10-Q 1 v358848_10q.htm FORM 10-Q

 

 

 

United States

Securities and Exchange Commission

Washington, DC 20549

 

 

  

Form 10-Q  

 

 

  

x QUARTERLY REPORT UNDER 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:
September 30, 2013 000-31279

 

 

 

OurPet’s Company

(Exact name of Registrant as specified in its charter)

 

 

 

Colorado 34-1480558
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
   
1300 East Street, Fairport Harbor, OH 44077
(Address of principal executive offices) (Zip code)

  

Registrant’s telephone number, including area code: (440) 354-6500

 

 

 

Indicate by check mark whether the registrant: (1) has 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No   ¨

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large Accelerated Filer ¨ Accelerated Filer ¨
       
Non-Accelerated Filer ¨ Smaller Reporting Company x

 

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

 

As of October 30, 2013, the Registrant had outstanding 16,256,265 shares of Common Stock, 189,616 shares of Convertible Preferred Stock, convertible into 1,896,160 shares of Common Stock, options exercisable for 1,308,208 shares of Common Stock and warrants exercisable for 1,730,596 shares of Common Stock.

 

As used in this Form 10-Q, the terms “Company,” “OurPet’s,” “Registrant,” “we,” “us” and “our” mean OurPet’s Company and its consolidated subsidiaries as a whole, unless the context indicates otherwise. Except as otherwise stated, the information is this Form 10-Q is as of September 30, 2013.

 

 

 

 
 

 

CONTENTS

 

 

Page
Number  

Part 1 – Financial Information  
   
Item 1 – Financial Statements (Unaudited):  
   
Condensed, Consolidated Balance Sheets of OurPet’s Company and Subsidiaries as of September 30, 2013 and December 31, 2012 3
   
Condensed, Consolidated Statements of Operations of OurPet’s Company and Subsidiaries for the three month and nine month periods ended September 30, 2013 and 2012 5
   
Condensed, Consolidated Statement of Changes in Stockholders’ Equity of OurPet’s Company and Subsidiaries for the nine month period ended September 30, 2013 6
   
Condensed, Consolidated Statements of Cash Flows of OurPet’s Company and Subsidiaries for the nine month periods ended September 30, 2013 and 2012 7
   
Condensed Notes to Consolidated Financial Statements (Unaudited) 8
   
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations:  
   
Forward Looking Statements 12
   
Overview 12
   
Results of Operations 13
   
Liquidity and Capital Resources 16
   
Critical Accounting Policies/Estimates 18
   
Off-Balance Sheet Arrangements 18
   
Item 3 – Quantitative and Qualitative Disclosures About Market Risk 18
   
Item 4 – Controls and Procedures 19
   
Part II – Other Information  
   
Item 1 – Legal Proceedings 19
   
Item 1A – Risk Factors 19
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 19
   
Item 3 – Defaults Upon Senior Securities 19
   

Item 4 – Mine Safety Disclosure

19
   
Item 5 – Other Information 19
   
Item 6 – Exhibits 19
   
Signatures 20
   
Certifications  

 

2
 

 

OURPET’S COMPANY AND SUBSIDIARIES

CONDENSED, CONSOLIDATED BALANCE SHEETS (Unaudited)

 

   September 30,   December 31, 
   2013   2012 
   Unaudited     
 ASSETS          
           
CURRENT ASSETS          
Cash and cash equivalents  $161,238   $21,269 
Accounts receivable - trade, less allowance for doubtful accounts of $37,667 and $ 37,873   2,934,786    2,540,640 
Inventories net of reserve   5,618,611    5,665,040 
Prepaid expenses   407,292    190,967 
Deferred Tax Asset   23,460    93,838 
           Total current assets   9,145,387    8,511,754 
           
PROPERTY AND EQUIPMENT          
Computers and office equipment   726,349    664,745 
Warehouse equipment   548,990    518,304 
Leasehold improvements   254,942    244,832 
Tooling   4,105,448    3,869,758 
Construction in progress   357,358    337,239 
           Total   5,993,087    5,634,878 
Less accumulated depreciation   4,068,823    3,638,343 
           Net property and equipment   1,924,264    1,996,535 
           
 OTHER ASSETS          
Amortizable Intangible Assets, less amortization of $322,647 and $285,075   326,763    296,478 
Intangible Assets   461,000    461,000 
Goodwill   67,511    67,511 
Deposits and other assets   18,003    18,003 
           Total other assets   873,277    842,992 
           
           Total assets  $11,942,928   $11,351,281 

  

The accompanying notes are an integral part of these condensed and consolidated financial statements.

 

3
 

 

OURPET’S COMPANY AND SUBSIDIARIES

CONDENSED, CONSOLIDATED BALANCE SHEETS, CONTINUED (Unaudited)

 

   September 30,   December 31, 
   2013   2012 
   Unaudited     
 LIABILITIES          
           
 CURRENT LIABILITIES          
Notes payable  $100,000   $100,000 
Current maturities of long-term debt   471,648    517,531 
Accounts payable - trade   1,534,058    1,610,752 
Accrued taxes payable   233,000    - 
Other accrued expenses   490,315    484,063 
           Total current liabilities   2,829,021    2,712,346 
           
 LONG-TERM LIABILITIES          
Long-term debt - less current portion above   783,614    837,150 
Revolving Line of Credit   1,885,032    2,259,032 
Deferred Income Taxes   218,438    196,435 
           Total long term liabilities   2,887,084    3,292,617 
           
           Total liabilities   5,716,105    6,004,963 
           
 STOCKHOLDERS' EQUITY          
           
 COMMON STOCK,          
no par value; 50,000,000 shares authorized, 16,256,265 and 15,883,560 shares issued and outstanding at September 30, 2013 and December 31, 2012 respectively   4,583,232    4,583,232 
           
 CONVERTIBLE PREFERRED STOCK,          
no par value; convertible into Common Stock at the rate of 10 common shares for each preferred share; 66,000 shares authorized, 66,000 shares issued and outstanding at September 30, 2013   602,679    602,679 
           
Series 2009 no par value; convertible into Common Stock at the rate of 10 common shares for each preferred share; 175,000 shares authorized, 123,616 shares issued and outstanding at September 30, 2013   865,312    865,312 
           
 PAID-IN CAPITAL   184,878    - 
           
 ACCUMULATED DEFICIT   (9,278)   (704,905)
           Total stockholders' equity   6,226,823    5,346,318 
           
           Total liabilities and stockholders' equity  $11,942,928   $11,351,281 

  

The accompanying notes are an integral part of these condensed and consolidated financial statements.

