##### Table of Contents

As filed with the Securities and Exchange Commission on April 7, 2006

---



United States

Securities and Exchange Commission

Washington, DC 20549



---



Form 10-KSB



|x |  | Annual Report Pursuant to Section 13 or 15(d)
|- |  | ---------------------------------------------

Of the Securities Exchange Act of 1934



For
the fiscal year ended December 31, 2005



OR



| ̈ |  | Transition Report Pursuant to Section 13 or 15(d)
|- |  | -------------------------------------------------

of the Securities Exchange Act of 1934



Commission file number: 000-31279



OurPets Company

(Exact name of Small Business Issuer as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Colorado                                                       |  | 34-1480558                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|1300 East Street, Fairport Harbor, OH    |  | 44077     
|(Address of principal executive offices) |  | (Zip code)



Issuers
telephone number: (440) 354-6500



Securities
registered under Section 12(b) of the Exchange Act: None



Securities registered under Section 12(g) of the Exchange Act: Common Stock, no par value



Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ̈



Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file
such reports) and (2) has been subject to such filing requirements for past 90 days. x Yes ̈No



Check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. x



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



Issuers revenues for the fiscal year ended December 31, 2005 were $6,566,407. The aggregate market value of the common stock of the registrant, no par value per share (the Common Stock), held by non-affiliates of
registrant was $2,118,383 as of March 27, 2006. As of March 27, 2006, the issuer had outstanding 14,969,473 shares of Common Stock.



Documents Incorporated by Reference



Part III  Portions of the registrants definitive proxy statement to be issued in conjunction with registrants annual meeting to be held
on May 17, 2006.



Transitional Small Business Disclosure
Format (Check one): Yes ̈No x



www.ourpets.com



---



---

##### Table of Contents

OURPETS COMPANY



FORM 10-KSB



For The Fiscal Year Ended December 31, 2005



INDEX



|         |  |                                                                                                                 |  |     
|-------- |  | --------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                 |  | Page
|PART I   |  |                                                                                                                 |  |     
|         |  |                                                                                                                
|Item 1.  |  | Description of Business                                                                                         |  | 3   
|Item 2.  |  | Description of Property                                                                                         |  | 7   
|Item 3.  |  | Legal Proceedings                                                                                               |  | 8   
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                             |  | 8   
|         |  |                                                                                                                
|PART II  |  |                                                                                                                 |  |     
|         |  |                                                                                                                
|Item 5.  |  | Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities  |  | 9   
|Item 6.  |  | Managements Discussion and Analysis or Plan of Operation                                                       |  | 10  
|Item 7.  |  | Financial Statements                                                                                            |  | 15  
|Item 8.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                            |  | 15  
|Item 8A. |  | Controls and Procedures                                                                                         |  | 15  
|Item 8B. |  | Other Information                                                                                               |  | 15  
|         |  |                                                                                                                
|PART III |  |                                                                                                                 |  |     
|         |  |                                                                                                                
|Item 9.  |  | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act |  | 16  
|Item 10. |  | Executive Compensation                                                                                          |  | 16  
|Item 11. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                  |  | 16  
|Item 12. |  | Certain Relationships and Related Transactions                                                                  |  | 16  
|Item 13. |  | Exhibits                                                                                                        |  | 17  
|Item 14. |  | Principal Accountant Fees and Services                                                                          |  | 18  
|         |  | Signatures                                                                                                      |  | 19  
|         |  | Certifications                                                                                                  |  | 36  



2



---

##### Table of Contents

This report on the Form 10-KSB (this Report) contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), including, without limitation, statements regarding our cash needs and ability to fund our requirements, building of our market
presence and ability to succeed as planned and our ability to successfully obtain and protect our patents. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results,
performance or achievements of the Company or industry results to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. See Item 1. Description of
BusinessRisk Factors for a discussion of these risks. When used in this Report, statements that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words
anticipates, plans, intends, expects and similar expressions are intended to identify such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this Report. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.



Introductory Note



OurPets Company, a Colorado corporation, is engaged in developing,
manufacturing and marketing various proprietary products for the retail pet business. As used herein, the terms OurPets, we, us and our include each of our subsidiaries, unless the context
otherwise requires.



PART I



|Item 1. | Description of Business.
|------- | ------------------------



Our management originally founded Napro, Inc. (Napro), an Ohio corporation, in 1985 as an enterprise for launching new ventures and acquiring
companies in various lines of business. In 1996, Napro formed a wholly owned Ohio subsidiary, Virtu Company (Virtu), to market proprietary products to the retail pet business under the OurPets® label. Napro then changed its name to OurPets Company effective March 19,
1998. On July 16, 1998, Manticus, Inc. (Manticus), a Colorado corporation, obtained all of the outstanding shares of OurPets/Napro in exchange for 8,000,000 shares of Manticus common stock. After the transaction, the former
holders of OurPets/Napro shares owned approximately 89% of Manticus shares. Effective August 10, 1998, OurPets/Napro was merged into Manticus and ceased to exist. Prior to this merger no affiliation or other relationship
existed between Manticus and us or our shareholders. As operations for the newly merged entity were, and continue to be, conducted in Ohio, Manticus proceeded to become licensed in the State of Ohio as a foreign corporation, known as OurPets
Company. Effective October 12, 1998, ManticusArticles of Incorporation was amended in the State of Colorado to reflect its new name as OurPets Company. After the merger, management of the former OurPets/Napro assumed
management of the surviving company.



We develop and market
products for improving the health, safety, comfort and enjoyment of pets. The products sold have increased from the initial Big Dog Feeder to approximately 150 products for dogs, cats, domestic and wild birds and other small animals.
Products are marketed under the OurPets and Pet Zone labels to customers, both domestic and foreign. The manufacturing of these products is subcontracted to other entities, both domestic and foreign, based upon price and quality.



According to the 2005/2006 APPMA National Pet Owners Survey, published by
the American Pet Products Manufacturers Association, Inc®, approximately 69.1 million U.S. households (63% of all households) currently own a pet, with approximately 45% of those households owning more than one pet. The most popular pets are dogs (40% of all households)
and cats (34% of all households).



3



---

##### Table of Contents

We sell our products in the following market segments:



|                                                                                                                                                                                                                                                                                                                                                
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|mass retailerseg. Wal-Mart, Kmart pet store chainseg. PetsMart, Petco pet catalogueseg. Drs. Foster & Smith, Care-A-Lot general catalogueseg. Solutions clubseg. Costco, Sams Club grocery chainseg. Ahold, Safeway, Publix pet food makerseg. Friskies, Ralston Purina pet distributors/pet dealerseg. Wolverton, Central Garden & Pet



The companies listed
above are intended to serve as examples solely for illustrative purposes. As a standard industry practice, price lists are provided to distributors, who in turn place products with retailers. Larger retailers with a national presence will generally
order product directly from us pursuant to the price list and subject to negotiated additional terms, if any. With the exception of a written price list, many of the arrangements with retailers or distributors are verbal and written contracts often
do not exist. Customers submit their own standard purchase orders based on our current price list. Even the larger retailers, which might have written contracts with us, are under no obligation to purchase specific product from us. While all of the
above companies may currently buy product from OurPets, none of these customers are under any contractual obligation to purchase a specific volume of product nor to continue making any purchases in the future. We currently have approximately
160 customers to whom we sell products, with the total number and identity of our customers changing from time to time. With the exceptions of PetsMart and Wal-Mart none of our customers account for 10% or more of our sales. While we had
approximately 160 customers for the year ended December 31, 2005, 46.7% of our revenue was derived from PetsMart and Wal-Mart. Revenue generated from each of these customers amounted to $1,537,852 and $1,530,629, respectively, which represents
23.4% and 23.3% of total revenue.



We currently market products
such as dog, cat and bird feeders, dog and cat toys, cat litter and related waste management products, and natural and nutritional pet supplements and treats. We conduct our marketing and sales activities through seven in-house officers and/or
employees and 80 independent sales agents. Domestic independent sales agents are paid commissions, which range from 3% to 15% of net sales to customers.



Our marketing strategies include, among others, trade shows, customer visitation, telemarketing, direct mail, trade journal advertising, product sampling
programs and customer support programs, such as advertising and promotional allowances.



We are one of many small companies in the accessory and consumable pet products market with no measurable percentage of that market. Our competition in the healthy feeding systems, interactive toys and healthy
consumable products markets are both domestic and foreign companies, many of whom manufacture their products in low cost areas such as Mexico and the Far East. Our competition in the premium cat litter market are mainly larger domestic companies.



Most of our products are proprietary and we have been granted
or assigned 25 United States patents for dog and cat feeders and have 42 United States patents pending for cat and dog toys, dog feeders and natural and nutritional pet supplements and treats. We registered our logo, OurPets, as a
registered trademark. To protect our trade names we obtained 17 additional trademark registrations and applied for three trademark registrations, which are still pending.



As of March 27, 2006, we had 18 full-time employees consisting of four officers, five other employees in sales and
marketing, one employee in engineering, three employees in finance and administration and five employees in warehousing and shipping. We do not have any employees in manufacturing since that operation is subcontracted to outside vendors. None of our
employees are subject to a collective bargaining agreement and we have not experienced any work stoppages, nor to our knowledge, are any threatened.



4



---

##### Table of Contents

We conduct our own research and development activities and also use outside sources to perform specific
projects such as engineering drawings and prototype models. Research and development costs are charged to expenses as incurred, and totaled $66,746 for the year ended December 31, 2005 and $51,661 for the year ended December 31, 2004.



Recent Events



On January 3, 2006, we acquired substantially all the assets and
assumed certain liabilities of Pet Zone Products Ltd. (Pet Zone). Pet Zones business is similar to ours, as it manufactures and distributes pet supply products including cat, dog and bird feeders, storage bins and cat and dog toys
to pet specialty distributors and retailers, mass retailers and grocery chains, among others. The purchase price consisted of $464,998 in cash (less 12.5% held back in escrow) and the issuance of 3,082,000 shares of OurPets Common Stock, along
with a warrant to purchase an additional 2,729,000 shares of OurPets Common Stock at a price ranging from $0.60 to $0.75 depending on the date the warrant is exercised. The warrant expires on January 2, 2011.



In conjunction with this acquisition Pet Zone invested $250,000 in the
Company in the form of a loan to be used in new product development. In connection with this investment, Pet Zone received a warrant to purchase 125,000 shares of OurPets Common Stock at a price of $.335 per share. The warrant expires on
January 3, 2011.



As part of the acquisition, we entered
into a Registration Rights Agreement with Pet Zone and certain other stockholders (the Registration Agreement), which provides, among other things, certain piggyback registration rights to these stockholders and that OurPets will
file a registration statement with the Securities and Exchange Commission upon the demand of a majority of the stockholders holding registrable shares pursuant to this Registration Agreement.



Finally, in connection with this acquisition, the Company and Pet Zone, along
with certain major stockholders, entered into a voting agreement (the Voting Agreement) pursuant to which the parties thereto agreed to vote all shares held by them to (i) ensure the Companys board of directors consists of
five members; (ii) elect to the board of directors three persons designated by our President, Dr. Steven Tsengas; and (iii) elect to the board of directors either one or two persons designated by Pet Zone, depending on the percentage
of the Companys common stock and warrants currently held by Pet Zone or certain parties related to Pet Zone.



Copies of the agreements discussed above were included as exhibits to the Companys Form 8-K filed with the Securities and Exchange Commission on
January 6, 2006, which also includes additional information about the Pet Zone acquisition.



5



---

##### Table of Contents

Risk Factors



We are currently integrating the Pet Zone business operations into our own operations, which can negatively impact our cash flow and profits until such
transition is successfully completed.



Our acquisition of
Pet Zones business involves the consolidation of business operations into one location, the deletion of duplicative services and other overhead items, the integration of differing policies and of our respective product lines. Until completed,
the costs of transitioning Pet Zones business into our operations can affect our cash flow and otherwise negatively affect our bottom line. The extent of such impact on our financial results cannot be accurately predicted at this time and may
be significant.



