As filed with the Securities and Exchange Commission on March 28, 2008

United States

Securities and Exchange Commission

Washington, DC 20549

 

 

Form 10-KSB

x Annual Report Pursuant to Section 13 or 15(d)

Of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2007

OR

¨ Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

Commission file number: 000-31279

OurPet’s Company

(Name of Small Business Issuer in Its Charter)

 

 

 

Colorado   34-1480558

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1300 East Street, Fairport Harbor, OH   44077
(Address of principal executive offices)   (Zip code)

Issuer’s telephone number: (440) 354-6500

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: Common Stock, no par value

 

 

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.   ¨

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.   x   Yes     ¨   No

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB.   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)   ¨   Yes     x   No

Issuer’s revenues for the fiscal year ended December 31, 2007 were $10,561,204. The aggregate market value of the common stock of the registrant, no par value per share (the “Common Stock”), held by non-affiliates of registrant was $3,252,970 as of March 17, 2008. As of March 17, 2008, the issuer had outstanding 15,243,984 shares of Common Stock.

Documents Incorporated by Reference

Part III – Portions of the registrant’s definitive proxy statement to be issued in conjunction with registrant’s annual meeting to be held on May 30, 2008.

Transitional Small Business Disclosure Format (Check one):  Yes   ¨     No   x

www.ourpets.com

 

 

 


Table of Contents

OURPET’S COMPANY

FORM 10-KSB

For The Fiscal Year Ended December 31, 2007

INDEX

 

          Page

PART I

     

Item 1.

   Description of Business    3

Item 2.

   Description of Property    6

Item 3.

   Legal Proceedings    7

Item 4.

   Submission of Matters to a Vote of Security Holders    7

PART II

     

Item 5.

   Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities    8

Item 6.

   Management’s Discussion and Analysis or Plan of Operation    9

Item 7.

   Financial Statements    14

Item 8.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    14

Item 8A(T).

   Controls and Procedures    14

Item 8B.

   Other Information    15

PART III

     

Item 9.

   Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange Act    16

Item 10.

   Executive Compensation    16

Item 11.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    16

Item 12.

   Certain Relationships and Related Transactions, and Director Independence    16

Item 13.

   Exhibits    16

Item 14.

   Principal Accountant Fees and Services    18
   Signatures    19
   Certifications    40


Table of Contents

This report on the Form 10-KSB (this “Report”) contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including, without limitation, statements regarding our cash needs and ability to fund our requirements, building of our market presence and ability to succeed as planned and our ability to successfully obtain and protect our patents. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. See “Item 1. Description of Business – Risk Factors” for a discussion of these risks. When used in this Report, statements that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “anticipates”, “plans”, “intends”, “expects” and similar expressions are intended to identify such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Introductory Note

OurPet’s Company, a Colorado corporation, is engaged in developing, manufacturing and marketing various proprietary products for the retail pet business. As used herein, the terms “OurPet’s,” “we,” “us” and “our” include each of our subsidiaries, unless the context otherwise requires.

PART I

Item 1. Description of Business.

Our management originally founded Napro, Inc. (“Napro”), an Ohio corporation, in 1985 as an enterprise for launching new ventures and acquiring companies in various lines of business. In 1996, Napro formed a wholly owned Ohio subsidiary, Virtu Company (“Virtu”), to market proprietary products to the retail pet business under the OurPet’s ® label. Napro then changed its name to OurPet’s Company effective March 19, 1998. On July 16, 1998, Manticus, Inc. (“Manticus”), a Colorado corporation, obtained all of the outstanding shares of OurPet’s/Napro in exchange for 8,000,000 shares of Manticus common stock. After the transaction, the former holders of OurPet’s/Napro shares owned approximately 89% of Manticus’ shares. Effective August 10, 1998, OurPet’s/Napro was merged into Manticus and ceased to exist. Prior to this merger no affiliation or other relationship existed between Manticus and us or our shareholders. As operations for the newly merged entity were, and continue to be, conducted in Ohio, Manticus proceeded to become licensed in the State of Ohio as a foreign corporation, known as OurPet’s Company. Effective October 12, 1998, Manticus’ Articles of Incorporation was amended in the State of Colorado to reflect its new name as OurPet’s Company. After the merger, management of the former OurPet’s/Napro assumed management of the surviving company.

We develop and market products for improving the health, safety, comfort and enjoyment of pets. The products sold have increased from the initial “Big Dog Feeder” to approximately 260 products for dogs, cats, domestic and wild birds and other small animals. Products are marketed under the OurPet’s, Pet Zone, SmartScoop, ecopure Naturals, Play-N-Squeak, Durapet, Go! Cat Go!, and DockDogs labels to customers, both domestic and foreign. The manufacturing of these products is subcontracted to other entities, both domestic and foreign, based upon price and quality.

According to the 2007/2008 APPMA National Pet Owners Survey, published by the American Pet Products Manufacturers Association, Inc ® , approximately 71.1 million U.S. households currently own a pet, with an estimated pet population of 74.8 million dogs, 88.3 million cats and 16.0 million birds.

 

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We sell our products in the following market segments:

mass retailers—eg. Wal-Mart, Kmart

pet superstores—eg. PetsMart, Petco

pet catalogues—eg. Drs. Foster & Smith, Care-A-Lot

general catalogues—eg. Solutions

clubs—eg. Costco, Sam’s Club

grocery chains—eg. Ahold, Safeway, Publix

pet food makers—eg. Friskies, Ralston Purina

pet distributors/pet dealers—eg. Wolverton, Central Garden & Pet

The companies listed above are intended to serve as examples solely for illustrative purposes. As a standard industry practice, price lists are provided to distributors, who in turn place products with retailers. Larger retailers with a national presence will generally order product directly from us pursuant to the price list and subject to negotiated additional terms, if any. With the exception of a written price list, many of the arrangements with retailers or distributors are verbal and written contracts often do not exist. Customers submit their own standard purchase orders based on our current price list. Even the larger retailers, which might have written contracts with us, are under no obligation to purchase specific product from us. While all of the above companies may currently buy product from OurPet’s, none of these customers are under any contractual obligation to purchase a specific volume of product nor to continue making any purchases in the future. We currently have approximately 200 customers to whom we sell products, with the total number and identity of our customers changing from time to time. With the exceptions of PetsMart and Wal-Mart none of our customers account for 10% or more of our sales. While we had approximately 200 customers for the year ended December 31, 2007, 51.1% of our revenue was derived from Wal-Mart and PetsMart. Revenue generated from each of these customers amounted to $2,781,821 and $2,612,842, respectively, which represents 26.3% and 24.8% of total revenue.

We currently market products such as dog, cat and bird feeders, dog and cat toys, cat and dog waste management products, and natural and nutritional pet supplements and topical products. We conduct our marketing and sales activities through nine in-house officers and/or employees and 80 independent sales agents. Domestic independent sales agents are paid commissions, which range from 3% to 15% of net sales to customers.

Our marketing strategies include, among others, trade shows, customer visitation, telemarketing, direct mail, trade journal advertising, product sampling programs and customer support programs, such as advertising and promotional allowances.

We are one of many small companies in the accessory and consumable pet products market with no measurable percentage of that market. Our competition in the healthy feeding systems, interactive toys and healthy consumable products markets are both domestic and foreign companies, many of whom manufacture their products in low cost areas such as Mexico and the Far East.

Most of our products are proprietary and we have been granted or assigned 45 United States patents for dog and cat feeders and have 56 United States patents pending for cat and dog toys, dog feeders and natural and nutritional pet supplements and treats. We registered our logo, “OurPet’s”, as a registered trademark. To protect our trade names we obtained 30 additional trademark registrations and applied for 6 trademark registrations, which are still pending.

As of March 17, 2008, we had 23 full-time employees consisting of four officers, six other employees in sales and marketing, one employee in engineering, four employees in finance and administration, two employees in operations and six employees in warehousing and shipping. We do not have any employees in manufacturing since that operation is subcontracted to outside vendors. None of our employees are subject to a collective bargaining agreement and we have not experienced any work stoppages, nor to our knowledge, are any threatened.

 

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We conduct our own research and development activities and also use outside sources to perform specific projects such as engineering drawings and prototype models. Research and development costs are charged to expenses as incurred, and totaled $153,184 for the year ended December 31, 2007 and $113,622 for the year ended December 31, 2006.

Risk Factors

We are still building our market presence and are subject to substantial competition that could inhibit our ability to succeed as planned.

We are one of many small companies in the pet product market with no measurable percentage of that market. We are still building our market presence as we compete with both domestic and foreign companies, many of whom manufacture their products in low cost areas such as Mexico and the Far East. Any reputation that we may successfully gain with retailers for quality product does not necessarily translate into name recognition or increased market share with the end consumer. Our products may not be well received by the pet owners, or other companies may surpass us in product innovations. Certain retailers have been adversely impacted by economic conditions causing them to file for bankruptcy protection. This could adversely effect our sales, if this trend continues or these retailers are unable to emerge from bankruptcy protection.

Additional financing may not be available when required by us.

We may need additional financing for new product launches, warehouse equipment, working capital, research and development of new products, strategic acquisitions, and molds and tooling to produce new products. If the financial resources are not available when needed, or are not available on affordable terms, then our ability to increase our sales and profits will be hampered, which in turn harms our financial performance.

The loss of key personnel could adversely affect our operations.

We are and will continue to be dependent on our key management personnel: Dr. Steven Tsengas, Chairman, President and Chief Executive Officer; Konstantine S. Tsengas, Vice President of Operations and Secretary; Scott T. Fitzhugh, Vice President of Sales and Marketing, and John G. Murchie, Vice President, Treasurer and Controller. The loss of one or more of these individuals could have a material adverse effect on our business and operations. In addition, we will need to attract and retain other qualified individuals to satisfy our personnel needs. We do not have employee contracts with our key personnel and may not succeed in retaining our key management personnel or in attracting and retaining new employees.

The inability to successfully obtain or protect our patents could harm our competitive advantage.

