Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction
with the consolidated financial statements and notes thereto as filed in our Annual Report on Form 10-K for the year ended October
31, 2016 as well as the consolidated financial statements and notes contained herein.
Forward-Looking Statements
The “Management’s Discussion and Analysis” (MD&A)
portion of this Form 10-Q contains forward-looking statements, including statements about these topics:
|
(1)
|
the increasing competition from virtual stores selling non-water products on the internet,
|
|
(2)
|
the potential adverse effect of climate changes and severe weather,
|
|
(3)
|
the outstanding debt levels may adversely impact the business profitability and ability to finance
future expansion, and
|
|
(4)
|
the cost pressures related to commodities affecting
our business.
|
The following factors could strain product profit margins and profitability
and cause actual results to differ materially from statements in MD&A about topic (1): We incorporate by reference
into this paragraph the full Risk Factor on page 13 of our 2016 Form 10-K beginning “
Internet
technology and virtual stores have lowered the barriers of entry
”.
The following factors could strain liquidity and working capital
availability and cause actual results to differ materially from statements in MD&A about topic (2): We incorporate
by reference into this paragraph the full Risk Factor on page 15 of our 2016 Form 10-K beginning “
Climate
changes and severe weather may impact
”.
The following factors could strain liquidity and working capital
availability in MD&A about topic (3): We incorporate by reference into this paragraph the full Risk Factor on page
15 of our 2016 Form 10-K beginning “
Our Company is significantly leveraged
”.
The following factors could cause actual results to differ materially
from statements in MD&A about topic (4): We incorporate by reference into this paragraph the full Risk Factor on
page 15 of our 2016 Form 10-K beginning “
Fluctuations in the cost of essential raw
materials and commodities
”.
Results of Operations
Overview and Trends
Our strategy of focusing sales efforts on new
water customers and providing value-added service has resulted in higher water volume and an increase in equipment rental units
for the first nine months of fiscal 2017 compared to the comparable period of 2016.
Sales in the first nine months of fiscal 2017
declined $5.2 million or 11% from $49.2 million in the first nine months of fiscal 2016, however sales of water products and rental
revenues increased slightly. The most notable sales decline for the period was in the office products category which accounted
for 64% of the net sales decline. Refreshment products and coffee sales also declined during the first nine months of fiscal 2017.
The effect of the total revenue decline through
the first nine months of fiscal 2017 resulted in a decrease in gross profit of $1.2 million, or 5%.
Operating expenses increased $473,000, or 2% during
the first nine months of fiscal 2017 as compared to 2016. This is the result of adding resources to increase sales volumes of traditional
water and coffee products and improving customer service levels. The result of the lower gross profit and increased operating expenses
resulted in a reduction in operating income of $1.6 million in the first nine months of fiscal 2017 compared to the comparable
period in 2016.
Results of Operations for the Three Months Ended July 31, 2017 (Third Quarter)
Compared to the Three Months Ended July 31, 2016
Sales
Sales for the three months ended July 31, 2017 were $14,944,000
compared to $16,394,000 for the corresponding period in 2016, a decrease of $1,450,000 or 9%. Other than equipment rental, all
sales categories declined. The most notable decline was that of office products. The comparative breakdown of sales of the product
lines for the respective three-month periods ended July 31, 2017 and 2016 is as follows:
Product Line
(000’s $)
|
|
2017
|
|
2016
|
|
Difference
|
|
% Diff.
|
Water
|
|
$
|
7,427
|
|
|
$
|
7,525
|
|
|
$
|
(98
|
)
|
|
|
(1
|
%)
|
Coffee
|
|
|
2,461
|
|
|
|
2,591
|
|
|
|
(130
|
)
|
|
|
(5
|
%)
|
Refreshment
|
|
|
2,214
|
|
|
|
2,626
|
|
|
|
(412
|
)
|
|
|
(16
|
%)
|
Equipment Rental
|
|
|
1,756
|
|
|
|
1,754
|
|
|
|
2
|
|
|
|
0
|
%
|
Office Products
|
|
|
677
|
|
|
|
1,444
|
|
|
|
(767
|
)
|
|
|
(53
|
%)
|
Other
|
|
|
409
|
|
|
|
454
|
|
|
|
(45
|
)
|
|
|
(10
|
%)
|
Total
|
|
$
|
14,944
|
|
|
$
|
16,394
|
|
|
$
|
(1,450
|
)
|
|
|
(9
|
%)
|
Water
– Sales of water decreased 1% for the third quarter
2017 as compared to the same period of 2016. Though volume increased 3% for the third quarter 2017 as compared to the same period
of 2016, the average price declined 4%.
