ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary
Note on Forward-Looking Statements
Some
of the matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation,”
“Business,” “Risk Factors” and elsewhere in this annual report include forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements
upon information available to management as of the date of this Form 10-Q and management’s expectations and projections about future
events, including, among other things:
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our
dependency on a single commodity could affect our revenues and profitability; |
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our
success in expanding our market presence in new geographic regions; |
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the
effectiveness of our hedging policy may impact our profitability; |
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the
success of our joint ventures; |
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our
success in implementing our business strategy or introducing new products; |
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our
ability to attract and retain customers; |
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our
ability to obtain additional financing; |
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our
ability to comply with the restrictive covenants we are subject to under our current financing; |
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the
effects of competition from other coffee manufacturers and other beverage alternatives; |
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the
impact to the operations of our Colorado facility; |
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general
economic conditions and conditions which affect the market for coffee; |
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the
potential adverse impact of the COVID-19 pandemic on our operations and results; |
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our
expectations regarding, and the stability of, our supply chain, including potential shortages or interruptions in the supply or delivery
of green coffee; |
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the
macro global economic environment; |
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our
ability to maintain and develop our brand recognition; |
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the
impact of rapid or persistent fluctuations in the price of coffee beans; |
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fluctuations
in the supply of coffee beans; |
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the
volatility of our common stock; and |
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other
risks which we identify in future filings with the Securities and Exchange Commission (the “SEC”). |
In
some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “could,”
“predict,” “potential,” “continue,” “expect,” “anticipate,” “future,”
“intend,” “plan,” “believe,” “estimate” and similar expressions (or the negative of such
expressions). Any or all of our forward looking statements in this quarterly report and in any other public statements we make may turn
out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently,
no forward-looking statement can be guaranteed. In addition we undertake no responsibility to update any forward-looking statement to
reflect events or circumstances that occur after the date of this quarterly report.
Overview
We
are 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, we believe that we are well-positioned
to increase our profitability and endure potential coffee price volatility throughout varying cycles of the coffee market and economic
conditions.
Our
operations have primarily focused on the following areas of the coffee industry:
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the
sale of wholesale specialty green coffee; |
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the
roasting, blending, packaging and sale of private label coffee; |
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the
roasting, blending, packaging and sale of our eight brands of coffee; and |
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sales
of our tabletop coffee roasting equipment. |
Our
operating results are affected by a number of factors including:
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the
level of marketing and pricing competition from existing or new competitors in the coffee industry; |
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our
ability to retain existing customers and attract new customers; |
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our
hedging policy; |
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fluctuations
in purchase prices and supply of green coffee and in the selling prices of our products; and |
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our
ability to manage inventory and fulfillment operations and maintain gross margins. |
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 acquire and invest in measures that
are expected to increase net sales.
Our
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
effect 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, irrespective of
sales volume.
The
supply and price of coffee beans are subject to volatility and are influenced by numerous factors which are beyond our control. Historically,
we have 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, we 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 our cost of sales. Gains on options
and futures contracts reduce our cost of sales and losses on options and futures contracts increase our cost of sales. The use of these
derivative financial instruments has generally enabled us to mitigate the effect of changing prices. We believe that, in normal economic
times, our hedging policies remain a vital element to our business model not only in controlling our cost of sales, but also giving us
the flexibility to obtain the inventory necessary to continue to grow our sales while trying to minimize margin compression during a
time of historically high coffee prices.
However,
no strategy can entirely eliminate pricing risks and we generally remain exposed to losses on futures contracts when prices decline significantly
in a short period of time, and we would generally remain exposed to supply risk in the event of non-performance by the counterparties
to any of our futures contracts. Although we have had net gains on options and futures contracts in the past, we have incurred significant
losses on options and futures contracts during some recent reporting periods. In these cases, our cost of sales has increased, resulting
in a decrease in our profitability or increase our losses. Such losses have and could in the future materially increase our cost of sales
and materially decrease our profitability and adversely affect our stock price. If our hedging policy is not effective, we may not be
able to control our coffee costs, we may be forced to pay greater than market value for green coffee and our profitability may be reduced.
Failure to properly design and implement an effective hedging strategy may materially adversely affect our business and operating results.
