UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2004
Commission File No. 1-4436
THE STEPHAN CO.
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(Exact Name of Registrant as Specified in its Charter)
Florida 59-0676812
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1850 West McNab Road, Fort Lauderdale, Florida 33309
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (954) 971-0600
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Securities Registered Pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on Which Registered
------------------- ------------------------------------
Common Stock, $.01 AMERICAN STOCK EXCHANGE
Par Value
Securities Registered Pursuant to Section 12(g) of the Act: None
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 the filing
requirements for at least the past 90 days.
YES |_| NO |X|
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 the 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. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES |_| NO |X|
As of August 31, 2005, the aggregate market value of the Common stock held by
non-affiliates of the Registrant was $14,880,631 based upon the last reported
sale price of $4.45 per share on the American Stock Exchange on such date.
The above amount excludes shares held by all executive officers
and directors of the Registrant
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date:
4,389,805 Shares of Common Stock, $.01 Par Value,
as of August 31, 2005
List hereunder the following documents if incorporated by reference and the part
of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) any annual report to security holders; (2) any proxy or
information statement; and (3) any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933:
NONE
2
THE STEPHAN CO. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
Page
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PART I
Item 1: Business......................................................... 5
Item 2: Properties....................................................... 10
Item 3: Legal Proceedings................................................ 11
Item 4: Submission of Matters to a Vote of Security Holders.............. 12
PART II
Item 5: Market for the Registrant's Common Equity
and Related Stockholder Matters................................. 13
Item 6: Selected Financial Data.......................................... 14
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 15
Item 7A: Quantitative and Qualitative Disclosures about Market Risk....... 23
Item 8: Financial Statements and Supplementary Data...................... 24
Item 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................. 24
Item 9A: Controls and Procedures.......................................... 24
PART III
Item 10: Directors and Executive Officers of the Registrant............... 25
Item 11: Executive Compensation........................................... 27
Item 12: Security Ownership of Certain Beneficial
Owners and Management........................................... 32
Item 13: Certain Relationships and Related Transactions................... 34
Item 14: Principal Accounting Fees and Services........................... 34
PART IV
Item 15: Exhibits, Financial Statement Schedules.......................... 35
Signatures................................................................. 38
3
PART I
Certain statements in this Annual Report on Form 10-K ("Form 10-K") under
"Item 1. Business", "Item 3. Legal Proceedings" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, condition (financial or
otherwise), performance or achievements to be materially different from any
future results, performance, condition or achievements expressed or implied by
such forward-looking statements.
Words such as "projects," "believe," "anticipates," "estimate," "plans,"
"expect," "intends," and similar words and expressions are intended to identify
forward-looking statements and are based on our current expectations,
assumptions, and estimates about us and our industry. In addition, any
statements that refer to expectations, projections or other characterizations of
future events or circumstances are forward-looking statements. Although we
believe that such forward-looking statements are reasonable, we cannot assure
you that such expectations will prove to be correct.
Our actual results could differ materially from those anticipated in such
forward-looking statements as a result of several factors, risks and
uncertainties. These factors, risks and uncertainties include, without
limitation, the results of the audit and review processes performed by our
independent auditors with respect to our Form 10-K for the year ended December
31, 2004; the possibility of delisting, or halt in trading of, the Company's
common stock from the American Stock Exchange and the repercussions from any
such delisting, or halt in trading; the continuing risks associated with our
failure to be in compliance with our periodic reporting requirements with the
Securities and Exchange Commission (specifically our delinquent Form 10-Q
reports for the quarters ended March 31, 2005 and June 30, 2005); our ability to
satisfactorily address any material weaknesses in our financial controls;
general economic and business conditions; competition; the relative success of
our operating initiatives; our development and operating costs; our advertising
and promotional efforts; brand awareness for our product offerings; the
existence or absence of adverse publicity; acceptance of any new product
offerings; changing trends in customer tastes; the success of any multi-branding
efforts; changes in our business strategy or development plans; the quality of
our management team; costs and expenses incurred by us in pursuing strategic
alternatives; the availability, terms and deployment of capital; the business
abilities and judgment of our personnel; the availability of qualified
personnel; our labor and employee benefit costs; the availability and cost of
raw materials and supplies; changes in or newly-adopted accounting principles;
changes in, or our failure to comply with, applicable laws and regulations;
changes in our product mix and associated gross profit margins; as well as
management's response to these factors, and other factors that may be more fully
described in the Company's literature, press releases and publicly-filed
documents with the Securities and Exchange Commission. You are urged to
carefully review and consider these disclosures, which describe certain factors
that affect our business.
4
We do not undertake, subject to applicable law, any obligation to publicly
release the results of any revisions, which may be made to any forward-looking
statements to reflect events or circumstances occurring after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events.
Therefore, we caution each reader of this report to carefully consider the
specific factors and qualifications discussed herein with respect to such
forward-looking statements, as such factors and qualifications could affect our
ability to achieve our objectives and may cause actual results to differ
materially from those projected, anticipated or implied herein.
Item 1. Business
GENERAL
The Company, founded in 1897 and incorporated in the State of Florida in
1952, is engaged in the manufacture, sale and distribution of hair care and
personal care products at both the wholesale and retail level. The Company is
comprised of The Stephan Co. ("Stephan") and its eight wholly-owned
subsidiaries, Foxy Products, Inc., Old 97 Company, Williamsport Barber and
Beauty Corp., Stephan & Co., Scientific Research Products, Inc. of Delaware,
Trevor Sorbie of America, Inc., Stephan Distributing, Inc. and Morris
Flamingo-Stephan, Inc.
The Company has identified three reportable operating segments, which are
Professional Hair Care Products and Distribution ("Professional"), Retail
Personal Care Products ("Retail") and Manufacturing. The Professional segment
generally consists of a customer base of distributors, which purchase the
Company's hair care products and beauty and barber supplies for sale to salons
and barbershops. In this segment, a distinction is made between "wet goods",
which include shampoos, conditioners, gels and similar hair treatments, and
"hard goods", which include scissors, clippers, combs, dryers and other products
used in styling hair. The customer base for our Retail segment is comprised of
mass merchandisers, chain drug stores and supermarkets that sell hair care and
other personal care products directly to the end user. The Manufacturing segment
manufactures products for subsidiaries of the Company, and manufactures private
label brands for certain customers.
THE STEPHAN CO.
Headquartered in Fort Lauderdale, Florida, we are principally engaged in
the manufacture of hair care products for sale by two of our subsidiaries,
Scientific Research Products, Inc. and Trevor Sorbie of America, Inc., and the
manufacture of products marketed under the STEPHAN brand name. We also
manufacture, market and distribute hair and skin care products under various
trade names through our subsidiaries. Retail product lines include brands such
as Cashmere Bouquet talc, Quinsana Medicated talc, Balm Barr and Stretch Mark
creams and lotions, Protein 29 liquid and gel grooming aids and Wildroot hair
care products for men. These brands, included in the Retail segment of our
business, are manufactured at our Tampa, Florida facility, as are the "Modern"
brand of Stiff Stuff products. The sales of these products are also included in
the Company's Retail segment. In addition, The Frances Denney division (included
5
in the Retail segment) markets a full line of cosmetics through retail and mail
order channels. Under the terms of an exclusive Trademark License and Supply
Agreement with Color Me Beautiful, Inc., we market the brand names HOPE,
INTERLUDE and FADE-AWAY through several retail chains, including J.C. Penney, in
the United States and Canada.
We also manufacture and sell products under the brand name "STEPHAN'S".
Such products consist of different types of shampoos, hair treatments,
after-shave lotion, dandruff lotion, hair conditioners and hair spray which are
distributed throughout the United States to approximately 350 beauty and barber
distributors and are included in our Professional segment. Our trademark,
"STEPHAN'S," and the design utilized thereby have been registered with the
United States Patent and Trademark Office, which registration is due for renewal
in November 2006. Retail brand sales of Stephan, including the Frances Denney
product line, accounted for approximately $3,348,000 of the Company's 2004 net
sales.
Under certain trademark licenses, we have been granted the exclusive use
of certain trademarks in connection with the manufacture and distribution of the
Cashmere Bouquet product line of the Colgate-Palmolive Company in the United
States and Canada. Any product sold under these license agreements is included
in our net sales.
Pursuant to an additional license and supply agreement, we have granted
Color Me Beautiful, Inc. ("CMB") a license to distribute certain products of our
Frances Denney line and to supply the requirements of CMB for such products. The
agreement provides for royalty payments by CMB based upon net sales, with
guaranteed minimum annual royalty payments throughout the term of the agreement
that are credited against accrued royalties. As a result of a decline in the net
sales of Frances Denney products by CMB, we have agreed to a reduction in the
amount of minimum royalty that CMB is required to pay.
The Company's Fort Lauderdale location serves as our corporate
headquarters. General management services are provided to our subsidiaries from
this location.
No single customer accounted for more than 10% of our consolidated
revenues in 2004. Private label production, which is the manufacturing of
products marketed and sold under the brand names of customers of the Company,
was not significant in 2004.
OLD 97 COMPANY.
Old 97 Company ("Old 97"), a wholly-owned subsidiary of the Company,
located in Tampa, Florida, markets products under brand names such as OLD 97,
KNIGHTS, and TAMMY. In addition to selling more than 100 different products,
including hair and skin care products, fragrances, personal grooming aids and
household items, Old 97 serves as an additional manufacturing facility for our
products. Its Tampa facility manufactures most of the products sold under the
Frances Denney line, all the talc manufactured for the Cashmere Bouquet and
Quinsana brands, as well as all the other retail hair and skin care brands sold
by Stephan and Stephan Distributing, Inc. The operations of Old 97 are included
in the Manufacturing segment of our business.
6
WILLIAMSPORT BARBER AND BEAUTY CORP.
Williamsport Barber and Beauty Corp. ("Williamsport"), a wholly-owned
subsidiary of the Company, is located in Williamsport, Pennsylvania.
Williamsport, a mail order beauty and barber supply company, with net sales of
approximately $4,475,000 in 2004, accounted for approximately 18.7% of our
consolidated revenues for the year and are included in the Professional business
segment.
STEPHAN & CO.
Stephan & Co., a wholly-owned subsidiary, had focused on the distribution
of personal care amenity products for cruise ships. For the year ended December
31, 2004, Stephan & Co. was successful in introducing its amenity program to
resorts and spas and had net sales of approximately $366,000 in 2004.
SCIENTIFIC RESEARCH PRODUCTS, INC. OF DELAWARE.
Scientific Research Products, Inc. of Delaware ("Scientific") is a
wholly-owned subsidiary, which accounted for 10.6% of our consolidated revenues
in 2004, with net sales of approximately $2,541,000. The majority of the sales
of Scientific are included in the Retail business segment.
TREVOR SORBIE OF AMERICA, INC.
Prior to its acquisition, Sorbie Acquisition Co. ("Sorbie") was one of our
major customers and a distributor of a professional line of hair care products
sold to salons in the United States and Canada through a network of
distributors. Net sales of Sorbie hair care products in 2004 were approximately
$698,000, representing 2.9% of our consolidated revenues, and are included in
the Professional business segment of the Company's business.
STEPHAN DISTRIBUTING, INC.
In 1997 the Company's wholly-owned subsidiary, Stephan Distributing, Inc.,
acquired several product lines from New Image Laboratories, Inc. ("New Image").
The primary brands acquired were a professional hair care line of products
marketed under the brand name "Image," and a retail hair care line known as
"Modern" and marketed under the brand name "Stiff Stuff." A portion of the
purchase price included a contingent payment of 125,000 shares of the Company's
common stock payable upon the achievement of certain earnings levels.
New Image commenced litigation against the Company seeking, among other
things, a declaratory decree that the 125,000 shares of the Company's common
stock held in escrow for the contingent payment of certain purchase price
adjustments be released from escrow and turned over to New Image. In the action
commenced by New Image against the Company in the United States District Court
for the Central District of California, the parties reached a settlement
7
pursuant to a stipulation of settlement and amendments thereto which provided,
among other things, as follows: (i) New Image relinquished title to 65,000 of
the 125,000 shares of the Company's common stock held in escrow and received
60,000 shares, (subsequently, New Image elected to sell the Company its 60,000
shares for $285,000), (ii) Stephan was awarded $44,000 in damages from New
Image, (iii) dividends, and interest accrued thereon, held in the escrow account
(approximately $72,000) will be distributed with Stephan receiving 52% of such
funds and New Image receiving 48% of such funds, which was used to satisfy, in
part, the award under (ii) above. As a result of this settlement, the Company
recorded an expense of approximately $285,000 for the quarter ended June 30,
2004 and the amount is reflected as a reduction of royalty and other income on
the consolidated statement of operations. In the third quarter of 2004, the
amount of the contingently returnable shares recorded in the financial
statements of the Company was offset against additional paid in capital when the
shares were retired. New Image's claim for diminution of the value of the shares
held in escrow was heard before a special master in late October 2004 and on
March 30, 2005, the special master recommended that judgment be entered in favor
of the Company. The federal court then entered an order confirming the findings
of the Special Master and entered judgment denying New Image's diminution claim.
New Image has not appealed the judgment.
Sales of professional brands acquired from New Image amounted to
approximately 5.4% of consolidated revenues for the year ended December 31,
2004. Sales of New Image products are included in the Company's Professional
business segment while sales of the Modern line are included in the Company's
Retail business segment.
MORRIS FLAMINGO-STEPHAN, INC.
Morris-Flamingo, Inc. ("Morris Flamingo") is a beauty and barber
distributor, which markets its products utilizing catalogs published under the
Morris Flamingo brand name as well as the Major Advance brand name. Sales for
the year ended December 31, 2004 were approximately $10,928,000, accounting for
approximately 45.6% of our consolidated revenues, and are included in the
Professional segment of the Company's business.
SEGMENT INFORMATION
"Operating Segments and Related Information," which provides information
on net sales, income before income taxes and cumulative effect of change in
accounting principle, interest income and expense and depreciation and
amortization for the last three years and identifiable assets for the last two
years, for each of our three business segments, is set forth in Note 9 of the
consolidated financial statements included elsewhere in this Form 10-K.
RAW MATERIALS, PACKAGING and COMPONENTS INVENTORY
The materials utilized by the Company and our subsidiaries in the
manufacture of its products consist primarily of common chemicals, alcohol,
perfumes, labels, plastic bottles, caps and cartons. All materials are readily
available at competitive prices from numerous sources and have in the past been
8
purchased from domestic suppliers. Neither the Company nor any of our
subsidiaries has ever experienced any significant shortage in supplies nor do we
anticipate any such shortages in the reasonably foreseeable future. Due to
market conditions in the petroleum industry, the Company continues to experience
price increases in both raw material and component prices; however, it is not
anticipated that these price increases will have a material adverse effect on
our operations and we believe that such increases can be passed on to our
customers.
The Company and its subsidiaries seek to maintain a level of finished
goods inventory sufficient for a period of at least three months. The Company
does not anticipate any change in such practice during the reasonably
foreseeable future.
BACKLOG
As of December 31, 2004 the Company did not have any significant amount of
backlog orders.
RESEARCH AND DEVELOPMENT
During each of the three prior fiscal years ending December 31, 2004,
expenditures on Company sponsored research relating to the development of new
products, services or techniques or the improvement of existing products,
services or techniques were not material and were expensed as incurred.
COMPETITION
The hair care and personal grooming business is highly competitive. We
believe that the principal competitive factors are price and product quality.
