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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
(Mark One)
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended July 31, 2011
OR
 
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ­­­­­_____ to _________

Commission File Number: 000-31797

CRYSTAL ROCK HOLDINGS, INC.
(Exact name of registrant as specified in Its charter)
 
 
Delaware  03-0366218 
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
1050 Buckingham St., Watertown, CT
(Address of principal executive offices)
06795
(Zip Code)
 
(860) 945-0661
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes   X                                                      No ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
Yes    X                                                      No ___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ____                                                                                     Accelerated filer ___
Non-accelerated filer ___                                                                           Smaller reporting company   X_
(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ___                                                      No   X_

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 
 
Class
Shares outstanding at
September 7, 2011
Common Stock, $.001 Par Value  21,388,681 
 
 
 

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY

Table of Contents
    Page 
PART I - FINANCIAL INFORMATION
 
 
    Item 1.              
 
Financial Statements. 
 
 
 
Condensed Consolidated Balance Sheets as of July 31, 2011 and October 31, 2010
 
3 
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2011 and 2010
 
4 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2011 and 2010
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
    Item 2. 
 
Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
 
    Item 3. 
 
Quantitative and Qualitative Disclosures About Market Risk.
 
 
    Item 4. 
 
Controls and Procedures. 
 
 
PART II - OTHER INFORMATION 
 
 
    Item 1. 
 
Legal Proceedings. 
 
27 
 
    Item 1A. 
 
Risk Factors. 
 
27 
 
    Item 2. 
 
Unregistered Sales of Equity Securities and Use of Proceeds.
 
27 
 
    Item 3.
 
Defaults Upon Senior Securities. 
 
27 
 
    Item 4. 
 
[Reserved.] 
 
 
    Item 5. 
 
Other Information. 
 
27 
 
    Item 6. 
 
Exhibits. 
 
 
SIGNATURE                    
  29 
 
 
2

 
 
 
             
CONDENSED CONSOLIDATED BALANCE SHEETS
 
             
   
July 31,
   
October 31,
 
   
2011
   
2010
 
   
(Unaudited)
       
             
ASSETS
 
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 3,971,025     $ 4,892,379  
Accounts receivable - net
    8,390,145       7,448,044  
Inventories - net
    2,664,623       2,448,500  
Current portion of deferred tax asset
    804,362       804,362  
Other current assets
    1,167,246       757,964  
                 
TOTAL CURRENT ASSETS
    16,997,401       16,351,249  
                 
PROPERTY AND EQUIPMENT - net
    8,450,083       9,111,114  
                 
OTHER ASSETS:
               
Goodwill
    32,123,294       32,123,294  
Other intangible assets - net
    3,052,257       3,232,051  
Other assets
    39,000       39,000  
                 
TOTAL OTHER ASSETS
    35,214,551       35,394,345  
                 
TOTAL ASSETS
  $ 60,662,035     $ 60,856,708  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
                 
CURRENT LIABILITIES:
               
Current portion of long term debt
  $ 2,214,000     $ 2,264,000  
Accounts payable
    2,438,156       1,732,426  
Accrued expenses
    2,741,751       3,044,515  
Current portion of customer deposits
    679,527       710,654  
Current portion of unrealized loss on derivatives
    148,515       174,228  
TOTAL CURRENT LIABILITIES
    8,221,949       7,925,823  
                 
Long term debt, less current portion
    10,518,500       12,179,000  
Deferred tax liability
    4,045,745       4,045,745  
Subordinated debt
    13,000,000       13,000,000  
Customer deposits
    2,582,084       2,704,716  
Long term portion of unrealized loss on derivatives
    339,169       608,072  
                 
TOTAL LIABILITIES
    38,707,447       40,463,356  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS' EQUITY:
               
Common stock - $.001 par value, 50,000,000 authorized shares.
               
21,960,229 issued and 21,388,681 outstanding shares as of
               
July 31, 2011 and October 31, 2010
    21,960       21,960  
Additional paid in capital
    58,462,497       58,462,497  
Treasury stock, at cost, 571,548 shares as ofJuly 31, 2011
               
    and October 31, 2010
    (870,391 )     (870,391 )
Accumulated deficit
    (35,359,642 )     (36,743,413 )
Accumulated other comprehensive loss, net of tax
    (299,836 )     (477,301 )
TOTAL STOCKHOLDERS' EQUITY
    21,954,588       20,393,352  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 60,662,035     $ 60,856,708  
                 
See the notes to the condensed consolidated financial statements.
 
   
 
 
3

 
 
 
                         
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
                         
   
Three months ended July 31,
   
Nine months ended July 31,
 
   
2011
   
2010
   
2011
   
2010
 
   
(unaudited)
   
(unaudited)
 
                         
NET SALES
  $ 18,314,676     $ 17,527,711     $ 53,102,842     $ 50,871,269  
                                 
COST OF GOODS SOLD
    8,532,953       7,619,389       25,447,141       23,192,108  
                                 
GROSS PROFIT
    9,781,723       9,908,322       27,655,701       27,679,161  
                                 
OPERATING EXPENSES:
                               
Selling, general and administrative expenses
    7,164,027       7,147,487       21,958,874       21,337,759  
Advertising expenses
    372,644       355,530       1,173,940       1,068,063  
Amortization
    265,052       273,469       816,042       822,892  
    (Gain) loss on disposal of property and equipment
    (8,764 )     (340 )     (11,924 )     52,238  
                                 
TOTAL OPERATING EXPENSES
    7,792,959       7,776,146       23,936,932       23,280,952  
                                 
INCOME FROM OPERATIONS
    1,988,764       2,132,176       3,718,769       4,398,209  
                                 
OTHER EXPENSE (INCOME):
                               
    Interest expense
    558,558       629,878       1,697,566       1,852,342  
    Loss (gain) on derivatives
    4,289       11,606       (3,689 )     11,606  
    Miscellaneous income
    -       (3,500,000 )     -       (3,500,000 )
TOTAL OTHER EXPENSE (INCOME), NET
    562,847       (2,858,516 )     1,693,877       (1,636,052 )
                                 
INCOME BEFORE INCOME TAX EXPENSE
    1,425,917       4,990,692       2,024,892       6,034,261  
                                 
INCOME TAX EXPENSE
    407,700       2,066,408       641,121       2,480,352  
                                 
NET INCOME
  $ 1,018,217     $ 2,924,284     $ 1,383,771     $ 3,553,909  
                                 
NET INCOME PER SHARE - BASIC
  $ 0.05     $ 0.14     $ 0.06     $ 0.17  
                                 
NET INCOME PER SHARE - DILUTED
  $ 0.05     $ 0.14     $ 0.06     $ 0.17  
                                 
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC
    21,388,681       21,480,681       21,388,681       21,478,809  
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED
    21,388,681       21,480,681       21,388,681       21,478,809  
 
See the notes to the condensed consolidated financial statements.
 
