UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 000-30444
KAHALA CORP.
(fka Sports Group International, Inc.)
(Exact name of registrant as specified in its charter)
Florida 59-3474394
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7730 E. Greenway Rd., Suite 104
Scottsdale, Arizona 85260
(Address of principal executive offices)
(480) 443-0200
(Registrant's telephone number, including area code)
Check whether issuer (1) has 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 the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's Common Stock, $.001 per
value per share, as of August 10, 2001 was 16,818,609 shares.
KAHALA CORP.
Quarter Ended June 30, 2001
FORM 10-QSB
INDEX
PAGE NUMBER
-----------
PART I - FINANCIAL INFORMATION 2
ITEM 1. FINANCIAL STATEMENTS (INCLUDING NOTES) 3-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN
OF OPERATION 10-16
PART II - OTHER INFORMATION 17
ITEM 1. LEGAL PROCEEDINGS 17
ITEM 2. CHANGES IN SECURITIES 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17
ITEM 5. OTHER INFORMATION 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18-22
SIGNATURES 23
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STATEMENT OF INFORMATION FURNISHED
The accompanying financial statements have been prepared in accordance with
Form 10-QSB instructions and applicable items of Regulation S-B, and in the
opinion of management, contain all adjustments (consisting of only normal and
recurring accruals) necessary to present fairly the Company's financial position
as of June 30, 2001 and the Company's results of operations and statement of
cash flows for the three months ended June 30, 2001 and 2000 and the six months
ended June 30, 2001 and 2000. These results have been determined on the basis of
generally accepted accounting principles and practices applied consistently with
those used in the preparation of the Company's 2000 Annual Report on Form
10-KSB.
Certain information and footnote disclosures normally included in financial
statements presented in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that the accompanying financial
statements be read in conjunction with the financial statements and related
notes thereto incorporated by reference in the Company's 2000 Annual Report on
Form 10-KSB.
2
KAHALA CORP.
CONSOLIDATED BALANCE SHEET
AS OF JUNE 30, 2001 (UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 49,463
Trade and other accounts receivable, net of allowance 1,217,604
Inventories 146,875
Prepaid expenses and other assets 90,905
Deferred income taxes 19,639
Notes receivable - current portion, net of allowance 524,974
------------
Total current assets 2,049,460
PROPERTY AND EQUIPMENT, net 677,269
LEASE DEPOSITS 157,942
NOTES RECEIVABLE - less current portion 2,683,608
GOODWILL, net of accumulated amortization 5,001,128
DEFERRED INCOME TAXES 496,315
------------
TOTAL ASSETS $ 11,065,722
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 141,380
Accrued liabilities 693,806
Line of credit 552,401
Notes payable - current portion 531,352
Acquisition notes payable 171,721
Confirmed bankruptcy liabilities - current portion 574,393
------------
Total current liabilities 2,665,053
NOTES PAYABLE - long-term portion 116,309
ACQUISITION NOTES PAYABLE - long-term portion 132,009
CONFIRMED BANKRUPTCY LIABILITIES - long term portion 548,379
DEFERRED FRANCHISE FEE INCOME 690,000
------------
Total liabilities 4,151,750
------------
STOCKHOLDERS' EQUITY:
Series A preferred stock, $10.00 par value, 575,000 shares
designated, 575,000 issued 5,750,000
Series B preferred stock, $10.00 par value, 650,000 shares
designated, 650,000 issued 6,500,000
Series C preferred stock, $10.00 par value, 160,000 shares
designated, 160,000 issued 1,600,000
Common stock, $.001 par value, 100,000,000 shares authorized,
16,818,609 issued and outstanding 16,819
Paid in capital 5,953,787
Accumulated deficit (12,906,634)
------------
Total stockholders' equity 6,913,972
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,065,722
============
3
KAHALA CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX AND THREE MONTHS ENDED JUNE 30, 2001 AND 2000 (UNAUDITED)
SIX MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
REVENUES:
Net product and store sales $ 1,283,431 $ 4,261,081 $ 597,242 $ 2,104,590
Franchise fees 397,250 597,143 169,500 529,643
Royalties 1,436,018 866,981 641,327 437,248
Rental income 86,797 123,600 38,399 61,800
------------ ------------ ------------ ------------
Total revenues 3,203,496 5,848,805 1,446,468 3,133,281
------------ ------------ ------------ ------------
EXPENSES:
Cost of product sales 535,475 1,535,286 260,392 774,492
Personnel expenses 1,247,190 1,829,001 653,113 1,029,546
Rent 486,558 866,667 196,897 431,957
Depreciation and amortization 184,821 283,683 84,188 201,028
General and administrative expenses 530,733 1,264,406 192,946 399,534
------------ ------------ ------------ ------------
Total expenses 2,984,777 5,779,043 1,387,536 2,836,557
------------ ------------ ------------ ------------
OPERATING (LOSS) INCOME 218,719 69,762 58,932 296,724
------------ ------------ ------------ ------------
OTHER (INCOME) AND EXPENSES
Loss on sale of assets 79,674 (325,000) 41,813 (325,000)
Interest expense 70,025 147,975 32,348 81,088
Interest income (50,453) (56,333) (24,787) (54,886)
------------ ------------ ------------ ------------
Total other expense 99,246 (233,358) 49,374 (298,798)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 119,473 303,120 9,558 595,522
INCOME TAX (BENEFIT) PROVISION -- -- -- 110,989
------------ ------------ ------------ ------------
NET INCOME $ 119,473 $ 303,120 $ 9,558 $ 484,533