If the hedges that we enter 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 increased losses. As previously announced, as a result of the volatile
nature of the commodities markets, we have and are continuing to scale back our 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
There
have been no changes to our critical accounting policies during the three and six months ended April 30, 2023. Critical accounting policies
and the significant estimates in accordance with such policies are regularly discussed with our Audit Committee. Those policies are discussed
under “Critical Accounting Policies” in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations” as well as in our consolidated financial statements and footnotes thereto, each included in our annual
report on Form 10-K filed with the SEC on March 29, 2023 for the fiscal year ended October 31, 2022.
Three
Months Ended April 30, 2023 Compared to the Three Months Ended April 30, 2022
Net
Sales. Net sales totaled $15,320,703 for the three months ended April 30, 2023, a decrease of $1,177,466, or 7.1%, from $16,498,169
for the three months ended April 30, 2022. The decrease in net sales was due to an increase of sales to our legacy customers partially
offset by a decrease in sales from our Generations/Steep N Brew subsidiary.
Cost
of Sales. Cost of sales for the three months ended April 30, 2023 was $12,488,522, or 81.5% of net sales, as compared to $14,505,415,
or 87.9% of net sales, for the three months April 30, 2022. Cost of sales consists primarily of the cost of green coffee and packaging
materials and realized and unrealized gains or losses on hedging activity. The decrease in cost of sales was due to our decreased sales.
Gross
Profit. Gross profit for the three months ended April 30, 2023 amounted to $2,832,181 or 18.5% of net sales, as compared to $1,992,754
or 12.1% of net sales, for the three months ended April 30, 2022. The increase in gross profits on a percentage basis was attributable
to the factors listed above.
Operating
Expenses. Total operating expenses decreased by $149,588 to $3,216,635 for the three months ended April 30, 2023 from $3,366,223
for the three months ended April 30, 2022. Selling and administrative expenses decreased by $143,338 and officers’ salaries decreased
by $6,250.
Other
Income (Expense). Other expense for the three months ended April 30, 2023 was $123,386, an increase of $72,184 from $51,202 for
the three months ended April 30, 2022. The increase in other expense was attributable to an increase in interest expense of $69,423,
an increase in our loss from our equity investments of $211 and a decrease in our interest income of $2,550, during the three months
ended April 30, 2023.
Income
Taxes. Our benefit for income taxes for the three months ended April 30, 2023 totaled $148,000 compared to a benefit of $385,681
for the three months ended April 30, 2022. The change was primarily attributable to the difference in the loss for the quarter ended
April 30, 2023 versus the income in the quarter ended April 30, 2022.
Net
(Loss) Income. We had a net loss of $359,840 or $(0.06) per share basic and diluted, for the three months ended April 30, 2023
compared to a net loss of $368,096, or $(0.06) per share basic and diluted for the three months ended April 30, 2022.
Six
Months Ended April 30, 2023 Compared to the Six Months Ended April 30, 2022
Net
Sales. Net sales totaled $33,646,818 for the six months ended April 30, 2023, an increase of $443,789, or 1.3%, from $33,203,029
for the six months ended April 30, 2022. The increase in net sales was due to an increase of sales to our legacy customers partially
offset by a decrease in sales from our Generations/Steep N Brew subsidiary.
Cost
of Sales. Cost of sales for the six months ended April 30, 2023 was $28,494,333, or 84.7% of net sales, as compared to $26,938,669,
or 81.1% of net sales, for the six months April 30, 2022. Cost of sales consists primarily of the cost of green coffee and packaging
materials and realized and unrealized gains or losses on hedging activity. The increase in cost of sales was due to our increased sales
and the higher costs of packaging.
Gross
Profit. Gross profit for the six months ended April 30, 2023 amounted to $5,152,485 or 15.3% of net sales, as compared to $6,264,360
or 18.9% of net sales, for the six months ended April 30, 2022. The decrease in gross profits on a percentage basis was attributable
to the factors listed above.
Operating
Expenses. Total operating expenses decreased by $749,136 to $6,337,963 for the six months ended April 30, 2023 from $7,087,099
for the six months ended April 30, 2022. Selling and administrative expenses decreased by $771,636 and officers’ salaries increased
by $22,500. Operating expenses decreased primarily due to our Generations joint venture not generating expenses for the six months ended
April 2023 compared to the six months ended April 30, 2022, partially offset by increase in various other categories.
