UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended - June 30, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from -
Commission file number - 333-113925
Kahiki Foods, Inc.
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(Exact name of small business issuer as specified in its charter)
Ohio
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(State or other jurisdiction or incorporation or organization)
31-1056793
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(I.R.S. Employer Identification No.)
1100 Morrison Road, Gahanna, Ohio 43230
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(Address of principal executive offices)
(614) 322-3180
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(Issuer's telephone number)
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(Former name, former address and former fiscal year,
if changed since last report)
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 the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes [ ] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 3,831,698 Common Shares and 930,741
Series A Convertible Preferred Shares as of August 4, 2006.
Transitional Small Business Disclosure Format (Check One): Yes [X] No [ ]
2
KAHIKI FOODS, INC.
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 4
- Balance Sheets as of June 30, 2006 (Unaudited) and
March 31, 2006
- Statements of Income (Unaudited) for the Three Months
Ended June 30, 2006 and 2005
- Statements of Cash Flows (Unaudited) for the Three
Months Ended June 30, 2006 and 2005
- Notes to Unaudited Financial Statements
Item 2. Management's Discussion and Analysis or Plan of Operation 21
Item 3. Controls and Procedures 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 3. Defaults upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
Index to Exhibits 31
Exhibits 34
3
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
KAHIKI FOODS, INC.
BALANCE SHEETS
June 30, 2006
(unaudited) March 31, 2006
------------- --------------
ASSETS
Current Assets
Cash $ - $ 833,655
Accounts receivable, net 1,955,870 2,231,727
Inventories 1,639,262 1,543,534
Refundable income taxes 492,760 493,365
Other current assets 204,816 284,315
------------- --------------
Total Current Assets 4,292,708 5,386,596
Property And Equipment, Net 12,129,027 12,211,280
Other Assets
Deferred loan costs 134,934 137,366
Restricted deposits 429,961 426,394
Other deposits 20,114 22,761
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Total Other Assets 585,009 586,521
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Total Assets $ 17,006,744 $ 18,184,397
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt $ 7,863,785 $ 9,029,071
Accounts payable 2,288,256 2,115,587
Accrued expenses 384,499 455,984
Income taxes payable - 20,240
------------- --------------
Total Current Liabilities 10,536,540 11,620,882
Deferred income taxes 66,000 66,000
Long-term debt 349,057 383,991
------------- --------------
Total Liabilities 10,951,597 12,070,873
Stockholders' Equity
Preferred stock, no par value, 1,000,000
shares authorized; 930,741 and 930,741
shares issued and outstanding,
respectively 2,094,167 2,094,167
Common stock, no par value, 9,000,000
shares authorized; 3,811,698 and
3,811,698 shares issued and
outstanding, respectively 2,820,954 2,813,460
Retained earnings 1,140,026 1,205,897
------------- --------------
Total Stockholders' Equity 6,055,147 6,113,524
------------- --------------
Total Liabilities And
Stockholders' Equity $ 17,006,744 $ 18,184,397
============= ==============
See notes to unaudited financial statements.
4
KAHIKI FOODS, INC.
STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended June 30,
2006 2005
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Net sales $ 6,057,323 $ 5,098,006
Cost of sales 4,793,307 4,288,653
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Gross profit 1,264,016 809,353
Selling, general and administrative
expenses 1,255,576 958,275
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Income (loss) from operations 8,440 (148,922)
Other income (expense):
Interest expense (129,792) (71,860)
Interest and other income 5,481 388
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Total other income (expense) (124,311) (71,472)
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Income (loss) before income taxes (115,871) (220,394)
Income tax expense (benefit) (50,000) -
------------ -------------
Net income (loss) (65,871) (220,394)
Less income allocable as preferred
stock dividends 26,178 -
------------ -------------
Income (loss) available
to common stockholders $ (92,049) $ (220,394)
============ =============
Weighted average shares outstanding:
Basic 3,811,698 3,661,261
Diluted 5,104,678 4,045,827
Net income (loss) per common share:
Basic $ (0.02) $ (0.06)
Diluted $ (0.01) $ (0.05)
See notes to unaudited financial statements.
5
KAHIKI FOODS, INC.
STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended June 30,
2006 2005
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Cash Flows From Operating Activities:
Net income (loss) $ (65,871) $ (220,394)
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization 239,898 179,270
Life insurance proceeds deposits 92,402 -
Net value of property and equipment
written off - 1,263
Compensation expense from stock options 7,494 -
Changes in operating assets and
liabilities:
Accounts receivable 275,857 (502,754)
Inventories (95,728) 262,446
Refundable income taxes 605 5,289
Other assets (13,823) (2,196)
Accounts payable 172,669 (15,522)
Accrued expenses (71,485) (58,488)
Income taxes payable (20,240) (5,350)
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Net cash provided by (used in)
operating activities 521,778 (356,436)
Cash Flows From Investing Activities:
Purchase of equipment and improvements (155,213) (1,700,727)
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Net cash used in investing activities (155,213) (1,700,727)
Cash Flows From Financing Activities:
Line of credit - net (891,124) 1,342,395
Proceeds from long-term debt - 2,282,810
Payments on long-term debt (309,096) (197,678)
Capitalized cost of financing - 7,750
Proceeds from the exercise of
stock options - 8,430
------------ -------------
Net cash provided by (used in)
financing activities (1,200,220) 3,443,707
------------ -------------
Net increase (decrease) in cash (833,655) 1,386,544
Cash - beginning of period 833,655 -
------------ -------------
Cash - end of period $ - $ 1,386,544
============ =============
Supplemental Disclosures Of Cash
Flow Information:
Cash paid for:
Interest $ 135,792 $ 109,051
Income taxes (30,365) 60
See notes to unaudited financial statements.
6
KAHIKI FOODS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
June 30, 2006
Note 1: Management's Plan
Kahiki incurred a loss from operations in its most recent fiscal year. In
addition, as identified below, Kahiki is in technical default of several
covenants in most of its debt. Total debt in technical default was $7,721,877 at
June 30, 2006 and $8,874,441 at March 31, 2006.
The death in July 2005 of Michael Tsao, former Chairman, President, and Chief
Executive Officer of Kahiki, caused technical defaults in several of Kahiki's
debts. He had personally guaranteed six small debts, and death of a guarantor
was a stated default in those loans. In addition, the loss from operations in
fiscal 2006 contributed to a failure to meet a financial covenant on debt with
KeyBank National Association ("KeyBank").
The defaults are caused by the death of Mr. Tsao (which cannot be cured), by
cross-default clauses in debt instruments (which cannot be cured until all
defaults are cured), by the failure to meet a financial covenant on debt with
KeyBank, and/or by our failure to submit in a timely manner certain reports
required by the loan documents.
We are in the process of complying with the requirements to file reports. We
have requested waivers from all lenders to remove the loans from default status.
Our major lenders, KeyBank and the State of Ohio, have given us waivers of
defaults that occurred through March 31, 2006. However, because of the
continuing defaults on the other debt, and the cross-default clauses in the
KeyBank and State of Ohio debts, these waivers are not effective for periods
subsequent to March 31, 2006.
We believe that it is possible that some of our lenders will not waive the
technical defaults in Kahiki's debt with them. We have prepared the financial
statements as if no creditor waived technical defaults, and consequently, we
classified all debt in default as a current liability.
Kahiki is current in all required payments of principal and interest on all our
debt. No creditor has requested acceleration of the debt. Our lenders have a
variety of responses available to them, including standing still, increasing the
interest rates on the debt, and withholding rights to operate the KeyBank
revolver loan. In addition, the lenders may call the debt that is in default.
We expect capital additions to be considerably less over the next twelve months
than in fiscal 2006. We also expect that we will have no additional debt, other
than temporary loans or capital leases on purchases of specific capital items.
