UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended: September 30, 2003
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
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES NO X
Approximate number of shares of Common Stock outstanding
as of November 7, 2003:
4,410,577
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets
as of September 30, 2003 and December 31, 2002 4-5
Unaudited Condensed Consolidated Statements
of Operations for the nine months ended
September 30, 2003 and 2002 6
Unaudited Condensed Consolidated Statements
of Operations for the three months ended
September 30, 2003 and 2002 7
Unaudited Condensed Consolidated Statements
of Cash Flows for the nine months ended
September 30, 2003 and 2002 8-9
Notes to Unaudited Condensed Consolidated
Financial Statements 10-19
ITEM 2. Management's Discussion and Analysis
of Financial Condition and
Results of Operations 19-22
ITEM 3. Quantitative and Qualitative
Disclosure About Market Risk 23
ITEM 4. Controls and Procedures 23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 24
ITEM 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
2
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This quarterly report contains certain "forward-looking" statements.
The Stephan Co. (the "Company") desires to take advantage of the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995
and is including this statement for the express purpose of availing itself
of the protections of such safe harbor with respect to all such forward-
looking statements. Such forward-looking statements involve risks,
uncertainties and other factors which may cause the actual results,
condition (financial or otherwise), performance, trends or achievements of
the Company and its subsidiaries to be materially different from any
results, condition, performance, trends or achievements projected,
anticipated or implied by such forward-looking statements.
Such factors include, but are not limited to, the following: general
economic and business conditions; competition; relative success of
operating initiatives; development and operating costs; advertising and
promotional efforts; brand awareness; the existence or absence of adverse
publicity; acceptance of any new product offerings; changing trends in
customer tastes; the success of multi-branding; changes in business
strategy or development plans; quality of management; costs and expenses
incurred by the Company in pursuing strategic alternatives; availability,
terms and deployment of capital; business abilities and judgment of
personnel; availability of qualified personnel; labor and employee benefit
costs; availability and cost of raw materials and supplies; changes in or
newly-adopted accounting principles; changes in, or failure to comply with,
applicable law; changes in product mix and associated gross profit margins;
and other factors or events referenced in this Form 10-Q.
The Company does not undertake, subject to applicable law, any
obligation to publicly release the results of any revisions which may be
made to any forward-looking statements to reflect events or circumstances
occurring after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events. Therefore, the Company cautions 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 the ability of
the Company to achieve its objectives and may cause actual results to
differ materially from those projected, anticipated or implied herein.
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
2003 2002
____________ ____________
CURRENT ASSETS
Cash and cash equivalents $12,188,533 $ 10,785,995
Accounts receivable, net 2,140,923 1,451,299
Inventories 8,205,584 7,623,764
Income taxes receivable 53,774 65,378
Prepaid expenses and
other current assets 570,870 357,829
____________ ____________
TOTAL CURRENT ASSETS 23,159,684 20,284,265
CERTIFICATES OF DEPOSIT 5,920,000 6,752,500
PROPERTY, PLANT AND EQUIPMENT, net 1,768,748 2,004,465
GOODWILL, net 5,857,980 5,857,980
TRADEMARKS, net 8,664,809 8,664,809
DEFERRED ACQUISITION COSTS, net 321,273 391,365
OTHER ASSETS, net 2,872,969 3,699,657
____________ ____________
TOTAL ASSETS $ 48,565,463 $ 47,655,041
============ ============
See notes to unaudited condensed consolidated financial statements
4
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
2003 2002
_____________ ____________
CURRENT LIABILITIES
Accounts payable and
accrued expenses $ 2,606,443 $ 2,018,236
Current portion of
long-term debt 2,353,907 1,496,147
____________ ____________
TOTAL CURRENT LIABILITIES 4,960,350 3,514,383
DEFERRED INCOME TAXES, net 1,138,882 655,773
LONG-TERM DEBT 4,625,000 6,395,443
____________ ____________
TOTAL LIABILITIES 10,724,232 10,565,599
____________ ____________
COMMITMENTS AND CONTINGENCIES (NOTE 3)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value 44,106 44,106
Additional paid in capital 18,417,080 18,417,080
Retained earnings 20,731,608 19,979,819
____________ ____________
39,192,794 38,441,005
LESS:
125,000 CONTINGENTLY
RETURNABLE SHARES (1,351,563) (1,351,563)
____________ ____________
TOTAL STOCKHOLDERS' EQUITY 37,841,231 37,089,442