 
4

 
 
 
             
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
             
   
Nine months ended July 31,
 
   
2011
   
2010
 
   
(Unaudited)
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 1,383,771     $ 3,553,909  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    2,687,884       2,799,424  
Provision for bad debts on accounts receivable
    262,544       267,889  
Provision for bad debts on notes receivable
    -       25,104  
Amortization
    816,042       822,892  
Non cash interest expense
    36,952       50,028  
(Gain) loss on derivatives
    (3,689 )     11,606  
(Gain) loss on disposal of property and equipment
    (11,924 )     52,238  
Changes in assets and liabilities:
               
Accounts receivable
    (1,204,645 )     (1,278,805 )
Inventories
    (211,123 )     120,443  
Other current assets
    (522,744 )     35,301  
Other assets
    -       4,896  
Accounts payable
    705,730       (618,089 )
Accrued expenses
    (302,764 )     2,052,013  
Customer deposits
    (153,759 )     86,197  
NET CASH PROVIDED BY OPERATING ACTIVITIES
    3,482,275       7,985,046  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment
    (1,867,614 )     (2,500,177 )
Proceeds from sale of property and equipment
    35,685       201,305  
Cash used for acquisitions
    (475,000 )     (76,055 )
Cash used for purchase of trademark
    (237,500 )     -  
NET CASH USED IN INVESTING ACTIVITIES
    (2,544,429 )     (2,374,927 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Principal payments on debt
    (1,859,200 )     (2,895,167 )
Payments of debt issuance costs
    -       (90,000 )
Proceeds from sale of common stock
    -       4,649  
NET CASH USED IN FINANCING ACTIVITIES
    (1,859,200 )     (2,980,518 )
                 
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
    (921,354 )     2,629,601  
                 
CASH AND CASH EQUIVALENTS - beginning of period
    4,892,379       3,095,307  
                 
CASH AND CASH EQUIVALENTS  - end of period
  $ 3,971,025     $ 5,724,908  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
                 
Cash paid for interest
  $ 1,679,717     $ 1,801,103  
                 
Cash paid for income taxes
  $ 417,970     $ 440,943  
                 
NON-CASH FINANCING AND INVESTING ACTIVITIES:
               
                 
Reduction in notes payable for acquisition
  $ 1,300     $ -  
                 
Notes payable issued in acquisitions
  $ 150,000     $ 7,895  
                 
See the notes to the condensed consolidated financial statements.
 

 
5

 
 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.
BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Form 10-Q instructions and in the opinion of management contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the condensed consolidated financial position, results of operations, and cash flows for the periods presented.  The results have been determined on the basis of generally accepted accounting principles and practices of the United States of America (“GAAP”), applied consistently with the Annual Report on Form 10-K of Crystal Rock Holdings, Inc. (the “Company”) for the year ended October 31, 2010.

Certain information and footnote disclosures normally included in audited consolidated financial statements presented in accordance with GAAP have been condensed or omitted. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended October 31, 2010.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

The financial statements herewith reflect the consolidated operations and financial condition of Crystal Rock Holdings, Inc. and its wholly owned subsidiary Crystal Rock LLC.

2.   GOODWILL AND OTHER INTANGIBLE ASSETS

Major components of intangible assets at July 31, 2011 and October 31, 2010 consisted of:

   
July 31, 2011
   
October 31, 2010
 
   
Gross Carrying Amount
   
Accumulated Amortization
   
Wgt. Avg. Amort. Years
   
Gross Carrying Amount
   
Accumulated Amortization
   
Wgt. Avg. Amort. Years
 
Amortized Intangible Assets:
                                   
Covenants Not to Compete
  $ 2,226,488     $ 1,794,866       3.29     $ 2,076,488     $ 1,635,605       3.25  
Customer Lists
    7,428,733       5,315,219       2.85       7,143,033       4,663,069       3.33  
Other Identifiable Intangibles
    716,914       209,793       28.12       516,366       205,162       25.07  
Total
  $ 10,372,135     $ 7,319,878             $ 9,735,887     $ 6,503,836          

 
6

 

 
Amortization expense for the three month periods ended July 31, 2011 and 2010 was $265,052  and $273,469, and for the nine month periods ended the same time was $816,042 and $822,892 respectively.  There were no changes in the carrying amount of goodwill for the nine month period ended July 31, 2011.
 
 
 
3.   DEBT
 
 
The Company and its subsidiary have a Credit Agreement (the “Agreement”) with Bank of America to provide a senior financing facility consisting of term debt and a revolving line of credit.  Under the Agreement, Bank of America is the Company’s sole lender.

 
The Agreement has a total loan capacity of $20,500,000 and obligates the Company to a $15,500,000 term note and access to a $5,000,000 revolving line of credit. The term note is to refinance its previous senior term debt and acquisition line of credit. The revolving line of credit can be used for the purchase of fixed assets, to fund acquisitions, to collateralize letters of credit, and for operating capital.  There was no balance on the line of credit but it collateralized a letter of credit of $1,531,000 as of July 31, 2011.  Consequently, as of that date, there was $3,469,000 available to borrow from the revolving line of credit. There was $12,732,500 outstanding on the term note as of July 31, 2011.

The Agreement amortizes the term note over a five year period with 59 equal monthly principal installments of $184,500, commencing May 5, 2010, and a final payment of $4,614,500 due at the end of five years. The revolving line of credit matures in three years from the commencement of the Agreement.   The Company is subject to various restrictive covenants under the agreement, and is prohibited from entering into other debt agreements without the bank’s consent. The Agreement also prohibits the Company from paying dividends without the prior consent of the bank.
 
 
Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin based on the achievement of a specified leverage ratio.  As of July 31, 2011, the margin was 1.50% for the term note and 1.25% for the revolving line of credit. The Company is required to fix the interest rate on 75% of the outstanding balance of the term note and accomplishes this by entering into interest rate swap agreements.  As of July 31, 2011, the Company had $3,183,000 of the term debt subject to variable interest rates.  The one-month LIBOR was .19% resulting in total variable interest rates of 1.69% and 1.44%, for the term note and the revolving line of credit, respectively, as of July 31, 2011.
 
The Agreement requires the Company to be in compliance with certain financial covenants at the end of each fiscal quarter.  The covenants include senior debt service coverage as defined of greater than 1.25 to 1, total debt service coverage as defined of greater than 1 to 1, and senior debt to EBITDA of no greater than 2.50 to 1.  As of July 31, 2011, the Company was in compliance with these covenants and terms of the Agreement.

In addition to the senior debt, the Company has subordinated debt owed to Henry, Peter and Jack Baker in the aggregate principal amount of $13,000,000 that is due October 5, 2015.  The interest rate on each of these notes is 12% per annum.
 
 
7

 
 
In November 2010, The Company made an acquisition that resulted in the issuance of a $150,000 note to the seller. The note was paid in full in February 2011.

