ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The preparation of this section requires us to make estimates and assumptions about our past, current and future activities, business practices, and financial records. Actual results may differ from these estimates and assumptions. Foreseeable risks and uncertainties are described elsewhere in this report and in detail under "Risk Factors Affecting the Company".
SUMMARY
For the quarter ended September 30, 2004, the Statements of Loss show a 45.2% decrease in sales and a 47.5% decrease in gross profit over the prior year. We incurred a net loss for the quarter ended September 30, 2004 of $165,557.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003
REVENUES
Net revenues for the quarter ended September 30, 2004 decreased 45.2% to $254,304 from $464,116 for the corresponding period in fiscal 2003. This decrease was primarily due to lost revenue of approximately $210,000 resulting from the sale or closure of two university kiosk locations, one hospital kiosk location and two retail stores. Revenues for our packaged Black Rhino Coffee(TM) products for the quarter ended September 30, 2004 decreased 67.6% to $22,198 from $68,582 for the corresponding period in fiscal 2003. During the quarter ended September 30, 2004, we reduced inventory levels for all wholesale Black Rhino Coffee(TM) customers in preparation for seasonal reductions in consumer purchases. Black Rhino Coffee(TM) sales accounted for approximately 8.7% of our total revenue for the quarter ended September 30, 2004. For the quarter ended September 30, 2004, kiosk and retail outlet revenue decreased 41.3% to $232,106 from $395,535 for the same period in fiscal 2003. Kiosk and retail outlet revenue was generated from four different clients, with the largest client representing 36.8% of total net revenue.
COSTS OF GOODS SOLD
Cost of goods sold for the quarter ended September 30, 2004 decreased to $123,179 from $214,278 for the same period in fiscal 2003. As a percentage of net revenues, cost of goods sold increased to 48.4% for the quarter ended September 30, 2004 from 46.17% for the comparable period in fiscal 2003. The increase was primarily due to a shift in the sales mix resulting from increased Black Rhino Coffee(TM) revenues as percentage of total net revenues. For the quarter ended September 30, 2004, net revenues for Black Rhino Coffee(TM) represented 8.7% of total revenues as compared to 14.8% for the comparable period in fiscal 2003.
OPERATING EXPENSES
Employee compensation and benefits for the quarter ended September 30, 2004 decreased to $124,035 from $219,878 for the same period in fiscal 2003. As a percentage of net revenues, employee compensation and benefits increased to 48.8% for the quarter ended September 30, 2004 from 47.4% for the comparable period in fiscal 2003. Employee compensation for administrative and corporate level employees for the quarter ended September 30, 2004 decreased to $29,548 from $37,962 for the same period in fiscal 2003.
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PART I FINANCIAL INFORMATION General and administrative expenses for the quarter ended September 30, 2004 decreased to $87,246 from $90,170 for the same period in fiscal 2003. As a percentage of net revenues, general and administrative expenses increased to 34.3% for the quarter ended September 30, 2004 from 19.43% for the comparable period in fiscal 2003. The increase is due to a $22,478 cost of in-store promotions and an increase of $8,875 in one-time slotting fees.
Occupancy costs for the quarter ended September 30, 2004 decreased to $23,941 from $61,007 for the same period in fiscal 2003. As a percentage of net revenues, occupancy costs for the quarter ended September 30, 2004 decreased to 9.4% from 13.1% for the comparable period in fiscal 2003. The decrease in occupancy costs as a percentage of net revenues is primarily due to the relocation of our corporate office.
Director and professional fees for the quarter ended September 30, 2004 decreased to $44,662 from $64,002 for the same period in fiscal 2003. As a percentage of net revenues, director and professional fees increased to 17.6% for the quarter ended September 30, 2004 from 13.8% for the comparable period in fiscal 2003. The increase was primarily due to an $18,000 contract for an investor relations program aimed at increasing investor awareness.
