UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-K
 
 (Mark
One)
 x
              ANNUAL
      REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
fiscal year ended December 31, 2007
 
 o
              TRANSITION
      REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
transition period from ________ to _______
 
 Commission
File Number 333-78252
 
 FIVE
STAR PRODUCTS, INC.
 (Exact
Name of Registrant as Specified in Its Charter)
 
 Delaware
              
              13-3729186(State
      or Other Jurisdiction of
                Incorporation
      or Organization)
              
              IRS
      Employer Identification
                Number)
 
 10
      East 40th Street, Suite 3110, New York,
                NY
      10016
 
 (646)
      742−1600
 
   Securities
      registered pursuant to Section 12(b) of the Act:
              NoneSecurities
      registered pursuant to Section 12(g) of the Act:
              Common
      Stock, $0.01 Par Value
                (Title
      of Class)
  Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes o   No
x
  
 
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.  Yes o   No
x
  Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes  x      No
o
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large
      accelerated filer
              o
              Accelerated
      filer
              oNon-accelerated
      filer
                (Do
      not check if a smaller reporting company)
              o
              Smaller
      reporting company
              x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes o   No
x
  The
aggregate market value of the registrant’s common stock held by non-affiliates
of the registrant, computed by reference to the price at which the common stock
was last sold, or the average bid and asked price of such common stock, as of
the last business day of the registrant’s most recently completed second
quarter, is $3,149,000
 
 
 As of
March 16, 2008, 16,509,577 shares of the registrant’s common stock were
outstanding.
  Certain
information omitted from Part III of this report is incorporated by reference
into Part III of this report from the registrant’s definitive Proxy Statement
for its 2008 Annual Meeting of Shareholders or by an amendment to this report on
Form 10-K/A to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this
report.
  
 
 TABLE OF CONTENTS
 
 PagePART
      IITEM 1.
                Business
                
                
                1ITEM 1A.
                Risk Factors
                
                
                6ITEM 1B.
                Unresolved Staff Comments
                
                
                7ITEM 2.
                Properties
                
                
                7ITEM 3.
                Legal Proceedings
                
                
                8ITEM 4.
                Submission of Matters to a Vote of Security
      Holders
                
                
                8PART
      IIITEM 5.
                Market for the Registrant’s Common Equity, Related Stockholder
      Matters and Issuer
                  Purchases of Equity Securities
                
                
                9ITEM 6.
                Selected Financial Data
                
                
                9ITEM 7.
                Management’s Discussion and Analysis of Financial Condition and
      Results of Operations.
                
                
                10ITEM 7A.
                Quantitative and Qualitative Disclosures About Market
      Risk
                
                
                16ITEM 8.
                Financial Statements and Supplementary Data
                
                
                17ITEM 9.
                Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                
                
                37ITEM 9A.
                Controls and Procedures
                
                
                37ITEM 9B.
                Other Information.
                
                
                38PART
      IIIITEM 10.
                Directors, Executive Officers and Corporate
      Governance
                
                
                38ITEM 11.
                Executive Compensation.
                
                
                38ITEM 12.
                Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
                
                
                38ITEM 13.
                Certain Relationships and Related Transactions, and Director
      Independence
                
                
                38ITEM 14.
                Principal Accounting Fees and Services
                
                
                38PART
      IVITEM 15.
                Exhibits, Financial Statement Schedules
                
                
                39SIGNATURES
                
                
                40
  
  
  Cautionary
Statement Regarding Forward-Looking Statements
  This
Annual Report on Form 10-K contains “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). The Private Securities Litigation Reform Act of
1995 provides a “safe harbor” for forward looking statements. Forward-looking
statements are not statements of historical facts, but rather reflect our
current expectations concerning future events and results. The words “may,”
“will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “could,”
“project,” “predict,” “expect,” “estimate,” “continue,” and “intend,” as well as
other similar words and expressions of the future, are intended to identify
forward-looking statements.
  These
forward-looking statements generally relate to our plans, objectives and
expectations for future events and include statements about our expectations,
beliefs, plans, objectives, intentions, assumptions and other statements that
are not historical facts. These statements are based upon our opinions and
estimates as of the date they are made. Although we believe that the
expectations reflected in these forward-looking statements are reasonable, such
forward-looking statements are subject to known and unknown risks and
uncertainties that may be beyond the our control, which could cause actual
results,  performance and achievements to differ materially from
results, performance and achievements projected, expected, expressed or implied
by the forward-looking statements. While we cannot assess the future impact that
any of these differences could have on our business, financial condition,
results of operations and cash flows or the market price of shares of our common
stock, the differences could be significant. You are cautioned not to unduly
rely on such forward-looking statements when evaluating the information
presented in this report.
  Examples
of events that could cause actual results to differ materially from historical
results or those anticipated, expressed or implied include, without limitation,
the loss of our key personnel, including members of our executive management
team; increased competition; changes in the economic climate and employment in
the market areas in which we operate; and the economic impact of any future
terrorist threats and attacks, acts of war or threats thereof and the response
of the United States to any such threats and attacks. Although we have taken
certain steps to mitigate any negative effect of the aforementioned items,
significant unfavorable changes could severely impact the assumptions used and
have an adverse effect on profitability.
  Additional
information concerning the factors that could cause actual results to differ
materially from those in the forward-looking statements is contained in Item 1.
“Business”, Item 7. “Management’s Discussion and Analysis of Financial Condition
and Results of Operations”, and elsewhere in this Annual Report on Form 10-K and
in our other filings with the Securities and Exchange Commission (the
“SEC”).  We undertake no obligation to publicly revise any
forward-looking statements or cautionary factors, except as required by
law.
  PART
I
  ITEM
1.  Business.
  General
Development of Business
  Five Star
Products Inc. (the “Company”, “we”, “our”, 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 also
services the Mid-Atlantic States, as far south as North Carolina. Five Star
operates two distribution centers, located in Newington, Connecticut and East
Hanover, New Jersey. All operations are coordinated from Five Star’s New Jersey
headquarters. At December 31, 2007, Five Star is a majority owned subsidiary of
National Patent Development Corporation (“NPDC”), which as of December 31, 2007
owns 57% of the Company’s common stock. At March 25, 2008, NPDC owned
approximately 76.4% of the Company’s then outstanding common stock (see Note 14
to the Consolidated Financial Statements).
  1
  The
Company currently has outstanding a $2,800,000 unsecured promissory note (the
“Promissory Note”) held by a wholly-owned subsidiary of NPDC. The Promissory
Note originally bore interest at a rate of 8% per annum, payable quarterly, and
matured on June 30, 2005. On June 30, 2005, the Company and NPDC agreed to
extend the Promissory Note for a one-year term maturing on June 30, 2006. In
consideration for NPDC extending the Promissory Note, the Company paid NPDC a
fee of $28,000, representing one percent of the Promissory Note’s then
outstanding balance. In addition, the interest rate on the Promissory Note was
increased to 9% per annum. On July 28, 2006, the Company and NPDC agreed to
extend the Promissory Note for a further one-year term maturing on June 30,
2007. In consideration for NPDC further extending the Promissory Note, during
July 2006, the Company paid NPDC a fee of $28,000, representing one percent of
the Promissory Note’s outstanding balance. The interest rate on the Promissory
Note remained at 9% per annum.
  On March
2, 2007, the Company entered into an amendment to the Promissory Note with NPDC
(the “March 2007 Amendment”). Pursuant to the March 2007 Amendment, the maturity
date of the Promissory Note was further extended from June 30, 2007 to June 30,
2009; the interest rate on the Promissory Note remains at 9% per annum. In
addition, the Promissory Note and any unpaid accrued interest is convertible, in
whole or in part, at NPDC’s option into shares of the Company’s common stock at
a price of $0.40 per share, subject to adjustment for stock splits, stock
dividends, combinations, reorganization and other similar recapitalizations. The
Company no longer has the right to prepay the Promissory Note prior to
maturity.
  NPDC
provides finance, tax, business development, insurance and employee benefit
administration services to the Company for a fee that is currently, and was from
April 2007 through December 2007 $40,000 per month. The fee for the three months
ended March 31, 2007 was approximately $28,000 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 any renewal thereof.
  On April
5, 2007, the Company acquired substantially all the assets (except “Excluded
Assets” as defined) and assumed the Assumed Liabilities (as defined) of
Right-Way Dealer Warehouse, Inc. (“Right-Way”) pursuant to the terms of a
definitive asset purchase agreement, dated as of March 13, 2007 (the
“Agreement”), with Right-Way for approximately $3,200,000 in cash and the
assumption of liabilities in the approximate amount of $50,000. Transaction
costs of $200,000 were incurred by the Company.  The assets consisted
primarily of approximately $1,186,000 of accounts receivable at fair value and
approximately $2,213,000 of inventory at fair value. The acquisition included
all of Right-Way’s Brooklyn Cash & Carry business and
operations
  Upon
closing of the transaction, the Company leased a warehouse at which the Brooklyn
Cash & Carry business is conducted from an affiliate of the principal of
Right-Way, with an option to purchase the warehouse, and a wholly-owned
subsidiary of the Company also entered into an employment agreement with Ronald
Kampner, the principal of Right-Way.
  2
  The
Company offers products from leading manufacturers such as Valspar/Cabot Stain,
William Zinsser & Company, DAP, General Electric Corporation, Newell/Irwin,
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. 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.
  Customers
  Our
largest customer accounted for approximately 5.9% of our sales in 2007 and our
10 largest customers accounted for approximately 20% of sales. All such
customers are unaffiliated and we do not have a long-term contractual
relationship with any of them.
  Management
Information System
  All of
our inventory control, purchasing, accounts payable and accounts receivable are
fully automated on an IBM iSeries computer system. In addition, our software
alerts buyers to purchasing needs, and monitors payables and receivables. This
system allows senior management to control closely all phases of our operations.
We also maintain a salesperson-order-entry system, which allows the salesperson
to scan product information and then download the information to a hand held
device. The hand held device contains all product and customer information and
interacts with the iSeries.
  Purchasing
  We rely
heavily upon our purchasing capabilities to gain a competitive advantage
relative to our competitors. Our capacity to stock the necessary products in
sufficient volume and its ability to deliver them promptly upon demand is an
essential component of our service, and a major factor in our
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 our strategic
purchasing decisions, we carry large quantities of inventory that support 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 effectively
coordinate our activities. In addition to senior management’s active
involvement, regional sales managers play an extremely critical role in this
day-to-day process.
  We have
developed strong, long-term relationships with the leading suppliers since our
predecessor company, J. Leven, was founded in 1912. As a major distributor of
paint sundry items, suppliers rely on us to introduce new products to market.
Furthermore, suppliers have grown to trust our ability to penetrate the market.
As a result, we are often called on first by manufacturers to introduce new
products into the marketplace.
  3
  Marketing
  The
do-it-yourself industry relies on distributors to link manufacturers’ products
to the various retail networks. The do-it-yourself market operates on this
two-step distribution process, 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 our 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 customers, are the most
integral part of our 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.
  Our size,
solid reputation for service, large inventory and attractive financing terms
provide sales representatives with advantages relative to competing sales
representatives from other distributors. In addition, the representatives’
efforts are supported 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.
  4
  Industry
Dynamics
  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. Five Star competes 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. 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
significant share in its principal market, the Northeast United
States.
  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.
  Patents,
Trademarks and other Intellectual Property
  Except
for our line of private-label products, we do not have any material patents,
trademarks or other intellectual property. We intend to expand the distribution
of our line of private-label products sold under the “Five Star”
name.
  Environmental
Matters and Governmental Regulations
  Our
activities may subject us to federal, state and local environmental laws and
regulations and OSHA regulations. We believe that we are in compliance in all
material respects with such environmental laws and regulations.
  Employees
  The
Company employs 237 people, all of which are full time. The Company considers
management-employee relations to be good at both of Five Star’s warehouse
facilities. The Teamsters union represents approximately 120 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.
  5
  ITEM 1A.  Risk
Factors.
  Set forth
below are risks and uncertainties that could cause the Company's actual results
to differ materially from the results contemplated by the forward-looking
statements contained in this report and other public statements made by the
Company. You are strongly urged to carefully consider the cautionary language
and risks set forth below.
  The
leases for our Connecticut and New Jersey warehouse facilities may expire and,
under certain circumstances, the lease for our Connecticut warehouse facility
may be canceled by the landlord prior to expiration.
  The
Company's leases for its Connecticut and New Jersey facilities expire in the
first quarter of 2009 and 2010, respectively. The landlord at our Connecticut
facility has the option to cancel the lease if there is a signed contract to
sell the building upon six months written notice. Exercise by the landlord of
the option and our inability to enter into a new lease under favorable terms
could have an adverse impact on our business.
  The
loss of our key personnel, including our executive management team, could harm
our business.
  Our
success is largely dependent upon the experience and continued services of our
executive management team and our other key personnel. The loss of one or more
of our key personnel and a failure to attract or promote suitable replacements
for them may adversely affect our business.
  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 which 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.
  Adverse changes in general business
conditions in theUnited
Statesand worldwide may
adversely affect our results of operations and financial
condition.
 Adverse
changes in general business conditions in the United States and worldwide may
reduce the demand for some of our products and adversely affect our results of
operations and financial condition. Higher inflation rates, interest rates, tax
rates and unemployment rates, higher labor and healthcare costs, recessions,
changing governmental policies, laws and regulations, and other economic factors
that adversely affect the demand for our home decorating, hardware and finishing
and related products could adversely affect our results of operations and
financial condition.
  Economic downturns in cyclical
segments of the economy may reduce the demand for some of our products and
adversely affect our sales and earnings.
  Our business involves the
sale of home decorating, hardware and finishing and related products to segments
of the economy that are cyclical in nature, particularly segments relating to
construction, housing and manufacturing. Our sales to these segments are
affected by the levels of discretionary consumer and business spending in these
segments. During economic downturns in these segments, the levels of consumer
and business discretionary spending may decrease. This decrease in spending will
likely reduce the demand for some of our products and adversely affect our sales
and earnings.
  6
  We
are controlled  by NPDC, which owns a majority of our outstanding
stock.
  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 December 31, 2007, NPDC owned 57% and beneficially owned approximately 70% 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 Note 6 to the Consolidated
Financial Statements for a description of transactions between the Company and
NPDC. In addition, John C. Belknap, our President and Chief Executive Officer,
is a director and officer of NPDC and Ira Sobotko, our Senior Vice President of
Finance is an officer of NPDC.  At March 25, 2008, NPDC increased its
actual ownership to 76.4% and its beneficial ownership to 83.5% (See Note 14 to
the Consolidated Financial Statements).
  ITEM 1B. Unresolved Staff
Comments.
  None
  ITEM 2.
Properties.
  Five Star
leases 236,000 square feet in New Jersey, 98,000 square feet in Connecticut,
1,300 square feet of sales offices in New York. GP Strategies Corporation
(“GPS”) has guaranteed the leases for our New Jersey and Connecticut warehouses,
having annual rentals of approximately $1,600,000 and expiring in the first
quarter of 2009. In February 2008, we extended the lease for the New Jersey
warehouse for 12 months to March 31, 2010.  In addition, the lease for
the New Jersey warehouse will no longer be guaranteed by GP Strategies, but will
be guaranteed by NPDC.  The landlord at our Connecticut facility has
the option to cancel the lease if there is a signed contract to sell the
building upon six months written notice. On September 20, 2006 we renegotiated
the New York sales office lease terms with the lessor. The terms are month to
month with a monthly base rent of $ 1,968 for the period October 2006 through
March 2007 and a monthly base rent of $ 2,028 for the period April 2007 through
March 2008. Except as described above, the current 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.
  On April
5, 2007, the Company, as Tenant, entered into the Agreement of Lease with
Kampner Realty, LLC, as Landlord, (the “Lease”) to lease a 40,000 square foot
warehouse located at 1202 Metropolitan Avenue, Brooklyn, New York, as part of
the Company’s acquisition of substantially all the assets of Right-Way. The
Lease has an initial term of five (5) years with two (2) successive five-year
renewal options and with an annual lease rent of $325,000 subject to adjustment
as provided in the Lease. The Company also has an option to purchase the
premises at any time during the initial term of the Lease for a purchase price
equal to the average of the appraisals of the premises undertaken by appraisers
retained by the Company and the landlord, Kampner Realty, LLC respectively,
after the closing of the transaction.  Kampner Realty, LLC is owned by
Ronald Kampner, who was hired and employed by a wholly-owned subsidiary of the
Company as part of the Company’s acquisition of Right-Way.  Ronald
Kampner was the principal owner and operator of Right-Way.
  7
  On June
11, 2007, the Company entered into an Amendment to the Lease which memorialized
that the Company’s purchase price for the premises is $7,750,000, the average of
the appraisals, subject to an annual 3% adjustment as provided in the
Lease.
  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.  Submission
of Matters to a Vote of Security Holders.
  The
Company’s Annual Meeting of Shareholders (the “Annual Meeting”) was held on
December 20, 2007.
  There
were present at the Annual Meeting in person or by proxy shareholders holding an
aggregate of 15,441,903 shares of common stock of a total number of 16,509,577
shares of common stock issued, outstanding and entitled to vote at the Annual
Meeting.
  At the
Annual Meeting, each of S. Leslie Flegel, John C. Belknap, Harvey P. Eisen,
Bruce Sherman and Carll Tucker was re-elected as a director of the
Company.  The results of the voting on the election of directors were
as follows:
  
