##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-KSB
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
 o
    
    TRANSITION REPORT UNDER SECTION 13
OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
 COMMISSION FILE NUMBER: 333-110630
 HARTVILLE GROUP, INC.
 (Name of Small Business Issuer in its Charter)
 
 NEVADA
    
    94-3360099(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)3840 GREENTREE AVENUE SWCANTON OHIO
    
    44706(Address of principal executive offices)
    
    (Zip Code)
 Issuers Telephone Number: (330) 484-8080
 Securities registered under Section 12(b) of the Exchange Act:
 (Title of each class)
    
    (Name of each exchange on which registered)NONE
    
    N/A
 Securities registered under Section 12(g) of the Exchange Act:
 COMMON STOCK, PAR VALUE $.001
(Title of each class)
 
 o þ
 þ o
 o
 o þ
     o þ




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##### 



PART IItem 1. Description of Business
    
    
    3Item 2. Description of Property
    
    
    9Item 3. Legal Proceedings
    
    
    9Item 4. Submission of Matters to a Vote of Security Holders
    
    
    9Part IIItem 5. Market for Common Equity and Related Stockholder Matters
    
    
    9Item 6. Managements Discussion and Analysis or Plan of Operation
    
    
    11Item 7. Financial Statements
    
    
    18Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    18Item 8A. Controls and Procedures
    
    
    19Item 8B. Other Information
    
    
    19PART IIIItem 9. Directors and Executive Officers of the Registrant
    
    
    20Item 10. Executive Compensation
    
    
    20Item 11. Security Ownership of Certain Beneficial Owners and Management
    
    
    20Item 12. Certain Relationships and Related Transactions
    
    
    20Item 13. Exhibits
    
    
    20SIGNATURES
    
    
    22CERTIFICATIONSEXHIBIT INDEX
 2




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##### 




    
    Changes in existing product liability, tort or warranty laws or the
introduction of new laws, regulations or policies that could affect
our business practices: these laws, regulations or policies could
impact our industry as a whole, or could impact only those portions
in which we are currently active.
    
    Changes in economic conditions, including changes in interest
rates, financial market performance and our industry: these types
of changes can impact the economy in general, resulting in a
downward trend that impacts not only our business, but all
companies with which we compete; or, the changes can impact only
those parts of the economy upon which we rely in a unique fashion,
including insurance related businesses.
    
    Changes in government regulations: changes in regulations could
have a negative impact on our earnings; for example, laws relating
to insurance regulation that could increase our costs of
operations.
    
    Changes in relationships with major customers and/or suppliers: an
adverse change in our relationships with major customers and/or
suppliers would have a negative impact on our earnings and
financial position.
    
    Armed conflicts and other military actions: the considerable
political and economic uncertainties resulting from these events,
could adversely affect our order intake and sales, particularly in
the insurance market.
    
    Factors that we have discussed in previous public reports and other
documents filed with the Securities and Exchange Commission.
  
 Item 1. Description of Business
  www.hartvillegroup.com
 3




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##### 



Basic Terminology & Definitions
    Hartville Group, Inc.  Flow Chart of Hypothetical Example Using Current Agreements
 
 4




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##### 



Principal Product
   Basic/Essential
    
    $
    1,500/$8,000Value/Classic
    
    $
    3,500/$11,000Choice/Champion
    
    $
    5,000/$13,000Best/Elite
    
    $
    2,500/$13,000
 Distribution Methods
  The Competition
  Royalty Agreements and Trademarks
  Government Regulation and Licenses
   5




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##### 



Employees
  RISK FACTORS
 Our independent registered public accounting firm included a going
concern modification in their opinion on our financial statements.
  We need to refinance our Convertible Debentures which mature on November 11 and 26, 2006 (November
2006)
  We will require continued financing to meet our working capital needs
  Many other pet insurance companies have gone out of business and without development and growth we
may not be able to continue as a viable entity.
  We are dependent on property casualty insurance companies without which we may not be able to
operate our business.
  We have experienced net losses in the past, and we may be unable to achieve or maintain
profitability in the future.
  We are dependent on the proper functioning of our information systems.
  6




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##### 



Our dependence on short term policies makes us vulnerable to loss of customers.
  Any failure by us to comply with applicable regulations may result in fines or injunctions against
the operation of our business and harm our financial results.
  Certain of our stockholders have registration rights that can cause us to file a registration
statement under the Securities Act covering resales of their stock, which sales could cause our
stock price to decline.
  Dilution of our stock is possible because of the number and price of warrants and convertible debt
outstanding.
  Volatility in our common share price may subject us to securities litigation, thereby diverting our
resources, which may have a material adverse affect on our results of operations.
  Securities and Exchange Commission rules concerning sales of low-priced securities may hinder the
purchase or sale of our common stock by investors.
  7




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##### 



Our securities have been thinly traded on the over-the-counter bulletin board, which may not
provide liquidity for our investors.
   Investors must contact a broker-dealer to trade Over-the-Counter Bulletin Board securities. As a
result, you may not be able to buy or sell our securities at the times that you may wish.
  We do not intend to pay dividends in the foreseeable future; therefore, you may never see a return
on your investment.
  Our stock price is volatile and you may not be able to sell your shares for more than what you
paid.
  If converted and exercised, holders of our convertible debentures and warrants could have
substantial control over us and this could negatively affect your investment.
  8




