SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended July 31, 2003
Commission File No. 000-31797
VERMONT PURE HOLDINGS, LTD.
(Exact name of registrant as specified in its charter)
Delaware 03-0366218
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Route 66; PO Box C; Randolph, VT 05060
(Address of principal executive offices) (Zip Code)
(802) 728-3600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class September 5, 2003
----- -----------------
Common Stock, $.001 Par Value 21,305,986
VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARIES
INDEX
Page Number
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of July 31,
2003 (unaudited) and October 31, 2002 3
Condensed Consolidated Statements of Operations for
the Three and Nine Months ended July 31, 2003 and
2002 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for
the Nine Months ended July 31, 2003 and 2002
(unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-22
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 23-24
Item 4. Controls and Procedures 25
Part II - Other Information 26-31
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures and Certifications 32-39
2
VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
July 31, October 31,
2003 2002
-------------- --------------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,480,675 $ 652,204
Accounts receivable - net 9,735,243 7,547,444
Inventories 3,407,994 4,067,740
Current portion of deferred tax asset 1,000,000 2,356,000
Other current assets 1,664,465 1,202,064
-------------- --------------
TOTAL CURRENT ASSETS 17,288,377 15,825,452
-------------- --------------
PROPERTY AND EQUIPMENT - net of accumulated depreciation 21,296,114 21,676,520
-------------- --------------
OTHER ASSETS:
Goodwill 70,955,609 70,427,887
Other intangible assets - net of accumulated amortization 834,974 648,089
Deferred tax asset 1,242,000 479,000
Other assets 170,237 277,123
-------------- --------------
TOTAL OTHER ASSETS 73,202,820 71,832,099
-------------- --------------
TOTAL ASSETS $ 111,787,311 $ 109,334,071
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long term debt $ 2,907,488 $ 4,881,817
Accounts payable 5,266,013 3,508,062
Accrued expenses 2,563,868 2,640,226
Current portion of customer deposits 168,849 178,937
Unrealized loss on derivatives 126,318 842,898
-------------- --------------
TOTAL CURRENT LIABILITIES 11,032,536 12,051,940
Long term debt, less current portion 48,062,732 46,539,557
Customer deposits 2,645,293 2,803,340
-------------- --------------
TOTAL LIABILITIES 61,740,561 61,394,837
-------------- --------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock - $.001 par value, 500,000
authorized shares, none issued and outstanding - -
Common stock - $.001 par value, 50,000,000
authorized shares, 21,305,986 shares and 21,235,927 shares issued and
outstanding at July 31, 2003 and at October 31, 2002, respectively 21,306 21,236
Additional paid-in capital 57,253,944 57,023,093
Accumulated deficit (7,102,182) (8,262,197)
Accumulated other comprehensive loss (126,318) (842,898)
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 50,046,750 47,939,234
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 111,787,311 $ 109,334,071
============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended July 31, Nine months ended July 31,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(unaudited) (unaudited)
NET SALES $ 22,535,761 $ 21,578,891 $ 55,680,303 $ 53,801,750
COST OF GOODS SOLD 12,847,769 10,783,602 29,712,761 26,211,873
------------ ------------ ------------ ------------
GROSS PROFIT 9,687,992 10,795,289 25,967,542 27,589,877
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling, general and administrative expenses 7,161,777 6,691,147 19,628,925 18,915,101
Advertising expenses 372,229 453,992 954,474 1,152,386
Amortization 47,356 58,050 125,705 174,152
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 7,581,362 7,203,189 20,709,104 20,241,639
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS 2,106,630 3,592,100 5,258,438 7,348,238
------------ ------------ ------------ ------------
OTHER EXPENSE:
Interest (1,138,926) (1,186,774) (3,288,000) (3,569,380)
Miscellaneous (20,962) (263,500) (30,423) (59,550)
------------ ------------ ------------ ------------
TOTAL OTHER EXPENSE, NET (1,159,888) (1,450,274) (3,318,423) (3,628,930)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAX EXPENSE 946,742 2,141,826 1,940,015 3,719,308
INCOME TAX EXPENSE 381,000 850,028 780,000 1,487,724
------------ ------------ ------------ ------------
NET INCOME $ 565,742 $ 1,291,798 $ 1,160,015 $ 2,231,584
============ ============ ============ ============
NET INCOME PER SHARE - BASIC $ 0.03 $ 0.06 $ 0.05 $ 0.11
============ ============ ============ ============
NET INCOME PER SHARE - DILUTED $ 0.03 $ 0.06 $ 0.05 $ 0.10
============ ============ ============ ============
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC 21,283,020 21,118,235 21,267,451 21,091,729
============ ============ ============ ============
WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED 21,799,354 21,978,485 21,823,767 22,111,467
============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended July 31,
-------------------------------
2003 2002
-------------- --------------
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,160,015 $ 2,231,584
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 3,736,353 3,209,817
Amortization 125,705 174,152
Change in deferred tax asset 593,000 1,245,404
Loss (gain) on disposal of property and equipment 35,473 (1,225)
Non cash compensation 38,997 52,400
Changes in assets and liabilities (net of effect of acquisitions):
Accounts receivable (2,187,799) (3,500,939)
Inventories 659,746 (1,455,445)
Other current assets (462,001) 550,426
Other assets 562,821 20,465
Accounts payable 1,757,951 1,437,558
Accrued expenses (244,481) 698,726
-------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 5,775,780 4,662,923
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (3,481,700) (3,993,938)
Proceeds from sale of property and equipment 90,279 27,750
Cash used for acquisitions - net of cash acquired (1,296,647) (4,987,073)
-------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (4,688,068) (8,953,261)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit borrowings 1,866,433 3,865,706
Proceeds from debt 2,043,320 4,200,000
Principal payments line of credit (1,866,433) (3,082,769)
Principal payments of debt (2,494,486) (1,949,078)
Proceeds from exercise of stock options - 308,349
Proceeds from sale of common stock 191,925 220,897
-------------- --------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (259,241) 3,563,105
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 828,471 (727,233)
CASH AND CASH EQUIVALENTS - beginning of year 652,204 1,099,223
-------------- --------------
CASH AND CASH EQUIVALENTS - end of period $ 1,480,675 $ 371,990
============== ==============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $ 3,285,333 $ 3,430,164
============== ==============
Cash paid for income taxes $ 198,433 $ 725,593
============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with Form 10-Q instructions and in the
opinion of management contain all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the condensed
consolidated financial position, results of operations, and cash flows
for the periods presented. The results have been determined on the
basis of generally accepted accounting principles and practices of the
United States of America, applied consistently with the Annual Report
on Form 10-K of Vermont Pure Holdings, Ltd. (the "Company") for the
year ended October 31, 2002.
Certain information and footnote disclosures normally included in
audited consolidated financial statements presented in accordance with
accounting principles generally accepted in the United States of
America have been condensed or omitted. The accompanying condensed
consolidated financial statements should be read in conjunction with
the condensed consolidated financial statements and notes thereto
incorporated by reference in the Company's Annual Report on Form 10-K
for the year ended October 31, 2002. The results of operations for the
interim periods are not necessarily indicative of the results to be
expected for the full year.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of
FASB Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. The Company has
adopted this pronouncement and is complying by continuing to apply
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued
to Employees," prominently disclosing the method of accounting for
stock based compensation in annual and interim financial statements,
and disclosing the effect of the method used on financial results.
