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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
___
| X | ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE
|___| SECURITIES EXCHANGE ACT OF 1934 {FEE REQUIRED}
For the Fiscal Year Ended December 31, 1998
OR
___
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
|___| OF THE SECURITIES EXCHANGE ACT OF 1934 {NO FEE REQUIRED}
For the transition period from _______ to ______
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 Each Class Name of Each Exchange on Which Registered
___________________ _________________________________________
Common Stock, $.01 AMERICAN STOCK EXCHANGE
Par Value
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
the filing requirements for at least the past 90 days.
YES 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. (X)
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant, computed by reference to the price at which the stock
was sold, or the average bid and asked prices of such stock, as of a
specified date within 60 days prior to the date of filing.
$ 23,629,290 as of April 15, 1999
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date:
4,725,858 Shares of Common Stock, $.01 Par Value,
as of April 15, 1999
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:
Portions of the Company's proxy statement for the Registrant's 1999 annual
meeting of stockholders, filed no later than 120 days after the end of the
Company's fiscal year are incorporated by reference in Part III of this
Form 10-K.
2
THE STEPHAN CO. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
Page
PART I ______
Item 1: Business................................................... 4
Item 2: Properties................................................. 10
Item 3: Legal Proceedings.......................................... 11
Item 4: Submission of Matters to a Vote of Security Holders......... 11
PART II
Item 5: Market for the Registrant's Common Equity
and Related Stockholder Matters........................... 12
Item 6: Selected Financial Data.................................... 13
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 14
Item 7A: Quantitative and Qualitative Disclosures About Market Risk. 19
Item 8: Financial Statements and Supplementary Data................ 19
Item 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 19
PART III
Item 10: Directors and Executive Officers of the Registrant......... 20
Item 11: Executive Compensation..................................... 20
Item 12: Security Ownership of Certain Beneficial
Owners and Management..................................... 20
Item 13: Certain Relationships and Related Transactions............. 20
PART IV
Item 14: Exhibits, Financial Statement Schedules
and Reports on Form 8-K.................................. 21
Signatures.......................................................... 23
3
PART I
Certain statements in this Annual Report on Form 10-K("Form 10-K")
under "Item 1. Business" 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 the actual results, condition (financial or otherwise), performance
or achievements of The Stephan Co. and its subsidiaries to be materially
different from any future results, performance, condition or achievements
expressed or implied by such forward-looking statements. Such factors
include, but are not limited to, the following: general economic and
business conditions; competition; success of operating initiatives;
development and operating costs; advertising and promotional efforts; brand
awareness; the existence or absence of adverse publicity; acceptance of new
product offerings; changing trends in customer tastes; the success of
multi-branding; changes in business strategy or development plans; quality
of management; 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 failure to comply with, law; the ability to
successfully integrate newly-acquired businesses and the ability to reduce
costs; the institution and outcome of litigation commenced against the
Company in respect of its overstatement of operating results for 1998
interim periods and any risks, uncertainties and problems inherent in such
litigation; and other factors or events referenced in the Form 10-K. The
Stephan Co. does not undertake and specifically declines any obligation to
publicly release the results of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the
date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
Item 1. Business
GENERAL
The Stephan Co.(the "Registrant" or 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 Registrant is comprised of The
Stephan Co. ("Stephan") and its eight wholly-owned subsidiaries, Foxy
Products, Inc., Old 97 Company, Williamsport Barber and Beauty Corp.,
Stephan & Co., Scientific Research Products, Inc. of Delaware, Trevor
Sorbie of America, Inc., Stephan Distributing, Inc. and Morris Flamingo-
Stephan, Inc.
THE STEPHAN CO.
Located in Fort Lauderdale, Florida, The Stephan Co. ("Stephan") is
principally engaged in the manufacture of hair care products for sale by
two of its subsidiaries, Scientific Research Products, Inc. and Trevor
Sorbie of America, Inc., and manufacturing of products marketed under the
STEPHAN brand name. Stephan also manufactures, markets and distributes
hair and skin care products under various trade names through different
divisions. Retail brands include product lines such as Cashmere Bouquet
talc, Quinsana Medicated talc, Balm Barr and Stretch Mark creams and
lotions and Protein 29 and Wildroot hair care products for men. These
brands, included in the Retail Personal Care Products ("Retail") segment of
4
business, are manufactured at the Company's Tampa, Florida facility, and
accounted for approximately $4,050,000 of the Company's sales, or
approximately 11.3% of the Registrant's consolidated revenues. In addition
The Frances Denney division of Stephan (included in the "Retail" segment of
business) continues to market 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., under the brand names HOPE,
INTERLUDE and FADE-AWAY through several retail chains, including J.C.
Penney, in the United States and Canada.
On December 31, 1995, the Registrant entered into an asset purchase
agreements (collectively, the "Acquisition Agreements") with each of
Colgate Palmolive Company and its subsidiary, The Mennen Company
(collectively, the "Sellers"), for the acquisition by the Registrant of
certain consumer product brands of the Colgate Palmolive, as well as a
licensing agreement for the domestic distribution of Colgate-Palmolive's
Cashmere Bouquet talc product line (the "U.S. Trademark License").
In December 1996, the Registrant entered into a Settlement Agreement
and Amendment with the Sellers (the "Settlement Agreement") to resolve
certain outstanding disputes with respect to the Acquisition Agreements.
The Settlement Agreement, among other things, provided for the licensing to
the Registrant of certain trademarks in Canada pursuant to a trademark
license agreement (the "Canadian Trademark License"). Additionally, the
Settlement Agreement provided that (i) deferred payments would be made with
respect to products sold under the Canadian Trademark License, (ii) total
deferred payments would be subject to a maximum of $4,000,000, and (iii)
the Registrant was required to pay the greater of $150,000 and 50% of such
deferred payments in immediately available funds, with the balance payable,
at the option of the Registrant, by wire transfer or a five-year promissory
note. In the event that the $4,000,000 maximum amount is not paid by
January 31, 2004, the Registrant must pay the difference in cash between
that amount and Deferred Payments made prior to such date.
The U.S. Trademark License grants the Registrant an exclusive license
to use certain trademarks relating to the Cashmere Bouquet product line in
connection with the manufacture and distribution of such product lines in
the United States. The Canadian Trademark License grants the Registrant an
exclusive license to use certain trademarks relating to the Cashmere
Bouquet powder product line in Canada. Each of the U.S. Trademark License
and the Canadian Trademark License has an initial term of ten years and is
automatically renewable for successive ten-year periods unless earlier
terminated by breach, mutual agreement or upon certain other specified
events. Any product sold under the License Agreement is included in net
sales for purposes of determining the deferred payments.
In March 1996, the Registrant entered into a Trademark License and
Supply Agreement with Color Me Beautiful, Inc. ("CMB") to license select
products of the Registrant's Frances Denney Line and to supply the
requirements of CMB for such products. The agreement provides CMB with the
exclusive right to market and distribute specified Denney products in
certain retail chain stores in the United States and Canada. The agreement
provides for royalty payments by CMB based upon net sales (as defined in
the agreement), with guaranteed minimum annual royalty payments throughout
the term of the Agreement which are credited against accrued royalties.
The agreement also provides for the Registrant to be the exclusive supplier
of products sold under the agreement. The agreement continues in effect
unless terminated (i) by the Registrant, upon the occurrence of certain
events including, among others, bankruptcy or a change of control (as
5
defined in the agreement) of CMB, (ii) by either party, upon the occurrence
of a material breach by the other, (iii) by CMB, on 180 days prior notice
or (iv) by mutual agreement.
Stephan also manufactures and sells products under the 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 is included in the Professional Hair
Care Products and Distribution ("Professional") segment of business. The
Registrant's trademark "STEPHAN'S" and the design utilized thereby has been
registered with the United States Patent and Trademark Office, which
registration is not due for renewal until the year 2001. Sales of the
parent company, Stephan, including the Frances Denney product line as well
as its other retail products, accounted for approximately $4,900,000 of
Company sales, or approximately 13.7% of the Registrant's consolidated
revenues.
The Fort Lauderdale location also serves as the Registrant's corporate
headquarters, and the Registrant provides general management services to
its subsidiaries from such location.
OLD 97 COMPANY.
Old 97 Company ("Old 97"), a wholly owned subsidiary of the
Registrant, located in Tampa, Florida, was purchased in 1988 by the
Registrant. Old 97 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 the Company's second
manufacturing facility. The Tampa facility manufactures most of the
products sold by the Frances Denney line, all the talc manufactured for the
Cashmere Bouquet and Quinsana brands, as well as all the other retail hair
and skin care brands sold by Stephan and Stephan Distributing, Inc. The
operations of Old 97 are included in the Manufacturing segment of business.
Old 97 is also responsible for distribution of the above products. In
addition to the above, Old 97 is responsible for the manufacturing of
custom "private label" products, which is the manufacturing of products
marketed and sold under the brand names of customers. In 1998, one private
label customer accounted for approximately 35% of the Tampa facility's
production, however no single customer accounted for more than 10% of the
Registrant's consolidated revenues. The loss of this private label
customer may have an adverse effect on the operations of the Tampa
facility. Private label production accounted for approximately $3,400,000
of the Company's sales, or approximately 9.5% of the Registrant's
consolidated revenues.
WILLIAMSPORT BARBER AND BEAUTY CORP.
Williamsport Barber and Beauty Corp. ("Williamsport"), a wholly owned
subsidiary of the Registrant, was acquired in January, 1992 and is located
in Williamsport, Pa. Williamsport, a large mail order beauty and barber
supply company, had sales of approximately $3,800,000, which accounted for
almost 11% of the Registrant's consolidated revenues for the year ended
December 31, 1998, and is included in the Professional business segment.
STEPHAN & CO.
Formerly known as Heads or Nails, Inc. and acquired by the Registrant
6
in August, 1993, Stephan & Co., a wholly owned subsidiary of the
Registrant, has focused on the manufacture and supply of personal care
amenity products for cruise ships, with production and shipping commencing
in December, 1995. Sales by Stephan & Co. for the year ended December 31,
1998 were not material.
