UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2006
Commission File No. 1-4436
THE STEPHAN CO.
_______________________________________________________________
(Exact Name of Registrant as Specified in its Charter)
Florida 59-0676812
________________________________ __________________
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1850 West McNab Road, Fort Lauderdale, Florida 33309
_______________________________________________________________
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (954) 971-0600
_____________
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on Which Registered
___________________ _________________________________________
Common Stock, AMERICAN STOCK EXCHANGE
$.01 Par Value
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES [ ] NO [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
the filing requirements for at least the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act).
Large accelerated filer[ ] Accelerated filer[ ] Non-accelerated filer[X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The aggregate market value of the voting and non-voting common equity
shares held by non-affiliates as of June 30, 2006, the last business day of
the Registrant's most recently completed second fiscal quarter was
$9,742,912, based upon the reported sale price of $3.15 per share on the
American Stock Exchange on such date.
The above amount excludes shares held by all executive officers and
directors of the Registrant
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date:
4,389,805 Shares of Common Stock, $.01 Par Value,
as of March 30, 2007
List hereunder the following documents if incorporated by reference and the
part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated: (1) any annual report to security holders; (2) any proxy
or information statement; and (3) any prospectus filed pursuant to Rule
424(b) or (c) under the Securities Act of 1933:
NONE
2
THE STEPHAN CO. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
Page
PART I ______
Item 1: Business................................................... 5
Item 1A: Risk Factors............................................... 9
Item 1B: Unresolved Staff Comments.................................. 15
Item 2: Properties................................................. 15
Item 3: Legal Proceedings.......................................... 16
Item 4: Submission of Matters to a Vote of Security Holders........ 17
PART II
Item 5: Market for the Registrant's Common Equity, Related Stock-
holder Matters and Issuer Purchases of Equity Securities. 18
Item 6: Selected Financial Data.................................... 19
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 20
Item 7A: Quantitative and Qualitative Disclosures about Market Risk. 27
Item 8: Financial Statements and Supplementary Data................ 27
Item 9: Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 27
Item 9A: Controls and Procedures.................................... 27
Item 9B: Other Information.......................................... 28
PART III
Item 10: Directors, Executive Officers and Corporate Governance..... 29
Item 11: Executive Compensation..................................... 29
Item 12: Security Ownership of Certain Beneficial Owners,
Management and Related Stockholder matters................ 29
Item 13: Certain Relationships and Related Transactions, and
Director Independence..................................... 29
Item 14: Principal Accountant Fees and Services..................... 29
PART IV
Item 15: Exhibits and Financial Statement Schedules................ 30
Signatures.......................................................... 33
3
PART I
Certain statements in this Annual Report on Form 10-K ("Form 10-K")
under "Item 1. Business", "Item 3. Legal Proceedings" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations," constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 (the "Reform Act").
Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results,
condition (financial or otherwise), performance or achievements to be
materially different from any future results, performance, condition or
achievements expressed or implied by such forward-looking statements.
Words such as "projects," "believe," "anticipates," "estimate,"
"plans," "expect," "intends," and similar words and expressions are
intended to identify forward-looking statements and are based on our
current expectations, assumptions, and estimates about us and our industry.
In addition, any statements that refer to expectations, projections or
other characterizations of future events or circumstances are forward-
looking statements. Although we believe that such forward-looking
statements are reasonable, we cannot assure you that such expectations will
prove to be correct.
Our actual results could differ materially from those anticipated in
such forward-looking statements as a result of several factors, risks and
uncertainties. These factors, risks and uncertainties include, without
limitation, the results of the audit and review processes performed by our
independent auditors with respect to our Form 10-K for the year ended
December 31, 2006; our ability to satisfactorily address any material
weakness in our financial controls; general economic and business
conditions; competition; the relative success of our operating initiatives;
our development and operating costs; our advertising and promotional
efforts; brand awareness for our product offerings; the existence or
absence of adverse publicity; acceptance of any new product offerings;
changing trends in customer tastes; the success of any multi-branding
efforts; changes in our business strategy or development plans; the quality
of our management team; the availability, terms and deployment of capital;
the business abilities and judgment of our personnel; the availability of
qualified personnel; our labor and employee benefit costs; the availability
and cost of raw materials and supplies; changes in or newly-adopted
accounting principles; changes in, or our failure to comply with,
applicable laws and regulations; changes in our product mix and associated
gross profit margins; as well as management's response to these factors,
and other factors that may be more fully described in the Company's
literature, press releases and publicly-filed documents with the Securities
and Exchange Commission. You are urged to carefully review and consider
these disclosures, which describe certain factors that affect our business.
We do not undertake, subject to applicable law, any obligation to
publicly release the results of any revisions, which may be made to any
forward-looking statements to reflect events or circumstances occurring
after the date of such statements or to reflect the occurrence of
4
anticipated or unanticipated events. Therefore, we caution each reader of
this report to carefully consider the specific factors and qualifications
discussed herein with respect to such forward-looking statements, as such
factors and qualifications could affect our ability to achieve our
objectives and may cause actual results to differ materially from those
projected, anticipated or implied herein.
Item 1. Business
GENERAL
The Company, founded in 1897 and incorporated in the State of Florida
in 1952, is engaged in the manufacture, sale and distribution of hair care
and personal care products at both the wholesale and retail level. The
Company is comprised of The Stephan Co. ("Stephan") and its nine wholly-
owned operating subsidiaries, Old 97 Company, Williamsport Barber and
Beauty Corp., Stephan & Co., Scientific Research Products, Inc. of
Delaware, Sorbie Distributing Corporation, Stephan Distributing, Inc.,
Morris Flamingo-Stephan, Inc., American Manicure, Inc. and Lee Stafford
Beauty Group, Inc.
The Company has identified three reportable operating segments, which
are Professional Hair Care Products and Distribution ("Professional"),
Retail Personal Care Products ("Retail") and Manufacturing. The
Professional segment generally consists of a customer base of distributors,
which purchase the Company's hair care products and beauty and barber
supplies for sale to salons, barbershops and beauty schools. In this
segment, a distinction is made between "wet goods", which include shampoos,
conditioners, gels and similar hair treatments, and "hard goods", which
include scissors, clippers, combs, dryers and other products used in the
cutting and styling of hair. The customer base for our Retail segment is
comprised of mass merchandisers, chain drug stores and supermarkets that
sell hair care and other personal care products directly to the end user.
The Manufacturing segment manufactures products for subsidiaries of the
Company, and manufactures private label brands for certain customers.
THE STEPHAN CO.
Headquartered in Fort Lauderdale, Florida, we are principally engaged
in the manufacture of hair care products for sale by one of our
subsidiaries, Scientific Research Products, Inc. and the manufacture of
products marketed under the STEPHAN brand name. We also manufacture,
market and distribute hair and skin care products under various trade names
through our subsidiaries. Retail product lines include brands such as
Cashmere Bouquet talc, Quinsana Medicated talc, Balm Barr and Stretch Mark
creams and lotions, Protein 29 liquid and gel grooming aids and Wildroot
hair care products for men. These brands, included in the Retail segment
of our business, are manufactured at our Tampa, Florida facility, as are
our "Stiff Stuff" products. The sales of these products are also included
in the Company's Retail segment. In addition, The Frances Denney division
(included in the Retail segment) markets a full line of cosmetics through
retail and mail order channels. Under the terms of an exclusive Trademark
License and Supply Agreement with Color Me Beautiful, Inc., we market the
5
brand names HOPE, INTERLUDE and FADE-AWAY through several retail chains in
the United States and Canada.
We also manufacture and sell products under the brand name
"STEPHAN'S". Such products consist of different types of shampoos, hair
treatments, after-shave lotion, dandruff lotion, hair conditioners and hair
spray which are distributed throughout the United States to approximately
350 beauty and barber distributors and are included in our Professional
segment. Our trademark, "STEPHAN'S," and the design utilized thereby have
been registered with the United States Patent and Trademark Office, which
registration is due for renewal in November 2011. Retail brand sales of
Stephan, including the Frances Denney product line, accounted for
approximately $2,797,000 of the Company's 2006 net sales.
Under certain trademark licenses, we have been granted the exclusive
use of certain trademarks in connection with the manufacture and
distribution of the Cashmere Bouquet product line of the Colgate-Palmolive
Company in the United States and Canada. Any product sold under these
license agreements is included in our net sales.
Pursuant to an additional license and supply agreement, we have granted
Color Me Beautiful, Inc. ("CMB") a license to distribute certain products
of our Frances Denney line and to supply the requirements of CMB for such
products. The agreement provides for royalty payments by CMB based upon
net sales, with guaranteed minimum annual royalty payments throughout the
term of the agreement that are credited against accrued royalties.
The Company's Fort Lauderdale location serves as our corporate
headquarters. General management services are provided to our subsidiaries
from this location.
No single customer accounted for more than 10% of our consolidated
revenues in 2006. Private label production, which is the manufacturing of
products marketed and sold under the brand names of customers of the
Company, was not material in 2006.
OLD 97 COMPANY.
Old 97 Company ("Old 97"), a wholly-owned subsidiary of the Company,
located in Tampa, Florida, markets products under brand names such as OLD
97, KNIGHTS, and TAMMY. In addition to selling more than 100 different
products, including hair and skin care products, fragrances, personal
grooming aids and household items, Old 97 serves as an additional
manufacturing facility for our products. The Tampa facility manufac-
tures most of the products sold under the Frances Denney line, all the talc
manufactured for the Cashmere Bouquet and Quinsana brands, as well as all
the other retail hair and skin care brands sold by Stephan, Stephan
Distributing, Inc. and Sorbie Distributing Corporation. Old 97 also
manufactures private label products for customers and sales, which were not
material, are included in the Manufacturing segment of our business.
WILLIAMSPORT BARBER AND BEAUTY CORP.
Williamsport Barber and Beauty Corp. ("Williamsport"), a wholly-owned
6
subsidiary of the Company, is located in Williamsport, Pennsylvania.
Williamsport, a mail order beauty and barber supply company, with net sales
of approximately $3,968,000 in 2006, accounted for approximately 18.2% of
our consolidated revenues for the year and are included in the Professional
business segment.
STEPHAN & CO.
Stephan & Co., a wholly-owned subsidiary, has focused on the
distribution of personal care amenity products to resorts, spas and cruise
ship lines. For the year ended December 31, 2006, Stephan & Co. had net
sales of approximately $588,000.
SCIENTIFIC RESEARCH PRODUCTS, INC. OF DELAWARE.
Scientific Research Products, Inc. of Delaware ("Scientific") is a
wholly-owned subsidiary, which accounted for 6.3% of our consolidated
revenues in 2006, with net sales of approximately $1,380,000. The majority
of the sales of Scientific are included in the Retail business segment.
SORBIE DISTRIBUTING CORPORATION
Sorbie Distributing Corporation ("Sorbie") is a wholly-owned
subsidiary and a distributor of a professional line of hair care products
sold to salons in the United States and Canada through a network of
distributors. Net sales of Sorbie hair care products in 2006 were
approximately $469,000, and are included in the Professional segment of the
Company's business.
STEPHAN DISTRIBUTING, INC.
Stephan Distributing, Inc., wholly-owned subsidiary, distributes a
professional hair care line of products marketed under the brand name
"Image," and a retail hair care line marketed under the brand name "Stiff
Stuff." Sales of Image professional brands amounted to approximately 4.2%
of consolidated revenues, or approximately $926,000 of net sales for the
year ended December 31, 2006. Sales of New Image products are included in
the Company's Professional business segment while sales of the Modern line
are included in the Company's Retail business segment.
MORRIS FLAMINGO-STEPHAN, INC.
Morris-Flamingo, Inc. ("Morris Flamingo") is a beauty and barber
distributor, which markets its products utilizing catalogs published under
the Morris Flamingo brand name as well as the Major Advance brand name.
Net sales for the year ended December 31, 2006 were approximately
$10,550,000, accounting for approximately 48.3% of our consolidated
revenues, and are included in the Professional segment of the Company's
business.
AMERICAN MANICURE, INC.
American Manicure, Inc. was established in June, 2005 to acquire the
assets and business of AM Laboratories, Inc., a company that distributed
7
"Natural" and "French" nail polish manicure kits to other distributors and
salons. For the year ended December 31, 2006, net sales were approximately
$256,000.
LEE STAFFORD BEAUTY GROUP, INC.
Incorporated in late 2005, Lee Stafford Beauty Group, Inc. was formed
to act as the exclusive manufacturer, marketer and distributor of the Lee
Stafford brand of hair care products in the United States. Lee Stafford is
a well-known hairdresser in Great Britain, with salons in London, Essex and
Brighton, as well as an upscale, unique product line distributed not only
in the United Kingdom, but also Europe, Australia and several other
countries. Sales for this company was nominal in 2006.
SEGMENT INFORMATION
"Operating Segments and Related Information," which provides informa-
tion on net sales, income before income taxes and cumulative effect of
change in accounting principle, interest income and expense and
depreciation and amortization for the last three years and identifiable
assets for the last two years, for each of our three business segments, is
set forth in Note 9 of the consolidated financial statements included
elsewhere in this Form 10-K.
