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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
/X/ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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
For the transition period from to
Commission File Number 033-78252
AMERICAN DRUG COMPANY
(Exact name of registrant as specified in its charter)
Delaware 13-3729186
(State of Incorporation) (I.R.S. Employer Identification No.)
9 West 57th Street, New York, NY 10019
(Address of principle executive offices) (Zip code)
Registrant's telephone number, including area code: (212) 826-8976
Securities registered pursuant to Section 12(b) of the Act: None
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 such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers to item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10- K. /X/
As of March 15, 1999, the aggregate market value of the outstanding shares of
the Registrant's Common Stock, par value $.01 per share, held by non-affiliates
was approximately $2,365,473 based on the closing price of the Common Stock on
the OTC Bulletin Board, which is operated by the NASDAQ Stock Market on March
15, 1999.
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date.
Class Outstanding at March 15, 1999
- ----- -----------------------------
Common Stock, par value $.01 per share 13,020,155 shares
DOCUMENTS INCORPORATED BY REFERENCE:
Part III incorporates certain information by reference from the Registrant's
definitive proxy statement to be filed for its 1999 Annual Meeting of
Shareholders.
TABLE OF CONTENTS
PART I Page
Item 1. Business 1
Item 2. Properties................................................7
Item 3. Legal Proceedings.........................................7
Item 4. Submission of Matters to a Vote of Security Holders.......7
PART II
Item 5. Market for the Registrant's Common
Equity and Related Stockholder Matters............................8
Item 6. Selected Financial Data...................................9
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................10
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk. .16
Item 8. Financial Statements and Supplementary Data..............17
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure...............40
PART III
Item 10. Directors and Executive Officers of the Registrant......40
Item 11. Executive Compensation..................................40
Item 12. Security Ownership of Certain Beneficial
Owners and Management............................................40
Item 13. Certain Relationships and Related Transactions..........41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K..............................................42
PART I
Item 1. Business
(a) General Development of Business
On September 30, 1998, a newly formed wholly owned subsidiary of
American Drug Company (the "Company"), Five Star Group, Inc. ("Five Star")
purchased from JL Distributors, Inc. ("JL"), a wholly owned subsidiary of GP
Strategies Corporation ("GP Strategies"), substantially all of the operating
assets of JL. The assets were purchased for $16,476,000 in cash and a $5,000,000
unsecured senior note. The unsecured senior note bears interest at the rate of
8% payable quarterly, with the principal due on September 30, 2003. Five Star is
a leading distributor of home decorating, hardware and finishing products in the
northeast. For the year ended December 31, 1997 and the nine months ended
September 30, l998, Five Star had sales of approximately $82,300,000 and
$64,148,000, respectively.
The Company was organized in 1993, as a wholly-owned subsidiary of GP
Strategies to initiate marketing and sales activities for generic pharmaceutical
and medical products in Russia and the Commonwealth of Independent States (the
"CIS"). NPD Trading (USA) Inc. ("NPD Trading") was formed in January 1990 as a
wholly-owned subsidiary of GP Strategies to provide consulting services to
American and Western corporations in Russia and Eastern Europe. The Company now
has two wholly owned subsidiaries, Five Star and NPD Trading.
The purchase by the Company of the assets of Five Star has changed the
focus of the Company. The Company plans to focus its efforts on growing the
distribution business and has taken several steps to reduce its traditional
operations from both a business and cost perspective. As a result of the
purchase of the assets of Five Star, the Company has shut down its Moscow
office. In addition, the Company closed its Washington, DC office and scaled
back the operations of its Prague office with respect to the business of NPD
Trading.
(b) Financial Information about Industry Segments
This item is not applicable because the Company has only a single line
of business.
(c) Narrative Description of Business
Five Star
Five Star is engaged in the wholesale distribution of home decorating,
hardware and finishing products. Five Star is composed of two strategically
located warehouse distribution centers and office locations in New Jersey and
Connecticut with over 360,000 square feet of space which enables Five Star to
service the market from Maine to Maryland. All operations are coordinated by
senior management from the headquarters in New Jersey, with each strategically
located facility having its own sales force.
Five Star is a leading distributor in the United States of paint sundry
items, interior and exterior stains, brushes, rollers, caulking compounds and
hardware products and offers products from leading manufacturers such as Cabot
Stain, William Zinsser & Company, Dap, General Electric Corporation, American
Tool, USG, Stanley Tools, Minwax and Minnesota Mining Company. Five Star
distributes its products to retail dealers, which include lumber yards, "do-it
yourself" centers, hardware stores and paint stores principally in the northeast
region. It carries an extensive inventory of the products it distributes and
provides delivery, generally within 24 to 72 hours. Five Star has grown to be
the largest independent distributor in the Northeast by providing a complete
line of competitively priced products, timely delivery and attractive pricing
and financing terms to its customers. Much of Five Star's success can be
attributed to a continued commitment to provide customers with the highest
quality service at reasonable prices.
As the largest distributor of paint sundry items in the Northeast, Five
Star enjoys cost advantages and favorable supply arrangements over the smaller
distributors in the industry. This enables Five Star to compete as a "low cost"
provider. Five Star uses a fully computerized warehouse system to track all
facets of its distribution operations. Five Star has enhanced the sophistication
of its warehouse and office facilities to take full advantage of economies of
scale, speed the flow of orders and to compete as a low cost distributor. Nearly
all phases of the selling process from inventory management to receivable
collection are automated and tracked at each facility. Furthermore, all
operations are overseen by senior management at the New Jersey facility. Five
Star is able to capitalize on manufacturer discounts by strategically timing
purchases involving large quantities.
Management takes a proactive approach in coordinating all phases of the
Company's operations. For example, sales managers require all sales
representatives to call on customers once every week. Each representative
transmits their orders through Five Star's automated sales system, to the IBM
AS400 computer located at the New Jersey facility. The salesperson system
combines the ability to scan product codes in the stores and download the
information to a laptop computer for final transmission. Based on the floor plan
of each warehouse and the location of products therein, the computer designs the
most efficient pattern for the orders to be picked. The orders are then relayed
to the appropriate location and picked in the evening. The warehouse facilities
are well-maintained and skillfully organized. A bar-coded part number attached
to the racking shelves identifies the location of each of the approximately
22,000 stock keeping units (SKUs). This numbering system allows the computer to
arrange picking in the most efficient order. The products are loaded onto Five
Star's trucks in the evening in the order that they will be unloaded, and are
then delivered directly to the customers' locations.
Customers
Five Star's largest customer accounted for approximately 2.4% of its sales
in 1998 and its 10 largest customers accounted for approximately 11% of such
sales. All such customers are unaffiliated and Five Star does not have a
long-term contractual relationship with any of them.
Management Information System
All of Five Star's inventory control, purchasing, accounts payable and accounts
receivable are now being fully automated on an IBM AS400 computer system. The
Computer Associates Warehouse Boss System installed in 1994 located at the New
Jersey and the Connecticut facilities allows Five Star to obtain maximum
efficiency and cost savings by coordinating the processing of orders, the
selection of optimal picking routines and the tracking of inventory levels. In
addition, Five Star's software alerts buyers to purchasing needs, and monitors
payables and receivables. This system allows senior management to closely
control all phases of Five Star's operations. Five Star recently implemented a
new salesperson-order-entry system, which allows the salesman to scan product
and then download the information to a laptop. The laptop will contain all
product and customer information and will interact with the AS400.
Five Star has developed strong, long-term relationships with the leading
suppliers since its predecessor company, J. Leven was founded in 1912. As a
major distributor of paint sundry items, suppliers rely on Five Star to
introduce new products to market. Furthermore, suppliers have grown to trust
Five Star's ability to penetrate the market. As a result, Five Star is often
called on first by manufacturers to introduce new products into the marketplace.
For example, Minwax, Best Liebco and Cabot Stain have utilized Five Star to
introduce and distribute some of their new product innovations.
