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 potential adverse effect of climate changes and severe weather,
|
|
(2)
|
the outstanding debt levels may adversely impact the business profitability and ability to finance
future expansion, and
|
|
(3)
|
the cost pressures related to commodities affecting
our business.
|
The following factors could strain liquidity and working capital
availability 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 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 (2): 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 (3): 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 stronger gross margin percentages for the first six months of fiscal 2017 compared to the comparable
period of 2016.
Sales in the first six months of fiscal 2017 declined $3.7 million
or 11% from $32.8 million in the first six months of fiscal 2016, however sales of water products increased 1%. The most notable
sales decline for the period was in the office products category which accounted for 65% of the net sales decline. Refreshment
products and coffee sales also declined during the first six months of fiscal 2017.
The effect of the total revenue decline through the first six months
of fiscal 2017 resulted in a decrease in gross profit of $455,000, or 3%.
Operating expenses increased $153,000, or 1% during the first six 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 $609,000 in the first six months of fiscal 2017 compared to the comparable period in 2016.
Results of Operations for the Three Months Ended April 30, 2017 (Second Quarter)
Compared to the Three Months Ended April 30, 2016
Sales
Sales for the three months ended April 30, 2017 were $14,475,000
compared to $16,711,000 for the corresponding period in 2016, a decrease of $2,236,000 or 13%. 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 April 30, 2017 and 2016 is as follows:
Product Line
(000’s $)
|
|
2017
|
|
2016
|
|
Difference
|
|
% Diff.
|
Water
|
|
$
|
6,711
|
|
|
$
|
6,905
|
|
|
$
|
(194
|
)
|
|
|
(3
|
%)
|
Coffee
|
|
|
2,624
|
|
|
|
2,993
|
|
|
|
(369
|
)
|
|
|
(12
|
%)
|
Refreshment
|
|
|
2,029
|
|
|
|
2,507
|
|
|
|
(478
|
)
|
|
|
(19
|
%)
|
Equipment Rental
|
|
|
1,759
|
|
|
|
1,744
|
|
|
|
15
|
|
|
|
1
|
%
|
Office Products
|
|
|
864
|
|
|
|
2,053
|
|
|
|
(1,189
|
)
|
|
|
(58
|
%)
|
Other
|
|
|
488
|
|
|
|
509
|
|
|
|
(21
|
)
|
|
|
(4
|
%)
|
Total
|
|
$
|
14,475
|
|
|
$
|
16,711
|
|
|
$
|
(2,236
|
)
|
|
|
(13
|
%)
|
Water
– Sales of water decreased 3% for the second
quarter 2017 as compared to the same period of 2016. The decrease is attributable to a volume decrease of 1% and an average price
decrease of 2%.
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.
Refreshment
– Complementary coffee products, single
serve drinks, small package water, and cups, all declined. The Company no longer services vending machines which accounted for
$214,000 of the sales decline in this category.
Equipment Rental
– The increase in sales was a result
of a 3% increase in the number of rental units in the field offset by a decrease of 2% 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 as well as a decreased focus on sales in this category.
Other
– The decrease is attributable to lower 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 April 30, 2017 resulted in a decrease of gross profit to $7,669,000 from $8,229,000 for the
comparable period in 2016, a decrease of $560,000, or 7%. As a percentage of sales, gross margin was 53% for the three months ended
April 30, 2017 compared to 49% for the same period a year ago. For the comparable three month periods, water accounted for 46%
and 41% of total sales in 2017 and 2016 respectively. Lower margin office product sales for the same periods accounted for 6% and
12% of total sales in 2017 and 2016 respectively. The improved sales in the higher margin products and the decrease in lower margin
office products coupled to improve our gross margin percentages though we realized a decline in gross profit dollars for the second
quarter of 2017 as compared to the second quarter 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 decreased to $7,368,000 in the second fiscal
quarter of 2017 from $7,436,000 in the comparable period in 2016, a decrease of $68,000, or 1%.
Selling, general and administrative (SG&A) expenses of $7,099,000
in the second fiscal quarter of 2017 decreased $51,000, or 1%, from $7,150,000 in the comparable period in 2016. Of total SG&A
expenses, route distribution costs decreased $288,000, or 9%, as a result of lower labor, truck leasing and insurance costs; combined
selling and marketing costs remained flat for the second fiscal quarter of 2017 as compared to the same period in 2016; and administration
costs increased $237,000, or 8%, 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 $99,000 in the second fiscal quarter of
2017 compared to $116,000 in the second quarter of 2016, a decrease of $17,000, or 15%. The decrease in advertising costs is primarily
related to lower utilization of printed advertising materials.
