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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K
(Mark One)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended October 31, 2011.

 [  ]
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 Number
1050 Buckingham St., Watertown, CT  06795
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code:  (860) 945-0661

Securities registered pursuant to Section 12(b) of the Act:
 
 Title of each class    Name of exchange on which registered
 Common Stock, par value $.001 per share    NYSE Amex
 
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  [_]   No  [X]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  [_]   No  [X]
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   [X]
 
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]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [  ] No [X]

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the last sale price per share of common stock on April 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter, as reported on the NYSE Amex, was $8,595,643.
 
 
 
 

 

 
The number of shares outstanding of the registrant's Common Stock, $.001 par value per share, was 21,388,681 on January 12, 2012.

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive proxy statement, to be filed not later than 120 days after the registrant’s fiscal year ended October 31, 2011, and delivered in connection with the registrant’s annual meeting of stockholders, are incorporated by reference into Part III of this Form 10-K.
 
 
 
 
 
 
 
 
 
 
 
 
2

 

   
 Table of Contents
 
Page
Part I
       
Item 1.
 
Business
 
Item 1A.
 
Risk Factors
 
Item 1B.
 
Unresolved Staff Comments
 
Item 2.
 
Properties
 
Item 3.
 
Legal Proceedings
 
Item 4.
 
Reserved
 
Part II
       
Item 5.
 
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Item 7.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 8.
 
Financial Statements and Supplementary Data
 
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
Item 9A.
 
Controls and Procedures
 
28
Item 9B.
 
Other Information
 
Part III
       
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
Item 11.
 
Executive Compensation
 
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
 
Item 14.
 
Principal Accountant Fees and Services
 
Part IV
       
Item 15.
 
Exhibits and Financial Statement Schedules
 
   
Signatures
   

Note: Items 6 and 7A are not required for smaller reporting companies and therefore are not furnished.
***************
In this Annual Report on Form 10-K, “Crystal Rock,” the “Company,” “we,” “us” and “our” refer to Crystal Rock Holdings, Inc. and its subsidiary, taken as a whole, unless the context otherwise requires.
***************
This Annual Report on Form 10-K contains references to trade names, label design, trademarks and registered marks of Crystal Rock Holdings, Inc. and its subsidiary and other companies, as indicated.  Unless otherwise provided in this Annual Report on Form 10-K, trademarks identified by (R) are registered trademarks or trademarks, respectively, of Crystal Rock Holdings, Ltd. or its subsidiary.  All other trademarks are the properties of their respective owners.
***************
Except for historical facts, the statements in this Annual Report on Form 10-K are forward-looking statements.  Forward-looking statements are merely our current predictions of future events.  These statements are inherently uncertain, and actual events could differ materially from our predictions.  Important factors that could cause actual events to vary from our predictions include those discussed in this Annual Report on Form 10-K under the heading “Risk Factors.”  We assume no obligation to update our forward-looking statements to reflect new information or developments.  We urge readers to review carefully the risk factors described in this Annual Report on Form 10-K and in the other documents that we file with the Securities and Exchange Commission.  You can read these documents at www.sec.gov.
 
 
 
 
3

 

 
PART I

ITEM 1.                      BUSINESS.

Introduction and Company Background
 
Crystal Rock Holdings, Inc., incorporated in Delaware in 1990, is engaged in the production, marketing and distribution of bottled water (the Crystal Rock® and Vermont Pure® brands)  and the distribution of coffee (including our Cool Beans® brand), ancillary products, and other office refreshment products as well as office products (the Crystal Rock Office® brand). We operate primarily as a distribution business to homes and offices, using our own trucks for distribution throughout New England, New York, and New Jersey.
 
Our distribution sales and services evolved from our initial business, sales of bottled water and cooler rentals.  We bottle our water and also have it bottled for us. All of our water products are still, non-sparkling waters as opposed to sparkling waters.  In addition to water and related services our other significant offerings have grown to include distribution of coffee and ancillary products, and other refreshment products including soft drinks and snacks.  To a lesser extent, we distribute these products through third party distributors and directly through vending machines.
 
Bottled water is a mainstream beverage and the centerpiece of many consumers’ healthy living lifestyles.  Sales of bottled water accounted for 40% of our total sales in fiscal 2011, compared to 44% in fiscal 2010. In addition, we believe that the development of the bottled water industry reflects public awareness of the potential contamination and unreliability of some municipal water supplies.  Conversely, bottled water has been the recent focus of publicity regarding concerns about the environmental effects of using plastic bottles, as well as the effect on the environment of water extraction and the production and disposal of plastic bottles (see Item 1A, Risk Factors).

Coffee, a product that is counter seasonal to water, is the second leading product in the distribution channel, accounting for 24% of our total sales in fiscal year 2011 and 23% of our total sales in 2010. We sell different brands and sizes of coffee products. We continue to promote our Cool Beans® brand coffee in an effort to increase profitability and create brand equity in the coffee category.  Because coffee is a commodity, coffee sales are affected by volatility in the world commodity markets.  An interruption in supply or a dramatic increase in pricing could have an adverse effect on our business.
 
The increase in coffee sales in recent years has been driven by the market growth of single-serve coffee products.   This development has revolutionized the marketplace and, while we expect the growth of these products to continue, innovation and changes in distribution are likely to play a significant role in the profitability of these products.

Water Sources, Treatment, and Bottling Operations

Water from local municipalities is the primary source for the Crystal Rock Waters® brand in 3 and 5 gallon bottles.  This accounts for 60% of our water bottled in these types of containers. Municipal water is purified through a number of processes beginning with filtration.  Utilizing carbon and ion exchange filtration systems, we remove chlorine and other volatile compounds and dissolved solids. After the filtration process, impurities are removed by reverse osmosis and/or distillation.  We ozonate our purified water (by injecting ozone into the water as an agent to prohibit the formation of bacteria) prior to storage.  Prior to bottling, we add pharmaceutical grade minerals to the water, including calcium and potassium, for taste. The water is again ozonated and bottled in a fully enclosed clean room with a high efficiency particulate air, or HEPA, filtering system designed to prevent any airborne contaminants from entering the bottling area, in order to create a sanitary filling environment.
 
 
 
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If for any reason the municipal sources for Crystal Rock® water were curtailed or eliminated, we could, though probably at greater expense, purchase water from other sources and have it shipped to our manufacturing facilities.

In conjunction with our acquisition of their Home and Office distribution assets, we entered into a contract with Mayer Brothers of Buffalo, New York to bottle our Crystal Rock® brand in that market.

The primary source of our natural spring water (primarily sold under the Vermont Pure® brand) is a spring owned by a third party in Stockbridge, Vermont that is subject to a 50- year water supply contract.  We also obtain water, under similar agreements with third parties, from springs in Bennington and Tinmouth, Vermont.  These three springs are approved by the State of Vermont as sources for natural spring water.  The contractual terms for these springs provide spring water in excess of our current needs and within the apparent capacity of the springs, and accordingly we believe that we can readily meet our bulk water supply needs for the foreseeable future. Water from these springs account for 40% of our total water bottled.

Percolation through the earth's surface is nature's best filter of water.  We believe that the age and extended percolation period of our natural spring water provides the natural spring water with certain distinct attributes: a purer water, noteworthy mineral characteristics (including the fact that the water is sodium free and has a naturally balanced pH), and a light, refreshing taste.

An interruption in or contamination of any of our spring sites would materially affect our business. We believe that we could find adequate supplies of bulk spring water from other sources, but that we might suffer inventory shortages or inefficiencies, such as increased purchase or transportation costs, in obtaining such supplies.

We are highly dependent on the integrity of the sources and processes by which we derive our products.  Natural occurrences beyond our control, such as drought, flood, earthquake or other geological changes, a change in the chemical or mineral content or purity of the water, or environmental pollution may affect the amount and quality of the water available from the springs or municipal sources that we use.  There is a possibility that characteristics of the product could be changed either inadvertently or by tampering before consumption.  Even if such an event were not attributable to us, the product’s reputation could be irreparably harmed.  Consequently, we would experience economic hardship.  Occurrence of any of these events could have an adverse impact on our business. We are also dependent on the continued functioning of our bottling processes.  An interruption could result in an inability to meet market demand and/or negatively impact the cost to bottle the products.

We have no material contractual commitments to the owners of our outside sources and bottling facilities other than for the products and services we receive.
 
We use outside trucking companies to transport bulk spring water from the source site to our bottling facilities.
 
 
 
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Products

We sell our major brands in three and five gallon bottles to homes and offices throughout New England, New York, and New Jersey. In general, Crystal Rock® is distributed in southern New England and upstate and western New York, while Vermont Pure® is primarily distributed throughout northern New England and upstate New York and secondarily in southern New England. We rent and sell water coolers to customers to dispense bottled water. Our coolers are available in various consumer preferences such as cold, or hot and cold, dispensing units. In addition, we sell and rent units to commercial accounts that filter water from the existing source on site.  We also rent and sell coffee brewing equipment and distribute a variety of coffee, tea and other hot beverage products and related supplies, as well as other consumable products used around the office.  We offer vending services in some locations.  We own the Cool Beans® brand of coffee which we distribute throughout our market area.  In addition to Cool Beans®, we sell other brands of coffee, most notably, Baronet and Green Mountain Coffee Roasters.

Our extensive distribution system and large customer lists afford us the opportunity to introduce new products that may benefit our current customers or appeal to new customers.  From time to time we may capitalize on these opportunities by expanding our product lines or replacing existing products with new ones.  In response to the increasingly competitive sales environment, we will consider distributing new products that we believe may enhance our sales and profitability.

Office Products Line

In 2010 we announced that we would add to our product lines in the future by offering a full line of office products using our Crystal Rock OfficeTM brand.  As part of this strategy, during fiscal 2011 and subsequently we have refocused our efforts on sales and marketing in order to better serve all of our product lines and enhance the value of our distribution system and customer base. We used cash to build an information technology infrastructure designed both to facilitate expansion of the Crystal Rock OfficeTM brand and improve our IT systems for our core business. We have worked to improve our sales and distribution systems, and we have established a Learning and Development Center in Watertown, Connecticut for our sales force.  We have also upgraded our website to enhance our customers’ abilities to order office and other products online.

Recognizing the value inherent in our distribution system, we do not maintain large inventories of office products.  Rather, we primarily purchase office products from large national vendors such as United Stationers that provide just-in-time delivery, with the result that the introduction of our office product line has not resulted, and is not expected to result, in a material outlay of resources to accommodate increased inventory.  We anticipate that the broader range of office products will contribute to our sales in the future so that this product line becomes a growing portion of our total sales.

We also expect to grow this part of our business by making appropriate acquisitions.  In November 2010 we acquired the assets of a small office products company in Hartford, Connecticut.  This acquisition provides us with a customer base and proven product line from which to expand in central Connecticut.  In 2011, we introduced office products sold under the Crystal Rock OfficeTM brand throughout Connecticut, and we plan to offer this class of products on a region-by-region basis throughout our entire market area in the future.  How rapidly we do this will depend, of course, on our level of success in the office products market.
 
 
 
6

 

 
Despite the advantage of not having to maintain a significant inventory for office products, we note that this line of products does not yield as much margin as our traditional lines, so that incremental sales will not proportionately be as profitable as our traditional lines have been.  No assurance can be given that we will achieve the anticipated sales and profitability in the future.

In addition to barriers to entry in this market such as establishing our brand name in the marketplace and developing our information technology systems, we face significant competition from other office products suppliers that have considerably greater assets and resources than we do and may be better known for office products sales in our markets.  We believe that we have a well-established distribution system and that the Crystal Rock® family of brands is well known in the regions in which we operate, and we hope to successfully leverage those advantages.  Nevertheless, price competition in the office product market can be robust, and there can be no assurance that our office products strategy will be successful.

Marketing and Sales of Branded Products

Crystal Rock products are marketed and distributed under four house brands - Crystal Rock Waters, Vermont Pure Natural Spring Water, Cool Beans Coffee and Crystal Rock Office. Through this combination of brands - and resale of other manufactured brands - we provide a choice of high quality products and value-added services to homes and offices.

Both our water brands feature three and five gallon premium bottled water in addition to a variety of small pack case offerings. Our coffee line includes over 70 varieties in fractional, pod and beans in bags, additionally, we also re-sell other coffee and tea selections.  The new office products line will feature over 40,000 products for supplying small and medium-sized business.  
 
We support this marketing and sales effort through a number of methods, including: e-commerce, direct mail, internet advertising, traditional advertising, social media, sales collateral, email marketing, digital/internet technologies, referrals and public relations.  We also sponsor local area sporting events, participate in trade shows, maintain high community visibility, and donate to many charitable events.

We market our home and office delivery service throughout most of New England, New York and parts of New Jersey.  A combination of telemarketers and sales personnel sell our products and services, and a professional marketing agency develops and manages our brands and market position. Our goal is to optimize our marketing and sales returns through efficient technology investments, personal customer interactions and maintaining consistent visibility. 

Advertising and Promotion

We advertise our products through a digital, online strategy focused on promoting expanded product and services, and we look to collect customer data in order to engage and market customer relationships both on and offline. Through a combination of websites, social platforms and internet advertising, we are centralizing and transitioning our marketing efforts to offer and incentivize current and new customers through a larger online presence while providing customers direct purchasing capability. In addition to Yellow Page advertising, we also promote our products through sales collateral, direct mail, various public relations and sponsorship opportunities.  

We endeavor to be highly visible in the communities that we serve. In recent years, we have sponsored professional minor league baseball and local sporting events and various charitable and cultural organizations, such as Special Olympics and the Multiple Sclerosis Society, by donating both product and money. In addition, we have been a significant sponsor of a United Way giving campaign to support Live United through the Greater Waterbury Connecticut United Way and featuring local giving options to support the United Way throughout our entire market area.
 
 
 
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Sales and Distribution

We sell and deliver products directly to our customers using our own employees and route delivery trucks.  We make deliveries to customers on a regularly scheduled basis.  We bottle our water at our facilities in Watertown, Connecticut, White River Junction, Vermont, and Halfmoon, New York and have water bottled for us in Buffalo and Clayton, New York.  We maintain numerous distribution locations throughout our market area.  From these locations we also distribute dispensing equipment, a variety of coffee, tea and other refreshment products, and related supplies.  We ship between our production and distribution sites using both our own and contracted carriers.

Supplies

We currently source all of our raw materials from outside vendors. As one of the largest Home and Office distributors in the country, we are able to capitalize on volume to continue to reduce costs.