RAW MATERIALS, PACKAGING and COMPONENTS INVENTORY
The materials utilized by the Company and our subsidiaries in the
manufacture of its products consist primarily of common chemicals, alcohol,
perfumes, labels, plastic bottles, caps and cartons. All materials are
readily available at competitive prices from numerous sources and have in
the past been purchased from domestic suppliers. Neither the Company nor
any of our subsidiaries has ever experienced any significant shortage in
supplies nor do we anticipate any such shortages in the reasonably
foreseeable future. Due to market conditions in the petroleum industry,
the Company continues to experience price increases in both raw material
and component prices as well as an increase in overall freight costs;
however, it is not anticipated that these price increases will have a
material adverse effect on our operations and we believe that such
increases can be passed on to our customers.
The Company and its subsidiaries seek to maintain a level of finished
goods inventory sufficient for a period of at least three months. The
Company does not anticipate any change in such practice during the
reasonably foreseeable future.
BACKLOG
As of December 31, 2006 the Company did not have any significant
amount of backlog orders.
RESEARCH AND DEVELOPMENT
During each of the three prior fiscal years ending December 31, 2006,
expenditures on Company sponsored research relating to the development of
8
new products, services or techniques or the improvement of existing
products, services or techniques were not material and were expensed as
incurred.
COMPETITION
The hair care and personal grooming business is highly competitive. We
believe that the principal competitive factors are price and product
quality. Products manufactured and sold by the Company and its
subsidiaries compete with numerous varieties of other such products, many
of which bear well known, respected and heavily advertised brand names and
are produced and sold by companies having substantially greater financial,
technical, personnel and other resources than the Company. Our products
account for a relatively insignificant portion of the total hair care and
personal grooming products manufactured and sold annually in the United
States.
GOVERNMENT AND INDUSTRY REGULATION, ENVIRONMENTAL MATTERS
Certain of our products are subject to regulation by the Food and Drug
Administration, in addition to other federal, state and local regulatory
agencies. The Company believes that its products are in substantial
compliance with all applicable regulations. The Company does not believe
that compliance with existing or presently proposed environmental
standards, practices or procedures will have a material adverse effect on
operations, capital expenditures or the competitive position of the
Company.
EMPLOYEES
As of December 31, 2006, in addition to its four executive officers,
the Company and its subsidiaries employed 98 people engaged in the
production, warehousing and distribution of its products. Although we do
not anticipate the need to hire a material number of additional employees,
the Company believes that any such employees, if needed, would be readily
available. No significant number of employees are covered by collective
bargaining agreements and the Company believes its employee relationships
are satisfactory.
Item 1A: Risk Factors
An investor should carefully consider the risks described below, in
addition to other information included elsewhere in this Annual Report on
Form 10-K and other documents we file with the SEC. The risks and
uncertainties described below are those that the Company has identified as
material, but are not the only risks and uncertainties facing the Company.
Our business is also subject to general risks and uncertainties that affect
other companies, such as overall U.S. and non-U.S. economic and industry
conditions, including global economic events, geopolitical events, changes
in laws or accounting rules, terrorism and/or other international
conflicts, natural disasters or other disruptions of unexpected
economic/business conditions. Additional risks and uncertainties not
currently known to us or that we currently believe are immaterial may also
impact our business operations, financial results and liquidity.
9
Many of the markets we serve are highly competitive, which could limit the
volume of products that we sell and reduce our operating margins.
Our products are sold in a competitive marketplace which is
experiencing increased trade concentration and the growing presence of
large-format retailers and discounters. With the growing trend toward
retail trade consolidation, we are increasingly dependent on key retailers,
and some of these retailers, including large-format retailers, have greater
bargaining strength than we do. They may use this leverage to demand higher
trade discounts, allowances or slotting fees which could lead to reduced
sales or profitability. We believe that significant points of competition
in our markets are product quality, price, product development, conformity,
to customer specifications, reliability and timeliness of delivery,
customer service and effectiveness of distribution. Maintaining and
improving our competitive position requires continued investment by us in
manufacturing, quality standards, marketing, customer service and support
of our distribution networks. The Company may have insufficient resources
in the future to continue to make such investments and, even if we make
such investments, we may not be able to maintain or improve our competitive
position.
We may also be negatively affected by changes in the policies of our
retail trade customers, such as inventory de-stocking, limitations on
access to shelf space, delisting of our products and other conditions. In
addition, private label brands sold by retail trade chains, which are
typically sold at lower prices, are a source of competition for some of our
product lines.
Consumers may reduce discretionary purchases of our products as a result of
a general economic downturn or other external factors.
We believe that consumer spending on specific hair care and fragrance
products may be influenced by general economic conditions and the
availability of discretionary income. As a result, we may experience
periods of declining sales during economic downturns. In addition, a
general economic downturn may result in reduced traffic in our customers'
stores which may, in turn, result in reduced net sales to our customers.
Any resulting material reduction in our sales could have a material adverse
effect on our business, its profitability or operating cash flows.
Our success depends on our ability to anticipate and respond to changing
consumer preferences.
The markets in which our products compete are characterized by
constant product innovation and changing consumer preferences. We believe
that our success depends in large part upon our ability to anticipate and
respond to changing consumer demands in a timely manner and to continually
appeal to our target consumers. Any failure to offer products that respond
to changing consumer preferences, or a shift in consumer preferences away
from our products, could adversely affect retail and consumer acceptance of
our products and have an adverse affect on our sales and our results of
operations.
10
Increases in our raw material or component costs or difficulties within our
supplier base could negatively affect our profitability.
Generally, our raw materials and component requirements are obtainable
from various sources and in desired quantities. While we currently
maintain alternative sources for raw materials and components, our business
is subject to the risk of price fluctuations and, perhaps, periodic delays
in the delivery of certain raw materials and components. Due to market
conditions in the petroleum industry, the Company continues to experience
price increases in both raw material and component prices as well as an
increase in overall freight costs. While the rise in material costs may
continue to impact our financial results, we have been able to offset most
of these cost increases through price recovery from our customers and cost
reductions. Our ability to continue to pass along cost increases on a
going forward basis is not guaranteed. In addition, a failure by our
suppliers to continue to supply us with raw materials or component parts on
commercially reasonable terms, or at all, would have a material adverse
effect on us.
We are exposed to certain inventory risks.
Our business is subject to the risk that the value of our inventory
will be affected adversely by our suppliers' price reductions or by product
changes affecting the usefulness or desirability of the products comprising
our inventory. We take various actions, including monitoring our inventory
levels and controlling the timing of purchases to reduce our inventory
risk. We are subject to the risk that our inventory values may decline in
value. In addition, the failure of anticipated orders to materialize could
result in our holding a significant amount of unsold inventories. We may be
required to offer sales discounts or other incentives to our customers in
order to sell such inventories or to write down the carrying value of
inventories we are unable to sell. Any such sales discounts or customer
incentives or inventory write-downs could have an adverse affect on our
sales and our results of operations.
Historically, the Company has grown primarily through acquisitions. If we
are unable to identify attractive acquisition candidates and successfully
integrate acquired operations, we may be adversely affected.
One of our principal growth strategies in the past has been to pursue
strategic acquisition opportunities. A substantial portion of our
historical growth has been from acquisitions. Attractive acquisition
opportunities may not be identified or acquired in the future, financing
may be unavailable on satisfactory terms or we may be unable to accomplish
our strategic objectives in effecting a particular acquisition. We may
encounter various risks in acquiring other companies or brands, including
the possible inability to integrate an acquired line of business into our
operations, diversion of management's attention and unanticipated problems,
some or all of which could materially and/or adversely affect our business
strategy, financial condition and results of operations.
11
The Company may be unable to successfully implement growth strategies. Our
ability to realize growth opportunities, apart from acquisitions, may be
limited.
The Company has identified growth opportunities involving new product
development, cross-selling, product bundling, cost reduction measures and
organic growth opportunities. However, our business operates in relatively
stable marketplaces and it may be difficult to successfully pursue these
strategies and realize material benefits therefrom. Even if the Company is
successful, other risks attendant to our businesses and the economy
generally may substantially or entirely eliminate the benefits. While we
have been successful with some of these strategies in the past, our growth
has principally come through acquisitions.
The price of our common stock may be volatile.
The trading price of our common stock may fluctuate widely as a result
of a number of factors, many of which are outside our control. In addition,
the stock market has experienced extreme price and volume fluctuations that
have affected the market prices of many companies. These broad market
fluctuations could adversely affect the market price of our common stock.
We may be unable to adequately protect our intellectual property.
While the Company believes that our trademarks, trade names and other
intellectual property have significant value, the market for our products
depends to a degree upon the value associated with our trademarks and trade
names. Competitors may infringe on our trademarks or successfully avoid
them through design innovation. Although most of our brand names are
registered in the United States and certain foreign countries, we may not
be successful in asserting trademark or trade name protection. In addition,
the laws of certain foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United States. The
costs required to protect our trademarks and trade names may be
substantial. Additionally, an adverse outcome in any intellectual property
litigation could subject us to significant liabilities to third parties,
require us to license our intellectual property rights from others, require
us to comply with injunctions to cease marketing or using certain products
or brands, or require us to redesign, reengineer, or re-brand certain
products or packaging. Further, we may incur costs in terms of legal fees
and expenses, whether or not the claim is valid, to respond to intellectual
property infringement claims. These or other liabilities or claims may
increase or otherwise have a material adverse effect on our financial
condition and future results of operations.
The Company has a significant amount of goodwill and intangible assets, and
their future impairment could have a material adverse effect on our
financial condition and results of operations.
The Company's goodwill and intangible assets were approximately $5,748,000
at December 31, 2006, and represented approximately 22% of total assets.
For the years ended December 31, 2006 and 2004, the Company incurred
impairment losses of $6,706,000 and $2,145,000, respectively, in connection
with the valuation of intangible assets. Because of the continued
significance of our goodwill and intangible assets, any future impairment
12
of these assets could have a material adverse effect on our financial
results.
If we lose key personnel, or fail to attract and retain qualified
experienced personnel, we may be unable achieve the Company's continuing
objectives.
We believe that the future success of the Company depends upon the
continued contributions of our highly qualified management personnel and on
our ability to attract and retain those personnel. These individuals have
developed strong relationships with customers and suppliers. There can be
no assurance that our current employees will continue to work for us or
that we will be able to hire the additional personnel necessary for our
continued growth. The Company's future growth and success depends on our
ability to identify, hire, train and retain qualified managerial personnel.
The impact of the Sarbanes-Oxley Act of 2002 will require the Company to
implement significant changes to internal control procedures and will force
the Company to incur substantial implementation and recurring costs.
The Public Company Accounting Oversight Board ("PCAOB"), adopted rules
for purposes of implementing Section 404 of the Sarbanes-Oxley Act of 2002
("SOX 404"), which included revised definitions of material weaknesses and
significant deficiencies in internal control over financial reporting. The
PCAOB defined a material weakness as "a significant deficiency, or a
combination of significant deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected." The new rules describe
certain circumstances as being both significant deficiencies and strong
indicators that material weaknesses in internal control over financial
reporting exist.
Management of the Company has identified deficiencies which, taken in
the aggregate, amount to material weaknesses in our internal control over
financial reporting. These material weaknesses in our internal controls
over financial reporting related to the fact that, as a small public
company, we have an insufficient number of personnel with clearly
delineated and fully documented responsibilities and with the appropriate
level of accounting expertise and we have insufficient documented
procedures to identify and prepare a conclusion on matters involving
material accounting issues and to independently review conclusions as to
the application of generally accepted accounting principles. The lack of a
sufficient number of accounting personnel is not considered appropriate for
an internal control structure designed for external reporting purposes.
The principal factors management considered in determining whether a
material weakness existed in this regard was based upon management's
evaluation and advice from our independent registered public accounting
firm. Inadequate internal control over financial reporting could cause
investors to lose confidence in our reported financial information, which
could have a negative effect on the trading price of our securities.
Pursuant to SOX 404, our management will be required to deliver a
report that assesses the effectiveness of our internal control over
financial reporting, and our auditors will be required to deliver an
13
attestation report on management's assessment of and operating
effectiveness of internal control over financial reporting. The effective
implementation date of SOX 404 has been postponed for non-accelerated
filers such as The Stephan Co. until the first year ending on or after
December 15, 2007 and Auditor reporting requirements become effective for
fiscal years ending on or after December 15, 2008. We have a substantial
effort ahead of us to complete the documentation of our internal control
system and financial processes, information systems, assessment of their
design, remediation of control deficiencies identified in these efforts and
management testing of the design and operation of internal control.
Management has estimated that the costs associated with the implementation
of SOX 404 will be material and may very well have an adverse effect on the
financial position, results of operations and cash flows of the Company.
Failure to comply with laws and government regulations could adversely
affect our ability to operate our business.
Many of our activities are regulated by federal and state statutes and
regulations. The manufacture, formulation, packaging, labeling,
distribution and advertising of our cosmetic, Over the Counter ("OTC") drug
and device products are subject to regulation by one or more federal and/or
state agencies, including but not limited to the Food and Drug
Administration ("FDA"), the Department of Transportation ("DOT"), the
Florida Department of Health ("FL DOH"), the Occupational Safety and Health
Administration ("OSHA"), the Environmental Protection Agency ("EPA") as
well as by foreign governments where we distribute some of our products.
Failure to comply with the rules or regulations established by these
agencies could subject us to enforcement actions or other consequences.