SCIENTIFIC RESEARCH PRODUCTS, INC. OF DELAWARE.
Purchased by the Company in April, 1994, Scientific Research Products
Inc. of Delaware, a wholly owned subsidiary of the Registrant, was prior
to such purchase, one of the Registrant's largest private label customers
and is a distributor of ethnic hair care products. Scientific Research
Products accounted for 16.7% of the Registrant's consolidated revenues,
with sales of approximately $6,000,000. In addition to the above,
Scientific is responsible for the distribution of the "Magic Wave" product
line, formerly marketed by Foxy Products, Inc., a company acquired by the
Registrant in 1986. Sales by Foxy Products, Inc. for the year ended
December 31, 1998 were not material. The majority of the sales of this
division is included in the Retail business segment.
TREVOR SORBIE OF AMERICA, INC.
On June 28, 1996, the Company entered into a Stock Purchase Agreement
with Sorbie Acquisition Co. ("Sorbie"), and the stockholders of Sorbie,
including the President and principal stockholder pursuant to which the
Company acquired Sorbie, as well as related agreements described below with
the President, Trevor Sorbie International, Mr. Trevor Sorbie, Samson Arms,
Inc. and Redken Laboratories.
In separate related agreements, the Company amended the existing
royalty contract between Sorbie, Trevor Sorbie International, Sorbie
Trading Limited and Mr. Trevor Sorbie. In accordance with the amended
agreement the royalty payment percentage rates payable upon future sales
were reduced. The amended royalty agreement also provides for the supply
to Sorbie Trading Limited and Trevor Sorbie International, at their option,
by Sorbie, of such companies' requirements of certain products. The
amended agreement contains certain non-competition provisions effective
until December 31, 1999, relating to the Sorbie Products (as defined in the
amended royalty agreement). The amended royalty agreement expires in
December 31, 2044 but any party thereto may renew it for successive ten-
year periods until December 31, 2093.
Sorbie, prior to the acquisition, was a major customer of the
Registrant and is a distributor of a professional line of hair care
products sold to salons in the United States, Canada and Mexico through a
network of distributors. Sales of Trevor Sorbie hair care products in 1998
were approximately $3,400,000 of the Company's sales, representing 9.4% of
the Registrant's consolidated revenues, and are included in the
Professional segment of business.
STEPHAN DISTRIBUTING, INC.
On June 26, 1997, the Company, through Stephan Distributing, Inc., a
newly-formed and wholly owned subsidiary, acquired several product lines
from New Image Laboratories, Inc. ("New Image"). The primary brand
acquired was a professional hair care line of products marketed under the
brand name "Image", in addition to a retail hair care line know as "Modern"
and marketed under the brand name "Stiff Stuff". Three smaller hair care
lines, "Ecoterra", "Pure Botanicals"/"Deep Earth", and "Modern Essences"
7
were also acquired in the transaction. The brands were acquired for (i)
250,000 shares of the Registrant's restricted common stock, valued at
$10.81 per share, with provision for half the shares to be held in escrow
pending, among other things, final adjustment of the purchase price in
accordance with the acquisition agreement and (ii) up to 100,000 restricted
shares to be issued over the next two years contingent upon the achievement
of certain earnings levels as set forth in the acquisition agreement. The
acquisition was accounted for as a purchase, with a net value of
approximately $2,700,000 based upon the quoted market price of the
Registrant's stock at the time of issuance.
Pursuant to the transaction, the Company acquired certain accounts
receivable, inventory, fixed assets and trademarks and assumed certain
outstanding trade and other liabilities of approximately $5,332,000. The
liabilities assumed are subject to the terms of a liquidating trust
agreement, and as provided for in such Agreement, the Registrant delivered
a note payable in the amount of $2,399,400, payable in two equal
installments due in December, 1997 and February, 1998.
Additionally, the Registrant provided the Trust, established pursuant
to such liquidating trust agreement, with a standby letter of credit in the
amount of $2,932,600. As indicated above, the purchase price is subject to
adjustment based upon the value of the net assets acquired, as determined
on the first anniversary of the closing date. The Registrant is currently
involved in litigation with New Image Laboratories regarding this purchase
price adjustment. The Registrant believes that based upon information
available to it at December 31, 1998, the 125,000 shares held in escrow and
the subject of the aforementioned litigation will be returned to the
Company. The value of trademarks recorded, approximating $4,100,000, is
net of this anticipated purchase price adjustment.
In addition to being popular hair care lines, the brands acquired from
New Image have international distribution which the Registrant believes
will enhance the distribution of other of the Registrant's products. Sales
of brands acquired from New Image Laboratories, Inc. amounted to
approximately $4,800,000 for the period ended December 31, 1998, which
represented over 13.3% of the Registrant's consolidated revenues. Sales of
Image products are included in the Professional business segment while
Modern sales are included in the Retail business segment.
MORRIS FLAMINGO-STEPHAN, INC.
On March 18, 1998, the Registrant and Morris Flamingo-Stephan, Inc.
signed an Asset Purchase Agreement (the "Agreement") with Morris-Flamingo,
L.P., Morris-Flamingo Beauty Products, Inc., Shaheen & Co., Inc. and Shouky
A. Shaheen, for the acquisition of certain assets and assumption of certain
liabilities (including the immediate payment of a note payable to Fleet
Capital Corporation of approximately $1,880,000) of Morris-Flamingo, L.P.
in exchange for 307,058 shares of the Registrant's restricted common stock.
The transaction was recorded as a purchase, and, based upon the net assets
received, goodwill of approximately $2,500,000 was recorded.
Morris-Flamingo, L.P. is a barber and beauty supply wholesaler,
similar to the Registrant's subsidiary, Williamsport Barber and Beauty
Corp., but markets their products utilizing catalogs published under the
Morris Flamingo brand name as well as the Major Advance brand name.
Additionally, this division manufactures hair pins, scissors and beauty
school cases. Sales for the period March 18, 1998 (acquisition date)
through December 31, 1998 were approximately $9,100,000, representing
8
25.4% of the Registrant's consolidated revenues, and are included in the
Professional segment of business.
RECENT DEVELOPMENTS
Subsequent to the year ended December 31, 1998, the Company discovered
that the method used by the Registrant to determine its cost of sales
during interim periods had resulted in the overstatement of its gross
profit and net income for certain interim periods. See Item 3 "Legal
Proceedings".
SEGMENT INFORMATION
"Operating Segments and Related Information", which provides
information on net sales, income from operations, capital expenditures and
depreciation for the last three years and identifiable assets for the last
two years, for each of the Registrant's three business segments, contained
in Footnote 10 of the 1998 Annual Report included elsewhere in this filing,
is hereby incorporated herein by reference.
RAW MATERIALS, PACKAGING and COMPONENTS INVENTORY
The materials utilized by the Registrant and its 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 Registrant
nor any of its subsidiaries has ever experienced any significant shortage
in supplies nor are any such shortages anticipated by the Registrant or its
subsidiaries in the reasonably foreseeable future.
The Registrant and its subsidiaries try to maintain a level of
finished goods inventory of their products sufficient for a period of at
least three months. The Registrant does not anticipate any change in such
practice during the reasonably foreseeable future.
BACKLOG
As of April 15, 1999, the dollar amount of backlog orders was not
believed by the Registrant to be material.
RESEARCH AND DEVELOPMENT
During each of the three prior fiscal years ending December 31, 1998,
expenditures by the Registrant and its subsidiaries 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 believed by the Registrant to be material and were expensed as
incurred.
COMPETITION
The hair care and personal grooming business is highly competitive in
terms of price and product quality. Products manufactured and sold by the
Registrant 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 Registrant. Products produced by the Registrant and its
9
subsidiaries 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
The Registrant's products are subject to regulation by the Food and
Drug Administration ("FDA"), in addition to other Federal, state and local
regulatory agencies. The Company believes that its products are in
material compliance with all applicable regulations. The Registrant
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 April 15, 1998, in addition to its nine officers, the Registrant
and its subsidiaries employed approximately 225 people engaged in the
production, warehousing, and distribution of their products. Although the
Registrant and its subsidiaries 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 any collective bargaining agreement and the
Company believes its employee relationships are satisfactory.
Item 2. Properties
The Registrant's administrative, manufacturing and warehousing
facilities are located in a building of approximately 33,000 square feet,
which it owns, located at 1850 West McNab Road, Fort Lauderdale, Florida
33309. Approximately two-thirds of the space is utilized by the Registrant
for the manufacture and warehousing of its products. The remainder of the
space is utilized by the Registrant for its administrative offices. The
Registrant also owns certain machinery and equipment suitable for the
manufacture of its products that is housed in its facility in Fort
Lauderdale, Florida. In addition to the facility described above, the
Registrant leases approximately 42,000 square feet of warehouse space
located at 5300 North Powerline Road, Fort Lauderdale, Florida 33309, under
a 3 year lease which commenced in May, 1998, with an annual rental of
$222,000.
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. Such building is utilized by Old 97 in the manufacture of its
various product lines. In October, 1994, Old 97 acquired land and two
buildings located at 4829 East Broadway Avenue, Tampa, Florida 33605. One
building comprising 12,500 square feet is being used for office facilities
and order fulfillment for the Frances Denney line. The second building,
with approximately 30,000 square feet, is used as a warehouse and
distribution facility. On December 30, 1998, Old 97 entered into a 1 year
lease agreement for an additional 20,000 square feet of warehouse space
located at 6706 N. 54th Street, Tampa, Florida 33610.
In connection with the acquisition of Williamsport Barber Supply, the
Company entered into a two year lease, which expired in January, 1994, for
office and warehouse space of approximately 6,000 square feet. Subsequent
to January, 1994, the Registrant leased the premises on a month to month
basis and commencing in February, 1997, the lease was extended five years,
10
expiring January 31, 2002. Monthly rent in the amount of $1,800 is payable
to the former owner of Williamsport Barber Supply, who is currently the
President of Williamsport Barber and Beauty Corp.
