OURPET’S COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(CONTINUED)
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
102,226
|
|
|
$
|
100,000
|
|
Accounts receivable - trade, less allowance for doubtful accounts of $74,824 and $37,824
|
|
|
4,561,144
|
|
|
|
4,294,810
|
|
Inventories net of reserve
|
|
|
7,746,643
|
|
|
|
7,914,613
|
|
Prepaid expenses
|
|
|
738,487
|
|
|
|
582,676
|
|
Total current assets
|
|
|
13,148,500
|
|
|
|
12,892,099
|
|
|
|
|
|
|
|
|
|
|
PROPERTY AND EQUIPMENT
|
|
|
|
|
|
|
|
|
Computers and office equipment
|
|
|
1,020,810
|
|
|
|
930,094
|
|
Warehouse equipment
|
|
|
581,123
|
|
|
|
561,173
|
|
Leasehold improvements
|
|
|
301,580
|
|
|
|
291,597
|
|
Tooling
|
|
|
4,636,196
|
|
|
|
4,334,257
|
|
Construction in progress
|
|
|
376,763
|
|
|
|
222,259
|
|
Total
|
|
|
6,916,472
|
|
|
|
6,339,380
|
|
Less accumulated depreciation
|
|
|
4,917,530
|
|
|
|
4,466,120
|
|
Net property and equipment
|
|
|
1,998,942
|
|
|
|
1,873,260
|
|
|
|
|
|
|
|
|
|
|
OTHER ASSETS
|
|
|
|
|
|
|
|
|
Amortizable Intangible Assets, less amortization of $533,429 and $493,690
|
|
|
391,857
|
|
|
|
357,341
|
|
Intangible Assets
|
|
|
477,328
|
|
|
|
477,328
|
|
Goodwill
|
|
|
67,511
|
|
|
|
67,511
|
|
Deposits and other assets
|
|
|
52,650
|
|
|
|
1,675
|
|
Total other assets
|
|
|
989,346
|
|
|
|
903,855
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
16,136,788
|
|
|
$
|
15,669,214
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
OURPET’S COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(CONTINUED)
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(unaudited)
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Current maturities of long-term debt
|
|
$
|
234,146
|
|
|
$
|
276,890
|
|
Accounts payable - trade
|
|
|
1,559,183
|
|
|
|
1,582,849
|
|
Other accrued expenses
|
|
|
813,077
|
|
|
|
571,858
|
|
Total current liabilities
|
|
|
2,606,406
|
|
|
|
2,431,597
|
|
|
|
|
|
|
|
|
|
|
LONG-TERM LIABILITIES
|
|
|
|
|
|
|
|
|
Long-term debt - less current portion above
|
|
|
702,511
|
|
|
|
876,248
|
|
Revolving Line of Credit
|
|
|
2,764,966
|
|
|
|
3,267,170
|
|
Deferred Income Taxes
|
|
|
337,767
|
|
|
|
333,834
|
|
Total long term liabilities
|
|
|
3,805,244
|
|
|
|
4,477,252
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
6,411,650
|
|
|
|
6,908,849
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
COMMON STOCK
|
|
|
|
|
|
|
|
|
No par value; 50,000,000 shares authorized,
17,712,348 and 17,625,739 shares issued and outstanding at September 30, 2016 and December 31, 2015 respectively
|
|
|
5,112,457
|
|
|
|
5,082,566
|
|
|
|
|
|
|
|
|
|
|
CONVERTIBLE PREFERRED STOCK
|
|
|
|
|
|
|
|
|
No par value; convertible into
Common Stock at the rate of 10 common shares for each preferred share; 4,825,000 shares authorized, 63,500 shares issued
and outstanding at September 30, 2016 and December 31, 2015 respectively
|
|
|
579,850
|
|
|
|
579,850
|
|
|
|
|
|
|
|
|
|
|
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, 2016 and December 31, 2015
|
|
|
865,312
|
|
|
|
865,312
|
|
|
|
|
|
|
|
|
|
|
PAID-IN CAPITAL
|
|
|
85,518
|
|
|
|
67,518
|
|
|
|
|
|
|
|
|
|
|
ACCUMULATED EARNINGS
|
|
|
3,082,001
|
|
|
|
2,165,119
|
|
Total stockholders' equity
|
|
|
9,725,138
|
|
|
|
8,760,365
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
$
|
16,136,788
|
|
|
$
|
15,669,214
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
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,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
7,259,904
|
|
|
$
|
5,986,645
|
|
|
$
|
18,872,791
|
|
|
$
|
17,170,795
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
4,816,434
|
|
|
|
3,974,468
|
|
|
|
13,025,620
|
|
|
|
11,746,204
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on sales
|
|
|
2,443,470
|
|
|
|
2,012,177
|
|
|
|
5,847,171
|
|
|
|
5,424,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
|
1,649,506
|
|
|
|
1,363,154
|
|
|
|
4,410,236
|
|
|
|
3,996,794
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
793,964
|
|
|
|
649,023
|
|
|
|
1,436,935
|
|
|
|
1,427,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
(24,125
|
)
|
|
|
(14,582
|
)
|
|
|
(58,593
|
)
|
|
|
(40,582
|
)
|
Interest expense
|
|
|
23,450
|
|
|
|
35,919
|
|
|
|
84,206
|
|
|
|
85,221
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
794,639
|
|
|
|
627,686
|
|
|
|
1,411,322
|
|
|
|
1,383,158
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
298,970
|
|
|
|
217,236
|
|
|
|
494,440
|
|
|
|
496,839
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
495,669
|
|
|
$
|
410,450
|
|
|
$
|
916,882
|
|
|
$
|
886,319
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Net Income per common share
|
|
$
|
0.03
|
|
|
|
0.02
|
|
|
$
|
0.05
|
|
|
$
|
0.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
.
