U

10QSB 1 q2final.htm U

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-QSB

(Mark One)

[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934 for the period ended March 31, 2004

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE Act of 1934 for the transition period from ___ to ___.

Commission file number: 000-23319

AVANI INTERNATIONAL GROUP INC.

(Name of Small Business Issuer in its charter)

Nevada 88-0367866

(State of (I.R.S. Employer

Incorporation) I.D. Number)

#328-17 Fawcett Road, Coquitlam, B.C. (Canada) V3K 6V2

(Address of principal executive offices) (Zip Code)

Issuer's telephone number 604-525-2386.

Securities registered under Section 12 (b) of the Act:

Title of each class Name of exchange on which

to be registered each class is to be registered

None None

Securities registered under Section 12(g) of the Act:

Common Stock

(Title of Class)

Check whether issuer (1) filed all reports to be filed by Section 13 or

15(d) of the Exchange Act during the past 12 months (or 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.

(1). Yes: X No:

(2). Yes: X No:

The number of shares issued and outstanding of issuer's common stock,

$.001 par value, as of June 30, 2004 was 14,582,571.

Transitional Small Business Issuer Format (Check One):

Yes: No: X

PART I - FINANCIAL INFORMATION

INDEX

Item 1. Financial Statements. Page No.

-Consolidated Condensed Balance Sheet as of

June 30, 2004 (unaudited) and December 31, 2003 (audited). 3

-Consolidated Interim Statements of Operations and

Comprehensive Loss for the Three Months and Six Months Ended

June 30, 2004 and 2003 (unaudited). 4

-Consolidated Interim Statement of Changes in Stockholders’

Equity for the Six Months Ended

June 30, 2004 (unaudited). 5

-Consolidated Interim Statement of Cash Flows

for the Three and Six Months Ended June 30, 2004

and 2003 (unaudited). 6

-Notes to Consolidated Interim Financial Statements. 7

Item 2. Management's Discussion and Analysis. 14

Item 3. Effectiveness of the Registrant’s Disclosure Controls and

Procedures 19

PART II - OTHER INFORMATION

Item 1. Legal Proceedings. 20

Item 2. Changes in Securities. 20

Item 3. Defaults upon Senior Securities. 20

Item 4. Submission of Matters to Vote of Securityholders. 20

Item 5. Other Information. 20

Item 6. Exhibits and Reports on Form 8-K. 20

Signatures 21

Item 1. Financial Statements.

Avani International Group Inc.

Consolidated Interim Balance Sheets

(Expressed in US dollars)

(Unaudited)

June 3 0

December 31

2004 ^(*)

2003

Assets

Current

Cash and cash equivalents

237,404

218,268

Accounts receivable (net of allowance for doubtful accounts

in 2004 - $5 7,789 ; 2003 - $5 4,073 )

1,345,080

72,144

Due from related party

442,392

Inventories

229,093

111,155

Prepaid expenses

35,618

5,396

1,847,195

849,355

Property, plant and equipment (Note 3)

1,553,414

1,430,329

Other assets

31,117

33,289

3,431,726

2,312,973

Liabilities and Stockholders’ Equity

Liabilities

Current

Accounts payable

790,365

328,963

Accrued liabilities

98,063

94,116

Debts payable

72,395

77,131

Unearned revenue and deposits

114,908

113,615

1,075,731

613,825

Obligations payable (Note 3)

285,745

1,010,141

1,361,476

1,623,966

Non-controlling interest (Note 2)

1,601,412

Stockholders’ Equity

Capital stock (Note 4)

Authorized

400,000,000 common shares, par value of $0.001

Issued and outstanding

14,5 8 2,571 (2003 – 14,522,571) common shares

14,5 83

14,523

Additional paid-in capital

7,693,120

7,606,817

Accumulated deficit

(7,099,988)

(6,808,595)

Accumulated other comprehensive income (loss)

- foreign exchange translation

(138,877)

(123,738)

468,838

689,007

3,431,726

2,312,973

(*) Represents the financial position of Avani International Group Inc. and its wholly-owned subsidiaries and Avani O2 Water Sdn Bhd (Note 2)

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

Avani International Group Inc.
Consolidated Interim Statements of Operations and Comprehensive Loss
(Expressed in US Dollars)
(Unaudited)
			Three-month periods ended				Six-month periods ended
			June 30				June 30
				*2004 ()**		2003		*2004 ()**		2003
Revenue
	Bottled water and supply sales		$	742,513	$	328,567	$	1,402,371	$	383,305
	Cooler rentals and equipment sales		4,830			5,422		24,421		10,038
				747,343		333,989		1,426,792		393,343
Cost of revenue
	Cost of goods sold (excluding
		depreciation)		260,144		153,361		716,064		196,235
	Depreciation		46,656			30,528		94,465		60,747
				306,800		183,889		810,529		256,982
Gross profit				440,543		150,100		616,263		136,361
Operating expenses
	Marketing			23,623		11,872		38,505		19,414
	General and administration		123,888			194,564		401,099		326,550
				147,511		206,436		439,584		345,964
Income (loss) from operations				293,032		(56,336)		176,679		(209,603)
Other income (expenses)
	Interest on debts payable			(1,470)		(9,853)		(2,988)		(16,040)
	Miscellaneous income (expense)			(20,052)		11,321		18,990		10,552