Our success will depend, in part, on our ability to maintain protection for our products under United States patent laws, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. We have 45 U.S. patents issued or assigned and 56 U.S. patent applications pending. Patent applications may not successfully result in an issued patent. Issued patents are still subject to challenges and infringements. Furthermore, others may independently develop similar products or otherwise circumvent our patent protection. Should we fail to obtain and protect our patents, our competitive advantage will be harmed.

The inability to successfully defend the alleged patent infringement actions against us would result in loss of business and expense.

We are currently defending litigation filed against us by a competitor that alleges that we infringed upon certain patents for self-cleaning litter boxes. If we are not successful in defending this litigation we would not be able to sell our SmartScoop™ self-scooping cat litter box and we would incur costs for damages paid to our competitor and for the write-off of our product development and tooling costs for our product.

 

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The exercise of too many warrants and stock options would dilute the value of the Common Stock, and stockholder voting power.

We currently have 15,243,984 shares of Common Stock outstanding which could be diluted by the following potential issuances of Common Stock. As of March 17, 2008, we had outstanding 66,000 shares of Convertible Preferred Stock (“Preferred Stock”) convertible into 660,000 shares of Common Stock at a conversion rate of $1.00 per share. Also as of March 17, 2008, we had outstanding 4,286,509 warrants to purchase an aggregate of 4,286,509 shares of Common Stock at exercise prices ranging from $0.284 to $1.444 per share and options to purchase an aggregate of 1,035,500 shares of Common Stock at exercise prices ranging from $0.21 to $1.55 per share. We have reserved an aggregate of 1,350,000 shares of Common Stock for issuance under the 1999 Stock Option Plan as of the date of this Report. In addition, the exercise of such warrants and options could have a material adverse effect on the future market price of, and liquidity in the market for, shares of Common Stock trading in the over-the-counter market. Further, while these warrants and options are outstanding, our ability to obtain additional financing on favorable terms may be adversely affected.

Resale of our securities are and will continue to be subject to restrictions.

Our securities are subject to Rule 15g-9 under the Exchange Act, which imposes additional sales practice requirements on broker-dealers that sell securities to persons other than established customers and “accredited investors” (generally, individuals with a net worth in excess of $1,000,000 or an annual income exceeding $200,000 or $300,000 together with their spouse). For transactions covered by such rule, a broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written consent to the transaction prior to the sale. Consequently, this rule may adversely affect the ability of broker-dealers to sell our securities and may adversely affect the ability of the holders of our securities to sell such securities in the secondary market.

SEC regulations define a “penny stock” to be any non-NASDAQ equity security that has a market price (as therein defined) of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. Prior to any transaction involving a penny stock, unless exempt, SEC rules require delivery of a disclosure schedule prepared by the broker-dealer relating to the penny stock market. Disclosure is also required to be made about commissions payable to both the broker-dealer and the registered representative and about current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.

Possible Volatility of Market Price of Common Stock.

The market price of our securities, like that of many other emerging companies, has been highly volatile, experiencing wide fluctuations not necessarily related to the operating performance of such companies. Factors such as our operating results, announcements by us or our competitors concerning innovations and new products or systems may have a significant impact on the market price of our securities. In addition, we have experienced, and expect to continue experiencing limited trading volume in our Common Stock.

Item 2. Description of Property.

We lease a 64,000 square foot production, warehouse and office facility in Fairport Harbor, Ohio from a related entity, Senk Properties, at a current monthly rental of $26,667 plus real estate taxes. Senk Properties is a general partnership comprised of Dr. Steven Tsengas, Konstantine S. Tsengas, Nicholas S. Tsengas and Evangelia S. Tsengas. Dr. Tsengas is our Chairman, President, Chief Executive Officer, a director and a major stockholder of the Company. Konstantine Tsengas is our Vice President and Secretary, as well as being a stockholder. Nicholas Tsengas and Evangelia Tsengas are both stockholders of OurPet’s. We have entered into a new ten year lease with Senk Properties which was effective upon completion of the 36,000 square foot warehouse expansion on June 1, 2007. The monthly rental is $26,667 for the first two years, $28,417 for the next

 

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two years, $30,167 for the next three years, $32,000 for the next two years, and $33,750 for the last year, all plus real estate taxes. We have the option to extend the lease for an additional ten years at a rent amount to be mutually agreed upon. We believe that this facility will provide adequate warehouse and office space to meet our needs for the foreseeable future. Any longer-range future growth can be accommodated by expanding that facility or leasing nearby space.

In the opinion of our management, all of the properties described here are adequately covered by insurance and such coverage is in accordance with the requirements contained in our various debt agreements.

Item 3. Legal Proceedings.

On March 31, 2000, SMP Company, Incorporated (formerly known as Sanar Manufacturing, Inc.) (“SMP”), a wholly-owned subsidiary of the Company, entered into an asset purchase agreement with Akon Plastic Enterprises, Inc. (“Akon”) whereby Akon agreed to purchase substantially all of the assets used by SMP in molding plastics. Further, as part of the sale, Akon and its President, David F. Harman (“Harman”), entered into an Indemnity Agreement whereby Akon and Harman, jointly and severally, agreed to indemnify us and the individual guarantors of the Small Business Administration loans to SMP against any liability for such loans, which were assumed as a part of the asset purchase by Akon. On June 5, 2003, we filed an action against Akon, the directors of Akon, and Harman in the Court of Common Pleas of Lake County, Ohio for damages, including non-payment of loans, due to Akon’s breach of the asset purchase agreement. Discovery has been completed and the parties to the litigation have each filed motions for summary judgment. The action remains pending as the court has not ruled yet on the summary judgment motions. While we believe that our case against Akon, its directors, and Harman is strong, we cannot predict the likely outcome of this action.

On October 12, 2007, Applica Consumer Products, Inc. (“Applica”) filed an action in the U.S. District Court, Eastern District of Texas, against the Company alleging patent infringement of certain of its patents. Applica has alleged that the Company’s SmartScoop™ self-scooping cat litter box infringes upon patents Applica controls for self-cleaning litter boxes. Applica is seeking damages and a permanent injunction prohibiting the Company from further infringement of Applica’s patents. The case is currently in the discovery stage. On or about December 2, 2007, Applica filed a complaint with the U.S. International Trade Commission in Washington D.C. whereby Applica is seeking an order that permanently excludes the Company from importing products that allegedly infringe on Applica’s patents. The Company believes these actions to be without merit and is vigorously defending against them.

In addition to the above matters and in the normal course of conducting its business, we may become involved in various other litigation, including, but not limited to, preference claims by debtors in bankruptcy proceedings. We are not a party to any litigation or governmental proceeding which our management or legal representatives believe could result in any judgments or fines against us that would have a material adverse effect or impact in our financial position, liquidity or results of operation.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2007.

 

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PART II

Item 5. Market For Common Equity, Related Stockholder Matters, and Small Business Issuer Purchases of Equity Securities.

Our Common Stock has been quoted on the Over-The-Counter Bulletin Board Market under the symbol “OPCO” since December 13, 2001. The following table sets forth, for each of the quarters indicated, the high and low bid quotations per share of Common Stock in the over-the-counter market (source, the Nasdaq Stock Chart). The bid quotations in the over-the-counter market represent prices between securities dealers, do not include retail markups, markdowns or commissions and may not represent actual transactions.

 

Quarter Ended

   High    Low

March 31, 2006

   0.55    0.40

June 30, 2006

   0.74    0.41

September 30, 2006

   0.70    0.35

December 31, 2006

   1.15    0.38

March 31, 2007

   1.15    0.74

June 30, 2007

   1.85    0.81

September 30, 2007

   1.73    1.07

December 31, 2007

   1.35    0.65

As of March 17, 2008, we had approximately 137 holders of record of Common Stock.

During 2007, the Company granted a stock option to an employee under its 1999 Stock Option Plan, which issuance we believe is an exempt transaction under Section 4(2) of the Securities Act. The option granted is as follows:

 

Date

Granted

  

Employee

  

Number of Shares

  

Price

  

Expiration Date

8/20/2007

   Meranda L. Myers    5,000    $ 1.55    8/20/2012

Each share of Common Stock has an equal right to receive dividends when and if the Board of Directors decides to declare a dividend after payment of any accrued dividends on Preferred Stock. We have never paid any cash dividends nor do we intend, in the foreseeable future, to make any cash distributions to our common stockholders as dividends. We cannot currently distribute cash dividends without violating our loan agreement with our bank.

There are no conversion rights or redemption or sinking fund provisions with respect to the Common Stock. All of the outstanding shares of Common Stock are fully paid and non-assessable.

 

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Item 6. Management’s Discussion and Analysis or Plan of Operation.

Overview

OurPet’s develops, designs, produces and markets a broad line of innovative, high-quality accessory and consumable pet products. These products include healthy feeding systems to improve the health and comfort of pets, interactive toys that provide fun, rewarding mental and physical challenges for pets, innovative maintenance to enhance the required maintenance needs of pets, and healthy consumable products for achieving and maintaining high mental, physical and immune levels of pets. Examples of products in each of these categories include the following:

 

Healthy Feeding Systems

     -   Pet Diners
       Stainless Steel Bowls
       Automatic Feed and Water Dispensers
       Portable Dog Products
       Domestic and Wild Bird Feeders

Interactive Toys

     -   Dog and Cat Toys
       Plush Toys
       Food Delivery Toys
       Talking Bird Mirrors

Innovative Maintenance

     -   Self-scooping Cat Litter Boxes
       Waste Management Products
       Premium Cat Litter

Healthy Consumables

     -   Nutritional Supplements
       Ice Cream Alternatives
       Gourmet Gravies
       Gourmet Sprays

These products are manufactured by domestic and foreign subcontractors and then sold by us to retailers and distributors who sell the products to the end consumer. According to the 2007/2008 APPMA National Pet Owners Survey approximately 71.1 million U.S. households currently own a pet with an estimated pet population of 74.8 million dogs, 88.3 million cats and 16.0 million birds.

As discussed below and in Liquidity and Capital Resources on Pages 11, 12, and 13, we have funded our operations principally from net cash provided by operating activities and with bank borrowings during 2007 and 2006.