Operating losses for the quarter ended September 30, 2004 decreased to $150,140 from $192,471 for the same period in fiscal 2003. As a percentage of net revenues, operating losses increased to 59.0% for the quarter ended September 30, 2004 from 41.5% for the comparable period in fiscal 2003. The decreased operating loss is primarily due to reductions in operating expenses associated with the disposal of retail kiosks and increased profitability resulting from packaged Black Rhino Coffee(TM) sales.
NET LOSS
Net loss for the quarter ended September 30, 2004 decreased to $165,559 from $203,999 for the same period in fiscal 2003. As a percentage of net revenues, net losses increased to 65.1% for the quarter ended September 30, 2004 from 44.0% for the comparable period in fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
As the accompanying financial statements show, for the quarter ended September 30, 2004, we had a net operating loss of $150,140, and an overall net loss of $165,559. At September 30, 2004, we had a working capital deficit of $1,529,512, and a shareholders' deficit of $1,374,617.
Because of our operating losses and financial situation, the Independent Auditor's Report of the accompanying financial statements expresses a "going concern" opinion. Going concern contemplates the realization of assets and the satisfaction of liabilities in the normal course of business over a reasonable length of time. Our ability to continue as a going concern is dependent upon several factors. These factors include our ability to: generate sufficient cash flows to meet our obligations on a timely basis; obtain acceptance of payment terms for certain payables to key vendors; obtain additional financing or refinancing as may be required; aggressively control costs, and; achieve profitability and positive cash flows.
We plan to address these challenges by building on the launch of our organic Black Rhino Coffee(TM) brand into the U.S. mass retail sector. Since introduction in May 2002 at the FMI supermarket convention, the brand has penetrated the shelves of approximately 600 supermarkets. The benefit of this channel of trade is that a small number of orders can significantly increase our revenues and earnings. We also believe that our transition from reliance on full-service units to an asset-light company concentrating more on brand ownership and management will reduce the capital needs for future large tangible asset acquisitions.
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PART I FINANCIAL INFORMATION Our operating activities decreased cash by $500 for the six months ended September 30, 2004. Net loss of $241,457 was the primary reason for the decrease.
We had net cash provided from financing activities for the six months ended September 30, 2004 totaling $137,508. During the quarter we received $75,000 for advances on future conversion of warrants and made payment against principal on notes and short term borrowings of $212,492.
RISK FACTORS AFFECTING THE COMPANY
WE HAVE A HISTORY OF LOSSES WHICH MAY CONTINUE, REQUIRING US TO SEEK ADDITIONAL SOURCES OF CAPITAL WHICH MAY NOT BE AVAILABLE, REQUIRING US TO CURTAIL OR CEASE OPERATIONS.
We incurred net losses of $241,457 for the quarter ended September 30, 2004 and $863,171 for the quarter ended September 30, 2003. We cannot assure you that we can achieve or sustain profitability on a quarterly or annual basis in the future. If revenues grow more slowly than we anticipate, or if operating expenses exceed our expectations or cannot be adjusted accordingly, we will continue to incur losses. We will continue to incur losses until we are able to establish significant sales of Black Rhino Coffee(TM). Our possible success is dependent upon the successful development and marketing of our products, as to which there is no assurance. Any future success that we might enjoy will depend upon many factors, including factors out of our control or which cannot be predicted at this time. These factors may include changes in or increased levels of competition, including the entry of additional competitors and increased success by existing competitors, changes in general economic conditions, increases in operating costs, including costs of supplies, personnel and equipment, reduced margins caused by competitive pressures and other factors. These conditions may have a materially adverse effect upon us or may force us to reduce or curtail operations. In addition, we will require additional funds to sustain and expand our sales and marketing activities, particularly if a well-financed competitor emerges. We anticipate that we will require approximately $500,000 to fund our continued operations for the next twelve months, depending on revenue from operations. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all. The inability to obtain sufficient funds from operations or external sources would require us to curtail or cease operations.