Coffee
– The decrease in sales was attributable to
a decline in our traditional higher volume bulk and K-cup lines. Bulk products sales continued to be negatively influenced by the
single serve lines and K-cup sales declined as a result of ongoing commoditization of coffee products and availability of products
on the internet through virtual storefronts.
Refreshment
– Complementary coffee products, single
serve drinks, small package water, and cups, all declined. The Company no longer services vending machines which accounted for
$219,000 of the sales decline in this category.
Equipment Rental
– The minimal increase in sales was
a result of a 2.1% increase in the number of rental units in the field partially offset by a decrease of 1.9% in the average monthly
rental price per rental unit.
Office Products
– The decrease in sales was a result
of implemented price increases on items previously sold at cost or near cost, a decreased focus on sales in this category and availability
of products on the internet through virtual storefronts.
Other
– The decrease is attributable to lower sales
of coolers, a decrease in late payment finance charges and a reduction in fees that are charged to offset energy costs for delivery
and freight, raw materials and bottling operations.
Gross Profit/Cost of Goods Sold
– The decrease
in sales for the three months ended July 31, 2017 resulted in a decrease of gross profit to $8,125,000 from $8,834,000 for the
comparable period in 2016, a decrease of $709,000, or 8%. As a percentage of sales, gross margin was 54% for the three months ended
July 31, 2017 and 2016.
Cost of goods sold includes all costs to bottle water, costs of
purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing
and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing
our product to our customers. We include distribution costs in selling, general, and administrative expense, and the amount is
reported below. The reader should be aware that other companies may include distribution costs in their cost of goods sold, in
which case, on a comparative basis, such other companies may have a lower gross margin as a result.
Operating Expenses and Income from Operations
Total operating expenses increased to $7,562,000 in the third fiscal
quarter of 2017 from $7,241,000 in the comparable period in 2016, an increase of $321,000, or 4%.
Selling, general and administrative (SG&A) expenses of $7,265,000
in the third fiscal quarter of 2017 increased $332,000, or 5%, from $6,933,000 in the comparable period in 2016. Of total SG&A
expenses, route distribution costs decreased $72,000, or 2%, as a result of lower labor, truck leasing and insurance costs; combined
selling and marketing costs decreased $9,000, or 1% as a result of lower labor costs for the third quarter of 2017 as compared
to the same period in 2016; and administration costs increased $413,000, or 15%, as a result of increased spending in the areas
of liability insurance, information technology and customer service improvements and provisions for bad debt.
Advertising expenses were $127,000 in the third fiscal quarter of
2017 compared to $137,000 in the third quarter of 2016, a decrease of $10,000, or 7%. The decrease in advertising costs is primarily
related to lower utilization of printed advertising materials.
Amortization decreased to $170,000 in the third fiscal quarter of
2017 from $171,000 in the comparable quarter in 2016, a decrease of $1,000, or less than 1%. Amortization is attributable to intangible
assets that were acquired as part of acquisitions. We had a gain of $1,000 from the sale of assets in the fiscal third quarter
of 2017 compared to no gains or losses in the third quarter of fiscal 2016. We routinely sell assets used in the normal course
of business as they are replaced with newer assets.
The income from operations for the three months ended July 31, 2017
was $563,000 compared to $1,593,000 in the comparable period in 2016, a decline of $1,030,000. The decline was the result of lower
sales and corresponding gross profit combined with higher administrations costs partially offset by lower route distribution and
sales and marketing costs.
Interest, Taxes, and Other Expenses
Net interest expense was $292,000 for the three months ended July
31, 2017 compared to $417,000 in the three months ended July 31, 2016, a decrease of $125,000. The decrease is attributable to
lower average interest rates and lower debt balances as a result of paying off subordinated debt that requires interest at 12%.