During 2007 we had a net borrowing of $400,000 from our line of credit facility with our bank under which we can borrow up to $2,000,000 based on the level of qualifying accounts receivable and inventories. At December 31, 2007 and December 31, 2006 we had balances of $1,700,000 and $1,300,000, respectively, under the line of credit with the bank at an interest rate of prime plus .75%.

In March of 2007, we executed an additional promissory note in favor of our bank under which we could borrow up to $300,000 for working capital and equipment purchase purposes. The note is payable in monthly payment of $9,362 including interest at 7.60% beginning in July of 2007 with interest only on amounts borrowed required to be paid in April through June of 2007. In connection with this new borrowing, we entered into an Amendment to Loan Agreement with our bank to modify our borrowing base and certain loan covenants.

In February of 2008, we entered into contribution agreements with six contributors, all of which are affiliated with the Company, pursuant to which each contributor loaned certain funds to us totaling $600,000. These funds will be used by us for expenses related to litigation on certain of its SmartScoop™ products and for expenses related to new product development. In consideration for these loans we (a) executed promissory notes

 

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due in two years with interest accruing at prime plus 2%, (b) issued warrants for the purchase of 300,000 shares of our Common Stock at an option price of $0.825 per share and (c) entered into piggyback registration rights agreements with the contributors.

Results of Operations

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

In the following discussion all references to 2007 are for the year ended December 31, 2007 and all references to 2006 are for the year ended December 31, 2006.

Net revenue for 2007 was $10,561,204, an increase of 11.9% in revenue from $9,441,697 in 2006, consisting of sales of proprietary products for the retail pet business. This increase of $1,119,507 was the result of an increase in sales of approximately $241,000 to our two major customers due to promotions of existing products and sales of new products. The balance of the increase was from sales to other customers which increased by approximately $879,000 including both sales of new products and sales to new customers. Total sales to all customers of new products in 2007 that were not sold in 2006, including the Dog and Cat Beds, Carriers, and Crates, Healthy Pet Diners, Anti-Stick and Odor Control Sprays, Play-N-Squeak Aquatic Items, and Smart-Scoop™ self-scooping cat litter boxes, were approximately $1,020,000. Our sales to foreign customers increased by approximately $215,000, or 79.4%, from 2006 mainly due to increased sales to customers in Canada, England and Korea.

While net revenue increased by 11.9% in 2007, cost of goods sold also increased by 12.6%, from $6,874,036 in 2006 to $7,743,553 in 2007. This increase of $869,517 was as a result of an increase of 11.2% in the cost of purchased products sold and freight due to the increased volume of products sold and higher freight costs as a result of increased fuel surcharges by our freight carriers. These increases were partially offset by higher gross margins on certain of our products. Our variable and fixed warehouse and overhead costs increased by 19.6% from 2006 due to (i) increased costs for salaries and wages of approximately $81,000 for additional employees in warehouse supervision and logistics, (ii) increased costs for depreciation of approximately $74,000 for tooling, and (iii) the rental cost for our new warehouse of approximately $40,000 which began in June 2007.

The net revenue increased by 11.9% and the cost of goods sold increased by 12.6% , which resulted in our gross profit on sales increasing by only 9.7%, or $249,990, from $2,567,661 in 2006 to $2,817,651 in 2007.

Selling, general and administrative expenses in 2007 were $2,283,585, an increase of $349,103, or 18.0%, from $1,934,482 in 2006. The significant increases were in (i) increased salaries and wages, payroll taxes and employee benefits of approximately $96,000 due to an additional employee in sales and marketing and an additional employee in administration and the increased accruals for payroll taxes and benefits due to the additional employees, (ii) increased sales and marketing expenses of approximately $61,000 mainly due to promotional expenses by our customers and increased cash discounts allowed to our customers resulting from higher sales, and (iii) accruals for commissions due to our sales representatives of approximately $97,000 mainly due to increased sales in 2007.

Income from our operations decreased by $99,113, from $633,179 in 2006 to $534,066 in 2007 as a result of our gross profit on sales increasing by $249,990, or 9.7%, which was less than the increase in selling, general and administrative expenses of $349,103, or 18.0%.

Interest expense for 2007 was $169,740 an increase of 1.4%, or $2,343, from $167,397 in 2006. This increase was primarily due to the interest expense for the bank term notes which increased by approximately $10,000 due to the new borrowing in 2007 of $300,000 which was more than the decrease of approximately $8,000 due to the reduction in principal balance of the Pet Zone loan.

 

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Litigation expenses were $182,381 for legal fees and expenses in 2007 as a result of us defending patent infringement actions filed against us in 2007 by a competitor alleging that our SmartScoop™ self-scooping cat litter box infringes on their patents.

Income before extraordinary items for 2007 was $186,886 as compared to $473,425 for 2006 or a decrease in profitability of $286,539. This decrease was mainly the result of our litigation expense of $182,381 in 2007 which did not occur in 2006 and the decrease in our income from operations of $99,113.

In 2006 we had an extraordinary gain realized from the debt forgiveness of $87,500 as a result of our executing an amended subordinated promissory note agreement with Pet Zone which reduced the subsequent payments due under the agreement.

The net income for 2007 was $186,886 as compared to net income in 2006 of $560,925 or a decrease in profitability of $374,039. This decrease was as a result of the following changes from 2006 to 2007:

 

Net revenue increase of 11.9%

   $ 1,119,507  

Cost of goods sold increase of 12.6%

     (869,517 )
        

Gross profit on sales increase of 9.7%

     249,990  

Selling, general and administrative expenses increase of 18.0 %

     (349,103 )

Other income and expense

     (2,702 )

Interest expense increase of 1.4%

     (2,343 )

Litigation expense

     (182,381 )

Extraordinary item

     (87,500 )
        

Decrease in Profitability

   $ (374,039 )
        

Liquidity and Capital Resources

Our operating activities provide cash by the sale of our products to customers with the principal use of cash being for the payments to suppliers that manufacture our products and for freight charges for shipments to our warehouse and to our customers. Our investing activities use cash mostly for the acquisition of equipment such as tooling, computers and software. Our financing activities provide cash, if needed, under our line of credit with our bank that had approximately $31,000 in available funds at December 31, 2007 based upon the balance of accounts receivable and inventories at that date.

As of December 31, 2007, we had $2,283,512 in principal amount of indebtedness consisting of:

 

Bank line of credit

   Prime plus .75%    $ 1,700,000

Bank term note

   7.60%      254,931

Bank term note

   7.75%      89,999

Pet Zone Products Ltd term loan

   7.75%      104,868

Installment notes payable

   7.0% to 7.5%      33,714

Other notes payable

   Prime plus 3% & 10%      100,000

The bank line of credit borrowing of $1,700,000 is under a line of credit agreement with our bank under which we can borrow up to $2,000,000 based on the level of qualifying accounts receivable and inventories. The line of credit agreement is renewable annually by the bank and therefore is classified as a current liability on our balance sheet. Currently the agreement has been renewed by the bank through September 30, 2008. Under our agreement with the bank we are currently required to: (i) maintain a debt service coverage ratio of 1.15; (ii) maintain a tangible net worth of $3,000,000; and (iii) obtain permission from the bank to incur additional indebtedness, enter into additional leases that would cause total lease payments to exceed $190,280 in any fiscal

 

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year, make any expenditures for property and equipment in excess of $300,000 in any fiscal year, or pay cash dividends other than dividends on our Preferred Stock subject to meeting the debt service coverage ratio or redeem any of our capital stock.

The installment notes payable are due in decreasing monthly payments from $3,554 to $801 including interest through March 2012. The other notes payable are due in the amount of $75,000 on February 1, 2009 to Beachcraft L.P. and $25,000 on July 31, 2008 to Over the Hill Ltd., plus accrued interest. Our indebtedness, which is secured by liens on our assets, was used to finance our equipment and working capital requirements. The agreements related to such indebtedness contain the customary covenants and default provisions.

The note payable to Beachcraft L.P. was originally for $150,000, $75,000 of which was repaid in 2003. As of February 1, 2004, a new note payable to Beachcraft L.P. was issued to replace the $75,000 remaining balance. The replacement note is due on February 1, 2009 with interest payable quarterly at prime plus 3%. In consideration for this refinancing we issued warrants for the purchase of 56,250 shares of Common Stock to Beachcraft L.P. at an exercise price of $0.30 per share with an expiration date of February 1, 2010. Subsequent to their issuance the warrants were adjusted to 57,204 warrants exercisable at $0.295 per share in accordance with the warrant anti-dilution provisions. These warrants were exercised in 2007.

Our short-term and long-term liquidity will depend on our ability to achieve cash-flow break even on our operations and to increase sales of our products. We recorded a profit of approximately $187,000 for the year ended 2007 and $561,000 for the year ended 2006. Absent a failure to maintain the required debt service coverage ratio and the tangible net worth required by our bank to maintain our line of credit, we should be able to fund our operating cash requirements for 2008. We have no material commitments for capital expenditures.

A schedule of our contractual obligations as of December 31, 2007 is as follows:

 

     Payments Due By Period

Contractual Obligation

   Total    Less than 1
year
   1-3
years
   4-5
years
   After 5
years

Long-Term Debt

   $ 2,283,512    $ 2,032,857    $ 242,642    $ 8,013    $ -0-

Capital Lease Obligations

     -0-      -0-      -0-      -0-      -0-

Purchase Obligations

     -0-      -0-      -0-      -0-      -0-

Other Long Term Liabilities

     -0-      -0-      -0-      -0-      -0-

Operating Leases

     3,937,715      347,009      760,315      805,919      2,024,472
                                  

Total Contractual Cash Obligations

   $ 6,221,227    $ 2,379,866    $ 1,002,957    $ 813,932    $ 2,024,472
                                  

Net cash provided by operating activities for the year ended December 31, 2007 was $73,299. Cash was provided by the net operating income for the year of $667,498, including the non-cash charges for depreciation of $430,750, amortization of $25,439, and stock option expense of $24,423. Cash was used for the net change of $(594,199) in our operating assets and liabilities as follows:

 

Accounts receivable increase

   $ (78,578 )

Inventories increase

     (546,532 )

Prepaid expenses increase

     (42,838 )

Patent cost increase

     (29,005 )

Other assets increase

     (4,666 )

Accounts payable increase

     149,580  

Accrued expenses decrease

     (42,160 )
        

Net change

   $ (594,199 )
        

 

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The increase in inventory of $546,532 from December 31, 2006 to December 31, 2007 was caused principally by the increase in finished goods inventory due to an increase in the number of products that we sell. Our accounts payable increased from December 31, 2006 to December 31, 2007 by $149,580 mainly due to the increased amount of finished goods being purchased in December 2007 as compared to December 2006.