Five Star is utilizing both internal and external resources to identify, correct
or reprogram and test systems for year 2000 compliance. During the third quarter
of 1998, Five Star entered into an agreement to purchase new software that will
be year 2000 compliant. This previously planned software upgrade will manage the
financial operations of Five Star, including order entry, inventory control and
accounts receivable and payable. Five Star has an implementation team led by the
Director of Information Systems, which began the project on November 1, 1998.
Five Star anticipates that they will complete the implementation of the new
software by September 1, 1999. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Recent Accounting
Pronouncements-Year 2000" for a discussion of the Company's preparations with
respect to the risks presented by the year 2000 issue.
Purchasing
Five Star relies heavily upon its purchasing capabilities to gain a competitive
advantage relative to its competitors. Five Star's capacity to stock the
necessary products in sufficient volume and its ability to deliver them promptly
upon demand is one of the strongest components of service in the distribution
business, and is a major factor in Five Star's success.
Since retail outlets depend upon their distributor's ability to supply products
quickly upon demand, inventory is the primary working capital investment for
most distribution companies, including Five Star. Through its strategic
purchasing decisions, Five Star carries large quantities of inventory relative
to its competitors and thus can boast fill ratios of approximately 95%, as
compared to industry averages as reported in trade publications of approximating
85%.
All purchasing decisions based on current inventory levels, sales projections,
manufacturer discounts and recommendations from sales representatives, are made
by the merchandising group, located in New Jersey, in order to effectively
coordinate Five Star's activities. Notwithstanding senior management's active
involvement, the sales managers play an extremely critical role in this
day-to-day process.
Marketing
The do-it-yourself industry relies on distributors to effectively link
manufacturer's products to the various retail networks. The do-it-yourself
market operates on this two-step distribution process, i.e., manufacturers deal
through distributors who in turn service retailers. This occurs principally
because most retailers are not equipped to carry sufficient inventory in order
to be cost effective in their purchases from manufacturers. Thus, distributors
add significant value by effectively coordinating and transporting products to
retail outlets on a timely basis. Five Star distributes and markets products
from hundreds of manufacturers to all of the various types of retailers from
regional paint stores, to lumber yards to independent paint and hardware stores.
The marketing efforts are directed by the Vice President of Sales at each
facility. These individuals are responsible for designing, implementing and
coordinating marketing policies. The Vice President of Sales at each facility
works closely with senior management to coordinate company-wide marketing plans
as well as to service Five Star's major multi-state customers. In addition, each
Vice President of Sales is responsible for overseeing the effort of his sales
representatives.
The sales representatives, by virtue of daily contact with Five Star's
customers, are the most integral part of Five Star's marketing strategy. It is
their responsibility to generate revenue, ensure customer satisfaction and
expand the customer base. Each representative covers an assigned geographic
area. The representatives are compensated based on a draw plus commission. Five
Star has experienced a very low turnover in its sales force as evidenced by the
fact that most representatives have over five years of experience with Five
Star. Many sales reps often have retail experience in the paint or hardware
industry when they are hired by Five Star.
Five Star's size, solid reputation for service, large inventory and attractive
financing terms provide sales representatives with tremendous advantages
relative to competing sales representatives from other distributors. In
addition, the representatives' efforts are strengthened by company-sponsored
marketing events. For example, each year in January, Five Star invites all of
its customers to a special trade show for Five Star's major suppliers, so that
suppliers may display their products and innovations. Customers are able to
order products directly from manufacturers at the show and in 1999 customers
placed orders totaling well over $6 million worth of merchandise. Five Star also
participates in a profitable advertising circular program in the spring and the
fall which contains discount specials and information concerning new product
innovations.
Five Star has continually enhanced its growth through complementary acquisitions
which have allowed it to preempt much of its competition as a high-quality,
competitively priced producer.
Industry Dynamics
The Do-It-Yourself Industry
The paint sundry items distribution industry is closely related to the
do-it-yourself market which has tended to exhibit elements of
counter-cyclicality. In times of recession, consumers tend to spend more on
home-improvements because they cannot afford contractor services or the cost to
trade up to bigger homes and in times of economic strength consumers spend
heavily in home improvements because they believe they can afford to complete
their home improvement projects. In 1998, according to the American Express
Retail Index, Americans spent more than $112 billion on home improvement and
expenditures are expected to reach $137 billion in 2003. In addition, 36% of
households are planning home improvement or redecorating projects in 1999 with
an average household expenditure of $2,747.
Painting is the quintessential do-it-yourself project. Painting has to be done
more frequently than most remodeling jobs, and it is a relatively inexpensive
way to update the appearance of a home. For these reasons, the paint and paint
sundry items industry tends to be counter-cyclical and a solid growth segment of
the do-it-yourself market.
Competition
Competition within the industry is intense. There are much larger national
companies commonly associated with national franchises such as Ace and TruServ
as well as smaller regional distributors, all of whom offer similar products and
services. Other than paint sundry item distributors, Five Star faces stiff
competition from Home Depot, which purchases directly from manufacturers and
dealer-owned distributors such as Ace and TruServ. Additionally, in some
instances manufacturers will bypass the distributor and choose to sell and ship
their products directly to the retail outlet. The principal means of competition
for Five Star are its strategically placed distribution centers and its
extensive inventory of quality name brand products. Five Star will continue to
focus its efforts on supplying its products to its customers at a competitive
price and on a timely, and consistent basis. In the future, Five Star will
attempt to acquire complementary distributors and to expand the distribution of
its line of private-label products sold under the "Five Star" name. Through
internal growth and acquisitions, Five Star has captured a leading share in its
principal market, the Northeast. This growth-oriented acquisition strategy of
acquiring complementary distributors has allowed Five Star to effectively
compete against a substantial number of its competitors. While other paint
sundry items distributors sell to the same retail networks as Five Star, they
are at a distinct disadvantage versus Five Star's experience, sophistication and
size.
Concomitantly, hardware stores that are affiliated with the large, dealer-owned
distributors such as Ace also utilize Five Star's services because they are
uncomfortable with relying solely on their dealer network. Most cooperative-type
distributors lack the level of service and favorable credit terms that
independent hardware stores enjoy with Five Star. Five Star effectively competes
with the dealer-owned distributors because it provides more frequent sales
calls, faster deliveries, better financing terms and a full line of vendors and
products to chose from.
NPD Trading
NPD Trading provides consulting services to American and Western
corporations doing business in Eastern Europe through an office in Prague. NPD
Trading's on-going efforts on behalf of ICF Kaiser International ("ICF") and
their associated company, Kaiser Engineers, secured for these companies
contracts to perform feasibility studies in the areas of hazardous waste
management and steel industry modernization in the Czech Republic. NPD Trading
is providing ICF with technical and commercial assistance on a contract for a
$250 million hot strip mini mill in the Czech Republic. To date, the Company has
received $1 million for this assistance, including $840,000 received in
September 1997. The Company expects to receive another $1 million payment
contingent upon the completed construction on the mini mill in 1999.
On March 17, 1998 and April 2, 1998, the Company was informed by
holders of an aggregate of $1,000,000 of the Company's convertible notes (the
"Notes") that they had elected to convert $1,000,000 of the Notes into an
aggregate of 82,306 shares of GP Strategies common stock. In accordance with the
terms of the original agreement, the Company and GP Strategies had agreed that
if the Notes were used to exercise the warrants issued by GP Strategies in
connection with the Note offering, GP Strategies had the right to receive from
the Company in exchange for the Notes shares of the Company's common stock at a
price equal to 60% of its then current market value. However, on April 30, 1998,
the Company and GP Strategies agreed that instead of issuing additional shares
of the Company's common stock which GP Strategies was entitled to, the Company
would assign to GP Strategies its expected future payments in the amount of
approximately $1,000,000 from ICF as a success fee in connection with the
completion of the Company's consulting project in the Czech Republic which is
anticipated to be completed in 1999.
Employees
The Company employs 265 people, 264 of whom are employees of Five Star.
Management-employee relations are considered excellent at both of Five Star's
warehouse facilities. Approximately 111 of Five Star's employees, warehouse
personnel and drivers are represented by unions. The 111 union employees at New
Jersey are represented by the Teamsters union. Connecticut is completely
non-unionized. Five Star has never experienced a labor strike at its facilities.