Our efforts at improving product flow within the plant have been initially
successful. We expect to continue on these activities. With this effort, we
freed up substantial cash from the sale of finished goods. We expect to be able
to fund future operations with cash flow from operating activities, although our
cash position will remain tight for the foreseeable future. If lenders exercise
their rights to accelerate our debt, we may not be able to fund our operations
with cash flow from operating activities. Future
7
financing transactions may also include the issuance of common stock from
exercise of options or warrants.
Note 2: Summary Of Significant Accounting Policies
Nature And Scope Of Business:
Kahiki manufactures frozen Asian and Pacific Rim foods. Our products include egg
rolls, appetizers, single serve entrees, family meal entrees, sauces, and
similar products. We sell our products to retail food stores, warehouse clubs,
and foodservice outlets. We sell under our own trade names. We also sell under
the private labels of several customers. We sell our products mainly in the
United States, but we also have outlets in Canada.
We operate on a fiscal year ending on March 31. We operate in a single business
segment of frozen food manufacturing.
Interim Financial Information:
Kahiki's interim financial statements are unaudited. They reflect all
adjustments (consisting only of normal recurring adjustments) which management
deems necessary for a fair presentation of the financial position and operating
results for the interim periods. The operating results for the three-month
periods ended June 30, 2006 and 2005 are not necessarily indicative of the
results for Kahiki's full fiscal year. These unaudited interim financial
statements are presented in accordance with the requirements of Form 10-QSB and,
consequently, do not include all of the disclosures made in Kahiki's annual
report on Form 10-KSB. You should read these financial statements and notes in
conjunction with the financial statements and notes thereto included in Kahiki's
Form 10-KSB for the fiscal year ended March 31, 2006.
Use Of Estimates:
We use estimates to prepare the financial statements, as required by generally
accepted accounting principles in the United States of America. These estimates
affect the values that we report in the financial statements and accompanying
footnotes for assets, liabilities, revenues, expenses, income, equity, and
contingencies. Our actual results could differ from these estimates.
Accounts Receivable And Risk Concentrations:
Kahiki's sales are concentrated in a single industry. Kahiki's sales are also
concentrated in a few large customers. We do not have long-term contracts with
our customers. Generally, Kahiki's customers may stop purchasing its products at
any time and with minimal or no notice. We expect customers to continue
purchasing from Kahiki because of the quality and taste of our products, and our
competitive prices.
We maintain a reserve ($100,000 at June 30, 2006 and $117,115 at March 31, 2006)
for approved promotional allowances on receivables.
We review our receivables on a monthly basis to ensure that they are properly
valued and collectible. We maintain an allowance for doubtful accounts ($30,000
at June 30 2006 and at March 31, 2006) to record the estimated risk of loss
related to our customers' ability to pay. We review payment histories
8
of our customers, historical trends of doubtful accounts, and general economic
conditions when estimating the amount of the necessary allowance.
Inventories:
Kahiki's inventories include perishable fresh poultry and other raw materials,
frozen work in process inventories, and frozen packaged finished products. Our
inventories also include packaging supplies. We maintain stringent safety
procedures to ensure freshness and wholesomeness of our inventories.
We value the inventory at the lower of cost (first-in, first-out method) or
market. We establish a provision for obsolete or slow moving inventory ($25,000
at June 30, 2006 and at March 31, 2006). On a monthly basis, we review
expiration dates of the products, changes in the product line, on-hand
quantities, and expected usage when determining the inventory provision. We
explore possibilities of donating slow moving inventories to charitable
organizations. We immediately destroy any obsolete food and packaging
inventories as soon as we identify them.
Impairment Of Assets With Long Lives:
We make a review at least annually to determine if there is a reduction in value
(an impairment in value) of any property and equipment or other asset with an
extended life. Based on those reviews, if circumstances indicate that we will
not recover the remaining cost of the asset from its use in future operations,
we write down the value of the asset to the value of the discounted cash flows
expected to result from the use of the asset or from its eventual disposition.
Interest Rate Swap:
In December 2004, Kahiki entered into an interest rate swap agreement to help
manage its interest costs and risks associated with changing interest rates. We
account for this swap at its fair value, based on market quotes. We record the
fair value in other non-current assets or other non-current liabilities in the
accompanying balance sheets, with an offsetting amount shown as an adjustment to
interest expense. The value was $24,000 at June 30, 2006 and $18,000 at March
31, 2006. In this swap, we pay a fixed rate of 6.96% and receive a variable rate
of LIBOR plus 2.5% on a notional principal amount. Our notional principal amount
was initially $1,000,000. It was $857,000 at June 30, 2006 and $893,000 at March
31, 2006. The notional principal amount decreases monthly as we make payments on
our term debt with KeyBank National Association ("KeyBank"). KeyBank is the
counterparty in the swap agreement. We monitor the bank's creditworthiness as
part of our quarterly reviews of the swap. The swap terminates in June 2012. We
record the differential paid or received on the swap each month as an adjustment
to interest expense. Kahiki does not have any other derivative instruments.
Revenue Recognition:
We record revenue when rights and risk of ownership have passed to our
customers, the price and terms are finalized and there is persuasive evidence of
an arrangement, product has been shipped or delivered to the customer, and
collection of the resulting receivables is reasonably assured. Customers do not
have the right to return products unless the products are damaged.
9
Freight Credits:
We give some customers an invoiced credit for freight. We record such credits as
freight costs and include them as part of cost of sales.
Promotional Allowances, Discounts, And Slotting Fees:
We sometimes offer promotions or co-operative advertising or discounts to
customers, or pay slotting fees to customers to obtain shelf space in retail
locations. We record all such amounts as a decrease in sales in the period we
incur them.
Broker Commissions:
We sell some products directly to our customers. We sell other products through
a network of brokers. We expense brokers' commissions and report them in
selling, general and administrative expenses on the accompanying income
statements.
Stock Based Compensation:
In prior fiscal years, Kahiki granted options to employees, directors, and
outside consultants. Through March 31, 2006 Kahiki elected to follow the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB 25") and related interpretations. Under APB 25, we did
not record expense at the date of grant of options.
Our accounting treatment for stock options changed effective April 1, 2006. In
December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 123R, Share Based Payment ("SFAS
123R"). This pronouncement supersedes the provisions of APB 25. The Securities
and Exchange Commission granted temporary relief from the provisions of SFAS
123R, and made it effective for small businesses, like Kahiki, for their first
fiscal year beginning after December 15, 2005. Kahiki adopted the provisions of
SFAS 123R as of April 1, 2006.
Among other provisions, SFAS 123R requires Kahiki to measure and record in its
financial statements the cost of employee services received in exchange for an
award of equity instruments, including stock options, based on the grant-date
fair value of the award. Kahiki will recognize that cost over the period during
which the employee is required to provide service in exchange for the award,
usually equivalent to the vesting period. We will use the "modified prospective"
method in preparing our financial statements, as allowed by SFAS 123R. The
modified prospective method permits companies to recognize compensation costs
only on new grants (including any vesting, modifications, or cancellations of
existing grants) beginning with the date of adoption. SFAS 123R also contains
deferred tax provisions for certain of the compensation expenses.
Income Taxes:
We use the liability method for determining our income taxes. We record current
and deferred tax liabilities and assets in accordance with enacted tax laws and
rates. We calculate the amounts of deferred tax liabilities and assets at the
end of each period using the tax rate expected to be in effect when taxes are
actually paid or recovered. We record as expense or income in a period the
effects of a change in tax rates in that period. We recognize
10
future tax benefits to the extent that realization of such benefits is more
likely than not. We provide deferred income taxes for the estimated income tax
effect of temporary differences between financial and tax bases in assets and
liabilities, and for certain tax credits that we may carry forward. We use a
valuation allowance, if necessary, to reduce deferred tax assets if it is more
likely than not that we will not realize some portion or all of the deferred tax
assets.
For interim reporting, Kahiki estimates a full year tax rate, and applies that
rate to its year-to-date income. For the three-month period ended June 30, 2006,
Kahiki's overall tax rate differs from the 34% federal rate primarily because of
the effects of state taxes.