				271,510		(54,868)		192,681		(215,091)
Non-controlling Interest				(363,475)		-		(392,410)		-
Net loss before cumulative effect of change in accounting policy				(91,965)		(54,868)		(199,729)		(215,091)
Cumulative effect of change in accounting policy (Note 2)				-		-		(91,664)		-

Net loss for the period				(91,965)		(54,868)		(291,393)		(215,091)
Foreign currency translation adjustment				(168,821)		(2,189)		(15,139)		17,642
Comprehensive loss for the period			$	(260,786)	$	(57,057)	$	(306,532)	$	(197,449)
Loss per share - basic and diluted			$	(0.01)	$	(0.01)	$	(0.02)	$	(0.02)
Weighted average shares outstanding				14,532,5711		9,522,571		14,527,5711		9,522,571
(*) Represents the operations and comprehensive loss of Avani International Group Inc. and its wholly-owned subsidiaries and Avani O2 Water Sdn Bhd (Note 2) The accompanying notes are an integral part of these consolidated interim financial statements. 4

Avani International Group Inc.
Consolidated Interim Statements of Changes in Stockholders’ Equity
(Expressed in US Dollars)
(Unaudited)
									Accumulated
					Additional				Other		Total
	Common Shares				Paid-in		Accumulated		Comprehensive		Stockholders’
	Shares			Amount	Capital		Deficit		Loss		Equity
Balance, January 1, 2003		9,522,571	$	9,523	$	7,291,813	$	(6,473,823)	$	(233,986)	$	593,527
Issuance of common stock on exercise of options		5,000,000		5,000		265,000		-		-		270,000
Stock option compensation		-		-		50,004		-		-		50,004
Net loss for the year		-		-		-		(334,772)		-		(334,772)
Foreign exchange translation adjustment		-		-		-		-		110,248		110,248
Balance, December 31, 2003		14,522,571		14,523		7,606,817		(6,808,595)		(123,738)		689,007
Issuance of common stock on exercise of options		60,000		60		2,940		-		-		3,000
Net loss for the period		-		-		-		( 291,393 )		-		( 291,393 )
Stock option compensation (Note 4)		-		-		83,363		-		-		83,363
Foreign exchange translation adjustment		-		-		-		-		(15,139)		(15,139)
Balance, June 3 0 , 2004		14,582,571	$	14,583	$	7,693,120	$	(7,099,988)	$	(138,877)	$	468,838
The accompanying notes are an integral part of these consolidated interim financial statements 5

Avani International Group Inc.
Consolidated Statements of Cash Flows
(Expressed in US Dollars)
(Unaudited)

For the six -month periods ended June 3 0					2004		2003
Cash provided by (used in)
Operating activities
	Net loss for the period			$	(291,393)	$	(215,091)
	Adjustments to reconcile net loss for the period to
	net cash used in operating activities
			Loss on forgiveness of receivable		-		10,522
			Depreciation		94,465		91,259
			Stock option compensation		83,363		27,900
			Non-controlling interest		392,410		-
			Cumulative effect of change in accounting policy		91,664		-
	(Increase) decrease in assets
			Accounts receivable		60,908		(92,369)
			Inventories		16,457		(51,446)
			Prepaid expenses		(10,398)		(32,091)
	Increase (decrease) in liabilities
		Accounts payable			55,388		103,121
		Accrued liabilities			(62,439)		15,944
		Unearned revenue and deposits			(37,902)		71,647
					392,523		(70,604)
Investing activities
	Proceeds from sale of subsidiary				-		1
Financing activities
	Proceeds from loans and obligation payable				-		293,878
	Payments on debts payable				-		(27,992)
	Advances to related parties				(309,536)		-
	Proceeds from share issuances				3,000		-
					(306,536)		265,886
Increase (decrease) in cash during the period					85,987		195,283
Effect of foreign exchange on cash					(66,851)		(24,493)
Cash and cash equivalents, beginning of period					218,268		101,211
Cash and cash equivalents, end of period				$	237,404	$	272,001
Supplemental Information:
	Interest paid			$	2,988	$	16,040
The following transactions which did not result in cash
flows have been excluded from financing activities:
	Loan receivable forgiven (Note 5)			$	-	$	10,522
(*) Represents the cash flows of Avani International Group Inc. and its wholly-owned subsidiaries and Avani O2 Water Sdn Bhd (Note 2)
The accompanying notes are an integral part of these consolidated interim financial statements. 6

Basis of Presentation and Ability to Continue as a Going Concern

The consolidated interim financial statements included herein, presented in accordance with United States generally accepted accounting principles and stated in US dollars, have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.

The consolidated interim financial statements for the six -month period ended June 3 0 , 2004 include the accounts of the Company, its subsidiaries and its related party Avani O2 Water Sdn. Bhd. ("Avani O2"), whose director is also a significant shareholder of the Company. As described in Note 2, the Company is the primary beneficiary of Avani O2, a variable interest entity (“VIE”) as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46R. Accordingly, Avani O2 was consolidated in the three-month and six-month periods ended June 30, 2004 . All material inter-company balances and inter-company transactions have been eliminated. The financial statements as of December 31, 2003 and for the three-month and six-month period s ended June 3 0 , 2003 include the accounts of the Company and its subsidiaries only.