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##### 



Item 2. Description of Property
  
 Item 3. Legal Proceedings
    
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Part II
 
 Item 5. Market for Common Equity and Related Stockholder Matters
  High
    
    LowFiscal 2004March 31, 2004
    
    $
    4.35
    
    
    $
    4.26June 30, 2004
    
    $
    6.60
    
    
    $
    6.50September 30, 2004
    
    $
    3.55
    
    
    $
    3.50December 31, 2004
    
    $
    1.75
    
    
    $
    1.72Fiscal 2005March 31, 2005
    
    $
    1.72
    
    
    $
    0.64June 30, 2005
    
    $
    0.69
    
    
    $
    0.64September 30, 2005
    
    $
    0.62
    
    
    $
    0.18December 31, 2005
    
    $
    0.20
    
    
    $
    0.10
 9




---



##### 



Equity Compensation Plan Information
  Recent Sales of Unregistered Securities
   10




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##### 



Item 6.
   Going Concern
  Refinancing Risk
   
    
    The convertible debt holders convert the debt into Common Stock
    
    The convertible debt holders extend the maturity dates of the convertible debt
    
    We refinance the convertible debt through existing or new investors
 Working Capital Risk
   
    
    We have improved the terms of our policies so that each policy will be more profitable, including:
 o
    
    7% premium increaseo
    
    5% premium tax passed through to customerso
    
    Added 2.5% of premium fee for handling claimso
    
    $10 policy holder fee
 11




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##### 



o
    
    Elimination of a 1.5% broker fee for reinsuranceo
    
    Improved annual bonus commission for reaching certain loss goals
 
    
    We have improved our marketing efforts in order to increase revenue to a profitable
level, including several actions taken in February 2006:
 o
    
    We hired a Chief Marketing Officero
    
    We entered into a three-year strategic partnership with the ASPCA® (American
Society for the Prevention of Cruelty to Animals®) as the preferred provider of pet
insurance
   Results of Operations
 Fiscal Year ended December 31, 2005 compared to fiscal year ended December 31, 2004
  QUARTER
    
    TIME FRAME
    
    HARTVILLE RE REINSURANCE PERCENTAGE2005
    
    2004First quarter
    
    January  March
    
    50%
    
    0%Second quarter
    
    April  June
    
    50%
    
    0%Third & Fourth quarters
    
    July  August 15
    
    50%
    
    100%August 15  December
    
    50%
    
    100% (existing policies)0% (new & renewed policies)
  QUARTER
    
    TIME FRAME
    
    COMMISSION PERCENTAGE2005
    
    2004First quarter
    
    January  March
    
    20%
    
    30%Second quarter
    
    April  June
    
    20%
    
    30%Third & Fourth quarters
    
    July  August 15
    
    20%
    
    30%August 15  December
    
    20%
    
    30% (existing policies)20% (new & renewed policies)
 
 12




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##### 



Fiscal Year ended December 31, 2004 compared to fiscal year ended December 31, 2003
   13




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##### 



Liquidity and Capital Resources
 Cash Requirements
    Sources and Uses of Cash  Operations
   Prepaid Expense Amount
    
    
    Amortization foryear endedDate issued
    
    Description
    
    Cash
    
    
    Non-Cash
    
    
    12-31-2005September-05
    
    Upfront interest - PIK
    
    
    
    
    
    $
    1,103,141
    
    
    $
    250,714November-04
    
    Upfront interest - Original bond
    
    $
    1,538,970
    
    
    
    
    
    
    $
    747,039November-04
    
    Professional fees
    
    $
    1,026,859
    
    
    
    
    
    
    $
    513,430November-04
    
    Finders Fee - Warrant
    
    
    
    
    
    $
    229,704
    
    
    $
    114,852
 14




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##### 



Sources and Uses of Cash  Financing
     Debt Instruments, Guarantees and Related Covenants
   15




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##### 



Cash Management
    16




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##### 



Critical Accounting Estimates
   Favorable Claims
    
    
    Unfavorable ClaimsAs Reported
    
    
    Loss Ratio
    
    
    Loss RatioPremiums
    
    $
    3,247,963
    
    
    $
    3,247,963
    
    
    $
    3,247,963Losses
    
    
    (2,100,988
    )
    
    
    (1,923,420
    )
    
    
    (2,227,932
    )Ceded costs
    
    
    (1,010,178
    )
    
    
    (1,162,434
    )
    
    
    (1,010,178
    )Reinsurance results
    
    
    136,797
    
    
    
    162,109
    
    
    
    9,853Commission income
    
    
    1,190,764
    
    
    
    1,495,275
    
    
    
    1,190,764General and administrative
    
    
    (7,354,907
    )
    
    
    (7,354,907
    )
    
    
    (7,354,907
    )Operating (loss) income
    
    
    (6,027,346
    )
    
    
    (5,697,523
    )
    
    
    (6,154,290
    )Other income
    
    
    92,710
    
    
    
    92,710
    
    
    
    92,710Other expense
    
    
    (2,082,426
    )
    
    
    (2,082,426
    )
    
    
    (2,082,426
    )(Loss) income before taxes
    
    
    (8,017,062
    )
    
    
    (7,687,239
    )
    
    
    (8,144,006
    )Provision for taxes
    
    
    
    
    
    
    
    
    
