ITEM 1. BUSINESS.
Introduction and Company Background
Crystal Rock Holdings, Inc., incorporated in Delaware in 1990, is engaged in the production, marketing and distribution of bottled water (the Crystal Rock® and Vermont Pure® brands) and the distribution of coffee (including our Cool Beans® brand), ancillary products and other office refreshment products, and office products (under the Crystal Rock Office® and Universal Business brands). We operate primarily as a distribution business to homes and offices, using our own trucks for distribution throughout New England, New York, and New Jersey.
Our distribution sales and services evolved from our initial business, sales of bottled water and cooler rentals. We bottle our water and also have it bottled for us. All of our water products are still, non-sparkling waters as opposed to sparkling waters. In addition to water and related services, our other significant food and drink offerings have grown to include distribution of coffee and ancillary products, and other refreshment products including soft drinks and snacks. To a lesser extent, we distribute these products through third party distributors and directly through vending machines.
Water
Bottled water is a mainstream beverage and the centerpiece of many consumers’ healthy living lifestyles. Sales of bottled water accounted for 41% in each of fiscal years 2013 and 2012. We believe that the development of the bottled water industry has for many years reflected public awareness of the potential contamination and unreliability of some municipal water supplies. Conversely, bottled water has been the recent focus of publicity regarding concerns about the possibly adverse environmental effects of using plastic bottles, as well as the effect on the environment of water extraction and the production and disposal of plastic bottles (see Item 1A, Risk Factors).
Coffee
Coffee, a product that is counter seasonal to water, is the second leading product in the distribution channel, accounting for 23% of our total sales in fiscal year 2013 and 24% of our total sales in fiscal year 2012. We sell different brands and sizes of coffee products. We continue to promote our Cool Beans® brand coffee in an effort to increase profitability and create brand equity in the coffee category. Because coffee is a commodity, coffee sales are affected by volatility in the world commodity markets. An interruption in supply or a dramatic increase in pricing could have an adverse effect on our business.
The increase in coffee sales in recent years has been driven by the market growth of single-serve coffee products. This development has revolutionized the marketplace and, while we expect the growth of these products to continue, innovation and changes in distribution are likely to play a significant role in the profitability of these products.
Refreshment and Equipment Rental
Ancillary products, such as soft drinks and snacks, accounted for 16% of our total revenues in each of fiscal years 2013 and 2012. Equipment rentals, primarily water coolers, made up 12% of our total revenues in each of those fiscal years.
Office Products and Other Revenue
While the contribution of water, coffee, refreshment products and cooler rentals to our revenues have been relatively flat over the past two fiscal years, since 2010 we have been pursuing strategies and opportunities intended to grow our revenues from sales of office products, as discussed more fully below. In fiscal 2013, we modified our long-term strategy in this regard from mainly pursuing organic growth to endeavoring to increase office products revenues through acquisitions, as well as by organic growth. We completed the acquisition of Universal Business Equipment Corp. in 2013 and are in the process of integrating Universal into Crystal Rock’s systems and operations. The contribution to total revenues from office products and other revenue in fiscal 2013 was 8%, compared to 7% in fiscal 2012.
Water Sources, Treatment, and Bottling Operations
Water from local municipalities is the primary source for the Crystal Rock Waters® brand in 3 and 5 gallon bottles. This accounts for 70% of our water bottled in these types of containers. Municipal water is purified through a number of processes beginning with filtration. Utilizing carbon and ion exchange filtration systems, we remove chlorine and other volatile compounds and dissolved solids. After the filtration process, impurities are removed by reverse osmosis and/or distillation. We ozonate our purified water (by injecting ozone into the water as an agent to prohibit the formation of bacteria) prior to storage. Prior to bottling, we add pharmaceutical grade minerals to the water, including calcium and potassium, for taste. The water is again ozonated and bottled in a fully enclosed clean room with a high efficiency particulate air, or HEPA, filtering system designed to prevent any airborne contaminants from entering the bottling area, in order to create a sanitary filling environment.
If for any reason the municipal sources for Crystal Rock® water were curtailed or eliminated, we could, though probably at greater expense, purchase water from other sources and have it shipped to our manufacturing facilities.
The primary source of our natural spring water (primarily sold under the Vermont Pure® brand) is a spring owned by a third party in Stockbridge, Vermont that is subject to a 50-year water supply contract, approximately 40 years of which remain. We also obtain water, under similar agreements with third parties, from springs in Bennington and Tinmouth, Vermont. These three springs are approved by the State of Vermont as sources for natural spring water. The contractual terms for these springs provide spring water in excess of our current needs and within the apparent capacity of the springs, and accordingly we believe that we can readily meet our bulk water supply needs for the foreseeable future. Water from these springs account for 30% of our total water bottled.
Percolation through the earth's surface is nature's best filter of water. We believe that the age and extended percolation period of our natural spring water provides the natural spring water with certain distinct attributes: a purer water, noteworthy mineral characteristics (including the fact that the water is sodium free and has a naturally balanced pH), and a light, refreshing taste.
An interruption in or contamination of any of our spring sites would materially affect our business. We believe that we could find adequate supplies of bulk spring water from other sources, but that we might suffer inventory shortages or inefficiencies, such as increased purchase or transportation costs, in obtaining such supplies.
We are highly dependent on the integrity of the sources and processes by which we derive our products. Natural occurrences beyond our control, such as drought, flood, earthquake or other geological changes, a change in the chemical or mineral content or purity of the water, or environmental pollution may affect the amount and quality of the water available from the springs or municipal sources that we use. There is a possibility that characteristics of the product could be changed either inadvertently or by tampering before consumption. Even if such an event were not attributable to us, the product’s reputation could be irreparably harmed. Consequently, we would experience economic hardship. Occurrence of any of these events could have an adverse impact on our business. We are also dependent on the continued functioning of our bottling processes. An interruption could result in an inability to meet market demand and/or negatively impact the cost to bottle the products.
We have no material contractual commitments to the owners of our outside sources and bottling facilities other than for the products and services we receive.
We use outside trucking companies to transport bulk spring water from the source site to our bottling facilities.
Products
We sell our Crystal Rock® and Vermont Pure® water brands in three and five gallon bottles to homes and offices throughout New England, New York, and New Jersey. In general, Crystal Rock® is distributed in southern New England and upstate and western New York, while Vermont Pure® is primarily distributed throughout northern New England and upstate New York and secondarily in southern New England. We rent and sell water coolers to customers to dispense bottled water. Our coolers are available in various consumer preferences such as cold, or hot and cold, dispensing units. In addition, we sell and rent units to commercial accounts that filter water from the existing source on site. We also rent and sell coffee brewing equipment and distribute a variety of coffee, tea and other hot beverage products and related supplies, as well as other consumable products used around the office. We offer vending services in some locations. We own the Cool Beans® brand of coffee which we distribute throughout our market area. In addition to Cool Beans®, we sell other brands of coffee, most notably, Baronet and Green Mountain Coffee Roasters.
Our extensive distribution system and large customer lists afford us the opportunity to introduce new products that may benefit our current customers or appeal to new customers. From time to time we may capitalize on these opportunities by expanding our product lines or replacing existing products with new ones. In response to the increasingly competitive sales environment, we will consider distributing new products that we believe may enhance our sales and profitability.
Office Products Line
In 2010 we announced that we would add to our product lines in the future by offering a full line of office products using our Crystal Rock Office® brand. Recognizing the value inherent in our distribution system, we do not maintain large inventories of office products. Rather, we primarily purchase office products from large national vendors that provide just-in-time delivery, with the result that the introduction of our office product line has not resulted, and is not expected to result, in a material outlay of resources to accommodate increased inventory. We anticipate that the broader range of office products will contribute to our sales in the future so that this product line becomes a growing portion of our total sales.
Our original strategy contemplated growing this portion of our business by, in part, improving our information technology (IT) infrastructure for a variety of reasons, including in order to facilitate online sales. Our original strategy also contemplated growth by acquisition. In November 2010, we acquired the assets of a small office products company in Hartford, Connecticut, which provided us with a customer base and proven product line from which to expand in central Connecticut. In 2011, we introduced office products sold under the Crystal Rock Office® brand throughout Connecticut, and our strategy is to offer office products on a region-by-region basis throughout our entire market area in the future. We had significant IT expenditures in fiscal 2011 and fiscal 2012, a significant portion of which was devoted toward developing the web-based and personnel aspects of selling the Crystal Rock Office® brand. However, in fiscal 2013 and subsequently, we determined that this effort was not yielding the desired result, and we decided to re-focus our strategy. We reduced our sales force, curtailed some of our IT expenses, and, to facilitate a more rapid integration of the office product line, system-wide, we acquired the assets of Universal Business Equipment Corp. in fiscal 2013. The acquisition increased our distribution in portions of our core market areas and enhanced our internet sales presence.
Despite the advantage of not having to maintain a significant inventory for office products, we note that this line of products does not yield as much margin as our traditional lines, so that incremental sales will not proportionately be as profitable as our traditional lines have been. No assurance can be given that we will achieve the anticipated sales and profitability in the future.
In addition to barriers to entry in this market such as establishing our brand name in the marketplace and developing our information technology systems, we face significant competition from other office products suppliers that have considerably greater assets and resources than we do and may be better known for office products sales in our markets. We believe that we have a well-established distribution system and that the Crystal Rock® family of brands is well known in the regions in which we operate, and we hope to successfully leverage those advantages. Nevertheless, price competition in the office product market can be robust, and there can be no assurance that our office products strategy will be successful.
Marketing and Sales of Branded Products
Crystal Rock products are marketed and distributed under four house brands - Crystal Rock Waters, Vermont Pure Natural Spring Water, Cool Beans Coffee and Crystal Rock Office. Through this combination of brands - and resale of other manufactured brands - we provide a choice of high quality products and value-added services to homes and offices.
Both our water brands feature three and five gallon premium bottled water in addition to a small pack case offerings. Our coffee line includes over 70 varieties in many different types of packaging. Additionally, we also re-sell other coffee and tea selections. The new office products line will feature over 40,000 products for supplying small and medium-sized business.
Over the last several years we have refocused our efforts on sales and marketing in order to better serve all of our product lines and enhance the value of our distribution system and customer base. With the intent of increasing sales over the long term, we have hired and trained an expanded sales force. In addition, we have incurred significant expenditures to build an information technology infrastructure designed to enhance sales administration and run our business more efficiently. However, late in 2013 we decided to shift the infrastructure platform that we had been constructing to one we had acquired during the year. During this transition period we contracted our sales force while we stabilize our customer relationship software. (For more information on our sales and technology project see Item 1A, Risk Factors, and Item 7, Management’s Discussion and Analysis.)