 Elected
      Directors
              
              Votes
      For
              
              Votes
      WithheldS.
      Leslie Flegel
              
              15,367,088
              
              74,815John
      C. Belknap
              
              15,367,338
              
              74,565Harvey
      P. Eisen
              
              15,366,804
              
              75,099Bruce
      Sherman
              
              15,367,254
              
              74,649Carll
      Tucker
              
              15,367,807
              
              74,096
 
 A vote of
the shareholders was taken at the Annual Meeting on the proposal to approve the
adoption of the Five Star Products, Inc. 2007 Incentive Stock Plan. The proposal
was approved by the shareholders with 12,834,563 shares voting in favor of the
proposal and 117,983 shares voting against the proposal. There were 149,437
abstentions.
  A vote of
the shareholders was taken at the Annual Meeting on the proposal to approve and
ratify selection of Eisner LLP as the Company’s independent registered public
accounting firm for the year ending December 31, 2007.  The proposal
was approved by the shareholders, with 15,315,288 shares voting in favor of the
proposal and 121,651 shares voting against the proposal.  There were
4,964 abstentions and no broker non-votes.
  8
  PART
II
  ITEM
5. Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchase of Equity Securities.
  The
following table presents the high and low bid and asked prices for the Company’s
common stock during each of the quarterly periods in the years ended December
31, 2007 and 2006. The Company’s common stock, $0.01 par value, is quoted on the
OTC Bulletin Board. Such quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
  
  Year
              Quarter
              High
              Low2007
              Fourth
              $0.91
              $0.62Third
              $0.88
              $0.61Second
              $0.80
              $0.54First
              $0.75
              $0.312006
              Fourth
              $0.35
              $0.17Third
              $0.25
              $0.16Second
              $0.27
              $0.15First
              $0.22
              $0.18
 