Products manufactured and sold by the Company and its subsidiaries compete with
numerous varieties of other such products, many of which bear well known,
respected and heavily advertised brand names and are produced and sold by
companies having substantially greater financial, technical, personnel and other
resources than the Company. Our products account for a relatively insignificant
portion of the total hair care and personal grooming products manufactured and
sold annually in the United States.
GOVERNMENT AND INDUSTRY REGULATION, ENVIRONMENTAL MATTERS
Certain of our products are subject to regulation by the Food and Drug
Administration, in addition to other federal, state and local regulatory
agencies. The Company believes that its products are in substantial compliance
with all applicable regulations. The Company does not believe that compliance
with existing or presently proposed environmental standards, practices or
procedures will have a material adverse effect on operations, capital
expenditures or the competitive position of the Company.
9
EMPLOYEES
As of December 31, 2004, in addition to its four executive officers, the
Company and its subsidiaries employed approximately 110 people engaged in the
production, warehousing and distribution of its products. Although we do not
anticipate the need to hire a material number of additional employees, the
Company believes that any such employees, if needed, would be readily available.
No significant number of employees are covered by collective bargaining
agreements and the Company believes its employee relationships are satisfactory.
Item 2. Properties
Our administrative, manufacturing and warehousing facilities are located
in a building of approximately 33,000 square feet, owned by the Company, located
at 1850 West McNab Road, Fort Lauderdale, Florida 33309. The Company utilizes
approximately two-thirds of the space for the manufacture and warehousing of our
products. The remainder of the space is utilized by the Company for its
administrative offices. The Company also owns certain machinery and equipment
used in the manufacture of our products that are stored in the facility in Fort
Lauderdale, Florida. In addition to this facility, the Company leases
approximately 43,000 square feet of warehouse space located at 5300 North
Powerline Road, Fort Lauderdale, Florida 33309, under a lease extension which
terminates July 31, 2005, at an annual net rental of $264,000. In August 2005,
the Company negotiated a month-to-month lease on reduced space of 15,000 square
feet for approximately $9,000 per month.
Old 97 owns three buildings totaling approximately 42,000 square feet of
space, one of which is located at 2306 35th Street, Tampa, Florida 33605. This
building is utilized by Old 97 in the manufacture of its various product lines.
It also owns two buildings located at 4829 East Broadway Avenue, Tampa, Florida
33605. One building, comprising 10,500 square feet, is being used for office
facilities and order fulfillment for the Frances Denney line. The second
building, consisting of approximately 30,000 square feet, is used as a warehouse
and distribution facility. From time to time, and as inventory levels dictate,
Old 97 leases temporary warehouse space, generally on a short-term basis. Old 97
is currently leasing a 44,000 square foot warehouse located in close proximity
to the general office and warehouse facility.
The Company leases office and warehouse space of approximately 6,000
square feet in Williamsport, Pennsylvania pursuant to a five-year lease expiring
January 31, 2007. Monthly rent in the amount of $2,100 is payable to the former
owner of Williamsport Barber Supply and the Company has the right to terminate
the lease upon 30-days notice.
In connection with the Morris Flamingo acquisition, the Company entered
into a lease, and subsequent lease extension, expiring in June 2005, for the
office, warehouse and manufacturing facility located at 204 Eastgate Drive,
Danville, Illinois 61834, at an annual rental payment of approximately $210,000,
subject to annual consumer price index increases, with purchase options ranging
from $1,850,000 to $2,000,000 over the remaining life of the lease. The Danville
facility has 7,500 square feet of office space and 85,500 square feet of
warehouse, distribution and manufacturing space. The landlord is Shaheen & Co.,
Inc, the former owner of Morris-Flamingo. Shouky A. Shaheen, a minority owner of
10
Shaheen & Co., Inc., is currently a member of the Board of Directors and a
significant shareholder of the Company. On May 4, 2005, the Company entered into
a Second Amendment of Lease Agreement (the "Amendment") extending the term of
the lease to June 30, 2015, with a five year renewal option, and increases the
annual rental to $302,780. The base rent is adjustable annually, in accordance
with the existing master lease, the terms of which, including a 90-day right of
termination by the Company, remain in full force and effect. In addition, the
Company has a purchase option, effective during the term of the lease, to
purchase the premises at the then fair market value of the building, or to match
any bona fide third-party offer to purchase the premises. On July 6, 2005, the
landlord notified the Company that their interpretation of the Amendment differs
from that of the Company as to the existence of the 90-day right of termination.
This matter is currently unresolved and the Company is unable, at this time, to
determine the outcome of the disagreement. However, if it is ultimately
determined that the early termination provision has been eliminated with the
Amendment, the Company's minimum lease obligation would amount to $151,390 in
2005, $302,780 in 2006, $302,780 in 2007, $302,780 in 2008 $302,780 in 2009 and
$1,665,289 thereafter.
Item 3. Legal Proceedings
In addition to the matters set forth below, the Company is involved in
other litigation arising in the normal course of business. It is the opinion of
our management that none of such matters, at December 31, 2004, would likely, if
adversely determined, have a material adverse effect on our financial position,
results of operations or cash flows.
For a description of certain legal proceedings involving the Company and
New Image, see Item 1. Business. For a description of certain legal proceedings
involving the Company and a shareholder, see Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Recent Events.
In the fourth quarter of 2003, Sorbie Acquisition Co. ("SAC"), a
wholly-owned subsidiary of the Company, and Trevor Sorbie International, Plc.
("TSI") commenced arbitration proceedings before the American Arbitration
Association in Pittsburgh, Pennsylvania. This arbitration proceeding arose from
a lawsuit filed against SAC by TSI alleging causes of action for breach of
contract, declaratory judgment and trademark infringement. On October 25, 2004,
the arbitration panel returned an award in favor of TSI with respect to certain
royalties due, including interest, and in favor of SAC with respect to the
infringement of SAC's rights to exclusive publicity in their territory. The
panel did not affirm any of the other claims alleged by either of the parties to
the proceeding. In Federal Court, SAC appealed the decision on certain grounds,
including an improper computation of the interest due on additional royalties.
The financial statements for the year ended December 31, 2004 reflect a
liability of approximately $724,000 for payment of the award. Also, SAC may
incur additional interest from the date of the award. Due to the complexities of
the issues involved, however, the Company is currently unable to predict the
outcome of the appeal, including whether or not the appeal will be heard.
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Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
2004.
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PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) Market Information
The Company's Common Stock is listed on the American Stock Exchange (the
"Exchange"). The following table sets forth the range of high and low sales
prices for the Company's Common Stock during each quarterly period within the
two most recent fiscal years:
High Low
Quarter Ended Sales Price Sales Price
------------- ----------- -----------
March 31, 2003 $ 3.61 $ 3.10
June 30, 2003 3.79 3.00
September 30, 2003 4.25 3.71
December 31, 2003 4.47 4.00
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March 31, 2004 $ 4.60 $ 4.32
June 30, 2004 4.88 4.41
September 30, 2004 6.80 3.30(1)
December 31, 2004 4.25(1) 3.45(1)
(1) Net of $2.00 per share special dividend paid September 15, 2004
(b) Holders
As of April 15, 2005, the Company's Common Stock was held of record by
approximately 320 holders. The Company's Common Stock is believed to be held
beneficially by approximately 1,200 shareholders in "street-name".
(c) Dividends
The Company declared and paid cash dividends at the rate of $.02 per share
for each quarter in 1996 through 2004. Future dividends, if any, will be
determined by the Company's Board of Directors, in its discretion, based on
various factors, including the Company's profitability, cash on hand and
anticipated capital needs. As indicated above, the Company paid a special
dividend of $2.00 per share on September 15, 2004, to holders of record on
September 8, 2004.
There are no contractual restrictions, including any restrictions on the
ability of any of the Company's subsidiaries, to transfer funds to the Company
in the form of cash dividends, loans or advances, that currently materially
limit the Company's ability to pay cash dividends or that the Company reasonably
believes are likely to materially limit the future payment of dividends on its
Common Stock.
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Item 6. Selected Financial Data
2004 2003 2002 2001 2000
(in thousands, except per share data)
---------------------------------------------------
Net sales $ 23,951 $25,336 $ 25,067 $28,296 $31,138
(Loss)/Income before
income taxes and
cumulative effect of
change in accounting
principle (2,034) 1,487 1,400 746 1,006
(Loss)/Income before
cumulative effect of
change in accounting
principle (2,176) 760 503 608 622
Cumulative effect of
change in accounting
principle, net of tax -- -- (6,762) -- --
Net (loss)/income (2,176) 760 (6,259) 608 622
Current assets 15,014 24,139 20,284 20,116 28,199
Total assets 34,719 48,063 47,655 57,062 58,769
Current liabilities 3,276 5,085 3,514 4,067 4,521
Long term debt 3,238 4,348 6,395 7,758 9,124
PER COMMON SHARE
(Basic and Diluted): (a)
(Loss)/Income before
cumulative effect of
change in accounting
principle (.50) .18 .12 .14 .14
Cumulative effect of
change in accounting
principle -- -- (1.58) -- --
Net (loss)/income (.50) .18 (1.46) .14 .14
Cash dividends 2.08 .08 .08 .08 .08
Notes to Selected Financial Data
(a) Net income/(loss) per common share is based upon the weighted average
number of common shares outstanding in accordance with Statement of
Financial Accounting Standards No. 128. The weighted average number of
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diluted shares outstanding were 4,348,908 for 2004, 4,312,711 for 2003,
4,285,577 for 2002, 4,285,577 for 2001, and 4,385,019 for 2000. The
weighted average number of basic shares outstanding were not significantly
different in any of the aforementioned years.
The following data should be read in conjunction with the audited consolidated
financial statements and related notes included elsewhere in this Form 10-K.
Selected Quarterly Financial Information (unaudited)
(in thousands, except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
3/31/04 6/30/04 9/30/04 12/31/04
------- ------- ------- --------
Net sales $ 5,959 $ 5,556 $ 7,305 $ 5,131
Gross profit 2,504 2,342 2,995 1,823
Net income/(loss) 78 312 29 (2,595)(a)
Net income/(loss)
per share .02 .07 .01 (.60)
(a) Includes an impairment loss on goodwill and trademarks in the amount of
$2,145.
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
3/31/03 6/30/03 9/30/03 12/31/03
------- ------- ------- --------
Net sales $ 6,949 $ 6,401 $ 6,698 $ 5,288
Gross profit 3,025 2,994 2,781 2,378
Net income/(loss) 480 134 402 (256)
Net income/(loss)
per share .11 .03 .09 (.05)
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004 AS COMPARED TO 2003
--------------------------------------------------
Net sales for 2004 decreased primarily as a result of declines in the
revenues from the Company's Retail business segment. The decline in net sales
for the Retail segment was approximately $1,638,000, largely as a result of the
return to a normal level of sales of Quinsana Medicated Talc to the military as
a result of the stabilization of troops deployed to the Middle East. The
Professional segment showed a small sales decrease, with an increase in hard
goods sales offsetting most of the decline in wet goods sales.
15
Gross profit decreased $1,514,000, to $9,664,000 in 2004 when compared to
2003 levels. This decrease was due to an overall decline in net sales, increased
write-downs of long-term inventory and a continuing change in the overall mix of
business. The gross margin in 2004 was 40.4%, compared to 44.1% in 2003. The
decrease, as indicated above, was due to an unfavorable sales mix. The Morris
Flamingo-Stephan and Williamsport subsidiaries (Professional business segment)
accounted for approximately 64.3% of consolidated net sales, an increase of 4.7%
over 2003 levels. These two subsidiaries have traditionally had lower gross
margins than other entities comprising the professional group. The Company
continues to devote efforts to improving the gross profit margins of these two
divisions, even though they have declined when compared to 2003. In 2004, as a
result of lower than anticipated sales and slow inventory movement during the
year, the Company recorded a charge reflected in cost of goods sold for $337,000
to reduce the carrying value of inventory. This contributed to the decline in
gross profit as well as contributing to the overall decrease in the gross
margin.
The Retail Personal Care Products operating segment experienced a
significant decrease in net sales as a result of the decrease in military sales
as explained above, in addition to a decline in net sales of the LeKair product
line. Net retail sales in 2004 were $5,734,000, as compared to $7,373,000 in
2003. The Company continues to utilize discounting in an attempt to maintain
market share, a practice which has an adverse effect on the overall gross profit
of the Company.
Net sales of the Manufacturing segment declined as a result of the decline
in wet goods sales, in addition to a decline in private label manufacturing;
however, management's efforts to "re-launch" the amenities business showed
favorable results, with net sales of $366,000 in 2004.
Selling, general and administrative expenses (SG&A) increased overall by
approximately $2,352,000, from $9,752,000 in 2003 to $12,104,000 in 2004.
Approximately $2,752,000 of SG&A expenses in 2004 were comprised of "non-cash"
expenses, including an impairment loss on goodwill and trademarks in the amount
of $2,145,000, $415,000 of additional payroll costs associated with certain
officers of the Company exercising stock options utilizing the "cashless method"
of exercise and $192,000 of additional royalty expense to reflect the results of
the Sorbie arbitration (see Item 3. Legal Proceedings, above). Other increases
in SG&A were the result of the reimbursement of an additional $158,000 for
expenses previously incurred by Eastchester Enterprises, in accordance with the
terms of the Merger Agreement (Eastchester Enterprises was the entity created by
the four Board members who were attempting to privatize the Company), $111,000
in additional legal expenses in connection with litigation and "going-private"
matters and additional rent expense of $72,000. In 2003, SG&A included officers
bonuses of $755,000; however no bonus was due or payable for the year ended
December 31, 2004.
Interest expense declined by approximately $312,000, from $403,000 in 2003
to $91,000 in 2004, a result of the payoff of an obligation to Colgate-Palmolive
in April 2004; interest income also declined $63,000 due to low interest rates
and significantly lower cash investments due to the payment of a special $2.00
per share dividend in September 2004. Interest income for the year ended
December 31, 2004, was $164,000, compared to $227,000 earned in 2003.
16
As indicated in previously filed reports, on April 7, 2004, the Company
and Colgate-Palmolive mutually agreed to settle all outstanding claims and
issues between them. The net result of this settlement was a reduction of the
Company's outstanding obligation by approximately $418,000. This amount is
reflected in other income. In addition to the Colgate-Palmolive settlement,
other income was impacted by the settlement of two lawsuits. In one case, the
Company received payment of $150,000 in connection with a customer's failure to
perform on a purchase order issued by them to the Company, and in July 2004, the
Company also settled a portion of the New Image litigation by agreeing to pay
New Image $285,000 (see Item 3. Legal Proceedings, above). Other income also
includes royalty payments from Color Me Beautiful in the amount of $50,000 in
connection with the marketing of Frances Denney products.
The loss before income taxes for the year ended December 31, 2004 was
$2,034,000, compared to income of $1,487,000 achieved for the corresponding
period in 2003, due to a decline in net sales and gross profit as well as the
increase in SG&A indicated above. The provision for income taxes of $142,000
includes a current benefit of $213,000 and a deferred tax expense of $355,000.
The net loss for the year ended December 31, 2004 was $2,176,000, a decline of
$2,936,000 from the corresponding period for 2003, however as mentioned above,
approximately $2,752,000 of SG&A expenses were "non-cash" in nature.
Basic and diluted loss per share for the year ended December 31, 2004 was
$.50, compared to earnings of $.18 for the year ended December 31, 2003, based
upon an average number of shares outstanding of 4,348,908 in 2004 and 4,312,711
in 2003.
