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EX-32.1 - EXHIBIT 32.1 - Crystal Rock Holdings, Inc.exh32_1.htm
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EX-31.1 - EXHIBIT 31.1 - Crystal Rock Holdings, Inc.exh31_1.htm
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EXCEL - IDEA: XBRL DOCUMENT - Crystal Rock Holdings, Inc.Financial_Report.xls
 


 
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, 2013
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.
 
Class   Shares outstanding at
Common Stock, $.001 Par Value     September 4, 2013
    21,366,911
 
                                                                     
 
 

 
 
 
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, 2013 and October 31, 2012  3
     
  Condensed Consolidated Statements of Operations for the Three and Nine Months Ended July 31, 2013 and 2012 4
     
  Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended July 31, 2013 and 2012      5
     
  Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2013 and 2012 6
     
  Notes to Condensed Consolidated Financial Statements   7-17
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.   18-26
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 26
     
Item 4. Controls and Procedures.  26-27
 
PART II - OTHER INFORMATION                  
 
Item 1. Legal Proceedings.   28
     
    Item 1A. Risk Factors. 28
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.  28
     
Item 3. Defaults Upon Senior Securities. 28
     
Item 4. Mine Safety Disclosures. 28
     
Item 5. Other Information. 28
     
Item 6. Exhibits. 29
     
SIGNATURE    30
 
 
 
2

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
July 31,
   
October 31,
 
   
2013
   
2012
 
 
(Unaudited)
 
             
ASSETS
 
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 2,882,911     $ 3,071,277  
Accounts receivable - net
    8,515,256       7,950,067  
Inventories - net
    2,514,015       2,629,665  
Current portion of deferred tax asset
    421,679       421,679  
Other current assets
    789,337       1,387,288  
                 
TOTAL CURRENT ASSETS
    15,123,198       15,459,976  
                 
PROPERTY AND EQUIPMENT - net
    7,472,217       8,127,582  
                 
OTHER ASSETS:
               
Goodwill
    12,156,790       12,156,790  
Other intangible assets - net
    1,552,964       2,312,433  
Other assets
    39,416       39,000  
                 
TOTAL OTHER ASSETS
    13,749,170       14,508,223  
                 
TOTAL ASSETS
  $ 36,344,585     $ 38,095,781  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
                 
CURRENT LIABILITIES:
               
Current portion of long term debt
  $ 1,691,277     $ 3,815,103  
Accounts payable
    1,823,481       1,709,506  
Accrued expenses
    2,039,819       2,254,994  
Current portion of customer deposits
    657,065       650,540  
Current portion of unrealized loss on derivatives
    33,202       127,180  
TOTAL CURRENT LIABILITIES
    6,244,844       8,557,323  
                 
Long term debt, less current portion
    8,904,768       7,251,000  
Deferred tax liability
    4,506,148       4,506,148  
Subordinated debt
    10,000,000       11,500,000  
Customer deposits
    2,524,791       2,487,123  
                 
TOTAL LIABILITIES
    32,180,551       34,301,594  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS' EQUITY:
               
Common stock - $.001 par value, 50,000,000 authorized shares,
               
21,960,229 issued and 21,366,911 outstanding shares as of
               
July 31, 2013 and 21,960,229 issued and 21,380,731
               
outstanding shares as of October 31, 2012
    21,960       21,960  
Additional paid in capital
    58,462,497       58,462,497  
Treasury stock, at cost, 593,318 shares as of July 31, 2013
               
    and 579,498 shares as of October 31, 2012
    (892,739 )     (878,560 )
Accumulated deficit
    (53,408,012 )     (53,735,401 )
Accumulated other comprehensive loss, net of tax
    (19,672 )     (76,309 )
TOTAL STOCKHOLDERS' EQUITY
    4,164,034       3,794,187  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 36,344,585     $ 38,095,781  
                 
See the notes to the condensed consolidated financial statements.
 
 
 
 
3

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Three months ended July 31,
   
Nine months ended July 31,
 
   
2013
   
2012
   
2013
   
2012
 
   
(unaudited)
   
(unaudited)
 
                         
NET SALES
  $ 18,351,802     $ 18,462,810     $ 52,742,150     $ 53,257,576  
                                 
COST OF GOODS SOLD
    8,378,042       8,497,374       25,298,329       25,849,125  
                                 
GROSS PROFIT
    9,973,760       9,965,436       27,443,821       27,408,451  
                                 
OPERATING EXPENSES:
                               
Selling, general and administrative expenses
    7,667,883       7,877,903       24,094,460       23,114,088  
Advertising expenses
    207,937       339,841       605,418       978,107  
Amortization
    239,510       229,011       725,291       698,163  
    Gain on disposal of property and equipment
    (11,372 )     (6,665 )     (22,448 )     (65,773 )
                                 
TOTAL OPERATING EXPENSES
    8,103,958       8,440,090       25,402,721       24,724,585  
                                 
INCOME FROM OPERATIONS
    1,869,802       1,525,346       2,041,100       2,683,866  
                                 
OTHER EXPENSE (INCOME):
                               
Interest expense
    384,871       548,633       1,488,024       1,643,949  
(Gain) loss on derivatives
    -       4,119       (16,505 )     (3,973 )
TOTAL OTHER EXPENSE, NET
    384,871       552,752       1,471,519       1,639,976  
                                 