 

4
 

 

OURPET’S COMPANY AND SUBSIDIARIES

CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   For the Three Months Ended September 30,   For the Nine Months Ended September 30, 
   2013   2012   2013   2012 
                 
Net revenue  $5,737,568   $4,269,952   $15,526,715   $14,213,342 
                     
Cost of goods sold   3,889,535    3,158,042    10,814,115    10,589,531 
                     
Gross profit on sales   1,848,033    1,111,910    4,712,600    3,623,811 
                     
Selling, general and administrative expenses   1,265,986    1,259,789    3,566,494    3,563,929 
                     
Income (loss) from operations   582,047    (147,879)   1,146,106    59,882 
                     
Other (income) and expense   (45,875)   68    (86,658)   (8,344)
Interest expense   38,641    36,019    125,978    119,174 
                     
Income (loss) before income taxes   589,281    (183,966)   1,106,786    (50,948)
                     
Income tax expense (benefit)   250,020    (53,869)   411,159    (11,033)
                     
Net income (loss)  $339,261   $(130,097)  $695,627   $(39,915)
                     
Basic and Diluted Earnings Per Common Share After Dividend Requirements For Preferred Stock:                    
Net Income (loss)  $0.02   $(0.01)  $0.04   $(0.01)
                     
Weighted average number of common and equivalent shares outstanding used to calculate basic and diluted earnings per share   18,892,361    15,811,250    17,958,153    15,809,771 

 

The accompanying notes are an integral part of these condensed and consolidated financial statements.

 

5
 

 

OURPET’S COMPANY AND SUBSIDIARIES

CONDENSED, CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2013

(Unaudited)

 

   Preferred Stock   Series 2009 Preferred Stock   Common Stock           Total 
   Number of       Number of       Number of       Paid-In   Accumulated   Stockholders' 
   Shares   Amount   Shares   Amount   Shares   Amount   Capital   Deficit   Equity 
                                     
Balance at December 31, 2012   66,000   $602,679    123,616   $865,312    15,883,560   $4,583,232   $-   $(704,905)  $5,346,318 
                                              
Net income   -    -    -    -    -    -    -    695,627    695,627 
Common Stock Issued Upon Exercise of Stock Options                       307,911         148,500         148,500 
Common Stock Issued Upon Exercise of Warrants                       64,794         9,378         9,378 
Stock-Based compensation expense   -    -    -    -    -    -    27,000    -    27,000 
                                              
Balance at September 30, 2013   66,000   $602,679    123,616   $865,312    16,256,265   $4,583,232   $184,878   $(9,278)  $6,226,823 

 

The accompanying notes are an integral part of these condensed and consolidated financial statements.

 

6
 

 

OURPET’S COMPANY AND SUBSIDIARIES

CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   For the Nine Months Ended 
   September 30, 
   2013   2012 
 CASH FLOWS FROM OPERATING ACTIVITIES          
Net income (Loss)  $695,627   $(39,915)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Loss on Sale of Fixed Asset  2,000  -
Depreciation expense  433,480  446,229
Amortization expense  37,572  30,751
Stock option expense  18,000  18,000
Warrant expense  9,000  9,000
(Increase) decrease in assets:          
Accounts receivable - trade  (394,146)  299,223
Inventories  46,429  695,357
Prepaid expenses  (216,325)  (18,343)
Deferred Tax Asset less Valuation Allowance  70,378  -
Amortizable Intangible Asset Additions  (67,857)  (44,970)
Deposits and other assets  -  (9,883)
Increase (decrease) in liabilities:          
Accounts payable - trade  (76,694)  (498,264)
Accrued expenses  239,252  (12,270)
Deferred tax liabilities   22,003    (11,034)
Net cash provided by operating activities   818,719    863,881 
           
 CASH FLOWS FROM INVESTING ACTIVITIES          
Acquisition of property and equipment   (363,209)   (275,481)
Net cash used in investing activities   (363,209)   (275,481)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Principal borrowings of long-term debt  145,816  32,166
Principal payments on long-term debt  (245,235)  (384,464)
Payment on bank line of credit  (374,000)  (380,968)
Issuances of Common Stock   157,878    - 
Net cash used in financing activities   (315,541)   (733,266)
Net increase (decrease) in cash  139,969  (144,866)
           
CASH AT BEGINNING OF PERIOD   21,269    364,978 
CASH AT END OF PERIOD  $161,238   $220,112 
         
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION        
Interest paid  $168,221  $95,561
Income taxes paid  $80,000  $-
           
SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS          
Non cash exercise of stock options/ warrants  $32,432  $3,500
Equipment Obtained Through Capital Lease  $20,816  $-

 

  

The accompanying notes are an integral part of these condensed and consolidated financial statements.

 

7
 

 

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2013

(Unaudited)

 

ORGANIZATION AND NATURE OF OPERATIONS

 

The management of OurPet’s Company 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.

 

 BASIS OF PRESENTATION

 

OurPet’s Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”). FASB sets generally accepted accounting principles to ensure the consistent reporting of the financial condition, results of operations, and cash flows. The accompanying unaudited, condensed, consolidated financial statements for the nine month period ended September 30, 2013 and September 30, 2012 have been prepared in accordance with such generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q, including the requirements of Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. They include the accounts of OurPet’s Company and its wholly-owned subsidiaries, Virtu, and SMP Company, Incorporated (collectively, “OurPet’s” or the “Company”). The December 31, 2012 Condensed Consolidated Balance Sheet information contained in this Form 10-Q was derived from the 2012 audited, consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America for an annual report. 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 condensed, consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the fiscal year ended December 31, 2012 that are included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 29, 2013. Operating results for the nine month period ended September 30, 2013 are not necessarily indicative of the results that may be expected for future fiscal periods.

 

USE OF ESTIMATES

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

INVENTORIES

 

Inventories are carried at the lower of cost, first-in, first-out method or market. Inventories at September 30, 2013 and December 31, 2012 consist of:

 

   2013   2012 
Finished goods  $4,374,150   $4,224,194 
Components, packaging and work in process   1,365,474    1,544,431 
Inventory reserve   (121,013)   (103,585)
Total  $5,618,611   $5,665,040 

 

All inventories are pledged as collateral for bank loans.

