Coffee Holding Co., Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended July 31, 2017; balance-sheet comparisons are to October 31, 2016. The company wholesales green coffee, roasts and sells private-label and branded coffee, and sells roasting equipment. Its operations are reported as one segment.
Financial performance and position
| Metric | Three months ended July 31, 2017 | Three months ended July 31, 2016 | Nine months ended July 31, 2017 | Nine months ended July 31, 2016 |
|---|---|---|---|---|
| Net sales | $17.98 million | $17.35 million | $55.40 million | $61.57 million |
| Gross profit | $3.08 million | $3.15 million | $8.93 million | $9.11 million |
| Gross margin | 17.1% | 18.2% | 16.1% | 14.8% |
| Income from operations | $180,000 | $1.28 million | $884,000 | $3.45 million |
| Net income attributable to Coffee Holding | $32,800 | $755,518 | $410,319 | $2.03 million |
| Basic and diluted EPS | $0.01 | $0.12 | $0.07 | $0.33 |
Cash flow: For the nine months, operating activities provided $2.51 million, versus $1.27 million used in the prior-year period. Investing activities used $3.48 million, including $2.89 million for the Comfort Foods acquisition and $586,000 for equipment. Financing activities provided $432,000. Cash declined $540,000 to $2.69 million.
Liquidity and debt: Working capital was $20.53 million, down from $21.67 million at October 31, 2016. Current assets were $31.25 million and current liabilities $10.72 million. The revolving line-of-credit balance was $7.41 million, up from $6.96 million; the company reported no other debt amount in the provided financial statements. The facility has a $12 million combined limit, bears interest at LIBOR plus 2.4% under the amended agreement, is secured by company assets, and matures February 28, 2018. The company reported covenant compliance at July 31, 2017.
Material changes and management commentary
- Quarterly sales grew 3.6%, but nine-month sales fell 10%. Management attributed the nine-month decline mainly to approximately $18.9 million less wholesale business with its largest green-coffee customer, partly offset by approximately $12.7 million of increased branded and private-label sales. In the quarter, approximately $4.0 million of added branded and private-label sales partly offset a $3.4 million decline from that wholesale customer.
- Nine-month gross margin improved, but gross profit declined slightly. Quarterly gross margin fell, which management linked partly to product mix and integrating Comfort Foods. Operating expenses increased $2.38 million for the nine months, including expenses from acquired subsidiaries and higher shipping, salary, insurance, depreciation, and technology costs. Net income attributable to the company fell substantially in both comparison periods.
- Comfort Foods was acquired in February 2017 for $2.3 million in cash, with approximately $605,000 of its bank debt also paid. The acquisition added $1.78 million of revenue from closing through July 31. Goodwill increased to $2.38 million. Management said the acquisition was intended to expand its northeastern presence.
- Management expects to fund operations, liabilities, capital expenditures, and debt payments through July 31, 2018 using operating cash flow and the credit facility; additional borrowing may be available if eligible receivables and inventory increase. This is an expectation, not a formal earnings forecast.
Risks, contingencies, and unusual items
- Coffee prices and supply are volatile. The company uses futures and options on a limited basis, recognizes gains and losses in cost of sales, and says hedging may not prevent margin pressure or losses. At July 31, it held 116 futures contracts for 4.35 million pounds of coffee, at a weighted-average $1.27 per pound; the stated market price was $1.39. No options were held.
- Commodity-contract results were uneven: nine-month realized and unrealized activity produced a net gain of $64,000, compared with $914,000 in the prior-year period. The filing notes that these instruments are not designated as accounting hedges, which can increase earnings volatility.
- Variable-rate debt exposes the company to interest-rate changes. Customer concentration remains material: four customers represented approximately 25% of nine-month sales and $3.19 million of receivables at July 31. A related-party vendor accounted for approximately $4.79 million of nine-month purchases.
- On September 13, 2017, after the reporting date, the board approved a new share-repurchase program of up to $2 million. The company also reported terminating the former Comfort Foods CEO’s advisory agreement on September 6, 2017.
- The company reported no material change in previously disclosed risk factors, no material pending litigation beyond routine matters, and no material off-balance-sheet arrangements. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether reduced sales to the largest wholesale customer continue, and whether growth in branded and private-label sales can offset that decline.
- Whether acquired businesses, particularly Comfort Foods, contribute sufficient profit to offset their added operating costs and acquisition-related goodwill.
- Cash conversion and working-capital trends, including inventory levels, receivables, and dependence on the revolving facility approaching its February 2018 maturity.
- Current borrowing availability, interest costs, and compliance with the credit agreement’s financial and operating covenants.
- Commodity exposure, hedge results, and the effect of coffee-price movements on gross margins and earnings.
- Customer concentration, the new $2 million repurchase authorization, and any subsequent developments not covered by this quarter’s results.