We support this marketing and sales effort through a number of methods, including: e-commerce, direct mail, internet advertising, traditional advertising, social media, sales collateral, email marketing, digital/internet technologies, referrals and public relations. We also sponsor local area sporting events, participate in trade shows, maintain high community visibility, and donate to many charitable events.
We market our home and office delivery service throughout most of New England, New York and parts of New Jersey. A combination of telemarketers and sales personnel sell our products and services, and a professional marketing agency develops and manages our brands and market position. Our goal is to optimize our marketing and sales returns through efficient technology investments, personal customer interactions and maintaining consistent visibility.
Advertising and Promotion
We advertise our products through a digital, online strategy focused on promoting expanded product and services, and we look to collect customer data in order to engage and market customer relationships both on and offline. Through a combination of websites, social platforms and internet advertising, we are centralizing and transitioning our marketing efforts to offer and incentivize current and new customers through a larger online presence while providing customers direct purchasing capability. In addition to Yellow Page advertising, we also promote our products through sales collateral, direct mail, various public relations and sponsorship opportunities.
We endeavor to be highly visible in the communities that we serve. We have sponsored professional minor league baseball and local sporting events and various charitable and cultural organizations, such as Special Olympics and the Multiple Sclerosis Society, by donating both product and money. In addition, we have been a significant sponsor of a United Way giving campaign to support Live United through the Greater Waterbury Connecticut United Way and featuring local giving options to support the United Way throughout our entire market area.
Sales and Distribution
We sell and deliver products directly to our customers using our own employees and route delivery trucks. We make deliveries to customers on a regularly scheduled basis. We bottle our water at our facilities in Watertown, Connecticut, White River Junction, Vermont, and Halfmoon, New York and have water bottled for us in Buffalo and Clayton, New York. We maintain numerous distribution locations throughout our market area. From these locations we also distribute dispensing equipment, a variety of coffee, tea and other refreshment products, and related supplies. We ship between our production and distribution sites using both our own and contracted carriers.
Supplies
We currently source all of our raw materials from outside vendors. As one of the largest Home and Office distributors in the country, we are able to capitalize on volume to continue to reduce costs.
We rely on trucking to receive raw materials and transport and deliver our finished products. Consequently, the price of fuel significantly impacts the cost of our products. We purchase our own fuel for our Home and Office delivery and use third parties for transportation of raw materials and finished goods between our warehouses. While volume purchases can help control erratic fuel pricing, market conditions ultimately determine the price. In the past, we have experienced substantial market fluctuation of fuel prices. However, when fuel prices have increased, we have been able to establish a fuel adjustment charge for our customers that covered the incremental rising cost of fuel. When fuel prices have decreased, they have not decreased enough to offset the incremental fuel cost over what we considered our “base” level for fuel cost. The risk remains that we may not be able to use fuel price adjustments to cover the cost of fuel increases in a volatile market for petroleum products, which could adversely affect our profitability.
Our principal coffee suppliers are Green Mountain Coffee Roasters and Baronet Coffee. Our principal bottle supplier is Parker Plastics.
No assurance can be given that we will be able to obtain the supplies we require on a timely basis or that we will be able to obtain them at prices that allow us to maintain the profit margins we have had in the past. We believe that we will be able to either renegotiate contracts with these suppliers when they expire or, alternatively, if we are unable to renegotiate contracts with our key suppliers, we believe that we could replace them. Any raw material disruption or price increase may result in an adverse impact on our financial condition and prospects. For instance, we could incur higher costs in renegotiating contracts with existing suppliers or replacing those suppliers, or we could experience temporary dislocations in our ability to deliver products to our customers, either of which could have a material adverse effect on our results of operations.
Seasonality
Our business is seasonal. The period from June to September, when we have our highest water sales, represents the peak period for sales and revenues due to increased consumption of cold beverages during the summer months in our core Northeastern United States market. Conversely, coffee has a peak sales period from November to March.
Competition
We believe that bottled water historically has been a regional business in the United States. The market includes several large regional brands owned by multi-national companies that operate throughout contiguous states. We also compete with smaller, locally-owned bottlers that operate in specific cities or market areas within single states.
With our Crystal Rock® and Vermont Pure® brands, we compete on the basis of pricing, customer service, the quality of our products, attractive packaging, and brand recognition. We consider our trademarks, trade names and brand identities to be very important to our competitive position and defend our brands vigorously. In addition, we offer polyethylene terephthalate (“PET”) plastic as an alternative bottle and have converted customers with health concerns about polycarbonate plastic to this container.
We feel that installation of filtration units in the home or commercial setting poses a competitive threat to our business. To address this, we have continued to develop our plumbed-in filtration business expanding it internally and through acquisitions and actively offering it as an alternative product to our bottled water.
Over the years, cheaper water coolers available from retail outlets have become more prevalent, making customer purchasing a more viable alternative to leasing. Traditionally, the rental of water coolers for offices and homes has been a very profitable business for us. As coolers have become cheaper and more readily available at retail outlets, our cooler rental revenue has declined. Although this rental revenue is very profitable for us, it may continue to decline or become less profitable in the future as a result of retail competition.
As discussed above, coffee is another significant component of our overall sales. The growth of this product line has been driven by single serve packages. Increased competition has developed for these products, not only from other food and beverage distributors, but office products distributors as well. In addition, retail and internet availability has increased. Machines to brew these packages are different from traditional machines and packages ideally need to be brewed in machines that accommodate the specific package. As a result, the popularity of a certain machine often dictates what products are successful in the marketplace. Consequently, our success, both from a sales and profitability perspective, may be affected by our access to distribution rights for certain products and machines and our decisions concerning which equipment to invest in.
We believe that it has become increasingly important to our competitive advantage to decrease the impact of our business on the environment. We traditionally use five gallon containers that are placed on coolers and are reused many times. To further “green” our business we generate solar electricity in our Watertown, Connecticut facility, use high efficiency lighting and vehicles and have instituted no-idling and other driving policies in all of our locations.
Trademarks
We own the trade names of the principal water brands that we sell, Vermont Pure Natural Spring Water® and Crystal Rock®. We also own the Cool Beans® coffee brand, Crystal Rock Office® products brand and own or have rights to other trade names that currently are not a significant part of our business. Our trademarks as well as label designs are, in general, registered with the United States Patent and Trademark Office.
Government Regulation
The Federal Food and Drug Administration (FDA) regulates bottled water as a “food.” Accordingly, our bottled water must meet FDA requirements of safety for human consumption, of processing and distribution under sanitary conditions and of production in accordance with the FDA “good manufacturing practices.” To assure the safety of bottled water, the FDA has established quality standards that address the substances that may be present in water which may be harmful to human health as well as substances that affect the smell, color and taste of water. These quality standards also require public notification whenever the microbiological, physical, chemical or radiological quality of bottled water falls below standard. The labels affixed to bottles and other packaging of the water is subject to FDA restrictions on health and nutritional claims for foods under the Fair Packaging and Labeling Act. In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water quality and treatment that are enforced by the FDA.
We are subject to the food labeling regulations required by the Nutritional Labeling and Education Act of 1990. We believe we are in compliance with these regulations.
We are subject to periodic, unannounced inspections by the FDA. Upon inspection, we must be in compliance with all aspects of the quality standards and good manufacturing practices for bottled water, the Fair Packaging and Labeling Act, and all other applicable regulations that are incorporated in the FDA quality standards. We believe that we meet the current regulations of the FDA, including the classification as spring water. All of our plants and distribution locations are registered with the FDA under the "Public Health Security and Bioterrorism Preparedness and Response Act of 2002". Most recently, the FDA put into effect the Bottled Water Microbial Rule to monitor water sources for E. coli bacteria. We have been in compliance with the testing requirements for this rule prior to and since its inception in December 2009.
We also must meet state regulations in a variety of areas to comply with purity, safety, and labeling standards. From time to time, our facilities and sources are inspected by various state departments and authorities.
Our product labels are subject to state regulation (in addition to federal requirements) in each state where the water products are sold. These regulations set standards for the information that must be provided and the basis on which any therapeutic claims for water may be made.
We use a comprehensive program of self-regulation and use third party auditors for testing and inspections to evaluate our compliance with federal and various state regulations.
In recent years, there has been legislative and executive action in state and local governments that has or would ban the use of bottled water in municipal buildings, enact local taxes on bottled water, and limit the sale by municipalities of water supplies to private companies for resale. Such regulation could adversely affect our business and financial results. For additional information, see “Risk Factors” below.
The laws that regulate our activities and properties are subject to change. As a result, there can be no assurance that additional or more stringent requirements will not be imposed on our operations in the future. Although we believe that our water supply, products and bottling facilities are in substantial compliance with all applicable governmental regulations, failure to comply with such laws and regulations could have a material adverse effect on our business.
Employees
As of January 7, 2014, we had 373 full-time employees and 17 part-time employees. None of the employees belong to a labor union. We believe that our relationships with our employees are good.
Additional Available Information
Our principal website is www.crystalrock.com. We make our annual, quarterly and current reports, and amendments to those reports, available free of charge on www.crystalrock.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Reports of beneficial ownership of our common stock, and changes in that ownership, by directors, officers and greater-than-10% shareholders on Forms 3, 4 and 5, are likewise available free of charge on our website.
The information on our website is not incorporated by reference in this Annual Report on Form 10-K or in any other report, schedule, notice or registration statement filed with or submitted to the SEC.
The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov. You may also read and copy the materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
ITEM 1A.
ITEM 1A. RISK FACTORS.
We operate in a competitive business environment that is influenced by conditions some of which are controllable and other are beyond our control. These conditions include, but are not limited to, the regional economy, monetary policy, and the political and regulatory environment. The following summarizes important risks and uncertainties that may materially affect our business in the future.
The Baker family currently owns a majority of our voting stock and controls the company. Such control affects our corporate governance, and could also have the effect of delaying or preventing a change of control of the company.
The Baker family group, consisting of four current directors Henry Baker (Chairman Emeritus), Peter Baker (CEO), John Baker (Executive Vice President) and Ross Rapaport (Chairman), as trustee, together own a majority of our common stock. Accordingly, these stockholders, acting together, can exert a controlling influence over the outcome of matters requiring stockholder approval, such as the election of directors, amendments to our certificate of incorporation, mergers and various other matters. The concentration of ownership could also have the effect of delaying or preventing a change of control of the company.