We are still building our market presence
and are subject to substantial competition that could inhibit our ability to succeed as planned.



We are one of many small companies in the pet product market with no measurable percentage of that market. We are still attempting to build our market
presence as we compete with both domestic and foreign companies, many of whom manufacture their products in low cost areas such as Mexico and the Far East. Any reputation that we may successfully gain with retailers for quality product does not
necessarily translate into name recognition or increased market share with the end consumer. Our products may not be well received by the pet owners, or other companies may surpass us in product innovations. Certain retailers have been adversely
impacted by economic conditions causing them to file for bankruptcy protection. This could adversely effect our sales, if this trend continues or these retailers are unable to emerge from bankruptcy protection.



Additional financing may not be available when required by us.



We may need additional financing for new product
launches, warehouse equipment, working capital, research and development of new products, strategic acquisitions, and molds and tooling to produce new products. If the financial resources are not available if needed, or are not available on
affordable terms, then our ability to increase our sales and profits will be hampered, which in turn harms our financial performance.



The loss of key personnel could adversely affect our operations.



We are and will continue to be dependent on our key management personnel: Dr. Steven Tsengas, Chairman, President and
Chief Executive Officer; Konstantine S. Tsengas, Vice President of Operations and Secretary; Scott T. Fitzhugh, Vice President of Sales, and John G. Murchie, Vice President, Treasurer and Controller. The loss of one or more of these individuals
could have a material adverse effect on our business and operations. In addition, we will need to attract and retain other qualified individuals to satisfy our personnel needs. We do not have employee contracts with our key personnel and may not
succeed in retaining our key management personnel or in attracting and retaining new employees.



The inability to successfully obtain or protect our patents could harm our competitive advantage.



Our success will depend, in part, on our ability to maintain protection for
our products under United States patent laws, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. We have 25 U.S. patents issued or assigned and 42 U.S. patent applications pending. Patent
applications may not successfully result in an issued patent. Issued patents are still subject to challenges and infringements. Furthermore, others may independently develop similar products or otherwise circumvent our patent protection. Should we
fail to obtain and protect our patents, our competitive advantage will be harmed.



The exercise of too many warrants and stock options would dilute the value of the Common Stock, and stockholder voting power.



We currently have 14,969,473 shares of Common Stock outstanding which could be diluted by the following potential issuances
of Common Stock. As of March 27, 2006, we had outstanding 66,000 shares of



6



---

##### Table of Contents

Convertible Preferred Stock (Preferred Stock) convertible into 660,000 shares of Common Stock at a conversion rate of $1.00 per share. Also as of
March 27, 2006, we had outstanding 3,786,754 warrants to purchase an aggregate of 3,786,754 shares of Common Stock at exercise prices ranging from $0.286 to $1.220 per share and options to purchase an aggregate of 918,000 shares of Common Stock
at exercise prices ranging from $0.210 to $0.625 per share. We have reserved an aggregate of 1,350,000 shares of Common Stock for issuance under the 1999 Stock Option Plan as of the date of this Report. In addition, the exercise of such warrants and
options could have a material adverse effect on the future market price of, and liquidity in the market for, shares of Common Stock trading in the over-the-counter market. Further, while these warrants and options are outstanding, our ability to
obtain additional financing on favorable terms may be adversely affected.



Resale of our securities are and will continue to be subject to restrictions.



Our securities are subject to Rule 15g-9 under the Exchange Act, which imposes additional sales practice requirements on broker-dealers that sell
securities to persons other than established customers and accredited investors (generally, individuals with a net worth in excess of $1,000,000 or an annual income exceeding $200,000 or $300,000 together with their spouse). For
transactions covered by such rule, a broker-dealer must make a special suitability determination for the purchaser and receive the purchasers written consent to the transaction prior to the sale. Consequently, this rule may adversely affect
the ability of broker-dealers to sell our securities and may adversely affect the ability of the holders of our securities to sell such securities in the secondary market.



SEC regulations define a penny stock to be any non-NASDAQ equity security that has a market price (as therein
defined) of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. Prior to any transaction involving a penny stock, unless exempt, SEC rules require delivery of a disclosure schedule
prepared by the broker-dealer relating to the penny stock market. Disclosure is also required to be made about commissions payable to both the broker-dealer and the registered representative and about current quotations for the securities. Finally,
monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.



Possible Volatility of Market Price of Common Stock.



The market price of our securities, like that of many other emerging companies, has been highly volatile, experiencing wide
fluctuations not necessarily related to the operating performance of such companies. Factors such as our operating results, announcements by us or our competitors concerning innovations and new products or systems may have a significant impact on
the market price of our securities. In addition, we have experienced, and expect to continue experiencing limited trading volume in our Common Stock.



|Item 2. | Description of Property.
|------- | ------------------------



We lease a 28,000 square foot production, warehouse and office facility in Fairport Harbor, Ohio from a related entity, Senk Properties. Senk Properties
is a general partnership comprised of Dr. Steven Tsengas, Konstantine S. Tsengas, Nicholas S. Tsengas and Evangelia S. Tsengas. Dr. Tsengas is our Chairman, President, Chief Executive Officer, a director and a major stockholder of the
Company. Konstantine Tsengas is our Vice President and Secretary, as well as being a stockholder. Nicholas Tsengas and Evangelia Tsengas are both stockholders of OurPets. The current monthly rental is $12,490 plus real estate taxes with annual
increases based upon the change in the indicated consumer price index in the preceding year. The initial lease term was five years ending on May 31, 1998. The lease was extended for two additional five year terms ending on May 31,2008,
with the possibility of three additional term extensions of five years each. We believe that this facility will provide adequate warehouse and office space to meet our needs for the immediate future. Any longer-range future growth can be
accommodated by expanding that facility or leasing nearby space.



In the opinion of our management, all of the properties described here are adequately covered by insurance and such coverage is in accordance with the requirements contained in our various debt agreements.



7



---

##### Table of Contents

|Item 3. | Legal Proceedings.
|------- | ------------------



On March 31, 2000, SMP Company, Incorporated (formerly known as Sanar Manufacturing, Inc.) (SMP), a wholly-owned subsidiary of the
Company, entered into an asset purchase agreement with Akon Plastic Enterprises, Inc. (Akon) whereby Akon agreed to purchase substantially all of the assets used by SMP in molding plastics. Further, as part of the sale, Akon and its
President, David F. Harman (Harman), entered into an Indemnity Agreement whereby Akon and Harman, jointly and severally, agreed to indemnify us and the individual guarantors of the Small Business Administration loans to SMP against any
liability for such loans, which were assumed as a part of the asset purchase by Akon. In September 2000, Akon breached the asset purchase agreement and in October 2000, we filed suit in the Court of Common Pleas, Summit County, Ohio for damages,
including non-payment of loans, resulting from Akons breach of the asset purchase agreement. In December 2001, Harman filed a Third-Party Complaint against us alleging intentional infliction of emotional distress seeking compensatory and
punitive damages against us and the individual guarantors. Both actions were dismissed without prejudice in March 2003. On June 5, 2003, we re-filed the action against Akon, the directors of Akon, and Harman in the Court of Common Pleas of Lake
County, Ohio where it is currently pending. Discovery was completed and the parties to the litigation each filed motions for summary judgment. The court has not ruled yet on the summary judgment motions. While we believe that our case against Akon,
its directors, and Harman is strong, we cannot predict the likely outcome of this action.



In addition to the above matters and in the normal course of conducting its business, we may become involved in various other litigation, including, but not limited to, preference claims by debtors in bankruptcy
proceedings. We are not a party to any litigation or governmental proceeding which our management or legal representatives believe could result in any judgments or fines against us that would have a material adverse effect or impact in our financial
position, liquidity or results of operation.



|Item 4. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------



No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2005.



8



---

##### Table of Contents

PART II



|Item 5. | Market For Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities.
|------- | ---------------------------------------------------------------------------------------------------------------



Our Common Stock has been quoted on the Over-The-Counter
Bulletin Board Market under the symbol OPCO since December 13, 2001. The following table sets forth, for each of the quarters indicated, the high and low bid quotations per share of Common Stock in the over-the-counter market
(source, the Nasdaq Stock Chart). The bid quotations in the over-the-counter market represent prices between securities dealers, do not include retail markups, markdowns or commissions and may not represent actual transactions.



|                   |  |      |  |     
|------------------ |  | ---- |  | ----
|Quarter Ended      |  | High |  | Low 
|March 31, 2004     |  | 0.52 |  | 0.26
|June 30, 2004      |  | 0.45 |  | 0.23
|September 30, 2004 |  | 0.30 |  | 0.23
|December 31, 2004  |  | 0.31 |  | 0.24
|March 31, 2005     |  | 0.30 |  | 0.24
|June 30, 2005      |  | 0.38 |  | 0.22
|September 30, 2005 |  | 0.68 |  | 0.25
|December 31, 2005  |  | 0.50 |  | 0.26



As of March 27,
2006, we had approximately 178 holders of record of Common Stock.



During 2005, the Company issued warrants to certain Directors in consideration for their guaranty of the Companys bank loan, which issuances we believe are exempt transactions under Section 4(2) of the Securities Act. The
warrants issued are as follows:



|            |  |                 |  |                  |  |       |      |                 |           
|----------- |  | --------------- |  | ---------------- |  | ----- | ---- | --------------- | ----------
|Date Issued |  | Holder          |  | Number of Shares |  | Price |      | Expiration Date
|11/14/2005  |  | Joseph T. Aveni |  | 50,000           |  | $     | 0.43 |                 | 11/14/2010
|11/14/2005  |  | Carl Fazio, Jr. |  | 50,000           |  | $     | 0.43 |                 | 11/14/2010
|11/14/2005  |  | Steven Tsengas  |  | 50,000           |  | $     | 0.43 |                 | 11/14/2010



During 2005 and the
first quarter of 2006, the Company granted stock options to its employees under its 1999 Stock Option Plan, which issuances we believe are exempt transactions under Section 4(2) of the Securities Act. The options granted are as follows:



|             |  |                    |  |                  |  |       |      |                 |            |    
|------------ |  | ------------------ |  | ---------------- |  | ----- | ---- | --------------- | ---------- | ---
|Date Granted |  | Employee           |  | Number of Shares |  | Price |      | Expiration Date |           
|3/1/2005     |  | Matthew R.Avon     |  | 25,000           |  | $     | 0.26 |                 | 3/1/2010   |    
|5/18/2005    |  | Paul M. Catalano   |  | 10,000           |  | $     | 0.29 |                 | 10/31/2005 | (a)
|5/18/2005    |  | Scott T. Fitzhugh  |  | 10,000           |  | $     | 0.29 |                 | 5/18/2010  |    
|5/18/2005    |  | Sarah W. Holland   |  | 10,000           |  | $     | 0.29 |                 | 5/18/2010  |    
|7/5/2005     |  | Gerald A. Sciarini |  | 25,000           |  | $     | 0.30 |                 | 7/5/2010   |    
|12/30/2005   |  | Mary A. Kostelnik  |  | 500              |  | $     | 0.36 |                 | 12/30/2010 |    
|12/30/2005   |  | Timothy D. Kovacic |  | 500              |  | $     | 0.36 |                 | 12/30/2010 |    
|12/30/2005   |  | Mark M. McCauley   |  | 500              |  | $     | 0.36 |                 | 12/30/2010 |    
|1/9/2006     |  | Jerome A. Spelic   |  | 10,000           |  | $     | 0.45 |                 | 1/9/2011   |    
|2/1/2006     |  | David S. Deily     |  | 10,000           |  | $     | 0.46 |                 | 2/1/2011   |    
|2/14/2006    |  | Christina M. Dakis |  | 10,000           |  | $     | 0.47 |                 | 2/14/2011  |    

|(a) |  | Termination of employment.
|--- |  | --------------------------



Each share of Common Stock has an equal right to receive dividends when and if the Board of Directors decides to declare a dividend after payment of any
accrued dividends on Preferred Stock. We have never paid



9



---

##### Table of Contents

any cash dividends nor do we intend, in the foreseeable future, to make any cash distributions to our common stockholders as dividends. We cannot currently
distribute cash dividends without violating our loan agreement with our bank.