IF WE ARE UNABLE TO OBTAIN ADDITIONAL FUNDING OUR BUSINESS OPERATIONS WILL BE HARMED AND IF WE DO OBTAIN ADDITIONAL FINANCING OUR THEN EXISTING SHAREHOLDERS MAY SUFFER SUBSTANTIAL DILUTION.
Additional capital will be required to effectively support the operations and to otherwise implement our overall business strategy, including rapid growth in establishing the Black Rhino Coffee brand. However, there can be no assurance that financing will be available when needed on terms that are acceptable to us. The inability to obtain additional capital will restrict our ability to grow and may reduce our ability to continue to conduct business operations. If we are unable to obtain additional financing, we will likely be required to curtail our marketing and development plans and possibly cease our operations. Any additional equity financing may involve substantial dilution to our then existing shareholders.
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PART I FINANCIAL INFORMATION OUR INDEPENDENT AUDITORS HAVE EXPRESSED SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN, WHICH MAY HINDER OUR ABILITY TO OBTAIN FUTURE FINANCING.
In their report dated July 6, 2004, our independent auditors stated that our financial statements for the year ended March 31, 2004 were prepared assuming that we would continue as a going concern. Our ability to continue as a going concern is an issue raised as a result of a loss for the year ended March 31, 2004 in the amount of $1,270,772 and stockholders deficit of $1,269,027 as of March 31, 2004. We continue to experience net operating losses. Our ability to continue as a going concern is subject to our ability to generate a profit and/or obtain necessary funding from outside sources, including obtaining additional funding from the sale of our securities, increasing sales or obtaining loans and grants from various financial institutions where possible. Our continued net operating losses and stockholders' deficit increases the difficulty in meeting such goals and there can be no assurances that such methods will prove successful.
WE MAY BE REQUIRED TO PAY OUTSTANDING SECURED PROMISSORY NOTES WHICH ARE CURRENTLY IN DEFAULT. IF WE ARE REQUIRED TO REPAY THE OUTSTANDING DEBT OUR WORKING CAPITAL MAY BE DEPLETED OR WE MAY BE REQUIRED TO RAISE ADDITIONAL FUNDS TO REPAY SUCH DEBT. OUR FAILURE TO REPAY THE SECURED PROMISSORY NOTES COULD RESULT IN LEGAL ACTION AGAINST US, WHICH COULD REQUIRE THE SALE OF SUBSTANTIAL ASSETS.
In an earlier private placement, we offered and sold units, with each unit consisting of a secured promissory note ("Secured Note") and warrants to purchase common stock. We are now obligated to make quarterly payments on the interest outstanding and to repay such Secured Notes. As of September 30, 2004, we were in default on the principal balance of the Secured Notes in the amount of $35,000 and approximately $50,000 in arrears on such interest payments relating to the Secured Notes. Under the terms of the Security Agreement relating to the Secured Notes, a noteholder has the right to:
o declare all principal and interest immediately due and owing;
o exercise its rights and remedies under the California Commercial Code as a secured creditor having a security interest in the collateral, which includes, but is not limited to, equipment, inventory, accounts, trademarks and tradenames and other intellectual property rights (the "Collateral"), and, in particular, sell any part of the Collateral; and
o exercise any other rights or remedies of a secured party under California law.
As of the date hereof, we have not received any notice of default relating to the Secured Notes. It is our understanding that the noteholders lien has lapsed due to the noteholders failure to file a continuation with the California Secretary of State. Due to the noteholders failure to file a continuation, the California Secretary of State has purged the lien from our records.
A SMALL NUMBER OF CUSTOMERS ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUE AND IF WE ARE UNABLE TO MAINTAIN OUR CURRENT CUSTOMER BASE OR ATTRACT A NEW CUSTOMER BASE WE WILL BE REQUIRED TO CURTAIL OR CEASE OPERATIONS.