Earnings Per Share:
Kahiki calculates basic earnings per share by dividing net income available for
common stockholders by the weighted average number of common shares outstanding
during the period. Our diluted earnings per share calculations include
adjustments to weighted average outstanding shares for the effects of dilutive
common stock equivalents, using the treasury stock method. These calculations
assume that all dilutive options, warrants, and preferred stock were converted
into common stock. Our stock options and warrants that have an exercise price
higher than the current market price are not dilutive.
Reclassifications:
We reclassified certain prior year amounts to conform to current
classifications.
Note 3: Inventories:
Kahiki's inventories at June 30, 2006 and March 31, 2006 contained the
following:
June 30, March 31,
2006 2006
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Raw food products $ 481,336 $ 509,947
Frozen work in process 228,056 188,343
Frozen and packaged finished goods 630,859 520,641
Packaging and supplies 324,011 349,603
Inventory reserve (25,000) (25,000)
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Total inventories $1,639,262 $1,543,534
========== ==========
11
Note 4: Property And Equipment:
Kahiki's property and equipment at June 30, 2006 and March 31, 2006 contained
the following:
June 30, March 31,
2006 2006
---------- ----------
Land $ 114,485 $ 114,485
Building and improvements 10,223,131 10,198,773
Machinery and equipment 3,440,227 3,311,177
Furniture and fixtures 163,493 161,689
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13,941,336 13,786,124
Less accumulated depreciation (1,812,309) (1,574,844)
---------- ----------
Total property and equipment $12,129,027 $12,211,280
========== ==========
Note 5: Other Current Assets And Other Assets:
Kahiki's other current assets at June 30, 2006 and March 31, 2006 contained the
following:
June 30, March 31,
2006 2006
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Deposit held by State of Ohio $ 92,023 $ 184,425
Current deferred taxes 56,000 56,000
Prepaid insurance 5,684 10,487
Interest rate swap 24,000 18,000
Other 27,109 15,403
---------- ----------
Total $ 204,816 $ 284,315
========== ==========
On July 22, 2005, Mr. Michael Tsao died. He was Kahiki's founder, Chairman of
the Board of Directors, President, and Chief Executive Officer. Kahiki had
maintained key man life insurance on Mr. Tsao. Kahiki had pledged a total of
$750,000 of the insurance as collateral on a loan from the State of Ohio
Department of Development ("ODOD"). Kahiki received that amount of proceeds from
the life insurance policies, plus interest, in the quarter ended September 30,
2005. We recorded all of those September proceeds as restricted deposits. Kahiki
deposited the $750,000 proceeds with a commercial bank acting as trustee for
Ohio on Kahiki's ODOD loan. Kahiki received a letter from ODOD indicating that
Kahiki could use part of the deposit to make its payments on the ODOD loan from
October 2005 to September 2006. ODOD further indicated that the trustee for the
ODOD loan will keep the remaining deposit, plus interest, as a reserve to be
applied toward the final loan payments (due in 2022). We allocated $368,720 as a
restricted deposit in other current assets, and the remainder as a non-current
restricted deposit held in other assets. We used $184,295 of the restricted
current deposit to make payments on the ODOD loan from October 2005 through
March 2006, and an additional $92,402 to make payments through June 30, 2006.
Our other current assets at June 30, 2006 include a remaining $92,023 portion of
the restricted deposit ($184,425 at March 31, 2006), representing payments due
on the loan from July 2006 through September 2006. Our "Restricted deposits" in
Other Assets on the accompanying June 30, 2006 and March 31, 2006 balance sheets
includes $399,961 and $396,394, respectively, for the long-term restricted
deposit plus accumulated interest. Kahiki received an additional $500,000 of
life
12
insurance proceeds on Mr. Tsao, plus interest, in the quarter ended December 31,
2005. Kahiki had no restrictions on the use of those funds, and we used those
December proceeds in our operations. On the accompanying statements of cash
flows, we adjusted "Net cash provided by (used in) operating activities" for the
effects of the restricted deposits from the September life insurance proceeds to
the extent that they were not used in operations upon receipt or were used in
operations subsequently to pay down the ODOD loan.
Our "Restricted deposits" in Other Assets on the accompanying June 30, 2006 and
March 31, 2006 balance sheets also includes a certificate of deposit from a
commercial bank in the amount of $30,000. We pledged this certificate of deposit
as additional collateral on a loan that is due in October 2009. The remaining
balance on this loan at June 30, 2006 was $73,561, and we are in default of
certain of its provisions at that date. We receive monthly interest on the
certificate of deposit at an annual rate of 5 1/4%. The certificate of deposit
matures in March 2007 but must be renewed.
Note 6: Notes Payable And Long-Term Debt:
We treat all capital leases as notes payable and debt. Kahiki's notes payable
and long-term debt at June 30, 2006 and March 31, 2006 contained the following:
June 30, March 31,
2006 2006
----------- -----------
Capital leases and loans for
the purchase of equipment:
Capital leases of equipment $ 352,979 $ 383,418
Capital leases of equipment,
in default 157,646 186,792
Loans payable, in default 143,836 229,088
Capital leases and loans for
the purchase of land and buildings:
Capital lease of land 55,902 60,372
ODOD loan, in default 3,812,500 3,850,000
Unsecured borrowings:
Loan payable 82,084 94,831
Note payable to Mrs. Alice Tsao, a
related party, in default 90,000 120,000
KeyBank financing:
Term loan, in default 1,909,019 1,988,561
Revolver loan, in default 1,608,876 2,500,000
----------- -----------
Total debt 8,212,842 9,413,062
Less current portion (7,863,785) (9,029,071)
----------- -----------
Long-term debt $ 349,057 $ 383,991
=========== ===========
Our debt is collateralized by all of our property and equipment, receivables,
inventory, cash, a certificate of deposit, short- and long-term deposits with
ODOD, a letter of credit, and certain personal guarantees of our Chairwoman. In
addition, Kahiki's debt to Mrs. Tsao is subordinated to some of its other debt.
13
If lenders accelerate payments on defaulted debt, all debt not currently in
default would become in default, and all debt would be due immediately.
In August 2004, Kahiki and KeyBank entered into a letter of credit agreement for
a standby letter of credit in the amount of $418,000. Kahiki is contingently
liable under this standby letter of credit. The agreement has an annual fee
equal to 1% of the commitment. ODOD is the beneficiary. The letter of credit
expires in August 2009, but has to be renewed because ODOD requires Kahiki to
provide the letter of credit as additional collateral on the ODOD loan until
loan expiration in November 2022.
Mr. Michael Tsao (former Chairman of Kahiki until his death) and Mrs. Alice Tsao
(currently Chairwoman of Kahiki) personally guaranteed several of Kahiki's
loans. At June 30, 2006, the remaining guarantees by Mrs. Tsao, and Mr. Tsao's
estate, total $301,482 on six loans. All of these notes are cognovit notes,
under which Kahiki (and Mrs. Tsao as guarantor) has waived notice and empowered
the lenders to confess judgment if there is a default.
In July 2006, we signed a small new debt agreement with KeyBank and we borrowed
$65,000 under that agreement. This is a short-term loan, due October 2006. We
used part of our estimated tax refund as collateral on the loan. The interest
rate is 9.25%. We used a similar amount late in June 2006 to pay off one of the
defaulted debts.
In July 2006, we also borrowed $104,964 from a commercial lender in the form of
a capital lease on the purchase of a specific piece of equipment. We will make
60 monthly payments of approximately $2,200 on this lease. The interest rate is
9.64%.
Note 7: Related Party Transactions
In December 2005, Kahiki wrote down the value of two company-owned vehicles to
their remaining market value. The combined market values were slightly less than
the remaining principal balance of the loans on the two vehicles. Kahiki then
transferred ownership of the two vehicles to Alice Tsao, Chairwoman of the Board
of Kahiki. Mrs. Tsao also took over the remaining principal balance on loans on
the two vehicles, and traded in both vehicles on a new personal vehicle. Kahiki
reimbursed Mrs. Tsao for the difference between the market value and the amount
of the remaining loans on the vehicles.