Net cash used in investing activities for the year ended December 31, 2007 was $632,078, which was used for the acquisition of property and equipment. Net cash provided by financing activities for the year was $557,222. Cash of $400,000 was provided by the net borrowing under the line of credit agreement with the bank, $328,376 was provided by the issuance of long-term debt and $33,753 was provided by issuances of Common Stock. Cash of $204,907 was used for the principal payments on long-term debt.

Net cash provided by operating activities for the year ended December 31, 2006 was $499,611. Cash was provided by the net operating income for the year of $825,477, including the non-cash charges for depreciation of $330,907, amortization of $21,145 and extraordinary item of $87,500. Cash was used for the net change of $(325,866) in our operating assets and liabilities excluding the changes as a result of the Pet Zone purchase. These changes consisted of increases in inventories of $259,909, patent cost of $23,625 and other assets of $768, and a decrease in accounts payable of $128,002, which were partially offset by decreases in accounts receivable of $22,954, prepaid expenses of $62,223 and a increase in accrued expenses of $1,261.

Net cash used in investing activities for the year ended December 31, 2006 was $1,064,881, which was used for the acquisition of a business and property and equipment. Net cash provided by financing activities for the year was $589,193. Cash of $300,000 was provided by the net borrowing under the line of credit with the bank and $467,595 was provided by the issuance of long-term debt. Cash of $178,402 was used for the principal payments on long-term debt.

Critical Accounting Policies/Estimates

We prepare our consolidated financial statements in accordance with United States generally accepted accounting principles. We have identified the accounting policies below as critical to our business operations and understanding of our results of operations. For a detailed discussion on the application of these and other accounting policies, see Summary of Significant Accounting Policies footnote to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-KSB. The application of these policies may require management to make judgments and estimates that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.

Inventories. Inventories are stated at the lower of cost or net realizable value. We estimate net realizable value based on intended use, current market value and inventory ageing analyses. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Impairment of Long-Lived Assets. We review long-lived assets for possible impairment by evaluating whether the carrying amount of assets exceed its recoverable amount. Our judgment regarding the existence of impairment is based on legal factors, market conditions and operational performance of our assets. Future adverse changes in legal environment, market conditions or poor operating results could result in losses or an inability to recover the carrying value of the long-lived assets, thereby possibly requiring an impairment charge in the future.

 

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Research and Development Expenses. Research and development expenditures are charged to operations when incurred and are included in cost of goods sold. If funding is not available from operations our ability to develop new and/or improved products could be adversely affected.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 7. Financial Statements

The financial statements of OurPet’s Company as of December 31, 2007 and 2006, and for the years then ended together with the Report of Independent Registered Public Accounting Firm are included in this Form 10-KSB on the pages indicated below.

 

     Page No.

Report of Independent Registered Public Accounting Firm

   20

Consolidated Balance Sheets

   21-22

Consolidated Statements of Operations

   23

Consolidated Statements of Stockholders’ Equity

   24

Consolidated Statements of Cash Flows

   25

Notes to Consolidated Financial Statements

   26-38

Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

During our two most recent calendar years or any later interim period, there have been no changes in, or disagreements with, our principal independent accountant or a significant subsidiary’s independent accountant.

Item 8A(T). Controls and Procedures.

As of December 31, 2007, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Rule 13a-15(b) of the Securities Exchange Act of 1934. Based upon that evaluation, our President and Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including our consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal controls over financial reporting or in other factors which could significantly affect internal controls over financial reporting that occurred during our most recent fiscal quarter.

Management’s Report on Internal Control Over Financial Reporting

Management is responsible for the preparation and fair presentation of the financial statements included in this annual report. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and reflect management’s judgments and estimates concerning effects of events and transactions that are accounted for or disclosed.

Management is also responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting includes those policies and procedures that pertain to the Company’s ability to record, process, summarize and report reliable financial data. Management recognizes that there are inherent limitations in the effectiveness of any internal control over financial reporting,

 

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including the possibility of human error and the circumvention or overriding of internal control. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.

In order to insure that the Company’s internal control over financial reporting is effective, management regularly assesses such controls and did so most recently for its financial reporting as of December 31, 2007. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management has concluded that the internal control over financial reporting was effective as of December 31, 2007. 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 Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

The Board of Directors, acting through its Audit Committee, is responsible for the oversight of the Company’s accounting policies, financial reporting and internal control. The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of management. The Audit Committee is responsible for the appointment and compensation of the independent auditor. It meets periodically with management and the independent auditors to ensure that they are carrying out their responsibilities. The Audit Committee is also responsible for performing an oversight role by reviewing and monitoring the financial and accounting procedures of the Company in addition to reviewing the Company’s financial reports. The independent auditors have full and unlimited access to the Audit Committee, with or without management, to discuss the adequacy of internal control over financial reporting, and any other matter which they believe should be brought to the attention of the Audit Committee.

Item 8B. Other Information.

None.

 

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PART III

Item 9. Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with Section 16(a) of the Exchange Act.

The information required by this Item with respect to the directors, executive officers, promoters, control persons and compliance with Section 16(a) of the Securities and Exchange Act and our Code of Ethics is incorporated by reference from the information provided under the headings “Election of Directors”, “Executive Compensation” and “Other Matters”, respectively, contained in our Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our Annual Meeting of Shareholders to be held on May 30, 2008.

Item 10. Executive Compensation.

The information required by this Item is incorporated by reference from the information provided under the headings “Executive Compensation”, “Compensation of Directors” and “Employment Contracts and Termination of Employment and Change-in-Control Arrangements”, respectively, contained in our Proxy Statement.

Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information required by this Item is incorporated herein by reference from the information provided under the headings “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management” of our Proxy Statement.

Item 12. Certain Relationships and Related Transactions, and Director Independence.

The information required by this Item is incorporated herein by reference from the information provided under the heading “Certain Relationships and Related Transactions, and Director Independence” of our Proxy Statement.

Item 13. Exhibits.

 

2.1    Asset Purchase Agreement dated January 3, 2006, between the Company and Pet Zone Products Ltd.(5)
3.1    Articles of Incorporation of the Company, dated May 23, 1996.(1)
3.1.1    Articles of Amendment to the Articles of Incorporation of the Company, effective September 1, 1998.(1)
3.1.2    Articles of Amendment to the Articles of Incorporation of the Company, adopted July 20, 1999.(1)
3.2    Bylaws of the Company.(1)
4.1    Common Stock Certificate.(1)
4.2    Preferred Stock Certificate.(1)
4.3    Promissory Note dated September 1, 1999 for $200,000, made by the Company to Joseph T. Aveni.(1)
4.4    Registration Rights Agreement dated January 3, 2006 among the Company, Pet Zone Products Ltd. and certain other stockholders.(5)
4.5    Voting Agreement dated January 3, 2006 among the Company, Steven Tsengas, Evangelia S. Tsengas, Konstantine S. Tsengas, Nicholas S. Tsengas, Senk Properties, Joseph T. Aveni, Carl Fazio, Jr., John G. Murchie, Pet Zone Products Ltd., Capital One Partners, LLC, LJR Limited Partnership, Nottingham Ventures, Ltd. and Spirk Ventures, Ltd.(5)

 

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Table of Contents
10.1    Asset Purchase Agreement, dated March 31, 2000, between Akon Plastic Enterprises, Inc. and Sanar Manufacturing Company, a wholly-owned subsidiary of OurPet’s Company.(1)
10.2    Lease Agreement dated March 17, 1993, with Addendums, between Senk Properties and GPI Division, NAPRO, Inc.(1)
10.5    1999 Stock Option Plan.(1)
10.6    Standard Option Agreement.(1)
10.7    Standard Common Stock Purchase Warrant.(1)
10.8    Indemnity Agreement, dated March 31, 2000, between Akron Plastic Enterprises, Inc. and its President, David Herman, individually, and OurPet’s Company and Dr. Steven Tsengas, Evangelia Tsengas, Nicholas Tsengas and Konstantine Tsengas.(1)
10.10    Small Business Administration loan agreement dated March 10, 1995 with Napro, Inc.(1)
10.12    Vendor Agreement between the Company and Wal-Mart Stores, Inc.(1)
10.17    PetsMart 2001 Vendor Purchasing Terms.(1)
10.18    Credit Agreement, Revolving Note and Security Agreements, dated December 31, 2001, between FirstMerit Bank, N.A., the Company, Virtu Company, Dr. Steven Tsengas and Evangelia S. Tsengas.(2)
10.19    Promissory Note dated February 1, 2004 for $75,000, made by the Company to Beachcraft Limited Partnership.(4)
10.20    Warrant issued to Pet Zone Products Ltd. to purchase 2,729,000 shares of the Company’s Common Stock dated January 4, 2006.(5)
10.21    Warrant issued to Pet Zone Products Ltd. to purchase 125,000 shares of the Company’s Common Stock dated January 4, 2006.(5)
10.22    Subordinated Promissory Note dated January 4, 2006 from the Company to Pet Zone Products Ltd.(5)
10.23    Commercial Security Agreement by and between the Company and FirstMerit Bank, N.A.(6)
10.24    Promissory Note executed by the Company in favor of FirstMerit Bank, N.A.(6)
10.25    Lease Agreement dated March 1, 2007 between Senk Properties and OurPet’s Company.(7)
10.26    Amended Subordinated Promissory Note dated as of October 18, 2006, executed by OurPet’s Company in favor of Pet Zone Products Ltd.(8)
10.27    Cat Litter Device Development Agreement dated January 15, 2007 by and between Nottingham-Spirk Design Associates, Inc. and OurPet’s Company.(9)
10.28    Form of Indemnification Agreement, by and between OurPet’s Company and each of its Directors.(9)
10.29    Amendment to Loan Agreement dated March 23, 2007 between FirstMerit Bank, N.A. and OurPet’s Company.(10)
10.30    Promissory Note dated March 23, 2007 executed by the Company in favor of FirstMerit Bank, N.A.(10)
10.31    Commercial Security Agreement dated March 23, 2007 by and between the Company and FirstMerit Bank, N.A.(10)
10.32    Contribution Agreement dated February 7, 2008 among OurPet’s Company, Capital One Partners LLC, Nottingham Ventures Ltd., Spirk Ventures Ltd. and LJR Limited Partnership.(11)