As permitted under the corporate governance rules of the NYSE MKT, we have, at the direction of the Baker family group, elected “controlled company” status under those rules. A controlled company is exempted from these NYSE MKT corporate governance rules: (1) the requirement that a listed company have a majority of independent directors, (2) the requirement that nominations to the company’s board of directors be either selected or recommended by a nominating committee consisting solely of independent directors, and (3) the requirement that officers’ compensation be either determined or recommended by a compensation committee consisting solely of independent directors. We do not currently utilize exemption (3) as we have a compensation committee consisting solely of three independent directors.
The personal interests of our directors and officers create conflicts.
As mentioned above, the Baker family group owns a majority of our common stock. In addition, in connection with the acquisition of the Crystal Rock Spring Water Company in 2000, we issued members of the Baker family group 12% subordinated promissory notes secured by all of our assets. As of October 31, 2013, the balance on these notes is $10,000,000. We also lease important facilities in Watertown and Stamford, Connecticut from Baker family interests. These interests of the Baker family create various conflicts of interest. Transactions between the Company and related parties are subject to review and approval by the Audit Committee, which consists entirely of independent directors.
Our success depends on the continued services of key personnel.
Our continued success will depend in large part upon the expertise of our senior management and their ability to execute our strategic planning. Peter Baker, our Chief Executive Officer and President, John Baker, our Executive Vice President, and Bruce MacDonald, our Chief Financial Officer, Treasurer and Secretary, have entered into employment agreements with Crystal Rock Holdings, Inc. These “at will” employment agreements do not prevent these employees from resigning. The departure or loss of any of these executives individually could have an adverse effect on our business and operations.
Our expansion strategy, which began in 2011 and has involved hiring additional sales personnel and building a new information technology (IT) infrastructure system, has been more difficult to execute than we expected. This has resulted in some operating inefficiencies and has negatively affected our earnings and cash flow. While we believe that we can resolve the issues facing us with modifications to our strategy, there is no assurance that we can manage the necessary changes in an optimal way so as to increase revenues and net income, and improve our cash flow.
Beginning in 2011 we increased operating expenses primarily in two areas, the first by hiring additional sales personnel, and the second by building a new information technology (IT) infrastructure system, the cost of which has been part of selling, general and administrative expense.
In 2011, we began to distribute products under the Crystal Rock Office® brand and commenced a hiring effort to increase our sales force substantially. By the middle of 2013, we had achieved limited office products growth, reduced our sales force and made an acquisition of an office products business in our market area that had higher annual sales in that line of business than we did.
The development of our enhanced IT infrastructure system has also been more costly and difficult than we expected. We have been working to build an enhanced system for customer relationship management (CRM) using the well-known platform Salesforce.com, a platform we originally intended to use for all of our CRM needs, including sales, our route system, and customer service. As originally devised, our strategy would have involved replacing our existing route system software with this platform, but difficulties encountered in making the different software systems compatible have pushed this plan back and resulted in operating inefficiencies over the past two years. We assessed the issues involved in this installation and, by late 2013, decided not to proceed with this project since it was not fulfilling our expectations. We were also not satisfied with the status of our Crystal Rock Office® brand website for online ordering of office products, and believe that software obtained in the acquisition will give us a stronger online platform from which to operate and grow our business going forward.
We are working to control our expenses by scaling back our development and deferring some of our IT investment until revenues stabilize and increase, but there can be no assurance that we can manage these changes in an optimal way so as to increase revenues and net income, and improve our cash flow.
Acquisitions may disrupt our operations or adversely affect our results.
We regularly evaluate opportunities to acquire other businesses. The expenses we incur evaluating and pursuing acquisitions could have a material adverse effect on our results of operations. If we acquire a business, we may be unable to manage it profitably or successfully integrate its operations with our own. Moreover, we may be unable to realize the financial, operational, and other benefits we anticipate from these acquisitions. Competition for future acquisition opportunities in our markets could increase the price we pay for businesses we acquire and could reduce the number of potential acquisition targets. Further, acquisitions may involve a number of special financial and business risks, such as:
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charges related to any potential acquisition from which we may withdraw;
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diversion of our management’s time, attention, and resources;
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decreased utilization during the integration process;
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loss of key acquired personnel;
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increased costs to improve or coordinate managerial, operational, financial, and administrative systems, including compliance with the Sarbanes-Oxley Act of 2002;
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dilutive issuances of equity securities, including convertible debt securities;
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the assumption of legal liabilities;
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amortization of acquired intangible assets;
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potential write-offs related to the impairment of goodwill;
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difficulties in integrating diverse corporate cultures; and
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additional conflicts of interests.
We rely upon a single software vendor that supplies the software for our route accounting system.
Our route accounting system is essential to our overall administrative function and success. An extended interruption in servicing the system could result in the inability to access information. Limited or no access to this information would likely inhibit the distribution of our products and the availability of management information, and could even affect our compliance with public reporting requirements. Our software vendor has a limited number of staff possessing the proprietary information pertaining to the operation of the software. Changes in personnel or ownership in the firm might result in disruption of service. Such changes would be addressed by retaining a new vendor to service the existing software or purchasing a new system. However, any of these events could have a material adverse impact on our operations and financial condition.
We face competition from companies with far greater resources than we have. In addition, methods of competition in the distribution of home and office refreshment products continue to change and evolve. If we are unable to meet these changes, our business could be harmed.
We operate in highly competitive markets. The principal methods of competition in the markets in which we compete are distribution capabilities, brand recognition, quality, reputation, and price. We have a significant number of competitors in our traditional water market, some of which have far greater resources than us. Among our principal competitors are Nestlé Waters North America, large regional brands owned by private groups, and local competitors in the markets that we serve. As we have expanded our product lines, most notably single serve coffee, we have become competitive with other businesses. These include large national and regional office supply companies and retail store chains. Price reductions and the introduction of new products by our competitors can adversely affect our revenues, gross margins, and profits.
Our industry has also been affected by the increasing availability of water coolers in discount retail outlets. This has negatively affected our rental revenue stream in recent years as more customers choose to purchase coolers rather than rent them. The reduction of rental revenue has been somewhat offset by the increase in coolers that we sell, although not to the extent that rentals have declined. We do not expect retail sales to replace rentals completely because we believe that the purchase option does not provide the quality and service that many customers want. However, third party retail cooler sales may continue to negatively impact our rental revenues in the future.
We depend upon maintaining the integrity of our water sources and manufacturing process. If our water sources or bottling processes were contaminated for any reason, our business would be seriously harmed.
Our ability to retain customers and the goodwill associated with our brands is dependent upon our ability to maintain the integrity of our water resources and to guard against defects in, or tampering with, our manufacturing process. The loss of integrity in our water sources or manufacturing process could lead to product recalls and/or customer illnesses that could materially adversely affect our goodwill, market share and revenues. Because we rely upon natural spring sites for sourcing some of our water supply, acts of God, such as earthquakes, could alter the geologic formation of the spring sites, constricting or even contaminating water flow.
In addition, we do not own any of our water sources. Although we believe the long term rights to our spring and municipal sources are well secured, any dispute over these rights that resulted in prolonged disruption in supply could cause an increase in cost of our product or shortages that would not allow us to meet the market demand for our product.
The bottled water industry is regulated at both the state and federal level. If we are unable to continue to comply with applicable regulations and standards in any jurisdiction, we might not be able to sell our products in that jurisdiction, and our business could be seriously harmed.
The FDA regulates bottled water as a food. Our bottled water must meet FDA requirements of safety for human consumption, labeling, processing and distribution under sanitary conditions and production in accordance with FDA “good manufacturing practices.” In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water quality and treatment, which are enforced by the FDA. We also must meet state regulations in a variety of areas. These regulations set standards for approved water sources and the information that must be provided and the basis on which any therapeutic claims for water may be made. We have received approval for our drinking water in Connecticut, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont. However, we can give no assurance that we will receive such approvals in the future.
Legislative and executive action in state and local governments banning the use of municipal funds for purchasing bottled water, enacting local taxes on bottled water or water extraction, and restricting water withdrawal and usage rights from public and private sources could adversely affect our business and financial results.
Recent initiatives have taken place in several major cities regarding bottled water, principally the smaller sizes sold in stores to retail consumers. Regulations have been proposed in some localities that would ban the use of public funds to purchase bottled water, enact local taxes on bottled water or water extraction, and restrict the withdrawal of water from public and private sources. These actions are purportedly designed to discourage the use of bottled water due in large part to concerns about the environmental effects of producing and discarding large numbers of plastic bottles. In developing these stories, local and national media have reported on the growth of the bottled water industry and on the pros and cons of consuming bottled water as it relates to solid waste disposal and energy consumption in manufacturing, as well as conserving the supply of water available to the public.
We believe that the adverse publicity associated with these reports is generally aimed at the retail, small bottle segment of the industry that is now a minimal part of our business, and that our customers can readily distinguish our products from the retail bottles that are currently the basis for concern in some areas. Our customers typically buy their water in reusable five-gallon containers that are placed on coolers and reused many times. Only approximately 4% of our total sales is from water sold in single serve packages. In addition, we continue to take steps to “green” our business by means of solar electricity generation, high efficiency lighting, no-idling and other driving policies, and the use of biodiesel.
While we believe that to date we have not directly experienced any adverse effects from these concerns, and that our products are sufficiently different from those under scrutiny, there is no assurance that adverse publicity about any element of the bottled water industry will not affect consumer behavior by discouraging buyers from buying bottled water products generally. In that case, our sales and other financial results could be adversely affected.
Our Company is significantly leveraged. Over the years, we have borrowed substantial amounts of money to finance acquisitions. If we are unable to meet our debt service obligations to our senior and subordinated lenders, we would be in default under those obligations, and that could hurt our business or even result in foreclosure, reorganization or bankruptcy.
At October 31, 2013 and 2012, our outstanding senior debt was $10,083,000 and $9,566,000, respectively, and our outstanding subordinated debt was $10,000,000 and $13,000,000 on the respective dates. The underlying loans are secured by substantially all of our assets. If we do not repay our indebtedness in a timely fashion, our secured creditors could declare a default and foreclose upon our assets, which would result in harmful disruption to our business, the sale of assets for less than their fully realizable value, and possible bankruptcy. We must generate enough cash flow to service this indebtedness until maturity.
Fluctuations in interest rates could significantly increase our expenses. We will have significant interest expense for the foreseeable future, which in turn may increase or decrease due to interest rate fluctuations. To partially mitigate this risk, we have used swaps to establish fixed interest rates on 75% of our outstanding senior term debt.