INCOME BEFORE INCOME TAX EXPENSE
    1,484,931       972,594       569,581       1,043,890  
                                 
INCOME TAX EXPENSE
    600,643       377,926       242,192       408,683  
                                 
NET INCOME
  $ 884,288     $ 594,668     $ 327,389     $ 635,207  
                                 
NET INCOME PER SHARE - BASIC
  $ 0.04     $ 0.03     $ 0.02     $ 0.03  
                                 
NET INCOME PER SHARE - DILUTED
  $ 0.04     $ 0.03     $ 0.02     $ 0.03  
                                 
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC
    21,368,218       21,386,297       21,373,946       21,387,881  
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED
    21,368,218       21,386,297       21,373,946       21,387,881  
 
 
 
4

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
   
Three months ended July 31,
   
Nine months ended July 31,
 
   
2013
   
2012
   
2013
   
2012
 
   
(unaudited)
   
(unaudited)
 
                         
                         
NET INCOME
  $ 884,288     $ 594,668     $ 327,389     $ 635,207  
OTHER COMPREHENSIVE INCOME, NET OF TAX:
                               
  Cash Flow Hedges:
                               
  Amortization of loss on derivative undesignated as cash flow hedge
    -       22,731       15,066       68,194  
  Unrealized gain on derivatives designated as cash flow hedges
    20,865       19,173       41,571       59,931  
  Other Comprehensive Income, net of tax
    20,865       41,904       56,637       128,125  
TOTAL COMPREHENSIVEINCOME
  $ 905,153     $ 636,572     $ 384,026     $ 763,332  
 
 
 
5

 
 
 
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Nine months ended July 31,
 
   
2013
   
2012
 
   
(Unaudited)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 327,389     $ 635,207  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    2,320,639       2,506,373  
Provision for bad debts on accounts receivable
    157,622       145,223  
Amortization
    725,291       698,163  
Non cash interest expense
    108,602       36,001  
Gain on derivatives
    (16,505 )     (3,973 )
Gain on disposal of property and equipment
    (22,448 )     (65,773 )
Changes in assets and liabilities:
               
Accounts receivable
    (722,811 )     (368,049 )
Inventories
    115,650       66,217  
Other current assets
    571,399       285,298  
Accounts payable
    113,975       (360,181 )
Accrued expenses
    (209,875 )     149,603  
Customer deposits
    44,193       (32,857 )
NET CASH PROVIDED BY OPERATING ACTIVITIES
    3,513,121       3,691,252  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment
    (1,639,691 )     (2,255,768 )
Proceeds from sale of property and equipment
    27,120       99,228  
Cash used for acquisitions
    (85,929 )     (7,000 )
NET CASH USED IN INVESTING ACTIVITIES
    (1,698,500 )     (2,163,540 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from long term debt
    2,273,000       -  
Principal payments on long term debt
    (4,261,808 )     (2,160,500 )
Purchase of treasury stock
    (14,179 )     (5,362 )
NET CASH USED IN FINANCING ACTIVITIES
    (2,002,987 )     (2,165,862 )
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (188,366 )     (638,150 )
                 
CASH AND CASH EQUIVALENTS - beginning of period
    3,071,277       5,378,575  
                 
CASH AND CASH EQUIVALENTS  - end of period
  $ 2,882,911     $ 4,740,425  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
                 
Cash paid for interest
  $ 1,489,681     $ 1,609,209  
                 
Cash paid (received) for income taxes
  $ (465,316 )   $ (197,499 )
                 
Notes payable issued in acquisitions
  $ 18,750     $ -  
                 
See the notes to the condensed consolidated financial statements.
 
 
 
 
6

 
 
 
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, 2012.

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, 2012.  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, 2013
   
October 31, 2012
 
   
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
  $ 2,401,488     $ 2,107,238       2.68     $ 2,386,488     $ 1,986,405       3.04  
Customer Lists
    7,880,610       6,935,089       2.81       7,821,186       6,339,881       2.41  
Other Identifiable Intangibles
    548,311       235,118       26.17       656,913       225,868       26.90  
Total
  $ 10,830,409     $ 9,277,445             $ 10,864,587     $ 8,552,154          

 
Amortization expense for the three month periods ending July 31, 2013 and 2012 was $239,510 and $229,111, respectively.  Amortization expense for the nine month periods ending July 31, 2013 and 2012 was $725,291 and $698,163, respectively.  There were no changes in the carrying amount of goodwill for the three and nine month periods ending July 31, 2013 and 2012.
 
 
 
7

 


3.
DEBT
 
On March 13, 2013, the Company amended its 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, the Company became obligated on $11,000,000 of debt in the form of a term note to refinance the previous senior term debt and to fund repayment of a portion of its outstanding subordinated debt. Additionally, the Agreement includes a $5,000,000 revolving line of credit that can be used for the purchase of fixed assets, to fund acquisitions, to collateralize letters of credit, and for operating capital.

The Agreement amortizes the term debt over a five year period with 59 equal monthly installments of $130,952 and a final payment of $3,273,832 due in March 2018. The revolving line of credit matures in March 2016.  There are various restrictive covenants under the Agreement, and the Company 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.
 
 
There was no balance on the line of credit but it collateralized a letter of credit of $1,466,000 as of July 31, 2013.  Consequently, as of that date, there was $3,534,000 available to borrow from the revolving line of credit. There was $10,476,000 outstanding on the term note as of July 31, 2013.

 
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, 2013, the margin was 2.50% for the term note and 2.25% for the revolving line of credit.  The Company fixed the interest rate on 75% of its term debt by purchasing an interest rate swap as of the date of the Agreement. As of July 31, 2013, the Company had $2,619,000 of the term debt subject to variable interest rates.  The one-month LIBOR was .19% on the last business day of July 2013 resulting in total variable interest rates of 2.69% and 2.44%, for the term note and the revolving line of credit, respectively, as of July 31, 2013.
 