 The
number of shareholders of record of the common stock as of March 20, 2008 was
2,489 and the closing price of the common stock on the OTC Bulletin Board on
that date was $.40 per share. The Company did not declare or pay any cash
dividends in 2007 and 2006. 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.
  ITEM 6.  
 Selected Financial Data.
  Not
required.
  9
  ITEM
7.     Management’s Discussion and Analysis of
Financial Condition and Results of Operations.
  Executive
summary
  The
Company reported net income for the year ended December 31, 2007 of $1,199,000,
an increase of $914,000 as compared to net income of $285,000 for the year ended
December 31, 2006. Basic and diluted net income per share was $0.08 and $0.07,
respectively, for the year ended December 31, 2007 compared to $0.02 basic and
diluted net income per share reported for the year ended December 31, 2006. The
improvement in the results in 2007 was primarily attributable to an overall
increase in sales and gross margin for the year ended December 31,
2007.  Sales increased by $15,625,000 to $123,713,000 in 2007 from
$108,088,000 in 2006. The overall increase in sales compared to 2006 was
primarily the result of in the Company’s April 2007 acquisition of substantially
all the assets (except certain excluded assets) of Right-Way.  See
Note 3 to the Consolidated Financial Statements.  The increase in
sales attributable to Right-Way totaled approximately
$10,236,000.  Sales were also positively impacted by the expansion
into the Delaware, Philadelphia, and the Carolina’s during 2007. Gross margin
increased to $21,467,000 in 2007 from $17,211,000 in 2006. The increase in gross
margin of $4,256,000 was primarily attributed to an overall increase in sales
and an increase in vendor rebates earned during 2007 as a result of the Company
meeting certain growth and volume targets, as well as increased margins from the
Right-Way Cash & Carry business.
  Overview
  Five Star
is a publicly held company that is a 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:
  ·
              its
      ability to negotiate the lowest prices from its
  suppliers,
  ·
              its
      ability to increase revenue by obtaining new customers, while maintaining
      a level fixed cost structure by utilizing its existing
      warehouses,
  ·
              the
      housing market in general,
  ·
              consumers’
      confidence in the economy,
  ·
              consumers’
      willingness to invest in their
homes,
  ·
              weather
      conditions that are conducive to home improvement
  projects.
  ·
              new
      U.S. housing starts,
  ·
              sales
      of existing homes,
  ·
              sales
      of high margin products to its
customers,
 ·
                purchases
      from each vendor,
 10
   Five Star
operates in the home improvement market. 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.    Management of the Company believes that
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.
  To
further expand, Five Star is considering strategies intended to grow its revenue
base in the Northeast and Mid-Atlantic States through internal initiatives and
to acquire complementary distributors.  There is no assurance that
these growth plans can be executed and, if executed, will be successful from an
operational or financial standpoint.  These plans could require
capital beyond the funds presently available to Five Star.
  On April
5, 2007, Five Star acquired substantially all the assets (except “Excluded
Assets” as defined) and assumed the Assumed Liabilities (as defined) of
Right-Way pursuant to the terms of a definitive asset purchase agreement, dated
as of March 13, 2007 (the “Agreement”), with Right-Way for approximately
$3,200,000 in cash and the assumption of liabilities in the approximate amount
of $50,000 (see Note 3 to the consolidated financial statement). The assets
consisted primarily of approximately $1,186,000 of accounts receivable at fair
value and approximately $2,213,000 of inventory at fair value. The acquisition
included all of Right-Way’s Brooklyn Cash & Carry business and operations,
which sells paint sundry and hardware supplies to local retail
stores.
  Upon
closing of the transaction, Five Star leased a warehouse at which the Brooklyn
Cash & Carry business is conducted from an affiliate of the principal of
Right-Way, with an option to purchase the warehouse, and a wholly-owned
subsidiary of Five Star also entered into an employment agreement with Ronald
Kampner, the principal of Right-Way, to serve as Senior Vice President of Sales
for Five Star.  The employment agreement provides for a three-year
term (subject to earlier termination), the payment of a base salary of $200,000
per annum, and cash incentive compensation as described in the employment
agreement. In addition, Mr. Kampner was granted options for 200,000 shares of
Five Star Products, Inc. common stock under the Five Star Products, Inc. 2007
Incentive Stock Plan.  The options vest if the Company meets certain
EBITDA targets for 2007 and the following two years and upon employee’s
continued employment.  The Company has determined that it has met 2007
EBITDA targets and accordingly recorded a charge of $24,000 for the year ended
December 31, 2007.
  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. As the Company
carries finished goods which turn over several times a year, and has the ability
to recover from its vendors the fair value of slow moving and reformulated
inventory, the Company does not record a reserve for inventory obsolescence. The
Company expenses defective finished goods in the period the defect is
discovered.
  11
  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 collectability 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 3.11% and 4.94% as of December 31, 2007 and December 31,
2006.
  Impairment
of long-lived tangible assets
  Impairment
of long-lived tangible assets with finite lives results in a charge to
operations whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.  Recoverability of
long-lived tangible assets to be held and used is measured by a comparison of
the carrying amount of the asset to future undiscounted net cash flows expected
to be generated by the asset.  If such assets are considered to be
impaired, the impairment to be recognized is measured by determining the amount
by which the carrying amount of the assets exceeds the fair value of the
asset.  Assets to be disposed of are reported at the lower of their
carrying amount or fair value less cost of sale.
  Results
of Operations
  The
Company had income before income taxes of $2,087,000 for the year ended December
31, 2007, as compared to income before income taxes of $546,000 for the year
ended December 31, 2006.  The increase in income before income taxes
of $1,541,000, or 282% for the year ended December 31, 2007 as compared to the
year ended December 31, 2006 was primarily a result of an increase in sales of
$15,625,000, which resulted in increased gross margin of $4,256,000, partially
offset by an overall increase in selling, general and administrative expenses of
$2,644,000. Gross margin percentage for the year ended December 31, 2007 was
favorably impacted by the increased vendor allowances due to achieving certain
growth levels.
  12
  Sales
  The
Company had sales of $123,713,000 for the year ended December 31, 2007, as
compared to sales of $108,088,000 for the year ended December 31,
2006.  The increase in sales of $15,625,000, or 14.5%, for the year
ended December 31, 2007 as compared to the year ended December 31, 2006 was the
result of the following: (i) $4,310,000 of sales attributed to the Right-Way
Brooklyn Cash and Carry facility; (ii) an overall increase in business within
the Connecticut and New Jersey-New York regions due to a $5,926,000 increase in
business from Right-Way’s customer base; (iii) an overall increase in business
from the Company’s traditional customer base; and (iv) an increase in revenue
due to the expansion into the Delaware, Philadelphia, and Carolina
regions.
  Gross
margin
  Gross
margin increased to $21,467,000, or 17.35% of net sales, for the year ended
December 31, 2007, as compared to $17,211,000, or 15.92% of net sales, for the
year ended December 31, 2006.  The increase in gross margin dollars of
$4,256,000, or 24.7%, for the year ended December 31, 2007 as compared to the
year ended December 31, 2006 was a direct result of increased sales and the
increased gross margin percentage. The increase in gross margin percentage for
the year ended December 31, 2007 was attributable principally to increased
vendor allowances recognized during the periods related to increased purchase
volume and achieving vendor growth and volume thresholds for the year. In
addition, the gross margin percentage was positively affected in 2007 by reduced
warehouse expenses as a percentage of sales, partially offset by reduced margins
earned on the sale of Cabot exterior stain products.
  Selling,
general and administrative expense
  The
Company had selling, general and administrative (“SG&A:”) expense of
$17,744,000 for the year ended December 31, 2007, as compared to $15,100,000 for
the year ended December 31, 2006.
  The
increase in SG&A expenses for the year ended December 31, 2007 of
$2,644,000, or 17.5%, was attributable primarily to increased delivery expense
and sales commissions due to increased sales, as well as increased general and
administrative expenses primarily related to the acquisition and operations of
Right-Way and increased professional fees.  The increased SG&A was
partially offset by increased vendor marketing allowances earned in the year as
a result of increased sales and purchasing volume.
  Interest
expense
  The
Company had interest expense of $1,681,000 for the year ended December 31, 2007
as compared to interest expense of $1,627,000 for the year ended December 31,
2006.  The $54,000 increase in interest expense for the year ended
December 31, 2007 was a result of an increase in average short-term borrowings
on the current credit facility, primarily due to the acquisition of the
operations of Right-Way, and an increase in interest rates.
  Income
taxes
  The
Company recognized an income tax expense for 2007 of $888,000 and an income tax
expense of $261,000 for 2006 at an effective tax rate of 42.5% in 2007 and 48%
in 2006.  The reduced effective rate in 2007 is due to reduced state
and local taxes.
  13
  Liquidity
and capital resources
  At
December 31, 2007 and 2006, the Company had cash of
$3,000.  Management believes that the current borrowing availability
on the Company’s credit facility, which was $5,579,000 on December 31, 2007,
will be sufficient to fund the Company’s working capital requirements through
March 2009. At December 31, 2007, the Company’s working capital was $8,328,000,
an increase of $4,666,000 from working capital of $3,662,000 at December 31,
2006.  This increase is primarily due to increased accounts receivable
and inventory for 2007 as compared to 2006, as well as the reclass of the note
payable to NPDC discussed below from current to non-current.  For the
year ended December 31, 2007, net cash provided by operating activities amounted
to $2,393,000.  Net cash provided by operating activities for 2007 was
negatively impacted by increases in inventory, offset by the increases in
accounts payable and accrued expenses and the decrease in accounts receivables.
The increase in inventory and accounts payable resulted from increased sales
volume and seasonal fluctuations. In addition, for the year ended December 31,
2007, cash flow used in investing activities was $4,063,000, which was comprised
of $3,400,000 related to the purchase of substantially all the assets of
Right-Way and $663,000 of additions to property, plant and
equipment.  During the year ended December 31, 2007, cash flow used in
operating and investing activities was funded from the net proceeds of short
term borrowings under the Company’s credit facility of $1,639,000.
  In 2003,
the Company’s wholly-owned subsidiary, Five Star Group, Inc. (“Five Star
Group”), 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 August 1,
2005, provides for a $35,000,000 revolving credit facility, which allows Five
Star Group to borrow based upon a formula of up to 65% of eligible inventory and
85% of eligible accounts receivable, as defined therein.  The interest
rates under the Loan Agreement, as amended, consist of LIBOR plus a credit
spread of 1.5% (6.34 % at December 31, 2007) for borrowings not to exceed
$15,000,000, and the prime rate (7.25% at December 31, 2007) for borrowings in
excess of the above-mentioned LIBOR-based borrowings.  The credit
spreads can be reduced in the event that Five Star Group achieves and maintains
certain performance benchmarks.  At December 31, 2007 and December 31,
2006, approximately $19,303,000 and $17,644,000 was outstanding under the Loan
Agreement and approximately $5,579,000 and $2,929,000 was available to be
borrowed, respectively.  Substantially all of the Company’s assets are
pledged as collateral for these borrowings.  Under the Loan Agreement,
the Company 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 30, 2007, the Company was in compliance with
the all required covenants, except for additions to fixed assets, for which the
Company received a waiver from its bank.
  The
following table sets forth the significant debt covenants at December 31,
2007:
  Covenant
              Required
              CalculatedMinimum
      tangible net worth
              $6,000,000
              $9,543,000Debt
      to tangible net worth
              <
      6
              2.02Fixed
      charge coverage
              >1.1
              1.88Quarterly
      income (loss)
              No
      loss in consecutive quarters
              $316,000
      – third quarter income$(144,000) - fourth
      quarter loss
 
 In
connection with the Loan Agreement, Five Star Group 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
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 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%.
  14
  The fair
value of the interest rate swap amounted to $69,000 and $320,000 at December 31,
2007 and December 31, 2006, respectively, and is included in Other assets in the
accompanying balance sheets.
  On June
17, 2004, Five Star Group 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%, whereby if LIBOR is below 2.25%, the Lender will
pay to Five Star Group 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
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, 2007 amount to
approximately $6,000, which has been charged to earnings during the year ended
December 31, 2007.
  Five Star
Group issued an unsecured note (the “Note”) payable to a wholly-owned subsidiary
of NPDC, which was scheduled to mature on June 30, 2006.  On July 28,
2006, the Company and NPDC agreed to extend the Note for a one-year term
maturing on June 30, 2007.  In consideration for the extension the
Company paid NPDC a fee of $28,000, representing one percent of the Note’s then
outstanding balance.  The interest rate on the Note remained at 9% per
annum.
 
 On March
2, 2007, the Company and NPDC amended the Note: (i) to extend the maturity date
from June 30, 2007 to June 30, 2009; (ii) to add a conversion feature such that
the holder of the Note, at its option, may convert the principal of the Note,
and any accrued interest, into shares of the Company’s common stock at a fixed
conversion price of $0.40 per share; and (iii) to eliminate the Company’s right
to prepay the Note prior to maturity.  The Company also granted NPDC
certain registration rights with respect to the shares of the Company’s common
stock issuable upon exercise of the Note pursuant to a Registration Rights
Agreement, dated as of March 2, 2007, between the Company and
NPDC.  The carrying value of the Note before the amendment
approximated the fair value of the amended Note; therefore, no gain or loss was
recognized as the result of the modification.  For each of the years
ended December 31, 2007 and 2006, the Company incurred interest expense on the
Note of $252,000.  The Note is subordinated to the indebtedness under
the Loan Agreement.
  15
  Recent
Accounting Pronouncements
  In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”,
which defines fair value, establishes a framework for measurement fair value and
expands disclosures about fair value measurements. SFAS No. 157 clarifies that
fair value should be based on assumptions that market participants will sue when
pricing an asset or liability and establishes a fair value hierarchy of three
levels that  prioritize the information used to develop those
assumptions. The provisions of SFAS No. 157 will become effective for the
Company beginning January 1, 2008. Generally, the provisions of this statement
are to be applied prospectively. The Company will adopt SFAS No. 157 in the
first quarter of 2008. Management expects that the adoption of SFAS No. 157 will
not have a material effect on the Company’s consolidated financial
statements.
  In
February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”.  This statement provides
companies with an option to report selected financial assets and liabilities at
fair value. This statement is effective for fiscal years beginning after
November 15, 2007 with early adoption permitted. The Company does not expect
that SFAS No. 159 will have any effect on the Company’s consolidated financial
statements.
  
  
  ITEM
7A.  Quantitative and Qualitative Disclosures About Market
Risk.
  Not
required.
      16
  ITEM
8.     Financial Statements and Supplementary
Data.
  INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS
  PageReport of Independent Registered Public Accounting
      Firm
                
                
                18Financial
      Statements:Consolidated Balance Sheets - December 31, 2007 and
      2006
                
                
                19Consolidated Statements of Operations and Comprehensive Income
      -
                  Years ended December 31, 2007 and
    2006
                
                
                20Consolidated Statements of Changes in Stockholders’ Equity -

                    Years ended December 31, 2007 and
    2006
                
                
                21Consolidated Statements of Cash Flows -
                  Years ended December 31, 2007 and
    2006
                
                
                22Notes to Consolidated Financial Statements
                
                
                23
     17
  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, 2007 and 2006 and the
related consolidated statements of operations and comprehensive income, changes
in stockholders’ equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our 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. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audits
include consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit 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, 2007 and 2006, and the consolidated
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the Unites States of
America.
  