These statements reflect all adjustments, consisting of normal recurring adjustments which, in the opinion of management, are necessary for fair presentation of the information contained therein. It is suggested that these consolidated interim financial statements be read in conjunction with the financial statements of the Company for the year ended December 31, 2003 and notes thereto included in the Company's 10-KSB annual report. The Company follows the same accounting policies in the preparation of interim reports.

Results of operations for the interim periods are not indicative of annual results.

These accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company has incurred accumulated losses to June 3 0 , 2004 of $ 7,693,120 which includes a loss of $ 291,393 for the six -month period ended June 3 0 , 2004. The continuation of the Company is dependent upon the continuing financial support of creditors and stockholders, obtaining additional long-term financing, as well as achieving and maintaining a profitable level of operations. The Company plans to raise additional equity and debt capital as necessary to finance the operating and capital requirements of the Company. Amounts raised will be used to provide financing for the marketing and promotion of the Company's business, capital expansion and for other working capital purposes. While the Company is expending its best efforts to achieve the above plans, there is no assurance that any such activity will generate sufficient funds for operations.

These conditions raise substantial doubt about the Company's ability to continue as a going concern. These financial statements do not include any adjustments that might arise from this uncertainty.

Change in Accounting Policy

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB 51” (which was amended in December 2003, FIN No. 46R). The primary objectives of FIN No. 46R are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46R for public entities that are small business issuers, as defined (“SBIs”), are as follows: (a) for interests in special-purpose entities: periods ended after December 15, 2003; (b) for all VIEs created before January 31, 2003: periods ending after December 15, 2004; and (c) for all VIEs created after January 31, 2003, FIN 46R is applicable immediately. The December 2003 amendment of FIN No. 46R also includes transition provisions that govern how an SBI which previously adopted the pronouncement (as it was originally issued) must account for consolidated VIEs.

Avani O2 was incorporated in July 1999 in Malaysia mainly to explore the opportunities of developing and marketing bottled water in South East Asia. In 2000, Avani O2 entered into a joint-venture agreement with the Company for the world-wide rights and licenses, except in Canada, to access and use , for all purposes , the Company’s technology of producing oxygen enriched bottled water. Avani O2 is considered a VIE of the Company because, pursuant to the joint-venture agreement, the Company is entitled to, among other things, receive a 2% royalty on all revenue from all Avani O2 licensed products, 30% of the before tax profits generated by the contributed bottling line contributed by the Company to Avani O2 and to appoint two of the three directors on the Board of Directors of Avani O2. As a result, the equity investors of Avani O2 do not have a controlling financial interest in Avani O2 and the Company is the primary beneficiary of Avani O2, the VIE. According to the above-noted requirements, the Company commenced consolidating Avani O2 in 2004. The prior year comparative information has not been restated to reflect a consolidation of Avani O2. The cumulative effect of the change in accounting policy of $91,664 was recorded in the Statement of Operations and Comprehensive Loss at January 1, 2004 and included in accumulated deficit. Subsequent to the elimination of intercompany balances and transactions, Avani O2 ha d net assets of $1, 601,412 as at June 3 0 , 2004 and net income of $ 392,410 for the six -month period then ended. These amounts were recorded as non-controlling interests in these consolidated interim financial statements.

Obligations Payable

		June 3 0 ,		December 31,
		2004		2003

Assignment of net profits interest	$	285,745	$	285,745
Instalments received o n sale of assets		-		724,396
	$	285,745	$	1,010,141

Obligations Payable - Continued

During 2002, the Company assigned a fully reserved account receivable in the amount of $200,944 to certain lenders in full settlement of a $475,771 loan payable. In addition to the assignment of the account receivable, the Company also assigned its net profits interest in production equipment located in Malaysia (the "Net Profits Interest”) to two of the lenders. The assignment of Net Profits Interest to these lenders will revert back to the Company when the lenders have received from such interest, an amount equal to $285,745, the principal amount of the cancelled loans. The Company will record reductions in this account as Net Profits Interests are received by the lenders. All Net Profits Interest balance and transactions between the Company and Avani O2 were eliminated in the consolidated interim financial statements for the six months ended June 30 , 2004.

In October 2002, the Company entered into an agreement with Avani O2 whereby the Company agreed to sell its Canadian building, related land and production equipment to Avani O2 with a carrying amount of approximately $1,065,000 for proceeds of CDN$1,650,000 (US$1,272,645 at year end exchange rates) plus interest charges at 8% per annum and applicable taxes. The proceeds were to be received over two years in twenty-four monthly installments of CDN$70,620 (US$54,469) and a final payment of CDN$220,686 (US$170,215). The gain on disposal of the properties wa s estimated to be $320,000 which was being deferred until the completion of the sale and then eliminated on consolidation. At December 31, 2003, prior to the consolidation of Avani O2, the installments received by the Company were recorded as obligations payable on the consolidated balance sheet. As at December 31, 2003, installments of $724,396 had been received from Avani O2. These assets were not classified as held for sale at December 31, 2003 as management anticipated that significant changes to the transaction would be made in 2004. The advances and balance as at June 3 0 , 2004 between the Company and Avani O2 were eliminated in the consolidated interim financial statements. Title to the property and production equipment will be transferred to Avani O2 when all of the instalments and payments have been received by the Company.

