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EX-31.2 - EXHIBIT 31.2 - Crystal Rock Holdings, Inc.exh31_2.htm
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2012
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ­­­­­_____ to _________

Commission File Number: 000-31797
 
CRYSTAL ROCK HOLDINGS, INC.
(Exact name of registrant as specified in Its charter)
 
 
 
 Delaware    03-0366218
 (State or other jurisdiction of     (I.R.S. Employer
 incorporation or organization)      Identification No.)
     
 1050 Buckingham St., Watertown, CT      06795
 (Address of principal executive offices)     (Zip Code)
(860) 945-0661
(Registrant's telephone number, including area code)

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

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

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
    Shares outstanding at
Class                                                                                               September 7, 2012
Common Stock, $.001 Par Value                                                                                      21,380,781
 
 
 
 
 
 

 
 
 
 

CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY

Table of Contents

PART I - FINANCIAL INFORMATION
 
Page
    Item 1.
Financial Statements.
 
 
 
Condensed Consolidated Balance Sheets as of July 31, 2012 and October 31, 2011
 
3
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2012 and 2011
4
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2012 and 2011
5
 
 
Notes to Condensed Consolidated Financial Statements
6-15
 
    Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
16-23
 
    Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
23
 
    Item 4.
Controls and Procedures.
23-24

PART II - OTHER INFORMATION
 
 
    Item 1.
Legal Proceedings.
25
 
    Item 1A.
Risk Factors.
25
 
    Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
25
 
    Item 3.
Defaults Upon Senior Securities.
25
 
    Item 4.
Mine Safety Disclosures.
25
 
    Item 5.
Other Information.
25
 
    Item 6.
Exhibits.
25-26

SIGNATURE
 
27
 
 
 
 

 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
             
CONDENSED CONSOLIDATED BALANCE SHEETS
 
             
   
July 31,
   
October 31,
 
   
2012
   
2011
 
 
(Unaudited)
       
             
ASSETS
 
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 4,740,425     $ 5,378,575  
Accounts receivable - net
    8,024,637       7,801,811  
Inventories - net
    2,607,610       2,673,827  
Current portion of deferred tax asset
    570,142       570,142  
Other current assets
    763,944       1,134,658  
                 
TOTAL CURRENT ASSETS
    16,706,758       17,559,013  
                 
PROPERTY AND EQUIPMENT - net
    7,891,036       8,174,096  
                 
OTHER ASSETS:
               
Goodwill
    32,123,294       32,123,294  
Other intangible assets - net
    2,060,244       2,788,408  
Other assets
    39,000       39,000  
                 
TOTAL OTHER ASSETS
    34,222,538       34,950,702  
                 
TOTAL ASSETS
  $ 58,820,332     $ 60,683,811  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
                 
CURRENT LIABILITIES:
               
Current portion of long term debt
  $ 2,214,000     $ 2,714,000  
Accounts payable
    2,238,446       2,598,627  
Accrued expenses
    2,950,354       2,800,751  
Current portion of customer deposits
    653,920       662,704  
Current portion of unrealized loss on derivatives
    99,350       142,558  
TOTAL CURRENT LIABILITIES
    8,156,070       8,918,640  
                 
Long term debt, less current portion
    7,804,500       9,465,000  
Deferred tax liability
    4,408,593       4,408,593  
Subordinated debt
    13,000,000       13,000,000  
Customer deposits
    2,491,699       2,515,772  
Long term portion of unrealized loss on derivatives
    91,339       265,645  
                 
TOTAL LIABILITIES
    35,952,201       38,573,650  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS' EQUITY:
               
Common stock - $.001 par value, 50,000,000 authorized shares,
               
21,960,229 issued and 21,383,531 outstanding shares as of
               
July 31, 2012 and 21,960,229 issued and 21,388,681
               
outstanding as of October 31, 2011
    21,960       21,960  
Additional paid in capital
    58,462,497       58,462,497  
Treasury stock, at cost, 576,698 shares as of July 31, 2012
               
    and 571,548 shares as of October 31, 2011
    (875,753 )     (870,391 )
Accumulated deficit
    (34,622,680 )     (35,257,887 )
Accumulated other comprehensive loss, net of tax
    (117,893 )     (246,018 )
TOTAL STOCKHOLDERS' EQUITY
    22,868,131       22,110,161  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 58,820,332     $ 60,683,811  
                 
 
See the notes to the condensed consolidated financial statements.
 

 
 
 
 
 
3

 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
                         
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
                         
   
Three months ended July 31,
   
Nine months ended July 31,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
   
(unaudited)
 
                         
NET SALES
  $ 18,462,810     $ 18,314,676     $ 53,257,576     $ 53,102,842  
                                 
COST OF GOODS SOLD
    8,497,374       8,532,953       25,849,125       25,447,141  
                                 
GROSS PROFIT
    9,965,436       9,781,723       27,408,451       27,655,701  
                                 
OPERATING EXPENSES:
                               
Selling, general and administrative expenses
    7,877,903       7,164,027       23,114,088       21,958,874  
Advertising expenses
    339,841       372,644       978,107       1,173,940  
Amortization
    229,011       265,052       698,163       816,042  
(Gain) on disposal of property and equipment
    (6,665 )     (8,764 )     (65,773 )     (11,924 )
                                 
TOTAL OPERATING EXPENSES
    8,440,090       7,792,959       24,724,585       23,936,932  
                                 
INCOME FROM OPERATIONS
    1,525,346       1,988,764       2,683,866       3,718,769  
                                 
OTHER EXPENSE (INCOME):
                               
    Interest expense
    548,633       558,558       1,643,949       1,697,566  
    Loss (gain) on derivatives
    4,119       4,289       (3,973 )     (3,689 )
TOTAL OTHER EXPENSE, NET
    552,752       562,847       1,639,976       1,693,877  
                                 
INCOME BEFORE INCOME TAX EXPENSE
    972,594       1,425,917       1,043,890       2,024,892  
                                 
INCOME TAX EXPENSE
    377,926       407,700       408,683       641,121  
                                 
NET INCOME
  $ 594,668     $ 1,018,217     $ 635,207     $ 1,383,771  
                                 
NET INCOME PER SHARE - BASIC
  $ 0.03     $ 0.05     $ 0.03     $ 0.06  
                                 
NET INCOME PER SHARE - DILUTED
  $ 0.03     $ 0.05     $ 0.03     $ 0.06  
                                 
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC
    21,386,297       21,388,681       21,387,881       21,388,681  
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED
    21,386,297       21,388,681       21,387,881       21,388,681  

See the notes to the condensed consolidated financial statements.
 