  
 EISNER
LLP
 New York,
New York
 March 27,
2008
  18
  FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
BALANCE SHEETS
 
 (in
thousands, except share and per share data)
 
 December
      31,
              
              
              December
      31,2007
              
              
              2006AssetsCurrent
      assetsCash
              
              $
              3
              
              
              $
              3Accounts
      receivable, less allowancefor
      doubtful accounts of $361 and $547, respectively
              
              
              11,254
              
              
              
              10,520Inventory
              
              
              26,965
              
              
              
              21,744Deferred
      income taxes
              
              
              469
              
              
              
              652Prepaid
      expenses and other current assets
              
              
              1,151
              
              
              
              520Total
      current assets
              
              
              39,842
              
              
              
              33,439Property
      and equipment, net
              
              
              833
              
              
              
              530Deferred
      income taxes
              
              
              24
              
              
              
              166Other
      assets
              
              
              391
              
              
              
              362Total
      Assets
              
              $
              41,090
              
              
              $
              34,497Liabilities
      and Stockholders’ EquityCurrent
      liabilitiesShort-term
      borrowings
              
              $
              19,303
              
              
              $
              17,664Note
      payable to NPDC
              
              
              
              
              
              
              2,800Accounts
      payable and accrued expenses(including
      due to affiliates of $129 and $79, respectively)
              
              
              12,211
              
              
              
              9,313Total
      current liabilities
              
              
              31,514
              
              
              
              29,777Convertible
      note payable to NPDC
              
              
              2,800Interest
      rate collar
              
              
              
              
              
              
              6Total
      liabilities
              
              
              34,314
              
              
              
              29,783Commitments
      (Note 10)Stockholders’
      equityCommon
      stock, authorized 30,000,000 shares,par
      value $.01 per share; 19,493,098 shares issued and16,509,577
      outstanding in 2007  and 17,293,098 sharesissued
      and 14,309,577 outstanding in 2006
              
              
              195
              
              
              
              173Additional
      paid-in capital
              
              
              9,544
              
              
              
              8,552Accumulated
      deficit
              
              
              (2,296
              )
              
              
              (3,495
              )Accumulated
      other comprehensive income
              
              
              33
              
              
              
              184Treasury
      stock, at cost 2,983,521 shares in 2007 and 2,983,521 shares in
      2006
              
              
              (700
              )
              
              
              (700
              )Total
      stockholders’ equity
              
              
              6,776
              
              
              
              4,714$
              41,090
              
              
              $
              34,497
  See
accompanying notes to the consolidated financial statements.
  19
  FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 
 (in
thousands, except per share data)
 
 
 
 Year
      Ended December 31,2007
              
              
              2006Sales
              
              $
              123,713
              
              
              $
              108,088Cost
      of goods sold
              
              
              102,246
              
              
              
              90,877Gross
      margin
              
              
              21,467
              
              
              
              17,211Selling,
      general andadministrative
      expenses
              
              
              (17,744
              )
              
              
              (15,100
              )Operating
      income
              
              
              3,723
              
              
              
              2,111Other
      income
              
              
              45
              
              
              
              62Interest
      expense (including $252 and 280to
      affiliates)
              
              
              (1,681
              )
              
              
              (1,627
              )Income
      before income taxes
              
              
              2,087
              
              
              
              546Income
      tax expense
              
              
              (888
              )
              
              
              (261
              )Net
      income
              
              
              1,199
              
              
              
              285Other
      comprehensive income,
                net
      of tax:Change
      in value of cash flow hedge
              
              
              (251
              )
              
              
              (75
              )Tax
      benefit
              
              
              100
              
              
              
              30Comprehensive
      income
              
              $
              1,048
              
              
              $
              240Net
      income per shareBasic
              
              $
              .08
              
              
              $
              .02Diluted
              
              $
              .07
              
              
              $
              .02
 
 See
accompanying notes to the consolidated financial statements.
  20
  FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
 Years
Ended December 31, 2007 and 2006
 (in
thousands)
 AccumulatedCommon
              
              
              Additional
              
              
              
              
              
              Treasury
              
              
              Other
              
              
              TotalStock
              
              
              Paid-in
              
              
              Accumulated
              
              
              Stock
              
              
              Comprehensive
              
              
              Stockholders’Par
      Value
              
              
              Capital
              
              
              Deficit
              
              
              At
      Cost
              
              
              Income
              
              
              EquityBalance
      at December 31, 2005
              
              $
              173
              
              
              $
              8,552
              
              
              $
              (3,780
              )
              
              $
              (700
              )
              
              $
              229
              
              
              $
              4,474Net
      income
              
              
              
              
              
              
              
              
              
              
              285
              
              
              
              
              
              
              
              
              
              
              
              285Decrease
      in market value of
                interest
      rate swap, net of tax
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (45
              )
              
              
              (45
              )Balance
      at December 31, 2006
              
              
              173
              
              
              
              8,552
              
              
              
              (3,495
              )
              
              
              (700
              )
              
              
              184
              
              
              
              4,714Net
      income
              
              
              
              
              
              
              
              
              
              
              1,199
              
              
              
              
              
              
              
              
              
              
              
              1,199Decrease
      in market value of
                interest
      rate swap, net of tax
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (151
              )
              
              
              (151
              )Exercise
      of stock options
              
              
              2
              
              
              
              29
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              31Issuance
      of common stock to
                non
      employee for services
              
              
              20
              
              
              
              700
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              720Equity
      based employee
                compensation
      expense
              
              
              
              
              
              
              263
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              263Balance
      at December 31, 2007
              
              $
              195
              
              
              $
              9,544
              
              
              $
              (2,296
              )
              
              $
              (700
              )
              
              $
              33
              
              
              $
              6,776
 
 
 
 
 
 
 See
accompanying notes to the consolidated financial statements.
  21
  FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 (in
thousands)
 Year
      Ended December 31,2007
              
              
              2006Cash
      flows from operating activities:Net  income
              
              $
              1,199
              
              
              $
              285Adjustments
      to reconcile net incometo
      net cash provided by operating activities:Depreciation
      and amortization
              
              
              360
              
              
              
              322Equity
      based compensation
              
              
              463
              
              
              
              -Accounts
      receivable allowance
              
              
              71
              
              
              
              88Deferred
      income taxes
              
              
              425
              
              
              
              (232
              )Gain
      on interest rate collar
              
              
              (6
              )
              
              
              (14
              )Changes
      in other operating items net of effect of acquisitionof
      Right-Way:Accounts
      receivable
              
              
              381
              
              
              
              (14
              )Inventory
              
              
              (3,007
              )
              
              
              1033Prepaid
      expenses and other current assets
              
              
              (391
              )
              
              
              258Accounts
      payable and accrued expenses
              
              
              2,898
              
              
              
              513Net
      cash  provided by  operating
activities
              
              
              2,393
              
              
              
              2,239Cash
      flows from investing activities:Additions
      to property and equipment
              
              
              (663
              )
              
              
              (140
              )Acquisition
      of Right-Way
              
              
              (3,400
              )
              
              
              -Cash
      used in investing activities
              
              
              (4,063
              )
              
              
              (140
              )Cash
      flows from financing activities:Net
      increase (decrease) in short-term borrowings
              
              
              1,639
              
              
              
              (2,100
              )Exercise
      of stock options
              
              
              31
              
              
              
              -Net
      cash provided by (used in)financing
      activities
              
              
              1,670
              
              
              
              (2,100
              )Net
      change in cash
              
              
              -
              
              
              
              -Cash
      at beginning of period
              
              
              3
              
              
              
              3Cash
      at end of period
              
              $
              3
              
              
              $
              3Supplemental
      disclosures of cash flow information:Cash
      paid during the periods for:Interest
              
              $
              1,677
              
              
              $
              1,661Income
      tax
              
              $
              302
              
              
              $
              32
 
 See
accompanying notes to the consolidated financial statements.
  22
  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. The Company serves
independent retail dealers in the Northeast and Mid Atlantic states. Five Star
operates two distribution centers located in Newington, Connecticut and East
Hanover, New Jersey.   All operations are coordinated from Five
Star’s New Jersey headquarters.  At December 31, 2007 and 2006, the
Company is a majority owned subsidiary of National Patent Development
Corporation (“NPDC”) (see Note 6).
  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
collectability of the resulting receivable is reasonably assured. Allowances for
estimated returns and allowances are recognized when sales are
recorded.
  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.
  Property 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.
  Vendor
allowances.  The Company accounts for vendor allowances under
the guidance provided by EITF Issue No. 02-16, “Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor,” and
EITF Issue No. 03-10, “Application of EITF Issue No. 02-16 by Resellers to Sales
Incentives Offered to Consumers by Manufacturers.” Vendor allowances reduce the
carrying cost of inventory unless they are specifically identified as a
reimbursement for promotional programs and/or other services provided. Any such
allowances received in excess of the actual cost incurred also reduce the
carrying cost of inventory.
  Shipping and handling
costs.  Shipping and handling costs are included as a part of
selling, general and administrative expenses. These costs amounted to $5,390,000
and $4,909,000 for the years ended December 31, 2007 and 2006,
respectively.
  Advertising
costs.  The Company expenses advertising costs as incurred.
Advertising expense was $77,000 and $40,000 for the years ended December 31,
2007 and 2006, respectively.
  23
  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" and FASB Interpretation No. 48 Accounting for
Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”.
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. At December 31, 2007, the fair value of the
Company’s $2,800,000 fixed rate convertible note payable to NPDC is
approximately $4,830,000, based on $0.40 per share fixed conversion price and
market price of the Company’s common stock at December 31, 2007. At December 31,
2006, the $2,800,000 carrying value of the note payable to NPDC approximates
estimated fair value based on the short maturity of the note. The carrying value
of short term borrowings approximates estimated fair value because borrowings
accrue interest which fluctuates with changes in LIBOR. 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 5).
  Stock based
compensation.  The Company accounts for stock based
compensation pursuant to SFAS No. 123 (revised 2004), “Share-Based Payment”
(“SFAS 123R”). Under SFAS 123R, compensation cost is recognized over the vesting
period based on the fair value of the award at the grant date.
  Earnings per
share.  Basic earnings per share (“EPS”) is based upon the
weighted average number of common shares outstanding during the
period.  Diluted earnings per share is based upon the weighted average
number of common shares outstanding during the period, adjusted for the issuance
of common shares upon the exercise for all potential dilutive stock options
using the treasury stock method and upon the conversion of the note payable to
NPDC.
  24
  EPS for
the years ended December 31, 2007 and 2006 are computed as follows (in
thousands, except per share amounts):
  Year
      ended December 31,2007
              
              
              2006Basic
      EPSNet
      income
              
              $
              1,199
              
              
              $
              285Weighted
      average shares outstanding
              
              
              15,944
              
              
              
              14,396Basic
      earnings per share
              
              $
              .08
              
              
              $
              .02Diluted
      EPSNet  income
              
              $
              1,199
              
              
              $
              285Interest
      on convertible note, net of tax
              
              
              126
              
              
              
              -Income
      available to common
                stockholders
      after assumed conversion
              
              $
              1,325
              
              
              $
              285Weighted
      average shares outstanding
              
              
              15,944
              
              
              
              14,396Dilutive
      effect of stock options
              
              
              187
              
              
              
              303Common
      shares issuable on conversion
                of
      the note
              
              
              2,196
              
              
              
              -Weighted
      average shares
                  outstanding,
      diluted
              
              
              18,327
              
              
              
              14,699Diluted  earnings
      per share
              
              $
              .07
              
              
              $
              .02
  As of
December 31, 2007, options to purchase 108,000 Company’s common shares are
excluded from the dilutive EPS calculation, because their effect is
anti-dilutive. In addition, performance based options to purchase 650,000
Company’s common shares are also excluded from the dilutive EPS calculation as
the performance criteria has not been met at December 31, 2007.
  Recent
Accounting Pronouncements
  In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”,
which defines fair value, establishes a framework for measurement fair value and
expands disclosures about fair value measurements. SFAS No. 157 clarifies that
fair value should be based on assumptions that market participants will sue when
pricing an assets or liability and establishes a fair value hierarchy of three
levels that  prioritize the information used to develop those
assumptions. The provisions of SFAS No. 157 will become effective for the
Company beginning January 1, 2008. Generally, the provisions of this statement
are to be applied prospectively. The Company will adopt SFAS No. 157 in the
first quarter of 2008. Management expects that the adoption of SFAS No. 157 will
not have a material effect on the Company’s consolidated financial
statements.
  In
February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”.  This statement provides
companies with an option to report selected financial assets and liabilities at
fair value. This statement is effective for fiscal years beginning after
November 15, 2007 with early adoption permitted. The Company does not expect
that SFAS No. 159 will have any effect on the Company’s consolidated financial
statements.
  25
  3.           Acquisition
of Right-Way Dealer Warehouse
  On April
5, 2007, Five Star acquired substantially all the assets of Right-Way Dealer
Warehouse, Inc. (“Right-Way”) for approximately $3,200,000 in cash and assumed
liabilities of Right Way in the approximate amount of $50,000. Transaction costs
of approximately $200,000 were incurred by the Company in connection with the
acquisition. The assets principally consisted of approximately $1,186,000 of
accounts receivable at fair value and approximately $2,213,000 of inventory at
fair value. The acquisition included all of Right-Way’s Brooklyn Cash &
Carry business and operations, and was made principally to increase the
Company’s presence and market share in its current geographic area.
  Upon
closing of the transaction, Five Star leased a warehouse at which the Brooklyn
Cash & Carry business is conducted from an affiliate of the principal of
Right-Way, with an option to purchase the warehouse, (see Note 6) and a
wholly-owned subsidiary of Five Star also entered into three-year employment
agreement with the principal of Right-Way to serve as Senior Vice President of
Sales for Five Star.  In addition, the former principal was granted an
option covering 200,000 shares of Five Star common stock (see Note
8).
  The
results of operations of Right-Way are included in the consolidated financial
statements from the date of acquisition.  The following unaudited pro
forma consolidated amounts give effect to the acquisition of Right-Way as if it
had occurred at the beginning of each period presented. Right-Way had filed for
reorganization under Chapter XI of the Bankruptcy Act prior to the acquisition
by the Company.  The pro forma results of operations have been
prepared for comparative purposes only and are not necessarily indicative of the
operating results that would have been achieved had the acquisition been
consummated as of the above dates, nor are they necessarily indicative of future
operating results.
  (in
thousands, except per share data)
  Years
      ended December 31,2007
              