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PART I FINANCIAL INFORMATION Our four largest clients represent 81.5% of our gross revenue for the quarter ended September 30, 2004. Our four largest clients represented 37.2% of the gross revenue for the quarter ended September 30, 2003. We would likely experience a material decline in revenues if we were to lose any of our major clients.
HIGH QUALITY CERTIFIED ORGANIC COFFEE IS LIMITED IN AVAILABILITY AND TRADED ON A NEGOTIATED BASIS. IF WE ARE UNABLE TO OBTAIN AN ADEQUATE SUPPLY OF CERTIFIED ORGANIC COFFEE, THEN OUR PROFITS MAY BE NEGATIVELY IMPACTED.
The supply and price of coffee are subject to significant volatility. Although most coffee trades in the commodity market, coffee of the quality sought by our company tends to trade on a negotiated basis at a substantial premium above commodity coffee prices, depending upon the supply and demand at the time of purchase. We acknowledge that high quality certified organic coffee is limited in availability. We depend upon our relationship with our roaster, with coffee brokers and importers and with exporters for our supply of certified organic green coffee. We believe, based on relationships established with our suppliers in the past, that the risk of non-delivery is low. However, an increase in the prices of specialty coffees could have an adverse effect on our profitability.
THERE CAN BE NO ASSURANCE THAT WE WILL BE ABLE TO MANAGE ANY SUBSTANTIAL EXPANSION OF OUR BUSINESS, AND A FAILURE TO DO SO COULD HAVE A MATERIALLY ADVERSE EFFECT ON OUR OPERATING RESULTS.
Our success will require significant expansion of our business. Any such expansion could place a significant strain on our resources and would require us to hire additional personnel to implement additional operating and financial controls and improve coordination between marketing, administration and finance functions. We would be required to install additional reporting and management information systems for sales monitoring, inventory control and financial reporting. There can be no assurance that we would be able to manage any substantial expansion of our business, and a failure to do so could have a materially adverse effect on our operating results.
IF WE ARE UNABLE TO RETAIN THE SERVICES OF MR. TKACHUK OR IF WE ARE UNABLE TO SUCCESSFULLY RECRUIT QUALIFIED MANAGERIAL AND SALES PERSONNEL HAVING EXPERIENCE IN BUSINESS, WE MAY NOT BE ABLE TO CONTINUE OUR OPERATIONS.
Our success depends to a significant extent upon the continued service of Mr. Todd Tkachuk, our President, Chief Financial Officer and Secretary. Loss of the services of Mr. Tkachuk could have a material adverse effect on our growth, revenues, and prospective business. We do not maintain key-man insurance on the life of Mr. Tkachuk. In addition, in order to successfully implement and manage our business plan, we will be dependent upon, among other things, successfully recruiting qualified managerial and sales personnel having experience in business. Competition for qualified individuals is intense. There can be no assurance that we will be able to find, attract and retain existing employees or that we will be able to find, attract and retain qualified personnel on acceptable terms.
WE HAVE RECENTLY COMMENCED SALES TO SUPERMARKETS, SPECIALTY FOOD STORES AND OTHER MASS RETAIL VENUES AND IF WE ARE NOT SUCCESSFUL IN ESTABLISHING OUR COMPANY WITHIN THE MASS RETAIL MARKET OUR REVENUE MAY BE SEVERELY IMPACTED.
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PART I FINANCIAL INFORMATION Our company's strategic goal is to establish our packaged consumer Black Rhino Coffee(TM) brand in domestic mass retail markets. We recently shipped orders of Black Rhino Coffee(TM) to major national food distributors in Kansas, South Carolina, Pennsylvania and Virginia. If we are not successful in entering the mass retail market our revenue may be severely impacted.
RISKS RELATING TO OUR CURRENT FINANCING ARRANGEMENT:
THERE ARE A LARGE NUMBER OF SHARES UNDERLYING OUR CONVERTIBLE DEBENTURES, AND WARRANTS THAT MAY BE AVAILABLE FOR FUTURE SALE AND THE SALE OF THESE SHARES MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.
