COFFEE HOLDING CO INC quarterly report, Q1 FY2012

Business context and reporting period

Coffee Holding Co., Inc. is a wholesale coffee roaster and dealer, selling green coffee, private-label coffee and its own branded products. This unaudited Form 10-Q covers the three months ended January 31, 2012, compared with the three months ended January 31, 2011.

Key financial metrics

Net sales rose 120%; gross profit increased 44%, while attributable net income grew 52%. Cash and cash equivalents were $7.36 million at January 31, 2012, versus $4.24 million at October 31, 2011. Working capital was $20.85 million. Current assets were $38.13 million and current liabilities $17.28 million.

The company had $1.80 million outstanding on its revolving credit facility at January 31, 2012, compared with $1.82 million at October 31, 2011. Total liabilities were $18.01 million; total consolidated equity was $23.38 million. Cash used in investing activities was $0.25 million, including a $0.20 million investment in Global Mark LLC. Financing activities used $0.22 million, including $0.19 million of dividends. The quarterly dividend was $0.03 per share.

Material changes versus the prior comparable period

• Management attributed the sales increase to higher selling prices, increased green-coffee sales, and growth in private-label and branded sales.
• Cost of sales increased to 92.1% of revenue from 87.9%; gross margin contracted by about 4.2 percentage points. Management cited higher costs and a greater share of green-coffee sales, which generally carry lower percentage margins than roasted products.
• Operating expenses rose 8.5% to $1.83 million. Other income of $47,950 in the prior-year quarter became other expense of $71,983, including a $20,137 equity-investment loss and lower interest income.
• Operating cash flow improved, but was supported in part by a $2.78 million increase in accounts payable and accrued expenses. Accounts receivable increased $1.94 million during the quarter.
• One customer accounted for approximately 68% of quarterly sales and $10.26 million of period-end receivables, versus 44% of sales and approximately $4.90 million of receivables in the prior-year quarter.

Outlook, risks and unusual items

• The filing provides no quantitative earnings, sales or margin guidance. Management says hedging may be used to a lesser extent as the business grows and its revenue mix changes.
• Coffee prices and supply are key risks. Futures and options are used to partially hedge coffee costs, but are not designated as accounting hedges; gains and losses are recognized in cost of sales and can add earnings volatility. The company reported a $1.58 million unrealized commodity gain in the quarter, while realized commodity losses were $0.79 million.
• On November 30, 2011, the company agreed to acquire a 40% interest in Global Mark LLC, an instant-coffee supplier, and may contribute up to $2.0 million to fund operations; approximately $0.20 million had been paid by quarter-end. The investment is accounted for under the equity method, and the company expects preferred pricing for instant coffee.
• The $7.0 million credit facility was extended through February 17, 2014; effective February 12, 2012, its rate was reduced to Wall Street Journal Prime plus 1%. The company reported covenant compliance at January 31. A CORDAID guarantee agreement expires March 31, 2012, and the parties do not expect to renew it.
• Related-party and supplier concentration warrant attention: purchases from a vendor whose employee is a company director were approximately $10.5 million, and purchases from that vendor were included in cost of sales. Four vendors represented approximately 64% of purchases.
• Management identified customer collection, inventory valuation, deferred tax asset realization, and goodwill and intangible-asset impairment as areas involving estimates. It reported no material change in risk factors, no material off-balance-sheet arrangements, and no pending material legal proceedings; disclosure controls were deemed effective.

Important facts for investors to verify

1. Whether the exceptional customer concentration persists and whether the large receivable balance is collected on schedule.
2. Whether the lower gross margin reflects a lasting shift toward lower-margin green coffee sales, and how commodity-price changes affect margins and hedge results.
3. Whether operating cash generation remains strong without a similar increase in payables, and how working capital evolves.
4. The use and funding terms of the Global Mark investment, and the effect of the nonrenewal of the CORDAID guarantee on financing and coffee-cooperative pre-financing.
5. The filing reports total consolidated equity of $23.38 million on the balance sheet, but MD&A cites total stockholders’ equity of $23.40 million; investors should reconcile this difference.
6. Potential dilution from the 267,000 warrants issued in the October 2011 offering, exercisable beginning April 2012 at $13.59 per share, and contingent shares related to the OPTCO acquisition.