Item 1: Business
General Development of Business
Five Star Products Inc. (the "Company" or "Five Star") is engaged in the wholesale distribution of home decorating, hardware and finishing products. It serves over 3,500 independent retail dealers in twelve states, making Five Star one of the largest distributors of its kind in the Northeast. Five Star operates two state -of -the -art warehouse facilities, located in Newington, CT and East Hanover, NJ. All operations are coordinated from Five Star's New Jersey headquarters. At December 31, 2004 Five Star is a majority owned subsidiary of National Patent Development Corporation ("NPDC").
The Company, which was then 37.5% owned by GP Strategies Corporation ("GPS"), purchased its business from GPS in 1998 in exchange for cash and a $5,000,000 unsecured 8% note payable ("the Note"). In 2002 and 2003, GPS converted $1,000,000 principal amount of the Note into 4,272,727 shares of the Company's common stock. In 2004, the Company, through a tender offer, repurchased approximately 2,628,000 shares of its common stock. The conversion of the Note and the tender offer increased GPS' ownership in the Company to approximately 64%. On July 30, 2004, GPS contributed its ownership interest in Five Star and the Note to National Patent Development Corporation ("NPDC"). On November 24, 2004, GPS completed the spin-off to its shareholders of the common stock of NPDC (the "Spin-Off").
GPS provided legal, tax, business development, insurance and employee benefit administrative services to the Company pursuant to a management services agreement for a fee of up to $10,000 per month ("the Agreement"). The Agreement is automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of the initial term or any renewal thereof. The Agreement was renewed for 2005. The management fee was increased to $25,000 per month effective October 1, 2004. In addition the Company agreed to reimburse GPS $16,666 per month for Jerome I. Feldman's (GPS' Chief Executive Officer) service to the Company effective October 1, 2004. As a result of the Spin-Off, GPS transferred to NPDC the rights and obligations under the Agreement.
In the first quarter of 2000, the Company expanded its sales territory with the addition of an established, dedicated sales force servicing the Mid-Atlantic States, and as far south as North Carolina. This addition to the sales force generates revenues of approximately $9 million annually. The Company services this new territory from its 236,000 square foot East Hanover, New Jersey facility, from which it also services the Northeast, enabling the Company to leverage its fixed costs over a broader revenue base.
The Company offers products from leading manufacturers such as Cabot Stain, William Zinsser & Company, DAP, General Electric Corporation, American Tool, USG, Stanley Tools, Minwax and 3M Company. The Company distributes its products to retail dealers, which include lumber yards, "do-it yourself" centers, hardware stores and paint stores principally in the northeast region. It carries an extensive inventory of the products it distributes and provides delivery, generally within 24 to 72 hours. The Company has grown to be one of the largest independent distributors in the Northeast by providing a complete line of competitively priced products, timely delivery and attractive pricing and financing terms to its customers. Much of the Company's success can be attributed to a continued commitment to provide customers with the highest quality service at reasonable prices.
As one of the largest distributors of paint sundry items in the Northeast, the Company enjoys cost advantages and favorable supply arrangements over the smaller distributors in the industry. This enables the Company to compete as a "low cost" provider. The Company uses a fully computerized warehouse system to track all facets of its distribution operations. The Company has enhanced the sophistication of its warehouse and office facilities to take full advantage of economies of scale, speed the flow of orders and to compete as a low cost distributor. Nearly all phases of the selling process from inventory management to receivable collection are automated and tracked; all operations are overseen by senior management at the New Jersey facility. The Company is able to capitalize on manufacturer discounts by strategically timing purchases involving large quantities.
Management takes a proactive approach in coordinating all phases of the Company's operations. For example, sales managers require all sales representatives to call on customers once every week. Each salesperson transmits his or her orders through the Company's automated sales system, to the IBM AS/400 computer located at the New Jersey facility. The salesperson system combines the ability to scan product codes in the customers' stores and download the information to a laptop computer for final transmission. Based on the floor plan of each warehouse and the location of products therein, the computer designs a pattern for the orders to be picked. The orders are then relayed to the appropriate location and typically picked in the evening. The warehouse
facilities are well-maintained and skillfully organized. A bar-coded part number attached to the racking shelves identifies the location of each of the approximately 23,000 stock keeping units (SKUs). The products are loaded onto The Company's trucks in the evening in the order that they will be unloaded, and are delivered directly to the customers locations the following morning.
Additional information about the Company may be found at www.fivestargroup.com ---------------------
Customers
Five Star's largest customer accounted for approximately 3.9% of its sales in 2004 and its 10 largest customers accounted for approximately 13.4% of such sales. All such customers are unaffiliated and Five Star does not have a long-term contractual relationship with any of them.
Management Information System
All of Five Star's inventory control, purchasing, accounts payable and accounts receivable are fully automated on an IBM AS/400 computer system. In addition, Five Star's software alerts buyers to purchasing needs, and monitors payables and receivables. This system allows senior management to control closely all phases of Five Star's operations. Five Star also maintains a salesperson-order-entry system, which allows the salesperson to scan product and then download the information to a laptop. The laptop contains all product and customer information and interacts with the AS/400.
Purchasing
Five Star relies heavily upon its purchasing capabilities to gain a competitive advantage relative to its competitors. Five Star's capacity to stock the necessary products in sufficient volume and its ability to deliver them promptly upon demand is one of the strongest components of service in the distribution business, and is a major factor in Five Star's success.
Since retail outlets depend upon their distributor's ability to supply products quickly upon demand, inventory is the primary working capital investment for most distribution companies, including Five Star. Through its strategic purchasing decisions, Five Star carries large quantities of inventory relative to its competitors and thus can boast fill ratios of approximately 95%.
All purchasing decisions based on current inventory levels, sales projections, manufacturer discounts and recommendations from sales representatives, are made by the merchandising group, located in New Jersey, in order to coordinate effectively Five Star's activities. In addition to senior management's active involvement, regional sales managers play an extremely critical role in this day-to-day process.
Five Star has developed strong, long-term relationships with the leading suppliers since its predecessor company, J. Leven, was founded in 1912. As a major distributor of paint sundry items, suppliers rely on Five Star to introduce new products to market. Furthermore, suppliers have grown to trust Five Star's ability to penetrate the market. As a result, Five Star is often
called on first by manufacturers to introduce new products into the marketplace. For example, Minwax, Bestt Liebco and Cabot Stain have utilized Five Star to introduce and distribute some of their new product innovations.
Marketing
The do-it-yourself industry relies on distributors to link manufacturer's products to the various retail networks. The do-it-yourself market operates on this two-step distribution process, i.e., manufacturers deal through distributors who in turn service retailers. This occurs principally because most retailers are not equipped to carry sufficient inventory in order to be cost effective in their purchases from manufacturers. Thus, distributors add significant value by effectively coordinating and transporting products to retail outlets on a timely basis. Five Star distributes and markets products from hundreds of manufacturers to all of the various types of retailers from regional paint stores, to lumber yards, to independent paint and hardware stores.
The marketing efforts are directed by regional sales managers. These individuals are responsible for designing, implementing and coordinating marketing policies. They work closely with senior management to coordinate company-wide marketing plans as well as to service Five Star's major multi-state customers. In addition, each regional sales manager is responsible for overseeing the efforts of his sales representatives.
The sales representatives, by virtue of frequent contact with Five Star's customers, are the most integral part of Five Star's marketing strategy. It is their responsibility to generate revenue, ensure customer satisfaction and expand the customer base. Each representative covers an assigned geographic area. The representatives are compensated based solely on commission. Five Star has experienced low turnover in its sales force; most representatives have a minimum of five years' experience with Five Star. Many sales representatives had retail experience in the paint or hardware industry when they were hired by Five Star.
Five Star's size, solid reputation for service, large inventory and attractive financing terms provide sales representatives with tremendous advantages relative to competing sales representatives from other distributors. In addition, the representatives' efforts are strengthened by company-sponsored marketing events. For example, each year in the first quarter, Five Star invites all of its customers to special trade shows for Five Star's major suppliers, so that suppliers may display their products and innovations. Five Star also participates in advertising circular programs in the spring and the fall which contain discount specials and information concerning new product innovations.
Five Star has a history of enhancing its growth through complementary acquisitions which have allowed it to preempt much of its competition as a high-quality, competitively priced distributor.
Industry Dynamics
The Do-It-Yourself Industry
The paint sundry items distribution industry is closely related to the do-it-yourself retail market, which has tended to exhibit elements of counter-cyclicality. In times of recession, consumers tend to spend more on home improvements if they cannot afford to trade up to bigger homes. In times of economic strength, consumers tend to spend heavily in home improvements because they believe they can afford to complete their home improvement projects. According to the National Retail Hardware Association, total retail sales by home improvement retailers are estimated to be $236 billion in 2004 and are projected to grow at a 5.3% compound rate through 2008.
Painting is the quintessential do-it-yourself project. Painting has to be done more frequently than most remodeling jobs, and it is a relatively inexpensive way to update the appearance of a home. For these reasons, the paint and paint sundry items industry tends to be counter-cyclical and a solid growth segment of the do-it-yourself market.