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." Pro-forma
information regarding net income and net income per share is presented
below as if the Company had accounted for its employee stock options
under the fair value method using SFAS No. 123, net of tax; such
pro-forma information is not necessarily representative of the effects
on reported net income
6
for future years due primarily to option vesting periods and to the
fair value of additional options in future years.
Three Months Ended Nine Months Ended
July 31, July 31,
2003 2002 2003 2002
-------- ---------- ---------- ----------
Net Income - As Reported $565,742 $1,291,798 $1,160,015 $2,231,584
Deduct: Fair Value of Options-
net of income tax 63,242 48,870 203,133 342,299
-------- ---------- ---------- ----------
Pro Forma Net Income $502,500 $1,242,928 $ 956,882 $1,889,285
======== ========== ========== ==========
Basic Net Income Per Share:
As Reported $ .03 $ .06 $ .05 $ .11
======== ========== ========== ==========
Pro Forma $ .02 $ .06 $ .04 $ .09
======== ========== ========== ==========
Diluted Net Income Per Share:
As Reported $ .03 $ .06 $ .05 $ .10
======== ========== ========== ==========
Pro Forma $ .02 $ .06 $ .04 $ .09
======== ========== ========== ==========
There were no stock options granted during the three month periods
ended July 31, 2003 and 2002. The weighted average fair value of the
options granted for the respective nine month periods, using the
Black-Scholes option pricing model, was $1.70 and $2.26, respectively.
In April 2003, the Company's shareholders approved an increase in the
authorized number of shares to be issued from its 1998 Incentive and
Non-Statutory Stock Option Plan from 1,500,000 to 2,000,000.
Assumptions used for estimating the fair value of the option on the
date of grant under the Black-Scholes option pricing model are as
follows for the three and nine month periods ending July 31, 2003 and
2002:
2003 2002
---- ----
Expected Dividend Yield 0% 0%
Expected Life 5 Years 5 Years
Risk free Interest Rate 5.7% 5.7%
Volatility 36% 53%
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." The statement amends
and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS 133. FAS 149 is
effective for contracts entered into or modified after June 30, 2003
except for the provisions that were cleared by the FASB in prior
pronouncements. The Company is currently assessing the financial impact
of adopting SFAS 149 in fiscal year 2003.
7
On May 15, 2003, the FASB issued SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity". SFAS 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). SFAS 150 affects the issuer's accounting for three
types of freestanding financial instruments.
* Mandatorily redeemable shares, which the issuing company is
obligated to buy back in exchange for cash or other assets.
* Instruments that do or may require the issuer to buy back some
of its shares in exchange for cash or other assets; includes
put options and forward purchase contracts.
* Obligations that can be settled with shares, the monetary
value of which is fixed, tied solely or predominantly to a
variable such as a market index, or varies inversely with the
value of the issuer's shares.
SFAS 150 does not apply to features embedded in a financial instrument
that is not a derivative in its entirety. Most of the guidance in SFAS
150 is effective for all financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The Company has
determined that implementation of this pronouncement has no material
affect on its financial statements.
3. SEGMENTS
The Company prepares detailed information to evaluate its operations on
a segment basis. It accounts for the business in three separate
segments, "Retail", "Retail-Gallons" and "Home and Office".
The segments are identifiable based on the types of products and their
distribution channels.
Retail - Characterized by the sale of water in small, portable
containers that are constructed from clear polyethylene terephthalate
PET plastic. Bottle sizes range from 8 oz. to 1.5 L. These products are
sold to wholesale beverage distributors, supermarkets and convenience
stores.
Retail - Gallons - Characterized by the sale of water in medium-sized,
portable containers that are constructed from HDPE plastic. Bottle
sizes range from one-gallon to 2.5 gallons. These products are sold to
supermarket chains. The Company has this product packed by other
companies and there is a different distribution pattern from other
retail products as well as a distinct retail customer base.
8
Home and Office - Characterized by the sale of five-gallon reusable
bottles of water and rental of water coolers delivered by the Company's
trucks and employees, and other products that are sold through this
distribution channel which are ancillary to the primary product, such
as office refreshments.
The Company allocates costs directly when possible and uses various
applicable allocation methods to allocate shared costs. There are no
inter-segment revenues for the periods reported.
For the three months ended July 31,
Home and Office Retail Retail - Gallons Total
------------------- ------------------ ------------------- -------------------
(000's $) 2003 2002 2003 2002 2003 2002 2003 2002
------ ------ ----- ----- ----- ---- ------ ------
Sales 13,352 12,853 7,915 8,214 1,269 512 22,536 21,579
Cost of Goods Sold 5,538 4,884 6,256 5,524 1,054 376 12,848 10,784
-------------------------------------------------------------------------------------------------
Gross Profit 7,814 7,969 1,659 2,690 215 136 9,688 10,795
Operating Expenses 5,605 5,139 1,842 1,988 134 76 7,581 7,203
-------------------------------------------------------------------------------------------------
Operating Income (Loss) 2,209 2,830 (183) 702 81 60 2,107 3,592
Interest Expense (819) (855) (274) (292) (46) (40) (1,139) (1,187)
Other Loss (4) (264) (17) (21) (264)
-------------------------------------------------------------------------------------------------
Income (Loss) Before Taxes 1,386 1,711 (474) 410 35 20 947 2,141
=================================================================================================
For the nine months ended July 31,
Home and Office Retail Retail-Gallons Total
------------------ ------------------ ----------------- ------------------
(000's $) 2003 2002 2003 2002 2003 2002 2003 2002
------ ------ ------ ------ ----- ----- ------ ------
Sales 36,793 36,335 16,487 16,435 2,400 1,032 55,680 53,802
Cost of Goods Sold 15,206 13,864 12,571 11,593 1,936 755 29,713 26,212
-------------------------------------------------------------------------------------------
Gross Profit 21,587 22,471 3,916 4,842 464 277 25,967 27,590
Operating Expenses 16,066 15,625 4,352 4,416 291 201 20,709 20,242
-------------------------------------------------------------------------------------------
Operating Income (Loss) 5,521 6,846 (436) 426 173 76 5,258 7,348
Interest Expense (2,367) (2,570) (804) (872) (117) (127) (3,288) (3,569)
Other Income (Loss) 10 (264) (40) 204 (30) (60)
-------------------------------------------------------------------------------------------
Income (Loss) Before Taxes 3,164 4,012 (1,280) (242) 56 (51) 1,940 3,719
===========================================================================================
4. Goodwill and Intangible and Other Assets
Effective November 1, 2001, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets." With the adoption of SFAS No. 142,
goodwill is no longer subject to amortization but is annually assessed
for impairment by applying a fair-value based test.
9
Within six months of adoption of SFAS No. 142, the Company was required
to complete a transitional impairment review using a fair value
methodology to identify if there was impairment to the goodwill or
intangible assets of indefinite life. Any impairment loss resulting
from the transitional impairment test would have been recorded as a
cumulative effect of a change in accounting principle for the quarter
ended April 30, 2002. The Company completed its evaluation of the
carrying value of goodwill during the second quarter of 2002 and
determined that there was no impairment of goodwill. SFAS No. 142
requires that goodwill be tested annually and between annual tests if
events or circumstances change that would more likely than not reduce
the fair value of a reporting unit below its carrying value. The
Company's annual evaluation of the carrying value of goodwill completed
during the second quarter of 2003 has also determined that there was no
impairment of goodwill. Subsequent impairment losses will be reflected
in operating income in the consolidated Statement of Operations.