============ ============ ============ ============
NET (LOSS) INCOME PER SHARE:
Basic $ (0.04) $ 0.03 $ (0.02) $ 0.05
============ ============ ============ ============
Diluted $ (0.04) $ 0.01 $ (0.02) $ 0.01
============ ============ ============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 14,468,458 8,801,389 15,367,973 9,128,614
============ ============ ============ ============
Diluted 14,468,458 22,968,056 15,637,973 23,547,677
============ ============ ============ ============
4
KAHALA CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (UNAUDITED)
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss) $ 119,473 $ 303,120
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 184,821 283,683
Deferred income taxes -- --
Loss (Gain) on sale of assets 79,674 (325,000)
Changes in assets and liabilities:
Trade and other accounts receivable 34,152 (158,373)
Inventories 16,292 (146,649)
Refundable lease deposits (1,000) --
Prepaids and other current assets (36,041) 5,994
Accounts payable (58,054) (88,021)
Accrued liabilities (385,433) (133,916)
Deferred franchise fee income (224,000) (216,220)
----------- -----------
Net cash provided by (used in) operating activities (270,116) (475,382)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (174,830) (470,309)
Collections on notes receivable 220,253 93,586
Proceeds from sale of property and equipment 166,509 1,275,000
----------- -----------
Net cash (used in) investing activities 211,932 898,277
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings on line of credit 455,401 --
Proceeds from borrowings on notes payable -- 70,000
Principal repayments on notes payable (337,385) (911,378)
Payments on confirmed bankruptcy liabilities (110,254) (112,827)
----------- -----------
Net cash provided by (used in) financing activities 7,762 (954,205)
----------- -----------
INCREASE (DECREASE) IN CASH (50,422) (531,310)
CASH, BEGINNING OF PERIOD 99,885 644,264
----------- -----------
CASH, END OF PERIOD $ 49,463 $ 112,954
=========== ===========
5
KAHALA CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS, (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, (UNAUDITED)
2001 2000
---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 40,429 $ 94,874
========== ==========
Income taxes paid $ -- $ --
========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING FINANCING ACTIVITIES:
Common stock issued as preferred stock dividends $ 680,500 $ 579,452
========== ==========
Sale of property & equipment under notes receivable $ 468,176 $1,830,000
========== ==========
6
KAHALA CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX AND THREE MONTHS ENDED JUNE 30, 2001
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements represent the financial
position of Kahala Corp. (the "Company") as of June 30, 2001, including our
results of operations for the three and six months ended June 30, 2001 and
2000 and cash flows for the six months ended June 30, 2001 and 2000. These
statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and the
instructions for Form 10-QSB. Accordingly, they do not include all the
information and footnotes required by generally accepted accounting
principles ("GAAP") for complete financial statements. In the opinion of
management, all adjustments to these unaudited financial statements
necessary for a fair presentation of the results for the interim period
presented have been made. The results for the three and six months ended
June 30, 2001 and 2000 may not necessarily be indicative of the results for
the entire fiscal year. These financial statements should be read in
conjunction with our Form 10-KSB for the year ended December 31, 2000,
including specifically the financial statements and notes to such financial
statements contained therein.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Our accounting policies, and the methods of applying those policies, which
affect the determination of our financial position, results of operations
or cash flows are summarized below:
CASH: includes all short-term highly liquid investments that are readily
convertible to known amounts of cash and have original maturities of three
months or less. At times, cash deposits may exceed government insured
limits.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries: Surf City
Acquisition Corp. II, Surf City Squeeze, Inc., Surf City Squeeze Franchise
Corp., Kona Coast Provisions, Inc. ("Kona"), Malibu Smoothie Franchise
Corp., Selman Systems, Inc. and its two operating subsidiaries, Frullati
Enterprises, Inc. and Frullati Franchise Systems, Inc., Fru-Cor, Inc.,
Rollerz Franchise Systems, LLC and Tahi Mana, LLC. All significant inter
company accounts and transactions are eliminated.
INVENTORIES: consist primarily of food products, drink mixes, supplements
and supplies. Inventories are recorded at the lower of cost or market on a
first-in, first-out basis.
REVENUE RECOGNITION: Initial franchise fees are deferred until
substantially all services and conditions relating to the sale of the
franchise have been performed or satisfied. The Company will occasionally
finance the initial franchise fee by taking a note receivable from the
franchisee. The notes receivable are typically payable by the franchisees
over three to five years.
7
Fees from Area Development Agreements or similar development arrangements
("ADA") are recognized as revenue on a pro rata basis based on the number
of stores opened to-date to total stores to be developed as stipulated in
the ADA. If the total number of stores stipulated in the ADA are not opened
at the expiration of the ADA, the balance of such fees is recognized.