 
 
 
 
4

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
 
             
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
             
   
Nine months ended July 31,
 
   
2012
   
2011
 
   
(Unaudited)
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 635,207     $ 1,383,771  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    2,506,373       2,687,884  
Provision for bad debts on accounts receivable
    145,223       262,544  
Amortization
    698,163       816,042  
Non cash interest expense
    36,001       36,952  
Gain on derivatives
    (3,973 )     (3,689 )
Gain on disposal of property and equipment
    (65,773 )     (11,924 )
Changes in assets and liabilities:
               
Accounts receivable
    (368,049 )     (1,204,645 )
Inventories
    66,217       (211,123 )
Other current assets
    285,298       (522,744 )
Accounts payable
    (360,181 )     705,730  
Accrued expenses
    149,603       (302,764 )
Customer deposits
    (32,857 )     (153,759 )
NET CASH PROVIDED BY OPERATING ACTIVITIES
    3,691,252       3,482,275  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment
    (2,255,768 )     (1,867,614 )
Proceeds from sale of property and equipment
    99,228       35,685  
Cash used for acquisitions
    (7,000 )     (475,000 )
Cash used for purchase of trademark
    -       (237,500 )
NET CASH USED IN INVESTING ACTIVITIES
    (2,163,540 )     (2,544,429 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Principal payments on long term debt
    (2,160,500 )     (1,859,200 )
Purchase of treasury stock
    (5,362 )     -  
NET CASH USED IN FINANCING ACTIVITIES
    (2,165,862 )     (1,859,200 )
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (638,150 )     (921,354 )
                 
CASH AND CASH EQUIVALENTS - beginning of period
    5,378,575       4,892,379  
                 
CASH AND CASH EQUIVALENTS  - end of period
  $ 4,740,425     $ 3,971,025  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
                 
Cash paid for interest
  $ 1,609,209     $ 1,679,717  
                 
Cash (received) paid for income taxes
  $ (197,499 )   $ 417,970  
                 
NON-CASH FINANCING AND INVESTING ACTIVITIES:
               
                 
Reduction in notes payable for acquisition
  $ -     $ 1,300  
                 
Notes payable issued in acquisitions
  $ -     $ 150,000  
                 

See the notes to the condensed consolidated financial statements.
 
 
 
5

 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.
BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Form 10-Q instructions and in the opinion of management contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the condensed consolidated financial position, results of operations, and cash flows for the periods presented.  The results have been determined on the basis of generally accepted accounting principles and practices of the United States of America (“GAAP”), applied consistently with the Annual Report on Form 10-K of Crystal Rock Holdings, Inc. (the “Company”) for the year ended October 31, 2011.

Certain information and footnote disclosures normally included in audited consolidated financial statements presented in accordance with GAAP have been condensed or omitted. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended October 31, 2011.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

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

2.           GOODWILL AND OTHER INTANGIBLE ASSETS

Major components of intangible assets consisted of:
   
July 31, 2012
   
October 31, 2011
       
   
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     $ 1,937,655       2.44     $ 2,226,488     $ 1,835,821       3.11  
Customer Lists
    7,434,733       6,109,450       1.97       7,428,733       5,522,370       2.63  
Other Identifiable Intangibles
    668,913       222,785       27.14       704,914       213,536       27.87  
Total
  $ 10,330,134     $ 8,269,890             $ 10,360,135     $ 7,571,727          


 
Amortization expense for the three month periods ending July 31, 2012 and 2011 was $229,011 and $265,052 respectively, and for the nine month periods ending the same time was $698,163 and $816,042 respectively.  There were no changes in the carrying amount of goodwill for the nine month periods ending July 31, 2012 and 2011.
 
 
 
6

 

 
3.           DEBT
 
 
The Company and its subsidiary have a Credit Agreement with Bank of America (the “Agreement”) 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 $1,504,000 as of July 31, 2012.  Consequently, as of that date, there was $3,496,000 available to borrow from the revolving line of credit. There was $10,018,500 outstanding on the term note as of July 31, 2012.

The Agreement amortizes the term note over a five year period with 59 equal monthly principal installments of $184,500, commencing May 5, 2010, and a final payment of $4,114,500 due at the end of five years. The revolving line of credit matures in April 2013.   The Company is subject to various restrictive covenants under the Agreement, and is prohibited from entering into other debt agreements without the bank’s consent. The Agreement also prohibits the Company from paying dividends without the prior consent of the bank.
 
 
Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin based on the achievement of a specified leverage ratio.  As of July 31, 2012, the margin was 2.75% for the term note and 2.50% for the revolving line of credit. The Company is required to fix the interest rate on 75% of the outstanding balance of the term note and accomplishes this by entering into interest rate swap agreements.  As of July 31, 2012, the Company had $2,129,625 of the term debt subject to variable interest rates.  The one-month LIBOR was .25% on the last business day of July 2012 resulting in total variable interest rates of 3.00% and 2.75%, for the term note and the revolving line of credit, respectively, as of July 31, 2012.
 
