Coffee Holding Co., Inc. (the “Company”) conducts wholesale coffee operations, including manufacturing, roasting, packaging, marketing and distributing roasted and blended coffees for private labeled accounts and its own brands, and it sells green coffee.  The Company’s core product, coffee, can be summarized and divided into three product categories (“product lines”) as follows:

The Company’s private label and branded coffee sales are primarily to customers that are located throughout the United States with limited sales in Canada and the Far East.  Such customers include supermarkets, wholesalers, and individually-owned and multi-unit retailers.  The Company’s unprocessed green coffee, which includes over 90 specialty coffee offerings, is sold primarily to specialty gourmet roasters and to coffee shop operators in the United States with limited sales in Australia, Canada, England and China.

 

The Company’s wholesale green, private label, and branded coffee product categories generate revenues and cost of sales individually but incur selling, general and administrative expenses in the aggregate. There are no individual product managers and discrete financial information is not available for any of the product lines. The Company’s product portfolio is used in one business and it operates and competes in one business activity and economic environment. In addition, the three product lines share customers, manufacturing resources, sales channels, and marketing support. Thus, the Company considers the three product lines to be one single reporting segment.

In the opinion of management, all adjustments (which include normal and recurring nature adjustments) necessary to present a fair statement of the Company’s financial position as of April 30,July 31, 2015, and results of operations for the three and sixnine months ended April 30,July 31, 2015 and 2014 and the cash flows for the sixnine months ended April 30,July 31, 2015 and 2014, as applicable, have been made.

The condensed consolidated financial statements include the accounts of the Company, the Company’s subsidiary, Organic Products Trading Company, LLC (“OPTCO”) and Generations Coffee Company, LLC (“GCC”), the entity formed as a result of the Company’s joint venture with Caruso’s Coffee, Inc.  The Company owns a 60% equity interest in GCC.  All significant inter-company transactions and balances have been eliminated in consolidation.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)(ASU) No. 2014-09, (“ASU 2014-09”), “Revenue from Contracts with Customers,” which requires an entity to recognize revenue representing the transfer of promised goods or services to customers in an amount that reflects the consideration which the company expects to receive in exchange for those goods or services.  ASU 2014-09 is intended to establish principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenues and cash flows arising from the entity’s contracts with customers.  ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when it becomes effective.  The original standard was effective for the Company on January 1, 2017, however, in April 2015, the FASB proposed a one-year deferral of this standard with a new effective date for the Company of January 1, 2018.  Early application is not permitted.  The Company is currently evaluating the effect that ASU 2014-09 will have on its condensed consolidated financial statements and related disclosures.

The balance represents advance payments made by OPTCO to several coffee growing cooperatives for the purchase of green coffee.  Interest is charged to the cooperatives for these advances.  Interest earned was $13,228$26,302 and $16,796$32,064 for the sixnine months ended AprilJuly 2015 and 2014, respectively.  The prepaid coffee balance was $121,112$1,014,911 at April 30,July 31, 2015 and $467,155 at October 31, 2014.

Trade accounts receivable are stated at the amount the Company expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectibility of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Past due balances over 60 days and other higher risk amounts are reviewed individually for collectibility. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.

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 the Company from its customers.  The allowances are summarized as follows:

The Company has used, and willintends to continue to use in a limited capacity, short-term coffee futures and options contracts primarily for the purpose of partially hedging and minimizing the effects of changing green coffee prices and to reduce our cost of sales.  The commodities held at the broker represent the market value of the Company’s trading account, which consists of options and future contracts for coffee held with a brokerage firm.  The Company uses 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 condensed consolidated financial statements with current recognition of gains and losses on such positions.  The Company’s accounting for options and futures contracts may increase earnings volatility in any particular period.

The Company has open position contracts held by the broker, which are summarized as follows:

On February 17, 2009, the Company entered into a financing agreement with Sterling National Bank (“Sterling”) for a $5,000,000 credit facility.  The credit facility is a revolving $5,000,000 line of credit and the Company can draw on the line at an amount up to 85% of eligible accounts receivable and 25% of eligible inventory consisting of green coffee beans and finished coffee not to exceed $1,000,000.  Sterling shall have the right from time to time to adjust the foregoing percentages based upon, among other things, dilution, its sole determination of the value or likelihood of collection of eligible accounts receivables owed to the Company and considerations regarding inventory.  The credit facility is payable monthly in arrears on the average unpaid balance of the line of credit at an interest rate equal to a per annum reference rate (3.25% and 3.75%) at April 30,July 31, 2015 and October 31, 2014, respectively.

 

On July 22, 2010, the credit facility was increased to $7,000,000.  In addition, OPTCO was added as a co-borrower and the inventory sublimit was raised from $1,000,000 to $2,000,000.  Subsequent to July 31, 2010, $1,800,000 of the credit facility was allocated to OPTCO.

