News Column


January 24, 2014

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-K and management's expectations and projections about future events, including, among other things: ? our dependency on a single commodity could affect our revenues and profitability; ? our success in expanding our market presence in new geographic regions; ? the effectiveness of our hedging policy may impact our profitability; ? the success of our joint ventures; ? our success in implementing our business strategy or introducing new products; ? our ability to attract and retain customers; ? our ability to retain key personnel; ? our ability to obtain additional financing; ? our ability to comply with the restrictive covenants we are subject to under our current financing; ? the effects of competition from other coffee manufacturers and other beverage alternatives; ? the impact to the operations of our Colorado facility; ? general economic conditions and conditions which affect the market for coffee; ? the macro global economic environment; ? our ability to maintain and develop our brand recognition; ? the impact of rapid or persistent fluctuations in the price of coffee beans; ? fluctuations in the supply of coffee beans; ? the volatility of our common stock; and ? 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," "will," "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 annual 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 annual report. 19 -------------------------------------------------------------------------------- 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: ? the sale of wholesale specialty green coffee; ? the roasting, blending, packaging and sale of private label coffee; and ? the roasting, blending, packaging and sale of our seven brands of coffee. Our 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 our products; and ? 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 invest in measures that are expected to increase net sales. These transactions include our acquisitions of Premier Roasters, LLC , including equipment and a roasting facility in La Junta, Colorado , 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 Organic Products 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 or 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 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. We have used, and continue to use, 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 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. See "Item 1 - Business - Our Use of Derivatives." 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 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. 20 -------------------------------------------------------------------------------- We 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: ? We 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 our agreements with our 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. ? Our allowance for doubtful accounts is maintained to provide for losses arising from customers' inability to make required payments. If there is deterioration of our 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 our accounts receivable that becomes uncollectible, would decrease our operating income by approximately $124,000 for the year ended October 31, 2013 . 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 us from our customers. ? Inventories are stated at lower of cost (determined on a first-in, first-out basis) or market. Based on our assumptions about future demand and market conditions, inventories are subject to be written-down to market value. If our 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 writedown would have decreased operating income by approximately $94,000 for the year ended October 31, 2013 . ? In accordance with ASC 740 "Income Taxes" ("ASC 740"), management routinely evaluates the likelihood of the realization of its income tax benefits and the recognition of its deferred tax assets. In evaluating the need for any valuation allowance, management will assess whether it is more likely than not that some portion, or all, of the deferred tax asset may not be realized. Ultimately, the realization of deferred tax assets is dependent upon the generation of future taxable income during those periods in which temporary differences become deductible and/or tax credits and tax loss carry-forwards can be utilized. In performing its analyses, management considers both positive and negative evidence including historical financial performance, previous earnings patterns, future earnings forecasts, tax planning strategies, economic and business trends and the potential realization of net operating loss carry-forwards within a reasonable timeframe. To this end, management considered (i) that the Company had taxable income from 2011 through 2012 of approximately $6,700,000 million and anticipates generating a sufficient level of future profits in order to realize the benefits of its deferred tax asset; (ii) tax planning strategies; and (iii) the adequacy of future income to realize the benefits of its remaining recorded deferred tax assets. The Company believes that the continued growth of its business will produce positive operating results. Furthermore, the Company will be filing for a net operating loss carryback, which will immediately utilize approximately $2,500,000 of its net operating losses, which will have the effect of realizing approximately $866,000 (through its anticipated income tax refund) of its deferred tax assets. As of and for the year ended October 31, 2013 , management has not established any valuation allowance. ? A liability for "unrecognized tax benefits" is recorded for any tax benefits claimed in the Company's tax filings that do not meet these recognition and measurement standards. As of October 31, 2013 and October 31, 2012 , no liability for unrecognized tax benefits was required to be reported. The guidance also discusses the classification of related interest and penalties on income taxes. The Company's policy is to record interest and penalties on uncertain tax positions as a component of income tax expense. No interest or penalties were recorded during the years ended October 31, 2013 and October 31, 2012 . ? Our goodwill consists of the cost in excess of the fair market value of the acquired net assets of OPTCO, which has been integrated into a structure that does not provide the basis for separate reporting units. Consequently, we are a single reporting unit for goodwill impairment testing purposes. We also have intangible assets consisting of our customer list and relationships and trademarks acquired from OPTCO. At October 31, 2013 our balance sheet reflected goodwill and intangible assets as set forth below: October 31, 2013 Customer list and relationships, net $ 123,750 Trademarks 180,000 Goodwill 440,000 $ 743,750 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. We 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 the Company is a single reporting unit, the closing NASDAQ Capital Market price of our common stock 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. 