As of December 26, 2004, we had 41,670,421 shares of common stock issued and outstanding and convertible debentures outstanding that may be converted into an estimated 307,125,000 shares of common stock at current market prices, and outstanding warrants and options to purchase 7,985,130 shares of common stock, including, 2,257,760 shares of common stock issued pursuant to the Securities Purchase Agreement dated December 5, 2003. In addition, pursuant to the Plan and Agreement of Reorganization and merger we assumed the rights and obligations or convertible promissory noted that are convertible into 75,604 shares. In addition, the number of shares of common stock issuable upon conversion of the outstanding convertible debentures may increase if the market price of our stock declines. All of the shares, including all of the shares issuable upon conversion of the debentures and upon exercise of our warrants, may be sold without restriction. The sale of these shares may adversely affect the market price of our common stock.
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR CONVERTIBLE DEBENTURES COULD REQUIRE US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF SHARES, WHICH WILL CAUSE DILUTION TO OUR EXISTING STOCKHOLDERS.
Our obligation to issue shares upon conversion of our convertible debentures is essentially limitless. The following is an example of the amount of shares of our common stock that are issuable, upon conversion of our convertible debentures (excluding accrued interest), based on market prices 25%, 50% and 75% below the market price, as of December 21, 2004 of $0.01.
Number % of % Below Price Per With Discount of Shares Outstanding Market Share at 20% Issuable Stock ------ ----- ------ -------- ----- 25% $.0075 $.0060 410,250,000 91.07% 50% $.005 $.0040 616,500,000 93.88% 75% $.0025 $.0020 1,235,250,000 96.85%
As illustrated, the number of shares of common stock issuable upon conversion of our convertible debentures will increase if the market price of our stock declines, which will cause dilution to our existing stockholders.
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PART I FINANCIAL INFORMATION THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR CONVERTIBLE DEBENTURES MAY ENCOURAGE INVESTORS TO MAKE SHORT SALES IN OUR COMMON STOCK, WHICH COULD HAVE A DEPRESSIVE EFFECT ON THE PRICE OF OUR COMMON STOCK.
The convertible debentures are convertible into shares of our common stock at a 20% discount to the trading price of the common stock prior to the conversion. The significant downward pressure on the price of the common stock as the selling stockholder converts and sells material amounts of common stock could encourage short sales by investors. This could place further downward pressure on the price of the common stock. The selling stockholder could sell common stock into the market in anticipation of covering the short sale by converting their securities, which could cause the further downward pressure on the stock price. In addition, not only the sale of shares issued upon conversion or exercise of debentures, warrants and options, but also the mere perception that these sales could occur, may adversely affect the market price of the common stock.
THE ISSUANCE OF SHARES UPON CONVERSION OF THE CONVERTIBLE DEBENTURES AND EXERCISE OF OUTSTANDING WARRANTS MAY CAUSE IMMEDIATE AND SUBSTANTIAL DILUTION TO OUR EXISTING STOCKHOLDERS.
The issuance of shares upon conversion of the convertible debentures and exercise of warrants may result in substantial dilution to the interests of other stockholders since the selling stockholders may ultimately convert and sell the full amount issuable on conversion. Although the selling stockholders may not convert their convertible debentures and/or exercise their warrants if such conversion or exercise would cause them to own more than 4.9% of our outstanding common stock, this restriction does not prevent the selling stockholders from converting and/or exercising some of their holdings and then converting the rest of their holdings. In this way, the selling stockholders could sell more than this limit while never holding more than this limit. There is no upper limit on the number of shares that may be issued which will have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock, including investors in this offering.
IF WE FAIL TO OBTAIN STOCKHOLDER APPROVAL TO INCREASE OUR AUTHORIZED SHARES OF COMMON STOCK, WE MAY BE REQUIRED TO REPAY THE CONVERTIBLE DEBENTURE AS WELL AS VARIOUS PENALTIES.