Five Star's contract with Local No. 11, affiliated with the International
Brotherhood of Teamsters expires on December 15, 2000.
As a result of the Company's decision to concentrate on its
distribution business, the Company closed its Washington, D.C. office, scaled
back the Prague office and eliminated the Moscow office.
(d) Financial Information about Foreign and Domestic Operations and Export
Sales.
Not Applicable.
Item 2. Properties
Five Star leases 250,000 square feet in New Jersey and 110,000 square
feet in Connecticut. Five Star's operating lease for the New Jersey facility
expires in March 2007 and the annual rent is $885,731. Five Star's lease for the
Connecticut facility expires in February 2001 and its annual rent is $379,780.
The Company's New York office space is provided by GP Strategies pursuant to the
Management Services Agreement. As part of the Management Services Agreement, GP
Strategies receives $10,000 a month for services provided by GP Strategies
employees, such as management, legal, tax, accounting, insurance and employee
benefit administration services.
The facilities leased by the Company and Five Star are considered to be
suitable and adequate for their intended uses and are considered to be well
maintained and in good condition.
Item 3. Legal Proceedings
There are currently no material legal proceedings pending to which the
Company is a party or to which any of its properties are subject.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The following table presents the high and low prices for the Common
Stock for 1998 and 1997. The Company's Common Stock, $.01 par value, is quoted
on the OTC Bulletin Board, which is operated by the NASDAQ Stock Market.
Quarter High Low
1998 First $0.14 $0.05
Second $0.42 $0.11
Third $0.45 $0.25
Fourth $0.45 $0.30
1997 First $0.31 $0.13
Second $0.28 $0.16
Third $0.22 $0.09
Fourth $0.17 $0.08
- ----------
The number of shareholders of record of the Common Stock as of March
15, 1999 was 4,646. On March 15, 1999, the average of the closing bid and asked
prices on the OTC Bulletin Board was $0.34. The Company has not declared any
cash dividends during or since its two most recent fiscal years. The current
policy of the Company's Board of Directors is to retain earnings, if any, to
finance the operation of the Company's business. The payment of cash dividends
on the Common Stock in the future will depend on the Company's earnings,
financial condition and capital needs and on other factors deemed pertinent by
the Company's Board of Directors.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share amounts)
Years Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Statement of Operations Data:
Revenue $17,184 $2,047 $ 1,104 $ 529 $ 799
Cost of goods sold 13,686 936 496 155 456
General and administrative
expenses 3,187 1,385 1,674 1,690 1,355
Net loss (664) (857) (1,498) (1,604) (1,302)
Loss per share:
Basic and diluted
before extraordinary item (.03) (.07) (.12) (.12) (.10)
Basic and diluted (.05) (.07) (.12) (.12) (.10)
December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Balance Sheet Data:
Current assets $ 32,291 $ 514 $1,018 $ 550 $ 70
Current liabilities 27,596 199 152 356 73
Non current liabilities 5,000 4,933 4,739 2,633 955
Working capital (deficiency) 4,695 315 866 194 (3)
Total assets 33,179 552 1,088 602 161
Total stockholders' equity (deficiency) 583 (4,580) (3,803) (2,387) (867)
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
Overview
On September 30, 1998, a newly formed wholly-owned subsidiary of the Company,
the Five Star Group, Inc. (Five Star) purchased from JL Distributors, Inc. (JL),
(formerly Five Star Group, Inc.) certain operating assets of JL. JL is a
wholly-owned subsidiary of GP Strategies Corporation (GP Strategies). The assets
were purchased for $16,476,000 in cash and a $5,000,000 unsecured five year
senior note. Five Star is a leading distributor of home decorating, hardware and
finishing products in the northeast. For the year ended December 31, 1997 and
the nine months ended September 30, 1998, Five Star had sales of approximately
$82,300,000 and $64,148,000, respectively.
The purchase by the Company of certain assets of Five Star has changed the focus
of the Company. The Company plans to focus its efforts in the future on growing
the distribution business, and has taken several steps to reduce its traditional
operations from both a business and cost perspective.
As a result of the purchase of the assets of Five Star, the Company has shut
down its Moscow office, and in the short-term, the Company will sell its
existing inventory of generic products in Moscow warehouses through a Russian
company, Akorta and other third parties. No such additional products will be
purchased in the United States. In addition, the Company has closed its
Washington, DC office and scaled back the operations of its Prague office with
respect to the business of NPD Trading.
Liquidity and Capital Resources
During the third quarter of 1998, GP Strategies deemed that the Company would
not have the ability to repay its loan to GP Strategies, and therefore made the
decision to contribute the amount due to Capital in excess of par value.
Therefore GP Strategies did not charge the Company interest in the third quarter
of 1998.
At December 31, 1998, the Company had cash of $119,000. On September 30, 1998,
Five Star entered into a $25,000,000 loan and security agreement with a group of
banks. The credit facility allowed Five Star to borrow up to 50% of eligible
inventory and up to 80% of eligible accounts receivable. The Company borrowed
$16,476,000 on September 30, 1998 to fund the cash portion of the purchase price
in connection with the purchase of JL. At December 31, 1998, the Company had
borrowed $16,971,000 and had $1,194,000 of additional availability under the
loan agreement.
The Company believes it has sufficient borrowing availability under existing
credit agreements, and through the operations of the Company, to fund the
working capital requirements of Five Star as well as the limited operations of
the Company's Prague office.
Results of operations
In 1998, loss before income taxes and extraordinary item was $(420,000), as
compared to a loss of $(857,000) before income taxes and extraordinary item for
1997. The reduced loss for 1998 was principally the result of the income earned
by Five Star since September 30,1998, as well as reduced selling, general and
administrative expenses incurred by the Company due to the curtailing of their
operations in Moscow during the year. The income earned by Five Star and the
reduced cost structure of the Company was partially offset by the effect of the
consulting revenues earned by the Company in 1997 totaling $840,000 relating to
a success fee attributable to a project with ICF Kaiser International in the
Czech Republic.
The Company's net loss decreased to $857,000 for 1997 from $1,498,000 incurred
for 1996 due to increased consulting fees and decreased general and
administrative expenses, partially offset by increased interest expenses
Sales
The Company had sales of $17,080,000 in 1998, compared to sales of $1,123,000 in
1997 and $842,000 in 1996. The increased sales in 1998 were the result of
$16,476,000 of sales earned by Five Star since September 30, 1998. The increased
sales in 1997 were generated by increased sales of medical equipment, partially
offset by reduced sales of generic drugs in the Commonwealth of Independent
States.
Consulting revenues
In 1998, the Company had consulting revenues of $104,000, compared to $924,000
in 1997 and $262,000 in 1996. The decrease in consulting revenues from 1997 to
1998 and the increase in consulting revenues from 1996 to 1997 was primarily due
to $840,000 in the form of a success fee related to a project with ICF Kaiser
International in the Czech Republic during 1997.
Gross margin
The Company had gross margin of $3,394,000 in 1998, compared to $187,000 in 1997
and $346,000 in 1996. The increased gross margin in 1998 was due to the gross
margin earned on the sales volume generated by Five Star since September 30,
1998.
Selling, general and administrative expense
The Company had Selling, general and administrative (SG&A) expense of $3,187,000
in 1998 compared to $1, 385,000 in 1997 and $1,674,000 in 1996. The increased
SG&A in 1998 is due the acquisition of substantially all the operating assets of
Five Star on September 30, 1998, partially mitigated by reduced SG&A incurred by
the rest of the Company due to reduced consulting, personnel costs and facility
costs in both Washington D.C. and Moscow. The decrease in general and
administrative expenses in 1997 compared to 1996 was primarily due to reduced
consulting, marketing expense and facility costs, partially offset by costs
associated with consulting projects.
Interest expense
The Company had interest expense of $611,000 in 1998, $463,000 in 1997 and
$312,000 in 1996. The increased interest expense in 1998 is the result of both
the short-term borrowings incurred by Five Star (see Note 3 to the consolidated
financial statements), as well as interest incurred on the $5,000,000 unsecured
senior note (see Note 1 to the consolidated financial statements). The increased
interest expense in 1998 was partially offset by reduced interest expense due to
GP Strategies as a result of the contribution to Capital in excess of par value
of the amount owed to GP Strategies by the Company during the third quarter of
1998. The increased interest expense in 1997 as compared to 1996 was the result
of the increased balance due to GP Strategies in 1997.