Competition
Competition within the industry is intense. There are large national distributors commonly associated with national franchises such as Ace and TruServ as well as smaller regional distributors, all of whom offer similar products and services. Five Star's customers face stiff competition from Home Depot and Lowe's, which purchase directly from manufacturers and dealer-owned distributors such as Ace and TruServ. Moreover, in some instances manufacturers will bypass the distributor and choose to sell and ship their products directly to the retail outlet. The principal means of competition for Five Star are its strategically placed distribution centers and its extensive inventory of quality, name-brand products. Five Star will continue to focus its efforts on supplying its products to its customers at a competitive price and on a timely, consistent basis. In the future, Five Star will attempt to acquire complementary distributors and to expand the distribution of its line of private-label products sold under the "Five Star" name. Through internal growth and acquisitions, Five Star has already captured a leading share in its principal market, the Northeast. This growth-oriented acquisition strategy of acquiring complementary distributors has allowed Five Star to compete against a substantial number of its competitors. While other paint sundry items distributors sell to the same retail networks as Five Star, they are at a distinct disadvantage due to Five Star's experience, sophistication and size.
Hardware stores that are affiliated with the large, dealer-owned distributors such as Ace also utilize Five Star's services because they are uncomfortable with relying solely on their dealer network. Most cooperative-type distributors lack the level of service and favorable credit terms that independent hardware stores enjoy with Five Star. Five Star effectively competes with the dealer-owned distributors because it provides more frequent sales calls, faster deliveries, better financing terms and a full line of vendors and products to choose from.
Employees
The Company employs approximately 260 people. Management-employee relations are considered good at both of Five Star's warehouse facilities. The Teamsters union represents approximately 94 union employees at the New Jersey warehouse facility. The Connecticut warehouse facility is completely non-unionized. Five Star has never experienced a labor strike at its facilities. Five Star's contract with Local No. 11, affiliated with the International Brotherhood of Teamsters expires on December 20, 2008.
Risk Factors
Competition Could Adversely Affect our Performance
Competition within the do-it-yourself industry is intense. There are large national distributors commonly associated with national franchises such as Ace and TruServ as well as smaller regional distributors, all of whom offer products and services similar to those offered by Five Star. Moreover, in some instances, manufacturers will bypass distributors and choose to sell and ship their products directly to retail outlets. In addition, Five Star's customers face stiff competition from Home Depot, and Lowe's, which purchases directly from manufacturers, and national franchises such as Ace and TruServ. Five Star competes principally through its strategically placed distribution centers and its extensive inventory of quality, name-brand products. Five Star will continue to focus its efforts on supplying its products to its customers at a competitive price and on a timely, consistent basis.
Our subsidiaries' inability to compete successfully would materially adversely affect our business and financial condition.
Changing economic conditions in the United States could harm our business.
Our revenues and profitability are related to general levels of economic activity and employment in the United States. As a result, any significant economic downturn or recession could harm our business or financial condition.
Control by NPDC
The Company is controlled by the Company's principal stockholder, NPDC, whose interest may not be aligned with those of the Company's other stockholders. As of March 15, 2005 NPDC owned approximately 64% of the Company's outstanding common stock. Accordingly, NPDC will be able to influence our management and affairs and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying, discouraging or preventing a change in control and might affect the market price of the Company's common stock. See Notes 8 and 17 to Notes to Consolidated Financial Statements for a description of transactions between the Company and NPDC.
Item 2.
Item 2. Properties
Five Star leases 236,000 square feet in New Jersey, 111,000 square feet in Connecticut, 1,300 square feet of sales offices in New York and 800 square feet in Maryland. Five Star's operating lease for the New Jersey facility expires in March, 2007, and the annual rent is $1,187,000. Five Star's lease for the Connecticut facility expires in February, 2007, and its annual rent is $402,000. The New York sales office pays $19,000 per year in rent and the Maryland office pays $11,000. The Company's White Plains, New York office space is provided by GPS pursuant to the Agreement. GPS, provided legal, tax, business development, insurance and employee benefit administrative services to the Company pursuant to the Agreement for a fee of up to $10,000 per month. The Agreement is automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of the initial term or any renewal thereof. The Agreement was renewed for 2005. The Agreement was amended and the management fee was increased to $25,000 per month effective October 1, 2004. As a result of the Spin-Off, GPS transferred to NPDC its rights and obligations under the agreement.
The facilities leased by the Company are considered to be suitable and adequate for their intended uses and are considered to be well maintained and in good condition.
Item 3.
Item 3. Legal Proceedings
The Company is from time to time subject to litigation or other legal proceedings arising in the ordinary course of business. The Company is not a party to any legal proceeding, the outcome of which is believed by management to have a reasonable likelihood of having any material adverse effect upon the financial condition and operating results of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
Part II
Item 5:
Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters
The following table presents the high and low prices for the Common Stock for 2004 and 2003. The Company's Common Stock, $.01 par value, is quoted on the OTC Bulletin Board, which is operated by the NASDAQ Stock Market.
Quarter High Low
2004 First $.30 $.13 Second $.32 $.21 Third $.30 $.14 Fourth $.45 $.19
2003 First $0.18 $.09 Second $0.19 $.10 Third $0.21 $.09 Fourth $0.20 $.07
The number of shareholders of record of the Common Stock as of March 15, 2005 was 3,559 and the closing price of the Common Stock on the OTC Bulletin Board on that date was $.26. The Company has not declared any cash dividends in 2004 and 2003. The current policy of the Company's Board of Directors is to retain earnings, if any, to finance the operation of the Company's business. The payment of cash dividends on the Common Stock in the future will depend on the Company's earnings, financial condition and capital needs and on other factors deemed pertinent by the Company's Board of Directors.
Equity Compensation Plan Information as of December 31, 2004.
For a description of the material terms of the Company's Non-Qualified Stock Option Plan, see Note 8 in the Notes to the Consolidated Financial Statements.
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share amounts)
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations Overview
Five Star is a publicly held company that is a leading distributor in the United States of home decorating, hardware, and finishing products. Five Star offers products from leading manufacturers in the home improvement industry and distributes those products to retail dealers, which include lumber yards, "do-it yourself" centers, hardware stores and paint stores. Five Star has grown to be one of the largest independent distributors in the Northeast United States by providing a complete line of competitively priced products, timely delivery and attractive pricing and financing terms to its customers.
The following key factors affect Five Star's financial and operation performance:
o its ability to negotiate the lowest prices from its suppliers,
o its ability to increase revenue by obtaining new customers, while maintaining a level fixed cost structure by utilizing its existing warehouses,
o the housing market in general,
o consumers' confidence in the economy,
o consumers' willingness to invest in their homes, and
o weather conditions that are conducive to home improvement projects.
The following key performance measures are utilized by the Company's management to run Five Star's business:
o new U.S. housing starts,
o sales of existing homes,
o sales of high margin products to its customers,
o purchases from each vendor, and
o performance benchmarks used by Home Depot and Lowe's, such as number of stores and square footage, as well as financial benchmarks.
Five Star operates in the Home Improvement market, which has grown in recent years and for which the Home Improvement Research Institute predicts average annual industry growth of nearly 5% for the next several years. Nonetheless, Five Star faces intense competition from large national distributors, smaller regional distributors, and manufacturers that bypass the distributor and sell directly to the retail outlet. The principal means of competition for Five Star are its strategically placed distribution centers and its extensive inventory of quality, name-brand products. In addition, Five Star's customers face stiff competition from Home Depot and Lowe's, which purchase directly from manufacturers. As a result of such competition, while the Home Improvement market has expanded significantly in recent years, Five Star's revenue has not increased at the same rate, and such revenue would have declined
if Five Star had not entered into new geographic sales territories as described below. In spite of this, the independent retailers that are Five Star's customers remain a viable alternative to Home Depot and Lowe's, due to the shopping preferences of and the retailer's geographic convenience for some consumers.
Five Star has continued to expand its sales territory with an addition of a sales force servicing the Mid-Atlantic States, as far south as North Carolina, which has generated additional annual revenues of approximately $9 million since 2000. Five Star services this territory from its existing New Jersey warehouse, enabling Five Star to leverage its fixed costs over a broader revenue base. To further expand, Five Star will attempt to grow its revenue base in the Mid-Atlantic States, to acquire complementary distributors and to expand the distribution of its use of private-label products sold under the "Five Star" name.
Results of Operations
Year Ended December 31, 2004 compared to Year Ended December 31, 2003
The Company recognized income before income taxes of $2 million for the year ended December 31, 2004 as compared to income before income taxes of $1 million for the year ended December 31, 2003. The increase in profitability of $1 million is primarily due to increased gross margin of $1.7 million, mainly offset by an increase in selling, general and administrative expense of $0.5 million
Sales. Sales increased by $6.9 million from $95.1 million in 2003 to $102 million in 2004. The increase was primarily a result of increased sales to the Company's existing customer base. Sales to existing customers have increased mainly due to Five Star offering more product lines for the retailers to stock, as well as Five Star conducting small local trade shows for its customers to create additional sales. Revenue was favorably affected by clement weather in the Northeast during 2004, causing an increase in home improvement projects.