21 -------------------------------------------------------------------------------- Year Ended October 31, 2013 (Fiscal Year 2013) Compared to the Year Ended October 31, 2012 (Fiscal Year 2012) Net Income (Loss). We had a net loss of $1,480,235 , or $0.23 per share basic and diluted, for the fiscal year ended October 31, 2013 compared to a net income of $2,485,677 , or $0.39 per share basic and $0.37 diluted for the fiscal year ended October 31, 2012 . The decrease in net income reflects the increased realized loss and decreased unrealized gains on hedging activities during the fiscal year. Net Sales. Net sales totaled $133,980,759 for the fiscal year ended October 31, 2013 , a decrease of $39,675,456 , or 22.8%, from $173,656,215 for the fiscal year ended October 31, 2012 . The decrease in net sales reflects an approximate 60% lower commodity price during the fiscal year which resulted in a decrease in the price per pound of coffee sold by us. Cost of Sales. Cost of sales for the fiscal year ended October 31, 2013 was $128,011,678 , or 95.5% of net sales, as compared to $161,649,282 , or 93.1%, of net sales for the fiscal year ended October 31, 2012 . 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 primarily reflects our lower green coffee prices offset by increased realized losses and decreased unrealized gains on hedging activities. Cost of sales includes purchases of approximately $31.2 million and $31.9 million in fiscal years 2013 and 2012, respectively, from a related party. Gross Profit. Gross profit for the fiscal year ended October 31, 2013 was $5,969,081 , a decrease of $6,037,852 from $12,006,933 for the fiscal year ended October 31, 2012 . Gross profit as a percentage of net sales decreased to 4.5% for the fiscal year ended October 31, 2013 from 6.9% for the fiscal year ended October 31, 2012 due to net realized hedging losses and unrealized hedging gains of $6,208,648 and $383,349 , respectively, during fiscal 2013 as compared to net realized and unrealized hedging losses and gains of $667,302 and $500,169 , respectively, during fiscal 2012. Operating Expenses. Total operating expenses decreased $85,359 , or 1.1%, to $7,521,910 for the fiscal year ended October 31, 2013 from $7,607,269 for the fiscal year ended October 31, 2012 . Selling and administrative expenses increased $39,620 , or 0.6%, to $6,939,819 for the year ended October 31, 2013 from $6,900,199 for the year ended October 31, 2012 . Officers' salary decreased $124,979 or 17.7% to $582,091 for the year ended October 31, 2013 from $707,070 for the year ended October 31, 2012 . Other Income (Expense). Other expense for the fiscal year ended October 31, 2013 was $168,821 , a decrease of $176,064 from $344,885 for the fiscal year ended October 31, 2012 . The decrease in other expense was attributable to an increase in interest and other income of $10,177 and a decrease in our loss from our equity investments of $62,288 , and a decrease in our loss from MF Global of $14,690 , and a decrease in interest expense of $88,909 . Income (Loss) Before Taxes and Non-controlling Interest in Subsidiary. We had a loss of $1,721,650 before income taxes and non-controlling interest in subsidiary for the fiscal year ended October 31, 2013 compared to income of $4,054,779 for the fiscal year ended October 31, 2012 resulting in a decrease of $5,776,429 for the year ended October 31, 2013 . The decrease was primarily attributable to our decreased realized trading gains. Income Taxes. Our (benefit) provision for income taxes for the fiscal year ended October 31, 2013 totaled $(393,767) compared to a provision of $1,470,381 for the fiscal year ended October 31, 2012 . The change was attributable to a lower total income. Liquidity and Capital Resources As of October 31, 2013 , we had working capital of $19,420,202 , which represented a $15,597 increase from our working capital of $19,404,605 as of October 31, 2012 , and total stockholders' equity of $21,750,065 which decreased by $1,867,614 from our total stockholders' equity of $23,617,679 as of October 31, 2012 . Our working capital increased primarily due to an increase of $289,290 in prepaid green coffee, $937,554 in prepaid and refundable income taxes, $628,011 in deferred income tax asset and a decrease in account payable and accrued expenses of $4,524,285 , and a decrease in due to broker of $383,349 , a decrease in income taxes payable of $21,122 , partially offset by a decrease of $3,532,914 in cash, $270,336 in accounts receivable, $1,930,563 in inventory, $367,519 in prepaid expenses and other current assets, and an increase of $666,682 in our line of credit. As of October 31, 2013 , the outstanding balance on our line of credit was $1,229,182 compared to $562,500 as of October 31, 2012 . Total stockholders' equity decreased primarily due to our net loss and our dividends paid for fiscal year ended October 31, 2013 . On February 17, 2009 , we 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 we 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 us 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 of 4.25% at October 31, 2013 and 2012. 22 -------------------------------------------------------------------------------- On July 22, 2010 , we had the credit facility 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. 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 is secured by all our tangible and intangible assets. The credit facility contains covenants that place annual restrictions on our 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 we maintain a minimum working capital at all times. We were in compliance with all required financial covenants at October 31, 2013 and 2012. On February 3, 2011 , we amended the 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. We provided a corporate guarantee to Sterling in connection with the amendment. For the fiscal year ended October 31, 2013 , our operating activities used net cash of $3,276,259 as compared to the fiscal year ended October 31, 2012 when operating activities provided net cash of $8,026,512 . The decreased cash flow from operations for the fiscal year ended October 31, 2013 was primarily due to decreases in net income of $3,912,281 , decreases in accounts receivable of $3,118,117 , prepaid green coffee of $528,044 , prepaid and refundable income taxes of $1,257,763 , deferred income taxes of $705,500 and increases in account payable of $2,921,578 , partially offset by increases in inventory of $261,789 , prepaid expenses and other current assets of $795,853 . For the fiscal year ended October 31, 2013 , our investing activities used net cash of $535,960 as compared to the fiscal year October 31, 2012 when net cash used by investing activities was $2,669,899 . The decrease in our uses of cash in investing activities was primarily due to our equity method investments of $2,100,000 . For the fiscal year ended October 31, 2013 , our financing activities provided net cash of $279,305 compared to net cash used in financing activities of $2,032,365 for the fiscal year ended October 31, 2012 . The change in cash flow from financing activities for the fiscal year ended October 31, 2013 was primarily due to our reduced borrowing and dividend payments. We expect to fund our operations, including paying our liabilities, funding capital expenditures and making required payments on our debts, through October 31, 2014 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. 23 --------------------------------------------------------------------------------

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