JVA

Business Context and Reporting Period

Company: Coffee Holding Co., Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: April 30, 2008 (Unaudited)
Business Overview: The Company is an integrated wholesale coffee roaster and dealer operating facilities in Brooklyn, New York, and La Junta, Colorado. It manufactures, roasts, packages, and distributes roasted and blended coffees for private label accounts and its own brands, while also selling green coffee. The Company consolidates a 60% interest in Generations Coffee Company, LLC.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 23.5% for the six months and 28.0% for the three months ended April 30, 2008, compared to the prior year periods. This growth was driven by higher sales volumes and price increases implemented to offset rising commodity costs.
• Margin Compression: Gross margins collapsed from 15.9% to 0.6% (six months) and turned negative (-9.2%) for the three months ended April 30, 2008. This was primarily due to a surge in green coffee prices and significant losses on hedging instruments.
• Hedging Losses: The Company incurred net losses on options and futures contracts of $1,489,236 for the six months and $2,082,679 for the three months ended April 30, 2008. In the comparable 2007 periods, the Company recorded net gains of $1,032,779 and $442,463, respectively.
• Profitability: The Company reported a net loss of $1.86 million for the six months ended April 30, 2008, a reversal from a net income of $648,592 in the prior year period.
• Debt Utilization: Borrowings under the $4 million line of credit increased from $897,191 to $2,556,762.

Guidance, Outlook, and Risks

• Management Commentary: Management attributes the losses to a surge in commodity prices driven by a weaker U.S. dollar and market speculation. They initiated price increases in early 2008 and anticipate these will have a positive impact on margins beginning in the third quarter of fiscal 2008.
• Hedging Strategy: The Company believes recent regulatory scrutiny has driven speculators out of the market and does not expect future trading losses. They intend to resume using hedging strategies to reduce cost of sales in the third quarter.
• Covenant Violations: As of April 30, 2008, the Company was in violation of the Fixed Charge Coverage Ratio and Total Debt to EBITDA Ratio covenants under its Merrill Lynch credit facility. A waiver was obtained from the lender as of the reporting date.
• Liquidity: The Company expects to fund operations for the next twelve months through operating cash flows and its existing credit facility. It also noted the ability to obtain additional loans by mortgaging its headquarters building if necessary.
• Customer Concentration: For the six months ended April 30, 2008, two customers accounted for approximately 34% and 10% of total sales, respectively.
• Vendor Concentration: Two vendors accounted for approximately 47% and 10% of purchases. One of these vendors has a director of the Company as an employee.

Investor Verification Checklist

• Covenant Compliance: Verify the status of the waiver for the Fixed Charge Coverage and Debt-to-EBITDA covenants and the likelihood of future compliance given the recent losses.
• Hedging Effectiveness: Assess the Company's ability to successfully implement hedging strategies in the third quarter to offset high coffee prices, as projected by management.
• Price Pass-Through: Monitor whether the price increases initiated in early 2008 are successfully sustaining margins without eroding sales volume.
• Inventory Valuation: Review inventory levels and potential write-downs, as the Company noted selling off "poorly priced inventories" at low profit levels.
• Customer/Vendor Dependency: Evaluate the risk associated with the high concentration of sales (44% from two customers) and purchases (57% from two vendors).