Summary of STEPHAN CO - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources

As of June 30, 2009, we had cash and cash equivalents of approximately $8.2 million. Our long-term debt was less than $0.5 million and was comprised primarily of that issued to the former owner of Bowman. Cash and cash equivalents increased by $235,000 during the first six months of 2009. The increase was due principally to cash flow from operations of $498,000 exceeding spending for dividends ($170,000), repayment of Bowman debt ($36,000) and treasury stock purchases ($30,000).

We have adequate liquidity and do not foresee the need for additional capital for day-to-day operations in the next twelve months.

Our cash balance will vary with growth or decline in operating income and changes in non-cash, non-debt working capital. Our cash flow will also benefit from the utilization of net operating loss carryforwards eliminating or reducing future federal income tax payments. At December 31, 2008, we had approximately $3.2 million of net operating loss carryforwards to offset future taxable income.

Since mid-1995, we have paid dividends every quarter. In 2004, we paid a special dividend of $2.00 per share, or about $9.0 million.

Beginning in mid-2008, we began the purchase of our stock in the open market. Since then we have purchased treasury stock of $311,000, including $30,000 in 2009.

Cash flow is driven by operating income which we endeavor to manage by 1) keeping expenses low, 2) competitively bidding purchases and freight costs, 3) developing new products, 4) searching out new markets or expanding existing markets through new product offerings to existing customers, 5) updating technology in critical customer service areas, 6) reducing purchases by utilizing existing inventory when possible, 7) increasing selling prices to the extent possible and 8) centralizing administrative functions. Capital expenditures generally are not significant for daily operations.

As the overall economy expands and contracts, or as we gain or lose customers, our cash flow will vary because we have, especially in the Brands Segment, high variable gross margins, and an increase or decrease in this segment could be significant to overall results. We expect soft demand in 2009 due to current economic conditions resulting in the probability of lower operating income. Cash and cash equivalents may be adversely impacted by these events.

Cash may also be used to acquire other related businesses. In 2008, we paid $500,000 as part of the total consideration for all of the outstanding common stock of Bowman Barber and Beauty Supply, Inc., a distributor in Wilmington, NC.

We have no significant off-balance sheet financing arrangements, except for an operating lease related to the Danville, IL warehouse. The annual lease payment is approximately $320,000 subject to CPI changes. The lease is also the subject of a lawsuit referred to in Legal Proceedings, Item 1, Part II of this report on Form 10-Q.

Effective June 3, 2009, the Company's CEO unilaterally reduced his salary by 35%. For the remainder of 2009, this action is expected to result in a decrease in SGA expense of approximately $150,000 relative to his previous contractual salary. See Note 6 to these Condensed Consolidated Financial Statements.

Results of Operations

SECOND QUARTER 2009 v. SECOND QUARTER 2008

Net income increased to $212,000 in the second quarter of 2009 compared to $136,000 in the comparable period of 2008. Earnings per share were $0.05 in 2009 compared to $0.03 in 2008. Revenue for the second quarter of calendar 2009 was $4.4 million compared to $4.3 million in the comparable period of 2008. Expenses declined to $1,778,000 (this amount included Bowman expenses of approximately $200,000) from $1,995,000. The total expense decline, excluding Bowman in 2009, was over $400,000 versus the prior year amount.

Operating income increased $60,000, or 37%, versus the second quarter of 2008. Income before income taxes remained steady from quarter-to-quarter, but net income increased by $76,000, or 56%, due to effect of a lower tax provision. See Note 1.

In our Distributors segment revenue for the second quarter of 2009 exceeded that in the second quarter of 2008 by about $260,000. Distributor revenue in 2009 for Bowman, acquired in August 2008, was approximately $680,000. Bowman's operating income in the second quarter was not significant. In our Brands segment revenue was $130,000 less than that in the second quarter of 2008. Our Distributor and Brands segments represented approximately 77% and 23% of consolidated revenue, respectively.

Gross profit as a percentage of revenue was 45.2% in the quarter ended June 30, 2009 compared to 50.3% in the second quarter of 2008. The lower-margin Distributor segment accounted for a higher proportion of total Company revenue in 2009 than in the second quarter of 2008, largely due to the inclusion of Bowman in 2009. Margins are generally lower in the Distributor segment relative to those in the Brands segment because our branded items are manufactured, but our Distributor items are purchased and resold. The shift in the revenue mix from Brands to Distributors also contributed to the gross profit percentage variance due to the operating leverage inherent in the Brands segment.