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, 2013, the Company was in compliance with these covenants and terms of the Agreement.

In addition to the senior debt, as of July 31, 2013, the Company has subordinated debt owed to Henry, Peter and John Baker.  On December 21, 2012 the Company made a discretionary payment of $1,500,000 to the subordinated debt holders. With a portion of the proceeds from the senior debt re-financing above, the Company paid down the amount of subordinated debt by an additional $1,500,000 leaving an aggregate remaining principal outstanding of $10,000,000 due by the amended maturity date of October 5, 2018. The interest rate on each of these notes is 12% per annum.
 
 
 
8

 

 
In the last twelve months, the Company made acquisitions resulting in the issuance of notes totaling $120,000 to the sellers that were outstanding on July 31, 2013. One of the notes, in the amount of $19,000, was subsequently paid in August 2013. The remaining note was due on March 20, 2013 but remains a liability and has not been paid because certain contingencies in the acquisition agreement that were required to be met for payment were not met subsequent to the transaction. The Company is currently discussing settlement of these contingencies with the seller and is uncertain of if or when the amount due, in whole or in part, will be paid.

4.
INVENTORIES
 
Inventories consisted of the following at:
 
   
July 31,
2013
   
October 31,
2012
 
Finished Goods   $ 2,365,288     $ 2,447,605  
Raw Materials     148,727       182,060  
Total Inventories   $ 2,514,015     $ 2,629,665  
 
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, 2013 and October 31, 2012 to be $30,000 and $31,000, 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 uses 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.
 
 
 
9

 
 
 
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 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 was to mature in January 2014.

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 were to mature.   In addition, the Company entered into a swap agreement (new swap) to fix the interest rate of up to 75% of the outstanding balance of the term note at 4.76% (2.01% plus the applicable margin, 2.75%).  The term note was re-financed in March 2013 and the new swap matured in April 2013.
 
In March 2013, the Company terminated the old and offsetting swaps and settled the remaining liability of $27,670 associated with them. The settlement was expensed during the three months ended April 30, 2013. In addition, the Company entered into a new interest rate swap agreement (latest swap) for the purpose of fixing at least 75% of the term loan under the Agreement with Bank of America. The latest swap fixes the rate on at least 75% of the outstanding balance of the term loan at 3.18% (.68% plus the applicable margin under the Agreement, 2.50%) until March 2016.
 
As of July 31, 2013, the total notional amount of the new swap agreement was $7,857,000.  On that date, the variable rate on the remaining portion of the term note was 2.69%.
 
 
 
10

 
 
 
At July 31, 2013 and October 31, 2012, the net unrealized loss or gain relating to interest rate swaps was recorded in current and long term liabilities and long term assets.  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 at October 31, 2012 and the latest swap at July 31, 2013, 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 were 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.

The table below details the adjustments to other comprehensive income (loss), on a before-tax and net-of tax basis, for the fiscal quarters ended July 31, 2013 and 2012.
 
   
Before-Tax
   
Tax Benefit
   
Net-of-Tax
 
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  
Three Months Ended July 31, 2013
                       
Gain on interest rate swap
    24,898       (9,959 )     14,939  
Reclassification adjustment for loss in income
    9,877       (3,951 )     5,926  
Net unrealized gain
  $ 34,775     $ (13,910 )   $ 20,865  
 
The reclassification adjustments of $9,877 and $67,135 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreement during the quarters ended July 31, 2013 and 2012, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in consolidated statements of operations as interest expense.  No other material amounts were reclassified during the quarters ended July 31, 2013 and 2012.

 
 
11

 
 
 
The table below details the adjustments to other comprehensive income (loss), on a before-tax and net-of tax basis, for the nine months ended July 31, 2013 and 2012.
 
   
Before-Tax
   
Tax Benefit
(Expense)
   
Net-of-Tax
 
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  
Nine months Ended July 31, 2013
                       
Loss on interest rate swap
  $ (27,653 )   $ 11,061     $ (16,592 )
Amortization of loss on derivative undesignated as cash flow hedge
    25,110       (10,044 )     15,066  
Reclassification adjustment for loss in income
    96,938       (38,775 )     58,163  
Net unrealized gain
  $ 94,395     $ (37,758 )   $ 56,637  
 
The reclassification adjustments of $96,938 and $224,400 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, 2013 and 2012, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in the condensed consolidated statements of operations as interest expense.  No other material amounts were reclassified during the nine months ended July 31, 2013 and 2012.

In the nine months ended July 31, 2013 the fair value of the swap entered into during the quarter resulted in an unrealized loss on derivative liability at the end of the period of $32,786. Also, as of that date, the estimated net amount of the existing loss that is reported in accumulated other comprehensive income that is expected to be reclassified into earnings within the next twelve months is $33,202, net of tax.

Derivatives designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $33,202 at July 31, 2013 and $64,603 at October 31, 2012.  There were no derivatives other than the interest rate swap designated as a hedging instrument as of July 31, 2013. As of October 31, 2012 there were derivatives consisting of interest rate swaps not designated as hedging instruments classified as liabilities on the Company’s consolidated balance sheet with a fair value of $62,577. During the first nine months of fiscal years 2013 and 2012, cash flow hedges are deemed 100% effective. During the quarter ended July 31, 2013, the only derivative was a cash flow hedge. The net loss on interest rate swaps not designated as cash flow hedges, classified as a loss on derivatives on the Company’s statements of operations, amounted to $4,119 for the quarter ended July 31, 2012. The net gain on interest rate swaps not designated as cash flow hedges, classified as a gain on derivatives on the Company’s statements of operations, amounted to $16,505 and $3,973 for the nine months ended July 31, 2013 and 2012, respectively.