              
              2006Sales
              
              $
              128,047
              
              
              $
              147,562Net
      income (loss)
              
              
              564
              
              
              
              (1,500
              )Earnings
      (loss) per share:Basic
              
              $
              0.04
              
              
              $
              (0.10
              )Diluted
              
              $
              0.03
              
              
              $
              (0.10
              )
  26
  4.           Property
and equipment
  Property
and equipment consist of the following (in thousands):
  December 31,
              
              Estimated
                useful lives2007
              
              
              2006Machinery
      and equipment
              
              
              714
              
              
              
              479
              
              5-7
      yearsFurniture
      and fixtures
              
              
              866
              
              
              
              1,304
              
              5
      yearsLeasehold
      improvements
              
              
              409
              
              
              
              982
              
              3-9
      years1,989
              
              
              
              2,765Accumulated
      depreciation and amortization
              
              
              (1,156
              )
              
              
              (2,235
              )$
              833
              
              
              $
              530
 
  Depreciation
and amortization expense for the years ended December 31, 2007 and 2006 was
$360,000 and $322,000, respectively.
  
  5.           Short-term
borrowings
  In 2003,
the Company’s wholly-owned subsidiary, Five Star Group, Inc. (“Five Star
Group”), entered into a Loan and Security Agreement (the “Loan Agreement”) with
Bank of America Business Capital (the “Lender”). The Loan Agreement has a
five-year term, with a maturity date of June 30, 2008. The Loan Agreement, as
amended on August 1, 2005, provides for a $35,000,000 revolving credit facility,
which allows Five Star Group to borrow based upon a formula of up to 65% of
eligible inventory and 85% of eligible accounts receivable, as defined therein.
The interest rates under the Loan Agreement, as amended, consist of LIBOR plus a
credit spread of 1.5% (6.34% at December 31, 2007) for borrowings not to exceed
$15,000,000 and the prime rate (7.25% at December 31, 2007) for borrowings in
excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be
reduced in the event that Five Star Group achieves and maintains certain
performance benchmarks. At December 31, 2007 and 2006, $19,303,000 and
$17,664,000 was outstanding under the Loan Agreement and approximately
$5,579,000 and $2,929,000 was available to be borrowed, respectively.
Substantially all of the Company’s assets are pledged as collateral for these
borrowings. Under the Loan Agreement, the Company 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, 2007, the
Company was in compliance with all covenant requirements, except for additions
to fixed assets, for which the Company received a waiver.
  In
connection with the Loan Agreement, on June 20, 2003, Five Star Group entered
into an interest rate swap with the lender which has been designated as a cash
flow hedge. Effective July 1, 2004 through June 30, 2008, Five Star Group is
required to pay a fixed interest rate of 3.38% to the Lender on notional
principal of $12,000,000. In return, the Lender is required to pay to Five Star
Group a floating rate, namely, LIBOR, on the same notional principal amount. The
credit spread under the Loan Agreement is not included in, and will be paid in
addition to the 3.38%.
  The fair
value of the interest rate swap amounted to $69,000, which is include in prepaid
expenses and other assets at December 31, 2007 and $320,000 at December 31,
2006, which is included in Other assets in the accompanying balance sheets.
Changes in the fair value of the interest rate swap were recognized in other
comprehensive income.
  27
  On June
17, 2004, Five Star Group entered into an interest rate collar transaction
during the period from July 1, 2004 through June 30, 2008 on a 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 is required to pay to Five
Star Group 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 is required to pay to the Lender the
difference between LIBOR and 5.75% on the same notional principal amount.
Changes in the fair value of the interest rate collar are recognized in
earnings.  During the year ended December 31, 2007 and 2006, the
Company recognized a gain of $6,000 and $15,000, respectively, which is charged
to other income, for the changes in the fair value of the interest rate
collar.
  
  6.           Related
party transactions
  (a)           Management
agreement
  NPDC
provides legal, tax, business development, insurance and employee benefit
administration services to the Company pursuant to a management services
agreement, for a fee that was $40,000 per month from April 2007 through December
2007. The fee for the three months ended March 31, 2007 was approximately
$28,000 per month. For the year ended December 31, 2006, the fee was $30,800 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 any renewal thereof. In addition, the Company agreed to
reimburse NPDC for $16,666 per month for Mr. Feldman’s (NPDC’s former Chief
Executive Officer) service to the Company effective October 1, 2004 through May
31, 2007, the termination date of Mr. Feldman’s contract. The management
agreement was renewed for 2008.
  Fees
incurred under the agreement totaled $527,000 and $370,000, for the years ended
December 31, 2007 and 2006 and are included in selling, general and
administrative expenses in the consolidated statements of operations. At
December 31, 2007 and 2006, the amount due to NPDC under the agreement was
$108,000 and $58,000, respectively.
  In
addition, NPDC incurred certain expenses on behalf of Five Star, primarily
involving insurance, legal and other professional expenses. Five Star reimbursed
NPDC for such expense, which amounted to approximately, $561,000 and $234,000
for the years ended December 31, 2007 and 2006, respectively.
  (b)           Related party
debt
  Five Star
Group issued an unsecured note (the “Note”) payable to a wholly-owned subsidiary
of NPDC, which was scheduled to mature on June 30, 2006.  On July 28,
2006, the Company and NPDC agreed to extend the Note for a one-year term
maturing on June 30, 2007.  In consideration for the extension the
Company paid NPDC a fee of $28,000, representing one percent of the Note’s then
outstanding balance.  The interest rate on the Note remained at 9% per
annum.
 
 On March
2, 2007, the Company and NPDC amended the Note: (i) to extend the maturity date
from June 30, 2007 to June 30, 2009; (ii) to add a conversion feature such that
the holder of the Note, at its option, may convert the principal of the Note,
and any accrued interest, into shares of the Company’s common stock at a fixed
conversion price of $0.40 per share; and (iii) to eliminate the Company’s right
to prepay the Note prior to maturity.  The Company also granted NPDC
certain registration rights with respect to the shares of the Company’s common
stock issuable upon exercise of the Note pursuant to a Registration Rights
Agreement, dated as of March 2, 2007, between the Company and
NPDC.  The carrying value of the Note before the amendment
approximated the fair value of the amended Note; therefore, no gain or loss was
recognized as the result of the modification.  For each of the years
ended December 31, 2007 and 2006, the Company incurred interest expense on the
Note of $252,000.
  28
  The Note
is subordinated to the indebtedness under the Loan Agreement (see Note
5).
  (c)           Other related party
transactions
  On
February 8, 2002, the Company entered into a Consulting and Severance Agreement
(the “Agreement”) with the former President and Chief Executive Officer of the
Company. Pursuant to the Agreement, he received $145,000 per year for consulting
services rendered to the Company and a severance fee at the rate of $5,000 per
year, for a five-year period ended February 8, 2007. In addition, in August,
2002, he was granted options to purchase 150,000 shares of Company common stock
at the quoted market price on the date of grant, which options vested annually
over the term of the Agreement in equal installments. Such options, which were
valued at an aggregate amount of $13,000, were exercised in August 2007. The
Agreement also granted him an option exercisable through February 8, 2007 to
require the Company to repurchase 192,308 shares of Company common stock held by
him for an aggregate purchase price of $25,000. Such option expired unexercised.
During this five-year period, he also received certain benefits, including
medical benefits, life insurance and use of an automobile.
  On April
5, 2007, the Company, in connection with its acquisition of Right-Way entered
into a lease for a warehouse with a company owned by the former principal
of Right-Way who presently serves as an officer of the Company. The lease
has an initial term of five years with two successive five-year renewal options
and provides for an annual rent of $325,000, subject to adjustment. Rent expense
for the warehouse for the year ended December 31, 2007 was
$217,000.  The Company also has an option to purchase the warehouse at
any time during the initial term of the lease for $7,750,000, subject to 3%
annual adjustment.
  7.           Income
taxes
  The
components of income tax expense (benefit) are as follows (in
thousands):
  Years
      ended December 31,
              
              2007
              
              
              2006CurrentFederal
              
              $
              348
              
              
              $
              353State
      and local
              
              
              115
              
              
              
              147Total
      current expense
              
              
              463
              
              
              
              500DeferredFederal
              
              
              357
              
              
              
              (185
              )State
      and local
              
              
              68
              
              
              
              (54
              )Total
      deferred (benefit) expense
              
              
              425
              
              
              
              (239
              )Total
      income tax expense
              
              $
              888
              
              
              $
              261
 
   29
  As of
December 31, 2007 and 2006, deferred tax assets and liabilities consist of the
following (in thousands):
  December 31,Deferred
      tax assets (liabilities)
              
              2007
              
              
              2006Allowance
      for doubtful accounts
              
              $
              89
              
              
              $
              170Accrued
      compensation
              
              
              341
              
              
              
              121Accrued
      expenses
              
              
              
              
              
              
              32Interest
      rate swap
              
              
              (28
              )Inventory
              
              
              67
              
              
              
              329Total
      current deferred tax assets
              
              
              469
              
              
              
              652Property
      and equipment
              
              
              317
              
              
              
              292Interest
      rate collar
              
              
              
              
              
              
              2Deferred
      compensation
              
              
              
              
              
              
              36Unamortized
      share-based compensation
              
              
              (293
              )Interest
      rate swap
              
              
              
              
              
              
              (128
              )Net
      long-term deferred tax assets
              
              
              24
              
              
              
              202Valuation
      allowance
              
              
              -
              
              
              
              (36
              )Net
      long-term deferred tax assets
              
              
              24
              
              
              
              166Net
      deferred tax assets
              
              $
              493
              
              
              $
              818
 
  A
reconciliation between the Company’s tax provision and the U.S. statutory rate
follows (in thousands):
 
 Years
      ended December 31,
              
              2007
              
              
              2006Tax
      at U.S. statutory rate
              
              $
              710
              
              
              
              34
              %
              
              $
              186
              
              
              
              34
              %State
      and local taxes net ofFederal
      benefit
              
              
              121
              
              
              
              5.8
              
              
              
              61
              
              
              
              11.2Items
      not deductible
              
              
              57
              
              
              
              2.7
              
              
              
              16
              
              
              
              2.9Other
              
              
              
              
              
              
              0
              
              
              
              (2
              )
              
              
              (0.3
              )Income
      taxes
              
              $
              888
              
              
              
              42.5
              %
              
              $
              261
              
              
              
              47.8
              %
 
  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 2006.  The valuation allowance was
decreased $36,000 during 2007 in connection with an adjustment of a deferred tax
asset related to deferred compensation, the net impact being zero on the
effective tax rate and thus not reflected in the rate
reconciliation.
  Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48 “Accounting for
Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)” (“FIN
48”). This interpretation was issued in July 2006 to clarify the uncertainty in
income taxes recognized in the financial statements by prescribing a recognition
threshold and measurement attribute for financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. As
required by FIN 48, the Company applied the “more-likely-then-not” recognition
threshold to all tax provisions, commencing at the adoption date, which resulted
in no unrecognized tax benefits as of such date or December 31, 2007.
Accordingly, the adoption of FIN 48 had no effect on the Company’s 2007
financial statements. Pursuant to FIN 48, the Company has opted to classify
interest and penalties that would accrue according to the provisions of relevant
tax law as interest and other expense, respectively, in the consolidated
statement of operations.
  30
  The
Company files income tax returns in the U.S. federal jurisdiction and various
states. For federal income tax purposes, the 2004 through 2007 tax years remain
open for examination by the tax authorities. For state tax purposes, the 2003
through 2007 tax years remain open for examination by the tax
authorities.
 