As a result of our large amount of debt, we may be perceived by banks and other lenders to be highly leveraged and close to our borrowing ceiling. Until we repay some of our debt, our ability to access additional capital may be limited. In turn, that may limit our ability to finance transactions and to grow our business. In addition, our senior credit agreement limits our ability to incur incremental debt without our lender’s permission.
Our senior credit agreement contains numerous covenants and restrictions that affect how we conduct our business.
Fluctuations in the cost of essential raw materials and commodities, including fuel costs, for the manufacture and delivery of our products could significantly impact our business.
Bottle manufacturers use plastic and other petroleum-based products for the manufacturing of our bottles. Increases in the cost of petroleum will likely have an impact on our bottle costs.
We rely on trucking to receive raw materials and transport and deliver our finished products. Consequently, the price of fuel significantly impacts the cost of our products. We purchase our own fuel for our Home and Office delivery and use third parties for transportation of raw materials and finished goods between our warehouses. While volume purchases can help control erratic fuel pricing, market conditions ultimately determine the price. In the past, we have experienced substantial market fluctuation of fuel prices. However, when fuel prices have increased, we have been able to establish a fuel adjustment charge for our customers that covered the incremental rising cost of fuel. When fuel prices have decreased, they have not decreased enough to offset the incremental fuel cost over what we considered our “base” level for fuel cost. The risk remains that we may not be able to use fuel price adjustments to cover the cost of fuel increases in a volatile market for petroleum products, which could adversely affect our profitability. Further, limitations on the supply or availability of fuel could inhibit our ability to get raw materials and distribute our products, which in turn could have an adverse affect on our business.
A significant portion of our sales is derived from coffee. The supply and price of coffee may be limited by climate, by international political and economic conditions, and by access to transportation, combined with consumer demand. An increase in the wholesale price of coffee could result in a reduction in our profitability. If our ability to purchase coffee were impaired by a market shortage, our sales might decrease, which would also result in a reduction of profitability.
We have a limited amount of bottling capacity. Significant interruptions of our bottling facilities could adversely affect our business.
We own three bottling facilities, and also contract with third parties, to bottle our water. If any of these facilities were incapacitated for an extended period of time, we would likely have to relocate production to an alternative facility. The relocation and additional transportation could increase the cost of our products or result in product shortages that would reduce sales. Higher costs and lower sales would reduce profitability.
Our business has been and may continue to be affected from time to time by extremes of weather, which may adversely affect our business.
While changing weather is a constant in our market area, we experienced extreme weather events in 2011 and 2012 that affected sales in those years and beyond. In late August 2011, Tropical Storm Irene caused considerable, widespread damage in parts of our market area. Flooding and resulting road damage reduced our ability to service customers in Vermont and Northern New York. In addition, our costs increased to access our springs and ship products. Subsequently, parts of Connecticut and Massachusetts experienced a major snowstorm in late October 2011, shutting off power and reducing access in some parts of those states for more than a week, with resulting service interruptions and operating cost increases in those areas. More recently, in late October 2012, Hurricane Sandy caused significant destruction in the coastal Connecticut, New York City, and northern New Jersey portions of our market area. Again, our customer service was interrupted, and we incurred extra costs. The effects of extreme weather like these storms is difficult to quantify because of other variables, but in general these disruptions were temporary and without permanent effects on our business. However, the cumulative effect of extremely adverse weather is not favorable to our business.
Our customer base is located in New England, New York and New Jersey. If there were to be a material decline in the economy in these regions, our business would likely be adversely affected.
Essentially all of our sales are derived from New England, New York and New Jersey. We believe that the economic recession experienced in these areas, particularly in 2008 and 2009, adversely affected our financial results, and these regions are still experiencing a variety of adverse effects from the recession. Continued adverse effects in the regional economies, or a significant negative change in the economy of any of these regions, changes in consumer spending in these regions, or the entry of new competitors into these regional markets, among other factors, could result in a decrease in our sales and, as a result, reduced profitability.
Our business is seasonal, which may cause fluctuations in our stock price.
Historically, the period from June to September represents the peak period for sales and revenues due to increased consumption of beverages during the summer months in our core Northeastern United States markets. Warmer weather in our geographic markets tends to increase water sales, and cooler weather tends to decrease water sales. To the extent that our quarterly results are affected by these patterns, our stock price may fluctuate to reflect them.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
`
None.
ITEM 2.
ITEM 2.
PROPERTIES.
As part of our Home and Office delivery operations, we have entered into or assumed various lease agreements for properties used as distribution points and office space. The following table summarizes these arrangements and includes our bottling facilities:
All locations are used primarily for warehousing and distribution and have limited office space for location managers and support staff. The exception is our headquarters in Watertown, Connecticut location, which has a substantial amount of office space for sales, accounting, information systems, customer service, and general administrative staff. We expect to renew leases that are expiring over the next twelve months with similar terms.
The landlord for the buildings in Stamford and the headquarters in Watertown, Connecticut is a trust with which Henry, John, and Peter Baker, and Ross Rapaport are affiliated. We believe that the rent charged under these leases is not more than fair market rental value.
We expect that these facilities will meet our needs for the next several years.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS.
None.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURE
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our Common Stock is traded on the NYSE MKT under the symbol CRVP. The table below indicates the range of the high and low daily closing prices per share of Common Stock as reported by the exchange.
Fiscal Year Ended October 31, 2013
Fiscal Year Ended October 31, 2012
The last reported sale price of our Common Stock on the NYSE MKT on January 17, 2014 was $1.07 per share.
As of that date, we had 344 record owners and believe that there were approximately 1,560 beneficial holders of our Common Stock.
No dividends have been declared or paid to date on our Common Stock. Our senior credit agreement prohibits us from paying dividends without the prior consent of the lender. It is unlikely that we will pay dividends in the foreseeable future.
Issuer Purchases of Equity Securities
The following table summarizes the stock repurchases, by month, that were made during the fourth quarter ended October 31, 2013.
(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 7.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand our Company. The MD&A should be read in conjunction with our consolidated financial statements and the accompanying notes. This overview provides our perspective on the individual sections of the MD&A, as well as a few suggestions for reading these pages. The MD&A includes the following sections:
■
Business Overview - a brief description of fiscal year 2013.
■
Results of Operations - an analysis of our consolidated results of operations for the two years presented in our consolidated financial statements.
■
Liquidity and Capital Resources - an analysis of cash flows, sources and uses of cash, and contractual obligations and a discussion of factors affecting our future cash flow.
■
Critical Accounting Policies - a discussion of accounting policies that require critical judgments and estimates. Our significant accounting policies, including the critical accounting policies discussed in this section, are summarized in the notes to the accompanying consolidated financial statements.
Business Overview
Sales were slightly lower and our business was less profitable for fiscal 2013 than in fiscal 2012. This continued a trend of lower operating income, net income and cash flow from fiscal 2010 to fiscal 2013. Among the factors that contributed to this continuing trend were competition and our response to competitive factors, as well as ongoing operational issues and less controllable factors such as adverse weather conditions and environmental and political issues. The 2013 decrease in sales was largely due to a decrease in combined coffee and refreshment product sales and a decrease in equipment rentals year over year, despite higher water and office products sales.
For our fiscal year ended October 31, 2012, we determined our goodwill was impaired (a non-cash charge) in the amount of $19,967,000, which materially reduced our income from operations and net income to losses. We did not have such a loss in 2013 but, net of the effect of the impairment, we were less profitable than in 2012.
In the past, we have discussed the impact of competition and operational initiatives on results of operations. Continued competitive pressures were the principal reason for lower sales in 2013. We continued to incur higher sales and administrative costs in an effort to build our sales organization and information technology infrastructure. However, as discussed above under “Business−Products−Office Products Line,” in fiscal 2013 we determined that the effort to build out our salesforce and IT infrastructure was not yielding the desired results, and we decided to re-focus our effort.
Accordingly, we completed the acquisition of Universal Business Equipment Corp. later in 2013. In addition to accelerating our expansion into the office products category, we feel this acquisition also brought valuable resources to our sales and IT organizations. As a result, we believe that we are better positioned to build on our customer relationships and internet capabilities.
In fiscal 2013 we continued to de-leverage the Company. We paid down $3 million of subordinated debt and re-financed our senior line of credit so that, as of October 31, 2013, we continued to have adequate cash on hand and borrowing capacity.
The market area in which we operate has an uncertain economic environment. While we have created opportunities that we expect will result in increased sales, we anticipate cost pressures related to commodities affecting our business, most notably fuel and coffee, as we continue to build our brands.
Results of Operations
Fiscal Year Ended October 31, 2013 Compared to Fiscal Year Ended October 31, 2012
Sales
Sales for fiscal year 2013 were $70,981,000 compared to $71,122,000 for 2012, a decrease of $141,000 or 1%. Sales attributable to acquisitions in fiscal year 2013 were $1,546,000. Net of acquisitions, sales decreased 2%.
The comparative breakdown of sales is as follows:
Water - The increase in sales is due to an acquisition completed at the beginning of the year. Net of the acquisition, sales would have decreased 1%. Water sales volume increased 1% as a result of the acquisition while pricing was essentially the same.
Coffee - There was a 3% decrease in sales of single-serve coffee, to $10,962,000 from $11,276,000, despite an increase of 17% in our Cool Beans® pod sales. Cool Beans® made up 8% of the category in 2013. There was also an 8% decrease in sales of our traditional coffee products for office and food service brewers. In general, coffee sales declined as a result of strong competition in the marketplace, as well as a changing customer preferences. Acquisitions did not materially affect this category in 2013 compared to 2012.
Refreshment - A decrease in soft drink, cup, and single serve water sales more than offset increased sales of coffee refreshment products.
Equipment Rental - The decrease in equipment rental revenue in fiscal year 2013 compared to the prior year was a result of a 3% increase in average units in the field while average rental price decreased 6%. Net of the acquisition, rental income decreased 1%.
Other - The increase is attributable to sales of office products which increased 57%. Part of the increase in office products sales was due to the acquisition of Universal Business Equipment Corp. in the final month of the year. Net of the acquisition, sales of office products increased 19%. Fees that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations decreased 15% based on the market price of diesel fuel.
Gross Profit/Cost of Goods Sold
Gross profit increased $69,000 in fiscal year 2013 compared to 2012, to $36,714,000 from $36,645,000. Gross profit as a percentage of sales was 52% for both years. The slight increase in gross profit was attributable to higher water sales and lower service costs as well as higher office products sales. Factors that negatively impacted gross profit in 2013 were lower sales in other product lines and a decrease in fuel adjustment charges that are charged to offset energy costs for delivery and freight, raw materials, and bottling operations.
Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale (including freight), as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers. We include distribution costs in selling, general, and administrative expense, and the amount is reported below. Other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result.
Income (loss) from Operations/Operating Expenses
Income from operations was $2,790,000 compared a loss from operations of $16,635,000 in 2012, an improvement of $19,425,000. The most significant component of improvement was the goodwill impairment of $19,967,000 recorded in 2012. There was no such impairment in 2013. Total operating expenses decreased to $33,924,000 for the year, from $53,280,000 the prior year, a decrease of $19,356,000.
Selling, general and administrative (SG&A) expenses were $32,185,000 in fiscal year 2013 and $31,152,000 in 2012, an increase of $1,033,000, or 3%. Of total SG&A expenses:
●
Route sales costs increased 7%, or $916,000, to $14,815,000 in fiscal year 2013 from $13,899,000 in fiscal year 2012, primarily related to higher labor, fuel, and vehicle costs. Included as a component of route sales costs are total direct distribution related costs which increased $948,000, or 7%, to $14,141,000 in fiscal year 2013 from $13,193,000 in fiscal year 2012, primarily as a result of higher labor, fuel, and vehicle costs;
●
Selling costs decreased 9%, or $480,000, to $4,574,000 in fiscal year 2013 from $5,054,000 in fiscal year 2012. The lower costs were attributable to reducing staff while re-assessing the Company’s sales strategy;
●
Administrative costs increased 5%, or $597,000, to $12,796,000 in fiscal year 2013 from $12,199,000 in fiscal year 2012. The increase was mostly attributable to higher labor costs in support of our IT infrastructure.
Advertising expenses decreased to $773,000 in fiscal year 2013 from $1,251,000 in 2012, a decrease of $478,000, or 38%. The decrease in advertising costs is primarily related to a decrease in agency costs and internet and Yellow Pages advertising.
Amortization increased $19,000, or 2%, to $999,000 in fiscal year 2013 from $980,000 in 2012. Amortization is attributable to intangible assets that were acquired as part of acquisitions in recent years.
There was a gain from the sale of miscellaneous assets in fiscal year 2013 of $32,000 compared to a gain on the sale of assets of $71,000 in fiscal year 2012. These were sales of miscellaneous assets no longer used in the course of business.
As of October 31, 2013, considering qualitative factors, we concluded it is more likely than not that the fair value of the Company is greater than its carrying amount; therefore performing the two-step goodwill impairment test was not necessary (Step 0). In performing this qualitative assessment we considered factors including, but not limited to, the following:
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Macroeconomic conditions including the general economic conditions, limitations on accessing capital, and other developments in equity and credit markets
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Industry and market considerations including any deterioration in the environment in which we operate, an increased competitive environment, a decline in market-dependent multiples or metrics, a change in the market for our products or services, or a regulatory or political development
●
Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
●
Overall financial performance including negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods
●
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; or litigation
●
Whether a sustained decrease in share price had occurred.
In fiscal year 2012, we incurred an impairment loss of $19,967,000. The impairment loss was a non-cash charge and was a result of the assessment of our goodwill as of October 31, 2012. Goodwill had been recorded for acquisitions from 1996 through 2009. The assessment of the carrying value of goodwill is a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches: quoted stock price (a market approach), value comparisons to publicly traded companies (see note 1) believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach). These approaches provide a reasonable estimation of the value of the Company and take into consideration the Company’s
1 These were the companies used in the year marked:
thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations. We used the following percentages for the weighted average of the three different approaches in fiscal year 2012:
The resulting estimated fair value is then compared to the Company’s equity value. Our step one assessment as of October 31, 2012 indicated that goodwill on our books may be impaired when we determined the Company’s fair value was less than the Company’s equity as of the valuation date.
When an impairment was indicated as of October 31, 2012, we used step two to determine the amount of the impairment. In that process we allocated the estimated fair value to all of the assets and liabilities of the Company (including unrecognized intangible assets) as if the Company had been acquired in a business combination using the estimated fair value as the price paid. We then recognized impairment in the amount by which the carrying value of goodwill exceeded the implied fair value of goodwill as determined in the allocation.
In establishing fair market valuations in both step one and step two of the goodwill impairment testing process, the Company assumed a nontaxable hypothetical transaction considering the feasibility of an acquisition structure and whether the assumed structure would result in the highest and best use and would provide maximum value to the seller, including consideration of related tax implications.
Impairment was primarily the result of a decline in estimate fair value resulting from the income approach which relies on a discounted cash flow analysis of the Company’s projected cash flows as well as an analysis of comparable “guideline” companies. These valuations are reflective of the competitive business environment that the Company operates in. In addition, as mentioned above, the Company has undertaken operating initiatives to increase its competitive advantage over the long term. These initiatives have increased operating expenses prior to generating anticipated sales which negatively impacted cash flow in the early years of the analysis.
Other Expense, Income Taxes, and Income (Loss) before Income Taxes
Interest expense was $1,867,000 for fiscal year 2013 compared to $2,181,000 for fiscal year 2012, a decrease of $314,000. The decrease is primarily attributable to lower outstanding debt, particularly subordinated debt.
Income before income taxes of $917,000 in fiscal year 2013 compared to a loss before income taxes in fiscal year 2012 was $18,821,000, an improvement of $19,738,000. Aside from the impairment charge, operating results declined by $229,000 from 2012 to 2013 as result of lower sales and higher operating costs.
Income tax expense for 2013 of $346,000 compares to a tax benefit for fiscal year 2012 of $343,000 and resulted in an effective tax rate of 38% in 2013 and (2%) in 2012. The tax benefit in 2012 is a result of the write-off of goodwill that resulted in the reversal of a deferred tax liability. The lower effective tax rate in 2012 is attributable to the exclusion of a portion of the impairment loss related to nondeductible goodwill from the determination of income taxes.
Net Income (Loss)
Net income for 2013 was $571,000 compared to a net loss in fiscal year 2012 of $18,478,000, an improvement of $19,049,000. As noted above, the most significant component of the net loss in 2012 was goodwill impairment of $19,967,000. Aside from the impairment charge, earnings were lower as a result of lower sales and higher operating costs. The net income and loss in the respective years was completely attributable to continuing operations.
In 2013, weighted average number of shares of Common Stock outstanding was 21,372,000 (basic and diluted) resulting in net income of $.03 per share. Based on the weighted average number of shares of Common Stock outstanding of 21,384,000 (basic and diluted), loss per share in 2012 was $.86 per share. This was an improvement of $.89 per share.
We terminated two (one hedged, one unhedged) interest rate hedge swap agreements during 2013 and entered into a new one. The net effect of the resulting swapped transactions was $50,000 in unrealized gains in 2013 compared to $170,000 of unrealized gains in 2012, net of reclassification adjustments and taxes. The decrease in unrealized gains during the year has been recognized as an adjustment to net income (loss) to arrive at comprehensive income as defined by the applicable accounting standards.
Liquidity and Capital Resources
As of October 31, 2013, we had working capital of $6,725,000 compared to $6,903,000 as of October 31, 2012, a decrease of $178,000. The decrease in working capital is primarily attributable to cash used for an acquisition in the fourth quarter and lower net income after considering the impairment charge in 2012. This was partially offset by a decrease in the current portion of long term debt as a result of the restructuring of the Company’s long term debt and 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.
Net cash provided by operating activities was $4,515,000 in 2013 compared to $4,110,000 in 2012, an increase of $405,000. The increase is reflective of favorable working capital changes. We use cash provided by operations to repay debt and fund capital expenditures. In fiscal year 2013, we used $4,673,000 for repayment of debt. This was $1,959,000 more than we paid in 2012. We used $1,070,000 less for capital expenditures in 2013 than in 2012. The decrease was a result of less need for coolers and brewers.
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:
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 October 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 $917,000 of scheduled senior debt. As of October 31, 2013 there was $10,083,000 of outstanding senior debt.
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 October 31, 2013, the Company had $2,521,000 of the term debt subject to variable interest rates. The one-month LIBOR was .18% on the last business day of October 2013 resulting in total variable interest rates of 2.68% and 2.43%, for the term note and the revolving line of credit, respectively, as of October 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, total debt service coverage as defined of greater than 1 to 1, and senior debt to EBITDA of less than 2.50 to 1. As of October 31, 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 October 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 that 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.
In addition to our senior and subordinated debt commitments, we have significant future cash commitments, primarily in the form of operating leases that are not reported on the balance sheet. These operating leases are described in Note 15 to our Audited Consolidated Financial Statements.
The following table sets forth our contractual commitments as of October 31, 2013:
(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 2.27% and subordinated debt at a rate of 12%.
(2)
Customer deposits have been excluded from the table. Deposit balances vary from period to period with water sales but future increases and decreases in the balances are not accurately predictable. Deposits are excluded because, net of periodic additions and reductions, it is probable that a customer deposit balance will always be outstanding as long as the business operates.
As of the date of this Annual Report on Form 10-K, we have no other material contractual obligations or commitments.
Factors Affecting Future Cash Flow
Generating cash from operating activities and access to credit is integral to the success of our business. We continue to generate cash from operating activities to service scheduled debt repayment and fund capital expenditures. In addition, we have capacity to borrow from our acquisition line of credit for capital expenditures and acquisitions. We also lease a significant amount of our vehicles and all of our buildings.
Adverse economic conditions in recent years have negatively impacted many businesses financial performance and restricted credit availability. In addition, we do not think that the economy in our region has fully recovered from the recession that started in 2008. The competitive landscape created by the economic environment has eroded our margin over that time. This has resulted in expansion of our product lines and our distribution scheduling. We anticipate that changes to our business will be successfully implemented. However, no assurance can be given that we will be profitable in the future and that the economic environment will not adversely affect our cash flow and results of operations or that we will have adequate access to credit.
Factors Affecting Quarterly Performance
Our business and financial trends vary from quarter to quarter based on, but not limited to, seasonal demands for our products, climate, and economic and geographic trends. Consequently, results for any particular fiscal quarter are not necessarily indicative, through extrapolation, or otherwise, of results for a longer period. In the past year we have experienced weather related events that have influenced quarterly performance. Although weather is always variable, we feel this year’s extremes, and their far reaching effects, are an aberration in the region.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles. Preparation of the statements in accordance with these principles requires that we make estimates, using available data and our judgment for such things as valuing assets, accruing liabilities, and estimating expenses. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies and estimates. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. We base our ongoing estimates on historical experience and other various assumptions that we believe to be reasonable under the circumstances.