 
12

 

 
6.
FAIR VALUES OF ASSETS AND LIABILITIES
       
 
Fair Value Hierarchy
 
The Company had no assets measured at fair value on a recurring basis as of July 31, 2013 or October 31, 2012.  The Company’s liabilities measured at fair value on a recurring basis are as follows:

   
Level 1
   
Level 2
   
Level 3
 
Liabilities:
                 
July 31, 2013
                 
Unrealized loss on derivatives
  $ -     $ 32,786     $ -  
       
October 31, 2012
     
Unrealized loss on derivatives
  $ -     $ 127,180     $ -  
 
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.

The Company’s assets and liabilities measured at fair value on a nonrecurring basis are as follows:

   
Level 1
   
Level 2
   
Level 3
 
Assets:
                 
October 31, 2012
                 
Goodwill (a)
  $ -     $ -     $ 12,156,790  
       
 
(a)  
In accordance with FASB Accounting Standards Codification Subtopic 350-20, goodwill with a carrying amount of $32,123,294 was written down to its implied fair value of $12,156,790, resulting in an impairment charge of $19,966,504, which was included in earnings for the year ended October 31, 2012.

There were no assets or liabilities measured at fair value on a nonrecurring basis at July 31, 2013.

 
 
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The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments.  The carrying amounts reported in the consolidated balance sheet for cash equivalents, trade receivables, and accounts payable approximate fair value based on the short-term maturity of these instruments.  The carrying value of senior debt approximates its fair value since it provides for variable market interest rates. Subordinated debt is carried at its approximate market value based on periodic comparisons to similar instruments in the market place.
 
7.
INCOME (LOSS) 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:

   
Three Months Ended
July 31,
   
Nine months Ended
July 31,
 
   
2013
   
2012
   
2013
   
2012
 
Net Income
  $ 884,288     $ 594,668     $ 327,389     $ 635,207  
Denominator:
                               
Basic Weighted Average Shares Outstanding
    21,368,218       21,386,297       21,373,946       21,387,881  
Dilutive effect of Stock Options
    -       -       -       -  
Diluted Weighted Average Shares Outstanding
    21,368,218       21,386,297       21,373,946       21,387,881  
Basic Income (Loss) Per Share
  $ .04     $ .03     $ .02     $ .03  
Diluted Income Per (Loss) Share
  $ .04     $ .03     $ .02     $ .03  

There were 211,500 and 269,500 options outstanding as of July 31, 2013 and 2012, respectively.  For the three month and nine month periods ended July 31, 2013 and 2012 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.
 
8.
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.
 
 
 
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The Company has stock-based compensation plans under which incentive and non-qualified stock options and restricted shares are granted.  The 1998 Incentive and Non-Statutory Stock Option Plan (1998 Plan) provided 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 1998 Plan was to award options to officers, employees, directors, and other individuals providing services to the Company.  As of April 10, 2013, no further options may be granted under the 1998 Plan.  As of July 31, 2013, there were 85,500 options outstanding under the 1998 Plan.

In April 2004, the Company’s stockholders approved the 2004 Stock Incentive Plan (2004 Plan).  The 2004 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 the 2004 Plan, 126,000 options are outstanding, 26,000 restricted shares have been granted, and 98,000 shares are available for grant at July 31, 2013.
 
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 three options, for a total of 58,000 shares that expired in the first nine months of 2013 and three options, for a total of 15,000 shares that expired in the first nine months of fiscal year of 2012.  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, 2013 and 2012.  The Company did not grant any equity based compensation during the three and nine months ended July 31, 2013 and 2012.
 
The following table summarizes information pertaining to outstanding stock options, all of which are exercisable, as of July 31, 2013:
 
Exercise
Price
Range
   
Outstanding
Options
(Shares)
   
Weighted Average
Remaining
Contractual Life
   
Weighted
Average
Exercise Price
   
Intrinsic Value
as of
July 31, 2013
 
$ 1.80 - $2.36       201,500       1.5     $ 2.32     $ -  
$ 3.18 - $3.38       10,000       .3       3.28       -  
          211,500       1.4     $ 2.38     $ -  

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, 2013 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.
 
 
 
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9.  
RECENT ACCOUNTING PRONOUNCEMENTS
 
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Income Taxes (Topic 740:) amending guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. The guidance requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented as a reduction of a deferred tax asset when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists, with certain exceptions. This accounting guidance is effective prospectively for the Company beginning in the first quarter of fiscal year 2015, with early adoption permitted. While the Company is currently evaluating the impact, its adoption is not expected to have a material impact on the Company’s consolidated financial statements.
 
In July 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815): permitting entities to designate the Fed Funds Effective Swap Rate as a U.S. benchmark interest rate for hedge accounting purposes. Prior to the issuance of this guidance, only interest rates on direct treasury obligations of the U.S. government and the LIBOR swap rate were considered benchmark interest rates in the U.S. This guidance is effective immediately and can be applied prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. Currently, the Company does not use the Fed Funds Effective Swap Rate as a benchmark interest rate, but may in the future.
 
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Comprehensive Income. ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For significant items not reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. The amendments in this ASU are effective for annual reporting periods, and interim periods within those annual reporting periods, beginning after December 15, 2012, which for the Company will be the first quarter of fiscal 2014. The adoption of ASU 2013-02 is not expected to have an impact on the Company’s net income, financial position or cash flows.
 
In July 2012, the FASB issued 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.  The Company does not anticipate that adoption will have a material impact on its operations or financial statements.
 