5. DEBT
Senior Debt Refinancing
On March 5, 2003 the Company refinanced its credit facility with
Webster Bank and other participants. The new credit facility refinanced
$28.5 million of existing senior debt, provides a working capital line
of $6.5 million for a term of two years, and makes available up to $15
million to be used for acquisitions and the partial repayment of the
outstanding 12% subordinated notes. Of the $15 million, up to $10
million is available for acquisitions in the Company's Home and Office
segment, and up to $5 million is available for the repayment of
subordinated debt if the Company is able to achieve specified financial
performance targets in fiscal year 2003. If the targets are not met,
there would be no further scheduled principal payments on the
subordinated debt until 2008 when the full senior facility is due.
The new agreement amortizes the payback of the existing debt over five
years and amortizes the payback of the new acquisition debt for three
years after the first two years. During the first two years, interest
only is paid on a monthly basis for amounts drawn down for acquisitions
and sub-debt repayment. The operating line of credit was renewed for
two years for a total of $6,500,000. Interest on all borrowings is tied
to the Company's performance based the 30 day LIBOR plus 200 basis
points.
During the nine months ended July 31, 2003 the Company borrowed
approximately $1,900,000 from its operating line of credit with Webster
Bank and $500,000 for an acquisition. As of July 31, 2003 the working
capital line had been paid off and there was a balance of $500,000
outstanding under the acquisition line of credit. In addition, letters
of credit totaling $636,264 secured by the operating line were issued
on the Company's behalf.
Use of the proceeds related to acquisitions and retirement of sub-debt
are restricted by the Company's attainment of certain covenants,
requirements, and projections.
10
Compliance with Financial Covenants of the Company's Bank Agreement
The Company's Loan and Security agreement, described above, requires
that it be in compliance with certain financial covenants at the end of
each fiscal quarter. The Company was in compliance with all of its
financial covenants at the end of the third quarter.
5. COMPREHENSIVE INCOME
The following table summarizes comprehensive income for the three and
nine months ended July 31, 2003 and 2002:
Three Months Ended Nine Months Ended
July 31, July 31,
2003 2002 2003 2002
-------- ---------- ---------- ----------
Net Income $565,742 $1,291,798 $1,160,015 $2,231,584
Comprehensive Income:
Unrealized gain (loss) on derivatives
designated as cash flow hedges - net of
tax. 233,657 (134,836) 379,421 122,432
-------- ---------- ---------- ----------
Comprehensive Income $799,399 $1,156,962 $1,539,436 $2,354,016
======== ========== ========== ==========
6. STOCK
Stock Issued to Directors
The Company issued 9,285 and 12,105 of its common shares to Directors
in lieu of cash for board fees in the first nine months of fiscal years
2003 and 2002, respectively. Expense of $39,000 and $52,400 for the
respective years was based on the market price on the date of issuance.
Employee Stock Purchase Plan
On June 15, 1999 the Company's stockholders approved the "Vermont Pure
Holdings, Ltd. 1999 Employee Stock Purchase Plan." On January 1, 2001,
employees commenced participation in the plan. The total number of
common shares issued under this plan during the nine months ended July
31, 2003 was 60,775 for proceeds of $189,265.
7. OPERATING LEASES
The Company's operating leases consist of trucks, office equipment and
rental property.
Future minimum rental payments over the terms of various lease
contracts are approximately as follows:
11
For the fiscal year ending October 31,:
2004 $1,882,000
2005 1,662,000
2006 1,341,000
2007 1,114,000
2008 929,000
Thereafter 1,779,000
----------
Total $8,707,000
----------
8. INVENTORIES
Inventories consisted of the following:
July 31, October 31,
2003 2002
---------- ----------
Raw Materials $1,267,256 $1,289,553
Finished Goods 2,140,738 2,778,187
---------- ----------
Total Inventory $3,407,994 $4,067,740
========== ==========
9. SHIPPING AND HANDLING COSTS
The Company classifies shipping and handling costs as a component of
selling, general and administrative expenses. Shipping and handling
costs were approximately $1,630,000 and $1,516,000 for the nine months,
and $735,000 and $854,000 for the three months ended July 31, 2003 and
2002, respectively. The Company does not charge these costs to its
customers.
10. EARNINGS PER SHARE AND WEIGHTED AVERAGE SHARES
The Company considers outstanding in-the-money stock options as
potential common stock in its calculation of diluted earnings per share
and uses the treasury stock method to calculate the applicable number
of shares. The following calculation provides the reconciliation of the
denominators used in the calculation of basic and fully diluted
earnings per share:
Three Months Ended Nine Months Ended
July 31, July 31,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net Income $ 565,742 $ 1,291,798 $ 1,160,015 $ 2,231,584
----------- ----------- ----------- -----------
Denominator:
Basic Weighted Average Shares
Outstanding 21,283,020 21,118,235 21,267,451 21,091,729
Effect of Stock Options 516,334 860,250 556,316 1,019,738
----------- ----------- ----------- -----------
Diluted Weighted Average Shares
Outstanding 21,799,354 21,978,485 21,823,767 22,111,467
----------- ----------- ----------- -----------
Basic Earnings Per Share $ .03 $ .06 $ .05 $ .11
=========== =========== =========== ===========
Diluted Earnings Per Share $ .03 $ .06 $ .05 $ .10
=========== =========== =========== ===========
12
In addition to the options used to calculate the effect of dilution,
there were 240,000 options outstanding for the three and nine months
periods ended July 31, 2003. These options were not included in the
dilution calculation because the options' exercise price exceeded the
market price of the underlying common shares. For the comparable
periods in 2002, all outstanding options were used to determine the
effect of dilution because the market price exceeded the exercise
prices.
11. CONTINGENCY
Litigation Settlement
In January 2003, the Company settled a suit alleging that a vendor did
not adequately perform the services rendered in connection with
approximately $500,000 of unpaid billings. In settling the suit, the
Company agreed to pay $50,000 to the vendor in full settlement of the
litigation. In conjunction with the settlement, the parties released
each other from any further liability in the case. A gain of $150,000
was recognized in the first quarter of 2003 since the Company had set
up a reserve for settlement of the suit that exceeded the final amount
paid. The gain has been included as a reduction of selling, general and
administrative expenses.
12. SUBSEQUENT EVENTS
Tax Audit
On September 3, 2003, the Company reached a settlement with the
Internal Revenue Service related to an audit of federal income tax for
its Crystal Rock subsidiary for the tax year ending October 5, 2000.
The settlement resulted in an increase in taxable income of $342,000.
The Company is in the process of determining the effect of this on its
financial statements and will recognize it in its fiscal fourth
quarter.
13
PART I - Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto as filed in our Annual Report on Form
10-K for the year ended October 31, 2002 as well as the condensed consolidated
financial statements and notes contained herein.