____________ ____________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 48,565,463 $ 47,655,041
============ ============
See notes to unaudited condensed consolidated financial statements
5
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended September 30,
______________________________
2003 2002
(As Restated,
See Note 1)
_____________ ____________
NET SALES $20,048,643 $19,880,311
COST OF GOODS SOLD 11,248,070 11,579,796
___________ ___________
GROSS PROFIT 8,800,573 8,300,515
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 7,285,559 6,741,986
___________ ____________
OPERATING INCOME 1,515,014 1,558,529
OTHER INCOME(EXPENSE)
Interest income 178,311 292,773
Interest expense (287,374) (374,232)
Royalty and other income 224,500 116,250
___________ ___________
INCOME BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,630,451 1,593,320
INCOME TAX EXPENSE 614,027 621,405
___________ ___________
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE 1,016,424 971,915
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF
TAX BENEFIT OF $1,662,911 - (6,761,576)
___________ ___________
NET INCOME/(LOSS) $ 1,016,424 $(5,789,661)
=========== ===========
BASIC AND DILUTED EARNINGS/(LOSS) PER SHARE:
INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE $ .24 $ .23
CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE - (1.58)
___________ ___________
BASIC AND DILUTED EARNINGS/(LOSS) PER SHARE: $ .24 $ (1.35)
=========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,308,832 4,285,577
=========== ===========
See notes to unaudited condensed consolidated financial statements
6
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
September 30,
_____________________________
2003 2002
(As Restated,
See Note 1)
____________ ____________
NET SALES $ 6,698,288 $ 6,721,107
COST OF GOODS SOLD 3,916,807 4,181,708
___________ ___________
GROSS PROFIT 2,781,481 2,539,399
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 2,319,991 2,128,405
___________ ____________
OPERATING INCOME 461,490 410,994
OTHER INCOME(EXPENSE)
Interest income 50,981 106,182
Interest expense ( 73,447) (104,844)
Royalty and other income 199,500 45,000
___________ ___________
INCOME BEFORE INCOME TAXES 638,524 457,332
INCOME TAX EXPENSE 236,157 217,233
___________ ___________
NET INCOME $ 402,367 $ 240,099
=========== ===========
BASIC AND DILUTED
EARNINGS PER SHARE $ .09 $ .06
=========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,308,832 4,285,577
=========== ===========
See notes to unaudited condensed consolidated financial statements
7
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
___________________________
2003 2002
(As Restated,
See Note 1)
___________ ____________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income/(loss) $ 1,016,424 $(5,789,661)
___________ ____________
Adjustments to reconcile net income/(loss)
to cash flows provided by
operating activities:
Depreciation 245,930 249,353
Amortization of intangible assets 70,092 70,098
Deferred income tax provision 483,109 (1,393,698)
Provision for doubtful accounts 75,249 63,925
Impairment loss on goodwill - 8,424,487
Changes in operating assets and
liabilities:
Certificate of deposit 832,500 555,000
Accounts receivable (764,873) (393,315)
Inventories (581,820) (163)
Income taxes receivable 11,604 279,308
Prepaid expenses
and other current assets (213,041) (369,913)
Other assets 826,688 1,060,540
Accounts payable and accrued expenses 588,207 (248,460)
___________ ___________
Total adjustments 1,573,645 8,297,162
___________ ___________
Net cash flows provided
by operating activities 2,590,069 2,507,501
___________ ___________
8
THE STEPHAN CO. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
____________________________
2003 2002
____________ ___________
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant
and equipment (10,213) (23,415)
___________ ___________
Net cash flows used in
investing activities (10,213) (23,415)
___________ ___________
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (912,683) (1,155,527)
Dividends paid (264,635) (264,635)
___________ ___________
Net cash flows used in
financing activities (1,177,318) (1,420,162)
___________ ___________
INCREASE IN CASH AND
CASH EQUIVALENTS 1,402,538 1,063,924
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 10,785,995 8,409,142
___________ ___________
CASH AND CASH EQUIVALENTS,
END OF PERIOD $12,188,533 $ 9,473,066
=========== ===========
Supplemental Disclosures of
Cash Flow Information:
Interest paid $ 220,693 $ 402,748
=========== ===========
Income taxes paid $ 88,629 $ 173,699
=========== ===========
See notes to unaudited condensed consolidated financial statements
9
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: In the opinion of management, all
adjustments (consisting only of normal recurring accruals) necessary for a
fair presentation of the financial position and results of operations of
The Stephan Co. and Subsidiaries (the "Company") are reflected in these
unaudited interim consolidated financial statements.