|
|
Diluted Net Income per common share
|
|
$
|
0.02
|
|
|
|
0.02
|
|
|
$
|
0.05
|
|
|
$
|
0.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
outstanding used to calculate
|
|
|
17,709,088
|
|
|
|
17,562,239
|
|
|
|
17,665,812
|
|
|
|
17,558,085
|
|
basic earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
equivalent shares outstanding used to
|
|
|
20,090,366
|
|
|
|
19,824,793
|
|
|
|
19,489,855
|
|
|
|
19,220,115
|
|
calculate diluted earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
OURPET’S COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES
IN STOCKHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2016
(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
|
|
|
Earnings
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2015
|
|
|
63,500
|
|
|
$
|
579,850
|
|
|
|
123,616
|
|
|
$
|
865,312
|
|
|
|
17,625,739
|
|
|
$
|
5,082,566
|
|
|
$
|
67,518
|
|
|
$
|
2,165,119
|
|
|
$
|
8,760,365
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock issued upon exercise of stock options/warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
86,609
|
|
|
|
29,891
|
|
|
|
|
|
|
|
|
|
|
|
29,891
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
916,882
|
|
|
|
916,882
|
|
Stock-Based
compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,000
|
|
|
|
|
|
|
|
18,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2016 (unaudited)
|
|
|
63,500
|
|
|
$
|
579,850
|
|
|
|
123,616
|
|
|
$
|
865,312
|
|
|
|
17,712,348
|
|
|
$
|
5,112,457
|
|
|
$
|
85,518
|
|
|
$
|
3,082,001
|
|
|
$
|
9,725,138
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
OURPET’S COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS
(Unaudited)
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
916,882
|
|
|
$
|
886,319
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Loss on fixed assets
|
|
|
10,853
|
|
|
|
20,656
|
|
Depreciation expense
|
|
|
451,411
|
|
|
|
456,981
|
|
Amortization expense
|
|
|
39,739
|
|
|
|
59,328
|
|
Stock option expense
|
|
|
18,000
|
|
|
|
18,000
|
|
(Increase) decrease in assets:
|
|
|
|
|
|
|
|
|
Accounts receivable - trade
|
|
|
(266,334
|
)
|
|
|
(932,311
|
)
|
Inventories
|
|
|
167,970
|
|
|
|
(908,560
|
)
|
Prepaid expenses
|
|
|
(155,811
|
)
|
|
|
11,467
|
|
Deposits and other assets
|
|
|
(50,975
|
)
|
|
|
-
|
|
Amortizable Intangible Assets
|
|
|
(74,255
|
)
|
|
|
(36,524
|
)
|
Increase (decrease) in liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable - trade
|
|
|
(23,666
|
)
|
|
|
(245,097
|
)
|
Accrued expenses
|
|
|
241,219
|
|
|
|
91,161
|
|
Deferred tax liabilities
|
|
|
3,933
|
|
|
|
(76,704
|
)
|
Net cash provided by (used in) in operating activities
|
|
|
1,278,966
|
|
|
|
(655,284
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Sale of property and equipment
|
|
|
1,000
|
|
|
|
-
|
|
Acquisition of property and equipment
|
|
|
(588,946
|
)
|
|
|
(490,341
|
)
|
Net cash used in investing activities
|
|
|
(587,946
|
)
|
|
|
(490,341
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Issuances of Common Stock
|
|
|
29,891
|
|
|
|
-
|
|
Principal borrowings of long-term debt
|
|
|
-
|
|
|
|
1,000,000
|
|
Principal payments on long-term debt
|
|
|
(216,481
|
)
|
|
|
(556,048
|
)
|
Net (payment) borrowing on bank line of credit
|
|
|
(502,204
|
)
|
|
|
611,000
|
|
Net cash (used in) provided by financing activities
|
|
|
(688,794
|
)
|
|
|
1,054,952
|
|
Net increase (decrease) in cash
|
|
|
2,226
|
|
|
|
(90,673
|
)
|
|
|
|
|
|
|
|
|
|
CASH AT BEGINNING OF PERIOD
|
|
|
100,000
|
|
|
|
192,448
|
|
CASH AT END OF PERIOD
|
|
$
|
102,226
|
|
|
$
|
101,775
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
84,707
|
|
|
$
|
126,552
|
|
Income taxes paid
|
|
$
|
245,490
|
|
|
$
|
472,150
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS
|
|
|
|
|
|
|
|
|
Non cash exercise of stock options/ warrants
|
|
$
|
28,997
|
|
|
$
|
6,933
|
|
Tooling Obtained through Asset Purchase
|
|
$
|
-
|
|
|
$
|
85,000
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
Notes to Condensed
Consolidated Financial Statements
ORGANIZATION AND NATURE OF OPERATIONS
Our management originally founded Napro,
Inc. (“Napro”), an Ohio corporation, in 1985 as an enterprise for launching new ventures and acquiring companies in
various lines of business. In 1996, Napro formed a wholly owned Ohio subsidiary, Virtu Company (“Virtu”), to market
proprietary products to the retail pet business under the OurPet’s® label. Napro then changed its name to OurPet’s
Company effective March 19, 1998. On July 16, 1998, Manticus, Inc. (“Manticus”), a Colorado corporation, obtained all
of the outstanding shares of OurPet’s/Napro in exchange for 8,000,000 shares of Manticus common stock. After the transaction,
the former holders of OurPet’s/Napro shares owned approximately 89% of Manticus’ shares. Effective August 10, 1998,
OurPet’s/Napro was merged into Manticus and ceased to exist. Prior to this merger, no affiliation or other relationship existed
between Manticus and us or our shareholders. Operations for the newly merged entity were, and continue to be, conducted in Ohio.
Manticus proceeded to become licensed in the State of Ohio as a foreign corporation, known as OurPet’s Company. Effective
October 12, 1998, Manticus’ Articles of Incorporation were amended in the State of Colorado to reflect its new name as OurPet’s
Company.
BASIS OF PRESENTATION
OurPet’s Company (“OurPet’s”
or the “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 periods ended September
30, 2016, and September 30, 2015, 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 and its wholly owned subsidiaries (collectively,
the “Company”), Virtu and SMP Company, Incorporated. The December 31, 2015, Condensed Consolidated Balance Sheet information
contained in this Form 10-Q was derived from the 2015 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, 2015, that are included in the Company’s Form 10-K
filed with the Securities and Exchange Commission on March 30, 2016. Operating results for the nine months ended September 30,
2016, are not necessarily indicative of the results that may be expected for future fiscal periods.
USE OF ESTIMATES
The preparation of condensed consolidated
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. All inventories are pledged as collateral for bank loans. Inventories at September
30, 2016, and September 30, 2015, consisted of:
|
|
2016
|
|
|
2015
|
|
Finished Goods
|
|
$
|
6,867,512
|
|
|
$
|
6,458,338
|
|
Components, packaging, and work in process
|
|
|
1,145,193
|
|
|
|
1,560,803
|
|
Inventory Reserve
|
|
|
(266,062
|
)
|
|
|
(216,466
|
)
|
Total
|
|
$
|
7,746,643
|
|
|
$
|
7,802,675
|
|
During the nine months ended September
30, 2016, the Company recorded additional inventory reserve charges of $167,787. Changes to the inventory reserve during 2016 and
2015 are shown below:
|
|
2016
|
|
|
2015
|
|
Beginning Balance
|
|
$
|
213,751
|
|
|
$
|
159,076
|
|
Increases to reserve
|
|
|
167,787
|
|
|
|
171,340
|
|
Write offs against reserve
|
|
|
(115,476
|
)
|
|
|
(113,950
|
)
|
Ending Balance
|
|
$
|
266,062
|
|
|
$
|
216,466
|
|
Monthly accruals are made to account for
obsolete and excess inventory. Quarterly reviews are also performed to determine if additional end-of-quarter adjustments are needed.