Accounts Receivable - Allowance for Doubtful Accounts
We routinely review our accounts receivable, by customer account aging, to determine if the amounts due are collectible based on information we receive from the customer, past history, and economic conditions. In doing so, we adjust our allowance accordingly to reflect the cumulative amount that we feel is uncollectible. This estimate may vary from the proceeds that we actually collect. If the estimate is too low, we may incur higher bad debt expenses in the future resulting in lower net income. If the estimate is too high, we may experience lower bad debt expense in the future resulting in higher net income.
Fixed Assets - Depreciation
We maintain buildings, machinery and equipment, and furniture and fixtures to operate our business. We estimate the life of individual assets to allocate the cost over the expected life. The basis for such estimates is use, technology, required maintenance, and obsolescence. We periodically review these estimates and adjust them if necessary. Nonetheless, if we overestimate the life of an asset or assets, at a point in the future, we would have to incur higher depreciation costs and consequently, lower net income. If we underestimate the life of an asset or assets, we would absorb too much depreciation in the early years resulting in higher net income in the later years when the asset is still in service.
Goodwill - Intangible Asset Impairment
We have acquired a significant number of companies. The excess of the purchase price over the fair value of the assets and liabilities acquired has been recorded as goodwill. If goodwill is not impaired, it would remain as an asset on our balance sheet at the value assigned in the acquisitions. If it is impaired, we would be required to write down the asset to an amount that accurately reflects its estimated implied value. If we elect not to perform a Step 0 assessment, the assessment of the carrying value of goodwill is a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches - quoted stock price (a market approach), value comparisons to publicly traded companies believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach). This approach provides a reasonable estimation of the value of the Company and takes into consideration the Company’s thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations. The resulting estimated fair value is then compared to its equity value.
We completed a valuation of the Company performed as of October 31, 2012 and determined that goodwill was impaired. We performed a qualitative assessment (Step 0) to determine if a similar approach was required as of October 31, 2013. In conducting the assessment we considered what adverse or positive mitigating events and circumstances would significantly influence the valuation. Qualitative factors that we considered in the Step 0 assessment included, but were not limited to, macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, other relevant entity-specific events and sustained declines in our share price We determined that is not more likely than not that the fair value of our reporting unit was less than the carrying value.
On October 31, 2012 the step one assessment yielded the following fair value:
The concluded fair value was less than the Company’s equity value as of October 31, 2012 by 3%. If the equity value exceeds the fair value in step one then step two estimates the fair value of the Company’s assets and liabilities (including unrecognized intangible assets). This value is then allocated among the assets and liabilities as if they had been acquired in a business combination and the estimated fair value was the price paid.
We relied, in part, on certain assumptions in making the valuation conclusion. If some or all of these assumptions change in the future, there may be a material impact on the valuation of the Company, which may result in an additional impairment of goodwill. These assumptions include, but are not limited to, the following:
■
We made certain assumptions in the calculation of discount rates, risk premiums, and capital structure weightings. However, changes in capital markets may significantly change these assumptions in the future.
■
We used our knowledge of the business, industry and economy to assemble financial projections including our plans to expand our product offerings. Unforeseen events that dramatically change such influential factors as the economy, environment, and weather may positively or negatively affect the accuracy of these projections.
■
Calculation of a control premium is a significant component in the assessment of goodwill. This is a common valuation technique that relies on assumptions based on equity markets, credit markets and the merger and acquisition environment and the availability of buyers.
In step two, we then allocated the estimated fair value to all of the assets and liabilities of the Company (including unrecognized intangible assets) as if the Company had been acquired in a business combination and the estimated fair value was the price paid. The amount of impairment recognized was the difference the carrying value of goodwill exceeded the implied value of goodwill as determined in this allocation.
In addition to the assumptions we made in the valuation process during step one, we used important resources and made assumptions in step two in order to allocate fair value. These include but are not limited to:
■
We relied on our experience in the industry and knowledge of the business to assign value to tangible and intangible assets such as customer relationships, workforce, contracts (leases), royalties and fixed assets.
■
Our ability to interpret data from other companies and valuations as well as publicly available economic reports.
■
Consideration and use of several commonly used valuation models such as Cost, Market and Income Approaches as well as Discounted cash Flow Analysis, Relief-from-Royalty, Excess Earnings Method, and Avoided Loss of Income Method and weighted average models (weighted average cost of capital and weighted average return on assets) to obtain and verify valuations and allocate them accordingly.
In establishing fair market valuations in both step one and step two of the goodwill impairment testing process, the Company assumed a nontaxable hypothetical transaction considering the feasibility of an acquisition structure and whether the assumed structure would result in the highest and best use and would provide maximum value to the seller, including consideration of related tax implications.
Income Taxes
We recognize deferred tax assets and liabilities based on temporary differences between the financial statement carrying amount of assets and liabilities and their corresponding tax basis. The valuation of these deferred tax assets and liabilities is based on estimates that are dependent on rate and time assumptions. If these estimates do not prove to be correct in the future, we may have over or understated income tax expense and, as a result, earnings.
Financial Accounting Standards Board (“FASB”) guidance clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. The guidance prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return in order for those tax positions to be recognized in the financial statements.
Off-Balance Sheet Arrangements
We lease various facilities and equipment under cancelable and non-cancelable short and long term operating leases, which are described in Item 2 of this Annual Report on Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our Consolidated Financial Statements and their footnotes are set forth on pages through.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer, and other members of our senior management team, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by us, including our consolidated subsidiary, in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive and Chief Financial officers, as appropriate to allow timely decisions regarding required disclosure.
The effectiveness of a system of disclosure controls and procedures is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of internal controls, and fraud. Due to such inherent limitations, there can be no assurance that any system of disclosure controls and procedures will be successful in preventing all errors or fraud, or in making all material information known in a timely manner to the appropriate levels of management.
Internal Control Over Financial Reporting
a) Management's Annual Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
• pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of October 31, 2013. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO 1992) in Internal Control-Integrated Framework.
Based on our assessment, management concluded that, as of October 31, 2013, the Company's internal control over financial reporting is effective based on those criteria.
This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report on Form 10-K.
b) Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting occurred during the fiscal quarter ended October 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this Item is incorporated by reference to the sections captioned “Directors,” “Our Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance” and “Committees of the Board of Directors” in our 2014 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2013.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to the sections captioned “Compensation of Executive Officers” and “Compensation of Non-Employee Directors” in our 2013 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2013.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Securities Authorized for Issuance Under Equity Compensation Plans.
The following table sets forth certain information as of October 31, 2013 about shares of our Common Stock that may be issued upon the exercise of options and other rights under our existing equity compensation plans and arrangements, divided between plans approved by our stockholders and plans or arrangements that were not required to be and were not submitted to our stockholders for approval.
Equity Compensation Plan Information
Additional information required by this Item is incorporated by reference to the section captioned “Security Ownership of Certain Beneficial Owners and Management” in our 2014 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2013.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this Item is incorporated by reference to the section captioned “Corporate Governance” in our 2014 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2013.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information required by this Item is incorporated by reference to the sections captioned “Independent Registered Public Accounting Firm Fees” and “Pre-Approval Policies and Procedures” in our 2014 proxy statement to be filed with the SEC within 120 days after the end of our fiscal year ended October 31, 2013.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
a)
The following documents are filed as part of this report:
(1) Financial Statements
(2) Schedules
None
(3) Exhibits:
* Management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Crystal Rock Holdings, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CRYSTAL ROCK HOLDINGS, INC.
By: /s/ Peter K. Baker
Dated: January 28, 2014
Peter K. Baker, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBITS TO CRYSTAL ROCK HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED OCTOBER 31, 2013
Exhibits Filed Herewith
Exhibit
Number Description
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of
Crystal Rock Holdings, Inc.
Watertown, Connecticut
We have audited the accompanying consolidated balance sheets of Crystal Rock Holdings, Inc. and subsidiary as of October 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Crystal Rock Holdings, Inc. and subsidiary as of October 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
January 28, 2014
See the accompanying notes to the consolidated financial statements.
See the accompanying notes to the consolidated financial statements.
See the accompanying notes to the consolidated financial statements.
See the accompanying notes to the consolidated financial statements.
See the accompanying notes to the consolidated financial statements.
CRYSTAL ROCK HOLDINGS, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1.
BUSINESS OF THE COMPANY AND BASIS OF PRESENTATION
Crystal Rock Holdings, Inc. and Subsidiary (collectively, the “Company”) is engaged in the production, marketing and distribution of bottled water and the distribution of coffee, ancillary products, various other refreshment products as well as office products. The Company operates exclusively as a home and office delivery business, using its own trucks to distribute throughout New England, New York, and New Jersey. In addition, it offers its products for sale over the internet and shipping through third parties.
The consolidated financial statements of the Company include the accounts of Crystal Rock Holdings, Inc. and its wholly-owned subsidiary, Crystal Rock LLC. All inter-company transactions and balances have been eliminated in consolidation.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2.
SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents - The Company considers all highly liquid temporary cash investments with a maturity of three months or less at date of purchase to be cash equivalents.
Accounts Receivable - Accounts receivable are carried at original invoice amount less an estimate made for doubtful accounts. Management establishes the allowance for doubtful accounts by regularly evaluating past due balances, collection history as well as general economic and credit conditions. Individual accounts receivable are written off when deemed uncollectible, with any future recoveries recorded as income when received.
Inventories - Inventories primarily consist of products that are purchased for resale and are stated at the lower of cost or market on a first in, first out basis.
Property and Equipment - Property and equipment are stated at cost net of accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets, which range from three to ten years for machinery and equipment, and from seven to thirty years for buildings and improvements, and three to seven years for other fixed assets. Leasehold improvements are depreciated over the shorter of the estimated useful life of the leasehold improvement or the term of the lease.
Goodwill and Other Intangibles - Intangible assets with lives restricted by contractual, legal, or other means are amortized over their useful lives. The Company defines an asset’s useful life as the period over which the asset is expected to contribute to the future cash flows of the entity. Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The amount of impairment for goodwill and other intangible assets is measured as the excess of their carrying values over their implied fair values. To test goodwill, we first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the applicable reporting unit is less than its carrying value. If, after assessing these events or circumstances, we determine that it is not more likely than not that the fair value of such reporting unit is less than its carrying amount, we will proceed to perform a two-step impairment analysis. For other separately recognized intangible assets with indefinite lives, we use a qualitative approach to test such assets for impairment if certain conditions are met. Management reviewed qualitative factors relative to the carrying value of goodwill as of October 31, 2013 and determined, without a step one assessment, that it was more likely than not that the fair value of the Company is greater than its carrying amount. The Company conducted a step one assessment of the carrying value of its goodwill as of October 31, 2012 and determined that goodwill was impaired. Other than goodwill, intangible assets consist primarily of customer lists and covenants not to compete, with estimated lives ranging from 3 to 10 years.