Kona sells mixes, supplements and related supplies to franchisees. Revenue
on such sales is recognized when the product is shipped. Sales from the
corporate-owned stores are recognized at the point of sale.
The Company is entitled to marketing program income (the "Program Income")
from suppliers on the basis of product volume shipped by those suppliers to
franchised and corporate-owned stores. Program Income is recognized when
suppliers have shipped, and stores have received, products for which
Program Income apply.
The Company also receives sublease rental income. The Company is the
primary lessee on certain franchised and licensed stores. Rental income is
recognized ratably over the term of the subleases.
INCOME TAXES: The Company provides for income taxes based on the provisions
of Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR
INCOME TAXES, which, among other things, requires that recognition of
deferred income taxes be measured by the provisions of enacted tax laws in
effect at the date of the financial statements.
USE OF ESTIMATES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the 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.
GOODWILL: is recorded for the difference between the purchase price of the
acquired business and the fair value of the identifiable net assets.
Goodwill is amortized on a straight-line basis over 20 years. The 20-year
period is based on the initial and renewable franchise periods in most
franchise agreements.
3. INCOME TAXES
The Company recognizes deferred income taxes for the differences between
financial accounting and tax bases of assets and liabilities. Income taxes
for the periods ended June 30, 2001 an 2000 consisted of the following:
SIX MONTHS ENDING JUNE 30, THREE MONTHS ENDING JUNE 30,
-------------------------- ----------------------------
2001 2000 2001 2000
-------- --------- -------- ---------
Current tax (benefit) provision $ 45,391 $ 121,200 $ 3,989 $ 63,156
Deferred tax (benefit) provision (45,391) (121,200) (3,989) 47,833
-------- --------- -------- ---------
Total income tax provision $ -0- $ -0- $ -0- $ 110,989
======== ========= ======== =========
8
4. NET LOSS PER SHARE
Net loss per share is calculated using the weighted average number of
shares of common stock outstanding during the year. Preferred stock
dividends are subtracted from the net income to determine the amount
available to common shareholders. Preferred stock convertible to 15,766,667
and 14,166,667 common shares and warrants to purchase one million common
shares were not considered in the calculation for diluted earnings per
share for the six months ended June 30, 2001 because the effect of their
inclusion would be anti-dilutive.
SIX MONTHS ENDING JUNE 30, 2001 THREE MONTHS ENDING MARCH 31, 2000
------------------------------------- ------------------------------------
PER INCOME
INCOME (LOSS) SHARES SHARE (LOSS) SHARES PER SHARE
------------- ---------- ------ --------- ---------- ---------
Net Income (Loss) $ 119,473 $ 9,559
Preferred stock dividends (680,500) (346,250)
BASIC EARNINGS PER SHARE
Loss available to common stockholders $(561,027) 14,001,541 $(0.04) $(336,691) 15,367,973 $(0.02)
Effect of dilutive securities N/A N/A
DILUTED EARNINGS PER SHARE $(0.04) $(0.02)
9
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
FORWARD-LOOKING STATEMENTS
Certain of the information discussed in this quarterly report, and in
particular in this section entitled "Management's Discussion and Analysis or
Plan of Operation," contain forward-looking statements that involve risks and
uncertainties that might adversely affect the Company's operating results in the
future in a material way. The words "believes," "may," "likely," "expects,"
"anticipates," and similar expressions identify forward-looking statements,
which speak only as of the date the statement was made. Such forward-looking
statements are within the meaning of that term in Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Such statements may include, but are not limited to, projections of
revenues, including sales of franchises and corporate-owned locations, income or
loss, plans for future operations, and financing needs or plans. Statements in
the Company's Annual Report on Form 10-KSB, including the Notes to the Company's
Consolidated Financial Statements and "Management Discussion and Analysis or
Plan of Operation", describe factors, among others, that could contribute to
such differences. Such factors include, without limitation, the effect of
national and regional economic and market conditions in the U.S. where the
Company franchises and operates store locations, costs of labor and employee
benefits, costs of marketing, the success or failure of marketing efforts, costs
of food and non-food items used in the operation of the Company's stores,
intensity of competition for locations and franchisees as well as customers,
perception of food safety, spending patterns and demographic trends, legal
claims and litigation, the availability of financing for the Company and its
franchisees at reasonable interest rates, and legislation and governmental
regulations affecting the Company's business. Many of these factors are beyond
the Company's control.
GENERAL
The Company was incorporated in the state of Florida in September 1997, as
Secretarial Services of Orlando, Inc. and in March 1999 changed its name to
Sports Group International, Inc. In January, 2001, the Company changed its name
to Kahala Corp. Prior to March 1999, the Company had no significant operations.
The term "Company" refers to Kahala Corp. and its subsidiaries. The Company's
common stock trades over-the-counter on the Electronic Bulletin Board under the
symbol "KAHA". From March, 1999 until January 31, 2001, the Company's common
stock traded on the over-the-counter Electronic Bulletin Board under the symbol
"SPGK."