4.   INVENTORIES
 
Inventories consisted of the following at:
 
 
   
July 31,
2011
   
October 31,
2010
 
Finished Goods
  $ 2,521,636     $ 2,265,019  
Raw Materials      142,987       183,481  
Total Inventories    $ 2,664,623     $ 2,448,500  
 
Finished goods inventory consists of products that the Company sells including, but not limited to, coffee, cups, soft drinks, snack foods, and office supplies.  Raw material inventory consists primarily of bottle caps.  The amount of raw and bottled water on hand does not represent a material amount of inventory.  The Company estimates that value as of July 31, 2011 and October 31, 2010 to be $60,000 and $56,000, respectively.  This value includes the cost of allocated overhead.  Bottles are accounted for as fixed assets.
 
5.   ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
Derivative Financial Instruments
The Company has stand-alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk.  The notional amount is an amount on which calculations, payments, and the value of the derivative are based.  The notional amount does not represent direct credit exposure.  Direct credit exposure is limited to the net difference between the calculated amount to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as an unrealized gain or loss on derivatives.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements.  The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and currently has no reason to believe that any counterparties will fail to fulfill their obligations.
 
 
8

 
 
Risk Management Policies - Hedging Instruments
The Company uses long-term variable rate debt as a source of funds for use in the Company’s general business purposes.  These debt obligations expose the Company to variability in interest payments due to changes in interest rates.  If interest rates increase, interest expense increases.  Conversely, if interest rates decrease, interest expense decreases.  Under the terms of its Credit Agreement with Bank of America, the Company is required to fix the interest rate on 75% of the outstanding balance of its term note.  To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments on a portion of its debt.
 
On October 5, 2007, the Company entered into an interest rate hedge swap agreement (old swap) in conjunction with an amendment to its credit facility with Bank of America.  The intent of the instrument was to fix the interest rate on 75% of the outstanding balance on the term loan (the swapped amount) with Bank of America as required by the facility.  The old swap fixed the interest rate for the swapped amount related to the previous facility at 4.87% and matures in January 2014.

In conjunction with its Credit Agreement with Bank of America, on April 5, 2010, the Company entered into an interest rate swap agreement (offsetting swap) to offset the old swap for which it receives 1.40% of the scheduled balance of the old term loan. The offsetting swap effectively removed any exposure to change in the fair value of the old swap and set a fixed net payment schedule based on the scheduled balance of the old term loan until January 2014 when both swaps mature.   In addition, the Company entered into a swap agreement (new swap) to fix the interest rate of 75% of the outstanding balance of the term note at 3.26% (2.01% plus the applicable margin, 1.25%).  The term note matures in May 2015 and new swap matures in April 2013.
 
As of July 31, 2011, the total notional amount of the new swap agreement was $9,549,000. On that date, the variable rate on the remaining 25% of the term note ($3,183,000) was 1.69%.  At July 31, 2011 and October 31, 2010, the net unrealized loss relating to interest rate swaps was recorded in current and long term liabilities.  The current portion is the valuation of the hedged instrument over the next twelve months while the balance of the unrealized loss makes up the long term portion.  For the effective portion of the hedges, which is the new swap, changes in the fair value of interest rate swaps designated as hedging instruments to mitigate the variability of cash flows associated with long-term debt are reported in other comprehensive income or loss net of tax effects.    The new swap was effective for the quarter and nine months ended July 31, 2011 but was entered into in the second quarter of fiscal year 2010. The old swap was effective during the nine months ended July 31, 2010 through April 5, 2010. The amounts relating to the old swap previously reflected in accumulated other comprehensive income are amortized to earnings over the remaining term of the undesignated cash flow hedge.  In fiscal year 2011, payments on the old swap, and receipt of income on the offsetting swap, are reported as gain or loss on derivatives and an adjustment to other comprehensive income or loss net of tax effects.
 
 
9

 

The table below details the adjustments to other comprehensive income, on a before-tax and net-of tax basis, for the three months ended July 31, 2011 and 2010.
 
   
Before-Tax
   
Tax Benefit (Expense)
   
Net-of-Tax
 
Three Months Ended July 31, 2010
                 
Loss on interest rate swap
  $ (258,480 )   $ 95,533     $ (162,947 )
Amortization of loss on derivative undesignated as cash flow hedge
    74,890       (28,794 )     46,096  
Reclassification adjustment for loss in income
    124,000       (43,953 )     80,047  
Net unrealized loss
  $ ( 59,590 )   $ 22,786     $ ( 36,804 )
Three Months Ended July 31, 2011
                       
Loss on interest rate swap
  $ (90,122 )   $ 35,148     $ (54,974 )
Amortization of loss on derivative undesignated as cash flow hedge
    59,031       (23,022 )     36,009  
Reclassification adjustment for loss in income
    98,993       (38,608 )     60,385  
Net unrealized gain
  $ 67,902     $ (26,482 )   $ 41,420  
 
The reclassification adjustments of $98,993 and $124,000 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreements during the three months ended July 31, 2011 and 2010, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in consolidated statement of income as interest expense.  No other material amounts were reclassified during the three months ended July 31, 2011 and 2010.

The table below details the adjustments to other comprehensive income, on a before-tax and net-of tax basis, for the nine months ended July 31, 2011 and 2010.
 
   
Before-Tax
   
Tax Benefit
(Expense)
   
Net-of-Tax
 
Nine Months Ended July 31, 2010
                 
Loss on interest rate swap
  $ (540,265 )   $ 211,460     $ (328,805 )
Amortization of loss on derivative undesignated as cash flow hedge
    100,809       (39,457 )     61,352  
Reclassification adjustment for loss in income
    353,000       (138,164 )     214,836  
Net unrealized loss
  $ (86,456 )   $ 33,839     $ (52,617 )
Nine Months Ended July 31, 2011
                       
Loss on interest rate swap
  $ (198,429 )   $ 77,387     $ (121,042 )
Amortization of loss on derivative undesignated as cash flow hedge
    177,093       (69,066 )     108,027  
Reclassification adjustment for loss in income
    312,262       (121,782 )     190,480  
Net unrealized gain
  $ 290,926     $ (113,461 )   $ 177,465  
 
The reclassification adjustments of $312,262 and $353,000 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreements during the nine months ended July 31, 2011 and 2010, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in consolidated statement of income as interest expense.  No other material amounts were reclassified during the nine months ended July 31, 2011 and 2010.
 
 
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In the nine months ended July 31, 2011, the fair value of the swaps changed from an unrealized loss on derivative liability at the beginning of the period of $782,300 to $487,684. Also, as of that date, the estimated net amount of the existing loss that is reported in accumulated other comprehensive loss that is expected to be reclassified into earnings within the next twelve months is $172,687.

