Coffee Holding Co Inc: Form 10-Q for the period ended Apr 30, 2024

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:

• 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 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;
• our expectations regarding, and the stability of, our supply chain, including potential shortages or interruptions in the supply or delivery of green 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,” “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:

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

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;

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• 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 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.

Recent Developments

On September 29, 2022, Coffee Holding Co., Inc, a Nevada corporation (“JVA”), entered into a Merger and Share Exchange Agreement (the “Merger Agreement”), by and among JVA, Delta Corp Holdings Limited, a Cayman Islands exempted company (“Pubco”), Delta Corp Holdings Limited, a company incorporated in England and Wales (“Delta”), CHC Merger Sub Inc., a Nevada corporation and wholly owned subsidiary of Pubco (“Merger Sub”), and each of the holders of ordinary shares of Delta as named therein (the “Sellers”). Upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into JVA, with JVA surviving as a direct, wholly-owned subsidiary of Pubco (the “Merger”). On June 29, 2023, JVA, Pubco, Delta, Merger Sub and the Sellers entered into Amendment 1 to the Merger Agreement (the “First Amendment”). On January 4, 2024, JVA, Pubco, Delta, Merger Sub and the Sellers entered into Amendment 2 to the Merger Agreement (the “Second Amendment”).

As a result of the Merger, each issued and outstanding share of JVA common stock, $0.001 par value per share (the “JVA Common Stock”), will be cancelled and converted for the right of the holder thereof to receive one ordinary share, par value $0.0001 of Pubco (the “Pubco Ordinary Shares”).

As a condition to the Merger, Pubco shall also acquire all of the issued and outstanding Delta securities from the Sellers in exchange for Pubco Ordinary Shares (the “Exchange” and, collectively with the Merger and the other transactions contemplated by the Merger Agreement, the “Transactions”). As a result of the Transactions, JVA and Delta will each become direct, wholly-owned subsidiaries of Pubco, with JVA stockholders receiving approximately $31.5 million (or 4.79%) worth of Pubco Ordinary Shares (the “Merger Consideration”) and Delta stockholders receiving approximately $625 million (or 95.21%) worth of Pubco Ordinary Shares (the “Exchange Consideration” and collectively with the Merger Consideration, the “Business Combination Consideration”), subject to certain adjustments, at an implied diluted value per share of $5.50. The Business Combination Consideration may be adjusted if Delta closes certain acquisitions prior to the closing of the Transactions. The Merger Agreement also includes an earn-out to existing stockholders of Delta, consisting of $50 million of additional Pubco Ordinary Shares, which will be released to Delta stockholders if and when Delta achieves $70 million or greater of net income for fiscal year ending 2023.

At the effective time of the Merger (the “Merger Effective Time”), each award of options to purchase JVA Common Stock (each, a “JVA Stock Option”) that is outstanding, whether vested or unvested, will be cancelled and substituted with option(s) to purchase Pubco Ordinary Shares to be granted under the Pubco equity plan (the “Substituted Options”). The Substituted Options will represent the right to purchase that number of shares of Pubco Ordinary Shares equal to the number of shares of JVA Common Stock underlying such JVA Stock Option immediately prior to the Merger Effective Time with a per-share exercise price of such Substituted Option equal to the exercise price per JVA Common Stock subject to such JVA Stock Option immediately prior to the Merger Effective Time.

Prior to execution of the Merger Agreement, JVA’s board of directors (the “Board”) unanimously (i) determined that the terms and provisions of the Merger Agreement and the transactions contemplated therein, including the Merger and Transactions, are fair, advisable to and in the best interests of JVA and its stockholders, (ii) approved the Merger Agreement and related Transactions, (iii) directed that the adoption of the Merger Agreement be submitted to a vote at a meeting of the stockholders of JVA, and (iv) resolved to recommend that JVA’s stockholders adopt the Merger Agreement.

JVA, Pubco, Delta and the Sellers have made customary representations and warranties in the Merger Agreement and have agreed to customary covenants regarding the operation of their respective businesses prior to the closing of the transactions contemplated thereby. Consummation of the Merger is subject to customary closing conditions, including, without limitation, (i) approval of the Merger Agreement and the transactions contemplated thereunder by a majority of JVA’s stockholders (the “JVA Stockholder Approval”), (ii) the absence of any law or order that prevents or prohibits the consummation of the Transaction, (iii) obtaining all requisite governmental authorizations, (iv) effectiveness of the Registration Statement of Pubco on Form F-4, and (v) approval of the listing of Pubco Ordinary Shares on the Nasdaq Capital Market.