Recent accounting pronouncements
The Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 130, (SFAS 130), "Reporting Comprehensive Income", in
June 1997 which requires a statement of comprehensive income to be included in
the financial statements for fiscal years beginning after December 15, 1997. The
Company has adopted this Statement and has no other comprehensive income;
therefore comprehensive income is the same as net income (loss).
In addition, in June of 1997, the FASB issued SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS 131 requires disclosure
of certain information about operating segments and about products and services,
geographic areas in which a company operates and their major customers. The
Company operates in one principal business segment, and accordingly, SFAS 131
had no impact on the Company's December 31, 1998 financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
This Statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Company will adopt SFAS No. 133 by January 1, 2000. The
Company is currently evaluating the impact the adoption of SFAS No. 133 will
have on the consolidated financial statements.
Year 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (year 2000) approaches. The "year
2000" problem is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
The issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
The Company is utilizing both internal and external resources to identify,
correct or reprogram and test systems for year 2000 compliance. The Company's
primary operating subsidiary, Five Star has during the third quarter of 1998
entered into an agreement to purchase new software that will be year 2000
compliant. This previously planned software upgrade will manage the financial
operations of Five Star including order entry, inventory control and accounts
receivable and payable. Five Star has an implementation team led by the Director
of Information Systems, which began the project on November 1, 1998. Five Star
anticipates that they will complete the implementation of the new software by
September 1, 1999. The cost of the new software, including implementation, is
estimated to be approximately $400,000. Five Star has arranged financing for
approximately $250,000 of the estimated cost over a four year period. In
addition, Five Star's other major information system is its warehouse management
system. Five Star is currently updating this system to a current release that is
year 2000 compliant. There will be no additional cost to this upgrade since all
upgrades related to the warehouse system are included in yearly maintenance.
Five Star has also identified various ancillary programs that need to be updated
and has contracted with third parties for this work to be completed within the
next six months. It is expected that the cost of these modifications will be
approximately $10,000.
In addition Five Star is examining their exposure to the year 2000 in other
areas of technology. These areas include telephone and E-mail systems, operating
systems and applications in free standing personal computers and other areas of
communication. A failure of these systems may impact the ability of Five Star to
service their customers which could have a material effect on their results of
operations. These issues are being handled by the information systems and
finance team at Five Star by identifying the problems and obtaining from vendors
and service providers either the necessary modifications to the software or
assurances that the systems will not be disrupted. Five Star believes that the
cost of the programming and equipment upgrades will not be in excess of $50,000.
In addition, certain personal computers and other equipment that is not year
2000 compliant will be upgraded through Five Star's normal process of equipment
upgrades. Five Star believes that the evaluation and implementation process will
be completed no later than the second quarter of 1999. Over the next year, Five
Star plans to concentrate its efforts on the implementation of its new data
processing systems, but it will also continue to develop and implement other
information technology projects needed in the ordinary course of business.
Five Star expects to finance these expenditures from a combination of working
capital and operating leases for a portion of the new computer equipment and
software. Therefore, Five Star does not expect the year 2000 issue to have a
material adverse impact on its financial position or results of operations.
Like other companies, the Company relies on its customers for revenues and on
its vendors for products and services of all kinds; these third parties all face
the year 2000 issue. An interruption in the ability of any of them to provide
goods or services, or to pay for goods or services provided to them, or an
interruption in the business operations of our customers causing a decline in
demand for services, could have a material adverse effect on the Company in
turn.
In addition, there is a risk, the probability of which the Company is not in a
position to estimate, that the transition to the year 2000 will cause wholesale,
perhaps prolonged, failures of electrical generation, banking,
telecommunications or transportation systems in the United States or abroad,
disrupting the general infrastructure of business and the economy at large. The
effect of such disruptions on the Company could be material.
The Company's various departments will communicate with their principal
customers and vendors about their year 2000 readiness, and expect this process
to be completed no later than the third quarter of 1999. None of the responses
received to date suggests that any significant customer or vendor expects the
year 2000 issue to cause an interruption in its operations which would have a
material adverse impact on the Company. However, because so many firms are
exposed to the risk of failure not only of their own systems, but of the systems
of other firms, the ultimate effect of the year 2000 issue is subject to a very
high degree of uncertainty.
The Company believes that its preparations currently under way are adequate to
assess and manage the risks presented by the year 2000 issue, and does not have
a formal contingency plan at this time.
The statements in this section regarding the effect of the year 2000 and the
Company's responses to it are forward-looking statements. They are based on
assumptions that the Company believes to be reasonable in light of its current
knowledge and experience. A number of contingencies could cause actual results
to differ materially from those described in forward-looking statements made by
or on behalf of the Company.
Forward-Looking Statements. This report contains certain forward-looking
statements reflecting management's current views with respect to future events
and financial performance. These forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those in the forward-looking statements, all of which are
difficult to predict and many of which are beyond the control of the Company,
but not limited to the risk that the acquisition of Five Star will achieve the
projected levels of profitability and revenues, as well as the Company's ability
to further scale down its operations in Prague, the risk that the Company's
preparations with respect to the risks presented by the year 2000 issue will not
be adequate, and those risks and uncertainties detailed in the Company's
periodic reports and registration statements filed with the Securities and
Exchange Commission.
Inflation
Inflation is not expected to have a significant impact on the Company's
business.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by Item 7A is not applicable to the
Company's business.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Reports 18
Financial Statements:
Consolidated Balance Sheets - December 31, 1998 and
1997 20
Consolidated Statements of Operations - Years ended
December 31, 1998, 1997 and 1996 22
Consolidated Statements of Changes in Stockholders'
Equity (Deficiency) - Years ended December 31,
1998, 1997 and 1996 23
Consolidated Statements of Cash Flows - Years ended
December 31, 1998, 1997 and 1996 24
Notes to Consolidated Financial Statements 25
INDEPENDENT AUDITORS' REPORT
The Board Directors and Stockholders
American Drug Company
We have audited the accompanying consolidated balance sheet of American
Drug Company and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity and cash
flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present
fairly, in all material respects, the consolidated financial position
of American Drug Company and subsidiaries at December 31, 1998, and the
consolidated results of its operations and its cash flows for the year
then ended, in conformity with generally accepted accounting
principles.