We rely on trucking to receive raw materials and transport and deliver our finished products.  Consequently, the price of fuel significantly impacts the cost of our products.  We purchase our own fuel for our Home and Office delivery and use third parties for transportation of raw materials and finished goods between our warehouses.  While volume purchases can help control erratic fuel pricing, market conditions ultimately determine the price. In the past, we have experienced substantial market fluctuation of fuel prices.  However, when fuel prices have increased, we have been able to establish a fuel adjustment charge for our customers that covered the incremental rising cost of fuel.  When fuel prices have decreased, they have not decreased enough to offset the incremental fuel cost over what we considered our “base” level for fuel cost.  The risk remains 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.

Our principal coffee suppliers are Green Mountain Coffee Roasters and Baronet Coffee. Our principal bottle supplier is Parker Plastics.
 
No assurance can be given that we will be able to obtain the supplies we require on a timely basis or that we will be able to obtain them at prices that allow us to maintain the profit margins we have had in the past.  We believe that we will be able to either renegotiate contracts with these suppliers when they expire or, alternatively, if we are unable to renegotiate contracts with our key suppliers, we believe that we could replace them.  Any raw material disruption or price increase may result in an adverse impact on our financial condition and prospects.  For instance, we could incur higher costs in renegotiating contracts with existing suppliers or replacing those suppliers, or we could experience temporary dislocations in our ability to deliver products to our customers, either of which could have a material adverse effect on our results of operations.

Seasonality

Our business is seasonal. The period from June to September, when we have our highest water sales, represents the peak period for sales and revenues due to increased consumption of cold beverages during the summer months in our core Northeastern United States market. Conversely, coffee has a peak sales period from November to March.
 
 
 
8

 
 
Competition

We believe that bottled water historically has been a regional business in the United States.  The market includes several large regional brands owned by multi-national companies that operate throughout contiguous states. We also compete with smaller, locally-owned bottlers that operate in specific cities or market areas within single states.
 
With our Crystal Rock® and Vermont Pure® brands, we compete on the basis of pricing, customer service, the quality of our products, attractive packaging, and brand recognition.  We consider our trademarks, trade names and brand identities to be very important to our competitive position and defend our brands vigorously.  In addition, we offer polyethylene terephthalate (“PET”) plastic as an alternative bottle and have converted customers with health concerns about polycarbonate plastic to this container.

We feel that installation of filtration units in the home or commercial setting poses a competitive threat to our business.  To address this, we have continued to develop our plumbed-in filtration business expanding it internally and through acquisitions and actively offering it as an alternative product to our bottled water.

Over the years, cheaper water coolers available from retail outlets have become more prevalent, making customer purchasing a more viable alternative to leasing.  Traditionally, the rental of water coolers for offices and homes has been a very profitable business for us.  As coolers have become cheaper and more readily available at retail outlets, our cooler rental revenue has declined.  Although this rental revenue is very profitable for us, it may continue to decline or become less profitable in the future as a result of retail competition.

As discussed above, coffee is another significant component of our overall sales.  The growth of this product line has been driven by single serve packages.  Increased competition has developed for these products, not only from other food and beverage distributors, but office products distributors as well. In addition, retail and internet availability has increased.  Machines to brew these packages are different from traditional machines and packages ideally need to be brewed in machines that accommodate the specific package.  As a result, the popularity of a certain machine often dictates what products are successful in the marketplace.  Consequently, our success, both from a sales and profitability perspective, may be affected by our access to distribution rights for certain products and machines and our decisions concerning which equipment to invest in.

We believe that it has become increasingly important to our competitive advantage to decrease the impact of our business on the environment.   We traditionally use five gallon containers that are placed on coolers and are reused many times.  To further “green” our business we generate solar electricity in our Watertown, Connecticut facility, use high efficiency lighting and vehicles and have instituted no-idling and other driving policies in all of our locations.
 
Trademarks

We own the trade names of the principal water brands that we sell, Vermont Pure Natural Spring Water® and Crystal Rock®.  We also own the Cool Beans® coffee brand, Crystal Rock Office® products brand and own or have rights to other trade names that currently are not a significant part of our business.   Our trademarks as well as label designs are, in general, registered with the United States Patent and Trademark Office.
 
 
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Government Regulation

The Federal Food and Drug Administration (FDA) regulates bottled water as a “food.”  Accordingly, our bottled water must meet FDA requirements of safety for human consumption, of processing and distribution under sanitary conditions and of production in accordance with the FDA “good manufacturing practices.”  To assure the safety of bottled water, the FDA has established quality standards that address the substances that may be present in water which may be harmful to human health as well as substances that affect the smell, color and taste of water.  These quality standards also require public notification whenever the microbiological, physical, chemical or radiological quality of bottled water falls below standard.  The labels affixed to bottles and other packaging of the water is subject to FDA restrictions on health and nutritional claims for foods under the Fair Packaging and Labeling Act.  In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water quality and treatment that are enforced by the FDA.

We are subject to the food labeling regulations required by the Nutritional Labeling and Education Act of 1990.  We believe we are in compliance with these regulations.

We are subject to periodic, unannounced inspections by the FDA.  Upon inspection, we must be in compliance with all aspects of the quality standards and good manufacturing practices for bottled water, the Fair Packaging and Labeling Act, and all other applicable regulations that are incorporated in the FDA quality standards.  We believe that we meet the current regulations of the FDA, including the classification as spring water.  All of our plants and distribution locations are registered with the FDA under the "Public Health Security and Bioterrorism Preparedness and Response Act of 2002". Most recently, the FDA put into effect the Bottled Water Microbial Rule to monitor water sources for E. coli bacteria.  We have been in compliance with the testing requirements for this rule prior to and since its inception in December 2009.

We also must meet state regulations in a variety of areas to comply with purity, safety, and labeling standards.  From time to time, our facilities and sources are inspected by various state departments and authorities.

Our product labels are subject to state regulation (in addition to federal requirements) in each state where the water products are sold.  These regulations set standards for the information that must be provided and the basis on which any therapeutic claims for water may be made.

The bottled water industry has a comprehensive program of self-regulation.  We are a member of the International Bottled Water Association, or IBWA.  As a member, our facilities are inspected annually by an independent laboratory, the National Sanitation Foundation, or NSF.  By means of unannounced NSF inspections, IBWA members are evaluated on their compliance with the FDA regulations and the Association's performance requirements, which in certain respects are more stringent than those of the federal and various state regulations.

In recent years, there has been an increasing amount of proposed legislative and executive action in state and local governments that would ban the use of bottled water in municipal buildings, enact local taxes on bottled water, and limit the sale by municipalities of water supplies to private companies for resale.  Such regulation could adversely affect our business and financial results.  For additional information, see “Risk Factors” below.
 
 
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The laws that regulate our activities and properties are subject to change.  As a result, there can be no assurance that additional or more stringent requirements will not be imposed on our operations in the future. Although we believe that our water supply, products and bottling facilities are in substantial compliance with all applicable governmental regulations, failure to comply with such laws and regulations could have a material adverse effect on our business.

Employees

As of January 12, 2012, we had 343 full-time employees and 12 part-time employees.   None of the employees belong to a labor union.  We believe that our relationships with our employees are good.

Additional Available Information
 
Our principal website is www.crystalrock.com.  We make our annual, quarterly and current reports, and amendments to those reports, available free of charge on www.crystalrock.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC).  Reports of beneficial ownership of our common stock, and changes in that ownership, by directors, officers and greater-than-10% shareholders on Forms 3, 4 and 5, are likewise available free of charge on our website.

The information on our website is not incorporated by reference in this Annual Report on Form 10-K or in any other report, schedule, notice or registration statement filed with or submitted to the SEC.
 
The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov.  You may also read and copy the materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

ITEM 1A.   RISK FACTORS.

We operate in a competitive business environment that is influenced by conditions some of which are controllable and other are beyond our control.  These conditions include, but are not limited to, the regional economy, monetary policy, and the political and regulatory environment.  The following summarizes important risks and uncertainties that may materially affect our business in the future.

The Baker family currently owns a majority of our voting stock and controls the company.  Such control affects our corporate governance, and could also have the effect of delaying or preventing a change of control of the company.

The Baker family group, consisting of four current directors Henry Baker (Chairman Emeritus), Peter Baker (CEO), John Baker (Executive Vice President) and Ross Rapaport (Chairman), as trustee, together own a majority of our common stock.  Accordingly, these stockholders, acting together, can exert a controlling influence over the outcome of matters requiring stockholder approval, such as the election of directors, amendments to our certificate of incorporation, mergers and various other matters.  The concentration of ownership could also have the effect of delaying or preventing a change of control of the company.
 
 
 
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As permitted under the corporate governance rules of the NYSE Amex, we have, at the direction of the Baker family group, elected “controlled company” status under those rules.  A controlled company is exempted from these NYSE Amex corporate governance rules:  (1) the requirement that a listed company have a majority of independent directors, (2) the requirement that nominations to the company’s board of directors be either selected or recommended by a nominating committee consisting solely of independent directors, and (3) the requirement that officers’ compensation be either determined or recommended by a compensation committee consisting solely of independent directors.  We do not currently utilize exemption (3) as we have a compensation committee consisting solely of two independent directors.

The personal interests of our directors and officers create conflicts.

As mentioned above, the Baker family group owns a majority of our common stock.  In addition, in connection with the acquisition of the Crystal Rock Spring Water Company in 2000, we issued members of the Baker family group 12% subordinated promissory notes secured by all of our assets. The current principal balance on these notes is $13,000,000.  We also lease important facilities in Watertown and Stamford, Connecticut from Baker family interests.  These interests of the Baker family create various conflicts of interest.  Transactions between the Company and related parties are subject to review and approval by the Audit Committee, which consists entirely of independent directors.

Our success depends on the continued services of key personnel.

Our continued success will depend in large part upon the expertise of our senior management and their ability to execute our strategic planning.  Peter Baker, our Chief Executive Officer and President, John Baker, our Executive Vice President, and Bruce MacDonald, our Chief Financial Officer, Treasurer and Secretary, have entered into employment agreements with Crystal Rock Holdings, Inc.  These “at will” employment agreements do not prevent these employees from resigning.  The departure or loss of any of these executives individually could have an adverse effect on our business and operations.

We depend upon maintaining the integrity of our water sources and manufacturing process.   If our water sources or bottling processes were contaminated for any reason, our business would be seriously harmed.

Our ability to retain customers and the goodwill associated with our brands is dependent upon our ability to maintain the integrity of our water resources and to guard against defects in, or tampering with, our manufacturing process.  The loss of integrity in our water sources or manufacturing process could lead to product recalls and/or customer illnesses that could materially adversely affect our goodwill, market share and revenues.  Because we rely upon natural spring sites for sourcing some of our water supply, acts of God, such as earthquakes, could alter the geologic formation of the spring sites, constricting or even contaminating water flow.

In addition, we do not own any of our water sources.  Although we believe the long term rights to our spring and municipal sources are well secured, any dispute over these rights that resulted in prolonged disruption in supply could cause an increase in cost of our product or shortages that would not allow us to meet the market demand for our product.
 
 
12

 
 
Our Company is significantly leveraged.  Over the years, we have borrowed substantial amounts of money to finance acquisitions.  If we are unable to meet our debt service obligations to our senior and subordinated lenders, we would be in default under those obligations, and that could hurt our business or even result in foreclosure, reorganization or bankruptcy.

At October 31, 2011 and 2010, our outstanding senior debt was $12,179,000 and $14,393,000, respectively, and our outstanding subordinated debt was $13,000,000 on both dates.  The underlying loans are secured by substantially all of our assets.  If we do not repay our indebtedness in a timely fashion, our secured creditors could declare a default and foreclose upon our assets, which would result in harmful disruption to our business, the sale of assets for less than their fully realizable value, and possible bankruptcy.  We must generate enough cash flow to service this indebtedness until maturity.
 
Fluctuations in interest rates could significantly increase our expenses.  We will have significant interest expense for the foreseeable future, which in turn may increase or decrease due to interest rate fluctuations.  To partially mitigate this risk, we have used swaps to establish fixed interest rates on 75% of our outstanding senior term debt.

As a result of our large amount of debt, we may be perceived by banks and other lenders to be highly leveraged and close to our borrowing ceiling.  Until we repay some of our debt, our ability to access additional capital may be limited.  In turn, that may limit our ability to finance transactions and to grow our business.  In addition, our senior credit agreement limits our ability to incur incremental debt without our lender’s permission.

Our senior credit agreement contains numerous covenants and restrictions that affect how we conduct our business.

We face competition from companies with far greater resources than we have.  In addition, methods of competition in the distribution of home and office refreshment products continue to change and evolve.  If we are unable to meet these changes, our business could be harmed.

We operate in highly competitive markets.  The principal methods of competition in the markets in which we compete are distribution capabilities, brand recognition, quality, reputation, and price.   We have a significant number of competitors in our traditional water market, some of which have far greater resources than us.  Among our principal competitors are Nestlé Waters North America, large regional brands owned by private groups, and local competitors in the markets that we serve.  As we have expanded our product lines, most notably single serve coffee, we have become competitive with other businesses.  These include large national and regional office supply companies and retail store chains.  Price reductions and the introduction of new products by our competitors can adversely affect our revenues, gross margins, and profits.
 
Our industry has also been affected by the increasing availability of water coolers in discount retail outlets.  This has negatively affected our rental revenue stream in recent years as more customers choose to purchase coolers rather than rent them.  The reduction of rental revenue has been somewhat offset by the increase in coolers that we sell, although not to the extent that rentals have declined. We do not expect retail sales to replace rentals completely because we believe that the purchase option does not provide the quality and service that many customers want.  However, third party retail cooler sales may continue to negatively impact our rental revenues in the future.
 
 
13

 
 
The bottled water industry is regulated at both the state and federal level.  If we are unable to continue to comply with applicable regulations and standards in any jurisdiction, we might not be able to sell our products in that jurisdiction, and our business could be seriously harmed.

The FDA regulates bottled water as a food.  Our bottled water must meet FDA requirements of safety for human consumption, labeling, processing and distribution under sanitary conditions and production in accordance with FDA “good manufacturing practices.”  In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water quality and treatment, which are enforced by the FDA.  We also must meet state regulations in a variety of areas.  These regulations set standards for approved water sources and the information that must be provided and the basis on which any therapeutic claims for water may be made.  We have received approval for our drinking water in Connecticut, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont.  However, we can give no assurance that we will receive such approvals in the future.

Legislative and executive action in state and local governments banning the use of municipal funds for purchasing bottled water, enacting local taxes on bottled water or water extraction, and restricting water withdrawal and usage rights from public and private sources could adversely affect our business and financial results.