There are no conversion rights or redemption or sinking fund provisions with respect to the Common Stock. All of the outstanding shares of Common Stock are fully paid and non-assessable.



|Item 6. | Managements Discussion and Analysis or Plan of Operation.
|------- | ----------------------------------------------------------



Overview



OurPets develops, designs, produces and markets a broad line of innovative, high-quality accessory and consumable pet products. These
products include healthy feeding systems to improve the health and comfort of pets, interactive toys that provide fun, rewarding mental and physical challenges for pets, innovative maintenance to enhance the required maintenance needs of pets, and
healthy consumable products for achieving and maintaining high mental, physical and immune levels of pets. Examples of products in each of these categories include the following:



|                        |  |   |  |                                                                                                                          
|----------------------- |  | - |  | -------------------------------------------------------------------------------------------------------------------------
|Healthy Feeding Systems |  |  |  | Pet Diners Stainless Steel Bowls Automatic Feed and Water Dispensers Portable Dog Products Domestic and Wild Bird Feeders
|                        |  |  
|Interactive Toys        |  |  |  | Cat Toys Plush Toys Food Delivery Toys Bird Mirrors                                                                      
|                        |  |  
|Innovative Maintenance  |  |  |  | Waste Management Products Premium Cat
Litter                                                                             
|                        |  |  
|Healthy Consumables     |  |  |  | Nutritional Supplements Ice Cream
Alternatives Gourmet Gravies Gourmet
Sprays                                            



These products are
manufactured by domestic and foreign subcontractors and then sold by us to retailers and distributors who sell the products to the end consumer. According to the 2005/2006 APPMA National Pet Owners Survey approximately 69.1 million U.S.
households currently own a pet with an estimated pet population of 73.9 million dogs, 90.5 million cats and 18.2 million birds.



As discussed below and in Liquidity and Capital Resources on Pages 12, 13 and 14, we have funded our operations principally from net cash provided by
operating activities during 2004 and with bank borrowings in 2005.



In November of 2005, we entered into a promissory note agreement with our bank under which we could borrow up to $300,000 for working capital purposes. The note is payable in monthly payments of $9,870 including interest at 7.75% beginning
in February of 2006. During 2005 we borrowed a total of $82,405 under the agreement.



During 2005 we had a net borrowing of $350,000 from our line of credit facility with our bank under which we can borrow up to $1,500,000 based on the level of qualifying accounts receivable and inventories. At
December 31, 2005 and December 31, 2004 we had balances of $1,000,000 and $650,000, respectively, under the line of credit with the bank at an interest rate of prime plus 1%.



10



---

##### Table of Contents

Results of Operations



Year Ended December 31, 2005 Compared to Year Ended December 31, 2004



In the following discussion all references to 2005 are for the year ended December 31, 2005 and all references to 2004
are for the year ended December 31, 2004.



Net revenue for
2005 was $6,566,407, an increase of 20.6% in revenue from $5,445,049 in 2004, consisting of sales of proprietary products for the retail pet business. This increase of $1,121,358 was primarily the result of an increase in sales of approximately
$423,000 to one of our two major customers due to promotions of existing products and sales of new products. The balance of the increase was from sales to other customers which increased by approximately $698,000 including both sales of new products
and sales to new customers. Total sales to all customers of new products in 2005 that were not sold in 2004 including the Store-N-Feed To Go, Groovy Dog Toys and Play-N-Squeak product extensions were approximately $406,000. Our sales to foreign
customers decreased by approximately $39,000, or 18.7%, from 2004 mainly due to decreased sales to customers in England, Finland and Japan.



While net revenue increased by 20.6% in 2005, cost of goods sold also increased by 19.0%, from $3,987,013 in 2004 to $4,745,084 in 2005. This increase of
$758,071 was as a result of the cost of purchased products sold and freight increasing by 18.0% due mainly to higher freight costs as a result of fuel surcharges by our freight carriers. Our variable and fixed warehouse and overhead costs increased
by 23.7% from 2004 due to increased costs for salaries and wages for additional employees in engineering for product development and in warehouse operations to make displays for customer promotions and special packaging for direct sales by our
customers. Also costs increased for depreciation expense for tooling and shipping supplies for pallets used for shipments to customers.



As a result of the net revenue increasing by 20.6% and the cost of goods sold percentage increasing by 19.0%, our gross profit on sales increased by
24.9%, or $363,287, from $1,458,036 in 2004 to $1,821,323 in 2005.



Selling, general and administrative expenses in 2005 were $1,487,351, an increase of $98,490, or 7.1%, from $1,388,861 in 2004. The significant increases were in (i) increased salaries and wages of approximately $44,000 due to an
additional employee in sales and marketing, an additional employee in administration and the accruals for managers bonus and employee profit sharing, (ii) accruals for professional services of approximately $13,000 due to the services of
a marketing consultant and a consultant to upgrade our web site which were partially offset by reduced legal fees, (iii) the increase in the accrual for the allowance for doubtful accounts of $21,000 due to the bankruptcy filings by two of our
customers, and (iv) increased travel expenses of approximately $11,000 due to the additional sales employee in 2005.



The income from operations improved by $264,797, from $69,175 in 2004 to $333,972 in 2005 as a result of our gross profit on sales increasing by $363,287,
or 24.9%, which was more than the increase in selling, general and administrative expenses of $98,490, or 7.1%.



Interest expense for 2005 was $78,403 an increase of 45.3%, or $24,462, from $53,941 in 2004. This increase was primarily due to the interest expense for
the bank line of credit which increased by approximately $27,000 due to an increase in our interest rate paid and in the amount borrowed from 6.25% and $650,000 respectively at December 31, 2004 to 8.25% and $1,000,000 at December 31,
2005. This increase was partially offset by a decrease in the interest expense for the SBA debt which decreased by approximately $3,000 as a result of the reduced principal balances from the installment payments.



11



---

##### Table of Contents

The net income for 2005 was $254,238 as compared to net income in 2004 of $12,940 or an improvement in
profitability of $241,298. This improvement was as a result of the following changes from 2004 to 2005:



|                                                              |  |   |           |  
|------------------------------------------------------------- |  | - | --------- | -
|Net revenue increase of 20.6%                                 |  | $ | 1,121,358 |  
|Cost of goods sold increase of 19.0%                          |  |   | (758,071  | )
|                                                              |  |   |           |  
|Gross profit on sales increase of 24.9%                       |  |   | 363,287   |  
|Selling, general and administrative expenses increase of 7.1% |  |   | (98,490   | )
|Other income and expense decrease of 42.0%                    |  |   | 963       |  
|Interest expense increase of 45.3%                            |  |   | (24,462   | )
|                                                              |  |   |           |  
|Improvement in Profitability                                  |  | $ | 241,298   |  
|                                                              |  |   |           |  



Liquidity and Capital Resources



Our operating activities provide cash by the sale
of our products to customers with the principal use of cash being for the payments to suppliers that manufacture our products and for freight charges for shipments to our warehouse and to our customers. Our investing activities use cash mostly for
the acquisition of equipment such as tooling, computers and software. Our financing activities provide cash, if needed, under our line of credit with our bank that had approximately $143,000 in available funds at December 31, 2005 based upon
the balance of accounts receivable and inventories at that date.



As of December 31, 2005, we had $1,242,028 in principal amount of indebtedness consisting of:



|                                                |  |                     |  |   |          
|----------------------------------------------- |  | ------------------- |  | - | ---------
|Bank line of credit                             |  | Prime plus 1%       |  | $ | 1,000,000
|Bank term note                                  |  | 7.75%               |  |   | 82,405   
|Small Business Administration (SBA) term loan |  | 6.999%              |  |   | 22,534   
|Installment notes payable                       |  | 7.022% & 7.517%     |  |   | 37,089   
|Other notes payable                             |  | Prime plus 3% & 10% |  |   | 100,000  



The bank line of
credit borrowing of $1,000,000 is under our line of credit agreement with our bank under which we can borrow up to $1,500,000 based on the level of qualifying accounts receivable and inventories. The line of credit agreement is renewable annually by
the bank and therefore is classified as a current liability on our balance sheet. Currently the agreement has been renewed by the bank through June 30, 2006. Under our agreement with the bank we are currently required to maintain a debt service
coverage ratio of 1.15, a tangible net worth of $1,500,000, and obtain permission from the bank to incur additional indebtedness, enter into additional leases which cause total lease payments to exceed $190,280 in any fiscal year, make any
expenditures for property and equipment in excess of $300,000 in any fiscal year, and pay cash dividends or redeem any of our capital stock.



The term loan with the SBA is payable in monthly installments of $2,180 including interest through October 2006. The installment notes payable for the
purchase of warehouse equipment are due in monthly payments of $1,374 including interest through June 2008. The other notes payable are due in the amount of $75,000 on February 1, 2007, to Beachcraft L.P. and $25,000 to Over the Hill Ltd., plus
accrued interest. Our indebtedness, which is secured by liens on our assets, was used to finance our equipment and working capital requirements. The agreements related to such indebtedness contain the customary covenants and default provisions.



The note payable to Beachcraft L.P. was originally for
$150,000 and $75,000 was repaid in 2003. As of February 1, 2004, a new note payable to Beachcraft L.P. was issued to replace the $75,000 remaining balance. The replacement note is due on February 1, 2007 with interest payable quarterly at
prime plus 3%. In consideration for this refinancing we issued warrants for the purchase of 56,250 shares of Common Stock to Beachcraft L.P. at an exercise price of $0.30 per share with an expiration date of February 1, 2008. Subsequent to
their issuance the warrants were adjusted to 57,011 warrants exercisable at $0.296 per share in accordance with the warrant anti-dilution provisions.



12



---

##### Table of Contents

Our short-term and long-term liquidity will depend on our ability to achieve cash-flow break even on our
operations and to increase sales of our products. We recorded a profit of approximately $254,000 for the year ended 2005 and $13,000 for the year ended 2004. At year end 2001 we closed on a new bank line of credit facility with an increased line of
credit. As a result, absent a failure to maintain the required debt service coverage ratio and the tangible net worth, we should be able to fund our operating cash requirements for 2006. We have no material commitments for capital expenditures.