In 2002, Mrs. Tsao loaned Kahiki $150,000. It is unsecured, and was originally
due in February 2005. Mrs. Tsao extended the loan to February 2006. It is now
due. The loan is subordinated to some of Kahiki's other debt. We reached an
agreement with Mrs. Tsao under which Kahiki is making monthly payments of
principal of $10,000 on this loan. We expect to pay it off in March 2007.
In December 2004 ($1,000,000) and in June 2005 ($1,000,000), Kahiki received
loans from Townsends, Inc. ("Townsends") under a convertible promissory note
agreement. Mr. Charles Dix, a Director of Kahiki, is President of Townsends. In
December 2004, Kahiki also entered into a poultry purchase agreement with
Townsends and a finished product co-pack and storage agreement with Townsends.
14
The poultry purchase agreement with Townsends requires Kahiki to purchase
chicken from Townsends each week at market prices less $0.09 per pound, with a
minimum price of $1.21 per pound and a maximum price of $1.81 per pound.
Kahiki's purchases can vary from 20,000 pounds per week to 40,000 pounds per
week but must average at least 30,000 pounds per week, measured quarterly. This
is a take-or-pay contract. Kahiki maintains average purchases at the required
level. We expect to be able to use the required average purchases in our weekly
production. The contract extends to December 2007. Either Kahiki or Townsends
may cancel the contract with one year's notice. Kahiki purchased $565,000 and
$537,000 of chicken from Townsends in the fiscal quarters ended June 30, 2006
and 2005, respectively. Kahiki had a payable to Townsends of $101,000 and
$73,000 at June 30, 2006 and March 31, 2006, respectively.
Kahiki also maintains a co-pack agreement with Townsends. Under that agreement,
Townsends may order and Kahiki must supply certain levels of product, made to
Townsends' specifications and packaged under Townsends' private label for sale
to food service operations. Kahiki's selling price to Townsends is limited by
the contract to Kahiki's inventory cost plus a stated markup percentage. The
contract extends to December 2007. Either Townsends or Kahiki may cancel the
contract with thirteen months notice. Under this agreement, Kahiki sold $315,000
and $0 of its products to Townsends in the fiscal quarters ended June 30, 2006
and 2005, respectively. Kahiki had a receivable from Townsends of $81,000 and
$144,000 at June 30, 2006 and March 31, 2006, respectively.
In April 2006, Kahiki purchased a fryer and refrigeration equipment from
Townsends for $100,000. Kahiki will use this equipment in its operations. Kahiki
is paying for this equipment at $20,000 per month from April through August
2006.
Kahiki's Board of Directors determined that the terms of the related party
transactions were commercially reasonable based on available data at the dates
of each of them. In particular, the Board of Directors considered the interest
rates and payment terms of the Notes, the discount from market prices on
chicken, and the then current market price of Kahiki's stock relating to the
conversion privilege on the debt with Townsends.
Note 8: Payables
At June 30, 2006, Kahiki had $267,009 of accounts payable over 90 days old. Of
these, $263,586 related to disputed costs with one contractor on our Morrison
Road facility.
In fiscal 2006, we contracted with a lender to advance the funds needed to have
a supplier build a new piece of equipment for Kahiki. After completion of the
equipment, Kahiki would lease the equipment under a capital lease. The lender
advanced $61,172 to the supplier as the initial deposit on the equipment. The
supplier declared bankruptcy before the equipment could be completed. The
bankruptcy estate of the supplier was unable to accept the contract in time to
complete the equipment to meet Kahiki's needs. Kahiki recorded the amounts
advanced by the lender as a payable to the lender. Kahiki expensed the deposit
in fiscal 2006, and will repay the lender.
15
Note 9: Accrued Liabilities:
Kahiki's accrued liabilities at June 30, 2006 and March 31, 2006 contained the
following:
June 30, March 31,
2006 2005
---------- ----------
Payroll and related accruals $ 254,419 $ 312,692
Interest 66,000 61,206
Property taxes 64,080 81,907
Other - 179
---------- ----------
Total $ 384,499 $ 455,984
========== ==========
Note 10: Stockholders' Equity:
Our Amended and Restated Articles of Incorporation authorize the issuance of up
to 10,000,000 shares of capital stock, consisting of 1,000,000 Series A
Convertible Preferred Shares without par value ("Preferred Shares"), and
9,000,000 Common Shares without par value.
Series A Convertible Preferred Shares:
The Preferred Shares provide for cumulative annual dividends at an annual rate
of $0.1125 per share. The holders of Preferred Shares can convert them into
Common Shares on a share for share basis (subject to anti-dilution rights). The
Preferred Shares have a liquidation preference of 1.5 times the invested amount
and entitle the class to elect up to two members of our Board of Directors. In
February 2006, Townsends acquired 930,741 Preferred Shares upon conversion of
$2,000,000 aggregate principal amount of notes and $94,167 of accrued interest.
The conversion price was $2.25 per Preferred Share. At June 30, 2006 and March
31, 2006, Kahiki had 930,741 Preferred Shares outstanding. Mr. Charles Dix,
President of Townsends, is a member of the Board of Directors of Kahiki.
Townsends has not exercised its right to elect a second member to the Board of
Directors.
Common Shares:
As of June 30, 2006, Kahiki has 3,811,698 Common Shares outstanding. In
addition, we have reserved 2,111,841 Common Shares for the conversion of
currently outstanding Preferred Shares (930,741), warrants (618,234) and options
(562,866), and we have reserved 186,450 Common Shares for the conversion of the
remaining options which Kahiki may grant under its option plan.
Kahiki has never paid cash dividends on any class of stock. Our ability to pay
dividends will depend upon our future earnings and net worth. Also, some of our
debt agreements restrict our ability to declare dividends.
Registration Statement:
We agreed to file and maintain a registration statement to register the shares
sold to Barron Partners LP in 2004, as well as to register the warrants and
options that were issued as part of the transaction. We have agreed with Barron
Partners LP to keep the registration statement effective until the shares being
offered may be sold without registration or restriction pursuant to Rule 144(k),
or if earlier, until their distribution of shares has been completed.
Kahiki and Townsends also entered into a Registration Rights Agreement. Under
16
this agreement, Kahiki agreed to file a registration statement with the U.S.
Securities and Exchange Commission on demand by Townsends between December 21,
2005 and December 20, 2009, for the purpose of registering the resale of Common
Shares into which the Preferred Shares may be converted.
Kahiki has an active registration statement covering these transactions, and
certain other Kahiki Common Shares, with a prospectus date of September 29,
2005. This prospectus relates to the resale of up to 4,938,048 of our Common
Shares by the selling shareholders listed in the prospectus. The selling
shareholders will receive all of the proceeds from the sale of Common Shares
under the prospectus. Of these shares, 1,378,700 shares are issuable upon the
exercise of warrants or options. We will receive the proceeds from any cash
exercise of the warrants and options by the selling shareholders. Selling
shareholders may sell at prevailing market prices or at prices negotiated at the
time of sale. Kahiki paid all expenses of registering the securities.
Note 11: Stock Options:
In July, 2001, the Shareholders adopted and approved Kahiki's 2001 Non Qualified
and Incentive Stock Option Plan ("Plan"). The Plan allows issuance of options to
purchase up to 600,000 Common Shares. Option holders have exercised a total of
111,350 options through June 30, 2006. The Plan has 302,200 options outstanding
at that date. The Plan has 186,450 remaining authorized but unissued options at
that date. In addition to options granted under the plan, Kahiki granted options
outside the Plan provisions prior to fiscal 2005. Our outstanding options
outside the Plan total 260,666 at June 30, 2006. We show a reconciliation of
Plan and non-Plan options below.
As part of the registration statement provisions, we will not grant options and
warrants to officers, directors, employees, 5% shareholders or affiliates for a
one year period following the date of the registration statement (until
September 29, 2006).