Forward-Looking Statements
When used in the Form 10-Q and in our future filings with the Securities and
Exchange Commission, the words or phrases "will likely result," "we expect,"
"will continue," "is anticipated," "estimated," "project," "outlook," or similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. We caution
readers not to place undue reliance on any such forward-looking statements, each
of which speaks only as of the date made. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical earnings and those presently anticipated or projected. Among
these risks are water supply and bottling capacity constraints in the face of
significant growth, dependence on outside distributors, and reliance on
commodity price fluctuations as they influence raw material pricing. We have no
obligation to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect anticipated or unanticipated events or
circumstances occurring after the date of such statements.
Results of Operations
Performance Overview - Recent Trends
Compared to the corresponding quarter in fiscal year 2002, our net income has
declined in each quarter of fiscal year 2003. In addition, our operating results
for the first nine months of the year have been affected by significant
decreases in gross margin. In general, these decreases are attributable to lower
sales and higher costs for raw materials, direct labor and operating overhead.
The sluggish economic environment in our core markets has had a negative effect
on sales in the home and office segment. These conditions have resulted in lower
volume through loss of customers, reduced business with continuing customers,
and increased competition causing lower average selling prices. In addition,
those products that reflect increased sales are lower margin products. The
retail segment has been transformed by competition. Price cuts by large
competitors in the branded market have significantly reduced sales of our
branded products. On the revenue side, an increase in sales of private label
products has more than made up for this. However, the competitive environment
has continued to decrease pricing for all products in this segment.
Fuel costs have increased both transportation and plastic costs. Higher
insurance costs have affected both employee benefits and property and casualty
expenses.
Despite these adverse trends, current profitability levels have allowed us to
continue to service our
14
debt, fund capital expansion, and continue our acquisition strategy.
Results to date this fiscal year have not altered our strategic direction, even
though growth and profitability trends have changed in the current fiscal year
compared to the past several years. We believe that variable external factors
such as economic conditions and commodity pricing will not change current trends
in the near term. While no assurance can be given that these factors will change
or moderate in the foreseeable future, we continue to position our business so
that cyclical improvements that have characterized these and similar factors in
the past are more likely to produce growth and improve our profitability.
For the Three Months Ended July 31, 2003 Compared to the Three Months Ended July
31, 2002
Sales - Sales for the third quarter of fiscal year 2003 were $22,536,000
compared to $21,579,000 for the same period of fiscal year 2002, an increase of
$957,000, or 4%. Net of acquisitions, sales increased 2% during the quarter.
Sales for the home and office segment for the third quarter of fiscal 2003 were
$13,352,000 compared to $12,853,000 for the corresponding period of fiscal year
2002, an increase of $499,000, or 4%. During the third quarter of 2003 the
Company completed several small acquisitions in the segment which accounted for
a 3% increase. Sales of $410,000 were attributable to the acquisitions for the
period. Net of acquisitions, sales for the home and office segment increased 1%.
The relatively flat sales for the quarter are reflective of a sluggish economy,
particularly in our core southern New England market. The economic environment
has resulted in lower market demand and increased competitive pressure for
products in this segment. This resulted in lower prices for water related
products. Of the total home and office segment sales for the quarter, water
sales totaled $6,472,000, a 4% decrease from the same period a year ago,
equipment rental totaled $2,130,000, a 3% decrease over the same period a year
ago, and sales of coffee and other items totaled $4,750,000, a 22% increase
compared to the same period a year ago. The increase in these ancillary product
sales reflects a recovery to more normal sales patterns compared to a year ago
and recovery of deposits for bottles not returned.
Sales of water in the one-gallon size have increased significantly over the last
year. We introduced the product to satisfy the needs of new private label retail
customers. Because the product has different production and distribution and a
distinct retail customer base, the inclusion of this business into the retail
reporting segment has noticeably altered the quantitative reporting of the
segment in the past year. Consequently, the results for the one-gallon size are
being reported in a separate segment. Sales for this segment were $1,269,000 for
the third quarter of fiscal year 2003 compared to $512,000 for the same period a
year ago, an increase of $757,000. The increase is attributable to increased
demand and new customers.
Sales for the retail segment, which include both private label and branded
products, for the third quarter of fiscal 2003 were $7,915,000 compared to
$8,214,000 for the corresponding period of fiscal year 2002, a decrease of
$299,000 or 4%. For the third quarter of the fiscal year, sales of private label
brands increased 14% compared to the third quarter a year ago. The increase is
attributable to the strength of market share for private label brands in the
category. In our branded
15
business, the increasingly competitive nature of the business and limited
distribution options resulted in significantly lower sales for our brands. Sales
of the branded products decreased 36% compared to the third quarter a year ago.
Average selling prices of retail-size products for the third quarter decreased
20% compared to the corresponding period in fiscal year 2002. The decrease in
average selling price was primarily attributable to increase in private label
business and the decline of the branded business. Sales volume, in cases,
increased 19% for the third quarter over the same period last year.
Cost of Goods Sold/Gross Profit - For the third quarter of fiscal year 2003,
cost of goods sold was $12,848,000 compared to $10,784,000 for the same period
in fiscal 2003, an increase of $2,064,000, or 19%. Gross profit for the third
quarter was $9,688,000 compared to $10,795,000 for the corresponding period a
year ago, a decrease of $1,107,000, or 10%. The decrease in gross profit is
primarily the result of lower sales for our higher margin products as well as
higher cost of sales. As a percentage of sales, gross profit for the third
quarter was 43% in 2003 and 50% in 2002. The decrease in the percentage is a
result of a higher sales mix of retail-size products and a lower gross profit
rate on those products.
Gross profit for the home and office segment was $7,814,000, or 59% of sales, in
the third quarter of fiscal 2003 compared to $7,969,000, or 62% of sales, for
the comparable period in 2002. The decrease in gross profit for the home and
office segment is attributable to lower sales of our higher margin water-related
products. The lower sales of these products were a result of both lower sales
volume and average selling prices due to economic conditions and competition. In
addition, increased cost of sales lowered margins. Increases in insurance and
employee benefits and the higher costs related to service of rental units
combined with lower sales volume per customer contributed significantly to
higher costs during the quarter.
Gross profit for the retail gallon segment increased to $215,000 in the third
quarter of fiscal 2003 from $136,000 in the corresponding period a year ago as a
result of higher sales volume. However, a decrease in average selling prices due
to new customers and product configurations as well as competitive pressures
caused gross margin as a percentage of sales to decrease to 17% from 27% for the
respective quarters.
Gross profit for the retail segment was $1,659,000, or 21% of sales, in the
third quarter of fiscal 2003 compared to $2,690,000, or 33% of sales, for the
comparable period in 2002. The decrease in gross profit for the retail segment
was the result of lower average selling prices, a direct result of the
competitive environment. In addition, raw material costs were higher than a year
ago because of higher plastic (resin) prices.
Operating Expenses - For the third quarter of fiscal year 2003, compared to the
corresponding period in fiscal year 2002, total operating expenses were
$7,581,000 and $7,203,000, respectively, an increase of $378,000, or 5%.
