United States
Securities and Exchange Commission
Washington, DC 20549
Form 10-QSB
| x | QUARTERLY REPORT UNDER TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
| For the quarterly period ended: | Commission File No: | |
| June 30, 2007 | 000-31279 |
OurPet’s Company
(Exact name of Small Business Issuer as specified 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, including area code: (440) 354-6500
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 the past 90 days.
| Yes x | No ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
| Yes ¨ | No x |
State the number of shares of outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of July 27, 2007, the Issuer had outstanding 15,174,651 shares of Common Stock, 66,000 shares of Convertible Preferred Stock, convertible into 660,000 shares of Common Stock, and warrants exercisable for 3,916,260 shares of Common Stock.
Transactional Small Business Disclosure Format
| Yes ¨ | No x |
| Page Number | ||
| Part 1–Financial Information |
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| Item 1–Financial Statements (unaudited): |
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| 3 | ||
| 5 | ||
| 6 | ||
| 7 | ||
| 8 | ||
| Item 2–Management’s Discussion and Analysis or Plan of Operation: |
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| 11 | ||
| 11 | ||
| 14 | ||
| 15 | ||
| 16 | ||
| 16 | ||
| Part II–Other Information |
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| 17 | ||
| Item 2–Unregistered Sales of Equity Securities and Use of Proceeds |
17 | |
| 17 | ||
| 17 | ||
| 17 | ||
| 18 | ||
| 18 | ||
| 20 | ||
2
OURPET’S COMPANY AND SUBSIDIARIES
| June 30, 2007 | December 31, 2006 | |||||
| (Unaudited) | ||||||
| ASSETS |
||||||
| CURRENT ASSETS |
||||||
| Cash and cash equivalents |
$ | 21,772 | $ | 30,400 | ||
| Accounts receivable–trade, less allowance for doubtful accounts of $ 22,784 and $ 21,322 |
1,563,824 | 1,160,832 | ||||
| Inventories |
2,857,637 | 2,848,980 | ||||
| Prepaid expenses |
174,122 | 48,231 | ||||
| Total current assets |
4,617,355 | 4,088,443 | ||||
| PROPERTY AND EQUIPMENT |
||||||
| Computers and office equipment |
341,997 | 300,326 | ||||
| Warehouse equipment |
227,590 | 107,453 | ||||
| Leasehold improvements |
61,381 | 61,381 | ||||
| Tooling |
2,731,770 | 2,719,585 | ||||
| Construction in progress |
624,933 | 360,223 | ||||
| Total |
3,987,671 | 3,548,968 | ||||
| Less accumulated depreciation |
1,709,511 | 1,490,767 | ||||
| Net property and equipment |
2,278,160 | 2,058,201 | ||||
| OTHER ASSETS |
||||||
| Patents, less amortization of $99,498 and $87,003 |
251,088 | 250,069 | ||||
| Goodwill |
67,511 | 67,511 | ||||
| Domain names and other assets |
12,350 | 12,155 | ||||
| Total other assets |
330,949 | 329,735 | ||||
| Total assets |
$ | 7,226,464 | $ | 6,476,379 | ||
The accompanying notes are an integral part of the unaudited consolidated financial statements.
3
OURPET’S COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
| June 30, 2007 | December 31, 2006 | |||||||
| (Unaudited) | ||||||||
| LIABILITIES |
||||||||
| CURRENT LIABILITIES |
||||||||
| Notes payable |
$ | 1,425,000 | $ | 1,400,000 | ||||
| Current maturities of long-term debt |
247,232 | 148,911 | ||||||
| Accounts payable—trade |
1,142,700 | 1,020,645 | ||||||
| Accrued expenses |
130,772 | 164,973 | ||||||
| Total current liabilities |
2,945,704 | 2,734,529 | ||||||
| LONG-TERM DEBT |
||||||||
| Long-term debt—less current portion above |
361,127 | 211,132 | ||||||
| Total liabilities |
3,306,831 | 2,945,661 | ||||||
| STOCKHOLDERS’ EQUITY |
||||||||
| COMMON STOCK, |
||||||||
| no par value; authorized 50,000,000 shares, issued and outstanding 15,174,651 and 15,035,473 shares |
4,094,237 | 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 |
107,590 | 88,986 | ||||||
| ACCUMULATED DEFICIT |
(884,873 | ) | (1,172,398 | ) | ||||
| Total stockholders’ equity |
3,919,633 | 3,530,718 | ||||||
| Total liabilities and stockholders’ equity |
$ | 7,226,464 | $ | 6,476,379 | ||||
The accompanying notes are an integral part of the unaudited consolidated financial statements.
