5,389,361
COST OF SALES 9,793,590 4,195,519
------------- ------------
GROSS PROFIT 1,261,959 1,193,842
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,073,550 907,386
DEPRECIATION AND AMORTIZATION 29,867 16,915
------------- ------------
OPERATING INCOME 158,542 269,541
OTHER INCOME (EXPENSE)
Interest income 95,775 134,875
Debt forgiveness income (Note 5) 150,409 -
Net loss on marketable securities - (37,625)
Miscellaneous expense (1,062) (48,505)
Interest expense (68,371) (12,479)
Dividends on preferred stock of subsidiary (Note 7) (24,500) (6,125)
------------- ------------
152,251 30,141
------------- ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 310,793 299,682
INCOME TAX EXPENSE (Note 9) (13,285) -
------------- ------------
INCOME FROM CONTINUING OPERATIONS 297,508 299,682
DISCONTINUED OPERATIONS (Note 12)
Loss on disposal of IFD, net of applicable
income tax benefit of $0 - (130,632)
------------- ------------
NET INCOME 297,508 169,050
</TABLE>
F-3
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Cont.)
Years ended December 31, 1998 and 1997
1998 1997
------------- ------------
LESS PREFERRED DIVIDENDS $ - $ 220,000
------------- ------------
INCOME (LOSS) APPLICABLE TO COMMON STOCK $ 297,508 $ (50,950)
============= ============
BASIC EARNINGS (LOSS) PER COMMON
SHARE (Note 14)
Income from continuing operations $ .06 $ .05
Discontinued operations - (.08)
------------- ------------
NET INCOME (LOSS) PER COMMON SHARE $ .06 $ (.03)
============= ============
DILUTED EARNINGS (LOSS) PER COMMON SHARE $ .05 $ .03)
============= ============
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Class A
Preferred Stock Common Stock Additional Total
---------------- ------------- paid-in Treasury stockholders'
Shares Amount Shares Amount capital Deficit stock equity
------ ------ ------ ------ --------- ------- --------- -------------
Balance at
December 31, 1996 100,000 $ 100 847,035 $ 847 $ 12,426,869 $(12,667,451) $(167,500) $ (407,135)
Common stock issued
in connection with
Regulation S offering,
less related expenses - - 1,612,200 1,612 1,330,168 - - 1,331,780
Redemption of
preferred stock (100,000) (100) 400,000 400 (130,300) - - (130,000)
Issuance of preferred
stock 100,000 100 - - - - - 100
Dividends on preferred
stock - - - - (220,000) - - (220,000)
Common stock
options exercised - - 275,000 275 442,225 - - 442,500
</TABLE>
F-5
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity (Cont.)
Years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Class A
Preferred Stock Common Stock Additional Total
---------------- ------------ paid-in Treasury stockholders'
Shares Amount Shares Amount capital Deficit stock equity
------ ------ ------ ------ ------- -------- --------- ------------
Common stock issued
in connection with
compensation plan - $ - 1,006,280 $1,006 $ 762,179 $ - $ - $ 763,185
Net income - - - - - 169,050 - 169,050
--------- -------- --------- ------- ----------- ------------ ----------- ----------
Balance at
December 31, 1997 100,000 100 4,140,515 4,140 14,611,141 (12,498,401) (167,500) 1,949,480
Issuance of common
stock - - 1,240,051 1,240 523,300 - - 524,540
Common stock issued
in connection with
compensation plan - - 946,520 947 589,755 - - 590,702
Net income - - - - - 297,508 - 297,508
--------- -------- --------- ------- ----------- ------------ ----------- ----------
Balance at
December 31, 1998 100,000 $100 6,327,086 $6,327 $15,724,196 $(12,200,893) $(167,500) $3,362,230
========= ======== ========= ======= =========== ============ =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 297,508 169,050
Loss from discontinued operations - 130,632
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 29,867 16,915
Loss on disposal of property and equipment 4,000 14,496
Net loss from marketable securities - 37,625
Dividends on preferred stock of subsidiary 24,500 6,125
Operating expenses paid with common stock 456,065 798,074
Debt forgiveness income (150,409) -
Changes in operating assets and liabilities:
Purchases of marketable securities - (73,687)
Sales of marketable securities - 36,062
(Increase) decrease in:
Accounts receivable (1,892,010) (933,160)
Inventory (1,374,808) -
Promotional rebates 270,496 (47,524)
Other current assets 82,539 22,789
Other assets (56,891) 85,812
Increase (decrease) in:
Accounts payable and accrued expenses 429,475 (34,180)
Income taxes payable 2,265 (60,629)
------- -------
Net cash flows provided by (used in) operating activities
of continued operations (1,877,403) 168,400
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (36,524) (118,202)
Payment of collateral security deposit - (75,000)
Refund of collateral security deposit 450,000 -
------- -------
Net cash flows provided by (used in) investing activities
of continued operations 413,476 (193,202)
</TABLE>
F-7
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Cont.)