 

Changes to the inventory reserve during 2013 and 2012 are shown below: 

 

   2013   2012 
Beginning Balance  $103,585   $150,497 
Increases to Reserve   134,947    111,910 
Write Offs against Reserve   (117,519)   (158,822)
Ending Balance  $121,013   $103,585 

 

8
 

 

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2013

(Unaudited)

 

Monthly accruals as a percentage of net sales are made to account for obsolete and excess inventory. Quarterly reviews are also performed at a more detailed level to determine if additional adjustments are needed. The above numbers reflect both the monthly accruals and quarterly adjustments.

 

The Company will continue its policy of regularly reviewing inventory quantities on hand based on related service levels and functionality. Carrying cost will be reduced to net realizable value for inventories in which their cost exceeds their utility due to changes in marketing and sales strategies, obsolescence, changes in price levels, or other causes. Furthermore, if future demand or market conditions for the Company’s products are less favorable than forecasted or if unforeseen technological changes negatively impact the utility of certain products or component inventory, the Company may be required to record additional inventory reserves, which would negatively affect its results of operations in the period when the inventory reserve adjustments are recorded. Once established, write downs of inventories are considered permanent adjustments to the cost basis of the obsolete or excess inventories.

 

ACCOUNTS RECEIVABLE

 

Accounts receivable have been adjusted for all known uncollectible accounts. An allowance for possible bad debts was established at September 30, 2013 and December 31, 2012 in the amount of $37,667 and $37,873 respectively. Management reviews accounts receivable on a regular basis, based on contracted terms and how recently payments have been received, to determine if any such amounts will potentially be uncollected. After all attempts to collect a receivable have failed, the receivable is written off.

 

RELATED PARTY TRANSACTIONS

 

The Company leases a 64,000 square foot production, warehouse, and office facility in Fairport Harbor, Ohio, from a related entity, Senk Properties LLC, at a current monthly rental of $27,250 plus real estate taxes. Senk Properties is a limited liability company owned by Dr. Steven Tsengas, Konstantine S. Tsengas, Nicholas S. Tsengas, and Evangelia S. Tsengas. Dr. Tsengas is our President, Chairman, 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.

 

The Company entered into a new ten year lease with Senk Properties for the Fairport Harbor facility that became effective upon completion of the 36,000 square foot warehouse expansion on June 1, 2007. The monthly rental was $26,667 for the first two years, $28,417 for the next three years, and $30,167 from June 1, 2012 through August 31, 2012 of the sixth year. On August 10, 2012, the Company executed a new ten and one-half year lease that reduced monthly payments effective September 1, 2012. The new lease’s payment schedule is $27,250 per month for the first two years, then $29,013 per month for the next two years, then $30,827 for the next three years, then $32,587 for the next two years, and lastly $34,347 for the final eighteen months, all plus real estate taxes. The Company has the option to extend the lease for an additional ten years at a rental amount to be mutually agreed upon.

 

On December 30, 2011 the Company entered into a second lease with Senk Properties for a 26,000 square foot production warehouse and office facility in Mentor, Ohio, with payments due on the first day of each month starting on January 1, 2012. This facility replaced the Hagerstown, Maryland, facility that housed Cosmic Pet operations until its lease expired in July of 2012. The current monthly rental rate is $8,542 for the first two years, then increases to $9,083 for the next two years, $9,732 for the next two years, $10,056 for the next year, $10,597 for the next two years, and $10,813 for the last year, all plus real estate taxes. The Company has the option to extend the lease for an additional ten years at a rent amount to be mutually agreed upon. 

 

Lease expense resulting from the foregoing agreements was $383,936 for the nine months ended September 30, 2013.

 

On January 15, 2007 and November 25, 2008, the Company entered into agreements with Nottingham-Spirk Design Associates, Inc. (“NSDA”). One of the principals of NSDA is John W. Spirk, Jr., 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 agreements address the invoicing and payment of NSDA’s fees and expenses related to the development of certain products on behalf of the Company. 

 

9
 

 

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2013

(Unaudited)

 

Through September 30, 2013, the Company was invoiced $781,061 by NSDA of which $435,496 was paid in cash, $50,000 paid with 50,454 shares of the Company’s common stock, and the remaining balance of $295,565 deferred. The balance of the deferred payments is payable as a fee based upon sales of certain products.  As of September 30, 2013, the fee accrued to date was $21,887.

 

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®, Pet Zone®, SmartScoop®, ecoPure Naturals®, Play-N-Squeak®, Durapet®, Go! Cat Go!®, Flappy®, Eat®, Smarter Toys®, Clipnosis® and Cosmic Pet® labels. Net revenue is comprised of gross sales less discounts given to distributors and returns and allowances.

 

For the three months ended September 30, 2013, 33.5% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $1,175,490 and $748,114 respectively, which represents approximately 20.5% and 13.0% of total revenue.

 

For the three months ended September 30, 2012, 30.8% of the Company’s revenue was derived from two major customers. Revenue generated from each of these customers amounted to $879,131 and $435,951 respectively, which represents 20.6% and 10.2% of total revenue.

 

For the nine months ended September 30, 2013, approximately 23.8% of the Company’s revenue was derived from one major customer. Revenue generated from this customer amounted to $3,691,343.

 

For the nine months ended September 30, 2012, 19.2% of the Company’s revenue was derived from one major customer. Revenue generated from this customer amounted to $2,733,362.

 

STOCK OPTIONS

 

“Share-Based Payment” standards require 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 the modified prospective transition method on January 1, 2006. 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 pro-forma disclosures. The amount of compensation expense recognized in 2013 and 2012 as a result of stock options is not material.

 

On February 13, 2012, the Board of Directors, by unanimous written consent, approved a second amendment to the 2008 Stock Option Plan (the “Plan”) whereby the maximum number of shares reserved and available for issuance under the Plan was increased by 750,000, from 1,000,000 to 1,750,000 shares. The amendment was approved at the 2012 Annual Meeting of Shareholders held on May 25, 2012.

 

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 anti-dilutive have not been included. As of September 30, 2013, common shares that are or could be potentially dilutive include 1,308,208 stock options at exercise prices from $0.22 to $0.98 a share, 1,730,596 warrants to purchase common stock at exercise prices from $0.36 to $0.99 a share, 660,000 shares underlying our original series of preferred stock at a conversion rate of $1.00 per share and 1,236,160 shares underlying a second Series 2009 Preferred Stock at a conversion rate of $.70 per share. As of September 30, 2012, common shares that are or could be potentially dilutive include 1,819,208 stock options at exercise prices from $0.22 to $0.98 a share, 4,930,257 warrants to purchase common stock at exercise prices from $0.2796 to $0.9916 a share, 660,000 shares underlying our original series of preferred stock at a conversion rate of $1.00 per share, and 1,236,160 shares underlying a second Series 2009 Preferred Stock at a conversion rate of $.70 per share.