The income before income taxes was $271,000 for the three months
ended July 31, 2017 compared to income before income taxes of $1,176,000 in the corresponding period in 2016, a decrease of $905,000.
The tax expense for the third quarter of 2017 was $100,000 compared to tax expense of $447,000 in the corresponding period of 2016.
Net Income
The net income for the three months ended July 31, 2017 was $171,000
compared to a net income of $729,000 in the corresponding period in 2016. The lower net income is attributable to lower sales and
corresponding gross profit combined with higher administration costs partially offset by lower route distribution, selling and
marketing costs as well as lower interest expense.
Results of Operations for the Nine Months Ended July 31, 2017 Compared to the Nine
Months Ended July 31, 2016
Sales
Sales for the nine months ended July 31, 2017 were $44,069,000
compared to $49,237,000 for the corresponding period in 2016, a decrease of $5,168,000, or 10%. The most notable decline was that
of office products.
The comparative breakdown of sales of the product lines for the
respective nine-month periods ended July 31, 2017 and 2016 is as follows:
Product Line
(000’s $)
|
|
2017
|
|
2016
|
|
Difference
|
|
% Diff.
|
Water
|
|
$
|
20,658
|
|
|
$
|
20,579
|
|
|
$
|
79
|
|
|
|
0
|
%
|
Coffee
|
|
|
7,786
|
|
|
|
8,505
|
|
|
|
(719
|
)
|
|
|
(8
|
%)
|
Refreshment
|
|
|
6,293
|
|
|
|
7,502
|
|
|
|
(1,209
|
)
|
|
|
(16
|
%)
|
Equipment Rental
|
|
|
5,293
|
|
|
|
5,289
|
|
|
|
4
|
|
|
|
0
|
%
|
Office Products
|
|
|
2,668
|
|
|
|
5,976
|
|
|
|
(3,308
|
)
|
|
|
(55
|
%)
|
Other
|
|
|
1,371
|
|
|
|
1,386
|
|
|
|
(15
|
)
|
|
|
(1
|
%)
|
Total
|
|
$
|
44,069
|
|
|
$
|
49,237
|
|
|
$
|
(5,168
|
)
|
|
|
(10
|
%)
|
Water
– Sales of water increased less than 1% for the
first nine months of fiscal 2017 as compared to the same period of 2016. The increase is attributable to an increase in volume
of 2.4% partially offset by a decrease in average price of 2.0%.
Coffee
– The decrease in sales was attributable to
a decline in our traditional higher volume lines, bulk and K-cup, while Cool Beans® pods increased 11%. Bulk products sales
continued to be negatively influenced by the single serve lines and K-cup sales declined as a result of ongoing commoditization
and availability of products on the internet through virtual storefronts. The increase in pod sales is a result of conversion of
the other lines as well as new sales but the volume of the product, to date, has not approached that of the others.
Refreshment
– Complementary coffee products, single
serve drinks, small package water, and cups, all declined. The Company no longer services vending machines which accounted for
$638,000 of the sales decline in this category.
Equipment Rental
– The small increase in sales was
a result of a 1.9% increase in the number of rental units in the field partially offset by a decrease of 1.8% in the average monthly
rental revenue per unit.
Office Products
– The decrease in sales was a result
of implemented price increases on items previously sold at cost or near cost, a decreased focus on sales in this category and availability
of products on the internet through virtual storefronts.
Other
– The decrease is primarily the result of a reduction
in fees that are charged to offset energy costs for delivery and freight, raw materials and bottling operations.
Gross Profit/Cost of Goods Sold
– The decrease
in sales for the nine months ended July 31, 2017 resulted in a gross profit decrease of $1,165,000 to $23,488,000 from $24,653,000
for the comparable period in 2016. As a percentage of sales, gross margin was 53% for the nine months ended July 31, 2017 compared
to 50% for the same period a year ago. Due to a changing sales mix with a reduction of lower margin sales items, the gross margin
percentage increased in 2017 as compared to 2016.
Cost of goods sold includes all costs to bottle water, costs of
purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing
and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing
our product to our customers. We include distribution costs in selling, general, and administrative expense, and the amount is
reported below. The reader should be aware that other companies may include distribution costs in their cost of goods sold, in
which case, on a comparative basis, such other companies may have a lower gross margin as a result.