Gross margin. Gross margin of $19.4 million or 19% of sales, in 2004 increased by $1.7 million or 9.4%, when compared to gross margin of $17.7 million, or 18.6% of sales, in 2003. The increase in gross margin dollars was primarily the result of increased sales. The increase in gross margin percentages from 2003 to 2004 were primarily a result of improved purchasing efficiencies and product mix sold, partially offset by increased warehousing costs. The Company includes warehousing costs in Cost of Goods Sold.
Selling, general and administrative. General and administrative expenses increased by $0.6 million or 3% primarily due to increased delivery expenses, salesmen commissions, medical expenses and legal and professional fees.
Interest expense. The increase in interest expense in 2004 of $0.1 million is the result of an increase in average borrowings related to the Company's Loan Agreement, offset by a decrease in average borrowings related to the Note.
Income taxes. The company recognized income tax expense of $0.8 million in 2004 and $0.4 in 2003, at an effective income tax rate of 42% for both years.
Year Ended December 31, 2003 compared to Year Ended December 31, 2002
The Company recognized income before income taxes of $1 million for the year ended December 31, 2003 as compared to income before income taxes of $0.7 million for the year ended December 31, 2003. The increase in profitability of $0.3 million is primarily due to increased gross margin of $1.1 million and other income of $0.5 million, primarily offset by an increase in selling, general and administrative expense of $1.4 million.
Sales. Sales increased by $1 million from $94.1 million in 2002 to $95.1 million in 2003. The slight increase in sales was primarily a result of increased sales to the Company's existing customer base.
Gross margin. Gross margin of $17.7 million or 18.6% of sales, in 2003 increased by $1.1 million or 6.7%, when compared to gross margin of $16.6 million, or 17.7% of sales, in 2002. The increase in gross margin dollars and percentage was primarily the result of increased sales, improved purchasing efficiencies and product mix sold, partially offset by increased warehousing costs. The Company includes warehousing costs in Cost of Goods Sold.
Selling, general and administrative. General and administrative expenses increased by $1.4 million or 10% primarily due to increased marketing expenses, office payroll and medical expenses and computer expense.
Interest expense. The decrease in interest expense in 2003 of $0.1 million is the result of an decrease in interest rates related to the Company's Loan Agreement, as well a decrease in average borrowings related to the Note.
Income taxes. The company recognized income tax expense of $0.4 million in 2003 and $0.3 million in 2003 at an effective income tax rate of 42% in 2003 and 46% in 2002.
Liquidity and Capital Resources
At December 31, 2004, the Company had cash of $4,000 and working capital of $3,578,000, a decrease in cash of $2,000 and a decrease in working capital of $2,310,000 from cash of $6,000 and working capital of $6,068,000 as of December 31, 2003, respectively. The Company believes that cash generated from operations and borrowing availability under existing credit agreements will be sufficient to fund the Company's working capital requirements for at least the next twelve months.
The decrease in working capital in 2004 is a result of the reclassification of the $2,800,000 note payable to NPDC from long-term to short-term debt, primary offset by increased accounts receivable due to increased revenue. The decrease in cash in 2004 was due to cash used in operations of $619,000 and cash used for additions to machinery and equipment of
$275,000; offset by cash provided by financing activities of $892,000, consisting of net proceeds from short-term borrowings of $1,549,000, offset by purchases of treasury stock of $657,000.
On June 20, 2003, the Company's wholly-owned subsidiary, Five Star Group, Inc., obtained a Loan and Security Agreement (the "Loan Agreement") with Bank of America (formerly Fleet Capital Corporation) (the "Lender"). The Loan Agreement has a five-year term, with a maturity date of June 30, 2008. The Loan Agreement, as amended on May 28, 2004, provides for a $28,000,000 revolving credit facility, which allows Five Star Group, Inc. to borrow based upon a formula of up to 55% of eligible inventory and 80% of eligible accounts receivable, as defined therein. The interest rates under the Loan Agreement consist of LIBOR plus a credit spread of 2% (4.28% at December 31, 2004) for borrowings not to exceed $15,000,000 and the prime rate (5.25% at December 31, 2004) for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star Group, Inc. achieves and maintains certain performance benchmarks. At December 31, 2004, approximately $18,234,000 was outstanding under the Loan Agreement and approximately $434,000 was available to be borrowed.
In March 2005, Five Star Group, Inc. amended the Loan Agreement to allow it to increase the maximum amount that can be borrowed under the revolving credit facility to $30,000,000 through June 30, 2005; reverting back to a maximum of $28,000,000 on July 1, 2005.
In connection with the Loan Agreement, Five Star Group, Inc. also entered into a derivative transaction with the Lender on June 20, 2003. The derivative transaction is an interest rate swap and has been designated as a cash flow hedge. Effective July 1, 2004 through June 30, 2008, Five Star Group, Inc. will pay a fixed interest rate of 3.38% to the Lender on notional principal of $12,000,000. In return, the Lender will pay to Five Star Group, Inc. a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the new Loan Agreement is not included in, and will be paid in addition to this fixed interest rate of 3.38%.
On June 17, 2004, Five Star Group, Inc. has also entered into a derivative interest rate collar transaction during the period from July 1, 2004 through June 30, 2008 on notional principal of $12,000,000. The transaction consists of an interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender will pay to Five Star Group, Inc. the difference between LIBOR and 2.25%, on the same notional principal amount. The transaction also consists of an interest rate cap of 5.75%, whereas if LIBOR is above 5.75%, Five Star Group, Inc. will pay to the Lender the difference between LIBOR and 5.75%, on the same notional principal amount.
The interest rate swap and interest rate collar entered into by the Company in connection with the Loan Agreement are being accounted for under SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires all derivatives to be recognized in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is immediately recognized in earnings. Changes
in the fair value of the interest rate swap, which has been designated as a cash flow hedge, were recognized in other comprehensive income. Changes in the fair value of the interest rate collar from June 17, 2004 through December 31, 2004 amount to approximately $19,000, which has been charged to earnings during year ended December 31, 2004.
Contractual Obligations and Commitments
The following table summarizes long-term debt, capital lease commitments, operating lease commitments, purchase commitments and employment agreements as of December 31, 2004 (in thousands):
Application of Critical Accounting Policies
The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Certain accounting policies have a significant impact on amounts reported in the financial statements. A summary of those significant accounting policies can be found in Note 2 to the Company's financial statements included herein.
Among the significant judgments made by management in the preparation of the Company's financial statements are the determination of the allowance for doubtful accounts and adjustments of inventory valuations. These adjustments are made each reporting period in the ordinary course of accounting.
Revenue recognition
Revenue on product sales is recognized at the point in time when the product has been shipped, title and risk of loss has been transferred to the customer, and the following conditions are met: persuasive evidence of an arrangement exists, the price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Allowances for estimated returns and allowances are recognized when sales are recorded.
Valuation of accounts receivable
Provisions for allowance for doubtful accounts are made based on historical loss experience adjusted for specific credit risks. Measurement of
such losses requires consideration of Five Star's historical loss experience, judgments about customer credit risk, and the need to adjust for current economic conditions. The allowance for doubtful accounts as a percentage of total gross trade receivables was 2.1 % and 5.5% as of December 31, 2004 and December 31, 2003, respectively. The Company wrote off approximately $487,000 in uncollectible accounts in 2004.
Recent Accounting Pronouncements
During December 2004, the Financial Accounting Standards Board ("FASB") issued a new standard entitled Statement of Financial Accounting Standards ("SFAS") 123R, Share-Based Payment, which would revise SFAS No. 123, Accounting for Stock Based Compensation, and amend SFAS No. 95, Statement of Cash Flows. Among other items, the new standard would require the expensing, in the financial statements, of stock options issued by the Company. The new standard will be effective July 1, 2005, for calendar year companies. Five Star is currently evaluating the method of adoption of SFAS No. 123R, including the valuation methods and assumptions that underlie the valuation of the awards. As permitted under SFAS No. 123 the Company currently accounts for share-based payments to employees using Accounting Principles Board ("APB") Opinion No. 25 intrinsic value method, and as such, recognizes no compensation cost for employee stock options. Accordingly the adoption of SFAS No. 123R fair value method could have a significant impact on the Company's results of operations, although it will have no impact on the Company's overall financial position. The impact of adoption of SFAS No. 123R cannot be predicted at this time, because it will depend on levels of share-based payments in the future.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment to ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research Bulleting No. 43, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) should be recognized as current period charges. In addition, FAS 151 requires that allocation of fixed production overhead to inventory be based on the normal capacity of the production facilities. The Company is required to adopt FAS 151 beginning January 1, 2006. The Company is currently assessing the impact that FAS 151 will have on its results of operations, financial position or cash flows.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of December 31, 2004, the Company had approximately $6.2 million of variable rate borrowings. The Company estimates that for every 1% fluctuation in general interest rates, assuming debt levels at December 31, 2004, interest expense would vary by $62,000.