 

10
 

 

OURPET’S COMPANY AND SUBSIDIARIES

NOTES TO CONDENSE, CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

SEPTEMBER 30, 2013

(Unaudited)

 

INCOME TAXES

 

The Company’s compliance with FASB ASC 740-10 does not have a material effect on the Company’s financial statements as the Company believes they have no uncertain tax positions.

 

As of September 30, 2013, the Company had net operating loss carryforwards (NOL’s) for federal income tax purposes of approximately $373,000. There can be no assurance that the Company will realize the entire benefit of the NOL’s. The federal NOL’s are available to offset future taxable income and expire from 2015 through 2028 if not utilized. In the first nine months of 2013, the Company decreased its deferred tax assets by approximately $70,400 from $93,838 to $23,460 due to the “more likely than not” projected utilization of NOL’s during 2013.

 

Also during the first nine months of 2013, the Company increased its deferred tax liabilities by approximately $22,000 from $196,435 to $218,438 for adjustments related to the accelerated deductibility of various Section 179 properties.

 

The estimated federal income tax expense payable for the nine months ended September 30, 2013 is $295,683. The estimated local income tax expense payable for the nine months ended September 30, 2013 is $23,094. The Company adjusted its income tax accrual accounts accordingly.

 

In 2013, the Internal Revenue Service reviewed the Company’s 2010 and 2011 federal income tax returns and found no adjustments necessary.

 

As of September 30, 2012, the Company had NOL’s for federal income tax purposes of approximately $575,000. For the first nine months of 2012, the Company kept its deferred tax asset at $155,279 due to the “more likely than not” utilization of NOL’s in coming years.

 

During the first nine months of 2012, the Company decreased its deferred tax liabilities by approximately $11,034 from $199,577 to $188,543. The decrease was for adjustments related to depreciation taken on assets previously claimed as Section 179 property.

 

The income tax benefit for the nine months ended September 30, 2012 was $11,033. During this same period, the Company made no further adjustments to its income tax accrual accounts.

 

The effective tax rate for both the three and nine months ended September 30, 2013 and 2012 is different from the tax expense that would result from applying the statutory tax rates primarily due to the recognition of valuation differences. For the 2013 reporting periods, effective tax rates of 34% and 2% were used for estimating federal and local income taxes, respectively. For the 2012 reporting periods, effective tax rates of 27% and 2% were used for estimating federal and local income taxes, respectively.

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Fair value estimates discussed herein are based on certain market assumptions and pertinent information available to management as of December 31, 2012 and September 30, 2013. A fair value hierarchy that prioritizes the inputs used to measure fair value, and requires fair value measurements to be categorized based on the observability of those inputs has been established by the applicable accounting guidance. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs). The respective carrying values of certain balance sheet financial instruments approximate their fair values and are classified within level 1 of the fair value hierarchy. 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.

 

SUBSEQUENT EVENTS

 

The Company has performed an evaluation of subsequent events for potential recognition and disclosure in the consolidated financial statements. On October 14, 2013, we signed a financing commitment letter from our bank whereby our revolver line of credit will be extended to June 30, 2015 from July 30, 2014. Final documents are anticipated to be executed in November, 2013.

 

11
 

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In December 2011, FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities, which amends ASC 210, Balance Sheet. This ASU requires entities to disclose gross and net information about both instruments and transactions eligible for offset in the statement of financial position and those subject to an agreement similar to a master netting arrangement. This would include derivatives and other financial securities arrangements. The effective date was January 1, 2013. The adoption of this ASU had no effect on the Company’s consolidated financial statements.

 

In February 2013, FASB issued an accounting standards update requiring new disclosures about reclassifications from “accumulated other comprehensive loss” to “net income.” These disclosures may be presented on the face of the statements or in the notes to the consolidated financial statements. This update was effective for fiscal years beginning after December 15, 2012. The adoption of these new standards had no effect on the Company’s consolidated financial statements.

 

RECLASSIFICATION

 

In the first quarter of 2013, we reclassified business and product development costs from cost of goods sold to selling, general, and administrative expenses to better reflect the true nature of these expenses. Amounts in the prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported income.

 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD LOOKING STATEMENTS

 

This quarterly report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which represent our expectations or beliefs concerning future events. Forward-looking statements generally include words such as “anticipates,” “believes,” “expects,” “planned,” “scheduled,” or similar expressions and statements. Although we believe these forward-looking statements are based on reasonable assumptions, statements made regarding future results are subject to a number of assumptions, uncertainties, and risks that could cause future results to be materially different from the results stated or implied in this document. 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-Q 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. We caution that these risk factors are not exclusive. Additionally, we do not undertake to update any forward looking statements that may be made from time to time by or on behalf of us except as required by law.

 

OVERVIEW

 

OurPet’s develops and markets products for improving the health, safety, comfort, and enjoyment of pets. Our mission is “To exceed pet and guardian expectations with innovative solutions.” The products sold have increased from the initial “Big Dog Feeder” to approximately 1,000 products for dogs, cats, and domestic and wild birds. Products are marketed under the OurPet’s®, Right Height®, Eat®, Smarter Toys®, Flappy®, Pet Zone®, SmartScoop®, Ecopure Naturals®, Play-N-Squeak®, Durapet®, Clipnosis® , Go! Cat!Go!®, and Cosmic Pet® labels to customers, both domestic and foreign. The manufacturing of these products is subcontracted to other entities, both domestic and foreign, based upon price, delivery, and quality.

 

According to the most recent 2013/2014 APPA National Pet Owners Survey, published by the American Pet Products Manufacturers Association, Inc.® (APPA), approximately 82.5 million U.S. households reported owning a pet with an estimated pet population of 83.3 million dogs, 95.6 million cats, and 20.6 million birds.  According to Packaged Facts: Pet Supplies and Pet Care Products in the U.S., June 2013, US pet industry sales totaled $59.12 billion in 2012.  For the same period, U.S. retail sales of pet supplies (OurPet’s segment) totaled $11.5 billion, which represents an increase of 3% over 2011.  While market growth is still below pre-recession rates, the economy is expected to gradually improve and the pet market as a whole is expected to rise to $75.09 billion by 2017. Annual sales growth of pet supplies is predicted at 4% in 2013 and 4.5% in 2014. Compound annual growth rate is likewise projected at 4-5% during 2012-2017. 