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 July 31, 2012, 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 each fiscal year to determine if additional principal is due on the term note. Based on the results of the calculation for fiscal year 2011, a $500,000 principal payment was paid February 6, 2012. On May 14, 2012, the Agreement was amended to change the definition of Consolidated Adjusted Operating Cash Flow to add $965,000 to the calculation of Cash Flow for the reference periods under the Agreement that end April 30, 2012, July 31, 2012 and October 31, 2012 and to allow for the use of up to $500,000 for the purchase of the Company’s stock.
 
 
7

 
In addition to the senior debt, as of July 31, 2012 the Company has subordinated debt owed to Henry, Peter and Jack Baker in the aggregate principal amount of $13,000,000 that is due October 5, 2015.  The interest rate on each of these notes is 12% per annum.

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

4.           INVENTORIES
 
Inventories consisted of the following at:
 
     
July 31,
     
October 31,
 
     
2012
     
2011
 
Finished Goods
  $ 2,474,190     $ 2,520,091  
Raw Materials
    133,420       153,736  
Total Inventories
  $ 2,607,610     $ 2,673,827  

Finished goods inventory consists of products that the Company sells such as, but not limited to, coffee, cups, soft drinks, and snack foods.  Raw material inventory consists primarily of bottle caps.  The amount of raw and bottled water on hand does not represent a material amount of inventory.  The Company estimates that value as of July 31, 2012 and October 31, 2011 to be $66,000 and $56,000, respectively.  This value includes the cost of allocated overhead.  Bottles are accounted for as fixed assets.
 
5.         ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING
 ACTIVITIES
 
Derivative Financial Instruments
The Company has stand-alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk.  The notional amount is an amount on which calculations, payments, and the value of the derivative are based.  The notional amount does not represent direct credit exposure.  Direct credit exposure is limited to the net difference between the calculated amount to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s condensed 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.
 
 
 
8

 
Risk Management Policies - Hedging Instruments
The Company uses long-term variable rate debt as a source of funds for use in the Company’s general business purposes.  These debt obligations expose the Company to variability in interest payments due to changes in interest rates.  If interest rates increase, interest expense increases.  Conversely, if interest rates decrease, interest expense decreases.  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 at least 75% of the outstanding balance on the term loan (the swapped amount) with Bank of America as required by the facility.  The old swap fixed the interest rate for the swapped amount related to the previous facility at 4.87% and matures in January 2014.

In conjunction with its Agreement with Bank of America, on April 5, 2010, the Company entered into an interest rate swap agreement (offsetting swap) to offset the old swap for which it receives 1.40% of the scheduled balance of the old term loan. The offsetting swap effectively removed any exposure to change in the fair value of the old swap and set a fixed net payment schedule based on the scheduled balance of the old term loan until January 2014 when both swaps mature.   In addition, the Company entered into a swap agreement (new swap) to fix the interest rate of at least  75% of the outstanding balance of the term note at 4.76% (2.01% plus the applicable margin, 2.75%).  The term note matures in May 2015 and the new swap matures in April 2013.
 
As of July 31, 2012, the total notional amount of the new swap agreement was $7,888,875.  On that date, the variable rate on the remaining portion of the term note was 3.00%.  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 4.76%.
 
At July 31, 2012 and October 31, 2011, the net unrealized loss relating to interest rate swaps was recorded in current and long term liabilities.  The current portion is the valuation of the hedged instrument over the next twelve months while the balance of the unrealized loss makes up the long term portion.  For the effective portion of the hedges, which is the new swap, changes in the fair value of interest rate swaps designated as hedging instruments to mitigate the variability of cash flows associated with long-term debt are reported in other comprehensive income or loss net of tax effects. The amounts relating to the old swap previously reflected in accumulated other comprehensive income are amortized to earnings over the remaining term of the undesignated cash flow hedge.  Payments on the old swap, and receipt of income on the offsetting swap, are reported as gain or loss on derivatives and an adjustment to other comprehensive income or loss net of tax effects.
 
 
 
9

 

 
The table below details the adjustments to other comprehensive income, on a before-tax and net-of tax basis, for the three months ended July 31, 2012 and 2011.
 
   
Before-Tax
   
Tax Benefit
(Expense)
   
Net-of-Tax
 
Three Months Ended July 31, 2011
                 
Loss on interest rate swap
  $ (90,122 )   $ 35,148     $ (54,974 )
Amortization of loss on derivative undesignated as cash flow hedge
    59,031       (23,022 )     36,009  
Reclassification adjustment for loss in income
    98,993       (38,608 )     60,385  
Net unrealized gain
  $ 67,902     $ (26,482 )   $ 41,420  
Three Months Ended July 31, 2012
                       
Loss on interest rate swap
  $ (35,180 )   $ 14,072     $ (21,108 )
Amortization of loss on derivative undesignated as cash flow hedge
    37,885       (15,154 )     22,731  
Reclassification adjustment for loss in income
    67,135       (26,854 )     40,281  
Net unrealized gain
  $ 69,840     $ (27,936 )   $ 41,904  

 
The reclassification adjustments of $67,135 and $98,993 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreement during the three months ended July 31, 2012 and 2011, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in the condensed consolidated statements of income as interest expense.  No other material amounts were reclassified during the quarters ended July 31, 2012 and 2011.

The table below details the adjustments to other comprehensive income, on a before-tax and net-of tax basis, for the nine months ended July 31, 2012 and 2011.
   