In connection with the Morris Flamingo acquisition, the Company
entered into a 3 year lease expiring in March, 2001, for the Morris
Flamingo existing office, warehouse and manufacturing facility located at
204 Eastgate Drive, Danville, Illinois 61834, at an annual rental payment
of approximately $210,000. The Danville facility has 7,500 square feet of
office space and 85,500 square feet of warehouse, distribution and
manufacturing space. The lease is held by Shouky Shaheen, the former owner
of Morris-Flamingo, who is currently a member of the Board of Directors and
a significant shareholder of the Registrant. The Registrant has the option
to terminate the lease with three month's notice at any time prior to the
expiration of the lease term.
The Registrant is currently engaged in negotiations to construct new
warehousing on existing land adjacent to the its Tampa manufacturing
facility in an effort to consolidate off-site locations and reduce rental
expense. It is anticipated that the cost of this new construction could be
as much as $1,000,000. The Registrant believes that the aforementioned
properties will be suitable and adequate for their intended use and purpose
for the reasonably foreseeable future
Item 3. Legal Proceedings
Subsequent to the year ended December 31, 1998, the Company discovered
that the method used by the Registrant to determine its cost of sales
during interim periods had resulted in the overstatement of its gross
profit and net income for the second and third quarters of 1998. This
accounting overstatement was due, in part, to the significant change in the
sales mix of the business as a result of the Morris Flamingo acquisition,
coupled with the decline in sales and gross profit margins of certain of
the Registrant's products. This error in the calculation of the Company's
gross profit also contributed to an overstatement of the inventory level of
approximately $5,000,000 as compared to the reported September 30, 1998
inventory level. The Company has restated its June 30, 1998 and September
30, 1998 quarterly interim financial information and will file amended
quarterly reports shortly with the Securities and Exchange Commission.
Following the Company's April 1, 1999 press release describing the
aforementioned matter, the Company, as well as certain of its officers,
were named as defendants in two class action suits filed in the United
States Federal District Court, Southern District of Florida. The lawsuit
alleges, among other things, certain violations of Federal Securities laws
and seeks an unspecified amount of damages. The Company has agreed to
indemnify its officers in respect of this matter and believes it has
meritorious defenses against these allegations, however, it is not possible
at this time to predict the outcome as many unknown factors exist such as
the likelihood of future claims, insurance limits, and the outcome of jury
trial.
Item 4. Submission of Matters to a Vote
of Security Holders
The Company has not submitted any matters to a vote of its security
holders since the Company's August,1998 Annual Meeting.
11
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters
(a) Market Information
The Registrant's Common Stock is traded on the American Stock Exchange
("AMEX"). The following table sets forth the range of high and low sales
prices for the Registrant's Common Stock for each quarterly period within
the Registrant's two most recent full fiscal years:
High Low
Quarter Ended Sales Price Sales Price
_____________ ___________ ___________
March 31, 1997 $ 14.88 $ 10.88
June 30, 1997 11.50 9.06
September 30, 1997 14.38 10.63
December 31, 1997 14.63 11.38
___________________________________________________________________________
March 31, 1998 $ 14.50 $ 12.50
June 30, 1998 14.25 12.25
September 30, 1998 13.75 9.31
December 31, 1998 12.75 9.50
On April 15, 1999, the American Stock Exchange ("AMEX") suspended
trading of the Registrant's common stock, pending the filing with the SEC
and AMEX of its 1998 Annual Report on Form 10-K.
(b) Holders
As of April 15, 1999, the Registrant's Common Stock was held of record
by approximately 430 holders. However, the Registrant's Common Stock is
believed to be held beneficially by others through approximately 2,000
brokerage accounts ("street-name shareholders").
(c) Dividends
The Company declared and paid cash dividends at the rate of $.02 per
share for each quarter in 1996, 1997 and 1998. Future dividends, if any,
will be determined by the Company's Board of Directors, at its discretion,
based on various factors, including the Company's profitability, cash on
hand and anticipated capital needs.
There are no contractual restrictions, including any restrictions on
the ability of any of the Registrant's subsidiaries, to transfer funds to
the Registrant in the form of cash dividends, loans or advances, that
currently materially limit the Registrant's ability to pay cash dividends
or that the Registrant reasonably believes are likely to materially limit
the future payment of dividends on its Common Stock.
12
Item 6. Selected Financial Data (a)
1998 1997 1996 1995 1994
(in thousands, except per share data)
____________________________________________________
Net sales $35,816 $27,113 $25,779 $26,197 $24,341
Income before
income taxes 977 7,697 7,093 6,426 6,200
Net Income 658 5,041 4,679 4,315 4,076
Current assets 28,623 25,735 19,706 20,438 17,342
Total assets 61,262 57,464 46,499 42,463 29,074
Current
liabilities 5,332 8,468 6,223 4,674 3,525
Long term debt 11,718 9,078 6,689 9,112 811
PER COMMON SHARE
(Basic and Diluted): (b)
Net Income .15 1.20 1.13 1.05 1.01
Cash dividends .08 .08 .08 .04 None
Notes to Selected Financial Data
(a) The selected financial data includes the operations of the Company and
its wholly-owned subsidiaries, Foxy Products, Inc. (acquired in 1986), Old
97 Company (acquired in 1988), Williamsport Barber and Beauty Corp.
(acquired in 1992), Stephan & Co., formerly Heads or Nails, Inc. (acquired
in 1993), Scientific Research Products, Inc. of Delaware (acquired in
1994), Trevor Sorbie of America, Inc. (acquired in 1996), Stephan
Distributing, Inc., a newly formed subsidiary which acquired the brands
from New Image Laboratories, Inc. in 1997, and Morris Flamingo-Stephan,
Inc., a newly formed subsidiary, which acquired the business of Morris-
Flamingo, L.P. in 1998.
(b) Net Income per common share is based upon the weighted average number
of common shares outstanding, in accordance with Statement of Financial
Accounting Standards No. 128, issued in February, 1997. The weighted
average number of shares outstanding were 4,535,649 for 1998, 4,213,372
for 1997, 4,138,629 for 1996, 4,120,304 for 1995, and 4,031,558 for 1994.
This data should be read in conjunction with the audited consolidated
financial statements and related notes included in this Annual Report.
13
Selected Quarterly Financial Information (unaudited)
(in thousands, except per share data)
As As
Previously As Previously As
Reported Restated Reported Restated
3/31/98 6/30/98 6/30/98 9/30/98 9/30/98 12/31/98
_______ _______ _______ _______ _______ ________
Net sales $ 7,651 $ 9,301 $ 9,301 $ 9,926 $ 9,926 $ 8,938
Gross profit 4,903 5,652 3,729 5,978 2,769 2,286
Net income 1,413 1,696 457 1,728 (458) (754)
Per share .33 .37 .10 .38 (.10) (.16)
3/31/97 6/30/97 9/30/97 12/31/97
_______ _______ _______ ________
Net sales $ 6,394 $ 7,106 $ 7,581 $ 6,032
Gross profit 4,059 4,716 5,040 3,106
Net income 1,226 1,460 1,607 748
Per share .30 .35 .37 .17
Information presented above for the quarters ended June 30, 1998 and
September 30, 1998 has been restated to correct for certain errors made in
the estimates used to determine the interim period inventory carrying
values and its cost of sales. See Item 3 "Legal Proceedings".
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
OVERVIEW
1998 was a challenging year for the Company as management completed
the integration of the New Image assets acquired in the third quarter of
1997, acquired the business of Morris-Flamingo, L.P. late in the first
quarter of 1998 and took steps to reposition existing professional and
retail brands to improve distribution in the long term. Net sales for the
year ended December 31, 1998 increased 32% to $35,816,000, up over
$8,700,000 from the previous year. However, the Company experienced a
substantial decline in net income, to approximately $658,000 in 1998 from
approximately $5,041,000 in 1997.
Subsequent to December 31, 1998, the Company discovered that the
method used to determine its cost of sales during interim periods had
resulted in the overstatement of its gross profit, net income and interim
inventory carrying values for the second and third quarters of 1998. This
accounting overstatement was due, in part, to the significant change in
sales mix of the business as a result of the Morris Flamingo acquisition
and a decline in the sales and gross profit margins of certain retail and
professional brands.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 AS COMPARED TO 1997
________________________________________________
Net sales for 1998 increased primarily as a result of the Morris-
Flamingo, L.P. acquisition, but at a significantly lower associated gross
profit level than other divisions or subsidiaries of the Company. In
addition, net sales from certain higher margin professional and retail
brands declined. These factors combined to cause an overall adverse change
14
in the mix of the Company's business and substantially depressed the gross
profit margin of the Company. The impact of this change was not realized
until the Company completed its December 31, 1998 inventory compilation, as
interim inventory values had been determined by estimates utilizing
historical gross profit margins and other factors. These factors, together
with an increase in selling, general, and administrative expenses, resulted
in the decrease of the overall net earnings of the Company.
Gross profit declined slightly more than $3,200,000, to $13,687,000 in
1998 when compared to the $16,921,000 achieved in 1997. This decline of
approximately 19% was due to the factors previously discussed, reflecting a
decline in the overall gross profit margin, from 62.4% in 1997 to 38.2% in
1998. As previously disclosed, the Company had anticipated that the
Morris-Flamingo, L.P. acquisition would have a negative impact on the
Company's gross profit margin and overall gross profit. After operating at
a loss for several years, management was able to make Morris Flamingo-
Stephan profitable for the year ended December 31, 1998 as a stand-alone
operational division(before any allocation of general corporate expenses).
However its gross profit margin of approximately 31% was well below what
the Company has experienced with its other lines. The Company is devoting
significant time and effort to trying to improve the gross profit margin of
Morris Flamingo-Stephan. It will take time to have a positive impact.
However, for the period ended December 31, 1998, the gross margin of Morris
Flamingo increased to 31% from 29% in 1997, representing an improvement
over the level this entity was operating at prior to the acquisition. In
addition, the Company is continuing its efforts to review and control the
selling, general and administrative expenses of this division.
Williamsport Barber and Beauty Corp, which operates in a similar market,
continued to perform well, with a gross profit margin of over 38%.