Recent initiatives have taken place in several major cities regarding bottled water, principally the smaller sizes sold in stores to retail consumers.  Regulations have been proposed in some localities that would ban the use of public funds to purchase bottled water, enact local taxes on bottled water or water extraction, and restrict the withdrawal of water from public and private sources.  These actions are purportedly designed to discourage the use of bottled water due in large part to concerns about the environmental effects of producing and discarding large numbers of plastic bottles.  In developing these stories, local and national media have reported on the growth of the bottled water industry and on the pros and cons of consuming bottled water as it relates to solid waste disposal and energy consumption in manufacturing, as well as conserving the supply of water available to the public.
 
We believe that the adverse publicity associated with these reports is generally aimed at the retail, small bottle segment of the industry that is now a minimal part of our business, and that our customers can readily distinguish our products from the retail bottles that are currently the basis for concern in some areas.  Our customers typically buy their water in reusable five-gallon containers that are placed on coolers and reused many times.  Only approximately 4% of our total sales is from water sold in single serve packages.  In addition, we continue to take steps to “green” our business by means of solar electricity generation, high efficiency lighting, no-idling and other driving policies, and the use of biodiesel.
 
While we believe that to date we have not directly experienced any adverse effects from these concerns, and that our products are sufficiently different from those under scrutiny, there is no assurance that adverse publicity about any element of the bottled water industry will not affect consumer behavior by discouraging buyers from buying bottled water products generally.  In that case, our sales and other financial results could be adversely affected.
 
Fluctuations in the cost of essential raw materials and commodities, including fuel costs, for the manufacture and delivery of our products could significantly impact our business.
 
 
14

 
 
Bottle manufacturers use plastic and other petroleum-based products for the manufacturing of our bottles.  Increases in the cost of petroleum will likely have an impact on our bottle costs.

We rely on trucking to receive raw materials and transport and deliver our finished products.  Consequently, the price of fuel significantly impacts the cost of our products.  We purchase our own fuel for our Home and Office delivery and use third parties for transportation of raw materials and finished goods between our warehouses.  While volume purchases can help control erratic fuel pricing, market conditions ultimately determine the price. In the past, we have experienced substantial market fluctuation of fuel prices.  However, when fuel prices have increased, we have been able to establish a fuel adjustment charge for our customers that covered the incremental rising cost of fuel.  When fuel prices have decreased, they have not decreased enough to offset the incremental fuel cost over what we considered our “base” level for fuel cost.  The risk remains 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.

We have a limited amount of bottling capacity.  Significant interruptions of our bottling facilities could adversely affect our business.

We own three bottling facilities, and also contract with third parties, to bottle our water.  If any of these facilities were incapacitated for an extended period of time, we would likely have to relocate production to an alternative facility.  The relocation and additional transportation could increase the cost of our products or result in product shortages that would reduce sales.  Higher costs and lower sales would reduce profitability.

We rely upon a single software vendor that supplies the software for our route accounting system.

Our route accounting system is essential to our overall administrative function and success.  An extended interruption in servicing the system could result in the inability to access information.  Limited or no access to this information would likely inhibit the distribution of our products and the availability of management information, and could even affect our compliance with public reporting requirements.  Our software vendor has a limited number of staff possessing the proprietary information pertaining to the operation of the software.  Changes in personnel or ownership in the firm might result in disruption of service.  Such changes would be addressed by retaining a new vendor to service the existing software or purchasing a new system.  However, any of these events could have a material adverse impact on our operations and financial condition.

Our customer base is located in New England, New York and New Jersey.  If there were to be a material decline in the economy in these regions, our business would likely be adversely affected.
 
 
15

 
 
Essentially all of our sales are derived from New England, New York and New Jersey.  We believe that the economic recession experienced in these areas, particularly in 2008 and 2009, adversely affected our financial results, and these regions are still experiencing a variety of adverse effects from the recession.  Continued adverse effects in the regional economies, or a significant negative change in the economy of any of these regions, changes in consumer spending in these regions, or the entry of new competitors into these regional markets, among other factors, could result in a decrease in our sales and, as a result, reduced profitability.

Our business is seasonal, which may cause fluctuations in our stock price.

Historically, the period from June to September represents the peak period for sales and revenues due to increased consumption of beverages during the summer months in our core Northeastern United States markets.  Warmer weather in our geographic markets tends to increase water sales, and cooler weather tends to decrease water sales.  To the extent that our quarterly results are affected by these patterns, our stock price may fluctuate to reflect them.

Acquisitions may disrupt our operations or adversely affect our results.
 
We regularly evaluate opportunities to acquire other businesses.  The expenses we incur evaluating and pursuing acquisitions could have a material adverse effect on our results of operations.  If we acquire a business, we may be unable to manage it profitably or successfully integrate its operations with our own.  Moreover, we may be unable to realize the financial, operational, and other benefits we anticipate from these acquisitions.  Competition for future acquisition opportunities in our markets could increase the price we pay for businesses we acquire and could reduce the number of potential acquisition targets.  Further, acquisitions may involve a number of special financial and business risks, such as:
 
  
charges related to any potential acquisition from which we may withdraw;
 
  
diversion of our management’s time, attention, and resources;
 
  
decreased utilization during the integration process;
 
  
loss of key acquired personnel;
 
  
increased costs to improve or coordinate managerial, operational, financial, and administrative systems, including compliance with the Sarbanes-Oxley Act of 2002;
 
  
dilutive issuances of equity securities, including convertible debt securities;
 
  
the assumption of legal liabilities;
 
  
amortization of acquired intangible assets;
 
  
potential write-offs related to the impairment of goodwill;
 
  
difficulties in integrating diverse corporate cultures; and
 
  
additional conflicts of interests.
 
 
 
16

 
 
ITEM 1B.
UNRESOLVED STAFF COMMENTS.

 
None.

ITEM 2.
PROPERTIES.

As part of our Home and Office delivery operations, we have entered into or assumed various lease agreements for properties used as distribution points and office space.  The following table summarizes these arrangements and includes our bottling facilities:

Location
Lease expiration
Sq. Ft.
     Annual Rent
Williston, VT
June 2014
10,720
$81,686
Bow, NH
May 2012
12,800
57,000
Rochester, NY
January 2017
15,000
60,000
Buffalo, NY
September 2021
20,000
92,000
Syracuse, NY
December 2015
10,000
38,520
Halfmoon, NY
October 2016
22,500
166,275
Plattsburgh, NY
Month-to-month
5,000
24,000
Watertown, CT*
October 2016
67,000
452,250
Stamford, CT
October 2020
22,000
248,400
White River Junction, VT
May 2014
15,357
77,706
Watertown, CT
May 2013
15,000
57,960
Groton, CT
June 2014
7,500
56,375
Canton, MA
Middlebury, CT
Watertown, CT
January 2015
February 2016
September 2013
23,966
3,750
1,931
149,788
24,413
24,000
* Corporate headquarters

All locations are used primarily for warehousing and distribution and have limited office space for location managers and support staff.  The exception is our headquarters in Watertown, Connecticut location, which has a substantial amount of office space for sales, accounting, information systems, customer service, and general administrative staff.

The landlord for the buildings in Stamford and the headquarters in Watertown, Connecticut is a trust with which Henry, John, and Peter Baker, and Ross Rapaport are affiliated.  We believe that the rent charged under these leases is not more than fair market rental value.

We expect that these facilities will meet our needs for the next several years.
 
 
ITEM 3.
LEGAL PROCEEDINGS.

None.
 

ITEM 4.
Reserved.
 
 
 
17

 
 
PART II

ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Our Common Stock is traded on the NYSE Amex under the symbol CRVP.  The table below indicates the range of the high and low daily closing prices per share of Common Stock as reported by the exchange.
 
                     Fiscal Year Ended October 31, 2011
 
High
Low
  First Quarter
$  .90
$.66
  Second Quarter
$1.00
$.77
  Third Quarter
$1.54
$.72
  Fourth Quarter
$  .90
$.68
 
                     Fiscal Year Ended October 31, 2010
 
High
Low
  First Quarter
$  .67
$.50
  Second Quarter
$  .81
$.57
  Third Quarter
$  .89
$.64
  Fourth Quarter
$  .84
$.60

The last reported sale price of our Common Stock on the NYSE Amex on January 12, 2012 was $.78 per share.

As of that date, we had 362 record owners and believe that there were approximately 2,000 beneficial holders of our Common Stock.

No dividends have been declared or paid to date on our Common Stock.  Our senior credit agreement prohibits us from paying dividends without the prior consent of the lender.  It is unlikely that we will pay dividends in the foreseeable future.

Issuer Purchases of Equity Securities

None.
 
 
18

 
 
 
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following Management's Discussion and Analysis (MD&A) is intended to help the reader understand our Company.  The MD&A should be read in conjunction with our consolidated financial statements and the accompanying notes. This overview provides our perspective on the individual sections of the MD&A, as well as a few helpful hints for reading these pages.  The MD&A includes the following sections:

§  
Business Overview a brief description of fiscal year 2011.

§  
Results of Operations — an analysis of our consolidated results of operations for the two years presented in our consolidated financial statements.
 
§  
Liquidity and Capital Resources — an analysis of cash flows, sources and uses of cash, and contractual obligations and a discussion of factors affecting our future cash flow.
 
§  
Critical Accounting Policies — a discussion of accounting policies that require critical judgments and estimates. Our significant accounting policies, including the critical accounting policies discussed in this section, are summarized in the notes to the accompanying consolidated financial statements.

Business Overview
 
Our sales were higher but our business was less profitable for fiscal year 2011 than in the same period a year ago. The increase in sales was largely due to an acquisition and expansion of product lines completed at the start of the fiscal year. Lower sales of traditional products, abnormally stormy weather, spending on information systems infrastructure and non-recurrence of a legal settlement resulted in lower profitability.

§  
Water sales were less than the previous year, in part, because of adverse winter weather in the first quarter of 2011 compared to abnormally warm weather in the third quarter of 2010 in the Company’s market area.
§  
Due to the fact that the sales increase related to products other than water, as a percentage of sales, gross margin declined. New products offered in conjunction with our brand expansion yield a lower gross margin than water and coffee, in general.
§  
We experienced higher operating expenses during the year, in part to upgrade our customer relationship and e-commerce software, which resulted in lower net income compared to a year ago.
§  
In 2010 we received legal settlement of $3,500,000, $2,100,000 net of tax, that did not recur in 2011.

In late August 2011, Tropical Storm Irene caused considerable and widespread damage in parts of our market area.  The primary effect on our business was 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.  There was no material limitation to our ability to service our customers, but our route and transportation costs temporarily increased in the fourth quarter of the fiscal year.  The storm impacted our business in that quarter and, to a lesser extent, in the first quarter of 2012. The effect is difficult to quantify because of other variables but there has been no lasting material effect on our business.
 
 
 
19

 

 
In addition, parts of Connecticut and Massachusetts experienced a major snowstorm in late October 2011, shutting off power and access in some parts of those states for more than a week.  Again, it became more difficult for our delivery trucks to reach our customers in those areas. The major portion of the financial effect from this event was in the first quarter of 2012.  Although it did not have a lasting material adverse effect on our operations, it did result in decrease in sales for the periods that were difficult to quantify.

We continue to have adequate cash on hand while reducing debt. In 2011, we used a significant amount of cash to commence an upgrade of our information technology infrastructure to facilitate an expansion of our product offerings and run our business more efficiently.

In 2011 we commenced our plan to sell office products. To date, we are selling these lines only in Connecticut.   Accordingly, these activities may require us to use more cash and increase debt to take advantage of market expansion and future sales growth and profit margin opportunities.

The market area in which we operate has an uncertain economic environment. 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

Fiscal Year Ended October 31, 2011 Compared to Fiscal Year Ended October 31, 2010

Sales
Sales for fiscal year 2011 were $71,610,000 compared to $67,781,000 for 2010, an increase of $3,829,000 or 6%.  Sales attributable to acquisitions in fiscal year 2011 were $1,395,000.  Net of the acquisitions, sales increased 4%.

The comparative breakdown of sales is as follows:

Product Line
 
2011
(in 000’s $)
   
2010
(in 000’s $)
   
Difference
(in 000’s $)
   
% Diff.
Water
  $ 28,993     $ 29,661     $ (668 )     (2 %)
Coffee and Related
    23,013       20,895       2,118       10 %
Equipment Rental
    8,655       8,912       (257 )     (3 %)
Other
    10,949       8,313       2,636       32 %
Total
  $ 71,610     $ 67,781     $ 3,829       6 %

Water – The aggregate decrease in water sales was a result of a 1% decrease in price and a 1% decrease in volume.  The decrease in price and the amount of water sold was attributable to competition. In addition, winter snow storms in southern New England and spring and summer flooding in northern New England reduced volume distribution during 2011. Acquisitions had no impact in the change of water sales in fiscal year 2011 compared to 2010.
 
Coffee and Related Products – The increase in sales was primarily due to a 15% increase of traditional coffee and 11% growth in sales of single serve coffee. Also there was a 3% increase in ancillary coffee refreshment products.  Coffee sales grew as a result of strong market demand despite higher pricing. Single serve coffee sales increased to $11,883,000 in 2011 from $10,679,000 in 2010. Acquisitions did not materially affect this category in 2011 compared to 2010.
 
 
 
20

 
 
Equipment Rental – The decrease in equipment rental revenue in fiscal year 2011 compared to the prior year was a result of a 4% decrease in placements that more than offset a 1% increase in average rental price.  The decrease in placements was due to lower market demand.  Acquisitions had no impact in the change of rental revenue in fiscal year 2011 compared to 2010.

Other – The increase in other revenue is attributable to higher sales of other products, which increased 2%, most notably water in single serve containers and cups. The increase also reflects an increase in fuel adjustment fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations as a result of higher fuel prices. Fuel adjustment charges increased 36% in 2011 from 2010. In addition, office products and stamps which were not sold the prior year, accounted for sales of $1,742,000 in 2011.

Gross Profit/Cost of Goods Sold
Gross profit increased $259,000, or 1%, in fiscal year 2011 compared to 2010, to $37,238,000 from $36,979,000. As a percentage of sales, gross profit decreased to 52% of sales from 55% for the respective periods.  The decrease in gross profit margin was attributable to higher product costs, particularly for coffee, and changes in product sales mix – most notably lower water and rental sales and higher sales of coffee, refreshment, and office products which yield a lower margin.  Gross profit in fiscal year 2011 was favorably impacted by an increase in fuel adjustment charges that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations.

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.  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.
 
