Overview

Coffee Holding (JVA) is an integrated wholesale coffee roaster and dealer in the United States and one of the few coffee companies that offers a broad array of coffee products across the entire spectrum of consumer tastes, preferences and price points. As a result, the company believe that Coffee Holding is well-positioned to increase its profitability and endure potential coffee price volatility throughout varying cycles of the coffee market and economic conditions.¹

The company's operations have primarily focused on the following areas of the coffee industry:

• the sale of wholesale specialty green coffee;
• the roasting, blending, packaging and sale of private label coffee;
• the roasting, blending, packaging and sale of its eight proprietary brands of coffee; and
• sales of its tabletop coffee roasting equipment.

The company's operating results are affected by a number of factors including:

• the level of marketing and pricing competition from existing or new competitors in the coffee industry;
• our ability to retain existing customers and attract new customers;
• our hedging policy;
• fluctuations in purchase prices and supply of green coffee and in the selling prices of its products; and
• our ability to manage inventory and fulfillment operations and maintain gross margins.

The company's net sales are driven primarily by the success of its sales and marketing efforts and its ability to retain existing customers and attract new customers. For this reason, Coffee Holding has made, and will continue to evaluate, strategic decisions to invest in measures that are expected to increase net sales. These transactions include its acquisition of Premier Roasters, LLC, including equipment and a roasting facility in La Junta, Colorado, the addition of a west coast sales manager to increase sales of its private label and branded coffees to new customers, its joint venture with Caruso’s Coffee, Inc. of Brecksville, Ohio, the transaction with OPTCO and its licensing arrangement with DTS8 Coffee Company, Ltd. On June 23, 2016, the company formed its wholly-owned subsidiary, Sonofresco, LLC (“SONO”), a Delaware limited liability company. On June 29, 2016, the company purchased through SONO, substantially all the assets, including equipment, inventory, customer list and relationships of Coffee Kinetics, LLC, a Washington limited liability company. On February 24, 2017, the company acquired 100% of the capital stock of Comfort Foods, Inc. (“CFI”), a Massachusetts based medium sized coffee roaster, manufacturing both branded and private label coffee for retail and foodservice customers. In April 2018, Generations Coffee Company, the entity formed as a result of its joint venture with Caruso’s Coffee, Inc., purchased substantially all the assets of Steep & Brew, Inc. The company believe these efforts will allow it to expand its business.

The company's net sales are affected by the price of green coffee. The company purchase its green coffee from dealers located primarily within the United States. The dealers supply it with coffee beans from many countries, including Colombia, Mexico, Kenya, Indonesia, Brazil and Uganda. The supply and price of coffee beans are subject to volatility and are influenced by numerous factors which are beyond its control. For example, in Brazil, which produces approximately 40% of the world’s green coffee, the coffee crops are historically susceptible to frost in June and July and drought in September, October and November. However, because the company purchase coffee from a number of countries and are able to freely substitute one country’s coffee for another in its products, price fluctuations in one country generally have not had a material impact on the price the company pay for coffee. Accordingly, price fluctuations in one country generally have not had a material effect on its results of operations, liquidity and capital resources. Historically, because the company generally have been able to pass green coffee price increases through to customers, increased prices of green coffee generally result in increased net sales.

The supply and price of coffee beans are subject to volatility and are influenced by numerous factors which are beyond its control. Historically, Coffee Holding has used, and intend to continue to use in a limited capacity, short-term coffee futures and options contracts primarily for the purpose of partially hedging the effects of changing green coffee prices. In addition, the company acquired, and expect to continue to acquire, futures contracts with longer terms, generally three to four months, primarily for the purpose of guaranteeing an adequate supply of green coffee. Realized and unrealized gains or losses on options and futures contracts are reflected in its cost of sales. Gains on options and futures contracts reduce its cost of sales and losses on options and futures contracts increase its cost of sales. The use of these derivative financial instruments has generally enabled it to mitigate the effect of changing prices. The company believe that, in normal economic times, its hedging policies remain a vital element to its business model not only in controlling its cost of sales, but also giving it the flexibility to obtain the inventory necessary to continue to grow its sales while trying to minimize margin compression during a time of historically high coffee prices. However, no strategy can entirely eliminate pricing risks and the company generally remain exposed to losses on futures contracts when prices decline significantly in a short period of time, and the company would generally remain exposed to supply risk in the event of non-performance by the counterparties to any of its futures contracts. Although Coffee Holding has had net gains on options and futures contracts in the past, Coffee Holding has incurred significant losses on options and futures contracts in the past. In these cases, its cost of sales has increased, resulting in a decrease in its profitability or increase in its losses. Such losses have and could in the future materially increase its cost of sales and materially decrease its profitability and adversely affect its stock price. See “Item 3, Quantitative and Qualitative Disclosures About Market Risk. If its hedging policy is not effective, the company may not be able to control its coffee costs, the company may be forced to pay greater than market value for green coffee and its profitability may be reduced.” Failure to properly design and implement an effective hedging strategy may materially adversely affect its business and operating results. If the hedges that the company enter do not adequately offset the risks of coffee bean price volatility or its hedges result in losses, its cost of sales may increase, resulting in a decrease in profitability or increased losses. As previously announced, as a result of the volatile nature of the commodities markets, Coffee Holding has and are continuing to scale back its use of hedging and short-term trading of coffee futures and options contracts, and intend to continue to use these practices in a limited capacity going forward.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventories, assets held for sale, income taxes, commodities held and loss contingencies. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