The Company is a party to an interest rate swap agreement designated as a cash flow hedge whereby changes in the cash flows of the swap will offset changes in the interest rate payments on the Company's variable-rate revolving loan, thereby reducing the Company's exposure to fluctuations in LIBOR. Changes in the fair value of the interest rate swap are recognized in accumulated other comprehensive income, net of income taxes.
Effective July 1, 2004 through June 30, 2008, Five Star Group, Inc. will pay a fixed interest rate of 3.38% to the Lender on notional principal of $12,000,000. In return, the Lender will pay to Five Star Group, Inc. a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the new Loan Agreement is not included in, and will be paid in addition to this fixed interest rate of 3.38%.
On June 17, 2004, Five Star Group has also entered into a derivative interest rate collar transaction during the period from July 1, 2004 through June 30, 2008 on notional principal of $12,000,000. The transaction consists of an interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender will pay to Five Star Group, Inc. the difference between LIBOR and 2.25%, on the same notional principal amount. The transaction also consists of an interest rate cap of 5.75%, whereas if LIBOR is above 5.75%, Five Star Group, Inc. will pay to the Lender the difference between LIBOR and 5.75%, on the same notional principal amount.
8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm 19
Financial Statements:
Consolidated Balance Sheets - December 31, 2004 and 2003 20
Consolidated Statements of Operations and Comprehensive Income - Years ended December 31, 2004, 2003 and 2002 21
Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2004, 2003 and 2002 22
Consolidated Statements of Cash Flows - Years ended December 31, 2004, 2003 and 2002 23
Notes to Consolidated Financial Statements 24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders of Five Star Products, Inc.:
We have audited the accompanying consolidated balance sheets of Five Star Products Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2003 and the related consolidated statements of operations and comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Five Star Products Inc. and subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 2004, in conformity with accounting principles generally accepted in the Unites States of America.
EISNER LLP New York, New York March 4, 2005
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2004, 2003 and 2002 (in thousands)
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Business and relationship with National Patent Development Corporation
Five Star Products, Inc. (the "Company" or "Five Star") owns 100% of Five Star Group, Inc. which is a wholesale distributor of home decorating, hardware and finishing products in the northeastern United States. At December 31, 2004 the Company is a majority owned subsidiary of National Patent Development Corporation ("NPDC").
The Company, which was then 37.5% owned by GP Strategies Corporation ("GPS"), purchased its business from GPS in 1998 in exchange for cash and a $5,000,000 unsecured 8% note payable ("the Note"). In 2002 and 2003, GPS converted $1,000,000 principal amount of the Note into 4,272,727 shares of the Company's common stock. In 2004, the Company, through a tender offer, repurchased approximately 2,628,000 shares of its common stock. The conversion of the Note and the tender offer increased GPS' ownership in the Company to approximately 64%. On July 30, 2004, GPS contributed its ownership interest in Five Star and the Note to NPDC. On November 24, 2004, GPS completed the spin-off to its shareholders of the common stock of NPDC.
2. Summary of significant accounting policies
Principles of consolidation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Revenue recognition. Revenue on product sales is recognized at the point in time when the product has been shipped, title and risk of loss has been transferred to the customer, and the following conditions are met: persuasive evidence of an arrangement exists, the price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Allowances for estimated returns and allowances are recognized when sales are recorded.
Reclassifications. Certain prior year amounts in the financial statements and notes thereto have been reclassified to conform to 2004 classifications.
Inventory. Inventory is valued at the lower of cost, using the first-in, first-out (FIFO) method, or market. Inventory consists solely of finished products, and includes allocated warehousing costs.
Machinery and equipment. Fixed assets are carried at cost less accumulated depreciation. Major additions and improvements are capitalized, while maintenance and repairs that do not extend the lives of the assets are expensed. Gain or loss, if any, on the disposition of fixed assets is recognized currently in operations. Depreciation is calculated primarily on a straight-line basis over estimated useful lives of the assets.
Shipping and handling costs. Shipping and handling costs are included as a part of selling, general and administrative expense. These cost amounted to $4,756,000, $4,416,000 and $4,441,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Advertising costs. The Company expenses advertising costs as incurred. Advertising expense was $91,000, $57,000 and $57,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Income taxes. Income taxes are provided for based on the asset and liability method of accounting pursuant to Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". Under SFAS No. 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Concentration of credit risk. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of accounts receivable. Sales are made principally to independently owned paint and hardware stores in the northeast United States.
Fair value of financial instruments. The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximate estimated fair values because of short maturities. The carrying value of short term borrowings approximates estimated fair value because borrowings accrue interest which fluctuates with changes in LIBOR. The estimated fair value for the Company's $2,800,000 fixed rate note payable to NPDC and GPS approximated carrying values at December 31, 2004 and 2003, respectively, using calculations based on market rates. Derivative instruments are carried at fair value representing the amount the Company would receive or pay to terminate the derivative.
Derivatives and hedging activities. SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" requires all derivatives to be recognized in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is immediately recognized in earnings. Changes in the fair value of the interest rate swap, which has been designated as a cash flow hedge, were recognized in other comprehensive income. Changes in the fair value of the interest rate collar are recognized in earnings (See Note 3).
Recent Accounting Pronouncements. During December 2004, the Financial Accounting Standards Board ("FASB") issued a new standard entitled Statement of Financial Accounting Standards ("SFAS") 123R, Share-Based Payment, which would revise SFAS No. 123, Accounting for Stock Based Compensation, and amend SFAS No. 95,
Statement of Cash Flows. Among other items, the new standard would require the expensing, in the financial statements, of stock options issued by the Company. The new standard will be effective July 1, 2005, for calendar year companies. Five Star is currently evaluating the method of adoption of SFAS No. 123R, including the valuation methods and assumptions that underlie the valuation of the awards. As permitted under SFAS No. 123 the Company currently accounts for share-based payments to employees using Accounting Principles Board ("APB") Opinion No. 25 intrinsic value method, and as such, recognizes no compensation cost for employee stock options. Accordingly the adoption of SFAS No. 123R fair value method could have a significant impact on the Company's results of operations, although it will have no impact on the Company's overall financial position. The impact of adoption of SFAS No. 123R cannot be predicted at this time, because it will depend on levels of share-based payments in the future. However had the Company adopted SFAS No. 123R in prior periods, the impact of that statement would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share shown below under "Stock-based compensation"
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment to ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research Bulleting No. 43, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) should be recognized as current period charges. In addition, FAS 151 requires that allocation of fixed production overhead to inventory be based on the normal capacity of the production facilities. The Company is required to adopt FAS 151 beginning January 1, 2006. The Company is currently assessing the impact that FAS 151 will have on its results of operations, financial position or cash flows.
Stock-based compensation. The Company has elected to continue to account for its stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board. Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees". Under the provisions of APB No. 25, employee compensation is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock.
Had the Company determined compensation cost based on the fair value method at the grant date for its stock options under SFAS No. 123, the Company's net income and per share amounts would have been changed to the pro forma amounts indicated below (in thousands, except per share amounts):
Year Ended December 31, 2004 2003 2002 ---- ---- ---- Net income - as reported $1,140 $598 $391 Compensation expense net of tax (12) (18) (33) ---- ----- ------- Pro forma net income $1,128 $580 $358 ====== ======== ====
Per share data Basic - as reported $0.08 $0.04 $0.03 Basic - pro forma $0.08 $0.04 $0.03 Diluted - as reported $0.07 $0.04 $0.03 Diluted - pro forma $0.07 $0.04 $0.03
The Company did not grant any options during 2004 and 2003. The weighted-average fair value of options granted in 2002 was approximately $0.08 using the Black-Scholes option-pricing model with the following assumptions.
Volatility 73% Risk -free interest rate 2.52%-4.14% Expected life in years 3 Dividend yield 0%
Earnings per share. Basic earnings per share (EPS) is based upon the weighted average number of common shares outstanding during the period. Diluted EPS is based upon the weighted average number of common shares outstanding during the period assuming the issuance of common shares for all dilutive potential common shares outstanding. For the years ended December 31, 2003 and 2002 options outstanding to purchase approximately 1,530,000 and 1,700,000 shares of common stock, respectively, were not included in the diluted per share computation because their effect would be anti-dilutive.