Income from Operations/Operating Expenses
Income from operations was $4,507,000 in 2011 compared to $6,133,000 in 2010, a decrease of $1,626,000.  Total operating expenses increased to $32,731,000 for the year, from $30,846,000 the prior year, an increase of $1,885,000.
 
Selling, general and administrative (SG&A) expenses were $30,059,000 in fiscal year 2011 and $28,254,000 in 2010, an increase of $1,805,000, or 6%.  Of total SG&A expenses:

  
Route sales costs increased 2%, or $201,000, to $13,565,000 in fiscal year 2011 from $13,364,000 in fiscal year 2010, primarily related to higher fuel costs which more than offset lower labor costs.  Included as a component of route sales costs are total direct distribution related costs which increased $169,000, or 1%, to $12,879,000 in fiscal year 2011 from $12,710,000 in fiscal year 2010, primarily as a result of higher fuel costs;
 
  
Selling costs increased 44%, or $1,395,000, to $4,592,000 in fiscal year 2011 from $3,197,000 in fiscal year 2010 as a result of higher computer related service costs to support the infrastructure improvement of e-commerce and customer relationship management software. During fiscal 2011, we expensed $1,512,000 related to information technology upgrades;
 
 
 
21

 
 
 
  
Administrative costs increased 2%, or $209,000, to $11,902,000 in fiscal year 2011 from $11,693,000 in fiscal year 2010, as a result of higher labor costs despite lower professional fees related to compliance and litigation.

Advertising expenses increased to $1,555,000 in fiscal year 2011 from $1,450,000 in 2010, an increase of $105,000, or 7%. The increase in advertising costs is primarily related to an increase in agency costs and internet advertising that more than offset a decrease in yellow page advertising and brochures.

Amortization decreased $12,000 to $1,068,000 in fiscal year 2011 from $1,080,000 in 2010.  Amortization is attributable to intangible assets that were acquired as part of acquisitions in recent years.

There was a loss from the sale of miscellaneous assets in fiscal year 2011 of $49,000 compared to a loss on the sale of assets of $63,000 in fiscal year 2010. These were sales of miscellaneous assets no longer used in the course of business.

We conducted an assessment of goodwill as of October 31, 2011 and 2010. The assessment of the carrying value of goodwill is a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches – quoted stock price (a market approach), value comparisons to publicly traded companies (see note 1) believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach).  These approaches provide a reasonable estimation of the value of the Company and take into consideration the Company’s thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations.  We used the following percentages for the weighted average of the three different approaches in both fiscal year 2011 and 2010:
   
Quoted stock price
20%
Value comparisons to publicly traded companies
20%
Discounted net cash flow
60%
 
The resulting estimated fair value is then compared to the Company’s equity value. The assessments concluded that the Company’s fair value exceeded the Company’s equity, therefore goodwill was not impaired as of the respective valuation dates.  Since step one indicated no impairment, step two was not necessary. If impairment had been indicated, we would have then allocated the estimated fair value to all of the assets and liabilities of the Company (including unrecognized intangible assets) as if the Company had been acquired in a business combination and the estimated fair value was the price paid. We then would have recognized impairment in the amount by which the carrying value of goodwill exceeded the implied value of goodwill as determined in this allocation.
 
_______________________________
 
1 These were the companies used in the year marked:
Company Name
  Exchange
  Symbol
2011
2010
Coca-Cola Bottling Co., Consolidated
NYSE
COKE
X
X
Farmer Bros. Co.
NASDAQ
FARM
X
X
Green Mountain Coffee Roasters, Inc.
NASDAQ
GMCR
X
X
Hansen Natural, Corp.
NASDAQ
HANS
X
X
Coca-Cola Enterprises, Inc.
NYSE
CCE
X
X
National Beverage Corp.
NASDAQ
FIZZ
X
X
Cott Corporation
Toronto
BCB
X
X
Coffee Holding Co., Inc.
NASDAQ
JVA
X
 
Dr. Pepper Snapple Group, Inc.
NYSE
DPS
X
 
Leading Brands, Inc.
NASDAQ
LBIX
X
 
Primo Water Corporation
NASDAQ
PRMW
X
 
 
 
 
22

 
 
Other Income and Expense, Income Taxes, and Income before Income Taxes
Interest expense was $2,247,000 for fiscal year 2011 compared to $2,450,000 for fiscal year 2010, a decrease of $203,000.  The decrease is primarily attributable to lower outstanding debt.
 
In fiscal year 2010 the Company received a one-time payment of $3,500,000 as a legal settlement that did not recur in 2011.

Income before income taxes in fiscal year 2011 was $2,255,000 compared to $7,166,000 in fiscal year 2010, a decrease of $4,911,000.   Operating results were lower as a result of higher operating expenses and the non-recurrence of the one-time payment mentioned above.

Tax expense for fiscal year 2011 was $770,000 compared to $2,910,000 for fiscal year 2010 and resulted in an effective tax rate of 34% in 2011 and 41% in 2010. The decrease in the effective tax rate from 2010 to 2011 was primarily a result of a settlement of a state tax issue that was favorable to the Company.  Our total effective tax rate is a combination of federal and state rates for the states in which we operate.

Net Income
Net income in fiscal year 2011 was $1,486,000 compared to net income of $4,256,000 in 2010, a decrease of $2,770,000.  The variance was primarily attributable to lower income from operations and non-operating legal settlement in 2010, net of a higher tax provision. Net income in both years was completely attributable to continuing operations.
 
Based on the weighted average number of shares of Common Stock outstanding of 21,389,000 (basic and diluted), income per share in fiscal year 2011 was $.07 per share.  This was a decrease of $.13 per share from fiscal year 2010, when the weighted average number of shares of Common Stock outstanding was 21,477,000 (basic and diluted) and we had net income of $.20 per share.
 
 
The fair value of our interest rate hedge swap agreements increased favorably $374,000 during fiscal year 2011 compared to an unfavorable decrease of $57,000 in 2010. This resulted in unrealized gain of $231,000 and unrealized loss of $29,000, net of reclassification adjustments and taxes, respectively, for the fiscal years ended October 31, 2011 and 2010.  The increase during the year has been recognized as an adjustment to net income to arrive at comprehensive income as defined by the applicable accounting standards.

 
 
 
23

 
 
Liquidity and Capital Resources

As of October 31, 2011, we had working capital of $8,640,000 compared to $8,425,000 as of October 31, 2010, an increase of $215,000.  The increase in working capital was primarily attributable to net cash provided by operations. Net cash provided by operating activities was $6,141,000 in 2011 compared to $9,130,000 in 2010, a decrease of $2,989,000. The decrease is a result of lower net income in 2011. A significant portion of net income was derived from a legal settlement which resulted in $2,100,000, net of tax.

We use cash provided by operations to repay debt and fund capital expenditures.  In fiscal year 2011, we used $2,413,000 for repayment of debt. This was $1,536,000 less than we paid in 2010 because of a $1,000,000 one-time repayment of senior debt and an unscheduled re-payment of $500,000 on our subordinated debt in 2010. We used $621,000 less for capital expenditures in 2011 than in 2010. We spent less on water bottles and coolers and more on coffee brewers in 2011 than in 2010.   In addition, there were less capital expenditures on computers and software in 2011 but we used $1,614,000 in cash to fund information technology infrastructure upgrades which were operating expenses due to the nature of the upgrades. We used $472,000 more cash to complete acquisitions in 2011 than the prior year.

As a result of lower debt re-payment and capital expenditures as well as less cash used for taxes, attributable to a lower tax rate, in 2011 there was a net increase in cash of $486,000 for the year. In 2010, the net increase in cash was $1,797,000 as a result of more cash provided by operating activities despite higher debt re-payment and capital expenditures.

Our Credit Agreement with Bank of America 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 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.  Since sufficient cash was generated from operations, we have not borrowed from the facility in the past two years so there was no balance on the line of credit as of October 31, 2011.  However, it collateralized a letter of credit of $1,531,000.  Consequently, as of October 31, 2011, there was $3,469,000 available to borrow from the revolving line of credit. There was $12,179,000 outstanding on the term note as of October 31, 2011.  In addition, as of that date, we had $13,000,000 of debt subordinated to our senior credit facility.

As of the end of fiscal year 2011, we had three interest rate hedge swap agreements. A 2007 agreement (old swap) fixed the interest rate on 75% of the outstanding balance on the term loan (the swapped amount) with Bank of America as required by the previous 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.  We entered into an agreement (offsetting swap) when the previous facility was amended to offset the old swap, for which we receive 1.40% of the scheduled balance of the old term loan effectively limiting 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 the old and offsetting swaps mature.   Finally, we entered into an agreement (new swap) to fix the interest rate of 75% of the outstanding balance of the new term note at 4.26% (2.01% plus the applicable margin, 2.25%) maturing May 2015.

As of October 31, 2011, the total notional amount committed to the new swap agreement was $9,134,000.  This agreement provides for a monthly settlement in which the Company would make or receive payments at a variable rate determined by a specified index (one-month LIBOR) in exchange for making payments at a fixed rate of 4.26%. On that date, the variable rate on the remaining 25% of the term note ($3,045,000) was 2.74%.
 
 
 
24

 

 
The Credit Agreement 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 October 31, 2011, we were in compliance with all of the financial covenants of our credit facility and we expect to be in compliance in the foreseeable future. Under the Agreement, the Company is obligated to calculate Consolidated Excess Cash Flow based on its financial results for the fiscal year to determine if additional principal is due on the term note. Based on the results for fiscal year 2011, a $500,000 principal payment is due by February 8, 2012.   The Agreement also prohibits us from paying dividends without prior consent of the lender.
 
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 balance sheet.  These operating leases are described in Note 15 to our Audited Consolidated Financial Statements.

The following table sets forth our contractual commitments as of October 31, 2011:

   
Payment due by Period
 
 
Contractual Obligations
 
Total
   
2012
      2013-2014       2015-2016    
After 2016
 
Debt
  $ 25,179,000     $ 2,714,000     $ 4,428,000     $ 18,037,000     $ -  
Interest on Debt (1)
    7,675,000       2,155,000       3,812,000       1,708,000       -  
Operating Leases
    13,842,000       3,457,000       5,544,000       3,291,000       1,550,000  
Total
  $ 46,696,000     $ 8,326,000     $ 13,784,000     $ 23,036,000     $ 1,550,000  

(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 2.74%, 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.
 
As of the date of this Annual Report on Form 10-K, we have no other material contractual obligations or commitments.

Inflation has had no material impact on our performance.

Factors Affecting Future Cash Flow

Generating cash from operating activities and access to credit is integral to the success of our business.  We continue to generate cash from operating activities to service scheduled debt repayment and fund capital expenditures.  In addition, we have capacity to borrow from our acquisition line of credit for capital expenditures and acquisitions.  We also lease a significant amount of our vehicles and all of our buildings.
 
Adverse economic conditions in recent years have negatively impacted many businesses financial performance and restricted credit availability.  Although our sales have increased the past two years we do not think that the economy in our region has fully recovered. The competitive landscape created by the economic environment has eroded our margin over that time. As mentioned above, we have used cash to build an information technology infrastructure to facilitate the expansion of our product offerings and run our business more efficiently to gain an immediate competitive edge and prosper when the economy in our region improves. However, no assurance can be given that the future economic environment will not adversely affect our cash flow and results of operations or that we will have adequate access to credit.
 
 
25

 
 
Factors Affecting Quarterly Performance

Our business and financial trends vary from quarter to quarter based on, but not limited to, seasonal demands for our products, climate, and economic and geographic trends.  Consequently, results for any particular fiscal quarter are not necessarily indicative, through extrapolation, or otherwise, of results for a longer period. In the past year we have experienced weather related events that have influenced quarterly performance.  Although weather is always variable, we feel this year’s extremes, and their far reaching effects, are an aberration in the region.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles.  Preparation of the statements in accordance with these principles requires that we make estimates, using available data and our judgment for such things as valuing assets, accruing liabilities, and estimating expenses.  We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies and estimates. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. We base our ongoing estimates on historical experience and other various assumptions that we believe to be reasonable under the circumstances.

Accounts Receivable – Allowance for Doubtful Accounts
We routinely review our accounts receivable, by customer account aging, to determine if the amounts due are collectible based on information we receive from the customer, past history, and economic conditions.  In doing so, we adjust our allowance accordingly to reflect the cumulative amount that we feel is uncollectible.  This estimate may vary from the proceeds that we actually collect.  If the estimate is too low, we may incur higher bad debt expenses in the future resulting in lower net income.  If the estimate is too high, we may experience lower bad debt expense in the future resulting in higher net income.

Fixed Assets – Depreciation
We maintain buildings, machinery and equipment, and furniture and fixtures to operate our business. We estimate the life of individual assets to allocate the cost over the expected life.  The basis for such estimates is use, technology, required maintenance, and obsolescence.   We periodically review these estimates and adjust them if necessary.  Nonetheless, if we overestimate the life of an asset or assets, at a point in the future, we would have to incur higher depreciation costs and consequently, lower net income.  If we underestimate the life of an asset or assets, we would absorb too much depreciation in the early years resulting in higher net income in the later years when the asset is still in service.
 
Goodwill – Intangible Asset Impairment
We have acquired a significant number of companies.  The excess of the purchase price over the fair value of the assets and liabilities acquired has been recorded as goodwill.  If goodwill is not impaired, it would remain as an asset on our balance sheet at the value assigned in the acquisitions.  If it is impaired, we would be required to write down the asset to an amount that accurately reflects its estimated value.  We completed a valuation of the Company performed as of October 31, 2011 and 2010, and goodwill was not impaired as of those dates.
 
 
26

 
 
The assessment of the carrying value of goodwill is a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches – quoted stock price (a market approach), value comparisons to publicly traded companies believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach).  This approach provides a reasonable estimation of the value of the Company and takes into consideration the Company’s thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations. The resulting estimated fair value is then compared to its equity value. On October 31, 2011 the step one assessment yielded the following fair value:

   
Determined
   
Controlling
             
   
Minority
   
Interest
             
   
Value
   
Value (a)
   
Weighting
   
Contribution
 
Quoted Stock Price
  $ 16,000,000     $ 20,800,000       20 %   $ 4,160,000  
Guideline Companies
  $ 25,267,000     $ 31,765,000       20 %   $ 6,353,000  
Discounted Net Cash Flow
  $ 29,000,000     $ 32,971,000       60 %   $ 19,783,000  
Concluded Fair Value
                          $ 30,296,000  
(a) Reflects application of the following control premiums: (1) 30% for the quoted stock price approach, (2)10% for guideline approach, and (3) zero for the discounted net cash flow (DCF) approach. Guideline and DCF approaches also reflect addition of cash balance.
 