Richard A. Eisner & Company, LLP
New York, New York
March 5, 1999
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
American Drug Company:
We have audited the consolidated balance sheet of AMERICAN DRUG COMPANY AND
SUBSIDIARIES as of December 31, 1997, and the related consolidated statements of
operations, changes in stockholders' equity (deficiency) and cash flows for each
of the years in the two-year period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AMERICAN DRUG
COMPANY AND SUBSIDIARIES at December 31, 1997, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
The consolidated financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 3 accompanying the 1997 consolidated financial statements, the Company has
suffered recurring losses from operations and has an accumulated deficit t
hat raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in the
Notes to those consolidated financial statements. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
KPMG LLP
New York, New York
March 27, 1998
AMERICAN DRUG COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share information)
December 31, December 31,
1998 1997
ASSETS
Current assets
Cash $ 119 $ 225
Accounts receivable, trade, less allowance
for doubtful accounts of $1,630 and $90
in 1998 and 1997 9,697 139
Inventory 22,446 149
Prepaid expenses and other current assets 29 1
--------- -------
Total current assets 32,291 514
-------- ------
Machinery and equipment, at cost 985 113
Less accumulated depreciation (173) (113)
--------- -------
812
Other assets 76 38
--------- -------
$ 33,179 $ 552
========= =======
See accompanying notes to the consolidated financial statements.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
(in thousands, except shares and per share information)
December 31, December 31,
1998 1997
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities
Short-term borrowings $ 16,971 $
Accounts payable and accrued expenses 10,625 199
---------- --------
Total current liabilities 27,596 199
---------- --------
7% convertible notes 1,000
------------ -------
Long-term debt to GP Strategies 5,000 3,933
--------- -------
Stockholders' equity (deficiency)
Common stock, authorized 30,000,000 shares,
par value $.01 per share
13,020,155 shares issued and outstanding 130 130
Capital in excess of par value 7,589 1,762
Accumulated deficit (7,136) (6,472)
--------- -------
Total stockholders' equity (deficiency) 583 (4,580)
---------- --------
$ 33,179 $ 552
======== =========
See accompanying notes to the consolidated financial statements.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share information)
Year Ended December 31,
1998 1997 1996
-------- --------- ---------
Sales $ 17,080 $ 1,123 $ 842
Cost of goods sold 13,686 936 496
--------- ---------- --------
Gross margin 3,394 187 346
Selling, general and
administrative expenses (3,187) (1,385) (1,674)
Management fee to GP Strategies (120) (120) (120)
Consulting revenues 104 924 262
Interest expense (611) (463) (312)
-------- ------- -------
Loss before income taxes
and extraordinary item (420) (857) (1,498)
Income tax expense (40)
Loss before extraordinary item (460) (857) (1,498)
Extraordinary item
Early extinguishment of debt (204)
Net loss $ (664) $ (857) $(1,498)
======== ======= ==========
Loss per share
Basic and diluted before extraordinary item $(.03) $(.07) $(.12)
----- ----- -----
Basic and diluted net loss per share (.05) (.07) (.12)
------ ------ ------
Weighted average number of
shares outstanding 13,020 13,020 13,020
======== ======== =========
See accompanying notes to the consolidated financial statements.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
EQUITY (DEFICIENCY)
Years Ended December 31, 1998, 1997 and 1996
(in thousands, except number of shares)
Shares of Capital in Total
Common Stock Common Excess of Deferred Stockholders'
Outstanding Stock Par Value Deficit Compensation Deficiency
Balance at December 31, 1995 13,020,155 $130 $1,682 $(4,117) $(82) $(2,387)
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss (1,498) (1,498)
Amortization of deferred compensation 82 82
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 13,020,155 130 1,682 (5,615) (3,803)
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss (857) (857)
Officers' compensation 80 80
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 13,020,155 130 1,762 (6,472) (4,580)
- ------------------------------------------------------------------------------------------------------------------------------------
Net loss (664) (664)
Contribution to capital by GP Strategies 5,407 5,407
Deferred finance cost-contribution to
capital by GP Strategies 330 330
Issuance of compensatory stock options 90 90
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 13,020,155 $130 $7,589 $(7,136) $ $ 583
- -----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
1998 1997 1996
Cash flows used in operations:
Net loss $ (664) $(857) $(1,498)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 191 33 37
Non cash compensation 90 80 82
Loss from extinguishment of debt 204
Changes in other operating items:
Accounts receivable 2,310 (55) 20
Inventory (1,906) 177 3
Prepaid expenses and other assets 235 20 29
Accounts payable, accrued expenses
and accrued interest (1,608) 338 73
--------- -------- ---------
Net cash used in operations (1,148) (264) (1,254)
---------- ----- -------
Cash flows from financing activities:
Net proceeds from short-term borrowings 16,971
Net proceeds from issuance of 7% convertible notes 950
Loans from GP Strategies 474 829
Repayment of loans from GP Strategies (97)
------------- -------- ---------
Net cash (used for) provided by financing activities 17,445 (97) 1,779
-------- -------- ------
Cash flows from investing activities:
Net assets of Five Star, less cash acquired (16,291)
Additions to machinery and equipment (112) (5)
------------ ----------- ----------
Net cash used in investing activities (16,403) (5)
--------- ----------- ---------
Net (decrease) increase in cash (106) (361) 520
Cash at beginning of period 225 586 66
---------- -------- ---------
Cash at end of period $ 119 $ 225 $ 586
========== ======== ========
Non cash financing and investing activities:
Senior note issued in Five Star acquisition $ 5,000
---------
7% convertible notes retired by
issuance of GP Strategies common stock 1,000
Contributions to capital by GP Strategies 5,737
See accompanying notes to the consolidated financial statements.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Acquisition of the assets and business of Five Star
American Drug Company (the "Company") has two subsidiaries, NPD Trading
(USA), Inc. (NPD Trading) and Five Star Group, Inc. (Five Star). NPD
Trading provides consulting services in Eastern Europe through an
office in Prague.
On September 30, 1998, a newly formed wholly-owned subsidiary of the
Company, the Five Star Group, Inc. (Five Star) purchased from JL
Distributors, Inc. (JL), (formerly the Five Star Group, Inc.)
substantially all the operating assets of JL, for approximately
$16,476,000 in cash and a $5,000,000 unsecured senior note. The
unsecured senior note bears interest at the rate of 8% payable
quarterly, with the principal due on September 30, 2003. Five Star is a
distributor of home decorating, hardware and finishing products in the
northeast. As part of this transaction, GP Strategies Corporation (GP
Strategies) sold a 16.5% interest in the Company to the employees and
management of Five Star. GP Strategies currently owns approximately 37%
of the Company. JL is a wholly-owned subsidiary of GP Strategies. The
acquisition was accounted for as a purchase. The excess of the fair
value of the net assets acquired over the purchase price was applied to
reduce the recorded value of fixed assets. Since the acquisition of
Five Star occurred on September 30, 1998, the results of operations for
Five Star prior to that date have not been included in the operations
of the Company for the periods presented.
The following shows on a proforma basis the results of operations of
the Company had the above transaction occurred on January 1, 1997 and
1998 (in thousands, except per share data):
December 31,
(unaudited)
1998 1997
Sales $81,091 $83,423
Income before extraordinary item 371 49
Net income 167 24
Basic income per share .01 -
Diluted income per share .01 -
Such information is not indicative of what actual results might have
been nor of what future results would be.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies
Inventory. Inventory is valued at the lower of cost, using the
first-in, first-out (FIFO) method, or market. Inventory consists solely
of finished products.
Fixed assets. Fixed assets are carried at cost. Major additions and
betterments are capitalized, while maintenance and repairs that do not
extend the lives of the assets are expensed currently. Gain or loss on
the disposition of fixed assets is recognized currently in operations.
Depreciation is calculated on a straight-line basis over the estimated
useful lives of the assets.
Principles of consolidation. The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries,
NPD Trading and Five Star. All significant intercompany balances and
transactions have been eliminated in consolidation.
Income taxes. Income taxes are provided for based on the asset and
liability method of accounting pursuant to Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). Under SFAS 109, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax
rates in effect for the year in which those temporary differences are
expected to be recovered or settled. Under SFAS 109, the effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Statement of cash flows. For purposes of the statement of cash flows,
the Company considers all liquid investments with original maturities
of three months or less to be cash equivalents.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Use of estimates. The preparation of 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 financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
Concentration of credit risk. Financial instruments that potentially
subject the Company to significant concentrations of credit risk
consist primarily of accounts receivable. Sales are made principally to
independently owned paint and hardware stores, and therefore, there are
no significant concentrations of credit risk.
Financial instruments. The carrying amounts of financial instruments
including cash, trade accounts receivable and trade accounts payable
approximated fair value as of December 31, 1998 and 1997 because of the
relatively short maturity of these instruments. The carrying amount of
short-term borrowings and of long-term debt to GP Strategies
approximated fair value because interest is charged at market rates.
Stock based compensation. The Company has adopted SFAS No. 123,
Accounting for Stock-Based Compensation, which permits entities to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123
also allows entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma net income and pro forma earnings per
share disclosures for employee stock option grants made in 1995 and
subsequent years as if the fair-value-based 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.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (Continued)
Earnings per share. The Company has adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings per Share", which
established standards for computing and presenting earnings per share
(EPS). The statement simplifies the standards for computing EPS,
replaces the presentation of primary EPS with a presentation of basic
EPS and requires a dual presentation of basic and diluted EPS on the
face of the income statement. Basic EPS are based upon the weighted
average number of common shares outstanding during the period. Diluted
EPS are based upon the weighted average number of common shares
outstanding during the period assuming the issuance of common shares
for all dilutive potential common shares outstanding. For the years
ended December 31, 1998, 1997 and 1996 the Company did not include any
potential common stock in its calculation of diluted EPS, because all
options and warrants are anti-dilutive.