 
 
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In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210), which 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. On January 31, 2013, the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarified that the scope of the disclosures is limited to 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 amendments are 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 is fiscal 2013 for the Company.  The Company does not anticipate that adoption will have a material impact on its operations or financial statements.
 
10.  
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.
 

 
17

 

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, 2012 as well as the condensed consolidated financial statements and notes contained herein.
 
Forward-Looking Statements

The “Management’s Discussion and Analysis” (MD&A) portion of this Form 10-Q contains forward-looking statements about these topics:
 
(1) the lower gross profits of products that we are offering in connection with our brand expansion and response to competition in our marketplace,
(2) the cost pressures related to commodities affecting our business,
(3) the possibility that the costs to upgrade our information technology infrastructure and increase our sales staff may not result in a financial pay back in the future, and
(4) the potential adverse effect of weather on our sales and costs.

The following factors could cause actual results to differ materially from statements in MD&A about topic (1):  The volume of and revenues from products that we sell may be greater or less than we anticipate.  If greater, the effect will likely reduce our gross margin overall as a result of lower prices in response to competition; 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, to the extent we hire more sales staff to increase sales revenue, there is no assurance we can succeed in achieving our sales goals.  We also incorporate by reference into this paragraph the full Risk Factor on page 13 of our Annual Report on Form 10-K for the Fiscal Year Ended October 31, 2012 (our 2012 Form 10-K) concerning risks of competition, and the full Risk Factor on page 17 of our 2012 Form 10-K concerning risks in connection with acquisitions.
 
The following factors could cause actual results to differ materially from statements in MD&A about topic (2):  We incorporate by reference into this paragraph the full Risk Factor on pages 15-16 of our 2012 Form 10-K concerning risks of fluctuation in the costs of essential raw materials and commodities.
 
The following factors could cause actual results to differ materially from statements in MD&A about topic (3):  We incorporate by reference into this paragraph the full Risk Factor on page 15 of our 2012 Form 10-K concerning risks of our expansion strategy.

The following factors could cause actual results to differ materially from statements in MD&A about topic (4):  We incorporate by reference into this paragraph the full Risk Factor on page 16 of our 2012 Form 10-K concerning risks of extremes of weather.

 
 
18

 


Results of Operations

Overview and Trends

Despite an increase in water sales, total sales in the first nine months of 2013 were slightly lower than for the same period in 2012 as other product lines declined.  Gross profit was essentially the same compared to the first nine months a year ago. A slightly more profitable sales mix produced an increase in gross profit as a percentage of sales.  Net income in the third quarter was higher than the same period a year ago but lower for the first nine months of 2013 compared to the same period a year ago. The improved results for the quarter reflected more profitable sales and lower operating costs. However, for the first nine months of the year operating costs were higher than in the comparable nine month period of the prior year, contributing to lower profitability for that period.

We refinanced our senior term note and line of credit and paid down $3 million of subordinated debt during the first nine months of fiscal year 2013. Over that time, we have decreased our total debt while continuing to fund operations from available cash.

Results of Operations for the Three Months Ended July 31, 2013 (Third quarter) Compared to the Three Months Ended July 31, 2012

Sales
Sales for the three months ended July 31, 2013 were $18,352,000 compared to $18,463,000 for the corresponding period in 2012, a decrease of $111,000 or 1%.  Acquisitions amounted to 1% of sales in the third quarter of 2013. Thus, net of acquisitions, sales in the third quarter were 2% less than the comparable period a year ago.
 
The breakdown of sales by product line for the respective three-month periods ended July 31, 2013 and 2012 is as follows:
 
Product Line
    2013       2012        Difference       % Diff.  
(000’s $)
                               
Water
  $ 8,092     $ 7,865     $ 227       3 %
Coffee
    3,788       3,986       (198 )     (5 %)
Refreshment
    3,100       3,170       (70 )     (2 %)
Equipment Rental
    2,054       2,124       (70 )     (3 %)
Other
    1,318       1,318       -       -  
Total
  $ 18,352     $ 18,463     $ (111 )     (1 %)

Water – Sales of water increased compared to the same period in the prior year because of a 5% increase in the total bottles sold offset by a 2% decrease in average selling price per bottle.  Net of acquisitions in 2012, water sales for the third quarter of 2013 increased 1% compared to the same quarter a year ago.

Coffee – Cool Beans pods sales increased 16% while other brands and sizes decreased 8% in the quarter.  The overall decrease was attributable to lower volume as a result of competition and lower prices dictated by lower commodity costs compared to a year ago. The increase in pod sales is primarily a result of being a lower price, high quality substitute for other single serve coffee products. Acquisitions had no material effect on sales for the quarter.
 
 
 
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Refreshment – Sales decreased primarily as a result of a decrease in sales of cups in the third quarter of 2013 compared to the same quarter a year ago. Acquisitions accounted for a 3% increase in sales in the third quarter of 2013 due to an acquisition of vending accounts in the quarter.

Equipment Rental – The decrease in sales was a result of a 7% decrease in average rental price as well as a 4% increase in average rental units in the field. Acquisitions in 2012 accounted for 1% of sales for the quarter.

Other – Sales of office products and stamps, which were $711,000 for the quarter, increased 14%. The fees that we charge to offset energy costs for delivery and freight, raw materials, and bottling operations decreased 6%.  These charges decreased to $572,000 in the third quarter of 2013 from $608,000 in the same period in 2012.