The concluded fair value exceeded the Company’s equity value as of October 31, 2011 by 37%. If the equity value exceeds the fair value in step one then step two estimates the fair value of the Company’s assets and liabilities (including unrecognized intangible assets). This value is then allocated among the assets and liabilities as if they had been acquired in a business combination and the estimated fair value was the price paid.

We relied, in part, on certain assumptions in making the valuation conclusion.  If some or all of these assumptions change in the future, there may be a material impact on the valuation of the Company, which may result in an additional impairment of goodwill.  These assumptions include, but are not limited to, the following:

§  
We made certain assumptions in the calculation of discount rates, risk premiums, and capital structure weightings. However, changes in capital markets may significantly change these assumptions in the future.
§  
We used our knowledge of the business, industry and economy to assemble financial projections including our plans to expand our product offerings.  Unforeseen events that dramatically change such influential factors as the economy, environment, and weather may positively or negatively affect the accuracy of these projections.
§  
Calculation of a control premium is a significant component in the assessment of goodwill. This is a common valuation technique that relies on assumptions based on equity markets, credit markets and the merger and acquisition environment and the availability of buyers.
 
 
 
27

 

 
Income Taxes
We recognize deferred tax assets and liabilities based on temporary differences between the financial statement carrying amount of assets and liabilities and their corresponding tax basis.  The valuation of these deferred tax assets and liabilities is based on estimates that are dependent on rate and time assumptions.  If these estimates do not prove to be correct in the future, we may have over or understated income tax expense and, as a result, earnings.

Financial Accounting Standards Board (“FASB”) guidance clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. The guidance prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return in order for those tax positions to be recognized in the financial statements.

 
Off-Balance Sheet Arrangements
 
We lease various facilities and equipment under cancelable and non-cancelable short and long term operating leases, which are described in Item 2 of this Annual Report on Form 10-K.

ITEM 8.                  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Our Consolidated Financial Statements and their footnotes are set forth on pages F-1 through F-26.
 
 
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A.
CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
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)).  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.

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.
 
 
 
28

 

Internal Control Over Financial Reporting

a) Management's Annual Report on Internal Control Over Financial Reporting
 
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of October 31, 2011. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Based on our assessment, management concluded that, as of October 31, 2011, the Company's internal control over financial reporting is effective based on those criteria.

This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report on Form 10-K.

b) Changes in Internal Control Over Financial Reporting
 
No change in our internal control over financial reporting occurred during the fiscal quarter ended October 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
 
29

 

 
ITEM 9B. OTHER INFORMATION.

None.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
30

 
 
PART III

ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information required by this Item is incorporated by reference to the sections captioned “Directors,” “Our Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance” and “Committees of the Board of Directors” in our 2012 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2011.

ITEM 11.
EXECUTIVE COMPENSATION.

The information required by this Item is incorporated by reference to the sections captioned “Compensation of Executive Officers” and “Compensation of Non-Employee Directors” in our 2012 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2011.

ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

Securities Authorized for Issuance Under Equity Compensation Plans.
 
The following table sets forth certain information as of October 31, 2011 about shares of our Common Stock that may be issued upon the exercise of options and other rights under our existing equity compensation plans and arrangements, divided between plans approved by our stockholders and plans or arrangements that were not required to be and were not submitted to our stockholders for approval.

Equity Compensation Plan Information

 
(a)
(b)
(c)
Plan Category
Number of Securities to be issued upon exercise
of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of Securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)).
Equity compensation plans approved by security holders
 
284,500
 
$2.57
 
1,939,500
Equity compensation plans not approved by security holders
 
-0-
 
-
 
-0-
Total
284,500
$2.57
1,939,500
 
Additional information required by this Item is incorporated by reference to the section captioned “Security Ownership of Certain Beneficial Owners and Management” in our 2012 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2011.
 
 
 
31

 
 
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
 
 
The information required by this Item is incorporated by reference to the section captioned “Corporate Governance” in our 2012 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2011.
 
ITEM 14.                                PRINCIPAL ACCOUNTANT FEES AND SERVICES.
 
The information required by this Item is incorporated by reference to the sections captioned “Independent Registered Public Accounting Firm Fees” and “Pre-Approval Policies and Procedures” in our 2012 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2011.
 
 
 
 
 
 
 
 
 
32

 
 
 
PART IV
 
  ITEM 15.       EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

a)  
The following documents are filed as part of this report:

(1) Financial Statements
  Report of Independent Registered Public Accounting Firm      F-1
  Consolidated Balance Sheets as of October 31, 2011 and 2010     F-2
  Consolidated Statements of Income for the years    
     ended October 31, 2011 and 2010    F-3
  Consolidated Statements of Changes in Stockholders’ Equity    
     and Comprehensive Income for the years ended October    
     31, 2011 and 2010    F-4
  Consolidated Statements of Cash Flows for the years ended    
     October 31, 2011 and 2010     F-5
  Notes to the Consolidated Financial Statements  F-6 -  F-27
 
(2) Schedules

None

(3) Exhibits:
Exhibit No.
Description
Filed with this Form 10-K
Incorporated by Reference
Form
Filing Date
Exhibit No.
3.1
Certificate of Incorporation
 
S-4
September 6, 2000
Exhibit B to Appendix A
 
3.2
Certificate of Amendment to Certificate of Incorporation
 
8-K
October 19, 2000
4.2
 
3.3
Amended and Restated By-Laws as adopted March 29, 2010
 
8-K
April 2, 2010
3.2
 
3.4
Certificate of Ownership and Merger of Crystal Rock Holdings, Inc. with and into Vermont Pure Holdings, Ltd.
 
8-K
April 30, 2010
3.1
 
4.1
Registration Rights Agreement with Peter K. Baker, Henry E. Baker, John B. Baker and Ross Rapaport
 
8-K
October 19, 2000
4.6
 
10.1*
1998 Incentive and Non-Statutory Stock Option Plan, as amended
 
14A
February 28, 2003
A
 
10.2*
2004 Stock Incentive Plan
 
14A
March 1, 2004
B
 
10.3*
Employment Agreement dated May 2, 2007 with Peter K. Baker
 
8-K
May 2, 2007
10.1
 
10.4*
Employment Agreement dated May 2, 2007 with Bruce S. MacDonald
 
8-K
May 2, 2007
10.3
 
10.5*
Employment Agreement dated May 2, 2007 with John B. Baker
 
8-K
May 2, 2007
10.2
 
10.6
Lease of Buildings and Grounds in Watertown, Connecticut from the Baker’s Grandchildren Trust
 
S-4
September 6, 2000
10.22
 
 
 
 
33

 
 
10.7
First Amendment to the Lease of Buildings and Grounds in Watertown, Connecticut from the Baker’s Grandchildren Trust
 
10-Q
September 14, 2007
10.4
 
10.8
Amended and Restated Credit Agreement dated April 5, 2010 with Bank of America.
 
 
8-K
April 9, 2010
10.1
 
10.9
Form of Amended and Restated Term Note dated April 5, 2010 to Bank of America.
 
 
8-K
April 9, 2010
10.2
 
10.10
Form of Amended and Restated Subordination and Pledge Agreement dated April 5, 2010 between Henry E. Baker and Bank of America.
 
 
8-K
April 9, 2010
10.3
 
10.11
Form of Amended and Restated Subordination and Pledge Agreement dated April 5, 2010 between John B. Baker and Peter K. Baker and Bank of America.
 
 
8-K
April 9, 2010
10.4
 
10.12
Form of Amended and Restated Promissory Note dated April 5, 2010 issued to Henry E. Baker, John B. Baker and Peter K. Baker
 
 
8-K
April 9, 2010
10.5
 
10.13
Form of Indemnification Agreement dated November 2, 2005 with each of Henry E. Baker, John B. Baker, Peter K. Baker, Phillip Davidowitz,David Jurasek, Bruce S. MacDonald and Ross S. Rapaport
 
10-K
January 30, 2006
10.21
 
10.14
Form of Indemnification Agreement dated November 2, 2005 with each of John M. Lapides and Martin A. Dytrych
 
10-K
January 30, 2006
10.22
 
10.15
Installation Agreement with American Capital Energy, Inc. dated August 29, 2007
 
10-K
January 29, 2008
10.29
 
10.16
Financial Assistance Agreement with Connecticut Innovations dated August 20, 2007
 
10-K
January 29, 2008
10.30
 
10.17*
Amendment No. 1 to Employment Agreement with Peter K. Baker dated September 10, 2009.
 
 
10-Q
September 14, 2009
10.1
 
10.18*
Amendment No. 1 to Employment Agreement with John B. Baker dated September 10, 2009.
 
 
10-Q
September 14, 2009
10.2
 
10.19
Settlement Agreement and General Release dated as of May 6, 2010 by and between Vermont Pure Holdings, et al. and Cozen et al.
 
 
10-Q
June 14, 2010
10.1
 
10.20
Letter of Waiver and Consent dated September 15, 2010 signed by Martin Dytrych, Henry Baker, Peter Baker, and John Baker.
 
 
8-K
October 1,2010
10.1
 
10.21
First Amendment to the Credit Agreement dated September 28, 2010 with Bank of America.
 
 
8-K
October 1,2010
10.2
 
10.22
Letter from Henry E., Peter K., and John B. Baker and Ross S. Rapaport, as trustee, to Bank America, as agreed to, to amend Subordination Agreements.
 
 
8-K
October 1,2010
10.3
 
10.23
Lease of Building and Land in Stamford, Connecticut from Henry E. Baker dated September 30, 2010.
 
 
8-K
October 1,2010
10.4
 
Amendment No. 2 to Employment Agreement with Peter K. Baker dated October 19, 2011.
 
X
       
 
 
 
 
34

 
 
 
Amendment No. 2 to Employment Agreement with John B. Baker dated October 19, 2011.
 
X
       
Subsidiary
X
       
Consent of Wolf & Company, P.C.
X
       
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
X
       
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
X
       
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
X
       
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
X
       
101
Interactive Data Files regarding (a) our Consolidated Balance Sheets as of October 31, 2011 and October 31, 2010, (b) our Consolidated Statements of Income for the years ended October 31, 2011 and 2010, (c) Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended October 31, 2011 and 2010 (d) our Consolidated Statements of Cash Flows for the years ended October 31, 2011 and 2010, and (e) the Notes to such Consolidated Financial Statements.
 
X
     
           * Management contract or compensatory plan.
 

 
 
 
 
 
 
 
 
 
 
35

 
 
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Crystal Rock Holdings, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
   CRYSTAL ROCK HOLDINGS, INC.
   
   
            By:   /s/ Peter K. Baker                            
Dated: January 27, 2012           Peter K. Baker, Chief Executive Officer
   
   
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 
Name
 
Title
 
       Date
/s/ Ross S. Rapaport
Ross S. Rapaport
 
 
Chairman of the Board of Directors
 
January 27, 2012
/s/ Henry E. Baker
Henry E. Baker
Director, Chairman Emeritus
January 27, 2012
 
/s/ John B. Baker
John B. Baker
 
Executive Vice President and Director
 
 
January 27, 2012
 
/s/ Peter K. Baker
Peter K. Baker
 
 
Chief Executive Officer and Director
 
January 27, 2012
/s/ Martin A. Dytrych
Martin A. Dytrych
Director
January 27, 2012
 
/s/ John M. Lapides
John M. Lapides
 
Director
 
January 27, 2012
     
/s/ Bruce S. MacDonald
Bruce S. MacDonald
Chief Financial Officer, Chief Accounting Officer and Secretary
January 27, 2012
 
 
 
 
 
 
36

 
 
 

 
EXHIBITS TO CRYSTAL ROCK HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED OCTOBER 31, 2011
Exhibits Filed Herewith
 
 
Exhibit
Number     
 Description
   
 10.24  Amendment No. 2 to Employment Agreement with Peter K. Baker dated October 19, 2011.
 10.25 Amendment No. 2 to Employment Agreement with John B. Baker dated October 19, 2011.
 21.1  Subsidiary
 23.1 Consent of Wolf & Company, P.C.
 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 32.1 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.
 32.2 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.
   
   
 
 
 
 
 
37

 
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
     
 PAGE
 
 Report of Independent Registered Public Accounting Firm      F-1
   
Financial Statements
   
 
 
Consolidated Balance Sheets as of October 31, 2011 and 2010 
   F-2
 
 
   
  Consolidated Statements of Income for the years ended October 31, 2011 and 2010    F-3
 
 
 
   
  Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended October 31, 2011 and 2010    F-4
        
 
Consolidated Statements of Cash Flows for the years ended October 31, 2011 and 2010 
   F-5
        
 
Notes to the Consolidated Financial Statements
   F-6 - F-27

 
 
 
 
 
 
 

 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 

To the Board of Directors of
Crystal Rock Holdings, Inc.
Watertown, Connecticut

We have audited the accompanying consolidated balance sheets of Crystal Rock Holdings, Inc. and subsidiary as of October 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Crystal Rock Holdings, Inc. and subsidiary as of October 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.


/s/ Wolf & Company, P.C.
Boston, Massachusetts
January 27, 2012
 
 
 
 
F-1

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
             
CONSOLIDATED BALANCE SHEETS
 
             
   
October 31,
   
October 31,
 
   
2011
   
2010
 
             
ASSETS
 
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 5,378,575     $ 4,892,379  
Accounts receivable, trade - net of reserve of $543,528 and
               
     $493,610 for 2011 and 2010, respectively
    7,801,811       7,448,044  
Inventories
    2,673,827       2,448,500  
Current portion of deferred tax asset
    570,142       804,362  
Other current assets
    1,134,658       757,964  
                 
TOTAL CURRENT ASSETS
    17,559,013       16,351,249  
                 
PROPERTY AND EQUIPMENT - net
    8,174,096       9,111,114  
                 
OTHER ASSETS:
               
Goodwill
    32,123,294       32,123,294  
Other intangible assets - net
    2,788,408       3,232,051  
Other assets
    39,000       39,000  
                 
TOTAL OTHER ASSETS
    34,950,702       35,394,345  
                 
TOTAL ASSETS
  $ 60,683,811     $ 60,856,708  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
                 
CURRENT LIABILITIES:
               
Current portion of long term debt
  $ 2,714,000     $ 2,264,000  
Accounts payable
    2,598,627       1,732,426  
Accrued expenses
    2,800,751       3,044,515  
Current portion of customer deposits
    662,704       710,654  
Current portion of unrealized loss on derivatives
    142,558       174,228  
TOTAL CURRENT LIABILITIES
    8,918,640       7,925,823  
                 
Long term debt, less current portion
    9,465,000       12,179,000  
Deferred tax liability
    4,408,593       4,045,745  
Subordinated debt
    13,000,000       13,000,000  
Customer deposits
    2,515,772       2,704,716  
Long term portion of unrealized loss on derivatives
    265,645       608,072  
                 
TOTAL LIABILITIES
    38,573,650       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
               
October 31, 2011 and 2010
    21,960       21,960  
Additional paid in capital
    58,462,497       58,462,497  
Treasury stock, at cost, 571,548 shares as of October 31, 2011
               
    and 2010
    (870,391 )     (870,391 )
Accumulated deficit
    (35,257,887 )     (36,743,413 )
Accumulated other comprehensive loss
    (246,018 )     (477,301 )
TOTAL STOCKHOLDERS' EQUITY
    22,110,161       20,393,352  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 60,683,811     $ 60,856,708  
                 
See the accompanying notes to the consolidated financial statements.
 