The Company has developed its business through the following acquisitions:
(i) the Surf City Squeeze concept was acquired by the Company on March 15, 1999
through a reverse merger with Surf City Acquisition Corp. II ("SCAC"), with the
transaction being accounted for as a recapitalization of SCAC, with SCAC as the
acquirer; (ii) the Frullati Cafe and Bakery concept was acquired by the Company
on May 21, 1999 through its acquisition of 100% of Selman Systems, Inc.
("Selman") (the Company also acquired eight individual Frullati Cafe & Bakery
units through its purchase of 100% of Fru-Cor, Inc. ("Fru-Cor") on July 7,
1999); and (iii) the Rollerz concept was acquired during the second quarter of
2000 from a corporation owned and controlled by the Company's President and CEO
(the "Rollerz Transaction"). In addition to the above-mentioned acquisitions,
the Company developed the Tahi Mana concept internally during 2000.
10
COMPANY OVERVIEW
The Company currently operates and franchises, under the Frullati Cafe and
Bakery, Surf City Squeeze, Rollerz, and Tahi Mana brand names (collectively, the
"Concepts"), juice bars and health food cafes that serve blended fruit drinks,
sandwiches, salads, soups, baked goods, healthy snacks, and nutritional
supplements in shopping malls, airports, medical centers, office buildings and
health clubs throughout the United States, Canada, and select Middle Eastern
countries. As of June 30, 2001, the Company, through its subsidiaries, has
approximately 209 total locations of the Concepts, of which 203 are either
franchised or licensed by third parties and 6 are directly owned and operated by
the Company or its subsidiaries. Of the 209 total locations of the Concepts, 113
operate as Surf City Squeeze outlets, 90 operate as Frullati Cafe & Bakery
outlets, 4 operate as Rollerz outlets, and 2 operate as Tahi Mana outlets. The
Company's corporate stores operate under the Frullati Cafe and Bakery, Surf City
Squeeze, and Rollerz brand names. The Company also sells proprietary smoothie
mixes and other nutrients and supplements to its franchisees and licensees
through its wholly owned subsidiaries.
The stores operating under the Frullati Cafe and Bakery brand name are
located primarily in shopping malls, airports and hospitals in the midwest,
southwest, and southeastern United States. The average Frullati Cafe and Bakery
store derives approximately 60% of its total revenue from blended fruit drinks
and other beverage sales and approximately 40% from the sale of sandwiches,
baked goods, soups, salads and other healthy food items. The stores operating
under the Surf City Squeeze brand name are located in shopping malls and health
clubs primarily in California, Arizona and Canada. The average Surf City store
derives the majority of its revenue from the sale of blended fruit drinks and
other beverages, and nutrients and supplements that are added to the drinks. The
stores operating under the Rollerz brand name are located in office buildings
and shopping malls in Arizona, Texas, and California. The average Rollerz store
derives approximately 75% of its total revenues from gourmet rolled sandwiches,
soups, salads, baked goods, and other healthy snacks and approximately 25% from
the sale of blended fruit drinks and other beverage items. The stores operating
under the Tahi Mana brand name are located in health clubs in Arizona. The
average Tahi Mana store derives the majority of its revenue from the sale of
blended fruit drinks and other beverages, nutrients and supplements that are
added to the drinks or can be taken home, and healthy snacks.
The Company derives its revenues primarily from area representative and
development fees, initial franchise and license fees, ongoing royalty payments,
sales from its company-owned stores, and sales of nutritional and health food
products to its franchisees and licensees. The Company's long-term strategy is
to operate primarily as a franchisor, and through strategic acquisitions and
internal growth, to become one of the larger franchisors of juice bars, healthy
food cafes, and other retail food concepts in the United States and select
international markets that include Canada, Europe, the Middle East, Australia,
and certain Pacific Rim countries. The Company also plans to operate a limited
number of company-owned stores in certain key markets where the stores can be
geographically concentrated. The Company has not yet identified other areas
where it may wish to operate company-owned stores.
11
RESULTS OF OPERATIONS
Total operating revenues for the six months ended June 30, 2001 decreased
by $2,645,309 to $3,203,496 from $5,848,805 during the same six month period in
2000. For the three months ended June 30, 2001, total operating revenues
decreased by $1,686,813 to $1,446,468 from $3,133,281 during the same period of
2000. This decrease in operating revenues is the result of the Company selling
nine company-owned Frullati Cafe & Bakery locations during the last six months
of 2000 to third party franchisees and selling five additional company-owned
outlets of the Concepts during the six months ending June 30, 2001 to third
party franchisees (collectively, the "Store Sales"). Additionally, during the
six months ended June 30, 2001, the Company closed a total of six
underperforming company-owned outlets of the Concepts in an effort to increase
the Company's overall profitability, five of which were closed during the three
month period ending June 30, 2001 (collectively, the "Store Closures"). The
decline in store revenues resulting from the Store Sales and the Store Closures
is partially offset by a corresponding increase in royalties and franchise fee
income from the company-owned stores sold to third party franchisees and brand
new franchises sold. Royalties for the six months ended June 30, 2001 include a
non-recurring $300,000 purchase closing in March, 2001 of the Company's future
royalties from the franchisees of its Concepts in the state of Illinois by
Rilwala Foods, Inc., an area representative of the Company whose principals
include Haresh Shah, a current director of the Company.