For example, noncompliance with applicable FDA policies or requirements
could subject us to suspensions of manufacturing or distribution of
products, seizure of products, product recalls, fines, criminal penalties,
injunctions, failure to approve pending product registrations or withdrawal
of product manufacturing permits. Likewise, our manufacturing facilities
are continually subject to inspection by governmental agencies.
Manufacturing operations could be interrupted or halted if a regulatory
authority is unsatisfied with the results of any inspection. Any
interruptions of this type could result in materially reduced sales of our
products or increased manufacturing costs. Further, failure to comply with
such laws and regulations could have a material adverse effect on our
business, financial condition, results of operations, and cash flows.
An increase in product liability claims or product recalls could harm our
business.
We face an inherent business risk of exposure to product liability
claims in the event that the use of our products is alleged to have
resulted in adverse effects. While we have taken, and will continue to
take, what we believe are appropriate precautions, we may not be able to
avoid significant product liability exposure. We currently have product
liability insurance, however, we cannot be assured that the level or
breadth of any insurance coverage will suffice to fully cover all potential
claims. Significant judgments against us for product liability for which
we have no insurance could have a material adverse effect on our business,
financial condition, results of operations and cash flows.
14
Product recalls or product field alerts may be issued at our
discretion or the discretion of the FDA or other governmental agencies
having regulatory authority over OTC drug, device and/or cosmetic product
manufacture, formulation, packaging, labeling, distribution or advertising.
Any recall or product field alert has the potential of damaging the
reputation of the product or our reputation and/or having a material
adverse effect on our business, financial condition, results of operations
or cash flows.
Item 1B: Unresolved Staff Comments
None
Item 2. Properties
Our administrative, manufacturing and warehousing facilities are
located in a building of approximately 33,000 square feet, owned by the
Company, located at 1850 West McNab Road, Fort Lauderdale, Florida 33309.
The Company utilizes approximately two-thirds of the space for the
manufacture and warehousing of our products. The remainder of the space is
utilized by the Company for its executive and administrative offices. The
Company also owns certain machinery and equipment used in the manufacture
of our products that are stored in the facility in Fort Lauderdale,
Florida. In addition to this facility, effective May 1, 2006, the Company
leases approximately 10,000 square feet of warehouse space located at 3137
N.W. 25th Avenue, Pompano Beach, Florida 33069, under the terms of a one
year lease, for approximately $7,300 per month.
Old 97 owns three buildings totaling approximately 42,000 square feet
of space, one of which is located at 2306 35th Street, Tampa, Florida
33605. This building is utilized by Old 97 in the manufacture of its
various product lines. It also owns two buildings located at 4829 East
Broadway Avenue, Tampa, Florida 33605. One building, comprising 10,500
square feet, is being used for office facilities and order fulfillment for
the Frances Denney line. The second building, consisting of approximately
30,000 square feet, is used as a warehouse and distribution facility. In
addition to the above facilities, Old 97 leases approximately 31,500 square
feet of warehouse space located at 3906 East 21st Avenue, Tampa, Florida
33605, under the terms of a two-year lease ending July 31, 2008, for
approximately $13,200 per month.
The Company leases office and warehouse space of approximately 6,000
square feet in Williamsport, Pennsylvania pursuant to a five-year lease
expiring January 31, 2012. Monthly rent in the amount of $2,400 is payable
to the former owner of Williamsport Barber Supply and the Company has the
right to terminate the lease upon 30-days notice.
The Company leases an office, warehouse and manufacturing facility
located at 204 Eastgate Drive, Danville, Illinois 61834. The facility has
7,500 square feet of office space and 85,500 square feet of warehouse,
distribution and manufacturing space. The landlord is Shaheen & Co., Inc,
the former owner of Morris-Flamingo. Shouky A. Shaheen, a minority owner
of Shaheen & Co., Inc., is currently a member of the Board of Directors and
a significant shareholder of the Company.
15
On May 4, 2005, the Company entered into a Second Amendment of Lease
Agreement (the "Amendment") with respect to the Danville, IL facility
extending the term of the lease to June 30, 2015, with a five year renewal
option, and increases the annual rental to approximately $303,000. The
base rent is adjustable annually, in accordance with the existing master
lease, the terms of which, including a 90-day right of termination by the
Company, remain in full force and effect. The Amendment provides a
purchase option, effective during the term of the lease, to purchase the
premises at the then fair market value of the building, or to match any
bona fide third-party offer to purchase the premises.
On July 6, 2005, the landlord notified the Company that its
interpretation of the Amendment differs from that of the Company as to the
existence of the 90-day right of termination. In October 2005, the
landlord filed a lawsuit in the Circuit Court for the 17th Circuit of
Florida in and for Broward County, styled Shaheen & Co., Inc. (Plaintiff) v
The Stephan Co., Case number 05-15175 seeking a declaratory judgment with
respect to the validity of the 90-day right of termination. In addition,
the lawsuit alleges damages with respect to costs incurred and the
weakening of the marketability of the property. This matter is currently
unresolved and the Company is unable, at this time, to determine the
outcome of the litigation. However, if it is ultimately determined that
the early termination provision has been eliminated with the Amendment, the
Company's minimum lease obligation would amount to $303,000 in each of the
years 2007 through 2011 and approximately $1,360,000 thereafter.
Item 3. Legal Proceedings
In addition to the matters set forth below, the Company is involved in
other litigation arising in the normal course of business. It is the
opinion of our management that none of such matters, at December 31, 2006,
would likely, if adversely determined, have a material adverse effect on
our financial position, results of operations or cash flows.
For a description of certain legal proceedings involving the Company
and a shareholder, see Item 2. Properties above.
In March 2006, in a case styled Trevor Sorbie International, Plc. v.
Sorbie Acquisition Co. (CASE NO. 05-14908-09), filed in the Circuit Court
of the 17th Judicial Circuit in and for Broward County, Florida, Trevor
Sorbie International, Plc. ("TSI") instituted efforts to collect on a
judgment it has against Sorbie Acquisition Co. ("SAC"). The judgment
derives from an October 25, 2004, Pennsylvania arbitration award in favor
of TSI and against SAC with respect to certain royalties and interest due.
The financial statements for the Company for the year ended December 31,
2006, reflect a liability of approximately $931,000, including interest,
for payment of this judgment. Among other things, the Florida lawsuit
alleges fraud and names as additional defendants The Stephan Co., Trevor
Sorbie of America, Inc. and Sorbie Distributing Corporation. The Company
is vigorously defending this legal action against TSI. While management
believes we may ultimately prevail and/or settle for an amount
substantially below the amount already accrued, management continues to
accrue interest on the entire obligation because, due to the limited
16
discovery taken and the complexities of the issues involved, the Company
cannot predict the outcome of the litigation.
In 1997, the Company's wholly-owned subsidiary, Stephan Distributing,
Inc., acquired several product lines from New Image Laboratories, Inc.
("New Image"). The purchase price included a contingent payment of 125,000
shares of the Company's common stock payable upon the achievement of
certain earnings levels. New Image commenced litigation against the
Company seeking certain purchase price adjustments. The parties reached a
settlement pursuant to a stipulation of settlement and amendments thereto
which provided, among other things, as follows: (i) New Image relinquished
title to 65,000 of the 125,000 shares of the Company's common stock held in
escrow and received 60,000 shares, (subsequently, New Image elected to sell
the Company its 60,000 shares for $285,000), (ii) Stephan was awarded
$44,000 in damages from New Image, (iii) dividends, and interest accrued
thereon, held in the escrow account (approximately $72,000) were
distributed with Stephan receiving 52% of such funds and New Image
receiving 48% of such funds, which was used to satisfy, in part, the award
under (ii) above. As a result of this settlement, the Company recorded an
expense of approximately $285,000 and the amount is reflected as a
reduction of royalty and other income on the consolidated statement of
operations for the year ended December 31, 2004. Also in 2004, the amount
of the contingently returnable shares recorded in the financial statements
of the Company was offset against additional paid in capital when the
shares were retired.
Item 4. Submission of Matters to a Vote of Security Holders
On November 9, 2006, the Company held an Annual Meeting of Stock-
holders to elect William Gross to another term as a Class III member of the
Board of Directors and ratify the appointment of Goldstein Lewin & Co. as
the Company's independent public accounting firm.
The results of the voting, with 3,470,839 shares voted, was as
follows: For the election of William Gross to another term; 2,922,692 for
with 548,147 withheld and with respect to the ratification of Goldstein
Lewin & Co.; 3,370,917 for, 96,772 against and 3,150 abstaining.
No other business was presented for consideration at the Annual
Meeting.
17
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters
(a) Market Information
The Company's Common Stock is listed on the American Stock Exchange
(the "Exchange"). The following table sets forth the range of high and low
sales prices for the Company's Common Stock for each quarterly period
during the two most recent fiscal years:
High Low
Quarter Ended Sales Price Sales Price
_____________ ___________ ___________
March 31, 2005 $ 5.10 $ 3.87
June 30, 2005 4.70 3.45
September 30, 2005 4.70 3.85
December 31, 2005 4.10 3.14
___________________________________________________________________________
March 31, 2006 $ 3.75 $ 3.31
June 30, 2006 3.70 3.05
September 30, 2006 3.17 2.91
December 31, 2006 3.62 2.96
(b) Holders
As of March 30, 2007, the Company's Common Stock was held of record
by approximately 345 holders. Additionally, the Company's Common Stock is
believed to be held beneficially by approximately 695 shareholders in
"street-name".
(c) Dividends
The Company declared and paid cash dividends at the rate of $.02 per
share for each quarter in 1996 through 2006. Future dividends, if any,
will be determined by the Company's Board of Directors, in its discretion,
based on various factors, including the Company's profitability, cash on
hand and anticipated capital needs. The Company paid a special dividend of
$2.00 per share on September 15, 2004, to holders of record on September 8,
2004.
There are no contractual restrictions, including any restrictions on
the ability of any of the Company's subsidiaries, to transfer funds to the
Company in the form of cash dividends, loans or advances, that currently
materially limit the Company's ability to pay cash dividends or that the
Company reasonably believes are likely to materially limit the future
payment of dividends on its Common Stock.
18
Item 6. Selected Financial Data
2006 2005 2004 2003 2002
(in thousands, except per share data)
____________________________________________________
Net sales $21,836 $22,262 $23,951 $25,336 $25,067
(Loss)/Income before
income taxes and
cumulative effect of
change in accounting
principle (5,731) (244) (2,034) 1,487 1,400
(Loss)/Income before
cumulative effect of
change in accounting
principle (3,602) (172) (2,176) 760 503
Cumulative effect of
change in accounting
principle, net of tax - - - - (6,762)
Net (loss)/income (3,602) (172) (2,176) 760 (6,259)
Current assets 15,019 16,853 15,014 24,139 20,284
Total assets 26,766 32,778 34,719 48,063 47,655
Current
liabilities 3,325 5,240 3,276 5,085 3,514
Long term debt 1,110 - 3,238 4,348 6,395
PER COMMON SHARE
(Basic and Diluted): (a)
(Loss)/Income before
cumulative effect of
change in accounting
principle (.82) (.04) (.50) .18 .12
Cumulative effect of
change in accounting
principle - - - - (1.58)
Net (loss)/income (.82) (.04) (.50) .18 (1.46)
Cash dividends .08 .08 2.08 .08 .08
Notes to Selected Financial Data
(a) Net (loss)/income per common share is based upon the weighted
average number of common shares outstanding in accordance with
19
Statement of Financial Accounting Standards No. 128. The weighted average
number of diluted shares outstanding were 4,389,805 for 2006 and 2005,
4,348,908 for 2004, 4,312,711 for 2003, and 4,285,577 for 2002. The
weighted average number of basic shares outstanding were not significantly
different in any of the aforementioned years.
The following data should be read in conjunction with the audited
consolidated financial statements and related notes included elsewhere in
this Form 10-K.
Selected Quarterly Financial Information (unaudited)
(in thousands, except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
3/31/06 6/30/06 9/30/06 12/31/06
_______ _______ _______ ________
Net sales $ 5,596 $ 5,361 $ 6,097 $ 4,782
Gross profit 2,218 2,354 2,572 1,897
Net income/(loss) 97 116 366 (4,181)
Net income/(loss)
per share .02 .03 .08 (.95)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
3/31/05 6/30/05 9/30/05 12/31/05
_______ _______ _______ ________
Net sales $ 5,517 $ 5,057 $ 6,568 $ 5,120
Gross profit 2,359 2,019 2,325 1,792
Net income/(loss) 74 (159) 94 (181)
Net income/(loss)
per share .02 (.04) .02 (.04)
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2006 AS COMPARED TO 2005
__________________________________________________
For the year ended December 31, 2006, the Company incurred a net loss
of approximately $3,602,000 as a result of a significant impairment to
goodwill and other intangible assets in the Company's Retail "reporting
unit", which includes the Frances Denney and LeKair brands, as well as the
brands acquired from Colgate-Palmolive, Inc. ("CP") in December 1995.
Based upon a valuation analysis of intangible assets for the year ended
December 31, 2006, prepared with the assistance of an independent valuation
firm, the Company reduced all of the goodwill attributed to the acquisition
of Scientific Research Products, Inc., acquired in 1994, by approximately
$1,411,000 and all of the trademarks associated with the brands LeKair, New
20
Era and Frances Denney, in addition to substantially all of the value
assigned to the brands acquired from CP, totaling approximately $5,295,000.
