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, 2005
Commission File No. 1-4436
THE STEPHAN CO.
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Florida 59-0676812
------------------------------- ----------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1850 West McNab Road, Fort Lauderdale, Florida 33309
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (954) 971-0600
-------------
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 if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES |_| NO |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES |_| NO |X|
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 |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act).
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). YES |_| NO |X|
The aggregate market value of the voting and non-voting common equity shares
held by non-affiliates as of June 30, 2005, the last business day of the
Registrant's most recently completed second fiscal quarter was $12,871,299,
based upon the reported sale price of $4.25 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 March 31, 2006
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
----
PART I
Item 1: Business........................................................ 5
Item 1A: Risk Factors.................................................... 9
Item 1B: Unresolved Staff Comments....................................... 13
Item 2: Properties...................................................... 13
Item 3: Legal Proceedings............................................... 14
Item 4: Submission of Matters to a Vote of Security Holders............. 15
PART II
Item 5: Market for the Registrant's Common Equity
and Related Stockholder Matters................................ 16
Item 6: Selected Financial Data......................................... 17
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 18
Item 7A: Quantitative and Qualitative Disclosures about Market Risk...... 25
Item 8: Financial Statements and Supplementary Data..................... 25
Item 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ 25
Item 9A: Controls and Procedures......................................... 26
Item 9B: Other Information............................................... 26
PART III
Item 10: Directors and Executive Officers of the Registrant.............. 27
Item 11: Executive Compensation.......................................... 29
Item 12: Security Ownership of Certain Beneficial Owners,
Management and Related Stockholder matters..................... 34
Item 13: Certain Relationships and Related Transactions.................. 35
Item 14: Principal Accountant Fees and Services.......................... 36
PART IV
Item 15: Exhibits and Financial Statement Schedules...................... 37
Signatures................................................................ 40
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, 2005; our ability to satisfactorily address any material weakness 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; 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.
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
4
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 nine wholly-owned operating
subsidiaries, Foxy Products, Inc., Old 97 Company, Williamsport Barber and
Beauty Corp., Stephan & Co., Scientific Research Products, Inc. of Delaware,
Sorbie Distributing Corporation, Stephan Distributing, Inc., Morris
Flamingo-Stephan, Inc. and American Manicure, 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,
barbershops and beauty schools. 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 the cutting and styling of 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 one of our subsidiaries,
Scientific Research Products, 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 our "Stiff Stuff" products. The sales of these products
are also included in the Company's Retail segment. In addition, The Frances
Denney division (included 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.,
5
we market the brand names HOPE, INTERLUDE and FADE-AWAY through several retail
chains 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 $2,867,000 of the Company's 2005 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.
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 2005. 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 2005.
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 manufac- tures 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, Stephan Distributing, Inc. and Sorbie Distributing Corporation. The
operations of Old 97 are included in the Manufacturing segment of our business.
WILLIAMSPORT BARBER AND BEAUTY CORP.
Williamsport Barber and Beauty Corp. ("Williamsport"), a wholly-owned
subsidiary of the Company, is located in Williamsport, Pennsylvania.
6
Williamsport, a mail order beauty and barber supply company, with net sales of
approximately $4,192,000 in 2005, accounted for approximately 18.8% of our
consolidated revenues for the year and are included in the Professional business
segment.
STEPHAN & CO.
Stephan & Co., a wholly-owned subsidiary, has focused on the distribution
of personal care amenity products to resorts and spas. For the year ended
December 31, 2005, Stephan & Co. had net sales of approximately $404,000.
SCIENTIFIC RESEARCH PRODUCTS, INC. OF DELAWARE.
Scientific Research Products, Inc. of Delaware ("Scientific") is a
wholly-owned subsidiary, which accounted for 6.8% of our consolidated revenues
in 2005, with net sales of approximately $1,524,000. The majority of the sales
of Scientific are included in the Retail business segment.
SORBIE DISTRIBUTING CORPORATION
Sorbie Distributing Corporation ("Sorbie") is a wholly-owned subsidiary
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 2005 were approximately $631,000, representing 2.8%
of our consolidated revenues, and are included in the Professional business
segment of the Company's business.
STEPHAN DISTRIBUTING, INC.
Stephan Distributing, Inc., wholly-owned subsidiary, distributes a
professional hair care line of products marketed under the brand name "Image,"
and a retail hair care line marketed under the brand name "Stiff Stuff." Sales
of professional brands acquired from New Image amounted to approximately 4.8% of
consolidated revenues, or approximately $1,073,000 of net sales for the year
ended December 31, 2005. 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, 2005 were approximately $11,227,000, accounting for
approximately 50.4% of our consolidated revenues, and are included in the
Professional segment of the Company's business.
AMERICAN MANICURE, INC.
American Manicure, Inc. was created in June, 2005 to acquire the assets
and business of AM Laboratories, Inc., a company that distributed "Natural" and
"French" nail polish manicure kits to other distributors and
7
salons. The transaction was accounted for as a purchase, and included primarily
inventory and accounts receivable amounting to approximately $150,000. The
purchase transaction was closed on June 17, 2005 and no goodwill was recorded as
a result of the acquisition. Sales for the year ended December 31, 2005 were not
material.
SEGMENT INFORMATION
"Operating Segments and Related Information," which provides informa- tion
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
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 as well as an increase
in overall freight costs; 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, 2005 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, 2005,
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
8
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.
EMPLOYEES
As of December 31, 2005, in addition to its four executive officers, the
Company and its subsidiaries employed 107 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 1A: Risk Factors
An investor should carefully consider the risks described below, in
addition to other information included elsewhere in this Annual Report on Form
10-K and other documents we file with the SEC. The risks and uncertainties
described below are those that the Company has identified as material, but are
not the only risks and uncertainties facing the Company. Our business is also
subject to general risks and uncertainties that affect other companies, such as
overall U.S. and non-U.S. economic and industry conditions, including global
economic events, geopolitical events, changes in laws or accounting rules,
terrorism and/or other international conflicts, natural disasters or other
disruptions of unexpected economic/business conditions. Additional risks and
uncertainties not currently known to us or that we currently believe are
immaterial may also impact our business operations, financial results and
liquidity.
Many of the markets we serve are highly competitive, which could limit the
volume of products that we sell and reduce our operating margins.
Our products are sold in a competitive marketplace which is experiencing
increased trade concentration and the growing presence of large-format retailers
and discounters. With the growing trend toward retail trade consolidation, we
9
are increasingly dependent on key retailers, and some of these retailers,
including large-format retailers, have greater bargaining strength than we do.
They may use this leverage to demand higher trade discounts, allowances or
slotting fees which could lead to reduced sales or profitability. We believe
that significant points of competition in our markets are product quality,
price, product development, conformity, to customer specifications, reliability
and timeliness of delivery, customer service and effectiveness of distribution.
Maintaining and improving our competitive position requires continued investment
by us in manufacturing, quality standards, marketing, customer service and
support of our distribution networks. The Company may have insufficient
resources in the future to continue to make such investments and, even if we
make such investments, we may not be able to maintain or improve our competitive
position.