Selling, general and administrative expenses ("SG&A") increased by $471,000, or
7%, for the third quarter compared to the corresponding period a year ago. Home
and office SG&A expenses increased $538,000, or 11%. The increase was primarily
due to increased sales personnel and administrative costs. SG&A expenses in the
retail segments decreased $67,000, or 4%. The decrease was attributable to lower
warehousing and selling costs associated with the
16
private label category more than offsetting higher administrative costs.
Increased administrative costs include insurance and employee benefits that are
reflective of the market for those products as well as legal and accounting
costs related to increased regulation for public companies.
Advertising and promotional expenses decreased $82,000, or 18%, during the third
quarter of 2003 compared to the corresponding period a year earlier. Promotion
and advertising costs in the home and office and retail segments decreased
$62,000 and $20,000 compared to the same period a year ago, respectively. The
decrease reflects the limited retail distribution opportunities (discussed
above) for our branded products and an emphasis in direct sales rather than
advertising in the home and office segment.
For the third quarter of fiscal year 2003, amortization decreased $10,000 for
the same period a year ago. The decrease was a result of the expiration of the
term of certain agreements associated with acquisitions in prior years. All
amortization is accounted for in the home and office segment.
Income from Operations - Income from operations for the third quarter of fiscal
2003 was $2,107,000 as compared to $3,592,000 for the corresponding period last
year, a decrease of $1,485,000 or 41%. The decrease in income is attributable to
lower operating margins. Income from operations in the home and office segment
decreased $621,000 to $2,209,000 in the third quarter of 2003 from $2,830,000 in
the third quarter of 2002 primarily due to lower sales prices and volume, and
higher cost of sales. Income from operations in the retail-gallons segment
increased $21,000 to $81,000 in the third quarter of 2003 compared to income of
$60,000 in the third quarter of 2002 as a result of higher sales volume for the
period. The retail segment decreased $885,000 to a loss from operations of
$183,000 in the third quarter of 2003 compared to income from operations
$702,000 in the third quarter of 2002 as a result of the net effect of higher
sales volume but lower average selling prices for the period.
Other Income/Expense - Interest expense decreased $48,000 to $1,139,000 in the
third quarter of fiscal 2003 from $1,187,000 in the third quarter of fiscal year
2002. The decrease in interest expense was a result of significantly lower
market interest rates on the variable rate senior debt. There was $21,000 of
expense in the quarter related to losses on sales of operating assets.
Income Before Income Taxes - Income before taxes for the third quarter of fiscal
year 2003 was $947,000 compared to income before taxes of $2,142,000 for the
corresponding period last year. The decrease of $1,195,000 in part reflects the
fact that lower interest charges did not offset the effect of lower operating
margins.
Income Tax/Net Income - Income tax expense was accrued at an effective rate of
40% for the third quarter of 2003 and 2002 resulting in tax expense of $381,000
and $850,000, respectively. Net income for the quarter was $566,000, or $.03 per
share (basic and diluted) in 2003 compared to $1,292,000, or $.06 per share
(basic and diluted) in 2002, a decrease of $726,000, or $.03 per share.
17
For the Nine Months Ended July 31, 2003 Compared to the Nine Months Ended July
31, 2002
Sales - Sales for the first three quarters of fiscal year 2003 were $55,680,000
compared to $53,802,000 for the corresponding period in fiscal year 2002, an
increase of $1,878,000, or 3%.
Sales for the home and office segment for the first nine months of fiscal 2003
were $36,793,000 compared to $36,335,000 for the corresponding period of fiscal
year 2002, an increase of $458,000, or 1%. The increase in sales is attributable
to small acquisitions made during the year. Sales from acquisitions totaled
$447,000 for the fiscal year to date. Of the total home and office segment sales
for the nine month period, water sales totaled $17,806,000, a decrease of 2%
from the same period a year ago, equipment rental was $6,400,000, a decrease of
3% from the same period a year ago and sales of coffee and other products were
$12,587,000, an increase of 9% compared to the same period a year ago. The
decrease in water-related sales is a result of lower sales volume due to
economic conditions and lower average selling prices due to competition in the
marketplace. The increase in other products compares to a particularly poor
corresponding period last year.
Sales for the retail gallon segment increased to $2,400,000 in the first nine
months of fiscal 2003 from $1,032,000 in the corresponding period a year ago, an
increase of $1,368,000. The increase is attributable to the fact that we did not
start selling this line of products until the second quarter of fiscal year
2002, higher demand, and new customers.
Sales for the retail segment for the first nine months of fiscal year 2003 were
$16,487,000 compared to $16,435,000 for the corresponding period of fiscal year
2002, an increase of $52,000. For the first nine months of the fiscal year,
sales of private label brands increased 24% compared to the same period a year
ago. Growth of private label brands reflects both new account acquisitions and
market share gain by the established customer base during the period. Sales of
the branded products decreased 34% compared to the first nine months a year ago.
The decrease is related to the increasingly competitive nature of the branded
retail business and limited distribution options in our core markets. Average
selling prices of retail-size products for the first nine months of fiscal year
2003 decreased 18% compared to the corresponding period in fiscal year 2002. The
decrease in average selling price was primarily attributable to increased
competition. Sales volume, in cases, increased 22% in the first nine months of
fiscal 2003 compared to the corresponding period last year.
Cost of Goods Sold/Gross Profit - For the first nine months of fiscal year 2003,
cost of goods sold was $29,713,000 compared to $26,212,000 for the same period
in fiscal 2003, or an increase of 13%. Gross profit for the first nine months
was $25,968,000 compared to $27,590,000 for the corresponding period a year ago,
a decrease of $1,622,000, or 6%. As a percentage of sales, gross profit for the
first nine months of fiscal year 2003 was 47% in 2003 and 51% in 2002. The
decrease in gross profit is primarily the result of lower sales of higher margin
products, decrease in average selling prices, and higher costs.
Gross profit for the home and office segment was $21,587,000, or 59% of sales,
in the first nine months of fiscal 2003 compared to $22,471,000, or 62% of
sales, for the comparable period in 2002. The decrease in gross profit for the
home and office segment is attributable to lower sales of our higher margin
water-related products. The lower sales of these products were a result of both
lower
18
sales volume of higher margin products and average selling prices. In addition,
increased cost of sales lowered margins. The increase in cost of sales is
attributable to higher insurance and employee benefit costs, higher costs
related to the reorganization of production and distribution in the upstate New
York region, and higher service costs as a result of lower sales volume per
customer.
Gross profit for the retail gallon segment increased to $464,000 in the first
nine months of fiscal 2003 from $277,000 in the corresponding period a year ago
as a result of higher sales. The higher gross margin is attributable to higher
sales. However, a decrease in average selling prices due to competitive
pressures caused gross margin as a percentage of sales to decrease to 19% from
27% for the respective quarters.
Gross profit for the retail segment was $3,916,000, or 24% of sales, in the
first nine months of fiscal 2003 compared to $4,842,000, or 29% of sales, for
the comparable period in 2002. The decrease in gross profit is attributable to
lower average selling prices and increased production costs. We have continued
to gain cost efficiencies from higher sales volume and lower product costs
through raw material savings resulting in lower product costs. However, these
improvements have been mitigated by increases in such things as energy, plastic
(resin), insurance, and employee benefits.