Before-Tax
   
Tax Benefit
(Expense)
   
Net-of-Tax
 
Nine Months Ended July 31, 2011
                 
Loss on interest rate swap
  $ (198,429 )   $ 77,387     $ (121,042 )
Amortization of loss on derivative undesignated as cash flow hedge
    177,093       (69,066 )     108,027  
Reclassification adjustment for loss in income
    312,262       (121,782 )     190,480  
Net unrealized gain
  $ 290,926     $ (113,461 )   $ 177,465  
Nine Months Ended July 31, 2012
                       
Loss on interest rate swap
  $ (124,514 )   $ 49,805     $ (74,709 )
Amortization of loss on derivative undesignated as cash flow hedge
    113,655       (45,461 )     68,194  
Reclassification adjustment for loss in income
    224,400       (89,760 )     134,640  
Net unrealized gain
  $ 213,541     $ (85,416 )   $ 128,125  
 
The reclassification adjustments of $224,400 and $312,262 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreements during the nine months ended July 31, 2012 and 2011, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in the condensed consolidated statements of income as interest expense.  No other material amounts were reclassified during the nine months ended July 31, 2012 and 2011.
 
 
 
10

 

 
From October 31, 2011 to July 31, 2012 the fair value of the swaps changed from an unrealized loss on derivative liability of $408,203 to $190,689. Also, as of July 31, 2012, 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 $88,106.

Derivatives designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s condensed consolidated balance sheets with a fair value of $99,350 at July 31, 2012 and $199,236 at October 31, 2011. Derivatives not designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s condensed consolidated balance sheets with a fair value of $91,339 at July 31, 2012 and $208,967 at October 31, 2011. During the first nine months and third quarter of fiscal years 2012 and 2011, cash flow hedges are deemed 100% effective.  The net loss on interest rate swaps not designated as cash flow hedges, classified as a loss on derivatives on the Company’s condensed consolidated statements of income, amounted to $4,119 and $4,289 for the quarters ending July 31, 2012 and 2011, respectively. The net gain on interest rate swaps not designated as cash flow hedges, classified as a gain on derivatives on the Company’s condensed consolidated statements of income, amounted to $3,973 and $3,689 for the nine months ending July 31, 2012 and 2011, respectively.

6.           FAIR VALUES OF ASSETS AND LIABILITIES

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

   
Level 1
   
Level 2
   
Level 3
 
Liabilities:
                 
July 31, 2012
                 
Unrealized loss on derivatives
  $ -     $ 190,689     $ -  
       
October 31, 2011
     
Unrealized loss on derivatives
  $ -     $ 408,203     $ -  
 
In determining the fair value, the Company uses a model that calculates a present value of the payments as they amortize through the life of the loan (float) based on the variable rate and compares them to the calculated value of the payment based on the fixed rate (fixed) defined in the swap.  In calculating the present value, in addition to the term, the model relies on other data – the “rate” and the “discount factor.”

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

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

7.           COMPREHENSIVE INCOME

The following table summarizes comprehensive income for the respective periods:

   
Three Months Ended
July 31,
   
Nine Months Ended
July 31,
 
   
2012
   
2011
   
2012
   
2011
 
Net income
  $ 594,668     $ 1,018,217     $ 635,207     $ 1,383,771  
Other comprehensive income:
                               
Amortization of loss on derivative undesignated as cash flow hedge – net of tax
        22,731           36,009           68,194           108,027  
Unrealized gain on derivatives designated as cash flow hedges – net of tax
    19,173       5,411         59,931         69,438  
Comprehensive income
  $ 636,572     $ 1,059,637     $ 763,332     $ 1,561,236  

8.           INCOME PER SHARE AND WEIGHTED AVERAGE SHARES

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



 
12

 
 

   
 
Three Months Ended
July 31,
   
Nine Months Ended
July 31,
 
   
2012
   
2011
   
2012
   
2011
 
Net Income
  $ 594,668     $ 1,018,217     $ 635,207     $ 1,383,771  
Denominator:
                               
Basic Weighted Average Shares Outstanding
    21,386,297       21,388,681       21,387,881       21,388,681  
Dilutive effect of Stock Options
    -       -       -       -  
Diluted Weighted Average Shares Outstanding
    21,386,297       21,388,681       21,387,881       21,388,681  
Basic Income Per Share
  $ .03     $ .05     $ .03     $ .06  
Diluted Income Per Share
  $ .03     $ .05     $ .03     $ .06  

There were 269,500 and 284,500 options outstanding as of July 31, 2012 and 2011, respectively.  For the three month and nine month periods ended July 31, 2012 and 2011 there were no options used to calculate the effect of dilution because all of the outstanding options’ exercise prices exceeded the market price of the underlying common shares and were therefore considered anti-dilutive.

9.           COMPENSATION PLANS

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

The Company has stock-based compensation plans under which incentive and non-qualified stock options and restricted shares are granted.  In April 1998, the Company’s stockholders approved the 1998 Incentive and Non-Statutory Stock Option Plan.  In April 2003, the Company’s stockholders approved an increase in the authorized number of shares to be issued under its 1998 Incentive and Non-Statutory Stock Option Plan from 1,500,000 to 2,000,000.  This plan provides for issuances of options to purchase the Company’s common stock under the administration of the compensation committee of the Board of Directors.  The intent of the plan is to reward options to officers, employees, directors, and other individuals providing services to the Company.  As of July 31, 2012, there were 1,879,500 shares available for grant and 120,500 options outstanding.

In April 2004, the Company’s stockholders approved the 2004 Stock Incentive Plan.  The plan provides for issuances of awards of up to 250,000 restricted or unrestricted shares of the Company’s common stock, or incentive or non-statutory stock options to purchase such common stock. Of the total amount of shares authorized under this plan, 149,000 options are outstanding, 26,000 restricted shares have been granted, and 75,000 shares are available for grant at July 31, 2012.
 