A schedule of our contractual obligations as of
December 31, 2005 is as follows:



|                                   |  |                        |           |                 |   |           |  |           |         |              |   |     |  |   |    
|---------------------------------- |  | ---------------------- | --------- | --------------- | - | --------- |  | --------- | ------- | ------------ | - | --- |  | - | ---
|                                   |  | Payments Due By Period
|Contractual Obligation             |  | Total                  |           | Less than1 year |   | 1-3 years |  | 4-5 years |         | After5 years
|Long-Term Debt                     |  | $                      | 1,242,028 |                 | $ | 1,219,185 |  | $         | 22,843  |              | $ | -0- |  | $ | -0-
|Capital Lease Obligations          |  |                        | -0-       |                 |   | -0-       |  |           | -0-     |              |   | -0- |  |   | -0-
|Purchase Obligations               |  |                        | -0-       |                 |   | -0-       |  |           | -0-     |              |   | -0- |  |   | -0-
|Other Long Term Liabilities        |  |                        | -0-       |                 |   | -0-       |  |           | -0-     |              |   | -0- |  |   | -0-
|Operating Leases                   |  |                        | 439,359   |                 |   | 178,164   |  |           | 261,195 |              |   | -0- |  |   | -0-
|                                   |  |                        |           |                 |   |           |  |           |         |              |   |     |  |   |    
|Total Contractual Cash Obligations |  | $                      | 1,681,387 |                 | $ | 1,397,349 |  | $         | 284,038 |              | $ | -0- |  | $ | -0-
|                                   |  |                        |           |                 |   |           |  |           |         |              |   |     |  |   |    



Net cash used in
operating activities for the year ended December 31, 2005 was $75,676. Cash was provided by the net income for the year of $497,926, which is net of the non-cash charges for depreciation of $223,949 and amortization of $19,739. Cash was used
for the net change of $(573,602) in our operating assets and liabilities as follows:



|                             |  |   |          |  
|---------------------------- |  | - | -------- | -
|Accounts receivable increase |  | $ | (229,739 | )
|Inventories increase         |  |   | (634,520 | )
|Prepaid expenses decrease    |  |   | 13,788   |  
|Patent cost increase         |  |   | (15,840  | )
|Other assets increase        |  |   | (153     | )
|Accounts payable increase    |  |   | 236,078  |  
|Accrued expenses increase    |  |   | 56,784   |  
|                             |  |   |          |  
|Net change                   |  | $ | (573,602 | )
|                             |  |   |          |  



Our accounts
receivable at December 31, 2005 increased by $229,739 from the amount at December 31, 2004 mainly as a result of our sales increasing by more than $200,000 in December 2005 compared to December 2004. The increase in inventory of $634,520
from December 31, 2004 to December 31, 2005 was caused principally by the increase in finished goods inventory due to increase in the number of products that we sell and to our products being added in early 2006 by some of our major
customers. Our accounts payable also increased from December 31, 2004 to December 31, 2005 by $236,078 mainly due to the increased amount of finished goods being purchased in December 2005 as compared to December 2004.



Net cash used in investing activities for the year ended December 31,
2005 was $342,320, which was used for the acquisition of property and equipment. Net cash provided by financing activities for the year was $395,484. Cash of $350,000 was provided by the net borrowing under the line of credit agreement with the bank
and $82,405 was provided by the borrowing under the term note with the bank. Cash of $36,921 was used for the principal payments on long-term debt.



Net cash provided by operating activities for the year ended December 31, 2004 was $370,186. Cash was provided by the net income for the year of
$237,852, which is net of the non-cash charges for depreciation of $214,525 and amortization of $10,387. Cash was provided by the net change of $132,334 in our operating assets and liabilities. These changes consisted of decreases in inventories of
$201,348 and prepaid expenses of $34,492



13



---

##### Table of Contents

and increases in accounts payable of $85,798 and in accrued expenses of $1,208, which were partially offset by increases in accounts receivable of $71,734,
patent costs of $117,639 and domain name and other assets of $1,139.



Net cash used in investing activities for the year ended December 31, 2004 was $297,010, which was used for the acquisition of property and equipment. Net cash used in financing activities for the year was $80,779. Cash was used for
$76,889 for the principal payments on long-term debt and $3,890 was used for the principal payments on capital lease obligations.



Critical Accounting Policies and Estimates



We prepare our consolidated financial statements in accordance with United States generally accepted accounting principles. We have identified the
accounting policies below as critical to our business operations and understanding of our results of operations. For a detailed discussion on the application of these and other accounting policies, see Summary of Significant Accounting Policies
footnote to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-KSB. The application of these policies may require management to make judgments and estimates that affect the reported amount of assets and
liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. Management uses historical experience and all available information
to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.



Inventories.    Inventories are stated at the lower of cost or net realizable value. We estimate net realizable value based on
intended use, current market value and inventory ageing analyses. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.



Impairment of Long-Lived Assets.    We review long-lived assets for possible impairment by
evaluating whether the carrying amount of assets exceed its recoverable amount. Our judgment regarding the existence of impairment is based on legal factors, market conditions and operational performance of our assets. Future adverse changes in
legal environment, market conditions or poor operating results could result in losses or an inability to recover the carrying value of the long-lived assets, thereby possibly requiring an impairment charge in the future.



Research and Development Expenses.    Research and
development expenditures are charged to operations when incurred and are included in cost of goods sold. If funding is not available from operations our ability to develop new and/or improved products could be adversely affected.



Off-Balance Sheet Arrangements



We have no off-balance sheet arrangements that have or are likely to have a
current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.



14



---

##### Table of Contents

|Item 7. | Financial Statements
|------- | --------------------



The financial statements of OurPets Company as of December 31, 2005 and 2004, and for the years then ended together with the Report of
Independent Registered Public Accounting Firm are included in this Form 10-KSB on the pages indicated below.



|                                                        |  |         
|------------------------------------------------------- |  | --------
|                                                        |  | Page No.
|Report of Independent Registered Public Accounting Firm |  | 20      
|Consolidated Balance Sheets                             |  | 21      
|Consolidated Statements of Operations                   |  | 22      
|Consolidated Statements of Stockholders Equity         |  | 23      
|Consolidated Statements of Cash Flows                   |  | 24      
|Notes to Consolidated Financial Statements              |  | 25      



|Item 8. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
|------- | -------------------------------------------------------------------------------------



During our two most recent calendar years or any later interim period, there
have been no changes in, or disagreements with, our principal independent accountant or a significant subsidiarys independent accountant.



|Item 8A. | Controls and Procedures.
|-------- | ------------------------



As of December 31, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our President
and Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Rule 13a-15(b) of the Securities Exchange Act of 1934. Based upon
that evaluation, our President and Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including
our consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal controls over financial reporting or in other factors which could significantly affect internal controls over
financial reporting that occurred during our most recent fiscal quarter.



|Item 8B. | Other Information.
|-------- | ------------------



None.



15



---

##### Table of Contents

PART III



|Item 9. | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.
|------- | ----------------------------------------------------------------------------------------------------------------



The information required by this Item with respect to the directors,
executive officers, promoters, control persons and compliance with Section 16(a) of the Securities and Exchange Act and our Code of Ethics is incorporated by reference from the information provided under the headings Election of
Directors, Executive Compensation and Other Matters, respectively, contained in our Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our Annual
Meeting of Shareholders to be held on May 17, 2006.



|Item 10. | Executive Compensation.
|-------- | -----------------------



The information required by this Item is incorporated by reference from the information provided under the headings Executive Compensation,
Compensation of Directors and Employment Contracts and Termination of Employment and Change-in-Control Arrangements, respectively, contained in our Proxy Statement.



|Item 11. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
|-------- | -----------------------------------------------------------------------------------------------



Equity Compensation Plan Information



|                                                           |  |                                                                                           |  |                                                                           |  |                                                                                                                                        
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|Plan Category                                              |  | Number of Securities to be Issued Upon Exercise
ofOutstanding Options,Warrants and Rights |  | Weighted Average Exercise Price ofOutstanding Options,Warrants and Rights |  | Number of SecuritiesRemaining Availablefor Future Issuance Under Equity Compensation
Plans(Excluding SecuritiesReflected in Column (a))
|                                                           |  | (a)                                                                                       |  | (b)                                                                       |  | (c)                                                                                                                                    
|Equity compensation plans approved by security holders     |  | 918,000                                                                                   |  | $0.330                                                                    |  | 432,000                                                                                                                                
|Equity compensation plans not approved by security holders |  | 25,614                                                                                    |  | $1.220                                                                    |  | -0-                                                                                                                                    
|                                                           |  |                                                                                           |  |                                                                           |  |                                                                                                                                        
|Total                                                      |  | 943,614                                                                                   |  | $0.355                                                                    |  | 432,000                                                                                                                                
|                                                           |  |                                                                                           |  |                                                                           |  |                                                                                                                                        



The equity
compensation plans not approved by security holders include the issuance of 25,614 warrants at $1.220 per share in 2002 to purchase Common Stock which expire on August 2, 2007 as payment in full for investor relations services to an unrelated
firm.



Other information required by this Item is incorporated
herein by reference from the information provided under the heading Security Ownership of Certain Beneficial Owners and Management of our Proxy Statement.



|Item 12. | Certain Relationships and Related Transactions.
|-------- | -----------------------------------------------



The information required by this Item is incorporated herein by reference from the information provided under the heading Certain Relationships
and Related Transactions of our Proxy Statement.



16



---

##### Table of Contents

|Item 13. | Exhibits.
|-------- | ---------



|      |  |                                                                                                                                                                                                                                                                                                                                                   
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1   |  | Asset Purchase Agreement dated January 3, 2006, between the Company and Pet Zone Products Ltd.(5)                                                                                                                                                                                                                                                 
|      | 
|3.1   |  | Articles of Incorporation of the Company, dated May 23, 1996.(1)                                                                                                                                                                                                                                                                                  
|      | 
|3.1.1 |  | Articles of Amendment to the Articles of Incorporation of the Company, effective September 1, 1998.(1)                                                                                                                                                                                                                                            
|      | 
|3.1.2 |  | Articles of Amendment to the Articles of Incorporation of the Company, adopted July 20, 1999.(1)                                                                                                                                                                                                                                                  
|      | 
|3.2   |  | Bylaws of the Company.(1)                                                                                                                                                                                                                                                                                                                         
|      | 
|4.1   |  | Common Stock Certificate.(1)                                                                                                                                                                                                                                                                                                                      
|      | 
|4.2   |  | Preferred Stock Certificate.(1)                                                                                                                                                                                                                                                                                                                   
|      | 
|4.3   |  | Promissory Note dated September 1, 1999 for $200,000, made by the Company to Joseph T. Aveni.(1)                                                                                                                                                                                                                                                  
|      | 
|4.4   |  | Registration Rights Agreement dated January 3, 2006 among the Company, Pet Zone Products Ltd. and certain other stockholders.(5)                                                                                                                                                                                                                  
|      | 
|4.5   |  | Voting Agreement dated January 3, 2006 among the Company, Steven Tsengas, Evangelia S. Tsengas, Konstantine S. Tsengas, Nicholas S. Tsengas, Senk Properties, Joseph T. Aveni, Carl Fazio, Jr.,
John G. Murchie, Pet Zone Products Ltd., Capital One Partners, LLC, LJR Limited Partnership, Nottingham Ventures, Ltd. and Spirk Ventures, Ltd.(5)
|      | 
|10.1  |  | Asset Purchase Agreement, dated March 31, 2000, between Akon Plastic Enterprises, Inc. and Sanar Manufacturing Company, a wholly-owned subsidiary of OurPets Company.(1)                                                                                                                                                                         
|      | 
|10.2  |  | Lease Agreement dated March 17, 1993, with Addendums, between Senk Properties and GPI Division, NAPRO, Inc.(1)                                                                                                                                                                                                                                    
|      | 
|10.5  |  | 1999 Stock Option Plan.(1)                                                                                                                                                                                                                                                                                                                        
|      | 
|10.6  |  | Standard Option Agreement.(1)                                                                                                                                                                                                                                                                                                                     
|      | 
|10.7  |  | Standard Common Stock Purchase Warrant.(1)                                                                                                                                                                                                                                                                                                        
|      | 
|10.8  |  | Indemnity Agreement, dated March 31, 2000, between Akron Plastic Enterprises, Inc. and its President, David Harman, individually, and OurPets Company and Dr. Steven Tsengas, Evangelia
Tsengas, Nicholas Tsengas and Konstantine Tsengas.(1)                                                                                                    
|      | 
|10.10 |  | Small Business Administration loan agreement dated March 10, 1995 with Napro, Inc.(1)                                                                                                                                                                                                                                                             
|      | 
|10.12 |  | Vendor Agreement between the Company and Wal-Mart Stores, Inc.(1)                                                                                                                                                                                                                                                                                 
|      | 
|10.17 |  | PetsMart 2001 Vendor Purchasing Terms.(1)                                                                                                                                                                                                                                                                                                         
|      | 
|10.18 |  | Credit Agreement, Revolving Note and Security Agreements, dated December 31, 2001, between FirstMerit Bank, N.A., the Company, Virtu Company, Dr. Steven Tsengas and Evangelia S.
Tsengas.(2)                                                                                                                                                     
|      | 
|10.19 |  | Promissory Note dated February 1, 2004 for $75,000, made by the Company to Beachcraft Limited Partnership.(4)                                                                                                                                                                                                                                     
|      | 
|10.20 |  | Warrant issued to Pet Zone Products Ltd. to purchase 2,729,000 shares of the Companys Common Stock dated January 4, 2006.(5)                                                                                                                                                                                                                     
|      | 
|10.21 |  | Warrant issued to Pet Zone Products Ltd. to purchase 125,000 shares of the Companys Common Stock dated January 4, 2006.(5)                                                                                                                                                                                                                       
|      | 
|10.22 |  | Subordinated Promissory Note dated January 4, 2006 from the Company to Pet Zone Products Ltd.(5)                                                                                                                                                                                                                                                  
|      | 
|11    |  | Statement of computation of Net Income (Loss) Per Share.                                                                                                                                                                                                                                                                                          
|      | 
|14    |  | OurPets Code of Ethics.(3)                                                                                                                                                                                                                                                                                                                       
|      | 
|21    |  | Subsidiaries of the Registrant.(1)                                                                                                                                                                                                                                                                                                                
|      | 
|31.1  |  | Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                             



17



---

##### Table of Contents

|     |  |                                                                                                                                                                     
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.2 |  | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                             
|     | 
|32.1 |  | Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|     | 
|32.2 |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.              