Gross Profit/Cost of Goods Sold – For the three months ended July 31, 2013, gross profit increased slightly to $9,974,000 from $9,965,000 for the comparable period in 2012. The increase in gross profit of $9,000 was primarily due to higher water sales and lower equipment 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 margin as a result.

Operating Expenses and Income from Operations
Total operating expenses decreased to $8,104,000 in the third quarter of 2013 from $8,440,000 in the comparable period in 2012, a decrease of $336,000, or 4%.

Selling, general and administrative (SG&A) expenses of $7,668,000 in the third quarter of 2013 decreased $210,000, or 3%, from $7,878,000 in the comparable period in 2012.  Of total SG&A expenses, route distribution costs increased $89,000, or 3%, as a result of higher labor and vehicle costs. Higher labor costs were primarily related to an increase in staffing for delivery and increased vehicle costs were related to leasing and maintenance costs for delivery vehicles; Selling costs decreased $170,000, or 14% primarily because of software implementation costs to support sales infrastructure in the third quarter 2012 that were lower in 2013 and lower labor costs.  Administrative costs decreased $129,000, or 4%, as a result of lower personnel related costs and lower software maintenance costs to support the new information systems installation referred to above despite higher labor costs.
 
 
 
20

 
 
 
Advertising expenses were $208,000 in the third quarter of 2013 compared to $340,000 in the third quarter of 2012, a decrease of $132,000, or 39%. The decrease in advertising costs is primarily related to a reduction in agency costs and the cost for printed material.

Amortization increased to $240,000 in the third quarter of 2013 from $229,000 in the comparable quarter in 2012, an increase of $11,000, or 5%.  Amortization is attributable to intangible assets that were acquired as part of acquisitions. The higher amortization in 2013 is attributable to more acquisition activity in recent years.

In addition, we had a gain of $11,000 from the sale of assets in the third quarter of 2013 which was an increase from the $5,000 gain from similar sales in the third quarter of 2012. We routinely sell assets used in the normal course of business as they are replaced with newer assets.

The income from operations for the three months ended July 31, 2013 was $1,870,000 compared to income from operations of $1,525,000 in the comparable period in 2012, an increase of $345,000, or 23%.  The increase was a result of lower operating costs.
 
Interest, Taxes, and Other Expenses
Interest expense was $385,000 for the three months ended July 31, 2013 compared to $549,000 in the three months ended July 31, 2012, a decrease of $164,000, or 30%.  The decrease is primarily attributable to the reduction of the subordinated debt during 2013. By reducing this debt, which has a rate of 12% a year, we effectively reduced our interest rate lowering our interest expense.
 
Income before income taxes was $1,485,000 for the three months ended July 31, 2013 compared to income before income taxes of $973,000 in the corresponding period in 2012, an increase of $512,000. Tax expense for the third quarter of fiscal year 2013 was $601,000 compared to $378,000 of tax expense the third quarter of fiscal year 2012.  The higher tax expense was a result of an increased income from operations and slightly higher effective tax rate of 40% in the third quarter of 2013 compared to 39% in the same quarter of 2012. The higher tax rate in 2013 was related to changes in estimated permanent items during the year that we did not have in the same period of 2012.
 
Net Income
Net income for the three months ended July 31, 2013 was $884,000 compared to $595,000 in the corresponding period in 2012.  The increase is attributable to slightly higher gross profit and lower operating and interest expenses in the third quarter of 2013 as compared to the same period in fiscal year 2012 as discussed above.

Results of Operations for the Nine months Ended July 31, 2013 Compared to the Nine months Ended July 31, 2012

Sales
Sales for the nine months ended July 31, 2013 were $52,742,000 compared to $53,258,000 for the corresponding period in 2012, a decrease of $516,000, or 1%.  The decrease was primarily the result of the decrease in traditional coffee sales and equipment rental and, to a lesser extent, decreases in refreshment products and fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations that more than offset a small increase in water sales.  Acquisitions accounted for 1% of total sales in the comparative period of 2013.
 
 
 
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The breakdown of sales by product line for the respective nine month periods ended July 31, 2013 and 2012 is as follows:
 
Product Line
    2013       2012       Difference       % Diff.  
(000’s $)                                
Water
  $ 21,866     $ 21,522     $ 344       2 %
Coffee
    12,149       12,720       (571 )     (4 %)
Refreshment
    8,704       8,786       (82 )     (1 %)
Equipment Rental
    6,168       6,333       (165 )     (3 %)
Other
    3,855       3,897       (42 )     (1 %)
Total
  $ 52,742     $ 53,258     $ (516 )     (1 %)

Water – The increase is a result of a 3% increase in volume despite a 1% decrease in average selling price. The increase in volume was primarily a result of acquisitions completed in 2012.  Net of acquisitions, water sales were essentially the same for the first nine months of 2013 compared the same period a year ago.

Coffee – Our Cool Beans brand increased 15% while other brands we sell were 5% less than the first nine months of 2012. The overall decrease was attributable to lower volume as a result of competition and lower prices dictated by lower commodity costs compared to a year ago. The increase in pod sales is primarily a result of offering a lower price, high quality substitute for other single serve coffee products. Acquisition activity had no material impact on coffee sales in the first nine months of 2013.

Refreshment – Sales, which include sales of complementary coffee products, single serve drinks, cups, single serve water sales, and vending items, were lower because of a decrease in all of those products. Acquisitions, including vending accounts, accounted for 2% of the sales for the first nine months of the year.

Equipment Rental – The decrease is attributable to a 6% decrease in average rental price while average rental units in the field increased 4%. Acquisitions accounted for 1% of the sales for the first nine months of the year.