 
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The options issued under the plans generally vest in periods up to five years based on the continuous service of the recipient and have 10 year contractual terms.  Share awards generally vest over one year.  Option and share awards provide for accelerated vesting if there is a change in control of the Company (as defined in the plans).
 
There were options, for a total of 15,000 shares, that expired in the first nine month period of 2012 and options for 20,000 shares that expired in the first nine month period of fiscal year of 2011.  Other than the expirations, there was no activity related to stock options and outstanding stock option balances or other equity based compensation during the three and nine month periods ended July 31, 2012 and 2011.  The Company did not grant any equity based compensation during the nine months ended July 31, 2012 and 2011.
 
The following table summarizes information pertaining to outstanding stock options, all of which are exercisable, as of July 31, 2012:
 
Exercise
Price
Range
   
Outstanding
Options
(Shares)
   
Weighted Average Remaining
Contractual
Life
   
Weighted
Average
Exercise Price
   
Intrinsic
Value
as of
July 31, 2012
 
  $1.80 - $2.60       234,500       2.5       $2.32     $ -  
  $2.81 - $3.38       20,000       1.3       3.28       -  
  $3.50 - $4.25       15,000       .3       4.07       -  
          269,500       2.3       $2.48     $ -  

Outstanding options were granted with lives of 10 years and provide for vesting over a term of 0-5 years.  Since all outstanding stock options were fully vested as of July 31, 2012 there was no unrecognized share based compensation related to unvested options as of that date.  All incentive and non-qualified stock option grants had an exercise price equal to the market value of the underlying common stock on the date of grant.

 
10.  
RECENT ACCOUNTING PRONOUNCEMENTS
 
In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment, which gives companies the option to perform a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. If a company determines that it is more likely than not that the fair value of such an asset exceeds its carrying amount, it would not need to calculate the fair value of the asset in that year. However, if a company concludes otherwise, it must calculate the fair value of the asset, compare that value with its carrying amount and record an impairment charge, if any. The amendments in the ASU are effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012, which is fiscal 2013 for the Company.  Early adoption is permitted.  The Company is currently assessing its adoption plans.

 
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In December 2011, the FASB issued an ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210), that provides amendments for disclosures about offsetting assets and liabilities. The amendments require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The amendments are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. Disclosures required by the amendments should be provided retrospectively for all comparative periods presented.   For the Company, the amendment is effective for fiscal year 2014. The Company is currently evaluating the impact these amendments may have on its disclosures.

In September 2011, the FASB issued 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 amendment will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, which will be fiscal 2013 for the Company.  Early adoption is permitted.  The Company is currently evaluating the impact this amendment may have on its disclosures.

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 amendment relates only to changes in financial statement presentation.

 
11.  
SIGNIFICANT ACCOUNTING POLICIES
 

Uncollectible Trade Accounts Receivable - Individual accounts receivable are written off when deemed uncollectible, with any future recoveries recorded as income when received.
 
 
 
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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto as filed in our Annual Report on Form 10-K for the year ended October 31, 2011 as well as the condensed consolidated financial statements and notes contained herein.
 
Forward-Looking Statements

The “Management’s Discussion and Analysis” portion of this Form 10-Q contains forward-looking statements about:
 
 
(1) the lower gross profits of new products that we are offering in connection with our brand expansion,
(2) cost pressures related to commodities affecting our business, and
(3) the cost to upgrade our information technology infrastructure may not result in a financial pay back in the future. 

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

 
16

 
The following factors could cause actual results to differ materially from those in the forward-looking statement (3): Over the past fifteen months we have undertaken an upgrade of our information technology infrastructure to support the sales of our traditional and expanded product lines.  We expect the implementation of this software to extend into the next few fiscal quarters. Although the upgrade is intended to enhance our customer service and improve sales by increasing the channels in which our products are offered, it is also necessary to provide an upgraded software platform that can be technically supported both internally and externally.  The project has required significant resources and added material expenses to our operations over the implementation time period.  Because we operate in a competitive marketplace, it is possible that the upgraded systems will not result in increased sales in the future or that, as mentioned above, increased sales will not result in increased profit. In addition, it is possible that the upgrade could cause a disruption in operations that could reduce sales or add additional operating expenses for a period of time in the future.
 
Results of Operations

Overview and Trends

Sales in the third quarter of 2012 were slightly higher than for the same period in 2011 resulting in sales that were essentially the same for the first nine months of the year compared to a year ago.  Gross profit increased compared to the third quarter a year ago and was down slightly for the year-to-date compared to the prior year.  New products that we are offering in conjunction with our brand expansion continue to yield a lower operating income, in general.  Our operating costs have been trending higher than a year ago through the nine month period as a result of the expenses for our information systems infrastructure upgrade.  The result was that we had a smaller net income in the third quarter and year to date compared to a year ago.

Results of Operations for the Three Months Ended July 31, 2012 Compared to the Three Months Ended July 31, 2011

Sales
Sales for the three months ended July 31, 2012 were $18,463,000 compared to $18,315,000 for the corresponding period in 2011, an increase of $148,000, or 1%.  There was no material effect on sales as a result of acquisition activity.

The comparative breakdown of sales of the product lines for the respective three-month periods ended July 31, 2012 and 2011 is as follows:

Product Line
   
2012
   
2011
   
Difference
   
% Diff.
 
$(000’s)                          
Water
    $ 7,865     $ 7,907     $ (42 )     (1 %)
Coffee
      3,986       4,152       (166 )     (4 %)
Refreshment
      3,170       2,999       171       6 %
Equipment Rental
      2,124       2,171       (47 )     (2 %)
Other
      1,318       1,086       232       21 %
Total
    $ 18,463     $ 18,315     $ 148       1 %
 
 
 
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Water – The decrease in water sales is primarily attributable to a 2% decrease in average selling price despite a 1% increase in volume.