---

|(1) |  | Incorporated by reference to the exhibits to the Companys Registration Statement on Form 10SB/A filed on May 31, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference to the exhibits to the Companys Annual Report on Form 10-KSB filed on March 26, 2002.
|--- |  | ----------------------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference to the exhibits to the Companys Annual Report of Form 10-KSB filed on March 26, 2004.
|--- |  | ----------------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference to the exhibits to the Companys Annual Report of Form 10-KSB filed on March 30, 2005.
|--- |  | ----------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference to the exhibits to the Companys Form 8-K filed on January 6, 2006.
|--- |  | ---------------------------------------------------------------------------------------------



All other Exhibits filed herewith.



|Item 14. | Principal Accountant Fees and Services.
|-------- | ---------------------------------------



The information required by this Item is incorporated by reference from the information provided under the heading Principal Accountant Fees and
Services contained in our Proxy Statement.



18



---

##### Table of Contents

SIGNATURES



In accordance with
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



Dated: April 7, 2006



OURPETS COMPANYBy:

/s/    STEVEN
TSENGASSteven TsengasChairman, President and Chief Executive Officer




Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                                                |  |                                                                                         |  |              
|----------------------------------------------- |  | --------------------------------------------------------------------------------------- |  | -------------
|Signature                                       |  | Title                                                                                   |  | Date         
|                                                |  |                                                                                        
|/s/    STEVEN TSENGASSteven Tsengas             |  | Chairman, President, Chief Executive Officer and Director (principal executive officer) |  | April 7, 2006
|                                                |  |                                                                                        
|/s/    JOHN G. MURCHIEJohn G. Murchie           |  | Vice President, Treasurer and Controller (principal accounting officer)                 |  | April 7, 2006
|                                                |  |                                                                                        
|/s/    JOSEPH T. AVENIJoseph T. Aveni           |  | Director                                                                                |  | April 7, 2006
|                                                |  |                                                                                        
|/s/    CARL FAZIO,
JR.Carl Fazio, Jr            |  | Director                                                                                |  | April 7, 2006
|                                                |  |                                                                                        
|/s/    JAMES D. IRELAND
IIIJames D. Ireland III |  | Director                                                                                |  | April 7, 2006
|                                                |  |                                                                                        
|/s/    JOHN SPIRKJohn Spirk                     |  | Director                                                                                |  | April 7, 2006



19



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Stockholders and Board of Directors

OurPets Company and Subsidiaries



We have audited the accompanying consolidated balance sheets of OurPets Company and Subsidiaries, a Colorado corporation, as of December 31, 2005 and December 31, 2004, 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 audits.



We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of
OurPets Company and Subsidiaries as of December 31, 2005 and December 31, 2004, and the consolidated results of their operations and cash flows for the years ended December 31, 2005 and December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America.



S. R. SNODGRASS, A. C.

Certified Public Accountants



Mentor, Ohio

March 13, 2006



20



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                                                                                                |  | December 31, |           
|                                                                                                                                                                                                                |  | 2005         |            |   | 2004 |  
|ASSETS                                                                                                                                                                                                          |  |              |            |   |      |   |            |  
|CURRENT ASSETS                                                                                                                                                                                                  |  |              |            |   |      |   |            |  
|Cash and cash equivalents                                                                                                                                                                                       |  | $            | 6,477      |   |      | $ | 28,989     |  
|Accounts receivabletrade, less allowance for doubtful accounts of $ 18,249 and $ 15,466                                                                                                                        |  |              | 930,772    |   |      |   | 701,033    |  
|Inventories                                                                                                                                                                                                     |  |              | 2,060,172  |   |      |   | 1,425,652  |  
|Prepaid expenses                                                                                                                                                                                                |  |              | 98,964     |   |      |   | 112,752    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total current assets                                                                                                                                                                                            |  |              | 3,096,385  |   |      |   | 2,268,426  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|PROPERTY AND EQUIPMENT                                                                                                                                                                                          |  |              |            |   |      |   |            |  
|Computers and office equipment                                                                                                                                                                                  |  |              | 196,198    |   |      |   | 155,263    |  
|Warehouse equipment                                                                                                                                                                                             |  |              | 107,453    |   |      |   | 106,389    |  
|Leasehold improvements                                                                                                                                                                                          |  |              | 31,927     |   |      |   | 25,393     |  
|Tooling                                                                                                                                                                                                         |  |              | 1,423,639  |   |      |   | 1,283,930  |  
|Construction in progress                                                                                                                                                                                        |  |              | 263,362    |   |      |   | 109,284    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total                                                                                                                                                                                                           |  |              | 2,022,579  |   |      |   | 1,680,259  |  
|Less accumulated depreciation                                                                                                                                                                                   |  |              | 1,159,860  |   |      |   | 935,911    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Net property and equipment                                                                                                                                                                                      |  |              | 862,719    |   |      |   | 744,348    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|OTHER ASSETS                                                                                                                                                                                                    |  |              |            |   |      |   |            |  
|Patents, less amortization of $65,857 and $46,118                                                                                                                                                               |  |              | 207,589    |   |      |   | 211,488    |  
|Domain name and other assets                                                                                                                                                                                    |  |              | 11,387     |   |      |   | 11,234     |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total other assets                                                                                                                                                                                              |  |              | 218,976    |   |      |   | 222,722    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total assets                                                                                                                                                                                                    |  | $            | 4,178,080  |   |      | $ | 3,235,496  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|LIABILITIES                                                                                                                                                                                                     |  |              |            |   |      |   |            |  
|CURRENT LIABILITIES                                                                                                                                                                                             |  |              |            |   |      |   |            |  
|Notes payable                                                                                                                                                                                                   |  | $            | 1,100,000  |   |      | $ | 675,000    |  
|Current maturities of long-term debt                                                                                                                                                                            |  |              | 119,185    |   |      |   | 36,920     |  
|Accounts payabletrade                                                                                                                                                                                          |  |              | 867,612    |   |      |   | 631,534    |  
|Accrued expenses                                                                                                                                                                                                |  |              | 150,687    |   |      |   | 93,903     |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total current liabilities                                                                                                                                                                                       |  |              | 2,237,484  |   |      |   | 1,437,357  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|LONG-TERM DEBT                                                                                                                                                                                                  |  |              |            |   |      |   |            |  
|Long-term debtless current portion above                                                                                                                                                                       |  |              | 22,843     |   |      |   | 134,624    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total long-term debt                                                                                                                                                                                            |  |              | 22,843     |   |      |   | 134,624    |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total liabilities                                                                                                                                                                                               |  |              | 2,260,327  |   |      |   | 1,571,981  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|STOCKHOLDERS EQUITY                                                                                                                                                                                            |  |              |            |   |      |   |            |  
|COMMON STOCK, no par value; authorized 50,000,000 shares, issued and outstanding 11,887,473 and 11,771,473 shares                                                                                               |  |              | 2,925,751  |   |      |   | 2,853,693  |  
|CONVERTIBLE PREFERRED STOCK, no par value; convertible into Common Stock at the rate of 10 common shares for each preferred share; authorized
5,000,000 shares, issued and outstanding 66,000 and 71,000 shares |  |              | 602,679    |   |      |   | 648,337    |  
|PAID-IN CAPITAL                                                                                                                                                                                                 |  |              | 122,646    |   |      |   | 149,046    |  
|ACCUMULATED DEFICIT                                                                                                                                                                                             |  |              | (1,733,323 | ) |      |   | (1,987,561 | )
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total stockholders equity                                                                                                                                                                                      |  |              | 1,917,753  |   |      |   | 1,663,515  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                      |  | $            | 4,178,080  |   |      | $ | 3,235,496  |  
|                                                                                                                                                                                                                |  |              |            |   |      |   |            |  



The accompanying notes
are an integral part of the consolidated financial statements.



21



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                                                                           |  |                                  |            |   |      |   |            |  
|-------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                           |  | For the Years Ended December 31, |           
|                                                                                                                           |  | 2005                             |            |   | 2004 |  
|Net revenue                                                                                                                |  | $                                | 6,566,407  |   |      | $ | 5,445,049  |  
|Cost of goods sold                                                                                                         |  |                                  | 4,745,084  |   |      |   | 3,987,013  |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Gross profit on sales                                                                                                      |  |                                  | 1,821,323  |   |      |   | 1,458,036  |  
|Selling, general and administrative expenses                                                                               |  |                                  | 1,487,351  |   |      |   | 1,388,861  |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Income from operations                                                                                                     |  |                                  | 333,972    |   |      |   | 69,175     |  
|Other income and expense, net                                                                                              |  |                                  | (1,331     | ) |      |   | (2,294     | )
|Interest expense                                                                                                           |  |                                  | (78,403    | ) |      |   | (53,941    | )
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Income before income taxes                                                                                                 |  |                                  | 254,238    |   |      |   | 12,940     |  
|Income tax expense                                                                                                         |  |                                  |           |   |      |   |           |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Net income                                                                                                                 |  | $                                | 254,238    |   |      | $ | 12,940     |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Basic and Diluted Earnings Per Common Share After Dividend Requirements For Preferred Stock:                               |  |                                  |            |   |      |   |            |  
|Net income                                                                                                                 |  | $                                | 0.02       |   |      | $ |           |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  
|Weighted average number of common and equivalent shares outstanding used to calculate basic and diluted earnings per share |  |                                  | 11,930,298 |   |      |   | 11,712,306 |  
|                                                                                                                           |  |                                  |            |   |      |   |            |  







The accompanying notes are an integral part of the consolidated financial
statements.