Earnings per share (EPS) for the years ended December 31, 2004, 2003 and 2002 are computed as follows (in thousands, except per share amounts):
3. Short-term borrowings
In 2003, the Company's wholly-owned subsidiary, Five Star Group, Inc., obtained a Loan and Security Agreement (the "Loan Agreement") with Bank of America Business Capital (formerly Fleet Capital Corporation) (the "Lender"). The Loan
Agreement has a five-year term, with a maturity date of June 30, 2008. The Loan Agreement, as amended on May 28, 2004, provides for a $28,000,000 revolving credit facility, which allows Five Star Group, Inc. to borrow based upon a formula of up to 55% of eligible inventory and 80% of eligible accounts receivable, as defined therein. The interest rates under the Loan Agreement consist of LIBOR plus a credit spread of 2% (4.28% at December 31, 2004) for borrowings not to exceed $15,000,000 and the prime rate (5.25% at December 31, 2004) for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star Group, Inc. achieves and maintains certain performance benchmarks. At December 31, 2004 and 2003, approximately $18,234,000 and $16,685,000 was outstanding under the Loan Agreement and approximately $434,000 and $480,000 was available to be borrowed, respectively. Substantially all of the Company's assets are pledged as collateral for these borrowings. Under the Loan Agreement Five Star is subject to covenants requiring minimum net worth, limitations on losses, if any, and minimum or maximum values for certain financial ratios. As of December 31, 2004 the Company was in compliance with all required covenants.
In March 2005, Five Star Group, Inc. amended the Loan Agreement to allow it to increase the maximum amount that can be borrowed under the revolving credit facility to $30,000,000 through June 30, 2005; reverting back to a maximum of $28,000,000 on July 1, 2005.
In connection with the Loan Agreement, Five Star Group, Inc. also entered into a derivative transaction with the Lender. The derivative transaction is an interest rate swap and has been designated as a cash flow hedge. Effective July 1, 2004 through June 30, 2008, Five Star Group, Inc. will pay a fixed interest rate of 3.38% to the Lender on notional principal of $12,000,000. In return, the Lender will pay to Five Star Group, Inc. a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the new Loan Agreement is not included in, and will be paid in addition to this fixed interest rate of 3.38%. The fair value of the interest rate swap amounted to $105,000 and $122,000 at December 31, 2004 and 2003, respectively and is included in other assets in the accompanying balance sheets.
On June 17, 2004, Five Star Group, Inc. also entered into a derivative interest rate collar transaction during the period from July 1, 2004 through June 30, 2008 on notional principal of $12,000,000. The transaction consists of an interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender will pay to Five Star Group, Inc. the difference between LIBOR and 2.25%, on the same notional principal amount. The transaction also consists of an interest rate cap of 5.75%, whereas if LIBOR is above 5.75%, Five Star Group, Inc. will pay to the Lender the difference between LIBOR and 5.75%, on the same notional principal amount. Changes in the fair value of the collar from June 17, 2004 through December 31, 2004 amount to approximately $19,000, which has been charged to earnings during the year ended December 31, 2004 and is shown as a non-current liability in the accompanying 2004 balance sheet.
4. 401(k) plan
The Company maintains a 401(k) Savings Plan for employees who have completed one year of service. The Savings Plan permits pre-tax contributions to the Savings Plan of 2% to 50% of compensation by participants pursuant to Section 401(k) of the Internal Revenue Code. The Company matches 40% of the participants' first 6% of compensation contributed, not to exceed an amount equivalent to 2.4% of that participant's compensation.
The Savings Plan is administered by a trustee appointed by the Board of Directors of the Company and all contributions are held by the trustee and invested at the participants' directions in various mutual funds. The Company's expense associated with the Savings Plan was approximately $123,000, $125,000 and $110,000 for the years ended December 31, 2004, 2003, and 2002, respectively.
5. Machinery and equipment
Machinery and equipment consist of the following (in thousands):
Depreciation and amortization expense for the years ended December 31, 2004, 2003, and 2002 was $293,000, $287,000, and $267,000, respectively.
6. Related party transactions
(a) Management agreement
GPS provided legal, tax, business development, insurance and employee benefit administrative services to the Company pursuant to a management services agreement for a fee of up to $10,000 per month ("the Agreement"). The Agreement was automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of the initial term or any renewal thereof. The Agreement is renewed for 2005. The management fee was increased to $25,000 per month effective October 1, 2004. In addition the Company agreed to reimburse GPS for $16,666 per month for Mr. Feldman's (GPS' Chief Executive Officer) service to the Company effective October 1, 2004. As a result of the spin-off of NPDC, GPS transferred to NPDC the rights and obligations under the Agreement.
Fees incurred under the Agreement totaled $215,000, $100,000 and $98,000, for the years ended December 31, 2004, 2003 and 2002, respectively, and are included in selling, general and administrative expenses in the consolidated statements of operations. At December 31, 2003, the amount due to GPS under the Agreement which is included in accounts payable and accrued expenses was $257,000. At December 31, 2004, the amount due to NPDC under the Agreement was $37,000, which is included in accounts payable and accrued expenses.
In addition, GPS and NPDC incurred certain expenses on behalf of Five Star, primarily involving insurance, legal and other professional expenses. Five Star
reimbursed GPS and NPDC for such expense, which amounted to approximately $239,000, $338,000 and $98,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
(b) Related party debt
The Company's wholly-owned subsidiary, Five Star Group, Inc., has an unsecured note payable (the "Note") to JL Distributors, Inc., a wholly-owned subsidiary of NPDC following the spin-off of NPDC from GPS on November 24, 2004. The Note, as amended, bears interest at 8%, which is payable quarterly, and matures on June 30, 2005. The Note is subordinated to the indebtedness under the Loan Agreement (see Note 3) according to an Agreement of Subordination & Assignment (the "Subordination Agreement") between Five Star Group, Inc. and JL Distributors, Inc. dated June 20, 2003. The Subordination Agreement permits the annual repayment of principal under certain circumstances. Pursuant to the provisions of the Subordination Agreement, the Company made repayments to GPS in the aggregate amount of $1,200,000 during 2003. In addition, in 2002 and 2003, GPS also exchanged $500,000 principal amount ($1,000,000 in total) of the Note for 2,272,727 and 2,000,000 shares of the Company's common stock, respectively. In connection with the 2003 exchange, in consideration for GPS agreeing to exchange at a price of $0.25 per share, which was at a significant premium to the market price of the Company's common stock on the day prior to the approval of the transaction, the Company agreed to terminate the voting agreement and thereby GPS obtained a controlling financial interest in the Company. The balance of the Note was $2,800,000 as of December 31, 2004.
(c) Other related party transactions
On February 8, 2002, the Company entered into a Consulting and Severance Agreement (the "Agreement") with Richard Grad, the former President and Chief Executive Officer of the Company. Pursuant to the Agreement, Mr. Grad will receive $145,000 per year for consulting services to be rendered to the Company and a severance fee at the rate of $5,000 per year, for a five-year period ending December 31, 2006. In addition, in August, 2002, Mr. Grad was granted options to purchase 150,000 shares of the Company's Common Stock at the quoted market price on the date of grant, which options will vest annually over the term of the Agreement in equal installments. Such options were valued at an aggregate amount of $13,000. The Agreement also provided for the repurchase by the Company of 192,308 shares of the Company's Common Stock held by Mr. Grad for an aggregate purchase price of $25,000. During this five-year period, Mr. Grad is also receiving certain benefits, including medical benefits, life insurance and use of an automobile.
On February 8, 2002, the Company entered into a Consulting and Severance Agreement (the "Agreement") with Cynthia Krugman, the former Controller of the Company. Pursuant to the Agreement, Ms. Krugman received $105,000 per year for consulting services to be rendered to the Company and a severance fee of $5,000 per year, for an eighteen-month period ended June 30, 2003. The Agreement also provided for the repurchase by the Company of 76,923 shares of the Company's Common Stock held by Ms. Krugman for an aggregate purchase price of $10,000. During this period, Ms. Krugman has received certain benefits, including medical benefits. Ms. Krugman is the daughter of Richard Grad.
7. Income taxes
A reconciliation between the Company's tax provision and the U.S. statutory rate follows (in thousands):
- --------------------------------------- -------------- -------------- ---------- Years ended December 31, 2004 2003 2002 - --------------------------------------- -------------- -------------- ---------- - --------------------------------------- -------------- -------------- ---------- Tax at U.S. statutory rate $673 $350 $ 245 State and local taxes net of Federal benefit 135 69 51 Items not deductible 25 23 19 Valuation allowance adjustment - - 1 Other 8 (9) 12 ------ ------ ------ Income taxes $841 $433 $ 328 ==== ==== =====
Under SFAS No. 109, a valuation allowance is provided when it is more likely than not that some portion of deferred tax assets will not be realized. The valuation allowance was unchanged during 2004 and 2003, and increased by $1,000 during 2002.
8. Stock options
On January 1, 1994, the Company's Board of Directors adopted the Five Star Products, Inc. 1994 Stock Option Plan (the "Stock Option Plan"), which became effective August 5, 1994. The Stock Option Plan, as amended provides for 4,000,000 shares of Common Stock to be reserved for issuance, subject to adjustment in the event of stock splits, stock dividends, recapitalizations, reclassifications or other capital adjustments. Unless designated as "incentive stock options" intended to qualify under Section 422 of the Internal Revenue Code, options granted under the Stock Option Plan are intended to be nonqualified options. Options may be granted to any director, officer or other key employee of the Company and its subsidiaries, and to consultants and other individuals providing services to the Company.
The term of any option granted under the Stock Option Plan will not exceed ten years from the date of the grant of the option and, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock of the Company, three years from the date of grant. The exercise price of any option will not be less than the fair market value of the Common Stock on the date of grant or, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock, 110% of such fair market value.