Coffee – Lower coffee sales are a result of a 6% decrease in single-serve coffee products.  Growth of our Cool Beans® brand was more than offset by a decline of other brands we sell. Sales of traditional coffee products remained relatively unchanged from last year for the quarter.

Refreshment – Increased sales of coffee refreshment products as well as cups and single-serve water offset a decrease in soft drink and vending sales.

Equipment Rental – The decrease in sales was a result of a 4% decrease in placements which more than offset a 2% increase in rental price.

Other – The increase is attributable to sales of office products which more than doubled. Stamp sales declined 17% as a result of lower demand.  Fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations decreased 12% based on the market price of diesel fuel.

Gross Profit/Cost of Goods Sold – For the three months ended July 31, 2012, gross profit increased 2% to $9,965,000 from $9,782,000 for the comparable period in 2011.  As a percentage of sales, gross profit increased to 54% in the third quarter of 2012 from 53% in the third quarter of 2011. The increase in gross profit of $183,000 was primarily due to higher sales and lower coffee and service costs.

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

Operating Expenses and Income from Operations
Total operating expenses increased 8% to $8,440,000 in the third quarter of 2012 from $7,793,000 in the comparable period in 2011, an increase of $647,000.

Selling, general and administrative (SG&A) expenses of $7,878,000 in the third quarter of 2012 increased $714,000, or 10%, from $7,164,000 in the comparable period in 2011.  Of total SG&A expenses, 1) route distribution costs increased $247,000, or 8%, primarily a result of higher vehicle costs; 2) selling costs increased $69,000, or 6% primarily as a result of higher labor costs and training costs to support our product offerings; and 3) administration costs increased $398,000, or 14%, as a result of higher labor and computer related services to support information technology infrastructure improvements intended to improve administrative efficiency.
 
 
 
18

 
Advertising expenses were $340,000 in the third quarter of 2012 compared to $373,000 in the third quarter of 2011, a decrease of $33,000, or 9%. The decrease in advertising costs is primarily related to lower marketing agency costs.

Amortization decreased to $229,000 in the third quarter of 2012 from $265,000 in the comparable quarter in 2011, a decrease of $36,000, or 14%.  Amortization is attributable to intangible assets that were acquired as part of acquisitions. The lower amortization in 2012 is attributable to less acquisition activity in recent years.

Income from operations for the three months ended July 31, 2012 was $1,525,000 compared to $1,989,000 in the comparable period in 2011, a decrease of $464,000, or 23%.  The decrease was a result of higher operating expenses despite higher sales and gross profit.

Interest, Taxes, and Other Expenses – Income Before Income Tax Expense
Interest expense was $549,000 for the three months ended July 31, 2012 compared to $559,000 in the three months ended July 31, 2011, a decrease of $10,000.  The decrease is attributable to lower outstanding debt despite slightly higher interest rates during the third quarter of 2012 compared to the third quarter of 2011.
 
Income before income taxes was $973,000 for the three months ended July 31, 2012 compared to income before income taxes of $1,426,000 in the corresponding period in 2011, a decrease of $453,000. The tax expense in the third quarter of fiscal year 2012 was $378,000 compared to tax expense of $408,000 related to income from operations in the third quarter of fiscal year 2011.  The lower tax expense was a result of lower income from operations. The tax rate of 39% in the third quarter of 2012 was higher than the comparable rate of 29% in 2011. The lower tax rate in 2011 was attributable to adjustment of the income tax rate for the first nine months of the year based on a favorable decision for the Company of an outstanding state tax issue.
 
 
Net Income
Net income for the three months ended July 31, 2012 was $595,000 compared to net income of $1,018,000 in the corresponding period in 2011.  The decrease is attributable to higher operating  and tax (as a percentage of sales) expenses despite higher sales and gross profit and in the third quarter of 2012 as compared to the same period in fiscal year 2011.

Results of Operations for the Nine Months Ended July 31, 2012 Compared to the Nine Months Ended July 31, 2012

Sales
Sales for the nine months ended July 31, 2012 were $53,258,000 compared to $53,103,000 for the corresponding period in 2011, an increase of $155,000, or less than 1%.  The increase was primarily the result of increased office product and stamp sales offset by a reduction in traditional coffee, and equipment rental sales.  There was no material effect on sales as a result of acquisition activity.

The comparative breakdown of sales of the product lines for the respective nine month periods ended July 31, 2012 and 2011 is as follows:
 
 
 
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Product Line
   
2012
   
2011
   
Difference
   
% Diff.
 
$(000’s)                          
Water
    $ 21,522     $ 21,491     $ 31       -  
Coffee
      12,720       13,057       (337 )     (3 %)
Refreshment
      8,786       8,647       139       2 %
Equipment Rental
      6,333       6,511       (178 )     (3 %)
Other
      3,897       3,397       500       15 %
Total
    $ 53,258     $ 53,103     $ 155       -  

Water – The slight increase is a result of a 1% increase in volume which was almost offset by a 1% decrease in average selling price.

Coffee – Lower coffee sales are a result of a 4% decrease in single-serve coffee products.  Growth of our Cool Beans® brand was more than offset by a decline of other brands we sell. Sales of traditional coffee products remained relatively unchanged from last year for the nine month period.

Refreshment – The increased sales of single-serve water and cups were slightly offset by lower soft drink and vending sales while coffee refreshment products were stable.

Equipment Rental – The decrease in rental revenue is attributable to a 4% decrease in placements that was only partially offset by a 1% increase in average rental price.

Other – The increase in other revenue is attributable to sales of office products and stamps which increased 63% and 27%, respectively, over the same period last year. In addition, fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations decreased 2% from the same period in 2011 due to the market price of diesel fuel.