It was determined that no additional adjustment was needed for the end of the third quarter of 2016.
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 forecast, 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 on September 30, 2016, and December 31, 2015,
in the amounts of $74,824 and $37,824, 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. The Company holds a credit risk insurance policy that
covers most of its international customers.
RELATED PARTY TRANSACTIONS
We lease a 64,000-square-foot production,
warehouse and office facility in Fairport Harbor, Ohio, and a 26,000-square-foot production, warehouse, and office facility in
Mentor, Ohio, from a related entity, Senk Properties LLC (“Senk Properties”). 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 chairman, Chief Executive Officer, a director and a major stockholder of the Company. Konstantine Tsengas is our Chief Operating
Officer and secretary, as well as a stockholder. Nicholas Tsengas and Evangelia Tsengas are both stockholders of the Company.
We first entered into a 10-year lease with
Senk Properties upon completion of the 36,000-square-foot warehouse expansion in Fairport Harbor, Ohio, on June 1, 2007. We renegotiated
this lease in 2012 to lower the monthly payments. The revised lease was effective September 1, 2012, and has a term of 10 and one-half
years. The monthly rental rate schedule is: $27,250 per month for the first two years; $29,013 per month for the next two years;
$30,827 for the next three years; $32,587 for the next two years; and lastly, $34,347 for the final 18 months, all plus real estate
taxes and insurance. As of the end of the third quarter of 2016, we were in the fifth year of the lease and were paying the monthly
rental rate of $30,827. We have the option to extend the lease for an additional 10 years at a rental rate to be mutually agreed
upon.
We entered into a second lease with Senk
Properties for our facility in Mentor, Ohio, on December 30, 2011. Payments for this lease started on January 1, 2012, and are
due on the first day of each month. The monthly rental rate schedule is: $8,542 for the first two years; $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 and insurance. As of the end of the third quarter of 2016, we were in the fifth year of the lease and
were paying the monthly rental rate of $9,732. We have the option to extend the lease for an additional 10 years at a rental rate
to be mutually agreed upon.
Lease expenses resulting from the foregoing
agreements were $364,658 for the nine months ended September 30, 2016.
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. 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.
The Company has been invoiced $781,061 by
NSDA, of which $485,390 has been paid in cash, $50,000 paid with 50,454 shares of the Company’s common stock, and the remaining
balance of $245,671 deferred. The balance of the deferred payments is payable as a fee based upon sales of certain products.
As of September 30, 2016, the fee accrued to date and not yet paid was $3,717.
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. Senk
Properties loaned $50,000 and Pet Zone Products, Ltd. loaned $100,000 of the $350,000. The notes had a three-year term, accrued
interest at a variable rate of prime plus 3%, and were payable with accrued interest on November 8, 2015. The Company repaid the
notes early in August of 2015 using proceeds from a new term loan issued by the Company’s bank. In connection with the subordinated
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 and have a five-year term expiring on November 8, 2017. The warrants had an original exercise
price of $0.50. Subsequent to their issuance, the warrants were adjusted to 353,944 warrants exercisable at $.4944 per share in
accordance with the warrants’ anti-dilution provisions. In March 2016, 14,000 of the warrants were exercised by a non-affiliated
party. In June 2016, another 36,563 warrants were exercised by the same party.
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®, PetZone®, SmartScoop®, EcoPure Naturals®, Play-N-Squeak®, Durapet®,
Flappy®, Go! Cat! Go!®, Eat®, Smarter Toys®, Clipnosis®, Cosmic Pet™, Festiva®, and Intelligent Pet
Care™ brand names. Net revenue is comprised of gross sales less discounts given to distributors, returns and allowances.
For the three months ended September 30,
2016, 38.6% of the Company’s revenue was derived from two major customers. Revenue generated from these customers amounted
to $1,553,280 (21.4%) and $1,249,711 (17.2%).
For the three months ended September 30,
2015, 34.3% of the Company’s revenue was derived from two major customers. Revenue generated from these customers amounted
to $1,362,539 (22.8%) and $689,692 (11.5%).
For the nine months ended September 30,
2016, 35.5% of the Company’s revenue was derived from two major customers. Revenue generated from these customers amounted
to $4,819,967 (25.5%) and $1,879,570 (10.0%).
For the nine months ended September 30,
2015, 25.4% of the Company’s revenue was derived from one major customer. Revenue generated from this customer amounted to
$4,362,458.
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. In both 2016 and 2015, the amount of compensation
expense recognized as a result of stock options was $18,000.
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 are not included. As of September 30, 2016, common shares that were or could have been
potentially dilutive included 553,000 stock options at exercise prices from $0.41 to $1.12 a share, 824,180 warrants to purchase
common stock at exercise prices from $0.42 to $0.59 a share, 635,000 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 $0.70 per share. As of September 30, 2015, common shares that are or could be potentially dilutive include 573,360 stock options
at exercise prices from $0.41 to $1.27 a share, 950,672 warrants to purchase common stock at exercise prices from $0.42 to $0.98
a share, 635,000 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 $0.70 per share.
INCOME TAXES
During the first nine months of 2016, the
Company increased its deferred tax liabilities by approximately $4,000 (from $333,834 to $337,767) 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, 2016, was $463,409. The estimated local income tax expense payable for the nine months ended September 30,
2016, was $27,259. The Company adjusted its income tax accrual accounts accordingly. The Company also paid approximately $1,200
in franchise taxes during the first three quarters.
During the first nine months of 2015, the
Company reduced its deferred tax liabilities by approximately $77,000, from $281,651 to $204,947, 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, 2015, was $542,744. The estimated local income tax expense payable for the nine months ended September 30,
2015, was $31,926. The Company adjusted its income tax accrual accounts accordingly.
The Company follows provisions of uncertain
tax positions as addressed in FASB Accounting Standards Codification 740-10-65-1. Based on management’s evaluation, the Company
has no position at September 30, 2016, or December 31, 2015, for which there is uncertainty about deductibility. The Company is
no longer subject to U.S. Federal and state income tax examinations by taxing authorities for years before December 31, 2013.
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, 2015, and September
30, 2016. 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 value 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.