Information presented for the quarter and nine-month periods ended
September 30, 2002 have been restated to reflect the adoption of a change
in accounting principle, in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 142 (See NEW FINANCIAL ACCOUNTING
STANDARDS elsewhere in Note 1).
The results of operations for the nine-month period ended September
30, 2003 is not necessarily indicative of the results to be achieved for
the year ending December 31, 2003. The December 31, 2002 condensed
consolidated balance sheet was derived from the audited consolidated
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America
("generally accepted accounting principles"). These interim financial
statements should be read in conjunction with the audited consolidated
financial statements and accompanying notes appearing in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002, previously
filed with the Securities and Exchange Commission.
Certain amounts previously reported in the 2002 financial statements
and notes thereto were reclassified to conform to the 2003 presentation.
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. SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information", requires the reporting
of segment information using a "management approach" as it relates to the
operating segments of a business. The Company manages its business in
three segments: (1) professional hair care products and distribution; (2)
retail personal care products; and (3) manufacturing.
USE OF ESTIMATES: The preparation of condensed consolidated
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities as of the date of the condensed
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates and assumptions.
10
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include
cash, money market investment accounts and short-term municipal bonds
having maturities of 90 days or less. The Company maintains cash deposits
at certain financial institutions in amounts in excess of the federally
insured limit. Cash and cash equivalents held in interest bearing accounts
as of September 30, 2003 and December 31, 2002 were approximately
$11,368,000 and $10,121,000, respectively.
INVENTORIES: Inventories are stated at the lower of cost
(determined on a first-in, first-out basis) or market, and are as follows:
September 30, December 31,
2003 2002
____________ ____________
Raw materials $ 2,068,395 $ 2,162,273
Packaging and components 2,989,272 3,100,917
Work in progress 355,118 328,976
Finished goods 5,509,163 5,579,290
____________ ____________
10,921,948 11,171,456
Less: Amount included in
other assets, net (2,716,364) (3,547,692)
____________ ____________
$ 8,205,584 $ 7,623,764
============ ============
Raw materials principally 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
actual bottles or containers (plastic or glass), jars, caps, pumps and
similar materials that become part of the finished product. Finished goods
include hair dryers, electric clippers, lather machines, scissors and salon
furniture. Included in other assets are raw materials, packaging and
components inventory not anticipated to be utilized in less than one year.
BASIC AND DILUTED EARNINGS PER SHARE: Basic and diluted earnings
per share are computed by dividing net income/(loss) by the weighted
average number of shares of common stock outstanding. The weighted average
number of shares outstanding for the nine and three-month periods ended
September 30, 2003 and 2002, were 4,308,832 and 4,285,577, respectively.
For the nine months ended September 30, 2003 and 2002, the Company had
664,620 and 693,648 outstanding stock options, respectively, a significant
portion of which were anti-dilutive. The inclusion of dilutive stock
options in the calculation of earnings per share did not have any
11
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
significant impact on the earnings per share amounts for the nine and three
months ended September 30, 2003 and 2002, respectively.
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 is reflected in net income/(loss)
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):
Nine Months Ended Three Months
September 30, Ended Sept. 30,
__________________ _______________
2003 2002 2003 2002
_______ _______ _______ _______
Net income/(loss), as reported $1,016 $(5,790) $ 402 $ 240
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects 124 234 41 78
________ ________ _______ _______
Pro forma net income/(loss) $ 892 $(6,024) $ 361 $ 162
======== ======== ======= =======
Net income/(loss) per share:
As reported $ .24 $ (1.35) $ .09 $ .06
Pro forma $ .21 $ (1.41) $ .08 $ .04
12
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
NEW FINANCIAL ACCOUNTING STANDARDS: In June 2001, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets."