22



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

For the Years Ended December 31, 2005 and December 31, 2004



|                                                           |  |                 |   |  |              |         |   |                 |            |        |   |                |                           |   |                    |   |  |   |            |   |  |   |          
|---------------------------------------------------------- |  | --------------- | - |  | ------------ | ------- | - | --------------- | ---------- | ------ | - | -------------- | ------------------------- | - | ------------------ | - |  | - | ---------- | - |  | - | ---------
|                                                           |  | Preferred Stock |   |  | Common Stock |         |   |                 |            |        |   |                | Total StockholdersEquity
|                                                           |  | Number ofShares |   |  | Amount       |         |   | Number ofShares |            | Amount |   | Paid-InCapital |                           |   | AccumulatedDeficit |   | 
|Balance at January 1, 2004                                 |  | 71,000          |   |  | $            | 648,337 |   |                 | 11,700,473 |        | $ | 2,832,393      |                           | $ | 170,346            |   |  | $ | (2,000,501 | ) |  | $ | 1,650,575
|Common Stock issued in payment of Preferred Stock dividend |  |                |   |  |              |        |   |                 | 71,000     |        |   | 21,300         |                           |   | (21,300            | ) |  |   |           |   |  |   |         
|Net income for the year                                    |  |                |   |  |              |        |   |                 |           |        |   |               |                           |   |                   |   |  |   | 12,940     |   |  |   | 12,940   
|                                                           |  |                 |   |  |              |         |   |                 |            |        |   |                |                           |   |                    |   |  |   |            |   |  |   |          
|Balance at December 31, 2004                               |  | 71,000          |   |  |              | 648,337 |   |                 | 11,771,473 |        |   | 2,853,693      |                           |   | 149,046            |   |  |   | (1,987,561 | ) |  |   | 1,663,515
|Preferred Stock converted into Common Stock                |  | (5,000          | ) |  |              | (45,658 | ) |                 | 50,000     |        |   | 45,658         |                           |   |                   |   |  |   |           |   |  |   |         
|Common Stock issued in payment of Preferred Stock dividend |  |                |   |  |              |        |   |                 | 66,000     |        |   | 26,400         |                           |   | (26,400            | ) |  |   |           |   |  |   |         
|Net income for the year                                    |  |                |   |  |              |        |   |                 |           |        |   |               |                           |   |                   |   |  |   | 254,238    |   |  |   | 254,238  
|                                                           |  |                 |   |  |              |         |   |                 |            |        |   |                |                           |   |                    |   |  |   |            |   |  |   |          
|Balance at December 31, 2005                               |  | 66,000          |   |  | $            | 602,679 |   |                 | 11,887,473 |        | $ | 2,925,751      |                           | $ | 122,646            |   |  | $ | (1,733,323 | ) |  | $ | 1,917,753
|                                                           |  |                 |   |  |              |         |   |                 |            |        |   |                |                           |   |                    |   |  |   |            |   |  |   |          







The accompanying notes are an integral part of the consolidated financial
statements.



23



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                            |  |                                 |          |   |      |   |          |  
|------------------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                            |  | For the YearsEnded December 31, |         
|                                                                                            |  | 2005                            |          |   | 2004 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                                        |  |                                 |          |   |      |   |          |  
|Net income                                                                                  |  | $                               | 254,238  |   |      | $ | 12,940   |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                                 |          |   |      |   |          |  
|Depreciation expense                                                                        |  |                                 | 223,949  |   |      |   | 214,525  |  
|Amortization expense                                                                        |  |                                 | 19,739   |   |      |   | 10,387   |  
|(Increase) decrease in assets:                                                              |  |                                 |          |   |      |   |          |  
|Accounts receivabletrade                                                                   |  |                                 | (229,739 | ) |      |   | (71,734  | )
|Inventories                                                                                 |  |                                 | (634,520 | ) |      |   | 201,348  |  
|Prepaid expenses                                                                            |  |                                 | 13,788   |   |      |   | 34,492   |  
|Patent costs                                                                                |  |                                 | (15,840  | ) |      |   | (117,639 | )
|Domain name and other assets                                                                |  |                                 | (153     | ) |      |   | (1,139   | )
|Increase in liabilities:                                                                    |  |                                 |          |   |      |   |          |  
|Accounts payabletrade                                                                      |  |                                 | 236,078  |   |      |   | 85,798   |  
|Accrued expenses                                                                            |  |                                 | 56,784   |   |      |   | 1,208    |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|Net cash provided by (used in) operating activities                                         |  |                                 | (75,676  | ) |      |   | 370,186  |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                        |  |                                 |          |   |      |   |          |  
|Acquisition of property and equipment                                                       |  |                                 | (342,320 | ) |      |   | (297,010 | )
|                                                                                            |  |                                 |          |   |      |   |          |  
|Net cash used in investing activities                                                       |  |                                 | (342,320 | ) |      |   | (297,010 | )
|                                                                                            |  |                                 |          |   |      |   |          |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                        |  |                                 |          |   |      |   |          |  
|Principal payments on long-term debt                                                        |  |                                 | (36,921  | ) |      |   | (76,889  | )
|Net borrowing on bank line of credit                                                        |  |                                 | 350,000  |   |      |   |         |  
|Issuance of long-term debt                                                                  |  |                                 | 82,405   |   |      |   |         |  
|Principal payments under capital lease obligations                                          |  |                                 |         |   |      |   | (3,890   | )
|                                                                                            |  |                                 |          |   |      |   |          |  
|Net cash provided by (used in) financing activities                                         |  |                                 | 395,484  |   |      |   | (80,779  | )
|                                                                                            |  |                                 |          |   |      |   |          |  
|Net decrease in cash                                                                        |  |                                 | (22,512  | ) |      |   | (7,603   | )
|CASH AT BEGINNING OF YEAR                                                                   |  |                                 | 28,989   |   |      |   | 36,592   |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|CASH AT END OF YEAR                                                                         |  | $                               | 6,477    |   |      | $ | 28,989   |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                                            |  |                                 |          |   |      |   |          |  
|Interest paid                                                                               |  | $                               | 69,475   |   |      | $ | 55,948   |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|SUPPLEMENTAL DISCLOSURE OF NON CASH TRANSACTIONS                                            |  |                                 |          |   |      |   |          |  
|Common Stock issued in payment of Preferred Stock dividend                                  |  | $                               | 26,400   |   |      | $ | 21,300   |  
|                                                                                            |  |                                 |          |   |      |   |          |  
|Preferred Stock converted into Common Stock                                                 |  | $                               | 45,658   |   |      | $ |         |  
|                                                                                            |  |                                 |          |   |      |   |          |  



The accompanying notes
are an integral part of the consolidated financial statements.



24



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Summary of
Significant Accounting Policies



Organization and
Nature of OperationsOurPets Company (the Company) management originally founded Napro, Inc. (Napro), an Ohio corporation, in 1985 as an enterprise for launching new ventures and acquiring companies in various
lines of business. In February 1996 Napro formed a wholly-owned Ohio subsidiary, Virtu Company (Virtu), to market proprietary products to the retail pet business under the OurPets label. Napro then changed its name to OurPets
Company effective March 19, 1998. On July 16, 1998, Manticus, Inc. (Manticus) obtained all of the outstanding shares of OurPets Company in exchange for 8,000,000 shares of common stock of Manticus in a transaction
accounted for as a pooling of interests. After the transaction, the holders of the former OurPets shares owned approximately 89% of the shares of Manticus, resulting in a reverse takeover. On October 12, 1998, Manticus changed its name to
OurPets Company.



The accompanying consolidated financial
statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of the Company and its wholly owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.



Use of EstimatesThe preparation of financial
statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



Policy of Cash EquivalentsFor purposes of the financial statements, cash equivalents include time deposits,
certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.



InventoryInventories are carried at the lower of cost, first-in, first-out method or market. Inventories at December 31, 2005 and
December 31, 2004 consist of:



|                         |  |      |           |      |   |          
|------------------------ |  | ---- | --------- | ---- | - | ---------
|                         |  | 2005 |           | 2004
|Finished goods           |  | $    | 1,620,421 |      | $ | 1,057,054
|Components and packaging |  |      | 439,751   |      |   | 368,598  
|                         |  |      |           |      |   |          
|Total                    |  | $    | 2,060,172 |      | $ | 1,425,652
|                         |  |      |           |      |   |          



All inventories are
pledged as collateral for bank and small business administration loans.



ImpairmentsAssets are evaluated for impairment when events change or change in circumstances indicates that the carrying amounts of the assets may not be recoverable. When any such impairment exists, the related assets are
written down to fair value.



Property and
EquipmentProperty and equipment are reported at cost. Depreciation and amortization are provided by using the straight-line and accelerated methods over the estimated useful lives of the assets. Amortization of assets under capital leases
and leasehold improvements is provided on a straight-line basis over the lesser of the useful lives of the related assets or the terms of the leases. The estimated useful lives of the assets are as follows:



|                               |  |             
|------------------------------ |  | ------------
|Computers and office equipment |  | 3 to 7 years
|Leasehold improvements         |  | 39 years    
|Tooling                        |  | 3 to 7 years
|Warehouse equipment            |  | 5 to 7 years



25



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Summary of Significant Accounting Policies (Continued)



All property and equipment is pledged as collateral for bank and small business administration loans.
Total depreciation for the years ended December 31, 2005 and December 31, 2004 was $ 223,949 and $ 214,525, respectively.



Intangible AssetsThe Company has filed for patents and trademarks for its proprietary products. The costs incurred of $15,840 in the year
ended December 31, 2005 and $117,639 in the year ended December 31, 2004 have been capitalized and are being amortized over 15 years on a straight-line basis. In 2002 the Company purchased a domain name for its website for $10,000 which is
not subject to amortization. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense. All intangible assets are pledged as collateral for the
bank loans.



Revenue Recognition and Major
CustomersWith respect to revenue from product sales, revenue is recognized only upon shipment of products to customers. The Company derives its revenues from the sale of proprietary pet products under the OurPets brand name. Net
revenue is comprised of gross sales less discounts given to distributors and returns and allowances.



For the year ended December 31, 2005, 46.7% of the Companys revenue was derived from two major customers. Revenue generated from each of these
customers amounted to $ 1,537,852 and $ 1,530,629, which represents 23.4% and 23.3% of total revenue, respectively.



For the year ended December 31, 2004, 45.7% of the Companys revenue was derived from two major customers. Revenue generated from each of these
customers amounted to $ 1,656,928 and $ 830,915, which represents 30.4% and 15.3% of total revenue, respectively.



Research and Development CostsResearch and development costs are charged to operations when incurred and are included in cost of goods sold.
The amount charged for the years ended December 31, 2005 and December 31, 2004 was $ 66,746 and $ 51,661, respectively.



Advertising CostsAdvertising costs are charged to operations when the advertising first takes place. Advertising expense for the years ended
December 31, 2005 and December 31, 2004 was $ 20,040 and $ 41,040, respectively.



Stock OptionsThe Company adopted Financial Accounting Standards Statement No. 123, Accounting for Stock-Based Compensation. This statement encourages, but does not require, the Company to
recognize compensation expense for all awards of equity instruments issued. The statement established a fair value based method of accounting for stock-based compensation plans. The standard applies to all transactions in which an entity acquires
goods or services by issuing equity instruments or by incurring liabilities in amounts based on the price of the entitys common stock or other equity instruments. Statement No. 123 permits companies to continue to account for such
transactions under Accounting Principles Board Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees, but requires disclosure of pro forma net income and earnings per share as if the Company had applied the new
method.



The Company has elected to follow APB No. 25, and
related interpretations, in accounting for its employee stock options. Accordingly, no compensation expense has been recognized with respect to the options granted to employees under the stock option plan. Had compensation expense been determined on
the basis of fair value pursuant to Statement No. 123, the Company estimated the fair value of each stock option at the date of grant by using the Black-Scholes option-pricing model with the following weighted-average assumptions: No dividend
yield, an expected life of 5 years, an expected volatility of 50%, and a risk-free interest rate of 5.0% in 2005 and 3.5% in 2004.