 

Net income for the three and nine months ended September 30, 2013 was $339,261 and $695,627, respectively. These numbers represent an increase in profit of $469,358 and $735,542, respectively, from the net loss of $130,097 and $39,915 for the same time periods in 2012.

 

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As discussed in Liquidity and Capital Resources on pages 16 through 18, we have funded our operations principally from the net cash provided from operating activities for the nine months ended September 30, 2013 and for the year ended December 31, 2012. Net cash provided by operating activities for the nine months ended September 30, 2013 was $818,719.

 

Under the Company’s credit facilities with our bank, the Company can borrow up to $5,000,000 based on the level of qualifying accounts receivable and inventories. As of September 30, 2013, we had a balance due of $1,885,032 under the line of credit with our bank at an interest rate of prime plus .50%.

 

RESULTS OF OPERATIONS

 

Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012

 

In the following discussion all references to 2013 are for the three months ended September 30, 2013 and all references to 2012 are for the three months ended September 30, 2012.

 

Net revenue consists of net sales of proprietary products for the retail pet business. For 2013 net revenue was $5,737,568, an increase of 34.4% in net revenue from $4,269,952 in 2012. This notable increase is impressive due to the fact that we were able to increase sales to a majority of our top customers during the third quarter and maintain our diverse customer base in a variety of channels. Our top two customers accounted for an increase in sales of approximately $650,000. Our top ten customers accounted for approximately a $1,022,000 net increase in sales with only one of these customers showing a decrease in dollars sold. Out of all of our customers sold to in 2012, the largest decrease in dollar terms was with a close-out customer and was under $100,000.

 

We added several new customers in the third quarter of 2013 which contributed approximately $52,000 in additional sales. Our sales to foreign customers increased by approximately $216,000, or 42%, from 2012 mainly due to increased sales to customers in Canada and Brazil.

 

We showed significant increases in sales in all of our primary channels. In the pet specialty channel (52% of 2013 sales), sales increased by approximately $982,000. In the “mass retail” channel (30% of 2013 sales), sales increased by approximately $317,000. In the grocery store channel (11% of 2013 sales), sales increased by approximately $202,000. All other channels (7% of 2013 sales) showed a net decrease of approximately $34,000. We will continue to focus on sales in our primary channels including E-Commerce as we believe there is potential for more growth to be realized from our strategic initiatives of market penetration and new product development.

 

Total sales of new products introduced in the third quarter of 2013 were approximately $147,000. Our hybrid stainless steel bonded rubber bowls that were introduced in the first quarter of 2013 added another approximately $301,000 to our third quarter sales. Our strongest product categories remained bowls/feeders and toys/accessories. Products in the bowls/feeders category comprised approximately 41% of 2013 sales and increased by approximately $597,000 over 2012 sales. Products in the toys/accessories category comprised approximately 46% of 2013 sales and increased by approximately $625,000 over 2012 sales.

 

The increase in sales resulted in our cost of goods sold increasing from $3,158,042 in 2012 to $3,889,535 in 2013. This increase of approximately $731,000 in cost of goods sold was due to the following: (i) the cost of purchased products sold increased by approximately $686,000 due to increased demand for product; (ii) freight costs increased by approximately $18,000; (iii) depreciation expense decreased by approximately $36,000 as a result of fewer capital expenditures; (iv) operating salaries and benefits increased by approximately $16,000; and (v) other operating expenses increased by approximately $47,000 resulting mostly from warranty charges and increased warehouse supplies. Our variable and fixed warehouse overhead costs increased by 6.1% from the comparable quarter in 2012 due to the above noted increase in operating expenses which was offset in part by the above noted decrease in depreciation expense.

  

Since the cost of purchased products as a percentage of net sales decreased from 56.4% in 2012 to 53.9% in 2013, the same amount of sales generated approximately an extra $107,000 in gross profit in 2013. Also the additional sales over and above 2012 sales of $1,467,616 added another approximately $676,000 to gross profit. These increases were slightly offset by the increased overhead costs resulting in a net increase of approximately $736,000 in gross profit. Gross profit margin increased to 32.2% in 2013 from 26.0% in 2012, as a result of more favorable product mix, price increases and better absorption of operating overhead.

 

Selling, general and administrative expenses in 2013 were $1,265,986, an increase of less than 1%, from $1,259,789 in 2012. This small increase resulted from the net of (i) an increase in payroll expenses of approximately $45,000; (ii) an increase in professional expenses of approximately $25,000 due to increased consulting expenses; (iii) a decrease of approximately $60,000 in sales and marketing expenses mainly from reduced promotions; and (iv) a net decrease of remaining selling, general, and administrative expenses of approximately $4,000.

 

13
 

  

In 2012, we had a loss from operations of $147,879. In 2013, as a result of our gross profit on sales increasing by $736,000, or 66.2%, and our selling, general and administrative expenses remaining fairly constant, we had income from operations of $582,047.

 

Other income for 2013 was $45,875 from a patent lawsuit settled in our favor. Other income for 2012 was negligible.

 

Interest expense for 2013 was $38,641, an increase of $2,622, from $36,019 in 2012. This change was due to a combination of factors. Interest expense for our bank line of credit decreased by approximately $9,700, resulting from the reduction in our average balance to $1,748,173 in 2013 from $2,763,350 in 2012 (interest rate remained the same at 3.75%). More interest expense was incurred for term loans of approximately $3,400 due to the addition of a new $500,000 term loan in December of 2012. Interest expense due on notes payable to subordinated note holders increased by approximately $6,700 from 2012 as a result of additional borrowings at the end of 2012. Lastly, interest expense due on leases and other miscellaneous payments increased by approximately $2,200.

 

In 2012, we had a tax benefit of $53,869 due to incurring a loss. In 2013, we earned income and had income tax expense of $250,020 to report. The difference of $303,889 was due to (i) an increase of approximately $187,700 in estimated federal income tax payable for 2013 versus 2012, (ii) an increase in estimated local income tax payable of approximately $14,300, (iii) an increase of approximately $64,300 in deferred tax assets utilized in 2013 as compared to 2012, and (iv) an increase of approximately $37,700 in deferred tax liabilities added in 2013 as compared to 2012.