Capital Stock

Transactions not disclosed elsewhere in these consolidated interim financial statements are as follows:

As at June 3 0 , 2004 and December 31, 2003, the Company had 22,862, 55 7 fully exercisable share purchase warrants outstanding. Of this amount, 1,500,000 warrants that were granted August 2003 are exercisable at any time within 5 years at an exercise price of $0.06 per share on or before September 2, 2008, and 550,000 warrants that were granted September 26, 2001 are exercisable at any time within 5 years at an exercise price of $0.06 on or before September 26, 2005, and $0.07 on or before September 26, 2006. The remaining 20,812,557 warrants were granted on May 13, 2002 and July 15, 2002 and they were exercisable at any time within 5 years at a price of $0.03 in the first two years, $0.05 in the third and fourth year and $0.07 in the last year.

Capital Stock - Continued

A summary of share purchase warrant transactions for the periods presented is as follows:

			Weighted
			Average
			Exercise
		Number	Price
Outstanding at January 1, 2003		21,362,557	$0.03
	Granted (a)	1,500,000	$0.06
Outstanding at December 31, 2003 and June 3 0 , 2004		22,862,557	$0.03

All of the share purchase warrants are exercisable on the grant date and remain outstanding at June 3 0 , 2004 and December 31, 2003.

On June 10, 2003, the Company granted 1,950,000 stock options to Company ’s employees and directors. Of this amount 1,150,000 stock options have an exercise period of two years. Each option entitles the holder to purchase one share of the Company’s common stock at $0.05 per share during the first year and $0.30 per share in the second year. Only 30% of the options granted during the period are exercisable immediately with the remaining 70% to be vested on the one year anniversary of the date of grant . Another 800,000 fully vested stock options have an exercisable period of 3 years and an exercise price of $0.05 per share.

The Company follows Statement of Financial Accounting Standard (“SFAS”) No.123, "Accounting for Stock-Based Compensation," which requires compensation cost associated with stock options granted to other than employees to be valued based on the fair value of the stock options, where such fair value was estimated using the Black-Scholes option pricing model. Unvested stock options are remeasured quarterly for the purpose of determining stock option compensation. As at June 3 0 , 2004, the fair value of these options was estimated using the following assumptions: a risk free interest rate of 1. 92 %, expected volatility of 200%, no dividend yield and an expected life of the options of two years. Compensation expense is amortized over the vesting period and compensation expense of $ 83,363 was recognized for the six -month period ended June 30 , 2004 (2003 – Nil) .

The Company applies Accounting Principles Board (“APB”) Opinion 25 and related interpretations in accounting for stock options granted to employees. Generally, under APB No. 25 compensation expense is recognized for the difference between the market price of the underlying stock and the exercise price of the stock options. Accordingly, no compensation has been recognized in connection with options granted to employees. Had compensation cost been determined based upon the fair value of the stock options at the grant date consistent with the fair value method prescribed in SFAS No. 123, the Company's net loss and loss per share would have been increased to the pro forma amounts as indicated below.

Capital Stock - Continued

As there w as no stock-based compensation awarded to employees during the period ended June 30, 2003 , the pro-forma information for the periods ended June 30, 2003 equals the information as reported on the Statement of Operations and Comprehensive Income (Loss).



			Three-month period ended June 30, 2004		Six-month period ended June 30, 2004
Net loss, as reported		$	(91,965)	$	(291,393)
Deduct: stock-based employee compensation expense
	determined under fair-value based method for all awards
	not included in net loss		(4,963)		(10,927)
Pro-forma net loss		$	(96,928)	$	(302,320)
Loss per share:
	Basic and diluted – as reported	$	(0.01)	$	(0.02)
	Basic and diluted – pro-forma	$	(0.01)	$	(0.02)

A summary of stock option transactions for the period presented is as follows:

		Weighted
		Average
		Exercise
	Number	Price


Outstanding at December 31, 2003	3,850,000	$ 0.07
Exercised	(60,000)	0.05
Outstanding at June 30, 2004	3,790,000	0.30
Exercisable at June 30, 2004	3,790,000	0.30
Exercisable at December 31, 2003	2,2 7 5,000	$ 0.10

1 1

Capital Stock - Continued

Stock options outstanding at June 3 0 , 2004 are summarized as follows:

Number	Year 1	Year 2	Expiry Date

300,000	$0.05	$0.30	November 18, 2004
2,250,000	$0.05	$0.30	June 9, 2005
1,240,000	$0.05	$0.05	June 9, 2006

3, 790,000

Major Customer and Supplier

During the six -month period ended June 3 0 , 2004, sales to one Malaysian customer totaled $ 357,149 . At June 3 0 , 2004, there were $ 950,610 amounts due from this customer in receivables. There were no sales to this customer in the prior year comparison as Avani O2 was not consolidated . For the six-month period ended June 30, 2003, sales to the largest customer, Avani O2, were $245,232 and there were $91,200 amounts due from Avani O2 at June 30, 2003. As at December 31, 2003, prior to consolidation of Avani O2, accounts receivable due from Avani O2 was $442,392.

