EXHIBIT 1.3
Kenlin Pet Supply, Inc.
Financial Statements
July 31, 1995
CONTENTS
Report of Independent Auditors............................. 1
Balance Sheets............................................. 2
Statements of Operations and Retained Earnings (Deficit)... 3
Statements of Cash Flows................................... 4
Notes to Financial Statements.............................. 5
Report of Independent Auditors
Board of Directors
Kenlin Pet Supply, Inc.
We have audited the accompanying balance sheets of Kenlin Pet Supply, Inc. as of
July 31, 1995 and 1994 and the related statements of operations and retained
earnings (deficit) and cash flows for each of the two years in the period ended
July 31, 1995 and the period August 21, 1992 (commencement date of operations)
through July 31, 1993. 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 audits.
We conducted our audits 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 audits provide 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 Kenlin Pet Supply, Inc. at July
31, 1995 and 1994 and the results of its operations and its cash flows for each
of the two years in the period ended July 31, 1995 and the period August 21,
1992 (commencement date of operations) through July 31, 1993 in conformity with
generally accepted accounting principles.
Ernst & Young LLP
Hackensack, New Jersey
September 22, 1995
1
Kenlin Pet Supply, Inc.
Balance Sheets
JULY 31 MARCH 30
1994 1995 1996
----------- ----------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 539,718 $ 41,681 $ 98,539
Accounts receivable, less allowances
of $133,044 in 1994 and $212,728 in 1995 3,247,337 3,952,587 5,069,213
Merchandise inventories 7,701,598 8,190,580 9,987,463
Miscellaneous receivables and other
current assets 501,649 529,718 544,185
Prepaid income taxes 92,300
Deferred taxes (Note 4) 163,100 203,900 203,900
----------- ----------- -----------
Total current assets 12,153,402 13,010,766 15,903,300
Other assets 66,508 80,131 83,630
Equipment, furniture, fixtures and
leasehold improvements, net of
accumulated depreciation of
$454,926 in 1994 and $764,454 in 1995 926,607 1,172,592 1,595,647
Intangibles and deferred financing
costs, net 1,206,044 775,847 1,032,789
Organization and start-up costs, net 430,793 289,905 242,286
Goodwill, net 2,860,195 2,785,041 2,967,003
----------- ----------- -----------
$17,643,549 $18,114,282 $21,824,655
=========== =========== ===========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable and
long-term debt (Note 2) $ 1,721,812 $ 462,638
Accounts payable 1,175,488 2,053,728 $ 2,402,652
Accrued expenses and other current
liabilities 759,188 960,574 1,129,376
Income taxes payable 472,027 61,547 230,509
----------- ----------- -----------
Total current liabilities 4,128,515 3,538,487 3,762,537
Other liabilities:
Deferred taxes (Note 4) 24,600 400 400
Notes payable and long-term debt
(Note 2) 9,205,430 8,950,265 11,080,507
Redeemable preferred stock (Note 3):
Cumulative, redeemable preferred stock,
par value $1.00 per share, authorized
10,000 shares, issued and outstanding
2,867 shares for 1994 and
3,107 shares for 1995 2,866,849 3,106,849 3,227,505
Common stockholders' equity (Notes 3 and 5):
Class A voting common stock,
par value $.01 per share,
authorized 11,000 shares,
issued and outstanding 2,822 shares 28 28 28
Class B non-voting common stock,
par value $.01 per share,
authorized 11,000 shares,
issued and outstanding 4,000 shares 40 40 40
Class C voting common stock,
par value $.01 per share,
authorized 11,000 shares,
issued and outstanding 2,378 shares 24 24 24
Additional paid-in capital 873,059 873,059 873,059
Retained earnings 545,004 1,645,130 2,880,555
----------- ----------- -----------
Total common stockholders' equity 1,418,155 2,518,281 3,753,706
----------- ----------- -----------
$17,643,549 $18,114,282 $21,824,655
=========== =========== ===========
See accompanying notes.
2
Kenlin Pet Supply, Inc.