Derivatives designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $228,432 at July 31, 2011 and $342,266 at October 31, 2010. Derivatives not designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $259,252 at July 31, 2011 and $440,034 at October 31, 2010. During the first nine months and third quarter of fiscal years 2011 and 2010, cash flow hedges are deemed 100% effective.  The net loss (gain) on interest rate swaps not designated as cash flow hedges, classified as a loss (gain) on derivatives on the Company’s income statement, amounted to ($3,689) and $4,289 for the nine months and quarter ended July 31, 2011, respectively. Similarly, there was a realized loss of $11,606 on the Company’s income statement for the nine months and quarter ended July 31, 2010.

6.   FAIR VALUES OF ASSETS AND LIABILITIES

 
Fair Value Hierarchy
 
The Company’s assets and liabilities measured at fair value are as follows:

   
Level 1
   
Level 2
   
Level 3
 
Liabilities:
                 
July 31, 2011
                 
Unrealized loss on derivatives
  $ -     $ 487,684     $ -  
       
October 31, 2010
     
Unrealized loss on derivatives
  $ -     $ 782,300     $ -  
 
In determining the fair value, the Company uses a model that calculates a present value of the payments as they amortize through the life of the loan (float) based on the variable rate and compares them to the calculated value of the payment based on the fixed rate (fixed) defined in the swap.  In calculating the present value, in addition to the term, the model relies on other data – the “rate” and the “discount factor.”

§  
In the “float” model, the rate reflects where the market expects LIBOR to be in for the respective period and is based on the Eurodollar futures market.
§  
The discount factor is a function of the volatility of LIBOR.

Payments are calculated by applying the rate to the notional amount and adjusting for the term. Then the present value is calculated by using the discount factor.
 
 
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The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments.  The carrying amounts reported in the consolidated balance sheet for cash equivalents, trade receivables, and accounts payable approximate fair value based on the short-term maturity of these instruments.  The carrying value of senior debt approximates its fair value since it provides for variable market interest rates. Subordinated debt is carried at its approximate market value based on periodic comparisons to similar instruments in the market place.

7.   COMPREHENSIVE INCOME

The following table summarizes comprehensive income for the respective periods:

   
Three Months Ended
July 31,
   
Nine Months Ended
July 31,
 
   
2011
   
2010
   
2011
   
2010
 
Net income
  $ 1,018,217     $ 2,924,284     $ 1,383,771     $ 3,553,909  
Other comprehensive income (loss):
                               
Amortization of loss on derivative undesignated as cash flow hedge – net of tax
        36,009           46,096           108,027           61,352  
Unrealized gain (loss) on derivatives designated as cash flow hedges – net of tax
    5,411       (82,900 )       69,438       (113,969 )
Comprehensive income
  $ 1,059,637     $ 2,887,480     $ 1,561,236     $ 3,501,292  

8.   INCOME PER SHARE AND WEIGHTED AVERAGE SHARES

The Company considers outstanding in-the-money stock options as potential common stock in its calculation of diluted earnings per share, unless the effect would be anti-dilutive, and uses the treasury stock method to calculate the applicable number of shares.  The following calculation provides the reconciliation of the denominators used in the calculation of basic and fully diluted earnings per share:

 
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Three Months Ended
July 31,
   
Nine Months Ended
July 31,
 
   
2011
   
2010
   
2011
   
2010
 
Net Income
  $ 1,018,217     $ 2,924,284     $ 1,383,771     $ 3,553,909  
Denominator:
                               
Basic Weighted Average Shares Outstanding
    21,388,681       21,480,681       21,388,681       21,478,809  
Dilutive effect of Stock Options
    -       -       -       -  
Diluted Weighted Average Shares Outstanding
    21,388,681       21,480,681       21,388,681       21,478,809  
Basic Income Per Share
  $ .05     $ .14     $ .06     $ .17  
Diluted Income Per Share
  $ .05     $ .14     $ .06     $ .17  

There were 284,500 and 569,500 options outstanding as of July 31, 2011 and 2010, respectively.  For the three and nine month period ended July 31, 2011 and 2010 there were no options used to calculate the effect of dilution because all of the outstanding options’ exercise prices exceeded the market price of the underlying common shares and were therefore considered anti-dilutive.

9.   COMPENSATION PLANS

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost is recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period).  The Company provides an estimate of forfeitures at the initial date of grant.

The Company has stock-based compensation plans under which incentive and non-qualified stock options and restricted shares are granted.  In April 1998, the Company’s stockholders approved the 1998 Incentive and Non-Statutory Stock Option Plan.  In April 2003, the Company’s stockholders approved an increase in the authorized number of shares to be issued under its 1998 Incentive and Non-Statutory Stock Option Plan from 1,500,000 to 2,000,000.  This plan provides for issuances of options to purchase the Company’s common stock under the administration of the compensation committee of the Board of Directors.  The intent of the plan is to reward options to officers, employees, directors, and other individuals providing services to the Company.  As of July 31, 2011, there were 1,864,500 shares available for grant.
In April 2004, the Company’s stockholders approved the 2004 Stock Incentive Plan.  The plan provides for issuances of awards of up to 250,000 restricted or unrestricted shares of the Company’s common stock, or incentive or non-statutory stock options to purchase such common stock. Of the total amount of shares authorized under this plan, 149,000 option shares are outstanding, 26,000 restricted shares have been granted, and 75,000 shares are available for grant at July 31, 2011.
 
 
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The options issued under the plans generally vest in periods up to five years based on the continuous service of the recipient and have 10 year contractual terms.  Share awards generally vest over one year.  Option and share awards provide for accelerated vesting if there is a change in control of the Company (as defined in the plans).
 
There were options for 20,000 and 5,000 shares that expired in the first nine months of fiscal year of 2011 and 2010, respectively.  Other than the expirations, there was no activity related to stock options and outstanding stock option balances or other equity based compensation during the nine month period ended July 31, 2011 and 2010.  There were options for 15,000 shares that expired in the three months ended July 31, 2011 and no option activity in the same period for the prior year. The Company did not grant any equity based compensation during the nine months ended July 31, 2011 and 2010.
 
The following table summarizes information pertaining to outstanding stock options, all of which are exercisable, as of July 31, 2011:
 
Exercise
Price
Range
   
Outstanding
Options
(Shares)
   
Weighted
Average Remaining
Contractual Life
   
Weighted
Average
Exercise Price
   
Intrinsic Value
as of
July 31, 2011
 
  $1.80 - $2.60       234,500       3.5     $ 2.32     $ -  
  $2.81 - $3.38       20,000       2.3       3.28       -  
  $3.50 - $4.25       25,000       .9       3.90       -  
  $4.28 - $4.98       5,000       .4       4.98       -  
          284,500       3.1     $ 2.57     $ -  

Outstanding options were granted with lives of 10 years and provide for vesting over a term of 0-5 years.  Since all outstanding stock options were fully vested as of July 31, 2011 there was no unrecognized share based compensation related to unvested options as of that date.  All incentive and non-qualified stock option grants had an exercise price equal to the market value of the underlying common stock on the date of grant.

