Weak Brew From Coffee Holding

Maybe McDonald's (NYSE:MCD) should consider itself lucky. A few years ago, a customer who spilled hot coffee on herself cost the restaurant chain $3 million in a lawsuit. But as bad as that was, it pales in comparison with the $21 million loss that investors in Coffee Holding (AMEX:JVA) suffered last Thursday.

Coffee Holding, which has no analysts following it and so no expectations that it needed to live up to when it released earnings last week, still managed to shock investors with its third-quarter earnings numbers. Ordinarily, you'd expect to see dancing in the streets when a company posts 69% revenue growth, as Coffee Holding did. Then again, ordinarily, you'd expect that level of revenue growth to be accompanied by profits of some sort, too. But profits are precisely what Coffee Holding lacked. Although the company still remains profitable year-to-date, with $0.12 per share in diluted earnings, its losses for the quarter increased by 257% year over year. Based on that news, the stock plunged 30% in the hours following the earnings release.

It's not just that losses ballooned. As CEO Andrew Gordon pointed out, the third quarter is always Coffee Holding's weakest. Nor is it just that margins have been under pressure all year, with gross margins year-to-date falling 670 basis points from last year's 25.2%.

My real worry about Coffee Holding is that free cash flow seems to be trending downward fast, belying the story told by the company's basic GAAP numbers. Last year, Coffee Holding saw net free cash outflows of $193,000 in its first three quarters, calling the validity of last year's profits numbers into question, too. This year, the situation deteriorated markedly, with net free cash outflows topping the million-dollar threshold. As shown on the company's Form 10-QSB, filed with the Securities and Exchange Commission on the day of the earnings release, Coffee Holding spent $4.1 million more of its free cash flow than it took in over the past nine months. That's not at all the kind of trend that investors like to see.

And as for the company burying its bad news in the SEC filing, and failing to detail it in a cash flow statement attached to its earnings release? Well, you already know how we feel about that.

After the stock's 30% drop, investors did return for another sip the next morning, to lift Coffee Holding's shares by 6% But I suspect that those investors would have been better served by just buying a fresh cup of some other company's shares -- because this coffee's gone cold.

Fool contributor Rich Smith has no position in either of the companies mentioned above.