Statements of Operations and Retained Earnings (Deficit)
PERIOD EIGHT MONTHS ENDED
ENDED YEAR ENDED JULY 31 MARCH 30
JULY 31 -------------------------- ---------------------------
1993 1994 1995 1995 1996
------------ ------------ ---------- ---------- ----------
(Unaudited)
Net sales $44,716,387 $53,253,525 $62,979,341 $42,888,323 $48,748,181
Cost of goods sold 33,394,092 38,603,547 45,783,989 31,250,001 35,338,857
------------ ------------ ---------- ---------- ----------
Gross profit 11,322,295 14,649,978 17,195,352 11,638,322 13,409,324
Selling, general and
administrative expenses 9,163,816 11,214,833 13,133,341 8,845,294 9,973,112
------------ ------------ ---------- ---------- ----------
Income from operations 2,158,479 3,435,145 4,062,011 2,793,028 3,436,212
Amortization expense 965,474 907,902 646,239 441,759 396,640
Interest expense 1,225,230 1,130,709 1,134,921 771,561 726,486
Other income-net 41,095 31,026 19,275 (7,271) (15,643)
Income before income taxes 8,870 1,427,560 2,300,126 1,572,437 2,297,443
Provision for income taxes
(Note 4) 28,200 623,226 960,000 649,016 941,362
------------ ------------ ---------- ---------- ----------
Net income (loss) (19,330) 804,334 1,340,126 923,421 1,356,081
Dividends on redeemable
preferred stock (240,000) (240,000) 120,985 120,656
Retained earnings (deficit)
at beginning of year - (19,330) 545,004 545,004 1,645,130
------------ ------------ ---------- ---------- ----------
Retained earnings (deficit)
at end of year $ (19,330) $ 545,004 $1,645,130 $1,347,440 $2,880,555
============ ============ ========== ========== ==========
See accompanying notes.
3
Kenlin Pet Supply, Inc.
Statements of Cash Flows
PERIOD EIGHT MONTHS ENDED
ENDED YEAR ENDED JULY 31 MARCH 30
JULY 31 ------------------------------ ---------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
(Unaudited)
OPERATING ACTIVITIES
Net income $ (19,330) $ 804,334 $ 1,340,126 $ 923,421 $ 1,356,081
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation and amortization 1,166,384 1,177,364 999,933 683,092 725,675
Loss on disposal of assets 9,575 17,134
Provision for doubtful accounts 143,582 167,820 182,084 30,517 99,971
Deferred tax benefit (121,500) (17,000) (65,000)
Changes in operating assets
and liabilities:
Accounts receivable (279,076) (174,498) (887,334) (1,053,016) (1,125,784)
Inventories 2,100,224 63,557 (488,982) (646,513) (1,179,433)
Miscellaneous receivables and
other current assets 29,322 (117,126) (120,369) 135,180 77,833
Other assets (59,358) (7,150) (13,623) (3,499)
Accounts payable (378,538) 213,565 878,240 828,576 220,507
Organization and start-up costs (38,020)
Accrued expenses and other current
liabilities 260,650 354,909 (209,094) (17,257) 296,337
----------- ----------- ----------- ----------- -----------
Net cash provided by operating activities 2,813,915 2,482,909 1,615,981 884,000 467,688
INVESTING ACTIVITIES
Cash paid for acquired business (877,012)
Purchase of equipment, furniture,
fixtures and leasehold improvements (282,020) (365,767) (599,679) (460,633) (563,740)
----------- ----------- ----------- ----------- -----------
Net cash used in investing activities (282,020) (365,767) (599,679) (460,633) (1,440,752)
FINANCING ACTIVITIES
Proceeds from (principal payments
on) notes payable and long-term debt (225,000) (1,590,550) (1,687,289) (1,480,777) 1,492,560
Net proceeds (repayments) on revolving
credit note payable (1,950,000) (646,950) 172,950 570,157 (462,638)
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by
financing activities (2,175,000) (2,237,500) (1,514,339) (910,620) 1,029,922
----------- ----------- ----------- ----------- -----------
Net (decrease) increase in cash
and cash equivalents 356,895 (120,358) (498,037) (487,253) 56,858
Cash and cash equivalents at beginning
of year 303,181 660,076 539,718 539,718 41,681
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of year $ 660,076 $ 539,718 $ 41,681 $ 52,465 $ 98,539
============ =========== =========== =========== ===========
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash paid during the year for:
Interest $ 1,194,831 $ 1,130,710 $ 1,134,921 $ 771,561 $ 726,486
Federal and state income taxes 197,500 118,756 1,527,780 1,035,692 843,753
Non-cash investing and financing
activities:
Issuance of note payable for
acquired business 650,000
Liabilities assumed from acquired
business 128,417
See accompanying notes.
4
Kenlin Pet Supply, Inc.