Employee Stock Purchase Plan

On June 15, 1999, the Company’s stockholders approved the 1999 Employee Stock Purchase Plan (“ESPP”).  On January 1, 2001, employees commenced participation in the plan.  There were no shares issued under this plan during the nine months ended July 31, 2011. The total number of shares of common stock issued under this plan during the nine months ended July 31, 2010 was 8,242 for proceeds of $4,648.

On March 29, 2007, the Company’s stockholders approved an increase in the number of shares available under the plan from 500,000 to 650,000 shares.  Effective January 1, 2006, ESPP shares are granted at 95% of the fair market value at the last day of the offering period. Prior to that, ESPP shares were granted at 85% of the fair market value at the lower of the first or last day of the offering period.  The plan reached its limit of shares in the option period ended December 31, 2009. There are no plans to increase the limit or create a similar plan.
 
 
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10.  
RECENT ACCOUNTING PRONOUNCEMENTS
 
In June 2011, the Financial Accounting Standards Board (FASB) issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income.  This ASU amends the disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in stockholder’s equity.  Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which will be fiscal 2013 for the Company.  Early application is permitted. There will be no impact to the consolidated financial results as the amendments relate only to changes in financial statement presentation.

In May 2011, the Financial Accounting Standards Board issued an ASU to Topic 820 on fair value measurement. The ASU provides amendments to achieve common fair value measurements and disclosure requirements in United States Generally Accepted Accounting Principles (“U.S. GAAP”) and International Financial Reporting Standards. The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the amendments do not result in a change in the application of the requirements for fair value measurements. The amendments (i) clarify the Board’s intent that the highest and best use concept for fair value measurement are only relevant in measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets and liabilities, (ii) include requirements for the measurement of fair value for instruments classified in shareholders’ equity, and (iii) clarifies that an entity should disclose quantitative information about unobservable inputs used in the fair value measurement that is categorized within Level 3 of the fair value hierarchy. The amendments also contain (i) provisions that permit fair value measurement on a net asset or liability position as opposed to on a gross basis if the reporting entity manages its financial instruments on a net exposure basis, (ii) clarifies that the application of a premium or discount in fair value measurements is related to the unit of account for the asset or liability being measured at fair value, and (iii) provides additional disclosure requirements for fair value measurements categorized within Level 3 of the fair value hierarchy. The amendments are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011, which is fiscal 2012 for the Company. Early application is not permitted for the Company. The Company is currently evaluating the effect, if any, the adoption of this amended guidance may have on its financial statements, however, the Company does not expect it to have a material effect on its fair value measurements or disclosures.
 
 
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In December 2010, the Financial Accounting Standards Board issued an update to accounting guidance for business combinations related to the disclosure of supplementary pro forma information. Accounting guidance for business combinations requires a public entity to disclose pro forma revenue and earnings for the combined entity as though the combination occurred at the beginning of the reporting period. This update clarifies that if a public entity presents comparative financial statements, the pro forma information for all business combinations occurring during the current year should be reported as though the combination occurred at the beginning of the prior annual reporting period. This update also expands the disclosure requirement to include the nature and amount of pro forma adjustments made to arrive at the disclosed pro forma revenue and earnings. This update is effective for business combinations for which the acquisition date is on or after annual reporting periods beginning after December 15, 2010, which will be fiscal 2012 for the Company. The effect of adoption will depend primarily on the Company’s acquisitions occurring after such date, if any.
 
11.  
SIGNIFICANT ACCOUNTING POLICIES
 
Uncollectible Trade Accounts Receivable - Individual accounts receivable are written off when deemed uncollectible, with any future recoveries recorded as income when received.

 
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The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto as filed in our Annual Report on Form 10-K for the year ended October 31, 2010 as well as the condensed consolidated financial statements and notes contained herein.

Forward-Looking Statements

The “Management’s Discussion and Analysis” portion of this Form 10-Q contains forward-looking statements about (1) the lower gross margins of new products that we are offering in connection with our brand expansion, and (2) cost pressures related to commodities affecting our business.  The following factors could cause actual results to differ materially from those in the forward-looking statement (1):  The volume of and revenues from new products, such as office products, that we sell may be greater or less than we anticipate.  If greater, the effect will likely reduce our gross margin overall; if less, the effect on our gross margin should be less significant, although in that case our results of operations could be adversely affected due to lower revenues.  In addition, establishing new product offerings, such as office products, and expanding distribution channels of existing products requires a significant investment of money and management time and requires us to develop systems, such as online ordering systems, to an extent we have not done previously.  There is no assurance we can succeed.  There are many competitors in the office products business, and some are bigger and better capitalized than we are.  To the extent that we try to grow that business by acquisitions, we may experience difficulties integrating the acquired businesses or assets, or we may fail to realize synergistic savings that we had hoped to realize.  Even if we establish a new product channel, it may not be profitable.
 
The following factors could cause actual results to differ materially from those in the forward-looking statement (2): We rely upon plastic as a raw material, a commodity that is subject to fluctuations in price and supply, for manufacturing our bottles.  Increases in the cost of petroleum would have an impact on our bottle costs.  We rely on trucking to receive raw materials and transport and deliver our finished products.  There is a risk that we may not be able to use fuel price adjustments to cover the cost of fuel increases in a volatile market for petroleum products, which could adversely affect our profitability.  Further, limitations on the supply or availability of fuel could inhibit our ability to get raw materials and distribute our products, which in turn could have an adverse affect on our business.  A significant portion of our sales is derived from coffee.  The supply and price of coffee may be limited by climate, by international political and economic conditions, and by access to transportation, combined with consumer demand.  An increase in the wholesale price of coffee could result in a reduction in our profitability.  If our ability to purchase coffee were impaired by a market shortage, our sales might decrease, which would also result in a reduction of profitability.

 
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Results of Operations

Overview and Trends

Sales were higher in the first nine months of 2011 compared to the same period in 2010. Since the sales increase related to lower margin product, as a percentage of sales, gross margin declined. Water sales have lagged the previous year in part because of adverse winter weather in the first quarter of 2011 combined with abnormally warm weather in the third quarter of 2010 in the Company’s market area. In addition, the new products offered in conjunction with our brand expansion tend to yield a lower gross margin, in general.  We also experienced higher operating expenses during the first nine months of the year, in part to upgrade of our customer relationship and e-commerce software, which resulted in lower net income compared to a year ago.

In late August, Tropical Storm Irene caused considerable and widespread damage in parts of our market area.  The primary effect on our business has been due to flooding that damaged or destroyed some highways, roads and bridges, making it more difficult for our delivery trucks to reach customers in Vermont and Northern New York.  In addition, our Vermont spring sources temporarily became inaccessible.  Access to these sources has now been restored, but one source will continue to experience limited access and longer trucking routes until further road repairs are completed.  There has been no material limitation to our ability to service our customers, but our route and transportation costs have temporarily increased.  To date, the storm has not materially impacted our business.  However, it is too early to assess whether these storm effects could adversely affect our financial results for the fourth quarter of fiscal 2011or for subsequent periods.