The Company's overall product mix was also adversely affected by a
decline in certain professional and retail brand sales. Net sales of
Trevor Sorbie of America products, Stephan Distributing, Inc.'s Image line
and Scientific Research Products' New Era line declined from $8,844,000 in
1997 to $8,568,000 in 1998. These sales are included in the operating
segment "Professional Hair Care Products and Distribution".
With respect to the Sorbie product line, management made a determined
effort in 1998 to reduce the amount of diverted product in the marketplace
by terminating certain distributors that were found to be diverting product
to other than professional distribution channels. In the opinion of
management, the long term value of the Sorbie brand can only be maintained
by a vigilant effort to control such diversion, despite a temporary decline
in sales.
Although net sales for Image products rose in 1998, they did not keep
pace with the increases experienced in 1997. In late 1997, Stephan
Distributing, Inc.'s net sales were, somewhat artificially, enhanced by a
"sell-in", of the Image brand, as distributors restocked depleted
inventories caused by New Image Laboratories' inability to maintain a
consistent source of supply. In addition, the Company re-evaluated its
international Image business and terminated certain distributorship
agreements for non-payment.
This had, in the short term, the effect of lowering Image's level of
sales in 1998 while new distributors were evaluated and relationships
established, but the Company believes, will ultimately enhance the long-
term growth of the Image line. The Company has since replaced its South
American distributor which it had terminated in 1998, and began selling in
15
that region again in the first quarter of 1999. Both the Sorbie and Image
lines are selling in a professional environment that is currently
experiencing a consolidation of distributors, which might have a negative
effect on the future sales and gross profit of the Company.
The operating segment "Retail Personal Care Products" also experienced
a decline in net sales as a whole. Net retail sales in 1998 were
$10,473,000, as compared to $11,628,000 in 1997, with the most significant
decline coming from some of the brands purchased from The Colgate-Palmolive
Co. in December 1995. This, in the Company's opinion, was primarily the
result of a reduction in the number of products carried by retailers and a
continuing consolidation in the chain-drug industry. When such a
consolidation occurs, items not carried by the surviving entity are usually
discontinued until they can be re-evaluated at a later date. This industry
consolidation also increases the amount of discounting and promotional
allowances large retailers demand of their suppliers, which diminishes the
profit margin on brands supplied by those retailers. As a result, the
Company has had to respond to these discounting pressures in order to
maintain as much market share as possible without sacrificing the best
interests of the Company. Retail Personal Care Products sales also
includes certain brands which did outperform last year. Retailers have
shown a renewed acceptance of "Stiff Stuff", a brand acquired from New
Image Laboratories, Inc., which had increased sales in 1998, along with
"Stretch Mark" and "Quinsana" products, and net sales of the Frances Denney
line almost doubled over 1997 levels. In addition, commencing in the first
quarter of 1999, a large national retailer began carrying a number of
"Stiff Stuff" products, increasing the exposure of that product line.
In the past, the gross profit margin, as well as gross profit, has
generally increased as the Registrant's business mix shifted away from
private labeling, or "contract" filling, to professional hair care products
and retail hair and skin care brands, which generally afforded the
Registrant a higher gross profit. As discussed above, the Company
experienced a decline in both the gross profit margin and gross profit in
1998, due to factors previously discussed, including a change in the sales
mix and competitive pressures. With the acquisition of Morris-Flamingo,
L.P., the Company anticipates that its overall gross profit margins will be
lower than those experienced in the past, but should increase in 1999 when
compared to 1998 due to price increases on certain product lines in 1999
and efforts implemented to reduce overall cost of sales through more
effective inventory management and production cost savings. Overall, the
Company presently expects gross profit to increase in the future, but not
at the historical rates the Company has previously experienced.
Selling, general and administrative expenses increased 34% from
$9,110,000 in 1997 to $12,240,000 in 1998. This increase is primarily due
to the expenses of Morris Flamingo-Stephan, Inc. Management is continually
trying to reduce overhead expenses where possible and is confident that a
continued scrutiny of certain expense categories will result in lower costs
and expenses in 1999.
Interest expense increased from $642,000 in 1997 to $969,000 in 1998
as a result of increased borrowings to finance the last note payment
related to the Image acquisition, and to repay the outstanding asset-based
financing in connection with the Morris-Flamingo, L.P. acquisition. In
November 1998, the Company refinanced all of its existing debt into a
seven-year term loan, taking advantage of the lower interest rates
available at that time. Other income includes the royalty payment of
$125,000 from Color Me Beautiful in connection with the marketing of
16
Frances Denney products.
YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO 1996
________________________________________________
Sales for the year ended December 31, 1997 increased $1,335,000 from
1996 sales, due significantly to the acquisition of several brand lines
from Image. Gross profit increased from $15,220,000 in 1996 to $16,921,000
in 1997, which represented a 11.2% increase. The gross profit margin
increased to 62.4% in 1997 from 59% in 1996.
As the product mix of sales continues to change from that of a private
label "contract" filler to that of a manufacturer and distributor of
professional hair care lines, the gross margin on these lines tends to
increase to cover the increased selling, general and administrative
expenses that those product lines require. Selling, general and
administrative expenses increased 10.6% in 1997 when compared to 1996, up
from $8,239,000 to $9,110,000. The increase in these expenses can be
attributed to several areas, such as national and regional sales personnel
and the related travel expenses that accompany a sales force, commissions
paid to sales representatives, promotional literature and point of purchase
materials and promotions, retail distribution expenses dictated by major
drug and department store retailers such as "slotting allowances",
promotional "buy one-get one free" offers, "end-cap", coupons and other
point of purchase rebates and sales allowances, increased freight and
delivery expenses, as well as an increase in payroll and related payroll
costs.
Interest expense increased $287,000, to $642,000, as a result of the
additional debt incurred in connection with the acquisitions made in 1997
and 1998. Other income increased $50,000 to $125,000 as a result of the
royalty provision of the Color Me Beautiful Trademark and Licensing
Agreement.
LIQUIDITY AND CAPITAL RESOURCES
_______________________________
Working capital was approximately $23,450,000 at December 31, 1998, an
increase of $6,180,000 from December 1997, due largely to the acquisition
of Morris-Flamingo, L.P. in March 1998 and the refinancing and
consolidation of existing debt in November 1998. Cash and cash equivalents
decreased approximately $410,000 to $8,082,000 when compared to the
$8,491,000 on hand in December 31, 1997.
Inventory has increased significantly from December 31,1997 as a
result of the Morris-Flamingo, L.P. acquisition, which has added a
significant amount of Stock Keeping Units (SKU's) that the Company must
manufacture and carry, and higher inventory levels of Image products. As
a result, more chemicals, raw materials, components and packaging are
required to be kept in stock in order to ensure availability for
production, as well as maintaining a higher level of finished goods
inventory.
The Company is subject to various covenants with respect to working
capital, current maturity coverage and funded debt ratios under the loan
agreements with Nationsbank, N.A. At December 31, 1998, the Company was
not in compliance with the current maturity coverage and funded debt ratio
covenants, but has obtained a waiver from the lender. Under the terms of
the waiver, the Company is subject to an additional 1% interest
17
until the covenant requirements are met.
It is anticipated that the Company will spend approximately $1,000,000
in new construction and modernization of the Tampa manufacturing plant.
These improvements will either be funded from existing cash resources or
new borrowings, depending upon available cash and current interest rates.
The Company has not experienced any adverse impact from the effects of
inflation in the past. Management maintains the 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 in the past, prices can be subject
to various political or economic pressures. The Company does not foresee
any increase in its raw material or component costs but believes it has the
flexibility of multiple vendors and the ability to increase prices to
offset any price changes.
YEAR 2000 COMPUTER SYSTEMS COMPLIANCE
The Year 2000, or Y2K problem, relates to the inability of computer
systems to properly recognize and process date sensitive information. Many
older computer software programs refer to years by their final two digits,
thus some computer systems may interpret the year 2000 as 1900, and cause
date related or operational failures. The problems caused by these
potential system failures may have a more significant impact on certain
types of businesses or industries than others, and these factors must be
taken into consideration when assessing the overall risk that a company may
be exposed to. Management has determined that the Company's Year 2000
compliance project takes all relevant factors into consideration when
determining that the risk of business disruption would be limited due to
the nature of the business the Company is involved in, the degree of
sophistication of customers and suppliers, and the financial stability of
the Company itself.
While it is the Company's assessment that its risk of exposure to Y2K
problems are low, certain Year 2000 risk factors could have a material
adverse effect on results of operations, liquidity and financial condition.
For the most part these risks are not within the Company's control. These
risk factors include, but are not limited to, unexpected failures by
significant business suppliers and/or customers, extended failures by
public utility companies or common carriers supplying goods or services to
the Company or delivering finished product manufactured by the Company, or
failures in the banking system and/or capital markets.
The Company has completed an assessment of its Information Technology
(IT) systems in conjunction with the integration of the software and
hardware currently in use and has determined that sales and accounts
receivable comprise the more significant IT systems that might be affected
by the Y2K problem. The Company believes that there currently is in place
sufficient collateral or alternative methods of maintaining information
should other IT systems fail. Costs related to the overall assessment of
the Company's Y2K readiness are not material.
The Company purchases all of its raw materials, components and
packaging from third party suppliers, and as such, may be at risk from
suppliers who may not be Y2K compliant. The inability or failure of
suppliers to be Y2K compliant may result in shortages that could adversely
impact the operations and condition of the Company. While it is difficult
to accurately project the disruptions that may occur under these
18
circumstances, the Company believes that it maintains a sufficient level of
inventory that would mitigate the disruption caused by an inability of one
or more current suppliers to fulfill the Company's orders. On the basis of
communications and correspondence with existing suppliers, the Company has
determined that most suppliers are attempting to be, or are already, Y2K
compliant.
In addition to the above, the Company has determined that there may
also be a risk arising from the inability of customers who are not Y2K
compliant to pay their invoices in a timely manner. The Company believes
it has adequate resources to lessen any disruption in sales and or cash
flow that may occur as a result of this and will continue to assess this
risk through Y2K readiness inquiries with customers.
As it relates specifically to the Company's and its subsidiaries'
computer systems and software, the Company is in the process of converting
all of its existing computer systems. The software in use is anticipated
to be updated by the third quarter of 1999 (at no additional cost other
than the normal quarterly software maintenance fee paid by the Company), at
which time the Company believes such software will be Year 2000 compliant.