During the six -month periods ended June 3 0 , 2004 and 2003, the Company purchased approximately 57 % and 49 % of its materials from one supplier. At June 3 0 , 2004 and December 31, 2003, there were $Nil amounts due to that supplier in accounts payable.

Related Party Transactions

During the six -month period ended June 3 0 , 2004, the Company accrued $ 36 ,000 as salary (2003 - $ 36 ,000) payable to the President of the Company. In addition, the Company accrued $ 6 ,000 (2003 - $Nil) of marketing expenses payable to the President of the Company. The Company also accrued consulting fees of approximately $ 45 ,000 (2003 - $Nil) payable to a significant stockholder of the Company who is also a director of Avani O2.

1 2

7 .

Segmented Information

The Company sells oxygen-enriched, purified bottled water to customers in Canada and other countries and to a customer in Malaysia through Avani O2 (Note 5). The Company has determined that it operates in one reporting segment. All activities in 2003 were related to the one reporting segment based in Canada. In 2004, geographic reporting information is as follows:

	Three-month periods ended June 30				Six-month periods ended June 30
		2004		2003		2004		2003
Revenue
Bottled water and supply sales
Canada and other countries	$	77,692	$	328,567	$	126,436	$	383,305
Malaysia (via Avani O2)		664,821		-		1,275,935		-
		742,513		328,567		1402,371		383,305
Cooler rentals and equipment sales in
Canada		4,830		5,422		24,421		10,038
	$	747,343	$	333,989	$	1,426,792	$	393,343

Cost of revenue
Cost of goods sold (excluding depreciation)
Canada	$	72,660	$	153,361	$	74,596	$	196,235
Malaysia (via Avani O2)		187,484		-		641,468		-
		260,144		153,361		716,064		196,235
Depreciation		46,656		30,528		94,465		60,747
	$	306,800	$	183,889	$	810,529	$	256,982

Income (loss) from operations
Canada	$	(70,444)	$	(56,336)	$	(215,731)	$	(209,603)
Malaysia (via Avani O2)		363,475		-		392,410		-
		293,031		(56,336)		176,679		(209,603)
Interest on debt payable in Canada		(1,470)		(9,853)		(2,988)		(16,040)
Miscellaneous income in Canada		(20,051)		11,321		18,990		10,552
		271,510		(54,868)		192,681		(215,091)
Non-controlling interest		(363,475)		-		(392,410)		-
Net loss before cumulative effect of change in
accounting policy		(91,965)		(54,868)		(199,729)		(215,091)
Cumulative effect of change in accounting
policy		-		-		(91,664)		-
	$	(91,965)	$	(54,868)	$	(291,393)	$	(215,091)

						June 30		December 31
						2004		2003
Property, plant and equipment
Canada					$	1,263,102	$	1,218,496
Malaysia						290,312		211,833
					$	1,553,414	$	1,430,329

1 3

Item 2. Management's Discussion and Analysis.

The Company has significant business relationships with Avani O2 Water Sdn. Bhd. (“Avani O2”), a Malaysian company and its affiliate. As discussed in the Company’s prior periodic, quarterly and annual filings, including the Company’s Form 10-KSB for the period ended December 31, 2003;

•

Avani O2 was incorporated in July 1999 in Malaysia mainly to explore the opportunities of developing and marketing bottled water in South East Asia. On February 18, 2000, the Company entered into an agreement with Avani O2 pursuant to which Avani O2 received, among other rights, the right and license to construct manufacturing facilities, and to produce and sell the Company’s proprietary water product worldwide, subject to certain conditions and exclusions, including a 30% pre-tax net profits interest and 2% gross royalty interest payable to the Company. On April 19, 2004, the agreement was amended by replacing the 30% pre tax net profits interest with a rental fee payable by Avani O2 to the Company equal to 20,000 Malaysian Ringitt (RM) per each bottling line per month plus 0.19RM per 355ml or 0.00054RM per ml per bottle commencing January 1, 2003.

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On October 25, 2002, the Company, together with its wholly owned subsidiary, Avani Oxygen Water Corp. entered into a Sale and Purchase Agreement with Avani O2 (“Asset Sale Agreement”), pursuant to which the Company agreed to sell all of the assets of its subsidiary consisting of its plant, production equipment, and real estate to Avani O2.

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Avani O2 is controlled by a significant shareholder of the Company.

Please refer to these filings for a broader description of the transactions and relationships with Avani O2 and its affiliate.

As described in Note 2 of the consolidated interim financial statements, the Company is the primary beneficiary of Avani O2, a variable interest entity (“VIE”) as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46R. Accordingly, the Company consolidated Avani O2 in the results for the second quarter of 2004. All material inter-company balances and inter-company transactions have been eliminated. The financial statements as of December 31, 2003 and for the six-month period ended June 30, 2003 include the accounts of the Company and its subsidiaries only.