    
    NET (LOSS) INCOME
    
    $
    (8,017,062
    )
    
    $
    (7,687,239
    )
    
    $
    (8,144,006
    )Net (loss) income per common share
    
    $
    (0.55
    )
    
    $
    (0.53
    )
    
    $
    (0.56
    )Weighted average common shares outstanding
    
    
    14,590,645
    
    
    
    14,590,645
    
    
    
    14,590,645
  
 17




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##### 



New Accounting Standards
   
 Item 7. Financial Statements .
   Report of Independent Registered Public Accounting Firm
    
    
    23Consolidated Balance Sheets
    
    
    24Consolidated Statements of Operations
    
    
    25Consolidated Statements of Cash Flows
    
    
    26Consolidated Statements of Stockholders Equity
    
    
    27Notes to Consolidated Financial Statements
    
    
    28
 
 Item 8. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
  18




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##### 



Item 8A.
Controls and Procedures
   
 Item 8B. Other Information
  19




---



##### 



Item 9. Directors and Executive Officers of the Registrant
  
 Item 10. Executive Compensation
  
 Item 11. Security Ownership of Certain Beneficial Owners and Management
  
 Item 12. Certain Relationships and Related Transactions
  
 Item 13. Exhibits
  Exhibit No.
    
    Identification of Exhibit3.1(1)
    
    Amended and Restated Articles of Incorporation3.2(2)
    
    Amended and Restated Bylaws of Hartville Group, Inc.3.3(3)
    
    Certificate of Amendment to Articles of Incorporation.4.1(1)
    
    Form of Common Stock certificate4.2(4)
    
    Form of Convertible Debenture4.3(4)
    
    Form of Common Stock Purchase Warrant10.1(5)
    
    Stock Purchase Agreement with Whiskers, Inc.10.4(5)
    
    Hartville Group, Inc. Common Stock Warrant10.5(6)
    
    Stock Purchase Agreement between Hartville Group, Inc. and certain investors10.6(6)
    
    Common Stock Purchase Warrant between Hartville Group, Inc. and certain investors10.7(7)
    
    Securities Purchase Agreement related to debentures and Warrants10.8(8)
    
    Securities Purchase Agreement, Form of Amendment to Securities Purchase Agreement and Form of
Securities Purchase Agreement10.9(9)+
    
    Employment Agreement, dated November 29, 20004, between Hartville Group, Inc. and Hirsch C. Ribakow10.10(9)
    
    Lease Agreement, dated June 30, 2004, between Hartville Group, Inc. and Jeffrey R. Hein
 20




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##### 



Exhibit No.
    
    Identification of Exhibit10.11(10)
    
    Letter Agreement, dated July 29, 2005, between Hartville Group, Inc. and certain investors10.12(4)
    
    Interest Amendment and Waiver Agreement, dated October 25, 2005, between Hartville Group, Inc. and
certain investors16.1(11)
    
    Letter from Pollard-Kelley regarding change in certifying accountant14.(12)
    
    Code of Ethics21(*)
    
    List of Subsidiaries31.1(*)
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.31.2(*)
    
    Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act.32.1(*)
    
    Certification of Chief Executive Officer and Chief Accounting Officer Pursuant to Section 906
of the Sarbanes-Oxley Act.
 
 *
    
    Filed herein.+
    
    Management contract.(1)
    
    Filed as an Exhibit to Hartville Groups registration statement on Form SB-2 (File No. 333-48544) filed on October
25, 2000 and herein incorporated by reference.(2)
    
    Filed as an Exhibit to Hartville Groups Form 10-QSB, filed on May 16, 2005 and herein incorporated by reference.(3)
    
    Filed as an Exhibit to Hartville Groups Form 8-K filed on September 16, 2002 and herein incorporated by reference.(4)
    
    Filed as an Exhibit to Hartville Groups Form 8-K, filed on October 27, 2005 and herein incorporated by reference.(5)
    
    Filed as an Exhibit to Hartville Groups Form 10-KSB/A, filed on January 9, 2004 and herein incorporated by
reference.(6)
    
    Filed as an Exhibit to Hartville Groups Form 8-K filed on November 10, 2003 and herein incorporated by reference.(7)
    
    Filed as an Exhibit to the Registrants Form 8-K filed on September 8, 2004 and herein incorporated by reference.(8)
    
    Filed as an Exhibit to the Registrants Form 8-K filed on November 26, 2004 and herein incorporated by reference.(9)
    
    Filed as an Exhibit to Hartville Groups Form SB-2 (File No. 333-125450), filed on June 2, 2005 and herein
incorporated by reference.(10)
    
    Filed as an Exhibit to Hartville Groups Form 10-QSB, filed on August 15, 2005 and herein incorporated by reference.(11)
    
    Filed as an Exhibit to Hartville Groups Form 8-K filed on January 24, 2005 and herein incorporated by reference.(12)
    
    Filed as an Exhibit to Hartville Groups Form 10-KSB, filed on April 13, 2004 and herein incorporated by reference. Item 14. Principal Accountant Fees and Services
  21




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##### 



Hartville Group, Inc.RegistrantBy:
    
    /s/ Dennis C. RushovichDennis C. RushovichPresident (Principal Executive Officer)By:
    
    /s/ Christopher R. SachsChristopher R. SachsPrincipal Financial and Accounting Officer
  Signature and Capacity/s/ Dennis C. Rushovich