4
OURPET’S COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| For the Three Months Ended June 30, |
For the Six Months Ended June 30, |
|||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
| Net revenue |
$ | 2,816,812 | $ | 2,196,069 | $ | 5,400,182 | $ | 4,303,510 | ||||||||
| Cost of goods sold |
2,003,351 | 1,673,559 | 3,899,856 | 3,221,637 | ||||||||||||
| Gross profit on sales |
813,461 | 522,510 | 1,500,326 | 1,081,873 | ||||||||||||
| Selling, general and administrative expenses |
601,044 | 462,177 | 1,135,724 | 901,635 | ||||||||||||
| Income from operations |
212,417 | 60,333 | 364,602 | 180,238 | ||||||||||||
| Acquisition consolidation expenses |
— | — | — | (55,292 | ) | |||||||||||
| Other income and expense, net |
1 | 6,469 | 2,069 | 32,183 | ||||||||||||
| Interest expense |
(40,406 | ) | (43,187 | ) | (79,146 | ) | (77,895 | ) | ||||||||
| Income before income taxes |
172,012 | 23,615 | 287,525 | 79,234 | ||||||||||||
| Income tax expense |
— | — | — | — | ||||||||||||
| Net income |
$ | 172,012 | $ | 23,615 | $ | 287,525 | $ | 79,234 | ||||||||
| Basic and Diluted Earnings Per Common Share After Dividend Requirements For Preferred Stock: |
||||||||||||||||
| Net Income |
$ | — | $ | — | $ | 0.01 | $ | — | ||||||||
| Weighted average number of common and equivalent shares outstanding used to calculate basic and diluted earnings per share |
17,828,206 | 15,745,465 | 17,531,447 | 15,510,021 | ||||||||||||
The accompanying notes are an integral part of the unaudited consolidated financial statements.
5
OURPET’S COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2007
(Unaudited)
| Preferred Stock | Common Stock | Paid-In Capital |
Accumulated Deficit |
Total Stockholders’ Equity | ||||||||||||||||
| Number of Shares |
Amount | Number of Shares |
Amount | |||||||||||||||||
| 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 |
— | — | 10,000 | 3,100 | — | — | 3,100 | |||||||||||||
| Common Stock issued upon exercise of warrants |
— | — | 78,724 | 29,686 | — | — | 29,686 | |||||||||||||
| Net income |
— | — | — | — | — | 287,525 | 287,525 | |||||||||||||
| Stock-based compensation expense |
— | — | — | — | 18,604 | — | 18,604 | |||||||||||||
| Balance at June 30, 2007 |
66,000 | $ | 602,679 | 15,174,651 | $ | 4,094,237 | $ | 107,590 | $ | (884,873 | ) | $ | 3,919,633 | |||||||
The accompanying notes are an integral part of the unaudited consolidated financial statements.