On February 3, 2011, the Company amended their credit facility regarding the creation of a sublimit within the revolving line of credit in the form of a $300,000 term loan for the benefit of GCC.  The Company provided a corporate guarantee to Sterling in connection with the amendment.

The initial term of the credit facility was for three years and expired on February 17, 2012.  The initial terms of the credit facility provided that the credit facility may be automatically extended for successive periods of one year each unless one party shall have provided the other party with a written notice of termination at least ninety days prior to the expiration of the then current term.  Prior to the expiration of the initial term, and effective as of February 12, 2012, the term was extended until February 17, 2014 and the interest rate was reduced to the Wall Street Journal Prime rate (which is currently 3.25%) plus one percent (1%).  On May 10, 2013, the credit facility was extended until February 17, 2015.  

The credit facility contains covenants that place annual restrictions on the Company’s operations, including covenants relating to debt restrictions, capital expenditures, minimum deposit restrictions, tangible net worth, net profit, leverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, and restrictions on intercompany transactions.  The credit facility also requires that the Company maintain a minimum working capital at all times.  The Company was in compliance with all required financial covenants at April 30,July 31, 2015 and October 31, 2014. 

Our net sales are driven primarily by the success of our sales and marketing efforts and our ability to retain existing customers and attract new customers.  For this reason, we have made, and will continue to evaluate, strategic decisions to invest in measures that are expected to increase net sales. These transactions include our acquisitions of certain assets of Premier Roasters, LLC, which included equipment and a roasting facility in La Junta, Colorado, the engagement of a West Coast Brand Manager to market our S&W brand and to increase sales of S&W coffee to new customers, our joint venture with Caruso’s Coffee, Inc. of Brecksville, Ohio, the transaction with OPTCO and the addition of three sales persons from the Café Bustelo division of Folgers to assist with the expansion of our Café Caribe and Supremo brands. We believe these efforts will allow us to expand our business.

Our net sales are affected by the price of green coffee. We purchase our green coffee from dealers located primarily within the United States. The dealers supply us 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 our 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 we purchase coffee from a number of countries and are able to freely substitute one country’s coffee for another in our products, price fluctuations in one country generally have not had a material impact on the price we pay for coffee. Accordingly, price fluctuations in one country generally have not had a material effectcoffee or on our results of operations, liquidity and capital resources. Historically, because we generally have been able to pass green coffee price increases through to customers, increased prices of green coffee generally result in increased net sales.

We have used, and willintend to continue to use in a limited capacity, short-term coffee futures and options contracts primarily for the purpose of partially hedging and minimizing the effects of changing green coffee prices and to reduce our cost of sales. In addition, we acquire futures contracts with longer terms, generally three to four months, primarily for the purpose of guaranteeing an adequate supply of green coffee at favorable prices. Although the use of these derivative financial instruments has generally enabled us to mitigate the effect of changing prices, no strategy can entirely eliminate pricing risks and we generally remain exposed to loss when prices decline significantly in a short period of time. In addition, we would remain exposed to supply risk in the event of non-performance by the counterparties to any of our futures contracts. If the hedges that we enter into do not adequately offset the risks of coffee bean price volatility or our hedges result in losses, our cost of sales may increase, resulting in a decrease in profitability or increase of our losses. As previously announced, as a result of the volatile nature of the commodities markets, we have and are scalingcontinuing to scale back our use of hedging and short-term trading of coffee futures and options contracts.contracts, and intend to continue to use these practices in a limited capacity going forward.  See Item 3, Quantitative and Qualitative Disclosures About Market Risk.

As of April 30,July 31, 2015, we had working capital of $21,326,464,$21,591,502, which represented a $2,150,338$1,885,300 decrease from our working capital of $23,476,802 as of October 31, 2014, and total stockholders’ equity of $23,741,112,$23,880,274, which represented a decrease of $1,980,759$1,841,597 from our total stockholders’ equity of $25,721,871 as of October 31, 2014. Our working capital decreased primarily due to a decrease of $168,228$467,462 in cash, a decrease of $2,263,522$3,424,104 in accounts receivable, a decrease$2,765,836 in inventory and an  increase of $2,536,227$1,770,000 in our inventory, a decreaseline of $82,747credit, partially offset by increases of $547,756 in prepaid green coffee, $29,039 in prepaid expenses and other current assets, a decrease of $346,043 in prepaid green coffee, an  increase of $3,272,578 in our  line of credit, which was partially offset by an  increase of $1,387,393$1,433,818 in prepaid and refundable income taxes, an increase of $1,095,226$1,099,090 in deferred income tax asset, a decreasedecreases of $489,696 in due from broker, a decrease of $331,051 in income taxes payable and a decrease of $3,215,641$3,093,085 in accounts payable and accrued expenses.expenses, $8,263 in due to broker and $331,051 in income taxes payable.  At April 30,July 31, 2015, the outstanding balance on our line of credit was $5,771,036$4,268,458, compared to $2,498,458 at October 31, 2014. Total stockholders’ equity decreased due to a decrease in retained earnings as a result of our net loss.