Dennis C. Rushovich
Director
    
    Dated March 30, 2006/s/ Nicholas J. Leighton

Nicholas J. Leighton
Director / Audit Committee Chairman
    
    Dated March 30, 2006/s/ Tomas A. Neuzil

Tomas A. Neuzil
Secretary and Director
    
    Dated March 30, 2006/s/ Alan J. Kaufman

Alan J. Kaufman
Director
    
    Dated March 30, 2006
 22




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##### 



Report of Independent Registered Public Accounting Firm
 
        23




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##### 



December 31,
    
    
    December 31,ASSETS
    
    2005
    
    
    2004Cash and cash equivalents
    
    $
    4,125,579
    
    
    $
    6,104,053Commissions receivable
    
    
    
    
    
    
    159,130Other receivables
    
    
    205,278
    
    
    
    2,291,950Prepaid taxes
    
    
    
    
    
    
    600,000Prepaid expenses
    
    
    2,371,861
    
    
    
    2,860,850Property and equipment  net
    
    
    1,640,883
    
    
    
    2,180,919Deferred policy acquisition costs  net
    
    
    1,004,051
    
    
    
    578,329Licensing fees, less accumulated amortization of $52,060 and $42,473
    
    
    2,429
    
    
    
    12,016Other assets
    
    
    67,570
    
    
    
    76,263Total Assets
    
    $
    9,417,651
    
    
    $
    14,863,510
 December 31,
    
    
    December 31,LIABILITIES AND STOCKHOLDERS' EQUITY
    
    2005
    
    
    2004Accounts payable and accrued expenses
    
    $
    556,300
    
    
    $
    792,425Reserve for claims
    
    
    377,573
    
    
    
    168,175Premium deposits
    
    
    1,691,743
    
    
    
    445,110Unearned commissions
    
    
    20,245
    
    
    
    19,284Debt (December 31, 2005 was offset by discount of $10,992,210 on convertible securities issued in 2004
and $108,227 on convertible secruities issued on September 30, 2004; December 31, 2004 was offset by
discount of $1,032,980 on convertible securities issued in 2004)
    
    
    1,296,570
    
    
    
    10,031,503Total Liabilities
    
    
    3,942,431
    
    
    
    11,456,497Stockholders EquityCommon stock, 50,000,000 shares authorized:$.001 par
value; 14,983,703 issued and 14,889,703 outstanding at
December 31, 2005 and 14,576,296 issued and outstanding at
December 31, 2004
    
    
    14,984
    
    
    
    14,576Additional paid in capital
    
    
    22,811,733
    
    
    
    12,656,372Retained deficit
    
    
    (17,280,997
    )
    
    
    (9,263,935
    )Treasury stock at cost, 94,000 shares
    
    
    (70,500
    )
    
    
    5,475,220
    
    
    
    3,407,013Total Liabilities and Stockholders Equity
    
    $
    9,417,651
    
    
    $
    14,863,510
  24




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##### 



December 31,
    
    
    December 31,2005
    
    
    2004Premiums
    
    $
    3,247,963
    
    
    $
    2,293,533Losses
    
    
    (2,100,988
    )
    
    
    (1,620,635
    )Ceded costs
    
    
    (1,010,178
    )
    
    
    (573,418
    )Reinsurance income
    
    
    136,797
    
    
    
    99,480Commission income
    
    
    1,190,764
    
    
    
    1,930,645General and administrative expenses
    
    
    (7,354,907
    )
    
    
    (9,200,298
    )Operating loss
    
    
    (6,027,346
    )
    
    
    (7,170,173
    )Other income
    
    
    92,710
    
    
    
    67,260Other expenses
    
    
    (2,082,426
    )
    
    
    (1,041,380
    )Loss before taxes
    
    
    (8,017,062
    )
    
    
    (8,144,293
    )Provision for taxes
    
    
    
    
    
    
    Net Loss
    
    $
    (8,017,062
    )
    
    $
    (8,144,293
    )Net loss per common share
    
    $
    (0.55
    )
    
    $
    (0.58
    )Weighted average common shares outstanding
    
    
    14,590,645
    
    
    
    14,016,975
  25




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##### 



December 31,
    
    
    December 31,2005
    
    
    2004Cash flows from (for) operating activitiesNet Loss
    
    $
    (8,017,062
    )
    
    $
    (8,144,293
    )Adjustments to derive cash flows:Depreciation
    
    
    841,357
    
    
    
    536,627Amortization
    
    
    423,375
    
    
    
    45,242Loss on disposal of property and equipment
    
    
    32,399
    
    
    
    Stock for services (Non-cash)
    
    
    
    
    
    
    1,859,911Amortization of discount on debt
    
    
    88,411
    
    
    
    Changes in operating assets and liabilitiesCommissions receivable
    
    
    159,130
    
    
    
    528,247Other receivables
    
    
    2,016,172
    
    
    
    (1,910,337
    )Prepaid taxes
    
    
    600,000
    
    
    
    (600,000
    )Deferred tax asset
    
    
    
    
    
    
    300,000Prepaid expenses
    
    
    1,592,130
    
    
    
    (2,575,914
    )Accounts payable and accrued expenses
    
    
    (236,223
    )
    
    
    611,092Premium deposits
    
    
    1,246,633
    
    
    