Cost of product sales decreased to $535,475 for the six months ended June
30, 2001, compared to $1,535,286 for the same six month period in 2001. For the
three months ended June 30, 2001, cost of product sales decreased to $260,392,
compared to $774,492 for the same period of 2000. This decrease is primarily the
result of the Store Sales and the Store Closures whereby the Company reduced the
number of its corporate-owned locations of the Concepts by a total of twenty
units during the period July 1, 2000 to June 30, 2001 as discussed in the
preceding paragraph. However, the gross margin of store and product revenues
decreased to approximately 58% for the six months ended June 30, 2001, compared
to approximately 64% for the six months ended June 30, 2000. Additionally, the
gross margin of store and product revenues decreased to approximately 56% for
the three months ended June 30, 2001, compared to approximately 63% for the same
three month period of 2000. These decreases are attributable to the Company's
revenues for the three and six months ending June 30, 2001 including a greater
proportion of sales from lower margin raw materials and related supplies sold by
its Kona subsidiary to the franchisees and licensees of the Company's Concepts
as the number of its corporate-owned units decreases, and that the Company's
remaining corporate-owned stores are generally poorer performing units of the
Concepts.
Personnel costs decreased by $581,811 to $1,247,190 for the six months
ended June 30, 2001, compared to $1,829,001 for the same six month period in
2000. For the three months ended June 30, 2001, personnel costs decreased by
$376,433 to $653,113, compared to $1,029,546 for the same three month period of
2000. These decreases in personnel costs are primarily attributable to the
reduction in staff associated with the Store Sales and Store Closures detailed
above, partially offset by an increase in the Company's corporate administrative
staff to support the additional franchisees who purchased the former
corporate-owned locations of the Concepts as part of the Store Sales.
12
Rent expense decreased by $380,109 to $486,558 for the six months ended
June 30, 2001, compared to $866,667 for the same six month period of 2000. For
the three months ended June 30, 2001, rent expense decreased $235,060 to
$196,897, compared to $431,957 for the same three month period of 2000. This
decrease in rent expense during both the three and six month periods ending June
30, 2001 is primarily the result of the Company selling a total of fourteen of
its corporate-owned locations of the Concepts during the period from July 1,
2000 through June 30, 2001, and closing an additional six underperforming
company-owned outlets of the Concepts during the six month period ended June 30,
2001, with five of these six outlets closed during the three month period ending
June 30, 2001.
General and administrative expenses decreased by $733,673 to $530,733 for
the six months ended June 30, 2001, compared to $1,264,406 for the same period
of 2000. For the three months ended June 30, 2001, general and administrative
expenses decreased $206,588 to $192,946, compared to $399,534 for the same three
month period of 2000. These decreases in general and administrative expenses are
primarily attributable to a decrease in legal fees during the first six months
of 2001, compared to the same period of 2000 when the Company was involved in a
significant lawsuit with Sports Group International, Inc., a Delaware
corporation, over a failed merger that was resolved during the second quarter of
2000 in favor of the Company.
Total other expense increased by $332,604 to $99,246 for the six months
ended June 30, 2001, compared to other income of $233,358 for the same six month
period of 2000. Total other expense increased by $348,172 to $49,374 for the
three months ended June 30, 2001, compared to other income of $298,798 during
the same period of 2000. This increase in other expenses for the six months
ended June 30, 2001 is due to a combination of the following two items: (i) a
$79,674 loss recognized on the sale of five of the Company's corporate-owned
locations of the Concepts and the closing of six underperforming corporate-owned
locations during the first six months of 2001, compared to a gain of $325,000
from the sale of six of the Company's corporate-owed locations of the Concepts
during the same six month period of 2000; and (ii) a decrease in interest
expense of $77,950 during the six months ended June 30, 2001 compared to the
same six month period of 2000, resulting from an overall decrease in the
Company's outstanding debt during the past twelve months. The increase in other
expenses for the three months ended June 30, 2001 is due to a combination of the
following events: (i) a $41,813 loss recognized on the sale of one of the
Company's corporate-owned locations of the Concepts and the closing of five
underperforming corporate-owned locations during the three months ending June
30, 2001, compared to a gain of $325,000 from the sale of six of the Company's
corporate-owed locations of the Concepts during the same three month period of
2000; and (ii) a decrease in interest expense of $48,740 in the three months
ended June 30, 2001 compared to the same three month period of 2000, resulting
from an overall decrease in the Company's outstanding debt during the past
twelve months.
13
The Company's future operating profitability has become more dependent upon
franchise and royalty revenue. Gross revenues will decrease as the transition is
made from corporate-owned locations to franchised locations. However, the
Company will continue to attempt to grow its existing Concepts through the
franchising of new locations and assisting franchisees in increasing volumes at
their existing locations.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2001, the Company's liquidity improved modestly versus March
31, 2001 and December 31, 2000, and substantially improved compared to the
second quarter of 2000. The Company's current ratio is 0.77 as of June 30, 2001,
0.67 as of March 31, 2001, 0.58 as of December 31, 2000, and 0.37 as of June 30,
2000.