Notes to Financial Statements
July 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
On August 21, 1992 (commencement of operations), Kenlin Acquisition Corporation
("Kenlin") purchased certain assets and assumed certain liabilities of Kenlin
Pet Supply, Inc. (the "Seller"). Prior to this transaction, Kenlin was
inactive. Also on this date, Kenlin changed its name to Kenlin Pet Supply, Inc.
(the "Company"). The transaction was accounted for as a purchase.
CONCENTRATION OF CREDIT RISK
The Company is engaged in the distribution of a broad line of pet supply
products, principally to retail outlets, in the Northeastern and Midatlantic
United States. No individual customer represents a significant percentage of
sales. The Company performs periodic credit evaluations of its customers and
requires certain customers to personally guarantee amounts due.
CASH EQUIVALENTS
Cash equivalents consist of highly-liquid investments with a maturity of three
months or less when purchased.
MERCHANDISE INVENTORIES
Inventories are stated at the lower of cost (average cost) or market.
INCOME TAXES
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
EQUIPMENT, FURNITURE, FIXTURES AND LEASEHOLD IMPROVEMENTS
Equipment, furniture, fixtures and leasehold improvements are stated at cost.
Depreciation is provided on the straight-line basis over estimated useful lives
of the related assets or the remaining term of the lease, which range from 3 to
10 years.
5
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLES AND DEFERRED FINANCING COSTS
Intangible assets include values assigned to a non-compete agreement
($1,500,000) and consulting services agreement ($750,000) with the controlling
shareholder of the Seller. The non-compete agreement is being amortized over a
period of five years and the consulting services agreement was amortized over a
2 year period. Accumulated amortization of the non-compete and consulting
services agreements at July 31, 1995 and 1994 was $1,632,740 and $1,315,480,
respectively. Goodwill, all of which resulted from the purchase transaction
described above is being amortized over 40 years. Accumulated amortization of
goodwill at July 31, 1995 and 1994 was $221,126 and $145,972, respectively.
Costs incurred in connection with long-term debt have been deferred and are
being amortized over the lives of the related debt issues using the interest
method. Accumulated amortization of deferred financing costs at July 31, 1995
and 1994 was $251,213 and $138,276, respectively.
ORGANIZATION AND START-UP COSTS
Costs associated with the organization of the corporation and other costs
incurred to complete the acquisition and start the business operations described
above are being amortized over 60 months. Accumulated amortization of these
costs at July 31, 1995 and 1994 was $414,536 and $273,648, respectively.
INTERIM FINANCIAL STATEMENTS
The accompanying unaudited interim financial statements as of March 30, 1996 and
for each of the eight month periods ended March 30, 1996 and 1995 include all
adjustments which, in the opinion of management, are necessary for a fair
presentation of the Company's financial position and results of operations and
cash flows for the periods presented. All adjustments are of a normal recurring
nature. The results of the Company's operations for the eight months ended
March 30, 1996 are not necessarily indicative of the results of operations for a
full fiscal year.
6
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
2. NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consists of the following:
JULY 31
1994 1995
----------- ----------
Revolving credit note payable $ 1,827,050 $2,000,000
Term note payable to bank, payable in
quarterly installments in increasing
amounts, including interest which has
accrued from the last monthly payment
of interest, through August 1998
(Tranche A Note) 2,184,450 462,638
Term note payable to bank, payable in
quarterly installments of $250,000
commencing November 30, 1997 through
August 31, 1998 and $375,000 through
August 31, 1999, including interest
which has accrued from the last
monthly payment of interest, through
August 1999 (Tranche B Note) 2,500,000 2,500,000
Subordinated note payable to Seller,
payable on August 31, 2002, with
interest payable in quarterly
installments commencing November 30,
1992 at 10%, through August 2002 4,415,742 4,415,742
Capital lease obligation 34,523
----------- ----------
10,927,242 9,412,903
Less current portion 1,721,812 462,638
----------- ----------
Total long-term debt $ 9,205,430 $8,950,265
=========== ==========
The revolving credit note payable represents the amount outstanding under a $6
million revolving credit note with a bank due the earlier of August 21, 1999 or
the date on which the two term loans are paid in full. Any unused portion of
the revolving credit facility is subject to a .5% commitment fee. Borrowings
under the revolving credit note are based on a specific borrowing formula based
on eligible assets. The outstanding balance under the revolving credit note has
been excluded from current liabilities because the Company intends that at least
that amount would remain outstanding under this agreement for an uninterrupted
period extending beyond one year from the balance sheet date. The revolving
credit note payable and two term loans ("senior loans") bear interest, payable
monthly, based upon a rate option selected by the Company and adjusted based
upon the
7
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
2. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
terms of each note. The rates in effect at July 31, 1995 are 10.38%, 10.63%,
and 13.13%, respectively (8.78%, 9.04% and 11.54%, respectively, at July 31,
1994). The senior loans are collateralized by substantially all assets of the
Company. Among other things, the senior loans restrict the Company's ability to
incur additional indebtedness and require the Company to maintain certain
financial ratios. In addition, the repayment terms of the senior loans call for
accelerated payments based upon "excess cash flow" (as defined). At July 31,
1995, $217,970 has been classified as a current liability based on 1995 excess
cash flows.