The Company currently uses a consultant to assist in the implementation of
the hardware and software system, and he is also monitoring the Y2K upgrade
procedures and related Company upgrade and integration plans. Based upon
the Company's current readiness and the procedures that have been
implemented, the Company does not anticipate costs relating to Year 2000
problems to have any material adverse effect on its financial condition,
results of operations or cash flows. While there are no specific
contingency plans, the Company feels that its overall financial stability,
the ability to maintain excess inventory quantities, and back-up production
capabilities will enable the Company to deal with Y2K problems as they
arise.
Item 7A. 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
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.
Item 8. Financial Statements and Supplementary Data
Reference is made to the financial statements and supplementary data
contained elsewhere in this Annual Report.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Not applicable
19
PART III
The information required by Part III Items 10-13 of Form 10-K are
incorporated herein by reference from the Registrant's Proxy Statement for
its 1998 annual meeting of stockholders which has been filed with the
Securities and Exchange Commission on April 30, 1999.
20
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K
(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.
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 by reference.
21
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 by reference.
27. Financial Data Schedule
(b) Financial Statements and Financial Statement Schedules
(i) Financial Statements
Independent Auditors' Report for the years ended
December 31, 1998, 1997 and 1996.
Consolidated Balance Sheets as of December 31, 1998
and 1997.
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997, and 1996.
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998, 1997, and 1996.
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997, and 1996.
Notes to Consolidated Financial Statements.
(ii) Financial Statement Schedules
All schedules are omitted because they are not applicable or
the required information is shown in the consolidated
financial statements or notes thereto.
22
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of The Stephan Co.:
We have audited the accompanying consolidated balance sheets of The Stephan
Co. and subsidiaries (the "Company") as of December 31, 1998 and 1997, and
the related consolidated statements of operations, changes in stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe 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 Company as of
December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Miami, Florida
May 19, 1999
F-1
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,1998 AND 1997
ASSETS
1998 1997
____________ ____________
CURRENT ASSETS
Cash and cash equivalents $ 8,081,762 $ 8,491,174
Cash on deposit with trustee 270,684 610,126
Accounts receivable, less
allowance for doubtful accounts
of $175,155 and $98,359 in 1998
and 1997, respectively 4,680,170 4,696,248
Inventories 15,286,370 11,667,672
Income taxes receivable 83,888 -
Prepaid expenses
and other current assets 219,897 269,304
____________ ____________
TOTAL CURRENT ASSETS 28,622,771 25,734,524
PROPERTY, PLANT AND EQUIPMENT, net 3,120,658 2,760,011
INTANGIBLE ASSETS, net 27,086,358 26,443,911
OTHER ASSETS 2,432,278 2,525,948
____________ ____________
TOTAL ASSETS $ 61,262,065 $ 57,464,394
============ ============
See notes to consolidated financial statements.
F-2
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,1998 AND 1997
LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997
___________ ___________
CURRENT LIABILITIES
Accounts payable and
accrued expenses $ 3,126,756 $ 3,704,383
Note payable to bank 400,000 400,000
Note payable to trustee - 1,199,700
Current portion of
long-term debt 1,804,971 1,773,788
Income taxes payable - 1,390,104
___________ ___________
TOTAL CURRENT LIABILITIES 5,331,727 8,467,975
DEFERRED INCOME TAXES, net 554,017 268,166
LONG-TERM DEBT, less current
maturities 11,718,169 9,078,114
___________ ___________
TOTAL LIABILITIES 17,603,913 17,814,255
___________ ___________
COMMITMENTS AND CONTINGENCIES (NOTES 2 and 11)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value;
25,000,000 shares authorized;
4,725,858 and 4,418,800 shares
issued and outstanding at
December 31, 1998 and 1997,
respectively 47,259 44,188
Additional paid in capital 19,692,043 15,979,709
Retained earnings 25,270,413 24,977,805
___________ ____________
45,009,715 41,001,702
LESS 125,000 CONTINGENTLY
RETURNABLE SHARES (1,351,563) (1,351,563)
___________ ____________
TOTAL STOCKHOLDERS' EQUITY 43,658,152 39,650,139
___________ ____________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $61,262,065 $57,464,394
=========== ===========
See notes to consolidated financial statements.
F-3
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
____________ ____________ ____________
NET SALES $ 35,816,190 $ 27,113,306 $ 25,778,618
COST OF GOODS SOLD 22,129,603 10,192,411 10,558,919
____________ ____________ ___________
GROSS PROFIT 13,686,587 16,920,895 15,219,699
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 12,239,694 9,110,001 8,239,386
____________ ____________ ___________
OPERATING INCOME 1,446,893 7,810,894 6,980,313
OTHER INCOME(EXPENSE)
Interest income 373,968 402,940 392,314
Interest expense (968,630) (641,654) (354,362)
Other 125,000 125,000 75,000
____________ ___________ ____________
INCOME BEFORE INCOME TAXES 977,231 7,697,180 7,093,265
INCOME TAXES 318,837 2,656,171 2,414,105
____________ ___________ ____________
NET INCOME $ 658,394 $ 5,041,009 $ 4,679,160
============ =========== ============
BASIC AND DILUTED
EARNINGS PER SHARE $ .15 $ 1.20 $ 1.13
============ =========== ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,535,649 4,213,372 4,138,629
============ =========== ============
See notes to consolidated financial statements.
F-4
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Common Stock Treasury
____________________ Additional Stock/
Paid in Retained Contingently
Shares Par Value Capital Earnings Returnable
Stock
_________ _________ __________ __________ __________
Balances, Jan. 1, 1996 4,122,484 $ 41,225 $12,583,995 $15,930,662 $ -
Stock issued for
Acquisition 32,632 326 517,707 - -
Stock options exercised 6,750 68 49,941 - -
Treasury stock purchased - - - - (184,325)
Treasury stock retired (14,400) (144) (184,181) - 184,325
Dividends paid - - - (331,086) -
Net income for 1996 - - - 4,679,160 -
_________ _________ __________ __________ ________
Balances, Dec. 31, 1996 4,147,466 41,475 12,967,462 20,278,736 -
Stock issued for
acquisition 250,000 2,500 2,700,625 - -
Contingently returnable
stock - - - - (1,351,563)
Stock issued to
Retire debt 34,534 345 442,100 - -
Treasury stock purchased - - - - (130,610)
Treasury stock retired (13,200) (132) (130,478) - 130,610
Dividends paid - - - (341,940) -
Net income for 1997 - - - 5,041,009 -
_________ _________ __________ __________ __________
Balances, Dec. 31, 1997 4,418,800 44,188 15,979,709 24,977,805 (1,351,563)
Stock issued for
acquisition 307,058 3,071 3,712,334 - -
Dividends paid - - - (365,786) -
Net income for 1998 - - - 658,394 -
_________ ________ ___________ ___________ ___________
Balances, Dec. 31, 1998 4,725,858 $ 47,259 $19,692,043 $25,270,413 $(1,351,563)
========= ======== =========== =========== ===========
See notes to consolidated financial statements.
F-5
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
_____________________________________________
1998 1997 1996
__________ ___________ ___________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 658,394 $ 5,041,009 $4,679,160
___________ ___________ ___________
Adjustments to reconcile net income
to net cash flows provided by
operating activities:
Depreciation 407,482 338,326 221,867
Amortization 1,208,079 1,094,948 889,944
Adjustment to goodwill 111,788 111,788 123,016
Loss on disposal of property,
plant and equipment 4,463 - -
Deferred income taxes 285,851 (30,295) 178,340
Provision for doubtful accounts 122,047 120,953 10,978
Changes in operating assets
and liabilities, net of effects
of acquisitions:
Accounts receivable 1,240,419 (750,621) 586,073
Inventories (956,960) (2,354,349) (555,425)
Prepaid expenses
and other current assets 131,613 24,121 (28,740)
Other assets 93,670 (1,024,841) (319,731)
Accounts payable
and accrued expenses (1,044,566) (1,385,587) (2,340,331)
Income taxes payable (1,473,992) 925,511 464,593
__________ __________ __________
Total adjustments 129,894 (2,930,046) (769,416)
__________ __________ __________
Net cash flows provided
by operating activities 788,288 2,110,963 3,909,744
__________ __________ __________
See notes to consolidated financial statements.
F-6
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
_____________________________________________
1998 1997 1996
__________ __________ __________
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired from acquisition 5,266 - 128,445
Colgate purchase price adjustment - - 331,000
Decrease(Increase) in cash on
deposit with trustee 339,442 (610,126) -
Purchase of property, plant
and equipment (684,932) (562,659) (229,238)
Purchase of intangible assets (85,291) (409,823) (75,284)
__________ __________ __________
Net cash flows (used in)/provided by
investing activities (425,515) (1,582,608) 154,923
__________ __________ __________
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (12,428,762) (1,841,907) (10,033,528)
Repayment of acquired debt (1,877,937) - -
Repayment of note payable
to trustee (1,199,700) (1,199,700) -
Proceeds from notes payable to bank 15,100,000 3,200,000 7,000,000
Acquisition of treasury stock - (130,610) (184,325)
Dividends paid (365,786) (341,940) (331,086)
Proceeds from exercise of
stock options - - 50,009
__________ __________ __________
Net cash flows used in
financing activities (772,185) (314,157) (3,498,930)
__________ __________ __________
NET INCREASE IN CASH AND
CASH EQUIVALENTS (409,412) 214,198 565,737
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 8,491,174 8,276,976 7,711,239
__________ __________ __________
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 8,081,762 $ 8,491,174 $ 8,276,976
========== ========== ==========
See notes to consolidated financial statements.
F-7
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Supplemental Disclosures of Cash Flow Information:
1998 1997 1996
__________ _________ __________
Interest paid $ 845,669 $ 644,862 $ 354,445
========== ========= ==========
Income taxes paid $ 1,341,899 $ 1,760,955 $ 1,612,417
========== ========= ==========
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
In connection with the acquisition of Morris-Flamingo, L.P. on March 18,
1998, the Company acquired inventories, accounts receivable, fixed and
intangible assets and assumed certain liabilities by issuance of common
stock with an approximate value, at the time of acquisition, of $3,700,000.