 

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Table of Contents
10.33    Contribution Agreement dated February 7, 2008 among OurPet’s Company, Senk Properties and Dr. William M. Fraser.(11)
10.34    Form of Promissory Note issued by OurPet’s to each Contributor.(11)
10.35    Form of Warrant issued by OurPet’s to each Contributor.(11)
10.36    Form of Registration Rights Agreement among OurPet’s and the Contributors. (11)
11    Statement of computation of Net Income Per Share.
14    OurPet’s Code of Ethics. (3)
21    Subsidiaries of the Registrant. (1)
31.1    Certification of the Chief Executive Officer pursuant to 17 CFR Section 240.13a-14(a) of the Sarbanes-Oxley Act of 2002.
31.2    Certification of the Principal Financial Officer pursuant to 17 CFR Section 240.13a-14(a) of the Sarbanes-Oxley Act of 2002.
32.1    Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(1) Incorporated by reference to the exhibits to the Company’s Registration Statement on Form 10SB/A filed on May 31, 2001.

 

(2) Incorporated by reference to the exhibits to the Company’s Annual Report on Form 10-KSB filed on March 26, 2002.

 

(3) Incorporated by reference to the exhibits to the Company’s Annual Report of Form 10-KSB filed on March 26, 2004.

 

(4) Incorporated by reference to the exhibits to the Company’s Annual Report of Form 10-KSB filed on March 30, 2005.

 

(5) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on January 6, 2006.

 

(6) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on August 18, 2006.

 

(7) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on August 25, 2006.

 

(8) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on October 23, 2006.

 

(9) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on January 19, 2006.

 

(10) Incorporated by reference to the exhibits to the Company’s Annual Report of Form 10-KSB filed on March 28, 2007.

 

(11) Incorporated by reference to the exhibits to the Company’s Form 8-K filed on February 12, 2008.

All other Exhibits filed herewith.

Item 14. Principal Accountant Fees and Services.

The information required by this Item is incorporated by reference from the information provided under the heading “Principal Accountant Fees and Services” contained in our Proxy Statement.

 

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SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: March 28, 2008

 

O UR P ET S C OMPANY
By:   / S /    S TEVEN T SENGAS        
  Steven Tsengas
 

Chairman, President and Chief

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

  

Title

 

Date

/ S /    S TEVEN T SENGAS        

Steven Tsengas

  

Chairman, President, Chief Executive Officer and Director

(principal executive officer)

  March 28, 2008

/ S /    J OHN G. M URCHIE        

John G. Murchie

  

Vice President, Treasurer and Controller

(principal accounting officer)

  March 28, 2008

/ S /    J OSEPH T. A VENI        

Joseph T. Aveni

   Director   March 28, 2008

/ S /    W ILLIAM M. F RASER        

William M. Fraser

   Director   March 28, 2008

/ S /    J AMES D. I RELAND III        

James D. Ireland III

   Director   March 28, 2008

/ S /    J OHN S PIRK        

John Spirk

   Director   March 28, 2008

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

OurPet’s Company and Subsidiaries

We have audited the accompanying consolidated balance sheets of OurPet’s Company and Subsidiaries, a Colorado corporation, as of December 31, 2007 and December 31, 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of OurPet’s Company and Subsidiaries as of December 31, 2007 and December 31, 2006, and the consolidated results of their operations and cash flows for the years ended December 31, 2007 and December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

We were not engaged to examine management’s assertion about the effectiveness of OurPet’s Company and Subsidiaries’ internal control over financial reporting as of December 31, 2007, which is included in Form 10-KSB and, accordingly, we do not express an opinion thereon.

S. R. Snodgrass, A. C.

Certified Public Accountants

Mentor, Ohio

March 3, 2008

 

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OURPET’S COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     December 31,
     2007    2006
ASSETS      

CURRENT ASSETS

     

Cash and cash equivalents

   $ 28,843    $ 30,400

Accounts receivable—trade, less allowance for doubtful accounts of $22,216
and $21,322

     1,239,410      1,160,832

Inventories

     3,395,512      2,848,980

Prepaid expenses

     91,069      48,231
             

Total current assets

     4,754,834      4,088,443
             

PROPERTY AND EQUIPMENT

     

Computers and office equipment

     295,591      300,326

Warehouse equipment

     228,542      107,453

Leasehold improvements

     120,705      61,381

Tooling

     3,267,127      2,719,585

Construction in progress

     145,011      360,223
             

Total

     4,056,976      3,548,968

Less accumulated depreciation

     1,747,447      1,490,767
             

Net property and equipment

     2,309,529      2,058,201
             

OTHER ASSETS

     

Patents, less amortization of $112,442 and $87,003

     253,635      250,069

Goodwill

     67,511      67,511

Domain names and other assets

     16,821      12,155
             

Total other assets

     337,967      329,735
             

Total assets

   $ 7,402,330    $ 6,476,379
             

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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OURPET’S COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (CONTINUED)

 

     December 31,  
     2007     2006  
LIABILITIES     

CURRENT LIABILITIES

    

Notes payable

   $ 1,800,000     $ 1,400,000  

Current maturities of long-term debt

     232,857       148,911  

Accounts payable—trade

     1,170,225       1,020,645  

Accrued expenses

     122,813       164,973  
                

Total current liabilities

     3,325,895       2,734,529  
                

LONG-TERM DEBT

    

Long-term debt—less current portion above

     250,655       211,132  
                

Total long-term debt

     250,655       211,132  
                

Total liabilities

     3,576,550       2,945,661  
                
STOCKHOLDERS’ EQUITY     

COMMON STOCK,
no par value; authorized 50,000,000 shares, issued and outstanding 15,243,984 and 15,035,473 shares

     4,167,804       4,011,451  

CONVERTIBLE PREFERRED STOCK,
no par value; convertible into Common Stock at the rate of 10 common shares for each preferred share; authorized 5,000,000 shares, issued and outstanding 66,000 shares

     602,679       602,679  

PAID-IN CAPITAL

     40,809       88,986  

ACCUMULATED DEFICIT

     (985,512 )     (1,172,398 )
                

Total stockholders’ equity

     3,825,780       3,530,718  
                

Total liabilities and stockholders’ equity

   $ 7,402,330     $ 6,476,379  
                

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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OURPET’S COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     For the Years
Ended December 31,
 
     2007     2006  

Net revenue

   $ 10,561,204     $ 9,441,697  

Cost of goods sold

     7,743,553       6,874,036  
                

Gross profit on sales

     2,817,651       2,567,661  

Selling, general and administrative expenses

     2,283,585       1,934,482  
                

Income from operations

     534,066       633,179  

Other income and expense, net

     4,941       7,643  

Interest expense

     (169,740 )     (167,397 )
                

Income before litigation expense, extraordinary item, and income taxes

     369,267       473,425  

Litigation expense

     (182,381 )     —    
                

Income before extraordinary item and income taxes

     186,886       473,425  

Extraordinary item—debt forgiveness

     —         87,500  
                

Income before income taxes

     186,886       560,925  

Income tax expense

     —         —    
                

Net income

   $ 186,886     $ 560,925  
                

Basic and Diluted Earnings Per Common Share After Dividend Requirements For Preferred Stock:

    

Income before extraordinary item and income taxes

   $ 0.01     $ 0.03  

Extraordinary item

     —         —    
                

Net income

   $ 0.01     $ 0.03  
                

Weighted average number of common and equivalent shares outstanding used to calculate basic and diluted earnings per share

     17,680,760       15,520,362  
                

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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OURPET’S COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2007 AND DECEMBER 31, 2006

 

    Preferred Stock   Common Stock   Paid-In
Capital
    Accumulated
Deficit
    Total
Stockholders'
Equity
    Number of
Shares
  Amount   Number of
Shares
  Amount      

Balance at January 1, 2006

  66,000   $ 602,679   11,887,473   $ 2,925,751   $ 122,646     $ (1,733,323 )   $ 1,917,753

Common Stock issued for purchase of business

  —       —     3,082,000     1,052,040     —         —         1,052,040

Common Stock issued in payment of Preferred Stock dividend

  —       —     66,000     33,660     (33,660 )     —         —  

Net income for the year

  —       —     —       —       —         560,925       560,925
                                         

Balance at December 31, 2006

  66,000     602,679   15,035,473     4,011,451     88,986       (1,172,398 )     3,530,718

Common Stock issued for payment of product development fees

  —       —     50,454     50,000     —         —         50,000

Common Stock issued upon exercise of stock options

  —       —     13,333     4,067     —         —         4,067

Common Stock issued upon exercise of warrants

  —       —     78,724     29,686     —         —         29,686

Common Stock issued in payment of Preferred Stock dividend

  —       —     66,000     72,600     (72,600 )     —         —  

Net income for the year

  —       —     —       —       —         186,886       186,886

Stock-based compensation expense

  —       —     —       —       24,423       —         24,423
                                         

Balance at December 31, 2007

  66,000   $ 602,679   15,243,984   $ 4,167,804   $ 40,809     $ (985,512 )   $ 3,825,780
                                         

The accompanying notes are an integral part of the consolidated financial statements.