Impairment for Long-Lived and Intangible Assets - The Company reviews long-lived assets and certain identifiable intangible assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recovered. Recoverability is assessed based on estimated undiscounted future cash flows. As of October 31, 2013 and 2012, the Company believes that there has been no impairment of its long-lived and intangible assets.
Stock-Based Compensation - The Company has two stock-based compensation plans under which incentive and non-qualified stock options and restricted shares may be granted. During 2013, options to purchase 51,250 shares of the Company’s stock were issued under one of these plans. Prior to 2013, there had been no grants under these plans since 2005. The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost is recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). The Company provides an estimate of forfeitures at initial grant date. This policy did not have a material impact on the Company’s results of operations as a result of the relatively small number of options issued, and not vested, in 2013 and no options being issued or vested in 2012.
Net Income Per Share - Net income per share is based on the weighted average number of common shares outstanding during each period. Potential common shares are included in the computation of diluted per share amounts outstanding during each period that income is reported. In periods in which the Company reports a loss, potential common shares are not included in the diluted earnings per share calculation since the inclusion of those shares in the calculation would be anti-dilutive. The Company considers outstanding “in-the-money” stock options, if any, as potential common stock in its calculation of diluted earnings per share and uses the treasury stock method to calculate the applicable number of shares.
Advertising Expenses - The Company expenses advertising costs at the commencement of an advertising campaign.
Customer Deposits - Customers receiving home or office delivery of water pay the Company a deposit for the water bottle that is refunded when the bottle is returned. Based on historical experience, the Company uses an estimate of the deposits it expects to refund over the next twelve months to determine the current portion of the liability, and classifies the remainder of the deposit obligation as a long term liability.
Income Taxes - When calculating its tax expense and the value of tax related assets and liabilities the Company considers the tax impact of future events when determining the value of assets and liabilities in its financial statements and tax returns. Accordingly, a deferred tax asset or liability is calculated and reported based upon the tax effect of the differences between the financial statement and tax basis of assets and liabilities as measured by the enacted rates that will be in effect when these differences reverse. A valuation allowance is recorded if realization of the deferred tax assets is not likely.
In accordance with the guidance pertaining to the accounting for uncertainty in income taxes, the Company uses a more-likely-than-not measurement attribute for all tax positions taken or expected to be taken on a tax return in order for those tax positions to be recognized in the financial statements.
Derivative Financial Instruments - The Company records all derivatives on the balance sheet at fair value. The Company utilizes interest rate swap agreements to hedge variable rate interest payments on its long-term debt. The interest rate swaps are recognized on the balance sheet at their fair value and are designated as cash flow hedges. Accordingly, the resulting changes in fair value of the Company’s interest rate swaps are recorded as a component of other comprehensive income (loss). The Company assesses, both at a hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of the related hedged items. Gains and losses that are related to the ineffective portion of a hedge or de-designated hedge are recorded in earnings.
Fair Value of Financial Instruments - The carrying amounts reported in the consolidated balance sheet for cash equivalents, trade receivables, and accounts payable approximate fair value based on the short-term maturity of these instruments. The carrying value of senior debt approximates its fair value since it provides for variable market interest rates. The Company uses a swap agreement to hedge the interest rates on its senior debt. The swap agreement is carried at its estimated settlement value. Subordinated debt is carried at its approximate market value based on periodic comparisons to similar instruments in the market place.
Fair Value Hierarchy - The Company groups its assets and liabilities, generally measured at fair value, in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuation is based on observable inputs other than level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable inputs to pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
The level of fair value hierarchy in which the fair value measurement falls is determined by the lowest level input that is significant to the fair value measurement.
Transfers between levels are recognized at the end of a reporting period, if applicable.
Revenue Recognition - Revenue is recognized when products are delivered to customers. A certain amount of the Company’s revenue is derived from leasing water coolers and coffee brewers. These leases are generally for the first 12 months of service and are accounted for as operating leases. To open an account that includes the rental of equipment, a customer is required to sign a contract that recognizes the receipt of the equipment, outlines the Company’s ownership rights, the customer’s responsibilities concerning the equipment, and the rental charge for twelve months. In general, the customer does not renew the agreement after twelve months, and the rental continues on a month to month basis until the customer returns the equipment in good condition. The Company recognizes the income ratably over the life of the lease. After the initial lease term expires, rental revenue is recognized monthly as billed.
Shipping and Handling Costs - The Company distributes its home and office products directly to its customers on its own trucks. The delivery costs related to the Company’s route system, which are reported under selling, general, and administrative expenses, were approximately $14,141,000 and $13,193,000 for fiscal years 2013 and 2012, respectively.
Reclassification
Certain amounts in the 2012 financial statements have been reclassified to conform with the 2013 presentation.
3.
MERGERS AND ACQUISITIONS
In fiscal year 2013, the Company purchased assets of Ralan, a company based in Connecticut; Health Waters based in New Jersey; and Universal Business Equipment Corp. based in Connecticut. The Company purchased assets of Valley Vending Service, Inc., New York; Girard Spring Water Co., Inc., Rhode Island; and Frontenac Crystal Springs Water, Inc., New York in fiscal year 2012. The purchase price paid for the acquisitions for the respective years is as follows:
Acquisition-related costs (included in selling, general and administrative expenses in the consolidated statements of operations) were $22,313 in fiscal year 2013 and $17,160 in fiscal year 2012.
The allocation of purchase price to the corresponding line item on the financial statements related to these acquisitions for the respective years is as follows:
The following table summarizes the pro forma consolidated condensed results of operations (unaudited) of the Company for the fiscal years ended October 31, 2013 and 2012 as though all the acquisitions had been consummated at the beginning of fiscal year 2012.
The operating results of the acquired entities have been included in the accompanying statements of operations since their respective dates of acquisition.
4.
ACCOUNTS RECEIVABLE
The activity in the allowance for doubtful accounts for the years ended October 31, 2013 and 2012 is as follows:
5.
INVENTORIES
Inventories at October 31 consisted of:
Finished goods inventory consists of products that the Company sells such as, but not limited to, coffee, cups, soft drinks, snack foods, and office products. Raw material inventory consists primarily of bottle caps. The amount of raw and bottled water on hand does not represent a material amount of inventory. The Company estimates that value as of October 31, 2013 and 2012 to be $50,000 and $31,000, respectively. This value includes the cost of allocated overhead. Bottles are accounted for as fixed assets.
6.
OTHER CURRENT ASSETS
At October 31, the balance of other current assets is itemized as follows:
7.
PROPERTY AND EQUIPMENT, NET
Property and equipment at October 31 consisted of:
Depreciation expense for the fiscal years ended October 31, 2013 and 2012 was $3,024,328 and $3,364,037, respectively.
8.
EQUIPMENT RENTAL
The carrying cost of the equipment rented to customers under contract, which is included in property and equipment in the consolidated balance sheets, is calculated as follows:
We expect to have revenue of $579,000 from the rental of equipment under contract at the end of the year over the next twelve months. After twelve months customer contracts convert to a month-to month basis.
9.
GOODWILL AND OTHER INTANGIBLE ASSETS
Components of other intangible assets at October 31 consisted of:
Amortization expense for amortizable intangible assets for fiscal years 2013 and 2012, was $998,942 and $980,427, respectively.
Estimated amortization expense for the next five years is as follows:
An assessment of the carrying value of goodwill was conducted as of October 31, 2013 and 2012. In 2013, it was determined that goodwill was not impaired. In 2012, based on the analysis, it was determined that the carrying amount of goodwill exceeded the implied fair value of goodwill by $19,966,504 on the assessment date, resulting in a non-cash impairment loss of that amount for the year.
In 2013, the Company elected to perform a qualitative (Step 0) assessment of goodwill. Qualitative factors that we considered in the Step 0 assessment included, but were not limited to, macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, other relevant entity-specific events and sustained declines in our share price. At the conclusion of the Step 0 assessment, the Company determined that is not more likely than not that the fair value of our reporting unit was less than the carrying value.
In 2012, the assessment of the carrying value of goodwill was a two step process. In step one, the fair value of the Company is determined, using a weighted average of three different approaches - quoted stock price (a market approach), value comparisons to publicly traded companies believed to have comparable reporting units (a market approach), and discounted net cash flow (an income approach). This approach provided a reasonable estimation of the value of the Company and took into consideration the Company’s thinly traded stock and concentrated holdings, market comparable valuations, and expected results of operations. The Company compared the resulting estimated fair value to its carrying amount as of October 31, 2012 and determined that the carrying amount exceeded the fair value. Therefore, the Company proceeded to step two of the impairment testing process. In step two, the Company allocated the estimated fair value to all of its assets and liabilities (including unrecognized intangible assets) as if the Company had been acquired in a business combination and the estimated fair value was the price paid. It then recognized an impairment loss in the amount by which the carrying value of goodwill exceeded the implied value of goodwill as determined in this allocation. The Company is a single reporting unit as it does not have separate management of product lines and shares sales, purchasing and distribution resources among the lines. Other than the impairment charge, there were no other changes in goodwill in fiscal 2012 and there were no changes in goodwill in fiscal 2013.
In establishing fair market valuations in both step one and step two of the goodwill impairment testing process, the Company assumed a nontaxable hypothetical transaction considering the feasibility of an acquisition structure and whether the assumed structure would result in the highest and best use and would provide maximum value to the seller, including consideration of related tax implications.
Impairment, in 2012, was primarily the result of a decline in estimated fair value resulting from the income approach which relies on a discounted cash flow analysis of the Company’s projected cash flows as well as an analysis of comparable “guideline” companies. These valuations are reflective of the competitive business environment that the Company operates in. In addition, the Company has undertaken operating initiatives to increase its competitive advantage over the long term. These initiatives have increased operating expenses prior to generating anticipated sales which negatively impacted cash flow in the early years of the analysis. There was no event or other change in circumstance that would more likely than not reduce the fair value of the Company’s underlying net assets below their carrying amount prior to the annual impairment test.
10.
OTHER ASSETS
At October 31, 2013 and 2012 the entire balance of other assets was related to equity in ownership interests.
11.
ACCRUED EXPENSES
Accrued expenses as of October 31 are as follows:
12.