Years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
--------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from debt issuance $ 1,600,000 $ -
Cash dividends on preferred stock - (220,000)
Payment for redemption of preferred stock - (130,000)
Proceeds from issuance of common stock and
preferred stock - 829,880
Proceeds from issuance of preferred stock of subsidiary - 105,000
--------------- -----------
Net cash flows provided by financing activities of
continued operations 1,600,000 584,880
CASH USED IN DISCONTINUED OPERATIONS - (373,349)
--------------- -----------
NET INCREASE IN CASH 136,073 186,729
CASH, beginning of year 189,626 2,897
--------------- -----------
CASH, end of year $ 325,699 $ 189,626
=============== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Interest paid $ 61,523 $ 37,100
=============== ===========
Income taxes paid $ 11,021 $ 60,629
=============== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
OPERATING, INVESTING AND FINANCING
ACTIVITIES
Conversion of subordinated debentures $ - $ 377,000
Non-cash issuance of common stock 659,177 532,611
Promotional rebates used to pay vendor debt - 260,557
--------------- -----------
Total non-cash operating, investing and
financing activities $ 659,177 $1,170,168
=============== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
<PAGE>
SYNERGY BRANDS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Synergy Brands, Inc. (formerly Krantor Corporation) (Synergy) is a
distributor of groceries, general household merchandise and health and beauty
aids in the promotional wholesale industry. In addition, Synergy also
distributes squid and premium handmade cigars throughout the United States.
In April 1994, Synergy formed a wholly-owned subsidiary, Island Wholesale
Grocers, Inc., which is a full-service wholesale delivery company capable of
providing direct store inventory deliveries within hours of receiving an order,
principally in the northeastern United States.
In December 1995, Synergy formed a wholly-owned subsidiary, Affiliated
Island Grocers, Inc., which did business under the name Island Frozen and Dairy
(IFD). IFD distributed specialty food, poultry and dairy products throughout the
northeastern United States. In June 1996, Synergy discontinued all operations of
IFD, and presented them as such in the consolidated financial statements (see
Note 12).
In September 1996, Synergy formed a wholly-owned subsidiary, New Era Foods,
Inc. (NEF), which is a company representing manufacturers, retailers and
wholesalers in connection with distribution of frozen seafood, grocery and
general merchandise products (see Note 10).
In October 1997, NEF formed a subsidiary, Premium Cigar Wrappers, Inc.
(PCW), for the purpose of producing premium cigar wrappers in the Dominican
Republic. NEF owns 66% of the common stock and approximately 22% of the
preferred stock of PCW (see Note 7).
In October 1998, NEF formed a wholly-owned subsidiary, PHS Group, Inc.
(PHS), which is a wholesale distributor of premium beauty salon products.
Principles of consolidation
The consolidated financial statements include the accounts of Synergy, its
wholly-owned subsidiaries and its majority-owned subsidiary (collectively, the
Company). All significant intercompany accounts and transactions have been
eliminated in consolidation.
Revenue recognition
The Company recognizes revenue at the time merchandise is shipped to the
customer. The Company returns merchandise to the supplier that is damaged or has
the wrong specifications. The cost is recovered from the trucking company or the
supplier, depending upon the nature of the return.
Cash equivalents
The Company considers time deposits with original maturities of three
months or less to be components of cash.
Marketable securities
Management determines the appropriate classification of its investments in
debt and equity securities at the time of purchase and re-evaluates such
determination at each balance sheet date. No securities were outstanding at
December 31, 1998.
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. All tobacco
inventory is included in current assets in conformity with standard industry
practice, not withstanding the fact that significant quantities of inventory may
be carried for several years for purposes of the curing process.
<PAGE>
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of accounts receivable. The
concentration of credit risk with respect to receivables is mitigated by the
credit worthiness of the Company's major customers. The Company maintains an
allowance for losses based upon the expected collectibility of all receivables.
Fair value approximates carrying value for all financial instruments.