The impairment of the trademarks has been included in Selling, General and
Administrative expenses, in accordance with Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
After taking into consideration prior years sales trends, the Company took
a conservative approach to the sales projections used in connection with
certain analysis by the valuation firm. Management believes that the
remaining carrying value of the above-mentioned retail trademarks is less
than the Company would realize if the brands were offered to third-party
buyers, based upon disclosed sales prices and multiples of brand revenue
indicated in published industry results.
In 2006, the Company's gross profit increased in spite of a decline in
overall net revenues. Net sales for the year ended December 31, 2006 was
$21,836,000, a decline of $426,000 from the previous year, but gross profit
increased to $9,041,000 when compared to $8,495,000 for the year ended
December 31, 2005. This increase, as well as an increase in the gross
profit margin from 38.2% in 2005 to 41.4% in 2006, was generally due to a
change in the sales mix as well as management's effective use of inventory
that was previously written off. Income from operations, before taking
into consideration the impairment of intangibles, was approximately $839,000
as a result of the increase in the gross profit described above, as well as
a decline in recurring selling, general and administration expenses
("SG&A"). Reductions in payroll and related expenses, rent expense due to
consolidation of warehouse space and legal and professional expenses were
the significant reasons that recurring SG&A expenses declined approximately
$564,000 in 2006 when compared to 2005.
The Professional segment experienced a sales decline of almost
$1,000,000 in 2006. A large part of this decline was in "hard goods", due
to a combination of factors including strong price consciousness by
customers in addition to some contraction of the customer base. A positive
growth in net sales was shown by our New Era and American Manicure brands
which offset a decline in the "wet goods" level of sales in 2006.
The Manufacturing segment showed increased sales, both from
existing distribution channels in addition to new private label customers.
The Company is optimistic that it can continue to provide quality products
to it's private label sector and increase sales in this segment. As
indicated above, while overall sales declined in 2006, this created a
change in the sales mix, since the significant decline in the Professional
segment was due to a decline in the sales of hard goods, which
traditionally has a lower gross margin than other lines. As a result,
gross profit increased $546,000 for the year ended December 31, 2006 when
compared to the results achieved in 2005.
Selling, general and administrative expenses (SG&A) increased overall
by approximately $4,731,000, from $8,766,000 in 2005 to $13,497,000 in 2006
as a result of the impairment charge discussed above. A large portion of
this decline can be attributed to decreases in promotional expenses, rent
expense as a result of consolidation of warehouse space, a decline in legal
expenses and a reduction in overall payroll costs.
21
Interest expense decreased slightly, as interest paid on actual
outstanding debt decreased by approximately $19,000 while interest expense
accrued on the Sorbie debt increased by approximately $16,000. The
continuing accrual of interest with respect to the Sorbie arbitration award
is more fully discussed in Item 3, above, however management believes we
may ultimately prevail and/or settle for an amount substantially below the
amount already accrued, but continues to accrue interest on the entire
obligation because it cannot predict the outcome of the litigation.
Actual interest paid on the Company's outstanding bank debt obligation
was $39,000 for the year ended December 31, 2006, compared to $58,000 in
2005. Interest income increased $106,000 due to higher interest rates and
an increase in the level of invested cash. Interest income for the year
ended December 31, 2006, was $233,000, compared to $127,000 earned in 2005.
The net loss per share for the year ended December 31, 2006 was
($.82), compared to a net loss per share in 2005 of ($.04), based upon an
average number of shares outstanding of 4,389,805 in 2006 and 2005.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2005 AS COMPARED TO 2004
__________________________________________________
In 2005, the Company incurred a net loss of $172,000 as a result of
reduced sales and gross profit, even though the Company experienced a
decrease in selling, general and administrative expenses. Net sales for
the year ended December 31, 2005 was $22,262,000, a decline of $1,689,000
from the previous year. Over 90% of this decline was due to a decrease in
the net sales of the Company's Retail business segment. This decline was
due, in part, to the continuing contraction in the ethnic hair care market,
as major distributors realigned inventory levels to cope with softening
demand. In addition, other retail brands, marketed mainly through general
retail markets, also declined as the Company attempted to restructure it's
distribution channels.
As a result of lower net sales, gross profit declined $1,169,000 for
the year ended December 31, 2005, to $8,495,000, when compared to
$9,664,000, the gross profit for the year ended December 31, 2004. The
gross profit margin declined slightly, from 40.4% in 2004 to 38.2% in 2005.
This was due to the continuing change in the sales mix as retail brand net
sales declined. The Morris Flamingo-Stephan and Williamsport subsidiaries
(Professional business segment) accounted for approximately 69.3% of
consolidated net sales, an increase of 7.8% over 2004 levels. These two
subsidiaries have traditionally lower gross margins than other entities
comprising the professional group.
In addition to the above, net sales of the Image and Sorbie brands of
the professional segment declined over $275,000 in 2005 when compared to
net sales in 2004. In mid-2005, the Company acquired a small manicure
company that markets it's nail care sets to distributors. Net sales for
this subsidiary, American Manicure, was approximately $135,000 for the
period. Sales of hotel and spa amenities continued to improve in 2005,
with net sales increasing almost 10% over the prior year.
22
Selling, general and administrative expenses (SG&A) decreased overall
by approximately $1,493,000, from $10,259,000 in 2004 to $8,766,000 in
2005. Approximately $907,000 of SG&A expenses in 2004 were of a non-
recurring nature and were comprised of "non-cash" expenses, including an
impairment loss on trademarks in the amount of $300,000,
$415,000 of additional payroll costs associated with certain officers of
the Company exercising stock options utilizing the "cashless method" of
exercise and $192,000 of additional royalty expense to reflect the results
of the Sorbie arbitration (see Item 3. Legal Proceedings, above). Other
decreases in SG&A were the result of significantly reduced marketing
expenditures, including reductions in payroll, shipping costs, commissions
and advertising.
Interest expense increased by approximately $59,000, from $91,000 in
2004 to $150,000 in 2005, a result of the continuing accrual of interest
with respect to the Sorbie arbitration award more fully discussed in Item 3
above. Actual interest paid on the Company's outstanding bank debt
obligation was $58,000 for the year ended December 31, 2005, compared to
$87,000 in 2004. Interest income declined $37,000 due to low interest
rates and significantly lower cash investments due to the payment of a
special $2.00 per share dividend in September 2004. Interest income for
the year ended December 31, 2005, was $127,000, compared to $164,000 earned
in 2004.
The net loss for the year ended December 31, 2005 was $172,000,
compared to $2,176,000 for the year ended December 31, 2004. As indicated
above, 2004 had several unusual expenses, in addition to legal settlements
which resulted in other income of approximately $283,000. As was the case
in 2004, in connection with the Frances Denney line, the Company received a
$50,000 royalty payment in 2005. The net benefit for income taxes includes
a net state income tax provision of approximately $77,000 and a deferred
Federal income tax benefit of approximately $149,000.
Basic and diluted net loss per share for the year ended December 31,
2005 was $.04, compared to a net loss per share in 2004 of $.50, based upon
an average number of shares outstanding of 4,389,805 in 2005 and 4,348,908
in 2004.
LIQUIDITY AND CAPITAL RESOURCES
_______________________________
Working capital increased $81,000 from December 31, 2005, and was
approximately $11,693,000 at December 31, 2006. Cash and cash equivalents
increased approximately $1,461,000, to $7,064,000 as compared to $5,603,000
as of December 31, 2005. The Company continues to secure its outstanding
debt with restricted cash. In the third quarter of 2006, the Company and
Wachovia Bank converted the balloon payment due in August 2006 to monthly
principal payments under the same terms and conditions as the original
obligation, payable through 2008.
The Company does not anticipate any significant capital expenditures
in the near term and management believes that there is sufficient cash on
hand, working capital and borrowing capacity to satisfy any upcoming
requirements currently anticipated to occur within the next year.
23
The Company does not have any off-balance sheet financing or similar
arrangements.
Inventory levels declined as management sustained efforts to reduce
the overall amount of inventory on hand through the use of effective
inventory control techniques, controlled purchasing and a program of
continued utilization of old or slow moving raw materials and components.
In addition, in 2006, there was an increase in the amount of
inventory that the Company deemed to be non-current.
The Company has not experienced any material adverse impact from
the effects of inflation in the last several years. Management maintains
some flexibility to increase prices and does not have any binding contract
pricing with either customers or vendors. Many of the Company's products,
as well as the components used, are petroleum-based products, and as a
result, the prices for raw materials are and will continue to be subject to
oil prices which, in turn, are subject to various political or economic
pressures. The Company does not presently foresee any material increase in
the costs of raw materials or component costs, and our management believes
it has the flexibility of calling upon multiple vendors and the ability to
increase prices to offset any price changes, however, if this trend
continues, it may adversely impact the Company's gross profit margin.
The following table sets forth certain information regarding future
contractual obligations of the Company as of December 31, 2006:
Payments due by period
(in thousands)
Less than 1-3 3-5 over
Contractual obligation Total 1 year years years 5 years
______________________ _______ _________ _______ _______ _______
Bank debt payable $ 2,220 $ 1,110 $ 1,110 - -
Employment contract 1,372 653 719 - -
Office and
Warehouse leases 3,003 519 756 663 1,065
_______ _______ _______ _______ _______
TOTAL OBLIGATIONS $ 6,595 $ 2,282 $ 2,585 $ 663 $ 1,065
======= ======= ======= ======= =======
NEW FINANCIAL ACCOUNTING STANDARDS
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" (SFAS 159), which
establishes a fair value option under which entities can elect to report
certain financial assets and liabilities at fair value, with changes in
fair value recognized in earnings. SFAS 159 is effective for fiscal years
beginning after November 15, 2007. Management is currently evaluating the
impact SFAS 159 will have on the Company's financial statements.
In September 2006, the Securities and Exchange Commission staff
published Staff Accounting Bulletin ("SAB") No. 108, "Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements." SAB No. 108 addresses quantifying the
24
financial statement effects of misstatements, specifically, how the effects
of prior year uncorrected errors must be considered in quantifying
misstatements in the current year financial statements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. The adoption of
SAB No. 108 by our Company in the fourth quarter of 2006 did not have a
material impact on our consolidated financial statements
In July 2006 the FASB issued FASB Interpretation No. 48, ("FIN 48")
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109". FIN 48 requires that we recognize in our financial
statements the impact of a tax position taken or expected to be taken in a
tax return, provided that that position is more likely than not of being
sustained on audit. FIN 48 is effective for fiscal years beginning after
December 15, 2006. We do not anticipate that FIN 48 will have any adverse
effect on our financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement
No. 3", effective for accounting changes and corrections of errors made in
fiscal year 2006 and beyond. In February 2006, the FASB issued SFAS No.
155, "Accounting for Certain Hybrid Financial Instruments, an amendment of
FASB Statements No. 133 and 140", effective for events occurring after the
first fiscal year that begins after September 15, 2006. In March 2006, the
FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets, an
amendment of FASB Statement No. 140", also effective for the first fiscal
year that begins after September 15, 2006. In September 2006, the FASB
issued SFAS No. 157, "Fair Value Measurements", effective for financial
statements issued for fiscal years beginning after November 15, 2007. SFAS
No. 157 defines fair value, establishes a framework for measuring fair
value and expands required disclosures in connection therewith. Also in
September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Retirement Plans", an amendment of FASB
Statements No. 87, 88, 106, and 132(R). The effect of these statements on
the Company's consolidated financial statements will be determined based
upon the nature and significance of future events, if any, that would be
subject to these statements.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
__________________________________________
The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States of
America ("generally accepted accounting principles") requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ significantly from those estimates if different assumptions were
used or different events ultimately transpire. We believe that the
following are the most critical accounting policies that requires
management to make difficult, subjective and/or complex judgments, often
due to a need to make estimates about matters that are inherently
uncertain:
25
VALUATION OF ACCOUNTS RECEIVABLE: The ultimate amount of collections
received against outstanding accounts receivable must take into account
returns, allowances and deductions that may be made by our customers. Many
retailers to whom we sell products take deductions for various forms of
marketing expenses, as well as participating in nationwide reclamation
cooperatives for processing damaged goods. Other expenses to which we are
subject to, in addition to those experienced in the retail environment (but
also with Professional products sold to distributors) include deductions
for freight if the invoice is paid within specified terms, co-op
advertising allowances, new store/warehouse allowances and, from time to
time, limited rebate programs. We attempt to estimate these costs, as well
as providing for anticipated bad debts, by recording allowances based upon
our experience, economic conditions, normal customer inventory levels
and/or competitive conditions. Actual returns, credits or allowances, as
well as the condition of any product actually returned, may differ
significantly from the estimates used by the Company.