We may also be negatively affected by changes in the policies of our
retail trade customers, such as inventory de-stocking, limitations on access to
shelf space, delisting of our products and other conditions. In addition,
private label brands sold by retail trade chains, which are typically sold at
lower prices, are a source of competition for some of our product lines.
Consumers may reduce discretionary purchases of our products as a result of a
general economic downturn or other external factors.
We believe that consumer spending on specific hair care and fragrance
products may be influenced by general economic conditions and the availability
of discretionary income. As a result, we may experience periods of declining
sales during economic downturns. In addition, a general economic downturn may
result in reduced traffic in our customers' stores which may, in turn, result in
reduced net sales to our customers. Any resulting material reduction in our
sales could have a material adverse effect on our business, its profitability or
operating cash flows.
Increases in our raw material or component costs or difficulties within our
supplier base could negatively affect our profitability.
Generally, our raw materials and component requirements are obtainable from
various sources and in desired quantities. While we currently maintain
alternative sources for raw materials and components, our business is subject to
the risk of price fluctuations and, perhaps, periodic delays in the delivery of
certain raw materials and components. Due to market conditions in the petroleum
industry, the Company continues to experience price increases in both raw
material and component prices as well as an increase in overall freight costs.
While the rise in material costs may continue to impact our financial results,
we have been able to offset most of these cost increases through price recovery
from our customers and cost reductions. Our ability to continue to pass along
cost increases on a going forward basis is not guaranteed. In addition, a
failure by our suppliers to continue to supply us with raw materials or
component parts on commercially reasonable terms, or at all, would have a
material adverse effect on us.
Historically, the Company has grown primarily through acquisitions. If we are
unable to identify attractive acquisition candidates and successfully integrate
acquired operations, we may be adversely affected.
10
One of our principal growth strategies in the past has been to pursue
strategic acquisition opportunities. A substantial portion of our historical
growth has been from acquisitions. Attractive acquisition opportunities may not
be identified or acquired in the future, financing may be unavailable on
satisfactory terms or we may be unable to accomplish our strategic objectives in
effecting a particular acquisition. We may encounter various risks in acquiring
other companies or brands, including the possible inability to integrate an
acquired line of business into our operations, diversion of management's
attention and unanticipated problems, some or all of which could materially
and/or adversely affect our business strategy, financial condition and results
of operations.
The Company may be unable to successfully implement growth strategies. Our
ability to realize growth opportunities, apart from acquisitions, may be
limited.
The Company has identified growth opportunities involving new product
development, cross-selling, product bundling, cost reduction measures and
organic growth opportunities. However, our business operates in relatively
stable marketplaces and it may be difficult to successfully pursue these
strategies and realize material benefits therefrom. Even if the Company is
successful, other risks attendant to our businesses and the economy generally
may substantially or entirely eliminate the benefits. While we have been
successful with some of these strategies in the past, our growth has principally
come through acquisitions.
We may be unable to adequately protect our intellectual property.
While the Company believes that our trademarks, trade names and other
intellectual property have significant value, the market for our products
depends to a degree upon the value associated with our trademarks and trade
names. Competitors may infringe on our trademarks or successfully avoid them
through design innovation. Although most of our brand names are registered in
the United States and certain foreign countries, we may not be successful in
asserting trademark or trade name protection. In addition, the laws of certain
foreign countries may not protect our intellectual property rights to the same
extent as the laws of the United States. The costs required to protect our
trademarks and trade names may be substantial. Additionally, an adverse outcome
in any intellectual property litigation could subject us to significant
liabilities to third parties, require us to license our intellectual property
rights from others, require us to comply with injunctions to cease marketing or
using certain products or brands, or require us to redesign, reengineer, or
re-brand certain products or packaging. Further, we may incur costs in terms of
legal fees and expenses, whether or not the claim is valid, to respond to
intellectual property infringement claims. These or other liabilities or claims
may increase or otherwise have a material adverse effect on our financial
condition and future results of operations.
The Company has a significant amount of goodwill and intangible assets, and
their future impairment could have a material adverse effect on our financial
condition and results of operations.
11
The Company's goodwill and intangible assets were $12,378,000 at December
31, 2005, and represented approximately 38% of total assets. For the year ended
December 31, 2004, the Company incurred an impairment loss of $2,145,000 in
connection with the valuation of intangible assets. Because of the significance
of our goodwill and intangible assets, any future impairment of these assets
could have a material adverse effect on our financial results.
If we lose key personnel, or fail to attract and retain qualified experienced
personnel, we may be unable achieve the Company's continuing objectives.
We believe that the future success of the Company depends upon the
continued contributions of our highly qualified management personnel and on our
ability to attract and retain those personnel. These individuals have developed
strong relationships with customers and suppliers. There can be no assurance
that our current employees will continue to work for us or that we will be able
to hire the additional personnel necessary for our continued growth. The
Company's future growth and success depends on our ability to identify, hire,
train and retain qualified managerial personnel.
The impact of the Sarbanes-Oxley Act of 2002 will require the Company to
implement significant changes to internal control procedures and will force the
Company to incur substantial implementation and recurring costs.
The Public Company Accounting Oversight Board ("PCAOB"), adopted rules for
purposes of implementing Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX
404"), which included revised definitions of material weaknesses and significant
deficiencies in internal control over financial reporting. The PCAOB defined a
material weakness as "a significant deficiency, or a combination of significant
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected." The new rules describe certain circumstances as being both
significant deficiencies and strong indicators that material weaknesses in
internal control over financial reporting exist.
Management of the Company has identified deficiencies which, taken in the
aggregate, amount to material weaknesses in our internal control over financial
reporting. These material weaknesses in our internal controls over financial
reporting 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
and advice from our independent registered public accounting firm. Inadequate
internal control over financial reporting could cause investors to lose
confidence in our reported financial information, which could have a negative
effect on the trading price of our securities.
12
Pursuant to SOX 404, our management will be required to deliver a report
that assesses the effectiveness of our internal control over financial
reporting, and our auditors will be required to deliver an attestation report on
management's assessment of and operating effectiveness of internal control over
financial reporting. The effective implementation date of SOX 404 has been
postponed for non-accelerated filers such as The Stephan Co. until the first
year ending on or after July 15, 2007. We have a substantial effort ahead of us
to complete the documentation of our internal control system and financial
processes, information systems, assessment of their design, remediation of
control deficiencies identified in these efforts and management testing of the
design and operation of internal control. Management has estimated that the
costs associated with the implementation of SOX 404 will be material and may
very well have an adverse effect on the financial position, results of
operations and cash flows of the Company.
Item 1B: Unresolved Staff Comments
None
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, effective May 1, 2006, the
Company leases approximately 10,000 square feet of warehouse space located at
3137 N.W. 25th Avenue, Pompano Beach, Florida 33069, under the terms of a one
year lease, for approximately $7,300 per month. This facility replaced the North
Powerline Road warehouse.
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.