In accordance with the terms of the senior loans, the Company had an interest
rate cap agreement for a notional principal amount of $5 million, which provided
for a maximum increase of 2.72% over the rate in effect at the date of the
agreement for a period of thirty months. This agreement expired in April 1995
The subordinated note payable is subject to a mandatory prepayment schedule at
such time that all senior loans have been paid in full ("senior loan payment
date"). The prepayment schedule provides that 20% of the principal be paid on
the first through fifth anniversary date of such payment date.
As of July 31, 1995, maturities of bank loans and notes payable over the next
five fiscal years are as follows:
1996 $ 462,638
1997 --
1998 750,000
1999 1,375,000
2000 2,375,000
Thereafter 4,450,265
3. CUMULATIVE REDEEMABLE PREFERRED STOCK
The cumulative, redeemable preferred stock is non-voting and has a minimum
liquidating preference of $1,000 per share and is subject to redemption by the
Company on the earlier of August 21, 1999 or the date of a redemption event, as
defined in the Certificate of Incorporation. Dividends are fixed at $240,000
per year and are on a paid-in-kind basis.
8
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
4. INCOME TAXES
The provision for income taxes is comprised of the following:
PERIOD
ENDED
JULY 31 YEAR ENDED JULY 31
1993 1994 1995
--------- ------------------------------
Current:
Federal $ 112,800 $480,000 $ 787,000
State 36,900 160,226 238,000
--------- -------- -----------
149,700 640,226 1,025,000
Deferred:
Federal (94,300) (13,000) (52,000)
State (27,200) (4,000) (13,000)
--------- -------- ----------
(121,500) (17,000) (65,000)
--------- -------- ----------
$ 28,200 $623,226 $ 960,000
========= ======== ==========
The Company's income tax provisions differ from the statutory rate principally
due to state income taxes and the nondeductibility of goodwill amortization for
tax purposes.
The components of the Company's current and long-term deferred tax accounts
consisted of the following:
CURRENT LONG-TERM TOTAL
------- ---------- --------
JULY 31, 1994
Deferred tax assets:
Bonus accrual $ 19,100 $ 19,100
Accounts receivable allowance 58,000 58,000
Capitalized inventory costs 112,000 112,000
-------- --------
Total deferred tax assets 189,100 189,100
Deferred tax liabilities:
Tax over book depreciation $ 24,600 24,600
Prepaid expenses 15,400 15,400
State taxes 10,600 10,600
-------- -------- --------
Total deferred tax liabilities 26,000 24,600 50,600
-------- -------- --------
Net deferred tax assets $163,100 $(24,600) $138,500
======== ======== ========
9
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
4. INCOME TAXES (CONTINUED)
CURRENT LONG-TERM TOTAL
------- --------- --------
JULY 31, 1995
Deferred tax assets:
Book over tax amortization $33,700 $ 33,700
Bonus accrual $ 27,100 27,100
Accounts receivable allowance 94,200 94,200
Capitalized inventory costs 124,800 124,800
-------- ------- --------
Total deferred tax assets 246,100 33,700 279,800
Deferred tax liabilities:
Tax over book depreciation 34,100 34,100
Prepaid expenses 27,200 27,200
State taxes 15,000 15,000
-------- ------- --------
Total deferred tax liabilities 42,200 34,100 76,300
-------- ------- --------
Net deferred tax assets (liabilities) $203,900 $ (400) $203,500
======== ======= ========
No valuation allowance on deferred tax assets was considered necessary at either
July 31, 1995 or 1994.