3. Short-term borrowings
On September 30, 1998, the Company's wholly-owned subsidiary Five Star
entered into a new three year Loan and Security Agreement dated as of
September 30, 1998 (the "Loan Agreement") by and among three banks. The
Loan Agreement provides for a $25,000,000 revolving credit facility,
which allows Five Star to borrow based upon a formula of up to 50% of
eligible accounts inventory and 80% of eligible accounts receivable, as
defined in the Loan Agreement. The interest rate on any loan under the
Loan Agreement is based on an adjusted prime rate or LIBOR rate, as
described in the Loan Agreement. At December 31, 1998, $16,971,000 was
outstanding under the Loan Agreement and approximately $1,194,000 was
available to be borrowed. Substantially all of the Company's assets are
pledged as collateral for these borrowings.
4. 401(k) plan
The Company's employees are included in the GP Strategies 401(k)
pension plan. The Company pays its allocable share of costs as
incurred. Such costs, including administrative expenses and the
employer's contributions, amounted to approximately $36,000, $13,000
and $13,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
5. Machinery and equipment
Major classes of machinery and equipment consist of the following (in
thousands):
December 31, Estimated
1998 1997 useful lives
---- ---- ------------
Machinery and equipment $ 50 $ 16 3 years
Furniture and fixtures 318 97 5 years
Leasehold improvements 617 3-9 years
-----------------
985 113
Less accumulated depreciation (173) (113)
$ 812 $
======= =========
Depreciation expense for the years ended December 31, 1998, 1997 and
1996 was $60,000, $10,000 and $17,000, respectively.
6. Long-term debt
On March 17, 1998 and April 2, 1998, the Company was informed by
holders of an aggregate of $1,000,000 of the Company's convertible
notes (the "Notes") that they had elected to convert all the Notes into
an aggregate of 82,306 shares of GP Strategies common stock. In
accordance with the terms of the original agreement the Company and GP
Strategies had agreed that if the Notes were used to exercise the
warrants issued by GP Strategies in connection with the Note offering,
GP Strategies had the right to receive from the Company in exchange for
the Notes, shares of the Company's common stock at a price equal to 60%
of its then current market value.
The company has recorded during 1998 the $330,000 fair value of the
warrants issued by GP Strategies to the noteholders as a credit to
capital in excess of par value. The unamortized balance of the related
debt issuance expense at the date of conversion of the Notes in the
amount of $204,000 has been recorded as an extraordinary charge upon
early extinguishment of debt.
On April 30, l998, the Company and GP Strategies agreed that instead of
issuing additional shares of the Company's common stock, the Company
would assign to GP Strategies its expected future payments in the
amount of approximately $1,000,000 from ICF Kaiser International as a
success fee in connection with the completion of the Company's
consulting project in the Czech Republic, which is anticipated to be
completed in l999.
Since this fee is contingent upon the successful completion of the
project, it has not been recorded by the Company. Only the amount of
the fee, if any, collected by the Company is required to be remitted to
GP Strategies. Accordingly, no liability to GP Strategies has been
recorded for any amount which may ultimately be collected in connection
with this project
7. Transactions with affiliates
Transactions with GP Strategies and its subsidiaries, other than loans
and capital contributions received, as disclosed elsewhere in the
financial statements, during the years ended December 31, 1998, 1997,
and 1996 are summarized below (in thousands):
December 31,
----------------------------
1998 1997 1996
---- ---- ----
Consulting fees earned from affiliate $ 101 $ 65 $ 25
======== ======= =======
Transactions with GP Strategies
Management fees incurred $ 120 $ 120 $ 120
Interest expense incurred 177 291 277
From inception through September 30, 1998, the Company was financed by
GP Strategies, by means of capital contributions, short-term
non-interest bearing advances and long-term interest bearing
obligations. The Company received $2,500,000 under its $2,500,000 loan
agreement with GP Strategies, plus additional funding totaling
$5,407,000 including accrued interest through September 30, 1998 (see
Note 12).
The management fee charged to the Company by GP Strategies covers
services provided by GP Strategies such as management, legal, tax,
accounting, insurance and employee benefit administration services.
The Company provided services to GSE Systems, Inc. (GSES), an affiliate
of GP Strategies, in assisting that affiliate to obtain a contract to
provide the Temelin Nuclear Power Plant and the St. Petersburg Nuclear
Power Plant with full scope simulators. GSES is a successor to General
Physics International Engineering and Simulation, Inc. Revenues from
GSES amounted to $101,000, $65,000 and $25,000, respectively, for the
years ended December 31, 1998, 1997, and 1996.
In 1994 the Company commenced paying $150,000 annually as compensation
to an officer of GP Strategies, in view of the additional time
allocated by this officer to the Company. This agreement was terminated
effective December 31, 1998.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
7. Transactions with affiliates (Continued)
As of January 1, 1994, the Company and GP Strategies entered into a
three-year Management Services Agreement pursuant to which certain
direct and indirect services will be provided to the Company by GP
Strategies. The services to be provided by GP Strategies include legal,
tax, accounting, insurance and employee benefit administration
services. The Company paid GP Strategies a fee of $10,000 per month
during the term of the agreement. The Agreement is automatically
renewable for successive one-year terms unless one of the parties
notifies the other in writing at least six months prior to the end of
the initial term of any renewal thereof. The Agreement was renewed for
1998 and 1999.
8. Income taxes
The Company and its subsidiaries have had net losses for years ended
December 31, 1998, 1997 and 1996, respectively. No Federal or State tax
expense has been provided for the years ended December 31, 1997 and
1996. For the year ended December 31, 1998, the Company has recorded a
current state and local tax provision of $40,000 that relates to the
Company's new subsidiary Five Star.
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate follows:
Years ended December 31, 1998 1997 1996
-----------------------------------------------------------------------
Tax at U.S. statutory rate $(212) $(283) $(557)
State and local taxes net of
Federal benefit 40
Net operating loss utilization 1,608
Valuation allowance
adjustment (1,396) 283 557
-----------------------------------------------------------------------
Taxes $40
-----------------------------------------------------------------------
Under SFAS No. 109, a valuation allowance is provided when it is more
likely than not that some portion of deferred tax assets will not be
realized. The Company has determined, based upon the Company's history
of operating losses, that 100% valuation reserves are required as of
December 31, 1998 and 1997.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
8. Income taxes (Continued)
As of December 31, 1998 and 1997, the Company had approximately
$304,000 and $1,700,000, respectively, of deferred tax assets and no
deferred tax liabilities. The tax effects that gave rise to these
deferred tax assets and the valuation allowance consist of the
following (in thousands):
December 31, December 31,
1998 1997
Deferred tax assets
Organization costs $ 3 $ 7
Allowance for doubtful accounts 40 34
Net operating loss carryforwards 42 1,525
Machinery and equipment 21 9
Deferred compensation 160 125
Inventory 38
-------- ---------
Deferred tax assets 304 1,700
------- ------
Valuation allowance (304) (1,700)
------- ---------
Net deferred tax assets after
valuation allowance $ $
========== =========
The change in the valuation allowance for the year ended December 31,
1997 amounted to an increase of $283,000, primarily attributable to an
increase of the Company's net operating loss. The change in the
valuation allowance for the year ended December 31,1998 amounted to a
decrease of $1,396,000, primarily attributable to utilization of the
net operating loss.
As of December 31, 1998, the Company has approximately $110,000 of net
operating loss carryovers, that expire in the year 2013. The decrease
to the net operating loss of approximately $4,407,000 results from
cancellation of indebtedness income, in connection with forgiveness of
certain obligations to GP Strategies.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
9. Employment and consulting agreement
(a) Employment agreement
As of January 1, 1994, the Company entered into an employment agreement
with its President and Chief Executive Officer. Pursuant to the
Employment Agreement, the officer devoted approximately one-half of his
time to serve as the Company's Chief Executive Officer and President.