6
OURPET’S COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| For the Six Months Ended June 30, |
||||||||
| 2007 | 2006 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income |
$ | 287,525 | $ | 79,234 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
| Depreciation expense |
218,744 | 165,798 | ||||||
| Amortization expense |
12,496 | 10,351 | ||||||
| Stock option expense |
18,604 | — | ||||||
| (Increase) decrease in assets: |
||||||||
| Accounts receivable—trade |
(402,992 | ) | 87,275 | |||||
| Inventories |
(8,657 | ) | (486,026 | ) | ||||
| Prepaid expenses |
(125,891 | ) | 22,898 | |||||
| Patent costs |
(13,515 | ) | (13,445 | ) | ||||
| Domain names and other assets |
(195 | ) | (36,140 | ) | ||||
| Increase (decrease) in liabilities: |
||||||||
| Accounts payable—trade |
122,055 | 278,982 | ||||||
| Accrued expenses |
(34,201 | ) | (70,097 | ) | ||||
| Net cash provided by operating activities |
73,973 | 38,830 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Acquisition of business |
— | (464,999 | ) | |||||
| Acquisition of property and equipment |
(438,703 | ) | (169,463 | ) | ||||
| Net cash used in investing activities |
(438,703 | ) | (634,462 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Principal payments on long-term debt |
(80,060 | ) | (79,985 | ) | ||||
| Net borrowing on bank line of credit |
25,000 | 325,000 | ||||||
| Issuances of Common Stock |
82,786 | — | ||||||
| Issuance of long-term debt |
328,376 | 467,595 | ||||||
| Net cash provided by financing activities |
356,102 | 712,610 | ||||||
| Net (decrease) increase in cash |
(8,628 | ) | 116,978 | |||||
| CASH AT BEGINNING OF PERIOD |
30,400 | 6,477 | ||||||
| CASH AT END OF PERIOD |
$ | 21,772 | $ | 123,455 | ||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION |
||||||||
| Interest paid |
$ | 74,892 | $ | 84,218 | ||||
| SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS |
||||||||
| Common Stock issued in payment for acquisition of business |
$ | — | $ | 1,052,040 | ||||
The accompanying notes are an integral part of the unaudited consolidated financial statements.
7
OURPET’S COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements and include the accounts of OurPet’s Company and its wholly-owned subsidiaries (the “Company”), Virtu Company (“Virtu”) and SMP Company Incorporated (“SMP”). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented have been included. All intercompany transactions have been eliminated. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the fiscal year ended December 31, 2006 included in the Company’s Form 10-KSB filed with the Securities and Exchange Commission on March 29, 2007.
INVENTORIES
Inventories are carried at the lower of cost, first-in, first-out method or market. Inventories at June 30, 2007 and December 31, 2006 consist of:
| 2007 | 2006 | |||||
| Finished goods |
$ | 2,240,308 | $ | 2,203,227 | ||
| Components and packaging |
617,329 | 645,753 | ||||
| Total |
$ | 2,857,637 | $ | 2,848,980 | ||
All inventories are pledged as collateral for bank and small business administration loans.
REVENUE RECOGNITION
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 brand names. Net revenue is comprised of gross sales less discounts given to distributors and returns and allowances.
For the three months ended June 30, 2007, 56.9% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $953,491 and $648,993, respectively which represents 33.9% and 23.0% of total revenue.
For the three months ended June 30, 2006, 54.2% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $677,707 and $512,343, respectively which represents 30.9% and 23.3% of total revenue.
For the six months ended June 30, 2007, 55.1% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $1,584,953 and $1,388,927, respectively, which represents 29.4% and 25.7% of total revenue.
For the six months ended June 30, 2006, 53.5% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $1,265,232 and $1,036,285, respectively which represents 29.4% and 24.1% of total revenue.
8
OURPET’S COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
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” (“ABP 25”) and related interpretations. FAS 123R requires the grant-date 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 is not material.
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 period, divided by the weighted average number of common and equivalent dilutive shares outstanding during the period. Potential common shares whose effect would be antidilutive have not been included. As of June 30, 2007, common shares that are or could be potentially dilutive include 1,006,000 stock options at exercise prices from $0.21 to $1.24 a share, 3,916,260 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 $1.00 per share. As of June 30, 2006, common shares that could be potentially dilutive include 919,000 stock options at exercise prices from $0.21 to $0.65 a share, 3,806,754 warrants to purchase Common Stock at exercise prices from $0.286 to $1.226 a share and 660,000 shares underlying the Preferred Stock at a conversion rate of $1.00 per share.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115, which provides all entities with an option to 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 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.