13
The Company leases an office, warehouse and manufacturing facility located
at 204 Eastgate Drive, Danville, Illinois 61834. The 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 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") with respect to the Danville, IL facility extending
the term of the lease to June 30, 2015, with a five year renewal option, and
increases the annual rental to approximately $303,000. 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. The Amendment provides 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 its interpretation
of the Amendment differs from that of the Company as to the existence of the
90-day right of termination. In October 2005, the landlord filed a lawsuit in
the Circuit Court for the 17th Circuit of Florida in and for Broward County,
styled Shaheen & Co., Inc. (Plaintiff) v The Stephan Co., Case number 05-15175
seeking a declaratory judgment with respect to the validity of the 90-day right
of termination. In addition, the lawsuit alleges damages with respect to costs
incurred and the weakening of the marketability of the property. This matter is
currently unresolved and the Company is unable, at this time, to determine the
outcome of the litigation. 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 $303,000 in each of the years
2006 through 2010 and approximately $1,360,000 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, 2005, 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 a
shareholder, see Item 2. Properties above and 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,
14
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.
In Pennsylvania State Court, SAC appealed the State Court's confirmation of the
Arbitration award and was notified on March 29, 2006 that the appeal was denied.
The financial statements for the year ended December 31, 2005 reflect a
liability of approximately $816,000 for payment of the award. Also, SAC may
continue to incur additional interest. 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 in Federal Court.
In 1997 the Company's wholly-owned subsidiary, Stephan Distributing, Inc.,
acquired several product lines from New Image Laboratories, Inc. ("New Image").
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. 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) were 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 and the amount is reflected as a reduction of royalty and other income
on the consolidated statement of operations for the year ended December 31,
2004. Also in 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.
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,
2005.
15
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, 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)
------------------------------------------------------------------------
March 31, 2005 $ 5.10(1) $ 3.87(1)
June 30, 2005 4.70(1) 3.45(1)
September 30, 2005 4.70(1) 3.85(1)
December 31, 2005 4.10(1) 3.14(1)
(1) Net of $2.00 per share special dividend paid September 15, 2004
(b) Holders
As of March 31, 2006, the Company's Common Stock was held of record by
approximately 340 holders. The Company's Common Stock is believed to be held
beneficially by approximately 1,000 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 2005. 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.
16
Item 6. Selected Financial Data
2005 2004 2003 2002 2001
(in thousands, except per share data)
----------------------------------------------------
Net sales $22,262 $23,951 $25,336 $25,067 $28,296
(Loss)/Income before
income taxes and
cumulative effect of
change in accounting
principle (244) (2,034) 1,487 1,400 746
(Loss)/Income before
cumulative effect of
change in accounting
principle (172) (2,176) 760 503 608
Cumulative effect of
change in accounting
principle, net of tax -- -- -- (6,762) --
Net (loss)/income (172) (2,176) 760 (6,259) 608
Current assets 16,853 15,014 24,139 20,284 20,116
Total assets 32,778 34,719 48,063 47,655 57,062
Current liabilities 5,240 3,276 5,085 3,514 4,067
Long term debt -- 3,238 4,348 6,395 7,758
PER COMMON SHARE
(Basic and Diluted): (a)
(Loss)/Income before
cumulative effect of
change in accounting
principle (.04) (.50) .18 .12 .14
Cumulative effect of
change in accounting
principle -- -- -- (1.58) --
Net (loss)/income (.04) (.50) .18 (1.46) .14
Cash dividends .08 2.08 .08 .08 .08
Notes to Selected Financial Data
(a) Net (loss)/income per common share is based upon the weighted average
number of common shares outstanding in accordance with Statement of
17
Financial Accounting Standards No. 128. The weighted average number of
diluted shares outstanding were 4,389,805 for 2005, 4,348,908 for 2004,
4,312,711 for 2003, 4,285,577 for 2002, and 4,285,577 for 2001. 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
3/31/05 6/30/05 9/30/05 12/31/05
------- ------- ------- --------
Net sales $ 5,517 $ 5,057 $ 6,568 $ 5,120
Gross profit 2,359 2,019 2,325 1,792
Net income/(loss) 74 (159) 94 (181)
Net income/(loss)
per share .02 (.04) .02 (.04)
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.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2005 AS COMPARED TO 2004
--------------------------------------------------
In 2005, the Company incurred a net loss of $172,000 as a result of
reduced sales and gross profit, even though the Company experienced a decrease
in selling, general and administrative expenses. Net sales for the year ended
18
December 31, 2005 was $22,262,000, a decline of $1,689,000 from the previous
year. Over 90% of this decline was due to a decrease in the net sales of the
Company's Retail business segment. This decline was due, in part, to the
continuing contraction in the ethnic hair care market, as major distributors
realigned inventory levels to cope with softening demand. In addition, other
retail brands, marketed mainly through general retail markets, also declined as
the Company attempted to restructure it's distribution channels. The Company is
optimistic that this will have a favorable impact on net sales starting in 2006.
As a result of lower net sales, gross profit declined $1,169,000 for the
year ended December 31, 2005, to $8,495,000, when compared to $9,664,000, the
gross profit for the year ended December 31, 2004. The gross profit margin
declined slightly, from 40.4% in 2004 to 38.2% in 2005. This was due to the
continuing change in the sales mix as retail brand net sales declined. The
Morris Flamingo-Stephan and Williamsport subsidiaries (Professional business
segment) accounted for approximately 69.3% of consolidated net sales, an
increase of 7.8% over 2004 levels. These two subsidiaries have traditionally
lower gross margins than other entities comprising the professional group.
In addition to the above, net sales of the Image and Sorbie brands of the
professional segment declined over $275,000 in 2005 when compared to net sales
in 2004. In mid-2005, the Company acquired a small manicure company that markets
it's nail care sets to distributors. Net sales for this new subsidiary, American
Manicure, was approximately $135,000 and the Company expects that this brand
will continue to enhance sales in 2006 and beyond. Sales of hotel and spa
amenities continued to improve in 2005, with net sales increasing almost 10%
over the prior year.
Selling, general and administrative expenses (SG&A) decreased overall by
approximately $3,338,000, from $12,104,000 in 2004 to $8,766,000 in 2005.
Approximately $2,752,000 of SG&A expenses in 2004 were of a non-recurring nature
and 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 decreases in SG&A were the result of
significantly reduced marketing expenditures, including reductions in payroll,
shipping costs, commissions and advertising.
Interest expense increased by approximately $59,000, from $91,000 in 2004
to $150,000 in 2005, a result of the continuing accrual of interest with respect
to the Sorbie arbitration award more fully discussed in Item 3 above. Actual
interest paid on the Company's outstanding bank debt obligation was $58,000 for
the year ended December 31, 2005, compared to $87,000 in 2004. Interest income
declined $37,000 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, 2005, was
$127,000, compared to $164,000 earned in 2004.
19
The net loss for the year ended December 31, 2005 was $172,000, compared
to $2,176,000 for the year ended December 31, 2004. As indicated above, 2004 had
several unusual expenses, in addition to legal settlements which resulted in
other income of approximately $283,000. As was the case in 2004, in connection
with the Frances Denney line, the Company received a $50,000 royalty payment in
2005. The net benefit for income taxes includes a net state income tax provision
of approximately $77,000 and a deferred Federal income tax benefit of
approximately $149,000.
Basic and diluted net loss per share for the year ended December 31, 2005
was $.04, compared to a net loss per share in 2004 of $.50, based upon an
average number of shares outstanding of 4,389,805 in 2005 and 4,348,908 in 2004.