These standards made changes to the accounting for business combinations,
goodwill and intangible assets. SFAS No. 142 provides that goodwill and
other intangible assets with indefinite lives will not be amortized, but
will be tested for impairment at least annually. The Company adopted SFAS
No. 142 on January 1, 2002. SFAS No. 142 requires that goodwill be tested
for impairment at the reporting unit level upon adoption and at least
annually thereafter. The initial step requires that the Company determine
the fair value of each reporting unit and compare it to the carrying value,
including goodwill, of the reporting unit. If the fair value exceeds the
carrying value, no impairment loss would be recognized. However, if the
carrying value of the reporting unit exceeds its fair value, the goodwill
of the reporting unit may be impaired. The amount, if any, of the
impairment would then be measured in the second step. As a result of the
impairment review mandated by SFAS No. 142, the Company determined that the
carrying value of certain goodwill and other intangible assets with
indefinite lives was impaired, decreasing the carrying value of goodwill
and other such intangible assets by approximately $8,424,000 ($6,762,000,
net of taxes), effective in the quarter ended March 31, 2002. The above
impairment charge impacted several different subsidiaries and divisions.
Based upon information available to the Company, in general, goodwill and
trademark valuations were performed using present value techniques
involving estimates of future cash flows.
Amortization expense for deferred acquisition costs and other
intangible assets subject to amortization, recorded as of December 31,
2002, is anticipated to be as follows: 2003: $93,000; 2004: $84,000; 2005:
$82,000; 2006: $66,000; 2007: $66,000.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others," an interpretation
of SFAS Nos. 5, 57 and 107 and rescission of FASB Interpretation No. 34.
The interpretation requires certain disclosures to be made by a guarantor
about its obligations under certain guarantees that it has issued. The
Company does not have existing circumstances that would make this
Interpretation relevant.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities," clarifying certain
implementation guidelines and incorporating clarifications of the
definition of a derivative. The Company does not have existing
circumstances that would make this Statement relevant.
13
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
This standard establishes guidelines to classify a financial instrument
more appropriately as a liability (or an asset in certain circumstances),
rather than as equity. This statement is part of the FASB's liabilities
and equities project relative to financial instruments. The Company does
not have existing circumstances that would make this Statement relevant.
In January 2003, the FASB issued FIN No. 46, "Consolidation of
Variable Interest Entities." FIN No. 46 provides accounting guidance for
consolidating of off-balance sheet entities with certain characteristics
(variable interest entities). The consolidation requirements apply to
variable interest entities created after January 31, 2003 and to variable
interest entities in which the Company maintains an interest after December
15, 2003. The Company does not have existing circumstances that would make
this Statement relevant.
NOTE 2: SEGMENT INFORMATION
In accordance with the guidelines established by SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," the
Company has identified three reportable operating segments based upon how
its management evaluates its business. These segments are Professional
Hair Care Products and Distribution ("Professional"), Retail Personal Care
Products ("Retail") and "Manufacturing". The Professional segment has a
customer base consisting generally 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 consists of mass
merchandisers, chain drug stores and supermarkets that sell products to
end-users. The Manufacturing segment manufactures products for different
subsidiaries of the Company and manufactures private label brands for
customers.
The Company conducts operations principally in the United States and
sales to international customers are not material to its consolidated net
sales. Income Before Income Taxes and Cumulative Effect of Change in
Accounting Principle as shown below reflects an allocation of corporate
overhead expenses incurred by the Manufacturing segment. The following
tables, in thousands, summarize Net Sales and Income Before Income Taxes
and Cumulative Effect of Change in Accounting Principle by reportable
segment (in thousands):
14
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 2: SEGMENT INFORMATION (continued)
NET SALES NET SALES
_______________ _______________
Nine Months Three Months
Ended Sept. 30, Ended Sept 30,
2003 2002 2003 2002
_______________ _______________
Professional $13,806 $13,926 $ 5,174 $ 5,081
Retail 5,971 5,626 1,461 1,562
Manufacturing 5,198 5,401 1,538 1,543
_______ _______ _______ _______
Total 24,975 24,953 8,173 8,186
Intercompany
Manufacturing (4,926) (5,073) (1,475) (1,465)
_______ _______ _______ _______
Consolidated $20,049 $19,880 $ 6,698 $ 6,721
======= ======= ======= =======
INCOME/(LOSS) BEFORE
INCOME TAXES AND
CUMULATIVE EFFECT INCOME/(LOSS)
OF CHANGE IN BEFORE
ACCOUNTING PRINCIPLE INCOME TAXES
____________________ _______________
Nine Months Three Months
Ended Sept. 30, Ended Sept. 30,
2003 2002 2003 2002
_______________ _______________
Professional $ 1,162 $ 865 $ 412 $ 389
Retail 604 873 179 155
Manufacturing (136) (145) 48 (87)
_______ _______ ______ ______
Consolidated $ 1,630 $ 1,593 $ 639 $ 457
======= ======= ====== ======
NOTE 3: COMMITMENTS AND CONTINGENCIES
In addition to the matters set forth below, the Company is involved in
other litigation matters arising in the ordinary course of business. It is
the opinion of management that none of such matters, at September 30, 2003,
would likely, if adversely determined, have a material adverse effect on
the Company's financial position, results of operations or cash flows.