From the date of the Merger Agreement until October 19, 2022 (the “Go-Shop Period”), JVA had the right to initiate, solicit, facilitate and encourage any inquiry or the making of any proposals or offers that would constitute an acquisition proposal involving more than fifteen percent (15%) of JVA’s assets or outstanding shares of common stock or in which the stockholders of JVA immediately preceding the contemplated transaction would hold less than eighty-five percent (85%) of the voting equity interest of the surviving company (each or any combination of the foregoing, a “Takeover Proposal”), including by way of providing access to non–public information to any third party pursuant to a non-disclosure agreement. Following the expiration of the Go-Shop Period, JVA ceased such activities and be subject to customary “no-shop” restrictions on its ability to solicit a Takeover Proposal from third parties and to provide non-public information to and engage in discussions with a third party in relation to a Takeover Proposal, except that JVA may continue to engage in the aforementioned activities with third parties from whom JVA has received a Takeover Proposal that the Board has determined constitutes or is reasonably likely to lead to a Superior Proposal (as defined below) and has determined that the failure to take such actions would be inconsistent with the Board’s fiduciary duties.

Prior to obtaining JVA Stockholder Approval, the Board may change its recommendation that stockholders vote to adopt the Merger Agreement (a “Change in Recommendation”) (i) in response to any material event or change in circumstances with respect to JVA that was not actually known or reasonably foreseeable by JVA prior to the date of the Merger Agreement (an “Intervening Event”) that the Board determines in good faith (after consultation with its financial advisor and outside legal counsel) that the failure to change its recommendation in such circumstances would be reasonably likely to violate its fiduciary duties to the stockholders of JVA under applicable law or (ii) if JVA has received a Takeover Proposal involving more than fifty percent (50%) of JVA’s assets or outstanding shares of common stock or in which the stockholders of JVA immediately preceding the contemplated transaction would hold less than fifty percent (50%) of the voting equity interest of the surviving company, that the Board determines in good faith (after consultation with its financial advisor and outside legal counsel) is reasonably likely to be consummated in accordance with its terms and, among other things, if consummated, would be more favorable from a financial point of view to JVA’s stockholders than the Transactions (a “Superior Proposal”) (in which case JVA may also terminate the Merger Agreement to enter into such Superior Proposal, subject to certain conditions including payment of the JVA Termination Fee, as described below).

Before the Board may change its recommendation in connection with an Intervening Event or a Superior Proposal, or terminate the Merger Agreement to accept a Superior Proposal, JVA must provide Delta prompt written notice of its decision to make a Change in Recommendation and for at least five (5) business days after such notice, JVA will negotiate with Delta to enable Delta to revise the terms of the Merger Agreement so that the Takeover Proposal no longer constitutes a Superior Proposal. Each time modifications to any material term of such alternative acquisition proposal determined to be a Superior Proposal are made, JVA must notify Pubco of such modification and such five (5) business day period will recommence.

The Merger Agreement may be terminated by each of Delta and of JVA under certain circumstances, including, among others by either Delta or JVA if the Merger has not been consummated by April 1, 2024 (the “Outside Date”). If the Merger Agreement is terminated under certain circumstances, including, among others, as a result of breach by either JVA or Delta of their respective representations, warranties or covenants in the Merger Agreement, whereby JVA or Delta, respectively, may be entitled to a termination fee in the amount of $750,000 plus disbursements of all documented, out-of-pocket expenses up to $250,000. In addition, if JVA terminates the Merger Agreement to accept a Takeover Proposal or the Board (i) adversely changes its recommendation to the stockholders of JVA regarding the adoption of the Merger Agreement or (ii) supports the approval of any JVA Takeover Proposal, then Delta shall be entitled to a termination fee of $1.3 million and plus a disbursement of reasonable expenses up to $2 million (the “JVA Termination Fee”).

The equityholders of Delta and JVA will have certain customary registration rights with respect to the Pubco Ordinary Shares to be received in the transaction pursuant to the terms of a registration rights agreement, dated September 29, 2022 (the “Registration Rights Agreement”).

On September 29, 2022, concurrently with the entry into the Merger Agreement, Delta, Pubco and JVA entered into Voting and Support Agreements (the “JVA Voting Agreement”) with Andrew Gordon, President and Chief Executive Officer of JVA, and David Gordon, Executive Vice President and Chief Operating Officer of JVA, pursuant to which Messrs. Gordon have agreed to vote in favor of adopting the Merger Agreement and the related transactions as contemplated thereunder. JVA Voting Agreements will terminate upon the earliest to occur of (i) the mutual written consent of each of Delta, Pubco, JVA and Messrs. Gordon, (ii) the Merger Effective Time, and (iii) the date of termination of the Merger Agreement in accordance with its terms. There was a shareholder vote in April 2024 on the Merger Agreement that did not pass. An additional vote is expected to occur before the end of fiscal 2024.