On August 9, 2004, we issued options to purchase 2,000 common shares each at an
exercise price of $3.40 per share (the then current market price) to Dr. Winston
Bash, Mr. Bob Binsky, and Mr. Charles Dix (each a director); 3,000 common shares
each at an exercise price of $3.40 per share to Mr. Bradford Sprague and Mr.
R.L. Richards (each a director and the chairmen of the Compensation Committee
and Strategy Committee, respectively); and 4,000 common shares at an exercise
price of $3.40 per share to Dr. Allen Proctor (a director and chairman of the
Audit Committee). They may exercise these options at any time through August 8,
2009.
We recorded a compensation expense of $7,494 in selling, general, and
administrative expenses on the accompanying income statement for the three
months ended June 30, 2006, upon adoption of SFAS 123R. This expense related to
previously-issued options.
17
If we had determined compensation costs for our options based on their fair
value at their grant dates consistent with the methodology in SFAS 123R, our
reported net income and earnings per share would change as indicated below for
the three months ended June 30, 2005:
2005
---------
Net income (loss) available to common
stockholders, as reported $(220,394)
Total stock-based compensation
expense determined under fair
value based methods for all
awards, net of tax benefit 13,758
---------
Net income (loss) available to common
stockholders, as adjusted $(234,152)
=========
Basic earnings per share:
As reported $ (0.06)
As adjusted (0.06)
Diluted earnings per share:
As reported $ (0.05)
As adjusted (0.06)
When Kahiki issues options, we estimate fair value at the date of grant by using
the Black-Scholes option-pricing model. We issued no options in fiscal 2006 or
in the quarter ended June 30, 2006.
Kahiki's stock options issued under the Plan are summarized as follows for the
fiscal year ended March 31, 2006 and the quarter ended June 30, 2006:
Weighted Average
Options Exercise Price
-------- ---------------
Balance outstanding at March 31, 2005 404,800 $0.83
Issued - -
Exercised (63,350) $0.36
Cancelled or expired (39,250) $2.31
--------
Balance outstanding at March 31, 2006
and at June 30, 2006 302,200 $0.74
========
Exercisable March 31, 2005 271,133 $0.62
Exercisable March 31, 2006 255,450 $0.70
Exercisable June 30, 2006 257,450 $0.70
18
Kahiki's stock options issued outside the Plan are summarized as follows for the
fiscal year ended March 31, 2006 and the quarter ended June 30, 2006:
Weighted Average
Options Exercise Price
-------- ---------------
Balance outstanding at March 31, 2005 386,666 $0.58
Issued - -
Exercised (126,000) $0.41
Cancelled or expired - -
--------
Balance outstanding at March 31, 2006
and at June 30, 2006 260,666 $0.67
========
Exercisable March 31, 2005 386,666 $0.58
Exercisable March 31, 2006 260,666 $0.67
Exercisable June 30, 2006 260,666 $0.67
In fiscal 2006, one optionee used 27,500 Common Shares in payment for the
exercise of 66,000 options issued outside the Plan, as allowed by the options.
Note 12: Common Stock Warrants
On February 27, 2004, Kahiki closed on a private offering of Common Shares and
Common Stock Warrants sold to Barron Partners LP. As part of the transaction, we
issued the following warrants:
Warrants to purchase Common Shares:
To Barron Partners LP 294,117 warrants at $2.25 per share
To Barron Partners LP 294,117 warrants at $3.00 per share
To three consultants 30,000 warrants at $2.25 per share
All the warrants were immediately exercisable and they expire in February 2009.
The warrants held by Barron Partners LP have a cashless exercise feature. If
Kahiki's stock price exceeds the strike price of the warrants, Barron Partners
LP may receive a proportionate amount of Common Shares without Kahiki receiving
any cash in payment. All warrants contain normal anti-dilution features, and we
will adjust the number of shares to be received upon exercise, and the exercise
price, if Kahiki has a corporate reorganization, restructuring, share dividend
or other corporate action, to maintain the rights of the warrant holders
substantially as if such action had not occurred.
19
Note 13: Earnings Per Share:
We calculated our earnings per share using the following values for the quarters
ending June 30, 2006 and 2005:
2006 2005
---------- ----------
Basic earnings per share:
Numerator - income (loss) available
to common shareholders $ (92,049) $ (220,394)
Denominator:
Weighted average outstanding
Common Shares 3,811,698 3,661,261
Basic earnings (loss) per share $ (0.02) $ (0.06)
Diluted earnings per share:
Numerator - net income (loss) $ (65,871) $ (220,394)
Denominator:
Weighted average outstanding
Common Shares 3,811,698 3,661,261
Effect of dilutive options 362,239 384,566
Dilutive Preferred Shares 930,741 -
---------- ----------
Total shares in denominator 5,104,678 4,045,827
Diluted earnings (loss) per share $ (0.01) $ (0.05)
Note 14: Reclassifications Of Financial Statement Amounts:
We reclassified or corrected certain amounts in the statements of cash flows for
the quarter ended June 30, 2005.
1. We previously amended the balance sheet as of March 31, 2005 to show a
$10,568 net cash overdraft at that date as an addition to accounts payable in
current liabilities rather than as a negative asset.
2. We combined the amounts for purchases of equipment, purchases of new facility
improvements, and minor amounts of proceeds from the sale of equipment. We now
report these as purchases of equipment and improvements. There was no change in
total cash used in investing activities from this combination.
3. We combined payments on long-term debt and payments of bond obligation. We
now report these as payments on long-term debt. There was no change in total
cash flows from financing activities from this combination.
These adjustments also changed subtotals and totals in the statement of cash
flows. All of these are changes in disclosure and not changes in policy.
20
This table shows the original amount and the revised amount for each such item.
The changes are keyed to the numbers identified in the paragraphs immediately
above.
Revised Original
Key Amount Amount
--- ------------ -----------
Statement of cash flows (unaudited)
for the three months ended
June 30, 2005:
CASH FLOWS FROM OPERATING ACTIVITIES:
Accounts payable 1 (15,522) (4,954)
Net cash provided by (used in)
operating activities 1 (356,436) (345,868)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements 2 (1,700,727) -
Purchase of equipment 2 - (649,226)
Purchase of new facility improvements 2 - (1,051,701)
Proceeds from the disposal of property
and equipment 2 - 200
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt 3 (197,678) (162,678)
Payments of bond obligation 3 - (35,000)
Net increase (decrease) in cash 1 1,386,544 1,397,112
Cash - beginning of period 1 - (10,568)
Cash - end of period 1 1,386,544 1,386,544
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
Please read this discussion and analysis and plan of operations in conjunction
with the accompanying unaudited financial statements and the notes thereto
included elsewhere in this report on Form 10-QSB. Some of the information
contained in this discussion and analysis or set forth elsewhere in this Form
10-QSB, including information with respect to our plans and strategies for our
business, includes forward-looking statements that involve risk and
uncertainties. (See the section titled "FORWARD-LOOKING STATEMENTS" for a more
complete discussion.)
OVERVIEW
We are a specialty branded food company that manufactures, distributes and sells
frozen Asian and Pacific Rim food products throughout the United States and
Canada. Most of our products are branded as Kahiki; some are private labeled
products for certain customers. Our customers are mainly food stores, membership
warehouse clubs, and supermarkets. Our sales are concentrated in a few
customers. We actively engage in promotions, and we pay slotting fees to certain
customers to gain shelf space for our products. We believe that Kahiki foods are
better-tasting than competitors' products. We maintain an active research and
development function to develop and market new products.
21
RESULTS OF OPERATIONS
The following table sets forth, for the three month periods ending June 30, 2006
and 2005, the percentage of net sales represented by the specified items
included in our unaudited statements of income. We have included this comparison
because we believe it adds a meaningful basis for period-to-period comparisons.
This financial data should not be viewed as a substitute for our historical
unaudited statements of income determined in accordance with accounting
principles generally accepted in the United States of America. This table does
not purport to be indicative of future results of operations.