We continue to operate in an uncertain economic environment in our market area. While we have created opportunities that we expect will result in increased sales, we anticipate cost pressures related to commodities affecting our business, most notably, fuel and coffee, and building our brands.

Results of Operations for the Three Months Ended July 31, 2011 (Third Quarter) Compared to the Three Months Ended July 31, 2010

Sales
Sales for the three months ended July 31, 2011 were $18,315,000 compared to $17,528,000 for the corresponding period in 2010, an increase of $787,000, or 4%.  Sales related to acquisitions totaled $276,000 in the third quarter of fiscal year 2011. Excluding sales from acquisitions, total sales increased by 3% in the third quarter of 2011 compared to the same period in 2010.
 
The comparative breakdown of sales of the product lines for the respective three-month periods ended July 31, 2011 and 2010 is as follows:

 
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Product Line
   
2011
   
2010
   
Difference
   
% Diff.
 
(000’s $)                          
Water
    $ 7,907     $ 8,035     $ (128 )     (2 %)
Coffee and Related
      5,395       4,747       648       14 %
Equipment Rental
      2,171       2,232       (61 )     (4 %)
Other
      2,842       2,514       328       13 %
Total
    $ 18,315     $ 17,528     $ 787       4 %

Water – Sales of water decreased compared to the same period in the prior year as a result of a 1% decrease in volume and 1% decrease in average selling price in the third quarter of 2011 compared to the same period in 2010.  Acquisitions were not material to the sales for this category.

Coffee and Related Products – Traditional coffee lines grew 21% and single serve grew 15% in the third quarter of 2011 compared to the same period in fiscal year 2010.  Ancillary refreshment products increased 4% in the third quarter compared to the same quarter a year ago. The increase in sales of coffee products is a result of an increase in the commodity price of coffee which resulted in price increases for the products. Acquisitions were not material to the sales for this category.

Equipment Rental – Equipment rental revenue decreased in the third quarter of 2011 compared to the comparable period in 2010 as a result of a 4% decrease in placements of equipment.  Average rental prices increased 1%.  Acquisitions had no material impact on the sales for the category.

Other – The increase in other revenue is attributable to sales of office products which were $336,000 for the quarter. This line of products was not sold a year ago.  In addition, fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations increased 23% to $863,000 in the third quarter of 2011 from $665,000 in the same period in 2010.  The office products sales were attributable to the acquisition of an office products company in the first quarter of 2011. Net of acquisitions, revenue in the category increased 4%.

Gross Profit/Cost of Goods Sold – For the three months ended July 31, 2011, gross profit decreased $126,000, or 1%, to $9,782,000 from $9,908,000 for the comparable period in 2010.  The decrease in gross profit was a result of lower prices and higher cost of goods sold despite an increase in fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations.   Higher costs are attributable to the commodity influence on coffee and higher service costs primarily related to fuel costs. Accordingly, as a percentage of sales, gross profit decreased to 53% in the third quarter of 2011 from 57% in the third quarter of 2010.

Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers.  We include distribution costs in selling, general, and administrative expense, and the amount is reported below.  The reader should be aware that other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result.
 
 
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Operating Expenses and Income from Operations
Total operating expenses increased to $7,793,000 in the third quarter of 2011 from $7,776,000 in the comparable period in 2010, an increase of $17,000.

Selling, general and administrative (SG&A) expenses of $7,164,000 in the third quarter of 2011 increased $16,000 from $7,148,000 in the comparable period in 2010.  Of total SG&A expenses, route distribution costs decreased $141,000, or 4%, as a result of lower labor costs that were partially offset by higher fuel costs; selling costs increased $240,000, or 26%, primarily as a result of higher sales-related compensation cost and computer software costs; and administration costs decreased $83,000, or 3%, as a result of lower professional fees despite higher computer software related costs.  The increase in computer software costs is primarily related to upgrading sales and customer management and e-commerce.
 
Advertising expenses were $373,000 in the third quarter of 2011 compared to $356,000 in the third quarter of 2010, an increase of $17,000, or 5%. The increase in advertising costs is primarily related to an increase in internet advertising and agency costs.

Amortization decreased to $265,000 in the third quarter of 2011 from $273,000 in the comparable quarter in 2010.  Amortization is attributable to intangible assets that were acquired as part of acquisitions in recent years.

Income from operations for the three months ended July 31, 2011 was $1,989,000 compared to $2,132,000 in the comparable period in 2010, a decrease of $143,000, or 7%.  The decrease was a result of higher cost of goods sold resulting in lower gross profit, as a percentage of sales, despite higher sales and stable operating costs.

Interest, Taxes, and Other Expenses
Interest expense was $559,000 for the three months ended July 31, 2011 compared to $630,000 in the three months ended July 31, 2010, a decrease of $71,000.  The decrease is attributable to lower outstanding debt and lower variable interest rates during the third quarter of 2011 compared to the third quarter of 2010.
 
Income before income taxes was $1,426,000 for the three months ended July 31, 2011 compared to income before income taxes of $4,991,000 in the corresponding period in 2010, a decrease of $3,565,000. The decrease in income from operations was primarily a result of a non-recurring legal settlement of $3,500,000 that the Company received in the third quarter of 2010.

The tax expense for the third quarter of fiscal year 2011 was $408,000 compared to tax expense of $2,066,000 in the third quarter of fiscal year 2010.  The effective tax rate for the third quarter of 2011 was 29% compared to 41% for the same period a year ago. The lower tax in the third quarter of 2011 was a result of lower income from operations and the non recurrence of the legal settlement from the third quarter of 2010. The lower tax rate in the third quarter of 2011 was attributable to adjustment of the income tax rate for the first nine months of the year based on a favorable decision for the Company of an outstanding state tax issue.
 
 
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Net Income
Net income decreased to $1,018,000 for the three months ended July 31, 2011 from $2,924,000 in the corresponding period in 2010.  The decrease of $1,906,000 is attributable to higher cost of goods sold resulting in lower gross profit, as a percentage of sales, despite higher sales, stable operating costs, and lower interest.  In addition, the $3,500,000 legal settlement received in the third quarter of 2010 did not recur in the third quarter of 2011. Net of tax, this settlement amounted to $2,079,000.

Results of Operations for the Nine Months Ended July 31, 2011 Compared to the Nine Months Ended July 31, 2010

Sales
Sales for the nine months ended July 31, 2011 were $53,103,000 compared to $50,871,000 for the corresponding period in 2010, an increase of $2,232,000, or 4%.  The increase was primarily the result of sales from acquisitions, an increase in the commodity price of coffee, and an increase in fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations. Sales as a result of acquisitions accounted for $1,146,000 of total sales for the first nine months of 2011.  Net of the acquisition related sales, total sales increased 2%, in the first nine months of fiscal year 2011 from the same period a year ago.
 