 
 8.           Stock
options
  The
Company has adopted the Five Star Products, Inc. 1994 Stock Option Plan,
effective August 5, 1994 (the “1994 Plan”). The 1994 Plan, which was amended on
January 1, 2002, 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. Although certain outstanding options
have been granted under the 1994 Plan, options may no longer be granted under
the plan.
   On March
1, 2007, the Board of Directors of Five Star adopted the Five Star Products,
Inc. 2007 Incentive Stock Plan (the “2007 Plan”), which was approved by the
shareholders of Five Star in December 2007. Based upon NPDC’s intent to vote its
shares of Five Star in favor of the 2007 Plan, which assured its approval, the
financial effect of all options and restricted stock granted under the 2007 Plan
was reflected as if shareholder approval had been obtained prior to the date of
the Plan’s approval by shareholders. Under the 2007 Plan, Five Star may grant
awards of non-qualified stock options, incentive stock options, restricted
stock, stock units, performance shares, performance units, and other incentives
payable in cash or in shares of Five Star’s common stock to officers, employees
or members of the Board of Directors of Five Star and its subsidiaries. Five
Star is authorized to grant an aggregate of 2,500,000 shares of Company common
stock under the 2007 Plan.  Five Star may issue new shares or use
shares held in treasury to deliver shares for equity grants or upon exercise of
non-qualified stock options.
 
 On
October 18, 2006, Five Star granted options to the Chief Executive Officer of
Five Star Group, to purchase 400,000 shares of Company common stock at an
exercise price equal to $0.18 per share, the average of the closing bid and
asked prices of the common stock on that date. The options were to vest upon
Five Star meeting certain EBITDA targets for 2007 and the following two years
and upon his continued employment with Five Star, as well as shareholder
approval of the 2007 Plan. Achievement of performance criteria was determined as
less than probable at December 31, 2006 and therefore no compensation expenses
were recognized. The EBITDA target and exercise price were modified in March
2007, as described below, effectively creating a new instrument and a new fair
value for measurement of compensation.
 
 On March
2, 2007, Five Star granted options under the 2007 Plan to purchase an aggregate
of 250,000 shares of Company common stock to an Executive Vice President of Five
Star Group, and another employee, and increased the exercise price and modified
the EBITDA target of the 400,000 options granted to the Chief Executive Officer
on October 18, 2006 as described above. The exercise price of the 650,000
options granted was equal to $0.38 per share, the average of the closing bid and
asked prices of Company common stock on March 2, 2007. The options vest if Five
Star meets certain EBITDA targets for 2007 and the following two years, and are
contingent upon continued employment with the Company.  Five Star
determined the estimated aggregate fair value of these options to be $185,000
based on the Black-Scholes valuation model. It was determined that the 2007
performance criteria was met as of December 31, 2007.  Therefore
compensation expense of $51,000 was recognized with respect to these performance
based criteria options for the year ended December 31, 2007.
  31
  On July
17, 2007, Five Star granted options under the 2007 Five Star Plan to purchase
125,000 shares of the Company’s common stock to an executive officer of the
Company.  The exercise price of the 125,000 options was equal to
$0.78, the average of the closing bid and asked prices of the common stock on
July 17, 2007.  The options will vest if Five Star meets certain
EBITDA targets over the next three years provided that the executive officer
continues to be an employee of Five Star. It was determined that the 2007
performance criteria was met as of December 31,
2007.    Five Star determined the estimated aggregate fair
value of these options on the date of grant to be $ 62,000 based on the
Black-Scholes valuation model and recorded compensation expense of $ 9,000 for
the year ended December 31, 2007.
  On April
5, 2007, Five Star granted the former principal of Right-Way (see Note 3) an
option covering 200,000 shares of Five Star’s common stock with an exercise
price of $ 0.75 per share under the 2007 Plan. The options will vest if the
Company meets certain EBITDA targets over the next three years and upon the
former principal’s continued employment with Five Star. Five Star determined the
estimated aggregate fair value of these options on the date of grant to be
$97,000 based on the Black-Scholes valuation model.  It was determined
that the 2007 performance criteria was met as of December 31, 2007 and,
accordingly, recorded a charge of $24,000 for the year ended December 31,
2007.
  The
weighted-average grant-date fair value of options granted and modified during
years ended December 31, 2007 and 2006 was $0.33 and $0.17,
respectively.
  The fair
value of each option award was estimated on the date of grant using the
Black-Scholes option pricing model using the following weighted-average
assumptions:
 
 Year Ended December 31,2007
              
              2006Dividend
      yield
              0%
              
              0
              %Expected
      volatility
              106%
              
              166
              %Risk-free
      interest rate
              4.55
              
              5Expected
      life (in years)
              3.8
              
              4
 
 During
2007 and 2006, the Company took into consideration guidance contained in SFAS
No. 123R and SAB No. 107 when reviewing and developing assumptions for 2007 and
2006 grants. The weighted average expected life for 2007 and 2006 grants of 3.8
and 4 years, respectively, reflects the alternative simplified method permitted
by SAB No. 107, which defines the expected life as average of the contractual
term of the option and the weighted-average vesting period for all option
tranches. Expected volatility for the 2007 and 2006 options grants is based on
historical volatility over the same number of years as the expected life, prior
to option grant date.
 
 As of
December 31, 2007, there was $259,000 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements. This cost is
expected to be recognized over the vesting periods of the options, which on a
weighted-average basis is approximately 2.2 years.
  32
 
 Activity
relating to stock options granted by the Company is as follows:
  Number
      of
                  Shares
                
                
                Weighted-
                  Average
                  Exercise
                  Price
                
                
                Weighted-
                  Average
                  Remaining
      Contractual
                  Terms
      (Years)
                
                
                Aggregate
                  Intrinsic
                  ValueOptions
      outstanding at December 31, 2005
                
                
                1,100,000
                
                
                $
                0.14Granted
                
                
                400,000
                
                
                
                0.18Expired
                
                
                (450,000
                )
                
                
                0.14Options
      outstanding at December 31, 2006
                
                
                1,050,000
                
                
                
                0.16
                
                
                
                1.2
                
                
                $
                148,500
                (*)Granted
                
                
                575,000
                
                
                
                0.60Exercised
                
                
                (200,000
                )
                
                
                0.16Forfeited
      or expired
                
                
                (450,000
                )
                
                
                0.14Options
      outstanding at December 31, 2007
                
                
                975,000
                
                
                
                0.51
                
                
                
                9.2
                
                
                $
                201,500
                (*)Options
      vested and expected to vest
                
                
                325,000
                
                
                
                0.51
                
                
                
                9.2
                
                
                $
                67,167
                (*)Options
      exercisable at December 31, 2007
                
                
                0
  *The
intrinsic value of stock options is the amount by which the market value of the
underlying stock exceeds the exercise price of the option.
  The total
intrinsic value of options exercised during the year ended December 31, 2007 was
$124,000.
 
 On March
2, 2007, Five Star granted its President and Chief Executive Officer, 1,000,000
shares of restricted stock, valued at $0.38 per share ($380,000), which will
vest if Five Star meets certain EBITDA targets for 2007 and the following two
years, contingent upon his continued employment with the Company and
NPDC.  At December 31, 2007, Five Star determined that achievement of
the performance criteria was met and therefore compensation expense of $106,000
was recognized for the year ended December 31, 2007. At December 31, 2007,
$274,000 remains to be charged over the lesser of the remaining 26 months or the
term of employment.
 
 9.           Shareholders
equity
  An
executive was named a Director of NPDC on March 2, 2007 and appointed as
Chairman of Five Star.  He entered into a three-year agreement with
Five Star ending on March 1, 2010, which provides for an annual fee of $100,000
and reimbursement (i) for all travel expenses incurred in connection with his
performance of services for Five Star and (ii) beginning in November 2007, for
up to $125,000 per year of the cost of maintaining an office. In addition, he
was issued 2,000,000 shares of Five Star common stock, all of which are fully
vested and not subject to forfeiture.  Pursuant to the agreement
between this executive and NPDC described below, if the fair market value of the
2,000,000 shares of Five Star common stock that he received pursuant to the
agreement is less than $280,000 on the last day of the term of the agreement, he
may require NPDC to repurchase the shares of Five Star common stock for
$280,000. The 2,000,000 shares were valued at $720,000 based on the closing
price of Five Star’s common stock on March 2, 2007. Such amount is being charged
to compensation expense over the term of the agreement.  The charge
for the year ended December 31, 2007 was $200,000. At December 31, 2007 the
unrecognized compensation was $520,000 of which $240,000 is included in Prepaid
expenses and other current assets and $280,000 is included in Other
assets.  The issuance of the Five Star shares reduced NPDC’s ownership
of Five Star from 64% to 58%, which was further reduced to 57% at December 31,
2007, by issuance of common shares pursuant to exercise of
options.
  33
  On March
2, 2007, NPDC and the executive entered into an agreement pursuant to which NPDC
sold him 200,000 shares of its common stock at a price of $2.40 per share, or
$480,000 in the aggregate.  He has the right to exchange any or all of
the 200,000 shares of NPDC common stock for Company common stock held by NPDC at
the rate of six shares of Company common stock for each share of NPDC common
stock.  The value of the option to convert the NPDC stock held by him
into shares of the Company which amounted to $264,000 is being recognized as
compensation expense by Five Star over the three-year term of the agreement. For
the year ended December 31, 2007, the Company recognized a compensation expense
of approximately $73,000 in connection with the option.  On March, 25,
2008 the executive resigned, his shares of Five Star Common Stock were
repurchased by NPDC, and the three year agreement discussed above was terminated
(see Note 14).
    10.           Commitments
and contingencies
  (a)           Commitments
  The
Company has several non-cancelable 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.
  Real
      Property
              
              
              Machinery
      and
                equipment
              
              
              Total2008
              
              $
              1,954
              
              
              
              979
              
              
              
              2,9332009
              
              
              704
              
              
              
              675
              
              
              
              1,3792010
              
              
              325
              
              
              
              338
              
              
              
              6632011
              
              
              325
              
              
              
              100
              
              
              
              4252012
              
              
              81
              
              
              
              
              
              
              
              81Total
              
              $
              3,389
              
              
              $
              2,092
              
              
              $
              5,481
 
  During
2007 and 2006, the Company incurred $3,502,000 and $3,026,000, respectively, of
rental expense. GPS, the Company’s former parent, has guaranteed the leases for
Five Star’s New Jersey and Connecticut warehouses, having annual rentals of
approximately $1,701,000 and expiring in the first quarter of 2009. In March
2008, the Company extended the New Jersey lease for 12 months, removed the
guarantee by GPS, and replaced it with a guarantee by NPDC.  The
landlord at Five Star’s Connecticut facility has the option to cancel the lease
upon six months written notice, if there is a signed contract to sell the
building.
  34
  (b)           Contingencies
  The
Company and its subsidiaries are from time to time involved in litigation
arising out of the ordinary course of business.  It is the view of
management that the ultimate resolution of the only presently pending lawsuit
(which is for a health related claim based on the alleged use of a product
claimed to be distributed by the Company) should not have a material adverse
effect on the consolidated financial position, results of operations or cash
flows of the Company.
 