In connection with the acquisition of certain assets and brands from New
Image Laboratories, Inc. on June 26, 1997, the Company acquired
inventories, accounts receivable, fixed and intangible assets and assumed
certain liabilities by issuance of common stock with an approximate value,
at the time of acquisition, of $2,700,000.
On September 9, 1997, the Company issued 34,534 shares of common stock to
Charles V. Hall, in satisfaction of the amount due him as a result of the
acquisition of Trevor Sorbie of America, Inc. in June, 1996.
In connection with the acquisition of Sorbie Acquisition Company and
Subsidiaries on June 28, 1996, the Company acquired inventories, accounts
receivable, fixed and intangible assets and assumed certain liabilities by
issuance of common stock with an approximate net value of $518,000.
See notes to consolidated financial statements.
F-8
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial
statements include the accounts of The Stephan Co. and its wholly-owned
subsidiaries, Foxy Products, Inc., Old 97 Company, Williamsport Barber and
Beauty Supply Corp., Stephan & Co., Scientific Research Products, Inc. of
Delaware, Trevor Sorbie of America, Inc., Stephan Distributing, Inc. and
Morris Flamingo-Stephan, Inc. (collectively, the "Company"). All
significant intercompany balances and transactions have been eliminated in
consolidation.
NATURE OF OPERATIONS: The Company is engaged in the manufacture,
sale, and distribution of hair and personal care grooming products
throughout the United States. Statement of Financial Accounting Standards
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. As explained more fully in Note 10, the Company has allocated
substantially all of its business into three segments, which include
professional hair care products and distribution, retail personal care
products and manufacturing.
USE OF ESTIMATES: The preparation of consolidated financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
MAJOR CUSTOMERS: In 1998, there were no sales to any single
customer in excess of 10% of net sales. Sales to a major customer in
excess of 10% of net sales for the years ended December 31, 1997 and 1996
were $2,819,000 and $3,056,000, respectively. 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 major customer could have an adverse effect on the Company.
LONG-LIVED ASSETS: SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of",
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and goodwill related to those assets to
be held and used, and for long-lived assets and certain identifiable
intangibles to be disposed of. SFAS No. 121 did not have a material
effect on the Company's financial position or results of operations.
STOCK-BASED COMPENSATION: On January 1, 1996, the Company
adopted SFAS No. 123, "Accounting for Stock-Based Compensation", which
permits entities to recognize as an expense over the vesting period the
fair value of all stock-based awards on the date of grant. Alternatively,
SFAS No. 123 allows entities to continue to measure compensation cost for
stock-based awards using the intrinsic value based method of accounting
F-9
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and to provide pro forma net income and pro forma earnings per
share disclosures as if the fair value method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the provisions
of APB Opinion No. 25 and provide the pro forma disclosure provisions of
SFAS No. 123. See Note 12 to the financial statements.
FAIR VALUE OF FINANCIAL INSTRUMENTS: Statement of Financial
Accounting Standards No. 107, "Disclosure about Fair Value of Financial
Instruments," requires disclosure of the fair value of financial
instruments, both assets and liabilities, recognized and not recognized in
the consolidated balance sheets of the Company, for which it is practicable
to estimate fair value. 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 instrument.
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.
There were no significant differences as of December 31, 1998 and 1997 in
the carrying value and fair market value of financial instruments.
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. Also included in cash
and cash equivalents is a $400,000 certificate of deposit pledged as
collateral against a $400,000 note payable to a bank. 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, 1998 and 1997 was
approximately $7,121,000 and $7,342,000, respectively.
INVENTORIES: Inventories are stated at the lower of cost
(determined on the first-in, first-out basis) or market. Capitalized
direct labor and overhead costs charged to inventory for the years ended
December 31, 1998 and 1997 were approximately $3,117,000 and $2,404,000,
respectively.
Capitalized direct labor and overhead costs included in inventory as of
December 31, 1998 and 1997 were approximately $1,871,000 and $1,476,000,
respectively.
F-10
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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
INTANGIBLE ASSETS: Intangible assets are amortized using the
straight-line method based on the following estimated useful lives:
Goodwill 20-40 years
Covenant not to compete 7 years
Trademarks 20-40 years
Deferred acquisition costs 10 years
The amount of impairment, if any, in unamortized Goodwill is measured
based on projected future results of operations. To the extent future
results of operations of those subsidiaries to which the Goodwill relates
through the period such Goodwill is being amortized are sufficient to
absorb the amortization of Goodwill, the Company has deemed there to be no
impairment of Goodwill.
INCOME TAXES: Income taxes are calculated under the asset and
liability method of accounting. Deferred income taxes are recognized by
applying the enacted statutory rates applicable to future year differences
between the financial statement carrying amounts and the tax basis of
existing assets and liabilities. A valuation allowance is recorded when it
is more likely than not that some portion or all of the deferred tax asset
will not be realized.
BASIC AND DILUTED EARNINGS PER SHARE: Basic and diluted earnings
per share are computed by dividing net income by the weighted average
number of shares of common stock outstanding. The Company has 496,501
outstanding stock options, of which 220,558 were exercisable. None of these
options were included in the calculation of earnings per share because
their inclusion would be antidilutive.
NEW FINANCIAL ACCOUNTING STANDARDS: In June, 1997, the Financial
Accounting Standards Board (FASB) issued SFAS No. 130, "Reporting
Comprehensive Income" and SFAS. No. 131, "Disclosures about Segments of an
Enterprise and Related Information". The provisions of SFAS No. 130 were
adopted by the Company in the first quarter of 1998. This statement
establishes standards for the reporting of comprehensive income and its
components. Implementation of this disclosure standard did not affect the
Company's financial position, results of operations or the manner in which
financial information is currently presented. In accordance with SFAS No.
131, the Company is required to modify or expand the financial statement
disclosures for operating segments, products and services, and geographic
areas. Implementation of this disclosure standard, which was adopted in
the year ended December 31, 1998, did not affect the Company's financial
position or results of operations.
F-11
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In June, 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The Statement provides
guidance for the recognition and measurement of derivatives and hedging
activities. This statement is not expected to have a material impact on
the Company's financial position, results of operations or cash flows.
RECLASSIFICATIONS: Certain reclassifications have been made to
prior year amounts to conform to current year presentation.
NOTE 2. SIGNIFICANT TRANSACTIONS
On March 18, 1998, the Company entered into an Asset Purchase
Agreement with Morris-Flamingo, L.P., Morris-Flamingo Beauty Products,
Inc., Shaheen & Co., Inc. and Shouky A. Shaheen, for the acquisition of
certain assets and liabilities (including payment of a note payable of
approximately $1,880,000) in exchange for 307,058 shares of the Company's
restricted (as provided for in Rule 144 of the Securities Act of 1933, as
amended (the "Securities Act")) common stock valued at $12.10 per share.
Morris-Flamingo is a wholesaler of barber and beauty supplies, as well as a
manufacturer of hairpins, scissors and beauty school cases. The
transaction was recorded as a purchase and goodwill of approximately
$2,545,000 was recorded.
The Company also entered into a 3 year lease agreement with Shouky A.
Shaheen for the existing office, warehouse and distribution facility
occupied by Morris-Flamingo in Danville, Illinois, at an annual rental of
approximately $210,000.
Unaudited pro-forma results of operations, assuming the acquisition of
Morris-Flamingo occurred as of the beginning of 1997, after giving effect
to certain adjustments such as interest and the amortization of goodwill
resulting from the acquisition, are summarized as follows (in thousands,
except per share data):
1998 1997
__________ __________
Net sales $ 38,958 $ 41,233
========== ==========
Income before income taxes $ 1,120 $ 7,618
========== ==========
Net Income $ 772 $ 4,989
========== ==========
Earnings per share $ .17 $ 1.10
========== ==========
On June 26, 1997, the Company acquired several product lines from New
Image Laboratories, Inc.(Image). The brands were acquired for 250,000
shares of the Company's restricted(as provided for by Rule 144 of the
Securities Act) common stock, valued at the time of acquisition, at $10.81
per share, with provision for half the shares to be held in escrow pending,
among other things, final adjustment of the purchase price in accordance
with the
F-12
NOTE 2. SIGNIFICANT TRANSACTIONS (Continued)
acquisition agreement and up to an additional 100,000 restricted shares of
Common Stock to be issued over the next two years contingent upon the
achievement of certain levels of earnings as set forth in the purchase
agreement. The Company will record the additional value of trademarks
resulting from this contingent payment, if necessary, once the contingency
is resolved. The acquisition was accounted for as a purchase, with a net
value of approximately $2,700,000 based upon the quoted market price of the
Company's stock at the time of issuance.
The Company acquired certain accounts receivable, inventories, fixed
assets and trademarks as well as assuming certain outstanding trade and
other liabilities of approximately $5,332,000. The liabilities acquired
are subject to the terms of a liquidating trust agreement, and as provided
for in the liquidating trust agreement, the Company delivered a non-
interest bearing, unsecured note payable in the amount of $2,399,400, which
was paid in two equal installments in December, 1997 and February, 1998.
Additionally, the Company provided the trustee under the trust with a
standby letter of credit in the amount of $2,932,600. Claims filed with
the Trustee are funded periodically by the Company at the request of the
Trustee, in addition to funds provided by the payment of the above note.
The rights of creditors to file claims against the Trust terminated on the
first anniversary of the agreement, and all funds on deposit with respect
to unfiled claims have been refunded to the Company and treated as a
reduction of intangible assets. Management of the Company has reduced the
value of the trademarks arising from the acquisition in accordance with the
amount it believes will ultimately be refunded. As of December 31, 1998,
the Trustee had on deposit funds approximating $270,000 for satisfaction of
claims filed in accordance with the provisions of the liquidating trust
agreement.