The Company anticipates that it will have sufficient liquidity to sustain
its operations over the next 12 months. In late December 1999, the Company
obtained a $1,000,000 credit facility from a national banking institution
comprised of an $800,000 term note (the "Term Note") and a $200,000 revolving
line of credit. During the first quarter of 2001, the Company entered into an
agreement with the same national banking institution to increase the amount of
its revolving line of credit from $200,000 to $500,000. As of June 30, 2001, the
balance outstanding under the Term Note is approximately $430,000 and
approximately $455,000 is outstanding under the $500,000 revolving line of
credit.
The Company does not anticipate the need for significant capital
expenditures in the near future. However, if certain prospective store locations
would be better as company-owned stores rather than franchised locations, the
Company may require significant capital to build-out and open those prospective
stores. The Company did incur $174,830 and $36,299 in capital expenditures
during the six and three month periods ended June 30, 2001, respectively.
The Company continues to finance the sale of its corporate-owned locations
by taking notes receivable from the buyers. Most of the notes are payable over
three to five years. Notes receivable balances totaled $3,208,582 at June 30,
2001. This practice of taking notes receivable has caused the Company to
carefully manage its cash flows in order to maintain relationships with vendors
and meet payments on its debt obligations. The Company has sold the majority of
its corporate-owned locations and does not anticipate an increase in notes
receivable at levels commensurate with that of the past twelve to eighteen
months.
Net cash used in operating activities was approximately $270,116 for the
first six months of 2001, compared to net cash used in operating activities of
$475,382 for the corresponding six month period of 2000. The primary sources of
cash from operating activities during the first six months of 2001 causing this
change are as follows: (i) the Company recognized a loss of $79,674 on the sale
of five of its corporate-owned locations of the Concepts and the closing of six
14
underperforming corporate-owned locations of the Concepts during the first six
months of 2001 compared to a gain of $325,000 from the sale of six of the
Company's corporate-owned locations of the Concepts during the same six month
period of 2000; (ii) a reduction in the Company's inventory levels of $16,292
during the six months ending June 30, 2001 compared to an increase in inventory
of $146,649 during the same six months of 2000 due to the above-referenced
reduction in the number of corporate-owned locations of the Company's Concepts;
and (iii) a reduction in the Company's trade and other accounts receivable of
$34,152 during the six months ending June 30, 2001 compared to an increase in
trade and other receivables of $146,649 during the same period of 2000 as the
Company was more aggressive in collecting its royalties and other related
receivables from franchisees and licensees during the first six months of 2001.
The sources of cash from operating activities detailed above are partially
offset by a decrease in accrued liabilities of approximately $385,433 during the
six months ended June 30, 2001 compared to a decrease of only $133,916 during
the same period of 2000 as the Company continues to reduce its overall level of
outstanding obligations. Additionally, the Company also experienced a decrease
in overall net income and depreciation and amortization during the first six
months of 2001 as compared to the first six months of 2000.
Net cash provided by investing activities was approximately $211,932 for
the first six months of 2001, compared to net cash provided by investing
activities of $898,277 during the comparable six month period of 2000. The
primary reason for this decrease is proceeds from the sale of property and
equipment is only $166,509 during the first six months of 2001, compared to
proceeds of $1,275,000 during the same period of 2000. This decrease in proceeds
from the sale of property and equipment during the first six months of 2001 is
the result of the Company receiving a greater percentage of the purchase price
of the corporate-owned locations of the Concepts sold to third party franchisees
during the first six months of 2001 in promissory notes and other deferred
arrangements rather than cash. The decrease in the proceeds from the sale of
property and equipment during the first six months of 2001 was partially offset
by the Company's purchases of $174,830 of property and equipment to construct
new outlets of its Concepts during the first six months of 2001, compared to
$470,309 of such purchases during the comparable period of 2000 when the Rollerz
Transaction was completed and the first Tahi Mana location was opened.
Net cash provided by financing activities for the first six months of 2001
was approximately $7,762, compared to net cash used in financing activities of
$954,205 during the same six month period of 2000. The primary reason for this
increase was the Company received $455,401 in net proceeds from borrowing on its
newly expanded $500,000 revolving line of credit discussed above during the
first six months of 2001, compared to net proceeds from borrowing on notes
payable of only $70,000 during the same period of 2000. The above-referenced
source of cash from financing activities during 2001 was partially offset by a
decrease of $573,993 in principal payments on notes payable during the first six
months of 2001 as compared to the same period of 2000, as the Company made
15
principal payments on a $1,200,000 promissory note held by the prior owners of
Fru-Cor, Inc. (the "Fru-Cor Note") of $600,000 during the first six months of
2000. The Fru-Cor Note was paid in full by the end of 2000.
The Company believes that it can effectively implement its growth plans for
the current fiscal year's operations with the $1,000,000 credit facility,
including the newly increased $500,000 revolving line of credit, discussed
above. Nevertheless, the Company is seeking additional debt or equity financing
from various sources, including investment banks, venture capitalists, and
private investors, to fund future expansion and for potential future
acquisitions.