    (1,094,538
    )Unearned Commission
    
    
    961
    
    
    
    19,284Accrued taxes
    
    
    
    
    
    
    (389,839
    )Reserve for Claims
    
    
    209,398
    
    
    
    331Net Cash for Operating Activities
    
    
    (1,043,319
    )
    
    
    (10,814,187
    )Cash Flows from Investing ActivitiesDeferred policy acquisition costs
    
    
    (839,511
    )
    
    
    (613,984
    )Additions to property and equipment
    
    
    (333,473
    )
    
    
    (1,404,198
    )Other
    
    
    8,446
    
    
    
    Net Cash for Investing Activities
    
    
    (1,164,538
    )
    
    
    (2,018,182
    )Cash Flows from Financing ActivitiesProceeds from notes payable
    
    
    263,163
    
    
    
    14,038,780Payment on notes payable
    
    
    (33,780
    )
    
    
    (3,005,821
    )Proceeds from issuance of common stock
    
    
    
    
    
    
    250,000Net Cash from Financing Activities
    
    
    229,383
    
    
    
    11,282,959Net Decrease in Cash and Cash Equivalents
    
    
    (1,978,474
    )
    
    
    (1,549,410
    )Cash and Cash Equivalents  Beginning
    
    
    6,104,053
    
    
    
    7,653,463Cash and Cash Equivalents  Ending
    
    $
    4,125,579
    
    
    $
    6,104,053
  26




---



##### 



Additional
    
    
    
    
    
    
    
    
    
    TotalCommon
    
    Stock
    
    Paid in
    
    Retained
    
    Treasury
    
    Stockholders'Shares
    
    Amount
    
    Capital
    
    Earnings
    
    Stock
    
    EquityBalance December 31, 2003
    
    
    12,096,909
    
    
    
    12,097
    
    
    
    9,006,838
    
    
    
    (1,119,642
    )
    
    
    
    
    
    
    7,899,293Sale of shares
    
    
    1,794,078
    
    
    
    1,794
    
    
    
    248,206
    
    
    
    
    
    
    
    
    
    
    
    250,000Beneficial conversion and repricing impact on convertible debt
    
    
    
    
    
    
    
    
    
    
    1,063,784
    
    
    
    1,063,784Warrants issued for services
    
    
    
    
    
    
    
    
    
    
    1,081,203
    
    
    
    
    
    
    
    
    
    
    
    1,081,203Stock issued for cashless warrant
    
    
    85,309
    
    
    
    85
    
    
    
    (85
    )
    
    
    
    
    
    
    
    
    
    
    Shares issued for services
    
    
    600,000
    
    
    
    600
    
    
    
    1,256,426
    
    
    
    
    
    
    
    
    
    
    
    1,257,026Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,144,293
    )
    
    
    
    
    
    
    (8,144,293
    )Balance December 31, 2004
    
    
    14,576,296
    
    
    
    14,576
    
    
    
    12,656,372
    
    
    
    (9,263,935
    )
    
    
    
    
    
    
    3,407,013Beneficial conversion and repricing impact on convertible debt
    
    
    
    
    
    
    
    
    
    
    10,155,769
    
    
    
    
    
    
    
    
    
    
    
    10,155,769Treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (70,500
    )
    
    
    (70,500
    )Stock issued for cashless warrant
    
    
    407,407
    
    
    
    408
    
    
    
    (408
    )
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,017,062
    )
    
    
    
    
    
    
    (8,017,062
    )Balance December 31, 2005
    
    
    14,983,703
    
    
    
    14,984
    
    
    
    22,811,733
    
    
    
    (17,280,997
    )
    
    
    (70,500
    )
    
    
    5,475,220
  27




---



##### 



Hartville Group, Inc. and Subsidiaries
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 December 31, 2005
 (audited)
 NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 The Company
  Basis of Presentation and Principles of Consolidation
  Use of Estimates
  Revenue Recognition Policies
    Financial Instruments and Concentration of Credit Risks
  28




---



##### 



Cash and Cash Equivalents
  Trust Funds
  Long-Lived Assets
  Leasehold improvements
    10 yearsFurniture and Fixtures
    7 yearsEquipment
    5 yearsSoftware
    3 years
   Deferred Acquisition Costs
  Reserve for Claims
 .
 29




---



##### 



Income Taxes
  Net loss per share
  Share-Based Awards
  New Accounting Standards
   NOTE 2  GOING CONCERN
  Refinancing Risk
   
    
    The convertible debt holders convert the debt into Common Stock
    
    The convertible debt holders extend the maturity dates of the convertible debt
    
    We refinance the convertible debt through existing or new investors
 30




---



##### 



Working Capital Risk
   
    
    We have improved the terms of our policies so that each policy will be more profitable, including:
 o
    
    7% premium increaseo
    
    5% premium tax passed through to customerso
    
    Added 2.5% of premium fee for handling claimso
    
    $10 policy holder feeo
    
    Elimination of a 1.5% broker fee for reinsuranceo
    
    Improved annual bonus commission for reaching certain loss goals
 
    
    We have improved our marketing efforts in order to increase revenue to a profitable
level, including several actions taken in February 2006:
 o
    
    We hired a Chief Marketing Officero
    
    We entered into a three-year strategic partnership with the ASPCA® (American
Society for the Prevention of Cruelty to Animals®) as the preferred provider of pet
insurance
   NOTE 3  OTHER RECEIVABLES
  December 31,
    