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.
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. 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"
20
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. 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.
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. 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.
21
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Working capital decreased $125,000 from December 31, 2004, and was
approximately $11,613,000 at December 31, 2005. Cash and cash equivalents
increased to $5,603,000 as compared to $4,402,000 as of December 31, 2004. The
Company continues to secure its outstanding debt with restricted cash. In the
first quarter of 2006, the Company and Wachovia Bank have agreed, in principle,
to convert the balloon payment due in August 2006 to monthly principal payments
under the same terms and conditions as the original obligation, through 2008.
The Company is currently engaged in the construction of additional
warehouse facilities on the Tampa, Florida manufacturing property, estimated to
cost approximately $1,000,000. The Company has reviewed construction designs and
site plans, and has initiated procedures for obtaining the necessary permits.
Other than the above, the Company does not anticipate any significant capital
expenditures in the near term and management believes that there is sufficient
cash on hand, working capital and borrowing capacity to satisfy upcoming
requirements.
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 through the use of effective inventory
control techniques, controlled purchasing and a program of continued utilization
of old or slow moving raw materials and components.
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, 2005:
Payments due by period
(in thousands)
Less than 1-3
Contractual obligation Total 1 year years
---------------------- ------- --------- -------
Bank debt payable $ 3,238 $ 3,238 $ --
Employment contract 1,966 594 1,372
------- ------- ------
TOTAL OBLIGATIONS $ 5,204 $ 3,832 $1,372
======= ======= ======
22
NEW FINANCIAL ACCOUNTING STANDARDS
----------------------------------
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3",
effective for accounting changes and corrections of errors made in fiscal year
2006 and beyond. The effect of this statement on the Company's consolidated
financial statements will be determined based upon the nature and significance
of future accounting changes or errors that would be subject to this statement.
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.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4", effective for fiscal years beginning after
June 15, 2005. SFAS No. 151 requires that the costs associated with certain
abnormal expenditures be recognized in the current period. It also requires that
the amount of fixed production overhead allocated to inventory be based upon
normal capacity of production facilities. The effect this statement would have
on the Company's consolidated financial statements is not expected to be
material.
RECENT EVENTS
-------------
On April 18, 2006, the Company announced that Romella International AB,
United Feature Syndicate, Inc., and The Stephan Company entered into a license
agreement for the use of the Charles Schulz "Peanuts" characters in the United
States and its possessions, with an initial licensing term extending through
March 2009. The agreement gives The Stephan Company distribution rights to
direct mail catalogs, Duty Free Shops, Department Stores, Home Shopping
Channels, Mass Market Retailers, Department Stores and Super Market/Grocery
Stores. The Company anticipates the lead line will be a fragrance geared towards
the younger market, using the Snoopy logo, followed by additions to the line
which would fall into the bath and body category. Cosmetic bags and other types
of carry-on bags are also part of the license agreement, which the Company
intends to market with its other fragrance and bath items.
On August 18, 2005, the Company entered into a License Agreement with
Simply Organic, Inc., for the exclusive rights to manufacture, market, and
distribute the SIMPLY ORGANIC(R) line of personal care and wellness products in
all retail and certain professional channels of distribution in the Western
Hemisphere. Utilizing natural anti-viral, anti-bacterial, moisturizing and
emulsifying ingredients, SIMPLY ORGANIC(R) products are currently sold in
upscale salons and spas as a "wellness" alternative to main-stream beauty
products. The Company believes that this new private label customer will enhance
sales in the 2006 fiscal year.
23
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
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
24
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.
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
In connection with the Company's change of auditors in 2005, the Form 8-K
filed September 19, 2005 is incorporated herein by reference.
25
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, 2005 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, 2005.
(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.
ITEM 9B. OTHER INFORMATION
None
26
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;
3/31/06) Director Other Directorships
-------- -------- -------------------
William M. 82 2005 Certified Public Accountant and Attorney.
Gross(2)(3) For more than the previous five years, he
has served as Authorized House Counsel for
the Company on a part time basis.
Shouky A. 75 1998 For more than the previous five years,
Shaheen President of Shaheen and Co. Mr. Shaheen is
also the former Owner of Morris Flamingo,
L.P., which was acquired by the Company in
March 1998.
Curtis 52 1996 For more than the previous five years,
Carlson partner in various law firms. Currently a
partner in the Miami-based law firm of
Carlson & Lewittes, PA.
Frank F. 62 1981 For more than the previous five years,
Ferola Chairman of the Board, President and Chief
Executive Officer of the Company.
Richard Barone 64 2005 Chairman, CEO and Portfolio Manager for
(1)(2)(3) 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.
David Pawl 57 2005 Retired. From 1997 to 2002 President of GE
(1)(3) Quartz, Inc., a subsidiary of General
Electric Company.
Elliot Ross 60 2005 Since 2000 co-founder of MFL Group, a
(1)(2) corporate consulting firm. Prior to 2000,
President and Director of State Industrial
Products.
(1) Member of the Audit Committee.
(2) Member of the Stock Option and Compensation Committee.
(3) Member of the Nominating Committee.
27
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.
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 Richard Barone, 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, 38, 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 2005.
Name # of Late Reports # of Late Transactions
---- ----------------- ----------------------
John DePinto 1 1
Michael S. Cordaro 1
Leonard Genovese 1 1
Richard A. Barone 2 1
Shouky Shaheen 1 1
Curtis Carlson 1 1
Frank F. Ferola 1 1
David Pawl 1 1
Elliot Ross 2 2
William M. Gross 1 1
28
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).
ITEM 11. EXECUTIVE COMPENSATION
Compensation
The following table sets forth information for the fiscal years ended
December 31, 2005, 2004 and 2003 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 2005.
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 2005 $742,172 $ 0 $ 0 $50,000(1) $ 0
Pres., CEO & 2004 $828,139 $ 0 $ 0 $50,000(1) $ 0
Board Chair 2003 $752,853 $630,000(2) $ 0 $50,000(1) $60,808
David Spiegel, CFO 2005 $180,437 $ 0 $ 0 $ 0 $ 0
2004 $188,781 $ 0 $ 0 $ 0 $ 0
2003 $165,816 $ 0 $ 0 $ 0 $ 0
Jeff Lovelace, 2005 $103,133 $ 0 $ 0 $ 0 $ 0
Director of Sales 2004 $104,500 $ 0 $ 0 $ 0 $ 0
2003 $ 83,326 $ 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 2005
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 2005.
Number of % of Total Potential Realizable
Securities Options Exercise Value At Assumed
Underlying Granted to Price Annual Rates of
Options Employees Per Exp. Stock Price
Name Granted in Year Share Date Appreciation (2)
---- ------- ------- ----- ---- ----------------
5% 10%
-- ---
Frank
F. Ferola 50,000(1) 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.
29
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 2005. 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, 2005. 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, 2005 ($3.42 per share).
Number of
Securities Underlying Value of
Unexercised Options Unexercised In-the-
Shares Held at Money Options at
Acquired December 31,2005 December 31, 2005
On $ Value ---------------- -----------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
Frank F. Ferola -- -- 200,000 50,000 -- --
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 2005, 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 91,116 shares are outstanding.