9
OURPET’S COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
RECENT ACCOUNTING PRONOUNCEMENTS – Continued
In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FAS No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN No. 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. EITF 06-11 applies to share-based payment arrangements with dividend protection features that entitle employees to receive (a) dividends on equity-classified nonvested shares, (b) dividend equivalents on equity-classified nonvested share units, or (c) payments equal to the dividends paid on the underlying shares while an equity-classified share option is outstanding, when those dividends or dividend equivalents are charged to retained earnings under FAS No. 123R, Share-Based Payment, and result in an income tax deduction for the employer. A consensus was reached that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase in additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the EITF will have in the Company’s financial condition.
10
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
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 | – | 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 then sell the products to the end consumer. According to the 2005/2006 APPMA National Pet Owners Survey approximately 69.1 million U.S. households currently own a pet with an estimated pet population of 73.9 million dogs, 90.5 million cats and 18.2 million birds.
As discussed below and in Liquidity and Capital Resources on Pages 14 and 15, we have funded our operations principally from net cash provided by operating activities and with bank borrowings during the year ended December 31, 2006 and the six months ended June 30, 2007.
Under our line of credit facility with our bank we can borrow up to $2,000,000 based on the level of qualifying accounts receivable and inventories. At June 30, 2007 we had a balance due of $1,325,000 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 payments of $9,362 including interest at 7.60% beginning in July 2007 with interest only on amounts borrowed beginning in April 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.
Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006
In the following discussion all references to 2007 are for the three months ended June 30, 2007 and all references to 2006 are for the three months ended June 30, 2006.
11
Net revenue for 2007 was $2,816,812, an increase of 28.3% in revenue from $2,196,069 in 2006, consisting of net sales of proprietary products for the retail pet business. This increase of $620,743 was primarily the result of an increase in sales of approximately $412,000 to our two largest customers due to promotions of existing products and sales of new products in 2007. The balance of the increase was from sales to other customers which increased by approximately $209,000 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 Portable Pet Crates, Healthy Pet Diners, Litter Box Sprays, Selecta and Non-Tip Bowls, and Play-N-Squeak product extensions, were approximately $344,000.
While net revenue increased by 28.3% in 2007, cost of goods sold increased by 19.7%, from $1,673,559 in 2006 to $2,003,351 in 2007. The increase in cost of goods sold was due to the cost of purchased products sold and freight increasing by 20.4% primarily as a result of the increased cost of the products used due to higher sales. Our variable and fixed warehouse and overhead cost increased by 16.7% from the comparable quarter in 2006 due to increased costs for salaries and wages for additional employees in warehouse supervision and in operations. Also, costs increased in depreciation expense for tooling and the rent expense as of result of the warehouse expansion to store our larger inventory and increased level of shipments.
As a result of the net revenue increasing by 28.3% and the cost of goods sold increasing by 19.7%, the Company’s gross profit on sales increased by $290,951 or 55.7% from $522,510 in 2006 to $813,461 in 2007.
Selling, general and administrative expenses in 2007 were $601,044, an increase of 30.0% or $138,867 from $462,177 for 2006. The significant increases were in (i) increased salaries and wages of approximately $48,000 due to an additional employee in administration and increased accruals for stock option expense, employee profit sharing and managers’ bonus, (ii) increased accruals for professional services of approximately $29,000 due to increased legal fees, computer and web site consulting fees, and accounting fees, (iii) increased commissions accrued for our sales representatives of approximately $29,000 due to the higher sales in 2007, and (iv) increased sales and marketing expenses of approximately $18,000 mainly due to promotional and marketing expenses by our customers.
Income from our operations increased by $152,084 from $60,333 in 2006 to $212,417 in 2007 as a result of the increase in our gross profit on sales of $290,951 or 55.7%, which exceeded the increase in selling, general and administrative expenses of $138,867 or 30.0%.
Other income and expense, net, in 2007 was $1, a decrease of $6,468 from $6,469 in 2006. The larger income in 2006 which was primarily due to our share of the proceeds from the sale of inventory belonging to Pet Zone Products Ltd. that we elected not to purchase in 2006 less the costs of disposal. Most of such inventory was disposed of in 2006, leaving only minimal amount to sell in 2007.