    
    December 31,2005
    
    
    2004Property & casualty insurance company not acquired
    
    $
    
    
    
    $
    2,303,333Officer
    
    
    
    
    
    
    46,069Insurance carriers
    
    
    181,408
    
    
    
    (76,121
    )Miscellaneous
    
    
    23,870
    
    
    
    18,669$
    205,278
    
    
    $
    2,291,950
   31




---



##### 



NOTE 4  PREPAID EXPENSES
  December 31,
    
    
    December 31,2005
    
    
    2004Interest on November 11, 2004 convertible debt
    
    $
    709,536
    
    
    $
    1,456,575Legal and other fees paid in conjunction with November 11, 2004 convertible debt
    
    
    596,811
    
    
    
    1,225,093Interest on September 30, 2005 convertible debt
    
    
    852,427
    
    
    
    Miscellaneous
    
    
    213,087
    
    
    
    179,182$
    2,371,861
    
    
    $
    2,860,850
 NOTE 5  LONG-LIVED ASSETS
  December 31,
    
    
    December 31,2005
    
    
    2004Furniture and fixtures
    
    $
    166,554
    
    
    $
    72,841Equipment
    
    
    404,414
    
    
    
    377,999Software
    
    
    2,295,803
    
    
    
    2,277,678Leasehold improvements
    
    
    195,219
    
    
    
    47,7813,061,990
    
    
    
    2,776,299Less: accumulated depreciation
    
    
    (1,421,107
    )
    
    
    (595,380
    )$
    1,640,883
    
    
    $
    2,180,919
 NOTE 6  NET DEFERRED POLICY ACQUISITION COSTS
  December 31,
    
    
    December 31,2005
    
    
    2004Beginning balance, net
    
    $
    578,329
    
    
    $
    Acquisition costs incurred
    
    
    2,230,573
    
    
    
    1,988,306Amortization of acquisition costs
    
    
    (1,804,851
    )
    
    
    (1,409,977
    )Ending balance, net
    
    $
    1,004,051
    
    
    $
    578,329
 32




---



##### 



NOTE 7  RESERVE FOR CLAIMS
  December 31,
    
    
    December 31,2005
    
    
    2004Beginning balance, net
    
    $
    168,175
    
    
    $
    167,844Incurred losses related to:Current year
    
    
    1,700,124
    
    
    
    1,405,200Prior year
    
    
    400,864
    
    
    
    215,435Total incurred
    
    
    2,100,988
    
    
    
    1,620,635Paid losses related to:Current year
    
    
    (1,325,655
    )
    
    
    (1,243,823
    )Prior year
    
    
    (565,935
    )
    
    
    (376,481
    )Total paid
    
    
    (1,891,590
    )
    
    
    (1,620,304
    )Ending balance, net
    
    $
    377,573
    
    
    $
    168,175
 Reserve for Claims is represented by:
 December 31,
    
    
    December 31,2005
    
    
    2004Reported claims
    
    $
    3,363
    
    
    $
    10,870Incurred but not reported claims
    
    
    374,210
    
    
    
    157,305$
    377,573
    
    
    $
    168,175
 NOTE 8  DEBT
 Notes Payable
   33




---



##### 



Other Debt
       34




---



##### 



Capitalized lease
    
    
    Debt2006
    
    $
    6,762
    
    
    $
    12,376,8112007
    
    
    7,354
    
    
    
    2008
    
    
    6,080
    
    
    
    Less
unamortized discount on convertible debt
    
    
    
    
    
    
    (11,100,437
    )$
    20,196
    
    
    $
    1,276,374
 NOTE 9  OTHER EXPENSES
  December 31,
    
    
    December 31,2005
    
    
    2004Liquidated damages  October 2003 Stock Purchase
    
    $
    316,602
    
    
    $
    401,646Interest expense on March 23, 2005 note
    
    
    12,527
    
    
    
    Interest expense on August 16, 2004 note
    
    
    
    
    
    
    38,709Interest expense on August 31, 2004 note
    
    
    
    
    
    
    77,000Brokerage fees on August 31, 2004 note
    
    
    
    
    
    
    230,000Brokerage fees on November 2004 convertible
    
    
    
    
    
    
    135,000Interest expense on capitalized lease
    
    
    3,630
    
    
    
    4,380Miscellaneous
    
    
    2,822
    
    
    
    9,976Non Cash Expenses:Amortization
of fees on November 2004 convertible debt
    
    
    628,282
    
    
    
    31,470Amortization of Prepaid Interest on November 2004 convertible debt
    
    
    747,039
    
    
    
    82,395Amortization of discount on November 2004 convertible debt
    
    
    46,570
    
    
    
    Amortization on August 31, 2004 warrants
    
    
    41,196
    
    
    
    30,804Amortization of Prepaid Interest on September 30, 2005 convertible debt
    
    
    250,714
    
    
    
    Amortization of discount on September 30, 2005 convertible debt
    
    
    645
    
    
    
    Loss on disposal
    
    
    32,399
    
    
    
    $
    2,082,426
    
    
    $
    1,041,380
 35




---



##### 



NOTE 10  LEASES
    For the year ended December 31,2006
    
    $
    151,4742007
    
    
    151,4742008
    
    
    151,4742009
    
    
    147,7322010
    
    
    150,000Thereafter
    
    
    600,000$
    1,352,154
 NOTE 11  NET LOSS PER SHARE
  Years EndedDecember 31,2005
    