YEAR ENDED DECEMBER 31, 2003 AS COMPARED TO 2002
------------------------------------------------
Net sales increased slightly for the year ended December 31, 2003, and
were favorably impacted by a higher than normal volume of sales of Quinsana
Medicated Talc to the military, as a result of the deployment of troops to the
Middle East. This factor was instrumental in increasing net sales for the Retail
segment by almost $650,000. It also helped increase the overall gross profit
margin of the Company because of the favorable impact these sales had on the
sales mix. Earnings per share, before the cumulative effect of a change in
accounting principle, for the year ended December 31, 2003 was $.18, compared to
the $.12 per share achieved for the comparable period in 2002.
Net sales of Professional "wet goods" for the year ended December 31, 2003
declined approximately $545,000, however, the net sales of "hard goods"
increased approximately $228,000 for that same period, leaving the overall
Professional segment down approximately $315,000 from the comparable period in
2002.
As a result of the decline in the net sales of wet goods, as described
above, net sales of the Manufacturing segment also declined. A small portion of
this decline can be attributed to a decline in private label manufacturing.
17
Gross profit for the year ended December 31, 2003, increased to
$11,178,000 from the $9,861,000 achieved in the comparable period of 2002. The
gross margin in 2003 was 44.1%, compared to 39.3% in 2002. These increases, as
indicated above, were due to the more favorable sales mix realized by the
Company as a result of higher sales of retail products.
Selling, general and administrative expenses for the year ended December
31, 2003 increased substantially over the comparable period in 2002, largely as
a result of management bonuses due officers in accordance with their employment
contracts. Insurance costs increased over $100,000, a significant portion of
which is as a result of the increased cost of the Directors and Officers
insurance.
Management bonuses were computed based upon the comparison of current year
earnings per share to a base year, in accordance with terms of the officers
employment contracts, and amounted to $755,000 for the year ended December 31,
2003, and was included in administrative expenses. No bonuses were payable for
the year ended December 31, 2002.
Interest income and interest expense both declined during the year ended
December 31, 2003, as a result of continued low interest rates. Included in
other income was the $50,000 royalty payment from Color Me Beautiful, as well as
a $187,000 settlement in connection with the Department of Transportation
lawsuit.
The provision for income taxes of $727,000 provided for in the statement
of operations includes state income taxes of approximately $120,000 payable to
certain states outside of Florida where the Company is deemed to have a business
nexus. In addition, both federal and state income taxes were adversely affected
by the non-deductibility of certain expenses incurred in connection with the
"going-private" transaction and are considered permanent differences.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Working capital decreased $7,315,000 from December 31, 2003, and was
approximately $11,738,000 at December 31, 2004. Cash and cash equivalents
decreased to $4,402,000 as compared to $13,302,000 as of December 31, 2003. The
decline in working capital and cash is significantly due to the payment of a
$2.00 per share special dividend (approximately $8,780,000) in September, 2004.
Total cash, including restricted cash, decreased from $18,945,000 at December
31, 2003 to $8,943,000 at December 31, 2004. The Company has continued to secure
its outstanding long-term debt with Wachovia Bank with restricted cash. The
long-term portion of restricted cash is classified as non-current and not
included in working capital or cash and cash equivalents.
The Company is currently considering construction of additional warehouse
facilities on the Tampa, Florida manufacturing property, estimated to cost
approximately $1,000,000. The Company is reviewing construction designs and site
plans, as well as initiating procedures for obtaining the necessary permits.
Other than the above, the Company does not anticipate any significant capital
18
expenditures in the near term and management believes that there is sufficient
cash on hand and working capital to satisfy upcoming requirements.
The Company had secured a $5,000,000 line of credit with Merrill Lynch
Business Financial Services, Inc. which expired in August 2004. Subsequent to
year-end, the Company renewed the line at a reduced amount of $1,500,000,
through August 2005. The line of credit, when used, bears interest at the rate
of LIBOR plus 2.25%.
The Company does not have any off-balance sheet financing or similar
arrangements.
Inventory levels declined as management sustained efforts to reduce the
overall amount of inventory on hand, both through the use of effective inventory
control techniques, as well as a continuing write-down of old, obsolete or slow
moving items.
The Company has not experienced any material adverse impact from the
effects of inflation in the last several years. Management maintains some
flexibility to increase prices and does not have any binding contract pricing
with either customers or vendors. Many of the Company's products, as well as the
components used, are petroleum-based products, and as a result, the prices for
raw materials are and will continue to be subject to oil prices which, in turn,
are subject to various political or economic pressures. The Company does not
presently foresee any material increase in the costs of raw materials or
component costs, and our management believes it has the flexibility of calling
upon multiple vendors and the ability to increase prices to offset any price
changes, however, if this trend continues, it may adversely impact the Company's
gross profit margin.
The following table sets forth certain information regarding future
contractual obligations of the Company as of December 31, 2004:
Payments due by period
(in thousands)
Less than 1-3
Contractual obligation Total 1 year years
---------------------- ------- --------- -------
Bank debt payable $ 4,348 $ 1,110 $3,238
Employment contract 4,042 725 3,317
------- ------- ------
TOTAL OBLIGATIONS $ 8,390 $ 1,835 $6,555
======= ======= ======
NEW FINANCIAL ACCOUNTING STANDARDS
----------------------------------
In January 2003, the Financial Accounting Standards Board (the "FASB")
issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN 46"), an interpretation of ARB 51. FIN 46, as revised in December 2003,
provides guidance on identifying entities for which control is achieved through
means other than through voting rights, variable interest entities ("VIE"), and
19
how to determine when and which business enterprises should consolidate the VIE.
In addition, FIN 46 requires both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE to make additional
disclosures. The consolidation provisions of FIN 46 are effective immediately
for variable interests in VIE's created after January 31, 2003. For variable
interests in VIE's created before February 1, 2003, the provisions of FIN 46 are
effective for the first interim or annual period ending after December 15, 2003.
The adoption of FIN 46 did not require a change in accounting treatment of any
VIE's. The Company did not become a party to any VIE's during 2004 and 2003.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity". This statement establishes
standards for the classification and measurement of financial instruments that
possess characteristics similar to both liability and equity instruments. SFAS
No. 150 also addresses the classification of certain financial instruments that
include an obligation to issue equity shares. On October 29, 2003, the FASB
voted to defer, for an indefinite period, the application of certain provisions
of the guidance in SFAS No. 150. The FASB decided to defer the application of
certain aspects of SFAS No. 150 until it could consider some of the resulting
implementation issues. The Company has adopted certain provisions of SFAS No.
150 which did not have a material impact on the Company's financial condition or
results of operations. The Company does not believe the effect of the provisions
of SFAS No. 150 that have been deferred to future periods will have a material
impact on the Company's financial statements.
In December 2004, the FASB issued a revised SFAS No. 123 impacting the
accounting treatment for share-based payments. The revised statement requires
companies to reflect in the income statement compensation expense related to the
grant-date fair value of stock options and other equity-based compensation
issued to employees over the period that such amounts are earned. The statement
is effective for the Company's 2006 fiscal year.
RECENT EVENTS
-------------
On April 30, 2003, the Board of Directors approved a definitive merger
agreement (the "Merger Agreement") pursuant to which the Company would be
acquired, in a "going-private" transaction, by Gunhill Enterprises, Inc., a
wholly-owned subsidiary of Eastchester Enterprises, Inc. Eastchester
Enterprises, Inc. is owned by Frank F. Ferola, Thomas M. D'Ambrosio, John
DePinto and Shouky A. Shaheen (all of whom, at the time, were current Board
members) together with their affiliates (the "Acquisition Group"). The Company
entered into the Merger Agreement following approval by its Board of Directors
based in part upon the unanimous recommendation of the Special Committee
comprised of two non-management and disinterested directors of the Company's
Board of Directors. The Special Committee had received an opinion from SunTrust
Robinson Humphrey that the consideration to be paid pursuant to the Merger
Agreement was fair from a financial point of view to the stockholders other than
the Acquisition Group.
20
On November 4, 2003, in connection with the "going-private" trans- action,
the Company filed a Preliminary Proxy with the Securities and Exchange
Commission ("SEC"). On August 25, 2004, the Merger Agreement was terminated and
the Acquisition Group withdrew its offer to acquire the shares of Stephan common
stock not owned by it and informed Stephan that it has decided not to pursue
such an acquisition at this time. As a result of the above, the Company incurred
termination expenses in the amount of $158,000 in accordance with the terms of
the Merger Agreement, payable to the Acquisition Group and the amount is
included in selling, general and administrative expenses in the statement of
operations.
As previously reported, the Company has not submitted any matters to a
vote of its security holders since the Company's September 1, 2000 Annual
Meeting. In accordance with the rules and regulations of the American Stock
Exchange ("AMEX"), the Company was required to promptly notify its stockholders
and AMEX, in writing, indicating the reasons for the failure to have a meeting
and to use good faith efforts to ensure that an annual meeting is held as soon
as reasonably practicable. The Company included annual meeting materials in its
revised proxy statement, filed with the SEC on April 13, 2004. In a press
release issued by the Company on October 29, 2004, the Company indicated that
the next annual meeting of shareholders, previously set for November 10, 2004,
had been delayed, and the Company expected to formally notify all shareholders
of the definitive date and location of such meeting in the near future. The
Company was required by AMEX to file a Corporate Governance Certification by
October 31, 2004, but has been unable to do so because the composition of the
Board of Directors and the Audit Committee does not meet the enhanced
independent requirements of AMEX. On November 19, 2004, the Company received a
warning letter from AMEX indicating that the Company was deficient with respect
to the above, in addition to not being in compliance with nominating committee
requirements and a web-site posting (or other public notice) of a code of
conduct and ethics for all directors, officers and employees. By January 11,
2005, the Company became compliant by appointing another independent Board
member and filing the appropriate Corporate Governance Certification.
As indicated above, the Company was not in compliance with Section 704 of
the AMEX Company Guide in that it has not held an annual meeting of stockholders
since September 1, 2000. On January 25, 2005, the Company received a letter from
AMEX requiring the submission of a timetable for compliance with the above
Section 704, relating to the holding an annual meeting of stockholders. The AMEX
requested that the timetable indicate actions the Company has taken, or will
take, in order to bring the Company into compliance with AMEX continued listing
standards by no later than May 31, 2005. In spite of its continuing efforts to
schedule an annual meeting of stockholders, the Company was unable to comply
with the May 31, 2005 deadline. The Company has previously been advised that
failure to meet this deadline of May 31, 2005 may cause the Company's common
stock to be delisted. In addition, the Company was not in compliance with
Sections 134, 1101 and 1003(d) of the AMEX Company guide due to the failure to
file a timely Annual Report on Form 10-K for the year ended December 31, 2004
and the Quarterly Report on Form 10-Q for the period ended March 31, 2005. On
June 7, 2005, The Company received notification that the AMEX was proceeding
with delisting procedures. These procedures allow the Company to appeal the
21
delisting process and as such, a hearing before a Listing Qualifications Panel
was held on July 27, 2005. On August 3, 2005, the Company received the Panel's
unanimous written decision, which grants the Company an extension of time until
September 30, 2005, to regain compliance with Amex listing standards. However,
the Panel also unanimously agreed that should the Company not be in complete
compliance with AMEX listing standards by September 30, 2005, the Amex could
then immediately move to delist the Company's common stock. The Panel based its
decision upon the Company's representations at the hearing and its public
filings.
The Company believes that if its common stock is delisted from AMEX, such
delisting is not expected to have a direct impact on the financial condition or
operations of the Company, but it could adversely affect the liquidity and price
of the Company's common stock, as well as the Company's ability to raise
additional capital.
On August 1, 2005, the Company entered into a Brand License Agreement with
The Quantum Beauty Company Limited (the "Licensor") for the exclusive rights to
manufacture, market and distribute the "Lee Stafford" brand of hair care
products in the Western Hemisphere (the "License Agreement"). The initial term
of the License Agreement is 5 years, with a minimum 5 year renewal at the
Licensor's option. The Company is subject to certain requirements, including
satisfactory compliance with manufacturing and quality standards, reporting
timeframes, payment of royalties, minimum marketing, advertising and promotional
expenditures as well as targeted sales goals increasing on an annual basis. On
the basis of targeted sales goals stipulated in the License Agreement, the
Company believes that overall, accounts receivable and inventory levels will
increase in the future and anticipates a positive impact on the sales and
earnings of the Company over the term of the License Agreement.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
------------------------------------------
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ significantly
from those estimates if different assumptions were used or different events
ultimately transpire. We believe that the following are the most critical
accounting policies that requires management to make difficult, subjective
and/or complex judgments, often due to a need to make estimates about matters
that are inherently uncertain:
VALUATION OF ACCOUNTS RECEIVABLE: The ultimate amount of collections
received against outstanding accounts receivable must take into account returns,
allowances and deductions that may be made by our customers. Many retailers to
whom we sell products take deductions for various forms of marketing expenses,
as well as participating in nationwide reclamation cooperatives for processing
damaged goods. Other expenses to which we are subject to, in addition to those
22
experienced in the retail environment (but also with Professional products sold
to distributors) include deductions for freight if the invoice is paid within
specified terms, co-op advertising allowances, new store/warehouse allowances
and, from time to time, limited rebate programs. We attempt to estimate these
costs, as well as providing for anticipated bad debts, by recording allowances
based upon our experience, economic conditions, normal customer inventory levels
and/or competitive conditions. Actual returns, credits or allowances, as well as
the condition of any product actually returned, may differ significantly from
the estimates used by the Company.
INVENTORIES: Inventories are stated at the lower of cost, determined by
the first-in, first-out (FIFO) method, or market. We periodically evaluate
inventory levels, giving consideration to factors such as the physical condition
of the goods, the sales patterns of finished goods and the useful life of
particular packaging, componentry and finished goods and estimate a reasonable
write-down amount to be provided for slow moving, obsolete or damaged inventory.
These estimates could vary significantly, either favorably or unfavorably, from
actual requirements based upon future economic conditions, customer inventory
levels or competitive factors that were not foreseen or did not exist when the
inventory write-downs were established.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL: The Company periodically
evaluates whether events or circumstances have occurred that would indicate that
long-lived assets may not be recoverable or that the remaining useful life may
be impaired. When such events or circumstances are present, the Company assesses
the recoverability of long-lived assets by determining whether the carrying
value will be recovered through the expected future cash flows resulting from
the use of the asset. If the results of this testing indicates an impairment of
the carrying value of the asset, an impairment loss equal to the excess of the
asset's carrying value over its fair value is recorded. The long-term nature of
these assets requires the estimation of its cash inflows and outflows several
years into the future and only takes into consideration circumstances known at
the time of the impairment test.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill and other indefinite lived intangible assets are to be evaluated for
impairment on an annual basis, and between annual tests, whenever events or
circumstances indicate that the carrying value of an asset may exceed its fair
value. The use of various acceptable and appropriate methods of valuation
requires the use of long-term planning forecasts and assumptions regarding
industry-specific economic conditions that are outside the control of the
Company.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
The Company does not own or maintain an interest in derivative or other
financial instruments for which fair value disclosure would be required under
Statement of Financial Accounting Standards No. 107. In addition, the Company
does not invest in securities that would require disclosure of market risk, nor
does it have floating rate loans or foreign currency exchange rate risks. The
Company has no interest rate risk on its fixed rate debt since the interest rate
on the note payable to a bank resets annually upon the anniversary of the loan
(August) at 50 basis points above the interest rate earned on the restricted
cash that collateralizes the loan.