Amortization decreased to $170,000 in the second 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 no gains or losses from the sale of assets in the second quarter
of 2017. We recognized a gain from the sale of assets of $1,000 in the second fiscal quarter 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 three months ended April 30,
2017 was $301,000 compared to $793,000 in the comparable period in 2016, a decline of $492,000. The decline was the result of lower
sales and corresponding gross profit combined with higher administrations costs partially offset by lower route distribution costs.
Interest, Taxes, and Other Expenses
Net interest expense was $344,000 for the three months ended April
30, 2017 compared to $406,000 in the three months ended April 30, 2016, a decrease of $62,000. The decrease is attributable to
lower average interest rates and lower debt balances.
The loss before income taxes was $43,000 for the three months ended
April 30, 2017 compared to income before income taxes of $387,000 in the corresponding period in 2016, a decrease of $430,000.
The tax benefit for the second quarter of 2017 was $16,000 compared to tax expense of $148,000 in the corresponding period of 2016.
Net Loss
The net loss for the three months ended April 30, 2017 was $27,000
compared to a net income of $239,000 in the corresponding period in 2016. The net loss is attributable to lower sales and corresponding
gross profit combined with higher administration costs partially offset by lower route distribution costs.
Results of Operations for the Six Months Ended April 30, 2017 (First Half) Compared
to the Six Months Ended April 30, 2016
Sales
Sales for the six months ended April 30, 2017 were $29,125,000 compared
to $32,842,000 for the corresponding period in 2016, a decrease of $3,717,000, or 11%. The most notable decline was that of office
products.
The comparative breakdown of sales of the product lines for the
respective six-month periods ended April 30, 2017 and 2016 is as follows:
Product Line
(000’s $)
|
|
2017
|
|
2016
|
|
Difference
|
|
% Diff.
|
Water
|
|
$
|
13,231
|
|
|
$
|
13,053
|
|
|
$
|
178
|
|
|
|
1
|
%
|
Coffee
|
|
|
5,326
|
|
|
|
5,913
|
|
|
|
(587
|
)
|
|
|
(10
|
%)
|
Refreshment
|
|
|
4,078
|
|
|
|
4,876
|
|
|
|
(798
|
)
|
|
|
(16
|
%)
|
Equipment Rental
|
|
|
3,537
|
|
|
|
3,535
|
|
|
|
2
|
|
|
|
0
|
%
|
Office Products
|
|
|
1,991
|
|
|
|
4,533
|
|
|
|
(2,542
|
)
|
|
|
(56
|
%)
|
Other
|
|
|
962
|
|
|
|
932
|
|
|
|
30
|
|
|
|
3
|
%
|
Total
|
|
$
|
29,125
|
|
|
$
|
32,842
|
|
|
$
|
(3,717
|
)
|
|
|
(11
|
%)
|
Water
– Sales of water increased 1% for the first half
2017 as compared to the same period of 2016. The increase is attributable to an increase in volume of 2% partially offset by a
decrease in average price of 1%.
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 7%. Bulk products sales
continued to be negatively influenced by the single serve lines and K-cup sales declined as a result of ongoing commoditization.
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
$419,000 of the sales decline in this category.
Equipment Rental
– The small increase in sales was
a result of a 2% increase in the number of rental units in the field partially offset by a decrease 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 as well as less focus on sales in this category.
Other
– The increase is the result of an increase in
the sales of equipment such as water coolers.
Gross Profit/Cost of Goods Sold
– The decrease
in sales for the six months ended April 30, 2017 resulted in a gross profit decrease of $455,000 to $15,363,000 from $15,818,000
for the comparable period in 2016. As a percentage of sales, gross margin was 53% for the six months ended April 30, 2017 compared
to 48% 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 $14,829,000 in the first half
of 2017 from $14,676,000 in the comparable period in 2016, an increase of $153,000, or 1%.
Selling, general and administrative (SG&A) expenses of $14,271,000
in the first half of 2017 increased $172,000, or 1%, from $14,099,000 in the comparable period in 2016. Of total SG&A expenses,
route distribution costs decreased $451,000, or 7%, as a result of lower labor, truck leasing and insurance costs; combined selling
and marketing costs increased $199,000, or 11%, as a result of an increase in staffing; and administration costs increased $424,000,
or 8%, 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 $218,000 in the first half of 2017 compared
to $251,000 in the first half of 2016, a decrease of $33,000, or 13%. The decrease in advertising costs is primarily related to
a reduction in printed sales materials.