Other – Sales of office products and stamps increased 12% to $2,002,000 for the first nine months of 2013 compared to $1,785,000 for the same period last year. Fees that we charge to offset energy costs for delivery and freight, raw materials, and bottling operations decreased 7% to $1,720,000 in the first nine months of 2013 from $1,858,000 in the same period in 2012, resulting in the overall slight decrease for the category.
 
 
 
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Gross Profit/Cost of Goods Sold – For the nine months ended July 31, 2013, gross profit increased $36,000 to $27,444,000 from $27,408,000, essentially the same compared to the same period in 2012.  As a percentage of sales, gross profit increased to 52% in the first nine months of 2013 from 51% in the first nine months of 2012. The slight increase in gross profit and gross profit as a percentage of sales was primarily due to higher water sales and lower equipment service costs in the first nine months of 2013 compared to the first nine months of the prior year.
 
Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers.  We include distribution costs in selling, general, and administrative expense, and the amount is reported below.  The reader should be aware that other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result.

Operating Expenses and Income from Operations
Total operating expenses increased to $25,403,000 in the first nine months of 2013 from $24,725,000 in the comparable period in 2012, an increase of $678,000, or 3%.

Selling, general and administrative (SG&A) expenses of $24,095,000 in the first nine months of 2013 increased $981,000, or 4%, from $23,114,000 in the comparable period in 2012.  Of total SG&A expenses, route distribution costs increased $782,000, or 8%, as a result of higher lease, fuel, and repair costs for vehicles and higher staffing costs for delivery; Selling costs decreased $398,000, or 10%, as a result of lower computer-related service costs to support the infrastructure improvement of e-commerce and customer relationship management software despite an increase in sales staffing. Administrative costs increased $597,000, or 7%, as a result of higher labor costs for increased administrative staffing as well as software maintenance costs to support the new information systems installation referred to above.
 
Advertising expenses were $605,000 in the first nine months of 2013 compared to $978,000 in the first nine months of 2012, a decrease of $373,000, or 38%. The decrease in advertising costs is primarily related to a decrease in marketing agency and printed material costs.

Amortization was $725,000 in the first nine months of 2013 compared to $698,000 in the first nine months of 2012.  The higher amortization in 2013 is attributable to more acquisition activity in recent years.  In addition, we had a gain of $22,000 from the sale of assets in the first nine months of 2013, a decrease from the $66,000 gain from similar sales in the first nine months of 2012. We routinely sell assets used in the normal course of business as they are replaced with newer assets.

Income from operations for the nine months ended July 31, 2013 was $2,041,000 compared to $2,684,000 in the comparable period in 2012, a decrease of $643,000, or 24%.  The decrease is attributable to higher route operating costs as well as higher labor costs related to sales and administration. This resulted in higher total operating costs despite lower net software support and sales and advertising costs.
 
 
 
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Interest, Taxes, and Other Expenses
Interest expense was $1,488,000 for the nine months ended July 31, 2013 compared to $1,644,000 in the nine months ended July 31, 2012, a decrease of $156,000, or 9%. The decrease is primarily attributable to the reduction of the subordinated debt during 2013. By reducing this debt, which has a rate of 12% a year, we effectively reduced our interest rate lowering our interest expense.
 
Net income before income taxes was $570,000 for the nine months ended July 31, 2013 compared to $1,044,000 in the corresponding period in 2012, a decrease of $474,000. The tax expense for the first nine months of fiscal year 2013 was $242,000 and was based on the expected effective tax rate of 42%.  We recorded a tax expense of $409,000 related to income from operations in the first nine months of fiscal year 2012 based on an anticipated effective tax rate of 39%.  The higher tax rate in 2013 was related to changes in estimated permanent items during the year that we did not have in the same period of 2012. Lower taxes in 2013 were a result of lower net income before taxes.

Net Income (Loss)
Net income of $327,000 for the nine months ended July 31, 2013 was $308,000 less than $635,000 in the corresponding period in 2012.  The decrease is attributable to lower sales and higher operating expenses as discussed above.

Liquidity and Capital Resources

As of July 31, 2013, we had working capital of $8,878,000 compared to $6,903,000 as of October 31, 2012, an increase of $1,975,000.  The increase in working capital is primarily attributable to a decrease in the current portion of long term debt as a result of the restructuring of the Company’s long term debt.  In addition, the repayment of the subordinated debt, a portion of which had been classified as current debt in anticipation of payment, was funded largely from the long term senior debt facility.

Cash provided from operating activities decreased to $3,513,000 from $3,691,000 for the first nine months of 2013 and 2012, respectively, a decrease of $178,000. In addition to the repayment of debt, we used $1,640,000 for capital expenditures in the first nine months of 2013 compared to $2,256,000. Capital expenditures primarily include coolers, brewers, and bottles.
 
On March 13, 2013, we amended our Credit Agreement to renew the line of credit and restructure our term loan.  Our Agreement with the Bank obligated us to $11,000,000 of debt in the form of a term note to refinance the previous senior term debt, line of credit, and to fund re-payment of a portion of our outstanding subordinated debt. A reconciliation of the funds used from the restructure of the term loan is as follows:
 
Previous term loan    $ 8,542,500  
Repayment of subordinated debt      1,500,000  
Administrative and termination fees     132,500  
To fund operating cash and debt repayment      825,000  
Total term loan obligation   $ 11,000,000  
                                                                                                                                                           
 
 
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With a portion of the proceeds from the senior debt re-financing above, we paid down $1,500,000 of the subordinated debt owed to Henry, Peter and John Baker. This followed a discretionary payment of $1,500,000 to the subordinated debt holders made in December 2012. Following the two payments, there was an aggregate remaining principal outstanding of $10,000,000 due by the amended maturity date of October 5, 2018. The interest rate on each of the subordinated notes is 12% per annum.