During 1998 and 1997, the Company distributed its products through an
unrelated intermediary and hence, all revenues were derived from this
organization. As a result, the Company has an inherent business risk in
concentrating its sales through this entity.
Property and equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is computed using the straight-line method over the estimated useful
lives of the assets, ranging from 3 to 5 years.
Maintenance and repairs of a routine nature are charged to operations as
incurred. Betterments and major renewals which substantially extend the useful
life of an existing asset are capitalized and depreciated over the asset's
estimated useful life. Upon retirement or sale of an asset, the cost of the
asset and the related accumulated depreciation or amortization are removed from
the accounts and any resulting gain or loss is credited or charged to income.
Preferred stock of subsidiary
Changes in preferred stock of the subsidiary are accounted for as equity
transactions and thus no gain or loss is recognized. Upon each new issuance of
the subsidiary's preferred stock, the Company will evaluate whether or not its
investment has been impaired and adjust accordingly.
Advertising
The Company expenses advertising and promotional costs as incurred.
Advertising expense was approximately $46,500 and $63,000 for the years ended
December 31, 1998 and 1997, respectively.
Income taxes
The Company uses the asset and liability method of computing deferred
income taxes. In the event differences between the financial reporting bases and
the tax bases of an enterprise's assets and liabilities result in deferred tax
assets, an evaluation of the probability of being able to realize the future
benefits indicated by such assets is required. A valuation allowance is provided
for a portion or all of the deferred tax assets when it is more likely than not
that such portion, or all of such deferred tax assets, will not be realized.
Earnings per share
The Company calculates earnings per share pursuant to Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128).
SFAS 128 requires dual presentation of basic and diluted earnings per share
(EPS) on the face of the statement of income for all entities with complex
capital structures, and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. Basic EPS calculations are based on the
weighted-average number of common shares outstanding during the period, while
diluted EPS calculations are based on the weighted-average of common shares and
dilutive common share equivalents outstanding during each period.
Management estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses
during the reporting period. Actual results could differ from management's
estimates.
Stock-based compensation plans
Statement of Financial Accounting Standards No. 123, 'Accounting for
Stock-Based Compensation" (SFAS 123), encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has elected to continue to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25) and related interpretations. Accordingly, compensation cost
for stock options is measured as the excess, if any, of the fair market value of
the Company's stock at the date of the grant over the amount the employees or
non-employees must pay to acquire the stock.
<PAGE>
2. MARKETABLE SECURITIES
Realized gains or losses on marketable securities are determined on the
specific identification method. Net realized losses on sales of securities
included in the determination of consolidated net loss amounted to $37,625 in
1997. No marketable securities were owned during 1998.
3. PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 1998 consisted of the following:
<TABLE>
<CAPTION>
<S> <C>
Office equipment $ 35,226
Machinery and equipment 48,825
Leasehold improvements 62,675
----------
146,726
Less accumulated depreciation and amortization 26,667
----------
$ 120,059
==========
4. INVENTORY
Inventory as of December 31, 1998 consisted of the following:
Salon finished goods $ 830,410
Tobacco raw materials 544,398
----------
$1,374,808
==========
5. LONG-TERM DEBT
Long-term debt at December 31, 1998 consisted of the following:
Settlement on revolving line-of-credit $ 200,000
Note payable to financial company due August 1999,
bearing interest at 12%; collateralized by inventory of NEF 1,000,000
Secured debentures; bearing interest at 12% payable
monthly; $200,000 principal due October 1999 and
remainder maturing October 2000; collateralized by
inventory and accounts receivable of PHS 600,000
Note payable to bank due July 5, 1996; non-interest
bearing; previously collateralized by inventory of IFD 75,000
----------
1,875,000
Less current portion 1,475,000
----------
$ 400,000
==========
</TABLE>
F-12
<PAGE>
Scheduled future maturities of long-term debt at December 31, 1998 were as
follows:
Year ending
December 31,
-------------
1999 $ 1,475,000
2000 400,000
----------------
$ 1,875,000
================
The Company financed its receivables in prior years through a revolving
line-of-credit facility with a commercial lender. In February 1999, the Company
entered into a settlement agreement with the lender for $200,000 to settle its
outstanding obligation. The settlement has been reflected in the 1998 financial
statements in debt forgiveness income.
In accordance with the terms of the secured debenture agreements, the
Company issued 300,000 shares of restricted common stock to the debenture
holders. The debentures contain provisions whereby the Company may be required
to issue additional shares of restricted common stock to the debenture holders
if the stock price is below a stated threshold at maturity date of the
debentures.