As indicated above, the purchase price is subject to adjustment based
upon the value of the net assets acquired, as determined on the first
anniversary of the closing date. Although the Company is currently
involved in litigation with Image with respect to the shares held in
escrow, the Company believes that based upon information available at
December 31, 1998, the 125,000 shares held in escrow will be returned to
the Company and, accordingly, reduced the value of trademarks and
stockholders' equity to reflect this anticipated purchase price adjustment.
On June 28, 1996, the Company entered into a Stock Purchase Agreement
with Sorbie Acquisition Co. and its subsidiaries (Sorbie), and all the
stockholders of Sorbie, including the President and principal stockholder,
as well as related agreements described below with the President, Trevor
Sorbie International, Trevor Sorbie, Samson Arms, Inc. and Redken
Laboratories. In separate agreements, the Company amended the existing
royalty contract between Sorbie, Trevor Sorbie International, Sorbie
Trading Limited and Trevor Sorbie. In accordance with the amended royalty
agreement, the royalty payment percentage rate payable upon future sales
was reduced.
In December 1996, the Company entered into a Settlement Agreement and
Amendment with Colgate-Palmolive Company and its subsidiary, The Mennen
Company, to resolve certain outstanding disputes with respect to the asset
purchase agreements to acquire certain consumer product brands, as well as
a licensing agreement for the domestic distribution of the Cashmere Bouquet
talc product line entered into in December, 1995. In general, the
F-13
NOTE 2. SIGNIFICANT TRANSACTIONS (Continued)
settlement (i) terminated an agreement which granted the Company the right
to cause Colgate Palmolive to repurchase certain products if certain
minimum net sales (as defined in the Settlement Agreement) were not
achieved, (ii) required Colgate Palmolive to remit $500,000 in cash to the
Company, and (iii) provided for the licensing to the Company of certain
trademarks in Canada pursuant to a trademark license agreement (the
"Canadian Trademark License"). Additionally, the Settlement Agreement
provided that (i) deferred payments would be made with respect to products
sold under the Canadian Trademark License, (ii) total deferred payments
would be subject to a maximum of $4,000,000 ($250,000 semi-annually through
January 31, 2004), and (iii) the Company was required to pay the greater of
$150,000 and 50% of such deferred payments in immediately available funds,
with the balance payable, at the option of the Company, by wire transfer or
a five-year promissory note. In the event that the $4,000,000 maximum
amount is not paid by January 31, 2004, the Company must pay the difference
in cash between that amount and deferred payments made prior to such date.
NOTE 3. ACCOUNTS RECEIVABLE
Accounts Receivable at December 31, 1998 and 1997 consisted of the
following:
1998 1997
___________ ___________
Accounts Receivable:
Trade $ 4,845,656 $ 4,753,965
Other 9,669 40,642
___________ ___________
4,855,325 4,794,607
Less: Allowance for
doubtful accounts (175,155) (98,359)
___________ ___________
$ 4,680,170 $ 4,696,248
=========== ===========
The following is an analysis of the allowance for doubtful accounts
for the year ended December 31:
1998 1997 1996
__________ __________ __________
Balance, beginning of year $ 98,359 $ 56,171 $ 46,401
Provision for doubtful
Accounts, net of recoveries 122,047 120,953 10,978
Uncollectible accounts
written off (45,251) (78,765) (1,208)
__________ __________ __________
Balance, end of year $ 175,155 $ 98,359 $ 56,171
========== ========== ==========
F-14
NOTE 4. INVENTORIES
Inventories at December 31, 1998 and 1997 consisted of the following:
1998 1997
____________ ____________
Raw materials $ 4,042,217 $ 3,750,094
Packaging and components 4,375,596 4,930,473
Work in progress 959,057 437,965
Finished goods 7,848,046 4,289,307
____________ ____________
17,224,916 13,407,839
Less: Amount included
in other assets (1,938,546) (1,740,167)
____________ ____________
$ 15,286,370 $ 11,667,672
============ ============
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 be
part of the finished product. Finished goods also 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.
NOTE 5. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment at December 31, 1998 and 1997 consisted
of the following:
1998 1997
____________ ____________
Land $ 379,627 $ 379,627
Buildings and improvements 1,979,823 1,873,508
Machinery and equipment 1,736,010 1,398,922
Furniture and office equipment 641,618 477,816
____________ ___________
4,737,078 4,129,873
Less: accumulated depreciation (1,616,420) (1,369,862)
____________ ___________
$ 3,120,658 $ 2,760,011
============ ===========
F-15
NOTE 6. INTANGIBLE ASSETS
Intangible assets at December 31, 1998 and 1997 consisted of the
following:
1998 1997
____________ ____________
Goodwill-Williamsport
Barber Supply $ 510,674 $ 510,674
Covenant not to compete-
Williamsport Barber Supply 275,000 275,000
Goodwill-Stephan & Co. 278,054 278,054
Goodwill-Scientific
Research Products, Inc. 1,976,446 2,088,234
Trademarks-Scientific Research 1,758,343 1,758,343
Trademarks-Frances Denney 4,442,455 4,442,455
Trademarks-Colgate/Mennen 9,548,070 9,548,070
Goodwill-Trevor Sorbie 5,622,130 5,622,130
Trademarks-Image/Modern 3,452,011 4,109,705
Goodwill-Morris Flamingo 2,544,831 -
Deferred Acquisition Costs 756,908 693,222
Other 103,005 103,005
___________ ____________
31,267,927 29,428,892
Less: accumulated amortization (4,181,569) (2,984,981)
____________ ____________
$ 27,086,358 $ 26,443,911
============ ============
Goodwill arising from the acquisition of Scientific Research Products of
Delaware, Inc. has been reduced by the tax effect of net operating loss
carryforwards utilized in the amount of $111,788 for each of the years
ended December 31, 1988 and 1987.
NOTE 7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1998 and 1997
consisted of the following:
1998 1997
____________ ____________
Accounts payable $ 2,273,765 $ 3,259,119
Accrued marketing expenses 258,192 121,311
Accrued payroll and bonuses 257,341 240,545
Accrued property taxes 92,671 24,552
Other accrued expenses 244,787 58,856
____________ ____________
$ 3,126,756 $ 3,704,383
============ ============
F-16
NOTE 8. LONG-TERM DEBT
Long-term debt at December 31, 1998 and 1997 consisted of the
following:
1998 1997
____________ ____________
6.65% note payable to bank, principal of
$92,500 plus interest, due monthly,
through November 30, 2005; unsecured $11,100,000 -
Guaranteed royalty payments to former
owner of Sorbie brand, payable in
quarterly installments of $22,401,
through December 31, 1999, discounted
at an 8% rate; unsecured. 105,704 183,172
7.85% note payable to bank, principal of
$100,000 plus interest, due monthly,
through June 26, 2001; collateralized
by a secondary security interest in the
brands acquired from Colgate-Palmolive
with a carrying value of approximately
$8,900,000. - 4,200,000
Revolving credit line note payable to
Bank, interest payable monthly, due
July 15, 1999; unsecured. - 4,000,000
Guaranteed minimum payments of $150,000 due
semi-annually to Colgate-Palmolive through
January 31, 2004 (pursuant to an agreement
described in Note 2), discounted at an 8%
rate; collateralized by a security interest
in the brands acquired with a carrying
value of approximately $8,600,000. 2,312,067 2,386,547
Other 5,369 82,183
____________ ____________
13,523,140 10,851,902
Less: current portion (1,804,971) (1,773,788)
____________ ____________
Long-term debt $ 11,718,169 $ 9,078,114
============ ============
At December 31, 1998 the Company has a $400,000 note payable to a bank
due January 9, 1999 with interest at 3/4% above the certificate of deposit
rate (5.5% in 1998 and 1997) that is pledged as collateral against the
note.
The note payable to bank has covenants with respect to current
maturity coverage, funded debt to earnings (as defined) and minimum working
capital. At December 31, 1998, the Company was not in compliance with the
current maturity coverage and funded debt to earnings covenants but has
obtained a waiver from the lender. Under the terms of the waiver, the
Company is subject to an additional 1% interest until the covenant
requirements are met.
At December 31, 1998, approximate maturities of long-term debt are
$1,805,000 for 1999, $1,491,000 for 2000, $1,442,000 for 2001, $1,416,000
for 2002, $1,393,000 for 2003, and $5,976,000 for 2004 through 2005.
F-17
NOTE 9. INCOME TAXES
The provision for income taxes is comprised of the following for the
years ended December 31:
1998 1997 1996
___________ ___________ ___________
Current Tax:
Federal $ 28,165 $ 2,318,398 $ 1,872,701
State 4,821 368,068 363,064
___________ ___________ ___________
Total Current 32,986 2,686,466 2,235,765
___________ ___________ ___________
Deferred Tax:
Federal 229,208 (26,425) 154,374
State 56,643 (3,870) 23,966
___________ ___________ ___________
Total Deferred 285,851 (30,295) 178,340
___________ ___________ ___________
Total provision
for income taxes $ 318,837 $ 2,656,171 $ 2,414,105
=========== =========== ===========
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 tax liability in the accompanying balance sheets
includes deferred tax assets and liabilities attributable to the following
items:
1998 1997
___________ ___________
Accounts receivable
allowances $ (65,911) $ (38,680)
Inventories (569,221) (221,862)
Amortization of
goodwill 1,572,394 537,035
Charitable contribution
carryforward (300,154) -
Accrued liabilities
and other (83,091) (8,327)
___________ ___________
Net deferred tax
liability $ 554,017 $ 268,166
=========== ===========
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 9. INCOME TAXES (Continued)
1998 1997 1996
________ ________ ________
Amount computed on pretax income 35.0% 35.0% 35.0%
Increase(decrease) in taxes:
State income taxes, net of
federal tax benefit 4.2 3.4 3.6
Charitable contributions of inventory (13.2) (2.8) (2.9)
Goodwill 7.3 - -
Benefit of graduated rates (1.0) (1.0) (1.0)
Other .3 ( .1) ( .3)
________ ________ ________
Total income tax 32.6% 34.5% 34.4%
======== ======== ========
NOTE 10. SEGMENT INFORMATION
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", effective for the year ended December
31, 1998. In accordance with the guidelines established by SFAS No. 131,
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 as a customer base distributors who purchase the Company's hair
products and beauty and barber supplies for sale to salons and barber
shops. The customer base for the Retail segment is mass merchandisers,
chain drug stores and supermarkets who sell the product to the end user.