Operating Expenses - For the nine months of fiscal year 2003 compared to the
corresponding period in fiscal year 2002, total operating expenses were
$20,709,000 and $20,242,000, respectively, an increase of $467,000. Selling,
general and administrative expenses ("SG&A") increased by $714,000, or 4%, for
the first nine months of fiscal year 2003 compared to the same period last year.
SG&A expenses for home and office increased $590,000, or 4%, for the first nine
months compared to the corresponding period a year ago. The increase in SG&A for
home and office was related to an increase in sales personnel. Also included in
the home and office segment is a gain of $150,000 which resulted from the
settlement of a lawsuit with a former software provider. The gain was derived
from reversal of the unused portion of a reserve for settlement of the suit.
SG&A expenses for the retail segments increased $124,000, or 3%. The increase
was a result of higher freight and warehouse costs related to increased sales.
Advertising and promotional expense decreased $198,000, or 17%, during the first
nine months of 2003 compared to the corresponding period a year earlier. The
decrease was primarily due to a decline in advertising in the retail segment as
result of a higher mix of private label products. Advertising costs in the home
and office segment decreased $100,000, or 15% for the first nine months compared
to a year ago. Promotion and advertising for the retail segment decreased
$98,000 in the period compared to a year ago, a 21% decrease. There is no
advertising or promotion expense in the retail-gallons segment.
For the first nine months of fiscal year 2003, amortization decreased $48,000 to
$126,000 from $174,000 for the same period a year ago. The decrease was a result
of the expiration of the term of certain agreements associated with acquisitions
in prior years. All amortization is accounted for in the home and office
segment.
Income from Operations - Income from operations for the first nine months of
fiscal year 2003 was $5,258,000 as compared to $7,348,000 for the corresponding
period last year, a decrease of
19
$2,090,000, or 29%. The decrease is primarily due to the lower operating
margins. Income from operations in the home and office segment decreased to
$5,521,000 in the first nine months of 2003 from $6,846,000 in the first nine
months of 2002 primarily because of lower sales volume and prices and higher
production and service costs. Income from operations in the retail-gallons
segment increased to $173,000 in the first nine months of 2003 compared to
$76,000 in the comparable period of 2002. The increase in this segment is due to
higher sales volume in the period. We experienced a loss from operations in the
retail segment of $436,000 in the first nine months of 2003 compared to income
of $426,000 in the first nine months of 2002 as a result of lower average
selling prices and higher costs for the period.
Other Income/Expense - Interest expense decreased $281,000 to $3,288,000 during
the first nine months of fiscal 2003 from $3,569,000 in the first nine months of
fiscal year 2002. The decrease in interest expense was a result of lower
interest rates on variable rate senior debt and operating line of credit.
Miscellaneous expenses were recorded in the first nine months of 2003 in the net
amount of $30,000 compared to $60,000 in 2002. In the first nine months of 2003,
the expense was related to the write-off of certain miscellaneous assets. In the
first nine months of 2002, $204,000 was recognized from the sale of a trademark,
net of legal expenses incurred for the transaction. This was offset by $264,000
recognized for a sales and use tax assessment by the State of New York as result
of a routine audit.
Income Before Income Taxes - Income before taxes for the first nine months of
fiscal year 2003 was $1,940,000 compared to income before taxes of $3,719,000
for the corresponding period last year. The decrease of $1,779,000 reflects in
part that lower interest charges did not offset the effect of lower operating
margins.
Income Tax/Net Income - Income tax expense was accrued at an effective rate of
40% for the first nine months of fiscal year 2003 and 2002 resulting in tax
expense for the respective periods of $780,000 and $1,488,000. Net income for
the first nine months of fiscal 2003 was $1,160,000, or $.05 per share (basic
and diluted) compared to $2,232,000, or $.11 per share basic ($.10 diluted) in
the first nine months of 2002, a decrease of $1,072,000, $.06 per share ($.05
diluted).
Liquidity and Capital Resources
On March 5, 2003 we refinanced our credit facility with Webster Bank and other
participants. The new credit facility refinanced $28.5 million of existing
senior debt, provided a working capital line of $6.5 million for a term of two
years, and makes available up to $15 million to be used for acquisitions and the
partial repayment of our outstanding 12% subordinated notes. Of the $15 million,
up to $10 million is available for acquisitions in our home and office delivery
segment, and up to $5 million is available for the repayment of subordinated
debt if we are able to achieve specified financial performance targets in fiscal
year 2003. If the targets are not met, there would be no principal payments on
the subordinated debt until 2008 when the full senior facility is paid.
As of July 31, 2003 we had working capital of $6,256,000 compared to $3,774,000
on October 31, 2002, an increase of $2,482,000. The increase in working capital
was a result of refinancing our debt. The refinancing improved working capital
in two ways. First, it extended the amortization of
20
the term loan, lowering payments in the earlier years, and thereby reclassifying
less debt as current. Second, it rolled the existing line of credit balance into
the term loan, thereby classifying it as long term debt. Increases in accounts
receivable are reflective of the seasonal upturn in the retail segment of the
business in the second and third quarters.
The line of credit balance was $1,500,000 at the time of the refinancing. We
borrowed up to $1,900,000 from our operating line of credit as a source of cash
during the nine month period to fulfill operating and capital needs. As of July
31, 2003, there was no outstanding balance on the operating line of credit and
we had borrowed $500,000 for an acquisition in our home and office segment.
There is $636,000 committed for letters of credit on the operating line. During
the first nine months of 2003, we paid $2,483,000 for scheduled debt repayments
to Webster Bank. We were in compliance with all of our financial covenants as of
July 31, 2003. Based on the financial results of the first nine months of fiscal
year 2003, we expect that we will not meet the performance targets to access the
$5 million available for repayment of sub-debt under the credit facility with
Webster Bank at the end of the year.
On June 11, 2003, we entered into an interest rate "swap" agreement with Webster
Bank in the notional amount of $10 million. The underlying debt for this
agreement is the new credit facility with Webster Bank described above. The
"swap" agreement fixes the interest rate for the notional amount for three years
at 1.74% plus the interest rate spread defined by the agreement, currently 2%.
This brings the total amount of our senior debt with fixed "swap" rates to $26
million though $12 million is scheduled to convert back to variable rates within
the next 12 months.
Lower debt service requirements for the new financing arrangement will provide
more cash in future periods. We expect that cash on hand and the cash generated
from future operations combined with the operating line of credit with Webster
Bank will provide sufficient cash flow for routine operations and growth in the
foreseeable future. However, no assurance can be given that this will be the
case and that adequate financing at reasonable interest rates will be secured if
more cash is needed.
We have reduced our deferred tax asset by $593,000 to reflect our utilization of
net operating losses to offset taxes that would have been payable for the
period. We have reduced the current portion and increased the long term portion
of the deferred tax asset to reflect current estimates of future utilization.
There is a total deferred tax asset of $2,242,000 as of July 31, 2003.
We used $3,482,000 for equipment purchases, mostly coolers, brewers, bottles and
racks related to home and office distribution. Capital spending is lower than
the corresponding period in fiscal 2002 because of the bottling line installed
last year.
We commissioned and received an independent opinion concerning the fair value of
our home and office reporting unit during fiscal years 2002 and 2003. The home
and office segment is the unit though which acquisitions have been made and
corresponding goodwill has been booked. For both years the assessment determined
that there is no impairment of the goodwill that was booked as a result of these
acquisitions.