Operating Expenses and Income from Operations
Total operating expenses increased to $22,391,000 in the first nine
months of 2017 from $21,918,000 in the comparable period in 2016, an increase of $473,000, or 2%.
Selling, general and administrative (SG&A) expenses of $21,536,000
in the first nine months of 2017 increased $504,000, or 2%, from $21,032,000 in the comparable period in 2016. Of total SG&A
expenses, route distribution costs decreased $523,000, or 5%, as a result of lower labor, truck leasing and insurance costs; combined
selling and marketing costs increased $189,000, or 7%, as a result of an increase in staffing; and administration costs increased
$838,000, or 10%, as a result of increased spending in the areas of information technology and customer service improvements and
provisions for bad debt partially offset by a decrease in overall labor costs.
Advertising expenses were $345,000 in the first nine months of 2017
compared to $389,000 in the first nine months of 2016, a decrease of $44,000, or 11%. The decrease in advertising costs is primarily
related to a reduction in printed sales materials.
Amortization increased to $511,000 in the first nine months of 2017
from $501,000 in the comparable period of 2016, an increase of $10,000, or 2%. Amortization is attributable to intangible assets
that were acquired as part of acquisitions. We had a gain of $1,000 from the sale of assets in the first nine months of 2017 compared
to a gain from the sale of assets of $4,000 in the first nine months of 2016. We routinely sell assets used in the normal course
of business as they are replaced with newer assets.
The income from operations for the nine months ended July 31, 2017
was $1,097,000 compared to $2,735,000 in the comparable period in 2016, a decrease of $1,638,000. The decline was the result of
lower sales and corresponding gross profit combined with higher selling and administration costs partially offset by lower route
distribution costs.
Interest, Taxes, and Other Expenses
Interest expense was $987,000 for the nine months ended July 31,
2017 compared to $1,220,000 in the nine months ended July 31, 2016, a decrease of $233,000. The decrease is attributable to lower
average interest rates and lower debt balances as a result of paying off subordinated debt that requires interest at 12%.
The income before income taxes was $110,000 for the nine months
ended July 31, 2017 compared to income before income taxes of $1,514,000 in the corresponding period in 2016, a decline of $1,404,000.
The tax expense for the first nine months of 2017 was $41,000 compared to a tax expense of $575,000 in 2016.
Net Income
The net income for the nine months ended July 31, 2017 was $69,000
compared to a net income of $939,000 in the corresponding period in 2016. The reduction in net income is attributable to lower
sales and corresponding gross profit combined with higher selling and administration costs partially offset by lower route distribution
costs.
Liquidity and Capital Resources
As of July 31, 2017, we had working capital of $3,117,000 compared
to $7,911,000 as of October 31, 2016, a decrease of $4,794,000. As permitted in the “Third Amendment”, we made a $4,500,000
prepayment on our subordinated debt. We paid $2,500,000 in cash and used proceeds from the revolving line of credit for the remaining
$2,000,000. Cash provided from operations during the nine months ended July 31, 2017 was $578,000.
Our Credit Agreement with Bank of America (the “Bank”)
provides a senior financing facility consisting of term debt and a revolving line of credit. As of July 31, 2017 we had $8,533,000
outstanding on our term loan. At July 31, 2017, there was a balance of $2,000,000 outstanding on the line of credit and a letter
of credit issued for $1,327,000 to collateralize the Company’s liability insurance program as of that date. Consequently,
as of July 31, 2017, there was $2,673,000 available to borrow from the revolving line of credit. The line of credit matures in
May 2018.
Our term debt amortizes over a five year period with 59 equal monthly
installments of $133,333 and a final payment of $4,133,333 due in May 2020. There are various restrictive covenants under the Credit
Agreement, and the Company is prohibited from entering into other debt agreements without the bank’s consent. The Credit
Agreement also prohibits the Company from paying dividends without the prior consent of the Bank.
Effective September 12, 2016, the Company further amended its Credit
Agreement with the Bank (the “Second Amendment”). Under the Second Amendment, interest is paid at a rate of one-month
LIBOR plus a margin based on the achievement of a specified leverage ratio. As of July 31, 2017, 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 a portion of its term debt by entering
into an interest rate swap. As of July 31, 2017, the Company had $4,266,000 of the term debt subject to variable interest rates.