INVENTORIES: Inventories are stated at the lower of cost, determined
by the first-in, first-out (FIFO) method, or market. We periodically
evaluate inventory levels, giving consideration to factors such as the
physical condition of the goods, the sales patterns of finished goods and
the useful life of particular packaging, componentry and finished goods and
estimate a reasonable write-down amount to be provided for slow moving,
obsolete or damaged inventory. These estimates could vary significantly,
either favorably or unfavorably, from actual requirements based upon future
economic conditions, customer inventory levels or competitive factors that
were not foreseen or did not exist when the inventory write-downs were
established.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL: The Company
periodically evaluates whether events or circumstances have occurred that
would indicate that long-lived assets may not be recoverable or that the
remaining useful life may be impaired. When such events or circumstances
are present, the Company assesses the recoverability of long-lived assets
determining whether the carrying value will be recovered through the
expected future cash flows resulting from the use of the asset. If the
results of this testing indicates an impairment of the carrying value of
the asset, an impairment loss equal to the excess of the asset's carrying
value over its fair value is recorded. The long-term nature of these assets
requires the estimation of its cash inflows and outflows several years into
the future and only takes into consideration circumstances known at the
time of the impairment test.
In accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets," goodwill and other indefinite lived intangible assets are to be
evaluated for impairment on an annual basis, and between annual tests,
whenever events or circumstances indicate that the carrying value of an
asset may exceed its fair value. The use of various acceptable and
appropriate methods of valuation requires the use of long-term planning
forecasts and assumptions regarding industry-specific economic conditions
that are outside the control of the Company. As previously indicated, for
the year ended December 31, 2006, the Company incurred an impairment loss
of approximately $6,706,000.
26
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
The Company does not own or maintain an interest in derivative or
other financial instruments for which fair value disclosure would be
required under Statement of Financial Accounting Standards No. 107. In
addition, the Company does not invest in securities that would require
disclosure of market risk, nor does it have floating rate loans or foreign
currency exchange rate risks. The Company has no interest rate risk on its
fixed rate debt since the interest rate on the note payable to a bank
resets annually upon the anniversary of the loan (August) at 50 basis
points above the interest rate earned on the restricted cash that
collateralizes the loan.
Item 8. Financial Statements and Supplementary Data
Reference is made to the consolidated financial statements and
supplementary data contained elsewhere in this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A: Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report, an
evaluation of the effectiveness of the design and operation of the
Company's disclosure controls and procedures was performed under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer. Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that a material weakness existed in our internal controls over
financial reporting and consequently our disclosure controls and procedures
were not effective as of the end of the period covered by this Annual
Report in timely alerting them as to material information relating to our
Company (including our consolidated subsidiaries) required to be included
in this Annual Report.
The material weakness in our internal controls over financial
reporting as of December 31, 2006 related to the fact that as a small
public company, we have an insufficient number of personnel with clearly
delineated and fully documented responsibilities and with the appropriate
level of accounting expertise and we have insufficient documented
procedures to identify and prepare a conclusion on matters involving
material accounting issues and to independently review conclusions as to
the application of generally accepted accounting principles. The lack of a
sufficient number of accounting personnel is not considered appropriate for
an internal control structure designed for external reporting purposes.
The principal factors management considered in determining whether a
material weakness existed in this regard was based upon management's
evaluation discussed above and advice from our independent registered
27
public accounting firm. As a result, management has determined that a
material weakness in the effectiveness of the Company's internal controls
over financial reporting still existed as of December 31, 2006.
(b) Change in Internal Control over Financial Reporting
No change in the Company's internal control over financial reporting
occurred during the Company's fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting. However, management of the
Company, as well as the Audit Committee, recognizes that current staffing
levels are inadequate and will have to be enhanced and/or institute
arrangements with other accounting firms to act in a consulting capacity in
an effort to satisfy our reporting obligations and over-all standards of
disclosure controls and procedures.
ITEM 9B. OTHER INFORMATION
None
28
PART III
The information required by Part III of this Form 10-K (Items 10-14)
is incorporated herein by reference from the Company's proxy statement with
respect to the Company's 2007 annual meeting of stockholders scheduled to
be filed with the Securities and Exchange Commission no later than April
30, 2007.
29
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a) Exhibits
10.1 Acquisition Agreement, dated December 31, 1995, between
Colgate-Palmolive Company and The Stephan Co., with exhibits, including the
Transition Agreement, included with the Form 8-K filed January 16, 1996,
and as amended on January 22, 1996, is incorporated herein by reference.
10.2 Acquisition Agreement, dated December 31, 1995, between
The Mennen Company and The Stephan Co., with exhibits, included with the
Form 8-K filed January 16, 1996 and as amended on January 22, 1996, is
incorporated herein by reference.
10.3 Letter agreement, dated December 31, 1995, between
Colgate-Palmolive Company, The Mennen Company and The Stephan Co., included
with the Form 8-K filed January 16, 1996 and as amended on January 22,
1996, is incorporated herein by reference.
10.4 Settlement Agreement and Amendment, dated December 5,
1996, between The Stephan Co., The Mennen Company and Colgate-Palmolive
Company, included with the Form 10-K filed April 15, 1997, is incorporated
herein by reference.
10.5 The Trademark License Agreement, dated December 5, 1996,
between Colgate-Palmolive Canada, Inc. and The Stephan Co., included with
the Form 10-K filed April 15, 1997, is incorporated herein by reference.
10.6 Trademark License and Supply Agreement, dated March 7,
1996, between Color Me Beautiful, Inc. and The Stephan Co., included with
the Form 8-K filed March 20, 1996, is incorporated herein by reference.
10.7 Agreement, dated June 28, 1996, for the acquisition of
Sorbie Acquisition Co. and Subsidiaries, with exhibits, included with the
Form 8-K filed July 15, 1996, and as such was amended on August 21,
September 16 and October 9, 1996, is incorporated herein by reference.
10.8 Amended and Restated Sorbie Products Agreement, dated
June 27, 1996, among Sorbie Acquisition Co., Sorbie Trading Limited, Trevor
Sorbie International, PLC and Trevor Sorbie, included with the Form 8-K/A
filed August 21, 1996, is incorporated herein by reference.
10.9 Settlement Agreement and Amendment, dated December 5,
1996, between The Stephan Co., The Mennen Company and Colgate-Palmolive
Company, included with the Form 10-K for the year ended December 31, 1996,
filed April 15, 1997, is incorporated herein by reference.
10.10 Trademark License and Supply Agreement, dated March 7,
1996, between Color Me Beautiful, Inc. and The Stephan Co., included with
the Form 8-K filed March 20, 1996, is incorporated herein by reference.
30
10.11 Acquisition Agreement, dated as of May 23, 1997, between
New Image Laboratories, Inc., The Stephan Co. and Stephan Distributing,
Inc., in connection with the acquisition of brands, included with the Form
10-Q for the period ended June 30, 1997, filed August 13, 1997, is
incorporated herein by reference.
10.12 Acquisition Agreement, dated as of March 18, 1998,
between Morris Flamingo-Stephan, Inc., The Stephan Co., Morris-Flamingo,
L.P., Morris-Flamingo Beauty Products, Inc., Shaheen & Co., Inc. and Shouky
A Shaheen, included with the Form 10-Q for the period ended June 30, 1998,
filed May 15, 1998, is incorporated herein by reference.
10.13 1990 Key Employee Stock Incentive Plan, as amended, as
set forth in the Definitive Proxy filed July 5, 2000, in connection with
the Company's 2000 Annual Meeting of Stockholders.
10.14 1990 Non-Employee (Outside Directors) Plan, as amended,
as set forth in the Definitive Proxy filed July 5, 2000, in connection with
the Company's 2000 Annual Meeting of Stockholders.
10.15 Merger Agreement, dated April 30, 2003, by and among The
Stephan Co., Gunhill Enterprises and Eastchester Enterprises, including
exhibits, included with Form 8-K filed May 8, 2003, is incorporated herein
by reference.
10.16 Working Capital Management Account agreement dated
September 19, 2003 with Merrill Lynch Business Financial Services Inc.,
creating a line of credit not to exceed $5,000,000, included with Form 8-K
filed October 3, 2003, and amended October 9, 2003, is incorporated herein
by reference.
10.17 Second Amended and Restated Agreement and Plan of Merger,
dated March 24, 2004, by and among The Stephan Co., Gunhill Enterprises and
Eastchester Enterprises, including exhibits, included with Form 8-K filed
March 30, 2004, is incorporated herein by reference.
10.18 Modification of employment agreement between the Company
and Frank F. Ferola, President and Chief Operating Officer, dated July 6,
2005, included with Form 10-K for the year ended December 31, 2004, filed
September 9, 2005, is incorporated herein by reference.
10.19 Brand License Agreement with The Quantum Beauty Company
Limited for the exclusive rights to manufacture, market and distribute the
"Lee Stafford" brand of hair care products included with the Form 8-K filed
August 4, 2005, is incorporated herein by reference.
10.20 Loan Modification Agreement with Wachovia Bank, dated
September 26, 2006, included with Form 10-Q for the nine months ended
September 30, 2006, filed November 13, 2006, is incorporated herein by
reference.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer.
31
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer.
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
(b) Financial Statements and Financial Statement Schedules
(i) Financial Statements
Reports of Independent Registered Public Accounting Firms.
Consolidated Balance Sheets as of December 31, 2006
and 2005.
Consolidated Statements of Operations for the years
ended December 31, 2006, 2005, and 2004.
Consolidated Statements of Changes in Stockholders'
Equity for the years ended December 31, 2006, 2005,
and 2004.
Consolidated Statements of Cash Flows for the years
ended December 31, 2006, 2005, and 2004.
Notes to Consolidated Financial Statements.
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Stephan Co.
Fort Lauderdale, FL
We have audited the accompanying consolidated balance sheets of The Stephan
Co. and subsidiaries (the "Company") as of December 31, 2006 and 2005, and
the related consolidated statements of operations, changes in stockholders'
equity, and cash flows for the years then ended. Our audits also included
the financial statement schedule listed in the Index at Item 15. These
financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards re-
quire that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
The Company is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of The Stephan
Co. and subsidiaries as of December 31, 2006 and 2005, and the consolidated
results of their operations and their cash flows for the years then ended,
in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
GOLDSTEIN LEWIN & CO.
Certified Public Accountants
Boca Raton, Florida
April 17, 2007
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of The Stephan Co.
Fort Lauderdale, FL
We have audited the accompanying consolidated statements of operations,
changes in stockholders' equity, and cash flows of The Stephan Co. and
subsidiaries (the "Company") for the year ended December 31, 2004. Our
audit also included the financial statement schedule for the year ended
December 31, 2004 listed in the Index at Item 15. These financial
statements and financial statement schedule for the year ended December 31,
2004, are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements and the
financial statement schedule based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
The Company is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we
express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable
basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the Company's results of operations and cash flows
for the year ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America. Also, in
our opinion, such financial statement schedule for the year ended December
31, 2004, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Fort Lauderdale, Florida
September 8, 2005
F-2
(i) Financial Statements
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
ASSETS
2006 2005
___________ ___________
CURRENT ASSETS
Cash and cash equivalents $ 7,064,332 $ 5,602,762
Restricted cash 1,110,000 3,335,557
Accounts receivable, net 1,716,733 1,431,650
Inventories 4,792,357 6,148,267
Income taxes receivable - 22,893
Prepaid expenses
and other current assets 335,429 311,905
___________ ___________
TOTAL CURRENT ASSETS 15,018,851 16,853,034
RESTRICTED CASH 1,206,392 -
PROPERTY, PLANT AND EQUIPMENT, net 1,573,560 1,682,951
DEFERRED INCOME TAXES, net 864,471 -
GOODWILL, net 2,602,802 4,013,458
TRADEMARKS, net 3,069,507 8,364,809
OTHER INTANGIBLE ASSETS, net 76,161 142,185
OTHER ASSETS 2,354,295 1,721,169
___________ ___________
TOTAL ASSETS $26,766,039 $32,777,606
=========== ===========
See notes to consolidated financial statements.
F-3
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
LIABILITIES AND STOCKHOLDERS' EQUITY
2006 2005
___________ ____________
CURRENT LIABILITIES
Accounts payable and
accrued expenses $ 2,215,449 $2,002,728
Current portion of
long-term debt 1,110,000 3,237,500
___________ ___________
TOTAL CURRENT LIABILITIES 3,325,449 5,240,228
DEFERRED INCOME TAXES, net - 1,343,257
LONG-TERM DEBT, less current
maturities 1,110,000 -
___________ ___________
TOTAL LIABILITIES 4,435,449 6,583,485
___________ ___________
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value;
1,000,000 shares authorized; none issued - -
Common stock, $.01 par value;
25,000,000 shares authorized;
4,389,805 shares issued at
December 31, 2006 and 2005 43,898 43,898
Additional paid in capital 17,646,069 17,556,731
Retained earnings 4,640,623 8,593,492
___________ ___________
TOTAL STOCKHOLDERS' EQUITY 22,330,590 26,194,121
___________ ___________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $26,766,039 $32,777,606
=========== ===========
See notes to consolidated financial statements.