Three months ended
Jun. 30, 2006 Jun. 30, 2005
------------- -------------
Percentages of net sales:
Net sales 100.0% 100.0%
Cost of sales 79.1 84.1
Gross profit 20.9 15.9
Selling, general, and
administrative expenses 20.8 18.8
Income (loss) from
operations 0.1 (2.9)
Interest expense (2.1) (1.4)
Other income (expense),net 0.1 -
Income tax expense 0.8 -
Net income (1.1)% (4.3)%
COMPARISON OF QUARTER ENDED JUNE 30, 2006 TO QUARTER ENDED JUNE 30, 2005
Net sales for the quarter ended June 30, 2006 were $959,317 higher than the
comparable quarter in fiscal 2006, an increase of 18.8%. We increased capacity
when we moved into the new facility. In the quarter, we were successful in
increasing sales to new accounts, both retail and membership warehouse club
stores, and also in the introduction of successful new products to existing
customers.
We moved into our new facility in the quarter ending June 30, 2005. We have
experienced operating inefficiencies in the start-up of our new facility.
Beginning in September 2005, we began to move Kahiki toward more efficient
manufacturing. We improved the flow of materials through our plant. We are
attempting to produce only what is being ordered by our customers. This effort
is ongoing. We expect that continued efforts to align production with orders
will help Kahiki improve its operations and cash flows, and provide a basis for
future growth. Results from our improvements to product flow within our facility
helped improve the gross margin in the quarter ended June 30, 2006. In the
quarter, we focused on streamlining the manufacturing process in the new
facility and improving purchasing cost control, especially for food costs. Gross
margins improved to 20.9% of net sales in the quarter compared to 15.9% a year
ago. We expect margins to improve, but anticipate improvements happening
gradually over several quarters as we continue to adjust product flow to orders
and gain process improvements, and continue to work out start up issues related
to the new facility.
22
Selling, general, and administrative costs increased in the quarter compared to
the same quarter last year. Some of the increase came from brokers fees and
other selling costs related to the higher sales. Payroll costs, costs for
consultants, and increased directors' fees all contributed to this increase. We
added management to assist in product innovation and marketing efforts.
Interest expense increased in the quarter. This is due mainly to higher debt
incurred in fiscal 2006 to complete the new facility and purchase equipment.
Higher interest rates also contributed to the increase. Also, we capitalized
interest while the new facility was being renovated. Now that construction has
been completed (May 2005) and we have moved into the new facility, we treat all
interest as expense and no further interest is capitalized.
For interim reporting, Kahiki estimates a full year tax rate, and applies that
rate to its year-to-date income.
We reported a substantially lower net loss in the quarter ended June 30, 2006
than in the same quarter a year ago. Improvements came from higher sales and the
initial effects of improving product flow within the plant.
LIQUIDITY AND CAPITAL RESOURCES
In December 2002, we arranged a state economic development loan with the State
of Ohio for $4.18 million. We began making principal payments on this loan in
December 2003. The loan matures December 1, 2022. We used the proceeds to
purchase our production facility, provide funds for improvements to the
building, and purchase equipment.
In December 2004, we completed a $2.227 million dollar financing package with
KeyBank National Association ("KeyBank") and a $2.0 million dollar financing
package with Townsends. Under the terms of the agreements, $2.227 million was
immediately available to help fund the completion of construction of our
production facility, and for working capital. Upon start-up of the new plant, an
additional $2.0 million was to be available for working capital. We received the
final $2 million in June 2005 ($1.0 million from each of KeyBank and Townsends).
The financing package also provides for a poultry supply and a co-pack and
storage agreement with Townsends. (In February 2006, Townsends converted the
$2.0 million principal of their notes, and accrued interest of $94,167, into
930,741 shares of Kahiki's no par value Series A Convertible Preferred Shares.)
Due to cost overruns on the building and equipment, we used all of the State of
Ohio loan, and the entire $4.227 million financing package with KeyBank and
Townsends, to complete the facility, and none for working capital. During the
year ended March 31, 2006, we spent $2,428,482 to complete the facility
improvements, and to purchase equipment.
In August 2004, Kahiki and KeyBank entered into a letter of credit agreement for
a standby letter of credit in the amount of $418,000. Kahiki is contingently
liable under this standby letter of credit. The agreement has an annual fee
equal to 1% of the commitment. The State of Ohio is the beneficiary. The letter
of credit expires in August 2009, but has to be renewed as Ohio requires Kahiki
to provide the letter of credit as additional collateral on the Ohio loan until
loan expiration in November 2022.
23
On June 1, 2004, we entered into an agreement with KeyBank for a revolving loan
facility. The borrowing base of the revolving loan facility is limited to the
lesser of (i) $2,500,000 or (ii) the sum of (A) 85% of eligible accounts
receivable, plus (B) 40% of eligible inventory. We used this line to pay off a
pre-existing $1,100,000 line, and to provide working capital. The revolving loan
matures on May 31, 2007. At June 30, 2006, we had outstanding borrowings of
$1,608,876 under this line.
Mr. Michael Tsao (former Chairman of Kahiki until his death) and Mrs. Alice Tsao
(currently Chairwoman of Kahiki) personally guaranteed several of Kahiki's
loans. At June 30, 2006, the remaining guarantees by Mrs. Tsao, and Mr. Tsao's
estate, total $301,000 on six loans. All of these notes are cognovit notes,
under which Kahiki (and Mrs. Tsao as guarantor) has waived notice and empowered
the lenders to confess judgment if there is a default.
We received notification in October of 2004 that Sam's Club discontinued our
product in their stores. Our product has always been sold as an "in and out"
item in Sam's. This means it is only sold for a time period of several weeks up
to several months. Our product was accepted back in to Sam's Club by the end of
June 2005. Sam's Club continues to be one of our largest customers. Our sales to
Sam's Club were 23% of our total sales in fiscal 2006.
Kahiki reported $521,778 of net cash provided by operating activities in the
quarter ended June 30, 2006. We used that cash to pay for capital additions and
to reduce our debt.
Kahiki incurred a loss from operations in its most recent fiscal year. In
addition, as identified below, Kahiki is in technical default of several
covenants in most of its debt. Total debt in technical default was
$7,721,877 at June 30, 2006.
The death in July 2005 of Michael Tsao, former Chairman, President, and Chief
Executive Officer of Kahiki, caused technical defaults in several of Kahiki's
debts. He had personally guaranteed six small debts, and death of a guarantor
was a stated default in those loans. In addition, the loss from operations in
fiscal 2006 contributed to a failure to meet a financial covenant on debt with
KeyBank.
The defaults are caused by the death of Mr. Tsao (which cannot be cured), by
cross-default clauses in debt instruments (which cannot be cured until all
defaults are cured), by the failure to meet a financial covenant on debt with
KeyBank, and/or by our failure to submit in a timely manner certain reports
required by the loan documents. The defaulted instruments with KeyBank include
Kahiki's interest rate swap agreement and its agreement underlying the required
letter of credit in favor of the State of Ohio for the Ohio loan. The term and
revolver notes with KeyBank are cognovit notes, under which Kahiki has waived
notice and empowered KeyBank to confess judgment if there is a default. Further
explanations of our debt arrangements are included in the accompanying footnotes
to the June 30, 2006 unaudited financial statements, and in the footnotes to our
annual report for the year ended March 31, 2006. Such explanations are
incorporated herein by reference.
We are in the process of complying with the requirements to file reports. We
have requested waivers from all lenders to remove the loans from default status.
Our major lenders, KeyBank and the State of Ohio, have given us waivers of
defaults that occurred through March 31, 2006. However, because of the
continuing defaults on the other debt, and the cross-default clauses in
24
the KeyBank and State of Ohio debts, these waivers are not effective for periods
subsequent to March 31, 2006.
We believe that it is possible that some of our lenders will not waive the
technical defaults in Kahiki's debt with them. We have prepared the financial
statements as if no creditor waived technical defaults, and consequently, we
classified all debt in default as a current liability.