 

 
F-2

 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
             
CONSOLIDATED STATEMENTS OF INCOME
 
             
   
Fiscal Year Ended October 31,
 
   
2011
   
2010
 
             
NET SALES
  $ 71,609,774     $ 67,780,639  
                 
COST OF GOODS SOLD
    34,371,757       30,801,309  
                 
GROSS PROFIT
    37,238,017       36,979,330  
                 
OPERATING EXPENSES:
               
Selling, general and administrative expenses
    30,058,454       28,253,658  
Advertising expenses
    1,555,392       1,449,902  
Amortization
    1,067,891       1,079,746  
Loss on disposal of property and equipment
    49,015       63,004  
                 
TOTAL OPERATING EXPENSES
    32,730,752       30,846,310  
                 
INCOME FROM OPERATIONS
    4,507,265       6,133,020  
                 
OTHER (EXPENSE) INCOME:
               
          Interest
    (2,246,905 )     (2,449,512 )
          Loss on derivatives
    (5,057 )     (17,027 )
          Miscellaneous income
    -       3,500,000  
                 
TOTAL OTHER (EXPENSE) INCOME, NET
    (2,251,962 )     1,033,461  
                 
INCOME BEFORE INCOME TAXES
    2,255,303       7,166,481  
                 
INCOME TAX EXPENSE
    769,777       2,910,260  
                 
NET INCOME
  $ 1,485,526     $ 4,256,221  
                 
NET INCOME PER SHARE - BASIC
  $ 0.07     $ 0.20  
                 
NET INCOME PER SHARE - DILUTED
  $ 0.07     $ 0.20  
                 
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC
    21,388,681       21,476,760  
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED
    21,388,681       21,476,760  
                 
See the accompanying notes to the consolidated financial statements.
 

 
 
 
F-3

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
                                                       
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
 
AND COMPREHENSIVE INCOME
 
                                                       
                                       
Accumulated
             
   
Common
         
Additional
         
Treasury
         
Other
             
   
Shares
   
Stock
   
Paid in
   
Treasury
   
Stock
   
Accumulated
   
Comprehensive
         
Comprehensive
 
   
Issued
   
Par Value
   
Capital
   
Shares
   
Amount
   
Deficit
   
Loss
   
Total
   
Income (Loss)
 
Balance, October 31, 2009
    21,951,987     $ 21,952     $ 58,457,807       479,548     $ (804,149 )   $ (40,999,634 )   $ (448,746 )   $ 16,227,230        
                                                                       
Shares issued under employee stock
                                                                     
purchase plan
    8,242       8       4,690                                       4,698        
                                                                       
Shares repurchased
                            92,000       (66,242 )                     (66,242 )      
                                                                       
Net income
                                            4,256,221               4,256,221     $ 4,256,221  
                                                                         
Unrealized loss on derivatives, net of reclassification
                                                                       
adjustment, amortization, and taxes
                                                    (28,555 )     (28,555 )     (28,555 )
Balance, October 31, 2010
    21,960,229     $ 21,960     $ 58,462,497       571,548     $ (870,391 )   $ (36,743,413 )   $ (477,301 )   $ 20,393,352     $ 4,227,666  
                                                                         
Net income
                                            1,485,526               1,485,526     $ 1,485,526  
                                                                         
Unrealized gain on derivatives, net of reclassification
                                                                       
adjustment, amortization, and taxes
                                                    231,283       231,283       231,283  
                                                                         
Balance, October 31, 2011
    21,960,229     $ 21,960     $ 58,462,497       571,548     $ (870,391 )   $ (35,257,887 )   $ (246,018 )   $ 22,110,161     $ 1,716,809  
                                                                         
See the accompanying notes to the consolidated financial statements.
 

 
 
F-4

 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
             
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
             
   
Fiscal Year Ended October 31,
 
   
2011
   
2010
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 1,485,526     $ 4,256,221  
Adjustments to reconcile net income to net cash provided by operating activities:
               
  Depreciation
    3,601,091       3,712,381  
  Provision for bad debts on accounts receivable
    354,624       351,836  
  (Recovery) provision for bad debts on notes receivable
    (3,797 )     57,323  
  Amortization
    1,067,891       1,079,746  
  Non cash interest expense
    48,952       63,647  
  Loss on derivatives
    5,057       17,027  
  Deferred tax expense
    597,068       325,686  
  Loss on disposal of property and equipment
    49,015       63,004  
                 
Changes in operating assets and liabilities:
               
  Accounts receivable
    (708,391 )     (370,155 )
  Inventories
    (220,327 )     (276,688 )
  Other current assets and liabilities
    (520,768 )     (25,251 )
  Other assets
    -       16,010  
  Accounts payable
    866,201       (694,731 )
  Accrued expenses
    (243,764 )     495,751  
  Customer deposits
    (236,894 )     58,006  
NET CASH PROVIDED BY OPERATING ACTIVITIES
    6,141,484       9,129,813  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Purchase of property and equipment
    (2,577,939 )     (3,198,877 )
  Proceeds from sale of property and equipment
    47,851       206,429  
  Cash used for acquisitions
    (475,000 )     (240,082 )
  Cash used for purchase of trademark
    (237,500 )     -  
NET CASH USED IN INVESTING ACTIVITIES
    (3,242,588 )     (3,232,530 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Principal payments on debt
    (2,412,700 )     (3,948,667 )
  Payments of debt issuance costs
    -       (90,000 )
  Purchase of treasury stock
    -       (66,242 )
  Sale of common stock
    -       4,698  
NET CASH USED IN FINANCING ACTIVITIES
    (2,412,700 )     (4,100,211 )
                 
NET INCREASE IN CASH
    486,196       1,797,072  
                 
CASH AND CASH EQUIVALENTS - Beginning of year
    4,892,379       3,095,307  
                 
CASH AND CASH EQUIVALENTS - End of year
  $ 5,378,575     $ 4,892,379  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION,
               
EXCLUDING NON-CASH FINANCING AND INVESTING ACTIVITIES:
               
Cash paid for interest
  $ 2,218,178     $ 2,391,407  
                 
Cash paid for taxes
  $ 588,070     $ 2,619,464  
                 
NON-CASH FINANCING AND INVESTING ACTIVITIES:
               
                 
 Reduction in notes payable for acquisition
  $ 1,300     $ -  
                 
 Notes payable issued in acquisitions
  $ 150,000     $ 50,000  
                 
See the accompanying notes to the consolidated financial statements.
 
 
 
 
 
F-5

 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
1.  
BUSINESS OF THE COMPANY AND BASIS OF PRESENTATION
 
Crystal Rock Holdings, Inc. and Subsidiary (collectively, the “Company”) is engaged in the production, marketing and distribution of bottled water and the distribution of coffee, ancillary products, various other refreshment products as well as office products. The Company operates exclusively as a home and office delivery business, using its own trucks to distribute throughout New England, New York, and New Jersey. In addition, it offers its products for sale over the internet and shipping through third parties.
 
The consolidated financial statements of the Company include the accounts of Crystal Rock Holdings, Inc. and its wholly-owned subsidiary, Crystal Rock, LLC.  All inter-company transactions and balances have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
2.  
SIGNIFICANT ACCOUNTING POLICIES
 
Cash Equivalents – The Company considers all highly liquid temporary cash investments with a maturity of three months or less at date of purchase to be cash equivalents.
 
Accounts Receivable - Accounts receivable are carried at original invoice amount less an estimate made for doubtful accounts. Management establishes the allowance for doubtful accounts by regularly evaluating past due balances, collection history as well as general economic and credit conditions. Individual accounts receivable are written off when deemed uncollectible, with any future recoveries recorded as income when received.
 
Inventories – Inventories primarily consist of products that are purchased for resale and are stated at the lower of cost or market on a first in, first out basis.
 
Property and Equipment – Property and equipment are stated at cost net of accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets, which range from three to ten years for machinery and equipment, and from seven to thirty years for buildings and improvements, and three to seven years for other fixed assets. Leasehold improvements are depreciated over the shorter of the estimated useful life of the leasehold improvement or the term of the lease.
 
Goodwill and Other Intangibles – Intangible assets with lives restricted by contractual, legal, or other means are amortized over their useful lives. The Company defines an asset’s useful life as the period over which the asset is expected to contribute to the future cash flows of the entity.  Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The amount of impairment for goodwill and other intangible assets is measured as the excess of their carrying values over their implied fair values.  The Company conducted assessments of the carrying value of its goodwill as of October 31, 2011 and 2010 and determined that goodwill was not impaired.  Other than goodwill, intangible assets consist primarily of customer lists and covenants not to compete, with estimated lives ranging from 3 to 10 years.
 
 
 
F-6

 
 
Impairment for Long-Lived and Intangible Assets – The Company reviews long-lived assets and certain identifiable intangible assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recovered.  Recoverability is assessed based on estimated undiscounted future cash flows.  As of October 31, 2011 and 2010, the Company believes that there has been no impairment of its long-lived and intangible assets.

Stock-Based Compensation – The Company has two stock-based compensation plans under which incentive and non-qualified stock options and restricted shares may be granted. There have been no grants under these plans since 2005. It also had an Employee Stock Purchase Plan (ESPP) which reached its approved share limit during fiscal year 2010.  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 initial grant date. This policy had no material impact on the Company’s 2011 and 2010 results of operations since no options were issued or vested during those years.

Net Income Per Share – Net income per share is based on the weighted average number of common shares outstanding during each period. Potential common shares are included in the computation of diluted per share amounts outstanding during each period that income is reported.  In periods in which the Company reports a loss, potential common shares are not included in the diluted earnings per share calculation since the inclusion of those shares in the calculation would be anti-dilutive. The Company considers outstanding “in-the-money” stock options, if any, as potential common stock in its calculation of diluted earnings per share and uses the treasury stock method to calculate the applicable number of shares.
 
Advertising Expenses – The Company expenses advertising costs at the commencement of an advertising campaign.
 
Customer Deposits – Customers receiving home or office delivery of water pay the Company a deposit for the water bottle that is refunded when the bottle is returned. Based on historical experience, the Company uses an estimate of the deposits it expects to refund over the next twelve months to determine the current portion of the liability, and classifies the remainder of the deposit obligation as a long term liability.
 
 
 
F-7

 
 
Income Taxes – When calculating its tax expense and the value of tax related assets and liabilities the Company considers the tax impact of future events when determining the value of assets and liabilities in its financial statements and tax returns.  Accordingly, a deferred tax asset or liability is calculated and reported based upon the tax effect of the differences between the financial statement and tax basis of assets and liabilities as measured by the enacted rates that will be in effect when these differences reverse.  A valuation allowance is recorded if realization of the deferred tax assets is not likely.
 
In accordance with the guidance pertaining to the accounting for uncertainty in income taxes, the Company uses a more-likely-than-not measurement attribute for all tax positions taken or expected to be taken on a tax return in order for those tax positions to be recognized in the financial statements.
 
Derivative Financial Instruments - The Company records all derivatives on the balance sheet at fair value. The Company utilizes interest rate swap agreements to hedge variable rate interest payments on its long-term debt.  The interest rate swaps are recognized on the balance sheet at their fair value and are designated as cash flow hedges. Accordingly, the resulting changes in fair value of the Company’s interest rate swaps are recorded as a component of other comprehensive income (loss).  The Company assesses, both at a hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of the related hedged items. Gains and losses that are related to the ineffective portion of a hedge or de-designated hedge are recorded in earnings.
 
Fair Value of 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. The Company uses a swap agreement to hedge the interest rates on its senior debt.  The swap agreement is carried at its estimated settlement value.  Subordinated debt is carried at its approximate market value based on periodic comparisons to similar instruments in the market place.
 
Fair Value Hierarchy - The Company groups its assets and liabilities, generally measured at fair value, in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on observable inputs other than level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
 
 
F-8

 

 
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The level of fair value hierarchy in which the fair value measurement falls is determined by the lowest level input that is significant to the fair value measurement.

Transfers between levels are recognized at the end of a reporting period, if applicable.

Revenue Recognition – Revenue is recognized when products are delivered to customers. A certain amount of the Company’s revenue is derived from leasing water coolers and coffee brewers.  These leases are generally for the first 12 months of service and are accounted for as operating leases.  To open an account that includes the rental of equipment, a customer is required to sign a contract that recognizes the receipt of the equipment, outlines the Company’s ownership rights, the customer’s responsibilities concerning the equipment, and the rental charge for twelve months.  In general, the customer does not renew the agreement after twelve months, and the rental continues on a month to month basis until the customer returns the equipment in good condition.  The Company recognizes the income ratably over the life of the lease. After the initial lease term expires, rental revenue is recognized monthly as billed.
 
Shipping and Handling Costs – The Company distributes its home and office products directly to its customers on its own trucks.  The delivery costs related to the Company’s route system, which are reported under selling, general, and administrative expenses, were approximately $12,879,000 and $12,710,000 for fiscal years 2011 and 2010, respectively.
 