23
Item 8. Financial Statements and Supplementary Data
Reference is made to the consolidated financial statements and
supplementary data contained elsewhere in this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Item 9A: Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report, an evaluation
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures was performed under the supervision and with the
participation of our management, including our principal executive officer and
principal financial officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that a material weakness existed
in our internal controls over financial reporting and consequently our
disclosure controls and procedures were not effective as of the end of the
period covered by this Annual Report in timely alerting them as to material
information relating to our Company (including our consolidated subsidiaries)
required to be included in this Annual Report.
The material weakness in our internal controls over financial reporting as
of December 31, 2004 related to the fact that as a small public company, we have
an insufficient number of personnel with clearly delineated and fully documented
responsibilities and with the appropriate level of accounting expertise and we
have insufficient documented procedures to identify and prepare a conclusion on
matters involving material accounting issues and to independently review
conclusions as to the application of generally accepted accounting principles.
The lack of a sufficient number of accounting personnel is not considered
appropriate for an internal control structure designed for external reporting
purposes. The principal factors management considered in determining whether a
material weakness existed in this regard was based upon management's evaluation
discussed above and advice from our independent registered public accounting
firm. As a result, management has determined that a material weakness in the
effectiveness of the Company's internal controls over financial reporting
existed as of December 31, 2004.
(b) Change in Internal Control over Financial Reporting
No change in the Company's internal control over financial reporting
occurred during the Company's fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting. However, management of the Company, as well as
the Audit Committee, recognizes that current staffing levels will have to be
enhanced and/or institute arrangements with other accounting firms to act in a
consulting capacity in an effort to satisfy our reporting obligations and
over-all standards of disclosure controls and procedures.
24
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS OF THE COMPANY
Board of Directors
Directors are elected on a staggered basis, with each class generally
standing for election for a three-year term. The Company's By-Laws provide that
the number of directors shall be set from time to time by resolution of the
Board of Directors and must be a minimum of one. The Board of Directors has set
the size of the Board at seven members.
Set forth below is certain information with respect to the members of the
Board of Directors:
Year first
Age elected as Principal Occupation(s)
(as of a Company During Past Five Years;
4/1/05) Director Other Directorships
------- -------- -------------------
William M. 81 (1) Certified Public Accountant and Attorney.
Gross For more than the previous five years, he
has served as Authorized House Counsel for
the Company on a part time basis.
Shouky A. 74 1998 For more than the previous five years,
Shaheen (2) President of Shaheen and Co. Mr. Shaheen
Shaheen is also the former Owner of Morris
Flamingo, L.P., which was acquired by the
Company in March 1998.
Curtis 51 1996 For more than the previous five years,
Carlson (3) partner in various law firms. Currently a
partner in the Miami-based law firm of
Carlson & Lewittes, PA.
Frank F. 61 1981 For more than the previous five years,
Ferola Chairman of the Board, President and Chief
Executive Officer of the Company.
Richard 63 (1) Chairman, CEO and Portfolio Manager for
Barone Ancora Advisors, an investment advisor based
in Cleveland, OH. Additionally, Chairman of
Ancora Capital and Ancora Securities, a
holding company and broker/dealer based in
Cleveland. Prior to founding Ancora
Advisors, from 2001-2003, portfolio manager
for Fifth Third Bank Invest Advisors. Prior
to that, President and CEO for Maxus
Investment Group.
(1) Not previously elected; appointed to fill vacancy.
(2) Member of the Compensation Committee.
(3) Member of the Audit Committee.
Committees of the Board
The Board has established three standing committees, consisting of (1) an
Audit Committee (2) a Stock Option & Compensation Committee and (3) a Nominating
Committee.
25
The Audit Committee reviews the internal and external audit functions of
the Company and makes recommendations to the Board of Directors with respect
thereto. It also has primary responsibility for the formulation and development
of the auditing policies and procedures of the Company, and for selecting the
Company's independent auditing firm. The Audit Committee is governed by the
Company's Audit Committee Charter. The Board of Directors of the Company has
determined that the current composition of the Audit Committee satisfies the
American Stock Exchange's requirements regarding the independence, financial
literacy and experience. The Chairman and financial expert of the Audit
Committee is William Gross; Mr. Gross is not an independent director.
Executive Officers
The four executive officers of the Company consist of Frank F. Ferola,
President, Chairman of the Board and Chief Executive Officer; David A. Spiegel,
Chief Financial Officer, Vice President and Treasurer; Tyler Kiester, Assistant
Secretary; and Curtis Carlson, Vice President and Secretary.
The following sets forth certain information with respect to the executive
officers of the Company who are not also directors (based solely on information
furnished by such persons):
Mr. David A. Spiegel, 57, was appointed as Chief Financial Officer in
January 1994. For more than the five years prior to 1994, Mr. Spiegel was the
independent public accountant for the Company.
Mr. Tyler Kiester, 37, was appointed Assistant Secretary in January 2003.
For more than the previous five years, Mr. Kiester has been employed by the
Company in various capacities.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's officers and directors and persons owning more than 10% of the
Company's common stock to file reports of ownership and changes in ownership
with the Securities and Exchange Commission and to furnish copies of all such
reports to the Company. The Company believes, based on the Company's stock
transfer records and written representations from certain reporting persons,
that, except as set forth below, all reports required under section 16(a) were
timely filed during 2004.
Name # of Late Reports # of Late Transactions
---- ----------------- ----------------------
John DePinto 1 2
Shouky Shaheen 1 2
Curtis Carlson 1 2
Frank F. Ferola 1 2
Leonard Genovese 1 2
Thomas D'Ambrosio 1 1
Code of Ethics
The Company has adopted a Code of Ethics that applies to all officers,
employees and directors. This Code requires continued observance of high ethical
standards such as honesty, integrity and compliance with the law in the conduct
of the business. The Code is posted on the Company website,
(www.thestephanco.com).
26
ITEM 11. EXECUTIVE COMPENSATION
Compensation
The following table sets forth information for the fiscal years ended
December 31, 2004, December 31, 2003 and December 31, 2002 as to the
compensation earned by the Company's Chief Executive Officer and the other most
highly compensated executive officers and/or other employees of the Company
whose total annual salary and bonus exceeded $100,000 for services rendered by
them in all capacities to the Company and its subsidiaries during fiscal year
2004.
Summary Compensation Table
Long-Term
Annual Compensation Compensation
------------------- ------------
Name and Other Securities
Principal Annual Underlying All Other
Position(s) Year Salary Bonus Compensation Options Compensation
----------- ---- ------ ----- ------------ ------- ------------
Frank F. Ferola 2004 $828,139 $ 0 $ 0 $50,000(1) $ 0
Pres., CEO & 2003 $752,853 $630,000(2) $ 0 $50,000(1) $ 60,808
Board Chair 2002 $677,567 $ 0 $ 0 $50,000(1) $ 0
David Spiegel, CFO 2004 $188,781 $ 0 $ 0 $ 0 $ 0
2003 $165,816 $ 0 $ 0 $ 0 $ 0
2002 $166,251 $ 0 $ 0 $ 0 $ 0
Jeff Lovelace, 2004 $104,500 $ 0 $ 0 $ 0 $ 0
Director of Sales 2003 $ 83,326 $ 0 $ 0 $ 0 $ 0
2002 $ 76,733 $ 0 $ 0 $ 0 $ 0
(1) Reflects stock options granted pursuant to employment agreements.
(2) Bonus earned in 2003 and paid in 2004.
Stock Option Grants in Fiscal Year 2004
The following table sets forth certain information concerning stock
options granted to those individuals named in the Summary Compensation Table who
were granted stock options in fiscal year 2004.
Number of % of Total
Securities Options Exercise Potential Realizable
Underlying Granted to Price Value At Assumed Annual
Options Employees in Per Exp. Rates of Stock Price
Name Granted Year Share Date Appreciation (2)
---- ------- ---- ----- ---- ----------------
5% 10%
--- ---
Frank F. Ferola 50,000(1)(3) 100% $4.26 1/1/2010 $271,848 $343,039
(1) Reflects Stock Options granted pursuant to employment agreements.
(2) Potential realizable value is based on the assumption that the Common
Stock appreciates at the annual rates shown (compounded annually) from the
date of grant until the expiration of the option term. These numbers are
calculated based on the requirements promulgated by the Commission and do
not reflect any estimate or prediction by the Company of future Common
Stock trading prices.
27
Option Exercises and Year-End Option Values
The following table sets forth information with respect to the number of
shares acquired upon exercise of stock options and the value realized upon
exercise of such stock options by the individuals named in the Summary
Compensation Table during 2004. The table also contains information regarding
the number of shares covered by both exercisable and unexercisable stock options
held by the same individuals as of December 31, 2004. Also reported are the
values for "in-the-money" stock options that represent the positive spread
between the respective exercise prices of outstanding stock options and the fair
market value of our common stock as of December 31, 2004 ($4.25 per share).
Number of
Securities Underlying Value of
Unexercised Options Unexercised In-the-
Shares Held at Money Options at
Acquired December 31,2004 December 31, 2004
On $ Value ---------------- -----------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
Frank F. Ferola 78,398 388,070 200,000 50,000 -- --
David Spiegel 2,233 10,944
Compensation of Directors
All directors of the Company are compensated for their services by payment
of $300 for each Board meeting attended.
During fiscal year 2004, options to purchase an aggregate of 20,248 shares
of Common Stock, at an exercise price of $4.82 per share, were granted by the
Company to the four directors of the Company who were not employees or regularly
retained consultants of the Company (each, an "Outside Director") pursuant to
the Company's 1990 Outside Directors' Stock Option Plan.
Under the Plan, each Outside Director is automatically granted, upon such
person's election or re-election to serve as a director of the Company, an
option exercisable over five years, to purchase shares of Common Stock. Upon
initial election to the Board of Directors, an Outside Director is granted an
option to purchase 5,062 shares of Common Stock at an exercise price equal to
the fair market value of the Common Stock on the date of grant. An option to
purchase an additional 5,062 shares of Common Stock (at an exercise price equal
to the fair market value of the Common Stock on the date of such grant) is
granted to each incumbent Outside Director during each fiscal year of the
Company thereafter on the earlier of (i) June 30 or (ii) the date on which the
stockholders of the Company elect directors at an annual meeting of such
stockholders or any adjournment thereof. The aggregate number of shares of
Common Stock reserved for grant under the Outside Directors' Stock Option Plan
is 202,500, of which options covering 80,992 shares are outstanding.
28
Employment and Termination Arrangements
Frank F. Ferola
On January 1, 1997, the Company entered into an employment agreement with
Mr. Frank F. Ferola. The agreement provides for a three year term, which may be
renewed for successive terms of three years if, at least thirty days prior to
the end of each term, Mr. Ferola gives notice of his election to renew. Mr.
Ferola renewed the agreement at the end of 1999, 2002, and, most recently on
March 7, 2005, terminating December 31, 2008.
Under the agreement, Mr. Ferola receives an annual base salary which is
increased annually by an amount equal to 10% of the previous years' base salary.
For the year ending December 31, 2004, Mr. Ferola's annual base salary was
$828,139. (However, by letter dated July 6, 2005, to the Company, Mr. Ferola
unilaterally reduced his salary to $540,000 per annum. See discussion under
Certain Relationships and Related Transactions.)
In addition, Mr. Ferola is entitled to receive an annual performance bonus
based on increases of at least 10% in the Company's earnings per share,
calculated by comparison to a base year (currently, 2002) and pursuant to a
formula set forth in his employment agreement. For the year ending December 31,
2004, Mr. Ferola was paid a bonus in the amount of $630,000.
Further, Mr. Ferola's employment agreement provides that he will receive
stock options with five year terms, under the 1990 Key Employee Stock Incentive
Plan or under a substitute plan directly from the Company, on each anniversary
date of the agreement of not less than 50,000 shares based on the closing price
of the stock on the last business day before the anniversary date.
Moreover, in the event of a "change in control" (as defined in the
employment agreement) of the Company, Mr. Ferola is entitled to receive an
amount equal to his base salary for the remaining term of his employment
agreement plus an additional 24 months' salary, plus a lump-sum payment in an
amount equal to the most recent annual bonus paid multiplied by the sum of the
number of years (including any fraction thereof) remaining in the term of his
agreement, plus two.
David Spiegel
Likewise, Mr. Spiegel has an arrangement with the Company where the
Company pays him a severance payment upon a "change in control" (as defined in a
letter agreement dated April 29, 2004, by and between Mr. Spiegel and the
Company) in an amount equal to his then-current monthly base salary, multiplied
by twelve, plus a lump-sum payment equal to his most recent annual bonus.
Tyler Kiester
Finally, Mr. Kiester has an arrangement whereby the Company pays him a
severance payment upon a "change in control" (as defined in a letter agreement
dated May 19, 2003, by and between Mr. Kiester and the Company) in an amount
equal to his then-current monthly base salary multiplied by twelve.
29
Compensation Committee Interlocks and Insider Participation
Shouky Shaheen, John DePinto, and Leonard Genovese served on the
Compensation Committee in 2004. In fiscal year 2004 the Company paid $273,000 in
rent to Shaheen & Co., Inc., a corporation in which Shouky A. Shaheen is a
majority owner, for a building the Company leases in Danville, Illinois. On May
4, 2005, the Company entered into a Second Amendment of Lease Agreement for the
Danville, IL facility which, among other things, increases the annual rental to
$302,780.
Report of the Compensation Committee on Executive Compensation
The following Report on Executive Compensation does not constitute
soliciting material and should not be deemed filed or incorporated by reference
in any other filing by us under the Securities Act of 1933 or the Securities
Exchange Act of 1934, except to the extent that we specifically incorporate this
report or the performance graph by reference therein.
The Compensation Committee is composed entirely of independent directors.
The Compensation Committee reviews the base salaries of our employees (as well
as our executive officers) on an annual basis, considering factors such as
corporate progress toward achieving objectives (without reference to any
specific performance-related targets) and individual performance experience and
expertise. The Compensation Committee has primary responsibility for the
administration of the Company's 1990 Key Employee Stock Incentive Plan (the
"Incentive Plan"), including principal responsibility for the granting of
options thereunder. The Compensation Committee is also responsible for
establishing the overall philosophy of the Company's executive compensation
program and overseeing the executive compensation plan developed to execute the
Company's compensation strategy.
Compensation Strategy
The Company's executive compensation program has been designed to (i)
align executive compensation with stockholder interests, (ii) attract, retain
and motivate a highly competent executive team, (iii) link compensation to
individual and Company performance and (iv) achieve a balance between incentives
for short-term and long-term performance and results. The Company's executive
compensation package consists of the payment of base salary, potential annual
bonus and stock options awarded through participation in the Incentive Plan. The
Compensation Committee reviews annually the compensation to be paid to the
Company's executive officers. In making such review, the Compensation Committee
evaluates information supplied by management. The Compensation Committee also
participates in the negotiation of employment contracts, including provisions
for salary and bonuses, with the Company's executive officers. Currently,
pursuant to the Company's employment agreements with certain of its executive
officers, each such executive officer receives a fixed annual base salary and
certain of such executive officers are entitled to receive a bonus amount
determined by a formula based on certain increases in the Company's earnings per
share for each fiscal year during the term of the agreement.
30
Base Salary
Base salary for executive officers is determined by the terms of written
employment agreements between the Company and such officers. The Compensation
Committee's policy is to negotiate salaries in relation to industry norms, the
principal job duties and responsibilities undertaken by such executives,
individual performance and other relevant criteria. A base salary comparison for
the Company's Chief Executive Officer was made to a group of public companies
that the Compensation Committee believes provides a meaningful comparison to the
Company. Several of these companies are included in the custom composite of
companies in the Standard & Poor's Midcap Consumer Products Index. The base
salary paid to the Company's Chief Executive Officer for fiscal year 2004 was in
the middle of the range of base salary paid by such companies.