Critical Accounting Estimates

There have been no changes to our critical accounting policies during the three and six months ended April 30, 2024. 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 February 9, 2024 for the fiscal year ended October 31, 2023.

Three Months Ended April 30, 2024 Compared to the Three Months Ended April 30, 2023

Net Sales. Net sales totaled $18,995,913 for the three months ended April 30, 2024, an increase of $3,675,210, or 24%, from $15,320,703 for the three months ended April 30, 2023. The increase in net sales was due to increased sales to new private label customers.

Cost of Sales. Cost of sales for the three months ended April 30, 2024 was $15,291,933, or 80.5% of net sales, as compared to $12,488,522, or 81.5% of net sales, for the three months ended April 30, 2023, an increase of $2,803,411. Cost of sales consists primarily of the cost of green coffee and packaging materials and realized and unrealized gains or losses on hedging activity. This increase was due to higher green coffee costs during the period.

Gross Profit. Gross profit for the three months ended April 30, 2024 amounted to $3,703,980 or 19.5% of net sales, as compared to $2,832,181 or 18.5% of net sales, for the three months ended April 30, 2023. The increase in gross profits on a percentage and dollar basis was attributable to the factors listed above.

Operating Expenses. Total operating expenses increased by $553,995 to $3,770,630 for the three months ended April 30, 2024 from $3,216,635 for the three months ended April 30, 2023. Selling and administrative expenses increased by $557,831 and officers’ salaries decreased by $3,836. The increase in selling and administrative expenses was due to higher payroll costs, professional fees, and insurance expense, partially offset by decreases in medical expenses. automobile costs, and advertising costs.

Other Income (Expense). Other expense for the three months ended April 30, 2024 was $32,823, a decrease of $90,563 from $123,386 for the three months ended April 30, 2023. The decrease in other expense was attributable to a decrease in interest expense of $45,853, and an increase in our interest income of $34,400, partially offset by an increase in our loss from our equity investments of $10,310 during the three months ended April 30, 2024.

Income Taxes. Our benefit for income taxes for the three months ended April 30, 2024 totaled $77,632 compared to a benefit of $148,000 for the three months ended April 30, 2023. The change was primarily attributable to the difference in the loss for the quarter ended April 30, 2024 versus the loss in the quarter ended April 30, 2023.

Net (Loss) Income. We had a net loss of $21,841 or $— per share basic and diluted, for the three months ended April 30, 2024 compared to a net loss of $359,840, or $0.06 per share basic and diluted for the three months ended April 30, 2023.

Six Months Ended April 30, 2024 Compared to the Six Months Ended April 30, 2023

Net Sales. Net sales totaled $38,536,315 for the six months ended April 30, 2024, an increase of $4,889,497, or 15%, from $33,646,818 for the six months ended April 30, 2023. The increase in net sales was due to increased sales to new private label customers..

Cost of Sales. Cost of sales for the six months ended April 30, 2024 was $31,352,036, or 81.4% of net sales, as compared to $28,494,333, or 84.7% of net sales, for the six months ended April 30, 2023. Cost of sales consists primarily of the cost of green coffee and packaging materials and realized and unrealized gains or losses on hedging activity. This increase was due to higher green coffee costs during the period.

Gross Profit. Gross profit for the six months ended April 30, 2024 amounted to $7,184,279 or 18.6% of net sales, as compared to $5,152,485 or 15.3% of net sales, for the six months ended April 30, 2023. The increase in gross profits on a percentage basis was attributable to the factors listed above.

Operating Expenses. Total operating expenses increased by $296,055 to $6,634,018 for the six months ended April 30, 2024 from $6,337,963 for the six months ended April 30, 2023. Selling and administrative expenses increased by $306,437 and officers’ salaries decreased by $10,382. Operating expenses increased due to higher payroll costs, professional fees, and insurance expense, partially offset by decreases in medical expenses. automobile costs, and advertising costs. for the six months ended April 30, 2024 compared to the six months ended April 30, 2023.

Other Income (Expense). Other expense for the six months ended April 30, 2024 was $156,373, an increase of $134,658 from $21,715 for the six months ended April 30, 2023. The increase was attributable to a decrease in other income of $234,041 due to an insurance claim, partially offset by a decrease in our interest expense of $58,780 and an increase in our interest income of $31,300, during the six months ended April 30, 2023.

Income Taxes. Our expense for income taxes for the six months ended April 30, 2024 totaled $64,705 compared to a benefit of $315,250 for the six months ended April 30, 2023. The change was primarily attributable to the difference in the income for the six months ended April 30, 2024 versus the loss in the six months ended April 30, 2023.