Additionally, the Agreement includes a $5,000,000 revolving line of credit that can be used for the purchase of fixed assets, to fund acquisitions, to collateralize letters of credit, and for operating capital.  As of July 31, 2013 we had an outstanding letter of credit of $1,466,000 on our line of credit resulting in $3,534,000 available to borrow from the facility as of that date.

The Agreement amortizes the term debt over a five year period with 59 equal monthly installments of $130,952 and a final payment of $3,273,832 due in March 2018. The line of credit matures in March 2016.  Subsequent to the refinancing, we have paid an additional $524,000 of scheduled senior debt. As of July 31, 2013 there was $10,476,000 or outstanding senior debt.  Net of proceeds from the re-financing and including regularly scheduled payments of the term loan, a total of $1,989,000 of cash was used for debt repayment in the first nine months of 2013.

Under the Agreement, interest is paid at a rate of one-month LIBOR plus a margin determined by certain leverage ratios specified in the agreement.  As of July 31, 2013, the Company had $2,619,000 of the term debt subject to variable interest rates.  The one-month LIBOR was .19% on the last business day of July 2013 resulting in total variable interest rates of 2.69% and 2.44%, for the term note and the revolving line of credit, respectively, as of July 31, 2013.
 
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 and 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, 2013, we were in compliance with the financial covenants of our credit facility. The Agreement prohibits us from paying dividends without prior consent of the lender.  The Company is prohibited from entering into other debt agreements without the Bank’s consent.

As of July 31, 2013, we had an interest rate swap agreement with Bank of America in effect that was entered into at the time of the Agreement.  The intent of the swap, is to fix the interest rate on at least 75% of the outstanding amortizing balance on the term loan for three years.  The swap fixes the interest rate for the swapped amount at 3.18% (.68% plus the applicable margin, 2.50%). An interest rate swap, which fixed the rate on the term loan associated with the Previous Agreement matured on April 5, 2013. In addition, in conjunction with the refinancing discussed above, we paid $27,670 to settle two unhedged swaps associated with previous senior financing arrangements at the time of the Agreement.

 
 
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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 as of July 31, 2013:

   
Payment due by Period
 
Contractual Obligations (2)
 
Total
   
Remainder
of 2013
      2014-2015       2016-2017    
After 2017
 
Debt
  $ 20,596,000     $ 513,000     $ 3,142,000     $ 3,142,000     $ 13,799,000  
Interest on Debt (1)
    7,534,000       612,000       2,921,000       2,728,000       1,273,000  
Operating Leases
    12,298,000       1,032,000       6,236,000       3,602,000       1,428,000  
Licensing Fees
    699,000       88,000       611,000       -       -  
Total
  $ 41,127,000     $ 2,245,000     $ 12,910,000     $ 9,472,000     $ 16,500,000  

(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 2.69%, and subordinated debt at a rate of 12%.
 
(2)  
Customer deposits have been excluded from the table.  Deposit balances vary from period to period with water sales but future increases and decreases in the balances are not accurately predictable.  Deposits are excluded because, net of periodic additions and reductions, it is probable that a customer deposit balance will always be outstanding as long as the business operates.
 
We have no other material contractual obligations or commitments.

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.
 
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.
 
 
 
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Changes in Internal Control over Financial Reporting.
 
No change in our internal control over financial reporting occurred during the nine months ended July 31, 2013 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, 2013 from the Risk Factors reported in our Annual Report on Form 10-K for the year ended October 31, 2012.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.
 
The following table summarizes the stock repurchases, by month, that were made during the third quarter ended July 31, 2013.

Issuer Purchases of Equity Securities
 
   
 
 
Total Number of Shares Purchased
   
 
 
Average Price Paid per Share (1)
   
Total Number of Shares as Part of a Publicly Announced Program (2)
   
Maximum Expenditure that May Yet be used for Purchases Under the Program (2)
 
May 1-31
    1,100     $ .93       1,100     $ 479,497  
June 1-30
    2,000       .92       2,000       477,652  
July 1-31
    -       -       -       477,652  
Total
    3,100     $ .93       3,100          
(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.
 
None.
 
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 Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2013 and October 31, 2012, (b) our Condensed Consolidated Statements of Operations for the Three and Nine months Ended July 31, 2013 and 2012, (c) our Condensed Consolidated Statements of Comprehensive Income for the Three and Nine months Ended July 31, 2013 and 2012, (d) our Condensed Consolidated Statements of Cash Flows for the Nine months Ended July 31, 2013 and 2012, and (e) 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 16, 2013
 
  CRYSTAL ROCK HOLDINGS, INC.
 
  By: /s/  Bruce S. MacDonald
     Bruce S. MacDonald
     Vice President, Chief Financial Officer
     (Principal Accounting Officer and Principal Financial Officer)
 
 
 
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Exhibits Filed Herewith
 
 
Exhibit
Number
 
Description
 
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002

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

 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
Interactive Data Files regarding (a) our Condensed Consolidated Balance Sheets as of July 31, 2013 and October 31, 2012, (b) our Condensed Consolidated Statements of Operations for the Three and Nine months Ended July 31, 2013 and 2012, (c) our Condensed Consolidated Statements of Comprehensive Income for the Three and Nine months Ended July 31, 2013 and 2012, (d) our Condensed Consolidated Statements of Cash Flows for the Nine months Ended July 31, 2013 and 2012, and (e) the Notes to such Condensed Consolidated Financial Statements.

 
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