For the sixnine months ended April 30,July 31, 2015, our operating activities used net cash of $3,019,469$1,806,268 as compared to the sixnine months ended April 30,July 31, 2014, whenduring which operating activities providedused net cash of $3,834,179.$1,805,450. The decreased cash flow from operations for the sixnine months ended April 30,July 31, 2015 was primarily due to our net loss of $1,960,357, an increase resulting in$1,821,605, deferred income taxes of $1,143,650, a  decrease resulting in accounts payable$1,149,500, prepaid and other current assets of $3,215,641 and an increase  resulting in$29,039, prepaid green coffee of $547,756, prepaid and refundable income taxes of $1,387,393 which was$1,433,818, accounts payable and accrued expenses of $3,093,085 and income taxes payable of $331,051, partially offset by a decrease in our inventories resulting in inventories of $2,536,227 and a decrease resulting in accounts receivable of $2,263,522.

For the sixnine months ended April 30,July 31, 2015, our investing activities used net cash of $341,337$351,194 as compared to the sixnine months ended April 30,July 31, 2014 when net cash used in investing activities was $166,851.$398,847. The increasedecrease in our uses of cash in investing activities was primarily due to increasedour decreased purchases of equipment.

For the sixnine months ended April 30,July 31, 2015, our financing activities provided net cash of $3,192,578$1,690,000 compared to net cash used inprovided by financing activities of $1,281,182$1,558,040 for the sixnine months April 30,ended July 31, 2014. The change in cash flow from financing activities for the sixnine months ended April 30,July 31, 2015 was primarily due to increasedfact that we did not purchase any treasury stock, partially offset by the increase in the payment of dividends of $28,000 and our reduced net borrowingborrowings from our credit facility.facility

On February 17, 2009, the Company entered into a financing agreement with Sterling National Bank (“Sterling”) for a $5,000,000 credit facility.  The credit facility is a revolving $5,000,000 line of credit and the Company can draw on the line at an amount up to 85% of eligible accounts receivable and 25% of eligible inventory consisting of green coffee beans and finished coffee not to exceed $1,000,000.  Sterling shall have the right from time to time to adjust the foregoing percentages based upon, among other things, dilution, its sole determination of the value or likelihood of collection of eligible accounts receivables owed to the Company, considerations regarding inventory.  The credit facility is payable monthly in arrears on the average unpaid balance of the line of credit at an interest rate equal to a per annum reference rate (3.25% and 3.75%) at April 30,July 31, 2015 and October 31, 2014, respectively.

 

On July 22, 2010, the credit facility was increased to $7,000,000.  In addition, OPTCO was added as a co-borrower and the inventory sublimit was raised from $1,000,000 to $2,000,000.  Subsequent to July 31, 2010, $1,800,000 of the credit facility was allocated to OPTCO.

On February 3, 2011, the Company amended their credit facility regarding the creation of a sublimit within the revolving line of credit in the form of a $300,000 term loan for the benefit of GCC.  The Company provided a corporate guarantee to Sterling in connection with the amendment.

The initial term of the credit facility was for three years and expired on February 17, 2012.  The initial terms of the credit facility provided that the credit facility may be automatically extended for successive periods of one year each unless one party shall have provided the other party with a written notice of termination at least ninety days prior to the expiration of the then current term.  Prior to the expiration of the initial term, and effective as of February 12, 2012, the term was extended until February 17, 2014 and the interest rate was reduced to the Wall Street Journal Prime rate (which is currently 3.25%) plus one percent (1%).  On May 10, 2013, the credit facility was extended until February 17, 2015.  

The credit facility contains covenants that place annual restrictions on the Company’s operations, including covenants relating to debt restrictions, capital expenditures, minimum deposit restrictions, tangible net worth, net profit, leverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, and restrictions on intercompany transactions.  The credit facility also requires that the Company maintain a minimum working capital at all times.  The Company was in compliance with all required financial covenants at April 30,July 31, 2015 and October 31, 2014.

  

As of April 30,July 31, 2015 and October 31, 2014, the outstanding balance under the bank line of credit was $4,534,036$3,031,458 and $2,498,458, respectively.

At April 30,July 31, 2015, the Company held 7075 options covering an aggregate of 2,812,500 pounds of green coffee beans at $1.791 per pound.  The fair market value of these options, which was obtained from observable market data of similar instruments was $127,575.  At July 31, 2015, the Company held 83 futures contracts (generally with terms of three to four months) for the purchase of 2,625,0003,112,500 pounds of green coffee at a weighted average price of $1.37$1.29 per pound.  The fair market value of coffee applicable to such contracts was $1.37$1.25 per pound at that date.  At October 31, 2014, the Company held 60 futures contracts for the purchase of 2,250,000 pounds of green coffee at a weighted average price of $2.00 per pound.  The fair market value of coffee applicable to such contracts was $1.88 per pound at that date.    The Company did not hold any options that were in the money at October 31, 2014.