    2004Net loss
    
    $
    (8,017,062
    )
    
    $
    (8,144,293
    )Weighted average common shares outstanding
    
    
    14,590,645
    
    
    
    14,016,975Dilutive effect of outstanding warrants and options
    
    
    
    
    
    
    Diluted common shares
    
    
    14,590,645
    
    
    
    14,016,975Basic net loss per share
    
    $
    (0.55
    )
    
    $
    (0.58
    )Diluted net loss per share
    
    $
    (0.55
    )
    
    $
    (0.58
    )
   36




---



##### 



Issued, outstanding and exercisable at December 31, 2005
    
    
    14,889,703
 Dollar
    
    
    Exerciseamount of
    
    
    price/
    
    
    SharesConvertible
    
    
    Convertible
    
    
    Outstanding/
    
    
    RemainingInstrument
    
Description
    
    

Debt
    
    

price
    
    

Exercisable
    
    

life (years)Warrant
    
    October 8, 2003 stock purchase
    
    
    N/A
    
    
    $
    1.90
    
    
    
    578,947
    
    
    
    0.8Warrant
    
    August 31, 2004 Convertible debt
    
    
    N/A
    
    
    $
    0.01
    
    
    
    499,999
    
    
    
    3.7Convertible Debt
    
    November 2004
    
    
    11,038,780
    
    
    $
    0.75
    
    
    
    14,718,373
    
    
    
    0.9Warrant
    
    November 2004 Convertible debt
    
    
    N/A
    
    
    $
    0.01
    
    
    
    4,699,175
    
    
    
    3.9Convertible Debt
    
    September 30, 2005
    
    
    1,103,141
    
    
    $
    0.20
    
    
    
    5,515,705
    
    
    
    0.9Warrant
    
    September 30, 2005 Convertible debt
    
    
    N/A
    
    
    $
    0.01
    
    
    
    5,515,705
    
    
    
    4.8Warrant
    
    Consulting Services
    
    
    N/A
    
    
    $
    3.00
    
    
    
    240,000
    
    
    
    0.9Warrant
    
    Consulting Services
    
    
    N/A
    
    
    $
    5.00
    
    
    
    250,000
    
    
    
    3.4Warrant
    
    Consulting Services
    
    
    N/A
    
    
    $
    6.00
    
    
    
    250,000
    
    
    
    3.4Warrant
    
    Consulting Services
    
    
    N/A
    
    
    $
    0.69
    
    
    
    150,003
    
    
    
    3.3Potential additional shares as of December 31, 2005
    
    
    
    
    
    
    
    
    
    
    32,417,907Total potential shares as of December 31, 2005
    
    
    
    
    
    
    
    
    
    
    47,307,610
  WeightedaverageExercise
    
    
    exerciseNumber of
    
    
    price
    
    
    price pershares
    
    
    range
    
    
    shareOutstanding at December 31, 2003
    
    
    1,010,526
    
    
    $
    0.87-$1.90
    
    
    $
    1.59Granted
    
    
    6,503,618
    
    
    $
    0.95-$6.00
    
    
    $
    1.67Exercised
    
    
    (216,888
    )
    
    $
    0.87-$1.90
    
    
    $
    1.50Canceled
    
    
    (214,691
    )
    
    $
    0.87
    
    
    $
    0.87Outstanding at December 31, 2004
    
    
    7,082,565
    
    
    $
    0.95-$6.00
    
    
    $
    1.45Granted
    
    
    5,665,708
    
    
    $
    0.01-$0.69
    
    
    $
    0.03Exercised
    
    
    (407,407
    )
    
    $
    0.01
    
    
    $
    0.01Canceled
    
    
    (157,037
    )
    
    $
    0.01-$3.00
    
    
    $
    2.30Outstanding at December 31, 2005
    
    
    12,183,829
    
    
    $
    0.01-$6.00
    
    
    $
    0.39
 NOTE 12  COMMITMENTS AND CONTINGENCIES
  37




---



##### 



NOTE 13- RELATED PARTY TRANSACTIONS
  NOTE 14  INCOME TAXES
  2005
    
    
    2004Federal statutory tax rate
    
    
    -34.0
    %
    
    
    -34.0
    %Change in net deferred income tax
assets, including effect of change
in valuation allowance
    
    
    34.0
    
    
    
    34.0Other
    
    
    
    
    
    
    Effective income tax rate
    
    
    0
    %
    
    
    0
    %
 38




---



##### 



HARTVILLE GROUP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
 NOTE 14  INCOME TAXES (continued)
  2005
    
    
    2004Deferred Income Tax Asset:Reserve discounting
    
    $
    
    
    
    $
    2,399Policy acquisition costs
capitalized for tax purposes
    
    
    389,926
    
    
    
    Net operating loss carryforward
    
    
    3,014,204
    
    
    
    2,963,293Total deferred income tax assets
    
    
    3,404,130
    
    
    
    2,965,692Valuation allowance
    
    
    (2,920,277
    )
    
    
    (2,769,060
    )Net deferred income tax assets
    
    
    483,853
    
    
    
    196,632Deferred Income Tax Liabilities:Deferred policy acquisition costs
    
    
    (341,377
    )
    