6. VENDOR DEBT
In 1997, the Company entered into an agreement with a vendor to repay its
accounts payable balance of $1,465,976. During 1998, the Company issued 350,000
shares of common stock to the vendor, and agreed to make monthly payments of
$22,222 from May 1998 through April 2000. No interest is being charged by the
vendor. In the event the vendor sells the Company's common stock at a price
different than the market price at the date of issuance, the Company's account
will be charged or credited with the differential.
The following are the scheduled maturities of vendor debt at December 31,
1998:
Year ending
December 31,
------------
1999 $ 266,664
2000 128,384
----------------
$ 395,048
================
7. MINORITY INTEREST
PCW was incorporated in October 1997 with 7,750 shares of authorized $.001
par value common stock. At December 31, 1998, PCW had 1,000 shares of common
stock outstanding which were issued at par value. The Company owns 66% of the
common stock and an unrelated individual owns the minority interest. For
financial reporting purposes, the assets, liabilities, results of operations and
cash flows for PCW are included in the Company's consolidated financial
statements and the outside investor's interest in PCW is reflected in the
preferred stock of subsidiary.
F-13
<PAGE>
PCW had 2,250 shares of authorized $.001 par value preferred stock issued
and outstanding at December 31, 1998. PCW issued 1,750 shares of preferred stock
at inception to two unrelated individuals at $60 per share, and 500 shares to
the Company for a 22% minority interest in the preferred stock. The holders of
PCW preferred stock are entitled to receive cumulative dividends at the rate of
$14 per share before any dividends on the common stock are paid. Included in
preferred stock of subsidiary is $30,625 of preferred stock dividends payable at
December 31, 1998. The Company's portion of the dividend has been eliminated in
consolidation. In the event of dissolution of PCW, the holders of the preferred
shares are entitled to receive $60 per share together with all accumulated
dividends, before any amounts can be distributed to the common stockholders. The
shares are convertible only at the option of PCW at $120 per share.
8. STOCKHOLDERS' EQUITY
In May 1997, the majority of common stockholders voted to authorize a
1-for-25 reverse split of the Company's $.001 par value common stock. Any
stockholders entitled to fractional shares were paid with cash based upon the
current fair market value of the stock. All references in the accompanying
financial statements to the number of common shares have been restated to
reflect the stock split.
In November 1997, the Company redeemed 100% of the Class A preferred stock
in exchange for $350,000 cash, 400,000 shares of common stock and options to
purchase 500,000 shares of restricted common stock exercisable at $1 per share.
Part of the cash payment was used to settle accrued dividends of $220,000. The
options were to vest if the Company achieved $1,000,000 in pretax income within
five years. During 1998, this restriction was removed and the options were
granted at $.50 per share. The preferred stock was thereafter reissued, at par
value, to an officer of the Company in recognition of services rendered;
however, all dividend privileges and stock redemption rights were stripped from
the stock. The stock retains the 13-to-1 voting privilege.
At December 31, 1998, the Company had outstanding warrants to purchase
112,500 shares of the Company's common stock, at $1.10 per share. The warrants
become exercisable when the shares are registered and expire at various dates
through 2002. At December 31, 1998, 112,500 shares of common stock were reserved
for that purpose.
During 1997, the Company issued 1,612,200 shares in connection with a
Regulation S offering at an average price of $.82 per share, resulting in
$1,331,780 proceeds net of offering expenses, including the conversion of
$377,000 of subordinated debt, and $125,000 of non-cash issuances as described
in the consolidated statement of cash flows.
In 1994, the Company adopted the 1994 Services and Consulting Compensation
Plan (the Plan). Under this Plan, 4,500,000 shares of common stock have been
reserved for issuance. Since the inception of the Plan, the Company has issued
2,289,970 shares for payment of services to employees and professional service
providers such as legal, marketing, promotional and investment consultants. The
Company had oversubscribed the Plan by 1,775,470 shares at December 31, 1998.
Common stock issued in connection with the Plan was valued at the fair value of
the common stock at the date of issuance at an amount equal to the service
provider's invoice amount. Under the Plan, the Company granted options to
selected employees and professional service providers.