The Company has never paid cash dividends on its common stock and does not
anticipate a change in this policy in the foreseeable future.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Factors that may affect the Company's future results are described in
detail at pages 31-32 of the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2000. These factors include, without limitation, the effect
of national and regional economic and market conditions in the U.S. where the
Company franchises and operates store locations, costs of labor and employee
benefits, costs of marketing, the success or failure of marketing efforts, costs
of food and non-food items used in the operation of the Company's stores,
intensity of competition for locations and franchisees as well as customers,
perception of food safety, spending patterns and demographic trends, legal
claims and litigation, the availability of financing for the Company and its
franchisees at reasonable interest rates, and legislation and governmental
regulations affecting the Company's business. Many of these factors are beyond
the Company's control. Due to the factors note above and in the Company's Form
10-KSB for the year ended December 31, 2000, the Company's future earnings and
stock price may be subject to significant volatility. Any shortfall in revenues
or earnings from levels expected by the investing public or securities analysts
could have an immediate and significant adverse effect on the trading price of
the Company's common stock.
16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
NONE - The Company is currently only party to routine litigation that is
incidental to its principal business of franchising and operating retail juice
bars and healthy food cafes.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
Ranch * 1, Inc., through its wholly owned subsidiaries, owns and operates
and franchises Ranch * 1 quick service restaurants that specialize in the sale
of grilled chicken sandwiches and other grilled chicken products, Ranch * 1
famous fries, and other food and beverage items. Currently, there are 51 Ranch *
1 restaurants operating in 12 states, the District of Columbia, and Taiwan, of
which 47 are franchised to third parties and the remaining four are corporately
owned. On July 3, 2001, Ranch * 1, Inc. and each of its wholly owned
subsidiaries (collectively, "Ranch 1") filed for Chapter 11 bankruptcy
protection in the U.S. Bankruptcy Court for the Southern District of New York.
During July, 2001, the Company, through a newly formed wholly owned
subsidiary, R 1 Franchise Systems, L.L.C. ("R 1 Franchise"), entered into a
Debtor-In-Possession Loan and Security Agreement with Ranch 1 to provide up to
$2,000,000 in secured debtor in possession financing to Ranch 1 during the
pendancy of its bankruptcy reorganization (the "Loan Agreement"). In connection
with the Loan Agreement, on July 6, 2001, the Company and R 1 Franchise entered
into a Memorandum of Agreement with a significant shareholder of the Company
that provides up to $2,500,000 to R 1 Franchise for purposes of the Loan
Agreement (the "Financing Agreement").
On July 31, 2001, the U.S. Bankruptcy Court for the Southern District of
New York entered a final order (the "Final Order") approving the Loan Agreement
between Ranch 1 and R 1 Franchise. As of August 13, 2001, R 1 Franchise has
advanced Ranch 1 $500,000 under the Loan Agreement.
In addition to customary terms and conditions, among other things, the
Final Order provided for R 1 Franchise to be paid a commission equal to 50% of
the initial franchise fees and area development fees generated from sales of new
Ranch * 1 franchises and area development rights introduced by R 1 Franchise
during the period when Ranch 1 is operating under Chapter 11 bankruptcy
protection.
A copy of the Loan Agreement, the Final Order, and the Financing Agreement
are attached to this Form 10-QSB as Exhibits 10.15, 10.16, and 10.17
respectively.
As contemplated by the Loan Agreement, the Company intends to negotiate
with the current Ranch 1 management team regarding the terms of a plan of
reorganization. Under the Loan Agreement, the Company has agreed that it will
not file a plan unless that plan provides for R1 Franchise (if R1 Franchise so
elects) to acquire the assets of Ranch 1. There can be no assurance, however,
that any such plan of reorganization will ever be successfully negotiated and/or
ultimately approved.
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
2.1 Order Confirming First Modified Joint Plan of
Reorganization Proposed by the Debtor and the Official
Committee of Unsecured Creditors, incorporated by
reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
2.2 First Modified Joint Plan of Reorganization Proposed by
the Debtor and the Official Committee of Unsecured
Creditors dated May 13, 1997, as amended July 22, 1997,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
2.3 Amended Disclosure Statement accompanying First
Modified Joint Plan of Reorganization Proposed by the
Debtor and the Official Committee of Unsecured
Creditors dated May 13, 1997, as amended July 22, 1997,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
2.4 Share Purchase Agreement between Sports Group
International, Inc. and Surf City Acquisition
Corporation II dated March 15, 1999, incorporated by
reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
2.5 Membership Interest Purchase Agreement between Sports
Group International, Inc. and Apache Peak Capital,
L.LC., dated March 12, 1999, incorporated by reference
to the Company's Registration Statement on Form 10-SB
filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
18
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
2.6 Share Purchase Agreement between Sports Group
International, Inc., Ziad S. Dalal and Selman Systems,
Inc. dated May 21, 1999, incorporated by reference to
the Company's Registration Statement on Form 10-SB
filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
2.7 Stock Purchase Agreement between Selman Systems, Inc.,
Kenneth L. Musgrave, Ltd., Tony Condor and Larry Pearce
dated May 21, 1999, incorporated by reference to the
Company's Registration Statement on Form 10-SB filed
with the Securities and Exchange Commission on December
20, 1999, File No. 0-30444.