The company believe the following critical accounting policies, among others, may be impacted significantly by judgment, assumptions and estimates used in the preparation of the financial statements:

• The company recognize revenue in accordance with the relevant authoritative guidance. Revenue is recognized at the point title and risk of ownership transfers to its customers which is upon the shippers taking possession of the goods because i) title passes in accordance with the terms of the purchase orders and with its agreements with its customers, ii) any risk of loss is covered by the customers’ insurance, iii) there is persuasive evidence of a sales arrangement, iv) the sales price is determinable and v) collection of the resulting receivable is reasonably assured. Thus, revenue is recognized at the point of shipment.
• The company's allowance for doubtful accounts is maintained to provide for losses arising from customers’ inability to make required payments. If there is deterioration of its customers’ credit worthiness and/or there is an increase in the length of time that the receivables are past due greater than the historical assumptions used, additional allowances may be required. For example, every additional one percent of its accounts receivable that becomes uncollectible, would decrease its operating income by approximately $86,000 for the quarter ended July 31, 2018. The reserve for sales discounts represents the estimated discount that customers will take upon payment. The reserve for other allowances represents the estimated amount of returns, slotting fees and volume based discounts estimated to be incurred by it from its customers.
• Inventories are stated at lower of cost (determined on a first-in, first-out basis) or market. Based on its assumptions about future demand and market conditions, inventories are subject to be written-down to market value. If its assumptions about future demand change and/or actual market conditions are less favorable than those projected, additional write-downs of inventories may be required. Each additional one percent of potential inventory write-down would have decreased operating income by approximately $152,000 for the quarter ended July 31, 2018.
• The commodities held at broker represent the market value of its trading account, which consists of option and futures contracts for coffee held with a brokerage firm. The company use options and futures contracts, which are not designated or qualifying as hedging instruments, to partially hedge the effects of fluctuations in the price of green coffee beans. Options and futures contracts are recognized at fair value in the consolidated financial statements with current recognition of gains and losses on such positions. The company classify options and futures contracts as trading securities and accordingly, unrealized holding gains and losses are included in earnings. The company record realized and unrealized gains and losses in its cost of sales in the statement of operations/income.
• The company account for income taxes in accordance with the relevant authoritative guidance. Deferred tax assets and liabilities are computed for temporary differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the balance sheet when it is determined that it is more likely than not that the asset will be realized.
• The company's goodwill consists of the cost in excess of the fair market value of the acquired net assets of OPTCO, SONO, CFI and GCC which has been integrated into a structure that does not provide the basis for separate reporting units. Consequently, Coffee Holding is a single reporting unit for goodwill impairment testing purposes. The company also have intangible assets consisting of its customer list and relationships and trademarks acquired from OPTCO and SONO. At July 31, 2018 its balance sheet reflected goodwill and intangible assets as set forth below:

as on July 31, 2018

Goodwill and the trademarks which are deemed to have indefinite lives are subject to annual impairment tests. Goodwill impairment tests require the comparison of the fair value and carrying value of reporting units. The company assess the potential impairment of goodwill and intangible assets annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon completion of such review, if impairment is found to have occurred, a corresponding charge will be recorded. The value assigned to the customer list and relationships is being amortized over a twenty year period.

Because Coffee Holding is a single reporting unit, the closing price of its common stock on the Nasdaq Capital Market as of the acquisition date was used as a basis to measure the fair value of goodwill. Goodwill and the intangible assets will be tested annually at the end of each fiscal year to determine whether they have been impaired. Upon completion of each annual review, there can be no assurance that a material charge will not be recorded. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment or decline in value may have occurred.

Liquidity and Capital Resources

As of July 31, 2018, the company had working capital of $19,336,134, which represented a $929,518 decrease from its working capital of $20,265,652 as of October 31, 2017, and total stockholders’ equity of $25,015,108, which increased by $63,559 from its total stockholders’ equity of $24,951,549 as of October 31, 2017. The company's working capital decreased primarily due to decreases of $4,831,418 in accounts receivable, $1,099,999 in inventories, $171,350 in prepaid green coffee, $178,848 in prepaid and refundable income taxes, increases of $317,176 in due from broker, $150,000 in note payable and $5,889 income taxes payable partially offset by increases of $2,754,371 in cash, $113,507 in prepaid expenses and other current assets, decreases of $1,698,519 in accounts payable and accrued expenses and $1,258,765 in its line of credit. As of July 3, 2018, the outstanding balance on its line of credit was $7,148,762 compared to $8,407,527 as of October 31, 2017. Total stockholders’ equity increased due to its net income and was partially offset by its purchase of treasury stock. $894,367.