Interest expense for 2007 was $40,406, a decrease of $2,781, from $43,187 in 2006. This decrease was primarily due to the interest expense for the bank line of credit which decreased by approximately $3,000 due to the decrease in average principal balance outstanding from $1,375,000 in 2006 to $1,281,250 in 2007.
The net income for 2007 was $172,012 as compared to $23,615 for 2006 or an increase in profitability of $148,397. This increase was as a result of the following changes from 2006 to 2007:
| Net revenue increase of 28.3% | $ | 620,743 | ||
| Cost of goods sold increase of 19.7% | (329,792 | ) | ||
| Gross profit on sales increase of 55.7% |
290,951 | |||
| Selling, general and administrative expenses increase of 30.0% |
(138,867 | ) | ||
| Other income and expense, net decrease | (6,468 | ) | ||
| Interest expense decrease | 2,781 | |||
| Increase in Profitability |
$ | 148,397 | ||
12
Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006
In the following discussion all references to 2007 are for the six months ended June 30, 2007 and all references to 2006 are for the six months ended June 30, 2006.
Net revenue for 2007 was $5,400,182, an increase of 25.5% in revenue from $4,303,510 in 2006, consisting of net sales of proprietary products for the retail pet business. This increase of $1,096,672 was primarily the result of an increase in sales of approximately $670,000 to our two largest customers due to promotions of existing products and sales of new products in 2007. The balance of the increase was from sales to other customers which increased by approximately $427,000 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 were approximately $502,000, including Portable Pop-Up Crates, Healthy Pet Diners, Litter Box Sprays, Selecta and Non-Tip Bowls, and Play-N-Squeak product extensions. Our sales to foreign customers increased by approximately $56,000, or 44%, from 2006 mainly due to increased sales to customers in Canada.
While net revenue increased by 25.5% in 2007, cost of goods sold increased by 21.1%, from $3,221,637 in 2006 to $3,899,856 in 2007. This increase was the result of the cost of purchased products sold and freight increasing by 20.9% due mainly to the cost of the products used by the increase in sales. Our variable and fixed warehouse and overhead costs increased by 21.9% from the six months of 2006 due to the increased costs for salaries and wages for additional employees in warehouse supervision and operations to make displays for customer promotions and increased level of shipments. Also, costs increased for depreciation expense for tooling and the addition of our warehouse to store our increased inventory and level of shipments.
As a result of the net revenue increasing by 25.5% and the cost of goods sold increasing by 21.1%, our gross profit on sales increased by $418,453 or 38.7% from $1,081,873 in 2006 to $1,500,226 in 2007.
Selling, general and administrative expenses in 2007 were $1,135,724, an increase of 26.0% or $234,089 from $901,635 in 2006. The significant increases were in (i) increased salaries and wages of approximately $86,000 due to an additional employee in administration and increased accruals for stock option expense, employee profit sharing and managers’ bonus, (ii) increased commissions accrued for our sales representatives of approximately $50,000 due to the higher sales in 2007, (iii) increased sales and marketing expenses of approximately $37,000 mainly due to promotional and incentive expenses by our customers, (iv) increased accruals for professional services of approximately $36,000 due to increased legal fees, computer and web site consulting fees, and accounting fees, (v) increased stockholder and investor relation expenses of approximately $11,000 due to increased public and investor relation fees in 2007.
The income from operations improved by $184,364 from $180,238 in 2006 to $364,602 in 2007 as a result of our gross profit on sales increasing by $418,453 or 38.7%, which was more than the increase in selling, general and administrative expenses of $234,089 or 26.0%.
In 2006, we incurred costs of $55,292 for consolidating the operations of Pet Zone into our operations, including salaries and wages of Pet Zone employees until their duties could be assumed by our employees and the costs of an order packing and shipping warehouse until these operations could be moved into our existing facility.