Gross Profit/Cost of Goods Sold – For the nine months ended July 31, 2012, gross profit decreased $248,000, or 1%, to $27,408,000 from $27,656,000 for the comparable period in 2011.  The decrease in gross profit was primarily due to a change in sales mix to lower margin products and higher transportation costs. Gross profit was 52% of sales, in the first nine months of both 2012 and 2011.
 
Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers.  We include distribution costs in selling, general, and administrative expense, and the amount is reported below.  The reader should be aware that other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross profit as a result.

Operating Expenses and Income from Operations
Total operating expenses increased to $24,725,000 in the first nine months of 2012 from $23,937,000 in the comparable period in 2011, an increase of $788,000, or 3%.

Selling, general and administrative (SG&A) expenses of $23,114,000 in the first nine months of 2012 increased $1,155,000, or 5%, from $21,959,000 in the comparable period in 2011.  Of total SG&A expenses, 1) route distribution costs increased $187,000, or 2%, as a result of higher labor and vehicle costs; 2) selling costs increased $939,000, or 32%, as a result of higher labor costs and computer service costs; and 3) administration costs increased $29,000 as a result of higher labor and computer services costs despite a lower provision for bad debts as well as consulting and legal fees that more than offset an increase in labor costs. In addition, there was a combined charge related to an employee termination and lease buyout of $284,000 in the first nine months of 2011 that did not recur in 2012. The computer service costs support the infrastructure improvement of e-commerce and customer relationship management software to enhance our customer service and improve sales by increasing the channels in which our products are offered as well as improve administrative efficiency.
 
 
 
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Advertising expenses were $978,000 in the first nine months of 2012 compared to $1,174,000 in the first nine months of 2011, a decrease of $196,000, or 17%. The decrease in advertising costs is primarily related to a decrease in marketing agency, Yellow Pages and internet advertising costs.

Amortization was $698,000 in the first nine months of 2012 compared to $816,000 in the first nine months of 2011.  Amortization is attributable to intangible assets that were acquired as part of acquisitions in recent years.

Income from operations for the nine months ended July 31, 2012 was $2,684,000 compared to $3,719,000 in the comparable period in 2011, a decrease of $1,035,000, or 28%.  The decrease is attributable to higher cost of goods sold, resulting in a slightly lower gross profit, and higher operating expenses.

Interest, Taxes, and Other Expenses – Income Before Income Tax Expense
Interest expense was $1,644,000 for the nine months ended July 31, 2012 compared to $1,698,000 in the nine months ended July 31, 2011, a decrease of $54,000.  The decrease in the first nine months of 2012 compared to the first nine months of 2011 is attributable to lower outstanding debt despite slightly higher interest rates in 2012.
 
Income before income taxes was $1,044,000 for the nine months ended July 31, 2012 compared to income before income taxes of $2,025,000 in the corresponding period in 2011, a decrease of $981,000.   The tax expense for the first nine months of fiscal year 2012 was $409,000 and was based on the expected effective tax rate of 39%.  We recorded a tax expense of $641,000 related to income from operations in the first nine months of fiscal year 2011 based on an anticipated effective tax rate of 32%.  The lower tax in the first nine months of 2012 was a result of lower income from operations despite a higher tax rate than the previous year. The lower tax rate in the first nine months of 2011 was attributable to adjustment of the income tax rate for the first nine months of the year based on a favorable decision for the Company of an outstanding state tax issue.

Net Income
Net income of $635,000 for the nine months ended July 31, 2012 decreased from net income of $1,384,000 in the corresponding period in 2011, a decrease of $749,000.  The decrease is attributable to higher cost of goods sold, resulting in a slightly lower gross profit, higher operating and tax (as a percentage of sales) expenses.
 
 
 
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Liquidity and Capital Resources

As of July 31, 2012, we had working capital of $8,551,000 compared to $8,640,000 as of October 31, 2011, a decrease of $89,000.  The decrease in working capital is primarily attributable to a decrease in cash of $638,000. In addition to funding routine working capital changes, cash was used primarily for re-payment of debt of $2,160,000 and capital spending of $2,256,000 in the first nine months of 2012. This more than offset cash provided generated from operations of 3,691,000 for the same periods

Our Agreement with Bank of America provides a senior financing facility consisting of term debt and a revolving line of credit.  The Agreement has a total loan capacity of $20,500,000 and obligates us to a $15,500,000 term note and access to a $5,000,000 revolving line of credit. As of July 31, 2012 there was $10,018,500 outstanding on the term loan. The revolving line of credit can be used for the purchase of fixed assets, to fund acquisitions, to collateralize letters of credit, and for operating capital.  There was no balance on the line of credit but it collateralized a letter of credit of $1,504,000 as of July 31, 2012 so, as of that date, there was $3,496,000 available to borrow from the line of credit.

The Agreement amortizes the term debt over a five year period with 59 equal monthly installments of $184,500, commencing May 5, 2010, and a final payment of $4,114,500 due at the end of five years. The revolving line of credit matures in April 2013.   The Company is subject to various restrictive covenants under the agreement, and is prohibited from entering into other debt agreements without the bank’s consent.

Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin based on the achievement of a specified leverage ratio.  As of July 31, 2012 the margin was 2.75% for the term note and 2.50% for the revolving line of credit. The Company is required to fix the interest rate on at least 75% of the outstanding balance of the term note and accomplishes this by entering into interest rate swap agreements.  As of July 31, 2012, the Company had $2,129,625 of the term debt subject to variable interest rates.  The one-month LIBOR was .25% resulting in total variable interest rates of 3.00% and 2.75%, for the term note and the revolving line of credit as of July 31, 2012.

In addition to the senior debt, the Company has subordinated debt owed to Henry, Peter and Jack Baker in the aggregate principal amount of $13,000,000 that is due October 5, 2015.
 