The Company's cash is maintained largely in FDIC, non interest-bearing accounts as a precaution in this uncertain economic environment. By doing so, the Company reduces its costs of banking activity and maintains liquidity and safety. If the Company were to invest its cash in interest-bearing, but uninsured, accounts then the annual savings would amount to approximately $60,000. The Company does not believe this modest return from such investing is worth the risk of loss at this point in time. We will continue to monitor the situation and may change our position if market conditions and rates of return improve sufficiently.

During most of 2008 we invested in auction rate securities that we sold, at par, in the fourth quarter of 2008, and the proceeds of those sales are reflected as cash and cash equivalents. In the first quarter of 2008, the auction of these investments, of which we held about $4.0 million, began to "fail," resulting in higher "penalty" interest income rates received by our Company. Consequently, our interest income in the first three quarters of 2008 was, and in our future 2009 Form 10-Q reports will continue to be, comparatively unfavorable to that in 2008.

The Company has a full valuation allowance against its net deferred tax assets at June 30, 2009 and December 31, 2008. We did not record deferred tax expense through the second quarter of 2009 due to net operating loss carryforwards, a portion of which management expects the Company to utilize. Through its continual evaluation of the realizability of its deferred tax assets, the Company concluded that it is more likely than not that a portion of its net operating loss carryforwards tax assets will be realized, given its continued profitability. If not for the full valuation allowance against its deferred tax assets, deferred expense of $130,000 would have been recorded. Total net operating loss carryforwards were approximately $3.2 million as of December 31, 2008.

In accordance with a letter dated April 29, 2009 to the Secretary of the Company, the Chairman of the Board & CEO of the Company, Frank F. Ferola, unilaterally further reduced his base salary by 35%. This reduction took effect June 3, 2009. In July 2005, Mr. Ferola unilaterally first reduced his salary from the amounts set forth in his Employment Agreement with the Company. All other terms and conditions of his Employment Agreement will remain in full force and effect. See Note 6 to these Condensed Consolidated Financial Statements.

YEAR-TO-DATE 2009 v. YEAR-TO-DATE 2008

Net income increased to $381,000 for the six months ended June 30, 2009, compared to $296,000 in the comparable period of 2008. Earnings per share were $0.09 in 2009 compared to $0.07 in 2008. Revenue for the six-month period of calendar 2009 was $9.0 million compared to $8.7 million during the comparable period of 2008. Expenses declined to $3,757,000 (this amount included Bowman expenses of approximately $400,000) from $3,936,000. The total expense decline, excluding Bowman in 2009, was over $550,000 versus the prior year amount.

Operating income for the six-month period increased $55,000, or 16%, over that in the comparable period of 2008. Income before income taxes was less than that in 2008 due to lower interest income. However, net income increased by $85,000, or 29%, due to effect of a lower tax provision. See Note 1.

Our Distributors segment revenue for the first six months of 2009 exceeded that in the comparable period of 2008 by about $580,000. Distributor revenue in 2009 for Bowman, acquired in August 2008, was approximately $1.3 million. Bowman's operating profit was approximately $75,000 for the six months ended June 30, 2009. Our Brands segment revenue was approximately $280,000 less than that in the first six months of 2008.

Gross profit as a percentage of revenue was 46.1% in the six-month period ended June 30, 2009 compared to 49.1% in the comparable period of 2008. The lower-margin Distributor segment accounted for a higher proportion of total Company revenue in 2009 than in the six months of 2008, largely due to the inclusion of Bowman in 2009. Margins are generally lower in the Distributor segment relative to those in the Brands segment because our branded items are manufactured, but our Distributor items are purchased and resold. The shift in the revenue mix from Brands to Distributors also contributed to the gross profit percentage variance due to the operating leverage inherent in the Brands segment.

Contributing to improved earnings, selling, general and administrative expenses ("SGA"), without Bowman in 2009, were nearly 15% lower than those in the comparable period of 2008. Bowman SGA expenses for the six months of 2009 totaled about $400,000. When Bowman's expenses are included in 2009 the condensed consolidated SGA decreased 11% from year-to-year.

We anticipate softness in our Distributor segment in the third quarter of 2009 due primarily to lower beauty school enrollments affecting our Morris Flamingo - Stephan, Inc. subsidiary. We will, however, increase our direct-to-salon marketing efforts with a new campaign for salon-only distribution of our Image and Sorbie brands. Further, Distributor revenue is expected to decline on a relative basis as we cycle the August 14, 2008 Bowman acquisition.