Other income and expense, net, in 2007 was $2,069, a decrease of $30,114 from $32,183 in 2006 which in both years is primarily our share of the proceeds from the sale of inventory that was not purchased, less the costs of disposal.
Interest expense for 2007 was $79,146, an increase of $1,251, from $77,895 in 2006. This increase was primarily due to the interest expense for the bank line of credit which increased by approximately $3,000 due the increase in average principal balance from $1,243,000 in 2006 to $1,289,000 in 2007.
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The net income for 2007 was $287,525 as compared to $79,234 for 2006 or an increase in profitability of $208,291. This increase was as a result of the following changes from 2006 to 2007:
| Net revenue increase of 25.5% |
$ | 1,096,672 | ||
| Cost of goods sold increase of 21.1% |
(678,219 | ) | ||
| Gross profit on sales increase of 38.7% |
418,453 | |||
| Selling, general and administrative expenses increase of 26.0% |
(234,089 | ) | ||
| Acquisition consolidation expense decrease |
55,292 | |||
| Other income and expense, net decrease |
(30,114 | ) | ||
| Interest expense increase |
(1,251 | ) | ||
| Increase in Profitability |
$ | 208,291 | ||
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities provide cash from 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 $522,000 in available funds at June 30, 2007 based upon the balance of accounts receivable and inventories at that date.
As of June 30, 2007, we had $2,033,359 in principal amount of indebtedness consisting of:
| Bank line of credit |
Prime plus .75% | $ | 1,325,000 | ||
| Bank term notes |
7.60% & 7.75% | 444,291 | |||
| Pet Zone Products Ltd term loan |
7.75% | 120,116 | |||
| Installment notes payable |
6.999% to 7.517% | 43,952 | |||
| Other notes payable |
Prime plus 3% & 10% | 100,000 |
The bank line of credit borrowing of $1,325,000 is under our line of credit agreement with our bank which allows us to 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 June 30, 2008. Under our agreements with the bank we are currently required to maintain a debt service coverage ratio of 1.15, a tangible net worth of $1,500,000, and obtain permission from the bank for any of the following: (a) to incur additional indebtedness, (b) enter additional leases if it would require total lease payments exceeding $190,280 in any fiscal year, (c) make any expenditures for property and equipment in excess of $300,000 in any fiscal year, and (d) pay cash dividends or redeem any of our capital stock other than dividends on our Preferred Stock subject to meeting the debt service coverage ratio. On September 30, 2007 the tangible net worth requirement will increase to $3,000,000.
The installment notes payable are due in decreasing monthly payments from $1,934 to $560 including interest through March 2012. The other notes payable are due in the amount of $75,000 on February 1, 2008, to Beachcraft L.P. and $25,000 on August 1, 2007 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.
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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, 2008 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 anti-dilution provisions of the warrants. These warrants were exercised during the second quarter of 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 $561,000 for the year ended 2006 and $254,000 for the year ended 2005. 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 2007. We have no material commitments for capital expenditures.
Net cash provided by operating activities for the six months ended June 30, 2007 was $73,973. Cash was provided by the net operating income for the six months ended June 30, 2007 of $537,369, including the non-cash charges for depreciation of $218,744, amortization of $12,496 and stock option expense of $18,604. Cash was used in the net change of $(463,396) in our operating assets and liabilities as follows:
| Accounts receivable increase |
$ | (402,992 | ) | |
| Inventories increase |
(8,657 | ) | ||
| Prepaid expenses increase |
(125,891 | ) | ||
| Patent costs increase |
(13,515 | ) | ||
| Other assets increase |
(195 | ) | ||
| Accounts payable increase |
122,055 | |||
| Accrued expenses decrease |
(34,201 | ) | ||
| Net change |
$ | (463,396 | ) | |
Accounts receivable increased to $1,586,608 at June 30, 2007 from $1,160,832 at December 31, 2006, an increase of $402,992. This increase was primarily as a result of the increase in the amount due of approximately $263,000 from our two major customers. Amounts due from each of these customers were $630,565 and $230,036, which represents 39.7% and 14.5% of total accounts receivable, respectively.