21
We used $1,297,000 in cash for several acquisitions in the home and office
segment. These were financed with the funds that were borrowed from the
acquisition line of credit and cash. We continue to pursue an active program of
evaluating acquisition opportunities in our existing home and office markets. If
the right opportunities become available, we anticipate using our capital
resources and financing from outside sources to complete desirable acquisitions.
Recent economic conditions have provided both opportunities and challenges. As
noted, poor economic conditions resulted in decreased sales in the home and
office segment. Continued negative economic changes in the northeastern United
States may adversely affect our financial results in the future. Inflation has
had no material impact on our performance. Since we have relied on debt to
finance our acquisition strategy, low market interest rates have significantly
reduced our interest costs. See item 3 for a discussion of interest rate risk.
22
PART I - Item 3
QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in
interest rates and commodity prices.
INTEREST RATE RISKS
We use interest rate "swap" agreements to curtail variable interest rate risk.
On November 3, 2000, we entered into a swap agreement with Webster Bank to fix
$8,000,000 of our long term debt at 8.82% interest for three years. On April 2,
2001, we entered into a swap agreement with Webster Bank to fix an additional
$4,000,000 of our long term debt at 8.53% interest for three years. On July 24,
2001, we entered into a swap agreement with Webster Bank to fix an additional
$4,000,000 of our long term debt at 7.25% interest for three years. On June 11,
2003, we entered into an interest rate swap agreement with Webster Bank for $10
million. The agreement fixes the interest rate for that portion of our senior
debt for three years at 3.74%. The swaps are fixed at these rates based on the
current applicable margin of 2% under our loan and security agreement with
Webster Bank. Under the agreement, the applicable margin can range, based on our
financial performance, from 1.25% to 2.25%.
As of July 31, 2003, we had approximately $2,300,000 of long term debt subject
to variable interest rates. Under the loan and security agreement with Webster
Bank, we paid interest at a rate of LIBOR plus a margin of 1.5% through March 5,
2003. The margin was adjusted to 2% on March 5, 2003 based on the new financing
arrangement with Webster Bank. A hypothetical 100 basis point increase in the
LIBOR rate would result in an additional $12,000 of interest expense on an
annualized basis.
On a weighted average basis, at our current applicable margin, we have
$26,000,000 of debt covered by swaps at 6.6%. Currently, this is above market
rates though the agreements are based on three year rate projections. In
November, 2003 and April, 2004 the oldest of our outstanding swaps mature. If
interest rates remain stable the termination of these agreements will lower our
interest costs whether the debt is fixed again or left variable. The swaps are
intended to stabilize our cash flow and expenses but ultimately may cost more or
less in interest than if we had carried all of our debt at a variable rate over
the swap term. Our new financing arrangement requires us to fix at least half of
our outstanding senior debt.
COMMODITY PRICE RISKS
Plastic - PET
In December 2002, we executed a new four year agreement with our bottle
supplier. The contract allows the vendor to pass-on to us any resin price
increases. These prices are related to supply and demand market factors for PET
and, to a lesser extent, the price of petroleum, an essential component of PET.
A hypothetical resin price increase of $.05 per pound, or 7% at current prices,
23
would result in an approximate price increase per bottle of $.002 or, at current
volume levels, $200,000 a year.
Coffee
The cost of our coffee purchases are dictated by commodity prices. We enter into
contracts to mitigate market fluctuation of these costs by fixing the price for
certain periods. Currently we have fixed the price of our anticipated supply
through December 2003 at "green" prices ranging from $.57-$.74 per pound. We are
not insulated from price fluctuations beyond that date. At our existing sales
levels, an increase in pricing of $.10 per pound would increase our total cost
for coffee by $75,000. In this case, competitors that had fixed pricing might
have a competitive advantage.
Fuel
We own and operate vehicles to deliver product to customers. The cost of fuel to
operate these vehicles fluctuates over time. We have entered into a contract
fixing the cost for 25% of the total fuel anticipated to be purchased during
fiscal 2003. The contract fixes fuel costs for the year (spread evenly) at an
average base cost before additives and taxes of $0.85 per gallon. Based on
consumption in 2002, a $0.10 increase per gallon in fuel cost would result in an
increase to operating costs of $50,000.
We also pay for fuel indirectly by hiring carriers to deliver product though we
do not have contracts with them. While the impact of a change in prices is less
predictable because of the absence of a contractual arrangement, we know that
fuel prices affect freight rates. Based on experience and estimates, we
anticipate that each $.10 per gallon increase in fuel costs would result in
additional freight cost of approximately $25,000 per year.
Recent increases in fuel prices that have increased the Company's costs in the
first nine months of 2003. As mentioned above, the increase in the cost of
petroleum related products also increases the cost of PET bottles that the
Company purchases. If fuel prices stay elevated for a prolonged period of time,
no assurance can be given that the Company will be able to effectively pass
these increased costs to its customers.
24
PART I - Item 4.
CONTROLS AND PROCEDURES
Our Chairman and Chief Executive Officer, 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 Chairman and 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 the Company, including our consolidated subsidiaries, in
reports that we file or submit under the Exchange Act, is recorded, processed,
summarized and reported, within the time periods specified in the Commission's
rules and forms.
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.
25
PART II - Other Information
Item 1 - Legal Proceedings
None.
Item 2 - Changes in Securities
(a) None.
(b) None.
(c) None.
Item 3 - Defaults upon Senior Securities
None.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
Item 5 - Other Information
In August 2003 we filed a lawsuit in federal court in Massachusetts
against Nestle Waters North America, Inc. and its parent company,
Nestle S.A. Our lawsuit alleges that Nestle has engaged, and continues
to engage, in false and misleading advertising of its Poland Spring(R)
brand of bottled water, and that Nestle has marketed and sold, and
continues to market and sell, Poland Spring(R) as "spring water" with
the knowledge that it is not spring water and does not meet the
scientific, regulatory or plain English definitions of the term. We
believe that these practices have helped Nestle, one of our major
competitors, to capture a very significant market share of the bottled
water market.
We have made claims under the federal Lanham Act, which creates civil
liability for any person who, in commercial advertising or promotion,
misrepresents the nature, characteristics, qualities or geographic
origin of goods, services or commercial activities. We have also made
claims under corresponding provisions of unfair trade practice laws in
approximately 25 states that provide a private right of action for such
violations. We are seeking an injunction that would require Nestle not
to engage in false advertising and to publish corrective advertising
that would retract its false and misleading statements. We are also
seeking monetary damages.
26
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
- ------ -----------
2.1 Agreement and Plan of Merger and Contribution by and among Vermont Pure Holdings, Ltd., Crystal Rock Spring Water
Company, VP Merger Parent, Inc., VP Acquisition Corp., and the stockholders named therein, dated as of May 5,
2000. (Incorporated by reference to Appendix A to the Form S-4 Registration Statement filed by Vermont Pure
Holdings, Ltd., f/k/a VP Merger Parent, Inc., File No. 333-45226, on September 6, 2000 (the "S-4 Registration
Statement").)
2.2 Amendment to Agreement and Plan of Merger and Contribution by and among Vermont Pure Holdings, Ltd., Crystal Rock
Spring Water Company, VP Merger Parent, Inc., VP Acquisition Corp., and the stockholders named therein, dated as
of August 28, 2000. (Incorporated by reference to Exhibit 2.1 of the S-4 Registration Statement.)