F-14
<PAGE>
The following is a summary of such stock option transactions for the years
ended December 31, 1998 and 1997 in accordance with the Plan:
<TABLE>
<CAPTION>
<S> <C> <C>
Weighted
average
Number of exercise
shares price
----------- --------
Outstanding at December 31, 1996 (26,800 exercisable): 26,800 $ 1.38
Granted 275,000 $ 1.61
Terminated (26,800) $ 1.38
Exercised (275,000) $ 1.61
-----------
Outstanding at December 31, 1997 - $ -
Granted 3,985,500 $ .60
-----------
Outstanding at December 31, 1998 (2,210,030 exercisable) 3,985,500 $ .60
===========
Option price $.40-$2.00
===========
Available for grant:
December 31, 1997 3,156,550
===========
December 31, 1998 -
</TABLE>
The Company applies APB 25 in accounting for its stock options.
Compensation cost charged to operations, related to options, was $6,250 in 1998.
Had compensation costs for the stock options been determined based on the fair
value at the grant date consistent with the method of SFAS 123, the Company's
net income and earnings per share would have been reduced to the pro forma
amounts indicated below:
1998 1997
-------- -------
Net income:
As reported $297,508 $169,050
======== ========
Pro forma $160,810 $147,724
======== ========
Net income (loss) per common share:
As reported $ .06 $ (.03)
======== ========
Pro forma $ .03 $ (.04)
======== ========
The weighted-average fair value at date of grant for options granted during
1998 and 1997 was $.034 and $.08 per option, respectively. The fair value of
each option grant is estimated using the Black-Shoales option-pricing model with
the following weighted-average assumptions used:
1998 1997
-------- -------
Dividend yield 0% 0%
Expected volatility 0% 0%
Risk-free rate of return 4.43-5.5% 6.5%
Expected life 1 to 5 years 1 to 4 years
F-15
<PAGE>
The Company has also reserved 100,000 shares for a stock option plan
(Option Plan) for non-employee, independent directors, which entitles each
non-employee, 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 1,200 options outstanding and exercisable and 98,900
available for grant at December 31, 1998 at an option price of $.50 per share.
9. INCOME TAXES
At December 31, 1998, the Company had a net operating loss carryforward of
approximately $9,818,000, which, if not utilized, will begin expiring in 2011.
The components of the deferred tax asset at December 31, 1998 were
approximately as follows:
Net operating loss carryover $ 3,338,000
Deferred compensation 108,400
Capital losses 12,800
Valuation allowance (3,459,200)
---------------
$ -
===============
The provision for income taxes for the years ended December 31, 1998 and
1997 consisted of the following:
1998 1997
--------------- ------------
Federal:
Current $ 6,085 $ -
State and local 7,200 -
--------------- ------------
Total $ 13,285 $ -
=============== ============
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, 1998 and 1997 is as follows:
1998 1997
------ ------
Federal income tax expense at statutory rate 34.0% 34.0%
Increase (decrease) resulting from:
Utilization of net operating loss carryforward (34.0%) (34.0%)
State and local income taxes, net of
Federal benefit 3.2% -
------ ------
3.2% -
====== ======
F-16
<PAGE>
10. COMMITMENTS AND CONTINGENCIES
Lease commitments
The Company leases office space in Wexford, Pennsylvania and Syosset, New
York, under operating leases expiring in August 2000 and April 2001,
respectively. The Company is also leasing a vehicle under an operating lease
expiring in 2003. Future minimum lease payments under non-cancelable operating
leases as of December 31, 1998 were as follows:
Year ending
December 31,
------------
1999 $ 44,070
2000 42,255
2001 18,400
2002 9,600
2003 9,600
--------
$123,925
========
Lease expense for the years ended December 31, 1998 and 1997 was
approximately $54,800 and $30,000, respectively.
Distribution agreements
In 1996, the Company entered into a ten-year agreement with a Chinese
trading company (ALT) to distribute frozen seafood in the United States under a
licensing arrangement. The Company acts as an agent for ALT. During 1997, the
Company marketed ALT's frozen seafood products and earned commissions based on
sales generated by the distribution agreement. Additionally, the Company sells
promotional grocery products to an agent of ALT. ALT provides the funding for
such purchases.
In consideration for ALT providing products and funding to the Company for
sale and distribution, and as security for doing so, the Company was required to
provide $2,052,995 in 1996 and an additional $200,000 in 1997, as collateral
security for performance by the Company under the terms of the agreement. The
Company had $450,000 refunded to it in 1998. The collateral security deposit
bears interest at 5% and is received quarterly.