15
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 3: COMMITMENTS AND CONTINGENCIES (continued)
The United States Court of Appeals for the Ninth Circuit entered an
order on April 29, 2002 that, among other things, reversed the judgment of
the United States District Court granting summary judgment in favor of New
Image Laboratories, Inc. ("New Image") against the Company on New Image's
contract claim for a price adjustment and on New Image's claim of breach of
the implied covenant of good faith and fair dealing. In addition, the
Ninth Circuit's opinion affirmed the lower court's ruling that on the
present record New Image is not entitled to (i) damages equal to the
diminution in the value of the Company's common stock price between the
scheduled and actual disbursement dates or (ii) any attorney's fees. As a
consequence of the Ninth Circuit's decision, the judgment granting New
Image all 125,000 shares of the Company's common stock being held in escrow
has been reversed and the case has been remanded back to the United States
District Court for further proceedings. On May 28, 2002, New Image filed a
Motion for Rehearing with the Ninth Circuit Court of Appeals and on June
26, 2002, the Court denied the petition for rehearing. A pretrial hearing
scheduled in connection with the remaining claims of the parties has been
postponed and settlement negotiations continue.
On November 1, 2001, a private label customer filed a lawsuit against
the Company alleging causes of action for breach of contract, declaratory
judgment, and trademark infringement. The Company denied the allegations
and has counter-sued the customer. The counterclaim seeks unspecified
compensatory damages, interest, attorneys fees, costs and other relief on
the breach of contract and anticipatory breach claims and, in excess of
$400,000 on an account stated claim. At this time, the Company is unable
to predict the outcome of this matter.
In November 2002, a stockholder filed a lawsuit in the Circuit Court
for the 17th Circuit of Florida in and for Broward County, styled Joan
Rosoff ("Plaintiff") v. Frank F. Ferola, Shouky Shaheen, Leonard A.
Genovese, Curtis Carlson, John DePinto, Thomas M. D'Ambrosio and The
Stephan Co., Case Number 0222253, against the Company alleging certain
breaches of fiduciary duties and responsibilities. The Company vigorously
defended the claim and on July 15, 2003, the Plaintiff filed a notice of
voluntary dismissal without prejudice.
Other than the above, there has been no material change in the
status of any other pending litigation since the Company's last filing of
its Annual Report on Form 10-K for the year ended December 31, 2002 with
the Securities and Exchange Commission.
16
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 3: COMMITMENTS AND CONTINGENCIES (continued)
As previously reported, on April 16, 2002, the Company announced that
the previously-formed Special Committee (consisting of two outside
directors) had accepted a bid by a management-led group to purchase all of
the shares of common stock of the Company not already owned by such group.
The acquisition group's initial bid was to purchase all of the Company's
common stock at $4 per share in cash, which offer was later revised to
$4.50 per share with $3.25 to be paid in cash, and $1.25 to be paid by a
42-month, unsecured debt instrument providing for interest at an annual
rate of 4 1/2%. To fund its payment obligations thereunder, the management
group has committed to use its best efforts to establish a separate payment
fund in an amount equal to 50% of the aggregate principal and interest
amount due under the debt instrument. On September 19, 2003, at no cost to
shareholders, the Company entered into a Working Capital Management Account
("WCMA") agreement with Merrill Lynch Business Financial Services Inc.
providing for the creation of a WCMA line of credit not to exceed
$5,000,000. Borrowings against the line of credit will be collateralized by
the Company's accounts receivable and inventories and the debt will bear a
variable interest rate using a 1- month LIBOR rate plus 2.25%. The
provisions of the credit line include periodic accounting and reporting
requirements, maintenance of certain business and financial ratios as well
as restrictions on additional borrowings.
In late 2001 and during 2002 the Special Committee received from
Curtis Rudolph, a shareholder of the Company, an indication of his interest
in acquiring the common stock of the Company; however, no offer was
forthcoming. In November 2002, Mr. Rudolph initiated an action in Florida
state court (Broward County, Florida) seeking to obtain a review of certain
"books and records" of the Company to which he claimed he was entitled as a
shareholder of the Company. The Company had previously denied him access
to those books and records due to his unwillingness to sign a non-
disclosure agreement relating to the Company's non-public information in
the standard form required of other potential bidders for the Company. In
January 2003, pursuant to a settlement agreement with the Company, Mr.