 

Net income for 2013 was $339,261 as compared to a net loss of $130,097 for 2012, or an increase in profit of $469,358. This increase was a result of the following changes from 2012 to 2013:

 

Net revenue increase of  34.4%  $1,467,616 
Cost of goods sold increase of 23.2%   (731,493)
Gross profit on sales increase of 66.2%   736,123 
Selling, general and administrative expenses increase of 0.5%   (6,197)
Income from operations, increase   729,926 
Other income and expense, net increase   45,943 
Interest expense increase of 7.3%   (2,622)
Income tax expense increase   (303,889)
Increase in profitability  $469,358 

 

Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012

 

In the following discussion all references to 2013 are for the nine months ended September 30, 2013 and all references to 2012 are for the nine months ended September 30, 2012.

 

Our net revenue consisted of net sales of proprietary products for the retail pet business. For 2013 net revenue totaled $15,526,715, an increase of 9.2% in revenue from $14,213,342 in 2012. Only approximately $121,000 of the total sales in 2013 came from “close-out” sales, down from $565,377 in 2012. A high percentage of our growth came from our largest customer to whom we increased sales by $939,000 or 27% of all positive customer variances from 2012 to 2013. The second largest contributing factor was sales to new customers which contributed approximately $531,000 of additional revenue during 2013.

 

While sales increased in all of our primary channels, the food, drug, and mass channels showed more growth than the pet specialty channel. The food, drug, and mass channels (approximately 47% of 2013 sales) increased by about $1,320,000 from 2012 or 22%. The pet specialty channel (approximately 47% of 2013 sales) increased by about $630,000 from 2012 or 10%. Our sales to foreign customers increased by approximately $188,000, or 11%, from 2012 mainly due to increased sales to customers in Canada and Brazil offset partially by decreased sales to customers in Japan.

 

Total sales of new products in 2013 that were not sold in 2012 were approximately $1,386,000. Our new hybrid stainless steel bonded rubber bowls accounted for approximately $921,000 of this total. Our top three product categories in 2013 all experienced growth over 2012. Sales of bowls/feeders increased by approximately $911,000 (17%); sales of toys/accessories increased by approximately $408,000 (6%); and sales of edibles/consumables increased by approximately $397,000 (48%) compared to the same period in 2012. These increases were offset by decreased sales in the waste/odor category of approximately $270,000 (26%) and a net decrease of $133,000 in all other product categories.

 

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Cost of goods sold increased by 2.1%, from $10,589,531 in 2012 to $10,814,115 in 2013. This increase of approximately $225,000 in cost of goods sold was caused by the following: (i) increased expenses of approximately $224,000, or 2.6%, in the cost of purchased products sold and freight due to increased demand for product; (ii) increased customer charges of approximately $38,000; (iii) decreased depreciation expense of approximately $24,000 from fewer capital expenditures; (iv) decreased payroll expenses of approximately $58,000 due to reductions in Cosmic Pet and operations staffing; and (v) increased expenses of approximately $45,000 for all other items, including increased warranty costs. Our variable and fixed warehouse overhead costs decreased by 0.9% from the comparable nine months in 2012 due to the decreased payroll expenses offset partly by other operating expense increases.

 

Since the cost of purchased products as a percentage of net sales decreased from 57.4% in 2012 to 54.0% in 2013, the same amount of sales generated approximately an extra $483,000 in profit in 2013. Also the additional sales over and above 2012 sales of $1,313,373 added another approximately $605,000 to gross profit. These increases contributed to an increase of approximately $1,089,000 in gross profit. Gross profit margin also increased from 25.5% in 2012 to 30.4% in 2013 as a result of more favorable product mix, price increases and better absorption of operating overhead.

 

Selling, general and administrative expenses in 2013 were $3,566,494, an increase of 0.1%, or $2,565, from $3,563,929 in 2012. Although the totals did not change much between the two years, there was some variation in the detail of the expenses. In 2013, there was: (i) an increase in salaries and wages, payroll taxes and employee benefits of approximately $90,000; (ii) a decrease in sales and marketing expenses of approximately $172,000, mainly due to decreased expenses related to online social media and trade shows; (iii) an increase in professional expenses of approximately $62,000 related to increased consulting charges;and (iv) an increase in product development costs of approximately $23,000.

 

Income from operations increased by $1,086,224, from $59,882 in 2012 to $1,146,106 in 2013, as a result of our gross profit on sales increasing by $1,088,789 and selling, general and administrative expenses increasing by $2,565.

 

“Other income” for 2013 was $86,658, comprised of approximately $26,000 received from an insurance claim settlement, approximately $17,000 received from a patent infringement settlement related to our Durapet® brand, and $45,875 from a separate patent lawsuit settled in our favor. This income was offset by a $2,000 write off of a fixed asset no longer in use. Other income for 2012 was $8,344 with the majority being from a $7,000 grant from the City of Mentor for relocation of the Company’s Cosmic Pet operation to Mentor, Ohio.

 

Interest expense for 2013 was $125,978, an increase of $6,804, from $119,174 in 2012. For 2013 we experienced (i) a decrease in interest expense for our bank line of credit of approximately $31,000, resulting from a lower average balance of $1,823,676 in 2013 from $2,913,127 in 2012 (interest rate remained the same at 3.75%); (ii) an increase in interest expense due on notes payable to subordinated note holders of approximately $30,600 as a result of additional borrowings at the end of 2012; and (iii) a net increase of approximately $7,200 on other borrowings.

 

In 2012, we had a tax benefit of $11,033 due to incurring a loss. In 2013, we earned income and had income tax expense of $411,159 to report. The difference of $422,192 was due to: (i) an increase of approximately $295,500 in estimated federal income tax payable for 2013 versus 2012, (ii) an increase in estimated local income tax payable of approximately $23,200 for 2013 versus 2012, (iii) an increase of approximately $70,400 in deferred tax assets utilized in 2013 as compared to 2012, and (iv) an increase in expense of $33,100 for the net change in deferred tax liabilities.

 

Net income for 2013 was $695,627 as compared to a net loss of $39,915 for 2012, or an increase in profit of $735,542. This increase was a result of the following changes from 2012 to 2013: 

 

Net revenue increase of 9.2%  $1,313,373 
Cost of goods sold increase of 2.1%   (224,584)
Gross profit on sales increase of 30.1%   1,088,789 
Selling, general and administrative expenses increase of 0.1%   (2,565)
Income from operations, increase   1,086,224 
Other income, net increase   78,314 
Interest expense increase of 5.7%   (6,804)
Income tax expense increase   (422,192)
Increase in profitability  $735,542 

  

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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 $1,996,607 in available funds as of September 30, 2013 based upon the balance of accounts receivable and inventories at that date.