  11.           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, 2007 and 2006 (in
thousands):
  2007
              
              
              2006Balance
      at beginning of year
              
              $
              547
              
              
              $
              480Charged
      to expense
              
              
              92
              
              
              
              88Reduction
      of allowance
              
              
              
              
              
              
              (175
              )Uncollectible
      accounts written off,net
      of recoveries
              
              
              (278
              )
              
              
              154Balance
      at end of year
              
              $
              361
              
              
              $
              547
 
  12.           Accounts
payable and accrued expenses
  Accounts
payable and accrued expenses are comprised of the following (in
thousands):
  
 December
      31,2007
              
              
              2006Accounts
      payable
              
              $
              7,614
              
              
              $
              6,715Accrued
      expenses
              
              
              2,887
              
              
              
              1,717Due
      to NPDC/GPS
              
              
              129
              
              
              
              79Other
              
              
              1,581
              
              
              
              802$
              12,211
              
              
              $
              9,313
 
  13.           401(k)
plan
  The
Company maintains a 401(k) Savings Plan (the “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.
  35
  The
Company’s expense associated with the Savings Plan was approximately $137,000
and $125,000 for the years ended December 31, 2007 and 2006,
respectively.
  14.          Subsequent
event
  On March
25, 2008, S. Leslie Flegel resigned as director and Chairman of the Board of the
Company, and as a director of NPDC, effective immediately. In connection with
Mr. Flegel’s resignation, the Company, NPDC and Mr. Flegel entered into an
agreement, dated March 25, 2008, pursuant to which Mr. Flegel sold to NPDC (i)
200,000 shares of NPDC common stock, which was exchangeable into 1,200,000
shares of Five Star common stock owned by NPDC, at $3.60 per
share  (which equates to $0.60 per share of Five Star common stock had
Mr. Flegel exercised his right to exchange these shares of NPDC’s common stock
into shares of Five Star common stock) and (ii) 1,698,336, shares of the
Company’s common stock at $0.60 per share.  In addition, Mr. Flegel’s
children and grandchildren agreed to sell to NPDC an additional 301,664 shares
the Company’s Common Stock at $0.60 per share.  The Company will
record a non-cash compensation expense of approximately $1,100,000 in the first
quarter of 2008 related to the above transactions.  The Lender amended
the covenants related to the Loan Agreement in March 2008 to exclude non-cash
charges related to any equity instruments (common stock, options and warrants)
issued to any employee, director, or consultant from the covenant calculations
(see Note 5).
  Mr.
Flegel agreed to be subject to one-year non-compete, standstill and
non-solicitation covenants. In addition, the agreement under which Mr. Flegel
received an annual fee of $100,000 and was to be reimbursed (i) for all travel
expenses incurred in connection with his performance of services to Five Star
and (ii) beginning in November 2007, for up to $125,000 per year of the cost of
maintaining an office was terminated.
  
   36
  ITEM
      9.
              Changes
      in and Disagreements with Accountants on Accounting and FinancialDisclosure
  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 Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’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.
  The
Company’s principal executive officer and principal financial officer, with the
assistance of other members of the Company’s management, have evaluated the
effectiveness of the Company’s disclosure controls and procedures pursuant to
the Exchange Act Rule 13a-15(e) as of December 31, 2007.  Based on
such evaluation, the Company’s principal executive officer and principal
financial officer have concluded that the Company’s disclosure controls and
procedures were effective as of such time.
  The
Company’s principal executive officer and principal financial officer have also
concluded that there have not been any changes in the Company’s internal control
over financial reporting during the quarter ended December 31, 2007 that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
  Management’s
Report on Internal Control over Financial Reporting
  Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Exchange Act Rule
13a-15(f)).  The Company’s internal control over financial reporting
is designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
  Management
of the Company, including its principal executive officer and principal
financial officer, assessed the effectiveness of the Company’s internal control
over financial reporting as of December 31, 2007.  In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control
— Integrated Framework.
  Based on
their assessment using those criteria, management concluded that, as of December
31, 2007, the Company’s internal control over financial reporting is
effective.
  This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
SEC that permit the Company to provide only management’s report in this annual
report.
  37
  ITEM
9B.              Other
Information
  None.
  PART
III
  ITEM
      10.
              Directors
      , Executive Officers and Corporate
Governance
  The
information required by this item is incorporated by reference to the Company’s
Proxy Statement for its 2008 Annual Meeting of Shareholders under the captions
“Directors and Executive Officers”, “Corporate Governance”, “Compliance with
Section 16(a) of the Exchange Act”, “Code of Ethics” and “Audit
Committee.”
  ITEM
11.               Executive
Compensation
  The
information required by this item is incorporated by reference to the Company’s
Proxy Statement for its 2008 Annual Meeting of Shareholders under the caption
“Executive Compensation.”
  ITEM
      12.
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Shareholder Matters
  The
information required by this item is incorporated by reference from the
Company’s Proxy Statement for its 2008 Annual Meeting of Shareholders under the
captions “Stock Ownership of Management and Principal Shareholders” and “Equity
Compensation Plan Information.”
  ITEM
      13.
              Certain
      Relationships and Related Transactions, and Director
      Independence
  This
information required by this item is incorporated by reference from the
Company’s Proxy Statement for its 2008 Annual Meeting of Shareholders under the
captions “Certain Transactions With Management” and “Director
Independence”.
  ITEM
      14.
              Principal
      Accountant Fees and Services
  The
information regarding principal accounting fees and services and the Company’s
pre-approval policies and procedures for audit and non-audit services provided
by the Company’s independent accountants is incorporated by reference to the
Company’s Proxy Statement for its 2008 Annual Meeting of Shareholders under the
caption “Principal Accounting Fees and Services.”
  38
  PART
IV
  ITEM
      15.
              Exhibits,
      Financial Statement Schedules
  (a)(1)  The
following financial statements are included in Part II, Item 8:
  PageReport of Independent Registered Public Accounting
      Firm
                
                
                18Financial
      Statements:Consolidated Balance Sheets - December 31, 2007 and
      2006
                
                
                19Consolidated Statements of Operations and Comprehensive Income
      -

                    Years ended December 31, 2007 and
    2006
                
                
                20Consolidated Statements of Changes in Stockholders’ Equity -

                    Years ended December 31, 2007 and
    2006
                
                
                21Consolidated Statements of Cash Flows -

                    Years ended December 31, 2007 and
    2006
                
                
                22Notes to Consolidated Financial Statements
                
                
                23
 
  (a)(2)Schedules
have been omitted because they are not required or are not applicable, or the
required information has been included in the financial statements or the notes
thereto.
  (a)(3)See
accompanying Index to Exhibits
   39
  SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
  FIVE
      STAR PRODUCTS, INC.Date:  March
      28, 2008
                By:
                /s/ JOHN
      C. BELKNAPName:
                John
      C. BelknapTitle:
                President
      and Chief Executive Officer
                  (Principal
      Executive Officer)
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
 
 Signature
              Capacity
              Date/s/ JOHN C. BELKNAP
              President,
      Chief Executive Officer and Director
              March
      28, 2008John
      C. Belknap
                /s/HARVEY P. EISEN
              (Principal
      Executive Officer)
                
                Director
              March
      28, 2008Harvey
      P. Eisen
                /s/ BRUCE SHERMAN
              Executive
      Vice President and Director
              March
      28, 2008Bruce
      Sherman
                /s/ CARLL TUCKER
              Director
              March
      28, 2008Carll
      Tucker
                /s/ IRA J. SOBOTKO
              Senior
      Vice President, Finance, Secretary and Treasurer
              March
      28, 2008Ira
      J. Sobotko
              (Principal
      Financial and Accounting Officer)
 
 
   40
  INDEX
TO EXHIBITS
 
 Exhibit
      No.
              Description3
              (i)
              *
              Certificate
      of Incorporation of the Registrant, as amended (conformed
      copy)3
              (ii)
              
              Amended
      By-laws of the Registrant (incorporated herein by reference to Exhibit 3.1
      of the Registrant’s Annual Report on Form 10-K/A for the year ended
      December 31, 2003 filed with the SEC on April 29, 2004 (SEC File No.
      000-25869))4.1
              
              
              Registration
      Rights Agreement dated as of March 2, 2007 between Registrant and JL
      Distributors, Inc. (incorporated herein by reference to Exhibit 10.2 of
      Registrant’s Current Report on Form 8-K dated March 1, 2007 filed with the
      SEC on March 7, 2007)4.2
              
              
              Registration
      Rights Agreement dated as of March 2, 2007 between Registrant and S.
      Leslie Flegel (incorporated herein by reference to Exhibit 10.4 of
      Registrant’s Current Report on Form 8-K dated March 1, 2007 filed with the
      SEC on March 7, 2007)4.3
              
              
              Registration
      Rights Agreement dated as of March 2, 2007 between Registrant and National
      Patent Development Corporation (incorporated herein by reference to
      Exhibit 10.6 of Registrant’s Current Report on Form 8-K dated March 1,
      2007 filed with the SEC on March 7, 2007)4.4
              
              #
              Restricted
      Stock Agreement, dated March 2, 2007, between the Company and John C.
      Belknap (incorporated by reference to Exhibit 10.7 to the Current Report
      on Form 8-K filed by the Registrant with the SEC on March 7,
      2007)4.5
              
              #
              Registration
      Rights Agreement dated as of March 2, 2007 between Registrant and John C.
      Belknap (incorporated herein by reference to Exhibit 10.8 of Registrant’s
      Current Report on Form 8-K dated March 1, 2007 filed with the SEC on March
      7, 2007)10.1
              
              #
              1994
      Stock Option Plan of the Registrant as amended on January 1, 2002
      (incorporated herein by reference to Exhibit 10 of the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2001 filed with the
      SEC on April 1, 2002 (SEC File No. 000-25869))10.2
              
              #
              Management
      Services Agreement, dated as of August 5, 1994, between GP Strategies
      Corporation and the Registrant (incorporated herein by reference to
      Exhibit 10.3 of the Registrant’s Registration Statement on Form S-1 filed
      on July 22, 1994, Registration Statement No.
  33-78252)
  
  Exhibit
      No.
              Description10.3
              
              
              Lease
      dated as of February 1, 1986 between Vernel Company and Five Star Group,
      Inc., as amended on July 25, 1994. (incorporated herein by reference to
      Exhibit 10.6 of the Registrant’s Annual Report on Form 10-K for the year
      ended December 31, 1998 filed with the SEC on March 31, 1999 (SEC File No.
      033-78252))10.4
              
              
              Lease
      dated as of May 4, 1983 between Vornado, Inc., and Five Star Group, Inc.
      (incorporated herein by reference to Exhibit 10.7 of the Registrant’s
      Annual Report on Form 10-K for the year ended December 31, 1998 filed with
      the SEC on March 31, 1999 (SEC File No. 033-78252))10.5
              
              
              Lease
      Modification and Extension Agreement dated July 6, 1996 between Hanover
      Public Warehousing, Inc. and Five Star Group, Inc. (incorporated herein by
      reference to Exhibit 10.8 of the Registrant’s Annual Report on Form 10-K
      for the year ended December 31, 1998 filed with the SEC on March 31, 1999
      (SEC File No. 033-78252) )10.6
              
              
              Agreement
      between Five Star Group and Local No. 11 affiliated with International
      Brotherhood of Teamsters dated December 12, 2000 (incorporated herein by
      reference to Exhibit 10.7 to the Registrant’s Annual Report on Form 10-K
      for the year ended December 31, 2000 filed with the SEC on April 2, 2001
      (SEC File No. 000-25869))10.7
              
              
              Memorandum
      of Agreement by and between Five Star Group, Inc. and Teamsters Local 11,
      affiliated with International Brotherhood of Teamsters dated December 12,
      2003 (incorporated herein by reference to Exhibit 10.7 of the Registrant’s
      Annual Report on Form 10-K for the year ended December 31, 2003 filed with
      the SEC on April 2, 2004)10.8
              
              
              Loan
      and Security Agreement dated as of June 20, 2003 by and between the
      Registrant, as Borrower, and Fleet Capital, as Lender (incorporated herein
      by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the quarter
      ended June 30, 2003 filed with the SEC on August 14,
  2003)10.9
              