 

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OURPET’S COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Years Ended
December 31,
 
     2007     2006  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 186,886     $ 560,925  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation expense

     430,750       330,907  

Amortization expense

     25,439       21,145  

Stock option expense

     24,423       —    

Debt forgiveness

     —         (87,500 )

(Increase) decrease in assets:

    

Accounts receivable—trade

     (78,578 )     22,954  

Inventories

     (546,532 )     (259,909 )

Prepaid expenses

     (42,838 )     62,223  

Patent costs

     (29,005 )     (23,625 )

Domain name and other assets

     (4,666 )     (768 )

Increase (decrease) in liabilities:

    

Accounts payable—trade

     149,580       (128,002 )

Accrued expenses

     (42,160 )     1,261  
                

Net cash provided by operating activities

     73,299       499,611  
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Acquisition of business

     —         (597,068 )

Acquisition of property and equipment

     (632,078 )     (467,813 )
                

Net cash used in investing activities

     (632,078 )     (1,064,881 )
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Principal payments on long-term debt

     (204,907 )     (178,402 )

Net borrowing on bank line of credit

     400,000       300,000  

Issuances of Common Stock

     33,753       —    

Issuance of long-term debt

     328,376       467,595  
                

Net cash provided by financing activities

     557,222       589,193  
                

Net increase (decrease) in cash

     (1,557 )     23,923  

CASH AT BEGINNING OF YEAR

     30,400       6,477  
                

CASH AT END OF YEAR

   $ 28,843     $ 30,400  
                

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

    

Interest paid

   $ 166,846     $ 174,740  
                

SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS

    

Common Stock issued in payment of Preferred Stock dividend

   $ 72,600     $ 33,660  
                

Common Stock issued in payment of product development fees

   $ 50,000     $ —    
                

Common Stock issued in payment for acquisition of business

   $ —       $ 1,052,040  
                

Debt forgiveness

   $ —       $ 87,500  
                

The accompanying notes are an integral part of the consolidated financial statements.

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of Operations —OurPet’s Company (the “Company”) management originally founded Napro, Inc. (“Napro”), an Ohio corporation, in 1985 as an enterprise for launching new ventures and acquiring companies in various lines of business. In February 1996 Napro formed a wholly-owned Ohio subsidiary, Virtu Company (“Virtu”), to market proprietary products to the retail pet business under the OurPet’s label. Napro then changed its name to OurPet’s Company effective March 19, 1998. On July 16, 1998, Manticus, Inc. (“Manticus”) obtained all of the outstanding shares of OurPet’s Company in exchange for 8,000,000 shares of common stock of Manticus in a transaction accounted for as a pooling of interests. After the transaction, the holders of the former OurPet’s shares owned approximately 89% of the shares of Manticus, resulting in a reverse takeover. On October 12, 1998, Manticus changed its name to OurPet’s Company.

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of the Company and its wholly owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates —The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Policy of Cash Equivalents —For purposes of the financial statements, cash equivalents include time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.

Accounts Receivable —Accounts receivable have been adjusted for all known uncollectible accounts. An allowance for possible bad debts was established at December 31, 2007 and 2006 in the amount of $22,216 and $21,322, respectively.

Inventory —Inventories are carried at the lower of cost, first-in, first-out method or market. Inventories at December 31, 2007 and December 31, 2006 consist of:

 

     2007    2006

Finished goods

   $ 2,525,024    $ 2,203,227

Components and packaging

     870,488      645,753
             

Total

   $ 3,395,512    $ 2,848,980
             

All inventories are pledged as collateral for bank loans.

Impairments —Assets are evaluated for impairment when events change or change in circumstances indicates that the carrying amounts of the assets may not be recoverable. When any such impairment exists, the related assets are written down to fair value.

Property and Equipment —Property and equipment are reported at cost. Depreciation and amortization are provided by using the straight-line and units sold for certain tooling methods over the estimated useful lives of

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

the assets. Amortization of leasehold improvements is provided on a straight-line basis over the lesser of the useful lives of the related assets or the terms of the leases. The estimated useful lives of the assets are as follows:

 

Computers and office equipment

   3 to 7 years

Leasehold improvements

   20 to 39 years

Tooling

   3 to 7 years

Warehouse equipment

   5 to 7 years

All property and equipment is pledged as collateral for bank loans. Total depreciation for the years ended December 31, 2007 and December 31, 2006 was $430,750 and $330,907, respectively.

Intangible Assets —The Company adopted the provisions of FASB Statement 142 “Goodwill and Other Intangible Assets” which states that goodwill and other intangible assets that are subject to amortization are required to be tested for impairment at least annually.

The Company has filed for patents and trademarks for its proprietary products. The costs incurred of $29,005 in the year ended December 31, 2007 and $23,625 in the year ended December 31, 2006 have been capitalized and are being amortized over 15 years on a straight-line basis. In 2002 and 2006 the Company purchased domain names for its website for $11,000 which is not subject to amortization. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense. All intangible assets are pledged as collateral for the bank loans.

Revenue Recognition and Major Customers —With respect to revenue from product sales, revenue is recognized only upon shipment of products to customers. The Company derives its revenues from the sale of proprietary pet products under the OurPet’s and Pet Zone’s brand names. Net revenue is comprised of gross sales less discounts given to distributors and returns and allowances.

For the year ended December 31, 2007, 51.1% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $2,781,821 and $2,612,842, which represents 26.3% and 24.8% of total revenue, respectively.

For the year ended December 31, 2006, 54.6% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $2,738,092 and $2,415,186, which represents 29.0% and 25.6% of total revenue, respectively.

Research and Development Costs —Research and development costs are charged to operations when incurred and are included in cost of goods sold. The amount charged for the years ended December 31, 2007 and December 31, 2006 was $153,184 and $113,622, respectively.

Advertising Costs —Advertising costs are charged to operations when the advertising first takes place. Advertising expense for the years ended December 31, 2007 and December 31, 2006 was $32,852 and $30,671, respectively.

Shipping and Handling Costs —Shipping and handling costs for products sold are included in cost of goods sold when incurred.

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

Stock Options— In December 2004, the FASB issued FAS No. 123R, “Share-Based Payment”, which revised FAS 123, “Accounting for Stock-Based Compensation”, and superseded ABP Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations. FAS 123R requires the grant-date fair value of all share-based payment awards that are expected to vest, including employee share options, to be recognized as employee compensation expense over the requisite service period. The Company adopted FAS 123R on January 1, 2006 and applied the modified prospective transition method. Under this transition method, the Company (1) did not restate any prior periods and (2) is recognizing compensation expense for all share-based payment awards that were outstanding, but not yet vested, as of January 1, 2006, based upon the same estimated grant-date fair values and service periods used to prepare the FAS 123 pro-forma disclosures. The amount of compensation expense recognized in 2007 and 2006 as a result of stock options was $24,423 and not material, respectively.

Net Income Per Common Share —Basic and diluted net income per Common Share is based on the net income attributable to common stockholders after preferred stock dividend requirements for the year, divided by the weighted average number of common and equivalent dilutive shares outstanding during the year. Potential common shares whose effect would be antidilutive have not been included. As of December 31, 2007, common shares that are or could be potentially dilutive include 1,000,500 stock options at exercise prices from $0.210 to $1.550 a share, 3,986,509 warrants to purchase Common Stock at exercise prices from $0.284 to $1.444 a share and 660,000 shares underlying the Preferred Stock at a conversion rate of $1.000 per share. As of December 31, 2006, common shares that are or could be potentially dilutive include 994,500 stock options at exercise prices from $0.210 to $0.650 a share, 3,994,984 warrants to purchase Common Stock at exercise prices from $0.285 to $1.215 a share and 660,000 shares underlying the Preferred Stock at a conversion rate of $1.000 per share.

Fair Value of Financial Instruments —Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2007. The respective carrying value of certain on balance sheet financial instruments approximated their fair values. These financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses. The fair value of the Company’s long-term debt is estimated based upon the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The carrying value approximates the fair value of the debt.

Income Taxes —Deferred income tax assets and liabilities are recorded for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Recently Issued Accounting Pronouncements —In September 2006, the FASB issued FAS No. 157, Fair Value Measurements , which provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The Standard does not expand the use of fair value in any new circumstances. FAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Liabilities – Including an amendment of FASB Statement No. 115, which provides all entities with an option to

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

report selected financial assets and liabilities at fair value. The objective of the FAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting. FAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS No. 157, Fair Value Measurements . The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In December 2007, the FASB issued FAS No. 141 (revised 2007), Business Combinations (“FAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. FAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

 

NOTES PAYABLE AND LONG-TERM DEBT

 

     December 31,
     2007    2006

Revolving note payable—Bank, under line of credit facility of up to $2,000,000 with interest at prime plus .75% (8.00% at December 31, 2007 and 9.00% at December 31, 2006). The note is secured by accounts receivable, equipment, inventory, trademarks, patents and the personal guarantee of certain stockholders.

   $ 1,700,000    $ 1,300,000

Note payable—Bank, loan of $300,000, due in 36 monthly installments of $9,362 including interest at 7.60% beginning July 23, 2007. This note is secured by all inventory, chattel paper, accounts, equipment and general intangibles.

     254,931      —  

Note payable—Bank, loan of $300,000, due in 34 monthly installments of $9,870 including interest at 7.75% beginning February 1, 2006 and a payment of interest only on the principal balance on January 1, 2006. This note is secured by all inventory, chattel paper, accounts, equipment, general intangibles and the personal guarantee of certain directors.

     89,999      196,603

Note payable—Pet Zone Products Ltd, due in quarterly installments of $9,878 through December 31, 2010 including interest at 7.75%. This note is subordinated to the bank loans.

     104,868      134,789

Note payable—former director and shareholder, due on February 1, 2009. Interest at prime plus 3% (10.25% at December 31, 2007 and 11.25% at December 31, 2006) payable quarterly. This note is subordinated to the bank loans.

     75,000      75,000

Note payable—shareholder and investor, due on July 31, 2008. Interest is payable quarterly at 10%. This note is subordinated to the bank loan.

     25,000      25,000

Installment notes payable—due in monthly payments decreasing from $3,554 to $801 including interest through March 27, 2012. Interest rates range from 7% to 7.5%.