Net cash used in investing activities for the six months ended June 30, 2007 was $438,703, which was used for the acquisition of property and equipment. Cash provided by financing activities for the six months ended June 30, 2007 was $353,376 consisting of $25,000 in net borrowing under the line of credit agreement with the bank and $328,376 in long-term debt. Cash of $80,060 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 unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-QSB. 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.
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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.
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.
FORWARD LOOKING STATEMENTS
When used in this Form 10-QSB, statements that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “anticipates,” “intends,” “expects” and similar expressions are intended to identify such forward-looking statements, which speak only as of the date of this Form 10-QSB. 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. Uncertainties, risks, and other factors that may cause actual results or performance to differ materially from any results of performance expressed or implied by forward-looking statements in this Form 10-QSB include: (1) our ability to manage our operating expenses and realize operating efficiencies, (2) our ability to maintain and grow our sales with existing and new customers, (3) our ability to retain existing members of our senior management team and to attract additional management employees, (4) our ability to manage fluctuations in the availability and cost of key materials and tools of production, (5) general economic conditions that might impact demand for our products, (6) competition from existing or new participants in the pet products industry, (7) our ability to design and bring to market new products on a timely and profitable basis, (8) challenges to our patents or trademarks on existing or new products, or (9) our ability to secure access to sufficient capital on favorable terms to manage and grow our business.
ITEM 3. CONTROLS AND PROCEDURES
As of June 30, 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 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.
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On March 28, 2007 we filed an action in the U.S. District Court, Northern District of Ohio against Worldwise, Inc. alleging patent infringement of our U.S. Patents 6,550,426 and 6,371,053. The action alleges damages and requests injunctive relief and unspecified damages. Worldwise, Inc. filed its answer and counterclaims seeking declaratory judgment of non-infringement and that our patents are invalid. We agreed, along with Worldwise, Inc., to submit our respective claims to mediation, which will take place in a few weeks. While we believe our position to be strong, we cannot predict the likely outcome of the mediation.
We are a party to other material legal proceedings, which are described in our previous Quarterly Report on Form 10-QSB under the caption “Item 1 – Legal Proceedings” filed on May 11, 2007. Except as discussed herein, during the fiscal quarter covered by this Quarterly Report on Form 10-QSB, we have not been named in any new material legal proceedings, and there have been no material developments in the previously reported legal proceedings.
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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on May 7, 2007.
There were 13,825,143 shares of Common Stock present at the meeting in person or by proxy. The results of the vote taken at such meeting with respect to each nominee for director were as follows:
| Nominee |
For | Against | Abstain | |||
| Joseph T. Aveni |
13,820,840 | 0 | 4,303 | |||
| Dr. William M. Fraser |
13,820,840 | 0 | 4,303 | |||
| James D. Ireland III |
13,820,840 | 0 | 4,303 | |||
| John Spirk |
13,820,840 | 0 | 4,303 | |||
| Dr. Steven Tsengas |
13,820,840 | 0 | 4,303 |
A vote was taken on the proposal to ratify the appointment of S.R. Snodgrass, A.C. as our independent auditors for the year ending December 31, 2007. Of the 13,825,143 shares present at the meeting in person or by proxy, 13,822,840 were voted in favor of such proposal, no shares were voted against such proposal, and 2,303 shares abstained from voting.
None.
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| 11* | Statement of Computation of Net Income Per Share. | |
| 31.1* | Certification of the President and Chief Executive Officer pursuant to 17 CFR Section 240.13a-14(a). | |
| 31.2* | Certification of the Principal Financial Officer pursuant to 17 CFR Section 240.13a-14(a). | |
| 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. | |
| * | Filed herewith |
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
OURPET’S COMPANY
| Dated: August 14, 2007 | /S/ STEVEN TSENGAS | |||
| Steven Tsengas Chairman, President and Chief Executive Officer (Principal Executive Officer) | ||||
| Dated: August 14, 2007 | /S/ JOHN G. MURCHIE | |||
| John G. Murchie Vice President, Treasurer and Controller (Principal Financial Officer) | ||||
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