PROFESSIONAL EMPLOYER ORGANIZATION
In early January 2014, the Company contracted
with a Professional Employer Organization (“PEO”) which co-employs the Company’s employees. The PEO and
the Company share and allocate responsibilities and liabilities. The PEO assumes much of the responsibilities and liabilities
for the business of employment such as risk management, human resources (“HR”) management, benefits administration,
workers’ compensation, payroll and payroll tax compliance. The Company retains the responsibility for the hiring, firing
and managing its employees and operations. The purpose of the Company’s contracting with a PEO was to strengthen
the Company’s HR functions and provide its employees with a wider range of benefits at more affordable prices. The
Company changed PEO providers in January of 2016 primarily for the purpose of obtaining better benefits at lower costs.
SUBSEQUENT EVENTS
The Company has performed an evaluation
of subsequent events and noted none to report.
RECENT ACCOUNTING PRONOUNCEMENTS
In August
2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (”ASU”) 2016-15
,
“
Statement
of Cash Flows (Topic 230): Classification of certain cash receipts and cash payments (a consensus of the emerging issues take force)
.
”
This
ASU addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon
debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest
rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance
claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies);
distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable
cash flows and application of the predominance principle. This guidance will be effective for the Company on January 1, 2018. The
Company does not believe the guidance will have a material impact on its consolidated financial statements.
In June 2016, the FASB
issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”
The ASU requires measurement and recognition of expected versus incurred credit losses for financial assets held. ASU 2016-13 is
effective for the Company in our first quarter of fiscal year 2020 with early adoption permitted beginning in the first quarter
of fiscal year 2019. We are currently evaluating the impact the adoption of this standard will have on our consolidated financial
statements.
In
April and May 2016, the FASB issued ASU 2016-10 – Revenue from Contracts with Customers (Topic 606): Identifying Performance
Obligations and Licensing, and ASU 2016-12,
Revenue from Contracts with Customers (Topic
606):Narrow-Scope Improvements and Practical Expedients. These amendments provide additional guidance to the new revenue standard
(Topic 606) that will be applicable for reporting periods beginning after December 15, 2017. Early adoption is not permitted. Management
is evaluating the impact of this guidance on our financial statements.
On March 30, 2016,
the FASB issued ASU No. 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting.” The ASU includes multiple provisions intended to simplify various aspects of the accounting for share-based
payments. Excess tax benefits for share-based payments will be recorded as a reduction of income taxes and reflected in operating
cash flows upon the adoption of this ASU. Excess tax benefits are currently recorded in equity and as financing activity under
the current rules. This guidance is effective for annual and interim reporting periods of public entities beginning after December
15, 2016. The Company is currently evaluating the impact of adopting this new standard.
In March 2016, the
FASB issued ASU 2016-08 – Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting
Revenue Gross versus Net), amending the new revenue recognition standard that it issued jointly with the FASB in 2014 - Revenue
from Contracts with Customers, (Topic 606). The amendments in this ASU provide more detailed guidance to clarify certain aspects
of the principal-versus-agent guidance in the original ASU. The ASU is effective for annual and interim reporting periods beginning
after December 15, 2017, based on ASU 2015-14. Early application is permitted but not before the original effective date of
December 15, 2016. The Company is currently assessing the impact of this guidance.
In February 2016, the
FASB issued ASU 2016-02, “Leases (Topic 842).” This update revises an entity’s accounting for operating leases
by a lessee, among other changes, and requires a lessee to recognize a liability to make lease payments and an asset representing
its right to use the underlying asset for the lease term in the statement of financial position. The distinction between finance
and operating leases has not changed and the update does not significantly change the effect of finance and operating leases on
the statement of cash flows. Additionally, this update requires both qualitative and specific quantitative disclosures. This update
is effective for the first interim and annual periods beginning after December 15, 2018, with early adoption permitted. At
adoption, this update will be applied using a modified retrospective approach. The Company is currently evaluating the impact of
adopting this new standard.
In January 2016,
the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This update
revises an entity’s accounting related to the classification and measurement of investments in equity securities (except
those accounted for under the equity method of accounting or those that result in consolidation of the investee), changes the presentation
of certain fair value changes relating to instrument specific credit risk for financial liabilities and amends certain disclosure
requirements associated with the fair value of financial instruments. This update is effective for the first interim and annual
periods beginning after December 15, 2017, with early adoption permitted for certain provisions of the update. The Company
is currently evaluating the impact of adopting this new standard.
In November 2015, accounting
guidance was issued which simplifies the presentation of deferred income taxes. The guidance requires that all deferred tax assets
and deferred tax liabilities, including any valuation allowances, be classified as long-term in the consolidated balance sheet.
This guidance is effective for annual and interim reporting periods beginning after December 15, 2016, with early adoption
permitted. The Company is currently evaluating the impact of adopting this new standard.
In August 2014, the
FASB issued ASU No. 2014-15, “Disclosures of Uncertainties About an Entity’s Ability to Continue as a Going Concern.”
The new standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about
an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted.
The Company does not expect that this guidance will have a material impact on its financial position, results of operations or
cash flows.
In May 2014, the FASB
issued an accounting standards update with new guidance on recognizing revenue from contracts with customers. The standards update
outlines a single comprehensive model for entities to utilize to recognize revenue when it transfers goods or services to customers
in an amount that reflects the consideration that will be received in exchange for the goods and services. Additional disclosures
will also be required to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising
from contracts with customers. The standards update is effective for fiscal years beginning after December 15, 2017, which has
been delayed from the original effective date of December 15, 2016. Early adoption is permitted as of the original effective date.
We are currently evaluating the impact of adopting this standards update on our consolidated financial statements and we have not
yet selected a transition method.
|
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
We develop and market products for improving
the health, safety, comfort and enjoyment of pets. Our mission is “to exceed pet and pet parent/owner expectations with innovative
solutions.” Our dual-brand strategy is focused on OurPets® for the “Pet Specialty” channel and PetZone®
for the “Food, Drug and Mass retail” channel. The products sold have increased from the initial Big Dog Feeder®
to approximately 1,000 products for dogs, cats and birds. Products are marketed under the OurPet’s®, Flappy®, Pet
Zone®, SmartScoop®, Ecopure Naturals®, Play-N-Squeak®, Durapet®, Clipnosis®, Go! Cat!Go!®, Cosmic Pet™,
Festiva®, and Intelligent Pet Care™ labels to domestic and international customers. The manufacturing of these products
is subcontracted to other entities, both domestic and international, based upon price, delivery and quality.
Packaged Facts, a leading publisher
in the United Sates of market studies on consumer products, recently published its report of the “U.S. Pet Market Outlook,
2016-2017.” In it, it estimates the overall pet products and services market totaled $77.07 billion in 2015. It expects the
industry to reach about $96 billion by the end of 2020. The pet supplies segment (OurPet’s segment) was the third-largest
segment in 2015 with $15.18 billion in revenue. This segment showed an increase of 4.7% from the previous year. U.S. retail channel
sales of pet products, which includes pet food and pet supplies, were estimated at $45.3 billion in 2015, up 3.4% over 2014 (U.S.
Pet Market Outlook, 2016-2017).
Packaged Facts cites higher income households
as crucial to the success of the pet industry. It also identifies the human/animal bond and humanization of pets as key drivers.
As it explains in its outlook study, “Humanization of pets is a natural expression of the ‘pets as family’ trend,
whereby pet owners treat their pets like children and are highly receptive to products similar to the ones they use for themselves”
(U.S. Pet Market Outlook, 2016-2017).
The pet industry has proven to be generally
recession resistant with annual growth rates favorable to the overall economy over a business cycle.
As discussed in “Liquidity and Capital
Resources” beginning on page 19, we funded our operations principally from the net cash provided from financing activities
for the nine-month period ended September 30, 2015, and from operating activities for the nine-month period ended September 30,
2016. Net cash provided by operating activities for the nine months ended September 30, 2016, was $1,278,966.
Under the Company’s credit facilities
with FirstMerit Bank (the “Company’s Bank” or “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, 2016, we had an outstanding balance of
$2,764,966 under our line of credit at a variable interest rate of 30-Day LIBOR plus 2.25%.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2016, Compared to Three
Months Ended September 30, 2015
In the following discussion, all references
to 2016 are for the three months ended September 30, 2016, and all references to 2015 are for the three months ended September
30, 2015.
Our net revenue is primarily derived from sales of proprietary
products for the retail pet business. In 2016, sales were approximately $7.3 million, which was about $1.3 million (21.3%) above
sales for the same quarter a year ago.
We continue to focus on our three main channels:
“pet specialty,” “food, drug, mass retail,” and “e-commerce.” In 2016, “pet specialty”
customers accounted for 48% of our sales; “food, drug, mass retail” customers accounted for 39% of our sales; and “e-commerce”
customers accounted for 8% of our sales. We also occasionally sell our products in “value” and “closeout”
channels, which made up 4% of our sales in 2016. Miscellaneous sales accounted for the other 1% of our revenue. Last year we completed
the conversion of our brands to deliver products that are specifically marketed to our three main channels. The OurPets® brand
is sold to the “pet specialty” channel. The Pet Zone brand is sold to the “food, drug, mass retail” channel.
Both brands are sold to the “e-commerce” channel.
Within the “pet specialty” channel, we grew sales
by 27%, or approximately $741,000, over a year ago. The growth in this channel mostly came from increased sales to one of our top
“pet specialty” customers. Sales to this customer were down going into the third quarter by approximately $642,000.
During the first half of the year, the customer transitioned from carrying our private label stainless steel rubber bonded bowls
and “toys and accessories” to OurPet’s branded products, and as such requested that fulfillment of orders be
put on hold until it was ready to accept product. During the third quarter, we were able to fulfill many of this customer’s
outstanding orders and more than made up for the deficit that existed from earlier in the year. For the quarter, sales to this
customer were up by approximately $919,000 over a year ago. Outside of this one customer, sales were fairly consistent with last
year for a number of customers. One of our other top “pet specialty” customers had decreased cat toy sales, which offset
some of the increases.
Within the “food, drug, mass retail”
channel, we grew sales by 19%, or approximately $458,000, over a year ago. Increased sales of cat toys to three of our top customers
accounted for most of the growth in this channel. We increased sales to one customer by approximately $191,000; to another customer
by approximately $101,000; and to a third customer by approximately $92,000. Several other customers accounted for the remaining
increase in sales. Sales of holiday cat toys and new cat toy items contributed to the increase.
Within the “e-commerce” channel,
sales decreased by 5%, or approximately $30,000, over a year ago. This decrease was mainly from one customer whom we sold to a
year ago that did not repeat an order with us. Sales to all other “e-commerce” customers grew by a net of 6% from a
year ago.
Within the “value” and “close-out”
channels, sales decreased by approximately $47,000 and increased by approximately $14,000, respectively, over a year ago.
Our net sales to international customers generated about $572,000
in revenue, or about 8% of total sales, for the quarter. International sales decreased by approximately $67,000, or 10.5%, compared
to a year ago, apparently impacted by the strong U.S. dollar. Most of our international sales for the third quarter came from Canada
(55%) and the United Kingdom (19%). Sales to customers in Canada were down by approximately $39,000, or 11.0%, from a year ago,
primarily due to an increased use of direct orders, where customers purchase product directly from our suppliers (FOB shipping
point) in return for lower prices. Sales to customers in the United Kingdom were down by approximately $110,000, or 50.1%, from
a year ago due to decreased sales to the “distributor” channel. Sales to our customer in Taiwan were up by approximately
$91,000 from a year ago.
Our two main product categories are toys/accessories
(56%) and bowls/feeders (33%). The other 11% of our sales is comprised of edible/consumable products (e.g. catnip, tuna) (5%),
waste/odor products (5%), and health/wellness products and dog houses (1%).
Sales of our toys/accessories increased
by approximately $979,000, or 31%, over a year ago. Sales of displays showcasing our cat toys to one of our top “pet specialty
customers” contributed approximately $318,000. Sales of our “Safari Friends,” “Dino Friends,” and
“Veggies” assortments for cats (new products from quarter one of this year) generated approximately $156,000. Sales
of electronic toys increased by approximately $188,000 while sales of holiday items grew by approximately $96,000 over a year ago.
A variety of toys made up the remaining increase in sales.
Sales of our bowls and feeders increased
by approximately $222,000, or 10%, over last year. Most of this growth came from increased sales to one of our top “pet specialty”
customers. We increased sales of “bowls and feeders” to this customer by more than $200,000 over a year ago. A number
of customers accounted for the rest of the growth. Sales of “bowls and feeders” to “food, drug, mass retail”
customers decreased by 6% and offset some of the increases. Sales of our raised feeders (which together with stainless bowls makes
up most of the “bowls and feeders” category) increased by 10% over a year ago.
Sales of our edibles/consumables decreased
by approximately $48,000, or 11%. Most of the decrease came from lower sales of catnip products to two of our international customers.
Sales of our waste and odor management category
grew by approximately $18,000, or 6%, over last year’s sales, primarily due to increased sales of litter box accessories.
Out of our total sales for the third quarter,
approximately 4% (or about $317,000) came from sales of new items introduced during the quarter. Some of the items introduced included:
new holiday cat toys, a new electronic “Pounce House” spin toy for cats, an “Intelligent Pet Care” litterbox
with Bluetooth
®
technology capabilities, and a new natural Switchgrass cat litter. As we begin to sell these products
and introduce them to the market, we expect them to help further our revenue growth in coming years.
Due mostly to the growth in our sales and
partially from an increase in operating costs, our “cost of goods sold” increased by approximately $842,000, or 21%,
from a year ago. Charges incurred to bring product to our location from overseas increased over last year as in 2015 we realized
a refund of approximately $94,000 from the U.S. Customs department for GSP (Generalized System of Preferences) for duties paid
to import stainless steel bowls from India. We did not receive nor expect to receive such a refund this year. Our overhead operating
expenses increased slightly (approximately $14,000), due to increases in quality assurance product testing and repairs and maintenance
costs for the warehouse. Also our order-processing costs increased due to contracting with local warehouses to assist in the receiving
of inventory to be stored off-site from our main location. We offset some of these increased costs by negotiating discounts with
a few of our vendors based on the favorable exchange rate between the U.S. Dollar and Chinese Yuan.
Our gross margin percentage stayed about
the same at 33.66% in 2016 compared 33.61% in 2015. As a result of increased sales, our gross profit margin dollars increased $431,293,
or 21.4%, from $2,012,177 in 2015 to $2,443,470 in 2016.
Selling, general and administrative expenses
in 2016 were $1,649,506 (an increase of 21.0% or $286,352) from $1,363,154 in 2015. This increase was the net result of: (1) an
increase in selling expenses of approximately $220,000 from increased commissions, promotions, and customer incentives; (2) an
increase in payroll expenses of approximately $51,000 from increased accruals related to bonus and profit sharing arrangements;
(3) an increase in marketing expenses of approximately $34,000 from a one-time public relations campaign related to the launch
of our Intelligent Pet Care™ products; (4) an increase in IT expenses of approximately $16,000 from increased software support
expenses; (5) a decrease in professional expenses of approximately $18,000 from decreased consulting expenses; (6) a decrease in
business and product development expenses of approximately $16,000; and (7) a net decrease of $1,000 in all other selling, general,
and administrative expenses.
Our income from operations increased by
$144,941, or 22.3%, from $649,023 in 2015 to $793,964 in 2016 due to the increase in gross profit on sales of $431,293, offset
by the increase in selling, general and administrative expenses of $286,352.
As a result of favorable patent litigation settlements, we earned
other income of approximately $24,000 in 2016 and $15,000 in 2015 from royalty and settlement income.
Interest expense for 2016 was $23,450, a
decrease of $12,469, from $35,919 in 2015. This net decrease was due to several factors. We decreased our average line of credit
balance by approximately $1,300,000 from a year ago, which resulted in interest on the line decreasing by about $6,800. The interest
rate on the line (2.25 + 30 day LIBOR rate) increased due to an approximate 0.3% increase in the monthly LIBOR rate. In the third
quarter of 2015, we borrowed a new $1,000,000 term loan from our Bank. This borrowing resulted in approximately $3,900 more in
interest expense than a year ago. We paid off the debt owed to contributors in the third quarter of 2015. We also paid off the
balance of the $500,000 term loan with our Bank in the fourth quarter of 2015. As a result of these pay-offs, we incurred approximately
$8,500 less in interest expense than a year ago. Finally, we paid down other smaller loans and leases, which resulted in approximately
$1,100 in less interest expense.
Due to the increase in income from 2015 to 2016, income tax
expense increased by approximately $82,000.
Net income for 2016 was $495,669 as compared
to net income of $410,450 for 2015, an increase of $85,219, or 20.8%. This increase was a result of the following changes from
2015 to 2016:
Net revenue increase of 21.3%
|
|
$
|
1,273,259
|
|
Cost of goods sold increase of 21.2%
|
|
|
(841,966
|
)
|
Gross profit increase of 21.4%
|
|
|
431,293
|
|
Selling, general, and administrative expenses increase of 21.0%
|
|
|
(286,352
|
)
|
Interest expense decrease of 34.7%
|
|
|
12,469
|
|
Increase in other income
|
|
|
9,543
|
|
Income tax expense increase
|
|
|
(81,734
|
)
|
Increase in profitability
|
|
$
|
85,219
|
|
Nine Months Ended September 30, 2016, Compared to Nine Months
Ended September 30, 2015
Our net revenue is primarily derived from sales of proprietary
products for the retail pet business. In 2016, sales were approximately $18.9 million and were about $1,700,000 above sales of
the first nine months of 2015. This equates to a 9.9% increase in sales. More than half of the growth came from increased sales
in the “food, drug, mass retail” channel.
We continue to focus on our three main channels:
“food, drug, mass retail,” “pet specialty,” and “e-commerce.” In 2016, “food, drug, mass
retail” customers accounted for 42% of our sales, “pet specialty” customers accounted for 42% of our sales, and
“e-commerce” customers accounted for 9%. We also sell our products in “value” and “closeout”
channels, which made up 6% of our sales in 2016. Miscellaneous sales accounted for the other 1% of our revenue. Last year we completed
the conversion of our brands to deliver products that are specifically marketed to our three main channels. The Pet Zone brand
is sold to the “food, drug, mass retail” channel. The OurPets® brand is sold to the “pet specialty”
channel. Both brands are sold to the “e-commerce” channel.
Within the “food, drug, mass retail”
channel, we grew sales by 12%, or approximately $873,000, over a year ago. Most of this growth came from increasing sales to our
top customer in this channel. Sales to our top customer grew by about $458,000. The rest of the increase came from a number of
customers. We increased sales to all five of our top customers in this channel.
Within the “pet specialty” channel,
sales increased by 1%, or approximately $70,000, over a year ago. We increased sales to several of our top “pet specialty”
customers. However those increases were offset with decreases from other customers. Sales of “bowls and feeders” were
generally down while sales of “toys and accessories” were up in the “pet specialty” channel.
Within the “e-commerce” channel,
we grew sales by 10%, or approximately $151,000, over a year ago. This increase was spread among several customers and was due
to increased sales of toys, litter boxes, and bowls, offset by decreased sales of dog houses.
Within the “value” channel,
we grew sales by approximately $207,000 over a year ago. Most of the increased sales were in the Pet Zone bowls/feeders category
with some in the toys/accessories and edibles/consumables categories.
Within the “closeout” channel,
we increased sales by approximately $250,000 over a year ago. The increased use of closeout sales was made to dispose of excess/slow
moving inventory.
Our net sales to international customers generated about $1,590,000
in revenue, or about 8% of total sales, for the first three quarters of the year. International sales decreased by approximately
$149,000, or 8.6%, compared to a year ago, apparently impacted by the strong U.S. dollar. Most of our international sales came
from Canada (61%) and the United Kingdom (21%). Sales to customers in Canada were up by approximately $78,000, or 8.6%, from a
year ago due to increased sales of bowls and consumables. Sales to customers in the United Kingdom were down by approximately $200,000,
or 37.3%, from a year ago due to decreases in consumables and toys. Sales to our customer in Saudi Arabia were also down by approximately
$41,000 from a year ago. Sales were up to our customer in Taiwan by approximately $71,000 from a year ago.
Our two main product categories are toys/accessories
(52%) and bowls/feeders (36%). The other 12% of our sales is comprised of edible/consumable catnip products (6%), waste/odor products
(4%), and health/wellness products and dog houses (2%).
Sales of our toys/accessories increased
by approximately $1,900,000, or 24%, over a year ago. This increase resulted from introducing new electronic cat toys and from
increasing the volume sold of products in our existing floor toys, interactive toys, wands and mice “cat toy” product
lines. The sales increase was not limited to one sector but was spread across all of our main channels. Our top two customers accounted
for approximately $1,300,000 of the increase.
Sales of our bowls and feeders decreased
by approximately $203,000, or 3%, over last year. This decrease occurred due to lower sales of stainless steel bowls. This market
has become quite competitive despite our enforcing various patent infringements. Sales of stainless steel bowls to our top “pet
specialty” customer were down by approximately $492,000 from last year. Sales of stainless steel bowls to all other customers
increased by a net of about $140,000 over a year ago, led by sales to a customer in the “value” channel. Sales of our
raised feeders (which together with stainless bowls makes up most of the “bowls and feeders” category) increased by
9% over a year ago. Most of the growth came from increased sales of our Designer Diner and Barking Bistro products.
Sales of edibles/consumables decreased by
approximately $119,000, or 9%. This decrease mostly occurred due to lower sales to the United Kingdom.
Sales of our litter boxes and litter box
accessories increased, contributing to the waste and odor category growing approximately $158,000, or 23%, over last year’s
sales.
Sales of new products in the first three
quarters of 2016 that were not previously sold were approximately $1,741,000, or 9.2%, of total sales. Most of these sales were
from products in the toys and accessories category, including the electronic “Fly By Spinner” toy and a variety of
assorted interactive cat natural floor toys and scratchers. The remainder of our new product sales came from new private label
stainless steel with bonded rubber bottom bowls and new products in the waste/odor category.
Our cost of goods sold increased by approximately
$1,279,000, or 10.9%, from $11,746,204 in 2015 to $13,025,620 in 2016. The increase resulted from both the extra sales volume and
an increase in costs. Charges incurred to bring product to our location from overseas increased over last year as in 2015 we realized
a refund of approximately $94,000 from the U.S. Customs department for GSP (Generalized System of Preferences) for duties paid
to import stainless steel bowls from India. Except for approximately $3,000 received in January related to last year’s refund,
we did not receive nor expect to receive such a refund this year. Our order-processing costs increased due to contracting with
local warehouses to assist in the receiving of inventory to be stored off-site from our main location. Our warehouse overhead costs
increased by approximately $141,000, or 7.2%, from the comparable nine months in 2015. Charges incurred for outside warehouse storage
space increased by approximately $55,000. Operating salaries, payroll taxes, and benefits increased by approximately $48,000. Expenses
related to quality control increased by approximately $23,000. Expenses incurred for warranty charges increased by approximately
$21,000. Miscellaneous items comprised the other $6,000 net decrease in overhead expenses. We offset some of these increased costs
by negotiating discounts with a few of our vendors based on the favorable exchange rate between the U.S. Dollar and Chinese Yuan.
Our gross margin percentage decreased from
31.59% in 2015 to 30.98% in 2016 due to the increase in operating costs and market pressures to maintain pricing and offer more
allowances.
The increase in sales allowed our gross
margin dollars to increase by approximately 7.8%, or approximately $423,000, from 2015 to 2016.
Selling, general and administrative expenses
in 2016 were $4,410,236 (an increase of 10.3%, or $413,442) from $3,996,794 in 2015. This increase was the net result of: (1) an
increase in selling expenses of approximately $251,000 from increased expenditures for customer incentives, shows, promotions,
commissions, and cash discounts allowed; (2) an increase in salaries, payroll taxes, and benefits of approximately $115,000; (3)
an increase in marketing expenses of approximately $76,000 from a one-time public relations campaign related to the launch of our
Intelligent Pet Care™ products and increased expenses for samples; (4) an increase in travel and entertainment expenses of
approximately $32,000; (5) an increase in bad debt expense of approximately $40,000; (6) a decrease in professional expenses of
approximately $59,000 from decreased consulting expenses; (7) a decrease in business and product development expenses of approximately
$55,000; and (8) a net increase of $13,000 in all other selling, general, and administrative expenses.
Most of the increase in gross profit on
sales of $422,580 was offset with the increase in selling, general and administrative expenses of $413,442. As a result, our income
from operations increased by only $9,138 (or 0.6%) to $1,436,935 in 2016 compared to $1,427,797 in 2015.
We earned “other income” of approximately $59,000
in 2016 and $41,000 in 2015. Of the $59,000 earned in 2016, $20,000 was derived from customer payments for tooling/molds needed
in the joint development of new toy products. The remaining approximately $39,000 of other income in 2016 and $41,000 in 2015 was
mostly from royalty income resulting from favorable patent litigation settlements.
Interest expense stayed about the same in
2016 as 2015. Interest expense for 2016 was $84,206, compared to $85,221 in 2015. We decreased our average line of credit balance
by approximately $113,000 from a year ago. However, the interest rate (2.25 + 30 day LIBOR rate) on the line of credit increased
due to an approximate 0.3% increase in the monthly LIBOR rate. As a result, interest on the line increased by about $3,700. In
the third quarter of 2015, we borrowed a new $1,000,000 term loan from our Bank. This new loan resulted in approximately $19,300
more in interest expense than a year ago. We paid off the debt owed to contributors in the third quarter of 2015. We also paid
off the balance of an outstanding $500,000 term loan with our Bank in the fourth quarter of 2015. As a result of these pay-offs,
we incurred approximately $20,900 less in interest expense than a year ago. Finally, we paid down other smaller loans and leases,
which resulted in approximately $3,100 in less interest expense.
Income tax expense decreased from 2015 to
2016 by approximately $2,400.
Net income for 2016 was $916,882 as compared to net income of
$886,319 for 2015, an increase of $30,563, or 3.4%. This increase was a result of the following changes from 2015 to 2016:
Net revenue increase of 9.9%
|
|
$
|
1,701,996
|
|
Cost of goods sold increase of 10.9%
|
|
|
(1,279,416
|
)
|
Gross profit increase of 7.8%
|
|
|
422,580
|
|
Selling, general, and administrative expenses increase of 10.3%
|
|
|
(413,442
|
)
|
Interest expense decrease of 1.2%
|
|
|
1,015
|
|
Increase in other income
|
|
|
18,011
|
|
Income tax expense decrease
|
|
|
2,399
|
|
Increase in profitability
|
|
$
|
30,563
|
|
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities provide cash from
the sale of our products to customers. The principal uses of cash are payments to suppliers that manufacture our products and freight
charges for shipments to our warehouses 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 lines of credit with our Bank,
which had $2,235,034 in available funds as of September 30, 2016, 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 2015,
we funded our operating cash requirements primarily through the working capital line of credit and borrowing of new debt. In the
first nine months of 2016, we funded our operating cash requirements primarily with net income. During the remainder of 2016, we
should be able to fund our operating cash requirements with net income and the working capital line of credit, if needed. Based
on our Bank’s loan covenants, we 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 2016.
During the third quarter of 2016, we entered into a commitment
to purchase an automatic packaging machine, with a cost of approximately $105,000, to be used at our Mentor facility. To finance
the purchase, we entered into a lease with Connext Financial. It will be a 60-month lease with a $1.00 buyout at the end of the
lease with an approximate 5.44% interest rate. We expect the lease to be finalized at the beginning of 2017.
Outstanding Debt
As of September 30, 2016, we had $3,701,623 in principal amount
of indebtedness consisting of:
Bank line of credit ($5,000,000)
|
|
30 day Libor plus 2.25%
|
|
$
|
2,764,966
|
|
Bank term note ($1,000,000 original balance)
|
|
30 day Libor plus 3%
|
|
|
800,000
|
|
Ohio 166 Loan
|
|
3.00% (Plus annual servicing fee of .25%)
|
|
|
4,033
|
|
Capitalized Lease
|
|
9.9%
|
|
|
3,570
|
|
Lake County Economic Development Loan Program
|
|
5.00%
|
|
|
47,338
|
|
Note Payable to Molor Products
|
|
Non-interest bearing
|
|
|
81,716
|
|
Our Bank line of credit indebtedness of
$2,764,966 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 at September 30, 2016, was $5,803,050. The line of credit
is a two-year revolver and therefore is classified as a long-term liability on our balance sheet. Approval was recently given by
our Bank to renew the line of credit through June 30, 2018. Under our agreement with our Bank we are required to: (1) maintain
a debt service coverage ratio of at least 1.00 to 1.15 measured quarterly on a trailing 12 month basis; (2) maintain a tangible
net worth of no less than $6,000,000 tested at the end of each quarter; and (3) obtain the Bank’s permission to incur
additional indebtedness, make any expenditures for property and equipment in excess of $750,000 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). As of September 30, 2016, we were in compliance with the covenant and default provisions under the agreement with our Bank.
We had a debt service coverage ratio of 1.78 and a tangible net worth of $8,788,442.
Changes in Cash- First Nine Months of 2016
Net cash provided by operating activities for the nine months
ended September 30, 2016, was $1,278,966. Cash was provided by the net income for the nine months of $916,882, as well as the non-cash
charges for (i) depreciation of $451,411; (ii) amortization of $39,739; (iii) stock option expense of $18,000; and (iv) loss on
fixed assets of $10,853.
Cash was used by the net change of $157,919
in our operating assets and liabilities as follows:
Accounts Receivable increase
|
|
$
|
(266,334
|
)
|
Inventories decrease
|
|
|
167,970
|
|
Prepaid Expenses increase
|
|
|
(155,811
|
)
|
Amortizable Intangible Assets increase
|
|
|
(74,255
|
)
|
Deposits and Other Assets increase
|
|
|
(50,975
|
)
|
Accounts payable decrease
|
|
|
(23,666
|
)
|
Accrued Expenses increase
|
|
|
241,219
|
|
Deferred Tax Liability increase
|
|
|
3,933
|
|
Net Change
|
|
$
|
(157,919
|
)
|
Accounts receivable increased due to increased
sales in the third quarter of 2016 compared to the fourth quarter of 2015. Inventories decreased due to close out sales and improved
management of our supply chain. Prepaid expenses increased due to prepayments for shows, royalty advances, and marketing videos,
offset by expense recognized for income taxes prepaid last year. Amortizable intangible assets increased mostly from patent costs
and to a lesser extent from amounts incurred for a Bluetooth® license and website development costs. Deposits increased due
to a down payment made pursuant to a commitment to purchase new packaging equipment. Accrued expenses increased from increased
expenses incurred for commissions, employee bonuses, salaries, and income taxes, offset partly by paying customer incentive payments
related to last year’s programs.
Net cash used for investing activities for
the nine months ended September 30, 2016, was $587,946. Approximately $249,000 was used for tooling/molds and approximately $213,000
was used for Bluetooth
®
technology development with the balance used to purchase various computer/software and various
other asset purchases.
Cash used by financing activities for the
nine months ended September 30, 2016, was $688,794 and consisted of: (1) net increased payments on our Bank line of credit of $502,204;
(2) principal payments on long-term debt of $216,481; and (3) issuances of common stock of $29,891. No changes were made to the
structure of our debt during the first nine months of 2016. All scheduled payments were made on time.
Changes in Cash- First Nine Months of 2015
Net cash used in operating activities for
the nine months ended September 30, 2015, was $655,284. Cash was provided by the net income for the nine months of $886,319, as
well as the non-cash charges for depreciation of $456,981, amortization of $59,328, stock option expense of $18,000, and loss on
fixed assets written off of $20,656. Cash was used by the net change of $2,096,568 in our operating assets and liabilities.
Accounts receivable increased due to the
increase in sales. Inventories increased due to bringing in more products in preparation of and transition to our new dual brand
strategy. Accounts payable decreased due to our accelerating payments to suppliers who agreed to share recent currency exchange
rate gains. Accrued expenses increased mostly from expecting higher income tax expense for the year and also from anticipating
more marketing and promotional charges due to agreements with certain customers.
Net cash used for investing activities for
the nine months ended September 30, 2015, was $490,341. This cash was mostly used for the purchase of software to assist with forecasting,
tooling costs related to our new Barking Bistro product and a new phone system. Cash provided by financing activities for the nine
months ended September 30, 2015, was $1,054,952 and consisted of: (1) net increased borrowings on the bank line of credit
of $611,000; (2) borrowing of a new term loan in the amount of $1,000,000; and (3) principal payments on long-term debt of $556,048.
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 the summarized significant accounting policies accompanying our audited consolidated
financial statements included in our Form 10-K filed on March 30, 2016. 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, 2015, 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 of long lived assets, intangible
assets, product warranties, prepaid expenses, and inventories 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, 2016.
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.