Other
Income (Expense). Other expense for the six months ended April 30, 2023 was $21,715, a decrease of $100,285 from $122,000 for
the six months ended April 30, 2022. The decrease was attributable to an increase in other income of $234,041 due to an insurance claim,
a decrease in our loss from our equity investments of $26,498, partially offset by an increase in our interest expense of $159,273 and
a decrease in our interest income of $981, during the six months ended April 30, 2023.
Income
Taxes. Our benefit for income taxes for the six months ended April 30, 2023 totaled $315,250 compared to a benefit of $248,275
for the six months ended April 30, 2022. The change was primarily attributable to the difference in the income for the six months ended
April 30, 2023 versus the income in the six months ended April 30, 2022.
Net
(Loss) Income. We had a net loss of $891,433 or ($0.16) per share basic and diluted, for the six months ended April 30, 2023
compared to a net loss of $87,233, or ($0.02) per share basic and diluted for the six months ended April 30, 2022. The decrease in net
income was due primarily to the reasons described above.
Liquidity
and Capital Resources
As
of April 30, 2023, we had working capital of $23,049,651, which represented a $2,212,573 decrease from our working capital of $25,262,224
as of October 31, 2022. Our working capital decreased primarily due to decreases of $1,047,861 in cash and cash equivalents, $1,212,055
in accounts receivable, $3,428,917 in inventories, $45,696 in due from broker and $150,120 in prepaid expenses and other current assets,
partially offset by decreases of $1,730,244 in accounts payable and accrued expenses, $876,148 in cash overdrafts, $982,172 in due to
broker and $83,512 in lease liability – current portion. As of April 30, 2023, the outstanding balance on our line of credit was
$7,520,000 compared to $8,314,000 as of October 31, 2022.
On
April 25, 2017 the Company and OPTCO (together with the Company, collectively referred to herein as the “Borrowers”) entered
into an Amended and Restated Loan and Security Agreement (the “A&R Loan Agreement”) and Amended and Restated Loan Facility
(the “A&R Loan Facility”) with Sterling National Bank (“Sterling”), which was later acquired by Webster Financial
Corp. (“Webster”), which consolidated (i) the financing agreement between the Company and Sterling, dated February 17, 2009,
as modified, (the “Company Financing Agreement”) and (ii) the financing agreement between Company, as guarantor, OPTCO and
Sterling, dated March 10, 2015 (the “OPTCO Financing Agreement”), amongst other things.
On
March 17, 2022, we reached an agreement for a new loan modification agreement and credit facility which extended the maturity date to
June 29, 2022. All other terms of the A&R Loan Agreement and A&R Loan Facility remained the same.
On
June 28, 2022, we reached an agreement for a new loan modification agreement and credit facility with Webster. The terms of the new agreement,
among other things: (i) provided for a new maturity date of June 30, 2024, and (ii) changed the interest rate per annum to SOFR plus
1.75% (with such interest rate not to be lower than 3.50%). All other terms of the A&R Loan Agreement and A&R Loan Facility remained
the same.
As
further explained in Note 5 to the unaudited financial statements, the Company is subject to certain covenants with respect to its line
of credit agreement. We were not in compliance with the net profit and non-borrower affiliate covenants as of October 31, 2022. We requested
a waiver from the lender and the waiver was granted and received on March 15, 2023. The lender also extended the due date of the October
31, 2022 financial statements until April 15, 2023. On March 15, 2023, the A&R Loan Agreement was also modified to, among other things:
(i) provide for a requirement for subordination agreements if necessary, (ii) change the terms of transactions with affiliates from a
dollar limitation to allowable in the ordinary course of business, and (iii) establish a new covenant for a fixed charge coverage ratio.
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 outstanding balance on our lines of credit were $7,520,000 and
$8,314,000 as of April 30, 2023 and October 31, 2022, respectively.
For
the six months ended April 30, 2023, our operating activities provided net cash of $1,234,180 as compared to the six months ended April
30, 2022 when operating activities used net cash of $1,496,738. The increased cash flow from operations for the six months ended April
30, 2023 was primarily due to our inventory position.
For
the six months ended April 30, 2023, our investing activities used net cash of $609,131 as compared to the six months ended April 30,
2022 when net cash used by investing activities was $871,919. The decrease in our uses of cash in investing activities was due to our
decreased purchases of machinery and equipment during the six months ended April 30, 2023.
For
the six months ended April 30, 2023, our financing activities used net cash of $1,672,910 compared to net cash provided by financing
activities of $1,697,519 for the six months ended April 30, 2022. The change in cash flow from financing activities for the six months
ended April 30, 2023 was due to our credit line activity.