The one-month LIBOR was 1.22% on July 31, 2017 resulting in total variable interest rates of 3.72% and 3.47%, for the term note
and the revolving line of credit, respectively, as of July 31, 2017.
The following information pertains to the Company's outstanding interest rate swap at
July 31, 2017. The pay rate is fixed and the receive rate is one month LIBOR.
Instrument
|
Notional Amount
|
Pay Rate
|
Receive Rate
|
Interest rate swap
|
$4,266,668
|
1.25%
|
1.22%
|
The Second Amendment requires the Company to be in compliance with
certain financial covenants as follows: (i) a maximum annual limit for capital expenditures of $4,000,000 each fiscal year, (ii)
consolidated adjusted operating cash flows to consolidated total debt service ratio, as defined, to be no less than 1.5 to 1 for
any reference period ending on or after October 31, 2016 and (iii) senior funded debt to consolidated adjusted EBITDA, as defined,
to be no greater than 2.5 to 1 as of the end of any fiscal quarter ending on or after October 31, 2016. As of July 31, 2017, the
Company was in compliance with these financial covenants.
On June 13, 2017, the Company entered into a Third Amendment (the
“Third Amendment”) to the Agreement with the Bank. The Third Amendment increases the aggregate principal amount available
under the revolving line of credit from $5,000,000 to $6,000,000. The Third Amendment allows the Company to use proceeds from the
revolving line of credit to make payments on the Subordinated Debt in an amount not to exceed $2,000,000. The Third Amendment also
allows for total prepayments on Subordinated Debt up to $4,500,000 in the aggregate. There were no other changes to the existing
term facility, applicable margins for outstanding balances of term debt, or outstanding line of credit amounts. Subsequent to the
execution of the Third Amendment, the Company paid an aggregate of $4,500,000 of subordinated debt principal payments to Peter
and Jack Baker and the Estate of Henry Baker.
In addition to the senior debt, as of July 31, 2017, the Company has subordinated debt
owed to Peter and John Baker in the aggregate principal amount of $4,500,000 that is due November 20, 2020. The interest rate on
each of these notes is 12% per annum.
In addition to our senior and subordinated debt commitments, we have significant future
cash commitments, primarily in the form of operating leases that are not reported on the consolidated balance sheet. The following
table sets forth our contractual commitments in the remainder of the current year and future fiscal years as of July 31, 2017:
|
|
Payment due by Period
|
Contractual Obligations
|
|
|
|
Remainder
|
|
|
|
|
|
|
|
|
Total
|
|
of 2017
|
|
2018-2019
|
|
2020-2021
|
|
After 2021
|
Debt (1)
|
|
$
|
15,033,000
|
|
|
$
|
400,000
|
|
|
$
|
5,200,000
|
|
|
$
|
9,433,000
|
|
|
$
|
-
|
|
Interest on Debt (2)
|
|
|
2,547,000
|
|
|
|
282,000
|
|
|
|
1,603,000
|
|
|
|
662,000
|
|
|
|
-
|
|
Operating Leases
|
|
|
8,074,000
|
|
|
|
704,000
|
|
|
|
4,725,000
|
|
|
|
2,587,000
|
|
|
|
58,000
|
|
Total
|
|
$
|
25,654,000
|
|
|
$
|
1,386,000
|
|
|
$
|
11,528,000
|
|
|
$
|
12,682,000
|
|
|
$
|
58,000
|
|
|
(1)
|
Debt payments in 2018 include
repayments of $2,000,000 outstanding under our line of credit.
|
|
(2)
|
Interest based on 50% of outstanding
senior debt at the hedged interest rate discussed above, 50% of outstanding senior debt
at a variable rate of 3.72%, line of credit at a rate of 3.47%, and subordinated debt
at a rate of 12%.
|
|
(3)
|
Customer
deposits have been excluded from the table. Deposit balances vary from period to period
with water sales but future increases and decreases in the balances are not accurately
predictable. Deposits are excluded because, net of periodic additions and reductions,
it is probable that a customer deposit balance will always be outstanding as long as
the business operates.
|
We have no other material contractual obligations or commitments.