Kahiki is current in all required payments of principal and interest on all our
debt. No creditor has requested acceleration of the debt. Our lenders have a
variety of responses available to them, including standing still, increasing the
interest rates on the debt, and withholding rights to operate the KeyBank
revolver loan. In addition, the lenders may call the debt that is in default.
We expect capital additions to be considerably less over the next twelve months
than in the last twelve months. We also expect that we will have no additional
debt, other than temporary loans or capital leases on purchases of specific
capital items.
Our efforts at improving product flow within the plant have been initially
successful. We expect to continue on these activities. With this effort, we
freed up substantial cash from the sale of finished goods. We expect to be able
to fund future operations with cash flow from operating activities, although our
cash position will remain tight for the foreseeable future. If lenders exercise
their rights to accelerate our debt, we may not be able to fund our operations
with cash flow from operating activities. Future financing transactions may also
include the issuance of common stock from exercise of options or warrants.
CRITICAL ACCOUNTING POLICIES
Use Of Estimates:
We use estimates to prepare the financial statements, as required by generally
accepted accounting principles in the United States of America. These estimates
affect the values that we report in the financial statements and accompanying
footnotes for assets, liabilities, revenues, expenses, income, equity, and
contingencies. Our actual results could differ from these estimates.
Accounts Receivable And Risk Concentrations:
Kahiki's sales are concentrated in a single industry. Kahiki's sales are also
concentrated in a few large customers. We do not have long-term contracts with
our customers. Generally, Kahiki's customers may stop purchasing its products at
any time and with minimal or no notice. We expect customers to continue
purchasing from Kahiki because of the quality and taste of our products, and our
competitive prices.
We maintain a reserve ($100,000 at June 30, 2006 and $117,115 at March 31, 2006)
for approved promotional allowances on receivables.
We review our receivables on a monthly basis to ensure that they are properly
valued and collectible. We maintain an allowance for doubtful accounts ($30,000
at June 30 2006 and at March 31, 2006) to record the estimated risk
25
of loss related to our customers' ability to pay. We review payment histories of
our customers, historical trends of doubtful accounts, and general economic
conditions when estimating the amount of the necessary allowance.
Inventories:
Kahiki's inventories include perishable fresh poultry and other raw materials,
frozen work in process inventories, and frozen packaged finished products. Our
inventories also include packaging supplies. We maintain stringent safety
procedures to ensure freshness and wholesomeness of our inventories.
We value the inventory at the lower of cost (first-in, first-out method) or
market. We establish a provision for obsolete or slow moving inventory ($25,000
at June 30, 2006 and at March 31, 2006). On a monthly basis, we review
expiration dates of the products, changes in the product line, on-hand
quantities, and expected usage when determining the inventory provision. We
explore possibilities of donating slow moving inventories to charitable
organizations. We immediately destroy any obsolete food and packaging
inventories as soon as we identify them.
Impairment Of Assets With Long Lives:
We make a review at least annually to determine if there is a reduction in value
(an impairment in value) of any property and equipment or other asset with an
extended life. Based on those reviews, if circumstances indicate that we will
not recover the remaining cost of the asset from its use in future operations,
we write down the value of the asset to the value of the discounted cash flows
expected to result from the use of the asset or from its eventual disposition.
Interest Rate Swap:
In December 2004, Kahiki entered into an interest rate swap agreement to help
manage its interest costs and risks associated with changing interest rates. We
account for this swap at its fair value, based on market quotes. We record the
fair value in other non-current assets or other non-current liabilities in the
accompanying balance sheets, with an offsetting amount shown as an adjustment to
interest expense. The value was $24,000 at June 30, 2006 and $18,000 at March
31, 2006. In this swap, we pay a fixed rate of 6.96% and receive a variable rate
of LIBOR plus 2.5% on a notional principal amount. Our notional principal amount
was initially $1,000,000. It was $857,000 at June 30, 2006 and $893,000 at March
31, 2006. The notional principal amount decreases monthly as we make payments on
our term debt with KeyBank National Association ("KeyBank"). KeyBank is the
counterparty in the swap agreement. We monitor the bank's creditworthiness as
part of our quarterly reviews of the swap. The swap terminates in June 2012. We
record the differential paid or received on the swap each month as an adjustment
to interest expense. Kahiki does not have any other derivative instruments.
Revenue Recognition:
We record revenue when rights and risk of ownership have passed to our
customers, the price and terms are finalized and there is persuasive evidence of
an arrangement, product has been shipped or delivered to the customer, and
collection of the resulting receivables is reasonably assured. Customers do not
have the right to return products unless the products are damaged.
26
Freight Credits:
We give some customers an invoiced credit for freight. We record such credits as
freight costs and include them as part of cost of sales.
Promotional Allowances, Discounts, And Slotting Fees: We sometimes offer
promotions or co-operative advertising or discounts to customers, or pay
slotting fees to customers to obtain shelf space in retail locations. We record
all such amounts as a decrease in sales in the period we incur them.
Broker Commissions:
We sell some products directly to our customers. We sell other products through
a network of brokers. We expense brokers' commissions and report them in
selling, general and administrative expenses on the accompanying income
statements.
Stock Based Compensation:
In prior fiscal years, Kahiki granted options to employees, directors, and
outside consultants. Through March 31, 2006 Kahiki elected to follow the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB 25") and related interpretations. Under APB 25, we did
not record expense at the date of grant of options.
Our accounting treatment for stock options changed effective April 1, 2006. In
December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 123R, Share Based Payment ("SFAS
123R"). This pronouncement supersedes the provisions of APB 25. The Securities
and Exchange Commission granted temporary relief from the provisions of SFAS
123R, and made it effective for small businesses, like Kahiki, for their first
fiscal year beginning after December 15, 2005. Kahiki adopted the provisions of
SFAS 123R as of April 1, 2006.
Among other provisions, SFAS 123R requires Kahiki to measure and record in its
financial statements the cost of employee services received in exchange for an
award of equity instruments, including stock options, based on the grant-date
fair value of the award. Kahiki will recognize that cost over the period during
which the employee is required to provide service in exchange for the award,
usually equivalent to the vesting period. We will use the "modified prospective"
method in preparing our financial statements, as allowed by SFAS 123R. The
modified prospective method permits companies to recognize compensation costs
only on new grants (including any vesting, modifications, or cancellations of
existing grants) beginning with the date of adoption. SFAS 123R also contains
deferred tax provisions for certain of the compensation expenses.
Income Taxes:
We use the liability method for determining our income taxes. We record current
and deferred tax liabilities and assets in accordance with enacted tax laws and
rates. We calculate the amounts of deferred tax liabilities and assets at the
end of each period using the tax rate expected to be in effect when taxes are
actually paid or recovered. We record as expense or income in
27
a period the effects of a change in tax rates in that period. We recognize
future tax benefits to the extent that realization of such benefits is more
likely than not. We provide deferred income taxes for the estimated income tax
effect of temporary differences between financial and tax bases in assets and
liabilities, and for certain tax credits that we may carry forward. We use a
valuation allowance, if necessary, to reduce deferred tax assets if it is more
likely than not that we will not realize some portion or all of the deferred tax
assets.
For interim reporting, Kahiki estimates a full year tax rate, and applies that
rate to its year-to-date income. For the three-month period ended June 30, 2006,
Kahiki's overall tax rate differs from the 34% federal rate primarily because of
the effects of state taxes.
FORWARD LOOKING STATEMENTS
This Quarterly Report contains forward-looking statements. Such statements are
not based on historical facts and are based on current expectations, including,
but not limited to statements regarding our plan for future development and the
operation of our business. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates," "may", and similar expressions
identify such forward-looking statements. These statements are not guarantees of
future performance and are subject to certain risks and uncertainties that could
cause actual results to differ materially from those expressed or forecasted.
Among the factors that could cause actual results to differ materially are the
following: acceleration of our debt by our lenders, a lack of sufficient capital
to finance our business plan on commercially acceptable terms; changes in labor,
equipment and capital costs; our inability to attract strategic partners;
general business and economic conditions; and the other risk factors described
from time to time in our reports filed with the Securities and Exchange
Commission.