Rudolph agreed to execute the non-disclosure agreement. By letter dated
January 13, 2003, Mr. Rudolph reiterated his interest in making a proposal
to acquire the Company. On or about February 14, 2003, Mr. Rudolph
submitted an unexecuted proposal to acquire substantially all of the assets
and assume certain liabilities of the Company. The Special Committee
rejected this proposal as it was unexecuted, contained certain unacceptable
terms, was subject to unacceptable conditions, and was structured as an
asset purchase rather than a stock purchase. In particular, the asset
purchase structure presented substantial negative tax consequences to the
Company and its shareholders and was deemed impractical. Under the
circumstances, the Special Committee determined Mr. Rudolph's proposal to
not be in the best interests of the Company's shareholders. The Board of
17
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 3: COMMITMENTS AND CONTINGENCIES (continued)
Directors, through its Special Committee, attempted to negotiate with Mr.
Rudolph, but no further offer has been forthcoming.
On April 30, 2003, the Board of Directors approved a definitive merger
agreement (the "Merger Agreement") pursuant to which the Company will be
acquired by Gunhill Enterprises, Inc., a wholly-owned subsidiary of
Eastchester Enterprises, Inc. Eastchester Enterprises, Inc. is owned by
Frank F. Ferola, Thomas M. D'Ambrosio, John DePinto and Shouky A. Shaheen
(all of whom are current Board members) together with their affiliates (the
"Acquisition Group"). The Company entered into the Agreement following
approval by its Board of Directors based in part upon the unanimous
recommendation of the Special Committee comprised of non-management and
disinterested directors of the Company's Board of Directors. The Special
Committee has received an opinion from SunTrust Robinson Humphrey that the
merger consideration to be paid pursuant to the Merger Agreement is fair
from a financial point of view to the stockholders other than the
Acquisition Group. On October 24, 2003, the Company executed an Amended
and Restated Merger Agreement extending certain dates and making minor
changes to the original Merger Agreement.
If prior to the closing of the transactions contemplated by the Merger
Agreement, as amended, the Special Committee concludes that its failure to
provide information to, or engage in discussions with, third parties who
are interested in acquiring the Company, would be inconsistent with its
fiduciary duties to Stephan's stockholders, then the Special Committee may
thereafter continue to provide information to, and engage in discussions
and negotiations with, such interested parties. Under specified
circumstances, Stephan has the right to terminate the Agreement and to
enter into an agreement with a party proposing a competing transaction
which is deemed superior to the transaction proposed by the Acquisition
Group.
Completion of the merger is subject to customary closing conditions,
including stockholder approval, and the Agreement does include a financing
contingency. The Special Committee has agreed to extend the closing date
of the transaction to no later than March 15, 2004. As discussed above,
the Company has secured a $5,000,000 line of credit with Merrill Lynch, a
portion of which may be used in the "going-private" transaction. Company
stockholder approval will be solicited by means of a proxy statement, which
will be mailed by the Company to stockholders upon completion of the
required Securities and Exchange Commission filing and review process.
Independent legal counsel and investment banking advisors have been
retained to advise the Special Committee in connection with the
transaction. After incurring approximately $450,000 of expenses through
September 30, 2003, it is estimated that the remaining costs associated
with this process will be in excess of $250,000.
18
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
NOTE 3: COMMITMENTS AND CONTINGENCIES (continued)
In accordance with the terms of employment contracts with certain key
officers, it is possible that management bonuses might be due to these
individuals on the basis of projected net income for the year ended
December 31, 2003. It is estimated that these bonuses could be in excess
of $2,500,000 and would be an additional expense for the year ended
December 31, 2003.
As previously reported, due to the length of time for the going
private transaction to be consummated, the Company has not submitted any
matters to a vote of its security holders since the Company's September 1,
2000 Annual Meeting. In accordance with the rules and regulations of the
American Stock Exchange (AMEX), the Company was required to promptly notify
its stockholders and AMEX, in writing, indicating the reasons for the
failure to have a meeting and to use good faith efforts to ensure that an
annual meeting is held as soon as reasonably practicable. In addition, the
current composition of the Board of Directors and the current composition
of the Audit Committee are in violation of AMEX rules. Due to the pending
going private transaction (which will result in the Company no longer being
an SEC-reporting company and its common stock will no longer be subject to
listing on AMEX or any other public market), the Company has requested that
AMEX grant it a waiver with respect to compliance with these AMEX rules.