We
expect to fund our operations, including paying our liabilities, funding capital expenditures and making required payments on our indebtedness,
through at least the next twelve months from the date these consolidated financial statements are issued, with cash provided by operating
activities and the use of our credit facility. In addition, an increase in eligible accounts receivable and inventory would permit us
to make additional borrowings under our line of credit.
Off-Balance
Sheet Arrangements
We
do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources
that is material to investors.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
Management,
which includes our President, Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”)) as of the end of the period covered by this report. Based upon that evaluation, our President, Chief Executive Officer and
Chief Financial Officer concluded that the disclosure controls and procedures were not effective due to the existence of material weaknesses
in our internal controls over financial reporting.
Material
Weakness Over Financial Reporting
During
the year ended October 31, 2020, our controls were inadequate to prevent and detect misstatements of stock-based compensation awards
and quantities of inventory at one of our subsidiaries. Accordingly, management determined that this control deficiency constituted a
material weakness.
During
the year ended October 31, 2021, we identified inappropriate system access controls over our financial reporting system. These controls
were not designed to prevent or detect unauthorized changes to source information, or implement an appropriate level of segregation of
duties. During this same period, we determined that we lacked adequate controls with respect to identifying and accounting for material
contracts. This was evidenced by our failure to properly identify and account for a material lease amendment.
Further,
during the year ended October 31, 2021, we determined that we lacked adequate controls with respect to physical custody of certain
hardware, electronic and hard copy records of Generations Coffee and its component operation known as Steep n’ Brew following
the Company’s relocation or vacating of certain premises used in the operations of that business unit. Accordingly, management
determined that the foregoing were control deficiencies that constituted material weaknesses.
Additionally,
on January 24, 2023, we concluded, after discussion with management, that our financial statements inaccurately accounted for certain
intercompany eliminations in our consolidated statements of operations for the fiscal year ended October 31, 2020. As a result, we determined
that there was an overstatement of net sales and cost of sales in the consolidated statement of operations of approximately $8.3 million
in our financial statements during the fiscal year ended October 31, 2020 which required a restatement of the previously issued financial
statements for the fiscal year ended October 31, 2020. This was due to inadequate design and implementation of controls to evaluate and
monitor the presentation and compliance with accounting principles generally accepted in the United States of America related to the
statement of operations. Accordingly, management has determined that this control deficiency constituted a material weakness.
Notwithstanding
such material weaknesses, we believe the financial information presented herein is materially correct and fairly presents the financial
position and operating results of the three and six months ended April 30, 2023 in conformity with U.S. generally accepted accounting
principles for interim financial information and in accordance with the rules and regulations of the SEC.
Remediation
Plan for the Material Weaknesses
As
previously disclosed in Item 9A of our Annual Report on Form 10-K for the fiscal year ended October 31, 2022, management has identified
material weaknesses as of that date. A “material weakness” is a deficiency, or combination of deficiencies, in internal control
over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim
financial statements will not be prevented or detected on a timely basis. To remediate the material weaknesses identified above, we are
initiating controls and procedures in order to:
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educating
control owners concerning the principles and requirements of each control, with a focus on those related to user access to our financial
reporting systems impacting financial reporting; |
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developing
and maintaining documentation to promote knowledge transfer upon personnel and function changes; |
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developing
enhanced controls and reviews related to our financial reporting systems; |
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performing
an in-depth analysis of who should have access to perform key functions within our financial reporting system that impact financial
reporting and redesigning aspects of the system to better allow the access rights to be implemented. |
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cross
referencing analysis to be completed on a quarterly basis; and |
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implementing
additional levels of internal review of financial statements and any adjustments made thereto. |
The
material weaknesses identified above will not be considered remediated until our remediation efforts have been fully implemented and
we have concluded that these controls are operating effectively.
Management
does not expect that our internal control over financial reporting will prevent or detect all errors and all fraud. A control system,
no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems
are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls
must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of
internal control over financial reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that
all control issues and instances of fraud, if any, have been or will be detected.
Changes
in Internal Control over Financial Reporting
Other
than the changes intended to remediate the material weakness as discussed above and in Part II, Item 9A of our Annual Report on Form
10-K for the year ended October 31, 2022, there was no change in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) during the fiscal quarter ended January 31, 2023 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.