30
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, 2005, Mr. Ferola's annual base salary was
$910,953. (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,
2005, Mr. Ferola was not due a bonus.
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
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.
31
Richard Barone, David Pawl and William Gross comprised the Compensation
Committee in 2005.
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 by reference therein.
The Compensation Committee is composed of a majority 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 agreement with its Chief Executive Officer,
Mr. Ferola receives a fixed annual salary.
Base Salary
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 2005 was in the middle of the range of base salary paid by such
companies.
32
Annual Bonus
Annual bonuses for the Chief Executive Officer is determined by a specific
bonus formulae set forth in his written employment agreement. Other executives
may be 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 the Chief Executive Officers' employment agreement,
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
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 2005
After various informal meetings during 2005, 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 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
previously indicated in this Item 11.
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:
Richard Barone, Chairman
David Pawl
William Gross
33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Equity Compensation Plans
As of December 31, 2005, an aggregate of 512,700 options had been granted
to executive officers under the 1990 Key Employee Stock Incentive Plan and an
aggregate of 546,330 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 March 31, 2006, 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 on Schedule 13D, pursuant to the Securities Exchange Act of
1934, as amended).
Number of Shares
Name and Address Beneficially Percent
of Beneficial Owner Owned * of Class
Merlin Partners, L.P., et al. 321,921 7.3
2000 Auburn Drive, Suite 420
Cleveland, OH 44122
Yorktown Avenue Capital, et al. 573,513 13.1
124 E. 4th Street
Tulsa, OK 74103
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 March 31, 2006, certain information
concerning the beneficial ownership of Common Stock by each of the seven
directors of the Company, the executive officers, and all current directors and
executive officers of the Company as a group (based solely upon information
furnished by such persons):
34
Number of
Shares
Name of Beneficially Percent
Beneficial Owner (1) Owned(2) of Class
---------------- -------- --------
Curtis Carlson......................................... 20,248 (4)
William M. Gross....................................... -- (4)
Frank F. Ferola........................................ 810,333 (3) 18.46%
John DePinto........................................... 128,452 2.93
Tyler Kiester ......................................... -- (4)
Shouky Shaheen......................................... 332,368 7.57%
David Spiegel.......................................... 700 (4)
Richard Barone......................................... 321,921 7.33%
Elliot Ross............................................ 5,000 (4)
David Pawl............................................. -- (4)
--------- --------
All executive officers and directors
as a group............................................. 1,619,022 36.88%
(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 - 245,558.
(3) Includes 43,174 shares owned by Mr. Frank Ferola's personal Charitable
foundation, of which Mr. Ferola is a co-trustee.
(4) Represents less than 1%.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In fiscal year 2005, the Company paid $191,384 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. per month
for his services as Vice-President and Secretary.
In fiscal year 2005, the Company paid $286,000 in rent to Shaheen & Co.,
Inc., a corporation in which Mr. Shaheen has an ownership interest, 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 facility
which, among other things, increases the annual rental to $303,000.
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 in 2005 to $540,000 per annum, subject to the contractual annual
10% increase ($594,000 in 2006). 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.
35
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Principal Accountant Fees and Services
The following table sets forth the fees billed to us by Goldstein Lewin &
Co. and Deloitte & Touche, our independent registered accounting firms, as of
and for the years ended December 31, 2005 and 2004.
For the Years Ended
December 31,
------------
2005 2004
---- ----
Audit fees(1) ........................................ $ 93,580 $190,400
Audit - related fees ................................. $ -- $ --
Tax fees(2) .......................................... $ -- $ 1,062
All other fees ....................................... $ -- $ --
-------- --------
$ 93,580 $191,462
======== ========
(1) Audit fees billed by Goldstein Lewin & Co. in 2005 related to 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, 2005. Audit fees billed by Deloitte & Touche, LLP in 2005 related to
the audit of our annual consolidated financial statements for the year
ended December 31, 2004 and services performed in connection with "comment
letters" received from the Securities and Exchange Commission. 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.
(2) Tax fees billed by Deloitte & Touche, LLP related to tax advice in
connection with real estate and personal property tax statements.
36
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.
37
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.
10.19 Brand License Agreement with The Quantum Beauty Company
Limited for the exclusive rights to manufacture, market and distribute the "Lee
Stafford" brand of hair care products included with the Form 8-K filed August 4,
2005, is incorporated herein by reference.
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.
38
(b) Financial Statements and Financial Statement Schedules
(i) Financial Statements
Reports of Independent Registered Public Accounting Firms.
Consolidated Balance Sheets as of December 31, 2005 and 2004.
Consolidated Statements of Operations for the years ended
December 31, 2005, 2004, and 2003.
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 2005, 2004, and 2003.
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2004, and 2003.
Notes to Consolidated Financial Statements.
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
39
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 sheet of The Stephan Co.
and subsidiaries (the "Company") as of December 31, 2005, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for year ended December 31, 2005. Our audit 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards re-quire 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 audit 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 audit provides 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, 2005, and the results of their operations and their cash flows
for the year ended December 31, 2005, 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, presents fairly in all
material respects the information set forth therein.
GOLDSTEIN LEWIN & CO.
Certified Public Accountants
Boca Raton, Florida
April 17, 2006
F-1
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 sheet of The Stephan Co.
and subsidiaries (the "Company") as of December 31, 2004, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the two 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 are the responsibility of the Company's
management. Our responsibility is to express an opinion on these 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 the results of their operations and their cash flows
for each of the two 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,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Fort Lauderdale, Florida
September 8, 2005
F-2
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
ASSETS
2005 2004
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 5,602,762 $ 4,402,463
Restricted cash 3,335,557 1,110,000
Accounts receivable, net 1,431,650 1,753,250
Inventories 6,148,267 7,164,901
Income taxes receivable 22,893 209,203
Prepaid expenses
and other current assets 311,905 374,079
----------- -----------
TOTAL CURRENT ASSETS 16,853,034 15,013,896
RESTRICTED CASH -- 3,430,408
PROPERTY, PLANT AND EQUIPMENT, net 1,682,951 1,627,227
GOODWILL, net 4,013,458 4,013,458
TRADEMARKS, net 8,364,809 8,364,809
OTHER INTANGIBLE ASSETS, net 142,185 216,652
OTHER ASSETS 1,721,169 2,052,405
----------- -----------
TOTAL ASSETS $32,777,606 $34,718,855
=========== ===========
See notes to consolidated financial statements.
F-3
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
LIABILITIES AND STOCKHOLDERS' EQUITY
2005 2004
----------- -----------
CURRENT LIABILITIES
Accounts payable and
accrued expenses $ 2,002,728 $ 2,165,751
Current portion of
long-term debt 3,237,500 1,110,000
----------- -----------
TOTAL CURRENT LIABILITIES 5,240,228 3,275,751
DEFERRED INCOME TAXES, net 1,343,257 1,488,116
LONG-TERM DEBT, less current
maturities -- 3,237,500
----------- -----------
TOTAL LIABILITIES 6,583,485 8,001,367
----------- -----------
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, 2005 and 2004 43,898 43,898
Additional paid in capital 17,556,731 17,556,731
Retained earnings 8,593,492 9,116,859
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 26,194,121 26,717,488
----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $32,777,606 $34,718,855
=========== ===========
See notes to consolidated financial statements.