              
              Agreement
      of Subordination & Assignment dated as of June 20, 2003 by JL
      Distributions, Inc., as Creditor, in favor of Fleet Capital Corporation,
      as Lender, to Five Star Group, Inc., as Debtor (incorporated herein by
      reference to Exhibit 10.2 of the Registrant’s Form 10-Q for the quarter
      ended June 30, 2003 filed with the SEC on August 14,
  2003)10.10
              
              
              First
      Modification Agreement, dated as of May 28, 2004, by and between Five Star
      Group, Inc., as borrower, and Fleet Capital Corporation, as Lender
      (incorporated herein by reference to Exhibit 10.11 of the Registrant’s
      Form 10-K for the year ended December 31, 2004 filed with the SEC on March
      31, 2005)
  
  Exhibit
      No.
              Description10.11
              
              
              Second
      Modification Agreement, dated as of March 22, 2005, by and between Five
      Star Group, Inc., as borrower, and Fleet Capital Corporation, as Lender
      (incorporated herein by reference to Exhibit 10.12 of the Registrant’s
      Form 10-K for the year ended December 31, 2004 filed with the SEC on March
      31, 2005)10.12
              
              
              Third
      Modification Agreement, dated as of June 1, 2005, by and between Five Star
      Group, as borrower, and Fleet Capital Corporation, as Lender (incorporated
      herein by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the
      second quarter ended June 30, 2005 filed with the SEC on August 12,
      2005).10.13
              
              
              Fourth
      Modification Agreement dated September 26, 2005, but effective as of
      August 1, 2005, by and between Five Star Group, Inc., as borrower, and
      Fleet Capital Corporation, as Lender (incorporated herein by reference to
      Exhibit 10.1 of the Registrant’s Form 10-Q for the third quarter ended
      September 30, 2005 filed with the SEC on November 15,
    2005).10.14
              
              
              Fifth
      Modification Agreement, dated November 14, 2005, by and between Five Star
      Group, Inc., as borrower, and Fleet Capital Corporation, as Lender
      (incorporated herein by reference to Exhibit 10.2 of the Registrant’s Form
      10-Q for the third quarter ended September 30, 2005 filed with the SEC on
      November 15, 2005).10.15
              
              
              Sixth
      Modification Agreement, dated March 23, 2006, by and between Five Star
      Group, Inc. as borrower and Fleet Capital Corporation, as Lender
      (incorporated herein by reference to Exhibit 10 of the Registrant’s Form
      10-K for the year ended December 31, 2005 filed with the SEC on March 31,
      2006)10.16
              
              
              Amended
      Note in the amount of $2,800,000 dated June 30, 2005 between the
      Registrant and National Patent Development Corporation (incorporated
      herein by reference to Exhibit 10.2 of the Registrant’s Form 10-Q for the
      second quarter ended June 30, 2005 filed with the SEC on August 12,
      2005).10.17
              
              #
              Consulting
      and Severance Agreement dated as of February 8, 2002 between the
      Registrant and Richard Grad (incorporated herein by reference to Exhibit
      10.11 of the Registrant’s Annual Report on Form 10-K for the year ended
      December 31, 2001 filed with the SEC on April 2, 2002 (SEC File No.
      000-25869)).10.18
              
              #
              Employment
      Agreement dated as of November 28, 2001 between the Registrant and Charles
      Dawson (incorporated herein by reference to Exhibit 10.12 of the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2001 filed with the SEC on April 2, 2002 (SEC File No. 000-25869)
      ).
  
  Exhibit
      No.
              Description10.19
              
              #
              Employment
      Agreement dated as of November 28, 2001 between the Registrant and Bruce
      Sherman (incorporated herein by reference to Exhibit 10.13 of the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2001 filed with the SEC on April 2, 2002 (SEC File No. 000-25869)
      ).10.20
              
              #
              Employment
      Agreement dated as of November 28, 2001 between the Registrant and Steven
      Schilit (incorporated herein by reference to Exhibit 10.14 of the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2001 filed with the SEC on April 2, 2002 (SEC File No.
      000-25869)).10.21
              
              
              Agreement
      dated as of January 22, 2004, between the Company and GP Strategies
      Corporation (incorporated herein by reference to Exhibit 99(d) of the
      Registrant Schedule TO filed with the SEC on February 6,
      2004).10.22
              
              
              Tax
      Sharing Agreement dated as of February 1, 2004 between Registrant and GP
      Strategies Corporation (incorporated herein by reference to Exhibit 10.19
      of the Registrant’s Annual Report on Form 10-K for the year ended December
      31, 2003 filed with the SEC on April 2, 2004)10.23
              
              #
              Employment
      Agreement dated as of October 18, 2006 between the Registrant and Bruce
      Sherman (incorporated herein by reference to Exhibit 10 of the
      Registrant’s Current Report on Form 8-K dated October 18, 2006 filed with
      the SEC on October 24, 2006)10.24
              
              #
              Consulting
      and Severance Agreement dated as of February 20, 2007 between Registrant
      and Steve Schilit (incorporated herein by reference to Exhibit 99.1 of
      Registrant’s Current Report on Form 8-K dated February 20, 2007 filed with
      the SEC on February 20, 2007)10.25
              
              
              Amended
      Note in the amount of $2,800,000 dated June 30, 2005 between the
      Registrant and JL Distributors, Inc. (incorporated herein by reference to
      Exhibit 10.1 of Registrant’s Current Report on Form 8-K dated March 1,
      2007 filed with the SEC on March 7, 2007)10.26
              
              #
              Agreement
      dated as of March 2, 2007 between Registrant and S. Leslie Flegel
      (incorporated herein by reference to Exhibit 10.3 of Registrant’s Current
      Report on Form 8-K dated March 1, 2007 filed with the SEC on March 7,
      2007)10.27
              
              
              Purchase
      Agreement dated as of March 2, 2007 between National Patent Development
      Corporation and S. Leslie Flegel (incorporated herein by reference to
      Exhibit 10.5 of Registrant’s Current Report on Form 8-K dated March 1,
      2007 filed with the SEC on March 7,
2007)
  
  Exhibit
      No.
              Description10.28
              
              #
              Employment
      Agreement dated as of February 23, 2007 between Registrant and Bruce
      Sherman (incorporated herein by reference to Exhibit 10.9 of Registrant’s
      Current Report on Form 8-K dated March 1, 2007 filed with the SEC on March
      7, 2007)10.29
              
              #
              Five
      Star Products, Inc. 2007 Incentive Stock Plan (incorporated herein by
      reference to Appendix A to the Company’s Proxy Statement filed by the
      Company with the SEC on November 16, 2007)10.30
              
              #
              Stock
      Option Agreement, dated March 1, 2007, between the Company and Bruce
      Sherman (incorporated herein by reference to Exhibit 10.11 to the Current
      Report on Form 8-K filed by the Company with the SEC on March 7,
      2007)10.31
              
              #
              Stock
      Option Agreement dated as of March 1, 2007 between Registrant and Charles
      Dawson (incorporated herein by reference to Exhibit 10.12 of Registrant’s
      Current Report on Form 8-K dated March 1, 2007 filed with the SEC on March
      7, 2007)10.32
              
              #
              Non-Qualified
      Stock Option Agreement dated as of March 1, 2007 between the Registrant
      and National Patent Development Corporation. (incorporated herein by
      reference to Exhibit 10.13 of Registrant’s Current Report on Form 8-K/A
      dated March 1, 2007 filed with the SEC on March 8,
2007)10.33
              
              
              Asset
      Purchase Agreement dated as of March 13, 2007 between Registrant and
      Right-Way Dealer Warehouse, Inc. (incorporated herein by reference to
      Exhibit 10 of Registrant’s Current Report on Form 8-K dated March 13, 2007
      filed with the SEC on March 19, 2007)10.34
              
              
              Agreement
      of Lease between Kampner Realty, LLC, as Landlord, and Five Star Products,
      Inc., as Tenant, for premises located at 1202 Metropolitan Avenue,
      Brooklyn, NY and Form of Contract of Sale between Kampner Realty, LLC and
      Five Star Products, Inc. (incorporated herein by reference to Exhibit 10.1
      to the Registrant’s Current Report on Form 8-K filed with the SEC on April
      11, 2007)10.35
              
              #
              Employment
      Agreement dated as of April 5, 2007 between Five Star Group, Inc. and
      Ronald Kampner (incorporated herein by reference to Exhibit 10.2 to the
      Registrant’s Current Report on Form 8-K filed with the SEC on April 11,
      2007)10.36
              
              
              Amendment
      to Agreement of Lease between Kampner Realty, LLC, as Landlord, and Five
      Star Products, Inc., as Tenant, for premises located at 1202 Metropolitan
      Avenue, Brooklyn, New York, agreed upon and entered into on June 11, 2007
      (incorporated herein by reference to Exhibit 10.1 to the Registrant’s
      Current Report on Form 8-K filed with the SEC on June 14,
      2007)
  
  Exhibit
      No.
              Description10.37
              
              #
              Stock
      Option Agreement dated as of July 30, 2007 between National Patent
      Development Corporation and Ira J. Sobotko (incorporated herein by
      reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q filed by
      National Patent Development Corporation on November 14,
    2007)10.38
              
              #
              Stock
      Option Agreement dated as of July 17, 2007 between the Company and Ira J.
      Sobotko (incorporated herein by reference to Exhibit 10.2 to the Quarterly
      Report on Form 10-Q filed by National Patent Development Corporation on
      November 14, 2007)10.39
              
              #
              Non-Qualified
      Stock Option Agreement, dated March 1, 2007, between National Patent
      Development Corporation and John C. Belknap (incorporated herein by
      reference to Exhibit 10.10 to the Current Report on Form 8-K filed by
      National Patent Development Corporation with the SEC on March 7,
      2007)10.40
              
              
              Agreement
      and Release, dated March 25, 2008, by and among Leslie Flegel, National
      Patent Development Corporation and Five Star Products, Inc. (incorporated
      herein by reference to Exhibit 10.1 to the Current Report on Form 10-K
      filed by the Registrant on March 27, 2008)10.41
              
              
              Sale
      Agreement, dated March 25, 2008, by and among National Patent Development
      Corporation, Five Star Products, Inc., Jason Flegel, Carole Flegel, Dylan
      Zachary Flegel UTMA – FL, Brooke Flegel UTMA – FL, Mark Flegel, Darryl
      Sagel, Lauren Sagel, Graham Spencer Sagel UTMA – NY and Alexa Danielle
      Sagel UTMA – NY (incorporated herein by reference to Exhibit 10.2 to the
      Current Report on Form 10-K filed by the Registrant on March 27,
      2008)10.42
              
              *
              Seventh
      Modification Agreement, dated March 23, 2007, by and between Five Star
      Group, Inc., as borrower, and Bank of America, N.A. (through its
      predecessor Fleet Capital Corporation), as Lender10.43
              
              *
              Eighth
      Modification Agreement, dated March 25, 2008, by and between Five Star
      Group, Inc., as borrower, and Bank of America, N.A. (through its
      predecessor Fleet Capital Corporation), as Lender14
              
              
              Code
      of Ethics Policy (incorporated herein by reference to Exhibit 14.1 of the
      Registrant’s Annual Report on Form 10-K/A for the year ended December 31,
      2003 filed with the SEC on April 29, 2004)21
              
              
              Subsidiaries
      of the Company (incorporated herein by reference to Exhibit 21 to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2006 filed with the SEC on April 2,
2007)
  
  Exhibit
      No.
              Description23
              
              *
              Consent
      of Independent Registered Public Accounting Firm – Eisner
    LLP31.1
              
              *
              Certification
      of the principal executive officer of the Company, pursuant to Securities
      Exchange Act Rule 13a-14(a)31.2
              
              *
              Certification
      of the principal financial officer of the Company, pursuant to Securities
      Exchange Act Rule 13a-14(a)32
              
              *
              Certifications
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      The Sarbanes-Oxley Act of 2002, signed by the principal executive officer
      and the principal financial officer of the
  Company
 ____________________
 *
              Filed
      herewith.#
              Management
      contract or compensatory plan or
arrangement.