 

Our short-term and long-term liquidity will continue to depend on our ability to achieve cash-flow break even on our operations and to increase sales of our products. In 2012, we funded our operating cash requirements primarily through inventory reductions and net income. In the first nine months of 2013, we funded our operating cash requirements primarily through positive net income. We should be able to continue doing so for the remainder of 2013. We also expect to comply with the debt service coverage ratio and tangible net worth required by our bank to maintain our line of credit through the end of 2013. We have no material commitments for capital expenditures.

 

As of September 30, 2013, we had $3,240,294 in outstanding principal amount of indebtedness consisting of:

 

Bank line of credit facility - $5,000,000  Prime plus .5%  $1,885,032 
Bank term note ($500,000 original balance)  5.45%   375,001 
Lake County Economic Development Loan  5.00%   119,463 
Contributor notes payable  Prime plus 2%   575,000 
Capitalized Lease s  Various   43,077 
Ohio 166 Loan  3.00% (plus annual servicing fee of 0.25%)   142,721 
Other notes payable  Prime plus 3% & 10%   100,000 

  

Unless indicated otherwise, the following discussion describes in detail each of the line items above.

 

The bank line of credit indebtedness of $1,885,032 is comprised of a single line of credit under which we can borrow up to a total of $5,000,000 based on the level of qualifying accounts receivable and inventories. Total eligible collateral as of September 30, 2013 was $3,881,639. The $5,000,000 line of credit is a two year revolver and therefore is classified as a long term liability on our balance sheet. Currently the $5,000,000 line of credit has been renewed by the bank through June 30, 2014 with a commitment from our bank to extend this to June 30, 2015. Under our agreement with the bank we are required to: (i) maintain a debt service coverage ratio of at least 1.15; (ii) maintain a tangible net worth of no less than $4,500,000; and (iii) obtain the bank’s permission to incur additional indebtedness, make any expenditures for property and equipment in excess of $500,000 in any fiscal year, redeem any of our capital stock, or pay cash dividends other than dividends on our preferred stock (subject to meeting the debt service coverage ratio).

 

On December 7, 2012, the Company entered into a new Business Loan Agreement with our lender, FirstMerit Bank. Included in the Business Loan Agreement was a modification to the debt service ratio calculation whereby all newly obtained capital or subordinated debt each year can offset unfunded capital expenditures. As of September 30, 2013, we were in compliance with the covenant and default provisions under the amended agreement with the bank, had a debt service coverage ratio of 3.42, and had a tangible net worth of $6,030,228.

 

Changes in Financing During 2013

 

In April, 2013, our bank approved a repayment schedule for all accrued interest and principal related to the outstanding $300,000 subordinated note, issued in 2008 and due to be paid in full on October 31, 2012. As explained in our Annual Report on Form 10-K filed with the SEC on March 29, 2013, this loan (including accrued interest) was not paid when due since at that time it would have put the Company in further violation of the bank’s debt service coverage ratio. Effective November 1, 2012, per the terms of this note, the interest rate increased to prime plus 500 basis points (8.25%). The repayment is conditioned on the Company’s meeting the bank’s revised debt service coverage ratio each quarter. In April 2013, the Company repaid all accrued interest (approximately $82,000). In the third quarter of 2013, the Company repaid $75,000 of the outstanding principal plus approximately $6,000 in newly accrued interest. The Company plans to continue paying $75,000 of the outstanding principal and any accrued interest per quarter until the loan is repaid in full.

 

Also in April 2013, the Company entered into a capital lease for the purchase of a truck for transporting products between our Fairport Harbor and Mentor facilities in Ohio. The principal amount of the lease is $20,816 and it is s payable over a four year term in equal monthly installments of $527. In June 2013, the Company received $125,000 in funds as part of the Lake County Economic Development Loan Program. This new loan is payable over a five year term beginning in July 2013 in equal monthly installments of $2,359, which includes interest accruing at a fixed rate of 5.0%. The Company plans to use the funds towards the purchase of certain information technology equipment, packaging equipment, and tooling for new products. The loan is secured by this equipment.

 

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On October 14, 2013 we signed a commitment letter issued to us by our bank that extends our $5,000,000 credit facility through June 30, 2015. We anticipate the final documents to be executed in November 2013. The credit facility is collateralized by a security interest in the cash, accounts receivable, inventory and all other property and assets of OurPet’s and its subsidiaries. Steven Tsengas, OurPet’s Chairman of the Board and Chief Executive Officer, and his wife, Evangelia Tsengas, have personally guaranteed the repayment of the credit facility. In consideration for their continued guarantees through June 30, 2015, they will be granted 125,000 warrants at an exercise price of $.55/share for the right to purchase OurPet’s common stock. The warrants will vest immediately and will have a five year term.

 

Financing Obtained in 2012

 

On June 11, 2012, the Company entered into a capital lease for equipment purchased in connection with our total warehouse logistics initiatives. This equipment will facilitate wireless connectivity throughout our Fairport Harbor facility. The capital lease is payable in 48 monthly payments of $838 per month from July 2012 through June 2015. As of September 30, 2013, the remaining balance on this capital lease totaled $24,066.

 

On November 8, 2012, the Company received $350,000 in funds and issued $350,000 of subordinated notes to four parties, two of which are affiliated with OurPet’s. The notes have a three year term, accrue interest at a variable rate of prime plus three percent (currently 6.25%), and are payable with accrued interest on November 8, 2015. In connection with these new notes, the Company also issued 350,000 warrants to the loan participants at a ratio of one warrant for each one dollar of funds loaned. The warrants vested immediately, have an exercise price of $.50 per share, and have a five year term expiring on November 8, 2017. A copy of the form of promissory note and form of warrant issued to each party are attached as Exhibits 10.68 and10.69, respectively, to our Quarterly Report on Form 10-Q filed with the SEC on November 14, 2012.

 

On December 7, 2012, the Company entered into a new Business Loan Agreement and into an Amendment to Note related to OurPet’s current $5,000,000 revolving credit facility with our lender, FirstMerit Bank. Pursuant to the Business Loan Agreement and the Amended Note, the credit facility was extended through June 30, 2014 at an interest rate of prime plus .5%. Steven Tsengas, OurPet’s Chairman of the Board and Chief Executive Officer, and his wife, Evangelia Tsengas, personally guaranteed the repayment of the credit facility. In consideration for their guarantees they were granted 315,500 warrants at an exercise price of $.42/share for the right to purchase OurPet’s common stock. The warrants vested immediately and have a five year term. Copies of the Business Loan Agreement and the Amendment to Note are attached as Exhibits 10.71 and 10.72, respectively, to our Form 8-K filed with the SEC on December 13, 2012.