26



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Summary of Significant Accounting Policies (Continued)



For purposes of pro forma disclosures, the estimated fair value of the options granted in 2005, 2004,
2003, 2002 and 2001 is amortized to expense from the date of grant to the date of expiration. The weighted-average fair value of options granted during 2005 and 2004 were $0.12 and $0.09, respectively. The Companys pro forma information
follows:



|                                              |  |                         |         |      |   |         |  
|--------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------- | -
|                                              |  | Year Ended December 31, |        
|                                              |  | 2005                    |         | 2004 |  
|Net income (loss) applicable to Common Stock: |  |                         |         |      |   |         |  
|As reported                                   |  | $                       | 227,838 |      | $ | (8,360  | )
|Less pro forma expense related to options     |  |                         | 16,203  |      |   | 10,768  |  
|                                              |  |                         |         |      |   |         |  
|Pro forma                                     |  | $                       | 211,635 |      | $ | (19,128 | )
|                                              |  |                         |         |      |   |         |  
|Basic Net Income (Loss) per Common Share:     |  |                         |         |      |   |         |  
|As reported                                   |  |                         | 0.02    |      |   | (0.00   | )
|Pro forma                                     |  |                         | 0.02    |      |   | (0.00   | )
|Diluted Net Income (Loss) per Common Share:   |  |                         |         |      |   |         |  
|As reported                                   |  |                         | 0.02    |      |   | (0.00   | )
|Pro forma                                     |  |                         | 0.02    |      |   | (0.00   | )



Net Income (Loss)
Per Common ShareBasic and diluted net income (loss) per Common Share is based on the net income (loss) attributable to common stockholders after preferred stock dividend requirements for the year, divided by the weighted average number of
common and equivalent dilutive shares outstanding during the year. Potential common shares whose effect would be antidilutive have not been included. As of December 31, 2005, common shares that are or could be potentially dilutive include
888,000 stock options at exercise prices from $0.210 to $0.625 a share, 932,754 warrants to purchase Common Stock at exercise prices from $0.286 to $1.220 a share and 660,000 shares underlying the Preferred Stock at a conversion rate of $1.000 per
share. As of December 31, 2004, common shares that are or could be potentially dilutive include 874,750 stock options at exercise prices from $0.100 to $0.625 a share, 791,880 warrants to purchase Common Stock at exercise prices from $0.288 to
$1.227 a share and 710,000 shares underlying the Preferred Stock at a conversion rate of $1.000 per share.



Fair Value of Financial InstrumentsFair value estimates discussed herein are based upon certain market assumptions and pertinent information
available to management as of December 31, 2005. The respective carrying value of certain on balance sheet financial instruments approximated their fair values. These financial instruments include cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses. The fair value of the Companys long-term debt is estimated based upon the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining
maturities. The carrying value approximates the fair value of the debt.



Income TaxesDeferred income tax assets and liabilities are recorded for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based
on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.



Recently Issued Accounting PronouncementsIn
December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (FAS) No. 123 (Revised 2004),



27



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Summary of Significant Accounting Policies (Continued)



Share-Based Payment. The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial
statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123 (Revised 2004) covers a wide range of share-based compensation arrangements including stock options, restricted stock
plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. The Company will adopt FAS No. 123 (Revised 2004) on January 1, 2006. The estimated compensation expense is not expected to be material to the
Companys results of operations or financial condition.



Notes Payable
and Long-term Debt



|                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              |           |      |   |        
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | ---- | - | -------
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  | December 31,
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  | 2005         |           | 2004
|Revolving note payableBank, under line of credit facility of up to $ 1,500,000 with interest at prime plus 1% (8.25% at
December 31, 2005 and 6.25% at December 31, 2004). The note is secured by accounts receivable, equipment, inventory, trademarks, patents and the personal guarantee of certain stockholders.                                                                                                 |  | $            | 1,000,000 |      | $ | 650,000
|Note payableBank, loan of up to $ 300,000, borrowed $ 82,405 through December 31,2005, due in 34 monthly installments of
$ 9,870 including interest at 7.75% beginning February 1, 2006 and a payment of interest only on the principal balance on January 1, 2006. This note was secured by all inventory, chattel paper, accounts, equipment, general intangibles
and the personal guarantee of certain directors. |  |              | 82,405    |      |   |       
|Note payableSmall Business Administration, bridge note increased to $ 175,000 in 1995, due in monthly installments of $ 2,180
through October 1, 2006 including interest at 6.999%. This note is secured by various equipment purchases, and the personal guarantee of certain stockholders.                                                                                                                         |  |              | 22,534    |      |   | 46,209 
|Note payableformer director and shareholder, due on February 1, 2007. Interest at prime plus 3% (10.25% at December 31, 2005
and 8.25% at December 31, 2004) payable quarterly. This note is subordinated to the bank loans.                                                                                                                                                                                         |  |              | 75,000    |      |   | 75,000 
|Note payableshareholder and investor, due on July 31, 2006. Interest is payable quarterly at 10%. This note is subordinated to the
bank loan.                                                                                                                                                                                                                                                                        |  |              | 25,000    |      |   | 25,000 
|Installment notes payabledue in 60 monthly payments of $1,374 including interest through June 1, 2008.                                                                                                                                                                                                                                                                                                               |  |              | 37,089    |      |   | 50,335 
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              |           |      |   |        
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              | 1,242,028 |      |   | 846,544
|Less current portion of long-term debt                                                                                                                                                                                                                                                                                                                                                                                |  |              | 1,219,185 |      |   | 711,920
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              |           |      |   |        
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  | $            | 22,843    |      | $ | 134,624
|                                                                                                                                                                                                                                                                                                                                                                                                                      |  |              |           |      |   |        



Future maturities of
long-term debt are as follows:



|                         |  |        |          
|------------------------ |  | ------ | ---------
|Year Ending December 31, |  | Amount
|2006                     |  | $      | 1,219,185
|2007                     |  |        | 15,323   
|2008                     |  |        | 7,520    
|                         |  |        |          
|                         |  | $      | 1,242,028
|                         |  |        |          



28



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Notes Payable and Long-term Debt (Continued)



The bank and small business administration loan agreements contain various restrictive and customary
covenants and default provisions under which the Company must obtain permission from its lenders to (i) purchase or retire any of its capital stock; (ii) pay dividends in cash on any of its capital stock; (iii) exceed $ 300,000
annually for capital expenditures; and (iv) pay principal on subordinated notes due to officers and directors. In addition, the Company must follow certain other requirements as to maintaining a minimum debt service coverage ratio of at least
1.15 to 1.00 and an adjusted tangible net worth of at least $ 1,500,000.



In July and August of 2000, the Company borrowed a total of $ 275,000 from an officer, directors, stockholders and investor for working capital purposes at an annual interest rate of 10%. A note for $ 75,000
is due on February 1, 2007 with interest payable quarterly and the other note for $ 25,000 is due on July 31, 2006 with interest payable quarterly. One of the notes for $ 25,000 and accrued interest and a cash payment totaling
$ 6,250 was paid on November 15, 2001 by conversion into 25,468 shares of Common Stock upon the exercise of warrants. Two of the notes for $75,000 were repaid on December 30, 2003 by $25,000 in cash and $50,000 by conversion into
147,058 shares of Common Stock. Another of the notes for $150,000 was reduced to $75,000 by a $75,000 cash payment on December 30, 2003. On February 1, 2004 the reduced note of $75,000 was extended at an interest rate of prime plus 3%
payable quarterly. In addition the lender received 57,011 warrants for the purchase of Common Stock at $ 0.296 per share as adjusted for the Common Stock issued in payment of the Preferred Stock dividends in 2005 and 2004.



Intangible Assets



|                                          |  |                         |         |                         |   |        |  |              |         |  |   |       
|----------------------------------------- |  | ----------------------- | ------- | ----------------------- | - | ------ |  | ------------ | ------- |  | - | ------
|                                          |  | As of December 31, 2005 |         | As of December 31, 2004
|                                          |  | Cost                    |         | Amortization            |   | Cost   |  | Amortization
|Amortized intangible assets:              |  |                         |         |                         |   |        |  |              |         |  |   |       
|Patents and trademarks                    |  | $                       | 273,446 |                         | $ | 65,857 |  | $            | 257,606 |  | $ | 46,118
|                                          |  |                         |         |                        
|Unamortized intangible assets:            |  |                         |         |                         |   |        |  |              |         |  |   |       
|Domain name                               |  | $                       | 10,000  |                         | $ |       |  | $            | 10,000  |  | $ |      
|                                          |  |                         |         |                        
|Amortization expense for year ended 12/31 |  | $                       | 19,739  |                         |   |        |  | $            | 10,387  |  |   |       
|                                          |  |                         |         |                        
|Estimated amortization expense:           |  |                         |         |                         |   |        |  |              |         |  |   |       
|For year ending 12/31/06                  |  | $                       | 20,255  |                         |   |        |  |              |         |  |   |       
|For year ending 12/31/07                  |  | $                       | 20,255  |                         |   |        |  |              |         |  |   |       
|For year ending 12/31/08                  |  | $                       | 20.255  |                         |   |        |  |              |         |  |   |       
|For year ending 12/31/09                  |  | $                       | 20,255  |                         |   |        |  |              |         |  |   |       
|For year ending 12/31/10                  |  | $                       | 20,255  |                         |   |        |  |              |         |  |   |       



Related Party Transactions



The Company leases warehouse and office facilities from a
related entity, Senk Properties. Current monthly rentals are $ 12,490 with annual increases each June in the monthly rental based upon the change in the indicated consumer price index in the preceding year plus real estate taxes. The initial term of
the lease was for five years ending on May 31, 1998 and it has been extended for two additional five year terms, with the possibility of three additional extensions of five years each. Lease expense for the year ended December 31, 2005 and
the year ended December 31, 2004 was $ 169,829 and $ 163,834, respectively.



29



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Concentration of Credit Risk



At December 31, 2005, 49.0% of the Companys accounts receivable was due from three major customers. Amounts due
from each of these customers were $220,530, $133,056, and $111,432, which represents 23.2%, 14.0%, and 11.8% of total accounts receivable, respectively.



At December 31, 2004, 43.1% of the Companys accounts receivable was due from three major customers. Amounts due from each of these customers
were $108,989, $99,954, and $99,686, which represents 15.2%, 14.0%, and 13.9% of total accounts receivable, respectively.



Capital Stock



From July through November 1999, the Company sold in a Private Placement 100,000 shares of no par value non-voting Convertible Preferred Stock. Each share
of the Preferred Stock is convertible into ten shares of Common Stock at a conversion rate of $ 1.00 per share. The Company may redeem the preferred shares at $ 10 per share or convert each preferred share into ten common shares, at the
option of the shareholder, at such time as the common shares are trading on a public exchange at a closing price of $ 4.00 or above for a period of ten consecutive business days. The holders of the Preferred are entitled to a 10% stock dividend
paid annually in common shares beginning twelve months from the final close of the Private Placement. Under certain conditions, each Preferred shareholder may elect to receive a cash dividend in lieu of the Common Stock dividend. The Company paid
brokers or dealers a cash sales commission of 8% and issued them warrants, which expire on October 31, 2006, to purchase 80,569 shares of Common Stock at an exercise price of $ 1.054 per share.



Warrants



At December 31, 2005, the Company had the following Common Stock purchase warrants outstanding, all of which were
exercisable:



|                                             |  |                 |  |               |  |                  
|-------------------------------------------- |  | --------------- |  | ------------- |  | -----------------
|                                             |  | Number ofShares |  | ExercisePrice |  | Expiration Date  
|1999 Private Placement to brokers or dealers |  | 80,569          |  | 1.054         |  | October 31, 2006 
|1999 Issuance to related parties             |  | 521,376         |  | 0.959         |  | December 14, 2006
|2001 Directors for fees                      |  | 14,488          |  | 1.208         |  | October 1, 2007  
|2002 Payment for services                    |  | 25,614          |  | 1.220         |  | August 3, 2007   
|2003 Note payable to director                |  | 12,717          |  | 0.403         |  | September 4, 2007
|2004 Note payable to stockholder             |  | 57,011          |  | 0.296         |  | February 1, 2008 
|2004 Directors for fees                      |  | 70,979          |  | 0.286         |  | October 1, 2010  
|2005 Directors for guarantees                |  | 150,000         |  | 0.430         |  | November 14, 2010
|                                             |  |                 |  |               |  |                  
|Total                                        |  | 932,754         |  |               |  |                  
|                                             |  |                 |  |               |  |                  



The exercise price and
number of warrant shares are subject to adjustment in the event of a Common Stock dividend or distribution, a stock split or reverse stock split, or reorganization of the Company. The financial statements reflect the adjustments for the Common Stock
issued in payment of the Preferred Stock dividends.