The agreement had a three-year term with an option to renew for
successive one-year periods. It provided that the officer would
receive, in connection with services rendered to the Company, a base
salary in the amount of $150,000, subject to adjustment by the
Compensation Committee of the Board of Directors. In addition, the
officer received options to purchase an aggregate of 500,000 shares of
Common Stock at an exercise price per share of $.50 under the Company's
Stock Option Plan.
The Company determined not to renew the Employment Agreement and the
Employment Agreement terminated on December 31, 1998.
(b) Consulting agreement
As of January 1, 1994, the Company entered into a consulting agreement
with its Chairman of the Board. Pursuant to the agreement, the Chairman
served as a consultant to the Company for a period of three years. In
lieu of consulting fees or other payments, the Company granted the
Chairman options to purchase an aggregate of 250,000 shares of Common
Stock at an exercise price per share of $.50, which options vested in
equal installments over a three year period commencing August 5, 1994.
The Chairman, who is the President of GP Strategies, was granted
options to purchase an additional 250,000 shares of Common Stock from
GP Strategies, pursuant to the GP Strategies American Drug Company
Stock Option Plan, on the same terms and subject to the same conditions
as those granted to him by the Company.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
9. Employment and consulting agreement (Continued)
(b) Consulting agreement (Continued)
The Company estimated the fair value of the services of the Chairman
for the initial three year period beginning January 1, 1994 to be
approximately $250,000. The Company estimated the fair value of the
options granted to the Chairman by the Company and by GP Strategies to
be approximately $250,000 in the aggregate. Such amount was recorded as
deferred compensation and as capital in excess of par value. The
deferred compensation was amortized over the three year vesting period
of the options. Amortization for the year ended December 31, 1996
amounted to $82,000 and is included in general and administrative
expenses. The unamortized balance of deferred compensation was
reflected as a deduction from stockholders' equity.
The Company valued the Chairman's services at $80,000 for the year
ended December 31, 1997, and has recorded this amount as a contribution
to capital and compensation expense. This agreement was terminated in
1998.
10. Major customers and customers' deposits
Several customers each accounted for more than 10% of the Company's
revenues as follows:
For the year ended December 31, 1998, no customer accounted for more
than 10% of the Company's revenue.
1997 Two customers accounted for 41% and 27 % of revenues,
respectively.
1996 One customer accounted for 18% of revenue.
Export revenues represented approximately $84,000, $1,123,000 and
$842,000 of the Company's revenues in 1998, 1997 and 1996.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
11. Stock options and warrants
(a) Stock option plan
On January 1, 1994, the Company's Board of Directors and sole
stockholder adopted the American Drug Company 1994 Stock Option Plan
(the "Stock Option Plan"), which became effective August 5, 1994. Under
the Stock Option Plan, a total of 2,000,000 shares of Common Stock have
been reserved for issuance, subject to adjustment in the event of stock
splits, stock dividends, recapitalizations, reclassifications or other
capital adjustments. Unless designated as "incentive stock options"
intended to qualify under Section 422 of the Internal Revenue Code,
options granted under the Stock Option Plan are intended to be
nonqualified options. Options may be granted to any director, officer
or other key employee of the Company and its subsidiary, and to
consultants and other individuals providing services to the Company.
The Compensation Committee of the Board of Directors will administer
the Stock Option Plan and will determine, among other things, the
persons to be granted options, the number of shares to be subject to
each option, the exercise price and vesting schedule of each option,
whether to accelerate the exercise date of the option for any reason,
and whether to cause the Company to make loans which enable an optionee
to pay the purchase price of any option. No options are transferable by
the optionee other than by will.
The term of any option granted under the Stock Option Plan will not
exceed ten years from the date of the grant of the option and, in the
case of incentive stock options granted to a 10% or greater holder in
the total voting stock of the Company, three years from the date of
grant. The exercise price of any option will not be less than the fair
market value of the Common Stock on the date of grant or, in the case
of incentive stock options granted to a 10% or greater holder in the
total voting stock, 110% of such fair market value.
In June 1998, the Company cancelled 1,440,000 options and issued
1,500,000 common stock options at a price of $.13 per share to both
employees of the Company and employees of GP Strategies who provide
services to the Company under the management services agreement. The
Company recorded a deferred compensation expense of $90,000 related to
the issuance of the options to the employees of GP Strategies.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
11. Stock options and warrants (Continued)
(a) Stock option plan (Continued)
At December 31, 1998 and 1997, the per share weighted-average fair
value of stock options granted during 1998 and 1996 was $.06 and $.40,
on the date of grant using the modified Black Scholes option-pricing
model with the following assumptions: 1998 - expected dividend yield
0%, risk-free interest rate of 5.6%, expected volatility of 66.7% and
an expected life of 3 years; 1996 - expected dividend yield 0%,
risk-free interest rate of 6.6%, expected volatility of 105.6%, and an
expected life of 5 years. There were no stock options granted during
the year ended December 31, 1997.
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized in the financial
statements for stock options issued to employees of the Company. Had
the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, the Company's net
loss would have been increased to the pro forma amounts indicated
below:
1998 1997
---- ----
Net loss As reported $(664) $(857)
Pro forma (670) (869)
Basic and diluted
loss per share As reported (.05) (.07)
Pro forma (.05) (.07)
Pro forma net income reflects only options granted in 1995 through
1998. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected in the pro forma net
income amounts presented above because compensation cost is reflected
over the options' vesting period of 5 years and compensation cost for
options granted prior to January 1, 1995 is not considered.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
11. Stock options and warrants (Continued)
Stock option activity during the periods indicated is as follows:
Number of Weighted-Average
Shares Exercise Price
Balance at December 31, 1995 1,510,000 $ .50
Granted 90,000 .50
---------- --------
Balance at December 31, 1996 1,600,000 .50
----------- ---------
Expired (60,000) .50
------------ --------
Balance at December 31, 1997 1,540,000 .50
----------- --------
Granted 1,500,000 .13
Cancelled (1,440,000) .50
----------- --------
Balance at December 31, 1998 1,600,000 .15
=========== ========
At December 31, 1998 and 1997, the range of exercise prices and
weighted-average remaining contractual life of outstanding options was
$.13 to $.50 and $.50 and 3 years and 3 years, respectively.
At December 31, 1998, 1997 and 1996, the number of options exercisable
was 1,350,000, 1,509,996 and 1,539,999, respectively, and the
weighted-average exercise price of exercisable options was $.17, $.50
and $.50, respectively.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
11. Stock options and warrants (Continued)
(b) Warrants to purchase common stock
In August 1994, GP Strategies entered into a Transfer and Distribution
Agreement with the Company whereby GP Strategies transferred to the
Company (the "Distribution") immediately prior to the closing of the
Distribution, all of its interest in NPD Trading in exchange for (i)
the issuance by the Company of 6,990,900 shares of Common Stock to GP
Strategies (ii) the issuance of 6,017,775 shares of Common Stock to be
distributed to GP Strategies stockholders, and (iii) the issuance of
6,017,775 warrants to be distributed to GP Strategies stockholders.
Each warrant was initially exercisable for a period of two years from
August 5, 1994 at an exercise price per share of $1.00. In August 1996,
the Board of Directors approved an extension of the Company's warrants
until August 5, 1998 and a reduction of the exercise price to $.50 per
share, subject to adjustment in certain circumstances and in August
1998, the Board of Directors approved a two-year extension of the
Company's warrants until August 5, 2000 and an increase in the exercise
price to $.75 per share, subject to adjustment in certain
circumstances.
The Company has the right to cancel the warrants if the closing price
of the Company's common stock as quoted by the OTC Bulletin Board
during any ten consecutive trading days shall equal or exceed $1.00 per
share.
12. Loans and advances from GP Strategies
In August 1994, GP Strategies entered into a $2.5 million loan
agreement with NPD Trading, under which GP Strategies would fund the
loan with either securities or cash, at its option. At September 30,
1998, the Company had borrowed the full $2,500,000 under its loan
agreement with GP Strategies and therefore had no remaining borrowing
availability under this agreement. GP Strategies advanced additional
funds to the Company, until the third quarter of 1998, when the total
amount due to GP Strategies, including accrued interest totaled
approximately $5,407,000. During the third quarter of 1998, GP
Strategies deemed that the Company would not have the ability to repay
its loan to GP Strategies, and therefore made the decision to
contribute the amount due to capital in excess of par value.