Pursuant to the A&R Loan Agreement, the terms of each of the Company Financing Agreement and the OPTCO Financing Agreement were amended and restated to, among other things:  provide for a new Maturity Date of February 28, 2018; (ii) consolidate the principal amounts of the Company Financing Agreement and the OPTCO Financing Agreement to provide for a maximum principal amount limit of $12,000,000 for the Borrowers, collectively, provided that OPTCO is limited to a $3,000,000 maximum principal amount sublimit; (iii) expand the borrowing base to include, along with 85% of eligible accounts receivable, up to the lesser of $2,000,000 as to the Company and $1,500,000 as to OPTCO; (iv) effective March 1, 2017, converted the interest rate on the average unpaid balance of the A&R Loan Facility from an interest rate per annum equal to the Wall Street Journal Prime Rate to an interest rate per annum equal to the sum of the LIBOR rate plus 2.4%; (v) require the Company and OPTCO to pay, collectively, upon the occurrence of certain termination events, a prepayment premium of 1.0% (as opposed to the 0.5% under the OPTCO Financing Agreement) of the maximum amount of the A&R Loan Facility in effect as of the date of the termination event; (vi) eliminate the over advance fee; and (vii) establish a Letter of Credit Facility (as defined in the A&R Loan Agreement) with a maximum obligation amount of $1,000,000, and subject to other terms and conditions described therein. Also on April 25, 2017, SONO and CFI (collectively referred to herein as the “Guarantors”), entered into a Guaranty Agreement (the “Guaranty Agreement”) in connection with the A&R Loan Agreement. The Guaranty Agreement was provided as an inducement to Sterling to extend credit to Borrowers in exchange for the Guarantors’ unconditional guarantee of the payment and performance obligations of the Borrowers under the Loan Agreement, as further defined in the Guaranty Agreement.

On March 23, 2018, the Company reached an agreement for a new loan modification agreement and credit facility with Sterling. The terms of the new agreement among other things:  provides for a new maturity date of March 31, 2020; (ii) increases the maximum principal amount to $14,000,000; and (iii) decreases the interest rate per annum to LIBOR plus 2 percent.

Each of the A&R Loan Facility and A&R Loan Agreement contains covenants, subject to certain exceptions, that place annual restrictions on the Borrowers’ operations, including covenants relating to debt restrictions, capital expenditures, indebtedness, minimum deposit restrictions, tangible net worth, net profit, leverage, employee loan restrictions, dividend and repurchase restrictions (common stock and preferred stock), and restrictions on intercompany transactions.

The A&R Loan Facility also requires that the company maintain a minimum working capital at all times, and the A&R Loan Agreement requires that the Borrowers, on a consolidated basis, maintain a minimum working capital at all times and achieve a minimum net profit amount as of fiscal year end during the term of the A&R Loan Agreement.

Each of the A&R Loan Facility and the A&R Loan Agreement is secured by all tangible and intangible assets of the Company. Other than as amended and restated by the A&R Loan Agreement, the Company Financing Agreement and the OPTCO Financing Agreement remains in full force and effect.

As of July 31, 2018 and October 31, 2017, the outstanding balance under the bank line of credit was $7,148,762 and $8,407,527, respectively.

For the nine months ended July 31, 2018, its operating activities provided net cash of $7,947,275 as compared to the nine months ended July 31, 2017 when operating activities provided net cash of $2,506,995. The increased cash flow from operations for the nine months ended July 31, 2018 was primarily due to its accounts receivable, inventories and unrealized gains partially offset by its accounts payable and deferred income taxes.

For the nine months ended July 31, 2018, its investing activities used net cash of $3,039,771 as compared to the nine months ended July 31, 2017 when net cash used by investing activities was $3,479,373. The decrease in its uses of cash in investing activities was due to the purchase of Steep & Brew during the nine months ended July 31, 2017, partially offset by a decrease in its outlays for equipment.

For the nine months ended July 31, 2018, its financing activities used net cash of $2,153,133 as compared to the nine months ended July 31, 2017 when net cash provided by financing activities was $432,121. The change in cash flow from financing activities for the nine months ended July 31, 2018 was due to its increased net principal payments on its line of credit of $994,065 and its increased treasury stock purchases of $878,538, partially offset by its decreased advances on its line of credit of $712,650.

The company expect to fund its operations, including paying its liabilities, funding capital expenditures and making required payments on its indebtedness, through July 31, 2019 with cash provided by operating activities and the use of its credit facility. In addition, an increase in eligible accounts receivable and inventory would permit it to make additional borrowings under its line of credit.

References

1. ^ https://fintel.io/doc/sec-jva-coffee-holding-co-10k-2019-january-29-17963