We presently do not have an adequate amount of authorized and unissued shares of common stock to issue in connection with the financing entered into with La Jolla Cover Investors, Inc. In the near future we intend to hold a meeting for the purpose of obtaining stockholder approval to increase our authorized shares of common stock of which we can provide no assurance that we will be able to obtain. In the event that we are unable to obtain an increase in our authorized common stock, we will be required to repay the debenture and we will be subject to prepayment penalties.
IF WE ARE REQUIRED FOR ANY REASON TO REPAY OUR OUTSTANDING CONVERTIBLE DEBENTURES, WE WOULD BE REQUIRED TO DEPLETE OUR WORKING CAPITAL, IF AVAILABLE, OR RAISE ADDITIONAL FUNDS. OUR FAILURE TO REPAY THE CONVERTIBLE DEBENTURES, IF REQUIRED, COULD RESULT IN LEGAL ACTION AGAINST US, WHICH COULD REQUIRE THE SALE OF SUBSTANTIAL ASSETS.
In December 2003, we entered into a Securities Purchase Agreement for the sale of an aggregate of $250,000 principal amount of convertible debentures. The convertible debentures are due and payable, with 7 3/4% interest, two years from the date of issuance, unless sooner converted into shares of our common stock. In addition, any event of default could require the early repayment of the convertible debentures at a price equal to 125% of the amount due under the debentures. We anticipate that the full amount of the convertible debentures, together with accrued interest, will be converted into shares of our common stock, in accordance with the terms of the convertible debentures. If we are required to repay the convertible debentures, we would be required to use our limited working capital and raise additional funds. If we were unable to repay the debentures when required, the debenture holders could commence legal action against us and foreclose on all of our assets to recover the amounts due. Any such action would require us to curtail or cease operations.
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PART I FINANCIAL INFORMATION IF WE FAIL TO REMAIN CURRENT ON OUR REPORTING REQUIREMENTS, WE COULD BE REMOVED FROM THE OTC BULLETIN BOARD WHICH WOULD LIMIT THE ABILITY OF BROKER-DEALERS TO SELL OUR SECURITIES AND THE ABILITY OF STOCKHOLDERS TO SELL THEIR SECURITIES IN THE SECONDARY MARKET.
Companies trading on the OTC Bulletin Board, such as us, must be reporting issuers under Section 12 of the Securities Exchange Act of 1934, as amended, and must be current in their reports under Section 13, in order to maintain price quotation privileges on the OTC Bulletin Board. If we fail to remain current on our reporting requirements, we could be removed from the OTC Bulletin Board. As a result, the market liquidity for our securities could be severely adversely affected by limiting the ability of broker-dealers to sell our securities and the ability of stockholders to sell their securities in the secondary market.
OUR DIRECTORS AND EXECUTIVE OFFICERS BENEFICIALLY OWN APPROXIMATELY 9.7% OF OUR STOCK; THEIR INTERESTS COULD CONFLICT WITH YOURS; SIGNIFICANT SALES OF STOCK HELD BY THEM COULD HAVE A NEGATIVE EFFECT ON OUR STOCK PRICE; STOCKHOLDERS MAY BE UNABLE TO EXERCISE CONTROL.
As of September 30, 2004, our executive officers, directors and affiliated persons beneficially owned approximately 9.7% of our common stock. As a result, our executive officers, directors and affiliated persons will have significant influence to:
o elect or defeat the election of our directors;
o amend or prevent amendment of our articles of incorporation or bylaws;
o effect or prevent a merger, sale of assets or other corporate transaction; and
o control the outcome of any other matter submitted to the stockholders for vote.
As a result of their ownership and positions, our directors and executive officers collectively are able to significantly influence all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, sales of significant amounts of shares held by our directors and executive officers, or the prospect of these sales, could adversely affect the market price of our common stock. Management's stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could reduce our stock price or prevent our stockholders from realizing a premium over our stock price.
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