Annual Bonus
Annual bonuses for the Chief Executive Officer and other executive
officers may be determined by specific bonus formulae set forth in written
employment agreements between the Company and such officers. Currently, only the
Chief Executive Officer is eligible to receive such a bonus (see EXECUTIVE
COMPENSATION section of this Proxy Statement). Other executives are paid bonuses
at the discretion of the Compensation Committee.
Stock Options
Long-term incentive compensation of executives is granted through
participation in the Incentive Plan. The Incentive Plan permits the Company to
grant stock options to executive officers at a price not less than 100% of the
fair market value of the Common Stock on the date of the grant. In addition to
any obligations pursuant to executive officers' employment agreements, stock
options may be granted, in the Compensation Committee's discretion, to executive
officers based upon its appraisal of the ability of such executive officers to
influence the long-term growth and profitability of the Company. The
Compensation Committee believes that providing a portion of the executive's
annual incentive compensation in the form of stock options encourages the
officers to share with the Company's stockholders the goals of increasing the
value of the Company's stock and contributing to the success of the Company.
Compensation Committee's Actions for Fiscal Year 2004
After various informal meetings during 2004, the Compensation Committee
did not award any discretionary stock options to any key employees and did not
grant any discretionary salary increases or award any bonuses. Options and bonus
were granted only pursuant to Mr. Ferola's employment agreement.
The Chief Executive Officer Compensation
As set forth in more detail herein, the Compensation Committee approved an
employment agreement on January 1, 1997 for Mr. Frank F. Ferola that was renewed
for successive terms until December 31, 2008. Based on the earnings formula
described therein, Mr. Ferola received annual bonus(es) and stock options as
shown in the EXECUTIVE COMPENSATION section of this Proxy Statement.
31
Section 162(m) Compliance
Section 162(m) of the Internal Revenue Code of 1986, as amended (the
"Code"), generally disallows a tax deduction to a public company for
compensation over $1 million annually paid to its chief executive officer and
four other most highly compensated executive officers. Qualifying
performance-based compensation will not be subject to the deduction limitation
if certain requirements are met. The Compensation Committee's current policy is
to structure the performance-based portion of the compensation of the Company's
executive officers (currently consisting of stock option grants and cash
bonuses) in a manner that complies with Section 162(m) of the Code whenever
practicable and appropriate in the judgment of the Compensation Committee.
COMPENSATION COMMITTEE:
Shouky Shaheen, Chairman
John DePinto
Leonard Genovese
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Equity Compensation Plans
As of December 31, 2004, an aggregate of 462,700 options had been granted
to executive officers under the 1990 Key Employee Stock Incentive Plan and an
aggregate of 496,330 options had been granted to all employees under the Plan.
Included in the above totals are options that have been granted and subsequently
cancelled and/or expired.
Non-employee directors of the Company are not granted options under the
1990 Key Employee Stock Incentive Plan, but are granted options under the 1990
Outside Directors' Stock Option Plan, discussed above under "Compensation of
Directors."
Stock Ownership by Certain Beneficial Owners
The following table sets forth, as of the Record Date, certain information
as to the stockholders (other than directors and executive officers of the
Company) known by the Company to own beneficially more than 5% of the Common
Stock (based solely upon filings by said holders with the Securities and
Exchange Commission (the "Commission") on Schedule 13D, pursuant to the
Securities Exchange Act of 1934, as amended (the "Exchange Act")).
Number of Shares
Name and Address Beneficially Percent
of Beneficial Owner Owned * of Class
------------------- ------- --------
Merlin Partners, L.P., et al. 314,721 7.2
2000 Auburn Drive, Suite 420
Cleveland, OH 44122
Yorktown Avenue Capital, et al. 348,700 7.9
124 E. 4th Street
Tulsa, OK 74103
32
Number of Shares
Name and Address Beneficially Percent
of Beneficial Owner Owned * of Class
------------------- ------- --------
David M. Knott, et al. 387,900 8.8
485 Underhill Blvd., Suite 205
Syosset, NY 11791
Richard L. Scott 438,500 10.0
Boult Cummings Conners &
Berry,PLC
414 Union Street, Suite 1600
Nashville, TN 37219
* Beneficial ownership, as reported in the above table, has been determined
in accordance with Rule 13d-3 Under the Exchange Act. Unless otherwise
indicated, beneficial ownership includes both sole voting and sole
dispositive power.
Stock Ownership by Management and Directors
The following table sets forth, as of the Record Date, certain information
concerning the beneficial ownership of Common Stock by each of the seven
nominees for election as a director of the Company (five of whom are currently
directors of the Company), each other director, the executive officers, and all
current directors and executive officers of the Company as a group (based solely
upon information furnished by such persons):
Number of
Shares
Name of Beneficially Percent
Beneficial Owner (1) Owned(2) of Class
-------------------- -------- --------
Curtis Carlson........................................ 25,310 (4)
William M. Gross...................................... 0 (4)
Frank F. Ferola....................................... 860,333(3) 19.60%
John DePinto.......................................... 133,514 3.0%
Leonard Genovese...................................... 35,310 (4)
Tyler Kiester ........................................ 0 (4)
Shouky Shaheen........................................ 337,430 7.69%
David Spiegel......................................... 700 (4)
Richard Barone........................................ 314,721 7.16%
Elliot Ross........................................... 0 (4)
David Pawl............................................ 0 (4)
--------- -----
All executive officers and directors
as a group............................................ 1,707,318 38.89%
(1) Beneficial ownership, as reported in the above table, has been determined
in accordance with Rule 13d-3 under the Exchange Act. Unless otherwise
indicated, beneficial ownership includes both sole voting and sole
dispositive power. Unless otherwise indicated, the address of each person
listed is c/o The Stephan Co., 1850 W. McNab Rd., Ft. Lauderdale, FL
33309.
(2) Includes the following shares that may be acquired upon the exercise of
options held by the specified person within 60 days of the Record Date:
Mr. John DePinto - 20,248; Mr. Frank Ferola - 200,000; Mr. Curtis Carlson
- 20,248; Mr. Leonard Genovese - 20,248; Mr. Shouky Shaheen - 5,062; and
all executive officers and directors as a group - 265,806.
(3) Includes 14,305 shares owned by Mr. Frank Ferola's personal Charitable
foundation, of which Mr. Ferola is a co-trustee.
(4) Represents less than 1%.
33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In fiscal year 2004, the Company paid $152,431 to Payton & Carlson, P.A.
and to Carlson & Associates, P.A., law firms of which Curtis Carlson is a
partner, for legal services rendered by such firms to the Company. Further,
commencing April 8, 2005, the Company began to pay Mr. Carlson $2,000.00 per
month for his services as Vice-President and Secretary.
In fiscal year 2004, the Company paid $273,000 in rent to Shaheen & Co.,
Inc., a corporation in which Shouky A. Shaheen is a majority owner, for a
building the Company leases in Danville, Illinois. On May 4, 2005, the Company
entered into a Second Amendment of Lease Agreement for the Danville, IL facility
which, among other things, increases the annual rental to $302,780.
By way of letter dated July 6, 2005, Frank F. Ferola, President, CEO and
Chairman of the Board, unilaterally reduced, on a temporary basis, his salary
from $910,953 per annum to $540,000 per annum. In the event of a "change of
control" in the Company (as defined in the July 6, 2005 letter) Mr. Ferola's
salary, as set forth in his employment contract, shall automatically resume.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Principal Accountant Fees and Services
The following table sets forth the fees billed to us by Deloitte & Touche,
our independent registered accounting firm, as of and for the years ended
December 31, 2004 and 2003.
For the Years Ended
December 31,
2004 2003
---- ----
Audit fees(1) ................................ $190,400 $164,100
Audit - related fees ......................... $ -- $ --
Tax fees(2) .................................. $ 1,062 $ 876
All other fees ............................... $ -- $ --
$191,462 $164,967
======== ========
(1) Audit fees billed by Deloitte & Touche, LLP in 2004 related to the audit
of our annual consolidated financial statements; the review of our interim
consolidated financial statements included in our Quarterly Reports on
Form 10-Q for the periods ended March 31, June 30 and September 30, 2004.
Audit fees billed by Deloitte & Touche, LLP in 2003 related to the audit
of our annual consolidated financial statements and the review of our
interim consolidated financial statements included in our Quarterly
Reports on Form 10-Q for the periods ended March 31, June 30 and September
30, 2003.
(2) Tax fees billed by Deloitte & Touche, LLP related to tax advice in
connection with real estate and personal property tax statements.
34
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a) Exhibits
10.1 Acquisition Agreement, dated December 31, 1995, between
Colgate-Palmolive Company and The Stephan Co., with exhibits, including the
Transition Agreement, included with the Form 8-K filed January 16, 1996, and as
amended on January 22, 1996, is incorporated herein by reference.
10.2 Acquisition Agreement, dated December 31, 1995, between The
Mennen Company and The Stephan Co., with exhibits, included with the Form 8-K
filed January 16, 1996 and as amended on January 22, 1996, is incorporated
herein by reference.
10.3 Letter agreement, dated December 31, 1995, between
Colgate-Palmolive Company, The Mennen Company and The Stephan Co., included with
the Form 8-K filed January 16, 1996 and as amended on January 22, 1996, is
incorporated herein by reference.
10.4 Settlement Agreement and Amendment, dated December 5, 1996,
between The Stephan Co., The Mennen Company and Colgate-Palmolive Company,
included with the Form 10-K filed April 15, 1997, is incorporated herein by
reference.
10.5 The Trademark License Agreement, dated December 5, 1996,
between Colgate-Palmolive Canada, Inc. and The Stephan Co., included with the
Form 10-K filed April 15, 1997, is incorporated herein by reference.
10.6 Trademark License and Supply Agreement, dated March 7, 1996,
between Color Me Beautiful, Inc. and The Stephan Co., included with the Form 8-K
filed March 20, 1996, is incorporated herein by reference.
10.7 Agreement, dated June 28, 1996, for the acquisition of Sorbie
Acquisition Co. and Subsidiaries, with exhibits, included with the Form 8-K
filed July 15, 1996, and as such was amended on August 21, September 16 and
October 9, 1996, is incorporated herein by reference.
10.8 Amended and Restated Sorbie Products Agreement, dated June 27,
1996, among Sorbie Acquisition Co., Sorbie Trading Limited, Trevor Sorbie
International, PLC and Trevor Sorbie, included with the Form 8-K/A filed August
21, 1996, is incorporated herein by reference.
10.9 Settlement Agreement and Amendment, dated December 5, 1996,
between The Stephan Co., The Mennen Company and Colgate-Palmolive Company,
included with the Form 10-K for the year ended December 31, 1996, filed April
15, 1997, is incorporated herein by reference.
10.10 Trademark License and Supply Agreement, dated March 7, 1996,
between Color Me Beautiful, Inc. and The Stephan Co., included with the Form 8-K
filed March 20, 1996, is incorporated herein by reference.
35
10.11 Acquisition Agreement, dated as of May 23, 1997, between New
Image Laboratories, Inc., The Stephan Co. and Stephan Distributing, Inc., in
connection with the acquisition of brands, included with the Form 10-Q for the
period ended June 30, 1997, filed August 13, 1997, is incorporated herein by
reference.
10.12 Acquisition Agreement, dated as of March 18, 1998, between
Morris Flamingo-Stephan, Inc., The Stephan Co., Morris-Flamingo, L.P.,
Morris-Flamingo Beauty Products, Inc., Shaheen & Co., Inc. and Shouky A Shaheen,
included with the Form 10-Q for the period ended June 30, 1998, filed May 15,
1998, is incorporated herein by reference.
10.13 1990 Key Employee Stock Incentive Plan, as amended.
10.14 1990 Non-Employee (Outside Directors) Plan, as amended.
10.15 Merger Agreement, dated April 30, 2003, by and among The
Stephan Co., Gunhill Enterprises and Eastchester Enterprises, including
exhibits, included with Form 8-K filed May 8, 2003, is incorporated herein by
reference.
10.16 Working Capital Management Account agreement dated September
19, 2003 with Merrill Lynch Business Financial Services Inc., creating a line of
credit not to exceed $5,000,000, included with Form 8-K filed October 3, 2003,
and amended October 9, 2003, is incorporated herein by reference.
10.17 Second Amended and Restated Agreement and Plan of Merger,
dated March 24, 2004, by and among The Stephan Co., Gunhill Enterprises and
Eastchester Enterprises, including exhibits, included with Form 8-K filed March
30, 2004, is incorporated herein by reference.
10.18 Modification of employment agreement between the Company and
Frank F. Ferola, President and Chief Operating Officer, dated July 6, 2005.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer.
32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
36
(b) Financial Statements and Financial Statement Schedules
(i) Financial Statements
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2004 and 2003.
Consolidated Statements of Operations for the years ended December
31, 2004, 2003, and 2002.
Consolidated Statements of Changes in Stockholders' Equity for the
years ended December 31, 2004, 2003, and 2002.
Consolidated Statements of Cash Flows for the years ended December
31, 2004, 2003, and 2002.
Notes to Consolidated Financial Statements.
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
37
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Stephan Co.
Fort Lauderdale, FL
We have audited the accompanying consolidated balance sheets of The Stephan Co.
and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
2004. Our audits also included the financial statement schedule listed in the
Index at Item 15. These financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statements and financial statement schedule
based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The Stephan Co. and subsidiaries as
of December 31, 2004 and 2003, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
As discussed in Notes 1 and 5 to the consolidated financial statements, the
Company changed its method of accounting for goodwill and other intangible
assets in 2002 to conform to Statement of Financial Accounting Standards No.
142.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Fort Lauderdale, Florida
September 8, 2005
F-1
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
ASSETS
2004 2003
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 4,402,463 $13,302,159
Restricted cash 1,110,000 1,110,000
Accounts receivable, net 1,753,250 1,444,508
Inventories 7,164,901 7,497,262
Income taxes receivable 209,203 --
Prepaid expenses
and other current assets 374,079 784,601
----------- -----------
TOTAL CURRENT ASSETS 15,013,896 24,138,530
RESTRICTED CASH 3,430,408 4,532,500
PROPERTY, PLANT AND EQUIPMENT, net 1,627,227 1,702,330
GOODWILL, net 4,013,458 5,857,980
TRADEMARKS, net 8,364,809 8,664,809
OTHER INTANGIBLE ASSETS, net 216,652 298,773
OTHER ASSETS 2,052,405 2,867,958
----------- -----------
TOTAL ASSETS $34,718,855 $48,062,880
=========== ===========
See notes to consolidated financial statements.
F-2
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
LIABILITIES AND STOCKHOLDERS' EQUITY
2004 2003
----------- ------------
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 2,165,751 $ 2,614,731
Current portion of long-term debt 1,110,000 2,442,273
Income taxes payable -- 28,270
----------- ------------
TOTAL CURRENT LIABILITIES 3,275,751 5,085,274
DEFERRED INCOME TAXES, net 1,488,116 1,133,051
LONG-TERM DEBT, less current maturities 3,237,500 4,347,500
----------- ------------
TOTAL LIABILITIES 8,001,367 10,565,825
----------- ------------
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value;
1,000,000 shares authorized; none issued -- --
Common stock, $.01 par value;
25,000,000 shares authorized;
4,389,805 shares issued at
December 31, 2004 and 4,410,577
issued at December 31, 2003 43,898 44,106
Additional paid in capital 17,556,731 18,417,080
Retained earnings 9,116,859 20,387,432
----------- ------------
26,717,488 38,848,618
LESS:
125,000 CONTINGENTLY
RETURNABLE SHARES -- (1,351,563)
----------- ------------
TOTAL STOCKHOLDERS' EQUITY 26,717,488 37,497,055
----------- ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $34,718,855 $ 48,062,880
=========== ============
See notes to consolidated financial statements.