Net (Loss) Income. We had net income of $329,183 or $0.06 per share basic and diluted, for the six months ended April 30, 2024 compared to a net loss of $891,943, or $0.16 per share basic and diluted for the six months ended April 30, 2023. The increase in net income was due primarily to the reasons described above.

Liquidity, Capital Resources and Going Concern

As of April 30, 2024, we had working capital of $18,723,150, which represented a $122,888 increase from our working capital of $18,600,262 as of October 31, 2023. Our working capital increased primarily due to the decrease of the outstanding balance on our line of credit to $3,000,000 from $9,620,000 as of April 30, 2024 and October 31, 2023, respectively, along with a decrease of $982,781 in accounts payable and accrued expenses, and a $572,725 increase in due from broker. This is offset by a $306,288 decrease in cash and cash equivalents, a $589,995 decrease in accounts receivable, a $3,474,176 decrease in inventories, a $76,151 decrease in prepaid expenses and other current assets, a $102,023 increase in due to broker and a $371,584 increase in lease liability – current portion.

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 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.

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. As further explained in Note 5 to the unaudited financial statements, we are required to maintain certain financial covenants with respect to our line of credit agreement. We were not in compliance with these requirements as of October 31, 2023. We have since received a waiver from the lender on May 24, 2024 and are in compliance with all requirements.

The current balance outstanding as of April 30, 2024 under the A&R Loan Agreement is $3.0 million. We are seeking to extend the term of the line of credit agreement and are currently in discussions with the lender. However, until such time as the line of credit is renewed, there is substantial doubt regarding our ability to continue as a going concern and the ability to meet our obligations as they become due within the twelve months from the date the consolidated financial statements are issued.

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 $3,000,000 and $9,620,000 as of April 30, 2024 and October 31, 2023, respectively.

For the six months ended April 30, 2024, our operating activities provided net cash of $3,390,694 as compared to the six months ended April 30, 2023 when operating activities used net cash of $1,234,180. The increase in cash flow from operations was partially due to net income of $329,183 for the six months ended April 30, 2024, compared to a net loss of $891,943 for the six months ended April 30, 2023. Non-cash charges, including depreciation and amortization, unrealized gain on commodities, loss on equity method investments, amortization of ROU assets, and deferred income taxes, resulted in cash provided of $46,835 for the six months ended April 30, 2024 and cash used of $798,995 for the six months ended April 30, 2023. The aggregate of accounts receivable, inventories, prepaid expenses and other current assets, and prepaid and refundable income taxes provided $4,194,892 and $4,791,092 in operating cash flow for the six months ended April 30, 2024 and 2023, respectively. The aggregate of lease liability, deposits and other assets, and accounts payable and accrued expenses used $1,089,577 and $1,865,974 of operating cash flow for the six months ended April 30, 2024 and 2023, respectively.

For the six months ended April 30, 2024, our investing activities used net cash of $2,925,927 as compared to the six months ended April 30, 2023 when net cash used by investing activities was $609,131. The decrease in our use of cash in investing activities was due to our decreased purchases of machinery and equipment during the six months ended April 30, 2024.

For the six months ended April 30, 2024, our financing activities used net cash of $6,622,909 compared to net cash used by financing activities of $1,672,910 for the six months ended April 30, 2023. The change in cash flow from financing activities for the six months ended April 30, 2024 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.

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, quantities of inventory at one of our subsidiaries and inaccurately accounted for certain intercompany eliminations in our consolidated statements of operations. 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. Accordingly, management determined that the foregoing were control deficiencies that constituted material weaknesses.

Further, during the year ended October 31, 2022, we concluded that we lacked adequate controls with respect to the preparation and review of journal entries and account reconciliations during the year-end financial statement closing process. Accordingly, management has determined that this control deficiency constituted a material weakness.

Further, during the year ended October 31, 2023, we concluded that we lacked adequate controls with respect to recording year end accruals for vendor liabilities and properly calculating required loan covenants. 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, 2023, 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:

• 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;
• developing and maintaining documentation to promote knowledge transfer upon personnel and function changes;
• developing enhanced controls and reviews related to our financial reporting systems;
• 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.
• cross referencing analysis to be completed on a quarterly basis; and
• 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.

Management will seek to remediate such deficiencies over the coming quarters.

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, 2023, 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 April 30, 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our operations and financial results are subject to various risks and uncertainties, including those described in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended October 31, 2023 filed with the Securities and Exchange Commission on February 9, 2024. There have been no material changes to our risk factors since the Company’s Annual Report on Form 10-K for the year ended October 31, 2023.