5. COMMON STOCKHOLDERS' EQUITY
The Class A and Class C common stock are convertible into an equal number of
shares of Class B common stock, and Class B common stock is convertible into an
equal number of shares of Class A common stock. All shares of Class C common
stock are subject to automatic conversion into an equal number of Class A common
stock upon closing of the first underwritten public offering pursuant to an
effective registration statement under the Securities Act of 1933 in an amount
not less than $20 million in gross proceeds.
In consideration for making the Tranche B Note, the Company has issued to the
bank Warrants to purchase up to 800 additional shares (plus additional "anti-
dilution" shares) of the Company's Class A common stock. The Warrants are
exercisable at $.01 per share, subject to adjustment under the terms of the
Warrant. The Warrants are subject to mandatory redemption at the option of the
holder at the earliest of August 21, 1997 or the occurrence of certain events
which effectively repay the senior loans and revolving loan. Redemption at the
option of the Company can also occur during certain periods as specified in the
Warrant. The mandatory and optional redemptions will be at per share values
defined in the Warrant and are based upon fair market value. The Warrant
expires on August 21, 2002.
10
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
5. COMMON STOCKHOLDERS' EQUITY (CONTINUED)
The Company has entered into option agreements with two key employee
stockholders which entitle them each to purchase Class A common stock in an
amount up to 2% (plus additional "anti-dilution" shares) of total common stock
on a fully diluted basis. These options become exercisable based upon a
financial calculation at a price equal to $.10 per share. The options terminate
at the earlier of August 21, 2012 or a terminating event, as defined.
At July 31, 1995, 7,779 shares of unissued Class A common stock of the Company
were reserved for issuance in accordance with the terms of the convertible
securities, the stock option agreements, and the Warrants and 7,000 shares of
the Class B common stock were reserved for issuance under the terms of the
convertible securities.
The Class B and Class C common stock are subject to put by the stockholder on or
after August 22, 1997 and call by the Company on or after August 22, 1998, each
at a price per share equal to the greater of the fair market value at the date
of put or call or an amount calculated based upon certain financial information
as defined in the Securities Purchase Agreement. The Agreement terminates on
the date there are no longer any preferred or common shares outstanding.
Under certain circumstances, Class C common stock has special voting rights as
compared to Class A common stock. In addition, the Company is party to a
Registration Rights Agreement which provides certain shares with rights to
request registration of their shares under the Securities Act of 1933 at any
time after August 21, 1997.
6. STOCK COMPENSATION PLAN
In August 1992, the Company established a Stock Compensation Plan under which
shares of common stock may be issued and options may be granted at the
discretion of the Board of Directors to employees, directors, officers,
consultants and advisors. In November 1993 an option to purchase up to 101
shares of the Company's Class A common stock for $.10 per share was granted to
an employee. The option vests in November 1995. The compensation element
related to this grant was not material.
11
Kenlin Pet Supply, Inc.
Notes to Financial Statements (continued)
7. EMPLOYEE BENEFIT PLAN
During 1993, the Company established an employee profit sharing plan covering
substantially all employees. The Company at its discretion contributes to the
plan an amount determined by the Board of Directors. The Company has accrued
$62,500, $52,500 and $50,500 for the years ended July 31, 1995 and 1994 and the
period ended July 31, 1993, respectively.
8. COMMITMENTS
The Company leases its principal warehouse and administrative facility under a
five year non-cancellable operating lease with a 5 year renewal option. Rental
expense under this operating lease was approximately $795,000, $714,000 and
$714,000 for the years ended July 31, 1995 and 1994 and the period ended July
31, 1993, respectively.
Approximate minimum future lease payments for noncancellable operating leases
with terms in excess of one year for each fiscal year are as follows:
1996 $924,000
1997 972,000
1998 51,000
The Company has entered into 5 year employment agreements with two key employee
stockholders. Each agreement provides for an annual base salary plus an annual
incentive bonus. The agreements expire on July 31, 1997.
9. EVENTS SUBSEQUENT TO AUDITED FINANCIAL STATEMENTS
On November 9, 1995, the Company acquired certain assets and assumed certain
liabilities of Specter Wholesale Supply, Inc., a company engaged in the
distribution of pet supplies. The aggregate purchase price was approximately
$1,200,000. The transaction was accounted for under the purchase method of
accounting. In addition, the Company entered into a ten year non-competition
agreement with the former owners for $500,000.
On June 18, 1996 the shareholders of the Company entered into an agreement with
Central Garden and Pet Company to sell all of the outstanding common stock of
the Company to Central Garden and Pet Company.
12