F-3
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
------------ ------------ ------------
NET SALES $ 23,950,648 $ 25,336,017 $ 25,066,950
COST OF GOODS SOLD 14,286,280 14,157,918 15,206,352
------------ ------------ ------------
GROSS PROFIT 9,664,368 11,178,099 9,860,598
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 12,103,784 9,752,137 8,509,114
------------ ------------ ------------
OPERATING (LOSS)/INCOME (2,439,416) 1,425,962 1,351,484
OTHER INCOME(EXPENSE)
Interest income 163,921 227,399 378,441
Interest expense (91,237) (403,028) (479,125)
Royalty and other income 332,745 237,000 148,750
------------ ------------ ------------
(LOSS)/INCOME BEFORE INCOME
TAXES AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE (2,033,987) 1,487,333 1,399,550
INCOME TAX EXPENSE (142,251) (726,874) (896,880)
------------ ------------ ------------
(LOSS)/INCOME BEFORE CUMULATIVE
EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (2,176,238) 760,459 502,670
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
TAX BENEFIT OF $1,662,911 -- -- (6,761,576)
------------ ------------ ------------
NET (LOSS)/INCOME $ (2,176,238) $ 760,459 $ (6,258,906)
============ ============ ============
BASIC AND DILUTED (LOSS)/
EARNINGS PER SHARE:
(LOSS)/INCOME BEFORE
CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE $ (.50) $ .18 $ .12
CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE -- -- (1.58)
------------ ------------ ------------
BASIC AND DILUTED (LOSS)/
EARNINGS PER SHARE $ (.50) $ .18 $ (1.46)
============ ============ ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,348,908 4,312,711 4,285,577
============ ============ ============
See notes to consolidated financial statements.
F-4
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Common Stock Additional Contingently
--------------------- Paid in Retained Returnable
Shares Par Value Capital Earnings Shares
---------- --------- ------------ ------------ -----------
Balances, Jan. 1, 2002 4,410,577 $ 44,106 $ 18,417,080 $ 26,591,571 $(1,351,563)
Dividends paid -- -- -- (352,846) --
Net loss -- -- -- (6,258,906) --
---------- -------- ------------ ------------ -----------
Balances, Dec. 31,2002 4,410,577 44,106 18,417,080 19,979,819 (1,351,563)
Dividends paid -- -- -- (352,846) --
Net income -- -- -- 760,459 --
---------- -------- ------------ ------------ -----------
Balances, Dec. 31, 2003 4,410,577 44,106 18,417,080 20,387,432 (1,351,563)
Stock options exercised 104,228 1,042 489,964 -- --
Contingently returnable
shares retired (125,000) (1,250) (1,350,313) -- 1,351,563
Dividends paid -- -- -- (9,094,335) --
Net loss -- -- -- (2,176,238) --
---------- -------- ------------ ------------ -----------
Balances, Dec. 31, 2004 4,389,805 $ 43,898 $ 17,556,731 $ 9,116,859 $ --
========== ======== ============ ============ ===========
See notes to consolidated financial statements.
F-5
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)/income $(2,176,238) $ 760,459 $(6,258,906)
----------- ----------- -----------
Adjustments to reconcile net (loss)/
income to net cash flows provided by
operating activities:
Depreciation 136,712 287,978 333,632
Amortization of deferred
acquisition costs 82,121 92,592 93,464
Write-down of inventories 337,215 92,670 851,158
Compensation expense resulting
from exercise of stock options 415,430 -- --
Loss on disposal of property
plant and equipment -- 34,422 --
Deferred income
tax provision/(benefit) 355,065 477,278 (879,512)
Provision for doubtful accounts 55,865 80,899 80,725
Impairment loss on goodwill
and trademarks 2,144,522 -- 8,424,487
Settlement of Colgate-
Palmolive debt (417,745) -- --
Changes in operating assets and liabilities:
Accounts receivable (364,607) (74,108) 276,804
Inventories (4,854) 33,832 811,373
Income taxes receivable/payable (237,473) 93,648 279,842
Prepaid expenses
and other current assets 410,522 (426,772) (91,369)
Other assets 815,553 831,699 (78,554)
Accounts payable
and accrued expenses (448,980) 596,495 (541,815)
----------- ----------- -----------
Total adjustments 3,279,346 2,120,633 9,560,235
----------- ----------- -----------
Net cash flows provided
by operating activities 1,103,108 2,881,092 3,301,329
----------- ----------- -----------
See notes to consolidated financial statements.
F-6
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Change in restricted cash 1,102,092 1,110,000 832,500
Purchase of property, plant
and equipment (61,608) (20,265) (30,094)
------------ ------------ ------------
Net cash flows provided by
investing activities 1,040,484 1,089,735 802,406
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (2,024,528) (1,101,817) (1,374,036)
Proceeds from exercise of
stock options 75,575 -- --
Dividends paid (9,094,335) (352,846) (352,846)
------------ ------------ ------------
Net cash flows used in
financing activities (11,043,288) (1,454,663) (1,726,882)
------------ ------------ ------------
NET (DECREASE)/INCREASE IN
CASH AND CASH EQUIVALENTS (8,899,696) 2,516,164 2,376,853
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 13,302,159 10,785,995 8,409,142
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 4,402,463 $ 13,302,159 $ 10,785,995
============ ============ ============
See notes to consolidated financial statements.
F-7
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Supplemental Disclosures of Cash Flow Information:
2004 2003 2002
-------- -------- --------
Interest paid $190,214 $248,051 $448,650
======== ======== ========
Income taxes paid $101,188 $122,255 $212,324
======== ======== ========
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
On August 20, 2004, 125,000 contingently returnable shares, carried at
$1,351,563, were retired and Common Stock and Additional Paid in Capital were
reduced by the same amount in the aggregate.
See notes to consolidated financial statements.
F-8
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of The Stephan Co. and its wholly-owned subsidiaries, Foxy
Products, Inc., Old 97 Company, Williamsport Barber and Beauty Supply Corp.,
Stephan & Co., Scientific Research Products, Inc. of Delaware, Trevor Sorbie of
America, Inc., Stephan Distributing, Inc. and Morris Flamingo-Stephan, Inc.
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation.
NATURE OF OPERATIONS: The Company is engaged in the manufacture, sale, and
distribution of hair and personal care grooming products principally throughout
the United States, and as more fully explained in Note 9, the Company has
allocated substantially all of its business into three segments, which include
professional hair care products and distribution, retail personal care products
and manufacturing.
USE OF ESTIMATES: The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America ("generally accepted accounting principles") requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
MAJOR CUSTOMERS: There were no sales to any single customer in excess of
10% of net sales in 2004. The Company performs ongoing credit evaluations of its
customers' financial condition and, generally, requires no collateral. The
Company does not believe that its customers' credit risk represents a material
risk of loss to the Company. However, the loss of a large customer could have an
adverse effect on the Company.
GOODWILL and OTHER INTANGIBLE ASSETS: Goodwill and trademarks represent
the excess of the purchase price over the fair value of identifiable assets of
businesses or brands acquired, respectively, in transactions accounted for as a
purchase. The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002.
Goodwill and trademarks having indefinite lives, which were being amortized over
various periods, are no longer being amortized and in accordance with SFAS No.
142, are now subject to periodic testing for impairment. Deferred acquisition
costs that have definite lives are continuing to be amortized over their
estimated useful lives of 10 years. Goodwill and trademarks of a reporting unit
(as defined in SFAS No. 142) are tested for impairment on an annual basis at a
minimum, or as circumstances dictate. As a result of implementing SFAS No. 142,
the Company incurred a $6,762,000 impairment charge (net of an income tax
benefit of $1,663,000) upon adoption in 2002. Periodic testing for impairment on
F-9
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
an annual basis necessitated an additional impairment loss in 2004 in the amount
of $2,145,000 in connection with goodwill arising from the purchase of Trevor
Sorbie and trademarks associated with the Stephan Distributing subsidiary. As a
result of the impairment loss, all goodwill associated with the Trevor Sorbie
brand has been written off (See Note 5).
IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets are reviewed for
impairment whenever events or changes in circumstances warrant, which may be an
indication that the carrying value of the asset may ultimately be unrecoverable.
The Company uses fair value methods to determine the amount of impairment, if
any. If necessary, an impairment loss equal to the difference between the
asset's fair value and its carrying value is recognized.
STOCK-BASED COMPENSATION: The Company adopted the disclosure requirements
of SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternate methods of transition for a voluntary change
to the fair value based method of accounting for stock-based compensation and to
require prominent disclosures in both annual and interim financial statements
about the methods of accounting for stock-based compensation and the effect of
the method used on reported results. As permitted by SFAS No. 148 and 123, the
Company continues to apply the accounting provisions of APB No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, with regard to the
measurement of compensation cost for options granted under the Company's
existing plans. No stock-based compensation cost, other than as discussed below,
is reflected in net (loss)/income as all options granted under the plans had an
exercise price not less than the market value of the underlying common stock on
the date of grant. Had expense been recognized using the fair value method
described in SFAS No. 123, using the Black-Scholes option-pricing model, the
Company would have reported the following results of operations (in thousands,
except per share amounts):
Year ended December 31,
--------------------------------
2004 2003 2002
-------- -------- --------
Net (loss)/income, as reported $ (2,176) $ 760 $ (6,259)
Add: Stock-based compensation
included in reported net income,
net of related tax effects 272 -- --
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects (400) (165) (311)
-------- -------- --------
Pro forma net (loss)/income $ (2,304) $ 595 $ (6,570)
======== ======== ========
Net (loss)/income per share:
As reported $ (.50) $ .18 $ (1.46)
Pro forma $ (.53) $ .14 $ (1.53)
F-10
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In connection with the pro-forma information above, the pro forma effect
takes into consideration only options granted since January 1, 1997 and is
likely to increase in future years as additional options are granted and
amortized ratably over the vesting period. The average fair value of stock
options granted during 2004, 2003 and 2002 was $ 2.37, $1.58, and $1.30,
respectively. The fair value of stock options granted was estimated using the
Black-Scholes option-pricing model and included the following assumptions for
the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002
---------- ---------- ----------
Life expectancy 5 years 5 years 5 years
Risk-free interest rate 3% 3% 3%
Expected volatility 69% 59% 55%
Dividends per share $.08 $.08 $.08
In the third quarter of 2004, officers of the Company exercised stock
options utilizing the "cashless method" of exercise. As such, the Company
recorded compensation expense in the amount of $415,430.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The estimated fair values of
financial instruments which are presented herein have been determined by the
Company using available market information and recognized valuation
methodologies. However, considerable judgment is required in interpreting market
data to develop estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of amounts the Company could realize in a
current market sale of such instruments.
The following methods and assumptions were used to estimate fair value:
- the carrying amounts of cash and cash equivalents, receivables and
accounts payable approximate fair value due to their short term
nature;
- discounted cash flows using current interest rates for financial
instruments with similar characteristics and maturity were used to
determine the fair value of notes payable and debt.
As of December 31, 2004 and 2003 there were no significant differences in
the carrying values and fair market values of financial instruments.
REVENUE RECOGNITION: Revenue is recognized when all significant
contractual obligations have been satisfied, which involves the delivery of
manufactured goods and reasonable assurance as to the collectability of the
resulting account receivable.
PROMOTIONAL AND SALES RETURNS ALLOWANCES: The Company participates in
various promotional activities in conjunction with its retailers and
distributors, primarily through the use of discounts, new warehouse allowances,
slotting allowances, co-op advertising and periodic price reduction programs.
All such costs are netted against sales and amounted to approximately $417,000,
F-11
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
$345,000 and $335,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. The allowances for sales returns and consumer and trade promotion
liabilities are established based on the Company's best estimate of the amounts
necessary to settle future and existing obligations for such items on products
sold as of the balance sheet date. While the Company believes that promotional
allowances are adequate and that the judgment applied is appropriate, amounts
estimated to be due and payable could differ materially from actual costs
incurred in the future.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash,
certificates of deposit, U. S. Government issues, and municipal bonds having
maturities of 90 days or less when acquired. The Company maintains cash deposits
at certain financial institutions in amounts in excess of federally insured
limits of $100,000. Cash and cash equivalents held in interest-bearing accounts
as of December 31, 2004 and 2003 were approximately $3,824,000 and $12,698,000,
respectively. At December 31, 2004 and 2003, the Company excluded restricted
cash in the amount of approximately $4,540,000 and $5,643,000, respectively,
from the above as they are pledged as collateral for a bank loan.
INVENTORIES: Inventories are stated at the lower of cost (determined on
the first-in, first-out basis) or market. Direct labor and overhead costs
charged to inventories for the years ended December 31, 2004 and 2003 were
approximately $3,166,000 and $2,940,000, respectively. Direct labor and overhead
costs capitalized in inventories as of December 31, 2004 and 2003 were
approximately $783,000 and $979,000, respectively.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are recorded
at cost. Routine repairs and maintenance are expensed as incurred. Depreciation
is provided on a straight-line basis over the estimated useful lives of the
assets as follows:
Buildings and improvements 15-30 years
Machinery and equipment 5-10 years
Furniture and office equipment 3-5 years
INCOME TAXES: Income taxes are calculated under the asset and liability
method of accounting. Deferred income taxes are recognized by applying the
enacted statutory rates applicable to future year differences between the
financial statement carrying amounts and the tax basis of existing assets and
liabilities. A valuation allowance is recorded when it is more likely than not
that some portion or all of the deferred tax asset will not be realized.
BASIC AND DILUTED EARNINGS PER SHARE: Basic and diluted earnings per share
are computed by dividing net (loss)/income by the weighted average number of
shares of common stock outstanding. For the years ended December 31, 2004, 2003
and 2002, the Company had 291,822, 547,570 and 672,120 outstanding stock
options, respectively. At December 31, 2003, 27,134 options were included in the
calculation of basic and diluted earnings per share. For the years ended
F-12
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
December 31, 2004 and 2002, none because their inclusion would be anti-dilutive,
and as such, 4,348,908 and 4,285,577 shares, respectively, were used for the
calculation of basic and diluted earnings per share.
NEW FINANCIAL ACCOUNTING STANDARDS: In January 2003, the Financial
Accounting Standards Board (the "FASB") issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), an interpretation of
ARB 51. FIN 46, as revised in December 2003, provides guidance on identifying
entities for which control is achieved through means other than through voting
rights, variable interest entities ("VIE"), and how to determine when and which
business enterprises should consolidate the VIE. In addition, FIN 46 requires
both the primary beneficiary and all other enterprises with a significant
variable interest in a VIE to make additional disclosures. The consolidation
provisions of FIN 46 are effective immediately for variable interests in VIE's
created after January 31, 2003. For variable interests in VIE's created before
February 1, 2003, the provisions of FIN 46 are effective for the first interim
or annual period ending after December 15, 2003. The adoption of FIN 46 did not
require a change in accounting treatment of any VIE's. The Company did not
become a party to any VIE's during 2004 or 2003.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity". This statement establishes
standards for the classification and measurement of financial instruments that
possess characteristics similar to both liability and equity instruments. SFAS
No. 150 also addresses the classification of certain financial instruments that
include an obligation to issue equity shares. On October 29, 2003, the FASB
voted to defer, for an indefinite period, the application of certain provisions
of the guidance in SFAS No. 150. The FASB decided to defer the application of
certain aspects of SFAS No. 150 until it could consider some of the resulting
implementation issues. The Company has adopted certain provisions of SFAS No.