F-4
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
2006 2005 2004
___________ ___________ ___________
NET SALES $21,836,315 $22,262,423 $23,950,648
COST OF GOODS SOLD 12,795,314 13,767,127 14,286,280
___________ ___________ ___________
GROSS PROFIT 9,041,001 8,495,296 9,664,368
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 13,497,397 8,766,298 10,259,262
IMPAIRMENT OF GOODWILL 1,410,655 - 1,844,522
___________ ___________ ___________
OPERATING LOSS (5,867,051) (271,002) (2,439,416)
OTHER INCOME(EXPENSE)
Interest income 233,192 127,313 163,921
Interest expense (147,313) (150,173) (91,237)
Royalty and other income 50,000 50,000 332,745
___________ __________ ___________
LOSS BEFORE INCOME TAXES (5,731,172) (243,862) (2,033,987)
INCOME TAX (BENEFIT)/EXPENSE (2,129,487) (71,679) 142,251
___________ __________ ___________
NET LOSS $(3,601,685) $ (172,183) $(2,176,238)
=========== =========== ===========
BASIC AND DILUTED
LOSS PER SHARE $ (.82) $ (.04) $ (.50)
=========== ========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,389,805 4,389,805 4,348,908
=========== ========== ===========
See notes to consolidated financial statements.
F-5
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Common Stock Additional Contingently
____________________ Paid in Retained Returnable
Shares Par Value Capital Earnings Shares
________ _________ ___________ ___________ ___________
Balances,
Jan. 1, 2004 4,410,577 $ 44,106 $18,417,080 $20,387,432 (1,351,563)
Stock options
exercised 104,228 1,042 489,964 - -
Contingently
returnable
shares retired (125,000) (1,250) (1,350,313) - 1,351,563
Dividends paid - - - (9,094,335 -
Net loss - - - (2,176,238) -
_________ _________ __________ __________ __________
Balances,
Dec. 31,2004 4,389,805 43,898 17,556,731 9,116,859 -
Dividends paid - - - (351,184) -
Net loss - - - (172,183) -
_________ ________ ___________ ___________ ___________
Balances,
Dec. 31, 2005 4,389,805 43,898 17,556,731 8,593,492 -
Stock options
granted - - 89,338 - -
Dividends paid - - - (351,184) -
Net loss - - - (3,601,685) -
_________ ________ ___________ __________ ___________
Balances,
Dec. 31, 2006 4,389,805 $ 43,898 $17,646,069 $4,640,623 -
========= ======== =========== ========== ===========
See notes to consolidated financial statements.
F-6
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
2006 2005 2004
___________ ___________ ___________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,601,685) $ (172,183) $(2,176,238)
___________ ___________ ___________
Adjustments to reconcile net loss
to net cash flows provided
by operating activities:
Depreciation 143,062 143,509 136,712
Stock option compensation 89,338 - -
Amortization of deferred
acquisition costs 66,024 74,467 82,121
Write-down of inventories - - 337,215
Compensation expense resulting
from exercise of stock options - - 415,430
Deferred income taxes (2,207,728) (144,859) 355,065
Provision for doubtful accounts 40,455 27,571 55,865
Impairment loss on goodwill
and trademarks 6,705,958 - 2,144,522
Settlement of Colgate-
Palmolive debt - - (417,745)
Changes in operating assets
and liabilities:
Accounts receivable (325,538) 294,029 (364,607)
Inventories 1,355,910 1,016,634 (4,854)
Income taxes receivable/payable 22,893 186,310 (237,473)
Prepaid expenses
and other current assets (23,524) 62,174 410,522
Other assets (633,126) 331,236 815,553
Accounts payable
and accrued expenses 212,721 (163,023) (448,980)
__________ _________ _________
Total adjustments 5,446,445 1,828,048 3,279,346
__________ _________ _________
Net cash flows provided
by operating activities 1,844,760 1,655,865 1,103,108
__________ _________ _________
See notes to consolidated financial statements.
F-7
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
2006 2005 2004
__________ __________ __________
CASH FLOWS FROM INVESTING ACTIVITIES:
Change in restricted cash 1,019,165 1,204,851 1,102,092
Purchase of property, plant
and equipment (33,671) (199,233) (61,608)
_________ _________ __________
Net cash flows provided by
investing activities 985,494 1,005,618 1,040,484
_________ _________ __________
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (1,017,500) (1,110,000) (2,024,528)
Proceeds from exercise of
stock options - - 75,575
Dividends paid (351,184) (351,184) (9,094,335)
___________ __________ __________
Net cash flows used in
financing activities (1,368,684) (1,461,184) (11,043,288)
___________ __________ __________
NET INCREASE/(DECREASE) IN
CASH AND CASH EQUIVALENTS 1,461,570 1,200,299 (8,899,696)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 5,602,762 4,402,463 13,302,159
___________ ___________ ___________
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 7,064,332 $ 5,602,762 $ 4,402,463
=========== =========== ===========
See notes to consolidated financial statements.
F-8
THE STEPHAN CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Supplemental Disclosures of Cash Flow Information:
2006 2005 2004
__________ __________ __________
Interest paid $ 38,950 $ 58,364 $ 190,214
========== ========== ==========
Income taxes paid $ 54,868 $ 69,526 $ 101,188
========== ========== ==========
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
On August 20, 2004, 125,000 contingently returnable shares, carried at
$1,351,563, were retired and Common Stock and Additional Paid in Capital
were reduced by the same amount in the aggregate.
See notes to consolidated financial statements.
F-9
THE STEPHAN CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
NATURE OF OPERATIONS: The Company is engaged in the manufacture,
sale, and distribution of hair and personal care grooming products
principally throughout the United States, and as more fully explained in
Note 9, the Company has allocated substantially all of its business into
three segments, which include professional hair care products and
distribution, retail personal care products and manufacturing.
PRINCIPLES OF CONSOLIDATION: The consolidated financial
statements include the accounts of The Stephan Co. and its wholly-owned
subsidiaries, Foxy Products, Inc., Old 97 Company, Williamsport Barber and
Beauty Supply Corp., Stephan & Co., Scientific Research Products, Inc. of
Delaware, Sorbie Distributing Corporation, Stephan Distributing, Inc.,
Morris Flamingo-Stephan, Inc., American Manicure, Inc. and Lee Stafford
Beauty Group, Inc. (collectively, the "Company"). All significant inter-
company balances and transactions have been eliminated in consolidation.
USE OF ESTIMATES: The preparation of consolidated financial
statements in conformity with accounting principles generally accepted in
the United States of America ("generally accepted accounting principles")
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates and the
differences could be material.
MAJOR CUSTOMERS: There were no sales to any single customer in
excess of 10% of net sales in 2006. The Company performs ongoing credit
evaluations of its customers' financial condition and, generally, requires
no collateral. The Company does not believe that its customers' credit
risk represents a material risk of loss to the Company. However, the loss
of a large customer could have an adverse effect on the Company.
GOODWILL and OTHER INTANGIBLE ASSETS: Goodwill and trademarks
represent the excess of the purchase price over the fair value of
identifiable assets of businesses or brands acquired, respectively, in
transactions accounted for as a purchase. Goodwill and trademarks having
indefinite lives are no longer being amortized and in accordance with
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"), are now subject to periodic testing for
impairment. Deferred acquisition costs that have definite lives are
continuing to be amortized over their estimated useful lives of 10 years.
Goodwill and trademarks of a reporting unit (as defined in SFAS No. 142) are
tested for impairment on an annual basis at a minimum, or as circumstances
dictate. Based upon a valuation analysis of intangible assets for the year
ended December 31, 2006, prepared with the assistance of an independent
valuation firm, an impairment loss was recognized amounting to approximately
$6,706,000. The Company reduced all of the goodwill attributed to the
F-10
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
acquisition of Scientific Research Products, Inc., by approximately
$1,411,000 and all of the trademarks associated with the brands LeKair,
New Era and Frances Denney, in addition to substantially all of the value
assigned to the brands acquired from the Colgate-Palmolive Company, totaling
approximately $5,295,000. The impairment of the trademarks has been included
in Selling, General and Administrative expenses, in accordance with
SFAS No. 142. In 2004, an impairment loss was recorded in the amount of
$2,145,000 in connection with goodwill arising from the purchase of Trevor
Sorbie and trademarks associated with the Stephan Distributing subsidiary.
As a result of the impairment loss, all goodwill associated with the Sorbie
brand was written off (See Note 5).
IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets are reviewed
for impairment whenever events or changes in circumstances warrant, which
may be an indication that the carrying value of the asset may ultimately be
unrecoverable. The Company uses fair value methods to determine the amount
of impairment, if any. If necessary, an impairment loss equal to the
difference between the asset's fair value and its carrying value is
recognized.
STOCK-BASED COMPENSATION: Effective January 1, 2006, the Company
adopted Statement of Financial Accounting Standards No. 123 (revised),
"Share-Based Payment" ("SFAS 123R"), and chose to utilize the modified
prospective transition method. Under this method, compensation costs
recognized at December 31, 2006 relate to the estimated fair value at the
grant date of 75,310 stock options granted subsequent to January 1, 2006 in
accordance with SFAS 123R. Prior to the adoption of SFAS 123R the Company
accounted for stock options in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and recognized no compensation
expense in net income for stock options granted using the intrinsic value
of the grant and had elected the disclosure only provisions of SFAS 123. In
accordance with the provisions of SFAS 123R, options granted prior to
January 1, 2006 have not been restated to reflect the adoption of SFAS 123R.
The required services for awards prior to January 1, 2006 had been rendered
prior to December 31, 2005.
As a result of adopting SFAS 123R on January 1, 2006, the Company's net
income for the year ended December 31, 2006 was reduced as a result of the
Company's recognition of approximately $89,000 of compensation expense
(included in Selling, General and Administrative Expenses). The impact on
basic and diluted earnings per share for the year ended December 31, 2006
amounted to approximately $.01 per share. The Company has used the Black-
Scholes option pricing model to estimate the fair value of stock options
using the following assumptions as of the respective date of grant during
2006:
F-11
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
Life expectancy - Key Employee 10 years
Life expectancy - Outside Director 5 years
Risk-free interest rate 5.2%
Expected volatility 61.1%
Dividends per share 2.1%
Weighted average fair
value at grant date $1.88
The above assumptions are based on a number of factors as follows:
(i) expected volatility was determined using the historical volatility of
the Company's stock price, (ii) the expected term of the options is based
on the period of time that the options granted are expected to be
outstanding, and (iii) the risk free rate is the U.S. Treasury rate
effective at the time of grant for the duration of the options granted.
Compensation cost is recognized on a straight-line basis over the vesting
period.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The estimated fair values of
financial instruments which are presented herein have been determined by
the Company using available market information and recognized valuation
methodologies. However, considerable judgment is required in interpreting
market data to develop estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of amounts the Company
could realize in a current market sale of such instruments.
The following methods and assumptions were used to estimate fair
value:
- the carrying amounts of cash and cash equivalents, receivables and
accounts payable approximate fair value due to their short term
nature;
- discounted cash flows using current interest rates for financial
instruments with similar characteristics and maturity were used to
determine the fair value of notes payable and debt.
As of December 31, 2006 and 2005 there were no significant differences
in the carrying values and fair market values of financial instruments.
REVENUE RECOGNITION: Revenue is recognized when all significant
contractual obligations have been satisfied, which involves the delivery of
the products sold and reasonable assurance as to the collectability of the
resulting account receivable.
SHIPPING AND HANDLING FEES AND COSTS: Expenses for the shipping
and delivery of products sold to customers are recorded as a component of
selling expenses and were $1,141,000, $1,139,000 and $1,227,000, in 2006,
2005 and 2004, respectively, and were included in Selling, General and
Administrative Expenses in the Consolidated Statements of Operations.
PROMOTIONAL AND SALES RETURNS ALLOWANCES: The Company partici-
pates in various promotional activities in conjunction with its retailers
F-12
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
and distributors, primarily through the use of discounts, new warehouse
allowances, slotting allowances, co-op advertising and periodic price
reduction programs. All such costs are netted against sales and amounted to
approximately $211,000, $289,000 and $417,000 for the years ended December
31, 2006, 2005 and 2004, respectively. The allowances for sales returns
and consumer and trade promotion liabilities are established based on the
Company's best estimate of the amounts necessary to settle future and
existing obligations for such items on products sold as of the balance
sheet date. While the Company believes that promotional allowances are
adequate and that the judgment applied is appropriate, amounts estimated to
be due and payable could differ materially from actual costs incurred in
the future.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include
cash, certificates of deposit, U. S. Government issues, and municipal bonds
having maturities of 90 days or less when acquired. The Company maintains
cash deposits at certain financial institutions in amounts in excess of
federally insured limits of $100,000. Cash and cash equivalents held in
interest-bearing accounts as of December 31, 2006 and 2005 were
approximately $6,242,000 and $5,095,000, respectively. At December 31, 2006
and 2005, the Company excluded restricted cash in the amount of
approximately $2,316,000 and $3,336,000, respectively, from the above as
they are pledged as collateral for a bank loan.
INVENTORIES: Inventories are stated at the lower of cost
(determined on the first-in, first-out basis) or market. Direct labor and
overhead costs charged to inventories for the years ended December 31, 2006
and 2005 were approximately $2,574,000 and $2,622,000, respectively. Direct
labor and overhead costs capitalized in inventories as of December 31, 2006
and 2005 were approximately $884,000 and $587,000, respectively.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are
recorded at cost. Routine repairs and maintenance are expensed as
incurred. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets as follows:
Buildings and improvements 15-30 years
Machinery and equipment 5-10 years
Furniture and office equipment 3-5 years
INCOME TAXES: Income taxes are calculated under the asset and
liability method of accounting. Deferred income taxes are recognized by
applying the enacted statutory rates applicable to future year differences
between the financial statement carrying amounts and the tax basis of
existing assets and liabilities. A valuation allowance is recorded when it
is more likely than not that some portion or all of the deferred tax asset
will not be realized.