F-4
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
2005 2004 2003
------------ ------------ ------------
NET SALES $ 22,262,423 $ 23,950,648 $ 25,336,017
COST OF GOODS SOLD 13,767,127 14,286,280 14,157,918
------------ ------------ ------------
GROSS PROFIT 8,495,296 9,664,368 11,178,099
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 8,766,298 12,103,784 9,752,137
------------ ------------ ------------
OPERATING (LOSS)/INCOME (271,002) (2,439,416) 1,425,962
OTHER INCOME(EXPENSE)
Interest income 127,313 163,921 227,399
Interest expense (150,173) (91,237) (403,028)
Royalty and other income 50,000 332,745 237,000
------------ ------------ ------------
(LOSS)/INCOME BEFORE
INCOME TAXES (243,862) (2,033,987) 1,487,333
INCOME TAX (BENEFIT)/EXPENSE (71,679) 142,251 (726,874)
------------ ------------ ------------
NET (LOSS)/INCOME $ (172,183) $ (2,176,238) $ 760,459
============ ============ ============
BASIC AND DILUTED (LOSS)/
EARNINGS PER SHARE $ (.04) $ (.50) $ .18
============ ============ ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,389,805 4,348,908 4,312,711
============ ============ ============
See notes to consolidated financial statements.
F-5
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Common Stock Additional Contingently
--------------------- Paid in Retained Returnable
Shares Par Value Capital Earnings Shares
---------- --------- ------------ ------------ ------------
Balances, Jan. 1, 2003 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 --
Dividends paid -- -- -- (351,184) --
Net loss -- -- -- (172,183) --
---------- -------- ------------ ------------ -----------
Balances, Dec. 31, 2005 4,389,805 $ 43,898 $ 17,556,731 $ 8,593,492 $ --
========== ======== ============ ============ ===========
See notes to consolidated financial statements.
F-6
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
2005 2004 2003
---------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)/income $ (172,183) $(2,176,238) $ 760,459
---------- ----------- ----------
Adjustments to reconcile net (loss)/
income to net cash flows provided by
operating activities:
Depreciation 143,509 136,712 287,978
Amortization of deferred
acquisition costs 74,467 82,121 92,592
Write-down of inventories -- 337,215 92,670
Compensation expense resulting
from exercise of stock options -- 415,430 --
Loss on disposal of property
plant and equipment -- -- 34,422
Deferred income taxes (144,859) 355,065 477,278
Provision for doubtful accounts 27,571 55,865 80,899
Impairment loss on goodwill
and trademarks -- 2,144,522 --
Settlement of Colgate-
Palmolive debt -- (417,745) --
Changes in operating assets
and liabilities:
Accounts receivable 294,029 (364,607) (74,108)
Inventories 1,016,634 (4,854) 33,832
Income taxes receivable/payable 186,310 (237,473) 93,648
Prepaid expenses
and other current assets 62,174 410,522 (426,772)
Other assets 331,236 815,553 831,699
Accounts payable
and accrued expenses (163,023) (448,980) 596,495
---------- ----------- ----------
Total adjustments 1,828,048 3,279,346 2,120,633
---------- ----------- ----------
Net cash flows provided
by operating activities 1,655,865 1,103,108 2,881,092
---------- ----------- ----------
See notes to consolidated financial statements.
F-7
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
2005 2004 2003
----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Change in restricted cash 1,204,851 1,102,092 1,110,000
Purchase of property, plant
and equipment (199,233) (61,608) (20,265)
----------- ------------ -----------
Net cash flows provided by
investing activities 1,005,618 1,040,484 1,089,735
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (1,110,000) (2,024,528) (1,101,817)
Proceeds from exercise of
stock options -- 75,575 --
Dividends paid (351,184) (9,094,335) (352,846)
----------- ------------ -----------
Net cash flows used in
financing activities (1,461,184) (11,043,288) (1,454,663)
----------- ------------ -----------
NET INCREASE/(DECREASE) IN
CASH AND CASH EQUIVALENTS 1,200,299 (8,899,696) 2,516,164
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 4,402,463 13,302,159 10,785,995
----------- ------------ -----------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 5,602,762 $ 4,402,463 $13,302,159
=========== ============ ===========
See notes to consolidated financial statements.
F-8
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Supplemental Disclosures of Cash Flow Information:
2005 2004 2003
---------- ---------- ----------
Interest paid $ 58,364 $ 190,214 $ 248,051
========== ========== ==========
Income taxes paid $ 69,526 $ 101,188 $ 122,255
========== ========== ==========
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-9
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
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, Sorbie
Distributing Corporation, Stephan Distributing, Inc., Morris Flamingo-Stephan,
Inc. and American Manicure, Inc. (collectively, the "Company"). All significant
intercompany balances and transactions have been eliminated in consolidation.
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 and the differences could be material.
MAJOR CUSTOMERS: There were no sales to any single customer in excess of
10% of net sales in 2005. 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. Goodwill and trademarks having indefinite lives 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. Periodic testing for impairment on an annual basis necessitated an
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 Sorbie brand was written off (See Note 5).
F-10
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
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,
---------------------------------
2005 2004 2003
-------- -------- --------
Net (loss)/income, as reported $ (172) $ (2,176) $ 760
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 (88) (400) (165)
-------- -------- --------
Pro forma net (loss)/income $ (260) $ (2,304) $ 595
======== ======== ========
Net (loss)/income per share:
As reported $ (.04) $ (.50) $ .18
Pro forma $ (.06) $ (.53) $ .14
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
F-11
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
options granted during 2005, 2004 and 2003 was $ 2.03, $2.37, and $1.58,
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, 2005, 2004 and 2003:
2005 2004 2003
-------- -------- --------
Life expectancy 5 years 5 years 5 years
Risk-free interest rate 4% 3% 3%
Expected volatility 61% 69% 59%
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, 2005 and 2004 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.
SHIPPING AND HANDLING FEES AND COSTS: Expenses for the shipping and
delivery of products sold to customers are recorded as a component of selling
expenses and were $1,139,000, $1,227,000 and $1,183,000, in 2005, 2004 and 2003,
respectively, and were included in Selling, General and Administrative Expenses
in the Consolidated Statements of Operations.
F-12
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
PROMOTIONAL AND SALES RETURNS ALLOWANCES: The Company partici- pates 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 $289,000,
$417,000 and $345,000 for the years ended December 31, 2005, 2004 and 2003,
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, 2005 and 2004 were approximately $5,095,000 and $3,824,000,
respectively. At December 31, 2005 and 2004, the Company excluded restricted
cash in the amount of approximately $3,336,000 and $4,540,000, 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, 2005 and 2004 were
approximately $2,622,000 and $3,166,000, respectively. Direct labor and overhead
costs capitalized in inventories as of December 31, 2005 and 2004 were
approximately $587,000 and $783,000, 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.
F-13
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
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, 2005, 2004
and 2003, the Company had 341,116, 291,822 and 547,570 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
December 31, 2005 and 2004, none were used because their inclusion would be
anti-dilutive, and as such, 4,389,805 and 4,348,908 shares, respectively, were
used for the calculation of basic and diluted earnings per share.