    
    (196,632
    )Depreciation
    
    
    (142,476
    )
    
    
    Total deferred income tax liabilities
    
    
    (483,853
    )
    
    
    (196,632
    )Net deferred income taxes
    
    $
    
    
    
    $
    
   NOTE 15  NON-QUALIFIED STOCK OPTION PLAN
   39




---



##### 



HARTVILLE GROUP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
 NOTE 16  SEGMENT INFORMATION
   Holding
    
    Insurance
    
    ReinsuranceCompany
    
    Agency
    
    company
    
    TotalFiscal 2005Gross Revenue
    
    $
    
    
    
    $
    1,190,764
    
    
    $
    3,247,963
    
    
    $
    4,438,727Operating income (loss)
    
    $
    (1,166,289
    )
    
    $
    (4,928,639
    )
    
    $
    68,122
    
    
    $
    (6,027,346
    )Operating income (loss)%
    
    
    0.0
    %
    
    
    -413.9
    %
    
    
    2.1
    %
    
    
    -135.8
    %Total assets
    
    $
    3,551,393
    
    
    $
    3,615,741
    
    
    $
    2,250,517
    
    
    $
    9,417,651Fiscal 2004Gross Revenue
    
    $
    
    
    
    $
    1,930,645
    
    
    $
    2,293,533
    
    
    $
    4,224,178Operating income (loss)
    
    $
    (3,919,317
    )
    
    $
    (3,281,110
    )
    
    $
    30,254
    
    
    $
    (7,170,173
    )Operating income (loss)%
    
    
    0.0
    %
    
    
    -169.9
    %
    
    
    1.3
    %
    
    
    -169.7
    %Total assets
    
    $
    9,560,180
    
    
    $
    4,499,523
    
    
    $
    803,807
    
    
    $
    14,863,510
 NOTE 17  SUBSEQUENT EVENTS
 
    
    Chief Marketing Officer  On February 9, 2006, the Company entered into an
Employment Agreement with Christopher Edgar (the Edgar Agreement), our Chief Marketing
Officer. The Edgar Agreement has an initial two-year term ending on January 19, 2008 and
shall renew for successive periods of one year unless terminated by either party at least 90
days prior to the end of any term. Pursuant to the Edgar Agreement, Mr. Edgar will not be
paid a base salary, but will be eligible for cash bonuses as determined by the Board of
Directors of the Company. As part of his compensation, Mr. Edgar is entitled to be granted
2,000,000 shares of the Companys common stock pursuant to a restricted stock agreement (the
Initial Restricted Shares) and stock options to purchase up to 500,000 shares of the
Companys common stock pursuant to a nonstatutory stock option plan to be adopted by the
Companys Board of Directors (the Initial Option Grant). The Initial Restricted Shares were
issued to Mr. Edgar on February 9, 2006 pursuant to a Restricted Stock Agreement. Pursuant to
the Restricted Stock Agreement, 500,000 shares of the Initial Restricted Shares shall vest,
subject to Mr. Edgars continuous status as an employee of the Company on such dates, on each
of March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006. The Initial
Restricted Shares become fully vested upon a change of control (as defined in the Restricted
Stock Agreement). Additionally, the vesting of certain Initial Restricted Shares may be
accelerated upon the termination of Mr. Edgars employment in certain circumstances as set
forth in the Edgar Agreement. Pursuant to the Edgar Agreement, Mr. Edgar is also entitled to
receive an additional grant of 1,000,000 shares of restricted common stock (the Additional
Restricted Shares) and options to purchase an additional 500,000 shares of common stock (the
Additional Option Grant) on or prior to January 2, 2007, subject to Mr. Edgars continuous
status as an employee of the Company on such date. The Additional Restricted Shares shall
vest, subject to Mr. Edgars continuous status as an employee of the Company on such dates,
as follows: 250,000 shares on each of March 31, 2007, June 30, 2007, September 30, 2007 and
December 31, 2007. The terms applicable to the Additional Restricted Shares, including the
acceleration of vesting, shall be substantially similar to those of the Initial Restricted
Shares. Shares subject to the Additional Option Grant shall vest according to the following
schedule, subject to Mr. Edgars continuous status as an employee of the Company on such
dates: 125,000 shares vest on each of March 31, 2007, June 30, 2007, September 30, 2007 and
December 31, 2007. The terms applicable to the Additional Option Grant, including the
acceleration of vesting, shall be substantially similar to those of the Initial Option Grant.
In the event that a change of control (as defined in the Edgar Agreement) occurs prior to the
grant of the Additional Restricted Shares and the Additional Option Grant, such grants shall
be made prior to such change of control.
 40




---



##### 



HARTVILLE GROUP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
 
    
    ASPCA strategic partnership  On February 23, 2006 the Company has entered into a
three-year strategic partnership with the ASPCA® (American Society for the Prevention of
Cruelty to Animals®) as the preferred provider of pet insurance to their more than one
million loyal supporters, we entered into an agreement with ASPCA. Under this agreement, we
are obligated to pay $83,750 in royalties per quarter.
 41




---



##### 



Exhibit Index
 Exhibit No.
    
    DescriptionEX 21
    
    List of SubsidiariesEX 31.1
    
    CertificationEX31.2
    
    CertificationEX32.1
    
    Certification
 42