Options granted vest 20% on date of grant with the balance vesting in equal annual installments over four years. At December 31, 2004, the Company had 1,500,000 shares of common stock reserved for future grants under the Stock Option Plan.
Activity relating to stock options granted by the Company:
Number of Weighted-Average Shares Exercise Price Balance at December 31, 2001 2,500,000 0.18 Granted 675,000 0.15 Cancelled (245,000) 0.27 --------- Balance at December 31, 2002 2,930,000 0.16 Cancelled (1,400,000) 0.13 ----------- Balance at December 31, 2003 1,530,000 0.19 Cancelled (430,000) 0.33 ----------- Balance at December 31, 2004 1,100,000 0.14 ========= Exercisable at December 31, 2004 770,000 0.14 =======
The following table summarizes information about the Plan's options at December 31, 2004:
9. Commitments and contingencies
The Company has several noncancellable leases which cover real property, machinery and equipment. Such leases expire at various dates and some of them have options to extend their terms.
Minimum rental obligations under long-term operating leases are indicated in the table below (in thousands). Figures for real property include estimated amounts of supplemental lease obligations, such as pro-rated assessments for property taxes or common-area expenses.
Machinery and Real Property equipment Total ---------- ----------------------- --------------------- ------------- 2005 $ 1,768 $ 434 $ 2,202 2006 1,779 373 2,152 2007 436 366 802 2008 - 302 302 2009 - 38 38 ---------- ----------------------- --------------------- ------------- ---------- ----------------------- --------------------- ------------- Total $ 3,983 $ 1,513 $5,496
During 2004, 2003, and 2002, the Company incurred $2,886,000, $2,914,000 and $2,882,000, respectively, of rental expenses. GPS has guaranteed the leases for the Company's New Jersey and Connecticut warehouses, totaling approximately $1,589,000 per year through the first quarter of 2007.
10. Valuation and Qualifying Accounts
The following is a summary of the allowance for doubtful accounts related to accounts receivable for the years ended December 31 (in thousands):
2004 2003 2002 ---- ---- ---- Balance at beginning of year $ 702 $640 $631 Charged to expense 91 107 438 Uncollectible accounts written off, net of recoveries (487) (45) (429) ----- ----- ---- Balance at end of year $ 306 $702 $640 ===== ==== ====
11. Accounts payable and accrued expenses
Accounts payable and accrued expenses are comprised of the following at December 31, 2004 and 2003 (in thousands):
December 31, 2004 2003 Accounts payable $11,597 $11,477 Accrued expenses 1,313 1,029 Due to NPDC/GPS 37 257 Other 1,557 203 ----- ---------- $14,504 $12,966
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
Selected Quarterly Financial Data (unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2004 and 2003 (in thousands, except per share data):
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
ITEM 9A. Controls and Procedures
"Disclosure controls and procedures" are the controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. These controls and procedures are designed to ensure that information required to be disclosed by an issuer in its Exchange Act reports is accumulated and communicated to the issuer's management, including its principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to the Exchange Act Rule 13a-15(e) as of December 31, 2004. Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective as of the end of the period covered by this report.
During the year ended December 31, 2004, there were no changes in the Company's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Jerome I. Feldman has been Chairman of the Board of the Company since 1994. In 1959 he founded GP Strategies Corporation ("GPS"), a global provider of training and e-Learning solutions. He has been a director of GSE Systems, Inc., ("GSE"), a real-time simulations company since 1994 and Chairman of the Board of GSE since 1997, Chairman of the Board and Chief Executive Officer of NPDC since August 2004 and a director of Valera Pharmaceuticals, Inc. since January 2005. Mr. Feldman is also Chairman of the New England Colleges Fund and a Trustee of Northern Westchester Hospital Foundation. Age 76
Charles Dawson has been President of the Company and of Five Star Group, Inc. ("Five Star") since 2002 and Vice President and a director of the Company since 1999. Since 1993 Mr. Dawson has held several managerial positions with Five Star. Age 49
Bruce Sherman has been Executive Vice President, Sales of the Company and of Five Star since 2002, Vice President and a director of the Company since 1999 and Vice President of Sales of Five Star since 1993. He is a member of the New York and New Jersey Paint and Decorating Association. Age 52
Steven Schilit has been Executive Vice President, Chief Operating Officer of the Company and of Five Star since 2002, Vice President and a director of the Company since 1999 and since 1981 has held several executive positions with Five Star. Age 58
John Moran has been a director of the Company since 2002. He is Chief Executive Officer of GSE and a director of GSE since November 2003 and had been Vice President of GPS since 2001, President and Chief Executive Officer of GP e-Learning Technologies, Inc. from 2000 to 2001 and from 1994 to 2000 he was Group President, Training and Technologies Group of General Physics Corporation. Age 54
Carll Tucker has been a director of the Company since 2002. In 1986 he founded Trader Publications and was its President until 1999, which published The Patent Trader newspaper and various local magazines, newsletters and programs for cultural institutions in Westchester, Putnam and Fairfield counties. Trader Publications was sold to Gannett Corporation in 1999. Mr. Tucker is the author of a weekly newspaper column in the Westchester Patent Trader, "Looseleaves", since 1983. Mr. Tucker is also a Trustee of Northern Westchester Hospital Center and was its Chairman of the Board from 1999-2001. Age 52
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires the Company's officers and directors, and persons who own more than 10% of a registered class of the Company's securities, to file reports of ownership and changes in ownership with the SEC and to furnish copies of such reports to the Company.
Based solely on its review of copies of such reports for 2004, the Company believes that during 2004, all reports applicable to its officers, directors and greater than 10% beneficial owners were filed on a timely basis.
Audit Committee
The Company has established an Audit Committee of the Board of Directors consisting of Carll Tucker. The Board of Directors has determined that Mr. Tucker qualifies as an "audit committee financial expert" under applicable SEC regulations and satisfies the independence requirements of the SEC.
Code of Ethics
The Company has adopted a Code of Ethics for directors, officers, and employees of the Company and its subsidiaries, including but not limited to the principal executive officer, the principal financial officer, the principal accounting officer or controller, or persons performing similar functions for the Company and its subsidiaries. The Code of Ethics and Conduct of Business Policy is available on the Company's website at www.fivestargroup.com. A copy of this Code of Business Conduct and Ethics is also incorporated by reference into this report as Exhibit 14.1. If the Company makes any substantive amendment to the Code of Ethics or grants any waiver from a provision of the Code of Ethics for its executive officers or directors, the Company will disclose the nature of such amendment or waiver on its website at www.fivestargroup.com. The Company will also provide a copy of such Code of Ethics and Code of Business Policy to any person upon written request made to the Company's Secretary in writing to the following address: Five Star Products, Inc., Attn: Secretary, 777 Westchester Avenue, White Plains, NY 10604, with a copy to Five Star Products, Inc., General Counsel at the same address.
Item 11. Executive Compensation
Executive Compensation
The following table and notes present the aggregate compensation paid by the Company's subsidiary, Five Star, to its President and to the Company's other executive officers for services rendered to Five Star in 2004.
SUMMARY COMPENSATION TABLE
Annual Compensation Salary Bonus All Other Name and Principal Position Year ($) ($) ($) - --------------------------- ---- --- --- --- Charles Dawson 2004 251,933 55,000 1,170(1) President 2003 234,018 40,000 695(1) 2002 226,615 20,000 602(1)
Steven Schilit 2004 211,140 55,000 8,181(2) Executive Vice President and 2003 212,027 40,000 5,968(2) Chief Operating Officer 2002 201,475 -0- 5,391(2)
Bruce Sherman 2004 219,013 55,000 6,842(3) Executive Vice President 2003 232,173 40,000 5,748(3) Sales 2002 221,650 20,000 5,115(3)
(1) Consists of executive life insurance premiums.
(2) Consists of $5,200, $4,800 and $4,400 as matching contributions made by the Company to the 401(k) Savings Plan for 2004, 2003 and 2002, respectively, and $2,981, $1,168, and $991 for executive life insurance premiums for 2004, 2003 and 2002, respectively.
(3) Consists of $5,088, $4,800 and $4,400 as matching contributions made by the Company to the 401(k) Savings Plan for 2004, 2003 and 2002 respectively, and $1,754, $948 and $718 for executive life insurance premiums for 2004, 2003 and 2002, respectively.
Option Grants in 2004
No options were granted to the named executive officers in 2004.
Aggregate Option Exercises in 2004 And Fiscal Year-End Option Values
The following table and note contain information concerning the exercise of stock options under the Plan during 2004 and unexercised options under the Plan held at the end of 2004 by the named executive officers. Unless otherwise indicated, options are to purchase shares of Common Stock.
Directors Compensation
During 2004, directors who were not employees of the Company or its subsidiaries received $1,500 for each meeting of the Board of Directors attended, and generally do not receive any additional compensation for service on the committees of the Board of Directors. Employees of the Company or its subsidiaries do not receive additional compensation for serving as directors.