NEW FINANCIAL ACCOUNTING STANDARDS: In May 2005, the FASB issued SFAS No.
154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No.
20 and FASB Statement No. 3", effective for accounting changes and corrections
of errors made in fiscal year 2006 and beyond. The effect of this statement on
the Company's consolidated financial statements will be determined based upon
the nature and significance of future accounting changes or errors that would be
subject to this statement.
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.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4", effective for fiscal years beginning after
June 15, 2005. SFAS No. 151 requires that the costs associated with certain
abnormal expenditures be recognized in the current period. It also requires that
the amount of fixed production overhead allocated to inventory be based upon
normal capacity of production facilities. The effect this statement would have
on the Company's consolidated financial statements is not expected to be
material.
NOTE 2. ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 2005 and 2004 consisted of the
following:
2005 2004
----------- -----------
Trade accounts receivable $ 1,540,303 $ 1,845,098
Less: Allowance for doubtful accounts (108,653) (91,848)
----------- -----------
Accounts receivable, net $ 1,431,650 $ 1,753,250
=========== ===========
F-14
NOTE 2. ACCOUNTS RECEIVABLE (Continued)
The following is an analysis of the allowance for doubtful accounts for
the year ended December 31:
2005 2004 2003
--------- --------- ---------
Balance, beginning of year $ 91,848 $ 112,924 $ 163,281
Provision for doubtful accounts 27,571 55,865 80,899
Uncollectible accounts written off,
net of recoveries (10,766) (76,941) (131,256)
--------- --------- ---------
Balance, end of year $ 108,653 $ 91,848 $ 112,924
========= ========= =========
NOTE 3. INVENTORIES
Inventories at December 31, 2005 and 2004 consisted of the following:
2005 2004
----------- -----------
Raw materials $ 1,692,277 $ 1,827,553
Packaging and components 2,238,763 2,187,901
Work in progress 454,217 429,552
Finished goods 3,402,742 4,651,422
----------- -----------
7,787,999 9,096,428
Less: Amount included
in other assets (1,639,732) (1,931,527)
----------- -----------
Balance, end of year $ 6,148,267 $ 7,164,901
=========== ===========
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
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.
F-15
NOTE 4. PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment at December 31, 2005 and 2004 consisted of
the following:
2005 2004
------------ ------------
Land $ 379,627 $ 379,627
Buildings and improvements 2,251,894 2,159,046
Machinery and equipment 1,947,080 1,852,551
Furniture and office equipment 583,566 571,710
------------ ------------
5,162,167 4,962,934
Less: accumulated depreciation (3,479,216) (3,335,707)
------------ ------------
Balance, end of year $ 1,682,951 $ 1,627,227
============ ============
NOTE 5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLE ASSETS
Since implementing SFAS No. 142, the Company performs annual im- pairment
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:
2005 2004
--------- ---------
Deferred acquisition costs $ 934,544 $ 934,544
Less: Accumulated amortization (792,359) (717,892)
--------- ---------
Balance, end of year $ 142,185 $ 216,652
========= =========
Amortization expense of other intangible assets for 2005, 2004 and 2003
was $74,000, $82,000 and $93,000, respectively. Amortization expense of other
intangible assets, recorded as of December 31, 2005, for the years ended
December 31, 2006 through 2008 is anticipated to be as follows: 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, 2005 and 2004
consisted of the following:
2005 2004
---------- ----------
Accounts payable $ 254,863 $ 384,831
Accrued marketing expenses 133,469 146,744
Accrued royalty and related
interest payable (Note 10) 815,711 723,902
Accrued payroll, bonuses
and related costs 410,149 324,783
Accrued "privatization" expenses -- 158,279
Accrued legal and professional fees 240,691 251,039
Other accrued expenses 147,845 176,173
---------- ----------
Balance, end of year $2,002,728 $2,165,751
========== ==========
Accrued "privatization" expenses shown above were due to Eastchester
Enterprises, an entity created by the four Board members who attempted to take
the Company private.
NOTE 7. LONG-TERM DEBT
Long-term debt at December 31, 2005 and 2004 consisted of the following:
2005 2004
----------- -----------
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 $ 3,237,500 $ 4,347,500
----------- -----------
3,237,500 4,347,500
Less: current portion (3,237,500) (1,110,000)
----------- -----------
Long-term debt $ -- $ 3,237,500
=========== ===========
In the first quarter of 2006, the Company and Wachovia Bank have agreed,
in principle, to convert the balloon payment due in August 2006 to monthly
principal payments under the same terms and conditions as the original
obligation, through 2008.
Assuming the conversion of the outstanding obligation was in effect as of
December 31, 2005, the approximate maturities of long-term debt would be
$1,110,000 in 2006, $1,110,000 in 2007 and 1,017,500 in 2008.
F-17
NOTE 8. INCOME TAXES
The provision/(benefit) for income taxes is comprised of the following for
the years ended December 31:
2005 2004 2003
--------- --------- --------
Current tax:
Federal $ -- $(105,047) $117,021
State 77,128 (107,767) 132,575
--------- --------- --------
Total current
provision/(benefit) 77,128 (212,814) 249,596
--------- --------- --------
Deferred tax:
Federal (135,767) 220,766 433,266
State (13,040) 134,299 44,012
--------- --------- --------
Total deferred
(benefit)/provision (148,807) 355,065 477,278
--------- --------- --------
Total (benefit)/provision
for income taxes $ (71,679) $ 142,251 $726,874
========= ========= ========
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:
2005 2004
----------- -----------
Accounts receivable allowances $ (40,886) $ (36,280)
Inventory allowance (126,894) (141,063)
Property, plant and equipment 46,728 68,800
Amortization of intangibles 2,559,360 2,085,642
Charitable contribution carryforward (652) (122,546)
State income taxes (101,467) (91,679)
Net operating loss carryover (954,285) (391,736)
Accrued liabilities and other (38,647) (5,568)
----------- -----------
1,343,257 1,365,570
Less: Valuation allowance -- 122,546
----------- -----------
Deferred income tax liability, net $ 1,343,257 $ 1,488,116
=========== ===========
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:
F-18
NOTE 8. INCOME TAXES (Continued)
2005 2004 2003
------ ------ ------
Amount computed on pretax income (34.0%) (34.0%) 35.0%
Increase(decrease) in taxes:
State income taxes, net of
federal tax benefit (3.5) .8 7.8
Goodwill impairment -- 30.8 --
Goodwill/Trademarks 1.3 .2 .2
Benefit of graduated rates -- -- (1.0)
Compensation limitations -- 8.1 --
Privatization transaction costs -- 2.7 6.7
Tax exempt interest (2.4) (1.0) (1.6)
Other 9.3 (.6) 1.8
------ ------ ------
Total income tax (29.3%) 7.0% 48.9%
====== ====== ======
For the year ended December 31, 2004, the Company had an income tax
valuation allowance of $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 $2,535,969 for Federal
income tax purposes which expire beginning in 2025 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:
(LOSS)/INCOME
NET SALES BEFORE INCOME TAXES
--------------------------- ---------------------------
2005 2004 2003 2005 2004 2003
--------------------------- ---------------------------
Professional $17,254 $17,538 $17,573 $ 1,012 $(1,801) $ 1,449
Retail 4,178 5,734 7,373 (79) 486 873
Manufacturing 5,132 5,689 6,713 (989) (292) (112)
------- ------- ------- ------- ------- -------
Total 26,564 28,961 31,659 (56) (1,607) 2,210
F-19
NOTE 9. SEGMENT INFORMATION (Continued)
(LOSS)/INCOME
NET SALES BEFORE INCOME TAXES
--------------------------- --------------------------
2005 2004 2003 2005 2004 2003
--------------------------- --------------------------
Intercompany
Manufacturing (4,302) (5,010) (6,323) (188) (427) (723)
------- ------- ------- ----- ------- ------
Consolidated $22,262 $23,951 $25,336 $(244) $(2,034) $1,487
======= ======= ======= ===== ======= ======
INTEREST INCOME INTEREST EXPENSE
---------------------- ----------------------
2005 2004 2003 2005 2004 2003
---------------------- ----------------------
Professional $ 52 $ 104 $ 174 $ 127 $ 56 $ 90
Retail 66 53 47 18 33 304
Manufacturing 9 7 6 5 2 9
------ ------ ------ ------ ------ ------
Total $ 127 $ 164 $ 227 $ 150 $ 91 $ 403
====== ====== ====== ====== ====== ======
DEPRECIATION AND
AMORTIZATION TOTAL ASSETS
-------------------------- ------------------
2005 2004 2003 2005 2004
-------------------------- ------------------
Professional $ 87 $ 78 $ 89 $11,774 $10,985
Retail 37 43 43 14,353 16,003
Manufacturing 94 98 249 6,651 7,731
------ ------ ------ ------- -------
Total $ 218 $ 219 $ 381 $32,778 $34,719
====== ====== ====== ======= =======
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.