Our credit facility requires that we be in compliance with certain financial covenants at the end of each fiscal quarter.  The covenants include senior debt service coverage as defined of greater than 1.25 to 1, total debt service coverage as defined of greater than 1 to 1, and senior debt to EBITDA as defined of less than 2.50 to 1.  As of July 31, 2012, we were in compliance with all of the financial covenants of our credit facility. The Agreement prohibits us from paying dividends without prior consent of the lender. Also under the Agreement, the Company is obligated to calculate Consolidated Excess Cash Flow based on its financial results for each fiscal year to determine if additional principal is due on the term note. Based on the results of the calculation for fiscal year 2011, in accordance with the agreement a $500,000 principal payment for the term loan was made on February 6, 2012.
 
 
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As reported on Form 8-K filed May 14, 2012, we recently amended the Agreement to change the definition of Consolidated Adjusted Operating Cash Flow to add $965,000 to the calculation of Cash Flow for the reference periods under the Agreement that end April 30, 2012, July 31, 2012 and October 31, 2012.  This revision is intended to reflect the expenditures for upgrades to the Company’s information technology infrastructure, which are expected to provide a long term benefit but do not qualify as capital expenditures under the Agreement.
 
As of July 31, 2012, we had three interest rate swap agreements with Bank of America in effect.  The intent of one swap, entered into on April 5, 2010, is to fix the interest rate on at least 75% of the outstanding balance on the term loan as required by the credit facility.  The swap fixes the interest rate for the swapped amount at 4.76% (2.01% plus the applicable margin, 2.75%).  An additional swap entered into on the same date offsets the swap that fixed the interest on a portion of the term loan and became ineffective when we entered into the Agreement.

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

   
Payment due by Period
 
 
Contractual Obligations (2)
 
Total
   
Remainder
of 2012
      2013-2014       2015-2016    
After 2016
 
Debt
  $ 23,019,000     $ 554,000     $ 4,428,000     $ 18,037,000     $ -  
Interest on Debt (1)
    6,053,000       527,000       3,826,000       1,700,000       -  
Operating Leases
    13,312,000       679,000       6,561,000       4,194,000       1,878,000  
Total
  $ 42,384,000     $ 1,760,000     $ 14,815,000     $ 23,931,000     $ 1,878,000  

(1)  
Interest based on 79% of outstanding senior debt at the hedged interest rate discussed above, 21% of outstanding senior debt at a variable rate of 3%, and subordinated debt at a rate of 12%.
 
(2)  
Customer deposits have been excluded from the table.  Deposit balances vary from period to period with water sales but future increases and decreases in the balances are not accurately predictable.  Deposits are excluded because, net of periodic additions and reductions, it is probable that a customer deposit balance will always be outstanding as long as the business operates.
 
We have no other material contractual obligations or commitments.

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

Item 3.  Quantitative and Qualitative Disclosures about Market Risks.

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

Item 4.  Controls and Procedures.
 
 
 
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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.
 
Changes in Internal Control over Financial Reporting.
 
No change in our internal control over financial reporting occurred during the nine months ended July 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
 
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PART II – OTHER INFORMATION
 
Item 1.                        Legal Proceedings.

None.

Item 1A.                      Risk Factors.
 
There was no change in the nine months ended July 31, 2012 from the Risk Factors reported in our Annual Report on Form 10-K for the year ended October 31, 2011.

Item 2.                      Unregistered Sales of Equity Securities and Use of Proceeds.
 
(c)  The following table summarizes the stock repurchases, by month, that were made during the three months ended July 31, 2012.

Issuer Purchases of Equity Securities
 
   
 
 
 
Total Number of Shares Purchased
   
 
 
 
 
Average Price Paid per Share (1)
   
 
Total Expenditure as Part of a Publicly Announced Program (2)
   
Maximum Expenditure that May Yet be used for Purchases Under the Program (2)
 
May 1-31
    -     $ -     $ -     $ 500,000  
June 1-30
    5,100       1.04       5,309       494,691  
July 1-31
    50       1.06       53       494,638  
Total
    5,150     $ 1.04     $ 5,362          
(1)  
Includes transaction costs
(2)  
On May 14, 2012 we announced a program to repurchase up to $500,000 of our common stock.  There is no expiration date for the plan to repurchase additional shares and the dollar limit may not be reached.


Item 3.                                Defaults Upon Senior Securities.
 
None.
 
Item 4.                                Mine Safety Disclosures.
 
Not Applicable.
 
Item 5.                                Other Information.
 
None.
 
 
 
 
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Item 6.                                Exhibits.

Exhibit
Number                      Description

 
3.1
Certificate of Incorporation (Incorporated by reference to Exhibit B to Appendix A to our registration statement on Form S-4, File No. 333-45226, filed with the SEC on September 6, 2000)

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

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

 
3.4
By-laws, as amended (Incorporated by reference to Exhibit 3.2 to our report on Form 8-K, filed with the SEC on April 2, 2010)

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

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

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2012 and October 31, 2011, (b) our Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2012 and 2011, (c) our Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2012 and 2011, and (d) the Notes to such Condensed Consolidated Financial Statements.


 
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SIGNATURE



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Dated: September 14, 2012

 
 
 
   CRYSTAL ROCK HOLDINGS, INC.
   
   
   By: /s/ Bruce S. MacDonald
                Bruce S. MacDonald
                Vice President, Chief Financial Officer
                (Principal Accounting Officer and Principal Financial Officer)
 
 
 
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Exhibits Filed Herewith

Exhibit
Number                      Description

 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002.

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

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2012 and October 31, 2011, (b) our Condensed Consolidated Statements of Income for the Three and Nine Months Ended July 31, 2012 and 2011, (c) our Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2012 and 2011, and (d) the Notes to such Condensed Consolidated Financial Statements.
 
 
 
 
 
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