Stock Option Plan



On December 4, 1999, the Board of Directors approved
the 1999 Stock Option Plan, which was approved by the shareholders on August 5, 2000. Stock options may be granted at the discretion of the Board of Directors for which the Company has reserved 1,350,000 shares of its Common Stock for issuance
upon the exercise of options granted under the Plan. The options vest one-third on each of the second, third and fourth anniversaries of the date of grant and expire on the fifth anniversary of the date of grant. The Company grants stock options at



30



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Stock Option Plan (Continued)



exercise prices equal to or greater than the fair market value of the Companys Common Stock on the date of grant. On May 8, 2003, the Board of
Directors approved the adjustment of the exercise price of unexercised stock options to the higher of 50% of the existing exercise price or the current market price on May 8, 2003. The following table summarizes the activity in options under
the Plan:



|                                 |  |                 |  |                                |    
|-------------------------------- |  | --------------- |  | ------------------------------ | ---
|                                 |  | Number ofShares |  | Weighted AverageExercise Price
|Outstanding at January 1, 2004   |  | 741,249         |  | $                              | .40
|Granted                          |  | 738,500         |  |                                | .31
|Exercised                        |  |                |  |                                |   
|Forfeited                        |  | 604,999         |  |                                | .38
|                                 |  |                 |  |                                |    
|Outstanding at December 31, 2004 |  | 874,750         |  |                                | .34
|Granted                          |  | 81,500          |  |                                | .29
|Exercised                        |  |                |  |                                |   
|Forfeited                        |  | 68,250          |  |                                | .45
|                                 |  |                 |  |                                |    
|Outstanding at December 31, 2005 |  | 888,000         |  |                                | .33
|                                 |  |                 |  |                                |    



The following table
summarizes options outstanding at December 31, 2005:



|            |  |                   |  |                              |      |                                          |           |                   |        |                              |   |     
|----------- |  | ----------------- |  | ---------------------------- | ---- | ---------------------------------------- | --------- | ----------------- | ------ | ---------------------------- | - | ----
|            |  |                   |  | Options Outstanding          |      | Options Exercisable                     
|Range       |  | NumberOutstanding |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractual Life |           | NumberExercisable |        | WeightedAverageExercisePrice
|$0.45-$0.63 |  | 54,000            |  | $                            | 0.61 |                                          | 0.9 Years |                   | 50,000 |                              | $ | 0.61
|$0.26-$0.35 |  | 803,500           |  | $                            | 0.31 |                                          | 3.6 Years |                   |       |                              |   |    
|$0.21       |  | 30,500            |  | $                            | 0.21 |                                          | 2.1 Years |                   | 13,499 |                              | $ | 0.21



There were 63,499 and
89,832 options exercisable at December 31, 2005 and December 31, 2004, respectively. The weighted average exercise price of options granted in 2005 and 2004 was $0.29 and $0.31, respectively.



Capital Leases



The Company was the lessee of equipment under a capital lease that expired in 2004. The assets and liabilities under capital
leases were recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. The assets were amortized on a straight-line basis over the lesser of their related lease terms or their estimated productive lives.
Amortization of assets under capital leases is included in depreciation expense for the year ended December 31, 2004 was $ 3,131.



Minimum future lease payments under operating leases as of December 31, 2005 are as follows:



|                             |  |   |        
|---------------------------- |  | - | -------
|2006                         |  | $ | 178,164
|2007                         |  |   | 183,521
|2008                         |  |   | 77,674 
|2009                         |  |   |       
|2010                         |  |   |       
|Thereafter                   |  |   |       
|                             |  |   |        
|Total minimum lease payments |  | $ | 439,359
|                             |  |   |        



Total rent expense of
the Company for the years ended December 31, 2005 and December 31, 2004 was $ 172,842 and $ 166,491, respectively.



31



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Income Taxes



There were income tax benefits of $87,815 and $5,152 from use of operating loss carryforwards by the Company for the years ended December 31, 2005
and December 31, 2004, respectively.



Following is a
reconciliation of the expected income tax expense/benefit to the amount based on the U.S. statutory rate of 34% for the years ended December 31, 2005 and December 31, 2004:



|                                                      |  |      |         |   |      |   |        |  
|----------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | -
|                                                      |  | 2005 |         |   | 2004 |  
|Income tax expense/benefit based on US statutory rate |  | $    | 87,815  |   |      | $ | 5,152  |  
|Current period change in the valuation allowance      |  |      | (87,815 | ) |      |   | (5,152 | )
|                                                      |  |      |         |   |      |   |        |  
|Provision for income taxes                            |  | $    |        |   |      | $ |       |  
|                                                      |  |      |         |   |      |   |        |  



The significant
components of the Companys deferred tax assets and liabilities are as follows:



|                                |  |              |          |   |      |   |          |  
|------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                |  | December 31, |         
|                                |  | 2005         |          |   | 2004 |  
|Deferred tax assets:            |  |              |          |   |      |   |          |  
|Net operating loss carryforward |  | $            | 435,443  |   |      | $ | 523,248  |  
|Valuation allowances            |  |              | (435,443 | ) |      |   | (523,248 | )
|                                |  |              |          |   |      |   |          |  
|Net deferred tax assets         |  | $            |         |   |      | $ |         |  
|                                |  |              |          |   |      |   |          |  



The Companys
valuation allowance decreased by approximately $87,800 and $5,200 for the years ended December 31, 2005 and December 31, 2004, respectively, which represents the effect of net income. The Company has recorded a valuation allowance to
record its deferred tax assets at estimated net realizable value due to the uncertainty of realization of these assets through future taxable income.



The Company has available at December 31, 2005, unused operating loss carryforwards that may be applied against future taxable income and that expire
as follows:



|             |  |                                             |           |                            |     
|------------ |  | ------------------------------------------- | --------- | -------------------------- | ----
|Year Of Loss |  | Amount of UnusedOperating LossCarryforwards |           | ExpirationDuringYearEnding
|1997         |  | $                                           | 283,805   |                            | 2012
|1998         |  |                                             | 150,362   |                            | 2018
|1999         |  |                                             | 438,086   |                            | 2019
|2000         |  |                                             | 141,177   |                            | 2020
|2002         |  |                                             | 267,255   |                            | 2022
|             |  |                                             |           |                            |     
|             |  | $                                           | 1,280,685 |                            |     
|             |  |                                             |           |                            |     



32



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Litigation



On March 31, 2000, SMP Company, Incorporated (formerly known as Sanar Manufacturing, Inc.) (SMP), a wholly-owned subsidiary of the
Company, entered into an asset purchase agreement with Akon Plastic Enterprises, Inc. (Akon) whereby Akon agreed to purchase substantially all of the assets used by SMP in molding plastics. Further, as part of the sale, Akon and its
President, David F. Harman (Harman), entered into an Indemnity Agreement whereby Akon and Harman, jointly and severally, agreed to indemnify us and the individual guarantors of the Small Business Administration loans to SMP against any
liability for such loans, which were assumed as a part of the asset purchase by Akon. In September 2000, Akon breached the asset purchase agreement and in October 2000, we filed suit in the Court of Common Pleas, Summit County, Ohio for damages,
including non-payment of loans, resulting from Akons breach of the asset purchase agreement. In December 2001, Harman filed a Third-Party Complaint against us alleging intentional infliction of emotional distress seeking compensatory and
punitive damages against us and the individual guarantors. Both actions were dismissed without prejudice in March 2003. On June 5, 2003, we re-filed the action against Akon, the directors of Akon, and Harman in the Court of Common Pleas of Lake
County, Ohio where it is currently pending. Discovery has been completed and the parties to the litigation are awaiting rulings by the court on their respective motions for summary judgment. While we believe that our case against Akon, its
directors, and Harman is strong, we cannot predict the likely outcome of this action.



In addition to the above matters and in the normal course of conducting its business, the Company may become involved in various other litigation, including, but not limited to, preference claims by debtors in
bankruptcy proceedings. The Company is not a party to any litigation or governmental proceeding which its management believes could result in any judgments or fines against it that would have a material adverse affect or impact in the Companys
financial position, liquidity or results of operations.



Subsequent Event



On January 3, 2006, the Company entered into an
Asset Purchase Agreement (the Purchase Agreement) with Pet Zone Products Ltd. (Pet Zone) pursuant to which the Company purchased substantially all the assets and assumed certain liabilities of Pet Zone. Pet Zone manufactures
and distributes pet supply products including cat, dog and bird feeders, storage bins, and cat and dog toys to pet specialty distributors and retailers, mass retailers and grocery chains, among others. The complementary strength of each company
should allow significant product and distribution synergies to be realized with each companys product sales being expanded to the others market segments and customers. The Company will gain potential entry into such new product
categories as bird feeders, waste management products, and cat and dog furniture.



The purchase price for Pet Zone consisted of $464,998 in cash, of which 12.5% was held back pending a final determination of Pet Zones accounts receivable and inventory, 3,082,000 shares of the Companys
Common Stock and a warrant to purchase 2,729,000 additional shares of the Companys Common Stock. The common shares issuable under the warrant may be purchased at a price of $0.60 per share if exercised on or before January 2, 2009 or
$0.675 per share if exercised on or after January 3, 2009 and on or before January 2, 2010 or $0.75 per share if exercised on or after January 3, 2010 and on or before the expiration of the warrant on January 2, 2011.



The Purchase Agreement required Pet Zone to invest $250.000 in the Company
in the form of a loan, evidenced by a subordinated note due in 20 quarterly payments of $15,197 including interest at 7.75% beginning March 31, 2006, with the proceeds to be used in the development of new products. In connection with this loan,
the Company also issued Pet Zone a warrant to purchase 125,000 shares of Common Stock at a price of $0.335 per share. This warrant expires on January 3, 2011.



33



---

##### Table of Contents

OURPETS COMPANY AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Subsequent Event (Continued)



Also on January 3, 2006, the Company entered into a Registration Rights Agreement with Pet Zone
and certain other stockholders holding the Companys common shares and/or common shares issuable upon exercise of the warrants issued pursuant to the Purchase Agreement, which provides, among other things, certain piggyback registration rights
to these stockholders and that the Company will file a registration statement with the Securities and Exchange Commission upon the demand of a majority of the stockholders holding registrable shares.



The aggregate purchase price will be approximately $1,517,000, including
$465,000 of cash and Common Stock valued at $1,052,000 based on the average closing price of the Companys common shares over the 30 days before and including January 3, 2006.



The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of
acquisition. The Company is in the process of obtaining valuations of certain assets; thus, the allocation of the purchase price is subject to refinement.



At January 3, 2006:



|                          |  |   |           |  
|------------------------- |  | - | --------- | -
|Accounts receivabletrade |  | $ | 253,000   |  
|Inventories               |  |   | 529,000   |  
|Equipment                 |  |   | 984,000   |  
|Intellectual property     |  |   | 40,000    |  
|Prepaids and deposits     |  |   | 22,000    |  
|                          |  |   |           |  
|Total assets acquired     |  |   | 1,828,000 |  
|                          |  |   |           |  
|Accounts payabletrade    |  |   | (281,000  | )
|Accrued expenses          |  |   | (13,000   | )
|Capital lease payable     |  |   | (17,000   | )
|                          |  |   |           |  
|Total liabilities assumed |  |   | (311,000  | )
|                          |  |   |           |  
|Net assets acquired       |  | $ | 1,517,000 |  
|                          |  |   |           |  



34