AMERICAN DRUG COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
13. Commitments and contingencies
The Company has several noncancellable leases which cover real property,
machinery and equipment. Such leases expire at various dates with, in some
cases, options to extend their terms.
Minimum rentals under long-term operating leases are as follows(in thousands):
Real Machinery and
property equipment Total
1999 $ 1,266 $ 1,291 $ 2,557
2000 1,266 1,019 2,285
2001 949 602 1,551
2002 886 404 1,290
2003 886 97 983
After 2003 3,031 20 3,051
- ------------------------------------------------------------------------------
Total $ 8,284 $3,433 $11,717
- ------------------------------------------------------------------------------
During 1998, 1997 and 1996, the Company incurred $804,000, $158,000 and
$164,000, respectively, of rental expenses.
Item 9. Changes in and Disagreements with Accountants and Financial Disclosure.
KPMG LLP was previously the Company's and its subsidiaries principal
accountants. On November 10, 1998, that firm's appointment as principal
accountants was terminated and Richard A. Eisner & Company, LLP was engaged as
principal accountants to audit the accounts of the Company and subsidiaries for
the year ending December 31, 1998. The decision to change accountants was
recommended by the Board of Directors of the Company.
In connection with the audits of the fiscal years ended December 31,
1996 and December 31, 1997, and the subsequent interim periods through June 30,
1998, there were no disagreements through November 10, 1998 with KPMG LLP on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements, if not resolved to their
satisfaction, would have caused them to make reference in connection with their
opinion to the subject matter of the disagreement.
The audit reports of KPMG LLP on the consolidated financial statements
of the Company as of and for the years ended December 31, 1997 and December 31,
1996 did not contain any adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles,
except as follows: KPMG LLP's auditors' report on the consolidated financial
statements of the Company and its subsidiary as of and for the years ended
December 31, 1997 and 1996 contained a separate paragraph stating that "the
Company has suffered recurring losses from operations and has an accumulated
deficit that raise substantial doubt about its ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty."
PART III
Item 10. Directors and Executive Officers of the Registrant
Information with respect to the directors of the Company is
incorporated herein by reference to the Company's definitive proxy statement
pursuant to Regulation 14A, which proxy statement will be filed no later than
120 days after the end of the fiscal year covered by this Report.
Item 11. Executive Compensation
Information with respect to Executive Compensation is incorporated
herein by reference to the Company's definitive proxy statement pursuant to
Regulation 14A, which proxy statement will be filed no later than 120 days after
the end of the fiscal year covered by this Report.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information with respect to Security Ownership of Certain Beneficial
Owners is incorporated herein by reference to the Company's definitive proxy
statement pursuant to Regulation 14A, which proxy statement will be filed no
later than 120 days after the end of the fiscal year covered by this Report.
Item 13. Certain Relationships and Related Transactions
Information with respect to Certain Relationships and Related
Transactions is incorporated herein by reference to the Company's definitive
proxy statement pursuant to Regulation 14A, which proxy statement will be filed
no later than 120 days after the end of the fiscal year covered by this Report.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following financial statements are included in Part II, Item 8:
Page
Independent Auditors' Reports.......................................18
Financial Statements:
Consolidated Balance Sheets -
December 31, 1998 and 1997..........................................20
Consolidated Statements of
Operations - Years ended
December 31, 1998, 1997 and 1996....................................22
Consolidated Statements of Changes in
Stockholders' Equity (Deficiency)- Years
ended December 31, 1998, 1997 and 1996..............................23
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996........................24
Notes to Consolidated Financial Statements..........................25
(a)(2) Schedules have been omitted because they are not required
or are not applicable, or the required information has been
included in the financial statements or the notes thereto.
(a)(3) See accompanying Index to Exhibits
(b) On November 10, 1998, the Registrant filed a Report on Form 8-K
reporting a change in the Registrant's Certifying Accountants in
response to Item 4.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
AMERICAN DRUG COMPANY
Richard T. Grad, President
and Chief Executive Officer
Dated: March 31, 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.
Signature Title
Richard T. Grad President, Chief Executive Officer and Director
(Principal Executive and Operating Officer)
Jerome I. Feldman Chairman of the Board
Cindy Krugman Vice President and Controller
(Principal Financial and Accounting Officer)
Scott N. Greenberg Director
Charles Dawson Director
INDEX TO EXHIBITS
Exhibit No. Document Page
3. Amended Certificate of Incorporation of the
Registrant. Incorporated herein by reference to
Exhibit 3 of the Registrant's Annual Report on Form
10-K for the year ended December 31, 1996.
3.1 By-laws of the Registrant. Incorporated herein by
reference to Exhibit 3.2 of the Registrant's
Registration Statement on Form S-1 filed on July 22,
1994, Registration Statement No. 33-78252.
10. 1994 Stock Option Plan of the Registrant. Incorporated herein by
reference to Exhibit 10.1 of the Registrant's Registration
Statement on Form S-1 filed on July 22, 1994, Registration
Statement No. 33-78252.
10.1 Management Services Agreement, dated as of August 5, 1994,
between GP Strategies Corporation and the Registrant.
Incorporated herein by reference to Exhibit 10.3 of the
Registrant's Registration Statement on Form S-1 filed on July
22,1994, Registration Statement No. 33-78252.
10.2 Employment Agreement, dated as of January 1, 1994, between Martin
M. Pollak and the Registrant. Incorporated herein by reference to
Exhibit 10.4 of the Registrant's Registration Statement on Form
S-1 filed on July 22, 1994, Registration Statement No. 33-78252.
10.3 Consulting Agreement, dated as of January 1, 1994,
between Jerome I. Feldman and the Registrant.
Incorporated herein by reference to Exhibit 10.5 of
the Registrant's Registration Statement on Form S-1
filed on July 22, 1994, Registration Statement No.
33-78252.
10.4 Form of Warrant Agreement, dated as of August 5,
1994, between the Registrant, The Harris Trust
Company of New York, as Warrant Agent, and the holder
of Warrants from time to time. Incorporated herein by
reference to Exhibit 10.8 of the Registrant's
Registration Statement on Form S-1 filed on July 22,
1994, Registration Statement No.
33-78252.
10.5 Voting Agreement, dated as of August 31, 1998, from GP Strategies
Corporation.*
10.6 Lease dated as of February 1, 1986 between Vernel Company and
Five Star Group, Inc., as amended on July 25, 1994.*
10.7 Lease dated as of May 4, 1983 between Vornado, Inc., and Five
Star Group, Inc.*
10.8 Lease Modification and Extension Agreement dated July 6, 1996
between Hanover Public Warehousing, Inc. and Five Star Group,
Inc.*
10.9 Agreement between Five Star Group and Local No. 11 affiliated
with International Brotherhood of Teamsters.*
10.10 Form of 7% Convertible Note due 2001 of the Registrant.
Incorporated herein by Reference to Exhibit 4.1 of the
Registrant's Form 10-Q for the second quarter ended June 30,
1996.
10.11 Asset Purchase Agreement dated as of August 31, 1998 between
American Drug Company and Five Star Group, Inc. Incorporated
herein by Reference to Exhibit 10 of the Registrant's Form 8-K
dated September 15, 1998.
10.12 Loan and Security Agreement by and among Fleet Bank, National
Association in its capacity as Agent for the ratable benefit of
Lenders named Within and The Lenders named Herein and Five Star
Group, Inc. formerly Five Star Acquisition Group Incorporated
herein by reference to the Registrant's Form 10-Q for the third
quarter ended September 30, 1998.
16 Letter from KPMG Peat Marwick re change in certifying accountant.
Incorporated by reference to Exhibit 16 to the Registrant's
Report on Form 8-K filed in November 18, 1998
21 Subsidiaries.*
22 N/A
23 Consent of Independent Auditors*
*Filed herewith