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 agreements. No bonuses were
payable for the years ended December 31, 2005 and 2004. 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
F-20
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
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. If it were determined that said change in control existed, the Company
would be contingently liable for additional compensation of approximately
$371,000 for the year ended December 31, 2005.
The Company was not a party to any non-cancelable operating leases at
December 31, 2005. Annual rent expense for each of the last three years is as
follows:
2005 $628,600
2004 692,800
2003 620,800
Included in rent expense above for the years ended December 31, 2005, 2004
and 2003 is $ 286,000, $273,000 and $213,000, 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
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 its interpretation
of the Amendment differs from that of the Company as to the existence of the
90-day right of termination. In October 2005, the landlord filed a lawsuit in
the Circuit Court for the 17th Circuit of Florida in and for Broward County,
styled Shaheen & Co., Inc. (Plaintiff) v The Stephan Co., Case number 05-15175
seeking a declaratory judgment with respect to the validity of the 90-day right
of termination. In addition, the lawsuit alleges damages with respect to costs
incurred and the weakening of the marketability of the property. This matter is
currently unresolved and the Company is unable, at this time, to determine the
outcome of the litigation. 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 $303,000 in each of the years
2006 through 2010 and approximately $1,360,000 thereafter.
In fiscal year 2005, the Company paid $191,384 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. per month
for his services as Vice-President and Secretary.
F-21
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
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, 2005, would likely, if
adversely determined, have a material adverse effect on the Company's financial
position, results of operations or cash flows.
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.
In Pennsylvania State Court, SAC appealed the State Court's confirmation of the
Arbitration award and was notified on March 29, 2006 that the appeal was denied.
The financial statements for the year ended December 31, 2005 reflect a
liability of approximately $816,000 for payment of the award. Also, SAC may
continue to incur additional interest. 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 in Federal Court.
In 1997 the Company's wholly-owned subsidiary, Stephan Distributing, Inc.,
acquired several product lines from New Image Laboratories, Inc. ("New Image").
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. 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) were 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 and the amount is reflected as a reduction of royalty and other income
F-22
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
on the consolidated statement of operations for the year ended December 31,
2004. Also in 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.
On November 4, 2003, in connection with a "going-private" transaction, the
Company filed a Preliminary Proxy with the Securities and Exchange Commission.
On August 25, 2004, the Merger Agreement was terminated and the Acquisition
Group withdrew its offer to acquire the shares of the Company's common stock not
owned by it and informed the Company that it had decided not to pursue such an
acquisition. 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 for the year ended
December 31, 2004.
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.
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 5-10 years from the date of
grant. Stock option activity for 2005, 2004, and 2003 is set forth below:
F-23
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS (Continued)
Key Employee Outside
Incentive Avg. Directors Avg.
Plan Price Plan Price
--------------------------------------------------------------------------------
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
Granted ................................ 50,000 4.26 25,310 4.71
Canceled ............................... (10,830) 3.94 (15,186) 4.25
Exercised .............................. -- --
-------- -------
Outstanding at December 31, 2005 ....... 250,000 $9.00 91,116 $3.93
======== =======
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 for the year
ended December 31, 2004.
The number of shares and average exercise price of options exercisable at
December 31, 2005, 2004 and 2003 were 200,000 shares at $10.19, 160,830 shares
at $11.59, and 396,330 shares at $6.79, respectively, for the 1990 Key Employee
Stock Incentive Plan and 65,806 at $3.89, 60,744 at $3.73, and 80,992 at $3.85,
respectively, for the Outside Directors Plan. At December 31, 2005 and 2004,
620,000 and 373,670 respectively, were available for future grants under the
terms of the 1990 Key Employee Stock Incentive Plan and 111,384 shares and
81,012 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, 2005 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 - $ 5.00 191,116 3.18 $ 4.12 115,806 $ 4.08
$10.00 - $13.50 150,000 2.00 $12.15 150,000 $12.15
--------- ---------
341,116 265,806
========= =========
F-24
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
ADVERTISING, PROMOTION and RETURNS ALLOWANCES
2005 2004 2003
-------- -------- --------
Balance, beginning of year $104,659 $152,906 $152,708
Additions 288,742 417,152 344,621
Utilizations 291,971 465,399 344,423
-------- -------- --------
Balance, end of year $101,430 $104,659 $152,906
======== ======== ========
DEFERRED TAX VALUATION ALLOWANCE
2005 2004 2003
-------- -------- --------
Balance, beginning of year $122,546 $121,747 $268,359
Additions -- 799 1,579
Utilizations/Expirations 122,546 -- 148,191
-------- -------- --------
Balance, end of year $ -- $122,546 $121,747
======== ======== ========
F-25
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
May 5, 2006
By: /s/ David A. Spiegel
-----------------------------------
David A. Spiegel
Principal Financial Officer
Principal Accounting Officer
May 5, 2006
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: May 5, 2006
Date: May 5, 2006
By: /s/ Curtis Carlson By: /s/ Richard A. Barone
------------------------------ ----------------------------
Curtis Carlson, Director Richard A. Barone, Director
Date: May 5, 2006 Date: May 5, 2006
By: /s/ William Gross By: /s/ David Pawl
------------------------------ ----------------------------
William Gross, Director David Pawl, Director
Date: May 5, 2006 Date: May 5, 2006
By: /s/ Elliot Ross
------------------------------
Elliot Ross, Director
Date: May 5, 2006
40