DEBT
Senior 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 October 31, 2013. Consequently, as of that date, there was $3,534,000 available to borrow from the revolving line of credit. There was $10,083,000 outstanding on the term note as of October 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 October 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 October 31, 2013, the Company had $2,521,000 of the term debt subject to variable interest rates. The one-month LIBOR was .18% on the last business day of October 2013 resulting in total variable interest rates of 2.68% and 2.43%, for the term note and the revolving line of credit, respectively, as of October 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 October 31, 2013, the Company was in compliance with these covenants and terms of the Agreement.
Subordinated Debt
As part of the acquisition agreement in 2000 with the former shareholders of Crystal Rock Spring Water Company, the Company issued subordinated notes in the amount of $22,600,000. The notes have an effective date of October 5, 2000, were for an original term of seven years (subsequently extended to 2015 as part of the Agreement described above) and bear interest at 12% per year. Scheduled repayments are made quarterly and are interest only for the life of the note unless specified financial targets are met. In April 2004, the Company repaid $5,000,000 of the outstanding principal. In April, 2005, the Company repaid an additional $3,600,000 of this principal.
On May 7, 2009, with the mutual consent of the three subordinated debt holders and Bank of America, the Company paid $500,000 to John B. Baker as a payment of principal on his note. Similarly, on September 29, 2010, with the mutual consent of the three subordinated debt holders and Bank of America, the Company paid $500,000 to Peter K. Baker as a payment of principal on his note.
On December 21, 2012, with a portion of the proceeds from the senior debt re-financing above, the Company made a discretionary payment of $1,500,000 to the subordinated debt holders 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.
The notes are secured by all of the assets of the Company but specifically subordinated, with a separate agreement between the debt holders, to the senior credit facility described above.
Notes Payable
A note for $19,000 issued in conjunction with an acquisition in 2012 was paid in full in August 2013.
Also in 2012, the Company made an acquisition that resulted in the issuance of a note for $101,000 to the seller. The note was due on March 20, 2013 but was not paid because certain contingencies in the acquisition agreement that were required to be met for payment were not met subsequent to the transaction. The resolution of the note payable was recognized as an offset to Selling, General, and Administrative expenses in fiscal year 2013.
Annual Maturities
Annual maturities of debt as of October 31, 2013 are summarized as follows:
13.
ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Derivative Financial Instruments
The Company has stand-alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amount is an amount on which calculations, payments, and the value of the derivative are based. The notional amount does not represent direct credit exposure. Direct credit exposure is limited to the net difference between the calculated amount to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s consolidated balance sheet as an unrealized gain or loss on derivatives.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and currently has no reason to believe that any counterparties will fail to fulfill their obligations.
Risk Management Policies - Hedging Instruments
The Company uses long-term variable rate debt as a source of funds for use in the Company’s general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest obligations. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments on a portion of its debt.
On October 5, 2007, the Company entered into an interest rate 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 fiscal year 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 note at 3.18% (.68% plus the applicable margin under the Agreement, 2.50%) until March 2016.
As of October 31, 2013, the total notional amount of the latest swap agreement was $7,562,000. On that date, the variable rate on the remaining portion of the term note was 2.68%.
At October 31, 2013, the net unrealized loss or gain 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 at October 31, 2012 and the latest swap at October 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 years ended October 31, 2013 and 2012.
The reclassification adjustments of $106,719 and $285,328 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreement during the years ended October 31, 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 years ended October 31, 2013 and 2012.
The fair value of the swap entered into during the year ended October 31, 2013 resulted in an unrealized loss on derivative liability at the end of the period of $44,655. Also, as of that date, the estimated net amount of the existing loss that is reported in accumulated other comprehensive loss that is expected to be reclassified into earnings within the next twelve months is $33,539, 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 $44,655 and $64,603 at October 31, 2013 and 2012, respectively. There were no derivatives other than the interest rate swap designated as a hedging instrument as of October 31, 2013. Derivatives not designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $62,577 at October 31, 2012. During 2013 and 2012, cash flow hedges were deemed 100% effective. The net gain (loss) on interest rate swaps not designated as cash flow hedges, classified as a loss on derivatives on the Company’s consolidated statements of operations, amounted to $5,578 and $5,151 for the years endings October 31, 2013 and 2012, respectively.
14.
FAIR VALUES OF ASSETS AND LIABILITIES
Fair Value Hierarchy
The Company’s assets and liabilities measured at fair value on a recurring basis are as follows:
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”.
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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.
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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:
(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 period.
There were no assets or liabilities measured at fair value on a nonrecurring basis in fiscal 2013.
15.
COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company’s operating leases consist of trucks, office equipment and rental property.
Future minimum rental payments, including related party leases described below, over the terms of various lease contracts are approximately as follows:
Rent expense was $4,155,000 and $3,889,000 for the fiscal years ended October 31, 2013 and 2012, respectively.
16.
STOCK BASED COMPENSATION
Stock Option and Incentive Plans
In April 1998, the Company’s shareholders approved the 1998 Incentive and Non Statutory Stock Option Plan (the “1998 Plan”). In April 2003, the Company’s shareholders approved an increase in the authorized number of shares to be issued under the 1998 Plan from 1,500,000 to 2,000,000. This plan provides for issuance of options to purchase up to 2,000,000 options to purchase the Company’s common stock under the administration of the compensation committee of the Board of Directors. The intent of this plan is to issue options to officers, employees, directors, and other individuals providing services to the Company. Of the total amount of shares authorized under this plan, 85,500 option shares are outstanding. As of April 10, 2013, no further options may be granted under the 1998 Plan.
In April 2004, the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”). This plan provides for issuances of awards of up to 250,000 of the Company’s common stock in the form of restricted or unrestricted shares, or incentive or non-statutory stock options for the purchase of the Company’s common stock. Of the total amount of shares authorized under this plan, 177,250 option shares are outstanding, 26,000 restricted shares have been granted, and 46,750 shares are available for grant at October 31, 2013.
All incentive and non-qualified stock option grants had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table summarizes the activity related to stock options and outstanding stock option balances during the last two fiscal years:
During 2013, 51,250 options were issued and 23,000 options expired from the 2004 Plan. In 2013, 35,000 options expired that were originally issued from the 1998 Plan. The total shares available for grant under all plans are 46,750 at October 31, 2013.
The following table summarizes information pertaining to outstanding stock options that are exercisable as of October 31, 2013:
Of the outstanding options as of October 31, 2013, 211,500 were vested. All of the outstanding options as of October 31, 2012 were vested.
Outstanding options were granted with lives of 10 years and provide for vesting over a term of 5 years. As of October 31, 2013 there is $25,424 of unrecognized future compensation expense that will be recognized over the next five years based on the vesting period of the options. Compensation is determined using the Black-Scholes model and the simplified method to derive the expected term of the options and historical volatility over the past five years.
17.
REPURCHASE OF COMMON STOCK
In May 2012, the Company’s Board of Directors approved the purchase of up to $500,000 of the Company’s common stock. In fiscal year 2013 the Company purchased 16,320 shares for an aggregate purchase price of $16,431. In fiscal year 2012 the Company purchased 7,950 shares for an aggregate purchase price of $8,169. The Company has used internally generated cash to fund these purchases.
18.
INCOME TAXES
The following is the composition of income tax (benefit) expense:
Deferred tax assets (liabilities) at October 31, 2013 and 2012, are as follows:
The Company established a valuation allowance of $81,959 in 2012 related to the capital loss carry forward deferred tax asset.
Income tax expense (benefit) differs from the amount computed by applying the statutory tax rate to net income (loss) before income tax expense as follows:
The Company recognizes interest and penalties related to the unrecognized tax benefits in tax expense. The Company had approximately $41,000 of interest and penalties accrued at October 31, 2013 and 2012.
Generally, the Company is subject to federal and state tax examinations by tax authorities for years after October 31, 2009.
19.
NET INCOME PER SHARE AND WEIGHTED AVERAGE SHARES
The following calculation provides the reconciliation of the denominators used in the calculation of basic and fully diluted earnings per share:
As of October 31, 2013 and 2012, there were 262,750 and 269,500, respectively, options outstanding that were not included in the dilution calculation because the options’ exercise price exceeded the market price of the underlying common shares.
20.
RETIREMENT PLAN
The Company has a defined contribution plan which meets the requirements of Section 401(k) of the Internal Revenue Code. All employees of the Company who are at least twenty-one years of age are eligible to participate in the plan. The plan allows employees to defer a portion of their salary on a pre-tax basis and the Company contributes 25% of amounts contributed by employees up to 6% of their salary. Company contributions to the plan amounted to $140,000, and $130,000, for the fiscal years ended October 31, 2013 and 2012, respectively.
21.
RELATED PARTY TRANSACTIONS
Directors and Officers
The Baker family group, consisting of four current directors Henry Baker (Chairman Emeritus), Peter Baker (CEO), John Baker (Executive Vice President) and Ross Rapaport (Chairman), as trustee, together own a majority of our common stock. In addition, in connection with the acquisition of Crystal Rock Spring Water Company in 2000, we issued members of the Baker family group 12% subordinated promissory notes secured by all of our assets. The balance on these notes as of October 31, 2013 is $10,000,000.
Henry Baker is employed by the Company as an at-will employee at the discretion of management. Mr. Baker’s sons, John Baker and Peter Baker, have employment contracts with the Company through December 31, 2014. They are also directors. The two contracts entitle the respective shareholders to annual compensation of $320,000 each and other bonuses and perquisites.
The Company leases a 67,000 square foot facility in Watertown, Connecticut and a 22,000 square foot facility in Stamford, Connecticut from a Baker family trust. The lease in Watertown expires in October 2016. On September 30, 2010 the Company finalized an amendment to its existing lease in Stamford which extended that lease to September 2020.
Future minimum rental payments under these leases are as follows:
The Company’s Chairman of the Board, Ross S. Rapaport, who also acts as Trustee in various Baker family trusts is employed by McElroy, Deutsch, Mulvaney & Carpenter LLP (formerly Pepe & Hazard, LLP) a business law firm that the Company uses from time to time. During fiscal 2013 and 2012 the Company paid approximately $97,000 and $25,000, respectively, for services provided by McElroy, Deutsch, Mulvaney & Carpenter LLP.
22. CONCENTRATION OF CREDIT RISK
The Company maintains its cash accounts at various financial institutions in non-interest bearing accounts. Effective December 31, 2010 the Dodd-Frank Act fully insured non-interest bearing transaction accounts through January 31, 2013. Effective after that date accounts are covered to $250,000 by the basic limit on federal deposit insurance.
23. 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 did not 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 were 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 adoption did not have a material impact on its operations or financial statements.
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 was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, which was fiscal 2013 for the Company. The adoption did not have a material impact on its operations or financial statements.