The continuing non-compliance with these AMEX rules could subject the
Company to civil penalties, in addition to the possibility that the stock
of the Company could be removed from listing.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
For the nine months ended September 30, 2003, net sales were
$20,049,000, compared to $19,880,000 achieved in the corresponding nine
months of 2002. The increase in net sales was principally due to increased
sales of Quinsana Medicated Talc to the military as a result of the
conflict in the Middle East, largely offset by a decline in net sales of
the Professional and Manufacturing segments. As indicated in previous
filings, we anticipated that this high level of talc sales would decline as
the number of troops in the region stabilized and the war with Iraq ended.
Talc sales to the military through September 2003 was over $1,500,000, or
over 7% of total sales for the nine months ended September 30, 2003. Since
April 2003, sales of Quinsana Medicated Talc have returned to normal
levels.
19
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003 AND 2002
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Gross profit for the nine months ended September 30, 2003, was
8,801,000 compared to gross profit of $8,301,000 achieved for the
corresponding nine-month period in 2002. Cost of sales for the nine months
ended September 30, 2003 was $11,248,000, when compared to the cost of
sales of $11,580,000 for the nine months ended September 30, 2002. Gross
profit increased overall principally due to a higher sales volume and a
change in the sales mix, with an overall increase in Retail sales as
previously indicated. As a result, there was an increase in the gross
profit margin, to 43.9% for the nine months ended September 30, 2003 from
41.8% for the nine months ended September 30, 2002.
Selling, general and administrative expenses for the nine months ended
September 30, 2003 increased by $544,000, to $7,286,000, when compared to
the corresponding 2002 nine-month period total of $6,742,000. This
increase was due, in large part, to expenses incurred in connection with
the "going-private" transaction, and included a payment to SunTrust
Robinson Humphrey for its fairness opinion. The Company continues its
efforts to control selling, general and administrative expenses even with
increased spending as a result of the Company's decision to evaluate
strategic alternatives to enhance shareholder value, as discussed in Note 3
of the unaudited condensed consolidated financial statements; however, no
assurance can be given that it can continue to keep reducing these
expenses.
Interest expense for the nine months ended September 30, 2003 was
$287,000, a decrease of approximately $87,000 from the $374,000 incurred in
the corresponding period of 2002, as a result of lower outstanding
indebtedness and lower interest rates. Interest income of $178,000 for the
nine months ended September 30, 2003 was lower than the $293,000 earned in
the corresponding nine months of 2002. Although the Company had more cash
invested in 2003, it received lower interest rates on its investments as
overall interest rates remained lower than the previous year. Other income
is comprised of royalty fees received from the licensing of Frances Denney
products and, in accordance with the terms of a negotiated settlement with
the Department of Transportation ("DOT") relative to the Tampa facility, a
one-time payment to the Company in the net amount of $187,000.
Income before the cumulative effect of a change in accounting
principle for the nine months ended September 30, 2003 was $1,016,000,
compared to $972,000 achieved for the nine months ended September 30, 2002.
Basic and diluted earnings per share, before the cumulative effect of a
change in accounting principle, were $0.24 for the nine months ended
September 30, 2003, compared to $0.23 for the nine months ended September
20
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003 AND 2002
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
30, 2002, based on a weighted average number of shares of 4,308,832 and
4,285,577 for the nine months ended September 30, 2003 and 2002,
respectively. The overall provision for income taxes decreased slightly on
income that was $37,000 higher than the corresponding nine-month period in
2002 as a result of the impact of state income taxes. Net income for the
nine-month period ended September 30, 2003 was $1,016,000 as compared to a
net loss of $5,790,000 for the nine-month period ended September 30, 2002.
For the three months ended September 30, 2003, net sales were
$6,698,000, compared to $6,721,000 for the three months ended September 30,
2002, a decline of $23,000. Sales of all segments were relatively flat,
with a decline in the Retail segment offset by an increase in Professional
sales. Gross profit for the three months ended September 30, 2003 was
$2,781,000, compared to gross profit of $2,539,000 achieved for the
corresponding three-month period in 2002 due to the favorable sales mix.
The gross profit margin increased to 41.5% for the three months ended
September 30, 2003, from 37.8% for the corresponding period in 2002 as
discussed above.