 
The comparative breakdown of sales of the product lines for the respective nine month periods ended July 31, 2011 and 2010 is as follows:

Product Line
   
2011
   
2010
   
Difference
   
% Diff.
 
(000’s $)            
Water
    $ 21,491     $ 21,876     $ (385 )     (2 %)
Coffee and Related
      17,235       15,926       1,309       8 %
Equipment Rental
      6,511       6,693       (182 )     (3 %)
Other
      7,866       6,376       1,490       23 %
Total
    $ 53,103     $ 50,871     $ 2,232       4 %

Water – Sales of water decreased in the first nine months of 2011 compared to the same period in 2010 as a result of a 1% decrease in volume and a 1% decrease price. Acquisitions were not material to the sales for this category.

Coffee and Related Products –   Traditional coffee lines grew 12% and single serve grew 9% in the first nine months of 2011 compared to the same period in fiscal year 2010.  Ancillary refreshment products increased 4% in the first nine months of 2011 compared to the same period a year ago. The increase in sales of coffee products is a result of an increase in the commodity price of coffee which resulted in price increases for the products.  Acquisitions were not material to the sales for this category.

Equipment Rental – Equipment rental revenue decreased in the first nine months of 2011 compared to the same period in 2010 as a result of a 5% decrease in placements that was only partially offset by a 2% increase in average rental price. Acquisitions had no material impact on the sales for the category.
 
 
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Other – The increase in other revenue is attributable to sales of office products which were $1,146,000 for the first nine months of 2011. This line of products was not sold a year ago.  In addition, fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations increased 40% to $1,888,000 in the first nine months of 2011 from $1,381,000 in the same period in 2010.  The office products sales were attributable to the acquisition of an office products company in the first quarter of 2011. Net of acquisitions, revenue in the category increased 5%.

Gross Profit/Cost of Goods Sold – For the nine months ended July 31, 2011, gross profit decreased $23,000, to $27,656,000 from $27,679,000 for the comparable period in 2010.  The decrease in gross profit was primarily due to lower prices and higher costs of goods sold despite higher sales which include an increase in fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations.   Higher costs are attributable to the commodity influence on coffee and higher service costs primarily related to fuel costs.  Accordingly, as a percentage of sales, gross profit decreased to 52% in the first nine months of 2011 from 54% in the first nine months of 2010.

Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers.  We include distribution costs in selling, general, and administrative expense, and the amount is reported below.  The reader should be aware that other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result.

Operating Expenses and Income from Operations
Total operating expenses increased to $23,937,000 in the first nine months of 2011 from $23,281,000 in the comparable period in 2010, an increase of $656,000, or 3%.

Selling, general and administrative (SG&A) expenses of $21,959,000 in the first nine months of 2011 increased $621,000, or 3%, from $21,338,000 in the comparable period in 2010.  Of total SG&A expenses, route distribution costs increased $5,000 as a result of higher fuel costs; selling costs increased $437,000, or 17%, as a result of higher sales related compensation costs; and administration costs increased $179,000, or 2%, as a result of higher software maintenance and development costs, combined one-time benefits related to an employee termination of $109,000, and lease buyout of $175,000, that more than offset a decrease in professional fees.  The increase in computer software costs is primarily related to upgrading sales and customer management and e-commerce.
 
Advertising expenses were $1,174,000 in the first nine months of 2011 compared to $1,068,000 in the first nine months of 2010, an increase of $106,000, or 10%. The increase in advertising costs is primarily related to an increase in agency costs and internet advertising.
 
 
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Amortization was $816,000 in the first nine months of 2011 compared to $823,000 in the first nine months of 2010.  Amortization is attributable to intangible assets that were acquired as part of acquisitions in recent years.

Income from operations for the nine months ended July 31, 2011 was $3,719,000 compared to $4,398,000 in the comparable period in 2010, a decrease of $679,000, or 15%.  Although sales were higher, the decrease was a result of higher cost of goods sold, resulting in lower gross profit margin, and higher operating expenses.

Interest, Taxes, and Other Expenses – Income from Continuing Operations
Interest expense was $1,698,000 for the nine months ended July 31, 2011 compared to $1,852,000 in the nine months ended July 31, 2010, a decrease of $154,000.  The decrease is attributable to lower outstanding debt and lower variable interest rates during the first nine months of 2011 compared to the same period in 2010.
 
Income before income taxes was $2,025,000 for the nine months ended July 31, 2011 compared to income before income taxes of $6,034,000 in the corresponding period in 2010, a decrease of $4,009,000.   The decrease in income from operations was primarily a result of a non-recurring legal settlement of $3,500,000 that the Company received in the third quarter of 2010.

The tax expense for the first nine months of fiscal year 2011 was $641,000 and was based on the expected effective tax rate of 32%.  We recorded a tax expense of $2,480,000 related to income from operations in the first nine months of fiscal year 2010 based on an anticipated effective tax rate of 41%.  The lower tax in the first nine months of 2011 was a result of lower income from operations and the non recurrence of the legal settlement from the third quarter of 2010. The lower tax rate in the first nine months of 2011 was attributable to adjustment of the income tax rate for the first nine months of the year based on a favorable decision for the Company of an outstanding state tax issue.

Net Income
Net income of $1,384,000 for the nine months ended July 31, 2011 decreased from net income of $3,554,000 in the corresponding period in 2010, a decrease of $2,170,000, or 61%.  The decrease is attributable to higher cost of goods sold, resulting in lower gross profit margin, and higher operating expenses in spite of higher sales and lower interest.  In addition, the $3,500,000 legal settlement received in 2010 did not recur in the 2011. Net of tax, this settlement amounted to $2,079,000.

Liquidity and Capital Resources

As of July 31, 2011, working capital was $8,776,000 compared to $8,425,000 as of October 31, 2010, an increase of $351,000.  The increase in working capital is primarily attributable to an increase in receivables as a result of a seasonal increase sales volume to the extent it was not offset by an increase in accounts payable. The decrease in cash of $921,000 is due to re-payment of debt and capital spending as well as an acquisition.  Net cash provided by operating activities decreased $4,503,000 to $3,482,000 in 2011 from $7,985,000 in 2010. The decrease was primarily a result of lower net income as a result of a non-recurring legal settlement of $3,500,000 received in 2010, an increase in inventory of $211,000, due to stocking more items, and a decrease in accrued expenses of $303,000, primarily a result of paying bonuses accrued at year end.
 
 
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Our Credit Agreement with Bank of America provides a senior financing facility consisting of term debt and a revolving line of credit.  The Agreement has a total loan capacity of $20,500,000 and obligates us to a $15,500,000 term note and access to a $5,000,000 revolving line of credit. As of July 31, 2011 there was $12,732,500 outstanding on the term loan. The revolving line of credit can be used for the purchase of fixed assets, to fund acquisitions, to collateralize letters of credit, and for operating capital.  There was no balance on the line of credit but it collateralized a letter of credit of $1,531,000 as of July 31, 2011 so, as of that date, there was $3,469,000 available to borrow from the line of credit.