2.3 Amendment to Agreement and Plan of Merger and Contribution by and among Vermont Pure Holdings, Ltd., Crystal Rock
Spring Water Company, VP Merger Parent, Inc., VP Acquisition Corp. and the stockholders named therein, dated as of
September 20, 2000. (Incorporated by reference to Exhibit 2.2 of the Report on Form 8-K filed by the Company on
October 19, 2000 (the "Merger 8-K").)
3.1 Certificate of Incorporation of the Company. (Incorporated by reference to Exhibit B to Appendix A to the Proxy
Statement included in the S-4 Registration Statement.)
3.2 Certificate of Amendment of Certificate of Incorporation of the Company filed October 5, 2000. (Incorporated by
reference to Exhibit 4.2 of the Merger 8-K.)
3.3 By-laws of the Company. (Incorporated by reference from Exhibit 3.3 to Form 10-Q for the Quarter ended July 31,
2001.)
4.1 Registration Rights Agreement among the Company, Peter K. Baker, Henry E. Baker, John B. Baker and Ross Rapaport.
(Incorporated by reference to Exhibit 4.6 of the Merger 8-K.)
10.1* 1993 Performance Equity Plan. (Incorporated by reference from Exhibit 10.9 of Registration Statement 33-72940.)
27
Exhibit
Number Description
- ------ -----------
10.2* 1998 Incentive and Non-Statutory Stock Option Plan, as amended. (Incorporated by reference to Appendix A to the
Definitive Proxy Statement dated March 10, 2003.)
10.3* 1999 Employee Stock Purchase Plan. (Incorporated by reference to Exhibit A of the 1999 Definitive Proxy
Statement.)
10.4* Employment Agreement between the Company and Timothy G. Fallon. (Incorporated by reference to Exhibit 10.13 of the
S-4 Registration Statement.)
10.5* Employment Agreement between the Company and Bruce S. MacDonald. (Incorporated by reference to Exhibit 10.14 of
the S-4 Registration Statement.)
10.6* Employment Agreement between the Company and Peter K. Baker. (Incorporated by reference to Exhibit 10.15 of the
S-4 Registration Statement.)
10.7* Employment Agreement between the Company and John B. Baker. (Incorporated by reference to Exhibit 10.16 of the S-4
Registration Statement.)
10.8* Employment Agreement between the Company and Henry E. Baker. (Incorporated by reference to Exhibit 10.17 of the
S-4 Registration Statement.)
10.9 Lease of Buildings and Grounds in Watertown, Connecticut from the Baker's Grandchildren Trust. (Incorporated by
reference to Exhibit 10.22 of the S-4 Registration Statement.)
10.10 Lease of Grounds in Stamford, Connecticut from Henry E. Baker. (Incorporated by reference to Exhibit 10.24 of the
S-4 Registration Statement.)
10.11 Lease of Building in Stamford, Connecticut from Henry E. Baker. (Incorporated by reference to Exhibit 10.23 of the
S-4 Registration Statement.)
10.12 Loan and Security Agreement between the Company and Webster Bank, M &T Bank, Banknorth Group, and Rabobank dated
March 5, 2003. (Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.13 Form of Term Note from the Company to Webster Bank and participants dated March 5, 2003. (Incorporated by
reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
28
Exhibit
Number Description
- ------ -----------
10.14 Amended and Restated Subordinated Promissory Note from the Company to Henry E. Baker dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.15 Amended and Restated Subordinated Promissory Note from the Company to Joan Baker dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.16 Amended and Restated Subordinated Promissory Note from the Company to John B. Baker dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.17 Amended and Restated Subordinated Promissory Note from the Company to Peter K. Baker dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.18 Amended and Restated Subordinated Promissory Note from the Company to Ross S. Rapaport, Trustee, dated March 5,
2003. (Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.19 Subordination and Pledge Agreement from Henry E. Baker to Webster Bank dated March 5, 2003. (Incorporated by
reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.20 Subordination and Pledge Agreement from Joan Baker to Webster Bank dated March 5, 2003. (Incorporated by reference
to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.21 Subordination and Pledge Agreement from John B. Baker to Webster Bank dated November 1, 2001. (Incorporated by
reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.22 Subordination and Pledge Agreement from Peter K. Baker to Webster Bank dated March 5, 2003. (Incorporated by
reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.23 Subordination and Pledge Agreement from Ross S. Rapaport, Trustee, to Webster Bank dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.24** Agreement between Vermont Pure Springs, Inc. and Zuckerman-Honickman Inc. dated December 12, 2002. (Incorporated
by reference to Exhibit 10.24 of Form 10-K for the year ended October 31, 2002.)
29
Exhibit
Number Description
- ------ -----------
10.25 Form of Acquisition/Capital Line of Credit Note from the Company to Webster Bank and participants dated March 5,
2003. (Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.26 Form of Revolving Line of Credit Note from the Company to Webster Bank and participants dated March 5, 2003.
(Incorporated by reference to Exhibit 10.12 of Form 10-Q for the quarter ended January 31, 2003.)
10.27*** Form of Indemnification Agreements, dated November 1, 2002, between the Company and the following Directors and
Officers:
Henry E. Baker
John B. Baker
Peter K. Baker
Phillip Davidowitz
Timothy G. Fallon
Robert C. Getchell
David Jurasek
Carol R. Lintz
Bruce S. MacDonald
David R. Preston
Ross S. Rapaport
Norman E. Rickard
Beat Schlagenhauf
(Incorporated by reference to Exhibit 10.27 of Form 10-K for the year ended October 31, 2002.)
10.28 Waiver from Webster Bank in reference to the debt service coverage covenant for the period ending January 31, 2002
pursuant to the Amended and Restated Loan and Security Agreement and extension to the Amended and Restated Line of
Credit Note between the Company and Webster Bank. (Incorporated by reference to Exhibit 10.12 of Form 10-Q for the
quarter ended January 31, 2003.)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley act of 2002.
30
Exhibit
Number Description
- ------ -----------
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley act of 2002.
* Relates to compensation
** Certain portions of this exhibit have been omitted pursuant to a request for
confidential treatment granted by the Securities and Exchange Commission.
*** The form contains all material information concerning the agreement and the
only differences are the name and the contact information of the director or
officer who is party to the agreement.
(b) Reports on Form 8-K
A Report on Form 8-K was filed on August 8, 2003 to announce a change
of independent accountants from Marcum & Kliegman LLP to Deloitte &
Touche LLP.
A Report on Form 8-K was filed on June 16, 2003 in conjunction with the
press release announcing our financial results for the second quarter
of fiscal year 2003.
31
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: September 15, 2003
Randolph, Vermont
VERMONT PURE HOLDINGS, LTD.
By: /s/ Bruce S. MacDonald
----------------------
Bruce S. MacDonald
Vice President, Chief Financial Officer
(Principal Accounting Officer and
Principal Financial Officer)
32
Vermont Pure Holdings, Ltd.
Quarterly Report on Form 10-Q
for the Quarter Ended July 31, 2003
Exhibits Filed Herewith
Exhibit
Number Description
- ------ -----------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley act of 2002.
33