     33,714      28,651
             
     2,283,512      1,760,043

Less current portion of long-term debt

     2,032,857      1,548,911
             
   $ 250,655    $ 211,132
             

Future maturities of long-term debt are as follows:

 

Year Ending December 31,

   Amount

2008

   $ 2,032,857

2009

     144,119

2010

     98,523

2011

     6,353

2012

     1,660
      
   $ 2,283,512
      

The bank loan agreements contain various restrictive and customary covenants and default provisions under which the Company must obtain permission from its lender to (i) purchase or retire any of its capital stock; (ii) pay dividends in cash on any of its capital stock other than dividends on our Preferred Stock subject to meeting the debt service coverage ratio; (iii) exceed $ 300,000 annually for capital expenditures; and (iv) pay

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTES PAYABLE AND LONG-TERM DEBT (continued)

 

principal on subordinated notes due to officers and directors. In addition, the Company must follow certain other requirements as to maintaining a minimum debt service coverage ratio of at least 1.15 to 1.00 and an adjusted tangible net worth of at least $3,000,000.

In July and August of 2000, the Company borrowed a total of $275,000 from an officer, directors, and stockholders for working capital purposes at an annual interest rate of 10%. A note for $25,000 is due on July 31, 2008 with interest payable quarterly. Three of the notes for $100,000 were repaid in 2001 and 2003 by $31,250 in cash and conversion into 172,526 shares of Common Stock. Another of the notes for $150,000 was reduced to $75,000 by a $75,000 cash payment on December 30, 2003. On February 1, 2004 the reduced note of $75,000 was extended (now due February 1, 2009) at an interest rate of prime plus 3% payable quarterly. In addition the lender received 57,204 warrants for the purchase of Common Stock at $0.295 per share as adjusted for the Common Stock issued in payment of the Preferred Stock dividends in 2006, 2005 and 2004. These warrants were exercised in 2007.

INTANGIBLE ASSETS

 

     As of December 31, 2007    As of December 31, 2006
     Cost    Amortization    Cost    Amortization

Amortized intangible assets:

           

Patents and trademarks

   $ 366,077    $ 112,442    $ 337,072    $ 87,003

Unamortized intangible assets:

           

Domain names

   $ 11,000    $ —      $ 11,000    $ —  

Amortization expense for year ended 12/31

   $ 25,439       $ 21,145   

Estimated amortization expense:

           

For year ending 12/31/08

   $ 26,331         

For year ending 12/31/09

   $ 26,331         

For year ending 12/31/10

   $ 26.331         

For year ending 12/31/11

   $ 26,331         

For year ending 12/31/12

   $ 26,331         

RELATED PARTY TRANSACTIONS

The Company leases warehouse and office facilities from a related entity, Senk Properties at a current monthly rental of $26,667. The Company entered into a new ten year lease with Senk Properties which was effective upon completion of the 36,000 square foot warehouse expansion on June 1, 2007. The monthly rental is $26,667 for the first two years, $28,417 for the next two years, $30,167 for the next three years, $32,000 for the next two years, and $33,750 for the last year. The Company has the option to extend the lease for an additional ten years at a rental to be mutually agreed upon. Lease expense for the year ended December 31, 2007 and the year ended December 31, 2006 was $273,286 and $178,926, respectively.

On January 15, 2007, the Company entered an agreement with Nottingham-Spirk Design Associates, Inc. (“NSDA”), one of the principals of NSDA is John Spirk, a member of the Company’s Board of Directors and a shareholder. Also, NSDA indirectly owns shares of the Company through its ownership in Pet Zone Products, Ltd., a significant shareholder of the Company. The agreement addresses the invoicing and payment of NSDA’s

 

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OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

RELATED PARTY TRANSACTIONS (continued)

 

fees and expenses related to the development of certain products on behalf of the Company. Through December 31, 2007, the Company has been invoiced $677,481 by NSDA including $241,125 in deferred payments of which $50,000 was paid with 50,454 shares of the Company’s Common Stock. The balance of the deferred payments is payable as a royalty based upon sales of the developed products. To date the Company’s Board of Directors has approved $497,544 of NSDA’s fees and expenses.

CONCENTRATION OF CREDIT RISK

The Company maintains cash balances at a bank. Accounts at the institution are insured by the Federal Deposit Insurance Corporation up to $100,000. Bank balances, including outstanding checks, at December 31, 2007 and December 31, 2006 were $168,533 and $217,134, respectively, which results in uninsured balances of $68,533 and $117,134 at December 31, 2007 and December 31, 2006, respectively.

At December 31, 2007, 41.8% of the Company’s accounts receivable was due from three major customers. Amounts due from each of these customers were $311,478, $113,049, and $103,379, which represents 24.7%, 8.9%, and 8.2% of total accounts receivable, respectively.

At December 31, 2006, 50.5% of the Company’s accounts receivable was due from two major customers. Amounts due from each of these customers were $401,164 and $196,466, which represents 33.9% and 16.6% of total accounts receivable, respectively.

CAPITAL STOCK

From July through November 1999, the Company sold in a Private Placement 100,000 shares of no par value non-voting Convertible Preferred Stock. Each share of the Preferred Stock is convertible into ten shares of Common Stock at a conversion rate of $1.00 per share. The Company may redeem the preferred shares at $10 per share or convert each preferred share into ten common shares, at the option of the shareholder, at such time as the common shares are trading on a public exchange at a closing price of $4.00 or above for a period of ten consecutive business days. The holders of the Preferred are entitled to a 10% stock dividend paid annually in common shares beginning twelve months from the final close of the Private Placement. Under certain conditions, each Preferred shareholder may elect to receive a cash dividend in lieu of the Common Stock dividend.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

WARRANTS

 

At December 31, 2007, the Company had the following Common Stock purchase warrants outstanding, all of which were exercisable:

 

     Number of
Shares
   Exercise
Price
  

Expiration Date

1999 Issuance to related parties

   525,762    0.951    December 14, 2008

2001 Directors for fees

   7,304    1.198    October 1, 2009

2002 Payment for services

   25,825    1.210    August 3, 2009

2003 Note payable to director

   12,844    0.399    September 4, 2009

2004 Directors for feed

   57,183    0.284    October 1, 2012

2005 Directors for guarantees

   151,408    0.426    November 14, 2012

2006 Acquisition of business

   2,756,566    0.594    January 2, 2013

2006 Note payable to stockholder

   125,750    0.333    January 3, 2013

2006 Payment for services

   20,161    0.496    April 20, 2013

2006 Director for guarantee

   252,161    0.694    August 2, 2013

2007 Directors for fees

   51,545    1.444    August 17, 2012
          

Total

   3,986,509      
          

The exercise price for the common shares issuable under the warrants to purchase 2,756,566 shares is $0.594 per share if exercised on or before January 2, 2011 or $0.669 per share if exercised on or after January 3, 2011 and on or before January 2, 2012 or $0.744 per share if exercised on or after January 3, 2012 and on or before the expiration of the warrants on January 2, 2013.

The exercise price and number of warrant shares are subject to adjustment in the event of a Common Stock dividend or distribution, a stock split or reverse stock split, or reorganization of the Company. The financial statements reflect the adjustments for the Common Stock issued in payment of the Preferred Stock dividends.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

STOCK OPTION PLAN

 

On December 4, 1999, the Board of Directors approved the 1999 Stock Option Plan, which was approved by the shareholders on August 5, 2000. Stock options may be granted at the discretion of the Board of Directors for which the Company has reserved 1,350,000 shares of its Common Stock for issuance upon the exercise of options granted under the Plan. The options vest one-third on each of the second, third and fourth anniversaries of the date of grant and expire on the fifth anniversary of the date of grant. The Company grants stock options at exercise prices equal to or greater than the fair market value of the Company’s Common Stock on the date of grant. On May 8, 2003, the Board of Directors approved the adjustment of the exercise price of unexercised stock options to the higher of 50% of the existing exercise price or the current market price on May 8, 2003. The following table summarizes activity in options under the Plan:

 

     Number of
Shares
   Weighted Average
Exercise Price

Outstanding at January 1, 2006

   888,000    $ .33

Granted

   167,500      .50

Exercised

   —        —  

Forfeited

   11,000      .48

Expired

   50,000      .625
       

Outstanding at December 31, 2006

   994,500      .34

Granted

   46,000      1.13

Exercised

   13,333      .31

Forfeited

   26,667      .37

Expired

   —        —  
       

Outstanding at December 31, 2007

   1,000,500      .38
       

The following table summarizes options outstanding at December 31, 2007:

 

          Options Outstanding    Options Exercisable

Range

   Number
Outstanding
   Weighted
Average
Exercise
Price
  

Weighted
Average
Remaining
Contractual Life

   Number
Exercisable
   Weighted
Average
Exercise
Price

$0.85-$1.55

   46,000    $ 1.13    4.3 Years    —      $ —  

$0.45-$0.65

   145,500    $ 0.51    3.6 Years    2,666    $ 0.45

$0.21-$0.35

   809,000    $ 0.31    1.6 Years    525,499    $ 0.31

There were 528,165 and 268,999 options exercisable at December 31, 2007 and December 31, 2006, respectively. The weighted average exercise price of options granted in 2007 and 2006 was $1.13 and $0.50, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

OPERATING LEASES

 

Minimum future lease payments under operating leases as of December 31, 2007 are as follows:

 

2008

   $ 347,009

2009

     375,004

2010

     385,311

2011

     399,180

2012

     406,739

Thereafter

     2,024,472
      

Total minimum lease payments

   $ 3,937,715
      

Total rent expense of the Company for the years ended December 31, 2007 and December 31, 2006 was $295,172 and $255,801, respectively.

EXTRAORDINARY ITEM

On October 18, 2006, the Company executed an amended subordinated promissory note with Pet Zone Products Ltd. which reduced the subsequent payments due under the agreement. As a result of this extinguishment of debt the Company recognized an extraordinary gain of $87,500 during 2006.

INCOME TAXES

There were income tax benefits of $65,634 and $192,461 from use of operating loss carryforwards by the Company for the years ended December 31, 2007 and December 31, 2006, respectively.