150 which did not have a material impact on the Company's financial condition or
results of operations. The Company does not believe the effect of the provisions
of SFAS No. 150 that have been deferred to future periods will have a material
impact on the Company's financial statements.
In December 2004, the FASB issued a revised SFAS No. 123 impacting the
accounting treatment for share-based payments. The revised statement requires
companies to reflect in the income statement compensation expense related to the
grant-date fair value of stock options and other equity-based compensation
issued to employees over the period that such awards are earned. The statement
is effective for the Company's 2006 fiscal year.
RECLASSIFICATIONS: Restricted cash collateralizing the current portion of
long-term debt has been reclassified as a current asset at December 31, 2003.
Changes in restricted cash balances have been presented as cash flows from
investing activities in the accompanying Consolidated Statements of Cash Flows.
Such amounts were previously classified as cash flows from financing activities.
As a result, net cash flows provided by investing activities in the
F-13
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
aforementioned Statements increased by $1,110,000 and $833,000 respectively,
with a corresponding decrease in cash flows provided by financing activities for
the years ended December 31, 2003 and 2002, respectively.
NOTE 2. ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 2004 and 2003 consisted of the
following:
2004 2003
----------- -----------
Trade accounts receivable $ 1,845,098 $ 1,557,432
Less: Allowance for doubtful accounts (91,848) (112,924)
----------- -----------
Accounts receivable, net $ 1,753,250 $ 1,444,508
=========== ===========
The following is an analysis of the allowance for doubtful accounts for
the year ended December 31:
2004 2003 2002
--------- --------- ---------
Balance, beginning of year $ 112,924 $ 163,281 $ 152,225
Provision for doubtful accounts 55,865 80,899 80,725
Uncollectible accounts written off,
net of recoveries (76,941) (131,256) (69,669)
--------- --------- ---------
Balance, end of year $ 91,848 $ 112,924 $ 163,281
========= ========= =========
NOTE 3. INVENTORIES
Inventories at December 31, 2004 and 2003 consisted of the following:
2004 2003
------------ ------------
Raw materials $ 1,827,553 $ 2,007,174
Packaging and components 2,187,901 2,612,798
Work in progress 429,552 257,476
Finished goods 4,651,422 5,338,369
------------ ------------
9,096,428 10,215,817
Less: Amount included
in other assets (1,931,527) (2,718,555)
------------ ------------
Balance, end of year $ 7,164,901 $ 7,497,262
============ ============
Raw materials include surfactants, chemicals and fragrances used in the
production process. Packaging materials include cartons, inner sleeves and boxes
used in the actual product, as well as outer boxes and cartons used for shipping
F-14
NOTE 3. INVENTORIES (Continued)
purposes. Components are the bottles or containers (plastic or used for shipping
purposes. Components are the bottles or containers (plastic or glass), jars,
caps, pumps and similar materials that will become part of the finished product.
Finished goods also include hair dryers, electric clippers, lather machines,
scissors and salon furniture.
Included in other assets is inventory not anticipated to be utilized
within one year and is comprised primarily of packaging, components and finished
goods. The Company reduces the carrying value of inventory to provide for these
slow moving goods that includes the estimated costs of disposal of inventory
that may ultimately become unusable or obsolete.
NOTE 4. PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment at December 31, 2004 and 2003 consisted of
the following:
2004 2003
----------- -----------
Land $ 379,627 $ 379,627
Buildings and improvements 2,159,046 2,129,570
Machinery and equipment 1,852,551 1,854,287
Furniture and office equipment 571,710 547,024
----------- -----------
4,962,934 4,910,508
Less: accumulated depreciation (3,335,707) (3,208,178)
----------- -----------
Balance, end of year $ 1,627,227 $ 1,702,330
=========== ===========
NOTE 5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 142 provides that goodwill and other intangible assets with
indefinite lives will not be amortized, but will be tested for impairment at
least annually. The Company adopted SFAS No. 142 on January 1, 2002. SFAS No.
142 requires that goodwill and other intangible assets be tested for impairment
upon adoption and at least annually thereafter.
As a result of the impairment review mandated by SFAS No. 142, the Company
determined that the carrying value of certain goodwill and trademarks with
indefinite lives was impaired, decreasing the carrying value of goodwill and
other such intangible assets, upon adoption, by approximately $8,424,000
($6,762,000, net of taxes).
The above impairment charge, recorded as a cumulative effect of change in
accounting principle, as prescribed by SFAS No. 142, impacted several different
subsidiaries and divisions. Based upon information available to the Company, in
general, goodwill and trademark valuations were performed using present value
techniques involving estimates of future cash flows. The change in the carrying
amount of goodwill and trademarks, by segment impacted, for the year ended
December 31, 2002 can be summarized as follows (in thousands):
F-15
NOTE 5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLE ASSETS (Continued)
Total Professional Retail
-------- ------------ --------
Balance, December 31, 2001 $ 22,947 $ 9,905 $ 13,042
Goodwill and trademark impairment
upon adoption of SFAS No. 142 (8,424) (3,440) (4,984)
-------- ------- --------
Balance, December 31, 2002 $ 14,523 $ 6,465 $ 8,058
======== ======= ========
Since implementing SFAS No. 142, the Company performs annual impairment
tests. For the year ended December 31, 2004, it was determined that an
additional impairment loss of approximately $2.15 million was necessary.
Approximately $1.85 million of this impairment was in connection with goodwill
arising from the purchase of the Trevor Sorbie of America line in June 1996 and
the remaining $.3 million was related to the trademarks associated with the
Stephan Distributing subsidiary. This charge was primarily based on management's
estimated fair value of each reporting unit using discounted present value of
cash flows and valuation models as of the test date. The impairment was a result
of the declining sales and an adverse outcome of litigation within the reporting
unit, including the operations of Trevor Sorbie of America. As a result of the
impairment loss, all goodwill associated with the Trevor Sorbie brand has been
written off and included in selling, general and administrative expenses in the
statement of operations.
Other intangible assets can be summarized as follows:
2004 2003
--------- ---------
Deferred acquisition costs $ 934,544 $ 934,544
Less: Accumulated amortization (717,892) (635,771)
--------- ---------
Balance, end of year $ 216,652 $ 298,773
========= =========
Amortization expense of other intangible assets for 2004, 2003 and 2002
was $82,000, $93,000 and $93,000, respectively. Amortization expense of other
intangible assets, recorded as of December 31, 2004, for the years ended
December 31, 2005 through 2009 is anticipated to be as follows: 2005: $75,000;
2006: $66,000; 2007: $66,000; 2008: $10,000.
F-16
NOTE 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 2004 and 2003
consisted of the following:
2004 2003
---------- ----------
Accounts payable $ 384,831 $ 539,311
Accrued marketing expenses 146,744 226,998
Accrued royalty payable 723,902 508,093
Accrued payroll, bonuses and related costs 324,783 1,046,311
Accrued "privatization" expenses 158,279 --
Accrued legal and professional fees 251,039 223,490
Other accrued expenses 176,173 70,528
---------- ----------
Balance, end of year $2,165,751 $2,614,731
========== ==========
Accrued "privatization" expenses shown above are due to Eastchester
Enterprises, an entity created by the four Board members who attempted to take
the Company private (See Note 10).
NOTE 7. LONG-TERM DEBT
Long-term debt at December 31, 2004 and 2003 consisted of the following:
2004 2003
----------- -----------
1.50% note payable to bank, principal
of $92,500 plus interest due monthly
through August 2, 2006; collateralized
by a security interest in a restricted
cash account of like amount, which
bears interest at 50 basis points below
the interest charged on the note. The
interest rate on the note and the cash
collateral resets annually. $ 4,347,500 $ 5,457,500
Guaranteed minimum payments of $250,000
due semi-annually to Colgate-Palmolive
through January 31, 2004, discounted
at an 8% rate; collateralized by a
security interest in the brand trade-
marks acquired from Colgate-Palmolive. -- 1,332,273
----------- -----------
4,347,500 6,789,773
Less: current portion (1,110,000) (2,442,273)
----------- -----------
Long-term debt $ 3,237,500 $ 4,347,500
=========== ===========
At December 31, 2004, approximate maturities of long-term debt are
$1,110,000 in 2005 and $3,237,500 in 2006.
On April 7, 2004, the Company and Colgate-Palmolive mutually agreed to
settle all outstanding claims and issues between them. The net result of this
settlement was a reduction of the above obligation by approximately $418,000.
This amount is included in other income in 2004.
F-17
NOTE 8. INCOME TAXES
The provision for income taxes is comprised of the following for the years
ended December 31:
2004 2003 2002
--------- -------- --------
Current tax:
Federal $(105,047) $117,021 $ --
State (107,767) 132,575 113,482
--------- -------- --------
Total current (benefit)/provision (212,814) 249,596 113,482
--------- -------- --------
Deferred tax:
Federal 220,766 433,266 703,396
State 134,299 44,012 80,002
--------- -------- --------
Total deferred provision 355,065 477,278 783,398
--------- -------- --------
Total provision for income taxes $ 142,251 $726,874 $896,880
========= ======== ========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax purposes.
The net deferred income tax liability in the accompanying consolidated
balance sheets includes deferred tax assets and liabilities attributable to the
following items:
2004 2003
----------- -----------
Accounts receivable allowances $ (36,280) $ (44,604)
Inventory allowance (141,063) (101,845)
Property, plant and equipment 68,800 95,208
Amortization of intangibles 2,085,642 1,601,809
Charitable contribution carryforward (122,546) (121,747)
State income taxes (91,679) (57,407)
Net operating loss carryover (391,736) --
Accrued liabilities and other (5,568) (360,110)
----------- -----------
1,365,570 1,011,304
Less: Valuation allowance 122,546 121,747
----------- -----------
Deferred income tax liability, net $ 1,488,116 $ 1,133,051
=========== ===========
F-18
NOTE 8. INCOME TAXES (Continued)
The provision for Federal and state income taxes differs from statutory
tax expense (computed by applying the U.S. Federal corporate tax rate to income
before taxes) as follows:
2004 2003 2002
------ ------ ------
Amount computed on pretax income (34.0%) 35.0% 35.0%
Increase(decrease) in taxes:
State income taxes, net of
federal tax benefit .8 7.8 9.1
Goodwill impairment 30.8 -- 19.2
Goodwill/Trademarks .2 .2 .2
Benefit of graduated rates -- (1.0) (1.0)
Compensation limitations 8.1 -- --
Privatization transaction costs 2.7 6.7 --
Tax exempt interest (1.0) (1.6) (1.8)
Other (.6) 1.8 3.3
------ ------ ------
Total income tax 7.0% 48.9% 64.0%
====== ====== ======
For the year ended December 31, 2004, the Company has an income tax
valuation allowance of approximately $122,546 in order to provide for the
likelihood that the Company's charitable contribution carryforward will expire
unused. The Company has net operating loss carryforwards of approximately
$1,021,000 for Federal income tax purposes which expire beginning in 2024 if not
utilized.
NOTE 9. SEGMENT INFORMATION
The Company has identified three reportable operating segments based upon
how management evaluates its business. These segments are Professional Hair Care
Products and Distribution ("Professional"), Retail Personal Care Products
("Retail") and Manufacturing. The Professional segment generally has a customer
base of distributors that purchase the Company's hair products and beauty and
barber supplies for sale to salons and barbershops. The customer base for the
Retail segment is mass merchandisers, chain drug stores and supermarkets that
sell the product to the end user. The Manufacturing segment manufactures
products for subsidiaries of the Company, and manufactures private label brands
for customers.
The Company conducts operations primarily in the United States and sales
to international customers are not material to consolidated revenues. The
following tables, in thousands, summarize significant accounts and balances by
reportable segment:
F-19
NOTE 9. SEGMENT INFORMATION (Continued)
(LOSS)/INCOME BEFORE INCOME TAXES
AND CUMULATIVE EFFECT OF CHANGE
NET SALES IN ACCOUNTING PRINCIPLE
-------------------------------- -----------------------------
2004 2003 2002 2004 2003 2002
-------------------------------- -----------------------------
Professional $ 17,538 $ 17,573 $ 17,891 $(1,801) $ 1,449 $ 1,081
Retail 5,734 7,373 6,728 486 873 885
Manufacturing 5,689 6,713 7,144 (292) (112) (29)
-------- -------- -------- ------- ------- -------
Total 28,961 31,659 31,763 (1,607) 2,210 1,937
Intercompany
Manufacturing (5,010) (6,323) (6,696) (427) (723) (537)
-------- -------- -------- ------- ------- -------
Consolidated $ 23,951 $ 25,336 $ 25,067 $(2,034) $ 1,487 $ 1,400
======== ======== ======== ======= ======= =======
INTEREST INCOME INTEREST EXPENSE
------------------- ------------------
2004 2003 2002 2004 2003 2002
------------------- ------------------
Professional $104 $174 $233 $ 56 $ 90 $270
Retail 53 47 95 33 304 201
Manufacturing 7 6 50 2 9 8
---- ---- ---- ---- ---- ----
Total $164 $227 $378 $ 91 $403 $479
==== ==== ==== ==== ==== ====
DEPRECIATION AND
AMORTIZATION TOTAL ASSETS
-------------------- ------------------
2004 2003 2002 2004 2003
-------------------- ------------------
Professional $ 78 $ 89 $135 $10,985 $17,116
Retail 43 43 43 16,003 20,866
Manufacturing 98 249 249 7,731 10,081
---- ---- ---- ------- -------
Total $219 $381 $427 $34,719 $48,063
==== ==== ==== ======= =======
The accounting policies used for each of the segments are the same as
those used for the Company and are described in the summary of significant
accounting policies in Note 1. Included in Manufacturing net sales are
intercompany sales to related segments, which are generally recorded at cost
plus 10%. Management of the Company evaluates the performance of each segment
based upon results of operations before income taxes, intercompany allocations,
interest and amortization.
F-20
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements with certain officers.
These agreements, which expire on various dates through December 2008, provide
for incentive bonuses based on consolidated earnings per share in excess of the
applicable base year, as defined in the employment agreement. No bonuses were
payable for the year ended December 31, 2004 and 2002. For the year ended
December 31, 2003, management bonuses included in selling, general and
administrative expenses were $755,000. In July 2005, the President of the
Company took a voluntary, unilateral reduction in compensation to $540,000 per
year. In accordance with the terms of the waiver of compensation, the President
retains the right to his original contractual compensation level upon the
occurrence of certain specified events relating to a change in control, or
reasonable likelihood of a change in control of the Company, as defined in the
waiver.
In August 2003, the Company secured a $5,000,000 line of credit with
Merrill Lynch Business Financial Services, Inc. which expired in August 2004.
The Company entered into negotiations to renew the line of credit and subsequent
to year-end, the Company renewed the line at a reduced amount of $1,500,000,
through August 2005. Although the credit line was available to the Company
during the renegotiation period, the line remained unused. The line of credit,
when used, bears interest at the rate of LIBOR plus 2.25%.