Employment Agreements
Charles Dawson. As of November 28, 2001, Charles Dawson and Five Star Group, Inc. entered into an employment agreement pursuant to which Mr. Dawson is employed as President of the Company for a period commencing January 1, 2002 until December 31, 2005, (the "Employment Term"), unless sooner terminated.
Commencing January 1, 2002, Mr. Dawson's base salary is $225,000, with annual increases of at least 3% effective on the second year of the Employment Term. Mr. Dawson will receive a target bonus of $100,000, calculated based upon the following two components: (1) earnings growth of the Company, and (2) an achievement of certain Company goals, weighted 75% and 25% respectively. Mr. Dawson's target bonus for the years 2004 and 2005, will be $120,000, and $130,000, respectively, which will be determined by components and weighting
factors based upon the goals and objectives of the Company, mutually agreed upon. Pursuant to the employment agreement, the Company granted Mr. Dawson under the Company's option plan, options to purchase 150,000 shares of the Company's Common Stock at an exercise price of $0.14 per share. Such options vest 20% immediately and 20% on each November 28, commencing November 28, 2001 and terminating on November 28, 2005. The Company is also required to provide Mr. Dawson with an automobile.
The Company may terminate the employment agreement for cause which is defined as (i) breach by Mr. Dawson of any of the terms of the employment agreement, provided that the Company has given fifteen days notice prior to termination for any breach of any of the terms of the employment agreement which are capable of cure, (ii) gross neglect by Mr. Dawson of his duties continuing for 30 days after written warning issued to Mr. Dawson setting forth the conduct constituting such gross neglect, (iii) conviction of Mr. Dawson for any felony or any crime involving moral turpitude; (iv) the conviction of Mr. Dawson of any offense involving the property of the Company or any of its affiliates; (v) the commission by Mr. Dawson of any act of fraud or dishonesty; (vi) the engagement by Mr. Dawson in misconduct resulting in serious injury to the Company, or (vii) the physical or mental disability of Mr. Dawson, whether totally or partially, if he is unable to perform substantially his duties for a period of (i) two consecutive months or (ii) shorter periods aggregating three months during any twelve month period, such termination to be effective thirty days after written notice of such decision delivered to Mr. Dawson. If Mr. Dawson is terminated for cause, he shall not be entitled to any compensation, including without limitation, the bonus, if any, after the date of termination for the year in which the termination takes place. If Mr. Dawson's employment is terminated by his death or disability, the Company is required to pay Mr. Dawson his base salary then in effect for the month during which termination occurred, and four months thereafter. In the event that termination occurs more than six months after the start of the then-current contract year, Mr. Dawson shall receive a bonus for that year prorated through the date of termination.
If the Company terminates the employment agreement for any reason, other than those set forth in the employment agreement, the Company is obligated to continue to pay Mr. Dawson's base salary as then in effect for the period commencing from the date of termination and ending on the termination date of the employment agreement and shall only be obligated to pay the Bonus, if any, through the date of termination on a pro rata basis.
Bruce Sherman As of November 28, 2001, Bruce Sherman and Five Star Group, Inc. entered into an employment agreement pursuant to which Mr. Sherman is employed as Executive Vice President, Sales of the Company for a period commencing January 1, 2002 until December 31, 2005, (the "Employment Term"), unless sooner terminated.
Commencing January 1, 2002, Mr. Sherman's base salary is $220,000, with annual increases of at least 3% effective on the second year of the Employment Term. Mr. Sherman will receive a target bonus of $100,000, calculated based upon the following two components: (1) earnings growth of the Company, and (2) an achievement of certain Company goals, weighted 75% and 25% respectively. Mr. Sherman's target bonus for the years 2004 and 2005, will be $120,000, and $130,000, respectively, which will be determined by components and weighting factors based upon the goals and objectives of the Company, mutually agreed
upon. Pursuant to the employment agreement, the Company granted Mr. Sherman under the Company's option plan, options to purchase 150,000 shares of the Company's Common Stock at an exercise price of $0.14 per share. Such options vest 20% immediately and 20% on each November 28, commencing November 28, 2001 and terminating on November 28, 2005. The Company is also required to provide Mr. Sherman with an automobile.
The Company may terminate the employment agreement for cause which is defined as (i) breach by Mr. Sherman of any of the terms of the employment agreement, provided that the Company has given fifteen days notice prior to termination for any breach of any of the terms of the employment agreement which are capable of cure, (ii) gross neglect by Mr. Sherman of his duties continuing for 30 days after written warning issued to Mr. Sherman setting forth the conduct constituting such gross neglect, (iii) conviction of Mr. Sherman for any felony or any crime involving moral turpitude; (iv) the conviction of Mr. Sherman of any offense involving the property of the Company or any of its affiliates; (v) the commission by Mr. Sherman of any act of fraud or dishonesty; (vi) the engagement by Mr. Sherman in misconduct resulting in serious injury to the Company, or (vii) the physical or mental disability of Mr. Sherman, whether totally or partially, if he is unable to perform substantially his duties for a period of (i) two consecutive months or (ii) shorter periods aggregating three months during any twelve month period, such termination to be effective thirty days after written notice of such decision delivered to Mr. Sherman. If Mr. Sherman is terminated for cause, he shall not be entitled to any compensation, including without limitation, the bonus, if any, after the date of termination for the year in which the termination takes place. If Mr. Sherman's employment is terminated by his death or disability, the Company is required to pay Mr. Sherman his base salary then in effect for the month during which termination occurred, and four months thereafter. In the event that termination occurs more than six months after the start of the then-current contract year, Mr. Sherman shall receive a bonus for that year prorated through the date of termination.
If the Company terminates the employment agreement for any reason, other than those set forth in the employment agreement, the Company is obligated to continue to pay Mr. Sherman's base salary as then in effect for the period commencing from the date of termination and ending on the termination date of the employment agreement and shall only be obligated to pay the Bonus, if any, through the date of termination on a pro rata basis.
Steven Schilit As of November 28, 2001, Steven Schilit and Five Star Group, Inc. entered into an employment agreement pursuant to which Mr. Schilit is employed as Executive Vice President and Chief Operating Officer of the Company for a period commencing January 1, 2002 until December 31, 2005, (the "Employment Term"), unless sooner terminated.
Commencing January 1, 2002, Mr. Schilit's base salary is $200,000, with annual increases of at least 3% effective on the second year of the Employment Term. Mr. Schilit will receive a target bonus of $100,000, calculated based upon the following two components: (1) earnings growth of the Company, and (2) an achievement of certain Company goals, weighted 75% and 25% respectively. Mr. Schilit's target bonus for the years 2004 and 2005, will be $120,000, and $130,000, respectively, which will be determined by components and weighting factors based upon the goals and objectives of the Company, mutually agreed upon. Pursuant to the employment agreement, the Company granted Mr. Schilit under the Company's option plan, options to purchase 150,000 shares of the
Company's Common Stock at an exercise price of $0.14 per share. Such options vest 20% immediately and 20% on each November 28, commencing November 28, 2001 and terminating on November 28, 2005. The Company is required also to provide Mr. Schilit with an automobile.
The Company may terminate the employment agreement for cause which is defined as (i) breach by Mr. Schilit of any of the terms of the employment agreement, provided that the Company has given fifteen days notice prior to termination for any breach of any of the terms of the employment agreement which are capable of cure, (ii) gross neglect by Mr. Schilit of his duties continuing for 30 days after written warning issued to Mr. Schilit setting forth the conduct constituting such gross neglect, (iii) conviction of Mr. Schilit for any felony or any crime involving moral turpitude; (iv) the conviction of Mr. Schilit of any offense involving the property of the Company or any of its affiliates; (v) the commission by Mr. Schilit of any act of fraud or dishonesty; (vi) the engagement by Mr. Schilit in misconduct resulting in serious injury to the Company, or (vii) the physical or mental disability of Mr. Schilit, whether totally or partially, if he is unable to perform substantially his duties for a period of (i) two consecutive months or (ii) shorter periods aggregating three months during any twelve month period, such termination to be effective thirty days after written notice of such decision delivered to Mr. Schilit. If Mr. Schilit is terminated for cause, he shall not be entitled to any compensation, including without limitation, the bonus, if any, after the date of termination for the year in which the termination takes place. If Mr. Schilit's employment is terminated by his death or disability, the Company is required to pay Mr. Schilit his base salary then in effect for the month during which termination occurred, and four months thereafter. In the event that termination occurs more than six months after the start of the then-current contract year, Mr. Schilit shall receive a bonus for that year prorated through the date of termination.
If the Company terminates the employment agreement for any reason, other than those set forth in the employment agreement, the Company is obligated to continue to pay Mr. Schilit's base salary as then in effect for the period commencing from the date of termination and ending on the termination date of the employment agreement and shall only be obligated to pay the Bonus, if any, through the date of termination on a pro rata basis.