Amortization increased to $340,000 in the first half of 2017 from
$330,000 in the comparable quarter in 2016, an increase of $10,000, or 3%. Amortization is attributable to intangible assets that
were acquired as part of acquisitions. We had no gains or losses from the sale of assets in the first half of 2017. We recognized
a gain from the sale of assets of $4,000 in the first half 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 six months ended April 30, 2017
was $533,000 compared to $1,142,000 in the comparable period in 2016, a decrease of $609,000. 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 $695,000 for the six months ended April 30,
2017 compared to $804,000 in the six months ended April 30, 2016, a decrease of $109,000. The decrease is attributable to lower
average interest rates and lower debt balances.
The loss before income taxes was $161,000 for the six months ended
April 30, 2017 compared to income before income taxes of $338,000 in the corresponding period in 2016, a decline of $499,000. The
tax benefit for the first six months of 2017 was $60,000 compared to a tax expense of $129,000 in 2016.
Net Loss
The net loss for the six months ended April 30, 2017 was $102,000
compared to a net income of $210,000 in the corresponding period in 2016. The net loss is attributable to lower sales and corresponding
gross profit combined with higher administration costs partially offset by lower route distribution costs.
Liquidity and Capital Resources
As of April 30, 2017, we had working capital of $2,868,000 compared
to $7,911,000 as of October 31, 2016, a decrease of $5,043,000. Of the decrease, $4,500,000 is attributable to the reclassification
of non-current subordinated debt to current liabilities as we anticipate to pay down the subordinated debt as allowed by the Third
Amendment to the Credit Agreement with Bank of America. Cash provided from operations during the six months ended April 30, 2017
was $66,000.
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 April 30, 2017 we had $8,933,000
outstanding on our term loan. We have no funds borrowed from our line of credit with the Bank. We have a letter of credit of $1,327,000
secured by our line of credit resulting in $3,673,000 available to borrow on the line of credit as of April 30, 2017.
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. The revolving line of credit matures in May 2018. 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 amended its
Credit Agreement with Bank of America (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 April 30, 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 April 30, 2017, the Company had $4,466,000 of the term debt subject to variable interest
rates. The one-month LIBOR was 0.99% on April 30, 2017 resulting in total variable interest rates of 3.49% and 3.24%, for the term
note and the revolving line of credit, respectively, as of April 30, 2017.
The following information pertains to the Company's outstanding interest rate swap at
April 30, 2017. The pay rate is fixed and the receive rate is one month LIBOR.
Instrument
|
Notional Amount
|
Pay Rate
|
Receive Rate
|
Interest rate swap
|
$4,466,668
|
1.25%
|
0.99%
|
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 April 30, 2017, the
Company was in compliance with these financial covenants.
In addition to the senior debt, as of April 30, 2017, the Company
has subordinated debt owed to Henry, Peter and John Baker in the aggregate principal amount of $9,000,000 that is due November
20, 2020. On June 13, 2017, the Company made principal payments of $4,500,000 in the aggregate to the subordinated debt holders
as allowed by the Third Amendment to the Credit Agreement with Bank of America. 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 April 30, 2017:
|
|
Payment due by Period
|
Contractual Obligations
|
|
Total
|
|
Remainder
of 2017
|
|
2018-2019
|
|
2020-2021
|
|
After 2021
|
Debt (1)
|
|
$
|
17,933,000
|
|
|
$
|
5,300,000
|
|
|
$
|
3,200,000
|
|
|
$
|
9,433,000
|
|
|
$
|
-
|
|
Interest on Debt (2)
|
|
|
2,726,000
|
|
|
|
514,000
|
|
|
|
1,553,000
|
|
|
|
659,000
|
|
|
|
-
|
|
Operating Leases
|
|
|
8,858,000
|
|
|
|
1,452,000
|
|
|
|
4,685,000
|
|
|
|
2,592,000
|
|
|
|
129,000
|
|
Total
|
|
$
|
29,517,000
|
|
|
$
|
7,266,000
|
|
|
$
|
9,438,000
|
|
|
$
|
12,684,000
|
|
|
$
|
129,000
|
|
|
(1)
|
Debt payments in 2017 include payments of subordinated debt of $4,500,000.
|
|
|
|
|
(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 3.49%, line of credit at a rate of 3.24%, 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.
|
Effective June 13, 2017, the Company entered into a
Third Amendment to its Credit Agreement with Bank of America. The Third Amendment increases the aggregate principal amount
available under the revolving credit line from $5,000,000 to $6,000,000. In addition the Third Amendment allows the Company to
use proceeds of the revolving credit line to make payments on the Subordinated Debt in an amount not to exceed $2,000,000. The
Third Amendment also permits prepayment of up to $4,500,000 in the aggregate of Subordinated Debt.
We have no other material contractual obligations or commitments.