The Company was not a party to any non-cancelable operating leases at
December 31, 2004. Annual rent expense for each of the last three years is as
follows:
2004 $692,800
2003 620,800
2002 600,800
Included in rent expense above for the years ended December 31, 2004, 2003
and 2002 is $ 273,000, $213,000 and $179,000, respectively, paid to Shaheen &
Co., Inc., the former owner of Morris Flamingo. Shouky A. Shaheen, a minority
owner of Shaheen & Co., Inc., who owns the building the Company leases in
Danville, Illinois, is currently a member of the Board of Directors and a
significant shareholder of the Company. On May 4, 2005, the Company entered into
a Second Amendment of Lease Agreement (the "Amendment") for the Danville, IL
facility. The Amendment extends the term of the lease to June 30, 2015, with a
five year renewal option, and increases the annual rental to $302,780. The base
rent is adjustable annually, in accordance with the existing master lease, whose
terms, including a 90-day right of termination by the Company, remain in full
force and effect. In addition, the Company has a purchase option, during the
term of the lease, to purchase the premises at the then fair market value of the
building, or to match any bona fide third-party offer to purchase the premises.
On July 6, 2005, the landlord notified the Company that their interpretation of
the Amendment differs from that of the Company as to the existence of the 90-day
right of termination. This matter is currently unresolved and the Company is
unable, at this time, to determine the outcome of the disagreement. However, if
it is ultimately determined that the early termination provision has been
F-21
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
eliminated with the Amendment, the Company's minimum lease obligation would
amount to $151,390 in 2005, $302,780 in 2006, $302,780 in 2007, $302,780 in 2008
$302,780 in 2009 and $1,665,289 thereafter.
In addition to the matters set forth below, the Company is involved in
other litigation arising in the normal course of business. It is the opinion of
management that none of such matters, at December 31, 2004, would likely, if
adversely determined, have a material adverse effect on the Company's financial
position, results of operations or cash flows.
In 1997 the Company's wholly-owned subsidiary, Stephan Distributing, Inc.,
acquired several product lines from New Image Laboratories, Inc. ("New Image").
The primary brands acquired were a professional hair care line of products
marketed under the brand name "Image," and a retail hair care line known as
"Modern" and marketed under the brand name "Stiff Stuff." A portion of the
purchase price included a contingent payment of 125,000 shares of the Company's
common stock payable upon the achievement of certain earnings levels.
New Image commenced litigation against the Company seeking, among other
things, a declaratory decree that the 125,000 shares of the Company's common
stock held in escrow for the contingent payment of certain purchase price
adjustments be released from escrow and turned over to New Image. In the action
commenced by New Image against the Company in the United States District Court
for the Central District of California, the parties reached a settlement
pursuant to a stipulation of settlement and amendments thereto which provided,
among other things, as follows: (i) New Image relinquished title to 65,000 of
the 125,000 shares of the Company's common stock held in escrow and received
60,000 shares, (subsequently, New Image elected to sell the Company its 60,000
shares for $285,000), (ii) Stephan was awarded $44,000 in damages from New
Image, (iii) dividends, and interest accrued thereon, held in the escrow account
(approximately $72,000) will be distributed with Stephan receiving 52% of such
funds and New Image receiving 48% of such funds, which was used to satisfy, in
part, the award under (ii) above. As a result of this settlement, the Company
recorded an expense of approximately $285,000 for the quarter ended June 30,
2004 and the amount is reflected as a reduction of royalty and other income on
the consolidated statement of operations. In the third quarter of 2004, the
amount of the contingently returnable shares recorded in the financial
statements of the Company was offset against additional paid in capital when the
shares were retired. New Image's claim for diminution of the value of the shares
held in escrow was heard before a special master in late October 2004 and on
March 30, 2005, the special master recommended that judgment be entered in favor
of the Company. The federal court then entered an order confirming the findings
of the Special Master and entered judgment denying New Image's diminution claim.
New Image has not appealed the judgment.
In the fourth quarter of 2003, Sorbie Acquisition Co. ("SAC"), a
wholly-owned subsidiary of the Company, and Trevor Sorbie International, Plc.
("TSI") commenced arbitration proceedings before the American Arbitration
Association in Pittsburgh, Pennsylvania. This arbitration proceeding arose
F-22
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
from a lawsuit filed against SAC by TSI alleging causes of action for breach of
contract, declaratory judgment and trademark infringement. On October 25, 2004,
the arbitration panel returned an award in favor of TSI with respect to certain
royalties due, including interest, and in favor of SAC with respect to the
infringement of SAC's rights of exclusive publicity in their territory. The
panel did not affirm any of the other claims alleged by either of the parties to
the proceeding. In Federal Court, SAC appealed the decision on certain grounds,
including an improper computation of the interest due on additional royalties.
The financial statements for the year ended December 31, 2004 reflect a
liability of approximately $725,000 for payment of the award. Also, SAC may
incur additional interest from the date of the award. Due to the complexities of
the issues involved, however, the Company is currently unable to predict the
outcome of the appeal, including whether or not the appeal will be heard.
On April 30, 2003, the Board of Directors approved a definitive merger
agreement (the "Merger Agreement") pursuant to which the Company would be
acquired, in a "going-private" transaction, by Gunhill Enterprises, Inc., a
wholly-owned subsidiary of Eastchester Enterprises, Inc. Eastchester
Enterprises, Inc. is owned by Frank F. Ferola, Thomas M. D'Ambrosio, John
DePinto and Shouky A. Shaheen (all of whom were current Board members) together
with their affiliates (the "Acquisition Group"). The Company entered into the
Merger Agreement following approval by its Board of Directors based in part upon
the unanimous recommendation of the Special Committee comprised of two
non-management and disinterested directors of the Company's Board of Directors.
The Special Committee had received an opinion from SunTrust Robinson Humphrey
that the consideration to be paid pursuant to the Merger Agreement was fair from
a financial point of view to the stockholders other than the Acquisition Group.
On November 4, 2003, in connection with the "going-private" trans- action,
the Company filed a Preliminary Proxy with the Securities and Exchange
Commission ("SEC"). On August 25, 2004, the Merger Agreement was terminated and
the Acquisition Group withdrew its offer to acquire the shares of Stephan common
stock not owned by it and informed Stephan that it has decided not to pursue
such an acquisition at this time. As a result of the above, the Company incurred
termination expenses in the amount of $158,000 in accordance with the terms of
the Merger Agreement, payable to the Acquisition Group and the amount is
included in selling, general and administrative expenses in the statement of
operations.
As previously reported, the Company has not submitted any matters to a
vote of its security holders since the Company's September 1, 2000 Annual
Meeting. In accordance with the rules and regulations of the American Stock
Exchange ("AMEX"), the Company was required to promptly notify its stockholders
and AMEX, in writing, indicating the reasons for the failure to have a meeting
and to use good faith efforts to ensure that an annual meeting is held as soon
as reasonably practicable. The Company included annual meeting materials in its
revised proxy statement, filed with the SEC on April 13, 2004. In a press
release issued by the Company on October 29, 2004, the Company indicated that
the next annual meeting of shareholders, previously set for November 10, 2004,
F-23
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
had been delayed, and the Company expected to formally notify all shareholders
of the definitive date and location of such meeting in the near future. The
Company was required by AMEX to file a Corporate Governance Certification by
October 31, 2004, but has been unable to do so because the composition of the
Board of Directors and the Audit Committee does not meet the enhanced
independent requirements of AMEX. On November 19, 2004, the Company received a
warning letter from AMEX indicating that the Company was deficient with respect
to the above, in addition to not being in compliance with nominating committee
requirements and a web-site posting (or other public notice) of a code of
conduct and ethics for all directors, officers and employees. By January 11,
2005, the Company became compliant by appointing another independent Board
member and filing the appropriate Corporate Governance Certification.
As indicated above, the Company was not in compliance with Section 704 of
the AMEX Company Guide in that it has not held an annual meeting of stockholders
since September 1, 2000. On January 25, 2005, the Company received a letter from
AMEX requiring the submission of a timetable for compliance with the above
Section 704, relating to the holding an annual meeting of stockholders. The AMEX
requested that the timetable indicate actions the Company has taken, or will
take, in order to bring the Company into compliance with AMEX continued listing
standards by no later than May 31, 2005. In spite of its continuing efforts to
schedule an annual meeting of stockholders, the Company was unable to comply
with the May 31, 2005 deadline. The Company has previously been advised that
failure to meet this deadline of May 31, 2005 may cause the Company's common
stock to be delisted. In addition, the Company was not in compliance with
Sections 134, 1101 and 1003(d) of the AMEX Company guide due to the failure to
file a timely Annual Report on Form 10-K for the year ended December 31, 2004
and the Quarterly Report on Form 10-Q for the period ended March 31, 2005. On
June 7, 2005, The Company received notification that the AMEX was proceeding
with delisting procedures. These procedures allow the Company to appeal the
delisting process and as such, a hearing before a Listing Qualifications Panel
was held on July 27, 2005. On August 3, 2005, the Company received the Panel's
unanimous written decision, which grants the Company an extension of time until
September 30, 2005, to regain compliance with Amex listing standards. However,
the Panel also unanimously agreed that should the Company not be in complete
compliance with AMEX listing standards by September 30, 2005, the Amex could
then immediately move to delist the Company's common stock. The Panel based its
decision upon the Company's representations at the hearing and its public
filings.
The Company believes that if its common stock is delisted from AMEX, such
delisting is not expected to have a direct impact on the financial condition or
operations of the Company, but it could adversely affect the liquidity and price
of the Company's common stock, as well as the Company's ability to raise
additional capital.
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS
1,000,000 shares of preferred stock, $0.01 par value are authorized;
however, no shares have been issued.
F-24
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS (Continued)
In 1990, the shareholders of the Company approved the 1990 Key Employee
Stock Incentive Plan, as amended, and the 1990 Non-Employee (Outside Directors)
Plan, as amended, and in 2000, the shareholders approved a ten-year extension of
both plans. The aggregate number of shares currently authorized pursuant to the
Key Employee Plan, as adjusted for stock splits and shareholder-approved
increases in 1994 and 1997, is 870,000 shares. The number of shares and terms of
each grant is determined by the Compensation Committee of the Board of
Directors, in accordance with the 1990 Key Employee Plan, as amended.
The Outside Directors Plan provides for annual grants, as adjusted for
stock splits, of 5,062 shares to non-employee directors. Such grants are granted
on the earlier of June 30 or the date of the Company's Annual Meeting of
Shareholders, at the fair market value at the date of grant. The aggregate
number of shares reserved for granting under this plan, as adjusted for stock
splits, is 202,500.
Stock options are granted at the discretion of the Compensation Committee
of the Board of Directors. The options become exercisable one year from the
grant date and are exercisable within a maximum of 10 years from the date of
grant. Stock option activity for 2004, 2003, and 2002 is set forth below:
Key Employee Outside
Incentive Avg. Directors Avg.
Plan Price Plan Price
-------------------------------------------------------------------------------
Outstanding at December 31, 2001 ... 647,470 $ 8.36 96,178 $ 7.02
Granted ............................ 70,000 3.00 20,248 3.67
Canceled ........................... (146,590) 8.47 (15,186) 11.23
Exercised .......................... -- --
-------- -------
Outstanding at December 31, 2002 ... 570,880 7.68 101,240 5.72
Granted ............................ 60,000 3.44 20,248 3.71
Canceled ........................... (184,550) 9.38 (20,248) 13.21
Exercised .......................... -- --
-------- -------
Outstanding at December 31, 2003 ... 446,330 6.41 101,240 3.82
Granted ............................ 50,000 4.32 20,248 4.82
Canceled ........................... -- (20,248) 4.18
Exercised .......................... (285,500) 3.49 (20,248) 3.73
-------- -------
Outstanding at December 31, 2004 ... 210,830 $ 9.87 80,992 $ 3.43
======== =======
In the third quarter of 2004, certain officers of the Company exercised
stock options utilizing the "cashless method" of exercise. As such, the Company
recorded compensation expense in the amount of $415,430, included in selling,
general and administrative expenses in the statement of operations.
F-25
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS (Continued)
The number of shares and average exercise price of options exercisable at
December 31, 2004, 2003 and 2002 were 160,830 shares at $11.59, 396,330 shares
at $6.79, and 510,880 shares at $8.23, respectively, for the 1990 Key Employee
Stock Incentive Plan and 60,744 at $3.73, 80,992 at $3.85, and 80,992 at $6.23,
respectively, for the Outside Directors Plan. At December 31, 2004 and 2003,
373,670 and 423,670 respectively, were available for future grants under the
terms of the 1990 Key Employee Stock Incentive Plan and 81,012 shares and
101,260 shares, respectively, were available for future grants under the terms
of the Outside Directors Plan.
The exercise price range of options outstanding and exercisable as of
December 31, 2004 for both the Key Employee Stock Incentive and Outside
Directors plans, the weighted average contractual lives remaining (in years) and
the weighted average exercise price are as follows:
Outstanding Exercisable
---------------------------- -------------------
Exercise Number Average Average Number Average
Price Range of shares Life Price of shares Price
--------------- ---------- ------- ------- --------------------
$ 3.00 - $ 5.00 141,822 4.73 $ 4.11 71,574 $ 3.76
$10.00 - $13.50 150,000 3.00 $12.15 150,000 $12.15
--------- ---------
291,822 221,574
========= =========
NOTE 12. SUBSEQUENT EVENT
On August 1, 2005, the Company entered into a Brand License Agreement with
The Quantum Beauty Company Limited (the "Licensor") for the exclusive rights to
manufacture, market and distribute the "Lee Stafford" brand of hair care
products in the Western Hemisphere (the "License Agreement"). The initial term
of the License Agreement is 5 years, with a minimum 5 year renewal at the
Licensor's option. The Company is subject to certain requirements, including
satisfactory compliance with manufacturing and quality standards, reporting
timeframes, payment of royalties, minimum marketing, advertising and promotional
expenditures as well as targeted sales goals increasing on an annual basis.
F-26
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
ADVERTISING, PROMOTION and RETURNS ALLOWANCES
2004 2003 2002
--------- --------- ---------
Balance, beginning of year $152,906 $152,708 $101,948
Additions 417,152 344,621 335,218
Utilizations 465,399 344,423 284,458
--------- --------- ---------
Balance, end of year $104,659 $152,906 $152,708
========= ========= =========
DEFERRED TAX VALUATION ALLOWANCE
2004 2003 2002
--------- --------- ---------
Balance, beginning of year $121,747 $268,359 $ --
Additions 799 1,579 268,359
Utilizations -- 148,191 --
--------- --------- ---------
Balance, end of year $122,546 $121,747 $268,359
========= ========= =========
F-27
SIGNATURES
Pursuant to the requirements of Section 13 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.
THE STEPHAN CO.
By: /s/ Frank F. Ferola
-----------------------------------
Frank F. Ferola
President and Chairman of the Board
September 9, 2005
By: /s/ David A. Spiegel
-----------------------------------
David A. Spiegel
Principal Financial Officer
Principal Accounting Officer
September 9, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By: /s/ Frank F. Ferola By: /s/ Shouky Shaheen
------------------------------ ----------------------------
Frank F. Ferola, Principal Shouky Shaheen, Director
Executive Officer and Director Date: September 9, 2005
Date: September 9, 2005
By: /s/ John DePinto By: /s/ Curtis Carlson
------------------------------ ----------------------------
John DePinto, Director Curtis Carlson, Director
Date: September 9, 2005 Date: September 9, 2005
By: /s/ Leonard Genovese By: /s/ Richard A. Barone
------------------------------ ----------------------------
Leonard Genovese, Director Richard A. Barone, Director
Date: September 9, 2005 Date: September 9, 2005
By: /s/ William Gross
------------------------------
William Gross, Director
Date: September 9, 2005
38