You should not rely on these forward-looking statements, which reflect only
Kahiki Food's opinion as of the date of this Quarterly Report. We do not assume
any obligation to revise forward-looking statements.
ITEM 3. CONTROLS AND PROCEDURES
Kahiki management is responsible for establishing and maintaining adequate
internal control over its disclosure controls and procedures.
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports filed or submitted under the Exchange
Act is recorded, processed, summarized and reported, within the time period
specified in the Commissions's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in the reports filed under the
Exchange Act is accumulated and communicated to management, as appropriate, to
allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including the Chief Executive Officer and the Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures.
28
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures as of the end of
the period covered by this report have been designed and are functioning
effectively to provide reasonable assurance that the information required to be
disclosed by us in reports filed under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
There were no significant changes in our internal control over financial
reporting that occurred during the period covered by this report that have
materially affected, or are reasonably likely to materially affect our internal
controls over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults upon Senior Securities
Most of our debt instruments include financial and other covenants that we must
meet. We were not in technical compliance with all covenants in our financial
and debt instruments at June 30, 2006. Our lenders have a variety of responses
available to them, including standing still, increases in some interest rates on
the debt, and withholding rights to operate the revolver loan. In addition, the
lenders may call the debt that is in default. No lender has exercised any such
rights.
Kahiki is current in all required payments of principal and interest on all our
debt. The defaults are caused by the death of Mr. Tsao (which cannot be cured),
by cross-default clauses in debt instruments (which cannot be cured until all
defaults are cured), and/or by our failure to submit in a timely manner certain
reports required by the loan documents. We are in the process of complying with
the requirements to file reports. We have requested waivers from all lenders to
remove the loans from default status. Total debt in default was $7,721,877 at
June 30, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibits filed with this Quarterly Report on Form 10-QSB are attached hereto.
For a list of our exhibits, see "Index to Exhibits" following the signature
page.
(b) Reports on Form 8-K
Not applicable.
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Signatures
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
KAHIKI FOODS, INC.
(Registrant)
/s/ Alan L. Hoover
- -----------------------------
Alan L. Hoover, President and Chief Executive Officer
Date: August 14, 2006
/s/ Frederick A. Niebauer
- -----------------------------
Frederick A. Niebauer, Chief Financial Officer and Treasurer
Date: August 14, 2006
30
INDEX TO EXHIBITS
EXHIBIT DESCRIPTION OF EXHIBIT LOCATION
- ------- -------------------------------- --------------------------------
3.1 Amended and Restated Articles Incorporated herein by reference
of Incorporation of Registrant to Exhibit 3.1 of Registration
Statement on Form SB-2
(Registration No. 333-126268)
3.2 Code of Regulations of the Incorporated herein by reference
Registrant to Exhibit 3.2 of Registration
Statement on Form SB-2
(Registration No. 333-113925)
4.1 Specimen Common Share Incorporated herein by reference
Certificate to Exhibit 4.1 of Registration
Statement on Form SB-2
(Registration No. 333-113925)
4.2 $2.25 Common Share Purchase Incorporated herein by reference
Warrant to Exhibit 4.2 of Registration
Statement on Form SB-2
(Registration No. 333-113925)
4.3 $3.00 Common Share Purchase Incorporated herein by reference
Warrant to Exhibit 4.3 of Registration
Statement on Form SB-2
(Registration No. 333-113925)
4.4* 2001 Non-Qualified and Incorporated herein by reference
Incentive Stock Option Plan to Exhibit 4.5 of Registration
of Registrant Statement on Form SB-2
(Registration No. 333-113925)
4.7 Specimen Series A Preferred Incorporated herein by reference
Share Certificate to Exhibit 4.7 of Report on Form
10-KSB for the fiscal year ended
March 31, 2006 filed on
July 14, 2006
10.1 Loan Agreement between Incorporated herein by reference
Registrant and The Director to Exhibit 10.2 of Registration
of Development of Ohio dated Statement on Form SB-2
as of December 1, 2002 (Registration No. 333-113925)
10.2 Convertible Note Purchase Incorporated herein by reference
Agreement between Registrant to Exhibit 10.1 of Report on
and Townsends, Inc. dated Form 8-K filed on December 28,
December 21, 2004 2004
10.3 Convertible Promissory Note of Incorporated herein by reference
Registrant to Townsends, Inc. to Exhibit 10.2 of Report on
dated December 21, 2004 Form 8-K filed on December 28,
2004
31
10.4 Convertible Promissory Note of Incorporated herein by reference
Registrant to Townsends, Inc. to Exhibit 10.2 of Report on
dated June 3, 2005 Form 8-K filed on June 9, 2005
10.5 Registration Rights Agreement Incorporated herein by reference
between Registrant and to Exhibit 10.3 of Report on Form
Townsends, Inc. dated 8-K filed on December 28, 2004
December 21, 2004
10.6 Supply Agreement between Incorporated herein by reference
Registrant and Townsends, Inc. to Exhibit 10.4 of Report on Form
dated December 21, 2004 8-K filed on December 28, 2004
10.7 Co-Pack and Storage Agreement Incorporated herein by reference
between Registrant and to Exhibit 10.5 of Report on Form
Townsends, Inc. dated 8-K filed on December 28, 2004
December 21, 2004
10.8 Term Promissory Note of Incorporated herein by reference
Registrant to KeyBank to Exhibit 10.6 of Report on Form
National Association dated 8-K filed on December 28, 2004
December 17, 2004
10.9 Subordinated Promissory Note Incorporated herein by reference
to Alice Tsao dated to Exhibit 10.9 of Report on Form
August 19, 2003 10-KSB/A for the fiscal year
ended March 31, 2005 filed on
March 30, 2006
10.10* Employment Agreement with Incorporated herein by reference
Alan L. Hoover to Exhibit 10.10 of Report on
Form 10-KSB for the fiscal year
ended March 31, 2006 filed on
July 14, 2006
10.11 Registration Rights Agreement Incorporated herein by reference
between Registrant and Barron to Exhibit 10.11 of Report on
Partners LP, dated Form 10-KSB for the fiscal year
February 27, 2004 ended March 31, 2006 filed on
July 14, 2006
10.12 Promissory Note of Incorporated herein by reference
Registrant to KeyBank to Exhibit 10.12 of Report on
National Association dated Form 10-KSB for the fiscal year
June 1, 2004 (revolver) ended March 31, 2006 filed on
July 14, 2006
10.13 Business Loan Agreement Incorporated herein by reference
(Asset Based) between to Exhibit 10.13 of Report on Form
Registrant and KeyBank 10-KSB for the fiscal year
National Association dated ended March 31, 2006 filed on
June 1, 2004 (revolver) July 14, 2006
32
10.14 Addendum to Business Loan Incorporated herein by reference
Agreement (Asset Based) to Exhibit 10.12 of Report on
between Registrant and KeyBank Form 10-KSB for the fiscal year
National Association dated ended March 31, 2006 filed on
June 1, 2004 (revolver) July 14, 2006
14.1 Code of Ethics Incorporated herein by reference
to Exhibit 14.1 of Report on Form
10-KSB for the fiscal year ended
March 31, 2005 filed on June 21,
2005.
16.1 Letter on change in accountant Incorporated herein by reference
to Exhibit 16.1 of Report on Form
8-K filed on December 28, 2004
31.1 Certification of the Chief Included herein
Executive Officer Pursuant to
Section 302 of the Sarbanes-
Oxley Act of 2002
31.2 Certification of the Chief Included herein
Financial Officer Pursuant to
Section 302 of the Sarbanes-
Oxley Act of 2002
32 Certification of the Chief Included herein
Executive Officer and Chief
Financial Officer pursuant to
Rule 15d-14(b) and Section 1350
of Chapter 63 of Title 18 of the
United States Code, as adopted
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- -----------
* Represents compensation arrangement.
33