3.  
MERGERS AND ACQUISITIONS
 
The Company purchased assets from Hartford Stamp, LLC an office products distributor, Timberline Office Supply, Inc. a small engraving company, and Cool Beans, LLC a coffee distributor in fiscal year 2011.  Similarly, it purchased assets in three separate transactions in fiscal year 2010: Frontenac Crystal Springs Water, Inc., New York; Linekin’s Inc. d/b/a Arrowood Spring Water, New York; and Massasoit Distributing, Inc., Massachusetts.  The purchase price paid for the acquisitions for the respective years is as follows:
 

 

 
 
F-9

 

 

 
 
Fiscal Year 2011
 
Hartford Stamp
   
Timberline
   
Cool
Beans
   
Total
 
Month Acquired
 
November
   
January
   
February
       
Cash
  $ 450,000     $ 25,000     $ 237,500     $ 712,500  
Issuance of Debt
    150,000       -       -       150,000  
Purchase Price
  $ 600,000     $ 25,000     $ 237,500     $ 862,500  
                                 

 
Fiscal Year 2010
 
Frontenac
   
Arrowood
   
Massasoit
   
Price
Adjustment
   
Total
 
Month Acquired
 
April
   
April
   
September
             
Cash
  $ 39,701     $ 33,714     $ 153,694     $ 12,973     $ 240,082  
Issuance of debt
    -       -       50,000       -       50,000  
Purchase Price
  $ 39,701     $ 33,714     $ 203,694     $ 12,973     $ 290,082  

Acquisition-related costs (included in selling, general and administrative expenses in the consolidated statements of income) were $12,035 in fiscal year 2011 and $13,325 in 2010.  The price adjustment is related to an acquisition in the previous year.

The allocation of purchase price to the corresponding line item on the financial statements related to these acquisitions for the respective years is as follows:

   
2011
   
2010
 
Accounts Receivable, net
  $ -     $ 3,195  
Property and Equipment, net
    183,000       36,637  
Other Intangible Assets, net
    674,500       250,250  
Inventories
    5,000       -  
Purchase Price
  $ 862,500     $ 290,082  

The following table summarizes the pro forma consolidated condensed results of operations (unaudited) of the Company for the fiscal years ended October 31, 2011 and 2010 as though all the acquisitions had been consummated at the beginning of fiscal year 2010.
   
2011
   
2010
 
Net Sales
  $ 71,609,774     $ 69,207,966  
Net Income
  $ 1,484,341     $ 4,294,191  
Net Income Per Share-Diluted
  $ .07     $ .20  
Weighted Average Common     Shares Outstanding-Diluted
    21,388,681       21,476,760  

The operating results of the acquired entities have been included in the accompanying statements of operations since their respective dates of acquisition.

4.  
ACCOUNTS RECEIVABLE

The activity in the allowance for doubtful accounts for the years ended October 31, 2011 and 2010 is as follows:
 
 
 
F-10

 
 
 
   
2011
   
2010
 
Balance, beginning of year
  $ 493,610     $ 435,790  
Provision
    354,624       351,836  
Write-offs
    (304,706 )     (294,016 )
Balance, end of year
  $ 543,528     $ 493,610  

5.  
INVENTORIES

Inventories at October 31 consisted of:
   
2011
   
2010
 
Finished Goods
  $ 2,520,091     $ 2,265,019  
Raw Materials
    153,736       183,481  
Total Inventories
  $ 2,673,827     $ 2,448,500  

Finished goods inventory consists of products that the Company sells such as, but not limited to, coffee, cups, soft drinks, snack foods, and office products.  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 October 31, 2011 and 2010 to be $56,000.  This value includes the cost of allocated overhead.  Bottles are accounted for as fixed assets.
 
 
6.  
OTHER CURRENT ASSETS
 
At October 31, the balance of other current assets is itemized as follows:

   
2011
   
2010
 
Notes Receivable - Current
  $ 14,900     $ 9,699  
Prepaid Insurance
    263,119       281,616  
Prepaid Property Taxes
    192,615       172,498  
Prepaid Fees
    60,654       59,838  
Prepaid Miscellaneous
    139,203       24,432  
Security Deposits
    61,473       74,628  
Prepaid Income Taxes
    402,694       135,253  
Total Other Current Assets
  $ 1,134,658     $ 757,964  

 
 

 
F-11

 
 

 
7.  
PROPERTY AND EQUIPMENT, NET
 
Property and equipment at October 31 consisted of:
 
         
 
Useful
Life
 
2011
   
2010
 
               
Leasehold improvements
Shorter of useful life of
  $ 1,566,079     $ 1,672,217  
 
asset or lease term
               
Machinery and equipment
3 - 10 yrs.
    20,512,418       20,444,318  
Bottles, racks and vehicles
3 - 7 yrs.
    4,772,078       5,369,583  
Furniture, fixtures and office equipment
3 - 7 yrs.
    2,308,301       2,341,779  
Construction in progress
      285,272       48,252  
Property and equipment before accumulated depreciation
    29,444,148       29,876,149  
Less accumulated depreciation
      21,270,052       20,765,035  
Property and equipment, net of accumulated depreciation
  $ 8,174,096     $ 9,111,114  
 
Depreciation expense for the fiscal years ended October 31, 2011 and 2010 was $3,601,091 and $3,712,381, respectively.
 
8.  
EQUIPMENT RENTAL

The carrying cost of the equipment rented to customers under contract, which is included in property and equipment in the consolidated balance sheets, is calculated as follows:


   
2011
   
2010
 
Original Cost
  $ 2,635,944     $ 2,819,133  
Accumulated Depreciation
    2,040,907       2,106,992  
Carrying Cost
  $ 595,037     $ 712,141  

We expect to have revenue of $569,000 from the rental of equipment under contract at the end of the year over the next twelve months. After twelve months customer contracts convert to a month-to month basis.
 
 
9.  
GOODWILL AND OTHER INTANGIBLE ASSETS
 
Components of other intangible assets at October 31 consisted of:
 
    2011      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     $ 1,835,821       3.11     $ 2,076,488     $ 1,635,605       3.25  
Customer Lists
    7,428,733       5,522,370       2.63       7,143,033       4,663,069       3.33  
Other Identifiable Intangibles
    704,914       213,536       27.87       516,366       205,162       25.07  
Total
  $ 10,360,135     $ 7,571,727             $ 9,735,887     $ 6,503,836          
 
 
 
F-12

 
 
 
Amortization expense for amortizable intangible assets for fiscal years 2011 and 2010, was $1,067,891 and $1,079,746, respectively.

 
Estimated amortization expense for the next five years is as follows:
 
 
Fiscal Year Ending October 31,
     
2012
  $ 973,000  
2013
    896,000  
2014
    482,000  
2015
    151,000  
2016
    12,000  

An assessment of the carrying value of goodwill was conducted as of October 31, 2011 and 2010.  In both years it was determined that goodwill was not impaired.  There were no changes in the carrying amount of goodwill for the fiscal years ended October 31, 2011 and 2010.

The assessment of the carrying value of goodwill is a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches – quoted stock price (a market approach), value comparisons to publicly traded companies believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach).  This approach provided a reasonable estimation of the value of the Company and took into consideration the Company’s thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations. The Company compared the resulting estimated fair value to its equity value as of October 31, 2011 and 2010 and determined there was no impairment of goodwill at those dates. Step two, which involves allocation of the fair value of the Company’s assets and liabilities, was not necessary because impairment was not indicated in step one. The Company is a single reporting unit as it does not have separate management of product lines and shares its sales, purchasing and distribution resources among the lines.
 
 
10.  
OTHER ASSETS

At October 31, the balance of other assets is itemized as follows:
   
2011
   
2010
 
Note receivable, unsecured, matured August 8, 2011, interest 0% per annum (net of an allowance for bad debt of $0 in 2011 and $145,259 in 2010)
  $ -     $ 9,699  
Ownership interests
    39,000       39,000  
 
    39,000       48,699  
 Current portion of note receivable     -       (9,699
 Total other assets   $ 39,000     $ 39,000  
 
 
 
F-13

 

 
In 2011, amounts received from the note receivable included a $3,797 recovery of previously reserved amounts.

11.  
ACCRUED EXPENSES

Accrued expenses as of October 31 are as follows:
 
   
2011
   
2010
 
 Payroll and Vacation
  $ 1,542,009     $ 1,610,436  
 Interest
    432,703       452,202  
 Health Insurance
    428,103       402,059  
 Accounting and Legal
    126,000       151,000  
 Termination Benefit
    137,682       153,407  
 Miscellaneous
    134,254       275,411  
 Total
  $ 2,800,751     $ 3,044,515  

12.  
DEBT

Senior Debt
The Company has 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 senior 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 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 October 31, 2011.  Consequently, as of October 31, 2011, there was $3,469,000 available to borrow from the revolving line of credit.  The revolving line of credit matures on March 30, 2013.

The Agreement amortizes the term note 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. There was $12,179,000 outstanding on the term note as of October 31, 2011.  Also, 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 prior consent of the bank.
 
 
Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin of 2.50% for the term note and 2.25% for the revolving line of credit as long as the Company is in compliance with the terms of the Agreement. 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 October 31, 2011, the Company had $3,045,000 of the term debt subject to variable interest rates.  The one-month LIBOR was .24% resulting in total variable interest rates of 2.74% and 2.49%, for the term note and the revolving line of credit as of October 31, 2011.
 
 
 
F-14

 
 
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 less than 2.50 to 1.  As of October 31, 2011, the Company was in compliance with these covenants and terms of the Agreement.  Also under the Agreement, the Company is obligated to calculate Consolidated Excess Cash Flow based on its financial results for the fiscal year to determine if additional principal is due on the term note. Based on the results for fiscal year 2011, a $500,000 principal payment is due by February 8, 2012.


Subordinated Debt
 
 
As part of the acquisition agreement in 2000 with the former shareholders of Crystal Rock Spring Water Company, the Company issued subordinated notes in the amount of $22,600,000.  The notes have an effective date of October 5, 2000, were for an original term of seven years (subsequently extended to 2015 as part of the Agreement described above) and bear interest at 12% per year.  Scheduled repayments are made quarterly and are interest only for the life of the note unless specified financial targets are met.  In April 2004, the Company repaid $5,000,000 of the outstanding principal.  In April, 2005, the Company repaid an additional $3,600,000 of this principal.

On May 7, 2009, with the mutual consent of the three subordinated debt holders and Bank of America, the Company paid $500,000 to John B. Baker as a payment of principal on his note. Similarly, on September 29, 2010, with the mutual consent of the three subordinated debt holders and Bank of America, the Company paid $500,000 to Peter K. Baker as a payment of principal on his note. As of October 31, 2011 and 2010, the Company had $13,000,000 of subordinated debt outstanding bearing an interest rate of 12%.

The notes are secured by all of the assets of the Company but specifically subordinated, with a separate agreement between the debt holders, to the senior credit facility described above.

Note Payable

In 2010, the Company made an acquisition that resulted in the issuance of a $50,000 note to the seller. The note was paid in 2011. The Company issued another note related to an acquisition for $150,000 in 2011 which it paid in full prior to the end of the year.



 
F-15

 


 
 
Annual Maturities
 
Annual maturities of debt as of October 31, 2011 are summarized as follows:

   
Term
   
Subordinated
   
Total
 
Fiscal year ending October 31,
                 
2012
  $ 2,714,000     $ -     $ 2,714,000  
2013
    2,214,000       -       2,214,000  
2014
    2,214,000       -       2,214,000  
2015
    5,037,000       13,000,000       18,037,000  
Total Debt
  $ 12,179,000     $ 13,000,000     $ 25,179,000  

13. 
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 consolidated 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.
 
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.  Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest obligations.  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.

 
F-16

 
 
On April 5, 2010, in conjunction with the Agreement, 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 new term note at 4.26% (2.01% plus the applicable margin, 2.50%) maturing May 2015.
 
As of October 31, 2011, the total notional amount committed to the new swap agreement was $9,134,000.  On that date, the variable rate on the remaining 25% of the term note ($3,045,000) was 2.74%.  This agreement provided for a monthly settlement in which the Company would make or receive payments at a variable rate determined by a specified index (one-month LIBOR) in exchange for making payments at a fixed rate of 4.26%.
 
At October 31, 2011 and 2010, the net unrealized loss relating to interest rate swaps was recorded in current liabilities.  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 is effective for the years ending October 31, 2011 and 2010. The old swap, which had the credit agreement with Bank America underlying at the time, was effective for fiscal 2010 through the date of the Agreement (April 5, 2010).  The amounts relating to the old swap previously reflected in accumulated other comprehensive income is amortized to earnings over the remaining term of the undesignated cash flow hedge.  Payments on the old swap, and receipt of income on the offsetting swap, are now reported as gain or loss on derivatives and an adjustment to other comprehensive income or loss net of tax effects.

The table below details the adjustments to other comprehensive income, on a before-tax and net-of tax basis, for the fiscal years ended October 31, 2011 and 2010.
 
   
Before-Tax
   
Tax Benefit
   
Net-of-Tax
 
Year Ended October 31, 2010
                 
Loss on interest rate swap
  $ (446,328 )   $ 174,915     $ (271,413 )
Amortization of loss on derivative undesignated as cash flow hedge
    176,508       (71,662 )     104,846  
Reclassification adjustment for loss in income
    230,020       (92,008 )     138,012  
Net unrealized loss
  $ (39,800 )   $ 11,245     $ (28,555 )
Year Ended October 31, 2011
                       
Loss on interest rate swap
  $ (262,172 )   $ 102,247     $ (159,925 )
Amortization of loss on derivative undesignated as cash flow hedge
    236,124       (92,089 )     144,035  
Reclassification adjustment for loss in income
    405,201       (158,028 )     247,173  
Net unrealized gain
  $ 379,153     $ (147,870 )   $ 231,283  
 
 
 

 
 
F-17

 

 
The reclassification adjustments of $405,201 and $230,020 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreement during the years ended October 31, 2011 and 2010, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in consolidated statements of income as interest expense.  No other material amounts were reclassified during the years ended October 31, 2011 and 2010.

In the year ended October 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 $408,203.  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 $151,542.

Derivatives designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $199,236 and $342,266 at October 31, 2011 and 2010, respectively. Derivatives not designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $208,967 and $440,034 at October 31, 2011 and 2010, respectively. During 2010, the Company de-designated an interest rate swap as a cash flow hedge and is amortizing the loss at the time of de-designation out of accumulated other comprehensive loss and into loss on derivatives over the remaining term of the hedged debt.  During 2011 and 2010, cash flow hedges are deemed 100% effective.  The net loss on interest rate swaps not designated as cash flow hedges, classified as loss on derivatives on the Company’s consolidated statements of income, amounted to $5,057 and $17,027 for the years endings October 31, 2011 and 2010, respectively.

14.  
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:
                 
October 31, 2011
                 
Unrealized loss on derivatives
  $ -     $ 408,203     $ -  
       
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.
 
 
F-18

 
§  
 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.

15.  
COMMITMENTS AND CONTINGENCIES
 
Operating Leases
The Company’s operating leases consist of trucks, office equipment and rental property.
 