Following is a reconciliation of the expected income tax expense/benefit to the amount based on the U.S. statutory rate of 34% for the years ended December 31, 2007 and December 31, 2006:

 

     2007     2006  

Income tax expense/benefit based on US statutory rate

   $ 65,634     $ 192,461  

Current period change in the valuation allowance

     (65,634 )     (192,461 )
                

Provision for income taxes

   $ —       $ —    
                

The significant components of the Company’s deferred tax assets and liabilities are as follows:

 

     December 31,  
     2007     2006  

Deferred tax assets:

    

Net operating loss carryforward

   $ 177,338     $ 242,972  

Valuation allowances

     (177,338 )     (242,972 )
                

Net deferred tax assets

   $ —       $ —    
                

The Company’s valuation allowance decreased by approximately $65,600 and $192,500 for the years ended December 31, 2007 and December 31, 2006, respectively, which represents the effect of net income. The

 

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Table of Contents

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

INCOME TAXES (continued)

 

Company has recorded a valuation allowance to record its deferred tax assets at estimated net realizable value due to the uncertainty of realization of these assets through future taxable income.

The Company has available at December 31, 2007, unused operating loss carryforwards that may be applied against future taxable income and that expire as follows:

 

Year Of Loss

   Amount of Unused
Operating Loss
Carryforwards
   Expiration
During Year
Ending

1999

   $ 113,151    2019

2000

     141,177    2020

2002

     267,255    2022
         
   $ 521,583   
         

LITIGATION

On March 31, 2000, SMP Company, Incorporated (formerly known as Sanar Manufacturing, Inc.) (“SMP”), a wholly-owned subsidiary of the Company, entered into an asset purchase agreement with Akon Plastic Enterprises, Inc. (“Akon”) whereby Akon agreed to purchase substantially all of the assets used by SMP in molding plastics. Further, as part of the sale, Akon and its President, David F. Harman (“Harman”), entered into an Indemnity Agreement whereby Akon and Harman, jointly and severally, agreed to indemnify us and the individual guarantors of the Small Business Administration loans to SMP against any liability for such loans, which were assumed as a part of the asset purchase by Akon. On June 5, 2003, we filed an action against Akon, the directors of Akon, and Harman in the Court of Common Pleas of Lake County, Ohio for damages, including non-payment of loans, due to Akon’s breach of the asset purchase agreement. Discovery has been completed and the parties to the litigation have each filed motions for summary judgment. The action remains pending as the court has not ruled yet on the summary judgment motions. While we believe that our case against Akon, its directors, and Harman is strong, we cannot predict the likely outcome of this action.

On October 12, 2007, Applica Consumer Products, Inc. (“Applica”) filed an action in the U.S. District Court, Eastern District of Texas, against the Company alleging patent infringement of certain of its patents. Applica has alleged that the Company’s SmartScoop™ self-scooping cat litter box infringes upon patents Applica controls for self-cleaning litter boxes. Applica is seeking damages and a permanent injunction prohibiting the Company from further infringement of Applica’s patents. On or about December 2, 2007, Applicia filed a complaint with the U.S. International Trade Commission in Washington D.C. whereby Applica is seeking an order that permanently excludes the Company from importing products that allegedly infringe on Applica’s patents. The Company believes these actions to be without merit and is vigorously defending against them.

In addition to the above matters and in the normal course of conducting its business, the Company may become involved in various other litigation, including, but not limited to, preference claims by debtors in bankruptcy proceedings. Other than the above matters the Company is not a party to any litigation or governmental proceeding which its management believes could result in any judgments or fines against it that would have a material adverse affect or impact in the Company’s financial position, liquidity or results of operations.

 

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Table of Contents

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

PURCHASE OF BUSINESS

 

On January 3, 2006, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Pet Zone Products Ltd. (“Pet Zone”) pursuant to which the Company purchased substantially all the assets and assumed certain liabilities of Pet Zone. The results of Pet Zone’s operations have been included in the consolidated financial statements since that date. Pet Zone manufactures and distributes pet supply products including cat, dog and bird feeders, storage bins, and cat and dog toys to pet specialty distributors and retailers, mass retailers and grocery chains, among others. The complementary strength of each company should allow significant product and distribution synergies to be realized with each company’s product sales being expanded to the other’s market segments and customers. The Company will gain potential entry into such new product categories as bird feeders, waste management products, and cat and dog furniture.

The purchase price for Pet Zone consisted of $455,928 in cash, subsequently adjusted to $494,505, 3,082,000 shares of the Company’s Common Stock valued at $1,052,040, and a warrant to purchase 2,729,000 additional shares of the Company’s Common Stock, subsequently adjusted to 2,756,566 shares in accordance with the warrant anti-dilution provisions.

The Purchase Agreement required Pet Zone to invest $250,000 in the Company in the form of a loan, evidenced by a subordinated note due in 20 quarterly payments of $15,197 including interest at 7.75% beginning March 31, 2006, with the proceeds to be used in the development of new products. In connection with this loan, the Company also issued Pet Zone a warrant to purchase 125,000 shares of Common Stock, subsequently adjusted to 125,750 shares in accordance with the warrant anti-dilution provisions. On October 18, 2006 the subordinated note was amended to require the remaining 17 quarterly payments be reduce to $9,878 including interest.

Also on January 3, 2006, the Company entered into a Registration Rights Agreement with Pet Zone and certain other stockholders holding the Company’s common shares and/or common shares issuable upon exercise of the warrants issued pursuant to the Purchase Agreement, which provides, among other things, certain piggyback registration rights to these stockholders and that the Company will file a registration statement with the Securities and Exchange Commission upon the demand of a majority of the stockholders holding registrable shares.

The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition.

At January 3, 2006:

 

Accounts receivable – trade

   $ 249,000  

Inventories

     502,000  

Equipment

     984,000  

Intangible assets

     40,000  

Goodwill

     68,000  
        

Total assets acquired

     1,843,000  
        

Accounts payable – trade

     (297,000 )
        

Total liabilities assumed

     (297,000 )
        

Net assets acquired

   $ 1,546,000  
        

 

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Table of Contents

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SUBSEQUENT EVENT

 

On February 7, 2008, the Company entered into contribution agreements with contributors, all of which are affiliated with the Company, pursuant to which each contributor loaned certain funds to the Company totaling $600,000. The funds will be used by the Company for expenses related to litigation on certain of its SmartScoop™ products and for expenses related to new product development. In consideration for the loans the Company (a) executed promissory notes with interest accruing at prime plus 2%, (b) issued warrants for the purchase of the Company’s Common Stock at an exercise price of $0.825 per share and (c) entered into piggyback registration rights agreements with the contributors.

 

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Exhibit 11

OURPET’S COMPANY AND SUBSIDIARIES

STATEMENT OF COMPUTATION OF NET INCOME PER SHARE

For the years ended December 31, 2007 and December 31, 2006

 

     2007     2006  

Income before extraordinary item

   $ 186,886     $ 473,425  

Preferred Stock dividend requirements

     (72,600 )     (33,660 )

Stock options expense

     —         (22,500 )
                

Income before extraordinary item attributable to common stockholders

   $ 114,286     $ 417,265  
                

Weighted average number of common and dilutive common equivalent shares outstanding

     17,680,760       15,520,362  
                

Income before extraordinary item per common share

   $ 0.01     $ 0.03  
                

Extraordinary item

   $     $ 87,500  
                

Extraordinary item per common share

   $     $  
                

Net income

   $ 186,886     $ 560,925  

Preferred Stock dividend requirements

     (72,600 )     (33,660 )

Stock options expense

     —         (22,500 )
                

Net income attributable to common stockholders

   $ 114,286     $ 504,765  
                

Net income per common share

   $ 0.01     $ 0.03  
                

 

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Exhibit 31.1

Certification of the Chief Executive Officer Pursuant to 17 CFR Section 240.13a-14(a)

I, Steven Tsengas, certify that:

1. I have reviewed this annual report on Form 10-KSB of OurPet’s Company.

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-15e) for the registrant and we have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

  c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and

 

  d) disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting.

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2008

/ S /    S TEVEN T SENGAS        

Chairman, President and Chief Executive Officer

(Principal Executive Officer)

 

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Exhibit 31.2

Certification of the Principal Financial Officer Pursuant to 17 CFR Section 240.13a-14(a)

I, John G. Murchie, certify that:

1. I have reviewed this annual report on Form 10-KSB of OurPet’s Company.

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-15e) for the registrant and we have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

  c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and

 

  d) disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting.

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2008

/ S /     J OHN G. M URCHIE        

Vice President, Treasurer and Controller

(Principal Financial Officer)

 

41

Exhibit 32.1

Certification Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of OurPet’s Company (the Company) on Form 10-KSB for the year ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, being the Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002, that:

 

  (1) I have reviewed this Report on Form 10-KSB for the year ended December 31, 2007 of OurPet’s Company.

 

  (2) This Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (3) The financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Report.

 

/ S /    S TEVEN T SENGAS        

BY STEVEN TSENGAS

Chairman of the Board, President and

Chief Executive Officer

Dated: March 28, 2008

This certification is made solely for the purpose of 18 U.S.C. Section 1350, subject to the knowledge standard contained in that statute, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to OurPet’s Company and will be retained by OurPet’s Company and furnished to the Securities and Exchange Commission or its staff upon request.

 

42

Exhibit 32.2

Certification Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report of OurPet’s Company (the Company) on Form 10-KSB for the year ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, being the Vice President, Treasurer and Controller of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002, that:

 

  (1) I have reviewed this Report on Form 10-KSB for the year ended December 31, 2007 of OurPet’s Company.

 

  (2) This Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (3) The financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Report.

 

/ S /    J OHN G. M URCHIE        

BY JOHN G. MURCHIE

Vice President, Treasurer and Controller

Dated: March 28, 2008

This certification is made solely for the purpose of 18 U.S.C. Section 1350, subject to the knowledge standard contained in that statute, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to OurPet’s Company and will be retained by OurPet’s Company and furnished to the Securities and Exchange Commission or its staff upon request.

 

43