Item 12. Security Ownership of Certain Beneficial Owners and Management
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of March 15, 2005, with respect to shares of Common Stock which are beneficially owned by (a) each person who owns more than 5% of the Company's Common Stock, (b) each director of the Company, (c) each of the persons named in the Summary Compensation Table and (d) all executive officers and directors of the Company as a group.
Beneficial Ownership
Number of Percentage Name and Address Common Shares of Class
National Patent Development Corporation 9,133,417(1) 63.8% 777 Westchester Avenue White Plains, NY 10604
Jerome I. Feldman 120,000(2) *
Charles Dawson 120,000(3) *
Bruce Sherman 120,000(3) *
Steven Schilit 120,000(3) *
John Moran 120,000(3) *
Carll Tucker 50,000(3) *
All directors and executive officers as a group (6 persons) 650,000(3) 4.1 - -------------- * The number of shares owned is less than one percent of the outstanding shares of Common Stock.
(1) See "Certain Relationships and Related Transactions."
(2) Includes and 120,000 shares of Common Stock issuable upon exercise of currently exercisable stock options held by Mr. Feldman.
(3) Includes 120,000 shares of Common Stock issuable upon exercise of currently exercisable stock options held by each of Messrs. Feldman, Dawson, Sherman, Schilit, Moran, and 50,000 shares of Common Stock issuable upon exercise of currently exercisable stock options held by Mr. Tucker, and 650,000 shares for all executives and officers as a group.
EQUITY COMPENSATION PLAN INFORMATION
The following is information as of December 31, 2004 about shares of Company Common Stock that may be issued upon exercise of options under the Company's Non-Qualified Stock Option Plan. For a description of the material terms of the Company's Non-Qualified Stock Option Plan, see Note 10 to the Notes to the Consolidated Financial Statements included in the Company's Annual Report for the year ended December 31, 2004.
Item 13. Certain Relationships and Related Transactions
On September 30, 1998, the Company purchased its business from GP Strategies Corporation ("GPS"), for approximately $16,500,000 in cash and a five year, 8%, $5,000,000 unsecured promissory note (the "Note"). The maturity of the Note has been extended until June 30, 2005, as amended on March 31, 2004.
On August 2, 2002 the Company entered into a transaction to reduce its long-term debt to GPS. The principal amount of the Note was reduced by $500,000 to $4,500,000. In connection with this debt reduction, GPS received 2,272,727 shares of the Company's common stock. The transaction valued the Company's common stock at $0.22 per share, which was a premium to the open market value at that time. As a result of this transaction, GPS' ownership of the Company increased to approximately 48% from approximately 37% of the Company's outstanding shares of common stock.
On October 8, 2003, GPS exchanged $500,000 principal amount of the Note for 2,000,000 shares of the Company's common stock, reducing the outstanding principal amount of the Note to $3,000,000 (as described below) and increasing GPS' ownership of the Company's common stock to approximately 54% of the then outstanding shares. In consideration for GPS agreeing to exchange the debt for common stock at a conversion price of $0.25 per share, which was more than twice the $0.11 closing market price of the Company's common stock on the day prior to approval of the transaction, the Company agreed to terminate the voting agreement between the Company and GPS. The voting agreement, which by its terms would in any case have terminated on June 30, 2004, provided that GPS (i) would
vote its shares of the Company's common stock so that not more than 50% of the members of the Company's board of directors would be officers or directors of the Company and (ii) would vote on matters other than the election of directors in the same proportion as the Company's other shareholders. The transaction was approved by a Special Committee of Company's board of directors; the Special Committee consisted of an independent non-management director who is unaffiliated with the Company.
On June 20, 2003, GPS entered into an Agreement of Subordination and Assignments (the "Subordination Agreement") with the Company and its lenders that permits the annual repayment of principal on the Note. Pursuant to the provisions of the Subordination Agreement, in 2004 GPS received partial repayment from the Company in the amount of $1,200,000, which along with the exchange transaction described above reduced the outstanding principal amount of the Note from $4,500,000 to $2,800,000. On July 30, 2004, GPS contributed its ownership interest in the Company and the Note to NPDC. On November 24, 2004, GPS completed the spin-off of the common stock NPDC.
On February 6, 2004, the Company announced an issuer tender offer through which it would repurchase up to 5,000,000 shares, or approximately 30% of its common stock currently outstanding, at $0.21 per share, originally set to expire on March 16, 2004. On March 17, 2004, the Company announced that it had increased the price it was offering to pay for the shares in the tender offer to $0.25 per share and extended the offer to March 31, 2004. Based on the final tabulation by the depositary for the tender offer, approximately 2,628,000 shares of common stock were tendered and acquired by the Company. The effect of the tender offer and the exchange transactions described above was to increase GPS' ownership in the Company to approximately 64%.
If, following the tender offer, GPS were to increase its ownership to at least 80% of Five Star's common stock, Five Star would become, for federal tax purposes, part of the affiliated group of which GPS is the common parent. As a member of such affiliated group, Five Star would be included in GPS's consolidated federal income tax returns, Five Star's income or loss would be included as part of the income or loss of the affiliated group and any of Five Star's income so included might be offset by the consolidated net operating losses, if any, of the affiliated group. The agreement between GPS and Five Star also provided that, if Five Star became a member of the affiliated group, GPS and Five Star would enter into a tax sharing agreement pursuant to which Five Star would make tax sharing payments to GPS equal to 80% of the amount of taxes Five Star would pay if Five Star were to file separate consolidated tax returns but did not pay as a result of being included in GPS affiliated group. As a result of the spin-off of NPDC, which held GPS's interest in Five Star, NPDC would enter into such tax sharing agreement in lieu of GPS.
GPS has guaranteed the leases for Five Star's New Jersey and Connecticut warehouses and leases for certain equipment, totaling approximately $1,589,000 per year through the first quarter of 2007. GPS's guarantee of such leases was in effect when the Company's business was conducted by a wholly-owned subsidiary of GPS. In 1998, GPS sold substantially all of the operating assets of the Five Star business to the predecessor corporation of the Company. As part of this transaction, the landlord of the New Jersey and Connecticut facilities and the
lessor of the equipment did not consent to the release of GPS's guarantee. GPS's guarantees have continued after the Spin-Off.
Five Star's White Plains, New York office space is provided by GPS pursuant to the Management Services Agreement described below.
In 2004, Michael Feldman received $17,000 from the Company and in 2003 received $51,000 from the Company. Michael Feldman is the son of Jerome I. Feldman. Jerome I. Feldman, is the Chairman of the Board of the Company. John Moran, the Chief Executive Officer of GSE and a former executive of the GPS is a director of the Company and Andrea D. Kantor, the Vice President and General Counsel of GPS, is also the General Counsel of the Company.
GPS provided legal, tax, business development, insurance and employee benefit administrative services to the Company pursuant to a management services agreement for a fee of up to $10,000 per month ("the Agreement"). The Agreement was automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of the initial term or any renewal thereof. The Agreement was renewed for 2005. The management fee was increased to $25,000 per month effective October 1, 2004. In addition the Company agreed to reimburse GPS for $16,666 per month for Mr. Feldman's (GPS' Chief Executive Officer) service to the Company effective October 1, 2004. As a result of the spin-off of NPDC, GPS transferred to NPDC the rights and obligations under the Agreement.
Fees incurred under the Agreement totaled $215,000, $100,000 and $98,000, for the years ended December 31, 2004, 2003 and 2002, respectively. At December 31, 2003, the amount due to GPS under the Agreement which is included in accounts payable and accrued expenses was $257,000. At December 31, 2004, the amount due to NPDC under the Agreement was $37,000, which is included in accounts payable and accrued expenses.
In addition, GPS and NPDC incurred certain expenses on behalf of Five Star, primarily involving insurance, legal and other professional expenses. Five Star reimbursed GPS and NPDC for such expense, which amounted to approximately $239,000, $338,000 and $98,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Independent Auditors Fees
The following table sets forth the fees billed to the Company for the fiscal years ended December 31, 2004 and 2003 for professional services rendered by the Company's independent auditors, Eisner LLP:
December 31, December 31, 2004 2003 ---- ---- Audit Fees(a)........................$100,000. $108,850 Audit-Related Fees(b)................$.10,000. $ 10,000 Tax Fees 0 -0- All other Fees..........................0..... -0- - ---------- (a) Audit fees consisted principally of fees for the audit of the annual financial statements and reviews of the condensed consolidated financial statements included in the Company's quarterly reports on Form 10-Q and review of registration statements.
(b) Audit-related fees consisted of the audit of the financial statements of the Company's employee benefit plan.
Policy on Pre-Approval of Services Provided by Independent Auditor
Pursuant to the requirements of the Sarbanes-Oxley Act of 2002, the terms of the engagement of Eisner LLP are subject to specific pre-approval policies of the Audit Committee. All audit and permitted non-audit services to be performed by Eisner LLP require pre-approval by the Audit Committee in accordance with pre-approval policies established by the Audit Committee. The procedures require all proposed engagements of Eisner LLP for services of any kind be directed to the Company's General Counsel and then submitted for approval to the Audit Committee prior to the beginning of any service.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following financial statements are included in Part II, Item 8: