<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 3 TO
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES OF
SMALL BUSINESS ISSUERS
Under Section 12(b) or (g) of The Securities Exchange Act of 1934
PET QUARTERS, INC.
(Name of Small Business Issuer in its charter)
<TABLE>
<CAPTION>
ARKANSAS 62-169-8524
<S> <C>
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
720 EAST FRONT STREET, LONOKE, ARKANSAS 72086
(Address of principal executive offices) (Zip Code)
</TABLE>
Issuer's telephone number 501-676-9222
Securities to be Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange on
Title of Each Class Which Registered
------------------- ----------------
NONE NONE
Securities to be Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK ($.001 PAR VALUE)
(Title of Class)
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C> <C>
PART I............................................................................................................1
Item 1. Description of Business......................................................................1
Item 2. Management's Discussion and Analysis Or Plan of Operations..................................10
Item 3. Description of Properties...................................................................16
Item 4. Security Ownership of Certain Beneficial Owners and Management..............................17
Item 5. Directors, Executive Officers, Promoters and Control Persons................................18
Item 6. Executive Compensation......................................................................20
Item 7. Certain Relationships and Related Transactions..............................................21
Item 8. Description of Securities...................................................................22
PART II..........................................................................................................22
Item 1. Market Price and Dividends on the Registrant's Common Equity and Other
Shareholder Matters.........................................................................22
Item 2. Legal Proceedings...........................................................................23
Item 3. Changes in and Disagreements with Accountants...............................................23
Item 4. Recent Sales of Unregistered Securities.....................................................24
Item 5. Indemnification of Directors and Officers...................................................25
PART III.........................................................................................................
Item 1. Index to Exhibits and Description of Exhibits...............................................
Signature Page...........................................................................................
</TABLE>
ii
<PAGE> 3
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
(a) BUSINESS DEVELOPMENT
PET QUARTERS, INC. ("Pet Quarters" or the "Company") was incorporated
on May 22, 1997, under the laws of the State of Arkansas. Currently, the
Company's principal business is to sell pet supplies through the Internet and
catalogs. The Company offers over 7,500 items or Stock Keeping Units (SKU's) for
pets through its web site, which is located at www.Pet Quarters.com. The Company
has three subsidiaries: PQ Acquisition Company, Inc. ("Acquisition"), Humboldt
Industries Incorporated ("Humboldt") and Maplewood Industries, Inc.
("Maplewood") (collectively, Humboldt and Maplewood shall be referred to herein
as "Humboldt Industries" or the "Catalog Division.").
Acquisition is an Arkansas corporation organized in 1999, for the sole
purpose of acting as an intermediate corporation to acquire Humboldt Industries.
Acquisition currently owns all of the issued and outstanding shares of stock of
Humboldt Industries.
As of August 1, 1999, the Company acquired Humboldt Industries for cash
of $4.6 million and common stock of Pet Quarters valued at $4.6 million.
Humboldt Industries is a fulfillment company (i.e., a company which, fulfills
the orders and ships the products purchased on the Company's web site and the
subsidiaries catalogs). Humboldt circulates two mail order pet catalogs, Home
Pet Shop and Dog's Outfitter, to its retail and wholesale customers both
domestically and internationally. Maplewood circulates the Maplewood Crafts
catalog and the Plastic Canvas catalog and distributes a wide variety of craft
kits and craft supplies, primarily focusing on the consumer marketplace.
Maplewood shares the Humboldt infrastructure, resources and associated costs.
In July of 1999, the Company reached an agreement to acquire
Chartendure, Ltd. ("Chartendure"), of the United Kingdom, for common stock of
Pet Quarters. Chartendure contracted with Interactive Bureau ("IB"), one of the
leading web site design firms, in August 1999 to develop a new web site for Pet
Quarters. The Pet Quarters common stock to be issued to Chartendure will be
issued when and if IB achieves certain milestones in the development of the web
site. In addition, Chartendure's principal shareholder will provide information
regarding pet care, feeding and health issues for pet owners. This information
is supplied by veterinary organizations and other industry professionals and
will be incorporated into the Pet Quarters' web site. This will become a
value-added feature of the web site and will be available, free of charge, to
persons accessing the Company's web site.
Pet Quarters borrowed $4,600,000 from the Sun Valley Trust on July 30,
1999 (the "Trust"), to acquire Humboldt Industries (the "Bridge Loan"). Both
unaffiliated individuals and entities and affiliated individuals contributed
money to the Trust to enable the Trust to make the Bridge Loan. Individuals
affiliated with Pet Quarters accounted for $1,023,000 of the $4,600,000, which
is disclosed in Note 8 on page F-20. An unaffiliated entity, Olympus Capital
("Olympus"), accounted for $2,000,000 of the $4,600,000, appointed the trustee,
hired counsel for the Trust and negotiated the terms of the Bridge Loan on
behalf of the Trust. Without the contribution from Olympus to the Trust, the
funds the Trust would have had available to loan to Pet Quarters would not have
been sufficient to enable Pet Quarters to complete the acquisition of Humboldt
Industries.
As an incentive for the Trust to make the Bridge Loan, Pet Quarters
issued 153,334 of its restricted shares of common stock (valued at $651,671 or
$4.25 per share, the closing price on July 30, 1999) to the Trust that were
distributed by the Trust to its beneficiaries.
The Bridge Loan is secured by all of the outstanding shares of stock of
Humboldt and Maplewood. The original note was payable in full on October 1,
1999. The Company failed to make the required payment, and shortly thereafter,
the trustee attempted to foreclose on the collateral (Humboldt and Maplewood).
On November 10, 1999, Pet Quarters executed an extension of the Bridge Loan. As
an inducement for Olympus to agree to the extension and leave its capital in the
Trust and not foreclose on the collateral, the beneficiaries of the Trust
granted Olympus the power and authority to direct the actions of the trustee of
the Trust. In addition, a five percent (5%) penalty of $230,000 was added to the
outstanding principal amount of the note, resulting in the current outstanding
principal balance of $4,830,000. After negotiation, the Company issued an
additional 275,000 restricted shares of Pet Quarters common stock valued at
$483,010 or $1.7564, the market price at the time of the extension to the Trust
and these shares were distributed to its beneficiaries. The interest rate was
reduced from 12.5% per annum to 10% per annum and the maturity date was extended
to May 10, 2000. In exchange, Pet Quarters agreed to make monthly partial
interest payments of $20,000 by the 10th day of each month commencing December
10, 1999.
The earned but unpaid interest accumulates interest free until Pet
Quarters raises additional capital, then, to the extent, Pet Quarters has raised
additional capital, Pet Quarters is required to pay all accrued but unpaid
interest to the Trust. The terms of the extension also required a partial
principal payment of $1,000,000 by February 10, 2000. To induce Olympus to
agree to the extension of the Bridge Loan, all of the beneficiaries of the
Trust agreed that Olympus would be entitled to preferential treatment and all
of the $1,000,000 due on February 10, 2000 was to be paid to Olympus through
the Trust rather than allocated among all of the beneficiaries. On February 3,
2000, Pet Quarters paid the $1,000,000 principal payment to the Trust. The
remaining principal balance plus accrued interest will be due in full on May
10, 2000. As of February 22, 2000, Pet Quarters is current on all obligations
with the Trust.
In connection with the extension of the Bridge Loan Expense, the
Company was also required to pay interest, attorney fees, and associated
expenses of the trustee in the amount of $204,723 (the "Outstanding Expenses").
These funds were borrowed from the Matthew J. Hoff Trust ("Hoff Trust") and
Michael Parnell. Mr. Parnell, as trustee for the Hoff Trust, and on his own
behalf, received two convertible notes for the Company for $102,361.50 each
(the "Expense Notes"). The Expense Notes were convertible, wholly or partially,
into common stock of the Company at a rate of $.50 of debt for each share of
common stock. The price of the common stock was in the range set forth below:
<TABLE>
<S> <C>
November 8 $1.00
November 9 1.53
November 10 2.03
November 11 2.125
November 12 2.00
</TABLE>
The terms of the Expense Notes required that each be converted on or
before February 10, 2000. After February 10, 2000, the conversion privilege
terminated. On January 27, 2000, the Expense Notes were converted into 409,446
shares of restricted common stock of the Company for both the Hoff Trust and
for Michael Parnell.
While the Bridge Loan and the extension of the Bridge Loan
("Extension") were negotiated with related parties of the Company, the Company
believes that the Bridge Loan and the Extension were negotiated in a manner
which resulted in terms which are as good as, or better than, the Company could
have received otherwise. At the time the Bridge Loan and the Extension were
negotiated, the Company could not rely on traditional methods of commercial
financing because of its limited business history and its lack of credit
worthiness. The negotiations between the Company and the Bridge Loan and
Extension creditors were protracted and reflected many of the points of concern
which prevented the Company from using commercial lines of credit. Despite the
fact that the Company could not have borrowed commercially at the time the
Bridge Loan and Extension were negotiated, the terms of those loans were
negotiated between two separate parties (i.e., the Company and the trust
representatives). The result of these negotiations are terms that are better
than any other option available to the Company at that time.
1
<PAGE> 4
(b) BUSINESS OF THE ISSUER
DOMESTIC PET PRODUCTS AND SERVICES INDUSTRY.
LARGE AND GROWING INDUSTRY. According to industry sources, Americans
spent approximately $23 billion on their pets in 1998, more than they did on
toys ($20.6 billion), on recorded music ($13.2 billion), and on books sold
through general retailers ($12 billion). Pets remain an integral part of family
life in the United States with 58 million, or 59%, of 98 million U.S. households
owning one or more pets. By 2001, the pet products and services industry is
expected to grow to $28.5 billion.
<TABLE>
<CAPTION>
ESTIMATED U.S. MARKET FOR PET FOOD, SERVICE, AND NON-FOOD PRODUCTS
-------------------------------------------------------------------------------------------------------
MARKET SEGMENT
(BILLIONS) % OF TOTAL MARKET
=======================================================================================================
<S> <C> <C>
Premium Food $6 25%
Other Food 7 30
Total Food 13 55
Services 6 25
Non-Food Products 4 20
TOTAL $23 100%
</TABLE>
=======================================================================
Source: Deutsche Banc Alex. Brown and Company estimates.
PET OWNERSHIP BREAKOUT. The popularity of dogs and cats as pets in
America is unrivaled and continues to be the primary driver of the pet products
and services industry.
<TABLE>
<CAPTION>
PET OWNERSHIP IN THE UNITED STATES
-------------------------------------------------------------------------------------------------------
TOTAL # OF U.S.
TOTAL # OF PETS % OF TOTAL HOUSEHOLDS % OF TOTAL
(MILLIONS) PETS (MILLIONS) HOUSEHOLDS
=======================================================================================================
<S> <C> <C> <C> <C>
Cats 59 30 32 33%
Dogs 53 27 36 37
Fish 56 28 6 6
Birds 14 7 5 5
Rabbits & Ferrets 6 3 2 2
Rodents 5 3 2 2
Reptiles 4 2 1 1
TOTAL 197 100%
</TABLE>
=======================================================================
Source: American Veterinary Medical Association
2
<PAGE> 5
Although the number of cats (59 million) surpasses the number of dogs
(53 million), four million more U.S. households own dogs than cats. According to
the Pet Industry Joint Advisory Council, virtually all dog owners purchase their
pets 1-5 packages of treats per month, 66% give their pets gifts, more than 50%
give their pets Christmas presents, and 25% give their pets birthday presents.
FAVORABLE DEMOGRAPHIC TRENDS. Demographic trends suggest that the
recession-resistant pet products and services industry will continue to grow for
years to come.
o Continued Family Formation. Most pets are owned by families with
children between the ages of 5 and 15. Families with children under 18 years old
are projected to grow at a steady pace over the next several years.
o Pet Ownership Increasingly Linked to Affluence. Furthermore, the
income distribution among pet-owning households is increasingly skewed towards
higher income brackets that can afford to spend more on pet products. According
to the American Veterinarian Medical Association, 64.6% of households with
incomes of $60,000 or more own a pet.
----------------------------------------------------------------
HOUSEHOLD INCOME HOUSEHOLDS OWNING A PET
================================================================
Less than $12,500 47.80%
$12,500 to $24,999 55.6
$25,000 to $39,000 60.7
$40,000 to $59,999 64.8
$60,000 or more 64.6
----------------------------------------------------------------
Source: The American Veterinarian Medical Association
INCREASED CONSUMER SPENDING ON PETS. The $13 billion pet food segment
of the pet products and services industry breaks down into non-premium
supermarket brands and premium brands. Historically, the segment has been
dominated by supermarket brands such as Alpo, Kal Kan and Purina, which
represent roughly 55% of all pet food supplies and are primarily sold through
grocery stores, convenience stores, and other mass merchant outlets. These
brands grow at a low single-digit annual rate, carry lower gross margins, and
are generally considered less nutritious than premium brands.
Through the 1980s, the supermarket brands had relatively little retail
competition. Over the past five years, however, supermarket brands have lost
market share. Premium brands such as Iams, Nutro, and Science Diet, which are
generally not available through supermarkets or mass merchants due to
manufacturers' restrictions, have increased in popularity as consumers have come
to understand the importance of diet in ensuring their pets' health. These
premium brands are sold primarily through superstores, specialty pet stores,
veterinarians, and farm and feed stores, due to manufacturers' insistence on
ensuring proper retail servicing and stable margins. Premium brand sales have
increased at a compound annual growth rate of approximately 18% over the past
five years and now account for an estimated 25% of the total pet food segment.
3
<PAGE> 6
The Company believes that premium purchases have increased due to the
demographics trends previously discussed, growing concern for animal welfare and
nutrition, recommendations by veterinarians and breeders, and the increasing
availability and variety of premium pet food products. The Company believes that
as consumers focus on pet health and care, they tend to purchase more and higher
quality pet products and services. This trend has had a positive effect on the
$5 billion non-food pet products segment and the $6 billion pet services
segment. The Company is not currently offering pet food products directly, but
is in discussion with third parties regarding fulfillment of pet food orders to
Company customers.
Typically, pet products are purchased on impulse during a customer's
regular visit to purchase pet food, cat litter, or flea control products. Demand
for non-bulk products is less price sensitive than for pet food and other bulk
products. Consequently, non-bulk, non-food pet products are less frequently
discounted, resulting in higher gross margins. For this reason, the pet supply
industry has attracted strong interest from supermarkets, although due to space
constraints, supermarkets tend to carry a limited assortment of basic items such
as collars, dog chews, leashes, flea collars, and toys. Pet supply stores carry
a wider variety of these basic items and an assortment of other products such as
grooming products, pet carriers, cat furniture, doghouses, vitamins, treats, and
veterinary products.
The pet services segment includes veterinary, boarding, grooming and
training services. Approximately 92% of all households with dogs and 78% of all
households with cats seek veterinary care at least once a year, and veterinary
expenditures in the United States have grown at a 9.5% compounded annual growth
rate since 1991. Although pet services vendors generally enjoy high margins,
execution and liability concerns generally restrict the ranks of such vendors to
larger and more experienced specialty retailers.
INTERNET AND RETAIL E-COMMERCE TRENDS.
SURGING INTERNET USAGE. International Data Corporation ("IDC")
estimates that there were 97 million Web users worldwide at the end of 1998 and
anticipates this number will grow to approximately 320 million users by the end
of 2002. In addition to the increase in the number of users, both the frequency
of use and the amount of time spent online have also grown significantly. In
1998, nearly 60% of all online households accessed their online service at least
once a day, increasing from only 35% the previous year. Industry observers
believe that this trend will continue in the future as more people use the
Internet as a source of information and news and as a convenient "virtual"
marketplace in which to conduct a wide variety of retail purchases.
The rapidly increasing popularity of Internet usage among a broad range
of age groups and demographic profiles is self-evident. From online news
services and government databases to online bookstores and brokerage firms, the
Internet is now a permanent fixture in the economic and social landscape of the
United States. Although
4
<PAGE> 7
the PC is expected to remain the core means of Internet access, Intelliquest
predicts that by 2000 alternative means of Internet access will be the driving
force of growth. Currently, an estimated 3.7 million people use a handheld
computer to go online, while 3.1 million access the Internet via a TV-set-top
box or WebTV.
RETAIL E-COMMERCE. According to a study released by the University of
Texas Center for Research in Electronic Commerce on June 10, 1999, the Internet
economy in 1998 generated revenues of $301.4 billion in the United States. The
study, commissioned by Cisco Systems, estimates that of the overall figure,
approximately one third, or $101 billion, can be attributed to e-commerce, with
much of the balance attributed to infrastructure and applications. Between 1995
and 1998, the Internet economy grew by 174.5%, compared with a worldwide
economic growth rate of 3.8% during the same period. Finally, the study shows
that a large part of Internet growth can be attributed to the transfer of
existing economic activity to the Internet rather than the creation of totally
new Internet activities.
Although estimates vary, the Yankee Group projects the U.S. consumer
segment of e-commerce to grow to $10 billion by 2000 while IDC forecasts $26.8
billion -- there is a consensus that the Internet e-commerce channel will be a
substantial component of both consumer-to-business and business-to-business
transactions in the future. According to Forrester Research, the total value of
goods and services purchased over the Internet is expected to increase to $1.3
trillion in 2003.
The Company believes that growth in Internet usage and e-commerce is
being fueled by a number of factors including:
o A large and growing installed base of personal computers in
the workplace and home;
o Advances in the performance and speed of personal computers
and modems;
o Improvements in network security, infrastructure and bandwidth
(including the development of high-speed connectivity options
for Internet users);
o Easier and cheaper access to the Internet; and
o The rapidly expanding availability of online content and
commerce sites.
An April 1999 study by Greenfield Online found that 39% of U.S.
Internet users spend less time shopping in offline stores and malls than on the
Internet. This finding is significant because Americans with Internet access
account for 60% of the total consumer buying power in the United States. An
April 1999 study by ActivMedia that showed the online premium specialty goods
market is flourishing, with the majority of premium specialty goods sites
already operating at a profit. The study found that the revenue generated by
sites specializing in items such as gourmet food, personal care and branded
consumer products is rising steadily. Sales in 1999 are expected to increase
tenfold over 1998, while sales in 2000 are expected to be four times greater
than in 1999.
5
<PAGE> 8
The unique characteristics of the Internet provide a number of
advantages for online retailers. Online retailers are able to "display" a larger
number of products than traditional store-based or catalog retailers at a lower
cost. In addition, online retailers are able to frequently adjust their featured
selections, editorial content, shopping interfaces and pricing, providing
significant merchandising flexibility. The minimal cost to publish on the
Internet, the ability to reach and serve a large and global group of customers
electronically from a central location, and the potential for personalized
low-cost customer interaction provide additional economic benefits for online
retailers. Unlike traditional retail channels, online retailers do not have the
burdensome costs of managing and maintaining a retail store infrastructure or
the significant printing and mailing costs of catalogs. Online retailers can
also easily obtain demographic and behavioral data about customers, increasing
opportunities for direct marketing and personalized services.
BUSINESS STRATEGY.
Pet Quarters' primary objective is to provide the consumer with an
efficient, low-cost, and value-added shopping experience. Key elements of the
Company's business strategy include the following:
The Company believes that consumers want both the convenience of online
shopping and at least the same breadth of products that they can find at
traditional retail outlets. The Company also believes that in-house fulfillment
is required to control not only costs, but also the customer's shopping
experience. The Company's business model is to build a fully integrated content
and commerce site with in-house product sourcing and fulfillment with
incomparable customer care. Uniquely, it is a model in which authoritative
content drives the commerce and builds the brand.
The rationale for this business model is:
o Content will drive commerce
o Content will attract advertising revenues
o Content will create "stickiness" and encourage more page views
o Content will build the brand and customer loyalty
The Company's recent acquisition of Humboldt Industries addresses the
need for a scalable in-house fulfillment solution. As a leader in the mail-order
pet product catalog business, currently distributing its two pet catalogs - Home
Pet Shop and the Dog's Outfitter - to retail and wholesale customers throughout
the United States and internationally, management believes that the fulfillment
and customer service platform provided by Humboldt will create tremendous
synergies that can be quickly translated to the Internet operation. The Company
believes that it is acquiring substantial direct marketing expertise through
this acquisition and intends to use Humboldt's catalog mailings as soon as
possible to expand awareness of Pet Quarters.com. Pet Quarters' senior
management team has over 100 years experience in the pet and animal healthcare
industry with expertise in retailing, services, product sourcing, fulfillment
and customer care, marketing and content development.
6
<PAGE> 9
Pet Quarters has global vision and appreciates the international
opportunity available to Internet supply companies. Building on the
international experience Humboldt accumulated over the past five years, Pet
Quarters plans to take advantage of selling into these international markets
over the Internet. The Chartendure acquisition and associated relationships
within the pet industry internationally will assist the Company as it pursues
development of an international brand on the Internet. Currently, international
sales account for approximately 2.5% of the Company's total sales.
Additionally, the Humboldt acquisition immediately brings the Company a
significant wholesale base of revenue that is currently not being pursued by the
competition. It is the Company's intention to address the wholesale opportunity
by developing a robust website for the wholesale customer to make purchases as
well as to access industry information and content of interest to them as
participants within the pet industry. The grooming industry constitutes a
significant portion of the wholesale revenues and as such, the Company views
this as a significant opportunity to extend the Pet Quarters brand through an
off-line affiliate program by offering an incentive based program compensating
the groomer for purchases made at the Pet Quarters.com website based on their
referrals.
The business-to-business (wholesale) sales may be characterized as
those pet professionals, including for example proprietors of pet hotel and
boarding facilities, managers and staff of animal shelters and humane societies,
veterinarians, groomers, breeders, show exhibitors, as well as those pet owners
with multiple animals, whose purchase requirements qualify them for wholesale
rates.
Quite simply, the veterinarian is the ultimate arbiter and authority of
pet healthcare and welfare and therefore, an important aspect of the
business-to-business opportunity that the Company intends to pursue. The
profession is to animals, particularly companion animals, what the medical
profession is to human healthcare, yet more so. Its professional associations,
the American Veterinary Medical Association, American Animal Hospital
Association in the US, and its equivalents in other countries, are the bodies
through which the veterinarians are themselves governed and the conduit for
governmental and public policy relating to the treatment and welfare of animals.
Approximately 92% of all households with dogs and 78% of all households with
cats seek veterinary care at least once a year, and veterinary expenditures in
the United States have grown at a 9.5% compounded annual growth rate since 1991.
Accordingly, the veterinarian is the most highly respected point of
recommendation for pet owners, and Pet Quarters' goal is to secure the
imprimatur of the veterinary community.
There are approximately 24,000 small animal veterinary practices in the
US. Working in partnership with the professional associations, Pet Quarters
seeks to provide veterinarians with a trustworthy and credible additional client
information point, which, because fellow professionals have written it,
veterinarians will feel comfortable promoting to their own clients.
7
<PAGE> 10
Likewise, other pet professionals such as breeders and groomers, are
important points of recommendation for pet owners and are being targeted by Pet
Quarters. The Kennel Clubs are the authorities for the regulation of breeding
and breeders and the registrars of all pedigree dogs (the Cat Fancies similarly
control the breeding and registration of pedigree cats). It is difficult to
overstate the potential of these organizations. The United Kennel Club in the US
registers approximately 240,000 dogs each year and the American Kennel Club
registers approximately one million. The opportunity to promote Pet Quarters
through strategic alliances with the Kennel Clubs before and after registration
of these pedigree puppies and kittens, taps a vast potential market of new pet
owners who are actively seeking advice on the care and welfare of their
companion animal. Through the support of the Kennel Clubs, Pet Quarters seeks
the active support of individual breeders, who are viewed as important sources
of knowledge and advice for the new and repeat pet owner.
Groomers handle many pets each day and in the course of grooming the
animal and handling it at close quarters, frequently notice health issues that
they communicate to the pet owner. Again, the groomer is a respected authority
on healthcare for the pet owner.
There are few published figures for this segment, though it is known
that more than 75% of US veterinary practices are computerized and an estimated
50% of practitioners are Internet enabled, though it is not known how many of
these are Web enabled in the home rather than in the practice. (This figure is
mirrored in the UK, Northern Europe and slightly less in the larger
English-speaking world). The Internet's potential for the development of
Business-to-Business transactions is universally acknowledged. However,
significant increase and uptake may be achieved by working with computer and
software companies to increase take-up and traffic with these closely defined
wholesale segments. A number of software companies now provide specialist
programs for veterinarians, are keen to increase their market share and are
looking at partnering with computer manufacturers for free provision.
Like most service-based professions, pet professionals - veterinarians,
pet hotel and kennel operators, breeders and groomers - cut across the age
demographic, with the older member more reluctant to embrace new technology.
However, the veterinary demographic is changing with more women than men
qualifying as veterinarians. This is particularly marked in the US. Breeders and
groomers have traditionally had a bias towards the female sex. A number of
reports have shown that use of the Internet has shifted to a much wider and
increasingly female demographic, accessing the Internet for information and
products. It should also be borne in mind that strong anecdotal evidence
suggests that women are more effective communicators with clients than their
male counterparts. This is particularly marked in vocation oriented
service-based professions or activities such as veterinary technical support
staff (more than 90% female), groomers, trainers and breeders.
8
<PAGE> 11
The Web demographics of the wholesale segment means that the Company
will necessarily need to target individuals and businesses that are already
web-enabled, as well as "newbies." Communication of the benefits is
straightforward with the former, whereas the benefits and even the means of
enablement will need to be addressed with the latter.
It is the Company's objective to continue building an online
pet-oriented community that provides value-added content and services to enrich
each customer's shopping experience. It is management's belief that the
Company's ultimate success depends on its ability to enrich the customer's
shopping experience by giving the customer access to authoritative information
on pet care and health issues and providing value-added services that create the
customer loyalty that is needed in order to establish a loyal base of pet
owners. Building an online community focused on pet issues reinforces the
Company's e-commerce efforts by giving consumers a reason to visit the website
even when there is no specific product purchase in mind.
To address the need for value-added content services, the Company will
develop, with the assistance of some of the worlds leading veterinary
organizations, the authoritative guide to pet care and health issues for the
Company's new web site that is currently being developed. Led by a group of pet
industry professionals with backgrounds in pet healthcare and nutrition,
marketing, and public relations, Pet Quarters.com is intended to be the premier
source for pet-related information, offering advice, services, and entertainment
for individuals interested in pets.
In order to establish the credibility of the content to be found on the
Company's website, Pet Quarters is working closely with a number of national and
international associations and affiliated organizations for their endorsements
and is seeking similar coordination with national veterinary associations. The
pet healthcare and nutrition advice presented at Pet Quarters.com will be
written by veterinary surgeons and is intended to be the most authoritative and
useful advice available anywhere on the Internet.
As part of the Chartendure acquisition, Chartendure engaged Interactive
Bureau ("IB") to redesign the Company's existing site to seamlessly incorporate
the expanded product line and content. The relationship between Chartendure and
IB is purely contractual, as both are totally separate entities with no common
management or ownership, and Pet Quarters is a beneficiary of that relationship.
For various reasons, including the highly fragmented nature of the
non-food pet products and services industry segments and the large number of
professional organizations dedicated to pet breeding, grooming, shows, and
healthcare, boarding and animal rescue, the Company believes that a high level
of pet industry expertise is essential for ultimate success. The Humboldt and
Chartendure acquisitions provide the Company access to highly experienced
professionals that are expert in pet products sourcing and fulfillment and pet
healthcare and other pet issues. The extensive network of contacts and
relationships that these acquisitions offer should prove invaluable to the
Company as it pursues its business model.
9
<PAGE> 12
Management recognizes the fact that online pet space has become very
crowded and the number of competitors continues to grow. However, Pet Quarters
is favorably positioned to capitalize on the online sale of pet supplies and
accessories due to its extensive pet industry experience, having a
state-of-the-art fulfillment and customer service platform with a significant
existing customer base, the ability to offer the customer purchases either
through the Internet or catalog, and its development of a robust, content driven
web site of authoritative content for pet owners and enthusiasts alike.
Additionally, management believes that there will be a significant
amount of consolidation occurring with the online pet space and that Pet
Quarters will be viewed as a valuable asset as it continues to develop strategic
relationships within the industry.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
RESULTS OF OPERATIONS: Three months ended September 30, 1999 (first
quarter) as compared to three months ended September 30, 1998.
SALES: Sales for the first quarter of 1999 as compared to same period
1998 were up dramatically primarily because of the acquisition of Humboldt
Industries on August 1, 1999. The sales figures for the first quarter of 1999
include two months of Humboldt Industries and three months of Pet Quarters.
Pet Quarters consolidated sales were $2,510,752 compared to $58,455 for
the same period in 1998. Humboldt Industries catalog sales contributed
$2,440,097 to the total sales for the quarter. Pet Quarters Internet sales
compared to the same period in 1998 were $70,655, which was a 21% increase.
The "Home Pet Shop" catalog is displayed on the Pet Quarters Internet
home page, allowing the consumer to request this catalog through the web site.
The Company has sent out over 10,000 of these catalogs since the acquisition of
Humboldt Industries. Revenues from sales out of such catalogs are considered
catalog sales, rather than as Internet sales.
COST OF GOODS SOLD: Cost of goods sold for the 1999 quarter was
$1,678,207 compared to $33,514 for the same period in 1998. Humboldt Industries
contributed $1,625,431 to this total while the cost of goods sold for Internet
sales were $52,776. The percent of cost of goods sold to sales for the Internet
division increased to 75% of sales in 1999 compared to 57% of sales for in 1998.
This increase was partially due to discounted pricing used to encourage
potential customers to make a purchase. The price discounting began in 1999 as a
result of competition in the Internet sales of pet supplies. Currently, Pet
Quarters' Internet pricing is the same as the pricing in the catalog division
for retail sales. There was also an increase in cost of sales of Internet sales
in the 1999 quarter compared to the 1998 quarter because of higher fulfillment
costs. The increase in fulfillment costs resulted from Pet Quarters contracting
its fulfillment of shipments to a third party in October 1998. With the
acquisition of Humboldt, Pet Quarters expects to better control its cost of
sales for Internet sales.
Humboldt began the fulfillment of the Internet sales in October 1999.
The catalog division (and the consolidated) percent of cost of goods sold to
sales is sixty-seven (67%) percent for the quarter ended September 30, 1999. The
Company does not anticipate additional increases in cost of goods sold although
there can be no assurance that competitive pressures in the future will not
result in additional price discounting.
10
<PAGE> 13
GROSS PROFIT: Gross profit for the quarter was $832,545 as compared to
$24,941 for the same period in 1998. Humboldt Industries contributed $814,666 of
this figure. Gross Profit for Pet Quarters' sales were $17,879 as compared to
$24,941 for the first quarter of 1998. Gross profit as a percentage for the
Pet Quarters declined to 25% as compared to 43% in the prior year. This decrease
was primarily due to lower prices on products to encourage potential customers
to make a purchase. Consolidated gross profit was thirty-three (33%) percent for
the quarter.
SELLING EXPENSES: Selling Expenses were $375,449 for the quarter as
compared to $148,894 in the prior year for the quarter. Humboldt Industries
contributed $259,068 to the total. Humboldt Industries' expenses were primarily
catalog creation, art supplies, postage and printing costs. Pet Quarters'
expenses were for advertising on the web site. The selling expenses for the
Internet division were $116,381 as compared to $148,894 for the prior year. This
is 165% of Internet sales as compared to 255% of sales for the period in 1998.
Consolidated Selling Expenses were 15% percent of sales for the quarter.
GENERAL AND ADMINISTRATION EXPENSES: General and administrative
expenses were $642,206 for the quarter as compared to $72,198 for the same
period in 1998. G & A expense increased due to the acquisition of the catalog
division which incurred G & A expenses of $411,324 for two months. Consolidated
G & A expenses were twenty-five percent (25%) of sales for the quarter.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization was
$311,963 for the three months ended September 30, 1999. Of this amount, $277,110
is the amortization of two months of goodwill associated with the acquisition of
Humboldt Industries. The Company is currently amortizing $138,555 per month for
5 years associated with this acquisition.
INTEREST EXPENSE: Interest expense for the quarter ended September 30,
1999 was $111,616. This is primarily composed of accrued interest expense in the
amount of $95,833 related to the bridge loan. Consolidated interest expense was
approximately 4% of sales.
BRIDGE LOAN ORIGINATION FEE: The Company paid to the Sun Valley Trust
(the "Trust") 153,334 shares of Pet Quarters restricted common stock as an
origination fee. The shares at the time the shares were issued had a market
price of $4.25 a share which results in a total value for the origination fee of
$651,670. This fee was amortized over the original term of the loan from August
1, 1999 through October 1, 1999. In addition, 4,334 shares of common stock with
a market value of $18,420 were issued for attorney fees associated with the
bridge loan. These expenses are reflected in the general and administrative
expenses of the Company for the quarter ended September 30, 1999.
INCOME TAX BENEFIT: The Company currently has substantial net operating
losses (NOL's) from inception through September 30, 1999. At this time, no
income tax benefit has been recognized.
11
<PAGE> 14
NET LOSS: The Company had a net loss of $1,260,360 in the first quarter
of 1999 as compared to a $194,161 loss in the same period in 1998. The loss
incurred was impacted by non-cash items including goodwill amortization related
to the acquisition of Humboldt Industries, stock grant amortization, and
amortization of the origination fee paid to the Sun Valley Trust in the form of
153,334 shares of Pet Quarters common stock.
CURRENT ASSETS: Total current assets include cash and equivalents,
accounts receivable, inventory, prepaid expenses, and other assets. The total
current assets for the Company were $2,822,538 ending September 30, 1999. This
compares to $285,774 in the same period in 1998. The majority of accounts
receivable consist of short-term credit typically due within 15 days. Deferred
advertising consists of prepaid costs associated with the production of the
Company's catalogs for which future sales are expected within the next year.
Inventory is the largest portion of current assets consisting of $2,066,900 as
of September 30, 1999 as compared to $70,790 as of September 30, 1998. The
increase is attributed to the Humboldt Industries acquisition.
PROPERTY, PLANT AND EQUIPMENT: Land, buildings, equipment, and
furniture and fixtures total $1,530,484 less accumulated depreciation $70,197 as
of September 30, 1999. This amount compares to $986,936 less accumulated
depreciation $6,211 during the first fiscal quarter of 1998. The Pet Quarters
acquisition included all businesses and assets of Humboldt Industries except the
land and the building (approximately 63,500 square feet). Pet Quarters is
currently paying $20,000 per month to lease the land and building in Hazleton,
PA under a five-year non-cancelable operating lease with the former owner of
Humboldt. Pet Quarters has an option to purchase the Humboldt Industries
facility, which consists of the building and ten (10) acres of land in the
Humboldt Industrial Park in Hazleton, PA, for two million five hundred thousand
($2,500,000). The option has a term of five (5) years expiring August 5, 2004.
GOODWILL: Goodwill in the amount of $8,036,167 represents the
unamortized balance of the excess paid above the assets acquired for the
purchase of Humboldt Industries. The total goodwill recorded in conjunction with
the acquisition was approximately $8.3 million. Goodwill is being amortized over
a period of five years.
LIABILITIES: The current payable liabilities include accounts payable,
accrued expenses, notes payable, and note payable to related party. The
short-term note payables include a bridge loan, which was utilized to purchase
Humboldt Industries. This amount was originally in the amount of $4,600,000 and
carried an interest rate of 12.5%. Also, included are a $300,000 loan from First
State Bank, Lonoke, Arkansas; a $90,000 loan from Pinetree Management
Corporation and FINCOM, Inc., both unrelated parties, for payment of a brokerage
fee due as a result of the Humboldt Industries purchase, and a $91,600 loan to
the Company by individuals including officers and directors which was used to
pay the first installment of the brokerage fee and interest accrued. The
$250,000 notes payable to a related party are amounts owed to Ammonia Hold, Inc.
which owns approximately 15% of the outstanding common stock of the Company. The
total liabilities for the quarter
12
<PAGE> 15
ending September 30, 1999 were $7,778,827. This compares to $39,792 for the same
period a year ago. In addition to the detail above, accounts payable increased
significantly with the Humboldt Industries acquisition. The inventory of
Humboldt and Maplewood typically carries terms of 30, 60, or 90 days; therefore,
a large accounts payable is normal. The payables for the Company were $1,667,253
as of September 30, 1999. In the same period in 1998, payables were $39,366.
Currently, the Company is involved in moving all inventory, order fulfillment,
and sales operations from the Arkansas location to Pennsylvania.
EQUITY: The stockholders' equity portion of the balance sheet totaled
$4,578,638 as of September 30, 1999. This compares to $1,274,378 for the first
quarter of 1998. The common stock account was $11,560 at the end of September
1998 as compared to $11,199 in September 1999. The lower amount is because a
founder of the Company sold two million (2,000,000) shares of Pet Quarters stock
back to the Company at par value. These shares are now authorized but unissued
shares of the Company. This was a voluntary transaction enabling the Company to
raise funds and purchase Humboldt Industries. Additional Paid-In-Capital
increased to $8,144,590 from $2,272,973. The majority of the increase came from
the acquisition of Humboldt Industries as the transaction was for a total of
nine million two hundred thousand ($9,200,000) dollars with half paid in common
stock and the balance in cash. Accumulated Deficit increased from a deficit of
($1,010,155) as of September 30, 1998, to an accumulated deficit of ($3,128,804)
as of September 30 1999.
RESULTS OF OPERATIONS: Twelve months ended June 30, 1999 compared to
twelve months ended June 30, 1998.
The period ending June 30, 1998 contains all the costs associated with
a start up Internet Company for a full year; however, Pet Quarters was a fully
operating entity for approximately the last two months of that fiscal year. The
primary reason is the Pet Quarters website was not fully operational until May
1998.
SALES: Sales for the year ending 1999 were $262,470 compared to
$43,835 in fiscal 1998. The Company's belief is that the Christmas season will
typically provide revenues that are significantly higher in the December quarter
than at other times of the year. The Company experienced a large increase in
order flow during the Christmas season of 1998 in comparison to the other
quarters during the year.
COST OF GOODS SOLD: Cost of good sold were $205,774 for 1999 and
$21,908 for 1998. The Company operated on a 22% margin in fiscal year 1999. This
compares to approximately 50% for 1998. Two reasons account for this disparity.
During the majority of 1999, Pet Quarters primarily used the fulfillment
capabilities of Loveland Pet Products of Mason, Ohio. Loveland's charge
increased cost of goods sold and effectively lowered the gross margin of the
Company. Secondly, Pet Quarters during the 1998 fiscal year and a portion of the
1999 fiscal year fulfilled its own orders from its facility in Lonoke, Arkansas.
13
<PAGE> 16
SELLING EXPENSES: The selling expenses for fiscal 1998 were $196,497
and in fiscal year 1999 were $489,272. The expenses were primarily the same for
both periods and consisted of both web-based and traditional publications,
web-sites and advertisers making up the bulk of the selling expenses. The
increase for fiscal year 1999 from fiscal year 1998, was due to 1998 being a
partial year.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative
expenses for fiscal 1998 were $647,114 and $588,870 in 1999. The expenses
included salaries, general expenses, professional fees for legal and accounting,
travel, website maintenance and other miscellaneous expenses. The
slightly higher amount recorded in 1998 is primarily due to the one-time
start-up cost of the business. New employees were added in 1999, and the general
and administrative costs going forward will increase. The Company believes these
costs are being well managed, contained and are reviewed to provide maximum
value toward the Company.
DEPRECIATION AND AMORTIZATION: During fiscal year 1998, the Company
recorded depreciation and amortization on office equipment, computer and
telephone equipment, warehouse equipment and the facility. Similar items were on
a depreciation and amortization schedule in 1999. The largest asset of
Pet Quarters during this time is the facility in Lonoke, Arkansas. The building
is being depreciated on a forty-year life.
NET LOSS: The loss in fiscal year 1998 of $816,179 increased to a
loss in fiscal year 1999 of $1,052,265, resulting largely from the increase in
selling, general and administrative expenses.
CURRENT ASSETS: The current assets are cash, accounts receivable,
inventory, deferred compensation, prepaid expenses, and other. In 1998 cash was
$375,843 and $37,726 in fiscal year 1999. The decrease was attributable to
working capital needs of the Company. Accounts Receivable is not significant
since the vast majority of sales are completed with a credit card. Inventory
decreased from $73,229 in 1998 to $33,783 in 1999. Pet Quarters need for
inventory on-hand was significantly decreased with the out-sourcing arrangement
with Loveland Pet Products. This relationship (now terminated because of our
purchase of Humboldt Industries) accounted for the decrease as the Company had
little need to keep Inventory on-site.
PROPERTY, PLANT, AND EQUIPMENT: This represents the land and facility
located in Lonoke, Arkansas.
CURRENT LIABILITIES: Accounts payable has increased from $13,679 in
1998 to $203,394 in 1999 which is attributable to an increase in sales for the
Company. A note payable to related party (Ammonia Hold, Inc.) increased to
$325,000 on June 30, 1999.
14
<PAGE> 17
STOCKHOLDERS' EQUITY: Stockholders' equity was $501,278 at June 30,
1999, a decline of $967,076. The decline was largely attributable to the net
loss for the year ended June 30, 1999 of $1,052,265.
LIQUIDITY AND CAPITAL RESOURCES: Since inception, the Company's
expenses have consistently exceeded its revenues. Operations have been
consistently funded with debt and proceeds from the issuance of Pet Quarters
common stock. Pet Quarters is currently in discussions to obtain additional debt
or equity, or both, for financing so that the Company may continue to execute
its business plan including fulfilling the Company's plan for a new web site
with content as described below under Pending Acquisition.
PENDING ACQUISITION: Pet Quarters has entered into an agreement to
acquire Chartendure. Chartendure's shareholders will receive four (4) milestone
payments of Pet Quarters stock in increments of two hundred twenty five thousand
(225,000) shares, but no shares have been issued or exchanged as of February 24,
2000. Chartendure does not have any current Internet operations but, under the
agreement with Pet Quarters, will contract with a professional design firm to
design and develop a new Pet Quarters web site. Through Chartendure's
shareholders relationships with a professional design firm, Pet Quarters expects
to be able to attract a highly qualified design firm to create a high quality
web site for Pet Quarters. These design and development milestones, in summary,
are as follows:
1. The first milestone will be effected when Chartendure and the
professional design firm with the approval of Pet Quarters
enter into and sign an agreement with respect to design and
development, an agreement on a new site map, and an agreement
as to the requirements for a suitable content management
system. Upon achievement of the first milestone, Pet Quarters
will issue 225,000 shares of its common stock in exchange for
26% of Chartendure issued and outstanding stock.
2. The second milestone will be effected by billings from the
professional design firm in the amount of 1/3 of the project
cost estimates set out in the design and development
agreement. These items will include the interface of key
elements of the new web site, production of sample pages for
the new web site, approval of the sample pages by Pet Quarters
and Chartendure, and a usability review. Upon achievement of
the second milestone, 225,000 shares of Pet Quarters' common
stock will be exchanged for 23% of Chartendure's stock.
3. The third milestone will be effected when 2/3 of the project
cost estimates have been completed. This will include final
design modifications, technical implementation, and
navigational usability and scalability evaluation. Upon
achievement of the third milestone, 225,000 shares of Pet
Quarters' common stock will be exchanged for 26% of
Chartendure's stock
4. The fourth milestone will be effected when the new Pet
Quarters web site is actually launched into service and use.
Upon achievement of the fourth milestone, 225,000 shares of
Pet Quarters' common stock will be exchanged for the
remaining 25% of the outstanding Chartendure stock.
In addition to the development of a new web site, Chartendure's
majority shareholder (90%) intends to provide the majority of the "content" of
the Pet Quarters web site which management expects will be an encyclopedia on
everything relating to pets, offering information, advice, services, virtual
clubs, products and entertainment for everyone interested in pets: prospective
purchasers, new owners, or, existing owners of pets. At every level, Pet
Quarters, through its content and community, will promote sensible and
responsible pet ownership, reiterating the central role of proper and regular
veterinary care. As part of the agreement with Chartendure, Pet Quarters expects
to enter into an employment contract with the 90% shareholder for his future
services in sourcing to Pet Quarters the content described above. As of February
24, 2000, an employment agreement has not been prepared or entered into between
the shareholder and Pet Quarters.
Chartendure was organized in October 1998 and has no historical
operations and no employees. (See Note 10 to the Pet Quarters financial
statements.)
YEAR 2000 COMPLIANCE: Many currently installed computer systems,
software programs, and embedded data chips are programmed using a 2-digit date
field and are therefore unable to distinguish dates beyond the 20th century
(collectively, the "Year 2000" issue). A failure to identify and correct any
mission-critical internal or third party Year 2000 processing problem could have
material adverse operational or financial consequence to the Company.
All mission-critical information systems and equipment and machinery
that contain embedded technology are Year 2000 compliant. The Company has also
obtained assurances from all mission-critical third parties as to their own Year
2000 preparedness. The Company assesses as "Mission-critical" any information
systems, equipment and machinery and third parties that substantially affect the
Company's ability to take, process and fulfill orders, impact the Company's
ability to gather and process financial information, or otherwise significantly
impact the customer experience. To date, the Company has not experienced any
problems related to the Year 2000 issue and does not expect any problems in the
future.
The Company has not incurred to date and does not expect to incur
material costs in its efforts to address the Year 2000 issue. The Company has
not tracked the costs of Company employees working on the Year 2000 issue. no
significant information technology projects have been deferred due to the year
2000 issue, and all costs related to the year 2000 issue have been funded from
operations.
YEAR 2000 DISCLOSURES: The Company contracts with PSI NET as a host of
the PetQuarters.com website and as its Internet Commerce Provider. The Company
experienced no year 2000 problems and incurred no material cost associated with
year 2000. The Company believes the risk to the business is no longer an issue.
Pet Quarters' agreement with PSI NET assures that no year 2000 problems exist
and does not anticipate that a contingency plan would be needed.
FORWARD-LOOKING STATEMENTS: This report contains statements that may be
considered forward-looking or predictions concerning future operations. Such
statements are based on management's belief or interpretation of information
currently available. These statements and assumptions involve certain risks and
uncertainties and management can give no assurance that such expectations will
be realized. Among all the facts and events that are not within the Company's
control and could have a material impact on future operating results are general
economic conditions, cost of Internet advertising, and the competitive
environment. In addition, the Year 2000 issue is extremely complex and
compliance failures on the part of customers and/or suppliers that
15
<PAGE> 18
are outside the control of the Company could have a negative impact on future
operating results.
ITEM 3. DESCRIPTION OF PROPERTIES.
The Company is headquartered in Lonoke, Arkansas. The Lonoke facility
is located at 720 East Front Street and includes a single building of
approximately 50,000 square feet of warehouse and distribution space and 5,000
square feet of office space. This property has an appraised value of $975,000 as
of October 1997, and has an outstanding lien in the amount of $300,000.
Humboldt's Hazelton, Pennsylvania, distribution center is the primary
fulfillment center and includes a call center, order processing, a catalog
design department, and a warehouse operation which stocks more than 14,000
separate items. The Hazelton facility includes an office and warehouse facility
of approximately 63,500 square feet and is located on a 10-acre site. The July
31, 1999 acquisition of Humboldt Industries did not include acquisition of the
Hazelton facility or the ten acres of property associated with it. Rather,
Pet Quarters currently leases these facilities and owns a five-year option to
purchase the building and the ten (10) acre site. At this facility the Company
employs approximately 80 persons including telemarketers, warehouse personnel,
customer service representatives, accounting, purchasing, technology, marketing
and merchandising staff.
The properties described above are the only properties owned or leased
by the Company. The Company currently has no plans to purchase or lease
additional properties, and intends to expand the Hazelton, Pennsylvania facility
before investing in new properties. Management of the Company believes that all
properties are adequately insured against casualty and risk.
16
<PAGE> 19
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
<TABLE>
<CAPTION>
Number of
Shares
Beneficially
------------
Name Class of Security Owned % Owned Position
---- ----------------- ------------ ------- --------
<S> <C> <C> <C> <C>
Ammonia Hold, Inc. Common Stock 1,687,500* 14.48 Shareholder
10 Gunnebo Drive
Lonoke, AR 72086
Matthew J. Hoff Trust Common Stock 980,500** 8.41 Shareholder
Michael Parnell Common Stock 1,785,337** 15.32 Shareholder
11320 South Ridge
Little Rock, AR 72212
Jack & Helene Rosenzweig Common Stock 1,089,097 9.35 Jack Rosenzweig
1 Maplewood Drive - CEO Humboldt Ind.
C/O Humboldt Ind.
Hazleton, PA 18201 Helene Rosenzweig
- Pres. Maplewood
Steven Dempsey Common Stock 910,156 7.81 President/Chairman
103 Red River Drive.
Sherwood, AR 72120
Dino Moshova Common Stock 517,328 4.44 Director
56 Stuart Place
Munsey Park, NY 11030
Gregg Rollins Common Stock 243,983*** 2.09 Chief Financial
1700 Royal Drive Officer
Conway, AR 72032
Mike Kelly Common Stock 0 0.00 President -
Humboldt Ind.
All officers and Common Stock 2,760,564 23.69****
directors as a group
</TABLE>
The ownership table is based upon 11,653,244 shares outstanding as of December
31, 1999.
* The Board of Directors of American Hold, Inc., are Michael D. Parnell,
President and CEO; Dan N. Thompson, CFO; Robert S. Ligow, Charles R.
Nickle, and William H. Ketchum. Any transaction concerning Pet Quarters,
including the disposition or purchase of common stock, requires board
authorization effected by a vote of the majority of the directors.
** Michael Parnell is owner of 804,837 and controls 980,500 shares as
Trustee of the Matthew J. Hoff Trust, dated June 22, 1998. Mr. Parnell
and the Hoff Trust paid the paid the interest on the Bridge Loan
Extension dated November 10, 1999. Mr. Parnell and the Hoff Trust were
each issued a convertible note in the amount of $102,361.50. The notes
were convertible at $.50 per share and were exercised on January 27, 2000
by both Mr. Parnell and the Hoff Trust. See Item 1.
*** This number includes 5,500 shares held by Mr. Rollins' minor children
and 150,000 shares subject to options.
**** Because beneficial ownership is broadly defined, some shares are counted
more than once.
At this time, the company is not involved in or aware of any arrangements
which will result in a change of control of the Company.
17
<PAGE> 20
ITEM 5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.
The following table gives certain information regarding directors,
executive officers, promoters and central persons of the Company as of November
30, 1999.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Steve Dempsey 43 Chairman, President and Director
Mike Kelly 37 President of Humboldt Industries
Gregg Rollins 42 Chief Financial Officer
Dino Moshova 37 Vice President of Technology and Director
Jack Rosenzweig 60 Chief Executive Officer of Humboldt
Helene Rosenzweig 60 President of Maplewood
Judith Patterson 57 Vice President of Humboldt
Michael Parnell 41 Founder and shareholder
</TABLE>
The information set forth below identifies the principal occupation and
activities of the directors and executive officers during the past five years.
MR. STEVE DEMPSEY has served as the President of the Company since
May 1998. He was vice president of Sales and Marketing at Paine-Webber, Inc.,
between February 1989 and November 1997. Mr. Dempsey is one of two directors of
the Company. Mr. Dempsey was appointed a director in June 1978. This term
expires in May 2001.
MR. MIKE KELLY is currently President of Humboldt and has been employed
since September 1, 1999. Mr. Kelly was a Vice President/General Manager with
Sporting Dogs Specialties (PetSmart Direct) between April 1987 and April 1998,
and Vice President of Home Trends from April 1998 until August 1999.
MR. GREGG ROLLINS has been employed as the Chief Financial Officer of
the Company since April 1999. Mr. Rollins was a senior vice president with
Leiblong Associates from 1998 until April, 1999 and was an account vice
president, assistant manager and sales manager with Paine Webber between 1988
and 1998.
MR. DINO MOSHOVA is a Director of the Company and has been a director
since inception. His term as director will continue until May, 2000. Mr. Moshova
has operated Moonbark Web Designer since September 1997. From September 1984
until September 1997, Mr. Moshova owned and operated Leisure Video of New York.
18
<PAGE> 21
MR. JACK ROSENZWEIG co-founded Humboldt Industries in January 1982 and
has served as the Chief Executive Officer of Humboldt since that time. Prior to
this time, Mr. Rosenzweig was President of Humboldt. Mr. Rosenzweig is the
husband of Helene Rosenzweig. He has thirty-seven years experience in the pet
industry.
MS. HELENE ROSENZWEIG is a co-founder of Humboldt Industries with her
husband, Jack, and serves as President of Maplewood which she founded in January
1989. Mrs. Rosenzweig served as the Executive Vice President of Humboldt from
January 1982 until July 31, 1999.
MS. JUDITH PATTERSON is the Vice President of Operations for Humboldt
Industries, Inc. and has occupied that position since July 1986. From 1981 until
July 1986, Ms. Patterson was Operations and Distribution Manager for Doskocil
Manufacturing Company, the leading manufacturer of in-flight kennels in the
world.
MICHAEL PARNELL, a founder of the Company, has submitted a settlement
offer in an action brought by the Securities and Exchange Commission. If the
submission is accepted, Mr. Parnell will pay a civil penalty in the amount of
$25,000 and will be permanently enjoined from selling securities in violation of
the registration provisions of the Securities Act of 1933 and from violating the
fraud provisions of the Securities Act of 1933 and the Securities Exchange Act
of 1934. Mr. Parnell consented to the proposed settlement without admitting or
denying the allegations of the complaint filed by the Securities and Exchange
Commission.
19
<PAGE> 22
ITEM 6. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
--------------------------
<TABLE>
<CAPTION>
Long-Term Compensation
Awards Payouts
Name and Principal Year Salary/ Other Annual Restricted Securities All other
Position Bonus ($) Compen- Stock Underlying Compen-
sation ($) Award(s) Options/ LTIP sation
($)(2) SARs (#)(3) Payouts ($)(4)
- --------------------------- -------- ------------ ------------ ----------- ------------ -------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Steven B. Dempsey,
Chairman & President 1999 100,000 none none none none
1998 55,000 none none none none
Mike Kelly,
President-Humboldt Div. 1999 135,000 none 221,875* none none
Jack Rosenzweig,
CEO-Humboldt Div. 1999 100,000 14,400 (auto) none none
1998 31,200 10,860 (auto)
1997 31,200 9,000 (auto)
1996 31,200 9,000 (auto)
Helene Rosenzweig,
Pres-Maplewood Div. 1999 100,000 14,400 (auto) none none
1998 31,200 13,320 (auto)
1997 31,200 13,320 (auto)
1996 31,200 9,000 (auto)
Greg Rollins,
Chief Financial Officer 1999 85,000 none 84,375* 225,000 none
</TABLE>
* Shares are being held in Pet Quarters lock-box to be given to employees
at the end of one year of employment. Mr. Kelly will receive 50,000
shares in September, 2000; Mr. Rollins will receive 75,000 shares in
April, 2000.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
-------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Percent of Total
Number of Securities Options/SARs
Underlying Options Granted to Exercise or Base
Granted Employees in Price
Name (#) Fiscal Year ($/Sh) Expiration Date
- ------------------------------- ----------------------- -------------------- ------------------ ----------------------
<S> <C> <C> <C> <C>
Greg Rollins 225,000 100% 1.125 April 12, 2003
through
April 12, 2004
- ------------------------------- ----------------------- -------------------- ------------------ ----------------------
</TABLE>
20
<PAGE> 23
EMPLOYMENT CONTRACTS
Jack Rosenzweig, Helene Rosenzweig, and Mike Kelly each entered into an
employment agreement with the Company, or a subsidiary thereof, effective as of
the consummation of the acquisition of Humboldt Industries, providing for a base
annual compensation of $100,000, $100,000, and $135,000, respectively. Each
agreement is for a term of two years, unless earlier terminated by the Company
or the employee. The employment agreements are substantially similar to each
other, obligating the employees to devote their full attention to the operations
of Humboldt Industries and restricting their rights to compete against
Pet Quarters upon departure. Each employee is entitled to his or her salary, the
same employee benefits provided to all other of Humboldt Industries' employees,
and a monthly car allowance.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
BRIDGE LOAN
The following persons, who are directors or officers of the Company or
hold 5% or more of the Company's common stock, are beneficiaries of the Trust,
which loaned the Company $4,600,000 (the "Bridge Loan") to purchase Humboldt
Industries. The dollar value of the beneficial interest of each person in the
Bridge Loan and his or her relationship to the Company is set forth opposite his
or her name.
Dino Moshova $23,000 Director
Gregg Rollins $90,000 Chief Financial Officer
Steven Dempsey $50,000 President and Chief Executive Officer
Michael Parnell $750,000 Founder
Jemima S. Parnell $110,000 Mother of Michael Parnell
OTHER TRANSACTIONS
Ammonia Hold, Inc. has made several advances to the Company in various
amounts totaling $250,000 as of the date hereof, which are each represented by a
promissory note from the Company. Each promissory note bears interest at a rate
of 8%.
On December 17, 1999, Michael Parnell loaned the Company $204,989.49
pursuant to a promissory note. The proceeds of the loan were used to reduce
short-term bank indebtedness. The promissory note bears interest at a rate of
10% per annum and is due on demand.
STOCK GRANTS. On September 9, 1999, the Company made grants of common
stock totaling 95,000 shares to three Humboldt employees. The grants were made
to retain the services of these employees and included 5,000 shares to Judith
Patterson, 40,000 shares to Melanie Rosenzweig and 50,000 shares to Mike Kelly.
Melanie Rosenzweig is the daughter of Jack and Helene Rosenzweig. The stock
grants require these employees to remain with the Company for a period of one
year in order for the grant to fully vest.
21
<PAGE> 24
ITEM 8. DESCRIPTION OF SECURITIES.
Pet Quarters is authorized to issue forty million (40,000,000) shares
of common stock par value $0.001 per share and ten million (10,000,000) shares
of preferred stock par value $0.001 per share. The voting powers, designations,
and preferences of the preferred may be fixed by the board of directors.
COMMON STOCK. Each share of Common Stock entitles the holder thereof to
one vote for each share on all matters submitted to the stockholders. The Common
Stock is not subject to redemption or to liability for further calls. Holders of
Common Stock will be entitled to receive such dividends as may be declared by
the Board of Directors of the Company out of funds legally available therefore
and to share pro rata in any distribution to stockholders. The stockholders have
no conversion, preemptive or other subscription rights. Shares of authorized and
unissued Common Stock are issuable by the Board of Directors without any further
stockholder approval.
PREFERRED STOCK. The Board of Directors is authorized, without further
action by the stockholders, to issue from time to time shares of Preferred Stock
in one or more classes or series and to fix the designations, voting rights,
liquidation preferences, dividend rights, conversion rights, rights and terms of
redemption (including sinking fund provisions) and certain other rights and
preferences of the Preferred Stock. The issuance of shares of Preferred Stock
under certain circumstances could adversely affect the voting power of the
holders of Common Stock and may have the effect of delaying, deferring or
preventing a change in control of the Company. As of the date of this
Prospectus, the Company has no plan or arrangement for the issuance of any
shares of Preferred Stock.
TRANSFER AGENT. The Company has appointed Atlas Stock Transfer
Corporation as the transfer agent and registrar of the Common Stock.
PART II
ITEM 1. MARKET PRICE AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND OTHER
SHAREHOLDER MATTERS.
Pet Quarters has a single class of common stock. There are forty
million (40,000,000) shares of common stock authorized, of which approximately
eleven million, two hundred forty-two thousand (11,242,000) shares are
outstanding. The Company may issue up to ten million (10,000,000) preferred
shares; however, at this time there are no preferred shares issued or
outstanding.
22
<PAGE> 25
The Company has not declared dividends on its common stock in the past
and has no present intention of declaring dividends in the future. The Company
anticipates that for the foreseeable future its earnings will be retained for
the operation and expansion of its business.
The Pet Quarters common stock is currently traded on the
over-the-counter bulletin board under the symbol PDEN.
As of January 20, 2000, the Company had 1,829 shareholders of record.
The Company's common stock began trading in May 1998. Below are the
quarterly high and low closing prices since inception as recorded by the
bulletin board. Bid prices were not available.
Period Low High
------ --- ----
April - June 1998 15/16 1 11/16
July - September 1998 11/32 1 11/100
October - December 1998 6/25 2
January - March 1999 9/16 1 13/16
April - June 1999 7/8 4 19/32
July - September 1999 2 15/16 6 9/16
ITEM 2. LEGAL PROCEEDINGS.
Pet Quarters is not currently involved in any lawsuits as a plaintiff
or defendant and has no knowledge of any pending legal action.
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.
Pet Quarters hired Crouch, Bierwolf, & Chisholm of 50 West Broadway,
Suite 1130, Salt Lake City, UT 84101, to perform the 1997 (2 months) and 1998
audits. In July, 1999, the Company dismissed Crouch, Bierwolf & Chisholm as its
principal independent accountants and hired Ernst & Young LLP. The board of
directors of the Company determined that it was in the best interests of the
Company to dismiss its former accountants and hire a national accounting firm
with an office in Arkansas. There were no disagreements with or adverse opinions
by the former accountants that related to the dismissal. The prior audit
contained a "going concern" opinion; however, this was not a point of contention
with either the audit firm or Pet Quarters. Ernst & Young has performed the 1999
Pet Quarters audit. The Pet Quarters board approved Ernst & Young as auditors on
July 8, 1999.
23
<PAGE> 26
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES.
The Company was founded by Matthew Hoff and Michael Parnell in May of
1997. Mr. Hoff contributed $4,100 for 4,100,000 shares of the Company's $.001
par value common stock. Mr. Parnell contributed $2,000 for 2,000,000 shares of
common stock. During June and July of 1997, the Company conducted a private
offering of securities pursuant to Rule 504 of Regulation D. In the course of
this offering, the Company raised $105,000 in proceeds from the sale of
1,050,000 shares of common stock at $.10 per share. The offering was made to
twenty-one persons, including public investors not affiliated with the Company.
The Company offered its securities through its officers and directors on a best
efforts basis. Consequently, there were no underwriting discounts or
commissions. Following these two offerings, the Company had a total of 7,150,000
shares of common stock outstanding.
In August 1997, the Company conducted a second private offering of
securities pursuant to Rule 504 of Regulation D. In this offering, common stock
was sold at $.50 per share to fifty-two persons, many of whom were current
shareholders, raising an additional $860,000, less offering costs of $31,567.
This offering was extended to persons who were affiliates with the Company or
some private investors. The Company offered its securities through its officers
and directors on a best efforts basis. Consequently, there were no underwriting
discounts or commissions.
The Company filed appropriate documentation to allow its stock to be
traded on the Over-The-Counter-Bulletin-Board (OTCBB), and in October 1997,
the Company's stock began to trade on the OTCBB.
In November 1997, the Company issued 1,777,500 shares of its common
stock to acquire land and a building from Ammonia Hold, Inc ("Ammonia Hold").
The stock had a fair market value of $888,750 and Ammonia Hold has substantial
ownership interest in Pet Quarters.
In June 1999, the Company repurchased 2,000,000 shares of its stock
from Matthew Hoff and retired the shares. During the fiscal year ended on June
30, 1999, the Company issued 180,000 shares of its common stock pursuant to its
management incentive plan. These shares were issued to retain the service of top
management personnel. On September 9, 1999, 95,000 additional shares of common
stock were issued to Humboldt Industries employees to retain them in management.
An additional 1,146,417 shares were issued to acquire Humboldt Industries and
153,334 were issued as part of the financing for the Humboldt Industries
acquisition. A total of 60,195 shares were issued to three (3) vendors of the
Company in order to secure their service during fiscal year 1999. Each of the
above transactions were private transactions which did not involve a public
offering. The transactions were exempted pursuant to Section 4(2) and other
provisions of the Securities Act of 1933, as amended.
24
<PAGE> 27
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's Articles of Incorporation provide that the Company, by
action of the Board of Directors, may indemnify its directors, officers, agents,
and employees to the fullest extent permitted by the Arkansas Business
Corporation Act, as amended. In addition, the Articles also provide that no
director shall be personally liable to the corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director; provided, however,
that the foregoing clause shall not eliminate or limit the liability of a
director for the following: (i) any breach of such director's duty of loyalty to
the Corporation or its stockholders; (ii) acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law; (iii) under
the Arkansas Business Corporation Act; or (iv) any transaction from which such
director derived an improper personal benefit.
These provisions are permitted pursuant to the Arkansas Business Corporation
Act.
25
<PAGE> 28
PET QUARTERS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
(1) Pro Forma Consolidated Statements of Operations for the three months
ended September 30, 1999 and Year Ended June 30, 1999
(unaudited)..........................................................................................F-2
(2) Consolidated Financial Statements - Pet Quarters, Inc. and
Subsidiary...........................................................................................F-5
Report of Independent Auditors
Consolidated Balance Sheets - September 30, 1999 (unaudited)
and June 30, 1999
Consolidated Statement of Operations for the three months ended
September 30, 1999 and 1998 (unaudited) and Year Ended
June 30, 1999
Consolidated Statements of Stockholders' Equity for the three months
ended September 30, 1999 (unaudited) and Year Ended June 30,
1999
Consolidated Statements of Cash Flows for the three months ended
September 30, 1999 (unaudited) and Year Ended June 30, 1999
Notes to Consolidated Financial Statements for the three months
ended September 30, 1999 (unaudited) and Year Ended June 30,
1999
(3) Financial Statements - Pet Quarters, Inc..............................................................F-23
Independent Auditors Report
Balance Sheet - June 30, 1998
Statements of Operations for the Year Ended June 30, 1998 and
the two months ended June 30, 1997
Statements of Stockholders' Equity for the Year Ended June 30,
1998 and the two months ended June 30, 1997
Statements of Cash Flows for the Year Ended June 30, 1998 and
the two months ended June 30, 1997
Notes to Financial Statements - June 30, 1998
(4) Combined Financial Statements - Humboldt Industries, Inc. and Affiliate...............................F-34
Report of Independent Auditors
Combined Balance Sheet - July 30, 1999
Combined Statement of Operations for the period January 1, 1999
to July 31, 1999
Combined Statement of Stockholders' Equity for the period
January 1, 1999 to July 31, 1999
Combined Statement of Cash Flows for the period January 1, 1999
to July 31, 1999
Notes to Combined Financial Statements - July 31, 1999
(5) Humboldt Industries, Inc. and Maplewood Industries, Inc...............................................F-46
Report of Independent Auditors
Combined Balance Sheet - December 31, 1998
Combined Statement of Operations and Deficit - Year Ended December 31, 1998
Combined Statement of Cash Flows - Year Ended December 31, 1998
Notes to Combined Financial Statements
(6) Financial Statements - Humboldt Industries, Inc.(a)...................................................F-54
Report of Independent Auditors
Balance Sheet - December 31, 1997
Statement of Operations and Deficit - Year Ended December 31, 1997
Statement of Cash Flows - Year Ended December 31, 1997
Notes to Financial Statements
</TABLE>
(a) Includes only the operating results of Humboldt Industries, Inc. Maplewood
Industries, Inc. is not included.
F-1
<PAGE> 29
PET QUARTERS, INC. AND SUBSIDIARIES
On August 1, 1999, Pet Quarters acquired for cash and stock all of the
outstanding stock of Humboldt Industries, inc. and Maplewood Industries, Inc.
The acquisition has been accounted for using the purchase method of accounting.
The operations of Humboldt and Maplewood have been included in Pet Quarters'
historical financial statements beginning August 1, 1999. Humboldt's and
Maplewood's businesses have been primarily the sale of pet supplies and craft
kits and supplies to retail and wholesale customers through mail order catalogs.
With the purchase by Pet Quarters, Humboldt and Maplewood fulfills the orders
and ships the products purchased on Pet Quarters' website.
PRO FORMA STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999
The pro forma consolidated statement of operations and financial data
for the Company presented below are based on historical data for the three
months ended September 30, 1999. The pro forma consolidated statement of
operations and selected data for the three months ended September 30, 1999
assume that the acquisition of Humboldt and Maplewood was consummated on July 1,
1999. The pro forma consolidated statement of operations and financial data do
not necessarily indicate the operating results or financial position which would
have resulted from the operation of the Company on a consolidated basis during
the periods presented, nor does this pro forma data necessarily represent any
future operating results or financial position of the Company. In addition, you
should also refer to the more complete historical results included elsewhere in
this document.
<TABLE>
<CAPTION>
Three Months ended September 30, 1999
----------------------------------------------------------------------
Humboldt-
Maplewood Pro forma
Pet Industries Pro forma Consolidated
Quarters July 1999 Adjustments Total
----------- ---------- ----------- ------------
<S> <C> <C> <C>
Sales $ 2,510,752 $1,220,049 $3,730,801
Cost of goods sold 1,678,207 812,716 2,490,923
----------- ---------- ----------
Gross profit 832,545 407,333 1,239,878
Selling expenses 375,449 129,534 504,983
General and administrative expenses (1) 642,206 205,662 23,000 870,868
Depreciation and amortization (2) 311,963 12,651 138,555 463,169
----------- ---------- --------- ----------
1,329,618 347,847 161,555 1,839,020
----------- ---------- --------- ----------
Operating loss (497,073) 59,486 (161,555) (599,142)
Total other expense(3) (763,287) (2,379) (38,333) (803,999)
----------- ---------- --------- ----------
Loss before income taxes (1,260,360) 57,107 (199,888) (1,403,141)
Income tax benefit 0 0 0 0
----------- ---------- --------- ----------
Net loss(4) $(1,260,360) $ 57,107 $(199,888) $(1,403,141)
=========== ========== ========= ==========
Net loss per share(5) $ (0.12)
===========
Pro Forma loss per share $ (0.12)
===========
Weighted average shares outstanding 10,797,196
============
Pro Forma weighted average shares
outstanding 11,342,614
==========
</TABLE>
- --------------------
(1) The pro forma consolidated statement of operations
data for the quarter ended September 30, 1999 reflect additional
compensation and costs associated with being a public company of
$23,000.
(2) Consists of additional goodwill for the month of July 1999 to be
recorded as a result of the acquisition of Humboldt Industries, Inc.,
in the amount of $138,555.
(3) Consists of additional interest expense for the month of July 1999 in
the amount of $38,333 associated with the bridge loan financing.
F-2
<PAGE> 30
(4) EBITDA represents loss from operations plus depreciation, amortization
and interest expense (including loan origination fee). Historical and
pro forma EBITDA for the three months ended September 30, 1999 is a
negative $185,110 and a negative $135,973, respectively. EBITDA is
provided because it is a measure commonly used by investors to analyze
and compare companies on the basis of operating performance. EBITDA is
not a measurement of financial performance under generally accepted
accounting principles and should not be construed as a substitute for
operating income, net income or cash flows from operating activities
for purposes of analyzing the Company's operating performance,
financial position or cash flows. EBITDA is not necessarily comparable
with similarly titled measures for other companies.
(5) The purchase price of Humboldt has been allocated to the assets
acquired and liabilities assumed based on estimated fair values. The
purchase price in excess of the fair value of net assets acquired has
been recorded as goodwill. Goodwill is being amortized over 5 years.
<TABLE>
<S> <C>
Purchase Price
Cash $ 4,600,000
Common Stock Issued 4,600,000
-----------
9,200,000
Broker Fees Incurred 180,000
-----------
Total Acquisition Cost 9,380,000
===========
Allocation of Purchase Cost
Estimated Fair Value of Assets Acquired $ 3,164,897
Estimated Value of Liabilities Assumed (2,098,173)
Goodwill 8,313,276
-----------
Total Allocation $ 9,380,000
===========
</TABLE>
The common stock issued totalled 1,146,417 shares at an average market
price of $4.01, based on the average closing price for the five days
prior to August 1, 1999. See Note 8 to Pet Quarters financial
statements for the year ended June 30, 1999.
F-3
<PAGE> 31
PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED JUNE 30, 1999
The following pro forma consolidated statement of operations and other
financial data for the Company presented below is based on historical operating
results for Pet Quarters, Inc. and Humboldt for the year ended June 30, 1999,
considering the consolidated historical results for the Company including its
acquisition of Humboldt Industries, Inc. The pro forma consolidated statement of
operations and selected data for the year ended June 30, 1999 assumes that the
acquisition of Humboldt Industries, Inc., was consummated on July 1, 1998. The
summary pro forma financial data do not necessarily indicate the operating
results or financial position which would have resulted from the operation of
the Company on a consolidated basis during the periods presented, nor does this
pro forma data necessarily represent any future operating results or financial
position of the Company. In addition to this summary financial date, you should
also refer to the more complete historical results included elsewhere in this
document.
<TABLE>
<CAPTION>
Year ended June 30, 1999
----------------------------------------------------------------------
Humboldt- Pro forma
Pet Maplewood Pro forma Consolidated
Quarters Industries Adjustments Total
----------- ----------- ----------- -----------
<S> <C> <C> <C>
Sales $ 262,470 $14,881,529 $15,143,999
Cost of goods sold 205,774 10,349,343 10,555,117
----------- ----------- -----------
Gross profit 56,696 4,532,186 4,588,882
Selling expenses 489,272 1,785,500 2,274,772
General and administrative expenses (1) 588,870 2,410,722 276,000 3,275,592
Depreciation and amortization (2) 36,824 47,271 1,662,655 1,746,750
----------- ----------- ----------- -----------
1,114,966 4,243,493 1,938,655 7,297,114
----------- ----------- ----------- -----------
Operating loss (1,058,270) 288,693 (1,938,655) (2,708,232)
Other income (expense)(3) 6,005 86,419 (460,000) (367,576)
----------- ----------- ----------- -----------
Loss before income taxes (1,052,265) 375,112 (2,398,655) (3,075,808)
Income tax benefit 0 0 0 0
----------- ----------- ----------- -----------
Net loss(4) $(1,052,265) $ 375,112 $(2,398,655) $(3,075,808)
=========== =========== =========== ===========
Net loss per share $ (0.09)
===========
Pro forma loss per share $ (0.28)
===========
Weighted average shares outstanding 11,453,382
===========
Pro forma weighted average shares
outstanding 11,014,800
==========
</TABLE>
- --------------------
(1) The pro forma consolidated statement of operations data for the year
ended June 30, 1999 reflect an increase in compensation and costs
associated with being a public company of $276,000.
(2) Includes goodwill to be recorded as a result of the acquisition of
Humboldt Industries, Inc., in the amount of $1,662,655.
(3) Interest expense reflects approximately $460,000 in additional interest
expense associated with the bridge loan financing at a rate of 10%.
(4) EBITDA represents loss from operations plus depreciation, amortization
and interest expense. EBITDA for the year ended June 30, 1999 was a
negative $1,018,637 and Proforma EBITDA for the same period was a
negative $850,673. EBITDA is provided because it is a measure
commonly used by investors to analyze and compare companies on the
basis of operating performance. EBITDA is not a measurement of
financial performance under generally accepted accounting principles
and should not be construed as a substitute for operating income, net
income or cash flows from operating activities for purposes of
analyzing the Company's operating performance, financial position or
cash flows. EBITDA is not necessarily comparable with similarly titled
measures for other companies.
F-4
<PAGE> 32
CONSOLIDATED FINANCIAL STATEMENTS
PET QUARTERS, INC. AND SUBSIDIARY
Year ended June 30, 1999 with Report of Independent Auditors
and Three Months ended September 30, 1999 and 1998 (Unaudited)
F-5
<PAGE> 33
Pet Quarters, Inc. and Subsidiary
Consolidated Financial Statements
Year ended June 30, 1999 and Three Months ended
September 30, 1999 and 1998 (Unaudited)
CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors................................................................................F-7
Consolidated Financial Statements
Consolidated Balance Sheets...................................................................................F-8
Consolidated Statements of Operations.........................................................................F-10
Consolidated Statements of Stockholders' Equity...............................................................F-11
Consolidated Statements of Cash Flows.........................................................................F-12
Notes to Consolidated Financial Statements....................................................................F-13
</TABLE>
F-6
<PAGE> 34
Report of Independent Auditors
The Board of Directors
Pet Quarters, Inc.
Lonoke, Arkansas
We have audited the accompanying consolidated balance sheets of Pet Quarters,
Inc. and subsidiary, as of June 30, 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall consolidated financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pet
Quarters, Inc. and subsidiary as of June 30, 1999 and the results of their
operations and their cash flows for the year then ended, in conformity with
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As more fully described in
Note 2, the Company has operating losses and is dependent upon future financing
to continue operations. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The consolidated financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
Ernst & Young LLP
Little Rock, Arkansas
October 1, 1999, except for Note 8 as to
which the date is November 10, 1999
F-7
<PAGE> 35
Pet Quarters, Inc. and Subsidiary
Consolidated Balance Sheets
<TABLE>
<CAPTION>
SEPTEMBER 30 JUNE 30
1999 1998 1999
----------- ---------- ----------
(Unaudited)
ASSETS
<S> <C> <C> <C>
Current assets:
Cash $ 151,546 $ 204,687 $ 37,726
Accounts receivable 202,071 869 2,654
Inventories 2,066,900 70,790 33,783
Deferred advertising costs 396,155 - -
Prepaid expenses and other current assets 5,866 9,428 2,250
----------- ---------- ----------
Total current assets 2,822,538 285,774 76,413
Property, plant and equipment:
Land 225,000 225,000 225,000
Buildings and improvements 744,405 708,075 708,600
Furniture and equipment 561,079 53,861 35,072
----------- ---------- ----------
1,530,484 986,936 968,672
Less accumulated depreciation (70,197) (6,211) (33,185)
----------- ---------- ----------
1,460,287 980,725 935,487
Goodwill, net of accumulated amortization of $277,109 at
September 30, 1999 8,036,167 - -
Intangible assets, net of accumulated amortization of
$15,147 in 1999 and $5,297 in 1998 38,473 47,671 30,385
----------- ---------- ----------
Total assets $12,357,465 $1,314,170 $1,042,285
=========== ========== ==========
</TABLE>
F-8
<PAGE> 36
<TABLE>
<CAPTION>
SEPTEMBER 30 JUNE 30
1999 1998 1999
----------- ----------- -----------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
<S> <C> <C> <C>
Accounts payable $ 1,667,253 $ 39,366 $ 203,394
Accrued expenses 409,697 426 12,613
Short-term notes payable (Note 9) 481,600 - -
Bridge loan payable (Note 8) 4,600,000 - -
Current portion of notes and capital leases payable 93,168 - -
Note payable to related party (Note 3) 250,000 - 325,000
----------- ----------- -----------
Total current liabilities 7,501,718 39,792 541,007
Long-term portion of notes and capital leases payable
(Note 7) 277,109 - -
----------- ----------- -----------
Total liabilities 7,778,827 39,792 -
Commitments (Note 11) - -
Stockholders' equity:
Common stock, $.001 par value per share, 40,000,000
shares authorized; 11,199,280 and 9,800,195 shares
issued and outstanding at September 30, 1999 and
June 30, 1999 respectively 11,199 11,560 9,800
Additional paid-in capital 8,144,590 2,272,973 2,498,867
Accumulated deficit (3,128,804) (1,010,155) (1,868,444)
----------- ----------- -----------
5,026,985 1,274,378 640,223
Less unamortized stock compensation (Notes 6 and 8) (448,347) - (138,945)
----------- ----------- -----------
Total stockholders' equity 4,578,638 1,274,378 501,278
----------- ----------- -----------
Total liabilities and stockholders' equity $12,357,465 $ 1,314,170 $ 1,042,285
=========== =========== ===========
</TABLE>
See accompanying notes.
F-9
<PAGE> 37
Pet Quarters, Inc. and Subsidiary
Consolidated Statements of Operations
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
SEPTEMBER 30 JUNE 30
1999 1998 1999
--------------------------------- -----------
(Unaudited)
<S> <C> <C> <C>
Sales, net of allowances and discounts $ 2,510,752 $ 58,455 $ 262,470
Cost of sales (Exclusive of Depreciation
Shown Separately Below) 1,678,207 33,514 205,774
----------- ----------- -----------
832,545 24,941 56,696
Operating expenses and costs:
Selling 375,449 148,894 489,272
Administrative and general 642,206 72,198 588,870
Depreciation and amortization 311,963 959 36,824
----------- ----------- -----------
1,329,618 222,051 1,114,966
----------- ----------- -----------
Loss from operations (497,073) (197,110) (1,058,270)
Other income (expense):
Interest expense (111,616) - (290)
Bridge loan origination fee (Note 8) (651,671) - -
Other income - - 2,809
Interest income - 2,949 3,486
----------- ----------- -----------
(763,287) 2,949 6,005
----------- ----------- -----------
Loss before income tax benefit (1,260,360) (194,161) (1,052,265)
Income tax benefit (Note 4) - - -
----------- ----------- -----------
Net loss $(1,260,360) $ (194,161) $(1,052,265)
=========== =========== ===========
Net loss per common share:
Basic $ (.12) $ (.02) $ (.09)
=========== =========== ===========
Diluted $ (.12) $ (.02) $ (.09)
=========== =========== ===========
Weighted average shares outstanding 10,797,000 11,560,000 11,453,000
=========== =========== ===========
</TABLE>
See accompanying notes.
F-10
<PAGE> 38
Pet Quarters, Inc. and Subsidiary
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL UNAMORTIZED
PAR PAID-IN ACCUMULATED STOCK
SHARES AMOUNT CAPITAL DEFICIT COMPENSATION TOTAL
------------- ------------ -------------- --------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Balance at July 1, 1998 11,560,000 $ 11,560 $ 2,272,973 $ (816,179) $ - $ 1,468,354
Shares bought from founder and
subsequently cancelled (Note 5) (2,000,000) (2,000) - - - (2,000)
Restricted stock issued to employees
(Note 6) 180,000 180 183,570 - (183,750) -
Amortization of stock compensation - - - - 44,805 44,805
Shares issued for services 60,195 60 42,324 - - 42,384
Net loss for the year ended
June 30, 1999 - - - (1,052,265) - (1,052,265)
---------- ---------- ------------ ------------ ---------- ------------
Balance at June 30, 1999 9,800,195 9,800 2,498,867 (1,868,444) (138,945) 501,278
Shares issued for acquisition of
Humboldt (Note 8) - unaudited 1,146,417 1,147 4,598,853 - - 4,600,000
Shares issued as origination fee for
bridge loan (Note 8) - unaudited 153,334 153 651,518 - (651,671) -
Shares issued as attorney fee for
bridge loan (Note 8) unaudited 4,334 4 18,416 - - 18,420
Restricted stock issued to
employees-unaudited 95,000 95 376,936 - (377,031) -
Amortization of stock compensation -
unaudited - - - - 67,629 67,629
Amortization of loan origination
fee-unaudited - - - 651,671 651,671
Net loss for three months ended
September 30, 1999 - unaudited - - - (1,260,360) - (1,260,360)
---------- ---------- ------------ ------------ ---------- ------------
Balance at September 30, 1999 -
unaudited 11,199,280 $ 11,199 $ 8,144,590 $ (3,128,803) $ (448,347) $ 4,578,638
========== ========== ============ ============ =========== ============
</TABLE>
See accompanying notes.
F-11
<PAGE> 39
Pet Quarters, Inc. and Subsidiary
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
SEPTEMBER 30 JUNE 30
1999 1998 1999
------------------------------- -----------
(Unaudited)
OPERATING ACTIVITIES
<S> <C> <C> <C>
Net (loss) $(1,260,360) $ (194,161) $(1,052,265)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 34,854 959 26,974
Amortization 277,109 -- 9,850
Stock issued for services 18,420 -- 42,384
Amortization of loan origination fee 651,671 -- --
Amortization of stock compensation expense 67,629 -- 44,805
Changes in operating assets and liabilities, net
of acquisition:
Accounts receivable (39,102) 2,142 357
Inventories 68,410 2,438 39,446
Prepaid expenses and other current assets (183,771) -- 7,178
Other assets 4,291 -- 36,238
Accounts payable (27,388) 25,872 189,715
Accrued expenses 177,672 (6,600) 11,472
Unearned income -- -- (5,885)
----------- ----------- -----------
Net cash used in operating activities (210,565) (169,350) (649,731)
INVESTING ACTIVITIES
Acquisition of Humboldt, net of cash (4,448,454) -- --
Purchases of property, plant, and equipment (34,924) (1,806) (11,386)
----------- ----------- -----------
Net cash used in investing activities (4,483,378) (1,806) (11,386)
FINANCING ACTIVITIES
Proceeds from notes payable and bridge loan 4,900,000 -- 325,000
Payments on notes payable and capital leases (92,237) -- --
Redemption of common stock -- -- (2,000)
----------- ----------- -----------
Net cash provided by financing activities 4,807,763 -- 323,000
----------- ----------- -----------
Net increase (decrease) in cash 113,820 (171,156) (338,117)
Cash at beginning of period 37,726 375,843 375,843
----------- ----------- -----------
Cash at end of period $ 151,546 $ 204,687 $ 37,726
=========== =========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 19,246 $ -- $ 290
Shares issued on the acquisition of Humboldt
Industries (Note 8) $ 4,600,000 $ -- $ --
</TABLE>
See accompanying notes.
F-12
<PAGE> 40
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF BUSINESS
Pet Quarters, Inc. and Subsidiary (the "Company") was organized under the laws
of the state of Arkansas on May 22, 1997, for the purpose of marketing and
selling pet supplies over the Internet. From May 22, 1997 to June 30, 1997, the
Company had no operations.
The Company has sold common stock in offerings that were exempt from
registration with the Securities and Exchange Commission ("SEC"). The Company's
common stock is currently traded on the OTC Bulletin Board. The Company is not
currently required to file periodic consolidated financial reports with the SEC,
however, the Company is planning to file a Form 10 on December 10, 1999 and will
begin filling with SEC required periodic reports.
The Consolidated Financial Statements include the accounts of PQ Acquisition
Company, Inc. which was organized in 1999 for the sole purpose of acting as an
intermediate corporation to acquire Humboldt Industries, Inc and Maplewood
Industries, Inc.
CONSOLIDATION
The financial statements include the accounts of the Company and its wholly
owned subsidiaries, Humboldt Industries, Inc. and Maplewood Industries, Inc.
beginning August 1, 1999. (See Note 8.)
INVENTORIES
Inventories are valued at the lower of cost, principally determined by the
first-in, first-out method, or market. Inventory at June 30, 1999 and 1998,
consists of pet supplies purchased for retail sale.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
depreciable assets, which range from five years for furniture and equipment to
thirty-nine years for buildings and improvements.
INCOME TAXES
The Company provides for income taxes based on the liability method.
No provision (benefit) for income taxes has been made due to net operating loss
carryforwards totaling approximately $1,843,000, that may offset future taxable
income (see Note 4).
F-13
<PAGE> 41
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The company records stock based compensation using provisions of Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees, for the preparation of its basic consolidated financial statements
(see Note 6). Such provisions require the company to recognize compensation cost
over the vesting period for the difference between the quoted market price of an
award at the date of grant and the purchase or exercise price of the shares.
INTANGIBLE ASSETS
Intangible assets are amortized on a straight-line basis over their estimated
lives, ranging from 3 to 5 years.
ADVERTISING COSTS
The Company expenses advertising costs, other than direct responses advertising
as they are incurred. Advertising expenses of approximately $430,000 were
incurred for the year ended June 30, 1999.
The Company's wholly owned subsidiaries, Humboldt Industries, Inc. and
affiliate, account for catalog costs in accordance with SOP 93-7, "Reporting on
Advertising Costs" in connection with the marketing of their direct response
products. Such expense is amortized over the period of benefit which is less
than one year using the ratio of current period revenue to the total of current
and estimated future period revenues.
CONCENTRATION OF CREDIT RISK
The Company's services are provided primarily to customers throughout the United
States. The Company receives payment largely by customers' use of credit cards
for internet sales and, for sales by Humboldt, the Company performs ongoing
credit evaluations of Humboldt's customers and generally does not require
collateral. Historically, credit losses have been within management's
expectations.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of merchandise, net of an
allowance for estimated customer returns and discounts.
F-14
<PAGE> 42
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT OF ASSETS
The Company accounts for any impairment of its long-lived assets using Statement
of Consolidated Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". Under SFAS No. 121, impairment losses are recognized when information
indicates the carrying amount of long-lived assets, identifiable intangibles and
goodwill related to those assets will not be recovered through future operations
or sale.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS No. 130, "Reporting of Comprehensive Income" in 1998.
Because the Company had no other items of comprehensive income, the impact of
adoption was not material.
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" which requires public business enterprises to report
financial and descriptive information about its reportable segments. See Note
11.
In March 1998, the Accounting Standards Executive Committee ("AcSEC") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." Under the SOP, qualifying
computer software costs are required to be capitalized and amortized against
income over the software's estimated useful life. The SOP is effective for
fiscal years beginning after December 15, 1998. The Company adopted SOP 98-1 in
the quarter ended September 30, 1999 which did not have a material effect on
operating results or the financial position of the Company.
F-15
<PAGE> 43
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement is
effective for all quarters of fiscal years beginning after June 15, 2000 and
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability at
its fair value. The Company does not anticipate that the adoption of SFAS No.
133 will have a material effect on earnings or the financial position of the
Company.
INTERIM FINANCIAL STATEMENTS (UNAUDITED)
The accompanying consolidated financial statements of the Company for the three
months ended September 30, 1999 and 1998 have been prepared in accordance with
generally accepted accounting principles for interim financial statements.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
The interim financial information is unaudited, but reflects all adjustments
consisting only of normal recurring accruals which are, in the opinion of
management, necessary for a fair presentation of the results of operations for
such interim periods. Operating results for the three months ended September 30,
1999 are not necessarily indicative of the results that may be expected for the
entire year.
2. GOING CONCERN UNCERTAINTY
The accompanying consolidated financial statements have been presented
in conformity with generally accepted accounting principles, which contemplates
continuation of the Company as a going concern. However, the Company has a
significant working capital deficiency and has incurred operating loss since its
formation. As discussed in Note 8, the Company has an outstanding bridge loan
for $4.6 million that matures within the next twelve months. The Company was
able to make a required payment of $1,000,000 on February 3, 1999 (unaudited).
Management believes that actions presently being taken will provide for the
Company to continue as a going concern. Such actions may include but are not
limited to a private equity stock placement which would be utilized to payoff
the bridge loan and other current debt, a strategic partnership or acquisition
that would provide the Company with the necessary capital, or sale of certain
assets. However, there are no assurances that management will be able to secure
additional equity capital or complete any other strategic transactions that will
permit the Company to meet its current obligations. If the Company defaults on
the extended terms of the Bridge Loan then the ownership of Humboldt Industries
will revert to the Trust, since their stock is held as collateral (Note 8).
F-16
<PAGE> 44
3. RELATED PARTY TRANSACTIONS
In November 1997, the Company issued 1,777,500 shares of its common stock, with
a fair value of $888,750, to acquire land and a building from Ammonia Hold,
Inc., a company owned by a principal shareholder of the Company. As a part of
the exchange a option to repurchase the building for the original sales price
was granted. This option expired on June 8, 1999.
At June 30, 1999, the Company had $325,000 notes payable to Ammonia Hold, Inc.
The notes are due on demand with an interest rate of 8%. The notes payable are
secured by property and inventory.
4. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax liabilities and assets are
as follows:
JUNE 30, 1999
----------------
DEFERRED TAX ASSETS:
Amortization of stock compensation $ 44,805
Net operating loss carryforward (1,843,683)
---------------
(1,798,878)
Effective tax rate 34%
---------------
Deferred tax asset 611,619
Valuation allowance (611,619)
---------------
Net deferred tax asset $ -
===============
The use of the liability method of accounting for income taxes requires that
deferred tax assets are reduced by a valuation allowance if it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. Whether a deferred tax asset will be realized depends upon sufficient
future taxable income and consideration of limitations on the ability to utilize
net operating loss carryforwards and other tax attributes.
Under limitations imposed by Internal Revenue Code Section 382, certain
potential changes in ownership of the Company may restrict future utilization of
net operating loss carryforwards. It is management's belief that a change in
ownership which would trigger the Section 382 limitations has not occurred.
However, a valuation allowance has been established for the entire net deferred
tax assets until such time as it is more likely than not that the deferred tax
assets will be realized.
At June 30, 1999, the Company has net operating loss carryforwards of
approximately $1,843,00 for income tax purposes that expire in years 2013
through 2019.
No income taxes were paid in 1998 and 1997. The Company's effective tax rate for
June 30, 1999 and 1998, is 0%. The effective tax rate for the years ended June
30, 1999 and 1998, is different than the
F-17
<PAGE> 45
statutory federal tax rate of 34%, due to the establishment of a valuation
allowance relating to the deferred tax assets.
5. STOCKHOLDERS' EQUITY
In June 1999, the Company retired 2,000,000 shares of common stock which had
been held by a founding stockholder of the Company. These shares were
subsequently cancelled. This transaction was completed in order to facilitate
the acquisition of Humboldt Industries, Inc. (see Note 8). These shares were
held by the founding stockholder under a verbal understanding with other
stockholders that the shares would be retired and canceled upon the occurrence
of certain future events including a business combination or issuance of
additional equity capital. The shares were originally issued so that the
founding stockholder would have voting control. For purposes of calculating net
loss per share, the 2,000,000 shares were deemed to have been retired and
canceled as of July 1, 1999.
The Company is authorized to issue 10,000,000 shares of preferred stock. The
voting powers, performances and other rights are subject to resolution of the
Board of Directors. No preferred shares are outstanding.
6. STOCK-BASED COMPENSATION
The Company's Board of Directors has given approval to the establishment of an
Management Incentive Plan under which shares of the Company's stock are granted
to employees. The shares are restricted for one year following the date of grant
and require that the employee remain in continuous employment for a period of 1
year from the date of grant. There are no grants outstanding under the Plan at
June 30, 1999.
In 1999, the Company granted stock awards to employees totaling 180,000 shares.
Total compensation cost for stock award issued to employees was $44,805 for the
year ended June 30, 1999.
In April 1999, the President of the Company granted to an officer an option to
purchase 225,000 shares at the fair market value at the date of grant of $1.125.
The grant was authorized by the President in connection with the employment of
this individual in April 1999.
F-18
<PAGE> 46
7. NOTES AND CAPITAL LEASES PAYABLE
<TABLE>
<CAPTION>
SEPTEMBER 30 JUNE 30
1999 1999
-------- ----------
(Unaudited)
<S> <C> <C>
Capital lease payable to a leasing company due in monthly installments of
$5,096 until May 2003 with no stated interest rate. The lease is
guaranteed by a stockholder $187,812 $ --
Capital lease payable to a leasing company due in monthly installments of
$3,332 until December 2004 with no stated interest rate. The lease is
guaranteed by a stockholder 165,363 --
Other notes payable 17,102 --
-------- ----------
370,277 --
Less current portion 93,168 --
-------- ----------
$277,109 $ --
======== ==========
</TABLE>
Maturities of notes and capital leases are as follows:
<TABLE>
<S> <C>
2000 $ 93,168
2001 84,056
2002 88,102
2003 56,589
2004 48,362
--------
$370,277
========
</TABLE>
Equipment leased under capital lease obligations is included in furniture and
equipment at July 31, 1999. Amortization of the leased equipment is included in
depreciation expense.
8. ACQUISITION
On August 1, 1999, the Company acquired 100% of the outstanding stock of
Humboldt Industries, Inc.("Humboldt Industries") and Maplewood Industries, Inc.
("Maplewood"), both of Hazleton, Pennsylvania, for $4.6 million cash and
1,146,417 shares of the Company's common stock, valued at $4.6 million on the
date of the acquisition. Humboldt Industries is in the pet supply catalog
business and distributes two pet catalogs - Home Pet Shop and the Dog's
Outfitter - to retail and wholesale customers throughout the United States and
in selected foreign markets. The acquisition was accounted for as a purchase
transaction. The purchase price allocated to assets and liabilities acquired is
based on preliminary information and is subject to change. The preliminary
allocation of purchase price results in goodwill in the amount of approximately
$8.3 million. Goodwill is amortized over a 5 year life. The cash paid was
financed through a bridge loan by borrowing $4.6 million from Sun Valley Trust
(the
F-19
<PAGE> 47
8. ACQUISITION (CONTINUED)
"Trust"). This loan was due in full on October 1, 1999 with an interest rate of
12.5%. Some of the investors in the Trust are also employees of the Company. In
conjunction with the bridge loan transaction, the Company issued 153,334 shares
of Common Stock with a market value on July 30, 1999 totalling of $651,671 as
payment for origination of the loan. This origination fee was amortized over the
term of the loan from August 1, 1999 through October 1, 1999. In addition, the
Company issued 4,334 shares of Common Stock with an estimated market value of
$18,420 for attorney fees associated with the bridge loan. The common stock of
Humboldt and Maplewood is pledged as security for the bridge loan.
On October 2, 1999, the Company went into default on the $4.6 million bridge
loan noted above. This bridge loan was extended on November 10, 1999 with key
changes from the original agreement as follows: The interest rate was reduced
from 12.5% to 10%, interest in the amount of $204,723 was paid current,
penalties in the amount of $230,000 were added to the principal balance (total
principal $4,830,000), $20,000 in interest payments are due monthly with the
remainder to accrue and be paid upon funding. On November 10, 1999, the Company
issued an additional 275,000 restricted shares to the trust at a value equal to
the average market value of $1.756 or $483,010. The terms of the extension
required a partial principal payment of $1,000,000 by February 10, 2000. This
payment was made on February 3, 2000 as required (unaudited). The remaining
principal balance plus accrued interest will be due in full on May 10, 2000.
In connection with the restructuring of the bridge loan on November 10, 1999,
two shareholders loaned the Company $204,000 which was the amount of the
interest due on November 10, 1999. The loan contains a conversion feature
whereby the holder of the notes may convert the note to shares of Pet Quarter's
common stock at a conversion price of $.50. The Company recorded in November
1999, $626,452 as additional expense of restructuring the debt which is the
intrinsic value of the conversion feature.
The operations of Humboldt have been consolidated with the operations of the
Company beginning August 1, 1999. Pro forma unaudited information, which
includes goodwill amortization and bridge loan interest expense, as if Humboldt
acquisition occurred as of July 1, 1998 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 YEAR ENDED JUNE 30
1999 1998 1999
------------ ------------ ------------------
(UNAUDITED)
<S> <C> <C> <C>
Sales $ 3,730,801 $ 2,999,822 $ 15,143,999
Cost of sales (2,490,923) (2,373,755) (10,555,117)
Operating expenses (1,839,020) (1,015,806) (7,297,114)
Other income (expenses) (803,999) 37,096 (367,576)
------------ ------------ ------------
Net loss $ (1,403,141) $ (352,643) $ (3,075,808)
============ ============ ============
</TABLE>
F-20
<PAGE> 48
8. ACQUISITION (CONTINUED)
The above pro forma unaudited information does not purport to be indicative of
the results which actually would have occurred had the acquisition been made at
the beginning of the respective periods.
9. SHORT-TERM NOTE PAYABLE (UNAUDITED)
On August 4, 1999, the Company obtained short-term financing in the amount of
$300,000 from a bank. The loan is secured by a first mortgage on land and
building located in Lonoke, Arkansas. The loan accrues interest at a rate of
6.5%.
In conjunction with the acquisition of Humboldt Industries (Note 8) the Company
has an obligation to pay a company a finders fee in the amount of $181,600.
F-21
<PAGE> 49
10. COMMITMENTS
In July 1999, Pet Quarters, Inc. entered into an agreement to acquire
Chartendure Ltd., of the United Kingdom. Under the agreement with Chartendure,
Chartendure's shareholders will receive 900,000 shares of Pet Quarters stock for
arranging and contracting for the development of a new web site for Pet
Quarters.
As part of the agreement, Chartendure will contract with a qualified web site
design and development firm for a new Pet Quarters web site. The shares of Pet
Quarters' common Stock will be issued only upon the achievement of certain
development milestones. Management will capitalize the payments to the web site
design and development firm in accordance with SOP 98-1. Management will expense
the shares of common stock at the market value at the time the shares are issued
to Chartendure's shareholders. The project has had limited progress to date and
no shares have been issued to date.
11. OPERATING SEGMENTS
Prior to the purchase of Humboldt effective August 1, 1999, the Company
operated in one segment-internet sales of pet supplies. Beginning August 1,
1999, the Company began through the purchase of Humboldt Industries a catalog
segment. Information on the Operating segments for the year ended June 30, 1999
and the three months ended September 30, 1999 and 1998 (unaudited) is as
follows:
<TABLE>
<CAPTION>
Three Months Ended Year Ended
September 30 June 30
1999 1998 1999
----------- ---------- -----------
(unaudited)
<S> <C> <C> <C>
Net sales:
Internet $ 70,655 $ 58,455 $ 262,470
Catalog 2,440,097 -- --
----------- ---------- -----------
Total $ 2,510,752 $ 58,455 $ 262,470
=========== ========== ===========
Loss from operations:
Internet $ (338,938) $ (197,100) $(1,058,270)
Catalog (158,135) -- --
----------- ---------- -----------
$ (497,073) $ (197,100) $(1,058,270)
=========== ========== ===========
Other income (expense):
Internet $ (758,528) $ 2,949 $ 6,005
Catalog (4,759) -- --
----------- ---------- -----------
$ (763,287) $ 2,949 $ 6,005
=========== ========== ===========
Assets:
Internet $ 1,654,760 $1,314,170 $ 1,042,285
Catalog 10,702,705 -- --
----------- ---------- -----------
$12,357,465 $1,314,170 $ 1,042,285
=========== ========== ===========
Capital expenditures:
Internet $ 4,464,798 $ 1,806 $ 11,386
Catalog 18,580 -- --
----------- ---------- -----------
$ 4,483,378 $ 1,806 $ 11,386
=========== ========== ===========
Depreciation and amortization:
Internet $ 9,554 $ 959 $ 36,824
Catalog 302,409 --
----------- ---------- -----------
$ 311,963 $ 959 $ 36,842
=========== ========== ===========
</TABLE>
Although the Company sells the same product at the same price through the
internet and catalog segments, the means of selling is different with the
internet segment having the potential for a much broader distribution with far
more customers than can be reached through the traditional catalog
distribution. Revenues by geographical location of customer is not practical to
determine.
F-22
<PAGE> 50
FINANCIAL STATEMENTS
PET QUARTERS, INC.
Year ended June 30, 1998
with Report of Independent Auditors
F-23
<PAGE> 51
PET QUARTERS, INC.
FINANCIAL STATEMENTS
YEAR ENDED JUNE 30,1998
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report........................................................................F-25
Balance Sheet.......................................................................................F-26
Statements of Operations............................................................................F-27
Statements of Stockholders' Equity..................................................................F-28
Statements of Cash Flows............................................................................F-29
Notes to the Financial Statements...................................................................F-30
</TABLE>
F-24
<PAGE> 52
Independent Auditors' Report
To the Stockholders and Board of Directors
Pet Quarters, Inc.
We have audited the accompanying balance sheet of Pet Quarters, Inc. as of June
30, 1998 and the related statement of operations, stockholders' equity and cash
flows for the year ended June 30, 1998 and the two months ended June 30, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pet Quarters, Inc. as of June
30, 1998 and the results of their operations and cash flows for the year ended
June 30, 1998 and the two months ended June 30, 1997 in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2, the Company's
operating loss raise substantial doubt about it ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Crouch, Bierwolf & Chisholm
Salt Lake City, Utah
October 25, 1998
F-25
<PAGE> 53
Pet Quarters, Inc.
Balance Sheet
June 30, 1998
<TABLE>
<CAPTION>
ASSETS
Current assets:
<S> <C>
Cash and cash equivalents (Note 1) $ 375,843
Accounts receivable (Note ) 3,011
Prepaid expenses 9,428
Inventory (Note 1) 73,229
-----------
Total current assets 461,511
Property, plant and equipment - net of accumulated
depreciation (Note 1) 979,877
Other assets-net of accumulated amortization (Note 6) 47,671
-----------
Total assets
$ 1,489,059
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,679
Accrued payroll taxes 1,141
Unearned income 5,885
-----------
Total current liabilities . 20,705
Commitments and contingencies (Note 3)
Stockholders' equity:
Common stock, par value $.001, authorized shares 40,000,000: 11,560,000
shares issued and outstanding 11,560
Additional paid in capital 2,272,973
Accumulated deficit (816,179)
-----------
Total stockholders' equity 1,468,354
-----------
Total liabilities and stockholders' equity $ 1,489,059
===========
The accompanying notes are an integral part of these financial statements
</TABLE>
F-26
<PAGE> 54
Pet Quarters, Inc.
Statement of Operations
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE TWO MONTHS
JUNE 30 1998 ENDED JUNE 30, 1997
----------- -------------------
<S> <C> <C>
Sales - net of allowance and discounts $ 43,835 $ --
Cost of sales 21,908 --
----------- -----------
Gross profit 21,927 --
Operating and administrative expenses 855,119 --
----------- -----------
Operating loss (833,192) --
Other income (expense):
Interest expense (4,384) --
Other income 15,001 --
Interest income 6,396 --
----------- -----------
Total other income 17,013 --
----------- -----------
Net (loss) $ (816,179) $ --
=========== ===========
Net (loss) per share $ (0.095) $ --
=========== ===========
Weighted average shares outstanding 8,568,125 6,625,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-27
<PAGE> 55
Pet Quarters, Inc.
Statement of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK PAID-IN ACCUMULATED
---------------------------
SHARES AMOUNT CAPITAL DEFICIT
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Inception at May 22, 1997 -- $ -- $ -- $ --
May 17, 1997, restricted shares issued for cash
at $.001 to founders 6,100,000 6,100 -- --
June 26, 1997, Shares issued for cash at $0.10
1,050,000 1,050 103,950 --
---------- ---------- ----------
Balance, June 30, 1997 7,150,000 7,150 103,950 --
---------- ---------- ---------- ----------
August 8, 1997, Restricted shares issued for
cash at $.50 119,500 120 59,630 --
Shares issued for land and
building (Note 1) 1,777,500 1,777 886,973 --
Shares issued for cash at $0.50 less offering
costs of $31,567 1,720,000 1,720 826,713 --
Shares issued for cash and services (Note 5) 790,000 790 394,210 --
Shares issued for cash at $.050 3,000 3 1,497 --
Net loss for the year ended
June 30,1998 -- -- -- (816,179)
---------- ---------- ---------- ----------
Balance June 30, 1998 11,560,000 $ 11,560 $2,272,973 $ (816,179)
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-28
<PAGE> 56
Pet Quarters, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE TWO MONTHS
JUNE 30 1998 ENDED JUNE 30, 1997
--------------------- --------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss $(816,179) $ --
Adjustments to reconcile net loss to net cash used by
operations:
Depreciation 6,211 --
Amortization 5,297 --
Stock issued for services 360,000 --
Changes in current assets and liabilities:
(Increase) decrease in:
Accounts receivable (3,011) --
Prepaid expenses (9,428) --
Inventories (73,229) --
Other assets (51,968) --
Increase(decrease) in:
Accounts payable 13,679 --
Payroll taxes payable 141 --
Unearned income 5,885 --
--------- ---------
Net cash used by operating activities (562,602) --
INVESTING ACTIVITIES
Expended for property, plant and equipment (97,338) --
--------- ---------
Net cash used by investing activities (97,338) --
FINANCING ACTIVITIES
Issuance of common stock 924,683 111,100
--------- ---------
Net cash provided by financing activities 924,683 111,100
--------- ---------
Increase in cash 264,743 111,100
Cash and cash equivalents at beginning of period 111,100 --
---------
--------- ---------
Cash and cash equivalents at end of period $ 375,843 $ 111,100
========= =========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 4,384 $ --
========= =========
Cash paid for income taxes $ -- $ --
========= =========
Stock issued for property $ 888,750 $ --
========= =========
Stock issued for services $ 360,000 $ --
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements
F-29
<PAGE> 57
Pet Quarters, Inc.
Notes to Financial Statements
June 30, 1998
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Pet Quarters, Inc. (the "Company") was organized under the laws of the State of
Arkansas on May 22, 1997. The Company was organized for the purpose of marketing
and selling pet supplies over the Internet.
ACCOUNTING METHOD
The Company's financial statements are prepared using the accrual method of
accounting.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
INVENTORIES
The Company uses the FIFO (first in, first-out) method for inventory valuation.
The Company has approximately $ 73,229 in pet supplies inventory that it has
been purchasing since its inception.
DEPRECIABLE PROPERTY
Equipment is stated at cost. Major renewals and betterments are capitalized
while expenditures for maintenance and repairs are charged to operations as
incurred. Depreciation is computed on the straight-line method over estimated
useful lives of five to thirty-nine years for equipment, fixtures and building.
Property and Equipment for June 30, 1998 consist of the following:
Land $ 225,000
Office equipment 11,473
Warehouse equipment 20,971
Computer 14,635
Telephone system 5,964
Building 708,045
---------
Total property, plant and equipment 986,088
Less: accumulated depreciation (6,211)
---------
Net Property and Equipment $ 979,877
=========
Depreciation expense was $6,211 for the period ended June 30, 1998.
F-30
<PAGE> 58
Pet Quarters, Inc.
Notes to Financial Statements (continued)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of merchandise, net of
an allowance for estimated customer returns and discounts.
NET (LOSS) PER SHARE
The computation of net (loss) per common share is based on the weighted average
number of common shares outstanding during the period.
PROVISION FOR INCOME TAXES
No provision for income taxes has been recorded due to net operating loss
carryforwards totaling approximately $381,384 that will be offset against future
taxable income. These NOL carryforwards begin to expire in the year 2012. No tax
benefit has been reported in the financial statements because the Company
believes there is a 50% or greater chance the carryforward will expire unused.
Deferred tax assets and the valuation account for June 30, 1998 is as follows:
Deferred tax asset:
NOL carryforward $ 130,345
Valuation allowance (130,345)
---------
Total $ --
=========
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect reported amounts of assets and liabilities, disclosure of contingent
assets and these financial statements, assets, liabilities and earnings involve
extensive reliance on management's estimates. Actual results could differ from
those estimates.
2. GOING CONCERN
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has operating losses and
is dependent upon financing to continue operations. The Company plans on selling
pet supplies on the Internet to supply working capital. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
F-31
<PAGE> 59
Pet Quarters, Inc.
Notes to Financial Statements (continued)
3. CONTINGENCIES AND COMMITMENT
The Company had the following contingencies and commitments at June 30, 1998:
Advertising: The Company has entered into various contracts for advertising on
the Internet, and on radio to be provided during the next year. Payments of
$75,087.50 in cash and 11,195 shares of common stock have been committed for
these services.
4. RELATED PARTY TRANSACTIONS
In November 1997, the Company purchased ten acres of land and a 55,000 square
foot manufacturing/office facility. The purchase price was 1,777,500 shares of
restricted common stock valued at $.50 per share, or $888,750. The building was
appraised for $975,000. The facility was purchased from a corporation whose
president and major shareholder is also a major shareholder of the Company.
The Company issued an option to the seller to repurchase the facility for
1,777,500 shares of restricted common stock of the Company. This option expires
in June 1999.
5. STOCKHOLDER'S EQUITY
The Company engaged a public relations firm to assist in a 504 offering. The
fees for their services was the sale of 790,000 shares of stock for $35,000. The
stock was selling for $.50 per share in the offering. Therefore, $360,000 was
booked as a consulting expense for the year (difference between the cash
received and the fair market value of the stock).
6. OTHER ASSETS
<TABLE>
<S> <C>
The Company has $47,671 in net other assets consisting of the following:
Internet costs - The Company paid a fee to list its goods on an Internet
shopping mall.
The Company is amortizing this cost over 5 years using the straight-line
method $46,838
Trademark - Money spent to register the Company's name as a trademark. The
trademark is being amortized over 5 years using the straight-line method 1,630
Web Page Cost - Cost to create a web page to showcase the Company's products
This cost is being amortized over 5 years 4,500
-------
Total Other Assets 52,968
Less: Accumulated Amortization 5,297
-------
Other Assets Net Amortization $47,671
=======
</TABLE>
F-32
<PAGE> 60
Pet Quarters, Inc.
Notes to Financial Statements (continued)
7. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, "Disclosure about Fair
Value of Financial Instruments." The carrying amounts and fair value of the
Company's financial instruments at June 30, 1998 are:
CARRYING AMOUNTS FAIR VALUES
---------------- -----------
Cash and cash equivalents $375,843 $375,843
======== ========
The Company in estimating its fair value disclosures for financial instruments
assumes the carrying amounts reported on the balance sheet for cash and cash
equivalents approximates their fair value.
F-33
<PAGE> 61
COMBINED FINANCIAL STATEMENTS
HUMBOLDT INDUSTRIES, INC. AND AFFILIATE
Period from January 1, 1999 to July 31, 1999
With Report of Independent Auditors
F-34
<PAGE> 62
Humboldt Industries, Inc. and Affiliate
Combined Financial Statements
Period from January 1, 1999 to July 31, 1999
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors......................................................................F-36
Audited Combined Financial Statements
Combined Balance Sheet..............................................................................F-37
Combined Statement of Operations....................................................................F-38
Combined Statement of Stockholders' Equity..........................................................F-39
Combined Statement of Cash Flows....................................................................F-40
Notes to Combined Financial Statements..............................................................F-41
</TABLE>
F-35
<PAGE> 63
Report of Independent Auditors
The Board of Directors of
Humboldt Industries, Inc. and Affiliate
Hazleton, Pennsylvania
We have audited the accompanying combined balance sheet of Humboldt Industries,
Inc. and Affiliate (the "Company") as of July 31, 1999, and the related combined
statements of operations, stockholders' equity and cash flows for the period
from January 1, 1999 to July 31, 1999. These combined financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these combined financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined financial position of Humboldt Industries,
Inc. and affiliate at July 31, 1999, and the combined results of their
operations and their cash flows for the seven month period then ended in
conformity with generally accepted accounting principles.
The accompanying combined financial statements have been prepared assuming that
the Company will continue as a going concern. As more fully described in Note 2,
the Company is a consolidated subsidiary of a parent company that has operating
losses and is dependent upon future financing to continue operations. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The combined financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification
of assets or the amounts and classification of liabilities that may result from
the outcome of this uncertainty.
Ernst & Young LLP
Little Rock, Arkansas
October 15, 1999, except for Note 6 as to
which the date is November 10, 1999.
F-36
<PAGE> 64
Humboldt Industries, Inc. and Affiliate
Combined Balance Sheet
July 31, 1999
<TABLE>
<CAPTION>
ASSETS
<S> <C>
Current assets:
Cash $ 151,473
Accounts receivable 160,315
Inventory (Note 3) 1,555,469
Deferred advertising costs (Note 1) 216,000
Other current assets 4,291
-----------
Total current assets 2,087,548
Leasehold improvements, furniture and equipment:
Leasehold improvements 33,140
Furniture and equipment 1,393,481
Less accumulated depreciation (893,803)
-----------
Total leasehold improvements, furniture and equipment 532,818
-----------
Total assets $ 2,620,366
===========
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable $ 1,491,247
Current portion of notes and capital leases payable 48,069
Accrued liabilities 219,420
-----------
Total current liabilities 1,758,736
Notes and capital leases payable (Note 4) 339,445
-----------
Total liabilities 2,098,181
Commitments and contingencies (Note 5)
Stockholders' equity:
Common stock 2,000
Additional paid-in capital 790,873
Accumulated deficit (270,688)
-----------
Total stockholders' equity 522,185
-----------
Total liabilities and stockholders' equity $ 2,620,366
===========
</TABLE>
See accompanying notes.
F-37
<PAGE> 65
Humboldt Industries, Inc. and Affiliate
Combined Statement of Operations
Period from January 1, 1999 to July 31, 1999
<TABLE>
<S> <C>
Sales $ 9,084,885
Cost of sales 5,935,829
-----------
Gross profit 3,149,056
Selling, general and administrative expenses:
Selling expenses 1,336,995
General and administrative 1,546,499
Depreciation 65,958
-----------
Total selling, general and administrative expenses 2,949,452
-----------
Income from operations 199,604
Other income (expense):
Interest expense (19,425)
Interest income 3,355
-----------
(16,070)
-----------
Net income, historical 183,534
Pro forma income tax provision 70,500
-----------
Pro forma net income $ 113,034
===========
</TABLE>
See accompanying notes.
F-38
<PAGE> 66
Humboldt Industries, Inc. and Affiliate
Combined Statement of Stockholders' Equity
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL DEFICITS TOTAL
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Balance at January 1, 1999 $ 2,000 $ 593,521 $(454,222) $ 141,299
Cash distributions to stockholder -- (76,973) -- (76,973)
Non-cash contribution by
stockholder (Note 5) -- 324,325 -- 324,325
Non-cash distribution to
stockholder (Note 5) -- (50,000) -- (50,000)
Net income for seven months ended
July 31, 1999 -- -- 183,534 183,534
--------- --------- --------- ---------
Balance at July 31, 1999 $ 2,000 $ 790,873 $(270,688) $ 522,185
========= ========= ========= =========
</TABLE>
See accompanying notes.
F-39
<PAGE> 67
Humboldt Industries, Inc. and Affiliate
Combined Statement of Cash Flows
Period from January 1, 1999 to July 31, 1999
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net income $ 183,534
Adjustments to reconcile net cash provided (used) by
operating activities:
Depreciation 65,958
Changes in assets and liabilities:
Accounts receivable (101,675)
Inventory (304,616)
Deferred advertising costs 37,000
Other assets 1,369
Accounts payable 107,027
Accrued expenses 150,228
---------
Net cash provided by operating activities 138,825
FINANCING ACTIVITIES
Repayments of notes payable and capital leases (58,553)
Distribution to stockholder (76,973)
---------
Net cash used in financing activities (135,526)
---------
Net increase in cash 3,299
Cash at beginning of year 148,174
---------
Cash at end of year $ 151,473
=========
SUPPLEMENTAL DISCLOSURES:
Net amounts stockholder contributed as additional
paid-in capital (Note 5) $ 274,325
=========
</TABLE>
See accompanying notes.
F-40
<PAGE> 68
Humboldt Industries, Inc.
Notes to Financial Statements
July 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Humboldt Industries, Inc. and Affiliate and its affiliate, Maplewood Industries,
Inc., (collectively the "Company") are engaged in the mail order sale of pet
training and grooming aids, health supplies and vaccines for dogs, cats and
other pets as well as the mail order sale of arts and crafts supplies. The
customer base is primarily located throughout the continental United States.
COMBINATION
The combined financial statements include the accounts of the Humboldt
Industries, Inc. and its affiliate, Maplewood Industries, Inc. These companies
were owned by the same shareholders and have common management. All significant
intercompany accounts and transactions have been eliminated in combination.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenue is recognized at the time of shipment of merchandise. When returned
goods are received, sales are reduced and the related merchandise is restocked
to inventory.
INVENTORY
Inventory consists of purchased finished products held for resale stated at the
lower of cost or market. The last-in, first-out ("LIFO") method is used to
determine cost for Humboldt Industries, Inc. and Affiliate while the first-in,
first-out ("FIFO") method is used to determine cost for Maplewood Industries,
Inc.
DEFERRED ADVERTISING COSTS
The Company accounts for catalog costs in accordance with SOP 93-7, "Reporting
on Advertising Costs" in connection with the marketing of its direct response
products. Such expense is amortized over the period of benefit which is less
than one year using the ratio of current period revenues to the total of current
and estimated future period revenues for each catalog. All other advertising
costs are expensed as incurred.
F-41
<PAGE> 69
Humboldt Industries, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LEASEHOLD IMPROVEMENTS, FURNITURE AND EQUIPMENT
These assets are stated at cost. Depreciation is being provided by accelerated
methods over the estimated useful lives of the assets.
INCOME TAXES
The Company elected to be treated as an S Corporation for federal and state
income tax reporting, whereby any income or loss will be included in the
individual shareholder's income tax return. As a result of the acquisition by
Pet Quarters, Inc. (see Note 6), the Company will begin in August 1999 to be
subject to federal and state income taxes. A pro forma provision for income
taxes is presented in the accompanying combined statement of operations.
IMPAIRMENT OF ASSETS
The Company accounts for any impairment of its long-lived assets using
Statements of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed
Of". Under SFAS No. 121, impairment losses are recognized when information
indicates the carrying amount of long-lived assets, identifiable intangibles and
goodwill related to those assets will not be recovered through future operations
or sale.
CONCENTRATION OF CREDIT RISK
Accounts receivable are comprised of a diversified customer base. The Company
employs credit monitoring policies that, in management's opinion, effectively
reduce any potential risk to an acceptable level.
2. GOING CONCERN UNCERTAINTY
The accompanying combined financial statements have been presented in conformity
with generally accepted accounting principles, which contemplates continuation
of the Company as a going concern. However, the Company is now a consolidated
subsidiary of Pet Quarters, Inc. which has a significant working capital
deficiency and has incurred operating losses since its formation. As discussed
in Note 6, Pet Quarters, Inc. has an outstanding bridge loan for $4.8 million
that matures May 10, 2000. Pet Quarters, Inc. believes that actions presently
being taken will provide for the Company to continue as a going concern. Such
actions may include but are not limited to a private equity stock placement
which would be utilized to payoff the bridge loan and other current debt, a
F-42
<PAGE> 70
Humboldt Industries, Inc.
Notes to Financial Statements (continued)
2. GOING CONCERN UNCERTAINTY (CONTINUED)
strategic partnership or acquisition that would provide the Company with the
necessary capital, or sale of certain assets. However, there are no assurances
that management will be able to secure additional equity capital or complete any
other strategic transaction that will permit the Company to meet its current
obligations.
3. INVENTORIES
<TABLE>
<S> <C>
The Company inventory consists of the following:
Humboldt at FIFO cost $ 1,857,751
Excess of FIFO cost over LIFO cost (544,531)
-----------
1,313,220
Maplewood at FIFO cost 242,249
-----------
$ 1,555,469
===========
4. NOTES AND CAPITAL LEASES PAYABLE
Capital lease payable to a leasing company due in monthly installments of $5,096
until May 2003 with no stated interest rate. The lease is guaranteed by a
stockholder. $195,215
Capital lease payable to a leasing company due in monthly installments of $3,332
until December 2004 with no stated interest rate. The lease is guaranteed by
a stockholder. 170,057
Other notes payable 22,242
--------
387,514
Less current portion 48,069
--------
$339,445
========
Annual maturities of notes and capital leases through December 31 are as
follows:
1999 $ 48,069
2000 82,320
2001 84,056
2002 88,102
2003 56,589
Thereafter 28,378
--------
$387,514
========
</TABLE>
F-43
<PAGE> 71
Humboldt Industries, Inc.
Notes to Financial Statements (continued)
4. NOTES AND CAPITAL LEASES PAYABLE (CONTINUED)
The Company paid interest of approximately $19,000 for the seven month period
ended July 31, 1999.
Equipment leased under capital lease obligations is included in furniture and
equipment at July 31, 1999. Amortization of the leased equipment is included in
depreciation expense.
The Company has a line of credit which permits borrowings up to $500,000 and
bears interest at the Bank's prime rate of interest 7.75% at July 31, 1999.
Collateral for the line consist of accounts receivable, inventory and general
intangibles. As of July 31, 1999, zero borrowings were outstanding under this
line of credit.
5. RELATED PARTY TRANSACTIONS
During the seven months ended July 31, 1999, the principal stockholder
contributed $324,325 of amounts due to the principal stockholder as additional
capital net of $50,000, the Company had as a receivable from a company owned by
the principal stockholder. These transactions are reflected in the accompanying
statement of stockholders' equity.
The former stockholders lease a building to the Company. A mortgage on the
building, aggregating approximately $1,500,000 at July 31, 1999, is guaranteed
by the Company.
Taxes, insurance and maintenance expenses related to the facility are paid by
the Company. Such expenses totaled approximately $75,000 for the seven months
ended July 31, 1999. Rent expense on the facility aggregated $140,000 for the
seven month period ended July 31, 1999. Future minimum lease payments are
$240,000 per year through July 31, 2004.
Future minimum rental commitments under the non-cancelable lease noted above as
of July 31, 1999 are as follows:
1999 $ 100,000
2000 240,000
2001 240,000
2002 240,000
2003 240,000
Thereafter 140,000
----------
$1,200,000
==========
F-44
<PAGE> 72
Humboldt Industries, Inc.
Notes to Financial Statements (continued)
6. SUBSEQUENT EVENT
On August 1, 1999, 100% of the outstanding stock of the Company was acquired by
Pet Quarters, Inc. ("Pet Quarters") for $4.6 million cash and 1,146,417 shares
of Pet Quarters, Inc. common stock, valued at $4.6 million as part of the
acquisition. The acquisition was accounted for as a purchase transaction with
related goodwill recorded on the books of Pet Quarters, in the amount of
approximately $8.3 million. The cash paid was financed through a bridge loan by
borrowing $4.6 from Sun Valley Trust (the "Trust"). This loan was due in full on
October 1, 1999 with interest accruing at a rate of 12.5%. Some of the investors
in the Trust are also Pet Quarters employees. In conjunction with the bridge
loan transaction, Pet Quarters issued 153,334 shares of Common Stock with a
market value of $651,671 as payment for origination of the loan. This
origination fee is being amortized over the term of the loan. In addition, Pet
Quarters issued 4,334 shares of Common Stock with a market value of $18,420 for
attorney fees associated with the bridge loan.
On October 2, 1999 Pet Quarters went into default on the $4.6 million bridge
loan noted above. This bridge loan was modified on November 10, 1999 with key
changes from the original agreement. The interest rate was reduced from 12.5% to
10%. Interest in the amount of $204,723 was paid current. Penalties in the
amount of $230,000 were added to the principal balance (total principal
$4,830,000), $20,000 in interest payments are due monthly with the remainder to
accrued and be paid upon funding. In addition, the Company issued an additional
275,000 restricted shares to the trust at a value of $483,010. The terms of the
extension required a principal payment of $1,000,000 by February 10, 2000. This
payment was made as required (unaudited). The remaining principal balance plus
accrued interest will be due in full on May 10, 2000.
F-45
<PAGE> 73
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
YEAR ENDED
DECEMBER 31, 1998
F-46
<PAGE> 74
[KKB LETTERHEAD]
Independent Auditors' Report
Boards of Directors
Humboldt Industries, Inc.
and Maplewood Industries, Inc.
Hazleton, Pennsylvania
We have audited the accompanying combined balance sheet of Humboldt Industries,
Inc. and Maplewood Industries, Inc. as of December 31, 1998 and the related
combined statements of operations and deficit and of cash flows for the year
then ended. These financial statements are the responsibility of the Companies'
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined financial position of Humboldt Industries,
Inc. and Maplewood Industries, Inc. as of December 31, 1998, and the combined
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles.
As discussed in Note 8 to the financial statements, the Companies were sold
effective August 1, 1999. The combined financial statements for the seven months
ended July 31, 1999, which included Humboldt Industries, Inc. and Maplewood
Industries, Inc., disclosed an uncertainty regarding their ability to continue
as a going concern.
Kingston, Pennsylvania
February 17, 1999
Note 8 dated December 10, 1999
KRONICK KALADA BERDY & CO., P.C.
1
F-47
<PAGE> 75
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
COMBINED BALANCE SHEET - DECEMBER 31, 1998
<TABLE>
<S> <C> <C>
ASSETS
Current assets:
Cash $ 148,178
Accounts receivable 58,039
Inventory 1,250,853
Due from commonly controlled
company 50,000
---------------
Total current assets 1,507,070
---------------
Leasehold improvements, furniture and equipment:
Leasehold improvements 33,139
Furniture and equipment 987,113
---------------
1,020,252
Less accumulated depreciation 827,845
---------------
192,407
Deferred catalog costs, net 253,000
Other assets 4,938
---------------
$ 1,957,415
===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of notes
payable, bank $ 30,434
Accounts payable 1,385,955
Accrued payroll and related expenses 66,138
---------------
Total current liabilities 1,482,527
Notes payable, bank, net of current
portion 9,264
Loan payable shareholders, unsecured,
non-interest bearing, due after
1999 324,325
---------------
Total liabilities 1,816,116
---------------
Shareholders' equity:
Common stock:
Humboldt Industries, Inc., $1 par;
authorized 100,000 shares; issued
and outstanding 1,000 shares 1,000
Maplewood Industries, Inc., $1 par;
authorized, issued and outstanding
1,000 shares 1,000
Additional paid in capital 593,521
Deficit (454,222)
---------------
141,299
---------------
$ 1,957,415
===============
</TABLE>
See notes to financial statements
F-48
<PAGE> 76
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
COMBINED STATEMENT OF OPERATIONS AND DEFICIT
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<S> <C>
Sales $ 14,943,683
Cost of sales 10,700,335
--------------
Gross profit 4,243,348
--------------
Selling, general and administrative
expenses:
Catalog costs 1,849,316
Other 2,393,555
--------------
4,242,871
--------------
Income from operations 477
Other income (expense):
Interest expense, net of interest
income ($5,000, 1998) (602)
Other income 100,000
--------------
99,398
--------------
Net income 99,875
Deficit, beginning (554,097)
--------------
Deficit, ending $ (454,222)
==============
</TABLE>
See notes to financial statements
F-49
<PAGE> 77
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
COMBINED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<S> <C>
Cash flows from operating activities:
Net income $ 99,875
Adjustments:
Depreciation 42,671
Loss on sale of auto 412
Changes in assets and liabilities:
Accounts receivable 84,980
Inventory 237,147
Deferred catalog costs 131,000
Other assets (1,879)
Accounts payable (262,210)
Accrued payroll and related
expenses 12,341
---------------
Net cash provided by operating
activities 344,337
---------------
Cash flows from investing activities:
Capital expenditures (27,365)
Due from commonly controlled company (24,962)
---------------
Net cash used in investing
activities (52,327)
---------------
Cash flows from financing activities:
Repayments of:
Long-term debt (32,738)
Loan payable, shareholders (218,042)
---------------
Net cash used in financing
activities (250,780)
---------------
Net increase in cash 41,230
Cash, beginning 106,948
---------------
Cash, ending $ 148,178
===============
Supplemental disclosure:
Cash paid during the year for interest
expense $ 5,544
===============
Noncash transaction:
During 1998 an employer obtained title to a Company vehicle by assuming the
remaining debt on the vehicle of approximately $10,000.
</TABLE>
See notes to financial statements
F-50
<PAGE> 78
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1998
1. Summary of significant accounting policies:
Principles of combination:
The combined financial statements include the accounts of Humboldt
Industries, Inc. and Maplewood Industries, Inc. (together, "the
Companies"). These Companies are owned by the same shareholders. All
significant intercompany accounts and transactions have been eliminated
in combination.
Description of business:
The Companies are Pennsylvania corporations which are engaged in the
mail order sale of training and grooming aids, health supplies,
vaccines for dogs, cats and other pets and arts and crafts supplies.
The customer base is primarily located throughout the continental
United States.
Use of estimates:
Management uses estimates and assumptions in preparing financial
statements. Those estimates and assumptions affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and
liabilities and the reported revenues and expenses.
Revenue recognition:
Revenue is recognized at the time of shipment of merchandise. When
returned goods are received, sales are reduced and the related
merchandise is restocked to inventory.
Inventory:
Inventory consists of purchased finished products held for resale
stated at the lower of cost or market. The last-in, first-out (LIFO)
method is used to determine cost for $1,034,000 of inventory; the
balance is at first-in, first-out.
Advertising costs:
The Companies incur catalog costs in connection with the marketing of
their direct response products. Such expense is amortized in generally
less than one year using the ratio of current period revenues to the
total of current and estimated future period revenues for each catalog.
Leasehold improvements, furniture and equipment and depreciation:
These assets are stated at cost. Depreciation is being provided by
accelerated methods over the estimated useful lives of the assets.
Income taxes:
The Companies elected to be treated as S Corporations for federal and
state income tax reporting, whereby any income or loss will be included
in the individual shareholder's income tax return.
F-51
<PAGE> 79
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1998
2. Cash:
At December 31, 1998 cash on deposit at a national bank exceeds the
FDIC insured limit by $44,000.
3. Inventories:
At December 31, 1998, inventory was valued at $1,034,000, using the
LIFO method (Note 1), which was less than the corresponding current
replacement value of approximately $1,642,000.
4. Due from commonly controlled company:
This non-interest bearing amount consists of reimbursement of expenses
incurred by the Companies on behalf of a commonly controlled company.
Such expense reimbursement aggregated $50,000 in 1998. Reimbursement
amount due at December 31, 1998 was $50,000.
5. Line of credit:
The Companies have a line of credit which permits borrowings up to
$500,000 and bears interest at the Bank's prime rate of interest (7.75%
at December 31, 1998). Collateral for the line consist of accounts
receivable, inventory and general intangibles. As of December 31, 1998,
the balance is zero.
6. Building lease:
The shareholders lease a building to the Companies. A mortgage on the
building, aggregating $1,559,000 at December 31, 1998, is guaranteed by
Humboldt Industries, Inc. ("Humboldt"). Humboldt does not require
collateral for this contingent liability.
Taxes, insurance and maintenance expenses related to the facility are
paid by Humboldt. Such expenses totalled $60,000 in 1998. Rent expense
on the facility aggregated $240,000 in 1998. Future minimum lease
payments are $240,000 per year through June 2001.
F-52
<PAGE> 80
HUMBOLDT INDUSTRIES, INC.
AND MAPLEWOOD INDUSTRIES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1998
7. Equipment commitments and rent expense:
Humboldt executed two operating leases for a telecommunication system
and a data processing system, which require monthly payments of
approximately $3,300 through December 2004 and $5,000 through June
2003, respectively. Rent expense approximated $91,000 in 1998.
8. Subsequent events:
On August 1, 1999, 100% of the outstanding stock of the Companies was
acquired by Pet Quarters, Inc. (the "Parent"). The combined financial
statements of the Companies for the seven months ended July 31, 1999
and the auditors' report thereon dual dated October 15, 1999 and
December 10, 1999 disclosed an uncertainty about their ability to
continue as going concerns. The uncertainty arose as a result of the
Parent having a significant working capital deficiency, because it has
incurred operating losses since its formation and because it, on
October 22, 1999, defaulted on a $4,600,000 bridge loan, which was
extended on November 19, 1999.
The common stock of the Companies is pledged as collateral for the
bridge loan. The extension had key changes and added penalties of
$230,000 to the bridge loan. A principal payment in the amount of
$1,000,000 is due on February 10, 2000 with the remainder due on May
10, 2000.
F-53
<PAGE> 81
HUMBOLDT INDUSTRIES, INC.
YEAR ENDED
DECEMBER 31, 1997
F-54
<PAGE> 82
Independent Auditors' Report
Board of Directors
Humboldt Industries, Inc.
Hazleton, Pennsylvania
We have audited the accompanying balance sheet of Humboldt Industries, Inc. as
of December 31, 1997 and the related statements of operations and deficit and of
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Humboldt Industries, Inc. as of
December 31, 1997, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
Kingston, Pennsylvania
February 18, 1998
KRONICK KALADA BERDY & CO., P.C.
1
F-55
<PAGE> 83
HUMBOLDT INDUSTRIES, INC.
BALANCE SHEET - DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash $ 92,788
Accounts receivable 141,961
Inventory 1,285,000
Due from commonly controlled
companies 108,892
---------------
Total current assets 1,628,641
---------------
Leasehold improvements, furniture and
equipment:
Leasehold improvements 33,139
Furniture and equipment 982,988
---------------
1,016,127
Less accumulated depreciation 797,859
---------------
218,268
---------------
Deferred catalog costs, net 318,000
Other assets 3,059
---------------
$ 2,167,968
===============
</TABLE>
See notes to financial statements
F-56
<PAGE> 84
<TABLE>
<S> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of notes
payable, bank $ 32,738
Accounts payable 1,544,188
Accrued payroll and related expenses 53,797
---------------
Total current liabilities 1,630,723
Notes payable, bank, net of current
portion 49,841
Loan payable shareholders, unsecured,
non-interest bearing, due after
1998 466,267
---------------
Total liabilities 2,146,831
---------------
Shareholders' equity:
Common stock, $1 par; authorized
100,000 shares; issued and out-
standing 1,000 shares 1,000
Additional paid in capital 593,521
Deficit (573,384)
---------------
21,137
---------------
$ 2,167,968
===============
</TABLE>
F-57
<PAGE> 85
HUMBOLDT INDUSTRIES, INC.
STATEMENT OF OPERATIONS AND DEFICIT
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Sales $ 12,237,912
Cost of sales 8,843,253
--------------
Gross profit 3,394,659
--------------
Selling, general and administrative
expenses:
Catalog costs 1,347,872
Other 1,987,431
--------------
3,335,303
--------------
Income from operations 59,356
--------------
Other income (expense):
Interest expense, net of interest
income ($7,000, 1997) (426)
Other income 19,205
--------------
18,779
Net income 78,135
Deficit, beginning (543,552)
Shareholders' distribution (107,967)
--------------
Deficit, ending $ (573,384)
==============
</TABLE>
See notes to financial statements
3
F-58
<PAGE> 86
HUMBOLDT INDUSTRIES, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Cash flows from operating activities:
Net income $ 78,135
Adjustments:
Depreciation 87,789
Changes in assets and liabilities:
Accounts receivable (59,792)
Inventory (282,000)
Deferred catalog costs 211,500
Accounts payable 151,391
Accrued payroll and related
expenses 9,263
------------
Net cash provided by operating
activities 196,286
------------
Cash flows from investing activities:
Capital expenditures (32,873)
Due from commonly controlled companies (44,059)
------------
Net cash used in investing
activities (76,932)
------------
Cash flows from financing activities:
Proceeds from long-term debt 25,739
Repayments of long-term debt (42,161)
Distribution to shareholders (107,967)
------------
Net cash used in financing
activities (124,389)
------------
Net decrease in cash (5,035)
Cash, beginning 97,823
------------
Cash, ending $ 92,788
============
Supplemental disclosure:
Cash paid during the year for interest
expense $ 7,426
============
</TABLE>
See notes to financial statements
4
F-59
<PAGE> 87
HUMBOLDT INDUSTRIES, INC.
NOTES TO FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997
1. Summary of significant accounting policies:
Description of business:
The Company, a Pennsylvania corporation, is engaged in the mail order
sale of training and grooming aids, health supplies and vaccines for
dogs, cats and other pets. The customer base is primarily located
throughout the continental United States.
Use of estimates:
Management uses estimates and assumptions in preparing financial
statements. Those estimates and assumptions affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and
liabilities and the reported revenues and expenses.
Revenue recognition:
Revenue is recognized at the time of shipment of merchandise. When
returned goods are received, sales are reduced and the related
merchandise is restocked to inventory.
Inventory:
Inventory consists of purchased finished products held for resale
stated at the lower of cost or market. The last-in, first-out (LIFO)
method is used to determine cost.
Advertising costs:
The Company incurs catalog costs in connection with the marketing of
its direct response products. Such expense is amortized in generally
less than one year using the ratio of current period revenues to the
total of current and estimated future period revenues for each catalog.
Leasehold improvements, furniture and equipment and depreciation:
These assets are stated at cost. Depreciation is being provided by
accelerated methods over the estimated useful lives of the assets.
Income taxes:
The Company elected to be treated as an S Corporation for federal and
state income tax reporting, whereby any income or loss will be included
in the individual shareholder's income tax return.
5
F-60
<PAGE> 88
HUMBOLDT INDUSTRIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997
2. Cash:
At December 31, 1997 cash on deposit at a national bank exceeds the
FDIC insured limit by $154,000.
3. Inventories:
At December 31, 1997, inventory was valued at $1,285,000, using the
LIFO method (Note 1), which was less than the corresponding current
replacement value of approximately $1,966,000.
4. Due from commonly controlled companies:
These non-interest bearing amounts consist of working capital advances
and reimbursement of expenses incurred by the Company on behalf of the
commonly controlled companies. Such expense reimbursement aggregated
$110,000 in 1997. Reimbursement amount due at December 31, 1997 was
$25,000.
5. Line of credit:
The Company has a line of credit which permits borrowings up to
$500,000 and bears interest at the Bank's prime rate of interest (8.5%
at December 31, 1997). Collateral for the line consist of accounts
receivable, inventory and general intangibles. As of December 31, 1997,
the balance was zero.
6. Building lease:
The shareholders lease a building to the Company. A mortgage on the
building, aggregating $1,622,000 at December 31, 1997, is guaranteed by
the Company. The Company does not require collateral for this
contingent liability.
Taxes, insurance and maintenance expenses related to the facility are
paid by the Company. Such expenses totalled $52,000 in 1997. Rent
expense on the facility aggregated $240,000 in 1997. Future minimum
lease payments are $240,000 per year through June 2001.
7. Equipment commitments and rent expense:
The Company executed two operating leases for a telecommunication
system and a data processing system, which require monthly payments of
approximately $3,300 through December 2004 and $5,000 through June
2003, respectively. Rent expense approximated $18,000 in 1997.
6
F-61
<PAGE> 89
PART III
ITEM 1. INDEX TO EXHIBITS AND DESCRIPTION OF EXHIBITS.
Exhibits.
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C> <C>
2.1 - Agreement of Purchase and Sale of Stock, dated as of
August 5, 1999, by and among Pet Quarters, Inc., Humboldt
Industries, Inc., and the other parties named therein.*
2.2 - Agreement of Purchase and Sale of Stock, dated as of July 2,
1999, by and among Pet Quarters, Inc., Chartendure Limited,
and the other parties named therein.*
3.1 - Articles of Incorporation, as amended, of Pet Quarters, Inc.*
3.2 - Bylaws of Pet Quarters, Inc.*
10.1 - Collateral Pledge Agreement, dated as of August 1, 1999, by
and between Pet Quarters, Inc., The Sun Valley Trust of
July 30, 1999, and the other parties named therein.*
10.2 - Modification of Note and Pledge Agreement, dated as of
November 10, 1999, by and among Pet Quarters, Inc., The Sun
Valley Trust of July 30, 1999, and the other parties named
therein.*
16.1 - Letter from Crouch, Bierwolf & Chisholm.
21.1 - List of Subsidiaries.*
27.1 - Financial Data Schedule, September 30, 1999.*
27.2 - Financial Data Schedule, June 30, 1999.*
</TABLE>
* Previously filed on Form 10-SB
<PAGE> 90
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
PET QUARTERS, INC.
Date: February 25, 1999 By: /s/ Steve Dempsey
--------------------------------------
(Signature)
Steve Dempsey
--------------------------------------
(Name)
President
--------------------------------------
(Title)
<PAGE> 91
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<S> <C> <C>
2.1 - Agreement of Purchase and Sale of Stock, dated as of
August 5, 1999, by and among Pet Quarters, Inc.,
Humboldt Industries, Inc., and the other parties
named therein.*
2.2 - Agreement of Purchase and Sale of Stock, dated as of
July 2, 1999, by and among Pet Quarters, Inc.,
Chartendure Limited, and the other parties named
therein.*
3.1 - Articles of Incorporation, as amended, of Pet Quarters, Inc.*
3.2 - Bylaws of Pet Quarters, Inc.*
10.1 - Collateral Pledge Agreement, dated as of August 1,
1999, by and between Pet Quarters, Inc., The Sun
Valley Trust of July 30, 1999, and the other
parties named therein.*
10.2 - Modification of Note and Pledge Agreement, dated as of
November 10, 1999, by and among Pet Quarters, Inc., The Sun
Valley Trust of July 30, 1999, and the other parties named
therein.*
16.1 - Letter from Crouch, Bierwolf & Chisholm.
21.1 - List of Subsidiaries.*
27.1 - Financial Data Schedule, September 30, 1999*
27.2 - Financial Data Schedule, June 30, 1999*
</TABLE>
* Previously filed on Form 10-SB
<PAGE> 1
EXHIBIT 16.1
[CROUCH, BIERWOLF & CHISHOLM LETTERHEAD]
December 21, 1999
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: Pet Quarters, Inc.
Ladies and Gentlemen:
We were previously the independent accountants for the Company. We
reported on the financial statements of the Company for the calendar year ended
December 31, 1998.
We have read the Company's statements included under Item 3 of its
Current Report on Form 10-SB dated December 10, 1999, and have no disagreements
with the disclosure made therein.
Very truly yours,
/s/ Crouch, Bierwolf & Chisholm
Crouch, Bierwolf & Chisholm