Future minimum rental payments, including related party leases described below, over the terms of various lease contracts are approximately as follows:
 
Fiscal Year Ending October 31,
 
2012
  $ 3,457,000  
2013
    3,161,000  
2014
    2,383,000  
2015
    1,811,000  
2016
    1,480,000  
Thereafter
    1,550,000  
Total
  $ 13,842,000  
 
Rent expense was $3,675,000 and $3,645,000 for the fiscal years ended October 31, 2011 and 2010, respectively.
 
16.  
 STOCK BASED COMPENSATION
 
Stock Option and Incentive Plans
In April 1998, the Company’s shareholders approved the 1998 Incentive and Non Statutory Stock Option Plan (the “1998 Plan”).  In April 2003, the Company’s shareholders approved an increase in the authorized number of shares to be issued under the 1998 Plan from 1,500,000 to 2,000,000.  This plan provides for issuance of options to purchase up to 2,000,000 options to purchase the Company’s common stock under the administration of the compensation committee of the Board of Directors.  The intent of this plan is to issue options to officers, employees, directors, and other individuals providing services to the Company.  Of the total amount of shares authorized under this plan, 135,500 option shares are outstanding and 1,864,500 option shares are available for grant at October 31, 2011.
 
In April 2004, the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”).  This plan provides for issuances of awards of up to 250,000 of the Company’s common stock in the form of restricted or unrestricted shares, or incentive or non-statutory stock options for the purchase of the Company’s 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 October 31, 2011.
 
 
 
F-19

 
 
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. The following table summarizes the activity related to stock options and outstanding stock option balances during the last two fiscal years:
 
   
Outstanding Options
(Shares)
   
Weighted Average
Exercise Price
 
Balance at October 31, 2009
    574,500     $ 2.91  
Expired
    (270,000 )     3.22  
Balance at October 31, 2010
    304,500       2.63  
Expired
    (20,000 )     3.47  
Balance at October 31, 2011
    284,500       2.57  
 
In 2011 and 2010, the 20,000 and 270,000 respective options that expired were originally issued from the 1998 Plan.
 
The total shares available for grant under all plans are 1,939,500 at October 31, 2011.
 
The following table summarizes information pertaining to outstanding stock options, all of which are exercisable, as of October 31, 2011:
 
Exercise
Price
Range
   
Outstanding
Options
(Shares)
   
Weighted Average Remaining
Contractual
Life
   
Weighted
Average
Exercise Price
   
Intrinsic
Value
 
  $1.80 - $2.60       234,500       3.24     $ 2.32     $ -  
  $2.81 - $3.38       20,000       2.04       3.28       -  
  $3.50 - $4.25       25,000       .63       3.90       -  
  $4.28 - $4.98       5,000       .17       4.98       -  
          284,500       2.87     $ 2.57     $ -  

All of the outstanding options as of October 31, 2011 and 2010 were vested.
 
Outstanding options were granted with lives of 10 years and provide for vesting over a term of 5 years.
 
Employee Stock Purchase Plan (ESPP)

The Company maintained an ESPP, under which, as originally approved, 500,000 shares of common stock were reserved for issuance. 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.  The ESPP enabled eligible employees to subscribe, through payroll deductions, to purchase shares of the Company's common stock at a purchase price equal to 95% of the fair market value on the last day of the payroll payment period.  During the fiscal year ended October 31, 2010 the plan reached its limit of 650,000 shares as 8,242 shares were issued for proceeds of $4,698.
 
 
 
F-20

 
 

17.  
REPURCHASE OF COMMON STOCK
 
In January 2006, the Company’s Board of Directors approved the purchase of up to 250,000 of the Company’s common shares at the discretion of management.  In May 2008, the Company’s Board of Directors approved the purchase of up to an additional 250,000 of the Company’s common shares at the discretion of management. In fiscal year 2010 the Company purchased an additional 92,000 for an aggregate purchase price of $66,242.  The purchase brought the total shares purchased since the inception of the plan to the limit of 500,000. Total proceeds used to purchase the stock were $605,697.  The Company has used internally generated cash to fund these purchases.  There were no shares purchased in fiscal year 2011.

18.  
LEGAL SETTLEMENT
 
On May 1, 2006, the Company filed a lawsuit in the Superior Court Department, County of Suffolk, Massachusetts, alleging malpractice and other wrongful acts against three law firms that had been representing the Company in litigation involving Nestlé Waters North America, Inc.: Hagens Berman Sobol Shapiro LLP, Ivey & Ragsdale, and Cozen O’Connor. The case is Vermont Pure Holdings, Ltd. vs. Cozen O'Connor et al., Massachusetts Superior Court CA No. 06-1814.

Until May 2, 2006, when the Company terminated their engagement, the three defendant law firms represented the Company in litigation in federal district court in Massachusetts known as Vermont Pure Holdings, Ltd. vs. Nestlé Waters North America, Inc. (the Nestlé litigation). The Company filed the Nestlé litigation in early August 2003.

The Company’s lawsuit alleged that the three defendant law firms wrongfully interfered with, and/or negligently failed to take steps to obtain, a proposed June 2003 settlement with Nestlé. The complaint included counts involving negligence, breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, tortious interference with economic relations, civil conspiracy, and other counts, and seeks declaratory relief and compensatory and punitive damages.
 
In July 2006, certain of the defendants filed a counterclaim against the Company seeking recovery of their fees and expenses in the Nestlé litigation. In August 2007, certain of the defendants filed a counterclaim against the Company that includes an abuse of process count in which it is alleged that the Company’s claims against them are frivolous and were not advanced in good faith, as well as a quantum meruit count in which these defendants allege that their services were terminated wrongfully and in bad faith and seek approximately $2.2 million in damages.

In July 2009 the Company entered into settlement agreements with some of the defendants in the lawsuit and settled the case in part.  On May 6, 2010, the Company reached a settlement with all of the remaining defendants in the action.  Pursuant to the 2010 settlement, mutual releases were executed, the Company received a one-time payment of $3.5 million and the case concluded.  The payment is included in miscellaneous income in the Company’s fiscal year ended 2010 consolidated statement of income.
 
 
 
F-21

 
 
 
19.  
INCOME TAXES
 
The following is the composition of income tax expense:
             
   
2011
   
2010
 
Current:
           
   Federal
  $ 189,581     $ 2,139,787  
   State
    129,026       433,539  
Total current
    318,607       2,573,326  
                 
Deferred:
               
   Federal
    403,678       301,468  
   State
    47,492       35,466  
Total deferred
    451,170       336,934  
Total income tax expense
  $ 769,777     $ 2,910,260  

Deferred tax assets (liabilities) at October 31, 2011 and 2010, are as follows:
       
   
2011
   
2010
 
Deferred tax assets:
           
Allowance for doubtful accounts
  $ 206,541     $ 187,572  
Accrued compensation
    158,832       196,690  
Accrued liabilities and reserves
    62,694       132,127  
Interest rate swaps
    142,075       287,973  
Capital loss carry forward
    81,959       81,959  
Subtotal
    652,101       886,321  
Valuation allowance
    (81,959 )     (81,959 )
Total deferred tax assets
    570,142       804,362  
                 
Deferred tax liabilities:
               
Depreciation
    (1,876,559 )     (1,754,815 )
Amortization
    (2,532,034 )     (2,290,930 )
Total deferred tax liabilities
    (4,408,593 )     (4,045,745 )
                 
Net deferred tax liability
  $ (3,838,451 )   $ (3,241,383 )

The Company established a valuation allowance of $81,959 for both 2011 and 2010 related to the capital loss carry forward deferred tax asset.



 
F-22

 




Income tax expense differs from the amount computed by applying the statutory tax rate to net income before income tax expense as follows:
             
   
2011
   
2010
 
Income tax expense computed at the statutory rate
  $ 766,803     $ 2,436,603  
State income taxes, net of federal benefit
    116,502       309,543  
Other differences
    (113,528 )     164,114  
Income tax expense
  $ 769,777     $ 2,910,260  

In fiscal year 2010, the Company recognized an increase to tax liability for uncertain tax positions of $137,000 related to a state income tax position taken in prior years and $11,000 of potential interest and penalty on another position taken.  This reserve was reversed in fiscal year 2011 as a result of a favorable final ruling on appeal of the position.

During fiscal year 2010, the Internal Revenue Service completed an examination of the Company’s federal income tax returns through tax years ended October 31, 2008.  The results of the examination did not have a material effect on the Company’s unrecognized tax benefits, financial condition or results of operations.  The Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. Generally, the Company is no longer subject to U.S. federal, state and local tax examinations by tax authorities for years before October 31, 2007.

A reconciliation of the beginning and ending amount of unrecognized tax benefits including interest and penalties is as follows:

Balance at November 1, 2009
  $ 52,000  
Increases related to current year tax positions
    -  
Increases related to the prior year tax positions
    148,000  
Decreases related to prior year tax positions
    -  
Settlements
    (23,000
Expiration of Statutes
    -  
Balance at October 31, 2010
  $ 177,000  
Increases related to current year tax positions
    -  
Increases related to the prior year tax positions
    9,000  
Decreases related to prior year tax positions
    -  
Settlements
    (145,000 )
Expiration of Statutes
    -  
Balance at October 31, 2011
  $ 41,000  

The Company recognizes interest and penalties related to the unrecognized tax benefits in tax expense.  During the year ended October 31, 2011 the Company reduced its accrued interest and penalties by $29,000. In the year ended October 31, 2010, it recognized $35,000 of interest and penalties. The Company had approximately $41,000 and $70,000 of interest and penalties accrued at October 31, 2011 and 2010, respectively.
 
 
F-23

 
 
20.  
NET INCOME PER SHARE AND WEIGHTED AVERAGE SHARES
 
The following calculation provides the reconciliation of the denominators used in the calculation of basic and fully diluted earnings per share:
   
2011
   
2010
 
Net Income
  $ 1,485,526     $ 4,256,221  
Denominator:
               
Basic Weighted Average Shares Outstanding
    21,388,681       21,476,760  
Effect of Stock Options
 
_ -
   
_ -
 
Diluted Weighted Average Shares Outstanding
    21,388,681       21,476,760  
                 
Basic Net Income Per Share
  $ .07     $ .20  
                 
Diluted Net Income Per Share
  $ .07     $ .20  
 
There were 284,500 and 304,500 options outstanding for the years ended October 31, 2011 and 2010, respectively, that were not included in the dilution calculation because the options’ exercise price exceeded the market price of the underlying common shares.
 
 
21.  
RETIREMENT PLAN
 
The Company has a defined contribution plan which meets the requirements of Section 401(k) of the Internal Revenue Code. All employees of the Company who are at least twenty-one years of age are eligible to participate in the plan. The plan allows employees to defer a portion of their salary on a pre-tax basis and the Company contributes 25% of amounts contributed by employees up to 6% of their salary. Company contributions to the plan amounted to $121,000, and $98,000, for the fiscal years ended October 31, 2011 and 2010, respectively.
 
22.  
RELATED PARTY TRANSACTIONS
 
Directors and Officers
The Baker family group, consisting of four current directors Henry Baker (Chairman Emeritus), Peter Baker (CEO), John Baker (Executive Vice President) and Ross Rapaport (Chairman), as trustee, together own a majority of our common stock.  In addition, in connection with the acquisition of Crystal Rock Spring Water Company in 2000, we issued members of the Baker family group 12% subordinated promissory notes secured by all of our assets.  The balance on these notes as of October 31, 2011 is $13,000,000.
 
Henry Baker is employed by the Company as an at-will employee at the discretion of management. Mr. Baker’s sons, John Baker and Peter Baker, have employment contracts with the Company through December 31, 2012.  They are also directors. The two contracts entitle the respective shareholders to annual compensation of $320,000 each and other bonuses and perquisites.
 
 
F-24

 
 
The Company leases a 67,000 square foot facility in Watertown, Connecticut and a 22,000 square foot facility in Stamford, Connecticut from a Baker family trust.  The lease in Watertown expires in October 2016.  On September 30, 2010 the Company finalized an amendment to its existing lease in Stamford which extended that lease to September 2020.
 
Future minimum rental payments under these leases are as follows:
 
Fiscal year ending October 31,
 
Stamford
   
Watertown
   
Total
 
2012
  $ 248,400     $ 452,250     $ 700,650  
2013
    248,400       461,295       709,695  
2014
    248,400       461,295       709,695  
2015
    248,400       470,521       718,921  
2016
    *248,400       470,521       718,921  
2017
    *248,400       -       248,400  
2018
    *248,400       -       248,400  
2019
    *248,400       -       248,400  
2020
    *227,700       -       227,700  
Totals
  $ 2,214,900     $ 2,315,882     $ 4,530,782  
* Rent negotiable, assumes rate of first five years.
 

The Company’s Chairman of the Board, Ross S. Rapaport, who also acts as Trustee in various Baker family trusts is employed by McElroy, Deutsch, Mulvaney & Carpenter LLP (formerly Pepe & Hazard, LLP) a business law firm that the Company uses from time to time.  During fiscal 2011 and 2010 the Company paid approximately $58,000 and $102,000, respectively, for services provided by McElroy, Deutsch, Mulvaney & Carpenter LLP.

In June 2010 the compensation committee approved a payment of $45,000 to Mr. Rapaport for work normally not required by his duties as chair of the Board. Payment of this amount was made in July 2010.

22.           CONCENTRATION OF CREDIT RISK
 
The Company maintains its cash accounts at various financial institutions in non-interest bearing accounts.  Effective December 31, 2010 the Dodd-Frank Act fully insures non-interest bearing transaction accounts through January 31, 2013.   Effective after that date accounts will be covered to $100,000 by the basic limit on federal deposit insurance.
 
23.           RECENT ACCOUNTING PRONOUNCEMENTS
 
In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-08, Intangibles – Goodwill and Other (Topic 350), Testing Goodwill for Impairment.  This ASU is intended to reduce the complexity and cost of performing an evaluation of impairment of goodwill.  Under the new guidance,  an entity will have the option of first assessing qualitative factors (events and circumstances) to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount.  If, after considering all relevant events and circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test will be unnecessary.  The amendments will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption is permitted.
 
 
F-25

 
 
In June 2011, the 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 FASB issued ASU 2011-04, Fair Value Measurement (Topic 820). 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 consolidated financial statements, however, the Company does not expect it to have a material effect on its fair value measurements or disclosures.
 
 
 
F-26

 
 

 
In December 2010, the FASB 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.

24.           SUBSEQUENT EVENTS

The Company entered into a lease to acquire vehicles in the normal course of its business. The vehicles were delivered in December 2011 and monthly payments of $29,000 commence on December 30, 2011.  The lease terms runs until November 30, 2017.

 
 
 
 
 
F-27