The following discusses the results of operations and the financial position of the consolidated accounts of the Company, its two wholly owned subsidiaries; Avani Oxygen Water Corporation, and Avani International Marketing Corporation and Avani O2 for the period ended June 30, 2004. As discussed above, Avani O2 is considered to be a Variable Interest Entity and its operations have been consolidated into the operations of the Company commencing in the first quarter of 2004 in accordance with US GAAP. The cumulative effect of the accounting change has been recorded in the Statement of Operations and Comprehensive Loss for the period ended June 30, 2004 and the prior year’s financial results and

positions have not been restated to reflect the consolidation of Avani O2.

Accordingly, increase in expenses between the three and six month periods ended June 30, 2004 and 2003 are principally due to the consolidation of Avani O2. Also, the consolidated balance sheet may not be indicative of the resources available to the Company to settle liabilities and commitments since the net assets of Avani O2 may not be readily available to the Company or are completely within the control of the Company’s management. Segmented information by geographic area is included in Note 8 of the consolidated interim financial statements. Readers should consider the effect of such change in accounting policy and the limitations on balance sheet resources when reviewing the discussion below.

Results of Operations.

Six Months Ended June 30, 2004 compared with Six Months Ended June 30, 2003.

Revenues for the six months ended June 30, 2004 were $1,426,792 representing an increase of $1,033,449 or 263% from revenues of $383,343 for the same period in 2003. The increase is based principally on higher water sales in Malaysia which occurred during the 2004 period attributable to product sales by Avani O2. During 2002, Avani O2 commenced its own manufacture and sale of a water product from its Malaysian plant under an agreement with the Company. These amounts represent private label sales to support Avani O2's product demand in the Far East. Revenues for the six-month period in 2004 consisted of $1,402,371 in water and supply sales (an increase of 366% from $383,305 for the prior period), $24,421 in cooler rentals and equipment sales (an increase of 243% from $10,038 for the same period in prior year).

Cost of revenue which includes depreciation for the six-month period in 2004 totaled $810,529, and increase of $553,547 or 215% from $256,982 for the same period in 2003. Cost of revenue as a percentage of sales was 56.8% for the 2004 period representing a decrease of 8.4% from 65.2% for the prior period. The decrease in cost of revenue as a percentage of sales for the 2004 period reflects the effect of the increased revenues on fixed costs and depreciation. Cost of revenue for the six-month period ended June 30, 2004 consisted of $716,064 in bottled water, supplies, coolers, and related equipment, and delivery costs (an increase of $519,849 or 265% from $196,235 for the prior period) and $94,465 in depreciation (an increase of $33,718 or 56% from $60,747 for the same period in prior year). The increase in costs of revenue is due mainly to higher material and labor costs associated with the increased production levels. Gross profit for the six-month period ended June 30, 2004 was $616,263, an increase of $479,902 or 352% from gross profit of $136,361 for the same period in 2003. The increase is due to the consolidation of Avani O2 in the Company’s operations, and for the reasons discussed above.

Operating expenses which includes marketing expenses, and general and administrative expenses for the six-month period ended June 30, 2004 totaled $439,584, an increase of $93,620 or 27.1% from $345,964 for the same period in 2003. General and administrative costs were $401,099 in 2004, an increase of 22.8% from $326,550 in the prior period. The increase is due mainly the inclusion of Avani O2’s general and administrative expenses of $101,478 in the consolidated statements of the Company. Marketing expenses totaled $38,505 for the six-month period in 2004 representing an increase of 98.3% from $19,414 for the prior period. The

increase is due to a promotion program in Canada which includes advertising and salesperson hiring. Income from operations for the 2004 period is $176,679 compared to a loss of $209,603 for the comparable period 2003 due

to the reasons discussed above.

During the 2004 period, the Company recorded interest on debts payable of $2,998 compared with $16,040 for the 2003 period. The amount in 2003 included mortgage interest of $10,044, which mortgages were paid off by the Company in the third quarter of 2003. Miscellaneous income for 2004 was $18,990 (which consisted of foreign exchange gains of $16,916 and vehicle leasing income of $1,345, compared with $10,552 in 2003.

During 2004, as a result of the consolidation of Avani 02, the Company recorded a non-controlling interest adjustment of $(392,410) and recorded a change of accounting policy adjustment of $(91,664). No such accounts were recorded for the 2003 period.

Net loss for the six-month period ended June 30, 2004 was $291,393 compared with a net loss of $215,091 for the prior period. The Company had a foreign currency transaction adjustment of ($15,139) in 2004 compared with $17,642 for the 2003 period. The increase in the foreign currency adjustment during 2004 is due principally to the increase in operation activities in 2004. Comprehensive loss for the 2004 period was $306,532 compared with a loss of $197,449. Loss per share was $0.02 in 2004 and 2003.

Liquidity and Capital Resources

Since its inception, the Company has financed its operations principally through the private placement of its common stock. In June 2001, the Company received $500,771 in loan proceeds from five private lenders. The loans are unsecured and were due and payable on December 31, 2001. During the 2001 period, $25,000 of a loan payable in favor of one lender was converted to 500,000 shares of common stock and 500,000 common stock purchase warrants. During 2002, the Company entered into agreements with each of the lenders pursuant to which each lender cancelled the full amount of their respective loan outstanding. In exchange, the Company assigned accounts receivable in the amount of $200,944 to four of the lenders which represented a full satisfaction of amounts owed to three of the four lenders, and a partial satisfaction of amounts owed to the fourth lender. The Company also assigned $285,745 in net profits interest to two lenders including the partially satisfied lender. The account receivable relates to water product sold to Avani O2. The net profits interest results from the Company’s agreement with Avani O2 under which Avani O2 received certain licensing rights from the Company. The assignment of net profits interest (amended to become monthly rental charges as discussed above) to these lenders will revert back to the Company when the lenders have received from such interest, an amount equal to the principal amount of the cancelled loans.