BASIC AND DILUTED EARNINGS PER SHARE: Basic and diluted earnings
per share are computed by dividing net (loss)/income by the weighted
average number of shares of common stock outstanding. For the years ended
F-13
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
December 31, 2006, 2005 and 2004, the Company had 346,178, 341,116 and
291,822 outstanding stock options, respectively. For the years ended
December 31, 2006, 2005 and 2004, no options were used in the calculation
of net loss per share because their inclusion would be anti-dilutive, and
as such, 4,389,805 shares were used for the calculation of basic and
diluted loss per share for 2006 and 2005 and 4,348,908 shares were used for
2004.
NEW FINANCIAL ACCOUNTING STANDARDS: In February 2007, the FASB issued
SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities" (SFAS 159), which establishes a fair value option under which
entities can elect to report certain financial assets and liabilities at
fair value, with changes in fair value recognized in earnings. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. Management is
currently evaluating the impact SFAS 159 will have on the Company's
financial statements.
In September 2006, the Securities and Exchange Commission staff
published Staff Accounting Bulletin ("SAB") No. 108, "Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements." SAB No. 108 addresses quantifying the
financial statement effects of misstatements, specifically, how the effects
of prior year uncorrected errors must be considered in quantifying
misstatements in the current year financial statements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. The adoption of
SAB No. 108 by our Company in the fourth quarter of 2006 did not have a
material impact on our consolidated financial statements
In July 2006 the FASB issued FASB Interpretation No. 48, ("FIN 48")
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109". FIN 48 requires that we recognize in our financial
statements the impact of a tax position taken or expected to be taken in a
tax return, provided that that position is more likely than not of being
sustained on audit. FIN 48 is effective for fiscal years beginning after
December 15, 2006. We do not anticipate that FIN 48 will have any adverse
effect on our financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement
No. 3", effective for accounting changes and corrections of errors made in
fiscal year 2006 and beyond. In February 2006, the FASB issued SFAS No.
155, "Accounting for Certain Hybrid Financial Instruments, an amendment of
FASB Statements No. 133 and 140", effective for events occurring after the
first fiscal year that begins after September 15, 2006. In March 2006, the
FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets, an
amendment of FASB Statement No. 140", also effective for the first fiscal
year that begins after September 15, 2006. In September 2006, the FASB
issued SFAS No. 157, "Fair Value Measurements", effective for financial
statements issued for fiscal years beginning after November 15, 2007. SFAS
No. 157 defines fair value, establishes a framework for measuring fair
value and expands required disclosures in connection therewith. Also in
F-14
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Retirement Plans", an amendment of FASB
Statements No. 87, 88, 106, and 132(R). The effect of these statements on
the Company's consolidated financial statements will be determined based
upon the nature and significance of future events, if any, that would be
subject to these statements.
NOTE 2. ACCOUNTS RECEIVABLE
Accounts receivable at December 31, 2006 and 2005 consisted of the
following:
2006 2005
__________ __________
Trade accounts receivable $1,856,128 $1,540,303
Less: Allowance for
doubtful accounts (139,395) (108,653)
__________ __________
Accounts receivable, net $1,716,733 $1,431,650
========== ==========
The following is an analysis of the allowance for doubtful accounts
for the year ended December 31:
2006 2005 2004
_________ _________ _________
Balance, beginning of year $ 108,653 $ 91,848 $ 112,924
Provision for doubtful
accounts 40,455 27,571 55,865
Uncollectible accounts
written off, net of recoveries (9,713) (10,766) (76,941)
_________ _________ _________
Balance, end of year $ 139,395 $ 108,653 $ 91,848
========= ========= =========
NOTE 3. INVENTORIES
Inventories at December 31, 2006 and 2005 consisted of the following:
2006 2005
____________ ____________
Raw materials $ 1,457,575 $ 1,692,277
Packaging and components 2,138,017 2,238,763
Work in progress 605,848 454,217
Finished goods 2,872,305 3,402,742
____________ ____________
7,073,745 7,787,999
Less: Amount included
in other assets (2,281,388) (1,639,732)
____________ ____________
Balance, end of year $ 4,792,357 $ 6,148,267
============ ============
F-15
NOTE 3. INVENTORIES (Continued)
Raw materials include surfactants, chemicals and fragrances used in
the production process. Packaging materials include cartons, inner sleeves
and boxes used in the actual product, as well as outer boxes and cartons
used for shipping purposes. Components are the bottles or containers
(plastic or glass), jars, caps, pumps and similar materials that will
become part of the finished product. Finished goods also include hair
dryers, electric clippers, lather machines, scissors and salon furniture.
Included in other assets is inventory not anticipated to be utilized
within one year and is comprised primarily of packaging, components and
finished goods. The Company reduces the carrying value of inventory to
provide for these slow moving goods that includes the estimated costs of
disposal of inventory that may ultimately become unusable or obsolete.
NOTE 4. PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment at December 31, 2006 and 2005 consisted
of the following:
2006 2005
__________ ___________
Land $ 379,627 $ 379,627
Buildings and improvements 2,230,025 2,251,894
Machinery and equipment 1,984,087 1,947,080
Furniture and office equipment 602,099 583,566
__________ __________
5,195,838 5,162,167
Less: accumulated depreciation (3,622,278) (3,479,216)
__________ __________
Balance, end of year $1,573,560 $1,682,951
========== ==========
NOTE 5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLE ASSETS
Since implementing SFAS No. 142, the Company performs annual im-
pairment tests. Based upon a valuation analysis of intangible assets for
the year ended December 31, 2006, prepared with the assistance of an
independent valuation firm, an impairment loss was recognized amounting to
approximately $6,706,000. The Company reduced all of the goodwill
attributed to the acquisition of Scientific Research Products, Inc., by
approximately $1,411,000 and all of the trademarks associated with the
brands LeKair, New Era and Frances Denney, in addition to substantially all
of the value assigned to the brands acquired from the Colgate-Palmolive
Company, totaling approximately $5,295,000. The impairment of the
trademarks has been included in Selling, General and Administrative
expenses. This impairment was due to a decline in sales attributable to
the Retail reporting unit as well as a more conservative approach to
forecasted future sales used in the valuation analysis, particularly as it
relates to the slow acceptance of new products the Company introduced in
the market place.
For the year ended December 31, 2004, it was determined that an
F-16
NOTE 5. GOODWILL, TRADEMARKS AND OTHER INTANGIBLE ASSETS (Continued)
impairment loss of approximately $2,145,000 was necessary. Approximately
$1,845,000 of this impairment was in connection with goodwill arising from
the purchase of the Trevor Sorbie of America line in June 1996 and the
remaining $300,000 was related to the trademarks associated with the
Stephan Distributing ("SDI") subsidiary. This charge was primarily based on
management's estimated fair value of each reporting unit using discounted
present value of cash flows and valuation models as of the test date. The
impairment was a result of the declining sales and an adverse outcome of
litigation within the reporting unit, including the operations of Trevor
Sorbie of America. As a result of the impairment loss, all goodwill
associated with the Trevor Sorbie brand has been written off. Included
in selling, general and administrative expenses in the statement of
operations. is the $300,000 impairment loss related to the SDI trademarks
Other intangible assets can be summarized as follows:
2006 2005
_________ _________
Deferred acquisition costs $ 780,182 $ 934,544
Less: Accumulated amortization (704,021) (792,359)
_________ _________
Balance, end of year $ 76,161 $ 142,185
========= =========
Amortization expense of other intangible assets for 2006, 2005 and
2004 was $66,000, $74,000 and $82,000, respectively. Amortization expense
for the years ended December 31, 2007 and 2008 is anticipated to be as
follows: 2007: $66,000; 2008: $10,000.
NOTE 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 2006 and 2005
consisted of the following:
2006 2005
___________ ___________
Accounts payable $ 515,638 $ 254,863
Accrued marketing expenses 113,768 133,469
Accrued royalty and related
interest payable (Note 10) 931,052 815,711
Accrued payroll and related costs 244,479 410,149
Accrued legal and professional fees 132,067 240,691
Accrued rent and property taxes 140,282 88,299
Other accrued expenses 138,163 59,546
___________ ___________
Balance, end of year $ 2,215,449 $ 2,002,728
=========== ===========
NOTE 7. LONG-TERM DEBT
Long-term debt at December 31, 2006 and 2005 consisted of the
following:
F-17
NOTE 7. LONG-TERM DEBT (Continued)
2006 2005
____________ ____________
1.50% note payable to bank, principal
of $92,500 plus interest due monthly
through December 2, 2008; collateralized
by a security interest in a restricted
cash account of like amount, which
bears interest at 50 basis points below
the interest charged on the note. The
interest rate on the note and the cash
collateral resets annually. $ 2,220,000 $ 3,237,500
___________ ___________
2,220,000 3,237,500
Less: current portion (1,110,000) (3,237,500)
___________ ___________
Long-term debt $ 1,110,000 $ -
=========== ===========
At December 31, 2006, the approximate maturities of long-term debt are
$1,110,000 in 2007 and $1,110,000 in 2008.
NOTE 8. INCOME TAXES
The provision/(benefit) for income taxes is comprised of the following
for the years ended December 31:
2006 2005 2004
___________ ___________ ___________
Current tax:
Federal $ - $ - $ (105,047)
State 75,494 77,128 (107,767)
___________ ___________ ___________
Total current
provision/(benefit) 75,494 77,128 (212,814)
___________ ___________ ___________
Deferred tax:
Federal (2,009,198) (135,767) 220,766
State (195,783) (13,040) 134,299
___________ ___________ ___________
Total deferred
(benefit)/provision (2,204,981) (148,807) 355,065
___________ ___________ ___________
Total (benefit)/provision
for income taxes $(2,129,487) $ (71,679) $ 142,251
=========== =========== ===========
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.
F-18
NOTE 8. INCOME TAXES (Continued)
The net deferred income tax asset/liability in the accompanying
consolidated balance sheets includes deferred tax assets and liabilities
attributable to the following items:
2006 2005
__________ ___________
Accounts receivable allowances $ (29,318) $ (40,886)
Inventory allowance (126,894) (126,894)
Property, plant and equipment 76,099 46,728
Amortization of intangibles (648,199) 2,559,360
State income taxes (96,560) (101,467)
Net operating loss carryover (1,162,039) (954,285)
Interest expense on Sorbie debt (77,950) -
Accrued liabilities and other (39,599) (39,299)
__________ ___________
(2,104,460) 1,343,257
Less: Valuation allowance 1,239,989 -
__________ ___________
Deferred income tax
(asset)/liability, net $ (864,471) $ 1,343,257
========== ===========
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:
2006 2005 2004
______ ______ ______
Amount computed on pretax income (34.0%) (34.0%) (34.0%)
Increase(decrease) in taxes:
State income taxes, net of
federal tax benefit (3.6) (3.5) .8
Goodwill impairment 26.7 - 30.8
Goodwill/Trademarks - 1.3 .2
Change in valuation allowance (.3) - -
Compensation limitations - - 8.1
Privatization transaction costs - - 2.7
Tax exempt interest - (2.4) (1.0)
Other .8 9.3 (.6)
_____ _____ _____
Total income tax (11.2%) (29.3%) 7.0%
===== ===== =====
For the year ended December 31, 2006, the Company had an income tax
valuation allowance of $1,239,989 to provide for the likelihood that the
utilization of the deferred tax asset may not be realized. For the year
ended December 31, 2004, the Company had an income tax valuation allowance
of $122,546 in order to provide for the likelihood that the Company's
charitable contribution carryforward will expire unused. The Company has
net operating loss carryforwards of approximately $3,088,000 for Federal
income tax purposes which expire beginning in 2026 if not utilized.
F-19
NOTE 9. SEGMENT INFORMATION
The Company has identified three reportable operating segments based
upon how management evaluates its business. These segments are
Professional Hair Care Products and Distribution ("Professional"), Retail
Personal Care Products ("Retail") and Manufacturing. The Professional
segment generally has a customer base of distributors that purchase the
Company's hair products and beauty and barber supplies for sale to salons
and barbershops. The customer base for the Retail segment is mass
merchandisers, chain drug stores and supermarkets that sell the product to
the end user. The Manufacturing segment manufactures products for
subsidiaries of the Company, and manufactures private label brands for
customers.
The Company conducts operations primarily in the United States and
sales to international customers are not material to consolidated revenues.