In December 1997, NEF entered into a 25-year exclusive worldwide
distribution agreement with a Dominican Republic corporation (DR) for the sale
and distribution of premium handmade cigars manufactured in the Dominican
Republic. There is an option to extend the term of the distribution agreement up
to an additional 25 years.
Litigation
The Company is a named defendant in various lawsuits arising from the
liquidation of IFD. The Company has evaluated the potential exposure of an
unfavorable outcome on various lawsuits and has accrued $60,635 at December 31,
1998 for obligations which are considered probable.
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 will not materially affect the
financial position, results of operations or cash flows of the Company.
F-17
<PAGE>
Guarantee
In March 1998, the Company guaranteed a $1,000,000 line-of-credit facility
to a Dominican cigar manufacturer, which is owned by a PCW stockholder. The
purpose of the line-of-credit is to provide financing to the cigar manufacturer
to which PCW will supply cigar wrappers.
11. MAJOR CUSTOMERS
The Company has one customer, the U.S. agent of ALT, which accounted for
100% of total sales for 1998 and 1997. Accounts receivable from this customer
accounted for approximately $2,903,500 (96%) of total trade accounts receivable
at December 31, 1998.
12. DISCONTINUED OPERATIONS
On June 30, 1996, the Company adopted a formal plan to discontinue the
operations of IFD that was completed during 1998. Accordingly, IFD is accounted
for as a discontinued operation in the accompanying 1997 consolidated financial
statements and had no revenues in 1998 or 1997. During 1997, the Company
incurred additional expenses related to the discontinued operations of IFD and
related litigation. The assets and liabilities of IFD included in the
accompanying consolidated balance sheet as of December 31, 1998 consisted of
approximately the following:
Current liabilities of discontinued operations -
Accounts payable and accrued expenses $ 60,635
Long-term debt 275,000
---------------
$ 335,635
===============
13. FOURTH QUARTER ADJUSTMENTS
The Company made a fourth quarter adjustment to correct an overstatement of
promotional rebates of approximately $223,000.
14. EARNINGS PER SHARE
The following data shows the amounts used in computing earnings per share
and the effect on the weighted-average number of shares of dilutive common
stock:
<TABLE>
<CAPTION>
<S> <C> <C>
1998 1997
--------- ------------
Net income applicable to common stockholders $ 297,508 $ (50,950)
========= ============
Weighted-average number of shares in basic EPS 5,101,041 1,630,220
Effect of dilutive securities (stock options and warrants) 523,549 17,320
--------- ----------
Weighted-average number of common shares and
dilutive potential common shares used in diluted EPS 5,624,590 1,647,540
========= ==========
</TABLE>
F-18
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
<S> <C> <C>
Exhibit No. Description Page
- ----------- ----------- ----
3.1 Certificate of Incorporation and amendments thereto (1) EX-1
3.2 By-Laws (2) EX-4
4 Warrants and debentures defining rights of security holders --
(3)
10.1 Distributorship Agreement dated October 1996 between Asia EX-6
Legend Trading Ltd. And New Era Foods Inc., as partially
assigned to Tenda Foods Corp. (4)
10.2 Distributorship Agreement dated December 1997 between Fabrica X-14
De Tobacco Valle Dorado SA and Gran Reserve Corporation as
partially assigned to New Era Foods Inc. (4)
10.3 Synergy Brands Inc. 1994 Services and Consulting Compensation --
Plan, as amended (5)
21 Listing of Company Subsidiaries EX-22
</TABLE>
(1) 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 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, and
(3) Copies of outstanding warrants and debentures are incorporated by
reference to the exhibits filed to the Form 8-K/A of the Company filed
with the Commission (File No. 0-19409) on 2/3/98. Description of rights
of Preferred Stock are included in Certificate of Designation regarding
Preferred Stock, as amended, and included as exhibit to the Form 10K/A
of the Company filed 9/3/98. 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 amendment or report filed for the purpose
of updating such description.
(4) Incorporated by reference to the exhibits to the Form 10K/A of the
Company filed 9/3/98.
(5) Incorporated by reference to the Registration Statement of the Company
on Form S-8 (File No. 333-21623) filed with the Commission on 2/12/97.
List of Subsidiaries
Corporation State of Incorporation
- ----------- ----------------------
New Era Foods Inc. Nevada
Island Wholesale Grocers Inc. New York
Premium Cigar Wrappers Inc. New York
Synergy Brands Distribution Inc. New York
PHS Group Inc. Pennsylvania
SYBR.Com Inc. New York
Net Cigar.Com Inc. New York
EX-22