In 2002, the Company raised a total of $75,750 from the private placement of its common stock and warrants. As discussed above, the Company also satisfied an outstanding payable in the amount of $124,800 in exchange for the issuance of its common stock and warrants which resulted in a controlling interest in the Company. In August 2003, the Company completed two separate transactions pursuant to which the Company sold 2,500,000 (a total of 5,000,000) shares of common stock of the Company at a price per share equal to $0.06 and received a consideration of $150,000 (a total of $300,000). In connection with the share issuance, the Company agreed to pay a finder's fee to a third party equal to

10% of the gross proceeds, totaling $30,000 in cash and 1,500,000 share purchase warrants.

The Company expects that all available cash, including cash received from Avani O2 from the Asset Sale Agreement, will be used by the Company to fund its ongoing operations. As of June 30, 2004, the Company has sufficient cash to fund its operations for the next four months.

As of June 30, 2004, the Company had working capital of $771,464. Working capital as of December 31, 2003 was $235,530. The increase in working capital is principally a result of consolidation of Avani O2.

Property, plant and equipment, net of accumulated depreciation, totaled $1,553,414, which consists of $1,263,102 in Company assets located in Canada and $290,312 in Avani O2 assets located in Malaysia as at June 30, 2004. Property, plant and equipment of the Company, net of accumulated depreciation, totaled $1,430,329 on December 31, 2003. The reduction is due to amortization that occurred during the period.

Historically, the Company has experienced significant losses from operations. However, during the first quarter of 2004, the Company’s operations improved due to the product sales through Avani O2 as discussed above. The Company expects to continue to sell products through Avani O2 to October 2004, when it transfers its property and production equipment to Avani O2. The Company recognizes that it will be required to seek other business opportunities in the near future as the Asset Sale Agreement with Avani O2 completes in October 2004. Since the second quarter of 2002, the Company began searching for business opportunities to acquire through a merger or share exchange. Management of the Company has conducted discussions and engaged in meetings with principals of a number of private companies, however, the Company has been unable to reach a formal agreement with such parties. The Company continues to search for other business opportunities to acquire, however, it cannot predict whether it will be successful in its efforts.

In the event that additional funding is required, the Company plans to raise additional capital through a combination of equity and debt financing.

The Company plans to propose to provide management services to or merge with Avani O2 after the completion of the sale of equipment and property. Both parties have not agreed on any plan, proposal, letter of understanding, agreement or arrangement yet. There is no guarantee that both parties will be able to reach any agreement or accomplish the acquisition between the Company and Avani O2.

In their auditors’ report on the consolidated financial statements for the year ended December 31, 2003, the Company’s independent auditors included an explanatory paragraph regarding the Company’s ability to continue as going concern. In addition, any future financings will result in significant dilution to existing shareholders (see disclosure relating to cautionary statements in the Company's Annual Report on Form 10-KSB for the year ending December 31, 2003).

Since the second quarter of 2002, the Company began searching for business opportunities to acquire through a merger or share exchange. Management of the Company has conducted discussions and engaged in meetings with principals of a number of private companies, however, the Company has been unable to reach a

formal agreement with such parties. The Company continues to search for other business opportunities to acquire, however, it cannot predict whether it will be successful in its efforts.

Cautionary Statements. Readers are urged to refer to the section entitled "Cautionary Statements in the Company's Form 10-KSB for the year ended December 31, 2003 and elsewhere therein for a broader discussion of such risks and uncertainties. These risks include the lack of profitable operations, limited distribution channels, the need for additional capital to sustain operations, and significant dilution to existing shareholders.

Critical Accounting Policies

Change in Accounting Policy. In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB 51” (which was amended in December 2003, FIN No. 46R). The primary objectives of FIN No. 46R are to provide guidance on the identification of entities for which control is achieved through means other than voting rights (variable interest entities or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity for which either: (1) the equity investors do not have a controlling financial interest; or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN No. 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. As amended in December 2003, the effective dates of FIN No. 46R for public entities that are small business issuers, as defined (“SBIs”), are as follows: (a) for interests in special-purpose entities: periods ended after December 15, 2003; (b) for all VIEs created before January 31, 2003: periods ending after December 15, 2004; and (c) for all VIEs created after January 31, 2003, FIN 46R is applicable immediately. The December 2003 amendment of FIN No. 46R also includes transition provisions that govern how an SBI which previously adopted the pronouncement (as it was originally issued) must account for consolidated VIEs.