 

On December 7, 2012, the Company obtained a new $500,000 loan from our bank. Of these proceeds, $116,983 were used to pay off the remaining balance of the $500,000 term loan obtained on July 16, 2010. The new loan is payable over a three year term beginning in January 2013 in equal monthly principal installments of $13,889 plus accrued interest at a fixed interest rate of 5.45%. This loan was secured by our accounts receivable, inventory, equipment, trademarks, and patents. Steven Tsengas, OurPet’s Chairman of the Board and Chief Executive Officer, and his wife provided an unlimited guarantee of the loan and for that guarantee were granted 62,500 warrants exercisable at $.42/share for the right to purchase OurPet’s common stock. A copy of the Promissory Note executed in connection with this new term loan is attached as Exhibit 10.73 to our Form 8-K filed with the SEC on December 13, 2012. As of September 30, 2013, this loan had a principal balance outstanding of $375,001.

 

Other Outstanding Debt

 

On September 30, 2011, the Company incurred $225,000 of long term debt payable to the State of Ohio under its 166 Program. The funds were used to purchase new tooling for our raised feeder product line. The loan is payable in equal monthly installments of $4,043 over a five year term at a fixed interest rate of 3.00% plus an additional .25% servicing fee. Payments began on November 1, 2011 with a maturity date of October 1, 2016. As of September 30, 2013, this loan had a principal balance outstanding of $142,721.

 

The other notes payable are due in the amount of $75,000 on December 1, 2013, to Beachcraft L.P., with interest payable quarterly at prime plus 3%, and $25,000 on November 1, 2013 to Over the Hill Ltd., plus accrued interest of 10%. This 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 customary covenants and default provisions.

 

17
 

 

Changes in Cash

 

Net cash provided by operating activities for the nine months ended September 30, 2013 was $818,719. Cash was provided by the net income for the nine months of $695,627, as well as the non-cash charges for depreciation of $433,480, amortization of $37,572, stock option expense of $18,000, warrant expense of $9,000, and loss on disposal of a fixed asset of $2,000. Cash was used by the net change of $376,960 in our operating assets and liabilities as follows: 

  

Accounts receivable increase  $(394,146)
Inventories decrease   46,429 
Prepaid expenses increase   (216,325)
Deferred Tax Asset decrease   70,378 
Amortizable Intangible Assets increase   (67,857)
Accounts payable decrease   (76,694)
Accrued expenses increase   239,252 
Deferred Tax liability, increase   22,003 
      
Net change  $(376,960)

 

Net cash used for various purchases for the nine months ended September 30, 2013 was $363,209. This cash was used mostly for the acquisition of tooling, computer equipment, and a used truck for transporting inventory between warehouses. Cash used in financing activities for the nine months ended September 30, 2013 was $315,541 and consisted of payments on the bank line of credit of $374,000, net debt payments of $99,419 on other borrowings, and issuances of common stock of $157,878 as a result of the exercise of stock options and warrants.

 

Net cash provided by operating activities for the nine months ended September 30, 2012 was $863,881. Cash of $464,065 was provided by the net loss for the six months of $39,915, plus the non-cash charges for depreciation of $446,229, amortization of $30,751, stock option expense of $18,000 and warrant expense of $9,000. Cash was also provided by the net change of $399,816 in our operating assets and liabilities. 

 

Net cash used acquisition of certain property and equipment for the nine months ended September 30, 2012 was $275,481. Cash used in financing activities for the nine months ended September 30, 2012 was $733,266 and consisted of payments on the bank line of credit of $380,968 and of principal payments on debt of $352,298.

 

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 discussed elsewhere in this quarterly report as critical to our business operations and understanding of our results of operations. 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.

 

In our Form 10-K for the fiscal year ended December 31, 2012, our most critical accounting policies and estimates upon which our financial status depends were identified as those relating to revenue recognition, research and development costs, income taxes, impairment, intangible assets, inventory, and inventory reserves. We reviewed our policies and determined that those policies remain our most critical accounting policies for the nine months ended September 30, 2013.

 

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  3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

As a smaller reporting company, OurPet’s is not required to provide the information required by this item.

 

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ITEM 4.      CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of September 30, 2013, an evaluation was performed under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended. Based upon that evaluation, our President and Chief Executive Officer and our Chief Financial Officer each concluded that our disclosure controls and procedures are effective as of September 30, 2013.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM  1.      LEGAL PROCEEDINGS

 

As previously disclosed in the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 15, 2013, we received a Notice of Impending Legal Action by Law Enforcement from the Office of the District Attorney for the County of Solano, California in connection with our waste management PIK-Up Bags on January 23, 2012. We responded promptly and cooperated with the State of California, and do not have any reason to believe that this action will result in any judgments or fines against OurPet’s that would have a material adverse effect or impact in its financial position, liquidity or results of operation..

 

We have not been named in any further material legal 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.

 

In addition to the matter above and in the normal course of conducting our business, we may become involved in other litigation, including, but not limited to, preference claims by debtors in bankruptcy proceedings.

 

ITEM 1A.         RISK FACTORS

 

There were no changes in our risk factors from those previously disclosed in Company’s Form 10-K filed with the Securities and Exchange Commission on March 29, 2013.

 

ITEM 2.          UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM  3.          DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM  4.          MINE SAFETY DISCLOSURE

 

Not Applicable.

 

ITEM  5.          OTHER INFORMATION

 

None.

 

ITEM  6.          EXHIBITS

 

11* Statement of Computation of Net Income Per Share.
   
31.1* Rule 13a-14(a) Certification of the Principal Executive Officer.
   
31.2* Rule 13a-14(a) Certification of the Principal Financial Officer.
   
32.1* Section 1350 Certification of the Principal Executive Officer.
   
32.2* Section 1350 Certification of the Principal Financial Officer.

 

 

*Filed herewith  

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    OURPET’S COMPANY
     
Dated: November 14, 2013  

/s/ Steven Tsengas 

    Steven Tsengas
    Chairman, President and Chief
    Executive Officer
    (Principal Executive Officer)
     
Dated: November 14, 2013  

/s/ Scott R. Mendes 

    Scott R. Mendes
    Chief Financial Officer and Treasurer
    (Principal Financial and Accounting Officer)

 

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