The following tables, in thousands, summarize significant accounts and
balances by reportable segment:
LOSS
NET SALES BEFORE INCOME TAXES
_______________________ __________________________
2006 2005 2004 2006 2005 2004
_______________________ __________________________
Professional $16,415 $17,254 $17,538 $ 1,177 $ 1,012 $(1,801)
Retail 4,281 4,178 5,734 (6,095) (79) 486
Manufacturing 4,670 5,132 5,689 (653) (989) (292)
_______ _______ _______ _______ _______ _______
Total $25,366 $26,564 $28,961 $(5,571) $ (56) $(1,607)
Intercompany
Manufacturing (3,530) (4,302) (5,010) (160) (188) (427)
_______ _______ _______ _______ _______ _______
Consolidated $21,836 $22,262 $23,951 $(5,731) $ (244) $(2,034)
======= ======= ======= ======= ======= =======
INTEREST INCOME INTEREST EXPENSE
______________________ _________________________
2006 2005 2004 2006 2005 2004
______________________ _________________________
Professional $ 117 $ 52 $ 104 $ 131 $ 127 $ 56
Retail 109 66 53 16 18 33
Manufacturing 7 9 7 - 5 2
______ ______ ______ ______ ______ ______
Total $ 233 $ 127 $ 164 $ 147 $ 150 $ 91
====== ====== ====== ====== ====== ======
DEPRECIATION AND
AMORTIZATION TOTAL ASSETS
______________________ _________________
2006 2005 2004 2006 2005
______________________ _________________
Professional $ 88 $ 87 $ 78 $12,345 $11,774
Retail 55 37 43 6,513 14,353
Manufacturing 66 94 98 7,908 6,651
_______ _______ ______ _______ _______
Total $ 209 $ 218 $ 219 $26,766 $32,778
======= ======= ====== ======= =======
F-20
NOTE 9. SEGMENT INFORMATION (Continued)
The accounting policies used for each of the segments are the same as
those used for the Company and are described in the summary of significant
accounting policies in Note 1. Included in Manufacturing net sales are
intercompany sales to related segments, which are generally recorded at
cost plus 10%. Management of the Company evaluates the performance of each
segment based upon results of operations before income taxes, intercompany
allocations, interest and amortization.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company has an employment agreement with its' Chief Executive
Officer ("CEO"). The agreement expires on December 31, 2008, but provides
for the unilateral renewal by the CEO. The contract includes an incentive
bonus award based on consolidated earnings per share in excess of the
applicable base year, as defined in the employment agreement. No bonuses
were payable for the years ended December 31, 2006 and 2005. In July 2005,
the CEO took a voluntary, unilateral reduction in compensation to $540,000.
In accordance with the terms of the employment agreement, this amended base
compensation level is subject to an annual increase of 10% in each of the
remaining years of the contract.
Also, the terms of the waiver of compensation allows the CEO to retain
the right to his original contractual compensation level at the time of the
occurrence of certain specified events relating to a change in control, or
reasonable likelihood of a change in control of the Company, as defined in
the waiver. If it was determined that said change in control existed, the
CEO would be entitled to a payment of approximately $635,000.
The Company was not a party to any non-cancelable operating leases at
December 31, 2006, except for a warehouse lease in Tampa, FL that expires
on July 31, 2008. The minimum annual rental due under this lease is
$158,400 for 2007 and $92,400 for 2008.
Annual rent expense for each of the last three years is as follows:
2006 $599,000
2005 628,600
2004 692,800
Included in rent expense above for the years ended December 31, 2006,
2005 and 2004 is $ 321,000, $229,000 and $273,000, respectively, paid to
Shaheen & Co., Inc., the former owner of Morris Flamingo. Shouky A.
Shaheen, a minority owner of Shaheen & Co., Inc., who owns the building the
Company leases in Danville, Illinois, is currently a member of the Board of
Directors and a significant shareholder of the Company. On May 4, 2005,
the Company entered into a Second Amendment of Lease Agreement (the
"Amendment") for the Danville facility. The Amendment extends the term of
the lease to June 30, 2015, with a five year renewal option, and increases
the annual rental to approximately $303,000. The base rent is adjustable
annually, in accordance with the existing master lease, whose terms,
including a 90-day right of termination by the Company, remain in full
force and effect. In addition, the Company has a purchase option, during
F-21
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
the term of the lease, to purchase the premises at the then fair market
value of the building, or to match any bona fide third-party offer to
purchase the premises.
On July 6, 2005, the landlord notified the Company that its
interpretation of the Amendment differs from that of the Company as to the
existence of the 90-day right of termination. In October 2005, the
landlord filed a lawsuit in the Circuit Court for the 17th Circuit of
Florida in and for Broward County, styled Shaheen & Co., Inc. (Plaintiff) v
The Stephan Co., Case number 05-15175 seeking a declaratory judgment with
respect to the validity of the 90-day right of termination. In addition,
the lawsuit alleges damages with respect to costs incurred and the
weakening of the marketability of the property. This matter is currently
unresolved and the Company is unable, at this time, to determine the
outcome of the litigation. However, if it is ultimately determined that
the early termination provision has been eliminated with the Amendment, the
Company's minimum lease obligation would amount to $303,000 in each of the
years 2007 through 2011 and approximately $1,360,000 thereafter.
In fiscal year 2006, the Company paid $35,500 to Carlson & Lewittes,
P.A. a law firm of which Curtis Carlson, an officer and director of the
Company, is a partner, for legal services rendered to the Company.
Additionally, the Company paid Mr. Carlson $2,000 per month for his
services as Vice-President and Secretary.
In addition to the matters set forth below, the Company is involved in
other litigation arising in the normal course of business. It is the
opinion of management that none of such matters, at December 31, 2006,
would likely, if adversely determined, have a material adverse effect on
the Company's financial position, results of operations or cash flows.
In March 2006, in a case styled Trevor Sorbie International, Plc. v.
Sorbie Acquisition Co. (CASE NO. 05-14908-09), filed in the Circuit Court
of the 17th Judicial Circuit in and for Broward County, Florida, Trevor
Sorbie International, Plc. ("TSI") instituted efforts to collect on a
judgment it has against Sorbie Acquisition Co. ("SAC"). The judgment
derives from an October 25, 2004, Pennsylvania arbitration award in favor
of TSI and against SAC with respect to certain royalties and interest due.
The financial statements for the Company for the year ended December 31,
2006, reflect a liability of approximately $931,000, including interest,
for payment of this judgment. Among other things, the Florida lawsuit
alleges fraud and names as additional defendants The Stephan Co., Trevor
Sorbie of America, Inc. and Sorbie Distributing Corporation. The Company
is vigorously defending this legal action against TSI. The Company
continues to accrue interest on the entire obligation because, due to the
limited discovery taken and the complexities of the issues involved, the
Company cannot predict the outcome of the litigation.
In 1997, the Company's wholly-owned subsidiary, Stephan Distributing,
Inc., acquired several product lines from New Image Laboratories, Inc.
("New Image"). The purchase price included a contingent payment of 125,000
shares of the Company's common stock payable upon the achievement of
F-22
NOTE 10. COMMITMENTS AND CONTINGENCIES (Continued)
certain earnings levels. New Image commenced litigation against the
Company seeking certain purchase price adjustments. The parties reached a
settlement pursuant to a stipulation of settlement and amendments thereto
which provided, among other things, as follows: (i) New Image relinquished
title to 65,000 of the 125,000 shares of the Company's common stock held in
escrow and received 60,000 shares, (subsequently, New Image elected to sell
the Company its 60,000 shares for $285,000), (ii) Stephan was awarded
$44,000 in damages from New Image, (iii) dividends, and interest accrued
thereon, held in the escrow account (approximately $72,000) were
distributed with Stephan receiving 52% of such funds and New Image
receiving 48% of such funds, which was used to satisfy, in part, the award
under (ii) above. As a result of this settlement, the Company recorded an
expense of approximately $285,000 and the amount is reflected as a
reduction of royalty and other income on the consolidated statement of
operations for the year ended December 31, 2004. Also in 2004, the amount
of the contingently returnable shares recorded in the financial statements
of the Company was offset against additional paid in capital when the
shares were retired.
On November 4, 2003, in connection with a "going-private" trans-
action, the Company filed a Preliminary Proxy with the Securities and
Exchange Commission. On August 25, 2004, the Merger Agreement was
terminated and the Acquisition Group withdrew its offer to acquire the
shares of the Company's common stock not owned by it and informed the
Company that it had decided not to pursue such an acquisition. As a result
of the above, the Company incurred termination expenses in the amount of
$158,000 in accordance with the terms of the Merger Agreement, payable to
the Acquisition Group and the amount is included in selling, general and
administrative expenses in the statement of operations for the year ended
December 31, 2004.
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS
1,000,000 shares of preferred stock, $0.01 par value are authorized;
however, no shares have been issued.
In 1990, the shareholders of the Company approved the 1990 Key
Employee Stock Incentive Plan, as amended, and the 1990 Non-Employee
(Outside Directors) Plan, as amended, and in 2000, the shareholders
approved a ten-year extension of both plans. The aggregate number of shares
currently authorized pursuant to the Key Employee Plan, as adjusted for
stock splits and shareholder-approved increases in 1994 and 1997, is
870,000 shares. The number of shares and terms of each grant is determined
by the Compensation Committee of the Board of Directors, in accordance with
the 1990 Key Employee Plan, as amended.
The Outside Directors Plan provides for annual grants, as adjusted for
stock splits, of 5,062 shares to non-employee directors. Such grants are
granted on the earlier of June 30 or the date of the Company's Annual
Meeting of Shareholders, at the fair market value at the date of grant. The
aggregate number of shares reserved for granting under this plan, as
adjusted for stock splits, is 202,500.
F-23
NOTE 11. 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 are exercisable within a maximum of 5-10 years
from the date of grant. Stock option activity for 2006, 2005, and 2004 is
set forth below:
Key Employee Outside
Incentive Avg. Directors Avg.
Plan Price Plan Price
__________________________________________________________________________
Outstanding at December 31, 2003.. 446,330 $ 6.41 101,240 $ 3.82
Granted........................... 50,000 4.32 20,248 4.82
Canceled.......................... - (20,248) 4.18
Exercised......................... (285,500) 3.49 (20,248) 3.73
__________ __________
Outstanding at December 31, 2004.. 210,830 9.87 80,992 3.43
Granted........................... 50,000 4.26 25,310 4.71
Canceled.......................... (10,830) 3.94 (15,186) 4.25
Exercised......................... - -
__________ __________
Outstanding at December 31, 2005.. 250,000 9.00 91,116 3.93
Granted........................... 50,000 3.54 25,310 3.15
Canceled.......................... - (5,062) 3.99
Expired........................... (50,000) 12.88 (15,186) 3.15
__________ __________
Outstanding at December 31, 2006.. 250,000 $ 7.14 96,178 $ 3.86
========== ==========
In the third quarter of 2004, certain officers of the Company
exercised stock options utilizing the "cashless method" of exercise. As
such, the Company recorded compensation expense in the amount of $415,430,
included in selling, general and administrative expenses in the statement
of operations for the year ended December 31, 2004.
The number of shares and average exercise price of options exercisable
at December 31, 2006, 2005 and 2004 were 200,000 shares at $8.04, 200,000
shares at $10.19, and 160,830 shares at $11.59, respectively, for the 1990
Key Employee Stock Incentive Plan and 70,868 at $4.12, 65,806 at $3.89, and
60,744 at $3.73, respectively, for the Outside Directors Plan. At December
31, 2006 and 2005, 620,000 were available for future grants under the terms
of the 1990 Key Employee Stock Incentive Plan and 106,322 shares and
111,384 shares, respectively, were available for future grants under the
terms of the Outside Directors Plan.
The exercise price range of options outstanding and exercisable as of
December 31, 2006 for both the Key Employee Stock Incentive and Outside
Directors plans, the weighted average contractual lives remaining (in
years) and the weighted average exercise price are as follows:
F-24
NOTE 11. CAPITAL STOCK AND STOCK OPTIONS (Continued)
Outstanding Exercisable
____________________________ ___________________
Exercise Number Average Average Number Average
Price Range of shares Life Price of shares Price
_______________ __________ _______ ________ ___________________
$ 3.00 - $ 5.00 246,178 5.97 $ 3.97 170,868 $ 4.22
$10.00 - $13.50 100,000 1.50 $11.78 100,000 $11.78
_________ _________
346,178 270,868
========= =========
F-25
(ii) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
ADVERTISING, PROMOTION and RETURNS ALLOWANCES
2006 2005 2004
_________ _________ _________
Balance, beginning of year $ 101,430 $ 104,659 $ 152,906
Additions 211,380 288,742 417,152
Utilizations 211,542 291,971 465,399
_________ _________ _________
Balance, end of year $ 101,268 $ 101,430 $ 104,659
========= ========= =========
DEFERRED TAX VALUATION ALLOWANCE
2006 2005 2004
__________ _________ _________
Balance, beginning of year $ - $ 122,546 $ 121,747
Additions 1,239,989 - 799
Utilizations/Expirations - 122,546 -
__________ _________ _________
Balance, end of year $1,239,989 $ - $ 122,546
========== ========= =========
F-26
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
April 17, 2007
By: /s/ David A. Spiegel
___________________________________
David A. Spiegel
Principal Financial Officer
Principal Accounting Officer
April 17, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
By: /s/ Frank F. Ferola By: /s/ Shouky Shaheen
______________________________ ____________________________
Frank F. Ferola, Principal Shouky Shaheen, Director
Executive Officer and Director Date: April 17, 2007
Date: April 17, 2007
By: /s/ Curtis Carlson By: /s/ Richard A. Barone
______________________________ ____________________________
Curtis Carlson, Director Richard A. Barone, Director
Date: April 17, 2007 Date: April 17, 2007
By: /s/ William Gross By: /s/ Elliot Ross
______________________________ ____________________________
William Gross, Director Elliot Ross, Director
Date: April 17, 2007 Date: April 17, 2007
33