Pursuant to a joint-venture agreement dated February 18, 2000 (amended January 2002 and April 2004), the Company is entitled to, among other things, receive a 2% royalty on all revenue from all Avani O2 licensed products, 30% of the before tax profits generated by the contributed bottling line contributed by the Company to Avani O2 and to appoint two of the three directors on the Board of Directors of Avani O2. .As a result, the equity investors of Avani O2 do not have a controlling financial interest in Avani O2 and the Company is the primary beneficiary of Avani O2, the VIE. According to the above-noted requirements, the Company commenced consolidating Avani O2 in the first quarter of 2004. The prior year comparative information has not been restated to reflect a consolidation of Avani O2. The cumulative effect of the change in accounting policy of $91,664 was recorded in the Statements of Operations and Comprehensive Loss at January 1, 2004 and included in accumulated deficit. Subsequent to the elimination of intercompany balances and transactions, Avani O2 has net assets of $1,601,412 as at June 30, 2004 and net income of $392,410 for the six-month period then ended. These amounts were recorded as non-controlling interests in these consolidated interim financial statements.

Revenue Recognition. Revenue on sales of bottled water and sales of cooler and equipment is recognized when the products are delivered and title transfers to customers. Sales terms generally do not permit a right of return. Revenue from

leasing of water coolers and filters are accounted for as operating leases and,

accordingly, rental income is reported over the terms of the leases. Deposits received for bottles and coolers are accrued as liabilities until refunded upon return of bottles and coolers. Freight charges billed to customers are included in Revenue while associated freight costs are included in Cost of Revenue.

As part of the settlement of the loan payables from two lenders, the Company assigned its Net Profits Interest referred to above to these lenders. The Company will recognize the revenue from the Net Profits Interest (subsequently amended to become a monthly rental fee) and reduce the amount of obligation payable related to the assignment of such interest when the lenders receive their assigned Net Profits Interest payments. For the three-month period ended March 31, 2004, all intercompany balances and transactions have been eliminated upon consolidation.

Stock Based Compensation. Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", requires the Company to provide pro-forma information regarding net income as if compensation cost for the Company's stock option plan had been determined in accordance with the fair value based method prescribed in SFAS No. 123. The value of stock options granted to consultants is recognized in these consolidated financial statements as compensation expense using the Black-Scholes option pricing model. Such compensation is amortized over the contract services period or, if none exists, from the date of grant until the options vest. Compensation associated with unvested options is remeasured on each balance sheet date using the Black Scholes option pricing model. The Company has not adopted the fair value method of accounting for stock-based compensation awarded to employees. For the three months ended March 31, 2003, compensation expenses of $83,363 was recognized for unvested options granted to non-employees in 2003. As there were no stock-based compensation awarded to employees during the sixmonths ended March 31, 2004, the pro-forma information equals the information as reported on the Statement of Operations and Comprehensive Loss.

Off Balance Sheet Arrangements.

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As described elsewhere herein, prior to consolidation, Avani O2 is the largest customer of the Company and has agreed to purchase all the production asset of the Company on October 1, 2004. As such, the Company’s continued operation is highly dependent on the collection of trade receivables and asset sale installment from Avani O2. Should Avani O2 default on any of these payments, it will have a severely adverse effect on the Company.

New Accounting Pronouncement

There were no new accounting pronouncement that impacted the Company since the issuance of the audited consolidated financial statements.

Item 3. Effectiveness of the registrant’s disclosure controls and procedures

At June 30, 2004, the Company carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined by Rule 13a-14(c) under the Securities Exchange Act of 1934) under the supervision and with the participation of the Company’s chief executive officer and chief financial

officer. Based on and as of the date of such evaluation, the aforementioned officers have concluded that the Company’s disclosure controls and procedures have functioned effectively so as to provide those officers the information necessary whether:

(i) this quarterly report on Form 10 QSB contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report on Form 10 QSB, and(ii) the financial statements, and other financial information included in this quarterly report on Form 10 QSB, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report on Form 10 QSB.

There have been no significant changes in the Company's internal controls or in other factors since the date of the Chief Executive Officer's and Principal Financial Officer's evaluation that could significantly affect these internal controls, including any corrective actions with regards to significant deficiencies and material weaknesses.

Part II OTHER INFORMATION

Item 1. Legal Proceedings.

None

Item 2. Changes in Securities.

On June 3, 2004, an optionee exercised an outstanding stock option and acquired 60,000 shares of Company common stock in exchange for the total payment of $3,000.

The offering was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Act”), including Rule 506 of Regulation D promulgated under the Act. Each subscriber was an “accredited investor,” each subscriber represented his or her intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, appropriate legends were affixed to the share certificates issued in such transactions, and no advertisement or general solicitation was used in connection with the offering.

Item 3. Defaults upon Senior Securities.

None

Item 4. Submission of Matters to a Vote of Securityholders.

None

Item 5. Other Information.

None

Item 6. Exhibits.

Exhibit 31 – Certification Pursuant To Section 302 Of The Sarbanes-Oxley Act Of 2002.

Exhibit 32 – Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002.

(b) Reports on Form 8-K.

None

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the

registrant has duly caused this report to be signed on its behalf by the

undersigned thereunto duly authorized.

AVANI INTERNATIONAL GROUP, INC.

Date: August 23, 2004 /s/Dennis Robinson

Dennis Robinson

Vice President and

Principal Financial Officer