3.1 Amended and Restated Articles of Incorporation of
Sports Group International, Inc., incorporated by
reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
3.2 Bylaws of Sports Group International, Inc.,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
4.1 Promissory Note with United Texas Bank, incorporated by
reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
4.2 Bank One Promissory Note, incorporated by reference to
the Company's Registration Statement on Form 10-SB
filed with the Securities and Exchange Commission on
December 20, 1999, File No. 0-30444.
19
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
4.3 Promissory Note between SCAC and the Petersen Trust,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
4.4 Consent and Waiver of Terms of Series A Preferred
Stock, incorporated by reference to the Company's
Registration Statement on Form 10-SB filed with the
Securities and Exchange Commission on December 20,
1999, File No. 0-30444.
10.1 Sports Group International, Inc.'s 1999 Stock Option
Plan, incorporated by reference to the Company's
Registration Statement on Form 10-SB filed with the
Securities and Exchange Commission on December 20,
1999, File No. 0-30444.
10.2 Employment Agreement between Mr. Kevin A. Blackwell and
Sports Group International, Inc. dated October 1, 1999,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.3 Employment Agreement between Mr. David A. Guarino and
Sports Group International, Inc. dated October 1, 1999,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.4 Series B Preferred Stock and Warrant Purchase Agreement
between Sports Group International, Inc., Robert E.
Petersen and Margaret Petersen dated May 20, 1999,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.5 Warrant to purchase 1,000,000 shares of the Company's
Common Stock, incorporated by reference to the
Company's Registration Statement on Form 10-SB filed
with the Securities and Exchange Commission on December
20, 1999, File No. 0-30444.
20
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
10.6 Master Franchise Agreement between Surf City Squeeze
Franchise Corp. and 1238176 Ontario, Inc. dated July 7,
1998, incorporated by reference to the Company's
Registration Statement on Form 10-SB filed with the
Securities and Exchange Commission on December 20,
1999, File No. 0-30444.
10.7 Indemnification Agreement for Kathryn Blackwell,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.8 Indemnification Agreement for Kevin Blackwell,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.9 Indemnification Agreement for David Guarino,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.10 Indemnification Agreement for Robert Corliss,
incorporated by reference to the Company's Registration
Statement on Form 10-SB filed with the Securities and
Exchange Commission on December 20, 1999, File No.
0-30444.
10.11 Indemnification Agreement for Don Plato, incorporated
by reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
10.12 Compromise Settlement and Non-Modification Agreement
between Sports Group International, Inc., Selman
Systems, Inc., and Ziad S. Dalal, dated February 1,
2000, incorporated by reference to the Company's
Amendment No. 1 to its Form 10-SB/A Registration
Statement filed with the Securities and Exchange
Commission on February 16, 2000.
21
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
10.13 Series C Preferred Stock Agreement between Sports Group
International, Inc. and Rilwala Group, Inc. dated
December 28, 2000, incorporated by reference to Exhibit
10.13 of the Company's 2000 Annual Report on Form
10-KSB filed with the Securities and Exchange
Commission on April 2, 2001, File No. 000-30444.
10.14 Exclusive Master Development Agreement and Investment
Agreement between Sports Group International, Inc. and
Rilwala Group, Inc. dated November 1, 2000,
incorporated by reference to Exhibit 10.14 of the
Company's 2000 Annual Report on Form 10-KSB filed with
the Securities and Exchange Commission on April 2,
2001, File No. 000-30444.
10.15 *(1) Debtor-In-Possession Loan and Security Agreement by and
between R 1 Franchise Systems, L.L.C. and Ranch * 1,
Inc (and its affiliated entities) dated July 5, 2001.
10.16 *(1) Final Order Entered by the United States Bankruptcy
Court for the Southern District of New York Authorizing
Ranch 1, Inc. (and its affiliated entities) to Obtain
Post-Petition Secured Financing Pursuant to Sections
364(C)(1), 364(C)(2) and 364(C)(3) of the Bankruptcy
Code, and Approving Joint Franchise Marketing
Agreement.
10.17 *(1)(2) Memorandum of Agreement dated July 6, 2001.
11 * Computation of Per Share Earnings - Located in the June
30, 2001 Statement of Operations and footnote four to
such financial statement filed herewith on page four
and nine, respectively.
21 Subsidiary Information. (See Chart), incorporated by
reference to the Company's Registration Statement on
Form 10-SB filed with the Securities and Exchange
Commission on December 20, 1999, File No. 0-30444.
- ----------
* Filed herewith.
(1) All schedules, exhibits, riders, and addendums to this Agreement have been
intentionally omitted with this filing and are available to the Commission
upon request.
(2) The Company has sought confidential treatment for portions of the
referenced exhibits.
(b) Reports on Form 8-K
NONE
22
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KAHALA CORP.
(Registrant)
By: /s/ Kevin Blackwell Date: August 13, 2001
---------------------------------------
Kevin Blackwell
President, CEO, and Director
By: /s/ David Guarino Date: August 13, 2001
---------------------------------------
David Guarino
Vice President, Chief Financial Officer
and Director (Principal Financial and
Accounting Officer)
23