The Manufacturing segment manufactures products for the different
subsidiaries of the Company, as well as manufacturing 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 table, in thousands, summarizes significant accounts and
balances by reportable segment:
NET SALES INCOME BEFORE INCOME TAXES
________________________ __________________________
1998 1997 1996 1998 1997 1996
________________________ __________________________
Professional $21,511 $12,284 $ 8,259 $ 505 $ 2,775 $ 1,265
Retail 10,473 11,628 13,761 173 4,338 5,680
Manufacturing 14,116 13,048 10,167 1,234 1,479 731
_______ _______ _______ ________ ________ ________
Total 46,100 36,960 32,187 $ 1,912 8,592 7,676
Intercompany
Manufacturing (10,284) (9,847) (6,408) (935) (895) (583)
_______ _______ _______ ________ ________ ________
Consolidated $35,816 $27,113 $25,779 $ 977 $ 7,697 $ 7,093
======= ======= ======= ======== ======== ========
F-19
NOTE 10. SEGMENT INFORMATION (Continued)
INTEREST INCOME INTEREST EXPENSE
_______________________ __________________________
1998 1997 1996 1998 1997 1996
_______________________ __________________________
Professional $ 101 $ 63 $ 32 $ 426 $ 73 $ 24
Retail 200 177 102 519 545 304
Manufacturing 73 163 258 24 24 26
_______ _______ _______ _______ _______ _______
Total $ 374 $ 403 $ 392 $ 969 $ 642 $ 354
======= ======= ======= ======= ======= =======
DEPRECIATION AND TOTAL
AMORTIZATION ASSETS
________________________ _________________
1998 1997 1996 1998 1997
________________________ _________________
Professional $ 686 $ 542 $ 302 $16,977 $13,614
Retail 851 847 777 24,910 22,121
Manufacturing 78 44 33 19,375 21,729
_______ _______ _______ _______ _______
Total $1,615 $1,433 $1,112 $61,262 $57,464
======= ======= ======= ======= =======
The accounting policies used for 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 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 11. COMMITMENTS AND CONTINGENCIES
In addition to the matters set forth below, the Company is involved in
other litigation matters arising in the normal course of business. It is
the opinion of management that any such matters, at December 31, 1998,
would not have a material adverse effect on the Company's financial
position, results of operations and cash flows.
The Company has entered into employment agreements with certain
officers and employees. These agreements, which expire on various dates
through June, 2001, provide for incentive bonuses based on consolidated
income before taxes, earnings per share, or earnings of a subsidiary. In
the aggregate, such bonuses were approximately $60,000, $68,000 and
$694,000 in 1998, 1997 and 1996, respectively, and are included in selling,
general and administrative expenses.
Annual rental payments due under existing operating leases at
December 31, 1998 are:
1999 $ 508,042
2000 $ 453,600
2001 $ 148,100
2002 $ 1,800
__________
$1,111,542
==========
F-20
NOTE 11. COMMITMENTS AND CONTINGENCIES (Continued)
Annual rent expense for each of the last three years is as follows:
1998 $616,445
1997 $242,186
1996 $134,956
Subsequent to the year ended December 31, 1998, the Company discovered
that the method used to estimate interim inventory figures resulted in the
use of incorrect inventory amounts and cost of sales in the financial
information of the second and third quarters of 1998. This error was
caused, in part, by the change in sales mix of the business as a result of
the Morris Flamingo acquisition and a decline in the sales and historical
gross profit margins of certain retail and professional brands. Subsequent
to the Company's April 1, 1999 press release referencing the foregoing, the
Company has learned that it has been named in two lawsuits seeking to
recover damages by shareholders who may have been adversely affected by
these inaccurate interim financial statements. The Company has agreed to
indemnify its officers and directors and believes it has meritorious
defenses against these allegations. However, it is impossible to predict
the outcome of any such matters as many unknown factors exist such as the
likelihood of future claims, insurance limits, and the outcome of jury
trial.
NOTE 12. 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 and the 1990 Outside Directors Plan. The
aggregate number of shares currently authorized pursuant to the Key
Employee Plan, as adjusted for stock splits and a shareholder-approved
increase 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.
F-21
NOTE 12. CAPITAL STOCK AND STOCK OPTIONS (Continued)
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 must be exercised within five years of the
grant date. Stock option activity for 1998, 1997, and 1996 is set forth
below:
Key Employee Outside
Option Avg. Directors Avg.
Plan Price Plan Price
__________________________________________________________________________
Outstanding at December 31, 1995.. 171,800 $15.95 36,498 $14.09
Granted........................... 112,500 17.81 15,186 15.75
Canceled.......................... (5,000) 14.33 (2,500) 7.41
Exercised......................... - (6,750) 7.41
__________ __________
Outstanding at December 31, 1996.. 279,300 16.77 42,434 15.89
Granted........................... 79,195 12.65 15,186 11.23
Canceled.......................... (104,800) 15.46 (9,562) 16.42
Exercised......................... - -
__________ __________
Outstanding at December 31, 1997.. 253,695 16.03 48,058 14.31
Granted........................... 178,000 13.54 20,248 13.20
Canceled.......................... (500) 15.13 (3,000) 18.50
Exercised......................... - - -
__________ __________
Outstanding at December 31, 1998.. 431,195 $15.00 65,306 $13.77
========== ====== ========== ======
The number of shares and average exercise price of options exercisable
at December 31, 1998, 1997 and 1996 were 174,000 shares at $15.00, 104,500
shares at $16.43 and 174,800 at $15.95 for the Key Employee Option Plan and
46,558 at $14.13, 34,372 at $15.80 and 25,248 at $16.54 for the Outside
Directors Plan, respectively. At December 31, 1998 and 1997, 337,555
shares and 445,055 shares, respectively, were available for future grants
under the terms of the Key Employee Option Plan and 85,069 shares and
102,317 shares, respectively, were available for future grants under the
terms of the Outside Directors Plan.
The Company continues to apply the provisions of Accounting Principles
Board Opinion No. 25, and related Interpretations in accounting for stock-
based compensation plans. Accordingly, no compensation expense has been
recorded in the accompanying consolidated statements of operations for
options granted in 1998, 1997 and 1996. However, pro forma disclosures of
net earnings and earnings per share must be made as if SFAS No. 123 had
been adopted. Had compensation costs for options granted been determined
on the basis of the fair value of the awards at the date of grant,
consistent with the treatment prescribed by SFAS No. 123, the Company's net
income and earnings per share, on a pro forma basis, would be as follows:
F-22
NOTE 12. CAPITAL STOCK AND STOCK OPTIONS (Continued)
(Dollars in thousands, except per share data)
1998 1997 1996
___________ ___________ __________
Net income:
As reported $ 673 $ 5,041 $ 4,679
Pro forma $ 123 $ 4,514 $ 4,418
Earnings per share:
As reported $ .15 $ 1.20 $ 1.13
Pro forma $ .03 $ 1.07 $ 1.07
The above pro forma effect only takes into consideration options
granted since January 1, 1995 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 options granted during 1998, 1997 and
1996 was $7.10, $8.52 and $3.32, respectively. The fair value of stock
options granted in 1998, 1997 and 1996 was estimated using the Black-
Scholes option-pricing model and included the following assumptions: a life
expectancy of 5 to 10 years for 1998, and 3 years for 1997 and 1996, a
risk-free interest rate of 5.0% for 1998, 6.2% for 1997 and 5.9% for 1996
and volatility of 47% for 1998, 48% for 1997 and 46% for 1996. Since the
Company did not start paying dividends until August, 1995, at an annual
yield of less than 1%, dividends paid were not material to the
determination of the fair value of options granted.
The exercise price range of options outstanding and exercisable for
both the Key Employee and Outside Directors plans, the weighted average
contractual life 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
_______________ __________ _______ ________ ___________________
$10.00 - $13.99 292,629 3.90 $12.95 85,186 $12.59
$14.00 - $16.99 151,372 1.90 $15.18 81,372 $15.55
$17.00 - $18.99 54,000 .25 $17.25 54,000 $17.25
_________ _________
496,501 220,558
========= =========
Included in the $10.00-$13.99 range above are 9,195 options which are
not exercisable until the stock trades for 20 consecutive trading days at a
price equal to $14.14 or higher and included in the $14.00-$16.99 range
above are 70,000 options which are not exercisable until the stock trades
for 20 consecutive trading days at a price equal to $19.18 or higher.
F-23
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:___________________________________
Frank F. Ferola
President and Chairman of the Board
May 20, 1999
By:___________________________________
David A. Spiegel
Principal Financial Officer
Principal Accounting Officer
May 20, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By:______________________________ By:_______________________________
Frank F. Ferola, Principal Thomas M. D'Ambrosio
Executive Officer and Director Vice President and Director
Date: May 20, 1999 Date: May 20, 1999
By:______________________________ By:_______________________________
John DePinto, Director Curtis Carlson, Director
Date: May 20, 1999 Date: May 20, 1999
By:______________________________ By:_______________________________
Leonard Genovese, Director Shouky Shaheen, Director
Date: May 20, 1999 May 20, 1999
23
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 20, 1999
By: /s/ David A. Spiegel
___________________________________
David A. Spiegel
Principal Financial Officer
Principal Accounting Officer
May 20, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By: /s/ Frank F. Ferola By: /s/ Thomas M. D'Ambrosio
______________________________ ____________________________
Frank F. Ferola, Principal Thomas M. D'Ambrosio
Executive Officer and Director Vice President and Director
Date: May 20, 1999 Date: May 20, 1999
By: /s/ John DePinto By: /s/ Curtis Carlson
______________________________ ____________________________
John DePinto, Director Curtis Carlson, Director
Date: May 20, 1999 Date: May 20, 1999
By: /s/ Leonard Genovese By: /s/ Shouky Shaheen
______________________________ ____________________________
Leonard Genovese, Director Shouky Shaheen, Director
Date: May 20, 1999 Date: May 20, 1999
23