The Agreement amortizes the term debt over a five year period with 59 equal monthly installments of $184,500, commencing May 5, 2010, and a final payment of $4,614,500 due at the end of five years. The revolving line of credit matures in three years.   The Company is subject to various restrictive covenants under the agreement, and is prohibited from entering into other debt agreements without the bank’s consent.

Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin based on the achievement of a specified leverage ratio.  As of July 31, 2011, the margin was 1.50% for the term note and 1.25% for the revolving line of credit. The Company is required to fix the interest rate on 75% of the outstanding balance of the term note and accomplishes this by entering into interest rate swap agreements.  As of July 31, 2011, the Company had $3,183,000 of the term debt subject to variable interest rates.  The one-month LIBOR was .19% resulting in total variable interest rates of 1.69% and 1.44%, for the term note and the revolving line of credit, respectively, as of July 31, 2011.

In addition to the senior debt, the Company has subordinated debt owed to Henry, Peter and Jack Baker in the aggregate principal amount of $13,000,000 that is due October 5, 2015.

In the first nine months of 2011, we used $1,810,000 for repayment of our senior term debt, including a seller note of $150,000 for an acquisition, and another $49,000 to repay debt from an acquisition closed in 2010. The total repayment amount of $1,859,000 in the first nine months of 2011 was $1,036,000 lower than the comparable period in 2010 because the Company made a one-time repayment of $988,000 and lowered its monthly payments when re-financing its term loan on May 5, 2010. In addition, $1,868,000 was used for capital expenditures. Cash expenditures for capital additions were mostly comprised of bottles, coolers and brewers and were $632,000 lower than for the same period last year.
 
Our credit facility requires that we be in compliance with certain financial covenants at the end of each fiscal quarter.  The covenants include senior debt service coverage as defined of greater than 1.25 to 1, total debt service coverage as defined of greater than 1 to 1, and senior debt to EBITDA as defined of no greater than 2.5 to 1.  As of July 31, 2011, we were in compliance with all of the financial covenants of our credit facility. The Agreement also prohibits us from paying dividends without prior consent of the lender.
 
 
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As of July 31, 2011, we had three interest rate swap agreements with Bank of America in effect.  The intent of one swap, entered into on April 5, 2010, is to fix the interest rate on 75% of the outstanding balance on the term loan as required by the credit facility.  The swap fixes the interest rate for the swapped amount at 3.26% (2.01% plus the applicable margin, 1.25%).  An additional swap entered into on the same date offsets the swap that fixed the interest on a portion of the term loan and became ineffective when we entered into the Agreement.

In addition to our senior and subordinated debt commitments, we have significant future cash commitments, primarily in the form of operating leases that are not reported on the consolidated balance sheet. The following table sets forth our contractual commitments in future fiscal years:

   
Payment due by Period
 
 
Contractual Obligations (2)
 
Total
   
Remainder
of 2011
      2012-2013       2014-2015    
After 2015
 
Debt
  $ 25,732,000     $ 553,000     $ 4,428,000     $ 20,751,000     $ -  
Interest on Debt (1)
    7,929,000       515,000       3,938,000       3,476,000       -  
Operating Leases
    11,297,000       908,000       5,918,000       3,516,000       955,000  
Total
  $ 44,958,000     $ 1,976,000     $ 14,284,000     $ 27,743,000     $ 955,000  

(1)  
Interest based on 75% of outstanding senior debt at the hedged interest rate discussed above, 25% of outstanding senior debt at a variable rate of 1.69%, and subordinated debt at a rate of 12%.
 
(2)  
Customer deposits have been excluded from the table.  Deposit balances vary from period to period with water sales but future increases and decreases in the balances are not accurately predictable.  Deposits are excluded because, net of periodic additions and reductions, it is probable that a customer deposit balance will always be outstanding as long as the business operates.
 
We have no other material contractual obligations or commitments.

With the exception of the impact of commodity costs on coffee and energy as described above, inflation has had no material impact on our performance.


Pursuant to Regulation S-K, Item 305(e), smaller reporting companies are not required to provide this information.


Our Chief Executive Officer and our Chief Financial Officer, and other members of our senior management team, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)  under the Securities Exchange Act of 1934, as amended, or the Exchange Act).  Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by us, including our consolidated subsidiary, in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive and Chief Financial officers, as appropriate to allow timely decisions regarding required disclosure.
 
 
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The effectiveness of a system of disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate levels of management.
 
Changes in Internal Control over Financial Reporting.
 
 
During the nine months ended July 31, 2011, there were no changes in our internal control over financial reporting that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II – OTHER INFORMATION
 
Item 1. Legal Proceedings.
 
None.
     
Item 1A. Risk Factors.
 
There was no change in the nine months ended July 31, 2011 from the Risk Factors reported in our Annual Report on Form 10-K for the year ended October 31, 2010.
             
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
None.
             
Item 3. Defaults Upon Senior Securities.
 
None.
             
Item 4. [Reserved.] 
             
Item 5. Other Information.
 
None.
             
Item 6. Exhibits.
 
 
Exhibit
Number   
 
Description
 
 
3.1
Certificate of Incorporation (Incorporated by reference to Exhibit B to Appendix A to our registration statement on Form S-4, File No. 333-45226, filed with the SEC on September 6, 2000)

 
3.2
Certificate of Amendment to Certificate of Incorporation (Incorporated by reference to Exhibit 4.2 to our current report on Form 8-K, filed with the SEC on October 19, 2000)

 
3.3
Certificate of Ownership and Merger of Crystal Rock Holdings, Inc. with and into Vermont Pure Holdings, Ltd. (Incorporated by reference to Exhibit 3.1 to our current report on Form 8-K, filed with the SEC on May 6, 2010)

 
3.4
Amended and Restated By-laws, as amended (Incorporated by reference to Exhibit 3.2 to our current report on Form 8-K, filed with the SEC on April 2, 2010)
 
 
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2011 and October 31, 2010, (b) our Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2011 and 2010, (c) our Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2011 and 2010, and (d) the Notes to such Condensed Consolidated Financial Statements.
 
 
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Dated:           September 14, 2011
 
 
  CRYSTAL ROCK HOLDINGS, INC. 
   
 
By: /s/ Bruce S. MacDonald
 
             Bruce S. MacDonald
 
             Vice President, Chief Financial Officer
               (Principal Accounting Officer and  
               Principal Financial Officer) 
 
 
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Exhibits Filed Herewith

                   
Exhibit
Number
Description
 
 
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2011 and October 31, 2010, (b) our Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2011 and 2010, (c) our Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2011 and 2010, and (d) the Notes to such Condensed Consolidated Financial Statements.
 
 
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