Selling, general and administrative expenses for the three months
ended September 30, 2003 increased by $192,000, from $2,128,000 to
$2,320,000, when compared to the corresponding three-month period of 2002,
largely as a result of the going-private expenses discussed previously and
increases in insurance and other taxes.
Interest income for the three-month period ended September 30, 2003
was $51,000, a decrease of approximately $55,000 when compared to $106,000
earned in the corresponding three-month period of 2002, as a direct result
of significantly lower interest rates. For the same reason, interest
expense for the three-month period ended September 30, 2003 was $73,000, a
decrease of $32,000 from the $105,000 paid in the corresponding three-month
period of 2002. Other income is comprised of a $12,500 quarterly royalty
fee from the licensing of Frances Denney products and the payment from the
DOT as discussed above.
Income tax expense for the three months ended September 30, 2003 was
$236,000 compared to $217,000, an increase of $19,000 for the corresponding
period in 2002. Net income of $402,000 for the three months ended
September 30, 2003, was a $162,000 increase from net income of $240,000
achieved in the three months ended September 30, 2002, largely as a result
of a $187,000 settlement with the DOT. Basic and diluted earnings per
share were $0.09 for the three months ended September 30, 2003 and $0.06
for the three months ended September 30, 2002.
21
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003 AND 2002
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
LIQUIDITY & CAPITAL RESOURCES
Cash and cash equivalents increased $1,403,000 from December 31, 2002,
to $12,189,000 at September 30, 2003. Total cash of $18,109,000 at
September 30, 2003 includes $5,920,000 of cash invested in certificates of
deposit pledged as collateral for a bank loan. Accounts receivable were
$2,141,000 at September 30, 2003, a net increase of $690,000 from the
$1,451,000 at December 31, 2002, due largely as a result of normally strong
third quarter sales of Morris Flamingo-Stephan; inventories increased
approximately $582,000 from $7,624,000 at December 31, 2002 to $8,206,000
at September 30, 2003, principally as a result of an increase in purchases.
Total current assets at September 30, 2003 were $23,160,000 compared
to $20,284,000 at December 31, 2002. Working capital increased $1,429,000
when compared to December 31, 2002, due in large part to the increase in
total cash and accounts receivable referred to above. In addition, prepaid
insurance increased as a result of payments made for renewals in the third
quarter, and the $187,000 due from the DOT for the I-4 settlement. The
Company does not anticipate any significant capital expenditures in the
near term and management believes that there is sufficient cash on hand and
working capital to satisfy upcoming requirements, including any funds that
may be needed in connection with the going-private transaction.
The Company does not have any off-balance sheet financing or similar
arrangements.
NEW FINANCIAL ACCOUNTING STANDARDS
See Note 1 to the Financial Statements included in Part I, Item 1 for
a discussion of new financial accounting standards.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
The preparation of consolidated financial statements in conformity
with 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 would
differ significantly from those estimates if different assumptions were
used or unexpected events transpire. Please see Item 7 in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002 filed with
the Securities and Exchange Commission.
22
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003 AND 2002
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not participate in derivative or other financial
instruments for which fair value disclosure would be required under SFAS
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.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES: Based upon an
evaluation of the Company's disclosure controls and procedures, which was
completed as of September 30, 2003 (the "Evaluation Date"), the Company's
principal executive officer and chief financial officer have concluded that
the disclosure controls and procedures in place were effective as of the
Evaluation Date.
(b) CHANGES IN INTERNAL CONTROLS: To the best of the Company's
knowledge and belief, there have been no significant changes in the
Company's internal controls or in other factors that could significantly
affect these controls subsequent to the Evaluation Date.
23
THE STEPHAN CO. AND SUBSIDIARIES
QUARTERLY REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
SEPTEMBER 30, 2003 AND 2002
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 3 to the Financial Statements included in Part I, Item 1 for
a discussion of legal proceedings.
Other than the above, there has been no material change in the status
of any other pending litigation since our last periodic report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 31.1 Certification by the Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification by the Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certification by the Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 Certification by the Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K during the quarter ended September 30, 2003:
None
24
SIGNATURES
Pursuant to the requirements 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.
/s/ Frank F. Ferola
_____________________________________
Frank F. Ferola
President and Chief Executive Officer
November 14, 2003
/s/ David A. Spiegel
____________________________________
David A. Spiegel
Chief Financial Officer
November 14, 2003
25