Coffee Holding Co., Inc. — Q1 FY2020 Form 10-Q
Business and period: The company roasts, packages, markets and distributes coffee, sells green coffee, and manufactures coffee roasters. It reports one operating segment. This unaudited quarter covers the three months ended January 31, 2020; comparisons are with the three months ended January 31, 2019 unless otherwise noted.
Financial performance and position
| Metric | Q1 FY2020 | Q1 FY2019 / prior date |
|---|---|---|
| Net sales | $19.29 million | $23.63 million |
| Gross profit and margin, including hedge effects | $3.11 million; 16.2% | $4.57 million; 19.3% |
| Operating income (loss) | $(0.56) million | $0.69 million |
| Net income (loss) attributable to Coffee Holding | $(0.60) million; $(0.11) per share | $0.31 million; $0.06 per share |
| Net cash provided by operating activities | $1.72 million | $0.81 million |
| Cash | $2.75 million | $2.40 million at October 31, 2019 |
| Working capital | $19.33 million | $20.23 million at October 31, 2019 |
| Line of credit | $5.87 million | $7.17 million at October 31, 2019 |
Sales fell 18.0%. Green coffee revenue declined to $6.79 million from $9.16 million; packaged coffee revenue declined to $12.50 million from $14.48 million. The filing attributes lower sales to customers slowing purchases amid green coffee market volatility, a change by Steep n Brew’s largest customer from a distribution agreement to a commission arrangement (about $1.3 million lower reported sales), and a decline of about $296,000 in sales to a former major green coffee customer.
Cost of sales was 83.8% of sales versus 80.7%. Management also presented gross profit excluding unrealized hedge losses: $4.10 million, or 21.2% of sales, versus $5.11 million, or 21.6%. Unrealized losses on coffee futures and options were $985,837 versus $543,149; management cited a 22% decline in the green coffee market in January as adversely affecting established positions. Operating expenses decreased $203,954 to $3.68 million, reflecting cost reductions, partly offset by stock compensation and higher freight costs.
Operating cash flow improved, primarily reflecting inventory usage and working-capital movements. Investing activities used $71,974, mainly for equipment purchases; financing activities used $1.30 million, primarily from net repayments on the credit line. Total liabilities were $14.28 million at January 31, including $5.87 million on the line of credit, $26,807 in notes payable, and $2.59 million in lease liabilities. The company reported compliance with its loan covenants at quarter-end.
Material changes, outlook and risks
- Credit facility: After quarter-end, on March 13, 2020, the company and OPTCO amended the Sterling facility, extending maturity to March 31, 2022 and reducing the interest rate to LIBOR plus 1.75%, subject to a 3.50% floor. The prior rate was LIBOR plus 2.00% (3.66% at January 31, 2020). The facility is secured by company assets.
- Liquidity outlook: Management said it expected to fund operations, liabilities, capital expenditures and debt payments through March 16, 2020 using operating cash flow and the credit facility; additional borrowing capacity could depend on eligible receivables and inventory. No longer-term quantitative guidance was provided.
- Commodity exposure: Coffee futures and options are not designated accounting hedges, and fair-value changes flow through earnings. The company said it had scaled back and intended to continue using hedging and short-term trading only in a limited capacity. These positions can increase earnings volatility and may not fully offset coffee-price or supply risks.
- Customer and supplier concentration: Six customers generated about 24% of quarterly sales and represented approximately $2.65 million of receivables. Six vendors accounted for about 28% of purchases.
- COVID-19: The filing added a risk factor warning that the pandemic could disrupt suppliers, sales efforts and business operations and adversely affect results; its potential impact could not then be estimated.
- Controls: Management concluded disclosure controls were not effective due to an unresolved material weakness in accounting for stock-based compensation awards. Remediation work was underway; management nevertheless stated it believed the reported financial information was materially correct and fairly presented.
- Other notable items: Adoption of lease accounting resulted in recognition of operating lease right-of-use assets and liabilities; no opening equity impact was reported. Stock-based compensation expense was $248,031 for the quarter. The filing reported no material pending litigation beyond routine matters.
Investor verification points
- Reconcile the reported gross margin and loss trend with the substantial unrealized commodity losses and the company’s discussion of gross profit excluding those losses.
- Track whether sales and customer relationships stabilize after the distribution-to-commission change and the decline in green coffee purchases.
- Review borrowing-base availability, covenant compliance, and the terms and continuing availability of the amended Sterling facility.
- Assess the pandemic’s realized effects on demand, supply chains and operations, which the filing said were not yet estimable.
- Monitor remediation of the stock-compensation accounting material weakness and the accounting and dilution implications of the 1,000,000 outstanding options.